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Original title: Future of Institutional DeFi and ETHereum
This week is the most important week in the history of Ethereum, the world's largest programmable blockchain network. This is the most anticipated network upgrade since its launch, the switch to a Proof of Stake (PoS) consensus mechanism, which will take place around September 15. This upgrade, known as the Merger, is the first in the Ethereum roadmap, that will bring the network's infrastructure to the future and prepare for increased security, sustainability and scalability.
In our recently released "The Impact of Mergers on Institutions" report, we discussed in detail the opportunities that mergers will create for institutions in the Web3 world. Written by MetaMask and ConsenSys crypto-economic research team, the report also explores factors such as network activity, security and valuation that lay the foundation for Ethereum's long-term growth and success. You can find the full text of the report here.
While the merger means institutions will have more attractive bet opportunities, improve security, and customer diversity and interoperability, some long-term criticisms of Ethereum, such as high transaction costs and slower transaction processing, will continue to exist. In this article, we will focus on some of the threats that the merged Ethereum ecosystem will face, some further upgrades planned after the merger, and what the future of decentralized finance (DeFi) looks like for institutional investors. The threat that the
merger has not been resolved
PoS mechanism may introduce an increasing risk of centralization, censorship and collusion into the Ethereum network. After the merger, large holders of ETH can theoretically interfere with the performance of the network. While this does not extend to catastrophic events like reversal trading, it has the potential to prevent the end result from happening for a long time, like a day. An example of this existential threat is the growth of liquid bet derivatives on Lido Finance, Rocket Pool and similar protocols. For example, Lido now controls nearly one-third of all ETH bets. Although there is decentralization within Lido (for example, there are 21 validators on Lido to be responsible for verification), potential attack vectors still exist. Improvements in
interoperability pose an existing threat to Ethereum. This includes the emergence of cross-chain messaging protocols such as Axelar, the proliferation of built-in interoperability protocols such as Cosmos and Polkadot, and improvements in bridge technology. All of these factors enable developers to build chain-independent applications while allowing users to move across chains more securely and frictionlessly.
While the merger may not directly address some of these criticisms, it does prepare for further upgrades outlined by Ethereum in its roadmap. Merger is a step in the right direction. However, it is only the first step in the journey toward a better Ethereum.
Ethereum Roadmap
The Surge
The first update after the merger will be burst. The burst will allow the Ethereum network to scale on a large scale through sharding. As a holistic concept, shards divide the data processing responsibilities of the database (decentralized or otherwise) to multiple nodes, allowing parallel transactions, storage and processing of information. As we mentioned in the previous chapter, sharding will shard the Ethereum network, which will work as independent blockchains. Currently, Ethereum processes an average of 15 transactions (TPS) per second. Ethereum co-founder Vitalik Buterin said that once its roadmap is completed, Ethereum’s processing power can reach up to 100,000 TPS.
sharding will also solve the existential threat posed by layer 2 (L2) such as Arbitrum and Polygon to Ethereum. Currently, Ethereum’s usage cost is significantly higher than most L2s.
Screenshot September 13, 2022 at 3:29:44 pm
Figure 1. Compared with Ethereum, various L2 GAS fees
Source: L2Fees
Complete Optimistic rollups like Optimism and zk-rollups like Starkware are used directly outside the basic layer of Ethereum, while settlement is still finally resolved on the basic layer.
improves transaction processing speeds and will reduce network congestion on Ethereum, thereby reducing transaction costs. This is achieved by L2 hierarchical segmentation of tasks in rollups and parallel processing of unrelated tasks through sharding. At first, these shards will work like rollups, bundling multiple transactions on each shard into one, and then publishing that transaction to the mainnet. Ultimately, these shards will be able to operate like standalone blockchains, with their own smart contracts and account balances. Transactions between different blocks will be conducted through cross-block communication.
The Verge
The next stage of the Ethereum roadmap, namely Verge, will focus on further improving the scalability of the network. This upgrade will focus on optimizing storage through Verkle Trees, a kind of mathematical proof , which is an upgrade of Merkle proof Ethereum currently used by Ethereum. By reducing the amount of data a validator needs to store on his computer to run the operation, the node size will be reduced and more users will be allowed to become validators. This will further disperse the power of the network and improve security.
The Purge
cleanup will reduce hardware requirements and simplify verification personnel storage by eliminating historical data and technical debt. This in turn will further reduce network congestion.
The Splurge
The final stage of the Ethereum roadmap will work to introduce smaller upgrades, which will essentially fine-tune the network. Buterin calls these upgrades "fun stuff." One thing to remember here is that these upgrades don't necessarily go one by one. They are quite independent and are carried out in parallel. The order of launch of these upgrades has not been determined, but all of them are underway.
organization DeFi future
Ethereum ecosystem is being built for long-term development. Despite current geopolitical and macroeconomic factors, as well as recent market volatility, communities remain committed to building innovative products and systems, and institutions are still strong in their willingness to participate in these innovations. Financial institutions, such as investment banks such as Goldman Sachs and Barclays, hedge funds such as Citadel Securities and Point72 Ventures, and retail banks such as Banco Santander and Itau Unibanco, are all putting their funds into cryptocurrencies, or further planning to offer cryptocurrency investment options to their clients.
As we continue to build a bear market, we believe that the future of institutional DeFi is bright.
For a long time, the debate surrounding cryptocurrency institutional investment was about traditional finance (TradFi) and DeFi. The increasing popularity of DeFi is often considered to be the death knell of TradFi. However, the digital asset management strategies of some TradFi companies in the downturn show that TradFi and DeFi are now complementing each other. This trend may increase after the merger, as institutions acknowledge that it is all long-term games.
As the merger improves the security of the Ethereum network and prepares for future scalability, we expect agencies to become more keen to participate in the Web3 ecosystem.
Over the past two years, DeFi innovation has created the infrastructure and tools that institutions need to adopt DeFi. From ensuring only the licensing loan pool of KYC participants, to on-chain asset management, optimal execution protocols against MEV, and a decentralized identity, more and more institutional-centric projects have entered the market.
We also see L2 projects such as Optimism, Polygon and Arbitrum achieve good yield farming of DeFi volumes. We expect that as the scale of L2 accelerates after the merger, more institutional-focused projects will enter the market. The transition from
to PoS has created compelling reward opportunities for institutions.As large ETH holders – including cryptocurrency exchanges, funds and custodians – have recognized that holding ETH has a strong position in DeFi, they have been able to earn a return of 4.06% annual rate of return on their ETH positions. After the merger, we expect the actual rate of return on ETH fixed investment to be between 5.5% and 13.2%, depending on several factors such as block rewards, transaction fees, and the maximum extractable value (MEV) that the validator deserves.
Figure 2. Estimated returns Source: ConsenSys
The opportunity for institutional DeFi is huge, and the merger will only help the market mature and create opportunities for investors chasing returns in high-risk areas. Institutional investors, who may have been skeptical about DeFi's investment opportunities, have now recognized that the growth of Web3 and its related financial instruments powered by DeFi is inevitable. They may not fully understand the drivers behind DeFi or Web3, but they already know that this asset class cannot be ignored.
Ethereum’s next phase roadmap will address the challenges of scale, thereby building confidence in the ecosystem, especially for those who may think that investments in crypto assets are too risky. We expect progress and innovation will arrive soon, whether it is crypto funds and DAOs, or traditional Web2 institutions.
This article is adapted from our exclusive report "The Impact of Mergers on Institutions", in which we discuss how changes in the Ethereum network after the merger will translate into opportunities for institutional investors.
You can download the full text of the report here here
Editor in charge: Kate
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