Ethereum's Power Play: Cancun Upgrade

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TLDR;

• ETH is currently facing scalability challenges, which are manifested in high gas fees and slow transaction times.

• The upcoming EIP-4844 proposal aims to solve these problems, making Ethereum more accessible to a wider range of users and applications.

• The proposal would specifically benefit the Layer-2 universe, and we beleive could also lead to flows into other ERC20 tokens.

• Outside of Layer-2, Ethereum Classic (ETC) and Lido (LDO) are potential beneficiaries of renewed interest in the Ethereum ecosystem.

• Each token presents unique value propositions: ETC's resilience to censorship and stable monetary policy, and Lido's innovative approach to decentralized liquid staking.

• Our view is the upgrade could positively impact tokens like $ARB, $OP, $LDO, and $ETC.

Introduction

In the evolving landscape, markets are constantly anticipating the next big move, acting as forward-looking discount mechanisms that price in future expectations. Given this nature, it's crucial to adopt a proactive approach, identifying and capitalizing on emerging themes rather than solely relying on current ones. These themes, often characterized by volatility and short-lived bursts, can hold the key to significant gains.

Our methodology revolves around uncovering these narratives early and positioning within them before they gain widespread attention. This approach necessitates being "ahead of the curve" to identify the primary beneficiaries of these themes.

With that in mind, our view is that anticipation of an impending Bitcoin ETF approval is driving the current rally. Since September, we've delved extensively into this topic, and the prevailing consensus suggests that these instruments are likely to receive regulatory approval by January 2024, with analysts estimating a near 90% probability.

This sentiment has permeated the market, fostering a self-fulfilling prophecy that has propelled BTCETH back to levels last witnessed in June 2022. Simultaneously, Bitcoin beta plays such as $STX, $T, $BCH, and even $BSV are commanding substantial premiums compared to historical norms. This pricing pattern reflects the current positioning of market participants and underscores the ETF narrative as the primary catalyst behind the ongoing surge.

Our view, therefore, is the risk:reward profile of any ‘ETF’ approval has diminished significantly. Forward pricing mechanisms are already ahead of the curve, leaving several pockets of opportunity that can be capitalized on by taking a broader market view. With that in mind, there’s one specific theme we believe offers enormous profit potential, and that leans heavily on the upcoming Ethereum Cancun upgrade.

The Cancun Upgrade

Anticipated to launch between Q4 2023 and Q1 2024, the Ethereum Cancun upgrade, also known as EIP-4844, is a major upgrade to the Ethereum network that is expected to significantly improve its scalability and reduce gas fees. This could make Ethereum more accessible to a wider range of users and applications, which could lead to increased adoption of the network.

One of the key features of the Cancun upgrade is the introduction of Proto-Danksharding. Danksharding is a more advanced form of sharding that uses blobs, or large amounts of data, to further increase transaction throughput. Blobs can be stored on the Ethereum network and accessed by nodes, but they are not visible to the Ethereum Virtual Machine (EVM). This allows for more efficient data storage and processing, which can help to reduce gas fees.

Proto-Danksharding is a transitional phase towards full Danksharding. It introduces a new type of transaction, called a blob-carrying transaction, which can carry blobs of data. This allows rollups, which are a type of Layer 2 scaling solution, to transmit their data more efficiently and at a lower cost.

The Cancun upgrade is also expected to introduce other improvements to the Ethereum network, such as:

• Execution-layer logic, which will allow the Ethereum network to process transactions more efficiently.

• Verification rules, which will help to ensure the security of the network.

• Multidimensional fee markets, which will allow users to pay different fees for different types of transactions.

These improvements are expected to make Ethereum more scalable, secure, and user-friendly. The upgrade is the largest of such since the ‘Merge’, and we beleive Cancun is a market event currently being underpriced and overshadowed by Bitcoin’s ETF approvals. This offers astute traders an opportunity to position ahead of the upcoming catalyst and accumulate positions in tokens most likely to benefit from these flows.

How the Cancun Upgrade Benefits Layer-2 Scaling Solutions

EIP 4844 is a proposed upgrade to Ethereum that would introduce a new type of transaction called a "blob-carrying transaction." Blob-carrying transactions would allow users to store data off-chain, which would reduce the amount of data that needs to be stored on the Ethereum mainnet. This would free up space on the mainnet and reduce gas fees for all users, including those using L2s like Arbitrum and Optimism.

In addition, EIP 4844 would also make it easier for L2s to process transactions. Currently, L2s have to pay a gas fee to the Ethereum mainnet for every transaction that they process. EIP 4844 would reduce the cost of these gas fees, which would make L2s even more affordable to use.

Overall, this upgrade is a major step forward for the Ethereum network, that could lead to increased adoption of the network by a wider range of users and applications. In our view, the largest beneficiaries are likely to be Layer-2 scaling solutions. The new improvements will make Layer-2s more scalable, secure, and user-friendly, and the upgrade is expected to benefit these protocols in a number of ways:

• Reduced gas fees: The introduction of Proto-Danksharding and other improvements to the network are expected to significantly reduce gas fees. This will make Layer-2 scaling solutions more affordable for users.

• Increased scalability: The Cancun upgrade is expected to increase the scalability of the Ethereum network. This will allow more transactions to be processed on the network, which could attract new users and applications to Layer-2 scaling solutions.

• Improved security: The Cancun upgrade is expected to improve the security of the Ethereum network. This will make it more attractive to users who are concerned about the security of their assets, which could also benefit Layer-2 scaling solutions.

• Improved user experience: The Cancun upgrade is expected to improve the user experience of the Ethereum network. This could make it easier for users to interact with Layer-2 scaling solutions, which could lead to increased adoption.

Core Positions: The Layer-2 Basket

In order to take advantage of capital rotation into these sectors, we recommend clients gain exposure to the leading Layer-2 ecosystems - Arbitrum (ARB) and Optimism (OP), both of which are built on top of Ethereum to help improve their scalability and performance.

Arbitrum is an optimistic rollup, which means that it bundles transactions together and then sends them to the Ethereum mainnet for verification. This allows Arbitrum to process transactions much faster and at a lower cost than Ethereum itself.

Optimism is a zero-knowledge rollup, which means that it uses cryptography to prove that transactions are valid without actually revealing the transaction data to the Ethereum mainnet. This makes Optimism even more scalable than Arbitrum, but it is also more complex and is still under development.

Additionally, looking at the wider ERC20 space, other tokens that may benefit from renewed interest in the ecosystem include:

Lido

Lido is a liquid staking platform that allows users to stake their Ethereum (ETH) without having to lock it up for an extended period of time. Lido does this by pooling ETH from users and staking it on the Ethereum network. In return, Lido users receive stETH, a liquid token that represents their staked ETH.

EIP-4844 is a proposed Ethereum Improvement Proposal that is expected to reduce transaction fees on the Ethereum network. EIP-4844 is also expected to make it easier and cheaper to withdraw staked ETH.

The implementation of EIP-4844 is expected to benefit Lido in a number of ways:

• Increased demand for liquid staking: EIP-4844 is expected to make staking ETH more attractive to users, as it will reduce the costs and risks associated with staking. This is likely to lead to increased demand for liquid staking solutions like Lido.

• Reduced costs: EIP-4844 is also expected to reduce the costs associated with liquid staking. This will make Lido more competitive and attractive to users.

• Improved user experience: EIP-4844 is expected to make it easier and cheaper to withdraw staked ETH. This will improve the user experience for Lido users and make it more likely that they will continue to use the platform.

Overall, the implementation of EIP-4844 is expected to have a positive impact on Lido. Lido is well-positioned to benefit from the increased demand for liquid staking, reduced costs, and improved user experience that are expected to result from EIP-4844.

In addition to the above, here are some specific ways in which Lido might benefit from EIP-4844:

• Increased liquidity for stETH: EIP-4844 is expected to make it easier for users to buy and sell stETH. This will increase the liquidity of stETH and make it more attractive to investors.

• More use cases for stETH: EIP-4844 is also expected to enable new use cases for stETH. For example, users may be able to use stETH as collateral for loans or to participate in other DeFi protocols. This will increase the value of stETH and make it more attractive to users.

• Increased revenue for Lido: Lido generates revenue from fees charged on liquid staking deposits and withdrawals. EIP-4844 is expected to increase the number of users who stake ETH through Lido, which will increase Lido's revenue.

Overall, EIP-4844 is a positive development for Lido. It is expected to increase the demand for liquid staking, reduce costs, improve the user experience, increase the liquidity of stETH, enable new use cases for stETH, and increase Lido's revenue.

Ethereum Classic - Beta play

Ethereum Classic is a smart contract platform that is a hard fork of the Ethereum blockchain. The fork was created in 2016 in response to the Ethereum community's decision to reverse a hack that had resulted in the theft of $60 million worth of Ether.

ETC is a high beta play on ETH, meaning that it is likely to move in the same direction as ETH, but with greater magnitude. This is because ETC has a smaller market capitalization than ETH, which makes it more volatile.

In the recent move higher in the cryptocurrency market, ETC has outperformed ETH. This is similar to how Bitcoin Cash (BCH) has outperformed Bitcoin (BTC) in the recent past as traders priced in the Bitcoin spot ETF.

We beleive this relationship will hold in the Ethereum ecosystem, with ETC being the ‘low-hanging fruit’ and most likely being traded as an ETH proxy.

Wrapping Up

In navigating the dynamic currents of the financial markets, the ability to discern and position ahead of emerging trends is paramount. While the anticipation of a Bitcoin ETF approval has been a driving force in recent market dynamics, our analysis suggests that the risk-reward profile for this event has diminished. Instead, we propose a strategic shift of focus towards the underappreciated Ethereum Cancun upgrade, EIP-4844.

The Cancun upgrade promises to usher in a new era for the Ethereum network, addressing scalability issues and reducing gas fees. Its impact on Layer-2 scaling solutions, such as Arbitrum and Optimism, is expected to be profound, offering reduced gas fees, increased scalability, improved security, and an enhanced user experience. Consequently, we advocate for core positions in the Layer-2 basket, specifically in Arbitrum (ARB) and Optimism (OP), as these ecosystems are poised to benefit substantially from the Cancun upgrade.

Expanding our perspective to the wider ERC20 space, tokens like Ethereum Classic (ETC) and Lido (LDO) emerge as potential beneficiaries of renewed interest in the Ethereum ecosystem. Each presents unique value propositions, from ETC's resilience to censorship and stable monetary policy to Lido's innovative approach to decentralized liquid staking.

That’s all for this week. Follow us on Twitter for more insights or join our email list to get real-time analysis on catalysts, events, and flows.