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Why Is BitMEX Ex-CEO Arthur Hayes So Bullish on Ethereum?

Why Is BitMEX Ex-CEO Arthur Hayes So Bullish on Ethereum?

Explainers Cryptocurrencies

06 May 2022

Arthur Hayes, the ex-CEO and co-founder of BitMEX, the crypto exchange and derivatives trading platform, and 100x Group, its holding company, recently published an exciting essay. In the piece, he analyzed Ethereum (ETH), praising its native cryptocurrency and calling it a commodity-linked bond.

It's not the first time Hayes has highlighted the positive aspects and potential benefits of Ethereum. Last April, he wrote in a blog post that while the smart contract blockchain imitated Bitcoin in "many ways," it offered "substantial improvement" and greatly expanded the potential use cases of blockchain tech by creating a decentralized computer. Hayes also mentioned that he wished he had bought ETH during the cryptocurrency's pre-sale.

Interestingly, Hayes hasn't always been fond of ETH. In August 2018, he called Ether a "double-digit shitcoin" mainly because of Ethereum's role in the 2017 ICO craze. Ethereum was then the primary blockchain for launching token sales, many of which were operated by fraudsters.

Since then, Hayes' views on ETH have changed drastically.

In his most recent essay, he analyzed Ether from the perspective of institutional investors, highlighting the cryptocurrency's bond-like features and benefits for corporate and traditional finance clients after the upcoming Ethereum merge, which will introduce PoS staking.

The Ethereum 2.0 upgrade is probably the most anticipated cryptocurrency event this year, in which the original Ethereum chain and the new Beacon Chain (often called ETH 2.0) will merge. This is likely to occur somewhere around Q3 2022. As a result, the staking-based Proof-of-Stake (PoS) consensus mechanism will replace the energy-intensive Proof-of-Work (PoW) algorithm, setting the grounds for larger improvements in the future, such as the introduction of shard chains to enhance the smart contract chain's scalability.

Without bashing Bitcoin, Hayes also modified the target allocation of his 2022 crypto portfolio from the initial 50% BTC and 50% ETH composition to 25% BTC and 75% ETH. At the same time, he predicted Ether to be traded north of $10,000 "when the dust settles at year-end."

In this article, we will explore Hayes' essay titled "Five Ducking Digits," explaining his most important arguments about Ether, Bitcoin, and institutional adoption.

Let's get started!

The Financial Fiduciary Dilemma

Hayes introduces the topic with a dilemma related to financial fiduciaries as well as possible bottlenecks that decrease the rate of crypto adoption among institutional investors.

According to Hayes, we are in an age when financial fiduciaries like advisors, portfolio managers, and even CEOs of publicly traded companies can "reap so much economic benefit for themselves against a backdrop of disastrous performance for the clients they claim to serve."

No matter the performance of their clients' assets, he argues that fiduciaries still make great profits due to the hefty fees they charge for providing their services. Hayes believes that service providers can be reluctant in offering crypto products to their clients as they cannot earn the same high commissions with them as with traditional financial products.

Furthermore, the excessive energy intensity of the current PoW algorithm makes the two leading cryptocurrencies Bitcoin and Ethereum unattractive choices for ESG investors as well as the financial fiduciaries that manage their money.

However, according to him, a change in the classification of crypto investments could solve these issues, especially in the case of Ether.

After the merge and the shift from PoW to PoS, validators within the Ethereum network can stake ETH to validate blocks. In exchange, they will receive rewards that could be utilized to earn interest on the coins they have contributed to securing the ecosystem. At the same time, as PoS consumes drastically less power than PoW, the upgrade will also serve as a viable solution in terms of ESG investments.

Hayes argues that ETH's classification will drastically change after the merge in multiple ways, making it an attractive asset for financial fiduciaries and institutions in general.

A Perpetual Commodity-Linked Bond

According to Hayes, Bitcoin is "the hardest form of money ever created," which is viewed as a store of value and an inflation hedge by investors.

Indeed, BTC has numerous properties that make it very similar to gold. This scarce precious metal has been utilized to retain the long-term purchasing power of currencies (among many other use cases) throughout human history.

BTC isn't tied to a physical location but "lives" in the digital world on the decentralized, transparent, and community-governed Bitcoin blockchain. For that reason, it lacks the biggest downside of gold, which has been regularly exploited by governments since ancient times to inflate currencies and bring in more money than the state owned at the time. For that reason, some believe that the cryptocurrency has more potential as a store of value than gold.

However, despite the above benefits, Hayes believes PoS Ether will have one major advantage over Bitcoin that will come in handy for institutional investors. Due to BTC utilizing the mining-based PoW algorithm, it lacks staking functionality on the protocol level. Therefore, investors can't earn interest natively on the Bitcoin blockchain. Such activity is only possible by moving the asset to an off-chain savings service or a DeFi solution on another blockchain.

On the other hand, institutional investors can leverage ETH to become validators after the merge, staking the cryptocurrency to generate a passive income.

Based on Ethereum researcher Justin Drake's estimates, stakers will be able to realize an annual percentage rate (APR) between 8% and 11.5% right after the merge.

At the same time, the analyst also expects Ether's circulating supply to start falling, taking between 5.5 and 38.2 years to reach 100 million ETH from the current 120 million. This will likely be due to the deflationary base fee burning mechanism introduced with the London upgrade as well as the anticipated 90% reduction of new coin emissions after the switch to PoS.

To become a validator, a minimum balance of 32 ETH is required, allowing one to receive both issuance rewards and a share of the network fees. Interestingly, Hayes has explored two ways institutions can acquire this sum in a profitable way.

The first one is by borrowing USD to buy ETH for a term, similar to how you would acquire a government bond. After staking the 32 ETH and accumulating rewards, institutions should sell both the 32 Ether and the earned interest for USD and repay the loan after. With this strategy, investors can generate an ROI of over 28% over five years.

Hayes also has a method for investors who don't want to commit to becoming full-fledged validators on Ethereum. Instead of utilizing the main blockchain, they can stake their Ether in various validation pools that allow traders to earn yields without validating blocks on the smart contract blockchain.

Instead, projects like the Lido Protocol issue 1 stETH for every ETH staked by users on the platform. stETH is backed 1:1 with ETH and represents the deposited Ether as well as the staking rewards earned by the user. It can be minted only by staking ETH, and it should be burned to redeem ETH deposits and the interest earned on them.

As major lending platforms and DeFi protocols like Aave and MakerDAO accept stETH as collateral, Hayes argues that this strategy works best if investors put their stETH at work. For example, they can use their stETH holdings to borrow money and reinvest it or lend them to maximize yields. He argues that this process is very similar to how the global credit market works – creating a debt asset (e.g., a loan) and using the same instrument as collateral to borrow more funds.

Of course, reusing collateral features increases risks, just like in traditional finance. In DeFi, Hayes argues that such activity could present a systemic risk in which a rug pull, smart contract hack, or other black swan event renders pool tokens like stETH worthless, negatively impacting the assets on the top as well - ETH in this case.

That said, the on-chain nature of decentralized finance and the full transparency that comes with it makes it easy to create extremely accurate tools to monitor systematic DeFi credit risk in this field, he argues.

PoS to Make ETH Attractive for ESG Investors

As the world seeks to combat global warming by reducing CO2 emissions and replacing fossil fuels with renewable energy, ESG investments have been at the center of focus in recent years.

ESG is an approach used to evaluate investments based on financial returns and environmental, social, and governance criteria.

Here, ESG investors are looking to put money into the stocks, bonds, and other financial instruments of organizations committed to achieving sustainable goals. This can include supporting certain social movements, leveraging ethical forms of governance that are centered around diversity and inclusion, and reducing their carbon footprint.

While Hayes argues that financial fiduciaries have already made it easy for companies to become ESG-compliant without actually fulfilling or committing to sustainable goals, it's an important criterion for attracting institutional crypto investment.

However, considering the heated debate around Bitcoin's energy consumption, most investors don't consider crypto an ESG investment. While the issue is definitely over-exaggerated considering BTC mining has become a lot greener in the past few months, the PoW algorithm requires tons of power to be leveraged to secure the network effectively.

Consequently, ESG investors will remain hesitant to pour money into BTC until almost all Bitcoin miners start using a 100% renewable energy mix to operate their equipment or the network changes its consensus mechanism from PoW to one that is less energy-intensive.

For Bitcoin, the latter option is not realistic to achieve, especially if we consider the extreme resilience the PoW mechanism has provided for the blockchain network over the years. On the other hand, Ethereum developers are currently working on achieving this goal with the merge.

According to Hayes, as PoS is considered ESG-compliant despite the fact that computers still have to be run to operate validator nodes, the merge will make ETH an attractive asset for investors building sustainable portfolios. In fact, this opens up Ether for "hundreds of billions of USD worth" of fiduciaries who can now safely invest in the cryptocurrency due to its new ESG classification, he argues.

In his essay, Hayes also mentioned Ethereum's competitors that utilize fast, highly scalable layer-one (L1) blockchain networks as well as PoS or other ESG-compliant mechanisms to reach a consensus among validators. However, he believes that "Ethereum killers" like Terra, Cardano, Solana, Polkadot, and Avalanche are significantly overvalued due to the massive hype around them.

While Hayes believes the native coins of these alternative smart contract platforms can still be good investments, the fundamentals of Ethereum are much stronger, which makes ETH a better investment.

The Road to a Five-Digit Cryptocurrency

In his essay, Hayes has thoroughly analyzed ETH and made multiple data-backed and sensible arguments on why the cryptocurrency presents an excellent opportunity for institutional investors after the expected merge.

While Bitcoin functions as a store of value and a hedge against inflation, post-merge ETH indeed has the potential to become the cryptocurrency industry's commodity-linked perpetual bond. By offering yield on the protocol level, institutions can leverage Ether to make higher-than-average ROI via various strategies that can involve USD loans, DeFi credit, and staking pools.

Furthermore, as Ethereum is soon transitioning to the less energy-intensive PoS consensus mechanism, ETH will likely become an attractive choice for ESG investors.

Serving as the hotbed for most major crypto trends in the past five years like DeFi, NFTs, ICOs, and DAOs, ETH is backed by strong fundamentals in terms of Ethereum's network activity. For that reason, the cryptocurrency offers great value for investors.

Yet, due to the high fees and lack of scalability of its main chain, competitor chains will also play an integral role in the industry. They offer a fast and inexpensive alternative for users to transfer money, earn coins with DeFi, play blockchain games, and trade NFTs.

Considering all the benefits of Ether, Hayes is ready to rearrange his portfolio from the original 50% ETH and 50% BTC allocation to 75% ETH and 25% BTC. At the same time, he is expecting Ether to reach $10,000 by the end of the year.

The question now is: will Hayes' predictions come true? In any case, it will be exciting to see how the upcoming Ethereum merge will shape the future crypto market.

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