The Breakdown - ETH Dencun Upgrade Transforms Blockchain Fee Competition

Episode Date: March 15, 2024

Ethereum's latest update has significantly decreased the cost of L2s -- bringing them all the way down to Solana levels. NLW explores the implications -- plus Microstrategy is is back issuing more debt to buy bitcoin. Today's Show Brought To You By Kraken - Go to https://kraken.com/thebreakdown and see what crypto can be Ledger - 5% to Bitcoin Developers When You Buy https://shop.ledger.com/pages/bitcoin-hardware-wallet Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, March 14th. Today we are talking Ethereum upgrades and more. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or get a bit.ly slash breakdown pod. Well, friends, Ethereum has completed the Denkoon upgrade unlocking significant scaling improvements. The hard fork was completed yesterday morning with no major problems on Mainnet. Blocks continue to be produced throughout the update, and they now include blobs.

And by the way, for those of you who are not familiar with Ethereum's, let's call it colorful and interesting terminology, you're going to hear a hell of a lot of weird words on this episode, so be prepared. For example, while Denkun introduced a number of changes to the code, the most impactful one is the introduction of proto-danksharting. This allows larger data bundles to be written to blocks in an area known as the blob space. These blobs validate the state data for Ethereum's numerous layer 2 roll-ups and are available as discounted block space. What the hell does that mean? Well, stripping away some of the jargon, this means that fees on layer 2 network have

been dramatically slashed. Indeed, we're already seeing the results with regular transactions on popular L2s like optimism reduced from around 30 cents to a few hundreds of a cent. The implications of this cost reduction are obvious for accessibility, making Ethereum layer 2 use affordable for a much wider range of people. It'll take a few days until we know where the fees will settle, but at the moment, it looks like the reduction will be something close to 99%. Beyond cheaper swaps and payments, the other interesting unlock from the fee reductions is the ability to put complex financial infrastructure on Ethereum

layer 2's. This impact is already visible in some places. For example, synthetics and on-chain perpetual futures roll-up saw gas costs reduced from $3 per action to just 14 cents. Investor Adam Cochran noted, L2 fees are now so cheap that you could run a central limit order book on an EVM. So let that race begin. Coinbase CEO Brian Armstrong tweeted, This is huge. Reducing transaction fees and confirmation times on layer two will open up so many more use cases for crypto.

We're finally getting scalability. Coinbase are, of course, one of the big beneficiaries of the upgrade, with their base layer two seeing fees slashed to a fraction of a penny. The thing to watch coming out of this upgrade is, in fact, this opening up of new design space. Many projects that were completely unthinkable to do on Ethereum just a few years ago are now possible. Blockworks Mikey Bolito is firmly locked into this thesis

is tweeting, the real catalyst for this cycle is the abundance of cheap, high-quality block space, which is all to say nothing of the technical achievement. Completing upgrades on a live blockchain is an extremely difficult problem. Ethereum developers have now pulled off another one flawlessly. Consequently, there was an outpouring of praise across crypto Twitter for Tim Beko and the entire dev team on this achievement. As just one example, DC investor wrote, This man has helped shepherd through some of the most important upgrades in Ethereum's history. I put respect on his name. With the Denkun upgrade completed, the Ethereum ecosystem is now locked into a modular approach to scaling. This has been a divisive choice, with other blockchains

like Solana choosing a monolithic approach. The difference is that modular scaling splits activity across numerous L2s, where a monolithic scaling is about increasing throughput and reducing fees while retaining a single blockchain. Both approaches have their benefits. Ethereum has largely chosen the modular approach to ensure that validators remain viable to run as a home operator. This theoretically should allow for more decentralization in the infrastructure layer. Solana's choice sacrifices home validation in favor of keeping all the activity together. The theoretical benefit is that there is less risk that liquidity fragments across dozens of layer 2s and app chains. The wisdom of each approach will likely take a long time to play out, but this will be a key differentiator between

the ecosystems moving forward. For now, the fees on Ethereum layer 2s are even cheaper than Solana, which could represent a big shift. Although to be clear, it's not that there's an optimal solution, per se, only tradeoffs and choices. Moving to the financial side of the upgrade, some research shop have been excited about Denkoun as a meaningful price catalyst. In February, investment bank Bernstein was constructive on the upgrade, stating that it paved the way for institutions to, quote, build more transparent and open tokenized financial markets on the Ethereum network. J.P Morgan was less optimistic in the short term, stating that the upgrade was, quote, largely priced in, and more recently, QCP Capital noted that previous upgrades have had

minimal price impact. They pointed to Bitcoin's taproot and the Ethereum merge as examples, but recognized that both occurred during bare markets. Analyst wrote, with current market dynamics, there could be price reflexivity on Ethereum and its layer 2's, potentially influenced by the already priced in Denkoon upgrade or a positive knee-jerk reaction, along with possible capital inflows into layer 2 ecosystems. Looking at the chart, we had a 3% sell-off as the upgrade got underway, which stabilized once it was completed. The Ethereum price stabilized throughout the afternoon, but fell into the evening,

leaving the token 2.2% down for the day. To sum, this is not a surprise. This was a technical upgrade with long-term implications for what can be built on Ethereum. In other words, it's very hard to price in any upside of the upgrade until new projects and new inflows and enables start showing up. Investor Ryan Watkins writes, Regardless of price action, Denkoon is one of the most exciting Ethereum upgrades in recent memory.

Although the immediate scalability gains are an extraordinary, Denkoon lays the foundation for sci-fi roll-up scalability in the future. Huge step towards mainstream accessibility for the largest and most secure smart contract platform on the planet. Now, for my bitcoiners who have made it this far, let me give you a little red meat to cleanse your palate. Less than a week after their last capital raise, Micro Strategy is back at it. The company has announced another 500 million in convertible debt issuance. They plan to use the funds to buy more Bitcoin.

The last round of convertible debt was originally announced at 600 million, but closed on Friday oversubscribed by 200 million. Those notes are now trading 42% above par, indicating that the market has plenty of appetite for another round. Last time, Micro Strategy was able to close with an interest rate of 0.625% through to a maturity date in 2030. They offered conversion into equity at a 42, 2.5% premium to the stock's price at the time of the raise. Since then, the stock has blown through the premium and is up a further 20%. Micro Strategy is up 250% since its local bottom in February, making it one of the best performing stocks traded on the NASDAQ. The stock is now trading it more than a 70% premium to the underlying Bitcoin. This new issuance will mature in 2031, but

interest rates and conversion premium are not yet quoted. Many have noted that Micro Strategy is currently in a brutal short squeeze. Roughly 20% short interest has stayed constant over the past few weeks, as the stock continued to rip. We'll see where short interest is on Friday when the next weekly position report is released, but for now, the working assumption is that someone is stuck. Twitter user Glenn Hoddle dug up an interesting comment from Trading View posted last week, which said, quote, monitoring this as of today. There is still a large hedge fund trapped with short interest on Microstrategy, roughly 17.65% of outstanding shares. This has barely dropped since the price gapped up, putting the cover costs somewhere between 1 and 3 billion,

depending on their source of collateral. It's clear to me that they have to either buy microstrategy shares and call options or fire sale and other asset to get out of this situation. Personally, I think if they wanted to exit, they would have already done so seeing the spot ETF inflows on Bitcoin. Someone is stuck. Preston Pish provided a more straightforward interpretation tweeting, what does this mean? This means the haters are going to pump my Fiat bags, which will be thoroughly transmuted into more Bitcoin per share on the balance sheet. Thank you, micro strategy haters. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best,

represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7-365 and moves at the speed of real life. Not everyone believes it. We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and lows of the industry, facing forwards towards progress throughout. And now they're inviting us to see what crypto can be. Learn more at crackin.com slash the breakdown. Disclamer, not investment advice. Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, DBA, DBA, CRACN.

Hello, breakers. Today's episode is sponsored by Ledger. As another cycle ramps up, it's another chance to think about your Bitcoin custody best practices, and of course, to help all the new folks do the same. Ledger is the global platform for securing Bitcoin and other crypto. Ledger combines both hardware wallets and the Ledger Live app to offer the best way to buy, sell, swap, and stake without sacrificing on security or self-custody. Ledger features cutting-edge technology in the form of a certified secure chip and a proprietary

operating system, but also brings ease of use. This makes Ledger a safe and secure way to manage your digital assets without all the stress. Check out the link to the Bitcoin Ledger Nano in the show notes. 5% of all sales of the Bitcoin Ledger Nano go to support Bitcoin development. Thanks once again to Ledger for supporting the breakdown. Over in the legal realm, the court has denied Genesis and Gemini's motion to dismiss, ordering it that the SEC's lawsuit against the firms can continue. The judge has found that the SEC, quote, has plausibly alleged that defendants offered and sold unregistered securities through the Gemini Earn Program, end quote. This case has been ongoing since January

2023 and is one of the last outstanding lawsuits against Gemini and Genesis. As this is an early motion, the judge is required to accept the SEC's pleaded facts as correct. There was some analysis of the legal precedence around securities law, with the judge finding that, quote, the complaint sufficiently alleges that Gemini Earned investors had an expectation of profits. Defendants marketed Gemini Earn as an investment opportunity and publicly touted investors' ability to earn returns. End quote. Gemini and Genesis for their part are arguing that the product involved the creation of loans, not securities. The company will be able to argue at this point as the case proceeds to a trial later in the year, but this early result is not promising.

Gemini's outside counsel said in a statement, this is simply a preliminary ruling and we are confident that Gemini will ultimately prevail in the case. The Gemini Earn program was not itself a security and did not involve the sale of any securities. Now let's turn to a little section on how the research shops are thinking about Bitcoin after this blistering move of the last couple weeks. There's some fairly different opinions out there, so let's see what people are saying. Swiss Block, for example, thinks that Bitcoin has come too far too fast and is due for a cool-off. The analytics firm wrote, Nothing rallies in a straight line, not even Bitcoin. A countermove seems to be near, end quote.

Bitcoin has almost doubled in price since the launch of the Bitcoin ETFs in mid-January, serious pullbacks. Swiss block leaned on a quickly dwindling relative strength index as their indicator, suggesting that momentum is exhausted. They wrote, We see Bitcoin dropping to 58,000 to 59,000 in the next move, but the top is not in. If that happened, that would be a 20% pullback, but obviously still comfortably above opening prices for the year. Matrixport pointed to the same flagging indicator this week, writing on Tuesday, this bull market still has legs, but the divergence between a declining RSI and still high Bitcoin prices could signal that BTC needs a consolidation before

for rallying again. Galaxy Digital CEO Mike Novogratz thinks Bitcoin will keep trending upwards as long as ETF flows remain strong. After that, he predicts the market will set a pretty firm floor. During a CNBC interview on Wednesday, Novagrat said that once ETF flows turn negative, quote, you'll see the first real correction. Things are frothy, funding rates are high, and so in times like this, you always have to be ready for a correction. I don't think we go back below 50,000 to 55,000. I think that's the new floor unless something dramatic happens. Novigrat said that the ETFs had led to a, quote, mindset shift. Baby boomer, are getting their first shot at Bitcoin investing through registered investment advisors. Novogratz also

reminded viewers that Bitcoiners don't like to sell, often thinking about their net worth in Bitcoin terms rather than pricing it in dollars. Currently, Novogratz thinks were in price discovery mode and Bitcoin could run as high as $100,000. A growing theme in mainstream commentary, however, is concerns about ownership concentration. Novogratz was asked whether the ETFs could grow to hold all of the Bitcoin in existence. He shrugged that notion off, stating that he doesn't think the ETFs will even get to 20% of total supply, adding, they're loading up now. it will reach an equilibrium at one point, and there are a lot of people who still want to custody their own coins or have them in foreign location custody if they don't trust the country they're in.

Meanwhile, sky-high ETF inflows have thrown many analysts for a loop. Before the products were launched, 10 billion worth of inflows for the year was considered a rousing success. The ATFs have blown through that in less than two months, leaving research notes constantly adjusting up their expectations. JPM securities wrote in a Wednesday note that they expect Bitcoin ETFs to receive 220 billion worth of inflows over the next three years. According to the assumptions about capital multipliers, they said that this would lead Bitcoin's price to quadruple to 280,000 by 2027. Inflows of that size would require the ETFs to keep up their starting pace of 5 billion in net inflows per month for the entire three years.

Analysts wrote that these massive inflows would be extremely constructive for Coinbase stock, which provides custody service for the majority of the ETFs. They consequently upgraded their price target on the stock from 220 to 300, making them highest among Wall Street analysts. Coinbase closed slightly above 250 yesterday with little movement over the past week. The stock is up 56% over the past month. JPM's view is that the ETFs, quote, activity inflows experience thus far is still likely the tip of the iceberg. They added that they expected flows to grow materially

as part of the, quote, longer process of capital allocation. To be clear, this call of 220 billion worth of inflows over three years is at the moment wildly above consensus, at least for the research houses. Last week, JPMorgan released a note stating that they expect ETF inflows to top out at $62 billion over two to three years. At the current pace, though, the ETFs will blow through, through J.P. Morgan's long-term estimate by the end of this year, so kind of hard to say.

Tuesday's record inflows into the Bitcoin ETF were enough to set a new annual record for global crypto funds. 10.6 billion worth of fresh capital has been deployed, surpassing the 2021 high watermark less than three months into this year. The comparison is perhaps a little closer than it appears, however. 2021 inflows were centered around the October launch of Bitcoin futures ETFs, so there's really only three months of strong flows that occurred that year. This record still speaks to the scale that could be expected throughout the rest of the year, with spot, ETFs much more suitable for buy-and-hold investors than their futures counterparts. Finally, according to on-chain data firm GlassNode, Bitcoin sentiment is, quote, one step closer

to Euphoria. In their weekly newsletter, GlassNode said that, quote, the classic wealth transfer from the Hodler cohort to speculators is now well underway, with significant upticks in spot profit-taking and demand for futures leverage. Glassnode has gathered a collection of metrics to judge when Bitcoin is in what they're calling the euphoria zone, which is coincided with massive price runups in the past. This year's rally has now just entered the euphoria zone, and by no means does that mean that they're suggesting we're at a frothy top? Previous euphoria zones have lasted for months. The last example began in December 2020, with Bitcoin running up 3x over the following four months. So friends, it continues to be exciting times in Bitcoin land and in crypto land more broadly.

There's competition, there's excitement, there's technology innovation, there's new buyers. It's a hard time to be anything other than excited, and so excited is what we will be. For now, I want to say one more big thank you to the sponsors of today's show. Go to crackin.com slash the breakdown and see what crypto can be, and check out the ledger Bitcoin Nano. 5% of all sales will go to supporting Bitcoin development. Until next time, guys, be safe and take care of each other. Peace.