Ethereum’s ‘Merge’ Is Disrupting Crypto Trading and Lending

Crypto markets linked to EtherETHUSD +4.51%  are facing disruption as the blockchain network behind the world’s second-largest cryptocurrency nears the end of a critical upgrade.

The final stage of Ethereum’s “Merge” is now about a week away. Expected to finish around Sept. 15, it will change the mechanics of processing transactions from the current “proof of work” system to a method based on “proof of stake,” designed to be far less energy intensive. Among other changes, it will eliminate the process of “mining” Ether tokens.

But the next week could be especially rocky for Ethereum’s native token, Ether, and related cryptos. Some decentralized finance (DeFi) trading and lending platforms have imposed limits on Ether borrowing amid a flurry of activity.

Exchanges including Coinbase Global COIN +7.08%  (ticker: COIN) have warned users of delays. Coinbase told users Wednesday that during the Merge it would briefly pause deposits and withdrawals of Ether. Also impacted will be ERC-20 tokens, which are used on the Ethereum network as the basis for trading and lending in “smart contracts,” and for creating nonfungible tokens, or NFTS.

This pause will also hit transfers on the Optimism and Polygon networks, according to Coinbase, and could take 24 hours to resolve following the Merge.

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A little disruption is to be expected, given the magnitude of the Merge’s impact on crypto. Ethereum is the largest crypto network after Bitcoin, and it’s extensively used for trading, lending, NFTs, and all sorts of DeFi apps. It also plays a foundational, or Layer 1, role in other blockchain projects and networks, including Polygon and Uniswap.

Interest in Ether and related products have boomed in the months leading up to the Merge. The token is up some 50% from June lows while its larger peer, BitcoinBTCUSD +8.65% , has remained largely unchanged.

But traders that want to hop on the Ether train may find it difficult to do so while the network undergoes a sea change.

Indeed, Coinbase isn’t alone in warning of disruptions. Robinhood Markets HOOD +2.54%  (HOOD) announced last week that it would pause withdrawals of Ether as well as six other tokens, including the “memecoin” Shiba InuSHIBUSD +6.16% , during the Merge. Bitfinex, another crypto exchange, said it would similarly halt deposits and withdrawals of Ether and linked tokens.

“Concerns regarding trading instability are certainly reasonable given the upcoming Merge is a technical overhaul of a live-running global network in which hundreds of billions of dollars are custodied, traded, borrowed, and lent monthly,” says Sadie Raney, the CEO of crypto hedge fund Strix Leviathan.

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“Beyond the technical risks, there are also several adversarial opportunities that arise from the event,” Raney added. That includes aggressive trading strategies that could heighten volatility in DeFi borrowing and lending apps.

Crypto miners will be left behind in the Merge. But they aren’t going down quietly—planning rival Ethreum networks that could compete with their own related tokens. Their networks would still use the old “proof of work” system where computers must solve complex puzzles to validate transactions.

That is causing more uncertainty in Ether, and it’s prompted several exchanges to say whether they would support the rival tokens. Coinbase, Binance, FTX, and Bitfinex say they will apply their normal standards to decide whether to list rival Ether tokens, based on competing blockchains. The Uniswap trading platform and the backers of the USDC stablecoin have committed to exclusively support the Ethereum blockchain and its token.

Some crypto traders see opportunity in the emerging “forked” Ether tokens, however. The rival tokens are set to trade at around $18 each, based on an analysis of futures contracts by crypto investment firm Paradigm. The rivals might turn out to be worthless, but there is a chance that Ether holders could receive an equivalent amount of the rival token once the Merge is completed—an incredible payoff if it pans out.

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That is partly why borrowing of Ether has soared on some DeFi platforms. If it all fizzles out, however, platforms could face a liquidity crunch, says Raney of Strix Leviathan, who added that the risks apply to the larger ecosystem.

Some DeFi platforms are taking action now to try to maintain stability. The lending platform Aave temporarily paused Ether borrowing on Wednesday. Another platform, Compound, has capped the amount of Ether traders can borrow and adjusted rates on the token.

Perhaps the only certainty: Volatility will continue to hit crypto until The Merge is complete.

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