Ethereum has scheduled its Merge to occur this week, as early as September 15. Ethereum’s Bellatrix update is now complete ⏤ the final step ahead of Ethereum’s transition from Proof-of-Work to Proof-of-Stake.
The Merge is by far the year’s most publicized blockchain upgrades of the year ⏤ understandable, considering that Ethereum is the second biggest digital asset by market cap. However, less publicized is the enormous profit that wealthy insiders have extracted from retail traders around the event.
Five ways wealthy insiders profit from the Merge at the expense of average investors
1. Charging less wealthy people (with less than 32 ETH) for staking-as-a-service
If someone has less than the 32 ETH (~$54,000) required to activate validator keys in Ethereum 2, they can’t participate in Proof-of-Stake rewards, which pay a variable 3-18% annually. Missing out on even a conservatively calculated 4% worth of annual rewards is tantamount to losing half of an otherwise staked position every 17 years, so ETH investors need to utilize staking-as-a-service.
There are various services to stake ETH with a third party who will validate blocks on one’s behalf and pass along some of its staking rewards. Of course, administrators of these services charge a fee ⏤ the first example of wealthy insiders extracting money from retail traders through the Merge.
2. Trading de-pegs of Lido’s staked ETHs
As noted above, passing along staking rewards without the minimum 32 ETH obviously incentivizes retail investors to deposit their smaller ETH positions with a staking service. The most popular staking services give back a proprietary “staked ETH” token as a representation of their position.
For example, the most popular Ethereum 2 staking-as-a-service provider is Lido, which gives users back its proprietary token, stETH, in exchange for their ETH deposits. Administrators for Lido control the private keys to $7.7 billion worth of ETH or a stunning one-third of all Proof-of-Stake ETH.
Lido has issued $7.2 billion in fully diluted stETH. It claims that ETH and stETH are supposed to trade a 1:1 parity, but alas, the pegs between ETH and the various staked ETHs break periodically, including stETH. This is the second example of wealthy insiders extracting money from retail traders through Ethereum’s Merge: trading de-pegged stETH.
Lido’s stETH became the first popular target for wealthy insiders capitalizing on this de-peg trade. Amid the June 2022 collapses of Celsius and Three Arrows Capital ⏤ both of which held large bags of stETH ⏤ traders began selling stETH at a discount to ETH. At its lowest, stETH was selling for 9% less than ETH. Days later, it fully regained its peg.
Tens of millions of dollars worth of stETH transactions cleared while it was de-pegged, allowing arbitrageurs to make millions in profit at the expense of stETH’s overwhelmingly retail investor community.
Worse, stETH has continued to regain its peg and de-pegged, repeating cycles of arbitrage profits. Today, over $5 billion worth of stETH are trading about 3% lower than ETH, an arbitrage opportunity of yet another $140 million. If it cycles through regaining its peg and then de-pegs again, arbitrageurs could siphon even more money.
3. Arbitraging cbETH
A third example of wealthy insiders extracting money from retail traders through Ethereum’s Merge simply mirrors the above model. The same arbitrage profits are available with Coinbase’s version of staked ETH: cbETH.
Lido’s staked token is stETH; Coinbase staked token is cbETH. There’s over $1 billion worth of cbETH that de-pegs at fluctuating discounts. Today, cbETH is trading for 5% less than ETH ⏤ a delta of $50 million.
4. Lido bribes
Unlike Coinbase, Lido allows members of its DAO to vote on governance matters selected by its administrators. Votes are cast based on holdings of Lido’s so-called governance token, LDO.
Governance tokens are susceptible to bribes. Because votes are largely unregulated across jurisdictions, the industry of DAO bribes is well-established. So much so, in fact, that an entire organization controlling $4 billion called Convex exists almost exclusively to benefit from bribing another multi-billion dollar organization, Curve.
Similarly, LDO holders negotiate — or outright publish — their rates to sway their votes to the highest bidder. This is the fourth example of wealthy insiders extracting money from retail traders through Ethereum’s Merge: bribing LDO token holders to act in their best interest.
It bears repeating, as noted above, that Lido’s LDO controls voting for approximately one-third of all Proof-of-Stake ETH.
5. MEV
A fifth example is simply ongoing Miner Extractable Value (MEV), which continues through the completion of the Merge and will morph into its Proof-of-Stake form: “MEV-Boost.” MEV (and its Proof-of-Stake equivalent, MEV-Boost) allow wealthy insiders to systematically front-run trades, disadvantaging average investors who cannot afford to pay for expensive, MEV-resistant software. MEV has extracted billions of dollars from average investors whose orders were front-run or forcibly re-ordered.
Wealthy insiders and financial professionals will continue to use these five tactics, plus many alternative strategies and variations, to enrich themselves during Ethereum’s Merge.
Untold numbers of fund managers have already quietly maneuvered into multi-million dollar trades that run counter to the interests of average investors. As long as they can find profit, they will continue to remain quiet.
