Gravity-Defying Ethereum Classic Faces Turbulence As Sibling Readies Gear Shift

At any other time, ethereum classics year-to-date return of 0.95% might seem paltry, but when measured against the $1 trillion in vanished cryptocurrency market value and the halving of leading assets bitcoin and ethereum, its a 2022 standout. Its recent performance has been even more spectacular. While ethereum surged 53% over the past 30 days, ethereum classic jumped 141%.

Whether ethereum classic can continue to outperform as its more-famous sibling gets a long-awaited upgrade remains to be seen, but it faces significant challenges.

The key reason for ethereum classics surge is ethereums planned switch away from a computationally intensive method of processing transactions known as proof-of-work (PoW) to a much more eco-friendly approach called proof-of-stake (PoS), tentatively scheduled for September 19. Much like bitcoin, ethereum, requires an army of specialized and energy-guzzling computers to operate. Aside from environmental concerns, this approach comes with scalability limitations that put an artificial cap on the processing power of the network. While the ethereum network can process a dozen or so transactions each second, payments processor Visa can handle as many as 60,000.

Ethereum classic, the original version of ethereum, came into existence in May 2016 as ethereum developers wrestled with how to recover from the DAO hack that saw 5% of all ether in existence at the time stolen. Many aggrieved parties wanted their money back, and the ultimate solution was to rewind Ethereums clock to before the hack began though a backward-incompatible solution known as a hard fork. An inadvertent byproduct of this approach was the creation of two ethereum chains. The chain that unwound the DAO hack would now be known as ethereum, while the original ethereum chain became ethereum classic.

When the merge occurs, every Ethereum miner will be forced to either sell its equipment or find a new blockchain to mine. Because of the specialized nature of much of the equipment used to mine ethereum, the only real option is ethereum classic. For instance, Antpool, the mining pool affiliated with leading crypto-mining equipment maker Bitmain, already pledged $10 million to support the ethereum classic ecosystem.

The PoW-PoS transition has been publicized for years, it was part of ethereums very first roadmap in 2015, but when the September transition was announced by the Ethereum Foundation on July 14, things became real for the cryptos miners. In fact, you can see how ethereum classic began its rapid ascent on that very day.

The question now for investors is whether factors behind the surge have legs. Cryptos history is ridden with buy-the-rumor, sell-the-news examples. Two recent data points occurred in April and October 2021, when Coinbase went public and the SEC approved the first bitcoin futures ETF, respectively. Each instance, telegraphed for weeks or months, represented a market top.

There is a fear of the same thing happening to ethereum classic. For one thing, ethereum classic is starting to give back some of this years gain. It is down 10% over the past five days. Here are some other causes for concern:

• Ethereum classic is not just a carbon copy of ethereum that happens to use PoW. Since the two projects split following the $50 million DAO hack in 2016, they have gone in different directions and have key technical differences. Plus, ethereum classic miners will be stuck with a much-less efficient PoW setup, essentially a set of cryptographic hand-cuffs.
• Ethereum classic has just a fraction of the user base and developer activity of ethereum. This mindshare is not easily replicated, something that would-be ethereum killers like solana, algorand, cardano, polkadot and many others are learning.
• It appears increasingly likely that ethereum classic will have more competition than just a PoS ethereum. There are discussions that jilted ethereum miners will fork (i.e. split), ethereum itself when the merge happens and continue to operate what would be a duplicate with the PoW engine.

Should this last scenario occur, then miners would have to decide which chain to support. That would not be an easy decision as many factors would come into play. Key considerations would include whether exchanges are likely to list what would be an ETHPoW token, necessary for liquidity, and what the development roadmap would be. The transition for ethereum is just the beginning of a longer strategy towards scaling up the project to be able to handle 100,000 transactions a second. A PoW Ethereum would not be able to follow that approach.

Expect more market volatility ahead, especially regarding these few assets. In addition, while the ethereum transition to PoS has gone according to plan so far, the September 19 transition is just a tentative date. Should the switch be pushed down the road, brace for renewed turmoil.