The Bitcoin (
BTC-USD) spot ETFs were quite a success.At this point, they are probably the most successful ETF launches ever.The speed of inflows and growth in AUM has shocked a lot of people, even though big players like Vanguard are still refusing to offer the ETFs to their clients.
Ever since the SEC approved them, there has been much speculation about whether an Ethereum (
ETH-USD) ETF would be next.This was most viscerally observed with the discount on the Grayscale Ethereum Trust ( OTCQX:ETHE) began to close around December and January.
The market was betting that ETHE would be next to be converted, and that an ETH ETF was around the corner.
Personally, I think this would offer a lot of interesting investment opportunities.ETH ETFs would be very different from the Bitcoin ETFs because ETH is a much more complicated cryptocurrency.Also ETH owners have the native opportunity to generate cash flows from the Ethereum blockchain.An ETF may or may not take these functions into account, and so ETH ETFs could very well be differentiated by whether they have yields or not.
Realistically, however, I view the odds of a fast ETF approval for ETH to be quite low, even though I don’t expect this to matter much for ETH’s price.I am not optimistic about ETHE being converted.
I’ve made the case that ETH could outperform BTC within a shorter time frame.
Since I published the article “
Ethereum Has Upside” on 12 December, ETH performance has remained slightly above BTC’s for most of the time.
This is despite the BTC ETFs.Thus, I think a lack of ETH ETF’s won’t matter that much for its price.I still believe ETH could continue its outperformance over BTC in the next few months, especially as the crypto bull market starts to heat up and altcoins really begin to outperform BTC.In some ways, we have already started to see this.
Solana (
SOL-USD) has outperformed both BTC and ETH by a huge margin.
As the bull market intensifies, I wouldn’t be surprised to see ETH continue to outperform BTC.
That said, I think it makes sense to address the prospects of an ETH ETF.
The Problem With an ETH ETF
The main problem is that ETH is very much like a security and Ethereum is very much like a tech corporation.Gary Gensler has been
rather ambivalent about whether ETH is a security or a commodity, and this lack of clarity will make an ETF that much harder to push through to approval.
If ETH is indeed a security, then it needs to first file with the SEC.There are ETFs on securities and there are ETFs on commodities (generally with futures) but there are no ETFs on unregistered securities.The problem with ETH is that it may be an unregistered security.
First of all,
ETH has a pre-mine, which means that some people were allowed to get more of the first allocations of ETH before anyone else had the opportunity to mine ETH.These people were investors and insiders.Let’s contrast this with Bitcoin.
Satoshi Nakamoto publicly released the Bitcoin whitepaper 2 months before mining the genesis block.Prior to the genesis block, no one had the ability to mine blocks.The 50 BTC mined in the genesis block which were the only BTC in existence at that point aren’t even spendable, so even though Satoshi mined it, it was deliberately made so that he couldn’t spend it.
After the genesis block, some other early adopters began running the open source Bitcoin software.They weren’t investors or insiders.They were just cryptography enthusiasts who were in the cryptography circles in which Satoshi first started talking about this new software he was writing.Every time someone new starts running Bitcoin, they are technically just the newest addition to this growing circle of cryptography enthusiasts.
This is a giant contrast to ETH, in which investors and developers got a huge amount of ETH before the blockchain even went live.This alone doesn’t make it a security, but it is obvious that there is a clear class distinction between those who got coins before the network even emerged and those who weren’t able to get coins until after the network emerged.With Bitcoin, network emergence led to getting coins – every single coin was mined after the network had already emerged (and the only set of coins which could be argued as having been mined at the same moment of network emergence aren’t even spendable).And this inherent class distinction in ETH certainly could feel like it was a security offering of a sort.Think of all the disclosures that may need to be made retroactively in regards to the pre-mine allocations.
Think of how the famous
DAO hack being walked back with a hard fork may need to be explained in greater detail in official SEC filings.
Second of all, I have raised the issue before that proof-of-stake gives a very equity-like characteristic to the native token.Proof-of-stake tokens have a yield.The yield is earned relatively passively.
Also, proof-of-stake tokens give the owners certain governance rights over the blockchain.If a lot of proof-of-stake token owners wanted to fork the blockchain, they could do it on the raw merit of them having possession of the tokens.Contrast this with proof-of-work.1 BTC is not a 1 in 21 million ownership/ governance stake in Bitcoin.Even if I owned all the BTC, I couldn’t fork the Bitcoin blockchain.
Similarly, if I owned all the gold in the world, I couldn’t change something fundamental about what gold is.So BTC is literally like a commodity.
It is just a lifeless bearer asset that does nothing more or less than simply exist.ETH however, is objectively not that.
ETH does a lot more because it offers yield and it offers governance rights.And while ETH is a bearer asset, its value is largely determined by the gas fees paid on the Ethereum blockchain; similarly, Microsoft stock’s value is largely determined by the revenues received from selling Microsoft products.
If you were to value ETH, you could do a valuation on the basis of it being a security, a commodity, and a currency all at the same time.Theoretically, it would make sense to add on a perpetual option to an ETH valuation because ETH gives you the option to switch between these characteristics.I cover this valuation method
in this article about Ethereum (just skip to the “ETH Valuation” section).
The fact that you could do it on the basis of future cash flows is a big indicator that ETH isn’t a pure cryptocurrency.Currencies don’t have yields, but securities and financialized products often do.
What Might An ETH ETF Look Like?
Because of the yield that ETH can offer, an ETH ETF could look interesting.For example, will it pay a dividend because the ETH in the ETF is staked?
Staked ETH can also be “restaked” now in other protocols like Eigenlayer.This gives even more yields.Will there be ETH ETFs that pay extra dividends because they are doing restaking too?
Also, what if someone just wanted pure ETH exposure without the staking yield? The ETF could theoretically stake with the AUM and pocket the yield.This might even allow them to drop the ETF expense ratio to 0.
Here’s another point to consider.
Assuming the ETH ETFs do pay a dividend, this dividend has to be paid in dollars.So they will sell a lot of the staking rewards, which are paid in ETH, to convert to dollars to distribute as dividends.
So they’ll probably need to cover those details too: how are they staking and where are they selling the ETH staking rewards?
What To Do With This Info
The main takeaway is that you should not trade on the basis that an ETH ETF will be imminent.So personally I am bearish on the “closing the discount” trade for ETHE.I don’t think we should expect this discount to close anytime soon.And based on recent action of the discount it looks like the market has started to catch on to the fact that converting ETHE to an ETF will not be as smooth a process as converting Grayscale Bitcoin Trust (
GBTC).
While long GBTC, short BTC or ProShares Bitcoin Strategy ETF (
BITO) was a great trade, I don’t think the same thing can be applied to ETHE and ETH.
The circumstances only seem similar.
And also related to this revelation: it should be clear that ETFs in other crypto assets are even less likely.The SEC has already accused many of the major alternative smart contract blockchain tokens of being unregistered securities.Almost all of these are proof-of-stake tokens with a large pre-mine.They all generate relatively passive yields for staking, and they all confer some element of governance rights to owners.
Does The Lack Of An ETF Hurt ETH?
I don’t think ETH would really be negatively affected just because of it being unsuitable for an ETF.
The crypto bull cycle is now in full swing and we probably won’t notice any material negative impact on ETH.As mentioned, the long ETHE short ETH trade isn’t something I would bet on.So ETHE discount might continue to widen from here, and this is the main point to watch for.
The fundamentals of ETH are quite strong.The Ethereum ecosystem has the vast majority of on-chain activity in all of crypto.The recent
Dencun upgrade will increase the total transactions throughput of the Ethereum ecosystem by significantly lowering the costs of rollups, which is the de facto scaling path that Ethereum is undertaking.Developers continue to innovate on Ethereum, and this only points to more value accruing to ETH.
Bottom Line
I think traders should be aware that an ETH ETF is unlikely to happen anytime soon.The fundamentals of Ethereum remain quite sound.It boasts the largest active on-chain ecosystem and it is still continuing to innovate.
While ETHE might not be a good discount-to-NAV trade, ETH remains a sound investment that may even outperform BTC in the short term.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S.exchange.Please be aware of the risks associated with these stocks..