Tagus Bits 'n Bobs Issue 6: Era of Ethereum ETFs

Jul 25

9 min read

23 July 2024

Deep Dive: Era of Ethereum ETFs

U.S. Spot Ethereum ETFs Launched - Anticipated Demand: Spot U.S. Ethereum ETFs are set to launch today (July 23, 2024) after receiving final approval from the SEC for their S-1 filings. While the demand for Ethereum ETFs may not initially match Bitcoin ETFs, Tagus Capital anticipates up to USD4.5bn in inflows within the first six months, accounting for around 30% of the net inflows seen in U.S. spot Bitcoin ETFs over an equivalent period since launch
Ethereum Undervalued: Ethereum is currently undervalued compared to Bitcoin, and robust related ETF inflows may trigger a rebound. If the ETH/BTC ratio reverts to the three-year median, Ethereum’s price relative to Bitcoin could outperform by nearly 20%.
SEC's Ethereum ETF Approval Milestones: SEC’s rapid U-turn in favour of Ethereum ETFs represents a significant milestone for digital assets and wider adoption
Ethereum ETFs Offer Competitive Fees: Following the competitive fee structure of Bitcoin ETFs, Ethereum ETF issuers have unveiled attractive fees to capture market share. BlackRock charges 0.25% (0.12% temporarily), Franklin Templeton offers 0.19%, and Bitwise, VanEck, Fidelity, and 21Shares plan to waive fees initially. However, Grayscale's Ethereum Trust conversion to ETF may experience fee-related rotation due to its maintained 2.5% fee, similar to its Bitcoin trust.
Absence of Staking in Ethereum ETFs: U.S. spot Ethereum ETFs approved by the SEC exclude staking, a feature that lets investors earn yields and protect against inflation by contributing to blockchain operations. This omission may make ETFs less attractive for some investors seeking income and direct exposure to the Ethereum network and its dApps. Staking approval could though potentially occur after the U.S. elections.
Ethereum's Tech Investor Appeal: Ethereum's dual role as a digital asset and technological ecosystem providing a secure layer for new applications may appeal to conventional financial investors who favour tech stocks over monetary assets like Bitcoin and gold. This raises though the Ethereum Paradox, i.e, the inverse relationship between ETH's value and network activity, where high usage can lead to congestion, higher fees, and potentially drive dApps to cheaper networks or L2s, lowering ETH's value.
Ethereum ETFs' Eco-Friendly Advantage: Ethereum's shift to the Proof of Stake system has significantly reduced its energy usage, making it more sustainable than Bitcoin's Proof of Work mechanism and potentially attracting long-term demand from environmentally conscious investors.
Long-Term Ethereum ETF Inflows to Gain on Bitcoin: Dependent on staking approval and distinct attributes versus Bitcoin, Ethereum ETFs may attract $55-65 billion within five years (40-45% of projected Bitcoin inflows), up from the 30% anticipated for the first six months, due to other features such as staking and green credentials.
Spot Solana ETF Unlikely Near Term: VanEck and 21Shares' U.S. spot Solana ETF applications face unlikely near-term approval. Factors contributing to this include the SEC's history of approving futures ETFs first, concerns over Solana's outages, and the SEC's previous classification of Solana’s token, SOL, as a security. A potential change in U.S. administration and SEC leadership may be required for approval.

SEC’s Seal of Approval: According to regulatory filings and statements from asset managers, U.S. spot Ethereum ETFs are set to begin trading on Tuesday, July 23, 2024, after the SEC approved their final S-1 registration statements. The approval includes eight ETF issuers (see Competitive Ethereum ETF Fees Table below + Grayscale’s Ethereum Mini Trust ETF) paves the way for their debut on various stock exchanges such as the Nasdaq, the New York Stock Exchange, and the Chicago Board Options Exchange. The launch of these Ethereum ETFs marks a major step for mainstream adoption of Ethereum and digital assets. The accelerated approval shows a softening regulatory stance in the U.S. and more bipartisan support.

Tagus Capital expects Ethereum ETFs to generate up to USD4.5 billion in total net inflows in the first six months, around 30% of the equivalent period for Bitcoin ETFs net inflows. Investor rotation from Grayscale's high-fee Ethereum Trust-ETF conversion to cheaper Ethereum ETF managers is anticipated - albeit, similar to the Bitcoin precedent. For Ethereum to exceed net ETF inflow projections beyond six-months, it must be recognised as a tech based asset through the wider adoption of Ethereum-powered initiatives like stablecoins and tokenisation products. This functionality of Ethereum might attract investors who favour tech stocks but are less likely to invest in monetary assets like gold. Currently, Ethereum is undervalued compared to Bitcoin based on ratio analysis. Robust ETF inflows could trigger a rebound. Ethereum ETFs are set to attract a wider investor base due to Ethereum's unique use cases as a decentralised computing platform and smart contracts as well as strong green credentials.

Projected Net flows: The demand for Ethereum ETFs is initially unlikely to match Bitcoin ETFs' initial success in terms of net inflows. Tagus Capital anticipates up to USD 4.5 billion in total inflows during the first six months for all the Ethereum ETFs, equating to a pro rata of approximately USD750 million per month (Tagus Bytes, May 24, 2024). This figure represents around 30% of the comparable period of $14.5 billion net inflows over six months since the launch of U.S. spot Bitcoin ETFs on January 11, 2024. The proportional relationship between Ethereum and Bitcoin's market capitalisation, currently around 32%, also aligns with these projections.

Projected Ethereum ETF Flows Proportional to Bitcoin ETF Flow

Source: Tagus Capital. Note: Six months: Total net flow.

Grayscale, managing $9.2bn in assets (as of July 22, 2024) for its Ethereum Trust (ETHE), has successfully converted it into a spot Ethereum ETF, similar to its Bitcoin Investment Trust (GBTC). Grayscale's 2.5% management fee for ETHE, is significantly undercut by new Ethereum ETF managers (see below), leading to investor rotation and not new inflows. This follows the precedent of Grayscale's Bitcoin Trust conversion into a spot Bitcoin ETF, which retained its high 1.5% fee and saw significant net outflows during the first six months. Grayscale's Ethereum Mini Trust ETF (ETH) which will be a spinout of 10% of ETHE's assets, may reduce some of the potential outflows given that the fees are at 0.15% (0% for the first 6 months applicable up to $2bn assets under management: AUM), the lowest amongst Ethereum ETF issuers. Grayscale Ethereum Trust has already moved approximately $1.1 billion worth of ETH to Coinbase Institutional on July 22, 2024 likely to relocate to the mini ETF in line with a seed target of 10% AUM of its existing Ethereum Trust (ETHE).

ETHE recently shifted from a discount to a premium in anticipation of the U.S. spot Ethereum ETF launch, reaching a 0.31% premium to net asset value (NAV), compared to a 25% discount a few months ago. After trading at a discount for three years, the removal of the NAV discount upon conversion gives trust investors multiple options. They may transfer capital into the new Grayscale Ethereum ETF, take profits, or rotate into other spot Ethereum ETFs with lower fees. Significant outflows have been observed with Grayscale's U.S. spot Bitcoin ETF (GBTC), as the higher 1.5% fee led to substantial net outflows from the original Bitcoin Trust, totaling $18.7 billion since the trust conversion. However, this was more than offset by $17.6bn in net inflows for ‘all’ Bitcoin ETFs (i.e., including GBTC outflows), led by Blackrock and Fidelity, which offer more competitive fees. Proportionally, a similar precedent is likely for Grayscales Ethereum Trust and the new Ethereum ETFs, albeit reduced by the competitive Grayscale’s mini Ethereum ETF. Tagus Capital’s projections of up to USD4.5billion total net inflows in the first six months accounts for this, i.e., potential outflows from Grayscale’s converted Ethereum ETF more than compensated by net inflows by the other new ETFs.

Grayscale's Ethereum Trust NAV Discount/Premium

Source: Grayscale, YCharts.

Ethereum Undervalued - SEC Approval May Trigger Rebound: Ethereum experienced extreme pessimism as recently as May 20, 2024, with a three-year low price ratio versus Bitcoin and minimal market expectations at that time for ETF approval, as noted in Tagus Bytes (May 21, 2024). However, the swift two-stage SEC approval of Ethereum ETFs via 19b-4 forms on May 23, 2024, and S-1 forms on July 22, 2024, indicates a potential rebound against Bitcoin as trading is about to begin on July 23, 2024. Ethereum remains undervalued compared to Bitcoin, and strong ETF inflows could trigger a rebound. If the ETH/BTC ratio returns to its three-year median, it could potentially increase by approximately 20% relative to Bitcoin’s price.

Ethereum Undervalued vs Bitcoin

Source: TagusCapital, YahooFinance.

Moreover, Ethereum’s price may be more sensitive to ETF inflows compared to Bitcoin, as a considerable percentage of ETH's total supply is locked in staking, bridges, and smart contracts, with a smaller amount available on centralised exchanges. Currently just below 28% of Ethereum’s overall supply is now being staked which has been progressively rising since the Merge when in September 2022 it was just 11.65%.

Ethereum Staked as % of Total Supply

Source: TheBlock.

Digital Gold vs Digital Oil: Bitcoin and Ethereum can be compared to digital asset equivalents of gold and oil (or even renewable energy post the Merge), respectively, in terms of their uniqueness. While Bitcoin operates as a digital asset, Ethereum has a dual role as both a digital asset and a technological base for creating new applications. This dual functionality may attract conventional financial investors who typically favour tech stocks and have holdings in rapidly expanding tech firms, but are less likely to invest in monetary assets like gold. In order for Ethereum to surpass medium-term net ETF inflow projections, it must gain recognition as a tech asset, a development that hinges on the wider adoption of Ethereum-powered initiatives such as stablecoin and tokenisation products.

Ethereum vs Bitcoin Comparisons and Distinctions

Source: Tagus Capital, Ultrasound.money, (Ammous, 2018).

Ethereum ETFs Gain Sustainability Edge: Ethereum and Bitcoin exhibit notable differences in sustainability, particularly following Ethereum's "Merge" in September 2022. This shift may influence ETF demand from traditional finance portfolios that prioritise responsible investing. Prior to Ethereum’s Merge, both cryptocurrencies relied on the energy-intensive Proof of Work mechanism. Bitcoin continues to use this method, consuming approximately 130 TWh per year and leaving a substantial carbon footprint. However, the Merge transitioned Ethereum to the more efficient Proof of Stake system, resulting in a 99.95% reduction in energy usage to around 0.01 TWh annually. This significant change has minimised Ethereum's environmental impact, eliminated the requirement for specialised hardware, and enhanced scalability. While Bitcoin aims to improve sustainability through the use of renewable energy for mining,Ethereum's post-Merge structure inherently encourages efficiency and reduced resource consumption, positioning it as the more eco-friendly alternative and may be reflected in Ethereum ETF demand in the long-term.

Estimated Ethereum Energy Consumption

Source: Digiconomist, Tagus Capital.

Long-Term Ethereum ETF Inflows Poised to Gain Ground on Bitcoin Proportionally:The potential long-term net inflows into spot U.S. Ethereum ETFs depend on several factors, such as the possibility of staking approval and greater adoption due to Ethereum's distinct attributes compared to Bitcoin. Tagus Capital forecasts USD 4.5 billion in net inflows over the next six months, which is around 30% of Bitcoin's supply during the same period and comparable to their relative market cap sizes. However, this gap may eventually narrow.

In the first 18 months, Tagus Capital expects USD 15-18 billion in net flows into Ethereum ETFs, a projection that could be exceeded if staking is approved. Previously, Tagus Capital predicted long-term Bitcoin flows (i.e., circa 5 years) to reach up to USD 140 billion, with USD 17.5 billion already materialising in just over seven months (Tagus Bits ‘n Bobs Issue 1: Spot Bitcoin ETF, Jan. 3, 2024). While Bitcoin is likely to maintain its lead in terms of total inflows, Ethereum's unique features, such as staking and green credentials, may increase the proportion of net inflows into Ethereum ETFs. Consequently, Ethereum ETFs could attract around USD 55-65 billion in net inflows over the next five years, accounting for around 40% to 45% of the estimated Bitcoin net inflows, up from the 30% projected for the next six months.

Solana ETF?: Both investment firms VanEck's and 21Shares towards the end of June filed for U.S. Solana ETF applications but are unlikely to be approved any time soon. The SEC has a history of approving ETFs investing in futures before spot ETFs for cryptocurrencies. For instance, Bitcoin futures ETFs were trading on the market since 2021, before the SEC cleared spot U.S. Bitcoin ETFs in January this year. Similarly, Ethereum futures ETFs were launched in October last year, and the SEC approved spot Ethereum ETFs in May. There is economic significance in issuing ETFs based on various digital assets beyond just Bitcoin and Ethereum, further emphasising the growing interest in the crypto market. Solana's native token, SOL, offers decentralisation, utility, and economic feasibility, positioning it as a potentially valuable digital commodity and alternative to traditional investment options for investors, builders, and entrepreneurs. Its unique features and growing ecosystem, and low fees, make it an attractive choice for those seeking innovative opportunities in the digital asset space. Asset manager 3iQ just ahead of VanEck and 21Shares already filed for a spot Solana ETF in Canada, which marked a North American first. There are also over $1 billion worth of Solana exchange-traded products already offered worldwide.

However, the SEC has not yet approved any ETFs investing in Solana futures, and the agency may have concerns over liquidity and the blockchain's history of outages. For approval, SOL would need to be deemed by the SEC as a commodity similar to the characteristics of Bitcoin and Ethereum. Notably, the SEC has said that SOL is a security in a past enforcement action against the Binance in 2023. A U.S. Solana ETF may therefore only be possible with a change in U.S. administration and SEC leadership. Gary Gensler's term as SEC chairman is set to end in 2026, but he may resign in accordance with long-standing SEC tradition if Donald Trump wins the 2024 US Presidential election and there is a change in political party control. Staking is a vital component for Solana’s token and arguably even more so than Ethereum, as the former has a higher current inflation rate of +5.1% (vs 0.34% for Etherum) and a significant proportion of its total supply, 66% (vs 28% for Ethereum), is currently staked. So integral to approval of a U.S. spot Solana TF is also approval of staking which is only likely with a change of guard at the SEC.

Total Solana Staked as % of Total Supply