The listing of the Ethereum spot ETF in the United States has greater long-term significance than short-term impact

Author: SoSoValue Research

On July 23, 2024, the U.S. Ethereum spot ETF officially began trading, marking exactly the 10th anniversary of Ethereum's first public offering (ICO) on July 22, 2014. Whether the listing date of the Ethereum ETF was intentionally chosen to coincide with this significant milestone or is merely a coincidence, this event will have epic significance for the sustainable development of the entire crypto world in the future. It marks an important step for POS public chains entering the mainstream financial world, which will undoubtedly attract more dimensions and numbers of builders to join the construction of the Ethereum ecosystem, and it also paves the way for subsequent infrastructures in the crypto world, such as Solana, to enter the mainstream world, having substantial significance for the popularization of the blockchain ecosystem.

On the other hand, since the Ethereum ETF is currently not allowed to stake from a regulatory perspective, investors holding the ETF will receive 3%-5% less staking mining yield (the risk-free rate of return in the Ethereum world) compared to directly holding Ethereum tokens, and the understanding threshold for the general public regarding Ethereum is relatively higher than that for Bitcoin. Therefore, the short-term impact of the U.S. Ethereum spot ETF on the price of Ethereum may be less significant than the short-term impact on BTC price after the approval of the Bitcoin spot ETF, primarily enhancing the relative stability of Ethereum's price and reducing volatility.

The following text will analyze the impact of the Ethereum spot ETF listing on the buying and selling power of Ethereum tokens in the short term, as well as its long-term effects on the crypto ecosystem.

I. Short-term: The buying and selling power is less than that of the Bitcoin ETF, and the impact of the Ethereum ETF is expected to be smaller than that of Bitcoin.

According to SoSoValue's continuous tracking of the Bitcoin spot ETF, the most significant factor affecting the price is daily net inflow, which refers to the actual new buying/selling scale brought to the crypto world by cash subscriptions/redemptions of the Bitcoin spot ETF (see Figure 1), thus affecting supply and demand and determining price. According to the S-1 filing, the U.S. Ethereum spot ETF has the same subscription and redemption mechanism as the Bitcoin spot ETF, both supporting only cash subscriptions, so daily net inflow will also be the most important observation indicator for the Ethereum spot ETF; the main differences are twofold:

• Selling pressure: Due to the more than 10 times management fee difference with Grayscale's Ethereum Trust (stock code: ETHE), the moving effect selling pressure is still present; and after experiencing the outflow of Grayscale's GBTC causing a mispricing of Bitcoin, the market is also prepared for the outflow of Grayscale's ETHE. However, unlike the Bitcoin ETF, Grayscale's Ethereum Trust has separately split 10% of its net assets to establish a low-fee Grayscale Ethereum Mini Trust (stock code: ETH) during the conversion to ETF, which may slightly reduce selling pressure.
• Buying pressure: Since the Ethereum ETF is not allowed to stake from a regulatory perspective, holding the Ethereum ETF will yield 3%-5% less staking mining income (the risk-free rate of return in the Ethereum world) compared to directly holding Ethereum tokens; at the same time, the general public's understanding of Ethereum is lower than that of Bitcoin, so if they are optimistic about cryptocurrencies, they will still prefer to allocate to the Bitcoin ETF, which has a clear scarcity and a total supply of only 21 million.

Figure 1: Breakdown of the impact of net outflow in the early stage of the Ethereum spot ETF listing on Bitcoin prices (Source: SoSoValue)

1. Selling pressure: The $9.2 billion Grayscale ETHE, with a management fee difference of over 10 times compared to competitors, will still bring early moving selling pressure, but it will be less than the impact of GBTC outflows.

Looking back at the significant net outflow caused by Grayscale's Bitcoin ETF (GBTC) in the early stages, there are two main reasons: on one hand, the significantly higher management fee compared to competitors led to a moving effect, where investors redeemed from the Grayscale Bitcoin ETF with a 1.5% management fee and bought other ETFs with around a 0.2% management fee; on the other hand, the early arbitrage of the trust's discount led to selling after the ETF price normalized. At the beginning of the year, the ETF (with GBTC's asset management scale of $28.4 billion) experienced continuous large-scale net outflows upon listing. The core reasons are mainly twofold: first, the management fee rate of Grayscale's GBTC is 1.5%, about six times that of competitors, causing long-term bullish investors in Bitcoin assets to shift to other ETFs; second, before the conversion to ETF, GBTC's discount had long remained around 20%, stimulating investors to buy discounted GBTC and short BTC over-the-counter to arbitrage the discount rate. After the trust's conversion to ETF, when the discount basically disappeared, this type of arbitrage capital sold the ETF to take profits. According to SoSoValue data, GBTC's net outflow continued from January 11 to May 2, then slowed down, during which its Bitcoin holdings decreased by 53%.

Figure 2: Net outflow situation since GBTC listing (Source: SoSoValue)

Unlike the direct conversion of GBTC, Grayscale's current conversion of the Ethereum Trust to ETF involves simultaneously splitting 10% of net assets to establish a low-fee Ethereum Mini ETF (stock code: ETH), meaning Grayscale will have two Ethereum ETFs with management fees of 2.5% and 0.15%, slightly alleviating the outflow pressure caused by high fees. According to the S-1 filing, Grayscale's Ethereum Trust (stock code: ETHE) will transfer about 10% of Ethereum to the Grayscale Ethereum Mini Trust (stock code: ETH) as initial funding for the mini trust; thereafter, the two Grayscale Ethereum ETFs will operate independently. For investors already holding ETHE, on July 23, each share of the Ethereum Trust ETHE they hold will automatically receive 1 share of the Ethereum Mini Trust ETH, while the net asset value of ETHE will be adjusted to 90% of its previous value. Considering ETHE's management fee rate is 2.5% and the mini trust ETH's management fee rate is 0.15% (with no management fee for the first $2 billion in the first six months), this means that for existing ETHE investors, 10% of their assets will automatically be allocated to the low-fee ETF. Referring to the final capital moving ratio of GBTC being around 50%, it is expected that the launch of the Ethereum Mini Trust ETH and the early bird management fee discount will alleviate the short-term outflow pressure of Grayscale ETHE.

On the other hand, because ETHE's discount has converged in advance, the outflow pressure from the closing of discount arbitrage is also expected to be less than that of GBTC. Grayscale ETHE once had a significant discount, reaching as high as 60% at the end of 2022, and in April-May 2024, the discount exceeded 20% at one point, but from the end of May, the discount converged to 1%-2%, and by July, it converged to below 1%; while GBTC maintained a discount rate of 6.5% just two days before its conversion to ETF (January 9). Therefore, for arbitrage capital, the motivation to take profits from ETHE has significantly decreased.

Figure 3: Comparison of Ethereum spot ETF fee rates (Source: S-1 filing)

Figure 4: Historical discount of Grayscale Ethereum Trust ETHE (Source: Bloomberg)

2. Buying pressure from the stock market: Public consensus on Ethereum is far less than that on Bitcoin, and the asset allocation motivation is less than that of the BTC spot ETF.

For the general public investors, the logic of Bitcoin is simple and easy to understand, and consensus has been reached: the gold of the digital world, with clear scarcity and a total of 21 million coins, fits very well into their existing investment framework; whereas Ethereum, as the largest foundational public chain, has a relatively complex mining mechanism and is influenced by various ecological forces. Most importantly, the supply quantity of Ethereum as an investment target involves constant inflation and deflation, with a dynamically complex calculation process, making the cognitive threshold relatively high, making it difficult for ordinary investors to understand intuitively. Simply put, on one hand, from the supply perspective, Ethereum's supply is theoretically unlimited; under the latest POS mechanism, the staking rewards from block rewards drive its supply to increase, while the user transaction gas fee burning driven by the activity of the on-chain ecosystem reduces its supply, thus forming a dynamic supply-demand balance mechanism; the latest supply is about 120 million coins, with a recent annual inflation rate of 0.6%-0.8%. On the other hand, from a conventional fundamental perspective, as a public chain, it faces competition from other public chains, and the general public investors do not have faith in the competitive outcome. Currently, there are public chain ecosystems such as Solana and Ton that are known to the general public, but analyzing their competitiveness poses a high threshold for ordinary investors. Therefore, if ordinary investors are optimistic about the investment value of cryptocurrencies, they may still prefer to allocate to the Bitcoin spot ETF, which has a scarce supply and no competition.

Public data also shows a significant difference in interest between the Ethereum ETF and the Bitcoin ETF. Comparing the Google search interest that represents public attention, Ethereum is only about 1/5 of Bitcoin's (see Figure 5); and observing the seed funding for the issuance of this Ethereum ETF (usually funded by the fund manager/underwriter), Fidelity's seed funding for its Ethereum ETF (stock code: FETH) is only 1/4 of that for its Bitcoin ETF (stock code: FBTC), with other issuers like VanEck and Invesco showing similarly large gaps (see Figure 6).

Figure 5: Comparison of Google search interest for Bitcoin and Ethereum (Source: Google Trend)

Figure 6: Comparison of seed funding scale for Ethereum ETF and Bitcoin ETF under the same issuer (Source: S-1 filing)

3. Buying pressure from within the crypto circle: Due to the lack of a 3%-5% basic staking yield on the ETH chain, demand is virtually nonexistent.

Crypto investors have also contributed to some buying pressure for the Bitcoin spot ETF, mainly due to the demand for proof of real-world assets. Crypto investors holding Bitcoin ETFs only need to pay an annual fee of 0.2%-0.25% to have proof of assets in the traditional financial market, facilitating their economic life in the public world, balancing financial assets and Bitcoin holdings, and enabling various leveraged operations, such as borrowing and lending, and constructing structured products, which is attractive to some high-net-worth crypto investors. Since Bitcoin uses a POW mining mechanism and does not have stable POS asset staking yields, considering the average deposit and withdrawal costs of cryptocurrencies and fiat currencies are around 0.2%-2%, the yield difference between holding Bitcoin ETFs and directly holding Bitcoin is not significant.

However, for the Ethereum spot ETF, since regulations do not allow the ETF to earn staking yields, for crypto investors, holding the ETF will yield 3%-5% less risk-free annual returns compared to directly holding Ethereum. Ethereum adopts a PoS (Proof of Stake) mechanism, where validator nodes stake Ethereum assets to verify transactions and maintain the network, earning block rewards, which is known as the POS mining mechanism. Since this yield comes from the network protocol and the system's built-in reward mechanism, it is regarded as the on-chain risk-free base yield of the Ethereum ecosystem. Recently, the staking yield for Ethereum has stabilized above 3%. Therefore, if investors use the ETF to achieve Ethereum position allocation, they will receive at least 3% less annual yield compared to directly holding Ethereum. Thus, the buying pressure from high-net-worth individuals in the crypto circle for the Ethereum spot ETF can be ignored.

Figure 7: Staking yield since Ethereum transitioned to the PoS mechanism (Source: The Staking Explorer)

II. Long-term: The Ethereum ETF paves the way for other crypto assets to integrate into the mainstream world.

As the largest public chain by scale, the approval of the Ethereum spot ETF is an important step for public chains to integrate into the mainstream financial world. Reviewing the SEC's standards for approving cryptocurrency ETFs, Ethereum meets the SEC's requirements in terms of anti-manipulation, liquidity, and pricing transparency, and we can expect more compliant crypto assets to gradually enter the public investors' view through spot ETFs in the future.

• Anti-manipulation: On one hand, the on-chain nodes are sufficiently decentralized, and the ETF assets do not allow staking. Ethereum has over 4,000 nodes, preventing any single node from controlling the overall network; additionally, the Ethereum spot ETF does not allow staking, preventing excessive control of the network by a few entities due to the staking mechanism. On the other hand, in the financial market, Ethereum's basic trading infrastructure is relatively mature, especially with its rich futures products on the Chicago Mercantile Exchange (CME), providing investors with more hedging options and price predictability, thus reducing the risk of market manipulation.
• Liquidity & Pricing Transparency: With a market capitalization of about $420 billion, Ethereum ranks in the top 20 of U.S. stock market valuations based solely on market cap, with a 24-hour trading volume of $18 billion and listed on nearly 200 exchanges, ensuring sufficient liquidity and fair pricing transparency.

In comparison, the public chain Solana also meets some of the above indicators to a certain extent (see Figure 8), and Vaneck and 21Shares have submitted applications for Solana spot ETFs. With the continuous enrichment of traditional financial market tools such as cryptocurrency futures, we can expect more crypto asset ETFs to be approved in the future, further occupying the minds of traditional investors and accelerating development.

Figure 8: Comparison of core data for representative Layer 1 public chains (Source: Public data compilation)

In summary, since the buying and selling power of the Ethereum spot ETF is weaker than that of the Bitcoin ETF, and considering the market's preparation for the outflow of Grayscale ETHE after experiencing the mispricing of Bitcoin caused by GBTC outflows, combined with the fact that it has been six months since the Bitcoin spot ETF was listed, the positive news of the Ethereum spot ETF approval has largely been reflected in the current Ethereum price through repeated market trading. It is expected that the short-term impact on Ethereum's price will be less than the previous impact of the Bitcoin spot ETF listing on Bitcoin, and Ethereum's volatility may also be smaller. If there is a mispricing again due to Grayscale outflows in the early listing stage, it will present a good opportunity for positioning. Investors can follow the U.S. Ethereum spot ETF dashboard launched by SoSoValue (https://sosovalue.com/assets/etf/us-eth-spot) for updates.

In the long term, the crypto ecosystem and the mainstream world are moving from separate developments to integration, which will involve a considerable cognitive adjustment process. The differences in understanding between new and old participants in the crypto ecosystem may be the core factor influencing cryptocurrency price fluctuations and creating investment opportunities in the next 1-2 years. Historically, the process of emerging assets integrating into the mainstream world has always involved divergences leading to trades, with significant volatility continuously creating investment opportunities, which is very much worth looking forward to.

The approval of the Ethereum ETF further opens the door for crypto ecosystem applications to enter mainstream asset allocation, and it can be anticipated that other public chains with a large user base and ecosystem, such as Solana, will gradually integrate into the mainstream world. As the crypto world enters the mainstream world, another aspect of the times, namely the process of the mainstream world entering the crypto world, is also quietly continuing to develop, with mainstream financial assets, primarily U.S. Treasury bonds, being tokenized in the form of RWA (Real World Assets) and gradually entering the crypto world, achieving efficient circulation of global financial assets.

If the approval of the Bitcoin ETF has opened the door to a new world of integration between crypto and traditional finance, then the approval of the Ethereum ETF is the first step through that door.