The Blog

Node Ahead 69: How popular will the Ethereum ETF be?

By Brett Munster

Welcome back to The Node Ahead, a cryptocurrency and digital asset resource for financial advisors. Every other week, we discuss the latest crypto news and the potential impacts it may have on you and your clients.

In this edition, we’ll be covering:

  • The upcoming Ethereum ETF
  • Corporations, bitcoin, and balance sheets

How big will the Ethereum ETF be?

In May of this year, we chronicled the circumstances that led to the surprise approval of the Ethereum ETFs. We discussed the two-step process for ETF applications: the 19b-4 form, which allows the asset to trade on exchanges, and the S-1 form, which covers the financial and risk disclosures for each issuer. Due to a last-minute change of heart by the SEC, the agency only had time to approve the 19b-4 form by the May 23rd deadline. Since then, the SEC has been working on the S-1 applications from each of the prospective Ethereum ETF issuers. In a Senate Banking hearing last week, SEC Chairman Gary Gensler indicated that he expects the S-1s to be approved and spot Ether ETFs to begin trading by this summer. Some analysts believe this could happen as early as July 2nd.

Similar to the bitcoin ETFs, the introduction of Ethereum ETFs represents a monumental shift in the accessibility of ETH for traditional financial players. Historically, investing in Ethereum required navigating the complexities of crypto exchanges, digital wallets, and the associated security and regulatory risks. This complexity posed a significant barrier to entry for institutional investors and those accustomed to traditional financial instruments.

An Ethereum ETF mitigates many of these risks and simplifies the investment process by allowing investors to buy and sell shares of the ETF through their existing brokerage accounts, just as they would with stocks or bonds. This seamless integration into traditional financial infrastructure lowers the entry barrier, making ETH accessible to a broader audience, including institutional investors, mutual funds, Registered Investment Advisors (RIAs), and individual investors who may have been hesitant to engage with cryptoassets directly. Moreover, the SEC’s approval legitimizes ETH as an investable asset and alleviates any regulatory concerns. The launching of the ETF is likely to attract significant capital from traditional finance into the Ethereum ecosystem, similar to the impact seen with bitcoin ETFs.

The key question is how popular the Ethereum ETF will be and what impact could that have on ETH’s price? While it is challenging to estimate the exact amount of capital that might flow into the Ethereum ETF post-approval, several indicators suggest it could be substantial.

Using bitcoin ETFs as a benchmark is a useful place to start. The bitcoin ETFs were the largest ETF launch in history by a wide margin, shattering every ETF record imaginable. Given BTC is the largest cryptoasset and the pent-up demand after a decade of waiting for approval, it’s likely the bitcoin ETF launch set a standard no other ETF will ever live up to. But just because Ethereum is unlikely to match bitcoin’s ETF launch in terms of capital inflow, that doesn’t mean it won’t still be wildly successful.

Ethereum, the second-largest crypto network, boasts a robust ecosystem of decentralized applications (dApps), decentralized finance (DeFi) platforms, and non-fungible tokens (NFTs), with a market cap roughly one-third that of bitcoin. In the first month of trading, bitcoin ETFs (excluding Grayscale) saw nearly $12 billion in cumulative growth, which grew to about $40 billion over five months. If Ethereum were to attract one-third of that capital, it could see $4 billion in net inflows in the first month and over $13 billion in five months—which by any reasonable measure would be considered an enormous success.

However, expectations should be tempered for a couple of reasons. First, the last-minute approval means issuers have less time to line up investors prior to launch. Unlike bitcoin ETF issuers, who had several months to prepare and attract investors, Ethereum ETF issuers may have as little as half that time, limiting their ability to do the same groundwork.

Second, the upcoming Ethereum ETFs will exclude staking. Staking involves locking up ETH to support the network and earning additional ETH in return, with current annual percentage yields (APYs) of around 2-5%. This has become a popular way to earn passive income for many Ethereum holders. By not including staking, the ETF misses out on this additional yield, potentially limiting its appeal to some investors especially those looking for yield-generating opportunities.

However, this exclusion could benefit existing Ethereum stakers.  Nearly 33 million ETH, accounting for 27% of the total supply, is staked on the Ethereum network. Staking rewards fluctuate depending on the usage of Ethereum and the number of stakers. The less stakers there are, the more often any one staker is chosen to validate blocks thus driving up the expected APY. Therefore, the exclusion of ETFs from staking could be beneficial for existing stakers, as at the very least, it prevents the dilution of staking returns and at best, possibly lead to an increase in the staking returns over time should the ETF grow to hold a significant percentage of the overall supply of ETH.

Given that holding Ethereum in an ETF is less financially rewarding than holding and staking ETH directly, a more conservative estimate might be that the Ethereum ETF attracts 10% – 20% of the capital that flowed into bitcoin ETFs. This would still result in billions of dollars in assets under management (AUM) by the end of the year.

The inflow of capital from an Ethereum ETF should exert significant upward pressure on ETH’s price over time, especially given the decreasing circulating supply since Ethereum switched to proof of stake. Unlike bitcoin, which has a consistent, predictable supply issuance, ETH’s annual issuance is flexible based on varying block rewards. Additionally, Ethereum has a burning mechanism that destroys a portion of transaction fees. When usage of Ethereum is high enough, more ETH is destroyed per day than created, thereby reducing the overall supply. This dynamic has been observed since Ethereum’s transition to proof of stake in September 2022.

Source: Glassnode

While the Ethereum ETF paves the way for increased institutional adoption of Ethereum, it is unlikely that any other digital asset will receive ETF approval in the near future. Bitcoin and Ethereum are unique in their market dominance, liquidity, and regulatory acceptance. Together, they represent the lion’s share of the crypto market and have established themselves as blue-chip assets within the digital asset space. Other cryptoassets, while innovative, lack the same level of market acceptance, liquidity, and stability, making them less likely to receive approval for an ETF.

Yet, the main reason we are unlikely to see another cryptoasset ETF is the market structure dynamics that enabled both the bitcoin and Ethereum ETF approvals, do not exist for other digital assets. Both BTC and ETH have robust, regulated futures markets that are highly correlated with their spot prices. The SEC has approved futures-based bitcoin and Ethereum ETFs but not for any other crypto asset. Grayscale’s win in their lawsuit meant that the SEC could not deny a bitcoin or Ethereum ETF based on fears of market manipulation because data from the futures market was available. However, since there are no regulated futures markets in the U.S. for other cryptoassets, the SEC can deny other ETF applications based on manipulation concerns, as it did with bitcoin for over a decade. Until there is a change of leadership at the SEC or another cryptoasset sees significant trading volumes and liquidity on a U.S.-based futures exchange, ETF approval is highly unlikely.

The unique position of Ethereum and bitcoin, coupled with regulatory caution and market dynamics, suggests we are unlikely to see another crypto asset ETF for quite some time. BTC and ETH ETFs might compete for capital inflows, but they will not have to compete with other crypto networks. Traditional finance’s focus will remain on these two established cryptoassets, giving them a competitive advantage.

Many investors will likely allocate capital to both bitcoin and Ethereum ETFs to diversify their exposure to the crypto industry. Professional investors typically do not hold only one stock or bond, so it makes sense to hold more than one cryptoasset. Ethereum’s value proposition differs from bitcoin’s, so investors will likely see merit in holding both. The allocations may vary (e.g., 50/50, 70/30, or 80/20), but regardless of the split, ETH is likely to see significant capital inflows. This, combined with a decreasing supply, is expected to drive ETH’s price higher over the long term.

While the Ethereum ETF is set to attract significant capital from institutional and individual investors alike, expecting the same level of inflows as the bitcoin ETFs experienced is unrealistic. However, if the Ethereum ETFs attract 10-20% of what the bitcoin ETFs did, it would still be a wildly successful outcome, outpacing all other traditional ETFs by a significant margin and likely leading to substantial price appreciation in ETH over time.

Corporations continue to add bitcoin to their balance sheets

Since 2021, I have argued that by the end of this decade, holding bitcoin on a balance sheet will be considered best practice. As a result, I believe that in time bitcoin will be held by most, if not all, public companies as a treasury reserve asset. In September of last year, the Financial Accounting Standards Board (FASB) changed the accounting rules to allow companies to recognize gains in the value of their cryptoasset holdings, eliminating one of the largest impediments to corporate adoption of bitcoin. Due to this rule change and the success of MicroStrategy, our “Bull Case for Bitcoin”, published at the beginning of the year, predicted that more companies would start buying bitcoin to hold on their balance sheets in 2024. That prediction appears to be coming to fruition.

MicroStrategy was the first, and by far the most aggressive, at implementing this strategy. The company announced its first bitcoin purchase back in August 2020. Since then, MicroStrategy has been using excess cash, stock issuance, and debt instruments to aggressively acquire more bitcoin. The company has purchased a total of 214,400 bitcoin at an average price of $35,158, bolstering its balance sheet by over $6 billion due to the increase in bitcoin’s price. Since that initial purchase, the stock is up 1,081%, more than any other company over that time frame not named Nvidia.

However, MicroStrategy wasn’t the only company to add bitcoin to their balance sheet. Both Tesla and Block also saw significant stock price increases shortly after announcing they had added bitcoin to their treasury in 2021. Excluding bitcoin mining companies, these three were the only public companies to buy and hold bitcoin on their balance sheets for several years. The primary reason why more companies didn’t adopt bitcoin in the following years was the accounting rules, which stipulated that companies could not recognize any gains in value but had to recognize all losses. That rule changed at the start of this year, allowing companies to recognize gains in their cryptoasset holdings.

With that rule change, it appears that the floodgates are beginning to open. In May, Semler Scientific, a company focused on developing advanced medical diagnostic products, announced a $40 million bitcoin purchase, which drove its stock price up 25%. In June, the company continued to add more Bitcoin to its treasury with a $17 million purchase and announced it was raising $150 million to buy more. For Semler Scientific, holding bitcoin serves as a risk management tool. The company operates in a highly regulated and competitive industry, where market conditions can be unpredictable. Bitcoin offers a form of financial stability and potential appreciation, providing a buffer against industry-specific risks as well as monetary debasement.

In April, Japanese investment firm Metplanet announced it was adopting bitcoin as its primary treasury asset to hedge against the sustained economic pressures in Japan, notably high government debt levels, prolonged periods of negative real interest rates, and a weak yen. The company bought more bitcoin in June and immediately saw its stock jump by 10%.

In June, DeFi Technologies, a publicly listed exchange-traded product (ETP) provider, announced its decision to adopt bitcoin as the company’s primary treasury reserve asset. Following the announcement, the price of DeFi Technologies’ shares rose 35% on Canadian stock exchanges.

In every instance of a company announcing the move to add bitcoin to their balance sheet, their stock increased in value shortly thereafter. As other companies see the benefits bitcoin has on their stock price and balance sheets, more will adopt a similar strategy. Not to mention that according to a recent report released by Coinbase, 56% of Fortune 500 companies are currently working on blockchain projects. It’s not much of a leap to go from building blockchain based services to holding cryptoassets on the balance sheet.

This doesn’t mean every company will move 100% of their cash into bitcoin, but the total amount of cash and cash equivalents sitting on the balance sheets of all S&P 500 companies is roughly $2.6 trillion. The largest portion of that capital is owned by tech companies, which issue little to no dividends and are the most likely of all large corporations to adopt bitcoin in the first place. Even if a small percentage of this capital begins to find its way into bitcoin, it could drive the price of bitcoin significantly higher.

Now that the accounting impediment is gone, it would be irresponsible for any CEO or CFO of a publicly listed company not to at least consider adding bitcoin to their corporate treasury, given the positive impact it has had on numerous other companies’ financials, stock prices, and media coverage. Corporations are increasingly recognizing bitcoin’s potential not just as an investment, but as a strategic treasury reserve asset to hedge against inflation, a way to diversify their portfolios, and drive innovation. As more and more companies incorporate bitcoin into their financial strategies, it gains further legitimacy as a mainstream financial asset.

In Other News

How crypto could stave off a US debt crisis.

David Hirsch, the chief of the crypto asset unit in the enforcement division of the SEC quit his job.

Bitcoin mining stabilizes power grids strained by AI data centers.The SEC ends its investigation into Consensys and won’t sue over Ethereum.

Disclaimer:  This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital.