Key Takeaways

• The Bitcoin ETFs received $15.1bn in net inflows between launch (Jan. 11, 2024) and June 15, 2024.

• Nine issuers are vying to launch 10 Ethereum spot ETFs in the United States.

• After approving all 19b-4 filings on May 23, the SEC is expected to allow the vehicles to go effective for trading in July 2024.

• As with the Bitcoin ETFs, we view the primary net new accessible market to be independent investment advisors, or those affiliated with banks or broker/dealers.

• We expect the net inflows into ETH ETFs to be 20-50% of the net flows into BTC ETFs over the first 5 months, with 30% as our target, implying $1bn/month of net inflows.

• In general, we believe ETHUSD is more price sensitive to ETF inflows than BTC due to significant portions of ETH total supply locked in staking, bridges and smart contracts, and a lower amount on centralized exchanges.

Introduction

For months, observers and analysts had downplayed the likelihood that the Securities & Exchange Commission (SEC) would approve spot-based Ethereum exchange traded products (ETPs). The pessimism derived from the SEC’s reluctance to definitively state that Ether is a commodity, reports of no engagement between the SEC and prospective issuers, and news of investigations and pending enforcement actions by the SEC relating to the Ethereum ecosystem. Bloomberg analysts Eric Balchunas and James Seyffart had pegged the likelihood of approval in May (when several of the first final approve/deny deadline of the prospective issuers was to occur) at 25%. However, on Monday May 20, the Bloomberg analysts abruptly increased the odds of approval to 75% after reports that securities exchanges had been contacted by the SEC. Indeed, all applications for spot Ether ETPs were approved by the SEC later that week. While we await the actual launch of these vehicles following the effectiveness of S-1 filings – which we expect to occur sometime in Summer 2024 – in this report take cues from the performance of the Bitcoin spot ETPs to make predictions about the demand that Ethereum ETPs will draw once they launch. We estimate that spot Ethereum ETPs will see approximately $5 billion in net inflows in the first five months of trading (approximately 30% of bitcoin ETP net flows).

Background

There are currently nine issuers vying to launch ten exchange traded products (ETPs) that hold spot-ETH. In the last several weeks, some issuers have backed out. ARK has chosen not to partner with 21Shares on an Ethereum ETP, while Valkyrie, Hashdex, and WisdomTree have fully withdrawn their applications. The chart below shows the current state of applicants sorted by their 19b-4 filing dates:

Grayscale is seeking to convert the Grayscale Ethereum Trust (ETHE) into an ETP just as the firm did with its Grayscale Bitcoin Investment Trust (GBTC) but has also filed for a “mini” version of the product.

The SEC approved all the 19b-4s – the rule changes allowing securities exchanges to list eventual spot-ETH ETPs – on May 23, but now each individual issuer needs to go back and forth with the regulator over its registration statement. Not until the SEC allows those S-1’s (or S-3 in the case of ETHE) to go effective can the products themselves actually start trading. Based on our research, as well as reporting by Bloomberg Intelligence, we believe the Ethereum spot ETPs could begin trading as soon as the week of July 11, 2024.

Learnings from BTC ETFs

The Bitcoin ETFs have been live for about just under 6 months and can serve as a useful foundation to examine the likely reception of Ethereum spot-ETFs.

Source: Bloomberg

Some observations from the first several months of Bitcoin spot ETP trading are below:

• Inflows have surprised to the upside so far. As of June 15, US Spot Bitcoin ETFs saw over $15bn worth of cumulative net inflows since launch, averaging $136m in net inflows per trading day. The aggregated amount of BTC held by these ETFs was ~870k BTC, amounting to 4.4% of the current supply of BTC. With BTC trading at ~$66k, AUM across all US spot ETFs totaled ~$58bn (note: ~619k BTC was held by GBTC prior to ETFs launching).

• ETF inflows have been partially responsible for BTC’s price appreciation. Regressing 1-week changes in BTC 5price and 1-week net ETF flows, we calculate an r-sq of 0.55, suggesting the two variables are highly correlated. Interestingly, we also find that price change is a better leading indicator for flows rather than vice versa.

• Unwinding of GBTC trade has been an overhang on overall ETF flows. Since converting the trust to an ETF, GBTC has experienced significant outflows in the first few months. Daily GBTC outflows peaked mid-March with $642m worth of outflows on 3/18/24. Outflows have since moderated, and GBTC has even seen few days of positive net inflows starting in May (78 days of outflows before seeing first day of net inflows on May 3). As of June 15, the balance of BTC held in GBTC has fallen since ETFs were launched, down from 619k to 278k BTC (-55%).

• ETF demand has been mostly retail-driven; institutional demand picking up. 13F filings reveal over 900 US investment firms have holdings in bitcoin ETFs as of 3/31/24, representing ~$11bn worth of holdings and accounting for ~20% of total bitcoin ETF ownership, suggesting most demand has been driven by retail. The list of institutional buyers includes prominent names across banks (e.g., JP Morgan, Morgan Stanley, Wells Fargo), hedge funds (e.g., Millennium, Point72, Citadel), and even pension funds (e.g., the State of Wisconsin Investment Board).

• Wealth management platforms have yet to ramp up access to bitcoin ETFs. The largest wealth platforms have yet to allow their brokers to recommend bitcoin ETFs, though Morgan Stanley is reportedly exploring enabling its brokers to solicit customer purchases. We wrote in our report Sizing the Market for a Bitcoin ETF that the access ramp for bitcoin ETFs across wealth platforms – including broker-dealers, banks, and RIAs – would likely span several years. The unlock of sales-driven inflows from institutional platform access has been minimal so far, but in our view, it will serve as a significant catalyst for bitcoin adoption in the near-to-medium term.

Estimating Potential ETH ETF Inflows

Using the Bitcoin ETPs as a proxy, we can estimate potential demand for similar Ethereum products.

To estimate potential inflows into an ETH ETF, we apply BTC/ETH multiples to bitcoin US spot ETF inflows based on the relative asset sizes across several markets where both BTC and ETH are traded. As of May 31:

• The market cap of BTC is 2.9x the size of ETH.

• Across all exchanges, futures markets for BTC are approximately 2x larger than ETH based on open interest levels and volume. Specifically for the CME, open interest levels are 8.4x greater for BTC than ETH while daily volume is 4.2x greater for BTC than ETH.

• AUM across various existing funds (split by Grayscale Trusts, and by product (e.g., futures, spot) and select global markets) show BTC funds ranging from ~2.6x – 5.3x larger than ETH funds.

Based on the above, we think that ether spot ETF inflows will be approximately 3x less than US spot bitcoin ETF inflows (in-line with the cap multiple) with a range of 2x to 5x. In other words, we think that ether spot ETF inflows could be 33% the size of US spot bitcoin ETF inflows with a range of 20% to 50% of size in dollars.

Applying this multiple to $15bn of bitcoin spot ETF inflows through June 15 would imply monthly ETH ETF inflows of ~$1.0bn for the first five months following ether ETF approval and launch (est. range: $600m to $1.5bn / per month).

We’ve seen several estimates that are lower than our prediction, due to several of the factors described below. That said, our $14bn first year bitcoin ETF inflows prediction from our prior report were based on the entrance of wealth management platforms, yet Bitcoin ETFs saw significant flows before those platforms have even arrived. Thus, we suggest caution when it comes to predicting underwhelming demand for ether ETFs.

Some structural/market differences between BTC and ETH will impact ETF flows:

Demand for spot ether ETF may be limited due to lack of staking rewards. Non-staked ETH has opportunity cost from foregoing: (i) inflationary rewards paid to validators (also negative dilutive impact), (ii) priority fees paid to validators, and MEV revenue paid through relayers to validators. Using Post-Merge data (>9/15/22) through 6/15/24, we estimate the annualized opportunity cost of foregoing staking rewards to be 5.6-ppt for spot ETH holders (or 4.4-ppt using YTD data), a non-insignificant difference. This would make a spot ETH ETF less attractive to potential buyers. Note that ETPs offered elsewhere outside the US (e.g., in Canada) offer additional yield for holders via staking. See Appendix for further discussion on value accrual for unstaked ETH holders vs. staked ETH validators.

Grayscale’s ETHE will likely be a drag on ether ETF inflows. Just as the GBTC Grayscale Trust experienced significant outflows on ETF conversion, the conversion of the ETHE Grayscale Trust to an ETF will similarly result in outflows. Assuming the pace of ETHE outflows matches that of GBTC over the first 150 days (i.e., 54.2% of the trust supply withdrawn), we estimate that outflows from ETHE will be ~319k ETH per month, which at the current price of ~$3,400 would be $1.1bn or a daily average outflow of $36m. Note that the % of supply held in these trusts is 3.2% of BTC supply and 2.4% of ETH supply, suggesting that the ETHE ETF conversion will be a relatively smaller drag on ETH price relative than the GBTC conversion. Also, unlike GBTC, ETHE does not face forced sellers due to bankruptcy (e.g., 3AC or Genesis), which would further support the idea that ETH would see relatively less sell pressure related to the Grayscale trusts than BTC.

Basis trade likely drove hedge fund demand for bitcoin ETFs. The basis trade has likely fueled ETF adoption by hedge funds that look to arbitrage the difference between spot and futures prices of bitcoin. As previously mentioned, 13F filings revealed over 900 US investment firms have holdings in bitcoin ETFs as of 3/31/24, including some prominent hedge funds like Millennium and Schonfeld. Throughout 2024, ETH has had higher funding rates across exchanges than BTC on average, which suggests that (i) there is relatively greater demand to go long ETH, and (ii) a spot ether ETF could potentially attract greater demand from hedge funds that look to enter the basis trade.

Factors Impacting Price Sensitivity of ETH vs. BTC

As our ether ETF inflows estimate is roughly equal to BTC flows relative to market cap, we would expect the price impact to be roughly the same, holding all else equal. However, there are several key differences in supply/demand between the two assets that may cause ether to be more price sensitive to ETF flows:

• Supply held on exchanges: Currently, a greater proportion of BTC supply is held on exchanges than ETH supply (11.7% vs. 10.3%), suggesting that ETH supply may be tighter, and that ETH price would be more price sensitive assuming a proportional level of inflows relative to market cap (note: this metric relies heavily on exchange address attribution and varies widely across data providers).

• Inflation & Burn: Following the latest halving on 4/20/24, the annual inflation rate of BTC is ~0.8%. Post-Merge (>9/15/22), Ethereum has seen net negative issuance (-0.19% annual) as new issuance paid to stakers (+0.63%) has been more than offset by burnt base fees (-0.83%). More recently over the past month, ETH base fees have been relatively lower (-0.34% annualized) and have failed to offset new issuance (+0.76% annualized), resulting in a net positive annualized inflation rate of +0.42%.

• Supply held in ETFs: So far since launch, the net amount of BTC going into US spot ETFs (ex-GBTC’s starting balance) has totaled 251k BTC or 1.3% of the current supply. If this pace is annualized, ETFs would absorb 583k BTC or 3.0% of BTC’s current supply, which would far outpace the dilution from miner rewards (0.81% inflation).

However, the actual market liquidity available to be purchased for ETFs is far less than the reported current supply. In our view, a better representation of the available market supply of each asset for ETFs would include adjustments for factors such as staked supply, dormant / lost supply, and supply held in bridges & smart contracts:

• Staked supply (discount: 30%): Staked supply reduces the amount of liquidity available to be absorbed by an ETF. Currently, there is no option to stake for BTC. Staked ETH is required to secure the network, but stakers can unstake some portion of their ETH be used elsewhere. Currently, the amount of ETH staked accounts for ~27% of ETH’s current supply and we apply a 30% discount to estimate the available market supply, resulting in a 8.2% factor supply discount.

• Dormant / lost supply (discount: 50%): Some BTC & ETH is assumed to have been unrecoverable (e.g., lost keys, boating accidents) so this reduces available supply; we use 10y+ dormant supply on BTC and ETH supply held in addresses last active > 7 years ago, which amounts to 16.6% and 6.7% of the current supply of BTC and ETH, respectively. We apply a discount rate of 50% to this balance as it is possible that the supply held in some of these presumed dormant addresses can come back online at any time.

• Supply in bridges & smart contracts (discount: 25%): This is supply that is locked in bridges and contracts to be used for productive reasons. For bitcoin, the balance of BTC custodied by BitGo for wrapped BTC (wBTC) is ~153k BTC and we estimate roughly the same amount locked in other bridges, which would total ~1.6% of BTC supply. ETH locked in smart contracts represents ~11.4% of the current supply. We apply a lower discount of 25% to this balance than staked supply as we presume this supply more liquid than staked supply (i.e., likely not subjected to same lock up requirements and withdrawal queues).

Applying discounted weightings to each of these factors to calculate an adjusted supply of BTC and ETH, we estimate that the available supply of BTC and ETH is respectively 8.7% and 14.4% less than their reported current supplies.

Overall, the price sensitivity should be greater for ETH compared to BTC to relative cap-weighted inflows due to: (i) lower available market supply based on the adjusted supply factors, (ii) lower % of supply on exchanges, and (iii) lower net emissions. Each of these elements should have a multiplicative effect with the others on price sensitivity (rather than additive) price tends to be more reflexive to greater changes in market supply and liquidity.

Looking Ahead

Looking ahead, several questions we have going forward in terms of adoption and second order effects:

• How should PMs and allocators think about BTC & ETH? Will existing holders migrate from bitcoin ETF to ETH? For allocators, some rebalancing is expected. Will a spot ether ETF attract new marginal buyers that have not bought into BTC yet? What will be the mix of potential buyers that will hold BTC-only, ETH-only, and a mix of both?

• When, if ever, can staking be added? Does not having staking rewards matter for adoption of spot ether ETFs? Could investment demand to obtain exposure to DeFi, tokenization, NFTs & other crypto-related applications drive even greater adoption of ether ETFs compared to Bitcoin given the lack of alternative investment products?

• What is the potential impact for other alts? Is it more likely that we could see other ETFs for alts be approved after ether?

Overall, we think the potential launch of spot ether ETFs should have a largely positive impact for market adoption of Ethereum and the broader crypto market for two primary reasons: (i) expanded accessibility across wealth segments, (ii) greater acceptance through formal recognition by regulators and trusted financial services brands. An ETF enables greater reach for both retail and institutions, provides wider distribution through more investment channels, and can support the case for ether in a portfolio to be used across more investment strategies. In addition, greater understanding of Ethereum by financial professionals would ideally result in accelerated investments and adoption of the technology.

Appendix: Value Accrual for Staked vs. Non-Staked ETH Holders

In general, changes to ETH supply come from new issuance (paid to validators) and burnt base fees, which have more than offset the inflationary impact from new issuance since the Shanghai upgrade (aka “the Merge”) went live in September 2022, reducing the supply of ETH by 0.20% on a net basis.

If issuers are prohibited from staking ETH in the ETF, then the ETF would represent a considerable opportunity cost in terms of lost validator income and dilution. From the perspectives of unstaked ETH holders vs. staked validators, considerations for value accrual across the various value flows:

• The base fee component of user transaction fees is burned, which reduces supply and benefits both unstaked & staked ETH holders equally.

• The priority fee component of user transaction fees is income that is collected by validators (no impact to unstaked ETH holders).

• MEV payments are paid by searchers to builders and redistributed to validators through MEV Boost, which similarly to priority fees, provide income to staked validators with no impact to unstaked ETH holders.

• New issuance from block rewards creates a dilutive effect for all ETH holders; for staked validators, however, the new issuance serves as another stream of income which more than offsets the dilutive effect of new issuance.