After receiving approval from the U.S. Securities and Exchange Commission, the first ethereum (ETH) spot exchange-traded funds started trading in July. This follows the successful approval of bitcoin (BTC) ETFs that were launched earlier this year. Before this, there was a lack of regulatory clarity that made it difficult for risk-averse investors to consider any crypto assets in their portfolios.
So why are these ETFs significant, and why are they tracking ethereum?
What are spot ETFs?
An ETF is an investment vehicle wrapper that complies with SEC regulations for reporting and other requirements. “Spot” means that these ETFs track the real-time “spot” price of the traded asset, as opposed to a “futures” ETF.
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Like company stock, an ETF is tradeable in exchanges such as the New York Stock Exchange and Nasdaq. This is consequential because many corporates and funds are set up to trade in exchanges as they normally have accounts with broker-dealers, such as Charles Schwab, T. Rowe Price and others, who can also help them store these ETFs.
Many corporates have been hesitant to invest in crypto due to regulatory uncertainty and custody concerns, among other reasons. Corporates may be more amenable to buying a small amount of these ETFs from their broker-dealers since they are already doing so in the normal course of business. Contrast this with crypto holders who have to fiddle with cryptographic seed phrases, software and hardware wallets, and the risk of hacks.
Why do the new ether ETFs matter?
Crypto advocates have been pushing for ETFs for years, as ETFs could open the nascent sector to corporate treasury inflows, which could be huge relative to the previous inflows, which were mostly individual retail sales.
In support of this, in 2023, the Financial Accounting Standards Board allowed for fair value accounting of digital crypto assets. This means that companies that possess digital crypto assets can reflect the rise and fall of the value of these assets in their balance sheets, whereas before, only value loss (and not gain) could be reflected. This means that if a digital asset such as bitcoin or ethereum moves counter to the price movement of other traditional assets, companies could use a small amount of digital assets in their books to offset their total asset values at the time of reporting.
Why the interest in ethereum?
Ethereum is the second-largest class of digital assets as per the industry standard price tracker CoinMarketCap. As of late August, the total crypto market cap was around $2.17 trillion, with bitcoin accounting for a little over half of that. Market cap is computed by multiplying the current spot trading price (in USD) by the total number of crypto tokens outstanding.
Ethereum’s market cap is roughly one-fourth the size of bitcoin’s. Note that these ratios change in real time and all cryptos are volatile assets (high financial beta).
For traditional finance people, store-of-value assets, such as gold and bitcoin, are typically less favored than assets with yield, such as bonds and dividend stocks. While gold can rise and fall in terms of value, holding it does not typically produce yield. For bitcoin, although the situation has somewhat changed with new applications such as ordinals, traditionally the only thing you could do with bitcoin was keep it or sell it for a profit.
Because ethereum is capable of executing what are called smart contracts, it has become a platform for decentralized exchanges, non-fungible token markets, games and myriad other applications.
Ethereum has native yield. The native yield of ethereum comes from the fact that all of the users of these applications have to pay ethereum “gas” fees to process their transactions on the blockchain. These gas fees are used to pay the validator server owners who keep the network running. Yield flows also allow finance people to better use their present valuation models.
Ethereum holders can do other activities including staking, liquid staking, etc., that could be likened to deposits in banks. Suffice to say, this ecosystem of blockchains and applications produces a huge “liquidity” of inflows to ethereum.
While the SEC has not allowed ETFs to do staking, which produces yield for the ETF holders, it does allow the bearers (such as corporate treasuries and traditional investors) to participate in ethereum’s future potential price growth, especially with the FASB accounting rule approval. Only holders of the actual ethereum crypto — and not ETF holders — can get the native yield, though.
What might the future hold?
While future adoption is speculative, some diehard fans believe that ethereum can eventually overtake bitcoin. Aside from the native yield that attracts investors, there is also the potential of the global traditional finance sector using a public blockchain to have a common transaction and asset ledger system. At the moment, transactions and asset ownership transfers are slow because each bank and financial institution has its own separate siloed transaction ledger database. With a common shared ledger, finance transactions could happen and settle and finalize faster.
Although there are many other chains on the market, such as Solana, and others that are competitors, ethereum is the biggest blockchain that has native yield for holders of the actual crypto and the one that traditional finance is looking at aside from bitcoin. With so many Layer 2 chains and applications, with their armies of ethereum believers, traders, developers and the like, it’s unlikely, in my opinion, that ethereum will fail and lose relevance.
For now, ethereum’s growth seems likely. SEC approval brings regulatory clarity, Gen Z increasingly is becoming more comfortable with digital assets, and slowly older generations and the global financial sector are beginning to accept them. While tech adoption is never a straight line going up, naysayers who bet against tech often end up on the losing side of the trade.
I believe this new ethereum ETF will encourage widespread adoption even more.
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The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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