Ethereum spot ETF is expected to start trading in mid to late July, and Galaxy estimates that it will attract $5 billion in capital inflows within five months of its launch. This article predicts the performance of the Ethereum spot ETF after its listing by comparing it with the Bitcoin spot ETF.
Key Points:
Background
Experience with Bitcoin ETF
Demand for ETFs driven mainly by retail investors, institutional demand is increasing
Wealth management platforms have not started buying Bitcoin ETF for clients
Estimating potential inflows for Ethereum ETF
Factors affecting the sensitivity of ETH and BTC prices
Future outlook
The Bitcoin spot ETF, launched on January 11, 2024, has accumulated $15.1 billion in net inflows as of June 15, 2024.
Nine issuers are working on launching 10 Ethereum spot ETFs in the United States. The U.S. Securities and Exchange Commission (SEC) approved all 19b-4 filings on May 23, and these ETFs are expected to start trading in July 2024.
Similar to the Bitcoin ETF, we believe that the primary source of net inflows will be independent investment advisors or investment advisors associated with banks and brokers/traders.
We expect the net inflows of the first five months of the Ethereum ETF to account for 20-50% of the net inflows of the Bitcoin ETF during the same period. Our target estimate is 30%, which means a monthly net inflow of $1 billion.
Overall, we believe that ETHUSD is more price-sensitive to ETF inflows than BTC, as a significant portion of ETH’s total supply is locked in staking, cross-chain bridges, and smart contracts, with fewer amounts held by centralized exchanges.
For months, observers and analysts have consistently underestimated the likelihood of the U.S. Securities and Exchange Commission (SEC) approving spot Ethereum exchange-traded products (ETPs). The pessimism stems from the SEC’s reluctance to explicitly recognize ETH as a commodity, the lack of communication between the SEC and potential issuers, and the SEC’s investigation and enforcement actions related to the Ethereum ecosystem.
However, all applications for spot Ethereum ETPs have been approved by the SEC. We expect these instruments to be launched after the effectiveness of the S-1 filings (we expect to see them launched sometime in the summer of 2024).
This report will refer to the performance of the Bitcoin spot ETP to predict the demand for the Ethereum ETP. We estimate that the Ethereum spot ETP will achieve approximately $5 billion in net inflows in the first five months of trading (about 30% of the net inflows of the Bitcoin ETP).
Currently, nine issuers are competing to launch 10 spot ETH exchange-traded products (ETPs). In recent weeks, some issuers have already withdrawn. ARK chose not to collaborate with 21Shares to launch an Ethereum ETP, while Valkyrie, Hashdex, and WisdomTree have withdrawn their applications.
The following figure shows the current status of applicants sorted by the 19b-4 application date:
Grayscale is seeking to convert the Grayscale Ethereum Trust (ETHE) into an ETP, just as the company did with its Grayscale Bitcoin Investment Trust (GBTC), but Grayscale has also applied for a “mini” version of the Ethereum ETP.
On May 23, the U.S. Securities and Exchange Commission approved all 19b-4 filings (allowing rule changes for the eventual listing of ETH spot ETPs on exchanges), but now each issuer needs to have repeated discussions with regulatory agencies regarding their registration statements.
The product itself can only truly start trading once the U.S. Securities and Exchange Commission allows these S-1 filings (or the S-3 filing for ETHE) to become effective. Based on our research and Bloomberg’s reports, we believe the Ethereum spot ETP may start trading as early as the week of July 11, 2024.
The launch of the Bitcoin ETF has been nearly six months, which can serve as a benchmark for predicting the potential popularity of the Ethereum spot ETF.
Source: Bloomberg
The following are some observations of the first few months of trading for the Bitcoin spot ETP:
So far, there has been a consistent increase in capital inflows. As of June 15, the U.S. spot Bitcoin ETF has accumulated over $15 billion in net inflows since its launch, with an average daily net inflow of $136 million. These ETFs hold a total of approximately 870,000 BTC, accounting for 4.4% of the current BTC supply. The BTC trading price is around $66,000, and the total AUM of all U.S. spot ETFs is approximately $58 billion (Note: Before the ETF launch, GBTC held approximately 619,000 BTC).
ETF inflows are partly responsible for the rise in BTC prices. Regression analysis of the 1-week change in BTC prices and ETF net inflows yielded an r-squared value of 0.55, indicating a high correlation between these two variables. Interestingly, we also found that price changes were leading indicators of inflows, rather than the other way around.
GBTC has been a major concern for the overall liquidity of ETFs. Since the trust was converted into an ETF, GBTC experienced significant outflows in the first few months. Daily outflows from GBTC peaked in mid-March, with outflows of $642 million on March 18, 2024. Since then, outflows have eased, and GBTC has even seen several days of positive net inflows starting in May. As of June 15, the BTC balance held by GBTC has decreased from 619,000 to 278,000 since the ETF launch.
13F filings show that as of March 31, 2024, over 900 U.S. investment firms hold Bitcoin ETFs with a value of approximately $11 billion, accounting for about 20% of the total BTC ETF holdings, indicating that most of the demand is driven by retail investors. Institutional buyers include major banks (such as JPMorgan, Morgan Stanley, Wells Fargo), hedge funds (such as Millennium, Point72, Citadel), and even pension funds (such as the Wisconsin Investment Board).
The largest wealth management platforms have not yet allowed their brokers to recommend Bitcoin ETFs, although it has been reported that Morgan Stanley is exploring allowing its brokers to solicit clients to purchase. In our report “Market Sizing of Bitcoin ETFs,” we stated that it may still take several years for wealth management platforms (including brokerage firms, banks, and RIAs) to help clients purchase Bitcoin ETFs. So far, there has been minimal inflow from wealth management platforms, but we believe it will be an important catalyst for Bitcoin adoption in the near to medium term.
Daily liquidity of GBTC after ETF approval (USD)
Referring to the situation with the Bitcoin ETP, we can approximate the potential demand for the Ethereum ETP.
Relative market size of BTC and ETH ETPs
To estimate the potential inflows for the Ethereum ETF, we applied the BTC/ETH multiples based on the relative market sizes of BTC and ETH trading on several markets to the net inflows of the U.S. Bitcoin spot ETF. As of May 31:
BTC’s market cap is 2.9 times that of ETH.
In all exchanges, based on open interest levels and trading volumes, the BTC futures market is approximately twice the size of ETH. Specifically, on the CME, BTC’s open interest is 8.4 times that of ETH, and BTC’s daily trading volume is 4.2 times that of ETH.
The AUM of existing funds (divided into Grayscale Trust, futures, spot, and selected global markets) shows that the scale of BTC funds is 2.6 to 5.3 times that of ETH funds.
Based on the above, we believe that the inflows for the Ethereum spot ETF will be approximately one-third (estimated range of 20%-50%) of the inflows for the Bitcoin spot ETF.
Applying this data to the $15 billion net inflows for the Bitcoin spot ETF as of June 15, it means that the monthly inflow for the first five months after the launch of the Ethereum ETF will be approximately $1 billion (estimated range: $600 million to $1.5 billion).
Estimated net inflows for the U.S. spot Ethereum ETF
Due to several factors, we see some estimates lower than our predictions. However, our previous report predicted the first-year net inflows for the Bitcoin ETF to be $14 billion, which assumed the entry of wealth management platforms, but there were already significant inflows for the Bitcoin ETF before these platforms entered. Therefore, we recommend caution in predicting the demand for the Ethereum ETF during periods of low demand.
There are several structural/market differences between BTC and ETH that will affect ETF liquidity:
The demand for the Ethereum spot ETF may be affected due to the lack of staking incentives. Non-staked ETH will loseOpportunity costs for the following are: (i) inflation rewards paid to validators, (ii) priority fees paid to validators, and (iii) MEV income paid to validators through relayers.
Based on data from September 15, 2022, to June 15, 2024, we estimate that the annualized opportunity cost of forgoing staking rewards for holders of spot ETH is 5.6% (if calculated using year-to-date data, the result is 4.4%), which is a significant difference.
This will reduce the attractiveness of spot Ethereum ETFs to potential buyers. Please note that ETPs offered outside the United States (e.g., Canada) provide additional income to holders through staking.
Sources of income for non-staked and staked ETH holders
Additionally, Grayscale’s ETHE may weigh down inflows into Ethereum ETFs. Just as GBTC Grayscale Trust experienced significant outflows during the ETF conversion, the conversion of ETHE Grayscale Trust to an ETF may also result in outflows.
Assuming the outflow rate of ETHE matches that of GBTC in the first 150 days (i.e., 54.2% of trust supply is redeemed), we estimate that the outflow of ETHE will be approximately 319,000 ETH per month. Calculated at the current price of $3,400, this would amount to a monthly outflow of $1.1 billion or a daily average of $36 million.
Please note that the percentages of tokens held by these trusts as a percentage of their respective total supplies are: BTC 3.2% and ETH 2.4%. This indicates that the selling pressure related to ETHE ETF conversion is likely to be smaller than that of BTC, especially considering that ETHE is not subject to forced liquidation due to bankruptcy cases (e.g., 3AC or Genesis), further supporting the view that the selling pressure related to ETH and Grayscale Trust is relatively smaller than that of BTC.
GBTC and ETHE (Projected) Net Flows
Arbitrage trading may drive demand for Bitcoin ETFs from hedge funds. Arbitrage trading can drive demand for Bitcoin ETFs from hedge funds that seek to profit from the price difference between Bitcoin spot and futures prices.
As mentioned earlier, 13F filings show that as of March 31, 2024, over 900 U.S. investment firms hold Bitcoin ETFs, including some well-known hedge funds such as Millennium and Schonfeld.
Throughout 2024, the average financing rate for ETH on various exchanges is higher than that of BTC, indicating that (i) there is relatively higher demand for going long on ETH and (ii) spot Ethereum ETFs may attract more demand from hedge funds utilizing arbitrage trading.
BTC and ETH Financing Rates
Since we estimate that the ratio of Ethereum ETF inflows to market cap is roughly equal to the ratio of Bitcoin flows to market cap, we expect the price impact to be roughly similar under all other conditions. However, there are several key differences in supply and demand between these two assets that could lead to Ethereum’s price being more sensitive to ETF flows:
BTC and ETH Market Supply Differences
Exchange-held supply: Currently, the proportion of BTC held by exchanges is higher than that of ETH (11.7% vs. 10.3%), indicating that ETH supply may be tighter. Assuming inflows are proportional to market cap, the price sensitivity of ETH would be higher (note: this metric heavily relies on exchange address attribution and varies greatly among different data providers).
Inflation and destruction: After the latest halving on April 20, 2024, BTC has an annual inflation rate of approximately 0.8%. After the Ethereum merge, ETH has experienced net negative issuance (annualized -0.19%) as the new issuance (+0.63%) paid to stakers has been offset by the burned base fee (-0.83%). In the past month, the base fee for ETH has been relatively low (annualized -0.34%), failing to offset the new issuance (annualized +0.76%), resulting in a net positive annualized inflation rate of +0.42%.
ETF-held supply: Since its launch, a net total of 251,000 BTC (excluding the initial balance of GBTC) has entered U.S. spot ETFs, accounting for 1.3% of the current supply. If calculated on an annual basis, ETFs would absorb 583,000 BTC, accounting for 3.0% of the current BTC supply, which would far exceed the dilution caused by miner rewards (0.81% inflation rate).
However, the actual market liquidity available for purchase is much lower than the reported current supply. We believe a better representation of the available market supply for each ETF asset would include adjustments for staked supply, dormant/lost supply, and supply held in cross-chain bridges and smart contracts:
Adjusted BTC and ETH Supply Calculations
Staked supply (discount: 30%): Staking reduces the amount of tokens available for ETF purchase. Currently, Bitcoin does not have a staking function. Ethereum, on the other hand, requires staked ETH to secure the network, but stakers can withdraw a portion of their staked ETH for other purposes. Currently, the amount of staked ETH represents approximately 27% of the current ETH supply. We apply a 30% discount to estimate the available market supply, resulting in a supply discount of 8.2%.
Dormant/lost supply (discount: 50%): A portion of BTC and ETH is considered irrecoverable (e.g., lost keys, shipwrecks), reducing the available supply. We use Bitcoin addresses dormant for over 10 years and Ethereum addresses dormant for over 7 years to calculate the dormant/lost supply, which accounts for 16.6% of the current BTC supply and 6.7% of the current ETH supply. We apply a 50% discount to this balance, as some of the supply held in dormant addresses may come back online at any time.
Supply held in cross-chain bridges and smart contracts (discount: 25%): This refers to the supply locked in cross-chain bridges and contracts for production purposes. For Bitcoin, BitGo’s custodied BTC for wrapped BTC (wBTC) amounts to approximately 153,000 BTC. We estimate a similar quantity locked in other cross-chain bridges, totaling about 1.6% of the BTC supply. The supply locked in smart contracts represents 11.4% of the current ETH supply. We apply a discount of 25% to this balance, lower than the discount applied to staked supply, as we assume this supply is more liquid than staked supply (i.e., it may not be subject to the same locking requirements and withdrawal queues).
By applying discount weights for each factor to calculate the adjusted supply for BTC and ETH, we estimate that the available supply for BTC and ETH is roughly 8.7% and 14.4% lower, respectively, than the reported current supply.
Overall, we believe the launch of spot Ethereum ETFs will have a significant positive impact on the adoption of Ethereum and the broader cryptocurrency market, primarily for two reasons:
(i) Expanding the reach of cryptocurrencies: ETFs expand the coverage of retail and institutional investors, provide broader distribution through more investment channels, and support the use of Ethereum in more investment strategies. Additionally, increased understanding of Ethereum among financial professionals will accelerate investment and adoption.
(ii) Formal recognition from regulatory bodies and trusted financial service brands: ETFs provide formal recognition for cryptocurrencies through regulatory oversight and the involvement of trusted financial institutions.
Related Reports
Bloomberg: Ethereum Spot ETF Listing Delayed Until July 8; SEC Requests Amendments to S-1 Filing
Bloomberg: Standard Chartered Establishing “Cryptocurrency Exchange” in London, Trading Bitcoin and Ethereum Spot
Reuters Also Bullish: Ethereum Spot ETF Could Launch as Early as July 4, How Much New Capital Can It Bring?