Author: GSR

Compile: Wu said blockchain

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Solana has cemented its position as one of the three giants in the cryptocurrency world. With the other two giants having already launched or about to launch spot ETFs, Solana may also launch a spot ETF in the near future, and its impact on SOL could be the biggest yet.

Note: GSR holds SOL.

Solana——以光速同步世界

Solana was founded by Anatoly Yakovenko and Raj Gokal in 2018 and launched in 2020. It is a delegated proof-of-stake blockchain designed for high performance and mass adoption. With extremely low transaction costs, widespread decentralized applications, and an active user and developer community, Solana has accumulated nearly 300 billion transactions and over $4 billion in total value locked. In addition, Solana continues to stand out among numerous projects, with recent highlights including the release of numerous high-profile tokens, various projects migrating to Solana, key innovations such as token extensions, and unique use cases around Solana such as order books, batch NFTs, DePINs, memecoins, etc.

Solana's success is based on its outstanding technology, which we believe provides a sustainable competitive advantage, especially in three particularly significant aspects. First, Solana's Proof of History provides a time concept for validators. Similar to the alternating transmission of mobile signal towers to avoid interference, Proof of History allows validators to generate blocks when it's their turn, without the need for the network to reach current block consensus first, bringing huge speed and scalability advantages. Secondly, unlike the single-threaded virtual machine behind the current cryptocurrency field, Solana supports parallel transaction processing, significantly increasing throughput and leveraging the primary source of computational speed improvement, with most performance improvements today coming from adding more cores rather than increasing the performance of each core. Finally, while Solana's historical high hardware and bandwidth requirements have to some extent sacrificed decentralization to optimize speed and security, as costs decrease (Moore's Law), Solana will naturally benefit from it and may become the first project to truly solve the blockchain trilemma and ultimately achieve its vision of synchronizing global state at the speed of light.

Undervalued cryptocurrency ETF may have further upside potential

As Solana establishes its position after Bitcoin and Ethereum, and both Bitcoin and Ethereum have launched (or are about to launch) US spot ETFs, it naturally raises a question - will Solana be the next one? In the current cycle, spot ETFs are the main driving factor for prices, making this question particularly important.

Simply put, within the current framework, the path to launch a spot digital asset ETF in the United States is clear. It requires a federally regulated futures market (currently there are no other futures markets besides Bitcoin and Ethereum), the futures market needs to exist for several years to demonstrate sufficient correlation, and the futures ETF needs to be approved before considering spot products. In other words, there will be no additional spot digital asset ETFs in the near future. However, we believe this severely underestimates the potential for transformation.

In fact, the change is already underway, and Donald Trump's recent support for the cryptocurrency industry has led the Democratic Party to relax its stance on digital assets in this tense election year. Although it was hard to imagine just a month ago, we have seen both houses of Congress pass bipartisan measures to overturn the controversial SEC cryptocurrency accounting policy (SAB 121), as well as the House of Representatives passing a comprehensive digital asset regulatory framework (FIT21). While the current legislative and regulatory structure is unlikely to adopt rules that allow for the launch of various spot digital asset ETFs, the Trump administration and liberal SEC commissioners may achieve this goal, especially through the Digital Asset Market Structure Act, which defines securities and commodities. Not only is this situation possible, it could even become a reality.

The key determinants of the next Spot ETF

Under looser regulations, we believe that the two key factors determining the next spot ETF are the level of decentralization and potential demand. In terms of the former, the level of decentralization may be the key to whether digital assets can obtain ETFs, whether FIT21 bypasses the Howey test by creating a new category of digital assets with key decentralization tests, or whether the SEC's proposed 'sufficiently decentralized' may affect the classification of securities. As for the latter, potential demand for any new ETF is equally important as it will be the biggest factor affecting profitability. Here, issuers may consider reputation risks, the ability to go through various internal committees, and the best interests of clients while considering potential demand. Overall, although native cryptocurrency issuers may apply for a large number of spot ETFs, we believe that larger issuers are more likely to focus on one or two digital assets with sufficient decentralization and high potential demand.

Next, we provide a brief analysis, attempt to quantitatively determine the decentralization score and demand score, and add them together to form the ETF potential score. Note that we convert various category indicators into Z-scores for the purpose of category merging, and then take the simple average of the Z-scores for each category to calculate the final decentralization and demand scores. Finally, note that many of the indicators used have flaws and a certain degree of subjectivity, but we believe that these indicators still have reference value for the current task.

Decentralization Analysis

Analyzing the level of decentralization of blockchain is difficult because there is no universally accepted definition, many indicators are still unsatisfactory, and this topic is highly complex, technical, and even philosophical. In addition, decentralization encompasses many concepts, such as permissionless participation, development control, influence of key figures, token distribution, ownership characteristics, and software and hardware diversity. Finally, it is worth noting that most public chains gradually become more decentralized over time, as evidenced in the following examples: Cardano's upcoming Voltaire era will substantially decentralize governance, and Solana's upcoming Firedancer client will make Solana the only network besides Bitcoin and Ethereum to have a second independent client on the mainnet. In conclusion, we believe that some more sound and referenceable decentralization indicators include:

· Nakamoto coefficient, a measure of the minimum number of independent entities that could collude to attack the network, with a higher value indicating a higher degree of decentralization.

· The stake requirements measure the difficulty of anyone participating in the network as a node operator or validator, including minimum stake requirements and hardware requirements. Less stake and lighter hardware contribute to greater decentralization.

· CCData governance rating, including various governance measures such as participation, transparency, and Decentralization.

As shown below, the four blockchains with decentralized scores higher than the average are Ethereum, Solana, Avalanche, and Aptos.

Requirements Analysis

Potential demand is another key determinant, and issuers may look at various indicators when evaluating future fund inflows. The most important of these is Token Market Cap, but overall, we believe the following three categories are particularly relevant:

· Market indicators, high market cap, high volume, and strong token performance may indicate strong future demand.

· The current total assets under management (AUM), high AUM of tokens in existing investment products globally, indicates that there may also be high demand for spot ETF products.

· Activity indicators, strong and active communities, and widespread usage may also be powerful signals of future demand.

As shown in the figure below, the three major blockchains with above-average demand scores are Ethereum, Solana, and NEAR.

Add up our decentralized score and demand score to get the final ETF feasibility score. Note that we set the decentralized weight to 33% and the demand weight to 67%, as we believe that decentralization may be a threshold factor, while potential demand may be the main criterion for issuers. Overall, Ethereum obtained approval for the critical spot ETH ETF 19b-4 file in May and is expected to launch multiple spot ETFs with a significant advantage in the summer. Next is Solana, which also has a positive score in both decentralization and demand, surpassing other digital assets by a significant margin except Ethereum. NEAR ranks third due to its good performance in both categories. Overall, the results clearly indicate that if the US allows additional spot digital asset ETFs, Solana will be the next one.

Potential Spot Solana ETF Impact on Price

To assess the potential impact of the spot Solana ETF on the price of SOL, we can simply refer to the impact of the spot Bitcoin ETF on Bitcoin. After all, the approval of the spot Bitcoin ETF and the subsequent huge influx of funds are the main factors that have pushed Bitcoin from $27,000 when market participants began to consider the possibility of a US spot ETF approval in October to the current level of about $63,000, achieving a 2.3x rise. This 2.3x will be our benchmark.

Next, we need to adjust the analysis, taking into account that the inflow of funds into the spot Solana ETF is significantly smaller than that of Bitcoin. Finally, we adjust by estimating the inflow of funds into the spot Solana ETF relative to Bitcoin. Here, we consider three simple scenarios.

· Pessimistic scenario: Solana's global investment products' assets under management account for 2% of Bitcoin. We believe this underestimates the potential inflow of Solana ETF funds, as this measure gives Bitcoin a significant lead. Grayscale Bitcoin Trust Fund was launched as early as 2013, while Solana was not introduced until 2020. Therefore, we consider 2% as the pessimistic scenario for fund inflow.

· Benchmark Scenario: We evaluate the performance of Solana by referring to the recent actual capital inflows. Here, we use capital inflow data from 2021 to 2023, as Solana was not well known before 2021 and to exclude the impact of spot Bitcoin ETF (launched in January) until 2024. During these three years, the cumulative inflow of Solana investment products accounted for 5% of Bitcoin's cumulative inflow. We consider this 5% as the benchmark scenario.

· Optimistic scenario: In the past two years, Solana has had a higher relative influx of funds, accounting for 31% and 9% of the Bitcoin influx in 2022 and 2023, respectively. While we do not expect Solana to fully keep up with the exceptionally high Bitcoin inflows in 2021 and 2024, we consider the average annual 14% relative inflow over the three years as a potential optimistic scenario.

Despite the fact that, in pessimistic, benchmark, and optimistic scenarios, the inflows into spot Solana ETFs may represent only 2%, 5%, or 14% of Bitcoin, respectively, we must now adjust the impact of spot ETFs on SOL based on their smaller size, which will be done through market capitalization. Specifically, over the past year, Solana's market capitalization has averaged only 4% of Bitcoin.

Taking all factors into account, we can adjust our relative inflow estimates in different scenarios based on Solana's 2.3x increase compared to Bitcoin. In a pessimistic scenario, Solana may rise 1.4x; in a benchmark scenario, it may rise 3.4x; and in an optimistic scenario, it may rise 8.9x. Furthermore, there are reasons to believe that the impact may be higher than these estimates, as unlike Bitcoin, SOL is actively used in staking and decentralized applications, and the relationship between relative inflows and relative scale may not be linear. Finally, it is worth noting that the potential reflection of a Solana spot ETF in the SOL price may be much less compared to Bitcoin at the start of our analysis, as inferred from the deviation of Grayscale Trust from net asset value. If this inference is correct, the significant potential for SOL to rise with a spot ETF in place can be seen as a 'free option'. In summary, if the U.S. allows more spot digital asset ETFs, then Solana will be prepared for spot ETFs, and the price impact may be the greatest to date.

Due to the lack of real-time creation and redemption mechanisms, the price of Grayscale Trust may deviate from its Net Asset Value (NAV). However, this deviation will disappear when the Trust converts to a Spot ETF because Spot ETF has such mechanism. On January 1, 2023, the Grayscale Bitcoin Trust (GBTC) traded at a 45% discount to its NAV (before BlackRock applied for a Spot Bitcoin ETF on June 15, 2023, and before Grayscale won the lawsuit against the SEC on August 31). However, by early October, this discount had reduced to 21%, indicating that the price of Bitcoin may already include the factors of increased opportunities for Spot Bitcoin ETF when we started measuring price impact.