Original Author: Charles Yu

Original text translation: Luffy, Foresight News

Key Points

• Bitcoin Spot ETF (launched on January 11, 2024) has received a net inflow of USD 15.1 billion as of June 15, 2024.
• 9 issuers are working on launching 10 Ethereum spot ETFs in the United States.
• The U.S. Securities and Exchange Commission (SEC) approved all 19 b-4 filings on May 23, and these ETFs are expected to start trading in July 2024.
• Like Bitcoin ETFs, we believe that the main source of net inflows comes from independent investment advisors or investment advisors associated with banks, brokers/traders.
• We expect that the net inflow of Ethereum ETF in the first 5 months will account for 20-50% of the net inflow of Bitcoin ETF in the same period. Our estimated target is 30%, which means a monthly net inflow of $1 billion.
• Overall, we believe that ETHUSD is more sensitive to ETF inflows than BTC, as a significant portion of ETH's total supply is locked in stake, cross-chain bridges, and smart contracts, while the amount held by centralized exchanges is relatively small.

For months, observers and analysts have underestimated the possibility of the U.S. Securities and Exchange Commission (SEC) approving a spot Ethereum exchange-traded product (ETP). The pessimism stems from the SEC's reluctance to explicitly recognize ETH as a commodity, the lack of news regarding contact between the SEC and potential issuers, and the SEC's ongoing investigations and enforcement actions related to the Ethereum ecosystem. Bloomberg analysts Eric Balchunas and James Seyffart initially estimated a 25% chance of approval in May. However, on Monday, May 20, Bloomberg analysts suddenly raised the probability to 75% due to reports of the SEC contacting securities exchanges.

In fact, later in the week, all spot Ethereum ETP applications were approved by the SEC. We look forward to the launch of these tools after the effectiveness of the S-1 application (we expect to launch at some point in the summer of 2024). This report will reference the performance of Bitcoin spot ETPs to predict the demand for Ethereum ETPs after their launch. We estimate that spot Ethereum ETPs will see approximately $5 billion in net inflows in the first five months of trading (about 30% of the net inflows of Bitcoin ETPs).

Background

Currently, there are 9 issuers competing to launch 10 spot ETH exchange-traded products (ETPs). In the past few weeks, some issuers have withdrawn. ARK has chosen not to collaborate with 21 Shares to launch an Ethereum ETP, while Valkyrie, Hashdex, and WisdomTree have withdrawn their applications. The following chart shows the current status of applicants sorted by the 19 b-4 application date:

Grayscale is seeking to convert the Grayscale Ethereum Trust (ETHE) into an ETP, similar to what 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 19 b-4 documents (allowing the final listing rule change of ETH spot ETP on the stock exchange), but now each issuer needs to discuss its registration statement with the regulatory agency repeatedly. The product itself can only truly begin trading when the U.S. Securities and Exchange Commission allows these S-1 documents (or ETHE's S-3 documents) to take effect. Based on our research and Bloomberg's report, we believe that the Ethereum spot ETP may start trading as early as the week of July 11, 2024.

Experience of Bitcoin ETF

The Bitcoin ETF has been launched for nearly 6 months, which can serve as a benchmark for predicting the potential popularity of the Ethereum Spot ETF.

Source: Bloomberg

Here are some observations from the past few months of Bitcoin spot ETP trading:

• So far, the inflow of funds has been on the rise. As of June 15th, the cumulative net inflow of the US Spot Bitcoin ETF since its launch exceeded US$15 billion, with an average daily net inflow of US$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 about US$66,000, and the total AUM of all US Spot ETFs is approximately US$58 billion (Note: Before the launch of ETF, GBTC held approximately 619,000 BTC).
• ETF inflows are partly responsible for the rise in BTC price. By regressing the 1-week change in BTC price against ETF net inflows, we calculate an R-squared of 0.55, indicating a high correlation between these two variables. Interestingly, we also find that price changes are leading indicators of inflow volume, rather than the other way around.
• GBTC has always been a major hidden danger to the overall liquidity of ETF. Since converting the trust to ETF, GBTC has experienced a large outflow of funds in the first few months. The daily fund outflow of GBTC reached its peak in mid-March, with a fund outflow of $642 million on March 18, 2024. Since then, the outflow of funds has eased, and GBTC has even seen several days of net inflows since May. As of June 15, the BTC balance held by GBTC has dropped from 619,000 to 278,000 since the launch of ETF.

ETF demand is mainly driven by retail investors, while institutional demand is recovering. According to 13F filings, as of March 31, 2024, over 900 U.S. investment firms held Bitcoin ETFs with a total value of approximately $11 billion, accounting for approximately 20% of the total Bitcoin ETF holdings. This indicates that most of the demand is driven by retail investors. The list of institutional buyers includes major banks such as JPMorgan, Morgan Stanley, and Wells Fargo, hedge funds such as Millennium, Point 72, Citadel, and even pension funds such as the Wisconsin Investment Board.

The wealth management platform has not yet started buying Bitcoin ETFs for clients. The largest wealth management platform has not yet allowed its brokers to recommend Bitcoin ETFs, but according to reports, Morgan Stanley is exploring allowing its brokers to solicit clients to purchase them. In our report on the market size of Bitcoin ETFs, we wrote that it may take several years for wealth management platforms (including brokerages, banks, and RIAs) to help clients purchase Bitcoin ETFs. So far, there has been little inflow of funds from wealth management platforms, but we believe it will be an important catalyst for Bitcoin adoption in the near to medium term.

After the ETF is approved, the daily flow of GBTC (in USD)

Estimating Potential Inflows of Ethereum ETF

Referring to the situation of Bitcoin ETP, we can roughly estimate the potential demand for Ethereum ETP in the market.

The relative size of the BTC and ETH ETP markets

To estimate the potential inflow of Ethereum ETF, we applied the BTC/ETH ratio to the inflow of US Bitcoin spot ETF based on the relative asset size of BTC and ETH transactions in multiple markets. As of May 31st:

• The market cap of BTC is 2.9 times that of ETH.
• Among all exchanges, the futures market for BTC is approximately twice the size of ETH based on open contract levels and trading volume. Specifically, on CME, the open contracts for BTC are 8.4 times that of ETH, while the daily trading volume of BTC is 4.2 times that of ETH.
• The AUM of various funds (divided into Grayscale Trust, futures, spot, and selected global markets) shows that the scale of the BTC fund is 2.6 to 5.3 times that of the ETH fund.

Based on the above, we believe that the inflow of Ethereum spot ETF will be about one-third of the inflow of Bitcoin spot ETF (estimated range 20%-50%).

Applying this data to the 15 billion U.S. dollar Bitcoin spot ETF inflows before June 15th means that in the first five months after the launch of the Ethereum ETF, the monthly inflow is estimated to be around 1 billion U.S. dollars (estimated range: 600 million to 1.5 billion dollars per month).

Estimated inflow of US Spot Ethereum ETF

Due to several factors, we see some valuations lower than our forecasts. That being said, our previous report predicted a first-year inflow of $14 billion for Bitcoin ETF, assuming the entry of wealth management platforms, but there has already been a significant inflow into Bitcoin ETF before the entry of these platforms. Therefore, we recommend caution when predicting low demand for Ethereum ETF.

Some structural/market differences between BTC and ETH will affect the liquidity of ETFs:

Due to the lack of staking rewards, the demand for Spot Ethereum ETF may be affected. The opportunity cost of non-staking ETH includes (i) the inflationary rewards paid to validators, (ii) the priority fees paid to validators, and the MEV income paid to validators through relayers. Based on data from September 15, 2022 to June 15, 2024, we estimate that the annual opportunity cost of giving up staking rewards for Spot ETH holders is 5.6% (4.4% if calculated using year-to-date data), which is a significant difference. This will reduce the attractiveness of Spot Ethereum ETF to potential buyers. Please note that ETPs offered outside the US (e.g., in Canada) provide additional returns to holders through staking.

The source of income for non-staked and staked ETH holders

Grayscale's ETHE may drag down the inflow of Ethereum ETF. Just as GBTC Grayscale Trust experienced a significant outflow of funds during the ETF conversion, the conversion of ETHE Grayscale Trust to ETF will also result in fund outflows. Assuming the outflow rate of ETHE matches the outflow rate 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. Based on 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 percentage of tokens held by these trusts in their respective total supplies is: BTC 3.2%, ETH 2.4%. This indicates that the pressure on ETH price from ETHE ETF conversion is lower than that of GBTC. Furthermore, unlike GBTC, ETHE will not face forced selling due to bankruptcy cases (e.g., 3AC or Genesis), which further supports the view that the selling pressure related to Grayscale Trusts is relatively smaller for ETH than BTC.

Net flow of GBTC and ETHE (forecast)

Basis trading may drive the demand for Bitcoin ETFs from hedge funds. Basis trading may drive the demand for Bitcoin ETFs from hedge funds, which seek to arbitrage the differences between Bitcoin spot and futures prices. As mentioned earlier, 13F filings show that as of March 31, 2024, over 900 U.S. investment firms held Bitcoin ETFs, including some well-known hedge funds such as Millennium and Schonfeld. Throughout 2024, the financing rate for ETH on various exchanges averaged higher than that of BTC, indicating (i) relatively greater demand for going long on ETH, and (ii) the potential for a spot Ethereum ETF to bring more demand from hedge funds looking to utilize basis trading.

BTC and ETH financing interest rate

Factors Affecting the Price Sensitivity of ETH and BTC

Since we estimate that the ratio of Ethereum ETF inflows to market capitalization is roughly equal to the ratio of Bitcoin flows to market capitalization, we expect the price impact to be roughly the same under all other conditions being equal. However, there are several key differences in the supply and demand of these two assets, which may lead to Ethereum prices being more sensitive to ETF flows:

• Exchange-held supply: Currently, the proportion of BTC held by exchanges is greater than that of ETH (11.7% vs. 10.3%), which suggests that the supply of ETH may be tighter. Assuming inflows are proportional to market capitalization, the price sensitivity of ETH will be higher. (Note: This indicator is heavily dependent on exchange address vesting and there is significant variation between different data providers).
• Inflation and Burn: 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 a net negative issuance (annualized -0.19%) because the new issuance paid to stakers (+0.63%) has been offset by the burned base fees (-0.83%). In the past month, the base fees of ETH have been relatively low (annualized -0.34%), which failed to offset the new issuance (annualized +0.76%), resulting in a net positive annualized inflation rate of +0.42%.
• ETF Holdings: Since its launch, a total of 251,000 BTC has entered the US spot ETF (excluding the initial balance of GBTC), accounting for 1.3% of the current supply. If calculated on an annual basis, the ETF will absorb 583,000 BTC, accounting for 3.0% of the current BTC supply, which will far exceed the dilution caused by miner rewards (0.81% inflation rate).

However, the actual market liquidity available for purchase is far lower than the reported current supply. We believe that a better representation of the available market supply for each asset in the ETF would include adjustments for staked supply, dormant/lost supply, as well as supply held in cross-chain bridges and smart contracts.

Adjusted supply calculation for BTC and ETH

• Staking supply (discount: 30%): Staking reduces the amount of tokens available for ETF purchase. Currently, Bitcoin does not have staking function. Ethereum requires staking ETH to secure the network, but stakers can unstake a portion of their ETH for other purposes. Currently, the staked ETH accounts for about 27% of the current ETH supply, and we use a 30% discount to estimate the available market supply, resulting in an 8.2% supply discount.
• Dormant / Lost Supply (Discount: 50%): Some BTC and ETH are considered irretrievable (e.g. lost keys, shipwrecks), resulting in a reduced available supply. We calculate the dormant/lost supply using BTC addresses that have been dormant for over 10 years and ETH addresses that have been dormant for over 7 years, which account for 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 some of the supply held in assumed dormant addresses may come back online at any time.
• Supply in cross-chain bridges and smart contracts (discount: 25%): This is the supply locked in cross-chain bridges and contracts for production purposes. For Bitcoin, BitGo's custodied BTC balance for wrapped BTC (wBTC) is approximately 153,000 BTC, and we estimate a similar amount locked in other cross-chain bridges, totaling about 1.6% of the BTC supply. The ETH locked in smart contracts accounts for 11.4% of the current supply. We apply a discount to this balance, lower than the staked supply, i.e., 25%, because we assume that this supply is more liquid than the staked supply (i.e., may not be subject to the same lock-up requirements and withdrawal queue restrictions).

The adjusted supply of BTC and ETH is calculated by applying discount weights to each factor. We estimate that the available supply of BTC and ETH is 8.7% and 14.4% less than the reported current supply.

Overall, the price sensitivity of ETH to relative market capitalization-weighted inflows should be higher than that of BTC, for the following reasons: (i) the available market supply is lower based on adjusted supply factors, (ii) the percentage of supply from exchanges is lower, and (iii) the inflation rate is lower. Each of these factors should have a multiplier effect on price sensitivity (rather than an additive effect), with prices often being more sensitive to significant changes in market supply and liquidity.

Looking Ahead

Looking ahead, we still face several issues in adopting and second-order effects.

• How should allocators view BTC and ETH? Will existing holders migrate from Bitcoin ETF to ETH? For allocators, some rebalancing is expected. Will spot Ethereum ETF attract new buyers who have not yet purchased BTC? What will the potential buyer's portfolio be? Will they only hold BTC, only hold ETH, or hold both?
• When can the staking function be added? Will the adoption of the spot Ethereum ETF be affected without staking rewards? Will the investment demand for DeFi, tokenization, NFT, and other encryption-related applications further increase the adoption rate of Ethereum ETF?
• What potential impact does this have on other altcoins? Are we more likely to see approval of ETFs for other altcoins after Ethereum?

Overall, we believe the launch of the Spot Ethereum ETF will have a significant positive impact on the adoption of Ethereum and the broader cryptocurrency market for two main reasons: (i) expanding the reach of cryptocurrencies, (ii) gaining greater recognition for cryptocurrencies through regulatory agencies and trusted financial service brands. ETFs can broaden the coverage of retail investors and institutions, provide wider distribution through more investment channels, and support Ethereum for a wider range of investment strategies in portfolios. In addition, financial professionals' further understanding of Ethereum will accelerate its investment and adoption.