(Kitco News) – The cryptocurrency market is set to get its next boost in sentiment and valuation as multiple spot Ethereum (ETH) exchange-traded funds (ETF) are expected to launch on Tuesday, marking the second major ETF listing of the year after the launch of multiple spot Bitcoin (BTC) ETFs in January.
What are we expecting today for the Ethereum ETFs?
We expect them to begin trading tomorrow. That means we should see a bunch of filings on SEC site today that say the ETFs' prospectuses have gone "effective". Likely after or around market close. Here are the race entrants: pic.twitter.com/AkBxEjBRvv— James Seyffart (@JSeyff) July 22, 2024
While the community is excited about the launch, analysts widely expect Ether ETFs to see a more muted debut compared to the Bitcoin ETFs, which broke volume and inflow records after launching and have recorded a net flow of $16.2 billion to date, according to data provided by Dune Analytics.
"There are some parallels and key differences between the BTC and ETH spot ETF launches, particularly in terms of market sizing, supply dynamics, price sensitivity, and native yield properties,” said Mara Schmiedt, CEO of Alluvial. “While BTC spot ETF inflows hit a higher-than-expected ~$60 billion AuM target in the US this year, we can anticipate ETH ETF inflows to reach approximately 30% of BTC's total market size, or ~$20 billion+ at current prices.”
While the flows are expected to be lower, they will still have a positive impact on Ether’s price, she said, especially because Ethereum has a lower market cap.
“ETH ETF inflows will likely result in higher pricing sensitivity and impact relative to BTC, potentially catapulting this number well over $20 billion in the initial months post-launch,” Schmiedt said. “An interesting and important difference between BTC and ETH is that staking on Ethereum introduces a native rate of return, currently around 3.3%, that may prove compelling to investors seeking fixed income-like alternatives to equities, enabling portfolio diversification and inflation hedging.”
“With roughly 38% of the current ETH supply locked in staking, bridges, and DeFi, and another 10% sitting on retail exchanges, ETF-driven ETH inflows could have a significant upward price impact,” she added. “The combination of ETH's supply constraints and possible ETF-induced demand shock could be the tipping point for Ethereum and other cryptocurrencies into the next market cycle.”
“The adoption of Ethereum ETFs marks another step towards bringing the worlds of crypto and traditional finance closer together,” said Adam Berker, Senior Legal Counsel at Mercuryo. “This action serves to further affirm ETH's status as a legitimate financial and investment instrument that has received the regulator’s approval. Furthermore, it opens up another way for institutional investors to invest in crypto through these ETFs, driving liquidity in the industry.”
He added that while it’s “hard to say whether the popularity of Ethereum ETFs will match those on Bitcoin when they first launched, they will definitely be in demand.”
“Since the news of the possible adoption of ETH ETFs first appeared, the market has been showing a good reaction to all subsequent updates that hinted towards a positive decision by the SEC,” Berker said. “I would also say that this is a positive signal when it comes to the potential adoption of ETFs on other crypto cryptocurrencies, as well.”
“When Bitcoin ETFs were adopted, they certainly laid down the groundwork for this type of instrument,” he added. “But in regards to Bitcoin, the SEC had no disputes regarding its status – whether it was to be considered a security or a commodity. In relation to Ethereum, such a dispute did, in fact, exist, but, nevertheless, the regulator decided to go through with approving it.”
Berker suggested that “since the SEC’s attitude towards other cryptocurrencies is more or less the same as towards Ethereum, we can assume with relative confidence that in the future, the regulator will look more favorably on proposed ETFs for other cryptocurrencies as well.”
“Another argument to support this stance is that cryptocurrencies are currently a popular instrument in the US,” he said. “The crypto regulation landscape thawed after BTC ETHs approval, and now the crypto industry is reacting positively to the sentiment around ETH ETFs.”
Andrew O’Neill, Digital Assets Managing Director at S&P Global Ratings, said the launch of Ether ETFs “will likely bring new investors to the Ethereum space,” and suggested that the top smart contract platform is evolving into a “settlement layer for financial markets.”
“In recent months we have seen the issuance of digital bonds on public blockchains, as well as Blackrock’s issuance of the BUIDL fund on Ethereum,” O’Neill said. “Investors need to understand the drivers of the value of Ether. Ethereum is fundamentally a tech platform and the value that flows to Ether holders is driven by the scale of adoption of that platform. One potentially significant use case is to act as a settlement layer for financial markets.”
He said “One key roadblock holding back blockchain adoption is a lack of interoperability,” adding, “To date, digital bonds have primarily issued on private permissioned blockchains set up by an institution.”
“Each of these private blockchains is a ‘walled garden’ that does not support a liquid secondary market for these bonds to trade,” he said. “Without a secondary market for digital bonds, they will not be adopted at scale. Ethereum provides one path to interoperability, but understanding its risks and dependencies is key to robust implementation.”
“Many private blockchains have been designed to be compatible with Ethereum’s Virtual Machine [EVM], which may support convergence around the Ethereum ecosystem over time,” O’Neill said. “Important risk considerations in that scenario will include concentration risks within Ethereum’s consensus mechanism and defining legal settlement finality (as in many jurisdictions legal frameworks governing settlement have been built with existing infrastructure in mind).”
Looking ahead, O’Neill said that S&P Global Ratings anticipates “institutions will continue testing the waters in the Ethereum ecosystem. Specifically, they may explore the use of token-level permissions to meet KYC obligations, and the use of zero-knowledge proof technology to address privacy requirements.”
“Regulatory developments may smooth the path for increased competition in U.S. crypto custody markets,” he added. “We are monitoring developments around the SEC’s ‘SAB 121’ rule,” which “currently requires crypto assets held in custody for clients to be reported on balance sheet with a corresponding liability.”
“This rule makes it prohibitive for U.S. banks to provide custody for crypto assets,” O’Neill explained. “Although the House and Senate initially voted to repeal SAB 121, this was vetoed by President Biden and the rule remains in place. There are reports that the SEC may grant exemptions to some institutions, which may help broaden the market of potential crypto custody providers.”
“As a result of SAB 121, there is little competition for crypto custody services in the US: indeed, the custody of Bitcoin held in ETFs is highly concentrated with a small number of providers,” he noted. “We expect this to be similar for Ether ETFs upon their launch. Initially these ETFs will not stake the underlying Ether, therefore concentration among custody providers will not affect concentration risks in the network itself.”
“It is likely that this will change eventually (some applications initially contemplated staking but removed this prior to approval, and staking products exist in other countries),” he concluded. “A competitive market for staking custodians at that point would help to mitigate concentration risks.”
The first 100 days
According to a report sent to Kitco Crypto from algorithmic trading firm Wintermute titled The First 100 Days: Forecasting Spot ETF Inflows & Price Impact, “The imminent launch of Ether ETFs are generating interest following the success of Spot Bitcoin vehicles which accumulated $13.8 billion in the first 100 days.”
“Analysts hold varying views on Ether ETFs. Optimistic arguments emphasize the aforementioned robust market presence and diverse applications, such as smart contracts, decentralized finance (DeFi), and non-fungible tokens (NFTs),” the report said. “On the other hand, cautious ones highlight regulatory complexities, including staking mechanisms, which could challenge ETF integration and demand.”
“To forecast Ether ETF inflows, analysts commonly use Bitcoin Spot ETF net inflows as a benchmark,” the report noted. “This approach makes sense because Bitcoin ETFs provide recent and relevant data. They also set a precedent in terms of investor behavior, regulatory response, and market dynamics, offering valuable insights into potential performance for Ether ETFs.”
“Analysts estimate that Ether ETF inflows will range between 15% and 20% of those observed with Bitcoin,” Wintermute analysts said. “This projection translates to an anticipated annualized inflow of approximately $4.8 billion to $6.4 billion in the first year.”
“However, our view is the actual demand may be lower, potentially ranging between $3.2 billion and $4 billion,” they added. “This conservative estimate is influenced by the absence of a staking mechanism, which could diminish Ethereum’s attractiveness as an ETF investment vehicle.”
“Nevertheless, potential changes in the SEC's regulatory stance, possibly swayed by the U.S. political landscape following November elections, could lead to a revised demand forecast,” the report said. “Highlighting this, recent comments from SEC Commissioner Hester Peirce suggested that staking is ‘open for consideration.’”
As for the effect of the ETF launches on Ether’s price, Wintermute analyst said, “Using basic assumptions and the baseline expectations that Ether ETFs will see 15-20% of Bitcoin’s flow, we forecast [an] 18% to 24% price increase under this scenario.”
“Given that markets do not operate in a vacuum, it's important to remember that this forecast is made without considering other market data,” they said. “It assumes a scenario similar to Adam Smith’s 'small island economy,' where no additional factors influence the market. In reality, this is not the case, so this exercise should be viewed more as a tool to manage expectations rather than a precise prediction.”
“Our perspective is that these ETFs will probably see lower-than-anticipated demand, primarily due to significantly reduced interest from institutional investors compared to Bitcoin ETFs,” the analysts said. “The absence of a staking mechanism diminishes Ethereum’s appeal as an ETF vehicle and whilst there are several potential narratives issuers can tap into, there's a distinct lack of collective story to rally behind.”
“Considering this, we project year-1 annualized flows to be between $3.2 billion and $4 billion,” the report concluded. “However, if staking is permitted in the ETFs – a change dependent on a significant political shift in the US – would expect this range to increase.”
