What is a spot ETH ETF: how does a spot Ethereum ETF work?

Following the excitement of the 2024 arrival of spot Bitcoin ETFs, we're seeing increased speculation about what crypto-themed exchange-traded fund (ETF) will be next. Chief among these rumors is how a spot Ether (ETH) ETF might be next given its popularity among institutions and retail traders. The crypto space didn't need to wait long for an answer.

Speculation around a possible spot ETH ETF rose towards mid-2024, with commentators debating the percentage likelihood that such a product would get the green light during the year. Optimism rose and fell, until a sudden acceleration in the process. The week of May 20, 2024 saw the U.S. Securities and Exchange Commission (SEC) request that all exchanges pursuing a Spot ETH ETF update their fillings immediately. Just days later on May 24, the commission approved key 19b-4 regulatory filings, clearing a path towards full approval. With the SEC's latest announcement to give spot ETH ETFs the go-ahead to start trading, all bets are off as we could possibly see another wave of mass adoption similar to the one witnessed with spot Bitcoin ETFs.

What does this all mean, and what happens next? From understanding what a spot ETF is to highlighting the pros and cons of trading a spot Ether ETF, here's everything you'll need to know when it comes to navigating the volatility surrounding the spot Ether ETF announcement.

What is Ethereum?

Conceived in 2013, Ethereum is a popular decentralized blockchain platform with smart contract utility. It revolutionized the crypto world by introducing self-governing smart contracts, allowing users to create and execute automated agreements. Ethereum's ecosystem thrives on the Ether (ETH) cryptocurrency, which acts as a fee for transactions and powers a diverse range of decentralized applications (DApps) like DeFi lending platforms and non-fungible tokens (NFT). These DApps operate without a central authority, opening up new possibilities across various fields.

Why is Ethereum so popular?

Among the various altcoins in the crypto space, Ethereum shines as a particularly captivating ecosystem for both retail and institutional crypto traders. Given its decade of growth and influence within the crypto space, Ethereum has certainly stood the test of time as it stands shoulders above other altcoins that were conceived in the early 2010s. As the first platform to pull off smart contracts without a hitch, Ethereum has achieved numerous feats that include introducing the first-ever NFT standard in 2018 and making a full transition from Proof of Work to Proof of Stake (PoS) as part of the Ethereum Merge. These milestones combined with the fervent Ethereum community and extensive number of DApps in the Ethereum ecosystem make Ethereum a powerhouse in the crypto space.

Now that we understand what Ethereum is and why it's so popular, let's dive into the fundamentals of a spot ETH ETF.

What is a spot ETH ETF?

Also known as a physically-backed Ether ETF, the spot ETH ETF resembles traditional exchange-traded funds, where institutions managing the ETF commit to purchasing ETH and holding ETH in their reserves. The ETF is then listed on a traditional stock exchange and issues shares representing ownership of the ETF. This effectively means traders gain exposure to the underlying ETH held in the institution's reserves when trading the spot ETH ETF.

One key thing to take note of when trading the spot ETH ETF is that owning shares of a spot ETH ETF doesn't directly grant ownership of individual ETH tokens held by the institution. Shareholders hold claims on the value of the ETH holdings, not the Ether itself. Additionally, while institutions hold the underlying ETH, they may use various strategies to manage it, such as lending it out or using it for staking, to potentially generate additional returns for the ETF.

Who is the spot ETH ETF for?

Many believe that the spot ETH ETF will be perfect for TradFi traders who are used to trading stocks and ETFs on traditional brokerages. While directly trading Ether has its charm, it's not for everyone given the inaccessibility and numerous barriers to entry that cryptocurrencies are known for. That's where spot ETH ETFs come in. As setting up wallets, navigating exchanges, and managing private keys can sometimes feel alien and complex, spot ETH ETFs will ease traders who are more familiar with TradFi in gaining exposure to ETH. By trading spot ETH ETFs, traders with little to no experience in crypto can gain convenient exposure to ETH's price movements without needing a cryptocurrency wallet or dealing with the intricacies of directly buying and storing ETH.

How does a spot ETH ETF work?

Confused about how a spot ETH ETF works? Think of the spot ETH ETF as a pool where traders contribute funds to buy ETH. This pool then tracks the price of Ether by holding the coins directly. When the price of Ethereum rises, the value of the ETF shares goes up proportionally, and vice versa. This is distinct from ETH futures-based ETFs, which track ETH's price through derivatives like ETH futures without holding the underlying asset.

To keep pace with the constantly fluctuating price of ETH, the ETF manager works behind the scenes to monitor the market and adjust the ETF's ETH holdings as needed. This typically involves creation and redemption units, which are large blocks of shares exchanged for the underlying Ether. This delicate balancing act aims to ensure your ETF shares accurately reflect the real-time market value of Ethereum, though slight differences can occur due to factors like trading costs and rebalancing schedules.

Advantages of trading spot ETH ETFs

Lowering the barrier to entry to gaining crypto exposure

As mentioned above, crypto can be hard to get into because of the numerous points for potential friction that'll deter anyone new to crypto trading. This can range from fumbling during the Know Your Customer process to choosing the right spot pair to trade the crypto you want. With the spot ETH ETF, traders who already have trading accounts with established TradFi brokerages can simply look up the ticker for the spot ETH ETF and trade it as they normally would with any other forex pair or stock.

Being open to institutional traders

With a spot ETH ETF, trading ETH becomes even more accessible from an institutional perspective. As institutions like pension funds and asset managers may have specific regulations that prevent them from trading Ether and other coins directly, smart money has long been barred off from gaining exposure to cryptocurrencies. With a spot ETH ETF, they might have a better chance of being allowed to trade it as it's an SEC-approved trading vehicle.

New ways to trade ETH

On top of traders buying and selling shares of spot ETH ETFs, traders can also consider alternative methods of trading spot ETH ETF shares. This can range from short-selling it to the downside if they're intending to hedge their overall portfolio or are bearish about Ether to executing options strategies like covered calls to generate additional gains on their spot ETH ETF holdings. Such alternatives will inject a fresh amount of liquidity into the crypto market as more traders gain exposure to Ether through trading the spot ETH ETF.

Disadvantages of trading spot ETH ETFs

ETF expense ratios

For those new to trading ETFs, one thing to take note of is expense ratios, which measures how much of a fund's assets are used for administrative and other operating expenses. While the exact ratio is yet to be known since the spot ETH ETF hasn't yet reached full approval at the time of writing, we can take Bitcoin futures ETFs for reference. The ProShares Bitcoin Strategy ETF has an expense ratio of 0.95%. This is considerably higher compared to other ETFs and mutual funds like the Vanguard S&P 500 ETF, which has an expense ratio of 0.03%. As this is an annualized fee that compounds over the length of time that traders hold the ETF, overall gains earned from trading the spot ETH ETF will definitely be impacted.

ETH ownership

As previously mentioned, share traders technically don't own the Ether since it's managed by the spot ETH ETF manager, who could potentially be lending out or staking the ETH for extra yield. This brings into question concerns of true ownership, since "not your keys, not your coins" is a mantra that many crypto natives swear by and could be a major concern if the ETF liquidates its assets and closes down the line. Judging by the recent amendment made by Fidelity's ETH ETF application, this might be the case should their version of spot ETH ETFs get approved.

The limitation of regular trading hours

Crypto markets are famous for being available 24 hours a day, seven days a week. Unfortunately, the same can't be said about spot ETH ETFs, whose shares are subject to the regular trading hours of when a typical stock market opens and closes. Due to this limitation, traders could potentially miss out on potential opportunities during times when the stock market is closed.

When were spot ETH ETFs approved?

The flurry of activity during late May 2024 suggested earlier this year that a spot ETH ETF approval is imminent. This was hinted at by institutions like BlackRock and ARK Invest who officially filed for spot ETH ETF approvals.

However, the investment management firms, alongside other applicants including Fidelity, Grayscale, and Bitwise, made amendments to their spot Ether ETF applications to remove plans for staking. The amendment was expected, as regulators may claim that staking blurs the lines between a digital asset and a security.

On Thursday 23 May, 2024, the SEC approved firms' 19b-4 regulatory filings following a remarkable turnaround for the spot ETH ETF's prospects. Although significant, this development is by no means the final hurdle. Next up, regulators must clear the S-1 filings made by prospective ETF issuers before the fund can be made available to traders. That process could take a further few weeks or months, with an exact timeframe not yet given.

Official spot ETH ETF approval

Thankfully, the dust seems to have settled as 23 July, 2024 marks the official day when spot Ether ETFs go live for trading. The total list of spot ETH ETF issuers include BlackRock, Grayscale, Franklin Templeton, VanEck, Bitwise, 21Shares, Fidelity, and Invesco. If you've previously traded spot Bitcoin ETFs, you'll likely find some of these names familiar. Planning to trade these spot ETH ETFs? One thing to note is that each issuer has its own set of related fees and fee waivers, so if you're intending to hold them for the long haul, it'd make sense to keep the fees in mind so they don't eat into your overall gains.

Looking ahead, Standard Chartered has announced that a spot Ether ETF approval might send ETH prices rallying to $8,000 by the end of 2024 and skyrocketing to $14,000 by 2025. According to their analysts, this prediction comes in light of high-profile names like Fidelity and Blackrock that pursued spot Ether ETF approvals, and the Dencun upgrade that makes Ethereum transactions more affordable overall.

Should you buy Ether instead?

Although spot ETH ETF shares may offer convenience that's considered useful for traders, the truth is that owning spot ETH ETF shares differs greatly from owning Ether directly. That raises the question — why not just buy ETH itself? To dissect this question further, it's important to consider your priorities and goals as a trader. If you're a trader that's inexperienced with trading crypto and simply want exposure to Ethereum, trading spot ETH ETF shares may be perfect for you. However, if you're a trader that prioritizes ownership and freedom to trade at whatever timing, then the spot ETH ETF might not be suitable for you.

Final words and next steps

Spot Ether ETFs offer a compelling bridge between the allure of Ethereum and the familiarity of TradFi. The availability of a spot Ether ETF as an option for traders represents a significant step forward in making Ethereum accessible to a wider audience. By simplifying access to crypto and allowing for diversification of trading portfolios, the spot ETH ETF opens the world of crypto to a whole new audience. Although trading shares of the spot ETH ETF comes with its own set of risks and disadvantages, it's undoubtedly popular among traders with specific trading preferences and could be the catalyst needed to create a spike in demand for crypto ETFs.

Keen to give trading Ether directly a go? Check out our ETH spot trading pairs and ETH price page for more information.