Points of impact: Ethereum ETFs and crypto markets

The approval of spot ether ETFs in the US marks another significant milestone in the mainstream adoption of crypto. Long term, it could pave the way for other digital assets to follow suit. On a shorter horizon, it will allow US institutions and individuals to access ETH in new ways. In this article, we analyze the different points of impact approval has on the market.

Pre-approval impact

Before official approval, Ethereum ETFs had an impact on the markets. On May 21, 2024, Bloomberg analysts significantly increased their estimated probability of a spot ether ETF approval to 75%, up from just 25% previously. This improvement came after the US SEC asked both exchanges and issuers to amend their filings and refile them with amendments.

On the back of the prediction, traders sparked the largest two-day gain for ETH, while also pushing bitcoin closer to its all-time highs. It's notable that the rally extended across the broader market, potentially signaling the broad positive effect on investor sentiment such an approval would have. Compare with Hong Kong, which launched the first spot ether ETFs on April 30, 2024 with an in-kind subscription/redemption mechanism. These ETFs have so far recorded minimal inflows and thus the market impact has been muted. In the UK, on May 22, the FCA authorized professional and institutional investors to trade Ethereum ETPs on the London Stock Exchange. It is too early to tell what the impact of this will be but it is likely to be less important than the US approval.

Immediate impact

Spot bitcoin ETFs had an immediate and strong impact on the markets. We anticipate spot ether ETFs to follow a similar trajectory and attract substantial inflows. At the time of writing, we estimate US-listed ETH ETFs might attract $300-500M in passive capital inflows during their first week of trading. There is also the potential of a broader altcoin rally, as this approval could set a precedent for other proof-of-stake cryptocurrencies to secure spot ETF approvals down the road. While some traders may tactically rotate funds from Bitcoin into Ether and other altcoins, we believe this overall trend will ultimately accelerate the inflow of capital into the cryptocurrency industry.

Institutional impact

Although it is tempting to compare bitcoin and ether ETFs, the two underlying assets differ in some key aspects:

1. Ether introduced EIP1559 - a deflationary mechanism based on transaction fees in the Ethereum network. This implies that institutions can value ether in a way more akin to traditional financial instruments, based on the activity and fees collected on the Ethereum network.

2. Ethereum's Proof-of-Stake mechanism - this encourages ETH holders to stake their tokens in order to contribute to the network's security and operations. Currently, over 25% of the total Ether supply is being staked. This staking mechanism reduces the available Ether supply in the market for ETF issuers to purchase, compared to the case for Bitcoin.

With easy access to ether provided by spot ETFs and considering the above factors mentioned, it is likely that institutional demand for ether will increase, serving the purpose of asset allocation as a complement to bitcoin within their portfolios. This enables diversification of cryptocurrency exposure according to their specific risk and return preferences, rather than relying solely on bitcoin.

On the other hand, the absence of a staking feature in the ether ETF may limit its growth in assets under management (AUM). Institutions that had purchased and staked ETH directly could potentially earn higher returns from the staking rewards. However, the spot ether ETF will still be in strong demand among certain institutional investors, particularly those from traditional finance and highly regulated sectors. These institutions are seeking exposure to ether but may be unable to directly stake their holdings due to compliance or operational constraints.

Retail impact

With nearly a decade of growth and development, ether has stood the test of time, establishing itself as a leader among the altcoins that emerged in the early 2010s. Ether's popularity has been bolstered by the versatility of its smart contract functionality, powering a wide range of applications in areas like decentralized finance (DeFi) and non-fungible tokens (NFTs). The introduction of spot ether ETFs along with future marketing campaigns, might help introduce ether and the broader Ethereum ecosystem to less crypto-savvy retail users. This has the potential to further promote growth and strengthen the overall Ethereum ecosystem, from both a capital and ecosystem perspective.

Mainstream adoption

The introduction of ether spot ETFs represents a major milestone in driving mainstream cryptocurrency adoption. This development also helps clear longstanding regulatory uncertainty surrounding cryptocurrencies. By combining institutional capital and increasing retail accessibility, this can initiate a virtuous cycle, bringing stable liquidity and greater real-world use cases for blockchain technologies. Crucially, the approval of ether ETFs establishes a precedent for recognizing other cryptocurrencies as legitimate investable assets, beyond bitcoin. Overall, this marks a significant step forward in integrating cryptocurrencies into the traditional financial ecosystem and spurring their widespread adoption.