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An ETH ETF Wouldn’t Deliver Full-Returns to Investors

Apr 30, 2024

As a seasoned crypto investor with experience in navigating the complexities of the digital asset space, I believe that while ETFs bring much-needed awareness and legitimacy to the investing public, they fall short when compared to private funds as an effective investment vehicle for Ethereum (ETH).

ETFs bring awareness but are less effective than private funds as an ETH investment vehicle.

As a researcher closely following the developments in the crypto space, I have noticed a surge of interest in the potential approval of spot Ethereum (ETH) Exchange-Traded Funds (ETFs), following the success of their bitcoin counterparts. However, based on current regulatory conditions, I believe it is an uphill battle to secure such approval. Furthermore, an ETH ETF would initially lack the staking reward component that is a significant part of Ethereum’s total return.

The main advantage of crypto-ETFs lies in their ability to make investing in cryptocurrencies more mainstream for traditional finance investors. With major ETF providers joining the market, it reduces the career risk associated with investing in crypto. While a spot Ethereum ETF offers several advantages for the industry, its return features do not match up to those of total return options.

As a financial analyst, I’ve noticed that the current reward for staking Ethereum is above 3% annually, based on the data from CoinMetrics and Research (CESR). This means that if an investor decides to put their funds into an Ethereum Exchange-Traded Fund (ETF), they might miss out on potential higher returns compared to someone directly staking their ETH. The benchmark composite Ethereum staking rate has even reached up to 8% in the previous twelve months.

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ETH ETFs — A liquidity mismatch due to staking

Staking, which involves validators entering and exiting a network, can limit network liquidity. In the summer of 2023, the entry queue reached 45 days as a result of heightened activity. However, it’s important to note that staking is not primarily focused on providing the required liquidity for securitization within the network. Given the significant demand for liquidity in an ETF, issuers may find it challenging to supply sufficient liquidity and ensure strong Ethereum returns, including staking rewards.

Structural Underperformance

As a researcher studying the Ethereum blockchain, I would put it this way: Leaving your ETH unstaked for extended periods is similar to keeping excess fiat currency in a savings account that earns no interest. In essence, you’re missing out on potential returns by not actively participating in the Ethereum network. This passive approach results in underperformance relative to a total return benchmark and creates negative tracking error. Ultimately, such a stance may not be sustainable for an investor aiming to maximize returns.

Private Fund Solution

As an analyst specializing in investments for accredited investors, I would recommend considering private funds as an alternative to directly buying and staking Ethereum (ETH) for total return exposure. By investing in a private fund, you can bypass regulatory hurdles associated with purchasing and holding ETH yourself. Moreover, skilled fund managers can manage the liquidity of your investment, enabling them to stake and unstake ETH on your behalf. With proper planning, a private fund offers transparency through regular audits, benchmarking against industry standards, and secure custody of assets in qualified institutions.

Disclosure: Methodic collaborated with CoinDesk’s index affiliate, CoinDesk Indices, on a privately managed fund. This fund employs the CoinDesk Ether Total Return Index as its benchmark. The CoinDesk Ether Total Return Index is a blend of the CoinDesk Ether Price Index (ETX) and the Composite Ether Staking Rate (CESR), both calculated by CoinDesk Indices, and overseen by digital asset manager CoinFund.

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2024-05-01 19:11