Grayscale Ethereum Trust: Approaching Our Final Destination? (ETHE)

In my last article covering the Grayscale Ethereum Trust (OTCQX:ETHE) I made the case that ETHE shares still provided arbitrage traders a terrific setup at a 30% discount to net asset value.

For me, ETHE is a very simple arbitrage trade. If we like ETH and we think there will ultimately be a spot ETH ETF in the United States either under this administration or the next one, I think ETHE is still a really great trade at a 30% discount.

The price has more than doubled since then; in part, because the NAV discount has been cut in half, in addition to the underlying simply performing well. I still like the setup here, but we are running out of rope on the arbitrage. In my view, when the market starts to price in a spot Ethereum (ETH-USD) ETF in the United States, the ETHE discount will likely close in the same way the Grayscale Bitcoin Trust (GBTC) NAV discount closed when the fund’s spot conversion prospects became increasingly more positive in late 2023.

The GBTC discount rate ended 2023 at about 8%. To this point, the Ethereum arb trade has worked out considerably well, as it has closed from 30% in September to just 14% as of article submission. Grayscale has indeed filed with the SEC to convert the Ethereum fund to a spot ETH ETF, with a final deadline in mid-June. Similar to how the discount in GBTC has completely closed with that fund’s successful conversion to a spot ETF, the same would theoretically be true for ETHE should a conversion application be approved as well. There are additional things to consider, and I’m actually not as convinced the conversion will be approved as others seem to be any longer.

Spot ETF Demand

Grayscale is not the only company that has eyes on a spot Ethereum ETF in the United States. As of article submission, there are no less than a half dozen companies vying for spot Ethereum ETFs with Franklin Templeton recently joining Grayscale, Ark 21Shares, VanEck, Invesco and BlackRock (BLK) in previously filing for spot funds. Stripping out the noise, the Bitcoin funds have performed well in my opinion:

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Source: BitcoinTreasuries.net as of 2/12/24, AUM at $49k BTC price

Although the initial reaction to the Bitcoin (BTC-USD) spot ETFs was a selloff in coin price coupled with a rotation in AUM that had net BTC flow just marginally higher, as the weeks continue to roll on we can see the demand for spot ETFs has been intensifying.

As of February 12th, there is more than 693k BTC spread out among the spot Bitcoin ETFs. Deducting the 619k BTC balance held by GBTC before the conversion shows us a 74k net flow of BTC into traditional financial products. At a $49k BTC price per coin, that net flow amounts to about $3.6 billion in new investment capital in these funds in roughly a month. I share this to make the point that spot ETFs are clearly what the market prefers to futures ETFs. Something else to consider is investment product fund flow by asset:

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Source: CoinShares & Bloomberg, figures in millions

Considering the spot Bitcoin ETF approvals happened just two weeks into 2024, it’s no surprise seeing the massive investment fund edge that BTC has over each of the other crypto assets in the table above. That said, it’s surprising to me that we don’t see more investment demand happening in Ethereum given the increase in spot ETH ETF applications.

Last year, we observed nearly $2 billion come into Bitcoin before the ETFs were approved, and the overwhelming majority of it came in the last few months of the year. I suspect the lack of investment flow into Ethereum so far in 2024 could be because the market may not believe there will be a spot ETF approval in May.

May Deadline Odds

The SEC has until May 23rd to make a ruling on the VanEck and Ark 21Shares ETFs. Some analysts believe the SEC will indeed approve these ETFs. And I’ve even speculated here on SA that Ethereum investment has some catching up to do. So far, we’re not seeing a spot ETF approval get front ran, and the only logical assumption would be that it’s far from a done deal.

Beyond simple fund flows and coin price, we can also look to betting markets like Polymarket to get a read on how independent bettors believe these May applications will shake out. The chart above shows the outcome odds for a spot ETH ETF approval by the end of May. Though the “yes” action was as high as 80% in early January just before the approval of the Bitcoin ETFs, the market is currently much less convinced about it now with just 48% favoring approval.

Staking Yields?

What will be important to watch play out is how the US Securities and Exchange Commission views any potential language about Ethereum staking within these funds. In early February, Ark 21 Shares amended its S-1. One of the notable changes included language about staking:

The Sponsor may, from time to time, stake a portion of the Trust’s assets through one or more trusted third party staking providers (“Staking Providers”). The Sponsor generally expects to stake ether tokens from the Trust’s Cold Vault Balance.

The lack of staking yield has long been a valid criticism of buying Grayscale’s ETH fund rather than simply buying ETH and staking it either directly or through a third party liquid staking provider like Lido Finance (LDO-USD). My personal read on this is staking will be very difficult to get through and will likely complicate these ETF approvals because the SEC has previously taken issue with “staking as a service” products.

This may be a reason why the betting markets don’t see approvals and May, and why other fund managers as measured by the previously shown CoinShares/Bloomberg data haven’t been frontrunning a major move in ETH through any meaningful ETH inflow so far this year.

Summary

Longing ETHE remains an arbitrage play above all else. For Ethereum price exposure in a traditional investment account, speculators aren’t limited to just ETHE. There are futures ETFs and public companies with large ETH positions in corporate treasury that don’t charge 2.5%. At a 14% discount to NAV, ETHE is still a nice trade if ETH stays flat or goes higher. However, the closer that NAV discount gets to 0%, the less attractive ETHE looks without staking yield in the fund. I’m personally still long ETHE, but I have reduced my position and will likely take the position off entirely in the event that we get cheaper spot ETF alternatives.

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