Summary Grayscale Bitcoin Trust's transition to an ETF may point to potential upside for Grayscale Ethereum Trust, though the market has increasingly priced this in. The SEC's endorsement of Bitcoin ETFs is very limited and does not signal a broad change in regulatory approach. There is hope for an Ethereum ETF in May 2024 based on the likely decision deadline, legal logic, and status of Ether, but the remaining upside is small, given risks. Overall, this appears a positive return trade, but there may no longer be sufficient compensation for the risk and volatility at current levels. The SEC's heavily caveated recent approval of a wave of Bitcoin (BTC-USD) ETFs on January 10 2024, and the expectation that that would happen, have fueled a excitement around crypto assets and mechanically closed what was a material NAV discount from earlier in 2023 for the Grayscale Bitcoin Trust ( GBTC ), which is now an ETF. It appears there is some potential upside in the Grayscale Ethereum Trust ( OTCQX:ETHE ) as a result, but I am no longer sure that the reward is compensation for the risk, especially in the context of a very narrow endorsement for Bitcoin ETFs from the SEC. A Very Limited Endorsement From The SEC There's now a chance that a similar dynamic plays out with the Grayscale Ethereum Trust. However, it's also important to note that Ethereum has to some degree rallied in sympathy with Bitcoin and the NAV discount has narrowed materially too. It's worth reading SEC Chair Gensler's note on Bitcoin ETF approval in full , which was definitely extremely muted and included the following statements in the broader announcement: Importantly, today’s Commission action is cabined to ETPs holding one non-security commodity, bitcoin. It should in no way signal the Commission’s willingness to approve listing standards for crypto asset securities. And then later in the same announcement. Though we’re merit neutral, I’d note that the underlying assets in the metals ETPs have consumer and industrial uses, while in contrast bitcoin is primarily a speculative, volatile asset that’s also used for illicit activity. Of course, we should not lose sight of the fact that the SEC has approved a raft of Bitcoin ETFs (or ETPs to use their preferred term). But the SEC has done so while continuing to express very extreme reservations about crypto. In a sense, Bitcoin ETFs may have won this battle, but the SEC appears to remain in a war against crypto assets more broadly. Without the legal ruling from summer 2023 , it appears extremely unlikely Bitcoin ETPs would have launched. Is There Hope For An Ethereum ETF In 2024? Despite the SEC's continued concerns around crypto, I believe there is hope for an Ether ETF later in 2024, here's why. The Deadline I believe that the Ethereum ETF application that the SEC has to first respond to comes from VanEck in the Federal Register on September 20, 2023. Assuming a 240-day comment period, that would create a deadline for the SEC on May 17, 2024. Others disagree on the precise date here, but May 2024 seems likely. Of course, there's no guarantee that the SEC makes a positive decision then. The Legal Logic Next, I believe the legal logic holds for Ether ETFs from the Grayscale legal ruling. The court essentially held that the SEC should not distinguish between spot trading and futures trading for the same security, because spot and futures trading are necessarily extremely correlated, both in theory and if you look at historic return patterns. Importantly, regulators must be consistent in their behavior on very similar topics. The full ruling is here for reference. Now, Ether futures ETFs are already approved such as the ProShares Ether Strategy ETF (EETH). Therefore, using similar logic to the Bitcoin legal case, an Ethereum spot ETF may be approved. The Status Of Ether Lastly, the SEC likely does not want to open the floodgates for all crypto products, and so it may find a way to reject Ether ETFs. The path here could be that Ether is a security not a commodity. However, again the same legal ruling that allowed a Bitcoin ETF could be invoked, since that rested on the fact that a futures ETF approval meant that a spot ETF could not be blocked. Also, the Chair of The U.S. Commodities Futures Trading Commodity has stated that Ether is a commodity in Congressional testimony . What Next? Despite the SEC's purposefully guarded and limited approval of Bitcoin ETFs, they may struggle to find grounds to block an Ether ETF when the decision point likely arrives in 2024. However, the tone of the Bitcoin ETF ruling suggests that they may try to find grounds to block Ether ETFs. As such an Ether ETF may not be considered a complete certainly following the Bitcoin ETF decision, but does appear highly likely. I would interpret that as an 80% chance of Ether ETF approval in May 2024. Does that create an investment opportunity? Scenario ETHE potential upside/downside Probability May 2024 approval +13% 85% no May 2024 approval -30% 15% Expected Return 6.6% Notes on the table above. +13% is ETHE's upside to NAV at the time of writing, though this is extremely volatile on an hourly basis. -30% assumes that the ETHE discount would widen back to similar levels as summer 2023 if an Ether ETF were blocked. That leads to a 6.6% expected return in about 4 months, or perhaps a 21% equivalent annualized return. That's not massively attractive in the context of other opportunities, but does suggest upside from current levels. Perhaps more importantly, if historical volatility is any guide, the move in Ether's price is likely to dwarf any move in the NAV discount. I do own ETHE today, but in the context of the SEC's apparently very reluctant approval of Bitcoin ETFs and the somewhat ambiguous status of Ether as a commodity from the SEC's perspective, I have trimmed some recent gains and am tempted to wait for the prospect of a wider NAV discount to add more to my position. I do think ETHE ETF approval more than likely happens in May, but the slim chance that things could go wrong given a very anti-crypto SEC when a high chance of ETF approval is largely priced in at this point gives me pause. Conclusion There is likely upside for the Grayscale Ethereum Trust should the discount to NAV close on a favorable ETF ruling in May 2024. However, this is a volatile asset and the SEC appears to continue to take a very anti-crypto stance in its regulatory approach. It may be challenging for the SEC to find a robust way to block Ether ETFs in the context of the court's Bitcoin ETF decision which should have a clear read-across to Ether, but, still the SEC may be incentivized to do so given their current apparent attitude to crypto products. I suspect Ether ETF conversion is very likely to happen, but given the relatively narrow discount and inherent crypto volatility I won't be adding to my ETHE position at current levels as the small level of potential remaining upside does come with considerable risk and given crypto volatility there may be better entry points in the future. Risks Most obviously ETHE may not be permitted to convert to an ETF. That would likely create a material loss as the NAV discount widens. There are other scenarios too such as a delayed decision or another legal challenge. All of these could create downside given increased uncertainty. Ether is extremely volatile and gains or losses in the underlying crypto asset will likely exceed the impact of any NAV discount changes. ETHE is a high fee investment, with a management fee of 2.5% currently. There are unique risks with crypto assets in that the underlying technology may fail or be hacked in some way, or that the custodian may somehow lose custody of the crypto asset. These scenarios could result in a total loss.
