ETFs bring awareness but are less effective than private funds as an ETH investment vehicle.
With the recent approval, launch, and success of spot bitcoin ETFs, all eyes have turned to the possibility of spot ETH ETF regulatory approval. However, under the current administration, this outcome is deemed unlikely. Moreover, an ETH ETF may initially lack a staking reward component, which is a crucial aspect of ETH total return.
The primary value of crypto-ETFs lies in normalizing crypto investing for traditional finance allocators. Large ETF providers entering the space lend legitimacy and enable allocators to invest in crypto without career risk. Despite the industry benefits of a spot ETH ETF, the return characteristics may not be as attractive as total return options.
Currently, rewards from staking ETH exceed 3% per annum, as per CESR, the benchmark composite ether staking rate. Investing in an ETH ETF could put investors at a disadvantage compared to staked investments, with CESR reaching as high as 8% over the past twelve months.
Mechanically, staking affects liquidity due to validator entry and exit queues, with queues reaching 45 days during a surge in activity in the summer of 2023. Staking, designed for network security, lacks the necessary liquidity for securitization, posing challenges for ETF issuers to provide liquidity and ETH total return, including staking rewards.
Passively holding unstaked ETH may lead to structural underperformance, akin to holding fiat currency in a demand deposit account without interest. This could result in persistent negative tracking error when compared to a total return benchmark, making it an unfavorable position for investors.
For accredited investors, private funds offer an effective solution to gain total return ETH exposure. Buying and staking ETH through a private fund structure avoids regulatory challenges, while managers can manage the fund’s liquidity to stake and unstake ETH on behalf of investors. With appropriate operational setup, a private fund can undergo auditing, benchmarking, and maintain assets in qualified custody.
Disclosure: Methodic has collaborated with CoinDesk’s index affiliate, CoinDesk Indices, on a private fund utilizing the CoinDesk Ether Total Return Index, which combines the CoinDesk Ether Price Index (ETX) and the Composite Ether Staking Rate (CESR) from CoinDesk Indices, administered by digital asset manager CoinFund.
