The Future of Ethereum ETF from the Success of Bitcoin ETF

Author: Andrew Kang, Co-founder of Mechanism Capital Source: X, @Rewkang Translation: Shan Ouba, Golden Finance

Bitcoin ETFs provide many new buyers with the opportunity to include Bitcoin in their portfolios. In contrast, the impact of Ethereum ETFs is still unclear.

When BlackRock submitted its Bitcoin ETF application, I was bullish when Bitcoin was at $25,000. Since then, Bitcoin prices have risen 2.6 times, while Ethereum has risen 2.1 times. From the bottom of the cycle, Bitcoin and Ethereum have both returned 4.0 times. So, how much upside can an Ethereum ETF bring? I think that if Ethereum cannot find a strong way to improve economic efficiency, its upside is not large.

Fund Flow Analysis

Overall, Bitcoin ETFs have accumulated $50 billion in AUM, an impressive figure. However, if the existing GBTC AUM and rotation are excluded, the net inflow since launch is only $14.5 billion. These are not real inflows because there are many neutral fund flows to consider, such as basis trades (selling futures, buying spot ETFs) and spot rotations. Based on CME data and analysis of ETF holders, I estimate that about $4.5 billion of net inflows can be attributed to basis trades. ETF experts believe that large holders such as BlockOne also converted spot Bitcoin into ETFs, which is about $5 billion. After deducting these flows, we conclude that the real net buying of Bitcoin ETFs is $5 billion.

From here we can simply extrapolate the situation for Ethereum. @EricBalchunas estimates that Ethereum inflows may be 10% of Bitcoin's. This implies $500 million in real net buying and $1.5 billion in reported net inflows over a 6-month period. Although Balchunas's estimate of the odds of approval is wrong, I think his lack of interest and pessimism about an Ethereum ETF is informative and reflects the broad interest in it from traditional finance.

Personal Forecast

My benchmark is 15%. Starting with $5 billion in real net buying of Bitcoin, adjusting Ethereum's market cap to 33% of Bitcoin's and an access factor of 0.5*, we get $840 million in real net buying and $2.52 billion in reported net inflows. There is a legitimate argument that ETHE is trading at less of a premium than GBTC, so I set my optimistic scenario at $1.5 billion in real net buying and $4.5 billion in reported net inflows. That’s about 30% of Bitcoin inflows.

In any case, the real net buying is much lower than the pre-ETF derivative flows, which totaled $2.8 billion and do not include spot pre-positioning. This means that the impact of the ETF is fully reflected in the price.

* The access factor adjusts the flows from the ETF that clearly favor Bitcoin over Ethereum, given the different holder bases of the two. For example, Bitcoin is a macro asset and is more attractive to institutions with access issues, such as macro funds, pensions, endowments, sovereign wealth funds, etc. Whereas Ethereum is more of a tech asset and is more attractive to VCs, crypto funds, technologists, retail investors, etc., who do not have many restrictions in accessing cryptocurrencies. The 50% ratio is derived by comparing the ratio of ETH to BTC on the CME open interest to market cap ratio.

Looking at CME data, Ethereum's open interest is significantly less than it was before the Bitcoin ETF was launched. Open interest represents 0.30% of supply, while Bitcoin is 0.6%. At first I thought this was an "early" sign, but it can also be said that this reflects the lack of interest of smart traditional financial money in Ethereum ETFs. Traders in the market are getting a good trade on Bitcoin, they usually have good information, and if they don't repeat Ethereum trades, there must be a good reason, which may mean that liquid intelligence is weak.

How did $5 billion push Bitcoin from $40,000 to $65,000?  

The short answer is that it didn't. There are many other buyers in the spot market. Bitcoin has become a globally recognized key investment asset with many structural accumulators such as Michael Saylor, Tether, family offices, high net worth individuals, etc. Ethereum also has some structural accumulators, but I think the number is much lower than Bitcoin.

Remember, Bitcoin reached a market cap of over $69,000/$1.2 trillion before the ETF existed. Market participants/institutions own a lot of spot crypto. Coinbase custody $193 billion, of which $100 billion is from its institutional program. In 2021, Bitgo reported custody of $60 billion and Binance custody of over $100 billion. 6 months after the ETF launch, custodying 4% of the total Bitcoin supply is significant, but only part of the demand equation.

Between MSTR and Tether, you already have billions of dollars of additional buy-in, but not only that, there was also under-allocation before the ETF launched. The idea that ETFs are seen as selling news events/market tops is popular during this time. Therefore, momentum selling in the short to medium term needs to be bought back (2x flow impact). In addition, shorts also need to be bought back once ETF inflows show a significant impact. Open interest actually fell before the launch - this is really surprising.

The Ethereum ETF is positioned very differently. Ethereum's price before the launch was 4x the low, while Bitcoin was 2.75x. Open interest on crypto exchanges increased by $2.1 billion, bringing it close to all-time highs. The market is (semi-)efficient. Many crypto players saw the success of the Bitcoin ETF, expected the same results for Ethereum, and positioned themselves accordingly.

I personally believe that the expectations of cryptocurrency participants are overestimated and out of touch with the real preferences of traditional financial allocators. Those who are deeply involved in the crypto field have a relatively high recognition and willingness to buy Ethereum. However, in reality, for many large groups of non-crypto native capital, the recognition of Ethereum as a key portfolio allocation is much lower.

The Prospects of Ethereum

One ​​of the most common reasons for selling Ethereum to traditional finance is to regard it as a "tech asset". Global computer, Web3 application store, decentralized financial settlement layer, etc. This is a good sales point, and I believed it in previous cycles. But when you look at the actual numbers, it is hard to convince.

In the last cycle, you could point to the growth rate of fees and argue that DeFi and NFTs generate more fees, cash flow, etc., making it a tech investment like a tech stock. But in this cycle, the quantification of fees has done the opposite. Most charts show flat or negative growth. Ethereum is a cash machine, but at $150 million 30-day annualized revenue, 300x P/S, and negative earnings/PE after inflation, how does an analyst explain this price to a family office or macro fund boss?

I even expect less "fake flow" (neutral fund flows) in the first few weeks for two reasons. First, the approval was a surprise and the issuer had less time to market to large holders to convert their Ethereum into an ETF format. Secondly, it is less attractive for holders to switch because they need to give up the yield they would have earned by staking or farming or using Ethereum as collateral in DeFi. But note that the collateralization rate is only 25%.

Does this mean that Ethereum will go to zero? Of course not, at a certain price, it will be considered a valuable asset. When Bitcoin rises in the future, it will be driven up to a certain extent. Before the launch of the ETF, I expect Ethereum to trade between $3,000 and $3,800. After the launch of the ETF, my expectation is $2,400 to $3,000. However, if Bitcoin rises to $100,000 by the end of 2024/Q1 2025, then this may drive Ethereum to a new all-time high, but the Ethereum/Bitcoin ratio will be lower. In the long term, there is still a lot of development to look forward to, and you have to believe that Blackrock/Fink is doing a lot of work to build some financial rails on the blockchain and tokenize more assets. How much value this will bring to Ethereum and on what timeline is uncertain.

I expect the Ethereum/Bitcoin ratio to continue to decline over the next year, ranging between 0.035 and 0.06. Although the sample size is small, we have seen Ethereum/Bitcoin make lower highs in each cycle, so this should not be surprising.