Author: BitMEX Research;Compiled by: Qin Jin, Carbon Chain Value< /p>Abstract: In this article, we discuss the possibility that an Ethereum ETF will be approved in the United States. We are particularly focused on the economics of staking and how the lack of yield may somewhat undermine the appeal of non-staking Ethereum ETF products. We also examine the challenges of implementing a staking Ethereum ETF, specifically the interrelationship between ETF redemptions and the Ethereum staking exit queue system. While these issues may be solvable in the long term, it may be some time before they are resolved in the U.S. given the race to get the product approved.
Overview
The Bitcoin ETF was launched in the United States on January 11, 2024, and these products have been a huge success. ETFs enable new money to enter Bitcoin, which appears to push the price of Bitcoin higher. This begs the question: When will the Ethereum ETF be approved? As with Bitcoin, large asset managers such as BlackRock and Fidelity have submitted Ethereum ETF applications to the U.S. Securities and Exchange Commission (SEC). The SEC seems keen to reject or delay these applications, as long as it has the ability to do so. As with Bitcoin, courts may eventually force the SEC’s hand, and also as with Bitcoin, the SEC may be accused of hypocrisy for allowing an Ethereum futures ETF. In our opinion, an Ethereum ETF is inevitable at some point, it's just a matter of timing. Staking
Ethereum’s staking consensus system and related yields are a key factor to consider for ETFs. Some argue that because Ethereum staking generates returns, or due to stakers’ block proposals, this makes Ethereum a “security” and therefore provides grounds for the SEC to reject an Ethereum ETF. This is not a question we want to analyze. If we were forced to classify some cryptocurrencies as securities and others not, we might take the simple Bitcoin maximization position that if a coin is issued, it is a security, and if not, it is not a security. Therefore, in our hypothetical system, Bitcoin and Dogecoin would not be classified as securities, while Ethereum would be. We don't bring staking into it. However, our point here is not important. The US Securities and Exchange Commission and the US courts will do what they should do. This is not an issue for us to discuss further. In this report, we will focus on the economic aspects of staking and the impact this may have on any ETF. In our view, regardless of what regulators decide, the staking yield issue will have a significant impact on ETFs and is an important economic issue. The Attractiveness of Staking
Ethereum’s staking yield is currently about 3.7%. Staking is a core part of Ethereum, both from a narrative and economic perspective. This yield is likely a factor that attracts investors to Ethereum and is a key factor that differentiates Bitcoin from Ethereum. While not all Ethereum investors care about yield, the issue of yield may be a more important consideration for institutional investors and ETF buyers. Of course, in the long run, the original price of Ethereum may be lower than that of Bitcoin, but Ethereum holders may receive higher returns than Bitcoin holders due to the staking benefits they can enjoy. However, for some ETF investors, the ETF may not be able to be pledged, so the staking system may make Ethereum less attractive or unsuitable for these investors. Existing Ethereum holders and subscribers may be reluctant to stop subscribing and convert their Ethereum holdings into ETFs because they do not want to lose their gains. At the same time, new funds may be reluctant to invest in Ethereum ETFs because they know they are not being treated as well as subscribers and therefore may receive lower returns. Perhaps these investors will choose Bitcoin ETFs. Some investors (i.e. those who require exchange-listed products to gain exposure to cryptocurrencies) are unable to directly stake or purchase tokens like stETH. How big an impact this factor will have is uncertain, but if staking yields increase, missing out on the yield could be a key factor for some new investors. Validator Exit Queue and ETF Redemption
The solution here may seem obvious. ETFs can directly subscribe to Ethereum. However, this may not be possible for regulatory reasons as well as practical reasons related to product redemptions. To withdraw from Ethereum's staking system, you need to go through two queues. We could also consider entering queues, but from an ETF perspective, these queues are not that important as any delay in deploying staking will only reduce the yield of the product. In contrast, exiting the queue may be an issue to consider during the ETF redemption process. The two exit queues are as follows:Standard exit queue:This is a first-in, first-out queue system for the staking exit process. This is considered crucial from a stability and security perspective of the subscription system, as it prevents too many subscribers from exiting too quickly. The queue is based on a churn limit, which is a limit on the number of validators allowed to exit per epoch (6.4 minutes). The current value of the churn limit is 14, which varies based on the total number of active validators. If the value is 14, that is approximately 100,000 Ethereum per day. Based on current Ethereum spot prices, this equates to roughly $400 million. From an ETF perspective, daily outflows could certainly be larger than this number under certain economic conditions (look at what GBTC has done since January 11, 2024). Due to the nature of queues, the more people who want to exit, the longer the wait will be. The line is almost empty at the moment, so the wait time is only about 12 hours. It’s not hard to see that in certain periods, perhaps periods of turmoil in the cryptocurrency market, perhaps times when people want to redeem their Ethereum ETFs, the wait could be longer, even up to several months. Therefore, this is a potential issue for staking Ethereum ETF providers. Authenticator scan delay: The second wait occurs after exiting the queue and is more of an implementation detail than an economic limitation on the system. The queue is basically a random wait, not a first-in-first-out type of queue. This delay applies both to validator withdrawals and to normal partial withdrawal payments. There is a limit of 16 times per slot or 512 times per epoch. This wait time is currently around nine days and, unlike the first wait time, will not increase significantly during times of financial stress. However, the nine-day waiting period is much longer than the redemption time for ordinary ETFs, which is usually one to two business days. If validators are marked down, there will be additional delays, resulting in longer wait times. Of course, price cutting is another risk of staking Ethereum ETF products, which needs to be explained clearly to potential investors. Therefore, the exit queue system will undoubtedly increase the difficulty of implementing an Ethereum staking ETF. Problems can be solved
Of course, these problems can be solved. First, the ETF could pledge only a portion of its Ethereum holdings, leaving the other portion available for immediate withdrawal. This will reduce profitability and increase product complexity, but is certainly feasible for established product providers. There may be teams that specialize in liquidity, which is not entirely different from what is the case with large ETFs that hold illiquid securities. The number of shares held by the ETF is equivalent to 9 days of average daily trading volume, which is comparable to the 9-day exit wait, although the two are not exactly the same. Additionally, the terms and conditions of the Ethereum Staking ETF may be modified to allow for a delay in the redemption process in certain circumstances. However, given the way the exit queue system works, it is possible that in the event of a downward spiral, large ETF redemptions would actually create more exit delays, which is not an ideal product structure and could arguably cause A systemic risk. Of course, from an Ethereum perspective, this risk exists with or without an ETF, but ETFs may exacerbate the problem. Another idea we like is to avoid Ethereum staking ETFs altogether and instead issue a stETH ETF. In this way, the redemption problem is completely solved or moved to Lido. It is worth noting that ARK/21 Shares has issued an Ethereum pledged ETP in Europe, with an asset size of US$640 million. ARK’s application for an Ethereum ETF in the United States also includes provisions that allow for the pledge of some of the fund’s assets. However, as we saw with Bitcoin, the SEC seems keen to put up every possible hurdle for ETF providers. As a result, product publishers are eager to get their products approved. It appears that issuers may not want to complicate the situation, as applying for the product requires explaining complex issues around redemptions and exit queues to the SEC and investors. Therefore, in our view, it may be several years before there is a meaningful collateralized Ethereum ETF in the United States. However, in the long term, these problems appear to be solvable. Conclusion
From a security and decentralization perspective, this issue with ETFs could be very positive for Ethereum. The last thing Ethereum needs is BlackRock becoming the largest validator. This could be worse for Ethereum than BlackRock being the largest Bitcoin holder, since Bitcoin holders have no role in block production or choosing between competing valid chains. Combining the roles of consensus agent and investor is a centralization risk. Therefore, any barriers to BlackRock staking are desirable. Maybe the exit queue line should be longer for exactly this purpose! We believe that ETF approval may not be as important for Ethereum compared to Bitcoin for several reasons: The Bitcoin ETF was launched first , so the approval of the Ethereum ETF will not be as fanfare. Ethereum culture is more about usage and technology/DAPS, while Bitcoin is more about holding and financial considerations, ETFs are more significance. Ethereum has the staking yield problem discussed in this article, which will reduce the appeal of ETFs. However, the approval of an Ethereum ETF is another exciting prospect in the cryptocurrency space, and once approved, we will actively track and report flow data. We will be the first to report on the extent to which Ethereum ETFs cannibalize Bitcoin ETFs, Ethereum in staking pools, or Ethereum locked in DEXs. Or, will ETFs cause new money to enter the system and drive up prices. 
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