Challenge for ETFs in the ether

The first month of trading for spot-price ether ETFs showed a rocky start for the products.

Since the much-hyped ETFs debuted July 23 on exchanges Cboe BZX and NYSE Arca, half a billion dollars has flowed out of the category, the result of $2 billion being redeemed by Grayscale customers who were eager to cash out of the high-fee Ethereum Trust.

But, excluding that product, about $1.5 billion poured into spot ether ETFs, with companies like BlackRock, Bitwise, and Fidelity garnering the highest sales. Still, the category is off to a slower start than that of the spot bitcoin ETFs that launched in January.

“I don’t think it’s lived up to expectations holistically,” said Bryan Armour, head of passive strategies research North America at Morningstar. That is in the context of the net negative sales and roughly 20 percent price drop in Ethereum over a month.

“The hard part right now is what to do about the performance problems, because crypto is very momentum-driven – and as the price falls, we’ll see how much investors stay interested in crypto and who is in it for the long haul,” Armour said.

Even so, a 20 percent drop is far from unheard of for ETFs in various categories, said David Mann, head of ETF product and capital markets at Franklin Templeton.

“I’ve seen a lot of big price drops for ETFs beyond Ethereum. It feels like it’s been within the margins of other drops in tech and AI” in recent months, Mann said. Additionally, between the second and sixth of August, the Nikkei fell by a total of 17.5 percent after Japan raised interest rates, a plunge that triggered a global stock sell-off.

Franklin’s Ethereum ETF has attracted about $35 million since its July 23 launch, and represented about $26 million in total assets as of August 7.

“We thought that there would be a strong possibility that the interest in Ethereum would somewhat match the market cap difference between it and bitcoin,” Mann said of the company’s schools of thought going into the product launch. It’s also worth noting that the launch happened more than six months after spot bitcoin ETFs appeared, and those products have so far proven to work as intended, with tight spreads and close price tracking, he said. As of August 7, the market cap for Ethereum was about $300 billion, compared with over $1 trillion for bitcoin.

“If the market-cap ratio is our guideline, we’re outperforming that from a flows perspective,” he said. “We’re actually really happy with how things have gone so far. We’ve had steady inflows every day.”

Selling financial advisors on crypto is another story. A survey in March from Franklin and the Digital Assets Council of Financial Professionals found that 35 percent of advisors said they planned to recommend digital assets to clients within six months. However, a separate survey in April from Cerulli showed less than three percent of advisors recommending cryptocurrency to clients, with over 12 percent discussing it or including it in portfolios when clients bring it up.

In a possible sign of things to come, Morgan Stanley earlier this month told its advisors that it would allow them to make certain bitcoin ETFs available to clients, marking a change in the firm’s stance on those products, according to a report by CNBC that was confirmed by InvestmentNews.

“I’ve had a couple of clients inquire about crypto – however, not as much as someone might think,” said Steven Calio, cofounder and CEO of CSG Financial, in an email. Most clients who work with advisors are less likely to have a strong interest in crypto compared to do-it-yourself investors, and he doesn’t directly recommend clients include it in their portfolios, he said.

However, he could decide to use extra cashflow to buy crypto, “fully expecting that money to go to zero,” he said. “I view this as my ‘gambling’ money, and I’m OK with the risk.”

Another advisor, Nick Rygiel, owner of Ironclad Financial, said that the advent of spot-price ETFs has gotten a few clients interested in crypto.

“However, the clients who already possess digital assets do so primarily in self-custody or through a custodian. For them, ether ETFs are less attractive due to the lack of staking capability and the potential for yield-generating opportunities available on-chain through decentralized finance (DeFi) applications,” Rygiel said in an email.

Ether ETFs have the benefit of exposure to the digital asset’s growth without burdening owners with the complications of holding it directly, he noted. But the lack of staking is a considerable drawback.

Less than two years ago, Ethereum made waves when it switched to a proof-of-stake model instead of proof-of-work, the latter being the consensus mechanism that is still employed by bitcoin. Proof of stake rewards those who hold the digital assets, giving them rates of two percent or more per year. However, ether ETFs do not get that benefit, with the products’ approval by the Securities and Exchange Commission having that caveat.

“ETFs for Ethereum are potentially very problematic, since ETH transitioned to a proof-of-stake protocol. Hypothetically, one of the ETFs could change Ethereum’s protocol in a material way if it gets large enough, something that can’t happen with bitcoin,” said Mike Alfred, a fintech entrepreneur and cofounder of bitcoin-focused hedge fund Alpine Fox, in an email. “I am not bullish on Ethereum or Ethereum ETFs at this time.”

Most of the spot ether ETFs on the market have low fees, with many of them having waivers in place that currently put net fees at zero. Even without the passive yields associated with staking, the products can have a benefit, Morningstar’s Armour said.

“You outsource all the administration and operations of buying, holding, putting in cold storage, making sure your bitcoin is secure. It seems like a worthwhile service if the fee is only 25 basis points,” he said.

The lack of a proof-of-stake yield is something investors should consider, but they should also weigh that against the potential drawbacks of buying, selling, and storing Ethereum, Franklin’s Mann said.

It also provides a good alternative to bitcoin ETFs, he said.

“Ethereum is a bit more of a technology play,” he said, comparing its Sharpe ratio and risk levels to those of tech company stock investments. “Ethereum is different from bitcoin. It’s got cash flows. It’s got revenue.”