What are Ether ETFs?

For years, there's been a growing buzz about exchange-traded funds — ETFs — and how they could fuel institutional interest in the crypto space.

ETFs come in different flavors, and we've already seen a few hit the market. To cut a long story short, they give investors exposure to digital assets, without owning them directly.

Here, we're going to delve into the world of Ether exchange-traded funds, explain how they work, and examine where this nascent market may be heading in the future.

What is an ETF??

While exchange-traded funds are a relatively new concept in crypto, they've been a mainstay in the stock market since the 1990s.

They're listed on exchanges just like normal stocks — but can reflect multiple assets. The first ETF ever launched tracked the S&P 500, enabling investors to gain exposure to major firms without buying shares individually. These days, ETFs can focus on firms in emerging markets, companies in a specific sector, or other asset classes such as commodities and bonds.

And this brings us neatly to the crypto space. The first application for a Bitcoin ETF was filed in 2013, but it took eight years before one received the regulatory approval to start trading. But there's an important caveat here, as the BTC-focused exchange-traded funds that have hit the market track futures contracts, and not spot prices.

Futures contracts are a form of derivative trading, where two parties enter into an agreement to buy or sell crypto at a pre-agreed price at a later date. Here's an example: Alice agrees to purchase 1 ETH for $3,000 from Bob in December 2023. No matter what the eventual price ends up being — $2,000 or $4,000 — the trade must be executed.

As the name suggests, futures allow traders to speculate on what cryptoassets will be worth in the future, meaning there's a risk they diverge from the value of Bitcoin, Ether and others.

At the time of writing, the only Ether ETFs that are available in the U.S. track futures contracts — rather than the spot price, ETH's current value on the market. Many in the crypto space are lobbying for the Securities and Exchange Commission to allow for spot Ether ETFs to be established. Not only would they be backed by real Ether, but they would also offer a more accurate reflection of this digital asset's value.

What Ether ETFs exist??

ETH futures ETFs are a fairly new development in America. At the start of October, three U.S. investment managers — ProShares, VanEck and Bitwise Asset Management — officially launched their offerings. Crucially, these exchange-traded funds are based on futures contracts that are regulated by another body, the Commodity Futures Trading Commission.

It's important to stress that there can be huge variations from one Ether ETF to another. While some purely focus on ETH and nothing else, others allocate part of their portfolio to BTC. You may also find ETFs that offer exposure to shares in companies that are operating in this space. There can also be wild variations in the expense ratios charged to investors — a charge that funds use to cover administration, compliance, management and marketing costs. While most have fees below 1%, even 0.1 or 0.2 percentage points can hugely eat into gains for investors with substantial holdings.

ProShares, which launched the first BTC futures ETF back in 2021, had the largest daily trading volume of the three investment managers on launch day — capturing 45% of the market share. The net expense ratio of its flagship Ether Strategy ETF stands at 0.95%, which is substantially more than rivals such as VanEck at 0.66%.

Other crypto asset managers have already begun a concerted push to convert their existing offerings into spot ETH ETFs. One of them is Grayscale Investments , which currently runs an Ethereum trust that has close to $5 billion in assets under management. The firm has already taken the SEC to court after its application to switch its Bitcoin trust to an ETF was repeatedly rejected.

Unfortunately, it's fair to say that Ether futures ETFs had a pretty tepid debut on the U.S. market. The Financial Times described their launch as a "damp squib" — primarily because these funds only mustered a collective trading volume of $6.6 million back on October 2. By comparison, the first comparable Bitcoin ETF commanded $1 billion in just two days when it launched in 2021. Of course, market sentiment was much different back then — and right now, retail interest in cryptocurrencies has taken a bit of a backseat.?

A number of exchange-traded products and notes (ETPs and ETNs) already exist for Ether in Europe and Canada — with billions of dollars in assets under management. Such funds are usually 100% collateralized with ETH that's held in cold storage with regulated custodians — but inevitably, they are characterized as the riskiest products of their type. On a sliding scale from 1 to 7, with 1 being the least risky, ETH ETNs are classified as a 7 by VanEck.

What are the benefits of Ether ETFs?

So… why are Ether ETFs regarded as an attractive proposition in the first place??

Well, it's a way for investors who are new to the world of crypto to gain exposure to a fast-growing ecosystem. Exchange-traded funds can also offer a greater degree of familiarity, as well as enhanced liquidity. Given a number of high-profile exchanges ended up freezing withdrawals and going bankrupt in 2022, ETFs can be regarded as a compelling alternative.

Ether ETFs are traded through brokerage accounts rather than crypto wallets — and as we explained earlier, investors who get involved never end up owning Ether directly. This can help alleviate some of the concerns surrounding the storage of digital assets, and ultimately increase adoption among institutions, family offices and high net worth individuals.

What are the disadvantages of Ether ETFs??

As previously mentioned, the cost can be a particular drawback. Those who own Ether directly often end up growing their exposure gradually through using techniques such as dollar cost averaging, where a fixed amount is invested on a regular basis — irrespective of ETH's current value. Fees can end up being charged whenever shares in an exchange-traded fund are bought or sold, and this can be impractical for those who seek to make multiple trades or slowly build up their position.

The current futures-focused landscape can also mean there is a significant disparity compared with spot prices. Two particular scenarios spring to mind. The first is known as "contango ," a phrase used to describe when the value of ETH futures is higher than its current market value. Conversely, if spot prices are higher, this scenario is referred to as "backwardation."?

Some critics may also argue that the emergence of crypto exchange-traded funds goes against the very reason why the likes of Bitcoin and Ether were created in the first place: delivering a decentralized alternative to the traditional financial ecosystem. Because investors don't own the underlying ETH, there's no way of making a withdrawal if things go wrong. There's even a chance that such funds could end up distorting the market and suppressing prices in the long-term.

Plus, if spot Ether ETFs do end up hitting the U.S. market — funds that would be backed by real Ether in custody — security concerns would eventually emerge. Why? Because institutions that hold substantial amounts of ETH on behalf of investors could end up being a prime target for hackers and cybercriminals. We've already seen exchanges and bridges lose eye-watering amounts following audacious attacks, meaning investment managers would need to have robust security measures in place.

Linen addresses these pitfalls by allowing long-term Ethereum holdings to be held securely — with investors remaining in control of their funds at all times. Wallets can also be accessed through third-party interfaces if required.

Where will Ether ETFs head in the future?

There are some big questions that remain unanswered. Will the SEC approve a spot Ether ETF? Will demand for existing exchange-traded funds increase as market sentiment starts to turn? Could Europe or Asia end up taking the lead in this market as regulatory uncertainty in America continues??

In recent weeks, crypto firms and asset managers have really been turning up the pressure in urging the SEC to greenlight their products — arguing that such funds could actually make regulation easier, not harder. Investors themselves have also been encouraged to write to politicians and make it clear that this is an issue that could sway their vote.?

While a number of bipartisan crypto bills are currently working their way through Congress, there's no guarantee that they'll be passed soon. Politicians themselves have said that the industry needs clear rules of the road to follow, with Patrick McHenry, the Republican chair of the House Financial Services Committee, warning in April : "Regulation by enforcement is not sufficient nor sustainable. Your approach is driving innovation overseas and endangering American competitiveness."

Unfortunately, many gray areas remain — and this extends to the status of Ether itself. At that same hearing, SEC chair Gary Gensler refused to be drawn on whether ETH now classifies as a security following the blockchain's switch from Proof-of-Work to Proof-of-Stake.

How much institutional interest is there in Ether ETFs??

Research in recent months suggests there is strong demand for crypto-focused ETFs — despite the dramatic bear market of 2022, and ongoing sideways price action since. Back in April, 325 institutional investors from around the world — 40% of whom manage more than $1 billion in assets — were surveyed by Brown Brothers Herriman for an annual report.

The findings were pretty staggering. Some 25% of those polled said that they planned to increase their exposure to cryptocurrencies through exchange-traded funds in the coming 12 months — a small decrease from 33% a year earlier.

And away from ETFs that focus specifically on the likes of Bitcoin and Ether, there appears to be great interest in so-called "thematic" funds that bring a number of crypto-related assets together — with 48% intending to add them to their portfolios.

Brown Brothers Herriman drew a direct line between this ongoing interest and the European Union's moves to offer clearer regulation in the form of Markets in Crypto Assets, otherwise known as MiCA for short. The report went on to say these measures are "expected to significantly 'derisk' investments in cryptoassets for asset managers and provide an 'additional layer of comfort' for fund managers."?

Its data also underlined why regulatory clarity in America needs to be treated as a matter of urgency — as while 55% of U.S. institutional investors plan to add thematic crypto ETFs to their portfolios, just 29% of their European counterparts feel the same way.?

What's next??

The crypto world is constantly maturing — and harsh lessons were learned after the wild excesses of 2020 and 2021 led to millions of people losing their life savings.

Bitcoin, Ether and other digital assets tend to be cyclical beasts, lurching between boom and bust every four years or so. The creation of ETFs by credible institutions has the potential to deliver a safer way of gaining exposure when interest in the market starts to pick up again.?

A big theme in the years to come concerns whether institutional investors will embrace Ether, and the Ethereum blockchain, more than they have done so in the past. Back in February, 77% of institutions polled by Nickel Digital Asset Management had predicted that The Merge would drive adoption. Given how Proof-of-Stake uses 99% less energy than Proof-of-Work, and many corporations are exceedingly mindful about their carbon footprint, this is little surprise.

But there are other ways for institutions to get involved in this space beyond ETFs — primarily by becoming stakers and operating their own nodes.

The crypto markets are notoriously hard to predict, but Ether exchange-traded funds — covering both futures contracts and spot prices — are already shaping up to be a vital theme as the industry continues to mature.