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May 2024: A Breakthrough for Spot Ethereum ETFs

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Research Team

 

  • Crypto markets appreciated and Ether outperformed the broader crypto market (as measured by the Grayscale Crypto Sectors Total Market Index) after regulators approved the initial filings for spot Ethereum ETFs in the U.S. market.
  • Also during the month, crypto-related legislation made progress on Capitol Hill. The latest survey conducted by The Harris Poll on behalf of Grayscale found that crypto remains a bipartisan issue ahead of November’s elections.
  • The Financials Crypto Sector led Grayscale’s Crypto Sectors, while Bitcoin moderately lagged the broader market, despite a pickup in net inflows into the U.S. spot Bitcoin ETFs.
  • Grayscale Research sees a favorable outlook for digital assets, but macro markets are already priced for smooth sailing, and could be susceptible to adverse surprises.

Crypto markets rallied in May 2024 as U.S. regulators seemingly paved the way for trading of spot Ethereum exchange-traded funds (ETFs). Like the spot Bitcoin ETFs listed in January 2024, these new products could open access to the crypto asset class to a wider range of investors, and potentially help accelerate public blockchain adoption.

Other than commodities, most traditional asset classes delivered positive returns during the month as market volatility broadly declined. On a risk-adjusted basis (i.e., accounting for each asset’s volatility), gains were led by growth stocks and emerging market (EM) currencies (Exhibit 1). Ethereum’s Ether token (ETH) outperformed on both an absolute and risk-adjusted basis, while Bitcoin’s risk-adjusted returns were in the middle of the range of traditional assets. The FTSE Grayscale Crypto Sectors Total Market Index—a measure of the returns for the largest and most liquid digital assets—gained 15% during May 2024, and its market capitalization reached $2.3tr.

Exhibit 1: Ether outperformed traditional assets and crypto markets

On May 23, 2024, the Securities and Exchange Commission (SEC) approved Form 19b-4 filings from several issuers for spot Ethereum ETFs, a sign of notable progress for these products to list on U.S. exchanges. Only days prior, SEC approval had not appeared likely; one week earlier, estimates from the decentralized prediction platform Polymarket implied only about a 10% chance of approval. Because approval was not anticipated, when Bloomberg analysts broke the news of possible approval on May 20, the price of ETH increased roughly 17% over the next five hours (Exhibit 2).

Exhibit 2: ETH price surged on possible approval of spot ETF in the U.S.

Based on international precedent, Grayscale Research believes that spot Ethereum ETFs would see about 25%-30% of the demand of spot Bitcoin ETFs (for more details, see our report The State of Ethereum). Over the longer run, Ethereum’s market capitalization will likely be determined by the network’s fee revenue and possibly other fundamentals, but over the short run, an increase in demand from the new ETFs could have implications for the token’s price. Although these products will not allow staking, at least initially, we do not expect this to have major implications for investor demand. Ethereum’s staking yield is just 3.6%, and all base transaction fees on the network are burned, rewarding all token holders with reduced supply.[1]

In addition to the unexpected approval of filings related to spot Ethereum ETFs, Congress made progress on various legislation related to regulation of the crypto industry. On May 8, the House of Representatives voted on a resolution to repeal SEC Staff Accounting Bulletin (SAB) 121, which required banks to hold capital against digital assets held in custody, thereby limiting their involvement in custody services; 71 Democrats voted in favor of the rule despite a veto threat from the White House.[2] The Senate subsequently passed the legislation—also on a bipartisan basis. On Friday May 31, President Biden vetoed the bill, citing a need for consumer protection..[3] Later in the month, on May 22, the House passed another crypto-focused bill, the Financial Innovation and Technology for the 21st Century Act (FIT21). The legislation, which would provide a comprehensive regulatory framework for crypto[4], now advances to the Senate. With these recent legislative moves as a backdrop, the latest survey conducted by The Harris Poll on behalf of Grayscale found that crypto is a bipartisan issue, with similar ownership rates among Republicans (18%) and Democrats (19%) (for details, see 2024 Election: The Role of Crypto).

From a Crypto Sectors perspective, the best performing market segments during May 2024 were Financials, Consumer & Culture, and Smart Contract Platforms, which includes Ethereum (Exhibit 3). As discussed further below, the Financials Crypto Sector may have benefited from progress on approval of spot ETH ETFs, because the Ethereum network is home to most DeFi activity and many tokenization projects. The Consumer & Culture Crypto Sector was lifted by strength in certain memecoins—tokens held primarily for entertainment value and related to internet culture.[5] A number of video game-related assets also boosted returns for the Consumer & Culture Crypto Sector during the month.[6]

Exhibit 3: Financials Crypto Sector outperformed

Bitcoin, the largest crypto asset component by market cap of the Currencies Crypto Sector, moderately lagged the broader market, with a 13% gain during May.[7] Inflows into U.S.-listed spot Bitcoin ETFs picked up during the month, totaling $2.1bn.[8] Since their introduction on January 11, the spot Bitcoin ETFs have gathered cumulative inflows of about nearly $14bn (Exhibit 4). At the same time, Bitcoin’s price may have been held back by a focus on the possible selling of coins related to Mt Gox. At one point, the failed crypto exchange handled more than 70% of Bitcoin trading volume, but it has been working through bankruptcy for the past decade. Last September, the bankruptcy trustees announced that creditor repayments would begin in October 2024. Wallets associated with failed exchange began moving Bitcoin on-chain late last month, renewing focus on the sales in crypto markets.[9] The estate holds nearly $10bn in Bitcoin[10], so the sales could have a material impact if exchanged for fiat.

Exhibit 4: Cumulative inflows into spot Bitcoin ETFs reached nearly $14bn

The Financials Crypto Sector was supported primarily by gains in the Uniswap (UNI) and Celsius (CEL) tokens.[11] Uniswap is an Ethereum-based automated market maker that allows for decentralized token swaps without intermediaries. Markets appeared to interpret the partial approval of spot ETH ETFs as positive for decentralized finance (DeFi) tokens in general, including UNI. While UNI’s monthly performance was strong for the month as a whole, on May 31, a governance vote that was meant to direct a portion of the protocol’s fee revenue to token holders was delayed, dropping the price 6% that day. Separately, the CEL token jumped roughly 750% after more than 90% of the token’s supply was burned as part of the failed crypto lender’s bankruptcy process.[12]

Lastly, within the Utilities & Services Crypto Sector, returns were driven primarily by increases for Chainlink (LINK), Ethereum Name Service (ENS), and Livepeer (LPT). The increase in LINK appeared to reflect news that the oracle network’s cofounder would present alongside a representative from payments service SWIFT at the Consensus conference, as well as the conclusion of a pilot program between Chainlink and the Depository Trust and Clearing Corporation (DTCC)—both potentially signs of public blockchain adoption by traditional financial institutions.[13] ENS Labs, the organization developing the ENS software, announced various upgrades to the project, including a planned transition to an Ethereum Layer 2.[14] Finally, Livepeer announced a subnet intended to support GPU sharing and other activity related to the artificial intelligence (AI) industry (see our report The Emergence of AI and Crypto Synergies).[15]

Crypto markets are benefiting from a variety of tailwinds, including steady inflows into the U.S.-listed spot Bitcoin ETFs, bipartisan efforts in Congress to bring regulatory clarity to the industry, and growth in activity within the Ethereum ecosystem. As long as the macro market backdrop remains benign, Grayscale Research believes that valuations can continue to climb through the (northern hemisphere) summer months and beyond. However, it’s important to stress that financial markets are already priced for smooth sailing: implied volatility has declined across many traditional assets (Exhibit 5). So while the favorable backdrop may continue, markets could be susceptible to adverse news about the economic outlook, Federal Reserve monetary policy, and/or the upcoming U.S. presidential election.

Exhibit 5: Implied volatility fell to low end of range

 

[1] Source: StakingRewards.com. Data as of May 31, 2024.

[2] Source: Axios, American Banker.

[3] Source: Axios, The Block.

[4] Source: House Financial Services Committee.

[5] A similar theme played out in public equity markets in mid-May, due to the reactivation of the X account of trader Keith Gill, known as Roaring Kitty. Source: New York Times.

[6] For example, IMX (+13%), PRIME (+18%), and YGG (+24%). Source: Artemis. Data as of May 31, 2024.

[7] Source: Artemis. Data as of May 31, 2024.

[8] Source: Bloomberg, Grayscale Investments. Data as of May 31, 2024.

[9] Source: The Block.

[10] Source: Arkham. Data as of May 31, 2024. The estate also holds about 141k of Bitcoin Cash.

[11] The Constitution DAO token “PEOPLE” also contributed significantly to returns for the Financials Crypto Sector during May 2024.

[12] Source: Artemis, Etherscan. Data as of May 31, 2024.

[13] Source: Decrypt, CoinDesk.

[14] Source: The Block.

[15] Source: Livepeer.

 

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