The approval of ETF is expected to drive up the price. Where will the ETH ecosystem go in the future?

Original title: "Exploring the Impacts of ETH ETF Approvals"

Author: Tanay Ved

Compiled by Shen Chao TechFlow

Key Points:

• The reversal in Ethereum ETF approval odds has driven a 25% rise in the price of ETH, as well as a rise in tokens related to the Ethereum ecosystem.

• Grayscale’s Ethereum Trust (ETHE) discount to net asset value (NAV) narrowed from 50% a year ago to when the ETF was approved 1.28%.

• ETH ETF’s non-participation in staking may have an impact on ETH’s supply dynamics, staking ecosystem, and network resiliency.

Introduction

In an unexpected turn, Securities and Exchange Commission(SEC) approved a spot exchange-traded fund (ETF) for ETH, the second largest digital asset. On May 23, eight issuers’ 19b-4 proposals were approved, including industry giants such as BlackRock, Fidelity, Bitwise, VanEck and Grayscale. Just four months ago, we saw the decade-long pursuit of a spot Bitcoin ETF come to an end, with 11 issuers competing in what was dubbed the “Cointucky Derby.” The launch was anticipated for months and subsequently attracted $12B in net inflows, making it the fastest-growing ETF launch in history.

However, for Ethereum, the situation is different. The security status of Ethereum and its proof-of-stake (PoS) consensus mechanism is unclear, with the U.S. Securities and Exchange Commission taking action against well-known industry players such as Coinbase and Consensys. Still, the odds of a spot Ethereum ETF being approved have shifted from unlikely in January to a reality in May, capping off a critical week that marks a major turning point in the regulatory landscape for the digital asset industry. In this issue, we measure the market reaction and network impact following the SEC’s approval of the issuance of a spot Ethereum ETF in the United States.

Market Reaction

With such a short time window to price this development, the market reacted quickly, raising the odds of approval to 75%, sparking ETH and immediate reaction to market prices of other Ethereum ecosystem tokens. PEPE (+80%) is the largest Meme on Ethereum, LDO (+44%) is the governance token of liquidity Staking provider Lido, UNI (+ 44%), the token of decentralized exchange (DEX) Uniswap, provided the highest returns, while ETH rose (+27%).

(Source: Coin Metrics reference exchange rate)

Since September 2022 Ethereum’s (ETH) performance relative to Bitcoin’s (BTC) (ETH/BTC ratio) has been in a downward trend since, but this news gives it a much-needed boost. Although it rose to 0.056 ahead of the ETF approval, it needs to break through key resistance levels to resume the uptrend and make up for its underperformance against other large crypto assets such as BTC and SOL. While the approval of 19b-4 does not accelerate gains, the anticipated approval of the S-1 registration statement and subsequent launch of the Ethereum ETF should lead to broader acceptance of ETH as an investable "commodity" and mainstream adoption of the Ethereum network a powerful driving force.

(Source: Coin Metrics Reference Exchange Rate)

Investor Sentiment and Market Positioning

SpotEthereumETFApproved market sentiment is reflected in Grayscale EthereumTrust Fund(ETHE) vs. Net Asset Value (NAV ) on the reduction of discounts. Compared to a discount of approximately 50% a year ago, ETHE’s market price has shrunk to within 1.28% of its NAV, with 20% of the shrinkage occurring within 5 days.

While this is reminiscent of what the Grayscale Bitcoin Trust (GBTC) was before it converted to an ETF in January of this year, the ETHE discount compressed even faster, highlighting that the change was unexpected market participants’ expectations. Nonetheless, investors have begun strategizing in anticipation of ETHE converting into an exchange-traded product following its public offering.

## (Source: Coin Metrics Institutional Metrics, Grayscale)

ETHFuturesOpen InterestContractsContracts (OI) reached a record $13.8 billion, indicating that the surrounding Ethereum## Speculation in #ETF has increased. Although this value is still lower than the BTC open interest level before the launch of the spot Bitcoin ETF, the growth in the value of outstanding ETH futures contracts on Binance, Ethereum and Chicago Mercantile Exchange (CME) shows that Retail and institutional investors are more active.

(Source: Coin Metrics Market Data)

How ETH ETF affects staking ?

One important development regarding the approval of spot Ethereum ETFs is that

they will not include

staking functionality. Issuers are unable to stake ETH, which could have potential impacts on ETH supply dynamics, the health of the Ethereum consensus layer, and the entire staking ecosystem.

Impact on Ethereum supply dynamics

As the native asset of the Ethereum ecosystem, ETH is at the core of its operations and security.

ETH can be used as a unit of account, store of value or collateral, and a diversified economic system is built on it.

This includes using ETH for staking to secure the Proof of Stake (PoS) consensus mechanism for network security, depositing ETH into smart contracts to support decentralized finance (DeFi) services, paying transaction fees, or as an investment and store of value. Assets are held in the user's account.

(Source: Coin Metrics network data)

Currently, at 120M ETH Of the total supply, 27% is staked in the consensus layer, 11% is held in smart contracts (unstaking), and 61% is held by external accounts (EOA). As ETF issuers absorb more of the circulating ETH, much of the supply is expected to be locked up, which could reduce the available supply in the market. The reduction in circulating supply, coupled with strong demand, may increase the likelihood of ETH price appreciation.

Impact on Ethereum Consensus Layer

Currently, there are 32 million ETH (27% of the total supply) through personal staking, Lido, etc. Staking pools or managed staking providers like Coinbase stake on the Ethereum beacon chain. However, excluding ETH ETF staking, the ratio of 27% staked to 73% unstaking is unlikely to change dramatically. Staking yield is a key component of the return on holding ETH. Therefore, excluding ETFs from staking may be beneficial to existing stakers as it prevents the dilution of staking returns that occurs when institutional capital enters the staking ecosystem.

(Source: Coin Metrics network data)

Consensus rewards (excluding tips and MEV) for verification The potential impact on investor returns can be seen in the chart above. Assuming that the Ethereum ETF issuer acquires 10% of the ETH supply (approximately 12 million ETH) and stakes 30% of it, the number of active validators in the consensus layer will increase by 11.25%, from the current 1 million to 1.125 million. Due to the inverse relationship, more validators and staked ETH causes the annual yield (APY) for stakers to decrease from approximately 2.9% to 2.7%. While this is not an exact measure, it illustrates the potential impact on staking yields if an ETF issuer stakes additional ETH.

It is also important to consider that the maximum effective balance per validator (currently set at 32 ETH) will be increased to 2048 ETH in the upcoming Electra upgrade, which may change validators and network security dynamic.

In addition, ETHETF does not include the pledge function that may have a negative impact on the pledge ratio of Ethereum and the Centralization has a positive impact. Currently, with staking rates growing rapidly, Lido and Coinbase hold 28% and 13% of the staked ETH market share respectively. If institutional capital participates in staking, Coinbase, as the primary ETF custodian, could become the primary beneficiary of staked ETH, exacerbating centralization risks.

These concerns have triggered discussions in the Ethereum community about adjusting the issuance rate of ETH to mitigate the negative effects of staking centralization, the reduced competitiveness of independent stakers, and the inflationary pressure faced by non-stakers. It remains to be seen whether the SEC will allow Ethereum ETFs to be staking in the long term. However, By not staking ETH, ETFs can help maintain a balanced staking ratio to a certain extent and promote a healthier staking distribution.

(Source: Coin Metrics network data)

Ethereum consensus layer The participation rate is 99.5%, indicating that the majority of validators maintain network security by voting and proposing blocks. This also means that Stakingrewards are being distributed to a larger pool of validators, ensuring decentralization. Going forward, the proposed issuance and effective balance changes, coupled with the SEC’s stance on ETFs containing staking, will shape the future of the Ethereum staking ecosystem.

Conclusion

The past week marked a major shift in the US digital asset regulatory landscape, including the passage of the FIT21 Crypto Market Structure Act and the approval of the Ethereum ETF. However, many questions remain unanswered: Can an Ethereum ETF achieve investment flows comparable to a Bitcoin ETF? Against the backdrop of these developments, how will Staking dynamics evolve? And what are the broader implications for other crypto markets? While these remain to be seen, regulatory clarity and greater accessibility will hopefully attract wider demand into ETH and its ecosystem.

Network Data Insights

Summary Highlights

(Source: Coin Metrics Network Data)

Ethereum’s (ETH) market capitalization is up 25% over the past week, while its adjusted transfer value is up 132%, to $8 billion. With the approval of the ETH ETF, activity and valuations for some ERC-20 tokens have also increased.

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