The State of Ethereum

This research post was originally written by Michael Zhao from Grayscale. You can find the original post on their blogspot at the following link: The State of Ethereum (grayscale.com).

Last week, the Securities and Exchange Commission (SEC) approved Form 19b-4 filings from several issuers for spot Ethereum exchange-traded funds (ETFs), a sign of notable progress for these products to list on U.S. exchanges. Like the spot Bitcoin ETFs listed in January, these new products could open access to the crypto asset class to a wider range of investors. Although both assets are based on the same public blockchain technology, Ethereum is a separate network with distinct use cases (Exhibit 1). Whereas Bitcoin today serves primarily as a store of value and digital alternative to gold, Ethereum is a decentralized computing platform hosting a rich ecosystem of applications, often analogized to a decentralized app store. New investors interested in exploring this asset may want to consider Ethereum’s distinct fundamentals, its competitive positioning, and its potential role in the growth of blockchain-based digital commerce.

Here are key insights covered in this analysis:

• The potential launch of spot Ethereum ETFs will introduce more investors to the concept of smart contracts and decentralized applications—and therefore to the potential for public blockchains to transform digital commerce.
• Ethereum is the largest asset (by market capitalization) in our Smart Contract Platforms Crypto Sector, and the largest blockchain network in terms of users and applications.^[1] It is pursuing a modular design philosophy to scale, in which more activity over time will take place on related Layer 2 networks. To maintain its dominance in a competitive market segment, Ethereum will need to bring in additional users and grow fee revenue.
• Based on international precedent, the Grayscale Research team expects that the U.S. spot Ethereum ETFs will see roughly 25%-30% of the demand of the spot Bitcoin ETFs. Significant portions of Ethereum supply (e.g., staked ETH) will not likely be available for the ETFs.
• Given higher initial valuations, the scope for additional price increases may be more limited compared to the launch of Bitcoin ETFs in January 2024, but Grayscale Research remains optimistic about the outlook for both assets.

Outside the U.S., Ethereum ETP AUM totals 25%-30% of Bitcoin ETP AUM

In terms of ETH supply, Grayscale Research believes that around 17% can be categorized as idle or relatively illiquid. According to data analytics platform Allium, this includes about 6% of ETH supply that has not been moved for over five years, as well as about 11% of ETH supply that is “locked” in various smart contracts (e.g., bridges, wrapped ETH, and various other applications). Moreover, 27% of ETH supply is staked. Recently, issuers of spot Ethereum ETF applications, including Grayscale, have removed mention of staking from public filings, signaling that the SEC may allow these products to trade in the United States without staking. Therefore, this portion of supply will not likely be available for purchase by the ETFs.

In addition to these categories, the ETH used as gas for network transactions is $2.8bn on an annual basis. This represents an additional 0.6% of supply at current ETH prices. There are also a number of protocols that hold a substantial portion of ETH on their treasuries, including the Ethereum foundation ($1.2bn worth of ETH), Mantle (~$879mm in ETH), and Golem ($995mm in ETH). In total, ETH in protocol treasuries accounts for about 0.7% of supply.Finally, about 4m ETH, or 3% of the total supply, is already held in ETH ETPs.

Altogether, these groups account for nearly 50% of ETH supply, although the categories are partly overlapping (e.g., ETH in protocol treasuries may be staked) (Exhibit 7). For any potential new U.S.-listed spot Ethereum ETFs, we believe that net purchases of ETH are more likely to be drawn from the remaining circulating supply. To the extent that existing uses limit the available supply available to the new spot ETF products, any incremental increase in demand could have a larger impact on price.

Looking Ahead

Although the launch of spot ETH ETFs in the U.S. market may have immediate effects on valuations, the importance of regulatory approval extends well beyond price. Ethereum offers an alternative framework for digital commerce based on decentralized networks. The modern online experience works reasonably well, but public blockchains may offer even more possibilities, including near-instant cross-border payments, true digital ownership, and interoperable applications. Although there are other smart contract platforms offering this utility today, the Ethereum ecosystem has the largest number of users, the most decentralized applications, and the deepest pools of capital.Grayscale Research expects that the new spot ETFs could introduce this transformative technology to a much broader range of investors and other observers—and help accelerate public blockchain adoption.

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