The discussion around Ethereum exchange-traded funds (ETFs) has taken a central stage, especially with the anticipation of spot Ethereum ETFs potentially launching in the US within the year.
Analysts at BitMEX have recently weighed in on this matter, highlighting a critical aspect that might impact the attractiveness of these ETFs to investors: the provision of staking yields.
According to the analyst, ETH’s offering of staking rewards presents both an opportunity and a challenge for formulating ETFs around the digital asset.
Notably, staking rewards refer to the earnings that participants receive for depositing their digital assets to support the operations and security of a blockchain network. These rewards are usually a portion of the transaction fees, new coins created through block rewards, or a combination.
The Ethereum Staking Yield Dilemma
The appeal of ETH spot ETFs to institutional investors and ETF buyers hinges considerably on the “yield from staking,” as noted by BitMEX Research analysts. They posit that without the inclusion of staking yields, the allure of spot ETH ETFs could wane, given the importance of these rewards in enhancing returns.
The analysts suggest that ETH’s price might even lag behind Bitcoin in the long term if ETFs do not incorporate staking yields, despite the potential for stakers to achieve higher returns through the rewards. The analysts noted:
However, the staking system may make Ethereum less attractive or unsuitable for some ETF investors, where the ETFs would presumably be unable to stake. […] At the same time, new money may be reluctant to invest in an Ethereum ETF, when they know they are getting a worse deal than the stakers and could therefore earn lower returns, maybe these investors might choose a Bitcoin ETF instead.
Notably, the analysts also pointed out that Ethereum’s staking system poses unique challenges for establishing spot ETH ETFs, primarily due to the intricacies of managing ETF redemptions alongside ETH’s staking exit queue system.
The system requires that stakers pass through two queues to exit, including a standard exit queue limiting daily withdrawals and a validator sweeping delay adding wait time.
For ETFs, managing daily outflows in alignment with these constraints presents operational hurdles, according to analysts, potentially affecting the fund’s liquidity and attractiveness to investors.
The analysts at BitMEX highlight that during periods of market volatility, the wait time for exiting staking could extend significantly, posing a challenge for prospective ETH staking ETFs.
Navigating Through Challenges
Despite the hurdles, there are pathways the analysts explored to circumvent the staking yield issue in ETH ETFs.
One strategy the analyst highlighted, as employed by some ETH staking exchange-traded products (ETPs) in Europe, involves staking only a portion of the holdings. This maintains liquidity for redemptions while still capitalizing on staking rewards. However, this approach inherently reduces the potential yields.
The analyst noted:
Another idea, one we like, is to avoid the Ethereum Staking ETFs altogether and instead issue an stETH ETF. With this, the redemption problem is entirely solved or transferred to Lido.
So far, institutions like Ark Invest/21Shares and CoinShares have already ventured into offering Ethereum-staking ETPs in Europe, the analysts pointed out, with services like Figment Europe and Apex Group poised to launch similar products on the SIX Swiss Exchange.
Notably, the discourse around ETH ETFs and the inclusion of staking yields is unfolding against a backdrop of regulatory scrutiny, with the US Securities and Exchange Commission (SEC) taking a cautious approach toward approving such products.
The analysts argue that the eventual approval of Ethereum ETFs is inevitable but remains a matter of timing, considering the regulatory challenges and the distinct nature of Ethereum staking. The analysts stated
As with Bitcoin, the courts may eventually force the SEC’s hands, and again as with bitcoin, the SEC may be accused of hypocrisy for allowing Ethereum Futures ETFs.
They also added:
Some argue that since Ethereum staking generates a yield or because stakers propose blocks, this makes Ethereum a ‘security’ and therefore this provides a rationale for the SEC to reject Ethereum ETFs.
Featured image from Unsplash, Chart from TradingView