Grayscale Ethereum Trust Remains Attractive After Read-Across From Bitcoin ETF Process

Summary SEC is likely to approve spot Bitcoin ETFs on or before January 2024 after legal vindication of Grayscale. Grayscale Ethereum Trust offers a wider NAV spread and may be subsequently approved on similar grounds by the SEC. Risks include a potential decline in crypto assets, wiping out any bump from ETF conversion. I believe it is highly likely that the SEC will soon approve various spot Bitcoin (BTC-USD) ETFs, perhaps in January 2024 or earlier, and then move to approve similar spot Ethereum ETFs with a similar rationale. This is based on a legal ruling on August 29, 2023 (Grayscale v. SEC, 22-1142, U.S. Court of Appeals for the District of Columbia Circuit), which the SEC has not appealed, and the window for an appeal expired in October 2023 . The ruling stated that "agencies must treat like cases alike" and the SEC's decision to allow two Bitcoin futures ETF but block Grayscale's spot Bitcoin ETF was "arbitrary and capricious." I think this is also increasingly the view of informed market participants, but despite this potential catalyst, the NAV discount remains material, leaving some upside should ETF conversion occur. I think Grayscale Ethereum Trust ( ETHE ) is more interesting at these levels given a wider discount to NAV at the time of writing. The main risk of this strategy is that both Bitcoin and Ethereum have rallied significantly on the prospect of a spot ETF driving additional crypto demand. Therefore, if there is no spot ETF, then the discount to NAV would likely widen and the price of the underlying fund holdings may well decline. ETF Conversion Opportunity It's important to note that, here, I'm focused on more of a 'dirty arb' setup, where conversion of a fund at a discount to NAV into an ETF wrapper will necessarily close virtually all of the discount to NAV. The closing of the discount to NAV is simply a fact of how ETFs operate. Wide NAV discounts can't persist in ETFs, otherwise, ETF units are bought and the underlying asset is sold until the NAV gap closes (and vice-versa if the ETF trades above NAV). That's a potentially profitable trade for funds too, but typically fund structures don't build in those trades to keep the fund close to NAV. I'm not focused on swings in crypto per se, though that is a risk to the trade, since changes in crypto values will impact the returns to the trade. For now, enthusiasm that Bitcoin will have a spot ETF from major providers has been a contributing factor in Bitcoin's rally. However, even though I like Grayscale Bitcoin Trust ( GBTC ), I like Grayscale Ethereum Trust ( ETHE ) more as the NAV spread is currently wider, even if approval may come perhaps 4 months later. Fund Price/share NAV/share Return if NAV discount closed today Deadline for SEC to approve/reject filings* GBTC (Bitcoin) $29.97 $33.43 +11.5% Jan 10 2024 ETHE (Ethereum) $17.22 $20.01 +16.2% May 17, 2024 Author's analysis, pricing, and NAV will change dynamically. *Estimated approval date is based on Ark Invest filings with a 240-day comment period after publication in the Federal Register on May 8, 2023, for Bitcoin ETF (filing from Ark) and publication in the Federal Register on September 20, 2023 for an Ethereum ETF (filing from Van Eck) other funds could be approved/rejected later or earlier, though 'across the board' approval/rejection may be more likely as being viewed as a fairer approach for the ETF sponsors and is an approach that the SEC has taken in the past such as with six Ethereum futures ETFs launched on October 2, 2023. Approval/rejection could also occur prior to the deadline. Risks One way to think about this is how much the crypto assets would have to decline for the trade to lose money if the ETF conversion is approved. For Bitcoin, an 11% decline would wipe out any profits, and for Ethereum, a 14% decline would do the same. The relatively high fees of the Grayscale fund products (2% of NAV annually) would eat into returns too. Of course, given volatility in crypto assets, losing money despite ETF conversion is clearly possible. Then of course there is the risk that the spot ETFs are not approved. Some believe the SEC will be able to use further technical arguments to block spot crypto ETFs. I view this as unlikely in light of the legal ruling, which left little ambiguity. The court was clear that the SEC should not block a spot Bitcoin ETF when a futures Bitcoin ETF exists. Therefore, pretty much anything else the SEC might try would fall foul of that legal decision. Plus as a government entity, such as the SEC, presumably, you take the law seriously and don't want to lose in court, which limits your credibility and authority. The only thing, in my view, that the SEC could likely do would be to reverse its decision on allowing a Bitcoin futures ETF, though that would be bizarre behavior and the SEC appears to be seriously reviewing the SEC filings currently. For example, you can see Ark progressively updating its S-1 filings for a Bitcoin ETF here and here over recent months. This is believed to be, in part, in response to SEC feedback. This recent interview with SEC Chair Gensler , contained limited information of substance, except that the SEC does seem to be actively reviewing the disclosures of the Bitcoin proposals, which updates to the S-1 filings support. Then I've mentioned that I view the Grayscale Ethereum Trust as the more attractive play given the slightly wider spread and an ultimately similar outlook for spot ETF approval. Of course, there's a risk that the SEC approves a Bitcoin ETF without a similar approval for Ethereum. However, the recent Ripple ruling where the SEC lost too, and again saw an appeal blocked, suggests that the SEC may have to treat Bitcoin, Ethereum, and Ripple somewhat consistently as assets that are now more part of the financial mainstream and less speculative Ponzi schemes. Still, there's a risk that the SEC decides to block a spot Ethereum ETF while permitting a spot Bitcoin ETF. Though even here, Ethereum Futures ETF exists , so the SEC may have a hard time blocking an Ethereum spot ETF on the logic of the Bitcoin ruling. Limitations I believe Grayscale's core funds of Bitcoin and Ethereum will convert to ETFs no later than H1 2024. However, I think the expectation that a broader set of Grayscale funds convert to ETFs is less certain. That's in part because Bitcoin and Ethereum are the two Grayscale funds with billions in assets. Other funds are far smaller and less significant by comparison. Furthermore, other funds contain assets like Litecoin, Filecoin, Solana, etc. Here the SEC has not blessed these crypto assets as being robust and relatively lower risk in the same way that Bitcoin, Ethereum, and Ripple now have legal/regulatory precedents. As such, it is not obvious that the SEC will grant ETF conversion for the 'longer tail' of crypto assets and Grayscale has not filed to do so. Therefore, I think there's a case to be made that these other funds convert at some point in the future, but there are material risks and the timeline is unclear. Conclusion Normally, when ETFs are filed by major providers they are approved by the SEC after a review period. The only reason crypto is different is because the SEC made a ruling blocking a spot Bitcoin ETF, that has now been vacated by the courts. We are now in some sense back to 'normal' with these ETF filings where approval after a review period involving some back and forth with the SEC is, in my view, the most likely outcome. I believe it now appears highly likely that ETF conversion will occur within months, if not sooner, closing NAV discounts for potential double-digit returns. That said, price movement in the underlying crypto assets remains a very real risk and could change the return profile of this strategy. This could create a loss even if conversion occurs, so hedging of the underlying assets might be warranted. I would also argue that this trade is less correlated to the broader equity market, which may be useful to some investors.