ETH is our highest conviction investment on a risk-adjusted basis over the next few months leading up to the ETF approval. On a high level, we think that ETH will benefit from several tailwinds - 1) positive shift in market positioning, 2) traditional finance inflows from the imminent ETF, 3) most investable crypto asset outside of BTC and will reach its all-time high price of ~$4800 within the next few months.

The market has been underweight ETH and sentiment is at rock bottom

We started scaling into ETH at the $3k levels a couple of weeks ago as we noticed that sentiment on the asset had reached rock bottom. 

We drew this conclusion by triangulating several data points. To start, Ethereum is the only crypto asset to have negative YTD flows on ETPs tracked by CoinShares.

Moreover, ETH Dominance has trended down from 21% during the Merge in Sep ‘22 to 15% in mid-May ‘24. This was the first time ETH Dominance reached such depths after the 3AC crash where ETH bore the brunt of forced liquidations. While this played out, Solana Dominance rose from ~1% to 3% as attention shifted to SOL amidst its outperformance post-FTX collapse.

As such, ETH has been unloved by institutions and retail alike as BTC ETFs drew in the TradFi crowd and SOL captured most of retail’s attention during its parabolic run. Furthermore, the implication here is that light market positioning would translate to limited downside in the event of a market-wide price crash.

Expectations of ETF inflows should flip this bearish sentiment and lead to a re-rating

In our view, ETH is the main beneficiary of a flurry of positive developments on the regulatory front over the past few weeks. First, the US Senate voted to overturn SEC’s SAB 121 which would have placed onerous accounting standards for the custody of crypto assets for banks. In quick succession, Congress voted to pass the FIT21 Bill, which aims to provide greater regulatory clarity of the treatment of crypto assets in the US. The icing on the cake came in the form of the SEC’s approval of the 19b-4 forms for 8 ETH ETFs, which is widely seen as a sign that an ETF approval is to come after S-1 forms are filed and approved.

On one hand, the ETF opens doors for TradFi capital to participate in the upside of ETH. We have already seen how impactful these inflows can be during the launch of the BTC ETFs in Jan ‘24. As of writing, the BTC ETFs have amassed $13.7b of cumulative inflows within 3 months, accompanied by a $434b market cap jump in BTC, a 32x market impact. We believe that the demand inelasticity of such inflows is a result of the low circulation of BTC on CEXes, as well as a large portion of dormant supply.

(Source: Glassnode)

We think that ETH will display greater demand inelasticity given a more favorable supply-side dynamic - with a lower relative amount being held on CEXes, ~28% of ETH being staked and a further 8% held in smart contracts. We can thus theorize the impact of ETH ETF inflows with daily inflows and demand inelasticity as drivers. In our base case, we think ETH should trade to all-time highs with  ETF approval.

On the other hand, the recent positive developments pushed by the US government signal a shift in rhetoric from the current administration toward their view on the crypto industry. This could put an end to the hostility displayed by US agencies towards crypto, which removes many left-tail outcomes for the industry and thus asset prices.

ETH has strong fundamentals and would be a strong addition to an allocator’s portfolio

TradFi asset managers like Blackrock and Fidelity have done most of the heavy lifting in de-risking the allocation to the crypto sector via BTC ETFs. We believe that an allocation to BTC could act as a gateway drug to institutional allocation to ETH - while BTC represents a bet on sound money and a hedge against currency debasement, a bet on ETH is a bet on continued advancement and adoption of Web 3.0 and blockchain technology.

Ethereum still retains its pole position as an execution layer for dApps. For instance, as the largest smart contract platform by market capitalization, Ethereum provides the best economic security for dApps. This is key for use cases that require a secure means for the settlement of assets. As a testament to this, it currently hosts $66b in DeFi TVL across key financial pillars like exchanges, borrowing/lending, and derivatives, which is 13x larger than Solana. Moreover, TradFi institutions like BlackRock are also using Ethereum to host various tokenized funds.

Ethereum also serves as a settlement and data availability layer for a burgeoning ecosystem of L2s, which offer scalability benefits that might be more suited for higher-frequency transaction use cases like gaming and social. There are now at least 55 Ethereum-based L2s hosting $47b of TVL.

(Source: L2Beat)

ETH the asset directly benefits from the economic activity transacting on the Ethereum network - a portion of ETH gas fees paid by users will be burnt by the network. In bull markets where activity heats up, we have seen monthly ETH burn going as high as $1.8b. Currently, this metric stands at ~$1b annualized, which makes Ethereum the most profitable blockchain network.

While there is much chatter about Solana being the next crypto asset to get an ETF approval, we think there are still some challenges that need to be addressed for us to bet on this outcome. First, we believe that SOL would require a futures listing on CME before even anyone considers filing an ETF application. Second, the SEC had previously labelled SOL as an outright security in one of its filings against Coinbase. We believe that the key implication here would be that ETH would be the main game in town for institutional investors to bet on the growth of blockchain platforms.

The market is still taking a cautiously optimistic view, leaving room for more upside

Since the news of the SEC’s approval of the 19b-4s, ETH has rallied a mere 20%. This is underwhelming compared to the ~70% rally that BTC saw leading up to its own ETF approval.

We believe that this might be due to the fear that a large portion of the $10.8b of assets in Grayscale Ethereum Trust would be liquidated. While some of these assets would inevitably be sold, we think that this risk would be mitigated by Grayscale cutting their fees or launching a mini-ETHE (similar to mini-GBTC) which would help to stem the outflows. We speculate that the $17+b of GBTC outflows contributed to the departure of Grayscale CEO Michael Sonnenshein and that the new CEO would leave no stone unturned in stemming the outflows for ETHE. We think that either the announcement of such measures or a smaller-than-expected outflow for ETHE would be the key catalyst to alleviating market fears.