Experts Warn of Risks in Spot Ethereum ETFs

Potential exchange-traded funds based on the second-largest cryptocurrency, which will lock assets in staking, pose risks to the Ethereum ecosystem, according to a report by S&P Global Ratings.

Experts suggest that spot ETH-ETFs could become “large enough to alter the concentration of validators in the network for better or worse.”

Analysts believe that potential issuers are unlikely to choose decentralized staking services like Lido. Instead, they are expected to prefer institutional cryptocurrency custodians.

The report indicates that the impact on Ethereum’s concentration will vary depending on whether issuers diversify their holdings across multiple custodians.

“Coinbase acts as custodian for eight of the 11 recently approved Bitcoin ETFs in the U.S. Three of the four largest crypto funds outside the country have named the exchange as an institutional staking provider. The emergence of new custodians could allow issuers to distribute their holdings among various organizations and reduce risks,” they added.

According to S&P Global researchers, centralization of any entity or protocol poses a threat to the network, as a concentrated number of liquidity providers or node operators could serve as a single point of failure or become a target for attack.

Analysts predict that the U.S. Securities and Exchange Commission (SEC) will approve spot Ethereum ETFs as early as May 2024, the first deadline for reviewing applications.

Impatient Coinbase

Coinbase’s Chief Legal Officer Paul Grewal urged the SEC to approve the conversion of Grayscale Ethereum Trust into a spot ETH-ETF. He stated that the exchange responded to the regulator’s request for comments on the instrument.

Today @coinbase responded to @SECGov‘s request for comment on the proposed @Grayscale Ether Trust ($ETHE) ETP. 27 pages and 96 citations that provide the (1) legal, (2) technical, and (3) economic rationale for approval. 1/6

— paulgrewal.eth (@iampaulgrewal) February 21, 2024

Grewal stated that representatives of the trading platform provided the “legal, technical, and economic rationale” necessary for the approval of Grayscale’s product.

“Our letter outlines what everyone who has paid even the slightest attention to this topic knows: ETH is not a security. In fact, both before and after [the update] The Merge, the SEC, CFTC, and the market have considered the asset not as a security but as a commodity,” Grewal added.

Coinbase argued that the approval of spot Bitcoin ETFs “applies with equal — and in some ways greater — force to the listing and trading” of Grayscale’s spot ETH-ETF.

The depth of the Ethereum market, narrow spreads, and spot correlation are “highly indicative” of a direction resistant to fraud and manipulation, the company believes.

“The notional dollar trading volume of ETH significantly exceeds that of the vast majority of stocks in the S&P 500 index, even when adjusted for aggregate market value,” Coinbase representatives emphasized in the letter.

On January 25, the SEC delayed the review of BlackRock’s Ethereum-ETF application until March 10. SEC Chairman Gary Gensler reminded that the approval of a spot exchange-traded fund based on Bitcoin was limited to only one cryptocurrency.

Morgan Creek Capital CEO Mark Yusko assessed the chances of imminent approval for an Ethereum-ETF as less than 50%. The expert noted the SEC’s hostility towards the industry as a whole.

JPMorgan analyst Nikolaos Panigirtzoglou shares a similar view. Analysts from investment bank TD Cowen also doubted the swift registration of spot Ethereum-ETFs.

Bloomberg exchange analyst James Seyffart bet 4 ETH that the SEC will not approve spot Ethereum-ETFs in March.