2023-09-28 09:59:15 ET
Summary
- Grayscale Ethereum Trust currently trades at a 32% discount to Net Asset Value, potentially offering a 47% return if the discount closes.
- Recent court ruling favoring Grayscale Bitcoin Trust's ability to convert to an ETF suggests ETHE may follow a similar path.
- The SEC may not appeal the ruling due to its clarity and logic, and delays due to a potential government shutdown.
Grayscale Ethereum Trust (ETHE) is a fund that holds the cryptocurrency Ether (ETH-USD). Currently that fund trades at a 32% discount to Net Asset Value. Hence if that NAV discount were too close to zero and the price of Ether was unchanged the fund could see a 47% return.
With the recent court ruling last August that strongly favored sister fund Grayscale Bitcoin Trust's (GBTC) ability to convert to an Exchange Traded Fund, there's reason to think that ETHE may ultimately be on a similar path.
The markets may be worried that we are still in the 45-day window for the SEC to appeal the ruling. However, the ruling appeared categoric and it's unclear how the SEC might challenge it successfully.
Also, time is running out, if the government were to shut down on October 1, then the SEC would likely be operating with a " skeletal " staff according to Chair Gary Gensler. That would make it hard for the SEC to file a legal challenge after this Friday, if indeed the government does shutdown.
The legal ruling came on August 29, 2023. 45 days after that is Friday, October 13. The SEC had already challenged the Ripple ruling by this point after the ruling, so there are reasons to think that the SEC may not challenge the ruling on spot Bitcoin ETFs. Let's unpack the logic of that assertion.
The Ruling Appears Definitive
Perhaps the strongest reason to believe an appeal is not coming is the ruling was pretty clear that spot products and futures products based on the same underlying instrument are basically the same thing and 99.9% correlated. Therefore for the SEC to allow a Bitcoin futures ETF and block a spot Bitcoin ETF was inconsistent. It's hard to see how the SEC argues against that logic, and they would need something to base an appeal on. It's unclear what the grounds for appeal are, the Ripple ruling was far more nuanced in comparison and importantly had follow on impacts to other areas of the SEC's work and legal battles, that's less true about the more focused spot Bitcoin ruling.
The SEC Has Been (So Far) Slower To Appeal Compared To The Ripple Case
The Ripple ruling was appealed on August 9 after a ruling on July 13. That's 27 days to appeal. If the SEC were on a similar timeline, they would have appealed the court's decision this Monday, September 25. Of course we're still close to that timing, such that an appeal could come this week, but if not then maybe an appeal is less likely.
A Government Shutdown May Impede the SEC's Ability To Appeal
Lastly, but significantly if no appeal is filed by this Friday and the government shuts down next Monday, then the SEC may not have the resources to mount an appeal before the apparent October 13 deadline. Of course, much depends on whether a shutdown occurs and how long it could last, but it's hard to see the SEC mounting a legal appeal without a full slate of working staff and even once the SEC staff are back, the backlog and disruption from any shutdown lasting more than a day or two, might impede the SEC getting a challenge launched before the deadline.
What Happens Next
If there is no appeal, then the SEC should ultimately follow the court's ruling and allow a spot Bitcoin ETF, likely from Grayscale and potentially many other providers. Of course, the ETFs themselves still needs to be reviewed and that's a slow process that the SEC has so far dragged its feet on and could easily take a few months. Plus it's likely that Grayscale may need a vote from fund holders in order to achieve a conversion. It's very likely that this would be supported, but it could add weeks to the process.
Still, that should bring the NAV discount on the Grayscale Bitcoin Trust from 23% to zero, for an almost 30% return (notwithstanding any moves in the Bitcoin price). The reason is because ETFs have mechanisms to trade at NAV buy creating or redeeming units depending on the direction of the deviation from NAV. If you look at ETFs, you'll see that a deviation from NAV of even 1% is pretty unusual.
The Implications For ETHE
If the Grayscale Bitcoin Trust sees value in ETF conversion, then converting the Grayscale Ethereum Trust might be a logical next step. That's why the relatively wider discount on ETHE may be enticing here. The fate of both funds is likely similar.
Risks
- Some have questioned whether Grayscale would really want to move away from fund structures with 2% annual fees to ETFs where fees are generally under 1%. There is certainly a risk that the funds do not convert to ETFs on that logic, however, if Grayscale maintains its fund structure it will likely lose assets to ETFs over time. Therefore, given the prospect of potential market share loss, Grayscale may be better served by leveraging its scale to create perhaps the largest ETFs in the spot cryptocurrency space and enjoying the growth there, even if revenue relative to assets does decline.
- There are still over two weeks for the SEC to appeal, and they may do so, especially if the government does not shut down.
- The SEC may accept the legal ruling, but find other ways to block a spot Bitcoin or Ethereum ETF on other procedural grounds if they wish to. As a regulator they do have substantial power and leeway, and it's quite rare for the courts to impede on that.
- Even if Grayscale embark on a spot Bitcoin ETF, a Ethereum ETF conversion may not follow.
- Grayscale funds are volatile following volatility in the cryptocurrency space and currently relatively high fee products. That creates risk for fund holders even if the NAV discount does close as returns need not be positive if the price of the underlying asset declines.
Conclusion
It is interesting that the NAV discounts for some of Grayscales fund products have widened recently despite the apparently positive legal ruling. The market may be expecting an SEC appeal of the ruling, which would push out any ETF conversion timeline and jeopardize conversion. However, the ruling appears robust and the SEC may be running out of time to appeal. Therefore, come next week, especially if there is a government shutdown it may make sense to look at Grayscales Ethereum Fund as Grayscale's major cryptocurrency may be on a path to close their discounts to NAV perhaps in the first half of 2024 with ETF conversion.
For further details see:
Grayscale Ethereum Trust's Widening NAV Discount May Create Opportunity