Digital asset management firm Grayscale Investments wants to launch an ethereum (ETH) futures exchange-traded fund (ETF) in the US, providing investors with a way to invest in the cryptocurrency without having to hold any coins.
What is Grayscale’s Ethereum Futures ETF?
Grayscale filed an application with the US Securities and Exchange Commission (SEC) on September 19 for the new ETF on the New York Stock Exchange (NYSE) Arca, an electronic exchange that lists exchange-traded products and equities. If approved, the Grayscale Ethereum Futures Trust would hold ether futures contracts traded on the Chicago Mercantile Exchange (CME) on behalf of investors.
The CME Globex platform is a financial derivatives exchange that provides two cash-settled Ethereum futures contracts – one representing 50 Ether (the ETH contract) and another representing 0.10 ether (the MET contract). Each has six consecutive monthly contracts plus up to two additional December contracts. (If the six months include December, only one additional December contract is listed.)
With its ETF, Grayscale aims for the daily changes in the net asset value (NAV) of its shares to reflect the daily changes in the price of the benchmark, which would be the average of the closing settlement prices for the first and second to expire ETH contracts.
The Trust would make an initial margin deposit to initiate an open position in the futures contracts. A margin deposit acts as a cash performance bond to assure the performance of the futures contracts that a trader purchases or sells. Futures contracts are marked to market at the end of each trading session, and the margin is adjusted accordingly. The Trust would hold the remainder of its assets in cash and cash equivalents at the Trust custodian or other financial institutions. The Trust would not need an ether custodian or crypto wallet as it would only hold ether futures contracts and never hold actual ETH.
What is a Futures ETF?
A futures exchange-traded fund is a type of investment fund that tracks the performance of a specific futures contract or a basket of futures contracts. Rather than holding the underlying assets themselves, futures ETFs use financial instruments such as futures contracts to track the underlying asset’s price movements. Futures contracts are financial derivatives that obligate the holder to buy or sell a particular asset, such as a commodity, stock index, or currency, at a set price on a specified date in the future.
Futures ETFs differ from traditional ETFs, which typically hold a portfolio of underlying assets, such as stocks or bonds, to replicate the performance of a specific asset class or index. Investors and traders use futures ETFs to gain exposure to commodities, currencies, indices, and other asset classes for speculation or hedging without trading futures contracts directly.
Some futures ETFs use leverage – which involves borrowing funds to take a more prominent position – to amplify the size of their returns, although this also increases the risk of losses.
What Does Grayscale’s Proposal Mean for ETH’s Future?
Grayscale is a significant investor in cryptocurrencies, and the ETF application indicates that it remains committed to facilitating investment in the market. It also indicates the firm’s confidence in the future of ethereum – the world’s second-largest cryptocurrency by market capitalization – as a profitable investment asset. The Grayscale Ethereum Trust fund was one of the first securities solely invested in the price of ETH, having launched in December 2017.
The Trust is “solely and passively invested in ETH, enabling investors to gain exposure to ETH in the form of a security while avoiding the challenges of buying, storing, and safekeeping ETH directly,” according to its website.
Much of the focus among cryptocurrency investors has been on calls to launch a spot Bitcoin ETF, for which the SEC has repeatedly rejected applications. More than ten financial firms have filed applications, including Fidelity, Digital Currency Group, Franklin Templeton, BlackRock, and Grayscale. Observers expect that a spot ETF would open up cryptocurrency investing to a broader range of investors, from individuals to large financial institutions, who have been waiting for a regulated and accessible investment vehicle to give them the confidence to enter the crypto markets. This could contribute to increased liquidity and stability in the Ether market.
Approval of a new cryptocurrency ETF would ease the tension between the SEC and the crypto industry driven by the regulator’s claims that cryptocurrencies are securities rather than currencies, commodities, or other forms of assets. The SEC’s lawsuits against cryptocurrency exchanges Binance and Coinbase have increased uncertainty among investors and hampered liquidity.
SEC in the Courts
Grayscale recently won a lawsuit in the DC Circuit Court challenging the SEC’s rejection of its application to convert the Grayscale Bitcoin Trust fund into a spot ETF as “arbitrary and capricious.” Grayscale’s lawyers are pushing the SEC to approve the Bitcoin ETF “expeditiously.”
Grayscale is strategically applying for a futures ETF for Ether rather than a spot ETF. While the SEC has so far rejected all spot ETF applications, it approved the ProShares Bitcoin Strategy ETF (BITO) in 2021.
In the SEC filing for the Ethereum ETF, Grayscale noted that in previously rejecting spot digital asset ETP proposals for Bitcoin, the Commission has raised concerns about the potential for fraud and manipulation in the underlying digital asset markets. However, Grayscale “believes the structure and operation of the Trust are designed to prevent fraudulent and manipulative acts and practices, to protect investors and the public interest, and to respond to the specific concerns that the Commission may have with respect to potential fraud and manipulation in the context of an ETH-based ETP.”
The firm added that the CME “is a regulated futures exchange with the requisite oversight, controls, and regulatory scrutiny necessary to maintain, promote, and effectuate fair and transparent trading of its listed products, including the ETH Contracts and MET Contracts.” In addition to the Bitcoin ETFs, several firms have filed registration statements with the SEC for ETH-based ETFs that would hold ETH futures contracts that trade on the CME and settle using the CME CF Ethereum Reference Rate (ERR). These offer identical exposure to the Grayscale Ethereum Trust, so Grayscale “believes that if the Commission allows these ETFs to begin trading, then it should also approve the Trust for trading.”
Cryptocurrency investors and enthusiasts continue to look to the SEC’s decision on the ETF applications to indicate how regulations will evolve.
Investors need to be aware that futures ETFs carry risks, including the risk of losses because of market volatility, leverage, and specific factors that can affect the futures contracts they invest in. Their performance can deviate from the actual spot prices of the underlying assets because of futures contract expiration, market conditions, and other factors.
Cryptocurrencies, in particular, are highly volatile assets that are subject to massive price swings in both directions. These investments are not suitable for all investors and require a good understanding of how they operate before risking any money.