Jun 11, 2020 00:28 AM | Nick Chong

Although it has become much easier to acquire Ether (ETH) over recent years, many investors may be hesitant to use spot exchanges such as Coinbase and Kraken due to concerns about cryptocurrency security. Relatively secure "cold" wallet solutions can be difficult to use, while storing digital assets on exchanges — which lose millions each year to security breaches — is risky. Regulated Ethereum futures markets such as ErisX, too, can be inaccessible to many investors.

The Grayscale Ethereum Trust has thus quickly become an alternative way for investors to gain exposure to ETH. Unfortunately, due to the structure of the product, which is backed by ETH held in reserves, the trust has a crucial drawback: a heavy premium over the spot market. 

What Is The Grayscale Ethereum Trust?

The Grayscale Ethereum Trust is a publicly-tradable investment vehicle, backed by Ethereum and operated by Digital Currency Group's Grayscale Investments. Grayscale Investments is best known for the Grayscale Bitcoin Trust, which holds nearly 2% of all BTC in circulation

Each share of the trust is currently backed by approximately 0.094 ETH, though this figure slowly decreases over time due to Grayscale's management fee of 2.5% per annum. Shares cannot be redeemed for the Ethereum that is contained in the trust as the digital asset manager has not yet been approved to offer a redemption program to its clients. 

Since May of 2019, after Grayscale received approval from the U.S. Financial Industry Regulatory Authority, these shares have been offered on over-the-counter (OTC) markets under the ticker "ETHE." With this listing, "all" individual and institutional investors were able to gain exposure to Ethereum in a manner that is arguably more secure and accessible compared to spot markets.

The Ethereum in Grayscale's trust is held by Coinbase Custody, a registered custodian in New York whose deposits are insured. ETHE is also the only way through which an investor can formally gain exposure to Ethereum through their IRAs or 401(k)s. 

ETHE Premium Grows As Demand For Ethereum Spikes

Due to an increase in demand for Ethereum and a wider recovery in the cryptocurrency market, shares of ETHE have rocketed higher over recent weeks. Demand for the trust was so high that as of June 4, TradingView.com found that ETHE had appreciated more than 600% since the start of 2019. Ethereum, on the other hand, was up by approximately 50%. 

By the end of June 4's trading session, the OTC market valued the trust at a new all-time high of $239.50 per share. At that same time, Ethereum was trading at $241.48 on Coinbase, analyst Ceteris Paribus observed.

Because each ETHE share corresponds to approximately 0.094 ETH, that meant that OTC ETHE buyers were paying around 1,000% more than the net asset value of each share. The discrepancy is depicted in the chart below, which shows that the gap between the trust and Ethereum is the largest it's been all year. 


It is unclear why the premium reached such a point: ETHE shares trading effectively for the same price as Ethereum meant that investors were buying exposure to the cryptocurrency at an implied price of approximately $2,500. 

Due to the fact that it is the only Ethereum investment vehicle available through tax-advantaged accounts, retail investors disregarded the premium to gain exposure to cryptocurrency. There may also be an information discrepancy that resulted in retail investors purchasing ETHE, assuming each share is backed 1:1 with Ethereum.

Unfortunately for those who bought the asset at the top, the OTC market for ETHE may be primed to fall. 

The Premium Is Unlikely to Last

The premium — unfortunately for institutions and fortunately for retail investors — is unlikely to last. 

ETHE trades on the secondary market, but shares are minted through a private placement process that only involves accredited investors. Accredited investors are defined by U.S. laws as an individual or entity that has a net worth (less one's home) of at least $1,000,000, or an income of $200,000 each year (or $300,000 for a couple). Institutions are accredited investors as well.  

In these rounds, the investors — which are mostly hedge funds according to Grayscale's Q1 2020 report — can buy ETHE shares for the same price as spot ETH, but must hold those shares for a lockup period of one year. The lockup prevents arbitrageurs from minting shares through Grayscale, dumping them on the secondary market, and profiting from the difference. 

Yet, accredited investors that want to play the long game can still make money from the premium. 

According to an analysis of the Ethereum Trust by Ceteris Paribus published in April, more than $50 million worth of ETHE shares minted last year will see their lockup period end in the coming seven weeks. Approximately $75 million will be unlocked by the end of October, then approximately $100 million by the end of 2020. 

The holders of these shares can choose to liquidate them on the secondary market for a profit, pocketing the difference between how much they paid one year ago and the ETHE price on the secondary market today, which has been subject to a heavy premium as aforementioned. 

The price of ETHE on the secondary market stands to crash heavily from the influx of shares likely to hit the market.

According to OTC Markets, the exchange through which ETHE is offered, 493,812 shares are being floated (available to be bought or sold) — a mere 3.6% of the 13,702,400 outstanding shares. 

Considering that the trust holds $355 million, the expected $50 million unlock will dramatically increase the float, likely by over 100%. Assuming consistent demand, the influx of supply will result in a drop in the ETHE price. As The Block's Larry Cermak explained:

"By the end of the month, a lot of the shares will be unlocked and the price of ETHE will collapse hard. To put it in other words, retail will get absolutely destroyed here. No other way around it."

The Need For Other Investment Venues

While investors can take advantage of the heavy premiums seen between Grayscale's Trust and physical ETH, this market dynamic accentuates the need for accessible and secure alternative investment venues for Ethereum.

For investors that want to avoid the hassle of using spot exchanges but still gain access to fairly priced Ethereum, a U.S.-regulated exchange-traded fund seems to be the option that makes the most sense. Yet as it stands, even Bitcoin doesn't have an ETF due to regulators’ fears of market manipulation and a lack of regulatory oversight. 

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