The Upside for Retail Investors of Ethereum Spot Exchange Traded Funds

Investors and regulators are monitoring the impact of two cryptocurrency spot exchange traded funds (ETFs) approved by the SEC in 2024.[1] The Bitcoin spot ETFs, which began trading in January, have garnered substantial interest from both retail and institutional investors. Conversely, the Ethereum spot ETFs were recently launched, and little data is available to evaluate their acceptance. In a recent study, I examine the potential implications of Ethereum spot ETFs for retail investors.

While Ethereum futures-based ETFs have been trading since October 2023, spot ETFs provide investors with direct exposure to Ethereum (Del Castillo, 2024). These two types of ETFs differ significantly in their structure and regulatory implications. A spot ETF directly holds the underlying asset, allowing investors to benefit from the asset’s current market price. In contrast, a futures-based ETF offers indirect exposure by holding various futures contracts, which can deviate from the spot price due to market conditions such as contango (where the futures price is higher than the spot price) and backwardation (where the current price is higher than prices trading in the futures market). While spot ETFs offer straightforward investment opportunities by closely tracking the asset’s market price, futures-based ETFs involve complexities and additional costs related to the rollover of futures contracts. These structural differences have important regulatory and investment implications that investors must carefully consider.[2]

Ethereum spot ETFs can streamline the investment process for retail investors, offering a more familiar and accessible avenue compared with direct cryptocurrency purchases. By enabling investors to buy and sell shares through existing brokerage accounts, these ETFs eliminate the need for navigating complex crypto exchanges or managing private keys associated with crypto wallets.

Furthermore, spot ETFs usually have lower minimum investment requirements, typically a few hundred dollars, enabling participation in the market for those with limited capital. This accessibility extends to traditional investment platforms, such as IRAs and 401(k) plans, where the introduction of Ethereum spot ETFs offers retail investors an opportunity to diversify their portfolios with cryptocurrency exposure.

The potential benefits of Ethereum spot ETFs for retail investors include increased accessibility, convenience, and diversification opportunities. However, it also underscores the substantial risks, including high volatility and the inability to participate in staking.[3] As the cryptocurrency market evolves, regulatory clarity and investor education will be critical in balancing these benefits and risks.

While Bitcoin spot ETFs present compelling long-term investment opportunities, Ethereum spot ETFs offer distinct advantages for retail investors, primarily due to the technological versatility and its broad application spectrum (Johnson, 2024). Unlike Bitcoin, which primarily serves as a store of value, Ethereum’s blockchain supports smart contracts and decentralized applications (dApps), enabling a variety of innovative use cases, including decentralized finance (DeFi) and non-fungible tokens (NFTs). This functional diversity provides Ethereum with a significant edge in promoting innovation and market disruption (Pineda, Jabba, and Nieto-Bernal, 2024).

Cryptocurrencies like Bitcoin and Ethereum show impressive historical returns of 25.19 percent and 25.94 percent annually from January 2018 through June 2024, but with high volatility – Bitcoin’s standard deviation is 68.41 percent, and Ethereum’s is 87.54 percent.[4] This volatility can lead to significant gains or losses, posing challenges for retail investors. In contrast, traditional investments like the Vanguard Bond Index and the S&P 500 Stock Index offer lower risk profiles and better risk-adjusted performance. It is necessary for retail investors to view cryptocurrency investments as long-term strategies due to their volatility, with an emphasis on patience and strategic commitment over short-term speculation.

Table 1.

Historical Performance of Bitcoin, Ethereum, and S&P 500

January 2018 – June 2024

 Investment (Symbol) Geometric Average Annualized Return Annualized Standard Deviation Sharpe Ratio
Bitcoin (BTC) 25.19% 68.41% 0.37
Ethereum (ETH) 25.94% 87.54% 0.30
Vanguard Bond Index (BND) 0.82% 6.19% 0.13
S&P 500 Stock Index (SPY) 13.31% 19.74% 0.67

Table 2 shows that over the study period both Bitcoin and Ethereum exhibited relatively low correlations with the Vanguard Bond Fund and the S&P 500 Fund, as evidenced by correlation coefficients of 0.22 and 0.38 for Bitcoin and 0.24 and 0.42 for Ethereum.[5] This implies that the price movements of Bitcoin and Ethereum are fairly independent of the broader bond and stock markets. Because they have demonstrated both high returns and low correlations, integrating Bitcoin and Ethereum into a portfolio could potentially improve both total returns and risk-adjusted returns by offering diversification benefits and reducing overall portfolio risk.

Table 2.

Correlation of Returns of Bitcoin, Ethereum, Bonds, and S&P 500

January 2018 – June 2024

BTC ETH BND SP500
BTC 1.00 0.72 0.22 0.38
ETH 0.72 1.00 0.24 0.42
BND 0.22 0.24 1.00 0.35
SP500 0.38 0.42 0.35 1.00

Investing directly in cryptocurrencies like Ethereum presents significant challenges, particularly for retail investors who often lack the necessary knowledge to navigate this complex and rapidly evolving market.[6] Unlike traditional assets such as stocks and bonds, Ethereum and other cryptocurrencies operate on blockchain technology, which requires a deeper understanding of technical concepts like smart contracts, decentralized finance, and tokenomics. Many retail investors enter the market without sufficient knowledge, driven by the fear of missing out. This lack of understanding can lead to common misconceptions, such as the belief that cryptocurrencies are guaranteed to yield high returns or that they are immune to market volatility. These gaps in knowledge can result in poor investment decisions and significant financial losses.

The impact of hype further complicates the landscape for retail investors. Media coverage and social media play substantial roles in shaping investor sentiment, often creating a buzz around cryptocurrencies like Ethereum. This hype can lead to irrational exuberance, where investors make decisions based on the fear of missing out rather than sound financial principles. Influencers and viral posts can inflate expectations and drive speculative buying, pushing prices to unsustainable levels. When the hype subsides or when negative news arises, these inflated prices can collapse, leading to severe losses for those who bought in at the peak. This cycle of hype and crash underscores the importance of due diligence and a cautious approach when investing in cryptocurrencies.

Retail investors keen on investing in Ethereum should strongly consider a spot ETF over holding the crypto outright. These ETFs provide a more accessible and familiar avenue for investors, facilitating purchase and sale through conventional brokerage accounts without the complexities of managing private keys or navigating crypto exchanges. With lower minimum investment requirements, Ethereum spot ETFs offer broader participation in the market, including through traditional investment platforms like IRAs and 401(k) plans. This accessibility not only enhances convenience but also promotes portfolio diversification with cryptocurrency exposure. While direct crypto investments entail high volatility and the inability to stake, Ethereum spot ETFs mitigate these risks while still tapping into the potential long-term benefits of cryptocurrency.

ENDNOTES

[1] ETFs offer retail investors diversified exposure to various asset classes with liquidity, allowing for cost-effective trading throughout the day on regulated securities exchanges.

[2] Cryptocurrency futures-based ETFs typically have expense ratios around 0.85 percent to 0.95 percent, while spot ETFs have significantly lower fees ranging from 0.20 percent to 0.30 percent.

[3] Staking allows Ethereum token holders to earn income passively by validating transactions. However, investors in Ethereum ETFs cannot participate in staking activities because the SEC considers staked crypto to be an investment contract.

[4] It almost goes with saying that past performance is no guarantee of future investment results.

[5] Historical correlations in this range indicate a weak positive relationship and suggest there could be other factors influencing these assets’ price more significantly.

[6] Investors who used the crypto exchange FTX faced substantial risks and incurred significant losses following its collapse in 2022.

REFERENCES

Del Castillo, M. (2024, June 25). Ethereum ETF process ‘going smoothly’ a testy SEC Chair declared. Fortune. https://fortune.com/2024/06/25/ethereum-etf-process-going-smoothly-a-testy-sec-chair-declares/

Johnson, H. (2024, May 1). Spot bitcoin ETFs: How do they work? AP Buyline. https://apnews.com/buyline-personal-finance/article/spot-bitcoin-etfs-how-do-they-work

Krause, David, Mainstreaming Cryptocurrency: The State of Wisconsin Investment Board’s Pioneering Investment in Bitcoin ETFs (June 03, 2024). Available at SSRN:  http://dx.doi.org/10.2139/ssrn.4852566

Krause, David. Democratization or Hype? The Retail Investor and Ethereum Spot Exchange Treaded Funds (June 15, 2024). Available at SSRN: http://dx.doi.org/10.2139/ssrn.4866495

Pineda, M., Jabba, D., & Nieto-Bernal, W. (2024). Blockchain Architectures for the Digital Economy: Trends and Opportunities. Sustainability, 16(1), 442.

This post comes to us from Professor David Krause at Marquette University – Department of Finance. It is based on his recent paper, “Democratization or Hype? The Retail Investor and Ethereum Spot Exchange Treaded Funds,” available here.

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