Grayscale Ethereum Trust: Despite ETF Launches, NAV Discount Is Gone

Dennis Diatel PhotographyGrayscale Ethereum Trust Overview Grayscale Ethereum Trust (OTCQX:ETHE) is an investment trust designed to hold Ether (ETH-USD). As such, it is distinctly not an ETF or other kind of open-end fund. It’s more like Berkshire Hathaway (BRK.A) and uses a closed-end approach to invest its shareholders’ capital. Crypto ETFs are a newer asset class, and the first Ethereum ETFs are set to launch this week on July 23. By taking an alternate route, Grayscale was ahead of the curve here, and it’s interesting to consider just how the launch will affect them. For my part, I think it isn’t much of a catalyst, and ETHE was a much better Buy when it had a large discount to NAV. Whatever temporary surge in ETH will occur here, I think it’s better to treat ETHE as a Hold for now. Immediate Impact When an ETF launches, the open-end nature of the fund means that capital will flow into it. Since these ETFs are designed hold ETH for investors (bypassing the need to have crypto wallets), the first they will do is use the capital to buy ETH. Like any open-end fund, money flowing in will result in more purchases of its portfolio assets, and money flowing out will result in sales. These can have bullish and bearish impacts, respectively. I think it’s therefore likely that the launches this week will result in an increase in the price of ETH and anything exposed to it, like ETHE for a short period of time. ETHE Price vs. NAV History (Grayscale Official Website)Throughout its life (since 2019), ETHE’s price movements have followed those of ETH, albeit not perfectly. For nearly all of 2023 and much of this year, the shares have even traded at a discount to NAV. Still, a rise in ETH has usually been met with a rise in ETHE, so there is that potential here. Long-Term View What’s more important for investors, those interested in the long-term view of their assets, is what happens if one invests in ETHE today with intention of holding on to it, and that in many ways is a judgment call about ETH and crypto broadly. Ether Why is Ether considered attractive enough to deserve its own ETFs and investment trusts like Grayscale’s? Well, I think the big reason is that it’s the #2 cryptocurrency after BTC. coinmarketcap.comThere are not many other major contenders in the crypto space quite like them. Of course, for its own worth, one has to imagine that ETH will be used as a currency at some point. The choice between having one’s wealth in USD or in ETH should really be the same as the choice of having one’s wealth in USD or CAD. The primary risk ought to be some form of exchange rate risk. It comes down to what value we think we get by being in another currency. I have always said to folks who asked me that if you need a cryptocurrency to complete a transaction, then buy it, and maybe keep a certain cushion of it on hand if the need for another such transaction arises. By owning shares of ETHE, however, this advantage is lost, and this is something I dislike about funds that specifically orient themselves toward crypto. Moreover, as ETFs and similar investment funds buy and hold ETH, I think it becomes more likely that cryptocurrencies have a harder time truly taking off as currencies. After all, they aren’t being used to facilitate transactions at that point. In their 2023 Form 10K, Grayscale reported having about 2.5% of all ETH in circulation. While some time has passed, one has to appreciate how large of a share that is for one entity. If too little ETH is ever used for transactions, I have a hard time seeing what kind of demand would exist to make something like ETHE a good investment to produce attractive, long-term returns. Demand isn’t created by undersupply. Demand is created by people wanting and needing something, and the case that much more demand for ETH will exist in the future, to the benefit of ETHE, still needs to be made. Bitcoin Another factor worth considering is ETH’s relationship to BTC. Just take a look at the three-year performance of each. ETH vs. BTC 3Y Performance (Seeking Alpha)While it’s not perfect, we do see a very close relationship. As BTC’s own halving this spring seemed to prompt a rally, ETH apparently followed suit. I think the best explanation for this is that crypto investors are often invested in both BTC and ETH, and they tend to add and trim positions concurrently as part of their diversification strategy. In the current environment, it’s also likely that long-term movements in BTC will affect ETHE as well, perhaps less directly than ETH. As long as crypto investors believe in both as strongly as they do, I expect this to be the case. Good news for BTC could also spell good news for ETH. Discount To NAV The last thing to consider with an investment like ETHE is whether or not a discount to NAV exists. I think large discounts, which have happened before, represent the most compelling buy case, as essentially a form of arbitrage. Currently, the market price is almost exactly the NAV. This means that folks buying ETHE because of the launch of these ETFs will depend entirely on an attractive enough increase in ETH, something I consider to be risky. Not only do I think a discount is needed but a pretty large one at that because of the long-term friction caused by the trust’s expenses, which are currently 2.5% of the fund’s assets. That’s a very significant drag over time, more than the typical rate of inflation, so essentially we have to hope that ETH beats inflation for ETHE to be breakeven over time. Otherwise, an investor has to manufacture that result with a better entry price and resisting temptation to get in when the discount narrows. Conclusion Whether it’s crypto or funds that specifically invest in them, they are tricky because they are non-productive assets. Warren Buffett himself is long-quoted saying the following about gold as an investment asset: Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head. Believers in gold naturally feel it is a hedge against inflation, but as Buffett pointed out, there’s nothing to it that has a compounding effect, and cryptocurrencies are similar in this regard. Folks who buy crypto as an investment need a compelling reason to believe they can later sell it for a much better price. Owning ETH indirectly through a trust like ETHE comes with the same risks but none of the advantages of having a currency on hand to transact. There’s also the 2.5% expense ratio. As such, the only buy case that exists is when ETHE, with its closed-end nature, trades substantially below NAV. At least then there is some intrinsic difference. That gap closed in recent months, and while we now have only just gotten confirmation that Ether ETFs will launch, we still need good prices to get good returns. Until a major discount to NAV appears again, I consider ETHE just be a Hold. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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