Over the last few months, the crypto internet has been dominated by the Bitcoin ETF talk. And for a good reason. At a $835.7 billion market cap, the pioneering crypto makes up 49% of the total crypto market, consisting of tens of thousands of tokens.
In Bitcoin’s 15-year life cycle, an exchange-traded fund (ETF) represents a pivotal divergence, a milestone in legitimacy. Once derided as “fraud” akin to tulip mania, “rat poison,” or “index of money laundering”, Bitcoin’s entry into the ETF arena discards those perception rags and replaces it with a brand new coat.
Long-Term Trickling from a Deep Pool
Having the blessing of the Securities and Exchange Commission (SEC) means that institutions can start apportioning their capital into a high-yielding asset. Bitcoin fits the bill because, even more so than gold, its supply is affixed, and even though Bitcoin is digital, it is grounded in physicality via the proof-of-work mining network.
As of October 2023, US ETFs have $5.6 trillion worth of equities. Even in low single-digit percentages, capital trickling into Bitcoin is poised to create a rising tide, a feedback loop owing to Bitcoin’s limited supply. Without the hassle of custodianship, investors get exposure to this tide, represented as ETF shares that track Bitcoin’s spot price.
Just one such Bitcoin ETF applicant is BlackRock. The world’s largest asset manager had already lined up capital to the tune of $2 billion, according to sources.
Following the approvals on January 11th, an expected sell-pressure transpired in a classic “sell the news event,” bringing the BTC price down -7.4% over the week. Yet, launching a new investment vehicle has been successful, tracking over $1.4 billion in AuM and $3.6 billion in volume in just two days.
But what of Bitcoin’s long-following shadow, Ethereum? Having transitioned from proof-of-work to proof-of-stake, the Ethereum project is perceived quite differently from Bitcoin. What are these differences and how would they reflect on their respective ETF investment vehicles?
The Store of Value: Bitcoin in the Spot ETF Market
For many years, it was not clear what Bitcoin would become. After all, Bitcoin underwent over 100 hard forks, splintering the original whitepaper vision of a “purely peer-to-peer version of electronic cash”.
Following the resolution of Bitcoin’s contentious block size wars in 2017, the Small Blockers faction won. Instead of increasing block size outright, they opted for soft Bitcoin scaling via the SegWit upgrade. This veered Bitcoin’s fate into a store-of-value asset instead of a low-friction P2P digital cash.
Hard limitations make it impossible to have it both ways. If the large block size faction had won, more computing power and bandwidth would have been required to run full mining nodes, leading to network centralization and potential transaction censorship.
On the other hand, smaller blocks retain decentralization but make it difficult to scale on-chain. As fewer transactions fit inside a block, higher network activity leads to higher transfer fees because waiting lines are formed. And if BTC transfer fees go up, Bitcoin’s daily currency proposition is diminished.
At least, without using layer 2 scaling solutions like the Lightning Network, harnessed by payment apps like Strike. Such payment systems can utilize Bitcoin as a vehicle to transfer cash and interface with the existing banking system.
I use send globally via strike app to bank all the time. It is near instant cash deposit settlement. Our family in the Philippines are in awe of the power of#Bitcoin
— General Plebian (@GenPlebian) December 23, 2023
In the end, Bitcoin cemented its position as true sovereign money, peer-to-peer but not inherently low friction. Rather, Bitcoin is the foundation for a financial edifice to be built upon. In the age of continuous fiat currency debasement via central banking, decentralized sovereignty overrides low friction, painting Bitcoin as a monetary escape hatch.
For people accustomed to fiat money erosion, this is a novel concept. Yet, Bitcoin ETF applicants are now incentivized to bring that concept in the public spotlight.
— Hashdex (@hashdex) December 28, 2023
This competitive marketing push alone is poised to deepen the capital pool for Bitcoin exposure. And the deeper it gets, the higher the Bitcoin price will likely go, creating a feedback loop of more capital inflows.
Ethereum’s Technological Utility: Beyond Mere Investment
While Bitcoin pioneered the concept of blockchain-based sovereign money, Ethereum is a work-in-progress infrastructure layer. One that onboards digital assets and supplants traditional financial services.
This purpose drove Ethereum’s proof-of-stake transition, as such blockchain networks rely on economic stakes instead of energy-hungry computing power. However, having a negligent energy footprint (compared to Bitcoin) is only the scaling starting point.
Daily operational financial infrastructure necessitates low friction (minimal fees) to be accessible and to truly take on TradFi. Ethereum is yet to achieve low friction, relying instead on many layer 2 scaling solutions.
This became even clearer in the latest roadmap, emphasizing Ethereum interoperability and security against cyber attacks, instead of L1 scaling for low transaction fees.
By popular demand, an updated roadmap diagram for 2023! pic.twitter.com/oxo58A2KuG
— vitalik.eth (@VitalikButerin) December 30, 2023
This approach poses two major problems:
- By ditching proof-of-work, the Ethereum blockchain becomes reliant on large stakeholders and cloud computing services such as Amazon Web Services (AWS). This reduces Ethereum’s perception as a decentralized network that could be a true TradFi substitute.
- In turn, Ethereum positioned itself among other PoS network alternatives, with similar centralization issues But those have been built from the ground up for L1 scaling, without the extra L2 scaling complexity for the end user to interface with.
In this cycle, this dynamic became more evident. Even though ETH is the second largest cryptocurrency by market cap, it lagged behind Bitcoin at +64% year-over-year performance. Ethereum lagged greatly behind its direct competitors Avalanche (AVAX) at +118% YoY, and Solana (SOL) at +321% YoY performance.
Ethereum’s lackluster performance transpired despite having an even lower inflation rate than Bitcoin. This could indicate that Ethereum’s perception is much more precarious than Bitcoin’s, which has a more coherent and focused “sound money” proposition.
That proposition is not duplicatable due to Bitcoin’s mining network effect. For instance, if Bitcoin code were to be tweaked to become a PoS chain, per the preference of Greenpeace, it would simply be a dead code without the network onboarders.
Ethereum’s network effect stems from holding dApp domination among PoS chains. Yet, it is not clear if that domination will not shift to AVAX, SOL or another PoS network. Additionally, while it is clear that Bitcoin is viewed as a commodity by regulatory bodies, Ethereum is still in the fog of regulatory obfuscation.
Market and Regulatory Dynamics
As of date, SEC Chair Gary Gensler hasn’t explicitly announced whether ETH is a security or a commodity. By the latest speculation, Bloomberg ETF analyst James Seyffart thinks that the SEC is leaning in the commodity designation by already approving Ethereum future ETFs in August.
James Seyffart at CryptoQuant webinar on January 4th:
“So again, Gary Gensler will not explicitly say whether Ethereum is a security or a commodity, but in their action, by approving those Ethereum futures ETFs, they’re implicitly accepting those Ethereum futures as commodities futures.”
Other PoS chains like SOL, ADA and AVAX are in the same regulatory uncertainty boat. In last year’s lawsuit against Coinbase, the SEC named them all as “crypto asset securities.” If Seyffart is correct, and ETH becomes a commodity per the preference of CFTC, this could give Ethereum an edge over its competitors.
Presently, spot-traded Ethereum ETFs are delayed until May 2024, from Grayscale Ethereum Futures ETF to Hashdex Nasdaq Ethereum ETF. Likewise, the SEC pushed back Cathie Wood’s ARK Invest, 21Shares and VanEck’s Ethereum ETF.
Given the limited market liquidity, compared to the Fed money supply extravaganza in 2021, Bitcoin is poised to be the greater beneficiary of the first move advantage than Ethereum.
There is a reason why the SEC failed to approve a single spot-traded Bitcoin ETF since the first application by Cameron and Tyler Winklevoss in 2013. Not only was Bitcoin less mature, but the banking sector wouldn’t give a leg up to its P2P competition.
Since those days, Bitcoin has overcome its underground, tulip, money laundering detractors. The digital asset is now secured by the world’s most powerful computing network, erecting an ecosystem of mining companies. This further bolstered investor confidence due to Bitcoin’s conservative coding practices.
On the other hand, Ethereum is perceived as a more patchworked crypto project yet to entrench itself as a DeFi vanguard to tackle TradFi. Burdened with technical and regulatory uncertainty, conservative Bitcoin is a far likelier candidate to receive sustained retail and institutional attention from the first ETF vehicle.