After Ripple Ruling, Grayscale Ethereum Trust Becomes More Interesting As A NAV Discount Play

Summary Grayscale Ethereum Trust, a fund holding Ethereum for investors, could see a 59% return if an ETF conversion closes its current 37% NAV discount. A court case against the SEC could allow the Grayscale Bitcoin Trust to convert to an ETF, the Grayscale Ethereum Fund could follow, eliminating its wider NAV discount. The court's recent Ripple ruling makes it more likely that Ethereum is not considered a security, increasing the chances of Grayscale converting its Ethereum fund into an ETF. Grayscale Ethereum Trust (ETHE) is a fund that holds Ethereum (ETH-USD) on behalf of investors. That's not terribly exciting, it carries a 2.5% annual fee, and there are other ways to access the cryptocurrency at lower cost if you wish to. However, the kicker is that legal challenges and a potential ETF conversion could cause the NAV discount to close. The current NAV discount is around 37% so if it were to close, that's a 59% return for investors (assuming no movement in the underlying price of Ethereum - a big assumption). The court's Ripple (XRP-USD) ruling just narrowed the NAV discount, but I would argue perhaps not be enough. Legal Challenge There's an active court case against the SEC with a decision expected in the next few weeks or months that could enable the larger Grayscale Bitcoin Trust (GBTC) to convert into an ETF if Grayscale wins the case, and there are few reasons from basic logic to one of the judge's questions during oral argument that suggest Grayscale may be well positioned to win that case. Definitely, not certain to win, but more likely than not to prevail. I've written a drill-down on the specifics of the legal case here . For the Grayscale Ethereum Fund, that's now very interesting, because both these Grayscale funds look very similar at a high level, holding billions of assets as the category leader, trading at a material discount to NAV and if they convert into ETF structures then the NAV discount drops to effectively zero. Equally, if they don't convert to ETFs and others do, they could lose market leadership to the likes of BlackRock and Fidelity over time, who have signaled based on preliminary ETF filings they could introduce ETFs if the SEC allows it, though those filings have not currently proceeded to ETFs yet based apparently on non-public SEC feedback that they are "inadequate". Note On ETF Market Leadership As an aside market leadership within an ETF category generally goes to the ETF that acquires the most assets out of the gate, and such funds generally then persist in the number one position. If Grayscale moves quickly on an ETF and brings over billions in assets, it may be able to transfer a leadership position in a fund to a similar leading ETF position. The reasons for this are a broader liquidity and narrower spreads that come from being the largest fund. That move may be strategically attractive to Grayscale for the long term, assuming crypto grows in relevance over time, even if fees have to come down a bit from the current 2.5% to achieve that outcome. Note On ETFs Trading At Or Close To NAV It's worth being aware that ETFs generally trade to NAV, unlike some other fund structures, since financial intermediaries create/redeem assets of the ETF by buying/selling the underlying assets to smooth out NAV premiums and discounts for ETFs. The current Grayscale funds for Bitcoin (BTC-USD) and Ethereum don't do that, hence the wide discount to NAV. That would likely change with an ETF structure, potentially collapsing today's rather large NAV discounts. The Ripple Ruling Importantly on July 13, the courts ruled that Ripple (another cryptocurrency) was, broadly speaking, not a security, "because purchasers did not have a reasonable expectation of profit tied to Ripple's efforts". That's important, the SEC has been guarded on defining whether Ethereum is a security or not, though they have generally referred to Bitcoin as a commodity, not a security. Of course, being a security shouldn't be a bad thing, but in this case, the SEC might go on to argue that it's an unregistered security and that then brings a host of legal problems given the current posture of the SEC toward crypto. It's possible the SEC appeals the ruling. Now with the Ripple ruling, it is more likely that Ethereum is not considered a security given its similarities with Ripple. Hence, if Bitcoin has success with its court case for a Bitcoin ETF, after today's legal decision, it may be easier for Grayscale to convert its Ethereum fund into an ETF if it chooses to, and there have been some Ethereum ETFs filings recently showing interest in this area, although the SEC has not approved them. Previously, even if Grayscale won its case against the SEC for a Bitcoin ETF, there was considerable risk that Ethereum would not be able to follow suit because the SEC would use arguments concerning how Ethereum was potentially a security to block any sort of ETF filing for Ethereum. Now that seems like a harder path for the SEC to pursue, though of course, they may find other angles. The Risks With Grayscale Ethereum Trust Still, there are likely two good reasons for the Grayscale Ethereum Trust to trade at a wider discount to NAV than the Grayscale Bitcoin Trust. Grayscale is fighting a court case to convert its Bitcoin Trust to an ETF. That implies an ETF conversion is likely if it wins. It hasn't shown the same public conviction for their Ethereum Fund, though it certainly explored an Ethereum futures ETF in May 2023 . So there's perhaps not identical conviction, but still some degree of momentum behind the Ethereum ETF concept. The court case really hinges on the SEC's apparent inconsistency in allowing an ETF based on Bitcoin futures, such as the ProShares Bitcoin Strategy ETF (BITO) and others, to trade, but blocking ETFs based on spot Bitcoin. In contrast, the SEC has been consistent in blocking all Ethereum ETFs. Yes, such ETF/ETPs exist in Canada and Europe currently, but not in the U.S. I supposed the next issue for the SEC may be there is (theoretically) an inconsistency between allowing a Bitcoin ETF (if they do) and not an Ethereum ETF after today's ruling suggesting that Ripple (and hence Ethereum) are not securities, like Bitcoin, but we aren't there yet. The SEC May Have To Pick Its Battles If you're a regulator, it's not a good look for the courts to reverse your decisions. It ultimately diminishes the effectiveness and predictability of the regulator. The SEC may be facing this issue with crypto. Yes, it wants to protect investors from fraud. However, it must do so in a coherent and consistent way. It may have to give up the battle on blocking ETFs associated with well-established cryptocurrencies. That may enable it to go after smaller and riskier schemes with more force, or to focus on other players such as Coinbase where legal action is pending. Investment Considerations Currently, the discount on the Grayscale Bitcoin Trust has narrowed to around 30% at the time of writing. Whereas the discount on the Grayscale Ethereum Trust is currently around 37% (note prices are volatile). The ruling on Ripple suggests that the chances of an Ethereum ETF are more correlated to a Bitcoin ETF than we previously thought. Therefore, if you're interested in investing in Grayscale Bitcoin Trust based on the chances of a favorable ruling from the courts on ETF conversion, after today's ruling, the Grayscale Ethereum ETF may be worth a look too. That may also diversify your underlying crypto exposure if you aren't committed to Bitcoin. Simple Outcomes Then, if converted to an ETF and trading at NAV, this is what your returns would look like. Fund NAV Discount Return if Traded at NAV Grayscale Ethereum Trust -37% +59% Grayscale Bitcoin Trust -30% +43% Of course, the NAV discount could well widen if Grayscale loses their SEC case, and the swings in value of crypto assets will significantly impact valuations too. Risks Grayscale could lose its court case against the SEC. That would likely cause the NAV discount for all their larger fund-based crypto products to widen. This article focuses on discounts to NAV, but the underlying NAV is highly volatile and a fall in the price of crypto assets could result in losing money even if the NAV discount narrows. It's quite possible Grayscale decides to keep its fund products in their current fund structures and don't convert them to ETFs, even with a favorable legal ruling. These trusts are generally high-fee products (2.5% of NAV annually in the case of Grayscale Ethereum Trust) those fees could erode your capital as you wait for a legal verdict or other events.