Grayscale's Ethereum Futures ETF filing: Why is it Important?

Grayscale Investments, a company that manages digital assets, wants to start an exchange-traded fund (ETF) for ethereum (ETH) futures in the US; this would give buyers a way to invest in the cryptocurrency without holding any coins.

What is the Ethereum Futures ETF from Grayscale?

On September 19, Grayscale sent an application to the US Securities and Exchange Commission (SEC) for the new ETF on the New York Stock Exchange (NYSE) Arca, an electronic exchange that offers exchange-traded products and stocks. If it gets accepted, the Grayscale Ethereum Futures Trust will hold Chicago Mercantile Exchange (CME) ether futures contracts on behalf of investors.

The CME Globex platform is a financial derivatives market that offers two cash-settled Ethereum futures contracts: the ETH contract, which is worth 50 Ether, and the MET contract, which is worth 0.10 Ether. Each has six contracts that run from one month to the next, plus up to two more contracts in December. (If the six months include December, only one more contract is mentioned for December.)

With its ETF, Grayscale wants the daily changes in the net asset value (NAV) of its shares to match the daily changes in the benchmark price, which would be the average of the closing settlement prices for the first and second ETH contracts to end.

To start an open trade in the futures contracts, the Trust would make a first margin deposit. A trader's margin investment acts as a cash performance bond to ensure that the futures contracts they buy or sell will be carried out. At the end of each trading session, futures contracts are "marked to market," and the margin is changed to match. The rest of the Trust's assets would be kept in cash and cash-like assets at the Trust manager or other financial institutions. The Trust would not need an ether custodian or a crypto wallet because it would only hold ether futures contracts and never hold real ETH.

What is an ETF for Futures?

A futures exchange-traded fund is an investment fund that follows the performance of a single futures contract or a basket of futures contracts. Futures ETFs do not hold the underlying assets themselves. Instead, they use financial tools like futures contracts to track the price changes of the underlying asset. Futures contracts are financial instruments that require the holder to buy or sell a specific object, like a commodity, stock index, or currency, at a set price on a particular date in the future.

Futures ETFs are different from traditional ETFs, which usually hold a portfolio of tangible assets like stocks or bonds to mimic the performance of a particular asset class or index. Investors and traders use futures exchange-traded funds (ETFs) to speculate on or protect themselves against commodities, currencies, indices, and other types of assets without dealing with futures contracts directly.

Some futures ETFs use leverage, which is when they borrow money to take a more significant stake to increase the size of their returns, but it also makes it more likely that they will lose money.

What does Grayscale's plan for the future of ETH mean?

Grayscale is a significant investor in cryptocurrencies, and its application for an ETF shows that it still wants to help people trade in the market. It also shows that the company thinks ethereum, the second-largest cryptocurrency by market value, will be a good investment. When it started in December 2017, the Grayscale Ethereum Trust fund was one of the first stocks that only invested in the price of ETH.

The Trust is "solely and passively invested in ETH," according to its website; this means that buyers can get exposure to ETH through security without having to buy, store, and keep safe ETH themselves.

Cryptocurrency investors have been calling for a spot in Bitcoin ETF, but the SEC has repeatedly turned down applications for this. Many finance companies, like Fidelity, Digital Currency Group, Franklin Templeton, BlackRock, and Grayscale, have submitted applications. Observers think a spot ETF would allow a broader range of investors, from individuals to big financial institutions, to invest in cryptocurrencies. These investors have been waiting for a regulated and easy-to-use investment vehicle to give them the confidence to enter the crypto markets; this could help the Ether market become more stable and have more buyers and sellers.

Approval of a new cryptocurrency ETF would ease the friction between the SEC and the crypto industry caused by the regulator's claim that cryptocurrencies are securities and not currencies, commodities, or other types of assets. The SEC's cases against the cryptocurrency exchanges Binance and Coinbase have made investors more nervous and made it harder for people to buy and sell cryptocurrencies.

The SEC in Court

Grayscale recently won a case in the DC Circuit Court that said the SEC's decision to turn the Grayscale Bitcoin Trust fund into a spot ETF was "arbitrary and capricious." The lawyers for Grayscale want the SEC to approve the Bitcoin ETF "as soon as possible."

Grayscale is filing for a futures ETF instead of a spot ETF for Ether as part of a plan. So far, the SEC has turned down all spot ETF applications, but in 2021, it gave the green light to the ProShares Bitcoin Strategy ETF (BITO).

In the paperwork that Grayscale sent to the SEC for the Ethereum ETF, they said that when the Commission turned down spot digital asset ETP plans for Bitcoin, they did so because they were worried about fraud and manipulation in the markets for the underlying digital assets. But Grayscale "believes that the structure and operation of the Trust are designed to prevent fraudulent and manipulative acts and practices, to protect investors and the public interest, and to address the specific concerns that the Commission may have about potential fraud and manipulation in an ETH-based ETP."

The company also said the CME "is a regulated futures exchange with the oversight, controls, and regulatory scrutiny needed to maintain, promote, and carry out fair and transparent trading of its listed products, including the ETH Contracts and MET Contracts." In addition to the Bitcoin ETFs, several companies have filed registration statements with the SEC for ETH-based ETFs holding ETH futures contracts that trade on the CME and settle using the CME CF Ethereum Reference Rate (ERR). These give the same exposure as the Grayscale Ethereum Trust, so Grayscale "believes that if the Commission lets these ETFs start trading, it should also let the Trust start trading."

The Bottom Line: Investors and fans of cryptocurrencies are still looking to the SEC's decision on the ETF applications to see how rules will change.

Investors need to know that futures ETFs come with risks, such as the chance of losing money because of market volatility, leverage, and specific factors that can affect their futures contracts. Their results can differ from the spot prices of the assets they are based on because futures contracts can expire, market conditions can change, and other things can happen.

Particularly volatile are cryptocurrencies, whose prices can go up or down by a considerable amount in either way. These trades are only suitable for some, and you need to know how they work before you put any money at risk.