Ethereum futures ETF was a surprise on its first day of launch. Why are institutions so uninterested?

Institutional interest in Ethereum limited amid bear market

Six different Ethereum futures financial instruments officially began trading on October 2 amid the ongoing cryptocurrency bear market. However, these instruments have yet to ignite institutional investors' enthusiasm for ETH. The total trading volume of the ETH futures ETF on its first day was less than $1.5 million. To put this in perspective, the first Bitcoin futures ETF (BITO) in 2021 had a trading volume of more than $1 billion when it debuted. This means that on its first day, the funds flowing into the ETH futures ETF were less than 2% of BITO.

Coinbase Research’s Duong highlighted a few key reasons for the discrepancy.

First, the timing of the ETF launch is different. ProShares launched the BTC futures ETF during the 2021 cryptocurrency bull run when market liquidity was abundant, while the ETH futures ETF was launched during the current bear market when funds are severely scarce.

Second, advisors have different levels of familiarity with these assets. Advisors are generally more familiar with Bitcoin, and it is easier to integrate into clients’ portfolios. ETH is often viewed as a more complex investment that still needs to be fully understood and accepted by traditional investment circles.

Finally, expectations have changed at the legal level. In the recent court ruling in Risely v. Uniswap, Judge Katherine Polk Failla classified ETH as a crypto commodity. This may have raised market expectations for an ETH spot ETF, while the response to an ETH futures ETF was less enthusiastic.

From the perspective of capital flows, the cryptocurrency bear market continues to significantly affect institutional capital. Data from Coinshares shows that net outflows have occurred 61.5% of the 39 weeks since 2022. Recent data shows that institutional interest in crypto assets has changed. As of October 4, ETH has outflowed more than $101 million this year, while BTC has inflowed $219 million during the same period. However, in recent weeks, BTC and ETH have had similar weekly net inflows, with BTC at $16.4 million and ETH at $12.9 million.

In summary, while ETH futures ETFs have not received the attention some expected, their trading volumes are within the normal range for new ETFs. They have also had a positive impact on institutional interest. However, factors such as the current bear market may hinder significant inflows of institutional capital before the broader crypto market heats up.

Potential risks associated with Ethereum staking

On October 5, JPMorgan Chase released a research report that shed light on concerns related to centralization within the Ethereum network. The report noted that ETH staking rewards have declined, from 7.3% before the Shanghai upgrade to 5.5%. This decline in yield, especially compared to the rise in yields in traditional financial markets, has weakened the appeal of Ethereum as an investment asset.

The report highlights that the top five liquidity providers, including Lido, Coinbase, Figment, Binance, and Kraken, collectively control 50% of the total ETH staked. Notably, Lido alone holds nearly a third of the total ETH staked, raising concerns about centralization.

Lido, which is seen by the crypto community as a better alternative to centralized exchange staking platforms, has been actively expanding its list of node operators. The expansion aims to reduce centralization risks by preventing any single entity from controlling a majority of staked ETH.

In addition, to address the centralization problem within the Ethereum blockchain, the Ethereum community is advocating for distributed validator technology (DVT), including solutions such as SSV and Obol. These DVT solutions enable multiple node operators to collaborate to run a single validator. This approach reduces the risks associated with validators without affecting the core functionality of the blockchain.

JPMorgan also expressed concerns about the practice of reusing assets as liquidity. This practice requires repeatedly using liquidity tokens as collateral in various DeFi protocols. If the value of the staked assets suddenly plummets or is compromised due to malicious attacks or vulnerabilities in the protocol, this practice may trigger a chain reaction of liquidations.

Ethereum Gas Fees Hit Rock Bottom

According to blockchain analysis platform Santiment, Ethereum gas fees have dropped to their lowest level in nearly a year. In the past week, the average cost of Ethereum transactions was only $1.13, a significant drop from the beginning of May. It is worth noting that the last time the gas fee was below $1.15, the price of Ethereum had bottomed out.

L2 solutions pave the way for Ethereum’s scaling

The sharp drop in Ethereum gas fees is closely related to the adoption of Layer 2 (L2) scaling solutions. Considering the cost efficiency, a large number of users have turned to L2 solutions, resulting in a significant increase in block space demand on these L2 platforms.

According to L2Beat, transaction activity on L2 scaling solutions has seen a significant surge in 2023. Recent data suggests that transactions per second (TPS) on L2 have reached 5.78 times that of the Ethereum blockchain.

Essentially, L2 is fulfilling its intended role: reducing the transaction burden on the Ethereum mannet and assisting its scalability. Santiment believes that lower gas fees can increase Ethereum's network usage and attract more decentralized applications and smart contracts. In the long run, as the Ethereum network gains more adoption, it may have a positive impact on the price of ETH.

Recently, a research report from Grayscale also pointed out that L2 solutions are paving the way for the expansion of Ethereum. Functionally, L2 enhances the scalability of Ethereum and reduces the network cost of users by 100 times. In August this year, Coinbase launched the Ethereum second-layer blockchain BASE, which is an important recognition of the Ethereum ecosystem and aims to open its decentralized applications to Coinbase's 100 million users.

Coinbase is working to promote mass adoption of DApps on its Ethereum L2 BASE. If some alternative L1 chains struggle to gain traction due to security and liquidity issues, integration with Ethereum L2 may become a more attractive option.

Source: Atemis. Past performance is not indicative of future results. Data from January 1, 2020 to September 18, 2013.

Usage of Ethereum’s L2 scaling solution has grown steadily over the past year, with total daily active addresses for L2 surpassing that of its leading L1 competitor.

Source: DeFi Llama. Past performance is not indicative of future results. Data as of September 25, 2023.

In addition to active addresses, total value locked (TVL) is also important because it reflects the extent to which users have entrusted their funds to a particular blockchain. The best performing L2 solutions, including Arbitrum and Optimism, have surpassed Ethereum’s L1 competitors, such as Solana and Avalanche, highlighting the market’s broad trust in the Ethereum ecosystem and the appeal of scaling solutions.

As the network scales, more activity will shift to more cost-effective L2 solutions. In return, L2 directly accumulates value for Ethereum. Specifically, for every transaction on L2, users need to pay a transaction fee. L2 keeps a portion of these fees (currently the average profit margin is about 1/4), while Ethereum network validators get the remaining 3/4.

For every transaction sent to L2, the Ethereum network also consumes a small portion of the total ETH supply. Therefore, incremental activity on Ethereum L2 directly increases the value of ETH. If Ethereum's L2 continues on its positive development trajectory, it will solidify Ethereum's position as the leading L1 blockchain.

ETH balance on centralized platforms hits 5-year low

According to data from Santiment on October 5, the amount of Ethereum stored on cryptocurrency trading platforms has dropped to 10.66 million ETH, the lowest point since May 2018. In contrast, the amount of Ethereum stored outside centralized trading platforms is 115.88 million ETH, a record high.

On October 4, approximately 110,000 ETH (worth over $180 million) was withdrawn from centralized exchanges, the largest single-day outflow from these platforms since August 21. These events are often viewed as an indicator of long-term optimism in the market’s valuation of ETH, reflecting enduring investor confidence.