US Bitcoin spot ETFs now command more than USD 140 billion worth of assets, but the market is now turning its attention to other cryptocurrencies following the SEC’s recent request for S-1 filings from all prospective Solana ETF issuers, and a commitment to a 30-day review period.
The revised submissions also include in-kind redemptions and staking, which are features not yet seen in any US crypto ETF product. These are promising signs given that the SEC recently clarified that “protocol staking activities” do not qualify as securities offerings under federal law.
This is a reversal from the SEC’s previous stance towards proof-of-stake cryptocurrencies under former chairman Gary Gensler, though it remains an opinion and not a formal SEC policy. Nevertheless, the market has responded positively with a clear uptick in allocations to Ethereum ETFs as the odds of approving these features turns increasingly more favourable.
Ethereum ETFs recorded a 19-day streak of positive net flows, with weekly inflows exceeding five times the recent average. BlackRock’s ETHA fund continued a 22-day run.
What will these additional features bring to crypto ETFs?
The current US Bitcoin and Ethereum ETFs offer the same exact spot exposure, but Bitcoin’s established track record and “digital gold” appeal makes it the default entry point for most traditional allocators looking for crypto exposure.
The complexity of Ethereum leaves the popular smart contract platform at a disadvantage, which is clearly visible in the lesser flows (even on a market-cap weighted basis).
If staking is approved, however, Ethereum, Solana and other potential proof-of-stake crypto ETFs would distinguish themselves as yield-bearing alternatives to their Bitcoin counterparts. Bitcoin cannot offer this feature through an ETF.
In-kind redemptions would allow investors to redeem their ETF shares for the underlying crypto assets rather than selling for cash. Cash redemptions trigger taxable events and add extra costs, so approving this feature would be a net positive for all crypto ETF products, including Bitcoin.
How would staking in an ETF work in practice?
Staking through an Ethereum ETF is not the same as staking assets directly on the Ethereum protocol.
The ETF relies on qualified custodians such as Coinbase Custody, BitGo, or Gemini to manage the staked assets. These custodians then delegate the assets to specialised validator operators like Kiln, Figment and Blockdaemon, who handle all the technical requirements to qualify for staking rewards (i.e., node maintenance, continuous uptime and avoiding penalties such as a slashing). The operators take a service fee from the rewards before crediting the remainder to the fund.
When staking directly, investors can select their own validators and set parameters. ETF investors do not have this flexibility. Those decisions are handled entirely by the custodian (as they hold the underlying assets).
The ETF filings propose two possible approaches for handling staking reward:
- 1) The rewards can be credited to the fund’s net asset value (NAV) through accretion. This means the rewards stay in the fund and increase the value of each share rather than being paid out to shareholders. This would likely defer taxable events until investors sell their shares.
- 2) The rewards could be paid out as income or dividends, in which case investors would be taxed in the year they are received.
Managing the liquidity reserves carefully will also be important for ETF issuers because Ethereum’s protocol enforces an “unbonding” period before the staked assets can be withdrawn – a waiting period is at least nine days and can extend to fifty days during periods of high network activity. This means the fund cannot stake all of its assets at once and needs to keep a portion liquid to meet daily settlement and redemptions. This will of course reduce the staking yield, with a 50 percent staking estimate on the conservative side and up to 70 percent in a more aggressive scenario.
Slashing is another thing to consider, even though the risk is extremely low. But if a slashing event were to occur, the penalty would be reflected in the fund’s NAV and therefore shared equally by all investors. Fund managers are expected to have the right safeguards in place to minimise this risk, but protection of principal cannot be fully guaranteed.
After accounting for commission and service fees (and also liquidity needs), the net yield for Ethereum ETF investors would range between 1.9 to 2.2 percent (direct staking yield on Ethereum is approx. 2.68 percent). While these returns are modest, they still compare favourably to gold ETF lending programs as many investors consider a yield of less than 1 percent a premium.
Traditional investors who are already comfortable with Bitcoin (or willing to take on more risk) now have a regulated way to access protocol yield. For institutional investors searching for alternative yield sources, the ETFs may also remove a few longstanding hurdles around token ownership rights and smart contract risks, since custody and operations are managed by the fund and any protocol risk would be reflected in the ETF’s NAV.
Current status and regulatory timeline
There is still no official confirmation on whether staking or in-kind redemptions will be approved for Ethereum or Solana ETFs.
Grayscale’s application for Ethereum staking is currently under formal proceedings but a financial decision is likely to be postponed until October 2025. BlackRock’s application follows a similar timeline, although its closed-door meeting with the SEC earlier this year has added to speculation that an approval could come sooner. The SEC has also delayed its decision on Franklin Templeton’s Ethereum ETF until July.
However, the recent wave of Solana ETF resubmissions has added pressure on the SEC to act quickly, especially after promising a 30-day response time and changing its stance on protocol staking activities. The launch of Solana futures on CME is also adding confidence to an imminent approval.
Should the SEC proceed, this would make it much easier for other proof-of-stake crypto products to come to market, including a Tron and hybrid Bitcoin-Ethereum ETF.
Impact on flows
The anticipation around these new features has already driven fresh capital into Ethereum ETFs, and inflows are likely to continue as we approach the Solana review deadline.
Ethereum’s staking yield is modest and even sits below most fixed-income alternatives, but adding a regulated yield with upside potential should see flows build up gradually over time, rather than a sudden surge at launch.
For some investors, the yield may justify diversifying into a regulated crypto fund. Others who previously avoided Ethereum due to its lack of income may now consider adding it to their crypto allocation strategies.
Meanwhile, Ethereum’s recent upgrade raised the validator staking cap from 32 ETH to 2048 ETH per validator, which could provide better economies of scale for custodians and validator operators managing the staked assets. Perhaps it may also help bring down fees.
It is also worth mentioning that staking-enabled ETFs already exist outside of the US. Canada’s 3iQ Ether ETF has seen steady demand, and the newer Solana staking ETF saw relatively good flows for its market size. A US equivalent would surely see meaningful inflows.
Outlook
US-listed Ethereum and Solana ETFs will be the poster child of whether enabling in-kind redemptions and staking yield can catalyse a new wave of institutional flows.
As previously mentioned, staking creates a clear distinction from the existing Bitcoin ETFs and may give traditional (and potentially institutional) investors a fresh incentive to diversify their exposure.
They could also finally bring meaningful capital into Solana’s ecosystem that has been dominated by memecoin volatility for the most part of this year.
But it is Ethereum’s longstanding underperformance, which is trailing roughly 75 percent since September 2022, that has the most room for a meaningful recovery. There are several demand indicators that support this. Net inflows into Ethereum ETFs have occasionally outpaced Bitcoin, whale accounts have been aggressively buying Ether in recent weeks, Ethereum’s staking queue is growing and Ether on crypto exchanges are reaching new reserve lows. If these trends hold, a potential supply shock cannot be ruled out.
We will be monitoring these trends closely.
ENDS
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