【LongHash Column】Grayscale Ethereum Trust premium nearly 10 times, what is brewing behind it?

While investing in Ethereum has become easier in recent years, many investors are still hesitant to use spot exchanges like Coinbase and Kraken due to security concerns regarding cryptocurrency transfers. Cold wallets are too complicated to use, and storing coins on exchanges poses high risks (resulting in losses of millions annually due to security breaches). Regulated Ethereum futures markets like ErisX are not accessible to the general public.

As a result, Grayscale Ethereum Trust has quickly emerged as a new option for investors to buy Ethereum. Unfortunately, this trust has a drawback: a significant premium compared to the price on the spot market, as its product is backed by reserved ETH.

What is Grayscale Ethereum Trust Fund?

Grayscale Ethereum Trust Fund is a publicly traded investment tool operated by Grayscale Investments, a subsidiary of Digital Currency Group, backed by Ethereum. Grayscale Investments is best known for its Grayscale Bitcoin Trust Fund, which holds nearly 2% of the total circulating Bitcoin supply.

Each share of the trust is backed by approximately 0.094 ETH. However, due to a 2.5% annual fee charged by Grayscale, this number gradually decreases. As the digital asset management firm has not yet received approval to offer redemption mechanisms to clients, the corresponding shares cannot be used to redeem Ethereum in the trust.

Since receiving approval from the Financial Industry Regulatory Authority (FINRA) in May 2019, the over-the-counter trading market has listed shares of the trust under the symbol "ETHE." With the trust shares available for trading, "all" individual and institutional investors can invest in Ethereum, which is considered safer and easier than the spot market.

The Ethereum held in Grayscale Trust is stored with Coinbase Custody, a registered custodian in New York with insurance. ETHE is the only way for investors to officially acquire Ethereum through retirement accounts like IRAs or 401(k)s.

ETHE Premiums Increase with Rising Ethereum Demand

With increasing demand for Ethereum and a gradual recovery in the cryptocurrency market, the price of ETHE has surged in recent weeks. The trust's demand is high, and according to data from Tradingview, as of June 4, the price of ETHE has risen by 600% since the beginning of 2019, while Ethereum itself has only increased by around 50% during the same period.

By the end of trading on June 4, the OTC price showed the trust's price per share reaching an all-time high of $239.5. Meanwhile, analyst Ceteris Paribus observed that Ethereum on Coinbase was at $241.48.

With each share of ETHE corresponding to about 0.094 ETH, buyers of OTC ETHE are actually paying nearly 1000% of the asset's net asset value. The specific premium changes can be seen in the chart, with the gap between ETHE and Ethereum reaching its highest point in a year.

It is not clear why the premium is so high: if one were to purchase ETHE shares equivalent to the price of Ethereum, it would mean that investors are effectively buying Ethereum at $2,500. While retail investors may not mind the premium since this is the only channel to invest in Ethereum through tax-advantaged accounts, there may be a potential information gap where investors believe they are purchasing ETHE at a 1:1 ratio with the underlying ETH.

For investors who bought in at the peak, this could pose a problem as OTC ETHE may be signaling an impending downturn.

The Premium May Not Last

However, what may delight retail investors could be a concern for institutions as the premium may not last long.

While ETHE trades on the secondary market, its shares are issued through a private placement process, accessible only to accredited investors. According to U.S. law, accredited investors are individuals or entities with a net worth (excluding their primary residence) of at least $1 million or an annual income of $200,000 (or $300,000 for married couples), and institutions are also considered accredited investors.

In these rounds, investors (mostly hedge funds, as per Grayscale's Q1 2020 report) can purchase ETHE shares at the current ETH price but must lock up their holdings for a year. This lock-up period prevents arbitrageurs from buying Grayscale-issued ETHE and immediately selling them on the secondary market to profit from the spread.

However, accredited investors can still profit from the premium if they take a long-term view.

According to an analysis report on the Ethereum trust by Ceteris Paribus, over $50 million worth of ETHE shares will be unlocked in the next 7 weeks, $75 million by the end of October, and $100 million by the end of 2020.

Those holding these shares can liquidate in the secondary market, earning the difference between the price they paid a year ago and the current market price of ETHE – which is currently at a significant premium.

However, a substantial influx of trust shares into the market could lead to a significant drop in the price of ETHE on the secondary market.

According to data from OTC Markets, the exchange offering ETHE trading has a circulating supply of 493,812 shares, representing only 2.5% of the total circulating supply of 13,702,400 shares.

Considering the trust holds shares worth $390 million, the anticipated $50 million unlocking will significantly increase the circulation (possibly by more than double). Assuming demand remains constant, a substantial increase in the supply could lead to a price drop in ETHE. As explained by Larry Cermak from The Block tweeted:

"By the end of this month, a massive amount of shares will be unlocked, causing the price of ETHE to crash. In other words, retail will get absolutely destroyed and have no way out."

Need for Alternative Investment Avenues

While investors can take advantage of the high premiums between Grayscale Trust and ETH, the activity in this market underscores the need for other secure investment avenues.

For those who do not want to deal with the hassle of using spot exchanges but still wish to purchase Ethereum at a premium, trading Exchange-Traded Funds (ETFs) regulated by the U.S. authorities seems to be the best option. However, even Bitcoin has yet to have an ETF due to concerns about market manipulation and lack of regulation.

This article is from our partner LONGHASH.