As more institutional investors dip their toes into the cryptocurrency investing space, the range of assets they are investing in is expanding to include ether, the native asset of the Ethereum blockchain. Interest in Ethereum funds is driving an ongoing price rally, which reached all-time highs above USD1,800 this week.
As more institutional investors dip their toes into the cryptocurrency investing space, the range of assets they are investing in is expanding to include ether, the native asset of the Ethereum blockchain. Interest in Ethereum funds is driving an ongoing price rally, which reached all-time highs above USD1,800 this week.
Recent weeks have seen a spate of high-profile cryptocurrency endorsements, with Elon Musk staking USD1.5 billion of Tesla’s reserves in bitcoin, and the world’s largest asset manager BlackRock filing for the ability to invest its funds in bitcoin futures.
Last week alone, investors poured USD195 million into funds focusing on Ethereum, with data from Coinshares showing that the crypto asset captured 80 per cent of all investment flows in digital assets funds.
The lion’s share of this investment went to Grayscale Investments’ Ethereum Trust, which saw investment flows “upwards of USD150 million” last week alone.
“We’ve certainly started seeing a lot of institutional inflows, and that has primarily been driven, in Q4 and in 2020, by the monetary inflation narrative. With respect to Ethereum, that has mostly been driven by the activity going on in decentralised finance,” says Phil Bonello, director of research at Grayscale Investments.
Grayscale is the world’s largest digital asset manager, with around USD32 billion in assets under management. The asset manager grew more than 10 times in size over the course of 2020, going from USD2 billion to USD20.2 billion by year-end.
In Grayscale’s Q4 report, the firm reported that institutional investors were responsible for an overwhelming 93 per cent of overall inflows.
Inflows into its Ethereum Trust are mostly coming from hedge funds and family offices, which tend to be the most flexible in their mandate. “That’s where the majority of inflows have been coming from, but you’re certainly starting to see a pick-up in wealth managers and RIAs (registered investment advisers),” says Bonello.
Bitcoin is still “the favourite from an institutional adoption perspective”, helped by public uptake from high-profile managers including Paul Tudor Jones, Bill Miller, and entrepreneur Michael Saylor.
“I think more and more asset managers who are not giving Bitcoin real consideration are going to have a tough time answering the question of ‘Why not?’,” says Bonello.
There are signs that Ethereum is also starting to be taken seriously by institutions.
“If you look at active addresses that are used on Ethereum, those are approaching all-time highs, and if you look at the number of addresses with at least 10,000 ETH in them, what I would consider very wealthy addresses, those continue to go up, which is a signal of institutional adoption,” says Bonello.
The launch of Ethereum futures on the CME this week has helped drive higher prices, but Bonello says that demand for ether has also risen due to more activity in decentralised finance (DeFi).
DeFi is a fast-growing movement to build open-source, transparent financial services like trading, borrowing, and lending, without the traditional financial intermediaries.
“In the last six months, the fees on Ethereum have skyrocketed because of DeFi and all the underlying activity there. With that, there’s been an increase in demand,” says Bonello.
A fee is charged in ether for completing a transaction on the Ethereum blockchain, and the amount fluctuates according to the demand. Ethereum transaction fees have risen by 260 per cent in the past month, and 22,443 per cent over the past year, which has increased demand for the asset.
DeFi was recently championed in a report published by a US regional central bank, St Louis Federal Reserve, which said the technology could increase the efficiency, transparency, and accessibility of financial infrastructure.
“DeFi may lead to a paradigm shift in the financial industry and potentially contribute toward a more robust, open, and transparent financial infrastructure,” concludes the report’s author, Fabian Schär, a professor at the University of Basel, who also notes the “spectacular growth” of DeFi-locked USD and Ether assets in recent years as a signal of its broadening adoption.
Bonello says that its use in digital transactions means Ethereum is “very familiar to a lot of people in the traditional financial world”, in a way that differentiates it from bitcoin. The structure of DeFi assets are familiar to people in the traditional world because they often have cash flows.
“The people who are invested in Ethereum are typically looking at it from more of a venture investing perspective, and are looking at the underlying assets in the decentralised finance world. These are nascent assets, but they have substantial growth, and because of that substantial growth, a lot of people in the traditional world are starting to pay attention.”
In an end-of-year report from Coinbase Institutional, the brokerage said that the “case for owning Ethereum we hear most frequently from our clients is a combination of i) its evolving potential as a store of value, and ii) its status as a digital commodity that is required to power transactions on its network”.
As for the future, Bonello says that the “bridges between the centralised, traditional financial world, and the decentralised financial world” could represent one of the major opportunities for Ethereum in the year ahead.
“I think that’s something to watch in 2021, as some financial institutions look and see the substantial amount of volumes and the collateral that has been locked in the decentralised finance space, and realise that there’s a major market opportunity to plug into that infrastructure,” says Bonello.
Another trend will be the adoption of Ethereum 2.0. In December, Ethereum launched the first phase of its network upgrade known as Ethereum 2.0, which will take place over the course of multiple years and hopes to enhance the network’s speed, efficiency, security, and scalability for processing transactions.
This upgrade will change how the network operates from a proof-of-work model to a proof-of-stake model. This means that instead of having miners compete to complete transactions and earn a reward, which relies on who has the most computing power, it will instead allow those who stake the highest amount of the network cryptocurrency the right to earn rewards for transactions.
Bonello believes that this upgrade will change the asset structure “substantially”. He says: “Rather than just being a pure commodity, it becomes something of a yield-generating asset, where you can lock up your ether, or stake it. By locking up that ether, you’re providing security for the network, and by providing security for the network, you are allowed a certain yield in proportion to the amount of ether that you staked.”
Other commentators also believe this could drive changes in the cryptocurrency marketplace. Anders Nysteen, quantitative analyst at Saxo Bank, says that this could help ease the constraints on Ethereum.
“With the limited supply of Bitcoin (BTC) and the large energy costs associated with verifying transactions through mining, it’s considered more a store of value than other cryptos such as Ethereum,” says Nysteen. “Ethereum (ETH) has industrial applications but the broad spectrum of applications is currently strongly constrained, as the network only allows processing of a small amount of transactions per second.”
He continues: “Apart from significantly boosting the bandwidth, the ETH 2.0 upgrade will move the verification process away from energy-intensive miners. The continuous flow of new issuances makes ETH inflationary by nature and a long-term holder who does not actively participate in staking will experience a leakage in value. However, the overall aim of ETH is to keep inflation at a sufficiently low level to have enough validators and thus keep the network safe.”
