Ethereum ETFs Optimism: Overrated or Overlooked?

Cryptocurrency is now mainstream. Gone are the days of digital assets being used by the fringes of society. A pivotal moment in this shift came in July 2024 when the U.S. Securities and Exchange Commission (SEC) approved spot Ethereum ETFs.

Fast forward to Donald Trump’s re-election as president, which has sparked a wave of optimism in cryptocurrency, driving the price of Bitcoin to an all-time high. Alongside launching the $TRUMP and $MELANIA meme coins and unveiling the World Liberty Financial venture, Trump’s pro-crypto stance marks a complete shift from skepticism to active involvement.

Meanwhile, Ethereum has lagged behind, prompting crypto analysts to predict a breakthrough for Ethereum ETFs. As investors seeking laggards shift their focus away from Bitcoin, many are turning to ETH as a promising alternative.

If this demand for traditional ETFs continues to increase, ETF providers need to start using native on-chain infrastructure to access staking yields, DeFi yields, and composability to remain competitive performance-wise.

Limitations of the Current ETF Offering

Cryptocurrency has transformed finance by eliminating the need for intermediaries, automating financial processes, and offering up a suite of new financial products. Yet ETF issuers are still stuck using dated infrastructure and intermediaries to invest in crypto products. This limits their ability to access the best-performing opportunities for clients and leads to ETF underperformance compared to equivalent on-chain products.

Without a system upgrade, they will be driven out by issuers who switch to on-chain technology. For example, ETH ETFs do not capture staking yield, let alone other opportunities in DeFi. Money-market ETFs for digital USDC don’t even exist yet despite the risk-free rate in DeFi being substantially higher—and very uncorrelated—to that of TradFi. This underscores the pressing need for innovation, as adopting on-chain technology offers untapped potential that traditional finance has yet to address or replicate.

Undermining the Ethos of Cryptocurrency

The core advantages of Ethereum’s decentralized design are lost when accessing Ethereum through an ETF. It reintroduces intermediaries and centralized control, which contradicts the original purpose of blockchain technology.

By contrast, it is inevitable that over time crypto ETF’s will evolve to provide non-custodial solutions to their end clients meaning that they take full responsibility for holding the private key or the actual assets. Spot crypto ETFs currently do not allow investors to hold the cryptocurrency as they rely on third-party intermediaries and custodians.

Non-custodial solutions give users greater control as well as transparency and security. As more investors become familiar with crypto, many may opt for non-custodial holdings of Ethereum to fully benefit from decentralized technology, such as lower costs, the removal of counterparty risk, and the ability to transact instantly. As the crypto ecosystem matures, the shift toward non-custodial crypto ETFs will empower investors to fully embrace the decentralized ethos, offering them a more secure, cost-effective, and transparent way to engage with blockchain technology.

ETFs Risk Falling Behind

The traditional set-up of ETFs brings crypto products to the attention of traditional finance institutions. However, without substantial innovation from providers into more natively on-chain technology to access opportunities, they risk being replaced by more modern products that can perform better and provide more security and transparency. Money markets are a great example of this. Traditional money market funds yield less than 5%, whereas the USDC risk-fee equivalent is in the double digits.

The true success of bridging DeFi and CeFi will be evident only when these yields converge, highlighting the necessity for providers to evolve and embrace on-chain solutions to stay competitive and relevant.