The final regulatory approval and launch of Ether ETFs in the US will likely bring new investors to the Ethereum space with one potentially significant use case being as a settlement layer for financial markets, writes Andrew O’Neill, Digital Assets managing director at S&P Global Ratings.
Ethereum is fundamentally a tech platform and the value that flows to ether holders is driven by the scale of adoption of that platform.
“In recent months we have seen the issuance of digital bonds on public blockchains, as well as Blackrock’s issuance of the BUIDL fund on Ethereum. This matters because investors need to understand the drivers of the value of ether,” he wrote.
One key roadblock holding back blockchain adoption is a lack of interoperability. To date digital bonds have primarily issued on private permissioned blockchains set up by an institution. Each of these private blockchains is a ‘walled garden’ that does not support a liquid secondary market for these bonds to trade. Without a secondary market for digital bonds, they will not be adopted at scale.
Looking ahead, S&P Global analysts expect that institutions will continue testing the waters in the Ethereum ecosystem. Specifically, they may explore the use of token-level permissions to meet KYC obligations, and the use of zero-knowledge proof technology to address privacy requirements.
Regulatory developments may smooth the path for increased competition in US crypto custody markets, and on this, S&P Global is monitoring developments around the SEC’s ‘SAB 121’ rule, which currently requires crypto assets held in custody for clients to be reported on balance sheet with a corresponding liability.
This rule makes it prohibitive for US banks to provide custody for crypto assets. Although the House and Senate initially voted to repeal SAB 121, this was vetoed by President Biden and the rule remains in place. There are reports that the SEC may grant exemptions to some institutions, which may help broaden the market of potential crypto custody providers.
As a result of SAB 121, there is little competition for crypto custody services in the US: indeed, the custody of bitcoin held in ETFs is highly concentrated with a small number of providers. We expect this to be similar for ether ETFs upon their launch.
Initially these ETFs will not stake the underlying ether, therefore concentration among custody providers will not affect concentration risks in the network itself. It is likely that this will change eventually (some applications initially contemplated staking but removed this prior to approval, and staking products exist in other countries). A competitive market for staking custodians at that point would help to mitigate concentration risks.