You may have seen the news that the Grayscale Ethereum Trust (ETHE), a publicly-traded fund tracking ETH established by the Digital Currency Group, is currently trading at a 423% premium. News reports say ETHE has purchased around 756,540 ETH since the end of 2019, which represents roughly 48.4% of the total ETH mined in 2020. It seems to indicate strong interest in ETH from mainstream investors.
Why are investors willing to pay an over 400%+ premium? Rational investors should have bought ETHE shares from the primary market, which means buy at parity, in exchange for share baskets (one basket contains 100 shares of 0.094 ETH each). However, subscribers in the primary market have to hold their ETHE shares for at least 1 year by product design. ETHE share creation is a kind of sale of restricted securities under Rule 144. For compliance purposes, primary market subscribers can only resell their shares after the lock-up period.
Arbitragers may try to buy in the primary market while short sell in the secondary market. However, there are very few (if any) shortable shares of ETHE in the market. ETHE was created in 2017, and listed in June 2019. Most of the ETHE shares were created for less than one year, thus still locked in and not sellable. When the locked shares mature, the premium declines, which happened in the second half of 2019 as you can tell from the chart above. But once locked shares are all dumped in the secondary market, premium could widen again. Secondary market trading of ETHE imposes no holding period restrictions and thus attract more speculators (individuals or hedge funds) and maybe also institutions with restricted mandate towards direct cryptocurrency trading. Once their trading or investment demands rise, premium goes wider further and lure more arbitragers to subscribe into the primary market. ETHE AUM grows when the premium widens.
Another interesting fact is that ETHE is not open for redemption, also due to regulatory constraints. It means ETHE could only buy ETH from the market (creation of the basket) but never sell ETH until a redemption program is legally approved. Holders of ETHE could only sell ETHE shares rather than ETH.
Grayscale Trusts in essence can only be a net buyer in the crypto market. Grayscale’s purchase is very much like staking of cryptos. Grayscale currently manages USD 2.4 billion and USD 244 million (NAV) respectively in its BTC and ETH trusts.
Grayscale’s BTC trust GBTC has the same restriction of holding periods and redemption. But the premium has significantly dropped to 18% since it’s more mature and the holding period restriction has reduced to 6 months recently for accredited investors.
When we evaluate the supply and demand of ETH, please don’t forget Grayscale, who can only buy and hold. It consumed almost 50% newly mined ETH this year, and justifies the ETH’s leading place so far in 2020.