An Ethereum ETF is expected this year, but spot ETFs could increase the risk of validator concentration.
The launch of spot exchange-traded funds (ETFs) based on the Ethereum cryptocurrency creates a risk of concentration of the second largest cryptocurrency by capitalization in the hands of a small group of large players, Bloomberg writes, citing a report from S&P Global. Analysts note that ETH coins blocked during staking may be concentrated in the hands of a limited number of so-called validators who ensure the operation of the network. Following the debut of a group of Bitcoin spot ETFs in the United States, several asset managers, including BlackRock, Fidelity and Ark Invest, have filed applications with the Securities and Exchange Commission (SEC) to create Ethereum spot ETFs. According to S&P Global and ETF market analysts at Bloomberg, the regulator may approve such funds as early as May of this year. According to the data in the applications, one of the key features of such an investment product will be the opportunity to receive additional income by staking cryptocurrency through external services.
Spot Ethereum exchange-traded funds (ETFs), if approved, could increase validator concentration risks on the Ethereum network. The study, titled “U.S. Ethereum ETFs May Increase Concentration Risk,” sheds light on the potential impact of Ethereum spot funds on the concentration of validators on the Ethereum network, especially those that involve staking. Analysts at S&P Global predict that future Ethereum ETF issuers will likely favor centralized Ethereum staking platforms, such as the Coinbase exchange. Traditional companies are unlikely to place client assets in decentralized financial protocols. The largest of these is Lido finance, which currently hosts about a third of all staked Ethereum coins worth about $30 billion.
“The increase in ETFs staking on ethereum could impact the composition of validators participating in the Ethereum network’s consensus mechanism. The participation of institutional custodians could reduce the current concentration on the Lido decentralized staking protocol. However, it could also introduce new concentration risk, especially if the a separate entity to house the majority of the ether included in these ETFs,” the analysis said.
Traditional Bitcoin spot ETFs store their assets in digital vaults, with their main function being to reflect the market price of the asset. However, Ethereum’s unique offering lies in staking — when a cryptocurrency is locked up to support network operations and secure transactions, rewarding participants in the process. Despite the potential benefits, staking comes with the risk of being “cut” if validators perform inefficiently or act maliciously. According to the study, Ethereum spot ETFs will not impact validator composition, but proposed staking-enabled Ethereum ETFs such as the Ark Invest and Franklin Templeton ETFs could become large enough to significantly impact validator power. “Ethereum spot ETFs that simply hold ether will not affect the composition of validators in the Ethereum consensus mechanism. However, ethereum spot ETFs that include staking will do just that — at least if inflows are high enough,” the analysis added. . “US spot ethereum ETFs that include staking could become large enough to change the concentration of validators on the Ethereum network for better or worse.”
The &P Global analysis also highlights particular concerns surrounding Lido and Coinbase. Both organizations pose a potential threat to validator concentration, but for slightly different reasons. The study notes that while Lido owns nearly 33% of ETH outstanding, it is unlikely that U.S. institutions launching Ethereum-allocated ETFs will interact directly with Lido due to regulatory and risk considerations. Instead, these ETFs could choose regulated digital asset custodians to place bets on, potentially reducing Lido’s dominance. However, this shift raises concerns about Coinbase’s role. The study warns that Coinbase, a large exchange with significant control of validators, could increase its stake in Ethereum through ETFs, leading to greater concentration. Additionally, Coinbase’s dual role as custodian of multiple Bitcoin ETFs and potential participation in Ethereum ETFs could increase concentration. However, the overall impact of ETFs on concentration depends on their betting practices. The study suggests that the introduction of new digital asset custodians could allow ETF issuers to diversify their holdings across different entities, potentially reducing concentration risk.
The issue of launching spot ETFs for other crypto assets remains open. On January 25, the SEC delayed consideration of BlackRock’s Ethereum ETF application until March 10. Commission Chairman Gary Gensler recalled that the approval of a Bitcoin spot exchange-traded fund was limited to only one cryptocurrency. The head of the investment company ARK Invest, Cathie Wood, said during a podcast with The Wall Street Journal that she does not expect the approval of ETFs for cryptocurrencies other than Bitcoin and Ethereum in the near future. Her company operates a spot fund for Bitcoin with 21 Shares and is awaiting approval of an application for a similar fund for Ethereum. According to Jeffrey Kendrick, head of currency and digital assets research at Standard Chartered, the price of ETH could rise to $4 thousand in anticipation of the approval of spot exchange-traded funds (ETFs) on Ethereum. Analysts at brokerage Bernstein published a report estimating the likelihood of the Ethereum ETF being approved by the US Securities and Exchange Commission before May at approximately 50%. They predict the likelihood of final approval within the next 12 months.
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