Fixed-income Hungry Institutions’ Next Play Is Likely Ether

Regulatory and withdrawal risks could slow mass adoption of ether for some large allocators


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key takeaways

  • Fidelity Digital Assets seeks to offer its institutional clients the ability to buy, trade, sell and custody ether by the end of 2022
  • Some institutions are likely to wait for Ethereum’s Shanghai upgrade, which is expected to enable staking withdrawals

The staking yields investors can now earn from ether is poised to bring in big-time institutional capital, according to industry participants. But regulatory and custodial risks remain high hurdles. 

Ethereum successfully carried out its long-awaited transition from proof-of-work to proof-of-stake last week — and some have said the Merge “completely changes” ether’s investment case for institutions.

In addition to eliminating all but a fraction of the blockchain’s energy consumption, the Merge to a proof-of-stake system allows token holders to earn additional tokens by participating in blockchain validation — resembling stable fixed-income routines that have long been a hallmark diversifier against the volatility of stocks and commodities. 

Vivek Raman, head of proof-of-stake at digital asset finance platform BitOoda, said validators can earn a block subsidy of roughly 4%, transaction fees currently at about 1.5% and maximum extractable value (MEV) of between 0.2% and 0.5% — an aggregate staking yield of about 6%.

“Yield is one of the core pillars of traditional finance and crypto finance, and the ETH staking yield will represent the ‘risk-free rate’ of the crypto ecosystem just like the Treasury yield represents the ‘risk-free rate’ for traditional finance,” he told Blockworks.

Pranav Kanade, portfolio manager of VanEck’s Digital Assets Alpha Strategy, said ETH has competitive yields when compared to other yield-bearing instruments such as investment-grade bonds, municipal bonds and Treasury bills. The frequency at which investors earn this yield is also a plus, he added.  

Executives at crypto hedge fund firm Globe 3 Capital told Blockworks they expect staking yields could go higher than 6% as volume picks up, locking additional assets on-chain.

“As these financial institutions start to enter the space and put digital assets on their books, they will naturally gravitate towards the most stable, largest, easiest to trade and secure, and highest yielding assets,” Globe 3 Capital Chief Investment Officer Matt Lason said. “Ethereum checks all those boxes.”

Fidelity Investments’ digital asset arm is looking to offer its institutional investors the ability to buy, trade, sell and custody ether — mirroring its current bitcoin products — by the end of the year, a company spokesperson confirmed.

“The narratives that come as a result of the Merge are likely to increase the overall levels of interest in the asset for many institutional investors, particularly over a long enough timeframe,” said Jack Neureuter, a research analyst at Fidelity Digital Assets.

Who will adopt first?

Adoption will likely start with crypto-native institutions, family offices and hedge funds before being incorporated in mutual fund and pension fund portfolios, Raman said.

Kanade agreed family offices and certain hedge funds could be interested in owning ether, noting that sovereign wealth funds and endowments may likewise go after exposures. 

Globe 3 Capital executives said its fund intends to always own some ether.

“We think the first adopters will naturally be risk takers looking for capital appreciation, and the yields will be a bonus to offset some of the risk,” Lason said. These include sovereign wealth funds, pension plans, and family offices.

Other institutions, such as passive asset managers, are unlikely to have the right mandate in place to have crypto exposure, some said.

“Although we are seeing signs that some TradFi institutions are dipping their toe into staking, for the vast majority it remains too challenging for them to directly own ETH compliantly,” Aplo CEO Oliver Yates said in an email. “This means that any of the returns related to staking that TradFi is receiving are usually indirect and through exposure to lenders they have invested in.” 

Hurdles remain

One of the biggest obstacles for institutions is uncertainty around the timeline for staked ether.

Ethereum’s Shanghai upgrade, estimated to be carried out in the next six to 12 months, would enable staking withdrawals, according to Ethereum’s website. 

“Staking ETH in the traditional sense opens them up to this risk, as we don’t know the timing of the Shanghai upgrade,” Kanade said.

“If they do participate in ETH staking, they are likely to explore the liquid staking derivatives that gives them ETH yield while preserving liquidity,” he said.

Regulatory uncertainty within the crypto segment broadly is yet another factor that institutions are considering, analysts said. 

The White House released its first “comprehensive framework” focused on the responsible development of digital assets. Some industry participants criticized the framework, telling Blockworks that it lacked details and leaned too heavily on regulation by enforcement. 

Reports gathered by the Biden Administration encourage the SEC and Commodity Futures Trading Commission (CFTC) “to aggressively pursue investigations and enforcement actions against unlawful practices in the digital assets space,” according to the framework.  

Though a bill introduced last month proposes bitcoin and ether to be regulated as commodities under the CFTC, SEC Chair Gary Gensler has said that most cryptoassets — aside from bitcoin, which he considers a commodity — are securities.

“Is staking yield a security?” Raman said. “If so, that requires a different set of investors.”

The macro environment will also play a role, the BitOoda executive added. The Federal Reserve raised interest rates by 75 basis points Wednesday for the third straight time in an effort to curb inflation.

“If traditional finance yields continue to rise due to the ongoing Fed hikes,” Raman said, the ETH staking yield may look less attractive relative to Treasury and traditional bond yields.”

Macaulay Peterson contributed reporting.

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