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Spot Ether ETF Applications Prompt S&P Alarm on Ethereum’s Concentration Risks

On Tuesday, S&P Global issued a warning, expressing concerns that approving proposed Spot Ethereum ETFs in the United States might exacerbate the network’s concentration issue by consolidating staked tokens among a limited number of providers.

Several proposed Spot Ethereum ETFs in the US, including applications from Ark Invest and Franklin Templeton, aim to enhance yield by engaging in “staking” the underlying ether.

Staking entails validators, also known as participants, committing a specific quantity of ether into a cryptocurrency wallet as collateral to maintain the blockchain’s functionality.

According to analysts Andrew O’Neill and Alexandre Berry from S&P, Spot Ether ETFs holding only ether are not likely to affect the validator mix in Ethereum’s consensus mechanism. However, those involving staking could have a significant impact, particularly with substantial inflows.

Outside the US, some Ether ETFs have already adopted this approach. S&P Global estimates that the total assets under management of non-US Spot Ether ETFs incorporating staking amount to approximately $800 million.

SEC Decision Deadline Nears for Spot Ethereum ETFs

Currently, the SEC is evaluating eight applications for Spot Ether ETFs, with the initial decision deadline scheduled for May 23, 2024. Analysts at Bernstein have indicated a 50% likelihood of an ETH ETF approval by May, with a near certainty expected by the end of the year.

S&P highlighted that the trading volume of US spot bitcoin ETFs surged to $12 billion just one month after approval as of February 14.

Drawing from this data, the analysts suggested that US Spot Ether ETFs, which include staking, “could become large enough to change validator concentrations in the Ethereum network.”

Such a potential shift could expose the network to risks such as inactivity due to a single point of failure or malicious collusion.

Coinbase Eyes Bigger Pie?

Coinbase acts as a custodian for 8 out of the 11 recently approved US bitcoin ETFs. Additionally, it is identified as a staking entity in three out of the four largest Ether staking ETFs outside the US.

According to analysts, Coinbase controls the second-largest share of validators on Ethereum, comprising 14.4% of the network. In contrast, the decentralized staking protocol Lido holds a higher share at 31.7% of the staked tokens.

However, S&P suggests that US institutions launching Ether staking ETFs are unlikely to directly engage with decentralized protocols like Lido. Instead, they are expected to opt for an institutional digital asset custodian such as Coinbase. This choice could potentially mitigate risks associated with Lido’s validator concentration.

S&P noted, “The emergence of new digital asset custodians may enable ETF issuers to spread their stakes across different entities and mitigate this risk.”

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