Ethereum Big Short Declaration: ETH/BTC Still Has to Drop for Another Year

Author: Andrew Kang, Co-founder of Mechanism Capital

Compiled by: Azuma, Odaily Planet Daily

Editor’s Note: This article is an analysis by Andrew Kang, co-founder of Mechanism Capital, on the future performance of ETH. In the article, Andrew focuses on the potential inflow scale of the Ethereum spot ETF and, in conjunction with the market structure differences between ETH and BTC, provides an aggressive prediction that "the ETH/BTC exchange rate will continue to decline over the next year, potentially ranging between 0.035 and 0.06."

Below is the full text by Andrew, compiled by Odaily.

The launch of the Bitcoin spot ETF has provided many potential new buyers with the opportunity to include BTC in their portfolios, but comparatively, the impact of the Ethereum spot ETF on ETH itself may not be as significant.

When BlackRock submitted its Bitcoin spot ETF application, the price of BTC was around $25,000, and I made an optimistic prediction at that time. Since then, BTC's return has reached 2.6 times, while ETH's return has been 2.1 times; if calculated from the cycle bottom, BTC's return is 4 times, and Ethereum is also 4 times.

So, how much incremental value can the Ethereum spot ETF bring this time? To conclude, I believe that unless Ethereum finds effective ways to improve its economic effects, the growth potential will be very limited.

ETF Net Inflow Analysis

Overall, Bitcoin spot ETFs have now accumulated over $50 billion in AUM (Assets Under Management).

This is a rather optimistic figure. However, if we strip out the capital flows associated with GBTC, you will find that the net inflow of funds will shrink to $14.5 billion.

In fact, this number still needs to be further reduced, as it still includes many "delta neutral" trades, particularly some "basis trades" (such as selling futures while buying the ETF) and "spot rotations" (selling spot to buy the ETF). Based on CME data and analysis of ETF holders, about $4.5 billion of the inflow is related to "basis trades"; additionally, some ETF experts have pointed out that large institutions like BlockOne have conducted significant "spot rotation" operations, with the scale of such trades expected to be around $5 billion. Excluding these "delta neutral" trades, we can estimate that the actual net inflow of the Bitcoin spot ETF is about $5 billion.

Based on this data, we can continue to predict the potential inflow situation for the Ethereum spot ETF.

Bloomberg analyst Eric Balchunas has estimated that the capital flow for the Ethereum spot ETF could be 10% of that for the Bitcoin spot ETF. This means that within six months after the Ethereum spot ETF starts trading, the reported net inflow figure may be around $1.5 billion, but the actual net inflow will be about $500 million. Although Balchunas has had some misses in his predictions regarding ETF approvals, I believe his pessimistic attitude towards the Ethereum spot ETF has some informational value, as it reflects the broader traditional financial market's interest in this product.

Personally, my baseline assumption is that the capital flow for the Ethereum spot ETF could be 15% of that for the Bitcoin spot ETF. Still using $5 billion as a base for calculation, combined with an adjustment factor of about 33% for Ethereum's market cap relative to Bitcoin's, and adding a 0.5 "access factor," we arrive at an actual net inflow of $840 million and a reported net inflow of $2.52 billion.

Note: The "access factor" here refers to the potential flow that ETFs can bring to BTC being greater than that which they can bring to ETH, due to the different potential buying entities. BTC, as a more macro asset, may be more attractive to macro funds, pensions, sovereign wealth funds, etc., while ETH, as a technical asset, may be more favored by venture capital funds, crypto funds, technical experts, and retail investors, who generally face fewer restrictions when trading cryptocurrencies. The 50% figure is derived from comparing the CME open interest and market cap ratios of ETH and BTC.

Considering that some analysts have raised reasonable supplementary points, namely that compared to GBTC, ETHE has a relatively smaller supply, I predict that the actual net inflow will be $1.5 billion, with a reported net inflow of $4.5 billion. This is roughly 30% of the capital flow for the Bitcoin spot ETF.

Regardless, the actual net inflow for the Ethereum spot ETF will be far lower than the derivative trading scale generated by ETF expectations, which is around $2.8 billion, not accounting for some spot front-running trades. This indicates that the ETF expectations have been fully digested by the market.

From CME data, prior to the ETF launch, the open interest ratio for ETH was also far lower than that for BTC—ETH contracts accounted for about 0.3% of the supply, while BTC accounted for about 0.6%. Initially, I thought this was simply because ETH was relatively "earlier," but it may also indicate that the traditional financial sector is not interested in the Ethereum spot ETF. Traders had profited significantly during the trading cycle of the Bitcoin ETF, and they usually have very accurate information; if they did not replicate the same operations on ETH, it may suggest that the flow performance of the Ethereum spot ETF will be relatively poor.

How Can $5 Billion Drive BTC Up?

How can just $5 billion pull BTC from $40,000 to $65,000? To continue with the conclusion, it hasn't done so.

There are many other buyers in the spot market. Bitcoin has truly become an investment asset with a certain level of recognition globally, with many institutional buyers such as MicroStrategy, Tether, family offices, and high-net-worth individual investors. Ethereum also has some institutional buyers, but their scale is far smaller than that of Bitcoin.

It is worth noting that before the Bitcoin spot ETF started trading, the price of BTC had already reached $69,000, with a market cap exceeding $1.2 trillion. Various market participants, including institutions, hold a significant amount of BTC in spot; assets held in custody by Coinbase amount to $193 billion, of which $100 billion comes from institutional clients; Bitgo reported its asset custody scale to be $60 billion; Binance's asset custody exceeds $100 billion. Six months after the Bitcoin spot ETF started trading, the ETF "only" held 4% of the total supply of Bitcoin, which is significant but only a small part of the market demand composition.

Another important distinction is that when the Bitcoin spot ETF launched, the market's capital allocation was somewhat lacking. At that time, the market generally believed that the launch of the ETF would lead to a "peak at launch" decline in BTC. Therefore, a large amount of capital had already exited before the launch of the Bitcoin spot ETF and then re-entered during the decline (amplifying the inflow scale of the ETF), and when the ETF showed good liquidity, some shorts had to cover their positions. Evidence for this data is that the open interest in BTC actually decreased before the Bitcoin spot ETF started trading.

The situation for the Ethereum spot ETF is completely different. Before the ETF launch, the price of ETH had already reached 4 times the low of this cycle, while BTC's price was only 2.75 times its low at that time. In the derivatives market, the open interest (OI) of ETH in crypto-native exchanges has increased by $2.1 billion, bringing the open interest close to historical highs. This means that many traders familiar with cryptocurrencies, seeing the success of the Bitcoin ETF, also expected ETH to achieve the same effect and made corresponding arrangements.

However, in my view, the expectations of cryptocurrency practitioners may be too high, and these expectations do not align with the actual preferences of the traditional financial market. People who have long focused on the crypto space usually have high attention and trust in Ethereum, but in reality, many capital groups outside the cryptocurrency realm see the appeal of allocating Ethereum as a key asset as much smaller.

When we promote Ethereum to traditional finance, we often use "technical asset" as a starting point, emphasizing its value as a global computer, Web3 application store, decentralized finance settlement layer, etc. This narrative had some appeal in previous cycles, but if you put the actual data on the table, you will find that this promotional model is not very persuasive.

In past cycles, you could cite the growth rate of transaction fees to demonstrate how DeFi and NFTs would create more fees and cash flow for Ethereum, thereby shaping Ethereum into a "technical asset" similar to tech stocks. However, in the current cycle, the quantification of these fees has had the opposite effect—data shows that Ethereum's fees are stagnating or even in negative growth. Although Ethereum itself is still a sustainable "cash" generating machine, how can analysts prove to their family offices or fund bosses that ETH's current price is reasonable based solely on $150 million in monthly revenue, a 300x price-to-sales ratio, and a negative price-to-earnings ratio?

Additionally, I believe that for two main reasons, there won't be too many "delta neutral" trades around the ETF in the initial weeks after its launch. First, the sudden approval of ETH caught many off guard, and the issuers did not have enough time to market the ETF to large institutions; second, for ordinary ETH holders, the incentive to convert their positions to the ETF is also low, as it means they would have to give up yields achievable through staking, DeFi farming, etc. Although the current overall staking rate for ETH is only 25%.

Does this mean ETH will go to zero? Of course not; at some price point, ETH will still be considered valuable, and when BTC continues to rise in the future, ETH will also rise to some extent.

Before the launch of the Ethereum spot ETF, I expected ETH's trading range to be between $3,000 and $3,800; after the ETF launch, my expectation is between $2,400 and $3,000. However, if BTC rises to $100,000 in the fourth quarter or the first quarter of next year, this may drive ETH to break new highs, but the ETH/BTC exchange rate will be lower.

I expect that over the next year, the ETH/BTC exchange rate will continue to decline, potentially ranging between 0.035 and 0.06. Although our observable sample is not large, we do see that the peak of the ETH/BTC exchange rate has been decreasing in each cycle, so it would not be too surprising if this happens again.