Ethereum merger and fork, ETF flows outperforming mutual funds, and US Treasury illiquidity made headlines this week
The Ethereum merger and subsequent fork is underway after six years. The question now for investors in exchange-traded products (ETPs) is which side of the civil war protocol their assets will be placed on.
The merger of the Ethereum blockchain with the proof-of-stake beacon chain unveiled in 2020 is essentially a “hot swap” of the engine underlying the world’s second-largest crypto asset, according to the Ethereum Foundation.
If successful, it could ensure the scalability of the asset and decisively reduce its emission to one-hundredth of the level produced by its proof-of-work outgoing protocol.
However, its new eco-friendly architecture is not without criticism. While the process of validating new blocks under PoS is less energy-intensive, proponents of the PoW hash model argue that PoS is a step towards greater centralization, since those who wish to participate in the validation of blocks — via staking — have a value of need to deposit around $60,000 from Ethereum.
This has created a divide among Ethereum network users, with some willing to migrate to PoS while some PoW miners are refusing to participate in the merger. The result is the fork planned today, which will see a new token minted – EthereumPoW – that will operate on the Ethereum network but still be based on PoW hashing.
This split raises an awkward question for ETP issuers, who must now decide which side of the fork client’s wealth should fall into.
ETC Group has been at the forefront on this front, recently announcing that it will launch the ETC Group Physical EthereumPoW (ZETW) to track the performance of the new PoW token.
The company said that all holders of its ETC Group Physical Ethereum (ZETH) would automatically receive ZETW securities on a 1:1 unit basis in their brokerage accounts, with CEO and co-founder Bradley Duke stating: “It is only right that investors investing in our products should receive the proceeds of this spin-off.”
CoinShares, meanwhile, is taking a more cautious approach as the issuer says it expects to share a portion of the new PoW token with investors in its existing Ethereum ETP “to the extent possible.”
For now, though, she’s wary of the potential for “significant price volatility” and “risks related to the stability of the technology.”
In turn, CoinShares said: “As a result, the issuer will continue to monitor the situation for ETHW, with a focus on the timing, launch and feasibility of the new protocol and underlying digital currency before finalizing any approach to an associated distribution fork event.”
Elsewhere, 21Shares is considering launching an ETP staking ETP on Ethereum to provide post-merger return opportunities.
Slow and Steady ETFs
ETF outflows in Europe have so far proved resilient during this year’s volatility, while UCITS mutual funds have suffered their heaviest outflows since 2008.
While packaged products posted €56 billion in the first seven months of the year, the legacy fund structure saw an exit of €161 billion over the same period, likely due to a preference for the low-cost passive approach, transparency and intraday trading, according to Bloomberg Intelligence Characteristics that prevail in ETFs.
This is a trend that appears to be playing out across periods of volatility, said Detlef Glow, head of Lipper EMEA research at Refinitiv, with inflows into passive products remaining steady throughout the global financial crisis and euro crisis.
Recent flows are consistent with a pattern seen for more than a decade – mutual fund assets rise when things are going well, but ETF inflows remain positive in risk-on and risk-free situations. ETFs have absorbed perhaps half the assets of mutual funds since the beginning of 2020, but only a tenth the size of mutual funds in Europe. This shows that they are now hitting above their weight.
US Treasury liquidity is nearing COVID levels
MSCI has warned that US Treasury market liquidity could be worse than during peak COVID-19 volatility if the Federal Reserve does not slow the pace of asset sell-offs.
The Fed announced a major asset purchase program early in the pandemic to keep markets functioning smoothly and improve liquidity conditions.
Although those goals are successful, the policymaker now plans to further drain the accumulated assets and grow its revenue to $60 billion per month. Since the announcement of that balance sheet contraction, US Treasury bond markets have eroded over the past 10 months, with investors facing higher transaction costs and hedge slippage, MSCI said.
Bank of America rates strategist Ralph Axel warned that declining liquidity and Treasury market resilience could pose one of the biggest threats to financial stability today, possibly worse than the housing bubble of the noughties.
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