Overview

BlackRock, the world’s largest asset manager, just filed an application to list an ETF that will hold ether, the native asset for the Ethereum blockchain, and directly track its underlying spot price. Ether immediately surged on the news, jumping almost 10% from $1,880 to briefly over $2,100 before starting to give back some of the gains.

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Key Background

The immediate surge in price mirrors a rally that affected bitcoin in June when BlackRock similarly filed an application to list a spot bitcoin ETF. ETFs stand for exchange-traded products, and they offer a convenient way for investors to buy exposure to an asset without having to directly procure it. This property is especially appealing to crypto investors, many of which are turned off by the technological and security challenges that come with buying the actual asset.

In the case of bitcoin, it surged more than 20% in June, as many industry watchers felt that an asset manager with the clout and reputation of BlackRock would not file an application without an expectation of success. It is worth noting that to date no spot crypto application has ever been approved by the Securities and Exchange Commission for any asset (and it has not been approved since despite growing optimism). As a result, while bitcoin is up 45% since that date, it has not been a smooth ride. In fact, the asset nearly gave up all of its gains in the fall before rallying once again in October.

Outlook and Implications

The first thing to remember is that a BlackRock spot ether ETF is months away at the earliest and there is no guarantee that it will ever list. The SEC has up to 240 days to decide whether or not to approve a product, which could push any potential start date all the way back until next fall. In addition, it is important to note a key distinction between the regulatory statuses of bitcoin and ether that could cause additional delays.

While virtually every interested party, including the SEC is in agreement that bitcoin is not a security, and it does not fall under its jurisdiction, ether’s outlook is cloudier. In fact, SEC Chairman Gary Gensler has prevaricated on the subject multiple times, including during a high-profile showdown with the Chairman of the House Financial Services Committee Patrick McHenry (R-NC) over whether he believes ether to be a security. Notably, the token was not cited as an unregistered security in any of the lawsuits brought by the SEC against exchanges like Coinbase or Binance, and the industry is still trying to read the tea leaves of this omission.

While this distinction may not directly decide whether or not ether can be wrapped in an ETF, such a debate could still slow down the process. If exchanges need to delist the token, it could harm global liquidity and oversight, and make the market more vulnerable. It is also likely that the SEC would want to see how a spot bitcoin ETF trades before approving products that track other assets. All of this means that after a week or two of excitement, which could be sustained if/when copycat applications suddenly come out of the woodwork, ether’s price is likely to continue along the same trajectory that it has been on, which has been sluggish.

Let’s explore in more detail.

Ethereum occupies a unique place in the world of crypto, as it straddles the line between being a safe haven/store of value token and a higher beta/more volatile play on the crypto industry on the whole. This means that its value proposition combines properties as a safe haven while also having qualities of a growth asset. This hybrid model has been borne out in recent years as ether has outperformed bitcoin but trailed high-profile alternative tokens such as Solana’s SOL or Binance’s BNB.

However, the script flipped in 2023 as excitement over a spot bitcoin ETF has grown. Now investors see bitcoin as the best way to inch back into crypto after a brutal 2022. Ethereum has lagged significantly behind BTC in terms of price and furthermore core fundamentals such as network usage and active participants has not moved much in a year.

All of this means that the outlook for ether was lackluster in the coming months before the application. Although it is starting to move slightly upwards on bitcoin’s coattails, its realized volatility on a monthly basis is the lowest that it has been in almost five years. Ether’s implied volatility (expectations of future volatility) trails bitcoin trails bitcoin even in this bullish market.

Decision Points

Investors should be cautious about making big purchases of ether on account of this news. The price is already starting to retract, and nothing about the announcement changes any fundamental properties of ether or its trajectory.

Still, ether’s prominent place in the world of crypto makes it an important component to any portfolio. But it must be done responsibly. Therefore, most ether traders may want to focus their immediate attention on generating gradual long exposure to the spot market, where there are a few options. Centralized exchanges are the most common way to purchase spot ether. But, because a centralized party controls these exchanges, they come with risks. For example, it is impossible to verify that assets are actually there unless/until you try to take them out. This lack of transparency is one of the reasons for the FTX implosion. There are efforts to mitigate this risk, such as proof of reserves, but they are not perfect nor widespread. Exchanges can also be more expensive for retail traders. For instance, Coinbase charges almost 300 basis points for a simple purchase.

Despite their name, the seven ETH futures-based exchange-traded funds actually track the underlying spot price of bitcoin. These can be purchased directly from a retail brokerage account and do not require holders to hold and safeguard crypto. However, these can come with hidden ‘rollover costs’ in addition to expense ratios. Rollover costs relate to the extra costs that come from having to purchase higher priced monthly futures contracts every 30 days. They eventually get passed onto the consumer. Fortunately, these costs could be minimized during periods of lower volatility.

If you want to get more adventurous, a long/short strategy where one goes long on ether and short some of its smaller competitors such as Solana’s sol, Cardano’s ada, and Algorand’s algo tokens may be appealing. However, note that historically these assets have been tightly correlated in both bull and bear markets. If one wants to take even more risk, consider using leverage with futures or options contracts or purchase shares in an ETF designed to multiply ether’s returns (though please note that the accelerated returns can go in both directions). To hedge, one can also short ether directly or purchase shares in an ETF such as the ProShares Short Ether Strategy (SETH: Nasdaq) that bets against ether’s upward price movement.

Finally, if one is interested in ether at a potential discount, consider shares in the Grayscale Ethereum Trust (ETHE: OTCQX). These shares currently trade at an 18% discount to NAV. The catch is that right now they are irredeemable for the underlying ether. However, if Grayscale is able convert ETHE into an ETF, which it applied to do in October, then it could be possible to pick up a slight premium on top of any spot price gains.

Maker
MKR
, a decentralized lending protocol, is dedicating significant effort towards supporting tokenized real-world assets. RWAs have quickly become a promising narrative in a market that may otherwise seem tepid.

RWAs include assets such as equities, bonds, real estate, and other financial instruments represented on a blockchain as a token that can be used in decentralized finance applications. Putting traditional assets on a blockchain has the potential to improve process efficiency, transparency, and allow access to new liquidity markets. Because they bridge traditional assets to digital infrastructure, RWAs open up DeFi to non-crypto native investors.

The Allure of Tokenized Assets

The popularity of RWAs could be chalked up to a few reasons. A primary one is that the assets have actual utility even before they are brought on-chain, unlike digital-first assets which sometimes have launched to investors before defining utility, as has been the case with non-fungible tokens.

A handful of major institutions, Goldman Sachs among them, have stated their intention to experiment with tokenized assets; institutional trust in this asset class has made it all the more interesting to investors who might not have initially been privy to RWAs. Assets abandoning old, traditional channels could be a use case that blockchain infrastructure has been waiting for.

Maker’s Long-Term Roadmap

Top protocols focused on RWAs include Ondo Finance, Maple Finance, and notably, Maker. Maker launched in 2017 and powers a decentralized, dollar-pegged stablecoin called DAI
DAI
. Last year, Huntington Valley Bank announced it was adding collateral to Maker, which would loan them up to $100 million in DAI. This marked the first partnership between a traditional bank and a decentralized lending protocol and one of the first big deposits of RWAs into Maker. Now, RWAs make up about 60% of Maker’s annualized revenue.

Rune Christensen, the CEO of Maker, outlined the future of the protocol earlier this year, reasserting its focus on RWAs. The main plan is to increase DAI supply to 100 billion within the next three years and introduce a sophisticated governance system consisting of multiple decentralized autonomous organizations to grow the protocol.

In June, Maker voters approved a proposal to augment the inventory of U.S. treasury bonds by $700 million. This expansion in T-bill reserves is projected to generate an annualized net yield of 4.5%, which will be used to back DAI. The price of Maker’s governance token MKR has experienced a steady increase, rising by approximately 68% since the announcement of the T-bill accrual. Investing in T-bills remains safe due to rising interest rates and their backing by the U.S. government.

Given the initial investor attraction to RWAs, Maker is making a decision to concentrate focus on diversified RWA reserves. Embracing RWAs can reduce risk and volatility in DeFi, and we expect to see significant infrastructure development in the coming months to support the facilitation of RWAs.

The decentralized finance market faced dual upheavals last weekend, leaving it feeling uneasy. Namely, both Curve Finance, a leading automated market maker, and Base, Coinbase’s
COIN
new Ethereum rollup, experienced separate events that had an impact on user and protocol funds, posing a threat to many others. Spooked traders withdrew roughly $1.5 billion worth of digital assets after hackers stole at least $52 million by leveraging Curve, Bloomberg and Fortune reported, respectively.

Meanwhile, the early stage exchange associated with Base, called LeetSwap, saw a vulnerability exploited to drain more than $635,948 worth of Ethereum-based tokens. The close proximity of these attacks, following a weekend with more than $50 million in unexpected DeFi activity, served as a stark reminder of the risks associated with DeFi.

Curve Finance Exploits

Curve Finance suffered an exploit of around $62 million on July 30, according to TechCrunch. It was a result of a vulnerability in the smart contract language, Vyper, that some parts of Curve were written in. Specifically, it was a reentrancy attack, where a malicious contract function calls another contract multiple times before the first call is completed. This action is done in order to exploit and thus drain funds in a contract.

Curve uses liquidity pools, instead of matching buyers and sellers to conduct swaps. These pools hold tokens that can be exchanged or withdrawn based on rates set by the pool. Each holds a pair of assets, so a user exchanging A for B would go to A/B pool – a pair pool is necessary to maintain pricing.

Curve pools using vulnerable versions of Vyper were affected. Because Curve pools are permissionless to deploy, several project pools affected, i.e. Alchemix lost $13.6 million and Metronome lost $1.6 million.

As all of this transpired, Curve’s utility token, CRV
CRV
fell 20% from $0.73. A white hat operation commenced as the attack was ongoing and one of the hackers, c0ffeebabe.eth was able to safeguard about $5.3 million.

Michael Egorov’s Pending Liquidations

By the morning of August 1, the market valuation of CRV had plummeted 46%. To add fuel to the fire, turns out that Curve founder Michael Egorov had already taken out a series of hefty loans against his CRV holding.

Some of the estimated loan positions:

• $70 million (47% of CRV circulating supply) used to take out a USDT
  USDT
  stablecoin loan from Aave, a leading DeFi lending protocol.
• $32 million CRV to borrow $10 million of FRAX
  FRAX
  on Fraxlend.
• $17 million CRV loan on Abracadabra. In response, the protocol proposed to increase interest rates to manage risk from its CRV exposure.

Widespread market fear ensued because, if the price of CRV dips below a certain threshold set by Aave
AAVE
parameters, Egorov’s position could be liquidated and cause catastrophic effects for individual traders relying on these protocols. So, as the market price of CRV declined, sell-pressure continued to deepen.

Egorov hastily started selling his LDO
LDO
holding for USDC
USDC
, as well as repaying some capital from Fraxlend. But this ultimately wasn’t enough. He spun up a new Curve pool in order to incentivize liquidity to decrease his debt, which helped temporarily.

A few entities stepped in to help — Justin Sun, founder of Tron, purchased $5 million worth of CRV from Egorov in an over-the-counter transaction. Several other buyers, including the operators behind protocols like Yearn, participated as well. It remains to be seen if all this effort can truly shield Egorov and the resulting chain of events that would have a ripple effect across the entire DeFi ecosystem. Of course, it raises the question of how decentralized these platforms are if individual choices can make or break their functionality.

BALD, Base, And Brash

Memecoin culture, with cryptocurrencies launched to represent jokes or memes, still holds a strong sway in the crypto ecosystem even though the hype surrounding these tokenized jokes is often short-lived and highly risky. A few days before the Curve exploit, on July 29, an anonymous developer launched BALD, a memecoin referencing the fact that Coinbase CEO Brian Armstrong is bald, was launched on Coinbase’s rollup built on the OP Stack. Currently, Base is on testnet and not fully live, so it only supports a one-way bridge. In short, it’s still extremely risky to use the experimental software and most people can only put money onto the platform. It’s not possible to cash out at scale.

Regardless, the BALD price jumped 40,000% within 48 hours and eventually about $80 million in value was bridged to the Base blockchain.

As the market crazed over BALD, on July 30, the memecoin deployer, who provided the token’s initial liquidity by adding his own ether via LeetSwap, managed to pull $12.5 million in liquidity off the exchange. The price of BALD immediately crashed, leaving the LeetSwap pool barren.

Then, to make matters worse, on July 31, LeetSwap suffered an exploit that led to it pausing trading activity. The attacker took advantage of a smart contract function and was able to manipulate the price of an asset and subsequently drain the pool. In this attack, about $630,000 was compromised. The following day, the team announced that it was working with white hats to retrieve funds stuck in pools that the hacker had not accessed and retrieved about 197 ETH. They also extended an olive branch deal with the exploiter, which was ignored.

When that market crash coincided with the above-mentioned and unconnected exploits, the deployer tweeted a brazen message that he will add modest liquidity to other DEXs but reserves the right to profit from the memecoin however he choses, adding “if you still decide to trade this token you will probably lose all your money.”

This action incited a community-wide investigation into the developer to understand their history and some intriguing wallet activity surfaced. Namely, the deployer was an early participant in the DeFi experiment SushiSwap and also clearly had a connection to a wallet affiliated with Sam Bankman-Fried’s company Alameda Research. However, astute observers keep in mind that many people had accounts that interacted with Alameda Research wallets and the affiliated FTX exchange.

In short, the BALD developer was among the numerous crypto traders who interacted with Alameda, the entity associated partnered with the FTX collapse. No concrete evidence has been confirmed in relation to the BALD deployer’s identity.

LeetSwap Proves Another DeFi Lesson About Risk

Though the Curve exploit was relatively small compared to previous DeFi hacks, the bigger concern lies in the founder’s ability to utilize 47% of circulating CRV for personal loans. Egorov’s account and activity was flagged before, yet no action was taken by the community. If these assets were to be liquidated, it would pose a threat to a number of DeFi protocols, which would cause a larger implosion than the initial exploit. The incident highlights the ongoing issues of centralization, overexposure, and dependencies on central points of failure, individual people. As was the case with both the BALD deployer and Egorov’s situation, large liquidity movements can jar literally everyone else using a particular open source protocol.

Regarding the Vyper attack, a post-mortem by the security research firm OtterSec noted that the bug had been patched in the past. But since security practices and processes are not all fleshed out, there was likely a failure in checking dependencies still left open after the initial bug patch. A team that is liable for staying up-to-date with security measures and how it might implicitly impact projects might have helped mitigate this risk. This conclusion led to a call to improve code review processes across the board. Public goods funding and bounties could help protect codebases as well.

On the other hand, LeetSwap was exploited due to a minor error, but neither the exploit nor the BALD rugpull will ultimately really define Base’s success. It is still a highly anticipated L2 even though it will likely stay volume poor for a bit before its live for all users.

All things considered, the tale of BALD is as old as time – speculation pumps the token, only to crash as early holders exit, similar to the PEPE
PEPE
frenzy earlier this year. Though, there was a lack of due diligence into the BALD deployer’s activity prior to the token pump, it is unlikely that it would have dissuaded the frenzied meme-coinery, even if the account’s unusual activity was broadly known. These twin tales serve as a stark reminder to the industry that some ill-intentioned builders won’t feel responsible for traders’ individual experiences, but rather are focused on profiting at all costs. Some traders did make millions of dollars with shrewd risk-taking during the market chaos. But for most, the money lost may have taught a lesson about the risks of the current state of DeFi infrastructure.

Crypto staking is breathing new life into decentralized finance on the Ethereum network. Staking activity remains resilient despite the ongoing down market and the U.S. Securities and Exchange Commission’s claims that staking violates securities laws, resulting in Kraken’s closure of its staking business and an impending lawsuit against Coinbase. Since the completion of the Shanghai/Capella upgrade on April 12, the amount of ETH staked per week surpassed previous all-time highs in May, before a slight deceleration this month.

A persistent growth in staking volumes and accompanying protocols could become an impetus for a DeFi summer round two, led by Ethereum protocol improvements and expanded liquidity prospects for stakers.

Riding The Wave Of Liquid Staking And LSTFi

Liquid staking makes up a major portion of staking volume. Lido, the leading liquid staking protocol, represents 32% of the total staked ETH. Before Shanghai/Capella, any ETH locked up could not be withdrawn. Instead, liquid staking protocols began to issue synthetic tokens, called liquid staking tokens, that represent locked up funds that users can transact with while earning yield.

There was fear that staking volume would stunt and massive withdrawals would take place post-upgrade, but the contrary happened:

• The amount of ETH staked has nearly converged with the amount of ETH held on centralized exchanges. At the beginning of 2023, the amount of ETH staked represented 58% of ETH held on exchanges.
• LSTFi protocols surfaced, enabling LSTs to be used in DeFi applications. To date, about $400 million in LSTs have been used in LSTfi protocols.
• Among LSTFi protocols, Lybra Finance currently dominates with $185 million in TVL. The protocol issues eUSD, an interest-bearing stablecoin. Users can deposit Lido stETH to mint eUSD; interest is earned on the underlying staked ETH, while eUSD price remains stable. The upcoming Lybra V2 will support additional LSTs.

Some anticipate this to mark the very beginning of LSTFi’s explosion. ETH is still underutilized, with only 17% of circulating ETH staked. With DeFi primitives built atop LSTs, users can improve capital efficiency and find additional routes to earn yield. As centralized exchanges halt staking services, the ongoing development of LSTFi is expected to gain momentum. The market’s enthusiastic response to LST-backed stablecoins is evident, but there’s still a chance that the onslaught of interest in LSTFi could be due to the novelty of the projects.

Staking As An Ethereum Validator

Liquid staking, because it requires no ETH minimum nor laborious processes, is an accessible way to participate in running the Ethereum network, unlike running a complex validator node. And yet, the ranks of Ethereum validators have swelled to 625,000 already in action and 91,000 in queue. New validators have to wait around 41 days to join the network since there is a limit of how many new validators can join per day. Each validator is limited to 32 ETH and so entities with sufficient resources are likely running several nodes. That means there are thousands of unique institutions and individuals are represented among these network participants.

Recently, core ETH developers proposed increasing the staking limit to 2,048 from 32 ETH. These developers believe the increase would improve network effectiveness and enable solo-stakers or individuals to earn more. If this proposal passes, it will also increase the diversity of participants on the network and encourage more solo-stakers. In the meantime, as long as running a validator node continues to be resource intensive, it will be the less popular route for individuals to stake with and institutions will generally dominate the staking landscape.

With the majority of eligible ETH still unstaked and the growth of LSTs, it is likely that staking activity will persist for those assets. Although, aside from the obvious, the long-term winners from this surge remain uncertain with staking slowing down. What is clear, as of June 2023, is that over the past 8 years the Ethereum experiment went from an experimental white paper to a global economic network with billions of dollars worth of assets impacting millions of users. Not bad for a blockchain network that critics originally thought wouldn’t be able to scale beyond a few thousand participants. Staking and building in layers have allowed Ethereum’s blockchain ecosystem to scale the network’s incentive model.