Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with, and is qualified in its entirety by reference to, our unaudited financial statements and related notes included elsewhere in this Quarterly Report, which have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The following discussion may contain forward-looking statements based on assumptions we believe to be reasonable. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those set forth under “Part II, Item 1A. Risk Factors” in this Quarterly Report, or in “Part I, Item 1A. Risk Factors” and “Forward-Looking Statements” or other sections of our Annual Report on Form 10-K for the year ended December 31, 2022.
Trust Overview
The Trust is a passive entity that is managed and administered by the Sponsor and does not have any officers, directors or employees. The Trust holds ETH and, from time to time on a periodic basis, issues Creation Baskets in exchange for deposits of ETH. As a passive investment vehicle, the Trust’s investment objective is for the value of the Shares (based on ETH per Share) to reflect the value of ETH held by the Trust, determined by reference to the Index Price, less the Trust’s expenses and other liabilities. While an investment in the Shares is not a direct investment in ETH, the Shares are designed to provide investors with a cost-effective and convenient way to gain investment exposure to ETH. To date, the Trust has not met its investment objective and the Shares quoted on OTCQX have not reflected the value of ETH held by the Trust, less the Trust’s expenses and other liabilities, but instead have traded at both premiums and discounts to such value, which at times have been substantial. The Trust is not managed like a business corporation or an active investment vehicle.
Forks
The Ethereum Network operates using open-source protocols, meaning that any user can download the software, modify it and then propose that the users and miners or validators, as applicable, of ETH adopt the modification. When a modification is introduced and a substantial majority of users and miners consent to the modification, the change is implemented and the network remains uninterrupted. However, if less than a substantial majority of users and miners consent to the proposed modification, and the modification is not compatible with the software prior to its modification, the consequence would be what is known as a “hard fork” of the Ethereum Network, with one group running the pre-modified software and the other running the modified software. The effect of such a fork is the existence of two versions of ETH running in parallel, yet lacking interchangeability. Holders of ETH on the original Ethereum Network, at the time the block is mined and the fork occurs, can then also receive an identical amount of new tokens on the new network.
Ethereum Fork on September 15, 2022 (ETHPoW)
Background and Measurement
The Ethereum Network completed the final stages of an upgrade referred to as the “Merge,” which is a stage of what was previously referred to as Ethereum 2.0, on September 15, 2022, and the Ethereum Network transitioned to a proof-of-stake model. Following the Merge, a hard fork of the Ethereum Network occurred, as certain ETH miners and network participants planned to maintain the proof-of-work consensus mechanism that was removed as part of the Merge. This version of the Ethereum Network was rebranded as Ethereum Proof-of-Work (“ETHPoW”).
Immediately following the hard fork on September 15, 2022, holders of ETH passively received Incidental Rights to an equal number of ETHPoW. At that time, the Trust held approximately 3,059,976 ETH and the newly created ETHPoW was inaccessible to the Trust. On the date of the hard fork, the Incidental Rights to ETHPoW were determined to have no value as there were insufficient observable market inputs to determine the fair value of ETHPoW and the ETHPoW assets were not supported by the Custodian.
Furthermore, on September 16, 2022, the Sponsor of the Trust announced that it had declared a distribution and established a record date for the distribution of the Incidental Rights to the shareholders of record as of the close of business on September 26, 2022 (“Record Date Shareholders”).
Subsequent Measurement and Distribution of Incidental Rights to ETHPoW
On September 26, 2022 (the “Record Date”), the Trust distributed the Incidental Rights to obtain approximately 3,059,976 ETHPoW tokens held by the Trust to the Record Date Shareholders.
On the Record Date, the Trust, acting on behalf of the Record Date Shareholders and pursuant to the terms of the Trust Agreement governing the Trust, appointed Grayscale Investments, LLC as agent (in this capacity, the “Agent”) on behalf of the Record Date
16
Shareholders and transferred the Incidental Rights to ETHPoW tokens held by the Trust to the Agent on behalf of the Record Date Shareholders. The Trust has no ownership interest in the distributed Incidental Rights to ETHPoW, no ability to control the actions of the Agent and no right to receive any information about the distributed Incidental Rights to ETHPoW or the disposition thereof or of the underlying ETHPoW from the Record Date Shareholders, their Agent or any other person. As of the Record Date, the Trust determined such Incidental Rights to have a fair value of $0 and no gain or loss was recognized as part of the Incidental Right distribution, due to the lack of a trading venue accessible to the Authorized Participant of the Trust and uncertainty regarding the ability to safely access and custody the ETHPoW.
The Agent will continue the process of evaluating the market environment to determine whether it can acquire the IR Virtual Currency and whether, when, and in what manner it may sell the IR Virtual Currency on behalf of the Record Date Shareholders.
Critical Accounting Policies and Estimates
Investment Transactions and Revenue Recognition
The Trust considers investment transactions to be the receipt of ETH for Share creations and the delivery of ETH for Share redemptions or for payment of expenses in ETH. At this time, the Trust is not accepting redemption requests from shareholders. The Trust records its investment transactions on a trade date basis and changes in fair value are reflected as net change in unrealized appreciation or depreciation on investments. Realized gains and losses are calculated using the specific identification method. Realized gains and losses are recognized in connection with transactions including settling obligations for the Sponsor’s Fee in ETH.
Principal Market and Fair Value Determination
To determine which market is the Trust’s principal market (or in the absence of a principal market, the most advantageous market) for purposes of calculating the Trust’s net asset value (“NAV”), the Trust follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820-10, which outlines the application of fair value accounting. ASC 820-10 determines fair value to be the price that would be received for ETH in a current sale, which assumes an orderly transaction between market participants on the measurement date. ASC 820-10 requires the Trust to assume that ETH is sold in its principal market to market participants or, in the absence of a principal market, the most advantageous market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact.
The Trust only receives ETH in connection with a creation order from the Authorized Participant (or its Liquidity Provider) and does not itself transact on any Digital Asset Markets. Therefore, the Trust looks to market-based volume and level of activity for Digital Asset Markets The Authorized Participant(s), or a Liquidity Provider on behalf of the Authorized Participant(s), may transact in a Brokered Market, a Dealer Market, Principal-to-Principal Markets and Exchange Markets, each as defined in the FASB ASC Master Glossary (collectively, “Digital Asset Markets”).
In determining which of the eligible Digital Asset Markets is the Trust’s principal market, the Trust reviews these criteria in the following order:
•First, the Trust reviews a list of Digital Asset Markets that maintain practices and policies designed to comply with anti-money laundering (“AML”) and know-your-customer (“KYC”) regulations, and non-Digital Asset Exchange Markets that the Trust reasonably believes are operating in compliance with applicable law, including federal and state licensing requirements, based upon information and assurances provided to it by each market.
•Second, the Trust sorts these Digital Asset Markets from high to low by market-based volume and level of activity of ETH traded on each Digital Asset Market in the trailing twelve months.
•Third, the Trust then reviews pricing fluctuations and the degree of variances in price on Digital Asset Markets to identify any material notable variances that may impact the volume or price information of a particular Digital Asset Market.
•Fourth, the Trust then selects a Digital Asset Market as its principal market based on the highest market-based volume, level of activity and price stability in comparison to the other Digital Asset Markets on the list. Based on information reasonably available to the Trust, Exchange Markets have the greatest volume and level of activity for the asset. The Trust therefore looks to accessible Exchange Markets as opposed to the Brokered Market, Dealer Market and Principal-to-Principal Markets to determine its principal market. As a result of the aforementioned analysis, an Exchange Market has been selected as the Trust’s principal market.
The Trust determines its principal market (or in the absence of a principal market the most advantageous market) annually and conducts a quarterly analysis to determine (i) if there have been recent changes to each Digital Asset Market’s trading volume and level of activity in the trailing twelve months, (ii) if any Digital Asset Markets have developed that the Trust has access to, or (iii) if recent
17
changes to each Digital Asset Market’s price stability have occurred that would materially impact the selection of the principal market and necessitate a change in the Trust’s determination of its principal market.
The cost basis of ETH received in connection with a creation order is recorded by the Trust at the fair value of ETH at 4:00 p.m., New York time, on the creation date for financial reporting purposes. The cost basis recorded by the Trust may differ from proceeds collected by the Authorized Participant from the sale of the corresponding Shares to investors.
Investment Company Considerations
The Trust is an investment company for GAAP purposes and follows accounting and reporting guidance in accordance with the FASB ASC Topic 946, Financial Services – Investment Companies. The Trust uses fair value as its method of accounting for ETH in accordance with its classification as an investment company for accounting purposes. The Trust is not a registered investment company under the Investment Company Act of 1940. GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates and these differences could be material.
Review of Financial Results (unaudited)
Financial Highlights for the Three Months Ended March 31, 2023 and 2022
(All amounts in the following table and the subsequent paragraphs, except Share, per Share, ETH and price of ETH amounts, are in thousands)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
|
2022 |
|
Net realized and unrealized gain (loss) on investment in ETH |
|
$ |
1,902,063 |
|
|
$ |
(1,129,682 |
) |
Net increase (decrease) in net assets resulting from operations |
|
$ |
1,872,425 |
|
|
$ |
(1,185,900 |
) |
Net assets |
|
$ |
5,521,623 |
|
|
$ |
10,165,791 |
|
Net realized and unrealized gain on investment in ETH for the three months ended March 31, 2023 was $1,902,063 which includes a realized gain of $21,794 on the transfer of ETH to pay the Sponsor’s Fee and net change in unrealized appreciation on investment in ETH of $1,880,269. Net realized and unrealized gain on investment in ETH for the period was driven by ETH price appreciation from $1,201.33 per ETH as of December 31, 2022 to $1,828.98 per ETH as of March 31, 2023. Net increase in net assets resulting from operations was $1,872,425 for the three months ended March 31, 2023, which consisted of the net realized and unrealized gain on investment in ETH, less the Sponsor’s Fee of $29,638. Net assets increased to $5,521,623 at March 31, 2023, a 51% increase for the three-month period. The increase in net assets resulted from the aforementioned ETH price appreciation, partially offset by the withdrawal of approximately 18,668 ETH to pay the foregoing Sponsor’s Fee.
Net realized and unrealized loss on investment in ETH for the three months ended March 31, 2022 was ($1,129,682) which includes a realized gain of $48,176 on the transfer of ETH to pay the Sponsor’s Fee and net change in unrealized depreciation on investment in ETH of ($1,177,858). Net realized and unrealized loss on investment in ETH for the period was driven by ETH price depreciation from $3,644.75 per ETH as of December 31, 2021 to $3,284.17 per ETH as of March 31, 2022. Net decrease in net assets resulting from operations was ($1,185,900) for the three months ended March 31, 2022, which consisted of the net realized and unrealized loss on investment in ETH, plus the Sponsor’s Fee of $56,218. Net assets decreased to $10,165,791 at March 31, 2022, a 10% decrease for the three-month period. The decrease in net assets resulted from the aforementioned ETH price depreciation and the withdrawal of approximately 19,141 ETH to pay the foregoing Sponsor’s Fee.
Cash Resources and Liquidity
The Trust has not had a cash balance at any time since inception. When selling ETH, Incidental Rights and/or IR Virtual Currency in the Digital Asset Market to pay Additional Trust Expenses on behalf of the Trust, the Sponsor endeavors to sell the exact number of ETH, Incidental Rights and/or IR Virtual Currency needed to pay expenses in order to minimize the Trust’s holdings of assets other than ETH. As a consequence, the Sponsor expects that the Trust will not record any cash flow from its operations and that its cash balance will be zero at the end of each reporting period. Furthermore, the Trust is not a party to any off-balance sheet arrangements.
In exchange for the Sponsor’s Fee, the Sponsor has agreed to assume most of the expenses incurred by the Trust. As a result, the only ordinary expense of the Trust during the periods covered by this Quarterly Report was the Sponsor’s Fee. The Trust is not aware of any trends, demands, conditions or events that are reasonably likely to result in material changes to its liquidity needs.
18
Selected Operating Data
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
|
2022 |
|
|
|
(All ETH balances are rounded to the nearest whole ETH) |
|
ETH: |
|
|
|
|
|
|
Opening balance |
|
|
3,037,631 |
|
|
|
3,114,532 |
|
Creations |
|
|
- |
|
|
|
- |
|
Sponsor’s Fee, related party |
|
|
(18,668 |
) |
|
|
(19,141 |
) |
Closing balance |
|
|
3,018,963 |
|
|
|
3,095,391 |
|
Accrued but unpaid Sponsor’s Fee, related party |
|
|
- |
|
|
|
- |
|
Net closing balance |
|
|
3,018,963 |
|
|
|
3,095,391 |
|
Number of Shares: |
|
|
|
|
|
|
Opening balance |
|
|
310,158,500 |
|
|
|
310,158,500 |
|
Creations |
|
|
- |
|
|
|
- |
|
Closing balance |
|
|
310,158,500 |
|
|
|
310,158,500 |
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, |
|
|
|
2023 |
|
|
2022 |
|
Price of ETH on principal market(1) |
|
$ |
1,828.98 |
|
|
$ |
3,284.17 |
|
NAV per Share(2) |
|
$ |
17.80 |
|
|
$ |
32.78 |
|
Index Price |
|
$ |
1,829.14 |
|
|
$ |
3,287.56 |
|
Digital Asset Holdings per Share(3) |
|
$ |
17.80 |
|
|
$ |
32.81 |
|
(1)The Trust performed an assessment of the principal market at March 31, 2023 and 2022, and identified the principal market as Coinbase Pro.
(2)As of March 31, 2023 and 2022, the NAV per Share was calculated using the fair value of ETH based on the price provided by Coinbase Pro, the Digital Asset Exchange that the Trust considered its principal market, as of 4:00 p.m., New York time, on the valuation date.
(3)The Trust’s Digital Asset Holdings per Share is derived from the Index Price as represented by the Index as of 4:00 p.m., New York time, on the valuation date. The Trust’s Digital Asset Holdings per Share is calculated using a non-GAAP methodology where the price is derived from multiple Digital Asset Exchanges. See “Item 1. Business—Overview of the ETH Industry and Market—ETH Value—The Index and the Index Price” in the Trust’s Annual Report on Form 10-K for a description of the Index and the Index Price. The Digital Asset Exchanges used to calculate the Index Price as of March 31, 2023 were Coinbase Pro, Kraken, LMAX Digital and Binance.US. The Digital Asset Exchanges used to calculate the Index Price as of March 31, 2022 were Coinbase Pro, Bitstamp, Kraken and LMAX Digital. See “Item 1. Business—Valuation of ETH and Determination of Digital Asset Holdings” in the Trust’s Annual Report on Form 10-K for a description of the Trust’s Digital Asset Holdings per Share.
For accounting purposes, the Trust reflects creations and the ETH receivable with respect to such creations on the date of receipt of a notification of a creation but does not issue Shares until the requisite number of ETH is received. At this time, the Trust is not accepting redemption requests from shareholders. Subject to receipt of regulatory approval from the SEC and approval by the Sponsor in its sole discretion, the Trust may in the future operate a redemption program. The Trust currently has no intention of seeking regulatory approval to operate an ongoing redemption program.
As of March 31, 2023, the Trust had a net closing balance with a value of $5,522,106,455, based on the Index Price (non-GAAP methodology). As of March 31, 2023, the Trust had a total market value of $5,521,623,421, based on the principal market (Coinbase Pro).
As of March 31, 2022, the Trust had a net closing balance with a value of $10,176,284,713, based on the Index Price (non-GAAP methodology). As of March 31, 2022, the Trust had a total market value of $10,165,791,337, based on the principal market (Coinbase Pro).
19
Historical Digital Asset Holdings and ETH Prices
As movements in the price of ETH will directly affect the price of the Shares, investors should understand recent movements in the price of ETH. Investors, however, should also be aware that past movements in the ETH price are not indicators of future movements. Movements may be influenced by various factors, including, but not limited to, government regulation, security breaches experienced by service providers, as well as political and economic uncertainties around the world.
The following chart illustrates the movement in the Trust’s Digital Asset Holdings per Share (as adjusted for the Share Split for periods prior to December 17, 2020) versus the Index Price and the Trust’s NAV per Share (as adjusted for the Share Split for periods prior to December 17, 2020) from December 14, 2017 to March 31, 2023. For more information on the determination of the Trust’s Digital Asset Holdings, see “Item 1. Business—Overview of the ETH Industry and Market—ETH Value—The Index and the Index Price” in the Trust’s Annual Report on Form 10-K.
20
The following table illustrates the movements in the Index Price from April 1, 2018 to March 31, 2023. During such period, the Index Price has ranged from $82.41 to $4,776.32, with the straight average being $1,181.74 through March 31, 2023. The Sponsor has not observed a material difference between the Index Price and average prices from the constituent Digital Asset Exchanges individually or as a group.
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|
High |
|
Low |
|
|
|
|
|
|
Period |
|
Average |
|
|
Index Price |
|
|
Date |
|
Index Price |
|
|
Date |
|
End of period |
|
|
Last business day |
|
Twelve months ended March 31, 2019 |
|
$ |
300.20 |
|
|
$ |
808.02 |
|
|
5/5/2018 |
|
$ |
82.41 |
|
|
12/14/2018 |
|
$ |
141.00 |
|
|
$ |
140.75 |
|
Twelve months ended March 31, 2020 |
|
$ |
194.09 |
|
|
$ |
350.60 |
|
|
6/26/2019 |
|
$ |
109.83 |
|
|
3/16/2020 |
|
$ |
133.55 |
|
|
$ |
133.55 |
|
Twelve months ended March 31, 2021 |
|
$ |
641.22 |
|
|
$ |
1,987.17 |
|
|
2/20/2021 |
|
$ |
130.15 |
|
|
4/1/2020 |
|
$ |
1,900.34 |
|
|
$ |
1,900.34 |
|
Twelve months ended March 31, 2022 |
|
$ |
3,120.63 |
|
|
$ |
4,776.32 |
|
|
11/9/2021 |
|
$ |
1,784.40 |
|
|
6/26/2021 |
|
$ |
3,287.56 |
|
|
$ |
3,287.56 |
|
Twelve months ended March 31, 2023 |
|
$ |
1,655.28 |
|
|
$ |
3,492.35 |
|
|
4/4/2022 |
|
$ |
913.51 |
|
|
6/18/2022 |
|
$ |
1,829.14 |
|
|
$ |
1,829.14 |
|
April 1, 2018 to March 31, 2023 |
|
$ |
1,181.74 |
|
|
$ |
4,776.32 |
|
|
11/9/2021 |
|
$ |
82.41 |
|
|
12/14/2018 |
|
$ |
1,829.14 |
|
|
$ |
1,829.14 |
|
The following table illustrates the movements in the Digital Asset Market price of ETH, as reported on the Trust’s principal market, from April 1, 2018 to March 31, 2023. During such period, the price of ETH has ranged from $82.34 to $4,776.95, with the straight average being $1,181.78 through March 31, 2023.
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|
High |
|
Low |
|
|
|
|
|
|
Period |
|
Average |
|
|
Digital Asset Market Price |
|
|
Date |
|
Digital Asset Market Price |
|
|
Date |
|
End of period |
|
|
Last business day |
|
Twelve months ended March 31, 2019 |
|
$ |
300.21 |
|
|
$ |
806.00 |
|
|
5/5/2018 |
|
$ |
82.34 |
|
|
12/14/2018 |
|
$ |
141.00 |
|
|
$ |
140.71 |
|
Twelve months ended March 31, 2020 |
|
$ |
194.10 |
|
|
$ |
350.76 |
|
|
6/26/2019 |
|
$ |
110.29 |
|
|
3/16/2020 |
|
$ |
133.58 |
|
|
$ |
133.58 |
|
Twelve months ended March 31, 2021 |
|
$ |
641.25 |
|
|
$ |
1,987.10 |
|
|
2/20/2021 |
|
$ |
130.22 |
|
|
4/1/2020 |
|
$ |
1,899.98 |
|
|
$ |
1,899.98 |
|
Twelve months ended March 31, 2022 |
|
$ |
3,120.74 |
|
|
$ |
4,776.95 |
|
|
11/9/2021 |
|
$ |
1,785.68 |
|
|
6/26/2021 |
|
$ |
3,284.17 |
|
|
$ |
3,284.17 |
|
Twelve months ended March 31, 2023 |
|
$ |
1,655.32 |
|
|
$ |
3,493.00 |
|
|
4/4/2022 |
|
$ |
913.24 |
|
|
6/18/2022 |
|
$ |
1,828.98 |
|
|
$ |
1,828.98 |
|
April 1, 2018 to March 31, 2023 |
|
$ |
1,181.78 |
|
|
$ |
4,776.95 |
|
|
11/9/2021 |
|
$ |
82.34 |
|
|
12/14/2018 |
|
$ |
1,828.98 |
|
|
$ |
1,828.98 |
|
21
The following chart sets out the historical closing prices for the Shares as reported by OTCQX and the Trust’s Digital Asset Holdings per Share from June 24, 2019 to March 31, 2023.
ETHE Premium/(Discount): ETHE Share Price vs. Digital Asset Holdings per Share ($)
The following chart sets out the historical premium and discount for the Shares as reported by OTCQX and the Trust’s Digital Asset Holdings per Share from June 24, 2019 to March 31, 2023.
ETHE Premium/(Discount): ETHE Share Price vs. Digital Asset Holdings per Share (%)
22