Ethereum Classic Trust (ETCG): 5 Months After ‘The Merge’

As we’ve now entered March 2023, we are just under 6 months passed since Ethereum’s (ETH-USD) merge from proof of work to proof of stake. This was a pretty remarkable technological achievement for the Ethereum developers but it wasn’t without some element of controversy from a small subsect of the Ethereum community: the miners.

Ethereum Merge Impact

To briefly explain for those who didn’t follow it closely, Ethereum was one of the few proof-of-work blockchains that could be profitably mined with GPU computers rather than the ASIC machines required by blockchains like Bitcoin (BTC-USD). The impact of moving from PoW to PoS meant many of the Ethereum miners had to quickly find a new way to monetize their GPU machines. This directly impacted public miners like Hut 8 Mining (HUT) and HIVE Blockchain (HIVE) as they had been using GPUs in their mining fleet.

There is some thinking in the crypto community, of which I’m in agreement, that those GPU machines can instead be repurposed for different Web3 activities rather than for transaction processing. Additionally, there was a very small push to develop an entirely new proof-of-work blockchain called Ethereum PoW (ETHW-USD). That chain has failed to attract much attention. There has also been some thinking about the viability of Ethereum Classic (ETC-USD) as it is also a PoW smart contract chain like Ethereum.

Ethereum Classic Activity

Speculation that there would be at least some miner migration from Ethereum to Ethereum Classic following the merge turned out to be true. More miners competing for the ETC block reward is usually a good thing for a blockchain from a fundamental perspective if it leads to diversification of the chain’s transaction validation. When this happens, it generally means the network is more secure and more difficult for an attacker to exploit.

You can see in the chart above, the mean hash rate for Ethereum Classic surged right after Ethereum’s merge last September. While a good portion of that hash rate has declined, it is still well above where it was before the merge happened. This is theoretically a good thing for Ethereum Classic’s network, but it isn’t necessarily a good thing for ETC holders.

This chart shows that there hasn’t been much economic activity happening on Ethereum Classic since the merge as ETC transactions have been steadily declining since September. This is not the case for Ethereum, which is flat, or Bitcoin, which has seen an increase in daily transactions going back to September.

Without additional economic activity happening on the Ethereum Classic blockchain, the ETC block reward doesn’t have as much outside demand, which theoretically puts downward pressure on the coin’s price if miners need to sell the ETC they mine to pay for operations. Given the lack of meaningful network usage coupled with the surge in mean hash rate, ETC miners have seen profitability fall by about 70% since the merge.

Grayscale’s Ethereum Classic Trust

All of this is particularly bad for Grayscale’s Ethereum Classic Trust (ETCG) because the trust has such a large portion of the total ETC outstanding. According to the form 10-K that Grayscale just released for the trust, the company owns 8.5% of the ETC in circulation:

As of December 31, 2022, the largest 100 ETC wallets held approximately 74.2% of the ETC in circulation, and as of December 31, 2022, the Trust holds approximately 8.5% of the ETC in circulation. Moreover, it is possible that other persons or entities control multiple wallets that collectively hold a significant number of ETC, even if they individually only hold a small amount, and it is possible that some of these wallets are controlled by the same person or entity. As a result of this concentration of ownership, large sales or distributions by such holders could have an adverse effect on the market price of ETC.

I should also note that Grayscale’s disclosure that 74.2% of the circulating coins held by the top 100 addresses is a really high level of concentration for a proof-of-work coin. Especially for a coin with such a higher market cap:

Cryptocurrency	Top 100 concentration
Bitcoin	14.9%
Bitcoin Cash (BCH-USD)	34.0%
Litecoin (LTC-USD)	43.5%
Dogecoin (DOGE-USD)	67.4%

Click to enlarge

Source: BitInfoCharts

Even if Grayscale were to liquidate the trust and sell the ETC, the coin would still suffer from a very high level of owner concentration. Likely as a response to ETCG holders owning such an immense amount of the ETC in existence, the pressure on ETCG shares has been noticeably extreme, and we can see that manifesting through a NAV discount that remains at very depressed levels:

Even after bouncing off the floor of 77% in late December, ETCG is still trading at a 63% discount to net asset value as of Wednesday’s close – which is the largest discount of any Grayscale fund.

Summary

ETCG is arguably one of the biggest contrarian bets in all of the public crypto-related tickers. Due to the lack of real user demand for the network or the ETC coin in general, I think a long bet on ETCG at this point is a bet that Grayscale will dissolve the trust and be able to distribute the proceeds from the coin sales for a larger value than where the fund shares are currently trading. That’s not an impossible outcome, but it’s a bet that I’m personally not willing to make at this time.

If network demand for the coin was robust, I’d see a 63% discount as a slam-dunk arbitrage. We just don’t have that opportunity in Ethereum Classic. I’m sympathetic to the “coin is law” mantra of the ETC community, and I think it would be great if there was more development happening on that chain. Despite the discount, I still can’t get terribly interested in ETCG unless something changes dramatically in Ethereum’s Classic activity. I’m not sure that’s likely at this point but anything is possible.

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