How do Ethereum ETFs work?
If you’ve ever wanted to invest in Ethereum without worrying about weak security or forgetting the password to your digital wallet, then an Ethereum ETF (EETH) may be useful for you.
Ethereum ETFs can be bought and sold just like shares that trade on exchange. All you have to do is open your brokerage account, and you can buy them seamlessly; as if they were your favourite stock.
Ethereum ETFs are 100% backed by ether (the native currency to the Ethereum blockchain). This means that Ethereum ETFs own real deal ether. They do not hold any derivatives. They just hold ether, which is fully owned by the fund on behalf of investors.
In this respect, Ethereum ETFs can be thought of like gold ETFs. Gold ETFs hold physical gold bars in bank vaults on behalf of investors. If you own the ETF, you own the gold. Ethereum ETFs work in a similar way.
Where is the ether custodied?
Ethereum ETFs will hold ether safely in the vaults of a large cryptocurrency custodian. These custodians will usually be regulated by national government bodies, such as the Securities Exchange Commission in the United States.
At these custodians, ether is stored in what is called “cold storage”. This is where a custodian, such as Coinbase, holds ether in a wallet that is disconnected from the internet. The wallets only go online when the Ethereum ETF is buying or selling ether. Even then, it is only for very short periods of time.
As an additional measure, the private keys to the Ethereum wallets are “sharded”. This involves splitting a key into parts and storing it in different locations around the world.
Moving ether in and out of these wallets requires multiple signatures from different people. This can involve intense security measures, such as facial recognition. It also always requires approval from two or more people. These two people must work for different organisations.
Are there any risks?
Cryptocurrency vaults are very safe places. Coinbase’s vault, for example, have military-grade security and in some instances are based on former military bases. Often, the digital wallets used by ETFs can be held in faraday cages, which block the flow of outside sources of electricity.
Nothing is perfect though. Just like money in your bank account always runs the risk of being stolen, so does cryptocurrency held in vaults. However, Ethereum ETFs take every measure to keep ether safe.
To our knowledge, there have been no examples of cryptocurrencies held by ETFs being hacked or stolen anywhere around the world as of December 2021. Examples of cryptocurrency getting hacked historically have almost always occurred on unregulated venues that do not have adequate risk controls. These exchanges also do not use cold storage.