How to read an Ethereum ETF prospectus? (Due diligence)

Understanding the Fund Structure

1. The prospectus outlines whether the ETF holds spot Ethereum directly or uses futures contracts to gain exposure. Spot-based ETFs require custodial arrangements with regulated digital asset custodians, while futures-based ETFs roll monthly contracts and may suffer from contango effects.

2. It specifies the fund’s legal domicile—U.S.-listed Ethereum ETFs are typically structured as 1940 Act funds, subject to SEC oversight, whereas offshore alternatives may follow different regulatory frameworks with less transparency.

3. The document details the fund’s share class structure, including whether institutional shares, retail shares, or fee-tiered classes exist, each carrying distinct expense ratios and minimum investment thresholds.

4. Governance provisions reveal how decisions about custody changes, asset freezes, or emergency redemptions are made—particularly relevant during network forks or consensus failures on the Ethereum blockchain.

Analyzing Custody and Security Arrangements

1. The prospectus names the designated custodian and describes its licensing status—for example, whether it is a state-chartered trust company, an SEC-registered broker-dealer, or a federally insured depository institution.

2. It discloses whether Ethereum holdings are stored in cold wallets, multi-signature environments, or insurance-backed vaults—and explicitly states whether losses from hacks or private key compromise are borne by shareholders or absorbed by the custodian.

3. Third-party attestations from cybersecurity auditors like NCC Group or Trail of Bits are referenced if included, along with frequency of penetration testing and hardware security module (HSM) certifications used for key management.

4. The document clarifies whether staked ETH is held on-chain via validator nodes or pooled through institutional staking providers—and how rewards, slashing penalties, and withdrawal queue delays are reflected in net asset value calculations.

Evaluating Expense Ratios and Fee Mechanics

1. The gross expense ratio appears prominently, but the prospectus also breaks down ancillary costs: custody fees, staking reward rebates, futures roll costs, and SEC filing fees that may be passed through to investors.

2. Some funds charge performance fees above a benchmark return threshold; these are detailed in the “Management Fees” section alongside clawback provisions and calculation methodology.

3. In-kind creation/redemption mechanics are described—including whether authorized participants must deliver ETH or cash, and how premium/discount arbitrage impacts intraday liquidity and tracking error.

4. Tax-related expenses are itemized separately, especially those arising from frequent staking distributions or forced sales due to redemption pressure, which can trigger capital gains distributions to all shareholders.

Reviewing Risk Disclosures

1. The prospectus lists Ethereum-specific risks such as protocol-level vulnerabilities, failed upgrades (e.g., Shanghai, Cancun), or prolonged finality delays affecting validator uptime and staking yield reliability.

2. It highlights counterparty risk tied to derivatives clearinghouses like CME Clearing when futures-based exposure is used—and explains margin requirements, default waterfalls, and cross-default clauses.

3. Regulatory uncertainty is addressed directly: references to ongoing enforcement actions against crypto exchanges, potential reclassification of ETH as a security by U.S. authorities, and jurisdictional conflicts between CFTC and SEC mandates appear verbatim.

4. Market structure risks include low order book depth on secondary markets, exchange delistings, and concentration among top Ethereum miners or staking pools exceeding 33% consensus control.

Frequently Asked Questions

Q: Does the prospectus indicate whether the ETF allows direct redemption in ETH?Most U.S. Ethereum ETFs restrict redemptions to authorized participants only and require delivery of ETH—not cash—to create or redeem shares. Retail investors cannot transact directly with the fund’s portfolio.

Q: How does the prospectus treat Ethereum’s transition to proof-of-stake?The document confirms whether staking rewards are automatically reinvested, distributed as dividends, or retained to offset operational expenses—and defines how slashed ETH is accounted for in NAV computation.

Q: Are smart contract exploits covered under the fund’s insurance policy?The prospectus explicitly states whether coverage extends to vulnerabilities in staking smart contracts deployed on Ethereum mainnet—or whether only custodial infrastructure is insured.

Q: What happens if Ethereum undergoes a contentious hard fork?The prospectus designates which chain the fund will recognize as authoritative—typically the one supported by the majority of hash rate or staked ETH—and describes valuation protocols for any fork tokens received.