Grayscale Ethereum Staking ETF 10-Q

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, 2023. 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 Ether and, from time to time on a periodic basis, issues Creation Baskets in exchange for deposits of Ether. As a passive investment vehicle, the Trust’s investment objective is for the value of the Shares (based on Ether per Share) to reflect the value of Ether 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 Ether, the Shares are designed to provide investors with a cost-effective and convenient way to gain investment exposure to Ether. To date, the Trust has not met its investment objective and the Shares quoted on OTCQX have not reflected the value of Ether 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 validators, as applicable, of Ethereum adopt the modification. When a modification is introduced and a substantial majority of users and validators consent to the modification, the change is implemented and the network remains uninterrupted. However, if less than a substantial majority of users and validators 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 would be the existence of two versions of Ethereum running in parallel, yet lacking interchangeability. Holders of Ether on the original Ethereum Network, at the time the block is validated and the fork occurs, can then also receive an identical amount of new tokens on the new network. Recent Developments The ETH Trust Distribution On April 23, 2024 the Sponsor announced the formation of Grayscale Ethereum Mini Trust (the “ETH Trust”) and its intention to effectuate the initial creation of shares of the ETH Trust through the contribution by the Trust of a certain amount of Ether to the ETH Trust as consideration and in exchange for newly created shares of the ETH Trust (“ETH Shares”). The ETH Trust has filed a registration statement on Form S-1 (Registration No. 333-278878) (as amended, the “ETH Trust Form S-1”) relating to the proposed issuance of baskets of ETH Shares to certain authorized participants on an ongoing basis, commencing following consummation of the ETH Trust Distribution (as defined below). Prior to effectiveness of the ETH Trust Form S-1, the ETH Trust will file a registration statement on Form 8-A (the “ETH Trust Form 8-A”) to register the ETH Shares under the Exchange Act, which is expected to become effective concurrently with the effectiveness of the ETH Trust Form S-1. Following the effectiveness of the ETH Trust Form S-1 and the ETH Trust Form 8-A, and approval of the ETH Trust 19b-4 Application (as defined below), the newly created ETH Shares will then be distributed to shareholders of the Trust as of a date to be determined by the Sponsor (the “Record Date”), pro rata based on a 1:1 ratio, such that for each one Share held by each shareholder on the Record Date, such shareholder will be entitled to receive one ETH Share on a subsequent date to be determined by the Sponsor (the “Distribution Date”) (such transactions collectively, the “ETH Trust Distribution”). In connection with the ETH Trust Distribution, the Sponsor anticipates that NYSE Arca will file an application with the SEC pursuant to Rule 19b-4 under the Exchange Act, to list the Shares of the ETH Trust on NYSE Arca (the “ETH Trust 19b-4 Application”). In addition, the ETH Trust intends to rely on an exemption or other relief from the SEC under 17 CFR §§ 242.101 and 102 (“Regulation M”) to operate its redemption program. As of the date of this filing, the ETH Trust 19b-4 Application has not been approved by the SEC and an exemption or other relief from Regulation M is not available for the ETH Trust. The Sponsor makes no representation as to when or if such approval will be obtained and when such an exemption or relief will be available. The ETH Trust will not seek effectiveness of its registration statement and no offering of ETH Shares will take place unless and until such approval is obtained and such an exemption or relief is available. As a result of the contemplated ETH Trust Distribution, following the Distribution Date, the Trust will hold a portion of the Ether that was held by the Trust as of the Record Date and the ETH Trust would hold the remaining portion of the Ether that was held by the Trust as of the Record Date, in each case, reduced by the portion of the sponsor’s fee attributable to such Ether accrued and paid between the Record Date and the Distribution Date. Neither the number of outstanding Shares nor the exposure of shareholders of the Trust to Ether underlying their aggregate shareholdings (including Shares and ETH Shares) are expected to change as a result of the contemplated ETH Trust Distribution. No consent, authorization, approval or proxy is being sought from shareholders in connection with the ETH Trust Distribution, and shareholders will not need to pay any consideration, exchange or surrender existing Shares or take any other action to receive ETH Shares on the Distribution Date. Following the ETH Trust Distribution, the Trust and the ETH Trust will operate as independent NYSE Arca listed exchanged-traded commodity products, and neither will have any share ownership, beneficial or otherwise, in the other. The Sponsor does not expect the ETH Trust Distribution to be a taxable event for the Trust or its shareholders. The Trust has filed a preliminary information statement on Schedule 14C (Registration No. 000-56193), describing the terms and conditions of the ETH Trust Distribution. For the avoidance of doubt, the Trust will not execute the ETH Trust Distribution as described herein or therein unless and until (i) NYSE Arca’s application with the SEC pursuant to Rule 19b-4 under the Exchange Act to list the Shares of the Trust on NYSE Arca has been approved, (ii) the ETH Trust 19b-4 Application has been approved and (iii) the ETH Trust Form S-1 and ETH Trust Form 8-A have become effective. There can be no assurance as to whether or when such approvals will be obtained or whether or when the ETH Trust Distribution will be effected. 14 Table of Contents Critical Accounting Policies and Estimates Investment Transactions and Revenue Recognition The Trust considers investment transactions to be the receipt of Ether for Share creations and the delivery of Ether for Share redemptions or for payment of expenses in Ether. 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 Ether. 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 in accordance with U.S. GAAP (“Principal Market 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 Ether 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 Ether 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 Ether in connection with a creation order from the Authorized Participant (or a 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, may transact in a Brokered Market, a Dealer Market, Principal-to-Principal Markets and Exchange Markets (referred to as “Trading Platform Markets” in this Quarterly Report), 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 Trading Platform 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 Ether 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, Trading Platform Markets have the greatest volume and level of activity for the asset. The Trust therefore looks to accessible Trading Platform 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, a Trading Platform 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 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. 15 Table of Contents The cost basis of Ether received in connection with a creation order is recorded by the Trust at the fair value of Ether 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 Ether 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, 2024 and 2023 (All amounts in the following table and the subsequent paragraphs, except Share, per Share, Ether and price of Ether amounts, are in thousands) Three Months Ended March 31, 2024 2023 Net realized and unrealized gain on investment in Ether $ 4,006,549 $ 1,902,063 Net increase in net assets resulting from operations $ 3,953,056 $ 1,872,425 Net assets (1) $ 10,711,110 $ 5,521,623 (1) Net assets in the above table and subsequent paragraphs are calculated in accordance with U.S. GAAP based on the Digital Asset Market price of Ether on the Digital Asset Trading Platform that the Trust considered its principal market, as of 4:00 p.m., New York time, on the valuation date. Net realized and unrealized gain on investment in Ether for the three months ended March 31, 2024 was $4,006,549, which includes a realized gain of $45,780 on the transfer of Ether to pay the Sponsor’s Fee and net change in unrealized appreciation on investment in Ether of $3,960,769. Net realized and unrealized gain on investment in Ether for the period was driven by Ether price appreciation from $2,281.10 per Ether as of December 31, 2023, to $3,637.95 per Ether as of March 31, 2024. Net increase in net assets resulting from operations was $3,953,056 for the three months ended March 31, 2024, which consisted of the net realized and unrealized gain on investment in Ether, less the Sponsor’s Fee of $53,493. Net assets increased to $10,711,110 at March 31, 2024, a 58% increase for the three-month period. The increase in net assets resulted from the aforementioned Ether price appreciation, partially offset by the withdrawal of approximately 18,359 Ether to pay the foregoing Sponsor’s Fee. Net realized and unrealized gain on investment in Ether for the three months ended March 31, 2023 was $1,902,063, which includes a realized gain of $21,794 on the transfer of Ether to pay the Sponsor’s Fee and net change in unrealized appreciation on investment in Ether of $1,880,269. Net realized and unrealized gain on investment in Ether for the period was driven by Ether price appreciation from $1,201.33 per Ether as of December 31, 2022, to $1,828.98 per Ether 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 Ether, 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 Ether price appreciation, partially offset by the withdrawal of approximately 18,668 Ether 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 Ether, 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 amount of Ether, Incidental Rights and/or IR Virtual Currency needed to pay expenses in order to minimize the Trust’s holdings of assets other than Ether. 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. 16 Table of Contents Selected Operating Data Three Months Ended March 31, 2024 2023 (All Ether balances are rounded to the nearest whole Ether) Ether: Opening balance 2,962,630 3,037,631 Creations —  —  Sponsor’s Fee, related party (18,359 ) (18,668 ) Closing balance 2,944,271 3,018,963 Accrued but unpaid Sponsor’s Fee, related party —  —  Net closing balance 2,944,271 3,018,963 Number of Shares: Opening balance 310,158,500 310,158,500 Creations —  —  Closing balance 310,158,500 310,158,500 As of March 31, 2024 2023 Price of Ether on principal market (1) $ 3,637.95 $ 1,828.98 Principal Market NAV per Share (2) $ 34.53 $ 17.80 Index Price (3) $ 3,637.90 $ 1,829.14 NAV per Share (3) $ 34.53 $ 17.80 (1) The Trust performed an assessment of the principal market at March 31, 2024 and 2023, and identified the principal market as Coinbase. (2) As of March 31, 2024 and 2023, the Principal Market NAV per Share was calculated using the fair value of Ether based on the price provided by Coinbase, the Digital Asset Trading Platform that the Trust considered its principal market, as of 4:00 p.m., New York time, on the valuation date. Prior to February 23, 2024, Principal Market NAV was referred to as NAV and Principal Market NAV per Share was referred to as NAV per Share. (3) The Trust’s NAV 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 NAV per Share is calculated using a non-GAAP methodology where the price is derived from multiple Digital Asset Trading Platforms. Prior to February 23, 2024, NAV was referred to as Digital Asset Holdings and NAV per Share was referred to as Digital Asset Holdings per Share. 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 Trading Platforms included in the Index as of March 31, 2024 were Coinbase, Kraken, LMAX Digital and Crypto.com. The Digital Asset Trading Platforms included in the Index as of March 31, 2023 were Coinbase, Kraken, LMAX Digital and Binance.US. See “Item 1. Business – Valuation of ETH and Determination of NAV” in the Trust’s Annual Report on Form 10-K for a description of the Trust’s NAV per Share. For accounting purposes, the Trust reflects creations and the Ether 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 amount of Ether 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 has not sought such relief as of the date of this Quarterly Report, and even if such relief is sought in the future, no assurance can be given as to the timing of such relief or that such relief will be granted. As of March 31, 2024, the Trust had a net closing balance with a value of $10,710,962,523, based on the Index Price (non-GAAP methodology). As of March 31, 2024, the Trust had a total market value of $10,711,109,737, based on the Digital Asset Market price of Ether on the Trust’s principal market (Coinbase). 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 Digital Asset Market price of Ether on the Trust’s principal market (Coinbase). Historical NAV and Ether Prices As movements in the price of Ether will directly affect the price of the Shares, investors should understand recent movements in the price of Ether. Investors, however, should also be aware that past movements in the Ether 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. 17 Table of Contents The following chart illustrates the movement in the Trust’s NAV per Share (as adjusted for the Share Split for periods prior to December 17, 2020) versus the Index Price and the Trust’s Principal Market NAV per Share (as adjusted for the Share Split for periods prior to December 17, 2020) from December 14, 2017 to March 31, 2024. For more information on the determination of the Trust’s NAV, 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. 18 Table of Contents The following table illustrates the movements in the Index Price from April 1, 2019 to March 31, 2024. During such period, the Index Price has ranged from $109.83 to $4,776.32, with the straight average being $1,546.49 through March 31, 2024. The Sponsor has not observed a material difference between the Index Price and average prices from the constituent Digital Asset Trading Platforms individually or as a group. High Low Period Average Index Price Date Index Price Date End of period Last business day 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 Twelve months ended March 31, 2024 $ 2,123.36 $ 4,033.10 3/11/2024 $ 1,531.25 10/12/2023 $ 3,637.90 $ 3,566.13 April 1, 2019 to March 31, 2024 $ 1,546.49 $ 4,776.32 11/9/2021 $ 109.83 3/16/2020 $ 3,637.90 $ 3,566.13 The following table illustrates the movements in the Digital Asset Market price of Ether, as reported on the Trust’s principal market, from April 1, 2019 to March 31, 2024. During such period, the price of Ether has ranged from $110.29 to $4,776.95, with the straight average being $1,546.52 through March 31, 2024. 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, 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 Twelve months ended March 31, 2024 $ 2,123.33 $ 4,033.86 3/11/2024 $ 1,530.88 10/12/2023 $ 3,637.95 $ 3,564.53 April 1, 2019 to March 31, 2024 $ 1,546.52 $ 4,776.95 11/9/2021 $ 110.29 3/16/2020 $ 3,637.95 $ 3,564.53 The following chart sets out the historical closing prices for the Shares as reported by OTCQX and the Trust’s NAV per Share from June 20, 2019 to March 31, 2024. 19 Table of Contents ETHE Premium/(Discount): ETHE Share Price vs. NAV per Share (Non-GAAP) ($) The following chart sets out the historical premium and discount for the Shares as reported by OTCQX and the Trust’s NAV per Share from June 20, 2019 to March 31, 2024. ETHE Premium/(Discount): ETHE Share Price vs. NAV per Share (Non-GAAP) (%)