Original author: GSR
Original translation: Wu Talks about Blockchain
Solana has solidified its position as one of the Big Three in crypto. With the other two already or about to launch spot ETFs, it is likely that Solana will also launch a spot ETF in the near future, and its impact on SOL may be the biggest yet.
Note: GSR holds SOL.
Solana — Synchronizing the World at the Speed of Light
Founded by Anatoly Yakovenko and Raj Gokal in 2018 and launched in 2020, Solana is a delegated proof-of-stake blockchain designed for high performance and mass adoption. With extremely low transaction costs, a wide range of decentralized applications, and an active user and developer community, Solana has accumulated nearly 300 billion transactions and over $4 billion in total locked value. In addition, Solana continues to stand out among many projects, with recent highlights including a large number of high-profile token launches, various projects migrating to Solana, the release of key innovations such as token expansion, and use cases unique to Solana such as order books, batched NFTs, DePINs, memecoins, etc.
The foundation of Solana’s success is its superior technology, which we believe provides sustainable competitive advantages in three particularly notable areas. The first is Solana’s proof-of-history, which provides validators with a notion of time. Similar to how mobile towers alternate transmissions to avoid interference, proof-of-history enables validators to generate blocks when it is their turn, without the network having to reach consensus on the current block first, resulting in huge speed and scalability advantages. Second, unlike the single-threaded virtual machines that underlie the current cryptocurrency space, Solana supports parallel transaction processing, which not only greatly increases throughput, but also takes advantage of the main source of computing speed improvements, with most performance improvements today coming from adding more cores rather than increasing the performance of each core. Finally, while Solana’s historically high hardware and bandwidth requirements have sacrificed decentralization to optimize for speed and security to some extent, as costs fall (Moore’s Law), Solana will naturally benefit, perhaps becoming the first project to truly solve the blockchain trilemma and ultimately realize its vision of synchronizing the global state at the speed of light.
Undervalued Cryptocurrency ETFs Have Further Potential for Growth
As Solana establishes its place behind Bitcoin and Ethereum, and both Bitcoin and Ethereum have (or are about to) launch US spot ETFs, the natural question is - will Solana be next? This question is particularly important in the current cycle when spot ETFs are the main driver of price.
In short, under the current framework, the path to launching a spot digital asset ETF in the U.S. is clear, there needs to be a federally regulated futures market (currently there is none other than Bitcoin and Ethereum), the futures market needs to exist for many years to demonstrate sufficient relevance, and the futures ETF needs to be approved before a spot product can be considered. In other words, there will be no additional spot digital asset ETFs in the near term. However, we believe this severely underestimates the likelihood of change.
In fact, change is already underway, with Donald Trump’s recent support for the crypto industry causing the Democratic Party to relax its stance on digital assets in a tense election year. While unimaginable a month ago, we have seen both houses of Congress pass a bipartisan measure to overturn the controversial SEC cryptocurrency accounting policy (SAB 121), as well as the House of Representatives passing a comprehensive digital asset regulatory framework (FIT 21). While the current legislative and regulatory structure is unlikely to adopt rules that would allow the launch of various spot digital asset ETFs, the Trump administration and liberal SEC commissioners may be able to achieve this goal, especially through the Digital Asset Market Structure Act that defines securities and commodities. Not only is this possible, but it may even become a reality.
Key Determinants of the Next Spot ETF
Under more relaxed laws and regulations, we believe the two key factors that determine the next spot ETF are decentralization and potential demand. In terms of the former, whether FIT 21 bypasses the Howey test by creating a new digital asset class with a key decentralization test, or the SECs suggestion of sufficient decentralization may affect securities classification, the degree of decentralization may be the key to whether a digital asset can get an ETF. In terms of the latter, the potential demand for any new ETF is equally important as it will be the largest factor affecting profitability. Here, issuers may weigh reputational risks, ability to pass various internal committees, and the best interests of their customers while considering potential demand. Overall, while crypto-native issuers may apply for a large number of spot ETFs, we believe larger issuers are more likely to focus on one or two digital assets with sufficient decentralization and high potential demand.
Next, we provide a brief analysis that attempts to quantitatively determine the decentralization score and demand score, and sum them to form the ETF likelihood score. Note that we convert the various category indicators to Z scores to facilitate combining categories, and then take a simple average of the Z scores for each category to calculate the final decentralization and demand scores. Finally, note that many of the indicators used have flaws and a certain degree of subjectivity, but we believe that these indicators are still useful for the current task.
Decentralized Analysis
Analyzing the degree of decentralization of a blockchain is difficult because there is no universally accepted definition, many metrics are less than ideal, and the topic is generally highly complex, technical, and even philosophical. In addition, decentralization encompasses many concepts, such as permissionless participation, development control, key person influence, token allocation/distribution, share characteristics, and software and hardware diversity. Finally, note that most public chains gradually become more decentralized over time, which is evident in the following groups, such as Cardano’s upcoming Voltaire era, which will substantially decentralize governance, or Solana’s upcoming Firedancer client, which will make Solana the only network besides Bitcoin and Ethereum to have a second independent client on the mainnet. In summary, we believe that some of the more sound and reference-worthy decentralization indicators are:
The Nakamoto coefficient measures the minimum number of independent entities that could collude to attack the network, with higher values indicating greater decentralization.
Staking requirements, which measure how easy it is for anyone to participate in the network as a node operator or validator, including minimum staking requirements and hardware requirements. Less staking and lighter hardware contribute to higher decentralization.
CCData Governance Rating, which includes various governance measures such as participation, transparency, and decentralization.
As shown below, the four blockchains with above-average decentralization scores are Ethereum, Solana, Avalanche, and Aptos.
demand analysis
Potential demand is another key determinant, and issuers may look at a variety of metrics when assessing future capital inflows. The most important of these is token market capitalization, but in general, we believe the following three categories are particularly valuable:
Market indicators: higher market capitalization, higher trading volume, and strong token performance may indicate strong future demand.
Total assets under management (AUM) of existing products. High AUM of tokens in existing investment products globally indicates that demand for spot ETF products may also be high.
Activity indicators: A strong, active community and widespread usage can also be strong signals of future demand.
As shown in the figure below, the top three blockchains with above-average demand scores are Ethereum, Solana, and NEAR.
Our Decentralization Score and Demand Score are added together to arrive at the final ETF Likelihood Score. Note that we weighted Decentralization at 33% and Demand at 67% as we believe decentralization may be a threshold factor, while latent demand may be the primary criteria used by issuers. Overall, Ethereum took first place by a wide margin, having received approval for a key spot ETH ETF 19 b-4 filing in May and with multiple spot ETFs expected to launch this summer. Next up is Solana, which also outperformed the other digital assets by a wide margin, being the only one other than Ethereum to have positive scores on both Decentralization and Demand. In third place is NEAR, which performed well in both categories. Overall, the results clearly indicate that if additional spot digital asset ETFs are allowed in the U.S., Solana will be next.
Impact of a potential spot Solana ETF on price
To assess the impact of a potential spot Solana ETF on the price of SOL, we can simply refer to the impact of a spot Bitcoin ETF on Bitcoin. After all, the approval of a spot Bitcoin ETF and the subsequent huge inflows were the main factors that pushed Bitcoin from $27,000 in October when market participants began to believe that US spot ETF approval was a real possibility to about $63,000 now, a 2.3x increase. This 2.3x will be our baseline.
Next, we need to adjust our analysis to account for the significantly smaller inflows into the spot Solana ETF relative to Bitcoin. Ultimately, we adjust by estimating the inflows into the spot Solana ETF relative to Bitcoin. Here, we consider three simple scenarios.
Pessimistic scenario: Solana Global Investment Products AUM is 2% of Bitcoin. We believe this underestimates potential Solana ETF inflows as this metric gives Bitcoin a large head start, with Grayscale Bitcoin Trust launching in 2013 and Solana not launching until 2020. Therefore, we use 2% as the pessimistic scenario inflows.
Baseline Scenario: We evaluate Solana’s performance with reference to actual near-term inflows. Here, we use inflow data from 2021 to 2023, as Solana was not well-known before 2021, and data until 2024 to exclude the impact of the spot Bitcoin ETF (launched in January). Over these three years, inflows into Solana’s investment products were 5% relative to Bitcoin’s cumulative inflows. We consider this 5% as the baseline scenario.
Optimistic Scenario: Solana has seen higher relative inflows over the past two years, accounting for 31% and 9% of Bitcoin’s inflows in 2022 and 2023, respectively. While we do not expect Solana to fully match Bitcoin’s periods of exceptionally high inflows in 2021 and 2024, we view a three-year average of 14% relative inflows per year as a potential optimistic scenario.
While the spot Solana ETF could see inflows of 2%, 5%, or 14% of Bitcoin in the pessimistic, baseline, and optimistic scenarios, respectively, we must now adjust the spot ETF’s impact on SOL for its smaller size, which will be adjusted by market capitalization. Specifically, Solana’s market cap has averaged just 4% of Bitcoin’s over the past year.
Taking all factors into account, we can adjust our relative inflow estimates based on Solana’s 2.3x growth relative to Bitcoin under different scenarios. This results in Solana potentially growing 1.4x in the pessimistic scenario, 3.4x in the baseline scenario, and 8.9x in the optimistic scenario. Furthermore, there are reasons to believe the impact could be higher than these estimates, as SOL is actively used in staking and decentralized applications, unlike Bitcoin, and the relationship between relative inflows and relative size may not be linear. Finally, it is important to note that a potential Solana spot ETF may be much less reflected in the price of SOL than Bitcoin was at the beginning of our analysis, as can be inferred from the deviation of Grayscale Trust relative to net asset value. If this inference is correct, the huge potential upside for SOL with a spot ETF can be considered a “free option”. In summary, if more spot digital asset ETFs are allowed in the United States, then Solana will be ready for a spot ETF, and the price impact may be by far the largest.
The Grayscale Trust’s price could deviate from its underlying net asset value (NAV) due to the lack of a real-time creation and redemption mechanism, but this deviation would disappear when the Trust converts to a spot ETF, which has such a mechanism. Grayscale Bitcoin Trust (GBTC) was trading at a 45% discount to NAV on January 1, 2023 (before BlackRock filed for a spot Bitcoin ETF on June 15, 2023, and Grayscale won its lawsuit against the SEC on August 31), but this discount was reduced to 21% by early October, suggesting that the price of Bitcoin may have already factored in the increased opportunity for a spot Bitcoin ETF by the time we begin measuring price impact.
