Description

Introduction: Ether Capital is a firm that invests in projects related to the Ethereum blockchain and the Web3 ecosystem. However, for all practical purposes, it has evolved into a company that simply owns and stakes Ether (ETH), the token that powers Ethereum. Ether Capital trades on the NEO Exchange in Canada under the symbol ETHC. It also trades OTC in the U.S. under the symbol DTSRF. The company’s website can be found here: https://www.ethcap.co/

Note: All values in this report are in Canadian dollars (unless otherwise stated). 

Summary

Toronto-based Ether Capital has no debt, plenty of cash to cover its minimal expenses, a sizable investment in a private company (potentially worth more than half its market cap), and is profitable on an operating basis, but at C$2.10/share, it trades at a 20% discount to the value of its ETH holdings of about C$2.60/share. More importantly, Ether Capital is poised to benefit from the upcoming ETH 2.0 transition as it is heavily involved in staking ETH and staking rewards are likely to rise. Therefore, I think Ether Capital will trade at a premium to the value of its ETH holdings when the ETH 2.0 transition is complete (if not before). I do not offer a traditional target price because I cannot predict the value of ETH, but I think Ether Capital should be trading at C$3+ today.

Ethereum Risk

Ether Capital is almost totally exposed to Ethereum. If Ethereum is hacked, the ETH 2.0 transition fails, the price of ETH crashes, or something else bad happens, then Ether Capital is doomed. Of course, anybody who owns ETH directly has the same risks. Ether Capital’s stock price has dropped from over C$5/share in November 2021 as the price of ETH has fallen from its all-time high levels. This investment idea is directed at investors who are looking for a cheap and easy way to benefit from rising ETH prices and ETH staking. 

Very Brief Discussion of Ethereum and Staking

I am not going to go into detail here since I am a finance person, not an expert on cryptocurrencies. There are many places to find information on Ethereum and the transition to Ethereum 2.0, including on Ether Capital’s website. Here is the view of Ether Capital’s management on Ethereum from one of its filings:

“Management of Ether Capital believes that Ethereum has already become the dominant ecosystem and go-to platform for blockchain application development and that the Ethereum platform is poised for significant future growth as it scales and additional applications and programs are created. Ether Capital believes that its deployment of funds into Ether and other Ethereum and Web 3 ecosystem investments differentiates the Company as a key industry participant with substantial holdings in the sector.”

Ethereum is significantly different than Bitcoin. While Bitcoin was designed to be a digital currency, the Ethereum blockchain validates and executes what are called “smart contracts”, agreements between two parties without an intermediary. ETH is the token used to pay for these programs to run on the Ethereum network. In this way, ETH, unlike Bitcoin, may rise in value as more applications are run on Ethereum. There are large numbers of programmers building applications for Ethereum, such as decentralized finance applications and NFTs (non-fungible tokens). 

Ethereum, like Bitcoin, presently validates transactions using the “proof-of-work” protocol. Basically, validators (“miners”) get rewards for using computer power to solve complex math problems to validate transactions. There are many people who consider proof-of-work to be the strongest way to validate transactions, but it has flaws. As originally designed, neither Bitcoin nor Ethereum can process transactions fast enough or cheaply enough to be viable for many purposes. Moreover, there is a high and wasteful cost in energy and equipment as powerful computers all over the world are competing to solve the same puzzles. Due to these and other issues, the programmers behind Ethereum are transitioning to a new blockchain that will use a validation protocol called “proof-of-stake”. Under proof of stake, validators will essentially put their ETH up as collateral, allowing them to collect fees but also risking the possibility that ETH will be taken from them (“slashed”) if they fail to validate transactions properly. 

The transition from proof-of-work to proof-of-stake will be done by joining the current active blockchain with a parallel one, called the beacon chain, that launched on December 1, 2020. The joining of the two Ethereum blockchains is known as the “merge”. The beacon change is currently undergoing development and testing. According to the programmers, the merge will be done without disruption to the Ethereum network. The merge has been long delayed as various tests are run to make certain that there are no problems and that the blockchain cannot be hacked. The delays are part of the reason why the ETH price has been weak. However, the programmers report that most of the work is now complete, and it is currently believed that the merge will take place sometime between September and November of this year. After the merge, Ethereum transactions should be much faster and cheaper, and the ecosystem should use much less energy. It is far more important that the merge is done properly rather than quickly.

Another big change has already happened. Unlike Bitcoin, Ethereum was not originally designed with a built-in limit on the amount of ETH that can be issued. However, last year, a change was made such that part of the fees (called “gas”) are destroyed (“burned”) in every transaction. Thus far, about 2.5 million ETH has been burned, but the total amount of ETH (currently about 120 million) continues to rise due to the mining rewards. After the merge, however, the total amount of ETH is expected to decline over time because the amount of ETH burned should exceed the rewards. Thus, ETH is expected to change from inflationary to deflationary.

Although the merge has not yet happened, it is already possible to stake ETH and collect rewards on the beacon (Ethereum 2.0) chain. The current annual staking reward for a validator is about 4.5%. After the merge, it is expected that the staking rewards will increase because both the transaction fees and validation awards (currently going to the miners) will flow to the people who have staked ETH. Nobody knows the exact yield because it is based on network use and the amount of ETH staked, but the consensus is that the annual staking yield will rise to 8%-10%.

At present, staked ETH and staking rewards cannot be moved from the beacon chain. Thus, staked ETH is illiquid. For this reason, Ether Capital has played it safe and not yet staked 100% of its ETH. However, post-merge, ETH will be available to stake and un-stake without a problem. I think this greater liquidity will change the ETH market considerably and drive prices of ETH higher as the supply/demand dynamic will completely change. Post-merge, holders will be incentivized to stake their ETH because the staking yield will be higher, the risk that the merge will be delayed or fail will be eliminated, and the staked ETH will be liquid. In other words, it will be considerably safer and more profitable to stake ETH after the merge than it is today. It follows, therefore, that the demand for ETH will rise as investors buy ETH solely to stake it and the supply of ETH in circulation will decline as more ETH is staked. Moreover, the burning of ETH will be a bigger factor.

More importantly, however, the Ethereum network should be more attractive to investors and people using ETH for decentralized finance, NFTs, and other projects. This is, of course, why the changes in Ethereum are happening! The merge is not just a way to make money. It is designed to make Ethereum more useful. If activity on the Ethereum network increases, then the total amount of transaction fees that can be paid to people who have staked ETH will rise. Even now (before the merge), Ethereum is on a run rate to generate about $7 billion in annual transaction fees.

Okay, so that is some of the basics on Ethereum. What is Ether Capital?

Background on Ether Capital

The predecessor company of Ether Capital was founded in 2009. In 2015, it acquired a company offering an app for managing cellphone fees (or something) called Movit Media. In 2018, after a series of transactions, Movit disappeared, and the company became Ether Capital. It raised C$45 million in an offering, using most of the proceeds to buy 42,588 ETH at an average price of US$686.83, roughly 50% of the current price. In 2019, Ether Capital raised an additional $1.1 million in a small offering.

Ether Capital staked ETH for the first time on the beacon blockchain in December 2020 by staking the minimum allowed amount of 32 ETH. Intending to stake more, in March 2021, it raised C$28.75 million (gross) in unit offering at a price of $3.35/unit. Each unit consisted of one share and a warrant to purchase ½ share at an exercise price of C$4.00. The warrants expire in March 2023 and trade in limited volume on the NEO Exchange. After completing this deal, Ether Capital purchased an additional 11,264 ETH at an average price of US$1,741. In January 2022, the company purchased another 578 ETH at an average price of US$3,910.

After some delays for regulatory reasons, Ether Capital staked 10,240 ETH in December 2021 and then staked additional 10,240 ETH in February 2022. After these transactions and earned staking rewards, Ether Capital now has about 21K staked ETH. It still owns 23,550 ETH which has not been staked; the company intends to stake around 10,000 more ETH this year, probably when there is more visibility on the timing of the merge in the fall.

In its short history, Ether Capital has made a few small investments outside of owning and staking ETH. However, the company’s management has decided that holding and staking ETH is its best investment opportunity at present, so the other investments have either already been closed or will be closed soon. The most significant non-ETH investment is in a company called Wyre, which will be discussed later.

Assets

Ether Capital currently holds about 44,550 combined ETH and staked ETH, which would be valued at C$89.1 million at the current price of about C$2,000 if the price of staked ETH is assumed to be the same as ETH. There is currently no market for staked ETH and it cannot be sold, but this will change after the merge is complete.

Ether holdings:

(in C$)

There are (fully-diluted) 33.8 million shares outstanding, so Ether Capital has about C$2.63/share in ETH and staked ETH. The company’s stock price recently closed at C$2.10, a discount of about 20% to the value of its ETH alone. Moreover, as of the end of Q1 2022, Ether Capital has C$5.6 million in cash and other liquid assets (C$0.16/share) and a material investment in Wyre (discussed later). The company would face a tax bill if it realized capital gains by selling its ETH, but it has no plans to do so in the foreseeable future as staking its ETH to generate more ETH is its main priority. The managers of Ether Capital are true believers that the value of ETH will be much higher in the future and have no interest in selling their ETH.

Difference between ETHC’s stock price and the value of its ETH:

(in C$)

Ether Capital’s current net annual staking yield is about 4.5%. At present, the company earns close to 2.5 ETH/day, or about C$5,000, from staking. Thus, at the current yield and ETH price, the company would earn about C$1.83 million, or C$0.055/share, per year on its staked ETH. Holding the yield constant, its staking rewards will rise by about 50% if it stakes another 10,000 ETH this year as intended.

However, all these numbers are constantly changing. The price of ETH changes by the second, the staking yield can change, and the amount of staked ETH rises slightly each day due to rewards. The ETH 2.0 transition was designed so that the staking rewards decline as more ETH is staked. Thus, the staking reward has been reduced a couple of times over the last few months. However, as explained above, it is widely believed the staking reward will rise after the merge. Using an 8% staking yield and assuming 31,000 staked ETH (its current amount plus an additional 10,000), Ether Capital’s staking awards would rise to a rate of about 2,500 ETH/year, or about C$5 million at the current price. 

Clearly, though, the current price will not hold for long. As everyone surely knows, the price of ETH and other cryptocurrencies has fallen significantly this year. If the ETH price declines, the value of Ether Capital’s assets will decline, taking the stock price down with it. However, ETH prices can also rise rapidly. As explained above, I think this is likely to happen if the merge is successful. I am not going to try to forecast the price of ETH, but appreciation in the price of ETH would surely increase the value of Ether Capital’s assets. If, for example, that ETH returns to its November 2021 high of about C$5,800, the value of Ether Capital’s ETH would be about C$258 million, or C$7.64/share. 

Ether Capital has a Twitter account @ethcapbotfolio that is updated once per day that shows the value of its ETH and ETH staking rewards for the previous 24 hours.

Consulting Fees

Apart from its staking awards, ETH collects consulting fees from a Canadian ETF issuer called Purpose Investments. Unlike in the U.S., Canadian authorities have allowed the listing of ETFs that directly hold cryptocurrencies. Purpose was the first to issue these in February 2021, and now offers five crypto-related funds. As Ether Capital CEO Brian Mosoff and other staff advise Purpose on creating and managing the crypto-related funds, Ether Capital gets a cut of the management fees that Purpose collects. Separately, Purpose does some tax and other accounting work for Ether Capital. The link between the two companies is Som Seif, who is both the CEO of Purpose and the executive chairman and co-chief investment officer of Ether Capital. So, clearly, these are blatant related party transactions, but they are beneficial to Ether Capital. In Q1 2022, the company collected C$450K in consulting fees and paid $10,500 to Purpose for the administrative work. 

Clearly, Ether Capital’s consulting fees are highly correlated with the price of ETH. If crypto prices rise, then the AUM of Purpose’s ETFs will probably also rise, generating higher fees. Conversely, if crypto prices fall (or if the Purpose ETFs lose market share), then AUM will decline, and the consulting fees paid to Ether Capital may disappear. For now, the consulting fees that Ether Capital collects from Purpose allow it cover most of its operating expenses (salaries, mainly), meaning that it does not need to sell ETH or raise capital to cover its costs.

Wyre Deal

Apart from its ownership of ETH, Ether Capital has made some investments in crypto and Web3 projects. However, as the current plan is to focus solely on ETH staking, it has either exited these investments or will eventually do so. In Q1 2022, it sold all the Uniswap and MKR tokens that it owned for C$5.8 million, realizing a gain of C$4.55 million. After these dispositions, its only remaining non-ETH investment is in a crypto payments company called Wyre. Ether Capital invested US$1.5 million in Wyre in December 2018 as part of a VC funding round. At the time, according to PitchBook, Wyre had a post-money valuation of US$48 million. Over the next three years, Wyre completed three more funding rounds at higher valuations. At the end of 2021, Ether Capital lifted the estimated value of its Wyre stake on its balance sheet to C$6.2 million from C$1.9 million previously. The same C$6.2 million valuation was used at the end of March. Then, in April 2022, it was announced that privately-owned payments company Bolt Financial had agreed to buy Wyre for US$1.5 billion. Bolt wants to add Wyre’s crypto capabilities to its existing payments platform. According to PitchBook, Bolt raised money at a post-money valuation of US$11 billion in its last funding round in February. Its acquisition of Wyre is expected to close later this year. 

Ether Capital has not yet raised its estimate of the value of its investment in Wyre. It is expected that most (about 90%) of acquisition price will be paid in Bolt Financial shares over the next four years. Ether Capital holds an estimated 3.9% (2.6% fully diluted) interest in Wyre, so it may receive Bolt shares valued at about US$39 million (0.026% x US$1.5 billion). If this assumption is accurate, then the firm’s Bolt shares would be worth about C$50 million, or about C$1.48/share, at the current exchange rate. Since Bolt is a private company, the Bolt shares received by Ether Capital will be illiquid. There will also (presumably) be a large tax bill after the shares are sold. Even so, the valuation of Ether Capital suggests that investors are pretty much ignoring the value of this asset completely. Its share price spiked briefly on the announcement of the deal in early April but continued to fall thereafter in concert with the price of ETH.

I do not know if Ether Capital will revise its estimate of the value of its Wyre investment when it reports its Q2 financials (expected in mid-August). It might hold off until the deal closes. Whenever it happens, the shares will certainly be valued at more than the C$6.2 million reported at the end of Q1 unless the deal falls through.

Income Statement

Ether Capital’s income statement reflects crypto transactions and revaluations, but the company has minimal overhead expenses apart from staff costs. In 2021, it earned nearly C$1.4 million in consulting revenue, almost covering its cash operating expenses. Then, in Q1 2022, it collected C$450K in consulting revenue and recorded C$722K in staking revenue. As its revenue exceeded its SG&A expense of just under C$800K, the firm reported an operating gain of about C$400K. Its net income, though, was negative due to the ETH price drop.

Based on the Q1 results, Ether Capital’s 2022 consulting revenue annualizes at C$1.8 million. Although its staking revenue varies based on the price of ETH, the staking yield, and the amount staked, it should be more than C$2 million this year even if the price of ETH remains depressed. Thus, as its run rate 2022 SG&A expense is about C$3.2 million, the company should report positive operating income for the year. Its net income may or may not be negative based on the value of its ETH assets and any asset sales. Ether Capital will certainly report a large net loss in Q2 as the price of ETH dropped about 65% in the quarter. However, this loss is obviously already reflected in Ether Capital’s stock price. Meanwhile, since the end of June, the price of ETH has rallied about 45%. Yes, that is how quickly it can change.

Balance Sheet

Ether Capital has no debt and, in fact, no liabilities whatsoever apart from small payables and accrued expenses. Its assets fluctuate due to value of its intangibles (ETH) and its investment in Wyre. At the end of Q1, its intangibles were valued at C$180.5 million and its Wyre investment was valued at C$6.2 million. Due to decline in the price of ETH, Ether Capital’s assets will show a drop when its Q2 balance sheet is released. 

Cash Flow Statement

Although it reported a net loss above C$3 million, Ether Capital recorded just a small operating cash (less than C$50K) loss in 2021 because most of its losses were non-cash impairments on the value of its ETH. The company has raised cash through equity offerings, sales of crypto, and warrant exercises. In Q1 of this year, the company used C$1.3 million for share repurchases.

Share Buybacks

In late-2021, Ether Capital’s board authorized the company to repurchase about 2.5 million of its own shares. Using proceeds from the MKR token sales, the company used C$1.3 million to repurchase about 379K shares in Q1 (C$3.47 average price). Given that Ether Capital trades below the value of its assets and its share price has fallen dramatically, it makes sense for the company to repurchase its own shares. I think it can easily afford further repurchases by using its idle balance sheet cash, its consulting income, and, in the future, its staking rewards. If the company does complete the full buyback of 2.5 million shares, it will reduce its shares outstanding by about 7%.

Toronto: The Birthplace of Ethereum

Unlike the mysterious creator of Bitcoin (“Satoshi Nakamoto”), the people behind Ethereum are actual known humans. The best-known of these is Vitalik Buterin, who is based in Toronto. Ether Capital, as it happens, is also based in Toronto. Taking advantage of this coincidence, Mosoff and others at Ether Capital have been promoting ETH as something that Canada should claim as its own. As such, Ether Capital has been working closely with various government officials and groups in Canada to promote favorable development and regulation of the ETH ecosystem. Mosoff is often interviewed and cited in news reports about ETH. Thus, there could be some benefit to shareholders from favorable regulation of ETH in Canada, the development of ETH in the country, and Ether Capital’s prominence in the industry.

Investor Relations

Ether Capital has excellent investor outreach for a company with half a dozen employees. The company has a fancy website at ethcap.co and is active with blogs, YouTube videos, investor presentations, social media, etc. If you want to learn about Ether Capital and ETH in general, I suggest checking it out.

Benefits of Owning Ether Capital

Besides investing in Ether Capital, ways to benefit from ETH’s possible price appreciation include owning ETH directly, investing an Ethereum ETFs (legal in Canada), buying the Grayscale Ethereum Trust (ETHE), or trading CME-listed futures. One certainly can buy ETH and stake it oneself, but most people do not have the expertise or interest in doing this. The risk of making a mistake and losing your ETH is too great. Instead, investors will typically open a crypto account and store and stake their ETH with a third party. There are downsides to this as well as opening a crypto account may be a hassle and trading may involve fees and commissions. Coinbase, for example, charges rather significant commissions and takes 25% of its customers’ ETH staking rewards for itself. Moreover, crypto wallets (unlike an equity like Ether Capital) typically cannot be set up in a tax-free account.

There are other concerns with holding and staking ETH with a third party that go beyond mere fees. There are, in fact, very real possibilities that a brokerage or other crypto company might steal your ETH, go bankrupt, simply disappear, get hacked, or make some other terrible mistake. In several recent bankruptcies of crypto exchanges and other crypto firms, investors have been unable to retrieve their crypto or their invested capital. In Canada, for example, crypto exchange QuadringaCX was exposed as a giant pyramid scheme after the mysterious death of its founder in 2018. Since then, investors have only recovered a fraction of their former holdings. More recently, defi firm Celsius went bankrupt and its crypto holdings are now stuck in bankruptcy court hell. As if that was not bad enough, Celsius also revealed that it “lost” 35,000 ETH when its staking firm misplaced (or something) the private keys needed to access the crypto. While there are similar possible risks in an investment in Ether Capital, I am not concerned that it will disappear, go out of business, or somehow lose its ETH. Unlike Celsius and some of these other firms, Ether Capital is not promising astronomical returns through dubious lending and borrowing schemes. Moreover, it is not a brokerage with high overhead expenses. Rather, Ether Capital pretty much just owns and stakes ETH.

As for ETFs and the Grayscale funds, they do not presently stake at all. Instead, they collect fees from investors. Grayscale’s fee on its ETH trust, for example, is a whopping 2.5%/year. Thus, instead of getting paid for staking, ETHE investors are paying Grayscale to just hold ETH for them. Making it even worse, the Grayscale funds trade at large discounts to their NAVs and investing in these funds brings weird tax complications. Meanwhile, Ether Capital does not charge management fees, collects staking income for its investors, and can cover its operating expenses with its consulting income.

Finally, while the CME Ethereum futures (which trade 23 hours/day, 5 days/week) may be a good way to benefit from price moves in ETH, they bring no staking income. They do have the tax and margin benefits typical of other futures (although the margin requirements are sky high) and are traded on a regulated exchange. One could sell ETH futures to hedge a long position in Ether Capital, but it seems rather pointless to own Ether Capital at all unless one wants long exposure to ETH. 

Valuation

I cannot use typical methods to determine a price target for Ether Capital as I cannot predict the price of ETH. The share price of Ether Capital will probably be >90% correlated with the price of ETH. There are various models that people use to value cryptocurrencies, but I cannot claim confidence in any of them. I do believe, however, that the price of ETH will rise if the merge happens this year and is successful because, mainly, the higher staking rewards will attract new investors. In the meantime, I think Ether Capital is undervalued based on the current (depressed) price of ETH. With a market cap of about C$71 million, the company holds nearly C$90 million of ETH and staked ETH, owns shares in Wyre that could (potentially) be worth another C$50 million, and has an additional C$5.5 million or so in cash and investments. Moreover, the company has no debt and is already profitable on an operating basis at even a modest staking yield. Thus, I think the stock should be trading (minimum) at C$3.00/share right now. At C$3, Ether Capital would have a market cap at about C$100 million, which would still be a significant discount to the value of its ETH and other assets.

Conclusion

If you want to own ETH, stake ETH, and benefit from the (hopefully) upcoming merge, you could do it yourself. If, on the other hand, you would rather leave it to crypto experts, Ether Capital looks like a great alternative. The company is now generating operating profit and does not collect management fees, so the cost of investing is basically nothing. As a bonus, the stock is trading at a discount to the value of its ETH assets (which may close post-merge) and investors seem to be ignoring the value of its investment in Wyre despite its impending acquisition. I cannot predict the price of ETH, but if it does rally due a successful merge or other reasons, the price of Ether Capital could increase many times over.

Catalyst

transition to ETH 2.0, Wyre sale, appreciation in price of ETH