Ethereum Spot ETF: a political dossier

While bitcoin has paved the way for approval for other crypto ETFs, the game may not be so simple for ethereum. This time, supporters of a hard line on crypto regulation have additional weapons at their disposal to delay the deadline as long as possible. Here are some explanations.

One race follows another. No sooner have the first 11 Bitcoin Spot ETFs been officially approved by the Securities and Exchange Commission (SEC), all eyes are already on one of the next big stories in the ecosystem: the Ethereum Spot ETFs.

"For the market, there is now no doubt that the next wave of Spot ETFs will involve Ethereum," explains Dramane Meïté, head of products at Hashdex, which is one of the most active asset managers in crypto ETFs. Hashdex is among the firms that have successfully launched a Bitcoin Spot ETF on Wall Street, and the company has applied for an Ethereum Spot ETF.

For many investors, the question is just when these products will be available. "I would say over a timeframe of 6 to 12 months," envisages Dramane Meïté.

Even though the price performance has fallen back somewhat in recent days, the ether price rose by 25% between 8 and 12 January, even touching $2,700 at one point. A first since May 2022.

However, the game seems far from won as this time, supporters of conservative regulation on cryptos, such as SEC boss Gary Gensler, have more arguments to delay the deadline as long as possible, even potentially beyond the next US election.

A political battle

Today, seven candidates are in the running for an Ethereum Spot ETF.

Among these are almost the same list as for the Bitcoin Spot ETFs: BlackRock, Fidelity, Ark Invest (in partnership with 21 Shares) with the next deadline due today from the SEC.

This deadline may be pushed back by the stock market watchdog. However, it will not be able to do the same from May, when the SEC will no longer be able to impose a new deadline on several applicants.

On paper, the game looks won since, like bitcoin, ether is quoted on the Chicago Mercantile Exchange (CME), the futures market.

Grayscale used this argument to sue the SEC. In 2022, the SEC refused to allow the asset manager to convert its Grayscale Bitcoin Trust (GBTC) into a Spot ETF on the grounds that it did not have the necessary guarantees to prevent price manipulation. Yet the US securities regulator had approved 'futures' ETFs that had the same feature (read our article on the subject).

At the end of August, US judges ruled that the SEC's rejection was an "arbitrary" decision, finding that the US agency had not demonstrated that the 'futures' and 'spot' markets operated differently and that one deserved different treatment.

"This decision has clearly been a turning point in the race for Spot Bitcoin ETFs, with the SEC losing its main argument for rejecting them," explains Morgane Fournel-Reicher, a lawyer at Kramer Levin. The logic should therefore be the same for ether 👀.

But will Gary Gensler let his arm be twisted so easily? Not so sure!

"Given his very conservative stance, it's possible he'll try again to delay approval," says a manager whose company has applied for an Ethereum spot ETF in the US.

"Even if the arrival of more crypto spot ETFs is inevitable, it's not clear that Gary Gensler (Biden's appointee in 2021, ed. note) wants it all to happen under his tenure," quips one investor. "He might be tempted to drag the issue out until after the US elections in order to pass on the hot potato to the next administration if there is a change of government", he added.

Just after the approvals for the first Bitcoin Spot ETFs were made official, Gary Gensler had described the result as "the most sustainable path", given the SEC's defeat in its case against Grayscale.

For Dramane Meïté, another rejection would have "put the SEC at risk of facing a multiplication of lawsuits. In fact, the agency was very active with the applicants in the months following the judges' decision."

Gary Gensler, on the other hand, made it clear that he "does not approve or support bitcoin", which he still considers to be a speculative and volatile asset that is also used for "illicit activities such as ransomware, money laundering, evasion of sanctions and terrorist financing".

Additional arguments to push back the deadline

On Ethereum, Gary Gensler and his supporters have additional arguments to push back the deadline. "With $280 billion in capitalisation, the ether market is much less developed than bitcoin, which is valued at almost $800 billion. The regulated ether futures market on the CME is also less developed than the bitcoin market; the SEC could use this argument to justify the absence of a market of significant size and consider a much greater risk of price manipulation," Dramane Meïté anticipates.

The second major argument concerns the legal status of ether, which is not considered a commodity, unlike bitcoin, which has been registered as such since 2015 by the CFTC (Commodity Futures Trading Commission), the other major US regulator after the SEC.

In a JP Morgan memo revealed by The Block in early January, the US bank explains that, in its view, "the SEC will need to classify Ethereum as a commodity rather than a security" in order to approve a spot ETF on Ethereum. Yet, for the moment, the game is far from won.

In February 2023, Gary Gensler explained to US media outlet The Intelligencer that he considered all cryptos, with the notable exception of bitcoin, to be securities.

🗣️ "There is a group of individuals behind (crypto-currencies) and the public anticipates profits based on that group," he argued, referring to the now very famous 1946 "Howey test" which considers any transaction involving assets expected to offer a return to be a sale of a financial security.

Ethereum's change of consensus in September 2022 didn't help the case as, in the aftermath, the SEC chairman explained that the Proof-of-Stake (PoS), i.e. tying up one's ethers within the network to participate in block validation and earn a return, could fall within the scope of the "Howey test".

For Philippe Lafaye, vice president of operations for quantitative fund Capital Fund Management, a reclassification of ether as a security "could have an impact on the way the product is designed and therefore cause a lot of back and forth with the SEC".

On several occasions, the SEC has had the opportunity to clearly qualify ether as a security. Yet it has never gone that far, which "contributes to maintaining the vagueness", notes Hashdex's head of products.

On 18 April, Gary Gensler actually chose not to comment when Patrick McHenry, chairman of the US House of Representatives Financial Services Committee, asked him whether he considered Ethereum to be a financial security or not.

The question of integrating staking into spot Ethereum ETFs hoped for by many asset managers therefore still seems a long way off.

"ETF issuers could use some of their reserves of ethers in staking to generate additional revenue to possibly lower management fees, for example. I think this system will be central to their business model," explains Laszlo Szabo, CEO of French start-up Kiln, the largest node operator on Ethereum, who says he is in discussions with the majority of US ETF issuers on the subject.

In Europe, some issuers of ETCs (Exchange Traded Products), which can be likened to the equivalent of US Spot ETFs, have already distributed returns from staking to their clients. These include CoinShares and WisdomTree.

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