After the approval of the Bitcoin spot ETF by the US SEC in early January, the market’s expectation for the approval of an Ethereum spot ETF has rapidly increased. However, an unresolved question remains: Is Ethereum considered a security or a commodity? This article, written by Steven Ehrlich, is compiled, organized, and written by Foresight News.
Introduction:
SEC plans to “forcefully reject” Ethereum spot ETF? Insider: Gensler still considers ETH a security.
Background:
May 24th is the approval date for the “Ethereum spot ETF”? US lawyer: There are still 90 days left! If not approved by the SEC, the latest would be mid-next year.
Table of Contents:
Is Ethereum considered a security?
Differences between Bitcoin and Ethereum
Coinbase’s letter to the SEC
The spring of the crypto world has arrived early. The trading price of Bitcoin has surpassed $60,000, rising more than 167% in the past 12 months. Within less than two months of the listing of Bitcoin spot ETFs, over $7 billion has flowed into these new funds.
Subsequently, the market has high expectations for the listing of Ethereum spot ETFs. With a market value of over $400 billion, ETH is second only to Bitcoin, which has a market value of over $1.2 trillion. In May, the US Securities and Exchange Commission (SEC) may make a final decision on 9 applications for Ethereum spot ETFs. However, unlike the seemingly established fact of Bitcoin ETF approval in early January, the future of Ethereum is not as clear.
The most immediate concern is whether the SEC considers Ethereum to be a security, which means it would need to be registered and regulated by the SEC under the Investment Company Act of 1940. Most ETFs, such as QQQ or SPDR S&P 500 Trust, fall under the jurisdiction of the so-called 40 Act because they are portfolios of stocks or registered securities.
Although the trading and activities of cryptocurrencies seem very similar to the securities market, the crypto asset community unanimously believes that the thousands of different cryptocurrencies behind the emerging industry worth over $2 trillion are not securities. In fact, they are angered by the view that “cryptocurrencies are securities,” calling it a curse on the decentralization spirit that Bitcoin introduced 15 years ago.
While the SEC approved the Bitcoin spot ETF in January this year after more than 10 years of waiting, to some extent confirming these beliefs, the law recognized the Bitcoin behind these funds as a commodity.
So far, the SEC has avoided discussing whether Ethereum is a security, although it claimed in a case against Coinbase in June 2023 that many tokens, including those related to blockchains like Cardano and Solana (essentially clones of Ethereum), are essentially securities. SEC Chairman Gary Gensler has remained silent on the question of whether Ethereum is a security.
During a congressional hearing in June 2023, Patrick McHenry, Chairman of the House Financial Services Committee, questioned Gensler about whether Ethereum is a security or a commodity. Gensler’s most common response at the end of a controversial discussion was, “I think you don’t want me to make a prejudgment…”
If the SEC determines that Ethereum is a security, it will insist on the issuer of the Ethereum ETF to treat it as a security in the approval application. While this may seem like a pile of legal documents, doing so would be an insult to insiders and idealists in the crypto industry, and would raise questions about the status of thousands of cryptocurrencies. However, considering the potential billions of dollars at stake in the emerging crypto ETF market, companies like Blackrock, Invesco, and Fidelity, which can quickly gain market share like Bitcoin ETFs, may benefit from the SEC’s decision.
An anonymous applicant said:
Following Bitcoin, Ethereum, established by Vitalik Buterin and others in 2015, is the second most important blockchain in the world. The difference between Ethereum and Bitcoin is that it allows developers to freely build countless applications on top of it, which are often called smart contracts.
Its success is crucial for the large ecosystem composed of companies such as Nike, Circle, Uniswap, and Blur, whose businesses involve everything from payments to decentralized finance, gaming, and NFT applications. In terms of market performance, the price of Ethereum has doubled in the past 12 months.
The origin story of Ethereum is significantly different from that of Bitcoin, which has caught the attention of lawyers at the US Securities and Exchange Commission. Bitcoin was launched in 2009, with its developer known as Satoshi Nakamoto mining the first so-called block, and anyone could join the network as a miner to mine and obtain new Bitcoins without any pre-distribution to the founder.
In contrast, Ethereum conducted its first token offering in mid-2014, while the founding team led by Vitalik Buterin retained a portion of the 72 million ETH created at the time. In many ways, Ethereum’s initial token offering is similar to the issuance of stocks by company founders in an initial public offering.
One of the determining factors in determining whether something is a security is related to central control. In the early days of Ethereum, this peer-to-peer network was controlled by a small group of developers. However, over time, Ethereum and its governance have become gradually decentralized.
Bill Hinman, who served as the SEC’s Director of Corporate Finance in 2018, stated:
Another conflicting signal comes from Ethereum futures ETFs launched last fall, such as VanEck’s Ethereum Strategy ETF and ProShares’ Ether Strategy ETF. Greg Xethalis, General Counsel of crypto venture capital firm Multicoin Capital, stated:
On the other hand, Prometheum in New York is the only broker-dealer registered with Finra that has obtained a special license to custody and trade digital assets. Prometheum plans to launch custody and trading services for Ethereum as “crypto asset securities” this spring.
Aaron Kaplan, CEO of Prometheum, believes that Ethereum is a security:
The potential profits for the first issuer of an Ethereum spot ETF could be substantial. In October 2021, ProShares launched the first Bitcoin futures ETF, called ProShares Bitcoin Strategy ETF (BITO), two weeks ahead of its competitors. On its first day of trading, it brought in over $1 billion in inflows and has since dominated the crypto futures ETF market.
BITO has $2 billion in assets and charges an expense ratio of 0.95%, holding a 90% market share. GBTC, the earliest promoter in the Bitcoin fund space, still maintains its market dominance with $26 billion in assets, despite its higher expense ratio of 1.5% (more than four times that of its Bitcoin spot ETF competitors), while its second-largest competitor, BlackRock, has $9 billion.
If this potential advantage is not enough, there are additional incentives. Spot commodity ETF applications submitted under the Securities Act of 1933 have a deadline or approval period of 240 days for careful consideration by the SEC. These types of applications require exchanges (such as Nasdaq or NYSE) to submit a separate form called 19-b4 in addition to the S-1 filing for new security issuances. Giang Bui, Head of Nasdaq US Stocks and ETPs, stated that these filings are reviewed by two different divisions of the SEC and follow different timelines. The S-1 is audited by the SEC’s Division of Corporation Finance, while the 19-b4 is audited by the SEC’s Division of Trading and Markets.
If the application for the Ethereum spot ETF is submitted under the 1940 Act, the issuer only needs to submit Form N-1a as its registration statement, which is audited by the SEC’s Division of Investment Management. This streamlined approach means that applications under the 40 Act require 60 days instead of 240 days to become effective. On Wall Street, this shortened timeframe can determine the success or failure of an initial public offering.
For the broader crypto industry, the approval of an Ethereum spot ETF under the 1940 Act could cause serious disruption in the market, especially in the Ethereum spot market. The pricing mechanism of this cryptocurrency may come into question as many key exchanges that determine prices, including Coinbase and Kraken, are not registered or authorized to trade securities.
When Ripple’s token XRP was sued by the SEC in December 2020, several exchanges, including Coinbase and OKCoin, delisted the digital asset. Given the importance of Ethereum, few expect ETH to be delisted by exchanges, but it could harm market demand. The smooth execution of a deep and orderly market is a crucial component of any ETF application.
Coinbase is a particularly prominent player in this drama as its position is to provide custody and prime brokerage services for new crypto ETF products. In fact, Paul Grewal, Chief Legal Officer of the company, sent a letter to the SEC at the end of February, urging the approval of the current Ethereum spot ETF application. Grewal asserted in the letter:
With nearly three months left until the SEC needs to make a decision on the current Ethereum spot ETF application, it is difficult to determine which viewpoint will ultimately prevail. Annemarie Tierney, an attorney at crypto advisory firm Liquid Advisors, said:
She also pointed out that the SEC clearly excluded Ethereum in its securities violation lawsuits against Coinbase, Kraken, and Binance.
Regardless, do not expect potential issuers of Ethereum spot ETFs to be fixated on the ideals of the crypto industry, as one applicant who has already launched a Bitcoin spot ETF said:
Related Reports:
SEC delays Fidelity’s “Ethereum spot ETF” decision, Bloomberg analyst reveals key timeline.
SEC delays BNY Mellon’s “Ethereum spot ETF” review for the second time, Gary Gensler: Passing BTC does not mean a comprehensive green light.
“When will the Ethereum spot ETF be approved?” Survey shows 52% optimistic by the end of 2024; TD Cowen, JPMorgan: Approval won’t come soon.