Ethereum
Securities and Exchange Commission Approves Ethereum ETFs
Following the approval and launch of Bitcoin exchange-traded funds (EFTs) in January 2024, the U.S. Securities and Exchange Commission (SEC) approved eight Ethereum ETFs for listing and trading on SEC-regulated exchanges on May 23, 2024. This approval represents a significant milestone that paves the way for increased institutional and retail investment in crypto ETFs and addresses critical regulatory concerns that have surrounded Ethereum for years. The approval of these Ethereum ETFs is particularly notable in light of recent comments by SEC Chairman Gary Gensler, who suggested that Ethereum, due to its staking mechanisms, could be classified as a security under SEC regulations.
The approval of these applications came without much resistance, which is a notable departure from the controversial process that preceded the approval of Bitcoin (BTC) ETFs. As reported in our previous articleThe SEC only approved BTC ETFs after three federal judges ordered the SEC to grant approval following Grayscale Investments’ court victory. In Grayscale Investments v. SEC, the D.C. Circuit ruled that the SEC was “arbitrary and capricious” in denying Grayscale’s request to list a BTC ETF.
In contrast, this time, the SEC approved the Ethereum ETF applications on its own initiative. While this move may have been intended to avoid further litigation and public scrutiny, the approval shows a gradual move away from “regulation by enforcement” and toward actions that foster the growth of the cryptocurrency industry and investor freedom.
This article begins by explaining what the SEC approved and why. Then, our team comments on what to expect in the future and what it all means for the cryptocurrency industry and investors going forward.
The approval order
The SEC has approved the listing and trading of eight Ethereum (ETH) ETFs: Grayscale Ethereum Trust, Bitwise Ethereum ETF, iShares Ethereum Trust, VanEck Ethereum Trust, ARK 21Shares Ethereum ETF[1]the Invesco Galaxy Ethereum ETF, the Fidelity Ethereum Fund, and the Franklin Ethereum ETF. All of the ETH ETF sponsors are familiar names from the first round of BTC ETFs.
The most significant development in the approval order was the SEC’s strong implication that ETH is a commodity, not a security. The SEC approved the applications under the rules applicable to commodity-based trust shares. None of the sponsors filed applications under the Investment Company Act of 1940, which is required for ETFs that trade in securities. Furthermore, the SEC cited only court precedents involving commodities, not securities, as justification for approving the applications.
The SEC also justified its approval in a manner reminiscent of how it explained the approval of BTC ETFs. The commission cited, among other things, the high correlation between ETH spot prices and the Chicago Mercantile Exchange’s (CME) ETH futures market. This is important because the CME’s oversight of ETH spot markets would help detect any market manipulation that could affect the integrity of ETH ETFs.
The SEC’s approval of Ethereum ETFs comes with specific conditions, including a ban on staking ETH via ETH ETFs. If sponsors of these ETFs want to obtain permission to stake ETH, they will need to submit a proposed rule change and wait for SEC approval.
And after?
Although the SEC approved sponsors’ applications to list ETH ETFs on public exchanges in late May, we likely won’t see the ETFs listed for trading on those exchanges until mid- to late July at the earliest. Each sponsor must submit an S-1 filing as a registration statement and await SEC approval before the ETFs can actually be listed for trading. The SEC recently returned the submitted S-1 forms with minor comments, asking sponsors to resubmit them by July 8, 2024, delaying the planned launch. Bloomberg ETF analyst Eric Balchunas previously said that a late June launch for ETH ETFs was a “legitimate possibility,” but recently revised his prediction, suggesting a launch date of mid- to late July, pending the SEC’s review and final approval of the resubmitted S-1 forms.
As with BTC ETFs, we expect another fierce battle for market dominance. Typically, early movers in the ETF space squeeze out competitors by gaining significant market share early on. Other factors, such as brand awareness, price competition, commitment to the cryptocurrency industry, and developments in disruptive technologies, may also prove important. But at this point, it’s unclear what factors will affect the ETH ETF market and to what extent each factor will affect the market. Price and market power will likely be important to investment banks, but analyst prowess may be relatively irrelevant given that ETH ETFs are single-asset funds.
While the SEC’s approval of ETH ETFs represents a clear and positive step in classifying ETH as a commodity, the SEC remains free to argue that staking ETH is an investment contract (i.e., a security) subject to its jurisdiction. That said, the SEC cannot rationally assert that ETH alone is not a title in the case of ETH ETFs but that it East a security in other cases. If sponsors want to put ETH in ETFs, the SEC could fight back much harder than it did in approving ETF applications in the first place. Notably, the Financial Innovation Technology for the 21st Century Act (FIT21) seeks to classify ETH and many other crypto assets as commodities. The House of Representatives passed FIT21 on May 22, 2024, but the bill’s prospects in the Senate are uncertain. It remains to be seen whether FIT21 will be the first piece of federal legislation on crypto assets.
The approval order only applies to ETH ETFs, and not to any other single-asset or multi-asset crypto funds. However, the fact that the SEC has now approved two crypto ETFs shows a shift in the policy and regulatory landscape regarding crypto assets. Even though the SEC treats the “vast majority” of crypto assets as securities, the focus will undoubtedly shift to which crypto asset will be the next to get ETF approval.
Our point of view
Overall, this is a positive step forward for the SEC and the crypto asset industry, which is aggressively taking on traditional financial markets, highlighting innovative investment and technology opportunities.
The approval order demonstrates that crypto assets can begin life as a security and transform into a commodity (or other non-security) over time. Thus, Ethereum founders, and the founders of many other crypto assets, can rest easy knowing that their assets are or can become so decentralized that the SEC cannot classify them as securities.
Even after the order is approved, we still expect SEC Chairman Gary Gensler to reiterate his position that most crypto assets are still securities in the eyes of the SEC. Chairman Gensler affirmed this belief following the approval of the BTC ETFs, and again in the days leading up to the order approving the ETH ETFs. But we are optimistic that the SEC’s decision to approve two crypto ETFs demonstrates the SEC staff’s commitment to a “merit-neutral” perspective.
The approval order will spur the growth of the retail cryptocurrency market in the United States. Once the ETFs are listed on public exchanges, U.S. investors will be able to buy, sell, and hold ETH in their IRAs, 401Ks, and brokerage accounts. In the years to come, it is very possible that we will view the SEC’s decision to approve ETH ETFs as a milestone in what has become a trend of integrating crypto assets into traditional financial networks through ETFs and other financial instruments.
While the SEC’s decision is certainly a step forward for investor freedom, it does prevent investors from unlocking the full potential of their investment. The decision to prohibit sponsors from placing ETH in ETFs likely deprives investors of an average of 2.61% additional return on ETH placed for a year. The issue of staking will raise many critical questions going forward: How will sponsors and investors craft staking agreements for each ETF? What will the SEC do when a sponsor submits a proposed rule change to allow staking? Can the SEC resolve this issue amicably by cooperating with the industry, or will the courts have to decide?
We believe the SEC cannot credibly claim that ETH alone is a security in some cases but not others, so the freedom to stake ETH in ETFs should not be as big an issue as the SEC wants to make it out to be. Still, the SEC may need to hear this from a judge before conceding.
In conclusion, we would be remiss not to remind readers that good governance by crypto and ETF-savvy executives and directors, as well as sound legal advice from SEC attorneys, will all be necessary to ensure continued market success in this sector. The digital asset sector is still a young, volatile and highly creative technology sector, which is fraught with pitfalls that have been identified as legal and regulatory “risk factors” in several prospectuses.
ETFs are complex. Crypto assets are more than complex. Sponsors and banks should not seek SEC approval for a crypto asset ETF, nor should a bank, broker-dealer, or RIA enter into a contract with a crypto asset ETF sponsor or authorized participant unless directed and advised by experienced counsel.
Special thanks to Ryan Chatoo, a summer associate in Foley’s Miami office, for his contribution to this article.
[1] On May 31, ARK Invest ended its partnership with 21Shares and is no longer involved in the ETF. The SEC has allowed 21Shares to continue operating under the renamed 21Shares Core Ethereum ETF.