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SEC paves the way for Ethereum ETFs deepening capital flows into the broader cryptocurrency sector

Date Published: 24/05/24

The Securities and Exchange Commission (SEC) cleared the path for the eventual launch of the US exchange-traded funds (ETFs) that invest directly in ether tokens, the second-largest cryptocurrency, marking another significant milestone for the industry.

After years of delays and legal obfuscation, the SEC approved proposals on 23 May from the major US trading venues – Cboe Global Markets, Nasdaq, and the New York Stock Exchange – to list Ethereum ETFs, in a rapid about-turn after markets had overwhelmingly priced in another decision deferral as little as a week ago. Bloomberg revealed the SEC’s anticipated pivot on 20 May, which sent Ethereum’s price soaring almost 20% higher within a few hours in anticipation of these approvals, peaking at $3,940 hours before the confirmation eventually came. The eight Ethereum ETF issuers, including BlackRock, Fidelity, Grayscale and VanEck, still require a separate approval from the SEC. Issuers must outline how the ETFs plan to mirror the performance of the underlying ether tokens. No deadline has been set for this decision, although it is considered a formality at this stage.

The approvals mark a significant U-turn for the SEC which tried to argue that Ethereum, the second largest cryptocurrency, is a security. The SEC has conceded defeat on these legal grounds in a crucial victory for the cryptocurrency sector. When the ETFs eventually launch, capital flows will be closely followed. Arguably, investor demand will not be as high as for the bitcoin ETFs earlier this year, while there is potentially selling pressure waiting. Among the would-be issuers is Grayscale, which has filed an S-3 registration statement as part of its bid to turn its existing Grayscale Ethereum Trust into a spot Ethereum ETF. According to its most recently published factsheet, the Grayscale Ethereum Trust – which launched in 2017 – had $8.6bn in assets under management and trades at a high single-digit discount to NAV. Grayscale’s Ethereum Trust management fee is 2.5%, which would likely be significantly undercut by new Ethereum ETF managers, when the SEC approves, potentially repeating a similar selling pressure from the conversion of the open-ended trust to an ETF. The question is to what degree trust investors transfer their capital into the new spot Ethereum ETFs or simply crystallise profits after the long-standing discount to NAV evaporates upon conversion. If history is a guide, a price correction – or continued choppy price action – could continue in the coming weeks.

Crypto market structure bill passes US House

A majority of US House of Representatives members voted in favour of legislation to establish regulatory clarity over digital assets. The Financial Innovation and Technology for the 21st Century Act (FIT 21) is a joint initiative by the House Agriculture Committee and the House Financial Services Committee. This legislation seeks to clearly define the regulatory roles of the SEC and the Commodity Futures Trading Commission (CFTC) concerning cryptocurrencies. It introduces the term “digital commodity” for digital assets that do not meet the bill’s criteria for securities, thereby assigning their oversight to the CFTC and excluding them from the SEC’s jurisdiction.

SEC Chair Gary Gensler said in a statement that FIT 21 “would create new regulatory gaps and undermine decades of precedent regarding the oversight of investment contracts, putting investors and capital markets at immeasurable risk.” President Biden is reportedly not threatening to veto the crypto market structure bill, which is an encouraging sign for the industry. The bill suggests the White House aims to work with Congress on future crypto legislation, further diverging from Gensler’s position.

Bitcoin pauses for breath after blistering 18-month rally

Bitcoin’s price has been range-bound for the past three months – between around $56,500 and $73,500 – after seven consecutive months of rallying, spurred by ETF narratives, the run-up to the fourth-ever “halving” event, and a growing proximity to central banks’ pivot to interest rate cuts.

It is now more than 18 months since the stunning collapse of Sam Bankman-Fried’s cryptocurrency exchange FTX in early November 2022. Since then, bitcoin’s price trough-to-peak has almost quadrupled in a blistering rally from the start of 2023 culminating in its current all-time high of approximately $73,800 reached in mid-March. The rally included a new seven-month record for the longest unbroken period of monthly price gains. In recent weeks, the price has finally started to cool off, which may last for several weeks to come if previous post-halving periods serve as an accurate guide.  

Bitcoin’s “halving” event is where every four years the mining reward paid out to bitcoin miners is slashed by half. On April 19, the block reward for bitcoin miners reduced from 6.25 bitcoin per mined block to 3.125 bitcoin per mined block. This is a cornerstone of bitcoin’s immutable monetary policy designed to slow the pace of new supply and reinforce its scarcity and inflation-resistant properties. The next halving is forecast sometime in 2028. At bitcoin’s current price at the time of writing (~$67,000), miners (i.e. the decentralised network of validators that verify all bitcoin transactions) are now paid just over $217,000 per mined block to keep the network operating smoothly. This reward is, of course, highly volatile as it is pegged to bitcoin’s price. This is now the fourth bitcoin cycle. In each of the previous three, bitcoin’s price peaked around 18 months after the halving. If history repeats or rhymes this cycle, the fiat currency value of bitcoin may continue to rise until around autumn 2025. 

For example, in the previous halving cycle, on 11 May 2020, the price of bitcoin surged eight-fold from around $8,500 to an all-time high of almost $69,000 in November 2021. Similar price surges occurred following the 2012 and 2016 halvings, with a notable trend of diminishing bitcoin returns in successive cycles, as the asset class matures. The four-year cycles instil confidence among bitcoin investors that a “crypto summer” will follow a customary post-halving multi-month re-accumulation period. While the sparse price history for bitcoin relative to traditional asset classes renders such forecasts unreliable by conventional technical analysis, this is unlikely to deter bitcoin investors. Confidence in bitcoin grows stronger with every passing cycle as adoption grows, supply shrinks and new waves of money printing and sovereign debt mountains balloon, eroding the value of associated fiat currencies. 

The coming 12 to 18 months are expected to see a flurry of cryptocurrency activity, partnerships and token launches, spurred by growing institutional adoption, gradual regulatory acceptance and accelerating utility of underlying crypto networks. It is also likely to usher in a new wave of excess and greed by opportunists looking to capitalise on the frenzy, which may well culminate in further self-inflicted crypto industry failures. Likely if a crypto summer does emerge, another winter will follow it. 

Tracking the ETF impact

The US spot bitcoin exchange-traded funds (ETFs) approvals by the Securities and Exchange Commission (SEC) on January 10 have proven to be hugely successful for managers and popular with investors. Since launch, cumulative trading volumes have surpassed $265bn, according to data from The Block, underscoring investor demand for the original cryptocurrency.

BlackRock’s iShares bitcoin ETF (IBIT) has acquired more than 283,000 bitcoins, worth almost $20 billion. IBIT has amassed a 50.7% market share of all ETF inflows, marking the fastest-growing ETF in history surpassing $10bn in record time including 70 consecutive days of unbroken daily inflows.

BlackRock’s position as a major player in bitcoin ETFs, along with the involvement of its global asset management peers, including Fidelity and Franklin Templeton, marks a shift in attitude by traditional finance and testament to the growing mainstream acceptance of bitcoin as a legitimate investment asset. Collectively, the 11 US-domiciled bitcoin ETFs own more than 850,000 bitcoins worth approximately $57bn at current prices (~$67,000).

However, the bitcoin ETF story so far is not one-way traffic. The combined inflows across ten of the bitcoin ETFs were offset by $17.6bn in outflows by the converted Grayscale bitcoin Trust (GBTC), originally set up in 2013 as a private, open-ended trust for accredited investors. Grayscale’s legal victory over the SEC paved the way for the regulator’s U-turn on the spot bitcoin ETF approvals. Last year, in the lead-up to the SEC’s anticipated approval of the bitcoin ETFs, speculators acquired GBTC shares in the secondary market at deep discounts to net asset value (NAV) of the underlying price of bitcoin. Discounts to NAV in GBTC were caused by a lack of liquidity and a smooth redemption mechanism. The speculative strategy aimed to capitalise on price appreciation following ETF approvals and the evaporation of the trading discount to NAV for GBTC shares upon ETF approval. In addition, Grayscale’s higher fees for its converted trust positioned its fund as less competitive to its ten new competitors. These catalysts sparked a wave of bitcoin selling pressure by GBTC. While many investors who sold GBTC shares are thought to have transferred into one of the other new zero-fee ETFs, data supporting that assumption is unavailable. Crucially, the GBTC bitcoin selling pressure was anticipated and arguably exacerbated by Grayscale’s apparent indifference to its own non-competitive posture on fees with peers. 

International bitcoin ETFs follow

Following in the footsteps of US-based asset managers are Hong Kong and Australia. On 15 April, Hong Kong conditionally approved its first spot bitcoin and ether exchange-traded funds (ETFs), marking a divergence from mainland China’s anti-cryptocurrency policy. At least three offshore Chinese asset managers will launch the virtual asset spot ETFs soon. Hong Kong units of China Asset Management, Harvest Fund Management, and Bosera Asset Management reportedly confirmed they had received conditional approvals from the Hong Kong Securities and Futures Commission (SFC) to launch the ETFs. The regulator has not commented directly. “The introduction of the virtual asset spot ETFs not only provides investors with new asset allocation opportunities but also reinforces Hong Kong’s status as an international financial centre and a hub for virtual assets,” Bosera Asset Management (International) reportedly said in its statement. Australia is also set for a wave of bitcoin ETF launches with VanEck Associates and BetaShares Holdings reportedly preparing for listings. The first Australian bitcoin ETFs are reportedly expected to be approved before the end of the year. Australia’s $2.3 trillion pension market may help drive inflows. Bloomberg reports that one-quarter of the country’s retirement assets sit in so-called self-managed superannuation programmes that allow individuals to pick their investments. This pool of capital is the primary target for Australian ETF issuers. 

However, there remains major resistance among pockets of global financial markets. Notably, Vanguard, the largest provider of ETFs in the US, said crypto “is more of a speculation than an investment”. Janel Jackson, global head of ETF Capital Markets and Broker & Index Relations, explains: “While [bitcoin] has been classified as a commodity, it is an immature asset class that has little history, no inherent economic value, no cash flow, and can create havoc within a portfolio.” Jackson adds that bitcoin and crypto volatility drastically impacts portfolio risk profile even with just a 5% allocation. Elsewhere, Swiss National Bank is resisting bitcoin campaigners' attempts to persuade Switzerland’s central bank to change Swiss law and allow cryptocurrencies to be added to its currency reserves. “We have not yet decided that we want to invest in bitcoin – actually for good reasons,” Chairman Thomas Jordan reportedly explained at its AGM. “Currency reserves are international payments. They have to be liquid. They have to be sustainable. And we have to be able to sell and buy them.”

While bitcoin enthusiasts would insist crypto offers permissionless cross-border payments with growing liquidity and a network increasingly powered by sustainable energy, it is clear that parts of the global financial establishment are yet to be persuaded by this maturity. Global adoption is a long and winding road. 

Consensys sues SEC over “unlawful seizure of authority” over Ethereum network

Consensys, the blockchain software firm founded by Joe Lubin, filed a lawsuit in late April against the SEC to prevent the regulator from taking its own legal action against MetaMask, a cryptocurrency wallet developed by the firm. The legal action centres on the SEC’s intention to regulate Ethereum’s ETH token as a security, despite the regulator’s public statements almost six years ago stating the opposite. In a well-known June 2018 speech by a former SEC director, it was stated on the record: “Based on my understanding of the present state of ether, the Ethereum network and its decentralised structure, current offers and sales of ether are not securities transactions.” 

On 10 April, the SEC sent Consensys a ‘Wells Notice’ stating its intent to bring enforcement action for violating federal securities laws and that MetaMask is an unregistered broker-dealer. Consensys calls the SEC’s action “unlawful seizure of authority” over Ethereum by the federal regulator. The Ethereum network, of which Lubin is also a co-founder, is decentralised. Consensys wrote: “No individual or group of individuals manages Ethereum or directs its affairs. Ethereum has no management team, no board of directors, no constitutive body of any kind. Rather, as detailed below, Ethereum is organised and develops democratically through the voluntary participation of a shifting mass of thousands of users, code developers, and other stakeholders.”

In its filing, Consensys wrote: “Years into its self-appointed campaign of regulatory escalation – and completely contrary to its conclusion six years ago – the SEC now has decided to claim the right to regulate ETH as a security.” In a statement on its website, Consensys explained: “We took this step for two very basic reasons: (1) the SEC should not be allowed to arbitrarily expand its jurisdiction to include regulating the future of the internet; and (2) the SEC’s reckless approach is bringing chaos to developers, market participants, institutions, and nations who are building or already managing critical systems running on Ethereum, the world’s largest platform for decentralised applications.”

However, the validity of this SEC’s Wells Notice is unclear following the regulator’s approval of spot Ethereum ETFs. Likewise, the status of the legal challenges against a dozen major cryptocurrencies – including Solana’s SOL, Cardano’s ADA and Polygon’s MATIC – that the SEC named as securities in June 2023. Further clarity on the regulatory status of these major cryptocurrencies would likely be another catalyst for renewed broadly digital asset adoption and capital flows.


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