Why Spot Ether ETFs Could Face a Difficult Path to Approval

The Securities and Exchange Commission (SEC) is considering applications for spot exchange-traded funds (ETFs) for ether (ETHUSD), the native token of the Ethereum blockchain and the second largest cryptocurrency by market capitalization. But experts are increasingly skeptical that approval will come any time soon. 

The agency’s approval of spot-bitcoin (BTCUSD) ETFs earlier this year turbocharged the demand for the cryptocurrency, propelling its price to multiple records, but an encore with ether appears less likely due to a number of factors.

The SEC has already delayed decisions on approvals for ether ETFs by Fidelity, BlackRock (BLK) and Grayscale, questioning whether the proposals are supported by the same arguments that led to the approval of the bitcoin funds, and over security concerns. 

“My cautiously optimistic attitude for ETH ETFs has changed from recent months. We now believe these will ultimately be denied May 23rd for this round. The SEC hasn’t engaged with issuers on Ethereum specifics. Exact opposite of #Bitcoin ETFs this fall,” Bloomberg Intelligence’s James Seyffart wrote in an X post last week.

Staking May Be Biggest Concern Around Ether ETF

Industry watchers are skeptical that approvals will come in May, as scheduled, for a variety of reasons. Primary among them is the fact that ether is staked—a process in which cryptocurrency holders lock up their funds as collateral to support the operations of a blockchain network in exchange for rewards in the form of additional cryptocurrency.

On March 18, Fidelity added an amendment to its proposal to allow traders to stake some of the assets held, and a day later Grayscale amended its application to add staking as well.

Last year, the SEC cracked down on staking, fining cryptocurrency exchange Kraken $30 million and forcing the company to shut down its staking-as-a-service business for not following securities law. It also sued Coinbase (COIN) for its staking offering. That litigation is still in process.

“When investors provide tokens to staking-as-a-service providers, they lose control of those tokens and take on risks associated with those platforms, with very little protection,” the SEC said at the time of the Kraken fine.

That could be interesting in the context of an Ether ETF, where investors do not actually hold the tokens. Instead, they get shares in a fund that has pooled their resources to invest in a portfolio comprising the underlying token.

In a note dated March 12, crypto researcher Noelle Acheson pointed out the uniqueness of staking ether could lead to denial because there’s “regulatory fog” surrounding the activity.

SEC Chair Has Consistently Criticized Crypto

Spot bitcoin ETFs were approved by the SEC in January after several failed attempts. The regulator had previously denied filings until last year when a U.S. Court of Appeals for the District of Columbia said the SEC failed to adequately explain its reasoning for the rejections, specifically in the case of the conversion of the Grayscale Bitcoin Trust (GBTC) into an ETF. That court ruling led the commission to approve the listing and trading of the spot bitcoin ETF shares.

Jake Chervinsky, chief legal officer at Variant, an early-stage crypto fund, wrote in post on X March 11  that the commission could come up with new grounds for denial that weren’t tested by Grayscale in court, which would likely also be subject to a court challenge. The SEC is more than willing to take litigation risk and lose in court based on a preference for being viewed as “fighters” in a war against crypto rather than being accused of rolling over, Chervinsky wrote.

Earlier this month, SEC Chair Gary Gensler declined to say in an interview with Yahoo Finance whether he would approve the Ether ETF applications. He continued to criticize cryptocurrency saying it “has challenges” and is “rife with abuses and fraud,” Yahoo Finance reported.

Differences Between Ether and Bitcoin

Acheson said that there’s a conceptual problem for Ether that didn’t apply to bitcoin. “This statement may irritate many, but ETH was created to be used, not held,” Acheson said. 

ETH can be a store of value among other functions, but that’s not where its main advantage lies, she said.

“It is the field for the largest distributed computing platform in the world, and powers a range of decentralized applications,” Acheson said, while bitcoin in her opinion is a product to be held. “Basically, for BTC a spot ETF makes sense. For ETH, less so,” she said.

Another point of difference could arise out of the classification of ether as a security, as opposed to bitcoin, which is considered a commodity. Bloomberg reported on Mar. 20 that the SEC is investigating Ethereum Foundation, in what could lead to classification of ether as a security.

If the SEC is able to classify ether as a security, it would have far reaching consequences not just for the token, but the cryptocurrency markets as a whole. Ether would have to abide by securities laws and the SEC would have more power to regulate the cryptocurrency and how its traded. It could also open doors for other crypto tokens to be classified as securities, leading to greater regulatory scrutiny.

Insiders See No Reason for SEC to Deny Ether ETF

Coinbase’s chief legal officer Paul Grewal said in a post on X last week that some regulators in the past have clarified ether’s status as commodity while the SEC itself has doubted whether the token could be identified as a security.

“The SEC has no good reason to deny the ETH ETP applications. And we hope they won’t try to invent one by questioning the long established regulatory status of ETH, which the SEC has repeatedly endorsed,” Grewal wrote.

On Monday, Graycale’s chief legal officer Craig Salm sounded an optimistic tone in posts on X, saying that the issues that were resolved in the run-up to the approval of the spot bitcoin ETFs were the same as those the SEC must weigh now.

“The only difference is rather than the ETF holding bitcoin, it holds ether,” Salm said. “So in many ways, the SEC already has engaged and issuers simply have less to engage on this time.”

“Perhaps I will feel differently as we get closer to final approve/deny dates in late May 2024, but at this point, I don’t think perceived lack of engagement from regulators should be indicative of one outcome or another,” Salm said.