The crypto industry has long resisted having its tokens classified as securities. However, the success of bitcoin’s spot ETFs, could prompt issuers to break ranks depending on the SEC’s next move.
By Steven Ehrlich, Forbes Staff
Spring has come early to cryptoland. Bitcoin is trading above $60,000, up more than 167% in the last 12 months and more than $7 billion has poured into the new bitcoin ETFs. The market is buzzing with anticipation for an ETF backed by bitcoin’s little brother ether, the native token associated with the Ethereum blockchain and used to create such things as NFTs. Ether has a market cap of more than $400 billion, second only to Bitcoin, whose market cap exceeds $1.2 trillion. In May, the SEC will likely pass final judgment on nine spot ether ETF applications. But unlike bitcoin’s decision day in early January, which seemed to be a fait accompli, ether’s outlook is far less certain.
The most immediate concern is whether the SEC believes that ether is a security, which means that it would be subject to registration and regulatory oversight by the SEC under the Investment Company Act of 1940. Most ETFs, like the QQQ or the SPDR S&P 500 trust, fall under the so-called 40 Act, precisely because they are bundles of stocks, or registered securities. Despite the fact that cryptocurrencies seem to trade and behave much like any number of stocks in the market, the digital asset community believes that the thousands of different cryptocurrencies behind the $1.8 trillion dollar industry are not securities. In fact, they bristle at the thought, calling it anathema to the decentralized ethos that launched bitcoin 15 years ago. To some extent, these beliefs were vindicated when the U.S. Securities and Exchange Commission greenlit spot bitcoin exchange-traded funds (ETFs) in January after a 10-plus year wait under the 1933 Securities Exchange Act, which recognized the underlying bitcoin in these funds as commodities.
So far, the SEC has avoided addressing the issue of whether ether is a security, though it has alleged, in its June 2023 case against Coinbase, that numerous tokens including those associated with blockchains Cardano and Solana, which are essentially clones of Ethereum, are in fact securities. SEC Chairman Gary Gensler has been conspicuously mum about ether’s status. During a congressional hearing in June 2023, House Financial Services Committee Chair Patrick McHenry grilled Gensler about whether ether was a security or a commodity. The most Gensler would say at the end of a contentious back-and-forth was “I think you would not want me to prejudge…”
If the SEC decides that ether is a security, it will insist on ETF issuers treating it as such in their applications for approval. While this might seem like just a bunch of legal paperwork, doing so would be an affront to crypto industry insiders and idealists, and throw into question the status of thousands of cryptocurrencies. However, given the potential billions at stake for early movers in the new booming market for crypto ETFs, those that can gain market share rapidly as Blackrock, Invesco, Fidelity have with their bitcoin ETFs could benefit from such an SEC ruling. When it comes to asset gathering and profits, “crypto community ideals” aren’t likely to carry much weight..
Said one applicant who requested anonymity, “At the end of the day, we’ll file under whatever jurisdiction or regulation the SEC wants.”
After Bitcoin, Ethereum, which was created by Vitalik Buterin and others in 2015, is the second most important blockchain in the world. It is distinguished from bitcoin in that it allows developers the freedom to create a myriad of applications, often called smart contracts, running over it. Its success is critical to a giant ecosystem of companies ranging from Nike and Circle to Uniswap to Blur, involved in businesses ranging from payments to decentralized finance and gaming, to NFT applications.The price of ETH has doubled in the past 12 months.
Ethereum’s origin story is significantly different from bitcoin’s and that is of keen interest to the lawyers at the Securities and Exchange Commission. Bitcoin was launched in 2009 after its pseudonymous developer Satoshi Nakamoto mined the first so-called block, making it possible for anyone to mine the asset without pre-established allotments for founders. Ethereum, by contrast, conducted a crowdsale in the form of an initial coin offering in mid 2014 and reserved a portion of the 72 million ether created at launch for the founding team led by Buterin. In many ways ETH’s initial coin offering was similar to how founders in a company issue stock in an initial public offering.
One of the measures determining whether something is a security has to do with centralized control, and during the early days of Ethereum’s the peer-to-peer network was controlled by a small group of developers. Over time, however, Ethereum and its governance have become more decentralized.
“Putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network, and its decentralized structure, current offers and sales of Ether are not securities transactions,” says Bill Hinman, former director of corporate finance for the SEC in 2018.
Another conflicting signal comes from last fall’s launch of Ether futures ETFs, like VanEck’s Ethereum Strategy ETF and ProShares’ Ether Strategy ETF. “If the SEC was going to take the position that ETH was a security, one would have expected it come up when they allowed ETH futures funds to launch last year, given that those funds hold ETH futures that are regulated exclusively by the CFTC as commodity futures — not futures on securities,” said Greg Xethalis, general counsel at crypto venture firm Multicoin Capital. On the other hand, New York’s Prometheum, the only Finra registered broker dealer granted a special license to custody and trade digital assets, plans to custody and trade ether as a “crypto asset security” this spring.
Prometheum’s CEO Aaron Kaplan believes ether is a security. “ If you think about it, Gary Gensler has been saying that basically everything besides bitcoin is a security.”
The potential profits for the issuer of the first spot eth ETF could be substantial. In October 2021, ProShares launched the first bitcoin futures ETF, called the ProShares Bitcoin Strategy ETF (BITO), two weeks before competitors. On its first day, it brought in more than $1 billion, and ever since then it remains the dominant crypto futures ETF by far. BITO has $2 billion in assets, charges 0.95% in annual expenses, and has a 90% market share. GBTC was the earliest mover in bitcoin funds, and despite an expense ratio of 1.5%— more than four times its spot bitcoin ETF rivals–it continues to hold the dominant market position, with $26 billion in assets versus $9 billion for its next biggest rival, BlackRock.
If that potential advantage is not enough, there’s an added incentive. Spot commodity applications filed under the Securities Act of 1933 have 240-day clocks, or approval time deadlines, for the SEC to mull over them. These types of applications require the listing exchange, such as Nasdaq or the New York Stock Exchange to file a separate form called a 19-b4, in addition to the S-1 form filed for new securities offerings. According to Giang Bui, head of U.S. Equities and ETPs at Nasdaq, these filings are reviewed by two different divisions of the SEC, and follow different timelines. The S-1 is reviewed by the SEC Division of Corporate Finance, and the 19-b4 is reviewed by the SEC Division of Trading and Markets.
If an ether ETF application was filed under the 40-Act, the issuer would need to only submit a form N-1a as their registration statement, which is reviewed by the SEC Division of Investment Management. This streamlined approach means that 1940s Act applications take 60-days rather than 240-days, before they can become effective. On Wall Street a shortened timeline can make or break an initial offering.
For the greater crypto industry, approval of an ether ETF under the 1940 Act could create significant havoc, especially in the ether spot market. The cryptocurrency’s pricing mechanism could be called into question because many critical exchanges where prices are determined, including Coinbase, and Kraken, are not registered or authorized to trade securities. When XRP, Ripple’s token, was sued by the SEC in December 2020, many exchanges including Coinbase and OKCoin delisted the digital asset. Given its prominence, few would expect ether to be delisted, but it could hurt market demand. The smooth functioning of deep and orderly markets is a key component of any ETF application. Coinbase is a particularly prominent player in this drama because it has positioned itself to provide custody and prime brokerage services to new crypto ETF products. In fact, it sent a letter to the SEC in late February its from Chief Legal Officer Paul Grewal imploring it to approve the ether ETF applications as submitted. “ETH is a commodity, not a security,” it asserts.
With nearly three months to go before the SEC needs to rule on the current ether ETF applications, its hard tell where it will fall. “The challenge is we’ve got a CFTC that’s saying that ether is a commodity and an SEC who previously said that eth was a commodity, and now is saying under this new administration that it could be a security,” says Annemarie Tierney, an attorney for crypto consultancy Liquid Advisors pointing out how the SEC conspicuously left ether out of its securities violation lawsuits against Coinbase, Kraken, and Binance. “They’re not listing eth as a security in any of these enforcement actions against the exchanges, so I don’t know how to take that,” she says.
Either way, don’t expect potential ether ETF issuers to get hung up on crypto industry ideals, “The SEC has done inconsistent things in the past,” says one applicant with a new bitcoin ETF already in the market. “If they said that we could only come to market with a spot ether ETF under the 40 Act, that’s definitely an option we would leave on the table.”
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