Insight
May 24, 2024
It has been an eventful two weeks in the US regulatory backdrop for crypto, perhaps the most momentous period in its history. A number of events transpired in rapid succession, all seemingly positive for the broader crypto ecosystem, marking an abrupt shift in policy ahead of the 2024 Presidential election. We unpack each event and its impact on the industry.
Staff Accounting Bulletin 121 (SAB 121) is an accounting rule put forth by the SEC that went into effect on April 11, 2022 with prescriptive rules about how public companies (or their subsidiaries) should account for them. In essence, it required these companies, which include banks, exchanges, custodians, and any other entity entrusted to safeguard crypto on behalf of others to record those assets on their balance sheet (as both an asset and liability). The issue, especially for publicly traded banks, is capital charges which affect their capital adequacy and leverage ratios, making crypto assets undesirable for banks to hold. The House had already voted to repeal the rule but the Senate’s decision, which included the help of 12 Democrats, was a major political message. The White House already sent a strongly worded statement that the President would veto the bill, which he must do by Tuesday of next week. But given the abrupt change in political climate, it is not clear now where the White House stands.
On Monday, May 18th, embattled FDIC Chair Martin Gruenberg, announced that he would step down following the appointment of a successor. Gruenberg had been under scrutiny after widespread allegations of sexual harassment and misconduct within the agency. While the departure had nothing to do with the FDIC’s policy on crypto, its attitude on the matter under Gruenberg’s leadership was anything but supportive. The joint statement from the FDIC, OCC, and Fed in the wake of the collapse of FTX was particularly memorable, warning banks that issuing or holding in principal digital assets would be “highly likely to be inconsistent with safe and sound banking practices.” While the impact of a change in leadership on the agency's stance on crypto remains uncertain, one thing is certain - there is room for enhancement from the current status quo.
It has not gone unnoticed that Presidential candidate Donald Trump’s change in attitude toward crypto coincided with an abrupt change in the current administration’s attitude towards crypto. On May 8th, Trump hosted a dinner at Mar-a-Lago for buyers of his NFT trading cards. While Trump was no fan crypto during his Presidency, according to media coverage, he was actively seeking support from cryptocurrency enthusiasts during the event. Then on May 21st, Trump’s Presidential campaign began accepting crypto donations, the first major party candidate to do so.
The Financial Innovation and Technology for the 21st Century Act (FIT 21) is a market structure reform bill introduced by the House Committee on Agriculture (and notably also went through the Financial Services Committee). It paves the way for a federal regulatory framework for the crypto industry, fulfilling a long-standing industry demand. Importantly, it would allow most cryptocurrencies to be treated as commodities and thus regulated by the CFTC, not the SEC. It passed the House on Wednesday with bipartisan support, including 70 democrats, roughly triple the support the SAB 121 repeal got. However, just one day prior to its passing, SEC Chair Gensler made his dissatisfaction with the bill known by issuing a statement. The morning of the vote the White House released a statement regarding the bill, featuring a significantly more collaborative tone compared to their previous statement about the repeal of SAB 121. While the bill would still need to pass the Senate before becoming a law, this statement from the White House was a major departure from their previous statement on crypto and a stark difference from the comments from the Chair of the SEC.
On Thursday afternoon, the SEC approved the 19b-4 change of rule request forms for exchanges to list and trade 8 spot ETH ETFs, making ETH the second cryptocurrency to get the ETF approval by the SEC. This cements the SEC’s viewpoint that ether is commodity and not a security. It will take some time before trading begins as it usually takes the SEC 30 days to review and approve registration statements. The spot bitcoin ETF situation was unique (trading began the next day) because the SEC had already been in heavy consultation with the issuers, unlike in this case where the SEC has yet to meet with a single issuer.
The approval by the agency is an abrupt change from its posture, one that many, including us, did not foresee just a week ago. It is important to note that the SEC Commissioners did not vote on this issue like they did in the case of the bitcoin ETFs, and the division of Trading and Markets is the entity that approved the 19b-4s. Presumably it wouldn’t have done so without support of the Commissioners, though. Our understanding of the situation is that things changed abruptly on Monday (5/20), likely in response to the changing regulatory and legal climate towards crypto as detailed above. Before that, the posture from the SEC towards crypto at large was not welcoming, allowing for a spot bitcoin ETF only after losing in court. Leading up to the May 23rd approval deadline for spot Ethereum ETFs, there had been no signs the regulator was leaning towards approval, as it had conducted zero meetings with prospective issuers while it had conducted 24 such meetings ahead of the spot bitcoin ETF approval. Ethereum development shop Consensys even went to the lengths of suing the regulator, alleging it was gearing to classify ether, the native asset of Ethereum, as a security, which would have effectively ended any hopes of a ’33 Act ETF.
There is no set amount of time for the SEC to deem the registration statements effective, but typically it takes about 30 days for the Division of Corporation Finance to review these documents. We may see meetings between the issuers and the SEC (and subsequent amendments filed) as the issuers work to get their documents in shape. The controversial issues, in-kind create/redeem and staking, at least seem to be foregone conclusions as to be out of consideration for any ETH ETF launch. Our guess is that like the spot bitcoin ETFs, the SEC won’t play favorites and allow trading to begin for them all at once. All the top players in the bitcoin ETF competition have returned for another round, with the exception of WisdomTree and Valkyrie. WisdomTree manages the smallest spot bitcoin ETF, while Valkyrie was recently acquired.
One important strategic change, however, is that Grayscale has opted to push its Grayscale Ethereum Mini Trust (ticker ETH), the (expected) low-cost alternative to the Grayscale Ethereum Trust (ticker ETHE) to the forefront this time, filing a 19b-4 (but not part of the initial SEC approval). Our guess is Grayscale does not want a replay of the spot bitcoin ETF launch, which saw the high-cost GBTC hemorrhage funds to competitors. The Grayscale Ethereum Mini Trust still hasn’t started the official SEC review process, however, so it’s unclear when it might begin trading, plus we don’t know fees for either ETH or ETHE yet. ETHE’s fee is currently 2.5%. We would expect fees for the cohort of spot ETH ETFs to be in the range of where they are for the BTC ETFs, 20 – 30 bps, with fee breaks based on AUM and duration.
While this game is always a challenge (the popularity of the spot bitcoin ETFs certainly has pleasantly outpaced our initial expectations), at this point we have some guideposts with the bitcoin ETFs, both spot and futures. Some analogies, however, have been very incongruous. For example, the ETH futures ETFs, which launched in October of last year, have been wildly unpopular compared to the launch of the BITO bitcoin futures ETF, gathering less than 2% of the inflows in the first 90 days. Much of that likely had to do with cycle timing as the launch of BITO marked THE last cycle peak, while the launch of the ETH futures ETFs came amidst a very bitcoin dominated part of the cycle (still true today).
It also may just be that investors appreciate ETH for its utility, the native currency of a platform to build and create, and not its monetary and investment purposes. Locking it away in an ETF may be antithetical to that utility driven vision. Bitcoin’s fixed supply vs ether’s uncapped supply is a defining feature difference, one that encourages different user behaviors, such as buy and hold vs use. The Ethereum community’s attempt to portray ether as “ultrasound money” a few years back really missed the point of Ethereum, its flexibility and utility, and instead tried to portray it as a better version of bitcoin (which swayed very few hard money enthusiasts).
With that as a caveat, using the launch of spot bitcoin ETFs as a guidepost, we can make some assumptions about the potential demand for ETH ETFs. Using a similar share of fund flows as a percentage of the initial market cap gets us to an estimated inflow for ETH ETFs of $4.5B, about a third of inflows into bitcoin ETFs (also a similar ratio of market caps).
As for price impact, Bitcoin’s historical guide serves as an important blueprint. There is a caveat, however, in that Ethereum ETFs have jumped many of the important steps in the twisting and turning path bitcoin had to go do before ultimately being approved. The ultimate impact will be subject to the fund flows into the ETFs and given the lack of popularity of the ETH futures ETFs in comparison to BTC counterparts, there’s a wide dispersion in fund flow outcomes.
With the approval question of ether ETFs now behind us, the natural question is what other cryptocurrencies might be in ETFs? The reality is that no other cryptocurrencies have regulated derivatives trading on the CME the way BTC and ETH did. As a result, satisfying the SEC’s demands around the ability to spot and prevent fraudulent and manipulative trading practices might prove to be more burdensome for would be applicants. The SEC has already asserted numerous cryptocurrencies are securities as well, like SOL, ATOM, MATIC, ADA, FIL and ICP, in its various lawsuits. While a final verdict has not been rendered supporting those cases, it seems unlikely that the SEC would allow an ETF for one of those assets. The reality is more likely that we see a pause in the ETF applications, and let regulators, legislators, and White House digest all the changes that have occurred over the recent past.
Bitcoin rose 3.0% on the week, but it was not without its twists and turns. At one point, as it became apparent that the SEC was gearing up to approve ETH ETFs on Monday, it appeared as if bitcoin would hit a new all-time high. But some rotation out of BTC into ETH that began on Tuesday and higher than expected PMI (inflation) readings on Thursday put a damper on that plan. Thursday saw an abrupt reversal in risk markets, including equities and crypto, with particular volatility for bitcoin into the 4 PM close. It’s not clear what the cause of the volatility into the close was, as GBTC registered only minor outflows and the total spot ETF complex registered inflows to the tune of $108M. The ETHBTC cross was particularly volatile at the close, falling 5.7% before rebounding.
Looking ahead, if Thursday’s price action is any indication, it’s likely that macro related events will be important market drivers, particularly over the short-term. The launch of spot ETH ETFs, tentatively targeted as a month from now, might have an impact on demand for BTC ETFs. While fresh money may come into the ecosystem, particularly given the improved regulatory backdrop, some of the money that comes into the ETH ETFs might come from BTC ETFs, even though the investment propositions are very different.
Regulation, Enforcement, and Taxation:
SEC Issues Order Approving Spot ETH ETFs - SEC
Coinbase, Kraken, Meta, Others Form Tech Coalition to Tackle 'Pig Butchering' Scams - CoinDesk
Investing:
Share of Bitcoin Volume During US Market Hours Surges to Record - Bloomberg
Crypto ETFs: Hong Kong Considers Allowing Staking for Ether ETFs - Bloomberg
Bitcoin Developers Tout ‘Programmability’ as the Catalyst for the Next Rally - Bloomberg
Industry:
Grayscale Investments Announces CEO Transition - Grayscale
Genesis Set to Return $3B Customer Assets in Finalized Bankruptcy Liquidation Plan - CoinDesk
Gemini Earn to Begin Returning Customers' Crypto by End Of Month As Court Approves Genesis Bankruptcy - The Block
This Man Did Not Invent Bitcoin - NYT
Court Ruling in COPA vs Craig Wright Case - Source
Bitcoin Is Coming to Ethereum Stalwart MetaMask: Sources - CoinDesk
'We Heard You': Coinbase Resumes XRP Trading in New York - Decrypt
No, A Sponsored Labeled Crypto Press Release Is Not an Alternative to Editorial Coverage - CoinDesk
May 31 - CME expiry
June 12 - FOMC interest rate decision
June 12 - May CPI reading
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