Impact of SEC’s Inquiry into Ethereum Foundation on ETH-ETF Approval: ForkLog Analysis

The Ethereum Foundation and several other unnamed organizations have received inquiries from the SEC regarding the status of ETH. ForkLog examines how this development might affect the approval of a spot exchange-traded fund based on the second-largest cryptocurrency by market capitalization.

Following the registration of a BTC-ETF on January 10, Bloomberg analysts Eric Balchunas and James Seyffart estimated the chances of a “green light” at 70% and 60% respectively. They advised focusing on May 23 as the final deadline for the proposal from VanEck.

The existence of an already registered Ethereum futures-based ETF, the presence of BlackRock among the applicants alongside Grayscale, Franklin Templeton, VanEck, Fidelity, and Invesco with Galaxy, as well as the absence of Ethereum being mentioned as a security in SEC lawsuits against Coinbase, Binance, and Kraken, made such expectations not unfounded.

Also fueled by the Dencun factor, Ether showed growth rates comparable to Bitcoin, despite active demand for exchange-traded products based on digital gold.

Following the news of the SEC’s “interest” in the Ethereum Foundation, the situation likely turned 180 degrees.

Earlier, citing the inactive nature of negotiations between ETH-ETF issuers and the regulator, Bloomberg experts lowered expectations for a positive verdict to 35%. They now effectively acknowledged that such an outcome in May is no longer to be expected.

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. https://t.co/TyAzAOrAC5

— James Seyffart (@JSeyff) March 19, 2024

Why the Ethereum Foundation?

According to Fortune, the current inquiries to the Ethereum Foundation and other organizations are linked to a campaign by the regulator that began in 2022 to classify ETH as a security.

The trigger was The Merge — the transition of the blockchain of the second-largest cryptocurrency by market capitalization to the Proof-of-Stake (PoS) consensus algorithm.

Back in 2023, SEC Chairman Gary Gensler warned that such a model could lead to tokens being interpreted as investment contracts. The lack of specifics in his responses to leading questions about the status of ETH allowed hope that the agency would avoid “repression.”

In addition to the “nature” of PoS, the agency was also interested in documents and financial reports related to the business operations of the Ethereum Foundation, reminiscent of the development of the SEC’s lawsuit against Ripple, which ended in a draw.

Founder and CIO of Ikigai Asset Management Travis Kling described the situation as a “coordinated attack” on ETH.

So this now very obviously feels like a coordinated attack on ETH. Hmm.

That’s interesting in light of Larry’s 576-1 record and the simple fact that he is unequivocally more powerful than Gary.

Wonder what’s gonna happen.

— Travis Kling (@Travis_Kling) March 20, 2024

“This is interesting in light of Larry [Fink, CEO of BlackRock]’s 576–1 record [of approved and rejected ETF applications] and the simple fact that he is unequivocally more powerful than Gary [Gensler],” wrote the expert.

The Stumbling Block

The uncertain status of ETH as a barrier to ETF approval was pointed out back in January by Morgan Creek Capital CEO Mark Yusko and JPMorgan analyst Nikolaos Panigirtzoglou.

Their opponents hoped that Ripple’s partial victory regarding XRP’s status and the absence of the CFTC’s classification of the second-largest cryptocurrency as a security would force the SEC to back down.

FOX Business journalist Eleanor Terrett in January suggested that such clarity might arise during court proceedings with Binance. The hope was linked to a hearing where it was noted that DAO tokens could be recognized as securities. Now she realized the reason for the agency’s low engagement in the process of interacting with issuers.

If this is true, then it explains why the @SECGov has been so mum with the $ETH spot ETF issuers.

The @SECGov staff may be waiting for any lingering investigations to wrap before @GaryGensler gives them direction. pic.twitter.com/YtAc3PaeFW

— Eleanor Terrett (@EleanorTerrett) March 20, 2024

“If this [inquiries to the Ethereum Foundation] — is true, then it explains why the SEC has been so cautious with issuers. The staff may be waiting for any lingering investigations to wrap before Gensler gives them direction,” she suggested.

Earlier, Terrett explained the regulator’s behavior as being under pressure from Senator Elizabeth Warren, exerted on the SEC head. According to her, she was stunned by the approval of spot exchange-traded funds based on the first cryptocurrency.

Additional Reasons

As one of the reasons for the “attack,” lawyer Scott Johnsson cited the “political factor.” In his opinion, Gensler needed to appease crypto-skeptics in power circles. The latter demand a tougher stance from the agency.

Big Boss (Part V)
Following leaks of a SEC campaign seeking to investigate the security status of ETH, I have some thoughts as to how this may fit into the current SEC landscapehttps://t.co/ti89MKwoc6

— Scott Johnsson (@SGJohnsson) March 21, 2024

Johnsson noted that the investigation would also help the Commission reject proposals for a spot Ethereum ETF, avoiding “undermining arguments” in lawsuits against Coinbase and Binance.

As a third version, he named the agency’s desire to take a “soft approach,” stating an ongoing investigation into ETH’s status instead of using enforcement measures.

The expert emphasized that as a formal reason for refusal, the SEC could cite insufficient correlation between futures and spot ETH markets.

Balchunas agreed that the indicator is not as convincing as it was in the case of Bitcoin. According to Johnsson, the situation may be temporary, as “correlation levels improve over time.”

Potential manipulation risks were also mentioned by BloFin specialists and industry lawyer Jake Chervinsky. Uncertainty is also added by the PoS mechanism, particularly due to the staking provision in several issuers’ proposals.

Postponed for Now, Approved Later?

ETF Store President Nate Geraci noted that the best time for the SEC to declare ETH a security was before the approval of ETH futures ETFs in October 2023. But that did not happen.

If SEC was going to argue eth = security, the time to do it was *BEFORE* they approved eth futures ETFs last Oct…

They didn’t do that.

Why not? Was perfect opportunity.

Also too late to make correlation argument IMO. If ok w/ grandma buying eth futures ETF, then why not spot?

— Nate Geraci (@NateGeraci) March 21, 2024

“In my opinion, it’s too late to make correlation arguments. If grandma [can buy] a futures ETH ETF, then why not a spot ETF?”, the expert wondered.

Former CFTC Commissioner and a16z partner Brian Quintenz noted that the SEC had already “clearly recognized” Ethereum’s status as not related to securities. This occurred in October 2023 when the agency approved Ethereum futures ETFs. He emphasized that this happened after The Merge.

3/ If the SEC had any doubt about the regulatory treatment of ETH in Oct 2023, it wouldn’t have approved the ETF. If ETH were in fact a security, then the CFTC-listed futures contracts (on which the ETFs were based) would be illegal, as any derivative on ETH would be considered…

— Brian Quintenz (@BrianQuintenz) March 20, 2024

“If ETH were a security, it would mean that CFTC-listed futures ETH ETFs would be illegal, as any derivatives on ETH would be considered a futures contract on securities and thus subject to different rules,” he explained.

Coinbase’s Chief Legal Officer Paul Grewal also noted Gensler’s inconsistency regarding ETH’s status. The expert emphasized that the SEC “has no valid reasons to reject ETH-ETF applications.”

Ripple CEO Brad Garlinghouse predicted that the Commission would eventually face another defeat.

The SEC picked fights with the industry and is losing badly in the Courts. They’re now fighting fellow regulators like the CFTC, and falling behind international counterparts. At what point will the SEC realize they will lose the war against ETH just as they lost against XRP? https://t.co/rG66npldf4

— Brad Garlinghouse (@bgarlinghouse) March 21, 2024

“The SEC picked fights with the industry and is losing badly in the courts. They’re now fighting fellow regulators like the CFTC and falling behind international counterparts. At what point will the SEC realize they will lose the war against ETH just as they lost against XRP?” wrote the top executive.

Potential confrontation with the CFTC regarding mandate boundaries and ETH was highlighted in an interview with CoinDesk by Columbia Business School associate professor Austin Campbell. The expert noted that many companies, investors, and exchanges interact with ETH. Unilateral steps to recognize the asset as a security would have “serious consequences for the US,” he added.

“You can’t just arbitrarily change your mind and harm people by hundreds of billions of dollars after a decade. The CFTC is likely to push back,” Campbell pointed out.

Will the “Crypto Mom” Prophecy Come True?

BlackRock’s Head of Digital Assets Robert Mitchnick did not focus on ETH in his latest speech, which can be perceived as a lack of high expectations for May.

?NEW: @BlackRock’s Head of Digital Assets Robert Mitchnick addresses how the asset manager is thinking about other #crypto products:

“For our clients, Bitcoin is overwhelmingly the number one priority. And then a little bit ethereum, and very little everything else.”

He says…

— Eleanor Terrett (@EleanorTerrett) March 22, 2024

“For our clients, Bitcoin is overwhelmingly the number one priority. And then a little bit of Ethereum, and very little of everything else,” stated the top manager.

It remains to be seen how events will unfold. Will the SEC “hear” the community’s arguments at some point and backtrack? As per Seyffart, the ETH-ETF might be approved later — in 2025.

Bitwise CIO Matt Hougan saw this as a plus, considering the May 23 target “not ideal.” He explained his position by the need to prepare for “digesting” digital gold-based instruments before switching to alternatives. An optimal period would be eight to nine months after the launch of BTC-ETF, he added.

In a pessimistic scenario, the industry will have to achieve its goals through the courts. Commissioner Hester Peirce mentioned such a prospect, which she “would not want to face again.” Back in January, she expressed hope that the product would not require a court case [Grayscale against the agency regarding ETHE] for approval.

There is also the option of changing SEC leadership, which will be possible following the US presidential elections in November. But that’s another story. Johnson, for example, considers a whole range of catalysts.

There should be a list of catalysts likely to happen next year if we get a new admin and change in SEC leadership, including:

1) Regulated futures for SOL and a ton of other projects;
2) ETH spot ETF;
3) $COIN enforcement withdrawal?
$COIN & @standwithcrypto has $70+M warchest… https://t.co/L8IrO5B5Fg

— Scott Johnsson (@SGJohnsson) March 25, 2024

Among them:

• regulated futures for SOL and other assets;
• spot ETH-ETF;
• withdrawal of enforcement action against Coinbase.

Analysts at Standard Chartered previously estimated the total inflow into ETH-ETF in the next 12 months, should it be approved, at $45 billion. For comparison, from January 10 to March 21, BTC-ETF received $11.3 billion.