Why the SEC could choose to deny ether ETFs, and what could happen next

Yet another potential milestone for crypto is just days away.

Or, we may find out US spot ether ETFs are — for now — not meant to be.

The Securities and Exchange Commission’s decision on such funds by fund firms Ark Invest and VanEck, slated to come by May 23, is only half of what to watch for next week.

In the case of a denial, the SEC is set to give its reasoning. There is also the question of whether a lawsuit follows, how quickly it is filed, and who would lead that charge.

Expected reasons for possible denial

The SEC was essentially forced to approve spot bitcoin ETFs in January after Grayscale Investments notched a legal victory against the regulator.

Then there was SEC Chair Gary Gensler’s warning in his statement published a day before spot bitcoin ETFs launched on Jan. 11: “Today’s commission action is cabined to ETPs holding one non-security commodity, bitcoin.”

A reasonable interpretation: Not so fast, prospective ether ETF issuers.

“I think the SEC is aware that sponsors may assume an air of inevitability of additional spot crypto approvals once multiple crypto ETPs have been approved,” said Arie Heijkoop, partner at law firm Haynes Boone. “It will take an extra cautious approach as a result before approving any further spot crypto ETP — at least under this current administration.”

Perhaps the biggest elephant in the room is the SEC’s reticence to call ether a security or a commodity.

A March 8 filing confirms the regulator continues to mull this question, Van Buren Capital general partner Scott Johnsson said in an X post.

The SEC asks in the document whether the listing exchange — in this case Nasdaq — filed to properly list and trade shares of BlackRock’s proposed iShares Ethereum Trust “given the nature of the underlying assets held by the trust.”

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The document also asks whether arguments supporting the list of spot bitcoin ETFs apply to ether given “its proof of stake consensus mechanism and concentration of control or influence by a few individuals or entities.”

Indeed, K&L Gates partner Richard Kerr noted during an ETF Prime podcast last week that the proposed spot ether ETFs are registered under the Securities Act of 1933 as commodities-based products. They would not be allowed to trade under that designation if ether is deemed a security, he noted.

More likely, Kerr added, the SEC will “very carefully try to push the decision on ETH down the line” by saying the correlation between the ether futures and spot markets is not as strong.

The SEC allowed ETFs that hold ether futures contracts to start trading last October.

Matthew Sigel, VanEck’s head of digital assets research, said during the same podcast he does not believe such an argument holds water.

A March analysis by crypto asset manager Bitwise found the correlation values for the ether futures and spot markets, when compared to bitcoin, differ up to 0.2% for the hourly correlation, 5% for the five-minute correlation and 8% for the one-minute correlation.

“We think the SEC may use any reason, not necessarily a logical one, to disapprove,” Sigel said. “But we would highlight that the correlation between ethereum spot and ethereum futures…is similar to what the SEC found acceptable for the approval of spot bitcoin ETFs.”

Approved or not, multiple industry watchers previously told Blockworks the SEC would almost definitely not allow ether products that stake their holdings.

Ark Invest and 21Shares, which previously proposed for their planned fund to stake the fund’s ETH, did not include such language in a May 10 filing.

Would a lawsuit follow?

An SEC denial could be challenged, as the bitcoin ETF rejections ultimately were.

Some lawyers have told Blockworks a court decision could be the best route to seeing these products launch.

But Johnsson said he would be surprised to see a lawsuit after Grayscale withdrew its ether futures ETF application earlier this month.

Grayscale CEO Michael Sonnenshein reportedly said at an event hosted by the Financial Times that the firm “decided to focus our energy on our spot products.”

A company spokesperson declined to comment further on the proposal withdrawal.

Johnsson noted in a separate X post that keeping the product in registration would have put the SEC “on record with a 19b-4 order” related to ether futures.

A 19b-4 form is filed by stock exchanges and other entities to record a rule change with the SEC. A regulatory decision on such a rule change was “critical” in Grayscale’s legal victory against the SEC last year, Johnsson added.

Existing US ether futures ETFs, registered under the Investment Company Act of 1940, did not go through the 19b-4 process.

Heijkoop said he doesn’t expect Grayscale’s ether futures product withdrawal to impact a decision to sue the SEC, if it comes to that.

“If a litigant can show strong correlation between ether futures and spot prices, I think the same premise of the Grayscale bitcoin court ruling should provide legal precedent here, which is that disparate treatment of futures and spot market products is ‘arbitrary and capricious’ in cases where strong correlation is present,” Heijkoop told Blockworks.

Neena Mishra, director of ETF research at Zacks Investment Research, puts low odds on a lawsuit, noting the regulator should approve the products based on the correlation argument.

Issuers, she guessed, would re-apply for ether funds and hope for more engagement with the SEC within the next 240-day period.

“The legal process is costly, and spot ether ETFs are likely to attract much less interest from investors compared to spot bitcoin ETFs,” Mishra explained. “Moreover, with elections approaching, issuers may prefer to wait until the outcomes are known. They will hope for an SEC chair who is more favorable towards cryptocurrency.”

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