Why the SEC Might Reject Spot Ether ETFs

The approval of spot bitcoin ETFs in the US in January was a major milestone for the cryptocurrency industry. With the successful launch in the rear-view mirror, investors are now hoping for spot Ether ETFs, but the outlook for them is murkier.

In the past few months, several firms, including BlackRock, Fidelity, Ark, Grayscale, and VanEck, have applied to issue spot ether ETFs, which would track the price of the native cryptocurrency of the Ethereum blockchain, ETH. May 23 is the final deadline for the SEC to make a decision on some of these applications.

While there is a lot of anticipation for ether ETFs, there are also some concerns that the Securities and Exchange Commission (SEC) may reject them, especially when looking at the timeline of events ahead of the approval of spot Bitcoin ETFs.

On the Unchained podcast, Eric Balchunas, senior ETF analyst at Bloomberg Intelligence and part of the team that called the exact spot bitcoin ETF approval date, said, “I was a little more optimistic a month ago.” Then, referencing his teammate in projecting the spot bitcoin ETF approvals, he said, “My partner in crime in this – we’re more like 50%.”

Hints That Things Are Different for the Spot Ether ETFs

The reason that people had been expecting spot ether ETFs to sail through was that both bitcoin and ether have one thing in common that other crypto assets do not have: both serve as the underlying asset for futures ETF products. In order for that to happen, both assets had been classified as commodities so that those futures products could be approved.

However, despite that, Grayscale had to sue the SEC and win in order for the agency to acquiesce and approve the spot bitcoin ETFs. On the day of the approvals, SEC Chair Gary Gensler published a statement emphasizing that the SEC’s hand was forced by the court and barely hiding some disdain for bitcoin itself, calling it “primarily a speculative, volatile asset that’s also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing.”

So one of the first big differences between the quest to get spot ether ETFs vs spot bitcoin ETFs approved is that, although years ago, bitcoin and ether were both classified as commodities ahead of the approval of their futures ETFs, no company is currently suing the SEC (which would be any applicant’s existing or future regulator) in order to get spot ether ETFs approved.

In fact, as Balchunas pointed out during the podcast, Grayscale, who was motivated to sue the SEC in order to be able to convert the assets in its Bitcoin trust to an ETF, might not be willing to do so for its Ethereum trust since the SEC approved all spot Bitcoin ETFs to begin trading at the same time. Basically, Grayscale, after spending a lot of money on this lawsuit, then ended up in a race with nine other spot ETF issuers and losing market share rather than keeping its first-mover advantage.

Another reason for skepticism that the SEC will approve the spot ether ETFs by May 23 is the fact that applicants are not at the same level of talks with the SEC as the spot bitcoin ETF applicants were at by the same point in the timeline up to the May 23 deadline.

Although, during the podcast, Balchunas thought of a hypothetical reason that the current level of talks may not be meaningful, he said it personally still gives him pause. “Now there’s obviously a template [for spot crypto asset ETFs] set up now because of all the work they did on the bitcoin prospectuses, but you’d think they would reach out at some point because ETH does have its specifics that you have to work on. So until we see engagement, we’re going to remain pretty mild on our odds.”

This hasn’t stopped crypto ETF watchers from pointing out that Coinbase had a meeting with the SEC on March 6. However, Balchunas tweeted in response to the discussion of that, “Normally I’d say this was [a] good sign but as far as I know the Staff has not given any comments yet to the issuers, which is not a good sign as we [are] past when they gave comments on btc ETFs.”

Concern About Correlation Between Ether Futures Versus Spot

Despite these differences, it does still leave the fact that the mere existence of the ether futures ETFs means that at some point, the SEC did agree to classify ether as a commodity. So, some watchers believe that the SEC may try to deny the ether ETFs using the same reason it had originally given for disapproving spot bitcoin ETFs during the period after bitcoin futures ETFs had been approved: a gap in the correlation of the futures and spot prices.

Spot and futures markets are theoretically linked, with prices expected to converge near a contract’s expiration date. This correlation is influenced by factors like storage costs, convenience yield, and market efficiency. The SEC typically expresses concern when the correlation is low as it could suggest fraud and manipulation within the spot market.

Balchunas, who didn’t have exact numbers, said “the correlation between ether and ether futures [may not be] not as great as bitcoin and bitcoin futures, and that is possibly what they’re going to use in a rejection.”

What eventually forced the SEC’s hand in the court case with Grayscale was the judges pointing out the tight correlation between the bitcoin futures and spot bitcoin prices.

This raises the question: what is the correlation between the prices of ether futures and spot ether?

Some players in the space are attempting to answer that question in order to pre-empt a rejection based on that reasoning by the SEC. For instance, Coinbase did an analysis of bitcoin futures and spot bitcoin similar to that of the SEC (though their data sample includes a few additional months) which showed much tighter spreads between the two – for instance, 99.1% on an hourly basis as opposed to 98.4% by the SEC, and 96.4% on a 5-minute basis as opposed to 94.6% by the SEC.

Coinbase’s analysis also included ETH futures and spot, at 99.3% correlation on an hourly basis and 96.2% on a 5-minute basis. The Commission’s analysis on ether futures vs. spot remains to be seen, but some crypto asset ETF watchers believe that the SEC may be setting up to deny based on this reasoning.

Reacting to the news of the SEC’s meeting with Coinbase (but not any issuers), Scott Johnson, a finance lawyer at Davis Polk & Wardwell, said on X, “This indicates to me that the SEC is likely going to approve/deny on the basis of correlation (which shouldn’t be a surprise). Why bring in Coinbase to discuss their correlation analysis before the actual issuers?”

So, What’s Next?

Not only is there no lawsuit against the SEC over a spot ETH ETF (as Balchunas said on the podcast, “It’s weird to sue the SEC”), but few of the applicants may be financially motivated to do so. “How much money is actually available for ether ETFs?” Balchunas asked. “Not that much in my opinion. Just look at the futures and they would give you some guide to the interest in that market.”

He says that if the SEC denies, “this will sort of become a thing. It’ll have them tangling with the industry again.” For that reason, he says, if he were the SEC, he would approve just to “move on with my life.” However, because the SEC may have gotten political blowback for approving the spot bitcoin ETFs, he says denying the spot ether ETFs might be like “throwing a bone to some of the people who were pissed off just to say, just prove, ‘We are not into this stuff.’”

For now, eyes will not only be on the SEC and its communications with applicants but also its analysis of the correlation numbers. At this point, the only certainty is that the spot ether ETF approval is not the slam dunk that some observers had been hoping for.