Crypto ETFs: A Second Wave Faces SEC Scrutiny

The recent approval of Bitcoin exchange-traded funds (ETFs) in the US has ignited a new battleground between asset managers and the Securities and Exchange Commission (SEC). As many as 12 companies, including industry giants like Grayscale and Fidelity, have filed applications to launch the next generation of crypto-linked ETFs, but the SEC is expected to take a cautious approach, potentially delaying their approval.

A History of Resistance

For over a decade, the SEC resisted approving spot Bitcoin ETFs, citing concerns about market manipulation and investor protection. This stance finally changed in January 2024 after Grayscale successfully challenged the SEC's reasoning in court.

This legal victory emboldened asset managers, leading to a surge of applications for various crypto ETFs. These products range from those tracking the price of Ether (ETH), the second-largest cryptocurrency, to complex leveraged and inverse products designed for day traders.

The SEC's Reluctance

Despite approving Bitcoin ETFs, the SEC remains apprehensive towards cryptocurrencies and complex financial instruments. Several factors contribute to this hesitation:

• Uncertainties around Ether (ETH): The legal status of Ether remains unclear, especially regarding its classification as a security or a commodity. This ambiguity adds another layer of complexity for the SEC to navigate.
• Concerns about investor risk: Complex products like leveraged and inverse ETFs can amplify market volatility, potentially exposing investors to significant losses. The SEC's past experiences with similar products, like a volatility-tracking note that went bust in 2018, further fuel their caution.
• Potential for legal challenges: Outright rejection of applications could invite legal battles, adding to the regulatory burden for the SEC.

The Approval Process: A Murky Path

The SEC's approval process for these new proposals lacks transparency. Unlike the standardised and speedy approval for options on existing Bitcoin ETFs, applications for the new wave could face significant delays. Additionally, the SEC hasn't engaged substantially with issuers yet, and the agency's future engagement remains unclear.

Navigating the Approval Process:

The SEC has several tools at its disposal to slow down the approval process for new crypto ETFs:

• Delaying filings: The SEC can raise questions and request additional information from issuers, extending the review period significantly.
• Suggesting withdrawal: If the SEC has concerns about a specific product, they may advise the issuer to withdraw the application.
• Formal rejection: Only in cases of materially misleading disclosures would the SEC formally reject an application, potentially triggering another legal battle.

Ether ETFs: A Separate Battleground

Applications for spot Ether ETFs present a unique challenge. Unlike Bitcoin ETFs that were approved within existing regulations, Ether ETFs require a rule change, imposing a deadline for SEC approval or denial. This adds another layer of pressure for both issuers and the regulatory body.

The outcome for Ether ETFs hinges heavily on the SEC's classification of Ether. While Bitcoin (BTC) is considered a commodity, the SEC hasn't made a similar determination for Ether. Its "proof-of-stake" blockchain mechanism, where users can earn rewards by locking up tokens, raises questions about whether it resembles a security.

This uncertainty casts a shadow over the future of Ether ETFs. While Grayscale, emboldened by its previous victory, may consider legal action if faced with rejection, the outcome remains uncertain.

Navigating a Sea of Uncertainty

The future of non-Bitcoin crypto ETFs in the US remains shrouded in uncertainty. While the initial approval of Bitcoin ETFs marked a significant step forward, the path for more complex products appears fraught with challenges. The SEC's cautious approach, coupled with the ambiguity surrounding Ether, suggests a prolonged period of regulatory scrutiny before widespread adoption of these new financial instruments. Only time will tell how this battle between innovation and regulation will unfold.

In addition to that, Ripple's XRF ETF and other crypto-related products are likely to encounter similar challenges and delays, reflecting the need for patience and a preparedness for potential bumps along the road in the journey towards broader crypto acceptance.

Regulatory Uncertainty Clouds Crypto Future

While the recent Bitcoin ETF approvals provide a glimmer of hope for broader crypto adoption, investors are increasingly frustrated with the SEC's slow pace and potential for further delays. The lack of regulatory clarity surrounding new crypto products, particularly with the upcoming U.S. presidential election potentially shifting regulatory stances, creates uncertainty and hinders investment decisions. Investors are eager for a clear framework that balances innovation with investor protection, allowing them to confidently capitalise on the potential of crypto-based financial instruments.