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On May 23, another milestone on digital assets’ road to mainstream adoption was reached, as the U.S. Securities and Exchange Commission (SEC) paved the way for eventual issuer approval of Ethereum (ETH) Exchange-Traded Funds (ETFs). The SEC has begun with the approval of eight issuers, although final approval is likely still some time away pending S-1 fillings. This approval mirrors the approval of Bitcoin (BTC) ETFs earlier this year, signifying growing regulatory acceptance of cryptocurrencies and their integration into mainstream financial markets.
The approval of Ethereum ETFs follows a rigorous application process and extensive market analysis, similar to the pathway that Bitcoin ETFs traversed. A key part of this is the use of CME data to prevent fraud and manipulation, which forms part a substantial part of the key requirements for the ETH ETF approval order. Indeed, the scope of the order is largely based around protection of investors and whether the ETFs could provide this.
Whilst ETH and BTC share similarities their underlying technologies and value propositions differ quite substantially. BTC is often compared to that of digital gold (with scarcity and predictable and limited issuance key points) acting as a store of value. Proponents say Ethereum’s value is derived from its utility as a platform for building and deploying decentralized applications (dApps) and smart contracts. The demand for ETH is partially driven by the need to pay transaction fees (known as “gas”) for executing smart contracts and using dApps on the Ethereum network. As a result, as adoption and usage of Ethereum-based applications increase, the demand for ETH is expected to rise, potentially driving its value higher.
The SEC's decision to greenlight these ETFs reflects a broader trend towards recognizing digital assets as legitimate investment vehicles. Key players in the financial sector following their BTC ETF products, are now poised to launch their Ethereum ETFs, further cementing the role of cryptocurrencies in institutional investment portfolios.
The introduction of Bitcoin ETFs in January 2024 set a precedent that significantly impacted the market, increasing investor confidence and driving substantial inflows into the digital asset space, with Bitcoin ETFs inflows around the $58 billion mark. Ethereum, the second-largest cryptocurrency by market capitalization, has long been seen as a pivotal player in the blockchain ecosystem due to its smart contract capabilities and widespread use in decentralized finance (DeFi).
The SEC's approval of Ethereum ETFs is poised to significantly boost Ethereum's market position. Institutional investors, who have been sitting on the sidelines due to regulatory concerns, are now expected to enter the market, bringing with them substantial capital and market influence. This influx of institutional investment is anticipated to drive additional attention to the space and contribute to its long-term stability.
Despite the positive outlook, the approval of Ethereum ETFs does not come without challenges. The SEC's cautious approach to cryptocurrency regulation remains evident, particularly concerning Ethereum's staking feature.
Staking is the process of locking up or "staking" ETH to become a validator on the Ethereum network. Validators are responsible for coordinating with various actors in the network to verify transactions, create new blocks, and verify the integrity of the blockchain. In return, validators earn rewards in the form of newly minted ETH. To become a validator, users must stake 32 ETH, which acts as an incentive to maintain honest behavior and secure the network. If a validator acts maliciously, their staked ETH can be slashed partially or fully removed as a penalty.
The SEC’s comments in the order specifically call out that Ethereum’s staking feature is considered outside the scope of the order. Because the agency has previously scrutinized staking services, some issuers have elected to address these regulatory concerns by excluding staking from their ETH ETF plans. This scrutiny could lead to further regulatory challenges for Ethereum and other cryptocurrencies that employ similar mechanisms as the SEC argued that these appear to be security-like products as they resembled investment contracts where ETH is invested with the expectation of profits.
This decision is likely to influence regulatory approaches in other jurisdictions, as regulators worldwide closely monitor developments in the United States. Countries with established cryptocurrency ecosystems, such as Europe, Asia, and the Middle East, may follow suit and explore the approval of similar ETF products. Indeed, in March the FCA (Britain's financial watchdog) approved the launch of crypto-backed exchange-traded notes for professional investors. the first of which was listed a day before the SEC approval.
The SEC's potential approval of Ethereum ETFs represents a significant milestone in the integration of digital assets into mainstream financial markets. It builds on the foundation laid by Bitcoin ETFs, providing further evidence of the maturing cryptocurrency market. Several prominent companies now include Bitcoin directly on their balance sheets. This reflects a nascent but growing market acceptance as a legitimate asset class in mainstream industries. Moreover, these milestones are tilting the use-cases for digital assets from short-term speculation to long-term investment opportunities.
However, the journey is not without its challenges. Regulatory scrutiny, particularly around staking, market manipulation and consumer protections will continue to shape the landscape. The industry must navigate these challenges to harness the full potential of digital assets and ensure their sustainable growth in the global financial system. We are already seeing DeFi assets appear in the work we do relating to solvency and litigation; but are increasingly being asked to help shape the future of digital assets relating to compliance standards, customer engagement, and tokenization.
At AlixPartners, we see many of our clients remaining engaged in the digital asset space, pushing the boundaries of innovation, while working in good faith with regulators, counsel, customers, and vendors to build strategies to leverage the unique options provided by digital assets. We continue to lean on our cross-industry expertise, proprietary blockchain tools, and “operator mindset” to offer valuable support for clients seeking to enhance compliance programs, design digital products, perform forensic analyses, or identify new business opportunities.
