The SEC is everywhere, what challenges does the Ethereum spot ETF face?

Griffin Ardern is Head of Research at BloFin Academy. Below is his analysis of the current cryptocurrency market situation. Some content is translated by AI and may contain deviations.

Current Progress of Ethereum ETF Approval and Its Importance

Compared to Bitcoin ETFs, especially those based on Ethereum futures, Ethereum ETFs are relatively smaller in scale and trading volume. The largest Ethereum futures ETF has an Assets Under Management (AUM) of less than $100 million, significantly smaller than some Bitcoin ETFs. However, it’s worth noting that this represents the largest AUM in Ethereum futures ETFs, with other AUMs even lower, almost negligible.

The approval of Ethereum spot ETFs could lead to increased investment, capital, and liquidity from the US stock market, supporting Ethereum’s price. This could mimic the impact of Bitcoin, where external liquidity significantly boosted its price, leading to new all-time highs in a relatively short period. However, challenges and uncertainties regarding the approval of Ethereum ETFs still exist.

If Ethereum ETFs are approved, they could set new standards for other cryptocurrencies and provide examples for them to apply for their own ETFs, especially those seeking to launch spot ETFs. These cryptocurrencies share similar characteristics with Ethereum, such as proof of stake and staking mechanisms.

Entities like BlackRock approving Ethereum ETFs could pave the way for ETFs covering other cryptocurrencies, expanding the range of crypto assets available to investors through regulated financial products. Conversely, if Ethereum ETFs are rejected, it could mean that only cryptocurrencies adhering to standards similar to Bitcoin, such as proof of reserves, would be considered for ETFs. This would exclude proof of stake (PoS) based cryptocurrencies from ETF consideration.

In summary, the approval of Ethereum ETFs is seen as a crucial and potentially transformative step for the future of cryptocurrency ETFs. It will benefit not only Ethereum but also set a precedent for how other PoS-based cryptocurrencies integrate into mainstream financial products. The crypto community eagerly anticipates this development as it could have significant implications for liquidity, investment, and wider acceptance of cryptocurrencies.

Given the current landscape and regulatory environment, the approval of Ethereum ETFs faces several significant challenges, particularly from the perspective of the Securities and Exchange Commission (SEC). Under Chairman Gary Gensler’s leadership, the SEC has expressed a preference for cryptocurrencies that adhere to standards similar to Bitcoin. This poses a particular challenge for Ethereum due to its security and securitization risks. (The SEC recently began investigating the Ethereum Foundation after Ethereum’s transition to POS)

Concerns have been raised about centralization and security labels due to Ethereum’s initial coin offering (ICO) in 2014 and the distribution of its assets. A significant amount of Ethereum was sold during its ICO, and a considerable portion is still held by the Ethereum Foundation and early investors. This concentration of holdings may be seen as deviating from the decentralized characteristic unique to cryptocurrencies like Bitcoin.

Furthermore, Ethereum’s transition from proof of work (PoW) to proof of stake (PoS) introduces another layer of complexity. This transition could change Ethereum’s classification, moving it from the “commodity” category closer to the securities category, as staking mechanisms and rewards are similar to stock dividends.

The SEC has also expressed concerns about potential market manipulation within the Ethereum ecosystem, especially considering the significant holders and protocols involved in staking protocols that could influence the network. Despite its deflationary mechanisms, Ethereum’s infinite supply may also give the SEC pause, given its preference for assets with capped supplies or explicit deflationary policies.

Based on these considerations, it appears that the likelihood of the SEC approving Ethereum spot ETFs in the short term is relatively low. Concerns surrounding security classification, centralization, market manipulation, and the shift to PoS pose significant obstacles. However, the future remains uncertain, particularly if Ethereum’s infrastructure and governance effectively address these concerns, regulatory perspectives may evolve. The possibility of approval exists but is overshadowed by significant regulatory challenges that need to be navigated.

Will the SEC Respect the Arguments in Grayscale’s Court Order?

Grayscale’s challenge to the SEC’s denial of an Ethereum ETF application, citing approval of a similar application for a Bitcoin ETF, has sparked significant attention to the cryptocurrency regulatory environment. This challenge highlights perceived inconsistencies in the SEC’s views on different cryptocurrencies and their evaluation criteria.

The SEC’s concerns about Ethereum, especially regarding its transition from proof of work (PoW) to proof of stake (PoS), the potential for market manipulation, and Ethereum’s overall security classification, are key factors in its reluctance to approve an Ethereum ETF. If Grayscale’s arguments effectively challenge the SEC’s position and if the court supports Grayscale’s viewpoint, it could compel the SEC to reconsider its stance.

If the court sides with Grayscale, indicating that the SEC’s handling of Ethereum ETF applications lacks consistency or fairness compared to Bitcoin, the SEC may come under pressure to make its approval process more consistent. This may involve reevaluating Ethereum under its new PoS mechanism and addressing specific concerns about security, decentralization, and market manipulation risks.

However, it’s important to note that the SEC’s approval decision is complex and multifaceted, considering a range of regulatory, market stability, and investor protection concerns. The outcome of Grayscale’s challenge may indeed influence the SEC’s approach, but the extent of its impact on the approval of an Ethereum ETF remains uncertain.

Price Before and After the Decision Announcement

In the cryptocurrency options market, traders have begun to consider the potential announcement of the approval or rejection of an Ethereum ETF. This anticipation is reflected in the implied volatility (IV) of Ethereum options, especially those expiring in May and June, showing higher IV. This indicates that traders expect greater volatility and price movements in Ethereum during the announcement period.

According to the latest data, if the Ethereum spot ETF is not approved or directly rejected, Ethereum’s price is expected to drop significantly, exceeding 20% to 25%. Conversely, if the ETF is approved, the price may rise by a similar magnitude, reflecting the market’s reaction to positive news, similar to past significant cryptocurrency announcements.

Interestingly, the skewness of the options market — reflecting the imbalance between call and put option prices — shows negative skewness for options expiring in the near term, such as March and April. This indicates that the market tends to hedge against the downside risk of potential ETF non-approval. For longer-term options, the skewness appears to be neutral to slightly positive, indicating a more balanced or slightly optimistic view of Ethereum’s future beyond the immediate announcement period.

Additionally, the butterfly spread, which provides insight into pricing tail risks, shows that Ethereum’s index is significantly higher than Bitcoin’s. This may even exceed the average annual index, indicating that traders, investors, and market makers are pricing in higher tail risks for Ethereum. This heightened concern may be related to the uncertainty of ETF approval and its potential impact on Ethereum’s price.

What Will Be The Impact of Bank of Japan’s Interest Rate Adjustment?

The Bank of Japan’s (BoJ) interest rate adjustment is significant, especially considering yen carry trades, which are a popular strategy in the global financial markets. Yen carry trades involve borrowing yen at historically low rates and investing in higher-yielding assets elsewhere, typically denominated in dollars. This strategy profits from the interest rate differential between the two currencies and the potential appreciation of the invested assets.

Before the BoJ potentially raises interest rates, investors can borrow yen at low costs and invest in higher-yielding assets in the US or other markets, profiting as long as the yen remains weak against the dollar. Japanese government bonds (JGBs) serving as collateral will maintain their value, facilitating this trade.

However, if the BoJ decides to raise rates, the dynamics of this trade could change dramatically. Higher rates in Japan could strengthen the yen against the dollar, reducing the attractiveness of yen carry trades. Additionally, if the BoJ ends its Yield Curve Control (YCC) policy — aimed at keeping long-term rates at target levels — it could lead to an increase in JGB yields and a decrease in their prices, affecting the collateral value for carry traders.

Due to the rate hike and the potential end of YCC, investors may be forced to liquidate their dollar-denominated investments to repay yen-denominated loans. This could lead to selling pressure on various assets, including US stocks, cryptocurrencies, precious metals like gold and silver, oil, and other commodities. Essentially, assets that benefited from cheap yen inflows may see reduced demand and price declines.

The impact of the BoJ’s interest rate adjustment extends beyond carry trades themselves. It marks a shift in Japan’s monetary policy stance, which could lead to yen strength. Yen strength would make yen-denominated assets more attractive and could potentially reverse the flow of funds from dollar-denominated assets to yen-denominated assets, impacting global asset prices and potentially prompting a reassessment of risk in global financial markets..

Discussion On The Current Cryptocurrency Market

The Cryptocurrency Market Volatility Leads to Significant Price Declines, forcing those unable to meet debt obligations to face additional margin calls or even liquidation. This situation necessitates selling assets to repay debts, potentially providing an opportunity for investments such as the yen or undervalued assets like the Nikkei 225. The yen’s strength implies an improvement in the performance of assets denominated in yen, encouraging investors to shift from assets denominated in dollars to those denominated in yen, thereby affecting the liquidity and value of the former.

In these conditions, Bitcoin appears to perform better, benefiting from more diversified liquidity sources, including the US stock market and the cryptocurrency market. Additionally, Bitcoin’s price is supported by market maker hedging activities during market downturns, unlike Ethereum, which relies more on liquidity from the cryptocurrency market, lacking similar support, leading to potentially larger price declines.

Observations from on-chain data show that despite recent price increases, large Ethereum holders (“whales”) continue to sell, indicating a lack of confidence in Ethereum’s short-term price stability. This selling pressure is exacerbated by panic selling during price declines. The decrease in the exchange rate between Ethereum and Bitcoin reflects investors’ expectations of Ethereum’s underperformance compared to Bitcoin.

It is expected that Ethereum’s performance may improve after a Federal Reserve rate cut, which could increase market liquidity. However, currently, Ethereum lacks diversified liquidity sources, relying mainly on stablecoins like USDT and USDC. In contrast, Bitcoin benefits from multiple liquidity channels, implying that any potential market downturn may be shorter for Bitcoin, while Ethereum and other altcoins may experience longer periods of stagnation.

The approval and launch of a Bitcoin spot ETF have solidified Bitcoin’s status as a key global macro asset, closely linked to traditional markets, unlike Ethereum and other altcoins, which lack such connections. This difference means that altcoins can only perform better when market conditions, such as Federal Reserve rate cuts, support increased liquidity in the cryptocurrency market.

Market inflow dynamics are changing, with outflows observed in products like GBTC, but Bitcoin asset allocation continues to drive sustained interest, especially in ETFs offered by entities like BITO and BlackRock. Even amidst overall market outflows, this sustained inflow underscores Bitcoin’s resilience and its attractiveness to US stock markets and institutional sector investors, expected to receive continued support.

Altcoins vs Bitcoin

When discussing altcoins versus Bitcoin, we are essentially seeking the most favorable outcome. However, focusing on a more realistic scenario, such as excluding external factors, reveals that the price movements of Ethereum and other altcoins are mainly influenced by two factors. Firstly, the allocation of liquidity in the cryptocurrency market plays a crucial role. There is approximately $1.5 trillion allocated in the crypto market, with Ethereum and altcoins competing for this liquidity. However, in the long term, it is expected that the Federal Reserve will implement interest rate cuts, with two to three cuts expected this year and possibly more next year. This adjustment may reintroduce liquidity into the crypto market, subsequently supporting the prices of Ethereum and other altcoins.

Currently, Bitcoin is expected to perform stronger as overall market conditions are bullish. Meanwhile, altcoins may be relatively weak in a scenario of limited liquidity. This situation is particularly relevant for traders in the Asia-Pacific region, where they play an important role in investing in lesser-known coins and altcoins. Currently, these traders tend to buy more Bitcoin and other mainstream cryptocurrencies like Ethereum or Solana.

The cryptocurrency market is increasingly segmented into submarkets. One focuses on Bitcoin and mainstream cryptocurrencies, with investments driven by global macroeconomic changes. Another, known as the speculative market, includes Ethereum, certain emerging coins, and meme coins. In this segmented market, especially traders from the Asia-Pacific region, they leverage limited liquidity through speculative trading.

Overall, while we are all exploring the best investment outcomes, considering various factors including market liquidity, regulatory environment, and global macroeconomic impacts, the performance of Bitcoin, Ethereum, and other cryptocurrencies will vary. Future market trends will be influenced by numerous variables, including regulatory decisions, technological developments, and changes in investor sentiment. In this constantly changing environment, maintaining flexibility and staying abreast of market dynamics will be key to successful investment in the crypto market.

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