Opinion: SEC is Chasing The difficulties of Ethereum Spot ETF
Colin Wu . 2024-03-25 . Data
Griffin Ardern is the head of the options trading and research departments at BloFin Academy. Below is his in-depth analysis of the current cryptocurrency market situation.


Current Progress of the Ethereum ETF Approval & Its Significance

Compared to Bitcoin ETFs, Ethereum ETFs, particularly those based on Ethereum futures, are relatively smaller in terms of size and trading volume. The largest Ethereum futures ETF has assets under management (AUM) of less than $100 million, which is significantly smaller when compared to some Bitcoin ETFs. However, it is noteworthy that this represents the largest AUM among Ethereum futures ETFs, with others having even lower AUM, which could be considered negligible.

The approval of an Ethereum spot ETF could lead to increased investment, funds, and liquidity flowing from the U.S. stock market, supporting Ethereum’s price. This could mirror the impact seen with Bitcoin, where external liquidity significantly boosted its price, leading to new all-time highs in a relatively short period. However, there are challenges and uncertainties regarding the approval of Ethereum ETFs.

If an Ethereum ETF is approved, it could set new standards and provide examples for other cryptocurrencies, such as Solana, to apply for their ETFs, particularly those seeking to launch spot ETFs. These cryptocurrencies share similar features with Ethereum, such as proof of stake and staking mechanisms.

Approval of Ethereum ETFs by entities like BlackRock could pave the way for ETFs covering other cryptocurrencies, broadening the scope of crypto assets available to investors through regulated financial products. On the contrary, if an Ethereum ETF is rejected, it could imply that only cryptocurrencies following the same standards as Bitcoin, such as proof of reserve, would be considered for ETFs. This would exclude cryptocurrencies based on proof of stake (PoS) from ETF consideration.

In summary, the approval of Ethereum ETFs is seen as a critical and potentially transformative step for the future of cryptocurrency ETFs. It would not only benefit Ethereum but also set a precedent for how other cryptocurrencies, especially those based on PoS, might be integrated into mainstream financial products. This development is eagerly awaited by the crypto community, as it could significantly impact liquidity, investment, and the broader acceptance of cryptocurrencies.

What Do You Think About the Probability of Approval?

Considering the current landscape and regulatory environment, the approval of an Ethereum ETF faces several significant challenges, particularly from the perspective of the Securities and Exchange Commission (SEC). The SEC, under the leadership of Chairman Gary Gensler, has indicated a preference for cryptocurrencies that adhere to a standard similar to Bitcoin. This poses a particular challenge for Ethereum due to its security and securitization risks.

The initial coin offering (ICO) of Ethereum, which took place in 2014, and the way in which its assets were distributed, raise concerns about centralization and the security label. A significant portion of Ethereum was sold during its ICO, and a considerable amount remains held by the Ethereum Foundation and early investors. This concentration of holdings could be seen as a departure from the decentralization characteristic of cryptocurrencies like Bitcoin.

Furthermore, Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS) introduces another layer of complexity. This shift potentially alters Ethereum’s classification, moving it away from the “commodity” category closer to that of securities due to the staking mechanism and the rewards it generates, akin to dividends from stocks.

The SEC has also expressed concerns about the potential for market manipulation within the Ethereum ecosystem, especially given the influence that major holders and protocols involved in staking could wield over the network. The infinite supply of Ethereum, despite its deflationary mechanisms, might also contribute to the SEC’s hesitation, given the preference for assets with a capped supply or clear deflationary policies.

Based on these considerations, it appears that the probability of the SEC approving an Ethereum spot ETF in the near term is relatively low. The concerns around security classification, centralization, market manipulation, and the shift to PoS present substantial hurdles. However, the future remains uncertain, and regulatory perspectives could evolve, especially if Ethereum’s infrastructure and governance address some of these concerns effectively. The possibility of approval exists but is clouded by significant regulatory challenges that need to be navigated.

Will SEC Respect the Argument in Greyscale’s Court Order?

Grayscale’s legal challenge against the SEC over the approval of a Bitcoin ETF while denying similar applications for Ethereum ETFs has brought significant attention to the regulatory landscape surrounding cryptocurrencies. This challenge highlights the perceived inconsistencies in the SEC’s approach to different cryptocurrencies and the criteria it uses to evaluate them.

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 the overall security classification of Ethereum, have been pivotal in its hesitance to approve an Ethereum ETF. Grayscale’s argument, if it effectively challenges the SEC’s stance, may compel the SEC to reconsider its position, especially if the court orders favor Grayscale’s perspective.

If the court sides with Grayscale, suggesting that the SEC’s treatment of Ethereum ETF applications lacks consistency or fairness compared to Bitcoin, the SEC might be pressured to align its approval processes more closely. This could involve re-evaluating Ethereum under its new PoS mechanism and addressing the specific concerns that have been raised about security, decentralization, and market manipulation risks.

However, it’s important to note that the SEC’s approval decisions are complex and multifaceted, taking into account a wide range of regulatory, market stability, and investor protection concerns. The outcome of Grayscale’s challenge could indeed influence the SEC’s approach, but the extent to which it will impact the approval of Ethereum ETFs remains uncertain.

The Price Before and After the Decision Announcement

In the cryptocurrency options market, traders have begun to account for the potential announcement of an Ethereum ETF approval or rejection. This anticipation is evident in the implied volatility (IV) of Ethereum options, particularly those expiring in May and June, which exhibit higher IVs. This suggests traders expect greater volatility and price movement for Ethereum around the announcement period.

Based on the most recent data, if the Ethereum spot ETF is not approved or outright rejected, there’s an expectation that the price of Ethereum could drop significantly, by more than 20% to 25%. Conversely, if the ETF is approved, the price could surge by a similar margin, reflecting the market’s reaction to positive news, similar to past events with significant crypto announcements.

Interestingly, the skew in the options market — reflecting the imbalance between call and put option prices — indicates a negative skew for near-term options expiring in March and April. This shows a market tendency to hedge against the downside risk, likely stemming from concerns over the ETF’s potential disapproval. For longer-term options, the skew appears neutral to slightly positive, suggesting a more balanced view or slight optimism about Ethereum’s future beyond the immediate announcement period.

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

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

The Bank of Japan’s (BoJ) interest rate adjustments have significant implications, especially considering the yen carry trade, a prevalent strategy in global finance. The yen carry trade involves borrowing in Japanese yen, which historically has had low interest rates, to invest in higher-yielding assets elsewhere, often denominated in US dollars. This strategy profits from the interest rate differential between the two currencies and the potential appreciation of the invested assets.

Before any potential rate hike by the BoJ, investors could borrow cheaply in yen, invest in higher-yielding US assets or other markets, and benefit as long as the yen remained weak against the US dollar. The collateral, often Japanese government bonds (JGBs), would maintain its value, facilitating this trade.

However, should the BoJ decide to increase interest rates, the dynamics of this trade could shift dramatically. Higher Japanese interest rates would likely strengthen the yen against the US dollar, reducing the attractiveness of the yen carry trade. Furthermore, if the BoJ ends its Yield Curve Control (YCC) policy — aimed at keeping long-term interest rates at a target level — it could lead to higher yields on JGBs, reducing their price and affecting the collateral value for those engaged in the carry trade.

As a consequence of a rate hike and potential end to YCC, investors might be compelled to liquidate their US dollar-denominated investments to repay yen-denominated borrowings. This could lead to selling pressure in various asset classes, including US stocks, cryptocurrencies, precious metals like gold and silver, oil, and other commodities. Essentially, assets that benefited from the inflow of cheap yen could see reduced demand and lower prices.

The impact of the BoJ’s rate hike extends beyond the carry trade. It signifies a shift in Japan’s monetary policy stance, potentially leading to a stronger yen. A stronger yen would make yen-denominated assets more attractive and could reverse the flows from US dollar-denominated assets, impacting global asset prices and possibly leading to a reevaluation of risk across global financial markets.

Discussing the Current Crypto Market

The volatility in the crypto market has led to significant price drops, compelling those unable to meet their debt obligations on time to face margin calls or even liquidation. This situation necessitates the selling of assets to settle debts, potentially making it an opportune moment to invest in undervalued assets such as the Japanese yen or the Nikkei 225. The strengthening of the Japanese yen suggests an improvement in the performance of yen-denominated assets, encouraging investors to shift from USD-denominated to yen-denominated assets, thereby affecting the liquidity and value of the former.

Bitcoin seems to fare better in these conditions, benefiting from more diversified liquidity sources, including both the U.S. stock and cryptocurrency markets. Additionally, Bitcoin prices are supported by market makers’ hedging activities during downturns, unlike Ethereum, which relies more heavily on cryptocurrency market liquidity and lacks similar support, leading to potentially greater price declines.

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

Ethereum’s performance may improve following anticipated Federal Reserve rate cuts, which could increase market liquidity. However, currently, Ethereum suffers from a lack of diverse liquidity sources, relying mainly on stablecoins like USDT and USDC. In contrast, Bitcoin benefits from multiple liquidity channels, suggesting a shorter duration for any potential market pullback for Bitcoin as opposed to Ethereum and other altcoins, which may experience prolonged downturns.

The approval and launch of Bitcoin spot ETFs have cemented Bitcoin’s status as a key global macro asset with solid links to traditional markets, unlike Ethereum and other altcoins, which lack such connections. This distinction means altcoins can only perform better when market conditions, driven by factors like Federal Reserve rate cuts, favor increased liquidity in the cryptocurrency market.

Market inflow dynamics are changing, with Bitcoin asset allocation driving continued interest, particularly in ETFs like BITO and those offered by BlackRock, despite outflows in products like GBTC. This continued inflow, even amidst overall market outflows, underscores Bitcoin’s resilience and its appeal to investors in the U.S. stock market and institutional sectors, anticipating sustained support.

Altcoins vs BTC

In the discussion about Altcoins versus Bitcoin, we’re all essentially seeking the most favorable outcomes. However, focusing on more realistic scenarios, such as the rejection of external factors, reveals that price movements in Ethereum and other altcoins are primarily influenced by two factors. Firstly, the allocation of liquidity in the cryptocurrency market plays a crucial role. With approximately $1.5 trillion allocated in the crypto market, Ethereum and altcoins compete for this liquidity. However, in the long term, it’s expected that the Federal Reserve will implement rate cuts, with two or three reductions anticipated this year and potentially more next year. This adjustment is likely to reintroduce liquidity to the crypto market, subsequently supporting the prices of Ethereum and other altcoins.

Currently, Bitcoin is expected to outperform, maintaining stronger performance due to the overall bullish market conditions. In contrast, altcoins may experience relative weakness as they navigate through limited liquidity. This situation is particularly relevant for traders in the Asia-Pacific region, who play a significant role in investing in lesser-known coins and altcoins. Presently, these traders are inclined to purchase more Bitcoin and other mainstream cryptocurrencies like Ethereum or Solana.

The crypto market is increasingly segmented into sub-markets. One focuses on Bitcoin and mainstream cryptocurrencies, with investments driven by global macroeconomic changes. The other, which could be termed the speculative market, includes Ethereum, certain emerging coins, and meme coins. In this segment, traders, especially those from the Asia-Pacific region, engage in speculative trading to capitalize on the limited liquidity available.

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