Why there may not be more US spot ETFs approved in the near future

Author: Ben Strack Source: blockworks Translation: Shan Ouba, Golden Finance

The approval of spot Bitcoin and Ethereum ETFs in the United States requires a regulated futures market - a precedent that may change. In addition to Bitcoin and Ethereum, spot crypto ETFs focusing on other assets can only be launched quickly if the current precedent changes.

In other words, the U.S. Securities and Exchange Commission (SEC) needs to see a regulated futures market - and correlation between the futures market and the spot market - before approving an ETF that directly holds cryptocurrencies.

In January, regulators approved a spot Bitcoin ETF. Last week, the SEC approved the 19b-4 proposal submitted by the exchange that launched the spot Ethereum ETF - a step towards future trading. While this latest move has sparked optimism that the market may focus on products such as Solana, XRP, and even Dogecoin in the future, SEC precedent does not support this hope in the short term.

"Without a functioning regulated market, I can't see the SEC approving it," said Bryan Armour, director of passive strategy research at Morningstar. He personally believes that the futures market does not reflect the situation in the underlying spot market more and its potential manipulation risks, but this is where the SEC draws the line.

The process from futures to spot

CME Group launched Bitcoin futures in December 2017. SEC Chairman Gary Gensler said at a virtual event in August 2021 that the committee "looks forward" to reviewing documents for Bitcoin futures contracts that are limited to CME trading. About two months later, ProShares launched the first Bitcoin futures ETF.

While the launch of a futures fund did not immediately pave the way for the launch of a U.S. spot Bitcoin ETF, it ultimately gave the process a major boost.

This is because Grayscale Investments sued the SEC in 2022, claiming that the regulator's decision to approve a Bitcoin futures fund but block spot Bitcoin products was "arbitrary and capricious."

Grayscale won the case last year, with the judge noting that "the Commission failed to reasonably explain the obvious financial and mathematical relationship between the spot and futures markets and did not meet the standard of rational decision-making."

History was then rewritten, and the SEC approved the first U.S. spot Bitcoin ETF in January of this year.

For Ethereum, the story is not much different.

Ethereum futures were launched in February 2021 through CME Group. Despite several failed attempts to launch an Ethereum futures fund, the SEC approved the Ethereum futures fund in October last year. The regulator then approved the 19b-4 proposal for spot Ethereum products listed on Cboe, NYSE Arca and Nasdaq.

The SEC noted in its May 23 order that “there has been a high degree of correlation between the CME Ethereum futures market and this subset of the spot Ethereum market over the past 2.5 years.”

Using data at hourly intervals, the correlation between the markets during the sample period was no less than 96.2%—essentially confirming an earlier analysis submitted by Ethereum ETF applicant Bitwise.

Could precedent change?

Armour, Bitwise senior crypto analyst Ryan Rasmussen, and others noted that precedent could change.

“To date, regulated futures markets have been a prerequisite for the approval of spot ETFs for Bitcoin and Ethereum,” Rasmussen told Blockworks. However, there is no guarantee that this prerequisite will be required for the approval of every future cryptocurrency spot ETF.

CME Group currently does not offer futures on cryptocurrencies other than Bitcoin and Ethereum.

Former President Donald Trump has expressed support for the crypto industry if elected, but has yet to detail any specific plans. More Democratic lawmakers have recently begun to support the space, with dozens straying from their party’s majority to support pro-crypto legislation.

“Things could change very quickly in Congress, especially if they come up with a market structure bill next year and really define what is a commodity and what is a security,” Bloomberg Intelligence analyst James Seyffart said in a conversation with Blockworks co-founder Michael Ippolito.

Further Bloomberg Intelligence analyst Eric Balchunas noted in the same podcast that Joe Biden’s reelection as president could mean other spot crypto ETFs won’t be approved by the SEC for a long time.

He said the commission’s attitude toward cryptocurrencies could change significantly if Trump wins — but added that whether Trump would actually support cryptocurrencies remains a “huge variable.”

Possible future crypto products

The unanswered question of whether Ethereum is a security or a commodity is seen as a roadblock to approval of an Ethereum fund. Some industry observers point out that the SEC’s latest Ethereum ETF order essentially clarifies that Ethereum is not a security. At the very least, it seems to indicate that the agency does not consider uncollateralized Ethereum to be a security, as the planned product will not collateralize its Ethereum holdings. Gensler has said that most crypto assets are securities, which would make their prospects for inclusion in ETFs questionable.

YouHodler head of markets Ruslan Lienkha said he expects to see applications for XRP and Solana ETFs.

The SEC classified Sol as a security in its lawsuit against Coinbase and Binance last year. Others deemed securities include Cardano (ADA), Polygon (MATIC), Filecoin (FIL) and NEAR Protocol (NEAR), among others.

Litecoin (LTC) and Dogecoin (DOGE) are among the top crypto assets that the SEC has not formally called securities.

Last year, a U.S. federal judge ruled that while Ripple's institutional sales of XRP were considered to constitute an unregistered securities offering, programmatic sales did not.

Rasmussen said most financial advisors and wealth managers are still trying to understand Bitcoin. For financial professionals, learning about Ethereum (ETH), Solana (SOL) and other crypto assets is the second or third step in their cryptocurrency journey.

He explained that as more crypto assets enter the market through ETFs, crypto index ETFs may play an important role in crypto investing.

Rasmussen said it is difficult to predict the launch timeline of these products.

He added: "Crypto index funds may see significant demand from advisors because they can provide advisors with broad exposure to the fast-growing cryptocurrency space while eliminating the difficulty of picking winners."