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SEC's Ethereum Probe Could be Bad News for Ether ETFs

SEC's investigation sends ripples across the industry

The Securities and Exchange Commission's (SEC) recent scrutiny of the Ethereum Foundation has ignited a wave of speculation among industry experts regarding its potential impact on the approval process of spot Ether exchange-traded funds (ETFs). This probe, highlighted by Fortune on March 20, involves subpoenas to various entities associated with the Ethereum Foundation, aiming to ascertain if ETH should be classified as a security—a stance the SEC reportedly began considering in 2022.

Paul Grewal, Coinbase's Chief Legal Officer, responded to these developments by asserting:

 "The SEC has no good reason to deny the ETH ETP applications," 

Grewal was referencing SEC Chair Gary Gensler's past congressional testimony where he stated that Ether is not a security. Grewal's statement underscores a prevailing expectation within the industry that Ether's regulatory status had been settled, suggesting this investigation could unsettle established positions.

This sentiment is echoed by Travis Kling, Chief Investment Officer of Ikigai Asset Management, who described the situation as a "coordinated attack on ETH" in a March 20 X post, reflecting the community's apprehension about the probe's timing and its implications for the future of Ethereum-based financial products.

With the SEC's actions casting a shadow of uncertainty, industry observers like Fox Business reporter Eleanor Terrett have speculated that this reluctance to engage with spot Ether ETF issuers could be a strategic move, influencing the likelihood of such ETFs receiving approval.

Diverse reactions from the crypto community

The cryptocurrency community has reacted strongly to the SEC’s intensified scrutiny of the Ethereum Foundation, with opinions varying from concern to outright disapproval. This varied response underscores the complexity of classifying ETH as a security, especially after its transition to a proof-of-stake consensus mechanism. 

Brian Quintenz, a former Commodity Futures Trading Commission (CFTC) commissioner, highlighted that the SEC had "explicitly acknowledged" Ether's non-security status by approving Ether futures ETFs last October. Quintenz's commentary reflects a broader industry belief that the regulatory landscape for Ether had been previously clarified.

Adding to the debate, Cardano founder Charles Hoskinson suggested that the SEC's perspective on Ether might have shifted following Ethereum's switch to proof-of-stake in September 2022. However, Quintenz countered that the Ethereum Merge, which marked this transition, was already a consideration in the SEC’s decision to approve Ether futures ETFs, indicating a complex regulatory interpretation.

Patrick McHenry, chair of the House Financial Services Committee, criticized the SEC's approach as contradictory to its previous actions and the CFTC's assessment. His view was encapsulated in a tweet: 

"Reports indicate @GaryGensler is moving to unilaterally classify #ETH as a security. This is contrary to the @CFTC's assessment and the @SECgov's prior actions."

Implications for Ether and the future of ETFs

The SEC's probing into the Ethereum Foundation and its implications for the classification of ETH as a security have cast a long shadow over the future of Ether ETFs. This uncertainty is compounded by the SEC's hesitation to approve spot Ether ETF applications, pushing decisions back to May or later. Applicants such as BlackRock, VanEck, ARK 21Shares, and Fidelity, among others, await a verdict that could set a precedent for the cryptocurrency industry's relationship with regulatory bodies.

Bloomberg ETF analysts Eric Balchunas and James Seyffart have notably adjusted their expectations, reducing the odds of an approved spot Ether ETF from 70% to 25% by May, signaling a significant shift in market sentiment. This adjustment reflects growing concerns over the SEC's approach to cryptocurrency regulation and its potential to stifle innovation within the space.

The debate extends beyond the immediate implications for Ether ETFs. If the SEC were to reclassify Ether as a security, it would challenge the existing framework under which CFTC-listed Ether futures ETFs operate, leading to a complex regulatory dilemma. As Brian Quintenz pointed out, such a reclassification would question the legality of existing Ether derivatives, impacting a wide range of investment products and strategies.

Despite these challenges, the crypto community remains hopeful for a favorable outcome. Balchunas and Seyffart anticipate that, while spot Ether ETFs may face initial denial, approval could follow before 2025.