Insights into the SEC’s Decision

The US Securities and Exchange Commission (SEC) approved the sale of spot Ether Exchange-Traded Funds (ETFs) in the United States on May 23, 2024. The SEC combined proposals from the Nasdaq, NYSE, and CBOE exchanges, which requested changes to existing rules to allow the trading of Ethereum Exchange-Rated Products (ETPs) and ETFs.

This is the SEC’s second decision regarding crypto Exchange-Traded Products. Earlier this year, in January 2024, the SEC, after a long battle, approved Bitcoin ETFs and ETPs. The exchanges had sought SEC approval for a rule change required to list these new products, which was successfully granted. However, trading will not start immediately, as issuers still need the SEC to approve individual ETF registration statements detailing investor disclosures. According to Reutersindustry participants said it was unclear how long the SEC’s approval process might take.

SEC’s Points of Concern

In its accelerated approval, the SEC focused predominantly on the following aspects:

Fraud and Manipulation Prevention: The Importance of the CME

Reflecting on Section 6(b)(5) of the Exchange Act, the SEC emphasized the necessity of comprehensive surveillance-sharing agreements with the Chicago Mercantile Exchange (CME) to detect and deter fraud and manipulation. Each exchange maintains a comprehensive surveillance-sharing agreement with the CME through their common membership in the Intermarket Surveillance Group. However, the CME does not currently engage in surveillance of spot ether markets, raising concerns about efficient oversight and the potential detection of fraud and manipulation. Even though spot ethers are not traded on the CME, the future contracts are. Therefore, the high correlation between the futures and spot market means that price manipulations in the spot market will likely affect the futures market as well.

To show this correlation, the exchanges submitted correlation analyzes aimed to determine whether price movements in the CME ether futures market closely align with those in the spot ether markets. These analyzes are essential for evaluating whether the CME’s surveillance over the futures market can effectively detect and deter fraud and manipulation in the spot ether markets.

In addition to the analyzes submitted by the applicants, the SEC carried out its own correlation analysis, reviewing the price data for CME ether futures and spot ETH/USD trading pairs on major platforms (Coinbase and Kraken) at hourly, five-minute, and one-minute intervals to capture different levels of trading activity over a lengthy period (from October 1, 2021 through March 29, 2024). The results of the SEC’s analysis confirmed that the CME ether futures market has been consistently highly correlated with this subset of the spot ether market throughout the past 2.5 years.

Investor Protection and Market Integrity

Further in its decision, the SEC analyzed Section 11A(a)(1)(C)(iii) of the Exchange Act ensuring that the ether-based ETPs proposals provide sufficient protection for investors and maintain the integrity of the market.

Similar to the Spot Bitcoin ETP Approval Order, there are several key requirements:

• The availability of pricing information – the availability of quotation and last-sale information for each ETPs via the securities information processor; the availability of intra-day indicative values ​​(IIV) and net asset values ​​on each ETP’s website; and the dissemination of IIV by major market data vendors, updated every 15 seconds during regular trading hours;
• The transparency of portfolio holdings – ETPs must regularly disclose their portfolio holdings, including the amount of ether and any cash or cash equivalents held. This information is typically required to be updated daily and made available on the ETP’s website and other major financial information platforms;
• Surveillance procedures and Surveillance-Sharing Agreements – similarly to the agreements with CME, the exchanges are to have in place data exchange agreements to share information with other regulated markets, enhancing the ability to detect and deter fraudulent and manipulative practices. Furtheremore, the exchanges need to specify the conditions under which they would implement trading halts and suspensions.

Other concerns: Volatility and Risk

In the final part of SEC’s analysis, the Other Commentsthe SEC included further discussions among commentators on investor protection, environmental considerations and volatility and risk concerns.

Regarding the volatility and risk concerns, one commentator raised concerns about ether’s price volatility, arguing that spot ether ETPs “would threaten retail investors and the broader financial system” by entangling the crypto industry with traditional finance. The SEC considered these potential benefits and concerns within the broader context, and concluded that they the proposals meet the Exchange Act requirements, including preventing fraud and manipulative acts.

When reading the response to this concern, the SEC ultimately left the issue unaddressed. The market volatility is inherent and potentially attractive to many investors, with the principle caveat emptor applying here. However, the major concern that the SEC and other supervisory authorities must focus on is the impact of merging crypto with traditional finance on the broader financial system as we know it. The gradual blending and introduction of multiple derivative assets could have significant effects on the financial system – effects that remain largely unexamined and unaddressed. Ignoring these potential consequences could lead to repeated 2007-2008 on a much larger scale.