Analysis of Recent Ethereum Events: Impact of Hong Kong Crypto ETFs, Prospects for US ETH ETFs, Will ETH Be Classified as a Security?

Author: Ebunker

Hong Kong Virtual Asset Spot ETF

On April 30, a total of 6 virtual asset spot ETFs under Bosera HashKey, Huaxia, and Harvest officially listed on the Hong Kong Stock Exchange and opened for trading. This includes Bosera HashKey Bitcoin ETF (3008.HK), Bosera HashKey Ethereum ETF (3009.HK), Huaxia Bitcoin ETF (3042.HK), Huaxia Ethereum ETF (3046.HK), Harvest Bitcoin Spot ETF (3439.HK), and Harvest Ethereum Spot ETF (3179.HK).

Li Yimei, CEO of Huaxia Fund, stated in an interview with Bloomberg TV that the launch of spot Bitcoin and Ethereum ETFs in Hong Kong "opens the door for many RMB holders seeking alternative investments. With the development of openness, we hope that in the future, investors from mainland China will have new opportunities to participate in this process." (Note: Currently, the ETFs launched in HK are only available to Hong Kong residents.)

However, from the data perspective, the trading performance of Hong Kong's virtual asset spot ETFs on their first day was lackluster, with a trading volume of HKD 87.58 million (USD 12 million) for the 6 Bitcoin and Ethereum spot ETFs. In contrast, the first-day trading volume for Bitcoin ETFs in the U.S. was USD 4.6 billion. Despite the unsatisfactory first-day trading data, it still opens the door for Hong Kong investors to alternative assets, and the market will increasingly accept such financial products. Industry insiders believe that due to the poor performance of the Chinese stock market and the ongoing turmoil in the real estate market, high-net-worth individuals in China may invest in Hong Kong's crypto asset ETFs through various channels in the medium to long term.

Prospects for U.S. ETH Spot ETF

Recently, asset management company Franklin Templeton listed its spot Ethereum ETF on the website of the U.S. Securities Depository and Clearing Corporation (DTCC), labeled as EZET. Theoretically, including this ETF on the DTCC website represents the first step in the trading process. However, this does not guarantee approval from the SEC, which will ultimately decide whether the ETF can be launched.

The DTCC website typically displays securities that meet trading and settlement requirements, including ETFs that satisfy specific registration or compliance criteria. Although this listing does not directly affect the SEC's decision, it does help adjust the ETF to meet market demand, thereby assisting in keeping the ETF's market price close to its net asset value (NAV).

In February of this year, like BlackRock, Grayscale, Vaneck, and Ark Invest, Franklin Templeton submitted an application for a spot ETH ETF to the SEC. However, the SEC recently postponed its decision on Franklin Templeton's ETF application, citing the need to review proposed rule changes for the listing and trading of shares on the CBOE BZX Exchange. The SEC has an additional 45 days, until June 11, for further evaluation.

Compared to Bitcoin ETFs, the prospects for Ethereum ETFs are not as optimistic. Bloomberg ETF analyst Eric Balchunas estimates that the likelihood of the SEC approving the May Ethereum ETF is about 35%. He believes that the SEC's less active stance compared to the Bitcoin ETF application process indicates a strategic move rather than just a delay. Additionally, SEC Chairman Gary Gensler's position on ETH potentially being classified as a security adds complexity to the decision-making process.

J.P. Morgan analysts expect that regulatory approval for spot Ethereum ETFs will continue to be delayed, and that approval may ultimately involve legal action, similar to Grayscale's lawsuit, which prompted the SEC to reconsider the spot Bitcoin ETF application.

The SEC's recognition of ETH futures ETFs has long been used as an argument for approving ETH spot ETF applications. Grayscale argues that the SEC-approved Bitcoin futures ETF carries the same risks as a Bitcoin spot ETF, thus strengthening this argument after Grayscale won its legal case against the SEC in August 2023. Van Buren Capital believes that the SEC may approve the ETH spot ETF to avoid losing in court again, but it is more likely willing to take another gamble in court.

Despite the challenges, U.S. investors and companies are still striving for the approval of the ETH spot ETF, as establishing a connection between cryptocurrencies and traditional financial products is considered a significant advancement. It remains unclear what action the SEC will take, and if the ETH spot ETF is approved, U.S. regulators may adopt a more progressive stance towards cryptocurrencies.

Will ETH Be Classified as a Security?

Fox Business recently reported that, according to court documents submitted by Ethereum software giant Consensys, SEC Chairman Gary Gensler began attempting to classify Ethereum as an unregistered security not in compliance with current federal regulations at least a year ago. Consensys is challenging the SEC's attempt to reclassify Ethereum as a security through litigation.

According to the documents, on March 28, 2023, Gurbir Grewal, head of the SEC's enforcement division, approved a formal investigation order regarding "ETH 2.0," authorizing SEC staff to investigate and subpoena various parties involved in ETH transactions.

The FOX report indicates that the SEC is determined to keep the investigation confidential, with sources who received subpoenas claiming they were forced to sign confidentiality agreements. As one of the companies that received a subpoena from the SEC, Consensys filed a preemptive lawsuit against the SEC last week, revealing that it also received a "Wells Notice" from the SEC earlier this month, potentially related to enforcement actions involving its MetaMask Swaps and staking services.

(Note: A "Wells Notice" refers to an informal alert issued by the SEC to a publicly listed company before filing a civil lawsuit, allowing the company to communicate and negotiate with the SEC before receiving a formal lawsuit.)

Historically, SEC Chairman Gensler has not provided a clear stance on whether ETH is a security. In April 2023, when Congressman Patrick McHenry asked him during a congressional hearing whether ETH is a security, Gensler refused to answer, attempting to obscure the SEC's preliminary determination to classify ETH as a security.

On April 30, House Financial Services Committee Chairman Patrick McHenry commented on the escalating dispute between the SEC and the cryptocurrency industry, accusing SEC Chairman Gary Gensler of "deliberately misleading Congress regarding the SEC's position on Ethereum, as new court documents reveal a deliberate attempt to distort the SEC's stance." He pointed out the clear disconnect between the SEC's public statements and its private actions regarding ETH, reflecting the arbitrary and capricious nature of the SEC's regulatory approach towards digital assets.

As of 2018, the SEC's position on Ethereum was relatively clear: Ethereum is not a security. At least, that was the position articulated by then-SEC Corporation Finance Director Bill Hinman and then-SEC Chairman Jay Clayton in their speeches. However, under the current SEC Chairman Gary Gensler, the agency's stance on Ethereum has subtly shifted. Shortly after Ethereum transitioned to a PoS consensus mechanism in 2022, Gensler stated that in PoS blockchains, users lock their tokens to secure the network and receive token rewards, which constitutes an investment contract and can be classified as a security, although he did not specifically name ETH.

Under Gensler's leadership, the SEC has initiated enforcement actions against several cryptocurrency exchanges, including Coinbase, Kraken, and Binance, on the grounds that these exchanges sold unregistered securities like Cardano's ADA and Solana's SOL to U.S. customers. However, in any previous SEC lawsuits, Ethereum has never been directly classified as a security.

Consensys believes this is a deliberate "power grab" by the SEC. Consensys is challenging the SEC's actions on two fronts: first, asserting that Ethereum does not meet the definition of a security and is therefore not subject to such regulations; second, accusing the SEC of unfairly targeting its MetaMask product.

The SEC has chosen not to comment on these ongoing legal matters. Ebunker believes that this case reflects the uncertain regulatory environment for cryptocurrencies in the U.S. and may impact Ethereum's future classification. Regarding why the SEC is now attempting to classify ETH as a security, many industry insiders believe this is a strategic move aimed at gaining regulatory authority over ETH and other tokens that may be classified as securities. As the second-largest blockchain by market capitalization and the platform for most mainstream DeFi, DAOs, and NFTs, reclassifying ETH as a security would undoubtedly have a significant impact on the entire crypto asset industry.