© Reuters. FILE PHOTO: US Securities and Exchange Commission (SEC) Chairman Gary Gensler testifies before a House Financial Services Committee oversight hearing on Capitol Hill in Washington, US ., on September 27, 2023. REUTERS/Jonathan Ernst/File Photo
By Suzanne McGee and Hannah Lang
(Reuters) – Buoyed by the successful launch of U.S. bitcoin exchange-traded funds (ETFs), asset managers are preparing to list a second wave of more complex crypto products, setting the stage for another fight with the US securities regulator
The Securities and Exchange Commission (SEC) rejected spot bitcoin ETFs for more than a decade, hoping to protect investors from market manipulation. But the SEC was forced to approve them last month after Grayscale Investments won a court challenge. A federal appeals court ruled that the SEC had not sufficiently detailed its reasoning for rejecting the products.
That decision encouraged 12 asset managers, including Grayscale, ProShares, VanEck, Invesco, Fidelity and Ark Investments, to apply to launch 25 next-generation cryptocurrency ETFs.
Many are complex products that would use options to amplify bitcoin's volatility. Others would follow the price of ether, the second cryptocurrency after bitcoin.
Investors hope the new products will help push cryptocurrencies into the mainstream. It hit $50,000 on February 12 for the first time in more than two years and ether has risen more than 12% this year on hopes that the SEC will approve spot products.
However, the SEC remains uncomfortable with cryptocurrencies and complex exchange-traded products, and lawyers and industry sources said they expect the agency to act cautiously. They noted that the legal status of ether is also ambiguous.
“There doesn't seem to be a rush to approve a second wave of products,” said Yesha Yadav, a professor specializing in digital asset regulation at Vanderbilt University, adding that the SEC would have to “deal” with how much risk it can bear. .
SEC Chairman Gary Gensler remains a critic of cryptocurrencies and, in approving bitcoin ETFs, warned that they were too risky and said the decision did not indicate that the SEC was willing to approve listing standards for crypto assets. more broadly.
An executive at one issuer said it was unclear whether the SEC's approval of bitcoin ETFs would pave the way for other products.
Some SEC filings are for products designed for day traders: leveraged exchange-traded bitcoin products would seek to boost returns by further amplifying the cryptocurrency's significant volatility. Other applications are for inverse products that allow speculators to bet on a price drop.
The SEC has approved many inverse and leveraged ETFs, but has been cautious after an exchange-traded note that tracked volatility failed in 2018, costing investors $2 billion in losses. In 2020, it capped ETF leverage at 200%, and the agency is due to review its rules on ETF risks this year, according to its regulatory agenda.
Gensler and Democratic SEC Commissioner Caroline Crenshaw also warned about the risks of inverse and leveraged ETFs. The SEC would only formally prevent the launch of these products if it found that their disclosures were materially misleading, people familiar with the matter said, but they added that it could delay the effective date of a filing or suggest an issuer withdraw it if the staff has doubts.
James Angel, an associate professor of finance at Georgetown University, said the SEC would likely avoid outright rejection of the applications, which could lead to a legal challenge.
“I think they will look for every possible detail or excuse to delay the process,” he added.
There is no clear process for SEC approval of options on bitcoin ETFs, which are typically approved days after an ETF launches, so approval could take months in the future, Reuters reported this month.
ProShares, Invesco, Fidelity and Ark Investments declined to comment or did not respond to requests for comment.
ETHER SHOCK?
Because spot ether ETFs would be a new product and require a rule change, the SEC must approve or reject them by a set deadline. VanEck's filing is the first to receive a decision on May 23, while the deadline for Grayscale's ether application is June 18.
The SEC has yet to substantially engage with issuers about the requests, but is expected to begin meetings next month, two other people familiar with the matter said. The agency has not yet disclosed meetings about the products in its public record.
When asked about this month's ether spot ETF filings, Gensler told CNBC that the SEC's five commissioners would review them. Both Democratic commissioners voted against bitcoin ETFs, while the two Republicans voted in favor. That means Gensler would likely have the deciding vote.
The arguments Grayscale used to defeat the SEC in its bitcoin ETF lawsuit could apply to ether products because the circumstances are similar. But some regulatory experts and issuers said Gensler could argue that ether is a different type of asset.
The SEC has said that bitcoin is a commodity, but has not made a determination on ether. Unlike bitcoin, ether is traded on a blockchain called “proof of stake” that allows users to earn yield in exchange for locking up tokens for a period of time. Gensler has questioned whether this setup resembles a traditional value.
“There are different circumstances that the SEC will consider. The most important circumstance is that they consider bitcoin to be a commodity and not a security,” said Frank Borger Gilligan, a securities attorney at Dickinson Wright, who said the SEC would want assurances that any product new had safeguards for investors.
When asked by CNBC last week whether another lawsuit would be necessary to force the SEC to approve ether ETFs, Grayscale CEO Michael Sonnenshein said it was “too early to tell.”
