Why Other Cryptos Might Struggle to Get Their Own ETFs

The recent approval of spot Ethereum exchange-traded funds (ETFs) by the U.S. Securities and Exchange Commission (SEC) marks a significant milestone in the evolving landscape of cryptocurrency investments. As major financial firms like BlackRock and Fidelity received the green light for their Ethereum ETFs, the focus has shifted to which cryptocurrency might be next in line. Solana has emerged as a top contender, yet substantial regulatory and market challenges suggest that achieving ETF status for other cryptocurrencies will not be straightforward.

SEC Approval and Its Implications

On Thursday, the SEC approved 19b-4 forms for eight spot Ethereum ETFs, allowing companies such as BlackRock and Fidelity to move forward. However, these issuers must still navigate the S-1 registration process, which could take several weeks before trading can commence. This approval represents a significant regulatory endorsement, providing a clear pathway for Ethereum. It also raises the question of which other cryptocurrencies might follow, with Solana leading speculative discussions.

Solana as the Next Contender

Prominent figures in the investment community, including Anthony Scaramucci, former White House Communications Director and managing partner at SkyBridge, expressed optimism about the possibility of a Solana ETF being next in line. "We are going to get a SOL ETF, get ready," Scaramucci posted after the approval of the spot Ethereum ETFs.

CNBC presenter Brian Kelly also speculated on the potential for an ETF for Solana, the fifth-largest cryptocurrency by market cap. "You got to think about Solana as probably the next one," Kelly said on Wednesday. "Bitcoin, Ethereum, and Solana are probably the big three for this cycle."

Kelly's comments echoed those of Joe McCann, a Solana investor and the founder, CEO, and CIO of crypto fund Asymmetric. "If there's an ETF that comes next, it's probably something like Solana," McCann stated. However, he noted a potential challenge, pointing out that language in the Coinbase lawsuit could impact Solana's prospects.

Regulatory Hurdles: The 'Unregistered Security' Issue

The question of whether certain cryptocurrencies are "unregistered securities" weighs heavily on their prospects for ETF approval. In June 2023, the SEC sued Coinbase, just a day after filing a lawsuit against Binance. These legal actions were followed by a similar lawsuit against Kraken in November of the previous year, all alleging securities law violations.

SEC's Classification of Cryptocurrencies

A critical aspect of these lawsuits is the SEC's classification of several cryptocurrencies as "unregistered securities." This list includes Solana, Cardano, Polygon, Near, and Internet Computer, among others. This classification poses a significant hurdle for these cryptocurrencies. In contrast, Bitcoin has never faced this issue, and Ethereum, at least in terms of its asset status, has been assigned a commodity-based designation, as reflected in the recent Ethereum ETF approvals. However, the SEC's concerns about staking have prompted issuers to remove staking features from their spot Ethereum ETF filings. This separation of Ethereum the asset from its staking functionality was a crucial factor in gaining approval.

Staking and Regulatory Concerns

Staking presents another layer of complexity. The SEC's concerns about staking cryptocurrencies were highlighted in the Coinbase lawsuit, where the agency claimed that staking features violated securities laws.

Bloomberg ETF analyst James Seyffart noted that the SEC is clear about Solana's status, stating, "Those lawsuits against Coinbase and Kraken and others flat out say 'Solana is a security.' This could very easily make this a very rocky road."

While many top cryptocurrencies are labeled as securities by the SEC, those closely related to Bitcoin, like Dogecoin and Litecoin, have been spared this classification. However, these cryptocurrencies face other challenges related to demand and liquidity.

Market Demand and Viability

Joe McCann suggested that Dogecoin could be a contender for an ETF due to its comparability to Bitcoin's launch, describing it as "definitely not a security." Similarly, Litecoin has been highlighted for regulatory feasibility. However, Seyffart and others have debated the actual market demand for ETFs based on these assets. Seyffart remarked, "I don't see much demand for an LTC ETF even if feasible? Personally, I'm not sure about DOGE either but who knows!"

From a regulatory perspective, Dogecoin and Litecoin might make more sense. Yet, the financial viability of launching such ETFs remains uncertain. Seyffart added, "If I'm an issuer, I don't know if I'm spending a couple hundred grand to launch a Litecoin ETF?" Conversely, he acknowledged that a Solana ETF would likely see the most demand among other digital assets, aside from Bitcoin and Ethereum.

The Importance of CFTC-Regulated Futures Markets

Before any cryptocurrency ETFs can be considered, CFTC-regulated futures markets play a crucial role. Both Bitcoin and Ethereum ETFs had futures products available before their approval, allowing for thorough correlation analysis between CME futures products and spot exchange rates. This correlation analysis is essential to ensure that the market conditions are favorable for the introduction of ETFs. For instance, CME Bitcoin futures were launched in December 2017, followed by CME Ether futures in February 2021. Subsequently, Bitcoin futures ETFs debuted in the U.S. in October 2021, with Ethereum futures ETFs following suit in October 2023.

Regulatory Frameworks and Legislative Developments

James Seyffart suggested that a spot Solana ETF could potentially emerge within a few years of establishing a CME-regulated futures market for Solana. However, he noted that legislative initiatives such as the Financial Innovation and Technology for the 21st Century Act (FIT21) could expedite the process.

FIT21, recently passed by the U.S. House of Representatives, aims to regulate the cryptocurrency industry comprehensively. This bill grants more power and funding to the Commodity Futures Trading Commission (CFTC) to oversee crypto spot markets and digital commodities, particularly Bitcoin. Despite its passage in the House, FIT21 faces uncertainty in the Senate, with top lawmakers showing limited interest or outright opposition.

Impact on Crypto Markets and ETF Approval

While FIT21 has the potential to place crypto markets under CFTC oversight, questions arise about its impact on the SEC's current regulatory stance. Seyffart noted that while the SEC decides on the approval orders for all ETFs, they are unlikely to approve an ETF holding a digital asset without federally regulated trading venues or futures trading venues. Nate Geraci, President of The ETF Store, echoed this sentiment, stating that no Solana ETF is likely until CME-traded Solana futures exist or Congress establishes a legitimate crypto regulatory framework. The market sentiment reflects this cautious approach, with the odds of a Solana ETF in 2024 priced at just 11% on the Ethereum-based prediction platform Polymarket, indicating limited investor confidence.

Bottom Line: Roadblocks to Spot Crypto ETFs

Despite the potential for regulatory frameworks like FIT21 to expedite the approval process, significant roadblocks remain for the introduction of spot cryptocurrency ETFs. The necessity of CFTC-regulated futures markets, coupled with legislative uncertainties and the SEC's regulatory stance, indicates that it might be a while before a Solana ETF or any other spot crypto ETF becomes a reality in the U.S. While overcoming the SEC's "unregistered security" label is one challenge, establishing a robust regulatory framework and market infrastructure is equally critical in shaping the future of cryptocurrency ETFs.