Cryptofinance: into the ether

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Hello and welcome to the FT Cryptofinance newsletter. This week we take a look at a momentous week in Washington.

Sometimes it can seem like a new crypto market structure emerges weekly and the last five days are no exception.

Entering Monday, few predicted that the US markets regulator would approve exchange-traded funds that invest in ether, the currency of the ethereum blockchain. But the Securities and Exchange Commission relented Thursday, and the biggest outstanding issue now is the start date.

The SEC was coy about the reasons for its change of heart, but the mood around cryptocurrencies in Washington is changing rapidly as the election approaches. The arrival of bitcoin ETFs in January received widespread attention. However, this minor move may have larger consequences for financial markets.

Many expect an influx of money into ether ETFs, which will provide a short-term boost to the cryptocurrency's price. Standard Chartered analyst Geoff Kendrick forecasts ether will rise to $8,000 from its current $3,700 by the end of the year and $14,000 by the end of 2025, with inflows of between $15 billion and $45 billion into ETFs in the first 12 months. .

Still, ether and ethereum simply do not have the bitcoin brand. Ethereum has always been presented as something more revolutionary than its larger rival: a platform or the building blocks of a decentralized world. But it never really captured the imagination of the general public. The largest ether fund, the Grayscale Investment Trust, only has $10 billion, compared to $28 billion for its bitcoin trust in January.

"The insight and simplicity of bitcoin's dominant narrative fits neatly into a group of alternatives for portfolio strategists, perhaps like gold, while ethereum is much more literally like a platform or early-stage technology company," said Alex Thorn, head of research at Galaxy. Digital, a cryptocurrency investment manager.

Arguably, it's not that large institutional investors and Wall Street banks haven't understood the appeal of ethereum, but rather that they haven't had regulatory clarity about what they can touch. Ether is a more problematic cryptocurrency than bitcoin, legally speaking, but this week it has managed to solve it.

“It's a game changer, it means the SEC doesn't see ether as a security,” said a top Wall Street CEO who has considered establishing a cryptocurrency-related business unit.

Unlike bitcoin, ether can generate a return for the holder when it is placed or staked in the process of securing and validating transactions on the ethereum network.

The amount you win depends on the amount you stake, the time period you lock it, and the trading activity on the blockchain. Those who stake their coins can currently expect a return of around 3 percent annually, paid out as crypto tokens. But the thing is that in the cryptocurrency market it is the closest thing to an interest rate and free money, in other words.

This concept causes problems for the SEC because it can give the appearance that ether is an unregulated digital fixed income security, something the agency is very keen to regulate.

To resolve this in the ETF decision, the SEC required issuers to give up their plans to engage in betting. That elides a definitive answer as to whether ether is a security and instead suggests that it is a commodity.

It's a good legal solution, but the distinction could have some unintended consequences. For starters, ETF providers are missing out.

As CCData noted, purchasing 1,000 ether on January 1 of last year would have turned $1.2 million into $3.66 million. Betting the same amount would have netted him $3.87 million, a profit of $217,000 or just under 6 percent more. If ETF issuers can't realize the performance, they may have to charge higher fees to clients to compensate.

Additionally, large scale purchases by ETF issuers will remove a large amount of ether from the market that will then not be staked.

“What happens if $20 billion is withdrawn from the market? It could be a turning point in terms of supply and demand. We've never really seen this kind of rapid demand shock in the market before,” said Mara Schmiedt, CEO of Alluvial, a betting infrastructure provider.

More generally, the approval of ether ETFs could also have the perverse effect of increasing annualized returns, which depend on the amount of activity in the market and the amount staked. If large amounts of ether were removed and there were more transactions on the network, throughput would likely increase. It has fallen steadily from 6 percent at the end of 2022; an increase could bring it closer to U.S. interest rates when the Federal Reserve begins to cut.

In this context, it is not difficult to imagine that Wall Street will exert pressure to remove the ban. More than that, it may no longer be in the SEC's best interest to be on the defensive regarding ether.

The other major news out of Washington this week was that Congress passed a major bill for cryptocurrency legislation, FIT21. Among other things, it makes the SEC's rival agency, the Commodity Futures Trading Commission, the main US cryptocurrency regulator.

However, an ETF is an SEC-regulated security and issuers will have large amounts of ether to back it. If ETF issuers were allowed to stake their currency, the SEC would regulate some of the largest market participants and exert some indirect influence on the underlying currency.

Through this lens, the structure of the ether market might end up not looking all that different from the US Treasury market, the largest and most important market in the world because it sets the price of money.

The US Treasury market is, in many ways, the original decentralized market. Trades are not channeled through a single exchange or clearinghouse, and there are fewer rules governing Treasuries than other asset classes. It does not have a single global regulator, but is divided among many. The SEC does not have jurisdiction over the primary market but is an important player.

The question really is how long can the SEC maintain its position on betting. If you want to remain influential in the cryptocurrency sector, things may have to change.

What is your opinion? Email me at philip.stafford@ft.com

Weekly highlights

As mentioned, Congress approved the first framework for crypto regulations in the US. The Financial Innovation and Technology for the 21st Century Act, or FIT21 as it is commonly known, is a big deal. It's not over yet, as the Senate and White House have to approve it, but the Biden administration has said it won't stand in its way. It will be worth watching in the coming weeks.
Hong Kong regulators forbidden Worldcoin operates in the territory due to privacy and personal data risks.

Sound phrase of the week: Wake up, America

At the FT Live cryptocurrency conference two weeks ago, Congressman Patrick McHenry, chairman of the US House of Representatives Financial Services Committee, sounded confident that he could get FIT 21 passed. did, by a clear 279-136 votes. The invoice

“...should serve as a wake-up call to the Senate and this Administration. “They must come to the table to ensure that Americans who interact with digital assets can do so safely.”

Data mining: risk and reward

The benefits of betting (and capitalizing) become clear when laid out. As a side note, the proportion of circulating ether currently up for grabs is quite low compared to its rivals, as CCData points out. Solana and Cardano have 63 percent and 66 percent of their respective supplies at stake.