There’s been a recent flurry of activity around crypto regulation in the US. Investment Manager Colin Morris explains why, despite Biden’s blocking the reversal of crypto legislation, the mood music is sounding positive.
Why the u-turn?
Three major pieces of previous guidance have surfaced.
1. Securities and Exchange Commission's Staff Accounting Bulletin (SAB121)
In 2022, the Securities and Exchange Commission’s Staff Accounting Bulletin issued guidance requiring companies holding customers' cryptocurrencies to treat these assets as liabilities and record them at fair value on their balance sheets.
This policy indirectly imposed heavy capital requirements on banks wanting to offer cryptocurrency services, hindering the sector’s ability to serve this market, especially considering these assets can quickly increase in value. Critics argued that the onerous rule highlighted a fundamental misunderstanding of the custodial nature of banks holding digital assets, treating them as liabilities instead of customer property.
Despite a decisive 60-38 tally (with support from both major parties in the Senate) to overturn SAB 121, the White House vetoed its reversal, so for now at least, it’s staying put.
2. Financial Innovation and Technology for the 21st Century (FIT21) Bill
This bill aims to:
- Regulate the U.S. crypto markets
- Establish protections for consumers
- Name the Commodity Futures Trading Commission (CFTC) the leading regulator of digital assets and the watchdog of the non-securities spot markets
- Clearly define what makes a crypto token a security or a commodity
The U.S. House voted 279-136 to approve the FIT21 Bill, with a very strong showing from House Democrats who historically have previously been against the crypto industry. Again, President Biden opposed the bill but didn’t say he’d veto it altogether. SEC Chair Gary Gensler also made a public statement arguing the bill was unnecessary and threatened existing securities regulations.
This legislation isn’t expected to pass through the Senate any time soon, but the bipartisan support in Congress has laid the foundations for a framework that could be agreed in the future.
3. Ethereum ETF 19b-4 approval
Following the successful launch of Bitcoin spot ETFs, the SEC had to meet the deadline of 23rd May 2024 to respond to filings for spot Ether ETFs. These were widely expected to be denied with a strong suggestion that Ethereum might be considered a security. Following radio silence from the SEC, the issuers stopped working on the filings.
On 20th May, the SEC suddenly asked issuers to update their filings and by 23rd May, all of the 19b-4 filings were approved. This means the ETFs can be listed on an exchange and satisfies concerns around the fitness of the market. Before any ETFs can be launched, a “prospectus”, needs to be approved, and although this is seen as a formality it could arrive later this month.
Until the SEC clarifies whether Ether is a commodity or a security, the products will stay registered as commodity-based trust shares.
What's behind the change in political sentiment?
Again, there are 3 main reasons:
1. Wall Street wants to make money
On February 14th, several major financial associations urged the SEC to make some specific changes to SAB 121 to address recent policy developments and the challenges it poses for banks. This was hot on the heels of the Bitcoin spot ETFs success (already amassing roughly $50bn of assets) compared to the $100bn Gold ETF market. Tether (a crypto stablecoin provider) announced Q1 profits of $4.52 billion, highlighting the opportunities currently denied to the US banking sector through a lack of supportive legislation.
2. The crypto lobby has teeth
Crypto-focused political action committees have raised around $85m from crypto companies, executives and retail investors to try and influence decisions – most notably spending $10m to successfully squash a Senate bid from crypto-critical Congresswoman Katie Porter
Looking at the numbers for the upcoming US election, being anti-crypto may be detrimental to candidates hoping to win over the country’s 50 million existing crypto investors. Former President Donald Trump may have recognised this – he’s recently made several pro-crypto comments and accused President Biden of being against the crypto industry.
3. Competition
The Hong Kong ETFs launch may have spurred the US to be more open to spot Ether ETFs. Setting aside the wider benefits for Wall Street and the US economy, the US benefits from the dollar being the de facto trading currency for crypto assets. Like with oil being priced in dollars, the crypto ecosystem largely uses dollars via stablecoins as a risk-off trading currency. Over $100bn is held by stablecoins and only 15 countries have bigger reserves in their treasury - which is why former House Speaker Paul Ryan is calling for more supportive stablecoin regulation.
The tokenised Treasury market has hit nearly $1.3 billion (up from almost $100 million in early 2023), propelled in part by BlackRock’s entrance, which boasts $460 million of deposits. The BlackRock USD Institutional Digital Liquidity Fund, represented by the BUIDL token on the Ethereum (ETH) network and backed by U.S. Treasury bills, repo agreements and cash, now boasts $375 million of deposits.
Will there be more crypto ETFs?
Crypto markets aren’t regulated at the moment, so it’s unlikely we’ll see more crypto ETFs any time soon. The 19b-4 approval requirements include monitoring an asset’s behaviour in a regulated market for up to 2 years. Bitcoin and Ether (the only crypto assets listed) are approved as they were monitored on the regulated futures market. Other crypto assets are unlikely to follow this path as the Commodity Futures Trading Commission may not view them as commodities, if they lack sufficient decentralisation of ownership and control.
As the approved Ether ETFs are all unstaked, they don’t benefit from yield from other transactions on the Ethereum blockchain. There’s demand for staked Ether ETFs, particularly if they’re launched in other regions, but it’s unlikely they’ll be approved any time soon – especially as the SEC has indicated they see staked ETH as a security.
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Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.