In an in depth authorized analysis shared through X, Davis Polk lawyer Scott Johnsson dissected the complicated path that Ethereum (ETH) should traverse to safe a spot Trade-Traded Fund (ETF) approval. This deep-dive evaluation, whereas drawing parallels to the profitable Bitcoin (BTC) spot ETF approval, highlights the distinctive challenges and potential regulatory shifts crucial for Ethereum’s spot ETF prospects.

Roadmap to spot Ethereum ETF — Roadmap to identify Ethereum ETF | Supply: X @SGJohnsson

Half I: Normal Roadmap To Spot ETF

Johnsson begins his evaluation by emphasizing the significance of understanding the overall regulatory path for a digital asset to transition right into a spot ETF providing. He factors out that BTC pioneered this journey by means of a 4-step path, with every step constructing on the prior one. “It took seven years from step 1 to spot ETF for BTC, with disapprovals and regulatory hurdles at almost every turn,” Johnsson notes, highlighting the prolonged and sophisticated course of concerned.

That is the timeline for BTC. You possibly can see it took 7 years from step 1 to identify ETF, with disapprovals alongside your entire interval. Throughout this time, arguments advanced and matured… ensuing within the present regime following the 19b-4 approval order for spot ETFs this previous month. pic.twitter.com/KchdpnRZwn

— Scott Johnsson (@SGJohnsson) January 25, 2024

For Ethereum, the timeline seems to be compressing, an commentary Johnsson attributes to the maturation of arguments and the refining of regulatory stances, notably influenced by key litigation occasions such because the Grayscale case.

Step-by-Step Course of For BTC’s Spot Approval:

Acquire a DCM Futures Itemizing: This step is pivotal, primarily establishing the regulatory classification of the asset as a non-security commodity and organising the mandatory futures marketplace for the asset.
’40 Act Futures ETF: This step positive aspects significance because it doesn’t necessitate specific SEC approval and implicitly ratifies the commodity designation by the SEC.
’33 Act Futures ETF: Integral within the Grayscale ruling, this step requires a proper 19b-4 approval from the SEC, laying the groundwork for logic relevant to identify approval.
Spot Approval: The last word aim, necessitating one other formal 19b-4 approval from the SEC.

Half II: The Threshold Query & Grayscale

Within the labyrinth of regulatory frameworks and authorized precedents, the journey to identify ETF approval hinges pivotally on navigating the nuances of Part 6(b)(5) of the Trade Act. Johnsson delves deep into this facet, figuring out it because the linchpin within the technique of securing a spot ETF approval. “The essence of the challenge lies in satisfying the stringent demands of Section 6(b)(5), particularly its stipulations concerning the potential for fraud and manipulation in the market,” Johnsson articulates, emphasizing the essential nature of this requirement.

Dissecting the SEC’s Strategy: The Three-Pronged Path

The SEC’s method to addressing these issues has traditionally unfolded alongside three potential pathways, every presenting its distinctive set of challenges and intricacies:

Inherent Resistance to Fraud and Manipulation: The primary path includes demonstrating that the digital asset (e.g. Ethereum) inherently possesses attributes that make it proof against fraud and manipulation. Johnsson notes, “This route demands a robust demonstration of the asset’s inherent market mechanisms and structures that inherently guard against fraudulent activities and manipulative schemes.” It’s a path much less traveled, primarily as a result of excessive threshold of proof and the complexities concerned in substantiating such inherent safeguards.
Different Means to Stop Fraud and Manipulation: The second avenue, as Johnsson outlines, “involves identifying and implementing additional measures that effectively mitigate the risks of fraud and manipulation, separate from the asset’s inherent characteristics.” This path necessitates a complete exploration of supplementary safeguards and regulatory mechanisms that may be fortified to guard the integrity of the market.
A Surveillance Sharing Settlement (SSA): The third and sometimes most scrutinized pathway revolves round establishing a strong Surveillance Sharing Settlement (SSA) with a major market. “The SSA is pivotal, as it represents a concrete, collaborative effort between the market and regulatory bodies to actively monitor and combat potential fraudulent activities and manipulative practices,” Johnsson explains.

The Grayscale Ruling: A Paradigm Shift

The panorama, nevertheless, skilled a seismic shift with the appearance of the Grayscale ruling, which introduced the SEC’s reliance on the “significant size” check below a obvious highlight. Johnsson dissects this improvement, stating, “The Grayscale ruling was a watershed moment, unraveling the SEC’s previously impervious stance and exposing the vulnerabilities and inconsistencies in the ‘significant size’ test.”

This check, which had lengthy been a cornerstone of the SEC’s rationale in denying earlier spot ETF purposes, was subjected to intense scrutiny. Johnsson illuminates this, saying, “The ‘significant size’ test, once a bastion of the SEC’s defense, was dissected and found lacking in coherence and consistency, marking a critical inflection point in the narrative surrounding spot ETF approvals.”

The ruling underscored two pivotal info that turned the tide: the shut correlation between spot and futures markets, and the an identical nature of SSAs with vital markets just like the CME. “This correlation and the homogeneity of the SSAs were the fulcrum on which the Grayscale ruling pivoted, compelling a reevaluation of how these factors are weighed in the approval process,” Johnsson observes.

He additional elaborates on the intricate dynamics post-Grayscale ruling, “The ruling didn’t just challenge the SEC’s previous denials; it necessitated a profound reconfiguration of the SEC’s approach, paving the way for BTC’s spot approval and setting new precedents for assets like ETH.”

Half III: BTC 19b-4 Approval Order

Johnsson examines the SEC’s tactful navigation across the “significant size” check, a transfer he perceives as each shrewd and indicative of the company’s responsive recalibration. “The SEC’s decision to sidestep this contentious test illustrates a deliberate shift, steering the discourse towards uncharted yet potentially more stable grounds,” he articulates. This strategic pivot, whereas resolving the rapid problem, subtly reshapes the regulatory panorama for future digital asset issues.

Embracing The “Other Means” Check: A Paradigm Shift

The SEC’s adoption of the “other means” check below the provisions of 6(b)(5) marked a pivotal shift from its earlier stance. Johnsson describes this as “a recalibration of approach, charting a new course in the SEC’s methodology to tackle the concerns of market manipulation and fraud.” This transfer, characterised by a complete correlation evaluation, signified a recent perspective on assessing the integrity and resilience of digital property available in the market.

The Methodological Refinement: A Rigorous Correlation Evaluation

Delving into the SEC’s correlation evaluation, Johnsson highlights the meticulousness and foresight embedded on this method. “The SEC’s methodology is not merely thorough; it’s a testament to their commitment to data-driven and forward-looking regulatory practices,” he asserts. The emphasis on a considerable pattern interval, intra-day buying and selling knowledge, and, crucially, consistency throughout the interval, underscores a rigorous and methodical method that units new precedents in digital asset analysis.

Johnsson factors out the SEC’s directive to exclude references to the Coinbase SSA within the 19b-4 purposes. He interprets this as a calculated, strategic maneuver, suggesting, “This deliberate omission opens a subtle yet profound window into the SEC’s broader strategy, hinting at a complex tapestry of considerations and tactical plays at work.”

Half IV: Ethereum Evaluation

Johnsson begins with an optimistic perspective, drawing parallels between Ethereum’s journey and the lately paved path by BTC. “The SEC’s approval of a BTC spot ETF, particularly its reliance on the ‘other means’ test and the correlation analysis, lays down a potential blueprint for ETH,” he observes. This precedent, he argues, gives a glimmer of hope, positing that “ETH, much like BTC, stands on the brink of achieving a similar breakthrough, provided it can navigate the intricate web of regulatory nuances.”

The Correlation Conundrum: Ethereum’s Distinctive Challenges

Regardless of the optimism, Johnsson delves into the distinctive challenges Ethereum faces, notably in establishing a adequate degree of futures-spot market correlation—a cornerstone of the SEC’s latest approval rationale. “ETH’s correlation metrics, while promising, are not a mirror image of BTC’s. This distinction forms the crux of the challenge, necessitating a nuanced understanding and strategic alignment with the SEC’s evolving benchmarks,” he explains.

He additional dissects the SEC’s methodological rigor, emphasizing that “Ethereum must not only demonstrate high correlation but also ensure consistency and robustness across a substantial historical sample, aligning with the SEC’s methodical and data-centric approach.”

Strategic Issues: The SEC’s Balancing Act

Johnsson highlights the broader strategic issues at play inside the SEC, notably in mild of its latest actions and authorized stances. “The SEC’s approach, especially its decisions regarding Coinbase and Binance, casts a long shadow over ETH’s prospects. The agency’s actions and the legal precedents they set form a complex tapestry that ETH’s application must deftly navigate,” he factors out.

He underscores the importance of ETH’s non-classification as a safety in latest SEC actions, suggesting that “This implicit recognition of ETH’s standing, whereas not an outright endorsement, gives a refined nod to its potential pathway in direction of spot ETF approval. […] The SEC listed a dozen+ digital property in every motion as alleged securities, […] Notably, ETH just isn’t included in both. Nor has there ever been such an allegation.

The Countdown To The Might Deadline For Ethereum

Because the May deadline looms, Johnsson presents a multifaceted evaluation of the converging elements that would affect the SEC’s choice. “The clock is ticking, and with each passing moment, the SEC’s decision matrix grows more intricate, woven with legal, strategic, and market considerations,” he states.

Additionally, Johnsson factors out the affect of BlackRock as regards to a possible spot Ethereum ETF. “Near undefeated in ETF applications led by highly influential Larry Fink. And there is strong reason to suspect they may have been a stronger catalyst to BTC approval than even the Grayscale ruling.”

The lawyer acknowledges the potential headwinds, particularly the SEC’s meticulous correlation methodology and the comparatively shorter historic buying and selling knowledge for Ethereum in comparison with Bitcoin. “Ethereum’s journey is not a straightforward sprint but a marathon laden with strategic hurdles and regulatory checkpoints,” Johnsson remarks, emphasizing the complexity of the trail forward.

In concluding his evaluation, Johnsson strikes a notice of cautious optimism. “That said, there should be plenty of clues leading up to the deadline which should inform us as to how the SEC is thinking about its decision. And it would certainly not surprise me if the SEC decided to avoid the DC Cir at all costs and simply issue approval,” he displays.

At press time, the Ethereum (ETH) value stood at $2,223.