Author: Cosmo Jiang, Liquid Strategies and Portfolio Manager; Erik Lowe, Content Director; Translation: 0xjs@Golden Finance
Regulation and political sentiment toward digital assets in the U.S. are changing in real time. Recent developments signal a potential turning point that could pave the way for innovation and growth in the U.S.
The current stance of the U.S. government and the U.S. SEC has hindered the development of our industry, creating resistance to innovation and forcing many entrepreneurs to move their blockchain-based businesses overseas. We are excited to see the first signs of change.
Republican Candidates Support Cryptocurrency
Momentum for pro-cryptocurrency policies began to build in early May. Former President Trump publicly shifted to a pro-crypto stance, hosting a dinner for buyers of his NFT trading cards at Mar-a-Lago on May 8 and announcing that he wanted digital asset businesses to stay in the United States. On May 21, he also made history by accepting cryptocurrency donations for his campaign, a first for a major party presidential candidate.
“I have a positive and open attitude towards cryptocurrency companies and everything related to this emerging industry. Our country must become a leader in this field.”
—Donald Trump, former US President, Truth Social, May 25, 2024
One could speculate that Trump supports cryptocurrencies for several reasons. First, the presidential election is close, and attracting the support of the cryptocurrency community could bring significant support to Trump. A study conducted by Security.org shows that 40% of American adults now own cryptocurrencies by 2024. In addition, Robert Kennedy was the first candidate to explicitly support cryptocurrencies. Recent polls show that he won key votes in swing states. Ultimately, politicians reflect the demands of marginal voters, and the major parties realize that supporting cryptocurrencies is a winning strategy.
Many speculated that the Democratic Party and Biden team saw Trump elevating cryptocurrencies into some of his campaign speeches and accepting donations in cryptocurrencies, and therefore decided to also take more pro-industry steps, which led to further rapid victories for the industry.
FIT21 bill receives bipartisan support in House of Representatives
The next critical moment was the passage of the 21st Century Financial Innovation and Technology Act (“FIT21”) by the House of Representatives on May 22. The bill seeks to establish a comprehensive regulatory framework for digital assets. The bill received bipartisan support, receiving 279 votes in favor (67%), indicating that cryptocurrency is becoming an increasingly important issue in the political landscape.
FIT21 aims to provide a clear, secure path for blockchain projects to raise funds, issue tokens, and operate secondary markets in the United States.
It also delineates whether digital assets should be classified as securities or commodities, depending on their degree of decentralization — a long-standing topic of discussion because it determines whether the Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC) regulates these assets.
For example, a digital asset could start out as an investment contract and become a digital commodity over time. FIT21 sets out standards for “decentralization,” one of which is that no issuer or affiliate should control 20% or more of the digital asset token supply or voting rights. This measure is intended to define when a project is sufficiently decentralized for its tokens to be considered digital commodities.
The bill also introduces measures to protect American consumers investing in digital assets, establishing trading rules such as customer fund segregation, token insider lockup periods, and annual sales volume limits.
“FIT21 is the first step in establishing a regulatory framework for digital assets – it must be improved through collaboration with the Senate and the Administration. While laying the foundation for responsible innovation, we must take further action to strengthen protections for consumers, investors, and taxpayers.”
“Digital currencies are already integrated into our economy, and their importance will only grow in the coming years. Millions of Americans own cryptocurrencies. American companies are at the forefront of global financial technology. Many jobs in my Bay Area community depend on this industry.
“The digital asset industry needs clearer rules and the federal government needs stronger enforcement powers to ensure the responsible development of this emerging technology.”
—Statement by U.S. House Speaker Emeritus Nancy Pelosi on FIT21 legislation, May 22, 2024
Despite initial opposition from President Biden, SEC Chairman Gary Gensler, and some House Democratic leaders, the bill was passed without a veto threat from the President. The bill will undoubtedly continue to evolve and still need to pass the Senate, but it is a meaningful starting point regardless. We will continue to monitor this matter as it develops.
Additionally, back on May 17, the Senate held a bipartisan vote to overturn the SEC’s SAB-121 rulemaking, further highlighting the change in sentiment. The main controversy surrounding SAB-121 was its strict and onerous requirements for financial institutions to record crypto assets on their balance sheets, which discouraged banks from offering digital asset custody services.
On May 31, Biden vetoed a vote to overturn SAB-121, arguing that the bill would “unduly restrict the SEC’s ability to enact appropriate guardrails and address future issues.”
Biden concluded his statement by saying he was positive about crypto innovation within the country, signaling a shift in tone from the current administration.
“My administration is eager to work with Congress to build on existing authorities to ensure a comprehensive and balanced regulatory framework for digital assets that will promote the responsible development of digital assets and payments innovation and help strengthen America’s leadership in the global financial system.”
— Joe Biden, President of the United States, letter to the House of Representatives, May 31, 2024
We believe Biden’s veto more likely reflects his reluctance to publicly oppose the commissioners he appoints, instead choosing to take a quieter approach by asking the SEC to change the rules on its own. We believe the House’s passage of FIT21 represents an important step toward creating a clearer regulatory environment for cryptocurrencies, and while the Senate’s motion to oppose SAB-121 was defeated, it demonstrates a broader effort to balance regulation and innovation in the cryptocurrency space.
Despite the Biden administration’s shifting stance on the digital asset space — with reports that Biden’s reelection campaign is reaching out to blockchain players to ask for guidance on future crypto policy — SEC Chairman Gensler remains resolute in his views. He expressed reservations about FIT21.
“The Financial Innovation and Technology Act of the 21st Century (“FIT 21”) would create new regulatory loopholes and undermine decades of precedent for regulating investment contracts, exposing investors and capital markets to untold risks.”
—Statement by SEC Chairman Gary Gensler on FIT21, May 22, 2024
Ethereum ETF approved
Many speculated that the rapid bipartisan turn in favor of cryptocurrencies prompted the SEC to approve an Ethereum ETF, another milestone development. All eight issuers, including Grayscale, Bitwise, BlackRock, VanEck, Ark 21Shares, Invesco, Fidelity, and Franklin, received approval to launch commodity-based trust units.
The approval came as a surprise. Polymarket, a decentralized prediction market platform, predicted as of May 5 that there was a 6% chance that the Ethereum ETF would be approved by May 31.
Issuers themselves believed that the SEC’s lack of involvement indicated that Ethereum ETFs were expected to be rejected by the May 23 deadline. Instead, the SEC suddenly changed its tune and contacted ETF issuers three days before the deadline, asking them to amend their 19b-4 filings the next day. The first step in the process is approval of the 19b-4, which was approved on May 23. The listing timeline for these ETFs is expected to be in the next 1-3 months as issuers prepare the more complex S-1 filings under the guidance of the SEC.
Bitcoin ETF was a “buy the rumor, buy the news” event, will the Ethereum ETF be the same?
In our November 2023 Blockchain Investor Letter, we discussed our view that the launch of a spot Bitcoin ETF would be a “buy the rumor, buy the news” event.
We wrote that an ETF would fundamentally change how Bitcoin is accessed, and that unlike previous major launches that marked the peaks of previous cycles (CME futures launch and Coinbase listing), this time around is different.
The launch of the Bitcoin ETF was a “buy the rumor, buy the news” event. Here are the results:
The market reacted positively following initial news of a possible Ethereum ETF approval. Ethereum initially surged 25% following early signs of a possible ETF approval. The discount on Grayscale’s closed-end Ethereum Trust, ETHE, narrowed drastically from 21% to just 1% in a matter of days.
Similar to the Bitcoin ETF earlier this year, an Ethereum ETF could attract a large influx of new investors, opening the door to investors who were previously excluded due to compliance reasons or brokerage account restrictions. In addition, we believe that for certain investor groups, the promotion of Ethereum as a "technology platform" may be easier to understand and accept than the promotion of Bitcoin as "digital gold."
Some may argue that Ethereum’s underperformance over the past 1.5 years could make it a strong catch-up trade candidate. Additionally, low expectations for inflows could provide a perfect opportunity for a surprise upside.
However, potential outflows from ETHE (similar to outflows from Grayscale’s converted Bitcoin ETF GBTC) could provide some initial resistance. However, 3AC and Genesis, among others, have less forced selling than GBTC; therefore, outflows may be less severe.
Furthermore, compared to the one-day gap between the SEC’s approval of the spot Bitcoin ETF and subsequent trading, the Ethereum ETF will begin trading much later after the approval date. Therefore, investors will have ample time to act on this information.
Ethereum ETFs and the potential knock-on effects of recent regulatory developments
We believe that the approval of the Ethereum ETF, the passage of FIT21, and the shifting political and regulatory environment for cryptocurrencies will have a ripple effect on the industry. In particular, we believe the long tail of digital assets is likely to benefit significantly.
Market Growth and Diversification - While the launch of a Bitcoin ETF is significant, especially as it relates to the use case of the cryptocurrency as a store of value, the existence of an Ethereum ETF could have a significant impact on the broader universe of tokens. Increased attention on Ethereum could spread to the broader protocol space as investors explore Ethereum as a technology platform.
Technological advancement and innovation — If FIT21 passes the Senate and/or creates a clear framework for token projects, this could accelerate the pace of innovation as entrepreneurs have a clear path to launch their projects with less regulatory resistance.
Integration with mainstream financial products - Bitcoin ETFs and now Ethereum ETFs will be offered on typical RIAs along with 2,844 other securities. We believe that over time, blockchain will be viewed as just another asset class.
More Cryptocurrency ETFs – Earlier this year, many speculated that the approval of a Bitcoin ETF could pave the way for other cryptocurrency ETFs. This has indeed been the case. The question now is, with the Ethereum ETF approved, what’s next? BlackRock’s ETF approval record currently stands at 577/1. Monitoring their next move may be illuminating.
Tokens as a form of capital formation — One of our core arguments is that many blockchain-based businesses will choose to organize using tokens rather than equity. Creating a regulatory framework where these tokens can begin to reflect the fundamental value creation of the underlying protocols, and share these cash flows in novel ways with the token holders who contribute to the protocols, is a critical step toward achieving this future.
All in all, the passage of the FIT21 bill and approval of the Ethereum ETF represent a major shift in the U.S. cryptocurrency regulatory and political landscape. For a while, the industry seemed at an impasse, with no idea when progress would be made. We are now in action.
While this regulatory framework will undoubtedly undergo multiple revisions, it provides a good start. These developments could usher in a new era of cryptocurrency innovation, attract a wider base of investors and users, and ensure that the U.S. cryptocurrency industry does not lag behind the rest of the world.
