EtherIndex LLC, a Wilmington, Del.-based corporation, has registered a trust called the EtherIndex Ether Trust with the Securities and Exchange Commission (SEC), marking the first ether-based trading fund.
The trust’s purpose is to give shareholders exposure to the daily change in the U.S. dollar price of ether, minus expenses and liabilities, according to its prospectus . Ether is a digital commodity based on the value token of the Ethereum computer network blockchain.
The trust is not actively managed.
The trust marks the most recent in a string of digital currency based trading funds. Last week, SolidX Partners Inc. registered the SolildX Bitcoin Trust, CCN.com reported, while the Winkelvoss Bitcoin Trust, which filed with the SEC in 2014, filed to switch its listing from Nasdaq to BATS Global Markets.
The EtherIndex Ether Trust will issue and redeem shares in one or more whole blocks (known as baskets) to and from registered broker-dealers or other authorized securities market participants on an ongoing basis. The trust will distribute baskets in exchange for an appropriate amount of ether.
On redemption, the trust will distribute ether equal in value to that of the shares being redeemed to the authorized participant in exchange for one or more baskets.
Authorized participants will sell shares to the public at prices determined by the price of ether represented by each share and the trading price at the time of sale.
The number of ether to be transferred and sold will vary based on the trust’s expenses and the price or the proceeds of the sales.
The Ethereum Network is in its early stages, the prospectus noted, the production version of the blockchain on the network having launched in March 2016. As a result, the network has experienced fewer attacks and undergone less testing the bitcoin network.
Because of its infancy, ether has seen sharp value fluctuations. Ether has posted one-day, one-month and since-inception changes of 31%, 16.7% and 53.7%, respectively. Such volatility could adversely impact the willingness of parties to purchase ether.
Ether is currently awarded to miners based upon “proof of work,” the prospectus noted, but there are plans to change awards to a “proof of stake” model in 2017.
As an alternative decentralized ledger protocol, Ethereum has an ideological lineage that contains as much Java, BitTorrent and Freenet as it does bitcoin. The Ethereum network allows decentralized business logic, known as “smart contracts,” represented as cryptographic boxes containing value that unlocks only it if certain conditions are met.
Smart contracts can enforce the terms of an agreement among a number of parties. The code can define rules in the same way a traditional legal document would. But unlike a traditional contract, a smart contract can take information as an input, process it, and take any actions required.
As a new technology, ether has not been accepted as a means of payment for goods and services by commercial outlets. Financial institutions can refuse to process funds for ether transactions, process ether wire transfers, or hold ether accounts.
A disruption in Internet connectivity could disrupt the Ethereum Network’s operations and impact the price of the trust’s shares.
The trust will not insure ether. There is a risk that the trust’s ether could be lost, stolen or destroyed by the loss or theft of the private keys held by the trust custodian.
The ether held in the trust custody account will be an appealing target for hackers, the prospectus noted. There is no guarantee that such loss will not occur. Such events could impact the operations and an investment in the shares.
The prospectus noted that ether has not been the subject of any known regulatory action. However, the sponsor believes ether will be treated in the same manner as bitcoin.
Aside from the U.S. Commodity Futures Trading Commission (CFTC), the Financial Crimes Enforcement Network of the U.S. Department of the Treasury (FinCEN) and the U.S. Internal Revenue Service (IRS), most major U.S. regulators have not adopted rules for the treatment of ether and other digital assets for purposes of commodities, tax and securities laws.
While the SEC has not commented on the legal characterization of ether as a security, it has acted against persons or entities misusing cryptocurrency similar to ether in connection with fraud, inaccurate information, and the offering of unregistered securities.
The CFTC has stated that bitcoin meets the definition of a commodity and the CFTC has regulatory authority over futures and other derivatives based on digital assets.
A U.S. magistrate judge in the U.S. District Court for the Eastern District of Texas and the German Ministry of Finance have stated that bitcoin is a form of money and a “unit of account,” respectively.
The IRS has classified bitcoin as property and not currency for U.S. federal income tax purposes, although the degree to which such interpretations will become normal is not known.
The New York State Department of Taxation and Finance defined digital assets as intangible property. Other states have given guidance on the tax treatment of bitcoin for state income or sales tax purposes.
The prospectus also summarizes other countries’ regulatory treatment of bitcoin.
Featured image from Ethereum Homestead.