EXPLAINER: What’s at stake if Grayscale wins in spot bitcoin ETF case

The US District of Columbia court of appeals will soon rule on whether the Securities and Exchange Commission (SEC) wrongly rejected an application from crypto asset manager Grayscale Investments to list an exchange-traded fund that tracks the price of bitcoin.

The case is being closely watched by the cryptocurrency and asset management industries, which have been trying for years to convince the SEC to approve a spot bitcoin ETF. They say it would allow investors to gain exposure to bitcoin, the world’s largest cryptocurrency, without having to own it. The SEC, though, worries spot bitcoin ETFs will be vulnerable to manipulation.

Here's what you need to know:

What went down with Grayscale?

The SEC in 2022 denied Grayscale’s application to convert its spot Grayscale bitcoin Trust into an ETF. While the agency has rejected spot bitcoin ETFs, it has approved bitcoin futures ETFs, which track agreements to buy or sell bitcoin at a pre-agreed price. Grayscale proposed using the same manipulation safeguards that were approved for those futures ETFs, but the SEC said that did not meet its bar.

Grayscale was just one of several asset managers, including Cathie Wood's ARK, Fidelity and Invesco, whose spot bitcoin ETF applications the SEC rejected on investor protection grounds. Unlike those other firms, Grayscale sued the SEC. As the defendant is a regulator, the case went straight to the appeals court.

What is Grayscale’s arguement?

Grayscale argued that the bitcoin futures ETF surveillance arrangements should also be satisfactory for Grayscale’s spot ETF, since both products rely on bitcoin’s underlying price.

Bitcoin futures ETFs track bitcoin futures that trade on the Chicago Mercantile Exchange (CME), the chief venue for those products. The CME “surveils futures market conditions and price movements on a real time and ongoing basis in order to detect and prevent price distortions, including price distortions caused by manipulative efforts”, the SEC has said.

Grayscale’s lead counsel, Donald Verrilli Jr, told the court in March that a spot bitcoin ETF would “better protect investors” because it would give them the benefit of CME oversight of the market. Currently, Americans mostly invest in bitcoin via less well-established or unregulated exchanges.

The SEC, however, says Grayscale lacks data to determine whether the CME futures surveillance agreement could also detect potential manipulation in the spot markets.

What happens once the court rules?

Both parties have 45 days to appeal the ruling, in which case it would either go to the US Supreme Court or an en banc panel review, which are used for unusually complex or important cases Grayscale’s CEO has said he’s prepared to appeal if the court rules in the SEC’s favour. It is unclear if the SEC would do the same if the court sides with Grayscale.

If Grayscale ultimately prevails and the SEC does not appeal, the court would specify how its decision should be executed. That could include instructing the SEC to approve the application, or to revisit Grayscale’s application, in which case the SEC could still reject the proposal on other grounds.

If the SEC wins, Grayscale could refile its application, but to succeed it would need to address the agency’s market manipulation concerns.

What would a Grayscale victory mean for other applications?

Several firms have this year filed spot bitcoin ETFs for listing on Nasdaq or CBOE Global Markets, including BlackRock, the world’s largest asset manager, Fidelity, WisdomTree, VanEck, Bitwise and Invesco.

Many have proposed working with Coinbase, the largest US-based crypto exchange, to police trading in the underlying bitcoin market. The SEC has formally acknowledged those applications, and can take as long as 240 days to decide.

It’s unclear what a win for Grayscale would mean for those applications, but it could factor into the SEC’s decisions on those proposals.

Which way it the court leaning?

During oral arguments, a panel of judges pressed the SEC, at times appearing sceptical of the regulator’s decision to approve bitcoin futures ETFs but deny spot bitcoin ETFs. Judge Neomi Rao said the SEC had “not offered any explanation” as to why Grayscale was in the wrong.

However, some former SEC lawyers have cautioned against reading too much into such comments, noting that courts are traditionally reluctant to undermine federal agencies.

Reuters