Grayscale Pulls Off a Win Over the SEC in Landmark Case – But Is It Over Yet?

On Tuesday, the court handed Grayscale Investments LLC a win against the US Securities and Exchange Commission (SEC). This ruling marks a pivotal moment in the digital asset manager's lawsuit regarding converting its Bitcoin Trust into a spot Bitcoin exchange-traded fund (ETF).

The decision came after the DC Circuit Court of Appeals failed to provide the ruling on Grayscale's Spot Bitcoin ETF lawsuit, most recently on Aug. 22 and before that on Aug. 18 and 15.

The crypto community has been eagerly awaiting a court decision this week. And finally, the verdict is in: the largest digital asset manager has won a crucial legal battle in its quest to launch a Bitcoin ETF, paving the way for the crypto industry to access billions of dollars from everyday investors.

The crypto investment firm has consistently maintained that the Commission acted “arbitrarily and capriciously” in rejecting spot Bitcoin ETF applications while highlighting the SEC's “unfair discrimination” against spot Bitcoin ETF issuers.

The firm's court victory over the SEC in a three-judge appeals panel in Washington represents a watershed moment for the largest cryptocurrency by market cap of $534 billion. Advocates say a spot Bitcoin ETF-based would result in a horde of retail investors and money.

Grayscale's Bitcoin Trust (GBTC) currently has $16.21 billion in assets under management (AUM), which has fallen significantly from $43.58 bln in November 2021. 

The Trust issues common units of fractional shares that represent ownership in the Trust, which are issued to accredited and authorized investors from time to time, with no set ongoing redemption program, in exchange for BTC that must be held for six months. The company charges a 2% annual fee to its investors.

Grayscale has long sought to convert its trust into an ETF because trusts, unlike ETFs, often trade at a discount to their holdings. 

What did the Court Rule?

However, the cryptocurrency asset manager's resounding legal victory in its efforts to offer a spot Bitcoin ETF does not mean that investors will be able to buy a Grayscale spot ETF yet. Simultaneously, this isolated win for one company won't derail the SEC's broader regulatory actions, which include enforcement against some of the industry's biggest players like Binance and Coinbase.

So, what does it mean? A federal appeals court ruled that the SEC was wrong to reject Grayscale's application to convert its flagship Grayscale Bitcoin Trust (GBTC) into an ETF. 

The SEC approved GBTC in 2015. Besides the trust, the financial regulator has also been allowing Bitcoin futures ETFs since October 2021. In contrast, the Commission has rejected every single application for a spot ETF. The application for a spot Bitcoin ETF was filed as early as 2013 by the Winklevoss Bitcoin Trust.

The SEC has contended that spot funds were prone to manipulation since cryptocurrencies trade on largely unregulated markets. 

Last year, Grayscale sued the SEC when the company tried to persuade the Commission to convert GBTC to a Spot Bitcoin ETF, which the SEC rejected. In its lawsuit, Grayscale argued that by not giving its request the same treatment it does to similar investment funds like Bitcoin futures ETF, the Commission had acted indiscriminately against them.

In its final oral argument in March this year, Grayscale argued that spot Bitcoin ETFs should be approved just like Bitcoin futures ETFs, and by denying a Spot Bitcoin ETF while approving a Bitcoin futures ETF, the SEC has been inconsistent, and its disapproval order against the company was contradictory.

The company further argued that both markets pose the same risk of fraud and manipulation as the pricing of both investment vehicles is “99.9% correlated.” As such, if the SEC is fine with CME's surveillance sharing agreement to protect against the risks in the futures market, then it should also be able to deem it sufficient to approve Bitcoin ETFs that track spot prices.

At the time, Grayscale's lead counsel, Donald Verrilli Jr., told the court that a spot Bitcoin ETF would “better protect investors” because it would give them the benefit of CME oversight of the market. 

Bitcoin futures ETFs track the price of bitcoin futures that trade on the Chicago Mercantile Exchange (CME), which “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.

On Tuesday, the court's panel of judges said Grayscale provided “advanced substantial evidence” that showed that its proposed bitcoin ETF is “materially similar” to the approved bitcoin futures ETFs because the underlying assets are “closely correlated” and because the surveillance sharing agreements with the CME are “identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin.”

As a result, Judge Neomi Rao ruled that the SEC was “arbitrary and capricious” to reject the filing because it failed to explain how owning BTC instead of BTC futures affects the CME's ability to detect fraud and the SEC's different treatment of similar products.

The crypto manager called this a “monumental step forward” for not just the Bitcoin ecosystem but also American investors and “all those who have been advocating for Bitcoin exposure through the added protections of the ETF wrapper.” 

Why is the Crypto Market Rejoicing?

The case has been closely watched by the crypto industry, which has been trying for years to convince the SEC to approve a spot Bitcoin ETF, which would allow investors to gain exposure to BTC without having to own it. 

So, the crypto market is rejoicing with enthusiasm on this news, with everyone stating that it is yet another win for the whole industry after Ripple won a partial victory against the SEC.

Grayscale has said converting to an ETF would help it unlock billions of dollars in value for investors by making it easier to create and redeem shares. The trust currently has a closed-end structure that doesn't allow investors to redeem shares whenever they want, such as during periods of drop in prices. This causes the trust shares to trade at steep discounts to the underlying Bitcoin. By converting it into an ETF, the crypto company can create and redeem shares to keep up with changing demand.

Coinbase chief legal officer Paul Grewal called it “a great moment for the industry,” adding, “While we still believe comprehensive federal crypto legislation is the best way forward, decisions like this are an important step toward the clarity the industry needs.”

The ruling now opens the door for a suite of products the regulator has deemed unsafe for retail investors. But more than that, it is seen as a big blow to the regulator. Also, it is opening the SEC's approach to crypto to legal challenges.

This shows that the courts are holding the SEC to account for its legal responsibilities, potentially providing momentum for those advocating for a shift of regulatory authority over the sector to another body—namely, the Commodity Futures Trading Commission (CFTC), which has oversight over derivatives.

And while the SEC may choose to appeal, if that decision stands, its effort to regulate digital assets as securities would certainly be weakened. The decision in Grayscale's case can also be used to further claims that the SEC has been misreading current law.

“The rulings show the courts will not blindly accept the SEC's conclusions on the application of securities laws to crypto,” said Coy Garrison, a former counsel to most crypto-friendly SEC Commissioner Hester Peirce. “The courts, not the SEC, have the final say,” he added.

Effect on Prices

Grayscale's victory against the SEC had GBTC recording a surge of 16.95% to now trade at $20.56. With this jump, the GBTC discount rapidly contracted to 18.06% from 24.89% a day ago and 44% in June 2023, as per Ycharts.com. GBTC discount is now at its lowest level in the last two years after peaking at almost 50% in mid-Dec. 2022. The fund first entered into negative territory in late Feb. 2021. 

This year, the discount stayed at around 40%, though it began to significantly decline following BlackRock's application for a spot BTC ETF in June before dropping below 20% for the first time since early 2022.

GBTC actually had its busiest trading session in 14 months, with nearly 20 million GBTC shares changing hands through the day, the most since the crypto market crash in June 2022.

The event also triggered more than $170 million in liquidation and 46,351 traders being liquidated over the past 24 hours, according to data provided by Coinglass.

Among the latest liquidations, Bitcoin accounted for almost $76 million, and overall, shorts were the ones who got punished the most at $120.4 million of all liquidations.

This was the result of the price of Bitcoin surging by 7.69% to almost $28,000 while managing $22.4 billion in trading volume in the last 24 hours, representing an increase of 191.50% from one day ago.

When it comes to open interest (OI), Bitcoin currently has $12.26 billion in OI, which is an increase of 9.64% in the past 24 hours. 

Since first spiking, prices have given up some of the gains, with BTC trading at $27,382 at the time of writing. Meanwhile, Ether is exchanging hands at $1,719, and the total crypto market cap jumped 4.3% to $1.135 trillion. 

Right before Grayscale's win, Bitcoin's exchange supply was boosted significantly, noted Santiment. Meanwhile, CryptoQuant shows the mean inflow or amount of BTC transferred to exchanges per transaction rose to 1.146, the highest since June 21.

The latest price, meanwhile, has turned the market sentiments from ‘fear' since last week to now ‘neutral' with the Crypto Fear & Greed Index having a reading of 49/100. 

What's Next? 

Both the parties, Grayscale and the SEC, now have 45 days to make a decision. The regulator can decide to either ask the full federal appeals court in Washington to review it, take an appeal straight to the Supreme Court, or abide by the decision.

“We are reviewing the court's decision to determine next steps,” said the SEC in a statement.

As for Grayscale, it is expected the company would have to file a new application for its ETF. Despite Grayscale having successfully challenged the SEC's decision, there's no legal guarantee that it would be at the front of the queue for review.

Additionally, there is no guarantee that its ETF application will be approved, despite the court's decision because the SEC could reject it on other grounds. One of the ways that the SEC could foil the Grayscale trust's ETF conversion is by canceling bitcoin futures ETFs rather than approving new spot products. 

The US may not have approved a spot ETF, but Europe has already taken that step. In fact, the first European spot Bitcoin ETF began trading just this month.

Meanwhile, in the US, there are more than a dozen other applications pending, including those from traditional finance heavyweights like Fidelity, Invesco, VanEck, WisdomTree, and BlackRock. Among them, the ETF proposal from the world's largest asset manager, BlackRock, is the most closely watched. It was first filed on June 15 and officially added by the SEC to its docket on July 13. While the SEC has a 100% rejection rate when it comes to spot bitcoin ETFs, BlackRock has had all but one of its previous 575 ETF applications accepted. 

All of these applications from TradFi giants are coming up for preliminary deadlines this week. SEC watchers are expecting the commission to most likely impose a 45-day delay that puts the decisions off until mid-October. 

Many of these have proposed working with Coinbase to police trading in the underlying Bitcoin market. The SEC has already acknowledged those applications formally and can take as long as 240 days to decide.

Still, many, like Ark Invest CEO Cathie Wood, believe that the SEC may approve not just one spot Bitcoin ETF but multiple applications at once. So, it's exciting times ahead for Bitcoin and the whole crypto market, especially with the halving in April 2024.