Crypto’s Grayscale Blasts SEC Over ‘Special Harshness’ Against Bitcoin Trading
(Reuters) – Crypto asset manager Grayscale Investments LLC, which manages the world’s largest bitcoin mutual fund, told a federal appeals court on Tuesday that the U.S. Securities and Exchange Commission is so suspicious of spot trading in bitcoin that it blocked a proposal to make it easier and safer for investors to gain exposure to the cryptocurrency.
That is the only reasonable conclusion, Grayscale argued in a new case filed with the District of Columbia US Circuit Court of Appeals, which is to be drawn from the SEC’s decision last June to reject a proposal by the New York Stock Exchange to convert Grayscale’s $15 billion bitcoin investment fund into an exchange-traded fund, despite the commission’s previous approval of exchange-traded funds based on bitcoin futures. (Challenges to final SEC orders are heard by federal appeals courts, not trial courts.)
Grayscale told the DC Circuit that its bitcoin trust, which is based on an index of spot or instantaneous bitcoin trading prices, is no more susceptible to fraud and manipulation than the SEC-approved exchange-traded bitcoin futures funds, which rely on nearly identical bitcoin trading price indices.
Since bitcoin futures and spot bitcoin prices are both anchored in the same underlying spot markets for the cryptocurrency, Grayscale’s lawyers at Munger, Tolles & Olson told the D.C. Circuit, the SEC’s refusal to approve an exchange-traded fund that references actual bitcoin, rather than bitcoin futures contracts, reflect a “special hardness based on [the SEC’s] opinion on bitcoin’s advantages compared to other types of investments.”
Bitcoin spot prices and bitcoin futures, Grayscale general counsel Craig Salm said in an exclusive interview, are subject to the same fraud risk that has historically worried the SEC. “So logically,” Salm said, “if you’re OK with one, you have to be OK with the other because otherwise you’d be arbitrary.”
The SEC did not immediately respond to a request for comment on Grayscale’s filing. The commission has said its rejection of Grayscale’s proposed spot bitcoin exchange-traded fund should not be seen as an assessment of the relative merits of bitcoin and bitcoin futures contracts or “an assessment of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment.”
The commission’s June order attributed its rejection of Grayscale’s application to concerns that the New York Stock Exchange does not have an adequate monitoring sharing agreement with a regulated market where a “significant proportion” of spot bitcoin trading takes place. The NYSE had pointed out that it shares information with the Chicago Mercantile Exchange, but the SEC said it was not convinced that the CME bitcoin futures market qualified as a “market of significant size” for spot bitcoin trading.
Grayscale’s new brief, which says the SEC’s rejection was arbitrary and capricious under the Administrative Procedure Act, argues that the SEC’s substantial market test is “deeply flawed” and has no basis in the text of the Securities and Exchange Act.
But while the test is appropriate, Grayscale argues, the commission has not applied it consistently to distinguish between exchange-traded funds based on spot bitcoin prices and those based on bitcoin futures contracts.
“This stark arbitrariness cannot be justified,” the letter claimed. “Rejecting the proposed spot bitcoin [exchange-traded product] here, the Commission applied an extremely strict version of the test – going so far as to make findings that directly contradict findings it made in its orders approving the bitcoin futures ETPs.”
Grayscale launched its bitcoin trust way back in 2013 through a private placement for accredited investors. Shares in the trust currently trade over the counter, but according to Grayscale, the shares trade at a discount from bitcoin’s actual price due to restrictions that would have been eliminated if the SEC had allowed the trust to be converted to an exchange-traded fund.
Grayscale’s brief claimed that the existing investors would reap about $4 billion if the trust were converted to an exchange-traded fund. The conversion will also impose public reporting requirements on the fund which, according to Grayscale, will improve investor protection. The asset manager told the DC Circuit that the investment market is “crying out” for a product that offers a safe and easy way to buy bitcoin — and that an exchange-traded fund based on the actual cryptocurrency is easier for investors to understand than a mutual fund. based on a bitcoin derivative.
A central pillar of Grayscale’s brief is the claim that bitcoin futures and spot bitcoin prices are inextricably linked. The filing refers several times to a letter that Vanderbilt University professor Robert Whaley sent to the SEC during the comment period on the NYSE’s request to allow trading of a gray-scale exchange-traded fund. Whaley, who developed key indices for the Chicago Board Options Exchange and NASDAQ, told the SEC that the bitcoin indices underlying the Grayscale Trust and bitcoin futures traded on the Chicago Mercantile Exchange are “almost perfect substitutes” for each other.
Whaley’s statistical conclusion, the Grayscale brief argued, is consistent with common sense, since bitcoin futures are derived from the spot price of actual bitcoin. If the spot price is tainted by fraud or manipulation, Grayscale said, the futures price will be similarly affected. So it is arbitrary, the brief argued, to refuse to allow an exchange-traded fund based on spot bitcoin prices while allowing a product based on futures.
It doesn’t matter, in the view of Grayscale chief counsel Salm, that the SEC-approved bitcoin futures funds trade on the Chicago Stock Exchange, which also regulates the futures contracts underlying those funds. Finally, Salm said, bitcoin futures and spot bitcoin indices come from the same trading market.
“I think we have very simple, straightforward and compelling arguments here,” Salm said. “In many ways, it’s not about bitcoin at all. It is about fair treatment under the law.”
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