Shades of Gray and the SEC go to court over a bitcoin ETF
by James · March 6, 2023
The years-long push for an exchange-traded fund that tracks bitcoin will finally get its day in court this week. Several different firms tried to bring a spot bitcoin ETF to the market in the US without success, but Grayscale Investments is taking it a step further for the future of Grayscale Bitcoin Trust (GBTC). After Grayscale’s proposal to convert the trust into an ETF was rejected last June, the firm sued the US Securities and Exchange Commission in the DC Circuit Court of Appeals. Oral arguments start on Tuesday. While a potential bitcoin ETF was once seen as a way to bring investors into crypto more broadly, the lawsuit comes as depressed prices and increased regulatory scrutiny have dampened retail interest in the space. Here are the most important things to know about the case. The arguments A main point in the case from Grayscale is that the SEC has already allowed bitcoin futures ETFs to enter the market, but has drawn the line at spot bitcoin. The largest of these funds, the ProShares Bitcoin Strategy ETF (BITO), now has nearly $800 million in assets under management. The SEC has argued that bitcoin futures, which are traded on the CME, are a regulated product while spot bitcoin is not, raising concerns about fraud in a market where there is “no adequate oversight.” Grayscale’s counter is that the two are so closely related that the SEC decision makes no sense. “Any fraud or manipulation in the spot market will necessarily affect the price of bitcoin futures, thereby affecting the net asset value of an ETP holding either spot bitcoin or bitcoin futures, as well as the price investors pay for such ETP’s shares,” it said Grayscale in a legal card. ETPs, or exchange-traded products, include ETFs. Jim Angel, an associate professor specializing in financial market structure at Georgetown University’s McDonough School of Business, said the SEC has a “really weak hand” in the matter. “You need a microscope to see the difference between the two – they are both ETFs to track bitcoin, the only difference is that BITO does it in a very inefficient way using bitcoin futures and it creates a lot of transaction costs because you have to roll over future position every month,” Angel said. The US Chamber of Commerce, NYSE Arca and Coinbase are among the groups that have filed amicus briefs on Grayscale’s side of the argument. The Grayscale discount One reason why Grayscale in particular has been at the forefront of this battle is that the Grayscale Bitcoin Trust, an over-the-counter product, trades at a large discount to its underlying asset value. Over the past year, the market price of a GBTC share has fallen by about 60%, according to Grayscale’s website. However, the value of the holdings per share has fallen by around 48%. The trust currently does not have a redemption mechanism, meaning professional investors cannot make arbitrage trades to keep the fund more closely aligned with the price of bitcoin. This also means that the under-return on the shares turns into a large discount for the shareholders. The fund traded nearly 50% below the value of its holdings last week, according to crypto news site The Block. However, converting to an ETF is a method of making a redemption process, and these products typically trade much closer to the price of the underlying assets than GBTC does. Bryan Armour, director of passive strategy research for North America at Morningstar, said there are other avenues for Grayscale to create a redemption process, but they could hurt assets under management and thus the firm’s fees. “I don’t see this as a high-probability case. I think Grayscale is using this as a stall tactic to keep current investors from redeeming,” Armor said. Crypto winter The excitement surrounding a bitcoin ETF has cooled considerably along with prices for crypto markets in general. Even with a solid start to 2023, the price of bitcoin is still down more than 60% from its all-time high. BTC.CM= 5Y mountain The rise and fall of bitcoin. The approval of a spot bitcoin ETF could quickly see investors move away from the futures ETFs, Armor said, but it wouldn’t have the same demand it might have before crypto prices started to fall. “There is an appetite, and there has been for a long time. It’s very unlikely to be as strong as it was before 2022, but putting it in ETF form could make it more accessible to advisers,” Armor said. The lawsuit also comes during a period of tumult for crypto more broadly. The industry has seen the implosion of several large firms, including the alleged fraud at FTX last year, and the SEC has been more aggressive on issues such as crypto betting. Grayscale and some other major industry players have said they want more regulatory clarity to expand the potential reach of crypto. “In times like these, when a significant amount of trust and confidence in the crypto ecosystem has been damaged, regulated access to the asset class is more important than ever. Products like spot ETFs will further open up access to bitcoin for those who want to keep it in shape of a security, in their brokerage or retirement account, through a regulated investment vehicle, with SEC reports, audited financials, tax documents and the like,” Grayscale CEO Craig Salm said in a blog post. The regulator, for its part, has said that blocking ETFs is not intended to be a comment on the digital asset area more broadly. “Thus, this case is about the law governing the listing and trading of new instruments on national securities exchanges, not whether investors can or should buy bitcoin products,” an SEC brief said. — CNBC’s Tanaya Macheel contributed reporting.
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