SEC Must Review Grayscale's Bitcoin ETF Bid After Previous Rejection, Appeals Court Rules

The U.S. may be about to get its first spot bitcoin exchange-traded fund, after a federal court ruled that the U.S. Securities and Exchange Commission (SEC) must review its rejection of Grayscale Investments' attempt to convert the Grayscale Bitcoin Trust (GBTC) into an ETF.

The legal victory potentially opens the door for a spot bitcoin ETF in the U.S. Advocates have long argued that allowing this type of product would enable a greater swath of the general public to invest in bitcoin without having to go through the trouble of buying it directly or deal with potential issues like their custody providers collapsing. The SEC has disapproved every such ETF application it's reviewed to date, though a new swath of applicants are now hoping for success.

Circuit Judge Neomi Rao, writing the D.C. Circuit Court of Appeals' opinion, said that federal agencies are required to "treat like cases alike."

"The Securities and Exchange Commission recently approved the trading of two bitcoin futures funds on national exchanges but denied approval of Grayscale’s bitcoin fund. Petitioning for review of the Commission’s denial order, Grayscale maintains its proposed bitcoin exchange-traded product is materially similar to the bitcoin futures exchange-traded products and should have been approved to trade on NYSE Arca. We agree," she said.

The SEC did not explain why it was treating these products differently, making the Grayscale denial "arbitrary and capricious," she added.

Bitcoin's price spiked after the ruling was unveiled.

The ruling seemed to specify that the issue wasn't the SEC's rejection of the application so much the agency's failure to properly explain itself.

"Grayscale has demonstrated its proposed bitcoin ETP is materially similar, across relevant regulatory factors, to the approved bitcoin futures ETPs," the ruling said. "First, the underlying assets – bitcoin and bitcoin futures – are closely correlated. And second, 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 and bitcoin futures."

Grayscale shared enough arguments that its proposed ETF was similar to the recently-approved Teucrium and Valkyrie bitcoin futures products, which warrants "the same regulatory treatment," the order said.

The order did not direct the SEC to immediately approve Grayscale's bid to convert its ETF application, but rather to review the application again.

"The Commission failed to adequately explain why it approved the listing of two bitcoin futures ETPs but not Grayscale’s proposed bitcoin ETP. In the absence of a coherent explanation, this unlike regulatory treatment of like products is unlawful. We therefore grant Grayscale’s petition for review and vacate the Commission’s order," the ruling said.

A Grayscale spokeswoman called the move "a monumental step forward for American investors," adding that the legal team was reviewing the opinion and would "be pursuing next steps with the SEC."

In a social media post, Grayscale CEO Michael Sonnenshein echoed the statement.

Long journey

Grayscale Investments, the manager behind world’s largest cryptocurrency fund, first applied for its GBTC closed-end fund to be converted into an exchange traded fund in October 2021. The SEC rejected the application, stating in its decision that the application failed to answer the SEC's questions about preventing market manipulation, as well as other concerns.

Grayscale then filed an appeal against the SEC barely an hour after the regulatory agency rejected its application. In the filing, Grayscale asked the U.S. Court of Appeals for the District of Columbia Circuit to review the SEC's order. Grayscale is a unit of Digital Currency Group, which is also the parent of CoinDesk.

The court decision comes after a flurry of large institutions filed applications for spot bitcoin ETFs, with asset manager BlackRock filing its application in June. BlackRock’s filing generated a large amount of optimism that a spot bitcoin ETF might be approved. Others like Fidelity, the large mutual-fund manager, have also applied for bitcoin ETFs. Seven bitcoin futures ETFs have been trading since 2021.

The Grayscale product has traded at a discount to the underlying asset since February 2021. The discount deepend to a record 50% in December after the SEC reiterated its reasons for denying Grayscale’s application to convert the trust into an ETF. However, following large names filing for bitcoin spot ETFs, GBTC saw its discount narrow to levels of around 25%, the smallest discount since early 2022.

Market analysts have long said that the conversion from a closed-end fund to an ETF will likely eliminate the discount of GBTC entirely, due to the nature of ETFs which generally trade close to their fair value.

The structure of the fund will largely stay the same, bar a few things. The shares will now be registered with the SEC under the Securities Act of 1933. Prior to the conversion, GBTC shares were offered through a private placement process — meaning they were initially only available to accredited investors and subject to a six month holding period.

Another alteration to the structure is the shares will be uplisted from over-the-counter markets to the NYSE Arca. The new structure will also allow for redemptions, which were not previously allowed.

Grayscale previously stated that it would lower its fees if GBTC got converted to an ETF. The fund charged a 2% annual fee.

A spokesperson for the SEC told CoinDesk it was "reviewing the court’s decision to determine next steps."

UPDATE (Aug. 29, 2023, 14:50 UTC): Adds detail from ruling, tweet from Grayscale executive.

UPDATE (Aug. 29, 2023, 15:37 UTC):Adds SEC response.