Shortly after Grayscale Investments' application for a Nasdaq-traded Bitcoin spot fund (ETF) was rejected by the U.S. Securities and Exchange Commission (SEC), the largest crypto asset manager filed a lawsuit against the exchange regulator.
NYSE Arca, a subsidiary of the New York Stock Exchange, had filed an application in October that would have allowed Grayscale to convert its $13.5 billion Grayscale Bitcoin Trust (GBTC) into a bitcoin spot ETF. The U.S. Securities and Exchange Commission (SEC) has now denied the request for the rule change. The regulator is concerned that investors are not adequately protected by Grayscale's proposal. Furthermore, the SEC justified the decision with concerns about market manipulation, although Bitcoin spot ETFs are already traded in countless countries around the world.
SEC acts arbitrarily
The lawsuit asks the U.S. Court of Appeals for the District of Columbia Circuit to review the SEC's order. Grayscale CEO Michael Sonnenshein had previously stated his intention to sue the SEC in the event of a rejection. He argues that the regulator should not distinguish between Bitcoin futures ETFs, which have already received approval in October 2021, and Bitcoin spot ETFs.
"Grayscale supports and believes in the SEC’s mandate to protect investors, maintain fair, orderly, and efficient markets and facilitate capital formation -- and we are deeply disappointed by and vehemently disagree with the SEC's decision to continue to deny spot Bitcoin ETFs from coming to the U.S. market. [...] We believe American investors overwhelmingly voiced a desire to see GBTC convert to a spot Bitcoin ETF, which would unlock billions of dollars of investor capital while bringing the world’s largest Bitcoin fund further into the U.S. regulatory perimeter." - Michael Sonnenshein, Grayscale CEO
Grayscale's lawyer, General Don Verrilli, noted some arbitrariness. He said the SEC had failed to treat similar investment vehicles consistently. In its order, however, the U.S. Securities and Exchange Commission emphasized that its disapproval was not based on an assessment of the relative investment quality of a bitcoin spot product compared to a CME bitcoin futures product. Nor is it an assessment of whether Bitcoin (BTC) or blockchain technology in general has utility or value as an innovation or investment, the SEC announced.
Are investors actually protected?
It's no secret that investors are in need of an ETF conversion of the Grayscale Bitcoin Trust (GBTC). That's because there is currently no way to convert the more than $12 billion in GBTC into real bitcoin, creating a 30% discount on the product over the past year. On top of that, there are annual management fees of 2%, which further diminish the wealth of trust investors. Without converting to a spot fund, they have no way out in sight. But Grayscale Trust investors aren't the only ones hoping for a spot ETF. In the traditional financial world, it's a well-known fact that futures-based ETFs often have to sacrifice performance relative to the underlying.
If a futures contract trades predominantly in a contango situation, as is usually the case with Bitcoin, an investor fares worse over time than with a direct investment. This is because the issuer has to exchange the deposited futures contracts for the next futures contract at the end of their term, and therefore pays the premium for the next futures contract, which is ultimately borne by the ETF investor. Over a longer investment horizon, this circumstance inevitably leads to a below-average performance compared to the underlying. A spot ETF would therefore also have advantages for investors who wish to trade ETFs on the New York Stock Exchange.
