SEC doubles down on decision to reject Grayscale spot ETF

The Securities and Exchange Commission doubled down last week on its decision to reject Grayscale’s bid to launch a bitcoin ETF, repeating its stance that such products are prone to fraud and manipulation, court records show.

Grayscale had claimed over the summer that the SEC was applying an unfair double standard by allowing bitcoin futures ETFs on the market and repeatedly denying proposals for ETFs that invest in spot bitcoin.

In June, the SEC rejected Grayscale’s proposal to convert its Bitcoin Trust into an ETF. Later that day, Grayscale sued the regulator, alleging the commission violated the Administrative Procedure Act and the Securities Exchange Act of 1934 by discriminating between issuers of the two types of ETFs on an “arbitrary and capricious” basis.

In October 2021, the ProShares Bitcoin Strategy ETF became the first bitcoin futures ETF. The fund had $575mn in assets as of December 9, according to CFRA’s ETF database. Other bitcoin futures ETFs on the market include the $20mn Valkyrie Bitcoin Strategy ETF and the $21mn VanEck Bitcoin Strategy ETF.

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The reply brief, filed last week, marks the SEC’s first response to Grayscale’s lawsuit. In it, the commission reiterated its stance that it had approved bitcoin futures ETFs because they are monitored closely by the Chicago Mercantile Exchange. Spot bitcoin ETFs, meanwhile, lack that level of federal oversight, the brief says.

NYSE Arca, where Grayscale wants its ETF to be listed, claims that the index that its proposed spot bitcoin ETF would track uses an advanced algorithm to mitigate fraud, manipulation and other anomalous trading activity. However, the SEC argues that those provisions are not sufficiently effective, its reply brief shows. Plus, bitcoin is an unregulated spot market without adequate surveillance, the commission noted.

“The SEC has remained consistent in its belief that while a futures-based bitcoin ETF is permissible, a spot-based one is not because there was risk of fraud and manipulation,” said Todd Rosenbluth, head of research at VettaFi. “Grayscale has a high burden to overcome in part because the SEC has blocked any such ETF numerous times as a wave of filings occurred under the current leadership.”

The SEC has rejected applications for bitcoin ETFs from a raft of companies, including WisdomTree, Fidelity and VanEck.

The SEC also argued that bitcoin futures ETFs and spot bitcoin ETFs should be treated differently from one another because they pose different risks for investors. The commission urged the Washington, DC, appeals court, where the case is filed, to affirm its view that it acted reasonably when rejecting Grayscale’s plans to convert its Bitcoin Trust, the regulator wrote.

The US Chamber of Commerce, NYSE Arca, Coinbase and the Blockchain Association have voiced their support for Grayscale’s lawsuit, filing amicus briefs in October that argue bitcoin futures ETFs are riskier than the proposed spot bitcoin ETFs.

“Coinbase champions the value of private-sector market surveillance adopted voluntarily by unregulated spot-trading platforms and asserts that ‘the largest players in the bitcoin market’ have investors’ best interests at heart,” the SEC wrote. “But Congress passed the securities laws on the premise that voluntary regulation is not always sufficient.”

The SEC is creating an “uneven playing field” by approving bitcoin futures-based ETFs and continuously denying spot bitcoin ETFs, and this puts Bitcoin Trust shareholders at an unfair disadvantage, Grayscale said in a statement posted to its website last week.

Grayscale and its lawyer at Davis Polk did not respond to requests for comment.

The regulator is also holding spot bitcoin to a higher standard than futures contracts without articulating a “sound basis for this decision”, Grayscale said. Since the November 8 collapse of FTX, the CoinDesk Bitcoin Price Index that Grayscale’s spot bitcoin ETF would have tracked has priced very similarly to the bitcoin futures index on the Chicago Mercantile Exchange, the Stamford, Connecticut-based company said.

Bitcoin futures ETFs have also closely tracked bitcoin prices lately, said Aniket Ullal, head of ETF data and analytics at CFRA Research. Bitcoin’s spot price and ProShares Bitcoin Strategy ETF have both returned negative 63 per cent year to December 9, according to CFRA data.

Despite the massive decline in bitcoin’s value, the seven bitcoin futures ETFs on the market have attracted a net $338mn in flows in the year to December 9, according to CFRA. Combined, the ETFs had $723mn in assets as of that date, the database shows.

“That number is meaningful relative to the current asset base in these products, but very small compared to the overall flows into US ETFs,” he said.

Overall, the $6.8tn US ETF market recorded $544bn in net inflows year to date through November 30, according to Morningstar Direct.

“Crypto investors are calling for more regulated options,” Grayscale said. “It is time that the SEC answers that call.”

The firm has until January 13 to respond to the SEC’s brief, court records show.

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