(Posted September 2023)

A three-judge panel of the District of Columbia Court of Appeals in Washington, DC ruled recently that U.S Securities and Exchange Commission (SEC) was wrong to reject an application from Grayscale Investments to create a spot bitcoin exchange-traded fund (ETF) which would track its underlying market price, giving investors exposure to the digital asset, without having to buy the currency. The SEC has denied all proposed bitcoin ETFs, including Grayscale’s, on the grounds that they do not meet its bar for preventing market manipulation. Grayscale Investments sued the SEC for rejecting their application, in response to which the Court ruled that SEC failed to fully explain its reasoning, when denying Grayscale’s product, and should review its decision.

While the ruling does not mean Grayscale’s ETF is automatically approved, it is a big boost for the decade-long industry effort to advance a bitcoin ETF product, and the cryptocurrency industry, with whom we concur here, was quick to support the ruling as it sets a precedent for the entire cryptocurrency industry, and could help several other asset managers, including BlackRock, Fidelity and Invesco who have similar filings pending with the SEC for spot bitcoin ETFs.

Background

Spot bitcoin ETFs would give investors exposure to the world’s largest cryptocurrency, by market capitalization, without having to own it. The SEC had rejected Grayscale’s application for a spot bitcoin ETF in June 2022, arguing the proposal did not meet anti-fraud & investor protection standards nor has the proposal shown that Grayscale Investments can protect investors from market manipulation. It cited the same reason in its denial of dozens of other applications for similar products. Grayscale sued the SEC, arguing that because the agency previously approved certain surveillance agreements to prevent fraud in bitcoin futures-based ETFs, the same setup should also be satisfactory for Grayscale’s spot fund, since both spot and futures funds rely on bitcoin’s price with bitcoin spot and future markets being highly correlated.

Ruling

The court ruled that the SEC failed to explain why it disagreed with Grayscale’s assertion that the bitcoin spot and futures markets are 99.9% correlated and opined that SEC’s unexplained discounting of the financial and mathematical relationship, between the spot and futures markets, falls short of the standard for reasoned decision-making. Case in point – The court brought up the fact that SEC failed to adequately explain why it approved the listing of two bitcoin futures ETPs (Exchange Traded Product) but not Grayscale’s proposed bitcoin spot ETP, and unlike regulatory treatment of like products is unlawful. Note: ETPs are a broader category that encompasses a number of investment instruments such as ETFs, Exchange Traded Notes (ETNs), and Exchange Traded Commodities (ETCs) and therefore, ETFs are a subset of ETPs.

The SEC has 45 days to appeal the ruling. If the SEC appeals the Grayscale ruling, the case would go either to the U.S. Supreme Court or a review by the entire D.C. appeals court. If the SEC chooses not to appeal, the court would issue a mandate specifying how its decision should be executed which could include instructing the SEC to approve the application, or to revisit Grayscale’s application, in which case the SEC could still reject the proposal on other grounds.

This current ruling is the second major legal victory for the crypto industry in recent months, after a judge ruled in July, in a case brought by the SEC, that Ripple Labs did not violate federal laws by selling its XRP token on public exchanges. The SEC has said it plans to appeal that finding. It remains to be seen how these rulings might affect proposals submitted in June by BlackRock, the world’s largest asset manager, and several other firms to offer spot bitcoin ETFs. The SEC has yet to deliver a decision on those applications.

While we whole-heartedly support SEC’s primary role of regulating the Financial Markets by ensuring new financial products are not manipulated, we concur with this ruling of the Court, as it imposes the fairness standard on the Regulating Agency to not “discriminate” against similar correlated products, on the Spot and Futures markets related to Bitcoin, and provide more transparency into SEC’s decision-making process when making such judgements.