Crypto asset manager Grayscale Investments LLC, which manages the world’s largest bitcoin investment fund, told a federal appeals court on Tuesday that the U.S. Securities and Exchange Commission is so suspicious of bitcoin spot trading that it blocked a proposal to make it easier and safer for investors to gain exposure to the cryptocurrency.
That is the only reasonable conclusion, Grayscale argued in a new brief filed with the District of Columbia U.S. Circuit Court of Appeals, to be drawn from the SEC’s decision last June to reject a proposal from the New York Stock Exchange to convert Grayscale’s $15 billion bitcoin investment trust into an exchange-traded fund, despite the commission’s previous approval of exchange-traded funds based on bitcoin futures. (Challenges to final SEC orders are heard by federal appellate courts, not trial courts.)
Grayscale told the D.C. Circuit that its bitcoin trust, which is based on an index of spot, or instantaneous, bitcoin trading prices, is no more susceptible to fraud and manipulation than the SEC-blessed exchange-traded bitcoin futures funds, which rely on nearly identical bitcoin trading price indexes.
Since bitcoin futures and spot bitcoin prices are both rooted in the same underlying spot markets for the cryptocurrency, Grayscale’s lawyers at Munger, Tolles & Olson told the D.C. Circuit, the SEC’s refusal to approve an exchange-traded fund that references actual bitcoin, rather than bitcoin futures contracts, reflects a “special harshness based on [the SEC’s] opinion about bitcoin’s merits as compared to other types of investments.”
Bitcoin spot prices and bitcoin futures, said Grayscale chief legal officer Craig Salm in an exclusive interview, are subject to the same fraud risk that has historically worried the SEC. “So logically speaking,” Salm said, “if you’re OK with one, you must also be OK with the other because you otherwise would be arbitrary.”
The SEC did not immediately respond to a request for comment on Grayscale’s filing. The commission has said that its rejection of Grayscale’s proposed spot bitcoin exchange-traded fund should not be viewed as a judgment on the relative merits of bitcoin and bitcoin futures contracts or “an assessment of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment.”
The commission’s June order attributed its rejection of Grayscale’s application to concerns that the New York Stock Exchange does not have an adequate surveillance-sharing agreement with a regulated market where a “significant share” of spot bitcoin trading takes place. The NYSE had pointed out that it shares information with the Chicago Mercantile Exchange, but the SEC said it was not convinced that the CME bitcoin futures market qualified as a “market of significant size” for spot bitcoin trading.
Grayscale’s new brief, which says that the SEC’s rejection was arbitrary and capricious under the Administrative Procedure Act, argues that the SEC’s significant market test is “deeply flawed” and has no basis in the text of the Securities and Exchange Act.
But even if the test is appropriate, Grayscale contends, the commission has not applied it consistently in distinguishing between exchange-traded funds based on spot bitcoin prices and those based on bitcoin futures contracts.
“That stark arbitrariness cannot be justified,” the brief argued. “In disapproving the proposed spot bitcoin [exchange-traded product] here, the commission applied an exceedingly stringent version of the test — going so far as to make findings that directly contradict findings that it made in its orders approving the bitcoin futures ETPs.”
Grayscale launched its bitcoin trust way back in 2013 through a private placement for accredited investors. Shares of the trust currently trade over the counter but, according to Grayscale, the shares trade at a discount from bitcoin’s actual price because of restrictions that would be eliminated if the SEC had allowed the trust to be converted into an exchange-traded fund.
Grayscale’s brief asserted that its existing investors would reap about $4 billion if the trust were converted to an exchange-traded fund. The conversion would also subject the fund to public reporting requirements that, according to Grayscale, would enhance investor protection. The asset manager told the D.C. Circuit that the investment market is “clamoring” for a product that offers a safe, simple way to buy bitcoin — and that an exchange-traded fund based on the actual cryptocurrency is easier for investors to understand than a fund based on a bitcoin derivative.
A central pillar of Grayscale’s brief is its contention that bitcoin futures and spot bitcoin prices are inextricably linked. The filing refers several times to a letter that Vanderbilt University professor Robert Whaley sent to the SEC during the comment period on the NYSE’s request to allow trading in a Grayscale exchange-based fund. Whaley, who developed key indexes for the Chicago Board Options Exchange and the NASDAQ, told the SEC that the bitcoin indexes underlying the Grayscale Trust and the bitcoin futures traded on the Chicago Mercantile Exchange are “near perfect substitutes” for one another.
Whaley’s statistical conclusion, the Grayscale brief argued, aligns with common sense, since bitcoin futures derive from the spot price of actual bitcoin. If the spot price is tainted by fraud or manipulation, Grayscale said, the futures price will likewise be affected. So it’s arbitrary, the brief argued, to refuse to allow an exchange-trade fund based on spot bitcoin prices while allowing a product based on futures.
It doesn’t matter, in the view of Grayscale chief legal officer Salm, that the SEC-approved bitcoin futures funds trade on the Chicago exchange, which also regulates the futures contracts underlying those funds. In the end, Salm said, bitcoin futures and spot bitcoin indexes arise from the same trading market.
“I believe we have very simple, straightforward and compelling arguments here,” Salm said. “In many ways it’s not about bitcoin at all. It’s about fair treatment under the law.”