New letter from Grayscale’s legal team: What to consider for the next Bitcoin ETF decision

On August 29, 2023, a panel of the D.C. Circuit Court of Appeals vacated the SEC’s June 2022 decision denying the Grayscale Bitcoin Trust (GBTC) conversion to a spot Bitcoin ETF. This is a major milestone in the GBTC conversion process—a victory that was celebrated by GBTC shareholders, the Grayscale team, and the broader Bitcoin, cryptocurrency, and investment community.

Today, after reviewing the court’s opinion, our legal team, along with attorneys from Davis Polk & Wardwell and Munger Tolles & Olsen, sent a letter to the SEC that contains important information to consider in determining next steps.

The following is the content of the letter, compiled by Golden Finance:

Dear Mr. Zhu, Ms. Barbero and Ms. Countryman:

On behalf of our client Grayscale Investments, LLC, the sponsor of the Grayscale Bitcoin Trust (BTC), we welcome the opportunity to meet with the Securities and Exchange Commission staff to discuss the future direction of the Trust as soon as possible in light of recent developments and its ongoing efforts to convert to an exchange-traded product (“ETP”).

On June 29, 2022, the Commission denied NYSE Arca, Inc.’s application to list and trade the Trust under Section 19(b)(1) and Rule 19b-4 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Grayscale subsequently sought to challenge the Commission’s ruling in the U.S. Court of Appeals for the D.C. Circuit under Section 25(a) of the Exchange Act, and on August 29, 2023, the Court of Appeals vacated the Commission’s denial.

After the Commission has had an opportunity to fully analyze the Court’s opinion in light of the record, including the grounds for denial set forth in the Rescission Order and the evidence and arguments presented and forwarded by Grayscale, NYSE Arca, and public commenters, we believe that the Commission should conclude that there is no reason to treat the Trust differently from ETPs that invest in bitcoin futures contracts traded on the Chicago Mercantile Exchange (“CME”), whose Rule 19b-4 filing is with the Commission. Accordingly, the Trust’s Rule 19b-4 filing should also be expeditiously approved.

If there were any other reason to seek to distinguish between spot bitcoin ETPs and bitcoin futures ETPs—whether based on the requirements of the Exchange Act, the rules being “designed to prevent fraudulent and manipulative acts and practices,” or some other reason—we believe it would have appeared in 15 Commission orders, including one denying the application of Rule 19b-4 for spot bitcoin, even after the bitcoin futures ETPs began trading.

Grayscale first raised this issue about two years ago (before all of these opposing orders), explaining why it would be unreasonable to deny its Rule 19b-4 application once the Commission determined that it could approve a Bitcoin futures ETP under the control standards of Section 6(b)(5) of the Exchange Act.

But now that the Court of Appeal has spoken, there is no available reason to distinguish the Bitcoin futures ETP from the spot Bitcoin ETP based on the legal analysis the Commission used in its previous rejection of the spot Bitcoin ETP. As the Commission has consistently explained, this is because:

An exchange that lists a bitcoin-based ETP can satisfy its obligations under Section 6(b)(5) of the Exchange Act by demonstrating that the exchange has entered into a comprehensive custody-sharing agreement with a large, regulated market for the underlying or reference bitcoin asset.

This is the test, and the Court of Appeal clearly found that it was met:

Grayscale has demonstrated that its proposed Bitcoin ETP is very similar to the approved Bitcoin futures ETP in terms of relevant regulatory factors. First, the underlying assets — Bitcoin and Bitcoin futures — are closely related. Second, the surveillance sharing agreement with CME is the same and should have the same potential to detect fraud or manipulation in the Bitcoin and Bitcoin futures markets.

The Trust’s Rule 19b-4 filing has now been pending for nearly three times the amount of time that Section 19(b) of the Exchange Act allows the Commission to take action. NYSE Arca initially submitted the Trust’s proposed rule change on October 19, 2021, and the Commission published the proposal in the Federal Register on October 19, 2021.

Pursuant to the requirement of section 19(b)(1) on November 8, 2021. Pursuant to section 19(b)(2)(A)(i), a 45-day time limit period was initiated during which the Commission would decide to approve or deny. Section 19(b)(2)(A)(ii) gave the Commission the authority to extend this deadline for an additional 45 days, until February 6, 2022, which the Commission exercised on December 15, 2021. On February 4, 2022, the Commission filed an action pursuant to section 19(b)(2)(B), in which the Agency was obligated to approve or deny by May 7, 2022 (180 days after the original publication date of November 8, 2021), with a deadline that could be extended by up to 60 days. On May 4, 2022, the Commission extended the deadline and denied the application on June 29, 2022—one week short of the maximum eight months Congress had left for final action.

As a result, the Board’s review of a Trust Fund Rule 19b-4 filing is now significantly longer than permitted by rule 19(b). Under rule 19(b)(2)(D), a proposed rule change is deemed to have been approved by the Board if the agency does not issue an order in a certain manner within the statutory period. We question whether a later order of disapproval would have been effective. The Court of Appeals’ reversal fully satisfied the Board’s obligation to act within the necessary time frame to avoid deemed approval under rule 19(b)(2)(D). But assuming deemed approval does not apply—at least if the Board immediately reexamines the filing in accordance with the Court’s reasoning—we believe there are three points the Board should consider as it considers its next steps.

• First, for every day that the Trust was not listed on NYSE Arca, existing investors in the Trust were unreasonably harmed by the Trust’s trading at a substantial discount to its net asset value. Such harm would have been avoided if the Trust had been treated the same as other Bitcoin futures ETPs for which the Commission had approved Rule 19b-4 filings. In fact, on the day the Court of Appeals announced its decision, the discount rate was tightened by more than 600 basis points in anticipation of the eventual approval of Rule 19b-4, representing a return of more than $2 billion in assets to investors in a single trading day, even though the price at that time was more than $3 billion below the net asset value of the Trust, which would have traded if the Trust had been approved to operate as an ETP.

• Second, U.S. investors seeking access to regulated Bitcoin investment products should not be forced into less efficient and more structurally complex products simply because these are the only product types that have not yet been approved by the Commission. Spot ETPs are strongly favored by investors, as evidenced by their commercial success in other commodities such as gold. Over time, investors and issuers of spot Bitcoin products like Grayscale suffer competitive harm by not being able to benefit from Bitcoin futures ETPs—which, unlike Grayscale, can use time-tested ETP wrappers to grow their assets under management. As a concrete illustration of this harm, on the day the Court of Appeals issued its decision, Bitcoin futures ETP10 benefited from net inflows, an increase of more than 800% over the average daily net fund flows during the prior 30-day period. It is reasonable to assume that the Trust would have attracted the majority of the investment if it had also been operating as an ETP on that day.

• Third, over the past few weeks, the Commission has received Rule 19b-4 filings related to multiple proposed spot Bitcoin ETPs, each of which seeks to compete with the Trust. As Grayscale noted in its comment letter in response to these filings, each of the 12 listed exchanges proposed to enter into surveillance-sharing agreements with major U.S. spot Bitcoin trading venues. Grayscale’s letter explains that the Commission’s prior order approving the Bitcoin futures ETP made clear that entering into a surveillance-sharing agreement with CME alone was sufficient to satisfy the requirements of Rule 6(b)(5) for Bitcoin futures ETPs. Therefore, based on the Court of Appeals’ reasoning, we believe that the Commission may not now impose additional new requirements on spot Bitcoin ETPs to enter into surveillance-sharing agreements with spot Bitcoin markets.

With the Commission’s approval, the Trust is ready to operate as an ETP. Therefore, we hope you agree that the best option now is for the Commission to issue an order approving NYSE Arca’s Rule 19b-4 filing and authorizing the staff to work with Grayscale and NYSE Arca to finalize the Trust’s expeditious listing. We believe that the Trust’s nearly one million investors deserve this level playing field as soon as possible.