Grayscale wins the case, what will the SEC do next?

On August 29th local time, Grayscale Investments won a key lawsuit against the U.S. Securities and Exchange Commission ( SEC ). A judge of the Washington, D.C. Circuit Court of Appeals ruled that the SEC's decision to approve the Bitcoin futures ETF and reject Grayscale's decision to convert GBTC into a spot Bitcoin ETF was "arbitrary and capricious."

The decision adds significant momentum to Grayscale’s years-long effort, with the company calling it “a monumental step forward for American investors” in a statement.

The new ruling is the second recent defeat for the SEC’s crypto stance in court, and is a stern rebuke of SEC Chairman Gary Gensler’s crackdown on the crypto industry. As BitTorrent reported earlier, the SEC has challenged a federal judge’s initial ruling on Ripple , which held that Ripple Labs’ XRP tokens were not securities when sold to the public.

The market reacted enthusiastically to the news. Grayscale Bitcoin Trust (GBTC) rose nearly 17% to $20.56 in secondary trading today, with assets under management increasing to $17.4 billion from $16.2 billion the day before. Bitcoin's 24-hour gain reached as much as 8.3%, and as of press time, it was $27,600.

'Arbitrary and capricious '

Bitpush previously reported that the SEC rejected Grayscale's conversion proposal in 2022, arguing that Bitcoin-based ETFs lacked sufficient supervision to detect fraud. Grayscale filed a lawsuit to overturn the SEC's decision accusing it of discriminating against its products while approving a similar Bitcoin futures ETF.

Grayscale's lawsuit focuses on the question of whether fund managers can offer spot Bitcoin ETFs to give retail investors access to real-time Bitcoin prices. Although the SEC has previously given the green light to ETFs based on Bitcoin futures, regulators believe that Bitcoin is traded on unregulated exchanges and is susceptible to market manipulation.

"The rejection of Grayscale's proposal is arbitrary and capricious because the Commission fails to explain its disparate treatment of similar products," Judge Neomi Rao wrote in the ruling.

In its opinion, the court said Grayscale "provided substantial evidence" that its products are similar to the SEC-approved bitcoin futures ETF. The underlying assets of the two products are closely related and "identical" to the Chicago Mercantile Exchange's custody sharing agreement.

During a hearing in the case in March, the judges questioned the SEC about its decision and appeared to support Grayscale’s argument that the underlying markets for spot bitcoin and bitcoin futures are equally subject to risk of fraud and manipulation.

Big positive for spot Bitcoin ETF?

Despite the SEC’s tough stance on the crypto industry, demand for spot Bitcoin ETFs is growing, with some of the largest and most well-known companies in the financial world recently submitting applications to the SEC to launch Bitcoin ETFs. The agency is considering proposals from companies such as BlackRock , WisdomTree , and Fidelity to launch spot Bitcoin ETFs.

Jeremy Senderowicz of Vedder Price Law Firm tweeted : “According to the court’s decision, this is a near-fatal blow to the SEC’s decision not to allow these products to be listed. If this decision stands, it negates the core basis for the SEC’s rejection of all spot Bitcoin ETFs over the past few years.”

This could be a watershed moment for bitcoin adoption. Proponents believe an ETF based on bitcoin spot will drive a massive influx of retail investors.

Grayscale said converting to an ETF would help it more easily create and redeem shares, helping its $16.2 billion trust unlock billions of dollars in value for investors. The trust’s closed-end structure doesn’t allow investors to redeem shares when prices fall, causing it to trade at a steep discount to the underlying bitcoin. As an ETF, it can create and redeem shares to meet changing demand.

Oppenheimer & Co analyst Owen Lau told Bloomberg that the ruling has added momentum to the digital asset industry following the Ripple case: "There is now huge optimism in the market."

Bloomberg Intelligence analyst James Seyffart said that although the possibility of GBTC being converted into an ETF has increased, it is "not 100%."

“What we do know is that the SEC cannot use the arguments about fraud and manipulation they have used in past rejection letters to reject a spot ETF while a Bitcoin futures ETF exists,” Seyffart tweeted.

Seyffart noted that the SEC may consider delisting the current Bitcoin futures ETF, but he believes such a move is "unlikely." He said: "It depends on Gary Gensler's leadership and the SEC's belief that a Bitcoin ETF cannot exist. It becomes more difficult for them to continue to deny, but not impossible."

What’s the SEC’s next move?

What's next? A lot depends on whether SEC Chairman Gary Gensler wants to give up or fight to the end.

Arie Heijkoop, a partner at the law firm Haynes Boone, said he does not expect the SEC to appeal.

Heijkoop said in a personal tweet: “The court explained the shortcomings of the SEC decision forcefully enough that it is unlikely to be overturned. If the SEC is still unwilling to approve a spot bitcoin [product], this decision does leave room for the SEC to review its denial of Grayscale and articulate additional reasons for the denial.”

Matt Hougan, chief investment officer of Bitwise Asset Management, analyzed that depending on the decision of the appeal, the SEC will face several options.

One is to approve all or part of the nine spot Bitcoin ETF applications as soon as possible. The SEC may agree with the court's ruling and issue an order allowing the exchange (NYSE Arca) where the Grayscale ETF is listed to continue listing the Grayscale fund, or approve other funds that have been applied for.

The Bitcoin spot ETF applications currently in the queue include: Grayscale Bitcoin Trust; Ark/21 Shares Bitcoin Trust; Bitwise Bitcoin ETF Trust; BlackRock Bitcoin ETF Trust; VanEck Bitcoin Trust; WisdomTree Bitcoin Trust; Valkyrie Bitcoin Fund; Invesco Galaxy Bitcoin ETF; Fidelity Wise Origin Bitcoin Trust.

The second is to delay as permitted by law. The first applicant to submit an application was Ark, which was published in the Federal Register on May 15. The SEC has up to 240 days to approve or reject these applications, which means the first deadline is January 10, 2024.

A third option is to come up with new reasons for denying the application and face the possibility of Grayscale suing again. The SEC can no longer use the argument that the market size is not large enough to prevent manipulation, but it may come up with other arguments.

Bloomberg analyst Seyffart concluded in his tweet that it is not yet certain whether the SEC will make a new decision in the coming weeks or months, or require Grayscale to submit Form 19b-4 (used to notify regulators of proposed rule changes). He emphasized that the SEC may find a reason that has not been used before to refuse to convert GBTC into an ETF, such as potential objections surrounding Bitcoin custody.

An SEC spokesman said it was reviewing the court's ruling and that the agency has 45 days to ask the full D.C. Circuit Court of Appeals to reconsider the decision. If the appeals court refuses to hear the case, the SEC will have 90 days to ask the U.S. Supreme Court to hear the case.