Gray Scale 3:0 wins, court reprimands SEC: How far is the Bitcoin spot ETF?

Author: Colin Wu, Wu Says Blockchain

Wu Says has learned that on August 29, the court ruled to approve Grayscale's review request and revoked the SEC's order. Specifically, the federal court ruled that the U.S. Securities and Exchange Commission (SEC) must review Grayscale Investments' decision to convert the Grayscale Bitcoin Trust (GBTC) into an ETF.

The background of the event is that Grayscale Investments first applied to convert its GBTC closed-end fund into an exchange-traded fund, namely a spot ETF, in October 2021. The SEC rejected the application, stating that it failed to address the SEC's concerns regarding market manipulation and other issues. Grayscale requested the U.S. Court of Appeals for the District of Columbia to review the SEC's order.

Grayscale's CEO stated that the D.C. Circuit Court made a favorable ruling challenging the SEC's decision to deny the conversion of GBTC into an ETF, and our legal team is actively reviewing the court's opinion.

Circuit Judge RAO delivered a scathing critique of the SEC in the court opinion, shocking the public, with the core argument being that the SEC's review standards for futures ETFs are consistent with those for spot ETFs, thus there is no reason to deny Grayscale's request.

The court opinion stated that the SEC's rejection of Grayscale's proposal was arbitrary and capricious, as the SEC failed to explain its different treatment of similar products. Therefore, we grant Grayscale's petition and revoke that order.

The judge's comments noted that among thousands of public comments, nearly all supported converting GBTC to an ETF; nevertheless, the SEC still rejected it. If we find that Grayscale is similar to Bitcoin futures ETPs on relevant regulatory factors, we must determine whether the SEC provided sufficient explanation; Grayscale provided indisputable evidence showing a 99.9% correlation between the Bitcoin spot market and CME futures contract prices.

The judge's comments pointed out that Grayscale has demonstrated that its proposed Bitcoin ETF is essentially similar to the approved Bitcoin futures ETFs in terms of relevant regulatory factors. First, the underlying assets, Bitcoin and Bitcoin futures, are closely related. Second, the monitoring sharing agreement with CME is the same and should have the same capability to detect fraud or manipulation in the Bitcoin and Bitcoin futures markets. The commission failed to explain why the monitoring sharing agreement with CME is sufficient to protect Bitcoin futures ETFs from potential fraud but not to prevent Grayscale's spot ETF from fraud.

The judge's comments noted that the SEC neither disputed Grayscale's evidence regarding the 99.9% correlation between the Bitcoin spot market and futures market nor suggested that market inefficiencies or other factors would undermine that correlation. The commission accused Grayscale of failing to provide other types of evidence; such an explanation, along with inconsistent treatment of similar products, is arbitrary and capricious. The SEC failed to adequately explain why it approved the listing of two Bitcoin futures ETPs but did not approve Grayscale's proposed Bitcoin ETP. In the absence of a coherent explanation, this disparate regulatory treatment of similar products is illegal.

What actions will the SEC take next?

Bloomberg ETF analyst James Seyffart pointed out that this does not mean GBTC will automatically convert into a spot ETF, but it does bring things a step closer. There is nothing here that tells us the timeline for when the SEC must issue another order. So I am not sure about the timeline. My initial thought was a 45-day or 60-day deadline. Regarding the appeal, the SEC has 45 days to request an en banc hearing. An en banc hearing essentially means the case is heard by all judges on the court (in this case, 17) rather than just a panel of 3 judges as in this initial decision.

Paradigm policy director Justin Slaughter noted that in this 3-0 ruling in favor of Grayscale, two judges appointed by Presidents Obama and Carter were very hostile to the SEC's arguments, and they not only ruled against the SEC but also agreed to join the opinion of the conservative judge Rao appointed by Trump. This means that Democratic judges are also disapproving of the SEC's decision. "What happens when the SEC loses in front of Democratic judges in multiple circuit courts? What will happen when these arguments reach a hostile and conservative Supreme Court?" (Background: Currently, Republicans are relatively supportive of cryptocurrencies, while the Democratic government opposes them.)

The market also reacted subsequently.

According to Lookonchain monitoring, a whale (0x82…c0ab) exchanged approximately 17.14 million USDC for 10,000 ETH on Uniswap V3 between 22:27 and 22:44, becoming one of the drivers of the nighttime ETH price surge.

According to @BTC__options, influenced by Grayscale's victory, cryptocurrency prices surged across the board, and short-term options IV began to rise rapidly, with BTC cycle options IV once rising to 50%, though it has since retreated. After the increase began, there was a significant volume of call options being purchased, especially for ETH, where the buying volume significantly exceeded that of BTC. However, at the same time, a large proportion of BTC trades were closing out or even buying puts. This indicates that the trading behavior of large BTC holders often leads the market, and unusual trading in BTC often triggers market movements. In recent months, BTC's indicator effectiveness has been strong, while ETH has lagged significantly behind BTC.

Full court document:

https://www.documentcloud.org/documents/23930872-22-1142-opinion