Explainer-Understanding Grayscale's victory in spot bitcoin ETF case

A representation of virtual currency Bitcoin is seen in front of a stock graph in this illustration taken

By Hannah Lang

(Reuters) -The U.S. District of Columbia Court of Appeals on Tuesday ruled that the Securities and Exchange Commission (SEC) was wrong to reject an application from crypto asset manager Grayscale Investments to list an exchange-traded fund that tracks the price of bitcoin, in a landmark decision.

The case has been closely watched by the cryptocurrency and asset management industries, which have been trying for years to convince the SEC to approve a spot bitcoin ETF. They say it would allow investors to gain exposure to bitcoin, the world's largest cryptocurrency, without having to own it. The SEC, though, worries spot bitcoin ETFs will be vulnerable to manipulation.

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The SEC last year denied Grayscale's application to convert its spot Grayscale Bitcoin Trust into an ETF, listed on the New York Stock Exchange's Arca market.

While the agency has rejected spot bitcoin ETFs, it has approved bitcoin futures ETFs, which track agreements to buy or sell bitcoin at a pre-agreed price. Grayscale and Arca proposed using the same market manipulation safeguards that were approved for those futures ETFs, but the SEC said that did not meet its bar.

Grayscale was just one of several asset managers, including Cathie Wood's ARK, Fidelity and Invesco, whose spot bitcoin ETF applications the SEC rejected on investor protection grounds. Unlike those other firms, Grayscale sued the SEC. Because the defendant is a regulator, the case went straight to the appeals court.


Grayscale argued that the bitcoin futures ETF surveillance arrangements should also be satisfactory for Grayscale's spot ETF, since both products rely on bitcoin's underlying price.

Bitcoin futures ETFs track bitcoin futures that trade on the Chicago Mercantile Exchange (CME), the chief venue for those products. The CME "surveils futures market conditions and price movements on a real time and ongoing basis in order to detect and prevent price distortions, including price distortions caused by manipulative efforts," the SEC has said.

Grayscale's lead counsel Donald Verrilli Jr told the court in March that a spot bitcoin ETF would "better protect investors" because it would give them the benefit of CME oversight of the market. Currently, Americans mostly invest in bitcoin via less well-established or unregulated exchanges.

The SEC, however, says Grayscale lacks data to determine whether the CME futures surveillance agreement could also detect potential manipulation in the spot markets.


The court's panel of judges said Grayscale showed that its proposed bitcoin ETF is "materially similar" to the approved bitcoin futures ETFs. That's because the underlying assets— bitcoin and bitcoin futures - are "closely correlated," and because the surveillance sharing agreements with the CME are "identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin."

With that in mind, the court ruled that the SEC was "arbitrary and capricious" to reject the filing because it "never explained why Grayscale owning bitcoins rather than bitcoin futures affects the CME’s ability to detect fraud."


Both parties have 45 days to appeal the ruling, in which case it would either go to the U.S. Supreme Court or an en banc panel review. It is unclear if the SEC will appeal. The regulator did not immediately respond to requests for comment on Tuesday.

If Grayscale ultimately prevails and the SEC does not appeal, the court would specify how its decision should be executed. That 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.


Several firms have this year filed spot bitcoin ETFs for listing on Nasdaq or CBOE Global Markets, including BlackRock, the world's largest asset manager, Fidelity, WisdomTree, VanEck, Bitwise and Invesco.

Many have proposed working with Coinbase, the largest U.S.-based crypto exchange, to police trading in the underlying bitcoin market. The SEC has formally acknowledged those applications, and can take as long as 240 days to decide.

It's unclear what Tuesday's ruling means for those applications, and it does not necessarily follow from the ruling that the SEC must approve a bitcoin ETF. But the ruling could factor into the SEC's decisions on those proposals.

(Reporting by Hannah Lang in Washington; editing by Michelle Price and Nick Zieminski)