SEC doubles down on decision to reject Grayscale spot ETF

The Securities and Exchange Commission doubled down last week on its decision to reject Grayscale’s bid to launch a bitcoin ETF, reiterating its position that such products are vulnerable to fraud and manipulation, court records show.

Grayscale had argued over the summer that the SEC was applying an unfair double standard by allowing bitcoin futures ETFs on the market and repeatedly rejecting proposals for ETFs investing in spot bitcoin.

In June, the SEC rejected Grayscale’s proposal to convert the Bitcoin Trust into an ETF. Later that day, Grayscale sued the regulator, alleging that the commission violated the Administrative Procedure Act and the Securities Exchange Act of 1934 by discriminating between issuers of the two types of ETFs on an “arbitrary and capricious” basis.

In October 2021, the ProShares Bitcoin Strategy ETF became the first bitcoin futures ETF. The fund had $575 million in assets as of Dec. 9, according to CFRA’s ETF database. Other bitcoin futures ETFs on the market include the $20mn Valkyrie Bitcoin Strategy ETF and the $21mn VanEck Bitcoin Strategy ETF.

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The response letter, filed last week, marks the SEC’s first response to Grayscale’s lawsuit. In it, the commission reiterated its position that it had approved bitcoin futures ETFs because they are closely monitored by the Chicago Mercantile Exchange. Spot bitcoin ETFs, meanwhile, lack that level of federal oversight, the brief said.

NYSE Arca, where Grayscale wants the ETF to be listed, claims that the index that the proposed spot bitcoin ETF will track uses an advanced algorithm to reduce fraud, manipulation and other abnormal trading activity. However, the SEC argues that these provisions are not sufficiently effective, its response brief shows. In addition, bitcoin is an unregulated spot market without adequate monitoring, the commission noted.

“The SEC has remained consistent in its belief that while a futures-based bitcoin ETF is permitted, a spot-based one is not because there were risks of fraud and manipulation,” said Todd Rosenbluth, head of research at VettaFi. “Grays have a high burden to overcome in part because the SEC has blocked such an ETF multiple times as a wave of filings occurred under current management.”

The SEC has rejected applications for bitcoin ETFs from a number of companies, including WisdomTree, Fidelity and VanEck.

The SEC also argued that bitcoin futures ETFs and spot bitcoin ETFs should be treated differently because they pose different risks to investors. The commission urged the Court of Appeals in Washington, DC, where the case is pending, to affirm its view that it acted reasonably in rejecting Grayscale’s plans to convert the Bitcoin Trust, the regulator wrote.

The US Chamber of Commerce, NYSE Arca, Coinbase and the Blockchain Association have voiced their support for Grayscale’s lawsuit, filing amicus briefs in October arguing that bitcoin futures ETFs are riskier than the proposed spot bitcoin ETFs .

“Coinbase champions the value of private sector market surveillance adopted voluntarily by unregulated spot trading platforms and asserts that ‘the largest players in the bitcoin market’ have investors’ best interests at heart,” the SEC wrote. “But Congress passed the securities laws with the understanding that voluntary regulation is not always sufficient.”

The SEC is creating an “uneven playing field” by approving bitcoin futures-based ETFs and continually denying spot bitcoin ETFs, and this puts Bitcoin Trust shareholders at an unfair disadvantage, Grayscale said in a statement posted on its website last week.

Grayscale and its attorney at Davis Polk did not respond to requests for comment.

The regulator also holds spot bitcoin to a higher standard than futures contracts without articulating a “sound basis for this decision,” Grayscale said. Since the collapse of FTX on Nov. 8, the CoinDesk Bitcoin Price Index that Grayscale’s spot bitcoin ETF would have tracked has priced very similarly to the bitcoin futures index on the Chicago Mercantile Exchange, the Stamford, Connecticut-based company said.

Bitcoin futures ETFs have also been closely tracking bitcoin prices recently, said Aniket Ullal, head of ETF data and analysis at CFRA Research. Bitcoin’s spot price and the ProShares Bitcoin Strategy ETF have both returned a negative 63 percent year to Dec. 9, according to CFRA data.

Despite the massive drop in bitcoin’s value, the seven bitcoin futures ETFs on the market attracted a net $338 million in flows in the year to Dec. 9, according to CFRA. Combined, the ETFs had $723 million in assets as of that date, the database shows.

“That number is meaningful relative to the current asset base in these products, but very small compared to the total flows into U.S. ETFs,” he said.

Overall, the $6.8 billion U.S. ETF market recorded $544 billion in net inflows so far this year through Nov. 30, according to Morningstar Direct.

“Crypto investors are calling for more regulated options,” Grayscale said. “It’s time for the SEC to answer that call.”

The firm has until January 13 to respond to the SEC’s letter, court records show.

*Ignites is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignites.com.

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