The lawsuit that could decide the future of crypto

Former Obama lawyer Don Verrilli. Paul J. Richards – Getty Images

Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insights on politics and regulation.

On Tuesday morning, at an office building a few blocks from the White House, crypto firm Grayscale posted a spread of pastries and coffee. In a week’s time, the company will argue before the DC Circuit Court of Appeals as one of the industry’s companies that was daring – or foolhardy – enough to challenge the Securities and Exchange Commission. Today it met a slightly lighter crowd of caffeine-deprived journalists.

Grayscale is part of Barry Silbert’s Digital Currency Group, which includes bankrupt lender Genesis and Polk Prize-winning CoinDesk, which is now reportedly up for sale. Despite the crypto empire’s financial woes, it still has deep pockets. It was evident in the breakfast’s star participant: the lawyer who was to represent Grayscale in court, Don Verrilli Jr. As a former law clerk to President Obama, Verrilli has argued some of the nation’s landmark Supreme Court cases, from marriage equality. to the Affordable Care Act. The grayscale lawsuit is far less glamorous, although some in the crypto industry would argue that it is of comparable importance.

The details of the case would far exceed this column’s word count, but here’s the short version: Grayscale manages the Grayscale Bitcoin Trust, a behemoth with nearly $15 billion in assets that, when it launched back in 2013, represented one of the first financial vehicles for investors to to gain exposure to Bitcoin without buying it directly.

Due to quirks of securities legislation, investors cannot redeem the shares in the trust back into Bitcoin, which has led to fluctuations in the share price relative to the amount of Bitcoin they hold. As has been widely discussed, the arbitrage opportunities created the fortunes of firms such as crypto hedge fund Three Arrows Capital – and led to their downfall.

Grayscale prefers to convert its trust into a more sensible vehicle — an exchange-traded fund, or ETF, that tracks the current price of Bitcoin, or the spot market. The SEC has been resistant to the idea. Although crypto’s favorite agency has approved ETFs based on the Bitcoin futures market — which the SEC claims is regulated by the Commodity Futures Trading Commission — it has rejected all applications for spot market ETFs because, you know, the crypto exchanges that sell Bitcoin are unregulated and must log in and register.

To put it as simply as possible, the SEC argues that the spot Bitcoin market remains unregulated and prone to fraud and manipulation. Grayscale argues that the SEC is “arbitrary and capricious” in approving futures Bitcoin ETFs and not spot-based ETFs because they are both priced from the same underlying markets.

Before we get too far into the weeds of financial jargon, here’s the bottom line: Grayscale believes that if the SEC approved a spot Bitcoin ETF, it would unlock billions for investors, possibly save the fate of its parent company, Digital Currency Group, and reverse the industry’s fortunes by allowing investors turn to regulated financial instruments instead of, for example, an offshore exchange based in the Bahamas.

To hear Verrilli describe it, the case is open and closed. Although he admits he had no background in crypto before his involvement with Grayscale, Verrilli insisted the case is more about SEC overreach than any blockchain-related quirks.

“Courts recognize that the agencies have expertise, but they don’t have a blank check,” he said.

Whether the three-judge DC Circuit panel agrees on March 7 remains to be seen, and there’s a good chance the lawsuit could become the first crypto case to reach the Supreme Court. If it does, Verrilli will feel right at home.

Leo Schwartz
[email protected]
@leomschwartz

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