Grayscale is finally getting its long-awaited day in court as it squares up against the SEC regarding the conversion of its Grayscale Bitcoin Trust (GBTC) into an ETF.
In oral arguments on Tuesday, things were heating up, according to our special contributor, Dan Mika. Also, I recently went on Scott Melker’s show, “Wolf of All Streets,” to bandy about my own hot takes on the lawsuit. (You can watch the episode here.) Let me cut to the chase, though, and lay out what I think are the most likely scenarios for how this case proceeds.
The SEC's Case Against A Bitcoin ETF
On the surface, things appear fairly simple: GBTC, which is listed on the OTCQX market, is a Delaware Statutory Trust that conducts the straightforward business of receiving and managing a pool of bitcoin. From 2014-2016, the fund had provisions for redemptions, meaning that it essentially acted like an ETF: Large shareholders could redeem shares for actual Bitcoin, forcing arbitrage between GBTC’s trading price and the value of the Bitcoin it held. (In theory, at least.)
The SEC smacked them for this, however. They removed that redemption ability and Grayscale paid a fine. Ever since then, they’ve been in limbo, waiting to turn redemptions back on. (For more detail, read my piece on the relevant regulation, GBTC Diamond Hand Bitcoin Motel.) As a result, GBTC has become a quasi-closed-end fund: Like the Hotel California, the Bitcoin can go in, but it can never leave.
Cue Grayscale taking a different tack. The firm has tried to convert GBTC directly into an ETF in the last few years. However, the SEC denied their application like they’ve denied all spot bitcoin ETF filings. But Grayscale called foul and filed a lawsuit.1
Inside the GBTC Lawsuit: What's In A Rule Change
But this isn’t necessarily a lawsuit, or even a product approval, in how investors generally think about them. What actually happened is that the New York Stock Exchange (NYSE) filed for a rule change with the SEC to allow for the listing and trading of GBTC.
As a self-regulatory organization, the NYSE gets to write its own rules about how it conducts business on its own exchange and how it enforces its rules, with the caveat that anytime they decide to change the rules, they need a “mother may I” permission slip from the SEC known as a 19b-4. In this particular case, the NYSE needed to file a 19b-4 because trading an ETF that held Bitcoin would necessarily be different than trading an ETF of equities, for example.
The SEC refused to approve that rule change due to a laundry list of concerns, but their biggest and most consistent objection has been market surveillance. They want to be certain, to whatever extent anyone can be, that the price of bitcoin won’t be subject to manipulation — you know, like those wild west markets in spot silver (of course, SLV exists, but I digress).
Grayscale then petitioned the appellate court of D.C. (because suing a federal agency means you skip to appeals courts), asking them to review the SEC’s decision. That’s it. They want the court to review the decision, which started in earnest this week during opening arguments.
Here’s what I see as the potential outcomes of this lawsuit.
#1: Grayscale Loses Its Lawsuit. Odds: 40%
Before Tuesday, I would have put this closer to 60%, but given the rather friendly reception they received from the court, I’m a bit less pessimistic.
According to the Congressional Research Service on APA actions, 2003 case law sets the standard that Grayscale will have to prove “that an agency failed to take a discrete action that it is required to take.” This is really quite a high standard to take about approving a rule change for a self-regulatory organization like the NYSE.
In general, courts are highly deferential to federal agencies. In fact, they are ordered to be so by things like Chevron deference – a case law that sets the standard that agencies have wide latitude in interpreting statutes. So almost regardless of anything new we hear, I don’t think the odds of a loss go much below 40%. It would be the easy out for the judges at hand.
#2: The Court Slaps The SEC's Hand, But Still No Bitcoin ETFs. Odds: 30%
It’s reasonably likely that the judges agree on a key point in Grayscale’s favor: All this rigamarole about how futures are so different from a spot that we can’t possibly rely on the Commodity Futures Trading Commission’s (CFTC’s) oversight is pretty weak. The data doesn’t support the SEC’s arguments here. But simply saying an argument is bad isn’t the same as giving the green light for an ETF.
Instead, I find it much more likely the panel of three judges tells the SEC to go back to the drawing board, enjoining the SEC to some sort of re-review period in which they must either approve or deny the conversion of GBTC on some other basis.
It’s something I think they could quite easily do; while not a lawyer, I suspect the SEC could go back to the original filings and simply lean on any number of other objections, kicking the can even further down the road.
#3: The Court Slaps The SEC's Hand & The SEC Clamps Down Further. Odds: 20%
Maybe I’m just being pessimistic, but another possible outcome is that the SEC loses, then turns around and clarifies certain rules about crypto—which is to say, they’ll conclude they should never have approved crypto futures ETFs to trade in the first place. And they’ll clear that up.
This may sound radical, but it’s not all that dissimilar to how various funds have been affected by rule changes over the years, from money market funds to those using leverage. The playing field does change, and products do go offline. It could happen here, too.
#4: The Court Slaps The SEC's Hand & They Allow GBTC To Convert To An ETF. Odds: 10%
I think the least likely outcome is the one Grayscale wants most: That is, an order from the three judges essentially “forcing” the SEC to approve spot bitcoin ETFs.
I think this is unlikely because the court cannot tell any agency how to do something, only that it must be done. Sure, they might give the SEC some sort of cure period – within 90 days or something – but during that cure period, the SEC could outline new rules for spot bitcoin filings (must be submitted on green paper! On a Tuesday!), which could restart this race all over again.
In that scenario, I find it fairly unlikely that GBTC’s conversion “jumps the line” ahead of anyone else precisely because it’s a conversion and not a clean filing.
Why I Remain In Favor Of A Spot Bitcoin ETF
While this makes for good financial theater, why should we care?
Personally, I’m in favor of investor choice, and I don’t believe retail investor protection is actually the SEC’s primary gig. So I remain very much in favor of a spot bitcoin ETF.
But perhaps the real value in these theatrics is to continue focusing on the deplorable state of crypto regulation. For insight into the status quo, one needs to look no further than the battle of press releases that the CFTC and the SEC currently have over whether ether (or anything else in crypto) should be considered a commodity, a security, or a security, even something new entirely.
This is not how the sausage is supposed to be made. What’s supposed to happen is legislators (like Lummis and Gillibrand, for instance) are supposed to propose new laws to cover things like this; then more legislators tweak those propositions; then eventually, votes are taken, and new laws are made. Like, you know, in the old days, when we all thought the world worked like Schoolhouse Rock taught us it should.
Instead, we have somehow ceded the future of financial innovation to a high school cafeteria shouting match over who gets the suitable table for lunch. Why should we care? Because we all know what happens when you let the bullies run the school: Good folks end up shoved in lockers.
For more news, information, and analysis, visit the Crypto Channel.
1: Karrie Gordon is popping in here to provide a quick explainer: The primary reason Grayscale filed their lawsuit was on the grounds of the SEC’s recent approval of bitcoin futures ETFs, both the ’40 Act funds but primarily the ’33 Act ones.
While the SEC denied GBTC conversion largely due to their concerns over sufficient market surveillance, Grayscale pushed back, arguing that this surveillance 1) already exists and 2) is already sufficient enough for the SEC when it comes to bitcoin futures ETFs.
By approving the ‘33 Act bitcoin futures ETFs, the SEC was also approving CME’s oversight of those bitcoin futures, which, Grayscale argues, inherently provides proxy spot bitcoin pricing surveillance as well, given the linked nature of the two markets. In fact, that surveillance was seen as sufficient enough for the SEC’s approval of the Teucrium Trading’s Hashdex Bitcoin Futures ETF (DEFI ). The judges seemed to agree with this particular perspective in hearings on Tuesday.