The SEC doubles down on its decision to reject Grayscale Spot ETF

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

Grayscale had alleged over the summer that the SEC was unfairly applying double standards by allowing Bitcoin futures ETFs on the market and repeatedly rejecting proposals for ETFs that invest in spot Bitcoin.

In June, the SEC rejected Grayscale's proposal to convert its Bitcoin Trust into an ETF. Later that day, Grayscale sued the regulator, claiming 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 $20 million Valkyrie Bitcoin Strategy ETF and the $21 million VanEck Bitcoin Strategy ETF.

The response letter, filed last week, is the SEC's first response to Grayscale's lawsuit. In it, the commission reiterated its stance that it approved Bitcoin futures ETFs because they are closely monitored by the Chicago Mercantile Exchange. Spot Bitcoin ETFs, on the other hand, lack this level of government oversight, the letter says.

NYSE Arca, where Grayscale is seeking to list its ETF, claims that the index its proposed spot Bitcoin ETF would track uses an advanced algorithm to mitigate fraud, manipulation and other anomalous trading activity. However, the SEC argues that these provisions are not sufficiently effective, as its brief response shows. Additionally, Bitcoin is an unregulated spot market without adequate oversight, the commission noted.

“The SEC has remained consistent in its belief that while a futures-based Bitcoin ETF is permissible, a spot-based one is not because there was a risk of fraud and manipulation,” said Todd Rosenbluth, head of research at VettaFi. “Grayscale has a heavy burden to manage, in part because the SEC has blocked any such ETF multiple times amid a wave of filings under current leadership.”

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 asked the Washington, D.C., appeals court where the case was filed to reiterate its view that it acted reasonably when it rejected Grayscale's plans to convert its Bitcoin trust, the regulator wrote.

The U.S. Chamber of Commerce, NYSE Arca, Coinbase and the Blockchain Association have expressed support for Grayscale's lawsuit and filed amicus briefs in October arguing that Bitcoin futures ETFs are riskier than proposed spot Bitcoin ETFs.

“Coinbase champions the value of private-sector market surveillance voluntarily undertaken by unregulated spot trading platforms, asserting that ‘the largest players in the Bitcoin market’ have the best interests of investors in mind,” the SEC wrote. “But Congress enacted the securities laws on the premise that voluntary regulation is not always sufficient.”

The SEC is creating an “unlevel playing field” by approving Bitcoin futures-based ETFs and continually denying spot Bitcoin ETFs, and this is putting Bitcoin Trust shareholders at a 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 “solid basis for this decision,” Grayscale said. Since FTX's collapse on Nov. 8, the CoinDesk Bitcoin Price Index, which would have been tracked by Grayscale's spot Bitcoin ETF, has been 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 tracking Bitcoin prices closely lately, said Aniket Ullal, head of ETF data and analytics at CFRA Research. The spot price of Bitcoin and the ProShares Bitcoin Strategy ETF have both returned negative 63 percent through December 9, according to CFRA data.

Despite Bitcoin's massive decline in value, the seven Bitcoin futures ETFs on the market have attracted net inflows of $338 million in the year ended December 9, according to CFRA. Combined, the ETFs had $723 million in assets at the time, the database shows.

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

Overall, the $6.8 trillion U.S. ETF market has seen net inflows of $544 billion year to date through Nov. 30, according to Morningstar Direct.

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

The company has until Jan. 13 to respond to the SEC's brief letter, court filings show.

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