Court Paves Way for First Bitcoin ETF

Grayscale Investments LLC got backing from a federal court to launch the first Bitcoin exchange-traded fund in the U.S., a watershed moment in the cryptocurrency industry's quest to tap billions of dollars from everyday investors.

A three-judge appeals panel in Washington on Tuesday overturned a decision by the U.S. Securities and Exchange Commission to block the ETF.

"The denial of Grayscale's proposal was arbitrary and capricious because the Commission failed to explain its different treatment of similar products," wrote Judge Neomi Rao.

Grayscale "advanced substantial evidence" that its product was similar to Bitcoin futures ETFs approved by the SEC. The underlying assets of both types of products are closely correlated and the surveillance sharing agreements with the Chicago Mercantile Exchange are "identical."

Grayscale says converting to an ETF would help it unlock about $5.7 billion in value from the $16.2 billion trust by making it easier to create and redeem shares.

Case History

In June 2022, the SEC rejected Grayscale's conversion proposal arguing that an ETF based on Bitcoin, which trades on unregulated markets, lacked adequate oversight to detect fraud.

Grayscale sued to overturn the decision accusing the SEC of discriminating against its product, while approving similar Bitcoin futures ETFs.

Grayscale sought to create an ETF because the trust's closed-end structure doesn't allow for investors to redeem shares when prices fall, causing the trust to trade at steep discounts to its underlying Bitcoin. As an ETF, it could create and redeem shares to keep up with changing demand.

During a hearing on the case in March, the judges grilled the SEC about its decision and seemed to side with Grayscale's argument that the underlying markets for spot Bitcoin and Bitcoin futures pose the same risk for fraud and manipulation.

"One is essentially the derivative of the other," Rao said. "They move together 99.9% of the time. So where's the gap in the commission's view?"

SEC lawyer Emily True Parise argued that, unlike spot Bitcoin, futures are traded on a public exchange with federal oversight, so the pricing and monitoring is more robust. Parise said Grayscale failed to provide enough data to show that fraud on the spot Bitcoin market would show up on the regulated futures market.

The case is Grayscale v. SEC, 22-1142, US Court of Appeals for the District of Columbia Circuit.

Chart: Bloomberg; Image: Adobe Stock