In a recent episode of "What Bitcoin Did" with host Peter McCormack, Grayscale's longtime chief executive, Michael Sonnenshein, said his company's decision to sue the U.S. Securities and Exchange Commission (SEC) was not taken lightly. In the sometimes contentious interview, Sonnenshein noted Grayscale has been in open communication with the top securities regulator, speaking often and on a regular basis.
"To actually take the decision to sue the regulator that oversees our business was a pretty heavy decision to have to make," Sonnenshein said. He added the stakes are "almost existential" for the future of Grayscale, and could have a significant bearing on "bitcoin itself." (Grayscale and CoinDesk are both owned by Digital Currency Group.)
Grayscale decided to sue in June 2022, on the same day its application to convert its Grayscale Bitcoin Trust (GBTC) into a "spot" exchange-traded fund (ETF) was denied. The trust today is the world's largest bitcoin investment vehicle, holding an estimated 3% of bitcoin's total supply and earning Grayscale millions of dollars in management fees per year. "You don't need to be a GBTC holder past, present or future to care about this lawsuit," Sonnenshein said.
It's hard to say whether the stakes here are as pivotal as claimed. There are certainly a lot of companies looking to enter the bitcoin ETF market. The SEC has denied about a dozen bitcoin ETF proposals so far, including from Fidelity, SkyBridge Capital and Valkyrie Investments. And the estimated 1 million investors in Grayscale's trusts could certainly benefit from a conversion – GBTC trades today at a massive discount to its underlying bitcoin holdings, in part because the "closed-end" trust model makes it easy to deposit but not withdraw bitcoin, limiting the chance for arbitrage.
(In fact, to give a sense of the demand, FTX's "adult in the room" John J. Ray III decided to sue Grayscale on behalf of bankrupt hedge fund Alameda Research, one of the largest holders of GBTC and Grayscale's Ethereum Trust, in a bid to pressure Grayscale to open withdrawals and reduce its fees. Grayscale has called the lawsuit "misguided.")
So why doesn't the SEC just approve these investment products? The SEC's consistent explanation – like the one given in a 70-plus-page briefing in December – has been that the spot bitcoin ETF proposals have not met its standards aimed at preventing fraud and protecting investors.
To say that's been an unsatisfying answer is to undersell it (more than GBTC is being undersold). In fact, many onlookers go as far as saying that the SEC is being "arbitrary and capricious," a phrase that comes up time and again when it comes to the watchdog's oversight of crypto. At least it's a phrase that came up repeatedly in the hundreds of letters interested and unconnected parties wrote to the SEC asking it to approve the bitcoin ETF product.
Approving a bitcoin ETF would be a proactive step towards providing consumers with a regulated way to gain exposure to bitcoin. While crypto is in the political doldrums today, there is still demand for these products – seen clear as day by reading some of the letters to the SEC. It's true the SEC has a mandate to protect investors, but preventing products from coming to market – when similar products are easy to access abroad – is just limiting the agency's ability to regulate effectively.
The core argument in favor of approving a spot bitcoin ETF, at least at this time, is that the SEC's concerns about manipulation are literally inconsistent – and possibly in violation of the Administrative Procedure Act, as Ribbit Capital's Sigal Mandelker and Jessi Brooks wrote. The agency has already approved exchange-traded products that use bitcoin futures contracts, particularly NYSE Arca's proposal to list and trade shares of the Teucrium Bitcoin Futures Fund and Nasdaq's proposal to list and trade shares of the Valkyrie XBTO Bitcoin Futures Fund. Both of the funds provide "surveillance-sharing agreements" designed to prevent manipulation, which the SEC says every spot BTC application has lacked.
Putting aside the additional costs and risks related to managing and "rolling over" bitcoin futures contracts, it's not clear this additional surveillance actually protects investors against the types of risks the SEC is concerned about. As Grayscale lawyers have noted in the past, "the reference rate for the CME Bitcoin futures market and the pricing indices that BTC and other spot bitcoin products use to value their shares are based on the same data: trading prices reported on the same bitcoin trading platforms." In other words, any potential fraud in bitcoin markets would hit spot- and futures-based products equally.
There's an additional argument to make that the SEC has often regulated crypto after the fact – going after firms after crimes were committed and, as the saying goes "regulating through enforcement." A bitcoin ETF would be a more proactive way for the SEC to expand its oversight while avoiding "picking winners and losers," University of Arkansas law professor Carol Goforth wrote.
It's possible the SEC will expand on its reasoning today, when it and Grayscale have the chance to present their opening arguments in the lawsuit. Analysts at Bloomberg Intelligence are giving Grayscale a 40% chance of winning the suit, which Sonnenshein said the company would consider appealing all the way to the U.S. Supreme Court if it loses.
In the podcast interview, Sonnenshein said he "can't imagine" why the SEC "wouldn't want" to benefit investors by converting the vehicle. Far from protecting consumers, the only explanation for Gary Gensler's "arbitrary and capricious" acts is to save face.
– D.K.
@danielgkuhn
daniel@coindesk.com
