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Node Notes: covering Grayscale’s recent victory over the SEC

Welcome to our new series, Node Notes, where we’re spotlighting topics from our bi-weekly research piece, The Node Ahead. If you want to read the full piece, you can check out our blog or sign up to receive The Node Ahead straight to your inbox. This edition of Node Notes is an excerpt from Node Ahead 51.

Grayscale vs. the SEC

Back in July 2022, we covered the history of GBTC and why Grayscale decided to sue the SEC. As a quick recap, Grayscale runs the GBTC Trust, which is the largest public holder of bitcoin with over 600,000 BTC. Once bitcoin ETFs started to emerge in jurisdictions outside the US, GBTC went from trading at a premium to trading at a discount. As a result, Grayscale filed to convert GBTC from a trust structure into an ETF in order to have its shares trade closer to bitcoin’s value. However, the SEC denied their application just as it has denied every other ETF application since 2013. In response, Grayscale sued the SEC, arguing the decision to reject the conversion to an ETF was “arbitrary,” given the regulator’s prior approval of a futures-based bitcoin ETF back in 2021.

In March of this year, the two sides gave their oral arguments, which we wrote about at the time. During those hearings, the SEC’s defense seemed unable to provide satisfactory answers to the Judges’ comments and questions. We predicted at the time it was likely that Grayscale would win the case, and on August 29th, that’s exactly what happened.

A U.S. court of appeals found the SEC’s reason for denying Grayscale’s Bitcoin spot ETF application was not reasonable. In fact, all three judges unanimously ruled 3-0 against the SEC. The court criticized the SEC’s inconsistent treatment of spot and futures-based bitcoin ETFs, saying the “denial of Grayscale’s proposal was arbitrary and capricious because the Commission failed to explain its different treatment of similar products.” According to the verdict, the SEC fell “short of the standard” needed to deny the application, its rationale was “incoherent,” and the SEC “failed to adequately explain” its argument. That is about as unequivocal of rejection as we have ever seen from the courts toward a federal regulator. Basically, the judges validated all the complaints those in the crypto industry have had regarding the SEC’s behavior over the past several years.

Now that Grayscale has won its case against the SEC, where do we go from here?

Three things to keep in mind:

First, just because Grayscale won doesn’t mean GBTC automatically becomes an ETF. The judges granted Grayscale’s petition for review, meaning the SEC will have 45 days to review Grayscale’s ETF application again. Although the judges ruled that the original rationale for denial was “arbitrary and capricious,” there is nothing stopping the SEC from denying GBTC again using a completely different reason. The SEC could decide to approve the conversion of GBTC into an ETF, but it’s also possible that the SEC will simply use alternative arguments to justify rejecting Grayscale’s application again. However, if the SEC were to take the latter route, coming up with a new excuse may further undermine the agency’s credibility as well as lead to more lawsuits that the SEC could very well lose again.

Second, this case has major implications for all future ETF applications, including the ones recently filed by Ark, Blackrock, and others. The SEC’s main reason for denying bitcoin spot ETF proposals over the past few years has been the argument that fraud and manipulation could affect spot and regulated futures markets differently. However, the court just struck down that rationale as the SEC could not provide any evidence of this. In fact, Grayscale presented data showing that there’s a 99.9% correlation between the two markets. Thus, the SEC can no longer deny an ETF application on the grounds of fraud and manipulation concerns.  Simply put, Grayscale’s victory makes it harder for the SEC to deny future spot bitcoin ETFs.

Furthermore, knowing all the objections they have used in the past have been either proven false or overturned by courts; it is possible the SEC will use this decision as an opportunity to save face and back away from its anti-ETF position. Gensler might very well use some version of “we disagree, but we have to respect the court’s decision” as a convenient excuse to back out of a losing battle.

Will we get a bitcoin ETF soon?

The odds of having a bitcoin ETF approved later this year or in the first half of next year significantly increased with this ruling. It’s also possible that the ETF opportunity doesn’t stop at bitcoin but could open the doors for ETH and other cryptoassets as well. Should an ETF be approved, it would instantly lower the barrier to entry for a large number of people who would prefer to invest in crypto through a more traditional instrument. There are potentially billions of dollars of capital sitting on the sidelines that may find its way into crypto if it could be bought and sold via an ETF.Third, the SEC is racking up losses faster than the 2017 Cleveland Browns. The SEC has now lost both its crypto cases against Ripple and Grayscale. The judge ruled in Coinbase’s favor in its lawsuit against the SEC, and odds are the SEC will lose its lawsuit against Coinbase too. Gensler has gone to considerable lengths to make his views seem like obvious, common-sense applications of law. But both the Ripple case and the Grayscale case have struck down the legal basis the SEC has used to justify its actions and highlighted the agency’s broad overreach. As the Wall Street Journal noted in a scathing editorial on the Grayscale decision, it’s become clear that Gensler grossly overstepped his power. “Mr. Gensler is holding bitcoin spot ETFs hostage in his crypto market power grab. Arbitrary regulation and regulatory overreaches are recurring themes of the Gensler SEC.” These court cases continue to undermine the SEC’s self-appointed jurisdiction over the crypto industry.

Disclaimer:  This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.