In October 2021, Grayscale announced that NYSE Arca filed Form 19b-4 with the Securities and Exchange Commission (SEC) to uplist our flagship product, Grayscale® Bitcoin Trust (OTCQX: GBTC), into a Bitcoin Spot ETF. As it stands today, hundreds of thousands of American investors — retail and institutional alike — and the investment community at large are waiting for U.S. regulators to approve a physically backed or “spot” Bitcoin ETF. Importantly, however, earlier this year the SEC approved a futures-based Bitcoin ETF.
The Grayscale team has been steadfast in our belief that this inconsistency creates an unlevel playing field for Bitcoin ETFs — and we strongly believe that the SEC should approve a spot-based Bitcoin ETF, allowing investors choice over which product best meets their investment needs.
As part of our filing to uplist GBTC into an ETF, there’s a standard 240-day open review period, during which anyone can submit comments to the SEC for consideration. Our lawyers at Davis Polk submitted a comment letter to the SEC, outlining a new argument in support of a Bitcoin ETF.
We sat down with Craig Salm, Grayscale’s Head of Legal, to discuss the letter and its implications.
Craig, thanks for making the time to chat with us. What’s the context for this new argument on behalf of a Bitcoin Spot ETF?
Grayscale’s attorneys at Davis Polk filed a letter with the SEC arguing that the approval of Bitcoin futures-based ETFs, but not Bitcoin spot-based ETFs, like GBTC, is “arbitrary and capricious,” and therefore in violation of the Administrative Procedure Act (APA).
This is noteworthy because it’s a new argument in the context of Bitcoin ETFs — reflective of the new market dynamics following the approval of several Bitcoin futures-based ETFs, and subsequent rejection of another spot-based ETF application.
Can you break through the legalese, and shed some additional light on the Davis Polk letter that was recently submitted to the SEC?
The APA requires the SEC to treat *like* situations *alike* absent a reasonable basis for different treatment. This means the SEC must treat similarly situated investment products similarly.
Bitcoin ETF products — Bitcoin futures-based ETFs registered under the ‘40 Act and Bitcoin spot-based ETFs registered under the ‘33 Act — are an example of two *like* situations that should be treated *alike*.
Prior to this year, Bitcoin ETF applications *were* treated alike: The SEC denied both futures-based and spot-based ETF applications, citing the potential for fraud and manipulation in the underlying spot Bitcoin market. Because both types of ETFs are priced based on the same underlying Bitcoin market, it’s intuitive then that the SEC would deny both types of ETFs, given their concerns.
Let’s examine the markets underpinning these two offerings:
- Today, Bitcoin futures-based ETFs are priced based on exchanges such as Coinbase, Kraken, Bitstamp, Gemini, and itBit.
- Today, Bitcoin spot-based ETF applications, like GBTC, are priced based on exchanges such as Coinbase, Kraken, Bitstamp, and LMAX.
Given the significant overlap, both offerings are therefore *alike* in the context of Bitcoin ETF approval.
Earlier this year, the SEC’s stance on these offerings shifted. While the SEC has approved several futures-based ETFs, they have continued to disapprove spot-based ETF applicants – creating an example of two *like* situations NOT being treated *alike* – and resulting in an uneven playing field for investors.
There’s some legal nuance here with the ‘40 Act and the ‘33 Act. Can you quickly explain the difference here?
The Investment Company Act of 1940 (“‘40 Act”) and the Securities Act of 1933 (“‘33 Act”) are both regulations implemented by the SEC to protect American investors. Various funds register their investment vehicles accordingly:
- If a fund’s assets are greater than 40% securities (e.g., stocks, bonds), it would have to be registered under the ‘40 Act. This means that the same fund could also hold 60% of other assets, like commodities or futures. This is legislation that underpins Bitcoin futures-based ETFs.
- The ‘33 Act allows funds to hold 100% of non-securities-based assets, like Bitcoin. This is the legislation that underpins Grayscale’s single-asset products, like GBTC.
There have been arguments that the ‘40 Act has more investor protections that than ‘33 Act, and that Chicago Mercantile Exchange (CME) Bitcoin Futures are more “regulated” than bitcoin, which makes these products *not* alike in the context of a Bitcoin ETF approval. Is that true?
No, that’s not true. There are a couple of dimensions to consider here.
Regarding the claim that the ‘40 Act has increased investor protections, I’d highlight that this law does not address fraud or manipulation in the assets or markets of assets that ETFs hold. Instead, the ’40 Act seeks “to remedy certain abusive practices in the *management* of investment companies” (i.e., ETFs), and places certain restrictions on ETFs and ETF sponsors. The ‘40 Act even explicitly lists out the types of abuses it seeks to prevent, and places certain restrictions on ETFs related to accounting, borrowing, custody, fees, and independent boards, among others. Notably, none of these restrictions address an ETF’s underlying asset or exchanges on which its pricing is derived (e.g., Coinbase or Kraken).
Regarding the claim that CME Bitcoin Futures are more “regulated” than bitcoin, I’d note that in each of the SEC’s previous spot-based Bitcoin ETF denials (including the latest), the SEC counterintuitively stated that the CME Bitcoin Futures market is not “significant” enough to grant approval. What this implies is that someone could, in theory, manipulate bitcoin on a spot exchange and have it impact the regulated CME Bitcoin Futures and, therefore, the futures-based ETF too. (Again, assuming you believe fraud or manipulation exists in the first place). Notably, again, the ‘40 Act doesn’t address this concern either.
It seems like the next natural question here is: why did the SEC not approve a spot-based ETF?
It’s unclear, and our team remains committed to working with the SEC on the conversion of GBTC into an ETF. In the meantime, we should not overlook that the approval of Bitcoin futures-based ETFs represent a major step forward for the entire investment community.
The SEC staff has a tough job and important decisions lie ahead. While the SEC continues to engage with the crypto ecosystem, it’s important to remember their mandate to protect investors, while promoting open, competitive markets. We believe this is possible with the approval of Bitcoin spot-based ETFs.
As it stands, the Bitcoin ETF landscape is unfair and discriminatory against GBTC shareholders and all of the other U.S. investors looking for an accessible and efficient way to gain their Bitcoin exposure. Fortunately, the Administrative Procedure Act (APA) exists to address situations just like this one — to govern the process by which federal agencies develop and issue regulations, ultimately to protect the American investor.
Where can investors go if they want to read Davis Polk’s letter in-full?
Davis Polk’s full letter is accessible on the SEC’s website here.
Any closing thoughts, Craig?
Just a note of thanks to Joe Hall, Annette Nazareth, Jai Massari, Greg Rowland, Zach Zweihorn, Paul Mishkin, Daniel Schwartz and the rest of the Davis Polk team, as well as Representatives Tom Emmer & Darren Soto, Blockchain Association, ADAM, Coin Center, and everyone else who has supported Grayscale’s mission to convert GBTC into an ETF.
Our team looks forward to the SEC’s response to this letter, and the others submitted on behalf of GBTC’s 19b-4 filing.
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