Watch What Happens As Grayscale And The SEC Square Off Over Conversions Of ETFs

Tuesday will see the beginning of oral arguments in Grayscale Investments' case against the US Securities and Exchange Commission, which will once again focus the attention of the cryptocurrency community on Washington.

‍

The $14.8 billion Grayscale Bitcoin Trust (ticker: GBTC), which has been trading at a significant loss to the bitcoin it holds for the past two years, is at the center of the drama. For a struggling business, this disruption has been painful: it penalized long-term investors and occasionally caused a panic among leveraged investors who flocked into the trust to take advantage of a once-common move.

‍

Also, Grayscale's parent firm, Digital Currency Group, which is dealing with bankruptcy in another area of its business, is dependent on the outcome of the litigation. According to a recent report, GBTC holds almost 3.3% of all Bitcoin in circulation and earned millions of dollars in fees in 2022.

‍

What Led Us Here

‍

Grayscale submitted plans to turn GBTC, the largest Bitcoin investment vehicle in the world, into an exchange-traded fund to the SEC in October 2021. The regulator has frequently refused to approve spot goods even though it has allowed futures-backed crypto products to operate.

‍

In June, the SEC denied Grayscale's request to turn the product into an ETF, citing worries about Bitcoin manipulation and fraud. Within hours of the rejection, Grayscale filed a lawsuit against the regulatory body in the US Court of Appeals for the District of Columbia Circuit, claiming that the organization was "failing to apply consistent treatment to similar investment vehicles" in light of the existence of Bitcoin ETFs with futures backing.

‍

GBTC Promotion

‍

The manager would be able to resolve the trust's ongoing 46% discount to its underlying Bitcoin if the SEC were to accept GBTC's conversion to an ETF. Since an ETF's structure enables shares to be issued and redeemed in response to changing demand, a fund's price often remains in line with its net asset value.

‍

However, in accordance with the current regulations, GBTC is not permitted to redeem shares. As a result, it has virtually become a closed-end fund, which is susceptible to such extreme dislocations.

‍

Grayscale announced at the end of 2017 that it was thinking about asking the SEC for approval to repurchase shares of its Bitcoin trust through a tender offer.

‍

A flurry of recent lawsuits against Grayscale center on the double-digit discount. Osprey Funds, a digital asset manager, launched a lawsuit against a competitor at the beginning of the year. Moreover, Fir Tree Capital Management is suing Grayscale.

‍

The Osprey lawsuit, according to Grayscale, is "frivolous," and the adoption of a spot-Bitcoin ETF would help its peers. In response to Fir Tree's move, the business has stated that it has always intended to convert GBTC into an ETF once US regulators have given their approval and that it feels that this is the optimal long-term product design for GBTC and its shareholders.

‍

Wilfred Daye of Samara Alpha Management believes that the discount at least partially reflects investors' general perceptions of the likelihood that Grayscale will win the legal battle.

‍

The market indicates that Grayscale's chances of turning GBTC into a spot-Bitcoin ETF in the foreseeable future are slim, he added.

‍

According to Grayscale, "GBTC was structurally built to reach the status of an exchange listings as an ETF," as with all of its products.

‍

Presently, market forces determine the price at which GBTC trades on the open market, according to a spokesman. "We are certain that the best way to address the current GBTC discount is to turn GBTC into an ETF. At that point, we would anticipate that any premium or discount on GBTC's share price will be eliminated by the arbitrage mechanism built into the ETF structure.

‍

Grayscale's Point of View

‍

Grayscale has maintained for a while that it wanted to turn GBTC into an ETF. Chief Executive Officer Michael Sonnenshein stated that such a conversion "has been the plan from Day 1" in a 2021 interview with Trade Algo. The company also stated in May of last year that a conversion could unleash up to $8 billion in value for investors.

‍

Grayscale has also publicly stated its position in the media. Last year, it urged investors to send letters for the GBTC conversion, a move that prompted hundreds of responses.

‍

According to Trade Algo, there is interest in a spot-Bitcoin ETF. "For anyone using the conventional financial railroads, a spot-Bitcoin ETF would be the ideal choice for exposure to Bitcoin. It will hold the asset and is the most effective strategy to gain exposure.

‍

Grayscale's attorney, Donald Verrilli, said in a lawsuit filed against the SEC last year that the agency had broken the law by failing to treat similar investment vehicles consistently when it denied the application. Verrilli has a distinguished legal experience. He served in the Obama administration previously, where he successfully argued the government's case in important Supreme Court issues involving same-sex marriages and the Affordable Care Act.

‍

According to the Grayscale spokeswoman, the conversion of GBTC to an ETF is the optimum long-term product structure for Grayscale's investors. "We are sure that our common sense and powerful legal arguments will prevail, and we are eager to deliver them to the D.C. Appeals Court on March 7, 2023. By the fall of 2023, we anticipate receiving the Court's definitive ruling.

‍

SEC's Defense

‍

Max Schatzow, partner and co-founder at RIA Attorneys, believes that recent regulatory crackdowns could have a "immense" impact on the Grayscale case.

‍

"Look, there's just not a marketplace that we believe is reliable enough to approve the spot-ETF product," the SEC stated in its denial letter, "and I think you can start accepting the SEC's case," Schatzow said. "You point to FTX, you point to all these other failed exchanges. If you ask me, it has a chance of less than one in four. It's impossible to predict the outcome of court cases, but taking on the SEC is challenging.

‍

Grayscale faces a "uphill battle" in its dispute with the SEC, according to Trade Algo. This is due to the SEC's stated requirement that Bitcoin-based ETFs must meet in order to pass the "arbitrary and capricious" test, which is "does the exchanges have a surveillance arrangement with a regulated market of considerable scale, making fraud less of a risk."

‍

According to Stein, the asset manager has a 40% probability of winning according to Trade Algo. But, Stein stated in a report from February that if Grayscale "defies those odds and succeeds," it may create value worth billions of dollars for GBTC investors.

‍