Why did the SEC reject the grayscale spot bitcoin ETF

Bitcoin ETF, as an asset that tracks the price of Bitcoin, does not need to go through the process of buying Bitcoin, such as registering a trading platform and passing various verifications. By investing in Bitcoin ETF, users can profit from the increase in Bitcoin. The first Bitcoin ETF is a futures ETF, the ProShares Bitcoin Strategy ETF (BITO). There is no real bitcoin spot ETF yet.

Grayscale submitted an application to the US SEC to convert GBTC into a Bitcoin spot ETF through NYSE Arca in October last year. Its CEO, Michael Sonneshein, once stated that if the Bitcoin spot ETF application is rejected by the SEC, it is very likely that legal action will be taken against the SEC. The reason is that Grayscale’s “Bitcoin spot ETF is no different from the Teucrium Bitcoin futures ETF that has been approved by the SEC. The SEC’s approval principles should not be inconsistent.”

As the deadline for the US SEC to approve or reject Grayscale’s Bitcoin spot ETF application is approaching on July 6, Grayscale CEO Michael Sonnenshein has issued an open letter to investors, hiring former US Deputy Attorney General Donald B. Verrilli, Jr serves as Senior Legal Strategist. Grayscale also said at the Consensus 2022 conference in Austin, Texas, that they are optimistic that a spot bitcoin ETF will eventually be approved by the SEC soon.

Today, however, the SEC has rejected Grayscale's application to convert its GBTC into a bitcoin spot ETF, saying the application failed to answer the SEC's questions about preventing fraud and manipulation, among other concerns.

Brett Harrison, CEO of FTX.US, talks about the reasons for rejection

The CEO of FTX.US analyzed the reasons for the SEC’s rejection of the grayscale spot ETF application:

The SEC has approved BITO, Proshares, and other futures ETFs that are based on the Chicago Mercantile Exchange (CME) with adequate protection against manipulation.

CME's Bitcoin futures are settled against the CF Benchmark Bitcoin Reference Rate (BRR), which is composed of the spot price of Bitcoin on eight global cryptocurrency exchanges. However, the SEC has rejected spot ETFs that use the same BRR to calculate NAV due to manipulation considerations. The reality is contradictory. The US Commodity Futures Trading Commission (CFTC) has approved BRR-based BTC futures, and the SEC has approved BRR-based futures ETFs, but the SEC has rejected ETFs directly based on BRR settlement.

The SEC has broadly rejected spot ETFs because the spot market is not licensed under the U.S. federal regulatory regime. There are mainly three situations:

ETFs such as EWJ (iShares MSCI Japan) contain financial instruments regulated in non-US jurisdictions. Bitcoin is regulated in many non-US jurisdictions and traded on regulated exchanges in non-US jurisdictions.

· ETFs such as HYG (iShares High Yield Corporate Bonds) contain debt instruments that are not traded on any licensed exchange.

ETFs such as FXE (Invesco Euro Trust) contain fiat currencies and have no market regulators.

The SEC has raised concerns that there is not yet sufficient liquidity or volume in the spot market in past spot ETF rejection decisions. But look at many corporate bond ETFs (such as HYG), etc., whose constituent stocks trade in the median single digits per day.

Ironically, the approval of a spot bitcoin ETF would bring greater regulation to the bitcoin spot market and help achieve many of the SEC's stated goals for spot cryptocurrencies. A large portion of the liquidity of existing institutions, as well as the capital of a large number of new participants, will go into these investment vehicles that trade primarily on SEC-regulated securities trading platforms. An oversight sharing agreement between fund issuers and spot trading platforms would also allow the SEC to exercise greater oversight of market activity, further ensuring the integrity and proper functioning of spot order books.

All parties talk about grayscale bitcoin spot ETF and supervision

Bloomberg Encryption Columnist Katherine Greifeld

Bloomberg's encryption columnist Katherine Greifeld wrote that regardless of whether the SEC passes its GBTC-to-spot ETF application (the SEC had not rejected Grayscale's application when the article was published), Grayscale is doomed to fail. Because even if the SEC agrees, GBTC's current 2% user management fee will not work in the ETF market. Taking ProShares Bitcoin Strategy ETF (BITO) as an example, its expense ratio is 0.95%. Once Grayscale falls into a price war, its annual management fee income of about 230 million US dollars will be greatly reduced.

Perianne, Founder, Chamber of Digital Commerce

Perianne, founder of Chamber of Digital Commerce, said that in the past few years, the SEC has received a large amount of data to prove that a substantive and regulated market surveillance framework has been developed around BTC transactions. According to estimates, 16% of Americans hold cryptocurrencies, and the BTC spot ETF will provide American investors with the opportunity to invest in Bitcoin under the protection of US securities laws. And, well-regulated jurisdictions like Canada and Australia have passed BTC spot ETFs for retail investors. The US SEC's decision is really "disappointing".

Messari founder Ryan Selkis

Messari founder Ryan Selkis said a "winning" lawsuit and eventual ETF switch would cut Grayscale's revenue by more than 50%. ETFs would imply an open redemption window and possibly lower fees to preserve AUM. This means that DCG will lose more than $200 million in annual profits.

Selkis believes that, at least during Gary Gensler's tenure, the SEC is unlikely to agree to Grayscale's conversion of GBTC to an ETF. This is partly related to the premium harvesting trades that occurred when GBTC traded at a premium rather than a discount, when Three Arrows capitalized on extremely high leverage.

Interestingly, the chances of the SEC blocking Grayscale out of pure malice is not zero, as they don't want to reward what they perceive as bad behavior. The distressed Grayscale deal was the first step toward bankruptcy for Sanjian, which leveraged a large stake in GBTC — at one point as much as 6% of the trust. The most prudent and realistic route to "fix" GBTC is through so-called Regulation M exemptions.