D.C. Circuit pressed SEC on Grayscale’s spot bitcoin ETF rejection

A three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit heard Grayscale Investments’ challenge to the Securities and Exchange Commission on March 7, 2023, pressing the regulator to explain why it had approved exchange-traded products holding bitcoin futures but rejected Grayscale’s proposed spot bitcoin product.

The argument placed the SEC’s treatment of bitcoin investment vehicles under direct judicial review. Grayscale contended that the agency had treated materially similar products differently without an adequate explanation. The SEC maintained that surveillance of the regulated bitcoin futures market did not necessarily establish that manipulation originating in spot markets would be detected.

No decision was issued on March 7. Questions from judges can reveal concerns about a party’s position, but they are not votes, findings or guarantees about the eventual judgment.

The dispute centered on market surveillance

NYSE Arca had proposed listing shares of the Grayscale Bitcoin Trust, commonly known as GBTC. The SEC disapproved that rule change on June 29, 2022, concluding that the exchange had not demonstrated the proposal was designed to prevent fraudulent and manipulative acts and practices as required by the Securities Exchange Act.

The agency’s analysis focused on whether the listing exchange had a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying assets. Bitcoin’s spot market was fragmented across trading venues, many outside direct SEC supervision.

Grayscale’s comparison was with two bitcoin futures exchange-traded products the SEC had permitted in 2022. Those products held futures traded on the Chicago Mercantile Exchange, a regulated market covered by surveillance arrangements. Grayscale argued that spot and futures bitcoin prices were sufficiently connected that CME surveillance should address manipulation concerns for both categories.

At the March 7 argument, Judge Neomi Rao questioned whether the SEC had adequately answered evidence about how the spot and futures markets moved together. Contemporaneous Reuters reporting recorded Rao’s concern that the agency had not explained why Grayscale’s analysis of the relationship was wrong.

SEC counsel Emily True Parise responded that correlation did not necessarily establish causation and that the available evidence did not demonstrate that spot-market misconduct would affect futures in a way the CME surveillance system could reliably detect. The dispute was therefore narrower than whether bitcoin was desirable: it concerned administrative consistency, market linkage and the evidentiary burden for an exchange listing.

Why the structure mattered

GBTC already provided securities-market exposure to bitcoin, but its shares traded over the counter and the trust lacked the continuous creation-and-redemption mechanism ordinarily used to keep an exchange-traded product’s share price near the value of its holdings. As a result, its shares could trade at a substantial discount or premium to the bitcoin represented by each share.

Conversion could have introduced that arbitrage mechanism and moved the shares onto NYSE Arca. It would not have eliminated bitcoin volatility, guaranteed that shares matched asset value at every moment or placed the global spot market under SEC supervision.

The hearing also mattered beyond Grayscale. Other sponsors had sought spot bitcoin products, and the SEC’s reasoning in this case could affect how future applications were assessed. On March 7, however, the court had only tested the parties’ arguments. It had not ordered the SEC to approve GBTC or any other product.

Later context

On August 29, 2023, the same panel granted Grayscale’s petition and vacated the SEC’s disapproval order, concluding that the agency had not adequately explained its different treatment of similar products. That later judgment confirms the importance of the issues examined on March 7, but it was not knowable when the argument ended and should not be read into the event-day outcome.