The years-long push for an exchange traded fund that tracks bitcoin will finally get its day in court this week. Several different firms tried to bring a spot bitcoin ETF to market in the U.S. without success, but Grayscale Investments is taking it a step further for the future of its Grayscale Bitcoin Trust (GBTC) . After Grayscale’s proposal to convert the trust to an ETF was rejected last June, the firm sued the U.S. Securities and Exchange Commission in the D.C. Circuit Court of Appeals. Oral arguments are set to begin on Tuesday . While a potential bitcoin ETF was once seen as a way to bring investors into crypto more broadly, the trial comes as depressed prices and heightened regulatory scrutiny have weakened retail interest in the space. Here are the key things to know about the case. The arguments A major point of the suit from Grayscale is that the SEC has already allowed bitcoin futures ETFs to enter the market, but has drawn the line at spot bitcoin. The largest of those funds, the ProShares Bitcoin Strategy ETF (BITO) , now has nearly $800 million in assets under management. The SEC has argued that bitcoin futures, which trade on the CME, are a regulated product, while spot bitcoin is not, raising concerns about fraud in a market where there is “no adequate surveillance.” Grayscale’s counter is that the two are linked so closely that SEC decision doesn’t make sense. “Any fraud or manipulation in the spot market would necessarily affect the price of bitcoin futures, thereby affecting the net asset value of an ETP holding either spot bitcoin or bitcoin futures as well as the price investors pay for such an ETP’s shares,” Grayscale said in a legal brief. ETPs, or exchanged traded products, include ETFs. Jim Angel, associate professor specializing in financial market structure at Georgetown University’s McDonough School of Business, said the SEC has a “really weak hand” in the case. “You need a microscope to tell the difference between two – they’re both ETFs to track bitcoin, the only difference is BITO does it in a very inefficient way using bitcoin futures and that creates a lot of transaction costs because you have to rollover the future position every month,” Angel said. The U.S. Chamber of Commerce, NYSE Arca and Coinbase are among the groups that have filed amicus briefs on Grayscale’s side of the argument. The Grayscale discount One reason that Grayscale in particular has been at the front of this fight is that its Grayscale Bitcoin Trust, an over-the-counter product, trades at a large discount to its underlying asset value. Over the past year, the market price of a GBTC share has fallen by roughly 60%, according to Grayscale’s website. The value of the holdings per share, however, have declined by about 48%. The trust does not currently have a redemption mechanism, which means that professional investors can’t do arbitrage trades to keep the fund closer in line with the price of bitcoin. This also means that the underperformance of the shares turn into a large discount for the shareholders. The fund was trading at nearly 50% below the value of the assets it holds last week, according to crypto news site The Block . Converting to an ETF, however, is one method of creating a redemption process, and those products usually trade much closer to the price of the underlying assets than the GBTC does. Bryan Armour, director of passive strategies research for North America at Morningstar, said there are other avenues for Grayscale to create a redemption process, but those might hurt assets under management and therefore the firm’s fees. “I don’t see this as a high probability case. I think Grayscale is using this as a stall tactic to not allow current investors to redeem,” Armour said. Crypto winter The excitement around a bitcoin ETF has cooled considerably along with the prices for crypto markets in general. Even with a solid start to 2023, the price of bitcoin is still down more than 60% from its all-time high. BTC.CM= 5Y mountain The rise and fall of bitcoin. The approval of a spot bitcoin ETF could quickly see investors move away from the futures ETFs, Armour said, but it wouldn’t have the same demand as it may have before crypto prices started to fall. “There is an appetite, and there has been for a long time. It’s very unlikely to be as strong as it was prior to 2022, but putting it in ETF form may make it more accessible for advisors,” Armour said. The trial also comes during a period of tumult for crypto more broadly. The industry has seen the implosion of several large firms, including the alleged fraud at FTX last year, and the SEC has been more aggressive on issues like crypto staking . Grayscale and some other major industry participants have said they would like more regulatory clarity to broaden the potential reach of crypto. “In times like these, when a significant amount of trust and confidence in the crypto ecosystem has been damaged, regulated access to the asset class is more important than ever. Products like spot ETFs would further open up access to bitcoin for those that want to hold it in the form of a security, in their brokerage or retirement account, through a regulated investment vehicle, with SEC reports, audited financials, tax documents, and the like,” Grayscale chief legal officer Craig Salm said in a blog post . The regulator, for its part, has said that blocking the ETF is not meant to be a comment on the digital asset space more broadly. “This case is thus about the law governing the listing and trading of new instruments on national securities exchanges, not whether investors can or should purchase bitcoin products,” one brief from the SEC said. — CNBC’s Tanaya Macheel contributed reporting.
