Grayscale Legal Team Letter: What to Consider in the Next Bitcoin ETF Resolution

Source: Grayscale; Compiler: Songxue, Golden Finance

On August 29, 2023, a panel of the D.C. Circuit Court of Appeals reversed the SEC’s June 2022 decision denying the Grayscale Bitcoin Trust’s (GBTC) conversion to a spot Bitcoin ETF. This is an important milestone in GBTC’s conversion process - a victory. Reap the celebrations from GBTC shareholders, the Grayscale team and the wider Bitcoin, cryptocurrency and investment community.

Today, after reviewing the court’s opinion, our legal team, along with attorneys from Davis Polk & Wardwell and Munger Tolles & Olsen, sent a letter to the SEC containing important information to consider when deciding next steps.

The following is the content of the letter, compiled by Golden Finance:

Dear Mr. Zhu, Ms. Barbero and Ms. Countryman:

Representation of our client Grayscale Investments, LLC, sponsor of the Grayscale Bitcoin Trust (BTC). We welcome the opportunity to meet with the Securities staff as soon as possible in light of recent developments to discuss the future direction with the Exchange Commission as the Trust continues its efforts to convert to an Exchange Traded Product (“ETP”).

On June 29, 2022, the Commission denied NYSE Arca, Inc.’s attempt to list and trade under Section 19(b)(1) and Rule 19b-4 of the Securities Exchange Act of 1934 (as amended, the “Exchange Act”) Trust Fund. Grayscale has since sought challenge to the Commission’s ruling under Section 25(a) of the Exchange Act in the U.S. Court of Appeals for the D.C. Circuit, and on August 29, 2023, the Court of Appeals reversed the Commission’s denial.

After the Commission has had the opportunity to fully analyze the court’s opinion based on the record, including the grounds for denial set forth in the order to vacate and the evidence and arguments advanced by Grayscale, NYSE Arca, and public commenters, we believe the Commission should conclude that there is no reason to The Trust is treated differently from ETPs investing in Bitcoin futures contracts traded on the Chicago Mercantile Exchange (“CME”) under Rule 19b-4 submitted to the Commission. Accordingly, the Trust’s Rule 19b-4 filing should also be approved expeditiously.

If there is any other reason to try to differentiate between a spot Bitcoin ETP and a Bitcoin futures ETP — whether it’s based on Exchange Act requirements, that the rules are “intended to prevent fraudulent and manipulative acts and practices,” or some other reason — we believe that even After the Bitcoin futures ETP began trading, it also appeared in 15 Commission orders, one of which denied spot Bitcoin’s application for Rule 19b-4.

Grayscale first raised the issue about two years ago (before all these opposing orders), explaining why once the Commission determined it was able to approve a bitcoin futures ETP under Exchange Act Section 6(b)(5) control standards , it would be unreasonable to deny its Rule 19b-4 application.

But now that the Court of Appeal has spoken, based on the legal analysis used by the Commission in its previous rejection of spot Bitcoin ETPs, there is no available reason to distinguish Bitcoin futures ETPs from spot Bitcoin ETPs. As the Commission has consistently explained, this is because:

An exchange listing a Bitcoin-based ETP can satisfy its obligations under Section 6(b) of the Exchange Act by demonstrating that the exchange has a comprehensive regulatory sharing agreement with a large-scale regulated market related to the underlying or referenced Bitcoin asset. (5) OBLIGATIONS UNDER ARTICLE.

This was the test, and the Court of Appeal clearly found that this requirement was met:

Grayscale has demonstrated that its proposed Bitcoin ETP is very similar to the approved Bitcoin futures ETP in terms of relevant regulatory factors. First, the underlying asset—Bitcoin and Bitcoin futures—are closely related. Second, the monitoring sharing agreement with the CME is the same and should have the same possibility of detecting fraud or manipulation in the Bitcoin and Bitcoin futures markets.

The trust’s rule 19b-4 filing is now pending at nearly three times the time that Exchange Act section 19(b) allows the Commission to take action. NYSE Arca originally submitted a proposed rule change for trust funds on October 19, 2021, and the Commission published the recommendation in the Federal Register on October 19, 2021.

Pursuant to the requirements of Section 19(b)(1) on November 8, 2021. Under Section 19(b)(2)(A)(i), a 45-day time limit period is initiated during which the Commission will decide whether to approve or deny. Section 19(b)(2)(A)(ii) provides the Commission with the authority to extend this period for an additional 45 days until February 6, 2022, and the Commission exercised this extension authority on December 15, 2021. On February 4, 2022, the Commission initiated proceedings under section 19(b)(2)(B), in which the agency was obligated to issue the document on May 7, 2022, 180 days after the original release date of November 8, 2021. days) before approval or rejection, the deadline may be extended by up to 60 days. On May 4, 2022, the committee extended the deadline and rejected the application on June 29, 2022—a week short of the maximum eight months remaining for final action by Congress.

As a result, the Board’s review of a trust fund’s Rule 19b-4 filing is now significantly longer than allowed under Rule 19(b). Under section 19(b)(2)(D), a proposed rule change will be deemed to have been approved by the Commission if the agency does not issue an order within a certain manner within the statutory period. We questioned the validity of the disapproval order issued later. The appellate court reversed in its entirety the Commission’s obligation to act within the time limit necessary to avoid being deemed approved under section 19(b)(2)(D). But assuming deemed approval does not apply – at least when the Commission immediately re-examines the document in light of the Court’s reasoning – we believe the Commission should consider three points when considering next steps.

• First, for every day that the Trust is not listed on NYSE Arca, existing investors in the Trust will be unreasonably harmed by its trading at a significant discount to NAV. This harm could be avoided if the Trust were treated the same as Bitcoin futures ETPs for which the Commission has approved its Rule 19b-4 filings. In fact, on the day the appeals court announced its ruling, in anticipation of the eventual approval of Rule 19b-4, the discount rate tightened by more than 600 basis points, meaning more than $2 billion was returned to investors in a single trading day U.S. dollar assets, even at prices at that time that were more than $3 billion below the trust’s net asset value, the trust would trade if it were approved to operate as an ETP. *Second, U.S. investors seeking to obtain regulated bitcoin investment products should not be forced into less efficient and more complexly structured products simply because these are the only types of products that have not yet received Commission approval. Spot ETPs are strongly favored by investors, as evidenced by their commercial success in other commodities such as gold. Over time, investors and issuers of spot bitcoin products like Grayscale suffer competitive harm by not being able to benefit from a bitcoin futures ETP - unlike Grayscale, a bitcoin futures ETP can use a time-tested ETP Wrapper to add assets under its management. As a concrete illustration of this damage, on the day of the appeals court’s ruling, Bitcoin futures ETP10 benefited from net inflows, increasing by more than 800% compared to the average daily net inflows during the previous 30-day period. It is reasonable to assume that if the trust were also operating as an ETP back in the day, the trust would attract the majority of investments.
• Third, over the past few weeks, the Commission has received Rule 19b-4 documents related to multiple proposed spot Bitcoin ETPs, each seeking to compete with the Trust. As Grayscale noted in comment letters in response to the filings, each of the 12 listed exchanges proposed entering into surveillance-sharing agreements with major U.S. Bitcoin spot trading venues. Grayscale’s letter explains that the Commission’s previous Bitcoin Futures ETP approval order made clear that an oversight sharing agreement with CME alone would be sufficient to satisfy the requirements of Section 6(b)(5) of the Bitcoin Futures ETP. Therefore, based on the Court of Appeal’s reasoning, we believe the Commission may not now impose additional new requirements on spot Bitcoin ETPs to enter into oversight-sharing agreements with the spot Bitcoin market.

Subject to committee approval, the trust is ready to operate as an ETP. Therefore, we hope you agree that the best option now is for the Commission to issue an order approving NYSE Arca’s Rule 19b-4 filing and authorizing staff to work with Grayscale and NYSE Arca to finalize the Trust’s expedited listing. We believe the Trust’s nearly one million investors deserve this level playing field as soon as possible.

We look forward to discussing the above issues with the Committee and its staff.