Analyzing SEC's Logic Loopholes! Why Did the Court Deem SEC's Rejection of Grayscale's Spot ETF Application Unreasonable

The U.S. Securities and Exchange Commission (SEC) recently lost a lawsuit against Grayscale, where the court ruled that the SEC needs to clearly explain the reasons for rejecting Grayscale's application to transition to an ETF, and how its regulatory standards differ from the already approved Bitcoin futures ETF. This development, similar to a partial victory in the Ripple lawsuit, is seen by the crypto community as a blow to the SEC's regulatory logic, leading to a surge in the cryptocurrency market.

Here are the key points from the court ruling in the Grayscale case:

Is Bitcoin "Spot" ETF the Hope of the Whole Village?

The Bitcoin "Spot" ETF exchange-traded funds have been a long-standing issue. In 2013, the Winklevoss brothers, founders of the Gemini exchange in the United States, applied to the SEC with the aim of allowing more investors to access Bitcoin through traditional financial markets. Since then, many entities in the United States have applied to the SEC, but they have been repeatedly rejected until the first Bitcoin "Futures" ETF appeared in October 2021.

However, people are still hopeful for the SEC to approve the Bitcoin "Spot" ETF because the spot market requires actual delivery of Bitcoin, which, compared to the derivative "futures," can bring real trading activity for Bitcoin in traditional markets.

With the traditional financial giant BlackRock announcing its entry into the application queue for the Bitcoin "Spot" ETF, it has boosted confidence among industry players. The belief is that BlackRock, with its unstoppable momentum, will convince regulators to approve the Bitcoin "Spot" ETF. Various application statuses

Grayscale's Bitcoin Trust Fund GBTC, due to low trading volume and significant discount, is also eager to transition into a Bitcoin "Spot" ETF. In April, reports surfaced: GBTC transitioning to a Bitcoin spot ETF, does Grayscale have a chance to win over the SEC?

Following the rejection of Grayscale's application by the SEC, a legal battle ensued, and during the court's response in March of this year, it was already evident that the SEC had some unclear explanations. After a judge ruled at the end of August that the SEC needed to reassess Grayscale's application, it led to a significant surge in the price of Bitcoin.

The community believes that the SEC's obstacles are not insurmountable, and it is very likely that the Bitcoin "Spot" ETF will be approved.

Why Doesn't the SEC Let the Bitcoin "Spot" ETF Pass?

According to the judgment of the lawsuit between Grayscale and the SEC, the reasons for the SEC's rejection of these Bitcoin "Spot" ETF applications are the same:

The design of these products does not prevent fraud and manipulation.

The SEC requires these entities to establish a "supervisory sharing agreement" with regulated markets. However, including BlackRock's application, none have passed the SEC's market testing so far.

Note: The court only described some of the reasons for rejecting spot ETFs, including custody, settlement, and other factors.

Why Did the Bitcoin "Futures" ETF Pass While the SEC's Standards Are Questioned?

The court believes that the SEC needs to provide a reasonable explanation for rejecting Grayscale's application for transformation.

Are the Regulatory Elements of "Futures" and "Spot" ETFs Similar?

The court stated that if they find Grayscale's application, which has already passed the Bitcoin "Futures" ETF regulatory elements, to be the same, the SEC must provide a reasonable explanation for its rejection.

The court believes that Grayscale has provided sufficient evidence to show that the Grayscale ETF is similar to the approved Bitcoin "Futures" ETF and therefore should receive the same regulatory treatment.

The following are the common points as recognized by the court:

• The price tracking of the Grayscale ETF closely matches the real-time price of the Bitcoin "Futures" ETF, almost identical to the proposed ETF by Grayscale. Grayscale: CoinDesk Bitcoin Price Index, Futures ETF: CME Futures Contract Price
• The listing exchanges for the Grayscale ETF and the Bitcoin Futures ETF have the same surveillance sharing agreement as CME.

The court believes that the spot market and futures market are closely related, and manipulation in either market would affect the price of Bitcoin futures. When the SEC approves the Bitcoin "Futures" ETF, it believes that by monitoring the CME futures market, it can detect fraudulent activities in either market.

This indirectly proves that the regulatory factors of the Grayscale ETF and the Bitcoin "Futures" ETF are similar.

SEC Standards Inconsistent? Similar Market Manipulation Risks for Grayscale ETF and Futures ETF

Facing market manipulation surveillance, the SEC believes that applications like Grayscale's "Spot" ETF cannot monitor and detect market manipulation. On the other hand, the SEC believes that Bitcoin "Futures" ETF does not need to prove market manipulators and must trade on a monitored large exchange like CME since the only asset held by the Bitcoin "Futures" ETF is traded on the monitored exchange CME.

However, Grayscale argues that even if they do not trade their held Bitcoin on CME, the market manipulation risk is similar to that of the Bitcoin "Futures" ETF and should be subject to the same regulatory conditions.

The court believes that the SEC failed to explain why these two similar products are treated differently. According to evidence provided by Grayscale, there is a 99.9% correlation between CME Bitcoin futures prices and spot market prices, indicating that market manipulation and fraud in the spot market would also pose a problem for Bitcoin futures and spot ETFs.

The SEC also fails to explain why a surveillance sharing agreement with CME is sufficient to protect the Bitcoin futures ETF from potential fraud but not for Grayscale's proposed Bitcoin ETF.

Furthermore, the court stated that while discussing the leading or lagging relationship between futures and spot markets was deemed unnecessary when approving the Bitcoin futures ETF, it was used as a reason to reject the Grayscale ETF due to the unclear leading or lagging relationship.

Will Approving the Grayscale ETF Affect the CME Futures Market?

The court stated that the SEC believes approving the Grayscale ETF would make it a significant force in the CME futures market because Grayscale holds a large amount of Bitcoin, but the SEC did not explain the relationship between the spot and futures markets clearly.

The court believes that Grayscale has presented evidence showing the rapid growth of the Bitcoin spot market, making it unlikely for Grayscale to dominate the price, but this was rejected by the SEC.

The court also believes that if the SEC is concerned that the Grayscale ETF will affect CME futures market prices, why wouldn't the Bitcoin futures ETF have the same effect? The same reasoning should apply to both spot and futures products.

Based on the court's various criticisms of the SEC's judgment criteria, the court approved Grayscale's review request and revoked the commission's order.

Approval of the Grayscale ETF Does Not Mean the Approval of Spot ETF is Imminent

This case shows that the court believes the SEC's review standards for futures ETFs and spot ETFs are not consistent, and ultimately requires the SEC to provide a reasonable explanation. Some pessimists also believe that if the SEC cannot provide a reasonable explanation for approving futures ETFs, it may lead to the delisting of Bitcoin futures ETFs.