The SEC needs to provide more clarity around crypto ETFs

Alexander Kirch/AA+W - stock.adobe.com

Those who keep up with the crypto market likely saw the news of Grayscale and their dilemma with the Securities and Exchange Commission. While this may seem like it only relates to a single trust, the historic nature of Grayscale's offering could have profound implications for the crypto industry.

Since 2013, Grayscale has been offering shares of the Grayscale Bitcoin Trust (GBTC), in which the firm uses investor cash to purchase and hold bitcoin, charging 2% of assets per year. However, as my colleague Dan Hoover has noted, GBTC shares "cannot be sold for six months after issuance, and cannot be redeemed for either BTC or USD." Essentially, this means that while money can enter the GBTC, it cannot leave it.

Grayscale has repeatedly submitted applications to the SEC, which would allow GBTC to be classified as an exchange-traded fund (ETF). This, in turn, would allow money to come out of the trust, yet these applications have been denied every time — injudiciously and without explanation.

Upon the last rejection, Grayscale appealed the SEC's decision, stating that the SEC did not properly explain the reason for their rejection. The appeals court agreed, ordering the SEC to review Grayscale's application again and better describe their reasons for rejection. The goal here is not for the SEC to immediately reverse their decision but for the SEC to give a more detailed response to Grayscale's positions, allowing them to work toward an effective compromise.

However, Grayscale is not the only company looking to launch the first "spot" bitcoin ETF. ARK and BlackRock (sponsor of the iShares ETFs) have both proposed their own trusts for classification as ETFs, and their greater experience — especially with nondiversified ETFs as well as their ability to see GBTC's applications and rejections — puts them at an advantage when it comes to seeking approval.

There are a few issues that have hindered the approval of Grayscale's proposal for their bitcoin trust to be classified as an ETF by the SEC. First, the surveillance-sharing agreements for the GBTC are being proposed with Coinbase, when the SEC is actively suing Coinbase for not providing these services. Second, the bitcoin in the trust are not held by a bank under the recognition of a nationally recognized regulator (for example, the Treasury's OCC). Lastly, no third party has expressed their willingness to certify that all bitcoin assets in the trust/ETF are free of money laundering and counterterrorism financing concerns.

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If these conditions are met, some critics who have expressed concern over GBTC may be willing to embrace its conversion to a fully redeemable ETF. Because some of Grayscale's competitors are aware of these concerns, they have been able to propose ways to address them in their own proposals.

Although there is uncertainty regarding cryptocurrency investment, there is always some degree of uncertainty with any form of investment. Nevertheless, the lack of clarity in the regulation surrounding the crypto market — as perfectly exemplified by the Grayscale situation — has prevented several investors from taking the leap into crypto investing, and several products from being listed on the market.

Grayscale hopes that by appealing the SEC's decision, they will be able to advocate for increased clarity in crypto regulation, thereby making the crypto market more equitable and fairer for all.

In their letter to the SEC, lawyers for Grayscale stated, "We hope you will agree that the best use of resources now is for the Commission to issue an order approving NYSE Arca's Rule 19b-4 filing and authorize the staff to work with Grayscale and NYSE Arca to finalize the prompt listing of the Trust's shares."

The implications of the announcement of Grayscale winning the appeal against the SEC had profound effects on the market. Bitcoin, ethereum and other major cap coins experienced a surge after the news, and Coinbase — the custodian in many bitcoin ETF applications — surged 14%. These increases were the result of the mere announcement that Grayscale's application would be reconsidered, not even that it would be approved.

With this in mind, it is clear that the approval of Grayscale's request to convert GBTC into an ETF could significantly impact the market. The recent successful appeal of the SEC's ruling is an essential first step in this process, as it will allow Grayscale to receive a more detailed decision to inform their future applications.