On August 29, 2023, in Grayscale Investments, LLC v. Securities and Exchange Commission, the US Court of Appeals for the D.C. Circuit found that the SEC wrongly rejected the application of Grayscale Investment, LLC (Grayscale application) to convert its spot bitcoin trust, Grayscale Bitcoin Trust, into the first spot bitcoin exchange-traded fund (ETF) (Grayscale Invs., LLC v. Sec. & Exch. Comm'n, (D.C. Cir. Aug. 29, 2023)).

While the SEC has previously rejected spot bitcoin ETF applications, it has approved applications for bitcoin futures ETFs, which track agreements to buy or sell bitcoin at a pre-agreed price. Grayscale and NYSE Arca, Inc. (Arca), the exchange on which the Grayscale spot bitcoin ETF would trade, proposed using the same market manipulation safeguards that were approved by the SEC in the bitcoin futures ETF applications. However, the SEC rejected the Grayscale application on the grounds that these market manipulation safeguards were insufficient for the spot bitcoin ETF.

According to the decision, Grayscale argued that the bitcoin futures ETF surveillance arrangements should also be satisfactory for its spot ETF because both products rely on bitcoin's underlying price. Bitcoin futures ETFs track bitcoin futures that trade on the Chicago Mercantile Exchange (CME), the chief venue for those products, regulated by the CFTC. According to the decision, the SEC has found that CME's surveillance can reasonably be relied upon to capture the effects on the CME bitcoin futures market caused by attempted manipulation of the proposed futures ETF, whether that attempt is made by directly trading on the CME bitcoin futures market or indirectly by trading outside of the CME bitcoin futures market. The SEC, however, argued that Grayscale lacks data to determine whether the CME futures surveillance agreement could also detect potential manipulation in the spot markets.

However, the court ruled that the SEC acted arbitrarily and capriciously in rejecting Grayscale's application because it never explained why CME's ability to detect fraud would be impacted by the ETF's holding of bitcoins rather than bitcoin futures. The court explained that Grayscale showed that its proposed bitcoin ETF is materially similar to the SEC-approved bitcoin futures ETFs because the underlying assets (bitcoin and bitcoin futures) are closely correlated and the surveillance sharing agreements with the CME are identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin.

For bitcoin ETFs, see Bitcoin ETF Tracker.

For details on crypto regulation in the US, see Cryptocurrency and Virtual Currency Regulatory Tracker.