ETF Edge - Grayscale’s Bitcoin Battle: Paving the Way for First Crypto ETF? 8/30/23

Episode Date: August 30, 2023

CNBC’s Bob Pisani spoke with Matt Hougan, CIO of Bitwise Investments, Craig Salm, Chief Legal Officer for Grayscale Investments and Jeremy Senderowicz, Shareholder at Vedder Price. After Grayscale��s big lawsuit against the SEC tipped the scales in favor of the crypto bulls this week, many are hoping this paves a clearer path ahead to finally seeing the nation’s first spot bitcoin ETF ever. So, how much closer are we to getting there – and what other key regulatory hurdles remain? In the “Markets 102” portion, Bob continued the conversation with Matt Hougan from Bitwise Investments. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis and breaking down what it means for investors. I'm your host, Bob Pizzani. Today on the show, it's all about Bitcoin after Grayskills' big lawsuit against the SEC, tip the scales in favor of the crypto bulls this week.

Many are hoping this pays a clearer path ahead. Finally seeing the nation's first spot Bitcoin ETF. How much closer are we to getting there? What are the regulatory hurdles remain? Here's my conversation with Matt Hogan. He's the CIO of Bitwise investments. Craig Salman is the chief legal officer for grayscale investments. And Jerry Senderowitz is the shareholder at Vetter Price

and an attorney advising ETFs for over 20 years. Craig, I want to start with you. I know you were personally involved in this case. You're the chief legal officer for Grayscale. It was a unanimous decision. How are you feeling? How's Grayscale doing? Yeah, so first, Bob, thank you so much for having me. It's great to be here.

We're feeling very, very good about the outcome of this case. Yesterday, a panel of free judges ruled by unanimous consent in Grayscale's favor. It's a win for us. It's a win for our shareholders. And it's a win for the whole crypto community. But just taking a step back, this is really culmination of something that started back in 2013. when we first launched GPTC, ultimately with the intention of eventually converting it into an ETF when permitted by the regulatory environment.

Fast forward, we refile this application to convert into an ETF. On the same day, the first Bitcoin futures ETF started trading. The reason why we did that is because we took the view that if the commission is okay with Bitcoin futures, which are derivatives of physical spot Bitcoin, which is in GBTC, they must also be okay with spot Bitcoin ETFs. Unfortunately, we were denied the following June. So, again, that very same day, we filed this lawsuit. Yesterday represents the culmination of all of that work with this, you know, three-judge panel ruling in our favor.

So it's great progress for our ETF efforts and a really positive step forward. And the court agree with you. Essentially, they said Bitcoin Futures, Bitcoin Spot like products. Right. You prove one. You have to prove the other. Matt, it seems like the ball's in the SEC's court right now. Gain this out for us.

What happens next? Yeah, I do think the ball is in the SEC's court. I think Grace Gale did a great job taking this thing. or making convincing arguments. And what it means is that the SEC can no longer deny spot Bitcoin ETFs on these concerns around market manipulation and surveillance. It had already blessed Bitcoin futures ETFs. Those track the spot price of Bitcoin.

So it has to allow spot Bitcoin ETFs under that standard. Now, there are other requirements in place. The SEC and issuers like Grayscale and Bitwise and BlackRock will go forward and discuss those other issues with the SEC. but I'm pretty optimistic that this was a major step forward for the industry, a major win for investors, and puts us hopefully on the path to seeing a spot Bitcoin ETF launch here in the U.S. sometime in the coming months. Jeremy, I read the ruling, and given how harsh is the word I would say the ruling was,

it would seem there's a fairly high barrier for an appeal. I mean, what grounds could they appeal on? And the court said Bitcoin futures and Bitcoin cash are fundamentally similar products. You approve one. You have to approve the other. It seems unlikely that an appellate court would reverse that. You're the lawyer here. What other arguments could they make if they want to do appeal?

Well, it's tough to say. I didn't see in the ruling any obvious grounds on which an appeals, on which the Supreme Court or the full, or the full D.C. Circuit could. would seize upon to overrule it. In addition to the resounding nature of the decision itself, it also helps the fact that the three-judge panel that heard it was a fairly diverse panel in terms of politics and background. So there weren't any, there isn't an obvious partisan slant or bias that someone could point

to as potential grounds for appeal. It's always possible that the court could, that the SEC could argue that the court, the court didn't properly credit the SEC's discretion, that they're entitled to exercise both under the statute and under relevant precedents that are still in effect governing the administrative procedures act. But I agree with you that based on both the lineup of judges, and the evidence presented by Grayscale and affirmed by the court, it looks like it would be a high bar. Yeah. I don't want to put you on the spot. We've argued the other side here, but what grounds for appeal would there be?

I mean, you're the lawyer. I know you're representing Grayscale here, but... I've been to the opinion many times. I have to say it was essentially the best possible opinion that we could have gotten. The court really leaned into the common sense and compelling legal arguments we've had, which is that futures and spot, for all regulatory purposes, for all ETF purposes, are essentially the same. So you have to treat them the same. I think it's a very clear argument to understand intuitively. We also gave quantitative analysis from Professor Bob Whaley, who was the inventor of the VIX index. Yeah, I know. He did a years-long study showing that futures and spot were 99.9% correlated, which is to say they are the same for ETF purposes. I wonder if they're regretting the decision to approve Bitcoin futures, because that was the mistake, if you want to call it a mistake, that they made. I mean, had they, once they committed to that, as the court pointed, they were essentially committed to the concept.

I would not call that a mistake at all. That is good for investors. It's good for the Bitcoin community. The hardcore people at the SEC who think that this is a mistake. I don't think so. I think they saw a reason why they were able to get comfortable with Bitcoin futures. They trade on the CME. They saw the surveillance that takes place there and feel that can account for things like fraud or manipulation.

Our view is that that surveillance can also account for any concerns in the underlying spot Bitcoin markets. We got to an impasse with the SEC. It was a professional disagreement. We chose to, you know, pursue this in litigation, which is not an easy decision to make. It's not something we take lightly just to our regulator, but it was something we felt we had to do on behalf of our investors. Well, you moved the balls forward, and it turned out to be, it was expensive. Yesterday, the court agreed with us. I will say, though, it's not technically back in the SEC's court today. Under the federal rules of appellate procedure, the ears of a 45-day window where they can appeal the decision. And so we just have to wait that out and respect that process. Well, yeah, so let me take the other side of this, Matt. If the SEC chooses not to appeal, what kind of time frame are we looking at to get these to the market? And there seems to be a consensus that if the SEC approves a Bitcoin ETF, they should approve all of them at once.

Matt and Craig, maybe you can both agree on that. I mean, does everybody at least agree on that and give us a time frame, you know, assuming there's no appeal? Yeah, I think lining up multiple products to launch at the same time would be the best possible outcome for investors, create a competitive field. You would likely see the lowest prices and the best quality products. So I'm hopeful that that's the outcome we see, but of course we don't know that. In terms of the timeline, you know, these 33-act Bitcoin ETFs move on a very specific regulatory

timeline with deadlines for review. The next deadline that is up is actually at the end of this week for the Bitwise application, but the SEC could delay that review for another 45 days. ultimately, the calendar ends and a decision needs to be made sometime toward the end of the year or early next year. But we don't know what's going to happen, Bob. But that's the window you're looking at. Sometime in the next, let's say, five or six months, we see significant progress. Do you agree with that? I mean, assuming there's no appeal. Yes, I mean, I'm focused on GBTC. Our circumstance is unique in that we have an actual fund today with billions of dollars of AUM.

It's trading tens of hundreds of millions of dollars in daily volume. It represents a lot of nearly a million investors across all 50 states, all wanting it to be an ETF. So the stakes are just a lot higher for us, and that's what we're really focused on right now, getting this over the finish line and converting GPDC into an ETF. Jeremy, could the SEC come up with some kind of new rationale out of nowhere about why this application should not be approved, and then dare a gray scale to sue them again? So, I mean, we know they can't use this argument that there is not a market of sufficient size to prevent manipulation. Okay, that's gone.

Are there any other arguments they could come up with? It's certainly possible they could come up with something. And I certainly don't want to give the SEC too many creative ideas about other ways they could possibly attempt to reject these filings. But for the last several years, the SEC really has put all its eggs in this basket of the that was rejected by the court yesterday. So it will, I think, be pretty difficult to make a compelling argument that all of a sudden there's a new issue that they haven't focused on in these denials for several years,

but are important enough to continue denying these applications. You know, Matt, there is one other possibility here, and sort of a scorched earth possibility. The SEC could just kill the Bitcoin futures ETF, right? I mean, is there anything that would prevent them from doing that? I don't think that's going to happen, but they could say, well, we made a mistake and kill it. Is that a possibility at all? I think that's highly unlikely for two reasons.

One, I don't think we have any example in the historical literature of that happening. And the other thing is that ETFs are good for investors. People want access to Bitcoin. They're buying it in a variety of ways, including unregulated ways. ways. An ETF would just make it safer, cheaper, more efficient, and add regulatory protections to help investors get the exposure that they're going to get anyway. So I think that would be a step backwards for investor protection. And I don't think that's what the SEC is trying to do. They've been careful and cautious about reviewing Bitcoin ETS for the last 10 years. Early on, the market really

wasn't ready for a spot Bitcoin ETF. I think the argument we and others are making is now we are. And I think that's still the likely path forward. Craig, I want to just switch gears a little talk about these applications have surveillance sharing agreements with the exchanges that would allow for sharing of information about market trading activity, about clearing activity, and about customer identification. There's also ways to seek to ensure investor assets can't be diverted by an exchange to an unauthorized party. And I know that was an issue with FTX. Is that enough to reduce concerns about market manipulation? because these concerns about market mitigation haven't gone away because of this ruling. But address that issue about the surveillance sharing.

Yeah, so, I mean, on the concern, any concern you might have about the underlying Bitcoin market structure, that is an identical concern for the Bitcoin futures. So it's just inconsistent to be okay with futures, but not spot. In terms of surveillance, this was in our 19 before. It was in our lawsuit. It was in the court's opinion yesterday. we all agree that the surveillance on the CME that has oversight over Bitcoin futures is sufficient to account for surveillance in the underlying Bitcoin market structure, which is what would

price directly in these UTFs. So we already have surveillance share agreements. It's with the CME. I think having more surveillance share agreements with exchanges like Coinbase is definitely another positive step forward, but it's not a need to have in this Bitcoin ETF context. Yeah. Meantime, Matt, these Bitcoin futures are doing well ever since BlackRock said they were going to go in here. I was talking to pro shares yesterday. They're Bitcoin strategy, ETF, the original

BITO, just passed a billion dollars in assets. So this is definitely stirring up some interest. Absolutely. Look, you have the world's largest asset manager saying Bitcoin is going to be an investment that many institutional investors want to make for the foreseeable future. That is a huge endorsement. Our view at Bitwise is we've entered or are entering the mainstream era of crypto, where it goes from being a niche asset to a mainstream asset. ETF progress is one example of that. BlackRock is one example of that. And people levering or moving into those Bitcoin futures ETFs is an example of investors

trying to get in ahead of that trade. If you think it is going mainstream, then it's an attractive asset in many ways, even today. Craig, what is the future for Grayscale here? I mean, I wonder how much of good news here. Now, you charge 2% right now for the Bitcoin fund. I don't think you're going to be able to charge 2% once it goes into a Bitcoin ETF. I mean, maybe I'm wrong, but you're likely going to have eight other competitors out there. I mean, how do you feel about all the competition now?

And are you going to reduce the fees? Yeah, so we've actually been very public about that for over a year now. We are going to reduce the fee for GBTC upon ETF conversion. But right now, we do have this time period or we have to honor the court's process away at this 45-day clock. And then we are otherwise very focused on actively construction. re-engaging with the SEC to get this over the finish line. Jeremy, give us a 30,000-foot view of the SEC and how they came out of this. Was their reputation damaged at all here? I mean, I'm thinking about a larger issue about their ability to create rules and regulation. Was there anything broad that you can

come away from this and say, well, the court has reduced the power of the SEC, or did they just make a simple legal error here? Okay. Well, I think in this particular case, there's an that the facts lined up really badly against the SEC, such that the court was able to rule against the SEC without necessarily casting aspersions on the SEC's larger regulatory agenda, whether in crypto or other areas of the financial industry. That said, I think it is noteworthy that the court did feel that the SEC exceeded its bound so dramatically in this particular case. And at the very least, it signals that the appeals courts are not necessarily going to be deferential to whatever the SEC, whatever rulemaking or other

activities the SEC might undertake. So while there isn't, this doesn't have direct precedent effect with respect to any of the other potentially controversial activities, the SEC might be undertaking, it does serve notice that the courts will be watching. Yeah, I agree with that completely. That magic phrase arbitrary and capricious, which is, I guess, part of the Administrative Procedure Act is the key thing to focus on here. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETS. This is the Market 102 portion of the podcast. We'll be continuing the conversation with Matt Hogan from Bitwise Investments. Matt, Thanks for sticking around.

We just spent 25 minutes talking about what happened in the legal case. I guess the broader question is, to what extent does this ruling help drive some kind of wider ownership in Bitcoin? And assuming a Bitcoin ETF happens. And to what extent does it make any price difference at all? Yeah. It's a massive difference in terms of ownership, Bob. You remember 2003 when GLD launched. At the time, Goldwell.

as a niche asset that didn't really belong in advisor portfolios, institutional portfolios. But once you could buy it in spot format easily through a standard brokerage account with regulatory protections, it really catapulted gold into the mainstream where it is today. Ultimately, that brought in $100 billion into the gold market. I think a spot Bitcoin ETF does something of the same thing. It moves it from the niche to the mainstream. It moves it from retail to financial professionals and I think you'll see big inflows. And of course, that's supportive for prices. Yeah, I would certainly agree that you've got a BlackRock that's interested, that will make it certainly somewhat broader potential ownership. But I'm wondering whether it really solves

the fundamental issue for cryptocurrencies. I mean, this is not the savior of the Bitcoin business, I don't think. I'm still waiting for a demonstration of a convincing use case. Is it money? Is it a store of value? Is it a unit of account? And beyond a small circle of fiat money anarchists, most people still seem to think it's some way to make money really fast. So I guess I'm trying to figure out,

I agree it could drive broader ownership, but does it necessarily mean suddenly that we have a new asset class that's in existence? How long is that going to take? Yeah, I think it's actually a big step forward to that, Bob. You know, I think of Bitcoin primarily as an asset that's trying to become a digital version of gold. And making it available in an investable wrapper from the world's largest asset manager puts us much closer to that use case.

Also, all the common criticism people make of Bitcoin that it's too volatile, that it's not regulated enough, that it's not easy enough to access, that you have to be a computer scientist to gain exposure to it, that you can't trust custody. All of those start to fall away. when it's packaged in everyone's favorite investment vehicles. So actually, I think it pushes us closer to its short-term use case as a store of value, and it actually pushes us closer to our long-term use case in terms of a means of payment, even, because it will lead to more regulatory protection, lower volatility, etc.

I do think this is a step-prudgeon moment at the market. I agree. The investable wrapper is an absolute key. I wonder if we can get more discussion away from crypto and more towards the wonders of blockchain and smart contracts and Ethereum, because that's what gets me excited, frankly. I am not entirely convinced of the use case around cryptocurrencies, but I am convinced that blockchain is a disruptive technology, and smart contracts are disruptive technology.

I certainly would like to hear more about that, man. I agree. Well, let's get to an Ethereum ETF. We can talk about that. Ethereum is the platform where that's taking place, and that's growing. It's quiet right now, but it's growing. seeing big companies like Starbucks and Nike also moving into that space the same way BlackRock

is moving into the Bitcoins. So maybe not a lot of coverage, but you'll hear about it, hear about it soon. Yeah. All right, Matt, thanks for joining us. Always a pleasure speaking with you. Matt Hogan is the CIO Bitwide asset management. And thank you, everyone, for listening to the ECF Edge podcast. Investco QQ believes new innovations create new opportunities, become an agent of innovation. InvescoQQQ, Invesco Distributors, Inc.