Grayscale Investments filed a lawsuit against the SEC late Wednesday evening, following the agency’s rejection of the firm’s application to convert its crown jewel Grayscale Bitcoin Trust (GBTC) into an ETF. The firm claims the move would solve the dramatic price discount plaguing GBTC.
The Grayscale lawsuit comes as no surprise; previously the firm publicly telegraphed its intent to pursue legal action if the SEC denied the company’s application. Earlier this year, the firm announced its intention to counter by filing an Administrative Procedures Act claim and retained former Solicitor General of the United States, Don Virelli, to lead the effort.
Making good on the threat to go to court is an escalation of the standoff between the firm’s leadership (and, indirectly, its parent company and CoinDesk owner: Digital Currency Group) and SEC chairman Gary Gensler. Publicly, Gensler has maintained a dim view of the value, utility, and legitimacy of most of the crypto ecosystem, with bitcoin (BTC) being no exception.
Meanwhile, Grayscale’s CEO Michael Sonnenshein has reiterated his commitment to the ETF conversion strategy, stating in a press release that both he and the firm are “deeply disappointed by and vehemently disagree with the SEC’s decision to continue to deny spot Bitcoin ETFs from coming to the US market.”
The Grayscale lawsuit standoff: both sides
The two parties in this issue, and now court case, have starkly different takes on the matter at hand.
The SEC’s position:
- There exists both widespread potential for, and proven examples of, market manipulation of bitcoin prices.
- Bitcoin-based financial products lack the agency oversight and monitoring that comes with a “sufficiently sized” exchange sharing information and centrally monitored by regulatory authorities.
- Grayscale’s application submissions failed to demonstrate:
- Adequate steps being taken to ensure investor protection against concerns of manipulation, wash trading, hacking, etc.
- The market for bitcoin is such that further protections are unnecessary.
- Converting to an ETF is the best solution to the severe discount at which shares of the trust trade, relative to the net asset value (NAV) of the bitcoins held by the trust.
- By disapproving of the conversion, it’s the SEC that’s responsible for “locking up” investor capital from flowing to GBTC, in turn causing harm to its investors.
- Bitcoin markets, GBTC, and NYSE Arca (the exchange on which the proposed ETF would trade) have put in place adequate controls, monitoring, and influence to ensure investor safety and orderly market operations.
- The outcry from the American public is overwhelmingly in favor of Grayscale’s ETF plan and that failing to allow it will cause danger and harm to the public.
Everyone wants it — so it costs more
Of central concern to Grayscale and its investors is what’s known as the “discount to NAV,” the decoupling of the value of the GBTC shares from the bitcoin it contains.
For most of the fund’s existence, it was the only product like it on the market and demand was much higher than the supply created through GBTC’s private sales to accredited investors. Even when observing the 6-12 month lockup period restricting the sale of these types of shares, private buyers purchasing GBTC at face value from Grayscale could expect to resell them on the open market for premiums often in excess of 40%. This was, of course, a much better option than redeeming them at face value.
In 2016, the SEC went after GBTC (then called The Bitcoin Trust) and its affiliated broker Genesis for violating Regulation M — which prohibits non-ETF funds like these from both selling and redeeming trust shares concurrently. Following a “no-fault” settlement, the trust ceased its redemption of GBTC shares for bitcoin, effectively requiring investors to use the open market to cash in on their investment.
While the market price for GBTC shares exceeded the face value of the bitcoin represented, a healthy arbitrage opportunity existed: investors could borrow BTC, use it to receive GBTC shares at face value and, after the required lockup period, sell the shares to pay back the loans and pocket a large difference in profit.
No one needs it — so it costs less
In late 2020, market prices exploded and the demand for bitcoin and GBTC took off. Huge sums flowed into Grayscale. They created and issued a massive number of shares to reflect the increasing pool of bitcoin within the trust.
However, in February of 2021, several alternative products launched, offering investors access to the same bitcoin-backed shares but with neither the lockup period nor the hefty 2% fund management fee that Grayscale charges. The ability to redeem shares directly, at any time for face value meant these products would naturally track the price of bitcoin, without any significant discounts or premiums.
Soon, demand collapsed and market prices for GBTC dropped along with it. Rather than offering a premium on the resale of GBTC, anyone holding shares in the trust was faced with the prospect of holding their GBTC indefinitely or selling it on the open market at a discount. In recent days that discount has fallen to the 30% level.
This meant that bitcoins in Grayscale packaging were worth far less than BTC bought directly on an exchange. Investors were locked into a losing trade. Now, with bitcoin prices bouncing below $20k, holding onto GBTC is an even worse proposition for a portfolio.
A manufactured hostage situation
The Grayscale lawsuit is described by the firm as if it was the last line of defense for investors, elevating the case to a Federal court in an effort to protect them from the capricious actions of the SEC. The firm has put on an absolutely massive lobbying and PR campaign to convince regulators, academics, investors, and the public that conversion to an ETF is safe, reasonable, and necessary.
The message that GBTC wants to amplify is unambiguous. As stated in a recent post on its site: “Converting GBTC to a spot Bitcoin ETF remains the best option for investors: it would effectively eliminate the discount and cause the shares to track the price of Bitcoin.”
Interestingly, the firm remains consistently unforthcoming about the fact that ETF conversion is not, in fact, the only way to fix the severe discount to NAV issue.
The Grayscale lawsuit implies a false dichotomy
Not addressed by the Grayscale lawsuit or its investor communication is that GBTC isn’t currently offering any new GBTC shares for sale and thus Regulation M shouldn’t necessarily prevent them from implementing a redemption program. Doing so would, of course, mean that any GBTC share could be redeemed by GBTC for face value — closing the discount to NAV, and “unlocking” the cash value Grayscale accuses the SEC of “locking” into their fund.
It appears Grayscale might be electing to preserve the discount in place while simultaneously mounting a pressure campaign that faults SEC for its investors’ current predicament. One could be forgiven for wondering if the 2% management fee of GBTC’s massive asset pool plays any role in Grayscale’s ETF-or-bust false dichotomy. No redemptions mean no NAV correction. It also means no large scale outflows to competitors’ less expensive funds.
Equally notable is the fact that parent company DCG has been continuously authorizing itself to buy GBTC shares on the open market. Given that these shares would be sold at a loss by their owner, bought at a discount by DCG, and then instantly increase to face value if the ETF is approved, it’s not surprising that its wholly owned subsidiary Grayscale is willing to play hardball with the SEC to get their way.
But is investor protection really the motivation?
Check back soon for further coverage of this story and our upcoming indepth analysis of Grayscale Bitcoin Trust.