Problematic SEC Stance Sets Up Catalyst For Bitcoin And Grayscale's Bitcoin Trust – Seeking Alpha

Leonid Sukala/iStock via Getty Images
On April 6th the SEC approved NYSE Arca’s proposed listing of the Teucrium Bitcoin Futures Fund (BCFU). Despite a meaningful difference in the registration type, the action itself was not overly noteworthy. This is because a number of other futures-based Bitcoin (BTC-USD) funds, such as ProShares Bitcoin Strategy ETF (BITO), have already been sanctioned.
However, though still giving the approval for the Fund to trade, the SEC disagreed with the conclusions presented by Arca and the Fund’s sponsor relating to the exchange’s surveillance-sharing agreement with the CME. As explained below, this nuanced disagreement is the key sticking point holding up the SEC’s approval of spot-backed Bitcoin ETFs. And in the Teucrium approval order, the SEC spent some time justifying their position of sanctioning futures-backed products, while disapproving those with direct backing by actual bitcoins.
The following article looks at the details of how this justification by the SEC is inconsistent, adding to the pressure for approval of spot-backed Bitcoin products. Additionally, some filings for spot-backed ETFs make slightly different, larger, and possibly more persuasive arguments than were made in the Teucrium case, especially concerning Arca’s surveillance-sharing agreement with the CME. Finally, filings for spot-backed ETF’s more directly challenge the SEC’s disparate treatment of spot and futures-backed products. These factors combined could lead to a reversal in the “disapproval” stance by the SEC in their upcoming decision on the conversion of the spot-backed Grayscale Bitcoin Trust (OTC:GBTC) to an ETF.
Other than the tightening of ESG disclosures, in coming quarters I am looking for sentiment to improve concerning the regulatory environment of the crypto-space. The initial decision on Grayscale is expected in July and carries a meaningful, though not majority, probability of winning approval. But even with a disapproval, the order will likely reduce uncertainty as to when and how a spot-backed product can be listed. And, supposing the SEC does maintain their current position on spot-based Bitcoin ETFs, Grayscale has given some indications they would seek a remedy under the Administrative Procedure Act. And the reaction to what seems to be an inevitable lawsuit if the SEC rules against Grayscale could provide short-term support in the space as well.
The all-time highs seen last year in the Bitcoin price came in the runup to the listing of Coinbase (COIN) and then again with the launch of Proshares’ BITO. Similar action could occur late summer or going into the fall with news on the long awaited Grayscale ETF. This timing coincides well with The Merge on Ethereum’s (ETH-USD) platform that looks to improve sentiment in the digital asset space as well. And of course, the elections this November are setting up to empower pro-crypto factions to control important committees in both the House and Senate.
Put simply, before listing a fund an exchange and the fund’s sponsor have the responsibility to show that the fund was designed to detect and deter fraud and manipulation. A common way to meet the requirement is to have a surveillance-sharing agreement with a significant, appropriate and regulated market.
In the Teucrium approval, Arca’s surveillance-sharing agreement with the CME was relied upon to meet this prong of the process. The SEC wrote:

..the CME’s surveillance can reasonably be relied upon to capture the effects on the CME bitcoin futures market caused by a person attempting to manipulate the proposed futures ETP by manipulating the price of CME bitcoin futures contracts, 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.
Order Granting Approval to List Teucrium Bitcoin Futures Fund (first link above),, 4/6/2022, p. 12 [emphasis added]
However, during the discussion of the adequacy of the surveillance-sharing agreement, the SEC made important and relatively lengthy footnotes. In one note they argued:

This reasoning, however, does not extend to spot bitcoin ETPs… If an exchange seeking to list a spot bitcoin ETP relies on the CME as the regulated market with which it has a comprehensive surveillance-sharing agreement, because the assets held by a spot bitcoin ETP would not be traded on the CME, that proposal would be significantly different from the current proposal. ..there would be reason to question whether a surveillance-sharing agreement with the CME would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct affecting the price of the spot bitcoin held by that ETP.
(previous reference, note 46, pp. 12-13)
Directly attached to the above assertion, the SEC highlighted that it has not been demonstrated that a person looking to manipulate a spot-based ETF would be likely to trade on the CME. Importantly, this highlighting seems to imply futures-based products are protected because it would be likely that those looking to manipulate a futures-backed product would trade futures on the CME (see also author’s endnote below). And in the text of the approval, the SEC chose to highlight the word “same” in the following introductory statement:

..the proposed “significant” regulated market (i.e., the CME) with which the listing exchange has a surveillance-sharing agreement is the same market on which these assets trade.
(previous reference, p. 12)
But… since both futures-backed and spot-backed Bitcoin products will have the same, or at least meaningfully similar, exposure to the spot Bitcoin markets, manipulation of the underlying asset would affect both types similarly. The upshot being, if futures-based products meet standards, so too will those directly backed by bitcoins.
Further, in the Teucrium order itself, and in a directly related context, the SEC was somewhat forced to agree with the above point.

..the Commission is not persuaded that the market for CME bitcoin futures contracts “stands alone;” has a “lack of connection” with, and is “not specifically materially influenced” by, other bitcoin markets… ..there is nothing that prevents the trade prices that contribute to the daily settlement price from themselves being influenced by activity in other bitcoin markets.
(previous reference, p. 16)
Putting it together, the pricing references used in the CME futures market and those proposed by spot-based ETF’s are both based on trading prices at the same digital asset marketplaces. So both futures-backed and spot Bitcoin exchange traded products have the same risks from manipulation of the underlying spot markets.
In approving the Teucrium product, the SEC said Arca’s surveillance-sharing agreement with the CME protects it from manipulation attempts made “indirectly by trading outside of the CME bitcoin futures market.” This approval is inconsistent with the denial of spot-based products that will also have agreements with the CME, as both share meaningfully similar risks from manipulation attempts outside of the CME’s Bitcoin futures market. Further, the SEC has specifically highlighted that there is not a “lack of connection” between the futures market and the spot market.
The approval of futures-backed products such the one from Teucrium, while denying those directly backed by bitcoins like Grayscale’s product, creates an unfairness between issuers that is not permitted by the Exchange Act. Look for a reversal in stance by the SEC over the summer concerning spot Bitcoin funds or the initiation of Administrative Procedure Act litigation testing the Commission’s fairness.
Most importantly, the approval of a “nonderivative” Bitcoin ETF in the U.S. will be a watershed moment for the digital asset space, creating positive sentiment similar or stronger to what occurred in 2021 with the launch of the first derivative based products. Investment in the Grayscale’s Bitcoin Trust has the added benefit of a likely reversal in its discount to NAV, currently at 30%, as its conversion to ETF date approaches.
Author’s endnote: The following concluding sentence from the SEC is overly complex, but worth breaking down. For clarity, the subject of the sentence is “none” and the verb is “conflicts”.

However, none of these deficiencies in Arca’s arguments concerning whether there is a reasonable likelihood that a would-be manipulator of the proposed ETP would have to trade on the CME conflicts with the Commission’s determination that, because the only non-cash assets held by the proposed ETP (i.e., CME bitcoin futures contracts) are traded on the CME itself, Arca’s surveillance-sharing agreement with the CME can reasonably be relied upon to assist in detecting and deterring fraudulent or manipulative misconduct related to those assets.
(previous reference, p. 16-17)
The operative clause at the end the sentence proposes the following: because the assets held by the Teucrium fund are being traded on the CME, a surveillance agreement with the CME is sufficient to meet requirements regarding detecting and deterring manipulation. But because these assets themselves are only derivatives of a commodity not traded on the CME, this proposal “sidesteps” the question of if the Bitcoin futures market has risk from possible manipulation in the underlying Bitcoin market.
In a recent letter to the SEC, Grayscale’s legal council attacked this thinking as follows:
In the words of the order, the CME “is the same market on which these assets trade”—meaning that the “significant market” test is little more than a tautology when it comes to an ETP investing in derivatives that trade in a market regulated by the Commodity Futures Trading Commission.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of BITO, BTC-USD, ETH-USD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.