Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insight on policy and regulation.
On Tuesday morning, at an office building a few blocks from the White House, the crypto firm Grayscale laid out a spread of pastries and coffee. In a week’s time, Grayscale would be arguing before the D.C. Circuit Court of Appeals as one of the industry’s companies daring—or foolhardy—enough to challenge the Securities and Exchange Commission. Today, it was facing a slightly easier crowd of undercaffeinated reporters.
Grayscale is part of Barry Silbert’s Digital Currency Group, which includes the bankrupt lender Genesis and the Polk Prize-winning CoinDesk, now reportedly up for sale. Despite the crypto empire’s economic woes, it still has deep pockets. That was evident in the breakfast’s star attendee: The advocate who would be representing Grayscale before the court, Don Verrilli Jr. As the former solicitor general for President Barack Obama, Verrilli has argued some of the nation’s landmark cases before the Supreme Court, from marriage equality to the Affordable Care Act. The Grayscale lawsuit is far less glamorous, although some in the crypto industry would argue it is of comparable importance.
The details of the case would far exceed this column’s wordcount, but here’s the short version: Grayscale manages the Grayscale Bitcoin Trust, a behemoth holding nearly $15 billion in assets that, when it launched back in 2013, represented one of the first financial vehicles for investors to get exposure to Bitcoin without buying it directly.
Because of quirks of security law, investors cannot redeem their shares in the trust back to Bitcoin, which has led to fluctuations in its share price relative to the amount of Bitcoin it holds. As has been extensively discussed, the arbitrage opportunities made the fortunes of firms such as the crypto hedge fund Three Arrows Capital—and led to their downfall.
Grayscale would prefer to convert its trust into a more sensical vehicle—an exchange-traded fund, or ETF, that tracks the current price of Bitcoin, or the spot market. The SEC has been resistant to the idea. Although crypto’s favorite agency has approved ETFs based on the Bitcoin futures market—which the SEC argues is regulated by the Commodity Futures Trading Commission—it has denied all applications for spot market ETFs, because, you know, the crypto exchanges selling Bitcoin are unregulated and need to come in and register.
To put it as simply as possible, the SEC is arguing that the spot Bitcoin market is still unregulated and subject to fraud and manipulation. Grayscale is arguing that the SEC is being “arbitrary and capricious” in approving futures Bitcoin ETFs and not spot-based ETFs because they are both priced from the same underlying markets.
Before we get too in the weeds with financial jargon, here’s the upshot: Grayscale believes that if the SEC approved a spot Bitcoin ETF, it would unlock billions for investors, possibly save the fate of its parent company, Digital Currency Group, and reverse the fortunes of the industry by allowing investors to turn to regulated financial instruments rather than, say, an offshores exchange based in the Bahamas.
To hear Verrilli describe it, the case is open and shut. Although he admits he had no background in crypto before his involvement with Grayscale, Verrilli insists that the case is more about SEC overreach than any blockchain-related particularities.
“Courts recognize that the agencies have expertise, but they don’t have a blank check,” he said.
Whether the panel of three D.C. Circuit judges agrees on March 7 remains to be seen, and there is a good chance the lawsuit could become the first crypto case to make it to the Supreme Court. If it does, Verrilli will feel right at home.
Leo Schwartz
leo.schwartz@fortune.com
@leomschwartz
