Big win for Big Crypto

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Ethan Wu (0:36)

Thank Pushkin.

It's the crypto investment product OG versus the SEC. Grayscale is one of the older players in the crypto investment space, and they've just won a big symbolic victory in court against the top US financial regulator. And it's not just Grayscale. Beneath the surface, a lot of things have been shifting in the crypto investment landscape. And it all raises the question, do you have a God-given right to lose money?

This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu, joined today in the New York studio by regulatory geek, Brooke Masters.

Brooke Masters (1:16)

Hola.

Ethan Wu (1:16)

And regulatory hater, Robert Armstrong.

Robert Armstrong (1:19)

Yo.

Ethan Wu (1:20)

All right, so let's take it back a bit. So there's Grayscale, it's this crypto asset manager, one of the earlier players in the crypto space founded in 2013 It's based in Connecticut. I think now it's got like tens of billions of dollars under management. And it's annoying to invest in Bitcoin. That's like the basic problem, right? You buy Bitcoin, you try to put it in your wallet, but if you screw up or forget the password, then you have Bitcoin sitting on a hard drive that you cannot access, potentially worth billions of dollars, and there is no customer service. You know, there's no way to get that if you don't know the password.

So, you know, Grayscale comes along and they offer a much more user-friendly product. You give them money, they go out and buy Bitcoin, they worry about all the custody issues, and you just get a share in their Bitcoin trust.

But there's always like a weird part of this Grayscale Bitcoin trust product, which is that you can put the money in, but it's pretty hard to take it out, right? It's a closed fund. This has been, I think, a bit of a friction point for investors in Grayscale. And so Grayscale wants to offer an ETF that invests directly in Bitcoin, the same way that you could buy an ETF that invests directly in gold. But this has not been smiled upon by the Securities and Exchange Commission.

But to understand why you need to go kind of a level deeper and understand the difference between actual Bitcoin and Bitcoin futures.

Robert Armstrong (2:40)

So the weird thing, I would say the absurd thing about how retail investments in Bitcoin have been regulated up until this point, is that the SEC has allowed these products to exist in the case of Bitcoin futures, just not spot Bitcoin, Bitcoin itself.

Now this is weird for a couple of reasons. Reason number one is that futures products have an intrinsic financial drag. For slightly technical reasons, the process of constantly buying new futures on an underlying asset to replace those that are expiring, that costs money. There's what they call a role cost to that. So there's just this drag in these futures-based Bitcoin products that is just a loss for the investor. So that's bad in itself. The other thing is the SEC says it doesn't want people investing in spot Bitcoin because that market is vulnerable to manipulation. It's not regulated. There may be baddies, God knows where, controlling the price.

It is, however, comfortable with you buying a futures-based product built on that potentially manipulated spot market. This is very strange. Why would that extra layer of complexity and expense solve the problem of the spot market? Well, the answer, the SEC, as I understand it, Brooke may read it a different way, is that, well, there is a futures regulator.

So there's the CFTC, which regulates American futures trading. So at least there's a grownup in the room.

Ethan Wu (4:30)

Yeah, this gets us right to the heart of the Grayscale versus SEC case. And Brooke, maybe you can kind of lay out what happened there.

Brooke Masters (4:35)

So what happened was Grayscale applied to convert the trust into an exchange traded product. And the SEC said, no.

They then took them to the DC Circuit, which for complicated reason is where you go when you're pissed off at the SEC. And those judges said, you have been approving ETFs based on Bitcoin futures. And you can't then say, oh, you can't do one based on actual Bitcoins. That's arbitrary and capricious, which is total bad news if you are a regulator. You can't be arbitrary and capricious.