SEC’s Rejection of Grayscale ETF Poses Regulatory Quandary

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On Wednesday, June 29, 2022, the U.S. Securities and Exchange Commission (SEC) published an 86-page decision, “Order Disapproving a Proposed Rule Change, as Modified by Amendment No. 1, to List and Trade Shares of Grayscale Bitcoin Trust under NYSE Arca Rule 8.201-E,” which in essence is a rejection of Grayscale’s exchange-traded fund (ETF).

There are a few parts of the discussion worth delving into, but perhaps none more so than what’s found on page 21, which states that many commentators argue that “the price of Bitcoin is subject to manipulation on the unregulated platforms, and approval of the proposal would invite additional manipulation.”

The footnote cites a letter in support of the proposal received from Noah Dreyfuss, CIO of Dreyfuss Capital Management, among others, which noted that “Frankly, one would find great difficulty in claiming that the spot Bitcoin market is free of manipulation.” Another letter cited, from Jonas M. Grant, said that “the Bitcoin market is no doubt susceptible to some manipulation.”

And yet, the SEC has been hesitant to provide the very regulation necessary to limit that manipulation. Commissioner Hester Peirce spelled out the issue perfectly in remarks prepared for the Regulatory Transparency Project Conference, saying,

“Watching the SEC refuse over the past four years to engage productively with crypto users and developers has prompted feelings of disbelief at the SEC’s puzzling, out-of-character approach to regulation. The commission, of course, occasionally has explained its actions – or inaction – but those explanations often have been confusing, unhelpful and inconsistent.”

And here we find ourselves yet again – with over 80 pages of explanatory content that, at its crux, is inconsistent. The first paragraph of the SEC’s analysis states,

“As with the previous proposals, the commission here concludes that information in the record regarding the Bitcoin market does not support a finding that the exchange has established other means to prevent fraudulent and manipulative acts and practices sufficient to justify dispensing with the detection and deterrence of fraud and manipulation that is provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot Bitcoin.

Likewise, the record does not support a finding that the exchange has demonstrated that the Bitcoin market as a whole or the relevant underlying Bitcoin market is uniquely and inherently resistant to fraud and manipulation.”

The inconsistency, of course, is that the SEC has had the opportunity over the past several years, as Commissioner Peirce has noted, to work together with the industry and other stakeholders to develop the kind of regulatory structure that would provide exchanges and other industry institutions a measuring stick by which to compare themselves.

It is one thing to say that the market has fraud and manipulation simply. Still, it is an entirely different thing to develop a strategy to bring the industry together and develop a guidebook, which would both keep investors safe while allowing the industry to expand and innovate.

Had the SEC been engaged with the digital assets space in a way that built relationships and bred trust, perhaps we would be in a different place right now. Perhaps regulations regarding cybersecurity would’ve prevented at least some of the more preventable hack headlines we’ve seen. Perhaps regulations on exchange operators would’ve quelled some fears of manipulation.

Perhaps the major players would’ve been put in a position where they would’ve seen more urgency in implementing security procedures. Perhaps many things, indeed. But until regulators stand up and decide to thoroughly and fairly do their jobs in a commonsense way, letters like these will still smack of inconsistency.


Richard Gardner is the CEO of Modulus. He has been a globally recognized subject matter expert for more than two decades, offering complex insight and analysis on cryptocurrency, cybersecurity, financial technology, surveillance technology, blockchain technologies and general management best practices.

 

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