Big win for Big Crypto

0:05Pushkin. 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.

0:45Hola. And regulatory hater, Robert Armstrong. Yo. 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 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.

1:18There's no way to get that if you don't know the password. So 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 was 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.

1:56But 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. 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. Yeah. For slightly technical reasons, the process of constantly buying new futures on an underlying asset to replace those that are expiring.

2:52Yeah. That costs money. There's what they call a roll cost to that. So there's just this drag in these futures-based Bitcoin products that is just a loss for the investor. Yeah. So that's bad in itself. Yeah. 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?

3:44Well, 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 grown up in the room. Yeah. This gets us right to the heart of the Grayscale versus SEC case. Brooke, maybe you can kind of lay out what happened there. 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 D.C. Circuit, which for complicated reason is where you go when you're pissed off at the SEC.

4:18And those judges said, uh-uh, you have been approving ETFs based on Bitcoin futures. Yes. 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. And in this sense, the judge was absolutely right. It is an arbitrary and capricious distinction to say, we'll let the futures-based products through because there's a grownup in the room and we won't allow the spot-based products because there is no grownups. Anything that's wrong with the spot market has to be wrong with the futures market.

4:56Yeah. If you had a Bernie Madoff future, it would be no less fraudulent than the Bernie Madoff spot market. Correct. But I think this stupidity has been maybe widely recognized by people watching this case, and it puts the SEC in a bit of an uncomfortable position. They're nervous about crypto. A A lot of people have lost money in this market. And while they may have lost the battle on futures, I think it's seemed that they've long wanted to just close off any avenue for legitimization, for getting normal retail investors an avenue into this market that they don't feel super comfortable with. But that seems to be shifting.

5:33Some of the bigger players have been getting into trying to issue these spot Bitcoin products. And there's now just a mounting amount of pressure on the agency to change their mind about how they approach this regulatory issue? I mean, they have a dozen applications pending. Yeah. From places like BlackRock, which is the world's biggest money manager, and Invesco and Cathie Wood's ARC and a whole range of players, big and small, trying to put together spot Bitcoin ETF applications. I think looking at that, they are responding to a demand in the market. People want to invest in Bitcoin. They would rather do it in a way that doesn't involve having a secret key that you can then like by mistake throw out or put into a landfill, as some of those famous stories are.

6:16And they'd also like to invest in Bitcoin in a place where the people who are holding the actual Bitcoin that you are trying to buy are not thieves. Or if they are thieves, you at least can sue them and get your money back because they're Americans and you have access to a court system. And so I think that there has been a recognition at the SEC that they're probably fighting a losing battle. And while they have certainly said nothing publicly about this, and I should be very clear that they have not said anything about, oh, yes, yes, we're going to approve something. These big ETF providers are not going to have been wasting their time and money in putting applications and then amending those applications to address concerns raised by the SEC, unless they're getting some sort of guidance behind the scene that the SEC is warming up to the idea that a properly run Bitcoin ETF, a spot one, is going to be okay.

7:03Yeah. And just to underline your point there, Brooke, you can imagine like three levels of investing in this market, right? One is you hold Bitcoin yourself in a wallet you run. Then one level up from that, you've got this futures market, which does exist and you can currently invest in through an ETF where nothing's going to get lost. But there's all of these frictional costs, the problem of having to constantly renew the contracts that underlie the product. And then spot Bitcoin is maybe, again, your platonic ideal of how you would want to invest in the Bitcoin market. You don't have to worry about losing stuff.

7:34It's lower fees in the futures market. It just very straightforwardly tracks what Bitcoin's doing. Now, of course, all of that's premised on Bitcoin itself, the stupidity or wisdom of that investment, right? None of these have any bearing on whether Bitcoin is smart or stupid. But you can own spot Bitcoin now. Yeah. But then you could lose it, right? But you pay a fee without custodying it yourself, but you pay a fee to whoever custody holds it for you. So that's a frictional cost, but it's at least smaller than the futurist product. And up till now, most of the folks doing the custodying do not have the greatest track record.

8:07There are things like Binance, which pretends not to have a headquarters so nobody can regulate it. And so I think, again, the nirvana is a custody arrangement and some sort of market surveillance to at least minimize the amount of crap that's going on with the market and also the chances that somebody's actually going to run off with your Bitcoin or get hacked. Because if BlackRock gets hacked and they lose your Bitcoin, they're on the hook. If Mt. Gawk gets hacked, good luck. Yeah. I want to push a little bit on something about the kind of case on behalf of the SEC that you're making, Brooke, which is we have kind of highfalutin debates about what's the security.

8:45We certainly have in the newsletter. Yeah, yeah. What should the American finance regulators be regulating? But underneath what you're saying, Brooke, It seems to be the real picture when push comes to shove is the finance regulators will regulate whatever the general public has concluded as an investable asset. Right. Maybe it's nonsense. Maybe it's crazy. But if enough people want to get involved in Bitcoin, the SEC has no choice. I think it's complicated. I mean, I think the SEC for years has been fighting this and saying, like, we actually don't think we should have to regulate this. Bitcoin is not a security.

9:24And I think everybody actually, there's not a lot of debate about that. Bitcoin itself is not a security. Bitcoin ETF is a security. So the SEC does have some duties there. But what you're saying, Brooke, to me sounds like the harm reduction strategies of drug laws, something like that, right? Like, this is a terrible product. You shouldn't invest in it. It has no intrinsic value. Its price is driven by the greater fool theory. Yeah. But the SEC should put guardrails in so that the misery of owning Bitcoin as an investment is reduced a little. And I think the point you're getting at, Rob, is that ETF is not an honorific, right?

10:08Right. The wrapper has not much to do with the validity of the of the investment. And, you know, I think this is where, again, the SEC isn't an uncomfortable position. They've taken this stance that will allow futures ETF that is effectively just a worse version of the spot ETF to exist, thereby bleeding out investor money through fees rather than through the volatility of Bitcoin. But that's outside of their remit to kind of make that call. And I think that's that's why they're coming under so much pressure. It's interesting. A couple of the consumer groups are saying, well, like the answer to this is ban the futures ETFs too.

10:40Just say none of it. Could be. I think it's kind of too late on that. But that's like a more consistent position, right? Absolutely. I mean, that's what the consumer groups have been pushing for forever. It is interesting how many crypto people compare the SEC's attempt to hold back the tide on this one with prohibition. Like we tried prohibition. It didn't work very well. It led to a lot of people shooting each other in Chicago. and ditto with, you know, I think we're coming around to the idea that it doesn't work with marijuana either. And so I think there is a harm reduction. I think you're not wrong, Rob.

11:09I just on principle would prefer, as I've written in the column, to just have investors learn their lesson from the market. You know, a lot of investors clearly got smoked in the first Bitcoin winter. That probably did the world of finance more good than all this regulation is going to do and another couple of winters and maybe the whole thing will go away. But, you know, I can see and I sympathize with the regulation as harm reduction approach, but I don't think it is the best in the long run. I think the SEC's hand has been forced. They've lost this one. That's the problem is they no longer have the option of ignoring the thing.

11:53Having allowed Bitcoin futures, which you can say maybe that was probably a stupid idea to begin with. Having allowed it, I think they are now trapped. In an ideal world, I kind of agree with you. I, for years, thought the SEC should not have anything to do with Bitcoin. But I think it's too late. It's a bit like, can you imagine the horse and carriage people? Those cars things, those kill a lot more people than horses. They are bad, but the car's there. Once the car's there, you got to have stoplights. Yes. Come smoke this government-approved weed. No, I mean, that's really where we are. And we'll see how that goes.

12:24I mean, what we know right now is that it makes New York City smell like marijuana. We'll see what I mean, all I would say about the prohibition metaphor is that an often forgotten historical fact is that during prohibition, people drank a lot less alcohol. You know, we've made a choice to make this stuff legal. And yes, there is less shootings with Tommy guns in Chicago, but a lot more people die of cirrhosis of a liver. Listeners, what are you drinking or smoking? Is it government approved? Let me know. Ethan.WuWuFT.com. All right. We'll be back in a moment with Long Short.

13:11Welcome back. This is Long Short, that part of the show where we go long a thing we love, short a thing we hate. As usual on an episode with two guests, I'm stepping out of the way. Brooke, do you have a long or a short? I have a short, but it's actually a thing I love and I'm very sad about it. I am short the administrative state, which actually I'm quite fond of because it does lots of good things. The grayscale decision we've been talking about, plus the recent decision by industry to sue to stop the new rules for private funds that the SEC put out recently, are going to be picked up by the courts.

13:43And they are going to use this to dismantle a lot of the regulatory state that's been built really since the New Deal. This is going to create all kinds of opportunities for industry to try and push back against rules. It is going to hamper efforts to impose new rules on all kinds of industries from cars to coal to the securities industry and farming even. And I think what we are seeing is a real sea change in the way American government works. If listeners are interested in this private funds decision, might I recommend today's unhedge newsletter. Rob, are you long something? Slightly more cheerfully, but also related to the US government.

14:26The two-year treasury is yielding 5 % again, or actually this morning it fell two basis points to 4.98 % I see on my smartphone here. But man, I think lending the US government money for 5 % over two years, if inflation doesn't explode upward again, you're going to be glad you did that. That seems like a pretty good return. So I'm long the two-year. Yeah. Simple man. See, 5%, I buy. All right, Brooke and Rob, thanks both for being here. We'll have you both back soon. And listeners, we'll be back in your feed on Tuesday with another episode of the Unhedged podcast. Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstat.

15:10Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 90-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.

15:48We'll be right back.