On today's episode, I sat down with Michael Sonnenshein and Craig Salm from Grayscale Investments. It's always great to catch up with Michael about the state of the industry, and I was excited to have Craig on this show to discuss some of the legal complexities around Grayscale's application to turn the Bitcoin Investment Trust into an ETF. So, we spent a bunch of time on that topic and we also talked about the broader suite of products that Grayscale has launched over the past year. Talked about the Biden EO and much more. So, I think you'll enjoy this one. Without further ado, here's my conversation with Michael and Craig from Grayscale.
Matt Walsh and Nick Carter are partners at Castle Island Ventures. All views expressed by them or the guests on this podcast are solely their opinions and do not reflect the opinions of Castle Island Ventures. You should not treat any opinion expressed by anyone on this podcast as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of their personal opinion. This podcast is for informational purposes only.
Brought down by bad mortgage investments. Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group AIG $85 billion.
This is a different kind of mortgage and the Fed is asleep.
The federal government is stepping in to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis.
The Bank of England has pumped 75 billion pounds more into Britain's ailing economy with a new round of quantitative easing.
You print a couple trillion dollars and all of a sudden people start to worry. So out of this worry, we have something called the Bitcoin.
All right, welcome back to On the Brink and very happy to have Michael Sonnenshein and Craig Salm from Grayscale. Michael, you've been on the podcast, I think, two or three times already, so we'll save the introduction for you. Craig, welcome to the pod. Would love to just hop right in and why don't we get a quick background on you before we hop into the meat of it.
Yeah, sure. Thanks so much for having me, Matt. So, I joined Grayscale as the first lawyer back in January 2018. There's actually a history even before I joined Grayscale of me annoying Michael for about a year and a half to get a job. We could probably go into that in a separate podcast, but um...
No, no, Matt's going to have to have us back on when I can tell the whole world I rejected you for a job first time around.
Yeah. So, we'll save that for another pod. But yeah, so I'm chief legal officer at Grayscale, responsible for all of the investment management, capital markets, helping with product creation, compliance, all the regulatory efforts that we do here at the firm.
That's great. Well, I'm excited to have you on and obviously legal is going to be a big part of what we want to talk about today. Why don't we hop right into it, guys? One of the things I wanted to have you on to talk about is just this conversion process of GBTC into an ETF. You guys have a massive campaign underway right now with comment letters. So maybe just set the stage for us in terms of where that product is today and what you guys are trying to accomplish.
Yeah. So Matt, this is the firm's number one priority and has been for years. Those of you who are less familiar with either Grayscale or this product, what Matt is referring to is the Grayscale Bitcoin Trust and it trades here in the US under symbol GBTC. It is the world's largest Bitcoin fund. It owns about almost 3.5% of the outstanding Bitcoin supply and has been around since 2013. What's interesting about GBTC is that when we initially structured it, we actually intended for it to ultimately become an ETF. In fact, we chose the same legal structure for GBTC as you see for a lot of other commodity-based ETFs like GLD and others. And over the years, GBTC has become what many would argue the investment option of choice for investors looking for access to Bitcoin right within their portfolios, whether it's next to stocks or ETFs or bonds or whether investors are looking to deploy Bitcoin exposure in tax-advantaged accounts like IRA and others. What's amazing about GBTC is that it's had a long and very positive relationship not just with the investment community, but with the regulatory community. And so the fund itself passively and solely holds Bitcoin. And it actually began trading here in the US in 2015 as symbol GBTC. What then kind of transpired with the fund as it continued to grow is that we actually approached the SEC to ensure that we could continue to advance the ball on ultimately having GBTC become an ETF. And so in 2020, we were able to have the fund become an SEC reporting company, the first digital currency investment vehicle to become SEC reporting. And those that don't know what that is, it essentially causes the company to now have to adhere to a higher standard of disclosure and financial reporting such that GBTC now files 10-Ks, 10-Qs, and 8-Ks. And so we've really continued to work proactively with the SEC even though they have continued to deny a lot of Bitcoin ETF applications believing that over time we will continue to address any concerns they may have about the underlying Bitcoin market. I think where we find ourselves today Matt is in an unfortunate unlevel playing field. So last year, the SEC began to change their mind a little bit about Bitcoin ETFs and approved the first batch of Bitcoin futures-based ETFs and have since that time continued to deny or reject spot Bitcoin ETF applications. And so for those people that aren't as keyed in on this topic, what that really means is that the SEC is okay with an ETF that holds Bitcoin futures, which is a derivative of Bitcoin, but they're not okay with an ETF that holds Bitcoin directly. And our view of that is that it really does create this unfair playing field. It forces investors who are waiting for the familiarity and the protections of an ETF to use the Bitcoin futures ETF simply because that's the only one that exists when really investors should have that choice. We feel that it is incumbent upon us to continue to advocate for investors and encourage investors to advocate for themselves as part of this process. So maybe Craig, you want to talk about the 19b-4 process, the 240-day timeline and kind of how that's shaping up.
Yeah, sure. So I mean, should we get the long story back in 2016-2017? Sure. So this is a process that we've been involved in since all the way back in 2016 when you saw the first wave of ETF applicants go to the SEC seeking to have this type of product approved. And back then you had both physical or spot-based Bitcoin ETFs like what GBTC would be as well as futures-based Bitcoin ETFs. And at the time, Grayscale, several other issuers were in front of the SEC, but ultimately the SEC was not comfortable with approving either spot Bitcoin or futures-based Bitcoin ETFs because of what they cited to be the potential for fraud and manipulation in the underlying Bitcoin markets. And if that's the concern, then it really makes a lot of sense that you would deny both the spot-based and the futures-based ETFs because both types of ETFs would be priced based on the same underlying Bitcoin market. So that risk permeates both products. And so there was one official disapproval order, the now famous Winklevoss disapproval order. It's about 120 pages citing all the SEC's concerns. And Grayscale saw that and realized the commission is not ready. So we voluntarily withdrew our application knowing that we could just then go back to operating GBTC as is continuing to build more AUM, gain more investors, more trading volume in OTCQX. As Michael mentioned, we also had the opportunity to get in front of the SEC again, not in the context of seeking to convert GBTC to an ETF, but seeking to make it an SEC reporting company. And what that did, as Michael mentioned, was make it more transparent, more robust, subject to SEC reporting standards, meaning 10-Ks, 10-Qs, audited financial statements, things like that. And I think that was really important for a lot of our more institutional and regulated investors because their risk compliance, legal, and other advisers really need that kind of regulatory framework to get comfortable with any investment. So we accomplished that major threshold. That was January 2020, making GBTC the first digital currency investment vehicle to be SEC reporting. So, a really major milestone. But then fast forwarding to last January, we had a new chair come in that expressed more receptivity to the Bitcoin markets, but specifically in the context of the CME Bitcoin futures. And so, we had positive statements over that summer. Fast forward to October and we actually saw the first Bitcoin futures ETF start trading. That was a very monumental event for all of crypto and what it signaled to us is well if the SEC is now comfortable with the futures-based product it should also be comfortable with spot-based products like what GBTC would be again because if you go back to what those underlying concerns have always been around the underlying markets if you signal you're okay with the futures product you must also be okay with the spot-based product. So last October, we refiled the application to convert GBTC into an ETF. And that's what kicked off this 240-day review period where the SEC invites the public to submit their own letters expressing their views on how they feel about this application and why they think or don't think that the SEC should approve of it.
Yeah. But that 240-day process, I don't think many people know. I mean, Matt, if you think about what it takes for the SEC to get comfortable with a new rule change like is the case here for a new ETF, I think some people may think that writing into the SEC may be the equivalent of calling the cops on your neighbor or something like that. That's not the case here, right? The SEC set up this process so they actually could hear from the investing public views in favor of or in perhaps views not in favor of a new rule change. So I think that's a really important thing that people understand about it.
Yeah. I mean it's a great demonstration of the democratic process at work and showing that our regulators want to take in as much information as they can so that they're being thoughtful about this and considering all the risks and where are the benefits and so on. And again going back to the SEC reporting context that Grayscale voluntarily became a part of. I mean the level of questions and engagement we got from the commission at that level was really impressive. You know they asking questions around how is bitcoin being used, how is it being traded, how do we think about custody and pricing and all the investor protection things that they are and should be really focused on. And so in the context that we're facing the now the 19b-4 process, they really want to make sure they're taking in all the information available. So there's letters right now on the SEC website, you can see from investors, from market participants, academics, others that have a really strong view on this issue and knowing that this is a really important process and knowing that a lot of the average investor might not necessarily know that they can become a part of it, we launched a campaign a couple of months ago to really enable and activate our investor base and the rest of the US public to let them know that this is something you can be a part of, you can express your views and here's how you can go do it. So, we created a public website grayscale.com/comments that explains the issue and allows anybody who visits to submit a letter to the SEC if they're interested. And last we checked this morning, I think a little over 2,600 letters have been submitted to the SEC on this issue. So, I don't know if that's a record, but it's definitely extremely impressive and really encouraging to see it.
Yeah, I think it's great what you guys have done in terms of set this up and be a lot more vocal about it. I mean, from where I sit, it's a little bit hard to kind of rationalize the SEC's posture here. So, you have this futures ETF that is approved, several of them that are approved. The SEC has this mandate around investor protections. This is a clearly inferior instrument than a spot product. There's tracking error there. There's a lot of roll costs. This clearly will not track the price of Bitcoin in the way that a spot product would. And if I look back to where you guys were in 2015 and you look at the Winklevoss denial, you look at the Bitwise denial, it's clear that the SEC is zoned in on two things. One, qualified custody and two, the spot market and how that works. And qualified custody is a solved problem. And as you point out, the futures ETF is approved. And so the functioning of the spot market, they seem to be comfortable enough for the futures contract. And I think the Fidelity letter had some good data that the futures actually drives the spot and not vice versa. So I guess my question is is it possible that this is just not a facts and circumstances issue at this point and the SEC is doing a power grab for oversight on the crypto spot markets and just will not approve an ETF until they get jurisdiction over a much bigger part of this market. Or maybe I'll pause there. Is this a political issue at this point as opposed to a facts and circumstances issue?
I think it's becoming quite a bit of a political issue. I think that's right, Matt. I think what's been interesting about the development of the asset class for the eight years that I've been involved in it is there hasn't really been one regulator that has raised their hand and said, 'As this asset class grows, we're gonna fold this into the domain that we oversee.' And instead because of the ever evolving nature of crypto it's getting bits and pieces from various governmental authorities and regulators. What is encouraging despite the confusion that may exist there is that there is now bipartisan support for digital currency and certainly for digital currency ETFs. We've seen submissions from various reps and senators. You want to maybe touch on some of those Craig that we've seen come out recently?
Yeah. So I mean we are seeing support as I mentioned from investors, from market participants, academics, but also policy makers and importantly bipartisan support because they're seeing that if America is going to stay competitive with the rest of the world and if we want the Silicon Valley of crypto and web 3 to not be in Singapore or some part of Europe or Canada, then one of the ways that we can do that is by further bringing crypto and Bitcoin and web 3 into the regulatory perimeter. And one way you can do that is by approving regulated, registered investment vehicles like a spot bitcoin ETF. And I think a couple of regulatory developments that have been really important have happened over the last couple of weeks. One is this executive order from the White House where that was the first time we saw a cohesive strategy from the top level of the US government saying that we want to think about how to regulate this space so that we can one promote innovation allow it to flourish while also protecting investors and consumers and to see that really perfect balance being struck and expressed by the president I think was really encouraging and something that's having an influence on a lot of policy makers as they're thinking about their own views on crypto and web 3. And then even within both parties, I think the Republican party for a long time has been a very clear proponent of crypto, whereas the Democratic side has been a little bit harder to convince around where are the benefits, how is it really democratizing finance and enabling the underserved or underbanked to be a part of it. But now you're seeing even within the Democratic party a lot of positive statements coming out from different more the policy makers, the younger generation of Congress people. I think though Matt like it's important though that for this conversation it's not necessarily going to be an issue that's solved in the context of how crypto is treated in general in DC.
Right? Our team has been and currently is still spending a ton of time in DC educating policy makers and staffers on these types of issues. But specific to the GBTC conversion to an ETF, this is an investor issue, right? You know, the last count, I think it is, Craig, there's over 800,000 accounts in the US that own GBTC, right? It's individuals, it's retirement accounts, it's held inside mutual funds, it's held inside ETFs. I mean, it's really all across the board. Retail, institutional, you name it. And so this is really a measure of whether or not the SEC can fulfill its mandate and protect investors or it's going to continue to kick the can down the road until they are maybe looking for some sign or some attribute that develops within the crypto market that somehow gives them more comfort to approve these kinds of products.
Yeah. So there's political issues at play. Another really important development that happened last November is following the futures-based ETFs being traded, we saw subsequent disapprovals of spot-based Bitcoin ETFs. And what that did was create this new legal argument that our attorneys at Davis Polk have submitted in the context of this 19b-4 comment letter period expressing the view that by approving futures-based Bitcoin ETFs but denying spot-based Bitcoin ETFs, you now potentially have a violation of something called the Administrative Procedure Act, which at a high level says that you have to treat like situations alike. You can't discriminate against issuers. And if you are doing that, then you're acting arbitrarily and capriciously, which is a violation of the APA. So, one of the many letters that have been submitted to the SEC on their website is Davis Polk laying out these arguments. We think they're quite persuasive, and we look forward to engaging with the commission on them. But what they really get to is that the reasons cited to date for why the futures ETFs are trading, but not the spot ETFs, is because of two things. One is the futures-based ETFs trade and are registered under the Investment Company Act of 1940 whereas the spot-based ETFs are registered under the Securities Act of 1933 and the Securities Exchange Act of 1934. And there have been some arguments that the '40 Act has more investor protections and that's why you could get more comfortable with the futures-based ETF but we would argue that that's a distinction without a difference because those investor protections are not focused on the underlying markets or the assets being traded. So it's not like the '40 Act is regulating Bitcoin markets or Bitcoin itself. Instead, it's protecting at the fund level to make sure things like accounting and custody and conflicts of interest don't exist and so on. So those investor protections that are important in the context of Bitcoin ETF approval are not really applicable. And then the other arguments that have been cited are the CME Bitcoin futures are regulated by the CFTC. So those are the assets that are inside the Bitcoin futures. Whereas Bitcoin is not regulated today by the CFTC or the SEC, at least not at a surveillance level and the type that you would see on a national securities exchange. But similarly, those differences don't really apply in the context of ETF approval because again the pricing which is the underlying issue the SEC has cited to date is something that would affect both the spot-based ETF and the futures-based ETF. So those two distinctions, we really think they are distinctions without a difference.
And that APA angle I thought was very interesting and I know it's in the comment letter right now, but is there a process to get some sort of a hearing on that issue or what would be the actual legal process in order to get someone to opine on whether or not that argument is valid.
Yeah. So right now it's just in the context of the SEC comment letter period. Another great thing about this whole process is the commission's required to read through and address all of those comments. So the Davis Polk letter will be one such comment that they will have to address over the course of our 240-day review period.
Yeah, we need the Matt Walsh Nick Carter letter. Okay.
Well, hey, you tell me where to submit. Actually, give me that URL again. We'll blast it out.
Should we flash the QR code on camera? Yeah. grayscale.com/comments and it lays out the steps pretty succinctly for you.
So, we'll definitely get on that. You guys mentioned the executive order. There was a school of thought here that the SEC was not going to do anything until this EO came down and there was all sorts of rumors about what was going to be in the EO. I'm curious what your just general views were on that executive order and what impact that will have not only on your business but on the whole landscape here.
I think, from our seat, given kind of the rumor mill that you just mentioned, this was largely a lot more positive than I think most people in the industry were expecting. You know, instead of kind of squandering any kind of innovation here. I think instead this was really a call to wake up. Don't be asleep at the wheel. Start doing the work. Start doing the research to figure out how we're going to embrace these technologies and really get back to this idea of American competitiveness as we think about technological innovation. I think obviously the proof will be in the pudding over the next whatever it was 60 or 90 days that were called on various governmental agencies. But I think to Craig's earlier point, how powerful a message that sends from the highest levels of the US government to all of the not only the regulatory community, but also to the investor community. So I think it's a little bit of a wait and see game, but nonetheless a lot more positive than I think a lot of folks could have thought this would have winded up.
Yeah. And I think the US really needed something like that because we're unique in that we have not one unified financial regulator, but many. And so if you look at other countries in contrast, Singapore has the Monetary Authority of Singapore, the UK has the Financial Conduct Authority, Canada has the Ontario Securities Commission, whereas in the US, we have all these different agencies that each have purview over some use case of crypto in different ways. So the fact that we got something from the top level down saying this is what you all need to do to weigh the risks and rewards of crypto and web 3 is really important. So now we have a focus on that. And I think we all agree that a lot of narratives around crypto are often misinformed for the worse. Whereas now, we'll actually have studies that are being done and we'll be able to see how can we allow this innovation to flourish? How can we protect investors and consumers? Do existing rules and regulations work as is or should we go to Congress and think about rewriting some of the rules so that they can allow crypto to continue to flourish within the US?
And maybe coordination, right? Maybe coordination is the key here, right? Because to your point, IRS, CFTC, SEC, Treasury, Office of the Comptroller of the Currency, FinCEN, I mean the list goes on and on and on. So to see greater coordination amongst these groups who are all having to come out with either certain policies or certain postures around crypto or certain elements of them, I think would also be really welcomed by the community as a whole.
You guys also hit on something that I think is really important that this does not turn into a partisan issue where you have the Elizabeth Warren wing of the Democratic Party that's obviously quite hostile to this, but then you have folks like Ritchie Torres in New York who's written a great op-ed piece this week in the New York Daily News, a liberal case for cryptocurrency, and you're starting to see some fractures in maybe the Democratic side of this. And so, from where I sit, this is really a bipartisan issue that should be about job creation and about keeping this industry in the United States. Do you guys see momentum here for this to continue to be kind of a bipartisan issue?
I don't see how it couldn't. And actually, it's so tragic and unfortunate everything that we're seeing unfold in Ukraine and Russia right now. And I think in a lot of our conversations in DC, even just over the last couple of weeks, many people have actually taken notice of the fact that crypto was one of the ways that humanitarian aid got to Ukraine faster than any other method possible for actually getting value into the hands of people who really needed it. And so it's unfortunate that it has to be those circumstances under which crypto shows another compelling use case to maybe some folks that would have historically been skeptics or naysayers about it. But again, kind of goes to show just the state of the world that we're living in, the need for financial innovation, the need to be able to move value seamlessly, instantaneously for free. And I do think that's a use case that definitely resonated.
