This is an audio transcript of the Unhedged podcast episode: ‘Big win for Big Crypto’
Ethan Wu
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
Ola!
Ethan Wu
. . . And regulatory hater, Robert Armstrong.
Robert Armstrong
Yo!
Ethan Wu
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 the 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. 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
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.
Ethan Wu
Yeah.
Robert Armstrong
For slightly technical reasons. The process of constantly buying new futures on an underlying asset to replace those that are expiring . . .
Ethan Wu
Yeah.
Robert Armstrong
That costs money. There’s a 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.
Ethan Wu
Yeah.
Robert Armstrong
So that’s bad in itself.
Ethan Wu
Yeah.
Robert Armstrong
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 is a grown-up in the room.
Ethan Wu
Yeah. This gets us right to the heart of the Grayscale vs SEC case. Brooke, maybe you can kind of lay out what happened there.
Brooke Masters
So what happened was Grayscale applied to convert the trust into an exchange-traded product, and the SEC said no.
Ethan Wu
Yeah.
Brooke Masters
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, uh-uh, you have been approving ETFs based on bitcoin futures.
Ethan Wu
Yes.
Brooke Masters
And you can’t then say, oh, you can’t do one based on actual bitcoins. That’s arbitrary and capricious . . .
Ethan Wu
Yeah.
Brooke Masters
Which is total bad news. If you are a regulator, you can’t be arbitrary and capricious.
Robert Armstrong
And in this sense, the judge was absolutely right. It is an arbitrary and capricious distinction, to say, well, let the futures-based products through because there is a grown-up in the room and we will . . . we won’t allow the spot-based products because there is no grown-ups. Anything that’s wrong with the spot market has to be wrong with the futures market.
Ethan Wu
Yeah.
Robert Armstrong
Like if you had a Bernie Madoff future, it would be no less fraudulent than the Bernie Madoff spot market.
Ethan Wu
Yes, correct.
Robert Armstrong
But, you know, I think this stupidity has been maybe, you know, widely recognised by people watching this case. And it puts the SEC in a bit of, you know, an uncomfortable position. They’re nervous about crypto. You know, 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 legitimisation, for, you know, getting normal retail investors an avenue into this market that they don’t feel super comfortable with. But that seems to be shifting. Some of the bigger players have been getting into trying to issue these spot bitcoin products. And there’s now just like, you know, like a mounting amount of pressure on the agency to change their mind about how they approach this regulatory issue.
Brooke Masters
I mean, they have a dozen applications pending . . .
Ethan Wu
Yeah.
Brooke Masters
. . . From places like BlackRock, which is the world’s biggest money manager, and Invesco and Cathie Wood’s ARKK, 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 we, you know, some of those famous stories are. And 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.
Ethan Wu
Yeah.
Brooke Masters
Or if they are thieves, you at least can sue them and get your money back because they’re Americans and you have to have access to a court system. And so I think that there has been a recognition at the SEC that they are 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 OK.
Ethan Wu
Yeah. 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 like 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 gonna 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. It’s lower fees in the futures market. It just very straightforwardly tracks what bitcoin is 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.
Robert Armstrong
But you can own spot bitcoin now.
Ethan Wu
Yeah, but then you could lose it.
Robert Armstrong
But you pay a fee without custodying it yourself. But you pay a fee to whoever custodies or holds it for you.
Ethan Wu
Yeah.
Robert Armstrong
So that’s a frictional cost, but it’s really smaller than the futures product.
Brooke Masters
And up til now most of the folks doing the custodying do not have the greatest track record. There are things like Binance which pretends not to have a headquarters (laughter) so nobody can regulate it.
Ethan Wu
Yeah.
Brooke Masters
And so I think again, the nirvana is a custody arrangement and some sort of market surveillance to at least minimise the amount of crap that’s going on with the market and also the chances that someone is actually gonna run off with your bitcoin or get hacked because, you know, like if BlackRock gets hacked and they lose your bitcoin, they’re on the hook.
Ethan Wu
Yeah.
Brooke Masters
If Mt Gox gets hacked, good luck.
Ethan Wu
Yeah.
Robert Armstrong
I wanna 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 a security; we certainly have in the newsletter.
Ethan Wu
Yeah, yeah.
Robert Armstrong
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.
Ethan Wu
Mm-hmm.
Robert Armstrong
Right? Maybe it’s nonsense. Maybe it’s crazy. But if enough people want to get involved in Bitcoin, the SEC has no choice.
Brooke Masters
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. And I think everybody — actually there’s not a lot of debate about that. Bitcoin itself is not a security and bitcoin ETF is a security, so the SEC does have some duties there.
Robert Armstrong
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.
Ethan Wu
Yeah.
Robert Armstrong
But the SEC should put guardrails in so that the misery of owning bitcoin as an investment is reduced . . .
Ethan Wu
Yeah.
Robert Armstrong
. . . A little.
Ethan Wu
And I think the point you’re getting at, Rob, is that ETF is not an honorific, right? The wrapper has not much to do with the validity of the investment. And you know, I think this is where again the SEC isn’t in an uncomfortable position, they’ve taken the stance that will allow a 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 why they’re coming under so much pressure.
Brooke Masters
It’s interesting, a couple of the consumer groups are saying, well, look, the answer to this is ban the futures ETFs, too. Just save none of it.
Ethan Wu
Could be.
Brooke Masters
I think it’s kind of too late on that.
Ethan Wu
But that’s like a more consistent position, right?
Brooke Masters
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.
Robert Armstrong
Hmmm.
Brooke Masters
Like we tried prohibition. It didn’t work very well. It led to a lot of people shooting each other in Chicago. (Ethan laughs) 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.
Robert Armstrong
I, 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 gonna do. And another couple of winters and maybe the whole thing will go away. But, you know, I can see and I sympathise with the regulation-as-harm-reduction approach, but I don’t think it is the best in the long run.
Brooke Masters
I think the SEC’s hand has been forced. They’ve lost this one. That’s the problem, and they no longer have the option of ignoring the thing, having 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 like the horse-and-carriage people, like, those cars things . . . (laughter) those kill a lot more people than horses. They are bad, but the car is there; once the car is there, you gotta have stoplights.
Robert Armstrong
Yes.
Ethan Wu
Come smoke this government-approved weed.
Robert Armstrong
No, I mean, that’s really where we are and we’ll see how that goes. I mean, what we know right now is that it makes New York City smell like marijuana. (Ethan laughs) 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 the liver.
Ethan Wu
Listeners, what are you drinking or smoking? (Laughter) Is it government government-approved? Let me know, ethan.wu@ft.com. All right. We’ll be back in a moment with Long/Short.
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Ethan Wu
Welcome 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 short?
Brooke Masters
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 gonna be picked up by the courts and 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 gonna 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.
Ethan Wu Hmm. If listeners are interested in this private funds decision, might I recommend today’s Unhedged newsletter? Robert, you’re long something.
Robert Armstrong
Slightly more cheerfully, but also related to the US government, the two-year Treasury is yielding 5 per cent again, or actually this morning it fell two basis points to 4.98 per cent, I see on my smartphone here. But man, I think lending the US government money for 5 per cent over two years? If inflation doesn’t explode upward again, you’re gonna be glad you did that. That seems like a pretty good return. So I’m long the two-year.
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Ethan Wu
Yeah, simple man. See 5 per cent, I buy. Yeah. (Laughter) All right. Brooke and Rob, thanks both for being here. I will have you both back soon. And listeners, we’ll be back on your feed on Tuesday with another episode of the Unhedged podcast. Catch you then.
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Ethan Wu
Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie and Jess Truglia. FT Premium can get the Unhedged newsletter for free. A 90-day free trial is available for everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.
