A representation of virtual currency Bitcoin is seen in front of a stock graph in this illustration taken
A representation of virtual currency Bitcoin is seen in front of a stock graph in this illustration taken January 8, 2021. Reuters

Federal appellate court judges are set to hear arguments on Tuesday in Grayscale Investments' case against the U.S. Securities and Exchange Commission over the agency's rejection of the crypto asset manager's application to create a spot bitcoin exchange-traded fund.

The case comes as the crypto industry has increasingly been at odds with the SEC over its crackdown on digital asset products, including those that offer investors returns on certain digital tokens.

The case's outcome could either offer vindication for the SEC's posture, or pave the way for other companies to offer spot bitcoin exchange-traded funds (ETFs) if the judges rule for Grayscale Investments LLC.

Other would-be issuers of spot bitcoin ETFs rejected by the SEC include FMR LLC's Fidelity, SkyBridge Capital and Valkyrie Investments Inc.

Valkyrie's chief investment officer, Steven McClurg, said in a statement that his company does not believe a spot bitcoin ETF will be approved within the next year. A representative for Skybridge declined to comment, and Fidelity did not immediately respond to a request for comment.

Grayscale's legal team plans to argue before the District of Columbia Court of Appeals in Washington that the SEC acted arbitrarily in rejecting applications for spot bitcoin ETFs when it had previously approved bitcoin futures ETFs, according to the company's lead counsel.

Bitcoin futures ETFs track bitcoin futures contracts, or agreements to purchase or sell bitcoin at a certain price on a specified date. A spot bitcoin ETF would track bitcoin's underlying market price. Proponents say a spot bitcoin ETF would enable investors to gain exposure to bitcoin without directly buying it.

The SEC rejected Grayscale's application to convert its flagship spot Grayscale Bitcoin Trust (GBTC) into an ETF last June, arguing the proposal did not meet standards aimed at preventing fraudulent practices and protecting investors. Grayscale sued the regulator almost immediately after its proposal was denied.

"The most basic way in which an agency can act in an arbitrary and capricious manner is to take like cases ... and treat them different, and essentially, that's what we have here," Donald Verrilli Jr., an Obama-era U.S. solicitor general who is lead counsel for Grayscale, told reporters in a briefing last week.

An SEC spokesperson declined to comment beyond its public filings in the case.

The agency has denied more than a dozen spot bitcoin ETF applications, all of which it said lacked surveillance-sharing agreements to detect potential manipulation.

Grayscale has argued in court filings that the SEC previously deemed agreements with the Chicago Mercantile Exchange -- where bitcoin futures trade -- as sufficient to prevent fraud in bitcoin futures-based ETFs, and that since both spot and futures funds rely on bitcoin's price, the setup should also be satisfactory for Grayscale's spot fund.

The company's chief executive officer, Michael Sonnenshein, has said he expects a final ruling in the case this fall, and that he anticipates the court will rule in Grayscale's favor. He told Reuters in January that Grayscale would appeal the case if the court backed the SEC's decision to reject its bitcoin ETF proposal.

Grayscale Bitcoin Trust, launched in 2013, has $14 billion in assets under management, according to Grayscale's website. The GBTC discount to bitcoin is hovering around 45%, having come under pressure after crypto exchange FTX collapsed in November.

If its legal challenge to the SEC was ultimately unsuccessful, Grayscale would explore options to return a portion of GBTC's capital to shareholders, Sonnenshein told investors in a letter in December.