The US securities regulator was wrong to reject an application from Grayscale Investments to create a spot bitcoin exchange-traded fund, a federal appeals court ruled on Tuesday, in a landmark victory that could pave the way for the first product of its kind.

A three-judge panel of the District of Columbia Court of Appeals in Washington said the Securities and Exchange Commission (SEC) failed to fully explain its reasoning when denying Grayscale's product and should review its decision.

The price of bitcoin, the world's largest cryptocurrency, was last up more than 6 percent at $27,858  following the news.

A spot bitcoin ETF would track its underlying market price, giving investors exposure to the digital asset without having to buy the currency. The SEC has denied all proposed bitcoin ETFs, including Grayscale's, saying they do not meet its bar for preventing market manipulation.

While the ruling does not mean Grayscale's ETF is automatically approved, it is a big boost for the decade-long industry effort to advance a bitcoin ETF product.

The court decision is a "historic milestone for American investors," Grayscale CEO Michael Sonnenshein said in a statement.

A Grayscale spokeswoman added that the company was reviewing the details and would pursue "next steps with the SEC."

The SEC has 45 days to appeal the ruling. An agency spokesperson said it was reviewing the court's decision in order to determine next steps.

The cryptocurrency industry was quick to hail the ruling. Several other asset managers, including BlackRock, Fidelity and Invesco, have similar filings pending with the SEC for a spot bitcoin ETF.

"This ruling is not just about Grayscale or Bitcoin, it sets a precedent for the broader crypto industry," said Ji Kim, general counsel and head of global policy at the Crypto Council for Innovation.

The SEC rejected Grayscale's application for a spot bitcoin ETF in June 2022, arguing the proposal did not meet anti-fraud and investor protection standards. It cited the same reason in its denial of dozens of other applications for similar products, including those from Fidelity and VanEck.

Grayscale sued the SEC, arguing that because the agency previously approved certain surveillance agreements to prevent fraud in bitcoin futures-based ETFs, the same setup should also be satisfactory for Grayscale's spot fund since both spot and futures funds rely on bitcoin's price.

The court said in its ruling that the SEC failed to explain why it disagreed with Grayscale's assertion that the bitcoin spot and futures markets are 99.9 percent correlated.

"The Commission's unexplained discounting of the obvious financial and mathematical relationship between the spot and futures markets falls short of the standard for reasoned decisionmaking," the court said in its opinion, which was filed by Judge Neomi Rao of the DC Court of Appeals.

The ruling is the second major legal victory for the crypto industry in recent weeks, after a judge ruled in July, in a case brought by the SEC, that Ripple Labs did not violate federal laws by selling its XRP token on public exchanges. The SEC has said it plans to appeal that finding.

If the SEC appeals the Grayscale ruling, the case would go either to the U.S. Supreme Court or a review by the entire DC appeals court.

If the SEC chooses not to appeal, the court would issue a mandate specifying how its decision should be executed. That could include instructing the SEC to approve the application, or to revisit Grayscale's application, in which case the SEC could still reject the proposal on other grounds.

It remains to be seen how the ruling might affect proposals submitted in June by BlackRock, the world's largest asset manager, and several other firms to offer spot bitcoin ETFs. The SEC has yet to deliver a decision on those applications. © Reuters