By Chris Prentice and Hannah Lang

NEW YORK (Reuters) -The U.S. Securities and Exchange Commission (SEC) will not appeal a recent court ruling that found it was wrong to reject an application from Grayscale Investments to create a spot bitcoin exchange-traded fund (ETF), said a source familiar with the matter.

The District of Columbia Court of Appeals in Washington in August ruled that the SEC was wrong to reject Grayscale's proposed bitcoin ETF, in a case that has been closely watched by the industry which has been trying for a decade to advance such products.

The SEC's decision not to appeal likely paves the way for the agency to review Grayscale's application.

A spokeswoman for Grayscale did not immediately provide comment.

A spot bitcoin ETF would give investors exposure to the world's largest cryptocurrency by market capitalization without having to own it. The SEC has denied all spot bitcoin ETF applications, including Grayscale's, on the grounds applicants have not shown they can protect investors from market manipulation.

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 be satisfactory for Grayscale's spot ETF, since both spot and futures funds rely on bitcoin's price.

The appeals court ruled that the SEC arbitrarily denied Grayscale's application because it never explained why the two arrangements were materially different.

The appeals court is expected to issue a mandate specifying how its decision should be executed, which will likely include instructing the SEC to revisit Grayscale's application.

Several other asset managers, including BlackRock, Fidelity and Invesco, have similar filings pending with the SEC for a spot bitcoin ETF. The SEC is due to decide on those applications by next year at the latest.

The SEC's press office did not immediately provide comment.

(Reporting by Chris Prentice and Hannah Lang; editing by Michelle Price and Rod Nickel)