Self-Regulatory Organizations; NYSE Arca, Inc.; Order Disapproving a Proposed Rule Change, as Modified by Amendment No. 1, Relating to the Listing and Trading of Shares of the SolidX Bitcoin Trust Under NYSE Arca Equities Rule 8.201, 16247-16260 [2017-06441]

Download as PDF Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices 10:00 a.m. and 3:00 p.m. Copies of such filing also will be available for inspection and copying at the principal office of FINRA. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–FINRA–2017–008 and should be submitted on or before April 24, 2017. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.15 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–06442 Filed 3–31–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–80319; File No. SR– NYSEArca–2016–101] Self-Regulatory Organizations; NYSE Arca, Inc.; Order Disapproving a Proposed Rule Change, as Modified by Amendment No. 1, Relating to the Listing and Trading of Shares of the SolidX Bitcoin Trust Under NYSE Arca Equities Rule 8.201 March 28, 2017. NYSE Arca (‘‘Exchange’’ or ‘‘NYSE Arca’’) has filed a proposed rule change to list and trade shares of the SolidX Bitcoin Trust.1 When an exchange 15 17 CFR 200.30–3(a)(12). Exchange filed the proposed rule change on July 13, 2016, and the Commission published notice of the proposed rule change in the Federal Register on August 2, 2016. See Exchange Act Release No. 78426 (July 27, 2016), 81 FR 50763 (Aug. 2, 2016) (‘‘Notice’’). On September 6, 2016, the Commission designated a longer period within which to act on the proposed rule change. See Exchange Act Release No. 78770 (Sept. 6, 2016), 81 FR 62780 (Sept. 12, 2016). On October 27, 2016, the Commission instituted proceedings under Section 19(b)(2)(B) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’), 15 U.S.C. 78s(b)(2)(B), to determine whether to approve or disapprove the proposed rule change. See Exchange Act Release No. 79171 (Oct. 27, 2016), 81 FR 76400 (Nov. 2, 2016) (‘‘Order Instituting Proceedings’’). On January 3, 2017, the Commission designated a longer period for Commission action on the proposed rule change. See Exchange Act Release No. 79726 (Jan. 3, 2017), 82 FR 2426 (Jan. 9, 2017) (designating March 30, 2017, as the date by which the Commission must either approve or disapprove the proposed rule change). On February 15, 2017, the Exchange filed Amendment No. 1 to the proposed rule change, amending and replacing the original filing in its entirety, and Amendment No. 1 was published for comment in the Federal Register on March 1, 2017, with a 15-day comment period that ended on March 16, 2017. See Exchange Act Release No. 80099 (Feb. 24, 2017), 82 FR 12253 (Mar. 1, 2017) (‘‘Amendment No. 1’’). mstockstill on DSK3G9T082PROD with NOTICES 1 The VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 makes such a filing,2 the Commission must determine whether the proposed rule change is consistent with the statutory provisions, and the rules and regulations, that apply to national securities exchanges.3 The Commission must approve the filing if it finds that the proposed rule change is consistent with these legal requirements, and it must disapprove the filing if it does not make such a finding.4 As discussed further below, the Commission is disapproving this proposed rule change because it does not find the proposal to be consistent with Section 6(b)(5) of the Exchange Act, which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.5 The Commission believes that, in order to meet this standard, an exchange that lists and trades shares of commoditytrust exchange-traded products (‘‘ETPs’’) must, in addition to other applicable requirements, satisfy two requirements that are dispositive in this matter.6 First, the exchange must have surveillancesharing agreements with significant markets for trading the underlying commodity or derivatives on that commodity. And second, those markets must be regulated.7 Based on the record before it, the Commission believes that the significant markets for bitcoin are unregulated. Therefore, as the Exchange has not entered into, and would currently be unable to enter into, the type of surveillance-sharing agreement that has been in place with respect to all previously approved commodity-trust ETPs—agreements that help address concerns about the potential for fraudulent or manipulative acts and practices in this market—the Commission does not find the proposed 2 Such filings are made under Section 19(b)(1) of the Exchange Act, 15 U.S.C. 78s(b)(1), and Exchange Act Rule 19b–4, 17 CFR 240.19b–4. 3 See Exchange Act Section 19(b)(2)(C), 15 U.S.C. 78s(b)(2)(C). 4 See id. 5 15 U.S.C. 78f(b)(5). 6 This approach is consistent with standards the Commission has applied to previous commoditytrust ETPs as well as the Commission’s recent action disapproving the proposed rule change of Bats BZX Exchange to list and trade shares issued by the Winklevoss Bitcoin Trust. See, e.g., Exchange Act Release No. 80206 (Mar. 10, 2017), 82 FR 14076, 14077 n.6 (Mar. 16, 2017) (‘‘Bats BZX Order’’). 7 As discussed below, infra notes 125–126 and accompanying text, the significant markets relating to the commodity-trust ETPs approved to date have been well-established regulated futures markets for the underlying commodity. PO 00000 Frm 00092 Fmt 4703 Sfmt 4703 16247 rule change to be consistent with the Exchange Act. I. Description of the Proposal The Exchange proposes to list and trade shares (‘‘Shares’’) of the SolidX Bitcoin Trust (‘‘Trust’’) as CommodityBased Trust Shares under NYSE Arca Equities Rule 8.201.8 The Trust would hold bitcoins as its primary asset,9 along with smaller amounts of cash, and the bitcoins would be in the custody of, and secured by, the Trust’s bitcoin custodian, SolidX Management LLC, which would also serve as the sponsor (‘‘Sponsor’’) of the Trust.10 The Bank of New York Mellon would serve as the Trust’s cash custodian and its administrator (‘‘Administrator’’).11 According to the Exchange, the Sponsor has arranged for insurance coverage to protect investors against loss or theft of the Trust’s bitcoins.12 The investment objective of the Trust would be for the Shares to track the price of bitcoins as measured by the TradeBlock XBX Index (‘‘XBX Index’’).13 The XBX Index is licensed by the Sponsor from Schvey, Inc., d/b/a TradeBlock, the index sponsor and calculation agent.14 As of January 15, 8 See NYSE Arca Equities Rule 8.201 (permitting the listing and trading of ‘‘Commodity-Based Trust Shares,’’ defined as a security (a) that is issued by a trust that holds a specified commodity deposited with the trust; (b) that is issued by the trust in a specified aggregate minimum number in return for a deposit of a quantity of the underlying commodity; and (c) that, when aggregated in the same specified minimum number, may be redeemed at a holder’s request by the trust, which will deliver to the redeeming holder the quantity of the underlying commodity). Other national securities exchanges that list and trade shares of commodity-trust ETPs have similar rules. See, e.g., BZX Rule 14.11(e)(4)(C) (permitting the listing and trading of Commodity-Based Trust Shares) and Nasdaq Rule 5711(d) (permitting the listing and trading of Commodity-Based Trust Shares). Commodity-trust ETPs differ from exchange-traded funds (ETFs) in a number of ways, including that they hold as an asset a single commodity, rather than a portfolio of multiple securities, and that they are not regulated under the Investment Company Act of 1940. 9 According to the Exchange, bitcoin is ‘‘an asset that can be transferred among parties via the Internet, but without the use of a central administrator or clearing agency.’’ Amendment No. 1, supra note 1, 82 FR at 12254 n.14. The Exchange also states that ‘‘[t]he Bitcoin Network (i.e., the network of computers running the software protocol underlying bitcoin involved in maintaining the database of bitcoin ownership and facilitating the transfer of bitcoin among parties) and the asset, bitcoin, are intrinsically linked and inseparable.’’ Id. at 12255. For the purpose of considering this proposal, this order describes bitcoin as a ‘‘digital asset’’ and a ‘‘commodity.’’ 10 See id. at 12254. 11 See id. 12 See id. at 12261. 13 See id. at 12255. 14 See id. at 12257. E:\FR\FM\03APN1.SGM 03APN1 16248 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices 2017, the eligible bitcoin exchanges for inclusion in the XBX Index are Bitfinex, Bitstamp, GDAX (f/k/a Coinbase), itBit, and OKCoin International.15 According to the Exchange: [T]he XBX represents the value of one bitcoin in U.S. dollars at any point in time and closes as of 4:00 p.m. Eastern time (‘‘E.T.’’) each weekday. The intra-day levels of the XBX incorporate the real-time price of bitcoin based on trading activity derived from constituent exchanges throughout each trading day. The closing level of the XBX is calculated using a proprietary methodology utilizing bitcoin trading data from constituent exchanges and is published at or after 4:00 p.m. E.T. each weekday. The XBX is published to two decimal places rounded on the last digit.16 The Net Asset Value (‘‘NAV’’) of the Trust would be calculated each business day by the Administrator, as promptly as practicable after 4:00 p.m. E.T., using the price set for bitcoin by the XBX Index.17 The Intraday Indicative Value (‘‘IIV’’) of the Trust would be calculated and disseminated by the Sponsor every 15 seconds during the Exchange’s regular trading session. The IIV would be calculated by using the prior day’s closing NAV per Share as a base and updating that value during the regular trading session on the Exchange to reflect intraday changes in the value of the Trust’s bitcoin holdings.18 The Trust would issue and redeem the Shares only in baskets of 100,000 Shares and only to authorized participants (‘‘Authorized Participants’’), and these transactions would be conducted ‘‘in-kind’’ for bitcoin or for cash.19 The Exchange states that for creating and redeeming baskets in-kind or for cash, Authorized Participants and market makers would be able to hedge their exposure to bitcoin using non-deliverable forward contracts (‘‘NDFs’’) and swap contracts that would create synthetic long or short exposure to bitcoin for hedging.20 15 See id. at 12258. at 12257. The Exchange represents that, according to the Sponsor, the XBX Index’s price variance weighting decreases the influence on the XBX Index of any particular exchange that diverges from the rest of the data points used by the XBX Index and thereby reduces the possibility of an attempt to manipulate the price of bitcoin as reflected by the XBX Index. See id. at 12259. 17 See id. at 12262. If for any reason, and as determined by the Sponsor, the Administrator is unable to value the Trust’s bitcoin using the XBX Index price, the Exchange’s proposal provides that the Administrator may use other specified criteria to value the holdings of the Trust. Id. at 12261. 18 See id. at 12265. 19 See id. at 12263. 20 See id. The Exchange states that the Sponsor expects that NDFs or swaps will be offered by several participants in the bitcoin marketplace, including bitcoin exchanges and bitcoin over-thecounter (‘‘OTC’’) market participants, and that the mstockstill on DSK3G9T082PROD with NOTICES 16 Id. VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 According to the Exchange, the underlying bitcoin marketplace operates 24 hours per day, 365 days per year. The Exchange cites the Trust’s registration statement (‘‘Registration Statement’’) for the proposition that the majority of bitcoin transactions are executed on public bitcoin exchanges where bitcoins are bought and sold daily for value in U.S. dollar (‘‘USD’’), euro, and other government-issued currencies,21 and the Exchange states that there are currently 30 bitcoin exchanges across the world.22 According to the Exchange, the various bitcoin exchanges are generally available to the public through online web portals, and trading information (including pricing, volume, and pending orders) is available on the exchanges’ Web sites, with most of this information publicly available to anyone who visits the Web sites.23 The Exchange states that, according to the Registration Statement, there are currently several U.S.-based regulated entities that facilitate bitcoin trading and that comply with anti-money laundering (‘‘AML’’) and know your customer (‘‘KYC’’) regulatory requirements: 24 • GDAX, which is based in California, is a bitcoin exchange that maintains money transmitter licenses in over 30 states, the District of Columbia, and Puerto Rico. GDAX is subject to the regulations enforced by the various state agencies that issued their respective money transmitter licenses to GDAX. In New York, GDAX applied for a BitLicense, a regulatory framework created by the New York Department of Financial Services (‘‘NYSDFS’’) that sets Sponsor itself (operating on a principal basis) also may offer NDFs and swaps in order to provide Authorized Participants and market makers with additional options for hedging their exposure to bitcoin. See id. 21 See Registration Statement on Form S–1, as amended, dated February 3, 2017 (File No. 333– 212479), at 38. 22 See id. at 12257. According to the Exchange, the Sponsor estimates that, in the global USDbitcoin market, trading volume in the OTC market averages about half of the trading volume on exchanges. See id. at 12259–60. 23 See id. at 12256–67. The Exchange represents that, according to the Sponsor, Bitfinex, one of the bitcoin exchanges included in the Trust’s underlying XBX Index, does not conduct business in New York or with New York residents and that another XBX Index component bitcoin exchange, OKCoin International, is open only to non-U.S. persons. See also id. at 12258 (acknowledging that certain spot bitcoin exchanges are open only to nonU.S. persons or do not conduct business with New York residents and that, as a result, the Sponsor must conduct some of its bitcoin trading on behalf of the Trust through a wholly-owned subsidiary, SolidX Management Ltd., an exempted limited company organized in the Cayman Islands specifically established to buy and sell bitcoin on behalf of the Trust on these bitcoin exchanges). 24 See id. at 12257. PO 00000 Frm 00093 Fmt 4703 Sfmt 4703 forth consumer protection, AML compliance, and cybersecurity rules tailored for digital currency companies operating and transacting business in New York. The NYSDFS granted a BitLicense to GDAX in January 2017.25 • itBit is a bitcoin exchange that was granted a limited-purpose-trustcompany charter by the NYSDFS in May 2015. Limited-purpose trusts, according to the NYSDFS, are permitted to undertake certain activities, such as transfer agency, securities clearance, investment management, and custodial services, but without the power to take deposits or make loans.26 • Gemini is a bitcoin exchange that is also regulated by the NYSDFS. In October 2015, the NYSDFS granted Gemini authorization to operate as a limited-purpose trust company.27 • SecondMarket, Inc., d/b/a Genesis Global Trading, is a member firm of the Financial Industry Regulatory Authority (‘‘FINRA’’) that makes a market in bitcoin by offering two-sided liquidity.28 The Exchange notes that the CFTC has stated that bitcoins and other virtual currencies are encompassed in the definition of ‘‘commodity’’ under the Commodity Exchange Act and are thus within the regulatory jurisdiction of the CFTC.29 According to the Exchange, the exchanges with the most significant bitcoin trading by volume—Bitfinex, Bitstamp, BTCC, BTC-e, GDAX, Huobi, itBit, Kraken, LakeBTC, OKCoin Exchange China, and OKCoin International—traded approximately 1.34 billion bitcoins, at USD-converted prices ranging between $199 and $1,203, for a total trade volume of over $784 billion from February 2014 through January 2017. The Sponsor represents that average global daily trading volume during this period was approximately $693 million.30 According to the Exchange, between January 16, 2016, and January 15, 2017 (including weekends and holidays), average daily bitcoin trading on Bitfinex, Bitstamp, GDAX, Gemini, itBit, and OKCoin International totaled approximately 44,000 bitcoins across all of those exchanges at prices that ranged between $371 and $1,161. Of that 25 See id. id. 27 See id. 28 See id. 29 See id. at 12261. The Exchange also cites views expressed by individual CFTC Commissioners for the proposition that derivatives based on bitcoin are subject to oversight by the CFTC, including oversight to prevent market manipulation of the price of bitcoin. Id. 30 See id. at 12257. 26 See E:\FR\FM\03APN1.SGM 03APN1 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices trading, Bitfinex accounted for 39%, Bitstamp accounted for 13%, GDAX accounted for 14%, Gemini accounted for 4%, itBit accounted for 9%, Kraken accounted for 3%, and OKCoin International accounted for 17% of bitcoins traded.31 The Exchange represents that, during the twelvemonth period from January 2016 through January 2017, the aggregate trading volume on the five constituent exchanges of the XBX Index as of January 15, 2017—Bitfinex, Bitstamp, GDAX, itBit, and OKCoin International—represented approximately 77% of the entire global USD-denominated bitcoin exchange market.32 According to the Exchange, although each bitcoin exchange has its own market price, it is expected that most bitcoin exchanges’ market prices should be relatively consistent with the bitcoinexchange market average, since market participants can choose the bitcoin exchange on which they buy or sell bitcoin. The Exchange also represents that, according to the Registration Statement, price differentials across bitcoin exchanges enable arbitrage between bitcoin prices on the various exchanges.33 As a result, according to the Exchange, the prices on bitcoin exchanges are the most accurate expression of the value of bitcoins. With respect to derivatives on bitcoin, the Exchange states that certain nonU.S.-bitcoin exchanges offer derivative products on bitcoin such as options, 31 See id. at 12259. id. at 12259–61. The Exchange further notes that, in addition to the five constituent exchanges of the XBX Index as of January 15, 2017, the global USD-denominated bitcoin exchange market also includes BTC-e, Gemini, LakeBTC, and Kraken. The Exchange represents that, although BTC-e is a USD-denominated bitcoin exchange with significant trading volume, BTC-e does not comply with certain of the Sponsor’s internal criteria regarding the exchanges on which the Sponsor will trade and that, therefore, the Sponsor will not transact with BTC-e. According to the Exchange, the Sponsor is aware of other smaller USDdenominated bitcoin exchanges, but the trading volume on these exchanges is insignificant, and the Sponsor does not intend to conduct business with these smaller exchanges. See id. at 12259 n.30. The Commission notes that, as of March 20, 2017, the TradeBlock Web site indicated that the XBX Index weighting assigned to the OKCoin International exchange was zero percent. See TradeBlock, https:// tradeblock.com/markets/index/ (last visited Mar. 20, 2017). 33 According to the Exchange, the Sponsor represents that, because bitcoin trades on more than 30 exchanges globally on a 24-hour basis, it is difficult for attempted market manipulation on any one exchange to affect the global market price of bitcoin, and that any attempt to manipulate the price would result in an arbitrage opportunity among exchanges, which would typically be acted upon by market participants. See id. at 12259. mstockstill on DSK3G9T082PROD with NOTICES 32 See VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 swaps, and futures.34 The Exchange refers to the Registration Statement and notes that BitMex (based in the Republic of Seychelles), CryptoFacilites (based in the United Kingdom), 796 Exchange (based in China), and OKCoin Exchange China all offer futures contracts settled in bitcoin. The Exchange also states that Coinut (based in Singapore) offers bitcoin binary options and ‘‘vanilla options’’ based on the Coinut index; that Nadex (based in Chicago) offers bitcoin binary options denominated in USD using the TeraBit Bitcoin Price Index; and that IGMarkets (based in the United Kingdom), Avatrade (based in the Republic of Ireland), and Plus500 (based in Israel) also offer bitcoin derivative products.35 The Exchange also notes the CFTC has approved the registration of TeraExchange LLC as a swap execution facility (‘‘SEF’’), where bitcoin swaps and NDFs may be entered into, and the registration of LedgerX provisionally as a SEF.36 The Exchange asserts that its own surveillance procedures are sufficient to detect and deter manipulation.37 The Exchange represents that the Exchange or FINRA, on behalf of the Exchange, or both, (a) will communicate as needed regarding trading in the Shares with other markets and other entities that are members of the Intermarket Surveillance Group, and (b) may obtain trading information regarding trading in the Shares from these other markets and other entities. In addition, the Exchange states that it may obtain information regarding trading in the Shares from markets and other entities that are members of the Intermarket Surveillance Group or with which the Exchange has in place a comprehensive surveillance-sharing agreement.38 34 According to the Exchange, the Sponsor is not aware of any bitcoin derivatives currently trading based on the XBX Index. See id. at 12258. 35 See id. at 12260. 36 See id. 37 The Exchange represents that its surveillance procedures generally focus on detecting securities trading outside their normal patterns, which could be indicative of manipulative or other violative activity. The Exchange represents that, when such situations are detected, surveillance analysis would follow and investigations would be opened, where appropriate, to review the behavior of all relevant parties for all relevant trading violations. See id. at 12266 (further representing that trading in the Shares will be subject to the existing trading surveillances administered by the Exchange, as well as cross-market surveillances administered by FINRA on behalf of the Exchange, which are designed to detect violations of Exchange rules and applicable federal securities laws, and further representing that these procedures are adequate to properly monitor Exchange trading of the Shares in all trading sessions and to deter and detect violations of Exchange rules and federal securities laws applicable to trading on the Exchange). 38 See id. at 12266. The Exchange also notes that, pursuant to NYSE Arca Equities Rule 8.201(g), the PO 00000 Frm 00094 Fmt 4703 Sfmt 4703 16249 According to the Exchange, the Sponsor believes that demand from new investors accessing bitcoin through investment in the Shares will broaden the investor base in bitcoin, which could further reduce the possibility of collusion among market participants to manipulate the bitcoin market.39 Further details regarding the proposal and the Trust can be found in Amendment No. 1 to the proposal,40 and in the Registration Statement.41 II. Summary of Comment Letters The comment period for the initial Notice of Proposed Rule Change closed on August 23, 2016, and the comment period for Amendment No. 1 closed March 16, 2017.42 As of March 24, the Commission had received 11 comment letters on the proposed rule change.43 Exchange is able to obtain information regarding trading in the Shares and the underlying bitcoin or any bitcoin derivative through Exchange-registered market makers, in connection with the market makers’ proprietary or customer trades effected on any relevant market. Id. 39 See id. at 12259. 40 See id. Compared to the initial Notice, see supra note 1, Amendment No. 1 makes the following substantive changes: (1) Identifies Foreside Fund Services, LLC as the order examiner in connection with the creation and redemption of baskets of Shares; (2) identifies SolidX Management LLC as the custodian of the Trust’s bitcoin and The Bank of New York Mellon as custodian of the Trust’s cash; (3) adds content regarding a recent loss of trading volume on the leading Chinese exchanges and asserts that trading volumes at these Chinese exchanges are now in line with volumes at USD exchanges; (4) notes that, in May 2016, the Gibraltar Financial Services Commission approved the BitcoinETI, which was listed on the Gibraltar Stock Exchange in July 2016 and on Deutsche Boerse Frankfurt in August 2016; (5) adds or changes certain details regarding the first alternative pricing source for the Shares; (6) adds disclosure that the Sponsor (operating on a principal basis) also may offer NDFs and swaps in order to provide Authorized Participants and market makers with additional options for hedging their exposure to bitcoin; (7) deletes text relating to the suspension or rejection of redemption orders; and (8) adds text stating that, to the extent that the Administrator has utilized the cascading set of rules described in ‘‘bitcoin Market Price,’’ in Amendment No. 1, the Trust’s Web site will note the valuation methodology used and the price per bitcoin resulting from that calculation. 41 See Registration Statement, supra note 21. 42 The initial comment period for the Order Instituting Proceedings closed on November 23, 2016, and the period for rebuttal comments closed on December 7, 2016. See Order Instituting Proceedings, supra note 1, 81 FR at 76401–02. 43 See Letters from Daniel H. Gallancy, CFA, SolidX Management LLP (Nov. 23, 2016) (‘‘SolidX Letter’’); Thaya B. Knight, Associate Director, Financial Regulation Studies, The Cato Institute (Dec. 1, 2016) (‘‘Cato Letter’’); Jerry Brito, Executive Director, Coin Center (Dec. 7, 2016) (‘‘Coin Center Letter’’); Joseph Colangelo, President, Consumers’ Research (Dec. 7, 2016) (‘‘Consumers’ Research Letter’’); Denise Krisko, CFA, President and CoFounder, Vident Investment Advisory, LLC (Dec. 7, 2016) (‘‘Vident Letter’’); Balaji Srinivasan, Chief Executive Officer & Cofounder, 21, et al. (Dec. 7, 2016) (‘‘Srinivasan Letter’’); Ken I. Maher (Dec. 8, E:\FR\FM\03APN1.SGM Continued 03APN1 16250 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices mstockstill on DSK3G9T082PROD with NOTICES Commenters address, among other things, investors’ interest in bitcoin and their desire to gain access to bitcoin through an ETP; 44 the state of development of bitcoin as a digital asset; 45 the inherent value of, and risks of investing in, bitcoin; 46 the appropriate measures for the Trust to secure its bitcoin holdings against theft or loss; 47 the creation and redemption processes for the Trust; 48 the proposed valuation method for the Trust’s holdings; 49 and the legitimacy or other benefits that Commission approval of the proposed ETP might confer upon bitcoin as a digital asset.50 Ultimately, however, comments on these topics do not bear on the basis for the Commission’s decision to disapprove the proposal. Accordingly, the Commission will summarize and address the comments that relate to the susceptibility of bitcoin or the Shares to fraudulent or manipulative acts and practices, including the need for surveillance-sharing agreements with significant regulated markets for trading in bitcoin or derivatives on bitcoin. A. Comments Regarding the Worldwide Market for Bitcoin Several commenters note that a significant volume of bitcoin trading occurs in markets outside the United 2016) (‘‘Maher Letter’’); Craig M. Lewis, Madison S. Wigginton Professor of Finance, Owen Graduate School of Management, Vanderbilt University (Feb. 13, 2017) (‘‘Lewis Paper’’); Douglas M. Yones, Head of Exchange Traded Products, New York Stock Exchange (Feb. 22, 2017) (‘‘NYSE Letter’’); Craig M. Lewis, Madison S. Wigginton Professor of Finance, Owen Graduate School of Management, Vanderbilt University (Mar. 3, 2017) (‘‘Lewis Paper II’’); Daniel H. Gallancy, CFA, SolidX Management LLP (Mar. 15, 2017) (‘‘SolidX Letter II’’). All comments on the proposed rule change are available on the Commission’s Web site at: https://www.sec.gov/ comments/sr-nysearca-2016-101/ nysearca2016101.shtml. 44 See, e.g., Cato Letter, supra note 43; Coin Center Letter, supra note 43; Vident Letter, supra note 43; Consumers’ Research Letter, supra note 43; SolidX Letter, supra note 43; Srinivasan Letter, supra note 43; NYSE Letter, supra note 43; Lewis Paper, supra note 43; SolidX Letter II, supra note 43. 45 See, e.g., Coin Center Letter, supra note 43; Vident Letter, supra note 43; Lewis Paper, supra note 43. 46 See, e.g., Vident Letter, supra note 43; Coin Center Letter, supra note 43; SolidX Letter, supra note 43; Maher Letter, supra note 43; Lewis Paper, supra note 43; SolidX Letter II, supra note 43. 47 See, e.g., Srinivasan Letter, supra note 43; Coin Center Letter, supra note 43; SolidX Letter, supra note 43; Consumers’ Research Letter, supra note 43; SolidX Letter II, supra note 43. 48 See, e.g., SolidX Letter, supra note 43; NYSE Letter, supra note 43; Lewis Paper, supra note 43. 49 See, e.g., SolidX Letter, supra note 43; NYSE Letter, supra note 43; Lewis Paper, supra note 43; Consumers’ Research Letter, supra note 43; SolidX Letter II, supra note 43. 50 See, e.g., Vident Letter, supra note 43; Coin Center Letter, supra note 43. VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 States that are largely unregulated.51 One commenter claims that several bitcoin exchanges do not offer the same regulatory safeguards that U.S. consumers have come to expect when they make investments in U.S. securities, and that bitcoin exchanges lack Commission oversight and have lost investor funds.52 The Lewis Paper also notes that the Commission does not regulate bitcoin exchanges.53 A different commenter expresses concerns that certain bitcoin exchanges that are components of the XBX Index, such as Bitfinex and OKCoin International, are not audited or governed by fair and transparent business practices.54 The Sponsor asserts that the majority of bitcoin transactions are executed on public bitcoin exchanges that typically publish real-time trade data on their respective Web sites and through application programming interfaces. The Sponsor claims that the existence and availability of the numerous pricing sources for bitcoin delivers unmatched price transparency when compared to most other assets.55 The Sponsor also asserts that the volume of bitcoin trading, both on-exchange and in the OTC market, is significant and that the bitcoin market is a liquid market. According to the Sponsor, between November 2015 and November 2016, the trading volume on the five constituent exchanges of the XBX Index (Bitfinex, Bitstamp, GDAX, itBit, and OKCoin International) represented the overwhelming majority of the entire USD-denominated bitcoin exchange market, and average daily trade volume on these exchanges during this period was approximately $24 million.56 The Sponsor acknowledges that a significant portion of bitcoin trading occurs on exchanges outside the United States.57 The Sponsor also claims that, while there is a significant volume of bitcoin trading in China, the prices on 51 See, e.g., Consumers’ Research Letter, supra note 43; Maher Letter, supra note 43. 52 See Consumers’ Research Letter, supra note 43, at 1–2. 53 See Lewis Paper, supra note 43, at 8. 54 See Maher Letter, supra note 43. This commenter also disputes some commenters’ statements that this ETP would give investors safe exposure to bitcoin by reducing security risk of holding the bitcoins, noting that investors will still bear the many risks of the bitcoin ecosystem itself. See id. 55 See SolidX Letter, supra note 43, at 12. 56 See id. at 13. The Sponsor also notes that there are three Chinese yuan-denominated exchanges on which trading volume is significant: BTCC, Huobi, and OKCoin Exchange China. See id. 57 See id. at 5, 13. For example, the Sponsor notes that Bitfinex, a component of the XBX Index, has continued to have the highest volume of trading on any of the USD-denominated bitcoin exchanges. See SolidX Letter, supra note 43, at 6. See also supra notes 31–32 and accompanying text. PO 00000 Frm 00095 Fmt 4703 Sfmt 4703 U.S. and Chinese exchanges tend to conform with minimal variation, in spite of various capital controls in effect in China.58 Consequently, for purposes of arbitrage among all the various bitcoin exchanges (including those that trade bitcoin for USD and Chinese yuan), the Sponsor concludes that the tendency for prices to conform supports the conclusion that the exchange market is efficient and is generally resistant to manipulation.59 The Sponsor also provides data that, it says, indicate that arbitrage across bitcoin markets helps to keep bitcoin prices aligned and to reduce the likelihood of manipulation and indicate that arbitrage functions within a few seconds to address price discrepancies.60 The Sponsor also submits that, as of January 2017, the volume of bitcoin trading on Chinese exchanges has declined to levels similar to those of USD-denominated exchanges that follow AML and KYC procedures applied by their respective jurisdictions.61 The Sponsor states that, in light of capital controls that apply in China, the Sponsor views the Chinese markets for bitcoin as separate and distinct from the USD markets.62 The Sponsor further asserts that the pricing differences between the XBX Index and the Chinese bitcoin exchanges are analogous to the location-based pricing differences in commodities markets, including the markets for gold, silver, platinum, and palladium—commodities that are the underlying assets for existing commodity-trust ETPs. The Sponsor states that, in addition to exchange trading, bitcoin has a robust, global OTC market and states that the parallel existence of an exchange-based and an OTC bitcoin market increases the difficulty of manipulation. Similarly, the Exchange notes that the OTC market for bitcoin as a standalone liquidity pool has greater daily trade volumes than any single bitcoin exchange.63 According to the Sponsor, a potential manipulator in the bitcoin marketplace would need to prevent other market participants from taking advantage of potential arbitrage opportunities between the exchanges, which would be further complicated by the high level of price transparency in the bitcoin market.64 The Sponsor notes that ‘‘Level-II type’’ quotes for bitcoin are 58 See SolidX Letter, supra note 43, at 5. id. at 13–14. 60 See SolidX Letter II, supra note 43, at 5. 61 See id. at 6. 62 See id. 63 See NYSE Letter, supra note 43, at 2. 64 See SolidX Letter, supra note 43, at 7. 59 See E:\FR\FM\03APN1.SGM 03APN1 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices mstockstill on DSK3G9T082PROD with NOTICES freely available from nearly all bitcoin exchanges.65 The Sponsor also claims that opening and closing prices for common financial instruments are a frequent target for market manipulators and that, because bitcoin trades continuously and never has an opening or closing price, the risk of such manipulation is eliminated.66 The Exchange also notes that bitcoin is traded continuously and asserts that this means that price discovery for bitcoin is widespread and continuous.67 The Sponsor also states that the Trust is materially identical to existing, physically-backed ETPs, which, the Sponsor asserts, have become an important component of the market.68 The Sponsor further claims that, as with any ETP, there may be attempts to spread false or misleading information about the Trust, but an attempt to manipulate the price of bitcoin through trading activity would be difficult, and controlling or artificially affecting the market would require a massive amount of capital distributed across numerous exchanges in multiple currencies and jurisdictions around the world.69 The Lewis Paper claims that the underlying market for bitcoin is inherently resistant to manipulation. This commenter posits that the underlying bitcoin market is not susceptible to manipulation because: (1) Unlike traditional securities, there is no inside information, and therefore bitcoin is not subject to the dissemination of false or misleading information; (2) manipulation through acquisition of a dominant market share is unlikely; (3) each bitcoin market is an independent entity, so demand for liquidity does not necessarily propagate across other exchanges; (4) a substantial OTC market provides additional liquidity and absorption of shocks; (5) compared to equity markets, trading on bitcoin exchanges is slower, and therefore cross-market arbitrage is available to all market participants at the same time; and (6) the market is not subject to ‘‘spoofing’’ or other high-frequencytrading tactics.70 65 See id. Generally, Level-II quotes provide bestprice orders and quotes from each market participant on a market. 66 See id. at 8. 67 See NYSE Letter, supra note 43, at 2. 68 See SolidX Letter, supra note 43, at 3. 69 See id. at 7. 70 See Lewis Paper, supra note 43, at 5–9; Lewis Paper II, supra note 43, at 2. The Lewis Paper also raises a number of arguments bearing on the susceptibility to manipulation of the XBX Index and the Shares. See Lewis Paper, supra note 43, at VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 Specifically with respect to the risk that a market participant might acquire a dominant position, the Lewis Paper notes that one of the risks associated with bitcoin is the possibility that a single investor or a small group acting in collusion could own a dominant share of the available bitcoin, and the Lewis Paper also notes that the Registration Statement states that it is possible, and in fact, reasonably likely, that a small group of early adopters holds a significant proportion of the bitcoin that has been mined.71 Since, according to the Lewis Paper, there is no registry showing which individuals or entities own bitcoin, or the quantity they own, it is not possible to know how large individual positions are.72 The Lewis Paper asserts that this issue is not unique to bitcoin, as there are no corresponding registries for precious metals.73 The Lewis Paper also asserts that a number of factors relevant to the Shares should ameliorate risks associated with possible manipulation due to a dominant market share.74 The Sponsor, which commissioned the Lewis Paper, agrees with the paper’s reasoning and with the assertion that the underlying bitcoin spot market is not susceptible to manipulation.75 The Exchange also agrees with the Lewis Paper’s analysis, claiming that trading in the Shares would not be expected to contribute to the manipulation of bitcoin prices and, in fact, may actually reduce the potential for fraud and manipulation.76 5–9. Those arguments are discussed below. See infra Sections III.B.3 & III.B.5. 71 See Lewis Paper, supra note 43, at 6. 72 Id. 73 Id. 74 Id. at 6–7. According to the Lewis Paper, those factors are: (a) That bitcoin held by the Trust will remain available to market participants through redemption of the Shares; (b) that, given the availability of arbitrage activity between the Shares and the underlying bitcoin market, the bitcoins held by the Trust will not represent a meaningful percentage of the bitcoin available for transaction purposes; (c) that a price increase in bitcoin following the introduction of a bitcoin ETP would be the result of increased demand for bitcoin, rather than a sign of price manipulation; (d) that the receive-versus-payment and delivery-versuspayment account arrangements that the Trust has with multiple bitcoin exchanges, the Trust’s transparent and rules-based redemption protocol, and the transparency of the Trust’s holdings and valuations, as well as of quotations and transactions in the Shares, would reduce the potential for fraud and manipulation in the bitcoin markets; (e) market participants can choose the bitcoin exchanges on which to trade and can arbitrage away price deviations; and (f) trading of the Shares on the Exchange may serve to make the overall bitcoin market more transparent, especially if OTC bitcoin trading shifts to bitcoin exchanges. Id. 75 See SolidX Letter II, supra note 43, at 3–4. 76 See NYSE Letter, supra note 43, at 5. PO 00000 Frm 00096 Fmt 4703 Sfmt 4703 16251 B. Comments Regarding Potential Manipulation of the XBX Index One commenter notes that the XBX Index includes several exchanges that many have expressed concerns about and that are not audited or governed by fair and transparent business practices.77 The Sponsor claims that the XBX Index is resistant to manipulation and responsive to market movements in real time and that it is therefore a superior mechanism—compared to using a single exchange—for valuing the Trust’s bitcoin holdings.78 The Sponsor asserts that the XBX Index price closely approximates actual bitcoin transaction prices across the various USDdenominated bitcoin exchanges and that it accurately reflects the fair value of bitcoin for valuation, for accounting purposes, and as a practical matter.79 The Sponsor states that the XBX Index’s methodology penalizes stale prices because, if an exchange does not have recent trading data, its weighting in the XBX Index is gradually reduced until it is de-weighted entirely.80 The Exchange states that the XBX Index’s proprietary methodology helps to protect the calculation of the XBX Index against any undue impact from bitcoin pricing outliers among the various exchanges and from any potential attempts to manipulate the price of bitcoin.81 The Lewis Paper claims that the following features of the XBX Index’s proprietary weighting methodology mitigate manipulation risk: (a) That lower trading volume reduces the weight an exchange is given in the average; (b) that the weight of an exchange is reduced the more a price deviates from the average; and (c) that weights are reduced for stale prices. The Lewis Paper claims that these features significantly increase the amount of capital required to manipulate bitcoin prices enough to affect XBX Index levels.82 C. Comments on the Derivatives Markets for Bitcoin The Lewis Paper states that one of the key differences between bitcoin and other commodities is the lack of a liquid and transparent derivatives market and that, although there have been nascent attempts to establish derivatives trading in bitcoin, bitcoin derivatives markets are not at this time sufficiently liquid to 77 See Maher Letter, supra note 43. SolidX Letter, supra note 43, at 9. 79 See id. at 8. 80 See id. at 9. 81 See NYSE Letter, supra note 43, at 2–3. 82 See Lewis Paper, supra note 43, at 8–9. 78 See E:\FR\FM\03APN1.SGM 03APN1 16252 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices be useful to Authorized Participants and market makers who would like to use derivatives to hedge exposures.83 The Lewis Paper claims that, for physical commodities that are not traded on exchanges, the presence of a liquid derivatives market is a necessary condition, but that, for digital assets like bitcoin, derivatives markets are not necessary because price discovery occurs on the OTC market and exchanges instead.84 The Sponsor states that it expects that bitcoin NDFs, swaps, or both will be offered by several participants in the bitcoin marketplace, including bitcoin exchanges and bitcoin OTC market participants, and that the Sponsor itself (operating on a principal basis) also may offer NDFs and swaps in order to provide Authorized Participants and market makers with the ability to hedge their exposure to bitcoin.85 D. Comments Regarding the Susceptibility of the Shares to Manipulation The Sponsor states that, as a fullfledged ETP in the United States, the Trust will provide investors with an opportunity to invest in bitcoin without being exposed directly to the risks associated with sourcing and holding bitcoin outside the regulated traditional financial markets.86 The Sponsor also claims that, because the Shares would be traded on the Exchange, they should not be subject to risks of manipulation beyond those applicable to any publicly listed stock.87 In addition, the Sponsor asserts that the dissemination of information on the Trust’s Web site— along with quotations for, and last-sale prices of transactions in, the Shares, and the IIV and NAV of the Trust—will help to reduce the ability of market participants to manipulate the bitcoin market or the price of the Shares, and that the Trust’s arbitrage mechanism will facilitate the correction of price 83 See id. at 8. id. (concluding that, for these assets, derivatives markets are not necessary because the OTC market and exchanges are close substitutes). 85 See SolidX Letter, supra note 43, at 14–15. The Sponsor notes that, while Authorized Participants and market makers will generally want to hedge their exposure to bitcoin in connection with basket creation and redemption orders, not all of them are ready, willing, and able to trade bitcoin, and they will require a mechanism to gain synthetic exposure to bitcoin for their hedging needs when they enter orders to create and redeem shares. Id. According to the Sponsor, Authorized Participants will be able to use NDFs and swap contracts to obtain synthetic long and short exposure to bitcoin for their hedging purposes. Id. 86 See SolidX Letter, supra note 43, at 4. For similar claims, see Consumers’ Research Letter, supra note 43, at 1–2; Coin Center Letter, supra note 43, at 1–2; NYSE Letter, supra note 43, at 1–2. 87 See SolidX Letter, supra note 43, at 7. mstockstill on DSK3G9T082PROD with NOTICES 84 See VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 discrepancies in bitcoin and the Shares.88 The Sponsor also asserts that the requirements of Section 6(b)(5) of the Exchange Act apply not to trading in bitcoin, but to trading in the Shares, and asserts that the rules of the Exchange will prevent fraudulent and manipulative acts and practices, and protect investors and the public interest, with respect to the Shares.89 Finally, the Sponsor argues that the requirements of Section 6(b)(5) of the Exchange Act do not include any inherent requirement for market surveillance and asserts that the Commission, in 2005, approved the listing and trading of shares of the Euro Currency Trust, even though, according to the Sponsor, exchange surveillance of the underlying foreign exchange markets did not exist.90 The Lewis Paper also argues that several institutional features of the bitcoin trading environment and the Trust make the price of the Shares resistant to manipulation because: (a) The Trust’s disclosures, creation and redemption activity, and price dissemination would increase transparency and diminish the risk of manipulation or unfair informational advantage; 91 (b) bitcoin prices are quoted to eight decimal places, mitigating incentives to move prices a penny up or down because the potential gains would be immaterial; 92 (c) bitcoin markets trade continuously, and the XBX Index is calculated continuously, and therefore the manipulation of opening and closing prices is not a significant risk; 93 (d) the listing and delisting criteria for the Shares are expected to help to maintain a minimum level of liquidity and thus minimize the potential for manipulation of Share prices; 94 and (e) the continuous cash and in-kind creation and redemption of Shares increases the Trust’s efficiency because the exchange trading of bitcoin lowers the costs of creating and redeeming Shares, which would tighten the spread between the Share price and the NAV and reduce manipulation risk.95 E. Comments Regarding the Protection of Investors and the Public Interest The Sponsor asserts that the structure of the Trust and the proposed rule change by the Exchange will serve the public interest by protecting investors 88 See Amendment No. 1, supra note 1, 82 FR at 12259. 89 See SolidX Letter II, supra note 43, at 1–2. 90 See id. at 3–4. 91 See Lewis Paper, supra note 43, at 7. 92 See id. at 9. 93 See id. 94 See id. 95 See id. at 10. PO 00000 Frm 00097 Fmt 4703 Sfmt 4703 from the risks of investing in bitcoins directly, citing the hacking of bitcoin exchanges, as well as schemes perpetrated upon investors by dishonest individuals.96 Several other commenters also raise similar points, arguing that approving the proposed rule change would benefit investor protection.97 The Sponsor argues that the risk of investor harm from manipulation in the Shares is hypothetical in nature and unlikely, while the harm to investors from a lack of access to an insured vehicle is overt and likely to continue in the absence of the Commission’s approval of the Exchange’s proposed rule change.98 The Sponsor also asserts that the Trust would provide other benefits to investors—such as limited counterparty risk, the simplicity of holding the Shares, and the lack of minimum investment requirements—and that approving the proposed rule change would enable U.S. exchanges to remain competitive internationally.99 Finally, the Sponsor asserts that disapproval of the proposed rule change would be in direct contravention of the goal of Section 6(b)(5) to protect investors and the public interest.100 Several commenters assert that the Trust’s insurance of its bitcoin holdings would ensure safe access to bitcoin for investors.101 The Sponsor notes that, in traditional and regulated systems, custodial and clearing firms mitigate risks and keep assets safe for the benefit of the investing public, but that no such mechanisms currently exist for bitcoin.102 The Sponsor claims that insurance is important to investor protection and the public interest because investors cannot be expected to assume the risks associated with the possible loss or theft of the Trust’s bitcoins.103 The Sponsor acknowledges that Trust investors will expect to assume the market risk associated with their investment (i.e., bitcoin price fluctuations), but claims that it is appropriate to minimize the investors’ risks regarding the adequacy of the mechanisms and infrastructure used to secure the Trust’s bitcoin holdings, since that is not, and should not be, a typical analysis undertaken by investors 96 See SolidX Letter II, supra note 43, at 2. e.g., Cato Letter, supra note 43; Srinivasan Letter, supra note 43; Consumers’ Research Letter, supra note 43; NYSE Letter, supra note 43. 98 See SolidX Letter II, supra note 43, at 2. 99 See SolidX Letter, supra note 43, at 2–4. 100 See SolidX Letter II, supra note 43, at 2. 101 See, e.g., SolidX Letter, supra note 43; Consumers’ Research Letter, supra note 43; Lewis Paper, supra note 43; NYSE Letter, supra note 43; SolidX Letter II, supra note 43. 102 See SolidX Letter, supra note 43, at 11. 103 See id. 97 See, E:\FR\FM\03APN1.SGM 03APN1 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices in the U.S. securities markets.104 The Sponsor also asserts that the Trust’s insurance policy and the proposed rule change will serve the public interest in a manner otherwise unavailable and notes that multiple commenters have emphasized the importance of the Trust’s insurance policy.105 The Exchange claims that, as a substitute to the investor safeguards offered by traditional custodians, bitcoin insurance is important for investor protection and the public interest.106 One commenter claims that the Trust’s insurance coverage is an important, market-based solution that substitutes for a traditional custodial infrastructure and a true transfer-agency function that does not exist in the underlying bitcoin market.107 Another commenter claims that the fact that the Trust carries insurance and will be exchange traded will prevent situations where consumers risk losing bitcoins or having them stolen due to a fiduciary’s flawed security protocols.108 III. Discussion and Commission Findings A. Overview mstockstill on DSK3G9T082PROD with NOTICES Under Section 19(b)(2)(C) of the Exchange Act, the Commission must approve the proposed rule change of a self-regulatory organization (‘‘SRO’’) if the Commission finds that the proposed rule change is consistent with the requirements of the Exchange Act and the applicable rules and regulations thereunder.109 If it is unable to make such a finding, the Commission must disapprove the proposed rule change.110 Additionally, under Rule 700(b)(3) of the Commission’s Rules of Practice, the ‘‘burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued thereunder . . . is on the self-regulatory organization that proposed the rule change.’’ 111 104 See id.; see also Lewis Paper, supra note 43, at 11. 105 See SolidX Letter II, supra note 43, at 2. 106 See NYSE Letter, supra note 43, at 4. 107 See Lewis Paper, supra note 43, at 11. 108 See Consumers’ Research Letter, supra note 43, at 2. 109 15 U.S.C 78s(b)(2)(C)(i). 110 15 U.S.C. 78s(b)(2)(C)(ii). 111 17 CFR 201.700(b)(3). The description of a proposed rule change, its purpose and operation, its effect, and a legal analysis of its consistency with applicable requirements must all be sufficiently detailed and specific to support an affirmative Commission finding. Id. Any failure of an SRO to provide the information elicited by Form 19b–4 may result in the Commission not having a sufficient basis to make an affirmative finding that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued thereunder that are applicable to the SRO. Id. VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 After careful consideration, and for the reasons discussed in greater detail below, the Commission does not believe that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Exchange Act and the applicable rules and regulations thereunder.112 Specifically, the Commission does not find that the proposed rule change is consistent with Section 6(b)(5) of the Exchange Act—which requires that the rules of a national securities exchange be designed, among other things, to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest 113— because the Commission believes that the significant markets for bitcoin are unregulated and that, therefore, the Exchange has not entered into, and would currently be unable to enter into, the type of surveillance-sharing agreement that helps address concerns about the potential for fraudulent or manipulative acts and practices in the market for the Shares. Accordingly, the 112 In disapproving the proposed rule change, as modified by Amendment No. 1, the Commission has considered its impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f); see also notes 70–74, 82–84, 91–95, 107, 148–158 & 169–176 and accompanying text. The Commission notes that, according to the Sponsor, the Trust is a means of providing a simple and costeffective way for investors to gain investment exposure to the performance of the USD price of bitcoin. See SolidX Letter, supra note 43, at 1; see also Lewis Paper, supra note 43, at 3, 11–16 (asserting that a bitcoin-based ETP would enable ordinary investors to construct more efficient and diversified portfolios). The Sponsor also asserts that bitcoin exchanges have been subject to hacking and investor schemes in the past, the losses from which are documented and quantifiable at approximately $2 billion, and that such losses will continue unless investors are able to invest in bitcoin through a regulated and insured product such as the Trust. See SolidX Letter II, supra note 43, at 2. Regarding competition, the Exchange has asserted that approval of the proposed rule change ‘‘will enhance competition among market participants, to the benefit of investors and the marketplace.’’ See Amendment No. 1, supra note 1, 82 FR at 12267. The Sponsor claims that the proposed rule change would further advance the goal of helping U.S. exchanges remain competitive in the international marketplace by demonstrating to future sponsors of new products that the Commission remains committed to fostering innovation in the U.S. securities markets. See SolidX Letter, supra note 43, at 3. Finally, regarding the potential effect of the proposed rule change on capital formation, the Exchange asserts that the Sponsor believes that demand from new investors accessing bitcoin through investment in the Shares will broaden the investor base in bitcoin. See Amendment No. 1, supra note 1, 82 FR at 12259. The Commission recognizes that the Exchange and commenters assert these economic benefits and specifically addresses the Sponsor’s claims about investor protection from hacking and other risks of bitcoin ownership below. See infra Section III.B.6. The Commission, however, for the reasons discussed throughout this order, must disapprove the proposed rule change because it is not consistent with the Exchange Act. 113 15 U.S.C. 78f(b)(5). PO 00000 Frm 00098 Fmt 4703 Sfmt 4703 16253 Commission disapproves the proposed rule change.114 B. Analysis 1. Commodity-Trust ETPs and Surveillance-Sharing Agreements The Exchange proposes to list and trade the Shares under NYSE Arca Equities Rule 8.201, which governs the listing of Commodity-Based Trust Shares.115 The proposal is similar to many past proposals to list and trade shares of ETPs holding precious metals.116 Accordingly, the Commission analyzes this proposal under the standards that it has applied to previous commodity-trust ETPs—and that it also applied in the recent Bats BZX Order.117 A key consideration for the Commission in determining whether to approve or disapprove a proposal to list and trade shares of a new commoditytrust ETP is the susceptibility of the shares or the underlying asset to manipulation. This consideration flows directly from the requirement in Section 6(b)(5) of the Exchange Act that a national securities exchange’s rules must be designed ‘‘to prevent fraudulent and manipulative acts and practices’’ and ‘‘to protect investors and the public interest.’’ 118 Since at least 1990, the Commission has expressed the view that the ability of a national securities exchange to enter into surveillance-sharing agreements ‘‘furthers the protection of investors and the public interest because it will enable the [e]xchange to conduct prompt investigations into 114 The Commission’s disposition of the Exchange’s proposed rule change is independent of, and serves a fundamentally different purpose than, any Commission actions with respect to the Securities Act of 1933 Registration Statement of the Trust. 115 The Commission notes that in settled actions the CFTC has designated bitcoin as a commodity and has asserted jurisdiction over the trading of at least certain derivatives on bitcoin, as well as certain leveraged or margined retail transactions in bitcoin. See In re Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15–29, 2015 WL 5535736 (CFTC Sept. 17, 2015) (Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions (‘‘Coinflip Settlement Order’’)), available at https:// www.cftc.gov/idc/groups/public/@ lrenforcementactions/documents/legalpleading/ enfcoinfliprorder09172015.pdf. 116 See, e.g., streetTRACKS Gold Shares, Exchange Act Release No. 50603 (Oct. 28, 2004), 69 FR 64614 (Nov. 5, 2004) (SR–NYSE–2004–22) (order approving the listing and trading of shares of commodity-trust ETP holding physical gold bullion). The Commission notes that the Sponsor also views the Trust to be materially identical to other existing commodity-trust ETPs. See SolidX Letter, supra note 43, at 3. 117 See Bats BZX Order, supra note 6, 82 FR at 14081–87. 118 15 U.S.C. 78f(b)(5). E:\FR\FM\03APN1.SGM 03APN1 16254 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices mstockstill on DSK3G9T082PROD with NOTICES possible trading violations and other regulatory improprieties.’’ 119 The Commission has also long held that surveillance-sharing agreements are important in the context of exchange listing of derivative security products, such as equity options.120 With respect to ETPs, when approving in 1995 the listing and trading of one of the first commodity-linked ETPs—a commodity-linked exchange-traded note—on a national securities exchange, the Commission continued to emphasize the importance of surveillance-sharing agreements, noting that the listing exchange had entered into surveillance-sharing agreements with each of the futures markets on which pricing of the ETP would be based and stating that ‘‘[t]hese agreements should help to ensure the availability of information necessary to detect and deter potential manipulations and other trading abuses, thereby making [the commodity-linked notes] less readily susceptible to manipulation.’’ 121 In 1998, in adopting Exchange Act Rule 19b–4(e) 122 to permit the generic listing and trading of certain new derivative securities products— including ETPs—the Commission again emphasized the importance of the listing exchange’s ability to obtain from underlying markets, through surveillance-sharing agreements (called information-sharing agreements in the release), the information necessary to detect and deter manipulative activity. Specifically, in adopting rules governing the generic listing of new derivative securities products, the Commission stated that the Rule 19b–4(e) procedures would ‘‘enable the Commission to continue to effectively protect investors and promote the public interest.’’ 123 119 See Exchange Act Release No. 27877 (Apr. 4, 1990), 55 FR 13344 (Apr. 10, 1990) (SR–NYSE–90– 14). 120 See Exchange Act Release No. 33555 (Jan. 31, 1994), 59 FR 5619, 5621 (Feb. 7, 1994) (SR–Amex– 93–28) (order approving listing of options on American Depositary Receipts). 121 Exchange Act Release No. 35518 (Mar. 21, 1995), 60 FR 15804 (Mar. 27, 1995) (SR–Amex–94– 30). See also Exchange Act Release No. 36885 (Feb. 26, 1996), 61 FR 8315 n.17 (Mar. 4, 1996) (SR– Amex–95–50) (approving the exchange listing and trading of Commodity Indexed Securities and noting that, through the comprehensive surveillance-sharing agreements, the listing exchange was able to obtain market surveillance information for transactions occurring on NYMEX and COMEX and from the London Metal Exchange through the Intermarket Surveillance Group. 122 17 CFR 240.19b–4(e). 123 Amendment to Rule Filing Requirements for Self-Regulatory Organizations Regarding New Derivative Securities Products, Exchange Act Release No. 40761 (Dec. 8, 1998), 63 FR 70952, 70959 (Dec. 22, 1998) (File no. S7–13–98) (‘‘NDSP Adopting Release’’) (also noting that ‘‘there should VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 The Commission also stressed the importance of these surveillance-sharing agreements comprehensively covering trading in the underlying assets. In the case of a product overlying domestic securities, the Commission said that the exchange listing a derivative securities product should ensure that it was either a common member of the Intermarket Surveillance Group with, or had entered into an information-sharing agreement with, each market trading each underlying security.124 Consistent with these statements, for the commodity-trust ETPs approved to date for listing and trading, there have been in every case well-established, significant, regulated markets for trading futures on the underlying commodity— gold, silver, platinum, palladium, and copper—and the ETP-listing exchange has entered into surveillance-sharing agreements with, or held Intermarket Surveillance Group membership in common with, those markets.125 The be a comprehensive ISA [information-sharing agreement] that covers trading in the new derivative securities product and its underlying securities in place between the SRO listing or trading a derivative product and the markets trading the securities underlying the new derivative securities product. Such agreements provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur.’’). 124 See id. at 70959. The Commission further noted that, ‘‘if a new SRO trades component securities underlying a new derivative securities product and is not a member of the ISG [Intermarket Surveillance Group], the SRO seeking to list and trade such new derivative securities product pursuant to Rule 19b–4(e) should enter into a comprehensive ISA with the non-ISG SRO. Conversely, if a new SRO seeks to list and trade a new derivative securities product pursuant to Rule 19b–4(e) and is not a member of the ISG, such SRO should enter into a comprehensive ISA with each SRO that trades securities underlying the new derivative securities product.’’ Id. at 70959 n.99. 125 See streetTRACKS Gold Shares, Exchange Act Release No. 50603 (Oct. 28, 2004), 69 FR 64614, 64618 (Nov. 5, 2004) (SR–NYSE–2004–22) (approval order notes the New York Stock Exchange’s representation that ‘‘the most significant gold futures exchanges are the COMEX division of the NYMEX and the Tokyo Commodity Exchange’’ and that the New York Stock Exchange has entered into a reciprocal Memorandum of Understanding with the NYMEX (of which COMEX is a division) ‘‘for the sharing of information related to any financial instrument based, in whole or in part, upon an interest in or performance of gold’’); iShares COMEX Gold Trust, Exchange Act Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751, 3754 (Jan. 26, 2005) (SR–Amex–2004–38) (approval order notes the American Stock Exchange’s representation that ‘‘the most significant gold futures exchanges are the COMEX division of the NYMEX and the Tokyo Commodity Exchange’’ and that the American Stock Exchange has ‘‘in place an Information Sharing Agreement with the NYMEX for the purpose of providing information in connection with trading in or related to COMEX gold futures contracts’’); iShares Silver Trust, Exchange Act Release No. 53521 (Mar. 20, 2006), 71 FR 14967, 14968, 14973 (Mar. 24, 2006) (SR–Amex– 2005–72) (approval order notes the American Stock Exchange’s representation that ‘‘the most significant PO 00000 Frm 00099 Fmt 4703 Sfmt 4703 silver futures exchanges are the COMEX and the Tokyo Commodity Exchange’’ and that the American Stock Exchange has ‘‘in place an Information Sharing Agreement with the NYMEX for the purpose of providing information in connection with trading in or related to COMEX silver futures contracts’’); ETFS Gold Trust, Exchange Act Release No. 59895 (May 8, 2009), 74 FR 22993, 22994–95, 22998 (May 15, 2009) (SR– NYSEArca–2009–40) (accelerated approval order notes NYSE Arca’s representation that the COMEX is one of the ‘‘major world gold markets’’ and that NYSE Arca ‘‘has an Information Sharing Agreement with NYMEX for the purpose of sharing information in connection with trading in or related to COMEX gold futures contracts’’); ETFS Silver Trust, Exchange Act Release No. 59781 (Apr. 17, 2009), 74 FR 18771, 18772, 18776 (Apr. 24, 2009) (SR– NYSEArca–2009–28) (accelerated approval order notes NYSE Arca’s representation that ‘‘the most significant silver futures exchanges are the COMEX . . . and the Tokyo Commodity Exchange’’ and that NYSE Arca ‘‘has an Information Sharing Agreement with NYMEX for the purpose of sharing information in connection with trading in or related to COMEX silver futures contracts’’); ETFS Palladium Trust, Exchange Act Release No. 60971 (Nov. 9, 2009), 74 FR 59283, 59285–86, 59291 (Nov. 17, 2009) (SR– NYSEArca–2009–94) (notice of proposed rule change includes NYSE Arca’s representation that ‘‘the most significant palladium futures exchanges are the NYMEX and the Tokyo Commodity Exchange,’’ that ‘‘NYMEX is the largest exchange in the world for trading precious metals futures and options,’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which NYMEX is a member); ETFS Platinum Trust, Exchange Act Release No. 60970 (Nov. 9, 2006), 74 FR 59319, 59321, 59327 (Nov. 17, 2009) (SR–NYSEArca-2009–95) (notice of proposed rule change includes NYSE Arca’s representation that ‘‘the most significant palladium futures exchanges are the NYMEX and the Tokyo Commodity Exchange,’’ that ‘‘NYMEX is the largest exchange in the world for trading precious metals futures and options,’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which NYMEX is a member); Sprott Physical Gold Trust, Exchange Act Release No. 61236 (Dec. 23, 2009), 75 FR 170, 171, 174 and n.27 (Jan. 4, 2010) (SR–NYSEArca-2009– 113) (notice of proposed rule change includes NYSE Arca’s representations that the COMEX is one of the ‘‘major world gold markets,’’ that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ and that NYMEX, of which COMEX is a division, is a member of the Intermarket Surveillance Group); Sprott Physical Silver Trust, Exchange Act Release No. 63043 (Oct. 5, 2010), 75 FR 62615, 62616, 62619 and n.26 (Oct. 12, 2010) (SR–NYSEArca-2010–84) (accelerated approval order notes NYSE Arca’s representation that the COMEX is one of the ‘‘major world silver markets,’’ that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ and that NYMEX, of which COMEX is a division, is a member of the Intermarket Surveillance Group); ETFS Precious Metals Basket Trust, Exchange Act Release No. 62402 (Jun. 29, 2010), 75 FR 39292, 39295, 39298 (July 8, 2010) (SR–NYSEArca–2010–56) (notice of proposed rule change includes NYSE Arca’s representation that ‘‘the most significant gold, silver, platinum and palladium futures exchanges are the COMEX and the TOCOM’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which NYMEX (of which COMEX is a division) is a member); ETFS White Metals Basket Trust, Exchange Act Release No. 62620 (July 30, 2010), 75 FR 47655, 47657, 47660 (Aug. 6, 2010) (SR–NYSEArca–2010–71) (notice of proposed rule change includes NYSE Arca’s representation that ‘‘the most significant silver, platinum and palladium futures exchanges are the E:\FR\FM\03APN1.SGM 03APN1 mstockstill on DSK3G9T082PROD with NOTICES Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices COMEX and the TOCOM’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which COMEX is a member); ETFS Asian Gold Trust, Exchange Act Release No. 63267 (Nov. 8, 2010), 75 FR 69494, 69496, 69500–01 (Nov. 12, 2010) (SR–NYSEArca– 2010–95) (notice of proposed rule change includes NYSE Arca’s representation that ‘‘the most significant gold futures exchanges are the COMEX and the Tokyo Commodity Exchange,’’ that ‘‘COMEX is the largest exchange in the world for trading precious metals futures and options,’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which COMEX is a member); Sprott Physical Platinum and Palladium Trust, Exchange Act Release No. 68101 (Oct. 24, 2012), 77 FR 65732, 65733, 65739 (Oct. 30, 2012) (SR–NYSEArca-2012–111) (accelerated approval order notes NYSE Arca’s representation that ‘‘[f]utures on platinum and palladium are traded on two major exchanges: The New York Mercantile Exchange . . . and Tokyo Commodities Exchange’’ and that NYSE Arca ‘‘may obtain information via ISG [Intermarket Surveillance Group] from other exchanges that are members of ISG or with which [NYSE Arca] has entered into a comprehensive surveillance sharing agreement, including COMEX’’); APMEX Physical—1 oz. Gold Redeemable Trust, Exchange Act Release No. 66627 (Mar. 20, 2012), 77 FR 17539, 17547 (Mar. 26, 2012) (SR–NYSEArca–2012–18) (notice of proposed rule change cross-references the proposed rule change to list and trade shares of the ETFS Gold Trust, in which NYSE Arca represented that the COMEX is one of the ‘‘major world gold markets’’ and notes that NYSE Arca ‘‘may obtain information via ISG from other exchanges that are members of ISG or with which [NYSE Arca] has entered into a comprehensive surveillance sharing agreement, including COMEX’’); JPM XF Physical Copper Trust, Exchange Act Release No. 68440 (Dec. 14, 2012), 77 FR 75468, 75469–72 (Dec. 20, 2012) (SR– NYSEArca–2012–28) (approval order notes NYSE Arca’s representation that a majority of copper derivatives trading occurs on the LME, the COMEX, and the Shanghai Futures Exchange and that NYSE Arca could obtain trading information from other members of the Intermarket Surveillance Group (including from the COMEX) and that it had entered into a comprehensive surveillance-sharing agreement with the LME with respect to trading in copper and copper derivatives); iShares Copper Trust, Exchange Act Release No. 68973 (Feb. 22, 2013), 78 FR 13726, 13727–30 (Feb. 28, 2013) (SR– NYSEArca–2012–66) (approval order notes NYSE Arca’s representation that the LME is the exchange with the greatest number of open copper futures and options contracts and that NYSE Arca had entered into a comprehensive surveillance-sharing agreement with the LME regarding trading in copper and copper derivatives and could also obtain trading information from other members of the Intermarket Surveillance Group, including the COMEX, which also trades copper futures); First Trust Gold Trust, Exchange Act Release No. 69847 (June 25, 2013), 78 FR 39399, 39400 n.15, 39405 (July 1, 2013) (SR–NYSEArca–2013–61) (notice of proposed rule change notes that FINRA, on behalf of the exchange, can obtain trading information regarding gold futures and options on gold futures from members of the Intermarket Surveillance Group, including the COMEX, and cross-references the proposed rule change to list and trade shares of the ETFS Gold Trust, in which NYSE Arca represented that the COMEX is one of the ‘‘major world gold markets’’); Merk Gold Trust, Exchange Act Release No. 71038 (Dec. 11, 2013), 78 FR 76367, 76369 n.26, 76374 (Dec. 17, 2013) (SR–NYSEArca– 2013–137) (notice of proposed rule change notes that the exchange can obtain trading information via the Intermarket Surveillance Group from other members, including the COMEX, and crossreferences the proposed rule change to list and trade shares of the ETFS Gold Trust, in which VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 Commission believes that the need for an exchange listing a commodity-trust ETP to have surveillance-sharing agreements with significant, regulated markets relating to the underlying commodity applies equally to a commodity-trust ETP that is based on bitcoin or another digital asset.126 The Sponsor argues that Section 6(b)(5) does not contain any inherent requirement for market surveillance and argues that the Commission, in 2005, approved the listing and trading of an ETP—the Euro Currency Trust—where the underlying market was not surveilled.127 The Commission, however, believes that its approval of the Euro Currency Trust is readily distinguishable from its disapproval of the proposed SolidX Bitcoin Trust. First, the Euro Currency Trust is not a commodity trust, and it is not listed and traded under the Exchange listing standards for commodity-based trusts. Second, the Commission’s approval order for the Euro Currency Trust notes that, in addition to a large OTC market in currency derivatives, currency options and futures were traded on regulated markets with the authority to perform surveillance on their members’ trading activities, to review positions held by members and large-scale customers, and to monitor the price movements of options and futures markets by comparing them with cash and other derivative markets’ prices.128 These regulated derivatives markets included the Philadelphia Stock Exchange and the Chicago Mercantile Exchange, which, along with the ETP’s listing exchange (the New York Stock Exchange) are members of the Intermarket Surveillance Group. Third, the Commission’s approval order notes a number of significant facts about the underlying spot market for foreign exchange, including: • That the listing exchange had represented that the foreign exchange NYSE Arca represented that the COMEX is one of the ‘‘major world gold markets’’); Long Dollar Gold Trust, Exchange Act Release No. 79518 (Dec. 9, 2016), 81 FR 90876, 90881, 90886 (Dec. 15, 2016) (SR–NYSEArca–2016–84) (accelerated approval order notes NYSE Arca’s representation that the most significant gold futures exchange is the COMEX and that the exchange can obtain trading information from other members of the Intermarket Surveillance Group). 126 See Bats BZX Order, supra note 6, 82 FR at 14087 (disapproving proposed rule change to list a bitcoin-based commodity-trust ETP on the basis that the listing exchange had not, and would not be able to, enter into a surveillance-sharing agreement with significant, regulated markets related to the underlying asset). 127 See supra note 90 and accompanying text. 128 Exchange Act Release No. 52843 (Nov. 28, 2005), 70 FR 72486, 72487 (Dec. 5, 2005) (Order Granting Accelerated Approval of a Proposed Rule Change regarding the Euro Currency Trust). PO 00000 Frm 00100 Fmt 4703 Sfmt 4703 16255 market is the largest and most liquid financial market in the world and that, as of April 2004, the foreign exchange market experienced average daily turnover of approximately $1.88 trillion; 129 • That the most significant participants in the spot market are the major international commercial banks that act both as brokers and as dealers; 130 and • That most trading in the global OTC foreign currency markets is conducted by regulated financial institutions, such as banks and broker dealers.131 Thus, significant, regulated markets related to foreign exchange trading exist, and the listing exchange of the Euro Currency Trust belongs to a multilateral surveillance-sharing agreement with those markets. Moreover, many prominent participants in the OTC foreign exchange market are regulated financial institutions. The markets related to foreign exchange therefore bear little resemblance to the markets currently related to bitcoin, which are either unregulated, not of significant size, or both. The rationale behind the Commission’s approval of the Euro Currency Trust is therefore consistent with the rationale for the Commission’s disapproval of the SolidX Bitcoin Trust. The Commission continues to believe that surveillance-sharing agreements between the exchange listing shares of a commodity-trust ETP and significant, regulated markets related to the underlying asset provide a ‘‘necessary deterrent to manipulation.’’ 132 To the extent there is some question as to the degree to which bitcoin is subject to manipulation, moreover, surveillancesharing agreements with significant, regulated markets relating to bitcoin would help answer that question and address instances of such manipulation. Therefore, the Commission’s analysis of the Exchange’s proposal examines whether regulated markets of significant size exist—in either bitcoin or derivatives on bitcoin—with which the Exchange has, or could enter into, a surveillance-sharing agreement. 2. The Worldwide Spot Market for Bitcoin The Commission believes—consistent with its conclusion in the Bats BZX Order 133—that the bulk of bitcoin trading occurs on markets where there 129 See 130 See id. at 72486. id. at 72487. 131 See id. Adopting Release, supra note 123, 63 FR at 70959. 133 See Bats BZX Order, supra note 6, 82 FR at 14084 & nn.103–106. 132 NDSP E:\FR\FM\03APN1.SGM 03APN1 16256 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices mstockstill on DSK3G9T082PROD with NOTICES is little to no regulation governing trading,134 and thus no meaningful governmental market oversight designed to detect and deter fraudulent and manipulative activity.135 The Commission also notes that none of the bitcoin spot markets identified by the Exchange or the Sponsor is currently a member of the Intermarket Surveillance Group.136 The Commission also believes that the bitcoin markets identified by the Exchange and the Sponsor as subject to certain regulatory requirements—GDAX, itBit, Gemini, and Genesis Global Trading—are not, in fact, regulated markets consistent with the requirements met with respect to previously approved commodity-trust ETPs. While the Exchange notes that GDAX, itBit, and Gemini are subject to consumer protection, KYC compliance, AML compliance, and cybersecurity requirements imposed by the NYSDFS,137 the Commission’s market oversight of national securities exchanges includes substantial additional requirements, including the requirement to have rules that are ‘‘designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and 134 Several commenters discussed the unregulated state of the underlying bitcoin markets. See supra notes 51–54 and accompanying text. The Commission believes that certain restrictions imposed by the Trust to conduct bitcoin transactions reflect the absence of meaningful regulatory oversight and transparency of certain non-U.S. bitcoin markets. For example, the Sponsor notes that Bitfinex, one of the bitcoin exchanges included in the Trust’s underlying XBX Index, does not conduct business in New York or with New York residents, and another XBX Index component bitcoin exchange, OKCoin International, is open only to non-U.S. persons. See supra note 23 and accompanying text. See also supra note 61 and accompanying text (noting that, as of January 2017, the volume of bitcoin trading on Chinese exchanges has declined to levels similar to those of USDdenominated exchanges that follow AML and KYC procedures applied by their respective jurisdictions). 135 See supra notes 51–54 and accompanying text. 136 See https://www.isgportal.org (listing the current members and affiliate members of the Intermarket Surveillance Group). 137 See supra notes 24–28 and accompanying text (noting that there are currently several U.S.-based regulated entities that facilitate bitcoin trading and that comply with U.S. AML and KYC regulatory requirements, and that a regulatory framework created by the NYSDFS sets forth consumer protection, AML compliance, and cyber security rules tailored for digital currency companies operating and transacting business in New York). The Commission notes that there is no basis in the record to support a finding that non-U.S. bitcoin exchanges that have not obtained a BitLicense are subject to AML, KYC, consumer protection, or cybersecurity requirements. VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest.’’ 138 Moreover, national securities exchanges are subject to Commission oversight of, among other things, their governance, membership qualifications, trading rules, disciplinary procedures, recordkeeping, and fees.139 Likewise, Designated Contract Markets that trade futures on commodities underlying other commodity-trust ETPs are registered with and regulated by the CFTC, and they must comply with, among other things, a similarly comprehensive range of regulatory principles and file their rule changes with the CFTC.140 Additionally, while the Exchange asserts that Genesis Global Trading is a FINRA member,141 the digital currency business of that firm, according to the Genesis Global Trading Web site, is conducted pursuant to a BitLicense issued by the NYSDFS, and only the securities activities of the firm are regulated by FINRA.142 Further, while the Exchange notes that the CFTC has asserted jurisdiction over derivatives on bitcoin,143 the Commission does not believe that the record supports a finding that there is currently a regulatory framework in the United States for detecting and deterring manipulation in the bitcoin spot markets. Although the CFTC can bring enforcement actions against manipulative conduct in spot markets for a commodity, spot markets are not required to register with the CFTC unless they offer leveraged, margined, or financed trading to retail customers.144 In all other cases, the CFTC does not set 138 15 U.S.C. 78f(b)(5). 6 of the Exchange Act, 15 U.S.C. 78f, requires national securities exchanges to register with the Commission and requires an exchange’s registration to be approved by the Commission, and Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b), requires national securities exchanges to file proposed rule changes with the Commission. 140 See, e.g., Designated Contract Markets (DCMs), U.S. Commodity Futures Trading Commission, available at https://www.cftc.gov/IndustryOversight/ TradingOrganizations/DCMs/index.htm. 141 See supra note 28 and accompanying text. 142 See Frequently Asked Questions, Genesis: A Digital Currency Group Company (FAQ: ‘‘Is Genesis Regulated?’’), https://genesistrading.com/ frequently-asked-questions/ (last visited Mar. 17, 2017). 143 See supra note 29 and accompanying text. 144 Commodity Exchange Act Section 2(c)(2)(D), 7 U.S.C. 2(c)(2)(D). See also Commodity Exchange Act Section 2(c)(2)(A), 7 U.S.C. 2(c)(2)(A) (defining CFTC jurisdiction to specifically cover contracts of sale of a commodity for future delivery (or options on such contracts), or an option on a commodity (other than foreign currency or a security or a group or index of securities), that is executed or traded on an organized exchange). 139 Section PO 00000 Frm 00101 Fmt 4703 Sfmt 4703 standards for, approve the rules of, examine, or otherwise regulate bitcoin spot markets. While the CFTC has brought settled enforcement actions against bitcoinrelated entities, these actions do not demonstrate that a regulatory framework for providing market oversight and deterring market manipulation currently exists for the bitcoin spot market. These actions have involved either (a) the failure of an entity to register with the CFTC before trading derivatives on bitcoin or offering leveraged, margined, or financed bitcoin trading to retail customers,145 or (b) the facilitation of wash trades in bitcoin swaps by a SEF registered with the CFTC.146 Based on the record, therefore, the Commission does not believe that the worldwide spot bitcoin markets, including the bitcoin exchanges that are constituents of the XBX Index, are regulated markets with which the Exchange has, or could enter into, a surveillance-sharing agreement.147 As noted above, the Lewis Paper asserts that, for several reasons, the underlying market for bitcoin is not susceptible to manipulation,148 and the Exchange agrees with this conclusion.149 While the Lewis Paper submits that arbitrage across bitcoin markets will help to keep worldwide bitcoin prices aligned with one another, hindering manipulation,150 the Commission believes that the Lewis Paper’s discussion of the possible sources of manipulation in the underlying bitcoin market is incomplete and does not form a basis to find that bitcoin cannot be manipulated—or to find, by implication, that no surveillance-sharing agreement is necessary between an exchange listing shares of a bitcoin-based ETP and 145 See Coinflip Settlement Order, supra note 115; In re BFXNA Inc., d/b/a Bitfinex, CFTC Docket No. 16–19 (CFTC June 2, 2016) (Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions (‘‘BFXNA Settlement Order’’)), available at https://www.cftc.gov/idc/ groups/public/@lrenforcementactions/documents/ legalpleading/enfbfxnaorder060216.pdf. 146 See In re TeraExchange LLC, CFTC Docket No. 15–33, 2015 WL 5658082 (CFTC Sept. 24, 2015) (Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions (‘‘TeraExchange Settlement Order’’)), available at https://www.cftc.gov/idc/groups/public/@ lrenforcementactions/documents/legalpleading/ enfteraexchangeorder92415.pdf. 147 The Exchange does not assert that it has a surveillance-sharing agreement with any bitcoin exchange. 148 See Lewis Paper, supra note 43; see also supra notes 70–74 and accompanying text. 149 See NYSE Letter, supra note 43, at 5; see also supra note 76 and accompanying text. 150 See Lewis Paper, supra note 43, at 6–7. E:\FR\FM\03APN1.SGM 03APN1 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices significant markets trading bitcoin or bitcoin derivatives.151 For example, while there is no inside information related to the earnings or revenue of bitcoin, there may be material non-public information related to the actions of regulators with respect to bitcoin; regarding order flow, such as plans of market participants to significantly increase or decrease their holdings in bitcoin; regarding new sources of demand, such as new ETPs that would hold bitcoin; or regarding the decision of a bitcoin-based ETP with respect to how it would respond to a ‘‘fork’’ in the blockchain, which would create two different, noninterchangeable types of bitcoin.152 mstockstill on DSK3G9T082PROD with NOTICES 151 The Sponsor also argues, in its second comment letter, that arbitrage across bitcoin markets helps to keep bitcoin prices aligned and reduces the likelihood of manipulation. See SolidX Letter II, supra note 43, at 5. The Sponsor offers several histograms purporting to show that pricing discrepancies across bitcoin markets are generally arbitraged away within several seconds. Id. These histograms, however, use data from only four bitcoin exchanges, based on the Sponsor’s argument that—in light of recently imposed capital controls in China and because Chinese exchanges trade bitcoins only against the Chinese yuan—the Chinese markets for bitcoin are ‘‘separate and distinct’’ from the USD market. Id. at 6–7. The Commission, however, believes that the Sponsor’s argument that the worldwide markets for trading bitcoins against various government currencies are ‘‘stable, resilient, fair and efficient,’’ see SolidX Letter, supra note 43, at 4, is at odds with its argument that there are at least two substantial segments of that market that have recently become ‘‘separate and distinct’’ from one another. See SolidX Letter II, supra note 43, at 6–7. Moreover, the Commission does not believe that the charts provided by the Sponsor establish there are two separate and distinct segments of the market. The data describe a limited period, and, while the charts purport to show a price differential between the XBX Index and the bitcoin prices on Chinese exchanges, the charts also appear to show a close correlation between the timing and direction of price movements in the two market ‘‘segments.’’ See id. If the market is not segmented, then the histograms (which show that pricing discrepancies across only four bitcoin markets are generally arbitraged away within several seconds) are not enough to establish that the worldwide markets are efficient. If anything, the data provided by the Sponsor show that bitcoin markets are still developing and that the efficiency of arbitrage between bitcoin markets may depend on, among other things, regulatory conditions that can change over time. And, even if the Commission assumed that bitcoin markets were efficient, other manipulation concerns—such as the potential for trading on material non-public information or potential issues arising from concentrated bitcoin holdings—would still be applicable. See infra notes 152–158 and accompanying text. 152 For example, as described in the Trust’s Registration Statement, supra note 21, in the event the bitcoin network undergoes a ‘‘hard fork’’ into two blockchains, the Trust would then hold equal amounts of both the original bitcoin and the alternative new bitcoin. As a result, the Sponsor would need to decide whether to continue to hold the original bitcoin, the alternative new bitcoin, or both and would need to decide what action to take with respect to the unselected bitcoin, such as the possible sale of the unselected bitcoin. The Sponsor’s decision to continue to hold either the VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 Additionally, the manipulation of asset prices, as a general matter, can occur simply through trading activity that creates a false impression of supply or demand, whether in the context of a closing auction or in the course of continuous trading, and does not require formal linkages among markets (such as consolidated quotations or routing requirements) or the complex quoting behavior associated with highfrequency trading. Although the Exchange notes that bitcoin trades continuously so that there are no opening or closing prices to manipulate, the Commission believes that continuous trading does not necessarily eliminate manipulation risk.153 While it may or may not be possible to acquire a dominant position in the bitcoin market as a whole, this risk exists, as the Lewis Paper concedes.154 And, as the Registration Statement discloses, it is reasonably likely that a small group of early adopters holds a significant proportion of the bitcoins that have been mined.155 The Lewis Paper lists a number of features of the Trust that should, the paper claims, ameliorate the risk of manipulation through ownership of a dominant market share,156 but these features generally address whether the Trust itself would acquire a dominant market share, or whether other market participants might acquire a dominant share of bitcoin ownership through participation in the underlying bitcoin markets. These features do not address the possible market effect of large bitcoin positions held by early adopters. Additionally, the Lewis Paper asserts that many features of the proposal that purportedly ameliorate the risk of price manipulation through a dominant market share are also factors that were used as a basis for the Commission’s approval of a commodity-trust ETP based on copper.157 The Commission notes, however, that the listing exchange for that copper-based ETP had entered into a surveillance-sharing original or alternative new bitcoin would be based on factors such as the market value and liquidity of the original bitcoin versus the alternative new bitcoin. Id. at 14. 153 See infra notes 164–165. 154 See supra notes 71–74 and accompanying text. 155 See Registration Statement, supra note 21, at 16. See also Lewis Paper, supra note 43, at 6. The Lewis Paper states that there is ‘‘no compelling evidence’’ to suggest that any single investor or group has acquired a dominant position in bitcoin, but its citation of ‘‘media estimates’’ regarding the holdings of certain individuals, see Lewis Paper, supra note 43, at 6 & n.7, only demonstrates that the risk of a person or group acquiring a significant proportion of all bitcoins cannot be quantified or dismissed. 156 See supra note 74. 157 See Lewis Paper, supra note 43, at 6 n.8. PO 00000 Frm 00102 Fmt 4703 Sfmt 4703 16257 agreement with the London Metal Exchange regarding trading in copper and copper futures and that the listing exchange was also a common member of the Intermarket Surveillance Group with the COMEX, which also trades copper futures.158 Thus, the Commission does not believe that the record supports a finding that the unique properties of bitcoin and the underlying bitcoin market are so different from the properties of other commodities and commodity futures markets that they justify a significant departure from the standards applied to previous commodity-trust ETPs. 3. The Susceptibility to Manipulation of the XBX Index The Sponsor, the Exchange, and the Lewis Paper all express the view that the XBX Index is resistant to manipulation because of its proprietary weighting methodology and its ability to respond to market movements in real time.159 In essence, they claim that the XBX Index’s weighting methodology is able to resist the effects of manipulation because it discounts prices from constituent exchanges based on lower volume at that exchange, price deviation from the average on other exchanges, and the staleness of reported prices.160 Additionally, the Sponsor and the Lewis Paper note that the XBX Index is not susceptible to a key mechanism of manipulation, opening and closing auctions.161 The Commission, however, does not agree that index-based pricing for the Trust’s bitcoin assets eliminates the risk of manipulation or the need to monitor that risk through surveillance-sharing agreements. While the XBX Index methodology uses an algorithm to discount prices that deviate from the average, this automatic discounting could attenuate, but not eliminate, the effect of manipulative activity on one of the constituent exchanges—just as it could attenuate, but not eliminate, the effect of bona fide liquidity demand on one of those exchanges. 158 See Exchange Act Release No. 68440 (Dec. 14, 2012), 77 FR 75468, 75472 (Dec. 20, 2012) (NYSEArca-2012–28) (approval of proposal to list and trade shares of the JPM XF Physical Copper Trust). 159 See supra Section II.B. See also supra note 16 (describing the Sponsor’s representation that the XBX Index’s price variance weighting decreases the influence on the XBX Index of any particular exchange that diverges from the rest of the data points used by the XBX Index and thereby reduces the possibility of an attempt to manipulate the price of bitcoin as reflected by the XBX Index). 160 See, e.g., Lewis Paper, supra note 43, at 8. 161 See SolidX Letter, supra note 43, at 8; Lewis Paper, supra note 43, at 9. E:\FR\FM\03APN1.SGM 03APN1 16258 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices The Lewis Paper asserts that the absence of formal ties between bitcoin exchanges (i.e., the absence of an analog to Regulation NMS in the U.S. equity markets) means that demands for liquidity will not propagate across the worldwide market for bitcoin, limiting the price impact of manipulative behavior in the underlying market.162 However, to the extent that market participants view pricing information from one exchange as indications of likely price moves on other exchanges, price moves on the first exchange might be, temporarily at least, reflected on those other exchanges, despite the discounting function of the XBX Index algorithm. And, as material non-public information—such as regulatory information—can exist with respect to bitcoin, use of that information might be possible across multiple component exchanges, affecting the level of the XBX Index without requiring the deployment of large amounts of capital.163 The Commission also observes that, while the XBX Index will be calculated continuously, this does not eliminate possible incentives for market participants to manipulate prices at single points in time. The Exchange notes that a closing level of the XBX Index will be calculated and published at or after 4:00 p.m. E.T.,164 and that the NAV of the Trust will be set using the XBX Index value as of 4:00 p.m. E.T., so the Commission believes that incentives would exist to manipulate the XBX Index at specific times.165 Accordingly, the Commission does not believe that the record supports the claim that the unique properties of the XBX Index—or of a commodity-trust ETP based on the XBX Index—are 162 Lewis Paper, supra note 43, at 8–9. Lewis Paper notes that, since each bitcoin exchange is an independent entity, a liquidity event on one exchange does not necessarily propagate across other exchanges. This, according to the Lewis Paper, makes prices more resilient to liquidity shocks, but also slows down the transmission of fundamental information. See id. at 9. The Commission does not believe that manipulative activity propagates across trading venues solely through demands on liquidity being transferred from one venue to another. For example, regulatory events may simultaneously affect more than one bitcoin exchange, and the dissemination of pricing information from trades on one exchange may affect traders’ view of supply and demand on other exchanges. 164 See supra note 16 and accompanying text. 165 The Lewis Paper argues that, because bitcoin is quoted in prices with eight decimal places, this ‘‘mitigates incentives to move prices a penny up or penny down because the potential gains from moving prices at the eighth decimal point are immaterial.’’ Lewis Paper, supra note 43, at 9. But the divisibility of bitcoin itself is not relevant, and even if it were, the incentive to move the price by one hundred-millionth of a bitcoin would increase as the price and volume of traded bitcoin increased. mstockstill on DSK3G9T082PROD with NOTICES 163 The VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 sufficient to isolate the Shares from any manipulative activity in the underlying market or, by extension, to justify a significant departure from the standards applied to previous commodity-trust ETPs. 4. The Market for Derivatives on Bitcoin As noted above,166 the commoditytrust ETPs previously approved by the Commission for listing and trading have had—in lieu of significant, regulated spot markets—significant, wellestablished, and regulated futures markets that were associated with the underlying commodity and with which the listing exchange had entered into a surveillance-sharing agreement. For the reasons discussed further below, the Commission believes that this proposal fails to support a finding that there are significant, regulated derivatives markets related to bitcoin with which the Exchange could enter into a surveillance-sharing agreement. The Exchange states that the CFTC has approved the registration of TeraExchange as a SEF and has provisionally registered another SEF, LedgerX, and that these are markets where market participants can enter into bitcoin swaps and NDFs.167 The Commission observes, however, that there is no evidence in the record that either of these venues transacts significant volume in bitcoin-related derivatives, and the Commission notes that the CFTC has, in fact, brought a settled enforcement action against one of those venues for facilitating prearranged, offsetting ‘‘wash’’ transactions and issuing a press release ‘‘to create the impression of actual trading in the Bitcoin swap.’’ 168 The Exchange names several non-U.S. bitcoin exchanges that offer derivative products on bitcoin such as options, swaps, and futures. The Commission, however, does not believe that the existence of these markets supports a finding that there are significant, regulated markets for bitcoin derivatives with which the Exchange could enter into a surveillance-sharing agreement. The record does not contain any evidence of the trading volume of these markets, the state of regulation of these markets, or the availability of surveillance-sharing agreements with the regulators of these markets. The Lewis Paper asserts that the existence of bitcoin derivative markets is not a necessary condition for a bitcoin 166 See supra notes 125–126 and accompanying text. 167 See supra notes 34–36 and accompanying text. TeraExchange Settlement Order, supra note 146 and accompanying text. 168 See PO 00000 Frm 00103 Fmt 4703 Sfmt 4703 ETP.169 The key requirement the Commission is applying here, however, is not that a futures or derivatives market is required for every ETP, but that—when the spot market is unregulated—there must be significant, regulated derivatives markets related to the underlying asset with which the Exchange can enter into a surveillancesharing agreement. 5. The Susceptibility of the Shares to Manipulation The Exchange represents that its existing surveillance measures, which focus on trading in the Shares, are sufficient to support the proposed rule change. Specifically, the Exchange represents that its surveillance procedures are adequate to properly monitor the trading of the Shares on the Exchange during all trading sessions and to detect and deter violations of Exchange rules and the applicable federal securities laws.170 The Exchange further represents that trading of the Shares through the Exchange will be subject to the Exchange’s surveillance procedures for derivative products, including Commodity-Based Trust Shares, and that the Exchange may obtain information regarding trading in the Shares through the Intermarket Surveillance Group, from other members of that group, or from markets with which the Exchange has a surveillance-sharing agreement.171 The Exchange also notes that, pursuant to its listing standards for Commodity-Based Trust Shares, the Exchange is able to obtain information regarding trading in the Shares and the underlying bitcoin, or any bitcoin derivative, from market makers registered with the Exchange, in connection with the market makers’ proprietary or customer trades effected on any relevant market.172 Moreover, as noted earlier, some commenters assert that regulation by the Exchange of activity in the ETP could substitute for a lack of regulation in underlying spot or derivatives markets.173 The Sponsor also argues that 169 See Lewis Paper, supra note 43, at 8. supra note 37 and accompanying text. 171 See supra note 38 and accompanying text. 172 See supra note 38. NYSE Arca Equities Rule 8.201(g) provides that a registered market maker in Commodity-Based Trust Shares must file with the Exchange and keep current a list identifying all accounts for trading in an underlying commodity, related commodity futures or options on commodity futures, or any other related commodity derivatives that the market maker may have or over which it may exercise investment discretion and must make available to the Exchange books, records, or other information relating to transactions in the underlying physical commodity, related commodity futures, or options on commodity futures. 173 See supra notes 86–87 and accompanying text. 170 See E:\FR\FM\03APN1.SGM 03APN1 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices mstockstill on DSK3G9T082PROD with NOTICES the Exchange’s listing standards will provide strong protection against manipulation of the Shares.174 The Commission notes the Exchange’s proposed surveillance procedures regarding the Shares, and the views expressed by the Lewis Paper and the Sponsor regarding the Trust’s disclosures and information dissemination procedures. The Commission, however, views these procedures as necessary, but not sufficient, in light of the discussion above noting that the Exchange has not entered into, and would currently be unable to enter into, surveillancesharing agreements with significant, regulated markets for trading either bitcoin itself or derivatives on bitcoin.175 In addition, while the Exchange would, pursuant to its listing rules, be able to obtain certain information regarding trading in the Shares and the underlying bitcoin or any bitcoin derivative through Exchange-registered market makers,176 the Commission observes that this trade information would be limited to the activities of its members that are market makers. Moreover, the Commission does not accept the premise that regulation of trading in the Shares is a sufficient and acceptable substitute for regulation in the spot or derivatives markets related to the underlying asset. Absent the ability to detect and deter manipulation of the Shares—through surveillance sharing with significant, regulated markets related to the underlying asset—the Commission does not believe that a national securities exchange can meet its Exchange Act obligations when listing shares of a commodity-trust ETP. 6. The Protection of Investors and the Public Interest The Sponsor argues that approval of the proposed rule change is consistent with the protection of investors because investors are currently being harmed by the inability to invest in an insured bitcoin vehicle and need to be protected from ‘‘ongoing losses related to hacking, errors and other operational hazards associated with direct bitcoin ownership.’’ 177 The Sponsor concludes that Section 6(b)(5) of the Exchange Act compels approval of the Exchange’s proposal, so that investors may invest in the Trust and thereby be protected from these risks.178 In essence, the Sponsor asserts that it is the risky nature of direct investment in the underlying 174 See SolidX Letter II, supra note 43, at 2–3. supra Sections III.B.2 & III.B.4. 176 See supra note 172 and accompanying text. 177 SolidX Letter II, supra note 43, at 2. 178 See supra note 39 and accompanying text. 175 See VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 bitcoin (including lack of insurance coverage) and the unregulated markets on which bitcoin trades that compel approval of the proposed rule change. The Sponsor offers no limiting principle to this argument, under which, by logical extension, the Commission would be required to approve the listing and trading of any ETP that arguably presented marginally less risk to investors than a direct investment in the underlying asset. The Commission disagrees with this reading of the Exchange Act. Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must approve a proposed rule change filed by a national securities exchange if it finds that the proposed rule change is consistent with the applicable requirements of the Exchange Act—including the requirement under Section 6(b)(5) that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices—and it must disapprove the filing if it does not make such a finding.179 Thus, even if a proposed rule change purports to protect investors from a particular type of investment risk—such as the susceptibility of an asset to loss or theft—the proposed rule change may still fail to meet other requirements under the Exchange Act.180 As explained above, the Commission has consistently, for commodity-trust ETPs, required that the listing exchange have surveillance-sharing agreements with significant, regulated markets related to the underlying asset. That requirement has not been met here. Therefore, the Commission—even if, for the sake of argument, it agreed that investment in the Trust might present fewer risks to investors than direct investments in bitcoin—would be unable to find that the proposed rule change is consistent with the statutory standard. C. Basis for Disapproval The Commission has, in past approvals of commodity-trust ETPs, emphasized the importance of surveillance-sharing agreements between the national securities exchange listing and trading the ETP, and significant markets relating to the 179 See Exchange Act Section 19(b)(2)(C), 15 U.S.C. 78s(b)(2)(C). 180 The Commission notes that the insurance policy for the Trust’s bitcoin holdings, as described by the Exchange and the Sponsor, see Amendment No. 1, supra note 1, 82 FR at 12261; SolidX Letter, supra note 43, at 2, 5, 11–12, covers theft and loss of the bitcoin holdings, but does not insure against the risk of loss resulting from fraudulent or manipulative acts and practices with respect to the underlying bitcoins or the Shares. PO 00000 Frm 00104 Fmt 4703 Sfmt 4703 16259 underlying asset.181 Such agreements, which are a necessary tool to enable the ETP-listing exchange to detect and deter manipulative conduct, enable the exchange to meet its obligation under Section 6(b)(5) of the Exchange Act to have rules that are designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.182 As described above, the Exchange has not entered into a surveillance-sharing agreement with a significant, regulated, bitcoin-related market. The Commission also does not believe, as discussed above, that the proposal supports a finding that the significant markets for bitcoin or derivatives on bitcoin are regulated markets with which the Exchange can enter into such an agreement. Therefore, as the Exchange has not entered into, and would currently be unable to enter into, the type of surveillance-sharing agreement that has been in place with respect to all previously approved commodity-trust ETPs, the Commission does not find the proposed rule change to be consistent with the Exchange Act and, accordingly, disapproves the proposed rule change. The Commission notes that bitcoin is still in the relatively early stages of its development and that, over time, regulated bitcoin-related markets of significant size may develop. Should such markets develop, the Commission could consider whether a bitcoin ETP would, based on the facts and circumstances then presented, be consistent with the requirements of the Exchange Act. IV. Conclusion For the reasons set forth above, the Commission does not find that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to a national securities exchange, and in particular, with Section 6(b)(5) of the Exchange Act. It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act,183 that the proposed rule change (SR– NYSEArca–2016–101), as modified by Amendment No. 1, be, and it hereby is, disapproved. 181 See supra notes 125–126 and accompanying text. The Commission has also emphasized this requirement in the context of disapproving a proposal to list and trade shares of a commoditytrust ETP. See Bats BZX Order, supra note 6, 82 FR at 14087. 182 15 U.S.C. 78f(b)(5). 183 15 U.S.C. 78s(b)(2). E:\FR\FM\03APN1.SGM 03APN1 16260 Federal Register / Vol. 82, No. 62 / Monday, April 3, 2017 / Notices For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.184 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–06441 Filed 3–31–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–80323; File No. SR–OCC– 2017–802] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning Enhancements to OCC’s Stock Loan Programs March 28, 2017. mstockstill on DSK3G9T082PROD with NOTICES Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, entitled Payment, Clearing and Settlement Supervision Act of 2010 (‘‘Payment, Clearing and Settlement Supervision Act’’) 1 and Rule 19b– 4(n)(1)(i) under the Securities Exchange Act of 1934 (‘‘Act’’),2 notice is hereby given that on February 28, 2017, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) an advance notice as described in Items I and II below, which Items have been prepared by OCC. The Commission is publishing this notice to solicit comments on the advance notice from interested persons. I. Clearing Agency’s Statement of the Terms of Substance of the Advance Notice This advance notice concerns a number of proposed enhancements to OCC’s Stock Loan/Hedge Program (‘‘Hedge Program’’) and Market Loan Program (collectively, the ‘‘Stock Loan Programs’’). The proposed changes would, among other things: (1) Require Clearing Members to have robust processes in place to reconcile open interest in the Stock Loan Programs at least once per stock loan business day; (2) provide further clarity and certainty regarding the formal record of stock loan positions being guaranteed by OCC at any given time (‘‘golden copy’’ rules); (3) further clarify that stock loan positions at OCC are not terminated until the records of OCC reflect the termination of such stock loan; (4) provide a specific timeframe in which Clearing Members in the Stock Loan 184 17 CFR 200.30–3(a)(12). U.S.C. 5465(e)(1). 2 17 CFR 240.19b–4(n)(1)(i). 1 12 VerDate Sep<11>2014 18:32 Mar 31, 2017 Jkt 241001 Programs must buy-in or sell-out of stock loan positions in the event of another Hedge or Market Loan Clearing Member suspension (as applicable); (5) provide OCC with the authority to withdraw from a Clearing Member’s account the value of any difference between the price reported by a Clearing Member instructed to execute a buy-in or sell-out of loaned stock as a result of another Clearing Member suspension and the price that OCC determines to be reasonable; and (6) allow OCC to close out the Matched-Book Positions of suspended Hedge Clearing Members through the termination by offset and ‘‘re-matching’’ of such positions without requiring the transfer of securities against the payment of settlement prices as currently required under OCC’s rules. All terms with initial capitalization not defined herein have the same meaning as set forth in OCC’s By-Laws and Rules.3 II. Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Advance Notice In its filing with the Commission, OCC included statements concerning the purpose of and basis for the advance notice and discussed any comments it received on the advance notice. The text of these statements may be examined at the places specified in Item IV below. OCC has prepared summaries, set forth in sections A and B below, of the most significant aspects of these statements. (A) Clearing Agency’s Statement on Comments on the Advance Notice Received From Members, Participants or Others Written comments were not and are not intended to be solicited with respect to the proposed changes and none have been received. OCC has, however, discussed the re-matching in suspension proposal with its Clearing Members at numerous member outreach forums and meetings. While members were generally supportive of the proposal, some members did raise concerns over the possibility of being re-matched with a counterparty with which the Clearing Member does not have an existing securities lending relationship. For example, some Clearing Members noted that they could be re-matched with counterparties with which they do not have an existing Master Securities Lending Agreement (‘‘MSLA’’),4 which 3 OCC’s By-Laws and Rules can be found on OCC’s public Web site: https://optionsclearing.com/ about/publications/bylaws.jsp. 4 Commission Staff received OCC’s consent to insert ‘‘Master Securities Lending Agreement’’ before the acronym ‘‘MSLA’’ pursuant to a telephone conversation on March [6], 2017. PO 00000 Frm 00105 Fmt 4703 Sfmt 4703 dictates all of the terms of the stock loan not governed by OCC’s By-Laws and Rules (e.g., Mark-to-Market percentage and rounding preferences). In addition, re-matched counterparties that do not have an existing securities lending relationship would need to make operational changes in order to make deliveries to their new counterparty in the event of a termination or buy-in to close out the loan. OCC carefully considered this member feedback in the development of its proposal, and in order to mitigate these concerns, the proposed rematching in suspension rules would require OCC to make reasonable efforts to re-match Hedge Clearing Members that maintain between them current executed MSLAs. Specifically, under the proposed changes, OCC would use a matching algorithm to re-match stock loan and stock borrow positions in order of priority based on the largest available stock borrow or stock loan positions, as applicable, for the selected Eligible Stock for which a MSLA exists between the Borrowing and Lending Clearing Members to ensure that members with existing securities lending relationships are re-matched to the greatest extent possible. Even in light of these concerns, however, Clearing Members generally agreed that it is preferable to maintain a stock loan with another counterparty rather than attempting to close out stock loan positions in the event of a Hedge Clearing Member suspension as in many cases (and particularly in stressed market conditions) it could be difficult for the borrower to return the securities to the lender since the securities would likely be being used for other purposes. (B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, Clearing, and Settlement Supervision Act Purpose of the Proposed Change OCC proposes a number of amendments to its By-Laws and Rules designed to enhance the overall resilience of its Stock Loan/Hedge Program (‘‘Hedge Program’’) and Market Loan Program (collectively, the ‘‘Stock Loan Programs’’). Specifically, the proposed changes would improve risk management in the Stock Loan Programs by, among other things: (1) Requiring Clearing Members to have robust processes in place to reconcile open interest in the Stock Loan Programs at least once per stock loan business day; (2) providing further clarity and certainty regarding the formal record of stock loan positions being guaranteed by OCC at any given time (‘‘golden copy’’ rules); (3) further E:\FR\FM\03APN1.SGM 03APN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 82, Number 62 (Monday, April 3, 2017)]
[Notices]
[Pages 16247-16260]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-06441]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80319; File No. SR-NYSEArca-2016-101]

Self-Regulatory Organizations; NYSE Arca, Inc.; Order
Disapproving a Proposed Rule Change, as Modified by Amendment No. 1,
Relating to the Listing and Trading of Shares of the SolidX Bitcoin
Trust Under NYSE Arca Equities Rule 8.201

March 28, 2017.
NYSE Arca (``Exchange'' or ``NYSE Arca'') has filed a proposed rule
change to list and trade shares of the SolidX Bitcoin Trust.\1\ When an
exchange makes such a filing,\2\ the Commission must determine whether
the proposed rule change is consistent with the statutory provisions,
and the rules and regulations, that apply to national securities
exchanges.\3\ The Commission must approve the filing if it finds that
the proposed rule change is consistent with these legal requirements,
and it must disapprove the filing if it does not make such a
finding.\4\
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\1\ The Exchange filed the proposed rule change on July 13,
2016, and the Commission published notice of the proposed rule
change in the Federal Register on August 2, 2016. See Exchange Act
Release No. 78426 (July 27, 2016), 81 FR 50763 (Aug. 2, 2016)
(``Notice''). On September 6, 2016, the Commission designated a
longer period within which to act on the proposed rule change. See
Exchange Act Release No. 78770 (Sept. 6, 2016), 81 FR 62780 (Sept.
12, 2016). On October 27, 2016, the Commission instituted
proceedings under Section 19(b)(2)(B) of the Securities Exchange Act
of 1934 (``Exchange Act''), 15 U.S.C. 78s(b)(2)(B), to determine
whether to approve or disapprove the proposed rule change. See
Exchange Act Release No. 79171 (Oct. 27, 2016), 81 FR 76400 (Nov. 2,
2016) (``Order Instituting Proceedings''). On January 3, 2017, the
Commission designated a longer period for Commission action on the
proposed rule change. See Exchange Act Release No. 79726 (Jan. 3,
2017), 82 FR 2426 (Jan. 9, 2017) (designating March 30, 2017, as the
date by which the Commission must either approve or disapprove the
proposed rule change). On February 15, 2017, the Exchange filed
Amendment No. 1 to the proposed rule change, amending and replacing
the original filing in its entirety, and Amendment No. 1 was
published for comment in the Federal Register on March 1, 2017, with
a 15-day comment period that ended on March 16, 2017. See Exchange
Act Release No. 80099 (Feb. 24, 2017), 82 FR 12253 (Mar. 1, 2017)
(``Amendment No. 1'').
\2\ Such filings are made under Section 19(b)(1) of the Exchange
Act, 15 U.S.C. 78s(b)(1), and Exchange Act Rule 19b-4, 17 CFR
240.19b-4.
\3\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\4\ See id.
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As discussed further below, the Commission is disapproving this
proposed rule change because it does not find the proposal to be
consistent with Section 6(b)(5) of the Exchange Act, which requires,
among other things, that the rules of a national securities exchange be
designed to prevent fraudulent and manipulative acts and practices and
to protect investors and the public interest.\5\ The Commission
believes that, in order to meet this standard, an exchange that lists
and trades shares of commodity-trust exchange-traded products
(``ETPs'') must, in addition to other applicable requirements, satisfy
two requirements that are dispositive in this matter.\6\ First, the
exchange must have surveillance-sharing agreements with significant
markets for trading the underlying commodity or derivatives on that
commodity. And second, those markets must be regulated.\7\
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\5\ 15 U.S.C. 78f(b)(5).
\6\ This approach is consistent with standards the Commission
has applied to previous commodity-trust ETPs as well as the
Commission's recent action disapproving the proposed rule change of
Bats BZX Exchange to list and trade shares issued by the Winklevoss
Bitcoin Trust. See, e.g., Exchange Act Release No. 80206 (Mar. 10,
2017), 82 FR 14076, 14077 n.6 (Mar. 16, 2017) (``Bats BZX Order'').
\7\ As discussed below, infra notes 125-126 and accompanying
text, the significant markets relating to the commodity-trust ETPs
approved to date have been well-established regulated futures
markets for the underlying commodity.
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Based on the record before it, the Commission believes that the
significant markets for bitcoin are unregulated. Therefore, as the
Exchange has not entered into, and would currently be unable to enter
into, the type of surveillance-sharing agreement that has been in place
with respect to all previously approved commodity-trust ETPs--
agreements that help address concerns about the potential for
fraudulent or manipulative acts and practices in this market--the
Commission does not find the proposed rule change to be consistent with
the Exchange Act.

I. Description of the Proposal

The Exchange proposes to list and trade shares (``Shares'') of the
SolidX Bitcoin Trust (``Trust'') as Commodity-Based Trust Shares under
NYSE Arca Equities Rule 8.201.\8\
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\8\ See NYSE Arca Equities Rule 8.201 (permitting the listing
and trading of ``Commodity-Based Trust Shares,'' defined as a
security (a) that is issued by a trust that holds a specified
commodity deposited with the trust; (b) that is issued by the trust
in a specified aggregate minimum number in return for a deposit of a
quantity of the underlying commodity; and (c) that, when aggregated
in the same specified minimum number, may be redeemed at a holder's
request by the trust, which will deliver to the redeeming holder the
quantity of the underlying commodity). Other national securities
exchanges that list and trade shares of commodity-trust ETPs have
similar rules. See, e.g., BZX Rule 14.11(e)(4)(C) (permitting the
listing and trading of Commodity-Based Trust Shares) and Nasdaq Rule
5711(d) (permitting the listing and trading of Commodity-Based Trust
Shares). Commodity-trust ETPs differ from exchange-traded funds
(ETFs) in a number of ways, including that they hold as an asset a
single commodity, rather than a portfolio of multiple securities,
and that they are not regulated under the Investment Company Act of
1940.
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The Trust would hold bitcoins as its primary asset,\9\ along with
smaller amounts of cash, and the bitcoins would be in the custody of,
and secured by, the Trust's bitcoin custodian, SolidX Management LLC,
which would also serve as the sponsor (``Sponsor'') of the Trust.\10\
The Bank of New York Mellon would serve as the Trust's cash custodian
and its administrator (``Administrator'').\11\ According to the
Exchange, the Sponsor has arranged for insurance coverage to protect
investors against loss or theft of the Trust's bitcoins.\12\
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\9\ According to the Exchange, bitcoin is ``an asset that can be
transferred among parties via the Internet, but without the use of a
central administrator or clearing agency.'' Amendment No. 1, supra
note 1, 82 FR at 12254 n.14. The Exchange also states that ``[t]he
Bitcoin Network (i.e., the network of computers running the software
protocol underlying bitcoin involved in maintaining the database of
bitcoin ownership and facilitating the transfer of bitcoin among
parties) and the asset, bitcoin, are intrinsically linked and
inseparable.'' Id. at 12255. For the purpose of considering this
proposal, this order describes bitcoin as a ``digital asset'' and a
``commodity.''
\10\ See id. at 12254.
\11\ See id.
\12\ See id. at 12261.
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The investment objective of the Trust would be for the Shares to
track the price of bitcoins as measured by the TradeBlock XBX Index
(``XBX Index'').\13\ The XBX Index is licensed by the Sponsor from
Schvey, Inc., d/b/a TradeBlock, the index sponsor and calculation
agent.\14\ As of January 15,

[[Page 16248]]

2017, the eligible bitcoin exchanges for inclusion in the XBX Index are
Bitfinex, Bitstamp, GDAX (f/k/a Coinbase), itBit, and OKCoin
International.\15\ According to the Exchange:
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\13\ See id. at 12255.
\14\ See id. at 12257.
\15\ See id. at 12258.

[T]he XBX represents the value of one bitcoin in U.S. dollars at
any point in time and closes as of 4:00 p.m. Eastern time (``E.T.'')
each weekday. The intra-day levels of the XBX incorporate the real-
time price of bitcoin based on trading activity derived from
constituent exchanges throughout each trading day. The closing level
of the XBX is calculated using a proprietary methodology utilizing
bitcoin trading data from constituent exchanges and is published at
or after 4:00 p.m. E.T. each weekday. The XBX is published to two
decimal places rounded on the last digit.\16\
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\16\ Id. at 12257. The Exchange represents that, according to
the Sponsor, the XBX Index's price variance weighting decreases the
influence on the XBX Index of any particular exchange that diverges
from the rest of the data points used by the XBX Index and thereby
reduces the possibility of an attempt to manipulate the price of
bitcoin as reflected by the XBX Index. See id. at 12259.

The Net Asset Value (``NAV'') of the Trust would be calculated each
business day by the Administrator, as promptly as practicable after
4:00 p.m. E.T., using the price set for bitcoin by the XBX Index.\17\
The Intraday Indicative Value (``IIV'') of the Trust would be
calculated and disseminated by the Sponsor every 15 seconds during the
Exchange's regular trading session. The IIV would be calculated by
using the prior day's closing NAV per Share as a base and updating that
value during the regular trading session on the Exchange to reflect
intraday changes in the value of the Trust's bitcoin holdings.\18\
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\17\ See id. at 12262. If for any reason, and as determined by
the Sponsor, the Administrator is unable to value the Trust's
bitcoin using the XBX Index price, the Exchange's proposal provides
that the Administrator may use other specified criteria to value the
holdings of the Trust. Id. at 12261.
\18\ See id. at 12265.
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The Trust would issue and redeem the Shares only in baskets of
100,000 Shares and only to authorized participants (``Authorized
Participants''), and these transactions would be conducted ``in-kind''
for bitcoin or for cash.\19\ The Exchange states that for creating and
redeeming baskets in-kind or for cash, Authorized Participants and
market makers would be able to hedge their exposure to bitcoin using
non-deliverable forward contracts (``NDFs'') and swap contracts that
would create synthetic long or short exposure to bitcoin for
hedging.\20\
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\19\ See id. at 12263.
\20\ See id. The Exchange states that the Sponsor expects that
NDFs or swaps will be offered by several participants in the bitcoin
marketplace, including bitcoin exchanges and bitcoin over-the-
counter (``OTC'') market participants, and that the Sponsor itself
(operating on a principal basis) also may offer NDFs and swaps in
order to provide Authorized Participants and market makers with
additional options for hedging their exposure to bitcoin. See id.
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According to the Exchange, the underlying bitcoin marketplace
operates 24 hours per day, 365 days per year. The Exchange cites the
Trust's registration statement (``Registration Statement'') for the
proposition that the majority of bitcoin transactions are executed on
public bitcoin exchanges where bitcoins are bought and sold daily for
value in U.S. dollar (``USD''), euro, and other government-issued
currencies,\21\ and the Exchange states that there are currently 30
bitcoin exchanges across the world.\22\ According to the Exchange, the
various bitcoin exchanges are generally available to the public through
online web portals, and trading information (including pricing, volume,
and pending orders) is available on the exchanges' Web sites, with most
of this information publicly available to anyone who visits the Web
sites.\23\
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\21\ See Registration Statement on Form S-1, as amended, dated
February 3, 2017 (File No. 333-212479), at 38.
\22\ See id. at 12257. According to the Exchange, the Sponsor
estimates that, in the global USD-bitcoin market, trading volume in
the OTC market averages about half of the trading volume on
exchanges. See id. at 12259-60.
\23\ See id. at 12256-67. The Exchange represents that,
according to the Sponsor, Bitfinex, one of the bitcoin exchanges
included in the Trust's underlying XBX Index, does not conduct
business in New York or with New York residents and that another XBX
Index component bitcoin exchange, OKCoin International, is open only
to non-U.S. persons. See also id. at 12258 (acknowledging that
certain spot bitcoin exchanges are open only to non-U.S. persons or
do not conduct business with New York residents and that, as a
result, the Sponsor must conduct some of its bitcoin trading on
behalf of the Trust through a wholly-owned subsidiary, SolidX
Management Ltd., an exempted limited company organized in the Cayman
Islands specifically established to buy and sell bitcoin on behalf
of the Trust on these bitcoin exchanges).
---------------------------------------------------------------------------

The Exchange states that, according to the Registration Statement,
there are currently several U.S.-based regulated entities that
facilitate bitcoin trading and that comply with anti-money laundering
(``AML'') and know your customer (``KYC'') regulatory requirements:
\24\
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\24\ See id. at 12257.
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GDAX, which is based in California, is a bitcoin exchange
that maintains money transmitter licenses in over 30 states, the
District of Columbia, and Puerto Rico. GDAX is subject to the
regulations enforced by the various state agencies that issued their
respective money transmitter licenses to GDAX. In New York, GDAX
applied for a BitLicense, a regulatory framework created by the New
York Department of Financial Services (``NYSDFS'') that sets forth
consumer protection, AML compliance, and cybersecurity rules tailored
for digital currency companies operating and transacting business in
New York. The NYSDFS granted a BitLicense to GDAX in January 2017.\25\
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\25\ See id.
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itBit is a bitcoin exchange that was granted a limited-
purpose-trust-company charter by the NYSDFS in May 2015. Limited-
purpose trusts, according to the NYSDFS, are permitted to undertake
certain activities, such as transfer agency, securities clearance,
investment management, and custodial services, but without the power to
take deposits or make loans.\26\
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\26\ See id.
---------------------------------------------------------------------------

Gemini is a bitcoin exchange that is also regulated by the
NYSDFS. In October 2015, the NYSDFS granted Gemini authorization to
operate as a limited-purpose trust company.\27\
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\27\ See id.
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SecondMarket, Inc., d/b/a Genesis Global Trading, is a
member firm of the Financial Industry Regulatory Authority (``FINRA'')
that makes a market in bitcoin by offering two-sided liquidity.\28\
---------------------------------------------------------------------------

\28\ See id.

The Exchange notes that the CFTC has stated that bitcoins and other
virtual currencies are encompassed in the definition of ``commodity''
under the Commodity Exchange Act and are thus within the regulatory
jurisdiction of the CFTC.\29\
---------------------------------------------------------------------------

\29\ See id. at 12261. The Exchange also cites views expressed
by individual CFTC Commissioners for the proposition that
derivatives based on bitcoin are subject to oversight by the CFTC,
including oversight to prevent market manipulation of the price of
bitcoin. Id.
---------------------------------------------------------------------------

According to the Exchange, the exchanges with the most significant
bitcoin trading by volume--Bitfinex, Bitstamp, BTCC, BTC-e, GDAX,
Huobi, itBit, Kraken, LakeBTC, OKCoin Exchange China, and OKCoin
International--traded approximately 1.34 billion bitcoins, at USD-
converted prices ranging between $199 and $1,203, for a total trade
volume of over $784 billion from February 2014 through January 2017.
The Sponsor represents that average global daily trading volume during
this period was approximately $693 million.\30\
---------------------------------------------------------------------------

\30\ See id. at 12257.
---------------------------------------------------------------------------

According to the Exchange, between January 16, 2016, and January
15, 2017 (including weekends and holidays), average daily bitcoin
trading on Bitfinex, Bitstamp, GDAX, Gemini, itBit, and OKCoin
International totaled approximately 44,000 bitcoins across all of those
exchanges at prices that ranged between $371 and $1,161. Of that

[[Page 16249]]

trading, Bitfinex accounted for 39%, Bitstamp accounted for 13%, GDAX
accounted for 14%, Gemini accounted for 4%, itBit accounted for 9%,
Kraken accounted for 3%, and OKCoin International accounted for 17% of
bitcoins traded.\31\ The Exchange represents that, during the twelve-
month period from January 2016 through January 2017, the aggregate
trading volume on the five constituent exchanges of the XBX Index as of
January 15, 2017--Bitfinex, Bitstamp, GDAX, itBit, and OKCoin
International--represented approximately 77% of the entire global USD-
denominated bitcoin exchange market.\32\
---------------------------------------------------------------------------

\31\ See id. at 12259.
\32\ See id. at 12259-61. The Exchange further notes that, in
addition to the five constituent exchanges of the XBX Index as of
January 15, 2017, the global USD-denominated bitcoin exchange market
also includes BTC-e, Gemini, LakeBTC, and Kraken. The Exchange
represents that, although BTC-e is a USD-denominated bitcoin
exchange with significant trading volume, BTC-e does not comply with
certain of the Sponsor's internal criteria regarding the exchanges
on which the Sponsor will trade and that, therefore, the Sponsor
will not transact with BTC-e. According to the Exchange, the Sponsor
is aware of other smaller USD-denominated bitcoin exchanges, but the
trading volume on these exchanges is insignificant, and the Sponsor
does not intend to conduct business with these smaller exchanges.
See id. at 12259 n.30. The Commission notes that, as of March 20,
2017, the TradeBlock Web site indicated that the XBX Index weighting
assigned to the OKCoin International exchange was zero percent. See
TradeBlock, https://tradeblock.com/markets/index/ (last visited Mar.
20, 2017).
---------------------------------------------------------------------------

According to the Exchange, although each bitcoin exchange has its
own market price, it is expected that most bitcoin exchanges' market
prices should be relatively consistent with the bitcoin-exchange market
average, since market participants can choose the bitcoin exchange on
which they buy or sell bitcoin. The Exchange also represents that,
according to the Registration Statement, price differentials across
bitcoin exchanges enable arbitrage between bitcoin prices on the
various exchanges.\33\ As a result, according to the Exchange, the
prices on bitcoin exchanges are the most accurate expression of the
value of bitcoins.
---------------------------------------------------------------------------

\33\ According to the Exchange, the Sponsor represents that,
because bitcoin trades on more than 30 exchanges globally on a 24-
hour basis, it is difficult for attempted market manipulation on any
one exchange to affect the global market price of bitcoin, and that
any attempt to manipulate the price would result in an arbitrage
opportunity among exchanges, which would typically be acted upon by
market participants. See id. at 12259.
---------------------------------------------------------------------------

With respect to derivatives on bitcoin, the Exchange states that
certain non-U.S.-bitcoin exchanges offer derivative products on bitcoin
such as options, swaps, and futures.\34\ The Exchange refers to the
Registration Statement and notes that BitMex (based in the Republic of
Seychelles), CryptoFacilites (based in the United Kingdom), 796
Exchange (based in China), and OKCoin Exchange China all offer futures
contracts settled in bitcoin. The Exchange also states that Coinut
(based in Singapore) offers bitcoin binary options and ``vanilla
options'' based on the Coinut index; that Nadex (based in Chicago)
offers bitcoin binary options denominated in USD using the TeraBit
Bitcoin Price Index; and that IGMarkets (based in the United Kingdom),
Avatrade (based in the Republic of Ireland), and Plus500 (based in
Israel) also offer bitcoin derivative products.\35\ The Exchange also
notes the CFTC has approved the registration of TeraExchange LLC as a
swap execution facility (``SEF''), where bitcoin swaps and NDFs may be
entered into, and the registration of LedgerX provisionally as a
SEF.\36\
---------------------------------------------------------------------------

\34\ According to the Exchange, the Sponsor is not aware of any
bitcoin derivatives currently trading based on the XBX Index. See
id. at 12258.
\35\ See id. at 12260.
\36\ See id.
---------------------------------------------------------------------------

The Exchange asserts that its own surveillance procedures are
sufficient to detect and deter manipulation.\37\ The Exchange
represents that the Exchange or FINRA, on behalf of the Exchange, or
both, (a) will communicate as needed regarding trading in the Shares
with other markets and other entities that are members of the
Intermarket Surveillance Group, and (b) may obtain trading information
regarding trading in the Shares from these other markets and other
entities. In addition, the Exchange states that it may obtain
information regarding trading in the Shares from markets and other
entities that are members of the Intermarket Surveillance Group or with
which the Exchange has in place a comprehensive surveillance-sharing
agreement.\38\
---------------------------------------------------------------------------

\37\ The Exchange represents that its surveillance procedures
generally focus on detecting securities trading outside their normal
patterns, which could be indicative of manipulative or other
violative activity. The Exchange represents that, when such
situations are detected, surveillance analysis would follow and
investigations would be opened, where appropriate, to review the
behavior of all relevant parties for all relevant trading
violations. See id. at 12266 (further representing that trading in
the Shares will be subject to the existing trading surveillances
administered by the Exchange, as well as cross-market surveillances
administered by FINRA on behalf of the Exchange, which are designed
to detect violations of Exchange rules and applicable federal
securities laws, and further representing that these procedures are
adequate to properly monitor Exchange trading of the Shares in all
trading sessions and to deter and detect violations of Exchange
rules and federal securities laws applicable to trading on the
Exchange).
\38\ See id. at 12266. The Exchange also notes that, pursuant to
NYSE Arca Equities Rule 8.201(g), the Exchange is able to obtain
information regarding trading in the Shares and the underlying
bitcoin or any bitcoin derivative through Exchange-registered market
makers, in connection with the market makers' proprietary or
customer trades effected on any relevant market. Id.
---------------------------------------------------------------------------

According to the Exchange, the Sponsor believes that demand from
new investors accessing bitcoin through investment in the Shares will
broaden the investor base in bitcoin, which could further reduce the
possibility of collusion among market participants to manipulate the
bitcoin market.\39\
---------------------------------------------------------------------------

\39\ See id. at 12259.
---------------------------------------------------------------------------

Further details regarding the proposal and the Trust can be found
in Amendment No. 1 to the proposal,\40\ and in the Registration
Statement.\41\
---------------------------------------------------------------------------

\40\ See id. Compared to the initial Notice, see supra note 1,
Amendment No. 1 makes the following substantive changes: (1)
Identifies Foreside Fund Services, LLC as the order examiner in
connection with the creation and redemption of baskets of Shares;
(2) identifies SolidX Management LLC as the custodian of the Trust's
bitcoin and The Bank of New York Mellon as custodian of the Trust's
cash; (3) adds content regarding a recent loss of trading volume on
the leading Chinese exchanges and asserts that trading volumes at
these Chinese exchanges are now in line with volumes at USD
exchanges; (4) notes that, in May 2016, the Gibraltar Financial
Services Commission approved the BitcoinETI, which was listed on the
Gibraltar Stock Exchange in July 2016 and on Deutsche Boerse
Frankfurt in August 2016; (5) adds or changes certain details
regarding the first alternative pricing source for the Shares; (6)
adds disclosure that the Sponsor (operating on a principal basis)
also may offer NDFs and swaps in order to provide Authorized
Participants and market makers with additional options for hedging
their exposure to bitcoin; (7) deletes text relating to the
suspension or rejection of redemption orders; and (8) adds text
stating that, to the extent that the Administrator has utilized the
cascading set of rules described in ``bitcoin Market Price,'' in
Amendment No. 1, the Trust's Web site will note the valuation
methodology used and the price per bitcoin resulting from that
calculation.
\41\ See Registration Statement, supra note 21.
---------------------------------------------------------------------------

II. Summary of Comment Letters

The comment period for the initial Notice of Proposed Rule Change
closed on August 23, 2016, and the comment period for Amendment No. 1
closed March 16, 2017.\42\ As of March 24, the Commission had received
11 comment letters on the proposed rule change.\43\

[[Page 16250]]

Commenters address, among other things, investors' interest in bitcoin
and their desire to gain access to bitcoin through an ETP; \44\ the
state of development of bitcoin as a digital asset; \45\ the inherent
value of, and risks of investing in, bitcoin; \46\ the appropriate
measures for the Trust to secure its bitcoin holdings against theft or
loss; \47\ the creation and redemption processes for the Trust; \48\
the proposed valuation method for the Trust's holdings; \49\ and the
legitimacy or other benefits that Commission approval of the proposed
ETP might confer upon bitcoin as a digital asset.\50\ Ultimately,
however, comments on these topics do not bear on the basis for the
Commission's decision to disapprove the proposal. Accordingly, the
Commission will summarize and address the comments that relate to the
susceptibility of bitcoin or the Shares to fraudulent or manipulative
acts and practices, including the need for surveillance-sharing
agreements with significant regulated markets for trading in bitcoin or
derivatives on bitcoin.
---------------------------------------------------------------------------

\42\ The initial comment period for the Order Instituting
Proceedings closed on November 23, 2016, and the period for rebuttal
comments closed on December 7, 2016. See Order Instituting
Proceedings, supra note 1, 81 FR at 76401-02.
\43\ See Letters from Daniel H. Gallancy, CFA, SolidX Management
LLP (Nov. 23, 2016) (``SolidX Letter''); Thaya B. Knight, Associate
Director, Financial Regulation Studies, The Cato Institute (Dec. 1,
2016) (``Cato Letter''); Jerry Brito, Executive Director, Coin
Center (Dec. 7, 2016) (``Coin Center Letter''); Joseph Colangelo,
President, Consumers' Research (Dec. 7, 2016) (``Consumers' Research
Letter''); Denise Krisko, CFA, President and Co-Founder, Vident
Investment Advisory, LLC (Dec. 7, 2016) (``Vident Letter''); Balaji
Srinivasan, Chief Executive Officer & Cofounder, 21, et al. (Dec. 7,
2016) (``Srinivasan Letter''); Ken I. Maher (Dec. 8, 2016) (``Maher
Letter''); Craig M. Lewis, Madison S. Wigginton Professor of
Finance, Owen Graduate School of Management, Vanderbilt University
(Feb. 13, 2017) (``Lewis Paper''); Douglas M. Yones, Head of
Exchange Traded Products, New York Stock Exchange (Feb. 22, 2017)
(``NYSE Letter''); Craig M. Lewis, Madison S. Wigginton Professor of
Finance, Owen Graduate School of Management, Vanderbilt University
(Mar. 3, 2017) (``Lewis Paper II''); Daniel H. Gallancy, CFA, SolidX
Management LLP (Mar. 15, 2017) (``SolidX Letter II''). All comments
on the proposed rule change are available on the Commission's Web
site at: https://www.sec.gov/comments/sr-nysearca-2016-101/nysearca2016101.shtml.
\44\ See, e.g., Cato Letter, supra note 43; Coin Center Letter,
supra note 43; Vident Letter, supra note 43; Consumers' Research
Letter, supra note 43; SolidX Letter, supra note 43; Srinivasan
Letter, supra note 43; NYSE Letter, supra note 43; Lewis Paper,
supra note 43; SolidX Letter II, supra note 43.
\45\ See, e.g., Coin Center Letter, supra note 43; Vident
Letter, supra note 43; Lewis Paper, supra note 43.
\46\ See, e.g., Vident Letter, supra note 43; Coin Center
Letter, supra note 43; SolidX Letter, supra note 43; Maher Letter,
supra note 43; Lewis Paper, supra note 43; SolidX Letter II, supra
note 43.
\47\ See, e.g., Srinivasan Letter, supra note 43; Coin Center
Letter, supra note 43; SolidX Letter, supra note 43; Consumers'
Research Letter, supra note 43; SolidX Letter II, supra note 43.
\48\ See, e.g., SolidX Letter, supra note 43; NYSE Letter, supra
note 43; Lewis Paper, supra note 43.
\49\ See, e.g., SolidX Letter, supra note 43; NYSE Letter, supra
note 43; Lewis Paper, supra note 43; Consumers' Research Letter,
supra note 43; SolidX Letter II, supra note 43.
\50\ See, e.g., Vident Letter, supra note 43; Coin Center
Letter, supra note 43.
---------------------------------------------------------------------------

A. Comments Regarding the Worldwide Market for Bitcoin
Several commenters note that a significant volume of bitcoin
trading occurs in markets outside the United States that are largely
unregulated.\51\ One commenter claims that several bitcoin exchanges do
not offer the same regulatory safeguards that U.S. consumers have come
to expect when they make investments in U.S. securities, and that
bitcoin exchanges lack Commission oversight and have lost investor
funds.\52\ The Lewis Paper also notes that the Commission does not
regulate bitcoin exchanges.\53\ A different commenter expresses
concerns that certain bitcoin exchanges that are components of the XBX
Index, such as Bitfinex and OKCoin International, are not audited or
governed by fair and transparent business practices.\54\
---------------------------------------------------------------------------

\51\ See, e.g., Consumers' Research Letter, supra note 43; Maher
Letter, supra note 43.
\52\ See Consumers' Research Letter, supra note 43, at 1-2.
\53\ See Lewis Paper, supra note 43, at 8.
\54\ See Maher Letter, supra note 43. This commenter also
disputes some commenters' statements that this ETP would give
investors safe exposure to bitcoin by reducing security risk of
holding the bitcoins, noting that investors will still bear the many
risks of the bitcoin ecosystem itself. See id.
---------------------------------------------------------------------------

The Sponsor asserts that the majority of bitcoin transactions are
executed on public bitcoin exchanges that typically publish real-time
trade data on their respective Web sites and through application
programming interfaces. The Sponsor claims that the existence and
availability of the numerous pricing sources for bitcoin delivers
unmatched price transparency when compared to most other assets.\55\
The Sponsor also asserts that the volume of bitcoin trading, both on-
exchange and in the OTC market, is significant and that the bitcoin
market is a liquid market. According to the Sponsor, between November
2015 and November 2016, the trading volume on the five constituent
exchanges of the XBX Index (Bitfinex, Bitstamp, GDAX, itBit, and OKCoin
International) represented the overwhelming majority of the entire USD-
denominated bitcoin exchange market, and average daily trade volume on
these exchanges during this period was approximately $24 million.\56\
---------------------------------------------------------------------------

\55\ See SolidX Letter, supra note 43, at 12.
\56\ See id. at 13. The Sponsor also notes that there are three
Chinese yuan-denominated exchanges on which trading volume is
significant: BTCC, Huobi, and OKCoin Exchange China. See id.
---------------------------------------------------------------------------

The Sponsor acknowledges that a significant portion of bitcoin
trading occurs on exchanges outside the United States.\57\ The Sponsor
also claims that, while there is a significant volume of bitcoin
trading in China, the prices on U.S. and Chinese exchanges tend to
conform with minimal variation, in spite of various capital controls in
effect in China.\58\ Consequently, for purposes of arbitrage among all
the various bitcoin exchanges (including those that trade bitcoin for
USD and Chinese yuan), the Sponsor concludes that the tendency for
prices to conform supports the conclusion that the exchange market is
efficient and is generally resistant to manipulation.\59\ The Sponsor
also provides data that, it says, indicate that arbitrage across
bitcoin markets helps to keep bitcoin prices aligned and to reduce the
likelihood of manipulation and indicate that arbitrage functions within
a few seconds to address price discrepancies.\60\
---------------------------------------------------------------------------

\57\ See id. at 5, 13. For example, the Sponsor notes that
Bitfinex, a component of the XBX Index, has continued to have the
highest volume of trading on any of the USD-denominated bitcoin
exchanges. See SolidX Letter, supra note 43, at 6. See also supra
notes 31-32 and accompanying text.
\58\ See SolidX Letter, supra note 43, at 5.
\59\ See id. at 13-14.
\60\ See SolidX Letter II, supra note 43, at 5.
---------------------------------------------------------------------------

The Sponsor also submits that, as of January 2017, the volume of
bitcoin trading on Chinese exchanges has declined to levels similar to
those of USD-denominated exchanges that follow AML and KYC procedures
applied by their respective jurisdictions.\61\ The Sponsor states that,
in light of capital controls that apply in China, the Sponsor views the
Chinese markets for bitcoin as separate and distinct from the USD
markets.\62\ The Sponsor further asserts that the pricing differences
between the XBX Index and the Chinese bitcoin exchanges are analogous
to the location-based pricing differences in commodities markets,
including the markets for gold, silver, platinum, and palladium--
commodities that are the underlying assets for existing commodity-trust
ETPs.
---------------------------------------------------------------------------

\61\ See id. at 6.
\62\ See id.
---------------------------------------------------------------------------

The Sponsor states that, in addition to exchange trading, bitcoin
has a robust, global OTC market and states that the parallel existence
of an exchange-based and an OTC bitcoin market increases the difficulty
of manipulation. Similarly, the Exchange notes that the OTC market for
bitcoin as a standalone liquidity pool has greater daily trade volumes
than any single bitcoin exchange.\63\
---------------------------------------------------------------------------

\63\ See NYSE Letter, supra note 43, at 2.
---------------------------------------------------------------------------

According to the Sponsor, a potential manipulator in the bitcoin
marketplace would need to prevent other market participants from taking
advantage of potential arbitrage opportunities between the exchanges,
which would be further complicated by the high level of price
transparency in the bitcoin market.\64\ The Sponsor notes that ``Level-
II type'' quotes for bitcoin are

[[Page 16251]]

freely available from nearly all bitcoin exchanges.\65\
---------------------------------------------------------------------------

\64\ See SolidX Letter, supra note 43, at 7.
\65\ See id. Generally, Level-II quotes provide best-price
orders and quotes from each market participant on a market.
---------------------------------------------------------------------------

The Sponsor also claims that opening and closing prices for common
financial instruments are a frequent target for market manipulators and
that, because bitcoin trades continuously and never has an opening or
closing price, the risk of such manipulation is eliminated.\66\ The
Exchange also notes that bitcoin is traded continuously and asserts
that this means that price discovery for bitcoin is widespread and
continuous.\67\
---------------------------------------------------------------------------

\66\ See id. at 8.
\67\ See NYSE Letter, supra note 43, at 2.
---------------------------------------------------------------------------

The Sponsor also states that the Trust is materially identical to
existing, physically-backed ETPs, which, the Sponsor asserts, have
become an important component of the market.\68\ The Sponsor further
claims that, as with any ETP, there may be attempts to spread false or
misleading information about the Trust, but an attempt to manipulate
the price of bitcoin through trading activity would be difficult, and
controlling or artificially affecting the market would require a
massive amount of capital distributed across numerous exchanges in
multiple currencies and jurisdictions around the world.\69\
---------------------------------------------------------------------------

\68\ See SolidX Letter, supra note 43, at 3.
\69\ See id. at 7.
---------------------------------------------------------------------------

The Lewis Paper claims that the underlying market for bitcoin is
inherently resistant to manipulation. This commenter posits that the
underlying bitcoin market is not susceptible to manipulation because:
(1) Unlike traditional securities, there is no inside information,
and therefore bitcoin is not subject to the dissemination of false or
misleading information;
(2) manipulation through acquisition of a dominant market share is
unlikely;
(3) each bitcoin market is an independent entity, so demand for
liquidity does not necessarily propagate across other exchanges;
(4) a substantial OTC market provides additional liquidity and
absorption of shocks;
(5) compared to equity markets, trading on bitcoin exchanges is
slower, and therefore cross-market arbitrage is available to all market
participants at the same time; and
(6) the market is not subject to ``spoofing'' or other high-
frequency-trading tactics.\70\
---------------------------------------------------------------------------

\70\ See Lewis Paper, supra note 43, at 5-9; Lewis Paper II,
supra note 43, at 2. The Lewis Paper also raises a number of
arguments bearing on the susceptibility to manipulation of the XBX
Index and the Shares. See Lewis Paper, supra note 43, at 5-9. Those
arguments are discussed below. See infra Sections III.B.3 & III.B.5.
---------------------------------------------------------------------------

Specifically with respect to the risk that a market participant
might acquire a dominant position, the Lewis Paper notes that one of
the risks associated with bitcoin is the possibility that a single
investor or a small group acting in collusion could own a dominant
share of the available bitcoin, and the Lewis Paper also notes that the
Registration Statement states that it is possible, and in fact,
reasonably likely, that a small group of early adopters holds a
significant proportion of the bitcoin that has been mined.\71\ Since,
according to the Lewis Paper, there is no registry showing which
individuals or entities own bitcoin, or the quantity they own, it is
not possible to know how large individual positions are.\72\ The Lewis
Paper asserts that this issue is not unique to bitcoin, as there are no
corresponding registries for precious metals.\73\ The Lewis Paper also
asserts that a number of factors relevant to the Shares should
ameliorate risks associated with possible manipulation due to a
dominant market share.\74\
---------------------------------------------------------------------------

\71\ See Lewis Paper, supra note 43, at 6.
\72\ Id.
\73\ Id.
\74\ Id. at 6-7. According to the Lewis Paper, those factors
are: (a) That bitcoin held by the Trust will remain available to
market participants through redemption of the Shares; (b) that,
given the availability of arbitrage activity between the Shares and
the underlying bitcoin market, the bitcoins held by the Trust will
not represent a meaningful percentage of the bitcoin available for
transaction purposes; (c) that a price increase in bitcoin following
the introduction of a bitcoin ETP would be the result of increased
demand for bitcoin, rather than a sign of price manipulation; (d)
that the receive-versus-payment and delivery-versus-payment account
arrangements that the Trust has with multiple bitcoin exchanges, the
Trust's transparent and rules-based redemption protocol, and the
transparency of the Trust's holdings and valuations, as well as of
quotations and transactions in the Shares, would reduce the
potential for fraud and manipulation in the bitcoin markets; (e)
market participants can choose the bitcoin exchanges on which to
trade and can arbitrage away price deviations; and (f) trading of
the Shares on the Exchange may serve to make the overall bitcoin
market more transparent, especially if OTC bitcoin trading shifts to
bitcoin exchanges. Id.
---------------------------------------------------------------------------

The Sponsor, which commissioned the Lewis Paper, agrees with the
paper's reasoning and with the assertion that the underlying bitcoin
spot market is not susceptible to manipulation.\75\ The Exchange also
agrees with the Lewis Paper's analysis, claiming that trading in the
Shares would not be expected to contribute to the manipulation of
bitcoin prices and, in fact, may actually reduce the potential for
fraud and manipulation.\76\
---------------------------------------------------------------------------

\75\ See SolidX Letter II, supra note 43, at 3-4.
\76\ See NYSE Letter, supra note 43, at 5.
---------------------------------------------------------------------------

B. Comments Regarding Potential Manipulation of the XBX Index

One commenter notes that the XBX Index includes several exchanges
that many have expressed concerns about and that are not audited or
governed by fair and transparent business practices.\77\
---------------------------------------------------------------------------

\77\ See Maher Letter, supra note 43.
---------------------------------------------------------------------------

The Sponsor claims that the XBX Index is resistant to manipulation
and responsive to market movements in real time and that it is
therefore a superior mechanism--compared to using a single exchange--
for valuing the Trust's bitcoin holdings.\78\ The Sponsor asserts that
the XBX Index price closely approximates actual bitcoin transaction
prices across the various USD-denominated bitcoin exchanges and that it
accurately reflects the fair value of bitcoin for valuation, for
accounting purposes, and as a practical matter.\79\ The Sponsor states
that the XBX Index's methodology penalizes stale prices because, if an
exchange does not have recent trading data, its weighting in the XBX
Index is gradually reduced until it is de-weighted entirely.\80\
---------------------------------------------------------------------------

\78\ See SolidX Letter, supra note 43, at 9.
\79\ See id. at 8.
\80\ See id. at 9.
---------------------------------------------------------------------------

The Exchange states that the XBX Index's proprietary methodology
helps to protect the calculation of the XBX Index against any undue
impact from bitcoin pricing outliers among the various exchanges and
from any potential attempts to manipulate the price of bitcoin.\81\
---------------------------------------------------------------------------

\81\ See NYSE Letter, supra note 43, at 2-3.
---------------------------------------------------------------------------

The Lewis Paper claims that the following features of the XBX
Index's proprietary weighting methodology mitigate manipulation risk:
(a) That lower trading volume reduces the weight an exchange is given
in the average; (b) that the weight of an exchange is reduced the more
a price deviates from the average; and (c) that weights are reduced for
stale prices. The Lewis Paper claims that these features significantly
increase the amount of capital required to manipulate bitcoin prices
enough to affect XBX Index levels.\82\
---------------------------------------------------------------------------

\82\ See Lewis Paper, supra note 43, at 8-9.
---------------------------------------------------------------------------

C. Comments on the Derivatives Markets for Bitcoin

The Lewis Paper states that one of the key differences between
bitcoin and other commodities is the lack of a liquid and transparent
derivatives market and that, although there have been nascent attempts
to establish derivatives trading in bitcoin, bitcoin derivatives
markets are not at this time sufficiently liquid to

[[Page 16252]]

be useful to Authorized Participants and market makers who would like
to use derivatives to hedge exposures.\83\ The Lewis Paper claims that,
for physical commodities that are not traded on exchanges, the presence
of a liquid derivatives market is a necessary condition, but that, for
digital assets like bitcoin, derivatives markets are not necessary
because price discovery occurs on the OTC market and exchanges
instead.\84\
---------------------------------------------------------------------------

\83\ See id. at 8.
\84\ See id. (concluding that, for these assets, derivatives
markets are not necessary because the OTC market and exchanges are
close substitutes).
---------------------------------------------------------------------------

The Sponsor states that it expects that bitcoin NDFs, swaps, or
both will be offered by several participants in the bitcoin
marketplace, including bitcoin exchanges and bitcoin OTC market
participants, and that the Sponsor itself (operating on a principal
basis) also may offer NDFs and swaps in order to provide Authorized
Participants and market makers with the ability to hedge their exposure
to bitcoin.\85\
---------------------------------------------------------------------------

\85\ See SolidX Letter, supra note 43, at 14-15. The Sponsor
notes that, while Authorized Participants and market makers will
generally want to hedge their exposure to bitcoin in connection with
basket creation and redemption orders, not all of them are ready,
willing, and able to trade bitcoin, and they will require a
mechanism to gain synthetic exposure to bitcoin for their hedging
needs when they enter orders to create and redeem shares. Id.
According to the Sponsor, Authorized Participants will be able to
use NDFs and swap contracts to obtain synthetic long and short
exposure to bitcoin for their hedging purposes. Id.
---------------------------------------------------------------------------

D. Comments Regarding the Susceptibility of the Shares to Manipulation

The Sponsor states that, as a full-fledged ETP in the United
States, the Trust will provide investors with an opportunity to invest
in bitcoin without being exposed directly to the risks associated with
sourcing and holding bitcoin outside the regulated traditional
financial markets.\86\ The Sponsor also claims that, because the Shares
would be traded on the Exchange, they should not be subject to risks of
manipulation beyond those applicable to any publicly listed stock.\87\
In addition, the Sponsor asserts that the dissemination of information
on the Trust's Web site--along with quotations for, and last-sale
prices of transactions in, the Shares, and the IIV and NAV of the
Trust--will help to reduce the ability of market participants to
manipulate the bitcoin market or the price of the Shares, and that the
Trust's arbitrage mechanism will facilitate the correction of price
discrepancies in bitcoin and the Shares.\88\ The Sponsor also asserts
that the requirements of Section 6(b)(5) of the Exchange Act apply not
to trading in bitcoin, but to trading in the Shares, and asserts that
the rules of the Exchange will prevent fraudulent and manipulative acts
and practices, and protect investors and the public interest, with
respect to the Shares.\89\ Finally, the Sponsor argues that the
requirements of Section 6(b)(5) of the Exchange Act do not include any
inherent requirement for market surveillance and asserts that the
Commission, in 2005, approved the listing and trading of shares of the
Euro Currency Trust, even though, according to the Sponsor, exchange
surveillance of the underlying foreign exchange markets did not
exist.\90\
---------------------------------------------------------------------------

\86\ See SolidX Letter, supra note 43, at 4. For similar claims,
see Consumers' Research Letter, supra note 43, at 1-2; Coin Center
Letter, supra note 43, at 1-2; NYSE Letter, supra note 43, at 1-2.
\87\ See SolidX Letter, supra note 43, at 7.
\88\ See Amendment No. 1, supra note 1, 82 FR at 12259.
\89\ See SolidX Letter II, supra note 43, at 1-2.
\90\ See id. at 3-4.
---------------------------------------------------------------------------

The Lewis Paper also argues that several institutional features of
the bitcoin trading environment and the Trust make the price of the
Shares resistant to manipulation because: (a) The Trust's disclosures,
creation and redemption activity, and price dissemination would
increase transparency and diminish the risk of manipulation or unfair
informational advantage; \91\ (b) bitcoin prices are quoted to eight
decimal places, mitigating incentives to move prices a penny up or down
because the potential gains would be immaterial; \92\ (c) bitcoin
markets trade continuously, and the XBX Index is calculated
continuously, and therefore the manipulation of opening and closing
prices is not a significant risk; \93\ (d) the listing and delisting
criteria for the Shares are expected to help to maintain a minimum
level of liquidity and thus minimize the potential for manipulation of
Share prices; \94\ and (e) the continuous cash and in-kind creation and
redemption of Shares increases the Trust's efficiency because the
exchange trading of bitcoin lowers the costs of creating and redeeming
Shares, which would tighten the spread between the Share price and the
NAV and reduce manipulation risk.\95\
---------------------------------------------------------------------------

\91\ See Lewis Paper, supra note 43, at 7.
\92\ See id. at 9.
\93\ See id.
\94\ See id.
\95\ See id. at 10.
---------------------------------------------------------------------------

E. Comments Regarding the Protection of Investors and the Public
Interest

The Sponsor asserts that the structure of the Trust and the
proposed rule change by the Exchange will serve the public interest by
protecting investors from the risks of investing in bitcoins directly,
citing the hacking of bitcoin exchanges, as well as schemes perpetrated
upon investors by dishonest individuals.\96\ Several other commenters
also raise similar points, arguing that approving the proposed rule
change would benefit investor protection.\97\ The Sponsor argues that
the risk of investor harm from manipulation in the Shares is
hypothetical in nature and unlikely, while the harm to investors from a
lack of access to an insured vehicle is overt and likely to continue in
the absence of the Commission's approval of the Exchange's proposed
rule change.\98\ The Sponsor also asserts that the Trust would provide
other benefits to investors--such as limited counterparty risk, the
simplicity of holding the Shares, and the lack of minimum investment
requirements--and that approving the proposed rule change would enable
U.S. exchanges to remain competitive internationally.\99\ Finally, the
Sponsor asserts that disapproval of the proposed rule change would be
in direct contravention of the goal of Section 6(b)(5) to protect
investors and the public interest.\100\
---------------------------------------------------------------------------

\96\ See SolidX Letter II, supra note 43, at 2.
\97\ See, e.g., Cato Letter, supra note 43; Srinivasan Letter,
supra note 43; Consumers' Research Letter, supra note 43; NYSE
Letter, supra note 43.
\98\ See SolidX Letter II, supra note 43, at 2.
\99\ See SolidX Letter, supra note 43, at 2-4.
\100\ See SolidX Letter II, supra note 43, at 2.
---------------------------------------------------------------------------

Several commenters assert that the Trust's insurance of its bitcoin
holdings would ensure safe access to bitcoin for investors.\101\ The
Sponsor notes that, in traditional and regulated systems, custodial and
clearing firms mitigate risks and keep assets safe for the benefit of
the investing public, but that no such mechanisms currently exist for
bitcoin.\102\ The Sponsor claims that insurance is important to
investor protection and the public interest because investors cannot be
expected to assume the risks associated with the possible loss or theft
of the Trust's bitcoins.\103\ The Sponsor acknowledges that Trust
investors will expect to assume the market risk associated with their
investment (i.e., bitcoin price fluctuations), but claims that it is
appropriate to minimize the investors' risks regarding the adequacy of
the mechanisms and infrastructure used to secure the Trust's bitcoin
holdings, since that is not, and should not be, a typical analysis
undertaken by investors

[[Page 16253]]

in the U.S. securities markets.\104\ The Sponsor also asserts that the
Trust's insurance policy and the proposed rule change will serve the
public interest in a manner otherwise unavailable and notes that
multiple commenters have emphasized the importance of the Trust's
insurance policy.\105\
---------------------------------------------------------------------------

\101\ See, e.g., SolidX Letter, supra note 43; Consumers'
Research Letter, supra note 43; Lewis Paper, supra note 43; NYSE
Letter, supra note 43; SolidX Letter II, supra note 43.
\102\ See SolidX Letter, supra note 43, at 11.
\103\ See id.
\104\ See id.; see also Lewis Paper, supra note 43, at 11.
\105\ See SolidX Letter II, supra note 43, at 2.
---------------------------------------------------------------------------

The Exchange claims that, as a substitute to the investor
safeguards offered by traditional custodians, bitcoin insurance is
important for investor protection and the public interest.\106\ One
commenter claims that the Trust's insurance coverage is an important,
market-based solution that substitutes for a traditional custodial
infrastructure and a true transfer-agency function that does not exist
in the underlying bitcoin market.\107\ Another commenter claims that
the fact that the Trust carries insurance and will be exchange traded
will prevent situations where consumers risk losing bitcoins or having
them stolen due to a fiduciary's flawed security protocols.\108\
---------------------------------------------------------------------------

\106\ See NYSE Letter, supra note 43, at 4.
\107\ See Lewis Paper, supra note 43, at 11.
\108\ See Consumers' Research Letter, supra note 43, at 2.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

A. Overview

Under Section 19(b)(2)(C) of the Exchange Act, the Commission must
approve the proposed rule change of a self-regulatory organization
(``SRO'') if the Commission finds that the proposed rule change is
consistent with the requirements of the Exchange Act and the applicable
rules and regulations thereunder.\109\ If it is unable to make such a
finding, the Commission must disapprove the proposed rule change.\110\
Additionally, under Rule 700(b)(3) of the Commission's Rules of
Practice, the ``burden to demonstrate that a proposed rule change is
consistent with the Exchange Act and the rules and regulations issued
thereunder . . . is on the self-regulatory organization that proposed
the rule change.'' \111\
---------------------------------------------------------------------------

\109\ 15 U.S.C 78s(b)(2)(C)(i).
\110\ 15 U.S.C. 78s(b)(2)(C)(ii).
\111\ 17 CFR 201.700(b)(3). The description of a proposed rule
change, its purpose and operation, its effect, and a legal analysis
of its consistency with applicable requirements must all be
sufficiently detailed and specific to support an affirmative
Commission finding. Id. Any failure of an SRO to provide the
information elicited by Form 19b-4 may result in the Commission not
having a sufficient basis to make an affirmative finding that a
proposed rule change is consistent with the Exchange Act and the
rules and regulations issued thereunder that are applicable to the
SRO. Id.
---------------------------------------------------------------------------

After careful consideration, and for the reasons discussed in
greater detail below, the Commission does not believe that the proposed
rule change, as modified by Amendment No. 1, is consistent with the
requirements of the Exchange Act and the applicable rules and
regulations thereunder.\112\ Specifically, the Commission does not find
that the proposed rule change is consistent with Section 6(b)(5) of the
Exchange Act--which requires that the rules of a national securities
exchange be designed, among other things, to prevent fraudulent and
manipulative acts and practices and to protect investors and the public
interest \113\--because the Commission believes that the significant
markets for bitcoin are unregulated and that, therefore, the Exchange
has not entered into, and would currently be unable to enter into, the
type of surveillance-sharing agreement that helps address concerns
about the potential for fraudulent or manipulative acts and practices
in the market for the Shares. Accordingly, the Commission disapproves
the proposed rule change.\114\
---------------------------------------------------------------------------

\112\ In disapproving the proposed rule change, as modified by
Amendment No. 1, the Commission has considered its impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f); see also notes 70-74, 82-84, 91-95, 107, 148-158 & 169-176
and accompanying text. The Commission notes that, according to the
Sponsor, the Trust is a means of providing a simple and cost-
effective way for investors to gain investment exposure to the
performance of the USD price of bitcoin. See SolidX Letter, supra
note 43, at 1; see also Lewis Paper, supra note 43, at 3, 11-16
(asserting that a bitcoin-based ETP would enable ordinary investors
to construct more efficient and diversified portfolios). The Sponsor
also asserts that bitcoin exchanges have been subject to hacking and
investor schemes in the past, the losses from which are documented
and quantifiable at approximately $2 billion, and that such losses
will continue unless investors are able to invest in bitcoin through
a regulated and insured product such as the Trust. See SolidX Letter
II, supra note 43, at 2. Regarding competition, the Exchange has
asserted that approval of the proposed rule change ``will enhance
competition among market participants, to the benefit of investors
and the marketplace.'' See Amendment No. 1, supra note 1, 82 FR at
12267. The Sponsor claims that the proposed rule change would
further advance the goal of helping U.S. exchanges remain
competitive in the international marketplace by demonstrating to
future sponsors of new products that the Commission remains
committed to fostering innovation in the U.S. securities markets.
See SolidX Letter, supra note 43, at 3. Finally, regarding the
potential effect of the proposed rule change on capital formation,
the Exchange asserts that the Sponsor believes that demand from new
investors accessing bitcoin through investment in the Shares will
broaden the investor base in bitcoin. See Amendment No. 1, supra
note 1, 82 FR at 12259. The Commission recognizes that the Exchange
and commenters assert these economic benefits and specifically
addresses the Sponsor's claims about investor protection from
hacking and other risks of bitcoin ownership below. See infra
Section III.B.6. The Commission, however, for the reasons discussed
throughout this order, must disapprove the proposed rule change
because it is not consistent with the Exchange Act.
\113\ 15 U.S.C. 78f(b)(5).
\114\ The Commission's disposition of the Exchange's proposed
rule change is independent of, and serves a fundamentally different
purpose than, any Commission actions with respect to the Securities
Act of 1933 Registration Statement of the Trust.
---------------------------------------------------------------------------

B. Analysis

1. Commodity-Trust ETPs and Surveillance-Sharing Agreements
The Exchange proposes to list and trade the Shares under NYSE Arca
Equities Rule 8.201, which governs the listing of Commodity-Based Trust
Shares.\115\ The proposal is similar to many past proposals to list and
trade shares of ETPs holding precious metals.\116\ Accordingly, the
Commission analyzes this proposal under the standards that it has
applied to previous commodity-trust ETPs--and that it also applied in
the recent Bats BZX Order.\117\
---------------------------------------------------------------------------

\115\ The Commission notes that in settled actions the CFTC has
designated bitcoin as a commodity and has asserted jurisdiction over
the trading of at least certain derivatives on bitcoin, as well as
certain leveraged or margined retail transactions in bitcoin. See In
re Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC
Docket No. 15-29, 2015 WL 5535736 (CFTC Sept. 17, 2015) (Order
Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the
Commodity Exchange Act, Making Findings and Imposing Remedial
Sanctions (``Coinflip Settlement Order'')), available at https://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder09172015.pdf.
\116\ See, e.g., streetTRACKS Gold Shares, Exchange Act Release
No. 50603 (Oct. 28, 2004), 69 FR 64614 (Nov. 5, 2004) (SR-NYSE-2004-
22) (order approving the listing and trading of shares of commodity-
trust ETP holding physical gold bullion). The Commission notes that
the Sponsor also views the Trust to be materially identical to other
existing commodity-trust ETPs. See SolidX Letter, supra note 43, at
3.
\117\ See Bats BZX Order, supra note 6, 82 FR at 14081-87.
---------------------------------------------------------------------------

A key consideration for the Commission in determining whether to
approve or disapprove a proposal to list and trade shares of a new
commodity-trust ETP is the susceptibility of the shares or the
underlying asset to manipulation. This consideration flows directly
from the requirement in Section 6(b)(5) of the Exchange Act that a
national securities exchange's rules must be designed ``to prevent
fraudulent and manipulative acts and practices'' and ``to protect
investors and the public interest.'' \118\
---------------------------------------------------------------------------

\118\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

Since at least 1990, the Commission has expressed the view that the
ability of a national securities exchange to enter into surveillance-
sharing agreements ``furthers the protection of investors and the
public interest because it will enable the [e]xchange to conduct prompt
investigations into

[[Page 16254]]

possible trading violations and other regulatory improprieties.'' \119\
The Commission has also long held that surveillance-sharing agreements
are important in the context of exchange listing of derivative security
products, such as equity options.\120\
---------------------------------------------------------------------------

\119\ See Exchange Act Release No. 27877 (Apr. 4, 1990), 55 FR
13344 (Apr. 10, 1990) (SR-NYSE-90-14).
\120\ See Exchange Act Release No. 33555 (Jan. 31, 1994), 59 FR
5619, 5621 (Feb. 7, 1994) (SR-Amex-93-28) (order approving listing
of options on American Depositary Receipts).
---------------------------------------------------------------------------

With respect to ETPs, when approving in 1995 the listing and
trading of one of the first commodity-linked ETPs--a commodity-linked
exchange-traded note--on a national securities exchange, the Commission
continued to emphasize the importance of surveillance-sharing
agreements, noting that the listing exchange had entered into
surveillance-sharing agreements with each of the futures markets on
which pricing of the ETP would be based and stating that ``[t]hese
agreements should help to ensure the availability of information
necessary to detect and deter potential manipulations and other trading
abuses, thereby making [the commodity-linked notes] less readily
susceptible to manipulation.'' \121\
---------------------------------------------------------------------------

\121\ Exchange Act Release No. 35518 (Mar. 21, 1995), 60 FR
15804 (Mar. 27, 1995) (SR-Amex-94-30). See also Exchange Act Release
No. 36885 (Feb. 26, 1996), 61 FR 8315 n.17 (Mar. 4, 1996) (SR-Amex-
95-50) (approving the exchange listing and trading of Commodity
Indexed Securities and noting that, through the comprehensive
surveillance-sharing agreements, the listing exchange was able to
obtain market surveillance information for transactions occurring on
NYMEX and COMEX and from the London Metal Exchange through the
Intermarket Surveillance Group.
---------------------------------------------------------------------------

In 1998, in adopting Exchange Act Rule 19b-4(e) \122\ to permit the
generic listing and trading of certain new derivative securities
products--including ETPs--the Commission again emphasized the
importance of the listing exchange's ability to obtain from underlying
markets, through surveillance-sharing agreements (called information-
sharing agreements in the release), the information necessary to detect
and deter manipulative activity. Specifically, in adopting rules
governing the generic listing of new derivative securities products,
the Commission stated that the Rule 19b-4(e) procedures would ``enable
the Commission to continue to effectively protect investors and promote
the public interest.'' \123\ The Commission also stressed the
importance of these surveillance-sharing agreements comprehensively
covering trading in the underlying assets. In the case of a product
overlying domestic securities, the Commission said that the exchange
listing a derivative securities product should ensure that it was
either a common member of the Intermarket Surveillance Group with, or
had entered into an information-sharing agreement with, each market
trading each underlying security.\124\
---------------------------------------------------------------------------

\122\ 17 CFR 240.19b-4(e).
\123\ Amendment to Rule Filing Requirements for Self-Regulatory
Organizations Regarding New Derivative Securities Products, Exchange
Act Release No. 40761 (Dec. 8, 1998), 63 FR 70952, 70959 (Dec. 22,
1998) (File no. S7-13-98) (``NDSP Adopting Release'') (also noting
that ``there should be a comprehensive ISA [information-sharing
agreement] that covers trading in the new derivative securities
product and its underlying securities in place between the SRO
listing or trading a derivative product and the markets trading the
securities underlying the new derivative securities product. Such
agreements provide a necessary deterrent to manipulation because
they facilitate the availability of information needed to fully
investigate a manipulation if it were to occur.'').
\124\ See id. at 70959. The Commission further noted that, ``if
a new SRO trades component securities underlying a new derivative
securities product and is not a member of the ISG [Intermarket
Surveillance Group], the SRO seeking to list and trade such new
derivative securities product pursuant to Rule 19b-4(e) should enter
into a comprehensive ISA with the non-ISG SRO. Conversely, if a new
SRO seeks to list and trade a new derivative securities product
pursuant to Rule 19b-4(e) and is not a member of the ISG, such SRO
should enter into a comprehensive ISA with each SRO that trades
securities underlying the new derivative securities product.'' Id.
at 70959 n.99.
---------------------------------------------------------------------------

Consistent with these statements, for the commodity-trust ETPs
approved to date for listing and trading, there have been in every case
well-established, significant, regulated markets for trading futures on
the underlying commodity--gold, silver, platinum, palladium, and
copper--and the ETP-listing exchange has entered into surveillance-
sharing agreements with, or held Intermarket Surveillance Group
membership in common with, those markets.\125\ The

[[Page 16255]]

Commission believes that the need for an exchange listing a commodity-
trust ETP to have surveillance-sharing agreements with significant,
regulated markets relating to the underlying commodity applies equally
to a commodity-trust ETP that is based on bitcoin or another digital
asset.\126\
---------------------------------------------------------------------------

\125\ See streetTRACKS Gold Shares, Exchange Act Release No.
50603 (Oct. 28, 2004), 69 FR 64614, 64618 (Nov. 5, 2004) (SR-NYSE-
2004-22) (approval order notes the New York Stock Exchange's
representation that ``the most significant gold futures exchanges
are the COMEX division of the NYMEX and the Tokyo Commodity
Exchange'' and that the New York Stock Exchange has entered into a
reciprocal Memorandum of Understanding with the NYMEX (of which
COMEX is a division) ``for the sharing of information related to any
financial instrument based, in whole or in part, upon an interest in
or performance of gold''); iShares COMEX Gold Trust, Exchange Act
Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751, 3754 (Jan. 26,
2005) (SR-Amex-2004-38) (approval order notes the American Stock
Exchange's representation that ``the most significant gold futures
exchanges are the COMEX division of the NYMEX and the Tokyo
Commodity Exchange'' and that the American Stock Exchange has ``in
place an Information Sharing Agreement with the NYMEX for the
purpose of providing information in connection with trading in or
related to COMEX gold futures contracts''); iShares Silver Trust,
Exchange Act Release No. 53521 (Mar. 20, 2006), 71 FR 14967, 14968,
14973 (Mar. 24, 2006) (SR-Amex-2005-72) (approval order notes the
American Stock Exchange's representation that ``the most significant
silver futures exchanges are the COMEX and the Tokyo Commodity
Exchange'' and that the American Stock Exchange has ``in place an
Information Sharing Agreement with the NYMEX for the purpose of
providing information in connection with trading in or related to
COMEX silver futures contracts''); ETFS Gold Trust, Exchange Act
Release No. 59895 (May 8, 2009), 74 FR 22993, 22994-95, 22998 (May
15, 2009) (SR-NYSEArca-2009-40) (accelerated approval order notes
NYSE Arca's representation that the COMEX is one of the ``major
world gold markets'' and that NYSE Arca ``has an Information Sharing
Agreement with NYMEX for the purpose of sharing information in
connection with trading in or related to COMEX gold futures
contracts''); ETFS Silver Trust, Exchange Act Release No. 59781
(Apr. 17, 2009), 74 FR 18771, 18772, 18776 (Apr. 24, 2009) (SR-
NYSEArca-2009-28) (accelerated approval order notes NYSE Arca's
representation that ``the most significant silver futures exchanges
are the COMEX . . . and the Tokyo Commodity Exchange'' and that NYSE
Arca ``has an Information Sharing Agreement with NYMEX for the
purpose of sharing information in connection with trading in or
related to COMEX silver futures contracts''); ETFS Palladium Trust,
Exchange Act Release No. 60971 (Nov. 9, 2009), 74 FR 59283, 59285-
86, 59291 (Nov. 17, 2009) (SR-NYSEArca-2009-94) (notice of proposed
rule change includes NYSE Arca's representation that ``the most
significant palladium futures exchanges are the NYMEX and the Tokyo
Commodity Exchange,'' that ``NYMEX is the largest exchange in the
world for trading precious metals futures and options,'' and that
NYSE Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' of which NYMEX is a member); ETFS Platinum
Trust, Exchange Act Release No. 60970 (Nov. 9, 2006), 74 FR 59319,
59321, 59327 (Nov. 17, 2009) (SR-NYSEArca-2009-95) (notice of
proposed rule change includes NYSE Arca's representation that ``the
most significant palladium futures exchanges are the NYMEX and the
Tokyo Commodity Exchange,'' that ``NYMEX is the largest exchange in
the world for trading precious metals futures and options,'' and
that NYSE Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' of which NYMEX is a member); Sprott Physical
Gold Trust, Exchange Act Release No. 61236 (Dec. 23, 2009), 75 FR
170, 171, 174 and n.27 (Jan. 4, 2010) (SR-NYSEArca-2009-113) (notice
of proposed rule change includes NYSE Arca's representations that
the COMEX is one of the ``major world gold markets,'' that NYSE Arca
``may obtain trading information via the Intermarket Surveillance
Group,'' and that NYMEX, of which COMEX is a division, is a member
of the Intermarket Surveillance Group); Sprott Physical Silver
Trust, Exchange Act Release No. 63043 (Oct. 5, 2010), 75 FR 62615,
62616, 62619 and n.26 (Oct. 12, 2010) (SR-NYSEArca-2010-84)
(accelerated approval order notes NYSE Arca's representation that
the COMEX is one of the ``major world silver markets,'' that NYSE
Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' and that NYMEX, of which COMEX is a division,
is a member of the Intermarket Surveillance Group); ETFS Precious
Metals Basket Trust, Exchange Act Release No. 62402 (Jun. 29, 2010),
75 FR 39292, 39295, 39298 (July 8, 2010) (SR-NYSEArca-2010-56)
(notice of proposed rule change includes NYSE Arca's representation
that ``the most significant gold, silver, platinum and palladium
futures exchanges are the COMEX and the TOCOM'' and that NYSE Arca
``may obtain trading information via the Intermarket Surveillance
Group,'' of which NYMEX (of which COMEX is a division) is a member);
ETFS White Metals Basket Trust, Exchange Act Release No. 62620 (July
30, 2010), 75 FR 47655, 47657, 47660 (Aug. 6, 2010) (SR-NYSEArca-
2010-71) (notice of proposed rule change includes NYSE Arca's
representation that ``the most significant silver, platinum and
palladium futures exchanges are the COMEX and the TOCOM'' and that
NYSE Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' of which COMEX is a member); ETFS Asian Gold
Trust, Exchange Act Release No. 63267 (Nov. 8, 2010), 75 FR 69494,
69496, 69500-01 (Nov. 12, 2010) (SR-NYSEArca-2010-95) (notice of
proposed rule change includes NYSE Arca's representation that ``the
most significant gold futures exchanges are the COMEX and the Tokyo
Commodity Exchange,'' that ``COMEX is the largest exchange in the
world for trading precious metals futures and options,'' and that
NYSE Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' of which COMEX is a member); Sprott Physical
Platinum and Palladium Trust, Exchange Act Release No. 68101 (Oct.
24, 2012), 77 FR 65732, 65733, 65739 (Oct. 30, 2012) (SR-NYSEArca-
2012-111) (accelerated approval order notes NYSE Arca's
representation that ``[f]utures on platinum and palladium are traded
on two major exchanges: The New York Mercantile Exchange . . . and
Tokyo Commodities Exchange'' and that NYSE Arca ``may obtain
information via ISG [Intermarket Surveillance Group] from other
exchanges that are members of ISG or with which [NYSE Arca] has
entered into a comprehensive surveillance sharing agreement,
including COMEX''); APMEX Physical--1 oz. Gold Redeemable Trust,
Exchange Act Release No. 66627 (Mar. 20, 2012), 77 FR 17539, 17547
(Mar. 26, 2012) (SR-NYSEArca-2012-18) (notice of proposed rule
change cross-references the proposed rule change to list and trade
shares of the ETFS Gold Trust, in which NYSE Arca represented that
the COMEX is one of the ``major world gold markets'' and notes that
NYSE Arca ``may obtain information via ISG from other exchanges that
are members of ISG or with which [NYSE Arca] has entered into a
comprehensive surveillance sharing agreement, including COMEX'');
JPM XF Physical Copper Trust, Exchange Act Release No. 68440 (Dec.
14, 2012), 77 FR 75468, 75469-72 (Dec. 20, 2012) (SR-NYSEArca-2012-
28) (approval order notes NYSE Arca's representation that a majority
of copper derivatives trading occurs on the LME, the COMEX, and the
Shanghai Futures Exchange and that NYSE Arca could obtain trading
information from other members of the Intermarket Surveillance Group
(including from the COMEX) and that it had entered into a
comprehensive surveillance-sharing agreement with the LME with
respect to trading in copper and copper derivatives); iShares Copper
Trust, Exchange Act Release No. 68973 (Feb. 22, 2013), 78 FR 13726,
13727-30 (Feb. 28, 2013) (SR-NYSEArca-2012-66) (approval order notes
NYSE Arca's representation that the LME is the exchange with the
greatest number of open copper futures and options contracts and
that NYSE Arca had entered into a comprehensive surveillance-sharing
agreement with the LME regarding trading in copper and copper
derivatives and could also obtain trading information from other
members of the Intermarket Surveillance Group, including the COMEX,
which also trades copper futures); First Trust Gold Trust, Exchange
Act Release No. 69847 (June 25, 2013), 78 FR 39399, 39400 n.15,
39405 (July 1, 2013) (SR-NYSEArca-2013-61) (notice of proposed rule
change notes that FINRA, on behalf of the exchange, can obtain
trading information regarding gold futures and options on gold
futures from members of the Intermarket Surveillance Group,
including the COMEX, and cross-references the proposed rule change
to list and trade shares of the ETFS Gold Trust, in which NYSE Arca
represented that the COMEX is one of the ``major world gold
markets''); Merk Gold Trust, Exchange Act Release No. 71038 (Dec.
11, 2013), 78 FR 76367, 76369 n.26, 76374 (Dec. 17, 2013) (SR-
NYSEArca-2013-137) (notice of proposed rule change notes that the
exchange can obtain trading information via the Intermarket
Surveillance Group from other members, including the COMEX, and
cross-references the proposed rule change to list and trade shares
of the ETFS Gold Trust, in which NYSE Arca represented that the
COMEX is one of the ``major world gold markets''); Long Dollar Gold
Trust, Exchange Act Release No. 79518 (Dec. 9, 2016), 81 FR 90876,
90881, 90886 (Dec. 15, 2016) (SR-NYSEArca-2016-84) (accelerated
approval order notes NYSE Arca's representation that the most
significant gold futures exchange is the COMEX and that the exchange
can obtain trading information from other members of the Intermarket
Surveillance Group).
\126\ See Bats BZX Order, supra note 6, 82 FR at 14087
(disapproving proposed rule change to list a bitcoin-based
commodity-trust ETP on the basis that the listing exchange had not,
and would not be able to, enter into a surveillance-sharing
agreement with significant, regulated markets related to the
underlying asset).
---------------------------------------------------------------------------

The Sponsor argues that Section 6(b)(5) does not contain any
inherent requirement for market surveillance and argues that the
Commission, in 2005, approved the listing and trading of an ETP--the
Euro Currency Trust--where the underlying market was not
surveilled.\127\ The Commission, however, believes that its approval of
the Euro Currency Trust is readily distinguishable from its disapproval
of the proposed SolidX Bitcoin Trust.
---------------------------------------------------------------------------

\127\ See supra note 90 and accompanying text.
---------------------------------------------------------------------------

First, the Euro Currency Trust is not a commodity trust, and it is
not listed and traded under the Exchange listing standards for
commodity-based trusts. Second, the Commission's approval order for the
Euro Currency Trust notes that, in addition to a large OTC market in
currency derivatives, currency options and futures were traded on
regulated markets with the authority to perform surveillance on their
members' trading activities, to review positions held by members and
large-scale customers, and to monitor the price movements of options
and futures markets by comparing them with cash and other derivative
markets' prices.\128\ These regulated derivatives markets included the
Philadelphia Stock Exchange and the Chicago Mercantile Exchange, which,
along with the ETP's listing exchange (the New York Stock Exchange) are
members of the Intermarket Surveillance Group.
---------------------------------------------------------------------------

\128\ Exchange Act Release No. 52843 (Nov. 28, 2005), 70 FR
72486, 72487 (Dec. 5, 2005) (Order Granting Accelerated Approval of
a Proposed Rule Change regarding the Euro Currency Trust).
---------------------------------------------------------------------------

Third, the Commission's approval order notes a number of
significant facts about the underlying spot market for foreign
exchange, including:
That the listing exchange had represented that the foreign
exchange market is the largest and most liquid financial market in the
world and that, as of April 2004, the foreign exchange market
experienced average daily turnover of approximately $1.88 trillion;
\129\
---------------------------------------------------------------------------

\129\ See id. at 72486.
---------------------------------------------------------------------------

That the most significant participants in the spot market
are the major international commercial banks that act both as brokers
and as dealers; \130\ and
---------------------------------------------------------------------------

\130\ See id. at 72487.
---------------------------------------------------------------------------

That most trading in the global OTC foreign currency
markets is conducted by regulated financial institutions, such as banks
and broker dealers.\131\

\131\ See id.
---------------------------------------------------------------------------

Thus, significant, regulated markets related to foreign exchange
trading exist, and the listing exchange of the Euro Currency Trust
belongs to a multilateral surveillance-sharing agreement with those
markets. Moreover, many prominent participants in the OTC foreign
exchange market are regulated financial institutions. The markets
related to foreign exchange therefore bear little resemblance to the
markets currently related to bitcoin, which are either unregulated, not
of significant size, or both. The rationale behind the Commission's
approval of the Euro Currency Trust is therefore consistent with the
rationale for the Commission's disapproval of the SolidX Bitcoin Trust.
The Commission continues to believe that surveillance-sharing
agreements between the exchange listing shares of a commodity-trust ETP
and significant, regulated markets related to the underlying asset
provide a ``necessary deterrent to manipulation.'' \132\ To the extent
there is some question as to the degree to which bitcoin is subject to
manipulation, moreover, surveillance-sharing agreements with
significant, regulated markets relating to bitcoin would help answer
that question and address instances of such manipulation. Therefore,
the Commission's analysis of the Exchange's proposal examines whether
regulated markets of significant size exist--in either bitcoin or
derivatives on bitcoin--with which the Exchange has, or could enter
into, a surveillance-sharing agreement.
---------------------------------------------------------------------------

\132\ NDSP Adopting Release, supra note 123, 63 FR at 70959.
---------------------------------------------------------------------------

2. The Worldwide Spot Market for Bitcoin
The Commission believes--consistent with its conclusion in the Bats
BZX Order \133\--that the bulk of bitcoin trading occurs on markets
where there

[[Page 16256]]

is little to no regulation governing trading,\134\ and thus no
meaningful governmental market oversight designed to detect and deter
fraudulent and manipulative activity.\135\ The Commission also notes
that none of the bitcoin spot markets identified by the Exchange or the
Sponsor is currently a member of the Intermarket Surveillance
Group.\136\
---------------------------------------------------------------------------

\133\ See Bats BZX Order, supra note 6, 82 FR at 14084 & nn.103-
106.
\134\ Several commenters discussed the unregulated state of the
underlying bitcoin markets. See supra notes 51-54 and accompanying
text. The Commission believes that certain restrictions imposed by
the Trust to conduct bitcoin transactions reflect the absence of
meaningful regulatory oversight and transparency of certain non-U.S.
bitcoin markets. For example, the Sponsor notes that Bitfinex, one
of the bitcoin exchanges included in the Trust's underlying XBX
Index, does not conduct business in New York or with New York
residents, and another XBX Index component bitcoin exchange, OKCoin
International, is open only to non-U.S. persons. See supra note 23
and accompanying text. See also supra note 61 and accompanying text
(noting that, as of January 2017, the volume of bitcoin trading on
Chinese exchanges has declined to levels similar to those of USD-
denominated exchanges that follow AML and KYC procedures applied by
their respective jurisdictions).
\135\ See supra notes 51-54 and accompanying text.
\136\ See https://www.isgportal.org (listing the current members
and affiliate members of the Intermarket Surveillance Group).
---------------------------------------------------------------------------

The Commission also believes that the bitcoin markets identified by
the Exchange and the Sponsor as subject to certain regulatory
requirements--GDAX, itBit, Gemini, and Genesis Global Trading--are not,
in fact, regulated markets consistent with the requirements met with
respect to previously approved commodity-trust ETPs. While the Exchange
notes that GDAX, itBit, and Gemini are subject to consumer protection,
KYC compliance, AML compliance, and cybersecurity requirements imposed
by the NYSDFS,\137\ the Commission's market oversight of national
securities exchanges includes substantial additional requirements,
including the requirement to have rules that are ``designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest.'' \138\ Moreover, national
securities exchanges are subject to Commission oversight of, among
other things, their governance, membership qualifications, trading
rules, disciplinary procedures, recordkeeping, and fees.\139\ Likewise,
Designated Contract Markets that trade futures on commodities
underlying other commodity-trust ETPs are registered with and regulated
by the CFTC, and they must comply with, among other things, a similarly
comprehensive range of regulatory principles and file their rule
changes with the CFTC.\140\ Additionally, while the Exchange asserts
that Genesis Global Trading is a FINRA member,\141\ the digital
currency business of that firm, according to the Genesis Global Trading
Web site, is conducted pursuant to a BitLicense issued by the NYSDFS,
and only the securities activities of the firm are regulated by
FINRA.\142\
---------------------------------------------------------------------------

\137\ See supra notes 24-28 and accompanying text (noting that
there are currently several U.S.-based regulated entities that
facilitate bitcoin trading and that comply with U.S. AML and KYC
regulatory requirements, and that a regulatory framework created by
the NYSDFS sets forth consumer protection, AML compliance, and cyber
security rules tailored for digital currency companies operating and
transacting business in New York). The Commission notes that there
is no basis in the record to support a finding that non-U.S. bitcoin
exchanges that have not obtained a BitLicense are subject to AML,
KYC, consumer protection, or cybersecurity requirements.
\138\ 15 U.S.C. 78f(b)(5).
\139\ Section 6 of the Exchange Act, 15 U.S.C. 78f, requires
national securities exchanges to register with the Commission and
requires an exchange's registration to be approved by the
Commission, and Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b),
requires national securities exchanges to file proposed rule changes
with the Commission.
\140\ See, e.g., Designated Contract Markets (DCMs), U.S.
Commodity Futures Trading Commission, available at https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/index.htm.
\141\ See supra note 28 and accompanying text.
\142\ See Frequently Asked Questions, Genesis: A Digital
Currency Group Company (FAQ: ``Is Genesis Regulated?''), https://genesistrading.com/frequently-asked-questions/ (last visited Mar.
17, 2017).
---------------------------------------------------------------------------

Further, while the Exchange notes that the CFTC has asserted
jurisdiction over derivatives on bitcoin,\143\ the Commission does not
believe that the record supports a finding that there is currently a
regulatory framework in the United States for detecting and deterring
manipulation in the bitcoin spot markets. Although the CFTC can bring
enforcement actions against manipulative conduct in spot markets for a
commodity, spot markets are not required to register with the CFTC
unless they offer leveraged, margined, or financed trading to retail
customers.\144\ In all other cases, the CFTC does not set standards
for, approve the rules of, examine, or otherwise regulate bitcoin spot
markets.
---------------------------------------------------------------------------

\143\ See supra note 29 and accompanying text.
\144\ Commodity Exchange Act Section 2(c)(2)(D), 7 U.S.C.
2(c)(2)(D). See also Commodity Exchange Act Section 2(c)(2)(A), 7
U.S.C. 2(c)(2)(A) (defining CFTC jurisdiction to specifically cover
contracts of sale of a commodity for future delivery (or options on
such contracts), or an option on a commodity (other than foreign
currency or a security or a group or index of securities), that is
executed or traded on an organized exchange).
---------------------------------------------------------------------------

While the CFTC has brought settled enforcement actions against
bitcoin-related entities, these actions do not demonstrate that a
regulatory framework for providing market oversight and deterring
market manipulation currently exists for the bitcoin spot market. These
actions have involved either (a) the failure of an entity to register
with the CFTC before trading derivatives on bitcoin or offering
leveraged, margined, or financed bitcoin trading to retail
customers,\145\ or (b) the facilitation of wash trades in bitcoin swaps
by a SEF registered with the CFTC.\146\ Based on the record, therefore,
the Commission does not believe that the worldwide spot bitcoin
markets, including the bitcoin exchanges that are constituents of the
XBX Index, are regulated markets with which the Exchange has, or could
enter into, a surveillance-sharing agreement.\147\
---------------------------------------------------------------------------

\145\ See Coinflip Settlement Order, supra note 115; In re BFXNA
Inc., d/b/a Bitfinex, CFTC Docket No. 16-19 (CFTC June 2, 2016)
(Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of
the Commodity Exchange Act, Making Findings and Imposing Remedial
Sanctions (``BFXNA Settlement Order'')), available at https://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfbfxnaorder060216.pdf.
\146\ See In re TeraExchange LLC, CFTC Docket No. 15-33, 2015 WL
5658082 (CFTC Sept. 24, 2015) (Order Instituting Proceedings
Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange Act,
Making Findings and Imposing Remedial Sanctions (``TeraExchange
Settlement Order'')), available at https://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfteraexchangeorder92415.pdf.
\147\ The Exchange does not assert that it has a surveillance-
sharing agreement with any bitcoin exchange.
---------------------------------------------------------------------------

As noted above, the Lewis Paper asserts that, for several reasons,
the underlying market for bitcoin is not susceptible to
manipulation,\148\ and the Exchange agrees with this conclusion.\149\
While the Lewis Paper submits that arbitrage across bitcoin markets
will help to keep worldwide bitcoin prices aligned with one another,
hindering manipulation,\150\ the Commission believes that the Lewis
Paper's discussion of the possible sources of manipulation in the
underlying bitcoin market is incomplete and does not form a basis to
find that bitcoin cannot be manipulated--or to find, by implication,
that no surveillance-sharing agreement is necessary between an exchange
listing shares of a bitcoin-based ETP and

[[Page 16257]]

significant markets trading bitcoin or bitcoin derivatives.\151\
---------------------------------------------------------------------------

\148\ See Lewis Paper, supra note 43; see also supra notes 70-74
and accompanying text.
\149\ See NYSE Letter, supra note 43, at 5; see also supra note
76 and accompanying text.
\150\ See Lewis Paper, supra note 43, at 6-7.
\151\ The Sponsor also argues, in its second comment letter,
that arbitrage across bitcoin markets helps to keep bitcoin prices
aligned and reduces the likelihood of manipulation. See SolidX
Letter II, supra note 43, at 5. The Sponsor offers several
histograms purporting to show that pricing discrepancies across
bitcoin markets are generally arbitraged away within several
seconds. Id. These histograms, however, use data from only four
bitcoin exchanges, based on the Sponsor's argument that--in light of
recently imposed capital controls in China and because Chinese
exchanges trade bitcoins only against the Chinese yuan--the Chinese
markets for bitcoin are ``separate and distinct'' from the USD
market. Id. at 6-7. The Commission, however, believes that the
Sponsor's argument that the worldwide markets for trading bitcoins
against various government currencies are ``stable, resilient, fair
and efficient,'' see SolidX Letter, supra note 43, at 4, is at odds
with its argument that there are at least two substantial segments
of that market that have recently become ``separate and distinct''
from one another. See SolidX Letter II, supra note 43, at 6-7.
Moreover, the Commission does not believe that the charts provided
by the Sponsor establish there are two separate and distinct
segments of the market. The data describe a limited period, and,
while the charts purport to show a price differential between the
XBX Index and the bitcoin prices on Chinese exchanges, the charts
also appear to show a close correlation between the timing and
direction of price movements in the two market ``segments.'' See id.
If the market is not segmented, then the histograms (which show that
pricing discrepancies across only four bitcoin markets are generally
arbitraged away within several seconds) are not enough to establish
that the worldwide markets are efficient. If anything, the data
provided by the Sponsor show that bitcoin markets are still
developing and that the efficiency of arbitrage between bitcoin
markets may depend on, among other things, regulatory conditions
that can change over time. And, even if the Commission assumed that
bitcoin markets were efficient, other manipulation concerns--such as
the potential for trading on material non-public information or
potential issues arising from concentrated bitcoin holdings--would
still be applicable. See infra notes 152-158 and accompanying text.
---------------------------------------------------------------------------

For example, while there is no inside information related to the
earnings or revenue of bitcoin, there may be material non-public
information related to the actions of regulators with respect to
bitcoin; regarding order flow, such as plans of market participants to
significantly increase or decrease their holdings in bitcoin; regarding
new sources of demand, such as new ETPs that would hold bitcoin; or
regarding the decision of a bitcoin-based ETP with respect to how it
would respond to a ``fork'' in the blockchain, which would create two
different, non-interchangeable types of bitcoin.\152\ Additionally, the
manipulation of asset prices, as a general matter, can occur simply
through trading activity that creates a false impression of supply or
demand, whether in the context of a closing auction or in the course of
continuous trading, and does not require formal linkages among markets
(such as consolidated quotations or routing requirements) or the
complex quoting behavior associated with high-frequency trading.
Although the Exchange notes that bitcoin trades continuously so that
there are no opening or closing prices to manipulate, the Commission
believes that continuous trading does not necessarily eliminate
manipulation risk.\153\
---------------------------------------------------------------------------

\152\ For example, as described in the Trust's Registration
Statement, supra note 21, in the event the bitcoin network undergoes
a ``hard fork'' into two blockchains, the Trust would then hold
equal amounts of both the original bitcoin and the alternative new
bitcoin. As a result, the Sponsor would need to decide whether to
continue to hold the original bitcoin, the alternative new bitcoin,
or both and would need to decide what action to take with respect to
the unselected bitcoin, such as the possible sale of the unselected
bitcoin. The Sponsor's decision to continue to hold either the
original or alternative new bitcoin would be based on factors such
as the market value and liquidity of the original bitcoin versus the
alternative new bitcoin. Id. at 14.
\153\ See infra notes 164-165.
---------------------------------------------------------------------------

While it may or may not be possible to acquire a dominant position
in the bitcoin market as a whole, this risk exists, as the Lewis Paper
concedes.\154\ And, as the Registration Statement discloses, it is
reasonably likely that a small group of early adopters holds a
significant proportion of the bitcoins that have been mined.\155\ The
Lewis Paper lists a number of features of the Trust that should, the
paper claims, ameliorate the risk of manipulation through ownership of
a dominant market share,\156\ but these features generally address
whether the Trust itself would acquire a dominant market share, or
whether other market participants might acquire a dominant share of
bitcoin ownership through participation in the underlying bitcoin
markets. These features do not address the possible market effect of
large bitcoin positions held by early adopters. Additionally, the Lewis
Paper asserts that many features of the proposal that purportedly
ameliorate the risk of price manipulation through a dominant market
share are also factors that were used as a basis for the Commission's
approval of a commodity-trust ETP based on copper.\157\ The Commission
notes, however, that the listing exchange for that copper-based ETP had
entered into a surveillance-sharing agreement with the London Metal
Exchange regarding trading in copper and copper futures and that the
listing exchange was also a common member of the Intermarket
Surveillance Group with the COMEX, which also trades copper
futures.\158\
---------------------------------------------------------------------------

\154\ See supra notes 71-74 and accompanying text.
\155\ See Registration Statement, supra note 21, at 16. See also
Lewis Paper, supra note 43, at 6. The Lewis Paper states that there
is ``no compelling evidence'' to suggest that any single investor or
group has acquired a dominant position in bitcoin, but its citation
of ``media estimates'' regarding the holdings of certain
individuals, see Lewis Paper, supra note 43, at 6 & n.7, only
demonstrates that the risk of a person or group acquiring a
significant proportion of all bitcoins cannot be quantified or
dismissed.
\156\ See supra note 74.
\157\ See Lewis Paper, supra note 43, at 6 n.8.
\158\ See Exchange Act Release No. 68440 (Dec. 14, 2012), 77 FR
75468, 75472 (Dec. 20, 2012) (NYSEArca-2012-28) (approval of
proposal to list and trade shares of the JPM XF Physical Copper
Trust).
---------------------------------------------------------------------------

Thus, the Commission does not believe that the record supports a
finding that the unique properties of bitcoin and the underlying
bitcoin market are so different from the properties of other
commodities and commodity futures markets that they justify a
significant departure from the standards applied to previous commodity-
trust ETPs.
3. The Susceptibility to Manipulation of the XBX Index
The Sponsor, the Exchange, and the Lewis Paper all express the view
that the XBX Index is resistant to manipulation because of its
proprietary weighting methodology and its ability to respond to market
movements in real time.\159\ In essence, they claim that the XBX
Index's weighting methodology is able to resist the effects of
manipulation because it discounts prices from constituent exchanges
based on lower volume at that exchange, price deviation from the
average on other exchanges, and the staleness of reported prices.\160\
Additionally, the Sponsor and the Lewis Paper note that the XBX Index
is not susceptible to a key mechanism of manipulation, opening and
closing auctions.\161\
---------------------------------------------------------------------------

\159\ See supra Section II.B. See also supra note 16 (describing
the Sponsor's representation that the XBX Index's price variance
weighting decreases the influence on the XBX Index of any particular
exchange that diverges from the rest of the data points used by the
XBX Index and thereby reduces the possibility of an attempt to
manipulate the price of bitcoin as reflected by the XBX Index).
\160\ See, e.g., Lewis Paper, supra note 43, at 8.
\161\ See SolidX Letter, supra note 43, at 8; Lewis Paper, supra
note 43, at 9.
---------------------------------------------------------------------------

The Commission, however, does not agree that index-based pricing
for the Trust's bitcoin assets eliminates the risk of manipulation or
the need to monitor that risk through surveillance-sharing agreements.
While the XBX Index methodology uses an algorithm to discount prices
that deviate from the average, this automatic discounting could
attenuate, but not eliminate, the effect of manipulative activity on
one of the constituent exchanges--just as it could attenuate, but not
eliminate, the effect of bona fide liquidity demand on one of those
exchanges.

[[Page 16258]]

The Lewis Paper asserts that the absence of formal ties between
bitcoin exchanges (i.e., the absence of an analog to Regulation NMS in
the U.S. equity markets) means that demands for liquidity will not
propagate across the worldwide market for bitcoin, limiting the price
impact of manipulative behavior in the underlying market.\162\ However,
to the extent that market participants view pricing information from
one exchange as indications of likely price moves on other exchanges,
price moves on the first exchange might be, temporarily at least,
reflected on those other exchanges, despite the discounting function of
the XBX Index algorithm. And, as material non-public information--such
as regulatory information--can exist with respect to bitcoin, use of
that information might be possible across multiple component exchanges,
affecting the level of the XBX Index without requiring the deployment
of large amounts of capital.\163\
---------------------------------------------------------------------------

\162\ Lewis Paper, supra note 43, at 8-9.
\163\ The Lewis Paper notes that, since each bitcoin exchange is
an independent entity, a liquidity event on one exchange does not
necessarily propagate across other exchanges. This, according to the
Lewis Paper, makes prices more resilient to liquidity shocks, but
also slows down the transmission of fundamental information. See id.
at 9. The Commission does not believe that manipulative activity
propagates across trading venues solely through demands on liquidity
being transferred from one venue to another. For example, regulatory
events may simultaneously affect more than one bitcoin exchange, and
the dissemination of pricing information from trades on one exchange
may affect traders' view of supply and demand on other exchanges.
---------------------------------------------------------------------------

The Commission also observes that, while the XBX Index will be
calculated continuously, this does not eliminate possible incentives
for market participants to manipulate prices at single points in time.
The Exchange notes that a closing level of the XBX Index will be
calculated and published at or after 4:00 p.m. E.T.,\164\ and that the
NAV of the Trust will be set using the XBX Index value as of 4:00 p.m.
E.T., so the Commission believes that incentives would exist to
manipulate the XBX Index at specific times.\165\
---------------------------------------------------------------------------

\164\ See supra note 16 and accompanying text.
\165\ The Lewis Paper argues that, because bitcoin is quoted in
prices with eight decimal places, this ``mitigates incentives to
move prices a penny up or penny down because the potential gains
from moving prices at the eighth decimal point are immaterial.''
Lewis Paper, supra note 43, at 9. But the divisibility of bitcoin
itself is not relevant, and even if it were, the incentive to move
the price by one hundred-millionth of a bitcoin would increase as
the price and volume of traded bitcoin increased.
---------------------------------------------------------------------------

Accordingly, the Commission does not believe that the record
supports the claim that the unique properties of the XBX Index--or of a
commodity-trust ETP based on the XBX Index--are sufficient to isolate
the Shares from any manipulative activity in the underlying market or,
by extension, to justify a significant departure from the standards
applied to previous commodity-trust ETPs.
4. The Market for Derivatives on Bitcoin
As noted above,\166\ the commodity-trust ETPs previously approved
by the Commission for listing and trading have had--in lieu of
significant, regulated spot markets--significant, well-established, and
regulated futures markets that were associated with the underlying
commodity and with which the listing exchange had entered into a
surveillance-sharing agreement. For the reasons discussed further
below, the Commission believes that this proposal fails to support a
finding that there are significant, regulated derivatives markets
related to bitcoin with which the Exchange could enter into a
surveillance-sharing agreement.
---------------------------------------------------------------------------

\166\ See supra notes 125-126 and accompanying text.
---------------------------------------------------------------------------

The Exchange states that the CFTC has approved the registration of
TeraExchange as a SEF and has provisionally registered another SEF,
LedgerX, and that these are markets where market participants can enter
into bitcoin swaps and NDFs.\167\ The Commission observes, however,
that there is no evidence in the record that either of these venues
transacts significant volume in bitcoin-related derivatives, and the
Commission notes that the CFTC has, in fact, brought a settled
enforcement action against one of those venues for facilitating
prearranged, offsetting ``wash'' transactions and issuing a press
release ``to create the impression of actual trading in the Bitcoin
swap.'' \168\
---------------------------------------------------------------------------

\167\ See supra notes 34-36 and accompanying text.
\168\ See TeraExchange Settlement Order, supra note 146 and
accompanying text.
---------------------------------------------------------------------------

The Exchange names several non-U.S. bitcoin exchanges that offer
derivative products on bitcoin such as options, swaps, and futures. The
Commission, however, does not believe that the existence of these
markets supports a finding that there are significant, regulated
markets for bitcoin derivatives with which the Exchange could enter
into a surveillance-sharing agreement. The record does not contain any
evidence of the trading volume of these markets, the state of
regulation of these markets, or the availability of surveillance-
sharing agreements with the regulators of these markets.
The Lewis Paper asserts that the existence of bitcoin derivative
markets is not a necessary condition for a bitcoin ETP.\169\ The key
requirement the Commission is applying here, however, is not that a
futures or derivatives market is required for every ETP, but that--when
the spot market is unregulated--there must be significant, regulated
derivatives markets related to the underlying asset with which the
Exchange can enter into a surveillance-sharing agreement.
---------------------------------------------------------------------------

\169\ See Lewis Paper, supra note 43, at 8.
---------------------------------------------------------------------------

5. The Susceptibility of the Shares to Manipulation
The Exchange represents that its existing surveillance measures,
which focus on trading in the Shares, are sufficient to support the
proposed rule change. Specifically, the Exchange represents that its
surveillance procedures are adequate to properly monitor the trading of
the Shares on the Exchange during all trading sessions and to detect
and deter violations of Exchange rules and the applicable federal
securities laws.\170\ The Exchange further represents that trading of
the Shares through the Exchange will be subject to the Exchange's
surveillance procedures for derivative products, including Commodity-
Based Trust Shares, and that the Exchange may obtain information
regarding trading in the Shares through the Intermarket Surveillance
Group, from other members of that group, or from markets with which the
Exchange has a surveillance-sharing agreement.\171\ The Exchange also
notes that, pursuant to its listing standards for Commodity-Based Trust
Shares, the Exchange is able to obtain information regarding trading in
the Shares and the underlying bitcoin, or any bitcoin derivative, from
market makers registered with the Exchange, in connection with the
market makers' proprietary or customer trades effected on any relevant
market.\172\
---------------------------------------------------------------------------

\170\ See supra note 37 and accompanying text.
\171\ See supra note 38 and accompanying text.
\172\ See supra note 38. NYSE Arca Equities Rule 8.201(g)
provides that a registered market maker in Commodity-Based Trust
Shares must file with the Exchange and keep current a list
identifying all accounts for trading in an underlying commodity,
related commodity futures or options on commodity futures, or any
other related commodity derivatives that the market maker may have
or over which it may exercise investment discretion and must make
available to the Exchange books, records, or other information
relating to transactions in the underlying physical commodity,
related commodity futures, or options on commodity futures.
---------------------------------------------------------------------------

Moreover, as noted earlier, some commenters assert that regulation
by the Exchange of activity in the ETP could substitute for a lack of
regulation in underlying spot or derivatives markets.\173\ The Sponsor
also argues that

[[Page 16259]]

the Exchange's listing standards will provide strong protection against
manipulation of the Shares.\174\
---------------------------------------------------------------------------

\173\ See supra notes 86-87 and accompanying text.
\174\ See SolidX Letter II, supra note 43, at 2-3.
---------------------------------------------------------------------------

The Commission notes the Exchange's proposed surveillance
procedures regarding the Shares, and the views expressed by the Lewis
Paper and the Sponsor regarding the Trust's disclosures and information
dissemination procedures. The Commission, however, views these
procedures as necessary, but not sufficient, in light of the discussion
above noting that the Exchange has not entered into, and would
currently be unable to enter into, surveillance-sharing agreements with
significant, regulated markets for trading either bitcoin itself or
derivatives on bitcoin.\175\ In addition, while the Exchange would,
pursuant to its listing rules, be able to obtain certain information
regarding trading in the Shares and the underlying bitcoin or any
bitcoin derivative through Exchange-registered market makers,\176\ the
Commission observes that this trade information would be limited to the
activities of its members that are market makers. Moreover, the
Commission does not accept the premise that regulation of trading in
the Shares is a sufficient and acceptable substitute for regulation in
the spot or derivatives markets related to the underlying asset. Absent
the ability to detect and deter manipulation of the Shares--through
surveillance sharing with significant, regulated markets related to the
underlying asset--the Commission does not believe that a national
securities exchange can meet its Exchange Act obligations when listing
shares of a commodity-trust ETP.
---------------------------------------------------------------------------

\175\ See supra Sections III.B.2 & III.B.4.
\176\ See supra note 172 and accompanying text.
---------------------------------------------------------------------------

6. The Protection of Investors and the Public Interest
The Sponsor argues that approval of the proposed rule change is
consistent with the protection of investors because investors are
currently being harmed by the inability to invest in an insured bitcoin
vehicle and need to be protected from ``ongoing losses related to
hacking, errors and other operational hazards associated with direct
bitcoin ownership.'' \177\ The Sponsor concludes that Section 6(b)(5)
of the Exchange Act compels approval of the Exchange's proposal, so
that investors may invest in the Trust and thereby be protected from
these risks.\178\ In essence, the Sponsor asserts that it is the risky
nature of direct investment in the underlying bitcoin (including lack
of insurance coverage) and the unregulated markets on which bitcoin
trades that compel approval of the proposed rule change. The Sponsor
offers no limiting principle to this argument, under which, by logical
extension, the Commission would be required to approve the listing and
trading of any ETP that arguably presented marginally less risk to
investors than a direct investment in the underlying asset.
---------------------------------------------------------------------------

\177\ SolidX Letter II, supra note 43, at 2.
\178\ See supra note 39 and accompanying text.
---------------------------------------------------------------------------

The Commission disagrees with this reading of the Exchange Act.
Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must
approve a proposed rule change filed by a national securities exchange
if it finds that the proposed rule change is consistent with the
applicable requirements of the Exchange Act--including the requirement
under Section 6(b)(5) that the rules of a national securities exchange
be designed to prevent fraudulent and manipulative acts and practices--
and it must disapprove the filing if it does not make such a
finding.\179\ Thus, even if a proposed rule change purports to protect
investors from a particular type of investment risk--such as the
susceptibility of an asset to loss or theft--the proposed rule change
may still fail to meet other requirements under the Exchange Act.\180\
---------------------------------------------------------------------------

\179\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\180\ The Commission notes that the insurance policy for the
Trust's bitcoin holdings, as described by the Exchange and the
Sponsor, see Amendment No. 1, supra note 1, 82 FR at 12261; SolidX
Letter, supra note 43, at 2, 5, 11-12, covers theft and loss of the
bitcoin holdings, but does not insure against the risk of loss
resulting from fraudulent or manipulative acts and practices with
respect to the underlying bitcoins or the Shares.
---------------------------------------------------------------------------

As explained above, the Commission has consistently, for commodity-
trust ETPs, required that the listing exchange have surveillance-
sharing agreements with significant, regulated markets related to the
underlying asset. That requirement has not been met here. Therefore,
the Commission--even if, for the sake of argument, it agreed that
investment in the Trust might present fewer risks to investors than
direct investments in bitcoin--would be unable to find that the
proposed rule change is consistent with the statutory standard.

C. Basis for Disapproval

The Commission has, in past approvals of commodity-trust ETPs,
emphasized the importance of surveillance-sharing agreements between
the national securities exchange listing and trading the ETP, and
significant markets relating to the underlying asset.\181\ Such
agreements, which are a necessary tool to enable the ETP-listing
exchange to detect and deter manipulative conduct, enable the exchange
to meet its obligation under Section 6(b)(5) of the Exchange Act to
have rules that are designed to prevent fraudulent and manipulative
acts and practices and to protect investors and the public
interest.\182\
---------------------------------------------------------------------------

\181\ See supra notes 125-126 and accompanying text. The
Commission has also emphasized this requirement in the context of
disapproving a proposal to list and trade shares of a commodity-
trust ETP. See Bats BZX Order, supra note 6, 82 FR at 14087.
\182\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

As described above, the Exchange has not entered into a
surveillance-sharing agreement with a significant, regulated, bitcoin-
related market. The Commission also does not believe, as discussed
above, that the proposal supports a finding that the significant
markets for bitcoin or derivatives on bitcoin are regulated markets
with which the Exchange can enter into such an agreement. Therefore, as
the Exchange has not entered into, and would currently be unable to
enter into, the type of surveillance-sharing agreement that has been in
place with respect to all previously approved commodity-trust ETPs, the
Commission does not find the proposed rule change to be consistent with
the Exchange Act and, accordingly, disapproves the proposed rule
change.
The Commission notes that bitcoin is still in the relatively early
stages of its development and that, over time, regulated bitcoin-
related markets of significant size may develop. Should such markets
develop, the Commission could consider whether a bitcoin ETP would,
based on the facts and circumstances then presented, be consistent with
the requirements of the Exchange Act.

IV. Conclusion

For the reasons set forth above, the Commission does not find that
the proposed rule change, as modified by Amendment No. 1, is consistent
with the requirements of the Exchange Act and the rules and regulations
thereunder applicable to a national securities exchange, and in
particular, with Section 6(b)(5) of the Exchange Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\183\ that the proposed rule change (SR-NYSEArca-2016-
101), as modified by Amendment No. 1, be, and it hereby is,
disapproved.
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\183\ 15 U.S.C. 78s(b)(2).

[[Page 16260]]

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For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\184\
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\184\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-06441 Filed 3-31-17; 8:45 am]
BILLING CODE 8011-01-P

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