Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order Setting Aside Action by Delegated Authority and Disapproving a Proposed Rule Change, as Modified by Amendments No. 1 and 2, To List and Trade Shares of the Winklevoss Bitcoin Trust, 37579-37605 [2018-16427]

Download as PDF Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices manage its credit exposures to its clearing members by better aligning each clearing member’s contributions to the credit risk it poses to OCC, thereby allowing OCC to better manage its credit exposures to its participants. Accordingly, based on the foregoing, the Commission believes that the proposed changes pertaining to the sizing, monitoring, and allocation of clearing fund requirements are consistent with Exchange Act Rule 17Ad–22(e)(4).137 C. Consistency With Rule 17Ad–22(e)(1) Under the Exchange Act Rule 17Ad–22(e)(1) under the Exchange Act requires that OCC establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions.138 The Commission has stated that, in establishing and maintaining policies and procedures to address legal risk, a covered clearing agency generally should consider whether its rules, policies and procedures, and contracts are clear, understandable, and consistent with relevant laws and regulations.139 The Commission believes that the proposed consolidation and reorganization of OCC’s Rules described above would improve readability by locating all rules related to the clearing fund in one place, thereby enhancing the clarity, transparency, consistency, and understandability of OCC’s Rules related to the clearing fund. Additionally, by amending the Rules to accurately reflect OCC’s current margin practices, the Commission believes OCC’s Rules will be more transparent and understandable. Accordingly, the Commission believes that the proposed textual reorganization and clarifications are consistent with Rule 17Ad–22(e)(1).140 sradovich on DSK3GMQ082PROD with NOTICES V. Conclusion It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Payment Supervision Act, that the Commission does not object to Advance Notice (SR– OCC–2018–803) and that OCC is authorized to implement the proposed change. 137 Id. 138 17 CFR 240.17Ad–22(e)(1). Clearing Agency Standards at 70802. 140 17 CFR 240.17Ad–22(e)(1). 139 Covered VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 By the Commission. Robert W. Errett, Deputy Secretary. [FR Doc. 2018–16417 Filed 7–31–18; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–83723; File No. SR– BatsBZX–2016–30] Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order Setting Aside Action by Delegated Authority and Disapproving a Proposed Rule Change, as Modified by Amendments No. 1 and 2, To List and Trade Shares of the Winklevoss Bitcoin Trust July 26, 2018. I. Introduction On June 30, 2016, Bats BZX Exchange, Inc. (‘‘BZX’’) filed a proposed rule change with the Commission, seeking to list and trade shares of the Winklevoss Bitcoin Trust.1 The Commission, acting through authority delegated to the Division of Trading and Markets,2 disapproved the proposed rule change on March 10, 2017,3 and BZX then filed a timely petition seeking Commission review of the disapproval by delegated authority.4 The Commission granted made this filing under Section 19(b)(1) of the Securities Exchange Act of 1934, 15 U.S.C. 78s(b)(1) (‘‘Exchange Act’’) and Rule 19b–4 thereunder, 17 CFR 240.19b–4. The Commission published notice of the proposed rule change in the Federal Register on July 14, 2016. See Exchange Act Release No. 78262 (July 8, 2016), 81 FR 45554 (July 14, 2016) (SR–BatsBZX–2016–30). On August 23, 2016, the Commission designated a longer period within which to act on the proposed rule change. See Exchange Act Release No. 78653 (Aug. 23, 2016), 81 FR 59256 (Aug. 29, 2016). On October 12, 2016, the Commission instituted proceedings under Section 19(b)(2)(B) of the 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. 79084 (Oct. 12, 2016), 81 FR 71778 (Oct. 18, 2016). On October 20, 2016, BZX filed Amendment No. 1 to the proposed rule change, replacing the original filing in its entirety, and Amendment No. 1 was published for comment in the Federal Register on November 3, 2016. See Exchange Act Release No. 79183 (Oct. 28, 2016), 81 FR 76650 (Nov. 3, 2016) (‘‘Amendment No. 1’’). On January 4, 2017, the Commission designated a longer period for Commission action on the proposed rule change. See Exchange Act Release No. 79725 (Jan. 4, 2017), 82 FR 2425 (Jan. 9, 2017). On February 22, 2017, BZX filed Amendment No. 2 to the proposed rule change (‘‘Amendment No. 2’’). Amendment No. 2 is available on the Commission’s website at https:// www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx 201630-1594698-132357.pdf. 2 See 17 CFR 200.30–3(a)(12). 3 See Exchange Act Release No. 80206 (Mar. 10, 2017), 82 FR 14076 (Mar. 16, 2017) (‘‘March Disapproval Order’’). 4 On March 17, 2017, pursuant to Rule 430 of the Rules of Practice, see 17 CFR 201.430(b)(1), BZX PO 00000 1 BZX Frm 00121 Fmt 4703 Sfmt 4703 37579 BZX’s Petition for Review, seeking public comments in support of or in opposition to the March Disapproval Order.5 Today’s order sets aside the March Disapproval Order, and, for the reasons discussed below, disapproves BZX’s proposed rule change.6 In response to BZX’s Petition for Review, the Commission has conducted a de novo review of BZX’s proposal 7— giving careful consideration to the entire record, including BZX’s amended proposal and Petition for Review and all comments and statements submitted by BZX and other persons—to determine whether the proposal is consistent with the requirements of the Exchange Act and the rules and regulations issued thereunder that are applicable to a national securities exchange.8 Specifically, the Commission has considered whether the BZX proposal is consistent with Exchange Act Section 6(b)(5), which requires, in relevant part, 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.’’ 9 Under 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 submitted a Notice of Intention to Petition for Review of Order Disapproving a Proposed Rule Change, and on March 24, 2017, BZX submitted its Petition for Review (‘‘Petition for Review’’). BZX’s Notice of Intention to Petition for Review is available on the Commission’s website at: https:// www.sec.gov/rules/sro/batsbzx/2017/batsbzxpetitionforreview.pdf. BZX’s Petition for Review is available on the Commission’s website at: https:// www.sec.gov/rules/sro/batsbzx/2017/petition-forreview-sr-batsbzx-2016-30.pdf. 5 On April 24, 2017, pursuant to Rule 431 of the Rules of Practice, see 17 CFR 201.431, the Commission issued an order granting the Petition for Review, see Exchange Act Release No. 80511 (Apr. 24, 2017), 82 FR 19770 (Apr. 28, 2017) (‘‘Review Order’’), and designated May 15, 2017, as the date by which any party to the action or any other person could file a written statement in support of or in opposition to the March Disapproval Order. See id. 6 Commissioner Peirce dissents from the Commission’s disapproval of this proposal, and her written dissent can be found on the Commission’s website, https://www.sec.gov. 7 Pursuant to Rule 431(a) of the Commission’s Rules of Practice, the Commission may affirm, reverse, modify, set aside, or remand for further proceedings, in whole or in part, an action made pursuant to delegated authority. 17 CFR 201.431(a). 8 Section 19(b)(2)(C) of the Exchange Act directs the Commission to approve a proposed rule change of an SRO, such as a national securities exchange, if the Commission finds that the proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to the SRO and directs the Commission to disapprove the proposed rule change if it is unable to make such a finding. See 15 U.S.C. 78s(b)(2)(C). 9 15 U.S.C. 78f(b)(5). E:\FR\FM\01AUN1.SGM 01AUN1 37580 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES thereunder . . . is on the self-regulatory organization [‘SRO’] that proposed the rule change.’’ 10 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,11 and any failure of an SRO to provide this information 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 applicable rules and regulations.12 BZX argues, among other things, that its proposal is consistent with Exchange Act Section 6(b)(5) on the grounds that the ‘‘geographically diverse and continuous nature of bitcoin trading makes it difficult and prohibitively costly to manipulate the price of bitcoin’’ 13—and that therefore the bitcoin market ‘‘generally is less susceptible to manipulation than the equity, fixed income, and commodity futures markets’’ 14—and because ‘‘novel systems intrinsic to this new market provide unique additional protections that are unavailable in traditional commodity markets.’’ 15 BZX also asserts that the March Disapproval Order failed to appreciate that the proposal provides ‘‘traditional means of identifying and deterring fraud and manipulation,’’ 16 and that the proposal meets the criteria that the Commission has utilized in approving other commodity-trust ETPs as it relates to the ability to monitor for, detect, and deter fraud and manipulation and violations of exchange rules and applicable federal securities laws and rules.17 BZX also claims that the March Disapproval Order overstates the extent to which surveillance and regulation of the underlying market have been present in prior commodity-trust ETP approval orders and the extent to which the Commission has relied on the existence of surveillance-sharing agreements between an ETP listing market and markets related to the underlying assets.18 10 Rule 700(b)(3), Commission Rules of Practice, 17 CFR 201.700(b)(3). 11 See id. 12 See id. 13 See Letter from Joanne Moffic-Silver, Executive Vice President, General Counsel & Corporate Secretary, BZX, at 12 (May 15, 2017) (‘‘BZX Letter II’’). 14 Id. 15 Id. at 26. 16 Id. 17 See id. at 22. 18 See id. at 26–27. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 The Commission addresses each of these arguments below. In Section III.B, the Commission addresses BZX’s assertion that bitcoin and bitcoin markets, including the Gemini Exchange, are uniquely resistant to manipulation and finds that the record before the Commission does not support such a conclusion. In Section III.C, the Commission addresses whether what BZX describes as ‘‘traditional means’’ of identifying and deterring fraud and manipulation are sufficient to meet the requirements of Exchange Act Section 6(b)(5) and also finds that the record does not support such a conclusion. Then, in Sections III.D and III.E, respectively, the Commission addresses the use and importance of surveillancesharing agreements to detect and deter fraud and manipulation, and whether BZX has entered into a comprehensive surveillance-sharing agreement with a regulated market of significant size related to bitcoin.19 Although surveillance-sharing agreements are not the exclusive means by which an ETP listing exchange can meet its obligations under Exchange Act Section 6(b)(5), such agreements are a widely used means for exchanges that list ETPs to meet their obligations, and the Commission has historically recognized their importance.20 And where, as here, a listing exchange fails to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, the listing exchange must enter into a surveillance-sharing agreement with a regulated market of significant size because ‘‘[s]uch 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.’’ 21 Based on the record before it, the Commission concludes that—unlike the listing exchanges for previously approved commodity-trust ETPs—BZX has not established that it has entered into, or currently could enter into, a surveillance-sharing agreement with a regulated market of significant size related to bitcoin. Finally, in Section III.F, the Commission addresses arguments raised 19 The Commission considers two markets that are members of the Intermarket Surveillance Group to have a comprehensive surveillance-sharing agreement with one another, even if they do not have a separate bilateral surveillance-sharing agreement. 20 See Section III.D.2(a), infra. 21 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, 70954, 70959 (Dec. 22, 1998) (File No. S7–13–98) (‘‘NDSP Adopting Release’’). PO 00000 Frm 00122 Fmt 4703 Sfmt 4703 regarding the protection of investors and the public interest, and, in Section III.G, the Commission discusses additional factors supporting disapproval of the BZX proposal. Although the Commission is disapproving this proposed rule change, the Commission emphasizes that its disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment. Rather, the Commission is disapproving this proposed rule change because, as discussed in detail below, BZX has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that its rules be designed to prevent fraudulent and manipulative acts and practices. While the record before the Commission indicates that a substantial majority of bitcoin trading occurs on unregulated venues overseas that are relatively new and that, generally, appear to trade only digital assets,22 and while the record does not support a conclusion that bitcoin derivatives markets have attained significant size,23 the Commission notes that regulated bitcoin-related markets are in the early stages of their development. Over time, regulated bitcoin-related markets may continue to grow and develop. For example, existing or newly created bitcoin futures markets may achieve significant size, and an ETP listing exchange may be able to demonstrate in a proposed rule change that it will be able to address the risk of fraud and manipulation by sharing surveillance information with a regulated market of significant size related to bitcoin, as well as, where appropriate, with the spot markets underlying relevant bitcoin derivatives. Should these circumstances develop, or conditions otherwise change in a manner that affects the Exchange Act analysis, the Commission would then have the opportunity to consider whether a bitcoin ETP would be consistent with the requirements of the Exchange Act. 22 For example, the Registration Statement for the Winklevoss Bitcoin Trust discloses that ‘‘[t]he Bitcoin Exchanges on which bitcoin trades are new and, in most cases, largely unregulated.’’ See Registration Statement on Form S–1, as amended, dated February 8, 2017, at 22 (File No. 333–189752) (‘‘Registration Statement’’). See also Sections III.E.1 and III.E.2, infra (discussing the distribution of bitcoin trading and the state of regulation of bitcoin spot markets). 23 See infra notes 312–316 and accompanying text. E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES II. Description of the Proposal BZX proposes to list and trade shares (‘‘Shares’’) of the Winklevoss Bitcoin Trust (‘‘Trust’’) as Commodity-Based Trust Shares under BZX Rule 14.11(e)(4).24 The Trust would hold only bitcoins as an asset,25 and the bitcoins would be in the custody of, and secured by, the Trust’s custodian, Gemini Trust Company LLC (‘‘Custodian’’), which is a limitedliability trust company chartered by the State of New York and supervised by the New York State Department of Financial Services (‘‘NYSDFS’’).26 Gemini Trust Company is also an affiliate of Digital Asset Services LLC, the sponsor of the Trust (‘‘Sponsor’’).27 The Trust would issue and redeem the Shares only in ‘‘Baskets’’ of 100,000 Shares and only to ‘‘Authorized Participants,’’ and these transactions would be conducted ‘‘in-kind’’ for bitcoin only.28 The investment objective of the Trust would be for the Shares to track the price of bitcoin on the Gemini Exchange, which is a digital-asset exchange owned and operated by the Gemini Trust Company.29 The Net Asset Value (‘‘NAV’’) of the Trust would be calculated each business day, based on the clearing price of that day’s 4:00 p.m. Eastern Time (‘‘ET’’) Gemini Exchange bitcoin auction, a two-sided auction open to all Gemini Exchange customers (‘‘Gemini Auction’’).30 The Intraday 24 BZX Rule 14.11(e)(4)(C) permits the listing and trading of ‘‘Commodity-Based Trust Shares,’’ which are 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. 25 Bitcoins are digital assets that are issued and transferred via a decentralized, open-source protocol used by a peer-to-peer computer network through which transactions are recorded on a public transaction ledger known as the ‘‘Bitcoin Blockchain.’’ The Bitcoin protocol governs the creation of new bitcoins and the cryptographic system that secures and verifies bitcoin transactions. See Amendment No. 1, supra note 1, 81 FR at 76652. The proposed rule change describes the ETP’s underlying bitcoin asset as a ‘‘digital asset’’ and as a ‘‘commodity,’’ see id. at 76652 & n.21, and describes the ETP as a Commodity-Based Trust. For the purpose of considering this proposal, this order describes a bitcoin as a ‘‘digital asset’’ and a ‘‘commodity.’’ 26 See id. at 76651–52. 27 See id. at 76651. 28 See id. at 76664–65. See also Amendment No. 2, supra note 1. 29 See Amendment No. 1, supra note 1, 81 FR at 76652. 30 See id. at 76652, 76664. In the event that the Sponsor determines that the Gemini Auction price, because of extraordinary circumstances, is ‘‘not an VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 Indicative Value (‘‘IIV’’) of the Trust would be calculated and disseminated by the Sponsor, every 15 seconds during BZX’s regular trading session, based on the most recent Gemini Auction price.31 BZX represents that it has entered into a comprehensive surveillancesharing agreement with the Gemini Exchange.32 Further details regarding the proposal and the Trust can be found in Amendments No. 1 and 2 to the proposal,33 and in the registration statement for the Trust.34 III. Discussion A. Overview The comment period for the proposed rule change filed by BZX ended November 25, 2016. The Commission, as of March 10, 2017, received 66 comment letters on the proposed rule change.35 Additionally, in response to appropriate basis for evaluation of the Trust’s bitcoin on a given Business Day,’’ BZX’s proposal provides that the Sponsor may use other specified criteria to value the holdings of the Trust. See id. at 76664. 31 See id. at 76666. 32 See id. at 76668. 33 See Amendments No. 1 and 2, supra note 1. 34 See Registration Statement, supra note 22. BZX represents in the proposed rule change that the Registration Statement will be effective as of the date of any offer and sale pursuant to the Registration Statement. See Amendment No. 1, supra note 1, 81 FR at 76651. 35 See Letters from Robert D. Miller, VP Technical Services, RKL eSolutions (July 11, 2016) (‘‘R.D. Miller Letter’’); Jorge Stolfi, Full Professor, Institute of Computing UNICAMP (July 13, 2016) (‘‘Stolfi Letter I’’); Guillaume Lethuillier (July 26, 2016) (‘‘Lethuillier Letter’’); Michael B. Casey (July 31, 2016) (‘‘Casey Letter I’’); Erik A. Aronesty, Sr. Software Engineer, Bloomberg LP (Aug. 2, 2016) (‘‘Aronesty Letter’’); Dan Anderson (Aug. 27, 2016) (‘‘Anderson Letter’’); Robert Miller (Oct. 12, 2016) (‘‘R. Miller Letter’’); Anonymous (Oct. 13, 2016) (‘‘Anonymous Letter I’’); Nils Neidhardt (Oct. 13, 2016) (‘‘Neidhardt Letter’’); Dana K. Barish (2 letters; Oct. 13, 2016) (‘‘Barish Letter I’’ and ‘‘Barish Letter II’’); Xin Lu (Oct. 13, 2016) (‘‘Xin Lu Letter’’); Rodger Delehanty CFA (Oct. 14, 2016) (‘‘Delehanty Letter’’); Dylan (Oct. 14, 2016) (‘‘Dylan Letter’’); Dana K. Barish (Oct. 14, 2016) (‘‘Barish Letter III’’); Dana K. Barish (2 letters; Oct. 15, 2016) (‘‘Barish Letter IV’’ and ‘‘Barish Letter V’’); Jorge Stolfi, Full Professor, Institute of Computing UNICAMP (Nov. 1, 2016) (‘‘Stolfi Letter II’’); Michael B. Casey (Nov. 5, 2016) (‘‘Casey Letter II’’); Anonymous (Nov. 8, 2016) (‘‘Anonymous Letter II’’); Chris Burniske, Blockchain Products Lead, ARK Investment Management LLC (Nov. 8, 2016) (‘‘ARK Letter’’); Colin Keeler (Nov. 14, 2016) (‘‘Keeler Letter’’); Robert S. Tull, (Nov. 14, 2016) (‘‘Tull Letter’’); Mark T. Williams (Nov. 15, 2016) (‘‘Williams Letter’’); Anonymous (Nov. 21, 2016) (‘‘Anonymous Letter III’’); XBT OPPS Team (Nov. 21, 2016) (‘‘XBT Letter’’); Anonymous (Nov. 22, 2016) (‘‘Anonymous Letter IV’’); Ken I. Maher (Nov. 22, 2016) (‘‘Maher Letter’’); Kyle Murray, Assistant General Counsel, Bats Global Markets, Inc. (Nov. 25, 2016) (‘‘BZX Letter I’’); Colin Baird (Nov. 26, 2016) (‘‘Baird Letter’’); Scott P. Hall (Jan. 5, 2017) (‘‘Hall Letter’’); Suzanne H. Shatto (Jan. 24, 2017) (‘‘Shatto Letter’’); Joshua Lim and Dan Matuszewski, Treasury & Trading Operations, Circle internet Financial, Inc. (Feb. 3, 2017) (‘‘Circle Letter’’); Zachary J. Herbert (Feb. 10, 2017) (‘‘Herbert Letter’’); Thomas PO 00000 Frm 00123 Fmt 4703 Sfmt 4703 37581 the Review Order, the Commission, as of July 13, 2018, received eight comments in connection with the Petition for Review.36 The comments cover a variety of topics, including the analysis of the BZX proposal in the March Disapproval Order,37 the nature of the worldwide market for bitcoin,38 the characteristics of the Gemini digital asset exchange,39 the need for surveillance-sharing agreements with significant markets,40 the state of the market for derivatives on bitcoin,41 and the protection of investors,42 as well as a number of comments on the nature of bitcoin and of the Bitcoin network, the structure of the Trust and the Trust’s valuation and security protocols, and Fernandez (Feb. 12, 2017) (‘‘Fernandez Letter’’); Diego Tomaselli (Feb. 17, 2017) (‘‘Tomaselli Letter’’); Hans Christensen (Feb. 20, 2017) (‘‘Christensen Letter’’); Jake Kim (Feb. 22, 2017) (‘‘Kim Letter’’); Andrea Dalla Val (Mar. 4, 2017) (‘‘Dalla Val Letter’’); Josh Barraza (Mar. 6, 2017) (‘‘Barraza Letter’’); Chad Rigsby (Mar. 6, 2017) (‘‘Rigsby Letter’’); Michael Lee (Mar. 6, 2017) (‘‘Lee Letter’’); Fabrizio Marchionne (Mar. 6, 2017) (‘‘Marchionne Letter’’); Ben Elron (Mar. 6, 2017) (‘‘Elron Letter’’); Patrick Miller (Mar. 6, 2017) (‘‘P. Miller Letter’’); Situation (Mar. 6, 2017) (‘‘Situation Letter’’); Steven Swiderski (Mar. 6, 2017) (‘‘Swiderski Letter’’); Marcia Paneque (Mar. 6, 2017) (‘‘Paneque Letter’’); Jeremy Nootenboom (Mar. 6, 2017) (‘‘Nootenboom Letter’’); Alan Struna (Mar. 6, 2017) (‘‘Struna Letter’’); Mike Johnson (Mar. 6, 2017) (‘‘Johnson Letter’’); Phil Chronakis (Mar. 7, 2017) (‘‘Chronakis Letter’’); Anonymous (Mar. 7, 2017) (‘‘Anonymous Letter V’’); Brian Bang (Mar. 7, 2017) (‘‘Bang Letter’’); Anthony Schulte (Mar. 7, 2017) (‘‘Schulte Letter’’); Melissa Whitman (Mar. 7, 2017) (‘‘Whitman Letter’’); Harold Primm (Mar. 8, 2017) (‘‘Primm Letter’’); Shad (Mar. 8, 2017) (‘‘Shad Letter’’); Anonymous (Mar. 8, 2017) (‘‘Anonymous Letter VI’’); Patrick Turley (Mar. 9, 2017) (‘‘Turley Letter’’); Anonymous (Mar. 9, 2017) (‘‘Anonymous Letter VII’’); Richard Kemble (Mar. 9, 2017) (‘‘Kemble Letter’’); Anonymous (Mar. 9, 2017) (‘‘Anonymous Letter VIII’’); Daniel Ackerman (Mar. 10, 2017) (‘‘Ackerman Letter’’); Obed Medina (Mar. 10, 2017) (‘‘Medina Letter’’); and John Paslaqua (Mar. 10, 2017) (‘‘Paslaqua Letter’’). All comments on the proposed rule change are available on the Commission’s website at: https://www.sec.gov/ comments/sr-batsbzx-2016-30/batsbzx 201630.shtml. 36 See Letters from Douglas A. Cifu, Chief Executive Officer, Virtu Financial (May 11, 2017) (‘‘Virtu Letter’’); James A. Overdahl, Partner, Delta Strategy Group (May 12, 2017) (‘‘Overdahl Letter’’); Daniel H. Gallancy, SolidX Management LLC (May 15, 2017) (‘‘SolidX Letter’’); Jonathan G. Harris (May 15, 2017) (‘‘Harris Letter’’); Mick Kalishman, C&C Trading, LLC (May 15, 2017) (‘‘C&C Letter’’); Eric W. Noll, President and Chief Executive Officer, Convergex Group (May 15, 2017) (‘‘Convergex Letter’’); Jeffrey Yass, Managing Director, Susquehanna International Group, LLP (May 15, 2017) (‘‘SIG Letter’’); and BZX Letter II, supra note 13. All comments submitted in support of or in opposition to the March Disapproval Order are available on the Commission’s website at: https:// www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx 201630.shtml. 37 See infra notes 44–48 and accompanying text. 38 See Sections III.B.1(a) and III.E.2(a), infra. 39 See Sections III.B.2(a) and III.E.1(a), infra. 40 See Section III.D.1, infra. 41 See Section III.E.3(a), infra. 42 See Section III.F.1, infra. E:\FR\FM\01AUN1.SGM 01AUN1 37582 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES the effect that Commission approval of the BZX proposal could have on bitcoin and the bitcoin markets.43 BZX’s primary argument is that the standard set forth in the March Disapproval Order—the need for a surveillance sharing agreement between the ETP listing exchange and significant, regulated markets related to the underlying asset 44—is not the only way that a listing exchange can satisfy Section 6(b)(5)’s requirement that its rules be designed to prevent fraudulent and manipulative acts and practices with respect to listing an ETP.45 BZX argues that, in the case of a bitcoin commodity-trust ETP, traditional measures to detect and deter manipulation are sufficient.46 BZX and certain commenters further argue that the March Disapproval Order misconstrued Section 6(b)(5) to mean that a bitcoin ETP can be listed and traded only if bitcoin ‘‘cannot be manipulated.’’ 47 They argue that such a standard is inconsistent with the ‘‘not readily susceptible to manipulation’’ standard applied to other commodities that underlie ETPs.48 These arguments do not accurately reflect the nature of the Commission’s inquiry and past practice. The Commission agrees that, if BZX had demonstrated that bitcoin and bitcoin markets are inherently resistant to fraud and manipulation, comprehensive surveillance-sharing agreements with significant, regulated markets would not be required, as the function of such agreements is to detect and deter fraud and manipulation. But because the underlying commodities market for this proposed commodity-trust ETP is not demonstrably resistant to manipulation, BZX, as the ETP listing exchange, must enter into surveillance-sharing agreements with, or hold Intermarket Surveillance Group membership in common with, at least one significant, regulated market relating to bitcoin. Moreover, the Commission is not applying a ‘‘cannot be manipulated’’ standard to this proposal. Instead, the Commission is examining whether the proposal meets the requirements of the Exchange Act and, pursuant to its Rules of Practice,49 is placing the burden on BZX to demonstrate the validity of its contention that the ‘‘novel systems 43 See Section III.G, infra. March Disapproval Order, supra note 3, 82 FR at 14082–84. 45 See BZX Letter II, supra note 13, at 26. 46 See id. at 12; see also id. at 13, 26. 47 See BZX Letter II, supra note 13, at 13; and Overdahl Letter, supra note 36, at 2, 9–11. 48 See BZX Letter II, supra note 13, at 13; and Overdahl Letter, supra note 36, at 2, 9–11. 49 See supra notes 10–12 and accompanying text. 44 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 intrinsic to this new market provide unique additional protections that are unavailable in traditional commodity markets,’’ 50 and to establish that the requirements of the Exchange Act have been met. Finding that BZX has not demonstrated that bitcoin and bitcoin markets are inherently resistant to manipulation, the Commission subjects the proposal to the analysis it has historically used to analyze commoditytrust ETPs, focusing particularly on whether there are comprehensive surveillance-sharing agreements with significant, regulated markets. Because adequate surveillance-sharing agreements are not in place—and any current surveillance-sharing agreements are with bitcoin-related markets that are either not significant, not regulated, or both—the Commission concludes that the proposal is inconsistent with Exchange Act Section 6(b)(5). Accordingly, the Commission will examine whether the proposed rule change is consistent with Section 6(b)(5) by first addressing the arguments by BZX and certain commenters that bitcoin and bitcoin markets are inherently resistant to manipulation. The Commission will then address BZX’s argument that what it describes as ‘‘traditional means’’ of identifying and deterring fraud and manipulation would be sufficient to comply with Exchange Act Section 6(b)(5), which requires that BZX’s rules be designed to ‘‘prevent fraudulent and manipulative acts and practices’’ and ‘‘to protect investors and the public interest.’’ 51 Finding these arguments unpersuasive, the Commission concludes that the proposal is inconsistent with previously approved commodity-trust ETPs, which have universally relied on surveillancesharing agreements with significant, regulated markets relating to the underlying commodity in order to prevent fraud and manipulation and to protect investors and the public interest. Finally, the Commission addresses and rejects additional factors that BZX contends support approval. B. The Susceptibility of Bitcoin and Bitcoin Markets to Manipulation BZX asserts that intrinsic properties of bitcoin and bitcoin markets, including the Gemini Exchange, provide resistance to manipulation. But BZX has failed to carry its burden to demonstrate that its assertion is correct. PO 00000 50 See 51 15 BZX Letter II, supra note 13, at 26. U.S.C. 78f(b)(5). Frm 00124 Fmt 4703 Sfmt 4703 1. The Structure of the Spot Market for Bitcoin (a) Summary of Comments Received BZX argues that intrinsic properties of bitcoin and bitcoin markets make manipulation ‘‘difficult and prohibitively costly.’’ 52 BZX argues that ‘‘novel systems intrinsic to this new market provide unique additional protections that are unavailable in traditional commodity markets.’’ 53 BZX asserts that the increasing strength and resilience of the global bitcoin marketplace serve to reduce the likelihood of price manipulation and that arbitrage opportunities across globally diverse marketplaces allow market participants to ensure approximately equivalent pricing worldwide. But BZX concedes that less liquid markets, such as the market for bitcoin, may be more susceptible to manipulation.54 BZX asserts that a number of new bitcoin market participants have emerged, changing the once concentrated and non-regulated landscape of the global bitcoin exchange marketplace, and that the emergence of these new market participants, who are chiefly arbitrageurs, causes global bitcoin exchange prices to converge.55 BZX adds that arbitrageurs must have funds distributed across multiple bitcoin exchanges to take advantage of temporary price dislocations, and that this distribution of funds discourages concentration of funds on any one particular bitcoin exchange and mitigates the potential for manipulation on a bitcoin exchange because doing so would require overcoming the liquidity supply of arbitrageurs that are actively eliminating any cross-market pricing differences.56 BZX also asserts that the bitcoin spot market generally is less susceptible to manipulation than the equity, fixed income, and commodity futures markets, in part, because: (a) A substantial over-the-counter (‘‘OTC’’) market provides liquidity and shock absorbing capacity; (b) the ‘‘24/7/365’’ trading of bitcoin provides constant arbitrage opportunities across all trading venues and means that there is no single market-close for investors to attempt to manipulate; and (c) it is unlikely that any one actor could obtain a dominant 52 BZX Letter II, supra note 13, at 12, 13, 26; see also Petition for Review, supra note 4, at 11. 53 See supra note 50 and accompanying text. 54 See BZX Letter I, supra note 35, at 7. 55 See Petition for Review, supra note 4, at 15. 56 See BZX Letter II, supra note 13, at 15–16; Petition for Review, supra note 4, at 15. E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES market share.57 BZX also claims that the transparency that the Trust will provide with respect to its bitcoin holdings, and the dissemination of the IIV and NAV of the Trust, will reduce the ability of market participants to manipulate the price of bitcoin or the price of the Shares.58 The Overdahl Letter, submitted in support of the BZX proposal,59 asserts that the fungibility of bitcoin across bitcoin exchanges facilitates arbitrage and helps keep prices within the bounds of arbitrage, constraining the possibility of price manipulation on any one bitcoin trading venue.60 Because of this linkage, the Overdahl Letter contends, manipulation of the bitcoin price on any one venue would require manipulation of the global bitcoin price to be effective, which would be prohibitively costly and is therefore unlikely. But the Overdahl Letter concedes that any market can potentially be manipulated.61 The Overdahl Letter further claims that, to the extent that ‘‘spoofing conduct’’ 62 is present in bitcoin markets, it is unlikely to have a material impact on the value of the Shares. According to the Overdahl Letter, this is because successful spoofing causes price oscillations of extremely small magnitudes (such as within the bid/ask spread) and does not result in a material change in the bitcoin price. This commenter also claims that spoofing victims are unlikely to be holders of the Shares, but rather market makers in the spot market, and concludes that the likelihood of spoofing in the bitcoin spot market is low.63 The Overdahl Letter further claims that even a ‘‘dominant’’ exchange (by trading volume) cannot dictate the global price of bitcoin because an exchange does not coordinate trading across its membership to influence the market price. This commenter argues that the existence of a dominant exchange in terms of trading volume does not imply that there is a dominant actor on the dominant exchange with the ability to attain a dominant market share to manipulate the price of bitcoin. Rather, this commenter argues, the larger the market share of an exchange, 57 See BZX Letter II, supra note 13, at 12; see also Petition for Review, supra note 4, at 11. 58 See Petition for Review, supra note 4, at 16. 59 See supra note 36. 60 See Overdahl Letter, supra note 36, at 1–2. 61 Id. 62 The Commodity Exchange Act defines ‘‘spoofing’’ as bidding or offering for sale with the intent to cancel the bid or offer before execution. See 7 U.S.C. 6c(a)(5)(C). 63 See Overdahl Letter, supra note 36, at 2, 9; see also Petition for Review, supra note 4, at 14. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 the harder it would be for a dominant actor to obtain a dominant market share of the dominant exchange’s trading volume.64 Another analysis—the Lewis Letter 65—argues that, as a general matter, the underlying market for bitcoin is inherently resistant to manipulation.66 The Lewis Letter posits that the underlying bitcoin market is not susceptible to manipulation because: (a) There is no inside information related to bitcoin, such as earnings announcements; (b) the asset is not subject to the dissemination of false or misleading information; (c) each bitcoin market is an independent entity, so that a demand for liquidity does not necessarily propagate across other exchanges; (d) a substantial OTC market provides additional liquidity and absorption of shocks; (e) there is no market-close pricing event to manipulate; (f) the market is not subject to ‘‘spoofing’’ or other high-frequencytrading tactics; (g) order books on exchanges worldwide are publicly visible and available through APIs (application program interfaces); and (h) it is unlikely that any one person could obtain a dominant market share because of the existence of in-kind creations and redemptions, arbitrage across bitcoin markets, and the enhanced transparency that a bitcoin ETP would bring to bitcoin markets.67 The Lewis Letter acknowledges the risk that a single investor or a small group acting in collusion could own a dominant share of the available bitcoin, but argues that the structure of the spot bitcoin market and the arbitrage mechanism reduce that risk.68 One commenter observes that the bitcoin/Chinese Yuan (BTC/CNY) quote is apt to trade at a significant premium Overdahl Letter, supra note 36, at 9. Craig M. Lewis, ‘‘SolidX Bitcoin Trust: A Bitcoin Exchange Traded Product’’ (Feb. 13, 2017) (‘‘Lewis Letter I’’), available at https://www.sec.gov/ comments/sr-nysearca-2016-101/nysearca20161011579480-131874.pdf; Craig M. Lewis, ‘‘Supplemental Submission to SolidX Bitcoin Trust: A Bitcoin Exchange Traded Product’’ (Mar. 3, 2017) (‘‘Lewis Letter II’’, and together with Lewis Letter I the ‘‘Lewis Letter’’), available at https:// www.sec.gov/comments/sr-nysearca-2016-101/ nysearca2016101-1610031-135950.pdf. The Lewis Letter was commissioned by SolidX Management LLC in support of the SolidX Bitcoin Trust. BZX Letter II, supra note 13, at 12; see also Exchange Act Release No. 80319 (Mar. 28, 2017), 82 FR 16247, 16249 n.43 (Apr. 3, 2017) (SR–NYSEArca–2016– 101) (‘‘SolidX Order’’). The Commission notes that the Lewis Letter made additional assertions directed to the particular structure and pricing mechanism of another proposed bitcoin-based commodity-trust ETP, and the Commission does not address those arguments in this order. 66 See Lewis Letter I, supra note 65, at 5–8. 67 See Lewis Letter I, supra note 65, at 5–9; Lewis Letter II, supra note 65, at 2. 68 See Lewis Letter I, supra note 65, at 6–7. PO 00000 64 See 65 See Frm 00125 Fmt 4703 Sfmt 4703 37583 to the bitcoin/U.S. dollar (BTC/USD) quote and points out that large arbitrage opportunities would not exist for long in efficient markets, but they do persist in bitcoin markets.69 Another commenter claims that, because trade is now sparse on regulated U.S. exchanges, including Gemini, arbitrage will not occur efficiently or proportionally to mitigate manipulation from the dominant unregulated bitcoin exchanges.70 One commenter asserts that, in January 2017, major Chinese bitcoin exchanges OKCoin, Huobi, and BTCC implemented changes requested by the People’s Bank of China to halt margin lending and to institute transaction fees. This commenter claims that these changes were put in place to discourage price manipulation, to drive down ‘‘fake’’ trading volume, and to dampen bitcoin volatility, and further claims that these changes have had profound and beneficial effects on bitcoin spot markets worldwide.71 One commenter states that the market for bitcoin, by trade volume, is very shallow. This commenter states that the majority of bitcoin is hoarded by a few owners or is out of circulation. The commenter also states that ownership concentration is high, with 50 percent of bitcoin in the hands of fewer than 1,000 people, and that this high ownership concentration creates greater market liquidity risk, as large blocks of bitcoin are difficult to sell in a timely and market efficient manner. This commenter claims that daily trade volume is only a small fraction of total bitcoin mined.72 One commenter asserts that the number of spot bitcoin exchanges worldwide far exceeds the number of venues for many commodity futures, some of which are underlying assets of existing commodity-trust ETPs. The commenter argues that, therefore, widespread global bitcoin liquidity makes bitcoin less susceptible to manipulation via trading activity conducted on a single exchange, as compared to less-liquid commodity futures that trade on a few exchanges.73 One commenter states that bitcoin trades on a number of exchanges around the world and that most of these exchanges can be considered isolated liquidity pools, which are more vulnerable to manipulation or security breach than the broader market.74 69 See ARK Letter, supra note 35, at 5. Maher Letter, supra note 35. 71 See SIG Letter, supra note 36, at 6. 72 See Williams Letter, supra note 35, at 1–2. 73 See SIG Letter, supra note 36, at 4–5. 74 See ARK Letter, supra note 35, at 8. 70 See E:\FR\FM\01AUN1.SGM 01AUN1 37584 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices Finally, both BZX and the Overdahl Letter argue that the Commodity Futures Trading Commission’s (‘‘CFTC’’) granting of registration to bitcoin swapexecution facilities (‘‘SEFs’’) means that the CFTC has addressed the issue of manipulation and determined that the underlying spot markets for bitcoin are not susceptible to manipulation.75 (b) Discussion BZX has not demonstrated that the structure of the spot market for bitcoin is uniquely resistant to manipulation. sradovich on DSK3GMQ082PROD with NOTICES (i) Bitcoin Market Structure & Arbitrage While two commenters questioned the effectiveness of arbitrage across bitcoin markets,76 BZX, the Overdahl Letter, and the Lewis Letter argue that the structure of the bitcoin spot market and the availability of arbitrage will help keep worldwide bitcoin prices aligned, hindering manipulation.77 The Overdahl Letter and Lewis Letter claim that economic analysis demonstrates that bitcoin markets are resistant to manipulation. But, as discussed below, the arguments submitted in support of this claim are incomplete and inconsistent, and are unsupported or contradicted by data. BZX, the Overdahl Letter, and the Lewis Letter offer broad assertions that the increasing strength and resilience of the non-stop global bitcoin market place, the emergence of new market participants, and the transparency of the market have facilitated arbitrage that has caused global bitcoin exchange prices to converge.78 But BZX, the Overdahl Letter, and the Lewis Letter offer no data or analysis regarding the actual effectiveness of arbitrage in the bitcoin spot market, either in terms of how closely prices are aligned across different bitcoin trading venues or how quickly price disparities are arbitraged away.79 Similarly, the commenter who asserts that regulatory actions by the People’s Bank of China were designed to discourage price manipulation, and have had profound and beneficial effects on bitcoin spot markets worldwide, has provided no empirical 75 See BZX Letter II, supra note 13, at 17; Overdahl Letter, supra note 36, at 12. The Overdahl Letter also notes that the CFTC-regulated CME Group recently created a standardized bitcoin reference rate and a bitcoin spot price index. Overdahl Letter, supra note 36, at 12. 76 See supra notes 69–70 and accompanying text. 77 See supra notes 52–68 and accompanying text. 78 See supra notes 52–68 and accompanying text. 79 While the Overdahl Letter compares the Gemini Exchange bitcoin price to the median price and the volume-weighted average price of a group of USD-denominated bitcoin markets, such an analysis does not demonstrate whether the range of prices across those other markets is broad or narrow. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 evidence to substantiate this claim.80 In addition, the Commission notes that one commenter asserts that large arbitrage opportunities persist in bitcoin markets.81 While BZX cites a comment letter relating to a different proposed rule change for the proposition that price discrepancies across four selected USDdenominated bitcoin markets are generally arbitraged away in under a minute,82 even if that limited factual assertion is true, BZX has not explained why it is relevant to the Commission’s consideration of the proposal, given that (a) the worldwide spot market for bitcoin is not limited to trading against the USD, (b) market participants could engage in creation or redemption transactions with the Trust using bitcoins sourced from any trading venue or from OTC transactions, and (c) the Gemini Exchange is not among the four bitcoin trading venues observed by the commenter. Thus, this argument does not support BZX’s broad assertion about the effectiveness of arbitrage across the worldwide bitcoin market. BZX also argues that manipulation in the bitcoin market is unlikely because would-be manipulators would have to overcome the liquidity supplied by arbitrageurs, who must have funds distributed across multiple bitcoin markets to engage in arbitrage,83 and the Overdahl Letter asserts that the manipulation of bitcoin is prohibitively expensive because manipulating the price of bitcoin on any given venue would require manipulation of the entire global bitcoin market to be effective.84 These theoretical arguments depend on effective arbitrage existing across bitcoin markets, but, as noted above, the Commission concludes that BZX has not provided a factual basis in the record to conclude that arbitrage across bitcoin exchanges is effective. Moreover, these arguments are inconsistent: If, in fact, market participants must disperse their capital across multiple trading venues to engage in effective arbitrage, then a market participant may be able to manipulate trading on a single trading venue by concentrating its capital and trading activity there. The Overdahl Letter’s argument that manipulation of one bitcoin trading venue would require overcoming liquidity on all bitcoin supra note 71 and accompanying text. supra note 69 and accompanying text. 82 See BZX Letter II, supra note 13, at 15 n.28 (citing Letter from Daniel H. Gallancy, SolidX Partners, Inc., to Brent J. Fields, Secretary, Commission (Mar. 15, 2017) (SR–NYSEArca-2016– 101)). 83 See supra note 56 and accompanying text. 84 See supra notes 60–61 and accompanying text. PO 00000 80 See 81 See Frm 00126 Fmt 4703 Sfmt 4703 venues is also inconsistent with the assertion by the Lewis Letter and another commenter that each bitcoin market is an independent entity and that, therefore, demand for liquidity does not necessarily propagate across other exchanges.85 In addition, BZX, the Overdahl Letter, and the Lewis Letter do not adequately take into account that a market participant with a dominant ownership position would not find it prohibitively expensive to overcome the liquidity supplied by arbitrageurs and could use dominant market share to engage in manipulation.86 And their arguments that substantial liquidity provided by the OTC market can absorb liquidity shocks and help resist manipulative activity are not supported by any data in the record on which the Commission could base a conclusion that OTC activity contributes to preventing manipulation. BZX also argues that bitcoin markets are uniquely resistant to manipulation because the 24/7/365 trading of bitcoin means that there is no single marketclose for investors to attempt to manipulate.87 Similarly, a commenter asserts that the large number of bitcoin trading venues makes bitcoin less susceptible to manipulation than an asset, such as a commodity, trading on a single exchange or just a few exchanges.88 In the context of the Trust, however, there is a single market and a single market-close event that an investor may have incentive to manipulate: The Gemini Auction, which the Trust would use to calculate NAV.89 And the argument by BZX and a commenter that the transparency of a bitcoin commodity-trust ETP regarding its bitcoin holdings, as well as its dissemination of the IIV and NAV, would reduce the ability of market participants to manipulate the price of bitcoin is unpersuasive because: (a) There is no comprehensive and accurate regulatory data source reflecting bitcoin pricing or trading; (b) there is no basis to conclude that the Trust’s IIV would be considered an authoritative price when several other spot prices for bitcoin are already disseminated and often differ from one another; 90 and (c) 85 See supra notes 67, 74 and accompanying text. Section III.B.1(b)(ii), infra (discussing the potential for market domination). 87 See supra note 57 and accompanying text. 88 See supra note 73 and accompanying text. 89 See Section III.E.1, infra. While the Lewis Letter makes a similar argument about the lack of a single market close, see supra note 67 and accompanying text, it does so in the context of a bitcoin ETP proposal that would not base its price on a single market auction. 90 For example, the website https:// data.bitcoinity.org/markets/arbitrage/USD tracks 86 See E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES the Trust’s NAV would differ from the Gemini Auction price only if the auction price, which is publicly disseminated itself, is determined not to reflect a fair price for bitcoin. Both the Overdahl Letter and the Lewis Letter contend that bitcoin markets are not subject to ‘‘spoofing,’’ a manipulative quoting strategy.91 Neither letter, however, presents any data or analysis to support its claim, and there is no basis in the record to conclude whether bitcoin spot markets are subject to spoofing or other deceptive quoting practices. As a general matter, the manipulation of asset prices 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.92 The Commission also notes that, in contrast to the theoretical arguments in the Overdahl Letter and the Lewis Letter, TeraExchange (a market for swaps on bitcoin) arranged for participants to make manipulative ‘‘wash’’ transactions.93 Finally, BZX’s, the Lewis Letter’s, and the Overdahl Letter’s discussions of the possible sources of manipulation are incomplete and do not form a basis to find that bitcoin is uniquely resistant to manipulation—or to find, by implication, that there is no need for a surveillance-sharing between an exchange listing shares of a bitcoinbased ETP and significant markets trading bitcoin or bitcoin derivatives. For example, assuming there is no inside information related to the price differences between last trades on 13 bitcoin markets. 91 See supra notes 62–63, 67 and accompanying text. 92 Even if transparent order books and transaction reports on bitcoin markets would include the quoting or trading activity of a person or group attempting to manipulate the market, along with the activity of all other market participants, such information could not, by itself, definitively establish in real time which activity represented bona fide trading interest and which did not. 93 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. See also Kevin Dowd & Martin Hutchinson, Bitcoin Will Bite the Dust, 35 Cato J. 357, 374 n.13 (2015) (Bitcoin markets are subject to the ‘‘usual market manipulation tactics.’’), available at https:// object.cato.org/sites/cato.org/files/serials/files/catojournal/2015/5/cj-v35n2-12.pdf. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 earnings or revenue of bitcoin, there may be material nonpublic information related to: The actions of regulators with respect to bitcoin; order flow, such as plans of market participants to significantly increase or decrease their holdings in bitcoin; new sources of demand, such as new ETPs that would hold bitcoin; or the decision of a bitcoin-based ETP, a bitcoin trading venue, or a bitcoin wallet service provider with respect to how it would respond to a ‘‘fork’’ in the blockchain, which would create two different, noninterchangeable types of bitcoin.94 Moreover, bitcoin is susceptible to the dissemination of false or misleading information regarding the types of material, nonpublic information just discussed. The Commission also notes a recent academic paper finding empirical evidence of trading in bitcoin markets based on material nonpublic information.95 Two additional risks that the Trust’s Registration Statement acknowledges— (1) hacking and (2) malicious control of the Bitcoin Network—further undermine BZX’s argument that bitcoin and bitcoin markets are inherently resistant to fraud and manipulation. The Trust’s Registration Statement recognizes that bitcoin trading venues can be and have been attacked by hackers, which can affect liquidity and result in volatile prices.96 Profitmotivated hackers can launch such attacks to manipulate bitcoin and achieve their ‘‘intended effect of artificially raising or lowering prices.’’ 97 94 For example, as described in the Trust’s Registration Statement, supra note 22, in the event the Bitcoin Network undergoes a ‘‘hard fork’’ into two blockchains, the Custodian and the Sponsor will determine which of the resulting blockchains to use as the basis for the assets of the Trust and, under certain circumstances, will have discretion to determine which blockchain is ‘‘most likely to be supported by a majority of users or miners.’’ Id. at 113. See also Lee Letter, supra note 35; Johnson Letter, supra note 35; Schulte Letter, supra note 35; Anonymous Letter V, supra note 35; Anonymous Letter VI, supra note 35. The decision of the Custodian and Sponsor to support one resulting blockchain over another could have a material effect on the relative value of the bitcoins in each of the blockchains. A fork between bitcoin and ‘‘Bitcoin Cash’’ occurred on August 1, 2017, and a fork between bitcoin and ‘‘Bitcoin Gold’’ occurred on October 24, 2017. 95 See Wenjun Feng, Yiming Wang & Zhengjun Zhang, Informed Trading in the Bitcoin Market, Fin. Res. Letters, Dec. 2, 2017, available at https:// www.sciencedirect.com/science/article/pii/ S1544612317306992. 96 Registration Statement, supra note 22, at 21–23, 29, 60–61. 97 Amir Feder, Neil Gandal, J.T. Hamrick, and Tyler Moore, The Impact of DDoS and Other Security Shocks on Bitcoin Currency Exchanges: Evidence From Mt. Gox, Journal of Cybersecurity (Jan. 31, 2018), at 137 (explaining that a profitmotivated hacker can manipulate bitcoin prices up or down by hacking larger trading venues while PO 00000 Frm 00127 Fmt 4703 Sfmt 4703 37585 The Trust’s Registration Statement also recognizes the risk of a ‘‘malicious actor’’ obtaining control of the processing power dedicated to mining on the Bitcoin Network and thus ‘‘exerting authority’’ over the Bitcoin Network.98 Such control can be used to manipulate bitcoin pricing.99 And there may be material nonpublic information related to hacking plans or attempts to gain control of the Bitcoin Network, and such information could be exploited through fraudulent trading. Based on the analysis above, the Commission concludes that there is an insufficient basis in the record before it to decide that the bitcoin spot markets are inherently resistant to manipulation. This conclusion, again, is bolstered by the Trust’s Registration Statement, which explains: Over the past four (4) years, a number of Bitcoin Exchanges have been closed due to fraud, failure or security breaches. In many of these instances, the customers of such Bitcoin Exchanges were not compensated or made whole for the partial or complete losses of their account balances in such Bitcoin Exchanges. . . . Further, the collapse of the largest Bitcoin Exchange in 2014 suggests that the failure of one component of the overall Bitcoin ecosystem can have consequences for both users of a Bitcoin Exchange and the Bitcoin industry as a whole.100 Additionally, the Commission notes that recent academic papers suggest that the price of bitcoin can be, and has been, manipulated through activity on trading on smaller trading venues, and thereby ‘‘create[ ] an unfair financial advantage for the perpetrator at the expense of ordinary participants’’), available at https:// academic.oup.com/cybersecurity/article/3/2/137/ 4831474; see also David Groshoff, Kickstarter My Heart: Extraordinary Popular Delusions and the Madness of Crowdfunding Constraints and Bitcoin Bubbles, 5 Wm. Mary Bus. L. Rev. 489, 519 (2014). 98 Registration Statement, supra note 22, at 17, 56. The Registration Statement notes that obtaining control in excess of 50% of the processing power on the Bitcoin network is sufficient, and that ‘‘there are some academics and market participants who believe the applicable threshold required to exert authority over the Bitcoin Network could be less than fifty (50) percent, which would increase the chances of a malicious actor exerting authority over the Bitcoin Network.’’ Id. at 17. 99 Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, Bitcoin.org (Oct. 31, 2008), at 4 (malicious actor could exploit his control of the Bitcoin Network by ‘‘using it to generate new coins’’), available at https://bitcoin.org/bitcoin.pdf; see also Kevin Dowd & Martin Hutchinson, Bitcoin Will Bite the Dust, 35 Cato J. 357, 372–74 (2015), available at https://object.cato.org/sites/cato.org/ files/serials/files/cato-journal/2015/5/cj-v35n212.pdf; Sanya Samtani and Varun Baliga, On Monopolistic Practices in Bitcoin: A Coded Solution, 11 Indian J. L. & Tech. 106, 107–08 (2015), available at https://ijlt.in/wp-content/uploads/2015/ 09/Sanya-Samtani-and-Varun-Baliga-5.pdf (malicious actor could achieve ‘‘devaluation’’ of bitcoin). 100 Registration Statement, supra note 22, at 23. E:\FR\FM\01AUN1.SGM 01AUN1 37586 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES bitcoin trading venues. One recent academic paper examined whether the growth of the circulating supply of Tether (a cryptocurrency that claims to be backed by the U.S. dollar) through new issuances ‘‘is primarily driven by investor demand, or is supplied to investors as a scheme to profit from pushing cryptocurrency prices up.’’ 101 Through statistical analysis of the blockchains of bitcoin and Tether, the authors conclude that entities associated with a specific cryptocurrency trading venue—which the authors link to Tether’s founders—‘‘use Tether to purchase bitcoin when prices are falling’’; that ‘‘[s]uch price supporting activities are successful, as Bitcoin prices rise after the period of intervention,’’ with ‘‘substantial aggregate price effects’’ across bitcoin trading platforms; and that this activity ‘‘occurs more aggressively right below salient round-number price thresholds where the price support might be most effective.’’ 102 The paper finds that the periods of strongest Tether flows are ‘‘associated with 50% of Bitcoin compounded return’’ from March 1, 2017, to March 31, 2018.103 Overall, the authors conclude that their findings ‘‘provide substantial support for the view that price manipulation may be behind substantial distortive effects in cryptocurrencies’’ and ‘‘suggest that external capital market surveillance and monitoring may be necessary to obtain a market that is truly free.’’ 104 The Commission also notes another recent academic paper, which concludes that there was fraudulent and manipulative activity on a single bitcoin trading venue.105 101 Griffin, John M. and Amin Shams, Is Bitcoin Really Un-Tethered (June 13, 2018) (manuscript at 33) (‘‘Griffin-Shams Paper’’), available at https:// ssrn.com/abstract_id=3195066. 102 Id. 103 See id. at 23–24. 104 Id. at 33; see also id. at 1 (‘‘[P]urchases with Tether are timed following market downturns and result in sizable increases in Bitcoin prices,’’ thus ‘‘Tether is used to provide price support and manipulate cryptocurrency prices.’’); id. at 2 (Bitcoin exchanges ‘‘largely operate outside the purview of financial regulators’’ and ‘‘[t]rading on unregulated exchanges . . . could leave cryptocurrencies vulnerable to gaming and manipulation.’’); id. at 3 (‘‘[T]he coordinated supply of Tether creates an opportunity to manipulate cryptocurrencies.’’); id. at 6 (‘‘Tether seems to be used both to stabilize and manipulate Bitcoin prices.’’). 105 See Neil Gandal, J.T. Hamrick, Tyler Moore & Tali Oberman, Price Manipulation in the Bitcoin Ecosystem, J. Monetary Econ., Jan. 2, 2018, available at https://doi.org/10.1016/ j.jmoneco.2017.12.004. According to the authors of this paper, the fraudulent and manipulative activity led to an average of approximately a four to five percent rise in the bitcoin/USD exchange rate in 2013 on days when that activity occurred, VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 These studies supplement the Commission’s conclusion that there is an insufficient basis in the record before it to decide that the bitcoin spot markets are inherently resistant to manipulation.106 Even without these studies, however, the Commission would still find that BZX has not demonstrated that the structure of the spot market for bitcoin is uniquely resistant to manipulation. Moreover, even if the record supported the proposition that some features of bitcoin and bitcoin markets mitigate some types of manipulation to some degree, the Commission concludes that such mitigation is insufficient to justify dispensing with the detection and deterrence of fraud and manipulation provided by surveillance-sharing agreements with significant, regulated markets.107 (ii) Market Domination While BZX argues that it is unlikely that any one actor could obtain a compared to a slight decline on days without such activity. Id. at 2. 106 While another recent academic paper examines the relationship between bitcoin and Tether and claims ‘‘not [to] find any evidence suggesting that Tether issuances cause subsequent increases in Bitcoin returns,’’ W.C. Wei, The Impact of Tether Grants on Bitcoin (May 9, 2018) (manuscript at 6) (‘‘Wei Paper’’), available at https://ssrn.com/abstract=3175876, the Commission believes that this paper’s analysis reflects significant limitations in the study design and is not as persuasive as the empirical papers cited herein that conclude there has been fraud and manipulative activity in bitcoin markets, including the Griffin-Shams Paper. First, the paper uses only daily traded price and aggregate trading volume, whereas the Griffin-Shams Paper, supra note 101, performs a more granular statistical analysis of blockchain transactions and finds that the largest effects of Tether issuances on bitcoin prices occur between three and twelve hours after a Tether issuance. Second, the paper uses a single vector autoregression specification with 52 coefficients, but without any robustness checks. And third, while the paper concludes that Tether issuances increase bitcoin trading volume but do not affect bitcoin returns, the paper does not include any discussion of or control for collinearity between changes in bitcoin trading volume and prices. Thus, the Commission does not believe that the Wei Paper supports a conclusion that bitcoin is inherently resistant to manipulation. 107 Even if BZX’s argument is that bitcoin and bitcoin markets are ‘‘not readily susceptible to manipulation,’’ BZX has not demonstrated that contention. Indeed, the Commission concludes, consistent with its past practice, that surveillancesharing agreements with significant, regulated markets ensure that commodity-trust ETPs are ‘‘less readily susceptible to manipulation.’’ Exchange Act Release No. 35518 (Mar. 21, 1995), 60 FR 15804, 15807 (Mar. 27, 1995) (SR–Amex–94–30); accord Exchange Act Release No. 82538 (Jan. 19, 2018), 83 FR 3807, 3810 (Jan. 26, 2018) (SR–CboeBZX–2018– 005) (‘‘The Exchange has in place a surveillance program for transactions in ETFs to ensure the availability of information necessary to detect and deter potential manipulations and other trading abuses, thereby making the Shares less readily susceptible to manipulation.’’). PO 00000 Frm 00128 Fmt 4703 Sfmt 4703 dominant market share,108 BZX does not address the risk of pre-existing dominant positions, a risk that the Lewis Letter acknowledges.109 Similarly, while the Overdahl Letter maintains that the existence of a dominant bitcoin exchange would not imply the existence of a dominant ownership position, and that the existence of a market with a large share of trading volume would make it more difficult for a market participant to obtain a dominant ownership position,110 the Overdahl Letter does not address the risk of pre-existing dominant positions in bitcoin. The Lewis Letter, however, specifically acknowledges this risk, noting: ‘‘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.’’ 111 The Lewis Letter goes on to explain that ‘‘[i]t is possible, and in fact, reasonably likely that a small group of early bitcoin adopters hold a significant proportion of the bitcoin that has thus far been created.’’ 112 Additionally, another commenter contends that the majority of bitcoin is held by a few owners, estimating that 50% of bitcoins are held by fewer than 1,000 people.113 The Lewis Letter argues that the nature of the spot bitcoin market and the arbitrage mechanism should reduce the risk of manipulation through ownership of a dominant market share,114 but this argument addresses whether market participants might acquire a dominant share of bitcoin ownership by trading in bitcoin markets 108 See supra note 57 and accompanying text. supra note 68 and accompanying text. 110 See supra note 64 and accompanying text. 111 Lewis Letter I, supra note 65, at 6. The Lewis Letter states that there is ‘‘no compelling evidence’’ to suggest that any single investor or group has acquired a dominant position in bitcoin, but its recognition that ‘‘there is no registry showing which individuals or entities own bitcoin or the quantity owned,’’ and its citation of ‘‘media estimates’’ regarding the holdings of certain individuals, demonstrates that there is some risk of a person or group holding or acquiring a significant proportion of bitcoins and that this risk should not be dismissed. Id. at 6 & n.7. 112 Lewis Letter I, supra note 65, at 6 (citing Amendment No. 4 to Form S–1 of SolidX Bitcoin Trust at 16). A recent letter from Commission staff notes such concerns of ‘‘potential manipulation in the underlying cryptocurrency markets.’’ Engaging on Fund Innovation & Cryptocurrency-Related Holdings, 2018 WL 480851, at *1–2 (SEC No Action Letter Jan. 18, 2018) (citing David Z. Morris, Could Bitcoin’s ‘Whales’ Manipulate the Market?, Fortune (Dec. 10, 2017)). See also Olga Kharif, The Bitcoin Whales: 1,000 People Who Own 40 Percent of the Market, Bloomberg Businessweek (Dec. 8, 2017), available at https://www.bloomberg.com/news/ articles/2017-12-08/the-bitcoin-whales-1-000people-who-own-40-percent-of-the-market. 113 See supra note 72 and accompanying text. 114 See supra note 68 and accompanying text. 109 See E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices and does not address the potential market effect of large bitcoin positions held by early adopters. Multiple academic studies have found the existence of concentrated holdings in an asset presents a meaningful risk of manipulation.115 Whether a dominant position came from being an early adopter of bitcoin or from trading activity would not alter the Commission’s view that a person or group with a dominant position may be capable of engaging in manipulative activity. The Commission thus cannot, on the record before it, conclude that bitcoin markets are uniquely resistant to manipulation. (iii) Prior Regulatory Actions Regarding Bitcoin Although commenters suggest that the CFTC has conclusively determined that bitcoin markets are not susceptible to manipulation because it has permitted the registration of bitcoin swap execution facilities as consistent with the Commodity Exchange Act (‘‘CEA’’),116 the CFTC has made no such sweeping finding as to bitcoin or bitcoin spot markets either in permitting the registration of those swap execution facilities or in more recently permitting the self-certification by Chicago Mercantile Exchange Inc. (‘‘CME’’) and Cboe Futures Exchange, LLC (‘‘CFE’’) of bitcoin futures contracts. The Commission notes that CFTC Chairman Giancarlo has described ‘‘heightened review’’ of the CME and CFE selfcertifications as addressing the narrower question of whether the particular bitcoin futures products and cashsettlement processes—under the specific terms proposed by those two futures exchanges—were ‘‘readily susceptible to manipulation.’’ 117 And the CFTC stated that the selfcertification process for bitcoin futures contracts ‘‘does NOT provide for . . . value judgments about the underlying spot market,’’ and U.S. law ‘‘does not provide for direct, comprehensive sradovich on DSK3GMQ082PROD with NOTICES 115 See, e.g., Craig Pirrong, The Economics of Commodity Market Manipulation: A Survey, J. Commodity Mkt., Mar. 2017, at 1 (describing manipulation in commodities markets); Franklin Allen, Lubomir P. Litov & Jianping Mei, Large Investors, Price Manipulation, and Limits to Arbitrage: An Anatomy of Market Corners, 10 Rev. Finance 645 (2006) (describing manipulation in equity and commodities markets). 116 See supra note 75. 117 See Written Testimony of J. Christopher Giancarlo, Chairman, Commodity Futures Trading Commission, Before the Senate Banking Committee at text accompanying n.17 (Feb. 6, 2018) (‘‘Giancarlo Testimony’’), available at https:// cftc.gov/PressRoom/SpeechesTestimony/ opagiancarlo37. See also infra notes 285–288 (discussing role of CFTC with respect to underlying bitcoin spot markets). VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 Federal oversight of underlying Bitcoin or virtual currency spot markets.’’ 118 Moreover, the CFTC’s statutory authority to review new derivative products differs substantially from the Commission’s authority, under Section 19(b) of the Exchange Act,119 with respect to the review of proposed rule changes by SROs. While there are ‘‘limited grounds’’ for the CFTC to take affirmative action to stay new product self-certifications,120 the Commission must, to approve a proposed rule change, make an affirmative finding that the proposed rule change is consistent with the Exchange Act, with the burden of demonstrating consistency with the Exchange Act resting with the SRO proposing the rule change.121 The Commission is also mindful that the primarily institutional markets that the CFTC supervises are materially different from the securities markets in which many retail investors participate directly. The CFTC acknowledges that ‘‘[m]ost participants in the futures markets are commercial or institutional commodities producers or consumers’’ and ‘‘[t]rading commodity futures and options is a volatile, complex and risky venture that is rarely suitable for individual investors or ‘retail customers.’ ’’ 122 Accordingly, the Commission cannot conclude that actions taken to date by the CFTC determine whether the proposed bitcoin ETP is consistent with the applicable requirements of the Exchange Act, and the Commission must reach its own decision, under its own statutory mandate, to determine whether the proposal is designed to ‘‘protect investors and the public interest.’’ 123 2. Manipulation of the Gemini Exchange and the Gemini Auction (a) Summary of Comments Received BZX acknowledges in its comment letter that less-liquid markets, such as the market for bitcoin, may be more 118 CFTC Backgrounder on Oversight of and Approach to Virtual Currency Futures Markets (Jan. 4, 2018) (‘‘CFTC Backgrounder’’), at 1, 2, available at https://www.cftc.gov/idc/groups/public/@ newsroom/documents/file/backgrounder_virtual currency01.pdf. See also infra note 288. 119 15 U.S.C. 78s(b). 120 See CFTC Backgrounder, supra note 118, at 2. 121 See supra notes 8, 10–12 and accompanying text. Compare 7 U.S.C. 7a-2(c) and 17 CFR 40.6 with 15 U.S.C. 78(b)(1) and 17 CFR 240.19b-4. 122 Futures Market Basics, CFTC, available at https://www.cftc.gov/ConsumerProtection/Education Center/FuturesMarketBasics/index.htm. Furthermore, the record does not contain evidence about whether CME or CFE can, in practice, actually obtain trading information from bitcoin exchanges, and thus whether the CFTC can obtain such information from CME or CFE. 123 15 U.S.C. 78f(b)(5). PO 00000 Frm 00129 Fmt 4703 Sfmt 4703 37587 easily manipulated, but claims that these concerns are mitigated with respect to the Shares and the trading on the Gemini Exchange. BZX asserts that the Gemini Auction price is based on an extremely similar mechanism to the one leveraged for BZX’s own Opening and Closing Auctions and allows full and transparent participation from all Gemini Exchange participants in the price discovery process. BZX states that the auction process leverages mechanics that have proven over the years to be robust and effective on BZX and other national listing exchanges in both liquid and illiquid securities alike. BZX argues that, because the time of the Gemini Auction coincides with BZX’s Closing Auction, efficient real-time arbitrage between the closing price of the Trust and the Gemini Auction price will be prevalent and will lead to resilient and effective pricing of both the Trust and the underlying bitcoin asset, leading to convergence between the Trust’s closing price and its NAV.124 BZX asserts that the Gemini Auction price typically deviates very little from the prevailing price on other bitcoin exchanges, and BZX presents statistics purporting to show that this price is consistent with the prices of other U.S.-based exchanges.125 BZX asserts that the Gemini Auction price is uniquely resistant to manipulation and that it more accurately reflects the bitcoin price than any other individual event or crossmarket snapshot, because the largest bitcoin transactions each day usually occur via the Gemini Auction. BZX also claims that volumes transacted in the Gemini Auction are generally more than 50% larger than the second-largest trade in the world, drawing an average daily volume of 1,200 bitcoins compared to approximately 800 bitcoins.126 In addition, BZX asserts that the Gemini Auction occurs at a scheduled time each day to maximize participation and price formation, while other liquidity events are often unpredictable and irregular.127 Another commenter claims that the Gemini Auction also concentrates liquidity and trading volume at a single moment each day.128 BZX further asserts that, from its launch through May 12, 2017, the Gemini Auction price on business days has deviated from the Gemini midpoint price (the midrange of the highest bid 124 See BZX Letter I, supra note 35, at 8; BZX Letter II, supra note 13, 10–11. See also SIG Letter, supra note 36, at 2–6; C&C Letter, supra note 36, at 1. 125 See BZX Letter I, supra note 35, at 8–9. 126 See BZX Letter II, supra note 13, at 19–20. 127 See id. at 20. 128 See Overdahl Letter, supra note 36, at 11. E:\FR\FM\01AUN1.SGM 01AUN1 37588 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES and lowest offer prices) by 0.22% on average and 0.71% at most, that it has deviated from the median price of all U.S.-based bitcoin exchanges by 0.52% on average, and that it has deviated from the median price of all global USDdenominated bitcoin exchanges by 0.70% on average.129 BZX also claims that the Gemini Exchange is regularly near the top of bitcoin exchanges in terms of market-quality metrics for overall trading.130 The Overdahl Letter asserts that the Gemini Auction price is reliable in that it generally reflects bitcoin traded at other U.S.-based bitcoin exchanges and bitcoin traded at USD-based exchanges globally and that, when noticeable discrepancies appear, arbitrage mechanisms quickly force prices back into alignment.131 The Overdahl Letter provides some update to the statistics provided by BZX and states that, from September 21, 2016 (the launch of the Gemini Auction), to March 1, 2017, the average daily deviation of the Gemini Auction price from the median 4:00 p.m. price of all U.S.-based bitcoin exchanges was 0.0058 percent and the average absolute deviation (that is, the average absolute value of deviations) was 0.1804 percent. The Overdahl Letter also states that, during the same period, the average daily deviation of the Gemini Auction price from the median 4:00 p.m. price of all global USDdenominated bitcoin exchanges was 0.0489 percent with an average absolute deviation of 0.2398 percent.132 The Overdahl Letter also contends that the surveillance agreement between the Gemini Exchange and BZX allows for continuous monitoring of trading activity to detect and deter manipulation of the Gemini Auction price and that BZX’s rules are reasonably designed to prevent fraudulent and manipulative acts and practices with respect to determining the NAV of the Trust Shares.133 The Overdahl Letter further claims that the Gemini Auction is designed to not be readily susceptible to manipulation because it includes pre-trading transparency, which allows for full and transparent participation by all participants, uses a mechanism similar to that used by other exchanges in setting opening and closing prices, and 129 See BZX Letter II, supra note 13, at 20. 130 Id. 131 See Overdahl Letter, supra note 36, at 1. 132 See id. at 4. 133 See id. at 2. Specifically, according to the Overdahl Letter, the type of potential manipulation most relevant for determining the NAV of the Trust’s Shares would be a malicious actor attempting to use the Gemini Auction price to influence the NAV of the Trust. See id. at 11. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 concentrates liquidity and trading volume in a single moment each day.134 Regarding the calculation of NAV, the Overdahl Letter also argues that the Trust’s valuation procedures greatly reduce the risk that a malicious actor could influence the NAV of the Trust by manipulating the Gemini Auction, because alternative means can be used to value the Trust’s bitcoin if the Trust sponsor determines that the Gemini Auction price does not reflect the fair value of bitcoin.135 Several commenters claim that the Gemini Exchange has low trading volumes,136 and one commenter claims that, of all the exchanges, Gemini has the worst pricing.137 Another commenter asserts that the Gemini Exchange has relatively low liquidity and trade volume and that there is a significant risk that the nominal ETP share price will be manipulated by relatively small trades that manipulate the bitcoin price at that exchange.138 This commenter states that, while U.S.based bitcoin exchanges are subjected to stricter regulations and auditing for the holding of client accounts, the trading itself seems to occur in a regulatory vacuum and seems impossible to audit effectively.139 This commenter expresses concerns regarding the Gemini Exchange Spot Price, noting that the nominal price of the Shares under the proposal is supposed to be tied to the market price of bitcoins at the Gemini Exchange, which is closely tied to the ETP proponents.140 One commenter claims that most daily trading volume is conducted on poorly capitalized, unregulated exchanges located outside the United States and that these non-U.S. exchanges and their practices significantly influence the price discovery process.141 Another commenter states that the biggest and most influential bitcoin exchange is located outside U.S. jurisdiction.142 One commenter states that, since 2013, the price of bitcoin has been Overdahl Letter, supra note 36, at 11. id. at 2. 136 See, e.g., Maher Letter, supra note 35; Stolfi Letter I, supra note 35; Anonymous Letter III, supra note 35. 137 See Anonymous Letter III, supra note 35. 138 See Stolfi Letter I, supra note 35; see also Stolfi Letter II, supra note 35 (concluding that the Gemini Auction volume has shown a decreasing trend since its inception and is now under $1 million USD during work days, and considerably less during weekends, and that ‘‘[w]ith such low volume, it seems possible to manipulate the NAV value by entering suitable bids or asks in the auction’’). 139 See Stolfi Letter II, supra note 35. 140 See Stolfi Letter I, supra note 35. 141 See Williams Letter, supra note 35, at 2. 142 See Anonymous Letter V, supra note 35. PO 00000 134 See 135 See Frm 00130 Fmt 4703 Sfmt 4703 defined mostly by the major Chinese exchanges, whose volumes dwarf those of exchanges outside China, and that the price of bitcoin is defined entirely by speculation, without any ties to fundamentals.143 Another commenter observes that Chinese markets drive much of the volume in the bitcoin markets.144 One commenter states that it makes sense to value the proposed ETP based on the Gemini Auction because doing so would guarantee sufficient liquidity and because other bitcoin trading venues are not subject to the same level of oversight as the Gemini Exchange.145 Another commenter asserts that the Gemini Auction is not a robust mechanism for price discovery because Gemini’s fee structure would make self-trading or collusive wash trades between accounts profitable, which would artificially inflate the volume of the Gemini Auction.146 One commenter states that the Gemini Auction could be an improvement over other bitcoin pricing mechanisms, but asserts that the Gemini Auction has not improved volume.147 The commenter observes that the Gemini Auction data show that traders in the auction are taking advantage of the discounted auction price. The commenter states that the daily two-sided Gemini Auction process was designed to maximize price discovery and reduce price volatility that could be the result of momentum pricing, but asks what measures have been put in place to address traders who take advantage of the discounted auction price. The commenter also states that, while other financial products sometimes have auctions to determine price, an auction on a stock exchange does not require money to be deposited in advance with the exchange to be in the auction. The commenter states that, by contrast, the Gemini Exchange requires dollars or bitcoin to be deposited before participation. The commenter believes that this is a problem because the Gemini Auction is limited and has failed on at least two occasions.148 Other commenters believe that the Gemini Exchange conducts sufficient volume to support the Winklevoss Bitcoin Trust. One commenter states that trading volume on the Gemini Exchange is sufficient and that 143 See Stolfi Letter II, supra note 35. ARK Letter, supra note 35, at 5. 145 See Delehanty Letter, supra note 35 (but noting that using the Gemini Auction to value the ETP, which is also the sponsor of the ETP, creates a potential conflict of interest). 146 See Anonymous Letter VIII, supra note 35. 147 See Anonymous Letter III, supra note 35. 148 See id. 144 See E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices manipulation of these Shares, while possible, would equally be possible for other exchange-traded funds.149 Another commenter asserts that trading volume in the recent Gemini bitcoin daily auctions seemed ‘‘to be of reasonable size.’’ 150 One commenter claims that there are more robust ways to value the Trust’s holdings than using the spot price of a single exchange, such as the Gemini Exchange.151 The commenter also states that the Gemini Exchange typically processes less than 10% of the total volume in the bitcoin/USD pair and states that an index of the most reliable exchanges should be constructed to value the Trust’s holdings. The commenter questions whether using only the Gemini Exchange’s spot price could serve to incentivize Authorized Participants and other market participants to direct traffic and flow to Gemini, at the expense of best execution.152 Another commenter takes a different view on the merits of single- versus multiple-price sources. This commenter observes that bitcoin spot prices diverge across exchanges due to various factors and that some exchanges may suffer from lack of oversight and a lack of transparency or fairness. The commenter claims that these facts strengthen the case for an investment product that does not rely on the spot price of less-credible exchanges to value its holdings and instead relies on the spot price on the Gemini Exchange, which is subject to substantive regulation of its exchange activity and custody of assets by the NYSDFS. This commenter also states that, while leveraged trading on some other exchanges has historically sparked excessive price volatility and instability, Gemini does not offer such products and would be able to serve as a trusted, regulated spot exchange for institutional market participants driving the arbitrage mechanism that ensures efficient pricing between the spot price and the Shares. The commenter claims that the Gemini Exchange has the potential for more-robust price discovery as liquidity is concentrated on that exchange.153 One commenter states that there is an inherent trade-off to using one exchange versus an average of several exchanges, some of which may be less scrupulous. The commenter acknowledges that manipulation is a legitimate concern, but notes that it is not uncommon to see a very small number of physical trades determine the base price for a much larger paper market.154 Other commenters view the risk of manipulation as more significant. One commenter states that it would be surprising if manipulative practices that would be illegal in other financial markets did not occur on certain bitcoin exchanges that experience lack of regulations and oversight, since these practices would be easy to implement, impossible to detect, perfectly legal under the rules applicable to those bitcoin exchanges, and extremely lucrative.155 This commenter also states that the Gemini Auction closing volumes have been low and have shown a slight decreasing trend since the inception of the Gemini Auction. The commenter states that, with low volumes, it seems possible to manipulate the NAV by entering suitable bids or asks in the Gemini Auction.156 Another commenter agrees that bitcoin traders can manipulate trading on the Gemini Exchange because of its low trading volumes and notes that the Trust’s documentation states that momentum pricing of bitcoin has resulted, and may continue to result, in speculation regarding future appreciation in the value of bitcoin, making the price of bitcoin more volatile.157 The commenter states that the value of bitcoin may therefore be more likely to fluctuate due to changing investor confidence in future appreciation in the Gemini Auction price, which could adversely affect an investment in the Shares.158 According to another commenter, in this unregulated environment, price manipulation and front-running of large buy or sell orders can happen and wellconnected customers can gain preferential treatment in order execution.159 (b) Discussion For the reasons discussed below, the Commission concludes that BZX has not demonstrated that the Gemini Exchange and the Gemini Auction are resistant to manipulation. Commenters disagree about whether the Gemini Exchange and the Gemini Auction are susceptible to manipulation. BZX promotes the Gemini Exchange as one of the top three bitcoin exchanges in the United States,160 and some commenters believe 149 See Anonymous Letter I, supra note 35. 150 See Delehanty Letter, supra note 35. 151 See ARK Letter, supra note 35, at 7–8. 152 See id. at 8–9. 153 See Circle Letter, supra note 35, at 2. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 PO 00000 154 See Delehanty Letter, supra note 35. 155 See Stolfi Letter II, supra note 35. 156 See id. 157 See Anonymous Letter III, supra note 35. 158 See id. 159 See Williams Letter, supra note 35, at 2. 160 See supra note 130 and accompanying text. Frm 00131 Fmt 4703 Sfmt 4703 37589 that the Gemini Exchange conducts sufficient volume to support the Winklevoss Bitcoin Trust.161 Other commenters, however, question these assertions, some noting that the majority of bitcoin trading, including trading denominated in USD, occurs on unregulated exchanges outside the United States,162 and one suggesting that the low liquidity and trading volume on the Gemini Exchange create a significant risk that the ETP share price could be manipulated by relatively small trades.163 While BZX claims in its May 2017 comment letter that the average volume of the Gemini Auction is 1,200 bitcoins,164 calculations based on public data from the Gemini Exchange website show that more recent Gemini Auction volume has been significantly lower. As of March 31, 2018, the average number of bitcoins traded in the Gemini Auction on a business day was just 178.07 bitcoins over the previous month, 122.20 bitcoins over the previous three months, and 138.46 bitcoins over the previous six months. Median volume figures for the same periods are even lower: 146.51 bitcoins, 85.09 bitcoins, and 90.42 bitcoins, respectively. Although the Gemini Exchange conducts the Gemini Auction on each calendar day, to better represent auction volume for days on which creations or redemptions might occur in the Shares, these calculations of average and median auction volume exclude auctions that occurred on weekends and days on which the U.S. equities markets were closed. Days on which no Gemini Auction price was reached were also excluded to avoid skewing data. The volume of the Gemini Auction is of particular relevance to BZX’s proposal, and to the susceptibility of the ETP shares to manipulation, because the Gemini Auction price is used to determine the NAV of the Trust, which is publicly disseminated and which is the price used for creation and redemption transactions. Taking into account the recent low auction volume calculated above, which is a small fraction of the 1,000 bitcoins in a creation or redemption basket,165 the Commission concludes that there is a substantial risk that either (1) any creation and redemption activity in the 161 See supra notes 149–150 and accompanying text. 162 See supra notes 141–144 and accompanying text. 163 See supra note 138 and accompanying text. BZX Letter II, supra note 13, at 20. 165 See Amendment No. 2, supra note 1 (setting size of creation unit at 100,000 shares, with the value of a share at 0.01 bitcoin, making content of a creation unit 1,000 bitcoins). 164 See E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES 37590 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices Trust would have a substantial effect on the Trust’s pricing or (2) Authorized Participants would be forced to source bitcoins on other venues where prices may or may not be aligned with that of the Gemini Auction, limiting the purported effectiveness of arbitrage. Additionally, given the current disparity between the Gemini Auction volume and the trading volume that would equal a creation unit—and the resulting likelihood that creation or redemption activity would substantially affect the Gemini Auction price—BZX has not shown that the ability of the Trust to use other criteria to value the Trust’s bitcoins in ‘‘extraordinary circumstances’’ 166 adequately addresses the risk that creations and redemptions, or manipulative activity such as front running, may affect the Gemini Auction price on an ordinary day. In light of the risks that creation and redemption activity may substantially affect the Gemini Auction price—and that the use of other valuation criteria may fail to address the effects of creation and redemption activity or of manipulative activity—the Commission cannot conclude that the bitcoin pricing mechanism of the Trust is uniquely resistant to manipulation. Further, given that recent Gemini Auction volumes are inadequate to support creation or redemption activity, BZX has not sufficiently supported its claim that the design and mechanisms of the Gemini Auction would allow for efficient arbitrage between the Shares and the underlying bitcoin. Similarly, the statistics offered by BZX and the Overdahl Letter to argue that the Gemini Auction creates a price closely aligned with U.S.-based and global USDdenominated bitcoin exchanges do not establish that bitcoin trading on the Gemini Exchange is uniquely resistant to manipulation because these statistics do not reflect, and cannot predict, the dynamics of trading on the Gemini Exchange if the Gemini Auction were used as the basis to calculate NAV for the Trust. Given the small size of the Gemini Auction relative to the size of a creation unit, the launch of the proposed ETP would be likely to fundamentally affect supply and demand in the Gemini Auction, and the use of the Gemini Auction price to calculate NAV would introduce a significant incentive to manipulate the Gemini Auction that does not currently exist. The Commission cannot therefore conclude that arbitrage would render the Shares uniquely resistant to manipulation. 166 See supra note 30. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 The Trust’s Registration Statement acknowledges that the reliance on a single bitcoin exchange has risks to shareholders in the Trust: ‘‘Trading on a single Bitcoin Exchange may result in less favorable prices and decreased liquidity for the Trust and, therefore, could have an adverse effect on the Trust and Shareholders.’’ 167 Moreover, although commenters have suggested that approval of the proposal would naturally lead to greater activity in the Gemini Auction,168 such speculation does not provide an adequate basis to decide that future Gemini Auction volume would be sufficient to prevent manipulation of the Gemini Auction from affecting the NAV of the Trust, and BZX has not explained how the favorable market quality metrics it attributes to the Gemini Exchange would be affected if trading interest at the Gemini Auction were dominated by creation and redemption activity.169 Therefore, again, the Commission cannot conclude that the pricing mechanism of the Trust would render the Shares uniquely resistant to manipulation. C. The Availability of ‘‘Traditional Means’’ To Detect and Deter Fraud and Manipulation BZX has not demonstrated, given the current absence of a surveillancesharing agreement with a regulated bitcoin market of significant size, that the alternative surveillance procedures BZX purports to identify—including BZX’s assertion that it would be able to obtain certain information regarding trading in the Shares and in the underlying bitcoin or any bitcoin derivative—would be sufficient to satisfy the requirement of Exchange Act Section 6(b)(5) that an exchange’s rules be designed to prevent fraudulent and manipulative acts and practices. 1. Summary of Comments Received BZX asserts that the March Disapproval Order failed to appreciate that the proposal provides ‘‘traditional means of identifying and deterring fraud and manipulation’’ that meet the criteria that the Commission has utilized in approving other commodity-trust ETPs.170 BZX states that a particular area of surveillance focus for the Commission in prior commodity-trust ETP approval orders was the implementation of exchange rules requiring market makers in the commodity-trust ETP shares to disclose their dealings in the underlying commodities. BZX contends that analogous requirements are included in this proposal, with BZX Rule 14.11(e)(4) mandating that market makers in the Shares disclose all of their commodity trading accounts, disclose all trading in bitcoin or bitcoin derivatives, and make available all related books and records.171 BZX also contends that, in the prior commodity-trust ETP approval orders, the Commission also reviewed the adequacy of the ETP listing exchange’s rules and procedures for surveillance of trading activity in the ETP shares. According to BZX, similar surveillance rules and procedures are in place at BZX regarding the proposed bitcoin ETP, as the listing exchange can obtain information regarding trading in Shares from Intermarket Surveillance Group members and affiliate members, as well as trading information available on the blockchain and information available through a surveillance-sharing agreement with the Gemini Exchange.172 The Overdahl Letter also contends that BZX’s rules are reasonably designed to prevent fraudulent and manipulative acts and practices with respect to determining the NAV of the Trust Shares.173 Specifically, according to the Overdahl Letter, the type of potential manipulation most relevant for determining the NAV of the Trust’s Shares would be a malicious actor attempting to use the Gemini Auction price to influence the NAV of the Trust. The Overdahl Letter also asserts that, in addition to BZX’s surveillance procedures and anti-manipulation rules, penalties for engaging in manipulative conduct serve as a deterrent against manipulation of the Gemini Auction price and the resulting Trust’s NAV. The Overdahl Letter states that, although a penalty is applied after a manipulation occurs or is attempted, penalties are nonetheless a useful tool for deterring, and therefore preventing, manipulation.174 Finally, one commenter claims that the March Disapproval Order reflects the Commission’s ‘‘unspoken but obvious concern’’ with bitcoin, and argues that this issue can be cured by having the bitcoin exchange sign a memorandum of understanding with the Commission to share information.175 171 See Statement, supra note 22, at 22. 168 See Maher Letter, supra note 35; Overdahl Letter, supra note 36, at 3; SIG Letter, supra note 36, at 8. 169 See supra note 130 and accompanying text. 170 See BZX Letter II, supra note 13, at 22, 26. PO 00000 167 Registration Frm 00132 Fmt 4703 Sfmt 4703 id. at 23. id. The surveillance-sharing agreement between BZX and the Gemini Exchange is discussed in Section III.E.1, infra. 173 See Overdahl Letter, supra note 36, at 2. 174 See id. at 11. 175 See Convergex Letter, supra note 36, at 2. 172 See E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices 2. Discussion The Commission concludes that BZX has not demonstrated—given the current absence of a surveillancesharing agreement with a regulated bitcoin market of significant size—that the alternative surveillance procedures discussed above would, by themselves, be sufficient to satisfy the requirement of Exchange Act Section 6(b)(5) that an exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.176 While BZX would, pursuant to its listing rules, be able to obtain certain information regarding trading in the Shares and in the underlying bitcoin or any bitcoin derivative through registered market makers,177 this trade information would be limited to the activities of members who were registered with BZX as market makers in the Shares and would not encompass all BZX market participants.178 Furthermore, neither BZX’s ability to surveil trading in the Shares nor its ability to share surveillance information with other securities exchanges trading the Shares would give BZX insight into the activity and identity of market participants trading in the underlying bitcoin in the OTC market or on other bitcoin trading venues. Additionally, while BZX represents that it can obtain information about bitcoin trading made publicly available through the bitcoin blockchain,179 the blockchain identifies parties to a transaction only by a pseudonymous public-key address, and it does not distinguish bitcoin trading activity from other transfers of bitcoin (e.g., for remittances, purchases of goods or services, or other purposes). Therefore, the public blockchain ledger, even in combination with the other monitoring abilities BZX identifies, does not provide comprehensive customer trading or identity information, which is particularly important here because pseudonymous bitcoin account holding means, among other things, that the number of accounts or number of trades would not reveal whether a person or group has a dominant ownership position in bitcoin, or is using or attempting to use a dominant ownership position to manipulate bitcoin pricing.180 One commenter asserts that existing ‘‘penalties for engaging in manipulative 176 See 15 U.S.C. 78f(b)(5). 177 See supra note 171 and accompanying text. 178 See BZX Rule 14.11(e)(4)(G). 179 See Amendment No. 1, supra note 1, 81 FR at 76668. 180 See also Section III.B.1(b)(ii), supra (discussing market domination). VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 conduct’’ can serve to deter manipulation of the Gemini Auction price and, therefore, the Trust’s NAV.181 However, the Commission concludes that, based on the facts and circumstances of this proposal, the ability of relevant authorities to potentially sanction manipulative activity after the fact—if it is discovered—is insufficient, by itself, to meet BZX’s obligation to have rules ‘‘designed to prevent fraudulent and manipulative acts and practices.’’ 182 Before penalties can be imposed for engaging in manipulative conduct, such conduct must be detected and investigated; as discussed below, that is the necessary function of comprehensive surveillance-sharing agreements.183 Moreover, as discussed below, a substantial majority of bitcoin trading occurs outside the United States,184 and even within the United States, there is no comprehensive federal oversight of bitcoin spot markets.185 Another commenter suggests that the Commission sign a Memorandum of Understanding (‘‘MOU’’) with the Gemini Exchange to address what the commenter claims is the Commission’s unspoken but obvious concern with bitcoin.186 While the Commission is a party to several MOUs, these are generally arrangements with other foreign or domestic regulators.187 MOUs are tools to assist the Commission in performing its regulatory functions, not a mechanism for the Commission to assume an SRO’s obligations under the Exchange Act. supra note 174 and accompanying text. U.S.C. 78f(b)(5) (emphasis added). 183 See Section III.D, infra. 184 See infra notes 281–282 and accompanying text. 185 See infra notes 286–288 and accompanying text. 186 See supra note 175 and accompanying text. 187 See, e.g., Memorandum of Understanding Between the Internal Revenue Service and the Securities and Exchange Commission for Tax Exempt Bonds/Municipal Securities Compliance (Mar. 2, 2010), available at https://www.sec.gov/ info/municipal/sec-irs-mou030210.pdf; Memorandum of Understanding Between the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission Regarding Coordination in Areas of Common Regulatory Interest (Mar. 11, 2008), available at https:// www.sec.gov/news/press/2008/2008-40_mou.pdf; and Memorandum of Understanding Between the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission Regarding the Oversight of Security Futures Product Trading and the Sharing of Security Futures Product Information (Mar. 17, 2004), available at https://www.cftc.gov/idc/groups/public/@ internationalaffairs/documents/file/ moubetweencftcandsec031704.pdf. PO 00000 181 See 182 15 Frm 00133 Fmt 4703 Sfmt 4703 37591 D. The Use of Surveillance-Sharing Agreements To Detect and Deter Fraudulent and Manipulative Acts and Practices With Respect to CommodityTrust ETPs The Commission has historically recognized the importance of comprehensive surveillance-sharing agreements to detect and deter fraudulent and manipulative activity. Because BZX has not demonstrated that bitcoin and bitcoin markets are uniquely resistant to manipulation—or that alternative means of detecting and deterring fraud and manipulation are sufficient in the absence of a surveillance-sharing agreement with a significant, regulated market related to bitcoin—the absence of such an agreement compels the Commission to conclude that the proposed rule change must be disapproved. 1. Summary of Comments Received BZX claims that the March Disapproval Order overstates the extent to which surveillance and regulation of the underlying market have been present in prior commodity-trust ETP approval orders, asserting that none of these orders ‘‘offers even a cursory analysis about whether the regulated markets for trading futures on the underlying commodity are ‘wellestablished’ or ‘significant.’ ’’ 188 In particular, BZX argues that the Commission orders approving the ETFS Platinum Trust ETP (‘‘Platinum Order’’) and the ETFS Palladium Trust ETP (‘‘Palladium Order’’),189 along with their exchange filings, discuss neither whether the New York Mercantile Exchange (‘‘NYMEX’’) and the Tokyo Commodity Exchange (‘‘TOCOM’’) are well-established or significant, nor the relevance of NYMEX being the largest exchange in the world for trading palladium and platinum derivatives.190 BZX claims that—because the exchange filings regarding the platinum and palladium ETPs note that TOCOM is not a member of the Intermarket Surveillance Group and that the respective listing exchange did not have a comprehensive surveillance-sharing agreement with TOCOM—those approval orders did not require the existence of an information-sharing agreement with the underlying 188 See BZX Letter II, supra note 13, at 26–27. Exchange Act Release No. 61219 (Dec. 22, 2009), 74 FR 68886 (Dec. 29, 2009) (SR–NYSEArca– 2009–95) (approving ETFS Platinum Trust); Exchange Act Release No. 61220 (Dec. 22, 2009), 74 FR 68895 (Dec. 29, 2009) (SR–NYSEArca–2009–94) (approving ETFS Palladium Trust). 190 See BZX Letter II, supra note 13, at 27. 189 See E:\FR\FM\01AUN1.SGM 01AUN1 37592 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices exchange.191 BZX further asserts that the Platinum Order and Palladium Order discuss only whether the listing exchange (1) can obtain information from market makers relating to their trading in the applicable commodity or related derivatives; (2) has a rule preventing market makers from using material, nonpublic information regarding trading in the underlying commodity or its derivatives; and (3) can obtain trading information via the Intermarket Surveillance Group from other Intermarket Surveillance Group member exchanges.192 BZX further asserts that, while the potential avenues for manipulation noted in the March Disapproval Order are a risk, these potential avenues of manipulation of the bitcoin market also exist in the context of other commoditytrust ETPs.193 BZX asserts that, in the Commission order approving the listing and trading of shares of iShares Copper Trust (‘‘Copper Order’’),194 the Commission found that demand from new investors would broaden the investor base in copper and thereby reduce the risk of collusion among copper market participants. BZX also argues that the Commission ‘‘took comfort’’ in approving the iShares Copper Trust because trading of the shares would be subject to the oversight of the listing exchange and the Commission, and because the manipulation of physical copper would be subject to CFTC jurisdiction. BZX asserts that the Trust is nearly identically situated to the iShares Copper Trust.195 Similarly, the Lewis Letter asserts that many features of a similar bitcoin commodity-trust ETP proposal—features 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 another copper commoditytrust ETP.196 BZX contends that previous ETP approvals demonstrate that the factors used to determine whether currencyderivative products are consistent with id. at 27–28. id. at 27. 193 See Petition for Review, supra note 4, at 12. The Overdahl Letter agrees with this assertion by BZX. See Overdahl Letter, supra note 36, at 10. 194 See Exchange Act Release No. 68973 (Feb. 22, 2013), 78 FR 13726 (Feb. 28, 2013) (SR–NYSEArca– 2012–66) (approving iShares Copper Trust). 195 See BZX Letter II, supra note 13, at 13–14; see also id. at 25. 196 See Lewis Letter I, supra note 65, at 6 & n.8 (referring to the SolidX Bitcoin Trust, see SolidX Order, supra note 65, and to the JPM XF Physical Copper Trust, Exchange Act Release No. 68440 (Dec. 14, 2012), 77 FR 75468 (Dec. 20, 2012) (SR– NYSEArca–2012–28)). the Exchange Act should also apply to commodity-trust ETPs. BZX argues that the Commission order approving the listing and trading of the streetTRACKS Gold Shares (‘‘Gold Order’’) 197—the first commodity-trust ETP—was based on an assumption that the currency market and the spot gold market were largely unregulated, but found that certain factors mitigated the concerns arising from the unregulated underlying markets.198 BZX claims that, in determining whether a commodity-trust ETP is consistent with the Exchange Act, the Commission’s approval orders have included an analysis of previously approved derivative products for which the underlying reference assets (1) are traded OTC; (2) are largely unregulated; and (3) are traded on markets with which the ETP listing exchange could not enter into a surveillance sharing agreement.199 While BZX concedes that the Commission has not approved a commodity-trust ETP when there were no derivatives markets related to the underlying commodity, BZX points out that the Commission has approved a number of currency-trust ETPs and asserts that the Commission approved the listing and trading of the CurrencyShares Hong Kong Dollar Trust and the CurrencyShares Singapore Dollar Trust based largely on the same factors that the Commission has considered in approving commoditytrust ETPs, despite a statement in the approval order for the CurrencyShares Hong Kong Dollar Trust and the CurrencyShares Singapore Dollar Trust that futures or options are not traded on the Hong Kong Dollar or Singapore Dollar.200 Similarly, one commenter argues that there are several commoditybased and other ETPs where the underlying market is either unregulated or lightly regulated, such as foreignexchange linked or related ETPs, or commodity-based ETPs that hold the underlying and not the derivative product.201 191 See sradovich on DSK3GMQ082PROD with NOTICES 192 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 197 See Exchange Act Release No. 50603 (Oct. 28, 2004), 69 FR 64614 (Nov. 5, 2004) (SR–NYSE– 2004–22) (approving streetTRACKS Gold Shares). 198 See BZX Letter II, supra note 13, at 28–29. 199 See id. at 29. 200 See id. at 28 n.59. See also Exchange Act Release No. 58365 (Aug. 14, 2008), 73 FR 49522 (Aug. 21, 2008) (SR–NYSEArca–2008–81) (approving CurrencyShares Hong Kong Dollar Trust, CurrencyShares Singapore Dollar Trust, and two other issues of CurrencyShares based on nonU.S. currencies). 201 See Convergex Letter, supra note 36, at 2. PO 00000 Frm 00134 Fmt 4703 Sfmt 4703 2. Discussion (a) The History and Importance of Surveillance-Sharing Agreements Relating to Derivative Securities Products Although BZX claims to have described ‘‘traditional means’’ of identifying and deterring fraud and manipulation, it overlooks the fact that the Commission has long recognized the importance of comprehensive surveillance-sharing agreements to detect and deter fraudulent and manipulative activity.202 The hallmarks 202 See streetTRACKS Gold Shares, Exchange Act Release No. 50603 (Oct. 28, 2004), 69 FR 64614, 64618–19 (Nov. 5, 2004) (SR–NYSE–2004–22); iShares COMEX Gold Trust, Exchange Act Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751, 3754– 55 (Jan. 26, 2005) (SR–Amex–2004–38); iShares Silver Trust, Exchange Act Release No. 53521 (Mar. 20, 2006), 71 FR 14967, 14968, 14973–74 (Mar. 24, 2006) (SR–Amex–2005–072); ETFS Gold Trust, Exchange Act Release No. 59895 (May 8, 2009), 74 FR 22993, 22994–95, 22998, 23000 (May 15, 2009) (SR–NYSEArca–2009–40); ETFS Silver Trust, Exchange Act Release No. 59781 (Apr. 17, 2009), 74 FR 18771, 18772, 18775–77 (Apr. 24, 2009) (SR– NYSEArca–2009–28); ETFS Palladium Trust, Exchange Act Release No. 61220 (Dec. 22, 2009), 74 FR 68895, 68896 (Dec. 29, 2009) (SR–NYSEArca– 2009–94) (notice of proposed rule change included NYSE Arca’s representation that ‘‘[t]he 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, Exchange Act Release No. 60971 (Nov. 9, 2009), 74 FR 59283, 59285–86, 59291 (Nov. 17, 2009)); ETFS Platinum Trust, Exchange Act Release No. 61219 (Dec. 22, 2009), 74 FR 68886, 68887–88 (Dec. 29, 2009) (SR– NYSEArca–2009–95) (notice of proposed rule change included NYSE Arca’s representation that ‘‘[t]he most significant platinum 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, Exchange Act Release No. 60970 (Nov. 9, 2009), 74 FR 59319, 59321, 59327 (Nov. 17, 2009)); Sprott Physical Gold Trust, Exchange Act Release No. 61496 (Feb. 4, 2010), 75 FR 6758, 6760 (Feb. 10, 2010) (SR– NYSEArca–2009–113) (notice of proposed rule change included NYSE Arca’s representation 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, Exchange Act Release No. 61236 (Dec. 23, 2009), 75 FR 170, 171, 174 (Jan. 4, 2010)); Sprott Physical Silver Trust, Exchange Act Release No. 63043 (Oct. 5, 2010), 75 FR 62615, 62616, 62619, 62621 (Oct. 12, 2010) (SR– NYSEArca–2010–84); ETFS Precious Metals Basket Trust, Exchange Act Release No. 62692 (Aug. 11, 2010), 75 FR 50789, 50790 (Aug. 17, 2010) (SR– NYSEArca–2010–56) (notice of proposed rule change included 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 COMEX is a member, Exchange Act Release No. 62402 (Jun. 29, E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices 2010), 75 FR 39292, 39295, 39298 (July 8, 2010)); ETFS White Metals Basket Trust, Exchange Act Release No. 62875 (Sept. 9, 2010), 75 FR 56156, 56158 (Sept. 15, 2010) (SR–NYSEArca–2010–71) (notice of proposed rule change included 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, Exchange Act Release No. 62620 (July 30, 2010), 75 FR 47655, 47657, 47660 (Aug. 6, 2010)); ETFS Asian Gold Trust, Exchange Act Release No. 63464 (Dec. 8, 2010), 75 FR 77926, 77928 (Dec. 14, 2010) (SR–NYSEArca–2010–95) (notice of proposed rule change included 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, Exchange Act Release No. 63267 (Nov. 8, 2010), 75 FR 69494, 69496, 69500–01 (Nov. 12, 2010)); Sprott Physical Platinum and Palladium Trust, Exchange Act Release No. 68430 (Dec. 13, 2012), 77 FR 75239, 75240–41 (Dec. 19, 2012) (SR– NYSEArca–2012–111) (notice of proposed rule change included 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 trading information via the Intermarket Surveillance Group,’’ of which COMEX is a member, Exchange Act Release No. 68101 (Oct. 24, 2012), 77 FR 65732, 65733, 65739 (Oct. 30, 2012)); APMEX Physical— 1 oz. Gold Redeemable Trust, Exchange Act Release No. 66930 (May 7, 2012), 77 FR 27817, 27818 (May 11, 2012) (SR–NYSEArca– 2012–18) (notice of proposed rule change included NYSE Arca’s representation that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which COMEX is a member, and that gold futures are traded on COMEX and the Tokyo Commodity Exchange, with a cross-reference to the proposed rule change to list and trade shares of the ETFS Gold Trust, in which NYSE Arca represented that COMEX is one of the ‘‘major world gold markets,’’ Exchange Act Release No. 66627 (Mar. 20, 2012), 77 FR 17539, 17542–43, 17547 (Mar. 26, 2012)); JPM XF Physical Copper Trust, Exchange Act Release No. 68440 (Dec. 14, 2012), 77 FR 75468, 75469–70, 75472, 75485–86 (Dec. 20, 2012) (SR– NYSEArca–2012–28); iShares Copper Trust, Exchange Act Release No. 68973 (Feb. 22, 2013), 78 FR 13726, 13727, 13729–30, 13739–40 (Feb. 28, 2013) (SR–NYSEArca–2012–66); First Trust Gold Trust, Exchange Act Release No. 70195 (Aug. 14, 2013), 78 FR 51239, 51240 (Aug. 20, 2013) (SR– NYSEArca–2013–61) (notice of proposed rule change included NYSE Arca’s representation that FINRA, on behalf of the exchange, may obtain trading information regarding gold futures and options on gold futures from members of the Intermarket Surveillance Group, including COMEX, or from markets ‘‘with which [NYSE Arca] has in place a comprehensive surveillance sharing agreement,’’ and that gold futures are traded on COMEX and the Tokyo Commodity Exchange, with a cross-reference to the proposed rule change to list and trade shares of the ETFS Gold Trust, in which NYSE Arca represented that COMEX is one of the ‘‘major world gold markets,’’ Exchange Act Release No. 69847 (June 25, 2013), 78 FR 39399, 39400, 39405 (July 1, 2013)); Merk Gold Trust, Exchange Act Release No. 71378 (Jan. 23, 2014), 79 FR 4786, 4786–87 (Jan. 29, 2014) (SR–NYSEArca–2013–137) (notice of proposed rule change included NYSE Arca’s representation that ‘‘COMEX is the largest gold futures and options exchange’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ including with VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 of such an agreement are that the agreement provides for the sharing of information about market trading activity, clearing activity, and customer identity; that the parties to the agreement have reasonable ability to obtain access to and produce requested information; and that no existing rules, laws, or practices would impede one party to the agreement from obtaining this information from, or producing it to, the other party.203 Since at least 1990, the Commission has explained 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 possible trading violations and other regulatory improprieties.’’ 204 The Commission has also long taken the position that surveillance-sharing agreements are important in the context of exchange listing of derivative security products, such as equity options. In 1994, the Commission stated: As a general matter, the Commission believes that the existence of a surveillance sharing agreement that effectively permits the sharing of information between an exchange proposing to list an equity option and the exchange trading the stock underlying the equity option is necessary to detect and deter market manipulation and other trading abuses. In particular, the Commission notes that surveillance sharing agreements provide an important deterrent to manipulation because they facilitate the availability of information needed to fully investigate a potential manipulation if it were to occur. These agreements are especially important in the context of derivative products based on foreign securities because they facilitate the collection of necessary regulatory, surveillance and other information from foreign jurisdictions.205 respect to transactions occurring on COMEX pursuant to CME and NYMEX’s membership, or from exchanges ‘‘with which [NYSE Arca] has in place a comprehensive surveillance sharing agreement,’’ Exchange Act Release No. 71038 (Dec. 11, 2013), 78 FR 76367, 76369, 76374 (Dec. 17, 2013)); Long Dollar Gold Trust, Exchange Act Release No. 79518 (Dec. 9, 2016), 81 FR 90876, 90881, 90886, 90888 (Dec. 15, 2016) (SR– NYSEArca–2016–84). 203 See, e.g., Letter from Brandon Becker, Director, Division of Market Regulation, Commission, to Gerard D. O’Connell, Chairman, Intermarket Surveillance Group (June 3, 1994), available at https://www.sec.gov/divisions/marketreg/mrnoaction/isg060394.htm. 204 See Exchange Act Release No. 27877 (Apr. 4, 1990), 55 FR 13344, 13345 (Apr. 10, 1990) (SR– NYSE–90–14). 205 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). The Commission further stated that it ‘‘generally believes that having a comprehensive surveillance sharing agreement in place, between the exchange where the ADR option PO 00000 Frm 00135 Fmt 4703 Sfmt 4703 37593 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.’’ 206 trades and the exchange where the foreign security underlying the ADR primarily trades, will ensure the integrity of the marketplace. The Commission further believes that the ability to obtain relevant surveillance information, including, among other things, the identity of the ultimate purchasers and sellers of securities, is an essential and necessary component of a comprehensive surveillance sharing agreement.’’ Id. 206 See Exchange Act Release No. 35518 (Mar. 21, 1995), 60 FR 15804, 15807 (Mar. 27, 1995) (SRAmex–94–30). In that matter, the Commission noted that the listing exchange had comprehensive surveillance-sharing agreements with all of the exchanges upon which the futures contracts overlying the notes traded and was able to obtain market surveillance information, including customer identity information, for transactions occurring on NYMEX and other futures exchanges. See id. at 15807 n.21; see also Exchange Act Release No. 36885 (Feb. 26, 1996), 61 FR 8315, 8319 n.17 (Mar. 4, 1996) (SR–Amex–95–50) (approving the exchange listing and trading of Commodity Indexed Securities, and noting: (a) That through the comprehensive surveillance-sharing agreements, the listing exchange was able to obtain market surveillance information, including customer identity information, for transactions occurring on NYMEX and COMEX and that, through the Intermarket Surveillance Group information-sharing agreement, the listing exchange was able to obtain, upon request, surveillance information with respect to trades effected on the London Metal Exchange, including client identity information and (b) that, if a different market were utilized for purposes of calculating the value of a designated futures contract, the listing exchange had represented that it would ensure that it entered into a surveillancesharing agreement with respect to the new relevant market). The Commission has made similar statements about surveillance-sharing agreements with respect to the listing and trading of stockindex, currency, and currency-index warrants. See, e.g., Exchange Act Release No. 36166 (Aug. 29, 1995), 60 FR 46660 (Sept. 7, 1995) (SR–PSE–94–28) (approving a proposal to adopt uniform listing and trading guidelines for stock-index, currency, and currency-index warrants). Specifically, the Commission noted that ‘‘a surveillance sharing agreement should provide the parties with the ability to obtain information necessary to detect and deter market manipulation and other trading abuses’’ and stated that the Commission ‘‘generally requires that a surveillance sharing agreement require that the parties to the agreement provide each other, upon request, information about market trading activity, clearing activity, and the identity of the ultimate purchasers for securities.’’ Id. at E:\FR\FM\01AUN1.SGM Continued 01AUN1 37594 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices In 1998, in adopting Exchange Act Rule 19b–4(e) 207 to permit the generic listing and trading of certain new derivatives 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 or ‘‘ISAs’’ in the release), the information necessary to detect and deter manipulative activity. Specifically, in adopting rules governing the generic listing of new derivatives 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’’ and stated that: It is essential that the SRO have the ability to obtain the information necessary to detect and deter market manipulation, illegal trading and other abuses involving the new derivative securities product. Specifically, 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.208 sradovich on DSK3GMQ082PROD with NOTICES Consistent with this principle, for the commodity-trust ETPs approved to date for listing and trading, there has been in every case at least one significant, regulated market for trading futures on the underlying commodity—whether gold, silver, platinum, palladium, or copper—and the ETP listing exchange has entered into surveillance-sharing agreements with, or held Intermarket Surveillance Group membership in common with, that market.209 In light of the history and purpose of looking to surveillance-sharing agreements, with respect to markets for assets underlying an ETP or for derivatives on those assets, the Commission interprets the terms ‘‘significant market’’ and ‘‘market of significant size’’ to include a market (or group of markets) as to which (a) there is a reasonable likelihood that a person 46665 n.35. In addition, the Commission stated that ‘‘[t]he ability to obtain relevant surveillance information, including, among other things, the identity of the ultimate purchasers and sellers of securities, is an essential and necessary component of a comprehensive surveillance sharing agreement.’’ Id. at 46665 n.36. 207 17 CFR 240.19b–4(e). 208 NDSP Adopting Release, supra note 21. 209 See supra note 202. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 attempting to manipulate the ETP would also have to trade on that market to successfully manipulate the ETP, so that a surveillance-sharing agreement would assist the ETP listing market in detecting and deterring misconduct, and (b) it is unlikely that trading in the ETP would be the predominant influence on prices in that market. This definition is illustrative and not exclusive. There could be other types of ‘‘significant markets’’ and ‘‘markets of significant size,’’ but this definition is an example that will provide guidance to market participants. (b) Response to Comments Regarding Surveillance-Sharing Agreements and Prior Commodity-Trust ETP Approvals Prior ETP approval orders are consistent with the standards the Commission is applying to the BZX proposal. However, more recent approval orders for the well-established model of a precious-metal trust—for example, the Platinum Order and the Palladium Order—found it unnecessary to perform the exhaustive analysis of underlying markets and surveillance sharing provided by the first approval order for a precious metal commoditytrust ETP, the Gold Order, especially since the proposed rule change for platinum and palladium ETPs discussed surveillance-sharing agreements with significant, regulated platinum and palladium markets.210 BZX argues that even the Gold Order relied on alternative factors—primarily the depth and liquidity of the spot gold market—to mitigate Commission concerns about approving a commoditytrust ETP based on an asset that traded in unregulated, over-the-counter markets with which no surveillance sharing agreement could be executed.211 The Gold Order does note the depth and liquidity of the gold market, likening the spot gold market to the ‘‘extremely large, diverse market’’ for OTC foreign exchange trading.212 Significantly, however, the Gold Order demonstrates that the Commission did take into account the availability of surveillancesharing agreements in approving the first commodity-trust ETP. The Gold Order states that ‘‘[i]nformation sharing agreements with markets trading securities underlying a Gold Order, supra note 197, 69 FR at 64614–15, 64618–19; Platinum Order, supra note 189, 74 FR at 68887–88; Palladium Order, supra note 189, 74 FR at 68896. 211 See supra notes 197–199 and accompanying text. Another commenter also asserts that the Commission has approved several commoditybased ETPs where the underlying market is either unregulated or lightly regulated. See supra note 201 and accompanying text. 212 Gold Order, supra note 197, 69 FR at 64619. PO 00000 210 See Frm 00136 Fmt 4703 Sfmt 4703 derivative are an important part of a self-regulatory organization’s ability to monitor for trading abuses in derivative products.’’ 213 And, while the Gold Order observes that that it is ‘‘not possible . . . to enter into an information sharing agreement with the OTC gold market,’’ the order continues: ‘‘Nevertheless, the Commission believes that the unique liquidity and depth of the gold market, together with the MOU [Memorandum of Understanding] with NYMEX (of which COMEX is a Division) and NYSE Rules 1300(b) and 1301, create the basis for the [ETP listing exchange] to monitor for fraudulent and manipulative practices in the trading of the Shares.’’ 214 Thus, even though the Commission found that the over-thecounter market for gold was ‘‘extremely deep and liquid,’’ 215 the Commission’s approval of the first precious metal ETP expressly relied on an agreement to share surveillance information between the listing exchange and a significant, regulated market for gold futures.216 In the years after the approval of the first precious-metal commodity-trust ETP, several other, virtually identical, commodity-trust ETPs have been approved.217 Among the approval orders were the Platinum Order and the Palladium Order, which BZX cites as examples of the Commission approving a commodity-trust ETP without requiring that there be a surveillancesharing agreement with a significant, regulated market for an underlying exchange. While neither the Platinum Order nor the Palladium Order expressly discusses such agreements, the record before the Commission at the time it issued those orders (including the notices of the proposed rule changes) shows that the ETP listing exchange was able to share surveillance information with the ‘‘largest exchange in the world for trading precious metal futures and options,’’ which had been trading both platinum futures and palladium futures for approximately 35 years at the time the Commission 213 Id. 214 Id. (emphasis added). 215 Id. 216 See id. In the Gold Order, the Commission also stated that the ETP listing exchange had ‘‘entered into a reciprocal Memorandum of Understanding (‘MOU’) with the NYMEX (of which COMEX is a division) for the sharing of information relating to any financial instrument based, in whole or in part, upon an interest in or performance of gold.’’ Id. at 64618. The Gold Order also notes volume figures for spot gold trading provided by the London Bullion Market Association and gold futures trading provided by COMEX. See id. at 64619. 217 See supra note 202. E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES approved commodity-trust ETPs holding those metals.218 Consistent with the discussion of ‘‘significant market’’ described above,219 the Commission has not previously, and does not now, require that an ETP listing exchange be able to enter into a surveillance-sharing agreement with each regulated spot or derivatives market relating to an underlying asset, provided that the market or markets with which there is such an agreement constitute a ‘‘significant market.’’ While BZX and the Overdahl Letter assert that the potential avenues for manipulation of the bitcoin market also exist in the context of other commoditytrust ETPs, this argument merely reinforces the Commission’s view that similar market structures—namely, surveillance-sharing agreements with significant, regulated markets—should be in place for a bitcoin-trust ETP just as they are for commodity-trust ETPs.220 BZX also argues that the proposal should be approved because it is ‘‘nearly identically situated’’ to the iShares Copper Trust. In particular, BZX asserts that the Commission approved the iShares Copper Trust because the Commission believed that approval of the ETP could reduce the risk of manipulation in the underlying spot market and that the Commission could rely on surveillance by the listing exchange and CFTC jurisdiction to address concerns about manipulation— factors it argues support approval here.221 The Copper Order, however, 218 See 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 for ETFS Palladium Trust includes NYSE Arca’s representation that ‘‘NYMEX is the largest exchange in the world for trading precious metals futures and options and has been trading palladium since 1974,’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which NYMEX is a member); Exchange Act Release No. 60970 (Nov. 9, 2009), 74 FR 59319, 59321, 59327 (Nov. 17, 2009) (SR–NYSEArca–2009–95) (notice of proposed rule change for ETFS Platinum Trust includes NYSE Arca’s representation that ‘‘NYMEX is the largest exchange in the world for trading precious metals futures and options and has been trading platinum since 1974,’’ and that NYSE Arca ‘‘may obtain trading information via the Intermarket Surveillance Group,’’ of which NYMEX is a member). See also supra note 189 and accompanying text. 219 See Section III.D.2(a), supra. 220 The proposal does not involve an ETP that is based on an index of commodities where the component commodities are subject to surveillancesharing agreements with significant, regulated markets. See, e.g., Exchange Act Release No. 53105 (Jan. 11, 2006), 71 FR 3129, 3136 (Jan. 19, 2006) (SR–Amex–2005–059) (approving DB Commodity Index Tracking Fund based on an index that tracks the performance of futures contracts on crude oil, heating oil, aluminum, gold, corn, and wheat). 221 See supra notes 194–195 and accompanying text. The Lewis Letter makes a similar argument. See supra note 196 and accompanying text. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 specifically noted the existence of surveillance-sharing agreements not only between the ETP listing market and copper futures markets, but also between the ETP listing market and a significant copper spot market, the London Metal Exchange.222 And the Copper Order’s analysis of the underlying physical market for copper does not reflect a determination that these factors could serve as an adequate alternative to a surveillance-sharing agreement, but was instead a response to certain commenters’ arguments that approving the iShares Copper Trust would affirmatively disrupt the physical copper market.223 BZX argues that the Commission should approve the proposal because it has previously approved currency-trust ETPs—the CurrencyShares Hong Kong Dollar Trust and the CurrencyShares Singapore Dollar Trust—without requiring the existence of a surveillancesharing agreement with underlying markets.224 However, BZX has proposed to list and trade the Shares as a commodity-based ETP, not a currencybased ETP,225 and the Commission as well as other agencies have distinguished bitcoin from currency.226 222 See Copper Order, supra note 194, 78 FR at 13727 n.7, and 13730. 223 See id. at 13731–33. 224 See supra note 200 and accompanying text. Another commenter also asserts that the Commission has approved several foreign exchange-linked ETPs where the underlying market is either unregulated or lightly regulated. See Convergex Letter, supra note 36, at 2. 225 See Amendment No. 1, supra note 1, 81 FR at 76651. 226 See In re Bitcoin Inv. Tr., Exchange Act Release No. 78282, 2016 WL 4363462, at *1 n.1 (July 11, 2016); In re Btc Trading, Corp., Securities Act Release No. 9685, Exchange Act Release No. 73783, 2014 WL 6872955, at *1 n.1 (Dec. 8, 2014); In re Voorhees, Securities Act Release No. 9592, 2014 WL 2465620, at *1 n.1 (June 3, 2014). The CFTC has concluded that Bitcoin is a virtual currency that is a commodity, ‘‘distinct from ‘real’ currencies, which are the coin and paper money of the United States or another country that are designated as legal tender, circulate, and are customarily used and accepted as a medium of exchange in the country of issuance.’’ In re Coinflip, Inc., CFTC No. 15–29, 2015 WL 5535736, at *1 n.2 (Sept. 17, 2015). The Treasury Department’s Financial Crimes Enforcement Network has noted: ‘‘In contrast to real currency, ‘virtual’ currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.’’ Guidance: Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (Mar. 18, 2013) (discussing 31 CFR 1010.100(m)), available at https://www.fincen.gov/resources/statutesregulations/guidance/application-fincensregulations-persons-administering. The IRS has concluded that ‘‘virtual currency is not treated as currency’’ for purposes of federal tax laws. IRS Virtual Currency Guidance, I.R.S. Notice 2014–21, 2014–16 I.R.B. 938, 2014 WL 1224474 (Apr. 14, 2014). PO 00000 Frm 00137 Fmt 4703 Sfmt 4703 37595 Even if the Commission were to apply the approach it took in approving currency-trust ETPs, the Commission would still conclude that the proposal is not consistent with the Exchange Act, because the deep, liquid, and longstanding markets for currencies, which are dominated by regulated entities, bear little resemblance to the current state of bitcoin markets. Foreign currency derivatives traded on national securities exchanges for decades before the Commission approved currencytrust ETPs. And when it approved the first foreign currency derivatives in 1982—options on the British pound, the German mark, the Swiss franc, the Canadian dollar, and the Japanese yen, each the sovereign currency of a developed nation—the Commission explained that ‘‘[t]he magnitude of the related foreign currency markets would appear to militate against a successful manipulation through inter-market trading activity.’’ 227 Similarly, when approving the listing and trading of additional foreign currency derivatives in 1992, the Commission recognized the ‘‘developed markets for the component foreign currencies’’ and observed that ‘‘the interbank foreign currency spot market is an extremely large, diverse market comprised of banks and other financial institutions worldwide.’’ 228 The Gold Order echoed this view of the currency markets.229 And the approval order for the CurrencyShares products that BZX cites includes the following representations by the listing exchange regarding the foreign currency markets: Most trading in the global over-the-counter (‘‘OTC’’) foreign currency markets is conducted by regulated financial institutions such as banks and broker-dealers. In addition, in the United States, the Foreign Exchange Committee of the New York Federal Reserve Bank has issued Guidelines for Foreign Exchange Trading, and centralbank sponsored committees in Japan and Singapore have published similar best practice guidelines. In the United Kingdom, the Bank of England has published the NonInvestment Products Code, which covers foreign currency trading. The Financial Markets Association, whose members include major international banking organizations, has also established best practices guidelines called the Model Code. Participants in the U.S. OTC market for 227 Exchange Act Release No. 19133 (Oct. 14, 1982), 47 FR 46946, 1982 WL 521987, at *5 (Oct. 21, 1982) (SR–Phlx–81–4). 228 Exchange Act Release No. 31627 (Dec. 21, 1992), 57 FR 62399, 1992 WL 394554, at *4–5 (Dec. 30, 1992) (SR–Amex–92–36). 229 See Gold Order, supra note 197, 69 FR at 64619. E:\FR\FM\01AUN1.SGM 01AUN1 37596 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices foreign currencies are generally regulated by their oversight regulators.230 comprehensive surveillance-sharing agreement. Neither BZX nor any of the commenters has provided data that would justify treating the markets for bitcoin similarly to the deep and liquid markets for fiat currencies. Moreover, the description of the worldwide market for bitcoin, in which both the trading venues and the participants are unregulated, bears little resemblance to the OTC markets for foreign currency, on which most trading is conducted by regulated financial institutions. Accordingly, the Commission’s previous approvals of derivatives securities products based on foreign currencies are not a basis for the Commission to approve the proposal despite the absence of a surveillance-sharing agreement with a regulated market of significant size related to bitcoin. 1. The Gemini Exchange sradovich on DSK3GMQ082PROD with NOTICES E. Whether BZX Has Entered Into Surveillance-Sharing Agreements With Regulated Markets of Significant Size Related to Bitcoin Although BZX asserts that it has entered into a comprehensive surveillance-sharing agreement with the Gemini Exchange with respect to bitcoin trading and that the Gemini Exchange is supervised by the NYSDFS, the record does not establish that the Gemini Exchange is a ‘‘regulated market’’ comparable to a national securities exchange or to the futures exchanges that are associated with the underlying assets of the commodity-trust ETPs approved to date. Even if the Gemini Exchange were ‘‘regulated,’’ the record does not support a finding that the Gemini Exchange represents a ‘‘significant’’ bitcoin-related market. Accordingly, the Commission finds that the surveillance-sharing agreement between BZX and the Gemini Exchange, even in combination with alternative means of detecting and deterring fraud and manipulation, is insufficient to demonstrate that the proposed rule change is consistent with Exchange Act Section 6(b)(5). Nor has BZX demonstrated that any of the current trading venues in the worldwide bitcoin spot market is a regulated market such that a comprehensive surveillancesharing agreement with those venues would satisfy the requirements of Section 6(b)(5). And BZX has likewise failed to carry its burden to demonstrate that there is a regulated market of significant size in derivatives related to bitcoin with which the ETP listing market has entered into a 230 Exchange Act Release No. 58365, supra note 200, 73 FR at 49523. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 (a) Summary of Comments Received BZX asserts that it has entered into a comprehensive surveillance-sharing agreement with the Gemini Exchange through which it can obtain customer identity information about bitcoin transactions and market data.231 Similarly, the Overdahl Letter claims that the surveillance-sharing agreement between the Gemini Exchange and BZX aims to detect and deter such conduct and that the agreement allows for continuous monitoring of trading activity to effectively conduct surveillance of the Gemini Auction price.232 BZX represents that the Gemini Exchange operates under the direct supervision and regulatory authority of the NYSDFS.233 This is because, BZX argues, the Gemini Exchange is a facility of the Custodian, which is a New York State-chartered limited liability trust company.234 BZX also represents that the Custodian is a fiduciary and that it must meet the capitalization, compliance, anti-money-laundering, consumer protection, and cyber security requirements set forth by the NYSDFS.235 BZX asserts that the Gemini Auction typically already transacts a volume greater than the proposed creation basket size for the Trust and that the Gemini Auction would likely support the needs of Authorized Participants to engage in basket creation or redemption.236 BZX claims that the global bitcoin marketplace has the potential to provide even more liquidity and to be a source of bitcoin for basket creation and hedging. BZX also asserts that all intraday order-book and trade information on the Gemini Exchange is publicly available through various electronic formats and is also redistributed by various online aggregators, and that, with the launch of the proposed Trust, the Sponsor must make important pricing data available in real time.237 As noted above, BZX also claims that the volume transacted in the Gemini Auction is generally more than 231 See Amendment No. 1, supra note 1, 81 FR at 76663, 76668; BZX Letter II, supra note 13, at 29– 30. 232 See Overdahl Letter, supra note 36, at 11. 233 See Amendment No. 1, supra note 1, 81 FR at 76651–52. 234 See id. at 76652. 235 See id. 236 See BZX Letter II, supra note 13, at 20; but see Section III.B.2(b), supra. 237 See BZX Letter I, supra note 35, at 9; see also Petition for Review, supra note 4, at 15–16. PO 00000 Frm 00138 Fmt 4703 Sfmt 4703 50% larger than the second-largest trade in the world, drawing an average daily volume of 1,200 bitcoins compared to approximately 800 bitcoins.238 One commenter claims that among USD bitcoin exchanges, Gemini has a 3% share and its liquidity measured by order book depth is significantly lower than that of several other exchanges. The commenter states that it is possible that, after the launch of an ETP, Gemini’s liquidity and volume will increase, but claims that the nature of bitcoin trading that leads to the concentration of volume and liquidity outside of U.S. borders makes any significant future increase unlikely.239 This commenter also observes that while Gemini is locally regulated by the NYSDFS, the global landscape of many unregulated bitcoin exchanges exerts huge influence on the Gemini Exchange and consequently on the proposed ETP.240 Another commenter claims that the Gemini Exchange has the lowest liquidity of the three exchanges in the United States and is one of the leastliquid of all exchanges that trade bitcoin for USD.241 One commenter asserts that the size and importance of the Gemini Exchange and the itBit Exchange have grown substantially and claims that, from January 23, 2017, to May 10, 2017, the combined market share of these exchanges jumped from just 0.33% to 7.14% of total worldwide bitcoin volume, equivalent to more than 10,000 bitcoins per day on average.242 This commenter also asserts that the geographic distribution of bitcoin spot trading has shifted in focus from Chinese-based platforms towards U.S.based venues, which indicates increased transparency and safer regulation in the near future. The commenter asserts that—although the Gemini Exchange and the itBit Exchange remain the only two NYSDFS-regulated bitcoin exchanges, and while a market share of 7.14% leaves much room for growth— 238 See BZX Letter II, supra note 13, at 19–20. Maher Letter, supra note 35 (noting that the market is very concentrated and is controlled by a small group of exchanges operating in China, three of which represented 96% of all bitcoin trade volume over a six-month period, and noting that the Gemini Exchange had a 0.07% share of bitcoin volume worldwide during that period, with a 3% share of USD-exchange volume). 240 See id. 241 See Anonymous Letter III, supra note 35. 242 See SIG Letter, supra note 36, at 7. The itBit Exchange is a commercial bitcoin trading venue based in New York, NY. The NYSDFS has granted a charter under New York Banking Law to itBit Trust Company, LLC. See Press Release, NYSDFS, NY[S]DFS Grants First Charter to a New York Virtual Currency Company(May 7, 2015), available at https://www.dfs.ny.gov/about/press/ pr1505071.htm. 239 See E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices the migration of global bitcoin trading volumes since mid-January 2017 is a positive trend.243 This commenter further asserts that, alongside Gemini Exchange and itBit Exchange, two other U.S.-based exchanges, GDAX and Kraken, have become significant spot bitcoin trading venues. According to this commenter, these four exchanges—the largest U.S. bitcoin exchanges—together now represent over 29% of worldwide bitcoin volume, up from just 1.47% on January 23, 2017. The commenter claims that, with almost a third of global spot bitcoin volume now occurring on these four U.S.-based trading venues, regulatory agencies and SROs have the opportunity to develop a robust framework of regulatory oversight and transparency that would support fair and orderly markets for both spot bitcoin and listed bitcoin-based ETPs.244 This commenter predicts that the launch of a regulated, U.S.-listed bitcoin ETP will help drive more bitcoin trading volume onto U.S.-based exchanges, and this commenter asserts that this supplemental liquidity is likely to manifest itself mainly on U.S.-based bitcoin exchanges such as Gemini, itBit, GDAX, and Kraken, which will be the most liquid venues during U.S. trading hours.245 The Overdahl Letter asserts that, between September 21, 2016, and March 1, 2017, the Gemini Exchange accounted for 24.03% of bitcoin trading volume on U.S. exchanges and 7.35% of the global USD market for bitcoin.246 The Overdahl Letter contends that the Gemini Auction price is reliable in that it generally reflects both prices for bitcoin traded at other U.S.-based bitcoin exchanges and prices for bitcoin traded at USD-based exchanges globally. The Overdahl Letter claims that significant deviations between the Gemini price and other prices are quickly reduced to normal (small) levels and that the Gemini price does not primarily cause these deviations. In addition, the Overdahl Letter concludes that, when price deviations are observed, pricing across exchanges tends to converge.247 The Overdahl Letter also notes the concern expressed by some commenters that the Gemini Exchange had relatively low trading volume and that, as a result, the exchange price was less reliable than if the volumes were larger. In response to this concern, the Overdahl Letter 243 See SIG Letter, supra note 36, at 7. id. at 7–8. 245 See id. at 8. 246 See Overdahl Letter, supra note 36, at 8. 247 See id. at 1, 7. 244 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 provides a list of ETPs approved by the Commission that, the Overdahl Letter claims, have underlying assets with lower average daily volume than the average daily volume of the Gemini Exchange.248 (b) Discussion BZX represents that it has entered into a comprehensive surveillancesharing agreement with the Gemini Exchange with respect to bitcoin trading and that the Gemini Exchange is supervised by the NYSDFS and is thereby subject to capitalization, antimoney-laundering, compliance, consumer protection, and cybersecurity requirements.249 The record, however, does not support a conclusion that the Gemini Exchange is a ‘‘regulated market’’ comparable to a national securities exchange or to the futures exchanges that are associated with the underlying assets of the commoditytrust ETPs approved to date. The record does not establish that the Gemini Exchange’s rules, including its trading rules, are subject to regulatory review or approval or that its trading operations are subject to regulatory examination. Commission regulation of the securities markets includes the elements of NYSDFS supervision described above,250 but national securities exchanges are also, among other things, required 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.’’ 251 Moreover, national securities exchanges must file proposed rules with the Commission regarding certain material aspects of their operations,252 and the Commission has the authority to disapprove any such rule that is not consistent with the requirements of the Exchange Act.253 id. at 13–14. Amendment No. 1, supra note 1, 81 FR at 76652, 76663, 76668; BZX Letter II, supra note 13, at 29–30. 250 See supra notes 233–235 and accompanying text. 251 15 U.S.C. 78f(b)(5). 252 17 CFR 240.19b–4(a)(6)(i). 253 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 PO 00000 248 See 249 See Frm 00139 Fmt 4703 Sfmt 4703 37597 Thus, national securities exchanges are subject to Commission oversight of, among other things, their governance, membership qualifications, trading rules, disciplinary procedures, recordkeeping, and fees.254 Even if the Gemini Exchange were ‘‘regulated,’’ the record would not support a conclusion that the Gemini Exchange conducts a significant volume of trading in bitcoin because there is no evidence in the record that there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on the Gemini Exchange (or any record evidence addressing how trading in the proposed ETP would or would not influence prices on the Gemini Exchange). Furthermore, there is insufficient evidence in the record to determine whether it is unlikely that trading in the ETP would be the predominant influence on prices on the Gemini Exchange. Indeed, if anything, the Gemini Auction size is currently so small that the proposed ETP could fundamentally affect supply and demand (and thus pricing) on the Gemini Exchange, not the other way around.255 The record thus includes at best uncertain information regarding the volume or liquidity of the Gemini Exchange, how the Gemini Exchange may influence the price of any ETP based on bitcoin, or how the existence of ETPs based on bitcoin may affect the Gemini Exchange. Commenters have provided varying estimates of the current and future volume of trading on proposed rule changes with the Commission and provides the Commission with the authority to disapprove proposed rule changes that are not consistent with the Exchange Act. Designated Contract Markets (commonly called ‘‘futures markets’’) registered with and regulated by the CFTC must comply with, among other things, a similarly comprehensive range of regulatory principles and must file rule changes with the CFTC. See, e.g., Designated Contract Markets (DCMs), CFTC, available at https://www.cftc.gov/ IndustryOversight/TradingOrganizations/DCMs/ index.htm. 254 The Commission notes that the NYSDFS recently issued ‘‘guidance’’ to supervised virtual currency business entities, including the Gemini Exchange, stating that these entities must ‘‘implement measures designed to effectively detect, prevent, and respond to fraud, attempted fraud, and similar wrongdoing.’’ See Maria T. Vulio, Superintendent of Financial Services, NYSDFS, Guidance on Prevention of Market Manipulation and Other Wrongful Activity (Feb. 7, 2018), available at https://www.dfs.ny.gov/legal/industry/ il180207.pdf. This guidance was issued after the comment period for this proposed rule change ended, and there is nothing in the record regarding how this guidance has been implemented by the NYSDFS or by the affected entities. 255 See Section III.B.2(b), supra. E:\FR\FM\01AUN1.SGM 01AUN1 37598 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices the Gemini Exchange.256 Moreover, because bitcoin markets are still evolving in significant ways, and because there is no comprehensive data source reflecting bitcoin trading, it is not currently possible to state with confidence what share of volume any particular spot trading venue has captured or will capture.257 Bitcoin trading activity is dispersed across markets and OTC transactions worldwide, and there is no centralized, regulatory data source for bitcoin trading statistics. Accordingly, any analysis of worldwide trading activity must use unofficial sources that gather and disseminate trading data, and even these sources cannot capture OTC transactions, or transactions that take place in what the Registration Statement characterizes as ‘‘dark pools.’’ 258 Further, as discussed above,259 recent volume in the Gemini Auction is a fraction of the size of a creation unit of the Trust, and therefore the Commission does not agree with the assertion by BZX that the Gemini Auction would support the needs of Authorized Participants to engage in basket creation or redemption. Finally, the comparison offered by the Overdahl Letter between the average trading volume on the Gemini Exchange and the average trading volume of the underlying assets of other ETPs is inapt.260 The issue here is not that the Gemini Exchange has low trading volume in an absolute sense but, rather, that the Trust would value its holdings using the Gemini Auction price, even though there is no basis in the record to find that the Gemini Auction represents a significant portion of worldwide bitcoin trading.261 Therefore, the Commission cannot conclude that the surveillance-sharing agreement between BZX and the Gemini Exchange, even in combination with the other means of detecting and deterring 256 See supra notes 237–248 and accompanying text. 257 See also supra note 239 and accompanying sradovich on DSK3GMQ082PROD with NOTICES text. 258 Registration Statement, supra note 22, at 62. Additionally, while the Overdahl Letter asserts that, between September 21, 2016, and March 1, 2017, the Gemini Exchange accounted for 7.35% of the global USD-denominated bitcoin market, which does not include trading in bitcoin against other fiat currencies, see supra note 246 and accompanying text, the Overdahl Letter does not explain why the bitcoin-USD market—a subset of the global bitcoin market—is the appropriate measure when Authorized Participants in the Trust would be able to source their bitcoins through any market or OTC transaction. 259 See supra note 165 and accompanying text. 260 See supra note 248 and accompanying text. 261 See also infra notes 263–268, 270 and accompanying text (summarizing commenters’ views that most bitcoin trading volume occurs outside the U.S. on unregulated exchanges). VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 fraud and manipulation discussed above,262 is sufficient to find that the proposal is consistent with Exchange Act Section 6(b)(5). 2. Other Bitcoin Spot Markets (a) Summary of Comments Received Several comment letters state that the majority of bitcoin trading occurs on exchanges outside the United States. One commenter claims that most daily trading volume is conducted on poorly capitalized, unregulated exchanges located outside the United States and that these non-U.S. exchanges and their practices significantly influence the price discovery process.263 Another commenter states that the biggest and most influential bitcoin exchange is located outside U.S. jurisdiction.264 One commenter states that, since 2013, the price of bitcoin has been defined mostly by the major Chinese exchanges, whose volumes dwarf those of exchanges outside China. According to the commenter, the Chinese exchanges are not regulated or audited and are suspected of engaging in unethical practices such as frontrunning, wash trades, and trading with insufficient funds. The commenter interprets pricing data from these Chinese exchanges to mean that the price of bitcoin is defined entirely by speculation, without any ties to fundamentals.265 One commenter claims that a sizeable number of traders and owners of bitcoin do not desire to trade in a well-regulated environment for reasons including tax evasion, evading capital controls, and money laundering. This commenter also states that U.S. bitcoin exchanges do not offer products such as fee-free trading, margin trading, or options, which drive traffic to the top non-U.S. exchanges. This commenter also claims that several Chinese exchanges actively engage in bitcoin mining operations, creating a conflict of interest, and notes that these exchanges are unaudited and unaccountable.266 One commenter observes that Chinese markets drive much of the volume in the bitcoin markets.267Another commenter also claims that the Chinese exchanges that account for the bulk of trading are subject to little regulatory oversight and that existing know-yourcustomer or identity-verification Section III.C.2, supra. Williams Letter, supra note 35, at 2. 264 See Anonymous Letter V, supra note 35. 265 See Stolfi Letter II, supra note 35. 266 See Maher Letter, supra note 35; see also Johnson Letter, supra note 35; Anonymous Letter V, supra note 35. 267 See ARK Letter, supra note 35, at 5. PO 00000 262 See 263 See Frm 00140 Fmt 4703 Sfmt 4703 measures are lax and can be easily bypassed.268 One commenter asserts that bitcoin is more transparent than the illiquid or opaque underlying assets of some other exchange-traded funds, because a large percentage of bitcoin transactions take place on electronic exchanges with actionable quotes and relatively tight bid/ask spreads and because transferring actual bitcoin between accounts at exchanges and other storage systems is also a transparent process, as transactions are printed using blockchain technology.269 BZX concedes in a comment letter that only a minority of the global spot bitcoin exchanges are subject to any regulatory regime.270 BZX also argues that, as the bitcoin exchange market has matured, a number of new entrants, including two New York limitedpurpose trust companies, have emerged and that these new entrants have markedly changed the onceconcentrated and non-regulated landscape of the bitcoin exchange market.271 BZX and the Overdahl Letter note that the CFTC has designated bitcoin as a commodity and assert that the CFTC is ‘‘broadly responsible for the integrity’’ of bitcoin spot markets.272 BZX acknowledges that the CFTC had not yet (as of the date of BZX’s submissions) brought any enforcement actions based on the anti-manipulation provisions of the Commodity Exchange Act,273 but notes that the CFTC has issued orders against U.S. and non-U.S. bitcoin exchanges for engaging in other activity prohibited by the Commodity Exchange Act and argues that, therefore, a regulatory framework for providing oversight and deterring market manipulation currently exists in the U.S.274 The Overdahl Letter asserts that any market can potentially be manipulated and states that this manipulation risk is 268 See Maher Letter, supra note 35. C&C Letter, supra note 36, at 2. 270 See BZX Letter I, supra note 35, at 2–3 (noting that only a minority of global bitcoin exchanges are fully regulated for their fiduciary and custodial activities, and naming Gemini Trust Company LLC and itBit Trust Company LLC as the only two exchange operators that are subject to substantive regulation, each overseen by the NYSDFS). 271 See BZX Letter II, supra note 13, at 15; see also Petition for Review, supra note 4, at 15. 272 See BZX Letter I, supra note 35, at 3; BZX Letter II, supra note 13, at 17; Overdahl Letter, supra note 36, at 2. 273 See BZX Letter I, supra note 35, at 3. The Commission notes that the CFTC has since obtained a federal court injunction against fraudulent activity related to ‘‘virtual currency.’’ See CFTC v. McDonnell, 287 F. Supp. 3d 213 (E.D.N.Y. 2018). 274 See BZX Letter I, supra note 35, at 3; BZX Letter II, supra note 13, at 18. 269 See E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices why the CFTC and the Commission have anti-manipulation authority.275 The Overdahl Letter also asserts that a host of other jurisdictions, including the U.K., Australia, Hong Kong, Singapore, Indonesia, and Thailand, have established some form of ‘‘regulatory sandbox’’ for blockchain, the technology that underlies bitcoin. The Overdahl Letter further asserts that, in March 2016, the Japanese cabinet approved bills treating bitcoin and other digital currencies as forms of money and that, in April 2017, Japan’s parliament recognized bitcoin as an authorized method of payment. The Overdahl Letter claims that Japan regulates bitcoin as a form of prepaid payment and is approving regulated virtualcurrency exchanges on which the Japanese regulator imposes capital, audit, and anti-money-laundering, and know-your-customer requirements. The Overdahl Letter concludes that, therefore, aside from the CFTC, another competent regulator with whom the Commission has a memorandum of understanding maintains a regulated bitcoin market.276 (b) Discussion Based on the record before it, the Commission concludes that BZX has not shown that any of the current trading venues in the worldwide bitcoin spot market is a regulated market. With respect to spot bitcoin trading outside the United States, BZX and commenters agree that the bulk of bitcoin trading has occurred in non-U.S. markets where there is little to no regulation governing trading,277 and thus no sufficient and verifiable governmental market oversight designed to detect and deter fraudulent and manipulative activity.278 And because no bitcoin spot market is currently a member of the Intermarket Surveillance Group, BZX is unable to use its membership in the Intermarket Surveillance Group to share surveillance information with those 275 See Overdahl Letter, supra note 36, at 2, 9– 10. 276 See id. at 12–13. supra notes 263–268, 270 and accompanying text. The Commission also notes more recent reporting that a large portion of bitcoin trading volume continues to take place overseas, see, e.g., Russo, et al., This Is Where People Are Buying Bitcoin All Over the World (Jan. 11, 2018), https://www.bloomberg.com/graphics/2017-bitcoinvolume/, although such reports are unnecessary to the Commission’s finding, based on the record before it, that BZX has not shown that any of the current trading venues in the worldwide bitcoin spot market is a regulated market. 278 See supra notes 263–268 and accompanying text. sradovich on DSK3GMQ082PROD with NOTICES 277 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 markets.279 Further, as noted above,280 the Bitcoin blockchain, while freely available to the public, identifies parties to a transaction only by a pseudonymous public-key address, and it does not distinguish bitcoin trading activity from other transfers of bitcoin, limiting its usefulness as a substitute for a surveillance-sharing agreement. One commenter asserts that substantial trading volume has recently migrated away from Chinese exchanges in response to regulatory efforts by the Chinese government. But, according to statistics provided by other commenters,281 a substantial majority of bitcoin trading continues to occur overseas,282 and BZX concedes in a comment letter that only a minority of the global spot bitcoin exchanges are subject to any regulatory regime.283 Moreover, the Registration Statement for the Winklevoss Bitcoin Trust states: The Bitcoin Exchanges on which bitcoin trades are new and, in most cases, largely unregulated. Furthermore, many Bitcoin Exchanges (including several of the most prominent U.S. Dollar-denominated Bitcoin Exchanges) do not provide the public with significant information regarding their ownership structure, management teams, corporate practices or regulatory compliance.284 Nor does the CFTC’s oversight of bitcoin-derivative trading venues indicate that the CFTC is, as BZX and the Overdahl Letter argue, ‘‘broadly responsible for the integrity of the bitcoin spot market’’ or that the CFTC’s enforcement powers with respect to spot trading mean that a ‘‘regulatory framework for providing oversight and deterring market manipulation currently exists in the United States.’’ 285 Spot bitcoin markets are not required to register with the CFTC, unless they offer leveraged, margined, or financed trading to retail customers.286 In all other cases, 279 See https://www.isgportal.org/isgPortal/ public/members.htm (listing the current members and affiliate members of the Intermarket Surveillance Group). 280 See Section III.C.2, supra. 281 See supra notes 243–244 and accompanying text. 282 See, supra notes 244, 264–265, 267 and accompanying text. 283 See supra note 270 and accompanying text. While BZX asserts that the Gemini Exchange is a regulated market, as discussed above, the Commission does not agree with that assessment. See Section III.E.1(b), supra. 284 Registration Statement, supra note 22, at 22. 285 See supra notes 272–274 and accompanying text. 286 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)(i), 7 U.S.C. 2(c)(2)(A)(i) (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 PO 00000 Frm 00141 Fmt 4703 Sfmt 4703 37599 including the Gemini Exchange, the CFTC does not set standards for, approve the rules of, examine, or otherwise regulate bitcoin spot markets.287 As the CFTC itself has stated, while the CFTC ‘‘has an important role to play,’’ U.S. law ‘‘does not provide for direct, comprehensive Federal oversight of underlying Bitcoin or virtual currency spot markets.’’ 288 Additionally, establishment by foreign regulators of what one commenter called ‘‘regulatory sandboxes’’ for blockchain technology,289 or the regulation of bitcoin as a method of prepaid payment by others,290 is not a sufficient basis for concluding that bitcoin trades worldwide on regulated markets with which the listing exchange can enter into a surveillance-sharing agreement. There is no evidence in the record before the Commission that any ‘‘regulatory sandbox,’’ however defined, has created a comprehensive regulatory regime for bitcoin trading venues, and, as explained in greater detail above in the context of the Gemini Exchange,291 a ‘‘regulated’’ market means a market that can detect and prevent fraud and manipulation under Exchange Act Section 6(b)(5). 3. The Derivatives Markets (a) Summary of Comments Received One commenter claims that the bitcoin markets are not yet efficient and attributes this inefficiency, in part, to the nascent state of the bitcoin derivatives market. This commenter states that derivatives provide investors more ways to hedge against bitcoin’s potential price movements, introduce more volume and liquidity, and generally give the markets more points of information about bitcoin’s future prospects, leading to tighter bid/ask spreads. The commenter claims that security or a group or index of securities), that is executed or traded on an organized exchange). 287 The Gemini Exchange is not registered with the CFTC. 288 CFTC Backgrounder, supra note 118, at 1. The Commission also notes the testimony of CFTC Chairman Giancarlo before the Senate Banking Committee that ‘‘the CFTC does not have authority to conduct regulatory oversight over spot virtual currency platforms or other cash commodities, including imposing registration requirements, surveillance and monitoring, transaction reporting, compliance with personnel conduct standards, customer education, capital adequacy, trading system safeguards, cyber security examinations or other requirements.’’ Giancarlo Testimony, supra note 117, Section I (CFTC Authority and Oversight Over Virtual Currencies). See also Section III.B.1(b)(iii), supra (discussing CFTC statutory authority over bitcoin derivatives products). 289 See supra note 276 and accompanying text. 290 Id. 291 See Section III.E.1(b), supra. E:\FR\FM\01AUN1.SGM 01AUN1 37600 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices most derivatives activity within the bitcoin markets is offered by entities outside of the purview of U.S. regulators.292 The commenter observes that the lack of a robust and regulated derivatives market means that market participants do not have a broad basket of tools at their disposal, making hedging difficult and keeping away many market makers that provide significant liquidity to traditional capital markets. The commenter claims that, while derivative products may be in development, a full suite of investor tools that will drive market efficiency and eliminate price disparities is likely at least a couple of years away.293 The commenter also states that, without a robust derivatives market for institutional investors to short the underlying asset or otherwise hedge their positions, there likely would be little counterbalance to the new demand generated by the ETP, and Authorized Participants could then have trouble sourcing bitcoin and hedging their positions, stalling the creation process.294 The commenter concludes that it would be premature to launch a bitcoin ETP because bitcoin markets are not liquid enough to support an openend fund and because an ecosystem of institutional-grade infrastructure players is not yet available to support such a product.295 One commenter disagrees with assertions linking inefficient bitcoin markets to nascent derivatives markets, stating that no evidence has been provided regarding the would-be effect of derivatives on the bitcoin market. The commenter claims that these assertions assume that bitcoin pricing is inefficient, which the commenter claims is not the case. The commenter also claims that these assertions assume that the lack of a derivatives market causes pricing to be inefficient, stating instead that there is direct evidence that many securities trade successfully and efficiently on U.S. and non-U.S. exchanges despite not having a direct derivatives market.296 The commenter also disagrees with the claim that, 292 See ARK Letter, supra note 35, at 5–6. id. at 6. This commenter also states that, within the United States, one market offers bitcoin forwards and no one currently offers regulated bitcoin futures or options, see id., but, as discussed below, see infra notes 310–311 and accompanying text, futures on bitcoin have begun trading on regulated U.S. designated contract markets. 294 See ARK Letter, supra note 35, at 13–14. 295 See id. at 2. 296 See Anonymous Letter IV, supra note 35. Several commenters also assert that regulation by BZX of activity in the ETP could substitute for a lack of regulation in underlying or derivatives markets. See, e.g., Baird Letter, supra note 35; Keeler Letter, supra note 35; Marchionne Letter, supra note 35; Bang Letter, supra note 35. sradovich on DSK3GMQ082PROD with NOTICES 293 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 absent a robust derivatives market, there would be little counterbalance to the new demand generated by the ETP, stating that it is impossible to predict the success or failure of the ETP. The commenter states that Authorized Participants may be able to source bitcoin from China.297 Another commenter claims that there are several bitcoin futures markets that have a significant impact on the spot price along with several OTC markets— such as the one that this commenter claims was recently launched by the Gemini Exchange—that also offer liquidity.298 The Lewis Letter 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 be useful to Authorized Participants and market makers who would like to use derivatives to hedge exposures.299 The Lewis Letter claims that, for physical commodities that are not traded on exchanges, the presence of a liquid derivatives market is a necessary condition, but claims that for digital assets like bitcoin, derivatives markets are not necessary because price discovery occurs on the OTC market and exchanges instead.300 (b) Discussion One commenter and the Lewis Letter assert that the existence of bitcoin derivative markets is not a necessary condition for a bitcoin ETP.301 The key standard the Commission is applying here, however, is not that a futures or derivatives market is required for every commodity-trust ETP, but that—when the spot market is unregulated—the requirement of preventing fraudulent and manipulative acts may possibly be satisfied by showing that the ETP listing market has entered into a surveillancesharing agreement with a regulated market of significant size in derivatives related to the underlying asset. That is because, where a market of significant size exists with respect to derivatives on the asset underlying a commodity-trust ETP, the Commission believes that there is a reasonable likelihood that a person attempting to manipulate the ETP by manipulating the underlying spot market would also have to trade in the Anonymous Letter IV, supra note 35. Dylan Letter, supra note 35, at 1. 299 See Lewis Letter I, supra note 65, at 8. 300 See id. at 8. 301 See supra note 296 and accompanying text; Lewis Letter I, supra note 65, at 8. PO 00000 297 See 298 See Frm 00142 Fmt 4703 Sfmt 4703 derivatives market in order to succeed, since arbitrage between the derivative and spot markets would tend to counter an attempt to manipulate the spot market alone.302 Thus, the Commission believes that there is a reasonable likelihood that a surveillance-sharing agreement with that derivatives market would assist the ETP listing market in detecting and deterring an attempt to manipulate the commodity-trust ETP. As noted above, the commodity-trust ETPs previously approved by the Commission have had—in lieu of regulated spot markets of significant size—a regulated futures market of significant size associated with the underlying commodity, and the listing exchange had entered into a surveillance-sharing agreement with that futures market or was able to obtain surveillance information through membership in the Intermarket Surveillance Group.303 Based on the record before it, the Commission cannot conclude that a regulated bitcoin futures market of significant size currently exists because, similar to the Gemini Exchange, there is no evidence in the record that there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on the bitcoin futures market, or any record evidence addressing how trading in the proposed ETP would or would not influence prices in the futures bitcoin market. Consistent with the view of commenters summarized above, BZX’s proposal describes the current derivative markets for bitcoin as ‘‘[n]ascent.’’ 304 BZX notes that certain types of options, futures, contracts for differences, and other derivative instruments are available in certain jurisdictions, but that many of them are not available in the United States and that these derivatives instruments are generally not regulated ‘‘to the degree that U.S. investors expect derivatives instruments to be regulated.’’ 305 BZX notes that the CFTC has approved the registration of TeraExchange LLC as a swap execution facility (‘‘SEF’’) and that, on October 9, 2014, TeraExchange announced that it had hosted the first executed bitcoin swap traded on a CFTC-regulated platform.306 Further, 302 See also Section III.D.2(a), supra (discussion of Commission interpretation of the terms ‘‘significant market’’ and ‘‘market of significant size’’). 303 See supra note 209 and accompanying text. 304 See Amendment No. 1, supra note 1, 81 FR at 76661. 305 See id. 306 See id.; see also ARK Letter, supra note 35, at 6 (noting that TeraExchange offers bitcoin forwards). E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES BZX’s proposal notes that, in 2015, CFTC temporarily registered another SEF that would trade swaps on bitcoin.307 The Commission acknowledges that TeraExchange, a market for swaps on bitcoin, has registered with the CFTC, but BZX’s description of trading activity on that market fails to note that the very activity it cites was the subject of an enforcement action by the CFTC. The CFTC found that TeraExchange had improperly arranged for participants to make prearranged, offsetting ‘‘wash’’ transactions of the same price, notional amount, and time period and had then issued a press release ‘‘to create the impression of actual trading in the Bitcoin swap.’’ 308 Neither BZX nor any commenter provides evidence of meaningful trading volume in bitcoin derivatives on any regulated marketplace. The CFTC has also registered LedgerX, a venue for trading bitcoin derivatives, as a SEF and a Derivatives Clearing Organization.309 Additionally, on December 1, 2017, the CFE and the CME self-certified new contracts with the CFTC for bitcoin futures contracts.310 CFE launched trading in its bitcoin futures contracts on December 10, 2017, and CME launched trading in its bitcoin futures contracts on December 17, 2017 (for a trade date of December 18, 2017).311 The record before the Commission, however, does not establish that the bitcoin derivatives markets are regulated markets of significant size. The record also does not establish how these markets may influence the price of any ETP based on bitcoin or how the existence of ETPs based on bitcoin may 307 See Amendment No. 1, supra note 1, 81 FR at 76661 (referring to Ledger X LLC). 308 See TeraExchange Settlement Order, supra note 93. 309 See Order of Registration in the Matter of the Application of LedgerX LLC for Registration as a Swap Execution Facility (CFTC July 6, 2017), available at https://www.cftc.gov/idc/groups/public/ @otherif/documents/ifdocs/ orgledgerxord170706.pdf; Order of Registration in the Matter of the Application of LedgerX, LLC for Registration as a Derivatives Clearing Organization (CFTC July 24, 2017), available at https:// www.cftc.gov/idc/groups/public/@otherif/ documents/ifdocs/ledgerxdcoregorder72417.pdf. 310 See Letter from Andrew Lowenthal, Senior Managing Director, CFE to Christopher J. Kirkpatrick, Secretary, CFTC (Dec. 1, 2017), available at https://www.cftc.gov/filings/ptc/ ptc120117cfedcm001.pdf; Letter from Christopher Bowen, Managing Director and Chief Regulatory Counsel, CME Group to Christopher J. Kirkpatrick, Office of the Secretariat, CFTC (Dec. 1, 2017), available at https://www.cftc.gov/filings/ptc/ ptc120117cmedcm001.pdf. 311 The Commission notes that the Cantor Exchange has also self-certified bitcoin binary options, see CFTC Backgrounder, supra note 118, at 2, but this product has not yet begun to trade. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 affect these markets. Publicly available data show that the median daily notional trading volume, from inception through April 24, 2018, has been 9,180 bitcoins on CME and 5,440 bitcoins on CFE, and that the median daily notional value of open interest on CME and CFE during the same period has been 7,875 bitcoins and 5,787 bitcoins, respectively.312 For all bitcoin contracts traded on LedgerX from inception through April 24, 2018, publicly available data show that the median daily notional volume has been 55 bitcoins and that the median daily notional value of open interest has been 663 bitcoins.313 But while these futures and derivative contract figures are readily available, meaningful analysis of the size of the CME, CFE, and LedgerX markets relative to the underlying bitcoin spot market is challenging, because reliable data about the spot market, including its overall size, are unavailable.314 The Commission notes that in recent testimony CFTC Chairman Giancarlo characterized the volume of the bitcoin futures markets as ‘‘quite small.’’ 315 The Commission also notes that the President and COO of Cboe recently acknowledged in a letter to the Commission staff that ‘‘the current bitcoin futures trading volumes on Cboe Futures Exchange and CME may not currently be sufficient to support ETPs seeking 100% long or short exposure to bitcoin.’’ 316 These statements reinforce the Commission’s conclusion that there is insufficient evidence to determine that the bitcoin derivatives markets are significant. Thus, while LedgerX, CME, and CFE are regulated markets for bitcoin derivatives, there is no basis in the record for the Commission to conclude 312 These futures volume figures were calculated by Commission staff using data published by CME and CFE on their websites. 313 These derivative contract volume figures were calculated by Commission staff using data published by LedgerX on its website. 314 See Section III.B.1(b)(i), supra. 315 CFTC Chairman Giancarlo testified: ‘‘It is important to put the new Bitcoin futures market in perspective. It is quite small with open interest at the CME of 6,695 bitcoin and at Cboe Futures Exchange (Cboe) of 5,569 bitcoin (as of Feb. 2, 2018). At a price of approximately $7,700 per Bitcoin, this represents a notional amount of about $94 million. In comparison, the notional amount of the open interest in CME’s WTI crude oil futures was more than one thousand times greater, about $170 billion (2,600,000 contracts) as of Feb[.] 2, 2018 and the notional amount represented by the open interest of Comex gold futures was about $74 billion (549,000 contracts).’’ Giancarlo Testimony, supra note 117, text accompanying nn.14–15. 316 Letter from Chris Concannon, President and COO, Cboe Global Markets, to Dalia Blass, Director, Division of Investment Management, Commission, at 5 (Mar. 23, 2018), available at https:// www.sec.gov/divisions/investment/cboe-globalmarkets-innovation-cryptocurrency.pdf. PO 00000 Frm 00143 Fmt 4703 Sfmt 4703 37601 that these markets are of significant size. Additionally, because bitcoin futures have been trading on CME and CFE only since December 2017, the Commission has no basis on which to predict how these markets may grow or develop over time, or whether or when they may reach significant size. Although BZX has not demonstrated that a regulated bitcoin futures market of significant size currently exists, the Commission is not suggesting that the development of such a market would automatically require approval of a proposed rule change seeking to list and trade shares of an ETP holding bitcoins as an asset. The Commission would need to analyze the facts and circumstances of any particular proposal and examine whether any unique features of a bitcoin futures market would warrant further analysis before approval. F. The Protection of Investors and the Public Interest BZX contends that, if approved, its ETP would protect investors and promote the public interest, but the Commission finds that BZX has not made such a showing on the current record. The Commission must consider any potential benefits in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act. And because BZX has not demonstrated that its proposed rule change is designed to prevent fraudulent and manipulative acts and practices, the Commission must disapprove the proposal. 1. Summary of Comments Received Several commenters asserted that access to bitcoin through an ETP would extend regulatory protections to investors. One commenter asserts that, if the U.S. were to approve an ETP and bring regulatory standards and oversight to cryptocurrencies, investors would not see major problems as they did with the Bitfinex and Mt. Gox hacks and that, if the ETP were not approved, investors would be forced to use those less-thanideal exchanges.317 One commenter asserts that the alternative to a regulated ETP is investors having to purchase 317 See Baird Letter, supra note 35. Bitfinex and Mt. Gox are bitcoin trading venues that have reportedly suffered significant losses from hacking. See Nathaniel Popper and Rachel Abrams, Apparent Theft at Mt. Gox Shakes Bitcoin World, The New York Times (Feb. 25, 2014), available at https://www.nytimes.com/2014/02/25/business/ apparent-theft-at-mt-gox-shakes-bitcoin-world.html; Amie Tsang, Bitcoin Plunges After Hacking of Exchange in Hong Kong, The New York Times (Aug. 3, 2016), available at https:// www.nytimes.com/2016/08/04/business/dealbook/ bitcoin-bitfinex-hacked.html. E:\FR\FM\01AUN1.SGM 01AUN1 37602 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES bitcoin at unregulated exchanges lacking SEC oversight.318 One commenter asserts that disapproval of the ETP would create a more risky environment for investors, who will not have the option of investing through regulated exchanges.319 One commenter argues that, because of the use of an auction process to determine NAV, the use of well-known and respected Authorized Participants, and the environment that allows market participants to use arbitrage techniques to hold pricing where it should be, the risk to investors who invest in the ETP may be lower than the risk borne by those who buy or sell bitcoin directly.320 And another commenter asserts that, with innovative use cases emerging for bitcoin and for the associated technology of blockchain each passing day, investors seeking exposure to bitcoin should have options similar to those currently available for physical bullion.321 BZX argues that the Shares would significantly reduce or eliminate costs and inefficiencies and would expand opportunities for investors by providing an inexpensive vehicle to gain exposure to bitcoin in a secure and easily accessible product that is familiar, transparent, and meaningfully regulated.322 BZX asserts that, for prospective investors in bitcoin, direct investment brings with it significant inconvenience, complexity, expense, and risk. As investor demand for exposure to bitcoin continues to increase, BZX asserts, these problems grow larger. BZX argues that the Shares would significantly reduce or completely remove each of these hurdles.323 BZX also argues that Commission should approve the proposal because Commission oversight of the trading of the ETP shares on a national securities exchange would enhance the transparency of the underlying bitcoin markets.324 BZX also asserts that the Gemini Exchange is uniquely positioned, because of its regulatory status and licensing, to be a venue on which traditional financial institutions will be comfortable transacting in bitcoin, and BZX posits that these financial institutions provide a bridge to the equities markets and other capital markets, improving price 318 See Keeler Letter, supra note 35. Bang Letter, supra note 35. 320 See Convergex Letter, supra note 36, at 2. 321 See Virtu Letter, supra note 36, at 2. 322 See BZX Letter II, supra note 13, at 8. 323 See id. at 3, 8. 324 See id. at 17; Petition for Review, supra note 4, at 16; Overdahl Letter, supra note 36, at 13; Virtu Letter, supra note 36, at 2. 319 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 discovery, liquidity, and transparency.325 The Overdahl Letter asserts that the approval of the proposed bitcoin ETP would facilitate a cost-effective and convenient means for investors to gain exposure to bitcoin similar to a direct investment in bitcoin, improving portfolio diversification opportunities for investors, and would help make bitcoin markets more transparent.326 The Overdahl Letter also argues that a bitcoin ETP will protect current investors in bitcoin by providing regulatory certainty.327 The Overdahl Letter predicts that the availability of a bitcoin ETP would help attract professional market makers to the spot market, as well as the market for bitcoin ETPs, and that the presence of these professional market makers would add to the resilience of the spot price on the exchange, improve liquidity and other measures of market quality, and promote trading volume at the exchange.328 The Lewis Letter asserts that bitcoin is relatively uncorrelated with other assets, enabling investors to construct more efficient portfolios.329 BZX and the Lewis Letter also assert that listing the shares on a national securities exchange and a shift from OTC trading to trading on exchanges would make the overall bitcoin market more transparent.330 Similarly, one commenter asserts that trading in the Shares and the adoption of best practices, such as IIV and NAV dissemination, will enhance the resiliency and efficiency of the market for bitcoin.331 One commenter believes that lack of regulation and consumer protection also increases the chance and incentives for market price manipulation and states that approving the ETP before structural protections and controls are firmly in place would put investors at undue risk.332 This commenter asserts that several fundamental flaws make bitcoin a dangerous asset class to force into an exchange-traded structure, including shallow trade volume, extreme hoarding, low liquidity, hyper price volatility, a global web of unregulated bucket-shop exchanges, high bankruptcy risk, and oversized exposure BZX Letter II, supra note 13, at 20–21. Overdahl Letter, supra note 36, at 13. 327 See Overdahl Letter, supra note 36, at 13. 328 See Overdahl Letter, supra note 36, at 3, 8. 329 See Lewis Letter I, supra note 65, at 11–16. 330 See id. at 7. See also Petition for Review, supra note 4, at 16. 331 See Virtu Letter, supra note 36, at 2. 332 See Williams Letter, supra note 35, at 2–3. PO 00000 325 See 326 See Frm 00144 Fmt 4703 Sfmt 4703 to trading in countries where there is no regulatory oversight.333 2. Discussion BZX, the Overdahl Letter, and other commenters assert that investment in bitcoin through a ETP would reduce the expense, complexity, and risk of bitcoin exposure.334 BZX, the Overdahl Letter, and the Lewis Letter further assert that approval of the Winklevoss Bitcoin Trust would make bitcoin markets more transparent,335 and the Overdahl Letter argues that approval of the proposal would protect investors by providing regulatory certainty.336 Additionally, the Overdahl Letter and Lewis Letter argue that approval of the proposal would improve the availability of investment and portfolio diversification opportunities for investors.337 The Commission acknowledges that each of these is a potential benefit of a bitcoin ETP. The Commission, however, must consider these potential benefits in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act. Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must disapprove a proposed rule change filed by a national securities exchange if it does not find 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.338 Thus, even if a proposed rule change would provide certain benefits to investors and the markets, the proposed rule change may still fail to meet other requirements under the Exchange Act.339 For the reasons discussed above, BZX has not met its burden of demonstrating an adequate basis in the record for the Commission to find that the proposal is consistent with 333 See id. at 1. Section III.F.1, supra. 335 See supra notes 324–326, 330 and accompanying text. 336 See supra note 327 and accompanying text. 337 See supra notes 326, 329 and accompanying text. 338 See Exchange Act Section 19(b)(2)(C), 15 U.S.C. 78s(b)(2)(C). 339 The Commission also notes that, according to the Trust’s Registration Statement, investors in the Trust would still be subject to some of the risks of holding bitcoin directly. See Registration Statement, supra note 22, at 29 (‘‘Security breaches, ‘cyber attacks,’ computer malware and computer hacking attacks have been a prevalent concern in the Bitcoin Exchange Market since the launch of the Bitcoin Network. Any cyber security breach caused by hacking . . . could harm the Trust’s business operations or result in loss of the Trust’s assets.’’). 334 See E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices Exchange Act Section 6(b)(5),340 and, accordingly, the Commission must disapprove the proposal. sradovich on DSK3GMQ082PROD with NOTICES G. Additional Factors Supporting Disapproval As addressed in detail above, the Commission is disapproving the proposed rule change because BZX has not met its burden to demonstrate that its proposal is consistent with Exchange Act Section 6(b)(5). BZX has neither entered into surveillance-sharing agreements with regulated, bitcoinrelated markets of significant size nor demonstrated that alternative means of compliance with Exchange Act Section 6(b)(5) would be sufficient. Because BZX has failed to carry its burden, the proposed rule change must be disapproved. The Commission also notes several inconsistencies between the BZX’s proposed rule change and the Trust’s Registration Statement that reinforce the need to disapprove BZX’s proposal. For example, in its proposal, BZX points to the following factors that, in its view, weigh in favor of approval. Those factors include ‘‘the liquidity of the market in the underlying commodity,’’ ‘‘the trading volume in derivatives based on the underlying commodity,’’ ‘‘listing exchange rules and procedures prohibiting use of material nonpublic information,’’ and ‘‘listing exchange rules regarding trading halts.’’ 341 But those factors cannot be reconciled with BZX’s current proposal and thus provide independent confirmation that the proposed rule change must be disapproved. Liquidity of bitcoin markets. The Trust’s Registration Statement concedes that underlying bitcoin markets are insufficiently liquid to protect against credible threats to those markets’ integrity. The Trust’s Registration Statement, for example, acknowledges that ‘‘operational interruption’’ in large bitcoin exchanges ‘‘may limit the liquidity of bitcoin’’ and ‘‘result in volatile prices and a reduction in confidence’’ and that ‘‘[t]rading on a single Bitcoin Exchange may result in less favorable prices and decreased liquidity.’’ 342 The Trust’s characterizations of the bitcoin markets contrast with, for example, the over-thecounter gold market, which the Commission noted had ‘‘unique liquidity and depth.’’ 343 This factor accordingly weighs against approval of the proposed rule change. Trading volume in derivatives based on the underlying commodity. The Trust’s Registration Statement recognizes that bitcoin derivatives markets are nascent and insufficiently developed in regulated marketplaces to serve meaningful purposes such as, for example, providing investors with credible information regarding bitcoin’s future prospects.344 As the Trust’s Registration Statement acknowledges, ‘‘[a] limited market currently exists for bitcoin-based derivatives.’’ 345 As explained above, the market for bitcoinbased derivatives is not yet well developed.346 That differs, for example, from platinum and palladium markets, where futures products on those metals had been trading for several decades before commodity-trust ETPs were launched, and where the Commission has noted that exchanges are able to adequately ‘‘obtain information regarding trading’’ in regulated derivatives. This factor accordingly weighs against approval of the proposed rule change. Listing exchange rules and procedures prohibiting use of material nonpublic information. Regardless of BZX’s rules and procedures regarding insider trading, many underlying bitcoin markets are, at present, opaque.347 According to the Trust’s Registration Statement, for example, ‘‘[m]any Bitcoin Exchanges do not provide the public with significant information regarding their ownership structure, management teams, corporate practices or regulatory compliance.’’ 348 The Trust itself thus recognizes that there is a significant risk that material nonpublic information may be used in a manner that could affect bitcoin prices and, in turn, any ETP using bitcoin as an underlying asset. This factor weighs against approval of the proposed rule change. Listing exchange rules regarding trading halts. Regardless of BZX’s rules regarding trading halts, BZX has not explained how it will respond to disruptions in trading in underlying bitcoin markets.349 The Trust’s Registration Statement acknowledges the unusual and severe nature of such trading halts in bitcoin, noting that ‘‘[e]ven the largest Bitcoin Exchanges have been subject to operational interruption (e.g., the temporary shutdown of Mt. Gox due to distributed 340 15 344 See 341 Petition 345 Registration U.S.C. 78f(b)(5). for Review, supra note 4, at 6–7 & n.17; see also BZX Letter II, supra note 13, at 22– 25. 342 Registration Statement, supra note 22, at 22. 343 Gold Order, supra note 197, 69 FR at 64619. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 PO 00000 Section III.E.3(a), supra. Statement, supra note 22, at 59. 346 See Section III.E.3(b), supra. 347 See Section III.B.1, supra. 348 Registration Statement, supra note 22, at 61. 349 See Section II, supra. Frm 00145 Fmt 4703 Sfmt 4703 37603 denial of service attacks (‘DDoS’) attacks by hackers and/or malware, and its permanent closure in February 2014).’’ 350 Moreover, as one commenter noted, the Gemini Auction has failed on at least two occasions.351 Such trading halts could result in volatile prices and reduced confidence in any ETP that uses bitcoin as an underlying asset. Accordingly, this factor weighs against approval of the proposed rule change. H. Other Comments Comment letters also addressed the following topics: 352 • The nature and uses of bitcoin; 353 • the state of development of bitcoin as a digital asset; 354 • the use of bitcoin for illegal activities; 355 • the inherent value of, and risks of investing in, bitcoin; 356 • the cost of electricity required to maintain the Bitcoin network; 357 • the desire of investors to gain access to bitcoin through an ETP; 358 350 Registration Statement, supra note 22, at 22. supra note 148 and accompanying text. 352 The Commission also received comments expressing support for the proposal, without articulating any argument in favor of the proposal. See Barraza Letter, supra note 35; Shad Letter, supra note 35. 353 See Stolfi Letter I, supra note 35; Stolfi Letter II, supra note 35; Chronakis Letter, supra note 35; Anonymous Letter VII, supra note 35. 354 See Stolfi Letter II, supra note 35; Barish Letter IV, supra note 35; ARK Letter, supra note 35; Lee Letter, supra note 35; Chronakis Letter, supra note 35; Struna Letter, supra note 35; Johnson Letter, supra note 35; Anonymous Letter V, supra note 35; Whitman Letter, supra note 35; Anonymous Letter VI, supra note 35; Barish Letter II, supra note 35; Ackerman Letter, supra note 35; Medina Letter, supra note 35; Paslaqua Letter, supra note 35; BZX Letter II, supra note 13, at 7–8. 355 See Xin Lu Letter, supra note 35; Anonymous Letter VI, supra note 35; Harris Letter, supra note 36, at 2. 356 See Stolfi Letter I, supra note 35; Stolfi Letter II, supra note 35; Shatto Letter, supra note 35; Lethuillier Letter, supra note 35; Delehanty Letter, supra note 35; Xin Lu Letter, supra note 35; Neidhardt Letter, supra note 35; XBT Letter, supra note 35; Williams Letter, supra note 35; ARK Letter, supra note 35; Kim Letter, supra note 35; Dalla Val Letter, supra note 35; Paneque Letter, supra note 35; Lee Letter, supra note 35; Chronakis Letter, supra note 35; Struna Letter, supra note 35; Johnson Letter, supra note 35; Whitman Letter, supra note 35; Primm Letter; supra note 35; Anonymous Letter VI, supra note 35; Barish Letter III, supra note 35; Barish Letter V, supra note 35; Anonymous Letter VII, supra note 35; Ackerman Letter, supra note 35; Paslaqua Letter, supra note 35; Harris Letter, supra note 36, at 2. 357 See Harris Letter, supra note 36, at 2. 358 See R.D. Miller Letter, supra note 35; R. Miller Letter, supra note 35; Hall Letter, supra note 35; Keeler Letter, supra note 35; Lethuillier Letter, supra note 35, at 2; Anonymous Letter I, supra note 35; Herbert Letter, supra note 35; Fernandez Letter, supra note 35; Tomaselli Letter, supra note 35; Circle Letter, supra note 35; Baird Letter, supra note 35; Stolfi Letter I, supra note 35; Anderson Letter, supra note 35; P. Miller Letter, supra note 35; 351 See E:\FR\FM\01AUN1.SGM Continued 01AUN1 37604 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES • investor understanding about bitcoin; 359 • the appropriate measures for the Trust to secure its bitcoin holdings against theft or loss; 360 • whether the Trust should insure its bitcoin holdings against theft or loss; 361 • the adequacy of the Trust’s procedures for handling potential ‘‘forks’’ in the bitcoin blockchain; 362 • the blockchain treatment of positions in the Shares, including short positions or derivative positions; 363 • the potential conflicts of interest related to the affiliations among the Sponsor, the Custodian, and the Gemini Exchange; 364 • the legitimacy or enhanced regulatory protection that Commission approval of the proposed ETP might confer upon bitcoin as a digital asset; 365 and • the value to the Commission of enhanced oversight over bitcoin markets from approving the proposal.366 Ultimately, however, additional discussion of these tangential topics is unnecessary, as they do not bear on the Swiderski Letter, supra note 35; Situation Letter, supra note 35; Paneque Letter, supra note 35; Nootenboom Letter, supra note 35; Chronakis Letter, supra note 35; Turley Letter, supra note 35; Kemble Letter, supra note 35; BZX Letter II, supra note 13, at 3, 8. 359 See Harris Letter, supra note 36, at 1. 360 See Barish Letter I, supra note 35; Barish Letter IV, supra note 35; Neidhardt Letter, supra note 35; Dylan Letter, supra note 35; Keeler Letter, supra note 35; Casey Letter I, supra note 35; Aronesty Letter, supra note 35; ARK Letter, supra note 35, at 10–11; Tull Letter, supra note 35; Stolfi Letter I, supra note 35; Stolfi Letter II, supra note 35; Anonymous Letter I, supra note 35; Lethuillier Letter, supra note 35, at 2–3; Delehanty Letter, supra note 35; Casey Letter II, supra note 35; Anonymous Letter IV, supra note 35; BZX Letter I, supra note 35, at 3, 6–7; Struna Letter, supra note 35. 361 See Lethuillier Letter, supra note 35, at 2–3; Aronesty Letter, supra note 35; Delehanty Letter, supra note 35; XBT Letter, supra note 35; ARK Letter, supra note 35, at 10–11; Anonymous Letter IV, supra note 35; BZX Letter I, supra note 35, at 6–7. 362 See Schulte Letter, supra note 35. 363 See Anonymous Letter II, supra note 35, at 3; Tull Letter, supra note 35. 364 See XBT Letter, supra note 35; Tull Letter, supra note 35; Stolfi Letter II, supra note 35; ARK Letter, supra note 35, at 9–10; Anonymous Letter III, supra note 35; BZX Letter I, supra note 35, at 5–6; Harris Letter, supra note 36. 365 See Stolfi Letter I, supra note 35; Circle Letter, supra note 35; Kim Letter, supra note 35; Delehanty Letter, supra note 35; Baird Letter, supra note 35; Anonymous Letter II, supra note 35, at 3; Keeler Letter, supra note 35; Dalla Val Letter, supra note 35; Elron Letter, supra note 35; P. Miller Letter, supra note 35; Marchionne Letter, supra note 35; Situation Letter, supra note 35; Paneque Letter, supra note 35; Nootenboom Letter, supra note 35; Chronakis Letter, supra note 35; Johnson Letter, supra note 35; Bang Letter, supra note 35; Primm Letter, supra note 35; Christensen Letter, supra note 35; Rigsby Letter, supra note 35. 366 See Convergex Letter, supra note 36, at 2. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 basis for the Commission’s decision to disapprove BZX’s proposal.367 I. Basis for Disapproval As discussed above,368 the central factor for the Commission in its current consideration of the BZX proposal is whether it is consistent with Exchange Act Section 6(b)(5), 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.369 Although BZX argues that its proposal can satisfy these requirements because bitcoin markets are inherently difficult to manipulate,370 and because alternative means of identifying fraud and manipulation would be sufficient,371 the Commission concludes that, as discussed above, BZX has not established that these proffered means of compliance—alone or in combination—are sufficient to meet the requirements of Exchange Act Section 6(b)(5).372 Thus, the Commission believes that BZX must demonstrate with respect to this proposal that—like the listing exchanges for previously approved commodity-trust ETPs 373—it can enter into a surveillance-sharing agreement with a regulated, bitcoin-related market of significant size. As discussed above, however, BZX has not shown that it can enter into such an agreement, because the proposal does not support a conclusion that the markets for bitcoin or derivatives on bitcoin are regulated markets of significant size.374 Therefore, BZX has not met its burden to 367 The Commission also received a statement from SolidX Management LLC, asserting that ‘‘[t]o the extent the Commission is inclined to reverse, modify, set aside or remand for further proceedings the BatsBZX Proposed Rule Change, then in accordance with Rule 431 and the factors set forth in Rule 411(b)(2) of the Rules of Practice, the Commission should, as a matter of equity . . . reverse, modify, set aside or remand for further proceedings its March 28, 2017 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 (Release No. 34– 80319; File No. SR–NYSEArca-2016–101).’’ SolidX Letter, supra note 36, at 1. No timely petition to review the March 28, 2017, disapproval order has been received from any party and, under the Rule 431(c) of Commission’s Rules of Practice, the period for the Commission to order review of the issuance of that disapproval order by delegated authority ended on April 7, 2017. 368 See Section I, supra. 369 15 U.S.C. 78f(b)(5). 370 See Sections III.B.1(a) and III.B.2(a), supra. 371 See Section III.C.1, supra. 372 See Sections III.B.1(b), III.B.2(b), and III.C.2, supra. 373 See Section III.D.2, supra. 374 See Sections III.E.1(b), III.E.2(b), and III.E.3(b), supra. PO 00000 Frm 00146 Fmt 4703 Sfmt 4703 demonstrate that the proposed rule change is consistent with Exchange Act Section 6(b)(5), and, accordingly, the Commission is disapproving the proposed rule change.375 While the Commission concludes that BZX must demonstrate the ability to enter into a surveillance-sharing agreement with a regulated market of significant size related to bitcoin, and while this factor strongly supports disapproval of BZX’s proposed rule change, the other factors BZX asks the Commission to weigh 376 also support the disapproval of the proposed rule change. Even considering these other factors, the Commission does not find BZX’s proposed rule change to be consistent with Exchange Act Section 6(b)(5)’s requirement 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.’’ 377 IV. Conclusion For the reasons set forth above, the Commission does not find, pursuant to Section 19(b)(2) of the Exchange Act, 375 In disapproving the proposed rule change, as modified by Amendments No. 1 and 2, the Commission has considered its impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f); see also supra notes 322–326, 329 and accompanying text. According to BZX, the Sponsor believes that the Shares will represent a cost-effective and convenient means of gaining investment exposure to bitcoin similar to a direct investment in bitcoin, allowing investors to more effectively implement strategic and tactical asset allocation strategies that use bitcoin, with lower cost than that associated with the direct purchase, storage, and safekeeping of bitcoin. See Amendment No. 1, supra note 1, 81 FR at 76662; see also Overdahl Letter, supra note 36, at 13 (asserting that approval of bitcoin ETP would improve the availability of investment and portfolio diversification opportunities for investors); Lewis Letter I, supra note 65, at 3, 11–16 (asserting that a bitcoin-based ETP would enable ordinary investors to construct more efficient portfolios). Regarding competition, BZX has asserted that approval of the proposed rule change ‘‘will enhance competition among market participants, to the benefit of investors and the marketplace.’’ Amendment No. 1, supra note 1, 81 FR at 76669. BZX also asserts that the Shares ‘‘would facilitate capital formation in the bitcoin marketplace in a manner nearly identical to other commodity-trust exchange traded products.’’ BZX Letter II, supra note 13, at 3, 30. Additionally, one commenter asserts that approval of the Proposal would allow the United States to continue its ‘‘historic technological leadership,’’ Baird Letter, supra note 35, while another commenter asserts that, with the approval of the Proposal, ‘‘bitcoin might become a much larger part of the world economy at risk.’’ Barish Letter III, supra note 35. The Commission recognizes that BZX and commenters assert the economic benefits described above, but, for the reasons discussed throughout, the Commission is disapproving the proposed rule change because it does not find that the proposed rule change is consistent with the Exchange Act. 376 See Section III.G, supra. 377 15 U.S.C. 78f(b)(5). E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices that the proposed rule change, as modified by Amendments No. 1 and 2, 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 Rule 431 of the Commission’s Rules of Practice, that the earlier action taken by delegated authority, Exchange Act Release No. 80206 (Mar. 10, 2017), 82 FR 14076 (Mar. 16, 2017), is set aside and, pursuant to Section 19(b)(2) of the Exchange Act, SR-BatsBZX–2016–30 is disapproved. By the Commission. Brent J. Fields, Secretary. [FR Doc. 2018–16427 Filed 7–31–18; 8:45 am] BILLING CODE 8011–01–P SMALL BUSINESS ADMINISTRATION [License No. 06/06–0346] sradovich on DSK3GMQ082PROD with NOTICES Stellus Capital SBIC, L.P.; Notice Seeking Exemption Under Section 312 of the Small Business Investment Act, Conflicts of Interest Notice is hereby given that Stellus Capital SBIC, L.P., 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, a Federal Licensee under the Small Business Investment Act of 1958, as amended (‘‘the Act’’), in connection with the financing of a small concern, has sought an exemption under Section 312 of the Act and Section 107.730, Financings which Constitute Conflicts of Interest of the Small Business Administration (‘‘SBA’’) Rules and Regulations (13 CFR 107.730). Stellus Capital SBIC, L.P. proposes to provide loan financing to KelleyAmerit Holdings, Inc. (d/b/a Amerit Fleet Solutions), 1331 North California Blvd., Suite 150, Walnut Creek, CA 94596. The financing is brought within the purview of § 107.730(a)(4) of the Regulations because Stellus Capital SBIC, L.P., seeks to purchase the loan financing to KelleyAmerit Holdings, Inc. from Stellus Capital Investment Corp., an Associate of Stellus Capital SBIC, L.P. Therefore, this transaction is considered discharging an obligation of an Associate, requiring a prior SBA exemption. Notice is hereby given that any interested person may submit written comments on this transaction within fifteen days of the date of this publication to the Associate Administrator, Office of Investment and Innovation, U.S. Small Business VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 Administration, 409 Third Street SW, Washington, DC 20416. A. Joseph Shepard, Associate Administrator for Office of Investment and Innovation. [FR Doc. 2018–16414 Filed 7–31–18; 8:45 am] BILLING CODE P SMALL BUSINESS ADMINISTRATION [License No. 01/01–0435] Ironwood Mezzanine Fund IV–A, L.P.; Notice Seeking Exemption Under Section 312 of the Small Business Investment Act, Conflicts of Interest Notice is hereby given that Ironwood Mezzanine Fund IV–A, L.P., 45 Nod Road, Suite 2, Avon, CT 06001, a Federal Licensee under the Small Business Investment Act of 1958, as amended (‘‘the Act’’), in connection with a financing of a small concern, has sought an exemption under Section 312 of the Act and Section 107.730, Financings which Constitute Conflicts of Interest of the Small Business Administration (‘‘SBA’’) Rules and Regulations (13 CFR 107.730). Ironwood Mezzanine Fund IV–A, L.P. proposes to provide debt and equity financing for the purpose of purchasing a subsidiary (Capewell Intermediate Holding, LLC) from an Associate, Capewell Holding, LLC. Capewell Holding, LLC is an Associate because Ironwood Mezzanine Fund III–A L.P., an Associate of Mezzanine Fund IV–A, L.P., owns more than ten percent of Capewell Holding, LLC. The financing is brought within the purview of § 107.730(a) of the Regulations because proceeds from the transaction will directly benefit Associates Ironwood Mezzanine Fund III, L.P. and Ironwood Mezzanine Fund III–A, L.P. Notice is hereby given that any interested person may submit written comments on this transaction within fifteen days of the date of this publication to the Associate Administrator, Office of Investment and Innovation, U.S. Small Business Administration, 409 Third Street SW, Washington, DC 20416. A. Joseph Shepard, Associate Administrator, Office of Investment and Innovation. [FR Doc. 2018–16415 Filed 7–31–18; 8:45 am] BILLING CODE P PO 00000 Frm 00147 Fmt 4703 Sfmt 4703 37605 SURFACE TRANSPORTATION BOARD [Docket No. FD 36208] Progressive Rail Incorporated— Continuance in Control Exemption— St. Paul & Pacific Railroad Company, LLC Progressive Rail Incorporated (PGR), a Class III rail carrier, has filed a verified notice of exemption under 49 CFR 1180.2(d)(2) to continue in control of St. Paul & Pacific Railroad Company, LLC (SPR), upon SPR’s becoming a Class III rail carrier. This transaction is related to a concurrently filed verified notice of exemption in St. Paul & Pacific Railroad Company, LLC—Change in Operator Exemption—Santa Cruz and Monterey Bay Railway Company, Docket No. FD 36207. In that proceeding, SPR seeks an exemption under 49 CFR 1150.31 to assume operations over approximately 31 miles of rail line (the Line) owned by the Santa Cruz County Regional Transportation Commission extending from milepost 0.433 at Watsonville Junction to milepost 31.39 at Davenport, Cal. The earliest this transaction may be consummated is August 15, 2018, the effective date of the exemption (30 days after the verified notice was filed). PGR states that it intends to consummate the transaction on August 16, 2018. PGR will continue in control of SPR upon SPR’s becoming a Class III rail carrier and remains in control of Class III carriers Airlake Terminal Railway Company, LLC, Central Midland Railway Company, Iowa Traction Railway Company, Iowa Southern Railway Company, Piedmont & Northern Railroad Company, and Chicago Junction Railway Company. PGR states that: (1) The rail line to be operated by SPR does not connect with any other railroads in the PGR corporate family; (2) the continuance in control is not part of a series of anticipated transactions that would connect this line with any other railroad in the PGR corporate family; and (3) the transaction does not involve a Class I rail carrier. Therefore, the transaction is exempt from the prior approval requirements of 49 U.S.C. 11323. See 49 CFR 1180.2(d)(2). Under 49 U.S.C. 10502(g), the Board may not use its exemption authority to relieve a rail carrier of its statutory obligation to protect the interests of its employees. Section 11326(c), however, does not provide for labor protection for transactions under §§ 11324 and 11325 that involve only Class III rail carriers. Accordingly, the Board may not impose labor protective conditions here because E:\FR\FM\01AUN1.SGM 01AUN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 83, Number 148 (Wednesday, August 1, 2018)]
[Notices]
[Pages 37579-37605]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16427]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83723; File No. SR-BatsBZX-2016-30]

Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order
Setting Aside Action by Delegated Authority and Disapproving a Proposed
Rule Change, as Modified by Amendments No. 1 and 2, To List and Trade
Shares of the Winklevoss Bitcoin Trust

July 26, 2018.

I. Introduction

On June 30, 2016, Bats BZX Exchange, Inc. (``BZX'') filed a
proposed rule change with the Commission, seeking to list and trade
shares of the Winklevoss Bitcoin Trust.\1\ The Commission, acting
through authority delegated to the Division of Trading and Markets,\2\
disapproved the proposed rule change on March 10, 2017,\3\ and BZX then
filed a timely petition seeking Commission review of the disapproval by
delegated authority.\4\ The Commission granted BZX's Petition for
Review, seeking public comments in support of or in opposition to the
March Disapproval Order.\5\ Today's order sets aside the March
Disapproval Order, and, for the reasons discussed below, disapproves
BZX's proposed rule change.\6\
---------------------------------------------------------------------------

\1\ BZX made this filing under Section 19(b)(1) of the
Securities Exchange Act of 1934, 15 U.S.C. 78s(b)(1) (``Exchange
Act'') and Rule 19b-4 thereunder, 17 CFR 240.19b-4. The Commission
published notice of the proposed rule change in the Federal Register
on July 14, 2016. See Exchange Act Release No. 78262 (July 8, 2016),
81 FR 45554 (July 14, 2016) (SR-BatsBZX-2016-30). On August 23,
2016, the Commission designated a longer period within which to act
on the proposed rule change. See Exchange Act Release No. 78653
(Aug. 23, 2016), 81 FR 59256 (Aug. 29, 2016). On October 12, 2016,
the Commission instituted proceedings under Section 19(b)(2)(B) of
the 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. 79084 (Oct. 12, 2016), 81 FR 71778 (Oct. 18, 2016). On
October 20, 2016, BZX filed Amendment No. 1 to the proposed rule
change, replacing the original filing in its entirety, and Amendment
No. 1 was published for comment in the Federal Register on November
3, 2016. See Exchange Act Release No. 79183 (Oct. 28, 2016), 81 FR
76650 (Nov. 3, 2016) (``Amendment No. 1''). On January 4, 2017, the
Commission designated a longer period for Commission action on the
proposed rule change. See Exchange Act Release No. 79725 (Jan. 4,
2017), 82 FR 2425 (Jan. 9, 2017). On February 22, 2017, BZX filed
Amendment No. 2 to the proposed rule change (``Amendment No. 2'').
Amendment No. 2 is available on the Commission's website at https://www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx201630-1594698-132357.pdf.
\2\ See 17 CFR 200.30-3(a)(12).
\3\ See Exchange Act Release No. 80206 (Mar. 10, 2017), 82 FR
14076 (Mar. 16, 2017) (``March Disapproval Order'').
\4\ On March 17, 2017, pursuant to Rule 430 of the Rules of
Practice, see 17 CFR 201.430(b)(1), BZX submitted a Notice of
Intention to Petition for Review of Order Disapproving a Proposed
Rule Change, and on March 24, 2017, BZX submitted its Petition for
Review (``Petition for Review''). BZX's Notice of Intention to
Petition for Review is available on the Commission's website at:
https://www.sec.gov/rules/sro/batsbzx/2017/batsbzx-petitionforreview.pdf. BZX's Petition for Review is available on the
Commission's website at: https://www.sec.gov/rules/sro/batsbzx/2017/petition-for-review-sr-batsbzx-2016-30.pdf.
\5\ On April 24, 2017, pursuant to Rule 431 of the Rules of
Practice, see 17 CFR 201.431, the Commission issued an order
granting the Petition for Review, see Exchange Act Release No. 80511
(Apr. 24, 2017), 82 FR 19770 (Apr. 28, 2017) (``Review Order''), and
designated May 15, 2017, as the date by which any party to the
action or any other person could file a written statement in support
of or in opposition to the March Disapproval Order. See id.
\6\ Commissioner Peirce dissents from the Commission's
disapproval of this proposal, and her written dissent can be found
on the Commission's website, https://www.sec.gov.
---------------------------------------------------------------------------

In response to BZX's Petition for Review, the Commission has
conducted a de novo review of BZX's proposal \7\--giving careful
consideration to the entire record, including BZX's amended proposal
and Petition for Review and all comments and statements submitted by
BZX and other persons--to determine whether the proposal is consistent
with the requirements of the Exchange Act and the rules and regulations
issued thereunder that are applicable to a national securities
exchange.\8\ Specifically, the Commission has considered whether the
BZX proposal is consistent with Exchange Act Section 6(b)(5), which
requires, in relevant part, 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.'' \9\
---------------------------------------------------------------------------

\7\ Pursuant to Rule 431(a) of the Commission's Rules of
Practice, the Commission may affirm, reverse, modify, set aside, or
remand for further proceedings, in whole or in part, an action made
pursuant to delegated authority. 17 CFR 201.431(a).
\8\ Section 19(b)(2)(C) of the Exchange Act directs the
Commission to approve a proposed rule change of an SRO, such as a
national securities exchange, if the Commission finds that the
proposed rule change is consistent with the requirements of the
Exchange Act and the rules and regulations thereunder applicable to
the SRO and directs the Commission to disapprove the proposed rule
change if it is unable to make such a finding. See 15 U.S.C.
78s(b)(2)(C).
\9\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

Under 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

[[Page 37580]]

thereunder . . . is on the self-regulatory organization [`SRO'] that
proposed the rule change.'' \10\ 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,\11\
and any failure of an SRO to provide this information 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
applicable rules and regulations.\12\
---------------------------------------------------------------------------

\10\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
\11\ See id.
\12\ See id.
---------------------------------------------------------------------------

BZX argues, among other things, that its proposal is consistent
with Exchange Act Section 6(b)(5) on the grounds that the
``geographically diverse and continuous nature of bitcoin trading makes
it difficult and prohibitively costly to manipulate the price of
bitcoin'' \13\--and that therefore the bitcoin market ``generally is
less susceptible to manipulation than the equity, fixed income, and
commodity futures markets'' \14\--and because ``novel systems intrinsic
to this new market provide unique additional protections that are
unavailable in traditional commodity markets.'' \15\ BZX also asserts
that the March Disapproval Order failed to appreciate that the proposal
provides ``traditional means of identifying and deterring fraud and
manipulation,'' \16\ and that the proposal meets the criteria that the
Commission has utilized in approving other commodity-trust ETPs as it
relates to the ability to monitor for, detect, and deter fraud and
manipulation and violations of exchange rules and applicable federal
securities laws and rules.\17\ BZX also claims that the March
Disapproval Order overstates the extent to which surveillance and
regulation of the underlying market have been present in prior
commodity-trust ETP approval orders and the extent to which the
Commission has relied on the existence of surveillance-sharing
agreements between an ETP listing market and markets related to the
underlying assets.\18\
---------------------------------------------------------------------------

\13\ See Letter from Joanne Moffic-Silver, Executive Vice
President, General Counsel & Corporate Secretary, BZX, at 12 (May
15, 2017) (``BZX Letter II'').
\14\ Id.
\15\ Id. at 26.
\16\ Id.
\17\ See id. at 22.
\18\ See id. at 26-27.
---------------------------------------------------------------------------

The Commission addresses each of these arguments below. In Section
III.B, the Commission addresses BZX's assertion that bitcoin and
bitcoin markets, including the Gemini Exchange, are uniquely resistant
to manipulation and finds that the record before the Commission does
not support such a conclusion. In Section III.C, the Commission
addresses whether what BZX describes as ``traditional means'' of
identifying and deterring fraud and manipulation are sufficient to meet
the requirements of Exchange Act Section 6(b)(5) and also finds that
the record does not support such a conclusion.
Then, in Sections III.D and III.E, respectively, the Commission
addresses the use and importance of surveillance-sharing agreements to
detect and deter fraud and manipulation, and whether BZX has entered
into a comprehensive surveillance-sharing agreement with a regulated
market of significant size related to bitcoin.\19\ Although
surveillance-sharing agreements are not the exclusive means by which an
ETP listing exchange can meet its obligations under Exchange Act
Section 6(b)(5), such agreements are a widely used means for exchanges
that list ETPs to meet their obligations, and the Commission has
historically recognized their importance.\20\ And where, as here, a
listing exchange fails to establish that other means to prevent
fraudulent and manipulative acts and practices will be sufficient, the
listing exchange must enter into a surveillance-sharing agreement with
a regulated market of significant size because ``[s]uch 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.'' \21\ Based on the record before it,
the Commission concludes that--unlike the listing exchanges for
previously approved commodity-trust ETPs--BZX has not established that
it has entered into, or currently could enter into, a surveillance-
sharing agreement with a regulated market of significant size related
to bitcoin.
---------------------------------------------------------------------------

\19\ The Commission considers two markets that are members of
the Intermarket Surveillance Group to have a comprehensive
surveillance-sharing agreement with one another, even if they do not
have a separate bilateral surveillance-sharing agreement.
\20\ See Section III.D.2(a), infra.
\21\ 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, 70954, 70959
(Dec. 22, 1998) (File No. S7-13-98) (``NDSP Adopting Release'').
---------------------------------------------------------------------------

Finally, in Section III.F, the Commission addresses arguments
raised regarding the protection of investors and the public interest,
and, in Section III.G, the Commission discusses additional factors
supporting disapproval of the BZX proposal.
Although the Commission is disapproving this proposed rule change,
the Commission emphasizes that its disapproval does not rest on an
evaluation of whether bitcoin, or blockchain technology more generally,
has utility or value as an innovation or an investment. Rather, the
Commission is disapproving this proposed rule change because, as
discussed in detail below, BZX has not met its burden under the
Exchange Act and the Commission's Rules of Practice to demonstrate that
its proposal is consistent with the requirements of the Exchange Act
Section 6(b)(5), in particular the requirement that its rules be
designed to prevent fraudulent and manipulative acts and practices.
While the record before the Commission indicates that a substantial
majority of bitcoin trading occurs on unregulated venues overseas that
are relatively new and that, generally, appear to trade only digital
assets,\22\ and while the record does not support a conclusion that
bitcoin derivatives markets have attained significant size,\23\ the
Commission notes that regulated bitcoin-related markets are in the
early stages of their development. Over time, regulated bitcoin-related
markets may continue to grow and develop. For example, existing or
newly created bitcoin futures markets may achieve significant size, and
an ETP listing exchange may be able to demonstrate in a proposed rule
change that it will be able to address the risk of fraud and
manipulation by sharing surveillance information with a regulated
market of significant size related to bitcoin, as well as, where
appropriate, with the spot markets underlying relevant bitcoin
derivatives. Should these circumstances develop, or conditions
otherwise change in a manner that affects the Exchange Act analysis,
the Commission would then have the opportunity to consider whether a
bitcoin ETP would be consistent with the requirements of the Exchange
Act.
---------------------------------------------------------------------------

\22\ For example, the Registration Statement for the Winklevoss
Bitcoin Trust discloses that ``[t]he Bitcoin Exchanges on which
bitcoin trades are new and, in most cases, largely unregulated.''
See Registration Statement on Form S-1, as amended, dated February
8, 2017, at 22 (File No. 333-189752) (``Registration Statement'').
See also Sections III.E.1 and III.E.2, infra (discussing the
distribution of bitcoin trading and the state of regulation of
bitcoin spot markets).
\23\ See infra notes 312-316 and accompanying text.

---------------------------------------------------------------------------

[[Page 37581]]

II. Description of the Proposal

BZX proposes to list and trade shares (``Shares'') of the
Winklevoss Bitcoin Trust (``Trust'') as Commodity-Based Trust Shares
under BZX Rule 14.11(e)(4).\24\ The Trust would hold only bitcoins as
an asset,\25\ and the bitcoins would be in the custody of, and secured
by, the Trust's custodian, Gemini Trust Company LLC (``Custodian''),
which is a limited-liability trust company chartered by the State of
New York and supervised by the New York State Department of Financial
Services (``NYSDFS'').\26\ Gemini Trust Company is also an affiliate of
Digital Asset Services LLC, the sponsor of the Trust (``Sponsor'').\27\
The Trust would issue and redeem the Shares only in ``Baskets'' of
100,000 Shares and only to ``Authorized Participants,'' and these
transactions would be conducted ``in-kind'' for bitcoin only.\28\
---------------------------------------------------------------------------

\24\ BZX Rule 14.11(e)(4)(C) permits the listing and trading of
``Commodity-Based Trust Shares,'' which are 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.
\25\ Bitcoins are digital assets that are issued and transferred
via a decentralized, open-source protocol used by a peer-to-peer
computer network through which transactions are recorded on a public
transaction ledger known as the ``Bitcoin Blockchain.'' The Bitcoin
protocol governs the creation of new bitcoins and the cryptographic
system that secures and verifies bitcoin transactions. See Amendment
No. 1, supra note 1, 81 FR at 76652. The proposed rule change
describes the ETP's underlying bitcoin asset as a ``digital asset''
and as a ``commodity,'' see id. at 76652 & n.21, and describes the
ETP as a Commodity-Based Trust. For the purpose of considering this
proposal, this order describes a bitcoin as a ``digital asset'' and
a ``commodity.''
\26\ See id. at 76651-52.
\27\ See id. at 76651.
\28\ See id. at 76664-65. See also Amendment No. 2, supra note
1.
---------------------------------------------------------------------------

The investment objective of the Trust would be for the Shares to
track the price of bitcoin on the Gemini Exchange, which is a digital-
asset exchange owned and operated by the Gemini Trust Company.\29\ The
Net Asset Value (``NAV'') of the Trust would be calculated each
business day, based on the clearing price of that day's 4:00 p.m.
Eastern Time (``ET'') Gemini Exchange bitcoin auction, a two-sided
auction open to all Gemini Exchange customers (``Gemini Auction'').\30\
The Intraday Indicative Value (``IIV'') of the Trust would be
calculated and disseminated by the Sponsor, every 15 seconds during
BZX's regular trading session, based on the most recent Gemini Auction
price.\31\
---------------------------------------------------------------------------

\29\ See Amendment No. 1, supra note 1, 81 FR at 76652.
\30\ See id. at 76652, 76664. In the event that the Sponsor
determines that the Gemini Auction price, because of extraordinary
circumstances, is ``not an appropriate basis for evaluation of the
Trust's bitcoin on a given Business Day,'' BZX's proposal provides
that the Sponsor may use other specified criteria to value the
holdings of the Trust. See id. at 76664.
\31\ See id. at 76666.
---------------------------------------------------------------------------

BZX represents that it has entered into a comprehensive
surveillance-sharing agreement with the Gemini Exchange.\32\ Further
details regarding the proposal and the Trust can be found in Amendments
No. 1 and 2 to the proposal,\33\ and in the registration statement for
the Trust.\34\
---------------------------------------------------------------------------

\32\ See id. at 76668.
\33\ See Amendments No. 1 and 2, supra note 1.
\34\ See Registration Statement, supra note 22. BZX represents
in the proposed rule change that the Registration Statement will be
effective as of the date of any offer and sale pursuant to the
Registration Statement. See Amendment No. 1, supra note 1, 81 FR at
76651.
---------------------------------------------------------------------------

III. Discussion

A. Overview

The comment period for the proposed rule change filed by BZX ended
November 25, 2016. The Commission, as of March 10, 2017, received 66
comment letters on the proposed rule change.\35\ Additionally, in
response to the Review Order, the Commission, as of July 13, 2018,
received eight comments in connection with the Petition for Review.\36\
The comments cover a variety of topics, including the analysis of the
BZX proposal in the March Disapproval Order,\37\ the nature of the
worldwide market for bitcoin,\38\ the characteristics of the Gemini
digital asset exchange,\39\ the need for surveillance-sharing
agreements with significant markets,\40\ the state of the market for
derivatives on bitcoin,\41\ and the protection of investors,\42\ as
well as a number of comments on the nature of bitcoin and of the
Bitcoin network, the structure of the Trust and the Trust's valuation
and security protocols, and

[[Page 37582]]

the effect that Commission approval of the BZX proposal could have on
bitcoin and the bitcoin markets.\43\
---------------------------------------------------------------------------

\35\ See Letters from Robert D. Miller, VP Technical Services,
RKL eSolutions (July 11, 2016) (``R.D. Miller Letter''); Jorge
Stolfi, Full Professor, Institute of Computing UNICAMP (July 13,
2016) (``Stolfi Letter I''); Guillaume Lethuillier (July 26, 2016)
(``Lethuillier Letter''); Michael B. Casey (July 31, 2016) (``Casey
Letter I''); Erik A. Aronesty, Sr. Software Engineer, Bloomberg LP
(Aug. 2, 2016) (``Aronesty Letter''); Dan Anderson (Aug. 27, 2016)
(``Anderson Letter''); Robert Miller (Oct. 12, 2016) (``R. Miller
Letter''); Anonymous (Oct. 13, 2016) (``Anonymous Letter I''); Nils
Neidhardt (Oct. 13, 2016) (``Neidhardt Letter''); Dana K. Barish (2
letters; Oct. 13, 2016) (``Barish Letter I'' and ``Barish Letter
II''); Xin Lu (Oct. 13, 2016) (``Xin Lu Letter''); Rodger Delehanty
CFA (Oct. 14, 2016) (``Delehanty Letter''); Dylan (Oct. 14, 2016)
(``Dylan Letter''); Dana K. Barish (Oct. 14, 2016) (``Barish Letter
III''); Dana K. Barish (2 letters; Oct. 15, 2016) (``Barish Letter
IV'' and ``Barish Letter V''); Jorge Stolfi, Full Professor,
Institute of Computing UNICAMP (Nov. 1, 2016) (``Stolfi Letter
II''); Michael B. Casey (Nov. 5, 2016) (``Casey Letter II'');
Anonymous (Nov. 8, 2016) (``Anonymous Letter II''); Chris Burniske,
Blockchain Products Lead, ARK Investment Management LLC (Nov. 8,
2016) (``ARK Letter''); Colin Keeler (Nov. 14, 2016) (``Keeler
Letter''); Robert S. Tull, (Nov. 14, 2016) (``Tull Letter''); Mark
T. Williams (Nov. 15, 2016) (``Williams Letter''); Anonymous (Nov.
21, 2016) (``Anonymous Letter III''); XBT OPPS Team (Nov. 21, 2016)
(``XBT Letter''); Anonymous (Nov. 22, 2016) (``Anonymous Letter
IV''); Ken I. Maher (Nov. 22, 2016) (``Maher Letter''); Kyle Murray,
Assistant General Counsel, Bats Global Markets, Inc. (Nov. 25, 2016)
(``BZX Letter I''); Colin Baird (Nov. 26, 2016) (``Baird Letter'');
Scott P. Hall (Jan. 5, 2017) (``Hall Letter''); Suzanne H. Shatto
(Jan. 24, 2017) (``Shatto Letter''); Joshua Lim and Dan Matuszewski,
Treasury & Trading Operations, Circle internet Financial, Inc. (Feb.
3, 2017) (``Circle Letter''); Zachary J. Herbert (Feb. 10, 2017)
(``Herbert Letter''); Thomas Fernandez (Feb. 12, 2017) (``Fernandez
Letter''); Diego Tomaselli (Feb. 17, 2017) (``Tomaselli Letter'');
Hans Christensen (Feb. 20, 2017) (``Christensen Letter''); Jake Kim
(Feb. 22, 2017) (``Kim Letter''); Andrea Dalla Val (Mar. 4, 2017)
(``Dalla Val Letter''); Josh Barraza (Mar. 6, 2017) (``Barraza
Letter''); Chad Rigsby (Mar. 6, 2017) (``Rigsby Letter''); Michael
Lee (Mar. 6, 2017) (``Lee Letter''); Fabrizio Marchionne (Mar. 6,
2017) (``Marchionne Letter''); Ben Elron (Mar. 6, 2017) (``Elron
Letter''); Patrick Miller (Mar. 6, 2017) (``P. Miller Letter'');
Situation (Mar. 6, 2017) (``Situation Letter''); Steven Swiderski
(Mar. 6, 2017) (``Swiderski Letter''); Marcia Paneque (Mar. 6, 2017)
(``Paneque Letter''); Jeremy Nootenboom (Mar. 6, 2017) (``Nootenboom
Letter''); Alan Struna (Mar. 6, 2017) (``Struna Letter''); Mike
Johnson (Mar. 6, 2017) (``Johnson Letter''); Phil Chronakis (Mar. 7,
2017) (``Chronakis Letter''); Anonymous (Mar. 7, 2017) (``Anonymous
Letter V''); Brian Bang (Mar. 7, 2017) (``Bang Letter''); Anthony
Schulte (Mar. 7, 2017) (``Schulte Letter''); Melissa Whitman (Mar.
7, 2017) (``Whitman Letter''); Harold Primm (Mar. 8, 2017) (``Primm
Letter''); Shad (Mar. 8, 2017) (``Shad Letter''); Anonymous (Mar. 8,
2017) (``Anonymous Letter VI''); Patrick Turley (Mar. 9, 2017)
(``Turley Letter''); Anonymous (Mar. 9, 2017) (``Anonymous Letter
VII''); Richard Kemble (Mar. 9, 2017) (``Kemble Letter''); Anonymous
(Mar. 9, 2017) (``Anonymous Letter VIII''); Daniel Ackerman (Mar.
10, 2017) (``Ackerman Letter''); Obed Medina (Mar. 10, 2017)
(``Medina Letter''); and John Paslaqua (Mar. 10, 2017) (``Paslaqua
Letter''). All comments on the proposed rule change are available on
the Commission's website at: https://www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx201630.shtml.
\36\ See Letters from Douglas A. Cifu, Chief Executive Officer,
Virtu Financial (May 11, 2017) (``Virtu Letter''); James A.
Overdahl, Partner, Delta Strategy Group (May 12, 2017) (``Overdahl
Letter''); Daniel H. Gallancy, SolidX Management LLC (May 15, 2017)
(``SolidX Letter''); Jonathan G. Harris (May 15, 2017) (``Harris
Letter''); Mick Kalishman, C&C Trading, LLC (May 15, 2017) (``C&C
Letter''); Eric W. Noll, President and Chief Executive Officer,
Convergex Group (May 15, 2017) (``Convergex Letter''); Jeffrey Yass,
Managing Director, Susquehanna International Group, LLP (May 15,
2017) (``SIG Letter''); and BZX Letter II, supra note 13. All
comments submitted in support of or in opposition to the March
Disapproval Order are available on the Commission's website at:
https://www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx201630.shtml.
\37\ See infra notes 44-48 and accompanying text.
\38\ See Sections III.B.1(a) and III.E.2(a), infra.
\39\ See Sections III.B.2(a) and III.E.1(a), infra.
\40\ See Section III.D.1, infra.
\41\ See Section III.E.3(a), infra.
\42\ See Section III.F.1, infra.
\43\ See Section III.G, infra.
---------------------------------------------------------------------------

BZX's primary argument is that the standard set forth in the March
Disapproval Order--the need for a surveillance sharing agreement
between the ETP listing exchange and significant, regulated markets
related to the underlying asset \44\--is not the only way that a
listing exchange can satisfy Section 6(b)(5)'s requirement that its
rules be designed to prevent fraudulent and manipulative acts and
practices with respect to listing an ETP.\45\ BZX argues that, in the
case of a bitcoin commodity-trust ETP, traditional measures to detect
and deter manipulation are sufficient.\46\ BZX and certain commenters
further argue that the March Disapproval Order misconstrued Section
6(b)(5) to mean that a bitcoin ETP can be listed and traded only if
bitcoin ``cannot be manipulated.'' \47\ They argue that such a standard
is inconsistent with the ``not readily susceptible to manipulation''
standard applied to other commodities that underlie ETPs.\48\
---------------------------------------------------------------------------

\44\ See March Disapproval Order, supra note 3, 82 FR at 14082-
84.
\45\ See BZX Letter II, supra note 13, at 26.
\46\ See id. at 12; see also id. at 13, 26.
\47\ See BZX Letter II, supra note 13, at 13; and Overdahl
Letter, supra note 36, at 2, 9-11.
\48\ See BZX Letter II, supra note 13, at 13; and Overdahl
Letter, supra note 36, at 2, 9-11.
---------------------------------------------------------------------------

These arguments do not accurately reflect the nature of the
Commission's inquiry and past practice. The Commission agrees that, if
BZX had demonstrated that bitcoin and bitcoin markets are inherently
resistant to fraud and manipulation, comprehensive surveillance-sharing
agreements with significant, regulated markets would not be required,
as the function of such agreements is to detect and deter fraud and
manipulation. But because the underlying commodities market for this
proposed commodity-trust ETP is not demonstrably resistant to
manipulation, BZX, as the ETP listing exchange, must enter into
surveillance-sharing agreements with, or hold Intermarket Surveillance
Group membership in common with, at least one significant, regulated
market relating to bitcoin.
Moreover, the Commission is not applying a ``cannot be
manipulated'' standard to this proposal. Instead, the Commission is
examining whether the proposal meets the requirements of the Exchange
Act and, pursuant to its Rules of Practice,\49\ is placing the burden
on BZX to demonstrate the validity of its contention that the ``novel
systems intrinsic to this new market provide unique additional
protections that are unavailable in traditional commodity markets,''
\50\ and to establish that the requirements of the Exchange Act have
been met.
---------------------------------------------------------------------------

\49\ See supra notes 10-12 and accompanying text.
\50\ See BZX Letter II, supra note 13, at 26.
---------------------------------------------------------------------------

Finding that BZX has not demonstrated that bitcoin and bitcoin
markets are inherently resistant to manipulation, the Commission
subjects the proposal to the analysis it has historically used to
analyze commodity-trust ETPs, focusing particularly on whether there
are comprehensive surveillance-sharing agreements with significant,
regulated markets. Because adequate surveillance-sharing agreements are
not in place--and any current surveillance-sharing agreements are with
bitcoin-related markets that are either not significant, not regulated,
or both--the Commission concludes that the proposal is inconsistent
with Exchange Act Section 6(b)(5).
Accordingly, the Commission will examine whether the proposed rule
change is consistent with Section 6(b)(5) by first addressing the
arguments by BZX and certain commenters that bitcoin and bitcoin
markets are inherently resistant to manipulation. The Commission will
then address BZX's argument that what it describes as ``traditional
means'' of identifying and deterring fraud and manipulation would be
sufficient to comply with Exchange Act Section 6(b)(5), which requires
that BZX's rules be designed to ``prevent fraudulent and manipulative
acts and practices'' and ``to protect investors and the public
interest.'' \51\ Finding these arguments unpersuasive, the Commission
concludes that the proposal is inconsistent with previously approved
commodity-trust ETPs, which have universally relied on surveillance-
sharing agreements with significant, regulated markets relating to the
underlying commodity in order to prevent fraud and manipulation and to
protect investors and the public interest. Finally, the Commission
addresses and rejects additional factors that BZX contends support
approval.
---------------------------------------------------------------------------

\51\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. The Susceptibility of Bitcoin and Bitcoin Markets to Manipulation

BZX asserts that intrinsic properties of bitcoin and bitcoin
markets, including the Gemini Exchange, provide resistance to
manipulation. But BZX has failed to carry its burden to demonstrate
that its assertion is correct.
1. The Structure of the Spot Market for Bitcoin
(a) Summary of Comments Received
BZX argues that intrinsic properties of bitcoin and bitcoin markets
make manipulation ``difficult and prohibitively costly.'' \52\ BZX
argues that ``novel systems intrinsic to this new market provide unique
additional protections that are unavailable in traditional commodity
markets.'' \53\ BZX asserts that the increasing strength and resilience
of the global bitcoin marketplace serve to reduce the likelihood of
price manipulation and that arbitrage opportunities across globally
diverse marketplaces allow market participants to ensure approximately
equivalent pricing worldwide. But BZX concedes that less liquid
markets, such as the market for bitcoin, may be more susceptible to
manipulation.\54\
---------------------------------------------------------------------------

\52\ BZX Letter II, supra note 13, at 12, 13, 26; see also
Petition for Review, supra note 4, at 11.
\53\ See supra note 50 and accompanying text.
\54\ See BZX Letter I, supra note 35, at 7.
---------------------------------------------------------------------------

BZX asserts that a number of new bitcoin market participants have
emerged, changing the once concentrated and non-regulated landscape of
the global bitcoin exchange marketplace, and that the emergence of
these new market participants, who are chiefly arbitrageurs, causes
global bitcoin exchange prices to converge.\55\ BZX adds that
arbitrageurs must have funds distributed across multiple bitcoin
exchanges to take advantage of temporary price dislocations, and that
this distribution of funds discourages concentration of funds on any
one particular bitcoin exchange and mitigates the potential for
manipulation on a bitcoin exchange because doing so would require
overcoming the liquidity supply of arbitrageurs that are actively
eliminating any cross-market pricing differences.\56\
---------------------------------------------------------------------------

\55\ See Petition for Review, supra note 4, at 15.
\56\ See BZX Letter II, supra note 13, at 15-16; Petition for
Review, supra note 4, at 15.
---------------------------------------------------------------------------

BZX also asserts that the bitcoin spot market generally is less
susceptible to manipulation than the equity, fixed income, and
commodity futures markets, in part, because: (a) A substantial over-
the-counter (``OTC'') market provides liquidity and shock absorbing
capacity; (b) the ``24/7/365'' trading of bitcoin provides constant
arbitrage opportunities across all trading venues and means that there
is no single market-close for investors to attempt to manipulate; and
(c) it is unlikely that any one actor could obtain a dominant

[[Page 37583]]

market share.\57\ BZX also claims that the transparency that the Trust
will provide with respect to its bitcoin holdings, and the
dissemination of the IIV and NAV of the Trust, will reduce the ability
of market participants to manipulate the price of bitcoin or the price
of the Shares.\58\
---------------------------------------------------------------------------

\57\ See BZX Letter II, supra note 13, at 12; see also Petition
for Review, supra note 4, at 11.
\58\ See Petition for Review, supra note 4, at 16.
---------------------------------------------------------------------------

The Overdahl Letter, submitted in support of the BZX proposal,\59\
asserts that the fungibility of bitcoin across bitcoin exchanges
facilitates arbitrage and helps keep prices within the bounds of
arbitrage, constraining the possibility of price manipulation on any
one bitcoin trading venue.\60\ Because of this linkage, the Overdahl
Letter contends, manipulation of the bitcoin price on any one venue
would require manipulation of the global bitcoin price to be effective,
which would be prohibitively costly and is therefore unlikely. But the
Overdahl Letter concedes that any market can potentially be
manipulated.\61\
---------------------------------------------------------------------------

\59\ See supra note 36.
\60\ See Overdahl Letter, supra note 36, at 1-2.
\61\ Id.
---------------------------------------------------------------------------

The Overdahl Letter further claims that, to the extent that
``spoofing conduct'' \62\ is present in bitcoin markets, it is unlikely
to have a material impact on the value of the Shares. According to the
Overdahl Letter, this is because successful spoofing causes price
oscillations of extremely small magnitudes (such as within the bid/ask
spread) and does not result in a material change in the bitcoin price.
This commenter also claims that spoofing victims are unlikely to be
holders of the Shares, but rather market makers in the spot market, and
concludes that the likelihood of spoofing in the bitcoin spot market is
low.\63\
---------------------------------------------------------------------------

\62\ The Commodity Exchange Act defines ``spoofing'' as bidding
or offering for sale with the intent to cancel the bid or offer
before execution. See 7 U.S.C. 6c(a)(5)(C).
\63\ See Overdahl Letter, supra note 36, at 2, 9; see also
Petition for Review, supra note 4, at 14.
---------------------------------------------------------------------------

The Overdahl Letter further claims that even a ``dominant''
exchange (by trading volume) cannot dictate the global price of bitcoin
because an exchange does not coordinate trading across its membership
to influence the market price. This commenter argues that the existence
of a dominant exchange in terms of trading volume does not imply that
there is a dominant actor on the dominant exchange with the ability to
attain a dominant market share to manipulate the price of bitcoin.
Rather, this commenter argues, the larger the market share of an
exchange, the harder it would be for a dominant actor to obtain a
dominant market share of the dominant exchange's trading volume.\64\
---------------------------------------------------------------------------

\64\ See Overdahl Letter, supra note 36, at 9.
---------------------------------------------------------------------------

Another analysis--the Lewis Letter \65\--argues that, as a general
matter, the underlying market for bitcoin is inherently resistant to
manipulation.\66\ The Lewis Letter posits that the underlying bitcoin
market is not susceptible to manipulation because: (a) There is no
inside information related to bitcoin, such as earnings announcements;
(b) the asset is not subject to the dissemination of false or
misleading information; (c) each bitcoin market is an independent
entity, so that a demand for liquidity does not necessarily propagate
across other exchanges; (d) a substantial OTC market provides
additional liquidity and absorption of shocks; (e) there is no market-
close pricing event to manipulate; (f) the market is not subject to
``spoofing'' or other high-frequency-trading tactics; (g) order books
on exchanges worldwide are publicly visible and available through APIs
(application program interfaces); and (h) it is unlikely that any one
person could obtain a dominant market share because of the existence of
in-kind creations and redemptions, arbitrage across bitcoin markets,
and the enhanced transparency that a bitcoin ETP would bring to bitcoin
markets.\67\ The Lewis Letter acknowledges the risk that a single
investor or a small group acting in collusion could own a dominant
share of the available bitcoin, but argues that the structure of the
spot bitcoin market and the arbitrage mechanism reduce that risk.\68\
---------------------------------------------------------------------------

\65\ See Craig M. Lewis, ``SolidX Bitcoin Trust: A Bitcoin
Exchange Traded Product'' (Feb. 13, 2017) (``Lewis Letter I''),
available at https://www.sec.gov/comments/sr-nysearca-2016-101/nysearca2016101-1579480-131874.pdf; Craig M. Lewis, ``Supplemental
Submission to SolidX Bitcoin Trust: A Bitcoin Exchange Traded
Product'' (Mar. 3, 2017) (``Lewis Letter II'', and together with
Lewis Letter I the ``Lewis Letter''), available at https://www.sec.gov/comments/sr-nysearca-2016-101/nysearca2016101-1610031-135950.pdf. The Lewis Letter was commissioned by SolidX Management
LLC in support of the SolidX Bitcoin Trust. BZX Letter II, supra
note 13, at 12; see also Exchange Act Release No. 80319 (Mar. 28,
2017), 82 FR 16247, 16249 n.43 (Apr. 3, 2017) (SR-NYSEArca-2016-101)
(``SolidX Order''). The Commission notes that the Lewis Letter made
additional assertions directed to the particular structure and
pricing mechanism of another proposed bitcoin-based commodity-trust
ETP, and the Commission does not address those arguments in this
order.
\66\ See Lewis Letter I, supra note 65, at 5-8.
\67\ See Lewis Letter I, supra note 65, at 5-9; Lewis Letter II,
supra note 65, at 2.
\68\ See Lewis Letter I, supra note 65, at 6-7.
---------------------------------------------------------------------------

One commenter observes that the bitcoin/Chinese Yuan (BTC/CNY)
quote is apt to trade at a significant premium to the bitcoin/U.S.
dollar (BTC/USD) quote and points out that large arbitrage
opportunities would not exist for long in efficient markets, but they
do persist in bitcoin markets.\69\ Another commenter claims that,
because trade is now sparse on regulated U.S. exchanges, including
Gemini, arbitrage will not occur efficiently or proportionally to
mitigate manipulation from the dominant unregulated bitcoin
exchanges.\70\
---------------------------------------------------------------------------

\69\ See ARK Letter, supra note 35, at 5.
\70\ See Maher Letter, supra note 35.
---------------------------------------------------------------------------

One commenter asserts that, in January 2017, major Chinese bitcoin
exchanges OKCoin, Huobi, and BTCC implemented changes requested by the
People's Bank of China to halt margin lending and to institute
transaction fees. This commenter claims that these changes were put in
place to discourage price manipulation, to drive down ``fake'' trading
volume, and to dampen bitcoin volatility, and further claims that these
changes have had profound and beneficial effects on bitcoin spot
markets worldwide.\71\
---------------------------------------------------------------------------

\71\ See SIG Letter, supra note 36, at 6.
---------------------------------------------------------------------------

One commenter states that the market for bitcoin, by trade volume,
is very shallow. This commenter states that the majority of bitcoin is
hoarded by a few owners or is out of circulation. The commenter also
states that ownership concentration is high, with 50 percent of bitcoin
in the hands of fewer than 1,000 people, and that this high ownership
concentration creates greater market liquidity risk, as large blocks of
bitcoin are difficult to sell in a timely and market efficient manner.
This commenter claims that daily trade volume is only a small fraction
of total bitcoin mined.\72\
---------------------------------------------------------------------------

\72\ See Williams Letter, supra note 35, at 1-2.
---------------------------------------------------------------------------

One commenter asserts that the number of spot bitcoin exchanges
worldwide far exceeds the number of venues for many commodity futures,
some of which are underlying assets of existing commodity-trust ETPs.
The commenter argues that, therefore, widespread global bitcoin
liquidity makes bitcoin less susceptible to manipulation via trading
activity conducted on a single exchange, as compared to less-liquid
commodity futures that trade on a few exchanges.\73\
---------------------------------------------------------------------------

\73\ See SIG Letter, supra note 36, at 4-5.
---------------------------------------------------------------------------

One commenter states that bitcoin trades on a number of exchanges
around the world and that most of these exchanges can be considered
isolated liquidity pools, which are more vulnerable to manipulation or
security breach than the broader market.\74\
---------------------------------------------------------------------------

\74\ See ARK Letter, supra note 35, at 8.

---------------------------------------------------------------------------

[[Page 37584]]

Finally, both BZX and the Overdahl Letter argue that the Commodity
Futures Trading Commission's (``CFTC'') granting of registration to
bitcoin swap-execution facilities (``SEFs'') means that the CFTC has
addressed the issue of manipulation and determined that the underlying
spot markets for bitcoin are not susceptible to manipulation.\75\
---------------------------------------------------------------------------

\75\ See BZX Letter II, supra note 13, at 17; Overdahl Letter,
supra note 36, at 12. The Overdahl Letter also notes that the CFTC-
regulated CME Group recently created a standardized bitcoin
reference rate and a bitcoin spot price index. Overdahl Letter,
supra note 36, at 12.
---------------------------------------------------------------------------

(b) Discussion
BZX has not demonstrated that the structure of the spot market for
bitcoin is uniquely resistant to manipulation.
(i) Bitcoin Market Structure & Arbitrage
While two commenters questioned the effectiveness of arbitrage
across bitcoin markets,\76\ BZX, the Overdahl Letter, and the Lewis
Letter argue that the structure of the bitcoin spot market and the
availability of arbitrage will help keep worldwide bitcoin prices
aligned, hindering manipulation.\77\ The Overdahl Letter and Lewis
Letter claim that economic analysis demonstrates that bitcoin markets
are resistant to manipulation. But, as discussed below, the arguments
submitted in support of this claim are incomplete and inconsistent, and
are unsupported or contradicted by data.
---------------------------------------------------------------------------

\76\ See supra notes 69-70 and accompanying text.
\77\ See supra notes 52-68 and accompanying text.
---------------------------------------------------------------------------

BZX, the Overdahl Letter, and the Lewis Letter offer broad
assertions that the increasing strength and resilience of the non-stop
global bitcoin market place, the emergence of new market participants,
and the transparency of the market have facilitated arbitrage that has
caused global bitcoin exchange prices to converge.\78\ But BZX, the
Overdahl Letter, and the Lewis Letter offer no data or analysis
regarding the actual effectiveness of arbitrage in the bitcoin spot
market, either in terms of how closely prices are aligned across
different bitcoin trading venues or how quickly price disparities are
arbitraged away.\79\ Similarly, the commenter who asserts that
regulatory actions by the People's Bank of China were designed to
discourage price manipulation, and have had profound and beneficial
effects on bitcoin spot markets worldwide, has provided no empirical
evidence to substantiate this claim.\80\ In addition, the Commission
notes that one commenter asserts that large arbitrage opportunities
persist in bitcoin markets.\81\
---------------------------------------------------------------------------

\78\ See supra notes 52-68 and accompanying text.
\79\ While the Overdahl Letter compares the Gemini Exchange
bitcoin price to the median price and the volume-weighted average
price of a group of USD-denominated bitcoin markets, such an
analysis does not demonstrate whether the range of prices across
those other markets is broad or narrow.
\80\ See supra note 71 and accompanying text.
\81\ See supra note 69 and accompanying text.
---------------------------------------------------------------------------

While BZX cites a comment letter relating to a different proposed
rule change for the proposition that price discrepancies across four
selected USD-denominated bitcoin markets are generally arbitraged away
in under a minute,\82\ even if that limited factual assertion is true,
BZX has not explained why it is relevant to the Commission's
consideration of the proposal, given that (a) the worldwide spot market
for bitcoin is not limited to trading against the USD, (b) market
participants could engage in creation or redemption transactions with
the Trust using bitcoins sourced from any trading venue or from OTC
transactions, and (c) the Gemini Exchange is not among the four bitcoin
trading venues observed by the commenter. Thus, this argument does not
support BZX's broad assertion about the effectiveness of arbitrage
across the worldwide bitcoin market.
---------------------------------------------------------------------------

\82\ See BZX Letter II, supra note 13, at 15 n.28 (citing Letter
from Daniel H. Gallancy, SolidX Partners, Inc., to Brent J. Fields,
Secretary, Commission (Mar. 15, 2017) (SR-NYSEArca-2016-101)).
---------------------------------------------------------------------------

BZX also argues that manipulation in the bitcoin market is unlikely
because would-be manipulators would have to overcome the liquidity
supplied by arbitrageurs, who must have funds distributed across
multiple bitcoin markets to engage in arbitrage,\83\ and the Overdahl
Letter asserts that the manipulation of bitcoin is prohibitively
expensive because manipulating the price of bitcoin on any given venue
would require manipulation of the entire global bitcoin market to be
effective.\84\ These theoretical arguments depend on effective
arbitrage existing across bitcoin markets, but, as noted above, the
Commission concludes that BZX has not provided a factual basis in the
record to conclude that arbitrage across bitcoin exchanges is
effective.
---------------------------------------------------------------------------

\83\ See supra note 56 and accompanying text.
\84\ See supra notes 60-61 and accompanying text.
---------------------------------------------------------------------------

Moreover, these arguments are inconsistent: If, in fact, market
participants must disperse their capital across multiple trading venues
to engage in effective arbitrage, then a market participant may be able
to manipulate trading on a single trading venue by concentrating its
capital and trading activity there. The Overdahl Letter's argument that
manipulation of one bitcoin trading venue would require overcoming
liquidity on all bitcoin venues is also inconsistent with the assertion
by the Lewis Letter and another commenter that each bitcoin market is
an independent entity and that, therefore, demand for liquidity does
not necessarily propagate across other exchanges.\85\ In addition, BZX,
the Overdahl Letter, and the Lewis Letter do not adequately take into
account that a market participant with a dominant ownership position
would not find it prohibitively expensive to overcome the liquidity
supplied by arbitrageurs and could use dominant market share to engage
in manipulation.\86\ And their arguments that substantial liquidity
provided by the OTC market can absorb liquidity shocks and help resist
manipulative activity are not supported by any data in the record on
which the Commission could base a conclusion that OTC activity
contributes to preventing manipulation.
---------------------------------------------------------------------------

\85\ See supra notes 67, 74 and accompanying text.
\86\ See Section III.B.1(b)(ii), infra (discussing the potential
for market domination).
---------------------------------------------------------------------------

BZX also argues that bitcoin markets are uniquely resistant to
manipulation because the 24/7/365 trading of bitcoin means that there
is no single market-close for investors to attempt to manipulate.\87\
Similarly, a commenter asserts that the large number of bitcoin trading
venues makes bitcoin less susceptible to manipulation than an asset,
such as a commodity, trading on a single exchange or just a few
exchanges.\88\ In the context of the Trust, however, there is a single
market and a single market-close event that an investor may have
incentive to manipulate: The Gemini Auction, which the Trust would use
to calculate NAV.\89\ And the argument by BZX and a commenter that the
transparency of a bitcoin commodity-trust ETP regarding its bitcoin
holdings, as well as its dissemination of the IIV and NAV, would reduce
the ability of market participants to manipulate the price of bitcoin
is unpersuasive because: (a) There is no comprehensive and accurate
regulatory data source reflecting bitcoin pricing or trading; (b) there
is no basis to conclude that the Trust's IIV would be considered an
authoritative price when several other spot prices for bitcoin are
already disseminated and often differ from one another; \90\ and (c)

[[Page 37585]]

the Trust's NAV would differ from the Gemini Auction price only if the
auction price, which is publicly disseminated itself, is determined not
to reflect a fair price for bitcoin.
---------------------------------------------------------------------------

\87\ See supra note 57 and accompanying text.
\88\ See supra note 73 and accompanying text.
\89\ See Section III.E.1, infra. While the Lewis Letter makes a
similar argument about the lack of a single market close, see supra
note 67 and accompanying text, it does so in the context of a
bitcoin ETP proposal that would not base its price on a single
market auction.
\90\ For example, the website https://data.bitcoinity.org/markets/arbitrage/USD tracks price differences between last trades
on 13 bitcoin markets.
---------------------------------------------------------------------------

Both the Overdahl Letter and the Lewis Letter contend that bitcoin
markets are not subject to ``spoofing,'' a manipulative quoting
strategy.\91\ Neither letter, however, presents any data or analysis to
support its claim, and there is no basis in the record to conclude
whether bitcoin spot markets are subject to spoofing or other deceptive
quoting practices. As a general matter, the manipulation of asset
prices 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.\92\ The Commission also notes that, in contrast
to the theoretical arguments in the Overdahl Letter and the Lewis
Letter, TeraExchange (a market for swaps on bitcoin) arranged for
participants to make manipulative ``wash'' transactions.\93\
---------------------------------------------------------------------------

\91\ See supra notes 62-63, 67 and accompanying text.
\92\ Even if transparent order books and transaction reports on
bitcoin markets would include the quoting or trading activity of a
person or group attempting to manipulate the market, along with the
activity of all other market participants, such information could
not, by itself, definitively establish in real time which activity
represented bona fide trading interest and which did not.
\93\ 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. See also Kevin Dowd & Martin
Hutchinson, Bitcoin Will Bite the Dust, 35 Cato J. 357, 374 n.13
(2015) (Bitcoin markets are subject to the ``usual market
manipulation tactics.''), available at https://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/5/cj-v35n2-12.pdf.
---------------------------------------------------------------------------

Finally, BZX's, the Lewis Letter's, and the Overdahl Letter's
discussions of the possible sources of manipulation are incomplete and
do not form a basis to find that bitcoin is uniquely resistant to
manipulation--or to find, by implication, that there is no need for a
surveillance-sharing between an exchange listing shares of a bitcoin-
based ETP and significant markets trading bitcoin or bitcoin
derivatives. For example, assuming there is no inside information
related to the earnings or revenue of bitcoin, there may be material
nonpublic information related to: The actions of regulators with
respect to bitcoin; order flow, such as plans of market participants to
significantly increase or decrease their holdings in bitcoin; new
sources of demand, such as new ETPs that would hold bitcoin; or the
decision of a bitcoin-based ETP, a bitcoin trading venue, or a bitcoin
wallet service provider with respect to how it would respond to a
``fork'' in the blockchain, which would create two different, non-
interchangeable types of bitcoin.\94\ Moreover, bitcoin is susceptible
to the dissemination of false or misleading information regarding the
types of material, nonpublic information just discussed. The Commission
also notes a recent academic paper finding empirical evidence of
trading in bitcoin markets based on material nonpublic information.\95\
---------------------------------------------------------------------------

\94\ For example, as described in the Trust's Registration
Statement, supra note 22, in the event the Bitcoin Network undergoes
a ``hard fork'' into two blockchains, the Custodian and the Sponsor
will determine which of the resulting blockchains to use as the
basis for the assets of the Trust and, under certain circumstances,
will have discretion to determine which blockchain is ``most likely
to be supported by a majority of users or miners.'' Id. at 113. See
also Lee Letter, supra note 35; Johnson Letter, supra note 35;
Schulte Letter, supra note 35; Anonymous Letter V, supra note 35;
Anonymous Letter VI, supra note 35. The decision of the Custodian
and Sponsor to support one resulting blockchain over another could
have a material effect on the relative value of the bitcoins in each
of the blockchains. A fork between bitcoin and ``Bitcoin Cash''
occurred on August 1, 2017, and a fork between bitcoin and ``Bitcoin
Gold'' occurred on October 24, 2017.
\95\ See Wenjun Feng, Yiming Wang & Zhengjun Zhang, Informed
Trading in the Bitcoin Market, Fin. Res. Letters, Dec. 2, 2017,
available at https://www.sciencedirect.com/science/article/pii/S1544612317306992.
---------------------------------------------------------------------------

Two additional risks that the Trust's Registration Statement
acknowledges--(1) hacking and (2) malicious control of the Bitcoin
Network--further undermine BZX's argument that bitcoin and bitcoin
markets are inherently resistant to fraud and manipulation. The Trust's
Registration Statement recognizes that bitcoin trading venues can be
and have been attacked by hackers, which can affect liquidity and
result in volatile prices.\96\ Profit-motivated hackers can launch such
attacks to manipulate bitcoin and achieve their ``intended effect of
artificially raising or lowering prices.'' \97\ The Trust's
Registration Statement also recognizes the risk of a ``malicious
actor'' obtaining control of the processing power dedicated to mining
on the Bitcoin Network and thus ``exerting authority'' over the Bitcoin
Network.\98\ Such control can be used to manipulate bitcoin
pricing.\99\ And there may be material nonpublic information related to
hacking plans or attempts to gain control of the Bitcoin Network, and
such information could be exploited through fraudulent trading.
---------------------------------------------------------------------------

\96\ Registration Statement, supra note 22, at 21-23, 29, 60-61.
\97\ Amir Feder, Neil Gandal, J.T. Hamrick, and Tyler Moore, The
Impact of DDoS and Other Security Shocks on Bitcoin Currency
Exchanges: Evidence From Mt. Gox, Journal of Cybersecurity (Jan. 31,
2018), at 137 (explaining that a profit-motivated hacker can
manipulate bitcoin prices up or down by hacking larger trading
venues while trading on smaller trading venues, and thereby
``create[ ] an unfair financial advantage for the perpetrator at the
expense of ordinary participants''), available at https://academic.oup.com/cybersecurity/article/3/2/137/4831474; see also
David Groshoff, Kickstarter My Heart: Extraordinary Popular
Delusions and the Madness of Crowdfunding Constraints and Bitcoin
Bubbles, 5 Wm. Mary Bus. L. Rev. 489, 519 (2014).
\98\ Registration Statement, supra note 22, at 17, 56. The
Registration Statement notes that obtaining control in excess of 50%
of the processing power on the Bitcoin network is sufficient, and
that ``there are some academics and market participants who believe
the applicable threshold required to exert authority over the
Bitcoin Network could be less than fifty (50) percent, which would
increase the chances of a malicious actor exerting authority over
the Bitcoin Network.'' Id. at 17.
\99\ Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash
System, Bitcoin.org (Oct. 31, 2008), at 4 (malicious actor could
exploit his control of the Bitcoin Network by ``using it to generate
new coins''), available at https://bitcoin.org/bitcoin.pdf; see also
Kevin Dowd & Martin Hutchinson, Bitcoin Will Bite the Dust, 35 Cato
J. 357, 372-74 (2015), available at https://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/5/cj-v35n2-12.pdf;
Sanya Samtani and Varun Baliga, On Monopolistic Practices in
Bitcoin: A Coded Solution, 11 Indian J. L. & Tech. 106, 107-08
(2015), available at https://ijlt.in/wp-content/uploads/2015/09/Sanya-Samtani-and-Varun-Baliga-5.pdf (malicious actor could achieve
``devaluation'' of bitcoin).
---------------------------------------------------------------------------

Based on the analysis above, the Commission concludes that there is
an insufficient basis in the record before it to decide that the
bitcoin spot markets are inherently resistant to manipulation. This
conclusion, again, is bolstered by the Trust's Registration Statement,
which explains:

Over the past four (4) years, a number of Bitcoin Exchanges have
been closed due to fraud, failure or security breaches. In many of
these instances, the customers of such Bitcoin Exchanges were not
compensated or made whole for the partial or complete losses of
their account balances in such Bitcoin Exchanges. . . . Further, the
collapse of the largest Bitcoin Exchange in 2014 suggests that the
failure of one component of the overall Bitcoin ecosystem can have
consequences for both users of a Bitcoin Exchange and the Bitcoin
industry as a whole.\100\
---------------------------------------------------------------------------

\100\ Registration Statement, supra note 22, at 23.

Additionally, the Commission notes that recent academic papers
suggest that the price of bitcoin can be, and has been, manipulated
through activity on

[[Page 37586]]

bitcoin trading venues. One recent academic paper examined whether the
growth of the circulating supply of Tether (a cryptocurrency that
claims to be backed by the U.S. dollar) through new issuances ``is
primarily driven by investor demand, or is supplied to investors as a
scheme to profit from pushing cryptocurrency prices up.'' \101\ Through
statistical analysis of the blockchains of bitcoin and Tether, the
authors conclude that entities associated with a specific
cryptocurrency trading venue--which the authors link to Tether's
founders--``use Tether to purchase bitcoin when prices are falling'';
that ``[s]uch price supporting activities are successful, as Bitcoin
prices rise after the period of intervention,'' with ``substantial
aggregate price effects'' across bitcoin trading platforms; and that
this activity ``occurs more aggressively right below salient round-
number price thresholds where the price support might be most
effective.'' \102\ The paper finds that the periods of strongest Tether
flows are ``associated with 50% of Bitcoin compounded return'' from
March 1, 2017, to March 31, 2018.\103\ Overall, the authors conclude
that their findings ``provide substantial support for the view that
price manipulation may be behind substantial distortive effects in
cryptocurrencies'' and ``suggest that external capital market
surveillance and monitoring may be necessary to obtain a market that is
truly free.'' \104\ The Commission also notes another recent academic
paper, which concludes that there was fraudulent and manipulative
activity on a single bitcoin trading venue.\105\
---------------------------------------------------------------------------

\101\ Griffin, John M. and Amin Shams, Is Bitcoin Really Un-
Tethered (June 13, 2018) (manuscript at 33) (``Griffin-Shams
Paper''), available at https://ssrn.com/abstract_id=3195066.
\102\ Id.
\103\ See id. at 23-24.
\104\ Id. at 33; see also id. at 1 (``[P]urchases with Tether
are timed following market downturns and result in sizable increases
in Bitcoin prices,'' thus ``Tether is used to provide price support
and manipulate cryptocurrency prices.''); id. at 2 (Bitcoin
exchanges ``largely operate outside the purview of financial
regulators'' and ``[t]rading on unregulated exchanges . . . could
leave cryptocurrencies vulnerable to gaming and manipulation.'');
id. at 3 (``[T]he coordinated supply of Tether creates an
opportunity to manipulate cryptocurrencies.''); id. at 6 (``Tether
seems to be used both to stabilize and manipulate Bitcoin
prices.'').
\105\ See Neil Gandal, J.T. Hamrick, Tyler Moore & Tali Oberman,
Price Manipulation in the Bitcoin Ecosystem, J. Monetary Econ., Jan.
2, 2018, available at https://doi.org/10.1016/j.jmoneco.2017.12.004.
According to the authors of this paper, the fraudulent and
manipulative activity led to an average of approximately a four to
five percent rise in the bitcoin/USD exchange rate in 2013 on days
when that activity occurred, compared to a slight decline on days
without such activity. Id. at 2.
---------------------------------------------------------------------------

These studies supplement the Commission's conclusion that there is
an insufficient basis in the record before it to decide that the
bitcoin spot markets are inherently resistant to manipulation.\106\
Even without these studies, however, the Commission would still find
that BZX has not demonstrated that the structure of the spot market for
bitcoin is uniquely resistant to manipulation. Moreover, even if the
record supported the proposition that some features of bitcoin and
bitcoin markets mitigate some types of manipulation to some degree, the
Commission concludes that such mitigation is insufficient to justify
dispensing with the detection and deterrence of fraud and manipulation
provided by surveillance-sharing agreements with significant, regulated
markets.\107\
---------------------------------------------------------------------------

\106\ While another recent academic paper examines the
relationship between bitcoin and Tether and claims ``not [to] find
any evidence suggesting that Tether issuances cause subsequent
increases in Bitcoin returns,'' W.C. Wei, The Impact of Tether
Grants on Bitcoin (May 9, 2018) (manuscript at 6) (``Wei Paper''),
available at https://ssrn.com/abstract=3175876, the Commission
believes that this paper's analysis reflects significant limitations
in the study design and is not as persuasive as the empirical papers
cited herein that conclude there has been fraud and manipulative
activity in bitcoin markets, including the Griffin-Shams Paper.
First, the paper uses only daily traded price and aggregate trading
volume, whereas the Griffin-Shams Paper, supra note 101, performs a
more granular statistical analysis of blockchain transactions and
finds that the largest effects of Tether issuances on bitcoin prices
occur between three and twelve hours after a Tether issuance.
Second, the paper uses a single vector autoregression specification
with 52 coefficients, but without any robustness checks. And third,
while the paper concludes that Tether issuances increase bitcoin
trading volume but do not affect bitcoin returns, the paper does not
include any discussion of or control for collinearity between
changes in bitcoin trading volume and prices. Thus, the Commission
does not believe that the Wei Paper supports a conclusion that
bitcoin is inherently resistant to manipulation.
\107\ Even if BZX's argument is that bitcoin and bitcoin markets
are ``not readily susceptible to manipulation,'' BZX has not
demonstrated that contention. Indeed, the Commission concludes,
consistent with its past practice, that surveillance-sharing
agreements with significant, regulated markets ensure that
commodity-trust ETPs are ``less readily susceptible to
manipulation.'' Exchange Act Release No. 35518 (Mar. 21, 1995), 60
FR 15804, 15807 (Mar. 27, 1995) (SR-Amex-94-30); accord Exchange Act
Release No. 82538 (Jan. 19, 2018), 83 FR 3807, 3810 (Jan. 26, 2018)
(SR-CboeBZX-2018-005) (``The Exchange has in place a surveillance
program for transactions in ETFs to ensure the availability of
information necessary to detect and deter potential manipulations
and other trading abuses, thereby making the Shares less readily
susceptible to manipulation.'').
---------------------------------------------------------------------------

(ii) Market Domination
While BZX argues that it is unlikely that any one actor could
obtain a dominant market share,\108\ BZX does not address the risk of
pre-existing dominant positions, a risk that the Lewis Letter
acknowledges.\109\ Similarly, while the Overdahl Letter maintains that
the existence of a dominant bitcoin exchange would not imply the
existence of a dominant ownership position, and that the existence of a
market with a large share of trading volume would make it more
difficult for a market participant to obtain a dominant ownership
position,\110\ the Overdahl Letter does not address the risk of pre-
existing dominant positions in bitcoin. The Lewis Letter, however,
specifically acknowledges this risk, noting: ``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.'' \111\ The Lewis Letter goes on to explain that
``[i]t is possible, and in fact, reasonably likely that a small group
of early bitcoin adopters hold a significant proportion of the bitcoin
that has thus far been created.'' \112\ Additionally, another commenter
contends that the majority of bitcoin is held by a few owners,
estimating that 50% of bitcoins are held by fewer than 1,000
people.\113\
---------------------------------------------------------------------------

\108\ See supra note 57 and accompanying text.
\109\ See supra note 68 and accompanying text.
\110\ See supra note 64 and accompanying text.
\111\ Lewis Letter I, supra note 65, at 6. The Lewis Letter
states that there is ``no compelling evidence'' to suggest that any
single investor or group has acquired a dominant position in
bitcoin, but its recognition that ``there is no registry showing
which individuals or entities own bitcoin or the quantity owned,''
and its citation of ``media estimates'' regarding the holdings of
certain individuals, demonstrates that there is some risk of a
person or group holding or acquiring a significant proportion of
bitcoins and that this risk should not be dismissed. Id. at 6 & n.7.
\112\ Lewis Letter I, supra note 65, at 6 (citing Amendment No.
4 to Form S-1 of SolidX Bitcoin Trust at 16). A recent letter from
Commission staff notes such concerns of ``potential manipulation in
the underlying cryptocurrency markets.'' Engaging on Fund Innovation
& Cryptocurrency-Related Holdings, 2018 WL 480851, at *1-2 (SEC No
Action Letter Jan. 18, 2018) (citing David Z. Morris, Could
Bitcoin's `Whales' Manipulate the Market?, Fortune (Dec. 10, 2017)).
See also Olga Kharif, The Bitcoin Whales: 1,000 People Who Own 40
Percent of the Market, Bloomberg Businessweek (Dec. 8, 2017),
available at https://www.bloomberg.com/news/articles/2017-12-08/the-bitcoin-whales-1-000-people-who-own-40-percent-of-the-market.
\113\ See supra note 72 and accompanying text.
---------------------------------------------------------------------------

The Lewis Letter argues that the nature of the spot bitcoin market
and the arbitrage mechanism should reduce the risk of manipulation
through ownership of a dominant market share,\114\ but this argument
addresses whether market participants might acquire a dominant share of
bitcoin ownership by trading in bitcoin markets

[[Page 37587]]

and does not address the potential market effect of large bitcoin
positions held by early adopters. Multiple academic studies have found
the existence of concentrated holdings in an asset presents a
meaningful risk of manipulation.\115\ Whether a dominant position came
from being an early adopter of bitcoin or from trading activity would
not alter the Commission's view that a person or group with a dominant
position may be capable of engaging in manipulative activity. The
Commission thus cannot, on the record before it, conclude that bitcoin
markets are uniquely resistant to manipulation.
---------------------------------------------------------------------------

\114\ See supra note 68 and accompanying text.
\115\ See, e.g., Craig Pirrong, The Economics of Commodity
Market Manipulation: A Survey, J. Commodity Mkt., Mar. 2017, at 1
(describing manipulation in commodities markets); Franklin Allen,
Lubomir P. Litov & Jianping Mei, Large Investors, Price
Manipulation, and Limits to Arbitrage: An Anatomy of Market Corners,
10 Rev. Finance 645 (2006) (describing manipulation in equity and
commodities markets).
---------------------------------------------------------------------------

(iii) Prior Regulatory Actions Regarding Bitcoin
Although commenters suggest that the CFTC has conclusively
determined that bitcoin markets are not susceptible to manipulation
because it has permitted the registration of bitcoin swap execution
facilities as consistent with the Commodity Exchange Act
(``CEA''),\116\ the CFTC has made no such sweeping finding as to
bitcoin or bitcoin spot markets either in permitting the registration
of those swap execution facilities or in more recently permitting the
self-certification by Chicago Mercantile Exchange Inc. (``CME'') and
Cboe Futures Exchange, LLC (``CFE'') of bitcoin futures contracts. The
Commission notes that CFTC Chairman Giancarlo has described
``heightened review'' of the CME and CFE self-certifications as
addressing the narrower question of whether the particular bitcoin
futures products and cash-settlement processes--under the specific
terms proposed by those two futures exchanges--were ``readily
susceptible to manipulation.'' \117\ And the CFTC stated that the self-
certification process for bitcoin futures contracts ``does NOT provide
for . . . value judgments about the underlying spot market,'' and U.S.
law ``does not provide for direct, comprehensive Federal oversight of
underlying Bitcoin or virtual currency spot markets.'' \118\
---------------------------------------------------------------------------

\116\ See supra note 75.
\117\ See Written Testimony of J. Christopher Giancarlo,
Chairman, Commodity Futures Trading Commission, Before the Senate
Banking Committee at text accompanying n.17 (Feb. 6, 2018)
(``Giancarlo Testimony''), available at https://cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo37. See also infra notes 285-288
(discussing role of CFTC with respect to underlying bitcoin spot
markets).
\118\ CFTC Backgrounder on Oversight of and Approach to Virtual
Currency Futures Markets (Jan. 4, 2018) (``CFTC Backgrounder''), at
1, 2, available at https://www.cftc.gov/idc/groups/public/@newsroom/documents/file/backgrounder_virtualcurrency01.pdf. See also infra
note 288.
---------------------------------------------------------------------------

Moreover, the CFTC's statutory authority to review new derivative
products differs substantially from the Commission's authority, under
Section 19(b) of the Exchange Act,\119\ with respect to the review of
proposed rule changes by SROs. While there are ``limited grounds'' for
the CFTC to take affirmative action to stay new product self-
certifications,\120\ the Commission must, to approve a proposed rule
change, make an affirmative finding that the proposed rule change is
consistent with the Exchange Act, with the burden of demonstrating
consistency with the Exchange Act resting with the SRO proposing the
rule change.\121\ The Commission is also mindful that the primarily
institutional markets that the CFTC supervises are materially different
from the securities markets in which many retail investors participate
directly. The CFTC acknowledges that ``[m]ost participants in the
futures markets are commercial or institutional commodities producers
or consumers'' and ``[t]rading commodity futures and options is a
volatile, complex and risky venture that is rarely suitable for
individual investors or `retail customers.' '' \122\
---------------------------------------------------------------------------

\119\ 15 U.S.C. 78s(b).
\120\ See CFTC Backgrounder, supra note 118, at 2.
\121\ See supra notes 8, 10-12 and accompanying text. Compare 7
U.S.C. 7a-2(c) and 17 CFR 40.6 with 15 U.S.C. 78(b)(1) and 17 CFR
240.19b-4.
\122\ Futures Market Basics, CFTC, available at https://www.cftc.gov/ConsumerProtection/EducationCenter/FuturesMarketBasics/index.htm. Furthermore, the record does not contain evidence about
whether CME or CFE can, in practice, actually obtain trading
information from bitcoin exchanges, and thus whether the CFTC can
obtain such information from CME or CFE.
---------------------------------------------------------------------------

Accordingly, the Commission cannot conclude that actions taken to
date by the CFTC determine whether the proposed bitcoin ETP is
consistent with the applicable requirements of the Exchange Act, and
the Commission must reach its own decision, under its own statutory
mandate, to determine whether the proposal is designed to ``protect
investors and the public interest.'' \123\
---------------------------------------------------------------------------

\123\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

2. Manipulation of the Gemini Exchange and the Gemini Auction
(a) Summary of Comments Received
BZX acknowledges in its comment letter that less-liquid markets,
such as the market for bitcoin, may be more easily manipulated, but
claims that these concerns are mitigated with respect to the Shares and
the trading on the Gemini Exchange. BZX asserts that the Gemini Auction
price is based on an extremely similar mechanism to the one leveraged
for BZX's own Opening and Closing Auctions and allows full and
transparent participation from all Gemini Exchange participants in the
price discovery process. BZX states that the auction process leverages
mechanics that have proven over the years to be robust and effective on
BZX and other national listing exchanges in both liquid and illiquid
securities alike. BZX argues that, because the time of the Gemini
Auction coincides with BZX's Closing Auction, efficient real-time
arbitrage between the closing price of the Trust and the Gemini Auction
price will be prevalent and will lead to resilient and effective
pricing of both the Trust and the underlying bitcoin asset, leading to
convergence between the Trust's closing price and its NAV.\124\ BZX
asserts that the Gemini Auction price typically deviates very little
from the prevailing price on other bitcoin exchanges, and BZX presents
statistics purporting to show that this price is consistent with the
prices of other U.S.-based exchanges.\125\
---------------------------------------------------------------------------

\124\ See BZX Letter I, supra note 35, at 8; BZX Letter II,
supra note 13, 10-11. See also SIG Letter, supra note 36, at 2-6;
C&C Letter, supra note 36, at 1.
\125\ See BZX Letter I, supra note 35, at 8-9.
---------------------------------------------------------------------------

BZX asserts that the Gemini Auction price is uniquely resistant to
manipulation and that it more accurately reflects the bitcoin price
than any other individual event or cross-market snapshot, because the
largest bitcoin transactions each day usually occur via the Gemini
Auction. BZX also claims that volumes transacted in the Gemini Auction
are generally more than 50% larger than the second-largest trade in the
world, drawing an average daily volume of 1,200 bitcoins compared to
approximately 800 bitcoins.\126\
---------------------------------------------------------------------------

\126\ See BZX Letter II, supra note 13, at 19-20.
---------------------------------------------------------------------------

In addition, BZX asserts that the Gemini Auction occurs at a
scheduled time each day to maximize participation and price formation,
while other liquidity events are often unpredictable and
irregular.\127\ Another commenter claims that the Gemini Auction also
concentrates liquidity and trading volume at a single moment each
day.\128\
---------------------------------------------------------------------------

\127\ See id. at 20.
\128\ See Overdahl Letter, supra note 36, at 11.
---------------------------------------------------------------------------

BZX further asserts that, from its launch through May 12, 2017, the
Gemini Auction price on business days has deviated from the Gemini
midpoint price (the midrange of the highest bid

[[Page 37588]]

and lowest offer prices) by 0.22% on average and 0.71% at most, that it
has deviated from the median price of all U.S.-based bitcoin exchanges
by 0.52% on average, and that it has deviated from the median price of
all global USD-denominated bitcoin exchanges by 0.70% on average.\129\
BZX also claims that the Gemini Exchange is regularly near the top of
bitcoin exchanges in terms of market-quality metrics for overall
trading.\130\
---------------------------------------------------------------------------

\129\ See BZX Letter II, supra note 13, at 20.
\130\ Id.
---------------------------------------------------------------------------

The Overdahl Letter asserts that the Gemini Auction price is
reliable in that it generally reflects bitcoin traded at other U.S.-
based bitcoin exchanges and bitcoin traded at USD-based exchanges
globally and that, when noticeable discrepancies appear, arbitrage
mechanisms quickly force prices back into alignment.\131\ The Overdahl
Letter provides some update to the statistics provided by BZX and
states that, from September 21, 2016 (the launch of the Gemini
Auction), to March 1, 2017, the average daily deviation of the Gemini
Auction price from the median 4:00 p.m. price of all U.S.-based bitcoin
exchanges was 0.0058 percent and the average absolute deviation (that
is, the average absolute value of deviations) was 0.1804 percent. The
Overdahl Letter also states that, during the same period, the average
daily deviation of the Gemini Auction price from the median 4:00 p.m.
price of all global USD-denominated bitcoin exchanges was 0.0489
percent with an average absolute deviation of 0.2398 percent.\132\
---------------------------------------------------------------------------

\131\ See Overdahl Letter, supra note 36, at 1.
\132\ See id. at 4.
---------------------------------------------------------------------------

The Overdahl Letter also contends that the surveillance agreement
between the Gemini Exchange and BZX allows for continuous monitoring of
trading activity to detect and deter manipulation of the Gemini Auction
price and that BZX's rules are reasonably designed to prevent
fraudulent and manipulative acts and practices with respect to
determining the NAV of the Trust Shares.\133\ The Overdahl Letter
further claims that the Gemini Auction is designed to not be readily
susceptible to manipulation because it includes pre-trading
transparency, which allows for full and transparent participation by
all participants, uses a mechanism similar to that used by other
exchanges in setting opening and closing prices, and concentrates
liquidity and trading volume in a single moment each day.\134\
Regarding the calculation of NAV, the Overdahl Letter also argues that
the Trust's valuation procedures greatly reduce the risk that a
malicious actor could influence the NAV of the Trust by manipulating
the Gemini Auction, because alternative means can be used to value the
Trust's bitcoin if the Trust sponsor determines that the Gemini Auction
price does not reflect the fair value of bitcoin.\135\
---------------------------------------------------------------------------

\133\ See id. at 2. Specifically, according to the Overdahl
Letter, the type of potential manipulation most relevant for
determining the NAV of the Trust's Shares would be a malicious actor
attempting to use the Gemini Auction price to influence the NAV of
the Trust. See id. at 11.
\134\ See Overdahl Letter, supra note 36, at 11.
\135\ See id. at 2.
---------------------------------------------------------------------------

Several commenters claim that the Gemini Exchange has low trading
volumes,\136\ and one commenter claims that, of all the exchanges,
Gemini has the worst pricing.\137\ Another commenter asserts that the
Gemini Exchange has relatively low liquidity and trade volume and that
there is a significant risk that the nominal ETP share price will be
manipulated by relatively small trades that manipulate the bitcoin
price at that exchange.\138\ This commenter states that, while U.S.-
based bitcoin exchanges are subjected to stricter regulations and
auditing for the holding of client accounts, the trading itself seems
to occur in a regulatory vacuum and seems impossible to audit
effectively.\139\ This commenter expresses concerns regarding the
Gemini Exchange Spot Price, noting that the nominal price of the Shares
under the proposal is supposed to be tied to the market price of
bitcoins at the Gemini Exchange, which is closely tied to the ETP
proponents.\140\
---------------------------------------------------------------------------

\136\ See, e.g., Maher Letter, supra note 35; Stolfi Letter I,
supra note 35; Anonymous Letter III, supra note 35.
\137\ See Anonymous Letter III, supra note 35.
\138\ See Stolfi Letter I, supra note 35; see also Stolfi Letter
II, supra note 35 (concluding that the Gemini Auction volume has
shown a decreasing trend since its inception and is now under $1
million USD during work days, and considerably less during weekends,
and that ``[w]ith such low volume, it seems possible to manipulate
the NAV value by entering suitable bids or asks in the auction'').
\139\ See Stolfi Letter II, supra note 35.
\140\ See Stolfi Letter I, supra note 35.
---------------------------------------------------------------------------

One commenter claims that most daily trading volume is conducted on
poorly capitalized, unregulated exchanges located outside the United
States and that these non-U.S. exchanges and their practices
significantly influence the price discovery process.\141\ Another
commenter states that the biggest and most influential bitcoin exchange
is located outside U.S. jurisdiction.\142\
---------------------------------------------------------------------------

\141\ See Williams Letter, supra note 35, at 2.
\142\ See Anonymous Letter V, supra note 35.
---------------------------------------------------------------------------

One commenter states that, since 2013, the price of bitcoin has
been defined mostly by the major Chinese exchanges, whose volumes dwarf
those of exchanges outside China, and that the price of bitcoin is
defined entirely by speculation, without any ties to fundamentals.\143\
Another commenter observes that Chinese markets drive much of the
volume in the bitcoin markets.\144\
---------------------------------------------------------------------------

\143\ See Stolfi Letter II, supra note 35.
\144\ See ARK Letter, supra note 35, at 5.
---------------------------------------------------------------------------

One commenter states that it makes sense to value the proposed ETP
based on the Gemini Auction because doing so would guarantee sufficient
liquidity and because other bitcoin trading venues are not subject to
the same level of oversight as the Gemini Exchange.\145\ Another
commenter asserts that the Gemini Auction is not a robust mechanism for
price discovery because Gemini's fee structure would make self-trading
or collusive wash trades between accounts profitable, which would
artificially inflate the volume of the Gemini Auction.\146\
---------------------------------------------------------------------------

\145\ See Delehanty Letter, supra note 35 (but noting that using
the Gemini Auction to value the ETP, which is also the sponsor of
the ETP, creates a potential conflict of interest).
\146\ See Anonymous Letter VIII, supra note 35.
---------------------------------------------------------------------------

One commenter states that the Gemini Auction could be an
improvement over other bitcoin pricing mechanisms, but asserts that the
Gemini Auction has not improved volume.\147\ The commenter observes
that the Gemini Auction data show that traders in the auction are
taking advantage of the discounted auction price. The commenter states
that the daily two-sided Gemini Auction process was designed to
maximize price discovery and reduce price volatility that could be the
result of momentum pricing, but asks what measures have been put in
place to address traders who take advantage of the discounted auction
price. The commenter also states that, while other financial products
sometimes have auctions to determine price, an auction on a stock
exchange does not require money to be deposited in advance with the
exchange to be in the auction. The commenter states that, by contrast,
the Gemini Exchange requires dollars or bitcoin to be deposited before
participation. The commenter believes that this is a problem because
the Gemini Auction is limited and has failed on at least two
occasions.\148\
---------------------------------------------------------------------------

\147\ See Anonymous Letter III, supra note 35.
\148\ See id.
---------------------------------------------------------------------------

Other commenters believe that the Gemini Exchange conducts
sufficient volume to support the Winklevoss Bitcoin Trust. One
commenter states that trading volume on the Gemini Exchange is
sufficient and that

[[Page 37589]]

manipulation of these Shares, while possible, would equally be possible
for other exchange-traded funds.\149\ Another commenter asserts that
trading volume in the recent Gemini bitcoin daily auctions seemed ``to
be of reasonable size.'' \150\
---------------------------------------------------------------------------

\149\ See Anonymous Letter I, supra note 35.
\150\ See Delehanty Letter, supra note 35.
---------------------------------------------------------------------------

One commenter claims that there are more robust ways to value the
Trust's holdings than using the spot price of a single exchange, such
as the Gemini Exchange.\151\ The commenter also states that the Gemini
Exchange typically processes less than 10% of the total volume in the
bitcoin/USD pair and states that an index of the most reliable
exchanges should be constructed to value the Trust's holdings. The
commenter questions whether using only the Gemini Exchange's spot price
could serve to incentivize Authorized Participants and other market
participants to direct traffic and flow to Gemini, at the expense of
best execution.\152\
---------------------------------------------------------------------------

\151\ See ARK Letter, supra note 35, at 7-8.
\152\ See id. at 8-9.
---------------------------------------------------------------------------

Another commenter takes a different view on the merits of single-
versus multiple-price sources. This commenter observes that bitcoin
spot prices diverge across exchanges due to various factors and that
some exchanges may suffer from lack of oversight and a lack of
transparency or fairness. The commenter claims that these facts
strengthen the case for an investment product that does not rely on the
spot price of less-credible exchanges to value its holdings and instead
relies on the spot price on the Gemini Exchange, which is subject to
substantive regulation of its exchange activity and custody of assets
by the NYSDFS. This commenter also states that, while leveraged trading
on some other exchanges has historically sparked excessive price
volatility and instability, Gemini does not offer such products and
would be able to serve as a trusted, regulated spot exchange for
institutional market participants driving the arbitrage mechanism that
ensures efficient pricing between the spot price and the Shares. The
commenter claims that the Gemini Exchange has the potential for more-
robust price discovery as liquidity is concentrated on that
exchange.\153\
---------------------------------------------------------------------------

\153\ See Circle Letter, supra note 35, at 2.
---------------------------------------------------------------------------

One commenter states that there is an inherent trade-off to using
one exchange versus an average of several exchanges, some of which may
be less scrupulous. The commenter acknowledges that manipulation is a
legitimate concern, but notes that it is not uncommon to see a very
small number of physical trades determine the base price for a much
larger paper market.\154\
---------------------------------------------------------------------------

\154\ See Delehanty Letter, supra note 35.
---------------------------------------------------------------------------

Other commenters view the risk of manipulation as more significant.
One commenter states that it would be surprising if manipulative
practices that would be illegal in other financial markets did not
occur on certain bitcoin exchanges that experience lack of regulations
and oversight, since these practices would be easy to implement,
impossible to detect, perfectly legal under the rules applicable to
those bitcoin exchanges, and extremely lucrative.\155\ This commenter
also states that the Gemini Auction closing volumes have been low and
have shown a slight decreasing trend since the inception of the Gemini
Auction. The commenter states that, with low volumes, it seems possible
to manipulate the NAV by entering suitable bids or asks in the Gemini
Auction.\156\ Another commenter agrees that bitcoin traders can
manipulate trading on the Gemini Exchange because of its low trading
volumes and notes that the Trust's documentation states that momentum
pricing of bitcoin has resulted, and may continue to result, in
speculation regarding future appreciation in the value of bitcoin,
making the price of bitcoin more volatile.\157\ The commenter states
that the value of bitcoin may therefore be more likely to fluctuate due
to changing investor confidence in future appreciation in the Gemini
Auction price, which could adversely affect an investment in the
Shares.\158\ According to another commenter, in this unregulated
environment, price manipulation and front-running of large buy or sell
orders can happen and well-connected customers can gain preferential
treatment in order execution.\159\
---------------------------------------------------------------------------

\155\ See Stolfi Letter II, supra note 35.
\156\ See id.
\157\ See Anonymous Letter III, supra note 35.
\158\ See id.
\159\ See Williams Letter, supra note 35, at 2.
---------------------------------------------------------------------------

(b) Discussion
For the reasons discussed below, the Commission concludes that BZX
has not demonstrated that the Gemini Exchange and the Gemini Auction
are resistant to manipulation. Commenters disagree about whether the
Gemini Exchange and the Gemini Auction are susceptible to manipulation.
BZX promotes the Gemini Exchange as one of the top three bitcoin
exchanges in the United States,\160\ and some commenters believe that
the Gemini Exchange conducts sufficient volume to support the
Winklevoss Bitcoin Trust.\161\ Other commenters, however, question
these assertions, some noting that the majority of bitcoin trading,
including trading denominated in USD, occurs on unregulated exchanges
outside the United States,\162\ and one suggesting that the low
liquidity and trading volume on the Gemini Exchange create a
significant risk that the ETP share price could be manipulated by
relatively small trades.\163\
---------------------------------------------------------------------------

\160\ See supra note 130 and accompanying text.
\161\ See supra notes 149-150 and accompanying text.
\162\ See supra notes 141-144 and accompanying text.
\163\ See supra note 138 and accompanying text.
---------------------------------------------------------------------------

While BZX claims in its May 2017 comment letter that the average
volume of the Gemini Auction is 1,200 bitcoins,\164\ calculations based
on public data from the Gemini Exchange website show that more recent
Gemini Auction volume has been significantly lower. As of March 31,
2018, the average number of bitcoins traded in the Gemini Auction on a
business day was just 178.07 bitcoins over the previous month, 122.20
bitcoins over the previous three months, and 138.46 bitcoins over the
previous six months. Median volume figures for the same periods are
even lower: 146.51 bitcoins, 85.09 bitcoins, and 90.42 bitcoins,
respectively. Although the Gemini Exchange conducts the Gemini Auction
on each calendar day, to better represent auction volume for days on
which creations or redemptions might occur in the Shares, these
calculations of average and median auction volume exclude auctions that
occurred on weekends and days on which the U.S. equities markets were
closed. Days on which no Gemini Auction price was reached were also
excluded to avoid skewing data.
---------------------------------------------------------------------------

\164\ See BZX Letter II, supra note 13, at 20.
---------------------------------------------------------------------------

The volume of the Gemini Auction is of particular relevance to
BZX's proposal, and to the susceptibility of the ETP shares to
manipulation, because the Gemini Auction price is used to determine the
NAV of the Trust, which is publicly disseminated and which is the price
used for creation and redemption transactions. Taking into account the
recent low auction volume calculated above, which is a small fraction
of the 1,000 bitcoins in a creation or redemption basket,\165\ the
Commission concludes that there is a substantial risk that either (1)
any creation and redemption activity in the

[[Page 37590]]

Trust would have a substantial effect on the Trust's pricing or (2)
Authorized Participants would be forced to source bitcoins on other
venues where prices may or may not be aligned with that of the Gemini
Auction, limiting the purported effectiveness of arbitrage.
---------------------------------------------------------------------------

\165\ See Amendment No. 2, supra note 1 (setting size of
creation unit at 100,000 shares, with the value of a share at 0.01
bitcoin, making content of a creation unit 1,000 bitcoins).
---------------------------------------------------------------------------

Additionally, given the current disparity between the Gemini
Auction volume and the trading volume that would equal a creation
unit--and the resulting likelihood that creation or redemption activity
would substantially affect the Gemini Auction price--BZX has not shown
that the ability of the Trust to use other criteria to value the
Trust's bitcoins in ``extraordinary circumstances'' \166\ adequately
addresses the risk that creations and redemptions, or manipulative
activity such as front running, may affect the Gemini Auction price on
an ordinary day. In light of the risks that creation and redemption
activity may substantially affect the Gemini Auction price--and that
the use of other valuation criteria may fail to address the effects of
creation and redemption activity or of manipulative activity--the
Commission cannot conclude that the bitcoin pricing mechanism of the
Trust is uniquely resistant to manipulation.
---------------------------------------------------------------------------

\166\ See supra note 30.
---------------------------------------------------------------------------

Further, given that recent Gemini Auction volumes are inadequate to
support creation or redemption activity, BZX has not sufficiently
supported its claim that the design and mechanisms of the Gemini
Auction would allow for efficient arbitrage between the Shares and the
underlying bitcoin. Similarly, the statistics offered by BZX and the
Overdahl Letter to argue that the Gemini Auction creates a price
closely aligned with U.S.-based and global USD-denominated bitcoin
exchanges do not establish that bitcoin trading on the Gemini Exchange
is uniquely resistant to manipulation because these statistics do not
reflect, and cannot predict, the dynamics of trading on the Gemini
Exchange if the Gemini Auction were used as the basis to calculate NAV
for the Trust. Given the small size of the Gemini Auction relative to
the size of a creation unit, the launch of the proposed ETP would be
likely to fundamentally affect supply and demand in the Gemini Auction,
and the use of the Gemini Auction price to calculate NAV would
introduce a significant incentive to manipulate the Gemini Auction that
does not currently exist. The Commission cannot therefore conclude that
arbitrage would render the Shares uniquely resistant to manipulation.
The Trust's Registration Statement acknowledges that the reliance
on a single bitcoin exchange has risks to shareholders in the Trust:
``Trading on a single Bitcoin Exchange may result in less favorable
prices and decreased liquidity for the Trust and, therefore, could have
an adverse effect on the Trust and Shareholders.'' \167\ Moreover,
although commenters have suggested that approval of the proposal would
naturally lead to greater activity in the Gemini Auction,\168\ such
speculation does not provide an adequate basis to decide that future
Gemini Auction volume would be sufficient to prevent manipulation of
the Gemini Auction from affecting the NAV of the Trust, and BZX has not
explained how the favorable market quality metrics it attributes to the
Gemini Exchange would be affected if trading interest at the Gemini
Auction were dominated by creation and redemption activity.\169\
Therefore, again, the Commission cannot conclude that the pricing
mechanism of the Trust would render the Shares uniquely resistant to
manipulation.
---------------------------------------------------------------------------

\167\ Registration Statement, supra note 22, at 22.
\168\ See Maher Letter, supra note 35; Overdahl Letter, supra
note 36, at 3; SIG Letter, supra note 36, at 8.
\169\ See supra note 130 and accompanying text.
---------------------------------------------------------------------------

C. The Availability of ``Traditional Means'' To Detect and Deter Fraud
and Manipulation

BZX has not demonstrated, given the current absence of a
surveillance-sharing agreement with a regulated bitcoin market of
significant size, that the alternative surveillance procedures BZX
purports to identify--including BZX's assertion that it would be able
to obtain certain information regarding trading in the Shares and in
the underlying bitcoin or any bitcoin derivative--would be sufficient
to satisfy the requirement of Exchange Act Section 6(b)(5) that an
exchange's rules be designed to prevent fraudulent and manipulative
acts and practices.
1. Summary of Comments Received
BZX asserts that the March Disapproval Order failed to appreciate
that the proposal provides ``traditional means of identifying and
deterring fraud and manipulation'' that meet the criteria that the
Commission has utilized in approving other commodity-trust ETPs.\170\
BZX states that a particular area of surveillance focus for the
Commission in prior commodity-trust ETP approval orders was the
implementation of exchange rules requiring market makers in the
commodity-trust ETP shares to disclose their dealings in the underlying
commodities. BZX contends that analogous requirements are included in
this proposal, with BZX Rule 14.11(e)(4) mandating that market makers
in the Shares disclose all of their commodity trading accounts,
disclose all trading in bitcoin or bitcoin derivatives, and make
available all related books and records.\171\ BZX also contends that,
in the prior commodity-trust ETP approval orders, the Commission also
reviewed the adequacy of the ETP listing exchange's rules and
procedures for surveillance of trading activity in the ETP shares.
According to BZX, similar surveillance rules and procedures are in
place at BZX regarding the proposed bitcoin ETP, as the listing
exchange can obtain information regarding trading in Shares from
Intermarket Surveillance Group members and affiliate members, as well
as trading information available on the blockchain and information
available through a surveillance-sharing agreement with the Gemini
Exchange.\172\
---------------------------------------------------------------------------

\170\ See BZX Letter II, supra note 13, at 22, 26.
\171\ See id. at 23.
\172\ See id. The surveillance-sharing agreement between BZX and
the Gemini Exchange is discussed in Section III.E.1, infra.
---------------------------------------------------------------------------

The Overdahl Letter also contends that BZX's rules are reasonably
designed to prevent fraudulent and manipulative acts and practices with
respect to determining the NAV of the Trust Shares.\173\ Specifically,
according to the Overdahl Letter, the type of potential manipulation
most relevant for determining the NAV of the Trust's Shares would be a
malicious actor attempting to use the Gemini Auction price to influence
the NAV of the Trust. The Overdahl Letter also asserts that, in
addition to BZX's surveillance procedures and anti-manipulation rules,
penalties for engaging in manipulative conduct serve as a deterrent
against manipulation of the Gemini Auction price and the resulting
Trust's NAV. The Overdahl Letter states that, although a penalty is
applied after a manipulation occurs or is attempted, penalties are
nonetheless a useful tool for deterring, and therefore preventing,
manipulation.\174\
---------------------------------------------------------------------------

\173\ See Overdahl Letter, supra note 36, at 2.
\174\ See id. at 11.
---------------------------------------------------------------------------

Finally, one commenter claims that the March Disapproval Order
reflects the Commission's ``unspoken but obvious concern'' with
bitcoin, and argues that this issue can be cured by having the bitcoin
exchange sign a memorandum of understanding with the Commission to
share information.\175\
---------------------------------------------------------------------------

\175\ See Convergex Letter, supra note 36, at 2.

---------------------------------------------------------------------------

[[Page 37591]]

2. Discussion
The Commission concludes that BZX has not demonstrated--given the
current absence of a surveillance-sharing agreement with a regulated
bitcoin market of significant size--that the alternative surveillance
procedures discussed above would, by themselves, be sufficient to
satisfy the requirement of Exchange Act Section 6(b)(5) that an
exchange's rules be designed to prevent fraudulent and manipulative
acts and practices.\176\
---------------------------------------------------------------------------

\176\ See 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

While BZX would, pursuant to its listing rules, be able to obtain
certain information regarding trading in the Shares and in the
underlying bitcoin or any bitcoin derivative through registered market
makers,\177\ this trade information would be limited to the activities
of members who were registered with BZX as market makers in the Shares
and would not encompass all BZX market participants.\178\ Furthermore,
neither BZX's ability to surveil trading in the Shares nor its ability
to share surveillance information with other securities exchanges
trading the Shares would give BZX insight into the activity and
identity of market participants trading in the underlying bitcoin in
the OTC market or on other bitcoin trading venues.
---------------------------------------------------------------------------

\177\ See supra note 171 and accompanying text.
\178\ See BZX Rule 14.11(e)(4)(G).
---------------------------------------------------------------------------

Additionally, while BZX represents that it can obtain information
about bitcoin trading made publicly available through the bitcoin
blockchain,\179\ the blockchain identifies parties to a transaction
only by a pseudonymous public-key address, and it does not distinguish
bitcoin trading activity from other transfers of bitcoin (e.g., for
remittances, purchases of goods or services, or other purposes).
Therefore, the public blockchain ledger, even in combination with the
other monitoring abilities BZX identifies, does not provide
comprehensive customer trading or identity information, which is
particularly important here because pseudonymous bitcoin account
holding means, among other things, that the number of accounts or
number of trades would not reveal whether a person or group has a
dominant ownership position in bitcoin, or is using or attempting to
use a dominant ownership position to manipulate bitcoin pricing.\180\
---------------------------------------------------------------------------

\179\ See Amendment No. 1, supra note 1, 81 FR at 76668.
\180\ See also Section III.B.1(b)(ii), supra (discussing market
domination).
---------------------------------------------------------------------------

One commenter asserts that existing ``penalties for engaging in
manipulative conduct'' can serve to deter manipulation of the Gemini
Auction price and, therefore, the Trust's NAV.\181\ However, the
Commission concludes that, based on the facts and circumstances of this
proposal, the ability of relevant authorities to potentially sanction
manipulative activity after the fact--if it is discovered--is
insufficient, by itself, to meet BZX's obligation to have rules
``designed to prevent fraudulent and manipulative acts and practices.''
\182\ Before penalties can be imposed for engaging in manipulative
conduct, such conduct must be detected and investigated; as discussed
below, that is the necessary function of comprehensive surveillance-
sharing agreements.\183\ Moreover, as discussed below, a substantial
majority of bitcoin trading occurs outside the United States,\184\ and
even within the United States, there is no comprehensive federal
oversight of bitcoin spot markets.\185\
---------------------------------------------------------------------------

\181\ See supra note 174 and accompanying text.
\182\ 15 U.S.C. 78f(b)(5) (emphasis added).
\183\ See Section III.D, infra.
\184\ See infra notes 281-282 and accompanying text.
\185\ See infra notes 286-288 and accompanying text.
---------------------------------------------------------------------------

Another commenter suggests that the Commission sign a Memorandum of
Understanding (``MOU'') with the Gemini Exchange to address what the
commenter claims is the Commission's unspoken but obvious concern with
bitcoin.\186\ While the Commission is a party to several MOUs, these
are generally arrangements with other foreign or domestic
regulators.\187\ MOUs are tools to assist the Commission in performing
its regulatory functions, not a mechanism for the Commission to assume
an SRO's obligations under the Exchange Act.
---------------------------------------------------------------------------

\186\ See supra note 175 and accompanying text.
\187\ See, e.g., Memorandum of Understanding Between the
Internal Revenue Service and the Securities and Exchange Commission
for Tax Exempt Bonds/Municipal Securities Compliance (Mar. 2, 2010),
available at https://www.sec.gov/info/municipal/sec-irs-mou030210.pdf; Memorandum of Understanding Between the U.S.
Securities and Exchange Commission and the U.S. Commodity Futures
Trading Commission Regarding Coordination in Areas of Common
Regulatory Interest (Mar. 11, 2008), available at https://www.sec.gov/news/press/2008/2008-40_mou.pdf; and Memorandum of
Understanding Between the U.S. Securities and Exchange Commission
and the U.S. Commodity Futures Trading Commission Regarding the
Oversight of Security Futures Product Trading and the Sharing of
Security Futures Product Information (Mar. 17, 2004), available at
https://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/file/moubetweencftcandsec031704.pdf.
---------------------------------------------------------------------------

D. The Use of Surveillance-Sharing Agreements To Detect and Deter
Fraudulent and Manipulative Acts and Practices With Respect to
Commodity-Trust ETPs

The Commission has historically recognized the importance of
comprehensive surveillance-sharing agreements to detect and deter
fraudulent and manipulative activity. Because BZX has not demonstrated
that bitcoin and bitcoin markets are uniquely resistant to
manipulation--or that alternative means of detecting and deterring
fraud and manipulation are sufficient in the absence of a surveillance-
sharing agreement with a significant, regulated market related to
bitcoin--the absence of such an agreement compels the Commission to
conclude that the proposed rule change must be disapproved.
1. Summary of Comments Received
BZX claims that the March Disapproval Order overstates the extent
to which surveillance and regulation of the underlying market have been
present in prior commodity-trust ETP approval orders, asserting that
none of these orders ``offers even a cursory analysis about whether the
regulated markets for trading futures on the underlying commodity are
`well-established' or `significant.' '' \188\ In particular, BZX argues
that the Commission orders approving the ETFS Platinum Trust ETP
(``Platinum Order'') and the ETFS Palladium Trust ETP (``Palladium
Order''),\189\ along with their exchange filings, discuss neither
whether the New York Mercantile Exchange (``NYMEX'') and the Tokyo
Commodity Exchange (``TOCOM'') are well-established or significant, nor
the relevance of NYMEX being the largest exchange in the world for
trading palladium and platinum derivatives.\190\ BZX claims that--
because the exchange filings regarding the platinum and palladium ETPs
note that TOCOM is not a member of the Intermarket Surveillance Group
and that the respective listing exchange did not have a comprehensive
surveillance-sharing agreement with TOCOM--those approval orders did
not require the existence of an information-sharing agreement with the
underlying

[[Page 37592]]

exchange.\191\ BZX further asserts that the Platinum Order and
Palladium Order discuss only whether the listing exchange (1) can
obtain information from market makers relating to their trading in the
applicable commodity or related derivatives; (2) has a rule preventing
market makers from using material, nonpublic information regarding
trading in the underlying commodity or its derivatives; and (3) can
obtain trading information via the Intermarket Surveillance Group from
other Intermarket Surveillance Group member exchanges.\192\
---------------------------------------------------------------------------

\188\ See BZX Letter II, supra note 13, at 26-27.
\189\ See Exchange Act Release No. 61219 (Dec. 22, 2009), 74 FR
68886 (Dec. 29, 2009) (SR-NYSEArca-2009-95) (approving ETFS Platinum
Trust); Exchange Act Release No. 61220 (Dec. 22, 2009), 74 FR 68895
(Dec. 29, 2009) (SR-NYSEArca-2009-94) (approving ETFS Palladium
Trust).
\190\ See BZX Letter II, supra note 13, at 27.
\191\ See id. at 27-28.
\192\ See id. at 27.
---------------------------------------------------------------------------

BZX further asserts that, while the potential avenues for
manipulation noted in the March Disapproval Order are a risk, these
potential avenues of manipulation of the bitcoin market also exist in
the context of other commodity-trust ETPs.\193\ BZX asserts that, in
the Commission order approving the listing and trading of shares of
iShares Copper Trust (``Copper Order''),\194\ the Commission found that
demand from new investors would broaden the investor base in copper and
thereby reduce the risk of collusion among copper market participants.
BZX also argues that the Commission ``took comfort'' in approving the
iShares Copper Trust because trading of the shares would be subject to
the oversight of the listing exchange and the Commission, and because
the manipulation of physical copper would be subject to CFTC
jurisdiction. BZX asserts that the Trust is nearly identically situated
to the iShares Copper Trust.\195\ Similarly, the Lewis Letter asserts
that many features of a similar bitcoin commodity-trust ETP proposal--
features 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 another copper commodity-trust
ETP.\196\
---------------------------------------------------------------------------

\193\ See Petition for Review, supra note 4, at 12. The Overdahl
Letter agrees with this assertion by BZX. See Overdahl Letter, supra
note 36, at 10.
\194\ See Exchange Act Release No. 68973 (Feb. 22, 2013), 78 FR
13726 (Feb. 28, 2013) (SR-NYSEArca-2012-66) (approving iShares
Copper Trust).
\195\ See BZX Letter II, supra note 13, at 13-14; see also id.
at 25.
\196\ See Lewis Letter I, supra note 65, at 6 & n.8 (referring
to the SolidX Bitcoin Trust, see SolidX Order, supra note 65, and to
the JPM XF Physical Copper Trust, Exchange Act Release No. 68440
(Dec. 14, 2012), 77 FR 75468 (Dec. 20, 2012) (SR-NYSEArca-2012-28)).
---------------------------------------------------------------------------

BZX contends that previous ETP approvals demonstrate that the
factors used to determine whether currency-derivative products are
consistent with the Exchange Act should also apply to commodity-trust
ETPs. BZX argues that the Commission order approving the listing and
trading of the streetTRACKS Gold Shares (``Gold Order'') \197\--the
first commodity-trust ETP--was based on an assumption that the currency
market and the spot gold market were largely unregulated, but found
that certain factors mitigated the concerns arising from the
unregulated underlying markets.\198\ BZX claims that, in determining
whether a commodity-trust ETP is consistent with the Exchange Act, the
Commission's approval orders have included an analysis of previously
approved derivative products for which the underlying reference assets
(1) are traded OTC; (2) are largely unregulated; and (3) are traded on
markets with which the ETP listing exchange could not enter into a
surveillance sharing agreement.\199\ While BZX concedes that the
Commission has not approved a commodity-trust ETP when there were no
derivatives markets related to the underlying commodity, BZX points out
that the Commission has approved a number of currency-trust ETPs and
asserts that the Commission approved the listing and trading of the
CurrencyShares Hong Kong Dollar Trust and the CurrencyShares Singapore
Dollar Trust based largely on the same factors that the Commission has
considered in approving commodity-trust ETPs, despite a statement in
the approval order for the CurrencyShares Hong Kong Dollar Trust and
the CurrencyShares Singapore Dollar Trust that futures or options are
not traded on the Hong Kong Dollar or Singapore Dollar.\200\ Similarly,
one commenter argues that there are several commodity-based and other
ETPs where the underlying market is either unregulated or lightly
regulated, such as foreign-exchange linked or related ETPs, or
commodity-based ETPs that hold the underlying and not the derivative
product.\201\
---------------------------------------------------------------------------

\197\ See Exchange Act Release No. 50603 (Oct. 28, 2004), 69 FR
64614 (Nov. 5, 2004) (SR-NYSE-2004-22) (approving streetTRACKS Gold
Shares).
\198\ See BZX Letter II, supra note 13, at 28-29.
\199\ See id. at 29.
\200\ See id. at 28 n.59. See also Exchange Act Release No.
58365 (Aug. 14, 2008), 73 FR 49522 (Aug. 21, 2008) (SR-NYSEArca-
2008-81) (approving CurrencyShares Hong Kong Dollar Trust,
CurrencyShares Singapore Dollar Trust, and two other issues of
CurrencyShares based on non-U.S. currencies).
\201\ See Convergex Letter, supra note 36, at 2.
---------------------------------------------------------------------------

2. Discussion
(a) The History and Importance of Surveillance-Sharing Agreements
Relating to Derivative Securities Products
Although BZX claims to have described ``traditional means'' of
identifying and deterring fraud and manipulation, it overlooks the fact
that the Commission has long recognized the importance of comprehensive
surveillance-sharing agreements to detect and deter fraudulent and
manipulative activity.\202\ The hallmarks

[[Page 37593]]

of such an agreement are that the agreement provides for the sharing of
information about market trading activity, clearing activity, and
customer identity; that the parties to the agreement have reasonable
ability to obtain access to and produce requested information; and that
no existing rules, laws, or practices would impede one party to the
agreement from obtaining this information from, or producing it to, the
other party.\203\
---------------------------------------------------------------------------

\202\ See streetTRACKS Gold Shares, Exchange Act Release No.
50603 (Oct. 28, 2004), 69 FR 64614, 64618-19 (Nov. 5, 2004) (SR-
NYSE-2004-22); iShares COMEX Gold Trust, Exchange Act Release No.
51058 (Jan. 19, 2005), 70 FR 3749, 3751, 3754-55 (Jan. 26, 2005)
(SR-Amex-2004-38); iShares Silver Trust, Exchange Act Release No.
53521 (Mar. 20, 2006), 71 FR 14967, 14968, 14973-74 (Mar. 24, 2006)
(SR-Amex-2005-072); ETFS Gold Trust, Exchange Act Release No. 59895
(May 8, 2009), 74 FR 22993, 22994-95, 22998, 23000 (May 15, 2009)
(SR-NYSEArca-2009-40); ETFS Silver Trust, Exchange Act Release No.
59781 (Apr. 17, 2009), 74 FR 18771, 18772, 18775-77 (Apr. 24, 2009)
(SR-NYSEArca-2009-28); ETFS Palladium Trust, Exchange Act Release
No. 61220 (Dec. 22, 2009), 74 FR 68895, 68896 (Dec. 29, 2009) (SR-
NYSEArca-2009-94) (notice of proposed rule change included NYSE
Arca's representation that ``[t]he 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, Exchange Act Release No. 60971 (Nov. 9,
2009), 74 FR 59283, 59285-86, 59291 (Nov. 17, 2009)); ETFS Platinum
Trust, Exchange Act Release No. 61219 (Dec. 22, 2009), 74 FR 68886,
68887-88 (Dec. 29, 2009) (SR-NYSEArca-2009-95) (notice of proposed
rule change included NYSE Arca's representation that ``[t]he most
significant platinum 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, Exchange Act
Release No. 60970 (Nov. 9, 2009), 74 FR 59319, 59321, 59327 (Nov.
17, 2009)); Sprott Physical Gold Trust, Exchange Act Release No.
61496 (Feb. 4, 2010), 75 FR 6758, 6760 (Feb. 10, 2010) (SR-NYSEArca-
2009-113) (notice of proposed rule change included NYSE Arca's
representation 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,
Exchange Act Release No. 61236 (Dec. 23, 2009), 75 FR 170, 171, 174
(Jan. 4, 2010)); Sprott Physical Silver Trust, Exchange Act Release
No. 63043 (Oct. 5, 2010), 75 FR 62615, 62616, 62619, 62621 (Oct. 12,
2010) (SR-NYSEArca-2010-84); ETFS Precious Metals Basket Trust,
Exchange Act Release No. 62692 (Aug. 11, 2010), 75 FR 50789, 50790
(Aug. 17, 2010) (SR-NYSEArca-2010-56) (notice of proposed rule
change included 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 COMEX is a member, Exchange Act Release No. 62402 (Jun. 29,
2010), 75 FR 39292, 39295, 39298 (July 8, 2010)); ETFS White Metals
Basket Trust, Exchange Act Release No. 62875 (Sept. 9, 2010), 75 FR
56156, 56158 (Sept. 15, 2010) (SR-NYSEArca-2010-71) (notice of
proposed rule change included 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, Exchange Act Release No. 62620 (July 30,
2010), 75 FR 47655, 47657, 47660 (Aug. 6, 2010)); ETFS Asian Gold
Trust, Exchange Act Release No. 63464 (Dec. 8, 2010), 75 FR 77926,
77928 (Dec. 14, 2010) (SR-NYSEArca-2010-95) (notice of proposed rule
change included 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, Exchange Act
Release No. 63267 (Nov. 8, 2010), 75 FR 69494, 69496, 69500-01 (Nov.
12, 2010)); Sprott Physical Platinum and Palladium Trust, Exchange
Act Release No. 68430 (Dec. 13, 2012), 77 FR 75239, 75240-41 (Dec.
19, 2012) (SR-NYSEArca-2012-111) (notice of proposed rule change
included 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 trading information via the Intermarket Surveillance
Group,'' of which COMEX is a member, Exchange Act Release No. 68101
(Oct. 24, 2012), 77 FR 65732, 65733, 65739 (Oct. 30, 2012)); APMEX
Physical--1 oz. Gold Redeemable Trust, Exchange Act Release No.
66930 (May 7, 2012), 77 FR 27817, 27818 (May 11, 2012) (SR-NYSEArca-
2012-18) (notice of proposed rule change included NYSE Arca's
representation that NYSE Arca ``may obtain trading information via
the Intermarket Surveillance Group,'' of which COMEX is a member,
and that gold futures are traded on COMEX and the Tokyo Commodity
Exchange, with a cross-reference to the proposed rule change to list
and trade shares of the ETFS Gold Trust, in which NYSE Arca
represented that COMEX is one of the ``major world gold markets,''
Exchange Act Release No. 66627 (Mar. 20, 2012), 77 FR 17539, 17542-
43, 17547 (Mar. 26, 2012)); JPM XF Physical Copper Trust, Exchange
Act Release No. 68440 (Dec. 14, 2012), 77 FR 75468, 75469-70, 75472,
75485-86 (Dec. 20, 2012) (SR-NYSEArca-2012-28); iShares Copper
Trust, Exchange Act Release No. 68973 (Feb. 22, 2013), 78 FR 13726,
13727, 13729-30, 13739-40 (Feb. 28, 2013) (SR-NYSEArca-2012-66);
First Trust Gold Trust, Exchange Act Release No. 70195 (Aug. 14,
2013), 78 FR 51239, 51240 (Aug. 20, 2013) (SR-NYSEArca-2013-61)
(notice of proposed rule change included NYSE Arca's representation
that FINRA, on behalf of the exchange, may obtain trading
information regarding gold futures and options on gold futures from
members of the Intermarket Surveillance Group, including COMEX, or
from markets ``with which [NYSE Arca] has in place a comprehensive
surveillance sharing agreement,'' and that gold futures are traded
on COMEX and the Tokyo Commodity Exchange, with a cross-reference to
the proposed rule change to list and trade shares of the ETFS Gold
Trust, in which NYSE Arca represented that COMEX is one of the
``major world gold markets,'' Exchange Act Release No. 69847 (June
25, 2013), 78 FR 39399, 39400, 39405 (July 1, 2013)); Merk Gold
Trust, Exchange Act Release No. 71378 (Jan. 23, 2014), 79 FR 4786,
4786-87 (Jan. 29, 2014) (SR-NYSEArca-2013-137) (notice of proposed
rule change included NYSE Arca's representation that ``COMEX is the
largest gold futures and options exchange'' and that NYSE Arca ``may
obtain trading information via the Intermarket Surveillance Group,''
including with respect to transactions occurring on COMEX pursuant
to CME and NYMEX's membership, or from exchanges ``with which [NYSE
Arca] has in place a comprehensive surveillance sharing agreement,''
Exchange Act Release No. 71038 (Dec. 11, 2013), 78 FR 76367, 76369,
76374 (Dec. 17, 2013)); Long Dollar Gold Trust, Exchange Act Release
No. 79518 (Dec. 9, 2016), 81 FR 90876, 90881, 90886, 90888 (Dec. 15,
2016) (SR-NYSEArca-2016-84).
\203\ See, e.g., Letter from Brandon Becker, Director, Division
of Market Regulation, Commission, to Gerard D. O'Connell, Chairman,
Intermarket Surveillance Group (June 3, 1994), available at https://www.sec.gov/divisions/marketreg/mr-noaction/isg060394.htm.
---------------------------------------------------------------------------

Since at least 1990, the Commission has explained 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 possible trading violations and other regulatory
improprieties.'' \204\ The Commission has also long taken the position
that surveillance-sharing agreements are important in the context of
exchange listing of derivative security products, such as equity
options. In 1994, the Commission stated:
---------------------------------------------------------------------------

\204\ See Exchange Act Release No. 27877 (Apr. 4, 1990), 55 FR
13344, 13345 (Apr. 10, 1990) (SR-NYSE-90-14).

As a general matter, the Commission believes that the existence
of a surveillance sharing agreement that effectively permits the
sharing of information between an exchange proposing to list an
equity option and the exchange trading the stock underlying the
equity option is necessary to detect and deter market manipulation
and other trading abuses. In particular, the Commission notes that
surveillance sharing agreements provide an important deterrent to
manipulation because they facilitate the availability of information
needed to fully investigate a potential manipulation if it were to
occur. These agreements are especially important in the context of
derivative products based on foreign securities because they
facilitate the collection of necessary regulatory, surveillance and
other information from foreign jurisdictions.\205\
---------------------------------------------------------------------------

\205\ 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). The Commission further
stated that it ``generally believes that having a comprehensive
surveillance sharing agreement in place, between the exchange where
the ADR option trades and the exchange where the foreign security
underlying the ADR primarily trades, will ensure the integrity of
the marketplace. The Commission further believes that the ability to
obtain relevant surveillance information, including, among other
things, the identity of the ultimate purchasers and sellers of
securities, is an essential and necessary component of a
comprehensive surveillance sharing agreement.'' Id.

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.'' \206\
---------------------------------------------------------------------------

\206\ See Exchange Act Release No. 35518 (Mar. 21, 1995), 60 FR
15804, 15807 (Mar. 27, 1995) (SR-Amex-94-30). In that matter, the
Commission noted that the listing exchange had comprehensive
surveillance-sharing agreements with all of the exchanges upon which
the futures contracts overlying the notes traded and was able to
obtain market surveillance information, including customer identity
information, for transactions occurring on NYMEX and other futures
exchanges. See id. at 15807 n.21; see also Exchange Act Release No.
36885 (Feb. 26, 1996), 61 FR 8315, 8319 n.17 (Mar. 4, 1996) (SR-
Amex-95-50) (approving the exchange listing and trading of Commodity
Indexed Securities, and noting: (a) That through the comprehensive
surveillance-sharing agreements, the listing exchange was able to
obtain market surveillance information, including customer identity
information, for transactions occurring on NYMEX and COMEX and that,
through the Intermarket Surveillance Group information-sharing
agreement, the listing exchange was able to obtain, upon request,
surveillance information with respect to trades effected on the
London Metal Exchange, including client identity information and (b)
that, if a different market were utilized for purposes of
calculating the value of a designated futures contract, the listing
exchange had represented that it would ensure that it entered into a
surveillance-sharing agreement with respect to the new relevant
market). The Commission has made similar statements about
surveillance-sharing agreements with respect to the listing and
trading of stock-index, currency, and currency-index warrants. See,
e.g., Exchange Act Release No. 36166 (Aug. 29, 1995), 60 FR 46660
(Sept. 7, 1995) (SR-PSE-94-28) (approving a proposal to adopt
uniform listing and trading guidelines for stock-index, currency,
and currency-index warrants). Specifically, the Commission noted
that ``a surveillance sharing agreement should provide the parties
with the ability to obtain information necessary to detect and deter
market manipulation and other trading abuses'' and stated that the
Commission ``generally requires that a surveillance sharing
agreement require that the parties to the agreement provide each
other, upon request, information about market trading activity,
clearing activity, and the identity of the ultimate purchasers for
securities.'' Id. at 46665 n.35. In addition, the Commission stated
that ``[t]he ability to obtain relevant surveillance information,
including, among other things, the identity of the ultimate
purchasers and sellers of securities, is an essential and necessary
component of a comprehensive surveillance sharing agreement.'' Id.
at 46665 n.36.

---------------------------------------------------------------------------

[[Page 37594]]

In 1998, in adopting Exchange Act Rule 19b-4(e) \207\ to permit the
generic listing and trading of certain new derivatives 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 or ``ISAs'' in the release), the information
necessary to detect and deter manipulative activity. Specifically, in
adopting rules governing the generic listing of new derivatives
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'' and stated that:
---------------------------------------------------------------------------

\207\ 17 CFR 240.19b-4(e).

It is essential that the SRO have the ability to obtain the
information necessary to detect and deter market manipulation,
illegal trading and other abuses involving the new derivative
securities product. Specifically, 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.\208\
---------------------------------------------------------------------------

\208\ NDSP Adopting Release, supra note 21.

Consistent with this principle, for the commodity-trust ETPs
approved to date for listing and trading, there has been in every case
at least one significant, regulated market for trading futures on the
underlying commodity--whether gold, silver, platinum, palladium, or
copper--and the ETP listing exchange has entered into surveillance-
sharing agreements with, or held Intermarket Surveillance Group
membership in common with, that market.\209\
---------------------------------------------------------------------------

\209\ See supra note 202.
---------------------------------------------------------------------------

In light of the history and purpose of looking to surveillance-
sharing agreements, with respect to markets for assets underlying an
ETP or for derivatives on those assets, the Commission interprets the
terms ``significant market'' and ``market of significant size'' to
include a market (or group of markets) as to which (a) there is a
reasonable likelihood that a person attempting to manipulate the ETP
would also have to trade on that market to successfully manipulate the
ETP, so that a surveillance-sharing agreement would assist the ETP
listing market in detecting and deterring misconduct, and (b) it is
unlikely that trading in the ETP would be the predominant influence on
prices in that market. This definition is illustrative and not
exclusive. There could be other types of ``significant markets'' and
``markets of significant size,'' but this definition is an example that
will provide guidance to market participants.
(b) Response to Comments Regarding Surveillance-Sharing Agreements and
Prior Commodity-Trust ETP Approvals
Prior ETP approval orders are consistent with the standards the
Commission is applying to the BZX proposal. However, more recent
approval orders for the well-established model of a precious-metal
trust--for example, the Platinum Order and the Palladium Order--found
it unnecessary to perform the exhaustive analysis of underlying markets
and surveillance sharing provided by the first approval order for a
precious metal commodity-trust ETP, the Gold Order, especially since
the proposed rule change for platinum and palladium ETPs discussed
surveillance-sharing agreements with significant, regulated platinum
and palladium markets.\210\
---------------------------------------------------------------------------

\210\ See Gold Order, supra note 197, 69 FR at 64614-15, 64618-
19; Platinum Order, supra note 189, 74 FR at 68887-88; Palladium
Order, supra note 189, 74 FR at 68896.
---------------------------------------------------------------------------

BZX argues that even the Gold Order relied on alternative factors--
primarily the depth and liquidity of the spot gold market--to mitigate
Commission concerns about approving a commodity-trust ETP based on an
asset that traded in unregulated, over-the-counter markets with which
no surveillance sharing agreement could be executed.\211\ The Gold
Order does note the depth and liquidity of the gold market, likening
the spot gold market to the ``extremely large, diverse market'' for OTC
foreign exchange trading.\212\ Significantly, however, the Gold Order
demonstrates that the Commission did take into account the availability
of surveillance-sharing agreements in approving the first commodity-
trust ETP.
---------------------------------------------------------------------------

\211\ See supra notes 197-199 and accompanying text. Another
commenter also asserts that the Commission has approved several
commodity-based ETPs where the underlying market is either
unregulated or lightly regulated. See supra note 201 and
accompanying text.
\212\ Gold Order, supra note 197, 69 FR at 64619.
---------------------------------------------------------------------------

The Gold Order states that ``[i]nformation sharing agreements with
markets trading securities underlying a derivative are an important
part of a self-regulatory organization's ability to monitor for trading
abuses in derivative products.'' \213\ And, while the Gold Order
observes that that it is ``not possible . . . to enter into an
information sharing agreement with the OTC gold market,'' the order
continues: ``Nevertheless, the Commission believes that the unique
liquidity and depth of the gold market, together with the MOU
[Memorandum of Understanding] with NYMEX (of which COMEX is a Division)
and NYSE Rules 1300(b) and 1301, create the basis for the [ETP listing
exchange] to monitor for fraudulent and manipulative practices in the
trading of the Shares.'' \214\ Thus, even though the Commission found
that the over-the-counter market for gold was ``extremely deep and
liquid,'' \215\ the Commission's approval of the first precious metal
ETP expressly relied on an agreement to share surveillance information
between the listing exchange and a significant, regulated market for
gold futures.\216\
---------------------------------------------------------------------------

\213\ Id.
\214\ Id. (emphasis added).
\215\ Id.
\216\ See id. In the Gold Order, the Commission also stated that
the ETP listing exchange had ``entered into a reciprocal Memorandum
of Understanding (`MOU') with the NYMEX (of which COMEX is a
division) for the sharing of information relating to any financial
instrument based, in whole or in part, upon an interest in or
performance of gold.'' Id. at 64618. The Gold Order also notes
volume figures for spot gold trading provided by the London Bullion
Market Association and gold futures trading provided by COMEX. See
id. at 64619.
---------------------------------------------------------------------------

In the years after the approval of the first precious-metal
commodity-trust ETP, several other, virtually identical, commodity-
trust ETPs have been approved.\217\ Among the approval orders were the
Platinum Order and the Palladium Order, which BZX cites as examples of
the Commission approving a commodity-trust ETP without requiring that
there be a surveillance-sharing agreement with a significant, regulated
market for an underlying exchange. While neither the Platinum Order nor
the Palladium Order expressly discusses such agreements, the record
before the Commission at the time it issued those orders (including the
notices of the proposed rule changes) shows that the ETP listing
exchange was able to share surveillance information with the ``largest
exchange in the world for trading precious metal futures and options,''
which had been trading both platinum futures and palladium futures for
approximately 35 years at the time the Commission

[[Page 37595]]

approved commodity-trust ETPs holding those metals.\218\
---------------------------------------------------------------------------

\217\ See supra note 202.
\218\ See 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 for ETFS Palladium Trust includes NYSE
Arca's representation that ``NYMEX is the largest exchange in the
world for trading precious metals futures and options and has been
trading palladium since 1974,'' and that NYSE Arca ``may obtain
trading information via the Intermarket Surveillance Group,'' of
which NYMEX is a member); Exchange Act Release No. 60970 (Nov. 9,
2009), 74 FR 59319, 59321, 59327 (Nov. 17, 2009) (SR-NYSEArca-2009-
95) (notice of proposed rule change for ETFS Platinum Trust includes
NYSE Arca's representation that ``NYMEX is the largest exchange in
the world for trading precious metals futures and options and has
been trading platinum since 1974,'' and that NYSE Arca ``may obtain
trading information via the Intermarket Surveillance Group,'' of
which NYMEX is a member). See also supra note 189 and accompanying
text.
---------------------------------------------------------------------------

Consistent with the discussion of ``significant market'' described
above,\219\ the Commission has not previously, and does not now,
require that an ETP listing exchange be able to enter into a
surveillance-sharing agreement with each regulated spot or derivatives
market relating to an underlying asset, provided that the market or
markets with which there is such an agreement constitute a
``significant market.''
---------------------------------------------------------------------------

\219\ See Section III.D.2(a), supra.
---------------------------------------------------------------------------

While BZX and the Overdahl Letter assert that the potential avenues
for manipulation of the bitcoin market also exist in the context of
other commodity-trust ETPs, this argument merely reinforces the
Commission's view that similar market structures--namely, surveillance-
sharing agreements with significant, regulated markets--should be in
place for a bitcoin-trust ETP just as they are for commodity-trust
ETPs.\220\ BZX also argues that the proposal should be approved because
it is ``nearly identically situated'' to the iShares Copper Trust. In
particular, BZX asserts that the Commission approved the iShares Copper
Trust because the Commission believed that approval of the ETP could
reduce the risk of manipulation in the underlying spot market and that
the Commission could rely on surveillance by the listing exchange and
CFTC jurisdiction to address concerns about manipulation--factors it
argues support approval here.\221\ The Copper Order, however,
specifically noted the existence of surveillance-sharing agreements not
only between the ETP listing market and copper futures markets, but
also between the ETP listing market and a significant copper spot
market, the London Metal Exchange.\222\ And the Copper Order's analysis
of the underlying physical market for copper does not reflect a
determination that these factors could serve as an adequate alternative
to a surveillance-sharing agreement, but was instead a response to
certain commenters' arguments that approving the iShares Copper Trust
would affirmatively disrupt the physical copper market.\223\
---------------------------------------------------------------------------

\220\ The proposal does not involve an ETP that is based on an
index of commodities where the component commodities are subject to
surveillance-sharing agreements with significant, regulated markets.
See, e.g., Exchange Act Release No. 53105 (Jan. 11, 2006), 71 FR
3129, 3136 (Jan. 19, 2006) (SR-Amex-2005-059) (approving DB
Commodity Index Tracking Fund based on an index that tracks the
performance of futures contracts on crude oil, heating oil,
aluminum, gold, corn, and wheat).
\221\ See supra notes 194-195 and accompanying text. The Lewis
Letter makes a similar argument. See supra note 196 and accompanying
text.
\222\ See Copper Order, supra note 194, 78 FR at 13727 n.7, and
13730.
\223\ See id. at 13731-33.
---------------------------------------------------------------------------

BZX argues that the Commission should approve the proposal because
it has previously approved currency-trust ETPs--the CurrencyShares Hong
Kong Dollar Trust and the CurrencyShares Singapore Dollar Trust--
without requiring the existence of a surveillance-sharing agreement
with underlying markets.\224\ However, BZX has proposed to list and
trade the Shares as a commodity-based ETP, not a currency-based
ETP,\225\ and the Commission as well as other agencies have
distinguished bitcoin from currency.\226\ Even if the Commission were
to apply the approach it took in approving currency-trust ETPs, the
Commission would still conclude that the proposal is not consistent
with the Exchange Act, because the deep, liquid, and longstanding
markets for currencies, which are dominated by regulated entities, bear
little resemblance to the current state of bitcoin markets. Foreign
currency derivatives traded on national securities exchanges for
decades before the Commission approved currency-trust ETPs. And when it
approved the first foreign currency derivatives in 1982--options on the
British pound, the German mark, the Swiss franc, the Canadian dollar,
and the Japanese yen, each the sovereign currency of a developed
nation--the Commission explained that ``[t]he magnitude of the related
foreign currency markets would appear to militate against a successful
manipulation through inter-market trading activity.'' \227\ Similarly,
when approving the listing and trading of additional foreign currency
derivatives in 1992, the Commission recognized the ``developed markets
for the component foreign currencies'' and observed that ``the
interbank foreign currency spot market is an extremely large, diverse
market comprised of banks and other financial institutions worldwide.''
\228\
---------------------------------------------------------------------------

\224\ See supra note 200 and accompanying text. Another
commenter also asserts that the Commission has approved several
foreign exchange-linked ETPs where the underlying market is either
unregulated or lightly regulated. See Convergex Letter, supra note
36, at 2.
\225\ See Amendment No. 1, supra note 1, 81 FR at 76651.
\226\ See In re Bitcoin Inv. Tr., Exchange Act Release No.
78282, 2016 WL 4363462, at *1 n.1 (July 11, 2016); In re Btc
Trading, Corp., Securities Act Release No. 9685, Exchange Act
Release No. 73783, 2014 WL 6872955, at *1 n.1 (Dec. 8, 2014); In re
Voorhees, Securities Act Release No. 9592, 2014 WL 2465620, at *1
n.1 (June 3, 2014). The CFTC has concluded that Bitcoin is a virtual
currency that is a commodity, ``distinct from `real' currencies,
which are the coin and paper money of the United States or another
country that are designated as legal tender, circulate, and are
customarily used and accepted as a medium of exchange in the country
of issuance.'' In re Coinflip, Inc., CFTC No. 15-29, 2015 WL
5535736, at *1 n.2 (Sept. 17, 2015). The Treasury Department's
Financial Crimes Enforcement Network has noted: ``In contrast to
real currency, `virtual' currency is a medium of exchange that
operates like a currency in some environments, but does not have all
the attributes of real currency. In particular, virtual currency
does not have legal tender status in any jurisdiction.'' Guidance:
Application of FinCEN's Regulations to Persons Administering,
Exchanging, or Using Virtual Currencies (Mar. 18, 2013) (discussing
31 CFR 1010.100(m)), available at https://www.fincen.gov/resources/statutes-regulations/guidance/application-fincens-regulations-persons-administering. The IRS has concluded that ``virtual currency
is not treated as currency'' for purposes of federal tax laws. IRS
Virtual Currency Guidance, I.R.S. Notice 2014-21, 2014-16 I.R.B.
938, 2014 WL 1224474 (Apr. 14, 2014).
\227\ Exchange Act Release No. 19133 (Oct. 14, 1982), 47 FR
46946, 1982 WL 521987, at *5 (Oct. 21, 1982) (SR-Phlx-81-4).
\228\ Exchange Act Release No. 31627 (Dec. 21, 1992), 57 FR
62399, 1992 WL 394554, at *4-5 (Dec. 30, 1992) (SR-Amex-92-36).
---------------------------------------------------------------------------

The Gold Order echoed this view of the currency markets.\229\ And
the approval order for the CurrencyShares products that BZX cites
includes the following representations by the listing exchange
regarding the foreign currency markets:
---------------------------------------------------------------------------

\229\ See Gold Order, supra note 197, 69 FR at 64619.

Most trading in the global over-the-counter (``OTC'') foreign
currency markets is conducted by regulated financial institutions
such as banks and broker-dealers. In addition, in the United States,
the Foreign Exchange Committee of the New York Federal Reserve Bank
has issued Guidelines for Foreign Exchange Trading, and central-bank
sponsored committees in Japan and Singapore have published similar
best practice guidelines. In the United Kingdom, the Bank of England
has published the Non-Investment Products Code, which covers foreign
currency trading. The Financial Markets Association, whose members
include major international banking organizations, has also
established best practices guidelines called the Model Code.
Participants in the U.S. OTC market for

[[Page 37596]]

foreign currencies are generally regulated by their oversight
regulators.\230\
---------------------------------------------------------------------------

\230\ Exchange Act Release No. 58365, supra note 200, 73 FR at
49523.

Neither BZX nor any of the commenters has provided data that would
justify treating the markets for bitcoin similarly to the deep and
liquid markets for fiat currencies. Moreover, the description of the
worldwide market for bitcoin, in which both the trading venues and the
participants are unregulated, bears little resemblance to the OTC
markets for foreign currency, on which most trading is conducted by
regulated financial institutions. Accordingly, the Commission's
previous approvals of derivatives securities products based on foreign
currencies are not a basis for the Commission to approve the proposal
despite the absence of a surveillance-sharing agreement with a
regulated market of significant size related to bitcoin.

E. Whether BZX Has Entered Into Surveillance-Sharing Agreements With
Regulated Markets of Significant Size Related to Bitcoin

Although BZX asserts that it has entered into a comprehensive
surveillance-sharing agreement with the Gemini Exchange with respect to
bitcoin trading and that the Gemini Exchange is supervised by the
NYSDFS, the record does not establish that the Gemini Exchange is a
``regulated market'' comparable to a national securities exchange or to
the futures exchanges that are associated with the underlying assets of
the commodity-trust ETPs approved to date. Even if the Gemini Exchange
were ``regulated,'' the record does not support a finding that the
Gemini Exchange represents a ``significant'' bitcoin-related market.
Accordingly, the Commission finds that the surveillance-sharing
agreement between BZX and the Gemini Exchange, even in combination with
alternative means of detecting and deterring fraud and manipulation, is
insufficient to demonstrate that the proposed rule change is consistent
with Exchange Act Section 6(b)(5). Nor has BZX demonstrated that any of
the current trading venues in the worldwide bitcoin spot market is a
regulated market such that a comprehensive surveillance-sharing
agreement with those venues would satisfy the requirements of Section
6(b)(5). And BZX has likewise failed to carry its burden to demonstrate
that there is a regulated market of significant size in derivatives
related to bitcoin with which the ETP listing market has entered into a
comprehensive surveillance-sharing agreement.
1. The Gemini Exchange
(a) Summary of Comments Received
BZX asserts that it has entered into a comprehensive surveillance-
sharing agreement with the Gemini Exchange through which it can obtain
customer identity information about bitcoin transactions and market
data.\231\ Similarly, the Overdahl Letter claims that the surveillance-
sharing agreement between the Gemini Exchange and BZX aims to detect
and deter such conduct and that the agreement allows for continuous
monitoring of trading activity to effectively conduct surveillance of
the Gemini Auction price.\232\
---------------------------------------------------------------------------

\231\ See Amendment No. 1, supra note 1, 81 FR at 76663, 76668;
BZX Letter II, supra note 13, at 29-30.
\232\ See Overdahl Letter, supra note 36, at 11.
---------------------------------------------------------------------------

BZX represents that the Gemini Exchange operates under the direct
supervision and regulatory authority of the NYSDFS.\233\ This is
because, BZX argues, the Gemini Exchange is a facility of the
Custodian, which is a New York State-chartered limited liability trust
company.\234\ BZX also represents that the Custodian is a fiduciary and
that it must meet the capitalization, compliance, anti-money-
laundering, consumer protection, and cyber security requirements set
forth by the NYSDFS.\235\
---------------------------------------------------------------------------

\233\ See Amendment No. 1, supra note 1, 81 FR at 76651-52.
\234\ See id. at 76652.
\235\ See id.
---------------------------------------------------------------------------

BZX asserts that the Gemini Auction typically already transacts a
volume greater than the proposed creation basket size for the Trust and
that the Gemini Auction would likely support the needs of Authorized
Participants to engage in basket creation or redemption.\236\ BZX
claims that the global bitcoin marketplace has the potential to provide
even more liquidity and to be a source of bitcoin for basket creation
and hedging. BZX also asserts that all intraday order-book and trade
information on the Gemini Exchange is publicly available through
various electronic formats and is also redistributed by various online
aggregators, and that, with the launch of the proposed Trust, the
Sponsor must make important pricing data available in real time.\237\
As noted above, BZX also claims that the volume transacted in the
Gemini Auction is generally more than 50% larger than the second-
largest trade in the world, drawing an average daily volume of 1,200
bitcoins compared to approximately 800 bitcoins.\238\
---------------------------------------------------------------------------

\236\ See BZX Letter II, supra note 13, at 20; but see Section
III.B.2(b), supra.
\237\ See BZX Letter I, supra note 35, at 9; see also Petition
for Review, supra note 4, at 15-16.
\238\ See BZX Letter II, supra note 13, at 19-20.
---------------------------------------------------------------------------

One commenter claims that among USD bitcoin exchanges, Gemini has a
3% share and its liquidity measured by order book depth is
significantly lower than that of several other exchanges. The commenter
states that it is possible that, after the launch of an ETP, Gemini's
liquidity and volume will increase, but claims that the nature of
bitcoin trading that leads to the concentration of volume and liquidity
outside of U.S. borders makes any significant future increase
unlikely.\239\ This commenter also observes that while Gemini is
locally regulated by the NYSDFS, the global landscape of many
unregulated bitcoin exchanges exerts huge influence on the Gemini
Exchange and consequently on the proposed ETP.\240\ Another commenter
claims that the Gemini Exchange has the lowest liquidity of the three
exchanges in the United States and is one of the least-liquid of all
exchanges that trade bitcoin for USD.\241\
---------------------------------------------------------------------------

\239\ See Maher Letter, supra note 35 (noting that the market is
very concentrated and is controlled by a small group of exchanges
operating in China, three of which represented 96% of all bitcoin
trade volume over a six-month period, and noting that the Gemini
Exchange had a 0.07% share of bitcoin volume worldwide during that
period, with a 3% share of USD-exchange volume).
\240\ See id.
\241\ See Anonymous Letter III, supra note 35.
---------------------------------------------------------------------------

One commenter asserts that the size and importance of the Gemini
Exchange and the itBit Exchange have grown substantially and claims
that, from January 23, 2017, to May 10, 2017, the combined market share
of these exchanges jumped from just 0.33% to 7.14% of total worldwide
bitcoin volume, equivalent to more than 10,000 bitcoins per day on
average.\242\ This commenter also asserts that the geographic
distribution of bitcoin spot trading has shifted in focus from Chinese-
based platforms towards U.S.-based venues, which indicates increased
transparency and safer regulation in the near future. The commenter
asserts that--although the Gemini Exchange and the itBit Exchange
remain the only two NYSDFS-regulated bitcoin exchanges, and while a
market share of 7.14% leaves much room for growth--

[[Page 37597]]

the migration of global bitcoin trading volumes since mid-January 2017
is a positive trend.\243\
---------------------------------------------------------------------------

\242\ See SIG Letter, supra note 36, at 7. The itBit Exchange is
a commercial bitcoin trading venue based in New York, NY. The NYSDFS
has granted a charter under New York Banking Law to itBit Trust
Company, LLC. See Press Release, NYSDFS, NY[S]DFS Grants First
Charter to a New York Virtual Currency Company(May 7, 2015),
available at https://www.dfs.ny.gov/about/press/pr1505071.htm.
\243\ See SIG Letter, supra note 36, at 7.
---------------------------------------------------------------------------

This commenter further asserts that, alongside Gemini Exchange and
itBit Exchange, two other U.S.-based exchanges, GDAX and Kraken, have
become significant spot bitcoin trading venues. According to this
commenter, these four exchanges--the largest U.S. bitcoin exchanges--
together now represent over 29% of worldwide bitcoin volume, up from
just 1.47% on January 23, 2017. The commenter claims that, with almost
a third of global spot bitcoin volume now occurring on these four U.S.-
based trading venues, regulatory agencies and SROs have the opportunity
to develop a robust framework of regulatory oversight and transparency
that would support fair and orderly markets for both spot bitcoin and
listed bitcoin-based ETPs.\244\ This commenter predicts that the launch
of a regulated, U.S.-listed bitcoin ETP will help drive more bitcoin
trading volume onto U.S.-based exchanges, and this commenter asserts
that this supplemental liquidity is likely to manifest itself mainly on
U.S.-based bitcoin exchanges such as Gemini, itBit, GDAX, and Kraken,
which will be the most liquid venues during U.S. trading hours.\245\
---------------------------------------------------------------------------

\244\ See id. at 7-8.
\245\ See id. at 8.
---------------------------------------------------------------------------

The Overdahl Letter asserts that, between September 21, 2016, and
March 1, 2017, the Gemini Exchange accounted for 24.03% of bitcoin
trading volume on U.S. exchanges and 7.35% of the global USD market for
bitcoin.\246\ The Overdahl Letter contends that the Gemini Auction
price is reliable in that it generally reflects both prices for bitcoin
traded at other U.S.-based bitcoin exchanges and prices for bitcoin
traded at USD-based exchanges globally. The Overdahl Letter claims that
significant deviations between the Gemini price and other prices are
quickly reduced to normal (small) levels and that the Gemini price does
not primarily cause these deviations. In addition, the Overdahl Letter
concludes that, when price deviations are observed, pricing across
exchanges tends to converge.\247\ The Overdahl Letter also notes the
concern expressed by some commenters that the Gemini Exchange had
relatively low trading volume and that, as a result, the exchange price
was less reliable than if the volumes were larger. In response to this
concern, the Overdahl Letter provides a list of ETPs approved by the
Commission that, the Overdahl Letter claims, have underlying assets
with lower average daily volume than the average daily volume of the
Gemini Exchange.\248\
---------------------------------------------------------------------------

\246\ See Overdahl Letter, supra note 36, at 8.
\247\ See id. at 1, 7.
\248\ See id. at 13-14.
---------------------------------------------------------------------------

(b) Discussion
BZX represents that it has entered into a comprehensive
surveillance-sharing agreement with the Gemini Exchange with respect to
bitcoin trading and that the Gemini Exchange is supervised by the
NYSDFS and is thereby subject to capitalization, anti-money-laundering,
compliance, consumer protection, and cybersecurity requirements.\249\
The record, however, does not support a conclusion that the Gemini
Exchange is a ``regulated market'' comparable to a national securities
exchange or to the futures exchanges that are associated with the
underlying assets of the commodity-trust ETPs approved to date.
---------------------------------------------------------------------------

\249\ See Amendment No. 1, supra note 1, 81 FR at 76652, 76663,
76668; BZX Letter II, supra note 13, at 29-30.
---------------------------------------------------------------------------

The record does not establish that the Gemini Exchange's rules,
including its trading rules, are subject to regulatory review or
approval or that its trading operations are subject to regulatory
examination. Commission regulation of the securities markets includes
the elements of NYSDFS supervision described above,\250\ but national
securities exchanges are also, among other things, required 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.'' \251\ Moreover, national securities exchanges must file
proposed rules with the Commission regarding certain material aspects
of their operations,\252\ and the Commission has the authority to
disapprove any such rule that is not consistent with the requirements
of the Exchange Act.\253\ Thus, national securities exchanges are
subject to Commission oversight of, among other things, their
governance, membership qualifications, trading rules, disciplinary
procedures, recordkeeping, and fees.\254\
---------------------------------------------------------------------------

\250\ See supra notes 233-235 and accompanying text.
\251\ 15 U.S.C. 78f(b)(5).
\252\ 17 CFR 240.19b-4(a)(6)(i).
\253\ 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 and provides the Commission with the authority
to disapprove proposed rule changes that are not consistent with the
Exchange Act. Designated Contract Markets (commonly called ``futures
markets'') registered with and regulated by the CFTC must comply
with, among other things, a similarly comprehensive range of
regulatory principles and must file rule changes with the CFTC. See,
e.g., Designated Contract Markets (DCMs), CFTC, available at https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/index.htm.
\254\ The Commission notes that the NYSDFS recently issued
``guidance'' to supervised virtual currency business entities,
including the Gemini Exchange, stating that these entities must
``implement measures designed to effectively detect, prevent, and
respond to fraud, attempted fraud, and similar wrongdoing.'' See
Maria T. Vulio, Superintendent of Financial Services, NYSDFS,
Guidance on Prevention of Market Manipulation and Other Wrongful
Activity (Feb. 7, 2018), available at https://www.dfs.ny.gov/legal/industry/il180207.pdf. This guidance was issued after the comment
period for this proposed rule change ended, and there is nothing in
the record regarding how this guidance has been implemented by the
NYSDFS or by the affected entities.
---------------------------------------------------------------------------

Even if the Gemini Exchange were ``regulated,'' the record would
not support a conclusion that the Gemini Exchange conducts a
significant volume of trading in bitcoin because there is no evidence
in the record that there is a reasonable likelihood that a person
attempting to manipulate the ETP would also have to trade on the Gemini
Exchange (or any record evidence addressing how trading in the proposed
ETP would or would not influence prices on the Gemini Exchange).
Furthermore, there is insufficient evidence in the record to determine
whether it is unlikely that trading in the ETP would be the predominant
influence on prices on the Gemini Exchange. Indeed, if anything, the
Gemini Auction size is currently so small that the proposed ETP could
fundamentally affect supply and demand (and thus pricing) on the Gemini
Exchange, not the other way around.\255\
---------------------------------------------------------------------------

\255\ See Section III.B.2(b), supra.
---------------------------------------------------------------------------

The record thus includes at best uncertain information regarding
the volume or liquidity of the Gemini Exchange, how the Gemini Exchange
may influence the price of any ETP based on bitcoin, or how the
existence of ETPs based on bitcoin may affect the Gemini Exchange.
Commenters have provided varying estimates of the current and future
volume of trading on

[[Page 37598]]

the Gemini Exchange.\256\ Moreover, because bitcoin markets are still
evolving in significant ways, and because there is no comprehensive
data source reflecting bitcoin trading, it is not currently possible to
state with confidence what share of volume any particular spot trading
venue has captured or will capture.\257\ Bitcoin trading activity is
dispersed across markets and OTC transactions worldwide, and there is
no centralized, regulatory data source for bitcoin trading statistics.
Accordingly, any analysis of worldwide trading activity must use
unofficial sources that gather and disseminate trading data, and even
these sources cannot capture OTC transactions, or transactions that
take place in what the Registration Statement characterizes as ``dark
pools.'' \258\ Further, as discussed above,\259\ recent volume in the
Gemini Auction is a fraction of the size of a creation unit of the
Trust, and therefore the Commission does not agree with the assertion
by BZX that the Gemini Auction would support the needs of Authorized
Participants to engage in basket creation or redemption.
---------------------------------------------------------------------------

\256\ See supra notes 237-248 and accompanying text.
\257\ See also supra note 239 and accompanying text.
\258\ Registration Statement, supra note 22, at 62.
Additionally, while the Overdahl Letter asserts that, between
September 21, 2016, and March 1, 2017, the Gemini Exchange accounted
for 7.35% of the global USD-denominated bitcoin market, which does
not include trading in bitcoin against other fiat currencies, see
supra note 246 and accompanying text, the Overdahl Letter does not
explain why the bitcoin-USD market--a subset of the global bitcoin
market--is the appropriate measure when Authorized Participants in
the Trust would be able to source their bitcoins through any market
or OTC transaction.
\259\ See supra note 165 and accompanying text.
---------------------------------------------------------------------------

Finally, the comparison offered by the Overdahl Letter between the
average trading volume on the Gemini Exchange and the average trading
volume of the underlying assets of other ETPs is inapt.\260\ The issue
here is not that the Gemini Exchange has low trading volume in an
absolute sense but, rather, that the Trust would value its holdings
using the Gemini Auction price, even though there is no basis in the
record to find that the Gemini Auction represents a significant portion
of worldwide bitcoin trading.\261\
---------------------------------------------------------------------------

\260\ See supra note 248 and accompanying text.
\261\ See also infra notes 263-268, 270 and accompanying text
(summarizing commenters' views that most bitcoin trading volume
occurs outside the U.S. on unregulated exchanges).
---------------------------------------------------------------------------

Therefore, the Commission cannot conclude that the surveillance-
sharing agreement between BZX and the Gemini Exchange, even in
combination with the other means of detecting and deterring fraud and
manipulation discussed above,\262\ is sufficient to find that the
proposal is consistent with Exchange Act Section 6(b)(5).
---------------------------------------------------------------------------

\262\ See Section III.C.2, supra.
---------------------------------------------------------------------------

2. Other Bitcoin Spot Markets
(a) Summary of Comments Received
Several comment letters state that the majority of bitcoin trading
occurs on exchanges outside the United States. One commenter claims
that most daily trading volume is conducted on poorly capitalized,
unregulated exchanges located outside the United States and that these
non-U.S. exchanges and their practices significantly influence the
price discovery process.\263\ Another commenter states that the biggest
and most influential bitcoin exchange is located outside U.S.
jurisdiction.\264\
---------------------------------------------------------------------------

\263\ See Williams Letter, supra note 35, at 2.
\264\ See Anonymous Letter V, supra note 35.
---------------------------------------------------------------------------

One commenter states that, since 2013, the price of bitcoin has
been defined mostly by the major Chinese exchanges, whose volumes dwarf
those of exchanges outside China. According to the commenter, the
Chinese exchanges are not regulated or audited and are suspected of
engaging in unethical practices such as front-running, wash trades, and
trading with insufficient funds. The commenter interprets pricing data
from these Chinese exchanges to mean that the price of bitcoin is
defined entirely by speculation, without any ties to fundamentals.\265\
---------------------------------------------------------------------------

\265\ See Stolfi Letter II, supra note 35.
---------------------------------------------------------------------------

One commenter claims that a sizeable number of traders and owners
of bitcoin do not desire to trade in a well-regulated environment for
reasons including tax evasion, evading capital controls, and money
laundering. This commenter also states that U.S. bitcoin exchanges do
not offer products such as fee-free trading, margin trading, or
options, which drive traffic to the top non-U.S. exchanges. This
commenter also claims that several Chinese exchanges actively engage in
bitcoin mining operations, creating a conflict of interest, and notes
that these exchanges are unaudited and unaccountable.\266\
---------------------------------------------------------------------------

\266\ See Maher Letter, supra note 35; see also Johnson Letter,
supra note 35; Anonymous Letter V, supra note 35.
---------------------------------------------------------------------------

One commenter observes that Chinese markets drive much of the
volume in the bitcoin markets.\267\Another commenter also claims that
the Chinese exchanges that account for the bulk of trading are subject
to little regulatory oversight and that existing know-your-customer or
identity-verification measures are lax and can be easily bypassed.\268\
---------------------------------------------------------------------------

\267\ See ARK Letter, supra note 35, at 5.
\268\ See Maher Letter, supra note 35.
---------------------------------------------------------------------------

One commenter asserts that bitcoin is more transparent than the
illiquid or opaque underlying assets of some other exchange-traded
funds, because a large percentage of bitcoin transactions take place on
electronic exchanges with actionable quotes and relatively tight bid/
ask spreads and because transferring actual bitcoin between accounts at
exchanges and other storage systems is also a transparent process, as
transactions are printed using blockchain technology.\269\
---------------------------------------------------------------------------

\269\ See C&C Letter, supra note 36, at 2.
---------------------------------------------------------------------------

BZX concedes in a comment letter that only a minority of the global
spot bitcoin exchanges are subject to any regulatory regime.\270\ BZX
also argues that, as the bitcoin exchange market has matured, a number
of new entrants, including two New York limited-purpose trust
companies, have emerged and that these new entrants have markedly
changed the once-concentrated and non-regulated landscape of the
bitcoin exchange market.\271\
---------------------------------------------------------------------------

\270\ See BZX Letter I, supra note 35, at 2-3 (noting that only
a minority of global bitcoin exchanges are fully regulated for their
fiduciary and custodial activities, and naming Gemini Trust Company
LLC and itBit Trust Company LLC as the only two exchange operators
that are subject to substantive regulation, each overseen by the
NYSDFS).
\271\ See BZX Letter II, supra note 13, at 15; see also Petition
for Review, supra note 4, at 15.
---------------------------------------------------------------------------

BZX and the Overdahl Letter note that the CFTC has designated
bitcoin as a commodity and assert that the CFTC is ``broadly
responsible for the integrity'' of bitcoin spot markets.\272\ BZX
acknowledges that the CFTC had not yet (as of the date of BZX's
submissions) brought any enforcement actions based on the anti-
manipulation provisions of the Commodity Exchange Act,\273\ but notes
that the CFTC has issued orders against U.S. and non-U.S. bitcoin
exchanges for engaging in other activity prohibited by the Commodity
Exchange Act and argues that, therefore, a regulatory framework for
providing oversight and deterring market manipulation currently exists
in the U.S.\274\
---------------------------------------------------------------------------

\272\ See BZX Letter I, supra note 35, at 3; BZX Letter II,
supra note 13, at 17; Overdahl Letter, supra note 36, at 2.
\273\ See BZX Letter I, supra note 35, at 3. The Commission
notes that the CFTC has since obtained a federal court injunction
against fraudulent activity related to ``virtual currency.'' See
CFTC v. McDonnell, 287 F. Supp. 3d 213 (E.D.N.Y. 2018).
\274\ See BZX Letter I, supra note 35, at 3; BZX Letter II,
supra note 13, at 18.
---------------------------------------------------------------------------

The Overdahl Letter asserts that any market can potentially be
manipulated and states that this manipulation risk is

[[Page 37599]]

why the CFTC and the Commission have anti-manipulation authority.\275\
The Overdahl Letter also asserts that a host of other jurisdictions,
including the U.K., Australia, Hong Kong, Singapore, Indonesia, and
Thailand, have established some form of ``regulatory sandbox'' for
blockchain, the technology that underlies bitcoin. The Overdahl Letter
further asserts that, in March 2016, the Japanese cabinet approved
bills treating bitcoin and other digital currencies as forms of money
and that, in April 2017, Japan's parliament recognized bitcoin as an
authorized method of payment. The Overdahl Letter claims that Japan
regulates bitcoin as a form of prepaid payment and is approving
regulated virtual-currency exchanges on which the Japanese regulator
imposes capital, audit, and anti-money-laundering, and know-your-
customer requirements. The Overdahl Letter concludes that, therefore,
aside from the CFTC, another competent regulator with whom the
Commission has a memorandum of understanding maintains a regulated
bitcoin market.\276\
---------------------------------------------------------------------------

\275\ See Overdahl Letter, supra note 36, at 2, 9-10.
\276\ See id. at 12-13.
---------------------------------------------------------------------------

(b) Discussion
Based on the record before it, the Commission concludes that BZX
has not shown that any of the current trading venues in the worldwide
bitcoin spot market is a regulated market.
With respect to spot bitcoin trading outside the United States, BZX
and commenters agree that the bulk of bitcoin trading has occurred in
non-U.S. markets where there is little to no regulation governing
trading,\277\ and thus no sufficient and verifiable governmental market
oversight designed to detect and deter fraudulent and manipulative
activity.\278\ And because no bitcoin spot market is currently a member
of the Intermarket Surveillance Group, BZX is unable to use its
membership in the Intermarket Surveillance Group to share surveillance
information with those markets.\279\ Further, as noted above,\280\ the
Bitcoin blockchain, while freely available to the public, identifies
parties to a transaction only by a pseudonymous public-key address, and
it does not distinguish bitcoin trading activity from other transfers
of bitcoin, limiting its usefulness as a substitute for a surveillance-
sharing agreement.
---------------------------------------------------------------------------

\277\ See supra notes 263-268, 270 and accompanying text. The
Commission also notes more recent reporting that a large portion of
bitcoin trading volume continues to take place overseas, see, e.g.,
Russo, et al., This Is Where People Are Buying Bitcoin All Over the
World (Jan. 11, 2018), https://www.bloomberg.com/graphics/2017-bitcoin-volume/, although such reports are unnecessary to the
Commission's finding, based on the record before it, that BZX has
not shown that any of the current trading venues in the worldwide
bitcoin spot market is a regulated market.
\278\ See supra notes 263-268 and accompanying text.
\279\ See https://www.isgportal.org/isgPortal/public/members.htm
(listing the current members and affiliate members of the
Intermarket Surveillance Group).
\280\ See Section III.C.2, supra.
---------------------------------------------------------------------------

One commenter asserts that substantial trading volume has recently
migrated away from Chinese exchanges in response to regulatory efforts
by the Chinese government. But, according to statistics provided by
other commenters,\281\ a substantial majority of bitcoin trading
continues to occur overseas,\282\ and BZX concedes in a comment letter
that only a minority of the global spot bitcoin exchanges are subject
to any regulatory regime.\283\ Moreover, the Registration Statement for
the Winklevoss Bitcoin Trust states:
---------------------------------------------------------------------------

\281\ See supra notes 243-244 and accompanying text.
\282\ See, supra notes 244, 264-265, 267 and accompanying text.
\283\ See supra note 270 and accompanying text. While BZX
asserts that the Gemini Exchange is a regulated market, as discussed
above, the Commission does not agree with that assessment. See
Section III.E.1(b), supra.

The Bitcoin Exchanges on which bitcoin trades are new and, in
most cases, largely unregulated. Furthermore, many Bitcoin Exchanges
(including several of the most prominent U.S. Dollar-denominated
Bitcoin Exchanges) do not provide the public with significant
information regarding their ownership structure, management teams,
corporate practices or regulatory compliance.\284\
---------------------------------------------------------------------------

\284\ Registration Statement, supra note 22, at 22.

Nor does the CFTC's oversight of bitcoin-derivative trading venues
indicate that the CFTC is, as BZX and the Overdahl Letter argue,
``broadly responsible for the integrity of the bitcoin spot market'' or
that the CFTC's enforcement powers with respect to spot trading mean
that a ``regulatory framework for providing oversight and deterring
market manipulation currently exists in the United States.'' \285\ Spot
bitcoin markets are not required to register with the CFTC, unless they
offer leveraged, margined, or financed trading to retail
customers.\286\ In all other cases, including the Gemini Exchange, the
CFTC does not set standards for, approve the rules of, examine, or
otherwise regulate bitcoin spot markets.\287\ As the CFTC itself has
stated, while the CFTC ``has an important role to play,'' U.S. law
``does not provide for direct, comprehensive Federal oversight of
underlying Bitcoin or virtual currency spot markets.'' \288\
---------------------------------------------------------------------------

\285\ See supra notes 272-274 and accompanying text.
\286\ 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)(i), 7
U.S.C. 2(c)(2)(A)(i) (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).
\287\ The Gemini Exchange is not registered with the CFTC.
\288\ CFTC Backgrounder, supra note 118, at 1. The Commission
also notes the testimony of CFTC Chairman Giancarlo before the
Senate Banking Committee that ``the CFTC does not have authority to
conduct regulatory oversight over spot virtual currency platforms or
other cash commodities, including imposing registration
requirements, surveillance and monitoring, transaction reporting,
compliance with personnel conduct standards, customer education,
capital adequacy, trading system safeguards, cyber security
examinations or other requirements.'' Giancarlo Testimony, supra
note 117, Section I (CFTC Authority and Oversight Over Virtual
Currencies). See also Section III.B.1(b)(iii), supra (discussing
CFTC statutory authority over bitcoin derivatives products).
---------------------------------------------------------------------------

Additionally, establishment by foreign regulators of what one
commenter called ``regulatory sandboxes'' for blockchain
technology,\289\ or the regulation of bitcoin as a method of prepaid
payment by others,\290\ is not a sufficient basis for concluding that
bitcoin trades worldwide on regulated markets with which the listing
exchange can enter into a surveillance-sharing agreement. There is no
evidence in the record before the Commission that any ``regulatory
sandbox,'' however defined, has created a comprehensive regulatory
regime for bitcoin trading venues, and, as explained in greater detail
above in the context of the Gemini Exchange,\291\ a ``regulated''
market means a market that can detect and prevent fraud and
manipulation under Exchange Act Section 6(b)(5).
---------------------------------------------------------------------------

\289\ See supra note 276 and accompanying text.
\290\ Id.
\291\ See Section III.E.1(b), supra.
---------------------------------------------------------------------------

3. The Derivatives Markets
(a) Summary of Comments Received
One commenter claims that the bitcoin markets are not yet efficient
and attributes this inefficiency, in part, to the nascent state of the
bitcoin derivatives market. This commenter states that derivatives
provide investors more ways to hedge against bitcoin's potential price
movements, introduce more volume and liquidity, and generally give the
markets more points of information about bitcoin's future prospects,
leading to tighter bid/ask spreads. The commenter claims that

[[Page 37600]]

most derivatives activity within the bitcoin markets is offered by
entities outside of the purview of U.S. regulators.\292\ The commenter
observes that the lack of a robust and regulated derivatives market
means that market participants do not have a broad basket of tools at
their disposal, making hedging difficult and keeping away many market
makers that provide significant liquidity to traditional capital
markets. The commenter claims that, while derivative products may be in
development, a full suite of investor tools that will drive market
efficiency and eliminate price disparities is likely at least a couple
of years away.\293\ The commenter also states that, without a robust
derivatives market for institutional investors to short the underlying
asset or otherwise hedge their positions, there likely would be little
counterbalance to the new demand generated by the ETP, and Authorized
Participants could then have trouble sourcing bitcoin and hedging their
positions, stalling the creation process.\294\ The commenter concludes
that it would be premature to launch a bitcoin ETP because bitcoin
markets are not liquid enough to support an open-end fund and because
an ecosystem of institutional-grade infrastructure players is not yet
available to support such a product.\295\
---------------------------------------------------------------------------

\292\ See ARK Letter, supra note 35, at 5-6.
\293\ See id. at 6. This commenter also states that, within the
United States, one market offers bitcoin forwards and no one
currently offers regulated bitcoin futures or options, see id., but,
as discussed below, see infra notes 310-311 and accompanying text,
futures on bitcoin have begun trading on regulated U.S. designated
contract markets.
\294\ See ARK Letter, supra note 35, at 13-14.
\295\ See id. at 2.
---------------------------------------------------------------------------

One commenter disagrees with assertions linking inefficient bitcoin
markets to nascent derivatives markets, stating that no evidence has
been provided regarding the would-be effect of derivatives on the
bitcoin market. The commenter claims that these assertions assume that
bitcoin pricing is inefficient, which the commenter claims is not the
case. The commenter also claims that these assertions assume that the
lack of a derivatives market causes pricing to be inefficient, stating
instead that there is direct evidence that many securities trade
successfully and efficiently on U.S. and non-U.S. exchanges despite not
having a direct derivatives market.\296\ The commenter also disagrees
with the claim that, absent a robust derivatives market, there would be
little counterbalance to the new demand generated by the ETP, stating
that it is impossible to predict the success or failure of the ETP. The
commenter states that Authorized Participants may be able to source
bitcoin from China.\297\
---------------------------------------------------------------------------

\296\ See Anonymous Letter IV, supra note 35. Several commenters
also assert that regulation by BZX of activity in the ETP could
substitute for a lack of regulation in underlying or derivatives
markets. See, e.g., Baird Letter, supra note 35; Keeler Letter,
supra note 35; Marchionne Letter, supra note 35; Bang Letter, supra
note 35.
\297\ See Anonymous Letter IV, supra note 35.
---------------------------------------------------------------------------

Another commenter claims that there are several bitcoin futures
markets that have a significant impact on the spot price along with
several OTC markets--such as the one that this commenter claims was
recently launched by the Gemini Exchange--that also offer
liquidity.\298\
---------------------------------------------------------------------------

\298\ See Dylan Letter, supra note 35, at 1.
---------------------------------------------------------------------------

The Lewis Letter 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 be useful to
Authorized Participants and market makers who would like to use
derivatives to hedge exposures.\299\ The Lewis Letter claims that, for
physical commodities that are not traded on exchanges, the presence of
a liquid derivatives market is a necessary condition, but claims that
for digital assets like bitcoin, derivatives markets are not necessary
because price discovery occurs on the OTC market and exchanges
instead.\300\
---------------------------------------------------------------------------

\299\ See Lewis Letter I, supra note 65, at 8.
\300\ See id. at 8.
---------------------------------------------------------------------------

(b) Discussion
One commenter and the Lewis Letter assert that the existence of
bitcoin derivative markets is not a necessary condition for a bitcoin
ETP.\301\ The key standard the Commission is applying here, however, is
not that a futures or derivatives market is required for every
commodity-trust ETP, but that--when the spot market is unregulated--the
requirement of preventing fraudulent and manipulative acts may possibly
be satisfied by showing that the ETP listing market has entered into a
surveillance-sharing agreement with a regulated market of significant
size in derivatives related to the underlying asset. That is because,
where a market of significant size exists with respect to derivatives
on the asset underlying a commodity-trust ETP, the Commission believes
that there is a reasonable likelihood that a person attempting to
manipulate the ETP by manipulating the underlying spot market would
also have to trade in the derivatives market in order to succeed, since
arbitrage between the derivative and spot markets would tend to counter
an attempt to manipulate the spot market alone.\302\ Thus, the
Commission believes that there is a reasonable likelihood that a
surveillance-sharing agreement with that derivatives market would
assist the ETP listing market in detecting and deterring an attempt to
manipulate the commodity-trust ETP.
---------------------------------------------------------------------------

\301\ See supra note 296 and accompanying text; Lewis Letter I,
supra note 65, at 8.
\302\ See also Section III.D.2(a), supra (discussion of
Commission interpretation of the terms ``significant market'' and
``market of significant size'').
---------------------------------------------------------------------------

As noted above, the commodity-trust ETPs previously approved by the
Commission have had--in lieu of regulated spot markets of significant
size--a regulated futures market of significant size associated with
the underlying commodity, and the listing exchange had entered into a
surveillance-sharing agreement with that futures market or was able to
obtain surveillance information through membership in the Intermarket
Surveillance Group.\303\ Based on the record before it, the Commission
cannot conclude that a regulated bitcoin futures market of significant
size currently exists because, similar to the Gemini Exchange, there is
no evidence in the record that there is a reasonable likelihood that a
person attempting to manipulate the ETP would also have to trade on the
bitcoin futures market, or any record evidence addressing how trading
in the proposed ETP would or would not influence prices in the futures
bitcoin market.
---------------------------------------------------------------------------

\303\ See supra note 209 and accompanying text.
---------------------------------------------------------------------------

Consistent with the view of commenters summarized above, BZX's
proposal describes the current derivative markets for bitcoin as
``[n]ascent.'' \304\ BZX notes that certain types of options, futures,
contracts for differences, and other derivative instruments are
available in certain jurisdictions, but that many of them are not
available in the United States and that these derivatives instruments
are generally not regulated ``to the degree that U.S. investors expect
derivatives instruments to be regulated.'' \305\ BZX notes that the
CFTC has approved the registration of TeraExchange LLC as a swap
execution facility (``SEF'') and that, on October 9, 2014, TeraExchange
announced that it had hosted the first executed bitcoin swap traded on
a CFTC-regulated platform.\306\ Further,

[[Page 37601]]

BZX's proposal notes that, in 2015, CFTC temporarily registered another
SEF that would trade swaps on bitcoin.\307\
---------------------------------------------------------------------------

\304\ See Amendment No. 1, supra note 1, 81 FR at 76661.
\305\ See id.
\306\ See id.; see also ARK Letter, supra note 35, at 6 (noting
that TeraExchange offers bitcoin forwards).
\307\ See Amendment No. 1, supra note 1, 81 FR at 76661
(referring to Ledger X LLC).
---------------------------------------------------------------------------

The Commission acknowledges that TeraExchange, a market for swaps
on bitcoin, has registered with the CFTC, but BZX's description of
trading activity on that market fails to note that the very activity it
cites was the subject of an enforcement action by the CFTC. The CFTC
found that TeraExchange had improperly arranged for participants to
make prearranged, offsetting ``wash'' transactions of the same price,
notional amount, and time period and had then issued a press release
``to create the impression of actual trading in the Bitcoin swap.''
\308\ Neither BZX nor any commenter provides evidence of meaningful
trading volume in bitcoin derivatives on any regulated marketplace.
---------------------------------------------------------------------------

\308\ See TeraExchange Settlement Order, supra note 93.
---------------------------------------------------------------------------

The CFTC has also registered LedgerX, a venue for trading bitcoin
derivatives, as a SEF and a Derivatives Clearing Organization.\309\
Additionally, on December 1, 2017, the CFE and the CME self-certified
new contracts with the CFTC for bitcoin futures contracts.\310\ CFE
launched trading in its bitcoin futures contracts on December 10, 2017,
and CME launched trading in its bitcoin futures contracts on December
17, 2017 (for a trade date of December 18, 2017).\311\
---------------------------------------------------------------------------

\309\ See Order of Registration in the Matter of the Application
of LedgerX LLC for Registration as a Swap Execution Facility (CFTC
July 6, 2017), available at https://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/orgledgerxord170706.pdf; Order of
Registration in the Matter of the Application of LedgerX, LLC for
Registration as a Derivatives Clearing Organization (CFTC July 24,
2017), available at https://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/ledgerxdcoregorder72417.pdf.
\310\ See Letter from Andrew Lowenthal, Senior Managing
Director, CFE to Christopher J. Kirkpatrick, Secretary, CFTC (Dec.
1, 2017), available at https://www.cftc.gov/filings/ptc/ptc120117cfedcm001.pdf; Letter from Christopher Bowen, Managing
Director and Chief Regulatory Counsel, CME Group to Christopher J.
Kirkpatrick, Office of the Secretariat, CFTC (Dec. 1, 2017),
available at https://www.cftc.gov/filings/ptc/ptc120117cmedcm001.pdf.
\311\ The Commission notes that the Cantor Exchange has also
self-certified bitcoin binary options, see CFTC Backgrounder, supra
note 118, at 2, but this product has not yet begun to trade.
---------------------------------------------------------------------------

The record before the Commission, however, does not establish that
the bitcoin derivatives markets are regulated markets of significant
size. The record also does not establish how these markets may
influence the price of any ETP based on bitcoin or how the existence of
ETPs based on bitcoin may affect these markets. Publicly available data
show that the median daily notional trading volume, from inception
through April 24, 2018, has been 9,180 bitcoins on CME and 5,440
bitcoins on CFE, and that the median daily notional value of open
interest on CME and CFE during the same period has been 7,875 bitcoins
and 5,787 bitcoins, respectively.\312\ For all bitcoin contracts traded
on LedgerX from inception through April 24, 2018, publicly available
data show that the median daily notional volume has been 55 bitcoins
and that the median daily notional value of open interest has been 663
bitcoins.\313\ But while these futures and derivative contract figures
are readily available, meaningful analysis of the size of the CME, CFE,
and LedgerX markets relative to the underlying bitcoin spot market is
challenging, because reliable data about the spot market, including its
overall size, are unavailable.\314\ The Commission notes that in recent
testimony CFTC Chairman Giancarlo characterized the volume of the
bitcoin futures markets as ``quite small.'' \315\ The Commission also
notes that the President and COO of Cboe recently acknowledged in a
letter to the Commission staff that ``the current bitcoin futures
trading volumes on Cboe Futures Exchange and CME may not currently be
sufficient to support ETPs seeking 100% long or short exposure to
bitcoin.'' \316\ These statements reinforce the Commission's conclusion
that there is insufficient evidence to determine that the bitcoin
derivatives markets are significant.
---------------------------------------------------------------------------

\312\ These futures volume figures were calculated by Commission
staff using data published by CME and CFE on their websites.
\313\ These derivative contract volume figures were calculated
by Commission staff using data published by LedgerX on its website.
\314\ See Section III.B.1(b)(i), supra.
\315\ CFTC Chairman Giancarlo testified: ``It is important to
put the new Bitcoin futures market in perspective. It is quite small
with open interest at the CME of 6,695 bitcoin and at Cboe Futures
Exchange (Cboe) of 5,569 bitcoin (as of Feb. 2, 2018). At a price of
approximately $7,700 per Bitcoin, this represents a notional amount
of about $94 million. In comparison, the notional amount of the open
interest in CME's WTI crude oil futures was more than one thousand
times greater, about $170 billion (2,600,000 contracts) as of Feb[.]
2, 2018 and the notional amount represented by the open interest of
Comex gold futures was about $74 billion (549,000 contracts).''
Giancarlo Testimony, supra note 117, text accompanying nn.14-15.
\316\ Letter from Chris Concannon, President and COO, Cboe
Global Markets, to Dalia Blass, Director, Division of Investment
Management, Commission, at 5 (Mar. 23, 2018), available at https://www.sec.gov/divisions/investment/cboe-global-markets-innovation-cryptocurrency.pdf.
---------------------------------------------------------------------------

Thus, while LedgerX, CME, and CFE are regulated markets for bitcoin
derivatives, there is no basis in the record for the Commission to
conclude that these markets are of significant size. Additionally,
because bitcoin futures have been trading on CME and CFE only since
December 2017, the Commission has no basis on which to predict how
these markets may grow or develop over time, or whether or when they
may reach significant size.
Although BZX has not demonstrated that a regulated bitcoin futures
market of significant size currently exists, the Commission is not
suggesting that the development of such a market would automatically
require approval of a proposed rule change seeking to list and trade
shares of an ETP holding bitcoins as an asset. The Commission would
need to analyze the facts and circumstances of any particular proposal
and examine whether any unique features of a bitcoin futures market
would warrant further analysis before approval.

F. The Protection of Investors and the Public Interest

BZX contends that, if approved, its ETP would protect investors and
promote the public interest, but the Commission finds that BZX has not
made such a showing on the current record. The Commission must consider
any potential benefits in the broader context of whether the proposal
meets each of the applicable requirements of the Exchange Act. And
because BZX has not demonstrated that its proposed rule change is
designed to prevent fraudulent and manipulative acts and practices, the
Commission must disapprove the proposal.
1. Summary of Comments Received
Several commenters asserted that access to bitcoin through an ETP
would extend regulatory protections to investors. One commenter asserts
that, if the U.S. were to approve an ETP and bring regulatory standards
and oversight to cryptocurrencies, investors would not see major
problems as they did with the Bitfinex and Mt. Gox hacks and that, if
the ETP were not approved, investors would be forced to use those less-
than-ideal exchanges.\317\ One commenter asserts that the alternative
to a regulated ETP is investors having to purchase

[[Page 37602]]

bitcoin at unregulated exchanges lacking SEC oversight.\318\ One
commenter asserts that disapproval of the ETP would create a more risky
environment for investors, who will not have the option of investing
through regulated exchanges.\319\ One commenter argues that, because of
the use of an auction process to determine NAV, the use of well-known
and respected Authorized Participants, and the environment that allows
market participants to use arbitrage techniques to hold pricing where
it should be, the risk to investors who invest in the ETP may be lower
than the risk borne by those who buy or sell bitcoin directly.\320\ And
another commenter asserts that, with innovative use cases emerging for
bitcoin and for the associated technology of blockchain each passing
day, investors seeking exposure to bitcoin should have options similar
to those currently available for physical bullion.\321\
---------------------------------------------------------------------------

\317\ See Baird Letter, supra note 35. Bitfinex and Mt. Gox are
bitcoin trading venues that have reportedly suffered significant
losses from hacking. See Nathaniel Popper and Rachel Abrams,
Apparent Theft at Mt. Gox Shakes Bitcoin World, The New York Times
(Feb. 25, 2014), available at https://www.nytimes.com/2014/02/25/business/apparent-theft-at-mt-gox-shakes-bitcoin-world.html; Amie
Tsang, Bitcoin Plunges After Hacking of Exchange in Hong Kong, The
New York Times (Aug. 3, 2016), available at https://www.nytimes.com/2016/08/04/business/dealbook/bitcoin-bitfinex-hacked.html.
\318\ See Keeler Letter, supra note 35.
\319\ See Bang Letter, supra note 35.
\320\ See Convergex Letter, supra note 36, at 2.
\321\ See Virtu Letter, supra note 36, at 2.
---------------------------------------------------------------------------

BZX argues that the Shares would significantly reduce or eliminate
costs and inefficiencies and would expand opportunities for investors
by providing an inexpensive vehicle to gain exposure to bitcoin in a
secure and easily accessible product that is familiar, transparent, and
meaningfully regulated.\322\ BZX asserts that, for prospective
investors in bitcoin, direct investment brings with it significant
inconvenience, complexity, expense, and risk. As investor demand for
exposure to bitcoin continues to increase, BZX asserts, these problems
grow larger. BZX argues that the Shares would significantly reduce or
completely remove each of these hurdles.\323\ BZX also argues that
Commission should approve the proposal because Commission oversight of
the trading of the ETP shares on a national securities exchange would
enhance the transparency of the underlying bitcoin markets.\324\ BZX
also asserts that the Gemini Exchange is uniquely positioned, because
of its regulatory status and licensing, to be a venue on which
traditional financial institutions will be comfortable transacting in
bitcoin, and BZX posits that these financial institutions provide a
bridge to the equities markets and other capital markets, improving
price discovery, liquidity, and transparency.\325\
---------------------------------------------------------------------------

\322\ See BZX Letter II, supra note 13, at 8.
\323\ See id. at 3, 8.
\324\ See id. at 17; Petition for Review, supra note 4, at 16;
Overdahl Letter, supra note 36, at 13; Virtu Letter, supra note 36,
at 2.
\325\ See BZX Letter II, supra note 13, at 20-21.
---------------------------------------------------------------------------

The Overdahl Letter asserts that the approval of the proposed
bitcoin ETP would facilitate a cost-effective and convenient means for
investors to gain exposure to bitcoin similar to a direct investment in
bitcoin, improving portfolio diversification opportunities for
investors, and would help make bitcoin markets more transparent.\326\
The Overdahl Letter also argues that a bitcoin ETP will protect current
investors in bitcoin by providing regulatory certainty.\327\ The
Overdahl Letter predicts that the availability of a bitcoin ETP would
help attract professional market makers to the spot market, as well as
the market for bitcoin ETPs, and that the presence of these
professional market makers would add to the resilience of the spot
price on the exchange, improve liquidity and other measures of market
quality, and promote trading volume at the exchange.\328\
---------------------------------------------------------------------------

\326\ See Overdahl Letter, supra note 36, at 13.
\327\ See Overdahl Letter, supra note 36, at 13.
\328\ See Overdahl Letter, supra note 36, at 3, 8.
---------------------------------------------------------------------------

The Lewis Letter asserts that bitcoin is relatively uncorrelated
with other assets, enabling investors to construct more efficient
portfolios.\329\ BZX and the Lewis Letter also assert that listing the
shares on a national securities exchange and a shift from OTC trading
to trading on exchanges would make the overall bitcoin market more
transparent.\330\ Similarly, one commenter asserts that trading in the
Shares and the adoption of best practices, such as IIV and NAV
dissemination, will enhance the resiliency and efficiency of the market
for bitcoin.\331\
---------------------------------------------------------------------------

\329\ See Lewis Letter I, supra note 65, at 11-16.
\330\ See id. at 7. See also Petition for Review, supra note 4,
at 16.
\331\ See Virtu Letter, supra note 36, at 2.
---------------------------------------------------------------------------

One commenter believes that lack of regulation and consumer
protection also increases the chance and incentives for market price
manipulation and states that approving the ETP before structural
protections and controls are firmly in place would put investors at
undue risk.\332\ This commenter asserts that several fundamental flaws
make bitcoin a dangerous asset class to force into an exchange-traded
structure, including shallow trade volume, extreme hoarding, low
liquidity, hyper price volatility, a global web of unregulated bucket-
shop exchanges, high bankruptcy risk, and oversized exposure to trading
in countries where there is no regulatory oversight.\333\
---------------------------------------------------------------------------

\332\ See Williams Letter, supra note 35, at 2-3.
\333\ See id. at 1.
---------------------------------------------------------------------------

2. Discussion
BZX, the Overdahl Letter, and other commenters assert that
investment in bitcoin through a ETP would reduce the expense,
complexity, and risk of bitcoin exposure.\334\ BZX, the Overdahl
Letter, and the Lewis Letter further assert that approval of the
Winklevoss Bitcoin Trust would make bitcoin markets more
transparent,\335\ and the Overdahl Letter argues that approval of the
proposal would protect investors by providing regulatory
certainty.\336\ Additionally, the Overdahl Letter and Lewis Letter
argue that approval of the proposal would improve the availability of
investment and portfolio diversification opportunities for
investors.\337\
---------------------------------------------------------------------------

\334\ See Section III.F.1, supra.
\335\ See supra notes 324-326, 330 and accompanying text.
\336\ See supra note 327 and accompanying text.
\337\ See supra notes 326, 329 and accompanying text.
---------------------------------------------------------------------------

The Commission acknowledges that each of these is a potential
benefit of a bitcoin ETP. The Commission, however, must consider these
potential benefits in the broader context of whether the proposal meets
each of the applicable requirements of the Exchange Act. Pursuant to
Section 19(b)(2) of the Exchange Act, the Commission must disapprove a
proposed rule change filed by a national securities exchange if it does
not find 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.\338\ Thus, even if a proposed rule change would provide
certain benefits to investors and the markets, the proposed rule change
may still fail to meet other requirements under the Exchange Act.\339\
For the reasons discussed above, BZX has not met its burden of
demonstrating an adequate basis in the record for the Commission to
find that the proposal is consistent with

[[Page 37603]]

Exchange Act Section 6(b)(5),\340\ and, accordingly, the Commission
must disapprove the proposal.
---------------------------------------------------------------------------

\338\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\339\ The Commission also notes that, according to the Trust's
Registration Statement, investors in the Trust would still be
subject to some of the risks of holding bitcoin directly. See
Registration Statement, supra note 22, at 29 (``Security breaches,
`cyber attacks,' computer malware and computer hacking attacks have
been a prevalent concern in the Bitcoin Exchange Market since the
launch of the Bitcoin Network. Any cyber security breach caused by
hacking . . . could harm the Trust's business operations or result
in loss of the Trust's assets.'').
\340\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

G. Additional Factors Supporting Disapproval

As addressed in detail above, the Commission is disapproving the
proposed rule change because BZX has not met its burden to demonstrate
that its proposal is consistent with Exchange Act Section 6(b)(5). BZX
has neither entered into surveillance-sharing agreements with
regulated, bitcoin-related markets of significant size nor demonstrated
that alternative means of compliance with Exchange Act Section 6(b)(5)
would be sufficient. Because BZX has failed to carry its burden, the
proposed rule change must be disapproved.
The Commission also notes several inconsistencies between the BZX's
proposed rule change and the Trust's Registration Statement that
reinforce the need to disapprove BZX's proposal. For example, in its
proposal, BZX points to the following factors that, in its view, weigh
in favor of approval. Those factors include ``the liquidity of the
market in the underlying commodity,'' ``the trading volume in
derivatives based on the underlying commodity,'' ``listing exchange
rules and procedures prohibiting use of material nonpublic
information,'' and ``listing exchange rules regarding trading halts.''
\341\ But those factors cannot be reconciled with BZX's current
proposal and thus provide independent confirmation that the proposed
rule change must be disapproved.
---------------------------------------------------------------------------

\341\ Petition for Review, supra note 4, at 6-7 & n.17; see also
BZX Letter II, supra note 13, at 22-25.
---------------------------------------------------------------------------

Liquidity of bitcoin markets. The Trust's Registration Statement
concedes that underlying bitcoin markets are insufficiently liquid to
protect against credible threats to those markets' integrity. The
Trust's Registration Statement, for example, acknowledges that
``operational interruption'' in large bitcoin exchanges ``may limit the
liquidity of bitcoin'' and ``result in volatile prices and a reduction
in confidence'' and that ``[t]rading on a single Bitcoin Exchange may
result in less favorable prices and decreased liquidity.'' \342\ The
Trust's characterizations of the bitcoin markets contrast with, for
example, the over-the-counter gold market, which the Commission noted
had ``unique liquidity and depth.'' \343\ This factor accordingly
weighs against approval of the proposed rule change.
---------------------------------------------------------------------------

\342\ Registration Statement, supra note 22, at 22.
\343\ Gold Order, supra note 197, 69 FR at 64619.
---------------------------------------------------------------------------

Trading volume in derivatives based on the underlying commodity.
The Trust's Registration Statement recognizes that bitcoin derivatives
markets are nascent and insufficiently developed in regulated
marketplaces to serve meaningful purposes such as, for example,
providing investors with credible information regarding bitcoin's
future prospects.\344\ As the Trust's Registration Statement
acknowledges, ``[a] limited market currently exists for bitcoin-based
derivatives.'' \345\ As explained above, the market for bitcoin-based
derivatives is not yet well developed.\346\ That differs, for example,
from platinum and palladium markets, where futures products on those
metals had been trading for several decades before commodity-trust ETPs
were launched, and where the Commission has noted that exchanges are
able to adequately ``obtain information regarding trading'' in
regulated derivatives. This factor accordingly weighs against approval
of the proposed rule change.
---------------------------------------------------------------------------

\344\ See Section III.E.3(a), supra.
\345\ Registration Statement, supra note 22, at 59.
\346\ See Section III.E.3(b), supra.
---------------------------------------------------------------------------

Listing exchange rules and procedures prohibiting use of material
nonpublic information. Regardless of BZX's rules and procedures
regarding insider trading, many underlying bitcoin markets are, at
present, opaque.\347\ According to the Trust's Registration Statement,
for example, ``[m]any Bitcoin Exchanges do not provide the public with
significant information regarding their ownership structure, management
teams, corporate practices or regulatory compliance.'' \348\ The Trust
itself thus recognizes that there is a significant risk that material
nonpublic information may be used in a manner that could affect bitcoin
prices and, in turn, any ETP using bitcoin as an underlying asset. This
factor weighs against approval of the proposed rule change.
---------------------------------------------------------------------------

\347\ See Section III.B.1, supra.
\348\ Registration Statement, supra note 22, at 61.
---------------------------------------------------------------------------

Listing exchange rules regarding trading halts. Regardless of BZX's
rules regarding trading halts, BZX has not explained how it will
respond to disruptions in trading in underlying bitcoin markets.\349\
The Trust's Registration Statement acknowledges the unusual and severe
nature of such trading halts in bitcoin, noting that ``[e]ven the
largest Bitcoin Exchanges have been subject to operational interruption
(e.g., the temporary shutdown of Mt. Gox due to distributed denial of
service attacks (`DDoS') attacks by hackers and/or malware, and its
permanent closure in February 2014).'' \350\ Moreover, as one commenter
noted, the Gemini Auction has failed on at least two occasions.\351\
Such trading halts could result in volatile prices and reduced
confidence in any ETP that uses bitcoin as an underlying asset.
Accordingly, this factor weighs against approval of the proposed rule
change.
---------------------------------------------------------------------------

\349\ See Section II, supra.
\350\ Registration Statement, supra note 22, at 22.
\351\ See supra note 148 and accompanying text.
---------------------------------------------------------------------------

H. Other Comments

Comment letters also addressed the following topics: \352\
---------------------------------------------------------------------------

\352\ The Commission also received comments expressing support
for the proposal, without articulating any argument in favor of the
proposal. See Barraza Letter, supra note 35; Shad Letter, supra note
35.
---------------------------------------------------------------------------

The nature and uses of bitcoin; \353\
---------------------------------------------------------------------------

\353\ See Stolfi Letter I, supra note 35; Stolfi Letter II,
supra note 35; Chronakis Letter, supra note 35; Anonymous Letter
VII, supra note 35.
---------------------------------------------------------------------------

the state of development of bitcoin as a digital asset;
\354\
---------------------------------------------------------------------------

\354\ See Stolfi Letter II, supra note 35; Barish Letter IV,
supra note 35; ARK Letter, supra note 35; Lee Letter, supra note 35;
Chronakis Letter, supra note 35; Struna Letter, supra note 35;
Johnson Letter, supra note 35; Anonymous Letter V, supra note 35;
Whitman Letter, supra note 35; Anonymous Letter VI, supra note 35;
Barish Letter II, supra note 35; Ackerman Letter, supra note 35;
Medina Letter, supra note 35; Paslaqua Letter, supra note 35; BZX
Letter II, supra note 13, at 7-8.
---------------------------------------------------------------------------

the use of bitcoin for illegal activities; \355\
---------------------------------------------------------------------------

\355\ See Xin Lu Letter, supra note 35; Anonymous Letter VI,
supra note 35; Harris Letter, supra note 36, at 2.
---------------------------------------------------------------------------

the inherent value of, and risks of investing in, bitcoin;
\356\
---------------------------------------------------------------------------

\356\ See Stolfi Letter I, supra note 35; Stolfi Letter II,
supra note 35; Shatto Letter, supra note 35; Lethuillier Letter,
supra note 35; Delehanty Letter, supra note 35; Xin Lu Letter, supra
note 35; Neidhardt Letter, supra note 35; XBT Letter, supra note 35;
Williams Letter, supra note 35; ARK Letter, supra note 35; Kim
Letter, supra note 35; Dalla Val Letter, supra note 35; Paneque
Letter, supra note 35; Lee Letter, supra note 35; Chronakis Letter,
supra note 35; Struna Letter, supra note 35; Johnson Letter, supra
note 35; Whitman Letter, supra note 35; Primm Letter; supra note 35;
Anonymous Letter VI, supra note 35; Barish Letter III, supra note
35; Barish Letter V, supra note 35; Anonymous Letter VII, supra note
35; Ackerman Letter, supra note 35; Paslaqua Letter, supra note 35;
Harris Letter, supra note 36, at 2.
---------------------------------------------------------------------------

the cost of electricity required to maintain the Bitcoin
network; \357\
---------------------------------------------------------------------------

\357\ See Harris Letter, supra note 36, at 2.
---------------------------------------------------------------------------

the desire of investors to gain access to bitcoin through
an ETP; \358\
---------------------------------------------------------------------------

\358\ See R.D. Miller Letter, supra note 35; R. Miller Letter,
supra note 35; Hall Letter, supra note 35; Keeler Letter, supra note
35; Lethuillier Letter, supra note 35, at 2; Anonymous Letter I,
supra note 35; Herbert Letter, supra note 35; Fernandez Letter,
supra note 35; Tomaselli Letter, supra note 35; Circle Letter, supra
note 35; Baird Letter, supra note 35; Stolfi Letter I, supra note
35; Anderson Letter, supra note 35; P. Miller Letter, supra note 35;
Swiderski Letter, supra note 35; Situation Letter, supra note 35;
Paneque Letter, supra note 35; Nootenboom Letter, supra note 35;
Chronakis Letter, supra note 35; Turley Letter, supra note 35;
Kemble Letter, supra note 35; BZX Letter II, supra note 13, at 3, 8.

---------------------------------------------------------------------------

[[Page 37604]]

investor understanding about bitcoin; \359\
---------------------------------------------------------------------------

\359\ See Harris Letter, supra note 36, at 1.
---------------------------------------------------------------------------

the appropriate measures for the Trust to secure its
bitcoin holdings against theft or loss; \360\
---------------------------------------------------------------------------

\360\ See Barish Letter I, supra note 35; Barish Letter IV,
supra note 35; Neidhardt Letter, supra note 35; Dylan Letter, supra
note 35; Keeler Letter, supra note 35; Casey Letter I, supra note
35; Aronesty Letter, supra note 35; ARK Letter, supra note 35, at
10-11; Tull Letter, supra note 35; Stolfi Letter I, supra note 35;
Stolfi Letter II, supra note 35; Anonymous Letter I, supra note 35;
Lethuillier Letter, supra note 35, at 2-3; Delehanty Letter, supra
note 35; Casey Letter II, supra note 35; Anonymous Letter IV, supra
note 35; BZX Letter I, supra note 35, at 3, 6-7; Struna Letter,
supra note 35.
---------------------------------------------------------------------------

whether the Trust should insure its bitcoin holdings
against theft or loss; \361\
---------------------------------------------------------------------------

\361\ See Lethuillier Letter, supra note 35, at 2-3; Aronesty
Letter, supra note 35; Delehanty Letter, supra note 35; XBT Letter,
supra note 35; ARK Letter, supra note 35, at 10-11; Anonymous Letter
IV, supra note 35; BZX Letter I, supra note 35, at 6-7.
---------------------------------------------------------------------------

the adequacy of the Trust's procedures for handling
potential ``forks'' in the bitcoin blockchain; \362\
---------------------------------------------------------------------------

\362\ See Schulte Letter, supra note 35.
---------------------------------------------------------------------------

the blockchain treatment of positions in the Shares,
including short positions or derivative positions; \363\
---------------------------------------------------------------------------

\363\ See Anonymous Letter II, supra note 35, at 3; Tull Letter,
supra note 35.
---------------------------------------------------------------------------

the potential conflicts of interest related to the
affiliations among the Sponsor, the Custodian, and the Gemini Exchange;
\364\
---------------------------------------------------------------------------

\364\ See XBT Letter, supra note 35; Tull Letter, supra note 35;
Stolfi Letter II, supra note 35; ARK Letter, supra note 35, at 9-10;
Anonymous Letter III, supra note 35; BZX Letter I, supra note 35, at
5-6; Harris Letter, supra note 36.
---------------------------------------------------------------------------

the legitimacy or enhanced regulatory protection that
Commission approval of the proposed ETP might confer upon bitcoin as a
digital asset; \365\ and
---------------------------------------------------------------------------

\365\ See Stolfi Letter I, supra note 35; Circle Letter, supra
note 35; Kim Letter, supra note 35; Delehanty Letter, supra note 35;
Baird Letter, supra note 35; Anonymous Letter II, supra note 35, at
3; Keeler Letter, supra note 35; Dalla Val Letter, supra note 35;
Elron Letter, supra note 35; P. Miller Letter, supra note 35;
Marchionne Letter, supra note 35; Situation Letter, supra note 35;
Paneque Letter, supra note 35; Nootenboom Letter, supra note 35;
Chronakis Letter, supra note 35; Johnson Letter, supra note 35; Bang
Letter, supra note 35; Primm Letter, supra note 35; Christensen
Letter, supra note 35; Rigsby Letter, supra note 35.
---------------------------------------------------------------------------

the value to the Commission of enhanced oversight over
bitcoin markets from approving the proposal.\366\
---------------------------------------------------------------------------

\366\ See Convergex Letter, supra note 36, at 2.
---------------------------------------------------------------------------

Ultimately, however, additional discussion of these tangential
topics is unnecessary, as they do not bear on the basis for the
Commission's decision to disapprove BZX's proposal.\367\
---------------------------------------------------------------------------

\367\ The Commission also received a statement from SolidX
Management LLC, asserting that ``[t]o the extent the Commission is
inclined to reverse, modify, set aside or remand for further
proceedings the BatsBZX Proposed Rule Change, then in accordance
with Rule 431 and the factors set forth in Rule 411(b)(2) of the
Rules of Practice, the Commission should, as a matter of equity . .
. reverse, modify, set aside or remand for further proceedings its
March 28, 2017 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 (Release No. 34-80319; File No. SR-NYSEArca-2016-101).''
SolidX Letter, supra note 36, at 1. No timely petition to review the
March 28, 2017, disapproval order has been received from any party
and, under the Rule 431(c) of Commission's Rules of Practice, the
period for the Commission to order review of the issuance of that
disapproval order by delegated authority ended on April 7, 2017.
---------------------------------------------------------------------------

I. Basis for Disapproval

As discussed above,\368\ the central factor for the Commission in
its current consideration of the BZX proposal is whether it is
consistent with Exchange Act Section 6(b)(5), 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.\369\ Although BZX argues
that its proposal can satisfy these requirements because bitcoin
markets are inherently difficult to manipulate,\370\ and because
alternative means of identifying fraud and manipulation would be
sufficient,\371\ the Commission concludes that, as discussed above, BZX
has not established that these proffered means of compliance--alone or
in combination--are sufficient to meet the requirements of Exchange Act
Section 6(b)(5).\372\
---------------------------------------------------------------------------

\368\ See Section I, supra.
\369\ 15 U.S.C. 78f(b)(5).
\370\ See Sections III.B.1(a) and III.B.2(a), supra.
\371\ See Section III.C.1, supra.
\372\ See Sections III.B.1(b), III.B.2(b), and III.C.2, supra.
---------------------------------------------------------------------------

Thus, the Commission believes that BZX must demonstrate with
respect to this proposal that--like the listing exchanges for
previously approved commodity-trust ETPs \373\--it can enter into a
surveillance-sharing agreement with a regulated, bitcoin-related market
of significant size. As discussed above, however, BZX has not shown
that it can enter into such an agreement, because the proposal does not
support a conclusion that the markets for bitcoin or derivatives on
bitcoin are regulated markets of significant size.\374\ Therefore, BZX
has not met its burden to demonstrate that the proposed rule change is
consistent with Exchange Act Section 6(b)(5), and, accordingly, the
Commission is disapproving the proposed rule change.\375\
---------------------------------------------------------------------------

\373\ See Section III.D.2, supra.
\374\ See Sections III.E.1(b), III.E.2(b), and III.E.3(b),
supra.
\375\ In disapproving the proposed rule change, as modified by
Amendments No. 1 and 2, the Commission has considered its impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f); see also supra notes 322-326, 329 and accompanying text.
According to BZX, the Sponsor believes that the Shares will
represent a cost-effective and convenient means of gaining
investment exposure to bitcoin similar to a direct investment in
bitcoin, allowing investors to more effectively implement strategic
and tactical asset allocation strategies that use bitcoin, with
lower cost than that associated with the direct purchase, storage,
and safekeeping of bitcoin. See Amendment No. 1, supra note 1, 81 FR
at 76662; see also Overdahl Letter, supra note 36, at 13 (asserting
that approval of bitcoin ETP would improve the availability of
investment and portfolio diversification opportunities for
investors); Lewis Letter I, supra note 65, at 3, 11-16 (asserting
that a bitcoin-based ETP would enable ordinary investors to
construct more efficient portfolios). Regarding competition, BZX has
asserted that approval of the proposed rule change ``will enhance
competition among market participants, to the benefit of investors
and the marketplace.'' Amendment No. 1, supra note 1, 81 FR at
76669. BZX also asserts that the Shares ``would facilitate capital
formation in the bitcoin marketplace in a manner nearly identical to
other commodity-trust exchange traded products.'' BZX Letter II,
supra note 13, at 3, 30. Additionally, one commenter asserts that
approval of the Proposal would allow the United States to continue
its ``historic technological leadership,'' Baird Letter, supra note
35, while another commenter asserts that, with the approval of the
Proposal, ``bitcoin might become a much larger part of the world
economy at risk.'' Barish Letter III, supra note 35. The Commission
recognizes that BZX and commenters assert the economic benefits
described above, but, for the reasons discussed throughout, the
Commission is disapproving the proposed rule change because it does
not find that the proposed rule change is consistent with the
Exchange Act.
---------------------------------------------------------------------------

While the Commission concludes that BZX must demonstrate the
ability to enter into a surveillance-sharing agreement with a regulated
market of significant size related to bitcoin, and while this factor
strongly supports disapproval of BZX's proposed rule change, the other
factors BZX asks the Commission to weigh \376\ also support the
disapproval of the proposed rule change. Even considering these other
factors, the Commission does not find BZX's proposed rule change to be
consistent with Exchange Act Section 6(b)(5)'s requirement 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.'' \377\
---------------------------------------------------------------------------

\376\ See Section III.G, supra.
\377\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

IV. Conclusion

For the reasons set forth above, the Commission does not find,
pursuant to Section 19(b)(2) of the Exchange Act,

[[Page 37605]]

that the proposed rule change, as modified by Amendments No. 1 and 2,
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 Rule 431 of the Commission's
Rules of Practice, that the earlier action taken by delegated
authority, Exchange Act Release No. 80206 (Mar. 10, 2017), 82 FR 14076
(Mar. 16, 2017), is set aside and, pursuant to Section 19(b)(2) of the
Exchange Act, SR-BatsBZX-2016-30 is disapproved.

By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2018-16427 Filed 7-31-18; 8:45 am]
BILLING CODE 8011-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.