Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order Disapproving a Proposed Rule Change To List and Trade Shares of the WisdomTree Bitcoin Trust Under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares, 69322-69335 [2021-26442]

Download as PDF 69322 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices SECURITIES AND EXCHANGE COMMISSION [Release No. 34–93700; File No. SR– CboeBZX–2021–024]) Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order Disapproving a Proposed Rule Change To List and Trade Shares of the WisdomTree Bitcoin Trust Under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares December 1, 2021. I. Introduction On March 26, 2021, Cboe BZX Exchange, Inc. (‘‘BZX’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule change to list and trade shares (‘‘Shares’’) of the WisdomTree Bitcoin Trust (‘‘Trust’’) under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares. The proposed rule change was published for comment in the Federal Register on April 15, 2021.3 On May 26, 2021, pursuant to Section 19(b)(2) of the Exchange Act,4 the Commission designated a longer period within which to approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to disapprove the proposed rule change.5 On July 13, 2021, the Commission instituted proceedings under Section 19(b)(2)(B) of the Exchange Act 6 to determine whether to approve or disapprove the proposed rule change.7 On September 29, 2021, the Commission designated a longer period for Commission action on the proposed rule change.8 This order disapproves the proposed rule change. The Commission concludes that 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 Exchange Act Section 6(b)(5), in particular, the requirement that the rules of a national securities 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 91521 (Apr. 9, 2021), 86 FR 19917 (‘‘Notice’’). Comments on the proposed rule change can be found at: https://www.sec.gov/comments/sr-cboebzx-2021024/srcboebzx2021024.htm. 4 15 U.S.C. 78s(b)(2). 5 See Securities Exchange Act Release No. 92032, 86 FR 29611 (June 2, 2021). 6 15 U.S.C. 78s(b)(2)(B). 7 See Securities Exchange Act Release No. 92392, 86 FR 38154 (July 19, 2021). 8 See Securities Exchange Act Release No. 93173, 86 FR 55065 (Oct. 5, 2021). lotter on DSK11XQN23PROD with NOTICES1 2 17 VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 exchange be ‘‘designed to prevent fraudulent and manipulative acts and practices’’ and ‘‘to protect investors and the public interest.’’ 9 When considering whether BZX’s proposal to list and trade the Shares is designed to prevent fraudulent and manipulative acts and practices, the Commission applies the same standard used in its orders considering previous proposals to list bitcoin 10-based commodity trusts and bitcoin-based trust issued receipts.11 As the Commission has explained, an exchange that lists bitcoin-based exchange-traded products (‘‘ETPs’’) can meet its obligations under Exchange Act Section 6(b)(5) by demonstrating that the exchange has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying or reference bitcoin assets.12 9 15 U.S.C. 78f(b)(5). 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, e.g., Notice, 86 FR at 19918. 11 See 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, Securities Exchange Act Release No. 83723 (July 26, 2018), 83 FR 37579 (Aug. 1, 2018) (SR– BatsBZX–2016–30) (‘‘Winklevoss Order’’); Order Disapproving a Proposed Rule Change, as Modified by Amendment No. 1, To Amend NYSE Arca Rule 8.201–E (Commodity-Based Trust Shares) and To List and Trade Shares of the United States Bitcoin and Treasury Investment Trust Under NYSE Arca Rule 8.201–E, Securities Exchange Act Release No. 88284 (Feb. 26, 2020), 85 FR 12595 (Mar. 3, 2020) (SR–NYSEArca–2019–39) (‘‘USBT Order’’). See also 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, Securities Exchange Act Release No. 80319 (Mar. 28, 2017), 82 FR 16247 (Apr. 3, 2017) (SR– NYSEArca-2016–101) (‘‘SolidX Order’’). The Commission also notes that orders were issued by delegated authority on the following matters: Order Disapproving a Proposed Rule Change To List and Trade the Shares of the ProShares Bitcoin ETF and the ProShares Short Bitcoin ETF, Securities Exchange Act Release No. 83904 (Aug. 22, 2018), 83 FR 43934 (Aug. 28, 2018) (NYSEArca–2017–139) (‘‘ProShares Order’’); Order Disapproving a Proposed Rule Change To List and Trade the Shares of the GraniteShares Bitcoin ETF and the GraniteShares Short Bitcoin ETF, Securities Exchange Act Release No. 83913 (Aug. 22, 2018), 83 FR 43923 (Aug. 28, 2018) (SR–CboeBZX–2018– 001) (‘‘GraniteShares Order’’); Order Disapproving a Proposed Rule Change To List and Trade Shares of the VanEck Bitcoin Trust under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares, Securities Exchange Act Release No. 93559 (Nov. 12, 2021), 86 FR 64539 (Nov. 18, 2021) (SR– CboeBZX–2021–019). 12 See USBT Order, 85 FR at 12596. See also Winklevoss Order, 83 FR at 37592 n.202 and accompanying text (discussing previous 10 Bitcoins PO 00000 Frm 00104 Fmt 4703 Sfmt 4703 The standard requires such surveillance-sharing agreements since they ‘‘provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur.’’ 13 The Commission has emphasized that it is essential for an exchange listing a derivative securities product to enter into a surveillancesharing agreement with markets trading the underlying assets for the listing exchange to have the ability to obtain information necessary to detect, investigate, and deter fraud and market manipulation, as well as violations of exchange rules and applicable federal securities laws and rules.14 The hallmarks of a surveillance-sharing 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.15 In the context of this standard, the terms ‘‘significant market’’ and ‘‘market of significant size’’ 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 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.16 A surveillance-sharing agreement must be entered into with a ‘‘significant market’’ to assist in Commission approvals of commodity-trust ETPs); GraniteShares Order, 83 FR at 43925–27 nn.35–39 and accompanying text (discussing previous Commission approvals of commodity-futures ETPs). 13 See Amendment to Rule Filing Requirements for Self-Regulatory Organizations Regarding New Derivative Securities Products, Securities Exchange Act Release No. 40761 (Dec. 8, 1998), 63 FR 70952, 70959 (Dec. 22, 1998) (‘‘NDSP Adopting Release’’). See also Winklevoss Order, 83 FR at 37594; ProShares Order, 83 FR at 43936; GraniteShares Order, 83 FR at 43924; USBT Order, 85 FR at 12596. 14 See NDSP Adopting Release, 63 FR at 70959. 15 See Winklevoss Order, 83 FR at 37592–93; 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. 16 See Winklevoss Order, 83 FR at 37594. 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. See id. E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices detecting and deterring manipulation of the ETP, because a person attempting to manipulate the ETP is reasonably likely to also engage in trading activity on that ‘‘significant market.’’ 17 Consistent with this standard, 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 (‘‘ISG’’) membership in common with, that market.18 Moreover, the surveillance-sharing agreements have been consistently present whenever the Commission has approved the listing and trading of derivative securities, even where the underlying securities were also listed on national securities exchanges—such as options based on an index of stocks traded on a national securities exchange—and were thus subject to the Commission’s direct regulatory authority.19 Listing exchanges have also attempted to demonstrate that other means besides surveillance-sharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices, including that the bitcoin market as a 17 See USBT Order, 85 FR at 12597. Winklevoss Order, 83 FR at 37594. 19 See USBT Order, 85 FR at 12597; Securities 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 Depository Receipts). The Commission has also required a surveillance-sharing agreement in the context of index options even when (i) all of the underlying index component stocks were either registered with the Commission or exempt from registration under the Exchange Act; (ii) all of the underlying index component stocks traded in the U.S. either directly or as ADRs on a national securities exchange; and (iii) effective international ADR arbitrage alleviated concerns over the relatively smaller ADR trading volume, helped to ensure that ADR prices reflected the pricing on the home market, and helped to ensure more reliable price determinations for settlement purposes, due to the unique composition of the index and reliance on ADR prices. See Securities Exchange Act Release No. 26653 (Mar. 21, 1989), 54 FR 12705, 12708 (Mar. 28, 1989) (SR–Amex–87–25) (stating that ‘‘surveillance-sharing agreements between the exchange on which the index option trades and the markets that trade the underlying securities are necessary’’ and that ‘‘[t]he exchange of surveillance data by the exchange trading a stock index option and the markets for the securities comprising the index is important to the detection and deterrence of intermarket manipulation.’’). And the Commission has required a surveillance-sharing agreement even when approving options based on an index of stocks traded on a national securities exchange. See Securities Exchange Act Release No. 30830 (June 18, 1992), 57 FR 28221, 28224 (June 24, 1992) (SR–Amex–91–22) (stating that surveillancesharing agreements ‘‘ensure the availability of information necessary to detect and deter potential manipulations and other trading abuses’’). lotter on DSK11XQN23PROD with NOTICES1 18 See VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 whole or the relevant underlying bitcoin market is ‘‘uniquely’’ and ‘‘inherently’’ resistant to fraud and manipulation.20 In response, the Commission has agreed that, if a listing exchange could establish that the underlying market inherently possesses a unique resistance to manipulation beyond the protections that are utilized by traditional commodity or securities markets, it would not necessarily need to enter into a surveillance-sharing agreement with a regulated significant market.21 Such resistance to fraud and manipulation, however, must be novel and beyond those protections that exist in traditional commodity markets or equity markets for which the Commission has long required surveillance-sharing agreements in the context of listing derivative securities products. No listing exchange has satisfied its burden to make such demonstration.22 Here, BZX contends that approval of the proposal is consistent with Section 6(b)(5) of the Exchange Act, in particular 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.23 As discussed in more detail below, BZX asserts that the proposal is consistent with Section 6(b)(5) of the Exchange Act because the Exchange has a comprehensive surveillance-sharing agreement with a regulated market of significant size,24 and there exist other means to prevent fraudulent and manipulative acts and practices that are sufficient to justify dispensing with the requisite surveillance-sharing agreement.25 Although BZX recognizes the Commission’s focus on potential manipulation of bitcoin ETPs in prior disapproval orders, BZX argues that such manipulation concerns have been sufficiently mitigated, and that the growing and quantifiable investor protection concerns should be the central consideration of the Commission.26 Specifically, as discussed in more detail below, the Exchange asserts that the significant increase in trading volume in bitcoin futures on the Chicago Mercantile 20 See USBT Order, 85 FR at 12597. Winklevoss Order, 83 FR at 37580, 37582– 91 (addressing assertions that ‘‘bitcoin and bitcoin [spot] markets’’ generally, as well as one bitcoin trading platform specifically, have unique resistance to fraud and manipulation); see also USBT Order, 85 FR at 12597. 22 See supra note 11. 23 See Notice, 86 FR at 19924. 24 See id. at 19929–30. 25 See id. at 19930. 26 See id. at 19920. 21 See PO 00000 Frm 00105 Fmt 4703 Sfmt 4703 69323 Exchange (‘‘CME’’), the growth of liquidity in the spot market for bitcoin, and certain features of the Shares and the Reference Rate (as defined herein) mitigate potential manipulation concerns to the point that the investor protection issues that have arisen from the rapid growth of over-the-counter (‘‘OTC’’) bitcoin funds, including premium/discount volatility and management fees, should be the central consideration as the Commission determines whether to approve this proposal.27 Further, BZX believes that the proposal would give U.S. investors access to bitcoin in a regulated and transparent exchange-traded vehicle that would act to limit risk to U.S. investors. According to BZX, the proposed listing and trading of the Shares would mitigate risk by: (i) Reducing premium and discount volatility; (ii) reducing management fees through meaningful competition; (iii) reducing risks associated with investing in operating companies that are imperfect proxies for bitcoin exposure; and (iv) providing an alternative to custodying spot bitcoin.28 In the analysis that follows, the Commission examines whether the proposed rule change is consistent with Section 6(b)(5) of the Exchange Act by addressing: in Section III.B.1 assertions that other means besides surveillancesharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices; in Section III.B.2 assertions that BZX has entered into a comprehensive surveillance-sharing agreement with a regulated market of significant size related to bitcoin; and in Section III.C assertions that the proposal is consistent with the protection of investors and the public interest. As discussed further below, BZX repeats various assertions made in prior bitcoinbased ETP proposals that the Commission has previously addressed and rejected and more importantly, BZX does not respond to the Commission’s reasons for rejecting those assertions but merely repeats them. The Commission concludes that BZX has not established that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the requisite surveillance-sharing agreement. The Commission further concludes that BZX has not established that it has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to bitcoin. As a result, the Commission is unable to find that the 27 See 28 See E:\FR\FM\07DEN1.SGM id. at 19929. id. at 19920. 07DEN1 69324 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices proposed rule change is consistent with the statutory requirements of Exchange Act Section 6(b)(5). The Commission again emphasizes that its disapproval of this proposed rule change 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 below, BZX has not met its burden to demonstrate that its proposal is consistent with the requirements of Exchange Act Section 6(b)(5). lotter on DSK11XQN23PROD with NOTICES1 Rate is the arithmetic mean of these 12 volume-weighted median trade prices.32 Each Share represents a fractional undivided beneficial interest in and ownership of the Trust. The Trust’s assets will consist of bitcoin held by the Bitcoin Custodian on behalf of the Trust. The Trust generally does not intend to hold cash or cash equivalents. However, there may be situations where the Trust will unexpectedly hold cash on a temporary basis.33 The administrator will determine the NAV and NAV per Share of the Trust on each day that the Exchange is open for regular trading after 4:00 p.m. E.T. II. Description of the Proposed Rule (often by 5:30 p.m. E.T. and almost Change always by 8:00 p.m. E.T.). The NAV of As described in more detail in the the Trust is the aggregate value of the Notice,29 the Exchange proposes to list Trust’s assets, less total liabilities of the and trade the Shares of the Trust under Trust. In determining the Trust’s NAV, BZX Rule 14.11(e)(4), which governs the the administrator values the bitcoin listing and trading of Commodity-Based held by the Trust based on the price set Trust Shares on the Exchange. by the Reference Rate as of 4:00 p.m. The investment objective of the Trust E.T.34 is to gain exposure to the price of The Trust will provide information bitcoin, less expenses and liabilities of the Trust’s operation.30 The Trust would regarding the Trust’s bitcoin holdings, as well as an Intraday Indicative Value hold bitcoin, and it would calculate the (‘‘IIV’’) per Share updated every 15 Trust’s net asset value (‘‘NAV’’) daily seconds, as calculated by the Exchange based on the value of bitcoin as or a third-party financial data provider reflected by the CF Bitcoin US during the Exchange’s Regular Trading Settlement Price (‘‘Reference Rate’’). Hours (9:30 a.m. to 4:00 p.m. E.T.). The The Reference Rate was created, and is IIV will be calculated by using the prior administered, by CF Benchmarks Ltd. day’s closing NAV per Share as a base (‘‘Benchmark Administrator’’). The Reference Rate aggregates the trade flow and updating that value during Regular Trading Hours to reflect changes in the of several bitcoin spot platforms, the value of the Trust’s bitcoin holdings composition of which currently during the trading day.35 includes Bitstamp, Coinbase, Gemini, When the Trust sells or redeems its itBit, and Kraken. In calculating the Reference Rate, the methodology creates Shares, it will do so in ‘‘in-kind’’ a joint list of the trade prices and sizes transactions in blocks of aggregations of from the Constituent Bitcoin Platforms Shares. When creating the Shares, (as defined herein) between 3:00 p.m. authorized participants will deliver, or E.T. and 4:00 p.m. E.T. The facilitate the delivery of, bitcoin to the methodology divides this list into 12 Trust’s account with the Bitcoin equally-sized time intervals of five Custodian in exchange for the Shares, minutes and calculates the volumeand, when redeeming the Shares, the weighted median trade price for each of Trust, through the Bitcoin Custodian, those time intervals.31 The Reference will deliver bitcoin to such authorized participants.36 29 See Notice, supra note 3. See also Registration Statement on Form S–1, dated March 11, 2021 (File No. 333–254134), filed with the Commission on behalf of the Trust (‘‘Registration Statement’’). 30 WisdomTree Digital Commodity Services, LLC (‘‘Sponsor’’) is the sponsor of the Trust, and Delaware Trust Company is the trustee. A thirdparty regulated custodian (‘‘Bitcoin Custodian’’) will be responsible for custody of the Trust’s bitcoin. The Sponsor is responsible for selecting the Bitcoin Custodian as well as an administrator, a transfer agent, a marketing agent, and an auditor for the Trust. See Notice, 86 FR at 19918, 19925–26. 31 According to BZX, the Reference Rate is based on materially the same methodology (except calculation time, as described herein) as the Benchmark Administrator’s CME CF Bitcoin Reference Rate (‘‘BRR’’), which was first introduced on November 14, 2016, and is the rate on which VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 bitcoin futures contracts are cash-settled in U.S. dollars on CME. The Reference Rate is calculated as of 4:00 p.m. E.T., whereas the CME CF BRR is calculated as of 4:00 p.m. London Time. The Reference Rate aggregates the trade flow of several bitcoin platforms during an observation window between 3:00 p.m. and 4:00 p.m. E.T. into the U.S. dollar price of one bitcoin at 4:00 p.m. E.T. The current constituent bitcoin platforms of the Reference Rate are Bitstamp, Coinbase, Gemini, itBit, and Kraken (‘‘Constituent Bitcoin Platforms’’). See Notice, 86 FR at 19926 & n.70. 32 See id. at 19926. 33 See id. at 19925. 34 See id. at 19927. 35 See id. at 19926. 36 See id. at 19925–26. PO 00000 Frm 00106 Fmt 4703 Sfmt 4703 III. Discussion A. The Applicable Standard for Review The Commission must consider whether BZX’s proposal is consistent with the Exchange Act. Section 6(b)(5) of the Exchange Act 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.’’ 37 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 thereunder . . . is on the self-regulatory organization [‘SRO’] that proposed the rule change.’’ 38 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,39 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.40 Moreover, ‘‘unquestioning reliance’’ on an SRO’s representations in a proposed rule change is not sufficient to justify Commission approval of a proposed rule change.41 37 15 U.S.C. 78f(b)(5). Pursuant to Section 19(b)(2) of the Exchange Act, 15 U.S.C. 78s(b)(2), 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. Exchange Act Section 6(b)(5) states that an exchange shall not be registered as a national securities exchange unless the Commission determines that ‘‘[t]he rules of the exchange 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; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers, or to regulate by virtue of any authority conferred by this title matters not related to the purposes of this title or the administration of the exchange.’’ 15 U.S.C. 78f(b)(5). 38 Rule 700(b)(3), Commission Rules of Practice, 17 CFR 201.700(b)(3). 39 See id. 40 See id. 41 Susquehanna Int’l Group, LLP v. Securities and Exchange Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (‘‘Susquehanna’’). E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices B. Whether BZX Has Met its Burden To Demonstrate That the Proposal Is Designed To Prevent Fraudulent and Manipulative Acts and Practices (1) Assertions That Other Means Besides Surveillance-Sharing Agreements Will Be Sufficient To Prevent Fraudulent and Manipulative Acts and Practices As stated above, the Commission has recognized that a listing exchange could demonstrate that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with a comprehensive surveillance-sharing agreement with a regulated market of significant size, including by demonstrating that the bitcoin market as a whole or the relevant underlying bitcoin market is uniquely and inherently resistant to fraud and manipulation.42 Such resistance to fraud and manipulation must be novel and beyond those protections that exist in traditional commodities or securities markets.43 BZX asserts that bitcoin is resistant to price manipulation. According to BZX, the geographically diverse and continuous nature of bitcoin trading render it difficult and prohibitively costly to manipulate the price of bitcoin.44 Fragmentation across bitcoin platforms, the relatively slow speed of transactions, and the capital necessary to maintain a significant presence on each trading platform make manipulation of bitcoin prices through continuous trading activity challenging.45 To the extent that there are bitcoin platforms engaged in or allowing wash trading or other activity intended to manipulate the price of bitcoin on other markets, such pricing does not normally impact prices on other platforms because participants will generally ignore markets with quotes that they deem non-executable.46 BZX further argues that the linkage between the bitcoin markets and the presence of arbitrageurs in those markets means that the manipulation of the price of bitcoin on any single venue would require manipulation of the global bitcoin price in order to be effective.47 Arbitrageurs must have lotter on DSK11XQN23PROD with NOTICES1 42 See USBT Order, 85 FR at 12597 n.23. The Commission is not applying a ‘‘cannot be manipulated’’ standard. Instead, the Commission is examining whether the proposal meets the requirements of the Exchange Act and, pursuant to its Rules of Practice, places the burden on the listing exchange to demonstrate the validity of its contentions and to establish that the requirements of the Exchange Act have been met. See id. 43 See id. at 12597. 44 See Notice, 86 FR at 19924 n.58. 45 See id. 46 See id. 47 See id. VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 funds distributed across multiple trading platforms in order to take advantage of temporary price dislocations, thereby making it unlikely that there will be strong concentration of funds on any particular bitcoin trading venue.48 As a result, BZX concludes that the potential for manipulation on a bitcoin trading platform would require overcoming the liquidity supply of such arbitrageurs who are effectively eliminating any cross-market pricing differences.49 As with the previous proposals, the Commission here concludes that the record does not support a finding that the bitcoin market is inherently and uniquely resistant to fraud and manipulation.50 BZX asserts that, because of how bitcoin trades occur, including through continuous means and through fragmented platforms, arbitrage across the bitcoin platforms essentially helps to keep global bitcoin prices aligned with one another, thus hindering manipulation. The Exchange, however, does not provide any data or analysis to support its assertions, either in terms of how closely bitcoin prices are aligned across different bitcoin trading venues or how quickly price disparities may be arbitraged away.51 As stated above, ‘‘unquestioning reliance’’ on an SRO’s representations in a proposed rule change is not sufficient to justify Commission approval of a proposed rule change.52 Efficient price arbitrage, moreover, is not sufficient to support the finding that a market is uniquely and inherently resistant to manipulation such that the Commission can dispense with 48 See id. id. 50 Two commenters also question the bitcoin market’s resistance to fraud and manipulation. One commenter asserts that the bitcoin network is the preferred network for global criminals, and a pyramid scheme in which the top holders encourage existing holders to keep holding and entice new retail investors to invest. See letter from Maulik Patel, dated July 4, 2021 (‘‘Patel Letter’’). Another commenter describes digital assets such as bitcoin, and the blockchains on which they rely, as having complexity that makes users vulnerable to fraud. See letter from Lourdes Ciao, dated June 24, 2021 (‘‘Ciao Letter 3’’). 51 For example, the Registration Statement states that ‘‘[i]f increases in throughput on the Bitcoin network lag behind growth in usage of bitcoin, average fees and settlement times may increase considerably . . . . which could adversely impact the value of the Shares.’’ See Registration Statement at 21. BZX does not provide data or analysis to address, among other things, whether such risks of increased fees and bitcoin transaction settlement times may affect the arbitrage effectiveness that BZX asserts. See also infra note 65 and accompanying text (referencing statements made in the Registration Statement that contradict assertions made by BZX). 52 See supra note 41. 49 See PO 00000 Frm 00107 Fmt 4703 Sfmt 4703 69325 surveillance-sharing agreements.53 The Commission has stated, for example, that even for equity options based on securities listed on national securities exchanges, the Commission relies on surveillance-sharing agreements to detect and deter fraud and manipulation.54 Here, the Exchange provides no evidence to support its assertion of efficient price arbitrage across bitcoin platforms, let alone any evidence that price arbitrage in the bitcoin market is novel or unique so as to warrant the Commission dispensing with the requirement of a surveillancesharing agreement. Moreover, BZX does not 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.55 In addition, the Exchange makes the unsupported claim that bitcoin prices on platforms with wash trades or other activity intended to manipulate the price of bitcoin do not influence the ‘‘real’’ price of bitcoin. The Exchange also asserts that, to the extent that there are bitcoin platforms engaged in or allowing wash trading or other manipulative activities, market participants will generally ignore those platforms. However, without the necessary data, such as lead-lag or other similar analyses, or other evidence, the Commission has no basis on which to conclude that bitcoin platforms are insulated from prices of others that engage in or permit fraud or manipulation.56 Additionally, the continuous nature of bitcoin trading does not eliminate manipulation risk, and neither does linkages among markets, as BZX asserts.57 Even in the presence of continuous trading or linkages among markets, formal (such as those with consolidated quotations or routing requirements) or otherwise (such as in the context of the fragmented, global bitcoin markets), manipulation of asset prices, as a general matter, can occur simply through trading activity that 53 See Winklevoss Order, 83 FR at 37586; SolidX Order, 82 FR at 16256–57; USBT Order, 85 FR at 12601. 54 See, e.g., USBT Order, 85 FR at 12601. 55 See, e.g., Winklevoss Order, 83 FR at 37584; USBT Order, 85 FR at 12600–01. 56 See USBT Order, 85 FR at 12601. See also infra notes 131–132 and accompanying text (explaining the lead-lag analysis as central to understanding whether it is reasonably likely that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP). 57 See Winklevoss Order, 83 FR at 37585 n.92 and accompanying text. E:\FR\FM\07DEN1.SGM 07DEN1 69326 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices creates a false impression of supply or demand.58 BZX also argues that the significant liquidity in the bitcoin spot market and the impact of market orders on the overall price of bitcoin mean that attempting to move the price of bitcoin is costly and has grown more expensive over the past year.59 According to BZX, in January 2020, for example, the cost to buy or sell $5 million worth of bitcoin averaged roughly 30 basis points (compared to 10 basis points in February 2021) with a market impact of 50 basis points (compared to 30 basis points in February 2021). For a $10 million market order, the cost to buy or sell was roughly 50 basis points (compared to 20 basis points in February 2021) with a market impact of 80 basis points (compared to 50 basis points in February 2021). BZX contends that as the liquidity in the bitcoin spot market increases, it follows that the impact of $5 million and $10 million orders will continue to decrease.60 However, the data furnished by BZX regarding the cost to move the price of bitcoin, and the market impact of such attempts, are incomplete. BZX does not provide meaningful analysis pertaining to how these figures compare to other markets or why one must conclude, based on the numbers provided, that the bitcoin market is costly to manipulate. Further, BZX’s analysis of the market impact of a mere two sample transactions is not sufficient evidence to conclude that the bitcoin market is resistant to manipulation.61 Even assuming that the Commission agreed with BZX’s premise, that it is costly to manipulate the bitcoin market and it is becoming increasingly so, any such evidence speaks only to establish that there is some resistance to manipulation, not that it establishes unique resistance to manipulation to warrant dispensing with the standard surveillance-sharing agreement.62 The Commission thus concludes that the record does not demonstrate that the nature of bitcoin trading renders the bitcoin market inherently and uniquely resistant to fraud and manipulation. Moreover, BZX does not sufficiently contest the presence of possible sources 58 See id. at 37585. Notice, 86 FR at 19925. 60 See id. 61 Aside from stating that the ‘‘statistics are based on samples of bitcoin liquidity in USD (excluding stablecoins or Euro liquidity) based on executable quotes on Coinbase Pro, Gemini, Bitstamp, Kraken, LMAX Exchange, BinanceUS, and OKCoin during February 2021,’’ the Exchange provides no other information pertaining to the methodology used to enable the Commission to evaluate these findings or their significance. See id. at 19925 nn.64–65. 62 See USBT Order, 85 FR at 12601. lotter on DSK11XQN23PROD with NOTICES1 59 See VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 of fraud and manipulation in the bitcoin spot market generally that the Commission has raised in previous orders, which have included (1) ‘‘wash’’ trading,63 (2) persons with a dominant position in bitcoin manipulating bitcoin pricing, (3) hacking of the bitcoin network and trading platforms, (4) malicious control of the bitcoin network, (5) trading based on material, non-public information, including the dissemination of false and misleading information, (6) manipulative activity involving the purported ‘‘stablecoin’’ Tether (USDT), and (7) fraud and manipulation at bitcoin trading platforms.64 In addition, BZX does not address risk factors specific to the bitcoin blockchain and bitcoin platforms, described in the Trust’s Registration Statement, that undermine the argument that the bitcoin market is inherently resistant to fraud and manipulation. For example, the Registration Statement acknowledges that ‘‘bitcoin [platforms] on which bitcoin trades are relatively new and, in some cases, unregulated, and, therefore, may be more exposed to fraud and security breaches than established, regulated exchanges for other financial assets or instruments’’; that ‘‘as an intangible asset without centralized issuers or governing bodies, bitcoin has been, and may in the future be, subject to security breaches, cyberattacks or other malicious activities’’; that ‘‘[t]he trading for bitcoin occurs on multiple trading venues that have various levels and types of regulation, but are not regulated in the same manner as traditional stock and bond exchanges’’ and if these spot markets ‘‘do not operate smoothly or face technical, security or regulatory issues, that could impact the ability of Authorized Participants to make markets in the Shares’’ which could lead to ‘‘trading in the Shares [to] occur at a material premium or discount against the NAV’’; that the bitcoin blockchain could be vulnerable to a ‘‘51% attack,’’ in which a bad actor that controls a majority of the processing power dedicated to mining on the bitcoin network may be able to alter the bitcoin blockchain on which the bitcoin network and bitcoin transactions rely; that the nature of the assets held at bitcoin platforms makes them ‘‘appealing targets for hackers’’ and that ‘‘a number of bitcoin [platforms] have been victims of 63 See supra note 56 and accompanying text. USBT Order, 85 FR at 12600–01 & nn.66– 67 (discussing J. Griffin & A. Shams, Is Bitcoin Really Untethered? (October 28, 2019), available at https://ssrn.com/abstract=3195066 and published in 75 J. Finance 1913 (2020)); Winklevoss Order, 83 FR at 37585–86. 64 See PO 00000 Frm 00108 Fmt 4703 Sfmt 4703 cybercrimes’’; and that bitcoin trading platforms ‘‘have been closed or faced issues due to fraud, failure’’ and ‘‘security breaches.’’ 65 BZX also asserts that other means to prevent fraud and manipulation are sufficient to justify dispensing with the requisite surveillance-sharing agreement. The Exchange mentions that the Reference Rate, which is used to value the Trust’s bitcoin, is itself resistant to manipulation based on the Reference Rate’s methodology.66 The Exchange states that the Reference Rate is calculated based on the ‘‘Relevant Transactions’’ 67 of all of its Constituent Bitcoin Platforms. All Relevant Transactions are added to a joint list, recording the time of execution, trade price, and size for each transaction, and the list is partitioned by timestamp into 12 equally-sized time intervals of five minute length.68 For each partition separately, the volume-weighted median trade price is calculated from the trade prices and sizes of all Relevant Transactions.69 The Reference Rate is then determined by the arithmetic mean of the volume-weighted medians of all partitions.70 According to BZX, ‘‘[b]y employing the foregoing steps, the Reference Rate thereby seeks to ensure that transactions in bitcoin conducted at outlying prices do not have an undue effect on the value of a specific partition, large trades or clusters of trades transacted over a short period of time will not have an undue influence on the index level, and the effect of large trades at prices that deviate from the prevailing price are mitigated from having an undue influence on the benchmark level.’’ 71 BZX concludes its analysis of the Reference Rate by noting that ‘‘an oversight function is implemented by the Benchmark Administrator in seeking to ensure that the Reference Rate is administered through codified policies for Reference Rate integrity.’’ 72 The Benchmark Administrator, in a comment letter, elaborates on how, in 65 See Registration Statement at 11, 18–20, 38. See also Winklevoss Order, 83 FR at 37585. 66 See Notice, 86 FR at 19925. 67 According to the Exchange, a ‘‘Relevant Transaction’’ is any cryptocurrency versus U.S. dollar spot trade that occurs during the observation window between 3:00 p.m. and 4:00 p.m. E.T. on a Constituent Bitcon Platform in the BTC/USD pair that is reported and disseminated by a Constituent Bitcoin Platform and observed by the Benchmark Administrator. See id. at 19926 n.71. 68 See id. at 19926. 69 See id. According to the Exchange, a volumeweighted median differs from a standard median in that a weighting factor, in this case trade size, is factored into the calculation. See id. 70 See id. 71 See id. 72 See id. E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices lotter on DSK11XQN23PROD with NOTICES1 its view, its oversight of the Reference Rate helps to prevent fraud and manipulation.73 The Benchmark Administrator states that it is subject to the UK Benchmarks Regulation (‘‘BMR’’), which is enforced by the UK Financial Conduct Authority (‘‘FCA’’), including requirements to surveil for attempted and actual manipulation.74 The Benchmark Administrator further states that, in order to fulfil its regulatory obligations under the UK BMR: It only includes as ‘‘Constituent Bitcoin Platforms’’ those trading platforms that conform to certain criteria, including assessment of a platform’s risks to market participants, compliance with law, and policies to identify and impede manipulative trading practices; 75 it has in place information-sharing agreements with each of the Constituent Bitcoin Platforms; 76 and it operates a Benchmark Surveillance Program, over which the UK FCA has authority, whereby it monitors for, investigates, and reports signs of manipulation.77 In addition, in its comment letter, the Benchmark Administrator asserts that CME, in the course of operating and overseeing its bitcoin futures market under the regulatory oversight of the Commodity Futures Trading Commission (‘‘CFTC’’), has in place information-sharing agreements with the Constituent Bitcoin Platforms for the purposes of impeding and detecting any attempted manipulation of the futures contracts, as they are the platforms from which trade data is gathered to compute the CME CF BRR; 78 and that given such agreements, ‘‘this would allow for [potentially manipulative acts to] be detected and deterred by CME.’’ 79 The Benchmark Administrator further asserts that, because the CME and BZX are both members of the ISG, BZX would also have access to this information to allow for detection and deterrence of manipulation should it occur.80 Simultaneously with the Exchange’s and the Benchmark Administrator’s assertions regarding the Reference Rate, the Exchange also states that, because the Trust will engage in in-kind 73 See letter from CF Benchmarks, dated April 2021 (‘‘CF Benchmarks Letter’’). 74 See id. at 2. 75 See id. at 3. The Benchmark Administrator further states that the same Constituent Bitcoin Platforms are used to compute the CME CF BRR, which it also administers, and which is used to settle the bitcoin-USD futures contracts listed for trading on CME. See id. at 2. 76 See id. at 2. 77 See id. at 4. 78 See id. at 2. 79 See id. at 7. 80 See id. VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 creations and redemptions only, the ‘‘manipulability of the Reference Rate [is] significantly less important.’’ 81 The Exchange elaborates further that, ‘‘because the Trust will not accept cash to buy bitcoin in order to create new shares or . . . be forced to sell bitcoin to pay cash for redeemed shares, the price that the Sponsor uses to value the Trust’s bitcoin is not particularly important.’’ 82 According to BZX, when authorized participants create Shares with the Trust, they would need to deliver a certain number of bitcoin per share (regardless of the valuation used), and when they redeem with the Trust, they would similarly expect to receive a certain number of bitcoin per share.83 As such, BZX argues that even if the price used to value the Trust’s bitcoin is manipulated, the ratio of bitcoin per Share does not change, and the Trust will either accept (for creations) or distribute (for redemptions) the same number of bitcoin regardless of the value.84 This, according to BZX, not only mitigates the risk associated with potential manipulation, but also discourages and disincentivizes manipulation of the Reference Rate because there is little financial incentive to do so.85 Based on assertions made and the information provided, the Commission can find no basis to conclude that BZX has articulated other means to prevent fraud and manipulation that are sufficient to justify dispensing with the requisite surveillance-sharing agreement. First, the record does not demonstrate that the proposed methodology for calculating the Reference Rate would make the proposed ETP resistant to fraud or manipulation such that a surveillancesharing agreement with a regulated market of significant size is unnecessary. Specifically, the Exchange has not assessed the possible influence that spot platforms not included among the Constituent Bitcoin Platforms would have on bitcoin prices used to calculate the Reference Rate.86 And as discussed above, the record does not establish that the broader bitcoin market is inherently and uniquely resistant to fraud and 81 See Notice, 86 FR at 19925. id. 83 See id. 84 See id. 85 See id. 86 As discussed above, while the Exchange asserts that bitcoin prices on platforms with wash trades or other activity intended to manipulate the price of bitcoin do not influence the ‘‘real’’ price of bitcoin, the Commission has no basis on which to conclude that bitcoin platforms are insulated from prices of others that engage in or permit fraud or manipulation. See supra note 56 and accompanying text. 82 See PO 00000 Frm 00109 Fmt 4703 Sfmt 4703 69327 manipulation. Accordingly, to the extent that trading on platforms not directly used to calculate the Reference Rate affects prices on the Constituent Bitcoin Platforms, the characteristics of those other platforms—where various kinds of fraud and manipulation from a variety of sources may be present and persist—affect whether the Reference Rate is resistant to manipulation. Moreover, the Exchange’s assertions that the Reference Rate’s methodology helps make the Reference Rate resistant to manipulation are contradicted by the Registration Statement’s own statements. Specifically, the Registration Statement states that ‘‘[b]itcoin [platforms] on which bitcoin trades . . . may be more exposed to fraud and security breaches than established, regulated exchanges for other financial assets or instruments, which could have a negative impact on the performance of the Trust.’’ 87 Constituent Bitcoin Platforms are a subset of the bitcoin platforms currently in existence. Although the Sponsor raises concerns regarding fraud and security of bitcoin platforms in the Registration Statement, the Exchange does not explain how or why such concerns are consistent with its assertion that the Reference Rate is resistant to fraud and manipulation. BZX also has not shown that its proposed use of 12 equally-sized time intervals of five minute length over the observation window between 3:00 p.m. and 4:00 p.m. E.T. to calculate the Reference Rate would effectively be able to eliminate fraudulent or manipulative activity that is not transient. Fraud and manipulation in the bitcoin spot market could persist for a ‘‘significant duration.’’ 88 The Exchange does not connect the use of such partitions to the duration of the effects of the wash and fictitious trading that may exist in the bitcoin spot market.89 The Commission thus concludes that the Exchange has not demonstrated that its Reference Rate methodology makes the proposed ETP resistant to manipulation. While the proposed procedures for calculating the Reference Rate using only prices from the Constituent Bitcoin Platforms are intended to provide some degree of protection against attempts to manipulate the Reference Rate, these procedures are not sufficient for the Commission to dispense with the 87 See Registration Statement at 19. USBT Order, 85 FR at 12601 n.66; see also id. at 12607. 89 The Commission has previously considered and rejected similar arguments about the valuation of bitcoin according to a benchmark or reference price. See id.; SolidX Order, 82 FR at 16258; Winklevoss Order, 83 FR at 37589–90. 88 See E:\FR\FM\07DEN1.SGM 07DEN1 69328 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices requisite surveillance-sharing agreement with a regulated market of significant size. Second, the Benchmark Administrator argues that its oversight of the Reference Rate and the CME’s information-sharing agreements with the Constituent Bitcoin Platforms help to prevent fraud and manipulation.90 However, the level of oversight of the Constituent Bitcoin Platforms, whose trade flows contribute to the Reference Rate, is not equivalent to the obligations, authority, and oversight of national securities exchanges or futures exchanges and therefore is not an appropriate substitute.91 National securities exchanges are 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.’’ 92 Moreover, national securities exchanges must file proposed rules with the Commission regarding certain material aspects of their operations,93 and the Commission has the authority to disapprove any such rule that is not consistent with the requirements of the Exchange Act.94 Thus, national securities exchanges are subject to Commission oversight of, among other things, their governance, membership qualifications, trading rules, disciplinary procedures, recordkeeping, and fees.95 lotter on DSK11XQN23PROD with NOTICES1 90 See CF Benchmarks Letter at 2–4. 91 See also USBT Order, 85 FR at 12603–05. 92 See 15 U.S.C. 78f(b)(5). 93 17 CFR 240.19b-4(a)(6)(i). 94 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 rules 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 (‘‘DCMs’’) (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. 95 See Winklevoss Order, 83 FR at 37597. The Commission notes that the New York State Department of Financial Services (‘‘NYSDFS’’) has issued ‘‘guidance’’ to supervised virtual currency business entities, stating that these entities must ‘‘implement measures designed to effectively VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 The Constituent Bitcoin Platforms, on the other hand, have none of these requirements (none are registered as a national securities exchange) 96—even if they may have, as the Benchmark Administrator asserts, AML/KYC compliance policies and prohibitions against wash trading and fraudulent claims of trading volume.97 In addition, although the Commission recognizes that the CFTC maintains some jurisdiction over the bitcoin spot market, under the Commodity Exchange Act, the CFTC does not have regulatory authority over bitcoin spot trading platforms, including the Constituent Bitcoin Platforms.98 Except in certain limited circumstances, bitcoin spot trading platforms are not required to register with the CFTC, and the CFTC does not set standards for, approve the rules of, examine, or otherwise regulate bitcoin spot markets.99 As the CFTC itself 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.’’ 100 And while the Benchmark Administrator asserts that the CME has in place information-sharing agreements with the Constituent Bitcoin Platforms, it does not provide any information on the scope, terms, or enforcement authority for such information-sharing agreements. Nor has BZX put any information in the record as to whether and how it would use or enforce such detect, prevent, and respond to fraud, attempted fraud, and similar wrongdoing.’’ See Maria T. Vullo, 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/docs/legal/ industry/il180207.pdf. The NYSDFS recognizes that its ‘‘guidance is not intended to limit the scope or applicability of any law or regulation’’ (id.), which would include the Exchange Act. Nothing in the record evidences whether the Constituent Bitcoin Platforms have complied with this NYSDFS guidance. Further, as stated previously, there are substantial differences between the NYSDFS and the Commission’s regulation. AML and KYC policies and procedures, for example, have been referenced in other bitcoin-based ETP proposals as a purportedly alternative means by which such ETPs would be uniquely resistant to manipulation. The Commission has previously concluded that such AML and KYC policies and procedures do not serve as a substitute for, and are not otherwise dispositive in the analysis regarding the importance of, having a surveillance sharing agreement with a regulated market of significant size relating to bitcoin. For example, AML and KYC policies and procedures do not substitute for the sharing of information about market trading activity or clearing activity and do not substitute for regulation of a national securities exchange. See USBT Order, 85 FR at 12603 n.101. 96 See 15 U.S.C. 78e, 78f. 97 See CF Benchmarks Letter at 5. 98 See USBT Order, 85 FR at 12604. 99 See id. 100 See Winklevoss Order, 83 FR at 37599 n.288. PO 00000 Frm 00110 Fmt 4703 Sfmt 4703 agreements. Moreover, such agreements are contractual in nature and do not satisfy the regulatory requirements or purposes of national securities exchanges and the Exchange Act. The CME (and the CFTC, as discussed above) does not have regulatory authority over the spot bitcoin trading platforms,101 and, while the CME is regulated by the CFTC, the CFTC’s regulations do not extend to the Constituent Bitcoin Platforms by virtue of such contractual agreements. In addition, although the Benchmark Administrator states that its oversight of the Reference Rate helps prevent fraud and manipulation, the oversight by the Benchmark Administrator does not represent a unique measure to resist manipulation beyond mechanisms that exist in securities or commodities markets. Other commodity-based and equity index ETPs approved by the Commission for listing and trading utilize reference rates or indices administered by similar benchmark administrators,102 and the Commission has not, in those instances, dispensed with the need for a surveillance-sharing agreement with a significant regulated market.103 Furthermore, the Benchmark Administrator does not itself exercise governmental regulatory authority. Rather, the Benchmark Administrator is a registered, privately-held company in England.104 The Benchmark Administrator’s relationship with the Constituent Bitcoin Platforms is based on their participation in the determination of reference rates, such as the Reference Rate. While the Benchmark Administrator is regulated 101 See supra notes 98–100 and accompanying text. 102 See, e.g., Securities Exchange Act Release Nos. 80840 (June 1, 2017) 82 FR 26534 (June 7, 2017) (SR–NYSEArca–2017–33) (approving the listing and trading of shares of exchange traded funds seeking to track the Solactive GLD EUR Gold Index, Solactive GLD GBP Gold Index, and the Solactive GLD JPY Gold Index); and 83046 (Apr. 13, 2018) 83 FR 17462 (Apr. 19, 2018) (SR–Nasdaq–2018–012) (approving the listing and trading of shares of an exchange-traded fund that seeks to track an equity index, the CBOE Russell 2000 30–Delta BuyWrite V2 Index). 103 See USBT Order, 85 FR at 12605. See also supra note 19. 104 See https://blog.cfbenchmarks.com/legal/ (stating that the Benchmark Administrator is authorized and regulated by the UK FCA as a registered Benchmark Administrator (FRN 847100) under the EU benchmark regulation, and further noting that the Benchmark Administrator is a member of the Crypto Facilities group of companies which is in turn a member of the Payward, Inc. group of companies, and Payward, Inc. is the owner and operator of the Kraken Exchange, a venue that facilitates the trading of cryptocurrencies). The Commission notes that the Kraken is one of the Constituent Bitcoin Platforms underlying the Reference Rate. E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices lotter on DSK11XQN23PROD with NOTICES1 by the UK FCA as a benchmark administrator, the UK FCA’s regulations do not extend to the Constituent Bitcoin Platforms by virtue of their trade prices serving as input data underlying the Reference Rate.105 Further, the oversight performed by the Benchmark Administrator of the Constituent Bitcoin Platforms is for the purpose of ensuring the accuracy and integrity of the Reference Rate.106 Such oversight serves a fundamentally different purpose as compared to the regulation of national securities exchanges and the requirements of the Exchange Act. While the Commission recognizes that this may be an important function in ensuring the integrity of the Reference Rate, such requirements do not imbue either the Benchmark Administrator or the Constituent Bitcoin Platforms with regulatory authority similar to that the Exchange Act confers upon self-regulatory organizations such as national securities exchanges.107 And although the Benchmark Administrator states that it has information-sharing agreements with each Constituent Bitcoin Platform, it does not describe the scope of such agreements or what authority the Benchmark Administrator would have to compel the platforms’ compliance with such agreements. Moreover, even assuming that the Constituent Bitcoin Platforms are as vigilant towards fraud and manipulation as the Benchmark Administrator describes, neither the Exchange nor the Benchmark Administrator attempts to establish that only the Constituent Bitcoin Platforms’ ability to detect and deter fraud and manipulation would matter, exclusive of other bitcoin spot markets. In other words, neither addresses how fraud and manipulation on other bitcoin spot markets may influence the price of bitcoin. Third, the Exchange does not explain the significance of the Reference Rate’s purported resistance to manipulation to the overall analysis of whether the proposal to list and trade the Shares is designed to prevent fraud and manipulation. Even assuming that the Exchange’s argument is that, if the Reference Rate is resistant to manipulation, the Trust’s NAV, and thereby the Shares as well, would be 105 See USBT Order, 85 FR at 12604. The Benchmark Administrator is also not required to apply certain provisions of EU benchmark regulation to the Constituent Bitcoin Platforms because the Reference Rate’s input data is not ‘‘contributed.’’ See Benchmark Statement, at 5 available at https://docs-cfbenchmarks.s3. amazonaws.com/CME+CF+Benchmark+ Statement.pdf. 106 See supra note 72 and accompanying text. 107 See 15 U.S.C. 78f(b). VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 resistant to manipulation, the Exchange has not established in the record a basis for such conclusion. That assumption aside, the Commission notes that the Shares would trade at market-based prices in the secondary market, not at NAV, which then raises the question of the significance of the NAV calculation to the manipulation of the Shares.108 Fourth, the Exchange’s arguments are contradictory. While arguing that the Reference Rate is resistant to manipulation, the Exchange simultaneously downplays the importance of the Reference Rate in light of the Trust’s in-kind creation and redemption mechanism.109 The Exchange points out that the Trust will create and redeem Shares in-kind, not in cash, which renders the NAV calculation, and thereby the ability to manipulate NAV, ‘‘significantly less important.’’ 110 In BZX’s own words, the Trust will not accept cash to buy bitcoin in order to create shares or sell bitcoin to pay cash for redeemed shares, so the price that the Sponsor uses to value the Trust’s bitcoin ‘‘is not particularly 108 One commenter states that BZX’s statement that the price used to value the Trust’s bitcoin ‘‘is not particularly important’’ focuses on the primary market and transactions with authorized participants. The commenter asserts that, for secondary market participants (e.g., retail investors), the price source used by the Sponsor should be viewed as important because the ETP’s value (i.e., its NAV) ‘‘has a relationship to the secondary market trading price, including for market makers and other liquidity participants in determining ET[P] pricing levels with respect to order flow, as well as for calculating premiums/ discounts between NAV and the secondary market price.’’ The commenter asserts that this is true for any ETP in the marketplace, but ‘‘arguably the price source is even more important for a bitcoin ET[P]’’ given the number of platforms worldwide where bitcoin is traded, the price differences between them, and the Commission’s concerns regarding potential bitcoin price manipulation. See letter from Global Digital Finance, dated August 9, 2021 (‘‘GDF Letter’’), at 6. The commenter, however, provides no further information on the relationship between NAV and secondary market prices in general, nor specifically in the context of ETPs with only inkind create/redeem processes, nor how market makers or other liquidity participants would use NAV to determine such an ETP’s ‘‘pricing levels with respect to order flow.’’ As for the assertion that the price source is even more important for bitcoin ETPs because of the number of platforms and the price differences between them, the commenter does not elaborate further and does not explain why the opposite conclusion is not equally valid—that the price source (i.e., the Constituent Bitcoin Platforms) is less important in light of other bitcoin platforms with different prices. 109 See supra notes 81–85 and accompanying text. 110 See Notice, 86 FR at 19925 (‘‘While the Sponsor believes that the Reference Rate which it uses to value the Trust’s bitcoin is itself resistant to manipulation based on the methodology further described below, the fact that creations and redemptions are only available in-kind makes the manipulability of the Reference Rate significantly less important.’’). PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 69329 important.’’ 111 If the Reference Rate that the Trust uses to value the Trust’s bitcoin ‘‘is not particularly important,’’ it follows that the Reference Rate’s resistance to manipulation is not material to the Shares’ susceptibility to fraud and manipulation. As the Exchange does not address or provide any analysis with respect to these issues, the Commission cannot conclude that the Reference Rate aids in the determination that the proposal to list and trade the Shares is designed to prevent fraudulent and manipulative acts and practices. Finally, the Commission finds that BZX has not demonstrated that in-kind creations and redemptions provide the Shares with a unique resistance to manipulation. The Commission has previously addressed similar assertions.112 As the Commission stated before, in-kind creations and redemptions are a common feature of ETPs, and the Commission has not previously relied on the in-kind creation and redemption mechanism as a basis for excusing exchanges that list ETPs from entering into surveillance-sharing agreements with significant, regulated markets related to the portfolio’s assets.113 Accordingly, the Commission is not persuaded here that the Trust’s inkind creations and redemptions afford it a unique resistance to manipulation.114 111 See id. (concluding that ‘‘because the Trust will not accept cash to buy bitcoin in order to create new shares or, barring a forced redemption of the Trust or under other extraordinary circumstances, be forced to sell bitcoin to pay cash for redeemed shares, the price that the Sponsor uses to value the Trust’s bitcoin is not particularly important.’’). 112 See Winklevoss Order, 83 FR at 37589–90; USBT Order, 85 FR at 12607–08. 113 See, e.g., iShares COMEX Gold Trust, Securities Exchange Act Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751–55 (Jan. 26, 2005) (SR– Amex–2004–38); iShares Silver Trust, Securities Exchange Act Release No. 53521 (Mar. 20, 2006), 71 FR 14969, 14974 (Mar. 24, 2006) (SR–Amex–2005– 072). 114 Putting aside the Exchange’s various assertions about the nature of bitcoin and the bitcoin market, the Reference Rate, and the Shares, the Exchange also does not address concerns the Commission has previously identified, including the susceptibility of bitcoin markets to potential trading on material, non-public information (such as plans of market participants to significantly increase or decrease their holdings in bitcoin; new sources of demand for bitcoin; the decision of a bitcoin-based investment vehicle on how to respond to a ‘‘fork’’ in the bitcoin blockchain, which would create two different, noninterchangeable types of bitcoin), or to the dissemination of false or misleading information. See Winklevoss Order, 83 FR at 37585. See also USBT Order, 85 FR at 12600–01. E:\FR\FM\07DEN1.SGM 07DEN1 69330 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices lotter on DSK11XQN23PROD with NOTICES1 (2) Assertions That BZX Has Entered Into a Comprehensive SurveillanceSharing Agreement With a Regulated Market of Significant Size As BZX has not demonstrated that other means besides surveillancesharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices, the Commission next examines whether the record supports the conclusion that BZX has entered into a comprehensive surveillancesharing agreement with a regulated market of significant size relating to the underlying assets. In this context, the term ‘‘market of significant size’’ includes a market (or group of markets) as to which (i) 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 in detecting and deterring misconduct, and (ii) it is unlikely that trading in the ETP would be the predominant influence on prices in that market.115 As the Commission has stated in the past, it considers two markets that are members of the ISG to have a comprehensive surveillance-sharing agreement with one another, even if they do not have a separate bilateral surveillance-sharing agreement.116 Accordingly, based on the common membership of BZX and the CME in the ISG,117 BZX has the equivalent of a comprehensive surveillance-sharing agreement with CME. However, while the Commission recognizes that the CFTC regulates the CME futures market,118 including the CME bitcoin futures market, and thus such market is ‘‘regulated,’’ in the context of the proposed ETP, the record does not, as explained further below, establish that the CME bitcoin futures market is a ‘‘market of significant size’’ as that term is used in the context of the applicable standard here.119 115 See Winklevoss Order, 83 FR at 37594. 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 provides guidance to market participants. See id. 116 See id. at 37580 n.19. 117 See Notice, 86 FR at 19924 n.60 and accompanying text. 118 While the Commission recognizes that the CFTC regulates the CME, the CFTC is not responsible for direct, comprehensive regulation of the underlying bitcoin spot market. See Winklevoss Order, 83 FR at 37587, 37599. See also supra notes 98–100 and accompanying text. 119 A commenter asserts that CME, Bakkt, and Crypto Facilities are the only venues that offer bitcoin futures trading under ‘‘relevant capital markets regulation.’’ See CF Benchmarks Letter at 6. BZX, however, argues only that the CME is a VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 (i) Whether There Is a Reasonable Likelihood That a Person Attempting To Manipulate the ETP Would Also Have To Trade on the CME Bitcoin Futures Market To Successfully Manipulate the ETP The first prong in establishing whether the CME bitcoin futures market constitutes a ‘‘market of significant size’’ is the determination that there is a reasonable likelihood that a person attempting to manipulate the ETP would have to trade on the CME bitcoin futures market to successfully manipulate the ETP. BZX notes that the CME began to offer trading in bitcoin futures in 2017.120 According to BZX, nearly every measurable metric related to CME bitcoin futures contracts, which trade and settle like other cash-settled commodity futures contracts, has ‘‘trended consistently up since launch and/or accelerated upward in the past year.’’ 121 For example, according to BZX, there was approximately $28 billion in trading in CME bitcoin futures in December 2020 compared to $737 million, $1.4 billion, and $3.9 billion in total trading in December 2017, December 2018, and December 2019, respectively.122 Additionally, CME bitcoin futures traded over $1.2 billion per day in December 2020 and represented $1.6 billion in open interest compared to $115 million in December 2019.123 Similarly, BZX contends that the number of large open interest holders 124 has continued to increase, even as the price of bitcoin has risen, as have the number of unique accounts trading CME bitcoin futures.125 BZX argues that the significant growth in CME bitcoin futures across each of trading volumes, open interest, large open interest holders, and total market participants since the USBT Order was issued is reflective of that market’s regulated market of significant size. In addition, as described above (see supra notes 91–100 and accompanying text), in the context of the proposed ETP, the Constituent Bitcoin Platforms are not ‘‘regulated.’’ They are not registered as ‘‘exchanges’’ and lack the obligations, authority, and oversight of national securities exchanges. Thus the Commission limits the scope of its analysis to CME. 120 According to BZX, each contract represents five bitcoin and is based on the CME CF BRR. See Notice, 86 FR at 19922. 121 See id. 122 See id. 123 See id. 124 BZX represents that a large open interest holder in CME bitcoin futures is an entity that holds at least 25 contracts, which is the equivalent of 125 bitcoin. According to BZX, at a price of approximately $30,000 per bitcoin on December 31, 2020, more than 80 firms had outstanding positions of greater than $3.8 million in CME bitcoin futures. See id. at 19922 n.54. 125 See id. at 19922. PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 growing influence on the spot price. BZX asserts that where CME bitcoin futures lead the price in the spot market such that a potential manipulator of the bitcoin spot market (beyond just the Constituent Bitcoin Platforms) would have to participate in the CME bitcoin futures market, it follows that a potential manipulator of the Shares would similarly have to transact in the CME bitcoin futures market.126 BZX further states that academic research corroborates the overall trend outlined above and supports the thesis that CME bitcoin futures pricing leads the spot market. BZX asserts that academic research demonstrates that the CME bitcoin futures market was already leading the spot price in 2018 and 2019.127 BZX concludes that a person attempting to manipulate the Shares would also have to trade on that market to manipulate the ETP.128 The Commission disagrees. The record does not demonstrate that there is a reasonable likelihood that a person attempting to manipulate the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate it. Specifically, BZX’s assertions about the general upward trends from 2018 to February 2021 in trading volume and open interest of, and in the number of large open interest holders and number of unique accounts trading in, CME bitcoin futures do not establish that the CME bitcoin futures market is of significant size. As the Commission has previously articulated, the interpretation of the term ‘‘market of significant size’’ or ‘‘significant market’’ depends on the interrelationship between the market with which the listing exchange has a surveillancesharing agreement and the proposed ETP.129 BZX’s recitation of data reflecting the size of the CME bitcoin futures market, alone, either currently or in relation to previous years, is not sufficient to establish an interrelationship between the CME bitcoin futures market and the proposed ETP.130 Further, the evidence in the record for this proposal also does not support a conclusion that the CME bitcoin futures market leads the bitcoin spot market in such a manner that the CME bitcoin 126 See id. at 19924, 19929. id. at 19923 & n.55 (citing Y. Hu, Y. Hou & L. Oxley, What role do futures markets play in Bitcoin pricing? Causality, cointegration and price discovery from a time-varying perspective, 72 Int’l Rev. of Fin. Analysis 101569 (2020) (available at: https://www.ncbi.nlm.nih.gov/pmc/articles/ PMC7481826/) (‘‘Hu, Hou & Oxley’’)). 128 See id. at 19923. 129 See USBT Order, 85 FR at 12611. 130 See id. at 12612. 127 See E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices futures market is a ‘‘market of significant size.’’ As the Commission has previously explained, establishing a lead-lag relationship between the bitcoin futures market and the spot market is ‘‘central to understanding whether it is reasonably likely that a would-be manipulator of the ETP would need to trade on the bitcoin futures market to successfully manipulate prices on those spot platforms that feed into the proposed ETP’s pricing mechanism.’’ 131 The Commission has previously stated that, in particular, if the spot market leads the futures market, this would indicate that it would not be necessary to trade on the futures market to manipulate the proposed ETP, because the futures price would move to meet the spot price.132 While BZX states that CME bitcoin futures pricing leads the spot market,133 it relies on the findings of a price discovery analysis in one section of a single academic paper to support the overall thesis.134 However, the findings of that paper’s Granger causality analysis, which is widely used to formally test for lead-lag relationships, are concededly mixed.135 In addition, the Commission considered an unpublished version of the paper in the USBT Order, as well as a comment letter submitted by the authors on that record.136 In the USBT Order, as part of the Commission’s conclusion that ‘‘mixed results’’ in academic studies failed to demonstrate that the CME bitcoin futures market constitutes a market of significant size, the Commission noted the paper’s inconclusive evidence that CME bitcoin 131 See id. id. 133 See Notice, 86 FR at 19923. 134 See supra note 127 and accompanying text. BZX references the following conclusion from the ‘‘time-varying price discovery’’ section of Hu, Hou & Oxley: ‘‘There exist no episodes where the Bitcoin spot markets dominates the price discovery processes with regard to Bitcoin futures. This points to a conclusion that the price formation originates solely in the Bitcoin futures market. We can, therefore, conclude that the Bitcoin futures markets dominate the dynamic price discovery process based upon time-varying information share measures. Overall, price discovery seems to occur in the Bitcoin futures markets rather than the underlying spot market based upon a time-varying perspective . . .’’ See Notice, 86 FR at 19923 n.55. 135 The paper finds that the CME bitcoin futures market dominates the spot markets in terms of Granger causality, but that the causal relationship is bi-directional, and a Granger causality episode from March 2019 to June/July 2019 runs from bitcoin spot prices to CME bitcoin futures prices. The paper concludes: ‘‘[T]he Granger causality episodes are not constant throughout the whole sample period. Via our causality detection methods, market participants can identify when markets are being led by futures prices and when they might not be.’’ See Hu, Hou & Oxley, supra note 127. 136 See USBT Order, 85 FR at 12609. lotter on DSK11XQN23PROD with NOTICES1 132 See VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 futures prices lead spot prices—in particular that the months at the end of the paper’s sample period showed that the spot market was the leading market—and stated that the record did not include evidence to explain why this would not indicate a shift towards prices in the spot market leading the futures market that would be expected to persist into the future.137 The Commission also stated that the paper’s use of daily price data, as opposed to intraday prices, may not be able to distinguish which market incorporates new information faster.138 BZX has not addressed either issue. Moreover, BZX does not provide results of its own analysis and does not present any other data supporting its conclusion. BZX’s unsupported representations constitute an insufficient basis for approving a proposed rule change in circumstances where, as here, the Exchange’s assertion would form such an integral role in the Commission’s analysis and the assertion is subject to several challenges.139 In this context, BZX’s reliance on a single paper, whose own lead-lag results are inconclusive, is especially lacking because the academic literature on the lead-lag relationship and price discovery between bitcoin spot and futures markets is unsettled.140 In the 137 See id. at 12613 n.244. id. 139 See Susquehanna, 866 F.3d at 447. 140 See, e.g., D. Baur & T. Dimpfl, Price discovery in bitcoin spot or futures?, 39 J. Futures Mkts. 803 (2019) (finding that the bitcoin spot market leads price discovery); O. Entrop, B. Frijns & M. Seruset, The determinants of price discovery on bitcoin markets, 40 J. Futures Mkts. 816 (2020) (finding that price discovery measures vary significantly over time without one market being clearly dominant over the other); J. Hung, H. Liu & J. Yang, Trading activity and price discovery in Bitcoin futures markets, 62 J. Empirical Finance 107 (2021) (finding that the bitcoin spot market dominates price discovery); B. Kapar & J. Olmo, An analysis of price discovery between Bitcoin futures and spot markets, 174 Econ. Letters 62 (2019) (finding that bitcoin futures dominate price discovery); E. Akyildirim, S. Corbet, P. Katsiampa, N. Kellard & A. Sensoy, The development of Bitcoin futures: Exploring the interactions between cryptocurrency derivatives, 34 Fin. Res. Letters 101234 (2020) (finding that bitcoin futures dominate price discovery); A. Fassas, S. Papadamou, & A. Koulis, Price discovery in bitcoin futures, 52 Res. Int’l Bus. Fin. 101116 (2020) (finding that bitcoin futures play a more important role in price discovery) (‘‘Fassas et al’’); S. Aleti & B. Mizrach, Bitcoin spot and futures market microstructure, 41 J. Futures Mkts. 194 (2021) (finding that relatively more price discovery occurs on the CME as compared to four spot exchanges); J. Wu, K. Xu, X. Zheng & J. Chen, Fractional cointegration in bitcoin spot and futures markets, 41 J. Futures Mkts. 1478 (2021) (finding that CME bitcoin futures dominate price discovery). See also C. Alexander & D. Heck, Price discovery in Bitcoin: The impact of unregulated markets, 50 J. Financial Stability 100776 (2020) (finding that, in a multidimensional setting, including the main price leaders within futures, perpetuals, and spot 138 See PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 69331 USBT Order, the Commission responded to multiple academic papers that were cited and concluded that, in light of the mixed results found, the exchange there had not demonstrated that it is reasonably likely that a wouldbe manipulator of the proposed ETP would transact on the CME bitcoin futures market.141 Likewise, here, given the body of academic literature to indicate to the contrary, the Commission concludes that the information that BZX provides is not a sufficient basis to support a determination that it is reasonably likely that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market.142 The Benchmark Administrator, in a comment letter, also asserts that a body of research from both academic and commercial sources ‘‘has amply demonstrated that price discovery for bitcoin is largely achieved through the CME BTC–USD futures market as opposed to the spot markets,’’ and that such conclusions ‘‘have not been widely challenged in the academic literature.’’ 143 This commenter argues that the combination of (1) the CME bitcoin futures market leading price formation, (2) the CME bitcoin futures market constituting a ‘‘significant proportion’’ of the bitcoin futures markets, CME bitcoin futures have a very minor effect on price discovery; and that faster speed of adjustment and information absorption occurs on the unregulated spot and derivatives platforms than on CME bitcoin futures) (‘‘Alexander & Heck’’). 141 See USBT Order, 85 FR at 12613 nn.239–244 and accompanying text. 142 In addition, the Exchange fails to address the lead-lag relationship (if any) between prices on other bitcoin futures markets and the CME bitcoin futures market, the bitcoin spot market, and/or the particular Constituent Bitcoin Platforms, or where price formation occurs when the entirety of bitcoin futures markets, not just CME, is considered. 143 See CF Benchmarks Letter at 6 (citing Fassas et al and A. Chang, W. Herrmann & W. Cai, Efficient Price Discovery in the Bitcoin Markets, Wilshire Phoenix, Oct. 14, 2020 (‘‘Wilshire Phoenix’’)). Another commenters also argues that the CME is a market of significant size. See GDF Letter at 5. This commenter states that there is ‘‘no doubt’’ that the CME represents a market of significant size because, as of May 2021, it had the second-largest amount of open interest, and represented roughly 15.5 percent of total open interest in bitcoin futures. The commenter also references the Wilshire Phoenix working paper which suggests that the CME bitcoin futures market contribute more to price discovery than its related spot markets. The commenter, however, also states that ‘‘the crypto markets do change rapidly,’’ and cites Alexander & Heck (see also supra note 140) for an opposing view that the CME bitcoin futures contribute far less than spot markets to price discovery. The Commission finds that this additional information is not sufficient to establish that the CME is a market of ‘‘significant size.’’ As noted above, data reflecting the size of the CME bitcoin futures market, alone, is not sufficient to establish an interrelationship between the CME bitcoin futures market and the proposed ETP, and the papers cited by the commenter evidences the unsettled nature of the academic literature. E:\FR\FM\07DEN1.SGM 07DEN1 69332 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices lotter on DSK11XQN23PROD with NOTICES1 market,144 (3) the Constituent Bitcoin Platforms accounting for a ‘‘significant proportion’’ of the bitcoin spot markets,145 (4) the Trust striking its NAV to the Reference Rate, which is calculated using transaction data from the Constituent Bitcoin Platforms, and (5) the Shares being traded by authorized participants who will use the CME bitcoin futures market and underlying bitcoin spot markets as ‘‘liquidity rails’’ for pricing and arbitrage, means that any attempted manipulator of the Trust will have to undertake trading on both the CME and at least one, likely more than one, of the five Constituent Bitcoin Platforms to engage in potentially manipulative acts.146 The commenter states that this demonstrates that the CME bitcoin futures market can be considered a ‘‘significant market.’’ 147 The Commission does not agree. The Commission has already addressed and rejected three of these assertions—that CME bitcoin futures lead price discovery,148 the size of the CME bitcoin futures market,149 and the relevance of using the Reference Rate to compute NAV.150 As with the size of the CME market, data reflecting the size of the Constituent Bitcoin Platforms as a proportion of all bitcoin spot trading also does not help to establish an interrelationship between the CME bitcoin futures market and the proposed ETP. Nor does it establish how fraud and manipulation on other bitcoin spot markets may influence the price of bitcoin. Finally, the commenter assumes, without any supporting evidence, that authorized participants 144 The commenter states that the CME accounts for approximately 15 percent of all bitcoin futures open interest, and asserts that, while it is difficult to ascertain what proportion of the total bitcoin derivatives market is represented by CME, it is likely that it constitutes significantly more than the 15 percent—‘‘very likely 30 percent plus’’—of all bona fide bitcoin futures trading. See CF Benchmarks Letter at 6. 145 The commenter states that, although difficult to fully verify due to the distributed nature of cryptocurrency trading and the difficulting identifying bona fide trading volumes, the BTC– USD markets of the Constituent Bitcoin Platforms constitute roughly 76 percent of all BTC–USD trading from cryptocurrency trading platforms whose volumes are publicly available during the period January 2020–March 2021. The commenter further estimates that the Constituent Bitcoin Platforms account for 15 percent of all bitcoin trading and ‘‘very likely 25 percent plus’’ of all bona fide bitcoin trading conducted on trading platforms. See id. at 4–5. 146 See id. at 7. 147 See id. 148 See supra notes 134–142 and accompanying text. 149 See supra notes 129–130 and accompanying text. 150 See supra notes 86–111 and accompanying text. VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 will use the CME bitcoin futures market (as well as underlying bitcoin spot market) ‘‘for pricing and arbitrage.’’ Even assuming the commenter is correct that authorized participants would transact on bitcoin futures markets, the commenter does not explain why they would transact on the CME rather than on any other bitcoin futures markets. The Commission accordingly concludes that the information provided in the record does not establish a reasonable likelihood that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP. Therefore, the information in the record also does not establish that the CME bitcoin futures market is a ‘‘market of significant size’’ with respect to the proposed ETP. (ii) Whether It Is Unlikely That Trading in the Proposed ETP Would Be the Predominant Influence on Prices in the CME Bitcoin Futures Market The second prong in establishing whether the CME bitcoin futures market constitutes a ‘‘market of significant size’’ is the determination that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market.151 BZX asserts that trading in the Shares would not be the predominant force on prices in the CME bitcoin futures market (or spot market) because of the significant volume in the CME bitcoin futures market, the size of bitcoin’s market capitalization, which is approximately $1 trillion, and the significant liquidity available in the spot market.152 BZX provides that, according to February 2021 data, the cost to buy or sell $5 million worth of bitcoin averages roughly 10 basis points with a market impact of 30 basis points.153 For a $10 million market order, the cost to buy or sell is roughly 20 basis points with a market impact of 50 basis points. Stated another way, BZX states that a market participant could enter a market buy or sell order for $10 million of bitcoin and only move the market 0.5 percent.154 BZX further asserts that more strategic purchases or sales (such as using limit orders and executing through OTC bitcoin trade desks) would likely have less obvious impact on the 151 See Winklevoss Order, 83 FR at 37594; USBT Order, 85 FR at 12596–97. 152 See Notice, 86 FR at 19925. 153 See id. According to BZX, these statistics are based on samples of bitcoin liquidity in U.S. dollars (excluding stablecoins or Euro liquidity) based on executable quotes on Coinbase Pro, Gemini, Bitstamp, Kraken, LMAX Exchange, BinanceUS, and OKCoin during February 2021. See id. nn.64– 65. 154 See id. at 19925. PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 market, which is consistent with MicroStrategy, Tesla, and Square being able to collectively purchase billions of dollars in bitcoin.155 Thus, BZX concludes that the combination of CME bitcoin futures leading price discovery, the overall size of the bitcoin market, and the ability for market participants (including authorized participants creating and redeeming in-kind with the Trust) to buy or sell large amounts of bitcoin without significant market impact, will help prevent the Shares from becoming the predominant force on pricing in either the bitcoin spot or the CME bitcoin futures market.156 The Commission does not agree. The record does not demonstrate that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market. As the Commission has already addressed and rejected one of the bases of BZX’s assertion—that CME bitcoin futures leads price discovery 157—it will only address below the other two bases: The overall size of, and the impact of buys and sells on, the bitcoin market. BZX’s assertions about the potential effect of trading in the Shares on the CME bitcoin futures market and bitcoin spot market are general and conclusory, repeating the aforementioned trade volume of the CME bitcoin futures market and the size and liquidity of the bitcoin spot market, as well as the market impact of a large transaction, without any analysis or evidence to support these assertions. For example, there is no limit on the amount of mined bitcoin that the Trust may hold. Yet BZX does not provide any information on the expected growth in the size of the Trust and the resultant increase in the amount of bitcoin held by the Trust over time, or on the overall expected number, size, and frequency of creations and redemptions—or how any of the foregoing could (if at all) influence prices in the CME bitcoin futures market. Moreover, in the Trust’s Registration Statement, the Sponsor acknowledges that the Trust may acquire large size positions in bitcoin, which would increase the risk of illiquidity in the underlying bitcoin. Specifically, the Sponsor, in the Registration Statement, states that the Trust may acquire large size positions in bitcoin, which will increase the risk of illiquidity by both making the positions more difficult to liquidate and increasing the losses incurred while 155 See id. id. 157 See supra notes 134–142 and accompanying text. 156 See E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices lotter on DSK11XQN23PROD with NOTICES1 trying to do so, or by making it more difficult for authorized participants to acquire or liquidate bitcoin as part of the creation and/or redemption of Shares of the Trust.158 Although the Trust’s Registration Statement concedes that the Trust could negatively affect the liquidity of bitcoin, BZX does not address this in the proposal or discuss how impacting the liquidity of bitcoin can be consistent with the assertion that the Shares are unlikely to be the predominant influence on the prices of the CME bitcoin futures market. Thus, the Commission cannot conclude, based on BZX’s statements alone and absent any evidence or analysis in support of BZX’s assertions, that it is unlikely that trading in the ETP would be the predominant influence on prices in the CME bitcoin futures market. The Commission also is not persuaded by BZX’s assertions about the minimal effect a large market order to buy or sell bitcoin would have on the bitcoin market.159 While BZX concludes by way of a $10 million market order example that buying or selling large amounts of bitcoin would have insignificant market impact, the conclusion does not analyze the extent of any impact on the CME bitcoin futures market. Even assuming that BZX is suggesting that a single $10 million order in bitcoin would have immaterial impact on the prices in the CME bitcoin futures market, this prong of the ‘‘market of significant size’’ determination concerns the influence on prices from trading in the proposed ETP, which is broader than just trading by the proposed ETP. While authorized participants of the Trust might only transact in the bitcoin spot market as part of their creation or redemption of Shares, the Shares themselves would be traded in the secondary market on BZX. The record does not discuss the expected number or trading volume of the Shares, or establish the potential effect of the Shares’ trade prices on CME bitcoin futures prices. For example, BZX does not provide any data or analysis about the potential effect the quotations or trade prices of the Shares might have on market-maker quotations in CME bitcoin futures contracts and whether those effects would constitute a predominant influence on the prices of those futures contracts. 158 See Registration Statement at 32. Notice, 86 FR at 19929 (‘‘For a $10 million market order, the cost to buy or sell is roughly 20 basis points with a market impact of 50 basis points. Stated another way, a market participant could enter a market buy or sell order for $10 million of bitcoin and only move the market 0.5%.’’). 159 See VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 Thus, because BZX has not provided sufficient information to establish both prongs of the ‘‘market of significant size’’ determination, the Commission cannot conclude that the CME bitcoin futures market is a ‘‘market of significant size’’ such that BZX would be able to rely on a surveillance-sharing agreement with the CME to provide sufficient protection against fraudulent and manipulative acts and practices. The requirements of Section 6(b)(5) of the Exchange Act apply to the rules of national securities exchanges. Accordingly, the relevant obligation for a comprehensive surveillance-sharing agreement with a regulated market of significant size, or other means to prevent fraudulent and manipulative acts and practices that are sufficient to justify dispensing with the requisite surveillance-sharing agreement, resides with the listing exchange. Because there is insufficient evidence in the record demonstrating that BZX has satisfied this obligation, the Commission cannot approve the proposed ETP for listing and trading on BZX. C. Whether BZX Has Met Its Burden To Demonstrate That the Proposal Is Designed To Protect Investors and the Public Interest BZX contends that, if approved, the proposed ETP would protect investors and the public interest. However, the Commission must consider these potential benefits in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act.160 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. BZX asserts that, with the growth of U.S. investor exposure to bitcoin through OTC bitcoin funds, so too has grown the potential risk to U.S. investors.161 Specifically, BZX argues that premium and discount volatility, high fees, insufficient disclosures, and technical hurdles are putting U.S. investor money at risk on a daily basis and that such risk could potentially be eliminated through access to a bitcoin ETP.162 As such, the Exchange believes 160 See Winklevoss Order, 83 FR at 37602. See also GraniteShares Order, 83 FR at 43931; ProShares Order, 83 FR at 43941; USBT Order, 85 FR at 12615. 161 See Notice, 86 FR at 19920. 162 See id. BZX states that while it understands the Commission’s previous focus on potential manipulation of a bitcoin ETP in prior disapproval orders, it now believes that ‘‘such concerns have been sufficiently mitigated and that the growing and quantifiable investor protection concerns PO 00000 Frm 00115 Fmt 4703 Sfmt 4703 69333 that approving this proposal (and comparable proposals submitted hereafter) would give U.S. investors access to bitcoin in a regulated and transparent exchange-traded vehicle that would act to limit risk to U.S. investors by: (i) Reducing premium and discount volatility; (ii) reducing management fees through meaningful competition; (iii) providing an alternative to custodying spot bitcoin; and (iv) reducing risks associated with investing in operating companies that are imperfect proxies for bitcoin exposure.163 According to BZX, OTC bitcoin funds are generally designed to provide exposure to bitcoin in a manner similar to the Shares. However, unlike the Shares, BZX states that ‘‘OTC bitcoin funds are unable to freely offer creation and redemption in a way that incentivizes market participants to keep their shares trading in line with their NAV and, as such, frequently trade at a price that is out-of-line with the value of their assets held.’’ 164 BZX represents that, historically, OTC bitcoin funds have traded at a significant premium to NAV.165 Although the Exchange concedes that trading at a premium (or potentially a discount) is not unique to OTC bitcoin funds and not inherently problematic, BZX believes that it raises certain investor protections issues. First, according to BZX, investors are buying shares of a fund for a price that is not reflective of the per share value of the fund’s underlying assets.166 Second, according to BZX, because only accredited investors, generally, are able to create or redeem shares with the issuing trust and can buy or sell shares directly with the trust at NAV (in exchange for either cash or bitcoin) without having to pay the premium or sell into the discount, these investors that are allowed to interact directly with the trust are able to hedge their bitcoin exposure as needed to satisfy holding should be the central consideration as the Commission reviews this proposal.’’ See id. 163 See id. 164 See id. BZX also states that, unlike the Shares, because OTC bitcoin funds are not listed on an exchange, they are not subject to the same transparency and regulatory oversight by a listing exchange. BZX further asserts that the existence of a surveillance-sharing agreement between BZX and the CME bitcoin futures market would result in increased investor protections for the Shares compared to OTC bitcoin funds. See id. at 19920 n.39. 165 See id. at 19920. BZX further represents that the inability to trade in line with NAV may at some point result in OTC bitcoin funds trading at a discount to their NAV. According to BZX, while that has not historically been the case, trading at a discount would give rise to nearly identical potential issues related to trading at a premium. See id. at 19920 n.40. 166 See id. at 19920. E:\FR\FM\07DEN1.SGM 07DEN1 69334 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices requirements and collect on the premium or discount opportunity. BZX argues, therefore, that the premium in OTC bitcoin funds essentially creates a direct payment from retail investors to more sophisticated investors.167 One commenter expresses support for the approval of bitcoin ETPs because they believe such ETPs would have lower premium/discount volatility and lower management fees than an OTC bitcoin fund.168 Another commenter asserts that the reality is that many U.S. investors are investing in products overseas, which complicates U.S. regulatory reach, or investing in U.S. bitcoin products that have historically exhibited significant premiums or discounts to net asset value, among other issues; and that to the extent that U.S. investors are able to use U.S. regulated products, that should increase investor protection.169 BZX also asserts that exposure to bitcoin through an ETP also presents advantages for retail investors compared to buying spot bitcoin directly.170 BZX asserts that, without the advantages of an ETP, an individual retail investor holding bitcoin through a cryptocurrency trading platform lacks protections.171 BZX explains that, typically, retail platforms hold most, if not all, retail investors’ bitcoin in ‘‘hot’’ (internet-connected) storage and do not make any commitments to indemnify retail investors or to observe any particular cybersecurity standard.172 Meanwhile, a retail investor holding spot bitcoin directly in a self-hosted wallet may suffer from inexperience in private key management (e.g., insufficient password protection, lost key, etc.), which could cause them to lose some or all of their bitcoin holdings.173 BZX represents that the Bitcoin Custodian would, by contrast, use ‘‘cold’’ (offline) storage to hold private keys, employ a certain degree of cybersecurity measures and operational best practices, be highly experienced in bitcoin custody, and be accountable for failures.174 In addition, BZX explains that retail investors would be able to hold the Shares in traditional brokerage accounts, which provide SIPC protection if a brokerage firm fails.175 Thus, with respect to custody of the Trust’s bitcoin assets, BZX concludes 167 See id. at 19921. letter from Anonymous, dated June 17, 2021 (‘‘Anonymous Letter’’). 169 See GDF Letter at 4. 170 See Notice, 86 FR at 19921. 171 See id. 172 See id. 173 See id. 174 See id. 175 See id. lotter on DSK11XQN23PROD with NOTICES1 168 See VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 that, compared to owning spot bitcoin directly, the Trust presents advantages from an investment protection standpoint for retail investors.176 BZX further asserts that a number of operating companies engaged in unrelated businesses have announced investments as large as $1.5 billion in bitcoin.177 Without access to bitcoin ETPs, BZX argues that retail investors seeking investment exposure to bitcoin may purchase shares in these companies in order to gain the exposure to bitcoin that they seek.178 BZX contends that such operating companies, however, are imperfect bitcoin proxies and provide investors with partial bitcoin exposure paired with additional risks associated with whichever operating company they decide to purchase. BZX concludes that investors seeking bitcoin exposure through publicly traded companies are gaining only partial exposure to bitcoin and are not fully benefitting from the risk disclosures and associated investor protections that come from the securities registration process.179 BZX also states that investors in many other countries, including Canada, are able to use more traditional exchangelisted and traded products to gain exposure to bitcoin, disadvantaging U.S. investors and leaving them with more risky means of getting bitcoin exposure.180 176 See id. One commeter agrees that there are certain advantages, particularly for ‘‘average’’ and first-time crypto investors, to bitcoin ETPs, including not having to secure keys or digital wallets, and greater protection from online hacking or theft if funds are secured offline in cold storage. See GDF Letter at 1–2. Another commenter is a NYSDFS-chartered trust company for purposes of providing non-discretionary fiduciary custody of digital assets. This commenter agrees that regulated, secure custodial solutions exist in the marketplace to support the Trust’s operations. The commenter states that NYSDFS subjects it to additional controls tailored to the risks presented by digital asset custody, including robust review of its wallet environment, capitalization, AML procedures, confidentiality, security, and storage architecture. The commenter states that its cold storage solution is the same architecture used by its affiliated trading platform, is built on best practices across both cyber and physical security, and has not lost any customer funds due to a security breach over the past eight years. The commenter specifies that this solution employs proprietary key generation ceremonies, a geographically distributed network of vaults to store the keys, and multiple levels of technical and protocol-specific consensus and security requirements. According to the commenter, it offers broad and deep digital asset insurance, and is regularly audited by major financial and security audit firms. See letter from Coinbase Custody Trust Company, LLC, dated May 7, 2021. 177 See Notice, 86 FR at 19921. 178 See id. 179 See id. at 19922. 180 See id. at 19920. BZX represents that the Purpose Bitcoin ETF, a retail bitcoin-based ETP launched in Canada, reportedly reached $421.8 million in assets under management in two days, demonstrating the demand for a North American PO 00000 Frm 00116 Fmt 4703 Sfmt 4703 In essence, BZX asserts that the risky nature of direct investment in the underlying bitcoin and the unregulated markets on which bitcoin and OTC bitcoin funds trade compel approval of the proposed rule change. BZX, however, offers no limiting principle to this argument, under which, by logical extension, the Commission would be required to approve the listing and trading of any ETP that arguably presents marginally less risk to investors than a direct investment in the underlying asset or in an OTC-traded product. The Commission disagrees with this reading of the Exchange Act. Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must approve a proposed rule change filed by a national securities exchange if it finds that the proposed rule change is consistent with the applicable requirements of the Exchange Act—including the requirement under Section 6(b)(5) that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices—and it must disapprove the filing if it does not make such a finding.181 Thus, even if a proposed rule change purports to protect investors from a particular type of investment risk—such as the susceptibility of an asset to loss or theft—the proposed rule change may still fail to meet the requirements under the Exchange Act.182 Here, even if it were true that, compared to trading in unregulated bitcoin spot markets, trading a bitcoinbased ETP on a national securities exchange provides some additional protection to investors, the Commission must consider this potential benefit in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act.183 As explained above, for bitcoin-based ETPs, the Commission has consistently market listed bitcoin ETP. BZX contends that the Purpose Bitcoin ETF also offers a class of units that is U.S. dollar denominated, which could appeal to U.S. investors. BZX also argues that without an approved bitcoin ETP in the U.S. as a viable alternative, U.S. investors could seek to purchase these shares in order to get access to bitcoin exposure. BZX believes that, given the separate regulatory regime and the potential difficulties associated with any international litigation, such an arrangement would create more risk exposure for U.S. investors than they would otherwise have with a U.S. exchange-listed ETP. See id. at 19920 n.37. BZX also notes that regulators in other countries have either approved or otherwise allowed the listing and trading of bitcoin-based ETPs. See id. at 19920 n.38. 181 See Exchange Act Section 19(b)(2)(C), 15 U.S.C. 78s(b)(2)(C). 182 See SolidX Order, 82 FR at 16259. 183 See supra note 160. E:\FR\FM\07DEN1.SGM 07DEN1 Federal Register / Vol. 86, No. 232 / Tuesday, December 7, 2021 / Notices required that the listing exchange have a comprehensive surveillance-sharing agreement with a regulated market of significant size related to bitcoin, or demonstrate that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the requisite surveillance-sharing agreement. The listing exchange has not met that requirement here. Therefore, the Commission is unable to find that the proposed rule change is consistent with the statutory standard. 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.184 For the reasons discussed above, BZX has not met its burden of demonstrating that the proposal is consistent with Exchange Act Section 6(b)(5),185 and, accordingly, the Commission must disapprove the proposal.186 D. Other Comments Comment letters also address the general nature and uses of bitcoin; 187 the state of development of bitcoin as a digital asset; 188 the state of regulation of bitcoin markets; 189 the inherent value of, and risks of investing in, bitcoin; 190 the desire of investors to gain access to bitcoin through an ETP; 191 the potential impact of Commission approval of the proposed ETP on the price of bitcoin 184 See 15 U.S.C. 78s(b)(2)(C). U.S.C. 78f(b)(5). 186 In disapproving the proposed rule change, the Commission has considered its impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). A commenter argues, for efficiency reasons, against approving a bitcoin ETP. This commenter asserts that the adoption of multiple digital assets would force merchants to deal with ‘‘complexity [that] doesn’t foster [the] modularity which is needed to gain economic efficiency.’’ See Ciao Letter 3 at 1. For the reasons discussed throughout, however, see supra note 37, the Commission is disapproving the proposed rule change because it does not find that the proposed rule change is consistent with the Exchange Act. See also USBT Order, 85 FR at 12615. 187 See, e.g., Ciao Letter 3; Patel Letter; letters from: Lourdes Ciao, dated June 2, 2021 (‘‘Ciao Letter 1’’); Lourdes Ciao, dated June 2, 2021 (‘‘Ciao Letter 2’’). 188 See, e.g., GDF Letter. 189 See, e.g., GDF Letter; letter from Douglas Slemmer, dated July 23, 2021 (‘‘Slemmer Letter’’). 190 See, e.g., Ciao Letter 1; Ciao Letter 3; Patel Letter; Slemmer Letter; letters from: Sam Ahn, dated April 12, 2021; Bradley M. Kuhn, dated April 25, 2021 (‘‘Kuhn Letter’’). 191 See, e.g., Kuhn Letter; GDF Letter. lotter on DSK11XQN23PROD with NOTICES1 185 15 VerDate Sep<11>2014 17:30 Dec 06, 2021 Jkt 256001 and on bitcoin markets; 192 the potential impact of Commission approval of bitcoin ETPs on the economy, U.S. monetary policy, U.S. innovation, and/ or U.S. geopolitical position; 193 the tax and/or retirement investment benefits or risks of a bitcoin ETP; 194 and the bitcoin network’s effect on the environment.195 Ultimately, however, additional discussion of these topics is unnecessary, as they do not bear on the basis for the Commission’s decision to disapprove the proposal. IV. Conclusion For the reasons set forth above, the Commission does not find, pursuant to Section 19(b)(2) of the Exchange Act, that the proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to a national securities exchange, and in particular, with Section 6(b)(5) of the Exchange Act. It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act, that proposed rule change SR– CboeBZX–2021–024 be, and hereby is, disapproved. By the Commission. J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2021–26442 Filed 12–6–21; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–93689; File No. SR– CboeBYX–2021–028] Self-Regulatory Organizations; Cboe BYX Exchange, Inc.; Notice of Filing of a Proposed Rule Change To Introduce a New Data Product To Be Known as the Short Volume Report December 1, 2021. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on November 22, 2021, Cboe BYX Exchange, Inc. (‘‘Exchange’’ or ‘‘BYX’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange. The 192 See, 193 See, e.g., GDF Letter. e.g., Ciao Letter 1; Ciao Letter 2; Ciao Letter 3. 194 See, e.g., Kuhn Letter; Ciao Letter 2; Ciao Letter 3. 195 See, e.g., Patel Letter. 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. PO 00000 Frm 00117 Fmt 4703 Sfmt 4703 69335 Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change Cboe BYX Exchange, Inc. (the ‘‘Exchange’’ or ‘‘BYX’’) is filing with the Securities and Exchange Commission (‘‘Commission’’) a proposed rule change to Exchange Rule 11.22(f) to introduce a new data product to be known as the Short Volume Report. The text of the proposed rule change is provided in Exhibit 5. The text of the proposed rule change is also available on the Exchange’s website (https://markets.cboe.com/us/ equities/regulation/rule_filings/byx/), at the Exchange’s Office of the Secretary, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to amend Rule 11.22(f) to provide for a new data product to be known as the Short Volume Report. The proposal introduces the Short Volume Report which will be available for purchase to BYX Members (‘‘Members’’) and nonMembers. The Exchange notes that the proposed data product is substantially similar to information included in the short sale volume report offered by the Nasdaq Stock Market LLC (‘‘Nasdaq’’) 3 and the TAQ Group Short Volume file offered by the New York Stock Exchange LLC (‘‘NYSE’’),4 with the 3 See the Nasdaq Price List—Equities, Nasdaq Web-based Reports, Nasdaq Short Sale Volume Reports at Price List—NASDAQ Global Data Products (nasdaqtrader.com). 4 See the NYSE Historical Proprietary Market Data Pricing, NYSE Group Summary Data Products, TAQ NYSE Group Short Volume (Daily File) at https:// E:\FR\FM\07DEN1.SGM Continued 07DEN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 86, Number 232 (Tuesday, December 7, 2021)]
[Notices]
[Pages 69322-69335]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-26442]

[[Page 69322]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-93700; File No. SR-CboeBZX-2021-024])

Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order
Disapproving a Proposed Rule Change To List and Trade Shares of the
WisdomTree Bitcoin Trust Under BZX Rule 14.11(e)(4), Commodity-Based
Trust Shares

December 1, 2021.

I. Introduction

On March 26, 2021, Cboe BZX Exchange, Inc. (``BZX'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to list and trade shares
(``Shares'') of the WisdomTree Bitcoin Trust (``Trust'') under BZX Rule
14.11(e)(4), Commodity-Based Trust Shares. The proposed rule change was
published for comment in the Federal Register on April 15, 2021.\3\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 91521 (Apr. 9,
2021), 86 FR 19917 (``Notice''). Comments on the proposed rule
change can be found at: https://www.sec.gov/comments/sr-cboebzx-2021-024/srcboebzx2021024.htm.
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On May 26, 2021, pursuant to Section 19(b)(2) of the Exchange
Act,\4\ the Commission designated a longer period within which to
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to disapprove the
proposed rule change.\5\ On July 13, 2021, the Commission instituted
proceedings under Section 19(b)(2)(B) of the Exchange Act \6\ to
determine whether to approve or disapprove the proposed rule change.\7\
On September 29, 2021, the Commission designated a longer period for
Commission action on the proposed rule change.\8\
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\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 92032, 86 FR 29611
(June 2, 2021).
\6\ 15 U.S.C. 78s(b)(2)(B).
\7\ See Securities Exchange Act Release No. 92392, 86 FR 38154
(July 19, 2021).
\8\ See Securities Exchange Act Release No. 93173, 86 FR 55065
(Oct. 5, 2021).
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This order disapproves the proposed rule change. The Commission
concludes that 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 Exchange Act Section 6(b)(5), in
particular, the 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.'' \9\
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\9\ 15 U.S.C. 78f(b)(5).
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When considering whether BZX's proposal to list and trade the
Shares is designed to prevent fraudulent and manipulative acts and
practices, the Commission applies the same standard used in its orders
considering previous proposals to list bitcoin \10\-based commodity
trusts and bitcoin-based trust issued receipts.\11\ As the Commission
has explained, an exchange that lists bitcoin-based exchange-traded
products (``ETPs'') can meet its obligations under Exchange Act Section
6(b)(5) by demonstrating that the exchange has a comprehensive
surveillance-sharing agreement with a regulated market of significant
size related to the underlying or reference bitcoin assets.\12\
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\10\ 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, e.g.,
Notice, 86 FR at 19918.
\11\ See 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,
Securities Exchange Act Release No. 83723 (July 26, 2018), 83 FR
37579 (Aug. 1, 2018) (SR-BatsBZX-2016-30) (``Winklevoss Order'');
Order Disapproving a Proposed Rule Change, as Modified by Amendment
No. 1, To Amend NYSE Arca Rule 8.201-E (Commodity-Based Trust
Shares) and To List and Trade Shares of the United States Bitcoin
and Treasury Investment Trust Under NYSE Arca Rule 8.201-E,
Securities Exchange Act Release No. 88284 (Feb. 26, 2020), 85 FR
12595 (Mar. 3, 2020) (SR-NYSEArca-2019-39) (``USBT Order''). See
also 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,
Securities Exchange Act Release No. 80319 (Mar. 28, 2017), 82 FR
16247 (Apr. 3, 2017) (SR-NYSEArca-2016-101) (``SolidX Order''). The
Commission also notes that orders were issued by delegated authority
on the following matters: Order Disapproving a Proposed Rule Change
To List and Trade the Shares of the ProShares Bitcoin ETF and the
ProShares Short Bitcoin ETF, Securities Exchange Act Release No.
83904 (Aug. 22, 2018), 83 FR 43934 (Aug. 28, 2018) (NYSEArca-2017-
139) (``ProShares Order''); Order Disapproving a Proposed Rule
Change To List and Trade the Shares of the GraniteShares Bitcoin ETF
and the GraniteShares Short Bitcoin ETF, Securities Exchange Act
Release No. 83913 (Aug. 22, 2018), 83 FR 43923 (Aug. 28, 2018) (SR-
CboeBZX-2018-001) (``GraniteShares Order''); Order Disapproving a
Proposed Rule Change To List and Trade Shares of the VanEck Bitcoin
Trust under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares,
Securities Exchange Act Release No. 93559 (Nov. 12, 2021), 86 FR
64539 (Nov. 18, 2021) (SR-CboeBZX-2021-019).
\12\ See USBT Order, 85 FR at 12596. See also Winklevoss Order,
83 FR at 37592 n.202 and accompanying text (discussing previous
Commission approvals of commodity-trust ETPs); GraniteShares Order,
83 FR at 43925-27 nn.35-39 and accompanying text (discussing
previous Commission approvals of commodity-futures ETPs).
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The standard requires such surveillance-sharing agreements since
they ``provide a necessary deterrent to manipulation because they
facilitate the availability of information needed to fully investigate
a manipulation if it were to occur.'' \13\ The Commission has
emphasized that it is essential for an exchange listing a derivative
securities product to enter into a surveillance-sharing agreement with
markets trading the underlying assets for the listing exchange to have
the ability to obtain information necessary to detect, investigate, and
deter fraud and market manipulation, as well as violations of exchange
rules and applicable federal securities laws and rules.\14\ The
hallmarks of a surveillance-sharing 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.\15\
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\13\ See Amendment to Rule Filing Requirements for Self-
Regulatory Organizations Regarding New Derivative Securities
Products, Securities Exchange Act Release No. 40761 (Dec. 8, 1998),
63 FR 70952, 70959 (Dec. 22, 1998) (``NDSP Adopting Release''). See
also Winklevoss Order, 83 FR at 37594; ProShares Order, 83 FR at
43936; GraniteShares Order, 83 FR at 43924; USBT Order, 85 FR at
12596.
\14\ See NDSP Adopting Release, 63 FR at 70959.
\15\ See Winklevoss Order, 83 FR at 37592-93; 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.
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In the context of this standard, the terms ``significant market''
and ``market of significant size'' 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 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.\16\ A surveillance-sharing
agreement must be entered into with a ``significant market'' to assist
in

[[Page 69323]]

detecting and deterring manipulation of the ETP, because a person
attempting to manipulate the ETP is reasonably likely to also engage in
trading activity on that ``significant market.'' \17\
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\16\ See Winklevoss Order, 83 FR at 37594. 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. See id.
\17\ See USBT Order, 85 FR at 12597.
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Consistent with this standard, 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
(``ISG'') membership in common with, that market.\18\ Moreover, the
surveillance-sharing agreements have been consistently present whenever
the Commission has approved the listing and trading of derivative
securities, even where the underlying securities were also listed on
national securities exchanges--such as options based on an index of
stocks traded on a national securities exchange--and were thus subject
to the Commission's direct regulatory authority.\19\
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\18\ See Winklevoss Order, 83 FR at 37594.
\19\ See USBT Order, 85 FR at 12597; Securities 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
Depository Receipts). The Commission has also required a
surveillance-sharing agreement in the context of index options even
when (i) all of the underlying index component stocks were either
registered with the Commission or exempt from registration under the
Exchange Act; (ii) all of the underlying index component stocks
traded in the U.S. either directly or as ADRs on a national
securities exchange; and (iii) effective international ADR arbitrage
alleviated concerns over the relatively smaller ADR trading volume,
helped to ensure that ADR prices reflected the pricing on the home
market, and helped to ensure more reliable price determinations for
settlement purposes, due to the unique composition of the index and
reliance on ADR prices. See Securities Exchange Act Release No.
26653 (Mar. 21, 1989), 54 FR 12705, 12708 (Mar. 28, 1989) (SR-Amex-
87-25) (stating that ``surveillance-sharing agreements between the
exchange on which the index option trades and the markets that trade
the underlying securities are necessary'' and that ``[t]he exchange
of surveillance data by the exchange trading a stock index option
and the markets for the securities comprising the index is important
to the detection and deterrence of intermarket manipulation.''). And
the Commission has required a surveillance-sharing agreement even
when approving options based on an index of stocks traded on a
national securities exchange. See Securities Exchange Act Release
No. 30830 (June 18, 1992), 57 FR 28221, 28224 (June 24, 1992) (SR-
Amex-91-22) (stating that surveillance-sharing agreements ``ensure
the availability of information necessary to detect and deter
potential manipulations and other trading abuses'').
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Listing exchanges have also attempted to demonstrate that other
means besides surveillance-sharing agreements will be sufficient to
prevent fraudulent and manipulative acts and practices, including that
the bitcoin market as a whole or the relevant underlying bitcoin market
is ``uniquely'' and ``inherently'' resistant to fraud and
manipulation.\20\ In response, the Commission has agreed that, if a
listing exchange could establish that the underlying market inherently
possesses a unique resistance to manipulation beyond the protections
that are utilized by traditional commodity or securities markets, it
would not necessarily need to enter into a surveillance-sharing
agreement with a regulated significant market.\21\ Such resistance to
fraud and manipulation, however, must be novel and beyond those
protections that exist in traditional commodity markets or equity
markets for which the Commission has long required surveillance-sharing
agreements in the context of listing derivative securities products. No
listing exchange has satisfied its burden to make such
demonstration.\22\
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\20\ See USBT Order, 85 FR at 12597.
\21\ See Winklevoss Order, 83 FR at 37580, 37582-91 (addressing
assertions that ``bitcoin and bitcoin [spot] markets'' generally, as
well as one bitcoin trading platform specifically, have unique
resistance to fraud and manipulation); see also USBT Order, 85 FR at
12597.
\22\ See supra note 11.
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Here, BZX contends that approval of the proposal is consistent with
Section 6(b)(5) of the Exchange Act, in particular 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.\23\ As discussed in more
detail below, BZX asserts that the proposal is consistent with Section
6(b)(5) of the Exchange Act because the Exchange has a comprehensive
surveillance-sharing agreement with a regulated market of significant
size,\24\ and there exist other means to prevent fraudulent and
manipulative acts and practices that are sufficient to justify
dispensing with the requisite surveillance-sharing agreement.\25\
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\23\ See Notice, 86 FR at 19924.
\24\ See id. at 19929-30.
\25\ See id. at 19930.
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Although BZX recognizes the Commission's focus on potential
manipulation of bitcoin ETPs in prior disapproval orders, BZX argues
that such manipulation concerns have been sufficiently mitigated, and
that the growing and quantifiable investor protection concerns should
be the central consideration of the Commission.\26\ Specifically, as
discussed in more detail below, the Exchange asserts that the
significant increase in trading volume in bitcoin futures on the
Chicago Mercantile Exchange (``CME''), the growth of liquidity in the
spot market for bitcoin, and certain features of the Shares and the
Reference Rate (as defined herein) mitigate potential manipulation
concerns to the point that the investor protection issues that have
arisen from the rapid growth of over-the-counter (``OTC'') bitcoin
funds, including premium/discount volatility and management fees,
should be the central consideration as the Commission determines
whether to approve this proposal.\27\
---------------------------------------------------------------------------

\26\ See id. at 19920.
\27\ See id. at 19929.
---------------------------------------------------------------------------

Further, BZX believes that the proposal would give U.S. investors
access to bitcoin in a regulated and transparent exchange-traded
vehicle that would act to limit risk to U.S. investors. According to
BZX, the proposed listing and trading of the Shares would mitigate risk
by: (i) Reducing premium and discount volatility; (ii) reducing
management fees through meaningful competition; (iii) reducing risks
associated with investing in operating companies that are imperfect
proxies for bitcoin exposure; and (iv) providing an alternative to
custodying spot bitcoin.\28\
---------------------------------------------------------------------------

\28\ See id. at 19920.
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In the analysis that follows, the Commission examines whether the
proposed rule change is consistent with Section 6(b)(5) of the Exchange
Act by addressing: in Section III.B.1 assertions that other means
besides surveillance-sharing agreements will be sufficient to prevent
fraudulent and manipulative acts and practices; in Section III.B.2
assertions that BZX has entered into a comprehensive surveillance-
sharing agreement with a regulated market of significant size related
to bitcoin; and in Section III.C assertions that the proposal is
consistent with the protection of investors and the public interest. As
discussed further below, BZX repeats various assertions made in prior
bitcoin-based ETP proposals that the Commission has previously
addressed and rejected and more importantly, BZX does not respond to
the Commission's reasons for rejecting those assertions but merely
repeats them. The Commission concludes that BZX has not established
that other means to prevent fraudulent and manipulative acts and
practices are sufficient to justify dispensing with the requisite
surveillance-sharing agreement. The Commission further concludes that
BZX has not established that it has a comprehensive surveillance-
sharing agreement with a regulated market of significant size related
to bitcoin. As a result, the Commission is unable to find that the

[[Page 69324]]

proposed rule change is consistent with the statutory requirements of
Exchange Act Section 6(b)(5).
The Commission again emphasizes that its disapproval of this
proposed rule change 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 below, BZX has not met
its burden to demonstrate that its proposal is consistent with the
requirements of Exchange Act Section 6(b)(5).

II. Description of the Proposed Rule Change

As described in more detail in the Notice,\29\ the Exchange
proposes to list and trade the Shares of the Trust under BZX Rule
14.11(e)(4), which governs the listing and trading of Commodity-Based
Trust Shares on the Exchange.
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\29\ See Notice, supra note 3. See also Registration Statement
on Form S-1, dated March 11, 2021 (File No. 333-254134), filed with
the Commission on behalf of the Trust (``Registration Statement'').
---------------------------------------------------------------------------

The investment objective of the Trust is to gain exposure to the
price of bitcoin, less expenses and liabilities of the Trust's
operation.\30\ The Trust would hold bitcoin, and it would calculate the
Trust's net asset value (``NAV'') daily based on the value of bitcoin
as reflected by the CF Bitcoin US Settlement Price (``Reference
Rate''). The Reference Rate was created, and is administered, by CF
Benchmarks Ltd. (``Benchmark Administrator''). The Reference Rate
aggregates the trade flow of several bitcoin spot platforms, the
composition of which currently includes Bitstamp, Coinbase, Gemini,
itBit, and Kraken. In calculating the Reference Rate, the methodology
creates a joint list of the trade prices and sizes from the Constituent
Bitcoin Platforms (as defined herein) between 3:00 p.m. E.T. and 4:00
p.m. E.T. The methodology divides this list into 12 equally-sized time
intervals of five minutes and calculates the volume-weighted median
trade price for each of those time intervals.\31\ The Reference Rate is
the arithmetic mean of these 12 volume-weighted median trade
prices.\32\
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\30\ WisdomTree Digital Commodity Services, LLC (``Sponsor'') is
the sponsor of the Trust, and Delaware Trust Company is the trustee.
A third-party regulated custodian (``Bitcoin Custodian'') will be
responsible for custody of the Trust's bitcoin. The Sponsor is
responsible for selecting the Bitcoin Custodian as well as an
administrator, a transfer agent, a marketing agent, and an auditor
for the Trust. See Notice, 86 FR at 19918, 19925-26.
\31\ According to BZX, the Reference Rate is based on materially
the same methodology (except calculation time, as described herein)
as the Benchmark Administrator's CME CF Bitcoin Reference Rate
(``BRR''), which was first introduced on November 14, 2016, and is
the rate on which bitcoin futures contracts are cash-settled in U.S.
dollars on CME. The Reference Rate is calculated as of 4:00 p.m.
E.T., whereas the CME CF BRR is calculated as of 4:00 p.m. London
Time. The Reference Rate aggregates the trade flow of several
bitcoin platforms during an observation window between 3:00 p.m. and
4:00 p.m. E.T. into the U.S. dollar price of one bitcoin at 4:00
p.m. E.T. The current constituent bitcoin platforms of the Reference
Rate are Bitstamp, Coinbase, Gemini, itBit, and Kraken
(``Constituent Bitcoin Platforms''). See Notice, 86 FR at 19926 &
n.70.
\32\ See id. at 19926.
---------------------------------------------------------------------------

Each Share represents a fractional undivided beneficial interest in
and ownership of the Trust. The Trust's assets will consist of bitcoin
held by the Bitcoin Custodian on behalf of the Trust. The Trust
generally does not intend to hold cash or cash equivalents. However,
there may be situations where the Trust will unexpectedly hold cash on
a temporary basis.\33\
---------------------------------------------------------------------------

\33\ See id. at 19925.
---------------------------------------------------------------------------

The administrator will determine the NAV and NAV per Share of the
Trust on each day that the Exchange is open for regular trading after
4:00 p.m. E.T. (often by 5:30 p.m. E.T. and almost always by 8:00 p.m.
E.T.). The NAV of the Trust is the aggregate value of the Trust's
assets, less total liabilities of the Trust. In determining the Trust's
NAV, the administrator values the bitcoin held by the Trust based on
the price set by the Reference Rate as of 4:00 p.m. E.T.\34\
---------------------------------------------------------------------------

\34\ See id. at 19927.
---------------------------------------------------------------------------

The Trust will provide information regarding the Trust's bitcoin
holdings, as well as an Intraday Indicative Value (``IIV'') per Share
updated every 15 seconds, as calculated by the Exchange or a third-
party financial data provider during the Exchange's Regular Trading
Hours (9:30 a.m. to 4:00 p.m. E.T.). The IIV will be calculated by
using the prior day's closing NAV per Share as a base and updating that
value during Regular Trading Hours to reflect changes in the value of
the Trust's bitcoin holdings during the trading day.\35\
---------------------------------------------------------------------------

\35\ See id. at 19926.
---------------------------------------------------------------------------

When the Trust sells or redeems its Shares, it will do so in ``in-
kind'' transactions in blocks of aggregations of Shares. When creating
the Shares, authorized participants will deliver, or facilitate the
delivery of, bitcoin to the Trust's account with the Bitcoin Custodian
in exchange for the Shares, and, when redeeming the Shares, the Trust,
through the Bitcoin Custodian, will deliver bitcoin to such authorized
participants.\36\
---------------------------------------------------------------------------

\36\ See id. at 19925-26.
---------------------------------------------------------------------------

III. Discussion

A. The Applicable Standard for Review

The Commission must consider whether BZX's proposal is consistent
with the Exchange Act. Section 6(b)(5) of the Exchange Act 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.'' \37\ 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 thereunder . . . is on the self-regulatory
organization [`SRO'] that proposed the rule change.'' \38\
---------------------------------------------------------------------------

\37\ 15 U.S.C. 78f(b)(5). Pursuant to Section 19(b)(2) of the
Exchange Act, 15 U.S.C. 78s(b)(2), 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. Exchange Act Section
6(b)(5) states that an exchange shall not be registered as a
national securities exchange unless the Commission determines that
``[t]he rules of the exchange 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; and are not designed
to permit unfair discrimination between customers, issuers, brokers,
or dealers, or to regulate by virtue of any authority conferred by
this title matters not related to the purposes of this title or the
administration of the exchange.'' 15 U.S.C. 78f(b)(5).
\38\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
---------------------------------------------------------------------------

The description of a proposed rule change, its purpose and
operation, its effect, and a legal analysis of its consistency with
applicable requirements must all be sufficiently detailed and specific
to support an affirmative Commission finding,\39\ 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.\40\ Moreover, ``unquestioning reliance'' on an SRO's
representations in a proposed rule change is not sufficient to justify
Commission approval of a proposed rule change.\41\
---------------------------------------------------------------------------

\39\ See id.
\40\ See id.
\41\ Susquehanna Int'l Group, LLP v. Securities and Exchange
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (``Susquehanna'').

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

[[Page 69325]]

B. Whether BZX Has Met its Burden To Demonstrate That the Proposal Is
Designed To Prevent Fraudulent and Manipulative Acts and Practices

(1) Assertions That Other Means Besides Surveillance-Sharing
Agreements Will Be Sufficient To Prevent Fraudulent and Manipulative
Acts and Practices
As stated above, the Commission has recognized that a listing
exchange could demonstrate that other means to prevent fraudulent and
manipulative acts and practices are sufficient to justify dispensing
with a comprehensive surveillance-sharing agreement with a regulated
market of significant size, including by demonstrating that the bitcoin
market as a whole or the relevant underlying bitcoin market is uniquely
and inherently resistant to fraud and manipulation.\42\ Such resistance
to fraud and manipulation must be novel and beyond those protections
that exist in traditional commodities or securities markets.\43\
---------------------------------------------------------------------------

\42\ See USBT Order, 85 FR at 12597 n.23. The Commission is not
applying a ``cannot be manipulated'' standard. Instead, the
Commission is examining whether the proposal meets the requirements
of the Exchange Act and, pursuant to its Rules of Practice, places
the burden on the listing exchange to demonstrate the validity of
its contentions and to establish that the requirements of the
Exchange Act have been met. See id.
\43\ See id. at 12597.
---------------------------------------------------------------------------

BZX asserts that bitcoin is resistant to price manipulation.
According to BZX, the geographically diverse and continuous nature of
bitcoin trading render it difficult and prohibitively costly to
manipulate the price of bitcoin.\44\ Fragmentation across bitcoin
platforms, the relatively slow speed of transactions, and the capital
necessary to maintain a significant presence on each trading platform
make manipulation of bitcoin prices through continuous trading activity
challenging.\45\ To the extent that there are bitcoin platforms engaged
in or allowing wash trading or other activity intended to manipulate
the price of bitcoin on other markets, such pricing does not normally
impact prices on other platforms because participants will generally
ignore markets with quotes that they deem non-executable.\46\ BZX
further argues that the linkage between the bitcoin markets and the
presence of arbitrageurs in those markets means that the manipulation
of the price of bitcoin on any single venue would require manipulation
of the global bitcoin price in order to be effective.\47\ Arbitrageurs
must have funds distributed across multiple trading platforms in order
to take advantage of temporary price dislocations, thereby making it
unlikely that there will be strong concentration of funds on any
particular bitcoin trading venue.\48\ As a result, BZX concludes that
the potential for manipulation on a bitcoin trading platform would
require overcoming the liquidity supply of such arbitrageurs who are
effectively eliminating any cross-market pricing differences.\49\
---------------------------------------------------------------------------

\44\ See Notice, 86 FR at 19924 n.58.
\45\ See id.
\46\ See id.
\47\ See id.
\48\ See id.
\49\ See id.
---------------------------------------------------------------------------

As with the previous proposals, the Commission here concludes that
the record does not support a finding that the bitcoin market is
inherently and uniquely resistant to fraud and manipulation.\50\ BZX
asserts that, because of how bitcoin trades occur, including through
continuous means and through fragmented platforms, arbitrage across the
bitcoin platforms essentially helps to keep global bitcoin prices
aligned with one another, thus hindering manipulation. The Exchange,
however, does not provide any data or analysis to support its
assertions, either in terms of how closely bitcoin prices are aligned
across different bitcoin trading venues or how quickly price
disparities may be arbitraged away.\51\ As stated above,
``unquestioning reliance'' on an SRO's representations in a proposed
rule change is not sufficient to justify Commission approval of a
proposed rule change.\52\
---------------------------------------------------------------------------

\50\ Two commenters also question the bitcoin market's
resistance to fraud and manipulation. One commenter asserts that the
bitcoin network is the preferred network for global criminals, and a
pyramid scheme in which the top holders encourage existing holders
to keep holding and entice new retail investors to invest. See
letter from Maulik Patel, dated July 4, 2021 (``Patel Letter'').
Another commenter describes digital assets such as bitcoin, and the
blockchains on which they rely, as having complexity that makes
users vulnerable to fraud. See letter from Lourdes Ciao, dated June
24, 2021 (``Ciao Letter 3'').
\51\ For example, the Registration Statement states that ``[i]f
increases in throughput on the Bitcoin network lag behind growth in
usage of bitcoin, average fees and settlement times may increase
considerably . . . . which could adversely impact the value of the
Shares.'' See Registration Statement at 21. BZX does not provide
data or analysis to address, among other things, whether such risks
of increased fees and bitcoin transaction settlement times may
affect the arbitrage effectiveness that BZX asserts. See also infra
note 65 and accompanying text (referencing statements made in the
Registration Statement that contradict assertions made by BZX).
\52\ See supra note 41.
---------------------------------------------------------------------------

Efficient price arbitrage, moreover, is not sufficient to support
the finding that a market is uniquely and inherently resistant to
manipulation such that the Commission can dispense with surveillance-
sharing agreements.\53\ The Commission has stated, for example, that
even for equity options based on securities listed on national
securities exchanges, the Commission relies on surveillance-sharing
agreements to detect and deter fraud and manipulation.\54\ Here, the
Exchange provides no evidence to support its assertion of efficient
price arbitrage across bitcoin platforms, let alone any evidence that
price arbitrage in the bitcoin market is novel or unique so as to
warrant the Commission dispensing with the requirement of a
surveillance-sharing agreement. Moreover, BZX does not 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.\55\
---------------------------------------------------------------------------

\53\ See Winklevoss Order, 83 FR at 37586; SolidX Order, 82 FR
at 16256-57; USBT Order, 85 FR at 12601.
\54\ See, e.g., USBT Order, 85 FR at 12601.
\55\ See, e.g., Winklevoss Order, 83 FR at 37584; USBT Order, 85
FR at 12600-01.
---------------------------------------------------------------------------

In addition, the Exchange makes the unsupported claim that bitcoin
prices on platforms with wash trades or other activity intended to
manipulate the price of bitcoin do not influence the ``real'' price of
bitcoin. The Exchange also asserts that, to the extent that there are
bitcoin platforms engaged in or allowing wash trading or other
manipulative activities, market participants will generally ignore
those platforms. However, without the necessary data, such as lead-lag
or other similar analyses, or other evidence, the Commission has no
basis on which to conclude that bitcoin platforms are insulated from
prices of others that engage in or permit fraud or manipulation.\56\
---------------------------------------------------------------------------

\56\ See USBT Order, 85 FR at 12601. See also infra notes 131-
132 and accompanying text (explaining the lead-lag analysis as
central to understanding whether it is reasonably likely that a
would-be manipulator of the proposed ETP would have to trade on the
CME bitcoin futures market to successfully manipulate the proposed
ETP).
---------------------------------------------------------------------------

Additionally, the continuous nature of bitcoin trading does not
eliminate manipulation risk, and neither does linkages among markets,
as BZX asserts.\57\ Even in the presence of continuous trading or
linkages among markets, formal (such as those with consolidated
quotations or routing requirements) or otherwise (such as in the
context of the fragmented, global bitcoin markets), manipulation of
asset prices, as a general matter, can occur simply through trading
activity that

[[Page 69326]]

creates a false impression of supply or demand.\58\
---------------------------------------------------------------------------

\57\ See Winklevoss Order, 83 FR at 37585 n.92 and accompanying
text.
\58\ See id. at 37585.
---------------------------------------------------------------------------

BZX also argues that the significant liquidity in the bitcoin spot
market and the impact of market orders on the overall price of bitcoin
mean that attempting to move the price of bitcoin is costly and has
grown more expensive over the past year.\59\ According to BZX, in
January 2020, for example, the cost to buy or sell $5 million worth of
bitcoin averaged roughly 30 basis points (compared to 10 basis points
in February 2021) with a market impact of 50 basis points (compared to
30 basis points in February 2021). For a $10 million market order, the
cost to buy or sell was roughly 50 basis points (compared to 20 basis
points in February 2021) with a market impact of 80 basis points
(compared to 50 basis points in February 2021). BZX contends that as
the liquidity in the bitcoin spot market increases, it follows that the
impact of $5 million and $10 million orders will continue to
decrease.\60\
---------------------------------------------------------------------------

\59\ See Notice, 86 FR at 19925.
\60\ See id.
---------------------------------------------------------------------------

However, the data furnished by BZX regarding the cost to move the
price of bitcoin, and the market impact of such attempts, are
incomplete. BZX does not provide meaningful analysis pertaining to how
these figures compare to other markets or why one must conclude, based
on the numbers provided, that the bitcoin market is costly to
manipulate. Further, BZX's analysis of the market impact of a mere two
sample transactions is not sufficient evidence to conclude that the
bitcoin market is resistant to manipulation.\61\ Even assuming that the
Commission agreed with BZX's premise, that it is costly to manipulate
the bitcoin market and it is becoming increasingly so, any such
evidence speaks only to establish that there is some resistance to
manipulation, not that it establishes unique resistance to manipulation
to warrant dispensing with the standard surveillance-sharing
agreement.\62\ The Commission thus concludes that the record does not
demonstrate that the nature of bitcoin trading renders the bitcoin
market inherently and uniquely resistant to fraud and manipulation.
---------------------------------------------------------------------------

\61\ Aside from stating that the ``statistics are based on
samples of bitcoin liquidity in USD (excluding stablecoins or Euro
liquidity) based on executable quotes on Coinbase Pro, Gemini,
Bitstamp, Kraken, LMAX Exchange, BinanceUS, and OKCoin during
February 2021,'' the Exchange provides no other information
pertaining to the methodology used to enable the Commission to
evaluate these findings or their significance. See id. at 19925
nn.64-65.
\62\ See USBT Order, 85 FR at 12601.
---------------------------------------------------------------------------

Moreover, BZX does not sufficiently contest the presence of
possible sources of fraud and manipulation in the bitcoin spot market
generally that the Commission has raised in previous orders, which have
included (1) ``wash'' trading,\63\ (2) persons with a dominant position
in bitcoin manipulating bitcoin pricing, (3) hacking of the bitcoin
network and trading platforms, (4) malicious control of the bitcoin
network, (5) trading based on material, non-public information,
including the dissemination of false and misleading information, (6)
manipulative activity involving the purported ``stablecoin'' Tether
(USDT), and (7) fraud and manipulation at bitcoin trading
platforms.\64\
---------------------------------------------------------------------------

\63\ See supra note 56 and accompanying text.
\64\ See USBT Order, 85 FR at 12600-01 & nn.66-67 (discussing J.
Griffin & A. Shams, Is Bitcoin Really Untethered? (October 28,
2019), available at https://ssrn.com/abstract=3195066 and published
in 75 J. Finance 1913 (2020)); Winklevoss Order, 83 FR at 37585-86.
---------------------------------------------------------------------------

In addition, BZX does not address risk factors specific to the
bitcoin blockchain and bitcoin platforms, described in the Trust's
Registration Statement, that undermine the argument that the bitcoin
market is inherently resistant to fraud and manipulation. For example,
the Registration Statement acknowledges that ``bitcoin [platforms] on
which bitcoin trades are relatively new and, in some cases,
unregulated, and, therefore, may be more exposed to fraud and security
breaches than established, regulated exchanges for other financial
assets or instruments''; that ``as an intangible asset without
centralized issuers or governing bodies, bitcoin has been, and may in
the future be, subject to security breaches, cyberattacks or other
malicious activities''; that ``[t]he trading for bitcoin occurs on
multiple trading venues that have various levels and types of
regulation, but are not regulated in the same manner as traditional
stock and bond exchanges'' and if these spot markets ``do not operate
smoothly or face technical, security or regulatory issues, that could
impact the ability of Authorized Participants to make markets in the
Shares'' which could lead to ``trading in the Shares [to] occur at a
material premium or discount against the NAV''; that the bitcoin
blockchain could be vulnerable to a ``51% attack,'' in which a bad
actor that controls a majority of the processing power dedicated to
mining on the bitcoin network may be able to alter the bitcoin
blockchain on which the bitcoin network and bitcoin transactions rely;
that the nature of the assets held at bitcoin platforms makes them
``appealing targets for hackers'' and that ``a number of bitcoin
[platforms] have been victims of cybercrimes''; and that bitcoin
trading platforms ``have been closed or faced issues due to fraud,
failure'' and ``security breaches.'' \65\
---------------------------------------------------------------------------

\65\ See Registration Statement at 11, 18-20, 38. See also
Winklevoss Order, 83 FR at 37585.
---------------------------------------------------------------------------

BZX also asserts that other means to prevent fraud and manipulation
are sufficient to justify dispensing with the requisite surveillance-
sharing agreement. The Exchange mentions that the Reference Rate, which
is used to value the Trust's bitcoin, is itself resistant to
manipulation based on the Reference Rate's methodology.\66\ The
Exchange states that the Reference Rate is calculated based on the
``Relevant Transactions'' \67\ of all of its Constituent Bitcoin
Platforms. All Relevant Transactions are added to a joint list,
recording the time of execution, trade price, and size for each
transaction, and the list is partitioned by timestamp into 12 equally-
sized time intervals of five minute length.\68\ For each partition
separately, the volume-weighted median trade price is calculated from
the trade prices and sizes of all Relevant Transactions.\69\ The
Reference Rate is then determined by the arithmetic mean of the volume-
weighted medians of all partitions.\70\ According to BZX, ``[b]y
employing the foregoing steps, the Reference Rate thereby seeks to
ensure that transactions in bitcoin conducted at outlying prices do not
have an undue effect on the value of a specific partition, large trades
or clusters of trades transacted over a short period of time will not
have an undue influence on the index level, and the effect of large
trades at prices that deviate from the prevailing price are mitigated
from having an undue influence on the benchmark level.'' \71\ BZX
concludes its analysis of the Reference Rate by noting that ``an
oversight function is implemented by the Benchmark Administrator in
seeking to ensure that the Reference Rate is administered through
codified policies for Reference Rate integrity.'' \72\
---------------------------------------------------------------------------

\66\ See Notice, 86 FR at 19925.
\67\ According to the Exchange, a ``Relevant Transaction'' is
any cryptocurrency versus U.S. dollar spot trade that occurs during
the observation window between 3:00 p.m. and 4:00 p.m. E.T. on a
Constituent Bitcon Platform in the BTC/USD pair that is reported and
disseminated by a Constituent Bitcoin Platform and observed by the
Benchmark Administrator. See id. at 19926 n.71.
\68\ See id. at 19926.
\69\ See id. According to the Exchange, a volume-weighted median
differs from a standard median in that a weighting factor, in this
case trade size, is factored into the calculation. See id.
\70\ See id.
\71\ See id.
\72\ See id.
---------------------------------------------------------------------------

The Benchmark Administrator, in a comment letter, elaborates on
how, in

[[Page 69327]]

its view, its oversight of the Reference Rate helps to prevent fraud
and manipulation.\73\ The Benchmark Administrator states that it is
subject to the UK Benchmarks Regulation (``BMR''), which is enforced by
the UK Financial Conduct Authority (``FCA''), including requirements to
surveil for attempted and actual manipulation.\74\ The Benchmark
Administrator further states that, in order to fulfil its regulatory
obligations under the UK BMR: It only includes as ``Constituent Bitcoin
Platforms'' those trading platforms that conform to certain criteria,
including assessment of a platform's risks to market participants,
compliance with law, and policies to identify and impede manipulative
trading practices; \75\ it has in place information-sharing agreements
with each of the Constituent Bitcoin Platforms; \76\ and it operates a
Benchmark Surveillance Program, over which the UK FCA has authority,
whereby it monitors for, investigates, and reports signs of
manipulation.\77\
---------------------------------------------------------------------------

\73\ See letter from CF Benchmarks, dated April 2021 (``CF
Benchmarks Letter'').
\74\ See id. at 2.
\75\ See id. at 3. The Benchmark Administrator further states
that the same Constituent Bitcoin Platforms are used to compute the
CME CF BRR, which it also administers, and which is used to settle
the bitcoin-USD futures contracts listed for trading on CME. See id.
at 2.
\76\ See id. at 2.
\77\ See id. at 4.
---------------------------------------------------------------------------

In addition, in its comment letter, the Benchmark Administrator
asserts that CME, in the course of operating and overseeing its bitcoin
futures market under the regulatory oversight of the Commodity Futures
Trading Commission (``CFTC''), has in place information-sharing
agreements with the Constituent Bitcoin Platforms for the purposes of
impeding and detecting any attempted manipulation of the futures
contracts, as they are the platforms from which trade data is gathered
to compute the CME CF BRR; \78\ and that given such agreements, ``this
would allow for [potentially manipulative acts to] be detected and
deterred by CME.'' \79\ The Benchmark Administrator further asserts
that, because the CME and BZX are both members of the ISG, BZX would
also have access to this information to allow for detection and
deterrence of manipulation should it occur.\80\
---------------------------------------------------------------------------

\78\ See id. at 2.
\79\ See id. at 7.
\80\ See id.
---------------------------------------------------------------------------

Simultaneously with the Exchange's and the Benchmark
Administrator's assertions regarding the Reference Rate, the Exchange
also states that, because the Trust will engage in in-kind creations
and redemptions only, the ``manipulability of the Reference Rate [is]
significantly less important.'' \81\ The Exchange elaborates further
that, ``because the Trust will not accept cash to buy bitcoin in order
to create new shares or . . . be forced to sell bitcoin to pay cash for
redeemed shares, the price that the Sponsor uses to value the Trust's
bitcoin is not particularly important.'' \82\ According to BZX, when
authorized participants create Shares with the Trust, they would need
to deliver a certain number of bitcoin per share (regardless of the
valuation used), and when they redeem with the Trust, they would
similarly expect to receive a certain number of bitcoin per share.\83\
As such, BZX argues that even if the price used to value the Trust's
bitcoin is manipulated, the ratio of bitcoin per Share does not change,
and the Trust will either accept (for creations) or distribute (for
redemptions) the same number of bitcoin regardless of the value.\84\
This, according to BZX, not only mitigates the risk associated with
potential manipulation, but also discourages and disincentivizes
manipulation of the Reference Rate because there is little financial
incentive to do so.\85\
---------------------------------------------------------------------------

\81\ See Notice, 86 FR at 19925.
\82\ See id.
\83\ See id.
\84\ See id.
\85\ See id.
---------------------------------------------------------------------------

Based on assertions made and the information provided, the
Commission can find no basis to conclude that BZX has articulated other
means to prevent fraud and manipulation that are sufficient to justify
dispensing with the requisite surveillance-sharing agreement. First,
the record does not demonstrate that the proposed methodology for
calculating the Reference Rate would make the proposed ETP resistant to
fraud or manipulation such that a surveillance-sharing agreement with a
regulated market of significant size is unnecessary. Specifically, the
Exchange has not assessed the possible influence that spot platforms
not included among the Constituent Bitcoin Platforms would have on
bitcoin prices used to calculate the Reference Rate.\86\ And as
discussed above, the record does not establish that the broader bitcoin
market is inherently and uniquely resistant to fraud and manipulation.
Accordingly, to the extent that trading on platforms not directly used
to calculate the Reference Rate affects prices on the Constituent
Bitcoin Platforms, the characteristics of those other platforms--where
various kinds of fraud and manipulation from a variety of sources may
be present and persist--affect whether the Reference Rate is resistant
to manipulation.
---------------------------------------------------------------------------

\86\ As discussed above, while the Exchange asserts that bitcoin
prices on platforms with wash trades or other activity intended to
manipulate the price of bitcoin do not influence the ``real'' price
of bitcoin, the Commission has no basis on which to conclude that
bitcoin platforms are insulated from prices of others that engage in
or permit fraud or manipulation. See supra note 56 and accompanying
text.
---------------------------------------------------------------------------

Moreover, the Exchange's assertions that the Reference Rate's
methodology helps make the Reference Rate resistant to manipulation are
contradicted by the Registration Statement's own statements.
Specifically, the Registration Statement states that ``[b]itcoin
[platforms] on which bitcoin trades . . . may be more exposed to fraud
and security breaches than established, regulated exchanges for other
financial assets or instruments, which could have a negative impact on
the performance of the Trust.'' \87\ Constituent Bitcoin Platforms are
a subset of the bitcoin platforms currently in existence. Although the
Sponsor raises concerns regarding fraud and security of bitcoin
platforms in the Registration Statement, the Exchange does not explain
how or why such concerns are consistent with its assertion that the
Reference Rate is resistant to fraud and manipulation.
---------------------------------------------------------------------------

\87\ See Registration Statement at 19.
---------------------------------------------------------------------------

BZX also has not shown that its proposed use of 12 equally-sized
time intervals of five minute length over the observation window
between 3:00 p.m. and 4:00 p.m. E.T. to calculate the Reference Rate
would effectively be able to eliminate fraudulent or manipulative
activity that is not transient. Fraud and manipulation in the bitcoin
spot market could persist for a ``significant duration.'' \88\ The
Exchange does not connect the use of such partitions to the duration of
the effects of the wash and fictitious trading that may exist in the
bitcoin spot market.\89\
---------------------------------------------------------------------------

\88\ See USBT Order, 85 FR at 12601 n.66; see also id. at 12607.
\89\ The Commission has previously considered and rejected
similar arguments about the valuation of bitcoin according to a
benchmark or reference price. See id.; SolidX Order, 82 FR at 16258;
Winklevoss Order, 83 FR at 37589-90.
---------------------------------------------------------------------------

The Commission thus concludes that the Exchange has not
demonstrated that its Reference Rate methodology makes the proposed ETP
resistant to manipulation. While the proposed procedures for
calculating the Reference Rate using only prices from the Constituent
Bitcoin Platforms are intended to provide some degree of protection
against attempts to manipulate the Reference Rate, these procedures are
not sufficient for the Commission to dispense with the

[[Page 69328]]

requisite surveillance-sharing agreement with a regulated market of
significant size.
Second, the Benchmark Administrator argues that its oversight of
the Reference Rate and the CME's information-sharing agreements with
the Constituent Bitcoin Platforms help to prevent fraud and
manipulation.\90\ However, the level of oversight of the Constituent
Bitcoin Platforms, whose trade flows contribute to the Reference Rate,
is not equivalent to the obligations, authority, and oversight of
national securities exchanges or futures exchanges and therefore is not
an appropriate substitute.\91\ National securities exchanges are
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.'' \92\ Moreover, national
securities exchanges must file proposed rules with the Commission
regarding certain material aspects of their operations,\93\ and the
Commission has the authority to disapprove any such rule that is not
consistent with the requirements of the Exchange Act.\94\ Thus,
national securities exchanges are subject to Commission oversight of,
among other things, their governance, membership qualifications,
trading rules, disciplinary procedures, recordkeeping, and fees.\95\
---------------------------------------------------------------------------

\90\ See CF Benchmarks Letter at 2-4.
\91\ See also USBT Order, 85 FR at 12603-05.
\92\ See 15 U.S.C. 78f(b)(5).
\93\ 17 CFR 240.19b-4(a)(6)(i).
\94\ 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 rules
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
(``DCMs'') (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.
\95\ See Winklevoss Order, 83 FR at 37597. The Commission notes
that the New York State Department of Financial Services
(``NYSDFS'') has issued ``guidance'' to supervised virtual currency
business entities, stating that these entities must ``implement
measures designed to effectively detect, prevent, and respond to
fraud, attempted fraud, and similar wrongdoing.'' See Maria T.
Vullo, 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/docs/legal/industry/il180207.pdf. The NYSDFS recognizes that its ``guidance is not
intended to limit the scope or applicability of any law or
regulation'' (id.), which would include the Exchange Act. Nothing in
the record evidences whether the Constituent Bitcoin Platforms have
complied with this NYSDFS guidance. Further, as stated previously,
there are substantial differences between the NYSDFS and the
Commission's regulation. AML and KYC policies and procedures, for
example, have been referenced in other bitcoin-based ETP proposals
as a purportedly alternative means by which such ETPs would be
uniquely resistant to manipulation. The Commission has previously
concluded that such AML and KYC policies and procedures do not serve
as a substitute for, and are not otherwise dispositive in the
analysis regarding the importance of, having a surveillance sharing
agreement with a regulated market of significant size relating to
bitcoin. For example, AML and KYC policies and procedures do not
substitute for the sharing of information about market trading
activity or clearing activity and do not substitute for regulation
of a national securities exchange. See USBT Order, 85 FR at 12603
n.101.
---------------------------------------------------------------------------

The Constituent Bitcoin Platforms, on the other hand, have none of
these requirements (none are registered as a national securities
exchange) \96\--even if they may have, as the Benchmark Administrator
asserts, AML/KYC compliance policies and prohibitions against wash
trading and fraudulent claims of trading volume.\97\ In addition,
although the Commission recognizes that the CFTC maintains some
jurisdiction over the bitcoin spot market, under the Commodity Exchange
Act, the CFTC does not have regulatory authority over bitcoin spot
trading platforms, including the Constituent Bitcoin Platforms.\98\
Except in certain limited circumstances, bitcoin spot trading platforms
are not required to register with the CFTC, and the CFTC does not set
standards for, approve the rules of, examine, or otherwise regulate
bitcoin spot markets.\99\ As the CFTC itself 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.'' \100\
---------------------------------------------------------------------------

\96\ See 15 U.S.C. 78e, 78f.
\97\ See CF Benchmarks Letter at 5.
\98\ See USBT Order, 85 FR at 12604.
\99\ See id.
\100\ See Winklevoss Order, 83 FR at 37599 n.288.
---------------------------------------------------------------------------

And while the Benchmark Administrator asserts that the CME has in
place information-sharing agreements with the Constituent Bitcoin
Platforms, it does not provide any information on the scope, terms, or
enforcement authority for such information-sharing agreements. Nor has
BZX put any information in the record as to whether and how it would
use or enforce such agreements. Moreover, such agreements are
contractual in nature and do not satisfy the regulatory requirements or
purposes of national securities exchanges and the Exchange Act. The CME
(and the CFTC, as discussed above) does not have regulatory authority
over the spot bitcoin trading platforms,\101\ and, while the CME is
regulated by the CFTC, the CFTC's regulations do not extend to the
Constituent Bitcoin Platforms by virtue of such contractual agreements.
---------------------------------------------------------------------------

\101\ See supra notes 98-100 and accompanying text.
---------------------------------------------------------------------------

In addition, although the Benchmark Administrator states that its
oversight of the Reference Rate helps prevent fraud and manipulation,
the oversight by the Benchmark Administrator does not represent a
unique measure to resist manipulation beyond mechanisms that exist in
securities or commodities markets. Other commodity-based and equity
index ETPs approved by the Commission for listing and trading utilize
reference rates or indices administered by similar benchmark
administrators,\102\ and the Commission has not, in those instances,
dispensed with the need for a surveillance-sharing agreement with a
significant regulated market.\103\
---------------------------------------------------------------------------

\102\ See, e.g., Securities Exchange Act Release Nos. 80840
(June 1, 2017) 82 FR 26534 (June 7, 2017) (SR-NYSEArca-2017-33)
(approving the listing and trading of shares of exchange traded
funds seeking to track the Solactive GLD EUR Gold Index, Solactive
GLD GBP Gold Index, and the Solactive GLD JPY Gold Index); and 83046
(Apr. 13, 2018) 83 FR 17462 (Apr. 19, 2018) (SR-Nasdaq-2018-012)
(approving the listing and trading of shares of an exchange-traded
fund that seeks to track an equity index, the CBOE Russell 2000 30-
Delta BuyWrite V2 Index).
\103\ See USBT Order, 85 FR at 12605. See also supra note 19.
---------------------------------------------------------------------------

Furthermore, the Benchmark Administrator does not itself exercise
governmental regulatory authority. Rather, the Benchmark Administrator
is a registered, privately-held company in England.\104\ The Benchmark
Administrator's relationship with the Constituent Bitcoin Platforms is
based on their participation in the determination of reference rates,
such as the Reference Rate. While the Benchmark Administrator is
regulated

[[Page 69329]]

by the UK FCA as a benchmark administrator, the UK FCA's regulations do
not extend to the Constituent Bitcoin Platforms by virtue of their
trade prices serving as input data underlying the Reference Rate.\105\
---------------------------------------------------------------------------

\104\ See https://blog.cfbenchmarks.com/legal/ (stating that the
Benchmark Administrator is authorized and regulated by the UK FCA as
a registered Benchmark Administrator (FRN 847100) under the EU
benchmark regulation, and further noting that the Benchmark
Administrator is a member of the Crypto Facilities group of
companies which is in turn a member of the Payward, Inc. group of
companies, and Payward, Inc. is the owner and operator of the Kraken
Exchange, a venue that facilitates the trading of cryptocurrencies).
The Commission notes that the Kraken is one of the Constituent
Bitcoin Platforms underlying the Reference Rate.
\105\ See USBT Order, 85 FR at 12604. The Benchmark
Administrator is also not required to apply certain provisions of EU
benchmark regulation to the Constituent Bitcoin Platforms because
the Reference Rate's input data is not ``contributed.'' See
Benchmark Statement, at 5 available at https://docs-cfbenchmarks.s3.amazonaws.com/CME+CF+Benchmark+Statement.pdf.
---------------------------------------------------------------------------

Further, the oversight performed by the Benchmark Administrator of
the Constituent Bitcoin Platforms is for the purpose of ensuring the
accuracy and integrity of the Reference Rate.\106\ Such oversight
serves a fundamentally different purpose as compared to the regulation
of national securities exchanges and the requirements of the Exchange
Act. While the Commission recognizes that this may be an important
function in ensuring the integrity of the Reference Rate, such
requirements do not imbue either the Benchmark Administrator or the
Constituent Bitcoin Platforms with regulatory authority similar to that
the Exchange Act confers upon self-regulatory organizations such as
national securities exchanges.\107\
---------------------------------------------------------------------------

\106\ See supra note 72 and accompanying text.
\107\ See 15 U.S.C. 78f(b).
---------------------------------------------------------------------------

And although the Benchmark Administrator states that it has
information-sharing agreements with each Constituent Bitcoin Platform,
it does not describe the scope of such agreements or what authority the
Benchmark Administrator would have to compel the platforms' compliance
with such agreements. Moreover, even assuming that the Constituent
Bitcoin Platforms are as vigilant towards fraud and manipulation as the
Benchmark Administrator describes, neither the Exchange nor the
Benchmark Administrator attempts to establish that only the Constituent
Bitcoin Platforms' ability to detect and deter fraud and manipulation
would matter, exclusive of other bitcoin spot markets. In other words,
neither addresses how fraud and manipulation on other bitcoin spot
markets may influence the price of bitcoin.
Third, the Exchange does not explain the significance of the
Reference Rate's purported resistance to manipulation to the overall
analysis of whether the proposal to list and trade the Shares is
designed to prevent fraud and manipulation. Even assuming that the
Exchange's argument is that, if the Reference Rate is resistant to
manipulation, the Trust's NAV, and thereby the Shares as well, would be
resistant to manipulation, the Exchange has not established in the
record a basis for such conclusion. That assumption aside, the
Commission notes that the Shares would trade at market-based prices in
the secondary market, not at NAV, which then raises the question of the
significance of the NAV calculation to the manipulation of the
Shares.\108\
---------------------------------------------------------------------------

\108\ One commenter states that BZX's statement that the price
used to value the Trust's bitcoin ``is not particularly important''
focuses on the primary market and transactions with authorized
participants. The commenter asserts that, for secondary market
participants (e.g., retail investors), the price source used by the
Sponsor should be viewed as important because the ETP's value (i.e.,
its NAV) ``has a relationship to the secondary market trading price,
including for market makers and other liquidity participants in
determining ET[P] pricing levels with respect to order flow, as well
as for calculating premiums/discounts between NAV and the secondary
market price.'' The commenter asserts that this is true for any ETP
in the marketplace, but ``arguably the price source is even more
important for a bitcoin ET[P]'' given the number of platforms
worldwide where bitcoin is traded, the price differences between
them, and the Commission's concerns regarding potential bitcoin
price manipulation. See letter from Global Digital Finance, dated
August 9, 2021 (``GDF Letter''), at 6. The commenter, however,
provides no further information on the relationship between NAV and
secondary market prices in general, nor specifically in the context
of ETPs with only in-kind create/redeem processes, nor how market
makers or other liquidity participants would use NAV to determine
such an ETP's ``pricing levels with respect to order flow.'' As for
the assertion that the price source is even more important for
bitcoin ETPs because of the number of platforms and the price
differences between them, the commenter does not elaborate further
and does not explain why the opposite conclusion is not equally
valid--that the price source (i.e., the Constituent Bitcoin
Platforms) is less important in light of other bitcoin platforms
with different prices.
---------------------------------------------------------------------------

Fourth, the Exchange's arguments are contradictory. While arguing
that the Reference Rate is resistant to manipulation, the Exchange
simultaneously downplays the importance of the Reference Rate in light
of the Trust's in-kind creation and redemption mechanism.\109\ The
Exchange points out that the Trust will create and redeem Shares in-
kind, not in cash, which renders the NAV calculation, and thereby the
ability to manipulate NAV, ``significantly less important.'' \110\ In
BZX's own words, the Trust will not accept cash to buy bitcoin in order
to create shares or sell bitcoin to pay cash for redeemed shares, so
the price that the Sponsor uses to value the Trust's bitcoin ``is not
particularly important.'' \111\ If the Reference Rate that the Trust
uses to value the Trust's bitcoin ``is not particularly important,'' it
follows that the Reference Rate's resistance to manipulation is not
material to the Shares' susceptibility to fraud and manipulation. As
the Exchange does not address or provide any analysis with respect to
these issues, the Commission cannot conclude that the Reference Rate
aids in the determination that the proposal to list and trade the
Shares is designed to prevent fraudulent and manipulative acts and
practices.
---------------------------------------------------------------------------

\109\ See supra notes 81-85 and accompanying text.
\110\ See Notice, 86 FR at 19925 (``While the Sponsor believes
that the Reference Rate which it uses to value the Trust's bitcoin
is itself resistant to manipulation based on the methodology further
described below, the fact that creations and redemptions are only
available in-kind makes the manipulability of the Reference Rate
significantly less important.'').
\111\ See id. (concluding that ``because the Trust will not
accept cash to buy bitcoin in order to create new shares or, barring
a forced redemption of the Trust or under other extraordinary
circumstances, be forced to sell bitcoin to pay cash for redeemed
shares, the price that the Sponsor uses to value the Trust's bitcoin
is not particularly important.'').
---------------------------------------------------------------------------

Finally, the Commission finds that BZX has not demonstrated that
in-kind creations and redemptions provide the Shares with a unique
resistance to manipulation. The Commission has previously addressed
similar assertions.\112\ As the Commission stated before, in-kind
creations and redemptions are a common feature of ETPs, and the
Commission has not previously relied on the in-kind creation and
redemption mechanism as a basis for excusing exchanges that list ETPs
from entering into surveillance-sharing agreements with significant,
regulated markets related to the portfolio's assets.\113\ Accordingly,
the Commission is not persuaded here that the Trust's in-kind creations
and redemptions afford it a unique resistance to manipulation.\114\
---------------------------------------------------------------------------

\112\ See Winklevoss Order, 83 FR at 37589-90; USBT Order, 85 FR
at 12607-08.
\113\ See, e.g., iShares COMEX Gold Trust, Securities Exchange
Act Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751-55 (Jan. 26,
2005) (SR-Amex-2004-38); iShares Silver Trust, Securities Exchange
Act Release No. 53521 (Mar. 20, 2006), 71 FR 14969, 14974 (Mar. 24,
2006) (SR-Amex-2005-072).
\114\ Putting aside the Exchange's various assertions about the
nature of bitcoin and the bitcoin market, the Reference Rate, and
the Shares, the Exchange also does not address concerns the
Commission has previously identified, including the susceptibility
of bitcoin markets to potential trading on material, non-public
information (such as plans of market participants to significantly
increase or decrease their holdings in bitcoin; new sources of
demand for bitcoin; the decision of a bitcoin-based investment
vehicle on how to respond to a ``fork'' in the bitcoin blockchain,
which would create two different, non-interchangeable types of
bitcoin), or to the dissemination of false or misleading
information. See Winklevoss Order, 83 FR at 37585. See also USBT
Order, 85 FR at 12600-01.

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

[[Page 69330]]

(2) Assertions That BZX Has Entered Into a Comprehensive Surveillance-
Sharing Agreement With a Regulated Market of Significant Size
As BZX has not demonstrated that other means besides surveillance-
sharing agreements will be sufficient to prevent fraudulent and
manipulative acts and practices, the Commission next examines whether
the record supports the conclusion that BZX has entered into a
comprehensive surveillance-sharing agreement with a regulated market of
significant size relating to the underlying assets. In this context,
the term ``market of significant size'' includes a market (or group of
markets) as to which (i) 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 in detecting and deterring misconduct,
and (ii) it is unlikely that trading in the ETP would be the
predominant influence on prices in that market.\115\
---------------------------------------------------------------------------

\115\ See Winklevoss Order, 83 FR at 37594. 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 provides guidance to market
participants. See id.
---------------------------------------------------------------------------

As the Commission has stated in the past, it considers two markets
that are members of the ISG to have a comprehensive surveillance-
sharing agreement with one another, even if they do not have a separate
bilateral surveillance-sharing agreement.\116\ Accordingly, based on
the common membership of BZX and the CME in the ISG,\117\ BZX has the
equivalent of a comprehensive surveillance-sharing agreement with CME.
However, while the Commission recognizes that the CFTC regulates the
CME futures market,\118\ including the CME bitcoin futures market, and
thus such market is ``regulated,'' in the context of the proposed ETP,
the record does not, as explained further below, establish that the CME
bitcoin futures market is a ``market of significant size'' as that term
is used in the context of the applicable standard here.\119\
---------------------------------------------------------------------------

\116\ See id. at 37580 n.19.
\117\ See Notice, 86 FR at 19924 n.60 and accompanying text.
\118\ While the Commission recognizes that the CFTC regulates
the CME, the CFTC is not responsible for direct, comprehensive
regulation of the underlying bitcoin spot market. See Winklevoss
Order, 83 FR at 37587, 37599. See also supra notes 98-100 and
accompanying text.
\119\ A commenter asserts that CME, Bakkt, and Crypto Facilities
are the only venues that offer bitcoin futures trading under
``relevant capital markets regulation.'' See CF Benchmarks Letter at
6. BZX, however, argues only that the CME is a regulated market of
significant size. In addition, as described above (see supra notes
91-100 and accompanying text), in the context of the proposed ETP,
the Constituent Bitcoin Platforms are not ``regulated.'' They are
not registered as ``exchanges'' and lack the obligations, authority,
and oversight of national securities exchanges. Thus the Commission
limits the scope of its analysis to CME.
---------------------------------------------------------------------------

(i) Whether There Is a Reasonable Likelihood That a Person Attempting
To Manipulate the ETP Would Also Have To Trade on the CME Bitcoin
Futures Market To Successfully Manipulate the ETP
The first prong in establishing whether the CME bitcoin futures
market constitutes a ``market of significant size'' is the
determination that there is a reasonable likelihood that a person
attempting to manipulate the ETP would have to trade on the CME bitcoin
futures market to successfully manipulate the ETP.
BZX notes that the CME began to offer trading in bitcoin futures in
2017.\120\ According to BZX, nearly every measurable metric related to
CME bitcoin futures contracts, which trade and settle like other cash-
settled commodity futures contracts, has ``trended consistently up
since launch and/or accelerated upward in the past year.'' \121\ For
example, according to BZX, there was approximately $28 billion in
trading in CME bitcoin futures in December 2020 compared to $737
million, $1.4 billion, and $3.9 billion in total trading in December
2017, December 2018, and December 2019, respectively.\122\
Additionally, CME bitcoin futures traded over $1.2 billion per day in
December 2020 and represented $1.6 billion in open interest compared to
$115 million in December 2019.\123\ Similarly, BZX contends that the
number of large open interest holders \124\ has continued to increase,
even as the price of bitcoin has risen, as have the number of unique
accounts trading CME bitcoin futures.\125\
---------------------------------------------------------------------------

\120\ According to BZX, each contract represents five bitcoin
and is based on the CME CF BRR. See Notice, 86 FR at 19922.
\121\ See id.
\122\ See id.
\123\ See id.
\124\ BZX represents that a large open interest holder in CME
bitcoin futures is an entity that holds at least 25 contracts, which
is the equivalent of 125 bitcoin. According to BZX, at a price of
approximately $30,000 per bitcoin on December 31, 2020, more than 80
firms had outstanding positions of greater than $3.8 million in CME
bitcoin futures. See id. at 19922 n.54.
\125\ See id. at 19922.
---------------------------------------------------------------------------

BZX argues that the significant growth in CME bitcoin futures
across each of trading volumes, open interest, large open interest
holders, and total market participants since the USBT Order was issued
is reflective of that market's growing influence on the spot price. BZX
asserts that where CME bitcoin futures lead the price in the spot
market such that a potential manipulator of the bitcoin spot market
(beyond just the Constituent Bitcoin Platforms) would have to
participate in the CME bitcoin futures market, it follows that a
potential manipulator of the Shares would similarly have to transact in
the CME bitcoin futures market.\126\
---------------------------------------------------------------------------

\126\ See id. at 19924, 19929.
---------------------------------------------------------------------------

BZX further states that academic research corroborates the overall
trend outlined above and supports the thesis that CME bitcoin futures
pricing leads the spot market. BZX asserts that academic research
demonstrates that the CME bitcoin futures market was already leading
the spot price in 2018 and 2019.\127\ BZX concludes that a person
attempting to manipulate the Shares would also have to trade on that
market to manipulate the ETP.\128\
---------------------------------------------------------------------------

\127\ See id. at 19923 & n.55 (citing Y. Hu, Y. Hou & L. Oxley,
What role do futures markets play in Bitcoin pricing? Causality,
cointegration and price discovery from a time-varying perspective,
72 Int'l Rev. of Fin. Analysis 101569 (2020) (available at: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7481826/) (``Hu, Hou &
Oxley'')).
\128\ See id. at 19923.
---------------------------------------------------------------------------

The Commission disagrees. The record does not demonstrate that
there is a reasonable likelihood that a person attempting to manipulate
the proposed ETP would have to trade on the CME bitcoin futures market
to successfully manipulate it. Specifically, BZX's assertions about the
general upward trends from 2018 to February 2021 in trading volume and
open interest of, and in the number of large open interest holders and
number of unique accounts trading in, CME bitcoin futures do not
establish that the CME bitcoin futures market is of significant size.
As the Commission has previously articulated, the interpretation of the
term ``market of significant size'' or ``significant market'' depends
on the interrelationship between the market with which the listing
exchange has a surveillance-sharing agreement and the proposed
ETP.\129\ BZX's recitation of data reflecting the size of the CME
bitcoin futures market, alone, either currently or in relation to
previous years, is not sufficient to establish an interrelationship
between the CME bitcoin futures market and the proposed ETP.\130\
---------------------------------------------------------------------------

\129\ See USBT Order, 85 FR at 12611.
\130\ See id. at 12612.
---------------------------------------------------------------------------

Further, the evidence in the record for this proposal also does not
support a conclusion that the CME bitcoin futures market leads the
bitcoin spot market in such a manner that the CME bitcoin

[[Page 69331]]

futures market is a ``market of significant size.'' As the Commission
has previously explained, establishing a lead-lag relationship between
the bitcoin futures market and the spot market is ``central to
understanding whether it is reasonably likely that a would-be
manipulator of the ETP would need to trade on the bitcoin futures
market to successfully manipulate prices on those spot platforms that
feed into the proposed ETP's pricing mechanism.'' \131\ The Commission
has previously stated that, in particular, if the spot market leads the
futures market, this would indicate that it would not be necessary to
trade on the futures market to manipulate the proposed ETP, because the
futures price would move to meet the spot price.\132\
---------------------------------------------------------------------------

\131\ See id.
\132\ See id.
---------------------------------------------------------------------------

While BZX states that CME bitcoin futures pricing leads the spot
market,\133\ it relies on the findings of a price discovery analysis in
one section of a single academic paper to support the overall
thesis.\134\ However, the findings of that paper's Granger causality
analysis, which is widely used to formally test for lead-lag
relationships, are concededly mixed.\135\ In addition, the Commission
considered an unpublished version of the paper in the USBT Order, as
well as a comment letter submitted by the authors on that record.\136\
In the USBT Order, as part of the Commission's conclusion that ``mixed
results'' in academic studies failed to demonstrate that the CME
bitcoin futures market constitutes a market of significant size, the
Commission noted the paper's inconclusive evidence that CME bitcoin
futures prices lead spot prices--in particular that the months at the
end of the paper's sample period showed that the spot market was the
leading market--and stated that the record did not include evidence to
explain why this would not indicate a shift towards prices in the spot
market leading the futures market that would be expected to persist
into the future.\137\ The Commission also stated that the paper's use
of daily price data, as opposed to intraday prices, may not be able to
distinguish which market incorporates new information faster.\138\ BZX
has not addressed either issue.
---------------------------------------------------------------------------

\133\ See Notice, 86 FR at 19923.
\134\ See supra note 127 and accompanying text. BZX references
the following conclusion from the ``time-varying price discovery''
section of Hu, Hou & Oxley: ``There exist no episodes where the
Bitcoin spot markets dominates the price discovery processes with
regard to Bitcoin futures. This points to a conclusion that the
price formation originates solely in the Bitcoin futures market. We
can, therefore, conclude that the Bitcoin futures markets dominate
the dynamic price discovery process based upon time-varying
information share measures. Overall, price discovery seems to occur
in the Bitcoin futures markets rather than the underlying spot
market based upon a time-varying perspective . . .'' See Notice, 86
FR at 19923 n.55.
\135\ The paper finds that the CME bitcoin futures market
dominates the spot markets in terms of Granger causality, but that
the causal relationship is bi-directional, and a Granger causality
episode from March 2019 to June/July 2019 runs from bitcoin spot
prices to CME bitcoin futures prices. The paper concludes: ``[T]he
Granger causality episodes are not constant throughout the whole
sample period. Via our causality detection methods, market
participants can identify when markets are being led by futures
prices and when they might not be.'' See Hu, Hou & Oxley, supra note
127.
\136\ See USBT Order, 85 FR at 12609.
\137\ See id. at 12613 n.244.
\138\ See id.
---------------------------------------------------------------------------

Moreover, BZX does not provide results of its own analysis and does
not present any other data supporting its conclusion. BZX's unsupported
representations constitute an insufficient basis for approving a
proposed rule change in circumstances where, as here, the Exchange's
assertion would form such an integral role in the Commission's analysis
and the assertion is subject to several challenges.\139\ In this
context, BZX's reliance on a single paper, whose own lead-lag results
are inconclusive, is especially lacking because the academic literature
on the lead-lag relationship and price discovery between bitcoin spot
and futures markets is unsettled.\140\ In the USBT Order, the
Commission responded to multiple academic papers that were cited and
concluded that, in light of the mixed results found, the exchange there
had not demonstrated that it is reasonably likely that a would-be
manipulator of the proposed ETP would transact on the CME bitcoin
futures market.\141\ Likewise, here, given the body of academic
literature to indicate to the contrary, the Commission concludes that
the information that BZX provides is not a sufficient basis to support
a determination that it is reasonably likely that a would-be
manipulator of the proposed ETP would have to trade on the CME bitcoin
futures market.\142\
---------------------------------------------------------------------------

\139\ See Susquehanna, 866 F.3d at 447.
\140\ See, e.g., D. Baur & T. Dimpfl, Price discovery in bitcoin
spot or futures?, 39 J. Futures Mkts. 803 (2019) (finding that the
bitcoin spot market leads price discovery); O. Entrop, B. Frijns &
M. Seruset, The determinants of price discovery on bitcoin markets,
40 J. Futures Mkts. 816 (2020) (finding that price discovery
measures vary significantly over time without one market being
clearly dominant over the other); J. Hung, H. Liu & J. Yang, Trading
activity and price discovery in Bitcoin futures markets, 62 J.
Empirical Finance 107 (2021) (finding that the bitcoin spot market
dominates price discovery); B. Kapar & J. Olmo, An analysis of price
discovery between Bitcoin futures and spot markets, 174 Econ.
Letters 62 (2019) (finding that bitcoin futures dominate price
discovery); E. Akyildirim, S. Corbet, P. Katsiampa, N. Kellard & A.
Sensoy, The development of Bitcoin futures: Exploring the
interactions between cryptocurrency derivatives, 34 Fin. Res.
Letters 101234 (2020) (finding that bitcoin futures dominate price
discovery); A. Fassas, S. Papadamou, & A. Koulis, Price discovery in
bitcoin futures, 52 Res. Int'l Bus. Fin. 101116 (2020) (finding that
bitcoin futures play a more important role in price discovery)
(``Fassas et al''); S. Aleti & B. Mizrach, Bitcoin spot and futures
market microstructure, 41 J. Futures Mkts. 194 (2021) (finding that
relatively more price discovery occurs on the CME as compared to
four spot exchanges); J. Wu, K. Xu, X. Zheng & J. Chen, Fractional
cointegration in bitcoin spot and futures markets, 41 J. Futures
Mkts. 1478 (2021) (finding that CME bitcoin futures dominate price
discovery). See also C. Alexander & D. Heck, Price discovery in
Bitcoin: The impact of unregulated markets, 50 J. Financial
Stability 100776 (2020) (finding that, in a multi-dimensional
setting, including the main price leaders within futures,
perpetuals, and spot markets, CME bitcoin futures have a very minor
effect on price discovery; and that faster speed of adjustment and
information absorption occurs on the unregulated spot and
derivatives platforms than on CME bitcoin futures) (``Alexander &
Heck'').
\141\ See USBT Order, 85 FR at 12613 nn.239-244 and accompanying
text.
\142\ In addition, the Exchange fails to address the lead-lag
relationship (if any) between prices on other bitcoin futures
markets and the CME bitcoin futures market, the bitcoin spot market,
and/or the particular Constituent Bitcoin Platforms, or where price
formation occurs when the entirety of bitcoin futures markets, not
just CME, is considered.
---------------------------------------------------------------------------

The Benchmark Administrator, in a comment letter, also asserts that
a body of research from both academic and commercial sources ``has
amply demonstrated that price discovery for bitcoin is largely achieved
through the CME BTC-USD futures market as opposed to the spot
markets,'' and that such conclusions ``have not been widely challenged
in the academic literature.'' \143\ This commenter argues that the
combination of (1) the CME bitcoin futures market leading price
formation, (2) the CME bitcoin futures market constituting a
``significant proportion'' of the bitcoin futures

[[Page 69332]]

market,\144\ (3) the Constituent Bitcoin Platforms accounting for a
``significant proportion'' of the bitcoin spot markets,\145\ (4) the
Trust striking its NAV to the Reference Rate, which is calculated using
transaction data from the Constituent Bitcoin Platforms, and (5) the
Shares being traded by authorized participants who will use the CME
bitcoin futures market and underlying bitcoin spot markets as
``liquidity rails'' for pricing and arbitrage, means that any attempted
manipulator of the Trust will have to undertake trading on both the CME
and at least one, likely more than one, of the five Constituent Bitcoin
Platforms to engage in potentially manipulative acts.\146\ The
commenter states that this demonstrates that the CME bitcoin futures
market can be considered a ``significant market.'' \147\
---------------------------------------------------------------------------

\143\ See CF Benchmarks Letter at 6 (citing Fassas et al and A.
Chang, W. Herrmann & W. Cai, Efficient Price Discovery in the
Bitcoin Markets, Wilshire Phoenix, Oct. 14, 2020 (``Wilshire
Phoenix'')). Another commenters also argues that the CME is a market
of significant size. See GDF Letter at 5. This commenter states that
there is ``no doubt'' that the CME represents a market of
significant size because, as of May 2021, it had the second-largest
amount of open interest, and represented roughly 15.5 percent of
total open interest in bitcoin futures. The commenter also
references the Wilshire Phoenix working paper which suggests that
the CME bitcoin futures market contribute more to price discovery
than its related spot markets. The commenter, however, also states
that ``the crypto markets do change rapidly,'' and cites Alexander &
Heck (see also supra note 140) for an opposing view that the CME
bitcoin futures contribute far less than spot markets to price
discovery. The Commission finds that this additional information is
not sufficient to establish that the CME is a market of
``significant size.'' As noted above, data reflecting the size of
the CME bitcoin futures market, alone, is not sufficient to
establish an interrelationship between the CME bitcoin futures
market and the proposed ETP, and the papers cited by the commenter
evidences the unsettled nature of the academic literature.
\144\ The commenter states that the CME accounts for
approximately 15 percent of all bitcoin futures open interest, and
asserts that, while it is difficult to ascertain what proportion of
the total bitcoin derivatives market is represented by CME, it is
likely that it constitutes significantly more than the 15 percent--
``very likely 30 percent plus''--of all bona fide bitcoin futures
trading. See CF Benchmarks Letter at 6.
\145\ The commenter states that, although difficult to fully
verify due to the distributed nature of cryptocurrency trading and
the difficulting identifying bona fide trading volumes, the BTC-USD
markets of the Constituent Bitcoin Platforms constitute roughly 76
percent of all BTC-USD trading from cryptocurrency trading platforms
whose volumes are publicly available during the period January 2020-
March 2021. The commenter further estimates that the Constituent
Bitcoin Platforms account for 15 percent of all bitcoin trading and
``very likely 25 percent plus'' of all bona fide bitcoin trading
conducted on trading platforms. See id. at 4-5.
\146\ See id. at 7.
\147\ See id.
---------------------------------------------------------------------------

The Commission does not agree. The Commission has already addressed
and rejected three of these assertions--that CME bitcoin futures lead
price discovery,\148\ the size of the CME bitcoin futures market,\149\
and the relevance of using the Reference Rate to compute NAV.\150\ As
with the size of the CME market, data reflecting the size of the
Constituent Bitcoin Platforms as a proportion of all bitcoin spot
trading also does not help to establish an interrelationship between
the CME bitcoin futures market and the proposed ETP. Nor does it
establish how fraud and manipulation on other bitcoin spot markets may
influence the price of bitcoin. Finally, the commenter assumes, without
any supporting evidence, that authorized participants will use the CME
bitcoin futures market (as well as underlying bitcoin spot market)
``for pricing and arbitrage.'' Even assuming the commenter is correct
that authorized participants would transact on bitcoin futures markets,
the commenter does not explain why they would transact on the CME
rather than on any other bitcoin futures markets.
---------------------------------------------------------------------------

\148\ See supra notes 134-142 and accompanying text.
\149\ See supra notes 129-130 and accompanying text.
\150\ See supra notes 86-111 and accompanying text.
---------------------------------------------------------------------------

The Commission accordingly concludes that the information provided
in the record does not establish a reasonable likelihood that a would-
be manipulator of the proposed ETP would have to trade on the CME
bitcoin futures market to successfully manipulate the proposed ETP.
Therefore, the information in the record also does not establish that
the CME bitcoin futures market is a ``market of significant size'' with
respect to the proposed ETP.
(ii) Whether It Is Unlikely That Trading in the Proposed ETP Would Be
the Predominant Influence on Prices in the CME Bitcoin Futures Market
The second prong in establishing whether the CME bitcoin futures
market constitutes a ``market of significant size'' is the
determination that it is unlikely that trading in the proposed ETP
would be the predominant influence on prices in the CME bitcoin futures
market.\151\
---------------------------------------------------------------------------

\151\ See Winklevoss Order, 83 FR at 37594; USBT Order, 85 FR at
12596-97.
---------------------------------------------------------------------------

BZX asserts that trading in the Shares would not be the predominant
force on prices in the CME bitcoin futures market (or spot market)
because of the significant volume in the CME bitcoin futures market,
the size of bitcoin's market capitalization, which is approximately $1
trillion, and the significant liquidity available in the spot
market.\152\ BZX provides that, according to February 2021 data, the
cost to buy or sell $5 million worth of bitcoin averages roughly 10
basis points with a market impact of 30 basis points.\153\ For a $10
million market order, the cost to buy or sell is roughly 20 basis
points with a market impact of 50 basis points. Stated another way, BZX
states that a market participant could enter a market buy or sell order
for $10 million of bitcoin and only move the market 0.5 percent.\154\
BZX further asserts that more strategic purchases or sales (such as
using limit orders and executing through OTC bitcoin trade desks) would
likely have less obvious impact on the market, which is consistent with
MicroStrategy, Tesla, and Square being able to collectively purchase
billions of dollars in bitcoin.\155\ Thus, BZX concludes that the
combination of CME bitcoin futures leading price discovery, the overall
size of the bitcoin market, and the ability for market participants
(including authorized participants creating and redeeming in-kind with
the Trust) to buy or sell large amounts of bitcoin without significant
market impact, will help prevent the Shares from becoming the
predominant force on pricing in either the bitcoin spot or the CME
bitcoin futures market.\156\
---------------------------------------------------------------------------

\152\ See Notice, 86 FR at 19925.
\153\ See id. According to BZX, these statistics are based on
samples of bitcoin liquidity in U.S. dollars (excluding stablecoins
or Euro liquidity) based on executable quotes on Coinbase Pro,
Gemini, Bitstamp, Kraken, LMAX Exchange, BinanceUS, and OKCoin
during February 2021. See id. nn.64-65.
\154\ See id. at 19925.
\155\ See id.
\156\ See id.
---------------------------------------------------------------------------

The Commission does not agree. The record does not demonstrate that
it is unlikely that trading in the proposed ETP would be the
predominant influence on prices in the CME bitcoin futures market. As
the Commission has already addressed and rejected one of the bases of
BZX's assertion--that CME bitcoin futures leads price discovery \157\--
it will only address below the other two bases: The overall size of,
and the impact of buys and sells on, the bitcoin market.
---------------------------------------------------------------------------

\157\ See supra notes 134-142 and accompanying text.
---------------------------------------------------------------------------

BZX's assertions about the potential effect of trading in the
Shares on the CME bitcoin futures market and bitcoin spot market are
general and conclusory, repeating the aforementioned trade volume of
the CME bitcoin futures market and the size and liquidity of the
bitcoin spot market, as well as the market impact of a large
transaction, without any analysis or evidence to support these
assertions. For example, there is no limit on the amount of mined
bitcoin that the Trust may hold. Yet BZX does not provide any
information on the expected growth in the size of the Trust and the
resultant increase in the amount of bitcoin held by the Trust over
time, or on the overall expected number, size, and frequency of
creations and redemptions--or how any of the foregoing could (if at
all) influence prices in the CME bitcoin futures market. Moreover, in
the Trust's Registration Statement, the Sponsor acknowledges that the
Trust may acquire large size positions in bitcoin, which would increase
the risk of illiquidity in the underlying bitcoin. Specifically, the
Sponsor, in the Registration Statement, states that the Trust may
acquire large size positions in bitcoin, which will increase the risk
of illiquidity by both making the positions more difficult to liquidate
and increasing the losses incurred while

[[Page 69333]]

trying to do so, or by making it more difficult for authorized
participants to acquire or liquidate bitcoin as part of the creation
and/or redemption of Shares of the Trust.\158\ Although the Trust's
Registration Statement concedes that the Trust could negatively affect
the liquidity of bitcoin, BZX does not address this in the proposal or
discuss how impacting the liquidity of bitcoin can be consistent with
the assertion that the Shares are unlikely to be the predominant
influence on the prices of the CME bitcoin futures market. Thus, the
Commission cannot conclude, based on BZX's statements alone and absent
any evidence or analysis in support of BZX's assertions, that it is
unlikely that trading in the ETP would be the predominant influence on
prices in the CME bitcoin futures market.
---------------------------------------------------------------------------

\158\ See Registration Statement at 32.
---------------------------------------------------------------------------

The Commission also is not persuaded by BZX's assertions about the
minimal effect a large market order to buy or sell bitcoin would have
on the bitcoin market.\159\ While BZX concludes by way of a $10 million
market order example that buying or selling large amounts of bitcoin
would have insignificant market impact, the conclusion does not analyze
the extent of any impact on the CME bitcoin futures market. Even
assuming that BZX is suggesting that a single $10 million order in
bitcoin would have immaterial impact on the prices in the CME bitcoin
futures market, this prong of the ``market of significant size''
determination concerns the influence on prices from trading in the
proposed ETP, which is broader than just trading by the proposed ETP.
While authorized participants of the Trust might only transact in the
bitcoin spot market as part of their creation or redemption of Shares,
the Shares themselves would be traded in the secondary market on BZX.
The record does not discuss the expected number or trading volume of
the Shares, or establish the potential effect of the Shares' trade
prices on CME bitcoin futures prices. For example, BZX does not provide
any data or analysis about the potential effect the quotations or trade
prices of the Shares might have on market-maker quotations in CME
bitcoin futures contracts and whether those effects would constitute a
predominant influence on the prices of those futures contracts.
---------------------------------------------------------------------------

\159\ See Notice, 86 FR at 19929 (``For a $10 million market
order, the cost to buy or sell is roughly 20 basis points with a
market impact of 50 basis points. Stated another way, a market
participant could enter a market buy or sell order for $10 million
of bitcoin and only move the market 0.5%.'').
---------------------------------------------------------------------------

Thus, because BZX has not provided sufficient information to
establish both prongs of the ``market of significant size''
determination, the Commission cannot conclude that the CME bitcoin
futures market is a ``market of significant size'' such that BZX would
be able to rely on a surveillance-sharing agreement with the CME to
provide sufficient protection against fraudulent and manipulative acts
and practices.
The requirements of Section 6(b)(5) of the Exchange Act apply to
the rules of national securities exchanges. Accordingly, the relevant
obligation for a comprehensive surveillance-sharing agreement with a
regulated market of significant size, or other means to prevent
fraudulent and manipulative acts and practices that are sufficient to
justify dispensing with the requisite surveillance-sharing agreement,
resides with the listing exchange. Because there is insufficient
evidence in the record demonstrating that BZX has satisfied this
obligation, the Commission cannot approve the proposed ETP for listing
and trading on BZX.

C. Whether BZX Has Met Its Burden To Demonstrate That the Proposal Is
Designed To Protect Investors and the Public Interest

BZX contends that, if approved, the proposed ETP would protect
investors and the public interest. However, the Commission must
consider these potential benefits in the broader context of whether the
proposal meets each of the applicable requirements of the Exchange
Act.\160\ 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.
---------------------------------------------------------------------------

\160\ See Winklevoss Order, 83 FR at 37602. See also
GraniteShares Order, 83 FR at 43931; ProShares Order, 83 FR at
43941; USBT Order, 85 FR at 12615.
---------------------------------------------------------------------------

BZX asserts that, with the growth of U.S. investor exposure to
bitcoin through OTC bitcoin funds, so too has grown the potential risk
to U.S. investors.\161\ Specifically, BZX argues that premium and
discount volatility, high fees, insufficient disclosures, and technical
hurdles are putting U.S. investor money at risk on a daily basis and
that such risk could potentially be eliminated through access to a
bitcoin ETP.\162\ As such, the Exchange believes that approving this
proposal (and comparable proposals submitted hereafter) would give U.S.
investors access to bitcoin in a regulated and transparent exchange-
traded vehicle that would act to limit risk to U.S. investors by: (i)
Reducing premium and discount volatility; (ii) reducing management fees
through meaningful competition; (iii) providing an alternative to
custodying spot bitcoin; and (iv) reducing risks associated with
investing in operating companies that are imperfect proxies for bitcoin
exposure.\163\
---------------------------------------------------------------------------

\161\ See Notice, 86 FR at 19920.
\162\ See id. BZX states that while it understands the
Commission's previous focus on potential manipulation of a bitcoin
ETP in prior disapproval orders, it now believes that ``such
concerns have been sufficiently mitigated and that the growing and
quantifiable investor protection concerns should be the central
consideration as the Commission reviews this proposal.'' See id.
\163\ See id.
---------------------------------------------------------------------------

According to BZX, OTC bitcoin funds are generally designed to
provide exposure to bitcoin in a manner similar to the Shares. However,
unlike the Shares, BZX states that ``OTC bitcoin funds are unable to
freely offer creation and redemption in a way that incentivizes market
participants to keep their shares trading in line with their NAV and,
as such, frequently trade at a price that is out-of-line with the value
of their assets held.'' \164\ BZX represents that, historically, OTC
bitcoin funds have traded at a significant premium to NAV.\165\
Although the Exchange concedes that trading at a premium (or
potentially a discount) is not unique to OTC bitcoin funds and not
inherently problematic, BZX believes that it raises certain investor
protections issues. First, according to BZX, investors are buying
shares of a fund for a price that is not reflective of the per share
value of the fund's underlying assets.\166\ Second, according to BZX,
because only accredited investors, generally, are able to create or
redeem shares with the issuing trust and can buy or sell shares
directly with the trust at NAV (in exchange for either cash or bitcoin)
without having to pay the premium or sell into the discount, these
investors that are allowed to interact directly with the trust are able
to hedge their bitcoin exposure as needed to satisfy holding

[[Page 69334]]

requirements and collect on the premium or discount opportunity. BZX
argues, therefore, that the premium in OTC bitcoin funds essentially
creates a direct payment from retail investors to more sophisticated
investors.\167\
---------------------------------------------------------------------------

\164\ See id. BZX also states that, unlike the Shares, because
OTC bitcoin funds are not listed on an exchange, they are not
subject to the same transparency and regulatory oversight by a
listing exchange. BZX further asserts that the existence of a
surveillance-sharing agreement between BZX and the CME bitcoin
futures market would result in increased investor protections for
the Shares compared to OTC bitcoin funds. See id. at 19920 n.39.
\165\ See id. at 19920. BZX further represents that the
inability to trade in line with NAV may at some point result in OTC
bitcoin funds trading at a discount to their NAV. According to BZX,
while that has not historically been the case, trading at a discount
would give rise to nearly identical potential issues related to
trading at a premium. See id. at 19920 n.40.
\166\ See id. at 19920.
\167\ See id. at 19921.
---------------------------------------------------------------------------

One commenter expresses support for the approval of bitcoin ETPs
because they believe such ETPs would have lower premium/discount
volatility and lower management fees than an OTC bitcoin fund.\168\
Another commenter asserts that the reality is that many U.S. investors
are investing in products overseas, which complicates U.S. regulatory
reach, or investing in U.S. bitcoin products that have historically
exhibited significant premiums or discounts to net asset value, among
other issues; and that to the extent that U.S. investors are able to
use U.S. regulated products, that should increase investor
protection.\169\
---------------------------------------------------------------------------

\168\ See letter from Anonymous, dated June 17, 2021
(``Anonymous Letter'').
\169\ See GDF Letter at 4.
---------------------------------------------------------------------------

BZX also asserts that exposure to bitcoin through an ETP also
presents advantages for retail investors compared to buying spot
bitcoin directly.\170\ BZX asserts that, without the advantages of an
ETP, an individual retail investor holding bitcoin through a
cryptocurrency trading platform lacks protections.\171\ BZX explains
that, typically, retail platforms hold most, if not all, retail
investors' bitcoin in ``hot'' (internet-connected) storage and do not
make any commitments to indemnify retail investors or to observe any
particular cybersecurity standard.\172\ Meanwhile, a retail investor
holding spot bitcoin directly in a self-hosted wallet may suffer from
inexperience in private key management (e.g., insufficient password
protection, lost key, etc.), which could cause them to lose some or all
of their bitcoin holdings.\173\ BZX represents that the Bitcoin
Custodian would, by contrast, use ``cold'' (offline) storage to hold
private keys, employ a certain degree of cybersecurity measures and
operational best practices, be highly experienced in bitcoin custody,
and be accountable for failures.\174\ In addition, BZX explains that
retail investors would be able to hold the Shares in traditional
brokerage accounts, which provide SIPC protection if a brokerage firm
fails.\175\ Thus, with respect to custody of the Trust's bitcoin
assets, BZX concludes that, compared to owning spot bitcoin directly,
the Trust presents advantages from an investment protection standpoint
for retail investors.\176\
---------------------------------------------------------------------------

\170\ See Notice, 86 FR at 19921.
\171\ See id.
\172\ See id.
\173\ See id.
\174\ See id.
\175\ See id.
\176\ See id. One commeter agrees that there are certain
advantages, particularly for ``average'' and first-time crypto
investors, to bitcoin ETPs, including not having to secure keys or
digital wallets, and greater protection from online hacking or theft
if funds are secured offline in cold storage. See GDF Letter at 1-2.
Another commenter is a NYSDFS-chartered trust company for purposes
of providing non-discretionary fiduciary custody of digital assets.
This commenter agrees that regulated, secure custodial solutions
exist in the marketplace to support the Trust's operations. The
commenter states that NYSDFS subjects it to additional controls
tailored to the risks presented by digital asset custody, including
robust review of its wallet environment, capitalization, AML
procedures, confidentiality, security, and storage architecture. The
commenter states that its cold storage solution is the same
architecture used by its affiliated trading platform, is built on
best practices across both cyber and physical security, and has not
lost any customer funds due to a security breach over the past eight
years. The commenter specifies that this solution employs
proprietary key generation ceremonies, a geographically distributed
network of vaults to store the keys, and multiple levels of
technical and protocol-specific consensus and security requirements.
According to the commenter, it offers broad and deep digital asset
insurance, and is regularly audited by major financial and security
audit firms. See letter from Coinbase Custody Trust Company, LLC,
dated May 7, 2021.
---------------------------------------------------------------------------

BZX further asserts that a number of operating companies engaged in
unrelated businesses have announced investments as large as $1.5
billion in bitcoin.\177\ Without access to bitcoin ETPs, BZX argues
that retail investors seeking investment exposure to bitcoin may
purchase shares in these companies in order to gain the exposure to
bitcoin that they seek.\178\ BZX contends that such operating
companies, however, are imperfect bitcoin proxies and provide investors
with partial bitcoin exposure paired with additional risks associated
with whichever operating company they decide to purchase. BZX concludes
that investors seeking bitcoin exposure through publicly traded
companies are gaining only partial exposure to bitcoin and are not
fully benefitting from the risk disclosures and associated investor
protections that come from the securities registration process.\179\
---------------------------------------------------------------------------

\177\ See Notice, 86 FR at 19921.
\178\ See id.
\179\ See id. at 19922.
---------------------------------------------------------------------------

BZX also states that investors in many other countries, including
Canada, are able to use more traditional exchange-listed and traded
products to gain exposure to bitcoin, disadvantaging U.S. investors and
leaving them with more risky means of getting bitcoin exposure.\180\
---------------------------------------------------------------------------

\180\ See id. at 19920. BZX represents that the Purpose Bitcoin
ETF, a retail bitcoin-based ETP launched in Canada, reportedly
reached $421.8 million in assets under management in two days,
demonstrating the demand for a North American market listed bitcoin
ETP. BZX contends that the Purpose Bitcoin ETF also offers a class
of units that is U.S. dollar denominated, which could appeal to U.S.
investors. BZX also argues that without an approved bitcoin ETP in
the U.S. as a viable alternative, U.S. investors could seek to
purchase these shares in order to get access to bitcoin exposure.
BZX believes that, given the separate regulatory regime and the
potential difficulties associated with any international litigation,
such an arrangement would create more risk exposure for U.S.
investors than they would otherwise have with a U.S. exchange-listed
ETP. See id. at 19920 n.37. BZX also notes that regulators in other
countries have either approved or otherwise allowed the listing and
trading of bitcoin-based ETPs. See id. at 19920 n.38.
---------------------------------------------------------------------------

In essence, BZX asserts that the risky nature of direct investment
in the underlying bitcoin and the unregulated markets on which bitcoin
and OTC bitcoin funds trade compel approval of the proposed rule
change. BZX, however, offers no limiting principle to this argument,
under which, by logical extension, the Commission would be required to
approve the listing and trading of any ETP that arguably presents
marginally less risk to investors than a direct investment in the
underlying asset or in an OTC-traded product.
The Commission disagrees with this reading of the Exchange Act.
Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must
approve a proposed rule change filed by a national securities exchange
if it finds that the proposed rule change is consistent with the
applicable requirements of the Exchange Act--including the requirement
under Section 6(b)(5) that the rules of a national securities exchange
be designed to prevent fraudulent and manipulative acts and practices--
and it must disapprove the filing if it does not make such a
finding.\181\ Thus, even if a proposed rule change purports to protect
investors from a particular type of investment risk--such as the
susceptibility of an asset to loss or theft--the proposed rule change
may still fail to meet the requirements under the Exchange Act.\182\
---------------------------------------------------------------------------

\181\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\182\ See SolidX Order, 82 FR at 16259.
---------------------------------------------------------------------------

Here, even if it were true that, compared to trading in unregulated
bitcoin spot markets, trading a bitcoin-based ETP on a national
securities exchange provides some additional protection to investors,
the Commission must consider this potential benefit in the broader
context of whether the proposal meets each of the applicable
requirements of the Exchange Act.\183\ As explained above, for bitcoin-
based ETPs, the Commission has consistently

[[Page 69335]]

required that the listing exchange have a comprehensive surveillance-
sharing agreement with a regulated market of significant size related
to bitcoin, or demonstrate that other means to prevent fraudulent and
manipulative acts and practices are sufficient to justify dispensing
with the requisite surveillance-sharing agreement. The listing exchange
has not met that requirement here. Therefore, the Commission is unable
to find that the proposed rule change is consistent with the statutory
standard.
---------------------------------------------------------------------------

\183\ See supra note 160.
---------------------------------------------------------------------------

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.\184\
---------------------------------------------------------------------------

\184\ See 15 U.S.C. 78s(b)(2)(C).
---------------------------------------------------------------------------

For the reasons discussed above, BZX has not met its burden of
demonstrating that the proposal is consistent with Exchange Act Section
6(b)(5),\185\ and, accordingly, the Commission must disapprove the
proposal.\186\
---------------------------------------------------------------------------

\185\ 15 U.S.C. 78f(b)(5).
\186\ In disapproving the proposed rule change, the Commission
has considered its impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f). A commenter argues, for efficiency
reasons, against approving a bitcoin ETP. This commenter asserts
that the adoption of multiple digital assets would force merchants
to deal with ``complexity [that] doesn't foster [the] modularity
which is needed to gain economic efficiency.'' See Ciao Letter 3 at
1. For the reasons discussed throughout, however, see supra note 37,
the Commission is disapproving the proposed rule change because it
does not find that the proposed rule change is consistent with the
Exchange Act. See also USBT Order, 85 FR at 12615.
---------------------------------------------------------------------------

D. Other Comments

Comment letters also address the general nature and uses of
bitcoin; \187\ the state of development of bitcoin as a digital asset;
\188\ the state of regulation of bitcoin markets; \189\ the inherent
value of, and risks of investing in, bitcoin; \190\ the desire of
investors to gain access to bitcoin through an ETP; \191\ the potential
impact of Commission approval of the proposed ETP on the price of
bitcoin and on bitcoin markets; \192\ the potential impact of
Commission approval of bitcoin ETPs on the economy, U.S. monetary
policy, U.S. innovation, and/or U.S. geopolitical position; \193\ the
tax and/or retirement investment benefits or risks of a bitcoin ETP;
\194\ and the bitcoin network's effect on the environment.\195\
Ultimately, however, additional discussion of these topics is
unnecessary, as they do not bear on the basis for the Commission's
decision to disapprove the proposal.
---------------------------------------------------------------------------

\187\ See, e.g., Ciao Letter 3; Patel Letter; letters from:
Lourdes Ciao, dated June 2, 2021 (``Ciao Letter 1''); Lourdes Ciao,
dated June 2, 2021 (``Ciao Letter 2'').
\188\ See, e.g., GDF Letter.
\189\ See, e.g., GDF Letter; letter from Douglas Slemmer, dated
July 23, 2021 (``Slemmer Letter'').
\190\ See, e.g., Ciao Letter 1; Ciao Letter 3; Patel Letter;
Slemmer Letter; letters from: Sam Ahn, dated April 12, 2021; Bradley
M. Kuhn, dated April 25, 2021 (``Kuhn Letter'').
\191\ See, e.g., Kuhn Letter; GDF Letter.
\192\ See, e.g., GDF Letter.
\193\ See, e.g., Ciao Letter 1; Ciao Letter 2; Ciao Letter 3.
\194\ See, e.g., Kuhn Letter; Ciao Letter 2; Ciao Letter 3.
\195\ See, e.g., Patel Letter.
---------------------------------------------------------------------------

IV. Conclusion

For the reasons set forth above, the Commission does not find,
pursuant to Section 19(b)(2) of the Exchange Act, that the proposed
rule change is consistent with the requirements of the Exchange Act and
the rules and regulations thereunder applicable to a national
securities exchange, and in particular, with Section 6(b)(5) of the
Exchange Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act, that proposed rule change SR-CboeBZX-2021-024 be, and
hereby is, disapproved.

By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-26442 Filed 12-6-21; 8:45 am]
BILLING CODE 8011-01-P

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