Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order Disapproving a Proposed Rule Change To List and Trade Shares of the Kryptoin Bitcoin ETF Trust Under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares, 74166-74180 [2021-28255]
Download as PDF
<![CDATA[
74166
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
Importantly, the Exchange has also
stated that extending the temporary
relief provided in SR–Phlx–2020–53
immediately upon filing and without a
30-day operative delay will allow the
Exchange to continue critical
adjudicatory and review processes in a
reasonable and fair manner and meet its
critical investor protection goals, while
also following best practices with
respect to the health and safety of its
employees.17 The Commission also
notes that this proposal extends without
change the temporary relief previously
provided by SR–Phlx–2020–53.18 As
proposed, the temporary changes would
be in place through March 31, 2022 and
the amended rules will revert back to
their original state at the conclusion of
the temporary relief period and, if
applicable, any extension thereof.19 For
these reasons, the Commission believes
that waiver of the 30-day operative
delay for this proposal is consistent
with the protection of investors and the
public interest. Accordingly, the
Commission hereby waives the 30-day
operative delay and designates the
proposal operative upon filing.20
At any time within 60 days of the
filing of the proposed rule change, the
Commission summarily may
temporarily suspend such rule change if
it appears to the Commission that such
action is necessary or appropriate in the
public interest, for the protection of
investors, or otherwise in furtherance of
the purposes of the Act. If the
Commission takes such action, the
Commission shall institute proceedings
to determine whether the proposed rule
should be approved or disapproved.
IV. Solicitation of Comments
khammond on DSKJM1Z7X2PROD with NOTICES
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
17 See FINRA Filing, 86 FR 71695, 71696 (noting
the same in granting FINRA’s request to waive the
30-day operative delay so that SR–FINRA–2021–
031 would become operative immediately upon
filing).
18 See supra note 6.
19 See supra note 4. As noted above, the Exchange
states that if it requires temporary relief from the
rule requirements identified in this proposal
beyond March 31, 2022, it may submit a separate
rule filing to extend the effectiveness of the
temporary relief under these rules.
20 For purposes only of waiving the 30-day
operative delay, the Commission has considered the
proposed rule change’s impact on efficiency,
competition, and capital formation. See 15 U.S.C.
78c(f).
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
Phlx–2021–75 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number SR–Phlx–2021–75. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549, on official
business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of the
filing also will be available for
inspection and copying at the principal
office of the Exchange. All comments
received will be posted without change.
Persons submitting comments are
cautioned that we do not redact or edit
personal identifying information from
comment submissions. You should
submit only information that you wish
to make available publicly. All
submissions should refer to File
Number SR–Phlx–2021–75 and should
be submitted on or before January 19,
2022.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.21
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021–28248 Filed 12–28–21; 8:45 am]
BILLING CODE 8011–01–P
21 17
PO 00000
CFR 200.30–3(a)(12).
Frm 00104
Fmt 4703
Sfmt 4703
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–93860; File No. SR–
CboeBZX–2021–029]
Self-Regulatory Organizations; Cboe
BZX Exchange, Inc.; Order
Disapproving a Proposed Rule Change
To List and Trade Shares of the
Kryptoin Bitcoin ETF Trust Under BZX
Rule 14.11(e)(4), Commodity-Based
Trust Shares
December 22, 2021.
I. Introduction
On April 9, 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 Kryptoin
Bitcoin ETF 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 28, 2021.3
On June 9, 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 23,
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), and in particular, the
requirement that the rules of a national
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Securities Exchange Act Release No. 91646
(Apr. 22, 2021), 86 FR 22485 (‘‘Notice’’). Comments
on the proposed rule change can be found at:
https://www.sec.gov/comments/sr-cboebzx-2021029/srcboebzx2021029.htm.
4 15 U.S.C. 78s(b)(2).
5 See Securities Exchange Act Release No. 92131,
86 FR 31772 (June 15, 2021).
6 15 U.S.C. 78s(b)(2)(B).
7 See Securities Exchange Act Release No. 92476,
86 FR 40883 (July 29, 2021).
8 See Securities Exchange Act Release No. 93175,
86 FR 55092 (Oct. 5, 2021).
2 17
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
securities 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
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 22485.
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’’); 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, Securities Exchange Act Release No.
93700 (Dec. 1, 2021), 86 FR 69322 (Dec. 7, 2021)
(SR–CboeBZX–2021–024) (‘‘WisdomTree 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) (SR–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).
khammond on DSKJM1Z7X2PROD with NOTICES
10 Bitcoins
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
related to the underlying or reference
bitcoin assets.12
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
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).
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
PO 00000
Frm 00105
Fmt 4703
Sfmt 4703
74167
agreement must be entered into with a
‘‘significant market’’ to assist in
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
‘‘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.
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 (‘‘ADRs’’)). 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’’).
E:\FR\FM\29DEN1.SGM
29DEN1
74168
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
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.22 No
listing exchange has satisfied its burden
to make such demonstration.23
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.24 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,25
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.26
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
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 USBT Order, 85 FR at 12597.
23 See supra note 11.
24 See Notice, 86 FR at 22495.
25 See id. at 22491–92.
26 See id. at 22492.
khammond on DSKJM1Z7X2PROD with NOTICES
21 See
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
central consideration of the
Commission.27 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.28
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.29
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
27 See
id. at 22487–88, 22491, 22495–96.
id. at 22491, 22495.
29 See id. at 22487.
28 See
PO 00000
Frm 00106
Fmt 4703
Sfmt 4703
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 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,30 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.31
The investment objective of the Trust
is to provide exposure to bitcoin at a
price that is reflective of the actual
bitcoin market where investors purchase
and sell bitcoin, less the expense of the
Trust’s operations.32 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 U.S.
Settlement Price (‘‘Reference Rate’’).
The administrator of the Reference Rate
is CF Benchmarks Ltd. (‘‘Benchmark
Administrator’’). The Reference Rate
aggregates the trade flow of several
bitcoin spot platforms. The current
platform composition of the Reference
30 See Notice, supra note 3. See also Amendment
No. 2 to Registration Statement on Form S–1, dated
April 9, 2021, submitted to the Commission by
Kryptoin Investment Advisors, LLC (‘‘Sponsor’’) on
behalf of the Trust (‘‘Registration Statement’’).
31 Although the name of the Trust is the Kryptoin
Bitcoin ETF Trust, the Trust is a commodity-based
ETP. The Trust is not an exchange-traded fund, i.e.,
an ‘‘ETF,’’ registered under the Investment
Company Act of 1940, as amended (‘‘1940 Act’’),
and is not subject to regulation under the 1940 Act.
32 Delaware Trust Company is the trustee, and
The Bank of New York Mellon will be the
administrator (‘‘Administrator’’) and transfer agent.
Foreside Fund Services, LLC will be the marketing
agent in connection with the creation and
redemption of ‘‘baskets’’ of Shares, and the Sponsor
will provide assistance in the marketing of the
Shares. Gemini Trust Company, LLC, a third-party
custodian (‘‘Custodian’’), will be responsible for
custody of the Trust’s bitcoin. See Notice, 86 FR at
22485, 22492–93.
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
khammond on DSKJM1Z7X2PROD with NOTICES
Rate is Bitstamp, Coinbase, Gemini,
itBit, and Kraken. In calculating the
Reference Rate, the methodology creates
a joint list of certain trade prices and
sizes from the constituent platforms
between 3:00 p.m. E.T. and 4:00 p.m.
E.T. The methodology then divides this
list into 12 equally-sized time intervals
of five minutes, and it calculates the
volume-weighted median trade price for
each of those time intervals.33 The
Reference Rate is the arithmetic mean of
these 12 volume-weighted median trade
prices.34
Each Share represents a fractional
undivided beneficial interest in the
bitcoin held by the Trust. The Trust’s
assets will consist of bitcoin held by the
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.35
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. The
NAV of the Trust is the aggregate value
of the Trust’s assets less its liabilities
(which include estimated accrued but
unpaid fees and expenses). In
determining the Trust’s NAV, the
Administrator will value the bitcoin
held by the Trust on the basis of the
price of bitcoin as determined by the
Reference Rate.36
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.37
33 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 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 id. at 22493.
34 See id.
35 See id. at 22492.
36 See id. at 22494.
37 See id. at 22493.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
When the Trust sells or redeems its
Shares, it will do so in ‘‘in-kind’’
transactions in blocks of 50,000 Shares.
When creating the Shares, authorized
participants will deliver, or facilitate the
delivery of, bitcoin to the Trust’s
account with the Custodian in exchange
for the Shares, and, when redeeming the
Shares, the Trust, through the
Custodian, will deliver bitcoin to such
authorized participants.38
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.’’ 39
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.’’ 40
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,41 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
38 See
id.
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).
40 Rule 700(b)(3), Commission Rules of Practice,
17 CFR 201.700(b)(3).
41 See id.
39 15
PO 00000
Frm 00107
Fmt 4703
Sfmt 4703
74169
with the Exchange Act and the
applicable rules and regulations.42
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.43
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.44 Such
resistance to fraud and manipulation
must be novel and beyond those
protections that exist in traditional
commodities or securities markets.45
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.46 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.47 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
42 See
id.
43 Susquehanna
Int’l Group, LLP v. Securities and
Exchange Commission, 866 F.3d 442, 447 (D.C. Cir.
2017) (‘‘Susquehanna’’).
44 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.
45 See id. at 12597.
46 See Notice, 86 FR at 22491 n.55.
47 See id.
E:\FR\FM\29DEN1.SGM
29DEN1
74170
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
quotes that they deem non-executable.48
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.49 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.50 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.51
The Sponsor, in a comment letter,
states that it agrees with the Exchange’s
assertion that the bitcoin spot market is
resistant to price manipulation. The
Sponsor asserts that the trading of
bitcoin on hundreds of spot platforms in
geographically diverse locations, the
dispersed nature of market liquidity,
and the level of capital necessarily
deployed across these platforms render
an attempted manipulation of the global
bitcoin spot market ‘‘challenging and
highly unlikely, if not impossible.’’ 52
The Sponsor further states that there
exists a large presence of arbitrageurs in
the form of automated market makers
and high-frequency and algorithmic
trading firms established to specifically
seek profits by actively trading any
temporary dislocations in the bitcoin
price between trading venues, and that
any attempt to manipulate the price of
bitcoin where these firms are active
would require exceeding the liquidity
supply of these arbitrageurs that are
effectively eliminating any cross-market
pricing deviations.53
48 See
id.
id.
50 See id.
51 See id.
52 See letter from Jason Toussaint, Chief Executive
Officer, Kryptoin Investment Advisors, LLC, dated
August 19, 2021 (‘‘Kryptoin Letter’’), at 3.
53 See id. The Custodian, in a comment letter,
states that it believes that certain of the
Commission’s historical concerns about the bitcoin
markets are ameliorated by the growth of the overall
bitcoin market and related growth of regulated
bitcoin derivatives. See letter from Gemini Trust
Company, LLC, dated August 19, 2021 (‘‘Gemini
Letter’’), at 2. Another commenter, however, asserts
that the bitcoin network is the preferred network for
global criminals and is 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’’).
khammond on DSKJM1Z7X2PROD with NOTICES
49 See
VerDate Sep<11>2014
22:59 Dec 28, 2021
Jkt 256001
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. BZX and the Sponsor
assert 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. Neither the Exchange nor
the Sponsor, however, provides 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.54 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.55
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.56 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.57 Here, neither the
Exchange nor the Sponsor provides
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, neither the
Exchange nor the Sponsor takes 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
54 In addition, the Registration Statement states
that bitcoin spot platforms are not subject to the
same regulatory oversight as traditional equity
exchanges, which could negatively impact the
ability of authorized participants to implement
arbitrage mechanisms. See Registration Statement at
22. See also infra note 69 and accompanying text
(referencing statements made in the Registration
Statement that contradict assertions made by BZX).
55 See supra note 43.
56 See Winklevoss Order, 83 FR at 37586; SolidX
Order, 82 FR at 16256–57; USBT Order, 85 FR at
12601.
57 See, e.g., USBT Order, 85 FR at 12601.
PO 00000
Frm 00108
Fmt 4703
Sfmt 4703
market share to engage in
manipulation.58
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.59 However, without the
necessary data 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.60
Additionally, the continuous nature
of bitcoin trading does not eliminate
manipulation risk, and neither do
linkages among markets, as BZX
asserts.61 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
creates a false impression of supply or
demand.62
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.63 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
58 See, e.g., Winklevoss Order, 83 FR at 37584;
USBT Order, 85 FR at 12600–01. See also
Registration Statement at 10 (stating that, as of the
date of the Registration Statement, ‘‘the largest 100
bitcoin wallets held a substantial amount of the
outstanding supply of bitcoin and it is possible that
some of these wallets are controlled by the same
person or entity’’; that ‘‘it is possible that other
persons or entities control multiple wallets that
collectively hold a significant number of bitcoin,
even if each wallet individually only holds a small
amount’’; and that ‘‘[a]s a result of this
concentration of ownership, large sales by such
holders could have an adverse effect on the market
price of bitcoin.’’).
59 See Notice, 86 FR at 22491 n.55.
60 See USBT Order, 85 FR at 12601.
61 See Winklevoss Order, 83 FR at 37585 n.92 and
accompanying text.
62 See id. at 37585.
63 See Notice, 86 FR at 22492, 22496.
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
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.64
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.65 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.66 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
of fraud and manipulation in the bitcoin
spot market generally that the
Commission has raised in previous
orders, which have included (1) ‘‘wash’’
trading,67 (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
khammond on DSKJM1Z7X2PROD with NOTICES
64 See
id.
65 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 22492 n.61.
66 See USBT Order, 85 FR at 12601.
67 See supra notes 59–60 and accompanying text.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
74171
manipulation at bitcoin trading
platforms.68
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 the ‘‘price of bitcoin as determined
by the bitcoin market has experienced
periods of extreme volatility and may be
influenced by, among other things,
trading activity and the closing of
bitcoin trading platforms due to fraud,
failure, security breaches or otherwise’’;
that the bitcoin blockchain could be
vulnerable to a ‘‘51% attack,’’ in which
a bad actor or actors that control 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, that some bitcoin
platforms have been the victim of
cybercrimes, subject to cybersecurity
breaches, or ‘‘hacked,’’ resulting in
losses, and that ‘‘[n]o bitcoin [platform]
is immune from these risks’’; that
bitcoin platforms on which bitcoin trade
are relatively new and, in some cases,
largely unregulated, and, therefore, may
be more exposed to fraud and security
breaches than established, regulated
exchanges for other financial assets or
instruments; and that ‘‘[o]ver the past
several years, a number of bitcoin
[platforms] have been closed or faced
issues due to fraud, failure, security
breaches or governmental
regulations.’’ 69
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.70 The
Exchange states that the Reference Rate
is calculated based on the ‘‘Relevant
Transactions’’ 71 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.72 For each partition
separately, the volume-weighted median
trade price is calculated from the trade
prices and sizes of all Relevant
Transactions.73 The Reference Rate is
then determined by the arithmetic mean
of the volume-weighted medians of all
partitions.74 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.’’ 75 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.’’ 76
The Custodian, in a comment letter,
agrees that BZX’s choice of the
Reference Rate, which includes a
composite of bitcoin prices from
underlying spot bitcoin platforms,
including the Custodian’s platform, is a
further factor in support of the proposed
ETP.77 The Custodian asserts that it and
other ‘‘regulated digital asset
exchanges’’ and custodians have a
history of operations in compliance
with a regulatory framework developed
specifically to address activities in
digital assets, including guidance by the
New York State Department of Financial
Services (‘‘NYSDFS’’) regarding the
implementation of anti-fraud measures.
The Custodian states that it meets this
obligation through automated systems
and robust internal controls and
surveillance, and that the growing
sophistication of market surveillance
tools and strategies in the bitcoin market
68 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.
69 See Registration Statement at 1, 11, 13. See also
Winklevoss Order, 83 FR at 37585.
70 See Notice, 86 FR at 22492, 22497.
71 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 Bitcoin 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 22493 n.66.
72 See id. at 22493.
73 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.
74 See id.
75 See id.
76 See id.
77 See Gemini Letter at 2.
PO 00000
Frm 00109
Fmt 4703
Sfmt 4703
E:\FR\FM\29DEN1.SGM
29DEN1
74172
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
khammond on DSKJM1Z7X2PROD with NOTICES
as well as the growing proportion of
bitcoin activity occurring on ‘‘regulated
exchanges’’ is a key development to
mollify concerns about price
manipulation or other manipulative
practices in the bitcoin market.78 The
Sponsor, in a comment letter, states that
global bitcoin and cryptocurrency
markets are subject to increasing levels
of regulation, oversight, and
enforcement actions by global
governments and regulatory bodies.79
Simultaneously with these 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.’’ 80 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.’’ 81 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.82
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.83 This, according to BZX, not
only mitigates the risk associated with
potential manipulation, but also
discourages and disincentivizes
manipulation of the Reference Rate
78 See id. The Custodian also states that it is
registered with the Financial Crimes Enforcement
Network (‘‘FinCEN’’) as a money service business
and maintains money transmitter licenses (or the
statutory equivalent) in all states where this is
required. See Gemini Letter at 3 and infra note 98.
79 See Kryptoin Letter at 7. The Sponsor states
that in January 2019, the Singapore Government
enacted the Payment Services Act, bringing
cryptocurrency dealing or exchange services under
the supervision of the Monetary Authority of
Singapore, Singapore’s central bank and financial
regulator. See id. The Sponsor, however, provides
no data, information, or analysis as to how such
‘‘global governments and regulatory bodies’’ oversee
bitcoin markets in general, or the Constituent
Bitcoin Platforms in particular; or how any such
regulation makes the listing and trading of the
Shares inherently resistant to fraud and
manipulation.
80 See Notice, 86 FR at 22492.
81 See id.
82 See id.
83 See id.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
because there is little financial incentive
to do so.84
The Sponsor, in a comment letter,
agrees that the in-kind process by which
the Shares will be created and redeemed
makes the Shares inherently resistant to
manipulation. The Sponsor states that
the ‘‘creation and redemption of Trust
Shares through the in-kind exchange
mechanism is solely dependent on the
amount of bitcoin to be received or
delivered by the Trust and is completely
independent of the value of bitcoin at
that point in time.’’ 85 The Sponsor also
states that, in contrast to other OTC
bitcoin funds that receive cash from
investors and then purchase bitcoin in
the spot market, the size and timing of
which can contribute to the value of
these funds’ quoted prices deviating
from NAV, the Trust and its Shares will
not be subjected to this potential source
of NAV deviation.86 The Sponsor
further states that the fact that the
Trust’s expenses are paid in bitcoin, not
cash, makes these expense payments
‘‘completely independent of the value of
bitcoin or the Reference Rate,’’ which
mitigates the risk associated with
potential manipulation and discourages
manipulation of the Reference Rate
because there is little financial incentive
to do so.87
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.88 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.89
84 See
id.
Kryptoin Letter at 1–2.
86 See id. at 2.
87 See id. at 14.
88 The Commission has previously considered
and rejected similar arguments about the valuation
of bitcoin according to a benchmark or reference
price. See, e.g., SolidX Order, 82 FR at 16258;
Winklevoss Order, 83 FR at 37587–90; USBT Order,
85 FR at 12599–601.
89 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 or Reference Rate, the Commission has no
basis on which to conclude that bitcoin platforms
85 See
PO 00000
Frm 00110
Fmt 4703
Sfmt 4703
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.
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.’’ 90 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.’’ 91 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.92
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
are insulated from prices of others that engage in
or permit fraud or manipulation. See supra notes
59–60 and accompanying text.
90 See Registration Statement at 11.
91 See USBT Order, 85 FR at 12601 n.66; see also
id. at 12607.
92 See WisdomTree Order, 86 FR at 69327.
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
manipulate the Reference Rate, these
procedures are not sufficient for the
Commission to dispense with the
requisite surveillance-sharing agreement
with a regulated market of significant
size.
Second, the Custodian asserts that the
growing sophistication of market
surveillance tools and strategies used by
the Constituent Bitcoin Platforms, as
well as the growing proportion of
bitcoin activity occurring on ‘‘regulated
exchanges,’’ ‘‘mollify concerns about
price manipulation or other
manipulative practices.’’ 93 However,
the level of regulation on the
Constituent Bitcoin Platforms is not
equivalent to the obligations, authority,
and oversight of national securities
exchanges or futures exchanges and
therefore is not an appropriate
substitute.94 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.’’ 95 Moreover, national
securities exchanges must file proposed
rules with the Commission regarding
certain material aspects of their
operations,96 and the Commission has
the authority to disapprove any such
rule that is not consistent with the
requirements of the Exchange Act.97
Thus, national securities exchanges are
subject to Commission oversight of,
among other things, their governance,
membership qualifications, trading
93 See
Gemini Letter at 2.
also USBT Order, 85 FR at 12603–05.
95 See 15 U.S.C. 78f(b)(5).
96 17 CFR 240.19b–4(a)(6)(i).
97 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 Commodity Futures Trading Commission
(‘‘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.
khammond on DSKJM1Z7X2PROD with NOTICES
94 See
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
rules, disciplinary procedures,
recordkeeping, and fees.98
The Constituent Bitcoin Platforms, on
the other hand, have none of these
requirements (none are registered as a
national securities exchange).99 Further,
although the Custodian claims that the
Constituent Bitcoin Platforms have
market surveillance tools and strategies
that are growing in sophistication, the
Custodian provides no supporting
evidence to substantiate its claims.
Moreover, even assuming that the
Constituent Bitcoin Platforms are as
vigilant towards fraud and manipulation
as the Custodian describes, neither the
Exchange nor the Custodian 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
98 See Winklevoss Order, 83 FR at 37597. The
Commission notes that the 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 Reference Rate’s
Constituent Bitcoin Platforms have complied with
this NYSDFS guidance. Further, as stated
previously, there are substantial differences
between the NYSDFS and FinCEN versus the
Commission’s regulation. Anti-Money Laundering
(‘‘AML’’) and Know-Your-Customer (‘‘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.
99 See 15 U.S.C. 78e, 78f.
PO 00000
Frm 00111
Fmt 4703
Sfmt 4703
74173
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.
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.100 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.’’ 101 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.’’ 102 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.103 As neither
the Exchange nor the Sponsor addresses
or provides 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.
100 See
supra notes 80–84 and accompanying text.
Notice, 86 FR at 22492 (‘‘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.’’).
102 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.’’).
103 Similarly, the Sponsor asserts that the Trust
and the Shares are inherently resistant to
manipulation due to the in-kind create/redeem
process. See Kryptoin Letter at 1. Yet in the
Sponsor’s own words, the creation and redemption
of Shares is ‘‘completely independent’’ of the value
of bitcoin at that point in time, i.e., completely
independent of the Reference Rate and the Trust’s
NAV. See id. at 2. As such, going by the Sponsor’s
own assertion, it again follows that the Reference
Rate’s resistance to manipulation is not material to
the Shares’’ susceptibility to fraud and
manipulation.
101 See
E:\FR\FM\29DEN1.SGM
29DEN1
74174
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
khammond on DSKJM1Z7X2PROD with NOTICES
Fifth, the Commission finds that
neither BZX nor the Sponsor has
demonstrated that in-kind creations and
redemptions provide the Shares with a
unique resistance to manipulation.104
The Commission has previously
addressed similar assertions.105 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.106
Accordingly, the Commission is not
persuaded here that the Trust’s in-kind
creations and redemptions afford it a
unique resistance to manipulation.107
Finally, the Sponsor, in a comment
letter, cites to the Commission’s 2004
approval of the SPDR Gold Trust as
evidence that a combination of (1) a
deep and liquid spot market, (2) an
information-sharing agreement with a
commodity futures exchange, and (3)
exchange trading rules to govern the
trading of ETP shares by liquidity
104 The Sponsor asserts that the in-kind create/
redeem process provides for an arbitrage pricing
mechanism whereby authorized participants trade
the price deviations ‘‘between the Trust’s secondary
market prices and NAV,’’ keeping the Shares’’ price
‘‘at or near NAV’’ (emphasis added). See Kryptoin
Letter at 2. However, this assertion is also
contradicted by the Sponsor’s statement that the inkind create/redeem process means that the amount
of bitcoin that an authorized participant delivers to
or receives from the Trust is ‘‘completely
independent’’ of the value of bitcoin, i.e.,
completely independent of NAV and the Reference
Rate used to compute it. See id. Moreover, the
prerequisite of an efficient arbitrage mechanism is
not unique to the proposal here, as it is a
fundamental premise of any ETP or exchangetraded fund, and the Commission has not
previously dispensed with the requirement of a
surveillance-sharing agreement based on an
efficient arbitrage mechanism.
105 See Winklevoss Order, 83 FR at 37589–90;
USBT Order, 85 FR at 12607–08.
106 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).
107 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.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
providers, justify dispensing with the
requisite surveillance-sharing
agreement.108 The Sponsor states that
the spot bitcoin market is deep and
liquid; 109 that the Exchange is a
member of ISG, as is the CME that lists
bitcoin futures; and that the Exchange
has rules in place to govern the trading
of the Trust’s Shares.110 The Sponsor
concludes that, therefore, there is a solid
base of evidence to support the
Commission’s approval of the proposed
ETP.111
The Commission disagrees. The
Commission considered and discussed
the Gold Order at length in the
Winklevoss Order. While the Gold
Order observes that it is ‘‘not possible
. . . to enter into an information sharing
agreement with the OTC gold market,’’
the order continues: ‘‘Nevertheless, the
Commission believes that the unique
liquidity and depth of the gold market,
together with the MOU [Memorandum
of Understanding] with NYMEX (of
which COMEX is a Division) and NYSE
Rules 1300(b) and 1301, create the basis
for the [ETP listing exchange] to monitor
for fraudulent and manipulative
practices in the trading of the
Shares.’’ 112 Thus, even though the
Commission found that the OTC market
for gold was ‘‘extremely deep and
liquid,’’ 113 the Commission’s approval
of the first precious metal ETP expressly
relied on an agreement to share
surveillance information between the
ETP listing exchange and a significant,
regulated market for gold futures.114 The
Commission continues to maintain that
the Gold Order demonstrates the
importance of establishing an agreement
to share surveillance information
between the ETP listing exchange and a
significant, regulated market.115
108 See Kryptoin Letter at 13, citing Securities
Exchange Act Release No. 50604 (Oct. 28, 2004), 69
FR 64614 (Nov. 5, 2004) (‘‘Gold Order’’).
109 The Sponsor states that, for the six-month
period ending August 13, 2021, average daily spot
bitcoin trading volume across approximately 40
spot exchanges was $9.88 billion. The Sponsor
compares this to estimates in the Gold Order of the
2003 high average daily gold trading volume of $7.9
billion (19 million troy ounces) and low average of
$5.67 billion (13.6 million troy ounces). The
Sponsor believes that the bitcoin spot market
therefore meets, and exceeds, the Commission’s
‘‘definition’’ of an extremely deep and liquid
market. See id. at 4.
110 The Sponsor cites BZX Rule 14.11(e)(4)(G)
regarding the types of records and information that
registered market makers in Commodity-Based
Trust Shares must provide to the Exchange. See id.
at 13–14.
111 See id. at 13.
112 See Gold Order, 69 FR at 64619.
113 See id.
114 See Winklevoss Order, 83 FR at 37592–94.
115 See id. at 37594. The Commission further
stated that ‘‘[c]onsistent with the discussion of
‘significant market’ . . . , the Commission has not
PO 00000
Frm 00112
Fmt 4703
Sfmt 4703
Accordingly, having a surveillancesharing agreement with CME is not
sufficient—the Exchange must
demonstrate that CME is ‘‘a significant,
regulated market.’’
(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.116
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.117
Accordingly, based on the common
membership of BZX and CME in the
ISG,118 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,119 including the CME bitcoin
futures market, and thus such market is
‘‘regulated,’’ in the context of the
previously, and does not now, require that an ETP
listing exchange be able to enter into a surveillancesharing agreement with each regulated spot or
derivatives market relating to an underlying asset,
provided that the market or markets with which
there is such an agreement constitute a ‘significant
market’.’’ See id. at 37595.
116 See id. 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.
117 See id. at 37580 n.19.
118 See Notice, 86 FR at 22491 nn.56–57 and
accompanying text.
119 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.
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
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.120
khammond on DSKJM1Z7X2PROD with NOTICES
(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 2017.121
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.’’ 122 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.123 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
2019.124 Similarly, BZX contends that
the number of large open interest
holders 125 has continued to increase,
even as the price of bitcoin has risen, as
have the number of unique accounts
trading CME bitcoin futures.126
120 As described above (see supra notes 93–99
and accompanying text), in the context of the
proposed ETP, the Reference Rate’s 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 the CME.
121 According to BZX, each contract represents
five bitcoin and is based on the CME CF Bitcoin
Reference Rate. See Notice, 86 FR at 22489.
122 See id.
123 See id.
124 See id.
125 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 22490 n.51.
126 See id. at 22490.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
The Sponsor, in a comment letter,
adds that CME trading volume has
continued to increase substantially:
Increasing by approximately 220
percent in July 2021 versus July 2020;
increasing by approximately 156
percent year-to-date July 2021 versus
year-to-date July 2020; reaching a record
daily notional traded value of $7.33
billion on February 23, 2021, and a
record open interest value of $3.17
billion on February 19, 2021; and in the
six-month period ending August 13,
2021, reaching an average daily trading
volume of $2.20 billion and average
open interest of $1.98 billion.127 The
Sponsor states that this exceeds the
2003 average daily COMEX gold futures
trading volume of approximately $2.04
billion.128
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.129
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
2019.130 BZX concludes that a person
attempting to manipulate the Shares
would also have to trade on that market
to manipulate the ETP.131
The Sponsor, in a comment letter,
also argues that there is a reasonable
likelihood that a person attempting to
manipulate the Shares would also have
to trade on the CME to manipulate the
Shares.132 Citing Hu, Hou & Oxley as
evidence that CME bitcoin futures lead
the price in the bitcoin spot markets,133
127 See
Kryptoin Letter at 5.
id. at 4.
129 See Notice, 86 FR at 22491.
130 See id. at 22491, 22496 & n.52 (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’’)).
131 See id. at 22491–92, 22496.
132 See Kryptoin Letter at 12.
133 See id. at 11 n.22.
128 See
PO 00000
Frm 00113
Fmt 4703
Sfmt 4703
74175
the Sponsor states that an attempt to
manipulate the spot market would
require participation in the CME bitcoin
futures market.134 The Sponsor asserts
that it follows, then, that an attempted
manipulation of the Shares would
similarly require participation in the
CME bitcoin futures market, because
both the CME CF Bitcoin Real-Time
Index (‘‘BRTI’’) and the BRR, upon
which CME bitcoin futures are settled,
are calculated by observing prices in the
underlying spot bitcoin markets.135 The
Sponsor asserts that an interrelationship
between the CME bitcoin futures market
and the Trust exists because the Trust’s
Reference Rate is based materially on
the same methodology as the BRTI and
BRR,136 and therefore it is reasonable to
assume that any effort to manipulate the
Trust’s NAV or Share price would also
require an attempted manipulation of
the CME bitcoin futures prices.137 The
Sponsor concludes that, because both
the Exchange and the CME are members
of the ISG, such attempted misconduct
would be effectively detected and
deterred.138
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 and
the Sponsor’s assertions about the
general upward trends from 2018 to
August 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. While BZX and the
Sponsor provide data showing absolute
growth in the size of the CME bitcoin
futures market, they provide no data
relative to the concomitant growth in
either the bitcoin spot markets or other
bitcoin futures markets (including
unregulated futures markets). Moreover,
even if the CME has grown in relative
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.139 BZX’s recitation of
data reflecting the size of the CME
bitcoin futures market, alone, either
134 See
id. at 12.
id.
136 See id. at 2.
137 See id. at 2–3, 12.
138 See id. at 3, 12.
139 See USBT Order, 85 FR at 12611.
135 See
E:\FR\FM\29DEN1.SGM
29DEN1
74176
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
currently or in relation to previous
years, is not sufficient to establish an
interrelationship between the CME
bitcoin futures market and the proposed
ETP.140
Moreover, while the Sponsor asserts
that an interrelationship exists between
the CME bitcoin futures market and the
Trust, on account of the Trust’s
Reference Rate being based materially
on the same methodology as the BRTI
and BRR,141 and asserts that it is
therefore reasonable to assume that any
effort to manipulate the Trust’s NAV or
Share price would also require an
attempted manipulation of the CME
bitcoin futures prices,142 the Sponsor
provides no mechanism or example that
would demonstrate the accuracy of the
assumption. Moreover, as addressed
above, the Sponsor itself undermines
such an assumption by its own
recognition that the Trust’s in-kind
create/redeem process is ‘‘completely
independent’’ of the value of bitcoin,143
and thereby completely independent of
the Reference Rate used to compute
such a value.
Further, the econometric evidence in
the record for this proposal also does
not support a conclusion that an
interrelationship exists between the
CME bitcoin futures market and the
bitcoin spot market such that it is
reasonably likely that a person
attempting to manipulate the proposed
ETP would also have to trade on the
CME bitcoin futures market to
successfully manipulate the proposed
ETP.144 While BZX and the Sponsor
state that CME bitcoin futures pricing
leads the spot market,145 they rely on
the findings of a price discovery
analysis in one section of a single
academic paper to support the overall
thesis.146 However, the findings of that
140 See
id. at 12612.
Kryptoin Letter at 2.
142 See id. at 2–3, 12.
143 See id. at 2 and supra notes 100–104 and
accompanying text.
144 See USBT Order, 85 FR at 12611. Listing
exchanges have attempted to demonstrate such an
‘‘interrelationship’’ by presenting the results of
various econometric ‘‘lead-lag’’ analyses. The
Commission considers such analyses to be central
to understanding whether it is reasonably likely
that a would-be manipulator of the ETP would need
to trade on the CME bitcoin futures market. See id.
at 12612.
145 See Notice, 86 FR at 22491; Kryptoin Letter at
12.
146 See supra note 130 and accompanying text.
BZX and the Sponsor reference 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
khammond on DSKJM1Z7X2PROD with NOTICES
141 See
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
paper’s Granger causality analysis,
which is widely used to formally test for
lead-lag relationships, are concededly
mixed.147 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.148 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.149 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.150 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.151 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
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 22491 n.52; Kryptoin Letter at 11
n.22.
147 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 130.
148 See USBT Order, 85 FR at 12609.
149 See id. at 12613 n.244.
150 See id.
151 See Susquehanna, 866 F.3d at 447.
PO 00000
Frm 00114
Fmt 4703
Sfmt 4703
futures markets is unsettled.152 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 wouldbe manipulator of the proposed ETP
would transact on the CME bitcoin
futures market.153 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.154
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
152 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); S. Aleti & B. Mizrach,
Bitcoin spot and futures market microstructure, 41
J. Futures Mkts. 194 (2021) (finding that relatively
more price discovery occurs on 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).
153 See USBT Order, 85 FR at 12613 nn.239–244
and accompanying text.
154 In addition, the Exchange fails to address the
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.
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
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
khammond on DSKJM1Z7X2PROD with NOTICES
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.155
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.156 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.157 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.158 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.159 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
155 See Winklevoss Order, 83 FR at 37594; USBT
Order, 85 FR at 12596–97.
156 See Notice, 86 FR at 22492, 22496.
157 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. at 22492
n.61.
158 See id. at 22492, 22496.
159 See id.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
the CME bitcoin futures market.160 The
Sponsor agrees.161
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 162
—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
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.163 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
160 See
id.
161 See Kryptoin Letter at 12.
162 See supra notes 144–154 and accompanying
text.
163 See Registration Statement at 18.
PO 00000
Frm 00115
Fmt 4703
Sfmt 4703
74177
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.164 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.
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
164 See Notice, 86 FR at 22492, 22496 (‘‘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%.’’).
E:\FR\FM\29DEN1.SGM
29DEN1
74178
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
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
khammond on DSKJM1Z7X2PROD with NOTICES
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.165 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.166 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.167 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
165 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.
166 See Notice, 86 FR at 22487.
167 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.
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
are imperfect proxies for bitcoin
exposure.168
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.’’ 169 BZX represents
that, historically, OTC bitcoin funds
have traded at a significant premium to
NAV.170 Although the Exchange
concedes that trading at a premium or
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.171 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
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.172
One commenter expresses support for
the approval of bitcoin ETPs because
they believe such ETPs would have
168 See
id.
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 22487
n.38.
170 See id. at 22487. 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 22487 n.39.
171 See id. at 22488.
172 See id. The Sponsor, in a comment letter,
states that sophisticated market participants have
referred to this potential source of profit at the
expense of retail investors as a ‘‘free put option’’
embedded in the OTC bitcoin funds. See Kryptoin
Letter at 9.
lower premium/discount volatility and
lower management fees than an OTC
bitcoin fund.173 The Sponsor, in a
comment letter, states that on a year-todate basis through August 13, 2021, the
OTC bitcoin fund’s total return was
19.91 percent versus its NAV of 56.56
percent; and on a one-year basis through
August 13, 2021, the fund’s total return
was 192.7 percent versus its NAV return
of 288.6 percent.174 The Sponsor also
states that, because OTC bitcoin funds
are not listed on an exchange, they are
therefore not subject to the same
transparency and regulatory oversight
by a listing exchange as the Trust’s
Shares would be.175
BZX also asserts that exposure to
bitcoin through an ETP also presents
advantages for retail investors compared
to buying spot bitcoin directly.176 BZX
asserts that, without the advantages of
an ETP, an individual retail investor
holding bitcoin through a
cryptocurrency trading platform lacks
protections.177 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.178
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.179 BZX represents that the
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.180 Thus, with respect to
custody of the Trust’s bitcoin assets,
169 See
PO 00000
Frm 00116
Fmt 4703
Sfmt 4703
173 See letter from Anonymous, dated June 17,
2021.
174 See Kryptoin Letter at 8. In addition to the
premium/discount volatility’s direct investment
risk to retail investors, the Sponsor also points to
two additional risks of the OTC bitcoin fund: (1)
The inability to redeem or sell back shares to the
fund in exchange for bitcoin or cash means that
sophisticated investors who previously created
shares directly with the fund at NAV before its
shares began trading at a discount are now facing
potentially substantial and widespread capital
losses; and (2) because the fund periodically closes
and does not accept any further investment through
private placement, accredited and institutional
investors could be unable to deploy capital in
compliance with their investment mandates. See id.
at 9.
175 See id.
176 See Notice, 86 FR at 22488.
177 See id.
178 See id.
179 See id.
180 See id.
E:\FR\FM\29DEN1.SGM
29DEN1
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
BZX concludes that, compared to
owning spot bitcoin directly, the Trust
presents advantages from an investment
protection standpoint for retail
investors.181
The Custodian, in a comment letter,
echoes some of the descriptions of the
custodial arrangement.182 The
Custodian also specifies that its offline
‘‘cold’’ storage solution will hold the
Trust’s bitcoin in Hardware Security
Modules that have achieved the highest
security level of U.S. federal
government standards and that are
physically protected at the Custodian’s
network of secure facilities and that to
carry out a transfer from the Trust’s
account, a quorum of these secure
facilities must be involved to sign the
transaction.183 Also, according to the
Custodian, it maintains digital asset
insurance, is regularly audited by major
financial and audit firms, and is subject
to independent third-party verification
that the Custodian’s operations and
security compliance structures meet the
most robust of industry standards.184
The Sponsor, in a comment letter, adds
that the Custodian will perform its
duties in a manner that meets the
definition of a qualified custodian under
the Investment Advisers Act of 1940, as
amended.185
BZX further asserts that a number of
operating companies engaged in
unrelated businesses have announced
investments as large as $1.5 billion in
bitcoin.186 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.187 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.188
181 See
id.
Gemini Letter at 2–3.
183 See id.
184 See id.
185 See Kryptoin Letter at 10.
186 See Notice, 86 FR at 22487.
187 See id. at 22488–89. The Custodian, in its
comment letter, agrees that the proposed ETP
would offer greater investor protection and
transparency than existing alternatives for retail
customers to gain proxy exposure to bitcoin. See
Gemini Letter at 2.
188 See Notice, 86 FR at 22489.
khammond on DSKJM1Z7X2PROD with NOTICES
182 See
VerDate Sep<11>2014
20:20 Dec 28, 2021
Jkt 256001
74179
BZX also states that investors in many
Here, even if it were true that,
other countries, including Canada, are
compared to trading in unregulated
able to use more traditional exchangebitcoin spot markets, trading a bitcoinlisted and traded products to gain
based ETP on a national securities
exposure to bitcoin, disadvantaging U.S. exchange provides some additional
investors and leaving them with more
protection to investors, the Commission
risky means of getting bitcoin
must consider this potential benefit in
exposure.189 The Sponsor, in a comment the broader context of whether the
letter, states that obtaining bitcoin
proposal meets each of the applicable
exposure through CME bitcoin futures
requirements of the Exchange Act.193 As
‘‘generally remain[s] beyond the scope
explained above, for bitcoin-based ETPs,
of comfort level of retail investors’’
the Commission has consistently
because of, among other reasons, the
required that the listing exchange have
risk of margin calls. The Sponsor states
a comprehensive surveillance-sharing
that this risk is eliminated entirely in
agreement with a regulated market of
the case of investors holding nonsignificant size related to bitcoin, or
margin bitcoin investment alternatives,
demonstrate that other means to prevent
such as a bitcoin ETP.190
fraudulent and manipulative acts and
In essence, BZX asserts that the risky
practices are sufficient to justify
nature of direct investment in the
dispensing with the requisite
underlying bitcoin and the unregulated
surveillance-sharing agreement. The
markets on which bitcoin and OTC
listing exchange has not met that
bitcoin funds trade compel approval of
requirement here. Therefore the
the proposed rule change. The
Commission is unable to find that the
Commission disagrees. Pursuant to
proposed rule change is consistent with
Section 19(b)(2) of the Exchange Act,
the statutory standard.
the Commission must approve a
Pursuant to Section 19(b)(2) of the
proposed rule change filed by a national Exchange Act, the Commission must
securities exchange if it finds that the
disapprove a proposed rule change filed
proposed rule change is consistent with
by a national securities exchange if it
the applicable requirements of the
does not find that the proposed rule
Exchange Act—including the
change is consistent with the applicable
requirement under Section 6(b)(5) that
requirements of the Exchange Act—
the rules of a national securities
including the requirement under
exchange be designed to prevent
Section 6(b)(5) that the rules of a
fraudulent and manipulative acts and
national securities exchange be
practices—and it must disapprove the
designed to prevent fraudulent and
filing if it does not make such a
manipulative acts and practices.194
finding.191 Thus, even if a proposed rule
For the reasons discussed above, BZX
change purports to protect investors
has not met its burden of demonstrating
from a particular type of investment
that the proposal is consistent with
risk—such as the susceptibility of an
Exchange Act Section 6(b)(5),195 and,
asset to loss or theft—the proposed rule
accordingly, the Commission must
change may still fail to meet the
disapprove the proposal.196
requirements under the Exchange
Act.192
D. Other Comments
189 See id. at 22487. 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 22487 n.36.
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
22487 n.37.
190 See Kryptoin Letter at 10.
191 See Exchange Act Section 19(b)(2)(C), 15
U.S.C. 78s(b)(2)(C).
192 See SolidX Order, 82 FR at 16259;
WisdomTree Order, 86 FR at 69334.
PO 00000
Frm 00117
Fmt 4703
Sfmt 4703
Comment letters also address the
general nature and uses of bitcoin; 197
the state of development of bitcoin as a
digital asset; 198 the inherent value of,
and risks of investing in, bitcoin; 199 the
desire of investors to gain access to
bitcoin through an ETP; 200 the
retirement investment benefits of a
193 See
supra note 165.
15 U.S.C. 78s(b)(2)(C).
195 15 U.S.C. 78f(b)(5).
196 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).
197 See, e.g., Patel Letter; letter from Sam Ahn,
dated April 28, 2021 (‘‘Ahn Letter’’).
198 See, e.g., Ahn Letter; Gemini Letter at 2.
199 See, e.g., Ahn Letter; Patel Letter; letter from
Bradley M. Kuhn, dated April 25, 2021 (‘‘Kuhn
Letter’’).
200 See, e.g., Kuhn Letter; Gemini Letter at 2;
Kryptoin Letter at 7.
194 See
E:\FR\FM\29DEN1.SGM
29DEN1
74180
Federal Register / Vol. 86, No. 247 / Wednesday, December 29, 2021 / Notices
bitcoin ETP; 201 and the bitcoin
network’s effect on the environment.202
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–2021–029 be, and hereby is,
disapproved.
By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2021–28255 Filed 12–28–21; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–93851; File No. SR–NYSE–
2021–73]
Self-Regulatory Organizations; New
York Stock Exchange LLC; Notice of
Filing of Proposed Rule Change To
Amend Rule 37 To Incorporate
Standards of Conduct for the
Exchange’s Trading Floor
khammond on DSKJM1Z7X2PROD with NOTICES
Pursuant to Section 19(b)(1) 1 of the
Securities Exchange Act of 1934 (the
‘‘Act’’) 2 and Rule 19b-4 thereunder,3
notice is hereby given that, on December
13, 2021, New York Stock Exchange
LLC (‘‘NYSE’’ or the ‘‘Exchange’’) filed
with the Securities and Exchange
Commission (the ‘‘Commission’’) the
proposed rule change as described in
Items I, II, and III below, which Items
have been prepared by the selfregulatory organization. The
Commission is publishing this notice to
solicit comments on the proposed rule
change from interested persons.
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
self-regulatory organization 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 those 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 parts of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule
Change
The Exchange proposes to amend
Rule 37 (Visitors) to incorporate
standards of conduct for the Exchange’s
Trading Floor modeled on the rules of
the Exchange’s affiliates NYSE
American LLC (‘‘NYSE American’’) and
NYSE Arca, Inc. (‘‘NYSE Arca’’), and to
add amended Rule 37 to the list of
minor rule violations in Rule 9217.
Background
Rule 37 currently provides that
visitors to the Floor shall not be
admitted to the Floor of the Exchange
except by permission of the Exchange.
Historically, the behavior and conduct
of members 4 on the trading Floor was
regulated by Floor Conduct and Safety
Guidelines administered by NYSE Floor
Officials. The NYSE eliminated the role
4 Rule 2(a) states that the term ‘‘member,’’ when
referring to a natural person, means a natural
person associated with a member organization who
has been approved by the Exchange and designated
by such member organization to effect transactions
on the Floor or any facility thereof.
201 See,
e.g., Kuhn Letter.
e.g., Patel Letter.
1 15 U.S.C. 78s(b)(1).
2 15 U.S.C. 78a.
3 17 CFR 240.19b-4.
202 See,
20:20 Dec 28, 2021
The Exchange proposes to amend
Rule 37 to incorporate standards of
conduct for the Exchange’s Trading
Floor modeled on rules of the
Exchange’s affiliates NYSE American
LLC and NYSE Arca, Inc., and to add
amended Rule 37 to the list of minor
rule violations in Rule 9217. The
proposed rule change is available on the
Exchange’s website at www.nyse.com, at
the principal office of the Exchange, and
at the Commission’s Public Reference
Room.
1. Purpose
December 22, 2021.
VerDate Sep<11>2014
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
Jkt 256001
PO 00000
Frm 00118
Fmt 4703
Sfmt 4703
and function of NYSE Floor Officials
earlier this year.5
NYSE American Rule 902NY
(Admission and Conduct on the Options
Trading Floor) and NYSE Arca Rule
6.2–O (Admission to and Conduct on
the Options Trading Floor) specify
standards of conduct and dress for
persons to follow while on the NYSE
American and NYSE Arca options
trading floors as well requirements for
trading floor badges. The rules are
substantially similar.
NYSE American Rule 902NY(b) and
NYSE Arca Rule 6.2–O(b) are titled
‘‘Conduct on the Floor’’ and provide
that a permit holder may be fined upon
the determination of a Trading Official
that the permit holder’s conduct on the
options trading floor was such as to
impair the maintenance of a fair and
orderly market, or to impair public
confidence in the operations of the
exchange. The provisions of NYSE
American Rule 902NY(b) and NYSE
Arca Rule 6.2–O(b) also apply to a
permit holder’s failure to adequately
supervise an employee to ensure his or
her compliance with this rule. Permit
holders adversely affected by a
determination made under these rules
may obtain review thereof consistent
with other NYSE American and NYSE
Arca rules, as applicable. However,
fines imposed by a Trading Official
under those rules do not preclude
further disciplinary action by the
respective exchanges.
Under NYSE American Rule 902NY(c)
and NYSE Arca Rule 6.2–O(c) titled
‘‘Standards of Dress and Conduct,’’ all
permit holders are required to act in a
manner consistent with a fair and
orderly market and with the
maintenance of public confidence in the
respective exchanges. Under the rules,
all persons on the options trading floors
must comply with certain standards of
dress and conduct, as follows. NYSE
American Rule 902NY(c)(1) and NYSE
Arca Rule 6.2–O(c)(1) provide that all
persons on the options trading floor,
whether permit holders, employees of
permit holders or visitors, shall at all
times, whether prior to, during or after
trading sessions, be dressed in a manner
appropriate for business purposes and
in accordance with good taste and
professional standards. The rules
provide that the term ‘‘good taste’’ shall
be interpreted in a conservative manner.
In addition, under the rules, the
following requirements and prohibitions
shall be observed:
5 See Securities Exchange Act Release No. 92193
(June 16, 2021), 82 FR 32024 (June 23, 2021) (SR–
NYSE–2020–105) (Order).
E:\FR\FM\29DEN1.SGM
29DEN1
]]>Agencies
[Federal Register Volume 86, Number 247 (Wednesday, December 29, 2021)]
[Notices]
[Pages 74166-74180]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-28255]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-93860; File No. SR-CboeBZX-2021-029]
Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order
Disapproving a Proposed Rule Change To List and Trade Shares of the
Kryptoin Bitcoin ETF Trust Under BZX Rule 14.11(e)(4), Commodity-Based
Trust Shares
December 22, 2021.
I. Introduction
On April 9, 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 Kryptoin Bitcoin
ETF 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 28, 2021.\3\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 91646 (Apr. 22,
2021), 86 FR 22485 (``Notice''). Comments on the proposed rule
change can be found at: https://www.sec.gov/comments/sr-cboebzx-2021-029/srcboebzx2021029.htm.
---------------------------------------------------------------------------
On June 9, 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 23, 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\
---------------------------------------------------------------------------
\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 92131, 86 FR 31772
(June 15, 2021).
\6\ 15 U.S.C. 78s(b)(2)(B).
\7\ See Securities Exchange Act Release No. 92476, 86 FR 40883
(July 29, 2021).
\8\ See Securities Exchange Act Release No. 93175, 86 FR 55092
(Oct. 5, 2021).
---------------------------------------------------------------------------
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), and
in particular, the requirement that the rules of a national
[[Page 74167]]
securities exchange be ``designed to prevent fraudulent and
manipulative acts and practices'' and ``to protect investors and the
public interest.'' \9\
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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 22485.
\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''); 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, Securities Exchange Act Release No. 93700 (Dec. 1,
2021), 86 FR 69322 (Dec. 7, 2021) (SR-CboeBZX-2021-024)
(``WisdomTree 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) (SR-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).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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 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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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 (``ADRs'')). 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'').
---------------------------------------------------------------------------
[[Page 74168]]
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.\22\ No listing exchange has satisfied its burden to make such
demonstration.\23\
---------------------------------------------------------------------------
\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 USBT Order, 85 FR at 12597.
\23\ See supra note 11.
---------------------------------------------------------------------------
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.\24\ 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,\25\ 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.\26\
---------------------------------------------------------------------------
\24\ See Notice, 86 FR at 22495.
\25\ See id. at 22491-92.
\26\ See id. at 22492.
---------------------------------------------------------------------------
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.\27\ 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.\28\
---------------------------------------------------------------------------
\27\ See id. at 22487-88, 22491, 22495-96.
\28\ See id. at 22491, 22495.
---------------------------------------------------------------------------
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.\29\
---------------------------------------------------------------------------
\29\ See id. at 22487.
---------------------------------------------------------------------------
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
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,\30\ 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.\31\
---------------------------------------------------------------------------
\30\ See Notice, supra note 3. See also Amendment No. 2 to
Registration Statement on Form S-1, dated April 9, 2021, submitted
to the Commission by Kryptoin Investment Advisors, LLC (``Sponsor'')
on behalf of the Trust (``Registration Statement'').
\31\ Although the name of the Trust is the Kryptoin Bitcoin ETF
Trust, the Trust is a commodity-based ETP. The Trust is not an
exchange-traded fund, i.e., an ``ETF,'' registered under the
Investment Company Act of 1940, as amended (``1940 Act''), and is
not subject to regulation under the 1940 Act.
---------------------------------------------------------------------------
The investment objective of the Trust is to provide exposure to
bitcoin at a price that is reflective of the actual bitcoin market
where investors purchase and sell bitcoin, less the expense of the
Trust's operations.\32\ 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 U.S. Settlement Price
(``Reference Rate''). The administrator of the Reference Rate is CF
Benchmarks Ltd. (``Benchmark Administrator''). The Reference Rate
aggregates the trade flow of several bitcoin spot platforms. The
current platform composition of the Reference
[[Page 74169]]
Rate is Bitstamp, Coinbase, Gemini, itBit, and Kraken. In calculating
the Reference Rate, the methodology creates a joint list of certain
trade prices and sizes from the constituent platforms between 3:00 p.m.
E.T. and 4:00 p.m. E.T. The methodology then divides this list into 12
equally-sized time intervals of five minutes, and it calculates the
volume-weighted median trade price for each of those time
intervals.\33\ The Reference Rate is the arithmetic mean of these 12
volume-weighted median trade prices.\34\
---------------------------------------------------------------------------
\32\ Delaware Trust Company is the trustee, and The Bank of New
York Mellon will be the administrator (``Administrator'') and
transfer agent. Foreside Fund Services, LLC will be the marketing
agent in connection with the creation and redemption of ``baskets''
of Shares, and the Sponsor will provide assistance in the marketing
of the Shares. Gemini Trust Company, LLC, a third-party custodian
(``Custodian''), will be responsible for custody of the Trust's
bitcoin. See Notice, 86 FR at 22485, 22492-93.
\33\ 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 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 id. at 22493.
\34\ See id.
---------------------------------------------------------------------------
Each Share represents a fractional undivided beneficial interest in
the bitcoin held by the Trust. The Trust's assets will consist of
bitcoin held by the 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.\35\
---------------------------------------------------------------------------
\35\ See id. at 22492.
---------------------------------------------------------------------------
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. The NAV of the Trust is the aggregate value of the
Trust's assets less its liabilities (which include estimated accrued
but unpaid fees and expenses). In determining the Trust's NAV, the
Administrator will value the bitcoin held by the Trust on the basis of
the price of bitcoin as determined by the Reference Rate.\36\
---------------------------------------------------------------------------
\36\ See id. at 22494.
---------------------------------------------------------------------------
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.\37\
---------------------------------------------------------------------------
\37\ See id. at 22493.
---------------------------------------------------------------------------
When the Trust sells or redeems its Shares, it will do so in ``in-
kind'' transactions in blocks of 50,000 Shares. When creating the
Shares, authorized participants will deliver, or facilitate the
delivery of, bitcoin to the Trust's account with the Custodian in
exchange for the Shares, and, when redeeming the Shares, the Trust,
through the Custodian, will deliver bitcoin to such authorized
participants.\38\
---------------------------------------------------------------------------
\38\ See id.
---------------------------------------------------------------------------
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.'' \39\ 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.'' \40\
---------------------------------------------------------------------------
\39\ 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).
\40\ 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,\41\ 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.\42\ 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.\43\
---------------------------------------------------------------------------
\41\ See id.
\42\ See id.
\43\ Susquehanna Int'l Group, LLP v. Securities and Exchange
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (``Susquehanna'').
---------------------------------------------------------------------------
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.\44\ Such resistance
to fraud and manipulation must be novel and beyond those protections
that exist in traditional commodities or securities markets.\45\
---------------------------------------------------------------------------
\44\ 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.
\45\ 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.\46\ 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.\47\ 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
[[Page 74170]]
quotes that they deem non-executable.\48\ 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.\49\ 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.\50\ 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.\51\
---------------------------------------------------------------------------
\46\ See Notice, 86 FR at 22491 n.55.
\47\ See id.
\48\ See id.
\49\ See id.
\50\ See id.
\51\ See id.
---------------------------------------------------------------------------
The Sponsor, in a comment letter, states that it agrees with the
Exchange's assertion that the bitcoin spot market is resistant to price
manipulation. The Sponsor asserts that the trading of bitcoin on
hundreds of spot platforms in geographically diverse locations, the
dispersed nature of market liquidity, and the level of capital
necessarily deployed across these platforms render an attempted
manipulation of the global bitcoin spot market ``challenging and highly
unlikely, if not impossible.'' \52\ The Sponsor further states that
there exists a large presence of arbitrageurs in the form of automated
market makers and high-frequency and algorithmic trading firms
established to specifically seek profits by actively trading any
temporary dislocations in the bitcoin price between trading venues, and
that any attempt to manipulate the price of bitcoin where these firms
are active would require exceeding the liquidity supply of these
arbitrageurs that are effectively eliminating any cross-market pricing
deviations.\53\
---------------------------------------------------------------------------
\52\ See letter from Jason Toussaint, Chief Executive Officer,
Kryptoin Investment Advisors, LLC, dated August 19, 2021 (``Kryptoin
Letter''), at 3.
\53\ See id. The Custodian, in a comment letter, states that it
believes that certain of the Commission's historical concerns about
the bitcoin markets are ameliorated by the growth of the overall
bitcoin market and related growth of regulated bitcoin derivatives.
See letter from Gemini Trust Company, LLC, dated August 19, 2021
(``Gemini Letter''), at 2. Another commenter, however, asserts that
the bitcoin network is the preferred network for global criminals
and is 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'').
---------------------------------------------------------------------------
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. BZX and
the Sponsor assert 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. Neither
the Exchange nor the Sponsor, however, provides 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.\54\ 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.\55\
---------------------------------------------------------------------------
\54\ In addition, the Registration Statement states that bitcoin
spot platforms are not subject to the same regulatory oversight as
traditional equity exchanges, which could negatively impact the
ability of authorized participants to implement arbitrage
mechanisms. See Registration Statement at 22. See also infra note 69
and accompanying text (referencing statements made in the
Registration Statement that contradict assertions made by BZX).
\55\ See supra note 43.
---------------------------------------------------------------------------
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.\56\ 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.\57\ Here,
neither the Exchange nor the Sponsor provides 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, neither the
Exchange nor the Sponsor takes 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.\58\
---------------------------------------------------------------------------
\56\ See Winklevoss Order, 83 FR at 37586; SolidX Order, 82 FR
at 16256-57; USBT Order, 85 FR at 12601.
\57\ See, e.g., USBT Order, 85 FR at 12601.
\58\ See, e.g., Winklevoss Order, 83 FR at 37584; USBT Order, 85
FR at 12600-01. See also Registration Statement at 10 (stating that,
as of the date of the Registration Statement, ``the largest 100
bitcoin wallets held a substantial amount of the outstanding supply
of bitcoin and it is possible that some of these wallets are
controlled by the same person or entity''; that ``it is possible
that other persons or entities control multiple wallets that
collectively hold a significant number of bitcoin, even if each
wallet individually only holds a small amount''; and that ``[a]s a
result of this concentration of ownership, large sales by such
holders could have an adverse effect on the market price of
bitcoin.'').
---------------------------------------------------------------------------
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.\59\ However, without the necessary data 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.\60\
---------------------------------------------------------------------------
\59\ See Notice, 86 FR at 22491 n.55.
\60\ See USBT Order, 85 FR at 12601.
---------------------------------------------------------------------------
Additionally, the continuous nature of bitcoin trading does not
eliminate manipulation risk, and neither do linkages among markets, as
BZX asserts.\61\ 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 creates
a false impression of supply or demand.\62\
---------------------------------------------------------------------------
\61\ See Winklevoss Order, 83 FR at 37585 n.92 and accompanying
text.
\62\ 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.\63\ 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
[[Page 74171]]
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.\64\
---------------------------------------------------------------------------
\63\ See Notice, 86 FR at 22492, 22496.
\64\ 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.\65\ 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.\66\ 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.
---------------------------------------------------------------------------
\65\ 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 22492
n.61.
\66\ 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,\67\ (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.\68\
---------------------------------------------------------------------------
\67\ See supra notes 59-60 and accompanying text.
\68\ 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 the ``price of bitcoin as
determined by the bitcoin market has experienced periods of extreme
volatility and may be influenced by, among other things, trading
activity and the closing of bitcoin trading platforms due to fraud,
failure, security breaches or otherwise''; that the bitcoin blockchain
could be vulnerable to a ``51% attack,'' in which a bad actor or actors
that control 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, that some bitcoin platforms have been the victim
of cybercrimes, subject to cybersecurity breaches, or ``hacked,''
resulting in losses, and that ``[n]o bitcoin [platform] is immune from
these risks''; that bitcoin platforms on which bitcoin trade are
relatively new and, in some cases, largely unregulated, and, therefore,
may be more exposed to fraud and security breaches than established,
regulated exchanges for other financial assets or instruments; and that
``[o]ver the past several years, a number of bitcoin [platforms] have
been closed or faced issues due to fraud, failure, security breaches or
governmental regulations.'' \69\
---------------------------------------------------------------------------
\69\ See Registration Statement at 1, 11, 13. 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.\70\ The
Exchange states that the Reference Rate is calculated based on the
``Relevant Transactions'' \71\ 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.\72\ For each partition
separately, the volume-weighted median trade price is calculated from
the trade prices and sizes of all Relevant Transactions.\73\ The
Reference Rate is then determined by the arithmetic mean of the volume-
weighted medians of all partitions.\74\ 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.'' \75\ 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.'' \76\
---------------------------------------------------------------------------
\70\ See Notice, 86 FR at 22492, 22497.
\71\ 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 Bitcoin 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 22493 n.66.
\72\ See id. at 22493.
\73\ 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.
\74\ See id.
\75\ See id.
\76\ See id.
---------------------------------------------------------------------------
The Custodian, in a comment letter, agrees that BZX's choice of the
Reference Rate, which includes a composite of bitcoin prices from
underlying spot bitcoin platforms, including the Custodian's platform,
is a further factor in support of the proposed ETP.\77\ The Custodian
asserts that it and other ``regulated digital asset exchanges'' and
custodians have a history of operations in compliance with a regulatory
framework developed specifically to address activities in digital
assets, including guidance by the New York State Department of
Financial Services (``NYSDFS'') regarding the implementation of anti-
fraud measures. The Custodian states that it meets this obligation
through automated systems and robust internal controls and
surveillance, and that the growing sophistication of market
surveillance tools and strategies in the bitcoin market
[[Page 74172]]
as well as the growing proportion of bitcoin activity occurring on
``regulated exchanges'' is a key development to mollify concerns about
price manipulation or other manipulative practices in the bitcoin
market.\78\ The Sponsor, in a comment letter, states that global
bitcoin and cryptocurrency markets are subject to increasing levels of
regulation, oversight, and enforcement actions by global governments
and regulatory bodies.\79\
---------------------------------------------------------------------------
\77\ See Gemini Letter at 2.
\78\ See id. The Custodian also states that it is registered
with the Financial Crimes Enforcement Network (``FinCEN'') as a
money service business and maintains money transmitter licenses (or
the statutory equivalent) in all states where this is required. See
Gemini Letter at 3 and infra note 98.
\79\ See Kryptoin Letter at 7. The Sponsor states that in
January 2019, the Singapore Government enacted the Payment Services
Act, bringing cryptocurrency dealing or exchange services under the
supervision of the Monetary Authority of Singapore, Singapore's
central bank and financial regulator. See id. The Sponsor, however,
provides no data, information, or analysis as to how such ``global
governments and regulatory bodies'' oversee bitcoin markets in
general, or the Constituent Bitcoin Platforms in particular; or how
any such regulation makes the listing and trading of the Shares
inherently resistant to fraud and manipulation.
---------------------------------------------------------------------------
Simultaneously with these 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.'' \80\ 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.'' \81\ 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.\82\
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.\83\
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.\84\
---------------------------------------------------------------------------
\80\ See Notice, 86 FR at 22492.
\81\ See id.
\82\ See id.
\83\ See id.
\84\ See id.
---------------------------------------------------------------------------
The Sponsor, in a comment letter, agrees that the in-kind process
by which the Shares will be created and redeemed makes the Shares
inherently resistant to manipulation. The Sponsor states that the
``creation and redemption of Trust Shares through the in-kind exchange
mechanism is solely dependent on the amount of bitcoin to be received
or delivered by the Trust and is completely independent of the value of
bitcoin at that point in time.'' \85\ The Sponsor also states that, in
contrast to other OTC bitcoin funds that receive cash from investors
and then purchase bitcoin in the spot market, the size and timing of
which can contribute to the value of these funds' quoted prices
deviating from NAV, the Trust and its Shares will not be subjected to
this potential source of NAV deviation.\86\ The Sponsor further states
that the fact that the Trust's expenses are paid in bitcoin, not cash,
makes these expense payments ``completely independent of the value of
bitcoin or the Reference Rate,'' which mitigates the risk associated
with potential manipulation and discourages manipulation of the
Reference Rate because there is little financial incentive to do
so.\87\
---------------------------------------------------------------------------
\85\ See Kryptoin Letter at 1-2.
\86\ See id. at 2.
\87\ See id. at 14.
---------------------------------------------------------------------------
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.\88\ 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.\89\ 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.
---------------------------------------------------------------------------
\88\ The Commission has previously considered and rejected
similar arguments about the valuation of bitcoin according to a
benchmark or reference price. See, e.g., SolidX Order, 82 FR at
16258; Winklevoss Order, 83 FR at 37587-90; USBT Order, 85 FR at
12599-601.
\89\ 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 or Reference Rate, 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
notes 59-60 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.'' \90\ 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.
---------------------------------------------------------------------------
\90\ See Registration Statement at 11.
---------------------------------------------------------------------------
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.'' \91\ 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.\92\
---------------------------------------------------------------------------
\91\ See USBT Order, 85 FR at 12601 n.66; see also id. at 12607.
\92\ See WisdomTree Order, 86 FR at 69327.
---------------------------------------------------------------------------
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
[[Page 74173]]
manipulate the Reference Rate, these procedures are not sufficient for
the Commission to dispense with the requisite surveillance-sharing
agreement with a regulated market of significant size.
Second, the Custodian asserts that the growing sophistication of
market surveillance tools and strategies used by the Constituent
Bitcoin Platforms, as well as the growing proportion of bitcoin
activity occurring on ``regulated exchanges,'' ``mollify concerns about
price manipulation or other manipulative practices.'' \93\ However, the
level of regulation on the Constituent Bitcoin Platforms is not
equivalent to the obligations, authority, and oversight of national
securities exchanges or futures exchanges and therefore is not an
appropriate substitute.\94\ 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.'' \95\ Moreover, national
securities exchanges must file proposed rules with the Commission
regarding certain material aspects of their operations,\96\ and the
Commission has the authority to disapprove any such rule that is not
consistent with the requirements of the Exchange Act.\97\ Thus,
national securities exchanges are subject to Commission oversight of,
among other things, their governance, membership qualifications,
trading rules, disciplinary procedures, recordkeeping, and fees.\98\
---------------------------------------------------------------------------
\93\ See Gemini Letter at 2.
\94\ See also USBT Order, 85 FR at 12603-05.
\95\ See 15 U.S.C. 78f(b)(5).
\96\ 17 CFR 240.19b-4(a)(6)(i).
\97\ 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 Commodity Futures Trading Commission (``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.
\98\ See Winklevoss Order, 83 FR at 37597. The Commission notes
that the 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 Reference Rate's
Constituent Bitcoin Platforms have complied with this NYSDFS
guidance. Further, as stated previously, there are substantial
differences between the NYSDFS and FinCEN versus the Commission's
regulation. Anti-Money Laundering (``AML'') and Know-Your-Customer
(``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).\99\ Further, although the Custodian claims that the
Constituent Bitcoin Platforms have market surveillance tools and
strategies that are growing in sophistication, the Custodian provides
no supporting evidence to substantiate its claims. Moreover, even
assuming that the Constituent Bitcoin Platforms are as vigilant towards
fraud and manipulation as the Custodian describes, neither the Exchange
nor the Custodian 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.
---------------------------------------------------------------------------
\99\ See 15 U.S.C. 78e, 78f.
---------------------------------------------------------------------------
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.
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.\100\ 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.'' \101\ 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.'' \102\ 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.\103\
As neither the Exchange nor the Sponsor addresses or provides 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.
---------------------------------------------------------------------------
\100\ See supra notes 80-84 and accompanying text.
\101\ See Notice, 86 FR at 22492 (``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.'').
\102\ 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.'').
\103\ Similarly, the Sponsor asserts that the Trust and the
Shares are inherently resistant to manipulation due to the in-kind
create/redeem process. See Kryptoin Letter at 1. Yet in the
Sponsor's own words, the creation and redemption of Shares is
``completely independent'' of the value of bitcoin at that point in
time, i.e., completely independent of the Reference Rate and the
Trust's NAV. See id. at 2. As such, going by the Sponsor's own
assertion, it again follows that the Reference Rate's resistance to
manipulation is not material to the Shares'' susceptibility to fraud
and manipulation.
---------------------------------------------------------------------------
[[Page 74174]]
Fifth, the Commission finds that neither BZX nor the Sponsor has
demonstrated that in-kind creations and redemptions provide the Shares
with a unique resistance to manipulation.\104\ The Commission has
previously addressed similar assertions.\105\ 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.\106\
Accordingly, the Commission is not persuaded here that the Trust's in-
kind creations and redemptions afford it a unique resistance to
manipulation.\107\
---------------------------------------------------------------------------
\104\ The Sponsor asserts that the in-kind create/redeem process
provides for an arbitrage pricing mechanism whereby authorized
participants trade the price deviations ``between the Trust's
secondary market prices and NAV,'' keeping the Shares'' price ``at
or near NAV'' (emphasis added). See Kryptoin Letter at 2. However,
this assertion is also contradicted by the Sponsor's statement that
the in-kind create/redeem process means that the amount of bitcoin
that an authorized participant delivers to or receives from the
Trust is ``completely independent'' of the value of bitcoin, i.e.,
completely independent of NAV and the Reference Rate used to compute
it. See id. Moreover, the prerequisite of an efficient arbitrage
mechanism is not unique to the proposal here, as it is a fundamental
premise of any ETP or exchange-traded fund, and the Commission has
not previously dispensed with the requirement of a surveillance-
sharing agreement based on an efficient arbitrage mechanism.
\105\ See Winklevoss Order, 83 FR at 37589-90; USBT Order, 85 FR
at 12607-08.
\106\ 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).
\107\ 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.
---------------------------------------------------------------------------
Finally, the Sponsor, in a comment letter, cites to the
Commission's 2004 approval of the SPDR Gold Trust as evidence that a
combination of (1) a deep and liquid spot market, (2) an information-
sharing agreement with a commodity futures exchange, and (3) exchange
trading rules to govern the trading of ETP shares by liquidity
providers, justify dispensing with the requisite surveillance-sharing
agreement.\108\ The Sponsor states that the spot bitcoin market is deep
and liquid; \109\ that the Exchange is a member of ISG, as is the CME
that lists bitcoin futures; and that the Exchange has rules in place to
govern the trading of the Trust's Shares.\110\ The Sponsor concludes
that, therefore, there is a solid base of evidence to support the
Commission's approval of the proposed ETP.\111\
---------------------------------------------------------------------------
\108\ See Kryptoin Letter at 13, citing Securities Exchange Act
Release No. 50604 (Oct. 28, 2004), 69 FR 64614 (Nov. 5, 2004)
(``Gold Order'').
\109\ The Sponsor states that, for the six-month period ending
August 13, 2021, average daily spot bitcoin trading volume across
approximately 40 spot exchanges was $9.88 billion. The Sponsor
compares this to estimates in the Gold Order of the 2003 high
average daily gold trading volume of $7.9 billion (19 million troy
ounces) and low average of $5.67 billion (13.6 million troy ounces).
The Sponsor believes that the bitcoin spot market therefore meets,
and exceeds, the Commission's ``definition'' of an extremely deep
and liquid market. See id. at 4.
\110\ The Sponsor cites BZX Rule 14.11(e)(4)(G) regarding the
types of records and information that registered market makers in
Commodity-Based Trust Shares must provide to the Exchange. See id.
at 13-14.
\111\ See id. at 13.
---------------------------------------------------------------------------
The Commission disagrees. The Commission considered and discussed
the Gold Order at length in the Winklevoss Order. While the Gold Order
observes that it is ``not possible . . . to enter into an information
sharing agreement with the OTC gold market,'' the order continues:
``Nevertheless, the Commission believes that the unique liquidity and
depth of the gold market, together with the MOU [Memorandum of
Understanding] with NYMEX (of which COMEX is a Division) and NYSE Rules
1300(b) and 1301, create the basis for the [ETP listing exchange] to
monitor for fraudulent and manipulative practices in the trading of the
Shares.'' \112\ Thus, even though the Commission found that the OTC
market for gold was ``extremely deep and liquid,'' \113\ the
Commission's approval of the first precious metal ETP expressly relied
on an agreement to share surveillance information between the ETP
listing exchange and a significant, regulated market for gold
futures.\114\ The Commission continues to maintain that the Gold Order
demonstrates the importance of establishing an agreement to share
surveillance information between the ETP listing exchange and a
significant, regulated market.\115\ Accordingly, having a surveillance-
sharing agreement with CME is not sufficient--the Exchange must
demonstrate that CME is ``a significant, regulated market.''
---------------------------------------------------------------------------
\112\ See Gold Order, 69 FR at 64619.
\113\ See id.
\114\ See Winklevoss Order, 83 FR at 37592-94.
\115\ See id. at 37594. The Commission further stated that
``[c]onsistent with the discussion of `significant market' . . . ,
the Commission has not previously, and does not now, require that an
ETP listing exchange be able to enter into a surveillance-sharing
agreement with each regulated spot or derivatives market relating to
an underlying asset, provided that the market or markets with which
there is such an agreement constitute a `significant market'.'' See
id. at 37595.
---------------------------------------------------------------------------
(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.\116\
---------------------------------------------------------------------------
\116\ See id. 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.\117\ Accordingly, based on
the common membership of BZX and CME in the ISG,\118\ 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,\119\ including the CME bitcoin futures market, and
thus such market is ``regulated,'' in the context of the
[[Page 74175]]
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.\120\
---------------------------------------------------------------------------
\117\ See id. at 37580 n.19.
\118\ See Notice, 86 FR at 22491 nn.56-57 and accompanying text.
\119\ 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.
\120\ As described above (see supra notes 93-99 and accompanying
text), in the context of the proposed ETP, the Reference Rate's
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 the 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.\121\ 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.'' \122\ 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.\123\
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.\124\ Similarly, BZX contends that the
number of large open interest holders \125\ has continued to increase,
even as the price of bitcoin has risen, as have the number of unique
accounts trading CME bitcoin futures.\126\
---------------------------------------------------------------------------
\121\ According to BZX, each contract represents five bitcoin
and is based on the CME CF Bitcoin Reference Rate. See Notice, 86 FR
at 22489.
\122\ See id.
\123\ See id.
\124\ See id.
\125\ 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 22490 n.51.
\126\ See id. at 22490.
---------------------------------------------------------------------------
The Sponsor, in a comment letter, adds that CME trading volume has
continued to increase substantially: Increasing by approximately 220
percent in July 2021 versus July 2020; increasing by approximately 156
percent year-to-date July 2021 versus year-to-date July 2020; reaching
a record daily notional traded value of $7.33 billion on February 23,
2021, and a record open interest value of $3.17 billion on February 19,
2021; and in the six-month period ending August 13, 2021, reaching an
average daily trading volume of $2.20 billion and average open interest
of $1.98 billion.\127\ The Sponsor states that this exceeds the 2003
average daily COMEX gold futures trading volume of approximately $2.04
billion.\128\
---------------------------------------------------------------------------
\127\ See Kryptoin Letter at 5.
\128\ See id. at 4.
---------------------------------------------------------------------------
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.\129\
---------------------------------------------------------------------------
\129\ See Notice, 86 FR at 22491.
---------------------------------------------------------------------------
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.\130\ BZX concludes that a person
attempting to manipulate the Shares would also have to trade on that
market to manipulate the ETP.\131\
---------------------------------------------------------------------------
\130\ See id. at 22491, 22496 & n.52 (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'')).
\131\ See id. at 22491-92, 22496.
---------------------------------------------------------------------------
The Sponsor, in a comment letter, also argues that there is a
reasonable likelihood that a person attempting to manipulate the Shares
would also have to trade on the CME to manipulate the Shares.\132\
Citing Hu, Hou & Oxley as evidence that CME bitcoin futures lead the
price in the bitcoin spot markets,\133\ the Sponsor states that an
attempt to manipulate the spot market would require participation in
the CME bitcoin futures market.\134\ The Sponsor asserts that it
follows, then, that an attempted manipulation of the Shares would
similarly require participation in the CME bitcoin futures market,
because both the CME CF Bitcoin Real-Time Index (``BRTI'') and the BRR,
upon which CME bitcoin futures are settled, are calculated by observing
prices in the underlying spot bitcoin markets.\135\ The Sponsor asserts
that an interrelationship between the CME bitcoin futures market and
the Trust exists because the Trust's Reference Rate is based materially
on the same methodology as the BRTI and BRR,\136\ and therefore it is
reasonable to assume that any effort to manipulate the Trust's NAV or
Share price would also require an attempted manipulation of the CME
bitcoin futures prices.\137\ The Sponsor concludes that, because both
the Exchange and the CME are members of the ISG, such attempted
misconduct would be effectively detected and deterred.\138\
---------------------------------------------------------------------------
\132\ See Kryptoin Letter at 12.
\133\ See id. at 11 n.22.
\134\ See id. at 12.
\135\ See id.
\136\ See id. at 2.
\137\ See id. at 2-3, 12.
\138\ See id. at 3, 12.
---------------------------------------------------------------------------
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 and the Sponsor's
assertions about the general upward trends from 2018 to August 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. While BZX and the Sponsor provide data showing
absolute growth in the size of the CME bitcoin futures market, they
provide no data relative to the concomitant growth in either the
bitcoin spot markets or other bitcoin futures markets (including
unregulated futures markets). Moreover, even if the CME has grown in
relative 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.\139\ BZX's recitation of data
reflecting the size of the CME bitcoin futures market, alone, either
[[Page 74176]]
currently or in relation to previous years, is not sufficient to
establish an interrelationship between the CME bitcoin futures market
and the proposed ETP.\140\
---------------------------------------------------------------------------
\139\ See USBT Order, 85 FR at 12611.
\140\ See id. at 12612.
---------------------------------------------------------------------------
Moreover, while the Sponsor asserts that an interrelationship
exists between the CME bitcoin futures market and the Trust, on account
of the Trust's Reference Rate being based materially on the same
methodology as the BRTI and BRR,\141\ and asserts that it is therefore
reasonable to assume that any effort to manipulate the Trust's NAV or
Share price would also require an attempted manipulation of the CME
bitcoin futures prices,\142\ the Sponsor provides no mechanism or
example that would demonstrate the accuracy of the assumption.
Moreover, as addressed above, the Sponsor itself undermines such an
assumption by its own recognition that the Trust's in-kind create/
redeem process is ``completely independent'' of the value of
bitcoin,\143\ and thereby completely independent of the Reference Rate
used to compute such a value.
---------------------------------------------------------------------------
\141\ See Kryptoin Letter at 2.
\142\ See id. at 2-3, 12.
\143\ See id. at 2 and supra notes 100-104 and accompanying
text.
---------------------------------------------------------------------------
Further, the econometric evidence in the record for this proposal
also does not support a conclusion that an interrelationship exists
between the CME bitcoin futures market and the bitcoin spot market such
that it is reasonably likely that a person attempting to manipulate the
proposed ETP would also have to trade on the CME bitcoin futures market
to successfully manipulate the proposed ETP.\144\ While BZX and the
Sponsor state that CME bitcoin futures pricing leads the spot
market,\145\ they rely on the findings of a price discovery analysis in
one section of a single academic paper to support the overall
thesis.\146\ However, the findings of that paper's Granger causality
analysis, which is widely used to formally test for lead-lag
relationships, are concededly mixed.\147\ 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.\148\
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.\149\ 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.\150\ BZX
has not addressed either issue.
---------------------------------------------------------------------------
\144\ See USBT Order, 85 FR at 12611. Listing exchanges have
attempted to demonstrate such an ``interrelationship'' by presenting
the results of various econometric ``lead-lag'' analyses. The
Commission considers such analyses to be central to understanding
whether it is reasonably likely that a would-be manipulator of the
ETP would need to trade on the CME bitcoin futures market. See id.
at 12612.
\145\ See Notice, 86 FR at 22491; Kryptoin Letter at 12.
\146\ See supra note 130 and accompanying text. BZX and the
Sponsor reference 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 22491 n.52; Kryptoin Letter at 11 n.22.
\147\ 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
130.
\148\ See USBT Order, 85 FR at 12609.
\149\ See id. at 12613 n.244.
\150\ 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.\151\ 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.\152\ 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.\153\ 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.\154\
---------------------------------------------------------------------------
\151\ See Susquehanna, 866 F.3d at 447.
\152\ 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); S.
Aleti & B. Mizrach, Bitcoin spot and futures market microstructure,
41 J. Futures Mkts. 194 (2021) (finding that relatively more price
discovery occurs on 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).
\153\ See USBT Order, 85 FR at 12613 nn.239-244 and accompanying
text.
\154\ In addition, the Exchange fails to address the
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 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
[[Page 74177]]
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.\155\
---------------------------------------------------------------------------
\155\ 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.\156\ 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.\157\ 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.\158\
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.\159\ 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.\160\ The Sponsor agrees.\161\
---------------------------------------------------------------------------
\156\ See Notice, 86 FR at 22492, 22496.
\157\ 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. at 22492 n.61.
\158\ See id. at 22492, 22496.
\159\ See id.
\160\ See id.
\161\ See Kryptoin Letter at 12.
---------------------------------------------------------------------------
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 \162\
--it will only address below the other two bases--the overall size of,
and the impact of buys and sells on, the bitcoin market.
---------------------------------------------------------------------------
\162\ See supra notes 144-154 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 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.\163\ 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.
---------------------------------------------------------------------------
\163\ See Registration Statement at 18.
---------------------------------------------------------------------------
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.\164\ 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.
---------------------------------------------------------------------------
\164\ See Notice, 86 FR at 22492, 22496 (``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
[[Page 74178]]
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.\165\ 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.
---------------------------------------------------------------------------
\165\ 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.\166\ 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.\167\ 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.\168\
---------------------------------------------------------------------------
\166\ See Notice, 86 FR at 22487.
\167\ 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.
\168\ 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.'' \169\ BZX represents that, historically, OTC
bitcoin funds have traded at a significant premium to NAV.\170\
Although the Exchange concedes that trading at a premium or 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.\171\ 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 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.\172\
---------------------------------------------------------------------------
\169\ 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 22487 n.38.
\170\ See id. at 22487. 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 22487 n.39.
\171\ See id. at 22488.
\172\ See id. The Sponsor, in a comment letter, states that
sophisticated market participants have referred to this potential
source of profit at the expense of retail investors as a ``free put
option'' embedded in the OTC bitcoin funds. See Kryptoin Letter at
9.
---------------------------------------------------------------------------
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.\173\ The
Sponsor, in a comment letter, states that on a year-to-date basis
through August 13, 2021, the OTC bitcoin fund's total return was 19.91
percent versus its NAV of 56.56 percent; and on a one-year basis
through August 13, 2021, the fund's total return was 192.7 percent
versus its NAV return of 288.6 percent.\174\ The Sponsor also states
that, because OTC bitcoin funds are not listed on an exchange, they are
therefore not subject to the same transparency and regulatory oversight
by a listing exchange as the Trust's Shares would be.\175\
---------------------------------------------------------------------------
\173\ See letter from Anonymous, dated June 17, 2021.
\174\ See Kryptoin Letter at 8. In addition to the premium/
discount volatility's direct investment risk to retail investors,
the Sponsor also points to two additional risks of the OTC bitcoin
fund: (1) The inability to redeem or sell back shares to the fund in
exchange for bitcoin or cash means that sophisticated investors who
previously created shares directly with the fund at NAV before its
shares began trading at a discount are now facing potentially
substantial and widespread capital losses; and (2) because the fund
periodically closes and does not accept any further investment
through private placement, accredited and institutional investors
could be unable to deploy capital in compliance with their
investment mandates. See id. at 9.
\175\ See id.
---------------------------------------------------------------------------
BZX also asserts that exposure to bitcoin through an ETP also
presents advantages for retail investors compared to buying spot
bitcoin directly.\176\ BZX asserts that, without the advantages of an
ETP, an individual retail investor holding bitcoin through a
cryptocurrency trading platform lacks protections.\177\ 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.\178\ 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.\179\ BZX represents that the 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.\180\ Thus, with respect to custody of the
Trust's bitcoin assets,
[[Page 74179]]
BZX concludes that, compared to owning spot bitcoin directly, the Trust
presents advantages from an investment protection standpoint for retail
investors.\181\
---------------------------------------------------------------------------
\176\ See Notice, 86 FR at 22488.
\177\ See id.
\178\ See id.
\179\ See id.
\180\ See id.
\181\ See id.
---------------------------------------------------------------------------
The Custodian, in a comment letter, echoes some of the descriptions
of the custodial arrangement.\182\ The Custodian also specifies that
its offline ``cold'' storage solution will hold the Trust's bitcoin in
Hardware Security Modules that have achieved the highest security level
of U.S. federal government standards and that are physically protected
at the Custodian's network of secure facilities and that to carry out a
transfer from the Trust's account, a quorum of these secure facilities
must be involved to sign the transaction.\183\ Also, according to the
Custodian, it maintains digital asset insurance, is regularly audited
by major financial and audit firms, and is subject to independent
third-party verification that the Custodian's operations and security
compliance structures meet the most robust of industry standards.\184\
The Sponsor, in a comment letter, adds that the Custodian will perform
its duties in a manner that meets the definition of a qualified
custodian under the Investment Advisers Act of 1940, as amended.\185\
---------------------------------------------------------------------------
\182\ See Gemini Letter at 2-3.
\183\ See id.
\184\ See id.
\185\ See Kryptoin Letter at 10.
---------------------------------------------------------------------------
BZX further asserts that a number of operating companies engaged in
unrelated businesses have announced investments as large as $1.5
billion in bitcoin.\186\ 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.\187\ 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.\188\
---------------------------------------------------------------------------
\186\ See Notice, 86 FR at 22487.
\187\ See id. at 22488-89. The Custodian, in its comment letter,
agrees that the proposed ETP would offer greater investor protection
and transparency than existing alternatives for retail customers to
gain proxy exposure to bitcoin. See Gemini Letter at 2.
\188\ See Notice, 86 FR at 22489.
---------------------------------------------------------------------------
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.\189\
The Sponsor, in a comment letter, states that obtaining bitcoin
exposure through CME bitcoin futures ``generally remain[s] beyond the
scope of comfort level of retail investors'' because of, among other
reasons, the risk of margin calls. The Sponsor states that this risk is
eliminated entirely in the case of investors holding non-margin bitcoin
investment alternatives, such as a bitcoin ETP.\190\
---------------------------------------------------------------------------
\189\ See id. at 22487. 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 22487 n.36. 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 22487 n.37.
\190\ See Kryptoin Letter at 10.
---------------------------------------------------------------------------
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. The Commission disagrees. 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.\191\ 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.\192\
---------------------------------------------------------------------------
\191\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\192\ See SolidX Order, 82 FR at 16259; WisdomTree Order, 86 FR
at 69334.
---------------------------------------------------------------------------
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.\193\ As explained above, for bitcoin-
based ETPs, the Commission has consistently 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.
---------------------------------------------------------------------------
\193\ See supra note 165.
---------------------------------------------------------------------------
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.\194\
---------------------------------------------------------------------------
\194\ 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),\195\ and, accordingly, the Commission must disapprove the
proposal.\196\
---------------------------------------------------------------------------
\195\ 15 U.S.C. 78f(b)(5).
\196\ 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).
---------------------------------------------------------------------------
D. Other Comments
Comment letters also address the general nature and uses of
bitcoin; \197\ the state of development of bitcoin as a digital asset;
\198\ the inherent value of, and risks of investing in, bitcoin; \199\
the desire of investors to gain access to bitcoin through an ETP; \200\
the retirement investment benefits of a
[[Page 74180]]
bitcoin ETP; \201\ and the bitcoin network's effect on the
environment.\202\ 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.
---------------------------------------------------------------------------
\197\ See, e.g., Patel Letter; letter from Sam Ahn, dated April
28, 2021 (``Ahn Letter'').
\198\ See, e.g., Ahn Letter; Gemini Letter at 2.
\199\ See, e.g., Ahn Letter; Patel Letter; letter from Bradley
M. Kuhn, dated April 25, 2021 (``Kuhn Letter'').
\200\ See, e.g., Kuhn Letter; Gemini Letter at 2; Kryptoin
Letter at 7.
\201\ See, e.g., Kuhn Letter.
\202\ 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-2021-029 be, and
hereby is, disapproved.
By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2021-28255 Filed 12-28-21; 8:45 am]
BILLING CODE 8011-01-P
