Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order Disapproving a Proposed Rule Change To List and Trade Shares of the Wise Origin Bitcoin Trust Under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares, 5527-5541 [2022-02001]

Download as PDF Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were either solicited or received. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The foregoing rule change is effective upon filing pursuant to Section 19(b)(3)(A) 22 of the Act and subparagraph (f)(2) of Rule 19b–4 23 thereunder, because it establishes a due, fee, or other charge imposed by the Exchange. At any time within 60 days of the filing of such 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 under Section 19(b)(2)(B) 24 of the Act to determine whether the proposed rule change should be approved or disapproved. IV. Solicitation of Comments 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: tkelley on DSK125TN23PROD with NOTICE 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 No. SR–ISE– 2022–02 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 No. SR–ISE–2022–02. 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 U.S.C. 78s(b)(3)(A). CFR 240.19b–4(f)(2). 24 15 U.S.C. 78s(b)(2)(B). 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 No. SR–ISE–2022–02, and should be submitted on or before February 22, 2022. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.25 J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2022–01968 Filed 1–31–22; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–94080; File No. SR– CboeBZX–2021–039] Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order Disapproving a Proposed Rule Change To List and Trade Shares of the Wise Origin Bitcoin Trust Under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares January 27, 2022. I. Introduction On May 10, 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 Wise Origin 22 15 25 17 23 17 1 15 VerDate Sep<11>2014 17:19 Jan 31, 2022 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. Jkt 256001 PO 00000 Frm 00073 Fmt 4703 Sfmt 4703 5527 Bitcoin Trust (‘‘Trust’’) under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares. The proposed rule change was published for comment in the Federal Register on June 1, 2021.3 On July 13, 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 August 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 November 15, 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 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 3 See Securities Exchange Act Release No. 91994 (May 25, 2021), 86 FR 29321 (‘‘Notice’’). Comments on the proposed rule change can be found at: https://www.sec.gov/comments/sr-cboebzx-2021039/srcboebzx2021039.htm. 4 15 U.S.C. 78s(b)(2). 5 See Securities Exchange Act Release No. 92388, 86 FR 38163 (July 19, 2021). 6 15 U.S.C. 78s(b)(2)(B). 7 See Securities Exchange Act Release No. 92721, 86 FR 48272 (Aug. 27, 2021). 8 See Securities Exchange Act Release No. 93571, 86 FR 64979 (Nov. 19, 2021). On December 27, 2021, the Exchange filed Amendment No. 1 to the proposal. As discussed below, however, see Section III.E, infra, the Commission views this amendment as untimely. Furthermore, even if this amendment had been timely filed, it would not alter the Commission’s conclusion that the Exchange’s proposal is not consistent with the Exchange Act. See Section III.E. 9 15 U.S.C. 78f(b)(5). 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 29321. E:\FR\FM\01FEN1.SGM 01FEN1 5528 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices tkelley on DSK125TN23PROD with NOTICE 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 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’’); 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, Securities Exchange Act Release No. 93860 (Dec. 22, 2021), 86 FR 74166 (Dec. 29, 2021) (SR–CboeBZX–2021–029); Order Disapproving a Proposed Rule Change To List and Trade Shares of the Valkyrie Bitcoin Fund Under NYSE Arca Rule 8.201–E (Commodity-Based Trust Shares), Securities Exchange Act Release No. 93859 (Dec. 22, 2021), 86 FR 74156 (Dec. 29, 2021) (SR– NYSEArca–2021–31); Order Disapproving a Proposed Rule Change to List and Trade Shares of the First Trust SkyBridge Bitcoin ETF Trust Under NYSE Arca Rule 8.201–E, Securities Exchange Act Release No. 94006 (Jan. 20, 2022), 87 FR 3869 (Jan. 25, 2022) (SR–NYSEArca–2021–37). 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 VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 The standard requires such surveillance-sharing agreements since they ‘‘provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur.’’ 13 The Commission has emphasized that it is essential for an exchange listing a derivative securities product to enter into a surveillancesharing agreement with markets trading the underlying assets for the listing exchange to have the ability to obtain information necessary to detect, investigate, and deter fraud and market manipulation, as well as violations of exchange rules and applicable federal securities laws and rules.14 The hallmarks of a surveillance-sharing agreement are that the agreement provides for the sharing of information about market trading activity, clearing activity, and customer identity; that the parties to the agreement have reasonable ability to obtain access to and produce requested information; and that no existing rules, laws, or practices would impede one party to the agreement from obtaining this information from, or producing it to, the other party.15 In the context of this standard, the terms ‘‘significant market’’ and ‘‘market of significant size’’ include a market (or group of markets) as to which (a) there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on that market to successfully manipulate the ETP, so that a surveillance-sharing agreement would assist in detecting and deterring misconduct, and (b) it is unlikely that trading in the ETP would be the predominant influence on prices in that market.16 A surveillance-sharing agreement must be entered into with a ‘‘significant market’’ to assist in detecting and deterring manipulation of the ETP, because a person attempting to and accompanying text (discussing previous Commission approvals of commodity-futures ETPs). 13 See Amendment to Rule Filing Requirements for Self-Regulatory Organizations Regarding New Derivative Securities Products, Securities Exchange Act Release No. 40761 (Dec. 8, 1998), 63 FR 70952, 70959 (Dec. 22, 1998) (‘‘NDSP Adopting Release’’). See also Winklevoss Order, 83 FR at 37594; ProShares Order, 83 FR at 43936; GraniteShares Order, 83 FR at 43924; USBT Order, 85 FR at 12596. 14 See NDSP Adopting Release, 63 FR at 70959. 15 See Winklevoss Order, 83 FR at 37592–93; Letter from Brandon Becker, Director, Division of Market Regulation, Commission, to Gerard D. O’Connell, Chairman, Intermarket Surveillance Group (June 3, 1994), available at https:// www.sec.gov/divisions/marketreg/mr-noaction/ isg060394.htm. 16 See Winklevoss Order, 83 FR at 37594. This definition is illustrative and not exclusive. There could be other types of ‘‘significant markets’’ and ‘‘markets of significant size,’’ but this definition is an example that will provide guidance to market participants. See id. PO 00000 Frm 00074 Fmt 4703 Sfmt 4703 manipulate the ETP is reasonably likely to also engage in trading activity on that ‘‘significant market.’’ 17 Consistent with this standard, for the commodity-trust ETPs approved to date for listing and trading, there has been in every case at least one significant, regulated market for trading futures on the underlying commodity—whether gold, silver, platinum, palladium, or copper—and the ETP listing exchange has entered into surveillance-sharing agreements with, or held Intermarket Surveillance Group (‘‘ISG’’) membership in common with, that market.18 Moreover, the surveillance-sharing agreements have been consistently present whenever the Commission has approved the listing and trading of derivative securities, even where the underlying securities were also listed on national securities exchanges—such as options based on an index of stocks traded on a national securities exchange—and were thus subject to the Commission’s direct regulatory authority.19 Listing exchanges have also attempted to demonstrate that other means besides surveillance-sharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices, including that the bitcoin market as a whole or the relevant underlying bitcoin market is ‘‘uniquely’’ and ‘‘inherently’’ 17 See USBT Order, 85 FR at 12597. Winklevoss Order, 83 FR at 37594. 19 See USBT Order, 85 FR at 12597; Securities Exchange Act Release No. 33555 (Jan. 31, 1994), 59 FR 5619, 5621 (Feb. 7, 1994) (SR–Amex–93–28) (order approving listing of options on American Depository Receipts (‘‘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’’). 18 See E:\FR\FM\01FEN1.SGM 01FEN1 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices 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.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 Index (as defined herein) mitigate potential manipulation concerns and 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 29331. 25 See id. at 29332. 26 See id. at 29332–33. 27 See id. at 29324, 29327. tkelley on DSK125TN23PROD with NOTICE 21 See VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 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 certain risks associated with investing in operating companies that are 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. Based on its analysis, 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 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. 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 28 See 29 See PO 00000 id. at 29327. id. at 29324. Frm 00075 Fmt 4703 Sfmt 4703 5529 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. The investment objective of the Trust is to seek to track the performance of bitcoin, as measured by the Fidelity Bitcoin Index PR (‘‘Index’’), adjusted for the Trust’s expenses and other liabilities.31 Each Share will represent a fractional undivided beneficial interest in and ownership of 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.32 In seeking to achieve its investment objective, the Trust would hold bitcoin and value its Shares daily as of 4:00 p.m. E.T. using the same methodology used to calculate the Index. The Index is designed to reflect the performance of bitcoin in U.S. dollars and is calculated using bitcoin price feeds from eligible bitcoin spot platforms. The current platform composition of the Index is Bitstamp, Coinbase, Gemini, itBit, and Kraken. The Index market value would be the volume-weighted median price of bitcoin in U.S. dollars over the previous 30 See Notice, supra note 3. See also draft Registration Statement on Form S–1, dated March 24, 2021, submitted to the Commission by the Sponsor on behalf of the Trust (‘‘Registration Statement’’). 31 FD Funds Management LLC (‘‘Sponsor’’) is the sponsor of the Trust, Delaware Trust Company is the trustee, and Fidelity Service Company, Inc. will be the administrator (‘‘Administrator’’). A thirdparty transfer agent will facilitate the issuance and redemption of Shares of the Trust, respond to correspondence by Trust shareholders and others relating to its duties, maintain shareholder accounts, and make periodic reports to the Trust. An affiliate of the Sponsor, Fidelity Distributors Corporation, 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. Fidelity Digital Asset Services, LLC will serve as the Trust’s custodian (‘‘Custodian’’). The Index methodology was developed by Fidelity Product Services, LLC (‘‘Index Provider’’) and is administered by the Fidelity Index Committee. Coin Metrics, Inc. is the third-party calculation agent for the Index. The Sponsor’s affiliates have an ownership interest in Coin Metrics, Inc. See Notice, 86 FR at 29321, 29327 n.57, 29328–29, 29329 n.63. 32 See id. at 29328. E:\FR\FM\01FEN1.SGM 01FEN1 5530 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices five minutes, which would be calculated by (1) ordering all individual transactions on eligible spot platforms over the previous five minutes by price, and then (2) selecting the price associated with the 50th percentile of total volume.33 The net asset value (‘‘NAV’’) of the Trust is the total assets of the Trust including, but not limited to, all bitcoin and cash, if any, less total liabilities of the Trust, each determined on the basis of generally accepted accounting principles. The NAV per Share of the Trust would be calculated by taking the fair market value of its total assets based on the volume-weighted median price of bitcoin used for the calculation of the Index, subtracting any liabilities (which include accrued expenses), and dividing that total by the total number of outstanding Shares. The Administrator would calculate the NAV of the Trust once each Exchange trading day. The NAV for a normal trading day will be released after 4:00 p.m. E.T.34 The Trust will provide information regarding the Trust’s bitcoin holdings, as well as an Intraday Indicative Value (‘‘IIV’’) per Share updated every 15 seconds, as calculated by the Exchange or a third-party financial data provider during the Exchange’s Regular Trading Hours (9:30 a.m. to 4:00 p.m. E.T.). The IIV will be calculated by using the prior day’s closing NAV per Share as a base and updating that value during Regular Trading Hours to reflect changes in the value of the Trust’s bitcoin holdings during the trading day.35 When the Trust sells or redeems its Shares, it will do so in ‘‘in-kind’’ transactions in blocks of 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.36 III. Discussion tkelley on DSK125TN23PROD with NOTICE 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 33 See id. at 29329. id. at 29329–30. 35 See id. at 29329. 36 See id. at 29328–29. 34 See VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 investors and the public interest.’’ 37 Under the Commission’s Rules of Practice, the ‘‘burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued thereunder . . . is on the self-regulatory organization [‘SRO’] that proposed the rule change.’’ 38 The description of a proposed rule change, its purpose and operation, its effect, and a legal analysis of its consistency with applicable requirements must all be sufficiently detailed and specific to support an affirmative Commission finding,39 and any failure of an SRO to provide this information may result in the Commission not having a sufficient basis to make an affirmative finding that a proposed rule change is consistent with the Exchange Act and the applicable rules and regulations.40 Moreover, ‘‘unquestioning reliance’’ on an SRO’s representations in a proposed rule change is not sufficient to justify Commission approval of a proposed rule change.41 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 37 15 U.S.C. 78f(b)(5). Pursuant to Section 19(b)(2) of the Exchange Act, 15 U.S.C. 78s(b)(2), the Commission must disapprove a proposed rule change filed by a national securities exchange if it does not find that the proposed rule change is consistent with the applicable requirements of the Exchange Act. Exchange Act Section 6(b)(5) states that an exchange shall not be registered as a national securities exchange unless the Commission determines that ‘‘[t]he rules of the exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers, or to regulate by virtue of any authority conferred by this title matters not related to the purposes of this title or the administration of the exchange.’’ 15 U.S.C. 78f(b)(5). 38 Rule 700(b)(3), Commission Rules of Practice, 17 CFR 201.700(b)(3). 39 See id. 40 See id. 41 Susquehanna Int’l Group, LLP v. Securities and Exchange Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (‘‘Susquehanna’’). PO 00000 Frm 00076 Fmt 4703 Sfmt 4703 fraudulent and manipulative acts and practices are sufficient to justify dispensing with a comprehensive surveillance-sharing agreement with a regulated market of significant size, including by demonstrating that the bitcoin market as a whole or the relevant underlying bitcoin market is uniquely and inherently resistant to fraud and manipulation.42 Such resistance to fraud and manipulation must be novel and beyond those protections that exist in traditional commodities or securities markets.43 BZX asserts that bitcoin is resistant to price manipulation. According to BZX, the geographically diverse and continuous nature of bitcoin trading render it difficult and prohibitively costly to manipulate the price of bitcoin.44 Fragmentation across bitcoin platforms, the relatively slow speed of transactions, and the capital necessary to maintain a significant presence on each trading platform make manipulation of bitcoin prices through continuous trading activity challenging.45 To the extent that there are bitcoin platforms engaged in, or allowing, wash trading or other activity intended to manipulate the price of bitcoin on other markets, such pricing does not normally impact prices on other platforms because participants will generally ignore markets with quotes that they deem non-executable.46 BZX further argues that the linkage between the bitcoin markets and the presence of arbitrageurs in those markets means that the manipulation of the price of bitcoin on any single venue would require manipulation of the global bitcoin price in order to be effective.47 Arbitrageurs must have funds distributed across multiple trading platforms in order to take advantage of temporary price dislocations, thereby making it unlikely that there will be strong concentration of funds on any particular bitcoin trading venue.48 As a result, BZX concludes that ‘‘the potential for manipulation on a [bitcoin] trading platform would require overcoming the liquidity supply of such arbitrageurs 42 See USBT Order, 85 FR at 12597 n.23. The Commission is not applying a ‘‘cannot be manipulated’’ standard. Instead, the Commission is examining whether the proposal meets the requirements of the Exchange Act and, pursuant to its Rules of Practice, places the burden on the listing exchange to demonstrate the validity of its contentions and to establish that the requirements of the Exchange Act have been met. See id. 43 See id. at 12597. 44 See Notice, 86 FR at 29327 n.51. 45 See id. 46 See id. 47 See id. 48 See id. E:\FR\FM\01FEN1.SGM 01FEN1 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices who are effectively eliminating any cross-market pricing differences.’’ 49 As with the previous proposals, the Commission here concludes that the record does not support a finding that the bitcoin market is inherently and uniquely resistant to fraud and manipulation. BZX asserts that, because of how bitcoin trades occur, including through continuous means and through fragmented platforms, arbitrage across the bitcoin platforms essentially helps to keep global bitcoin prices aligned with one another, thus hindering manipulation. The Exchange, however, does not provide any data or analysis to support its assertions, either in terms of how closely bitcoin prices are aligned across different bitcoin trading venues or how quickly price disparities may be arbitraged away.50 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.51 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.52 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.53 Here, the Exchange provides no evidence to support its assertion of efficient price arbitrage across bitcoin platforms, let alone any evidence that price arbitrage in the bitcoin market is novel or unique so as to warrant the Commission dispensing with the requirement of a surveillancesharing agreement. Moreover, BZX does not take into account that a market participant with a dominant ownership position would not find it prohibitively 49 See id. example, the Registration Statement states that ‘‘[a]s the use of digital asset networks increases without a corresponding increase in throughput of the networks, average fees and settlement times can increase significantly,’’ and that such ‘‘[i]ncreased fees and decreased settlement speeds . . . could adversely impact the value of the Shares.’’ See Registration Statement at 15. BZX does not provide data or analysis to address, among other things, whether such risks of increased fees and bitcoin transaction settlement times may affect the arbitrage effectiveness that BZX asserts. See also infra note 64 and accompanying text (referencing statements made in the Registration Statement that contradict assertions made by BZX). 51 See supra note 41. 52 See Winklevoss Order, 83 FR at 37586; SolidX Order, 82 FR at 16256–57; USBT Order, 85 FR at 12601. 53 See, e.g., USBT Order, 85 FR at 12601. tkelley on DSK125TN23PROD with NOTICE 50 For VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 expensive to overcome the liquidity supplied by arbitrageurs and could use dominant market share to engage in manipulation.54 In addition, the Exchange makes the unsupported claim that bitcoin prices on platforms with wash trades or other activity intended to manipulate the price of bitcoin do not influence the ‘‘real’’ price of bitcoin. The Exchange also asserts that, to the extent that there are bitcoin platforms engaged in or allowing wash trading or other manipulative activities, market participants will generally ignore those platforms. However, without the necessary data 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.55 Additionally, the continuous nature of bitcoin trading does not eliminate manipulation risk, and neither do linkages among markets, as BZX asserts.56 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.57 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.58 According to BZX, in January 2020, for example, the cost to buy or sell $5 million worth of bitcoin averaged roughly 30 basis points (compared to 10 basis points in February 2021) with a market impact of 50 basis points (compared to 30 basis points in February 2021). For a $10 million market order, the cost to buy or sell was roughly 50 basis points (compared to 20 basis points in February 2021) with a market impact of 80 basis points (compared to 50 basis points in February 2021). BZX contends that as the liquidity in the bitcoin spot market increases, it follows that the impact of $5 million and $10 million orders will continue to decrease.59 54 See, e.g., Winklevoss Order, 83 FR at 37584; USBT Order, 85 FR at 12600–01. 55 See USBT Order, 85 FR at 12601. 56 See Winklevoss Order, 83 FR at 37585 n.92 and accompanying text. 57 See id. at 37585. 58 See Notice, 86 FR at 29328. 59 See id. PO 00000 Frm 00077 Fmt 4703 Sfmt 4703 5531 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.60 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.61 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,62 (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.63 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 60 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 29328 nn.58–59. 61 See USBT Order, 85 FR at 12601. 62 See supra note 55 and accompanying text. 63 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. E:\FR\FM\01FEN1.SGM 01FEN1 tkelley on DSK125TN23PROD with NOTICE 5532 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices and manipulation. For example, the Registration Statement acknowledges that ‘‘[platforms] on which bitcoin trades are relatively new and largely unregulated, and, therefore, may be more exposed to fraud and security breaches than established, regulated exchanges for other financial assets or instruments’’; that ‘‘[o]ver the past several years, a number of bitcoin spot markets have been closed or faced issues due to fraud, failure, security breaches or governmental regulations’’; that ‘‘[t]he nature of the assets held at bitcoin spot markets makes them appealing targets for hackers and a number of bitcoin spot markets have been victims of cybercrimes’’ and that ‘‘[n]o bitcoin [platform] is immune from these risks’’; that ‘‘many [bitcoin] spot markets lack certain safeguards put in place by more traditional exchanges to enhance the stability of trading on the [platform]’’; that ‘‘[a] lack of stability in the bitcoin spot markets, manipulation of bitcoin spot markets by customers and/or the closure or temporary shutdown of such [platforms] due to fraud, business failure, hackers or malware, or government-mandated regulation may reduce confidence in bitcoin generally and result in greater volatility in the market price of bitcoin and the Shares of the Trust’’ and that such ‘‘closure or temporary shutdown of a bitcoin spot market may impact the Trust’s ability to determine the value of its bitcoin holdings or for the Trust’s [a]uthorized [p]articipants to effectively arbitrage the Trust’s Shares’’; that ‘‘[t]he potential consequences of a spot market’s failure or failure to prevent market manipulation could adversely affect the value of the Shares’’; that many spot markets and over-the-counter (‘‘OTC’’) market venues ‘‘do not provide the public with significant information regarding their ownership structure, management teams, corporate practices or oversight of customer trading’’; and 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.’’ 64 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 Index, which is used to value the Trust’s bitcoin, is itself resistant to 64 See Registration Statement at 3, 8–9, 13. See also Winklevoss Order, 83 FR at 37585. VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 manipulation based on the Index’s methodology, as described above.65 According to the Exchange, ‘‘using rolling five-minute segments [to calculate the Index] means malicious actors would need to sustain efforts to manipulate the market over an extended period of time, or would need to replicate efforts multiple times across exchanges, potentially triggering review.’’ 66 The use of a median price reduces the ability of outlier prices to impact the NAV, as it systematically excludes those prices from the NAV calculation. The Exchange asserts that the use of a volume-weighted median (as opposed to a traditional median) serves as an additional protection against attempts to manipulate the NAV by executing a large number of lowdollar trades, because any manipulation attempt would have to involve a majority of global spot bitcoin volume in a three-minute window to have any influence on the NAV.67 Further, removing the highest and lowest prices further protects against attempts to manipulate the NAV, requiring bad actors to act on multiple exchanges at once to have any ability to influence the price.68 Simultaneously with the Exchange’s assertions regarding the Index, the Exchange also states that, because the Trust will engage in in-kind creations and redemptions, the ‘‘manipulability of the Index [is] significantly less important.’’ 69 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.’’ 70 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.71 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 65 See Notice, 86 FR at 29328. id. at 29329. According to the Exchange, this extended period also supports authorized participant activity by capturing volume over a longer time period, rather than forcing authorized participants to mark an individual close or auction. See id. 67 See id. 68 See id. 69 See id. at 29328. 70 See id. 71 See id. 66 See PO 00000 Frm 00078 Fmt 4703 Sfmt 4703 creations) or distribute (for redemptions) the same number of bitcoin regardless of the value.72 This, according to BZX, not only mitigates the risk associated with potential manipulation, but also discourages and disincentivizes manipulation of the Index because there is little financial incentive to do so.73 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 Index would make the proposed ETP resistant to fraud or manipulation such that a surveillancesharing agreement with a regulated market of significant size is unnecessary.74 Specifically, the Exchange has not assessed the possible influence that spot platforms not included among the Index’s constituent bitcoin platforms would have on bitcoin prices used to calculate the Index.75 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 other spot bitcoin platforms not directly used to calculate the Index affects prices on the Index’s constituent bitcoin platforms, the characteristics of those other spot bitcoin platforms—where various kinds of fraud and manipulation from a variety of sources may be present and persist 76—may affect whether the Index is resistant to manipulation. Moreover, the Exchange’s assertions that the Index’s methodology helps make the Index resistant to manipulation are contradicted by the Registration Statement’s own statements. Specifically, the Registration Statement states that ‘‘[s]pot markets on which bitcoin trades are relatively new and largely unregulated, and, therefore, may be more exposed to fraud and 72 See id. id. 74 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. 75 As discussed above, the Commission has no basis on which to conclude that bitcoin platforms are insulated from prices of others that engage in or permit fraud or manipulation. See supra note 55 and accompanying text. 76 See supra note 64 and accompanying text (describing, among other things, the risks associated with spot bitcoin markets that are new and largely unregulated). 73 See E:\FR\FM\01FEN1.SGM 01FEN1 tkelley on DSK125TN23PROD with NOTICE Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices security breaches than established, regulated exchanges for other financial assets or instruments’’; that ‘‘[o]ver the past several years, a number of bitcoin spot markets have been closed or faced issues due to fraud, failure, security breaches or governmental regulations’’; and that ‘‘[n]o bitcoin [platform] is immune from these risks’’ 77 Moreover, the Registration Statement specifically acknowledges that ‘‘[p]ricing sources used by the Index are digital asset spot markets that facilitate the buying and selling of bitcoin and other digital assets’’ and that ‘‘[a]lthough many pricing sources refer to themselves as ‘exchanges,’ they are not registered with, or supervised by, the SEC or CFTC and do not meet the regulatory standards of a national securities exchange or designated contract market.’’ 78 The Registration Statement further admits that ‘‘[t]he Index is based on various inputs which include price data from various third-party bitcoin spot markets’’ and [t]he Index Provider does not guarantee the validity of any of these inputs, which may be subject to technological error, manipulative activity, or fraudulent reporting from their initial source.’’ 79 The Registration Statement concludes that ‘‘[f]or these reasons, among others, purchases and sales of bitcoin may be subject to temporary distortions or other disruptions due to various factors . . . [which] could affect the price of bitcoin used in Index calculations and, therefore, could adversely affect the level of the Index.’’ 80 The Index constituent bitcoin platforms are a subset of the spot bitcoin trading venues 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 Index is resistant to fraud and manipulation. In addition, as described above, for purposes of calculating the Trust’s NAV per Share, the Trust’s holdings of bitcoin would be valued using the Index.81 Even though the Sponsor also raises concerns in the Registration Statement regarding manipulative activity and fraudulent reporting with respect to the inputs from the Index’s constituent bitcoin platforms, the Exchange does not sufficiently explain how or why such concerns are consistent with its assertion that the Index methodology, 77 See Registration Statement at 8. id. at 25. 79 See id. 80 See id. 81 See Notice, 86 FR at 29329. 78 See VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 and therefore the Trust’s NAV calculation, is resistant to fraud and manipulation. Second, BZX has not shown that its proposed use of a volume-weighted median price of bitcoin over time intervals of five minutes to calculate the Index market value 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.’’ 82 The Exchange does not connect the use of such partitions to the duration of the effects of fraudulently reported prices or other manipulative activity that may exist in the bitcoin spot market.83 Third, the Exchange does not explain the significance of the Index’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 Index 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 Index is resistant to manipulation, the Exchange simultaneously downplays the importance of the Index in light of the Trust’s in-kind creation and redemption mechanism.84 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.’’ 85 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.’’ 86 If the Index that the Trust 82 See USBT Order, 85 FR at 12601 n.66; see also id. at 12607. 83 See WisdomTree Order, 86 FR at 69327. 84 See supra notes 69–73 and accompanying text. 85 See Notice, 86 FR at 29328 (‘‘While the Sponsor believes that the Index 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 available in-kind makes the manipulability of the Index significantly less important.’’). 86 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 PO 00000 Frm 00079 Fmt 4703 Sfmt 4703 5533 uses to value the Trust’s bitcoin ‘‘is not particularly important,’’ it follows that the Index’s resistance to manipulation is not material to the Shares’ susceptibility to fraud and manipulation. As the Exchange does not address or provide any analysis with respect to these issues, the Commission cannot conclude that the Index aids in the determination that the proposal to list and trade the Shares is designed to prevent fraudulent and manipulative acts and practices. Finally, the Commission finds that BZX has not demonstrated that in-kind creations and redemptions provide the Shares with a unique resistance to manipulation. The Commission has previously addressed similar assertions.87 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.88 Accordingly, the Commission is not persuaded here that the Trust’s inkind creations and redemptions afford it a unique resistance to manipulation.89 (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 surveillanceTrust 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.’’). 87 See Winklevoss Order, 83 FR at 37589–90; USBT Order, 85 FR at 12607–08. 88 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). 89 Putting aside the Exchange’s various assertions about the nature of bitcoin and the bitcoin market, the Index, 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. E:\FR\FM\01FEN1.SGM 01FEN1 5534 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices 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.90 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.91 Accordingly, based on the common membership of BZX and the CME in the ISG,92 BZX has the equivalent of a comprehensive surveillance-sharing agreement with the CME. However, while the Commission recognizes that the CFTC regulates the CME futures market,93 including the CME bitcoin futures market, and thus such market is ‘‘regulated,’’ in the context of the proposed ETP, the record does not, as explained further below, establish that the CME bitcoin futures market is a ‘‘market of significant size’’ as that term is used in the context of the applicable standard here.94 (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 (a) Assertions by BZX The first prong in establishing whether the CME bitcoin futures market constitutes a ‘‘market of significant size’’ tkelley on DSK125TN23PROD with NOTICE 90 See Winklevoss Order, 83 FR at 37594. This definition is illustrative and not exclusive. There could be other types of ‘‘significant markets’’ and ‘‘markets of significant size,’’ but this definition is an example that provides guidance to market participants. See id. 91 See id. at 37580 n.19. 92 See Notice, 86 FR at 29327 n.54 and accompanying text. 93 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. 94 In the context of the proposed ETP, the Index’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. See WisdomTree Order, 86 FR at 69330 n.119. VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 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 2017.95 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.’’ 96 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.97 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 2019.98 Similarly, BZX contends that the number of large open interest holders 99 has continued to increase, even as the price of bitcoin has risen, as have the number of unique accounts trading CME bitcoin futures.100 In addition, the Sponsor, in a separate submission to the Commission, represents that ‘‘[b]etween Q1 2019 & Q2 2021, quarterly CME bitcoin futures volume grew more than 20x.’’ 101 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 95 According to BZX, each contract represents five bitcoin and is based on the CME CF Bitcoin Reference Rate. See Notice, 86 FR at 29325. 96 See id. 97 See id. 98 See id. 99 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 29325 n.47. 100 See id. at 29325. 101 See Submission by the Sponsor to the Commission in connection with a meeting between representatives of the Sponsor, BZX, and Commission staff on September 8, 2021, (‘‘Sponsor Submission’’) at 4, available at: https:// www.sec.gov/comments/sr-cboebzx-2021-039/ srcboebzx2021039-250110.pdf. PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 Index’s 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.102 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 2019.103 BZX concludes that a person attempting to manipulate the Shares would also have to trade on that market to manipulate the ETP.104 The Commission disagrees. The record does not demonstrate that there is a reasonable likelihood that a person attempting to manipulate the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate it. Specifically, BZX’s assertions about the general upward trends from 2018 to February 2021 in trading volume and open interest of, and in the number of large open interest holders and number of unique accounts trading in, CME bitcoin futures, as well as the Sponsor’s assertions about the growth in quarterly CME bitcoin futures volume from 2019 to 2021, do not establish that the CME bitcoin futures market is of significant size. While BZX provides data showing absolute growth in the size of the CME bitcoin futures market, it provides 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 surveillancesharing agreement and the proposed ETP.105 BZX’s recitation of data reflecting the size of the CME bitcoin futures market, alone, either currently or in relation to previous years, is not sufficient to establish an interrelationship between the CME 102 See Notice, 86 FR at 29327. id. at 29327 & n.48 (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’’)). 104 See id. at 29327. 105 See USBT Order, 85 FR at 12611. 103 See E:\FR\FM\01FEN1.SGM 01FEN1 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices bitcoin futures market and the proposed ETP.106 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.107 While BZX states that CME bitcoin futures pricing leads the spot market,108 it relies on the findings of a price discovery analysis in one section of a single academic paper to support the overall thesis.109 However, the findings of that paper’s Granger causality analysis, which is widely used to formally test for lead-lag relationships, are concededly mixed.110 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.111 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 106 See id. at 12612. id. 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. 108 See Notice, 86 FR at 29327. 109 See supra note 103 and accompanying text. BZX references the following conclusion from the ‘‘time-varying price discovery’’ section of Hu, Hou & Oxley: ‘‘There exist no episodes where the Bitcoin spot markets dominates the price discovery processes with regard to Bitcoin futures. This points to a conclusion that the price formation originates solely in the Bitcoin futures market. We can, therefore, conclude that the Bitcoin futures markets dominate the dynamic price discovery process based upon time-varying information share measures. Overall, price discovery seems to occur in the Bitcoin futures markets rather than the underlying spot market based upon a time-varying perspective . . .’’ See Notice, 86 FR at 29327 n.48. 110 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 103. 111 See USBT Order, 85 FR at 12609. tkelley on DSK125TN23PROD with NOTICE 107 See VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 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.112 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.113 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.114 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.115 In the 112 See id. at 12613 n.244. id. 114 See Susquehanna, 866 F.3d at 447. 115 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) (‘‘Kapar & Olmo’’); E. Akyildirim, S. Corbet, P. Katsiampa, N. Kellard & A. Sensoy, The development of Bitcoin futures: Exploring the interactions between cryptocurrency derivatives, 34 Fin. Res. Letters 101234 (2020) (finding that bitcoin futures dominate price discovery); A. Fassas, S. Papadamou, & A. Koulis, Price discovery in bitcoin futures, 52 Res. Int’l Bus. Fin. 101116 (2020) (finding that bitcoin futures play a more important role in price discovery) (‘‘Fassas et al’’); S. Aleti & B. Mizrach, Bitcoin spot and futures market microstructure, 41 J. Futures Mkts. 194 (2021) (finding that relatively more price discovery occurs on the CME as compared to four spot exchanges); J. Wu, K. Xu, X. Zheng & J. Chen, Fractional cointegration in bitcoin spot and futures markets, 41 J. Futures Mkts. 1478 (2021) (finding that CME bitcoin futures dominate price discovery). See also C. Alexander & D. Heck, Price discovery in Bitcoin: The impact of unregulated markets, 50 J. Financial Stability 100776 (2020) (finding that, in a multidimensional setting, including the main price leaders within futures, perpetuals, and spot markets, CME bitcoin futures have a very minor 113 See PO 00000 Frm 00081 Fmt 4703 Sfmt 4703 5535 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.116 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.117 (b) Sponsor Submission While BZX does not provide in its filing results of its own analysis nor presents any other data to support its conclusion that CME bitcoin futures pricing leads the spot market, the Sponsor in the Sponsor Submission provides information to show that the CME bitcoin futures market leads price discovery across global USD and USDT bitcoin futures and spot markets. The Sponsor states that its findings are based on tick level trade data aggregated in one-second intervals for USD and USDT bitcoin spot and futures prices from Coin Metrics spanning January 1, 2019, to March 31, 2021. According to the Sponsor, the data for futures includes both ordinary and perpetual futures. The Sponsor explains that its dataset is limited to BTC–USD and BTC–USDT trades to exclude any impact caused by exchange rate movements. With respect to whether the CME bitcoin futures market leads the spot markets or vice versa, the Sponsor concedes that ‘‘conclusions are mixed.’’ The Sponsor attributes the lack of agreement to the use of classic metrics derived from the Vector Error Correction Model (‘‘VECM’’), which it states likely involves ‘‘substantial imputation’’ when used with data sets such as CME bitcoin futures trading data. This imputation, effect on price discovery; and that faster speed of adjustment and information absorption occurs on the unregulated spot and derivatives platforms than on CME bitcoin futures) (‘‘Alexander & Heck’’). 116 See USBT Order, 85 FR at 12613 nn.239–244 and accompanying text. 117 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 Index constituent bitcoin platforms, or where price formation occurs when the entirety of bitcoin futures markets, not just the CME, is considered. E:\FR\FM\01FEN1.SGM 01FEN1 5536 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices tkelley on DSK125TN23PROD with NOTICE the Sponsor argues, ‘‘can produce biased results.’’ 118 In contrast, the Sponsor argues that its analysis accounts for the characteristics of CME bitcoin futures trading data by applying the Hayashi-Yoshida (‘‘HY’’) estimator. According to the Sponsor, the use of the HY estimator is more suitable for ‘‘disparate and infrequent data,’’ as it is free from imputation, and it has also previously proven useful in price discovery research, including bitcoin spot markets.119 Based on its analysis, the Sponsor argues that the results demonstrate that the CME bitcoin futures market has consistently led bitcoin price discovery across global USD bitcoin markets.120 As a result of its study, the Sponsor concludes that there is a reasonable likelihood that a person attempting to manipulate the ETP would have to trade in the CME bitcoin futures market because: (1) The CME bitcoin futures market leads in bitcoin price discovery across USDbased trading in bitcoin futures and spot markets globally; and (2) arbitrage between the CME bitcoin futures market and spot markets would tend to counter an attempt to manipulate the spot market alone.121 The Sponsor Submission does not provide sufficient evidence for the Commission to conclude that it is reasonably likely that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP. By applying its selected analytical method, the Sponsor presents conclusory results that suggest that CME bitcoin futures lead price discovery. Even if the Commission were to accept these results at face value, the Sponsor has not demonstrated that other analyses that reached different and opposite conclusions were, in fact, ‘‘spurious’’ results, or otherwise were results on which the Commission cannot reasonably rely. In fact, the Sponsor highlights that in the academic literature, ‘‘conclusions are mixed’’ on the lead-lag relationship between 118 See Sponsor Submission at 8. The Sponsor states that prior lead-lag studies employ methods that assume that the prices/returns under consideration are synchronous and so adjustments need to be made for non-synchronous and/or infrequent data. According to the Sponsor, adjustments such as imputation or synchronous sampling can lead to ‘‘spurious results’’ for these methods. See id. at 19. 119 See id. at 8. The Sponsor further explains that, due to the ‘‘high sparsity’’ of CME futures data, the framework of correlation-based lead-lag analysis using the HY estimator is more suitable because this approach is free from any imputation or sampling and has proven useful in price discovery research. See id. at 19. 120 See id. at 9. 121 See id. at 7. VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 bitcoin spot and futures markets. Namely, there are analytical methodologies that lead to the conclusion that the spot market price leads the CME futures price, those that conclude that the CME futures price leads the spot market price, as well as those that conclude that unregulated futures markets lead the CME futures market in price discovery.122 While the Sponsor dismisses the validity of these other results due to the theoretical possibility that imputation or synchronous sampling can lead to spurious or unreliable results, it does not provide any detail to support that any of the other results are actually inaccurate. Moreover, the Commission cannot accept the Sponsor’s results at face value based on the extent of the information it provides. While the Sponsor provides in graphs aggregate average ‘‘lead’’ times (in seconds) that suggest that the CME futures market has the largest ‘‘lead’’ in each quarter of the sample period, the Sponsor does not provide the specific results of each of its pairwise assessments (e.g., CME compared to Coinbase; CME compared to Gemini; etc.) or—crucially—the Sponsor’s confidence intervals around each such pairwise result. Provision of pairwise results and confidence intervals is common in the academic literature that the Sponsor itself cites in the Sponsor Submission.123 The Commission is thus unable to assess the Sponsor’s specific results or statistical significance of those results. Confidence intervals are particularly important, given that the Sponsor’s results show that the ‘‘lead’’ of the CME bitcoin futures market has steadily decreased over the sample period to within about one second of ‘‘lead’’ time, which is the tick data aggregation interval for the study, and to below one second compared to the leading non-regulated USD bitcoin futures market. The Sponsor also has not discussed whether its findings are sensitive to its choice to aggregate tick level trade data into onesecond intervals, particularly as the estimated ‘‘lead’’ times decrease over the sample period; or whether the Sponsor’s critique of other studies—that imputation or synchronous sampling can lead to ‘‘spurious’’ or otherwise unreliable results—applies to its findings as well because of the aggregation that the Sponsor used. Further, the Sponsor has not discussed the robustness of its two-dimensional methodology—which examines pairwise lead-lag relationships within and across the bitcoin spot and futures markets—to the critique in the multidimensional Alexander & Heck study that: ‘‘omitting substantial information flows from other markets can produce misleading results . . . . [I]n a twodimensional model one or other of the instruments must necessarily be identified as price leader.’’ 124 The Commission accordingly concludes that the information provided in the record for this proposal does not establish a reasonable likelihood that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP. Therefore, the information in the record also does not establish that the CME bitcoin futures market is a ‘‘market of significant size’’ with respect to the proposed ETP. (ii) Whether It Is Unlikely That Trading in the Proposed ETP Would Be the Predominant Influence on Prices in the CME Bitcoin Futures Market The second prong in establishing whether the CME bitcoin futures market constitutes a ‘‘market of significant size’’ is the determination that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market.125 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.126 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.127 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 124 See Alexander & Heck, supra note 115, at 2. Winklevoss Order, 83 FR at 37594; USBT Order, 85 FR at 12596–97. 126 See Notice, 86 FR at 29328. 127 See id. According to BZX, these statistics are based on samples of bitcoin liquidity in U.S. dollars (excluding stablecoins or Euro liquidity) based on executable quotes on Coinbase Pro, Gemini, Bitstamp, Kraken, LMAX Exchange, BinanceUS, and OKCoin during February 2021. See id. nn.58– 59. 125 See 122 The Sponsor points to Kapar & Olmo and Fassas et al. as results that suggest that CME futures lead the spot markets, and to Alexander & Heck as results that suggest that CME futures lag. See id. at 8. See also supra note 115. 123 See, e.g., Sponsor Submission (citing B. Schei, High Frequency Lead-Lag Relationships in the Bitcoin Market, Copenhagen Business School Master’s Thesis (2019) (unpublished)). PO 00000 Frm 00082 Fmt 4703 Sfmt 4703 E:\FR\FM\01FEN1.SGM 01FEN1 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices buy or sell order for $10 million of bitcoin and only move the market 0.5 percent.128 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.129 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 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.130 In its submission, the Sponsor similarly argues that the CME futures market-leading price discovery across USD-based bitcoin trading markets, as well as its aggregate significant trading volume and liquidity, make it unlikely that trading in a bitcoin ETP would be the predominant influence on prices in CME bitcoin futures.131 Specifically, the Sponsor concludes that it is unlikely that trading in a bitcoin ETP would be the predominant influence on CME bitcoin futures market or bitcoin spot prices because of: (1) The CME bitcoin futures market leading in bitcoin price discovery across USD-based trading in bitcoin futures and spot markets globally; (2) significant trading volume in USD-based bitcoin futures; and (3) the highly liquid bitcoin spot market.132 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 and the Sponsor’s assertions—that CME bitcoin futures leads price discovery 133—the Commission will only address below the other bases—the overall size, volume, and liquidity of, and the impact 128 See id. at 29328. id. 130 See id. 131 See Sponsor Submission at 7. 132 See id. The Sponsor states that bitcoin trading volume and market capitalization has continued to grow (2019 Q1–2021 Q2), see Sponsor Submission at 10, and that spot trading costs and market impact have decreased over the last year (January 2020– February 2021), see id. 133 See supra notes 107–124 and accompanying text. tkelley on DSK125TN23PROD with NOTICE 129 See VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 of buys and sells on, the CME bitcoin futures market and spot bitcoin market. BZX’s and the Sponsor’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. Thus, the Commission cannot conclude, based on BZX’s and the Sponsor’s statements alone and absent any evidence or analysis in support of BZX’s and the Sponsor’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.134 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 134 See Notice, 86 FR at 29328 (‘‘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%.’’). PO 00000 Frm 00083 Fmt 4703 Sfmt 4703 5537 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 and the Sponsor have not provided sufficient information to establish both prongs of the ‘‘market of significant size’’ determination, the Commission cannot conclude that the CME bitcoin futures market is a ‘‘market of significant size’’ such that BZX would be able to rely on a surveillance-sharing agreement with the CME to provide sufficient protection against fraudulent and manipulative acts and practices. The requirements of Section 6(b)(5) of the Exchange Act apply to the rules of national securities exchanges. Accordingly, the relevant obligation for a comprehensive surveillance-sharing agreement with a regulated market of significant size, or other means to prevent fraudulent and manipulative acts and practices that are sufficient to justify dispensing with the requisite surveillance-sharing agreement, resides with the listing exchange. Because there is insufficient evidence in the record demonstrating that BZX has satisfied this obligation, the Commission cannot approve the proposed ETP for listing and trading on BZX. C. Whether BZX Has Met Its Burden To Demonstrate That the Proposal Is Designed To Protect Investors and the Public Interest BZX contends that, if approved, the proposed ETP would protect investors and the public interest. However, the Commission must consider these potential benefits in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act.135 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.136 Specifically, BZX argues that premium and discount volatility, high fees, insufficient disclosures, and 135 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. 136 See Notice, 86 FR at 29331. E:\FR\FM\01FEN1.SGM 01FEN1 5538 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices 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.137 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 certain risks associated with investing in operating companies that are proxies for bitcoin exposure.138 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.’’ 139 BZX represents that, historically, OTC bitcoin funds have traded at significant premiums or discounts compared to their NAV.140 BZX argues that, in contrast, a bitcoin ETP would provide an alternative to OTC bitcoin funds offering investors access to direct bitcoin exposure with real time trading and transparency on pricing/valuation, liquidity, and active arbitrage—advantages of the ETP structure.141 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.142 BZX also asserts that exposure to bitcoin through an ETP also presents advantages for investors compared to buying spot bitcoin directly.143 BZX asserts that, without the advantages of an ETP, an investor holding bitcoin through a cryptocurrency trading platform lacks protections.144 BZX explains that, typically, OTC trading platforms hold most, if not all, investors’ bitcoin in ‘‘hot’’ (internetconnected) storage and do not make any commitments to indemnify investors or to observe any particular cybersecurity standard.145 Meanwhile, an investor holding spot bitcoin directly in a selfhosted 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.146 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.147 Thus, with respect to custody of the Trust’s bitcoin assets, BZX concludes that, compared to owning spot bitcoin directly, the Trust presents advantages for investors.148 BZX further asserts that a number of operating companies engaged in unrelated businesses have announced investments as large as $1.5 billion in bitcoin.149 Without access to bitcoin ETPs, BZX argues that investors seeking investment exposure to bitcoin may purchase shares in these companies in order to gain the exposure to bitcoin that they seek.150 BZX contends that such operating companies, however, are imperfect bitcoin proxies and provide investors with partial or indirect bitcoin exposure paired with additional risks associated with whichever operating company they decide to purchase.151 BZX also states that investors in many other countries, including Canada, are able to use more traditional exchangelisted and traded products to gain exposure to bitcoin, disadvantaging U.S. investors and leaving them with more risky means of getting bitcoin exposure.152 144 See tkelley on DSK125TN23PROD with NOTICE 137 See id. 138 See id. at 29324. 139 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 29324 n.39. 140 See id. at 29324. 141 See id. 142 See letter from Anonymous, dated June 17, 2021 (‘‘Anonymous Letter’’). 143 See Notice, 86 FR at 29324. VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 id. id. 146 See id. 147 See id. 148 See id. 149 See id. 150 See id. 151 See id. 152 See id. at 29323. BZX represents that the Purpose Bitcoin ETF, a 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 145 See PO 00000 Frm 00084 Fmt 4703 Sfmt 4703 In essence, BZX asserts that the risky nature of direct investment in the underlying bitcoin and the unregulated markets on which bitcoin and OTC bitcoin funds trade compel approval of the proposed rule change. 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.153 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.154 Here, even if it were true that, compared to trading in unregulated bitcoin spot markets, trading a bitcoinbased ETP on a national securities exchange provides some additional protection to investors, the Commission must consider this potential benefit in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act.155 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 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 29323 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 29323 n.37. See also Anonymous Letter (stating that ‘‘institutions can simply buy the Canadian ETFs, leaving US retail investors holding the bag’’ and that ‘‘[a]pproving an [ETP] in the US will correct this imbalance quickly and give relief to US-based investors who are stuck with an asset that is trading at a discount to NAV.’’). 153 See Exchange Act Section 19(b)(2)(C), 15 U.S.C. 78s(b)(2)(C). 154 See SolidX Order, 82 FR at 16259; WisdomTree Order, 86 FR at 69334. 155 See supra note 135. E:\FR\FM\01FEN1.SGM 01FEN1 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices listing exchange has not met that requirement here. Therefore, the Commission is unable to find that the proposed rule change is consistent with the statutory standard. Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must disapprove a proposed rule change filed by a national securities exchange if it does not find that the proposed rule change is consistent with the applicable requirements of the Exchange Act— including the requirement under Section 6(b)(5) that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices.156 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),157 and, accordingly, the Commission must disapprove the proposal.158 D. Other Comments Comment letters also address the general nature and uses of bitcoin; 159 the inherent value of bitcoin; 160 and the desire of investors to gain access to bitcoin through an ETP.161 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. E. The Exchange’s Untimely Amendment to the Proposal The deadline for rebuttal comments in response to the Order Instituting Proceedings was October 1, 2021.162 On December 27, 2021, the Exchange filed Amendment No. 1 to the proposed rule change to amend and replace in its entirety the proposal as submitted on May 10, 2021. Because this amendment was filed months after the deadline for comments on the proposed rule change, the Commission deems Amendment No. 1 to have been untimely filed.163 Even if the amendment had been timely filed, the Commission would still conclude that the Exchange has not met its burden to demonstrate that its proposal is consistent with Exchange Act Section 6(b)(5). The Exchange 156 See 15 U.S.C. 78s(b)(2)(C). U.S.C. 78f(b)(5). 158 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). 159 See letter from Sam Ahn, dated June 8, 2021 (‘‘Ahn Letter’’). 160 See Ahn Letter. 161 See Anonymous Letter; Sponsor Submission at 4–5. 162 See supra note 7. 163 The untimely filing of Amendment No. 1 also does not allow the Commission sufficient time to solicit public comment. tkelley on DSK125TN23PROD with NOTICE 157 15 VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 makes four primary changes in the amendment.164 First, the Exchange argues that, based on a review of the Commission’s past approvals and disapprovals of ETPs, the applicable standard does not require the underlying commodity market to be regulated, but rather requires that the listing exchange has in place a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying commodity. The Exchange states that, therefore, the CME bitcoin futures market is the proper market for the Commission to consider in determining whether the proposal is consistent with the Exchange Act. The Commission does not disagree. As the Commission has clearly and consistently stated, an exchange that lists bitcoin-based ETPs can meet its obligation under Exchange Act Section 6(b)(5) that its rules be designed to prevent fraudulent and manipulative acts and practices 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.165 As discussed in detail in Section III.B.2, the Commission has considered the Exchange’s arguments with respect to the CME bitcoin futures market, and the Commission concludes that the Exchange has failed to demonstrate that the CME bitcoin futures market is such a ‘‘market of significant size.’’ Second, the Exchange incorporates a version of the Sponsor Submission’s lead-lag analysis into the amendment.166 The Exchange states that the Sponsor attributes the ‘‘mixed results’’ in previous academic studies that have failed to demonstrate that the CME bitcoin futures market constitutes a market of significant size to the problems associated with high sparsity of some of the data used, the VECM econometric approach, and imputation of price data. The Sponsor believes that its framework of correlation-based leadlag analysis using the HY estimator is more suitable.167 The amendment includes a new table, not in the original Sponsor Submission, that asserts that— although the ‘‘lead’’ in seconds of the CME bitcoin futures market has steadily decreased over the sample period—the ‘‘strength’’ of CME bitcoin futures price 164 In addition, in Amendment No. 1, among other things, the Exchange amends its description of the Trust, the Index, the Custodian, and the CME bitcoin futures market. 165 See supra notes 11 and 12 and accompanying text. 166 See supra Section III.B.2.i.b. 167 See supra note 119 and accompanying text. PO 00000 Frm 00085 Fmt 4703 Sfmt 4703 5539 leadership has not deteriorated based on the ‘‘ratio’’ of the CME bitcoin futures market’s ‘‘average lead among all markets over the absolute average of every market’s overall lead-lag.’’ However, the incorporation of the Sponsor’s lead-lag analysis still contains the same shortcomings as the Sponsor’s original submission.168 The amendment elaborates on the potential bias that imputation or sampling for nonsynchronous and/or infrequent data can introduce into results by citing an academic study by Buccheri et al.169 that investigates the difficulties to identifying price discovery with VECM models due to the high sparsity of data in markets that record trades at the submillisecond level. The Exchange asserts that there is such ‘‘high sparsity’’ in CME bitcoin futures data, but provides no information that verifies this assertion. Further, even assuming CME bitcoin futures data has such ‘‘high sparsity’’ and that VECM-derived metrics using CME bitcoin futures data ‘‘are potentially biased,’’ neither the Exchange nor the Sponsor demonstrates that the Buccheri et al. critique of VECM methods applications to submillisecond frequencies actually applies to the bitcoin price data analyses and that the mixed conclusions in previous academic studies on whether the CME bitcoin futures market leads or lags bitcoin price discovery were inaccurate or misleading. With respect to the Sponsor’s own results using the HY estimator, the amendment still does not provide the specific results for each pairwise leadlag analysis, or confidence intervals around such results; it merely provides aggregated results that show the average lead-lag that a market has with all other markets in a quarter.170 Even accepting the results at face value and assuming their statistical significance, the Exchange has not explained why the ‘‘ratio’’ of the CME bitcoin futures market’s lead over other markets is a better indicator of the ‘‘strength’’ of price leadership than the absolute average lead time in seconds. In particular, the Exchange has not explained how such ‘‘ratio’’ provides evidence that it is reasonably likely that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to manipulate the proposed ETP, notwithstanding that— accepting the Sponsor’s results—the CME’s absolute average lead in seconds 168 See supra Section III.B.2.i.b. Buccheri, G. Bormetti, F. Corsi & F. Lillo, Comment on: Price discovery in high resolution, 19 J. Financial Econometrics 439 (2021). 170 See supra note 123 and accompanying text. 169 G. E:\FR\FM\01FEN1.SGM 01FEN1 tkelley on DSK125TN23PROD with NOTICE 5540 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices has steadily decreased over time as, in the Exchange’s words, ‘‘the window of arbitrage opportunity has closed with increasing speed.’’ The Sponsor’s analysis is thus flawed for these reasons. In any event, the Sponsor’s analysis would constitute a result that is merely part of the ‘‘mixed conclusions’’ of studies on this topic without establishing a more definitive result from which the Commission could conclude that there is 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, and thus the Sponsor has not established that that the CME bitcoin futures market is a ‘‘market of significant size’’ with respect to the proposed ETP. Third, the amendment sets forth new arguments to establish that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market. According to the Exchange, a lead-lag analysis performed by the Sponsor concludes that the CME bitcoin futures market continues to ‘‘lead’’ price discovery after the launch of the ProShares Bitcoin Strategy ETF (‘‘BITO’’),171 even though the trading volume on CME increased significantly after the launch. The Exchange states that it would be unreasonable to assume that such price leadership would deteriorate with increased trade activity in the spot market. The Exchange also presents a lead-lag analysis of BITO performed by the Sponsor to show that there is no significant lead-lag relationship between BITO and other bitcoin markets, and that BITO, as a general bitcoin ETP example, only has a minor impact on price discovery in the bitcoin markets. The Exchange states that it believes there would similarly be no material relationship between the Shares and the CME bitcoin futures market. The Exchange further states that, in the gold market, which it believes is an analogous market to bitcoin in terms of price discovery, futures lead price discovery despite the spot market having 10 times more volume. Finally, the Exchange states that trading of the Shares on the secondary market could have a ‘‘positive impact’’ on the CME bitcoin futures market’s leading position because CME bitcoin futures are used in hedging activities by market 171 The Exchange states that the Sponsor selected BITO for its analysis as BITO is a Commissionregistered ETF that seeks to invest primarily in CME bitcoin futures contracts, is listed and traded on a US regulated national securities exchange, and was launched on October 18, 2021. VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 participants. The Exchange states that ‘‘[g]iven there is a lag between the secondary market transaction, the striking of NAV per Share in the primary market and the settlement of the primary market transaction,’’ authorized participants will seek to hedge their exposure through the use of bitcoin futures. The Commission does not have the opportunity to consider these new ‘‘predominant influence’’ contentions and the statistical analyses that underlie them given the untimeliness of Amendment No. 1. In any event, no contention has sufficient detail to demonstrate that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market. Among other things, the description of the leadlag analysis regarding the launch of BITO lacks confidence intervals, and thus the Commission is unable to assess the specific results or statistical significance of those results. Moreover, even accepting the results at face value and assuming their statistical significance, the Exchange does not explain why results that show that increased trading volume in CME bitcoin futures did not reduce CME bitcoin futures’ price leadership should also be considered to support the proposition that increased trading volume in spot bitcoin as a result of the proposed ETP also would not reduce CME bitcoin futures’ price leadership. Moreover, the relevant question is not the impact of the proposed ETP on CME bitcoin futures’ price leadership, but on CME bitcoin futures prices themselves. The Sponsor’s lead-lag analysis does not address this. Further, with respect to the BITO lead-lag analysis, neither the Exchange nor the Sponsor provides any rationale for why it is reasonable to consider BITO—a CME bitcoin futuresbased fund—to be relevant in the analysis regarding a spot bitcoin-based product such as the proposed ETP. Nor does the Exchange or the Sponsor explain why results that purport to indicate that BITO does not have significant price leadership over other bitcoin markets in general should also be considered evidence that the proposed ETP likely would not have significant price leadership over CME bitcoin futures in particular.172 Further, even assuming the Exchange’s summary of the academic literature regarding price discovery in the gold market is 172 Nor does the Exchange explain why the results should be considered evidence that trading in the proposed ETP likely would not have a predominant influence on CME bitcoin futures prices, as the applicable standard requires. PO 00000 Frm 00086 Fmt 4703 Sfmt 4703 accurate, it does not help the Exchange to meet its burden with respect to the proposed ETP.173 For example, except to conclude summarily that gold and bitcoin markets are ‘‘analogous,’’ the Exchange provides no explanation as to why price discovery results from the gold market would shed light on price discovery in the bitcoin market. In any event, as noted above, the Exchange has not explained the connection between price discovery results and whether trading in the proposed ETP would likely be the predominant influence on prices in the CME bitcoin futures market. Finally, even if, as the Exchange claims, authorized participants would use bitcoin futures to hedge any gap between their primary market and secondary market transactions, the Exchange has not explained why such participants would use the CME bitcoin futures market, as opposed to other bitcoin futures markets. Fourth, citing the recent launch of exchange-traded funds that provide exposure to bitcoin through CME bitcoin futures (‘‘Bitcoin Futures ETFs’’), the Exchange claims that ‘‘there is no basis for determining that the Bitcoin Futures ETFs satisfy Section 6(b)(5) of the Exchange Act while the Trust does not.’’ The Exchange asserts that Bitcoin Futures ETFs and the Trust are ‘‘exposed to the same underlying pricing data and the same risks of manipulation,’’ and thus are ‘‘substantially similar products.’’ The Commission disagrees with the premise of these arguments. Among other things, the proposed rule change does not relate to the same underlying holdings as the Bitcoin Futures ETFs. The Commission considers the proposed rule change on its own merits and under the standards applicable to it. Namely, with respect to this proposed rule change, the Commission must apply the standards as provided by Section 6(b)(5) of the Exchange Act, which it has applied in connection with its orders considering previous proposals to list bitcoin-based commodity trusts and bitcoin-based trust issued receipts.174 173 See USBT Order, 85 FR at 12613. supra note 11. Moreover, the Exchange has not established that the Trust and the Bitcoin Futures ETFs have the ‘‘same pricing sources.’’ While the five constituent bitcoin platforms that currently underlie the Index are the same platforms that currently underlie the CME CF Bitcoin Reference Rate, even assuming the Index would generally track the CME CF Bitcoin Reference Rate, as discussed above in Section III.B.1, the Index is only used to value the Trust’s bitcoin for purposes of calculating NAV. The Shares, by contrast, would trade at market-based prices in the secondary market, not at NAV. See supra note 81 and subsequent text. 174 See E:\FR\FM\01FEN1.SGM 01FEN1 Federal Register / Vol. 87, No. 21 / Tuesday, February 1, 2022 / Notices Accordingly, even if the Exchange’s Amendment No. 1 had been timely filed, there is no additional information in such amendment that would enable the Commission to approve the proposed rule change as amended. 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–2021–039 be, and hereby is, disapproved. By the Commission. Vanessa A. Countryman, Secretary. [FR Doc. 2022–02001 Filed 1–31–22; 8:45 am] SECURITIES AND EXCHANGE COMMISSION [Release No. 34–94064; File No. SR– NASDAQ–2022–007] Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Reduce NOM’s Options Regulatory Fee January 26, 2022. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’), 1 and Rule 19b–4 thereunder,2 notice is hereby given that on January 20, 2022, The Nasdaq Stock Market LLC (‘‘Nasdaq’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed rule change as described in Items I and II, below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. tkelley on DSK125TN23PROD with NOTICE I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend The Nasdaq Options Market LLC’s (‘‘NOM’’) Pricing Schedule at Options 7, Section 5 to reduce the NOM Options Regulatory Fee or ‘‘ORF’’. 2 17 U.S.C. 78s(b)(1). CFR 240.19b–4. VerDate Sep<11>2014 17:19 Jan 31, 2022 Jkt 256001 II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change BILLING CODE 8011–01–P 1 15 While the changes proposed herein are effective upon filing, the Exchange has designated the amendments become operative on February 1, 2022. The text of the proposed rule change is available on the Exchange’s website at https://listingcenter.nasdaq.com/ rulebook/nasdaq/rules, at the principal office of the Exchange, and at the Commission’s Public Reference Room. 1. Purpose NOM previously filed to waive its ORF from October 1, 2021 through January 31, 2022.3 The Waiver Filing provided that NOM would continue monitoring the amount of revenue collected from the ORF to determine if regulatory revenues would exceed regulatory costs when it recommenced assessing ORF on February 1, 2022. If so, the Exchange committed to adjust its ORF.4 At this time, after a review of its regulatory revenues and regulatory costs, the Exchange proposes to reduce the ORF from $0.0020 (the amount of the ORF prior to the waiver) to $0.0016 per contract side as of February 1, 2022, to ensure that revenue collected from the ORF, in combination with other regulatory fees and fines, does not exceed the Exchange’s total regulatory costs. The options industry continues to experience high options trading volumes and volatility. At this time, NOM believes that the options volume it experienced in the second half of 2021 is likely to persist into 2022. The anticipated options volume would impact NOM’s ORF collection which, in 3 See Securities Exchange Act Release No. 92600 (August 6, 2021), 86 FR 44455 (August 12, 2021) (SR–NASDAQ–2021–057) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Amend NOM’s Options Regulatory Fee) (‘‘Waiver Filing’’). 4 Id at 44456. PO 00000 Frm 00087 Fmt 4703 Sfmt 4703 5541 turn, has caused NOM to propose reducing the ORF to ensure that revenue collected from the ORF, in combination with other regulatory fees and fines, would not exceed the Exchange’s total regulatory costs. Collection of ORF Upon recommencement of the ORF on February 1, 2022,5 NOM will assess its ORF for each customer option transaction that is either: (1) Executed by a Participant on NOM; or (2) cleared by a NOM Participant at The Options Clearing Corporation (‘‘OCC’’) in the customer range,6 even if the transaction was executed by a non-Participant of NOM, regardless of the exchange on which the transaction occurs.7 If the OCC clearing member is a NOM Participant, ORF will be assessed and collected on all cleared customer contracts (after adjustment for CMTA 8); and (2) if the OCC clearing member is not a NOM Participant, ORF will be collected only on the cleared customer contracts executed at NOM, taking into account any CMTA instructions which may result in collecting the ORF from a non-member.9 In the case where a Participant both executes a transaction and clears the transaction, the ORF will be assessed to and collected from that Participant. In the case where a Participant executes a transaction and a different member clears the transaction, the ORF will be assessed to and collected from the Participant who clears the transaction and not the Participant who executes the transaction. In the case where a nonmember executes a transaction at an away market and a Participant clears the transaction, the ORF will be assessed to and collected from the Participant who clears the transaction. In the case where 5 Prior to the Waiver Filing, the Exchange similarly collected ORF as described herein. 6 Participants must record the appropriate account origin code on all orders at the time of entry of the order. The Exchange represents that it has surveillances in place to verify that Participants mark orders with the correct account origin code. 7 The Exchange uses reports from OCC when assessing and collecting the ORF. 8 CMTA or Clearing Member Trade Assignment is a form of ‘‘give-up’’ whereby the position will be assigned to a specific clearing firm at OCC. 9 By way of example, if Broker A, a NOM Participant, routes a customer order to CBOE and the transaction executes on CBOE and clears in Broker A’s OCC Clearing account, ORF will be collected by NOM from Broker A’s clearing account at OCC via direct debit. While this transaction was executed on a market other than NOM, it was cleared by a NOM Participant in the member’s OCC clearing account in the customer range, therefore there is a regulatory nexus between NOM and the transaction. If Broker A was not a NOM Participant, then no ORF should be assessed and collected because there is no nexus; the transaction did not execute on NOM nor was it cleared by a NOM Participant. E:\FR\FM\01FEN1.SGM 01FEN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 87, Number 21 (Tuesday, February 1, 2022)]
[Notices]
[Pages 5527-5541]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-02001]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-94080; File No. SR-CboeBZX-2021-039]

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

January 27, 2022.

I. Introduction

On May 10, 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 Wise Origin Bitcoin
Trust (``Trust'') under BZX Rule 14.11(e)(4), Commodity-Based Trust
Shares. The proposed rule change was published for comment in the
Federal Register on June 1, 2021.\3\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 91994 (May 25,
2021), 86 FR 29321 (``Notice''). Comments on the proposed rule
change can be found at: https://www.sec.gov/comments/sr-cboebzx-2021-039/srcboebzx2021039.htm.
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On July 13, 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 August 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 November 15, 2021, the Commission designated a longer period for
Commission action on the proposed rule change.\8\
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\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 92388, 86 FR 38163
(July 19, 2021).
\6\ 15 U.S.C. 78s(b)(2)(B).
\7\ See Securities Exchange Act Release No. 92721, 86 FR 48272
(Aug. 27, 2021).
\8\ See Securities Exchange Act Release No. 93571, 86 FR 64979
(Nov. 19, 2021). On December 27, 2021, the Exchange filed Amendment
No. 1 to the proposal. As discussed below, however, see Section
III.E, infra, the Commission views this amendment as untimely.
Furthermore, even if this amendment had been timely filed, it would
not alter the Commission's conclusion that the Exchange's proposal
is not consistent with the Exchange Act. See Section III.E.
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This order disapproves the proposed rule change. The Commission
concludes that BZX has not met its burden under the Exchange Act and
the Commission's Rules of Practice to demonstrate that its proposal is
consistent with the requirements of Exchange Act Section 6(b)(5), and
in particular, the requirement that the rules of a national securities
exchange be ``designed to prevent fraudulent and manipulative acts and
practices'' and ``to protect investors and the public interest.'' \9\
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\9\ 15 U.S.C. 78f(b)(5).
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When considering whether BZX's proposal to list and trade the
Shares is designed to prevent fraudulent and manipulative acts and
practices, the Commission applies the same standard used in its orders
considering previous proposals to list bitcoin \10\-based

[[Page 5528]]

commodity trusts and bitcoin-based trust issued receipts.\11\ As the
Commission has explained, an exchange that lists bitcoin-based
exchange-traded products (``ETPs'') can meet its obligations under
Exchange Act Section 6(b)(5) by demonstrating that the exchange has a
comprehensive surveillance-sharing agreement with a regulated market of
significant size related to the underlying or reference bitcoin
assets.\12\
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\10\ Bitcoins are digital assets that are issued and transferred
via a decentralized, open-source protocol used by a peer-to-peer
computer network through which transactions are recorded on a public
transaction ledger known as the ``bitcoin blockchain.'' The bitcoin
protocol governs the creation of new bitcoins and the cryptographic
system that secures and verifies bitcoin transactions. See, e.g.,
Notice, 86 FR at 29321.
\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''); 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, Securities Exchange
Act Release No. 93860 (Dec. 22, 2021), 86 FR 74166 (Dec. 29, 2021)
(SR-CboeBZX-2021-029); Order Disapproving a Proposed Rule Change To
List and Trade Shares of the Valkyrie Bitcoin Fund Under NYSE Arca
Rule 8.201-E (Commodity-Based Trust Shares), Securities Exchange Act
Release No. 93859 (Dec. 22, 2021), 86 FR 74156 (Dec. 29, 2021) (SR-
NYSEArca-2021-31); Order Disapproving a Proposed Rule Change to List
and Trade Shares of the First Trust SkyBridge Bitcoin ETF Trust
Under NYSE Arca Rule 8.201-E, Securities Exchange Act Release No.
94006 (Jan. 20, 2022), 87 FR 3869 (Jan. 25, 2022) (SR-NYSEArca-2021-
37). 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).
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The standard requires such surveillance-sharing agreements since
they ``provide a necessary deterrent to manipulation because they
facilitate the availability of information needed to fully investigate
a manipulation if it were to occur.'' \13\ The Commission has
emphasized that it is essential for an exchange listing a derivative
securities product to enter into a surveillance-sharing agreement with
markets trading the underlying assets for the listing exchange to have
the ability to obtain information necessary to detect, investigate, and
deter fraud and market manipulation, as well as violations of exchange
rules and applicable federal securities laws and rules.\14\ The
hallmarks of a surveillance-sharing agreement are that the agreement
provides for the sharing of information about market trading activity,
clearing activity, and customer identity; that the parties to the
agreement have reasonable ability to obtain access to and produce
requested information; and that no existing rules, laws, or practices
would impede one party to the agreement from obtaining this information
from, or producing it to, the other party.\15\
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\13\ See Amendment to Rule Filing Requirements for Self-
Regulatory Organizations Regarding New Derivative Securities
Products, Securities Exchange Act Release No. 40761 (Dec. 8, 1998),
63 FR 70952, 70959 (Dec. 22, 1998) (``NDSP Adopting Release''). See
also Winklevoss Order, 83 FR at 37594; ProShares Order, 83 FR at
43936; GraniteShares Order, 83 FR at 43924; USBT Order, 85 FR at
12596.
\14\ See NDSP Adopting Release, 63 FR at 70959.
\15\ See Winklevoss Order, 83 FR at 37592-93; Letter from
Brandon Becker, Director, Division of Market Regulation, Commission,
to Gerard D. O'Connell, Chairman, Intermarket Surveillance Group
(June 3, 1994), available at https://www.sec.gov/divisions/marketreg/mr-noaction/isg060394.htm.
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In the context of this standard, the terms ``significant market''
and ``market of significant size'' include a market (or group of
markets) as to which (a) there is a reasonable likelihood that a person
attempting to manipulate the ETP would also have to trade on that
market to successfully manipulate the ETP, so that a surveillance-
sharing agreement would assist in detecting and deterring misconduct,
and (b) it is unlikely that trading in the ETP would be the predominant
influence on prices in that market.\16\ A surveillance-sharing
agreement must be entered into with a ``significant market'' to assist
in detecting and deterring manipulation of the ETP, because a person
attempting to manipulate the ETP is reasonably likely to also engage in
trading activity on that ``significant market.'' \17\
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\16\ See Winklevoss Order, 83 FR at 37594. This definition is
illustrative and not exclusive. There could be other types of
``significant markets'' and ``markets of significant size,'' but
this definition is an example that will provide guidance to market
participants. See id.
\17\ See USBT Order, 85 FR at 12597.
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Consistent with this standard, for the commodity-trust ETPs
approved to date for listing and trading, there has been in every case
at least one significant, regulated market for trading futures on the
underlying commodity--whether gold, silver, platinum, palladium, or
copper--and the ETP listing exchange has entered into surveillance-
sharing agreements with, or held Intermarket Surveillance Group
(``ISG'') membership in common with, that market.\18\ Moreover, the
surveillance-sharing agreements have been consistently present whenever
the Commission has approved the listing and trading of derivative
securities, even where the underlying securities were also listed on
national securities exchanges--such as options based on an index of
stocks traded on a national securities exchange--and were thus subject
to the Commission's direct regulatory authority.\19\
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\18\ See Winklevoss Order, 83 FR at 37594.
\19\ See USBT Order, 85 FR at 12597; Securities Exchange Act
Release No. 33555 (Jan. 31, 1994), 59 FR 5619, 5621 (Feb. 7, 1994)
(SR-Amex-93-28) (order approving listing of options on American
Depository Receipts (``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'').
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Listing exchanges have also attempted to demonstrate that other
means besides surveillance-sharing agreements will be sufficient to
prevent fraudulent and manipulative acts and practices, including that
the bitcoin market as a whole or the relevant underlying bitcoin market
is ``uniquely'' and ``inherently''

[[Page 5529]]

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\
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\20\ See USBT Order, 85 FR at 12597.
\21\ See Winklevoss Order, 83 FR at 37580, 37582-91 (addressing
assertions that ``bitcoin and bitcoin [spot] markets'' generally, as
well as one bitcoin trading platform specifically, have unique
resistance to fraud and manipulation); see also USBT Order, 85 FR at
12597.
\22\ See USBT Order, 85 FR at 12597.
\23\ See supra note 11.
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Here, BZX contends that approval of the proposal is consistent with
Section 6(b)(5) of the Exchange Act, in particular Section 6(b)(5)'s
requirement that the rules of a national securities exchange be
designed to prevent fraudulent and manipulative acts and practices and
to protect investors and the public interest.\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\
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\24\ See Notice, 86 FR at 29331.
\25\ See id. at 29332.
\26\ See id. at 29332-33.
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Although BZX recognizes the Commission's focus on potential
manipulation of bitcoin ETPs in prior disapproval orders, BZX argues
that such manipulation concerns have been sufficiently mitigated.\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
Index (as defined herein) mitigate potential manipulation concerns and
should be the central consideration as the Commission determines
whether to approve this proposal.\28\
---------------------------------------------------------------------------

\27\ See id. at 29324, 29327.
\28\ See id. at 29327.
---------------------------------------------------------------------------

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 certain
risks associated with investing in operating companies that are proxies
for bitcoin exposure; and (iv) providing an alternative to custodying
spot bitcoin.\29\
---------------------------------------------------------------------------

\29\ See id. at 29324.
---------------------------------------------------------------------------

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.
Based on its analysis, 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 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. 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.
---------------------------------------------------------------------------

\30\ See Notice, supra note 3. See also draft Registration
Statement on Form S-1, dated March 24, 2021, submitted to the
Commission by the Sponsor on behalf of the Trust (``Registration
Statement'').
---------------------------------------------------------------------------

The investment objective of the Trust is to seek to track the
performance of bitcoin, as measured by the Fidelity Bitcoin Index PR
(``Index''), adjusted for the Trust's expenses and other
liabilities.\31\ Each Share will represent a fractional undivided
beneficial interest in and ownership of 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.\32\
---------------------------------------------------------------------------

\31\ FD Funds Management LLC (``Sponsor'') is the sponsor of the
Trust, Delaware Trust Company is the trustee, and Fidelity Service
Company, Inc. will be the administrator (``Administrator''). A
third-party transfer agent will facilitate the issuance and
redemption of Shares of the Trust, respond to correspondence by
Trust shareholders and others relating to its duties, maintain
shareholder accounts, and make periodic reports to the Trust. An
affiliate of the Sponsor, Fidelity Distributors Corporation, 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. Fidelity Digital Asset Services, LLC
will serve as the Trust's custodian (``Custodian''). The Index
methodology was developed by Fidelity Product Services, LLC (``Index
Provider'') and is administered by the Fidelity Index Committee.
Coin Metrics, Inc. is the third-party calculation agent for the
Index. The Sponsor's affiliates have an ownership interest in Coin
Metrics, Inc. See Notice, 86 FR at 29321, 29327 n.57, 29328-29,
29329 n.63.
\32\ See id. at 29328.
---------------------------------------------------------------------------

In seeking to achieve its investment objective, the Trust would
hold bitcoin and value its Shares daily as of 4:00 p.m. E.T. using the
same methodology used to calculate the Index. The Index is designed to
reflect the performance of bitcoin in U.S. dollars and is calculated
using bitcoin price feeds from eligible bitcoin spot platforms. The
current platform composition of the Index is Bitstamp, Coinbase,
Gemini, itBit, and Kraken. The Index market value would be the volume-
weighted median price of bitcoin in U.S. dollars over the previous

[[Page 5530]]

five minutes, which would be calculated by (1) ordering all individual
transactions on eligible spot platforms over the previous five minutes
by price, and then (2) selecting the price associated with the 50th
percentile of total volume.\33\
---------------------------------------------------------------------------

\33\ See id. at 29329.
---------------------------------------------------------------------------

The net asset value (``NAV'') of the Trust is the total assets of
the Trust including, but not limited to, all bitcoin and cash, if any,
less total liabilities of the Trust, each determined on the basis of
generally accepted accounting principles. The NAV per Share of the
Trust would be calculated by taking the fair market value of its total
assets based on the volume-weighted median price of bitcoin used for
the calculation of the Index, subtracting any liabilities (which
include accrued expenses), and dividing that total by the total number
of outstanding Shares. The Administrator would calculate the NAV of the
Trust once each Exchange trading day. The NAV for a normal trading day
will be released after 4:00 p.m. E.T.\34\
---------------------------------------------------------------------------

\34\ See id. at 29329-30.
---------------------------------------------------------------------------

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

\35\ See id. at 29329.
---------------------------------------------------------------------------

When the Trust sells or redeems its Shares, it will do so in ``in-
kind'' transactions in blocks of 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.\36\
---------------------------------------------------------------------------

\36\ See id. at 29328-29.
---------------------------------------------------------------------------

III. Discussion

A. The Applicable Standard for Review

The Commission must consider whether BZX's proposal is consistent
with the Exchange Act. Section 6(b)(5) of the Exchange Act requires, in
relevant part, that the rules of a national securities exchange be
designed ``to prevent fraudulent and manipulative acts and practices''
and ``to protect investors and the public interest.'' \37\ Under the
Commission's Rules of Practice, the ``burden to demonstrate that a
proposed rule change is consistent with the Exchange Act and the rules
and regulations issued thereunder . . . is on the self-regulatory
organization [`SRO'] that proposed the rule change.'' \38\
---------------------------------------------------------------------------

\37\ 15 U.S.C. 78f(b)(5). Pursuant to Section 19(b)(2) of the
Exchange Act, 15 U.S.C. 78s(b)(2), the Commission must disapprove a
proposed rule change filed by a national securities exchange if it
does not find that the proposed rule change is consistent with the
applicable requirements of the Exchange Act. Exchange Act Section
6(b)(5) states that an exchange shall not be registered as a
national securities exchange unless the Commission determines that
``[t]he rules of the exchange are designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general,
to protect investors and the public interest; and are not designed
to permit unfair discrimination between customers, issuers, brokers,
or dealers, or to regulate by virtue of any authority conferred by
this title matters not related to the purposes of this title or the
administration of the exchange.'' 15 U.S.C. 78f(b)(5).
\38\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
---------------------------------------------------------------------------

The description of a proposed rule change, its purpose and
operation, its effect, and a legal analysis of its consistency with
applicable requirements must all be sufficiently detailed and specific
to support an affirmative Commission finding,\39\ and any failure of an
SRO to provide this information may result in the Commission not having
a sufficient basis to make an affirmative finding that a proposed rule
change is consistent with the Exchange Act and the applicable rules and
regulations.\40\ Moreover, ``unquestioning reliance'' on an SRO's
representations in a proposed rule change is not sufficient to justify
Commission approval of a proposed rule change.\41\
---------------------------------------------------------------------------

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

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

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

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

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

[[Page 5531]]

who are effectively eliminating any cross-market pricing differences.''
\49\
---------------------------------------------------------------------------

\44\ See Notice, 86 FR at 29327 n.51.
\45\ See id.
\46\ See id.
\47\ See id.
\48\ See id.
\49\ See id.
---------------------------------------------------------------------------

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

\50\ For example, the Registration Statement states that ``[a]s
the use of digital asset networks increases without a corresponding
increase in throughput of the networks, average fees and settlement
times can increase significantly,'' and that such ``[i]ncreased fees
and decreased settlement speeds . . . could adversely impact the
value of the Shares.'' See Registration Statement at 15. BZX does
not provide data or analysis to address, among other things, whether
such risks of increased fees and bitcoin transaction settlement
times may affect the arbitrage effectiveness that BZX asserts. See
also infra note 64 and accompanying text (referencing statements
made in the Registration Statement that contradict assertions made
by BZX).
\51\ See supra note 41.
---------------------------------------------------------------------------

Efficient price arbitrage, moreover, is not sufficient to support
the finding that a market is uniquely and inherently resistant to
manipulation such that the Commission can dispense with surveillance-
sharing agreements.\52\ 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.\53\ Here, the
Exchange provides no evidence to support its assertion of efficient
price arbitrage across bitcoin platforms, let alone any evidence that
price arbitrage in the bitcoin market is novel or unique so as to
warrant the Commission dispensing with the requirement of a
surveillance-sharing agreement. Moreover, BZX does not take into
account that a market participant with a dominant ownership position
would not find it prohibitively expensive to overcome the liquidity
supplied by arbitrageurs and could use dominant market share to engage
in manipulation.\54\
---------------------------------------------------------------------------

\52\ See Winklevoss Order, 83 FR at 37586; SolidX Order, 82 FR
at 16256-57; USBT Order, 85 FR at 12601.
\53\ See, e.g., USBT Order, 85 FR at 12601.
\54\ See, e.g., Winklevoss Order, 83 FR at 37584; USBT Order, 85
FR at 12600-01.
---------------------------------------------------------------------------

In addition, the Exchange makes the unsupported claim that bitcoin
prices on platforms with wash trades or other activity intended to
manipulate the price of bitcoin do not influence the ``real'' price of
bitcoin. The Exchange also asserts that, to the extent that there are
bitcoin platforms engaged in or allowing wash trading or other
manipulative activities, market participants will generally ignore
those platforms. However, without the necessary data 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.\55\
---------------------------------------------------------------------------

\55\ 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.\56\ 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.\57\
---------------------------------------------------------------------------

\56\ See Winklevoss Order, 83 FR at 37585 n.92 and accompanying
text.
\57\ 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.\58\ According to BZX, in
January 2020, for example, the cost to buy or sell $5 million worth of
bitcoin averaged roughly 30 basis points (compared to 10 basis points
in February 2021) with a market impact of 50 basis points (compared to
30 basis points in February 2021). For a $10 million market order, the
cost to buy or sell was roughly 50 basis points (compared to 20 basis
points in February 2021) with a market impact of 80 basis points
(compared to 50 basis points in February 2021). BZX contends that as
the liquidity in the bitcoin spot market increases, it follows that the
impact of $5 million and $10 million orders will continue to
decrease.\59\
---------------------------------------------------------------------------

\58\ See Notice, 86 FR at 29328.
\59\ 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.\60\ 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.\61\ 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.
---------------------------------------------------------------------------

\60\ 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 29328
nn.58-59.
\61\ 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,\62\ (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.\63\
---------------------------------------------------------------------------

\62\ See supra note 55 and accompanying text.
\63\ 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

[[Page 5532]]

and manipulation. For example, the Registration Statement acknowledges
that ``[platforms] on which bitcoin trades are relatively new and
largely unregulated, and, therefore, may be more exposed to fraud and
security breaches than established, regulated exchanges for other
financial assets or instruments''; that ``[o]ver the past several
years, a number of bitcoin spot markets have been closed or faced
issues due to fraud, failure, security breaches or governmental
regulations''; that ``[t]he nature of the assets held at bitcoin spot
markets makes them appealing targets for hackers and a number of
bitcoin spot markets have been victims of cybercrimes'' and that ``[n]o
bitcoin [platform] is immune from these risks''; that ``many [bitcoin]
spot markets lack certain safeguards put in place by more traditional
exchanges to enhance the stability of trading on the [platform]''; that
``[a] lack of stability in the bitcoin spot markets, manipulation of
bitcoin spot markets by customers and/or the closure or temporary
shutdown of such [platforms] due to fraud, business failure, hackers or
malware, or government-mandated regulation may reduce confidence in
bitcoin generally and result in greater volatility in the market price
of bitcoin and the Shares of the Trust'' and that such ``closure or
temporary shutdown of a bitcoin spot market may impact the Trust's
ability to determine the value of its bitcoin holdings or for the
Trust's [a]uthorized [p]articipants to effectively arbitrage the
Trust's Shares''; that ``[t]he potential consequences of a spot
market's failure or failure to prevent market manipulation could
adversely affect the value of the Shares''; that many spot markets and
over-the-counter (``OTC'') market venues ``do not provide the public
with significant information regarding their ownership structure,
management teams, corporate practices or oversight of customer
trading''; and 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.'' \64\
---------------------------------------------------------------------------

\64\ See Registration Statement at 3, 8-9, 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 Index, which is used
to value the Trust's bitcoin, is itself resistant to manipulation based
on the Index's methodology, as described above.\65\ According to the
Exchange, ``using rolling five-minute segments [to calculate the Index]
means malicious actors would need to sustain efforts to manipulate the
market over an extended period of time, or would need to replicate
efforts multiple times across exchanges, potentially triggering
review.'' \66\ The use of a median price reduces the ability of outlier
prices to impact the NAV, as it systematically excludes those prices
from the NAV calculation. The Exchange asserts that the use of a
volume-weighted median (as opposed to a traditional median) serves as
an additional protection against attempts to manipulate the NAV by
executing a large number of low-dollar trades, because any manipulation
attempt would have to involve a majority of global spot bitcoin volume
in a three-minute window to have any influence on the NAV.\67\ Further,
removing the highest and lowest prices further protects against
attempts to manipulate the NAV, requiring bad actors to act on multiple
exchanges at once to have any ability to influence the price.\68\
---------------------------------------------------------------------------

\65\ See Notice, 86 FR at 29328.
\66\ See id. at 29329. According to the Exchange, this extended
period also supports authorized participant activity by capturing
volume over a longer time period, rather than forcing authorized
participants to mark an individual close or auction. See id.
\67\ See id.
\68\ See id.
---------------------------------------------------------------------------

Simultaneously with the Exchange's assertions regarding the Index,
the Exchange also states that, because the Trust will engage in in-kind
creations and redemptions, the ``manipulability of the Index [is]
significantly less important.'' \69\ 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.'' \70\ 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.\71\
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.\72\
This, according to BZX, not only mitigates the risk associated with
potential manipulation, but also discourages and disincentivizes
manipulation of the Index because there is little financial incentive
to do so.\73\
---------------------------------------------------------------------------

\69\ See id. at 29328.
\70\ See id.
\71\ See id.
\72\ See id.
\73\ See id.
---------------------------------------------------------------------------

Based on assertions made and the information provided, the
Commission can find no basis to conclude that BZX has articulated other
means to prevent fraud and manipulation that are sufficient to justify
dispensing with the requisite surveillance-sharing agreement.
First, the record does not demonstrate that the proposed
methodology for calculating the Index 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.\74\ Specifically, the Exchange has not assessed the
possible influence that spot platforms not included among the Index's
constituent bitcoin platforms would have on bitcoin prices used to
calculate the Index.\75\ 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 other spot bitcoin platforms not directly used to calculate
the Index affects prices on the Index's constituent bitcoin platforms,
the characteristics of those other spot bitcoin platforms--where
various kinds of fraud and manipulation from a variety of sources may
be present and persist \76\--may affect whether the Index is resistant
to manipulation.
---------------------------------------------------------------------------

\74\ 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.
\75\ As discussed above, the Commission has no basis on which to
conclude that bitcoin platforms are insulated from prices of others
that engage in or permit fraud or manipulation. See supra note 55
and accompanying text.
\76\ See supra note 64 and accompanying text (describing, among
other things, the risks associated with spot bitcoin markets that
are new and largely unregulated).
---------------------------------------------------------------------------

Moreover, the Exchange's assertions that the Index's methodology
helps make the Index resistant to manipulation are contradicted by the
Registration Statement's own statements. Specifically, the Registration
Statement states that ``[s]pot markets on which bitcoin trades are
relatively new and largely unregulated, and, therefore, may be more
exposed to fraud and

[[Page 5533]]

security breaches than established, regulated exchanges for other
financial assets or instruments''; that ``[o]ver the past several
years, a number of bitcoin spot markets have been closed or faced
issues due to fraud, failure, security breaches or governmental
regulations''; and that ``[n]o bitcoin [platform] is immune from these
risks'' \77\ Moreover, the Registration Statement specifically
acknowledges that ``[p]ricing sources used by the Index are digital
asset spot markets that facilitate the buying and selling of bitcoin
and other digital assets'' and that ``[a]lthough many pricing sources
refer to themselves as `exchanges,' they are not registered with, or
supervised by, the SEC or CFTC and do not meet the regulatory standards
of a national securities exchange or designated contract market.'' \78\
The Registration Statement further admits that ``[t]he Index is based
on various inputs which include price data from various third-party
bitcoin spot markets'' and [t]he Index Provider does not guarantee the
validity of any of these inputs, which may be subject to technological
error, manipulative activity, or fraudulent reporting from their
initial source.'' \79\ The Registration Statement concludes that
``[f]or these reasons, among others, purchases and sales of bitcoin may
be subject to temporary distortions or other disruptions due to various
factors . . . [which] could affect the price of bitcoin used in Index
calculations and, therefore, could adversely affect the level of the
Index.'' \80\
---------------------------------------------------------------------------

\77\ See Registration Statement at 8.
\78\ See id. at 25.
\79\ See id.
\80\ See id.
---------------------------------------------------------------------------

The Index constituent bitcoin platforms are a subset of the spot
bitcoin trading venues 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 Index is
resistant to fraud and manipulation. In addition, as described above,
for purposes of calculating the Trust's NAV per Share, the Trust's
holdings of bitcoin would be valued using the Index.\81\ Even though
the Sponsor also raises concerns in the Registration Statement
regarding manipulative activity and fraudulent reporting with respect
to the inputs from the Index's constituent bitcoin platforms, the
Exchange does not sufficiently explain how or why such concerns are
consistent with its assertion that the Index methodology, and therefore
the Trust's NAV calculation, is resistant to fraud and manipulation.
---------------------------------------------------------------------------

\81\ See Notice, 86 FR at 29329.
---------------------------------------------------------------------------

Second, BZX has not shown that its proposed use of a volume-
weighted median price of bitcoin over time intervals of five minutes to
calculate the Index market value 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.'' \82\ The Exchange does not connect the use of
such partitions to the duration of the effects of fraudulently reported
prices or other manipulative activity that may exist in the bitcoin
spot market.\83\
---------------------------------------------------------------------------

\82\ See USBT Order, 85 FR at 12601 n.66; see also id. at 12607.
\83\ See WisdomTree Order, 86 FR at 69327.
---------------------------------------------------------------------------

Third, the Exchange does not explain the significance of the
Index'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 Index 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 Index is resistant to manipulation, the Exchange
simultaneously downplays the importance of the Index in light of the
Trust's in-kind creation and redemption mechanism.\84\ 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.'' \85\ 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.'' \86\ If the Index that the Trust uses to
value the Trust's bitcoin ``is not particularly important,'' it follows
that the Index's resistance to manipulation is not material to the
Shares' susceptibility to fraud and manipulation. As the Exchange does
not address or provide any analysis with respect to these issues, the
Commission cannot conclude that the Index aids in the determination
that the proposal to list and trade the Shares is designed to prevent
fraudulent and manipulative acts and practices.
---------------------------------------------------------------------------

\84\ See supra notes 69-73 and accompanying text.
\85\ See Notice, 86 FR at 29328 (``While the Sponsor believes
that the Index 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 available in-kind
makes the manipulability of the Index significantly less
important.'').
\86\ See id. (concluding that ``because the Trust will not
accept cash to buy bitcoin in order to create new shares or, barring
a forced redemption of the Trust or under other extraordinary
circumstances, be forced to sell bitcoin to pay cash for redeemed
shares, the price that the Sponsor uses to value the Trust's bitcoin
is not particularly important.'').
---------------------------------------------------------------------------

Finally, the Commission finds that BZX has not demonstrated that
in-kind creations and redemptions provide the Shares with a unique
resistance to manipulation. The Commission has previously addressed
similar assertions.\87\ 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.\88\ Accordingly,
the Commission is not persuaded here that the Trust's in-kind creations
and redemptions afford it a unique resistance to manipulation.\89\
---------------------------------------------------------------------------

\87\ See Winklevoss Order, 83 FR at 37589-90; USBT Order, 85 FR
at 12607-08.
\88\ 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).
\89\ Putting aside the Exchange's various assertions about the
nature of bitcoin and the bitcoin market, the Index, 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.
---------------------------------------------------------------------------

(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-

[[Page 5534]]

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.\90\
---------------------------------------------------------------------------

\90\ See Winklevoss Order, 83 FR at 37594. This definition is
illustrative and not exclusive. There could be other types of
``significant markets'' and ``markets of significant size,'' but
this definition is an example that provides guidance to market
participants. See id.
---------------------------------------------------------------------------

As the Commission has stated in the past, it considers two markets
that are members of the ISG to have a comprehensive surveillance-
sharing agreement with one another, even if they do not have a separate
bilateral surveillance-sharing agreement.\91\ Accordingly, based on the
common membership of BZX and the CME in the ISG,\92\ BZX has the
equivalent of a comprehensive surveillance-sharing agreement with the
CME. However, while the Commission recognizes that the CFTC regulates
the CME futures market,\93\ including the CME bitcoin futures market,
and thus such market is ``regulated,'' in the context of the proposed
ETP, the record does not, as explained further below, establish that
the CME bitcoin futures market is a ``market of significant size'' as
that term is used in the context of the applicable standard here.\94\
---------------------------------------------------------------------------

\91\ See id. at 37580 n.19.
\92\ See Notice, 86 FR at 29327 n.54 and accompanying text.
\93\ 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.
\94\ In the context of the proposed ETP, the Index'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. See WisdomTree Order, 86 FR at 69330
n.119.
---------------------------------------------------------------------------

(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
(a) Assertions by BZX
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.\95\ 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.'' \96\ 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.\97\ 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.\98\ Similarly, BZX contends that the number of large
open interest holders \99\ has continued to increase, even as the price
of bitcoin has risen, as have the number of unique accounts trading CME
bitcoin futures.\100\ In addition, the Sponsor, in a separate
submission to the Commission, represents that ``[b]etween Q1 2019 & Q2
2021, quarterly CME bitcoin futures volume grew more than 20x.'' \101\
---------------------------------------------------------------------------

\95\ According to BZX, each contract represents five bitcoin and
is based on the CME CF Bitcoin Reference Rate. See Notice, 86 FR at
29325.
\96\ See id.
\97\ See id.
\98\ See id.
\99\ 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 29325 n.47.
\100\ See id. at 29325.
\101\ See Submission by the Sponsor to the Commission in
connection with a meeting between representatives of the Sponsor,
BZX, and Commission staff on September 8, 2021, (``Sponsor
Submission'') at 4, available at: https://www.sec.gov/comments/sr-cboebzx-2021-039/srcboebzx2021039-250110.pdf.
---------------------------------------------------------------------------

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 Index's 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.\102\
---------------------------------------------------------------------------

\102\ See Notice, 86 FR at 29327.
---------------------------------------------------------------------------

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.\103\ BZX concludes that a person
attempting to manipulate the Shares would also have to trade on that
market to manipulate the ETP.\104\
---------------------------------------------------------------------------

\103\ See id. at 29327 & n.48 (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'')).
\104\ See id. at 29327.
---------------------------------------------------------------------------

The Commission disagrees. The record does not demonstrate that
there is a reasonable likelihood that a person attempting to manipulate
the proposed ETP would have to trade on the CME bitcoin futures market
to successfully manipulate it. Specifically, BZX's assertions about the
general upward trends from 2018 to February 2021 in trading volume and
open interest of, and in the number of large open interest holders and
number of unique accounts trading in, CME bitcoin futures, as well as
the Sponsor's assertions about the growth in quarterly CME bitcoin
futures volume from 2019 to 2021, do not establish that the CME bitcoin
futures market is of significant size. While BZX provides data showing
absolute growth in the size of the CME bitcoin futures market, it
provides 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.\105\ BZX's recitation of data
reflecting the size of the CME bitcoin futures market, alone, either
currently or in relation to previous years, is not sufficient to
establish an interrelationship between the CME

[[Page 5535]]

bitcoin futures market and the proposed ETP.\106\
---------------------------------------------------------------------------

\105\ See USBT Order, 85 FR at 12611.
\106\ See id. at 12612.
---------------------------------------------------------------------------

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.\107\ While BZX states that
CME bitcoin futures pricing leads the spot market,\108\ it relies on
the findings of a price discovery analysis in one section of a single
academic paper to support the overall thesis.\109\ However, the
findings of that paper's Granger causality analysis, which is widely
used to formally test for lead-lag relationships, are concededly
mixed.\110\ 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.\111\ 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.\112\ 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.\113\ BZX has not addressed either
issue.
---------------------------------------------------------------------------

\107\ See id. 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.
\108\ See Notice, 86 FR at 29327.
\109\ See supra note 103 and accompanying text. BZX references
the following conclusion from the ``time-varying price discovery''
section of Hu, Hou & Oxley: ``There exist no episodes where the
Bitcoin spot markets dominates the price discovery processes with
regard to Bitcoin futures. This points to a conclusion that the
price formation originates solely in the Bitcoin futures market. We
can, therefore, conclude that the Bitcoin futures markets dominate
the dynamic price discovery process based upon time-varying
information share measures. Overall, price discovery seems to occur
in the Bitcoin futures markets rather than the underlying spot
market based upon a time-varying perspective . . .'' See Notice, 86
FR at 29327 n.48.
\110\ 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
103.
\111\ See USBT Order, 85 FR at 12609.
\112\ See id. at 12613 n.244.
\113\ 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.\114\ 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.\115\ 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.\116\ 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.\117\
---------------------------------------------------------------------------

\114\ See Susquehanna, 866 F.3d at 447.
\115\ 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) (``Kapar & Olmo''); E. Akyildirim, S. Corbet, P.
Katsiampa, N. Kellard & A. Sensoy, The development of Bitcoin
futures: Exploring the interactions between cryptocurrency
derivatives, 34 Fin. Res. Letters 101234 (2020) (finding that
bitcoin futures dominate price discovery); A. Fassas, S. Papadamou,
& A. Koulis, Price discovery in bitcoin futures, 52 Res. Int'l Bus.
Fin. 101116 (2020) (finding that bitcoin futures play a more
important role in price discovery) (``Fassas et al''); S. Aleti & B.
Mizrach, Bitcoin spot and futures market microstructure, 41 J.
Futures Mkts. 194 (2021) (finding that relatively more price
discovery occurs on the CME as compared to four spot exchanges); J.
Wu, K. Xu, X. Zheng & J. Chen, Fractional cointegration in bitcoin
spot and futures markets, 41 J. Futures Mkts. 1478 (2021) (finding
that CME bitcoin futures dominate price discovery). See also C.
Alexander & D. Heck, Price discovery in Bitcoin: The impact of
unregulated markets, 50 J. Financial Stability 100776 (2020)
(finding that, in a multi-dimensional setting, including the main
price leaders within futures, perpetuals, and spot markets, CME
bitcoin futures have a very minor effect on price discovery; and
that faster speed of adjustment and information absorption occurs on
the unregulated spot and derivatives platforms than on CME bitcoin
futures) (``Alexander & Heck'').
\116\ See USBT Order, 85 FR at 12613 nn.239-244 and accompanying
text.
\117\ 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 Index constituent bitcoin platforms, or where
price formation occurs when the entirety of bitcoin futures markets,
not just the CME, is considered.
---------------------------------------------------------------------------

(b) Sponsor Submission
While BZX does not provide in its filing results of its own
analysis nor presents any other data to support its conclusion that CME
bitcoin futures pricing leads the spot market, the Sponsor in the
Sponsor Submission provides information to show that the CME bitcoin
futures market leads price discovery across global USD and USDT bitcoin
futures and spot markets. The Sponsor states that its findings are
based on tick level trade data aggregated in one-second intervals for
USD and USDT bitcoin spot and futures prices from Coin Metrics spanning
January 1, 2019, to March 31, 2021. According to the Sponsor, the data
for futures includes both ordinary and perpetual futures. The Sponsor
explains that its dataset is limited to BTC-USD and BTC-USDT trades to
exclude any impact caused by exchange rate movements.
With respect to whether the CME bitcoin futures market leads the
spot markets or vice versa, the Sponsor concedes that ``conclusions are
mixed.'' The Sponsor attributes the lack of agreement to the use of
classic metrics derived from the Vector Error Correction Model
(``VECM''), which it states likely involves ``substantial imputation''
when used with data sets such as CME bitcoin futures trading data. This
imputation,

[[Page 5536]]

the Sponsor argues, ``can produce biased results.'' \118\
---------------------------------------------------------------------------

\118\ See Sponsor Submission at 8. The Sponsor states that prior
lead-lag studies employ methods that assume that the prices/returns
under consideration are synchronous and so adjustments need to be
made for non-synchronous and/or infrequent data. According to the
Sponsor, adjustments such as imputation or synchronous sampling can
lead to ``spurious results'' for these methods. See id. at 19.
---------------------------------------------------------------------------

In contrast, the Sponsor argues that its analysis accounts for the
characteristics of CME bitcoin futures trading data by applying the
Hayashi-Yoshida (``HY'') estimator. According to the Sponsor, the use
of the HY estimator is more suitable for ``disparate and infrequent
data,'' as it is free from imputation, and it has also previously
proven useful in price discovery research, including bitcoin spot
markets.\119\ Based on its analysis, the Sponsor argues that the
results demonstrate that the CME bitcoin futures market has
consistently led bitcoin price discovery across global USD bitcoin
markets.\120\ As a result of its study, the Sponsor concludes that
there is a reasonable likelihood that a person attempting to manipulate
the ETP would have to trade in the CME bitcoin futures market because:
(1) The CME bitcoin futures market leads in bitcoin price discovery
across USD-based trading in bitcoin futures and spot markets globally;
and (2) arbitrage between the CME bitcoin futures market and spot
markets would tend to counter an attempt to manipulate the spot market
alone.\121\
---------------------------------------------------------------------------

\119\ See id. at 8. The Sponsor further explains that, due to
the ``high sparsity'' of CME futures data, the framework of
correlation-based lead-lag analysis using the HY estimator is more
suitable because this approach is free from any imputation or
sampling and has proven useful in price discovery research. See id.
at 19.
\120\ See id. at 9.
\121\ See id. at 7.
---------------------------------------------------------------------------

The Sponsor Submission does not provide sufficient evidence for the
Commission to conclude that it is reasonably likely that a would-be
manipulator of the proposed ETP would have to trade on the CME bitcoin
futures market to successfully manipulate the proposed ETP. By applying
its selected analytical method, the Sponsor presents conclusory results
that suggest that CME bitcoin futures lead price discovery. Even if the
Commission were to accept these results at face value, the Sponsor has
not demonstrated that other analyses that reached different and
opposite conclusions were, in fact, ``spurious'' results, or otherwise
were results on which the Commission cannot reasonably rely. In fact,
the Sponsor highlights that in the academic literature, ``conclusions
are mixed'' on the lead-lag relationship between bitcoin spot and
futures markets. Namely, there are analytical methodologies that lead
to the conclusion that the spot market price leads the CME futures
price, those that conclude that the CME futures price leads the spot
market price, as well as those that conclude that unregulated futures
markets lead the CME futures market in price discovery.\122\ While the
Sponsor dismisses the validity of these other results due to the
theoretical possibility that imputation or synchronous sampling can
lead to spurious or unreliable results, it does not provide any detail
to support that any of the other results are actually inaccurate.
---------------------------------------------------------------------------

\122\ The Sponsor points to Kapar & Olmo and Fassas et al. as
results that suggest that CME futures lead the spot markets, and to
Alexander & Heck as results that suggest that CME futures lag. See
id. at 8. See also supra note 115.
---------------------------------------------------------------------------

Moreover, the Commission cannot accept the Sponsor's results at
face value based on the extent of the information it provides. While
the Sponsor provides in graphs aggregate average ``lead'' times (in
seconds) that suggest that the CME futures market has the largest
``lead'' in each quarter of the sample period, the Sponsor does not
provide the specific results of each of its pairwise assessments (e.g.,
CME compared to Coinbase; CME compared to Gemini; etc.) or--crucially--
the Sponsor's confidence intervals around each such pairwise result.
Provision of pairwise results and confidence intervals is common in the
academic literature that the Sponsor itself cites in the Sponsor
Submission.\123\ The Commission is thus unable to assess the Sponsor's
specific results or statistical significance of those results.
Confidence intervals are particularly important, given that the
Sponsor's results show that the ``lead'' of the CME bitcoin futures
market has steadily decreased over the sample period to within about
one second of ``lead'' time, which is the tick data aggregation
interval for the study, and to below one second compared to the leading
non-regulated USD bitcoin futures market. The Sponsor also has not
discussed whether its findings are sensitive to its choice to aggregate
tick level trade data into one-second intervals, particularly as the
estimated ``lead'' times decrease over the sample period; or whether
the Sponsor's critique of other studies--that imputation or synchronous
sampling can lead to ``spurious'' or otherwise unreliable results--
applies to its findings as well because of the aggregation that the
Sponsor used. Further, the Sponsor has not discussed the robustness of
its two-dimensional methodology--which examines pairwise lead-lag
relationships within and across the bitcoin spot and futures markets--
to the critique in the multi-dimensional Alexander & Heck study that:
``omitting substantial information flows from other markets can produce
misleading results . . . . [I]n a two-dimensional model one or other of
the instruments must necessarily be identified as price leader.'' \124\
---------------------------------------------------------------------------

\123\ See, e.g., Sponsor Submission (citing B. Schei, High
Frequency Lead-Lag Relationships in the Bitcoin Market, Copenhagen
Business School Master's Thesis (2019) (unpublished)).
\124\ See Alexander & Heck, supra note 115, at 2.
---------------------------------------------------------------------------

The Commission accordingly concludes that the information provided
in the record for this proposal does not establish a reasonable
likelihood that a would-be manipulator of the proposed ETP would have
to trade on the CME bitcoin futures market to successfully manipulate
the proposed ETP. Therefore, the information in the record also does
not establish that the CME bitcoin futures market is a ``market of
significant size'' with respect to the proposed ETP.
(ii) Whether It Is Unlikely That Trading in the Proposed ETP Would Be
the Predominant Influence on Prices in the CME Bitcoin Futures Market
The second prong in establishing whether the CME bitcoin futures
market constitutes a ``market of significant size'' is the
determination that it is unlikely that trading in the proposed ETP
would be the predominant influence on prices in the CME bitcoin futures
market.\125\
---------------------------------------------------------------------------

\125\ 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.\126\ 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.\127\ 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

[[Page 5537]]

buy or sell order for $10 million of bitcoin and only move the market
0.5 percent.\128\ 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.\129\ 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 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.\130\
---------------------------------------------------------------------------

\126\ See Notice, 86 FR at 29328.
\127\ See id. According to BZX, these statistics are based on
samples of bitcoin liquidity in U.S. dollars (excluding stablecoins
or Euro liquidity) based on executable quotes on Coinbase Pro,
Gemini, Bitstamp, Kraken, LMAX Exchange, BinanceUS, and OKCoin
during February 2021. See id. nn.58-59.
\128\ See id. at 29328.
\129\ See id.
\130\ See id.
---------------------------------------------------------------------------

In its submission, the Sponsor similarly argues that the CME
futures market-leading price discovery across USD-based bitcoin trading
markets, as well as its aggregate significant trading volume and
liquidity, make it unlikely that trading in a bitcoin ETP would be the
predominant influence on prices in CME bitcoin futures.\131\
Specifically, the Sponsor concludes that it is unlikely that trading in
a bitcoin ETP would be the predominant influence on CME bitcoin futures
market or bitcoin spot prices because of: (1) The CME bitcoin futures
market leading in bitcoin price discovery across USD-based trading in
bitcoin futures and spot markets globally; (2) significant trading
volume in USD-based bitcoin futures; and (3) the highly liquid bitcoin
spot market.\132\
---------------------------------------------------------------------------

\131\ See Sponsor Submission at 7.
\132\ See id. The Sponsor states that bitcoin trading volume and
market capitalization has continued to grow (2019 Q1-2021 Q2), see
Sponsor Submission at 10, and that spot trading costs and market
impact have decreased over the last year (January 2020-February
2021), see id.
---------------------------------------------------------------------------

The Commission does not agree. The record does not demonstrate that
it is unlikely that trading in the proposed ETP would be the
predominant influence on prices in the CME bitcoin futures market. As
the Commission has already addressed and rejected one of the bases of
BZX's and the Sponsor's assertions--that CME bitcoin futures leads
price discovery \133\--the Commission will only address below the other
bases--the overall size, volume, and liquidity of, and the impact of
buys and sells on, the CME bitcoin futures market and spot bitcoin
market.
---------------------------------------------------------------------------

\133\ See supra notes 107-124 and accompanying text.
---------------------------------------------------------------------------

BZX's and the Sponsor'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. Thus, the
Commission cannot conclude, based on BZX's and the Sponsor's statements
alone and absent any evidence or analysis in support of BZX's and the
Sponsor'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.\134\ 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.
---------------------------------------------------------------------------

\134\ See Notice, 86 FR at 29328 (``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 and the Sponsor have not provided sufficient
information to establish both prongs of the ``market of significant
size'' determination, the Commission cannot conclude that the CME
bitcoin futures market is a ``market of significant size'' such that
BZX would be able to rely on a surveillance-sharing agreement with the
CME to provide sufficient protection against fraudulent and
manipulative acts and practices.
The requirements of Section 6(b)(5) of the Exchange Act apply to
the rules of national securities exchanges. Accordingly, the relevant
obligation for a comprehensive surveillance-sharing agreement with a
regulated market of significant size, or other means to prevent
fraudulent and manipulative acts and practices that are sufficient to
justify dispensing with the requisite surveillance-sharing agreement,
resides with the listing exchange. Because there is insufficient
evidence in the record demonstrating that BZX has satisfied this
obligation, the Commission cannot approve the proposed ETP for listing
and trading on BZX.

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

BZX contends that, if approved, the proposed ETP would protect
investors and the public interest. However, the Commission must
consider these potential benefits in the broader context of whether the
proposal meets each of the applicable requirements of the Exchange
Act.\135\ 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.
---------------------------------------------------------------------------

\135\ 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.\136\ Specifically, BZX argues that premium and
discount volatility, high fees, insufficient disclosures, and

[[Page 5538]]

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.\137\ 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 certain risks
associated with investing in operating companies that are proxies for
bitcoin exposure.\138\
---------------------------------------------------------------------------

\136\ See Notice, 86 FR at 29331.
\137\ See id.
\138\ See id. at 29324.
---------------------------------------------------------------------------

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.'' \139\ BZX represents that, historically, OTC
bitcoin funds have traded at significant premiums or discounts compared
to their NAV.\140\ BZX argues that, in contrast, a bitcoin ETP would
provide an alternative to OTC bitcoin funds offering investors access
to direct bitcoin exposure with real time trading and transparency on
pricing/valuation, liquidity, and active arbitrage--advantages of the
ETP structure.\141\ 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.\142\
---------------------------------------------------------------------------

\139\ 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 29324 n.39.
\140\ See id. at 29324.
\141\ See id.
\142\ See letter from Anonymous, dated June 17, 2021
(``Anonymous Letter'').
---------------------------------------------------------------------------

BZX also asserts that exposure to bitcoin through an ETP also
presents advantages for investors compared to buying spot bitcoin
directly.\143\ BZX asserts that, without the advantages of an ETP, an
investor holding bitcoin through a cryptocurrency trading platform
lacks protections.\144\ BZX explains that, typically, OTC trading
platforms hold most, if not all, investors' bitcoin in ``hot''
(internet-connected) storage and do not make any commitments to
indemnify investors or to observe any particular cybersecurity
standard.\145\ Meanwhile, an 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.\146\ 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.\147\ Thus, with respect to custody of the Trust's bitcoin
assets, BZX concludes that, compared to owning spot bitcoin directly,
the Trust presents advantages for investors.\148\
---------------------------------------------------------------------------

\143\ See Notice, 86 FR at 29324.
\144\ See id.
\145\ See id.
\146\ See id.
\147\ See id.
\148\ See id.
---------------------------------------------------------------------------

BZX further asserts that a number of operating companies engaged in
unrelated businesses have announced investments as large as $1.5
billion in bitcoin.\149\ Without access to bitcoin ETPs, BZX argues
that investors seeking investment exposure to bitcoin may purchase
shares in these companies in order to gain the exposure to bitcoin that
they seek.\150\ BZX contends that such operating companies, however,
are imperfect bitcoin proxies and provide investors with partial or
indirect bitcoin exposure paired with additional risks associated with
whichever operating company they decide to purchase.\151\
---------------------------------------------------------------------------

\149\ See id.
\150\ See id.
\151\ See id.
---------------------------------------------------------------------------

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.\152\
---------------------------------------------------------------------------

\152\ See id. at 29323. BZX represents that the Purpose Bitcoin
ETF, a 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 29323 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 29323 n.37. See also
Anonymous Letter (stating that ``institutions can simply buy the
Canadian ETFs, leaving US retail investors holding the bag'' and
that ``[a]pproving an [ETP] in the US will correct this imbalance
quickly and give relief to US-based investors who are stuck with an
asset that is trading at a discount to NAV.'').
---------------------------------------------------------------------------

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.\153\ 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.\154\
---------------------------------------------------------------------------

\153\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\154\ 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.\155\ 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

[[Page 5539]]

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.
---------------------------------------------------------------------------

\155\ See supra note 135.
---------------------------------------------------------------------------

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.\156\
---------------------------------------------------------------------------

\156\ 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),\157\ and, accordingly, the Commission must disapprove the
proposal.\158\
---------------------------------------------------------------------------

\157\ 15 U.S.C. 78f(b)(5).
\158\ 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; \159\ the inherent value of bitcoin; \160\ and the desire of
investors to gain access to bitcoin through an ETP.\161\ 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.
---------------------------------------------------------------------------

\159\ See letter from Sam Ahn, dated June 8, 2021 (``Ahn
Letter'').
\160\ See Ahn Letter.
\161\ See Anonymous Letter; Sponsor Submission at 4-5.
---------------------------------------------------------------------------

E. The Exchange's Untimely Amendment to the Proposal

The deadline for rebuttal comments in response to the Order
Instituting Proceedings was October 1, 2021.\162\ On December 27, 2021,
the Exchange filed Amendment No. 1 to the proposed rule change to amend
and replace in its entirety the proposal as submitted on May 10, 2021.
Because this amendment was filed months after the deadline for comments
on the proposed rule change, the Commission deems Amendment No. 1 to
have been untimely filed.\163\
---------------------------------------------------------------------------

\162\ See supra note 7.
\163\ The untimely filing of Amendment No. 1 also does not allow
the Commission sufficient time to solicit public comment.
---------------------------------------------------------------------------

Even if the amendment had been timely filed, the Commission would
still conclude that the Exchange has not met its burden to demonstrate
that its proposal is consistent with Exchange Act Section 6(b)(5). The
Exchange makes four primary changes in the amendment.\164\ First, the
Exchange argues that, based on a review of the Commission's past
approvals and disapprovals of ETPs, the applicable standard does not
require the underlying commodity market to be regulated, but rather
requires that the listing exchange has in place a comprehensive
surveillance-sharing agreement with a regulated market of significant
size related to the underlying commodity. The Exchange states that,
therefore, the CME bitcoin futures market is the proper market for the
Commission to consider in determining whether the proposal is
consistent with the Exchange Act.
---------------------------------------------------------------------------

\164\ In addition, in Amendment No. 1, among other things, the
Exchange amends its description of the Trust, the Index, the
Custodian, and the CME bitcoin futures market.
---------------------------------------------------------------------------

The Commission does not disagree. As the Commission has clearly and
consistently stated, an exchange that lists bitcoin-based ETPs can meet
its obligation under Exchange Act Section 6(b)(5) that its rules be
designed to prevent fraudulent and manipulative acts and practices 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.\165\ As discussed in
detail in Section III.B.2, the Commission has considered the Exchange's
arguments with respect to the CME bitcoin futures market, and the
Commission concludes that the Exchange has failed to demonstrate that
the CME bitcoin futures market is such a ``market of significant
size.''
---------------------------------------------------------------------------

\165\ See supra notes 11 and 12 and accompanying text.
---------------------------------------------------------------------------

Second, the Exchange incorporates a version of the Sponsor
Submission's lead-lag analysis into the amendment.\166\ The Exchange
states that the Sponsor attributes the ``mixed results'' in previous
academic studies that have failed to demonstrate that the CME bitcoin
futures market constitutes a market of significant size to the problems
associated with high sparsity of some of the data used, the VECM
econometric approach, and imputation of price data. The Sponsor
believes that its framework of correlation-based lead-lag analysis
using the HY estimator is more suitable.\167\ The amendment includes a
new table, not in the original Sponsor Submission, that asserts that--
although the ``lead'' in seconds of the CME bitcoin futures market has
steadily decreased over the sample period--the ``strength'' of CME
bitcoin futures price leadership has not deteriorated based on the
``ratio'' of the CME bitcoin futures market's ``average lead among all
markets over the absolute average of every market's overall lead-lag.''
---------------------------------------------------------------------------

\166\ See supra Section III.B.2.i.b.
\167\ See supra note 119 and accompanying text.
---------------------------------------------------------------------------

However, the incorporation of the Sponsor's lead-lag analysis still
contains the same shortcomings as the Sponsor's original
submission.\168\ The amendment elaborates on the potential bias that
imputation or sampling for non-synchronous and/or infrequent data can
introduce into results by citing an academic study by Buccheri et
al.\169\ that investigates the difficulties to identifying price
discovery with VECM models due to the high sparsity of data in markets
that record trades at the sub-millisecond level. The Exchange asserts
that there is such ``high sparsity'' in CME bitcoin futures data, but
provides no information that verifies this assertion. Further, even
assuming CME bitcoin futures data has such ``high sparsity'' and that
VECM-derived metrics using CME bitcoin futures data ``are potentially
biased,'' neither the Exchange nor the Sponsor demonstrates that the
Buccheri et al. critique of VECM methods applications to sub-
millisecond frequencies actually applies to the bitcoin price data
analyses and that the mixed conclusions in previous academic studies on
whether the CME bitcoin futures market leads or lags bitcoin price
discovery were inaccurate or misleading.
---------------------------------------------------------------------------

\168\ See supra Section III.B.2.i.b.
\169\ G. Buccheri, G. Bormetti, F. Corsi & F. Lillo, Comment on:
Price discovery in high resolution, 19 J. Financial Econometrics 439
(2021).
---------------------------------------------------------------------------

With respect to the Sponsor's own results using the HY estimator,
the amendment still does not provide the specific results for each
pairwise lead-lag analysis, or confidence intervals around such
results; it merely provides aggregated results that show the average
lead-lag that a market has with all other markets in a quarter.\170\
Even accepting the results at face value and assuming their statistical
significance, the Exchange has not explained why the ``ratio'' of the
CME bitcoin futures market's lead over other markets is a better
indicator of the ``strength'' of price leadership than the absolute
average lead time in seconds. In particular, the Exchange has not
explained how such ``ratio'' provides evidence that it is reasonably
likely that a would-be manipulator of the proposed ETP would have to
trade on the CME bitcoin futures market to manipulate the proposed ETP,
notwithstanding that--accepting the Sponsor's results--the CME's
absolute average lead in seconds

[[Page 5540]]

has steadily decreased over time as, in the Exchange's words, ``the
window of arbitrage opportunity has closed with increasing speed.'' The
Sponsor's analysis is thus flawed for these reasons. In any event, the
Sponsor's analysis would constitute a result that is merely part of the
``mixed conclusions'' of studies on this topic without establishing a
more definitive result from which the Commission could conclude that
there is 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, and thus the Sponsor has not
established that that the CME bitcoin futures market is a ``market of
significant size'' with respect to the proposed ETP.
---------------------------------------------------------------------------

\170\ See supra note 123 and accompanying text.
---------------------------------------------------------------------------

Third, the amendment sets forth new arguments to establish that it
is unlikely that trading in the proposed ETP would be the predominant
influence on prices in the CME bitcoin futures market. According to the
Exchange, a lead-lag analysis performed by the Sponsor concludes that
the CME bitcoin futures market continues to ``lead'' price discovery
after the launch of the ProShares Bitcoin Strategy ETF (``BITO''),\171\
even though the trading volume on CME increased significantly after the
launch. The Exchange states that it would be unreasonable to assume
that such price leadership would deteriorate with increased trade
activity in the spot market. The Exchange also presents a lead-lag
analysis of BITO performed by the Sponsor to show that there is no
significant lead-lag relationship between BITO and other bitcoin
markets, and that BITO, as a general bitcoin ETP example, only has a
minor impact on price discovery in the bitcoin markets. The Exchange
states that it believes there would similarly be no material
relationship between the Shares and the CME bitcoin futures market. The
Exchange further states that, in the gold market, which it believes is
an analogous market to bitcoin in terms of price discovery, futures
lead price discovery despite the spot market having 10 times more
volume. Finally, the Exchange states that trading of the Shares on the
secondary market could have a ``positive impact'' on the CME bitcoin
futures market's leading position because CME bitcoin futures are used
in hedging activities by market participants. The Exchange states that
``[g]iven there is a lag between the secondary market transaction, the
striking of NAV per Share in the primary market and the settlement of
the primary market transaction,'' authorized participants will seek to
hedge their exposure through the use of bitcoin futures.
---------------------------------------------------------------------------

\171\ The Exchange states that the Sponsor selected BITO for its
analysis as BITO is a Commission-registered ETF that seeks to invest
primarily in CME bitcoin futures contracts, is listed and traded on
a US regulated national securities exchange, and was launched on
October 18, 2021.
---------------------------------------------------------------------------

The Commission does not have the opportunity to consider these new
``predominant influence'' contentions and the statistical analyses that
underlie them given the untimeliness of Amendment No. 1. In any event,
no contention has sufficient detail to demonstrate that it is unlikely
that trading in the proposed ETP would be the predominant influence on
prices in the CME bitcoin futures market. Among other things, the
description of the lead-lag analysis regarding the launch of BITO lacks
confidence intervals, and thus the Commission is unable to assess the
specific results or statistical significance of those results.
Moreover, even accepting the results at face value and assuming their
statistical significance, the Exchange does not explain why results
that show that increased trading volume in CME bitcoin futures did not
reduce CME bitcoin futures' price leadership should also be considered
to support the proposition that increased trading volume in spot
bitcoin as a result of the proposed ETP also would not reduce CME
bitcoin futures' price leadership. Moreover, the relevant question is
not the impact of the proposed ETP on CME bitcoin futures' price
leadership, but on CME bitcoin futures prices themselves. The Sponsor's
lead-lag analysis does not address this. Further, with respect to the
BITO lead-lag analysis, neither the Exchange nor the Sponsor provides
any rationale for why it is reasonable to consider BITO--a CME bitcoin
futures-based fund--to be relevant in the analysis regarding a spot
bitcoin-based product such as the proposed ETP. Nor does the Exchange
or the Sponsor explain why results that purport to indicate that BITO
does not have significant price leadership over other bitcoin markets
in general should also be considered evidence that the proposed ETP
likely would not have significant price leadership over CME bitcoin
futures in particular.\172\ Further, even assuming the Exchange's
summary of the academic literature regarding price discovery in the
gold market is accurate, it does not help the Exchange to meet its
burden with respect to the proposed ETP.\173\ For example, except to
conclude summarily that gold and bitcoin markets are ``analogous,'' the
Exchange provides no explanation as to why price discovery results from
the gold market would shed light on price discovery in the bitcoin
market. In any event, as noted above, the Exchange has not explained
the connection between price discovery results and whether trading in
the proposed ETP would likely be the predominant influence on prices in
the CME bitcoin futures market. Finally, even if, as the Exchange
claims, authorized participants would use bitcoin futures to hedge any
gap between their primary market and secondary market transactions, the
Exchange has not explained why such participants would use the CME
bitcoin futures market, as opposed to other bitcoin futures markets.
---------------------------------------------------------------------------

\172\ Nor does the Exchange explain why the results should be
considered evidence that trading in the proposed ETP likely would
not have a predominant influence on CME bitcoin futures prices, as
the applicable standard requires.
\173\ See USBT Order, 85 FR at 12613.
---------------------------------------------------------------------------

Fourth, citing the recent launch of exchange-traded funds that
provide exposure to bitcoin through CME bitcoin futures (``Bitcoin
Futures ETFs''), the Exchange claims that ``there is no basis for
determining that the Bitcoin Futures ETFs satisfy Section 6(b)(5) of
the Exchange Act while the Trust does not.'' The Exchange asserts that
Bitcoin Futures ETFs and the Trust are ``exposed to the same underlying
pricing data and the same risks of manipulation,'' and thus are
``substantially similar products.''
The Commission disagrees with the premise of these arguments. Among
other things, the proposed rule change does not relate to the same
underlying holdings as the Bitcoin Futures ETFs. The Commission
considers the proposed rule change on its own merits and under the
standards applicable to it. Namely, with respect to this proposed rule
change, the Commission must apply the standards as provided by Section
6(b)(5) of the Exchange Act, which it has applied in connection with
its orders considering previous proposals to list bitcoin-based
commodity trusts and bitcoin-based trust issued receipts.\174\
---------------------------------------------------------------------------

\174\ See supra note 11. Moreover, the Exchange has not
established that the Trust and the Bitcoin Futures ETFs have the
``same pricing sources.'' While the five constituent bitcoin
platforms that currently underlie the Index are the same platforms
that currently underlie the CME CF Bitcoin Reference Rate, even
assuming the Index would generally track the CME CF Bitcoin
Reference Rate, as discussed above in Section III.B.1, the Index is
only used to value the Trust's bitcoin for purposes of calculating
NAV. The Shares, by contrast, would trade at market-based prices in
the secondary market, not at NAV. See supra note 81 and subsequent
text.

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

[[Page 5541]]

Accordingly, even if the Exchange's Amendment No. 1 had been timely
filed, there is no additional information in such amendment that would
enable the Commission to approve the proposed rule change as amended.

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-2021-039 be, and
hereby is, disapproved.

By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2022-02001 Filed 1-31-22; 8:45 am]
BILLING CODE 8011-01-P

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