[Federal Register Volume 84, Number 200 (Wednesday, October 16, 2019)]
[Notices]
[Pages 55382-55414]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-22486]
[[Page 55381]]
Vol. 84
Wednesday,
No. 200
October 16, 2019
Part II
Securities and Exchange Commission
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Self-Regulatory Organizations; NYSE Arca, Inc.; Order Disapproving a
Proposed Rule Change, as Modified by Amendment No. 1, Relating to the
Listing and Trading of Shares of the Bitwise Bitcoin ETF Trust Under
NYSE Arca Rule 8.201-E; Notice
Federal Register / Vol. 84 , No. 200 / Wednesday, October 16, 2019 /
Notices
[[Page 55382]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87267; File No. SR-NYSEArca-2019-01]
Self-Regulatory Organizations; NYSE Arca, Inc.; Order
Disapproving a Proposed Rule Change, as Modified by Amendment No. 1,
Relating to the Listing and Trading of Shares of the Bitwise Bitcoin
ETF Trust Under NYSE Arca Rule 8.201-E
October 9, 2019.
I. Introduction
On January 28, 2019, NYSE Arca, Inc. (``NYSE Arca'') 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 Bitwise Bitcoin ETF Trust
(``Trust'') under NYSE Arca Rule 8.201-E, Commodity-Based Trust Shares.
The proposed rule change was published for comment in the Federal
Register on February 15, 2019.\3\ On March 29, 2019, 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\ The
Commission received comment letters in response to the Original
Notice.\6\
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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. 85093 (Feb. 11,
2019), 84 FR 4589 (Feb. 15, 2019) (``Original Notice'').
\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 85461 (Mar. 29,
2019), 84 FR 13339 (Apr. 4, 2019). The Commission designated May 16,
2019, as the date by which it should approve, disapprove, or
institute proceedings to determine whether to disapprove the
proposed rule change.
\6\ See Letters from Anonymous (Feb. 15, 2019) (``Anonymous
Letter I''); Roald Johansson (Feb. 15, 2019) (``Johansson Letter'');
Samantha Puddifoot (Feb. 17, 2019) (``Puddifoot Letter''); Paul
Jones (Feb. 17, 2019) (``Jones Letter''); Nayna Mallya (Feb. 18,
2019) (``Mallya Letter''); Chris (Feb. 18, 2019) (``Chris Letter'');
Avinash Shenoy (Feb. 18, 2019) (``Shenoy Letter I''); Sami dos
Santos (Feb. 18, 2019) (``Santos Letter''); Vineet Jain (Feb. 19,
2019) (``Jain Letter''); Adam Malkin (Feb. 19, 2019) (``Malkin
Letter''); James Perrott (Feb. 19, 2019) (``Perrott Letter''); Sarah
Malone (Mar. 6, 2019) (``Malone Letter''); Anthony Darwin (Mar. 6,
2019) (``Darwin Letter''); D. Barnwell (Mar. 6, 2019) (``Barnwell
Letter''); Dina Pinto (Mar. 6, 2019) (``Pinto Letter''); Louise
Fitzgerald (Mar. 19, 2019) (``Fitzgerald Letter I''); Hugh Neil
(Mar. 23, 2019) (``Neil Letter''); Martyn Denscombe (Mar. 23, 2019)
(``Denscombe Letter''); Carl Ross (Mar. 23, 2019) (``C. Ross
Letter''); Rob (Mar. 24, 2019) (``Rob Letter''); Emma Buckley (Mar.
25, 2019) (``Buckley Letter''); Paul Arssov (Mar. 27, 2019)
(``Arssov Letter''); Shravan Kumar (Mar. 29, 2019) (``Kumar
Letter''); John Monterio (Mar. 30, 2019) (``Monterio Letter''); Bill
Blake (Apr. 18, 2019) (``Blake Letter''). All comments on the
proposed rule change can be found at: https://www.sec.gov/comments/sr-nysearca-2019-01/srnysearca201901.htm. Bitwise Asset Management
also provided the Commission with a written presentation at a
meeting on March 19, 2019. See Commission Staff Memorandum to File
re: Meeting with Bitwise Asset Management, NYSE Arca, Inc., and
Vedder Price P.C. (Mar. 20, 2019) (attaching Presentation to the
Commission by Bitwise Asset Management (``Bitwise Submission I'')),
available at https://www.sec.gov/comments/sr-nysearca-2019-01/srnysearca201901-5164833-183434.pdf.
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On May 7, 2019, NYSE Arca filed Amendment No. 1 to the proposed
rule change, which replaced and superseded the proposed rule change as
originally filed. On May 14, 2019, the Commission published the
proposed rule change, as modified by Amendment No. 1, for notice and
comment and instituted proceedings to determine whether to approve or
disapprove the proposed rule change, as modified by Amendment No. 1.\7\
And on August 12, 2019, the Commission designated a longer period for
Commission action on the proposed rule change.\8\ The Commission
received additional comment letters in response to the Notice and
OIP.\9\
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\7\ See Securities Exchange Act Release No. 85854 (May 14,
2019), 84 FR 23125 (May 21, 2019) (``Notice and OIP'').
\8\ See Securities Exchange Act Release No. 86629 (Aug. 12,
2019), 84 FR 42036 (Aug. 16, 2019).
\9\ See Letters from Anonymous (May 14, 2019) (``Anonymous
Letter II''); Avinash Shenoy (May 15, 2019) (``Shenoy Letter II'');
Sam Ahn (May 15, 2019) (``Ahn Letter I''); Hu Liang, CEO, and Thomas
Eidt, General Counsel, Omniex Holdings, Inc. (May 16, 2019)
(``Omniex Letter''); John Bird (May 18, 2019) (``Bird Letter'');
John LeStarge (May 20, 2019) (``LeStarge Letter''); Justin Ross (May
20, 2019) (``J. Ross Letter''); Matthew Hougan, Hong Kim, and Micah
Lerner, Bitwise Asset Management (May 24, 2019) (``Bitwise
Submission II''); Louise Fitzgerald (May 31, 2019) (``Fitzgerald
Letter II''); Fan Xia (June 7, 2019) (``Xia Letter''); Kristin
Smith, Blockchain Association (June 10, 2019) (``Blockchain
Association Letter''); Stephen McKeon, Assoc. Professor of Finance,
University of Oregon, Partner, Collaborative Fund (June 11, 2019)
(``Collaborative Fund Letter''); Sam McIngvale, Chief Executive
Officer, Coinbase Custody Trust Company, LLC (June 11, 2019)
(``Coinbase Custody Letter''); James C. Wiandt, Donostia Ventures
LLC (June 11, 2019) (``Donostia Ventures Letter''); Matthew Hougan,
Hong Kim, and Micah Lerner, Bitwise Asset Management, Annotated
Commentary on the Winklevoss Order (June 11, 2019) (``Bitwise
Submission III); Matthew Hougan, Global Head of Research, Bitwise
Asset Management, CFE Futures Question (June 11, 2019) (``Bitwise
Submission IV''); Matthew Hougan, Global Head of Research, Bitwise
Asset Management, Bitfinex Question (June 11, 2019) (``Bitwise
Submission V''); Bart Mallon, Co-Managing Partner, Cole-Frieman &
Mallon LLP (June 12, 2019) (``Mallon Letter''); Robert (June 13,
2019) (``Robert Letter''); Sam Ahn (June 18, 2019) (``Ahn Letter
II''); Sam Ahn (June 20, 2019) (``Ahn Letter III''); Matthew P.
Walsh, Founding Partner, Castle Island Ventures (June 23, 2019)
(``Castle Island Ventures Letter''); Spencer Bogart, General
Partner, Blockchain Capital (June 24, 2019) (``Blockchain Capital
Letter''); Scott Page (July 5, 2019) (``Page Letter''); Bill Blake
(July 16, 2019) (``Blake Letter''); Tagomi Holdings Inc. (Sept. 18,
2019) (``Tagomi Letter''); Patrick Neal (Sept. 24, 2019) (``Neal
Letter''). All comments on the proposed rule change, as modified by
Amendment No. 1 can be found at: https://www.sec.gov/comments/sr-nysearca-2019-01/srnysearca201901.htm. Bitwise Asset Management also
provided the Commission with a written presentation at a meeting on
September 12, 2019. See Commission Staff Memorandum to File re:
Meeting with Bitwise Asset Management, Inc., NYSE Arca, Inc., Vedder
Price P.C., and Wilson Sonsini Goodrich & Rosati (Sept. 17, 2019)
(attaching Presentation to the Commission by Bitwise Asset
Management (``Bitwise Submission VI'')), available at https://www.sec.gov/comments/sr-nysearca-2019-01/srnysearca201901-6135582-192240.pdf.
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This order disapproves the proposed rule change, as modified by
Amendment No. 1. Although the Commission is disapproving this proposed
rule change, the Commission emphasizes that its disapproval does not
rest on an evaluation of whether bitcoin,\10\ 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, NYSE Arca 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.'' \11\
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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. The proposed
rule change, as modified by Amendment No. 1, describes the exchange-
traded product's underlying asset as a ``digital asset'' and as a
``commodity,'' see Notice and OIP, supra note 7, 84 FR at 23127-28,
and describes the exchange-traded product as a Commodity-Based
Trust. For the purpose of considering this proposal, this order
describes a bitcoin as a ``digital asset'' and as a commodity.
\11\ 15 U.S.C. 78f(b)(5).
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When considering whether NYSE Arca's proposal to list the Shares is
designed to prevent fraudulent and manipulative acts and practices, the
Commission has applied the same analysis used in its orders considering
previous proposals to list a bitcoin-based commodity trust--the
``Winklevoss Order''--and bitcoin-based trust issued receipts.\12\ For
example, in
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the Winklevoss Order, the Commission explained that, although
surveillance-sharing agreements with markets relating to underlying
assets are not the exclusive means by which an exchange-traded product
(``ETP'') listing exchange can meet its obligations under Exchange Act
Section 6(b)(5), such agreements are a widely used means for exchanges
that list ETPs to meet their obligations, and the Commission has long
recognized their importance.\13\ The Commission found in the Winklevoss
Order and in orders considering bitcoin-based trust issued receipts,
that, if the listing exchange for an ETP fails to establish that the
underlying commodity market is inherently resistant to fraud and
manipulation,\14\ or that other means to prevent fraudulent and
manipulative acts and practices will be sufficient, the listing
exchange must enter into a surveillance-sharing agreement with a
regulated market of significant size relating to the underlying or
reference assets since ``[s]uch agreements provide a necessary
deterrent to manipulation because they facilitate the availability of
information needed to fully investigate a manipulation if it were to
occur.'' \15\
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\12\ 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). The Commission also notes
that orders were issued by delegated authority on the following
matters, which are under review before the Commission: Order
Disapproving a Proposed Rule Change to List and Trade the Shares of
the ProShares Bitcoin ETF and the ProShares Short Bitcoin ETF,
Securities Exchange Act Release No. 83904 (Aug. 22, 2018), 83 FR
43934 (Aug. 28, 2018) (NYSEArca-2017-139) (``ProShares Order'');
Order Disapproving a Proposed Rule Change Relating to Listing and
Trading of the Direxion Daily Bitcoin Bear 1X Shares, Direxion Daily
Bitcoin 1.25X Bull Shares, Direxion Daily Bitcoin 1.5X Bull Shares,
Direxion Daily Bitcoin 2X Bull Shares, and Direxion Daily Bitcoin 2X
Bear Shares Under NYSE Arca Rule 8.200-E, Securities Exchange Act
Release No. 83912 (Aug. 22, 2018), 83 FR 43912 (Aug. 28, 2018) (SR-
NYSEArca-2018-02) (``Direxion Order''); and 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'').
\13\ See Winklevoss Order, supra note 12, 83 FR at 37580. See
also id. at 37592 n.202 and accompanying text (discussing previous
Commission approvals of commodity-trust ETPs); GraniteShares Order,
supra note 12, 83 FR at 43925-27 nn.35-39 and accompanying text
(discussing previous Commission approvals of commodity-futures
ETPs). 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. See
Winklevoss Order, supra note 12, 83 FR at 37592-93.
\14\ Winklevoss Order, supra note 12, 83 FR at 37582. While the
Commission has not applied a ``cannot be manipulated'' standard to
such proposals, the burden is on the listing exchange to demonstrate
the validity of its contention that the underlying market is
uniquely resistant to market manipulation and fraudulent activity
and to establish that the requirements of the Exchange Act have been
met. See id. In the Winklevoss Order, the Commission found that,
even if the record had supported the proposition that some features
of bitcoin and bitcoin markets mitigate some types of manipulation
to some degree, such mitigation would be insufficient to justify
dispensing with the detection and deterrence of fraud and
manipulation provided by surveillance-sharing agreements with
significant, regulated markets. See id. at 37586.
\15\ Id. at 37580 (citing 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, 70954, 70959 (Dec. 22, 1998) (File No. S7-13-
98)). See also ProShares Order, supra note 12, 83 FR at 43936;
Direxion Order, supra note 12, 83 FR at 43914; GraniteShares Order,
supra note 12, 83 FR at 43924. The Commission has stated that it
considers two markets that are members of the Intermarket
Surveillance Group to have a comprehensive surveillance-sharing
agreement with one another, even if they do not have a separate
bilateral surveillance-sharing agreement. See Winklevoss Order,
supra note 12, 83 FR at 37580 n.19.
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The listing exchange must enter into a surveillance-sharing
agreement with a regulated market of significant size relating to the
underlying or reference assets. In this context, 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\ Thus,
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.'' Consistent with these principles, 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, and the ETP listing
exchange has entered into surveillance-sharing agreements with, or held
Intermarket Surveillance Group membership in common with, that
market.\17\
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\16\ See Winklevoss Order, supra note 12, 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 id.
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As discussed further below, Bitwise Asset Management, Inc.
(collectively with its affiliates, ``the Sponsor'') \18\ argues that
the proposal addresses the Commission's analysis because (1) the
``real'' bitcoin spot market--as opposed to the ``fake'' and non-
economic bitcoin spot market--and the Trust's net asset value (``NAV'')
process are each uniquely resistant to market manipulation and
fraudulent activity; and (2) NYSE Arca has entered into a surveillance-
sharing agreement with a regulated bitcoin futures market of
significant size.\19\ As support for its propositions, the Sponsor has
presented an analysis of the bitcoin spot market that asserts that a
small set of identified platforms have ``real'' trading volume, unlike
the remaining 95% of the spot bitcoin market, which the Sponsor asserts
is dominated by fake and non-economic activity, such as wash
trades.\20\ The Sponsor would base its pricing mechanism for the
proposed ETP on this purportedly ``real'' segment of the market, and
the Sponsor's analyses and comments focus solely on this segment of the
market when asserting that the underlying bitcoin market is uniquely
resistant to manipulation.\21\ Additionally, NYSE Arca asserts that its
existing surveillance procedures are adequate to properly monitor
trading of the Shares and to detect and deter violations of NYSE Arca's
rules and federal securities laws,\22\ and that approval of the
proposal would be consistent with the protection of investors and the
public interest.\23\
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\18\ Amendment No. 1 identifies Bitwise Investment Advisers, LLC
as the Sponsor, see Notice and OIP, supra note 7, 84 FR at 23126.
Bitwise Asset Management, Inc. authored the comment letters and
presentations submitted on behalf of the Sponsor in support of NYSE
Arca's proposal. For purposes of this Order, the Sponsor's affiliate
Bitwise Index Services, LLC will also be referred to as the Sponsor.
\19\ See id. at 23128, 23134; Bitwise Submission I, supra note
6, at 84; Bitwise Submission III, supra note 9, at 51. With respect
to key elements of its proposal--such as several assertions about
the nature of the underlying bitcoin markets and their
susceptibility to manipulation--NYSE Arca conveys the position of
the Sponsor. This Order will therefore address statements in the
Notice and OIP that recount what the Sponsor asserts along with
other representations and comments by the Sponsor.
\20\ See Bitwise Submission I, supra note 6, at 23, 60; Bitwise
Submission II, supra note 9, at 2, 34-36. See infra Section
III.B.1(c) for discussion of the Sponsor's methodology for
distinguishing ``real'' trading volume from fake and non-economic
activity.
\21\ See Bitwise Submission I, supra note 6, at 67-69, 91, 118;
Bitwise Submission II, supra note 9, at 13.
\22\ See Notice and OIP, supra note 7, 84 FR at 23136.
\23\ See id.
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Accordingly, the Commission examines below whether the proposed
rule change, as modified by Amendment No. 1, is consistent with Section
6(b)(5) of the Exchange Act by addressing in Section III.B.1 below
assertions that
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bitcoin and the relevant bitcoin market are uniquely resistant to
manipulation and fraudulent activity; addressing in Section III.B.2
below assertions that other means are available to prevent fraudulent
and manipulative activity in the Shares; addressing in Section III.B.3
below assertions that NYSE Arca has entered into a surveillance-sharing
agreement with a regulated market of significant size related to
bitcoin; and addressing in Section III.C below assertions that the
proposal is consistent with the protection of investors and the public
interest. Because, among other things, the Sponsor has asserted that
95% of the bitcoin spot market consists of fake and non-economic
activity, but has not established that it has in fact identified the
``real'' bitcoin market, or that the ``real'' bitcoin market is
isolated from the fraudulent and manipulative activity, we find, in
each case, that NYSE Arca has not met its burden to demonstrate that
its proposal is consistent with the requirements of Exchange Act
Section 6(b)(5), and therefore the Commission disapproves this proposed
rule change.
II. Description of the Proposed Rule Change, as Modified by Amendment
No. 1
As described in detail in the Notice and OIP,\24\ NYSE Arca
proposes to list and trade the Shares under NYSE Arca Rule 8.201-E,
which covers the listing and trading of Commodity-Based Trust Shares on
NYSE Arca.\25\ Bitwise Investment Advisers, LLC would be the Sponsor of
the Trust.\26\
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\24\ See Notice and OIP, supra note 7.
\25\ See NYSE Arca Rule 8.201-E (permitting the listing and
trading of ``Commodity-Based Trust Shares,'' defined as a security
(a) that is issued by a trust that holds a specified commodity
deposited with the trust; (b) that is issued by such trust in a
specified aggregate minimum number in return for a deposit of a
quantity of the underlying commodity; and (c) that, when aggregated
in the same specified minimum number, may be redeemed at a holder's
request by such trust, which will deliver to the redeeming holder
the quantity of the underlying commodity).
\26\ See Notice and OIP, supra note 7, 84 FR at 23126.
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According to NYSE Arca, the investment objective of the Trust would
be to provide exposure to bitcoin at a price that reflects the
purportedly ``real'' bitcoin spot market--as opposed to the ``fake''
and non-economic bitcoin market \27\--where investors can purchase and
sell bitcoin, minus the expenses of the Trust's operation.\28\ The
Trust would use the Bitwise Daily Bitcoin Reference Price to calculate
its daily NAV, and the Sponsor would produce the Bitwise Daily Bitcoin
Reference Price once per day at 4:00 p.m. E.T., using the prices and
volume from selected platforms that trade bitcoin in the bitcoin spot
market (``platforms'' or ``trading platforms'') that the Sponsor
asserts currently account for substantially all of the ``real'' spot
global volume of bitcoin traded on such platforms, excluding trading in
capital-controlled countries.\29\ To calculate the Bitwise Daily
Bitcoin Reference Price, the Sponsor would examine six five-minute
periods leading up to 4:00 p.m. E.T., calculate the volume-weighted
median price of each of these periods, and then calculate an equal-
weighted average of the six volume-weighted median prices.\30\
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\27\ See infra Section III.B.1(c)(i) (describing the Sponsor's
assertions about the nature and extent of ``fake'' and non-economic
trading in the bitcoin market).
\28\ See Notice and OIP, supra note 7, 84 FR at 23126.
\29\ NYSE Arca, the Sponsor, and other commenters may refer to
the spot trading of bitcoin on ``exchanges.'' The platforms that
trade bitcoin in the bitcoin spot market are not registered with the
Commission as national securities exchanges. See Sections 5 and 6 of
the Exchange Act, 15 U.S.C. 78e, 78f.
\30\ See Notice and OIP, supra note 7, 84 FR at 23131. See also
id. at 23130 n.20 (describing the reduction in the number of
platforms used to calculate the Bitwise Daily Bitcoin Reference
Price from ten to nine).
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NYSE Arca would also calculate an intraday indicative value
(``IIV'') every fifteen seconds during the core trading day, based on
the Bitwise Real-Time Bitcoin Price. The Sponsor would calculate the
Bitwise Real-Time Bitcoin Price from the same set of selected platforms
with purportedly ``real'' volume, using a volume-weighted price
methodology. Instead of equally weighting prices captured over six
five-minute periods, however, the Bitwise Real-Time Bitcoin Price would
use only the price from the last trade on each platform, and it would
use the trailing thirty-minute volume on those platforms as a weighting
factor.\31\
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\31\ See id. at 23132. Further details regarding the Trust and
the Shares, including investment strategies, calculation of NAV and
IIV, creation and redemption procedures, and additional background
information about bitcoins and the Bitcoin network, among other
things, can be found in the Notice and OIP (see supra note 7) and
the registration statement filed with the Commission on Form S-1/A
(File No. 333-229180) under the Securities Act of 1933
(``Registration Statement''), as applicable.
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III. Discussion
A. The Applicable Standard for Review
The Commission must consider whether NYSE Arca's proposal is
consistent with Exchange Act Section 6(b)(5), which requires, in
relevant part, that the rules of a national securities exchange be
designed ``to prevent fraudulent and manipulative acts and practices''
and ``to protect investors and the public interest.'' \32\ 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.'' \33\
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\32\ 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.78(f)(b)(5).
\33\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
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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,\34\ 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.\35\ 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.\36\
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\34\ See id.
\35\ See id.
\36\ Susquehanna Int'l Group, LLP v. Securities and Exchange
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017).
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B. Whether NYSE Arca Has Met Its Burden To Demonstrate That the
Proposal Is Designed To Prevent Fraudulent and Manipulative Acts and
Practices
In analyzing whether the NYSE Arca has met its burden to
demonstrate that its proposal is consistent with Exchange Act Section
6(b)(5), the Commission examines below whether the record supports the
Sponsor's assertions that bitcoin and the relevant bitcoin market are
uniquely resistant to manipulation
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and fraudulent activity such that a sufficient surveillance-sharing
agreement is unnecessary. See infra Section III.B.1. The Commission
first addresses whether the record demonstrates that the inherent
properties of bitcoin would make the proposed ETP uniquely resistant to
manipulation. See infra Section III.B.1(a). The Commission next
addresses the Sponsor's contention that, based on its analysis, ``when
fake and/or non-economic data is removed, the remaining or `real'
market for bitcoin is significantly smaller, more orderly and more
regulated than commonly understood,'' \37\ and whether, focusing solely
on the asserted characteristics of the ``real'' market for bitcoin, the
record demonstrates that the nature of the ``real'' spot market for
bitcoin would make the proposed ETP uniquely resistant to manipulation.
See infra Section III.B.1(b). The Commission then addresses whether the
record demonstrates that the Sponsor, through its analysis, has shown
that the ``real'' spot market for bitcoin is isolated from other
trading platforms that may be dominated by fake or non-economic
trading, such that the proposed ETP based on those trading platforms in
the identified ``real'' market would be uniquely resistant to
manipulation. See infra Section III.B.1(c). The Commission also
considers whether the record demonstrates that any additional aspects
of the Trust and its methods for determining NAV, handling creations
and redemptions, and calculating fees (see infra Section III.B.1(d)),
or NYSE Arca's rules, including its surveillance procedures (see infra
Section III.B.2), would provide sufficient means to prevent fraud and
manipulation. The Commission concludes that NYSE Arca has not
demonstrated that a surveillance-sharing agreement with a significant,
regulated market is unnecessary.
---------------------------------------------------------------------------
\37\ Notice and OIP, supra note 7, 84 FR at 23129.
---------------------------------------------------------------------------
The Commission then examines whether the record supports the
Sponsor's assertion that the bitcoin futures market, as represented by
bitcoin futures listed and traded on the Chicago Mercantile Exchange
(``CME''), is a significant, regulated market, such that a
surveillance-sharing agreement with that market would provide a
necessary deterrent to manipulation because it would facilitate the
availability of information needed to fully investigate a manipulation
if it were to occur.\38\ See infra Section III.B.3. The Commission
addresses the Sponsor's comparison of the size of the bitcoin futures
and spot markets and the Sponsor's representations about the
correlation of prices between these markets, as well as whether the
record establishes that there is a reasonable likelihood that a person
attempting to manipulate the proposed ETP would also have to trade on
the bitcoin futures market to manipulate the proposed ETP. The
Commission concludes that--because NYSE Arca has not demonstrated that
the bitcoin futures market is ``significant,'' as the Commission has
interpreted that term in this context \39\--NYSE Arca has not met its
burden to demonstrate that its proposal is consistent with Exchange Act
Section 6(b)(5). Finally, the Commission addresses and rejects other
factors that the Sponsor contends support approval. See infra Section
III.B.4.
---------------------------------------------------------------------------
\38\ The Sponsor's arguments address both trading on the CME and
the Cboe Futures Exchange (``CFE''), see, e.g., id. at 23134, but
the Commission notes that the CFE ceased offering new bitcoin
futures contracts as of March 2019. See New CFE Products Being Added
in March 2019--Update, Cboe (Mar. 14, 2019), available at https://markets.cboe.com/resources/product_update/2019/New-CFE-Products-Being-Added-in-March-2019-Update.pdf (last visited Oct. 7, 2019).
\39\ See supra note 16 and accompanying text.
---------------------------------------------------------------------------
1. Assertions That Bitcoin and the Bitcoin Market Are Uniquely
Resistant to Market Manipulation and Fraudulent Activity
(a) The Sponsor's Assertions About the Inherent Properties of Bitcoin
(i) Representations Made and Comments Received
The Sponsor argues that the digital nature of bitcoin makes it
unique compared to other commodities in three important ways--
fungibility, transportability, and ``exchange tradability''--that
combine to provide unique protections against, and allow bitcoin to be
uniquely resistant to, attempts at price manipulation.\40\ The Sponsor
represents that bitcoin is a globally fungible commodity with low
transaction costs, near-zero transportation costs that allow nearly
instantaneous transportation, and low-to-zero storage costs.\41\
According to the Sponsor, bitcoin is globally fungible because a
bitcoin is the same anywhere in the world.\42\ In addition, a commenter
compares the fungibility of bitcoin to that of gold and states that
this fungibility reduces the overhead costs of evaluating the qualities
of each asset to arrive at a fair price.\43\
---------------------------------------------------------------------------
\40\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission I, supra note 6, at 114; Bitwise Submission III, supra
note 9, at 47. See also Omniex Letter, supra note 9, at 4 (stating
that, as the Sponsor has detailed, the digital nature of bitcoin
makes it unique due to ``exchange-tradability,'' fungibility, and
transportability).
\41\ See Notice and OIP, supra note 7, 84 FR at 23128; Bitwise
Submission I, supra note 6, at 14.
\42\ See Notice and OIP, supra note 7, 84 FR at 23128; Bitwise
Submission I, supra note 6, at 15.
\43\ See Blockchain Capital Letter, supra note 9, at 6.
---------------------------------------------------------------------------
The Sponsor represents that bitcoin is inherently transportable at
a cost approaching zero and can be safely stored at established,
regulated third-party custodians, in a ``limitless'' amount, at costs
of 0% to 1.5% a year.\44\ A commenter states that bitcoin's portability
is a valuable and unprecedented attribute and states that bitcoin can
be quickly and easily transferred anywhere in the world.\45\ While the
Sponsor points to spreads of $0.01 on certain bitcoin platforms as
evidence of low transaction costs,\46\ when discussing the limitations
of arbitrage quality in the bitcoin market, the Sponsor also
acknowledges the presence of certain frictions, including trading fees,
withdrawal fees, withdrawal times and hedging costs, risk of default or
computer hacking, and difficulties operating across different countries
and fiat currencies.\47\
---------------------------------------------------------------------------
\44\ See Notice and OIP, supra note 7, 84 FR at 23129; Bitwise
Submission I, supra note 6, at 17-18; Bitwise Submission II, supra
note 9, at 2.
\45\ See Blockchain Capital Letter, supra note 9, at 5-6 (noting
that bitcoin's reduced transaction fees and accelerated transaction
timeframe lower barriers to enter the market).
\46\ See Notice and OIP, supra note 7, 84 FR at 23129; Bitwise
Submission I, supra note 6, at 16.
\47\ See Bitwise Submission II, supra note 9, at 65-66
(describing trading fees on two bitcoin platforms that range from
0.00% to 0.25% and withdrawal fees that ``can range from a little to
a lot,'' including 3% for substantial U.S. dollar withdrawals on one
bitcoin platform). The Sponsor represents that the U.S. dollar,
Euro, and Japanese Yen are examples of fiat currencies. See id. at
15.
---------------------------------------------------------------------------
The Sponsor argues that having price discovery for bitcoin
conducted on the open market--bitcoin's purported ``exchange
tradability''--makes bitcoin unique as compared to other commodities
that have their prices set using off-market, ``coordinated fix
pricing.'' \48\ The Sponsor points to recent market manipulation
scandals that it states were driven by coordinated fix pricing,
including those related to the London Interbank Offered Rate
(``LIBOR'') in 2012, global forex in 2013, the gold fix in 2014, and
the Australian
[[Page 55386]]
Bank Bill Swap Rate in 2016.\49\ In addition, the Sponsor asserts that
bitcoin's lack of a physical delivery location makes it unique and
prevents cornering, a form of manipulation in the commodities
market.\50\
---------------------------------------------------------------------------
\48\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission III, supra note 9, at 47, 137. The Sponsor acknowledges
that conducting price discovery in an open, transparent, online
setting introduces risks, but asserts that these risks must be
weighed against the benefits of open price discovery and can be
controlled through the design of the Trust. See Notice and OIP,
supra note 7, 84 FR at 23133; Bitwise Submission III, supra note 9,
at 137.
\49\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission I, supra note 9, at 116; Bitwise Submission III, supra
note 9, at 137.
\50\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission III, supra note 9, at 47. For example, Amendment No. 1
states that, in May 2011, the U.S. Commodity Futures Trading
Commission (``CFTC'') filed suit against trading firms for
attempting to manipulate the price of oil by cornering the market
for oil storage in Cushing, Oklahoma. See Notice and OIP, supra note
7, 84 FR at 23133. According to Amendment No. 1, a disconnect
between the size of the storage market in the reference price market
(Cushing) and the much larger real market for WTI crude oil created
an opportunity for individuals and firms to attempt to profit from
artificially manipulating the small market for storage while holding
larger positions in the underlying commodity. See id. at 23133.
---------------------------------------------------------------------------
(ii) Analysis
The Commission concludes that the record does not demonstrate that
bitcoin's asserted fungibility, transportability, and ``exchange-
tradability'' make bitcoin uniquely resistant to manipulation. The
manipulation of asset prices can occur through trading activity that
creates a false impression of supply or demand,\51\ and the Commission
concludes that the Sponsor's concessions that 95% of the reported
trading in bitcoin is ``fake'' or non-economic (including wash trading
or trading that is simply fabricated) \52\--and that the early bitcoin
market may have been subject to market manipulation \53\--effectively
concede that the properties of bitcoin do not make it inherently
resistant to manipulation.\54\
---------------------------------------------------------------------------
\51\ See Winklevoss Order, supra note 12, 83 FR at 37585.
\52\ See Bitwise Submission I, supra note 6, at 23; Bitwise
Submission II, supra note 9, at 2, 35-36. A ``wash trade'' is a
transaction such as a purchase and sale simultaneously or within a
short period of time, that involves no changes in beneficial
ownership, and is a means of creating artificial market activity.
See In re Silseth, Release No. 7317, 1996 WL 427988, at *1 & n.3
(July 30, 1996); Reddy v. CFTC, 191 F.3d 109, 115 (2d Cir. 1999).
Wash trading is manipulative and defrauds investors. See id.; Santa
Fe Indus., Inc. v. Green, 430 U.S. 462, 476-77 (1977); Ernst & Ernst
v. Hochfelder, 425 U.S. 185, 199 (1976).
\53\ See Bitwise Submission III, supra note 9, at 49 (describing
reports of manipulation at the failed Mt. Gox platform in 2013).
\54\ The Commission also notes that several commenters have
asserted that bitcoin prices can be manipulated. See infra notes 69-
73 and accompanying text.
---------------------------------------------------------------------------
Moreover, contrary to the Sponsor's argument, the Commission does
not agree that the relative fungibility of an asset makes it inherently
resistant to manipulation and notes that fungible assets, such as
securities and exchange-traded derivatives, trade subject to
substantial regulatory oversight and surveillance-sharing agreements
that would be unnecessary if fungibility were sufficient protection
against manipulation.\55\ Further, transportation and storage costs for
bitcoin are not zero, contrary to the Sponsor's claims,\56\ as bitcoin
mining and recording transactions to the blockchain have costs. Bitcoin
mining involves significant costs for electrical power and computer
hardware, and the Sponsor acknowledges that bitcoin is subject to
transaction fees charged by trading platforms, withdrawal fees,
expenses for custody arrangements, and other factors that impose
frictions on trading.\57\ The Sponsor also points to the presence of a
spread on bitcoin platforms,\58\ which, even if small, indicates the
presence of trading costs. Therefore claims in the record about
bitcoin's fungibility and transportability do not suffice to establish
unique resistance to manipulation.\59\
---------------------------------------------------------------------------
\55\ The Commission notes that, while the Sponsor asserts that
bitcoin is fungible to the degree that it is ``the same anywhere in
the world'' and that all bitcoin are treated equally, see supra
notes 40-43 and accompanying text, if a market participant seeks to
trade bitcoins on a trading platform that complies with Anti-Money
Laundering (``AML'') and Know Your Customer (``KYC'') standards,
those bitcoins may be subject to review regarding their provenance
and may not be accepted if they have previously been used for money
laundering, drug trades, human trafficking, or other criminal
purposes.
\56\ See supra notes 44-47 and accompanying text.
\57\ See supra notes 44, 47, and accompanying text. See also
Registration Statement, supra note 31, at 9, 12 (recognizing
transaction costs and fees).
\58\ See supra note 46 and accompanying text.
\59\ Contrary to the Sponsor's characterization that bitcoin is
available in a ``limitless'' amount, see supra note 44, the
Registration Statement represents that the Bitcoin protocol
currently ``limits both the total amount of bitcoin that will be
produced and the rate at which it is released'' such that the
``supply of bitcoin is programmatically limited to 21 million
bitcoin.'' Registration Statement, supra note 31, at 1, 19.
---------------------------------------------------------------------------
While the Sponsor attempts to distinguish bitcoin from certain
commodities that have their prices set using off-market, coordinated
fix pricing and asserts that bitcoin's use of prices set in the open
market makes it uniquely resistant to certain forms of manipulation
that have been witnessed with such commodities,\60\ the Commission has
required the listing exchange for a derivatives securities product to
have a surveillance-sharing agreement even where the underlying was
exchange-traded.\61\ And, as discussed further below,\62\ NYSE Arca has
not demonstrated that the bitcoin market itself, or the segment of the
market used for the proposed ETP's pricing mechanism, is uniquely
resistant to manipulation. Thus, the Commission cannot conclude that
the nature of bitcoin itself would make the proposed ETP uniquely
resistant to manipulation, such that a surveillance-sharing agreement
with a significant, regulated market would not be required.
---------------------------------------------------------------------------
\60\ See supra notes 48-50, and accompanying text.
\61\ See infra note 135 and accompanying text (concerning equity
options).
\62\ See infra Sections III.B.1(b) and III.B.1(c) for additional
discussion of the spot market for bitcoin.
---------------------------------------------------------------------------
(b) The Sponsor's Assertions About the Nature of the Spot Market for
Bitcoin
The Sponsor contends that it has identified a ``real'' spot market
for bitcoin that is isolated from the remaining 95% of the bitcoin spot
market, which the Sponsor asserts is dominated by ``fake'' or non-
economic trading, and the Sponsors proffers its methodology for
distinguishing this ``real'' bitcoin trading from fake or non-economic
bitcoin trading. In this subsection of the order, the Commission
analyzes the Sponsor's claims regarding the ``real'' spot market as
identified by the Sponsor and examines whether the record demonstrates
that the nature of trading in, and the degree of regulation of, this
``real'' bitcoin spot market make it uniquely resistant to
manipulation. And, in the following subsection of this order,\63\ the
Commission analyzes the Sponsor's proffered methodology for isolating
``real'' bitcoin trading activity from fake or non-economic activity--
an analysis that bears on the nature of the spot market for bitcoin
considered in this section, because the purportedly ``real'' bitcoin
spot market that the Sponsor identifies cannot be uniquely resistant to
manipulation unless it is free from the influence of prices derived
from fake or non-economic trading, or fraudulent or manipulative
activity, in the broader bitcoin market.
---------------------------------------------------------------------------
\63\ See infra Section III.B.1(c).
---------------------------------------------------------------------------
(i) Representations Made and Comments Received
(A) The Sponsor's Assertions Regarding Arbitrage and Efficiency in the
Bitcoin Spot Market
The Sponsor asserts that, once fake and non-economic trading have
been removed, the remaining ``real'' market for bitcoin, as identified
by the Sponsor's research, is significantly smaller, more orderly, and
more regulated ``than commonly understood,'' and moreover, that this
``real'' market is uniquely resistant to manipulation.\64\ The Sponsor
asserts that bitcoin trades at a single price on ``real'' trading
[[Page 55387]]
platforms globally, that extremely effective arbitrage is in place
between those platforms, and that a distributed market has emerged in
which no single platform represents the majority of ``real'' trading
volume.\65\ The Sponsor asserts that these characteristics of the
``real'' bitcoin market provide unique resistance to manipulation
because an attempt to manipulate the market would need to involve a
non-trivial amount of bitcoin's total global liquidity and either be
coordinated simultaneously across multiple platforms or involve a
significant spike in volume on a single platform (which would trigger
review as part of the Sponsor's NAV process).\66\ Therefore, according
to the Sponsor, any attempt at manipulation would be relatively
difficult, risky, and costly to carry out.\67\ In addition, a commenter
asserts that bitcoin has a highly liquid secondary market that is
conducive to an efficient market and price discovery.\68\ Several
commenters generally assert that manipulation is present in the bitcoin
market \69\ or provide evidence of manipulation in the bitcoin market,
including Ponzi schemes; \70\ spoofing, layering, and front running;
\71\ trading by dominant market participants; \72\ and suspicious
trading patterns or price movements.\73\
---------------------------------------------------------------------------
\64\ See Notice and OIP, supra note 7, 84 FR at 23129, 23133;
Bitwise Submission I, supra note 6, at 23.
\65\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission I, supra note 6, at 117-118; Bitwise Submission III,
supra note 9, at 47. The Sponsor argues that these characteristics
of the bitcoin market arise from bitcoin's fungibility and
transportability, as discussed further above in Section I.A.1(a).
\66\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission I, supra note 6, at 118.
\67\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission I, supra note 6, at 117; Bitwise Submission III, supra
note 9, at 33.
\68\ See Blockchain Capital Letter, supra note 9, at 6
(asserting that these characteristics are partly a byproduct of
bitcoin's divisibility, fungibility, and portability).
\69\ See Bird Letter, supra note 9 (asserting that bitcoin is
not immune to manipulation by a group, individual, or software);
Kumar Letter, supra note 6 (calling it ``common knowledge'' that the
bitcoin market is manipulated); Perrott Letter, supra note 6
(stating that we are still very much in a volatile and manipulated
market); Pinto Letter, supra note 6 (stating that the bitcoin market
is volatile and manipulated by the very few); C. Ross Letter, supra
note 6 (referring to manipulation as a ``prime issue''); Shenoy
Letter I, supra note 6 (incorporating letter from Avinash Shoney
(Sept. 29, 2018), regarding SR-CboeBZX-2018-040 (``Shenoy Letter
III''), at 1, available at https://www.sec.gov/comments/sr-cboebzx-2018-040/srcboebzx2018040-4460679-175814.pdf) (asserting that it is
a ``widely known fact'' that the bitcoin market is manipulated).
\70\ See Kumar Letter, supra note 6 (arguing that Ponzi schemes
are common and referencing the recently shut down BitConnect
platform).
\71\ See Shenoy Letter III, supra note 69, at 1, 8 (representing
that spoofing, layering, and front-running are prevalent; that pump-
and-dump schemes organized through messaging apps are ubiquitous and
make use of coordinated actions of trading bots and the speed at
which news spreads on social media; and that trading bots have been
known to artificially inflate the price of cryptocurrencies by up to
300%). See also Shenoy Letter II, supra note 9, at 1 (stating that
high-frequency traders have been using trading bots to front-run
other investors in the equity world for several decades). This
commenter asserts that, considering past manipulation of the markets
for LIBOR, foreign currencies, U.S. Treasuries, gold, and silver, it
would not be so hard to manipulate a smaller market such as the
market for bitcoin. See Shenoy Letter III, supra note 69, at 1.
\72\ See Shenoy Letter III, supra note 69, at 1 (stating that
research by economists indicates that it is likely that past events
involved manipulation of bitcoin's price by just one or two major
players, and that miners, some of whom have a large concentration of
power and large bitcoin positions, have an interest in seeing the
price of bitcoin rise); Bird Letter, supra note 9 (asserting that
trading by a single entity recently caused the price of bitcoin to
drop more than $1,000 in minutes across the market, including on the
Sponsor's identified ``real'' platforms, and that this incident
disproves the assertion that bitcoin is uniquely resistant to
manipulation).
\73\ One commenter asserts that an observed digital-asset-
trading pattern known as ``Bart'' frequently occurs around bitcoin
futures expiry and may be caused by high-frequency traders. See
Shenoy Letter III, supra note 69, at 1-2, 6, 7. This commenter
represents that it is common to see price movement that appears to
be market reaction to news before the news is released, which is
indicative of market manipulation and insider trading. See id. at 3-
5. This commenter also states that most bitcoin platforms do not
block masked VPN IP addresses, raising questions about the ability
of trading platforms to restrict access to authorized users only and
prevent manipulation. See id. at 2-3. Another commenter refers to an
apparent ``price pump'' of approximately $800 million for bitcoin in
under a week. See Perrott Letter, supra note 6. Another commenter
states that three small platforms lost over $200 million in investor
funds in 2019. See Blake Letter II, supra note 9.
---------------------------------------------------------------------------
The Sponsor argues that the ``real'' bitcoin market is organized,
efficient, resilient, and robust, with ``extremely tight spreads and
effective arbitrage.'' \74\ The Sponsor asserts that spreads in the
``real'' bitcoin market make bitcoin one of the most tightly quoted
financial instruments in the world.\75\ For example, the Sponsor
represents that in April 2019, the average median spread on the ten
platforms that it identifies as ``real''--Binance, Bitfinex, Coinbase
Pro, Kraken, Bitstamp, bitFlyer, Gemini, itBit, Bittrex, and Poloniex
\76\--was $1.31 and the five most liquid ``real'' platforms had median
spreads ranging from $0.01 to $1.75, constituting a range of 0.01% to
0.03% as compared to bitcoin's trading price of around $5,000 that
month.\77\
---------------------------------------------------------------------------
\74\ See Notice and OIP, supra note 7, 84 FR at 23131; Bitwise
Submission II, supra note 9, at 13, 85; Bitwise Submission III,
supra note 9, at 147; Bitwise Submission VI, supra note 9, at 10.
See also Omniex Letter, supra note 9, at 4 (stating that the
Sponsor's study demonstrates that the actual market for bitcoin is
more orderly and efficient than commonly perceived and exhibits
robust price discovery and effective arbitrage).
\75\ See Notice and OIP, supra note 7, 84 FR at 23129; Bitwise
Submission II, supra note 9, at 55-56. See also Notice and OIP,
supra note 7, 84 FR at 23128 (asserting that the current efficiency
of the spot bitcoin market matches or exceeds that of other major
financial markets).
\76\ See Bitwise Submission II, supra note 9, at 34-35.
\77\ See id. at 55-56. See also Notice and OIP, supra note 7, 84
FR at 23129 (describing that the bitcoin platform Coinbase Pro had a
median spread in March 2019 of $0.01, with bitcoin valued at
approximately $5,000); Bitwise Submission I, supra note 6, at 16
(stating that, on leading platforms, bitcoin commonly trades with a
$0.01 spread with a price of approximately $4,000), 28 (stating that
at the time of a December 12, 2018, snapshot, Coinbase Pro had a
spread of $0.01, or 0.0003% based on bitcoin's trading price of
$3,419), 111 (stating that average spreads on the ``real'' platforms
ranged from 0.01% to 0.10% and that two of these platforms had a
single tick as their median spread). But see Bitwise Submission II,
supra note 9, at 70 n.182 (referring to one platform (Poloniex) as
``too small and illiquid to support meaningful arbitrage trading''
and stating that another (Bitfinex) has a 3% fee on withdrawals that
``rais[es] certain challenges for institutional arbitrage
activity'').
---------------------------------------------------------------------------
The Sponsor provides an analysis of arbitrage across the ten
identified platforms in the ``real'' bitcoin spot market and concludes
that prices on these platforms trade closely together and have their
disparities rapidly arbitraged away.\78\ According to the Sponsor, this
conclusion holds regardless of venue, currency pair, or any other
identifiable factor.\79\ For the purposes of its analysis, the Sponsor
has taken, once per second, the last-traded price on each of the ten
platforms and used an equal-weighted average to calculate a real-time
consolidated spot price (``consolidated price'').\80\ The Sponsor has
plotted the price of bitcoin on each of the ten platforms from January
2018 through mid-May 2019 on a chart, and concludes that it is
``difficult to see meaningful gaps'' between the prices on each
platform.\81\ The Sponsor has then calculated the average deviation
from the consolidated price for each of the ten platforms on a second-
by-second basis since January 2019 and finds that the average deviation
for any given platform ranged from 0.06% to 0.20% during that period,
with an average deviation across all platforms of 0.12%.\82\ The
Sponsor
[[Page 55388]]
asserts that these results show that the platforms trade ``incredibly
tightly,'' with average deviations at a level within the trading fees
on the platforms.\83\ Therefore, according to the Sponsor, the results
suggest that institutional-quality arbitrageurs and algorithmic
programs are at work to keep prices closely aligned.\84\
---------------------------------------------------------------------------
\78\ See Bitwise Submission II, supra note 9, at 60-65; Bitwise
Submission III, supra note 9, at 31, 35.
\79\ See Bitwise Submission III, supra note 9, at 37.
\80\ See Bitwise Submission II, supra note 9, at 60 (stating
that the Sponsor chose to use equal-weighting to remove any
suggestion that one platform appears to trade closely to a
consolidated price only because it has an undue influence over the
consolidated price).
\81\ See id. at 60-61. See also Bitwise Submission I, supra note
6, at 67 (showing graph of prices on the ten platforms from January
2018 through mid-March 2019, and stating that they form a
``singular'' price).
\82\ See Bitwise Submission II, supra note 9, at 61-62. The
Sponsor provides an earlier analysis that shows average deviations
for each platform ranging from 0.13% to 0.25% from January 2018
through mid-March 2019. See Notice and OIP, supra note 7, 84 FR at
23131; Bitwise Submission I, supra note 6, at 68. See also Bitwise
Submission III, supra note 9, at 35 (representing that its earlier
analysis shows that the average deviation in price between each of
the ten platforms and the globally integrated price in April 2019
was between 0.06% and 0.19%).
\83\ See Bitwise Submission II, supra note 9, at 62 (noting that
``taker'' trading fees on the ten platforms range from 0.04% to
0.35%, and that a market participant would need to incur these fees
on both sides of the trade to immediately capture the arbitrage
opportunity). See also Bitwise Submission I, supra note 6, at 68
(stating that average deviations are well within the expected
arbitrage band when taking into account platform-level fees of
around 30 basis points, volatility, and hedging costs).
\84\ See Bitwise Submission II, supra note 9, at 62.
---------------------------------------------------------------------------
In addition, the Sponsor has identified instances in which the
price of bitcoin on a particular ``real'' platform deviated by more
than 1% from the consolidated price during the 12 months starting in
April 2018.\85\ The Sponsor has then graphed the number of instances
where a platform had a price deviation greater than 1% away from the
consolidated price for a specific number of seconds, both across all
ten ``real'' platforms and for each platform.\86\ The Sponsor states
that, in the aggregate, the results show that more than 50% of all
pricing discrepancies greater than 1% were arbitraged away within 5
seconds and that more than 90% of all such pricing discrepancies were
arbitraged away within 34 seconds.\87\ According to the Sponsor, these
results were remarkably consistent across all platforms and show that
pricing discrepancies greater than 1% were rare and quickly arbitraged
away.\88\ The Sponsor also asserts that these results suggest that
bitcoin has a global network of spot platforms that are tightly
arbitraged and form a single, global price.\89\ The Sponsor states that
its conversations with leading market makers suggest that such market
makers maintain capital at multiple platforms to facilitate this
arbitrage.\90\
---------------------------------------------------------------------------
\85\ See id.
\86\ See id. at 62-64.
\87\ See id. at 63; Bitwise Submission III, supra note 9, at 33,
35. In its earlier analysis, the Sponsor has examined deviations
greater than 1% that lasted more than 100 seconds. Based on a
provided histogram of these instances, the Sponsor concludes that
such sustained deviations were extremely rare and of diminished
frequency in recent months. See Notice and OIP, supra note 7, 84 FR
at 23131; Bitwise Submission I, supra note 6, at 69; Bitwise
Submission III, supra note 9, at 33, 35.
\88\ See Bitwise Submission II, supra note 9, at 62-63.
\89\ See id. at 65.
\90\ See Bitwise Submission III, supra note 9, at 33.
---------------------------------------------------------------------------
The Sponsor argues that the efficiency of the ``real'' bitcoin
market has improved dramatically over the past eighteen months and is
now approaching its practical limit, in that prices are ``nearly
perfectly'' arbitraged, spreads are ``incredibly tight,'' and the
market is liquid on a twenty-four hour, seven-day-a-week basis.\91\ In
particular, according to the Sponsor, the strength of arbitrage on the
bitcoin spot market and quality of that market has improved
significantly since December 2017.\92\ The Sponsor has charted the
average deviation of the price of bitcoin on the ten ``real'' spot
platforms, as measured against the consolidated price, monthly from
January 2018 through April 2019, and concludes that the data show a
pronounced downward trend, indicating increasingly efficient
arbitrage.\93\ The Sponsor attributes improvements in arbitrage on the
bitcoin platforms in part to the December 2017 introduction of the
bitcoin futures market, which allows arbitrageurs to gain short
exposure in bitcoin and created a two-sided market with easy hedging,
and to the growth of contract volume on that market.\94\ The Sponsor
also points to the February 2018 emergence and subsequent growth of the
institutional short lending market for bitcoin, which allows
arbitrageurs to capitalize on short term price dislocations in the
bitcoin market.\95\ The Sponsor further asserts that the 2018 entry of
well-established, institutional, and algorithmic market-makers into the
bitcoin market has brought increased order and efficiency to the
market.\96\ The Sponsor states that it ``does not discount the
possibility'' that the bitcoin market was susceptible to market
manipulation in 2013, prior to the development of material regulation
or the entry of large market participants, but asserts that concerns
raised about market conditions during that earlier period are mitigated
by the current existence of a well-functioning, distributed market with
multiple, significant platforms connected by efficient arbitrage.\97\
---------------------------------------------------------------------------
\91\ See Notice and OIP, supra note 7, 84 FR at 23131; Bitwise
Submission I, supra note 6, at 111.
\92\ See Notice and OIP, supra note 7, 84 FR at 23128; Bitwise
Submission II, supra note 9, at 72; Bitwise Submission III, supra
note 9, at 3.
\93\ See Notice and OIP, supra note 7, 84 FR at 23128; Bitwise
Submission II, supra note 9, at 72. See also Bitwise Submission I,
supra note 6, at 106 (providing a graph of aggregate monthly price
deviation from December 2017 through mid-March 2019). In addition,
the Sponsor has provided an updated chart showing the average
deviation of the price of bitcoin on the ``real'' spot platforms, as
measured against the consolidated price, through August 2019,
showing similar average deviations in May through August 2019 as
compared to the earlier portion of 2019. See Bitwise Submission VI,
supra note 9, at 7, 24.
\94\ See Bitwise Submission I, supra note 6, at 107; Bitwise
Submission II, supra note 9, at 82 (citing May 2018 letter from
Federal Reserve Bank of San Francisco that explains that the impact
of the futures market aligns with the impact the introduction of
futures has had on other markets); Bitwise Submission III, supra
note 9, at 3; Bitwise Submission VI, supra note 9, at 7. See also
Bitwise Submission III, supra note 9, at 145 (quoting May 2018
letter from Federal Reserve Bank of San Francisco that stated that
the rapid raise in the price of bitcoin, and subsequent price drop
following the issuance of bitcoin futures, is consistent with
pricing dynamics suggested elsewhere in financial theory and
previously observed trading behavior).
\95\ See Bitwise Submission I, supra note 6, at 110; Bitwise
Submission II, supra note 9, at 82-83; Bitwise Submission III, supra
note 9, at 3; Bitwise Submission VI, supra note 9, at 7.
\96\ See Notice and OIP, supra note 7, 84 FR at 23128; Bitwise
Submission I, supra note 6, at 108-109; Bitwise Submission II, supra
note 9, at 83; Bitwise Submission III, supra note 9, at 3; Bitwise
Submission VI, supra note 9, at 7. The Sponsor states that expansion
of the bitcoin custody market in 2018 and 2019, and emergence of a
strong market for insurance on custodied bitcoin assets, has also
increased efficiency of the market and enabled a larger number of
market makers to enter the market. See Bitwise Submission II, supra
note 9, at 84; Bitwise Submission III, supra note 9, at 3. See also
Bitwise Submission VI, supra note 9, at 8 (stating that bitcoin
custody has become ``fully institutional'' and detailing the
custodians for bitcoin that were regulated or had insurance in 2017,
2018, and 2019).
\97\ See Bitwise Submission III, supra note 9, at 49 (describing
reports of manipulation at the failed Mt. Gox platform in 2013).
---------------------------------------------------------------------------
The Sponsor asserts that efficient arbitrage exists despite the
apparent existence of arbitrage opportunities in the bitcoin market
(from apparent pricing discrepancies on different platforms), because
these apparent opportunities are usually driven by one of three
factors.\98\ First, the Sponsor represents that platforms that
exaggerate and fake their volume utilize algorithms that generally
display prices that mirror the ``real'' bitcoin spot market, but that
these algorithms rely on trend-following software rather than effective
arbitrage and thus deviate more from the consolidated price.\99\
Second, the Sponsor asserts that bitcoin prices on platforms in
capital-controlled markets may trade at significant sustained premiums
or discounts to the integrated global market because capital controls
make it difficult or impossible to conduct arbitrage.\100\ Third, the
Sponsor states that certain platforms conduct
[[Page 55389]]
trading in so-called cryptographic ``stablecoins,'' \101\ rather than
in the U.S. dollar.\102\ According to the Sponsor, while stablecoins
have values that fluctuate, many popular data aggregators assume that
these stablecoins maintain a stable price of $1.00, and therefore do
not incorporate the fluctuating nature of stablecoins when displaying
bitcoin prices, unlike arbitrageurs that do take this into
account.\103\
---------------------------------------------------------------------------
\98\ See Bitwise Submission II, supra note 9, at 66-68.
\99\ See id. at 67.
\100\ See id. See also Bitwise Submission III, supra note 9, at
31 (stating that capital controls prevent arbitrage or make it
significantly more difficult, which is why the Bitwise Daily Bitcoin
Reference Price methodology excludes platforms domiciled in capital-
controlled countries).
\101\ The term ``stablecoin'' is a marketing term broadly used
in the industry to refer to a digital asset that purports to
minimize price volatility. However, the Commission notes that the
use of the term to refer to a digital asset does not mean that the
asset does in fact exhibit stability.
\102\ See Bitwise Submission II, supra note 9, at 67.
\103\ See id. at 67-68. For example, the Sponsor states that the
price of the stablecoin Tether (USDT) has fluctuated between $0.91
and $1.05 in the past year, but that coinmarketcap.com displays the
price of bitcoin-USDT on the Binance platform as if Tether is worth
$1, which makes it appear as though bitcoin is trading at a premium
on Binance. See id. See also Bitwise Submission I, supra note 6, at
72-74 (asserting that if you adjust for the price of Tether, prices
for bitcoin-USD and bitcoin-USDT trading pairs line up ``exactly'').
---------------------------------------------------------------------------
Several commenters assert that there is effective arbitrage in the
bitcoin market.\104\ One commenter represents that, in recent years,
spreads in the bitcoin market have narrowed, arbitrage has improved,
and the market has become increasingly efficient, due to the entry of
large, established market makers; the launch and growth of a large,
regulated bitcoin derivatives market; the development of a short
lending market in bitcoin; and the emergence of algorithmically-driven
trading tools.\105\ Another commenter states that, through the use of
high-frequency trading or automated trading ``bots,'' global arbitrage
in the bitcoin market is very cost-effective and efficient.\106\ A
third commenter asserts that effective arbitrage exists among the
platforms with ``real'' volume.\107\ In addition, one commenter states
that the global bitcoin market is deep and robust, divided among
multiple spot platforms and futures exchanges, and supported by
institutional market makers, and that it is unlikely that an attempt to
manipulate the market could last long.\108\
---------------------------------------------------------------------------
\104\ See Shenoy Letter III, supra note 69, at 9; Omniex Letter,
supra note 9, at 4; Castle Island Ventures Letter, supra note 9, at
3.
\105\ See Castle Island Ventures Letter, supra note 9, at 3.
\106\ See Shenoy Letter III, supra note 69, at 9.
\107\ See Omniex Letter, supra note 9, at 4.
\108\ See Donostia Ventures Letter, supra note 9, at 4.
---------------------------------------------------------------------------
In contrast, one commenter asserts that the Sponsor's claims
regarding arbitrage and the expectation that bitcoin would trade at the
same price across platforms are not true because bitcoin trades at
different prices in different countries, such as what can be seen in
South Korea or what was seen in India during the peak at the end of
2017.\109\ This commenter adds that platforms that operate across
regions may be able to conduct arbitrage and circumvent some capital
controls, which creates the possibility that the existence of this
``channel'' adds noise to the estimation of capital controls.\110\ This
commenter also states that the bitcoin market is not orderly because
the supply is inelastic and the demand drivers are opaque.\111\
---------------------------------------------------------------------------
\109\ See Fitzgerald Letter II, supra note 9.
\110\ See id.
\111\ See id.
---------------------------------------------------------------------------
(B) The Sponsor's Assertions Regarding Regulation of the Bitcoin Spot
Market
The Sponsor asserts that the ``real'' bitcoin spot market is
``substantially more regulated'' than would be suggested by
``conventional wisdom.'' \112\ Specifically, the Sponsor argues that
the ten platforms in the ``real'' bitcoin market are more established,
more likely to be located in developed markets, more regulated, and
more likely to utilize sophisticated market surveillance tools than the
broader set of platforms that report significant volume.\113\ The
Sponsor represents that all ten of the ``real'' platforms are domiciled
or based in what it describes as ``developed'' markets.\114\ The
Sponsor further represents that nine of these ten platforms are
regulated by the U.S. Department of Treasury's Financial Crimes
Enforcement Network (``FinCEN'') division as Money Services Businesses
(``MSB'') and six are regulated by the New York State Department of
Financial Services (``NYSDFS'') under its BitLicense program.\115\
According to the Sponsor, the requirements for a BitLicense include
having to implement measures designed to detect, prevent, and respond
to fraud, attempted fraud, and similar wrongdoing, including market
manipulation, and to monitor, control, investigate, and report back to
the NYSDFS regarding any wrongdoing.\116\ The Sponsor states that five
of the ten ``real'' platforms have robust internal or third-party
market surveillance tools to monitor, report, and correct for abusive
trading behavior.\117\ According to the Sponsor, this trend toward
adopting market surveillance tools has been, in part, a response to the
MSB and BitLicense regulations.\118\
---------------------------------------------------------------------------
\112\ See Bitwise Submission II, supra note 9, at 48.
\113\ See Notice and OIP, supra note 7, 84 FR at 23130. See also
Bitwise Submission II, supra note 9, at 85 (stating that the bitcoin
market is supported by increasingly effective regulation on the spot
platforms); Bitwise Submission III, supra note 9, at 171 (stating
that many bitcoin spot platforms face significant regulation).
\114\ See Notice and OIP, supra note 7, 84 FR at 23130. The
Sponsor states that approximately 30% of all ``real'' reported
volume takes place on platforms domiciled in the United States, with
the remainder domiciled in Malta, Hong Kong, the United Kingdom, and
Japan. See Bitwise Submission I, supra note 6, at 64; Bitwise
Submission II, supra note 9, at 47-48; Bitwise Submission III, supra
note 9, at 9, 67.
\115\ See Notice and OIP, supra note 7, 84 FR at 23130; Bitwise
Submission I, supra note 6, at 81; Bitwise Submission II, supra note
9, at 49; Bitwise Submission III, supra note 9, at 9. See also
Tagomi Letter, supra note 9, at 2. The Sponsor states that the MSB
license has associated obligations designed to ensure that FinCEN
can protect against money laundering, and include having an AML
policy, having customer identification and verification policies,
and filing Suspicious Activity Reports for suspicious customer
transactions. See Notice and OIP, supra note 7, 84 FR at 23130;
Bitwise Submission I, supra note 6, at 77-78; Bitwise Submission II,
supra note 9, at 50-51.
\116\ See Notice and OIP, supra note 7, 84 FR at 23130; Bitwise
Submission II, supra note 9, at 51-52; Bitwise Submission III, supra
note 9, at 73.
\117\ See Notice and OIP, supra note 7, 84 FR at 23130; Bitwise
Submission I, supra note 6, at 82; Bitwise Submission II, supra note
9, at 53; Bitwise Submission III, supra note 9, at 73.
\118\ See Bitwise Submission II, supra note 9, at 52.
---------------------------------------------------------------------------
One commenter states that BitLicense regulation has driven advances
in the bitcoin market and that, after the NYSDFS added guidelines in
2018 requiring surveillance and reporting of market manipulation, the
platforms with BitLicenses have implemented sophisticated market
surveillance tools that help foster a safer and more established
market.\119\ Another commenter states that, to obtain a BitLicense, the
platforms must demonstrate to the NYSDFS that they meet the
requirements for a BitLicense and must commit to ongoing review by the
NYSDFS, which, according to the commenter, means that these platforms
``have embraced the need for policies, procedures, and surveillance.''
\120\ This commenter asserts that it believes that all of the platforms
in which it participates, including those outside of New York, must
have a robust surveillance program and that the listed platforms meet
these standards and are continuing to develop these programs.\121\ This
commenter further asserts that these platforms typically employ
sophisticated third-party surveillance tools that use the qualities
[[Page 55390]]
of bitcoin to scrutinize transaction histories and conduct
surveillance.\122\
---------------------------------------------------------------------------
\119\ See Castle Island Ventures Letter, supra note 9, at 2-3.
\120\ See Tagomi Letter, supra note 9, at 2 (representing that
the BitLicense requirements mostly relate to the prevention of money
laundering and to the security of the platforms' systems).
\121\ See id.
\122\ See id.
---------------------------------------------------------------------------
The Sponsor acknowledges that the Trust's Registration Statement
represents that the platforms on which bitcoin trades are ``relatively
new and, in some cases, largely unregulated, and, therefore may be more
exposed to fraud and security breaches than established, regulated
exchanges for other financial assets or instruments, which could have a
negative impact on the performance of the Trust.'' \123\ The Sponsor
states that regulation of bitcoin platforms varies and is not
equivalent to the regulation of national securities exchanges, but that
many bitcoin spot platforms face significant regulation and are well-
capitalized, and that the design of the Trust would mitigate the impact
of the failure of any individual platform.\124\ Further, the Sponsor
states that the regulations surrounding MSB licenses and BitLicenses,
while not as extensive as the obligations of and oversight for national
securities exchanges and futures exchanges, provide business oversight
and regulatory compliance requirements and thus convey certain critical
protections.\125\
---------------------------------------------------------------------------
\123\ See Bitwise Submission III, supra note 9, at 171 (quoting
Registration Statement, supra note 31, at 7).
\124\ See id. (acknowledging that regulation of bitcoin trading
platforms is ``not pari passu with the regulation of national
securities exchanges''); Registration Statement, supra note 31, at
15 (``The trading for spot bitcoin occurs on multiple trading
venues'' that are ``not regulated in the same manner as traditional
stock and bond exchanges''); Bitwise Submission I, supra note 6, at
76 (``We acknowledge that we're using the term `regulated' loosely
here. We are not implying that bitcoin spot exchanges are `regulated
markets' or that they are on an equal legal status with national
securities exchanges or futures exchanges, but rather that the 10
bitcoin spot exchanges highlighted earlier interface with other
forms of regulation.''). For additional discussion about the
Sponsor's arguments that the design of the Trust would make the
proposed ETP uniquely resistant to manipulation, see infra Section
III.B.1(d).
\125\ See Notice and OIP, supra note 7, 84 FR at 23130; Bitwise
Submission II, supra note 9, at 49.
---------------------------------------------------------------------------
The Sponsor states that, out of the ten identified ``real''
platforms, Binance is the only one not registered as an MSB and Kraken
is the only significant U.S.-based platform that has not pursued a
BitLicense, and that both platforms have expressed a strong preference
for self-regulation and voiced concerns about regulatory
overreach.\126\ The Sponsor asserts that Binance and Kraken have been
aggressive in adopting internal tools to address AML, KYC, and other
concerns through the use of technology.\127\ Further, the Sponsor
attributes the ``conventional wisdom'' that the bitcoin platforms are
almost entirely unregulated to characterizations of the ``fake''
platforms that dominate the reported trading volume, rather than the
ten platforms with ``real'' trading volume.\128\
---------------------------------------------------------------------------
\126\ See Bitwise Submission II, supra note 9, at 53-54. The
Sponsor states that Bittrex pursued a BitLicense, but was denied by
the NYSDFS. See id. at 54 n.140.
\127\ See id. at 54.
\128\ See id. at 48-49.
---------------------------------------------------------------------------
Several commenters assert that there is a lack of regulation in the
bitcoin market.\129\ One commenter states that while regulation of the
bitcoin market is improving through the Commission's efforts to root
out bad actors, it still is not comparable to the traditional markets,
and that bitcoin platforms lack real-time and historical surveillance
capabilities to identify and stop suspicious trading activities.\130\
Another commenter states that, while most platforms have AML and KYC
requirements for transactions between fiat currencies and digital
assets, many allow participants to open accounts to trade between
digital assets and other digital assets with only a name and email
address, bypassing AML and KYC requirements.\131\
---------------------------------------------------------------------------
\129\ See Kumar Letter, supra note 6 (calling it ``common
knowledge'' that the bitcoin market is unregulated and manipulated);
Page Letter, supra note 9 (referring to the bitcoin sector as
unregulated); Shenoy Letter II, supra note 9, at 1 (suggesting that
currently the bitcoin market does not have precise regulation or
apparent external oversight).
\130\ See Shenoy Letter III, supra note 69, at 1, 10.
\131\ See Fitzgerald Letter II, supra note 9.
---------------------------------------------------------------------------
(ii) Analysis
The Commission concludes that the record does not demonstrate that
the identified characteristics of the ``real'' spot market, such as the
claimed effectiveness of arbitrage and the presence of some degree of
regulation, establish that the segment of the market that the Sponsor
identifies--or that NAV and IIV pricing based on that segment--are
uniquely resistant to manipulation sufficient to justify dispensing
with the detection and deterrence of fraud and manipulation provided by
surveillance-sharing agreements with significant, regulated markets.
While the Sponsor asserts that the ``real'' bitcoin market is ``more
orderly and more regulated than commonly understood,'' \132\
characteristics of the identified ``real'' segment of the bitcoin
market that differ from the common understanding of the broader bitcoin
market do not establish that the ``real'' bitcoin market is uniquely
resistant to manipulation. Moreover, as discussed further below in
Section III.B.1(c), the Sponsor asserts that 95 percent of the spot
bitcoin market consists of fake and non-economic activity,\133\ but has
not established that the ``real'' bitcoin market is isolated from that
fraudulent and manipulative activity.\134\
---------------------------------------------------------------------------
\132\ See supra note 64 and accompanying text.
\133\ See supra note 52 and accompanying text.
\134\ See infra Section 0 for discussion about the Sponsor's
assertions that it has separated the ``real'' bitcoin spot market
from the rest of the market that is dominated by fake and non-
economic trading, and that fake volume does not impact price
discovery on the ``real'' bitcoin spot market. The Commission
emphasizes that, as discussed further below, if prices on the
identified ``real'' spot market are affected by manipulative
activity on other platforms, then it would fundamentally undercut
any claims that the ``real'' market is uniquely resistant to
manipulation.
---------------------------------------------------------------------------
(A) Arbitrage and Efficiency in the Bitcoin Spot Market
The record does not establish that the effectiveness of arbitrage
in the ``real'' spot bitcoin market would, by itself, protect against
the influence of fake and non-economic trading in the broader bitcoin
market or provide unique resistance to manipulation sufficient to do
away with the need for a surveillance-sharing agreement with a
significant, regulated market. The Commission also notes that its
reliance on surveillance-sharing agreements for derivative securities
products has not been limited to ETPs based on commodities, but has
also extended to equity options based on securities listed on national
securities exchanges.\135\
[[Page 55391]]
Accordingly, even efficient price arbitrage does not eliminate the need
for surveillance-sharing agreements. There is no evidence in the record
that arbitrage in the bitcoin market is of such unique effectiveness
that it would essentially insulate the proposed ETP from attempts at
manipulation in a way beyond that of existing derivative securities
products that trade on highly regulated markets.
---------------------------------------------------------------------------
\135\ See Winklevoss Order, supra note 12, 84 FR at 37593
(citing 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 Depositary Receipts)). The Commission
has also required a surveillance-sharing agreement in the context of
index options even when (i) all of the underlying index component
stocks were either registered with the Commission or exempt from
registration under the Exchange Act; (ii) all of the underlying
index component stocks traded in the U.S. either directly or as ADRs
on a national securities exchange; and (iii) effective international
ADR arbitrage alleviated concerns over the relatively smaller ADR
trading volume, helped to ensure that ADR prices reflected the
pricing on the home market, and helped to ensure more reliable price
determinations for settlement purposes, due to the unique
composition of the index and reliance on ADR prices. See Securities
Exchange Act Release No. 26653 (Mar. 21, 1989), 54 FR 12705, 12708
(Mar. 28, 1989) (SR-Amex-87-25) (stating that ``surveillance-sharing
agreements between the exchange on which the index option trades and
the markets that trade the underlying securities are necessary'' and
that ``[t]he exchange of surveillance data by the exchange trading a
stock index option and the markets for the securities comprising the
index is important to the detection and deterrence of intermarket
manipulation.''). And the Commission has required a surveillance-
sharing agreement even when approving options based on an index of
stocks traded on a national securities exchange. See Securities
Exchange Act Release No. 30830 (June 18, 1992), 57 FR 28221, 28224
(June 24, 1992) (SR-Amex-91-22) (stating that surveillance-sharing
agreements ``ensure the availability of information necessary to
detect and deter potential manipulations and other trading
abuses''). See also Registration Statement, supra note 31, at 2
(stating that the ``real'' bitcoin spot market ``is now operating at
a level of efficiency and scale similar in material respects to
established global equity, fixed income and commodity markets'').
---------------------------------------------------------------------------
Further, even if the record showed that the quality of available
arbitrage in the ``real'' bitcoin market makes manipulation more
difficult, costly, and risky to carry out than it would be
otherwise,\136\ that would speak to providing some resistance to
manipulation, rather than a unique resistance to manipulation that
would justify dispensing with a surveillance-sharing agreement with a
significant, regulated market. Similarly, the Commission concludes that
claims by the Sponsor and a commenter that the ``real'' spot bitcoin
market is organized, efficient, resilient, or robust, or has tight
spreads,\137\ do not suffice to distinguish the proposed ETP from other
derivative securities products, such as equity options, where the
Commission required surveillance-sharing agreements with a significant,
regulated market even though effective arbitrage exists among the
relevant markets.
---------------------------------------------------------------------------
\136\ See supra notes 66-67 and accompanying text.
\137\ See supra notes 68, 74-77, and accompanying text.
---------------------------------------------------------------------------
The Sponsor ``does not discount the possibility'' that the early
bitcoin market may have been subject to market manipulation,
particularly with respect to reports of manipulation regarding the
failed Mt. Gox platform in 2013.\138\ Rather, the Sponsor points to
improvements in the strength of arbitrage and overall market quality in
the bitcoin spot market since December 2017.\139\ The Commission
concludes that the Sponsor's acknowledgement of past fraud and
manipulation in the bitcoin spot market, combined with the Sponsor's
reliance on changes in the market within just the last two years,
effectively concedes that bitcoin and the bitcoin spot market are not
inherently resistant to manipulation.\140\
---------------------------------------------------------------------------
\138\ See Bitwise Submission III, supra note 9, at 49.
\139\ See supra notes 91-97 and accompanying text.
\140\ In the Winklevoss Order, the Commission concluded that
there was an insufficient basis in the record before it to decide
that the bitcoin spot market is inherently resistant to
manipulation. See Winklevoss Order, supra note 12, 83 FR at 37585-86
(noting that possible sources of fraud and manipulation in the
bitcoin spot market included (1) ``wash'' trading, (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 or
misleading information, (6) manipulative activity involving Tether,
and (7) fraud and manipulation at Mt. Gox, a bitcoin trading
platform).
---------------------------------------------------------------------------
The Commission also believes that arbitrage in the ``real'' bitcoin
market would not prevent manipulation by, for example, an actor with a
dominant ownership position in bitcoin. The existence of concentrated
holdings in an asset presents a meaningful risk of manipulation. An
actor or group of actors acting in concert who obtain or have a pre-
existing dominant ownership position in actual bitcoin would not
necessarily find it prohibitively expensive to engage in manipulation
across the trading platforms the Sponsor identifies, despite efficient
arbitrage on the identified ``real'' bitcoin market.\141\ Furthermore,
there are other possible sources of fraud and manipulation in the
purportedly ``real'' bitcoin market,\142\ including hacking of the
trading platforms the Sponsor uses for its pricing mechanism,\143\
malicious control of the Bitcoin Network,\144\ and trading based on
material non-public information.\145\ Accordingly, the Commission
cannot conclude that the ``real'' bitcoin market is uniquely resistant
to manipulation.
---------------------------------------------------------------------------
\141\ See id. at 37584, 37586-87, 37591. The Commission is
unconvinced by the Sponsor's assertions that no dominant market
position can be exploited to manipulate bitcoin prices. See Bitwise
Submission III, supra note 9, at 31 (discussing ``The Not-So-Killer
Whales of Bitcoin,'' Chainalysis, Oct. 10, 2018, available at
https://blog.chainalysis.com/reports/bitcoin-whales-oct). Indeed,
the analysis that the Sponsor cites concludes that bitcoin ``trading
whales certainly have the capability of executing transactions large
enough to move the market.'' ``The Not-So-Killer Whales of
Bitcoin,'' Chainalysis, Oct. 10, 2018. The cited analysis also
concludes that a group of only 15 early bitcoin adopters hold over
33% of all outstanding bitcoin (id.), and the Sponsor has not
demonstrated that these early adopters are unable to manipulate
prices if they so choose. The cited analysis also concedes that
12.5% of the outstanding bitcoin is owned by what it characterizes
as ``criminal whales'' (id.), and the Sponsor has not demonstrated
that these ``criminals'' are unable to manipulate prices. This
analysis fails to consider that persons who would together own a
dominant market share can collude to manipulate bitcoin prices. See
Winklevoss Order, supra note 12, 83 FR at 37586-87. And this
analysis fails to consider that ``pseudonymous bitcoin account
holding means, among other things, that the number of accounts or
number of trades would not reveal whether a person or group has a
dominant ownership position in bitcoin, or is using or attempting to
use a dominant ownership position to manipulate bitcoin pricing.''
Id. at 37591.
\142\ See Winklevoss Order, supra note 12, 83 FR at 37585-86.
See also notes 69-73 and accompanying text (summarizing comments
asserting that Ponzi schemes, spoofing, layering, front running,
market domination, and suspicious trading patterns or price
movements occur in bitcoin markets).
\143\ See Winklevoss Order, supra note 12, 83 FR at 37585. The
Sponsor recognizes that the risk that a profit-motivated hacker can
manipulate bitcoin prices up or down by hacking some trading venues
while trading on other trading venues is ``still a concern today.''
Bitwise Submission III, supra note 9, at 45. See also Registration
Statement, supra note 31, at 7 (``The nature of the assets held at
bitcoin exchanges makes them appealing targets for hackers'' and
``[n]o bitcoin exchange is immune from these risks.'').
\144\ See Winklevoss Order, supra note 12, 83 FR at 37585-86.
The Sponsor recognizes that ``[t]here is a theoretical risk that a
malicious actor could attempt to exert control over the Bitcoin
Network by conducting a so-called 51% attack, which would involve
becoming the dominant source of mining power on the network,'' and
that ``51% attacks can theoretically allow you to double spend
bitcoin you already own or censor transactions of others.'' Bitwise
Submission III, supra note 9, at 45.
\145\ See Winklevoss Order, supra note 12, 83 FR at 37585-86.
The Sponsor ``agree[s] with the Commission's argument that the
potential for material nonpublic information about bitcoin exists.''
Bitwise Submission III, supra note 9, at 43.
---------------------------------------------------------------------------
Moreover, even to the extent that the spot market has evolved as
the Sponsor asserts, NYSE Arca and the Sponsor have not demonstrated
that these changes will endure and thus have not demonstrated that the
relevant market is inherently resistant to manipulation. As the Trust's
Registration Statement acknowledges, bitcoin platforms are ``relatively
new . . . and may be more exposed to fraud and security breaches than
established, regulated exchanges for other financial assets or
instruments.'' \146\ The Sponsor also argues that ``many bitcoin spot
exchanges face significant regulation and are well-capitalized'' and
that the Trust is designed in a way that would mitigate the impact that
a failure of an individual platform would have on the Trust or its NAV
or holdings.\147\ This argument, however, focuses on the presence of
some regulation and design features of the Trust, and does not
demonstrate that the nature of the spot platforms makes them inherently
resistant to manipulation.
---------------------------------------------------------------------------
\146\ See supra note 123 and accompanying text. Furthermore, the
nature of trading in bitcoin markets could change over time as
market participants gain more experience. For example, institutional
market-makers and short-term lenders could decide to pull back from
the bitcoin market, or bitcoin futures contract volume could
decrease and make hedging more difficult and expensive, affecting
the spot market. Moreover, the use or adoption of bitcoin could
contract, leading to a lower demand for bitcoin in the spot market
and a subsequent impact on volumes and volatility.
\147\ See supra notes 124-125 and accompanying text.
---------------------------------------------------------------------------
The Sponsor has made sweeping claims that up to 95% of the volume
reported by bitcoin platforms is wash trading or simply fabricated,
while asking the Commission to approve the
[[Page 55392]]
listing of a bitcoin ETP based upon a small segment of the market that
it asserts is uniquely resistant to the influence of this
activity.\148\ These claims, when combined with statements regarding
the relatively new state of the bitcoin market and, as discussed
further below, the proposed ETP's pricing mechanism,\149\ suggest that
further development of the market is needed to establish that the
Sponsor's representations remain sound.
---------------------------------------------------------------------------
\148\ See infra Section III.B.1(c).
\149\ See infra note 369 and accompanying text (quoting
statements in the Registration Statement that the Bitwise Daily
Bitcoin Reference Price ``is based on a new and untested calculation
methodology''). In addition, see discussion infra note 465 and
accompanying text regarding statements in the Registration Statement
regarding the bitcoin futures market.
---------------------------------------------------------------------------
Further, the record does not demonstrate that arbitrage in the
``real'' spot market is as effective as the Sponsor claims.\150\ While
the Sponsor describes its analysis on arbitrage in the ``real'' spot
market,\151\ it provides a selective and incomplete analysis. For
example, the Sponsor presents the average deviation from the
consolidated price over an approximately five-month period as a single
data point for each platform,\152\ which may obscure transient events.
The Sponsor's analysis of the duration of 1% price deviations from the
consolidated price also lumps together all deviations over 1%,
regardless of size,\153\ and thus obscures whether some deviations were
quite large and how long a large deviation persists.\154\
---------------------------------------------------------------------------
\150\ Because the Sponsor does not include any markets in
capital-controlled countries within its identified set of ``real''
platforms, based on difficulties in conducting arbitrage with
platforms in such countries, the Commission does not consider the
quality of arbitrage between the ``real'' platforms and such
markets. See supra notes 100, 109-110, and accompanying text.
\151\ See supra notes 78-90, 93, and accompanying text. The
Sponsor also describes its earlier analysis utilizing similar
metrics over slightly different time periods. See supra notes 81-82,
87, and 93, and accompanying text.
\152\ See supra note 82 and accompanying text.
\153\ See supra notes 85-88 and accompanying text.
\154\ In addition, the Sponsor ignores that on the platform-
level histograms, the scaling of the ``y'' axis that displays the
deviation count varies considerably, reflecting the finding that on
some of the platforms (e.g., bitFlyer) the 1% price deviations are
more than ten times more frequent than on other platforms (e.g.,
Bitfinex). The Sponsor's histograms compare deviation counts on the
``y'' axis of up to 120 for Binance and 700 for bitFlyer to
deviation counts on the ``y'' axis of 20 for Bitfinex. See Bitwise
Submission II, supra note 9, at 63-64. In addition, the Sponsor has
generated a line graph showing the price of bitcoin on the ten
``real'' platforms for an approximately seventeen-month period and
concludes that it is ``difficult to see meaningful gaps'' between
each line. See supra note 81 and accompanying text. Yet, given the
scaling used, in which grid lines represent an increase in the price
of bitcoin by 2,000 USD, a deviation would need to be very large to
produce perceptible gaps.
---------------------------------------------------------------------------
Moreover, in a separate context where the Sponsor attempts to
explain why a particular market participant does not track prices for
two of its identified ``real'' platforms, the Sponsor refers to one of
these ``real'' platforms (Poloniex) as ``too small and illiquid to
support meaningful arbitrage trading'' and states that another
(Bitfinex) has a 3% fee on withdrawals that ``rais[es] certain
challenges for institutional arbitrage activity.'' \155\ In addition,
statements by commenters that assert that arbitrage on the spot
platforms is effective are conclusory and not supported with data.\156\
---------------------------------------------------------------------------
\155\ See supra note 77.
\156\ See supra notes 104-108 and accompanying text. But see
supra notes 109-111 (questioning the effectiveness of arbitrage on
the bitcoin spot markets).
---------------------------------------------------------------------------
(B) Regulation of the Spot Market
Even if the Commission assumes that the arbitrage among these
``real'' platforms is effective, the record does not demonstrate that
the level of regulation present in the ``real'' bitcoin spot market
provides a unique ability to deter and detect fraud and
manipulation.\157\ The Sponsor has not demonstrated that its selected
platforms with ``real'' volumes are ``regulated markets'' comparable to
a national securities exchange or futures exchange, although they may
be registered with FinCEN or NYSDFS.\158\
---------------------------------------------------------------------------
\157\ With respect to the assertion that all of the ``real''
platforms are domiciled or based in what the Sponsor terms
``developed'' markets (see supra note 114 and accompanying text),
nothing in the record explains how this characteristic would make
the platforms resistant to fraud and manipulative activity.
\158\ See supra note 115-116 and accompanying text. See also
supra notes 119-122 and accompanying text.
---------------------------------------------------------------------------
The Commission concludes, and the Sponsor itself expressly
acknowledges, that the level of regulation on bitcoin spot platforms
``varies'' and is not equivalent to the obligations and oversight of
national securities exchanges or futures exchanges.\159\ The Sponsor
does not argue that state or other federal regulation of the bitcoin
spot platforms is a substitute for federal securities law standards,
including the requirements of the Exchange Act. Indeed, the Sponsor
agrees with the Commission that, irrespective of other applicable
regulations, the Exchange Act here requires a comprehensive
surveillance-sharing agreement with a regulated market of significant
size relating to the underlying or reference assets.\160\
---------------------------------------------------------------------------
\159\ See supra notes 123-125.
\160\ The Sponsor ``believe[s] that the Commission has correctly
identified the need for, value of, and definition of surveilled
derivatives market of significant size,'' but argues that the CME
futures market is ``significant in size'' compared to the ``real''
spot market it identifies. Bitwise Submission III, supra note 9, at
151. See also id. at 97 (stating that the Sponsor ``agree[s] with
the Commission and recognize[s] the importance of comprehensive
surveillance-sharing agreements to detect and deter fraudulent and
manipulative activity,'' and asserting that the CME bitcoin futures
market is ``significant'' based on the Sponsor's ``understanding of
the true size of the bitcoin spot market''). The argument that the
CME bitcoin futures market is ``significant'' is addressed in
Section III.B.3 below.
---------------------------------------------------------------------------
Furthermore, there are substantial differences between the NYSDFS
and FinCEN regulation versus the Commission's regulation of the
national securities exchanges. While there may be overlap between the
Commission's regulation and the NYSDFS's and FinCEN's regulation of
digital assets,\161\ national securities exchanges are also, among
other things, required to have rules that are ``designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest.'' \162\ Moreover, national
securities exchanges must file proposed rules with the Commission
regarding certain material aspects of their operations,\163\ and the
Commission has the authority to disapprove any such rule that is not
consistent with the requirements of the Exchange Act.\164\ Thus,
national securities exchanges are subject to
[[Page 55393]]
Commission oversight of, among other things, their governance,
membership qualifications, trading rules, disciplinary procedures,
recordkeeping, and fees.\165\
---------------------------------------------------------------------------
\161\ See CFTC v. McDonnell, 287 F. Supp. 3d 213, 220-23, 228
(E.D.N.Y), adhered to on denial of reconsideration, 321 F. Supp. 3d
366 (E.D.N.Y. 2018).
\162\ 15 U.S.C. 78f(b)(5).
\163\ 17 CFR 240.19b-4(a)(6)(i).
\164\ Section 6 of the Exchange Act, 15 U.S.C. 78f, requires
national securities exchanges to register with the Commission and
requires an exchange's registration to be approved by the
Commission, and Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b),
requires national securities exchanges to file proposed rules
changes with the Commission and provides the Commission with the
authority to disapprove proposed rule changes that are not
consistent with the Exchange Act. Designated Contract Markets
(commonly called ``futures markets'') registered with and regulated
by the CFTC must comply with, among other things, a similarly
comprehensive range of regulatory principles and must file rule
changes with the CFTC. See, e.g., Designated Contract Markets
(DCMs), CFTC, available at http://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/index.htm.
\165\ See Winklevoss Order, supra note 12, 83 FR at 37597. The
Commission notes that the NYSDFS has issued ``guidance'' to
supervised virtual currency business entities, stating that these
entities must ``implement measures designed to effectively detect,
prevent, and respond to fraud, attempted fraud, and similar
wrongdoing.'' See Maria T. Vullo, Superintendent of Financial
Services, NYSDFS, Guidance on Prevention of Market Manipulation and
Other Wrongful Activity (Feb. 7, 2018), available at https://www.dfs.ny.gov/docs/legal/industry/il180207.pdf. The NYSDFS
recognizes that its ``guidance is not intended to limit the scope or
applicability of any law or regulation'' (id.), which would include
the Exchange Act. One commenter asserts that, since the NYSDFS
issued this guidance, ``BitLicense exchanges have implemented
sophisticated market surveillance tools from reputable firms like
NICE Actimize, Irisium and NASDAQ, helping to foster a safer and
more established crypto asset market.'' Castle Island Ventures
Letter, supra note 9, at 3. However, the commenter provides no
additional information in support of these assertions, and the
Commission cannot fully evaluate the NYSDFS guidance because, among
other things, there is nothing further in the record before the
Commission regarding how the NYSDFS guidance has been implemented
either by the NYSDFS or by the purportedly ``real'' bitcoin trading
platforms that hold BitLicenses. FinCEN's guidance regarding the
application of its regulations to digital assets notes that its
guidance does not ``affect the obligations of any of the
participants described herein under other regulatory frameworks,''
for example, obligations under ``federal securities law.'' FinCEN
Guidance No. FIN-2019-G001: Application of FinCEN's Regulation to
Certain Business Models Involving Convertible Virtual Currencies, at
24 n.75 (May 9, 2019), available at https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf. See
also FinCEN Guidance No. FIN-2013-G001: Application of FinCEN's
Regulations to Persons Administering, Exchanging, or Using Virtual
Currencies, at 1 n.1 (Mar. 18, 2013), available at https://www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf (noting
that FinCEN's guidance ``should not be interpreted as a statement by
FinCEN about the extent to which [certain] activities comport with
other federal or state statutes, rules, regulations, or orders.'').
---------------------------------------------------------------------------
In any event, the Commission also finds persuasive several
commenters that describe the deficiencies of regulation of the
purportedly ``real'' spot market the Sponsor utilizes.\166\
Significantly, Binance, based in Malta and the single largest bitcoin
trading platform among the platforms the Sponsor identifies as
``real''--representing 39% of the purportedly ``real'' bitcoin volume
\167\--has not registered with either FinCEN or the NYSDFS; four of the
ten platforms the Sponsor utilizes--representing 69% of the purportedly
``real'' bitcoin volume \168\--do not have a BitLicense from the
NYSDFS; and half of the bitcoin platforms the Sponsor utilizes lack
internal or third-party market surveillance tools.\169\
---------------------------------------------------------------------------
\166\ See supra notes 129-131 and accompanying text.
\167\ See Bitwise Submission II, supra note 9, 35 (based on
April 2019 volume).
\168\ See Bitwise Submission III, supra note 9, at 125.
\169\ See supra notes 115, 117-122, and accompanying text. The
Sponsor's discussion about what protections the platforms Binance
and Kraken have in place in the absence of FinCEN or BitLicense
registration, see supra notes 126-128 and accompanying text,
arguably infers the presence of some of the protections that might
otherwise be provided by these specific registrations, rather than
show a unique level of protection. In addition, the Sponsor notes
that one platform (Bittrex) pursued a BitLicense but was denied by
the NYSDFS, see supra note 126, but does not explain how the mere
fact that this platform applied for a BitLicense is relevant to the
consideration of whether that platform is regulated.
---------------------------------------------------------------------------
The Commission also notes that NYSE Arca has not stated that it has
entered or will enter into surveillance-sharing agreements with those
``real'' spot platforms that utilize surveillance tools. Moreover, even
if NYSE Arca did enter into such agreements, it is not clear what
ability NYSE Arca would have to compel the sharing of surveillance
data. Unlike national securities exchanges, the bitcoin spot platforms
are not self-regulatory organizations, and therefore do not have legal
power to impose discipline upon their participants.
Therefore, the Commission concludes that the record does not
demonstrate that the identified ``real'' market is uniquely resistant
to manipulation, such that a surveillance-sharing agreement with a
significant, regulated market would not be needed to adequately deter
and detect fraud and manipulation.
(c) The Sponsor's Methodology for Distinguishing the ``Real'' Volume on
the Bitcoin Spot Market From Fake or Non-Economic Trading Volume
In the previous section, the Commission examines the Sponsor's
identified ``real'' spot market for bitcoin and asserted
characteristics of that market, such as the presence of arbitrage and
regulation, and considers whether the record establishes that this
segment of the market is uniquely resistant to manipulation.\170\ And,
as discussed further in the next section, the Sponsor generally
proposes to use prices and volumes from its identified ``real''
platforms to calculate the Bitwise Bitcoin Daily Reference Price, which
the Trust will use for NAV and IIV pricing.\171\ Yet, for the
Commission to determine that effective arbitrage and regulation make
this ``real'' segment of the market uniquely resistant to manipulation,
the Commission would have to conclude that the Sponsor's analysis
correctly identifies the segment of the market that represents ``real''
volume and establishes that this segment is not affected by trading in
other segments of the market that the Sponsor concedes is fake or non-
economic. Therefore, the Commission examines below the Sponsor's
analysis of the bitcoin market to identify ``real'' versus fake or non-
economic trading and the reliability of the Sponsor's claims that its
ten identified platforms represent the ``real'' volume on the spot
bitcoin market. Further, the Commission examines whether the Sponsor
has shown that prices on the broader bitcoin market do not influence
price discovery on the identified ``real'' platforms.
---------------------------------------------------------------------------
\170\ See supra Section III.B.1(b).
\171\ See infra Section III.B.1(d).
---------------------------------------------------------------------------
(i) Representations Made and Comments Received
The Sponsor argues that through its research, it has identified
certain platforms that represent substantially all of the ``real''
global spot market for bitcoin, as distinguished from the approximately
95% of the bitcoin spot market that the Sponsor identifies as rife with
trading that is fake or non-economic in nature.\172\ In this context,
the Sponsor considers as ``fake volume'' any reported trading volume
that does not reflect legitimate price discovery, including wash
trading and reports of trades that did not occur.\173\ The Sponsor
states that it has analyzed 83 platforms using three tests, described
further below, and claims that, based on its analysis, the following
ten platforms have ``real'' volume--Binance, Bitfinex, Coinbase Pro,
Kraken, Bitstamp, bitFlyer, Gemini, itBit, Bittrex, and Poloniex.\174\
The Sponsor states that the average daily volume on these platforms for
April 2019 was $554,488,345.\175\ According to the Sponsor, these
results suggest that $10.5 billion of the $11 billion in reported
average daily spot bitcoin volume, or roughly 95% of all reported
volume, is fake volume or wash trading.\176\
---------------------------------------------------------------------------
\172\ See Notice and OIP, supra note 7, 84 FR at 23129-30;
Bitwise Submission I, supra note 6, at 60; Bitwise Submission II,
supra note 9, at 34-35. The Sponsor states that the goal of its
research was to identify those platforms with a significant
prevalence of fake volume in a repeatable, data-driven manner. See
Bitwise Submission II, supra note 9, at 19.
\173\ See Bitwise Submission II, supra note 9, at 19;
Registration Statement, supra note 31, at 3, 23-24. The Sponsor
describes transactions that are reported by a platform without
corresponding trading taking place as ``fraudulent prints.'' See
Bitwise Submission II, supra note 9, at 19.
\174\ See Bitwise Submission II, supra note 9, at 34-35.
\175\ See id. at 35.
\176\ See id.
---------------------------------------------------------------------------
The Sponsor represents that platforms inflate or exaggerate trade
volume in several ways, including by fraudulently
[[Page 55394]]
printing trades, engaging directly in wash trading on their own
platforms, and paying market makers to engage in wash trading.\177\ The
Sponsor further asserts that platforms have two powerful motives for
exaggerating volume--attracting trader attention by appearing higher on
data aggregators' league tables (i.e., rankings for trading platforms)
and attracting listings and attendant listing fees from initial coin
offerings.\178\ In addition to the Sponsor's efforts to distinguish
platforms with predominantly fake or non-economic trading from
platforms with ``real'' volume,\179\ the Sponsor provides other
evidence of fake or non-economic trading in the bitcoin market.\180\
---------------------------------------------------------------------------
\177\ See id. at 36-37. The Sponsor also represents that
platforms economically incentivize trading activity by paying
traders to trade and offer lower fee tiers or preferential trading
to traders that attain high volumes of trade. See id. at 37. One
commenter states that proprietary trading is standard on most
platforms and makes up 20% of trading on some platforms. See Shenoy
Letter III, supra note 69, at 1.
\178\ See Bitwise Submission II, supra note 9, at 37.
\179\ See infra Section III.B.1(c).
\180\ See Notice and OIP, supra note 7, 84 FR at 23129
(describing that, in connection with the Sponsor's initial analysis,
the Sponsor has identified several widespread, superficial
indicators of fake or non-economic trading volume, including
perfectly consistent, alternating buy and sell orders of roughly
equal size, relatively large reported spreads on platforms that
report large volumes, relatively small real-world footprints for
platforms with large reported volumes, multiple hours and days with
zero volume not correlated with factors such as business hours or
volatility, and roughly identical volume every hour of every day);
Bitwise Submission I, supra note 6, at 24-39 (comparing Coinbase
Pro, as a platform with a BitLicense that is generally well-known,
with platforms CoinBene, RightBTC, and CHAOEX, and describing
trading characteristics of the ``suspicious'' platform); Bitwise
Submission II, supra note 9, at 6-12 (asserting that the current
reported data on bitcoin trading volume is surprising and describing
the history of concerns around data reliability in the bitcoin
market).
---------------------------------------------------------------------------
The Sponsor claims that the results of its analysis are consistent
with the findings from a previous similar study by the Sponsor using
data from an earlier time period that identified the same ten platforms
as having ``actual volume.'' \181\ The Sponsor asserts that after the
findings from its earlier study became public, it received extensive
media coverage and support from social media and thought leaders.\182\
According to the Sponsor, the results were also widely embraced by
leading data providers in the digital asset market, with several
displaying volume statistics based on the ten identified ``real''
platforms or admitting that concerns about reported data are ``valid''
and subsequently working to improve data transparency.\183\ The Sponsor
represents that nine of the platforms identified as having fake or non-
economic volume reported a drop in volume of over 90% after the
Sponsor's analysis became public.\184\ In addition, the Sponsor asserts
that data patterns on certain platforms rapidly shifted to match the
real-world patterns identified by the Sponsor.\185\ Further, the
Sponsor asserts that its findings are consistent with the ``common
institutional understanding'' of the actual market.\186\
---------------------------------------------------------------------------
\181\ See Bitwise Submission I, supra note 6, at 60; Bitwise
Submission II, supra note 9, at 35. The earlier study focused on
data from March 4, 2019, through March 9, 2019, and the later study
focused on data from April 28, 2019, through May 5, 2019. See
Bitwise Submission II, supra note 9, at 19, 35. The Sponsor states
that the earlier study showed that the ``real'' average daily spot
bitcoin volume was $273 million, as compared to $6 billion in
reported volume, indicating that roughly 95% of the volume was fake.
See id. at 35. See also Notice and OIP, supra note 7, 84 FR at
23129-30; Bitwise Submission I, supra note 6, at 61. The Sponsor
further represents that, in the earlier study, it excluded South
Korean platforms from its analysis because they are an isolated
market due to capital controls and that one additional platform
passed all tests but was too small, with less than $1 million
average daily volume, to include as an identified ``real'' platform.
See Bitwise Submission I, supra note 6, at 60.
\182\ See Bitwise Submission II, supra note 9, at 35-36. See
also Bitwise Submission VI, supra note 9, at 13.
\183\ See Bitwise Submission II, supra note 9, at 103-104;
Bitwise Submission III, supra note 9, at 131. See also Bitwise
Submission VI, supra note 9, at 14 (asserting that coinmarketcap.com
confirmed that concerns raised in the report were ``valid'' and
launched an initiative to improve its metrics, two digital asset
data providers adopted the ten identified ``real'' platforms as
representing the market, and one digital asset data provider
launched transparency ratings that require verified data feeds for
platforms with volume claims).
\184\ See Bitwise Submission VI, supra note 9, at 15 (comparing
average daily volume from March 2019 and August 2019). The Sponsor
also represents that only three of the 73 platforms that it named as
having fake or non-economic volume responded to the Sponsor's
research. See id. at 16.
\185\ See id. at 18-21.
\186\ Bitwise Submission I, supra note 6, at 70. The Sponsor
asserts that (1) every regulated digital asset product that has
launched has drawn prices entirely, or almost entirely, from a
subset of the ten ``real'' platforms; (2) the ten ``real'' platforms
dominated the list of thirteen platforms that the New York Attorney
General contacted as part of its Virtual Markets Integrity
Initiative; (3) the Blockchain Transparency Institute identified 56
platforms suspected of having fake volume, none of which are among
the ten ``real'' platforms; and (4) other media-level investigations
have reached similar conclusions. See id. at 70-71.
---------------------------------------------------------------------------
Several commenters question the Sponsor's findings, which were made
public after its initial study.\187\ One commenter argues that the
Sponsor's analysis raises more questions than it answers and that, with
manipulation a prime issue, if 95% of the platforms are reporting fake
volume, then it is unwise to base an ETP on the remaining 5%.\188\
Another commenter asserts that articles about the Sponsor's initial
study on online media were not a coincidence because online media has a
financial interest in priming, or manipulating, the public to enhance
its image, to poach customers, or to drive sales through fear of
missing out on an investment.\189\ One commenter states that issues
about manipulation on the platforms, as discussed in articles about the
Sponsor's initial study, have not been satisfactorily resolved.\190\
---------------------------------------------------------------------------
\187\ See Arssov Letter, supra note 6 (stating that he disputes
and disagrees with most of the statements and findings in the
Sponsor's initial analysis and that the Sponsor does not know what
market manipulation in digital assets looks like); Denscombe Letter,
supra note 6 (stating that the report is inaccurate, misleading, and
unfair).
\188\ See C. Ross Letter, supra note 6. See also Buckley Letter,
supra note 6 (suggesting that the Sponsor is asking the Commission
to grant approval based on its word that, while 95% of the bitcoin
volume is manipulated, the other 5% is not).
\189\ See Denscombe Letter, supra note 6.
\190\ See Fitzgerald Letter I, supra note 6.
---------------------------------------------------------------------------
The Sponsor describes that, to gather data for its analysis, it has
built its own data collection system using the live trading information
available on the bitcoin spot platforms' websites about the current
order book and recent trades.\191\ The Sponsor represents that its data
collection process scrapes data from these websites four times a
second, collecting price, trade size, and on-screen timestamp for
ongoing trades, and bid/ask price, order amount, and timestamp of
recording the data for order book entries.\192\ The Sponsor states that
it was common for the data collection process to break down, and that
it monitored its data collection process to stop problems with the data
scrapers and prepared fixes, but there were gaps in the data that it
has accounted for in the analytical phase.\193\ In addition, the
Sponsor states that it has acquired historical bitcoin trade data from
third parties for parts of the analysis that require a continuous
historical data set.\194\
---------------------------------------------------------------------------
\191\ See Bitwise Submission II, supra note 9, at 14. The
Sponsor states that the inability to gather granular market data
from a comprehensive set of bitcoin platforms has made proving the
existence of fake volume on platforms difficult. See id. The Sponsor
asserts that it created and now maintains a website that captures
the ``real'' spot bitcoin trading volume on an ongoing basis. See
Bitwise Submission III, supra note 9, at 131.
\192\ See Bitwise Submission II, supra note 9, at 16. See also
Notice and OIP, supra note 7, 84 FR at 23129 (describing a similar
data collection process in connection with the Sponsor's earlier
analysis); Bitwise Submission I, supra note 6, at 41.
\193\ See Bitwise Submission II, supra note 9, at 18. According
to the Sponsor, the data collection process would break if the html
structure of the web page being scraped changed in any meaningful
way, which was a common occurrence. See id.
\194\ See id.
---------------------------------------------------------------------------
Several commenters raise concerns about the Sponsor's data
collection methods. One commenter claims that accessing data through
trading
[[Page 55395]]
platforms' websites is more appropriate for illustration than research
because these websites are not updated in real time, or even within a
quarter of a second, and therefore this collection method can access
only a fraction of the trades.\195\ Another commenter asserts that it
is plausible that a group of bad of actors have used trading bots to
manipulate the data on the other platforms to secure approval of an
ETP.\196\ This commenter also states that it has concerns about the
data presented, because a single organization conducted the study, the
methodology and data source are unclear, and the traffic data are only
collected from a single source.\197\ A third commenter questions
whether the data used to identify the platforms reporting fake volume
are reliable.\198\
---------------------------------------------------------------------------
\195\ See Arssov Letter, supra note 6.
\196\ See Denscombe Letter, supra note 6.
\197\ See id.
\198\ See C. Ross Letter, supra note 6.
---------------------------------------------------------------------------
The Sponsor states that it has selected the platforms to analyze by
creating a list of 83 platforms that represent the top bitcoin trading
pairs on coinmarketcap.com as of December 5, 2018.\199\ The Sponsor
adds that it has considered all trading pairs where bitcoin is the base
currency, or where the quote currency is either a fiat currency or a
stablecoin.\200\ Further, the Sponsor argues that, while new platforms
with astronomical volumes have appeared every week on
coinmarketcap.com, leading the list of platforms representing the top
bitcoin trading pairs to become stale quickly, that list is
sufficiently consistent that the core analysis remains relevant.\201\
---------------------------------------------------------------------------
\199\ See Bitwise Submission II, supra note 9, at 15. With
respect to the Sponsor's earlier analysis, the Sponsor represents
that it has generated a list of 81 platforms to analyze at that time
by looking at all platforms reporting more than $1 million in
average daily volume for bitcoin-fiat and bitcoin-stablecoin pairs
to coinmarketcap.com on December 5, 2018. See Notice and OIP, supra
note 7, 84 FR at 23129; Bitwise Submission I, supra note 6, at 41.
\200\ See Bitwise Submission II, supra note 9, at 15.
\201\ See id. at 18.
---------------------------------------------------------------------------
With respect to the bitcoin over-the-counter (``OTC'') market, the
Sponsor claims that its ``[c]onversations with leading market makers''
suggest that very little bitcoin OTC volume is crossed internally and
that most volume is settled on the spot platforms.\202\ The Sponsor
asserts that any incremental volume in the OTC or dark pool market is
not a significant fraction of the global spot market for bitcoin, and
that counting these trades separately would mostly lead to double
counting.\203\
---------------------------------------------------------------------------
\202\ See Bitwise Submission III, supra note 9, at 133.
\203\ See id. In this context, the term ``dark pool'' is used as
described in the registration statement for the Winklevoss Bitcoin
Trust, which described ``dark pools'' as bitcoin trading platforms
that do not publicly report limit order book data. See Winklevoss
Bitcoin Trust, Form S-1/A (File No. 333-189752), at 62.
---------------------------------------------------------------------------
Several commenters question the Sponsor's selection of certain
bitcoin platforms for its analysis, to the exclusion of other platforms
and the OTC market. One commenter argues that the Sponsor selectively
analyzed data, excluding many factors.\204\ This commenter states that
the Sponsor excluded platforms from South Korea on the basis of capital
controls, but included platforms from China and Hong Kong, where
capital controls are also in place.\205\ This commenter also claims
that the Sponsor's selection of trading pairs is unusual because the
market is not based solely on the chosen trading pairs and there are
arbitrage opportunities in trading digital assets against other digital
assets.\206\ Another commenter argues that, while the Sponsor suggests
that virtually all trading occurs on non-Asian platforms, it is
unlikely that Asian investors would use United States or European
Union-based platforms and be subject to their capital controls, and
that the Sponsor ignores trading on both the Hong Kong-based platform
Bitmex and OTC trading.\207\ This commenter states that a previous ETP
filer claimed that OTC volume among United States-based brokers is $500
million a day, and that, even if this figure is overstated, it suggests
that global average daily volume in bitcoin is significantly higher
than $273 million.\208\ Another commenter argues that, even if capital-
controlled markets present difficulties for arbitrage, it does not mean
that market participants in these capital-controlled markets cannot
participate in, influence, or manipulate the bitcoin market.\209\ This
commenter asserts that market participants in Venezuela, Zimbabwe, and
other significant capital-controlled countries participate in the
bitcoin market and that getting around capital controls to participate
in and manipulate the market is not difficult.\210\
---------------------------------------------------------------------------
\204\ See Fitzgerald Letter II, supra note 9. See also C. Ross
Letter, supra note 6 (asserting that the ten identified platforms
seem ``rather convenient'' for the Sponsor to build its case upon).
\205\ See Fitzgerald Letter II, supra note 9.
\206\ See id.
\207\ See Blake Letter I, supra note 6. See also Arssov Letter,
supra note 6 (stating that two-thirds or more of digital asset
trading occurs outside of the United States, but most of the ten
identified platforms on the list are based in the United States and
reflect only a fraction of the total trades).
\208\ See Blake Letter I, supra note 6. See also Shenoy Letter
III, supra note 69, at 6, 9 (claiming that OTC bitcoin volume
typically is 2-3 times larger than volumes on platforms and that an
estimated 1 to 1.5 billion bitcoins are traded on the OTC market
daily).
\209\ See Robert Letter, supra note 9.
\210\ See id.
---------------------------------------------------------------------------
The Sponsor states that it used a single week time period--April
28, 2019, through May 5, 2019--for its visualized data to balance
concerns that too short a period may not give natural market patterns
enough time to develop, and that too long a period may make anomalous
patterns less distinct, because platforms attempting to fake volume may
periodically change their algorithms.\211\ According to the Sponsor, it
has based its analysis on data from the last week before it finalized
the research, to be as current as possible, but the Sponsor asserts
that any single week sample would lead to a similar conclusion.\212\
---------------------------------------------------------------------------
\211\ See Bitwise Submission II, supra note 9, at 19. See also
Notice and OIP, supra note 7, 84 FR at 23129 (stating that when
selecting March 4, 2019, through March 8, 2019, as the time period
for its earlier analysis, the Sponsor deliberately utilized a short
time period to show that fake volume is a current problem in the
bitcoin market and because platforms change algorithms used to fake
volume over time, which obscures the results of data-driven analyses
that consider longer time periods).
\212\ See Bitwise Submission II, supra note 9, at 19.
---------------------------------------------------------------------------
The Sponsor states that one tool that it has used for its analysis
is a trade size histogram, which is a data visualization technique that
allows one to see the percentage of trading volume on a platform that
occurs at particular trade sizes over a specified period.\213\ The
Sponsor asserts that it has cut off the histograms after 10 bitcoins
because the vast majority of trade volume occurs in the 0-10 bitcoins
range, and the Sponsor finds it ``visually helpful'' to focus on this
range.\214\ The Sponsor has used the six platforms with BitLicenses as
a baseline for what a group of legitimate trade size histograms look
like, because, according to the Sponsor, the BitLicense establishes a
conservative set of platforms that are not likely to have pervasive
fake volume or wash trading.\215\ The Sponsor states that it finds two
patterns among the platforms with BitLicenses--trade volume percentages
generally trend downward as trade size increases and there are
behavioral preferences around round numbers--and that these patterns
are consistent with documented trading behavior in traditional
markets.\216\ The Sponsor argues that, in contrast, six platforms
outside the set of platforms with BitLicenses follow unnatural patterns
and that the only realistic
[[Page 55396]]
explanation is that these platforms are reporting artificial
volume.\217\
---------------------------------------------------------------------------
\213\ See id.
\214\ See id. at 20-21.
\215\ See id. at 21.
\216\ See id. at 22-23. See also Bitwise Submission I, supra
note 6, at 26 (stating that the ``real'' platform Coinbase Pro has
varying trade sizes, with a greater-than-random number of round
trade sizes).
\217\ See Bitwise Submission II, supra note 9, at 23-24. The
Sponsor also argues that the discrepancy in trading patterns cannot
be attributed to low volume, because the six platforms outside the
reference set all report volumes that are greater than that of the
largest platform with a BitLicense. See id. at 24. The Sponsor
states that in its earlier analysis, it finds that the trade size
histograms for the platforms that have passed all of its data tests
show consistent, intuitive patterns, while those from other
platforms reflect patterns that are idiosyncratic and often
transparently programmatic (e.g., bell curve-like distributions or
increasing volume for larger trade sizes). See Notice and OIP, supra
note 7, 84 FR at 23129; Bitwise Submission I, supra note 6, at 42-
50. See also Bitwise Submission I, supra note 6, at 32, 55-57.
---------------------------------------------------------------------------
The Sponsor states that the second tool it has used for its
analysis is an examination of the alignment of volume spikes, asserting
that, while the bitcoin spot market is fractured across multiple
platforms, all of these platforms should respond to the same
developments in the market.\218\ The Sponsor claims that the hourly
trade volume for one platform with a BitLicense, Coinbase Pro, shows
varying volume throughout the day, a pattern of volume that does not
repeat across days, and several large volume spikes.\219\ The Sponsor
further claims that the six platforms with BitLicenses all exhibit
similar patterns, with an obvious alignment of volume spikes,
particularly around May 3, 2019, and argues that this demonstrates a
connected market.\220\ In contrast, the Sponsor points to the volume
patterns of six platforms outside of the reference set of platforms
with BitLicenses and asserts that they exhibit idiosyncratic and highly
unusual volume patterns and lack volume spikes that align with
platforms in the ``real'' bitcoin market, strongly suggesting that
these platforms are posting fake volume.\221\
---------------------------------------------------------------------------
\218\ See Bitwise Submission II, supra note 9, at 24.
\219\ See id. at 25.
\220\ See Bitwise Submission II, supra note 9, at 26-27. See
also Bitwise Submission I, supra note 6, at 25, 27 (stating the
``real'' platform Coinbase Pro has a trade volume that varies, with
a mix between buys and sells that is unequal and streaky).
\221\ See Bitwise Submission II, supra note 9, at 27-29. The
Sponsor claims that none of the six platforms outside the reference
set have volume spikes that align with the May 3, 2019, spike that
was present in all platforms within the reference set. See id. at
29. The Sponsor states that in its earlier analysis, it finds that
volume spikes rise and fall concurrently across the platforms that
have passed all data tests, but other platforms have no discernable
volume spikes or patterns that are disconnected or wholly
idiosyncratic and do not repeat on other platforms. See Notice and
OIP, supra note 7, 84 FR at 23129; Bitwise Submission I, supra note
6, at 51-52. See also Bitwise Submission I, supra note 6, at 29-31,
35-36, 38-39, 55-57 (also noting that essentially all of the trades
on one ``suspicious'' platform print inside the prevailing bid and
ask).
---------------------------------------------------------------------------
The third tool that the Sponsor says it has used for its analysis
is a spread patterning analysis based on the spread between the highest
price at which someone is willing to buy bitcoin and lowest price at
which someone is willing to sell bitcoin, denominated in dollars.\222\
The Sponsor asserts that the spread on Coinbase Pro shows price
oscillation and is generally quite low and anchored near zero.\223\ The
Sponsor further claims that the spreads on the six platforms with
BitLicenses generally have low spreads, that the spikes in spreads are
short-lived, and that the spreads exhibit a consistently spiky form,
suggesting that they are responding to current events.\224\ The Sponsor
asserts that the differences between the spreads on the platforms with
BitLicenses are driven by differences in fee structures, such as the
use of a maker-taker fee model by some platforms.\225\ In contrast, the
Sponsor claims that the spread analysis for six platforms outside the
reference set shows spreads that are anchored on high dollar amounts
and oscillate in artificial patterns.\226\ According to the Sponsor,
there is no economic reason for these spread patterns if there is true
liquidity on the platforms and these patterns indicate the presence of
automated bots that perform wash trading.\227\
---------------------------------------------------------------------------
\222\ See Bitwise Submission II, supra note 9, at 29.
\223\ See id. at 29-30. See also Bitwise Submission I, supra
note 6, at 28 (stating that the spread of bitcoin on the ``real''
platform Coinbase Pro was $0.01, or 0.0003% of bitcoin's current
trading price).
\224\ See Bitwise Submission II, supra note 9, at 31-32.
\225\ See id. at 32.
\226\ See id. at 33-34.
\227\ See id. at 34. The Sponsor states that, in its earlier
analysis, it finds that well-known platforms show a consistent
pattern of spreads, anchoring on zero, with random variability and
periodic spikes, while many platforms with very high levels of
volume report average spreads that are 1,000% to 35,000% higher than
spreads on platforms that have passed all of the Sponsor's tests and
exhibit spread patterns that reveal artificial, programmatic
drivers, including spreads that unnaturally anchor on arbitrarily
high dollar values or stay fixed for extended periods. See Notice
and OIP, supra note 7, 84 FR at 23130; Bitwise Submission I, supra
note 6, at 53-54. See also Bitwise Submission I, supra note 6, at
33, 37, 55-56.
---------------------------------------------------------------------------
In conclusion, the Sponsor finds that only ten of the 83 platforms
it analyzed have ``real'' volume because they passed all three tests,
whereas 73 platforms failed one or more of its tests.\228\ As discussed
further below, the Sponsor subsequently removed one platform, Bitfinex,
from its selection of platforms used for the Trust's NAV and IIV
pricing, due to a court order obtained by the New York Attorney General
(``NYAG'') against Bitfinex's operator,\229\ but the Sponsor maintains
that Bitfinex's volume is ``real.'' \230\
---------------------------------------------------------------------------
\228\ See Bitwise Submission II, supra note 9, at 34-35. For the
trade histograms, volume graphs, and spread graphs of all 83
platforms that the Sponsor has analyzed, see id. at 86-102. The
Sponsor states that it is excluding those platforms based in South
Korea, because their volumes are isolated from the global bitcoin
market due to capital controls. See id. at 34. However, the Sponsor
also states that 73 of the 83 platforms failed one or more of the
three tests (see id.), and the Commission notes that this figure
includes the South Korean platforms.
\229\ See infra notes 325, 331-338, and accompanying text.
\230\ See Bitwise Submission V, supra note 9, at 5. The Sponsor
argues that having real volume and being ineligible to contribute
prices to the Trust's pricing mechanism are not mutually exclusive,
and that Bitfinex has passed all of the Sponsor's tests for having
real volume. See id. The Sponsor asserts that the Bitwise Crypto
Index Committee reviewed the NYAG's court order against iFinex (the
operator of Bitfinex) and subsequent legal documents, and found no
evidence contradicting the Sponsor's finding that the Bitfinex
volume is real. See id. at 5-6 (arguing that, as further evidence
that trading on Bitfinex is real, the court documents confirm that
investors deposited billions of dollars with the platform).
---------------------------------------------------------------------------
Two commenters raise specific concerns about the Sponsor's methods
of analysis.\231\ One commenter states that the Sponsor has not
provided a longitudinal picture of all of the platforms and that the
time period used for the visualized data is a very short snapshot.\232\
This commenter asserts that the narrative of the Sponsor's report could
look very different if trades larger than 10.0 bitcoins were included
and that the report is not complete due to this exclusion.\233\ This
commenter also notes that the Sponsor focuses most of its analysis on
the six platforms with a BitLicense, rather than all ten of the
platforms that the Sponsor identifies as ``real.'' \234\ Another
commenter disagrees with the Sponsor's assertion that market
participants are more likely to trade small amounts of bitcoin than
large amounts, and more likely to trade whole bitcoin than fractions of
bitcoin, and claims that the order books on the ten ``real'' platforms
show people trading more in fractions of bitcoin than whole amounts of
bitcoin.\235\ This commenter argues that before being used as a basis
for granting an ETP, the Sponsor's analysis should be scrutinized
regarding the methodology and where data was acquired, independent
verification of the claims, and multiple sources for data
collection.\236\
---------------------------------------------------------------------------
\231\ See Denscombe Letter, supra note 6; Fitzgerald Letter II,
supra note 9.
\232\ See Fitzgerald Letter II, supra note 9.
\233\ See id.
\234\ See id.
\235\ See Denscombe Letter, supra note 6 (stating that the
platforms show orders of 15 to 33 bitcoins).
\236\ See id. (asserting that, to be fair to all of the
organizations studied, there would need to be at least five years'
worth of longitudinal data from the ten ``real'' platforms for
independent analysis for any abnormalities and irregularities).
---------------------------------------------------------------------------
Several commenters raise questions about specific platforms that
the
[[Page 55397]]
Sponsor identifies as ``real.'' \237\ One commenter asserts that
Bitfinex has long had questions raised about its operations, and that
while the Sponsor has sound reasoning for dropping Bitfinex from its
consolidated bitcoin price, the deletion raises questions about why the
Sponsor ever included Bitfinex in its consolidated price, along with
Binance, another non-United States domiciled platform with a ``colorful
past.'' \238\ Another commenter asserts that it is ``essential'' to
further analyze Binance and Kraken because Binance has not registered
as an MSB and Kraken has not pursued a BitLicense, and both platforms
have had recent negative press.\239\ A third commenter represents that,
in April 2018, Kraken refused to answer the NYAG's inquiry into the
bitcoin market, which heightens the need to independently analyze
longitudinal data from the ``real'' platforms.\240\
---------------------------------------------------------------------------
\237\ See Blake Letter I, supra note 6; Blake Letter II, supra
note 9; Denscombe Letter, supra note 6; Fitzgerald Letter II, supra
note 9.
\238\ See Blake Letter II, supra note 9 (stating that Tether and
Bitfinex's connections to Tether ``are just too painful to even
write about at this time''). See also Blake Letter I, supra note 6
(questioning the Sponsor's claim that Binance is a European Union-
based Maltese company).
\239\ See Fitzgerald Letter II, supra note 9 (representing that
the Kraken CEO stated that, among other things, bitcoin traders want
minimal documentation for onboarding and do not care about many of
the things that concern regulators, including regulatory approval
and protection from risky investments and market manipulation).
\240\ See Denscombe Letter, supra note 6.
---------------------------------------------------------------------------
One commenter asserts that it seems unlikely that there are zero
platforms that have a mixture of some real and some fake volume, and
that the more likely scenario is that some platforms are faking some of
their volume and therefore the ``true'' volume in the ``real'' bitcoin
market is certainly higher than the Sponsor's calculation.\241\ In
response to this commenter, the Sponsor acknowledges that there is
likely a gray area between platforms with 100% real volume and 100%
fake volume.\242\ According to the Sponsor, the 73 platforms that it
has not identified as ``real'' platforms include an occasional example
that ``doesn't seem outright fake.'' \243\ The Sponsor cites as an
example its analysis of the Gate.io platform, and the Sponsor
acknowledges that there is room to reasonably argue whether Gate.io's
volume is fake or whether some percentage of its volume should be
included in the total ``real'' volume.\244\ However, the Sponsor
asserts that Gate.io does not have enough volume to meaningfully alter
the Sponsor's conclusions, which would not change even if the Sponsor
counted all of Gate.io's volume as ``real.'' \245\
---------------------------------------------------------------------------
\241\ See Blake Letter I, supra note 6.
\242\ See Bitwise Submission II, supra note 9, at 38.
\243\ See id.
\244\ See id. (stating that the trade size histogram for Gate.io
does not show the expected spikes around 1.0 or 2.0 bitcoins, that
the volume spike analysis shows hourly volume that seems more
patterned than the reference set with a muted volume peak on May 3,
2019, and that the spread patterning analysis shows a high median
spread around $4).
\245\ See id. (comparing Gate.io's reported $12 million average
daily volume in April 2019 to the $554 million total daily volume of
the ten ``real'' platforms).
---------------------------------------------------------------------------
The Sponsor argues that to address whether the total ``real''
volume should be higher, it should focus, among the platforms it has
identified as ``fake,'' on those platforms with more significant
reported volume.\246\ The Sponsor asserts that, when it shared its
initial analysis on Twitter, the public closely examined its work and
raised questions about certain platforms that were not included in the
list of ``real'' platforms but that the public believed had real-world
footprints; but only three of these platforms had ``meaningful''
volume--HitBTC, Huobi, and OKEx.\247\ The Sponsor claims that its
analysis for OKEx shows that the vast majority of OKEx's bitcoin volume
is entirely fake, based on the volume spike analysis for April 28,
2019, through May 5, 2019, showing a nearly constant hourly volume with
an extremely muted spike on May 3, 2019, along with a trade size
histogram that shows no round-number spikes, an atypical rise in volume
between 1 and 6 bitcoins, and an unusually long tail volume above 6
bitcoins.\248\ In addition, the Sponsor states that it believes that
HitBTC's volume is predominantly wash trading because the trade size
histogram shows almost no volume after 0.5 bitcoin, with no spikes at
round numbers, and the hourly volumes are completely detached from the
reference set of platforms, with most volume happening on April 29 and
30, 2019.\249\ The Sponsor further claims that while Huobi appeared to
fare well on the Sponsor's tests, weekly trade size histograms for
Huobi from the weeks before and after the Sponsor's initial analysis
became public indicate that those engaging in wash trading at Huobi
changed their trade size signatures to be more in line with, and
thereby evade, the Sponsor's detection methods for fake volume.\250\
---------------------------------------------------------------------------
\246\ See id.
\247\ See id. at 38-39 (stating that the April 2019 average
daily volume on HitBTC, Huobi, and OKEx was $127,010,643,
$128,043,683, and $228,879,610, respectively).
\248\ See id. at 39.
\249\ See id.
\250\ See id. at 40-42 (stating that trade size histograms from
the period March 3, 2019, through April 14, 2019, show an anomalous
pattern with a resurgence of trade volume between 5-11 bitcoins
before the Sponsor's initial analysis became public on March 21,
2019, followed by the complete disappearance of this pattern in the
subsequent three weeks). The Sponsor asserts that while Huobi might
have taken action to clean up wash trading after the Sponsor's
initial analysis became public, that ``view is challenged'' because
Huobi's reported trade volume did not meaningfully drop during that
time period. See id. at 42-43. See also Bitwise Submission VI, supra
note 9, at 18-21 (asserting that the trade size histograms for the
platforms Coinsuper, CHAOEX, and IDAX similarly exhibited a change
within the three weeks after the Sponsor's further analysis became
public).
---------------------------------------------------------------------------
The Sponsor also points to three independent, third-party
researchers that estimated the amount of real volume at HitBTC, Huobi,
and OKEx, and ``seem to agree'' that OKEx's volume is nearly entirely
fake and that the vast majority of volume on HitBTC and Huobi is
fake.\251\ The Sponsor states that, if it incorporates the simple
weighted average of these estimates (as applied to the reported volume
statistics for the three platforms for April 2019) to the Sponsor's
calculations of ``real'' trading volume, it would increase the ``real''
average daily spot bitcoin trading volume in April 2019 to $622
million, or 12% higher than the Sponsor's original figure.\252\ The
Sponsor argues that while this adjustment is non-negligible, it would
not materially change the Sponsor's conclusions.\253\
---------------------------------------------------------------------------
\251\ See Bitwise Submission II, supra note 9, at 43.
\252\ See id. at 43-44. See also Bitwise Submission VI, supra
note 9, at 17.
\253\ See Bitwise Submission II, supra note 9, at 44.
---------------------------------------------------------------------------
The commenter that raised the likely mix of real and fake volume
asserts in response to the Sponsor's argument that it ``seems a bit too
pat an answer'' for the Sponsor to essentially focus on three large
platforms that have mostly fake volume and conclude that any real
portion of the volume that the Sponsor identified as fake is too small
to matter.\254\ This commenter argues that the Sponsor's position
ignores the hundreds of smaller platforms that might have real volume
and that might, in the aggregate, make up a notable amount of total
volume.\255\ This commenter represents that three small platforms that
were not part of the Sponsor's analysis lost over $200 million in
investor funds and argues that, if the vast majority of platforms have
entirely fake volume or too little volume to matter, it could not be
the case that these three platforms obtained
[[Page 55398]]
over $200 million in client funds to lose or steal.\256\
---------------------------------------------------------------------------
\254\ See Blake Letter II, supra note 9.
\255\ See id.
\256\ See id.
---------------------------------------------------------------------------
Finally, the Sponsor asserts that the fake or non-economic trading
volume does not influence price discovery in the ``real'' bitcoin spot
market represented by the ten identified platforms.\257\ According to
the Sponsor, the only ways that prices on platforms with fake volume
could influence prices on platforms with real volume are: (1) If
arbitrage exists between platforms with fake volume and the ``real''
spot market, thus spreading the impact of the ``fake'' platforms'
prices; or (2) if market participants take prices on platforms with
fake volume as a legitimate market signal and adjust their view of the
market as a result.\258\ The Sponsor argues that arbitrage cannot exist
between two platforms if one platform does not have real and meaningful
liquidity.\259\ Therefore, according to the Sponsor, platforms with a
preponderance of fake volume cannot and do not participate in the
coordinated central liquidity pool or ``automatically influence'' the
consolidated price just by having a different price.\260\
---------------------------------------------------------------------------
\257\ See Bitwise Submission II, supra note 9, at 2.
\258\ See id. at 69.
\259\ See id.
\260\ See id.
---------------------------------------------------------------------------
With respect to whether market participants view platforms with
fake volume as providing legitimate market signals, the Sponsor asserts
that a ``preponderance of the evidence'' suggests that investors do not
view prices or volumes on platforms with fake volume as legitimate
market signals.\261\ Instead, according to the Sponsor, ``real
investors simply ignore these fake exchanges.'' \262\ In support of its
argument, the Sponsor represents that all regulated financial products,
including regulated bitcoin futures in the United States and listed
bitcoin ETPs in Europe, draw prices almost exclusively from a subset of
the bitcoin platforms that the Sponsor identifies as having real
volume.\263\ The Sponsor states that Coinbase Pro has the highest
volume amongst platforms used for pricing regulated bitcoin products,
but was ranked as the 37th largest platform by average daily volume on
coinmarketcap.com in April 2019.\264\ According to the Sponsor, the
absence of any of the platforms with larger reported volumes from the
pricing mechanisms for regulated financial products suggests that the
institutional investor marketplace understands that real price
discovery does not take place on these platforms and chooses to ignore
them.\265\
---------------------------------------------------------------------------
\261\ See id. at 69, 71.
\262\ Id. at 71.
\263\ See id. at 69.
\264\ See id.
\265\ See id. The Sponsor identifies the current pricing sources
for CME bitcoin futures, CFE bitcoin futures, XBT Bitcoin Tracker
One, and Amun Bitcoin ETF, and represents that these are all a
subset of the platforms that the Sponsor identifies as ``real.'' See
id. at 69-70.
---------------------------------------------------------------------------
In further support of its argument, the Sponsor asserts that
leading digital asset arbitrage and execution-focused firms track only
those platforms that the Sponsor identifies as having real volume.\266\
The Sponsor represents that, for example, a digital asset dealer and
trading platform, SFOX, tracks prices on only eight platforms, all of
which are among the ten platforms that the Sponsor identifies as having
real volume.\267\ The Sponsor asserts that, as a leading digital asset
dealer, SFOX has every incentive to identify as many arbitrage
opportunities as possible, so its focus on these platforms ``is
telling.'' \268\ Finally, the Sponsor argues that data aggregator
league tables are extremely volatile and that the volatility of the
league tables ``stretches the boundaries of credulity.'' \269\
According to the Sponsor, volatility in reported volume rank has
``historically strengthened'' the market's understanding that these
platforms are fake and ``can safely be ignored.'' \270\
---------------------------------------------------------------------------
\266\ See id. at 70.
\267\ See id.
\268\ See id. With respect to the two platforms that the Sponsor
identifies as ``real'' platforms but SFOX does not include, Poloniex
and Bitfinex, the Sponsor states that it ``guesses'' that SFOX
excludes these because of difficulties conducting arbitrage. See id.
at 70 n.182.
\269\ See id. at 71. The Sponsor represents that the spot
bitcoin platform Fcoin had $12 million, $802 million, and $1.7
billion reported average daily volume in February, March, and April
2019, respectively. See id. The Sponsor argues that it is ``hard to
believe'' this rise in volume. See id.
\270\ See id.
---------------------------------------------------------------------------
One commenter states that, in a global digital asset market, if
prices move on platforms with allegedly fake volume, the platforms with
``good'' volume must follow or experience losses.\271\ Another
commenter states that the bitcoin market is global and interconnected,
and that if 95% of platforms are reporting fake volume, then it is
unwise for the proposed ETP to be based on the remaining 5%.\272\
---------------------------------------------------------------------------
\271\ See Arssov Letter, supra note 6.
\272\ See C. Ross Letter, supra note 6.
---------------------------------------------------------------------------
(ii) Analysis
The Sponsor asserts that 95% of reported bitcoin spot volume
represents fake or non-economic trading, yet bases the proposed ETP on
a set of platforms that the Sponsor has identified as representing real
volume, will use these platforms for NAV and IIV pricing, and argues
that this ``real'' portion of the bitcoin market is uniquely resistant
to manipulation and not affected by the other 95%.\273\ The Sponsor and
commenters recognize that a significant amount of fraudulent,
manipulative, fake, or otherwise non-economic trading activity has
occurred in the bitcoin market.\274\ Because Section 6(b)(5) of the
Exchange Act requires that the proposal must be designed ``to prevent
fraudulent and manipulative acts and practices,'' NYSE Arca and the
Sponsor must show in this case that this fraudulent, manipulative,
fake, or otherwise non-economic trading activity in the broader bitcoin
market does not affect the smaller ``real'' portion of the bitcoin
market on which the proposed ETP is based. Therefore, as a threshold
matter, before discussing the Sponsor's methods of analysis or its
conclusions regarding which platforms represent ``real'' trading
volume, the Commission considers whether the record supports the
Sponsor's assertion that ``fake volume does not influence price
discovery in the real bitcoin spot market.'' \275\ In the absence of
this showing, NYSE Arca and the Sponsor will not be able to establish
that the identified ``real'' bitcoin market is uniquely resistant to
fraud and manipulation, because prices based on fraudulent and
manipulative activity on platforms with fake or non-economic volume
could be used to affect prices on the identified ``real'' platforms.
---------------------------------------------------------------------------
\273\ See supra notes 172, 257, and accompanying text.
\274\ See supra notes 69-73, 176-186 and accompanying text. The
Commission notes that while the Sponsor provides a response to a
discussion in the Winklevoss Order about certain commenters and the
concerns they raised about specific instances of manipulation (see
Bitwise Submission III, supra note 9, at 41, 45, 49), those comments
are not part of the record of the current proposed rule change under
consideration.
\275\ See Bitwise Submission II, supra note 9, at 2.
---------------------------------------------------------------------------
(A) Influence of Prices on Platforms With Fake or Non-Economic Volume
on Prices on Platforms With ``Real'' Volume
NYSE Arca and the Sponsor have failed to support the Sponsor's
assertions that the prices on platforms with fake volume do not
influence prices on the ``real'' platforms. In particular, the record
contains no data on where in the bitcoin market price formation occurs
and whether or not price movements on the ``real'' spot platforms
evidence correlation with price movements on the platforms with
``fake'' or non-economic volume, with one set of platforms moving at a
later time than the other (i.e., a ``lead-lag
[[Page 55399]]
relationship''). Without data to show the lead-lag relationship between
prices on the two sets of platforms or any evidence about the
directionality of the lead-lag relationship--which might indicate that
changes in prices on platforms with fake volume are or are not leading
to changes in prices on the ``real'' platforms--the Commission has no
basis on which to conclude that prices on the ``real'' platforms are
insulated from prices in the rest of the market. Thus the Commission
cannot conclude that it would be appropriate to consider the nature of
these platforms alone in an analysis of whether the bitcoin market is
uniquely resistant to manipulation.
The Sponsor makes many unsupported, conclusory statements to
support its contention that ``everyone knows where the real market
is.'' \276\ The Sponsor argues that arbitrage ``cannot exist'' between
platforms with real volume and platforms with a preponderance of fake
volume,\277\ without presenting any data or real-world examples that
might indicate the presence or absence of arbitrage between such
platforms. Moreover, the Sponsor's contention that such arbitrage
cannot exist rests on an assumption that platforms with a
``preponderance of fake volume'' do not have any ``real and meaningful
liquidity'' that could support arbitrage,\278\ without support for that
assumption. As discussed further below, the Sponsor acknowledges that
there is a gray area between platforms with entirely real volume and
platforms with entirely fake volume.\279\ Yet the Sponsor does not
address whether the presence of real volume on platforms with a
significant amount of fake volume would significantly affect pricing.
---------------------------------------------------------------------------
\276\ See id. at 71. See also supra notes 257-270 and
accompanying text.
\277\ See supra notes 259-260 and accompanying text.
\278\ See supra notes 259-260 and accompanying text.
\279\ See supra note 242 and accompanying text. See infra notes
305-314 and accompanying text for discussion of whether the Sponsor
has identified all ``real'' volume on the bitcoin spot platforms
included in its analysis and whether ``real'' volume on other
portions of the bitcoin spot market might undercut its assertions.
---------------------------------------------------------------------------
In addition, the Sponsor concludes that the evidence that it cites
``suggests'' that investors do not look to platforms with fake volume
for legitimate market signals, but does not persuasively address
alternative explanations for the cited evidence that would lead to a
different conclusion.\280\ The Sponsor looks at which platforms other
providers of financial products select for their pricing
mechanisms,\281\ but other providers' reliance on certain bitcoin
trading platforms does not demonstrate that prices on platforms with
purportedly fake volume do not influence prices on the purportedly
``real'' platforms. The Sponsor also fails to address alternative
reasons for these products' reliance on certain platforms, including
the presence of a degree of regulation on these platforms. Moreover,
the platforms used for these pricing mechanisms do not line up exactly
with the Sponsor's ten identified ``real'' platforms,\282\ indicating
that at least some institutional market participants do not agree that
all of the Sponsor's identified ``real'' platforms provide the most
reliable prices. Further, while the Sponsor points to the platforms
tracked by digital asset dealer and trading platform SFOX, the overlap
with the Sponsor's ``real'' platforms is anecdotal evidence at best,
and any incentives SFOX may have to identify arbitrage opportunities is
not a substitute for an analysis of whether prices on certain platforms
have an influence on general market pricing.\283\ And while the
volatility of data aggregator league tables raises questions about
reported trading volume that may be relevant to probe,\284\ mere belief
that the reported trading volume is questionable is no substitute for
data-driven analysis of how other market participants would adjust
their pricing in response to prices on other platforms, even if they
agree that those platforms have predominantly--but not entirely--fake
volume. Further, the Sponsor's arguments rely on a description of how
institutional market participants behave, but the Sponsor does not
provide information regarding what portion of the market is made up of
institutional versus retail participants. The Commission also notes
that while the Sponsor asserts that coinmarketcap.com is the most
widely cited source for bitcoin volume,\285\ as of October 6, 2019,
coinmarketcap.com does not separate ``real'' versus ``fake'' platforms
and prices.\286\ This shows that the focus on the Sponsor's identified
``real'' platforms or a subset thereof, to the exclusion of the vast
majority of platforms with reported volume on data aggregators such as
coinmarketcap.com, is not necessarily shared by other participants in
the bitcoin market.
---------------------------------------------------------------------------
\280\ See supra notes 261-270 and accompanying text.
\281\ See supra notes 263-265 and accompanying text.
\282\ See supra note 265.
\283\ See supra notes 266-268 and accompanying text.
\284\ See supra notes 269-270 and accompanying text.
\285\ See Bitwise Submission I, supra note 6, at 23.
\286\ As of October 6, 2019, coinmarketcap.com lists the top 100
digital asset platforms by reported volume and by ``adjusted
volume,'' the latter of which it represents is ``[v]olume from spot
markets excluding markets with no fees and transaction mining.'' See
Top 100 Currency Exchanges by Trade Volume, CoinMarketCap, available
at https://coinmarketcap.com/rankings/exchanges (last visited Oct.
6, 2019). Although the ``adjusted volume list indicates some
adjustment for certain types of trading activity, the identification
of at least 100 platforms with ``adjusted volume'' differs
considerably from the Sponsor's identification of only ten ``real''
platforms.
---------------------------------------------------------------------------
For the reasons above, the Commission does not believe that NYSE
Arca and the Sponsor have demonstrated that prices on platforms with
fake or non-economic volume do not influence prices on platforms with
real volume. Given the Sponsor's claims about the prevalence of fake or
non-economic trading activity within the overall bitcoin market, the
Commission considers this lack of proof to fundamentally undercut the
Sponsor's contention that the ``real'' bitcoin market is uniquely
resistant to fraudulent and manipulative activity.\287\
---------------------------------------------------------------------------
\287\ If the platforms with fake or non-economic volume cannot
be disambiguated from the platforms with ``real'' volume, this also
undercuts the Sponsor's assertions about whether NYSE Arca has a
surveillance-sharing agreement with a significant, regulated market.
For further discussion, see infra Section III.B.3.
---------------------------------------------------------------------------
(B) The Sponsor's Identification of Platforms With Predominantly
``Real'' Volume
NYSE Arca and the Sponsor have not provided sufficient data to
substantiate the Sponsor's claims that it has identified the ten
platforms that have ``real'' volume, as distinguished from those
platforms dominated by fake or non-economic trading \288\ and the
Sponsor's data analysis is incomplete or inconsistent and limits the
Commission's ability to evaluate the Sponsor's claims.\289\ For
example, the Sponsor asserts that its data analysis of trade size
distribution only includes trade sizes of 0 to 10 bitcoins because the
vast majority of trade volume occurs in the lower range and because the
Sponsor finds the histogram presentation of this range ``visually
helpful.'' \290\ As two commenters recognize, however, this data
presentation cuts off larger orders that occur in the bitcoin market,
and the inclusion of larger orders could make
[[Page 55400]]
the Sponsor's analysis look materially different.\291\
---------------------------------------------------------------------------
\288\ See supra notes 172-176, 191-194, 199-203, 211-228, and
accompanying text.
\289\ See supra notes 151-156 and accompanying text.
\290\ See supra note 214 and accompanying text.
\291\ See supra notes 233, 235, and accompanying text.
---------------------------------------------------------------------------
Further, the Sponsor admits that the inability to gather
comprehensive market data ``has made proving the existence of fake
volume on exchanges in a comprehensive manner difficult.'' \292\ The
Sponsor acknowledges that its data scraping methodology broke down
frequently, resulting in gaps in the data that it accounted for in the
analytical phase,\293\ but does not address what steps it took to
ensure that these data gaps did not affect its analysis. The use here
of a single one-week period of data may reflect selection bias and is
insufficient to reveal the full picture regarding platforms over time
or during different periods.\294\ While the Sponsor asserts that any
single week sample would ``exhibit the same characteristics and lead to
a similar conclusion,'' \295\ the Sponsor has not provided any support
for this assertion or any explanation why the selected one-week period
is or is not representative of the properties of the bitcoin spot
market in other periods. Several commenters also raise questions and
concerns about the Sponsor's methodology for selecting what data to
collect and analyze, collecting the data, and analyzing the data.\296\
For many parts of the analysis, the Sponsor first looks to the trade
sizes, volume spikes, and spread patterns for its reference set of
platforms with BitLicenses, and then compares these to other
platforms.\297\ The Sponsor makes observations about how trade sizes,
volume spikes, or spread patterns differ for platforms outside of its
reference set of platforms with BitLicenses, and assumes that these
differences are indications of fake or non-economic volume. The Sponsor
does not appear to acknowledge that there could be other reasons for
observed differences in trading patterns among the platforms, such as
artefacts of algorithmic trading. In addition, the Commission notes
that anecdotal recitations of support for the Sponsor's initial
analysis in the news or social media are no substitute for full,
independent analysis or replication of the results.\298\
---------------------------------------------------------------------------
\292\ See supra note 191.
\293\ See supra note 193 and accompanying text.
\294\ See supra notes 211-212 and accompanying text. See also
supra note 232 and accompanying text (asserting that the time period
used is a ``very short snapshot'' and a longitudinal picture is
lacking).
\295\ Bitwise Submission II, supra note 9, at 19.
\296\ See supra notes 195-198, 204-210, 231-236, and
accompanying text.
\297\ See supra notes 215-217, 219-221, 223-227, and
accompanying text.
\298\ See supra notes 182-183 and accompanying text. But see
supra notes 187-190 and accompanying text (questioning the Sponsor's
findings in its initial analysis).
---------------------------------------------------------------------------
The Commission notes that the Sponsor relies heavily on conclusory
statements that are insufficient to support its findings. For example,
the Sponsor's assertions that the findings in its initial analysis are
consistent with the ``common institutional understanding of the true
nature of the actual market'' are conclusory and unsupported.\299\ The
Commission notes that several commenters raise questions about specific
platforms that the Sponsor identifies as having ``real'' volume,
casting doubt on the contention that there is common understanding of
the ``real'' market.\300\ With respect to the Sponsor's initial
selection of platforms to analyze, the Sponsor states that its list of
platforms became stale quickly, but asserts that its ``core analysis''
remains relevant.\301\ This representation simply assumes without any
support that significant volume on new platforms would be fake or non-
economic volume, and it provides the Commission with no basis to
conclude that this would be the case. Similarly, the Sponsor's
statement that any incremental volume in the OTC dark pool market is
not a significant fraction of the spot market and would mostly lead to
double-counting is conclusory, relies solely on anecdotal
evidence,\302\ and is inconsistent with a commenter's estimate of the
size of the OTC bitcoin market.\303\ Moreover, with respect to the
Sponsor's argument that the NYAG's inquiry concerning Bitfinex's
operator does not alter the Sponsor's conclusion that Bitfinex has real
volume, the Sponsor makes the conclusory and insufficient assertion
that it found no evidence in legal documents contradicting this
finding, without describing the types of evidence it found and why such
evidence would not change the Sponsor's analysis.\304\
---------------------------------------------------------------------------
\299\ See supra note 186 and accompanying text.
\300\ See supra notes 237-240 and accompanying text.
\301\ See supra note 201 and accompanying text.
\302\ See supra notes 202-203 and accompanying text.
\303\ See supra note 208 and accompanying text (asserting that
U.S.-based OTC volume in bitcoin may be as high as $500 million a
day; the Commission notes that this volume is comparable to the $554
million in total daily volume for the same period across all ten of
the ``real'' platforms). See also Registration Statement, supra note
31, at 20 (``OTC trading tends to be in large blocks of bitcoin.'').
\304\ See supra note 230 and accompanying text; infra notes 331-
338 and accompanying text (discussing, among other things, the NYAG
allegations). See also supra note 238 and accompanying text
(asserting that the recent actions regarding Bitfinex raises
questions about why it was ever included in the Sponsor's list of
``real'' platforms).
---------------------------------------------------------------------------
Further, the Sponsor has not shown that it has identified all
``real'' volume on the bitcoin spot platforms included in its analysis.
In response to a commenter, the Sponsor acknowledges that there is a
``gray area'' between platforms with all real volume and all fake
volume, and that some of the 73 platforms that failed one or more of
its tests may include some amount of real volume.\305\ The Sponsor
cites one example, the Gate.io platform, and asserts that Gate.io does
not have enough volume to meaningfully alter the Sponsor's conclusion,
even if it was made up of entirely real volume, because Gate.io's
reported average daily volume in April 2019 of $12 million is
significantly lower than the $554 million in total daily volume for the
same period across all ten of the ``real'' platforms.\306\ However, the
Sponsor does not acknowledge that the average daily volume per platform
within its set of ten selected platforms was $55.4 million in April
2019, or that $12 million is higher than the average daily volume for
two of the ten platforms and almost as much average daily volume as a
third.\307\ This shows that the inclusion of an additional $12 million
in real volume is not immaterial to the Sponsor's claims. Further, the
Sponsor does not consider the possibility that any other platform with
volume comparable to that found on Gate.io would also have a material
amount of ``real'' trading.
---------------------------------------------------------------------------
\305\ See supra notes 241-243 and accompanying text.
\306\ See supra notes 244-245 and accompanying text.
\307\ See Bitwise Submission II, supra note 9, at 35 (providing
a table with the average daily volume on each of the ten ``real''
platforms for April 2019).
---------------------------------------------------------------------------
The Sponsor then discusses the HitBTC, Huobi, and OKEx platforms,
because, according to the Sponsor, these were the only platforms that
were cited by ``the public'' as having ``real-world footprints'' that
have ``meaningful'' volume but that were excluded from the Sponsor's
list of ``real'' platforms.\308\ Reliance on the set of platforms that
``the public'' raised to set the scope for further analysis presents an
incomplete picture. The Sponsor does not describe any means by which it
might know what motivations other individuals had to identify
particular platforms as having a real-world footprint or how extensive
those individuals' efforts were to identify other platforms for
[[Page 55401]]
consideration. Moreover, the Sponsor does not define what it considers
to be ``meaningful'' volume. The Commission notes that the April 2019
average daily volume for each of HitBTC, Huobi, and OKEx is
significantly higher than the April 2019 average daily volume for all
but one of the identified ``real'' platforms.\309\
---------------------------------------------------------------------------
\308\ See supra notes 246-247 and accompanying text.
\309\ See supra notes 247, 307.
---------------------------------------------------------------------------
The Sponsor's analysis of HitBTC and OKEx relies on circular
reasoning and uses evidence that suggests the presence of fake or non-
economic trading to conclude that the trading volume on these platforms
is ``almost entirely fake,'' without discussing how the presence of
some real volume affects the results.\310\ The Sponsor further
dismisses volume on Huobi as fake based on trade size histograms over
time, suggesting that changes in the trade size histograms after the
Sponsor's initial analysis became public indicate that wash traders
adjusted their trade size signatures to avoid the Sponsor's detection
methods.\311\ The Sponsor's assertion is conclusory and does not
address the possible presence of real volume on Huobi. Moreover, the
Commission notes that, if market participants changed their trading
behavior to avoid detection of fake or non-economic trading after the
Sponsor's first analysis became public, the Sponsor's methodology may
have been tainted when it conducted its later analysis, and these
efforts to disguise fake or non-economic volume may prevent the Sponsor
or market participants from distinguishing ``real'' volume from
``fake'' volume in the future.
---------------------------------------------------------------------------
\310\ See supra notes 248-249 and accompanying text.
\311\ See supra note 250 and accompanying text.
---------------------------------------------------------------------------
The Sponsor then considers estimates from third-party researchers
about the amount of real volume on these three platforms and
acknowledges that the estimated amounts might increase the Sponsor's
calculated real volume in the spot market by a non-negligible amount,
but asserts that this volume would not ``materially'' change the
Sponsor's conclusions.\312\ The Sponsor's assertion is unsupported and
does not address that the researchers' estimated real volume, at
between approximately $16 million and $25 million per platform, is
similar to the average daily volume reported for the individual
``real'' platforms. The presence of this volume indicates that there
may be more non-negligible real volume on other platforms, but the
Sponsor does not explain whether or how more real volume from other
platforms would change its analysis.\313\ Instead, the Sponsor merely
asserts in conclusory fashion that the additional real volume, as
estimated by the third-party researchers, would not ``materially''
impact its analysis and does not address how real volume on a platform
dominated by fake or non-economic volume would interact with the
market.
---------------------------------------------------------------------------
\312\ See supra notes 251-253 and accompanying text.
\313\ The Commission notes that a commenter questions the
Sponsor's focus on three large platforms and argues that the Sponsor
has ignored smaller platforms that might, in the aggregate, contain
a notable amount of real volume. See supra notes 254-256 and
accompanying text.
---------------------------------------------------------------------------
Finally, NYSE Arca and the Sponsor do not address the potential
effect on the ten identified platforms of real volume on other portions
of the bitcoin spot market not included in the set of 83 platforms that
the Sponsor analyzed. For example, the Sponsor does not consider real
volume on newer platforms or the OTC market and how such volume would
affect its analysis. Moreover, while the Sponsor excludes South Korean
platforms on the basis that trading volumes on those platforms are
isolated from the globally connected market due to capital controls,
this does not mean that the trading volume is not real.\314\ The
Sponsor also does not indicate whether trading on those portions of the
market represents ``real'' trading or fake or non-economic trading, or
address whether pricing on those segments of the market would affect
prices on the ``real'' platforms.
---------------------------------------------------------------------------
\314\ See supra note 228 and accompanying text. The Commission
notes that the Sponsor does not clearly explain how it handled the
South Korean platforms in its analysis. While the Sponsor states
that it has excluded these platforms, it still includes the trade
size histograms, volume graphs, and spread graphs for the South
Korean platforms, and its statement that 73 platforms have failed
one or more of its tests includes the South Korean platforms among
the 73. In contrast, when describing its first analysis, the Sponsor
indicates that it has excluded the South Korean platforms at the
outset. See supra note 181.
---------------------------------------------------------------------------
For these reasons, the Commission determines that the record does
not support a conclusion that the Sponsor has identified a segment of
the bitcoin spot market, representing real volume and forming the basis
of the Trust's NAV and IIV pricing, that is uniquely resistant to
manipulation.\315\
---------------------------------------------------------------------------
\315\ For discussion about how the Sponsor's analysis impacts
arguments about whether the bitcoin futures market is a market of
significant size, see infra Section III.B.3.
---------------------------------------------------------------------------
(d) Features of the Bitwise Bitcoin ETF Trust
(i) Representations Made and Comments Received
NYSE Arca represents that the Sponsor believes that several
additional features of the structure of the Trust would provide unique
resistance to fraudulent and manipulative practices.\316\ The Sponsor
asserts that, because the Trust's NAV is based on substantially all
``real'' spot bitcoin trading volume and is volume-weighted, any
attempt to manipulate the NAV must involve a majority of spot bitcoin
trading volume over a significant period of time.\317\ The Sponsor also
asserts that the unique design of the Bitwise Daily Bitcoin Reference
Price, and thus the Trust's NAV, the exclusive use of in-kind creations
and redemptions, and the decision to accrue fees in bitcoin, provide
unique resistance to short term attempts at manipulation.\318\
---------------------------------------------------------------------------
\316\ See Notice and OIP, supra note 7, 84 FR at 23133. See also
Bitwise Submission III, supra note 9, at 13 (arguing that the
Trust's pricing methodology makes market manipulation of the NAV
more difficult, because a bad actor must manipulate the majority of
trading volume to impact the price, and easier to identify, because
the manipulative activity must be repeated to have a significant
effect). See supra Section III.B.1(b) for additional discussion
about how the ``exchange-tradability'' of bitcoin and the nature of
the bitcoin market impact the proposed ETP's resistance to
manipulation.
\317\ See Notice and OIP, supra note 7, 84 FR at 23133.
\318\ See id.
---------------------------------------------------------------------------
The Sponsor represents that the Trust will value its shares daily
based on the Bitwise Daily Bitcoin Reference Price, which is based on
prices drawn from selected platforms that represent substantially all
of the economically significant spot trading volume on global bitcoin
platforms, excluding those in countries that impose capital
controls.\319\ The Sponsor describes the calculation of the Bitwise
Daily Bitcoin Reference Price separately from its description of how it
has identified the ``real'' market for bitcoin, as discussed
above.\320\ The Sponsor states that to calculate the Bitwise Daily
Bitcoin Reference Price, it relies on a methodology that begins with
the Sponsor's tracking of over 200 on-line digital-asset trading
platforms and eliminating a significant portion of those platforms,
based on a number of factors.\321\ According to the Sponsor, these
factors serve to eliminate platforms that, for example, are domiciled
in emerging market countries or countries that have capital controls;
lack a functioning and stable Application Programming Interface \322\
[[Page 55402]]
for the transmission of price and volume data; have issues with
significant downtime, problems with customer withdrawals, or known
security issues; are or may be subject to extraordinary legal or
regulatory activity; or do not have at least $1 million average daily
volume for bitcoin-fiat or bitcoin-stablecoin trading pairs over the
past calendar quarter.\323\ The Sponsor represents that, at least
quarterly, the Bitwise Crypto Index Committee reviews published trading
data from all platforms that pass this screening process and removes
platforms that show persistent signs of artificial or inflated
volume.\324\ The Sponsor further represents that, through this process,
it has identified ten platforms to use for the Bitwise Daily Bitcoin
Reference Price, and has more recently eliminated one platform,
Bitfinex, due to the recent NYAG inquiry of its operator.\325\
---------------------------------------------------------------------------
\319\ See id. at 23126, 23128.
\320\ See supra notes 172-176 and accompanying text.
\321\ See Notice and OIP, supra note 7, 84 FR at 23131.
\322\ An ``Application Programming Interface,'' or ``API,'' is
``a set of clearly defined methods of communication between various
software components which can make it easier to develop a computer
program by providing all the building blocks, which are then put
together by programmers.'' Securities Exchange Act Release No. 82873
(Mar. 14, 2018), 83 FR 13008, 13028 n.158 (Mar. 26, 2018)
(Transaction Fee Pilot for NMS Stocks Proposing Release) (File No.
S7-05-18).
\323\ See Notice and OIP, supra note 7, 84 FR at 23131.
\324\ See id. The Sponsor states that this analysis includes a
review of bid/ask spreads, actual claimed executed trades with price
and volume, and any other factors that the Committee deems relevant.
See id.
\325\ See id. at 23130 n.20, 23131.
---------------------------------------------------------------------------
As noted above, the Sponsor argues that the ten platforms it
selected for the Bitwise Daily Bitcoin Reference Price's pricing
mechanism currently account for substantially all of the ``real'' spot
global volume of bitcoin, excluding capital-controlled countries,
although the number of platforms and percentage of global volume
represented is subject to change.\326\ The Sponsor asserts that this
composition mitigates against idiosyncratic platform risk because the
failure of any individual platform will not materially affect pricing
for the Trust.\327\ Moreover, the Sponsor asserts that using a larger
number of platforms to calculate the NAV supports liquidity of the
Trust and mitigates idiosyncratic risks that can exist at an individual
platform over short periods of time.\328\ The Sponsor also asserts that
the use of a large number of platforms contributing prices to the NAV,
in a well-arbitraged and fractured market, makes market manipulation
more difficult because the malicious actor would need to manipulate
multiple platforms simultaneously or dramatically skew the historical
distribution of volume to impact the NAV.\329\ The Sponsor further
asserts that the reliance on substantially all of spot trading volume
in bitcoin for pricing the Trust increases this difficulty, because
significantly more capital would be required to attempt to influence
NAV and it would be difficult to profit from that manipulation.\330\
---------------------------------------------------------------------------
\326\ See id. at 23131.
\327\ See id. at 23131-32; Bitwise Submission I, supra note 6,
at 92. See also Bitwise Submission III, supra note 9, at 171
(asserting that the Trust's procedures to incorporate prices from a
large number of spot bitcoin platforms, and allow the Bitwise Crypto
Index Committee to remove a platform from contributing to prices
when it faces a disruption, ensures that the Trust's NAV always
draws prices from platforms trading at a globally integrated price).
The Sponsor represents that, while in the past trading has been
disrupted at individual bitcoin platforms, there is no history of
systemic disruptions across all platforms in the ``modern
evolution'' of the bitcoin market. See Bitwise Submission III, supra
note 9, at 171.
\328\ See Bitwise Submission III, supra note 9, at 127. See also
Bitwise Submission V, supra note 9, at 2-3 (representing that
individual platforms may experience idiosyncratic issues, including
hacking, withdrawal issues, regulatory actions, and legal actions,
that cause their prices to temporarily detach from the globally
integrated price when the idiosyncratic issues break or weaken the
arbitrage mechanism). One commenter asserts that it agrees with the
Sponsor that a benefit of a multi-platform approach is that it
minimizes the potential adverse impact of any single platform going
off-line due to technical problems or other concerns, and mutes the
impact of potentially manipulated prices or volume stemming from a
single platform. See Omniex Letter, supra note 9, at 3.
\329\ See Notice and OIP, supra note 7, 84 FR at 23132; Bitwise
Submission I, supra note 6, at 96.
\330\ See Notice and OIP, supra note 7, 84 FR at 23132; Bitwise
Submission I, supra note 6, at 93, 97.
---------------------------------------------------------------------------
The Sponsor states that on April 25, 2019, the Bitwise Crypto Index
Committee voted to immediately remove Bitfinex from the list of
platforms that contribute prices to the Bitwise Daily Bitcoin Reference
Price, along with other Bitwise Crypto Indexes, because the NYAG had
obtained a court order against iFinex Inc., operator of Bitfinex, based
on allegations of fraudulent conduct.\331\ The Sponsor asserts that the
removal of Bitfinex was in keeping with the committee's rule to exclude
platforms subject to extraordinary regulatory action, which requirement
exists to limit platforms included in the pricing mechanism to those
that are positive actors in the market and limit the potential for
interruptions in service or unusual pricing due to government or
regulatory enforcement actions.\332\ According to the Sponsor,
extraordinary legal or regulatory action increases the risk that a
platform will exhibit idiosyncratic pricing issues or have to halt
withdrawals, shut down, or face other challenges.\333\ The Sponsor
asserts that the removal of Bitfinex from the pricing mechanism on the
same day that the extraordinary legal threat emerged suggests that the
screening rules and ongoing monitoring process are useful, proactive,
and constructive, and protect the Bitwise Daily Bitcoin Reference Price
from the ``slightest possibility'' of anomalous pricing arising from
the developments.\334\ The Sponsor further asserts that heightened
scrutiny of stablecoins after this incident makes it extremely unlikely
that the fraudulent printing of a stablecoin asset could easily happen
in the future.\335\
---------------------------------------------------------------------------
\331\ See Bitwise Submission III, supra note 9, at 47; Bitwise
Submission V, supra note 9, at 1. See also Notice and OIP, supra
note 7, 84 FR at 23130 n.20. The NYAG, which began its investigation
in November 2018, alleges ``that the operators of the `Bitfinex'
trading platform, who also control the `tether' virtual currency,
engaged in a cover-up to hide the apparent loss of $850 million of
co-mingled client and corporate funds.'' Press Release, New York
State Office of the Attorney General, Attorney General James
Announces Court Order Against ``Crypto'' Currency Company under
Investigation for Fraud (Apr. 25, 2019), available at https://ag.ny.gov/press-release/2019/attorney-general-james-announces-court-order-against-crypto-currency-company. The NYAG further alleges,
``The filings explain how Bitfinex no longer has access to over $850
million dollars of co-mingled client and corporate funds that it
handed over, without any written contract or assurance, to a
Panamanian entity . . . a loss Bitfinex never disclosed to
investors. In order to fill the gap, executives of Bitfinex and
Tether engaged in a series of conflicted corporate transactions
whereby Bitfinex gave itself access to up to $900 million of
Tether's cash reserves, which Tether for years repeatedly told
investors fully backed the tether virtual currency `1-to-1.' '').
Id. The NYAG explained, however, that it ``does not seek to enjoin
or interfere with the orderly operations of Bitfinex or Tether's
legitimate businesses, if any, including orders by legitimate
traders on the Bitfinex platform, or legitimate tether holders, to
redeem their tethers for dollars. Indeed, protecting legitimate
traders using the Bitfinex platform, and legitimate holders of
tether, primarily those residing in New York, is why a preliminary
injunction is necessary now to preserve the status quo pending the
completion of OAG's investigation.'' Affirmation of Brian M.
Whitehurst in Support of OAG's Ex Parte Application for an Order
Pursuant to General Business Law Sec. 354, James v. iFinex, Inc.,
et al., No. 450545/2019, 2019 WL 2176835 (N.Y. Sup. Ct. Apr. 25,
2019), Doc. No. 1, at para. 96. The court subsequently denied a
motion to dismiss brought by iFinex Inc. and its related entities.
James v. iFinex Inc., et al., No. 450545/2019, 2019 WL 3891172 (N.Y.
Sup. Ct. Aug. 19, 2019). iFinex Inc. and its related entities have
appealed the court's denial of their motion to dismiss. Notice of
Appeal, James v. iFinex Inc., et al., No. 450545/2019 (N.Y. Sup. Ct.
Aug. 19, 2019), Doc. No. 117.
\332\ See Bitwise Submission V, supra note 9, at 1.
\333\ See id. at 3.
\334\ See id. at 5-6. See also id. at 3 (asserting that the
benefit of proactively removing Bitfinex as a pricing source is that
it protects against potential short-term downstream impacts if a
negative idiosyncratic event occurs in the future). One commenter
states that the Sponsor's reasons for removing Bitfinex are sound
and follow the outlined index procedures, but raise a flag. See
Blake Letter II, supra note 9.
\335\ See Bitwise Submission III, supra note 9, at 47.
---------------------------------------------------------------------------
With respect to the removal of Bitfinex, which represented 14.1% of
all ``real'' spot bitcoin volume in April 2019, the Sponsor argues that
``the loss
[[Page 55403]]
of any single exchange does not impact the Bitwise Daily Bitcoin
Reference Price in a meaningful way.'' \336\ The Sponsor asserts that,
with prices tightly aligned, removing one or two platforms would not
meaningfully impact the calculated price.\337\ In addition, the Sponsor
states that, while having more platforms to calculate the price is
better, there are diminishing returns for each additional platform and
at some point it is enough to calculate a good price and not be exposed
to idiosyncratic risk, especially with a pricing methodology that
mitigates against the impact of outlier prices.\338\
---------------------------------------------------------------------------
\336\ See Bitwise Submission V, supra note 9, at 4.
\337\ See id. (representing that the average deviation in price
as compared to the consolidated price in 2019 was 0.11% for
Bitfinex, which falls in the middle of the 0.05% to 0.20% range seen
across the ten ``real'' platforms).
\338\ See id. at 4-5.
---------------------------------------------------------------------------
The Sponsor asserts that the procedures by which it relies on the
prices and volumes from the selected platforms to calculate the Bitwise
Daily Bitcoin Reference Price are designed to protect the price, and
thereby the Trust's NAV, from potential manipulation.\339\ The Sponsor
argues that the use of six consecutive five-minute segments over a
thirty-minute period means that malicious actors would need to sustain
efforts to manipulate the market over an extended period of time or
replicate efforts multiple times, which could trigger review by
platforms, market participants, and regulators.\340\ The Sponsor
asserts that the use of a median price eliminates the ability of
outlier prices to impact the NAV, because the methodology
systematically excludes outliers from the NAV calculation.\341\ The
Sponsor also asserts that the use of a volume-weighted median, instead
of a traditional median, protects against attempts to manipulate the
NAV by executing multiple low-dollar trades, because any manipulation
attempt would have to involve a majority of global spot bitcoin volume
in a five-minute window to impact the pricing mechanism.\342\ According
to the Sponsor, the methodology it uses for the Bitwise Daily Bitcoin
Reference Price is similar to the settlement pricing methodology for
the CME CF Bitcoin Reference Rate used for CME futures, which the
Sponsor represents has documented protection against the impact of
pricing variance.\343\ Finally, the Sponsor asserts that the
``carefully designed lag'' between the strike time of the NAV at 4:00
p.m. E.T. and the time the NAV is distributed allows time for the
Sponsor to algorithmically and manually review contributed prices for
any anomalous behavior and correct unusual pricing if it occurs.\344\
---------------------------------------------------------------------------
\339\ See Notice and OIP, supra note 7, 84 FR at 23131.
\340\ See id.; Bitwise Submission I, supra note 6, at 98
(asserting that the extended thirty-minute period 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 also Omniex Letter, supra note 9,
at 4 (asserting that the Trust's NAV process is uniquely resistant
to manipulation because a bad actor would need to manipulate
multiple platforms over an extended period of time to impact the
NAV).
\341\ See Notice and OIP, supra note 7, 84 FR at 23131; Bitwise
Submission I, supra note 6, at 99. See also Bitwise Submission III,
supra note 9, at 127 (asserting that the Sponsor's pricing
methodology is designed to systematically exclude aberrant prices as
an extra protection against idiosyncratic platform risks at
individual platforms).
\342\ See Notice and OIP, supra note 7, 84 FR at 23131; Bitwise
Submission I, supra note 6, at 99.
\343\ See Notice and OIP, supra note 7, 84 FR at 23131; Bitwise
Submission I, supra note 6, at 99; Bitwise Submission III, supra
note 9, at 15. The Sponsor argues that a cited study shows the
protective qualities of using volume-weighted median pricing, and
that while the Sponsor's approach differs in drawing from a larger
number of platforms and using a shorter time window, the shorter
time window maintains the protective qualities of the approach while
improving the timeliness of the NAV price. See Bitwise Submission I,
supra note 6, at 99 (citing Andrew Paine and William J. Knottenbelt,
Imperial College Centre for Cryptocurrency Research and Engineering,
``Analysis of the CME CF Bitcoin Reference Rate and CME CF Bitcoin
Real Time Index'' (Nov. 14, 2016)).
\344\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission I, supra note 6, at 100. The Sponsor notes that the NAV
would generally be distributed by 5:30 p.m. E.T. See Notice and OIP,
supra note 7, 84 FR at 23133; Bitwise Submission I, supra note 6, at
100.
---------------------------------------------------------------------------
The Sponsor asserts that the Trust's method of calculating the NAV
differs from that proposed for use by the Winklevoss Bitcoin Trust, and
that these differences help make the NAV calculation and the Trust
itself uniquely resistant to manipulation.\345\ One commenter asserts
that the current proposal is better than that discussed in the
Winklevoss Order because the Trust proposes to use many bitcoin
platforms that account for a majority of total global volume of
bitcoin, as compared to using a small related platform that represents
perhaps 1% of global bitcoin trading.\346\
---------------------------------------------------------------------------
\345\ See Bitwise Submission III, supra note 9, at 81. The
Commission notes that the Sponsor discusses several points of
comparison between the specifics of its proposal and the Winklevoss
Trust, see supra note 9, at 75, 77, 79, and 81, but these particular
comparisons are not relevant to the question of whether the proposal
is consistent with the standards of the Exchange Act.
\346\ See Anonymous Letter I, supra note 6. This commenter
favorably compares the proposal to United States bitcoin futures,
which also use a ``tiny'' number of platforms for their pricing
methodology, and the now-withdrawn proposal from Cboe BZX Exchange,
Inc., for another bitcoin ETP (the VanEck SolidX Bitcoin Trust) that
would have used prices from a few OTC desks, when there is no reason
to use OTC pricing due to lack of an alternative. See id. See also
Securities Exchange Act Release No. 85119 (Feb. 13, 2019), 84 FR
5140 (Feb. 20, 2019) (Notice of Filing of Proposed Rule Change to
List and Trade Shares of SolidX Bitcoin Shares Issued by the VanEck
SolidX Bitcoin Trust, Under BZX Rule 14.11(e)(4), Commodity-Based
Trust Shares) (SR-CboeBZX-2019-004).
---------------------------------------------------------------------------
Other commenters also support the Sponsor's proposed method of
calculating the Trust's NAV.\347\ One commenter argues that to the
extent that the NAV becomes aberrant, stale, or incorrect, the real
price discovery would occur in the proposed ETP.\348\ This commenter
cites as an example ETPs with foreign-listed equities that have NAVs
that are out-of-sync with the trading day in the United States.\349\
However, another commenter points to risks disclosed in a prior version
of the Trust's registration statement that states that the NAV may not
always correspond to market price and investors may be adversely
affected.\350\
---------------------------------------------------------------------------
\347\ See Omniex Letter, supra note 9, at 3-4; Donostia Ventures
Letter, supra note 9, at 3-4.
\348\ See Donostia Ventures Letter, supra note 9, at 3-4.
\349\ See id.
\350\ See C. Ross Letter, supra note 6.
---------------------------------------------------------------------------
The Sponsor asserts that its methodology for calculating the
Bitwise Real-Time Bitcoin Price, which will be the basis for the
Trust's IIV, is similar to the approach used for the NAV, but brought
into real time.\351\ The Sponsor argues that the use of ten platforms
to calculate the Bitwise Real-Time Bitcoin Price mitigates against
idiosyncratic platform risk and against pricing disruptions at an
individual platform due to a halt, hacking, or data error.\352\ The
Sponsor also argues that the use of contributory weights based on the
trailing thirty-minute volume, rather than the last trade size or
volume over a short time period, protects against attempts to
manipulate the IIV by capturing more volume, while using the price of
the most recent trade on each platform ensures the timeliness of the
IIV.\353\ The Sponsor asserts that the use of a median price eliminates
the influence of outlier prices and the use of a volume-weighted median
protects against attempts to manipulate the price by executing multiple
low-dollar trades.\354\ According to the Sponsor, it expects the IIV
will closely track the globally integrated bitcoin price on the
[[Page 55404]]
selected platforms, but that the IIV may differ from the NAV due to the
IIV's use of real-time prices.\355\ The Sponsor asserts that this will
not create confusion in the marketplace, because Authorized
Participants are the only investors that interact with the NAV and the
Sponsor will communicate clearly its NAV calculation method.\356\
---------------------------------------------------------------------------
\351\ See Bitwise Submission I, supra note 6, at 174-181. The
Commission notes that the Sponsor uses the terminology ``Indicative
Index Value'' in Bitwise Submission I, but the terminology ``Bitwise
Real-Time Bitcoin Price'' in other places. For consistency, in this
Order the Commission will refer to this price as the ``Bitwise Real-
Time Bitcoin Price.''
\352\ See id. at 176.
\353\ See id. at 177-178.
\354\ See id. at 179.
\355\ See id. at 180-181.
\356\ See id. at 181. The Sponsor represents that there are many
instances in the ETP market where the IIV and NAV differ due to the
calculation methodology, market hours overlap, or other factors, and
the Sponsor does not observe negative impacts on trading, liquidity,
or otherwise for these ETFs. See id. The Sponsor further represents
that the CME bitcoin futures market similarly relies on and
distributes a Reference Rate (comparable to the NAV) and a Real-Time
Rate (similar to the IIV), and the market is able to understand and
evaluate the differences between these two rates. See id.
---------------------------------------------------------------------------
One commenter states that an inaccurate NAV will break the
arbitrage mechanism because redemptions are made based on NAV.\357\
According to this commenter, while most ETPs have NAVs that are
calculated once per day, the bitcoin market is so volatile that intra-
day NAV measures are required for an ETP with bitcoin as the underlying
asset.\358\ This commenter also represents that non-concurrent trading
hours between digital asset platforms and the ETP market may increase
the gap between the ETP price and the NAV.\359\
---------------------------------------------------------------------------
\357\ See Shenoy Letter III, supra note 69, at 6.
\358\ See id.
\359\ See id. at 6-7.
---------------------------------------------------------------------------
The Sponsor argues that the exclusive use of in-kind creations,
redemptions, and fee accruals (except in the case of liquidation)
provides long-term investors in the Trust with significant, redundant,
and strong protection against attempts to manipulate the Bitwise Daily
Bitcoin Reference Price and thus the NAV.\360\ According to the
Sponsor, denominating those transactions exclusively in bitcoin ensures
that the Trust would maintain the appropriate amount of bitcoin-per-
Share, even if the NAV or the Bitwise Daily Bitcoin Reference Price
were manipulated.\361\ The Sponsor also asserts that exclusive use of
in-kind creations and redemptions externalizes the cost and risk of
transacting in the underlying spot market for bitcoin.\362\
---------------------------------------------------------------------------
\360\ See Notice and OIP, supra note 7, 84 FR at 23132-33;
Bitwise Submission I, supra note 6, at 103-104 (citing letter from
Jeffrey Yass, Managing Director, Susquehanna International Group,
LLP (May 15, 2017), regarding SR-BatsBZX-2016-30 (``Susquehanna
Letter''), available at https://www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx201630-1761310-152159.pdf, for additional explanation
of the protective benefits of in-kind creations and redemptions). A
commenter on a previous bitcoin ETP proposal asserts that in-kind
creation and redemption allows market participants to source primary
market liquidity freely and at the most efficiently priced levels
across multiple platforms and OTC counterparties, thus largely
insulating investors from manipulative activity on any single
platform. See Susquehanna Letter, id. at 6.
\361\ See Notice and OIP, supra note 7, 84 FR at 23133; Bitwise
Submission III, supra note 9, at 13.
\362\ See Bitwise Submission III, supra note 9, at 13.
---------------------------------------------------------------------------
One commenter supports the Sponsor's assertions and argues that
processing all creations and redemptions in-kind and requiring payment
of the Trust's expenses exclusively in bitcoin would ``cause[ ] the
fund to exist in a `bitcoin-denominated world,' where even grotesque
manipulation of the Trust's NAV would not harm holders of the fund.''
\363\ This commenter represents that the current proposal is unique in
promising to accrue all fees in bitcoin, in addition to exclusively
using in-kind creations and redemptions, meaning that the Trust's
entire economic life would be denominated in bitcoin and the Trust
would insulate investors from the potential negative long-term impact
of NAV manipulation.\364\ In addition, this commenter asserts that
investors on the secondary market would ignore an incorrect NAV and
instead focus price discovery efforts on the proposed ETP itself.\365\
---------------------------------------------------------------------------
\363\ Donostia Ventures Letter, supra note 9, at 2. See also
Castle Island Ventures Letter, supra note 9, at 3 (asserting that
the exclusive use of in-kind creations and redemptions, and accrual
of all fees in-kind, provides significant protections to investors
against an attempt to manipulate the NAV, and citing the Donostia
Ventures Letter for further articulation of the reasons).
\364\ See Donostia Ventures Letter, supra note 9, at 3.
\365\ See id. at 3-4. Another commenter questions this
assertion, asks how an investor would know the actual price of
bitcoin, and disputes that market participants are always rational.
See Robert Letter, supra note 9. This commenter also questions
whether traders on the CME bitcoin futures market who own bitcoin on
the spot market could be actively involved in price manipulation
through mechanisms available on CME and simultaneous trading across
global platforms. See Robert Letter, supra note 9.
---------------------------------------------------------------------------
The Sponsor asserts that it does not anticipate a situation in
which it would need to fair-value bitcoin, because the loss of one,
two, or even many platforms would still leave the Sponsor with
sufficient pricing feeds to adequately price bitcoin according to its
rules.\366\ According to the Sponsor, in the extraordinarily unlikely
event that all, or all but one, of the platforms stopped providing
prices, the Sponsor's pricing procedures allow for fair valuing the
asset based on all available pricing inputs, which would likely include
prices on the remaining platform (if one exists), futures prices,
exchange-traded swap prices, or other sources.\367\ The Sponsor asserts
that it could also temporarily halt creations and redemptions in such
circumstances.\368\
---------------------------------------------------------------------------
\366\ See Bitwise Submission I, supra note 6, at 212.
\367\ See id.
\368\ See id. The Sponsor represents that, in the past, other
ETPs have halted creation and redemption activity due to fundamental
disruptions of their underlying markets, such as was the case for
the Van Eck Vectors Egypt Index ETF during the spring of 2014, when
the Egyptian stock market closed for multiple days. See id.
---------------------------------------------------------------------------
(ii) Analysis
The Commission concludes that NYSE Arca has not demonstrated that
additional features of the Trust, including its NAV and IIV pricing and
its use of in-kind creations, redemptions, and accrual of fees, would
make the proposed ETP uniquely resistant to manipulation. Specifically,
NYSE Arca has not demonstrated that the design of the Bitwise Daily
Bitcoin Reference Price, and the Trust's NAV, would make the proposed
ETP uniquely resistant to manipulation. The Trust's Registration
Statement acknowledges risks associated with the Bitwise Daily Bitcoin
Reference Price--specifically, that the Bitwise Daily Bitcoin Reference
Price ``was recently developed,'' ``has a limited history,'' and ``is
based on a new and untested calculation methodology.'' \369\ NYSE Arca
and the Sponsor do not address these representations in the
Registration Statement or why a new and untested pricing methodology
could be counted upon to provide unique resistance to manipulation. As
discussed elsewhere, the Trust's Registration Statement also
acknowledges that bitcoin spot platforms are ``relatively new, and in
some cases, largely unregulated,'' and that the bitcoin futures market
has ``limited trading history and operational experience.'' \370\ The
Sponsor has made sweeping claims that up to 95% of the volume reported
by bitcoin platforms is wash trading or simply fabricated, while asking
the Commission to approve a bitcoin ETP based upon a small segment of
the market that it asserts is uniquely resistant to the influence of
this activity.\371\ These untested claims, when combined with
statements regarding the relatively new state of the bitcoin market and
the proposed ETP's pricing mechanism, show that further
[[Page 55405]]
development of the market is needed to establish the Sponsor's
representations.
---------------------------------------------------------------------------
\369\ See Registration Statement, supra note 31, at 6, 9-10
(stating that the Sponsor ``does not guarantee the validity of any
of these [pricing] inputs, which may be subject to technological
error, manipulative activity, or fraudulent reporting from their
initial source''). The Trust's Registration Statement contains
similar stated risks for the Bitwise Real-Time Bitcoin Price, which
the Trust would use to calculate the IIV. See id. at 10.
\370\ See supra note 123 and accompanying text; infra note 465
and accompanying text.
\371\ See supra Section III.B.1(c).
---------------------------------------------------------------------------
In addition, the Sponsor's use of the Bitwise Crypto Index
Committee to remove platforms facing a disruption from the Trust's
pricing mechanism, such as what occurred with the removal of
Bitfinex,\372\ is an ad hoc, ex post adjustment and cannot be counted
upon to provide unique resistance to manipulation. Moreover, the
Sponsor's assertion that--after the court order against Bitfinex's
operator--fraudulent printing of a stablecoin asset in the future is
extremely unlikely, is unpersuasive.\373\ The Commission does not
believe that the deterrent value, if any, of past accusations of fraud
involving stablecoins on future stablecoin schemes is sufficient to
show resistance, let alone unique resistance, to manipulation.
Additionally, even assuming that the designed lag time between the
strike time of the NAV and the time of NAV distribution may allow a
limited period of time for the Sponsor to review for and correct some
anomalous behavior before the NAV is distributed, this ad hoc process
cannot be relied upon as a sufficient antidote to fraud and
manipulation on the underlying platforms, especially sustained
manipulation, and is no substitute for a comprehensive surveillance-
sharing agreement.\374\
---------------------------------------------------------------------------
\372\ See supra notes 331-334 and accompanying text.
\373\ See supra note 335 and accompanying text.
\374\ See supra note 344 and accompanying text. The Sponsor also
describes that in certain circumstances it could fair-value bitcoin
or temporarily halt creations and redemptions, see supra notes 366-
368 and accompanying text, but does not assert that these
characteristics would make the Trust uniquely resistant to
manipulation.
---------------------------------------------------------------------------
Further, the record does not demonstrate that the Sponsor's
proposed methodology for calculating the Bitwise Daily Bitcoin
Reference Price, and thus the Trust's NAV, using prices and volumes
from the selected platforms would make the proposed ETP uniquely
resistant to manipulation. As discussed above, NYSE Arca and the
Sponsor have not shown that fake or non-economic volume in the spot
market would not affect prices on the selected platforms used to
calculate the Bitwise Daily Bitcoin Reference Price, including
prolonged effects.\375\ Moreover, NYSE Arca and the Sponsor have not
shown that other parts of the spot market, including OTC trading, and
trading in capital-controlled countries, would not affect the prices on
the selected platforms.\376\ To the extent that trading on platforms
not used to calculate the Bitwise Daily Bitcoin Reference Price affects
prices on the selected platforms, the characteristics of those other
platforms affect whether the Trust is uniquely resistant to
manipulation. While the proposed procedures for calculating the Trust's
NAV using prices from the selected platforms might provide some
protections against attempts at manipulation,\377\ these procedures
would not sufficiently reduce the risk of fraudulent or manipulative
trading activity or the need to monitor this risk through a
surveillance-sharing agreement with a regulated market of significant
size. In particular, the Sponsor has not shown that its proposed use of
six consecutive five-minute segments over a thirty-minute period to
calculate the Trust's NAV would effectively be able to eliminate
fraudulent or manipulative activity that is not transient.\378\ The
Sponsor does not connect the five or thirty minute windows to the
duration of the effects of the wash and fictitious trading that the
Sponsor concedes exists in the bitcoin spot market. Indeed, the Sponsor
recognizes that many bitcoin trading platforms in what it calls the
``fake and non-economic'' bitcoin market engage in sustained
manipulation every hour of every day, and often for the entire week the
Sponsor examined.\379\ Because the Sponsor concedes that bitcoin
trading platforms with ``fake and non-economic'' trading manipulate
their prices every hour of every day, and the Commission has concluded
that the Sponsor has failed to isolate the pricing on these ``fake''
platforms that the Sponsor eschews and the ``real'' platforms that the
Sponsor employs, the Commission concludes that the Sponsor has not
demonstrated that its NAV pricing--including its use of five and thirty
minute windows--make the proposed ETP uniquely resistant to
manipulation.
---------------------------------------------------------------------------
\375\ See supra notes 276-287 and accompanying text.
\376\ See supra Section III.B.1(c).
\377\ See supra notes 339-343 and accompanying text.
\378\ See supra note 340 and accompanying text.
\379\ See Bitwise Submission I, supra note 6, at 43-50, 52, 54-
57; Bitwise Submission II, supra note 9, at 28-29, 33-34. While the
Sponsor's own analysis of wash trading sufficiently demonstrates
that fraud or manipulation of bitcoin spot pricing could exceed
thirty minutes, evidence of other types of fraud and manipulation
provide additional support. See supra notes 69-73, 138, 140-145,
331. See also Winklevoss Order, supra note 12, 83 FR at 37585
(discussing an academic paper concluding that hacking and
manipulation of the Mt. Gox bitcoin trading platform affected the
global price of bitcoin between April 2011 and November 2013),
37586-87 (stating that a person or persons with a dominant position
in bitcoin would be able to hold that position for longer than
thirty minutes and that ``early bitcoin adopters'' have held such a
position for a much longer period), 37585-86 (noting an academic
paper, the ``Griffin-Shams Paper,'' suggesting that the price of
bitcoin was manipulated with Tether from March 1, 2017, to March 31,
2018); Affirmation of Brian M. Whitehurst in Support of OAG's Ex
Parte Application for an Order Pursuant to General Business Law
Sec. 354, James v. iFinex, Inc., et al., No. 450545/2019, 2019 WL
2176835 (N.Y. Sup. Ct. Apr. 25, 2019), Doc. No. 1, at paras. 48-93
(describing allegedly improper conduct over the course of many
months involving Bitfinex). Regarding the academic findings that the
price of bitcoin was manipulated with Tether, the Sponsor contends
that these ``findings unwind if you assume that all (or even most)
of the growth in issuance of Tether . . . reflects organic demand,''
but the Sponsor does not offer any support for such an assumption.
Bitwise Submission III, supra note 9, at 47. Instead, the Sponsor
claims that allegations in the NYAG investigation, see supra note
331, do not in and of themselves ``suggest that the Tether issuance
was fraudulent or reflected anything other than organic investor
demand,'' and therefore, ``while worrisome, do not support the
accusations in the Griffin-Shams paper at this time,'' but nothing
in the NYAG action casts any doubt on the conclusion that the price
of bitcoin is susceptible to manipulation through activity on
bitcoin trading venues. See Winklevoss Order, supra note 12, 83 FR
at 37585-86.
---------------------------------------------------------------------------
Moreover, the Sponsor's identification of differences between the
NAV process for another proposed bitcoin ETP and the NAV process for
the current proposal does not establish that the Sponsor's proposed NAV
process would make the Trust uniquely resistant to manipulation.\380\
In addition, these concerns about the Sponsor's process for calculating
the NAV would apply to the IIV, which would be calculated using a
similar process, and the Commission notes that publishing the IIV every
fifteen seconds would not ameliorate the risk of manipulation if the
underlying pricing mechanism is not demonstrably resistant to
manipulation.\381\
---------------------------------------------------------------------------
\380\ See supra note 345 and accompanying text. The Commission
notes that, in the Winklevoss Order, the Commission raised concerns
based on the relative size of the volume of the auction that would
serve as the basis for the pricing mechanism as compared to the size
of the creation or redemption basket. See Winklevoss Order, supra
note 12, 83 FR at 37589-90. While the Sponsor and a commenter
provide comparative information about the liquidity of the Trust's
proposed pricing mechanism (see supra notes 345-346 and accompanying
text), the Commission concludes that this is not a relevant
comparison because the Commission does not use the liquidity of the
platforms selected for the Trust's pricing mechanism as a basis for
its current decision.
\381\ See supra notes 351-356 and accompanying text.
---------------------------------------------------------------------------
Because, as discussed above, the Sponsor has not established that
its research identified those platforms in the spot market with
``real'' trading volume,\382\ NYSE Arca and the Sponsor have also
failed to demonstrate that the Bitwise Daily Bitcoin Reference Price
would draw prices from selected platforms that represent
``substantially all'' of the economically significant spot trading
volume, outside of capital-
[[Page 55406]]
controlled countries.\383\ The Sponsor acknowledges that there is some
additional real volume to be found on other platforms, but simply
asserts that any adjustments to account for such additional real volume
would not materially change the Sponsor's conclusions.\384\ In
addition, in response to a law enforcement action by the NYAG, the
Sponsor removed the second largest ``real'' bitcoin platform from the
calculation of the Bitwise Daily Bitcoin Reference Price--Bitfinex, at
purportedly 14.1% of the ``real'' market in April 2019--but provides
only a cursory and insufficient analysis to support its assertion that
this removal does not meaningfully impact the Bitwise Daily Bitcoin
Reference Price.\385\ The Sponsor asserts that Bitfinex's average
deviation from the consolidated price falls ``comfortably in the
middle'' of the average deviation from the consolidated price for each
of the ten identified ``real'' platforms,\386\ but does not, for
example, provide any data about how this might translate to any price
difference in the Bitwise Daily Bitcoin Reference Price if calculated
with and without Bitfinex. The Sponsor asserts that there are
diminishing returns to the value of each additional platform in
protecting against idiosyncratic platform risk.\387\ But the Sponsor
does not adequately address the effect of the reliance on less of the
``real'' volume in the spot market to support the Trust's pricing
mechanism, including the impact of removal of this segment of ``real''
volume from the Trust's pricing mechanism on the Sponsor's assertion
that any attempt to manipulate the NAV must involve a majority of spot
bitcoin trading volume.\388\
---------------------------------------------------------------------------
\382\ See supra Section III.B.1(c).
\383\ See supra notes 319-338 and accompanying text.
\384\ See supra notes 242-253 and accompanying text.
\385\ See supra notes 331-338 and accompanying text. The
Commission notes that Amendment No. 1 states throughout that the
Trust's pricing mechanism will be based on ten platforms and that
these ten platforms represent substantially all of the ``real'' spot
market for bitcoin, and contains only one reference in a footnote to
the removal of Bitfinex and reduction in the number of platforms
contributing to the Bitwise Daily Bitcoin Reference Price from ten
to nine. See Notice and OIP, supra note 7, 84 FR at 23130 n.20. In
addition, the Sponsor's submission detailing its analysis of the
bitcoin spot market does not mention the removal of Bitfinex from
the Trust's pricing mechanism. See Bitwise Submission II, supra note
9. The Commission does not believe that the Sponsor has fully
explained the impact of removing Bitfinex on many of its
representations and assertions.
\386\ See supra note 337 and accompanying text.
\387\ See supra note 338 and accompanying text.
\388\ See supra note 317 and accompanying text.
---------------------------------------------------------------------------
In addition, while the Sponsor describes at length the analysis
that it conducted to identify spot platforms with real volume, NYSE
Arca and the Sponsor have not established that the Bitwise Daily
Bitcoin Reference Price would continue to rely on those platforms that
the Sponsor identifies (or might in the future identify) as
representing substantially all of the ``real'' spot trading volume. The
Sponsor acknowledges that the number of platforms used to construct the
Bitwise Daily Bitcoin Reference Price and the percentage of global
volume that they represent is subject to change.\389\
---------------------------------------------------------------------------
\389\ See supra note 326 and accompanying text.
---------------------------------------------------------------------------
Moreover, the methodology the Sponsor uses to select the platforms
from which it draws the Bitwise Daily Bitcoin Reference Price differs
from the methodology it uses for the analysis that purports to identify
those spot platforms with real volume.\390\ For example, one factor for
eliminating platforms from the Trust's pricing mechanism is whether the
platform is domiciled in an emerging market country,\391\ but the
Sponsor does not articulate this factor as a basis for considering a
platform's volume not to be ``real.'' While the Sponsor has currently
identified the same ten platforms for inclusion in the Bitwise Daily
Bitcoin Reference Price as it designated as ``real'' during the course
of its described analysis--before removing one platform due to a state
law enforcement action--the current overlap does not demonstrate that
the methodologies would generate the same results. And the Sponsor has
not explained how--if the differing methodologies identify different
sets of bitcoin platforms in the future--such divergences would affect
its representations that the Bitwise Daily Bitcoin Reference Price is
based on platforms that represent substantially all of the ``real''
spot trading volume.
---------------------------------------------------------------------------
\390\ Compare supra notes 321-325 and accompanying text with
supra notes 199-200, 211-228 and accompanying text.
\391\ See supra note 323 and accompanying text.
---------------------------------------------------------------------------
Finally, the record does not demonstrate that in-kind creations and
redemptions, or the decision to accrue the Trust's fees exclusively in
bitcoin, would provide unique resistance to manipulation.\392\ In-kind
creations and redemptions are a common feature of ETPs, and the
Commission has not excused exchanges that list ETPs that rely on this
mechanism from the need to enter into surveillance-sharing agreements
with regulated markets related to the portfolios assets.\393\ Further,
the accrual of the Trust's fees in bitcoin does not protect buyers and
sellers of the Shares in the secondary market, because these secondary
market participants will not trade at NAV but at market-based
prices.\394\ Moreover, the Trust's Registration Statement recognizes
the risk that disruptions at bitcoin trading platforms ``could
adversely affect the availability of bitcoin and the ability of
Authorized Participants to purchase or sell bitcoin and therefore their
ability to create and redeem shares of the Trust.'' \395\
---------------------------------------------------------------------------
\392\ See supra notes 360-362 and accompanying text. See also
supra notes 363-365 and accompanying text.
\393\ 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).
\394\ The Sponsor emphasizes that, at most, only ``shareholders
[of the Trust] would be protected'' by in-kind creations and
redemptions. Bitwise Submission III, supra note 9, at 13. See also
Registration Statement, supra note 31, at 28 (in-kind creation and
redemptions protect ``shareholders of the Trust'').
\395\ Registration Statement, supra note 31, at 6.
---------------------------------------------------------------------------
Therefore the Commission concludes that the record does not
establish that features of the Trust would make the Trust's NAV or the
proposed ETP uniquely resistant to manipulation.
2. Assertions That Other Means Are Available To Detect and Deter Fraud
and Manipulation
(a) Comment Received
One commenter asserts that NYSE Arca's rules are designed to
prevent fraudulent and manipulative acts and practices, because trading
in the Shares would be subject to rules governing equity securities
that are aimed at preventing fraud and manipulation.\396\ This
commenter represents that such rules include regulations addressing
initial and continued listing standards, restrictions on market maker
accounts, trading halt procedures, and trading surveillance.\397\ With
respect to surveillance, the commenter states that trading in the
Shares will be subject to trading surveillances by NYSE Arca, and the
Financial Industry Regulatory Authority (``FINRA'') on NYSE Arca's
behalf, and that NYSE Arca and FINRA can communicate with Intermarket
Surveillance Group members and obtain information regarding trading in
the Shares and underlying bitcoin from NYSE Arca members registered as
market makers.\398\ This commenter further asserts that NYSE Arca can
obtain trading surveillance from a
[[Page 55407]]
regulated bitcoin futures market of significant size.\399\
---------------------------------------------------------------------------
\396\ See Omniex Letter, supra note 9, at 3.
\397\ See id.
\398\ See id. See also Notice and OIP, supra note 7, 84 FR at
23135.
\399\ See Omniex Letter, supra note 9, at 3-4.
---------------------------------------------------------------------------
(b) Analysis
The Commission finds that, although one commenter raises aspects of
NYSE Arca's existing rules that it asserts might provide other means to
prevent fraud and manipulation,\400\ these alternative procedures would
not, without a surveillance-sharing agreement with a regulated market
of significant size, be sufficient to satisfy the requirement of
Exchange Act Section 6(b)(5) that an exchange's rules be designed to
prevent fraudulent and manipulative acts and practices.\401\ In the
Winklevoss Order, the Commission considered an assertion by the listing
exchange that its surveillance procedures, which included pre-existing
procedures, information available from the Bitcoin blockchain, and a
surveillance-sharing agreement with a spot bitcoin platform, would
provide ``traditional means'' of preventing fraud and manipulation,
sufficient to prevent fraudulent and manipulative acts and
practices.\402\ The Commission found that the listing exchange had not
demonstrated that the alternative surveillance procedures would be, by
themselves, sufficient to satisfy Exchange Act Section 6(b)(5).\403\
---------------------------------------------------------------------------
\400\ See supra notes 396-399 and accompanying text.
\401\ See 15 U.S.C. 78f(b)(5). See infra Section 0 for further
discussion about whether NYSE Arca's surveillance-sharing agreement
with the bitcoin futures market is with a regulated market of
significant size.
\402\ See Winklevoss Order, supra note 12, 83 FR at 37590-91.
\403\ See id. at 37591.
---------------------------------------------------------------------------
Here, as in the Winklevoss Order, while NYSE Arca would, pursuant
to its listing rules, be able to obtain certain information regarding
trading in the Shares and in the underlying bitcoin or any bitcoin
derivative through registered market makers,\404\ this trade
information would be limited to the activities of members who were
registered with NYSE Arca as market makers in the Shares and would not
encompass all NYSE Arca market participants.\405\ Furthermore, as in
the Winklevoss Order, neither NYSE Arca's ability to surveil trading in
the Shares nor its ability to share information with other securities
exchanges trading the Shares would give NYSE Arca insight into the
activity and identity of market participants trading in the underlying
bitcoin in the OTC market or on other bitcoin trading platforms.\406\
Additionally, while the commenter asserts that NYSE Arca rules
addressing initial and continued listing standards and trading halt
procedures also are aimed at preventing fraud and manipulation,\407\
these aspects of NYSE Arca's rules, on their own, would not be
sufficient to detect, investigate, or prevent fraudulent and
manipulative acts and practices. The Commission finds that the argument
raised by the commenter that NYSE Arca's rules would prevent fraud and
manipulation are essentially the same as those arguments made by the
listing exchange in the Winklevoss Order, and therefore the Commission
must reach the same conclusion that the alternative surveillance
procedures raised by the commenter are not sufficient, by themselves,
to satisfy Exchange Act Section 6(b)(5).\408\
---------------------------------------------------------------------------
\404\ See supra note 398 and accompanying text.
\405\ See Winklevoss Order, supra note 12, 83 FR at 37591.
\406\ See supra note 398 and accompanying text. See also
Winklevoss Order, supra note 12, 83 FR at 37591.
\407\ See supra note 396-397 and accompanying text.
\408\ See Winklevoss Order, supra note 12, 83 FR at 37591.
---------------------------------------------------------------------------
3. Assertions That NYSE Arca Has Entered Into a Surveillance-Sharing
Agreement With a Regulated Market of Significant Size Related to
Bitcoin
(a) Representations Made and Comments Received
The Sponsor asserts that, in light of its understanding of the
small size of the ``real'' bitcoin spot market, the bitcoin futures
market represents a large, surveilled, and regulated market, as the
Commission has defined that requirement.\409\ The Sponsor further
asserts that, given the significant size of the bitcoin futures market,
and the close relationship in prices between the derivatives market and
the spot market, there is a reasonable likelihood that a person
attempting to manipulate the proposed ETP would have to trade on that
market to successfully manipulate the proposed ETP, because arbitrage
between the derivative and spot markets would tend to counter an
attempt to manipulate the spot market alone.\410\ According to the
Sponsor, NYSE Arca's ability to obtain information regarding trading in
the Shares and futures from markets and other entities that are members
of the Intermarket Surveillance Group, which includes CME (and CFE),
would assist NYSE Arca in detecting and deterring misconduct.\411\
---------------------------------------------------------------------------
\409\ See Notice and OIP, supra note 7, 84 FR at 23134. In this
context, the Sponsor refers to the bitcoin futures market as
consisting of the market for cash-settled bitcoin futures contracts
on CFE and CME. See Bitwise Submission II, supra note 9, at 56. As
noted above, CFE ceased offering new bitcoin futures contracts as of
March 2019, see supra note 38, and therefore the Commission
considers here whether CME bitcoin futures market is a regulated
market of significant size. See infra note 457.
\410\ See Notice and OIP, supra note 7, 84 FR at 23134.
\411\ See id. See also Omniex Letter, supra note 9, at 5
(asserting that NYSE Arca would have the ability itself to obtain
information regarding trading in the Shares and could obtain
information regarding futures trading from CME as a member of
Intermarket Surveillance Group); Collaborative Funds Letter, supra
note 9, at 2 (asserting that NYSE Arca's surveillance agreement with
CME and CFE satisfies the concerns in the Winklevoss Order regarding
mitigation of market manipulation). But see Ahn Letter II, supra
note 9 (questioning the presumption that the bitcoin futures market
is regulated because, according to the commenter, the bitcoin
futures market does not contain all the regulatory features that the
Commission requires in the context of a surveillance-sharing
agreement).
---------------------------------------------------------------------------
The Sponsor asserts that its assessment that the CME bitcoin
futures market is significant is based on its understanding of the true
size of the bitcoin spot market, which, according to the Sponsor, is
significantly smaller than commonly understood, as well as on the
recent and significant growth in trading volume on the CME bitcoin
futures exchange.\412\ The Sponsor argues that, while the bitcoin
futures market volume appears to be small in comparison to the reported
spot bitcoin volume, it looks ``much more important'' in comparison to
the ``real'' bitcoin spot market.\413\ In particular, the Sponsor
represents that the combined average daily volume for the CME and CFE
futures markets in April 2019 was $268 million, which is 2.4% of
April's reported spot market volume (approximately $11 billion), but
48.4% of the Sponsor's calculated ``real'' spot market volume
(approximately $554 million).\414\ The Sponsor asserts that in April
2019, the average daily volume on the CME of $258 million was larger
than that of any of the ten identified ``real'' spot bitcoin platforms,
ahead of Binance and more than twice as large as Bitfinex.\415\ The
Sponsor also asserts that the bitcoin futures market compares similarly
to the ``real'' bitcoin spot
[[Page 55408]]
market in surrounding months.\416\ According to the Sponsor, while the
bitcoin futures market ``would clearly not satisfy'' the requirement
that someone attempting to manipulate the spot market would be
reasonably likely to have to trade in the derivatives market if the
bitcoin spot market were trading $11 billion per day, the Sponsor's
``new understanding of the true size of the bitcoin spot market
reshapes this discussion considerably.'' \417\
---------------------------------------------------------------------------
\412\ See Bitwise Submission III, supra note 9, at 97.
\413\ See Bitwise Submission II, supra note 9, at 57; Bitwise
Submission III, supra note 9, at 11.
\414\ See Bitwise Submission II, supra note 9, at 57; Bitwise
Submission III, supra note 9, at 11. The Sponsor also asserts that
in April 2019, the CME futures contract traded an average daily
volume of over 67,000 bitcoin (on a notional basis), while
coinmarketcap.com reported an average daily volume of over 2.2
million bitcoin, but the ``real'' average daily spot volume was
roughly 108,000 bitcoin. See Bitwise Submission III, supra note 9,
at 155.
\415\ See Bitwise Submission II, supra note 9, at 58; Bitwise
Submission III, supra note 9, at 11.
\416\ The Sponsor asserts that at the time of its first
analysis, in March 2019, the average daily volume of the bitcoin
futures market was $91 million, as compared to reported daily volume
in the spot market of approximately $6 billion and ``real'' daily
volume in the spot market of around $273 million. See Notice and
OIP, supra note 7, 84 FR at 23134; Bitwise Submission I, supra note
6, at 121. The Sponsor further asserts that bitcoin futures market
average daily volume in March 2019 was nearly as large as the
average daily volume for the largest ``real'' spot platform,
Binance, and larger than the rest. See Notice and OIP, supra note 7,
84 FR at 23134; Bitwise Submission I, supra note 6, at 65, 123. The
Sponsor has graphed futures volume as expressed as a percentage of
``real'' spot volume from December 2017 through February 2019 and
asserts that this chart shows an increase to approximately 35% in
February 2019. See Bitwise Submission I, supra note 6, at 122. The
Sponsor asserts that, while in earlier periods bitcoin futures
volume was consistently less than 10% the size of ``real'' spot
volume, since February 2019, bitcoin futures volume has consistently
averaged more than 25% as a percentage of ``real'' spot volume, and
was more than 50% of ``real'' spot volume in May 2019. See Bitwise
Submission III, supra note 9, at 157, 159. The Sponsor also asserts
that in May 2019, the CME bitcoin futures market had a higher
average daily trading volume than any of the ten ``real'' bitcoin
spot platforms and set new average daily trading volume records. See
Bitwise Submission IV, supra note 9, at 5. In addition, the Sponsor
asserts that in August 2019, the average daily volume of the bitcoin
futures market was $234 million, as compared to reported daily
volume in the spot market of approximately $17 billion and ``real''
daily volume in the spot market of around $1 billion. See Bitwise
Submission VI, supra note 9, at 29. See also id. at 25 (showing
aggregate average daily volume of the ten ``real'' spot bitcoin
platforms from December 2017 through August 2019 and asserting that,
since March 2019, volume has increased substantially).
\417\ Bitwise Submission II, supra note 9, at 59.
---------------------------------------------------------------------------
In addition, the Sponsor asserts that, since the CME and CFE
contracts launched in December 2017, the volume and significance of
bitcoin futures contracts has grown substantially, with the vast
majority of the volume linked to CME's contract.\418\ The Sponsor
represents that, from December 2017 to April 2019, the combined average
daily notional volume of CME and CFE bitcoin futures grew from 9,286
bitcoin to 69,177 bitcoin, showing a growth of 645%.\419\ The Sponsor
asserts that, while CME's bitcoin futures notional volume in dollars
has shown some variability, and declined along with a decline in prices
in late 2018, volumes have strongly picked up in 2019.\420\ The Sponsor
also asserts that CME's bitcoin futures notional volume in bitcoin
shows strong and steady growth, with a ``remarkable'' expansion in
2019.\421\ The Sponsor further asserts that CME bitcoin futures
notional volume as a percentage of ``real'' bitcoin spot volume has
been strong and steadily growing, with further acceleration in April
and May 2019.\422\
---------------------------------------------------------------------------
\418\ See id. at 56, 58-59; Bitwise Submission III, supra note
9, at 11.
\419\ See Bitwise Submission II, supra note 9, at 56. See also
Bitwise Submission III, supra note 9, at 155 (asserting that in
April 2019, the CME futures contract traded an average daily volume
of more than 67,000 bitcoin on a notional basis, representing a
roughly 630% increase over the median daily notional trading volume
on CME since inception). The Sponsor also has graphed the average
number of futures contracts traded daily and regulated bitcoin
futures volume as a percentage of ``real'' bitcoin spot volume from
December 2017 through May 2019. See Bitwise Submission II, supra
note 9, at 56, 59.
\420\ See Bitwise Submission II, supra note 9, at 74-75. The
Sponsor represents that in the first 20 days of May 2019, the
average daily volume for CME futures contracts was $517 million, the
highest level ever for a month, and dollar volume hit an all-time
high on May 13, 2019, with $1.3 billion in notional volume traded
and a record of 33,677 bitcoin contracts traded. See id. at 74;
Bitwise Submission III, supra note 9, at 11. The Sponsor has graphed
CME average daily volume in USD to provide more detail on this
trend. See Bitwise Submission II, supra note 9, at 75; Bitwise
Submission VI, supra note 9, at 26. In addition, the Sponsor
represents that the average daily volume for CME futures contracts
in August 2019 was $234,385,300 and that the volume ``increased
substantially'' since March 2019. See Bitwise Submission VI, supra
note 9, at 9, 26.
\421\ See Bitwise Submission II, supra note 9, at 75-76. The
Sponsor has graphed CME average daily volume in bitcoin. See id. at
76.
\422\ See id. at 76-77. The Sponsor represents that in April and
May 2019, volumes on the CME bitcoin futures market often exceeded
those on the largest ``real'' spot platform, and sometimes
significantly. See id. at 77. According to the Sponsor, on May 13,
2019, CME volumes, at $1.3 billion, were two times as large as the
largest spot bitcoin platform, Binance, at approximately $650
million. See id.; Bitwise Submission III, supra note 9, at 11. The
Sponsor has graphed CME bitcoin futures volume as a percentage of
``real'' bitcoin spot volume. See Bitwise Submission II, supra note
9, at 77; Bitwise Submission VI, supra note 9, at 9, 28.
---------------------------------------------------------------------------
With respect to CFE's decision in March 2019 to stop further
issuance of its bitcoin futures, the Sponsor asserts that the consensus
is that the limited volume on CFE will migrate to the already dominant
CME contract.\423\ The Sponsor argues that CFE's decision to stop
offering new bitcoin futures contracts suggests that CFE lost a
competitive battle with CME to attract investors and traders to its
contract, and does not suggest anything about the long-term health of
the bitcoin futures market, noting that, after CFE's announcement, CME
bitcoin futures volume set new monthly records in April and May
2019.\424\ The Sponsor also represents that it is common for futures
volumes to concentrate on a single contract and a single exchange
because there is an advantage to aggregating liquidity.\425\
---------------------------------------------------------------------------
\423\ See Bitwise Submission I, supra note 6, at 123; Bitwise
Submission II, supra note 9, at 74; Bitwise Submission IV, supra
note 9, at 4. The Sponsor asserts that the CME futures contract has
dominated the market and that, on May 13, 2019, the CME futures
contract traded at $1.2 billion in notional value, while the CFE
contract traded at $62 million in notional value. See Bitwise
Submission II, supra note 9, at 73-74. See also id. at 56
(representing that from December 2017 to April 2019, the CME futures
contract grew from 57% to 98% of the total regulated bitcoin futures
market); Bitwise Submission IV, supra note 9, at 3-4 (showing the
average daily trading volume in most active monthly contract for CME
and CFE, and discussing reasons why the CME contract became
dominant). In addition, the Sponsor asserts, based on a graph it has
prepared showing the average daily volume for CME and CFE bitcoin
futures from December 2017 through August 2019, that CFE's decision
to stop issuing its bitcoin futures has not diminished the trend of
increased bitcoin futures volume. See Bitwise Submission VI, supra
note 9, at 27.
\424\ See Bitwise Submission IV, supra note 9, at 4.
\425\ See id.
---------------------------------------------------------------------------
The Sponsor argues that prices on the bitcoin futures market are
closely aligned with the Bitwise Daily Bitcoin Reference Price and the
Bitwise Real-Time Bitcoin Price, and that strong arbitrage exists
between these prices.\426\ The Sponsor asserts that there is a logical
connection between the prices, because the CME futures settlement price
is based on prices pulled from four of the platforms that contribute to
the Bitwise Daily Bitcoin Reference Price and Bitwise Real-Time Bitcoin
Price, and the CFE futures settlement price is based on prices pulled
from one such platform.\427\ The Sponsor further asserts that its
analysis demonstrates that all ``real'' bitcoin spot markets trade
effectively at a single price, suggesting that the CME bitcoin futures
market must trade at a price tightly linked to the consolidated spot
price.\428\ The Sponsor acknowledges that the correlation between the
prices is limited by the term structure of the futures contract and the
asymmetric cost of hedging a futures position, because it is less
expensive to hedge a short position in bitcoin futures than a long
position in bitcoin futures.\429\
---------------------------------------------------------------------------
\426\ See Notice and OIP, supra note 7, 84 FR at 23134; Bitwise
Submission II, supra note 9, at 77-82.
\427\ See Notice and OIP, supra note 7, 84 FR at 23134; Bitwise
Submission I, supra note 6, at 124; Bitwise Submission II, supra
note 9, at 77.
\428\ See Bitwise Submission II, supra note 9, at 77.
\429\ See Notice and OIP, supra note 7, 84 FR at 23134.
---------------------------------------------------------------------------
[[Page 55409]]
The Sponsor asserts that there are low levels of average deviation
between the CME futures contract price and the consolidated spot
price.\430\ According to the Sponsor, a line graph comparing the CME
bitcoin futures contract price with the consolidated spot price from
January 2018 through May 2019 shows some ``minor discrepancies'' in
January to March 2018, but the Sponsor asserts that, following that
period, ``the two lines are virtually identical.'' \431\ The Sponsor
has also examined the average deviation of the price of the CME
contract and consolidated spot price on a second-by-second basis from
December 2017 through April 2019.\432\ The Sponsor asserts that in
December 2017, average deviations were nearly 2%, but then came down
substantially, largely hovering below 0.25%.\433\ According to the
Sponsor, these average deviations are similar to the 0.05% to 0.20%
average deviation for individual spot platforms over the same time
frame, with slightly wider deviations in the futures market that are to
be expected because of futures markets' term structure.\434\
---------------------------------------------------------------------------
\430\ See Bitwise Submission II, supra note 9, at 78-81.
\431\ See id. at 78. See also Bitwise Submission I, supra note
6, at 125 (providing a line graph of a global spot price as compared
to the CME futures price from 2018 through early March 2019 that,
according to the Sponsor, shows that arbitrage between the CME
futures price and global spot price is ``firmly established'').
\432\ See Bitwise Submission II, supra note 9, at 78-79.
\433\ See id. at 79.
\434\ See id.
---------------------------------------------------------------------------
The Sponsor represents that all futures markets exhibit contango,
when futures contracts trade at a higher price than the spot market,
and backwardation, when futures contracts trade at a lower price than
the spot market.\435\ According to the Sponsor, bitcoin futures have
traded essentially in-line with the spot market, without significant
contango or backwardation, but backwardation and contango have appeared
occasionally, with backwardation appearing much more frequently than
contango.\436\ The Sponsor asserts that the most significant periods of
backwardation in the bitcoin futures market occurred during pronounced
pullbacks in the bitcoin spot market.\437\ The Sponsor further asserts
that the level of backwardation in the bitcoin futures market is
strictly constrained by arbitrage, but that backwardation can emerge
and persist because the cost of borrowing bitcoin to short in the spot
market is relatively high.\438\ The Sponsor argues that the ``extremely
low'' average deviation between prices in normal months and rationally
constrained deviations during stress periods, such as November 2018,
suggests that institutional-quality arbitrageurs are enforcing strong
arbitrage between the CME futures market and the spot market at all
times.\439\
---------------------------------------------------------------------------
\435\ See id.
\436\ See id.
\437\ See id. The Sponsor represents that on November 14, 2018,
the bitcoin spot market fell from $6,200 to $5,500 over concerns
about a bitcoin cash fork and that this downward move and concerns
about bitcoin's outlook drove the futures market into backwardation,
which generally persisted through January 2019, when the bitcoin
market stabilized. See id. at 79-80. According to the Sponsor, the
average backwardation during this period was 0.74%, which explains
the higher average deviation between the CME futures price and spot
bitcoin price from November 2018 through January 2019, but the
average deviation settled back to below 0.25% as the term structure
of the futures market normalized. See id. at 80.
\438\ See id. at 80 (representing that the cost of borrowing
bitcoin to short historically ranges from 5% to 10% per year, or
0.4% to 0.8% per month, and that this monthly cost is directly in-
line with levels of observed backwardation in November 2018 through
January 2019).
\439\ See id. at 80-81.
---------------------------------------------------------------------------
The Sponsor asserts that the speed at which price discrepancies are
arbitraged away also demonstrates the quality of arbitrage between the
CME bitcoin futures price and bitcoin spot price.\440\ The Sponsor has
created a histogram displaying the speed at which pricing discrepancies
above 1% between the CME bitcoin futures price and consolidated bitcoin
spot price were arbitraged away.\441\ The Sponsor represents that these
data show that more than 50% of all pricing discrepancies greater than
1% were arbitraged away within 1 second, and that more than 90% of all
pricing discrepancies greater than 1% were arbitraged away within 49
seconds.\442\ According to the Sponsor, the results demonstrate that
the CME bitcoin futures price and the consolidated spot price trade
closely together and their disparities are rapidly arbitraged away,
meeting the Commission's criteria for demonstrating effective arbitrage
between markets.\443\
---------------------------------------------------------------------------
\440\ See id. at 81.
\441\ See id.
\442\ See id. (asserting that these data echo the data comparing
individual spot bitcoin platforms against one another).
\443\ See id.
---------------------------------------------------------------------------
Several commenters assert that the CME bitcoin futures market
constitutes a significant market.\444\ One commenter represents that
the bitcoin futures market is larger than those associated with other
ETPs that the Commission has previously approved, such as the palladium
futures market associated with the Aberdeen Standard Physical Palladium
Shares ETF, formerly known as ETFS Palladium Trust, and the freight
futures market associated with the Breakwave Dry Bulk Shipping
ETF.\445\ Another commenter states that the bitcoin futures market is
now large and robust, regularly trading over $100 million in daily
notional trading volume, and represents a material proportion of the
overall bitcoin market.\446\ A third commenter states that the bitcoin
futures market had low volumes until recently, although there has been
an increase in volume since April 2019, and that the size of the
bitcoin futures market pales in comparison to others futures
markets.\447\ This commenter asserts that the futures market has not
even completed one calendar year and so cannot be considered
mature.\448\
---------------------------------------------------------------------------
\444\ See Castle Island Ventures Letter, supra note 9, at 2;
Collaborative Fund Letter, supra note 9, at 1-2 (asserting that the
Sponsor's study identifying the ten platforms with ``real and
verifiable volume'' means that the CME futures market is of
significant size ``by nearly any definition''); Omniex Letter, supra
note 9, at 4-5 (asserting that the Sponsor's analysis shows CME's
bitcoin futures market is a large, surveilled, and regulated market,
when compared with the ``real'' bitcoin market, and that there is a
close relationship in pricing between the bitcoin futures market and
the spot market).
\445\ See Collaborative Fund Letter, supra note 9, at 2.
\446\ See Castle Island Ventures Letter, supra note 9, at 2.
\447\ See Shenoy Letter III, supra note 69, at 10.
\448\ See id.; see also id. at 13 (recommending a longitudinal
observation over a period of at least another cycle of the futures
market to observe the stability of the market and allow for the
emergence of genuine price discovery and reduction of opaqueness).
---------------------------------------------------------------------------
Finally, the Sponsor asserts that it examined the net inflows in
the first year of existence for two types of ETPs--commodity ETPs that
were first to market in the United States and blockchain-technology-
related ETPs--and that, given the size of these inflows as compared to
the size of the ``real'' bitcoin market, it is unlikely that trading in
the proposed ETP would become the predominant influence on prices in
that market.\449\ The Sponsor represents that the net inflows of these
comparable ETPs in their first year on the market ranged from
approximately $2 million to approximately $3 billion, with a median on
the lower end of that range.\450\ The Sponsor asserts that, over the
course of a year, a spot market that is trading $273 million per day
could easily absorb $3 billion in total inflows.\451\ The Sponsor also
asserts that the CoinShares Bitcoin Tracker One ETN and CoinShares
Tracker Euro ETN, both listed on Nasdaq Stockholm, each attracted
approximately $50 million in
[[Page 55410]]
assets in the first year.\452\ The Sponsor further asserts that the GLD
ETP, which attracted $469 million in its first day on the market and
more than $1 billion over its first three days, was an outlier that was
more than two times larger than any other ETP and orders of magnitude
larger than the average result.\453\ According to the Sponsor, a
similar outcome is extremely unlikely for the proposed ETP because the
gold market is significantly larger and more established than the
bitcoin market, and conditions have changed in the ETP market such that
brokerage and advisory platforms now have detailed due diligence and
approval processes that smooth out asset growth.\454\
---------------------------------------------------------------------------
\449\ See Notice and OIP, supra note 7, 84 FR at 23134.
\450\ See id.; Bitwise Submission I, supra note 6, at 128, 130.
\451\ See Bitwise Submission I, supra note 6, at 130.
\452\ See id. at 129.
\453\ See id. at 131.
\454\ See id.
---------------------------------------------------------------------------
(b) Analysis
The Commission concludes that NYSE Arca has not entered into a
surveillance-sharing agreement with a regulated bitcoin futures market
of significant size. The Sponsor acknowledges that the ``Commission has
correctly identified the need for, value of, and definition of a
surveilled derivatives market of significant size,'' and contends that
the CME futures market is ``significant in size'' compared to the
``real'' spot market that the Sponsor identifies.\455\ The Sponsor
argues that, given the relative size of the bitcoin futures markets and
the close relationship in prices between the derivatives market and the
``real'' spot market, there is a reasonable likelihood that a person
attempting to manipulate the proposed ETP would also have to trade on
the derivatives market to successfully manipulate the ETP.\456\ While
the Commission recognizes that the CFTC regulates the CME and CFE
futures markets, the evidence that the Sponsor presents regarding the
relative size of the bitcoin futures market and the relationship in
prices between the spot and futures markets does not, as explained
further below, establish the interrelationship between the futures
market and the proposed ETP, or directionality of that
interrelationship, that would make the bitcoin futures market a
``market of significant size'' in the context of the proposed ETP.\457\
---------------------------------------------------------------------------
\455\ Bitwise Submission III, supra note 9, at 151. See also
supra note 124.
\456\ See supra note 410 and accompanying text. The Commission
notes that, based on the common membership of NYSE Arca, CME, and
CFE in the Intermarket Surveillance Group, see supra note 411 and
accompanying text, NYSE Arca has the equivalent of a comprehensive
surveillance-sharing agreement with CME and CFE. See supra note 15.
In addition, although one commenter questions whether the bitcoin
futures market is regulated, see supra note 411, the Commission
recognizes that the CFTC comprehensively regulates CME and CFE.
However, the CFTC is not responsible for direct, comprehensive
regulation of the underlying bitcoin spot market. See Winklevoss
Order, supra note 12, 83 FR at 37587, 37599.
\457\ While the Sponsor's assertions about the bitcoin futures
market address trading on the both the CME and the CFE, as noted
above, the CFE ceased offering new bitcoin futures contracts as of
March 2019, see supra note 38. Therefore any surveillance sharing
between NYSE Arca and the CFE would not cover an actively traded
bitcoin futures market. While the Commission considers evidence in
the record concerning the CFE bitcoin futures market in the context
of the overall bitcoin futures market, the Commission does not take
a position on whether the CFE bitcoin futures market would
constitute a significant, regulated market if it were still offering
new bitcoin futures contracts. The Commission notes that the ICE
Futures U.S. exchange began offering bitcoin futures contracts as of
September 2019. See BAKKT Bitcoin (USD) Monthly And Daily Futures
Contracts Trading to Begin on Monday, September 23, 2019, ICE
Futures U.S. (Aug. 16, 2019), available at https://www.theice.com/publicdocs/futures_us/exchange_notices/ICE_Futures_US_BTC_Launch2019_20190816.pdf (last visited Oct. 7,
2019). However, the record contains no information about the volume
of ICE Futures U.S.'s bitcoin futures product or whether the Sponsor
has a relevant surveillance-sharing agreement with ICE Futures U.S.
---------------------------------------------------------------------------
The Sponsor's assertions about the size of the bitcoin futures
market, either in an absolute sense or in comparison to the size of
what the Sponsor identifies as the ``real'' spot market, do not
establish that the bitcoin futures market is significant.\458\ As
described in the Winklevoss Order and Commission orders considering
bitcoin-related trust issued receipts, the Commission's interpretation
of the term ``market of significant size'' depends on the
interrelationship between the market with which the listing exchange
has a surveillance-sharing agreement and the proposed ETP.\459\ This
interrelationship must be such that there is a reasonable likelihood
that a person attempting to manipulate the proposed ETP would also have
to trade on that market to successfully manipulate the ETP.\460\ The
Sponsor's assertions about the size of the bitcoin futures market,
including in comparison to the ``real'' bitcoin spot market that serves
as the basis for the proposed ETP's pricing mechanism, are not
sufficient to establish an interrelationship between the bitcoin
futures market and the proposed ETP.
---------------------------------------------------------------------------
\458\ See supra notes 412-422 and accompanying text. Several
commenters similarly make arguments that rely on the absolute or
relative size of the bitcoin futures market. See supra notes 444-448
and accompanying text.
\459\ See Winklevoss Order, supra note 12, 83 FR at 37594;
ProShares Order, supra note 12, 83 FR at 43936; GraniteShares Order,
supra note 12, 83 FR at 43925; Direxion Order, supra note 12, 83 FR
at 43914.
\460\ See supra note 16 and accompanying text.
---------------------------------------------------------------------------
As discussed above, the Sponsor has not shown that it has
identified all of the ``real'' volume in the bitcoin spot market, and
it has failed to support its assertion that the presence of more
``real'' volume in the market would not materially change its
conclusions, which would include its conclusions about whether the
bitcoin futures market is ``significant.'' \461\ Therefore, the
approximately $554 million in average daily volume in the spot market
that the Sponsor cites may be significantly understated--and the
relative size of the bitcoin futures market may be respectively
overstated.\462\ In any event, without accurate information about the
size of the ``real'' bitcoin spot market, the Sponsor cannot
substantiate its arguments about the relative sizes of the futures and
spot markets for bitcoin, and thus has not met its burden to
demonstrate that the proposed rule change is consistent with the
Exchange Act. In addition, while the Sponsor cites growth in the
bitcoin futures market, particularly during April and May 2019,\463\
this growth will not necessarily continue without a slowdown or even
reversal.\464\ The Trust's Registration Statement acknowledges that the
bitcoin futures market ``has limited trading history and operational
experience and may be less liquid, more volatile and more vulnerable to
economic, market and industry changes than more established futures
markets.'' \465\ NYSE Arca and the Sponsor do not address this
statement or whether future volatility in bitcoin futures market
volumes would affect whether this market is significant.\466\
---------------------------------------------------------------------------
\461\ See supra Section III.B.1(c).
\462\ See supra note 414 and accompanying text.
\463\ See supra notes 418-422 and accompanying text.
\464\ While the Sponsor asserts that a graph of the average
daily volume for CME and CFE bitcoin futures from December 2017
through August 2019 shows a continuing trend of increased bitcoin
futures volume since the CFE stopped issuing new bitcoin futures,
this graph shows lower volume in July and August 2019, as compared
to April and May 2019. See supra note 423.
\465\ Registration Statement, supra note 31, at 11.
\466\ The Sponsor's assertions that the volume on the CFE
futures market in recent months will likely migrate to the CME
contract now that the CFE has stopped further issuance of its
bitcoin futures is speculative. See supra notes 423-425 and
accompanying text. However, particularly given the limited size of
the CFE bitcoin futures market in recent months, the Commission's
analysis does not depend on whether or not this volume migrates to
the CME bitcoin futures market.
---------------------------------------------------------------------------
In addition, the record does not establish that there is a close
alignment between the ``real'' bitcoin spot market, which serves as the
basis for the Trust's NAV and IIV pricing, and the bitcoin futures
market.\467\ The Sponsor presents
[[Page 55411]]
an analysis of the level of average deviation between the CME futures
contract price and the consolidated spot price, and of the speed at
which pricing discrepancies of over 1% between the CME bitcoin futures
price and the consolidated spot price are arbitraged away.\468\
However, the Sponsor's comparison between the spot and futures markets
suffers from the same flaws seen in its analysis of arbitrage among the
``real'' spot platforms.\469\
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\467\ See supra notes 426-443 and accompanying text.
\468\ See supra notes 430-443 and accompanying text. See supra
Section III.B.1(b) for discussion about the Sponsor's calculation of
a ``consolidated price'' for the bitcoin spot market.
\469\ See supra notes 151-154 and accompanying text.
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The Sponsor's argument relies heavily on conclusory statements that
are insufficient. For example, the Sponsor asserts that evidence
``suggests'' that institutional-quality arbitrageurs are enforcing
strong arbitrage between the futures and spot markets at all times, but
this is post hoc reasoning, rather than an analysis of the underlying
reasons for any price correlation, and, further, the Sponsor simply
assumes that its descriptions of the reasons for contango and
backwardation in bitcoin futures trading explain the observed
deviations between spot and futures prices.\470\ The Sponsor also
points to overlap between certain ``real'' platforms used in the
Trust's pricing mechanism and the pricing mechanism for the CME bitcoin
futures (and the CFE bitcoin futures that are no longer traded), and
asserts that its analysis showing that all ``real'' bitcoin spot
markets trade effectively at a single price suggests that the bitcoin
futures market trades at a price tightly linked to the consolidated
spot price calculated by the Sponsor.\471\ However, as discussed above,
the Sponsor has not provided sufficient evidence to support its
assertions regarding the effectiveness of arbitrage in the ``real''
spot market.\472\ In addition, the Sponsor has not demonstrated that
its consolidated spot price is comparable to the price that would be
generated by the Trust's pricing mechanism.\473\
---------------------------------------------------------------------------
\470\ See supra note 439 and accompanying text. The Commission
notes that the Sponsor's discussion of backwardation and contango in
the bitcoin futures market, see supra notes 435-439 and accompanying
text, is generally not relevant because it does not bear directly on
whether the bitcoin futures market is a market ``of significant
size.''
\471\ See supra notes 427-428 and accompanying text.
\472\ See supra notes 151-154 and accompanying text.
\473\ While the Notice and OIP refers to alignment of the
bitcoin futures market with the Bitwise Daily Bitcoin Reference
Price and the Bitwise Real-Time Bitcoin Price, see supra note 426
and accompanying text, the Sponsor's analysis compares the futures
market to its calculated consolidated spot price, which is not the
same as the price that would be generated by the Trust's pricing
mechanism. The Commission notes that an earlier analysis by the
Sponsor compared the CME futures market to a global spot price, see
supra note 431, which again is not the same as the Trust's pricing
mechanism.
---------------------------------------------------------------------------
The Commission also notes that the record contains no evidence
about the lead-lag relationship between the bitcoin futures market and
the spot market, which is central to understanding whether it is
reasonably likely that a would-be manipulator of the ETP would need to
trade on the bitcoin futures market to successfully manipulate prices
on those spot platforms that feed into the proposed ETP's pricing
mechanism. In particular, if the spot market leads the futures market,
this would indicate that it would not be necessary to trade on the
futures market to manipulate the proposed ETP, even if arbitrage worked
efficiently, because the futures price would move to meet the spot
price. Additionally, NYSE Arca and the Sponsor have not provided
sufficient data to support the Sponsor's assertions that it is unlikely
that trading in the proposed ETP would become the predominant influence
on prices in the bitcoin market.\474\ The Sponsor's assertions about
the likely inflows for the proposed ETP are speculative, and the
Sponsor has not provided the data underlying its cited analysis.
---------------------------------------------------------------------------
\474\ See supra notes 449-454 and accompanying text.
---------------------------------------------------------------------------
Finally, the Commission notes that the charts and graphs that the
Sponsor has prepared present a particular view of its analysis that
vary based on choices made, including scaling. For example, the Sponsor
provides a line graph of the CME bitcoin futures contract price versus
the consolidated spot price from January 2018 through May 2019 and
asserts that, ``[w]hile some minor discrepancies exist in the January-
March 2018 time frame, after that, the two lines are virtually
identical.'' \475\ Due to the scaling of the line graph--the graph
covers over 16 months and the ``y'' axis ranges from 2,500 to 20,000
USD--it is very difficult to see differences between the lines
representing the CME futures contract price and the consolidated spot
price, even during the January through March 2018 period that had noted
``minor discrepancies.'' \476\ In contrast, as part of the Sponsor's
discussion of contango and backwardation, the Sponsor has prepared a
line graph of the CME bitcoin futures contract price versus the
consolidated spot price from November 13, 2018, through November 16,
2018--this time scaled to show a four-day period and with a ``y'' axis
ranging from 5,200 to 6,200 USD--that shows visible differences between
the lines.\477\ In addition, the Sponsor's presentation of average
deviation, without accompanying information about median, minimum, or
maximum deviations, may obscure transient events. Further, the
Sponsor's choice to group together all deviations over 1%, regardless
of size, obscures whether some deviations were quite large and how long
a large deviation would persist.
---------------------------------------------------------------------------
\475\ Bitwise Submission II, supra note 9, at 78. See also supra
note 431 and accompanying text.
\476\ The Commission notes that the Sponsor does not elaborate
on the reasons for these discrepancies and why they do not affect
its conclusions.
\477\ See Bitwise Submission II, supra note 9, at 80.
---------------------------------------------------------------------------
Therefore the Commission cannot conclude, based on the current
record, that the CME bitcoin futures market is a ``market of
significant size,'' such that NYSE Arca would be able to rely on
surveillance-sharing with the CME to provide sufficient protection
against fraudulent and manipulative acts and practices.\478\ The
Commission recognizes that, over time, bitcoin-related markets may
continue to grow and develop. For example, existing or newly created
bitcoin futures markets that are regulated may achieve significant
size, and an ETP listing exchange may be able to demonstrate in a
proposed rule change that it will be able to address the risk of fraud
and manipulation by sharing surveillance information with a regulated
market of significant size related to bitcoin, as well as, where
appropriate, with the relevant spot markets underlying such bitcoin
derivatives. Should these circumstances develop, or conditions
otherwise change in a manner that affects the Exchange Act analysis,
the Commission would then have an opportunity to consider whether a
bitcoin ETP would be consistent with the requirements of the Exchange
Act.\479\
---------------------------------------------------------------------------
\478\ The Commission notes that a surveillance-sharing agreement
with a bitcoin futures exchange is distinguishable from a
surveillance-sharing agreement with a spot bitcoin platform, which
would lack the ability of a self-regulatory organization to
discipline its members to compel compliance with surveillance-
sharing requirements. Further, unlike the record underlying the
Winklevoss Order, the record here does not contain evidence that
NYSE Arca would have a surveillance-sharing agreement with one or
more of the underlying spot platforms.
\479\ See Winklevoss Order, supra note 12, 83 FR at 37580.
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4. Assertions That Arguments Are Mutually Reinforcing
The Sponsor asserts that, while each of its two main arguments that
it has
[[Page 55412]]
satisfied the standard set forth in the Commission's orders concerning
bitcoin-based commodity trusts and trust issued receipts is convincing
on its own--that the underlying bitcoin market and the Trust's NAV
process are uniquely resistant to market manipulation and fraudulent
activity, and that NYSE Arca has entered into a surveillance-sharing
agreement with a regulated bitcoin futures market of significant size--
the two arguments together are ``mutually reinforcing and positive.''
\480\ The Sponsor also states that while it does not intend to suggest
that the bitcoin market is immune from all forms of potential
manipulation, the risks of trading on a platform must be weighed
against the benefits, and that, as with past Commission approvals of
ETPs, the unique quality of the bitcoin market adds comfort to the
presence of a surveillance-sharing agreement between the listing
exchange and a regulated market of significant size.\481\ The Sponsor
draws a comparison to the Commission's approval of the streetTRACKS
Gold Shares ETP, in which, according to the Sponsor, the Commission
hinged its approval on the existence of a surveilled market for gold
futures, but took ``comfort'' in the liquidity and diversity of the OTC
market for gold.\482\
---------------------------------------------------------------------------
\480\ See Bitwise Submission III, supra note 9, at 51, 107.
\481\ See id. at 43.
\482\ See id. (citing Securities Exchange Act Release No. 50603
(Oct. 28, 2004), 69 FR 64614, 64619 (Nov. 5, 2004) (SR-NYSE-2004-22)
(``Gold Order''), which describes the importance of information
sharing agreements with markets trading securities underlying a
derivative, the presence of the information sharing agreement
between the listing exchange and the gold futures market, and the
nature of both the OTC and futures markets for gold). See also id.
at 107; Notice and OIP, supra note 7, 84 FR at 23128; Bitwise
Submission I, supra note 6, at 89.
---------------------------------------------------------------------------
Despite the Sponsor's assertions that its arguments are mutually
reinforcing,\483\ NYSE Arca and the Sponsor do not articulate any basis
for applying a lesser standard for either measure as set forth in the
Commission's orders concerning bitcoin-based commodity trusts and trust
issued receipts.\484\ As the Commission has stated above, in the
absence of a showing that the bitcoin market is uniquely resistant to
manipulation, or that other alternative means are present to prevent
fraud and manipulation, a surveillance-sharing agreement with a
regulated market of significant size related to bitcoin is required to
ensure that, in compliance with the Exchange Act, the proposal is
designed to prevent fraudulent and manipulative acts and
practices.\485\
---------------------------------------------------------------------------
\483\ See supra notes 480-482 and accompanying text.
\484\ Even if NYSE Arca could show that bitcoin or the bitcoin
market had certain properties that provided some resistance to
manipulation, it would not lessen the need for a surveillance-
sharing agreement with a significant, regulated market related to
bitcoin or bitcoin derivatives. Conversely, the Commission concludes
that even if NYSE Arca could show that it had entered into a
surveillance-sharing agreement with a regulated market of
substantial, but not ``significant,'' size, it would not lessen the
need to show that bitcoin or the bitcoin market is uniquely
resistant to manipulation.
\485\ See supra note 15 and accompanying text.
---------------------------------------------------------------------------
The Sponsor asserts that, in the Gold Order, the Commission ``found
comfort'' in the liquidity and diversity of the gold OTC market.\486\
Yet the Sponsor acknowledges that the Commission's approval in the Gold
Order ``hinged'' on the existence of a surveilled market for gold
futures.\487\ The Gold Order both recognized these characteristics of
the gold OTC market and reflected the Commission's view that
``[i]nformation sharing agreements with markets trading securities
underlying a derivative are an important part of a self-regulatory
organization's ability to monitor for trading abuses in derivative
products.'' \488\ Further, the Gold Order states that ``the Commission
believes that the unique liquidity and depth of the gold market,
together with the MOU [Memorandum of Understanding] with NYMEX (of
which COMEX is a Division) and NYSE Rules 1300(b) and 1301, create the
basis for the [ETP listing exchange] to monitor for fraudulent and
manipulative practices in the trading of the Shares.'' \489\ Moreover,
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 and the ETP listing
exchange has entered into surveillance-sharing agreements with, or held
Intermarket Surveillance Group membership in common with, that
market.\490\ Thus, even if the Commission accepted the representations
by the Sponsor about the liquidity and depth of the spot market for
bitcoin, the Commission's disapproval of NYSE Arca's proposal would
nonetheless be consistent with the Gold Order and the Commission's
other approvals of commodity-trust ETPs.
---------------------------------------------------------------------------
\486\ See supra note 482 and accompanying text.
\487\ See supra note 482 and accompanying text.
\488\ See Gold Order, supra note 482, 69 FR at 64619.
\489\ Id. (emphasis added). See also Winklevoss Order, supra
note 12, 83 FR at 37594-95 (discussing Commission approvals of gold,
platinum, palladium, and copper ETPs). The Sponsor acknowledges that
the ``availability of a surveillance-sharing agreement with a
derivatives market of significant size'' relating to the ``gold
market'' provides protection against market manipulation. Bitwise
Submission III, supra note 9, at 107.
\490\ See Winklevoss Order, supra note 12, 83 FR at 37594.
---------------------------------------------------------------------------
C. Whether NYSE Arca Has Met Its Burden To Demonstrate That the
Proposal Is Consistent With the Protection of Investors and the Public
Interest
NYSE Arca contends that, if approved, its ETP would protect
investors and the public interest, but the Commission finds that NYSE
Arca has not made such a showing on the current record. The Commission
must consider any potential benefits in the broader context of whether
the proposal meets each of the applicable requirements of the Exchange
Act. And because NYSE Arca has not demonstrated that its proposed rule
change is designed to prevent fraudulent and manipulative acts and
practices, the Commission must disapprove the proposal.
1. Representations Made and Comments Received
NYSE Arca asserts that the proposal will facilitate the listing and
trading of a new type of ETP based on the price of bitcoin that will
enhance competition among market participants, to the benefit of
investors and the marketplace.\491\ In addition, the Sponsor asserts
that the proposed bitcoin ETP would provide many benefits to the
bitcoin market and potential benefits to investors, and would be an
incremental positive to the market by creating another regulated market
for price discovery.\492\ According to the Sponsor, the design of the
Trust and the fundamental nature of the bitcoin market would help
mitigate risk factors that come from pricing, valuation, market
manipulation, and related concerns.\493\ The Sponsor represents that
broker-dealers have expressed a desire for the ability to offer clients
a bitcoin ETP as a way to allow their clients to have institutionally-
managed exposure to bitcoin, rather than buying bitcoin individually
from platforms.\494\
---------------------------------------------------------------------------
\491\ See Notice and OIP, supra note 7, 84 FR at 23136.
\492\ See Bitwise Submission I, supra note 6, at 202; Bitwise
Submission III, supra note 9, at 167.
\493\ See Bitwise Submission I, supra note 6, at 202.
\494\ See id. at 204.
---------------------------------------------------------------------------
One commenter states that the proposed ETP would provide investors
with a familiar, easily accessible, and secure financial product that
would be subject to disclosure requirements and a more substantive
regulatory regime than that imposed by the spot platforms.\495\ This
commenter also states that the
[[Page 55413]]
proposed ETP would reduce risks that investors face when directly
transacting in bitcoin via spot platforms, including risks relating to
cryptographic key maintenance, hacking attacks, and computer
errors.\496\ This commenter further asserts that the proposed ETP would
enhance protections for all investors by encouraging disciplined and
sophisticated institutional participants to join the market, and would
reduce retail-specific risks because Shares would be purchased through
brokerage accounts with associated client risk tolerance and
suitability obligations.\497\ Another commenter states that the ETP
structure has allowed investors easy, secure, and low-cost access to
important markets, and that it would be a ``win'' for investors if this
protection and the related opportunity was extended to bitcoin.\498\ In
addition, one commenter states that the proposed Shares would provide
certain investors with the opportunity to acquire investment exposure
in bitcoin, without participating directly in the spot market and
having to make arrangements to custody bitcoin.\499\
---------------------------------------------------------------------------
\495\ See Omniex Letter, supra note 9, at 2.
\496\ See id. (stating that bitcoin spot platforms may be
pressured to improve their services to compete with the proposed
ETP).
\497\ See id.
\498\ See Donostia Ventures Letter, supra note 9, at 5.
\499\ See Tagomi Letter, supra note 9, at 1.
---------------------------------------------------------------------------
The Sponsor states that investors in the proposed ETP would need to
consider and study the risk factors in the Trust's Registration
Statement, including the high historical volatility of bitcoin,
uncertainty regarding its long-term prospects for adoption, new
technological advances, and regulatory changes.\500\ The Sponsor
asserts that the primary risks of the proposed ETP would be those
inherent to the underlying asset's returns, volatility, and
functioning, rather than unique risks that pertain to custody, pricing,
liquidity, arbitrage, or market manipulation.\501\ The Sponsor also
asserts that issues that might be relevant to investment advisors
investing in digital-asset-related funds on behalf of retail investors
are whether bitcoin can be valued as a non-cashflow-generating asset,
its high volatility, concerns over custody and locating bitcoin, and
the ability of advisors or investors to understand bitcoin.\502\
---------------------------------------------------------------------------
\500\ See Bitwise Submission I, supra note 6, at 202.
\501\ See id. at 203.
\502\ See id. at 205.
---------------------------------------------------------------------------
One commenter asserts that the proposed ETP is not motivated by a
legitimate desire to protect consumers or drive regulation, and that
the primary intentions behind the proposal are to allow bitcoin to
become part of the mainstream investor's portfolio, increase the mass
adoption of cryptocurrencies and thus drive up the price through mass
speculation.\503\ This commenter also asserts that disreputable
individuals are operating in the bitcoin market and it is important not
to send the wrong signal by supporting an ETP without the proper legal
and regulatory framework in place to protect the public.\504\ Another
commenter states that the Sponsor's presentation is ``condescending''
and assumes that the public needs protecting by an ETP, and that the
public should keep control of its digital assets and accept the risks
that come with self-ownership.\505\ A third commenter states that if
the root causes of manipulation by the platforms are not identified and
eliminated, an ETP based on bitcoin would not only fail to solve them,
but would compound them before any meaningful and sustainable risk
measures and fail-safes have been identified and implemented to
guarantee investor protection.\506\
---------------------------------------------------------------------------
\503\ See Kumar Letter, supra note 6.
\504\ See id.
\505\ See Buckley Letter, supra note 6.
\506\ See Fitzgerald Letter I, supra note 6. See also Shenoy
Letter III, supra note 69, at 11 (asserting that the proposed ETP
would not reduce the opaqueness of the marketplace or provide
meaningful price discovery because the underlying root-cause of
issues such as regulation, manipulation, and transparency have not
been addressed at a trading platform level).
---------------------------------------------------------------------------
2. Analysis
As it has in disapproving previous proposals for bitcoin-related
ETPs, the Commission acknowledges that, as compared to trading in
unregulated bitcoin spot markets, trading a bitcoin-based ETP on a
national securities exchange may provide some additional protection to
investors, but 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.\507\ 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.\508\ Thus, even if a proposed rule change would provide
certain benefits to investors and the markets, the proposed rule change
may still fail to meet other requirements under the Exchange Act.
---------------------------------------------------------------------------
\507\ See Winklevoss Order supra note 12, 83 FR at 37602;
GraniteShares Order, supra note 12, 83 FR at 43931; ProShares Order,
supra note 12, 83 FR at 43941; Direxion Order, supra note 12, 83 FR
at 43919.
\508\ See 15 U.S.C. 78s(b)(2)(C). The Sponsor acknowledges that,
``[n]otwithstanding all'' the purported benefits that the ``launch
of a bitcoin ETP would provide'' to the bitcoin market and
investors, ``it is critical and primary that any bitcoin ETP
proposal meet each of the applicable requirements of the Exchange
Act prior to approval.'' Bitwise Submission III, supra note 9, at
167.
---------------------------------------------------------------------------
For the reasons discussed above, NYSE Arca has not met its burden
of demonstrating that the proposal is consistent with Exchange Act
Section 6(b)(5),\509\ and, accordingly, the Commission must disapprove
the proposal.\510\
---------------------------------------------------------------------------
\509\ 15 U.S.C. 78f(b)(5).
\510\ In disapproving the proposed rule change, as modified by
Amendment No. 1, the Commission has considered its impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f); see also supra notes 491-498 and accompanying text.
According to NYSE Arca, the proposal will facilitate the listing and
trading of a new type of ETP based on the price of bitcoin, which
will enhance competition among market participants, to the benefit
of investors and the marketplace. See Notice and OIP, supra note 7,
84 FR at 23136. Additionally, the Sponsor asserts that the proposed
ETP would incrementally improve the market by creating another
regulated market for price discovery. See Bitwise Submission I,
supra note 6, at 202. The Sponsor also asserts that the launch of a
bitcoin ETP would be supportive of the United States' digital asset
market, which may have important economic advantages for the United
States from a competitiveness standpoint. See Bitwise Submission
III, supra note 9, at 167 (stating that bitcoin ETPs have been
approved on the Nasdaq Nordic exchange in Sweden and the Six Swiss
Exchange in Switzerland). The Commission recognizes that NYSE Arca
and the Sponsor assert the economic benefits discussed above, but,
for the reasons discussed throughout, the Commission is disapproving
the proposed rule change because it does not find that the proposed
rule change is consistent with the Exchange Act.
---------------------------------------------------------------------------
D. Other Comments
Comment letters also addressed the general nature and uses of
bitcoin; \511\ the state of development of bitcoin as a digital asset;
\512\ the inherent value of, and risks of investing in, bitcoin; \513\
the volatility of bitcoin prices; \514\ the desire of investors to gain
access to bitcoin
[[Page 55414]]
through an ETP; \515\ the legitimacy or enhanced regulatory protection
that Commission approval of the proposed ETP might confer upon bitcoin
as a digital asset; \516\ the potential impact of Commission approval
of the proposed ETP on the price of bitcoin and on the U.S. economy;
\517\ insurance and custody of fund holdings; \518\ handling of fund
holdings after a hard fork or ``airdrop'' (i.e., an unsolicited
distribution of digital assets free of charge); \519\ and the
protection of individual freedom, privacy, and property rights.\520\
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.
---------------------------------------------------------------------------
\511\ See Blockchain Capital Letter, supra note 9; Puddifoot
Letter, supra note 6; Santos Letter, supra note 6.
\512\ See Blockchain Capital Letter, supra note 9; Page Letter,
supra note 9; Puddifoot Letter, supra note 6; Santos Letter, supra
note 6; Xia Letter, supra note 9.
\513\ See Ahn Letter II, supra note 9; Ahn Letter III, supra
note 9; Chris Letter, supra note 6; Mallya Letter, supra note 6;
Neil Letter, supra note 6; Page Letter, supra note 9.
\514\ See Bitwise Submission I, supra note 6, at 205; Bird
Letter, supra note 9; Perrott Letter, supra note 6; Pinto Letter,
supra note 6; Shenoy Letter III, supra note 69, at 6-7.
\515\ See Blockchain Association Letter, supra note 9;
Collaborative Fund Letter, supra note 9; Mallon Letter, supra note
9; Omniex Letter, supra note 9; Puddifoot Letter, supra note 6; J.
Ross Letter, supra note 9; Shenoy Letter II, supra note 9.
\516\ See Anonymous Letter I, supra note 6; Anonymous Letter II,
supra note 9; Barnwell Letter, supra note 6; Blockchain Association
Letter, supra note 9; Castle Island Ventures Letter, supra note 9;
Collaborative Fund Letter, supra note 9; J. Ross Letter, supra note
9; Santos Letter, supra note 6; Shenoy Letter II, supra note 9.
\517\ See Bitwise Submission III, supra note 9, at 167; Mallon
Letter, supra note 9; Neal Letter, supra note 9.
\518\ See Bitwise Submission I, supra note 6, at 133-167, 205-
210; Castle Island Ventures Letter, supra note 9; Coinbase Custody
Letter, supra note 9; Monterio Letter, supra note 6; Santos Letter,
supra note 6.
\519\ See Bitwise Submission I, supra note 6, at 182-188, 213-
215.
\520\ See Ahn Letter III, supra note 9; Blockchain Association
Letter, supra note 9; Omniex Letter, supra note 9; Rob Letter, supra
note 6; Santos Letter, supra note 6.
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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, as modified by Amendment No. 1, is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to a national securities exchange, and in
particular, with Section 6(b)(5) of the Exchange Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act, that proposed rule change SR-NYSEArca-2019-01, as
modified by Amendment No. 1, is disapproved.
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\521\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\521\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-22486 Filed 10-15-19; 8:45 am]
BILLING CODE 8011-01-P