Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Order Disapproving a Proposed Rule Change to List and Trade Shares of the ARK 21Shares Bitcoin ETF Under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares

I. Introduction

On May 13, 2022, Cboe BZX Exchange, Inc. (“BZX” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 19b-4 thereunder, a proposed rule change to list and trade shares (“Shares”) of the ARK 21Shares Bitcoin ETF (“Trust”) under BZX Rule 14.11(e)(4), Commodity-Based Trust Shares. The proposed rule change was published for comment in the Federal Register on June 1, 2022.

On July 12, 2022, pursuant to Section 19(b)(2) of the Exchange Act, 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. On August 29, 2022, the Commission instituted proceedings under Section 19(b)(2)(B) of the Exchange Act to determine whether to approve or disapprove the proposed rule change, and on November 15, 2022, the Commission designated a longer period for Commission action on the proposed rule change.

This order disapproves the proposed rule change. The Commission concludes that BZX has not met its burden under the Exchange Act and the Commission's Rules of Practice to demonstrate that its proposal is consistent with the requirements of Exchange Act Section 6(b)(5), 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.”

When considering whether BZX's proposal to list and trade the Shares is designed to prevent fraudulent and manipulative acts and practices, the Commission applies the same analytical framework used in its orders considering previous proposals to list bitcoin -based commodity trusts and bitcoin-based trust issued receipts to assess whether a listing exchange of an exchange-traded product (“ETP”) can meet its obligations under Exchange Act Section 6(b)(5). As the Commission has explained, an exchange that lists bitcoin-based ETPs can meet its obligations under Exchange Act Section 6(b)(5) by demonstrating that the exchange has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying or reference bitcoin assets.

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. A surveillance-sharing agreement entered into with a “significant market” assists 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.”

Although surveillance-sharing agreements are not the exclusive means by which a listing exchange of a commodity-trust ETP can meet its obligations under Exchange Act Section 6(b)(5), such agreements have previously provided the basis for the exchanges that list commodity-trust ETPs to meet those obligations, and the Commission has historically recognized their importance. And where, as here, a listing exchange fails to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, the listing exchange must enter into a surveillance-sharing agreement with a regulated market of significant size because such agreements detect and deter fraudulent and manipulative activity.

The Commission has long recognized that surveillance-sharing 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” and thus “enable the Commission to continue to effectively protect investors and promote the public interest.” As the Commission has emphasized, it is essential for an exchange listing a derivative securities product to have the ability that surveillance-sharing agreements provide to obtain information necessary to detect, investigate, and deter fraud and market manipulation, as well as violations of exchange rules and applicable federal securities laws and rules. 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.

The Commission has explained that the ability of a national securities exchange to enter into surveillance-sharing agreements “furthers the protection of investors and the public interest because it will enable the [e]xchange to conduct prompt investigations into possible trading violations and other regulatory improprieties.” The Commission has also long taken the position that surveillance-sharing agreements are important in the context of exchange listing of derivative security products, such as equity options, because a surveillance-sharing agreement “permits the sharing of information” that is “necessary to detect” manipulation and “provide[s] an important deterrent to manipulation because [it] facilitate[s] the availability of information needed to fully investigate a potential manipulation if it were to occur.” With respect to ETPs, when approving the listing and trading of one of the first commodity-linked ETPs—a commodity-linked exchange-traded note—on a national securities exchange, the Commission continued to emphasize the importance of surveillance-sharing agreements, stating that the listing exchange had entered into surveillance-sharing agreements with each of the futures markets on which pricing of the ETP would be based and stating that “[t]hese agreements should help to ensure the availability of information necessary to detect and deter potential manipulations and other trading abuses, thereby making [the commodity-linked notes] less readily susceptible to manipulation.”

Consistent with these statements, 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 (“ISG”) membership in common with, that market. Moreover, the surveillance-sharing agreements have been consistently present whenever the Commission has approved the listing and trading of derivative securities, even where the underlying securities were also listed on national securities exchanges—such as options based on an index of stocks traded on a national securities exchange—and were thus subject to the Commission's direct regulatory authority.

Listing exchanges have also attempted to demonstrate that other means besides surveillance-sharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices, including that the bitcoin market as a whole or the relevant underlying bitcoin market is “uniquely” and “inherently” resistant to fraud and manipulation. In response, the Commission has stated that, if a listing exchange could establish that the underlying market inherently possesses a unique resistance to manipulation beyond the protections that are utilized by traditional commodity or securities markets, the listing market would not necessarily need to enter into a surveillance-sharing agreement with a regulated significant market. Such resistance to fraud and manipulation, however, must be novel and beyond those protections that exist in traditional commodity markets or securities markets for which surveillance-sharing agreements in the context of listing derivative securities products have been consistently present.

Here, BZX contends that approval of the proposal is consistent with Section 6(b)(5) of the Exchange Act, and, in particular, Section 6(b)(5)'s requirement that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest. As discussed in more detail below, BZX asserts that the proposal is consistent with Section 6(b)(5) of the Exchange Act because the Exchange has a comprehensive surveillance-sharing agreement with a regulated market of significant size, and there exist other means to prevent fraudulent and manipulative acts and practices that are sufficient to justify dispensing with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin.

In the analysis that follows, the Commission examines whether the proposed rule change is consistent with Section 6(b)(5) of the Exchange Act by addressing: in Section III.B.1 assertions that other means besides surveillance-sharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices; in Section III.B.2 assertions that BZX has entered into a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin; in Section III.B.3 assertions that the Commission must approve the proposal because the Commission has approved the listing and trading of ETFs and ETPs that hold Chicago Mercantile Exchange (“CME”) bitcoin futures; and in Section III.C assertions that the proposal is consistent with the protection of investors and the public interest.

Based on its analysis, the Commission concludes that BZX has not established that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin. The Commission further concludes that BZX has not established that it has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin, the underlying bitcoin assets that would be held by the Trust. As discussed further below, BZX repeats various assertions made in prior bitcoin-based ETP proposals, including in the Previous ARK Filing, that the Commission has previously addressed and rejected, including in the prior ARK 21Shares Order—and more importantly, BZX does not respond to many of the Commission's reasons for rejecting those assertions. As a result, the Commission is unable to find that the proposed rule change is consistent with the statutory requirements of Exchange Act Section 6(b)(5).

The Commission emphasizes that its disapproval of this proposed rule change does not rest on an evaluation of the relative investment quality of a product holding spot bitcoin versus a product holding CME bitcoin futures, or an assessment of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment. Rather, the Commission is disapproving this proposed rule change because, as discussed below, BZX has not met its burden to demonstrate that its proposal is consistent with the requirements of Exchange Act Section 6(b)(5).

II. Description of the Proposed Rule Change

As described in more detail in the Notice, the Exchange proposes to list and trade the Shares of the Trust under BZX Rule 14.11(e)(4), which governs the listing and trading of Commodity-Based Trust Shares on the Exchange.

The investment objective of the Trust is to seek to track the performance of bitcoin, as measured by the performance of the S&P Bitcoin Index (“Index”), adjusted for the Trust's expenses and other liabilities. Each Share would represent a fractional undivided beneficial interest in the bitcoin held by the Trust. The Trust's assets would consist of bitcoin held by the Custodian on behalf of the Trust. The Trust generally does not intend to hold cash or cash equivalents. However, there may be situations where the Trust would unexpectedly hold cash on a temporary basis.

In seeking to achieve its investment objective, the Trust would hold bitcoin and would value the Shares daily based on the Index. The Index is a U.S. dollar-denominated composite reference rate for the price of bitcoin. The Index price is currently sourced from the following platforms: Binance, Bitfinex, Bitflyer, Bittrex, Bitstamp, Coinbase Pro, Gemini, HitBTC, Huobi, Kraken, KuCoin, and Poloniex. The Index methodology is intended to determine the fair market value for bitcoin by determining the principal market for bitcoin as of 4:00 p.m. E.T. daily.

The Net Asset Value (“NAV”) of the Trust means the total assets of the Trust including, but not limited to, all bitcoin and cash, if any, less total liabilities of the Trust, each determined on the basis of generally accepted accounting principles. The NAV of the Trust is the aggregate value of the Trust's assets less its estimated accrued but unpaid liabilities (which include accrued expenses). In determining the Trust's NAV, the Administrator would value the bitcoin held by the Trust based on the price set by the Index as of 4:00 p.m. E.T. The Administrator would determine the NAV of the Trust on each day that the Exchange is open for regular trading, as promptly as practical after 4:00 p.m. E.T.

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

When the Trust sells or redeems its Shares, it would do so in “in-kind” transactions in blocks of 5,000 Shares. Authorized participants will deliver, or facilitate the delivery of, bitcoin to the Trust's account with the Custodian in exchange for Shares when they purchase Shares, and the Trust, through the Custodian, will deliver bitcoin to such authorized participants when they redeem Shares with the Trust.

III. Discussion

A. The Applicable Standard for Review

The Commission must consider whether BZX's proposal is consistent with the Exchange Act. Section 6(b)(5) of the Exchange Act requires, in relevant part, that the rules of a national securities exchange be designed “to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest.” 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.”

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, 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. 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.

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

(1) Assertions That Other Means Besides Surveillance-Sharing Agreements Will Be Sufficient To Prevent Fraudulent and Manipulative Acts and Practices

(i) Assertions Regarding the Bitcoin Market

As stated above, the Commission has recognized that a listing exchange could demonstrate that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying bitcoin assets, including by demonstrating that the bitcoin market as a whole or the relevant underlying bitcoin market is uniquely and inherently resistant to fraud and manipulation. Such resistance to fraud and manipulation, however, must be novel and beyond those protections that exist in traditional commodities or securities markets.

(a) BZX's Assertions

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

In addition, BZX provides results of statistical analysis by the Sponsor in support of its assertions regarding linkages between bitcoin markets and efficient arbitrage across such markets. First, according to BZX, using daily bitcoin prices from January 1, 2018, to October 1, 2021, the Sponsor calculated the Pearson correlation of returns across certain bitcoin spot markets, non-U.S. bitcoin ETPs, and the CME, and concluded that there is a high degree of correlation across these markets. BZX argues that, in markets that are globally and efficiently integrated, one would expect changes in prices of an asset across all markets to be highly correlated, and that “the rationale behind this is that quick and efficient arbitrageurs would capture potentially profitable opportunities, consequently converging prices to the average intrinsic value very rapidly.” Further, BZX states that pair-wise correlations of bitcoin returns were also calculated on hourly and minute-by-minute sampling frequencies in order to estimate the intra-day associations across the different bitcoin markets, and that the results remain largely the same, with correlations ranging between 70% and 97% among the centralized markets, and between 55% and 72% between non-U.S. bitcoin ETPs and centralized markets. BZX asserts that this suggests that bitcoin prices across all considered markets move very similarly and in a very efficient manner to quickly reflect changes in market conditions, not only on a daily basis, but also at much higher intra-day frequencies.

Second, BZX asserts that, according to the Sponsor's research, this high correlation holds true during periods of extreme price volatility. Employing a “statistical comoment called cokurtosis,” which, according to BZX, measures to what extent two random variables change together, the Sponsor found, using hourly bitcoin returns and minute-by-minute returns, that the bitcoin markets tend to move very similarly, especially for extreme price deviations. BZX states that this is evidence of a robust global bitcoin market “that quickly reacts in a unanimous manner to extreme price movements across both the spot markets, futures and [non-U.S.] ETP markets.” According to BZX, this implies that “no single [b]itcoin market can deviate significantly from the consensus, such that the market is sufficiently large and has an inherent unique resistance to manipulation.”

Third, based on the Sponsor's research using daily bitcoin price series, BZX argues that cross-platform spreads in bitcoin have been declining consistently over the past several years. BZX contends that the “clear and sharp” decline in the spread indicates that the bitcoin market has become more efficient over time. In addition, based on the Sponsor's research, BZX argues that the magnitude of outlier spreads have also declined over time, and that the market has experienced a 38% year-on-year decline in the annual median spread, indicating “a greater degree of [b]itcoin price convergence across [platforms] and a more efficient market.” Further, based on the Sponsor's calculations of a 7-day rolling standard deviation of the spread from January 1, 2017, to October 1, 2021, BZX asserts that the dispersion in bitcoin prices across all platforms has decreased over time, indicating that prices on all the considered platforms converge towards the “intrinsic average” much more efficiently, and suggesting that the market has become better at quickly reaching a “consensus price” for bitcoin. BZX posits that, as the pricing of the “crypto market” becomes increasingly efficient, pricing methodologies become “more accurate and less susceptible to manipulation.” BZX further asserts that the “clustering of prices across a variety of sources within the primary market” points towards robust price discovery mechanisms and efficient arbitrage. BZX states that the cross-platform spreads, and therefore the process of price discovery in the bitcoin market, “has improved significantly over time despite the market experiencing rather uniform albeit sinusoidal volatility.” BZX argues that this further supports the argument that the bitcoin market has exhibited significant improvements in terms of price discovery over time, irrespective of and despite the volatility of the asset itself, which can be attributed to efficient arbitrage operations.

Fourth, BZX asserts that one factor that has contributed to the overall efficiency of, and improved price discovery within, the bitcoin market is the increase in the number of participants, and subsequently, “the total dollar amount allocated to this market.” BZX's measure of participation is based on the increase from January 2016 to June 2021 in the number of wallet addresses holding bitcoin.

Finally, BZX contends that this increase in the number of participants has resulted in higher liquidity in the bitcoin market, as exhibited by the “daily aggregated dollar notional of the bid and ask order books within the first 100 price levels across several of the largest centralized crypto [platforms] from October 2020 to April 2021.” According to BZX, “the dollar notional that is allocated closest to the mid price has increased from around $230 million to $860 million over that period, representing a 270% increase in half a year.” BZX states that the “increased notional order book” indicates that there is a “higher degree of consensus” among investors regarding the price of bitcoin, and that this “hampers any attempt of price manipulation by any single large entity.” Additionally, according to BZX, the Sponsor found that movements in the bid and ask dollar notional of the “bitcoin order book” within a six-hour window around “extreme” price events were indicative of an efficient market, whereby large market movements are “quickly and dynamically absorbed” by a “thick order book” and market participants' reactions are “quick to restore the market back to its equilibrium level.”

(b) Analysis

As with the previous proposals, including the Previous ARK Filing, the Commission here concludes that the record does not support a finding that the bitcoin market is inherently and uniquely resistant to fraud and manipulation such that the Commission can dispense with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying bitcoin assets.

BZX asserts that, because of how bitcoin trades occur, including through continuous means and through fragmented platforms, arbitrage across the bitcoin platforms essentially helps to keep global bitcoin prices aligned with one another, thus hindering manipulation. The Exchange also provides various statistics from the Sponsor, including pairwise correlations and cokurtosis estimates using minute-level data, which purport to show that bitcoin prices are closely and increasingly aligned across markets and that any price disparities are quickly arbitraged away. However, even accepting at face value the Sponsor's statistical results that, through October 1, 2021, spot bitcoin prices exhibited high correlation and high cokurtosis on a pairwise basis across the selected spot bitcoin markets, this would only indicate that spot bitcoin prices during the sample period tended to move in tandem. Such data do not provide any information on how large price disparities typically are among such markets, or on how long price disparities typically persist. Nor do the Sponsor's statistics or BZX's assertions provide any insight into what size or duration of price disparities would be profitable for a would-be manipulator, and thus they do not inform BZX's conclusion that bitcoin pricing has become “less susceptible to manipulation.” The Commission is thus unable to conclude from the evidence provided that arbitrage across bitcoin markets is efficient, let alone so efficient as to make the markets inherently resistant to fraud and manipulation.

In any event, the Commission has explained that efficient price arbitrage is not sufficient to support the finding that a market is uniquely or inherently resistant to manipulation such that the Commission can dispense with surveillance-sharing agreements. The Commission has stated, for example, that even for equity options based on securities listed on national securities exchanges, the Commission relies on surveillance-sharing agreements to detect and deter fraud and manipulation. Equities that underlie such options trade on U.S. equity markets that are deep, liquid, and highly interconnected. Moreover, BZX's data regarding the increase in the number of wallet addresses holding bitcoin do not provide any information on the concentration of bitcoin within or among such wallets, or take into account that a market participant with a dominant ownership position would not find it prohibitively expensive to overcome the liquidity supplied by arbitrageurs and could use dominant market share to engage in manipulation.

In addition, the Exchange makes the unsupported claim that, to the extent that there are bitcoin platforms engaged in or allowing wash trading or other activity intended to manipulate the price of bitcoin on other markets, market participants will generally ignore those platforms. However, the record does not demonstrate that wash trading and other possible sources of fraud and manipulation in the broader bitcoin spot market will be ignored by market participants. Without the necessary data or other evidence, the Commission has no basis on which to conclude that bitcoin platforms are insulated from prices of others that engage in or permit fraud or manipulation. Indeed, the notion that a platform would be insulated from prices on other platforms is contradicted by the Exchange's assertions and the Sponsor's statistical evidence that bitcoin markets are “highly correlated,” including during periods of extreme price volatility.

Further, the continuous nature of bitcoin trading does not support the finding that the bitcoin market is uniquely or inherently resistant to manipulation, and neither do linkages among markets, as BZX asserts. Even in the presence of continuous trading or linkages among markets, formal (such as those with consolidated quotations or routing requirements) or otherwise (such as in the context of the fragmented, global bitcoin markets), manipulation of asset prices, as a general matter, can occur simply through trading activity that creates a false impression of supply or demand.

In addition, BZX does not sufficiently contest the presence of possible sources of fraud and manipulation in the spot bitcoin market that the Commission has identified in previous orders, including: (1) as discussed above, “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 (for example, plans of market participants to significantly increase or decrease their holdings in bitcoin, new sources of demand for bitcoin, or the decision of a bitcoin-based investment vehicle on how to respond to a “fork” in the bitcoin blockchain, which would create two different, non-interchangeable types of bitcoin) or based on the dissemination of false and misleading information; (6) manipulative activity involving purported “stablecoins,” including Tether (USDT); and (7) fraud and manipulation at bitcoin trading platforms.

Finally, BZX does not address risk factors specific to the bitcoin blockchain and bitcoin platforms, described in the Trust's Registration Statement, that undermine the argument that the bitcoin market is inherently resistant to fraud and manipulation. For example, the Registration Statement acknowledges that “it may be possible for a bad actor to manipulate the [b]itcoin network and hinder transactions”; that “[s]pot markets on which bitcoin trades are relatively new and largely unregulated, and, therefore, may be more exposed to fraud and security breaches than established, regulated exchanges for other financial assets or instruments, which could have a negative impact on the performance of the Trust”; that “[o]ver the past several years, a number of bitcoin spot markets have been closed or faced issues due to fraud, failure, security breaches or governmental regulations”; that “[t]he nature of the assets held at bitcoin spot markets makes them appealing targets for hackers and a number of bitcoin spot markets have been victims of cybercrimes” and “[n]o bitcoin [platform] is immune from these risks”; that “[t]he potential consequences of a spot market's failure or failure to prevent market manipulation could adversely affect the value of the Shares[,] . . . . [t]he blockchain infrastructure could be used by certain market participants to exploit arbitrage opportunities through schemes such as front-running, spoofing, pump-and-dump and fraud across different systems, platforms or geographic locations” . . . . and “[a]s a result of reduced oversight, these schemes may be more prevalent in digital asset markets than in the general market for financial products”; that “many [bitcoin] spot markets and over-the-counter market venues . . . do not provide the public with significant information regarding their ownership structure, management teams, corporate practices or oversight of customer trading” and “many [bitcoin] spot markets lack certain safeguards put in place by more traditional exchanges to enhance the stability of trading on the exchange”; that “[s]ecurity breaches, cyber-attacks, computer malware and computer hacking attacks have been a prevalent concern in relation to digital assets”; and that the bitcoin blockchain could be vulnerable to a “51% attack,” in which a bad actor or actors that control a majority of the processing power dedicated to mining on the bitcoin network may be able to alter the bitcoin blockchain on which the bitcoin network and bitcoin transactions rely. The Exchange also acknowledges in the proposed rule change that “largely unregulated currency and spot commodity markets do not provide the same protections as the markets that are subject to the Commission's oversight.”

(ii) Assertions Regarding the Index and the Create/Redeem Process

(a) BZX's Assertions

BZX also argues that the Index, which would be used to value the Trust's bitcoin, is itself resistant to manipulation based on the Index's methodology. BZX states that the Index is a U.S. dollar-denominated composite reference rate for the price of bitcoin. The Index price is currently sourced from the following bitcoin platforms selected by the Data Provider based on a combination of qualitative and quantitative metrics: Binance, Bitfinex, Bitfiyer, Bittrex, Bitstamp, Coinbase Pro, Gemini, HitBTC, Huobi, Kraken, KuCoin, and Poloniex. According to BZX, the Index methodology is intended to determine the fair market value for bitcoin by determining the “principal market” for bitcoin as of 4:00 p.m. E.T. daily. To rank the credibility and quality of each underlying bitcoin platform, the Data Provider dynamically assigns a score to the key characteristics for each platform. BZX states that the score determines which platform should be designated as the “principal market” at a given point of time by computing a weighted average of the values assigned to four different platform characteristics: (i) oversight; (ii) microstructure efficiency; (iii) data transparency; and (iv) data integrity. The methodology then applies a five-step weighting process for identifying a principal market and the last price on that market. Following this weighting process, an “executed exchange price” is assigned for bitcoin as of 4:00 p.m. E.T. The Data Provider takes the last traded prices at that moment in time on that trading venue for the relevant pair (bitcoin/USD) when determining the Index price.

BZX asserts that, because there are multiple bitcoin spot markets that may contribute prices to the Index price, in a well-arbitraged and fractured market, manipulation is more difficult as a malicious actor would need to manipulate multiple spot markets simultaneously to impact the Index price or dramatically skew the historical distribution of volume between the various platforms. In addition, BZX asserts that the Data Provider has dedicated resources and established committees to ensure all prices are representative of the market, and that any price challenges will result in an independent analysis of the price. This includes assessing whether the price from the selected platform is biased according to analyses designed to recognize patterns consistent with manipulative activity, such as a quick reversion to previous traded levels following a sharp price change or any significant deviations from the volume weighted average price on a particular platform or pricing on any other eligible platform. BZX further represents that, after the “Lukka Prime price” is generated, the S&P DJI (“Index Provider”) performs independent quality checks as a second layer of validation to those employed by the Data Provider, and may submit a price challenge to the Data Provider. In such circumstances, according to BZX, the Data Provider will “perform an independent review of the price challenge to ensure the price is representative of the fair value of a particular cryptocurrency.”

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

(b) Analysis

Based on the assertions made and the information provided with respect to the Index and the create/redeem process, the record is inadequate to conclude that BZX has articulated other means to prevent fraud and manipulation that are sufficient to justify dispensing with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin.

The record does not demonstrate that the proposed methodology for calculating the Index would make the proposed ETP resistant to fraud or manipulation sufficient to dispense with the ability to detect and deter fraud and manipulation that is provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin. Specifically, BZX has not assessed the possible influence that spot platforms not included among the Index's underlying platforms would have on bitcoin prices used to calculate the Index. As discussed above, BZX does not sufficiently contest the presence of possible sources of fraud and manipulation in the spot bitcoin market generally. Instead, BZX focuses its analysis on the eligibility and attributes of the Index's underlying platforms, the Index's methodology for identifying a “principal market,” and the procedures for determining whether an Index pricing input was subject to manipulation. In doing so, what the Exchange does not address is that, to the extent that trading on spot bitcoin platforms not directly used to calculate the Index affects prices on the Index's underlying platforms, the activities on those other platforms—where various kinds of fraud and manipulation from a variety of sources may be present and persist—may affect whether the Index is resistant to manipulation. Importantly, the record does not demonstrate that these possible sources of fraud and manipulation in the broader spot bitcoin market do not affect the Index's underlying platforms that represent a portion of the spot bitcoin market. To the extent that fraudulent and manipulative trading on the broader bitcoin market could influence prices or trading activity on the platforms underlying the Index, the platforms underlying the Index (and thus the Index) would not be inherently resistant to manipulation.

Moreover, the Exchange's assertions that the Index's methodology helps make the Index resistant to manipulation conflict with the Registration Statement. Specifically, the Registration Statement represents, among other things, that “[s]pot markets on which bitcoin trades are relatively new and largely unregulated, and, therefore, may be more exposed to fraud and security breaches than established, regulated exchanges for other financial assets or instruments”; and that “[t]he potential consequences of a spot market's failure or failure to prevent market manipulation could adversely affect the value of the Shares[,] . . . . [t]he blockchain infrastructure could be used by certain market participants to exploit arbitrage opportunities through schemes such as front-running, spoofing, pump-and-dump and fraud across different systems, platforms or geographic locations” . . . . and “[a]s a result of reduced oversight, these schemes may be more prevalent in digital asset markets than in the general market for financial products.” The Index's underlying bitcoin platforms are a subset of the bitcoin trading venues currently in existence.

The Registration Statement also states, specifically with respect to the Index, that “[p]ricing sources used by the Index are digital asset spot markets that facilitate the buying and selling of bitcoin and other digital assets” and that “[a]lthough many pricing sources refer to themselves as `exchanges,' they are not registered with, or supervised by, the [Commission] or [Commodity Futures Trading Commission] and do not meet the regulatory standards of a national securities exchange or designated contract market,” and “[f]or these reasons, among others, purchases and sales of bitcoin may be subject to temporary distortions or other disruptions . . . . [which] could affect the price of bitcoin used in Index calculations and, therefore, could adversely affect the bitcoin price as reflected by the Index.” The Sponsor further states in the Registration Statement that “[t]he Index is based on various inputs which include price data from various third-party bitcoin spot markets” and that “[t]he Index Provider does not guarantee the validity of any of these inputs, which may be subject to technological error, manipulative activity, or fraudulent reporting from their initial source.” Moreover, the Exchange describes a process through which the Data Provider may select an “alternative primary market” upon detection or referral of suspect manipulative activities. Although the Sponsor raises concerns regarding fraud and security of bitcoin platforms in the Registration Statement, as well as concerns specific to the Index's underlying bitcoin platforms, leading to the potential need for an “alternative” basis for the Index price, the Exchange does not explain how or why such concerns are consistent with its assertion that the Index is resistant to fraud and manipulation.

In addition, BZX represents that, to rank the credibility and quality of each underlying bitcoin platform, the Data Provider dynamically assigns a score to the key characteristics for each platform, namely: (i) oversight; (ii) microstructure efficiency; (iii) data transparency; and (iv) data integrity. BZX states that the score determines which platform should be designated as the “principal market” and derives the Index price from such market. However, the existing level of oversight of the Index's underlying bitcoin platforms, whose trade flows might contribute to the Index, is not equivalent to the obligations, authority, and oversight of national securities exchanges or futures exchanges and therefore is not an appropriate substitute. For example, the Commission's market oversight of national securities exchanges includes substantial requirements, including the requirement 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.” Moreover, national securities exchanges must file proposed rules with the Commission regarding certain material aspects of their operations, and the Commission has the authority to disapprove any such rule that is not consistent with the requirements of the Exchange Act. Thus, national securities exchanges are subject to Commission oversight of, among other things, their governance, membership qualifications, trading rules, disciplinary procedures, recordkeeping, and fees. The Index's underlying spot bitcoin platforms have none of these requirements—none are registered as a national securities exchange and none are comparable to a national securities exchange or futures exchange.

In addition, although BZX argues that the Data Provider's various procedures of Index oversight helps to identify patterns consistent with manipulative activity, the record does not suggest that the purported oversight represents a unique measure to resist or prevent fraud or manipulation beyond protections that exist in traditional securities or commodities markets. Rather, the oversight performed by the Data Provider of the Index's underlying bitcoin platforms appears to be for the purpose of ensuring the accuracy and integrity of the Index. Such Index accuracy and integrity oversight serves a fundamentally different purpose as compared to the regulation of national securities exchanges and the requirements of the Exchange Act. While the Commission recognizes that this may be an important function in ensuring the integrity of the Index, such requirements do not imbue the Data Provider or the Index's underlying platforms with regulatory authority similar to that which the Exchange Act confers upon self-regulatory organizations such as national securities exchanges. Furthermore, other commodity-based ETPs approved by the Commission for listing and trading utilize reference rates or indices administered by similar data providers or benchmark administrators, and the Commission has not, in those instances, dispensed with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying assets.

The Commission thus concludes that the Exchange has not demonstrated that its Index methodology makes the proposed ETP resistant to manipulation. While the proposed procedures for calculating the Index using only prices from the Index's underlying platforms are intended to provide some degree of protection against attempts to manipulate the Index, these procedures are not sufficient for the Commission to dispense with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin.

Further, BZX does not explain the significance of the Index's purported resistance to manipulation to the overall analysis of whether the proposal to list and trade the Shares is designed to prevent fraud and manipulation. To the extent that BZX's argument is that the price of the Trust's Shares would be resistant to manipulation if the Index is resistant to manipulation, BZX has not established in the record a basis for this conclusion because BZX has not established a link between the price of the Shares and the Index, either in the primary or secondary market. The Trust uses the Index to calculate the value of the bitcoin it holds according to the methodology discussed above. However, the Trust will create or redeem baskets in the primary market only upon the receipt or distribution of bitcoins from/to authorized participants, and only for the amount of bitcoin represented by the Shares in such baskets, without reference to the value of such bitcoin as determined by the Index or otherwise. In the secondary market, the Shares would trade at market-based prices, and market participants may or may not take into account the value of bitcoin as measured by the Index in determining such prices. The Exchange provides no information on the relationship between the Index and secondary market prices generally, or how the use of the Index would mitigate fraud and manipulation of the Shares in the secondary market.

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

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

(2) Assertions That BZX Has Entered Into a Comprehensive Surveillance-Sharing Agreement With a Regulated Market of Significant Size Related to the Underlying Bitcoin Assets

As BZX has not demonstrated that other means besides surveillance-sharing agreements will be sufficient to prevent fraudulent and manipulative acts and practices, the Commission next examines whether the record supports the conclusion that BZX has entered into a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying bitcoin assets. In this context, the term “market of significant size” includes a market (or group of markets) as to which (i) there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on that market to successfully manipulate the ETP, so that a surveillance-sharing agreement would assist in detecting and deterring misconduct, and (ii) it is unlikely that trading in the ETP would be the predominant influence on prices in that market.

As the Commission has explained, it considers two markets that are members of the ISG to have a comprehensive surveillance-sharing agreement with one another, even if they do not have a separate bilateral surveillance-sharing agreement. Accordingly, based on the common membership of BZX and the CME in the ISG, BZX has the equivalent of a comprehensive surveillance-sharing agreement with the CME. However, while the Commission recognizes that the CFTC regulates the CME futures market, including the CME bitcoin futures market, and thus such market is “regulated,” in the context of the proposed ETP, the record does not, as explained further below, establish that the CME bitcoin futures market is a “market of significant size” related to spot bitcoin, the underlying bitcoin assets that would be held by the Trust.

(i) Whether There Is a Reasonable Likelihood That a Person Attempting To Manipulate the ETP Would Also Have To Trade on the CME Bitcoin Futures Market To Successfully Manipulate the ETP

The first prong in establishing whether the CME bitcoin futures market constitutes a “market of significant size” related to spot bitcoin is the determination that there is a reasonable likelihood that a person attempting to manipulate the ETP would have to trade on the CME bitcoin futures market to successfully manipulate the ETP. In previous Commission orders, the Commission explained that the lead-lag relationship between the bitcoin futures market and the spot market is “central” to understanding this first prong.

(a) BZX's Assertions

According to the Exchange, “academic research . . . supports the thesis that [CME bitcoin futures] pricing leads the spot market and, thus, a person attempting to manipulate the Shares would also have to trade on that market to manipulate the ETP.” The Exchange further asserts that, “[a]ccording to the Sponsor's research presented above,” the CME bitcoin futures market “is the leading market for bitcoin price formation.” BZX argues that, where CME bitcoin futures lead the price in the spot market such that a potential manipulator of the bitcoin spot market (beyond just the constituents of the Index) would have to participate in the CME bitcoin futures market, it follows that a potential manipulator of the Shares would similarly have to transact in the CME bitcoin futures market “because the Index is based on spot prices.” Further, BZX asserts that the Trust only allows for in-kind creation and redemption, which reduces the potential for manipulation of the Shares through manipulation of the Index or any of its individual constituents, again emphasizing that a potential manipulator of the Shares would have to manipulate the entirety of the bitcoin spot market, which is led by the CME bitcoin futures market. As such, BZX believes that the significant market test outlined above is satisfied and that common membership in ISG between the Exchange and the CME would assist the listing exchange in detecting and deterring misconduct in the Shares.

(b) Analysis

The record does not demonstrate that there is a reasonable likelihood that a person attempting to manipulate the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP. First, the econometric evidence in the record for the proposal does not support the conclusion that an interrelationship exists between the CME bitcoin futures market and the spot bitcoin market such that it is reasonably likely that a person attempting to manipulate the proposed ETP would also have to trade on the CME bitcoin futures market. The Exchange and the Sponsor exclusively rely on the findings of one section of the Hu, Hou & Oxley paper; however, they do not address issues that the Commission has previously raised with respect to this single paper. As the Commission previously explained, including in the ARK 21Shares Order, the findings of this paper's Granger causality analysis, which is widely used to formally test for lead-lag relationships, are concededly mixed.

Moreover, BZX does not present any other data supporting its conclusion. Specifically, the Exchange does not provide any additional evidence of an interrelationship between the CME bitcoin futures market, which is the regulated market, and spot bitcoin platforms, which are the markets on which the assets held by the proposed ETP would trade. As discussed in previous disapprovals, including the ARK 21Shares Order, analyses regarding whether the CME bitcoin futures market leads the spot market remain inconclusive. Thus, as in previous disapprovals, because the lead-lag analysis regarding whether the CME bitcoin futures market leads the spot market is “central” to understanding the first prong, the Commission determines that the evidence in the record is inadequate to conclude that an interrelationship exists between the CME bitcoin futures market and the spot bitcoin market such that it is reasonably likely that a person attempting to manipulate the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP.

The Exchange also makes additional assertions that are conclusory and presuppose, without additional supporting evidence, that the CME bitcoin futures market leads the price in the spot bitcoin market. For example, the Exchange's assertion that “a potential manipulator of the Shares would. . . have to transact in the CME [b]itcoin [f]utures market because the Index is based on spot prices” presupposes that “[CME] [b]itcoin [f]utures lead the price in the spot market” and assumes a link between the Index and the Shares that, as discussed above, the Exchange has not established. Likewise, the Exchange states that the Trust's in-kind create/redeem process supports the conclusion that a would-be manipulator would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP because the spot bitcoin market “is led by the CME [b]itcoin [f]utures market.” However, as discussed already, the evidence in the record is inadequate to conclude that CME bitcoin futures prices lead spot bitcoin prices, and, as also discussed further above, BZX has not demonstrated that in-kind creations and redemptions provide the Shares with a unique resistance to manipulation.

The Commission thus concludes that the information that BZX provides is not sufficient to support a determination that it is reasonably likely that a would-be manipulator of the proposed ETP would have to trade on the CME bitcoin futures market to successfully manipulate the proposed ETP. Therefore, the information in the record also does not establish that the CME bitcoin futures market is a “market of significant size” related to the assets to be held by the proposed ETP.

(ii) Whether It Is Unlikely That Trading in the Proposed ETP Would Be the Predominant Influence on Prices in the CME Bitcoin Futures Market

The second prong in establishing whether the CME bitcoin futures market constitutes a “market of significant size” related to spot bitcoin is the determination that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market.

(a) BZX's Assertions

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

(b) Analysis

The Commission does not agree with BZX's assertions, which are substantially the same assertions that BZX made, and the Commission discussed, in the ARK 21Shares Order. Now, as then, the record does not demonstrate that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market. As the Commission has already addressed and rejected one of the bases of BZX's assertion—that CME bitcoin futures lead price discovery —the Commission will only address below the other two bases: the overall size of, and the impact of buys and sells on, the bitcoin market.

BZX's assertions about the potential effect of trading in the Shares on the CME bitcoin futures market and spot bitcoin market are general and conclusory, citing to the aforementioned trade volume of the CME bitcoin futures market and the size and liquidity of the spot bitcoin market, as well as the market impact of a single transaction in spot bitcoin, without any analysis or evidence to support these assertions. For example, there is no limit on the amount of mined bitcoin that the Trust may hold. Yet BZX does not provide any information on the expected growth in the size of the Trust and the resultant increase in the amount of bitcoin held by the Trust over time, or on the overall expected number, size, and frequency of creations and redemptions—or how any of the foregoing could (if at all) influence prices in the CME bitcoin futures market. Thus, the Commission cannot conclude, based on BZX's statements alone and absent any evidence or analysis in support of BZX's assertions, that it is unlikely that trading in the ETP would be the predominant influence on prices in the CME bitcoin futures market.

The Commission also is not persuaded by BZX's assertions about the minimal effect a market order to buy or sell bitcoin would have on the bitcoin market. While BZX concludes by way of an example of a $10 million market order that buying or selling large amounts of bitcoin would have insignificant market impact, the conclusion does not analyze the extent of any impact on the CME bitcoin futures market or the CME bitcoin futures market's prices. Accordingly, such statistics, without more, are not relevant to the Commission's consideration of whether trading in the ETP would be the predominant influence on prices in the CME bitcoin futures market.

To the extent that BZX is suggesting that a single $10 million order in bitcoin would have immaterial impact on the prices in the CME bitcoin futures market, the Exchange has not adequately explained why a single market order in spot bitcoin is an appropriate proxy for trading in the Shares. As stated above, the second prong in establishing whether the CME bitcoin futures market constitutes a “market of significant size” is the determination that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market. While authorized participants of the Trust might transact in the spot bitcoin market as part of their creation or redemption of Shares, the Shares themselves would be traded in the secondary market on BZX. Furthermore, the record does not discuss the expected number or trading volume of the Shares, or establish the potential effect of the Shares' trade prices on CME bitcoin futures prices. For example, BZX does not provide any data or analysis about the potential effect the quotations or trade prices of the Shares might have on market-maker quotations in CME bitcoin futures contracts and whether those effects would constitute a predominant influence on the prices of those futures contracts.

Thus, the Commission cannot conclude, based on the assertions in the filing and absent sufficient evidence or analysis in support of these assertions, that it is unlikely that trading in the proposed ETP would be the predominant influence on prices in the CME bitcoin futures market.

Therefore, because BZX has not provided sufficient information to establish both prongs of the “market of significant size” determination, the Commission cannot conclude that the CME bitcoin futures market is a “market of significant size” related to spot bitcoin such that BZX would be able to rely on a surveillance-sharing agreement with the CME to provide sufficient protection against fraudulent and manipulative acts and practices.

(3) Assertions That the Proposed Spot Bitcoin ETP Is Comparable to Bitcoin Futures-Based ETFs

(i) BZX's Assertions

BZX asserts that, after allowing the listing and trading of bitcoin futures ETFs and ETPs that hold primarily CME bitcoin futures, disapproving spot bitcoin ETPs “seems. . . arbitrary and capricious.” BZX asserts that CME bitcoin futures pricing is based on pricing from spot bitcoin markets and that the pricing mechanism applicable to the Shares is similar to that of CME bitcoin futures. BZX argues that a statement in the Commission's prior approval of CME bitcoin futures ETPs “makes clear that the Commission believes that CME's surveillance can capture the effects of trading on the relevant spot markets on the pricing of CME [b]itcoin [f]utures.” BZX asserts that it is “not logically possible” for the Commission to conclude that the CME bitcoin futures market represents a significant market for CME bitcoin futures ETPs, but also conclude that the CME bitcoin futures market does not represent a significant market for a spot bitcoin ETP. BZX also states that CME bitcoin futures ETFs and ETPs are potentially more susceptible to potential manipulation than a spot bitcoin ETP that offers only in-kind creation and redemption. BZX asserts that any objective review of the proposals to list spot bitcoin ETPs compared to the CME bitcoin futures ETFs and ETPs would lead to the conclusion that spot bitcoin ETPs should be available to U.S. investors because “any concerns related to preventing fraudulent and manipulative acts and practices related to [s]pot [b]itcoin ETPs would apply equally to the spot markets underlying the futures contracts held by a [CME] [b]itcoin [f]utures ETF.”

(ii) Analysis

The Commission disagrees with these assertions and conclusions. The proposed rule change does not relate to the same underlying holdings as ETFs regulated under the 1940 Act that provide exposure to bitcoin through CME bitcoin futures, or CME bitcoin futures-based ETPs that have registered their offerings under the Securities Act but are not regulated under the 1940 Act. The Commission considers the proposed rule change on its own merits and under the standards applicable to it. Namely, with respect to this proposed rule change, the Commission must apply the standards as provided by Section 6(b)(5) of the Exchange Act, which it has applied in connection with its orders considering previous proposals to list bitcoin-based commodity trusts and bitcoin-based trust issued receipts.

In focusing on whether “concerns related to preventing fraudulent and manipulative acts and practices related to [s]pot [b]itcoin ETPs would apply equally to the spot markets underlying the futures contracts held by a [CME] [b]itcoin [f]utures ETF,” the Exchange mischaracterizes the framework that the Commission has articulated in the Winklevoss Order. As stated in the Winklevoss Order, the Commission is not applying a “cannot be manipulated” approach—either on the CME bitcoin futures market or the spot bitcoin markets. Rather, as the Commission has repeatedly emphasized, and also summarized above, the Commission is examining whether the proposal meets the requirements of the Exchange Act and, pursuant to its Rules of Practice, is placing the burden on BZX to demonstrate the validity of its contention that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the detection and deterrence of fraud and manipulation provided by a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin, or to establish that it has entered into such a surveillance-sharing agreement.

Consistent with this approach, the Commission's consideration (and thus far, disapproval) of proposals to list and trade spot bitcoin ETPs does not focus on an assessment of the overall risk of fraud and manipulation in the spot bitcoin or futures markets, or on the extent to which such risks are similar. Rather, the Commission's focus has been consistently on whether the listing exchange has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying bitcoin assets of the ETP under consideration, so that it would have the ability to detect and deter manipulative activity. For reasons articulated in the orders approving proposals to list and trade CME bitcoin futures-based ETPs ( i.e., the Teucrium Order and the Valkyrie XBTO Order), the Commission found that in each such case the listing exchange has entered into such a surveillance-sharing agreement. Applying the same framework to this proposed spot bitcoin ETP, however, as discussed and explained above, the Commission finds that BZX has not.

Moreover, for the CME bitcoin futures ETPs under consideration in the Teucrium Order and the Valkyrie XBTO Order, the proposed “significant” regulated market ( i.e., the CME) with which the listing exchange has a surveillance-sharing agreement is the same market on which the underlying bitcoin assets ( i.e., CME bitcoin futures contracts) trade. Thus, the CME's surveillance can reasonably be relied upon to detect and deter manipulative activity caused by a person attempting to manipulate the CME bitcoin futures ETP through directly trading on the CME bitcoin futures market. Additionally, as explained in the Teucrium and the Valkyrie XBTO Orders, the CME's surveillance can also reasonably be relied upon to capture the effects on the CME bitcoin futures market caused by a person attempting to manipulate the CME bitcoin futures ETP by manipulating the price of CME bitcoin futures contracts when that attempt is made indirectly by trading outside of the CME bitcoin futures market. Regarding the approved Teucrium Bitcoin Futures Fund in the Teucrium Order (“Teucrium Fund”), for example, when the CME shares its surveillance information with the listing exchange, the information would assist in detecting and deterring fraudulent or manipulative misconduct related to the non-cash assets held by the Teucrium Fund. Accordingly, the Commission explains in the Teucrium Order and the Valkyrie XBTO Order that it is unnecessary for a listing exchange to establish a reasonable likelihood that a would-be manipulator would have to trade on the CME itself to manipulate a proposed ETP whose only non-cash holdings would be CME bitcoin futures contracts.

However, as the Commission also states in those Orders, this reasoning does not extend to spot bitcoin ETPs. Spot bitcoin markets are not currently “regulated.” If an exchange seeking to list a spot bitcoin ETP relies on the CME as the regulated market with which it has a comprehensive surveillance-sharing agreement, the assets held by the spot bitcoin ETP would not be traded on the CME. Because of this significant difference, with respect to a spot bitcoin ETP, there would be reason to question whether a surveillance-sharing agreement with the CME would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct affecting the price of the spot bitcoin held by that ETP. If, however, an exchange proposing to list and trade a spot bitcoin ETP identifies the CME as the regulated market with which it has a comprehensive surveillance-sharing agreement, the exchange could overcome the Commission's concern by demonstrating that there is a reasonable likelihood that a person attempting to manipulate the spot bitcoin ETP would have to trade on the CME in order to manipulate the ETP, because such demonstration would help establish that the exchange's surveillance-sharing agreement with the CME would have the intended effect of aiding in the detection and deterrence of fraudulent and manipulative misconduct related to the spot bitcoin held by the ETP.

Because, here, BZX is seeking to list a spot bitcoin ETP that relies on the CME as the purported “significant” regulated market with which it has a comprehensive surveillance-sharing agreement, the assets held by the proposed ETP would not be traded on the CME. Thus there is reason to question whether a surveillance-sharing agreement with the CME would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct affecting the price of the spot bitcoin held by the proposed ETP. An exchange can overcome this concern by demonstrating that there is a reasonable likelihood that a person attempting to manipulate the proposed ETP would have to trade on the CME in order to manipulate the ETP because such demonstration would help establish that an exchange's surveillance-sharing agreement with the CME would have the intended effect of aiding in the detection and deterrence of fraudulent and manipulative misconduct related to the spot bitcoin held by the proposed ETP. As discussed and explained above, the Commission finds that BZX has not made such demonstration.

To the extent that the Exchange is arguing that the CME's surveillance would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct that impacts spot bitcoin ETPs in the same way as it would for misconduct that impacts the CME bitcoin futures ETFs/ETPs, the information in the record for this filing does not support such a claim. BZX asserts that CME bitcoin futures pricing “is based on pricing from spot bitcoin markets;” that “the pricing mechanism applicable to the Shares is similar to that of the CME [b]itcoin [f]utures;” and that “this view is also consistent with the Advisor's research,” which the Commission assumes is a reference to the Sponsor's statistical claims that crypto markets are “highly correlated.” However, even accepting at face value the Sponsor's statistical claim that, minute-by-minute, CME bitcoin futures prices are highly correlated with spot bitcoin prices, such a result provides no support for the causal connection that the Exchange asserts here—namely, that CME bitcoin futures pricing “is based on” pricing from spot bitcoin markets. Moreover, if, as the Exchange claims here in the context of its arbitrary/capricious argument, CME bitcoin futures prices are “based on” spot bitcoin prices, the Exchange does not explain how this is consistent with, and indeed how it does not contradict, the Exchange's claims in the context of its “significant market” arguments that CME bitcoin futures prices “lead” spot bitcoin prices.

Moreover, even if the Exchange had demonstrated, statistically, a causal connection between spot bitcoin prices and CME bitcoin futures prices, which it has not, it does not necessarily follow that the CME's surveillance would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct that impacts spot bitcoin ETPs in the same way as it would for misconduct that impacts the CME bitcoin futures ETFs/ETPs—particularly when such misconduct occurs off of the CME itself. This is because it does not—absent supporting data—necessarily follow that any manipulation that impacts spot bitcoin also similarly impacts CME bitcoin futures contracts. The Exchange has not provided analysis or data that assesses the reaction (if any) of CME bitcoin futures contracts to instances of fraud and manipulation in spot bitcoin markets.

In addition, the disapproval of the proposal would not constitute an “arbitrary and capricious” administrative action in violation of the Administrative Procedure Act. Importantly, the issuers are not similarly situated. The issuers of CME bitcoin futures-based ETFs/ETPs propose to hold only CME bitcoin futures contracts (which are traded on the CME itself) as their only non-cash holdings, and the Trust proposes to hold only spot bitcoin (which is not traded on the CME). As explained in detail above, and in the Teucrium Order, the Valkyrie XBTO Order, and the Grayscale Order, because of this important difference, for a spot bitcoin ETP, there is reason to question whether a surveillance-sharing agreement with the CME would, in fact, assist in detecting and deterring fraudulent and manipulative misconduct affecting the price of the spot bitcoin held by that ETP. And as discussed above, neither the Exchange nor any other evidence in the record for this filing, sufficiently demonstrates that the CME's surveillance can be reasonably relied upon to capture the effects of manipulation of the spot bitcoin assets underlying the proposed ETP when such manipulation is not attempted on the CME itself.

Moreover, the analytical framework for assessing compliance with the requirements of Exchange Act Section 6(b)(5) that the Commission applies here ( i.e., comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying bitcoin assets) is the same one that the Commission has applied in each of its orders considering previous proposals to list bitcoin-based commodity trusts and trust issued receipts. The Commission has applied this framework to each proposal by analyzing the evidence presented by the listing exchange and statements made by commenters. Exchange Act Section 6(b)(5) can be satisfied by a proper showing; the Commission has in fact recently approved proposals by NYSE Arca, Inc. and the Nasdaq Stock Market to list and trade shares of ETPs holding CME bitcoin futures as their only non-cash holdings. And in the orders approving the CME bitcoin futures-based ETPs, the Commission explicitly discussed how an exchange seeking to list and trade a spot bitcoin ETP could overcome the lack of a one- to-one relationship between the regulated market with which it has a surveillance-sharing agreement and the market(s) on which the assets held by a spot bitcoin ETP could be traded: by demonstrating that there is a reasonable likelihood that a person attempting to manipulate the spot bitcoin ETP would have to trade on the regulated market ( i.e., on the CME) to manipulate the spot bitcoin ETP.

When considering past proposals for spot bitcoin ETPs, the Commission has, in particular, reviewed the econometric and/or statistical evidence in the record to determine whether the listing exchange's proposal has met the applicable standard. The Commission's assessment fundamentally presents quantitative, empirical questions, but, as discussed above, the Exchange has not provided evidence sufficient to support its arguments.

The requirements of Section 6(b)(5) of the Exchange Act apply to the rules of national securities exchanges. Accordingly, the relevant obligation to have a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin, or other means to prevent fraudulent and manipulative acts and practices that are sufficient to justify dispensing with such a surveillance-sharing agreement, resides with the listing exchange. Because there is insufficient evidence in the record demonstrating that BZX has satisfied this obligation, the Commission cannot approve the proposed ETP for listing and trading on BZX.

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

BZX contends that, if approved, the proposed ETP would protect investors and the public interest. However, the Commission must consider these potential benefits in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act. Because BZX has not demonstrated that its proposed rule change is designed to prevent fraudulent and manipulative acts and practices, the Commission must disapprove the proposal.

(1) BZX's Assertions

The Exchange states that the proposal is designed to protect investors and the public interest. BZX asserts that access for U.S. retail investors to gain exposure to bitcoin via a transparent and U.S. regulated, exchange-traded vehicle remains limited. According to the Exchange, current options include: (i) OTC bitcoin funds with high management fees and potentially volatile premiums and discounts; (ii) facing the technical risk, complexity, and generally high fees associated with buying spot bitcoin; (iii) purchasing shares of operating companies that they believe will provide proxy exposure to bitcoin with limited disclosure about the associated risks; or (iv) purchasing CME bitcoin futures ETFs that represent a sub-optimal investment for long-term investors. BZX explains that over the past several years, U.S. investor exposure to bitcoin through OTC bitcoin funds has grown into the tens of billions of dollars and more than a billion dollars of exposure through CME bitcoin futures ETFs. BZX states that with that growth, so too has grown the quantifiable investor protection issues to U.S. investors through roll costs for bitcoin futures ETFs and premium/discount volatility and management fees for OTC bitcoin funds. BZX asserts that the concerns related to the prevention of fraudulent and manipulative acts and practices have been sufficiently addressed to be consistent with the Exchange Act and, as such, approving the proposal (and comparable proposals) would provide U.S. investors access to bitcoin in a regulated and transparent exchange-traded vehicle that would act to limit risk to U.S. investors by: (i) reducing premium and discount volatility; (ii) reducing management fees through meaningful competition; (iii) reducing risks and costs associated with investing in CME bitcoin futures ETFs and operating companies that are imperfect proxies for bitcoin exposure; and (iv) providing an alternative to custodying spot bitcoin.

BZX states that a number of operating companies engaged in unrelated businesses have announced investments as large as $5.3 billion in bitcoin. BZX argues that, without access to bitcoin ETPs, retail investors seeking investment exposure to bitcoin may purchase shares in these companies in order to gain exposure to bitcoin. BZX contends that such operating companies, however, are imperfect bitcoin proxies and provide investors with partial bitcoin exposure paired with additional risks associated with whichever operating company they decide to purchase. BZX concludes that investors seeking bitcoin exposure through publicly traded companies are gaining only partial exposure to bitcoin and are not fully benefitting from the risk disclosures and associated investor protections that come from the securities registration process.

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

(2) Analysis

The Commission disagrees that the proposal should be approved because it is designed to protect investors and the public interest. Here, even if it were true that, compared to trading in unregulated spot bitcoin markets or OTC bitcoin funds, trading a spot bitcoin-based ETP on a national securities exchange could provide some additional protection to investors, or that the Shares would provide more efficient exposure to bitcoin than other products on the market such as CME bitcoin futures ETFs/ETPs, 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. Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must approve a proposed rule change filed by a national securities exchange if it finds that the proposed rule change is consistent with the applicable requirements of the Exchange Act—including the requirement under Section 6(b)(5) that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices—and it must disapprove the filing if it does not make such a finding. Thus, even if a proposed rule change purports to protect investors from a particular type of investment risk—such as experiencing a potentially high premium/discount by investing in OTC bitcoin funds or roll costs by investing in bitcoin futures ETFs/ETPs—or purports to provide benefits to investors and the public interest—such as enhancing competition—the proposed rule change may still fail to meet the requirements under the Exchange Act.

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

IV. Conclusion

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

It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act, that proposed rule change SR-CboeBZX-2022-031 be, and it hereby is, disapproved.