SEC Rejects BZX Bid to List Winklevoss Bitcoin Trust

The U.S. Securities and Exchange Commission on July 26, 2018 disapproved Bats BZX Exchange’s proposed rule change to list and trade shares of the Winklevoss Bitcoin Trust, concluding that the exchange had not demonstrated compliance with federal requirements intended to prevent fraudulent and manipulative practices.

The 92-page order concerned a proposed exchange-traded product that would have held bitcoin and used a Gemini Exchange auction to value its shares. The decision prevented that specific product from reaching a national securities exchange and clarified the evidentiary burden the SEC was applying to bitcoin-based commodity trusts.

A new decision after Commission review

BZX originally filed the proposed rule change on June 30, 2016. SEC staff, acting under delegated authority, disapproved it on March 10, 2017. BZX petitioned for Commission review, which produced the July 26, 2018 order.

The procedural distinction mattered: the Commission formally set aside the staff’s earlier action, conducted a de novo review of the record and then disapproved the proposal again. It did not reverse the practical outcome.

Under the proposal, the trust would have held only bitcoin. Gemini Trust Company would have served as custodian, while the product’s daily net asset value would have been based on the Gemini Exchange’s 4 p.m. Eastern Time bitcoin auction. Creation and redemption transactions would have occurred in baskets of 100,000 shares and in kind for bitcoin. An indicative value would have been disseminated every 15 seconds during BZX’s regular trading session.

Those mechanics offered a familiar exchange-listed wrapper for bitcoin exposure. The SEC nevertheless found that product design alone did not establish compliance with Section 6(b)(5) of the Securities Exchange Act, which requires exchange rules to be designed to prevent fraudulent and manipulative acts and protect investors and the public interest.

Surveillance was the central obstacle

BZX argued that bitcoin’s geographically distributed, continuous trading made manipulation difficult and that the market had protections unavailable in traditional commodity markets. The Commission found that the record did not substantiate those claims.

Its analysis centered on surveillance-sharing. BZX had an agreement with Gemini, but the Commission did not consider Gemini a regulated bitcoin market of significant size for this purpose. Nor did the record establish that the bitcoin derivatives markets then operating through LedgerX, CME and Cboe Futures Exchange were sufficiently large.

That finding reflected the market structure visible on July 26, 2018. Regulated U.S. bitcoin futures had begun trading only in December 2017, and the Commission said reliable information about the overall size of the global spot market was unavailable. It also observed that a substantial majority of bitcoin trading appeared to occur on relatively new, unregulated overseas venues.

The SEC expressly limited the meaning of its decision. It said the disapproval was not an evaluation of whether bitcoin or blockchain technology had utility or value. The defect was the record supporting BZX’s rule filing, particularly the absence of demonstrated surveillance arrangements with a regulated, bitcoin-related market of significant size or adequate alternative protections.

Peirce challenges the standard

Commissioner Hester M. Peirce issued a contemporaneous dissent. She argued that the statutory inquiry should focus on BZX’s rules for trading and supervising the trust’s shares, rather than the characteristics of the underlying bitcoin spot market. In her view, BZX’s listing standards, market-maker obligations and authority to halt trading satisfied the relevant standard.

Peirce also contended that an exchange-listed product could encourage institutional participation, stronger custody practices, additional arbitrage and closer scrutiny of trading venues. The majority acknowledged that an exchange-traded product could reduce some costs and complexities of direct bitcoin exposure, but concluded that potential benefits could not substitute for the required Exchange Act showing.

As of July 26, 2018, the order left open the possibility that a future proposal could produce a different result if regulated bitcoin markets grew or surveillance arrangements improved. It did not establish when, or whether, those conditions would develop.