Notice2021-27824
Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Notice of Filing of Amendment No. 1 to 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
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
December 27, 2021
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 86 Issue 245 (Monday, December 27, 2021)</title>
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[Federal Register Volume 86, Number 245 (Monday, December 27, 2021)]
[Notices]
[Pages 73360-73391]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-27824]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-93822; File No. SR-CboeBZX-2021-051]
Self-Regulatory Organizations; Cboe BZX Exchange, Inc.; Notice of
Filing of Amendment No. 1 to 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
December 17, 2021.
I. Introduction
On July 20, 2021, Cboe BZX Exchange, Inc. (``BZX'') filed with the
Securities and Exchange Commission (``Commission''), pursuant to
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'' or
``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ 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. The proposed rule
change was published for comment in the Federal Register on August 6,
2021.\3\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 92543 (Aug. 2,
2021), 86 FR 43289. Comments on the proposed rule change can be
found at: <a href="https://www.sec.gov/comments/sr-cboebzx-2021-051/srcboebzx2021051.htm">https://www.sec.gov/comments/sr-cboebzx-2021-051/srcboebzx2021051.htm</a>.
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[[Page 73361]]
On September 15, 2021, pursuant to Section 19(b)(2) of the Exchange
Act,\4\ the Commission designated a longer period within which to
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to disapprove the
proposed rule change.\5\ On November 2, 2021, the Commission instituted
proceedings under Section 19(b)(2)(B) of the Exchange Act \6\ to
determine whether to approve or disapprove the proposed rule change.\7\
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\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 92989, 86 FR 52530
(Sept. 21, 2021).
\6\ 15 U.S.C. 78s(b)(2)(B).
\7\ See Securities Exchange Act Release No. 93510, 86 FR 61820
(Nov. 8, 2021).
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On December 9, 2021, the Exchange filed Amendment No. 1 to the
proposed rule change, which replaced and superseded the proposed rule
change as originally filed.\8\ The Commission is publishing this notice
to solicit comments from interested persons on Amendment No. 1, as
described in Items II and III below, which Items have been prepared by
the Exchange.
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\8\ Amendment No. 1 is available at: <a href="https://www.sec.gov/comments/sr-cboebzx-2021-051/srcboebzx2021051-9436437-263630.pdf">https://www.sec.gov/comments/sr-cboebzx-2021-051/srcboebzx2021051-9436437-263630.pdf</a>.
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II. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes a rule change to list and trade shares of the
ARK 21Shares Bitcoin ETF (the ``Trust''),\9\ under BZX Rule
14.11(e)(4), Commodity-Based Trust Shares. The shares of the Trust are
referred to herein as the ``Shares.''
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\9\ The Trust was formed as a Delaware statutory trust on June
22, 2021 and is operated as a grantor trust for U.S. federal tax
purposes. The Trust has no fixed termination date.
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The text of the proposed rule change is also available on the
Exchange's website (<a href="http://markets.cboe.com/us/equities/regulation/rule_filings/bzx/">http://markets.cboe.com/us/equities/regulation/rule_filings/bzx/</a>), at the Exchange's Office of the Secretary, and at
the Commission's Public Reference Room.
III. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
This Amendment No. 1 to SR-CboeBZX-2021-051 amends and replaces in
its entirety the proposal as originally submitted on July 20, 2021. The
Exchange submits this Amendment No. 1 in order to clarify certain
points and add additional details to the proposal.
The Exchange proposes to list and trade the Shares under BZX Rule
14.11(e)(4),\10\ which governs the listing and trading of Commodity-
Based Trust Shares on the Exchange.\11\ 21Shares US LLC is the sponsor
of the Trust (the ``Sponsor''). The Shares will be registered with the
Commission by means of the Trust's registration statement on Form S-1
(the ``Registration Statement'').\12\ As further discussed below, the
Commission has historically approved or disapproved exchange filings to
list and trade series of Trust Issued Receipts, including spot-based
Commodity-Based Trust Shares, on the basis of whether the listing
exchange has in place a comprehensive surveillance sharing agreement
with a regulated market of significant size related to the underlying
commodity.\13\ A survey of previously approved series of Commodity-
Based Trust Shares and Currency Trust Shares makes clear that the spot
markets for commodities and currencies held in such ETPs are generally
unregulated. In fact, the Commission specifically noted in the
Winklevoss Order that the first gold ETP approval order, which was also
the first commodity-trust ETP, ``was based on an assumption that the
currency market and the spot gold market were largely unregulated.''
\14\ This makes clear that the applicable standard is not whether the
underlying commodity market itself is regulated. Further to this point,
prior orders have also emphasized that in every prior approval order
for Commodity-Based Trust Shares there was a regulated derivatives
market of significant size, generally a Commodity Futures Trading
Commission (the ``CFTC'') regulated futures market.\15\
[[Page 73362]]
Despite the lack of regulation of the underlying spot commodity and
currency markets, the Commission approved series of Currency and
Commodity-Based Trust Shares, including those that held gold, silver,
platinum, palladium, copper, and other commodities and currencies,
because it determined that the futures markets for these commodities
and currencies represented regulated markets of significant size and
that the listing exchange had a surveillance sharing agreement in place
with that market.\16\
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\10\ The Commission approved BZX Rule 14.11(e)(4) in Securities
Exchange Act Release No. 65225 (August 30, 2011), 76 FR 55148
(September 6, 2011) (SR-BATS-2011-018).
\11\ All statements and representations made in this filing
regarding (a) the description of the portfolio, (b) limitations on
portfolio holdings or reference assets, or (c) the applicability of
Exchange rules and surveillance procedures shall constitute
continued listing requirements for listing the Shares on the
Exchange.
\12\ See draft Registration Statement on Form S-1, dated June
28, 2021 submitted to the Commission by the Sponsor on behalf of the
Trust. The descriptions of the Trust, the Shares, and the Index (as
defined below) contained herein are based, in part, on information
in the Registration Statement. The Registration Statement is not yet
effective and the Shares will not trade on the Exchange until such
time that the Registration Statement is effective.
\13\ See Securities Exchange Act Release No. 83723 (July 26,
2018), 83 FR 37579 (August 1, 2018). This proposal was subsequently
disapproved by the Commission. See Securities Exchange Act Release
No. 83723 (July 26, 2018), 83 FR 37579 (August 1, 2018) (the
``Winklevoss Order'').
\14\ See Winklevoss Order at 37592 and Exchange Act Release No.
50603 (Oct. 28, 2004), 69 FR 64614 (Nov. 5, 2004) (SR-NYSE-2004-22)
(order approving the listing and trading of streetTRACKS Gold
Shares) (the ``First Gold Approval Order'').
\15\ See Winklevoss Order at 37592. See also the First Gold
Approval Order at 64618-19; iShares COMEX Gold Trust, Exchange Act
Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751, 3754-55 (Jan.
26, 2005) (SR-Amex-2004-38); iShares Silver Trust, Exchange Act
Release No. 53521 (Mar. 20, 2006), 71 FR 14967, 14968, 14973-74
(Mar. 24, 2006) (SR-Amex-2005-072); ETFS Gold Trust, Exchange Act
Release No. 59895 (May 8, 2009), 74 FR 22993, 22994-95, 22998, 23000
(May 15, 2009) (SR-NYSEArca-2009-40); ETFS Silver Trust, Exchange
Act Release No. 59781 (Apr. 17, 2009), 74 FR 18771, 18772, 18775-77
(Apr. 24, 2009) (SR-NYSEArca-2009-28); ETFS Palladium Trust,
Exchange Act Release No. 61220 (Dec. 22, 2009), 74 FR 68895, 68896
(Dec. 29, 2009) (SR-NYSEArca-2009-94) (notice of proposed rule
change included NYSE Arca's representation that ``[t]he most
significant palladium futures exchanges are the NYMEX and the Tokyo
Commodity Exchange,'' that ``NYMEX is the largest exchange in the
world for trading precious metals futures and options,'' and that
NYSE Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' of which NYMEX is a member, Exchange Act
Release No. 60971 (Nov. 9, 2009), 74 FR 59283, 59285-86, 59291 (Nov.
17, 2009)); ETFS Platinum Trust, Exchange Act Release No. 61219
(Dec. 22, 2009), 74 FR 68886, 68887-88 (Dec. 29, 2009) (SR-NYSEArca-
2009-95) (notice of proposed rule change included NYSE Arca's
representation that ``[t]he most significant platinum futures
exchanges are the NYMEX and the Tokyo Commodity Exchange,'' that
``NYMEX is the largest exchange in the world for trading precious
metals futures and options,'' and that NYSE Arca ``may obtain
trading information via the Intermarket Surveillance Group,'' of
which NYMEX is a member, Exchange Act Release No. 60970 (Nov. 9,
2009), 74 FR 59319, 59321, 59327 (Nov. 17, 2009)); Sprott Physical
Gold Trust, Exchange Act Release No. 61496 (Feb. 4, 2010), 75 FR
6758, 6760 (Feb. 10, 2010) (SR-NYSEArca-2009-113) (notice of
proposed rule change included NYSE Arca's representation that the
COMEX is one of the ``major world gold markets,'' that NYSE Arca
``may obtain trading information via the Intermarket Surveillance
Group,'' and that NYMEX, of which COMEX is a division, is a member
of the Intermarket Surveillance Group, Exchange Act Release No.
61236 (Dec. 23, 2009), 75 FR 170, 171, 174 (Jan. 4, 2010)); Sprott
Physical Silver Trust, Exchange Act Release No. 63043 (Oct. 5,
2010), 75 FR 62615, 62616, 62619, 62621 (Oct. 12, 2010) (SR-
NYSEArca-2010-84); ETFS Precious Metals Basket Trust, Exchange Act
Release No. 62692 (Aug. 11, 2010), 75 FR 50789, 50790 (Aug. 17,
2010) (SR-NYSEArca-2010-56) (notice of proposed rule change included
NYSE Arca's representation that ``the most significant gold, silver,
platinum and palladium futures exchanges are the COMEX and the
TOCOM'' and that NYSE Arca ``may obtain trading information via the
Intermarket Surveillance Group,'' of which COMEX is a member,
Exchange Act Release No. 62402 (Jun. 29, 2010), 75 FR 39292, 39295,
39298 (July 8, 2010)); ETFS White Metals Basket Trust, Exchange Act
Release No. 62875 (Sept. 9, 2010), 75 FR 56156, 56158 (Sept. 15,
2010) (SR-NYSEArca-2010-71) (notice of proposed rule change included
NYSE Arca's representation that ``the most significant silver,
platinum and palladium futures exchanges are the COMEX and the
TOCOM'' and that NYSE Arca ``may obtain trading information via the
Intermarket Surveillance Group,'' of which COMEX is a member,
Exchange Act Release No. 62620 (July 30, 2010), 75 FR 47655, 47657,
47660 (Aug. 6, 2010)); ETFS Asian Gold Trust, Exchange Act Release
No. 63464 (Dec. 8, 2010), 75 FR 77926, 77928 (Dec. 14, 2010) (SR-
NYSEArca-2010-95) (notice of proposed rule change included NYSE
Arca's representation that ``the most significant gold futures
exchanges are the COMEX and the Tokyo Commodity Exchange,'' that
``COMEX is the largest exchange in the world for trading precious
metals futures and options,'' and that NYSE Arca ``may obtain
trading information via the Intermarket Surveillance Group,'' of
which COMEX is a member, Exchange Act Release No. 63267 (Nov. 8,
2010), 75 FR 69494, 69496, 69500-01 (Nov. 12, 2010)); Sprott
Physical Platinum and Palladium Trust, Exchange Act Release No.
68430 (Dec. 13, 2012), 77 FR 75239, 75240-41 (Dec. 19, 2012) (SR-
NYSEArca-2012-111) (notice of proposed rule change included NYSE
Arca's representation that ``[f]utures on platinum and palladium are
traded on two major exchanges: The New York Mercantile Exchange . .
. and Tokyo Commodities Exchange'' and that NYSE Arca ``may obtain
trading information via the Intermarket Surveillance Group,'' of
which COMEX is a member, Exchange Act Release No. 68101 (Oct. 24,
2012), 77 FR 65732, 65733, 65739 (Oct. 30, 2012)); APMEX Physical--1
oz. Gold Redeemable Trust, Exchange Act Release No. 66930 (May 7,
2012), 77 FR 27817, 27818 (May 11, 2012) (SR-NYSEArca-2012-18)
(notice of proposed rule change included NYSE Arca's representation
that NYSE Arca ``may obtain trading information via the Intermarket
Surveillance Group,'' of which COMEX is a member, and that gold
futures are traded on COMEX and the Tokyo Commodity Exchange, with a
cross-reference to the proposed rule change to list and trade shares
of the ETFS Gold Trust, in which NYSE Arca represented that COMEX is
one of the ``major world gold markets,'' Exchange Act Release No.
66627 (Mar. 20, 2012), 77 FR 17539, 17542-43, 17547 (Mar. 26,
2012)); JPM XF Physical Copper Trust, Exchange Act Release No. 68440
(Dec. 14, 2012), 77 FR 75468, 75469-70, 75472, 75485-86 (Dec. 20,
2012) (SR-NYSEArca-2012-28); iShares Copper Trust, Exchange Act
Release No. 68973 (Feb. 22, 2013), 78 FR 13726, 13727, 13729-30,
13739-40 (Feb. 28, 2013) (SR-NYSEArca-2012-66); First Trust Gold
Trust, Exchange Act Release No. 70195 (Aug. 14, 2013), 78 FR 51239,
51240 (Aug. 20, 2013) (SR-NYSEArca-2013-61) (notice of proposed rule
change included NYSE Arca's representation that FINRA, on behalf of
the exchange, may obtain trading information regarding gold futures
and options on gold futures from members of the Intermarket
Surveillance Group, including COMEX, or from markets ``with which
[NYSE Arca] has in place a comprehensive surveillance sharing
agreement,'' and that gold futures are traded on COMEX and the Tokyo
Commodity Exchange, with a cross-reference to the proposed rule
change to list and trade shares of the ETFS Gold Trust, in which
NYSE Arca represented that COMEX is one of the ``major world gold
markets,'' Exchange Act Release No. 69847 (June 25, 2013), 78 FR
39399, 39400, 39405 (July 1, 2013)); Merk Gold Trust, Exchange Act
Release No. 71378 (Jan. 23, 2014), 79 FR 4786, 4786-87 (Jan. 29,
2014) (SR-NYSEArca-2013-137) (notice of proposed rule change
included NYSE Arca's representation that ``COMEX is the largest gold
futures and options exchange'' and that NYSE Arca ``may obtain
trading information via the Intermarket Surveillance Group,''
including with respect to transactions occurring on COMEX pursuant
to CME and NYMEX's membership, or from exchanges ``with which [NYSE
Arca] has in place a comprehensive surveillance sharing agreement,''
Exchange Act Release No. 71038 (Dec. 11, 2013), 78 FR 76367, 76369,
76374 (Dec. 17, 2013)); Long Dollar Gold Trust, Exchange Act Release
No. 79518 (Dec. 9, 2016), 81 FR 90876, 90881, 90886, 90888 (Dec. 15,
2016) (SR-NYSEArca-2016-84).
\16\ Id.
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The Exchange acknowledges that unregulated currency and commodity
markets do not provide the same protections as the markets that are
subject to the Commission's oversight. However, the Commission has
consistently looked to surveillance sharing agreements with an
underlying futures market to determine whether ETPs holding currency or
commodities were consistent with the Act, as established above. As
such, the Commission's regulated market of significant size test does
not require that the spot bitcoin market be regulated to approve this
proposal. To the contrary, precedent makes clear that any requirement
that the spot bitcoin market be a ``regulated market'' prior to
approval would be incongruous with all prior spot commodity and
currency approval orders. With this in mind, the CME Bitcoin Futures
market is the proper market for the Commission to consider in
determining whether this proposal is consistent with the Act. The
Exchange has a comprehensive surveillance sharing agreement in place
with CME, which operates a bitcoin futures market that, as established
by the included analysis below, represents a regulated market of
significant size related to the underlying commodity (bitcoin) to be
held by the Trust. Therefore, both the Exchange and the Sponsor believe
that the CME Bitcoin Futures market satisfies the standard that the
Commission has applied to all previously approved series of Commodity-
Based Trust Shares and that this proposal should be approved.
Background
Bitcoin is a digital asset based on the decentralized, open source
protocol of the peer-to-peer computer network launched in 2009 that
governs the creation, movement, and ownership of bitcoin and hosts the
public ledger, or ``blockchain,'' on which all bitcoin transactions are
recorded (the ``Bitcoin Network'' or ``Bitcoin''). The decentralized
nature of the Bitcoin Network allows parties to transact directly with
one another based on cryptographic proof instead of relying on a
trusted third party. The protocol also lays out the rate of issuance of
new bitcoin within the Bitcoin Network, a rate that is reduced by half
approximately every four years with an eventual hard cap of 21 million.
It's generally understood that the combination of these two features--a
systemic hard cap of 21 million bitcoin and the ability to transact
trustlessly with anyone connected to the Bitcoin Network--gives bitcoin
its value.\17\ The first rule filing proposing to list an exchange-
traded product to provide exposure to bitcoin in the U.S. was submitted
by the Exchange on June 30, 2016.\18\ At that time, blockchain
technology, and digital assets that utilized it, were relatively new to
the broader public. The market cap of all bitcoin in existence at that
time was approximately $10 billion. No registered offering of digital
asset securities or shares in an investment vehicle with exposure to
bitcoin or any other cryptocurrency had yet been conducted, and the
regulated infrastructure for conducting a digital asset securities
offering had not begun to develop.\19\ Similarly, regulated U.S.
bitcoin futures contracts did not exist. The CFTC had determined that
bitcoin is a commodity,\20\ but had not engaged in
[[Page 73363]]
significant enforcement actions in the space. The New York Department
of Financial Services (``NYDFS'') adopted its final BitLicense
regulatory framework in 2015, but had only approved four entities to
engage in activities relating to virtual currencies (whether through
granting a BitLicense or a limited-purpose trust charter) as of June
30, 2016.\21\ While the first over-the-counter bitcoin fund launched in
2013, public trading was limited and the fund had only $60 million in
assets.\22\ There were very few, if any, traditional financial
institutions engaged in the space, whether through investment or
providing services to digital asset companies. In January 2018, the
Staff of the Commission noted in a letter to the Investment Company
Institute and SIFMA that it was not aware, at that time, of a single
custodian providing fund custodial services for digital assets.\23\
Fast forward to the fourth quarter of 2021 and the digital assets
financial ecosystem, including bitcoin, has progressed significantly.
The development of a regulated market for digital asset securities has
significantly evolved, with market participants having conducted
registered public offerings of both digital asset securities \24\ and
shares in investment vehicles holding bitcoin futures.\25\
Additionally, licensed and regulated service providers have emerged to
provide fund custodial services for digital assets, among other
services. For example, in May 2021, the Staff of the Commission
released a statement permitting open-end mutual funds to invest in
cash-settled bitcoin futures; in December 2020, the Commission adopted
a conditional no-action position permitting certain special purpose
broker-dealers to custody digital asset securities under Rule 15c3-3
under the Exchange Act (the ``Custody Statement''); \26\ in September
2020, the Staff of the Commission released a no-action letter
permitting certain broker-dealers to operate a non-custodial
Alternative Trading System (``ATS'') for digital asset securities,
subject to specified conditions; \27\ in October 2019, the Staff of the
Commission granted temporary relief from the clearing agency
registration requirement to an entity seeking to establish a securities
clearance and settlement system based on distributed ledger
technology,\28\ and multiple transfer agents who provide services for
digital asset securities registered with the Commission.\29\
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\17\ For additional information about bitcoin and the Bitcoin
Network, see <a href="https://bitcoin.org/en/getting-started">https://bitcoin.org/en/getting-started</a>; <a href="https://www.fidelitydigitalassets.com/articles/addressing-bitcoin-criticisms">https://www.fidelitydigitalassets.com/articles/addressing-bitcoin-criticisms</a>; and <a href="https://www.vaneck.com/education/investment-ideas/investing-in-bitcoin-and-digital-assets/">https://www.vaneck.com/education/investment-ideas/investing-in-bitcoin-and-digital-assets/</a>.
\18\ See Winklevoss Order.
\19\ Digital assets that are securities under U.S. law are
referred to throughout this proposal as ``digital asset
securities.'' All other digital assets, including bitcoin, are
referred to interchangeably as ``cryptocurrencies'' or ``virtual
currencies.'' The term ``digital assets'' refers to all digital
assets, including both digital asset securities and
cryptocurrencies, together.
\20\ See ``In the Matter of Coinflip, Inc.'' (``Coinflip'')
(CFTC Docket 15-29 (September 17, 2015)) (order instituting
proceedings pursuant to Sections 6(c) and 6(d) of the CEA, making
findings and imposing remedial sanctions), in which the CFTC stated:
``Section 1a(9) of the CEA defines `commodity' to include, among
other things, `all services, rights, and interests in which
contracts for future delivery are presently or in the future dealt
in.' 7 U.S.C. 1a(9). The definition of a `commodity' is broad. See,
e.g., Board of Trade of City of Chicago v. SEC, 677 F. 2d 1137, 1142
(7th Cir. 1982). Bitcoin and other virtual currencies are
encompassed in the definition and properly defined as commodities.''
\21\ A list of virtual currency businesses that are entities
regulated by the NYDFS is available on the NYDFS website. See
<a href="https://www.dfs.ny.gov/apps_and_licensing/virtual_currency_businesses/regulated_entities">https://www.dfs.ny.gov/apps_and_licensing/virtual_currency_businesses/regulated_entities</a>.
\22\ Data as of March 31, 2016 according to publicly available
filings. See Bitcoin Investment Trust Form S-1, dated May 27, 2016,
available: <a href="https://www.sec.gov/Archives/edgar/data/1588489/000095012316017801/filename1.htm">https://www.sec.gov/Archives/edgar/data/1588489/000095012316017801/filename1.htm</a>.
\23\ See letter from Dalia Blass, Director, Division of
Investment Management, U.S. Securities and Exchange Commission to
Paul Schott Stevens, President & CEO, Investment Company Institute
and Timothy W. Cameron, Asset Management Group--Head, Securities
Industry and Financial Markets Association (January 18, 2018),
available at <a href="https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm">https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm</a>.
\24\ See Prospectus supplement filed pursuant to Rule 424(b)(1)
for INX Tokens (Registration No. 333-233363), available at: <a href="https://www.sec.gov/Archives/edgar/data/1725882/000121390020023202/ea125858-424b1_inxlimited.htm">https://www.sec.gov/Archives/edgar/data/1725882/000121390020023202/ea125858-424b1_inxlimited.htm</a>.
\25\ See Prospectus filed by Stone Ridge Trust VI on behalf of
NYDIG Bitcoin Strategy Fund Registration, available at: <a href="https://www.sec.gov/Archives/edgar/data/1764894/000119312519309942/d693146d497.htm">https://www.sec.gov/Archives/edgar/data/1764894/000119312519309942/d693146d497.htm</a>.
\26\ See Securities Exchange Act Release No. 90788, 86 FR 11627
(February 26, 2021) (File Number S7-25-20) (Custody of Digital Asset
Securities by Special Purpose Broker-Dealers).
\27\ See letter from Elizabeth Baird, Deputy Director, Division
of Trading and Markets, U.S. Securities and Exchange Commission to
Kris Dailey, Vice President, Risk Oversight & Operational
Regulation, Financial Industry Regulatory Authority (September 25,
2020), available at: <a href="https://www.sec.gov/divisions/marketreg/mr-noaction/2020/finra-ats-role-in-settlement-of-digital-asset-security-trades-09252020.pdf">https://www.sec.gov/divisions/marketreg/mr-noaction/2020/finra-ats-role-in-settlement-of-digital-asset-security-trades-09252020.pdf</a>.
\28\ See letter from Jeffrey S. Mooney, Associate Director,
Division of Trading and Markets, U.S. Securities and Exchange
Commission to Charles G. Cascarilla & Daniel M. Burstein, Paxos
Trust Company, LLC (October 28, 2019), available at: <a href="https://www.sec.gov/divisions/marketreg/mr-noaction/2019/paxos-trust-company-102819-17a.pdf">https://www.sec.gov/divisions/marketreg/mr-noaction/2019/paxos-trust-company-102819-17a.pdf</a>.
\29\ See, e.g., Form TA-1/A filed by Tokensoft Transfer Agent
LLC (CIK: 0001794142) on January 8, 2021, available at: <a href="https://www.sec.gov/Archives/edgar/data/1794142/000179414219000001/xslFTA1X01/primary_doc.xml">https://www.sec.gov/Archives/edgar/data/1794142/000179414219000001/xslFTA1X01/primary_doc.xml</a>.
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Outside the Commission's purview, the regulatory landscape has
changed significantly since 2016, and cryptocurrency markets have grown
and evolved as well. The market for bitcoin is approximately 100 times
larger, with a market cap of over $1 trillion.\30\ According to the CME
Bitcoin Futures Report, from October 25, 2021 through November 19,
2021, CFTC regulated bitcoin futures represented approximately $2.9
billion in notional trading volume on Chicago Mercantile Exchange
(``CME'') (``CME Bitcoin Futures'') on a daily basis and notional
volume was never below $1.2 billion per day.\31\ Open interest was over
$4 billion for the entirety of the period and at one point reached $5.5
billion. The CFTC has exercised its regulatory jurisdiction in bringing
a number of enforcement actions related to bitcoin and against trading
platforms that offer cryptocurrency trading.\32\ The U.S. Office of the
Comptroller of the Currency (the ``OCC'') has made clear that
federally-chartered banks are able to provide custody services for
cryptocurrencies and other digital assets.\33\ The OCC recently granted
conditional approval of two charter conversions by state-chartered
trust companies to national banks, both of which provide cryptocurrency
custody services.\34\ NYDFS has granted no fewer than twenty-five
BitLicenses, including to established public payment companies like
PayPal Holdings, Inc. and Square, Inc., and limited purpose trust
charters to entities providing cryptocurrency custody services,
including the Trust's Custodian. The U.S. Treasury Financial Crimes
Enforcement Network (``FinCEN'') has released extensive guidance
regarding the applicability of the Bank Secrecy Act (``BSA'') and
implementing regulations to virtual currency businesses,\35\ and has
proposed rules imposing requirements on entities subject to the BSA
that are specific to the technological context of virtual
currencies.\36\ In addition, the Treasury's
[[Page 73364]]
Office of Foreign Assets Control (``OFAC'') has brought enforcement
actions over apparent violations of the sanctions laws in connection
with the provision of wallet management services for digital
assets.\37\
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\30\ As of December 1, 2021, the total market cap of all bitcoin
in circulation was approximately $1.08 trillion.
\31\ Data sourced from the CME Bitcoin Futures Report: 19 Nov,
2021, available at: <a href="https://www.cmegroup.com/ftp/bitcoinfutures/Bitcoin_Futures_Liquidity_Report.pdf">https://www.cmegroup.com/ftp/bitcoinfutures/Bitcoin_Futures_Liquidity_Report.pdf</a>.
\32\ The CFTC's annual report for Fiscal Year 2020 (which ended
on September 30, 2020) noted that the CFTC ``continued to
aggressively prosecute misconduct involving digital assets that fit
within the CEA's definition of commodity'' and ``brought a record
setting seven cases involving digital assets.'' See CFTC FY2020
Division of Enforcement Annual Report, available at: <a href="https://www.cftc.gov/media/5321/DOE_FY2020_AnnualReport_120120/download">https://www.cftc.gov/media/5321/DOE_FY2020_AnnualReport_120120/download</a>.
Additionally, the CFTC filed on October 1, 2020, a civil enforcement
action against the owner/operators of the BitMEX trading platform,
which was one of the largest bitcoin derivative exchanges. See CFTC
Release No. 8270-20 (October 1, 2020) available at: <a href="https://www.cftc.gov/PressRoom/PressReleases/8270-20">https://www.cftc.gov/PressRoom/PressReleases/8270-20</a>.
\33\ See OCC News Release 2021-2 (January 4, 2021) available at:
<a href="https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-2.html">https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-2.html</a>.
\34\ See OCC News Release 2021-6 (January 13, 2021) available
at: <a href="https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-6.html">https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-6.html</a> and OCC News Release 2021-19 (February 5, 2021)
available at: <a href="https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-19.html">https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-19.html</a>.
\35\ See FinCEN Guidance FIN-2019-G001 (May 9, 2019)
(Application of FinCEN's Regulations to Certain Business Models
Involving Convertible Virtual Currencies) available at: <a href="https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf">https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf</a>.
\36\ See U.S. Department of the Treasury Press Release: ``The
Financial Crimes Enforcement Network Proposes Rule Aimed at Closing
Anti-Money Laundering Regulatory Gaps for Certain Convertible
Virtual Currency and Digital Asset Transactions'' (December 18,
2020), available at: <a href="https://home.treasury.gov/news/press-releases/sm1216">https://home.treasury.gov/news/press-releases/sm1216</a>.
\37\ See U.S. Department of the Treasury Enforcement Release:
``OFAC Enters Into $98,830 Settlement with BitGo, Inc. for Apparent
Violations of Multiple Sanctions Programs Related to Digital
Currency Transactions'' (December 30, 2020) available at: <a href="https://home.treasury.gov/system/files/126/20201230_bitgo.pdf">https://home.treasury.gov/system/files/126/20201230_bitgo.pdf</a>.
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In addition to the regulatory developments laid out above, more
traditional financial market participants have embraced and continue to
embrace cryptocurrency: Large insurance companies,\38\ asset
managers,\39\ university endowments,\40\ pension funds,\41\ and even
historically bitcoin skeptical fund managers \42\ are allocating to
bitcoin. The largest over-the-counter bitcoin fund previously filed a
Form 10 registration statement, which the Staff of the Commission
reviewed and which took effect automatically, and is now a reporting
company.\43\ Established companies like Tesla, Inc.,\44\ MicroStrategy
Incorporated,\45\ and Square, Inc.,\46\ among others, have recently
announced substantial investments in bitcoin in amounts as large as
43,200 BTC \47\, worth around $2.5 billion (Tesla) valued at a BTCUSD
price of $60,000 and 121,043 BTC worth $7.2 billion (MicroStrategy).
The foregoing examples demonstrate that bitcoin has gained mainstream
usage and recognition.
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\38\ On December 10, 2020, Massachusetts Mutual Life Insurance
Company (MassMutual) announced that it had purchased $100 million in
bitcoin for its general investment account. See MassMutual Press
Release ``Institutional Bitcoin provider NYDIG announces minority
stake purchase by MassMutual'' (December 10, 2020) available at:
<a href="https://www.massmutual.com/about-us/news-and-press-releases/press-releases/2020/12/institutional-bitcoin-provider-nydig-announces-minority-stake-purchase-by-massmutual">https://www.massmutual.com/about-us/news-and-press-releases/press-releases/2020/12/institutional-bitcoin-provider-nydig-announces-minority-stake-purchase-by-massmutual</a>.
\39\ See e.g., ``BlackRock's Rick Rieder says the world's
largest asset manager has `started to dabble' in bitcoin'' (February
17, 2021) available at: <a href="https://www.cnbc.com/2021/02/17/blackrock-has-started-to-dabble-in-bitcoin-says-rick-rieder.html">https://www.cnbc.com/2021/02/17/blackrock-has-started-to-dabble-in-bitcoin-says-rick-rieder.html</a> and
``Guggenheim's Scott Minerd Says Bitcoin Should Be Worth $400,000''
(December 16, 2020) available at: <a href="https://www.bloomberg.com/news/articles/2020-12-16/guggenheim-s-scott-minerd-says-bitcoin-should-be-worth-400-000">https://www.bloomberg.com/news/articles/2020-12-16/guggenheim-s-scott-minerd-says-bitcoin-should-be-worth-400-000</a>.
\40\ See e.g., ``Harvard and Yale Endowments Among Those
Reportedly Buying Crypto'' (January 25, 2021) available at: <a href="https://www.bloomberg.com/news/articles/2021-01-26/harvard-and-yale-endowments-among-those-reportedly-buying-crypto">https://www.bloomberg.com/news/articles/2021-01-26/harvard-and-yale-endowments-among-those-reportedly-buying-crypto</a>.
\41\ See e.g., ``Virginia Police Department Reveals Why its
Pension Fund is Betting on Bitcoin'' (February 14, 2019) available
at: <a href="https://finance.yahoo.com/news/virginia-police-department-reveals-why-194558505.html">https://finance.yahoo.com/news/virginia-police-department-reveals-why-194558505.html</a>.
\42\ See e.g., ``Bridgewater: Our Thoughts on Bitcoin'' (January
28, 2021) available at: <a href="https://www.bridgewater.com/research-and-insights/our-thoughts-on-bitcoin">https://www.bridgewater.com/research-and-insights/our-thoughts-on-bitcoin</a> and ``Paul Tudor Jones says he
likes bitcoin even more now, rally still in the `first inning'''
(October 22, 2020) available at: <a href="https://www.cnbc.com/2020/10/22/-paul-tudor-jones-says-he-likes-bitcoin-even-more-now-rally-still-in-the-first-inning.html">https://www.cnbc.com/2020/10/22/-paul-tudor-jones-says-he-likes-bitcoin-even-more-now-rally-still-in-the-first-inning.html</a>.
\43\ See Letter from Division of Corporation Finance, Office of
Real Estate & Construction to Barry E. Silbert, Chief Executive
Officer, Grayscale Bitcoin Trust (January 31, 2020) <a href="https://www.sec.gov/Archives/edgar/data/1588489/00000000020000953/filename1.pdf">https://www.sec.gov/Archives/edgar/data/1588489/00000000020000953/filename1.pdf</a>.
\44\ See Form 10-K submitted by Tesla, Inc. for the fiscal year
ended December 31, 2020 at 23: <a href="https://www.sec.gov/ix?doc=/Archives/edgar/data/1318605/000156459021004599/tsla-10k_20201231.htm">https://www.sec.gov/ix?doc=/Archives/edgar/data/1318605/000156459021004599/tsla-10k_20201231.htm</a>.
\45\ See Form 10-Q submitted by MicroStrategy Incorporated for
the quarterly period ended September 30, 2020 at 8: <a href="https://www.sec.gov/ix?doc=/Archives/edgar/data/1050446/000156459020047995/mstr-10q_20200930.htm">https://www.sec.gov/ix?doc=/Archives/edgar/data/1050446/000156459020047995/mstr-10q_20200930.htm</a>.
\46\ See Form 10-Q submitted by Square, Inc. for the quarterly
period ended September 30, 2020 at 51: <a href="https://www.sec.gov/ix?doc=/Archives/edgar/data/1512673/000151267320000012/sq-20200930.htm">https://www.sec.gov/ix?doc=/Archives/edgar/data/1512673/000151267320000012/sq-20200930.htm</a>.
\47\ Amount obtained from <a href="https://bitcointreasuries.net">https://bitcointreasuries.net</a> as of
December 3, 2021.
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Despite these developments, access for U.S. retail investors to
gain exposure to bitcoin via a transparent and U.S. regulated, U.S.
exchange-traded vehicle remains limited. Instead current options
include: (i) Paying a potentially high premium (and high management
fees) to buy over-the-counter bitcoin funds (``OTC Bitcoin Funds''), to
the advantage of more sophisticated investors that are able to create
shares at net asset value (``NAV'') directly with the issuing trust;
\48\ (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; \49\ or
(iv) through the purchase of Bitcoin Futures ETFs, which represent a
sub-optimal structure for long-term investors that will cost them
collectively tens of millions of dollars every year, as further
discussed below. Meanwhile, investors in many other countries,
including Canada \50\ and Brazil, are able to use more traditional
exchange listed and traded products (including exchange-traded funds
[[Page 73365]]
holding physical bitcoin) to gain exposure to bitcoin, disadvantaging
U.S. investors and leaving them with more risky means of getting
bitcoin exposure.\51\ Additionally, investors in other countries,
specifically Canada, generally pay lower fees than U.S. retail
investors that invest in OTC Bitcoin Funds due to the fee pressure that
results from increased competition among available bitcoin investment
options. Without an approved and regulated spot bitcoin ETP in the U.S.
as a viable alternative, U.S. investors could seek to purchase shares
of non-U.S. bitcoin vehicles in order to get access to bitcoin
exposure. Given the separate regulatory regime and the potential
difficulties associated with any international litigation, such an
arrangement would create more risk exposure for U.S. investors than
they would otherwise have with a U.S. exchange listed ETP. Further to
this point, the lack of a U.S.-listed spot bitcoin ETP is not
preventing U.S. funds from gaining exposure to bitcoin--several U.S.
exchange-traded funds are using Canadian bitcoin ETPs to gain exposure
to spot bitcoin. In addition to the benefits to U.S. investors
articulated throughout this proposal, approving this proposal (and
others like it) would provide U.S. exchange-traded funds with a U.S.-
listed and regulated product to provide such access rather than relying
on either flawed products or products listed and primarily regulated in
other countries.
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\48\ The largest OTC Bitcoin Fund has grown its AUM from
approximately $2.6 billion on February 26, 2020, the date on which
the Commission issued the disapproval order for the United States
Bitcoin and Treasury Investment Trust, to $37.1 billion on December
1, 2021, according to Grayscale's website. See Securities Exchange
Act Release No. 88284 (February 26, 2020), 85 FR 12595 (March 3,
2020) (SR-NYSEArca-2019-39) (the ``Wilshire Phoenix Disapproval'').
While the price of one bitcoin has increased approximately 690% in
the intervening period, the total AUM has increased by approximately
1540%, indicating that the increase in AUM was created beyond just
price appreciation in bitcoin. The premium and discount for OTC
Bitcoin Funds is known to move rapidly. For example, over the period
of 12/21/20 to 1/21/20, the premium for the largest OTC Bitcoin Fund
went from 40.18% to 2.79%. While the price of bitcoin appreciated
significantly during this period and NAV per share increased by
41.25%, the price per share increased by only 3.58%. This means that
investors are buying shares of a fund that experiences significant
volatility in its premium and discount outside of the fluctuations
in price of the underlying asset. Even operating within the normal
premium and discount range, it's possible for an investor to buy
shares of an OTC Bitcoin Fund only to have those shares quickly lose
10% or more in dollar value excluding any movement of the price of
bitcoin. That is to say--the price of bitcoin could have stayed
exactly the same from market close on one day to market open the
next, yet the value of the shares held by the investor decreased
only because of the fluctuation of the premium. As more investment
vehicles, including mutual funds and ETFs, seek to gain exposure to
bitcoin, the easiest option for a buy and hold strategy for such
vehicles is often an OTC Bitcoin Fund, meaning that even investors
that do not directly buy OTC Bitcoin Funds can be disadvantaged by
extreme premiums (or discounts) and premium volatility.
\49\ Recently a number of operating companies engaged in
unrelated businesses--such as Tesla (a car manufacturer) and
MicroStrategy (an enterprise software company)--have announced
investments as large as $5.3 billion in bitcoin. Without access to
bitcoin exchange-traded products, retail investors seeking
investment exposure to bitcoin may end up purchasing shares in these
companies in order to gain the exposure to bitcoin that they seek.
In fact, mainstream financial news networks have written a number of
articles providing investors with guidance for obtaining bitcoin
exposure through publicly traded companies (such as MicroStrategy,
Tesla, and bitcoin mining companies, among others) instead of
dealing with the complications associated with buying spot bitcoin
in the absence of a bitcoin ETP. See e.g., ``7 public companies with
exposure to bitcoin'' (February 8, 2021) available at: <a href="https://finance.yahoo.com/news/7-public-companies-with-exposure-to-bitcoin-154201525.html">https://finance.yahoo.com/news/7-public-companies-with-exposure-to-bitcoin-154201525.html</a>; and ``Want to get in the crypto trade without
holding bitcoin yourself? Here are some investing ideas'' (February
19, 2021) available at: <a href="https://www.cnbc.com/2021/02/19/ways-to-invest-in-bitcoin-without-holding-the-cryptocurrency-yourself-.html">https://www.cnbc.com/2021/02/19/ways-to-invest-in-bitcoin-without-holding-the-cryptocurrency-yourself-.html</a>.
Such operating companies, however, are imperfect bitcoin proxies and
provide investors with partial bitcoin exposure paired with a host
of additional risks associated with whichever operating company they
decide to purchase. Additionally, the disclosures provided by such
operating companies with respect to risks relating to their bitcoin
holdings are generally substantially smaller than the registration
statement of a bitcoin ETP, including the Registration Statement,
typically amounting to a few sentences of narrative description and
a handful of risk factors. In other words, 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.
\50\ The Exchange notes that the Purpose Bitcoin ETF, a retail
physical bitcoin ETP launched in Canada, reportedly reached $1.2
billion in assets under management as of October 15, 2021 (``AUM''),
demonstrating the demand for a North American market listed bitcoin
exchange-traded product (``ETP''). The Purpose Bitcoin ETF also
offers a class of units that is U.S. dollar denominated, which could
appeal to U.S. investors.
\51\ The Exchange notes that securities regulators in a number
of other countries have either approved or otherwise allowed the
listing and trading of bitcoin ETPs. Specifically, these funds
include the Purpose Bitcoin ETF, Bitcoin ETF, VanEck Vectors Bitcoin
ETN, WisdomTree Bitcoin ETP, Bitcoin Tracker One, BTCetc bitcoin
ETP, Amun Bitcoin ETP, Amun Bitcoin Suisse ETP, 21Shares Short
Bitcoin ETP, CoinShares Physical Bitcoin ETP.
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Bitcoin Futures ETFs
The Exchange and Sponsor applaud the Commission for allowing the
recent launch of the ETFs registered under the Investment Company Act
of 1940, as amended (the ``1940 Act''), that provide exposure to
bitcoin through CME Bitcoin Futures (``Bitcoin Futures ETFs'').
Allowing such products to list and trade is a productive first step in
providing transparent, exchange-listed tools for expressing a view on
bitcoin for U.S. investors and traders. However, as has been reported
by numerous outlets, the structure of such products provides negative
outcomes for buy and hold investors as compared to an ETP that would
hold actual bitcoin instead of derivatives contracts (``Spot Bitcoin
ETPs'').\52\ Specifically, the cost of rolling CME Bitcoin Futures
contracts (which has reached as high as 17% annually \53\ excluding a
fund's management fees and borrowing costs, if any) will cause the
Bitcoin Futures ETFs to lag the performance of bitcoin itself and, at
over a billion dollars in assets under management, would cost U.S.
investors hundreds of millions of dollars on an annual basis. Such
rolling costs would not be required for Spot Bitcoin ETPs that hold
bitcoin. Further, Bitcoin Futures ETFs have grown so rapidly that they
face potentially running into CME position limits, which would force a
Bitcoin Futures ETF to invest in non-futures assets for bitcoin
exposure and cause potential investor confusion and lack of certainty
about what such Bitcoin Futures ETFs are actually holding to try to get
exposure to bitcoin, not to mention completely changing the risk
profile associated with such an ETF. While Bitcoin Futures ETFs
represent a useful trading tool, they are clearly a sub-optimal
structure for U.S. investors that are looking for long-term exposure to
bitcoin that will, based on the calculations above, unnecessarily cost
U.S. investors millions of dollars every year and the Exchange believes
that any proposal to list and trade a Spot Bitcoin ETP should be
reviewed by the Commission with this important investor protection
context in mind.
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\52\ See e.g., ``Bitcoin ETF's Success Could Come at
Fundholders' Expense,'' Wall Street Journal (October 24, 2021),
available at: <a href="https://www.wsj.com/articles/bitcoin-etfs-success-could-come-at-fundholders-expense-11635080580">https://www.wsj.com/articles/bitcoin-etfs-success-could-come-at-fundholders-expense-11635080580</a>; ``Physical Bitcoin
ETF Prospects Accelerate,'' <a href="http://ETF.com">ETF.com</a> (October 25, 2021), available
at: <a href="https://www.etf.com/sections/blog/physical-bitcoin-etf-prospects-shine?nopaging=1&__cf_chl_jschl_tk__=pmd_JsK.fjXz9eAQW9zol0qpzhXDrrlpIVdoCloLXbLjl44-1635476946-0-gqNtZGzNApCjcnBszQql">https://www.etf.com/sections/blog/physical-bitcoin-etf-prospects-shine?nopaging=1&__cf_chl_jschl_tk__=pmd_JsK.fjXz9eAQW9zol0qpzhXDrrlpIVdoCloLXbLjl44-1635476946-0-gqNtZGzNApCjcnBszQql</a>.
\53\ Id.
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As discussed further below, the Commission's primary test in
determining whether to approve or disapprove a series of Commodity-
Based Trust Shares, a product type which includes Spot Bitcoin ETPs, is
whether the listing exchange has in place a comprehensive surveillance
sharing agreement with a regulated market of significant size in the
underlying asset. Previous disapproval orders have made clear that a
regulated market of significant size is generally a futures and/or
options market rather than the spot commodity markets, which are often
unregulated.\54\ Leaving aside the analysis of that standard for
now,\55\ Cboe believes it would be inconsistent to allow the listing
and trading of Bitcoin Futures ETFs that hold primarily CME Bitcoin
Futures while simultaneously disapproving Spot Bitcoin ETPs on the
basis that the CME Bitcoin Futures market is not a regulated market of
significant size. If the CME Bitcoin Futures market were not, in the
opinion of the Commission, a regulated market of significant size,
permitting Bitcoin Futures ETFs that trade on such market would seem to
be inconsistent with the requirement under the Act of being designed to
``prevent fraudulent and manipulative acts and practices'' as
articulated in the Winklevoss Order and other disapproval orders.\56\
One may argue that the 1940 Act provides certain investor protections
that could mitigate some of these concerns, but the investor protection
mechanisms under the 1940 Act relate primarily to the composition of a
1940 Act fund's board of directors, limitations on leverage and
transactions with affiliates, among others. Those requirements--which
primarily relate to a 1940 Act fund's internal structure and
operations, rather than to the markets for the assets which the 1940
Act fund trades--would not confer additional protections to investors
in relation to the underlying CME Bitcoin Futures market that would
justify different regulatory outcomes for Bitcoin Futures ETFs and Spot
Bitcoin ETPs.\57\
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\54\ See Winklevoss Order at 37593, specifically footnote 202,
which includes the language from numerous approval orders for which
the underlying futures markets formed the basis for approving series
of ETPs that hold physical metals, including gold, silver,
palladium, platinum, and precious metals more broadly; and 37600,
specifically where the Commission provides that ``when the spot
market is unregulated--the requirement of preventing fraudulent and
manipulative acts may possibly be satisfied by showing that the ETP
listing market has entered into a surveillance-sharing agreement
with a regulated market of significant size in derivatives related
to the underlying asset.'' As noted above, the Exchange believes
that these citations are particularly helpful in making clear that
the spot market for a spot commodity ETP need not be ``regulated''
in order for a spot commodity ETP to be approved by the Commission,
and in fact that it's been the common historical practice of the
Commission to rely on such derivatives markets as the regulated
market of significant size because such spot commodities markets are
largely unregulated.
\55\ As further outlined below, both the Exchange and the
Sponsor believe that the CME Bitcoin Futures market represents a
regulated market of significant size and that this proposal and
others like it should be approved on this basis.
\56\ 15 U.S.C. 78f(b)(5). For additional detail, see Winklevoss
Order at 37600.
\57\ The largest OTC Bitcoin Funds holding spot Bitcoin today
are not 1940 Act Funds.
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Further to this point, part of the analysis of the regulated market
of significant size test is whether an underlying market is
sufficiently large to support an ETP is whether trading in the ETP is
likely to be the predominant influence on prices in the market of
[[Page 73366]]
significant size.\58\ According to publicly available data, the largest
Bitcoin Futures ETF represents 3,803 contracts \59\ of the total 9,625
contracts of open interest in December CME Bitcoin Futures \60\ as of
12/2/21 (roughly 40% of open interest). This seems to directly
contradict the previously articulated standards by the Commission in
the disapproval orders issued for Spot Bitcoin ETPs related to whether
the trading in the ETP would be the predominant influence on prices in
that market.\61\ While it is difficult at this point to assess the
direct impact on pricing of the CME Bitcoin Futures based on the launch
of the Bitcoin Futures ETFs, such circumstances, especially related to
the generally predictable trading behaviors of an ETF, seem to have the
potential to represent a significant influence over pricing in the
market. Allowing Spot Bitcoin ETPs to come to market will alleviate
these concerns because such ETPs would be transacting in the spot
bitcoin market on a more limited basis (acquiring spot bitcoin as
needed and not rolling contracts on a monthly basis). As further
discussed below, research indicates that the CME Bitcoin Futures market
is a regulated market of significant size that generally leads price
discovery across USD-based trading in bitcoin futures and spot markets
globally.
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\58\ See Winklevoss Order at 37594.
\59\ See Fund Holdings Information available at <a href="https://www.proshares.com/funds/bito.html">https://www.proshares.com/funds/bito.html</a>.
\60\ See Volume and Open Interest data available at <a href="https://www.cmegroup.com/markets/cryptocurrencies/bitcoin/bitcoin.volume.html">https://www.cmegroup.com/markets/cryptocurrencies/bitcoin/bitcoin.volume.html</a>.
\61\ See Winklevoss Order at 37594-37595.
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To the extent the Commission may view differential treatment of
Bitcoin Futures ETFs and Spot Bitcoin ETPs as warranted based on the
Commission's concerns about the custody of physical Bitcoin that a Spot
Bitcoin ETP would hold (compared to cash-settled futures
contracts),\62\ the Sponsor believes this concern is mitigated to a
significant degree by the custodial arrangements that the Trust has
contracted with Coinbase Trust Company, LLC (the ``Custodian'') to
provide. In the Custody Statement, the Commission stated that the
fourth step that a broker-dealer could take to shield traditional
securities customers and others from the risks and consequences of
digital asset security fraud, theft, or loss is to establish, maintain,
and enforce reasonably designed written policies, procedures, and
controls for safekeeping and demonstrating the broker-dealer has
exclusive possession or control over digital asset securities that are
consistent with industry best practices to protect against the theft,
loss, and unauthorized and accidental use of the private keys necessary
to access and transfer the digital asset securities the broker-dealer
holds in custody. While bitcoin is not a security and the Custodian is
not a broker-dealer, the Sponsor believes that similar considerations
apply to the Custodian's holding of the Trust's bitcoin. After diligent
investigation, the Sponsor believes that the Custodian's policies,
procedures, and controls for safekeeping, exclusively possessing, and
controlling the Trust's bitcoin holdings are consistent with industry
best practices to protect against the theft, loss, and unauthorized and
accidental use of the private keys. As a trust company chartered by the
New York Department of Financial Services, the Sponsor notes that the
Custodian is subject to extensive regulation and has among the longest
track records in the industry of providing custodial services for
digital asset private keys. The Custodian has represented to the Trust
that it has never suffered a loss of bitcoin belonging to customers.
Under the circumstances, therefore, to the extent the Commission
believes that its concerns about the risks of spot bitcoin custody
justifies differential treatment of a Bitcoin Futures ETF versus a Spot
Bitcoin ETP, the Sponsor believes that the fact that the Custodian
employs the same types of policies, procedures, and safeguards in
handling spot bitcoin that the Commission has stated that broker-
dealers should implement with respect to digital asset securities would
appear to weaken the justification for treating a Bitcoin Futures ETF
compared to a Spot Bitcoin ETP differently due to spot bitcoin custody
concerns.
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\62\ See, e.g., Division of Investment Management Staff, Staff
Statement on Funds Registered Under the Investment Company Act
Investing in the Bitcoin Futures Market, May 11, 2021 (``The Bitcoin
futures market also has not presented the custody challenges
associated with some cryptocurrency-based investing because the
futures are cash-settled'').
---------------------------------------------------------------------------
Based on the foregoing, the Exchange and Sponsor believe that any
objective review of the proposals to list Spot Bitcoin ETPs compared to
the already listed and traded Bitcoin Futures ETFs would lead to the
conclusion that Spot Bitcoin ETPs should be available to U.S. investors
and, as such, this proposal and other comparable proposals to list and
trade Spot Bitcoin ETPs should be approved by the Commission. Stated
simply, U.S. investors stand to lose hundreds of millions of dollars
from holding Bitcoin Futures ETFs, losses which could be prevented by
the Commission approving Spot Bitcoin ETPs. Additionally, any concerns
related to preventing fraudulent and manipulative acts and practices
related to Spot Bitcoin ETPs would apply equally to the spot markets
underlying the futures contracts held by a Bitcoin Futures ETF. While
the 1940 Act does offer certain investor protections, those protections
do not relate to mitigating potential manipulation of the holdings of
an ETF in a way that warrants distinction between Bitcoin Futures ETFs
and Spot Bitcoin ETPs. To be clear, both the Exchange and Sponsor
believe that the CME Bitcoin Futures market is a regulated market of
significant size and that such manipulation concerns are mitigated, as
described extensively below. After allowing the listing and trading of
Bitcoin Futures ETFs that hold primarily CME Bitcoin Futures, however,
the only consistent outcome would be approving Spot Bitcoin ETPs on the
basis that the CME Bitcoin Futures market is a regulated market of
significant size. Including in the analysis the significant and
preventable losses to U.S. investors that comes with Bitcoin Futures
ETFs, disapproving Spot Bitcoin ETPs seems even more arbitrary and
capricious. Given the current landscape, approving this proposal (and
others like it) and allowing Spot Bitcoin ETPs to be listed and traded
alongside Bitcoin Futures ETFs would establish a consistent regulatory
approach, provide U.S. investors with choice in product structures for
bitcoin exposure, and offer flexibility in the means of gaining
exposure to bitcoin through transparent, regulated, U.S. exchange-
listed vehicles.
Bitcoin Futures
CME began offering trading in CME Bitcoin Futures in December 2017.
Each contract represents five bitcoin and is based on the CME CF
Bitcoin Reference Rate.\63\ The contracts trade and settle like other
cash-settled commodity futures contracts. Nearly every measurable
metric related to CME Bitcoin Futures has trended consistently up since
launch and/or accelerated upward in the past year, which is captured in
the following charts.
---------------------------------------------------------------------------
\63\ According to CME, the CME CF Bitcoin Reference Rate
aggregates the trade flow of major bitcoin spot exchanges during a
specific calculation window into a once-a-day reference rate of the
U.S. dollar price of bitcoin. Calculation rules are geared toward
maximum transparency and real-time replicability in underlying spot
markets, including Bitstamp, Coinbase, Gemini, itBit, and Kraken.
For additional information, refer to <a href="https://www.cmegroup.com/trading/cryptocurrency-indices/cf-bitcoin-reference-rate.html?redirect=/trading/cf-bitcoin-reference-rate.html">https://www.cmegroup.com/trading/cryptocurrency-indices/cf-bitcoin-reference-rate.html?redirect=/trading/cf-bitcoin-reference-rate.html</a>.
---------------------------------------------------------------------------
[[Page 73367]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.001
Additional Analysis \64\
---------------------------------------------------------------------------
\64\ Unless otherwise noted, all data and analysis presented in
this section and referenced elsewhere in the filing has been
provided by the Sponsor.
---------------------------------------------------------------------------
According to the Sponsor, the increase in the volume on the CME is
reflected in a higher proportion of the bitcoin market share. This is
illustrated by plotting the proportion of monthly volume traded in
bitcoin on the CME \65\ (categorized as regulated in the chart and used
as the numerator) in relation to the total bitcoin market, which
comprises of the sum of the volume of bitcoin futures on the CME and
the spot volume on cryptocurrency exchanges \66\ (categorized as
unregulated and used as the denominator) from January 1, 2018 to
December 1, 2021 illustrates this point.
---------------------------------------------------------------------------
\65\ Data on Bitcoin futures is obtained from <a href="https://www.cmegroup.com/markets/cryptocurrencies/bitcoin/bitcoin.volume.html">https://www.cmegroup.com/markets/cryptocurrencies/bitcoin/bitcoin.volume.html</a>.
\66\ Data on Bitcoin volume traded on cryptocurrency exchanges
is obtained from <a href="https://www.cryptocompare.com">https://www.cryptocompare.com</a>.
---------------------------------------------------------------------------
[[Page 73368]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.002
The proportion of volume traded on the CME has increased from less
than 5% at inception, to more than 20% over three and a half years.
Furthermore, the CME market, as well as other crypto-linked markets,
and the spot market are highly correlated. In markets that are globally
and efficiently integrated, one would expect that changes in prices of
an asset across all markets to be highly correlated. 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.
Bitcoin markets exhibit a high degree of correlation. Using daily
Bitcoin prices from centralized exchanges, ETP providers, and the CME
from January 20, 2021 to December 1, 2021,\67\ the Sponsor calculates
the Pearson correlation of returns \68\ across these markets and find a
high degree of correlation.
---------------------------------------------------------------------------
\67\ The calculation of correlations used the period January 20,
2021 to December 1, 2021 as this is the common period across all the
exchanges and data sources being analyzed.
\68\ The Pearson correlation is a measure of linear association
between two variables, and indicates the magnitude as well as
direction of this relationship. The value can range between -1
(suggesting a strong negative association) and 1 (suggesting a
strong positive association).
---------------------------------------------------------------------------
Correlations are between 57% and 99%, with the latter found mainly
across centralized exchanges due to their higher level of
interconnectedness. The lower correlations pertain mainly to the ETPs,
which are relatively newer products and are mainly offered by a few
competing market makers who are required to trade in large blocks, thus
making it economically infeasible to capture small mispricings. As
additional investors and arbitrageurs enter the market and capture the
mispricing opportunities between these markets, it is likely that there
will be much higher levels of correlations across all markets.
[[Page 73369]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.003
According to the Sponsor's research, this relationship holds true
during periods of extreme price volatility. This implies that no single
Bitcoin market can deviate significantly from the consensus for a
prolonged period of time, such that the global Bitcoin market is
sufficiently large and has an inherent unique resistance to
manipulation. Hence, the Sponsor introduces a statistical component
called cokurtosis, which measures to what extent two random variables
change together. If two returns series exhibit a high degree of
cokurtosis, this means that they tend to undergo extreme positive and
negative changes simultaneously. A cokurtosis value larger than +3 or
less than -3 is considered statistically significant. This table shows
that the level of cokurtosis is positive and very high between all
market combinations,\69\ which suggests that Bitcoin markets tend to
move very similarly especially for extreme price deviations. These
results present 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 ETP markets.
---------------------------------------------------------------------------
\69\ The cokurtosis was calculated using hourly Bitcoin returns
across centralized exchanges, ETPs--21Shares Bitcoin ETP (Ticker:
ABTC) and VanEck Vectors Bitcoin ETN (Ticker: VBTC)--and CME Bitcoin
Futures.
---------------------------------------------------------------------------
[[Page 73370]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.004
The Sponsor further believes that academic research corroborates
the overall trend outlined above and supports the thesis that the 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. Specifically, the Sponsor believes that
such research supports the evidence in the literature (highlighted
later on) that bitcoin futures lead the bitcoin spot market in price
formation.\70\
---------------------------------------------------------------------------
\70\ See Hu, Y., Hou, Y. and Oxley, L. (2019). ``What role do
futures markets play in Bitcoin pricing? Causality, cointegration
and price discovery from a time-varying perspective'' (available at:
<a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7481826/">https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7481826/</a>). This
academic research paper concludes that ``There exist no episodes
where the Bitcoin spot markets dominates the price discovery
processes with regard to Bitcoin futures. This points to a
conclusion that the price formation originates solely in the Bitcoin
futures market. We can, therefore, conclude that the Bitcoin futures
markets dominate the dynamic price discovery process based upon
time-varying information share measures. Overall, price discovery
seems to occur in the Bitcoin futures markets rather than the
underlying spot market based upon a time-varying perspective.''
---------------------------------------------------------------------------
Section 6(b)(5) and the Applicable Standards
The Commission has approved numerous series of Trust Issued
Receipts,\71\ including Commodity-Based Trust Shares,\72\ to be listed
on U.S. national securities exchanges. In order for any proposed rule
change from an exchange to be approved, the Commission must determine
that, among other things, the proposal is consistent with the
requirements of Section 6(b)(5) of the Act, specifically including: (i)
The requirement that a national securities exchange's rules are
designed to prevent fraudulent and manipulative acts and practices;
\73\ and (ii) the requirement that an exchange proposal be designed, in
general, to protect investors and the public interest. The Exchange
believes that this proposal is consistent with the requirements of
Section 6(b)(5) of the Act and that this filing sufficiently
demonstrates that the CME Bitcoin Futures market represents a regulated
market of significant size and that, on the whole, the manipulation
concerns previously articulated by the
[[Page 73371]]
Commission are sufficiently mitigated to the point that they are
outweighed by quantifiable investor protection issues that would be
resolved by approving this proposal.
---------------------------------------------------------------------------
\71\ See Exchange Rule 14.11(f).
\72\ Commodity-Based Trust Shares, as described in Exchange Rule
14.11(e)(4), are a type of Trust Issued Receipt.
\73\ As the Exchange has stated in a number of other public
documents, it continues to believe that bitcoin is resistant to
price manipulation and that ``other means to prevent fraudulent and
manipulative acts and practices'' exist to justify dispensing with
the requisite surveillance sharing agreement. The geographically
diverse and continuous nature of bitcoin trading render it difficult
and prohibitively costly to manipulate the price of bitcoin. The
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. To the
extent that there are bitcoin exchanges engaged in or allowing wash
trading or other activity intended to manipulate the price of
bitcoin on other markets, such pricing does not normally impact
prices on other exchange because participants will generally ignore
markets with quotes that they deem non-executable. Moreover, the
linkage between the bitcoin markets and the presence of arbitrageurs
in those markets means that the manipulation of the price of bitcoin
price on any single venue would require manipulation of the global
bitcoin price in order to be effective. 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 exchange or OTC platform. As a result, the
potential for manipulation on a trading platform would require
overcoming the liquidity supply of such arbitrageurs who are
effectively eliminating any cross-market pricing differences.
---------------------------------------------------------------------------
(i) Designed To Prevent Fraudulent and Manipulative Acts and Practices
In order to meet this standard in a proposal to list and trade a
series of Commodity-Based Trust Shares, the Commission requires that an
exchange demonstrate that there is a comprehensive surveillance-sharing
agreement in place \74\ with a regulated market of significant size.
Both the Exchange and CME are members of ISG.\75\ The only remaining
issue to be addressed is whether the CME Bitcoin Futures market
constitutes a market of significant size, which both the Exchange and
the Sponsor believe that it does. 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 manipulate the ETP, so that a surveillance-sharing agreement
would assist the listing exchange 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.\76\
---------------------------------------------------------------------------
\74\ As previously articulated by the Commission, ``The standard
requires such surveillance-sharing agreements since ``they provide a
necessary deterrent to manipulation because they facilitate the
availability of information needed to fully investigate a
manipulation if it were to occur.'' The Commission has emphasized
that it is essential for an exchange listing a derivative securities
product to enter into a surveillance- sharing agreement with markets
trading underlying securities for the listing exchange to have the
ability to obtain information necessary to detect, investigate, and
deter fraud and market manipulation, as well as violations of
exchange rules and applicable federal securities laws and rules. 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 historically held that joint membership in the
Intermarket Surveillance Group (``ISG'') constitutes such a
surveillance sharing agreement. See Wilshire Phoenix Disapproval.
\75\ For a list of the current members and affiliate members of
ISG, see <a href="http://www.isgportal.com">www.isgportal.com</a>.
\76\ See Wilshire Phoenix Disapproval.
---------------------------------------------------------------------------
The Commission has also recognized that the ``regulated market of
significant size'' standard is not the only means for satisfying
Section 6(b)(5) of the act, specifically providing that a listing
exchange could demonstrate that ``other means to prevent fraudulent and
manipulative acts and practices'' are sufficient to justify dispensing
with the requisite surveillance-sharing agreement.\77\
---------------------------------------------------------------------------
\77\ See Winklevoss Order at 37580. The Commission has also
specifically noted that it ``is not applying a `cannot be
manipulated' standard; instead, the Commission is examining whether
the proposal meets the requirements of the Exchange Act and,
pursuant to its Rules of Practice, places the burden on the listing
exchange to demonstrate the validity of its contentions and to
establish that the requirements of the Exchange Act have been met.''
Id. at 37582.
---------------------------------------------------------------------------
(a) Manipulation of the ETP
The topic of price discovery in Bitcoin markets, including both
spot and futures, has attracted the attention of many researchers.
Nevertheless, despite the use of similar measures of price discovery,
the literature has presented mixed evidence according to analysis by
the Sponsor.
On the one hand, an early study by Corbet et al. (2018) \78\
applied four metrics of price discovery including the information share
approach of Hasbrouck (1995),\79\ the component share methodology of
Gonzalo and Granger (1995),\80\ the information leadership approach of
Yan and Zivot (2010),\81\ and the information leadership share measure
of Putnins (2013) \82\ between the CME, CBOE, and spot prices using
data sampled on a one-minute frequency. The authors find that price
discovery is focused on the spot market. Similar evidence is presented
by Baur and Dimpfl (2019),\83\ where the authors use data sampled on a
five-minute interval and conclude that price discovery occurs in the
spot market.
---------------------------------------------------------------------------
\78\ Corbet S., Lucey B., Peat M., Vigne S. Bitcoin futures--
What use are they? Economics Letters. 2018;172:23-27.
\79\ Hasbrouck J. One security, many markets: Determining the
contributions to price discovery. The Journal of Finance.
1995;50(4):1175-1199.
\80\ Gonzalo J., Granger C. Estimation of common long-memory
components in cointegrated systems. Journal of Business & Economic
Statistics. 1995;13(1):27-35.
\81\ Yan B., Zivot E. A structural analysis of price discovery
measures. Journal of Financial Markets. 2010;13(1):1-19.
\82\ Putni[ncedil][scaron] T.J. What do price discovery metrics
really measure? Journal of Empirical Finance. 2013;23:68-83.
\83\ Baur D.G., Dimpfl T. Price discovery in bitcoin spot or
futures? Journal of Futures Markets. 2019;39(7):803-817.
---------------------------------------------------------------------------
On the other hand, a study by Kapar and Olmo (2019) \84\ finds
contradictory evidence using daily-sampled data, concluding that the
CME futures market dominates price discovery based on the approaches of
Gonzalo and Granger (1995) and Hasbrouck (1995). Similarly, Akyildirim
et al. (2019) \85\ show that Bitcoin futures play a significant role in
price discovery relative to the spot market using the four previously
mentioned measures of price discovery.
---------------------------------------------------------------------------
\84\ Kapar B., Olmo J. An analysis of price discovery between
Bitcoin futures and spot markets. Economics Letters. 2019;174:62-64.
\85\ Akyildirim E., Corbet S., Katsiampa P., Kellard N., Sensoy
A. The development of bitcoin futures: Exploring the interactions
between cryptocurrency derivatives. Finance Research Letters.
2019;34:1-9.
---------------------------------------------------------------------------
One potential reason for the mixed evidence, according to Hu et al.
(2020) \86\ is that cointegration relationships may go undetected if
the underlying model formulation is constrained to be time-invariant.
As such, the authors apply time-varying cointegrating coefficients
based on the works of Park and Hahn (1999) \87\ and Shi et al.
(2018),\88\ and conclude that futures prices Granger-cause spot prices
and that futures prices dominate Bitcoin price discovery.
---------------------------------------------------------------------------
\86\ Hu, Yang et al. ``What role do futures markets play in
Bitcoin pricing? Causality, cointegration and price discovery from a
time-varying perspective?.'' International Review of Financial
Analysis vol. 72 (2020): 101569.
\87\ Park J.Y., Hahn S.B. Cointegrating regressions with time
varying coefficients. Econometric Theory. 1999;15(5):664-703.
\88\ Shi S., Phillips P.C., Hurn S. Change detection and the
causal impact of the yield curve. Journal of Time Series Analysis.
2018;39(6):966-987.
---------------------------------------------------------------------------
[[Page 73372]]
Additionally, the Bitcoin futures market is by orders of magnitude
larger than the entire spot market of all cryptoassets in terms of
traded volume. According to a study by the Blockchain Lab of
Massachusetts Institute of Technology, ``the derivative market leads
price discovery of bitcoin more frequently than the spot markets. The
spot market is more likely to indicate the direction of the price
movement while the derivatives market is more likely to lead the
magnitude of the price movement'', says the report.\89\
---------------------------------------------------------------------------
\89\ Eguren, Luisa, Fondufe, Bryan, Hogan, Caleb, and Matthews,
Claire. ``Price Discovery in the Bitcoin Spot and Derivatives
Markets'' Massachusetts Institute of Technology Blockchain Lab
Program, May 15th, 2020.
---------------------------------------------------------------------------
The Bitcoin futures market has processed more than $1 trillion in
futures volume per month since the start of the year. In November 2021,
Bitcoin futures volume accounted for $1.58 trillion, while spot volume,
in the same time frame, amounted to $1.4 trillion including both
crypto-only and fiat currency volumes of all cryptoassets, not just
Bitcoin. Namely, the Bitcoin futures market is 12% larger than the
entire spot market in terms of volume just in the last month. Over the
past three months, the average monthly spot volume was $1.3 trillion
while the average Bitcoin futures volume was significantly greater
(approximately 30%) than the spot at $1.71 trillion.\90\
---------------------------------------------------------------------------
\90\ According to data from CryptoCompare and Coinglass.
---------------------------------------------------------------------------
In the past twelve months, the average monthly futures volume for
Bitcoin was $1.89 trillion, while the monthly spot volume for all
cryptoassets was $1.24 trillion.\91\ In other words, since the start of
the year, the Bitcoin futures market is 52% larger than the spot volume
of all cryptoassets traded on exchanges. As of December 2, 2021, the
ratio of Bitcoin spot vs futures volume currently stands at 0.17.\92\
In other words, the Bitcoin spot market accounts for 17% of the bitcoin
futures market in volume terms.
---------------------------------------------------------------------------
\91\ Id.
\92\ Id.
---------------------------------------------------------------------------
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 \93\) 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.
---------------------------------------------------------------------------
\93\ As further described below, the ``Index'' for the Fund is
the S&P Bitcoin Index. The current exchange composition of the Index
is Binance, Bitfinex, Bitflyer, Bittrex, Bitstamp, Coinbase Pro,
Gemini, HitBTC, Huobi, Kraken, KuCoin, and Poloniex.
---------------------------------------------------------------------------
Further, the Trust only allows for in-kind creation and redemption,
which, as further described below, 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, the Exchange believes that part (a) of the significant market
test outlined above is satisfied and that common membership in ISG
between the Exchange and CME would assist the listing exchange in
detecting and deterring misconduct in the Shares.
(a) Predominant Influence on Prices in Spot and Bitcoin Futures
The Exchange and Sponsor also believe that trading in the Shares
would not be the predominant force on prices in the CME Bitcoin Futures
market or spot market for a number of reasons, including the
significant volume in the CME Bitcoin Futures market, the size of
bitcoin's market cap, and the significant liquidity available in the
spot market. Moreover, the fact that the Shares are created in-kind
means that they are fully collateralized and should remain close to NAV
given that investors and market makers would arbitrage any significant
price deviations between the price of the Shares and prices in the spot
market. In addition to the CME Bitcoin Futures market data points cited
above, the spot market for bitcoin is also very liquid. According to
data from CoinRoutes from February 2021, the cost to buy or sell $5
million worth of bitcoin averages roughly 10 basis points with a market
impact of 30 basis points.\94\ For a $10 million market order, the cost
to buy or sell is roughly 20 basis points with a market impact of 50
basis points. Stated another way, a market participant could enter a
market buy or sell order for $10 million of bitcoin and only move the
market 0.5%. More strategic purchases or sales (such as using limit
orders and executing through OTC bitcoin trade desks) would likely have
less obvious impact on the market--which is consistent with
MicroStrategy, Tesla, and Square being able to collectively purchase
billions of dollars in bitcoin. As such, 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 CME Bitcoin Futures markets, satisfying
part (b) of the test outlined above.
---------------------------------------------------------------------------
\94\ These statistics are based on samples of bitcoin liquidity
in USD (excluding stablecoins or Euro liquidity) based on executable
quotes on Coinbase Pro, Gemini, Bitstamp, Kraken, LMAX Exchange,
BinanceUS, and OKCoin during February 2021.
---------------------------------------------------------------------------
(b) Other Means to Prevent Fraudulent and Manipulative Acts and
Practices
As noted above, the Commission also permits a listing exchange to
demonstrate that ``other means to prevent fraudulent and manipulative
acts and practices'' are sufficient to justify dispensing with the
requisite surveillance-sharing agreement. The Exchange and Sponsor
believe that such conditions are present. According to the Sponsor, a
significant portion of the considerations around Bitcoin pricing have
historically stemmed from a lack of consistent pricing across markets.
However, according to the Sponsor's research, cross-exchange spreads in
Bitcoin have been declining consistently over the past several years.
Based on the daily Bitcoin price series from several popular
centralized exchanges \95\ the Sponsor has calculated the largest
cross-exchange percentage spread (labelled as %C-Spread) by deducting
the highest or maximum price (P) at time t from the lowest or minimum,
and dividing by the lowest across all exchanges (i). Formally, this is
expressed as:
---------------------------------------------------------------------------
\95\ The exchanges include Binance, Bitfinex, Bithumb, Bitstamp,
Cexio, Coinbase, Coinone, Gateio, Gemini, HuobiPro, itBit, Kraken,
Kucoin, and OKEX.
[GRAPHIC] [TIFF OMITTED] TN27DE21.005
[[Page 73373]]
The results show a clear and sharp decline in the %C-Spread,
indicating that the Bitcoin market has become more efficient as cross-
exchange prices have converged over time.
[GRAPHIC] [TIFF OMITTED] TN27DE21.006
In addition, the magnitude of outlier % C-spreads has also declined
over time. This boxplot shows that, not only did the median value of
the %C-Spread decline over time, but also the extreme outlier values.
For instance, the maximum %C-Spread for 2017, 2018, 2019, 2020, and
2021 are 29.14%, 14.45%, 8.54%, 6.04%, and 7.1%, respectively. The
market has experienced a 38% year-on-year decline in the annual median
%C-Spread indicating a greater degree of Bitcoin price convergence
across exchanges and a more efficient market.
[[Page 73374]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.007
The dispersion ([sigma]) of Bitcoin Prices has also declined over
the same period. This chart shows the 7-day rolling standard deviation
of the %C-Spread from January 1, 2017 to December 1, 2021. The
Sponsor's research finds that the dispersion in Bitcoin prices across
all exchanges has decreased over time, indicating that prices on all
the considered exchanges converge towards the intrinsic average much
more efficiently. This suggests that the market has become better at
quickly reaching a consensus price for Bitcoin.
As the pricing of the Bitcoin market becomes increasingly
efficient, pricing methodologies become more accurate and less
susceptible to manipulation. The clustering of prices across a variety
of sources within the primary market points towards robust price
discovery mechanisms and efficient arbitrage.
[[Page 73375]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.008
One factor that has contributed to the overall efficiency, price
discovery, and lower volatility of the Bitcoin market is the increase
in the number of participants, and subsequently, the total dollar
amount allocated to this market. This can be illustrated by the
following chart, which shows the number of wallet addresses holding
Bitcoin from March 2012 to December 2021.
[GRAPHIC] [TIFF OMITTED] TN27DE21.009
The increase in the number of participants has manifested itself in
higher liquidity in the market. This is exhibited in the following
chart, which shows 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 exchanges from October 2020 to April 2021.
Specifically, 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.
[[Page 73376]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.010
An increased notional order book suggests that there is a higher
degree of consensus among investors regarding the price of Bitcoin.
Moreover, this market characteristic hampers any attempt of price
manipulation by any single large entity.
As a robustness check, the Sponsor investigates whether the dollar
notional in the order book changes significantly prior to, and post an
extreme price event. Specifically, for events constituting large
increases in the price of Bitcoin, if the ask (or sell) side of the
order book experiences a significant shrinkage in the dollar notional
right before the event, then this may be an indication of market
manipulation whereby the ask-side of the order book becomes
sufficiently thin for a large order to move the price upward.
Similarly, for events constituting large decreases in the price of
Bitcoin, if the bid (or buy) side of the order book experiences a
significant shrinkage in the dollar notional prior to such events, then
this may be an indication of market manipulation whereby the thinner
bid-side of the order book may potentially lead to significant downward
price movements.
Using the top and bottom 0.1% of hourly price changes from October
2020 to April 2021 as events of extreme upward and downward market
movements, respectively, the Sponsor plotted the bid (left charts) and
ask (right charts) dollar notional of the Bitcoin order book within a
six-hour window around these events in the chart below, which shows the
results for extreme upward price movements. The extreme price events
(indicated by the dashed green lines) perfectly coincide with the
decrease in dollar notional of the ask-side of the order book. This is
indicative of an efficient market, whereby large market movements are
quickly and dynamically absorbed by a thick orderbook. Moreover, the
dollar notional on the ask side after the event is replenished back to
its pre-event level, which implies that market participants' reactions
are quick to restore the market back to its equilibrium level.
[[Page 73377]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.011
The same results and conclusions are found for extreme downward
price movements. The charts below show that such price events perfectly
coincide with shrinkages on the bid side of the order book (left
charts), indicating an efficient and dynamic Bitcoin market. Moreover,
the bid-side of the order book after the event is also restored back to
its pre-event level, which suggests that the market is symmetrically
efficient in moving back to equilibrium.
[[Page 73378]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.012
Finally, offering only in-kind creation and redemption will provide
unique protections against potential attempts to manipulate the Shares.
While the Sponsor believes that the Index which it uses to value the
Trust's bitcoin is designed to reduce the risk of manipulation based on
the methodology further described below, the fact that creations and
redemptions are only available in-kind makes the manipulability of the
Index significantly less important. Specifically, because the Trust
will not accept cash to buy bitcoin in order to create new shares or,
barring a forced redemption of the Trust or under other extraordinary
circumstances, be forced to sell bitcoin to pay cash for redeemed
shares, the price that the Sponsor uses to value the Trust's bitcoin is
not particularly important.\96\ When authorized participants are
creating with the Trust, they need to deliver a certain number of
bitcoin per share (regardless of the valuation used) and when they're
redeeming, they can similarly expect to receive a certain number of
bitcoin per share. As such, even if the price used to value the Trust's
bitcoin is manipulated (which the Sponsor believes that its methodology
is resistant to), 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
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.
---------------------------------------------------------------------------
\96\ While the Index will not be particularly important for the
creation and redemption process, it will be used for calculating
fees.
---------------------------------------------------------------------------
(ii) Designed To Protect Investors and the Public Interest
The Exchange believes that the proposal is designed to protect
investors and the public interest. Over the past 1.5 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 Bitcoin Futures ETFs. 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. The Exchange
believes that the concerns related to the prevention of fraudulent and
manipulative acts and practices have been sufficiently addressed to be
consistent with the Act. As such, the Exchange believes that approving
this proposal (and comparable proposals) provides the Commission with
the opportunity to allow U.S. investors with 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 Bitcoin Futures ETFs and operating companies that are imperfect
proxies for bitcoin exposure; and (iv) providing an alternative for
investors to self-custodying spot bitcoin.
ARK 21Shares Bitcoin ETF
Delaware Trust Company is the trustee (``Trustee''). The Bank of
New York Mellon will be the administrator (``Administrator'') and
transfer agent (``Transfer Agent''). Foreside Global Services, LLC will
be the marketing agent (``Marketing Agent'') in connection with the
creation and redemption of ``Baskets'' of Shares. ARK Investment
Management LLC (``ARK'') will provide assistance in the marketing of
the Shares. Coinbase Custody Trust Company, LLC, a third-party
regulated custodian (the ``Custodian''), will be responsible for
custody of the Trust's bitcoin.
According to the Registration Statement, each Share will represent
a fractional undivided beneficial interest in the bitcoin held by the
Trust. The Trust's assets will consist of bitcoin
[[Page 73379]]
held by the Custodian on behalf of the Trust. The Trust generally does
not intend to hold cash or cash equivalents. However, there may be
situations where the Trust will unexpectedly hold cash on a temporary
basis.
According to the Registration Statement, the Trust is neither an
investment company registered under the Investment Company Act of 1940,
as amended,\97\ nor a commodity pool for purposes of the Commodity
Exchange Act (``CEA''), and neither the Trust nor the Sponsor is
subject to regulation as a commodity pool operator or a commodity
trading adviser in connection with the Shares.
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\97\ 15 U.S.C. 80a-1.
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When the Trust sells or redeems its Shares, it will do so in ``in-
kind'' transactions in blocks of 5,000 Shares (a ``Creation Basket'')
at the Trust's NAV. 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. Authorized participants may
then offer Shares to the public at prices that depend on various
factors, including the supply and demand for Shares, the value of the
Trust's assets, and market conditions at the time of a transaction.
Shareholders who buy or sell Shares during the day from their broker
may do so at a premium or discount relative to the NAV of the Shares of
the Trust.
Investment Objective
According to the Registration Statement and as further described
below, 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 (the ``Index''), adjusted for the Trust's expenses and
other liabilities. In seeking to achieve its investment objective, the
Trust will hold bitcoin and will value the Shares daily based on the
Index. The Trust will process all creations and redemptions in-kind in
transactions with authorized participants. The Trust is not actively
managed.
The Index
As described in the Registration Statement, the Fund will use the
Index to calculate the Trust's NAV. The Index is a U.S. dollar-
denominated composite reference rate for the price of bitcoin. There is
no component other than bitcoin in the Index. The underlying exchanges
are sourced by Lukka Inc. (the ``Data Provider'') \98\ based on a
combination of qualitative and quantitative metrics to analyze a
comprehensive data set and evaluate factors including legal/regulation,
KYC/transaction risk, data provision, security, team/exchange, asset
quality/diversity, market quality and negative events. The Index price
is currently sourced from the following set of exchanges: Binance,
Bitfinex, Bitflyer, Bittrex, Bitstamp, Coinbase Pro, Gemini, HitBTC,
Huobi, Kraken, KuCoin, and Poloniex. As the digital ecosystem continues
to evolve, the Data Provider can add additional or remove exchanges
based on the processes established by Lukka's Pricing Integrity
Oversight Board.\99\
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\98\ Lukka is an independent third-party digital asset data
company engaged by the Sponsor to provide fair market value (FMV)
bitcoin prices. This price, commercially available from Lukka, will
form the basis for determining the value of the Trust's Bitcoin
Holdings. Lukka is not affiliated with the Trust or the Sponsor
other than through a commercial relationship. All of Lukka's
products are also SOC 1 and 2 Type 2 certified.
\99\ The purpose of Lukka's Pricing Integrity Oversight Board is
to ensure (i) the integrity and validity of the Lukka pricing and
valuation products and (ii) the Lukka pricing and valuation products
remain fit for purpose in the rapidly evolving market and
corresponding regulatory environments.
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The Index methodology is intended to determine the fair market
value (``FMV'') for bitcoin by determining the principal market for
bitcoin as of 4 p.m. ET daily. The Index methodology uses a ranking
approach that considers several exchange characteristics including
oversight and intra-day trading volume. Specifically, to rank the
credibility and quality of each exchange, the Data Provider dynamically
assigns a Base Exchange Score (``BES'') score to the key
characteristics for each exchange.
The BES reflects the fundamentals of an exchange and determines
which exchange should be designated as the principal market at a given
point of time. This score is determined by computing a weighted average
of the values assigned to four different exchange characteristics. The
exchange characteristics are as follows: (i) Oversight; (ii)
microstructure efficiency; (iii) data transparency and (iv) data
integrity.
Oversight
This score reflects the rules in place to protect and to give
access to the investor. The score assigned for exchange oversight will
depend on parameters such as jurisdiction, regulation, ``Know Your
Customer and Anti-Money Laundering Compliance'' (KYC/AML), among other
proprietary factors.
Microstructure Efficiency
The effective bid ask spread is used as a proxy for efficiency. For
example, for each exchange and currency pair, the Data Provider takes
an estimate of the ``effective spread'' relative to the price.
Data Transparency
Transparency is the term used for a quality score that is
determined by the level of detail of the data offered by an exchange.
The most transparent exchanges offer order-level data, followed by
order book, trade-level, and then candles.
Data Integrity
Data integrity reconstructs orders to ensure the transaction
amounts that make up an order equal the overall order amount matching
on both a minute and daily basis. This data would help expose nefarious
actions such as wash trading or other potential manipulation of data.
The methodology then applies a five-step weighting process for
identifying a principal exchange and the last price on that exchange.
Following this weighting process, an executed exchange price is
assigned for bitcoin as of 4 p.m. ET. The Index price is determined
according to the following procedure:
<bullet> Step 1: Assign each exchange a Base Exchange Score
(``BES'') reflecting static exchange characteristics such as oversight,
microstructure and technology, as discussed below.
<bullet> Step 2: Adjust the BES based on the relative monthly
volume each exchange services. This new score is the Volume Adjusted
Score (``VAS'').
<bullet> Step 3: Decay the VAS based on the time passed since the
last trade on the exchange. Here, the Data Provider is assessing the
level of activity in the market by considering the frequency (volume)
of trades. The decay factor reflects the time since the last trade on
the exchange. This is the final Decayed Volume Adjusted Score
(``DVAS''), which tracks the freshness of the data by tracking most
recent trades.
<bullet> Step 4: Rank the exchanges by the DVAS score and designate
the highest-ranking exchange as the principal market for that point in
time. The principal market is the exchange with the highest DVAS.
<bullet> Step 5: After selecting a primary exchange, an executed
exchange price is used for bitcoin representing FMV at 4 p.m. ET. The
Data Provider takes the last traded prices at that moment in time on
that trading venue for the relevant
[[Page 73380]]
pair (Bitcoin/USD) when determining the Index price.
As discussed in the Registration Statement, the fact that there are
multiple bitcoin spot markets that may contribute prices to the Index
price makes manipulation more difficult in a well-arbitraged and
fractured market, 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 exchanges.
The Data Provider has designed a series of automated algorithms
designed to supplement the core Lukka Prime Methodology in enhancing
the ability to detect potentially anomalous price activity which could
be detrimental to the goal of obtaining a Fair Market Value price that
is representative of the market at a point in time.\100\
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\100\ Upon request, Lukka can provide additional information and
detail to the Commission regarding the algorithms and data quality
checks that are put in place, with confidential treatment requested.
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In addition to the automated algorithms, the Data Provider has
dedicated resources and has established committees to ensure all prices
are representative of the market. Any price challenges will result in
an independent analysis of the price. This includes assessing whether
the price from the selected exchange 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 exchange or pricing on any other exchange
included in the Lukka Prime eligibility universe. Policies and
procedures for any adjustments to prices or changes to core parameters
(e.g., exchange selection) are described in the Lukka Price Integrity
Manual.\101\
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\101\ Upon request, Lukka can provide the Commission the Lukka
Pricing Integrity Manual, with confidential treatment requested.
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Upon detection or external referral of suspect manipulative
activities, the case is raised to the Price Integrity Oversight Board.
These checks occur on an on-going, intraday basis and any
investigations are typically resolved promptly, in clear cases within
minutes and in more complex cases same business day. The evidence
uncovered shall be turned over to the Data Provider's Price Integrity
Oversight Board for final decision and action. The Price Integrity
Oversight Board may choose to pick an alternative primary market and
may exclude such market from future inclusion in the Index methodology
or choose to stand by the original published price upon fully
evaluating all available evidence. It may also initiate an
investigation of prior prices from such markets and shall evaluate
evidence presented on a case-by-case basis.
After the Lukka Prime price is generated, the S&P DJI (``The Index
Provider'') performs independent quality checks as a second layer of
validation to those employed by the Data Provider, including checks
against assets with large price movements, assets with missing prices,
assets with zero prices, assets with unchanged prices, assets that have
ceased pricing and assets where the price does not match the Lukka
Prime primary exchange. The Index Provider may submit a price challenge
to Lukka if any of the checks listed above are found to be material.
Lukka will perform an independent review of the price challenge to
ensure the price is representative of the fair value of a particular
cryptocurrency. If there is a change, the process will follow that
described in the Recalculation Policy found on the The Index Provider
Digital Assets Indices Policies & Practices and Index Mathematics
Methodology.
In addition, The Index Provider currently provides the below
additional quality assurance mechanisms with respect to crypto price
validation. These checks are based on current market conditions,
internal system processes and other assessments. The Index Provider
reserves the right within its sole discretion to supplement, modify
and/or remove individual checks and/or the parameters used within the
checks, at any time without notice.
Crypto Price and Exchange Validation
<bullet> Check for any assets with no price received from Lukka;
<bullet> Check for any assets with a zero price received from
Lukka;
<bullet> Check for any assets with a large change from the previous
day. (Outliers +/- 40%);
<bullet> Check for any assets with a stale price, aggregating the
number of days the price remains stale;
<bullet> Confirm the Lukka price matches the Lukka Prime primary
exchange price;
<bullet> Confirm the Lukka price is consistent with other Lukka
Prime exchange prices;
<bullet> Check the volume of the Lukka Prime exchanges and
challenge the Lukka primary exchange if the exchange is not within the
top percentile of the trading volume for that asset;
<bullet> Aggregation of Lukka Prime primary exchange changes.
Availability of Information
In addition to the price transparency of the Index, the Trust will
provide information regarding the Trust's bitcoin holdings as well as
additional data regarding the Trust. The Trust will provide an Intraday
Indicative Value (``IIV'') per Share updated every 15 seconds, as
calculated by the Exchange or a third-party financial data provider
during the Exchange's Regular Trading Hours (9:30 a.m. to 4:00 p.m.
E.T.). The IIV will be calculated by using the prior day's closing NAV
per Share as a base and updating that value during Regular Trading
Hours to reflect changes in the value of the Trust's bitcoin holdings
during the trading day.
The IIV disseminated during Regular Trading Hours should not be
viewed as an actual real-time update of the NAV, which will be
calculated only once at the end of each trading day. The IIV will be
widely disseminated on a per Share basis every 15 seconds during the
Exchange's Regular Trading Hours by one or more major market data
vendors. In addition, the IIV will be available through on-line
information services.
The website for the Trust, which will be publicly accessible at no
charge, will contain the following information: (a) The current NAV per
Share daily and the prior business day's NAV and the reported closing
price; (b) the BZX Official Closing Price \102\ in relation to the NAV
as of the time the NAV is calculated and a calculation of the premium
or discount of such price against such NAV; (c) data in chart form
displaying the frequency distribution of discounts and premiums of the
Official Closing Price against the NAV, within appropriate ranges for
each of the four previous calendar quarters (or for the life of the
Trust, if shorter); (d) the prospectus; and (e) other applicable
quantitative information. The Trust will also disseminate the Trust's
holdings on a daily basis on the Trust's website. The price of bitcoin
will be made available by one or more major market data vendors,
updated at least every 15 seconds during Regular Trading Hours.
Information about the Index, including key elements of how the Index is
calculated, will be publicly available at <a href="https://www.spglobal.com/spdji/en/indices/digital-assets/sp-bitcoin-index/">https://www.spglobal.com/spdji/en/indices/digital-assets/sp-bitcoin-index/</a>/.
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\102\ As defined in Rule 11.23(a)(3), the term ``BZX Official
Closing Price'' shall mean the price disseminated to the
consolidated tape as the market center closing trade.
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The NAV for the Trust will be calculated by the Administrator once
a day and will be disseminated daily to all market participants at the
same time. Quotation and last-sale information
[[Page 73381]]
regarding the Shares will be disseminated through the facilities of the
Consolidated Tape Association (``CTA'').
Quotation and last sale information for bitcoin is widely
disseminated through a variety of major market data vendors, including
Bloomberg and Reuters, as well as the Index. Information relating to
trading, including price and volume information, in bitcoin is
available from major market data vendors and from the exchanges on
which bitcoin are traded. Depth of book information is also available
from bitcoin exchanges. The normal trading hours for bitcoin exchanges
are 24 hours per day, 365 days per year.
Net Asset Value
NAV means the total assets of the Trust including, but not limited
to, all bitcoin and cash less total liabilities of the Trust, each
determined on the basis of generally accepted accounting principles.
The Administrator determines 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. EST. 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 values the bitcoin held by the Trust based on the price
set by the Index as of 4:00 p.m. EST. The Administrator also determines
the NAV per Share.
Creation and Redemption of Shares
According to the Registration Statement, on any business day, an
authorized participant may place an order to create one or more
baskets. Purchase orders must be placed by 4:00 p.m. Eastern Time, or
the close of regular trading on the Exchange, whichever is earlier. The
day on which an order is received is considered the purchase order
date. The total deposit of bitcoin required is an amount of bitcoin
that is in the same proportion to the total assets of the Trust, net of
accrued expenses and other liabilities, on the date the order to
purchase is properly received, as the number of Shares to be created
under the purchase order is in proportion to the total number of Shares
outstanding on the date the order is received. Each night, the Sponsor
will publish the amount of bitcoin that will be required in exchange
for each creation order. The Administrator determines the required
deposit for a given day by dividing the number of bitcoin held by the
Trust as of the opening of business on that business day, adjusted for
the amount of bitcoin constituting estimated accrued but unpaid fees
and expenses of the Trust as of the opening of business on that
business day, by the quotient of the number of Shares outstanding at
the opening of business divided by 5,000. The procedures by which an
authorized participant can redeem one or more Creation Baskets mirror
the procedures for the creation of Creation Baskets.
Rule 14.11(e)(4)--Commodity-Based Trust Shares
The Shares will be subject to BZX Rule 14.11(e)(4), which sets
forth the initial and continued listing criteria applicable to
Commodity-Based Trust Shares. The Exchange will obtain a representation
that the Trust's NAV will be calculated daily and that these values and
information about the assets of the Trust will be made available to all
market participants at the same time. The Exchange notes that, as
defined in Rule 14.11(e)(4)(C)(i), the Shares will be: (a) Issued by a
trust that holds a specified commodity \103\ deposited with the trust;
(b) issued by such trust in a specified aggregate minimum number in
return for a deposit of a quantity of the underlying commodity; and (c)
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.
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\103\ For purposes of Rule 14.11(e)(4), the term commodity takes
on the definition of the term as provided in the Commodity Exchange
Act. As noted above, the CFTC has opined that Bitcoin is a commodity
as defined in Section 1a(9) of the Commodity Exchange Act. See
Coinflip.
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Upon termination of the Trust, the Shares will be removed from
listing. The Trustee, Delaware Trust Company, is a trust company having
substantial capital and surplus and the experience and facilities for
handling corporate trust business, as required under Rule
14.11(e)(4)(E)(iv)(a) and that no change will be made to the trustee
without prior notice to and approval of the Exchange. The Exchange also
notes that, pursuant to Rule 14.11(e)(4)(F), neither the Exchange nor
any agent of the Exchange shall have any liability for damages, claims,
losses or expenses caused by any errors, omissions or delays in
calculating or disseminating any underlying commodity value, the
current value of the underlying commodity required to be deposited to
the Trust in connection with issuance of Commodity-Based Trust Shares;
resulting from any negligent act or omission by the Exchange, or any
agent of the Exchange, or any act, condition or cause beyond the
reasonable control of the Exchange, its agent, including, but not
limited to, an act of God; fire; flood; extraordinary weather
conditions; war; insurrection; riot; strike; accident; action of
government; communications or power failure; equipment or software
malfunction; or any error, omission or delay in the reports of
transactions in an underlying commodity. Finally, as required in Rule
14.11(e)(4)(G), the Exchange notes that any registered market maker
(``Market Maker'') in the Shares must file with the Exchange in a
manner prescribed by the Exchange and keep current a list identifying
all accounts for trading in an underlying commodity, related commodity
futures or options on commodity futures, or any other related commodity
derivatives, which the registered Market Maker may have or over which
it may exercise investment discretion. No registered Market Maker shall
trade in an underlying commodity, related commodity futures or options
on commodity futures, or any other related commodity derivatives, in an
account in which a registered Market Maker, directly or indirectly,
controls trading activities, or has a direct interest in the profits or
losses thereof, which has not been reported to the Exchange as required
by this Rule. In addition to the existing obligations under Exchange
rules regarding the production of books and records (see, e.g., Rule
4.2), the registered Market Maker in Commodity-Based Trust Shares shall
make available to the Exchange such books, records or other information
pertaining to transactions by such entity or registered or non-
registered employee affiliated with such entity for its or their own
accounts for trading the underlying physical commodity, related
commodity futures or options on commodity futures, or any other related
commodity derivatives, as may be requested by the Exchange.
Trading Halts
With respect to trading halts, the Exchange may consider all
relevant factors in exercising its discretion to halt or suspend
trading in the Shares. The Exchange will halt trading in the Shares
under the conditions specified in BZX Rule 11.18. Trading may be halted
because of market conditions or for reasons that, in the view of the
Exchange, make trading in the Shares inadvisable. These may include:
(1) The extent to which trading is not occurring in the bitcoin
underlying the Shares; or (2) whether other unusual conditions or
circumstances detrimental to the maintenance of a fair and orderly
market are present. Trading in the Shares also will be subject to Rule
[[Page 73382]]
14.11(e)(4)(E)(ii), which sets forth circumstances under which trading
in the Shares may be halted.
Trading Rules
The Exchange deems the Shares to be equity securities, thus
rendering trading in the Shares subject to the Exchange's existing
rules governing the trading of equity securities. BZX will allow
trading in the Shares during all trading sessions on the Exchange. The
Exchange has appropriate rules to facilitate transactions in the Shares
during all trading sessions. As provided in BZX Rule 11.11(a), the
minimum price variation for quoting and entry of orders in securities
traded on the Exchange is $0.01 where the price is greater than $1.00
per share or $0.0001 where the price is less than $1.00 per share.
Surveillance
The Exchange believes that its surveillance procedures are adequate
to properly monitor the trading of the Shares on the Exchange during
all trading sessions and to deter and detect violations of Exchange
rules and the applicable federal securities laws. Trading of the Shares
through the Exchange will be subject to the Exchange's surveillance
procedures for derivative products, including Commodity-Based Trust
Shares. The issuer has represented to the Exchange that it will advise
the Exchange of any failure by the Trust or the Shares to comply with
the continued listing requirements, and, pursuant to its obligations
under Section 19(g)(1) of the Exchange Act, the Exchange will surveil
for compliance with the continued listing requirements. If the Trust or
the Shares are not in compliance with the applicable listing
requirements, the Exchange will commence delisting procedures under
Exchange Rule 14.12. The Exchange may obtain information regarding
trading in the Shares and CME Bitcoin Futures via ISG, from other
exchanges who are members or affiliates of the ISG, or with which the
Exchange has entered into a comprehensive surveillance sharing
agreement.\104\
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\104\ For a list of the current members and affiliate members of
ISG, see <a href="http://www.isgportal.com">www.isgportal.com</a>.
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Information Circular
Prior to the commencement of trading, the Exchange will inform its
members in an Information Circular of the special characteristics and
risks associated with trading the Shares. Specifically, the Information
Circular will discuss the following: (i) The procedures for the
creation and redemption of Baskets (and that the Shares are not
individually redeemable); (ii) BZX Rule 3.7, which imposes suitability
obligations on Exchange members with respect to recommending
transactions in the Shares to customers; (iii) how information
regarding the IIV and the Trust's NAV are disseminated; (iv) the risks
involved in trading the Shares outside of Regular Trading Hours \105\
when an updated IIV will not be calculated or publicly disseminated;
(v) the requirement that members deliver a prospectus to investors
purchasing newly issued Shares prior to or concurrently with the
confirmation of a transaction; and (vi) trading information.
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\105\ Regular Trading Hours is the time between 9:30 a.m. and
4:00 p.m. Eastern Time.
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In addition, the Information Circular will advise members, prior to
the commencement of trading, of the prospectus delivery requirements
applicable to the Shares. Members purchasing the Shares for resale to
investors will deliver a prospectus to such investors. The Information
Circular will also discuss any exemptive, no-action and interpretive
relief granted by the Commission from any rules under the Act.
2. Statutory Basis
The Exchange believes that the proposal is consistent with Section
6(b) of the Act \106\ in general and Section 6(b)(5) of the Act \107\
in particular in that it is 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 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.
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\106\ 15 U.S.C. 78f.
\107\ 15 U.S.C. 78f(b)(5).
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The Commission has approved numerous series of Trust Issued
Receipts,\108\ including Commodity-Based Trust Shares,\109\ to be
listed on U.S. national securities exchanges. In order for any proposed
rule change from an exchange to be approved, the Commission must
determine that, among other things, the proposal is consistent with the
requirements of Section 6(b)(5) of the Act, specifically including: (i)
The requirement that a national securities exchange's rules are
designed to prevent fraudulent and manipulative acts and practices;
\110\ and (ii) the requirement that an exchange proposal be designed,
in general, to protect investors and the public interest. The Exchange
believes that this proposal is consistent with the requirements of
Section 6(b)(5) of the Act and that this filing sufficiently
demonstrates that the CME Bitcoin Futures market represents a regulated
market of significant size and that, on the whole, the manipulation
concerns previously articulated by the Commission are sufficiently
mitigated to the point that they are outweighed by quantifiable
investor protection issues that would be resolved by approving this
proposal.
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\108\ See Exchange Rule 14.11(f).
\109\ Commodity-Based Trust Shares, as described in Exchange
Rule 14.11(e)(4), are a type of Trust Issued Receipt.
\110\ As the Exchange has stated in a number of other public
documents, it continues to believe that ``other means to prevent
fraudulent and manipulative acts and practices'' exist to justify
dispensing with the requisite surveillance sharing agreement. The
geographically diverse and continuous nature of bitcoin trading
render it difficult and prohibitively costly to manipulate the price
of bitcoin. The 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. To the extent that there are bitcoin exchanges engaged
in or allowing wash trading or other activity intended to manipulate
the price of bitcoin on other markets, such pricing does not
normally impact prices on other exchange because participants will
generally ignore markets with quotes that they deem non-executable.
Moreover, the linkage between the bitcoin markets and the presence
of arbitrageurs in those markets means that the manipulation of the
price of bitcoin price on any single venue would require
manipulation of the global bitcoin price in order to be effective.
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 exchange or OTC
platform. As a result, the potential for manipulation on a trading
platform would require overcoming the liquidity supply of such
arbitrageurs who are effectively eliminating any cross-market
pricing differences.
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(i) Designed To Prevent Fraudulent and Manipulative Acts and Practices
In order to meet this standard in a proposal to list and trade a
series of Commodity-Based Trust Shares, the Commission requires that an
exchange demonstrate that there is a comprehensive surveillance-sharing
agreement in place \111\ with a regulated
[[Page 73383]]
market of significant size. Both the Exchange and CME are members of
ISG.\112\ The only remaining issue to be addressed is whether the CME
Bitcoin Futures market constitutes a market of significant size, which
both the Exchange and the Sponsor believe that it does. 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 manipulate the ETP, so that a
surveillance-sharing agreement would assist the listing exchange 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.\113\
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\111\ As previously articulated by the Commission, ``The
standard requires such surveillance-sharing agreements since ``they
provide a necessary deterrent to manipulation because they
facilitate the availability of information needed to fully
investigate a manipulation if it were to occur.'' The Commission has
emphasized that it is essential for an exchange listing a derivative
securities product to enter into a surveillance-sharing agreement
with markets trading underlying securities for the listing exchange
to have the ability to obtain information necessary to detect,
investigate, and deter fraud and market manipulation, as well as
violations of exchange rules and applicable federal securities laws
and rules. 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 historically held that joint membership
in ISG constitutes such a surveillance sharing agreement. See
Wilshire Phoenix Disapproval.
\112\ For a list of the current members and affiliate members of
ISG, see <a href="http://www.isgportal.com">www.isgportal.com</a>.
\113\ See Wilshire Phoenix Disapproval.
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The Commission has also recognized that the ``regulated market of
significant size'' standard is not the only means for satisfying
Section 6(b)(5) of the act, specifically providing that a listing
exchange could demonstrate that ``other means to prevent fraudulent and
manipulative acts and practices'' are sufficient to justify dispensing
with the requisite surveillance-sharing agreement.\114\
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\114\ See Winklevoss Order at 37580. The Commission has also
specifically noted that it ``is not applying a `cannot be
manipulated' standard; instead, the Commission is examining whether
the proposal meets the requirements of the Exchange Act and,
pursuant to its Rules of Practice, places the burden on the listing
exchange to demonstrate the validity of its contentions and to
establish that the requirements of the Exchange Act have been met.''
Id. at 37582.
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(a) Manipulation of the ETP
The topic of price discovery in Bitcoin markets, including both
spot and futures, has attracted the attention of many researchers.
Nevertheless, despite the use of similar measures of price discovery,
the literature has presented mixed evidence.
On the one hand, an early study by Corbet et al. (2018) \115\
applied four metrics of price discovery including the information share
approach of Hasbrouck (1995),\116\ the component share methodology of
Gonzalo and Granger (1995),\117\ the information leadership approach of
Yan and Zivot (2010),\118\ and the information leadership share measure
of Putnins (2013) \119\ between the CME, CBOE, and spot prices using
data sampled on a one-minute frequency. The authors find that price
discovery is focused on the spot market. Similar evidence is presented
by Baur and Dimpfl (2019),\120\ where the authors use data sampled on a
five-minute interval and conclude that price discovery occurs in the
spot market.
---------------------------------------------------------------------------
\115\ Corbet S., Lucey B., Peat M., Vigne S. Bitcoin futures--
What use are they? Economics Letters. 2018;172:23-27.
\116\ Hasbrouck J. One security, many markets: Determining the
contributions to price discovery. The Journal of Finance.
1995;50(4):1175-1199.
\117\ Gonzalo J., Granger C. Estimation of common long-memory
components in cointegrated systems. Journal of Business & Economic
Statistics. 1995;13(1):27-35.
\118\ Yan B., Zivot E. A structural analysis of price discovery
measures. Journal of Financial Markets. 2010;13(1):1-19.
\119\ Putni[ncedil][scaron] T.J. What do price discovery metrics
really measure? Journal of Empirical Finance. 2013;23:68-83.
\120\ Baur D.G., Dimpfl T. Price discovery in bitcoin spot or
futures? Journal of Futures Markets. 2019;39(7):803-817.
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On the other hand, a study by Kapar and Olmo (2019) \121\ finds
contradictory evidence using daily-sampled data, concluding that the
CME futures market dominates price discovery based on the approaches of
Gonzalo and Granger (1995) and Hasbrouck (1995). Similarly, Akyildirim
et al. (2019) \122\ show that Bitcoin futures play a significant role
in price discovery relative to the spot market using the four
previously mentioned measures of price discovery.
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\121\ Kapar B., Olmo J. An analysis of price discovery between
Bitcoin futures and spot markets. Economics Letters. 2019;174:62-64.
\122\ Akyildirim E., Corbet S., Katsiampa P., Kellard N., Sensoy
A. The development of bitcoin futures: Exploring the interactions
between cryptocurrency derivatives. Finance Research Letters.
2019;34:1-9.
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One potential reason for the mixed evidence, according to Hu et al.
(2020) \123\ is that cointegration relationships may go undetected if
the underlying model formulation is constrained to be time-invariant.
As such, the authors apply time-varying cointegrating coefficients
based on the works of Park and Hahn (1999) \124\ and Shi et
al.(2018),\125\ and conclude that futures prices Granger-cause spot
prices and that futures prices dominate Bitcoin price discovery.
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\123\ Hu, Yang et al. ``What role do futures markets play in
Bitcoin pricing? Causality, cointegration and price discovery from a
time-varying perspective?.'' International Review of Financial
Analysis vol. 72 (2020): 101569.
\124\ Park J.Y., Hahn S.B. Cointegrating regressions with time
varying coefficients. Econometric Theory. 1999;15(5):664-703.
\125\ Shi S., Phillips P.C., Hurn S. Change detection and the
causal impact of the yield curve. Journal of Time Series Analysis.
2018;39(6):966-987.
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[[Page 73384]]
Additionally, the Bitcoin futures market is by orders of magnitude
larger than the entire spot market of all cryptoassets in terms of
traded volume. According to a study by the Blockchain Lab of
Massachusetts Institute of Technology, ``the derivative market leads
price discovery of bitcoin more frequently than the spot markets. The
spot market is more likely to indicate the direction of the price
movement while the derivatives market is more likely to lead the
magnitude of the price movement'', says the report.\126\
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\126\ Eguren, Luisa, Fondufe, Bryan, Hogan, Caleb, and Matthews,
Claire. ``Price Discovery in the Bitcoin Spot and Derivatives
Markets'' Massachusetts Institute of Technology Blockchain Lab
Program, May 15th, 2020
---------------------------------------------------------------------------
The Bitcoin futures market has processed more than $1 trillion in
futures volume per month since the start of the year. In November 2021,
Bitcoin futures volume accounted for $1.58 trillion, while spot volume,
in the same time frame, amounted to $1.4 trillion including both
crypto-only and fiat currency volumes of all cryptoassets, not just
Bitcoin. Namely, the Bitcoin futures market is 12% larger than the
entire spot market in terms of volume just in the last month. Over the
past three months, the average monthly spot volume was $1.3 trillion
while the average Bitcoin futures volume was significantly greater
(approximately 30%) than the spot at $1.71 trillion according to data
from CryptoCompare and Coinglass.
In the past twelve months, the average monthly futures volume for
Bitcoin was $1.89 trillion, while the monthly spot volume for all
cryptoassets was $1.24 trillion. In other words, since the start of the
year, the Bitcoin futures market is 52% larger than the spot volume of
all cryptoassets traded on exchanges. As of December 2, the ratio of
Bitcoin spot vs futures volume currently stands at 0.17. In other
words, the Bitcoin spot market accounts for 17% of the bitcoin futures
market in volume terms.
According to the Sponsor's research presented above, the CME
Bitcoin Futures market is the leading market for bitcoin price
formation. 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 \127\) 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.
---------------------------------------------------------------------------
\127\ As further described below, the ``Index'' for the Fund is
the S&P Bitcoin Index. The current exchange composition of the Index
is Binance, Bitfinex, Bitflyer, Bittrex, Bitstamp, Coinbase Pro,
Gemini, HitBTC, Huobi, Kraken, KuCoin, and Poloniex.
---------------------------------------------------------------------------
Further, the Trust only allows for in-kind creation and redemption,
which, as further described below, 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, the Exchange believes that part (a) of the significant market
test outlined above is satisfied and that common membership in ISG
between the Exchange and CME would assist the listing exchange in
detecting and deterring misconduct in the Shares.
(b) Predominant Influence on Prices in Spot and Bitcoin Futures
The Exchange and Sponsor also believe that trading in the Shares
would not be the predominant force on prices in the CME Bitcoin Futures
market or spot market for a number of reasons, including the
significant volume in the CME Bitcoin Futures market, the size of
bitcoin's market cap, and the significant liquidity available in the
spot market. Moreover, the fact that the Shares are created in-kind
means that they are fully collateralized and should remain close to NAV
given that investors and market makers would arbitrage any significant
price deviations between the price of the Shares and prices in the spot
market. In addition to the CME Bitcoin Futures market data points cited
above, the spot market for bitcoin is also very liquid. According to
data from CoinRoutes from February 2021, the cost to buy or sell $5
million worth of bitcoin averages roughly 10 basis points with a market
impact of 30 basis points.\128\ For a $10 million market order, the
cost to buy or sell is roughly 20 basis points with a market impact of
50 basis points. Stated another way, a market participant could enter a
market buy or sell order for $10 million of bitcoin and only move the
market 0.5%. More strategic purchases or sales (such as using limit
orders and executing through OTC bitcoin trade desks) would likely have
less obvious impact on the market--which is consistent with
MicroStrategy, Tesla, and Square being able to collectively purchase
billions of dollars in bitcoin. As such, 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 CME Bitcoin Futures markets, satisfying
part (b) of the test outlined above.
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\128\ These statistics are based on samples of bitcoin liquidity
in USD (excluding stablecoins or Euro liquidity) based on executable
quotes on Coinbase Pro, Gemini, Bitstamp, Kraken, LMAX Exchange,
BinanceUS, and OKCoin during February 2021.
---------------------------------------------------------------------------
(c) Other Means To Prevent Fraudulent and Manipulative Acts and
Practices
As noted above, the Commission also permits a listing exchange to
demonstrate that ``other means to prevent fraudulent and manipulative
acts and practices'' are sufficient to justify dispensing with the
requisite surveillance-sharing agreement. The Exchange and Sponsor
believe that such conditions are present. According to the Sponsor, a
significant portion of the considerations around Bitcoin pricing have
historically stemmed from a lack of consistent pricing across markets.
However, according to the Sponsor's research, cross-exchange spreads in
Bitcoin have been declining consistently over the past several years.
Based on the daily Bitcoin price series from several popular
centralized exchanges \129\ the Sponsor has calculated the largest
cross-exchange percentage spread (labelled as %C-Spread) by deducting
the highest or maximum price (P) at time t from the lowest or minimum,
and dividing by the lowest across all exchanges (i). Formally, this is
expressed as:
---------------------------------------------------------------------------
\129\ The exchanges include Binance, Bitfinex, Bithumb,
Bitstamp, Cexio, Coinbase, Coinone, Gateio, Gemini, HuobiPro, itBit,
Kraken, Kucoin, and OKEX.
[GRAPHIC] [TIFF OMITTED] TN27DE21.013
[[Page 73385]]
The results show a clear and sharp decline in the %C-Spread,
indicating that the Bitcoin market has become more efficient as cross-
exchange prices have converged over time.
[GRAPHIC] [TIFF OMITTED] TN27DE21.014
In addition, the magnitude of outlier % C-spreads has also declined
over time. This boxplot shows that, not only did the median value of
the %C-Spread decline over time, but also the extreme outlier values.
For instance, the maximum %C-Spread for 2017, 2018, 2019, 2020, and
2021 are 29.14%, 14.45%, 8.54%, 6.04%, and 7.1%, respectively. The
market has experienced a 38% year-on-year decline in the annual median
%C-Spread indicating a greater degree of Bitcoin price convergence
across exchanges and a more efficient market.
[[Page 73386]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.015
The dispersion ([sigma]) of Bitcoin Prices has also declined over
the same period. This chart shows the 7-day rolling standard deviation
of the %C-Spread from January 1, 2017 to December 1, 2021. The
Sponsor's research finds that the dispersion in Bitcoin prices across
all exchanges has decreased over time, indicating that prices on all
the considered exchanges converge towards the intrinsic average much
more efficiently. This suggests that the market has become better at
quickly reaching a consensus price for Bitcoin.
As the pricing of the crypto market becomes increasingly efficient,
pricing methodologies become more accurate and less susceptible to
manipulation. The clustering of prices across a variety of sources
within the primary market points towards robust price discovery
mechanisms and efficient arbitrage.
[[Page 73387]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.016
One factor that has contributed to the overall efficiency, price
discovery, and lower volatility of the Bitcoin market is the increase
in the number of participants, and subsequently, the total dollar
amount allocated to this market. This can be illustrated by the
following chart, which shows the number of wallet addresses holding
Bitcoin from March 2012 to December 2021.
[GRAPHIC] [TIFF OMITTED] TN27DE21.017
The increase in the number of participants has manifested itself in
higher liquidity in the market. This is exhibited in the following
chart, which shows 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 exchanges from October 2020 to April 2021.
Specifically, 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.
[[Page 73388]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.018
An increased notional order book suggests that there is a higher
degree of consensus among investors regarding the price of Bitcoin.
Moreover, this market characteristic hampers any attempt of price
manipulation by any single large entity.
As a robustness check, the Sponsor investigates whether the dollar
notional in the order book changes significantly prior to, and post an
extreme price event. Specifically, for events constituting large
increases in the price of Bitcoin, if the ask (or sell) side of the
order book experiences a significant shrinkage in the dollar notional
right before the event, then this may be an indication of market
manipulation whereby the ask-side of the order book becomes
sufficiently thin for a large order to move the price upward.
Similarly, for events constituting large decreases in the price of
Bitcoin, if the bid (or buy) side of the order book experiences a
significant shrinkage in the dollar notional prior to such events, then
this may be an indication of market manipulation whereby the thinner
bid-side of the order book may potentially lead to significant downward
price movements.
Using the top and bottom 0.1% of hourly price changes from October
2020 to April 2021 as events of extreme upward and downward market
movements, respectively, the Sponsor plotted the bid (left charts) and
ask (right charts) dollar notional of the Bitcoin order book within a
six-hour window around these events in the chart below, which shows the
results for extreme upward price movements. The extreme price events
(indicated by the dashed green lines) perfectly coincide with the
decrease in dollar notional of the ask-side of the order book. This is
indicative of an efficient market, whereby large market movements are
quickly and dynamically absorbed by a thick orderbook. Moreover, the
dollar notional on the ask side after the event is replenished back to
its pre-event level, which implies that market participants' reactions
are quick to restore the market back to its equilibrium level.
The same results and conclusions are found for extreme downward
price movements. The charts below show that such price events perfectly
coincide with shrinkages on the bid side of the order book (left
charts), indicating an efficient and dynamic Bitcoin market. Moreover,
the bid-side of the order book after the event is also restored back to
its pre-event level, which suggests that the market is symmetrically
efficient in moving back to equilibrium.
[[Page 73389]]
[GRAPHIC] [TIFF OMITTED] TN27DE21.019
[GRAPHIC] [TIFF OMITTED] TN27DE21.020
Finally, offering only in-kind creation and redemption will provide
unique protections against potential attempts to manipulate the Shares.
While the Sponsor believes that the Index which it uses to value the
Trust's bitcoin is
[[Page 73390]]
itself resistant to manipulation based on the methodology further
described below, the fact that creations and redemptions are only
available in-kind makes the manipulability of the Index significantly
less important. Specifically, because the Trust will not accept cash to
buy bitcoin in order to create new shares or, barring a forced
redemption of the Trust or under other extraordinary circumstances, be
forced to sell bitcoin to pay cash for redeemed shares, the price that
the Sponsor uses to value the Trust's bitcoin is not particularly
important.\130\ When authorized participants are creating with the
Trust, they need to deliver a certain number of bitcoin per share
(regardless of the valuation used) and when they're redeeming, they can
similarly expect to receive a certain number of bitcoin per share. As
such, even if the price used to value the Trust's bitcoin is
manipulated (which the Sponsor believes that its methodology is
resistant to), 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
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.
---------------------------------------------------------------------------
\130\ While the Index will not be particularly important for the
creation and redemption process, it will be used for calculating
fees.
---------------------------------------------------------------------------
(ii) Designed To Protect Investors and the Public Interest
The Exchange believes that the proposal is designed to protect
investors and the public interest. Over the past 1.5 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 Bitcoin Futures ETFs. 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. The Exchange
believes that the concerns related to the prevention of fraudulent and
manipulative acts and practices have been sufficiently addressed to be
consistent with the Act and, to the extent that the Commission
disagrees with that assertion, also believes that such concerns are now
outweighed by these investor protection concerns. As such, the Exchange
believes that approving this proposal (and comparable proposals)
provides the Commission with the opportunity to allow U.S. investors
with 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 Bitcoin Futures ETFs and operating companies that are
imperfect proxies for bitcoin exposure; and (iv) providing an
alternative to custodying spot bitcoin.
Commodity-Based Trust Shares
The Exchange believes that the proposed rule change is designed to
prevent fraudulent and manipulative acts and practices in that the
Shares will be listed on the Exchange pursuant to the initial and
continued listing criteria in Exchange Rule 14.11(e)(4). The Exchange
believes that its surveillance procedures are adequate to properly
monitor the trading of the Shares on the Exchange during all trading
sessions and to deter and detect violations of Exchange rules and the
applicable federal securities laws. Trading of the Shares through the
Exchange will be subject to the Exchange's surveillance procedures for
derivative products, including Commodity-Based Trust Shares. The issuer
has represented to the Exchange that it will advise the Exchange of any
failure by the Trust or the Shares to comply with the continued listing
requirements, and, pursuant to its obligations under Section 19(g)(1)
of the Exchange Act, the Exchange will surveil for compliance with the
continued listing requirements. If the Trust or the Shares are not in
compliance with the applicable listing requirements, the Exchange will
commence delisting procedures under Exchange Rule 14.12. The Exchange
may obtain information regarding trading in the Shares and listed
bitcoin derivatives via the ISG, from other exchanges who are members
or affiliates of the ISG, or with which the Exchange has entered into a
comprehensive surveillance sharing agreement.
Availability of Information
The Exchange also believes that the proposal promotes market
transparency in that a large amount of information is currently
available about bitcoin and will be available regarding the Trust and
the Shares. In addition to the price transparency of the Index, the
Trust will provide information regarding the Trust's bitcoin holdings
as well as additional data regarding the Trust. The Trust will provide
an IIV per Share updated every 15 seconds, as calculated by the
Exchange or a third-party financial data provider during the Exchange's
Regular Trading Hours (9:30 a.m. to 4:00 p.m. E.T.). The IIV will be
calculated by using the prior day's closing NAV per Share as a base and
updating that value during Regular Trading Hours to reflect changes in
the value of the Trust's bitcoin holdings during the trading day.
The IIV disseminated during Regular Trading Hours should not be
viewed as an actual real-time update of the NAV, which will be
calculated only once at the end of each trading day. The IIV will be
widely disseminated on a per Share basis every 15 seconds during the
Exchange's Regular Trading Hours by one or more major market data
vendors. In addition, the IIV will be available through on-line
information services.
The website for the Trust, which will be publicly accessible at no
charge, will contain the following information: (a) The current NAV per
Share daily and the prior business day's NAV and the reported closing
price; (b) the BZX Official Closing Price in relation to the NAV as of
the time the NAV is calculated and a calculation of the premium or
discount of such price against such NAV; (c) data in chart form
displaying the frequency distribution of discounts and premiums of the
Official Closing Price against the NAV, within appropriate ranges for
each of the four previous calendar quarters (or for the life of the
Trust, if shorter); (d) the prospectus; and (e) other applicable
quantitative information. The Trust will also disseminate the Trust's
holdings on a daily basis on the Trust's website. The price of bitcoin
will be made available by one or more major market data vendors,
updated at least every 15 seconds during Regular Trading Hours.
Information about the Index, including key elements of how the Index is
calculated, will be publicly available at <a href="https://www.spglobal.com/spdji/en/indices/digital-assets/sp-bitcoin-index/">https://www.spglobal.com/spdji/en/indices/digital-assets/sp-bitcoin-index/</a>.
The NAV for the Trust will be calculated by the Administrator once
a day and will be disseminated daily to all market participants at the
same time. Quotation and last-sale information regarding the Shares
will be disseminated through the facilities of the CTA.
Quotation and last sale information for bitcoin is widely
disseminated through a variety of major market data vendors, including
Bloomberg and Reuters, as well as the Index. Information relating to
trading, including price and volume information, in bitcoin is
available from major market data vendors and from the exchanges on
which bitcoin are traded.
[[Page 73391]]
Depth of book information is also available from bitcoin exchanges. The
normal trading hours for bitcoin exchanges are 24 hours per day, 365
days per year
For the above reasons, the Exchange believes that the proposed rule
change is consistent with the requirements of Section 6(b)(5) of the
Act.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purpose of the Act. The Exchange notes that the
proposed rule change, rather will facilitate the listing and trading of
an additional exchange-traded product that will enhance competition
among both market participants and listing venues, to the benefit of
investors and the marketplace.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Exchange has neither solicited nor received written comments on
the proposed rule change.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#f381869f96de909c9e9e969d8780b3809690dd949c85"><span class="__cf_email__" data-cfemail="0d7f786168206e6260606863797e4d7e686e236a627b">[email protected]</span></a>. Please include
File Number SR-CboeBZX-2021-051 on the subject line.
Paper Comments
<bullet> Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-CboeBZX-2021-051. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of the Exchange. All comments
received will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-CboeBZX-2021-051, and should be
submitted on or before January 18, 2022.
---------------------------------------------------------------------------
\131\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\131\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-27824 Filed 12-23-21; 8:45 am]
BILLING CODE 8011-01-P
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This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.