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SEC Rejects Proposal to List Bitcoin-Based ETP on Regulated Exchange

joseph.moreno@cwt.com's picture
Commentary by Joseph Moreno

By a three-to-one vote, the SEC rejected a second application by the Bats BZX Exchange ("BZX") (now owned by Cboe Global Markets) to list a bitcoin-backed exchange-traded product ("ETP"). The proposal, which was previously rejected by the SEC Division of Trading and Markets, would have permitted the listing and trading of shares of the "Winklevoss Bitcoin Trust." The ETP would have (i) held only bitcoins as an asset and (ii) tracked the price of bitcoin on the Gemini Exchange, a cryptocurrency exchange founded by Cameron and Tyler Winklevoss. To date, the SEC has not approved a cryptocurrency-backed ETP.

Exchange Act Section 6(b)(5) requires that the rules of a national securities exchange be designed to (i) "prevent fraudulent and manipulative acts and practices" and (ii) "protect investors and the public interest." In its Order, the SEC asserted that the price of bitcoin can be (and has been) manipulated through activity on bitcoin trading venues. The SEC rejected the claim by BZX that it could monitor the Gemini Exchange for potential price manipulation, finding that the Gemini Exchange did not materially represent the bitcoin market. The SEC pointed to BZX's lack of surveillance-sharing agreements with significant, regulated markets as inconsistent with SEC-approved commodity-trust ETPs. The SEC further rejected the argument that bitcoin spot markets are inherently resistant to manipulation due to the decentralized nature of blockchain technology. In sum, the SEC found that BZX failed to establish that its various surveillance proposals were sufficient to protect investors from fraud as required to comply with Exchange Act Section 6(b)(5).

Commissioner Hester Peirce dissented from the SEC order and argued that the BZX proposal met the Exchange Act Section 6(b)(5) standard. Ms. Peirce contended that her fellow Commissioners focused too heavily on the shortcomings of the underlying bitcoin spot market, and failed to give proper consideration to BZX's surveillance and fraud detection capabilities. She asserted that many commodity-based ETPs would be in danger if the Order's standard for bitcoin were universally applied. Further, Ms. Peirce stated that the outcome undermined investor protection and represented a missed opportunity to institutionalize and legitimize the bitcoin market.

Commentary

The SEC's decision in this matter is disappointing and illustrates the "chicken and egg" nature of the cryptocurrency industry. On the one hand, the SEC took issue with the fact that BZX had not demonstrated that it had entered into a surveillance-sharing agreement with a regulated, bitcoin-related market of significant size. Then, in the next breath, the SEC questioned whether regulated markets for bitcoin or derivatives on bitcoin of significant size exist. This was an opportunity for significant institutional involvement in the bitcoin market that the SEC has blocked by applying a standard that seems impossible to meet at the current time, and it does not bode well for other cryptocurrency-related ETP's that are currently pending. Hopefully, Commissioner Peirce can convince her fellow Commissioners that an open-minded approach to this technology going forward will be more productive than the current strategy of kicking the can down the road.

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