[Federal Register Volume 87, Number 16 (Tuesday, January 25, 2022)]
[Notices]
[Pages 3869-3882]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-01384]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-94006; File No. SR-NYSEArca-2021-37]
Self-Regulatory Organizations; NYSE Arca, Inc.; Order
Disapproving a Proposed Rule Change To List and Trade Shares of the
First Trust SkyBridge Bitcoin ETF Trust Under NYSE Arca Rule 8.201-E
January 20, 2022.
I. Introduction
On May 6, 2021, NYSE Arca, Inc. (``NYSE Arca'' or ``Exchange'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule
change to list and trade shares (``Shares'') of the First Trust
SkyBridge Bitcoin ETF Trust (``Trust'') under NYSE Arca Rule 8.201-E
(Commodity-Based Trust Shares). The proposed rule change was published
for comment in the Federal Register on May 27, 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. 91962 (May 21,
2021), 86 FR 28646 (May 27, 2021) (``Notice''). Comments on the
proposed rule change can be found at: https://www.sec.gov/comments/sr-nysearca-2021-37/srnysearca202137.htm.
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On July 7, 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 August 20, 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\
On November 15, 2021, the Commission designated a longer period for
Commission action on the proposed rule change.\8\
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\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 92333, 86 FR 36826
(July 13, 2021).
\6\ 15 U.S.C. 78s(b)(2)(B).
\7\ See Securities Exchange Act Release No. 92714, 86 FR 47662
(Aug. 26, 2021).
\8\ See Securities Exchange Act Release No. 93570, 86 FR 64975
(Nov. 19, 2021).
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This order disapproves the proposed rule change. The Commission
concludes that NYSE Arca has not met its burden under the Exchange Act
and the Commission's Rules of Practice to demonstrate that its proposal
is consistent with the requirements of Exchange Act Section 6(b)(5),
and in particular, the requirement that the rules of a national
securities exchange be ``designed to prevent fraudulent and
manipulative acts and practices'' and ``to protect investors and the
public interest.'' \9\
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\9\ 15 U.S.C. 78f(b)(5).
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When considering whether NYSE Arca's proposal to list and trade the
Shares is designed to prevent fraudulent and manipulative acts and
practices, the Commission applies the same standard used in its orders
considering previous proposals to list bitcoin \10\-based commodity
trusts and bitcoin-based trust issued receipts.\11\ As the Commission
has explained, an exchange that lists bitcoin-based exchange-traded
products (``ETPs'') can meet its obligations under Exchange Act Section
6(b)(5) by demonstrating that the exchange has a comprehensive
surveillance-sharing agreement with a regulated market of significant
size related to the underlying or reference bitcoin assets.\12\
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\10\ Bitcoins are digital assets that are issued and transferred
via a decentralized, open-source protocol used by a peer-to-peer
computer network through which transactions are recorded on a public
transaction ledger known as the ``bitcoin blockchain.'' The bitcoin
protocol governs the creation of new bitcoins and the cryptographic
system that secures and verifies bitcoin transactions. See, e.g.,
Notice, 86 FR at 28646-47.
\11\ See Order Setting Aside Action by Delegated Authority and
Disapproving a Proposed Rule Change, as Modified by Amendments No. 1
and 2, To List and Trade Shares of the Winklevoss Bitcoin Trust,
Securities Exchange Act Release No. 83723 (July 26, 2018), 83 FR
37579 (Aug. 1, 2018) (SR-BatsBZX-2016-30) (``Winklevoss Order'');
Order Disapproving a Proposed Rule Change, as Modified by Amendment
No. 1, To Amend NYSE Arca Rule 8.201-E (Commodity-Based Trust
Shares) and To List and Trade Shares of the United States Bitcoin
and Treasury Investment Trust Under NYSE Arca Rule 8.201-E,
Securities Exchange Act Release No. 88284 (Feb. 26, 2020), 85 FR
12595 (Mar. 3, 2020) (SR-NYSEArca-2019-39) (``USBT Order''); Order
Disapproving a Proposed Rule Change To List and Trade Shares of the
WisdomTree Bitcoin Trust Under BZX Rule 14.11(e)(4), Commodity-Based
Trust Shares, Securities Exchange Act Release No. 93700 (Dec. 1,
2021), 86 FR 69322 (Dec. 7, 2021) (SR-CboeBZX-2021-024)
(``WisdomTree Order''); Order Disapproving a Proposed Rule Change to
List and Trade Shares of the Valkyrie Bitcoin Fund under NYSE Arca
Rule 8.201-E (Commodity-Based Trust Shares), Securities Exchange Act
Release No. 93859 (Dec. 22, 2021), 86 FR74156 (Dec. 29, 2021) (SR-
NYSEArca-2021-31) (``Valkyrie Order''); Order Disapproving a
Proposed Rule Change to List and Trade Shares of the Kryptoin
Bitcoin ETF Trust under BZX Rule 14.11(e)(4), Commodity-Based Trust
Shares, Securities Exchange Act Release No. 93860 (Dec. 22, 2021),
86 FR 74166 (Dec. 29, 2021) (SR-CboeBZX-2021-029) (``Kryptoin
Order''). See also Order Disapproving a Proposed Rule Change, as
Modified by Amendment No. 1, Relating to the Listing and Trading of
Shares of the SolidX Bitcoin Trust Under NYSE Arca Equities Rule
8.201, Securities Exchange Act Release No. 80319 (Mar. 28, 2017), 82
FR 16247 (Apr. 3, 2017) (SR-NYSEArca-2016-101) (``SolidX Order'').
The Commission also notes that orders were issued by delegated
authority on the following matters: Order Disapproving a Proposed
Rule Change To List and Trade the Shares of the ProShares Bitcoin
ETF and the ProShares Short Bitcoin ETF, Securities Exchange Act
Release No. 83904 (Aug. 22, 2018), 83 FR 43934 (Aug. 28, 2018) (SR-
NYSEArca-2017-139) (``ProShares Order''); Order Disapproving a
Proposed Rule Change To List and Trade the Shares of the
GraniteShares Bitcoin ETF and the GraniteShares Short Bitcoin ETF,
Securities Exchange Act Release No. 83913 (Aug. 22, 2018), 83 FR
43923 (Aug. 28, 2018) (SR-CboeBZX-2018-001) (``GraniteShares
Order''); Order Disapproving a Proposed Rule Change To List and
Trade Shares of the VanEck Bitcoin Trust Under BZX Rule 14.11(e)(4),
Commodity-Based Trust Shares, Securities Exchange Act Release No.
93559 (Nov. 12, 2021), 86 FR 64539 (Nov. 18, 2021) (SR-CboeBZX-2021-
019).
\12\ See USBT Order, 85 FR at 12596. See also Winklevoss Order,
83 FR at 37592 n.202 and accompanying text (discussing previous
Commission approvals of commodity-trust ETPs); GraniteShares Order,
83 FR at 43925-27 nn.35-39 and accompanying text (discussing
previous Commission approvals of commodity-futures ETPs).
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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
[[Page 3870]]
were to occur.'' \13\ 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 the
underlying assets 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.\14\ 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.\15\
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\13\ See Amendment to Rule Filing Requirements for Self-
Regulatory Organizations Regarding New Derivative Securities
Products, Securities Exchange Act Release No. 40761 (Dec. 8, 1998),
63 FR 70952, 70959 (Dec. 22, 1998) (``NDSP Adopting Release''). See
also Winklevoss Order, 83 FR at 37594; ProShares Order, 83 FR at
43936; GraniteShares Order, 83 FR at 43924; USBT Order, 85 FR at
12596.
\14\ See NDSP Adopting Release, 63 FR at 70959.
\15\ See Winklevoss Order, 83 FR at 37592-93; Letter from
Brandon Becker, Director, Division of Market Regulation, Commission,
to Gerard D. O'Connell, Chairman, Intermarket Surveillance Group
(June 3, 1994), available at https://www.sec.gov/divisions/marketreg/mr-noaction/isg060394.htm.
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In the context of this standard, the terms ``significant market''
and ``market of significant size'' include a market (or group of
markets) as to which (a) there is a reasonable likelihood that a person
attempting to manipulate the ETP would also have to trade on that
market to successfully manipulate the ETP, so that a surveillance-
sharing agreement would assist in detecting and deterring misconduct,
and (b) it is unlikely that trading in the ETP would be the predominant
influence on prices in that market.\16\ A surveillance-sharing
agreement must be entered into with a ``significant market'' to assist
in detecting and deterring manipulation of the ETP, because a person
attempting to manipulate the ETP is reasonably likely to also engage in
trading activity on that ``significant market.'' \17\
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\16\ See Winklevoss Order, 83 FR at 37594. This definition is
illustrative and not exclusive. There could be other types of
``significant markets'' and ``markets of significant size,'' but
this definition is an example that will provide guidance to market
participants. See id.
\17\ See USBT Order, 85 FR at 12597.
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Consistent with this standard, for the commodity-trust ETPs
approved to date for listing and trading, there has been in every case
at least one significant, regulated market for trading futures on the
underlying commodity--whether gold, silver, platinum, palladium, or
copper--and the ETP listing exchange has entered into surveillance-
sharing agreements with, or held Intermarket Surveillance Group
(``ISG'') membership in common with, that market.\18\ Moreover, the
surveillance-sharing agreements have been consistently present whenever
the Commission has approved the listing and trading of derivative
securities, even where the underlying securities were also listed on
national securities exchanges--such as options based on an index of
stocks traded on a national securities exchange--and were thus subject
to the Commission's direct regulatory authority.\19\
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\18\ See Winklevoss Order, 83 FR at 37594.
\19\ See USBT Order, 85 FR at 12597; Securities Exchange Act
Release No. 33555 (Jan. 31, 1994), 59 FR 5619, 5621 (Feb. 7, 1994)
(SR-Amex-93-28) (order approving listing of options on American
Depository Receipts (``ADRs'')). The Commission has also required a
surveillance-sharing agreement in the context of index options even
when (i) all of the underlying index component stocks were either
registered with the Commission or exempt from registration under the
Exchange Act; (ii) all of the underlying index component stocks
traded in the U.S. either directly or as ADRs on a national
securities exchange; and (iii) effective international ADR arbitrage
alleviated concerns over the relatively smaller ADR trading volume,
helped to ensure that ADR prices reflected the pricing on the home
market, and helped to ensure more reliable price determinations for
settlement purposes, due to the unique composition of the index and
reliance on ADR prices. See Securities Exchange Act Release No.
26653 (Mar. 21, 1989), 54 FR 12705, 12708 (Mar. 28, 1989) (SR-Amex-
87-25) (stating that ``surveillance-sharing agreements between the
exchange on which the index option trades and the markets that trade
the underlying securities are necessary'' and that ``[t]he exchange
of surveillance data by the exchange trading a stock index option
and the markets for the securities comprising the index is important
to the detection and deterrence of intermarket manipulation.''). And
the Commission has required a surveillance-sharing agreement even
when approving options based on an index of stocks traded on a
national securities exchange. See Securities Exchange Act Release
No. 30830 (June 18, 1992), 57 FR 28221, 28224 (June 24, 1992) (SR-
Amex-91-22) (stating that surveillance-sharing agreements ``ensure
the availability of information necessary to detect and deter
potential manipulations and other trading abuses'').
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Listing exchanges have also attempted to demonstrate that other
means besides surveillance-sharing agreements will be sufficient to
prevent fraudulent and manipulative acts and practices, including that
the bitcoin market as a whole or the relevant underlying bitcoin market
is ``uniquely'' and ``inherently'' resistant to fraud and
manipulation.\20\ In response, the Commission has agreed that, if a
listing exchange could establish that the underlying market inherently
possesses a unique resistance to manipulation beyond the protections
that are utilized by traditional commodity or securities markets, it
would not necessarily need to enter into a surveillance-sharing
agreement with a regulated significant market.\21\ Such resistance to
fraud and manipulation, however, must be novel and beyond those
protections that exist in traditional commodity markets or equity
markets for which the Commission has long required surveillance-sharing
agreements in the context of listing derivative securities
products.\22\ No listing exchange has satisfied its burden to make such
demonstration.\23\
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\20\ See USBT Order, 85 FR at 12597.
\21\ See Winklevoss Order, 83 FR at 37580, 37582-91 (addressing
assertions that ``bitcoin and bitcoin [spot] markets'' generally, as
well as one bitcoin trading platform specifically, have unique
resistance to fraud and manipulation); see also USBT Order, 85 FR at
12597.
\22\ See USBT Order, 85 FR at 12597.
\23\ See supra note 11.
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In its proposed rule change to list and trade Shares, NYSE Arca
contends that approval of the proposal is consistent with Section
6(b)(5) of the Exchange Act, in particular Section 6(b)(5)'s
requirement that the rules of a national securities exchange be
designed to prevent fraudulent and manipulative acts and practices and
to protect investors and the public interest.\24\ As discussed in more
detail below, NYSE Arca asserts that the proposal is consistent with
Section 6(b)(5) of the Exchange Act because the Exchange has a
comprehensive surveillance-sharing agreement with a regulated market of
significant size,\25\ and there exist other means to prevent fraudulent
and manipulative acts and practices that are sufficient to justify
dispensing with the requisite surveillance-sharing agreement.\26\
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\24\ See Notice, 86 FR at 28660-61.
\25\ See id. at 28656-58.
\26\ See id. at 28658.
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Moreover, although NYSE Arca recognizes the Commission's focus on
potential manipulation of bitcoin ETPs in prior disapproval orders,
NYSE Arca states that the Commission should also consider the direct,
quantifiable investor protection issues in determining whether to
approve the proposal.\27\ Specifically, NYSE Arca believes that the
proposal would give U.S. investors access to bitcoin in a regulated and
transparent exchange-traded vehicle that would act to limit risk to
U.S. investors by: (i) Reducing premium and discount volatility; (ii)
reducing management fees through meaningful competition; (iii) reducing
risks associated with investing in operating companies that are
imperfect proxies for
[[Page 3871]]
bitcoin exposure; and (iv) providing an alternative to custodying spot
bitcoin.\28\
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\27\ See id. at 28650.
\28\ See id. at 28649.
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In the analysis that follows, the Commission examines whether the
proposed rule change is consistent with Section 6(b)(5) of the Exchange
Act by addressing: In Section III.B.1 assertions that other means
besides surveillance-sharing agreements will be sufficient to prevent
fraudulent and manipulative acts and practices; in Section III.B.2
assertions that NYSE Arca has entered into a comprehensive
surveillance-sharing agreement with a regulated market of significant
size related to bitcoin; and in Section III.C assertions that the
proposal is consistent with the protection of investors and the public
interest.
Based on the analysis, the Commission concludes that NYSE Arca has
not established that other means to prevent fraudulent and manipulative
acts and practices are sufficient to justify dispensing with the
requisite surveillance-sharing agreement. The Commission further
concludes that NYSE Arca has not established that it has a
comprehensive surveillance-sharing agreement with a regulated market of
significant size related to bitcoin. As discussed further below, NYSE
Arca repeats various assertions made in prior bitcoin-based ETP
proposals that the Commission has previously addressed and rejected--
and more importantly, NYSE Arca does not respond to the Commission's
reasons for rejecting those assertions but merely repeats them. As a
result, the Commission does not find that the proposed rule change is
consistent with the statutory requirements of Exchange Act Section
6(b)(5).
The Commission again emphasizes that its disapproval of this
proposed rule change does not rest on an evaluation of whether bitcoin,
or blockchain technology more generally, has utility or value as an
innovation or an investment. Rather, the Commission is disapproving
this proposed rule change because, as discussed below, NYSE Arca has
not met its burden to demonstrate that its proposal is consistent with
the requirements of Exchange Act Section 6(b)(5).
II. Description of the Proposed Rule Change
As described in more detail in the Notice,\29\ the Exchange
proposes to list and trade the Shares of the Trust under NYSE Arca Rule
8.201-E, which governs the listing and trading of Commodity-Based Trust
Shares on the Exchange.
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\29\ See Notice, supra note 3. See also Registration Statement
on Form S-1/A, dated May 6, 2021 (File No. 333-254529), filed with
the Commission on behalf of the Trust (``Registration Statement'').
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The investment objective of the Trust will be for the Shares to
reflect the performance of the value of bitcoin, less the Trust's
liabilities and expenses.\30\ The Trust will not seek to reflect the
performance of any benchmark or index. In order to pursue its
investment objective, the Trust will seek to purchase and sell such
number of bitcoin so that the total value of the bitcoin held by the
Trust is as close to 100 percent of the net assets of the Trust as is
reasonably practicable to achieve.\31\
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\30\ See Notice, 86 FR at 28652. First Trust Advisors L.P. is
the sponsor of the Trust, and Delaware Trust Company is the trustee.
The sub-adviser for the Trust is SkyBridge Capital II, LLC (``Sub-
Adviser''). The Bank of New York Mellon (``Administrator'') is the
transfer agent and the administrator of the Trust. The bitcoin
custodian for the Trust is NYDIG Trust Company LLC (``Bitcoin
Custodian''). See id. at 28646.
\31\ See id. at 28652.
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The Shares would represent units of fractional undivided beneficial
interest in, and ownership of, the Trust. The Trust will hold only
bitcoins, which the Bitcoin Custodian will custody on behalf of the
Trust. The Trust generally will not hold cash or cash equivalents;
however, the Trust may hold cash and cash equivalents on a temporary
basis to pay extraordinary expenses.\32\
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\32\ See id. at 28652, 28654. The Administrator acts as
custodian of the Trust's cash and cash equivalents. See id. at
28654. While the Trust may from time to time incur certain
extraordinary, non-recurring expenses that must be paid in U.S.
dollars or other fiat currency, such events would only impact the
amount of bitcoin represented by a Share of the Trust. See id. at
28655.
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The net asset value (``NAV'') of the Trust will be determined in
accordance with Generally Accepted Accounting Principles as the total
value of bitcoin held by the Trust, plus any cash or other assets, less
any liabilities including accrued but unpaid expenses. The NAV of the
Trust will be determined as of 4:00 p.m. ET on each day that the Shares
trade on the Exchange (``Business Day'').\33\ The Trust will use the CF
Bitcoin US Settlement Price (``Reference Rate'') to calculate the
Trust's NAV.
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\33\ The Trust's daily activities will generally not be
reflected in the NAV determined for the Business Day on which the
transactions are effected (the trade date), but rather on the
following Business Day. See id. at 28654.
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The Reference Rate is administered by CF Benchmarks Ltd.
(``Benchmark Administrator'') and serves as a once-a-day benchmark rate
of the U.S. dollar price of bitcoin (USD/BTC), calculated as of 4:00
p.m. ET \34\ The Reference Rate aggregates the trade flow of several
bitcoin platforms during an observation window between 3:00 p.m. and
4:00 p.m. ET into the U.S. dollar price of one bitcoin at 4:00 p.m., ET
The current constituent bitcoin platforms of the Reference Rate are
Bitstamp, Coinbase, Gemini, itBit, and Kraken (``Constituent
Platforms''). In calculating the Reference Rate, the methodology
creates a joint list of all ``Relevant Transactions'' \35\ from the
Constituent Platforms. The methodology divides this list into a number
of equally sized time intervals and calculates the volume-weighted
median trade price for each of those time intervals.\36\ The Reference
Rate is the equally weighted average of the volume-weighted median
trade prices of all intervals.\37\
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\34\ According to NYSE Arca, the Reference Rate is based on
materially the same methodology (except calculation time) as the
Benchmark Administrator's CME CF Bitcoin Reference Rate (``CME CF
BRR''), which was first introduced on November 14, 2016, and is the
rate on which bitcoin futures contracts are cash-settled in U.S.
dollars on the Chicago Mercantile Exchange (``CME''). See id. at
28654.
\35\ According to the Exchange, a ``Relevant Transaction'' is
any cryptocurrency versus U.S. dollar spot trade that occurs during
the observation window between 3:00 p.m. and 4:00 p.m., ET, on a
Constituent Platform in the BTC/USD pair that is reported and
disseminated by a Constituent Platform through its publicly
available Automatic Programming Interface (``API'') and observed by
the Benchmark Administrator. See id. at 28655.
\36\ According to the Exchange, a volume-weighted median differs
from a standard median in that a weighting factor, in this case
trade size, is factored into the calculation. See id. at 28655 n.64.
\37\ See id. at 28654-55.
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The Trust's website, as well as one or more major market data
vendors, will provide an intra-day 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 Core Trading
Session (9:30 a.m. to 4:00 p.m. ET). The IIV will be calculated by
using the prior day's closing NAV per Share as a base and updating that
value during the Exchange's Core Trading Session to reflect changes in
the value of the Trust's NAV during the trading day.\38\
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\38\ See id. at 28659.
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The Trust will issue and redeem Shares to authorized participants
on an ongoing basis in blocks of 50,000 Shares (``Creation Units'').
The creation and redemption of Creation Units will be effected in ``in-
kind'' transactions based on the quantity of bitcoin attributable to
each Share. The creation and redemption of Creation Units require the
delivery to the Trust, or the distribution by the Trust, of the number
of bitcoins represented by the Creation Units being created or
redeemed.\39\
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\39\ See id. at 28658-59.
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[[Page 3872]]
III. Discussion
A. The Applicable Standard for Review
The Commission must consider whether NYSE Arca's proposal is
consistent with the Exchange Act. Section 6(b)(5) of the Exchange Act
requires, in relevant part, that the rules of a national securities
exchange be designed ``to prevent fraudulent and manipulative acts and
practices'' and ``to protect investors and the public interest.'' \40\
Under the Commission's Rules of Practice, the ``burden to demonstrate
that a proposed rule change is consistent with the Exchange Act and the
rules and regulations issued thereunder . . . is on the self-regulatory
organization [`SRO'] that proposed the rule change.'' \41\
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\40\ 15 U.S.C. 78f(b)(5). Pursuant to Section 19(b)(2) of the
Exchange Act, 15 U.S.C. 78s(b)(2), the Commission must disapprove a
proposed rule change filed by a national securities exchange if it
does not find that the proposed rule change is consistent with the
applicable requirements of the Exchange Act. Exchange Act Section
6(b)(5) states that an exchange shall not be registered as a
national securities exchange unless the Commission determines that
``[t]he rules of the exchange are designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general,
to protect investors and the public interest; and are not designed
to permit unfair discrimination between customers, issuers, brokers,
or dealers, or to regulate by virtue of any authority conferred by
this title matters not related to the purposes of this title or the
administration of the exchange.'' 15 U.S.C. 78f(b)(5).
\41\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
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The description of a proposed rule change, its purpose and
operation, its effect, and a legal analysis of its consistency with
applicable requirements must all be sufficiently detailed and specific
to support an affirmative Commission finding,\42\ and any failure of an
SRO to provide this information may result in the Commission not having
a sufficient basis to make an affirmative finding that a proposed rule
change is consistent with the Exchange Act and the applicable rules and
regulations.\43\ Moreover, ``unquestioning reliance'' on an SRO's
representations in a proposed rule change is not sufficient to justify
Commission approval of a proposed rule change.\44\
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\42\ See id.
\43\ See id.
\44\ Susquehanna Int'l Group, LLP v. Securities and Exchange
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (``Susquehanna'').
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B. Whether NYSE Arca has Met Its Burden To Demonstrate That the
Proposal Is Designed To Prevent Fraudulent and Manipulative Acts and
Practices
(1) Assertions That Other Means Besides Surveillance-Sharing Agreements
Will Be Sufficient To Prevent Fraudulent and Manipulative Acts and
Practices
As stated above, the Commission has recognized that a listing
exchange could demonstrate that other means to prevent fraudulent and
manipulative acts and practices are sufficient to justify dispensing
with a comprehensive surveillance-sharing agreement with a regulated
market of significant size, including by demonstrating that the bitcoin
market as a whole or the relevant underlying bitcoin market is uniquely
and inherently resistant to fraud and manipulation.\45\ Such resistance
to fraud and manipulation must be novel and beyond those protections
that exist in traditional commodities or securities markets.\46\
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\45\ See USBT Order, 85 FR at 12597 n.23. The Commission 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. See id.
\46\ See id. at 12597.
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NYSE Arca asserts that certain aspects of the market for bitcoin
help to mitigate the potential for fraud and manipulation in connection
with bitcoin pricing.\47\ Specifically, according to NYSE Arca, the
significant liquidity in the bitcoin spot market and the impact of
market orders on the overall price of bitcoin have made attempts to
move the price of bitcoin increasingly expensive over the past
year.\48\ The Exchange states that, in January 2020, for example, the
cost to buy or sell $5 million worth of bitcoin averaged roughly 30
basis points (compared to 10 basis points in February 2021) with a
market impact of 50 basis points (compared to 30 basis points in
February 2021). For a $10 million market order, the cost to buy or sell
was roughly 50 basis points (compared to 20 basis points in February
2021) with a market impact of 80 basis points (compared to 50 basis
points in February 2021). NYSE Arca contends that, as the liquidity in
the bitcoin spot market increases, it follows that the impact of $5
million and $10 million orders will continue to decrease.\49\
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\47\ See Notice, 86 FR at 28658.
\48\ See id.
\49\ See id.
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The Exchange's assertions about the bitcoin market do not
constitute other means to prevent fraud and manipulation sufficient to
justify dispensing with the requisite surveillance-sharing agreement.
First, the data furnished by NYSE Arca regarding the cost to move the
price of bitcoin, and the market impact of such attempts, are
incomplete. NYSE Arca does not provide meaningful analysis pertaining
to how these figures compare to other markets or why one must conclude,
based on the numbers provided, that the bitcoin market is costly to
manipulate. Further, NYSE Arca's analysis of the market impact of a
mere two sample transactions is not sufficient evidence to conclude
that the bitcoin market is resistant to manipulation.\50\ Even assuming
that the Commission agreed with NYSE Arca's premise, that it is costly
to manipulate the bitcoin market, and it is becoming increasingly so,
any such evidence speaks only to establish that there is some
resistance to manipulation, not that it establishes unique resistance
to manipulation to warrant dispensing with the standard surveillance-
sharing agreement.\51\
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\50\ Aside from stating that the ``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,'' the Exchange provides no other information
pertaining to the methodology used to enable the Commission to
evaluate these findings or their significance. See Notice, 86 FR at
28658 n.91.
\51\ See USBT Order, 85 FR at 12601.
---------------------------------------------------------------------------
Moreover, NYSE Arca does not sufficiently contest the presence of
possible sources of fraud and manipulation in the bitcoin spot market
generally that the Commission has raised in previous orders, which have
included: (1) ``wash'' trading; (2) persons with a dominant position in
bitcoin manipulating bitcoin pricing; (3) hacking of the bitcoin
network and trading platforms; (4) malicious control of the bitcoin
network; (5) trading based on material, non-public information (such as
plans of market participants to significantly increase or decrease
their holdings in bitcoin; new sources of demand for bitcoin; the
decision of a bitcoin-based investment vehicle on how to respond to a
``fork'' in the bitcoin blockchain), or based on the dissemination of
false and misleading information; (6) manipulative activity involving
the purported ``stablecoin'' Tether (USDT); and (7) fraud and
manipulation at bitcoin trading platforms.\52\
---------------------------------------------------------------------------
\52\ See USBT Order, 85 FR at 12600-01 & nn.66-67 (discussing J.
Griffin & A. Shams, Is Bitcoin Really Untethered? (October 28,
2019), available at https://ssrn.com/abstract=3195066 and published
in 75 J. Finance 1913 (2020)); Winklevoss Order, 83 FR at 37585-86;
Valkyrie Order, 86 FR at 74160.
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[[Page 3873]]
In addition, NYSE Arca does not address risk factors specific to
the bitcoin blockchain and bitcoin platforms described in the Trust's
Registration Statement that undermine its assertions about the bitcoin
market. For example, the Registration Statement acknowledges that
``platforms on which users trade bitcoin are relatively new and, in
some cases, largely unregulated, and, therefore, may be more exposed to
fraud and security breaches than established, regulated exchanges for
other financial assets or instruments;'' that the bitcoin blockchain
could be vulnerable to a ``51% attack,'' in which a malicious actor(s)
or botnet that controls a majority of the processing power dedicated to
mining on the bitcoin network may be able to alter the bitcoin
blockchain on which the bitcoin network and bitcoin transactions rely;
that the nature of the assets held at bitcoin platforms makes them
``appealing targets for hackers'' and that ``a number of bitcoin
platforms have been victims of cybercrimes;'' that ``in 2019 there were
reports claiming that 80-95% of bitcoin trading volume on [bitcoin
platforms] was false or non-economic in nature;'' and that, over the
past several years, bitcoin trading platforms ``have been closed due to
fraud and manipulative activity, business failure or security
breaches.'' \53\
---------------------------------------------------------------------------
\53\ See Registration Statement at 16, 18, 20-21.
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NYSE Arca also asserts that other means to prevent fraud and
manipulation are sufficient to justify dispensing with the requisite
surveillance-sharing agreement. The Exchange states that the Reference
Rate, which is used to determine the value of the Trust's bitcoin and
NAV, is itself resistant to manipulation based on the Reference Rate's
methodology.\54\ The Reference Rate mitigates the effects of potential
manipulation of the bitcoin market because the Reference Rate is
exclusively based on Constituent Platforms.\55\ According to the
Exchange, the capital necessary to maintain a significant presence on
any Constituent Platform would make manipulation of the Reference Rate
unlikely.\56\ The Exchange, moreover, asserts that ``[b]itcoin trades
in a well-arbitraged and distributed market'', and ``[t]he linkage
between the bitcoin markets and the presence of arbitrageurs in those
markets means that the manipulation of the price of bitcoin on any
Constituent Platform [(and, as implied by the Exchange, the Reference
Rate)] would likely require overcoming the liquidity supply of such
arbitrageurs who are potentially eliminating any cross-market pricing
differences.'' \57\
---------------------------------------------------------------------------
\54\ See Notice, 86 FR at 28658.
\55\ See id. at 28661.
\56\ See id.
\57\ See id.
---------------------------------------------------------------------------
Simultaneously with the Exchange's assertions regarding the
Reference Rate, the Exchange also states that, because the Trust will
engage in in-kind creations and redemptions only, the ``manipulability
of the Reference Rate [is] significantly less important.'' \58\ The
Exchange elaborates further that, ``because the Trust will not accept
cash to buy bitcoin in order to create or redeem Shares, the price that
the Sponsor uses to value the Trust's bitcoin is not particularly
important.'' \59\ According to NYSE Arca, when authorized participants
create Shares with the Trust, they would need to deliver a certain
number of bitcoin per Share (regardless of the valuation used), and
when they redeem with the Trust, they would similarly expect to receive
a certain number of bitcoin per Share.\60\ As such, NYSE Arca argues
that, even if the price used to value the Trust's bitcoin has been
manipulated, the ratio of bitcoin per Share does not change, and the
Trust will either accept (for creations) or distribute (for
redemptions) the same number of bitcoin regardless of the value.\61\
This, according to NYSE Arca, not only mitigates the risk associated
with potential manipulation, but also discourages and disincentivizes
manipulation of the Reference Rate because there is little financial
incentive to do so.\62\
---------------------------------------------------------------------------
\58\ See id. at 28658.
\59\ See id.
\60\ See id.
\61\ See id.
\62\ See id.
---------------------------------------------------------------------------
Based on assertions made and the information provided, the
Commission can find no basis to conclude that NYSE Arca has articulated
other means to prevent fraud and manipulation that are sufficient to
justify dispensing with the requisite surveillance-sharing agreement.
The record does not demonstrate that the proposed methodology for
calculating the Reference Rate would make the proposed ETP resistant to
fraud or manipulation such that a surveillance-sharing agreement with a
regulated market of significant size is unnecessary.\63\
---------------------------------------------------------------------------
\63\ The Commission has previously considered and rejected
similar arguments about the valuation of bitcoin according to a
benchmark or reference price. See, e.g., SolidX Order, 82 FR at
16258; Winklevoss Order, 83 FR at 37587-90; USBT Order, 85 FR at
12599-601; WisdomTree Order, 86 FR at 69326-28; Valkyrie Order, 86
FR at 74160-63; Kryptoin Order, 86 FR at 74172-73.
---------------------------------------------------------------------------
NYSE Arca has not shown that its proposed use of a number of
equally-sized time intervals over the observation window between 3:00
p.m. and 4:00 p.m., E.T., to calculate the Reference Rate would
effectively be able to eliminate fraudulent or manipulative activity
that is not transient. Fraud and manipulation in the bitcoin spot
market could persist for a ``significant duration.'' \64\ The Exchange
does not connect the use of such partitions to the duration of the
effects of fraud and manipulation in the bitcoin spot market.\65\ Thus,
the Exchange fails to establish how the Reference Rate's methodology
eliminates fraudulent or manipulative activity that is not
transient.\66\
---------------------------------------------------------------------------
\64\ See USBT Order, 85 FR at 12601 n.66; see also id. at 12607.
\65\ See WisdomTree Order, 86 FR at 69327.
\66\ See USBT Order, 85 FR at 12607.
---------------------------------------------------------------------------
Moreover, the record does not demonstrate that the Benchmark
Administrator's reliance solely on the Constituent Platforms to
calculate the Reference Rate make the proposed ETP resistant to fraud
or manipulation. For example, even assuming, as the Exchange asserts,
that the capital necessary to maintain a significant presence on any
Constituent Platform make the Reference Rate resistant to manipulation,
the Exchange has not assessed the possible influence that spot
platforms not included among the Constituent Platforms would have on
bitcoin prices used to calculate the Reference Rate. As discussed
above, the Exchange has not sufficiently addressed the presence of
possible sources of fraud and manipulation in the broader spot market
previously raised by the Commission or by the Trust's Registration
Statement.\67\ Accordingly, to the extent that trading on platforms not
directly used to calculate the Reference Rate affects prices on the
Constituent Platforms, the characteristics of those other platforms--
where various kinds of fraud and manipulation from a variety of sources
may be present and persist--may affect whether the Reference Rate is
resistant to manipulation.
---------------------------------------------------------------------------
\67\ See supra notes 52-53 and accompanying text.
---------------------------------------------------------------------------
Likewise, the Commission is unpersuaded by NYSE Arca's assertion
that arbitrage across bitcoin markets makes it unlikely that the price
of bitcoin on the Constituent Platforms would be manipulated. Here, the
Exchange provides insufficient evidence to support its assertion of
price arbitrage across bitcoin platforms and does not
[[Page 3874]]
take into account that a market participant with a dominant ownership
position would not find it prohibitively expensive to overcome the
liquidity supplied by arbitrageurs and could use dominant market share
to engage in manipulation.\68\
---------------------------------------------------------------------------
\68\ See, e.g., Winklevoss Order, 83 FR at 37584; USBT Order, 85
FR at 12600-01.
---------------------------------------------------------------------------
In addition, the Exchange's assertions about the Reference Rate are
contradicted by the Registration Statement, which states that ``the
[Reference Rate] has a limited history and there are limitations with
the price of bitcoin reflected there.'' \69\ The Registration Statement
further states that ``platforms on which users trade bitcoin. . . may
be more exposed to fraud and security breaches than established,
regulated exchanges for other financial assets or instruments, which
could have a negative impact on the performance of the Trust.'' \70\
The Constituent Platforms are a subset of the bitcoin platforms
currently in existence. Although the Sponsor raises concerns regarding
fraud and security of bitcoin platforms in the Registration Statement,
which would include the Constituent Platforms, the Exchange does not
explain how or why such concerns are consistent with its assertion that
the use of the Reference Rate mitigates the effects of potential
manipulation of the bitcoin market.
---------------------------------------------------------------------------
\69\ See Registration Statement at 35.
\70\ See id. at 18.
---------------------------------------------------------------------------
NYSE Arca also does not explain the significance of the Reference
Rate's purported resistance to manipulation to the overall analysis of
whether the proposal to list and trade the Shares is designed to
prevent fraud and manipulation. Even assuming that the Exchange's
argument is that, if the Reference Rate is resistant to manipulation,
the Trust's NAV, and thereby the Shares as well, would be resistant to
manipulation, the Exchange has not established in the record a basis
for such conclusion. That assumption aside, the Commission notes that
the Shares would trade at market-based prices in the secondary market,
not at NAV, which then raises the question of the significance of the
NAV calculation to the manipulation of the Shares.
The Exchange's arguments are also contradictory. While arguing that
the Reference Rate is resistant to manipulation, the Exchange
simultaneously downplays the importance of the Reference Rate in light
of the Trust's in-kind creation and redemption mechanism.\71\ The
Exchange points out that the Trust will create and redeem Shares in-
kind, not in cash, which renders the NAV calculation, and thereby the
ability to manipulate NAV, ``significantly less important.'' \72\ The
Trust will not accept cash to buy bitcoin in order to create Shares or
sell bitcoin to pay cash for redeemed Shares. Accordingly, in NYSE
Arca's own words, the price that the Sponsor uses to value the Trust's
bitcoin ``is not particularly important.'' \73\ If the Reference Rate
that the Trust uses to value the Trust's bitcoin ``is not particularly
important,'' it follows that the Reference Rate's resistance to
manipulation is not material to the Shares' susceptibility to fraud and
manipulation. As the Exchange does not address or provide any analysis
with respect to these issues, the Commission cannot conclude that the
Reference Rate aids in the determination that the proposal to list and
trade the Shares is designed to prevent fraudulent and manipulative
acts and practices.
---------------------------------------------------------------------------
\71\ See supra notes 58-62 and accompanying text.
\72\ See Notice, 86 FR at 28658 (``While the Sponsor believes
that the Reference Rate used to value the Trust's bitcoin is itself
resistant to manipulation based on the methodology described above,
the fact that creations and redemptions are only available in-kind
makes the manipulability of the Reference Rate significantly less
important.'').
\73\ See id.
---------------------------------------------------------------------------
The Commission thus concludes that the Exchange has not
demonstrated that its use of the Reference Rate makes the proposed ETP
resistant to manipulation. While the proposed procedures for
calculating the Reference Rate using only prices from the Constituent
Platforms are intended to provide some degree of protection against
attempts to manipulate the Reference Rate, these procedures are not
sufficient for the Commission to dispense with the requisite
surveillance-sharing agreement with a regulated market of significant
size.
Finally, the Commission finds that NYSE Arca has not demonstrated
that in-kind creations and redemptions provide the Shares with a unique
resistance to manipulation. The Commission has previously addressed
similar assertions.\74\ As the Commission stated before, in-kind
creations and redemptions are a common feature of ETPs, and the
Commission has not previously relied on the in-kind creation and
redemption mechanism as a basis for excusing exchanges that list ETPs
from entering into surveillance-sharing agreements with significant,
regulated markets related to the portfolio's assets.\75\ Accordingly,
the Commission is not persuaded here that the Trust's in-kind creations
and redemptions afford it a unique resistance to manipulation.
---------------------------------------------------------------------------
\74\ See Winklevoss Order, 83 FR at 37589-90; USBT Order, 85 FR
at 12607-08.
\75\ See, e.g., iShares COMEX Gold Trust, Securities Exchange
Act Release No. 51058 (Jan. 19, 2005), 70 FR 3749, 3751-55 (Jan. 26,
2005) (SR-Amex-2004-38); iShares Silver Trust, Securities Exchange
Act Release No. 53521 (Mar. 20, 2006), 71 FR 14969, 14974 (Mar. 24,
2006) (SR-Amex-2005-072).
---------------------------------------------------------------------------
(2) Assertions That NYSE Arca Has Entered Into a Comprehensive
Surveillance-Sharing Agreement With a Regulated Market of Significant
Size
As NYSE Arca has not demonstrated that other means besides
surveillance-sharing agreements will be sufficient to prevent
fraudulent and manipulative acts and practices, the Commission next
examines whether the record supports the conclusion that NYSE Arca has
entered into a comprehensive surveillance-sharing agreement with a
regulated market of significant size relating to the underlying assets.
In this context, the term ``market of significant size'' includes a
market (or group of markets) as to which (i) there is a reasonable
likelihood that a person attempting to manipulate the ETP would also
have to trade on that market to successfully manipulate the ETP, so
that a surveillance-sharing agreement would assist in detecting and
deterring misconduct, and (ii) it is unlikely that trading in the ETP
would be the predominant influence on prices in that market.\76\
---------------------------------------------------------------------------
\76\ See Winklevoss Order, 83 FR at 37594. This definition is
illustrative and not exclusive. There could be other types of
``significant markets'' and ``markets of significant size,'' but
this definition is an example that provides guidance to market
participants. See id.
---------------------------------------------------------------------------
In its proposal, NYSE Arca asserts that the CME, either alone as
the sole market for bitcoin futures or as a group of markets together
with the Constituent Platforms, is a ``market of significant size.''
\77\ As the Commission has stated in the past, it considers two markets
that are members of the ISG to have a comprehensive surveillance-
sharing agreement with one another, even if they do not have a separate
bilateral surveillance-sharing agreement.\78\ Accordingly, based on the
common membership of NYSE Arca and the CME in the ISG,\79\ NYSE Arca
has the equivalent of a comprehensive surveillance-sharing agreement
with the CME. However, while the Commission recognizes that the
Commodity Futures Trading Commission (``CFTC'') regulates the CME
futures market,\80\ including the
[[Page 3875]]
CME bitcoin futures market, and thus such market is ``regulated'' in
the context of the proposed ETP, the record does not, as explained
further below, establish that the CME bitcoin futures market, either
alone as the sole market for bitcoin futures or as a group of markets
together with the Constituent Platforms, is a ``market of significant
size'' as that term is used in the context of the applicable standard
here.
---------------------------------------------------------------------------
\77\ See Notice, 86 FR at 28656-58, 28661.
\78\ See Winklevoss Order, 83 FR at 37580 n.19.
\79\ See Notice, 86 FR at 28656.
\80\ While the Commission recognizes that the CFTC regulates the
CME, the CFTC is not responsible for direct, comprehensive
regulation of the underlying bitcoin spot market. See Winklevoss
Order, 83 FR at 37587, 37599. See also infra notes 125-127 and
accompanying text.
---------------------------------------------------------------------------
(a) Whether There Is a Reasonable Likelihood That a Person Attempting
To Manipulate the ETP Would Also Have To Trade on the CME Bitcoin
Futures Market, Alone or Together With Constituent Platforms, To
Successfully Manipulate the ETP
The first prong in establishing whether the CME bitcoin futures
market constitutes a ``market of significant size'' is the
determination that there is a reasonable likelihood that a person
attempting to manipulate the ETP would have to trade on the CME bitcoin
futures market to successfully manipulate the ETP.\81\
---------------------------------------------------------------------------
\81\ See Winklevoss Order, 83 FR at 37594.
---------------------------------------------------------------------------
NYSE Arca notes that the CME began to offer trading in bitcoin
futures in 2017.\82\ According to NYSE Arca, nearly every measurable
metric related to CME bitcoin futures contracts, which trade and settle
like other cash-settled commodity futures contracts, has ``trended
consistently up since launch and/or accelerated upward in the past
year.'' \83\ For example, according to NYSE Arca, there was
approximately $28 billion in trading in the CME bitcoin futures in
December 2020 compared to $737 million, $1.4 billion, and $3.9 billion
in total trading in December 2017, December 2018, and December 2019,
respectively.\84\ Additionally, CME bitcoin futures traded over $1.2
billion per day in December 2020 and represented $1.6 billion in open
interest compared to $115 million in December 2019.\85\ Similarly, NYSE
Arca contends that the number of large open interest holders \86\ has
continued to increase, even as the price of bitcoin has risen, as have
the number of unique accounts trading CME bitcoin futures.\87\
---------------------------------------------------------------------------
\82\ According to NYSE Arca, each contract represents five
bitcoin and is based on the CME CF BRR. See Notice, 86 FR at 28651.
\83\ See id.
\84\ See id.
\85\ See id.
\86\ NYSE Arca represents that a large open interest holder in
CME bitcoin futures is an entity that holds at least 25 contracts,
which is the equivalent of 125 bitcoin. According to NYSE Arca, at a
price of approximately $30,000 per bitcoin on December 31, 2020,
more than 80 firms had outstanding positions of greater than $3.8
million in CME bitcoin futures. See id. at 28652 n.60.
\87\ See id. at 28652.
---------------------------------------------------------------------------
In addition, NYSE Arca states that there was approximately $4.321
billion in trading volume and $2.582 billion in open interest in CME
bitcoin futures as of April 7, 2021, compared to $433 million in
trading volume and $238 million in open interest as of February 26,
2020.\88\ NYSE Arca states that the growth of the CME bitcoin futures
market has coincided with similar growth in the bitcoin spot market and
that the market for CME bitcoin futures is rapidly approaching the size
of markets for other commodity interests.\89\ NYSE Arca concludes that,
as the CME bitcoin futures market continues to develop and more closely
resemble other commodity futures markets, it can be reasonably expected
that the relationship between the CME bitcoin futures market and the
bitcoin spot market will behave similar to other future/spot market
relationships, including periods where a lead-lag relationship between
the CME bitcoin futures market and bitcoin spot market exists.\90\
---------------------------------------------------------------------------
\88\ See id. at 28657.
\89\ See id.
\90\ See id. at 28657-58.
---------------------------------------------------------------------------
NYSE Arca also asserts that the CME is the primary market for
bitcoin futures and ``compares favorably'' with other markets that were
deemed to be markets of significant size in past precedents.\91\ In
particular, NYSE Arca states that the bitcoin market is similar to the
gold market and that the CME is similarly situated to COMEX with
respect to gold ETPs.\92\ Namely, the Exchange states that, when the
Commission approved the listing of gold ETPs and other commodity trust
ETPs, rather than requiring surveillance-sharing agreements with the
relevant OTC markets, the Commission relied on the surveillance-sharing
agreements between the listing exchange and the regulated markets for
trading futures on the underlying commodity.\93\
---------------------------------------------------------------------------
\91\ See id. at 28656.
\92\ See id. at 28656-57.
\93\ See id. at 28657.
---------------------------------------------------------------------------
In addition, NYSE Arca asserts that a would-be manipulator of
bitcoin prices would be reasonably likely to do so through the CME
bitcoin futures market in order to take advantage of the leverage
inherent in trading futures contracts.\94\ The Exchange argues that,
given the tremendous growth in the spot bitcoin market since 2019, the
chances of succesfully deploying a manipulative scheme are ``increased
exponentially'' if a would-be manipulator can affect the CME bitcoin
futures market (and thus the spot market) by posting only the minimum
margin required.\95\ According to the Exchange, because the CME bitcoin
futures market is the ``cheapest'' route to manipulate bitcoin, it is
highly likely such manipulators would attempt to do so there rather
than any spot market.\96\
---------------------------------------------------------------------------
\94\ See id. at 28657.
\95\ See id. The Exchange states that, as of April 12, 2021, the
initial margin required in connection with CME bitcoin futures for
the April 2021 contract ranged from 42% to 38%. See id. at 28657
n.88.
\96\ See id. at 28657.
---------------------------------------------------------------------------
Further, NYSE Arca maintains that, due to the decentralized nature
of the bitcoin network, bitcoin manipulators would be much more likely
to attempt to manipulate a limited number of futures markets rather
than attempt simultaneous executions on potentially dozens of different
spot bitcoin platforms.\97\ NYSE Arca states that, even if a would-be
manipulator does attempt to manipulate bitcoin across platforms, such a
scheme would also necessarily include some attempt to manipulate the
price of bitcoin futures, including the CME.\98\
---------------------------------------------------------------------------
\97\ See id.
\98\ See id.
---------------------------------------------------------------------------
The record does not demonstrate that there is a reasonable
likelihood that a person attempting to manipulate the proposed ETP
would have to trade on the CME bitcoin futures market to successfully
manipulate the proposed ETP. The Exchange's assertions about the size
of the CME bitcoin futures market, including the trading volume and
open interest of, and number of large open interest holders and unique
accounts trading in, CME bitcoin futures, and its assertion that the
CME is the primary market for bitcoin futures, do not establish that
the CME bitcoin futures market is of significant size. While NYSE Arca
provides data showing absolute growth in the size of the CME bitcoin
futures market, it provides no data relative to the concomitant growth
in either the bitcoin spot markets or other bitcoin futures markets
(including unregulated futures markets). Morover, even if the CME has
grown in relative size, as the Commission has previously articulated,
the interpretation of the term ``market of significant size'' or
``significant market'' depends on the interrelationship between the
market with which the listing exchange has a surveillance-sharing
agreement and the proposed ETP.\99\ NYSE Arca's recitation of data
reflecting the size of the CME bitcoin futures market and its
unsupported claim that the CME is the primary
[[Page 3876]]
market for bitcoin futures are not sufficient to establish an
interrelationship between the CME bitcoin futures market and the
proposed ETP.\100\
---------------------------------------------------------------------------
\99\ See USBT Order, 85 FR at 12611.
\100\ See id. at 12612.
---------------------------------------------------------------------------
Further, the econometric evidence in the record for this proposal
also does not support the conclusion that an interrelationship exists
between the CME bitcoin futures market and the bitcoin spot market such
that it is reasonably likely that a person attempting to manipulate the
proposed ETP would also have to trade on the CME bitcoin futures market
to successfully manipulate the proposed ETP.\101\ The Exchange asserts
that the relationship between the CME bitcoin futures market and the
bitcoin spot market ``can be reasonably expected'' to behave similarly
to other future/spot market relationships, including periods where a
lead-lag relationship between the CME bitcoin futures market and
bitcoin spot market exists,\102\ but the only data NYSE Arca presents
to support its ``expectation'' is the growth in and current size of the
CME bitcoin futures market. NYSE Arca's ``expectation'', without any
supporting evidence or analysis, constitutes an insufficient basis for
approving a proposed rule change in circumstances where, as here, the
Exchange's assertion would form such an integral role in the
Commission's analysis.\103\
---------------------------------------------------------------------------
\101\ See id. at 12611. Listing exchanges have attempted to
demonstrate such an ``interrelationship'' by presenting the results
of various econometric ``lead-lag'' analyses. The Commission
considers such analyses to be central to understanding whether it is
reasonably likely that a would-be manipulator of the ETP would need
to trade on the CME bitcoin futures market. See id. at 12612.
\102\ See Notice, 86 FR at 28657-58.
\103\ See Susquehanna, 866 F.3d at 447.
---------------------------------------------------------------------------
Likewise, the Exchange's comparison of the bitcoin spot market to
the gold spot market is inapposite and does not establish the CME
bitcoin futures market's significance. First, the Exchange provides no
data or analysis to support its assertion that the bitcoin market is
similar to the gold market or that the COMEX gold futures market is
similar to the CME bitcoin futures market. Further, as discussed above,
for the commodity-trust ETPs approved to date for listing and trading,
including where the underlying commodity is gold, there has been in
every case at least one significant, regulated market for trading
futures.\104\ The Exchange's unsupported assertions that the bitcoin
market is similar to the gold market or that the CME is similarly
situated to COMEX with respect to futures does not establish that the
CME bitcoin futures market is a significant market or that it is
reasonably likely that an actor attempting to manipulate the price of
the proposed ETP's assets would have to trade in the CME bitcoin
futures market.
---------------------------------------------------------------------------
\104\ See Winklevoss Order, 83 FR at 37594.
---------------------------------------------------------------------------
The Exchange also asserts that it is ``highly likely'' that would-
be manipulators of bitcoin prices would attempt to do so in the CME
bitcoin futures market because it is the ``cheapest'' route to
manipulate bitcoin.\105\ However, the only data the Exchange provides
to support its assertion is the initial margin requirement for CME
bitcoin futures as of April 12, 2021.\106\ The Exchange does not
provide any additional data or analysis to support its conclusions or
any examples that would demonstrate that such assertions are
reasonable. Furthermore, the Exchange does not provide any information
on the margin requirements for bitcoin futures markets other than the
CME. As stated above, ``unquestioning reliance'' on an SRO's
representations in a proposed rule change is not sufficient to justify
Commission approval of a proposed rule change.\107\
---------------------------------------------------------------------------
\105\ See Notice, 86 FR at 28657.
\106\ See supra note 95.
\107\ See supra note 44.
---------------------------------------------------------------------------
Indeed, although the Exchange implies that the ``cheapest'' route
to manipulate bitcoin price is through CME bitcoin futures because of
its margin requirement, other bitcoin futures platforms require even
less margin than the CME. For example, the contract specifications for
a bitcoin futures contract on BitMex (XBTUSD) specifies a maximum
initial leverage ratio of 100-to-1,\108\ meaning that the required
margin for bitcoin futures on BitMex is 1% of the notional value of the
open contract position versus, according to the Exchange, 38% to 42%
for CME bitcoin futures.\109\ Thus, applying the Exchange's logic, it
would appear to be ``cheaper,'' i.e., require less capital commitment,
to manipulate the bitcoin price using bitcoin futures traded on BitMex
or other unregulated futures platforms rather than the CME, given the
lower margin requirements on such unregulated platforms. The Exchange,
however, does not address the significance of other futures markets'
lower margin requirements to its assertion that a person attempting to
manipulate the ETP would also have to trade on the CME bitcoin futures
market.
---------------------------------------------------------------------------
\108\ See https://www.bitmex.com/app/contract/XBTUSD (last
visited Dec. 1, 2021). Other unregulated platforms that trade
bitcoin futures have similar margin requirements. For example,
Deribit has an initial minimum margin requirement of 1% for bitcoin
futures. See https://legacy.deribit.com/pages/docs/futures (last
visited Dec. 1, 2021). Binance has an initial minimum margin
requirement of 2% for trading bitcoin futures. See https://www.binance.com/en/support/announcement/34801a0c405a4b058f9ae18a1a34cad3 (last visited Dec. 1, 2021).
\109\ See Notice, 86 FR at 28657 n.88.
---------------------------------------------------------------------------
Similarly, although the Exchange asserts that, due to the
decentralized nature of the bitcoin network, bitcoin manipulators would
be more likely to attempt to manipulate a limited number of bitcoin
futures markets rather than attempt simultaneous executions on
potentially dozens of different bitcoin spot platforms, NYSE Arca
provides no evidence to back up its assertions. The Exchange also
claims that, even if a would-be manipulator does attempt to manipulate
bitcoin across platforms, such a scheme would also necessarily include
some attempts to manipulate the price of bitcoin futures, including the
CME. The Exchange, however, does not explain, or provide supporting
evidence to establish, why one must ``necessarily'' conclude such
outcome, especially as it relates to the CME. In other words, even
assuming that the Commission concurred with the Exchange's premise that
a would-be manipulator would attempt to manipulate the ETP by trading
on the bitcoin futures market, the Exchange does not explain why such
manipulator would do so specifically on the CME.
NYSE Arca also asserts that the CME, if not alone as the sole
market for bitcoin futures, then together with the Constituent
Platforms, is a ``market of significant size.'' The Exchange argues
that, because CME bitcoin futures are cash-settled by reference to a
final settlement price based on the CME CF BRR, anyone attempting to
manipulate the CME CF BRR would have to trade on the Constituent
Platforms, and the resulting manipulative trading patterns would be
detectable by the Benchmark Administrator and the CME because of the
CME's and the Benchmark Administrator's oversight of the Constituent
Platforms.\110\ The Exchange, moreover, states that each Constituent
Platform must: (1) Enter into a data sharing agreement with the CME;
(2) cooperate with inquiries and investigations of regulators and the
Benchmark Administrator; and (3) submit each of its clients to its
Know-
[[Page 3877]]
Your Customer (``KYC'') procedures.\111\ As a result, in the case of
any suspicious trades, the CME and the Exchange would be able to
discover all material trade information, including the identities of
the customers placing the trades.\112\
---------------------------------------------------------------------------
\110\ See Notice, 86 FR at 28657. The Exchange states that
because the CME CF BRR is based solely on price data from the
Constituent Platforms, manipulating the CME CF BRR must necessarily
entail manipulating the price data at one or more Constituent
Platforms. The Exchange also states that the CME CF BRR calculation
agent receives trading data from the Constituent Platforms through
its API. See id. at 28657 nn.85-86.
\111\ See id. at 28657.
\112\ See id.
---------------------------------------------------------------------------
The Commission is not persuaded by the Exchange's arguments. The
Exchange does not explain the significance of its assertions, including
its assertion that the CME and the Benchmark Administrator would be
able to detect manipulative trading patterns on the Constituent
Platforms, in the overall analysis of whether there is a reasonable
likelihood that a person attempting to manipulate the proposed ETP
would have to trade on the CME bitcoin futures market to successfully
manipulate the ETP.\113\ In other words, even assuming that the
Commission concurs with NYSE Arca's assertion that the CME and the
Benchmark Administrator can detect manipulation on the Constituent
Platforms because CME bitcoin futures are cash-settled by reference to
the CME CF BRR, the Exchange does not establish how this aids in the
determination that either the CME bitcoin futures market, alone or
together with the Constituent Platforms, is a significant market with
respect to bitcoin. Moreover, the Exchange provides nothing to support
its assertion that, to manipulate the CME CF BRR, the would-be
manipulator would have to trade on the Constituent Platforms. Similar
to the discussion above with respect to Constituent Platforms and the
Reference Rate, the Exchange has not assessed the possible influence
that spot platforms not included among the Constituent Platforms would
have on the spot price of bitcoin on the Constituent Platforms and
bitcoin prices used to calculate the CME CF BRR. To the extent that
trading on platforms not directly used to calculate the CME CF BRR
affects prices on the Constituent Platforms, transactions on those
other platforms could affect the CME CF BRR.
---------------------------------------------------------------------------
\113\ As further discussed below, the Commission finds that the
level of regulation of the Constituent Platforms, including the
oversight by the CME and the Benchmark Administrator, is not
equivalent to the obligations, authority, and oversight of national
securities exchanges or futures exchanges and therefore is not an
appropriate substitute. See infra notes 118-132 and accompanying
text.
---------------------------------------------------------------------------
Furthermore, even assuming that the record does establish that the
CME, together with the Constituent Platforms, is a market of
significant size, NYSE Arca acknowledges that it has not entered into a
surveillance-sharing agreement with any of the Constituent
Platforms.\114\ As the Commission has previously stated, a
surveillance-sharing agreement with a regulated, significant market
facilitates the ETP listing exchange's ability to obtain the necessary
information to detect and deter manipulative misconduct.\115\ Although
NYSE Arca states that the Constituent Platforms must enter into a data
sharing agreement with the CME, and the CME and NYSE Arca, by virtue of
their ISG membership, have a comprehensive surveillance-sharing
agreement with one another, NYSE Arca does not have a surveillance
sharing agreement with any of the Constituent Platforms.\116\
Accordingly, the Exchange fails to provide a basis for the Commission
to conclude that it has entered into a comprehensive surveillance-
sharing agreement with a regulated market of significant size relating
to the underlying assets.\117\
---------------------------------------------------------------------------
\114\ See Notice, 86 FR at 28656 n.72.
\115\ See Winklevoss Order, 83 FR at 37549.
\116\ See Notice, 86 FR at 28657.
\117\ See, e.g., USBT Order, 85 FR at 12614-15.
---------------------------------------------------------------------------
The Constituent Platforms, moreover, are not ``regulated.'' The
level of regulation of the Constituent Platforms is not equivalent to
the obligations, authority, and oversight of national securities
exchanges or futures exchanges and therefore is not an appropriate
substitute.\118\ National securities exchanges are required to have
rules that are ``designed to prevent fraudulent and manipulative acts
and practices, to promote just and equitable principles of trade, to
foster cooperation and coordination with persons engaged in regulating,
clearing, settling, processing information with respect to, and
facilitating transactions in securities, to remove impediments to and
perfect the mechanism of a free and open market and a national market
system, and, in general, to protect investors and the public
interest.'' \119\ Moreover, national securities exchanges must file
proposed rules with the Commission regarding certain material aspects
of their operations,\120\ and the Commission has the authority to
disapprove any such rule that is not consistent with the requirements
of the Exchange Act.\121\ Thus, national securities exchanges are
subject to Commission oversight of, among other things, their
governance, membership qualifications, trading rules, disciplinary
procedures, recordkeeping, and fees.\122\
---------------------------------------------------------------------------
\118\ See id., 85 FR at 12603-05.
\119\ See 15 U.S.C. 78f(b)(5).
\120\ 17 CFR 240.19b-4(a)(6)(i).
\121\ Section 6 of the Exchange Act, 15 U.S.C. 78f, requires
national securities exchanges to register with the Commission and
requires an exchange's registration to be approved by the
Commission, and Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b),
requires national securities exchanges to file proposed rules
changes with the Commission and provides the Commission with the
authority to disapprove proposed rule changes that are not
consistent with the Exchange Act. Designated contract markets
(``DCMs'') (commonly called ``futures markets'') registered with and
regulated by the CFTC must comply with, among other things, a
similarly comprehensive range of regulatory principles and must file
rule changes with the CFTC. See, e.g., Designated Contract Markets
(DCMs), CFTC, available at http://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/index.htm.
\122\ See Winklevoss Order, 83 FR at 37597.
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The Constituent Platforms, on the other hand, have none of these
requirements (none are registered as a national securities
exchange).\123\ While the Exchange asserts that the Constituent
Platforms must submit their clients to KYC procedures, such
requirements are fundamentally different from the Exchange Act's
requirements for national securities exchanges.\124\ In addition,
although the Commission recognizes that the CFTC maintains some
jurisdiction over the bitcoin spot market, under the Commodity Exchange
Act, the CFTC does not have regulatory authority over bitcoin spot
trading platforms, including the Constituent Platforms.\125\ Except in
certain limited circumstances, bitcoin spot trading platforms are not
required to register with the CFTC, and the CFTC does not set standards
for, approve the rules of, examine, or otherwise regulate bitcoin spot
markets.\126\ As the CFTC itself stated, while the CFTC ``has an
important role to play,'' U.S. law ``does not provide for direct,
comprehensive Federal oversight of underlying Bitcoin or virtual
currency spot markets.'' \127\
---------------------------------------------------------------------------
\123\ See 15 U.S.C. 78e, 78f.
\124\ See USBT Order, 85 FR at 12603. The Commission has
previously concluded that such KYC policies and procedures do not
serve as a substitute for, and are not otherwise dispositive in the
analysis regarding the importance of having a surveillance sharing
agreement with a regulated market of significant size relating to
bitcoin. For example, KYC policies and procedures do not substitute
for the sharing of information about market trading activity or
clearing activity and do not substitute for regulation of a national
securities exchange. See USBT Order, 85 FR at 12603 n.101.
\125\ See USBT Order, 85 FR at 12604.
\126\ See id.
\127\ See Winklevoss Order, 83 FR at 37599 n.288 (quoting CFTC
Backgrounder on Oversight of and Approach to Virtual Currency
Futures Markets (Jan. 4, 2018), at 1, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/backgrounder_virtualcurrency01.pdf).
---------------------------------------------------------------------------
And while NYSE Arca asserts that the Constituent Platforms must
enter into data sharing agreements with the CME, it does not provide
any information on the scope, terms, or enforcement authority for such
data sharing
[[Page 3878]]
agreements. Nor has NYSE Arca put any information in the record as to
whether and how it would use or enforce such agreements. Moreover, such
agreements are contractual in nature and do not satisfy the regulatory
requirements or purposes of national securities exchanges and the
Exchange Act. The CME (and the CFTC, as discussed above) does not have
regulatory authority over the spot bitcoin trading platforms,\128\ and,
while the CME is regulated by the CFTC,\129\ the CFTC's regulations do
not extend to the Constituent Platforms by virtue of such contractual
agreements.
---------------------------------------------------------------------------
\128\ See supra notes 125-127 and accompanying text.
\129\ See supra note 80 and accompanying text.
---------------------------------------------------------------------------
Further, although NYSE Arca states that the Constituent Platforms
must cooperate with inquiries and investigations of regulators and the
Benchmark Administrator, it does not describe the scope of such
requirements or what authority the Benchmark Administrator or
regulators would have to compel the platforms' cooperation or provide
meaningful supporting evidence of the extent of such cooperation.
Moreover, the Benchmark Administrator does not itself exercise
governmental regulatory authority. Rather, the Benchmark Administrator
is a registered, privately-held company in England.\130\ The Benchmark
Administrator's relationship with the Constituent Platforms is based on
their participation in the determination of reference rates, such as
the Reference Rate. While the Benchmark Administrator is regulated by
the UK FCA as a benchmark administrator, the UK FCA's regulations do
not extend to the Constituent Platforms by virtue of their trade prices
serving as input data underlying the Reference Rate.\131\
---------------------------------------------------------------------------
\130\ See https://blog.cfbenchmarks.com/legal/ (stating that the
Benchmark Administrator is authorized and regulated by the UK
Financial Conduct Authority (``UK FCA'') as a registered Benchmark
Administrator (FRN 847100) under the EU benchmark regulation, and
further noting that the Benchmark Administrator is a member of the
Crypto Facilities group of companies which is in turn a member of
the Payward, Inc. group of companies, and Payward, Inc. is the owner
and operator of the Kraken Exchange, a venue that facilitates the
trading of cryptocurrencies). The Commission notes that the Kraken
is one of the Constituent Platforms underlying the Reference Rate.
\131\ See USBT Order, 85 FR at 12604. The Benchmark
Administrator is also not required to apply certain provisions of EU
benchmark regulation to the Constituent Platforms because the
Reference Rate's input data is not ``contributed.'' See Benchmark
Statement, at 5 available at https://docs-cfbenchmarks.s3.amazonaws.com/CME+CF+Benchmark+Statement.pdf.
---------------------------------------------------------------------------
Further, the oversight performed by the Benchmark Administrator
serves a fundamentally different purpose as compared to the regulation
of national securities exchanges and the requirements of the Exchange
Act. While the Commission recognizes that the Benchmark Administrator's
oversight functions may be important for ensuring the integrity of the
Reference Rate, such requirements do not imbue either the Benchmark
Administrator or the Constituent Platforms with regulatory authority
similar to that the Exchange Act confers upon self-regulatory
organizations such as national securities exchanges.\132\
---------------------------------------------------------------------------
\132\ See 15 U.S.C. 78f(b).
---------------------------------------------------------------------------
The Commission accordingly concludes that the information provided
in the record does not establish a reasonable likelihood that a would-
be manipulator of the proposed ETP would have to trade on the CME
bitcoin futures market to successfully manipulate the proposed ETP.
Moreover, NYSE Arca has not entered into a surveillance-sharing
agreement with the Constituent Platforms, and the Constituent Platforms
are not ``regulated'' markets. Accordingly, the information in the
record also does not establish that the CME bitcoin futures market,
alone or together with the Constituent Platforms, is a ``market of
significant size'' with respect to the proposed ETP or that NYSE Arca
has a surveillance-sharing agreement with such a market.
(b) Whether It Is Unlikely That Trading in the Proposed ETP Would be
the Predominant Influence on Prices in the CME Bitcoin Futures Market
or Constituent Platforms
The second prong in establishing whether a market (or group of
markets) constitutes a ``market of significant size'' is the
determination that it is unlikely that trading in the proposed ETP
would be the predominant influence on prices in that market.\133\ As
discussed above, NYSE Arca asserts that CME, either alone as the sole
market for bitcoin futures or as a group of markets together with the
Constituent Platforms, satisfies this prong.\134\
---------------------------------------------------------------------------
\133\ See Winklevoss Order, 83 FR at 37594; USBT Order, 85 FR at
12596-97.
\134\ See Notice, 86 FR at 28656.
---------------------------------------------------------------------------
First, NYSE Arca asserts that trading in the Shares would not be
the predominant force on prices in the CME bitcoin futures market (or
spot market) because of the significant volume in the CME bitcoin
futures market, the size of bitcoin's market capitalization, which is
approximately $1 trillion, and the significant liquidity available in
the spot market.\135\
---------------------------------------------------------------------------
\135\ See id. at 28657.
---------------------------------------------------------------------------
To support its assertion about the growth of the CME bitcoin
futures market, NYSE Arca states that there was approximately $4.321
billion in trading volume and $2.582 billion in open interest in CME
bitcoin futures as of April 7, 2021, compared to $433 million in
trading volume and $238 million in open interest as of February 26,
2020.\136\ Based on these figures, NYSE Arca concludes that, as the CME
bitcoin futures market continues to develop, it can be reasonably
expected that the relationship between the bitcoin futures market and
bitcoin spot market will behave similarly to other future/spot market
relationships, including periods where a lead-lag relationship between
the bitcoin futures market and bitcoin spot market exists.
---------------------------------------------------------------------------
\136\ See id. at 28657.
---------------------------------------------------------------------------
NYSE Arca also provides that, according to February 2021 data, the
cost to buy or sell $5 million worth of bitcoin averages roughly 10
basis points with a market impact of 30 basis points.\137\ 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,
NYSE Arca states that a market participant could enter a market buy or
sell order for $10 million of bitcoin and only move the market 0.5
percent.\138\ NYSE Arca further asserts that 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.\139\ Thus, NYSE
Arca concludes that the combination of CME bitcoin futures' important
role in price discovery, the overall size of the bitcoin market, and
the ability for market participants (including authorized participants
creating and redeeming in-kind with the Trust) to buy or sell large
amounts of bitcoin without significant market impact, will help prevent
the Shares from becoming the predominant force on pricing in either the
bitcoin spot or the CME bitcoin futures market.\140\
---------------------------------------------------------------------------
\137\ See id. at 28658. According to NYSE Arca, these statistics
are based on samples of bitcoin liquidity in U.S. dollars (excluding
stablecoins or Euro liquidity) based on executable quotes on
Coinbase Pro, Gemini, Bitstamp, Kraken, LMAX Exchange, BinanceUS,
and OKCoin during February 2021. See id. at 28658 n.89.
\138\ See id. at 28658.
\139\ See id.
\140\ See id.
---------------------------------------------------------------------------
NYSE Arca also provides the results from a study conducted by the
Benchmark Administrator (``CF
[[Page 3879]]
Benchmarks Analysis'') to determine the extent of ``slippage'' (i.e.,
the difference between the expected price of a trade and the price at
which the trade was actually executed), which the Exchange states
offers further evidence that trading in the Shares is unlikely to be
the predominant influence in the bitcoin spot market.\141\ According to
NYSE Arca, the CF Benchmarks Analysis simulated the purchase of 50
bitcoins a day for 686 days (an amount chosen specifically to replicate
hypothetical trades by an ETP) and found that the maximum amount of
slippage on a particular day was 0.3%, with the remainder of values
between 0% and 0.15%.\142\ According to NYSE Arca, the CF Benchmarks
Analysis demonstrates that the slippage in the study could be described
as having been largely negligible or, at most, minor during the
observation period.\143\
---------------------------------------------------------------------------
\141\ See id. at 28658 & n.90 (citing CF Benchmarks, ``An
Analysis of the Suitability of the CME CF BRR for the Creation of
Regulated Financial Products,'' December 2020 (``CF Benchmarks
Analysis''), available at: https://docsend.com/view/kizk7rarzaba6jxf).
\142\ See id. at 28658.
\143\ See id.
---------------------------------------------------------------------------
The record does not demonstrate that it is unlikely that trading in
the proposed ETP would be the predominant influence on prices in the
CME bitcoin futures market or the spot market, including the
Constituent Platforms.\144\ As the Commission has already addressed and
rejected one of the bases of NYSE Arca's assertion--CME bitcoin
futures' role in price discovery \145\--it will only address below the
other bases--the overall size of, and the impact of buys and sells on,
the bitcoin market and slippage.
---------------------------------------------------------------------------
\144\ See USBT Order, 85 FR at 12613-14. The Exchange asserts
that the CME, either alone as the sole market for the bitcoin
futures or as a group of markets together with the Constituent
Platforms, is a ``market of significant size.'' As noted above, the
second prong in establishing whether a market (or group of markets)
constitutes a ``market of significant size'' is the determination
that it is unlikely that trading in the proposed ETP would be the
predominant influence on prices in that market. The Exchange states
throughout its filing that trading in the Shares would not be the
predominant influence on prices in the CME bitcoin futures market or
spot market rather than the Constituent Platforms. See supra notes
135, 140, and 141 and accompanying text. Since the Constituent
Platforms are a subset of the the bitcoin spot platforms currently
in existence, the Commission's analysis with respect to the spot
market applies equally to the Constituent Platforms.
\145\ See supra notes 102-103 and accompanying text.
---------------------------------------------------------------------------
NYSE Arca's assertions about the potential effect of trading in the
Shares on the CME bitcoin futures market and bitcoin spot market are
general and conclusory, repeating the aforementioned trade volume of
the CME bitcoin futures market, and providing general statements about
the size and liquidity of the bitcoin spot market as well as the market
impact of a large transaction in the spot market, without any analysis
or evidence to support these assertions. For example, there is no limit
on the amount of mined bitcoin that the Trust may hold. Yet NYSE Arca
does not provide any information on the expected growth in the size of
the Trust and the resultant increase in the amount of bitcoin held by
the Trust over time, or on the overall expected number, size, and
frequency of creations and redemptions--or how any of the foregoing
could (if at all) influence prices in the CME bitcoin futures market or
the spot market.
Moreover, in the Trust's Registration Statement, the Sponsor
acknowledges that there is no limit on the number of bitcoins that the
Trust may acquire and that the Trust itself may have an impact on the
supply and demand of bitcoins. Specifically, the Registration Statement
states that the if the number of bitcoins acquired by the Trust is
large enough relative to global bitcoin supply and demand, further
creations and redemptions of Shares could have an impact on the supply
of and demand for bitcoins and that such an impact could affect the
price of bitcoin in U.S. dollars.\146\ Although the Trust's
Registration Statement concedes that the Trust could impact the price
of bitcoin, NYSE Arca does not address this in the proposal or discuss
how impacting the price of bitcoin can be consistent with the assertion
that the Shares are unlikely to be the predominant influence on the
prices of the CME bitcoin futures market or the spot market. Thus, the
Commission cannot conclude, based on NYSE Arca's statements alone and
absent any evidence or analysis in support of NYSE Arca's assertions,
that it is unlikely that trading in the ETP would be the predominant
influence on prices in the CME bitcoin futures market or the spot
market.
---------------------------------------------------------------------------
\146\ See Registration Statement at 21.
---------------------------------------------------------------------------
The Commission also is not persuaded by NYSE Arca's assertions
about the minimal effect a large market order to buy or sell bitcoin
would have on the bitcoin market.\147\ While NYSE Arca concludes by way
of a $10 million market order example that buying or selling large
amounts of bitcoin would have insignificant market impact, the
conclusion does not analyze the extent of any impact on the CME bitcoin
futures market, the market that the Exchange, in the proposal, argues
is the significant market under consideration. Even assuming, however,
that NYSE Arca is suggesting that a single $10 million order in bitcoin
would have immaterial impact on the prices in the CME bitcoin futures
market, this prong of the ``market of significant size'' determination
concerns the influence on prices from trading in the proposed ETP,
which is broader than just trading by the proposed ETP. While
authorized participants of the Trust might only transact in the bitcoin
spot market as part of their creation or redemption of Shares, the
Shares themselves would be traded in the secondary market on NYSE Arca.
The record does not discuss the expected number or trading volume of
the Shares, or establish the potential effect of the Shares' trade
prices on CME bitcoin futures prices, or the spot market prices. For
example, NYSE Arca does not provide any data or analysis about the
potential effect the quotations or trade prices of the Shares might
have on market-maker quotations in CME bitcoin futures contracts and
whether those effects would constitute a predominant influence on the
prices of those futures contracts.
---------------------------------------------------------------------------
\147\ See Notice, 86 FR at 28659 (``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%.'').
---------------------------------------------------------------------------
Similarly, although NYSE Arca cites to the CF Benchmark Analysis as
evidence that trading in the Shares is unlikely to be the predominant
influence in the bitcoin spot market, NYSE Arca states that the
simulation in the analysis was done specifically to replicate
hypothetical trades by an ETP. The study further states that the
simulation was performed to ``represent a large [b]itcoin trade of the
kind that institutional traders might need to undertake for a major
client, or that an issuer of a financial product (such as an ETF or a
derivative) would be required to execute in order to facilitate trading
of that product.'' \148\ As discussed above, this prong concerns the
influence on prices from trading in the proposed ETP. Under the
proposal, the Shares themselves would be traded in the secondary market
on NYSE Arca, and the CF Benchmark Analysis does not discuss the effect
of the trade prices of ETP shares or other bitcoin derivatives on the
bitcoin market, or more importantly, CME bitcoin futures market.
Likewise, the CF Benchmark Analysis only analyzes the prices of
hypothetical bitcoin spot transactions as compared to the CME CF BRR--a
spot price index--and does not analyze the
[[Page 3880]]
extent of any impact of such hypothetical transactions on prices in the
CME bitcoin futures market specifically.
---------------------------------------------------------------------------
\148\ See CF Benchmark Analysis, at 16.
---------------------------------------------------------------------------
Thus, because NYSE Arca has not provided sufficient information to
establish both prongs of the ``market of significant size''
determination, the Commission cannot conclude that the CME bitcoin
futures market, either alone as the sole market for bitcoin futures or
as a group of markets together with the Constituent Platforms, is a
``market of significant size'' such that NYSE Arca would be able to
rely on a surveillance-sharing agreement with the CME to provide
sufficient protection against fraudulent and manipulative acts and
practices.
The requirements of Section 6(b)(5) of the Exchange Act apply to
the rules of national securities exchanges. Accordingly, the relevant
obligation for a comprehensive surveillance-sharing agreement with a
regulated market of significant size, or other means to prevent
fraudulent and manipulative acts and practices that are sufficient to
justify dispensing with the requisite surveillance-sharing agreement,
resides with the listing exchange. Because there is insufficient
evidence in the record demonstrating that NYSE Arca has satisfied this
obligation, the Commission cannot approve the proposed ETP for listing
and trading on NYSE Arca.
C. Whether NYSE Arca Has Met Its Burden To Demonstrate That the
Proposal Is Designed To Protect Investors and the Public Interest
NYSE Arca contends that, if approved, the proposed ETP would
protect investors and the public interest. However, the Commission must
consider these potential benefits in the broader context of whether the
proposal meets each of the applicable requirements of the Exchange
Act.\149\ Because NYSE Arca has not demonstrated that its proposed rule
change is designed to prevent fraudulent and manipulative acts and
practices, the Commission must disapprove the proposal.
---------------------------------------------------------------------------
\149\ See Winklevoss Order, 83 FR at 37601. See also
GraniteShares Order, 83 FR at 43931; ProShares Order, 83 FR at
43941; USBT Order, 85 FR at 12615.
---------------------------------------------------------------------------
NYSE Arca asserts that, with the growth of U.S. investor exposure
to bitcoin through OTC bitcoin funds, so too has grown the potential
risk to U.S. investors.\150\ Specifically, NYSE Arca argues that
premium and discount volatility, high fees, insufficient disclosures,
and technical hurdles are exposing U.S. investors to risks that could
potentially be eliminated through access to a bitcoin ETP.\151\ As
such, the Exchange believes that approving this proposal (and
comparable proposals) represents an opportunity for U.S. investors to
gain exposure to bitcoin in a regulated and transparent exchange-traded
vehicle that limits risks by: (i) Reducing premium and discount
volatility; (ii) reducing management fees through meaningful
competition; (iii) providing an alternative to custodying spot bitcoin;
and (iv) reducing risks associated with investing in operating
companies that are imperfect proxies for bitcoin exposure.\152\
---------------------------------------------------------------------------
\150\ See Notice, 86 FR at 28649.
\151\ See id. NYSE Arca states that while it understands the
Commission's previous focus on potential manipulation of a bitcoin
ETP in prior disapproval orders, it believes that ``such concerns
have been sufficiently mitigated and may be outweighed by the
growing and quantifiable investor protection concerns related to OTC
[b]itcoin [f]unds.'' See id.
\152\ See id.
---------------------------------------------------------------------------
According to NYSE Arca, OTC bitcoin funds are generally designed to
provide exposure to bitcoin in a manner similar to the Shares. However,
unlike the Shares, NYSE Arca states that ``OTC [b]itcoin [f]unds are
unable to freely offer creation and redemption in a way that
incentivizes market participants to keep their shares trading in line
with their NAV and, as a result, shares of OTC [b]itcoin [f]unds
frequently trade at a price that is out-of-line with the value of their
assets held.'' \153\ NYSE Arca represents that, historically, OTC
bitcoin funds have traded at a significant premium to NAV.\154\
Although the Exchange concedes that trading at a premium or a discount
is not unique to OTC bitcoin funds and not inherently problematic, NYSE
Arca believes that it raises certain investor protections issues.
First, according to NYSE Arca, investors are buying shares of a fund
for a price that is not reflective of the per share value of the fund's
underlying assets.\155\ Second, according to NYSE Arca, because only
accredited investors, generally, are able to purchase shares directly
from the issuing fund at NAV (in exchange for either cash or bitcoin)
without having to pay the premium or sell into the discount, these
investors that are allowed to purchase directly with the fund are able
to hedge their bitcoin exposure as needed to satisfy holding
requirements and collect on the premium or discount opportunity.\156\
NYSE Arca argues, therefore, that the premium in OTC bitcoin funds
essentially creates a transfer in value from retail investors to more
sophisticated investors.\157\ NYSE Arca further asserts that the risk
of manipulation of a bitcoin ETP is also present in and potentially
magnified by OTC bitcoin funds.\158\
---------------------------------------------------------------------------
\153\ See id. NYSE Arca also states that, unlike the Shares,
because OTC bitcoin funds are not listed on an exchange, they are
not subject to the same transparency and regulatory oversight by a
listing exchange. NYSE Arca further asserts that the existence of a
surveillance-sharing agreement between NYSE Arca and the CME bitcoin
futures market would result in increased investor protections for
the Shares compared to OTC bitcoin funds. See id. at 28649 n.44.
\154\ See id. at 28649. NYSE Arca further represents that the
inability to trade in line with NAV may at some point result in OTC
bitcoin funds trading at a discount to their NAV, which has occurred
more recently with respect to one prominent OTC bitcoin fund.
According to NYSE Arca, while that has not historically been the
case, and it is not clear whether such discounts will continue, such
a prolonged, significant discount scenario would give rise to nearly
identical potential issues related to trading at a premium. See id.
at 28649 n.45.
\155\ See id. at 28650.
\156\ See id.
\157\ See id.
\158\ See id.
---------------------------------------------------------------------------
NYSE Arca also asserts that exposure to bitcoin through an ETP
presents advantages for retail investors compared to buying spot
bitcoin directly.\159\ NYSE Arca asserts that, without the advantages
of an ETP, an individual retail investor holding bitcoin through a
cryptocurrency trading platform lacks protections.\160\ NYSE Arca
explains that, typically, retail platforms hold most, if not all,
retail investors' bitcoin in ``hot'' (internet-connected) storage and
do not make any commitments to indemnify retail investors or to observe
any particular cybersecurity standard.\161\ Meanwhile, a retail
investor holding spot bitcoin directly in a self-hosted wallet may
suffer from inexperience in private key management (e.g., insufficient
password protection, lost key, etc.), which could cause them to lose
some or all of their bitcoin holdings.\162\ NYSE Arca represents that
the Bitcoin Custodian would, by contrast, use ``cold'' (offline)
storage to hold private keys, meet a certain degree of cybersecurity
measures and operational best practices, be highly experienced in
bitcoin custody, and be accountable for failures.\163\ In addition,
NYSE Arca explains that retail investors would be able to hold the
Shares in traditional brokerage accounts, which provide SIPC protection
if a brokerage firm fails.\164\ Thus, with respect to custody of the
Trust's bitcoin assets, NYSE Arca concludes that, compared to
[[Page 3881]]
owning spot bitcoin directly, the Trust presents advantages from an
investment protection standpoint for retail investors.\165\
---------------------------------------------------------------------------
\159\ See id.
\160\ See id.
\161\ See id.
\162\ See id.
\163\ See id. at 28650-51. NYSE Arca represents that the Sub-
Adviser has previously conducted substantial due diligence on the
capabilities of the Bitcoin Custodian. See id. at 28651 n.54.
\164\ See id. at 28651.
\165\ See id.
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NYSE Arca further asserts that a number of operating companies
engaged in unrelated businesses have recently announced investments as
large as $1.5 billion in bitcoin.\166\ Without access to bitcoin ETPs,
NYSE Arca argues that retail investors seeking investment exposure to
bitcoin may purchase shares in these companies in order to gain the
exposure to bitcoin that they seek.\167\ NYSE Arca contends that such
operating companies, however, are imperfect bitcoin proxies and provide
investors with partial bitcoin exposure paired with additional risks
associated with whichever operating company they decide to
purchase.\168\ NYSE Arca concludes that investors seeking bitcoin
exposure through publicly traded companies are gaining only partial
exposure to bitcoin, without the full benefit of the risk disclosures
and associated investor protections that come from the securities
registration process.\169\
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\166\ See id.
\167\ See id.
\168\ See id.
\169\ See id.
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NYSE Arca also states that investors in many other countries,
including Canada, are able to use more traditional exchange listed and
traded products to gain exposure to bitcoin, disadvantaging U.S.
investors and leaving them with riskier, more expensive, and less
regulated means of getting bitcoin exposure.\170\ NYSE Arca anticipates
that with the addition of more bitcoin ETPs in non-U.S. jurisdictions
expected to grow, such risks will only continue to grow.\171\
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\170\ See Notice, 86 FR at 28649. NYSE Arca represents that the
Purpose Bitcoin ETF, a retail bitcoin-based ETP launched in Canada,
reportedly reached $421.8 million in assets under management in two
days and has achieved $993 million in assets as of April 14, 2021,
demonstrating the demand for a North American market listed bitcoin
ETP. NYSE Arca contends that the demand for the Purpose Bitcoin ETF
is driven primarily by investors' desire to have a regulated and
accessible means of exposure to bitcoin. NYSE Arca further
represents that the Purpose Bitcoin ETF offers a class of units that
is U.S. dollar denominated, which could appeal to U.S. investors.
NYSE Arca argues that without an approved bitcoin ETP in the U.S. as
a viable alternative, U.S. investors could seek to purchase these
shares in order to get access to bitcoin exposure. NYSE Arca
believes that, 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. See id.
\171\ See id.
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NYSE Arca further asserts that several funds registered under the
Investment Company Act of 1940 (``1940 Act'') have effective
registration statements that contemplate bitcoin exposure through a
variety of means, including through investments in bitcoin futures
contacts and through OTC bitcoin funds and that it is anticipated that
other 1940 Act funds will begin to pursue bitcoin through other
means.\172\ NYSE Arca asserts that these funds that have already
invested in bitcoin instruments have no reported issues regarding
custody, valuation, or manipulation of the instruments held by these
funds.\173\ NYSE Arca argues that, while these funds offer investors
some means of exposure to bitcoin, the current offerings fall short of
giving investors an accessible, regulated product that provides
concentrated exposure to bitcoin.\174\
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\172\ See id.
\173\ See id.
\174\ See id.
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In essence, NYSE Arca asserts that the risky nature of a direct
investment in the underlying bitcoin and the unregulated markets on
which bitcoin and OTC bitcoin funds trade compel approval of the
proposed rule change. In addition, NYSE Arca essentially argues that,
unlike other regulated products available, the Shares would offer more
concentrated exposure to bitcoin and should therefore be approved.
The Commission disagrees. Pursuant to Section 19(b)(2) of the
Exchange Act, the Commission must approve a proposed rule change filed
by a national securities exchange if it finds that the proposed rule
change is consistent with the applicable requirements of the Exchange
Act--including the requirement under Section 6(b)(5) that the rules of
a national securities exchange be designed to prevent fraudulent and
manipulative acts and practices--and it must disapprove the filing if
it does not make such a finding.\175\ Thus, even if a proposed rule
change purports to protect investors from a particular type of
investment risk, such as the susceptibility of an asset to loss or
theft, or to provide more efficient exposure to an asset class than
another product, the proposed rule change may still fail to meet the
requirements under the Exchange Act.\176\
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\175\ See Exchange Act Section 19(b)(2)(C), 15 U.S.C.
78s(b)(2)(C).
\176\ See SolidX Order, 82 FR at 16259; WisdomTree Order, 86 FR
at 69334.
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Here, even if it were true that, compared to trading in unregulated
bitcoin spot markets or OTC bitcoin funds, trading a bitcoin-based ETP
on a national securities exchange provides some additional protection
to investors, or that the Shares would provide more concentrated
exposure to bitcoin than other products on the market, the Commission
must consider this potential benefit in the broader context of whether
the proposal meets each of the applicable requirements of the Exchange
Act.\177\ As explained above, for bitcoin-based ETPs, the Commission
has consistently required that the listing exchange have a
comprehensive surveillance-sharing agreement with a regulated market of
significant size related to bitcoin, or demonstrate that other means to
prevent fraudulent and manipulative acts and practices are sufficient
to justify dispensing with the requisite surveillance-sharing
agreement. The listing exchange has not met that requirement here.
Therefore the Commission is unable to find that the proposed rule
change is consistent with the statutory standard.
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\177\ See supra note 149. The Commission notes that the proposed
rule change does not relate to a product regulated under the 1940
Act. The Commission considers the proposed rule change on its own
merits and under the standards applicable to it. Namely, with
respect to this proposed rule change, the Commission must apply the
standards as provided by Section 6(b)(5) of the Exchange Act, which
it has applied in connection with its orders considering previous
proposals to list bitcoin-based commodity trusts and bitcoin-based
trust issued receipts.
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Pursuant to Section 19(b)(2) of the Exchange Act, the Commission
must disapprove a proposed rule change filed by a national securities
exchange if it does not find that the proposed rule change is
consistent with the applicable requirements of the Exchange Act--
including the requirement under Section 6(b)(5) that the rules of a
national securities exchange be designed to prevent fraudulent and
manipulative acts and practices.\178\
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\178\ See 15 U.S.C. 78s(b)(2)(C).
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For the reasons discussed above, NYSE Arca has not met its burden
of demonstrating that the proposal is consistent with Exchange Act
Section 6(b)(5),\179\ and, accordingly, the Commission must disapprove
the proposal.\180\
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\179\ 15 U.S.C. 78f(b)(5).
\180\ In disapproving the proposed rule change the Commission
has considered its impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
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D. Other Comments
The Commission received a comment letter that addressed the general
nature and value of bitcoin.\181\ Ultimately, however, additional
discussion of this topic is unnecessary, as it does not bear
[[Page 3882]]
on the basis for the Commission's decision to disapprove the proposal.
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\181\ See letter from Sam Ahn, dated June 4, 2021.
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IV. Conclusion
For the reasons set forth above, the Commission does not find,
pursuant to Section 19(b)(2) of the Exchange Act, that the proposed
rule change is consistent with the requirements of the Exchange Act and
the rules and regulations thereunder applicable to a national
securities exchange, and in particular, with Section 6(b)(5) of the
Exchange Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act, that proposed rule change SR-NYSEArca-2021-37 be, and
hereby is, disapproved.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-01384 Filed 1-24-22; 8:45 am]
BILLING CODE 8011-01-P