[Federal Register Volume 81, Number 201 (Tuesday, October 18, 2016)]
[Notices]
[Pages 71778-71782]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-25082]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-79084; File No. SR-BatsBZX-2016-30]
Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order
Instituting Proceedings To Determine Whether To Approve or Disapprove a
Proposed Rule Change to BZX Rule 14.11(e)(4), Commodity-Based Trust
Shares, To List and Trade Winklevoss Bitcoin Shares Issued by the
Winklevoss Bitcoin Trust
October 12, 2016.
On June 30, 2016, Bats BZX Exchange, Inc. (``BZX'' or ``Exchange'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
list and trade Winklevoss Bitcoin Shares (``Shares'') issued by the
Winklevoss Bitcoin Trust (``Trust'') under BZX Rule 14.11(e)(4). The
proposed rule change was published for comment in the Federal Register
on July 14, 2016.\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. 78262 (Jul. 8,
2016), 81 FR 45554 (``Notice'').
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The Commission has received six comment letters on the proposed
rule change.\4\ On August 23, 2016, pursuant
[[Page 71779]]
to Section 19(b)(2) of the Act,\5\ 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.\6\ This order institutes
proceedings under Section 19(b)(2)(B) of the Act \7\ to determine
whether to approve or disapprove the proposed rule change.
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\4\ See Letters from Robert D. Miller, VP Technical Services,
RKL eSolutions (July 11, 2016) (``Miller Letter''); Jorge Stolfi,
Full Professor, Institute of Computing UNICAMP (July 13, 2016)
(``Stolfi Letter''); Guillaume Lethuillier (July 26, 2016)
(``Lethuillier Letter''); Michael B. Casey (July 31, 2016) (``Casey
Letter''); Erik A. Aronesty, Sr. Software Engineer, Bloomberg LP
(Aug. 2, 2016) (``Aronesty Letter''); and Dan Anderson (Aug. 27,
2016) (``Anderson Letter''). All comments on the proposed rule
change are available on the Commission's Web site at: https://www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx201630.shtml.
\5\ 15 U.S.C. 78s(b)(2).
\6\ See Securities Exchange Act Release No. 78653, 81 FR 59256
(Aug. 29, 2016). The Commission designated October 12, 2016, as the
date by which it should approve, disapprove, or institute
proceedings to determine whether to disapprove the proposed rule
change.
\7\ 15 U.S.C. 78s(b)(2)(B).
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I. Summary of the Proposal \8\
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\8\ The Commission notes that additional information regarding
the Trust and the Shares, including investment objectives, risks,
creation and redemption procedures, fees, portfolio holdings
disclosure policies, calculation of NAV, distributions, and taxes,
as well as additional background information about bitcoins and the
Bitcoin network, including information relating to Bitcoin network
operations, bitcoin transfers and transactions, cryptographic
security used in the Bitcoin network, Bitcoin mining and creation of
new bitcoins, the mathematically controlled supply of bitcoins,
modifications to the Bitcoin protocol, among other things, can be
found in the Notice (see supra note 3) and the registration
statement filed with the Commission on Form S-1 (File No. 333-
189752) under the Securities Act of 1933 (``Registration
Statement''), as applicable.
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The Exchange proposes to list and trade the Shares under BZX Rule
14.11(e)(4), which governs the listing and trading of Commodity-Based
Trust Shares on the Exchange.\9\ The Shares, which will be registered
with the Commission by means of the Trust's Registration Statement,\10\
represent units of fractional undivided beneficial interest in and
ownership of the Trust. Digital Asset Services, LLC will be the sponsor
of the Trust (``Sponsor''). Gemini Trust Company, LLC, the custodian of
the Trust (``Custodian''), will hold the deposited bitcoins on behalf
of the Trust in a segregated custody account. The Exchange has
represented that the Custodian will use its proprietary and patent-
pending offline (i.e., air-gapped) cold-storage system to store the
Trust's bitcoins.\11\
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\9\ See BZX Rule 14.11(e)(4)(C) (permitting the listing and
trading of ``Commodity-Based Trust Shares,'' defined as a security
(a) that is issued by a trust that holds a specified commodity
deposited with the trust; (b) that is issued by such Trust in a
specified aggregate minimum number in return for a deposit of a
quantity of the underlying commodity; and (c) that, when aggregated
in the same specified minimum number, may be redeemed at a holder's
request by such Trust which will deliver to the redeeming holder the
quantity of the underlying commodity).
\10\ See Registration Statement, supra note 8. The Exchange
states that the most recent amendment to the Registration Statement
was filed on June 29, 2016, and that the Registration Statement will
be effective as of the date of any offer and sale pursuant to the
Registration Statement.
\11\ According to the Exchange, the Custodian is an affiliate of
the Sponsor and a New York State-chartered limited liability trust
company that operates under the direct supervision and regulatory
authority of the New York State Department of Financial Services.
The Trust's public Bitcoin addresses are established by the
Custodian using its proprietary hardware and software security
technology. The Trust will employ security procedures, described in
greater detail in the Notice and the Registration Statement, to
safeguard the bitcoin assets of the Trust. See Notice and
Registation Statement, supra notes 3 and 8, respectively.
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According to the Exchange, the Trust will hold only bitcoins as an
asset.\12\ The investment objective of the Trust is for the Shares to
track the price of bitcoins, as measured by the spot price at 4:00 p.m.
Eastern time on the Gemini Exchange \13\ each day the Exchange is open
for trading, minus the Trust's liabilities (which include accrued but
unpaid fees and expenses). On each business day, the Trust's
administrator will use the Gemini Exchange spot price as measured at
4:00 p.m. Eastern time to calculate the Trust's net asset value
(``NAV''). The Trust will issue and redeem the Shares in ``Baskets''
only to certain Authorized Participants on an ongoing basis.\14\
Creation Baskets will be distributed to the Authorized Participants by
the Trust in exchange for the delivery to the Trust of the appropriate
number of bitcoins (i.e., bitcoins equal in value to the value of the
Shares being purchased). On a redemption, the Trust will distribute
bitcoins equal in value to the value of the Shares being redeemed to
the redeeming Authorized Participant in exchange for the delivery to
the Trust of one or more Baskets. On each business day, the value of a
Basket for a creation transaction and the value of a Basket for a
redemption transaction will be equal to one another (i.e., each Basket
will consist of 50,000 Shares, and the value of the Basket will be
equal to the value of 50,000 Shares at the NAV per Share on that day).
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\12\ As described in greater detail in the Notice and the
Registration Statement, a bitcoin (with a lower case ``b'') is a
digital asset that is based on the decentralized, open-source
protocol of the peer-to-peer Bitcoin computer network. The Bitcoin
network (with a capital ``B'') hosts the decentralized public
transaction ledger, known as the ``Blockchain,'' on which all
bitcoins are recorded. See Notice and Registation Statement, supra
notes 3 and 8, respectively.
\13\ The Gemini Exchange is a digital-asset exchange owned and
operated by the Custodian and is an affiliate of the Sponsor.
\14\ Each Basket will consist of 50,000 Shares, and the value of
the Basket will be equal to the value of 50,000 Shares at their NAV
per Share on that day.
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II. Summary of Comment Letters
The Commission has received six comment letters on the proposed
rule change.\15\ The following is a summary of those letters.
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\15\ See supra note 4 and accompanying text.
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A. Timing of the Proposal and Investor Access to Bitcoin
One commenter states that the proposal is a timely opportunity for
the Exchange and investors, and that the proposal will allow investors
to invest in the technology without having to deal with the complexity
of holding bitcoins directly.\16\ Another commenter states that it
supports the goals of the Trust and finds the proposal to be
appropriate and timely, noting that Bitcoin is in a pivotal year and is
maturing, and noting that the average number of daily Bitcoin
transactions is currently 200,000, that more than 350,000 unique
addresses are being used to hold bitcoins,\17\ and that the Bitcoin
miners (who validate transaction blocks through computational hashes)
conduct more than a billion hashes per second.\18\ In addition, the
commenter states that, in practice, while using Bitcoin may appear
complex and forbidding, based on fear of theft and concerns about legal
and tax issues, among other things, the Trust can help a whole category
of people to gain access, albeit indirectly, to Bitcoin.\19\
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\16\ See Miller Letter, supra note 4.
\17\ Additional information about Bitcoin addresses and storage,
mining, bitcoin transfers, and the Blockchain, among other things,
can be found in the Notice. See Notice, 81 FR at 45556-45561, supra
note 3.
\18\ See Lethuillier Letter at 1-2, supra note 4.
\19\ See id. at 2.
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B. Need for Additional Control and Security Measures
With respect to security measures to be implemented by the Trust,
one commenter recommends that additional steps mandating ``proof of
control'' audits be employed to protect the consumers of this ETP.\20\
Specifically, the commenter recommends a monthly ``proof of control''
audit of all of the Trust's bitcoins to be performed by the Custodian
and provided to the Sponsor, who should display the signed messages on
its Web site to publicly demonstrate proof of control over the bitcoins
held by the Trust.\21\ According to this commenter, the message to be
signed can be the mined hash of a
[[Page 71780]]
predetermined block height, which is guaranteed to be both easily
verifiable and unknown in advance,\22\ and the signatures can be
created with the private keys still in cold storage and air-gapped.\23\
This commenter notes that publicly identifying the addresses holding
the bitcoins adds no risk to them being stolen due to the nature of
Bitcoin.\24\ According to the commenter, the bitcoins remain secure
from even quantum attack as the public key is never revealed, no
additional risk is incurred by publishing the proof-of-control audit,
and opening control to public audit vastly increases confidence in
possession and control of the underlying asset.\25\ In addition, the
commenter notes that publishing the proof-of-control audit on a monthly
basis would not place an undue burden on either the Sponsor or
Custodian, as less-regular audits are scheduled in any event.\26\
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\20\ See Casey Letter, supra note 4.
\21\ See id. at 2.
\22\ See id.
\23\ See id.
\24\ See id.
\25\ See id.
\26\ See id.
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Another commenter addressed proof-of-control audits, adding that,
unlike with non[hyphen]digital assets, an ``audit'' of assets in
bitcoins can be low cost, public, and automated, and that there is no
legitimate reason to maintain secrecy of the holdings involved in a
trust or exchange.\27\ This commenter notes that a well[hyphen]managed
trust should be able to trivially update its proof of assets at least
once every day, if not more often (every time a bitcoin is moved or
acquired).\28\ This commenter proposes that the Commission require that
any trust holding bitcoins either (i) maintain insurance on its assets,
or (ii) allow for public, daily audit of funds. Without one of those
two measures, the commenter states, investors in a bitcoin trust cannot
be reasonably assured that their investment is being soundly
custodied.\29\ The commenter concludes by stating that, given the
nature of bitcoins as electronic assets, a public and daily proof,
rather than the stated provisions for private audits, should also be
considered.\30\
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\27\ See Aronesty Letter, supra note 4.
\28\ See id.
\29\ See id.
\30\ See id.
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Another commenter states that, according to the proposed rule
change, the Custodian's Cold Storage System utilizes multiple-signature
(``Multisig'') technology with an ``M-of-N'' signing design that
requires a signature from more than one (1) Signer (but fewer than the
full complement of potential Signers) in order to move the Trust's
bitcoins.\31\ The commenter recommends amending the proposal in order
to unambiguously specify the M-of-N signing design used to secure the
Custodian's Cold Storage System and to require the Trust to notify
interested third parties, such as the Commission or, as the case may
be, the Trust's insurer, of any modification of the Multisig
characteristics in the future.\32\ Specifically, this commenter notes
that the proposed rule change fails to provide a meaningful description
of the security level of the storage system Multisig.\33\ The proposal,
the commenter asserts, ``merely defines what a [M]ultisig is, in
general, while only excluding the extreme cases M = 1, insecure, and M
= N, unpractical.'' \34\ The commenter states that the present signing
design is complicated by the fact that the Signers, which are hardware
devices, are activated by Signatories, which are human beings.\35\ The
commenter states that, as result, the given definition is overly
abstract and incomplete. Because the signing design is critical to the
safety of the funds, the commenter asserts, ``the Trust should
communicate the following elements to the interested third parties such
as the Commission or, as the case should be, the Trust's insurer: (i)
Exact number of required Signers; (ii) Exact number of potential
Signers; (iii) detailed explanation of why the chosen M-of-N
configuration is adequate; (iv) complete list of the Signatories and
what Signer(s) they can activate; and (v) useful information related to
the Signatories' keys. . . . '' \36\ The commenter adds that the Trust
should notify the relevant persons without delay of any modification of
any of the above elements: (i) Through (iii) should be publicly
announced, and, for security reasons, (iv) and (v) should be notified
to the interested third parties only.\37\
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\31\ Additional information about the ``M-of-N'' signing design
can be found in the Notice. See Notice, 81 FR at 45566-45567, supra
note 3.
\32\ See Lethuillier Letter at 3, supra note 4.
\33\ See id.
\34\ See id.
\35\ See id.
\36\ See id.
\37\ See id.
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C. Need for Insurance on the Fund's Holdings
A commenter notes that ``[b]ecause safety measures cannot prevent
thefts from the outside or the inside, [and] because human rationality
is inherently bounded,'' he does not support the fact that the Trust's
bitcoins are not insured.\38\ This commenter further asserts that the
Gemini Exchange was able to discover on its own a failure to secure the
secret keys that would maintain the safe custody of bitcoins.\39\
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\38\ See Lethuillier Letter at 2-3, supra note 4.
\39\ See id.
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D. Need for Regulation of the Bitcoin ETP Industry
One commenter states that, despite the advances in Bitcoin
development, owning and controlling bitcoins remains a highly
specialized task, which includes secure management of private keys and
``fairly advanced technological know-how.'' \40\ Because of the
difficulty and specialized knowledge required to manage bitcoins, many
investors rely on exchanges to act as custodians of their value. As a
result, the commenter believes that a Bitcoin ETP is a major milestone
and improvement and that it is crucial that the Commission regulate
this industry.\41\ The commenter concludes by noting that the concerns
regarding bitcoin security would be greatly diminished were it possible
to trade an ETP backed by bitcoins, rather than the bitcoins
themselves.\42\
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\40\ See Anderson Letter, supra note 4.
\41\ See id.
\42\ See id.
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E. Speculative Nature of Bitcoin as an Underlying Digital Asset
One commenter disagreed with the notion that bitcoins are
commodities; rather, the commenter likened bitcoins to be more like
``penny stock'' or shares of a ponzi scheme.\43\ The commenter notes
that the market price of a bitcoin, like that of a penny stock or ponzi
fund, is ``entirely speculative, based on expectations of traders about
future prices, which will be based on expectations of future
expectations.'' \44\ The commenter asserts that Bitcoin has the
essential characteristics of a penny stock or a pyramid scheme: The
profit of early investors comes entirely from the investment of later
ones.\45\ In the commenter's view, because bitcoins are primarily used
for investment, bitcoins should be regulated like a security, in which
case they should be regulated the same way a penny stock or ponzi fund
would be.\46\ The commenter concludes that the proposed ETF does not
add any productive mechanism to the underlying bitcoins, but rather
makes bitcoins accessible to investments funds, such as retirement
funds.\47\
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\43\ See Stolfi Letter, supra note 4.
\44\ See id.
\45\ See id.
\46\ See id.
\47\ See id.
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[[Page 71781]]
F. Concerns Regarding the Gemini Exchange and the Gemini Exchange Spot
Price
One commenter expresses concerns regarding the Gemini Exchange Spot
Price.\48\ Specifically, the commenter states, the nominal price of the
shares under the proposal is supposed to be tied to the market price of
bitcoins at the Gemini Exchange, which is closely tied to the ETP
proponents.\49\ In addition, the commenter states, the Gemini Exchange
has relatively low liquidity and trade volume in bitcoins.\50\ The
commenter asserts that there is a significant risk that the nominal ETP
share price ``will be manipulated, by relatively small trades that
manipulate the bitcoin price at that exchange.'' \51\
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\48\ See id.
\49\ See id.
\50\ See id.
\51\ See id.
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III. Proceedings To Determine Whether To Approve or Disapprove SR-
BatsBZX-2016-30 and Grounds for Disapproval Under Consideration
The Commission is instituting proceedings pursuant to Section
19(b)(2)(B) of the Act \52\ to determine whether the proposed rule
change should be approved or disapproved. Institution of such
proceedings is appropriate at this time in view of the legal and policy
issues raised by the proposed rule change. Institution of proceedings
does not indicate that the Commission has reached any conclusions with
respect to any of the issues involved. Rather, as described below, the
Commission seeks and encourages interested persons to provide comments
on the proposed rule change.
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\52\ 15 U.S.C. 78s(b)(2)(B).
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Pursuant to Section 19(b)(2)(B) of the Act,\53\ the Commission is
providing notice of the grounds for disapproval under consideration.
The Commission is instituting proceedings to allow for additional
analysis of the proposed rule change's consistency with Section 6(b)(5)
of the Act, which requires, among other things, that the rules of a
national securities exchange be ``designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade,'' and ``to protect investors and the public
interest.'' \54\
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\53\ Id.
\54\ 15 U.S.C. 78f(b)(5).
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IV. Procedure: Request for Written Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
issues identified above, as well as any other concerns they may have
with the proposal. In particular, the Commission invites the written
views of interested persons concerning whether the proposal is
consistent with Section 6(b)(5) or any other provision of the Act, or
the rules and regulations thereunder. Although there do not appear to
be any issues relevant to approval or disapproval that would be
facilitated by an oral presentation of views, data, and arguments, the
Commission will consider, pursuant to Rule 19b-4, any request for an
opportunity to make an oral presentation.\55\
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\55\ Section 19(b)(2) of the Act, as amended by the Securities
Act Amendments of 1975, Public Law 94-29 (June 4, 1975), grants the
Commission flexibility to determine what type of proceeding--either
oral or notice and opportunity for written comments--is appropriate
for consideration of a particular proposal by a self-regulatory
organization. See Securities Act Amendments of 1975, Senate Comm. on
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st
Sess. 30 (1975).
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Interested persons are invited to submit written data, views, and
arguments regarding whether the proposal should be approved or
disapproved by November 8, 2016. Any person who wishes to file a
rebuttal to any other person's submission must file that rebuttal by
November 22, 2016. The Commission asks that commenters address the
sufficiency of the Exchange's statements in support of the proposal,
which are set forth in the Notice,\56\ in addition to any other
comments they may wish to submit about the proposed rule change. In
particular, the Commission seeks comment on the following:
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\56\ See supra note 3.
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1. The proposed fund, if approved, would be the first exchange-
traded product available on U.S. markets to hold a digital asset such
as bitcoins, which have neither a physical form (unlike commodities)
nor an issuer that is currently registered with any regulatory body
(unlike securities, futures, or derivatives), and whose fundamental
properties and ownership can, by coordination among a majority of its
network processing power, be changed (unlike any of the above).
Moreover, as the Exchange acknowledges in its proposal, less than three
years ago, the bitcoin exchange then responsible for nearly three-
quarters of worldwide bitcoin trading lost a substantial amount of its
bitcoin holdings through computer hacking or fraud and failed.\57\ What
are commenters' views about the current stability, resilience,
fairness, and efficiency of the markets on which bitcoina are traded?
What are commenters' views on whether an asset with the novel and
unique properties of a bitcoin is an appropriate underlying asset for a
product that will be traded on a national securities exchange? What are
commenters' views on the risk of loss via computer hacking posed by
such an asset? What are commenters' views on whether an ETP based on
such an asset would be susceptible to manipulation?
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\57\ See Notice, supra note 3, at 25 n.19.
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2. According to the Exchange, the Gemini Exchange Spot Price is
representative of the accurate price of a bitcoin because of the
positive price-discovery attributes of the Gemini Exchange marketplace.
What are commenters' views on the manner in which the Trust proposes to
value its holdings?
3. According to the Exchange, the Gemini Exchange is a Digital
Asset exchange owned and operated by the Custodian and is an affiliate
of the Sponsor. What are commenters' views regarding whether any
potential conflict of interest or other issue might arise due to the
relationship between entities such as the Sponsor, the Custodian, and
the Gemini Exchange?
4. According to several commenters, there is a need for the
Exchange to provide additional information regarding ``proof of
control'' auditing, multisig protocols, and insurance with respect to
the bitcoins held in custody on behalf of the Trust, in the interest of
adequate security and investor confidence in bitcoin control. What are
commenters' views on these recommendations regarding additional
security, control, and insurance measures?
5. A commenter notes that the Gemini Exchange has relatively low
liquidity and trading volume in bitcoins and that there is a
significant risk that the nominal ETP share price ``will be
manipulated, by relatively small trades that manipulate the bitcoin
price at that exchange.'' \58\ What are commenters' views on the
concerns expressed by this commenter? What are commenters' views
regarding the susceptibility of the price of the Shares to
manipulation, considering that the NAV would be based on the spot price
of a single bitcoin exchange? What are commenters' views generally with
respect to the liquidity and transparency of the bitcoin market, and
thus the suitability of bitcoins as an underlying asset for an ETP?
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\58\ See Stolfi Letter, supra note 4.
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6. The Exchange asserts that the widespread availability of
information
[[Page 71782]]
regarding Bitcoin, the Trust, and the Shares, combined with the ability
of Authorized Participants to create and redeem Baskets each Business
Day, thereby utilizing the arbitrage mechanism, will be sufficient for
market participants to value and trade the Shares in a manner that will
not lead to significant deviations between intraday Best Bid/Best Ask
and the Intraday Indicative Value or between the Best Bid/Best Ask and
the NAV. In addition, the Exchange asserts that the numerous options
for buying and selling bitcoins will both provide Authorized
Participants with many options for hedging their positions and provide
market participants generally with potential arbitrage opportunities,
further strengthening the arbitrage mechanism as it relates to the
Shares. What are commenters' views regarding these statements? Do
commenters' agree or disagree with the assertion that Authorized
Participants and other market makers will be able to make efficient and
liquid markets in the Shares at prices generally in line with the NAV?
What are commenters' views on whether the relationship between the
Gemini Exchange and the Trust's Sponsor and Custodian might affect the
arbitrage mechanism?
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-BatsBZX-2016-30 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Numbers SR-BatsBZX-2016-30. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of these filings also will be available
for inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-BatsBZX-2016-30 and should
be submitted on or before November 8, 2016. Rebuttal comments should be
submitted by November 22, 2016.
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\59\ 17 CFR 200.30-3(a)(57).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\59\
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-25082 Filed 10-17-16; 8:45 am]
BILLING CODE 8011-01-P