In a lengthy order issued on July 26, 2018, by a 3-1 vote the U.S. Securities and Exchange Commission (“SEC”) denied an application by the CBOE Bats BZX Exchange, Inc., (“BZX”) seeking to list and trade shares of the Winklevoss Bitcoin Trust. The denial marks the culmination of a two-year effort by the Winklevoss brothers to launch the first bitcoin-based exchange-traded fund, or ETF, in the United States. In denying the application, the SEC cited various concerns about the lack of oversight in the underlying bitcoin market, and ruled that BZX did not demonstrate that bitcoin and bitcoin markets are uniquely resistant to manipulation, or that alternative means of detecting and deterring fraud and manipulation are sufficient in the absence of a surveillance-sharing agreement with a significant, regulated market related to bitcoin.

In support of its application, BZX argued that (1) the “geographically diverse and continuous nature of bitcoin trading makes it difficult and prohibitively costly to manipulate the price of bitcoin,” and therefore the bitcoin market “generally is less susceptible to manipulation than the equity, fixed income, and commodity futures markets,” and (2) “novel systems intrinsic to this new market provide unique additional protections that are unavailable in traditional commodity markets.” At least two former SEC Chief Economists submitted comment letters supporting BZX’s application and arguing that the underlying market for bitcoin is inherently resistant to manipulation.

In denying the application, the SEC observed that a substantial majority of bitcoin trading occurs on unregulated venues overseas that are relatively new and that generally appear to trade only digital assets. While the record did not support a conclusion that bitcoin derivatives markets have attained significant size, the SEC noted that regulated bitcoin-related markets are still in the early stages of their development. It therefore concluded that BZX did not demonstrate that the structure of the spot market for bitcoin is uniquely resistant to manipulation. Likewise, the SEC determined that current trading venues for bitcoin are not resistant to market manipulation. According to the SEC, BZX did not demonstrate, given the current absence of a surveillance-sharing agreement with a regulated bitcoin market of significant size, that BZX’s proposed alternative surveillance procedures BZX purports to identify—including BZX’s assertion that it would be able to obtain certain information regarding trading in the shares and in the underlying bitcoin or any bitcoin derivative—would be sufficient to satisfy the requirement that an exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.

The SEC speculated that, over time, regulated bitcoin-related markets may continue to grow and develop. For example, existing or newly created bitcoin futures markets may achieve significant size, and an ETF listing exchange may in the future be able to demonstrate that it will be able to address the risk of fraud and manipulation by sharing surveillance information with a regulated market of significant size related to bitcoin, as well as, where appropriate, with the spot markets underlying relevant bitcoin derivatives. Should these circumstances develop, or conditions otherwise change in a manner that affects the relevant analysis, the SEC would then have the opportunity to consider whether a bitcoin ETF would be consistent with the requirements of the federal securities laws.

Still, the SEC order emphasized “that its disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment.” Instead, the SEC tried to limit the scope of its order to this specific application, and noted that while BZX did not meet its burden, its proposal is consistent with relevant provisions of the federal securities laws, in particular the requirement that an exchange’s own rules be designed to prevent fraudulent and manipulative acts and practices.

In her vigorous dissent, Commissioner Peirce argued that the application satisfied the statutory standard and that the SEC should permit BZX to list and trade the Winklevoss bitcoin ETF. She expressed deep concern that the denial of the application “undermines investor protection by precluding greater institutionalization of the bitcoin market.” Commissioner Peirce believes more “institutional participation would ameliorate many of the Commission’s concerns with the bitcoin market that underlie its disapproval order.” More generally, she asserted that the majority’s “interpretation and application of the statutory standard sends a strong signal that innovation is unwelcome in our markets, a signal that may have effects far beyond the fate of bitcoin” ETFs.