Statement Regarding the Commission’s Approval of Proposed Rule Changes to List and Trade Shares of Spot Bitcoin Exchange-Traded Products

Today marks the Commission’s long-anticipated approval of applications to list and trade shares of spot bitcoin exchange-traded products (“ETPs”). While I concur with the approval of the spot bitcoin ETP applications under the standards set forth in Section 19(b)(2) of the Securities Exchange Act of 1934 (“Exchange Act”), [1] I have strong concerns with three aspects of the order (the “Approval Order”): [2]

1) The Approval Order improperly attempts to validate the application of the “significant size” test to spot bitcoin ETPs that was struck down by judicial review.

2) The Approval Order invents a novel, previously unarticulated standard to form the basis for approval.

3) The Approval Order disguises the Commission’s motivation for accelerating the approval of the applications, which is to prevent a first-mover advantage among spot bitcoin ETPs.

The Commission’s rationale and legal analysis in the Approval Order may serve as precedent for future matters that come before the Commission. Even though the Commission is approving the listing applications in this instance, the underlying analytical approach effectively amounts to merit regulation. Thus, the flawed reasoning in the Approval Order could reverberate for years to come.

1) Singling Out Bitcoin ETPs for Disparate Treatment

The Commission most recently disapproved a spot bitcoin ETP application on March 10, 2023. [3] In dissenting from that decision, Commissioner Peirce and I noted that the legal standard set forth in the disapproval order appeared to be unique to the context of considering spot bitcoin ETPs. [4] In particular, the Commission required an exchange to establish “that it has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin.” [5] While the Commission has applied this standard to other types of commodity-based ETPs, [6] in the case of spot bitcoin ETP applications, the Commission has made it virtually impossible for an exchange to establish that the relevant bitcoin futures market is one of “significant size.”

Unlike any other type of commodity ETP, spot bitcoin ETPs can establish that a futures market is of significant size only if: (1) 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 the ETP listing market in detecting and deterring misconduct, and (2) it is unlikely that trading in the ETP would be the predominant influence on prices in that market. [7] Yet the Commission has never provided an explanation for this standard and appears to have acted in an arbitrary and capricious manner in using it to disapprove prior spot bitcoin ETP applications.

Rather than treating bitcoin like any other commodity, the Approval Order doubles down on the novel “significant size” test by continuing to consider whether the spot bitcoin ETP applications satisfy that test. Today’s action is a missed opportunity to state that bitcoin ETP applications should be considered under the test used for every other commodity-based ETP. In those other contexts, significant size appears “to refer to the significance, presumably measured by liquidity and volume, of a particular venue for trading futures as compared to the overall market for futures in the relevant commodity.” [8] Under that standard, spot bitcoin ETP applications should have been approved long ago.

Disappointingly, the Approval Order continues to apply the novel “significant size” test and concludes – like the disapproval orders that preceded it – that the CME bitcoin futures market is not one of “significant size.” [9] This conclusion is surprising in light of the unanimous decision of the U.S. Court of Appeals for the D.C. Circuit (D.C. Circuit) in Grayscale Investments, LLC v. SEC. [10] In that matter, the D.C. Circuit specifically evaluated the differential application of the “significant market” requirement by the Commission in the spot bitcoin ETP context relative to the bitcoin futures ETP context, where the test was deemed satisfied.

According to the D.C. Circuit’s opinion, given the high correlation between the price of spot bitcoin and bitcoin futures, “the Commission failed to explain why a surveillance sharing agreement with the CME was sufficient to protect bitcoin futures ETPs from potential fraud, but not Grayscale’s proposed bitcoin ETP.” [11] The D.C. Circuit concluded that the Commission’s order disapproving the Grayscale application for a spot bitcoin ETP was arbitrary and capricious under an analysis of the Commission’s “significant market” test because “[t]he Commission’s reasons for approving the [bitcoin futures] ETPs seem to apply equally to Grayscale, but Grayscale’s listing was denied.” [12]

Why does the Approval Order continue to apply the “significant market” test and conclude that the test is not satisfied without providing any further analysis? Under the Grayscale ruling, that conclusion continues to be arbitrary and capricious, even if the Commission now has decided to approve spot bitcoin ETP applications on separate grounds. The Commission continues to treat spot bitcoin ETPs differently than bitcoin futures ETPs under the “significant market” test, but the Approval Order provides no additional explanation for the differential treatment. Accordingly, the legal analysis in the Approval Order is inconsistent with the directive set forth in the D.C. Circuit’s opinion. [13]

Even worse, the Approval Order describes the D.C. Circuit’s opinion in a manner that obscures the specific focus of that opinion on the application of the “significant market” test. According to the Approval Order, the D.C. Circuit “held that the Commission failed to adequately explain its reasoning” with respect to the determination that “the [applicant] had not established that the CME bitcoin futures market was a market of significant size related to spot bitcoin, or that the ‘other means’ asserted were sufficient to satisfy the statutory standard.” [14] However, while the Commission has noted that an applicant could obtain approval if it demonstrated that there were “other means” to prevent fraudulent and manipulative acts in the event that the “significant market” test was not satisfied, the Grayscale decision singularly focuses on the Commission’s application of the “significant market” test. The term “other means” does not appear once in the twenty-one page opinion.

Thus, framing the Grayscale decision as a failure to adequately explain the Commission’s differential treatment – whether under the “significant market” test or evaluating “other means” for preventing fraud – is disingenuous. The D.C. Circuit painstakingly demonstrated that the Commission failed to adequately explain differential results under the “significant market” test specifically. The inaccurate language in the Approval Order – which implies that the Court had a more general concern with the Commission’s disapproval order – provides license to the Commission to continue to differentially apply the “significant market” test without any additional explanation.

2) Invention of a New Standard

Because the Commission decided to disregard the D.C. Circuit and find that spot bitcoin ETFs continue to fail the significant market test, it needed a new basis for an approval. The Commission grasps onto an analysis included in the ARK 21Shares Bitcoin ETF application (the “ARK Application”) that the price of spot bitcoin is highly correlated to the price of bitcoin futures. [15] Using that analysis, the Commission determined that, in contrast to previous proposals, “the Commission is able to conclude that fraud or manipulation that impacts prices in spot bitcoin markets would likely similarly impact CME bitcoin futures prices.” [16] Coupled with the fact that “CME’s surveillance can assist in detecting those impacts on CME bitcoin futures prices,” there is a basis for finding that the applicant’s comprehensive surveillance-sharing agreement with the CME “can be reasonably expected to assist in surveilling for fraudulent and manipulative acts and practices.” [17]

Thus, with the wave of a wand, gone is the need to satisfy the “significant market” test that was developed for the apparent purpose of prohibiting spot bitcoin ETPs. According to the Approval Order, even though the “significant market” test is not satisfied here, there are “other means” of preventing fraud and the Commission can approve the applications on that basis. Those “other means” appear to be identical to the standard that had been used to disapprove spot bitcoin ETP applications, except that applicants no longer need to establish that the futures market is one of significant size.

Applicants presumably spent years attempting to satisfy the Commission’s novel “significant market” test because that was the roadmap presented to them. A review of the ARK Application reveals that the correlation analysis used as the basis for the Approval Order was presented as evidence that the high correlation between the price of spot bitcoin and bitcoin futures should lead the Commission to conclude that the CME bitcoin futures market is one of “significant size.” [18]

This means that – up to and including the latest round of applications – applicants have been attempting in vain to demonstrate that their proposals satisfy the “significant market” test. Rather than requiring applicants to make multiple attempts in the dark in hopes that they might finally present an argument leading to approval under the “significant market” test, the Commission should have actively made its expectations known. Doing so would have spared years of attempts at satisfying an unattainable standard, and focus could have shifted to satisfying the comparatively easier standard that is used as the basis for approval today. Why would an applicant seek approval under the “significant market” test when the Commission has a different test with the same elements except for the need to establish that an exchange is a significant market?

All of this assumes that the Approval Order reflects a change in outcome based on new information presented in the ARK Application. A skeptic might wonder whether the Grayscale decision forced the Commission’s hand, causing the Commission to search for a basis of approval that satisfied the court without admitting that the “significant market” test was improper and flawed.

3) Flawed Reason for Accelerating the Approval of the Applications

Section 19(b)(2)(C)(iii) of the Exchange Act provides that “[t]he Commission may not approve a proposed rule change earlier than 30 days after the date of publication [of a notice], unless the Commission finds good cause for so doing and publishes the reason for the finding.” [19] Here, the Commission has found good cause to dispose of the 30-day notice requirement.

I agree that good cause exists, but disagree with the Approval Order’s rationale for reaching that conclusion. The Approval Order asserts that the changes to the applications “do not raise any novel regulatory issues.” [20] This statement is implausible in light of the changes to the creation and redemption process that have been made.

Previous applications have described an in-kind creation and redemption feature. For example, the initial ARK Application filed in April 2023 represents that “the Trust only allows for in-kind creation and redemption.” [21] The most recent amendment to the ARK Application replaces the in-kind creation and redemption feature with a cash-only creation and redemption feature. [22]

The Commission has not explained why this change does not present “novel” regulatory issues. A number of commenters deemed the in-kind creation and redemption feature to be significant. For example, one commenter, responding to media reports that the Commission “is considering allowing only cash creation/redemption,” stated that “in-kind creation/redemption is far more efficient and beneficial to shareholders.” [23] That commenter noted that other commodity-based ETPs “generally don’t even offer cash creation/redemptions.” [24]

The Approval Order is absent of any analysis as to how the cash-only creation and redemption feature helps to prevent, or perhaps promote, fraud. The removal of in-kind creations and redemptions – coupled with the fact that no other commodity-based ETP prohibits in-kind creations and redemptions – makes one wonder how the Commission reached its conclusion. The statement that the changes to the applications do not present novel regulatory issues is merely conclusory.

Perhaps the actual motivation for accelerating the approval is to avoid a first-mover advantage whereby the first spot bitcoin ETP to market acquires the lion’s share of investor assets. Section 19(b)(2)(C)(iii) does not prescribe the particular circumstances that are necessary to form a “good cause” finding for acceleration. In my view, the Commission could have formed its “good cause” finding by referencing the potential anti-competitive results of failing to accelerate, especially in light of other provisions of the Exchange Act concerning competition. For example, when reviewing a rule of a self-regulatory organization, Section 3(f) of the Exchange Act requires the Commission to consider whether the action will promote efficiency, competition, and capital formation. [25] Further, Section 23(a)(2) of the Exchange Act requires the Commission to consider the impact of any rule or regulation would have on competition. [26] Accordingly, my “good cause” finding is based on the effects on competition.

Conclusion

It is important that the Commission’s orders provide transparency into its analysis and reasoning. In that regard, I would have preferred if the rationale set forth in the Approval Order adhered more closely to the analysis set forth in this statement. However, because I have independent reasons for concluding that the applications satisfy the standards for approval set forth in the Exchange Act, I support the issuance of the Approval Order despite my objections to the legal analysis set forth in that order.