By Anne Sherry, J.D.
Bitwise’s tactic of presenting the bitcoin market as 5 percent "real" and 95 percent "fake" backfired in front of an agency already skittish about market manipulation.
The SEC rejected another proposed bitcoin ETF, the Bitwise Bitcoin ETF, which NYSE Arca sought to list. Bitwise had attempted to distinguish its ETF from those the SEC has previously rejected on the basis that its ETF would be pegged only to legitimate activity in the bitcoin spot market, excluding the 95 percent of the market consisting of wash trades or other "fake" activity. The Commission found, however, that NYSE Arca failed to establish that it has identified the subset of real activity or that the "real" market is isolated from the "fake" activity (Release No. 34-87267, October 9, 2019).
In 2018 the SEC rejected the listing of the Winklevoss Bitcoin Trust, suggesting in its order that the bitcoin derivatives markets are not large enough to permit an ETF. Exchange Act Section 6(b)(5) requires that an exchange’s rules be "designed to prevent fraudulent and manipulative acts and practices," and the agency ruled that if the listing exchange does not establish that the market is inherently resistant to manipulation or that other means to prevent manipulation will suffice, the listing exchange must enter into a surveillance-sharing agreement with a regulated market of significant size. The Winklevoss order suggested that there is no sufficiently large, regulated market for bitcoin.
Bitwise presented an analysis of the underlying bitcoin spot market that concluded that "when fake and/or non-economic data is removed, the remaining or ‘real’ market for bitcoin is significantly smaller, more orderly and more regulated than commonly understood." In Bitwise’s view, by focusing on the "real" market for bitcoin, the proposed ETF would be uniquely resistant to manipulation. As it turns out, this was the wrong argument to take with an agency that already viewed the bitcoin market as precarious. The SEC wrote that Bitwise’s "concessions that 95% of the reported trading in bitcoin is ‘fake’ and that the early bitcoin market may have been subject to market manipulation effectively concede that the properties of bitcoin do not make it inherently resistant to manipulation."
Specifically, Bitwise focused on ten platforms in the "real" bitcoin market, nine of which are regulated as money services businesses by FinCEN and six of which have BitLicenses issued by New York. Bitwise and some commenters argued that the spot market has evolved to take into account guidance issued by these regulators, but the SEC wrote that even if this is true, NYSE Arca and Bitwise did not demonstrate that those improvements will endure.
NYSE Arca and Bitwise also failed to demonstrate that the "real" market was isolated from or resistant to the manipulation that affects 95 percent of the market as a whole. Here, the SEC’s tone was incredulous: "[Bitwise] has made sweeping claims that up to 95% of the volume reported by bitcoin platforms is wash trading or simply fabricated, while asking the Commission to approve the listing of a bitcoin ETP based upon a small segment of the market that it asserts is uniquely resistant to the influence of this activity." The proponents offered no data on where price formation occurs in the bitcoin market and whether there is correlation between price movements on the "real" and "fake" platforms, with one lagging behind the other. Without this data, the SEC could not conclude that prices on the "real" platforms are insulated from the rest of the market.
Like the Winklevoss order, the Bitwise order hints at the futility of seeking surveillance-sharing agreements with bitcoin spot platforms. NYSE Arca did not state that it had, or would, enter into such agreements with the "real" spot platforms that use surveillance tools, but the SEC wrote that even if it did, it is not clear how it could compel the sharing of surveillance data. Because they are not self-regulatory organizations, the bitcoin spot platforms lack the legal power to impose discipline on their participants.
The release is No. 34-87267.
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