Cameron and Tyler Winklevoss's four-year pursuit to launch the first bitcoin exchange-traded fund in the U.S. ended on Friday, March 10, 2017, when the SEC issued an order denying an approval necessary for the ETF to trade on their designated exchange. More importantly, the SEC's reasoning in their order seems to effectively bar the ability of any U.S. exchange to trade shares that represent pooled interests in a portfolio of bitcoin.

Specifically, the SEC's order disapproved the filing by Bats BZX Exchange, on which the shares of the Winklevoss Bitcoin Trust were to trade, of a proposed exchange-rule change necessary in order to list and trade shares of the Trust. The SEC rejected the requested rule change because, in its view, the rule change would have compromised the requirement that the rules of each national securities exchange be designed "to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest."

While at a high level the SEC clearly registered its concern that trading in bitcoin leaves investors unduly vulnerable to losses from improper behavior, the SEC rested its analysis on the exchange's failure to satisfy two technical requirements: First, the exchange must have surveillance-sharing agreements with significant markets for trading the underlying commodity or derivatives on that commodity. And second, those markets must be regulated.

In arriving at their conclusion, the SEC reviewed 59 comment letters, as well as a white paper submitted on behalf of SolidX Bitcoin Trust's similar bid for an exchange listing (in that case, on the New York Stock Exchange Arca). The paper, by Craig M. Lewis, a professor of finance at Vanderbilt University and former Chief Economist and Director of the SEC's Division of Economic and Risk Analysis, was given focused attention by the SEC, particularly its argument that the underlying bitcoin market is not susceptible to manipulation - a conclusion he supported by outlining eight key features of bitcoin, including the lack of inside information related to earnings, corporate actions, and similar value drivers for corporate securities; a structure that makes the bitcoin market resistant to "spoofing" and other high-frequency-trading tactics; and the high improbability of any one person's obtaining a dominant market share.

Despite the apparently comprehensive nature of the analysis in Professor Lewis's paper, the SEC ultimately disagreed that "the unique properties of bitcoin and the underlying bitcoin market are so different from the properties of other commodities and commodity futures markets that they justify a significant departure from the standards applied to previous commodity-trust [exchange-traded products (ETPs)]." The SEC observed that "while there is no inside information related to the earnings or revenue of bitcoin, there may be material non-public information related to the actions of regulators with respect to bitcoin; regarding order flow, such as plans of market participants to significantly increase or decrease their holdings in bitcoin; regarding new sources of demand, such as new ETPs that would hold bitcoin; or regarding the decision of a bitcoin-based ETP with respect to how it would respond to a 'fork' in the blockchain, which would create two different, non-interchangeable types of bitcoin."

In addition, the SEC believed that the bitcoin markets pose significant risk of manipulation of asset prices through trading or other activities that create a false impression of supply and demand.

The SEC's rejection of the BATS BZX Exchange rule request is based, in part, on the reliance of the Trust on pricing based on trading on the Gemini Exchange, which the SEC found to not have a large enough volume of trading in bitcoin, and on the SEC's determination that the supervision of the Gemini Trust Company by the New York State Department of Financial Services is not enough to elevate the Gemini Exchange to the ranks of "regulated markets" for the SEC's purposes.

For some, this may give hope that the SEC will approve another of the bitcoin or blockchain ETFs currently seeking to list for trading on an exchange. (The similar SolidX Bitcoin Trust request to the SEC was most recently postponed on January 3, 2017, and the SEC is scheduled to approve or disapprove that request by March 30, 2017.)

But the SEC's lengthy discussion of the significant extent to which trading in bitcoin "occurs on unregulated exchanges outside the United States" and its assessment that "bitcoin is still in the relatively early stages of its development" strongly suggest that the SEC is willing to reject all similar applications for the foreseeable future, and wait to see if "over time, regulated bitcoin-related markets of significant size may develop." 

Which means that bitcoin ETFs may now face a wait that will make the Winklevoss's past four years seem short.

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