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Federal Register / Vol. 86, No. 149 / Friday, August 6, 2021 / Notices
The Sponsor further believes that academic research corroborates the overall trend outlined above and supports the thesis that the Bitcoin Futures pricing leads the spot market and, thus, a person attempting to manipulate the Shares would also have to trade on that market to manipulate the ETP. Specifically, the Sponsor believes that such research indicates that bitcoin futures lead the bitcoin spot market in price formation.51

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Section 6b5 and the Applicable Standards The Commission has approved numerous series of Trust Issued Receipts,52 including Commodity-Based Trust Shares,53 to be listed on U.S.
national securities exchanges. In order for any proposed rule change from an exchange to be approved, the Commission must determine that, among other things, the proposal is consistent with the requirements of Section 6b5 of the Act, specifically including: i The requirement that a national securities exchanges rules are designed to prevent fraudulent and manipulative acts and practices; 54 and 51 See Hu, Y., Hou, Y. and Oxley, L. 2019.
What role do futures markets play in Bitcoin pricing? Causality, cointegration and price discovery from a time-varying perspective available at: https www.ncbi.nlm.nih.gov/pmc/
articles/PMC7481826/. This academic research paper concludes that There exist no episodes where the Bitcoin spot markets dominates the price discovery processes with regard to Bitcoin futures.
This points to a conclusion that the price formation originates solely in the Bitcoin futures market. We can, therefore, conclude that the Bitcoin futures markets dominate the dynamic price discovery process based upon time-varying information share measures. Overall, price discovery seems to occur in the Bitcoin futures markets rather than the underlying spot market based upon a time-varying perspective.
52 See Exchange Rule 14.11f.
53 Commodity-Based Trust Shares, as described in Exchange Rule 14.11e4, are a type of Trust Issued Receipt.
54 As the Exchange has stated in a number of other public documents, it continues to believe that bitcoin is resistant to price manipulation and that other means to prevent fraudulent and manipulative acts and practices exist to justify dispensing with the requisite surveillance sharing agreement. The geographically diverse and continuous nature of bitcoin trading render it difficult and prohibitively costly to manipulate the price of bitcoin. The fragmentation across bitcoin platforms, the relatively slow speed of transactions, and the capital necessary to maintain a significant presence on each trading platform make manipulation of bitcoin prices through continuous trading activity challenging. To the extent that there are bitcoin exchanges engaged in or allowing wash trading or other activity intended to manipulate the price of bitcoin on other markets, such pricing does not normally impact prices on other exchange because participants will generally ignore markets with quotes that they deem non-executable.
Moreover, the linkage between the bitcoin markets and the presence of arbitrageurs in those markets means that the manipulation of the price of bitcoin price on any single venue would require
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ii the requirement that an exchange proposal be designed, in general, to protect investors and the public interest.
The Exchange believes that this proposal is consistent with the requirements of Section 6b5 of the Act and that it has sufficiently demonstrated that, on the whole, the manipulation concerns previously articulated by the Commission are sufficiently mitigated to the point that they are outweighed by quantifiable investor protection issues that would be resolved by approving this proposal.
Specifically, the Exchange lays out below why it believes that the significant increase in trading volume in Bitcoin Futures, the growth of liquidity at the inside in the spot market for bitcoin, and certain features of the Shares and the Index as defined below mitigate potential manipulation concerns to the point that the investor protection issues that have arisen from the rapid growth of over-the-counter bitcoin funds since the Commission last reviewed an exchange proposal to list and trade a bitcoin ETP, including premium/discount volatility and management fees, should be the central consideration as the Commission determines whether to approve this proposal.
i Designed To Prevent Fraudulent and Manipulative Acts and Practices In order to meet this standard in a proposal to list and trade a series of Commodity-Based Trust Shares, the Commission requires that an exchange demonstrate that there is a comprehensive surveillance-sharing agreement in place 55 with a regulated manipulation of the global bitcoin price in order to be effective. Arbitrageurs must have funds distributed across multiple trading platforms in order to take advantage of temporary price dislocations, thereby making it unlikely that there will be strong concentration of funds on any particular bitcoin exchange or OTC platform. As a result, the potential for manipulation on a trading platform would require overcoming the liquidity supply of such arbitrageurs who are effectively eliminating any cross-market pricing differences.
55 As previously articulated by the Commission, The standard requires such surveillance-sharing agreements since they provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur. The Commission has emphasized that it is essential for an exchange listing a derivative securities product to enter into a surveillance-sharing agreement with markets trading underlying securities for the listing exchange to have the ability to obtain information necessary to detect, investigate, and deter fraud and market manipulation, as well as violations of exchange rules and applicable federal securities laws and rules. The hallmarks of a surveillancesharing agreement are that the agreement provides for the sharing of information about market trading activity, clearing activity, and customer identity;
that the parties to the agreement have reasonable ability to obtain access to and produce requested
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market of significant size. Both the Exchange and CME are members of the Intermarket Surveillance Group the ISG.56 The only remaining issue to be addressed is whether the Bitcoin Futures market constitutes a market of significant size, which the Exchange believes that it does. The terms significant market and market of significant size include a market or group of markets as to which: a There is a reasonable likelihood that a person attempting to manipulate the ETP
would also have to trade on that market to manipulate the ETP, so that a surveillance-sharing agreement would assist the listing exchange in detecting and deterring misconduct; and b it is unlikely that trading in the ETP would be the predominant influence on prices in that market.57
The Commission has also recognized that the regulated market of significant size standard is not the only means for satisfying Section 6b5 of the act, specifically providing that a listing exchange could demonstrate that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the requisite surveillance-sharing agreement.58
a Manipulation of the ETP
The significant growth in Bitcoin Futures across each of trading volumes, open interest, large open interest holders, and total market participants since the Wilshire Phoenix Disapproval was issued are reflective of that markets growing influence on the spot price, which according to the academic research cited above, was already leading the spot price in 2018 and 2019.
Where Bitcoin Futures lead the price in the spot market such that a potential manipulator of the bitcoin spot market beyond just the constituents of the Index 59 would have to participate in information; and that no existing rules, laws, or practices would impede one party to the agreement from obtaining this information from, or producing it to, the other party. The Commission has historically held that joint membership in ISG
constitutes such a surveillance sharing agreement.
See Wilshire Phoenix Disapproval.
56 For a list of the current members and affiliate members of ISG, see www.isgportal.com.
57 See Wilshire Phoenix Disapproval.
58 See Winklevoss Order at 37580. The Commission has also specifically noted that it is not applying a cannot be manipulated standard;
instead, the Commission is examining whether the proposal meets the requirements of the Exchange Act and, pursuant to its Rules of Practice, places the burden on the listing exchange to demonstrate the validity of its contentions and to establish that the requirements of the Exchange Act have been met.
Id. at 37582.
59 As further described below, the Index for the Fund is the S&P Bitcoin Index. The current exchange composition of the Index is Binance,
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