On March 10, 2017, the U.S. Securities Exchange Commission (“SEC“) issued an order disapproving BATS BZX Exchange’s proposal to list and trade shares of the Winklevoss Bitcoin Trust. The proposal, if granted, would have established a bitcoin exchange-traded fund (“ETF“) that market participants could invest in through the BATS BZX Exchange platform.

The SEC rejected the Winklevoss Bitcoin Trust due to the lack of regulation in the bitcoin market. It explained that “the significant markets for bitcoin are unregulated and that, therefore, the Exchange has not entered into, and would currently be unable to enter into, the type of surveillance-sharing agreement that helps address concerns about the potential for fraudulent or manipulative acts and practices in the market for the Shares.” The SEC concluded that the bitcoin market is largely unregulated, unlike the markets for other commodities such as gold and silver, and therefore the Winklevoss Bitcoin Trust is susceptible to manipulation. “Absent the ability to detect and deter manipulation of the Shares—through surveillance sharing with significant, regulated markets related to the underlying asset—the [SEC] does not believe that a national securities exchange can meet its” regulatory obligations.

The SEC considered the U.S. Commodity Futures Trading Commission’s (“CFTC“) jurisdiction over virtual currencies as “commodities,” but found it insufficient to prevent manipulation in bitcoin spot markets. It explained that “[a]lthough the CFTC can bring enforcement actions against manipulative conduct in spot markets for a commodity, spot markets are not required to register with the CFTC, unless they offer leveraged, margined, or financed trading to retail customers.”

This creates a bit of a chicken and egg situation, with regulated products not being approved because there are insufficient regulated markets with which to have surveillance-sharing agreements. The SEC order offers some hope for bitcoin ETFs that remain on the docket for approval, noting that bitcoin is “still in the relatively early stages of its development and that, over time, regulated bitcoin-related markets of significant size may develop.” As the spot bitcoin market likely will remain largely unregulated, it is most likely that the SEC will require bitcoin-based derivatives products, such as futures or options, to be traded on regulated exchanges before approving a bitcoin ETF. However, if bitcoin prices remain high, but still volatile, it may not be very long before we see a bitcoin derivatives product traded on an exchange registered with the CFTC as more traders seek to speculate or hedge bitcoin risk.

The SEC order is available here.