On December 15 and 19, 2017, the Chicago Board Options Exchange (“CBOE”) proposed in separate filings two rule changes which would exempt its proposed bitcoin ETFs from certain market manipulation rules. The rule changes suggested by the CBOE pertain to rules governing advisors and brokers that would support the ETF products when launched. The CBOE currently plans to list a total of four ETFs.

The SEC is asking for public comment on the proposed rule changes (released on December 28 and January 2) that, if approved, would result in the listing of the first bitcoin-based ETFs in the United States. The SEC will be accepting written comments for three weeks after the filings are published in the Federal Register.

Summary of Proposed Rule Changes

Current rules provide as follows:

  • First, under current regulations, advisors to a company managing funds must have a “firewall” between any brokers or dealers with whom they might be affiliated. This wall is intended to prevent advisors and brokers from sharing information about the company’s portfolio.
  • Second, current rules disallow anyone managing a fund from using insider information to increase the fund’s worth.

The CBOE is requesting exceptions to the above rules, on the basis of the nature of blockchain technology and its built-in safeguards.

Rationale for Rule Changes

The filings state that the CBOE does not believe bitcoin can qualify as a “commodity at risk of being manipulated under the same rules as other commodities, noting that price manipulation would require a bad actor to influence the entire Bitcoin blockchain worldwide.

The filings also state that it would be difficult for any individual person to have insider trading knowledge as a result of the broad, distributed and global nature and infrastructure of the Bitcoin network:

“There is [no] inside information about revenue, earnings, corporate activities or sources of supply; manipulation of the price on any single venue would require manipulation of the global bitcoin price in order to be effective; a substantial over-the-counter market provides liquidity and shock-absorbing capacity; bitcoin’s 24/7/365 nature provides constant arbitrage opportunities across all trading venues; and it is unlikely that any one actor could obtain a dominant market share.”

Likelihood of Regulatory Approval

Approval from the SEC to list any bitcoin-related ETF products is not guaranteed; past attempts at launching bitcoin ETFs have failed with the SEC rejecting some filings or forcing companies to withdraw their applications.

For example, the highly anticipated application by the Bats BZX Exchange to list and trade shares of the Winklevoss Bitcoin Trust, a bitcoin-based ETF, was rejected by the SEC in March 2017. In its 38-page ruling, the SEC listed significant barriers to the approval of trading in bitcoin securities, given a lack of safeguards in the market to prevent fraud and manipulation. The SEC declined to permit rule changes which would have allowed the ETF, requiring that a trade in such securities be conducted only on an exchange which has a surveillance-sharing agreement with a significant, regulated, bitcoin-related market. The SEC suggested these conditions could potentially be met over time but that the regulator would first want to observe “regulated bitcoin-related markets of significant size”.

As of December 2017, two different bitcoin futures products have come on the market in the United States since that decision, one listed by the CBOE and the other by CME Group Inc.

However, just recently on January 8, trusts controlled by Rafferty Asset Management LLC and Exchange Traded Concepts LLC each canceled plans to launch three bitcoin ETFs after staff at the SEC expressed concerns regarding the “liquidity and valuation” of futures contracts based on the digital asset. Further, in a letter dated January 18, 2018 to representatives of the Investment Company Institute and the Securities Industry and Financial Markets Association, the SEC reiterated that it would not be receptive to the registration of cryptocurrency-related funds until questions regarding fair value, liquidity and investor protection have been addressed. These comments underscore the caution with which U.S. regulatory authorities continue to approach cyptocurrency-based funds.

Cryptocurrency Funds in Canada

To date, no bitcoin based ETF has been approved for distribution to the public in Canada by the Canadian securities regulators. On September 21, 2017, Evolve Funds Group Inc. filed a preliminary prospectus to qualify the Evolve Bitcoin ETF which would invest in CBOE Bitcoin futures. More recently, on January 5, 2018, Harvest Portfolios Group Inc. filed a preliminary prospectus to qualify an ETF to replicate its proprietary Blockchain Technologies Index for which SEC approval is pending. The regulatory approach by the Canadian regulators to these initiatives will be interesting in particular as ETFs are generally required to replicate widely recognized and used market indices.