Winklevoss Twins Confront Skeptics to SEC on Bitcoin ETPChristopher Condon
Cameron and Tyler Winklevoss watched Facebook Inc.’s rapid rise even as they claimed Mark Zuckerberg stole their idea for the social-networking site. Their proposal for an investment tracking the virtual currency Bitcoin faces a protracted fight to win over regulators and market makers.
The twins, who attended Harvard University at the same time as Facebook founder Zuckerberg, this week filed with the U.S. Securities and Exchange Commission to create the Winklevoss Bitcoin Trust, a variation of an exchange-traded fund that would hold Bitcoins and issue shares on a secondary exchange.
The trust would be the first product in the $2 trillion ETF industry to track a virtual asset, rather than securities such as stocks and bonds or commodities such as gold and oil. The biggest hurdle for the 31-year-old brothers is persuading the SEC, which has moved haltingly when approving funds that break new ground, to give their product the green light. Reginald Browne, head of exchange-traded product trading at Knight Capital Group Inc., the largest lead market maker for ETFs and their cousins ETPs on the New York Stock Exchange, said he expects the examination to take years.
“I like new, creative ideas but I would need a lot more information to figure out the investor metrics of that proposal,” Browne, who is based in Jersey City, New Jersey, said in a telephone interview.
ETPs require the backing of a lead market maker, a trading firm that agrees to quote prices to buyers and sellers of its shares at all times. Knight’s position as largest market maker is followed by Goldman Sachs Group Inc., according to Laura Morrison, head of trading and listing services for ETFs at NYSE Euronext.
Bitcoin is a virtual currency that can be used to buy and sell a broad range of items, from electronics to illegal narcotics. Created four years ago by a person or group using the name Satoshi Nakamoto, the value of Bitcoins has varied widely, reaching a high of $266 in the second quarter and a low of $45, according to the filing. The Winklevosses own about $10 million of Bitcoins, 1 percent of the outstanding amount.
Regulators haven’t released comprehensive guidance on how Bitcoins might be regulated. Individuals who own and trade them aren’t required to register as money-service businesses, the U.S. Financial Crimes Enforcement Network said in a report released on March 18.
“When I read the headlines my initial reaction was to chuckle,” William Borden, a senior vice president for wealth management at UBS AG in San Francisco. “While I find developments in the Bitcoin story to be intriguing, I doubt that the Winklevoss ETF would be how I would play it should I ever decide to buy Bitcoin.”
The first and largest ETP, the $134 billion SPDR S&P 500 ETF Trust, appeared in 1993 as an easy way for investors to track the S&P 500 Index with a single security that trades throughout the day like a stock. The industry has expanded steadily into bonds, commodities, currencies and other asset classes, capturing $2.14 trillion as of May 30, according to research firm ETFGI LLP in London.
Most ETPs in the U.S. are structured as funds under the 1940 Investment Company Act. The proposed product would be established as a grantor trust because it wouldn’t qualify as a fund, Kathleen H. Moriarty, a partner at Chicago-based law firm Katten Muchin Rosenman LLP who helped prepare the registration statement, said in an interview.
“It can’t be a 1940 Act product because it would have to hold securities, and we think Bitcoins are not securities,” Moriarty said.
The $38.8 billion SPDR Gold Trust, which holds bars of gold bullion in a London vault, is structured as a grantor trust. Its shares, representing fractional claims on the physical gold, trade on the NYSE Arca exchange.
“I think there’s a precedent for it in precious metals products, but this is a unique asset,” Moriarty said. “There necessarily will be novel questions that need to be asked.”
Those questions will include whether the product is operationally sound, whether it can be hedged and whether market makers can make a “fair and orderly market,” said Adam Patti, chief executive officer and founder of IndexIQ Inc., a New York-based sponsor of ETFs that focus on alternative-investment strategies.
The SEC’s division of corporate finance reviews registration statements for securities issuers to make sure they comply with disclosure requirements, John Nester, a spokesman, said in an interview. The review doesn’t produce any comment on a product’s utility, he said. The Bitcoin trust would also require approval from the agency’s division for trading and markets, he said.
The SEC has moved at a deliberate pace in approving products that may be complex or unique in their approach. SPDR Gold Trust opened 18 months after its initial registration statement, according to data compiled by Bloomberg. The agency froze approval for new ETFs that make significant use of derivatives in March 2010, seven months after warning that some products could confuse individual investors. While the ban was partly lifted in December, the SEC still doesn’t approve new ETFs that amplify returns or provide the inverse performance of an index.
Bitcoins are created, or “mined,” by computers that solve difficult cryptographic problems to verify transactions. As more Bitcoins are created, the problems become more difficult. Pioneers could mine coins on their laptops. Now, high-powered computer equipment is needed.
Bitpay, Bitcoin’s largest payment processor, has signed up over 4,500 merchants across the world to accept payments. The currency traded at $90 yesterday on Tokyo-based Mt.Gox, the largest Bitcoin exchange.
“Bitcoin is in many ways the cyber version of gold,” said Nicholas Colas, chief marketing officer at New York-based trading services firm ConvergEx Group. “The biggest challenge will be how you categorically assure the SEC and investors that Bitcoins that underly the ETF are secure.”
The trust aims to attract investors who might be put off by the complexities and costs associated with trading in the digital currency.
“We recognized that there was not an easy way to gain Bitcoin exposure, so we’re trying to creating a simple solution,” Tyler Winklevoss said in an e-mailed statement.
Cameron and Tyler Winklevoss rose to prominence in 2010 when they were portrayed in the movie “The Social Network,” which recounts the early years of Facebook. The film includes the allegation that Zuckerberg as a Harvard sophomore agreed to write code for the twins on a similar social-networking website before surreptitiously starting Facebook. The company, which started in 2004, has since expanded to become the largest social network in the world with more than 1.1 billion users.
The Winklevoss twins sued Facebook and in 2008 agreed to a $65 million cash and stock settlement. The twins later filed another suit seeking to reopen the case, saying the company didn’t disclose an accurate valuation of its shares before they agreed to the deal. In 2011, a federal judge threw out the suits.
The twins both participated in the 2008 Beijing Olympics where they competed in rowing. They are from Greenwich, Connecticut.