BOSTON – Cameron and Tyler Winklevoss watched Facebook’s rapid rise even as they accused Mark Zuckerberg of stealing 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 at the same time as Facebook founder Zuckerberg, this week filed with the Securities and Exchange Commission to create the Winklevoss Bitcoin Trust, a variation of an exchange-traded fund, or ETF, 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.
The examination will take years, said Reginald M. Browne, head of exchange-traded product trading at Knight Capital Group, the largest lead market-maker for ETFs and their cousins ETPs, or exchange-traded products, on the New York Stock Exchange.
“I like new, creative ideas, but I would need a lot more information to figure out the investor metrics of that proposal,” said Browne, based in Jersey City, N.J.
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, according to Laura V. 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.
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 March 18.
“When I read the headlines, my initial reaction was to chuckle,” William P. 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 United States 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 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 S. Patti, CEO and founder of IndexIQ, a New York-based sponsor of ETFs that focus on alternative-investment strategies.
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 more than 4,500 merchants worldwide to accept payments.
“Bitcoin is, in many ways, the cyberversion of gold,” said Nicholas J. 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 underlie the ETF are secure.”