Sep. 11, 2017
I am Matt Corallo, a long-time developer of Bitcoin (around the 10th publicly recorded individual to contribute to the Bitcoin codebase), an expert on Bitcoin's operation, vocal Bitcoin advocate, and strong proponent of the availability of a Bitcoin Exchange-Traded Product (ETP).
I have very grave concerns with the proposed rules for the maintaining of Bitcoin deposits and the lack of consumer protection in the event of Bitcoin Network rule changes in the current filings.
As described in the S-1 filing for the "Bitcoin Investment Trust" (BIT), a "permanent fork" of Bitcoin may occur when two groups of users disagree as to the rules which define the system (its "consensus rules"). More specifically, such a "permanent fork" is likely to occur when one group of users wish to make a change to Bitcoin's consensus rules, while another group does not. This leads to two cryptocurrencies, and may lead to significant ambiguity around which should be referred to as "Bitcoin".
The latest S-1 filing by the BIT, allows the BIT to, in the event of a permanent fork, "in consultation with the Index Provider, select a Bitcoin Network"; ie they will be allowed to select any cryptocurrency resulting from a permanent fork which they will term Bitcoin, with no clear restrictions. This creates a gaping divergence of interest between the Sponsor and the investors in the proposed ETP.
Digital Currency Group ("DCG"), as the sole owner of the Sponsor, in conjunction with TradeBlock (the "Index Provider", in which DCG is an
investor) would be enabled to, through such a selection, shift significant value towards one cryptocurrency over another. As an investor in numerous Bitcoin startups, DCG further has a strong incentive to encourage rule changes and adoption of cryptocurrencies which benefit their portfolio companies as well as their own operations, possibly over rule changes which benefit the investors in the proposed ETP.
Further, in the currently-proposed rule changes, DCG is not explicitly barred from trading on the value of different cryptocurrencies prior to the announcement of the BIT's decision as to which fork will receive the future attention of the proposed Bitcoin ETP, and its investors' capital.
Finally, it is important to note that, in the event of a permanent fork, there is likely to be significant market confusion as investors, businesses, and users decide which cryptocurrency they will term "Bitcoin". During this time period, the BIT is not restricted from selecting a cryptocurrency immediately (as it did on July 28th with respect to the Bitcoin Cash fork two days later [1]), nor restricted to selecting the cryptocurrency which the majority of the Bitcoin community terms "Bitcoin". In such a scenario, the BIT could cause significant longer-term market confusion, effectively misrepresenting itself to consumers, all while complying with its currently-proposed rules and filings.
These scenarios are possibly best illustrated by the case of the Ethereum/Ethereum Classic fork, which the BIT S-1 lists as a prime example of such a "permanent fork". DCG invested heavily on one side of the fork, almost entirely at odds with the remainder of the Ethereum userbase, businesses, and exchanges. While the vast majority of market participants in Ethereum shifted their value to the new Ethereum Network, DCG promoted and invested in Ethereum Classic. If DCG had, at that time, owned the Sponsor of an Ethereum ETP under the proposed rules for the BIT ETP, they would be free to, and perfectly justified under the S-1 in, declaring the ETP to hold only Ethereum Classic, potentially to their own gain, and to significant market confusion.
Recently, DCG and some of its portfolio companies have been strongly promoting "Segwit2x" (a proposed rule change to the Bitcoin Network).
While it is still months off, the Bitcoin community is already split in whether it should be adopted, very likely leading to such a "permanent fork" and a debate over which cryptocurrency should be termed "Bitcoin"
and which should adopt a new name. It is still very much an open question which cryptocurrency exchanges will adopt the BTC ticker symbol for, and whether significant market confusion will result.
As a final note, the latest BIT S-1 claims that "as a practical matter, a modification to the source code only becomes part of the Bitcoin Network if accepted by participants collectively having a majority of the processing power on the Bitcoin Network". This may be somewhat misleading as it conflicts with the previous S-1 statements that the BIT is allowed to select a cryptocurrency which results from a permanent fork freely. Additionally, were it to be the case that the BIT simply followed the majority of processing power on the Bitcoin Network, it would likely lead to additional confusion as a significant majority of processing power on the Bitcoin network shifts back and forth between different forks as profitability of mining on each changes.
As noted in several other comments provided in regards to SR-NYSEArca-2017-06, the adoption of rule changes to allow the listing of a Bitcoin ETP would be very much in line with the SEC's mission, and to the significant benefit of US consumers. However, additional rules must be put in place to protect investors in the event of a permanent fork of the Bitcoin network such as the one DCG and its portfolio companies is advocating for now, rules I believe to be rather straightforward and simple to write.
Matt
[1] While the Bitcoin Cash fork appeared highly unlikely to take the name "Bitcoin" with any large part of the community at the time, several prominent community members had, and have since, indicated that they would refer to Bitcoin Cash simply as "Bitcoin" if certain conditions are met.
http://www.prnewswire.com/news-releases/grayscale-investments-llc-statement-regarding-bitcoin-investment-trust-and-bitcoin-cash-300496137.html