FR 2025-03968

Editorial Commentary on Nasdaq Stock Market LLC's Proposed Rule Change to List and Trade Grayscale Polkadot Trust Shares

General Summary

The document is a formal notice disseminated by the Securities and Exchange Commission (SEC) regarding a rule change proposal filed by The Nasdaq Stock Market LLC. The proposal aims to introduce the listing and trading of shares for the Grayscale Polkadot Trust under Nasdaq Rule 5711(d), specifically focusing on Commodity-Based Trust Shares. Grayscale Polkadot Trust is a Delaware statutory trust set to manage Polkadot (DOT) tokens, offering an alternative investment route into digital assets without direct ownership of the tokens themselves.

The proposal outlines the structure, operation, and the regulatory framework associated with listing the shares of the Grayscale Polkadot Trust. It's intended to provide investors with a simplified and cost-effective way to gain exposure to Polkadot tokens, minimizing the direct acquisition and management challenges associated with digital currencies.

Significant Issues or Concerns

1. Lack of Transparency in Pricing Methodology: The Sponsor has significant discretion in determining the Index Price of DOT tokens, especially when primary methodologies become unavailable or deemed inaccurate. Decisions on the usage of cascading rules or changing methodologies are solely at the Sponsor's discretion without predefined criteria, which might raise concerns about the transparency and reliability of the Index.

2. Liquidity Provider's Terms: The proposal highlights that a "Variable Fee" paid to Liquidity Providers can be changed at any time by the Sponsor without predefined criteria. This could lead to unpredictability in costs for Authorized Participants and may be perceived as a lack of transparency in fee structuring.

3. Redemption Constraints: The document states that redemption of Shares will only be permitted under specific regulatory and sponsor approval, which may limit liquidity options for investors who are shareholders of the Trust.

4. Potential Conflicts of Interest and Regulatory Oversight: Concerns might arise over potential conflicts of interest, particularly because of the overlapping roles of entities such as the Custodian, Liquidity Providers, and the Sponsor. There does not appear to be clear measures delineated for managing these potential conflicts, which could affect investor confidence and trust.

Impact on the Public

The proposed rule change to list and trade shares of the Grayscale Polkadot Trust on the Nasdaq Stock Market aims to open up the market for investors interested in gaining exposure to Polkadot (DOT) without directly owning the digital asset. This move could enhance market accessibility and provide an alternative investment vehicle, potentially encouraging more participation in the digital asset market.

However, the proposal has some areas where lack of clarity and transparency in the decision-making processes related to liquidity management and index price calculation could concern investors. Potential changes without predefined criteria could lead to market uncertainty, especially regarding how the Sponsor might exercise its discretion in making these changes and determining what constitutes a "good faith assessment" of price accuracy.

Additionally, the fact that some of the Digital Asset Trading Platforms could be non-U.S. licensed might raise questions about regulatory compliance and protections typically afforded to more mainstream financial products.

Impact on the Public

The listing and trading of the Grayscale Polkadot Trust shares on the Nasdaq will provide investors with easier access to the digital asset market, particularly for those who prefer not to handle digital assets directly due to the complexities and risks involved. However, the potential lack of transparency and clarity regarding certain operational and pricing practices, as outlined in the notice, raises valid concerns. Investors may need to exercise caution and closely follow subsequent SEC assessments or solicitations concerning this proposal until these issues are adequately addressed.

Additionally, the public would need to be aware of the distinct differences between trading shares of the Trust and direct transactions of DOT on digital asset trading platforms. The proposed structure allows for only authorized participants to engage in the creation and redemption of shares, which could limit direct investor control over their investments in the trust.

Overall, the decision to approve this proposal will rely heavily on Nasdaq's ability to demonstrate sufficient measures to prevent fraud and manipulation while protecting investor interests, as required by the Securities Exchange Act of 1934. The public, especially potential retail investors interested in digital assets, should be attentive to the developments and any forthcoming decisions on the rule change as they could set important precedents for future digital asset-based investment products.

Commentary on Proposed Rule Change by Nasdaq for Listing Grayscale Polkadot Trust Shares

The proposed rule change filed by The Nasdaq Stock Market LLC aims to list and trade shares of the Grayscale Polkadot Trust (DOT) under Nasdaq Rule 5711(d), which governs Commodity-Based Trust Shares on the exchange. The shares of the trust are referred to as the "Shares."

Valuation and Investment Mechanics

The core asset of this trust is the DOT token, the native digital currency of the Polkadot Network. Each share of the Grayscale Polkadot Trust represents a proportional interest in the Trust's assets, which are predominantly composed of DOT tokens. The value of these tokens is determined by the Index Price, which represents the U.S. dollar value of DOT derived from various Digital Asset Trading Platforms included in the CoinDesk DOT CCIXber Reference Rate (the "Index"), calculated at 4:00 p.m., New York time, on each business day.

The Trust's investment objective is straightforward: it seeks for the value of the Shares, based on the DOT per Share, to mirror the value of the DOT held by the Trust, minus the Trust's expenses and liabilities. Litigators might scrutinize the fee structure here, especially since the Trust's expenses, which include a Sponsor's Fee (a fee, payable in DOT, calculated daily in U.S. dollars at an annual rate determined by the NAV Fee Basis Amount at a specific New York time).

Financial Transparency and Concerns

One potential issue associated with the proposed rule change is the determination and transparency of the "Index Price"—the U.S. dollar value of DOT. The Index Price is pivotal as it factors into several calculations, including the Trust's Net Asset Value (NAV), calculated similarly through a comprehensive process involving the Index Price and deduction of Trust expenses. This is done by multiplying the Index Price by the Trust's total DOT tokens while taking into account fees and liabilities that may reduce the value over time.

A notable concern is the high level of discretionary authority vested in the sponsor regarding fee structures and Index Price calculations. For example, the Variable Fee associated with Cash Orders can be changed by the Sponsor "in its sole discretion" without predefined criteria. Similarly, the Sponsor holds the ability to switch Index Providers or amend how the Index Price is calculated without seeking consent from shareholders. While flexibility in operational procedures can be beneficial for adapting to market conditions, this level of discretion might raise transparency concerns for investors who value a stable and predictable financial structure.

Impact on Investor Protection

The proposed rule change emphasizes the Trust's commitment to maintaining just and equitable principles in trade, promoting a free and open market, and ensuring investor protection and public interest in line with Section 6(b)(5) of the Securities Exchange Act of 1934. Despite the Sponsor's discretion over key financial tools like the Variable Fee and Index Price, Nasdaq posits that comprehensive surveillance procedures, including a partnership with Coinbase Derivatives LLC and a membership with the Intermarket Surveillance Group (ISG), will effectively monitor and deter misconduct.

The Exchange underscores that any fluctuation between the market prices of DOT and the Index Price should be understood by investors in correlation with the Shares' value, given how the Shares are designed to reflect the current DOT market prices, discounted by Trust expenses.

Concerns of Market Manipulation and Volatility

The document highlights several market platforms for trading DOT, including Bitfinex, Bybit, Crypto.com, and others. While this variety potentially enhances transparency, several of these platforms do not possess U.S. licenses or registrations and are not available to U.S. customers. The absence of surveillance-sharing agreements with fully regulated U.S. markets might raise concerns about potential market manipulation. This factor, combined with the comments regarding the absence of predefined criteria for a "good faith assessment" in determining the Index Price when unavailable, could impact investor confidence due to perceived potential for price manipulation or inconsistencies.

Moreover, the role of Liquidity Providers, who handle transactions with a variable fee based on Total Basket NAV, is subject to the Sponsor's discretion on market conditions, which could be seen as another area of concern regarding fee transparency.

Conclusion

The proposed rule change for listing the Grayscale Polkadot Trust on Nasdaq under Rule 5711(d) focuses on providing an investment vehicle for the DOT token while maintaining compliance with existing regulations to prevent fraud and protect investors. However, the discretion allowed to Sponsors in determining fee structures and calculating the Index Price without predefined criteria could present challenges regarding transparency and investor protection.

Potential investors and regulatory bodies might focus on ensuring robust checks and balances are in place, especially around these discretionary powers, to prevent any potential conflict of interest or market manipulation. Overall, while the proposal aims to enhance market competition and investor convenience, it also raises important questions about regulatory oversight and market integrity that may need addressing.