While perhaps not as active in regulating the crypto space as their counterparts at the SEC, the CFTC’s role is likely to grow as traditional financial markets look to create more instruments based on digital assets.
Why would the CFTC be contacting your company or fund if you transact in digital assets?
Your digital asset may be deemed a commodity, future, or other derivative and therefore under the Commodity Futures Trading Commission’s (CFTC) jurisdiction. The definition of commodity is broad in the Commodity Exchange Act, including physical commodities, currencies, interest rates, and “all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in.” The CFTC first asserted jurisdiction over virtual currencies as commodities in 2015. This finding was most recently upheld in federal district court in October 2018. With larger, institutional players in the commodities space employing sophisticated compliance teams, there are fewer CFTC data points to draw from than from the SEC. However, because many crypto-enabled projects deal in agreements for “future” tokens, the CFTC is likely to grow its regulation of the digital asset space.
What could happen next?
- Demand for registration. If you are a platform facilitating the exchange of digital currencies, you must register with the CFTC. There are examples of successful registrations in the crypto space, such as TeraExchange, a Bitcoin swap trading platform, and LedgerX, which offers physically settled Bitcoin options. Both of these companies use traditional instruments that have digital assets as the underlying asset. The option or swap itself is not blockchain enabled.
- Regulation compliance. Compared to traditional commodities and derivatives registration, virtual currency platforms are under the CFTC’s “heightened review” regime. The heightened review regime includes additional safeguards, surveillance, and disclosures. For the first time ever, the CFTC’s Department of Enforcement released its Enforcement Manual to the public in May 2019. The release is intended to increase certainty and transparency to regulated entities.
- Enforcement. The CFTC has taken a number of enforcement actions against cryptocurrency-enabled trading platforms that failed to follow regulations. Exchanges, platforms, and other intermediaries come into the CFTC’s jurisdiction when U.S. customers or markets are involved. Merely being created, domiciled, or operated outside the U.S. does not offer immunity from enforcement. In March 2019, 1pool Ltd., located in the Marshall Islands, entered into a Consent Order with the CFTC after a finding that the company was offering unregistered commodity transactions. The transactions were required to be registered by the CFTC because they were margined in Bitcoin. The order included $175,000 in civil penalties and $246,000 in disgorgement of gains.
- Caution: the CFTC and SEC do not need to agree! A determination by the CFTC that a certain digital asset is a commodity is not affected by the SEC’s security analysis. Liability can flow from both.
- Something else. The foregoing list is not an exclusive nor exhaustive description of actions regulators could take. The digital assets space is evolving quickly technologically, but also legally. Accordingly, we strongly encourage engagement with counsel as soon as practicable in connection with any of the aforementioned regulatory actions or otherwise in connection with any action, positions, or other activity that may lead to regulatory action.