Last week, the CFTC issued a “Digital Assets Primer” that was published by its LabCFTC. If you had just arrived in the 21st century from another time or planet, this 36-page PowerPoint-style presentation would provide you with a good foundation in this asset and the CFTC’s framework for regulating it. The CFTC makes clear that the Primer is purely an educational tool and does not state CFTC policy, endorse any financial products, or assert jurisdiction over any particular digital asset. Here are the high points of what is, essentially, a public service of LabCFTC.
Definitions: The Primer defines a “digital asset” as “anything that can be stored and transmitted electronically, and has associated ownership or use rights,” and explains that, in order to function, digital assets require an ecosystem that includes basic technology building blocks, such as a platform, code developers, a network to transfer, and entities to track the assets. The Primer defines “virtual currency” as a specific type of digital asset -- a digital representation of value whose intended purpose is to serve as a medium of exchange. As an example, the Primer cites bitcoin, which is a “convertible” virtual currency because it can be exchanged for fiat currency.
Regulation: The Primer balances the benefits of digital assets—increased transaction speed and efficiency, greater financial inclusion and liquidity, among other things—against the typical risks related to trading in financial instruments, such as market manipulation and illicit transactions, as well as risks unique to digital assets, such as cybersecurity, potential failure of systems, consumption of resources (presumably by crypto miners), and governance issues. The key actors in the development of digitals are government regulators—the CFTC, SEC, FinCEN, the OCC and the Fed—and private stakeholders, including developers, participants in the financial markets, and trade associations. Coordination among these actors helps ensure that any new rules and regulations will be developed in a way that accommodates digital products.
CFTC Regulation: The Primer explicates the CFTC’s role with respect to digital assets. For starters, the definition of “commodity” is broad enough to include non-tangible commodities, which could include digital assets, and certain digital assets might constitute swaps or other derivatives. The CFTC’s jurisdiction over virtual currencies has been confirmed since 2015 through a series of cases—both CFTC findings in administrative proceedings as well as federal court decisions—and CFTC guidance and pronouncements. In addition, the CFTC’s jurisdiction over leveraged retail commodity transactions—those contracts that don’t result in actual delivery within 28 days—is relevant to virtual currency, as the Commission explained in guidance from earlier this year, which explained “actual delivery” in the context of virtual currency transactions. The CFTC’s jurisdiction would also extend to those market participants and intermediaries involved in transactions in digital assets that constitute derivatives.
The Primer also points out the relevance of anti-money laundering regulation, since the CFTC has recently actively joined the ranks of AML enforcers. The CFTC joined with the SEC and FinCEN in 2019 to issue a joint statement reminding entities engaged in digital asset transactions to comply with the anti-money laundering requirements of the Bank Secrecy Act. This statement presaged the CFTC’s recent entry into BSA enforcement, including an action against an offshore cryptocurrency derivatives trading platform.
CFTC Digital Asset Derivatives Regulation: Finally, the Primer discusses the CFTC’s approval process for the digital assets derivatives that it regulates. It points out that such derivatives offer a variety of benefits, including hedging and speculative trading, providing a means to exchange value among different digital assets, and a providing a way to obtain price exposure to virtual currencies without taking ownership, since they are cash-settled. The markets for digital assets derivates are developing; bitcoin derivatives have been listed for trading, as has a futures contract based on ether. The CFTC has sought to provide transparency on the product certification and review process, issuing guidance in 2018 for listing or clearing currency derivative products. This includes guidance to designated contract markets (DCMs) and swap execution facilities (SEFs) about how to either self-certify a virtual currency derivative or submit the proposed contract to the CFTC for approval. As part of such guidance, the Primer sets out the issues that the CFTC considers in reviewing both cash-settled and physically-settled digital asset derivatives, such as the reliability of contract settlement prices, and physical transfer and storage protocols.
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The CFTC continues to divide its regulatory efforts between nursing the developing virtual currency industry and ensuring that the industry complies with applicable law. This Primer is the latest example of such efforts, and gives actors in this industry reason to believe that the CFTC will be a positive force for growth of this industry.