Amid the Bitcoin and blockchain craze, the U.S. Commodity Futures Trading Commission has begun to pay attention to the digital currency market

As more and more market participants are increasingly interested in Bitcoin derivatives, the U.S. Commodity Futures Trading Commission (CFTC) is paying more and more attention to the development of the virtual currency field. In a little over a year, at least two trading facilities registered with the CFTC have offered Bitcoin derivatives trading in the United States. Another company plans to offer Bitcoin derivatives on its platform and applied for registration of a derivatives clearing house for Bitcoin derivatives in 2014.

The Commodity Futures Trading Commission has also taken notice of the innovative distributed ledger technology known as “blockchain.” In a speech in late 2015, CFTC Chairman蒂莫西G.马萨德and Commissioner J.克里斯托弗•吉安卡洛both commented on the potential impact of blockchain technology on the financial ecosystem.

Appoints LedgerX CEO Paul Chou to Technical Advisory Board

At the upcoming CFTC meeting on January 26, the committee will also focus on the impact of blockchain derivatives on the market, with the topic of discussion being "smart futures contracts." Commissioner Giancarlo believes that "smart derivatives" using blockchain technology will be able to achieve many innovations, including "real-time self-valuation, automatic calculation, execution of payment margin, and even automatic termination of contracts to prevent counterparty default."

To better understand the Bitcoin blockchain and other distributed ledger technologies, the CFTC invited Paul L. Chou, CEO of Bitcoin startup LedgerX, an experienced Bitcoin trading expert, to join the Technical Advisory Committee (TAC). LedgerX aims to establish a regulated, reasonable futures market for Bitcoin market participants that can accept investments from mainstream financial companies. The platform has received support from Google Ventures and has attracted a group of financial celebrities and regulatory members to the company's board of directors, including former CFTC Chairman Jim Newsome, former Ameritrade CEO Tom Lewis, and former CFTC Commissioner Mark Wetjen.

Is the Bitcoin Market Susceptible to Manipulation?

As more CFTC-registered trading facilities self-certify trading in bitcoin derivatives contracts, market participants should expect the CFTC to take an interest in and scrutinize the bitcoin spot market, particularly with a focus on whether specific bitcoin derivatives listed for trading are susceptible to manipulation, a statutory requirement under the Commodity Exchange Act (CEA) that applies to all CFTC-registered trading facilities.

Not long ago, the Commodity Futures Trading Commission of the United States took enforcement actions against two platforms related to Bitcoin derivatives. One is the Bitcoin futures trading platform Coinflip, and the other is the Bitcoin swap trading platform TeraExchange. In the Coinflip case, the CFTC claimed that it had the power to regulate the trading of Bitcoin-based derivative contracts, and Coinflip conducted commodity option trading activities without any registration, which was not in compliance with the law, so the CFTC ordered it to close. In the TeraExchange case, the swap execution facility (SEF) in the derivatives trading market was involved. Because TeraExchange is a Bitcoin swap trading platform, the CFTC suspected that TeraExchange was involved in false transactions. Although SEF publicly announced that specific Bitcoin transactions represented actual market liquidity, the CFTC believed that TeraExchange had pre-arranged money laundering transactions.

The CFTC has been actively investigating and combating violations related to the manipulation of indices, including spot market transactions. The CFTC recently ruled on a case involving multiple investment banks related to the World Markets/Reuters foreign exchange (FX) benchmark, which can be a reference for Bitcoin market participants.

These cases demonstrate that the CFTC will investigate suspected attempts to manipulate indices used to settle derivatives contracts, even if the conduct is limited to trading in the underlying commodity itself and outside the CFTC’s jurisdiction. Therefore, as the Bitcoin derivatives market develops, we may see the CFTC’s investigation focus on monitoring Bitcoin spot market activity and any conduct that has an impact on Bitcoin price indices, even though the CFTC’s jurisdiction is primarily limited to Bitcoin derivatives.

The legal definition of Bitcoin

At the same time as the CFTC’s enforcement action against Coinflip, it also revealed for the first time how it defines virtual currencies under the Commodity Exchange Act (CEA). Whether Bitcoin should be regulated as a currency or another form of property is a question that has troubled many regulators in the United States (see Skadden Clients Warn “CFTC Assessing Authority in Bitcoin Markets”, September 30, 2015). In the Coinflip case, the CFTC ruled that virtual currencies such as Bitcoin are commodities, but in keeping with other federal regulators, the CFTC did not determine that Bitcoin is a “currency” (within the meaning of the Commodity Exchange Act).

Many people are speculating whether the CFTC will consider Bitcoin to be money, which is classified as an "excluded commodity" in the CEA. If traded between non-retail counterparties in the form of swaps or forwards, currency transactions qualify as exempt from tax under most CFTC regulations. In addition, retail customers are prohibited from engaging in over-the-counter derivative trading activities, except for foreign exchange transactions with certain financial institutions, such as retail foreign exchange dealers, futures merchants, broker-dealers, and banks. It is generally believed that over-the-counter foreign exchange transactions are less regulated than transactions in designated contract markets (i.e., futures exchanges) registered with the CFTC.

Whether intentional or not, the CFTC’s legal analysis in the Coinflip case seemed to imply that virtual currencies such as Bitcoin are “exempt commodities.” Treating Bitcoin as an “exempt commodity” would prevent Bitcoin operators from relying on certain foreign exchange regulatory exemptions in the CEA. In its analysis, the CFTC noted that Coinflip’s Bitcoin options were illegal in part because they could not rely on the “trade option exemption.” This exemption only applies to options on exempt commodities or agricultural products (non-excluded commodities such as currencies). Notably, when the CFTC determined that Coinflip could not apply to the exemption, the CFTC did not mention that the trade option exemption did not apply to “excluded commodities.” Instead, the CFTC believed that Coinflip could not rely on the “trade option exemption” because participants on the Coinflip platform did not meet the exemption’s requirements, namely that the buyer of the option must be a commercial user of Bitcoin.

This clearly indicates that a bitcoin option can satisfy the "trading options exemption" if the buyer of the option is a commercial user of bitcoin, and therefore bitcoin can only be an "exempt commodity." This conclusion has other implications: commercial users of bitcoin (e.g., retailers accepting bitcoin as payment, miners participating in bitcoin mining, or bitcoin merchants) can all claim the "trading options exemption." Similarly, as an "exempt commodity," bitcoin forward contracts that result in bitcoin being traded between commercial market participants may be excluded from the jurisdiction of the CEA and the CFTC.

Summarize

As long as participants’ interest in bitcoin derivatives remains, the CFTC will likely continue to actively regulate the market. Bitcoin market participants should be prepared that the CFTC may insist on establishing its authority in this market, even on issues that are indirectly related to bitcoin derivatives. As blockchain technology applications continue to develop, the CFTC is likely to face more new challenges. Because many financial institutions have speculated that blockchain can significantly improve the efficiency of collecting margin and collateral for derivatives and the efficiency of clearing and settling securities transactions. Compared with other innovative technologies, bitcoin derivatives and blockchain applications have the potential to test the industry and CFTC regulators in the coming years.

Translator's note: According to the Commodity Futures Modernization Act, at the level of trading products, the product forms include futures, options, swaps, forwards, etc.; the underlying assets include agricultural products, exempted commodities and excluded commodities, etc. Among them: Excluded commodities are mainly financial commodities. Exempt commodities refer to commodities other than excluded commodities and agricultural products, usually including energy, metals, chemicals, emission rights, etc.

Original text: https://www.lexology.com/library/detail.aspx?g=3278e068-9377-483d-bf61-9f42aed7ef9d
By Skadden, Arps, Slate, Meagher & Flom LLP
Compiled by: printemps
Source (translation): Babbitt Information (http://www.8btc.com/cftc-focus-bitcoin)