The U.S. Commodity Futures Trading Commission’s (CFTC) LabCFTC office on October 17, 2017 issued A CFTC Primer on Virtual Currencies (Primer) indicating, among other things, that certain initial coin offerings (ICOs) within the United States or affecting U.S. residents may be within the CFTC’s jurisdiction.
The Primer follows an investigative report (The DAO Report) and a number of warnings to issuing companies, promoters and investors released by the U.S. Securities and Exchange Commission (SEC) over the past four months related to ICOs. For further information on the SEC’s actions, please refer to Dechert OnPoint, SEC Focuses on Initial Coin Offerings: Tokens May Be Securities Under Federal Securities Laws.
The Primer provides an overview of virtual currencies and their use cases, outlines the CFTC’s role in the oversight of virtual currencies, and warns investors of some the potential risks related to investment in and use of virtual currencies. In a concurrent press release, the CFTC announced that the Primer is the first in a series to be issued regarding financial technology (FinTech) innovation. In the release, Daniel Gorfine, Director of LabCFTC and Chief Innovation Officer of the CFTC, stated “As people worldwide try to understand and wrap their heads around the virtual currency ecosystem, we thought it timely and important for our first primer to help explain the space, identify how developments involve the CFTC, and highlight risks that investors or users of virtual currencies should carefully consider.” While the Primer does not describe the CFTC’s official policies or positions, or carry the force of law, it does represent a public statement by the CFTC staff and provides insight as to their view of virtual currencies and, particularly, ICOs.
In the Primer, the CFTC staff notes that the definition of “commodity” in the Commodity Exchange Act (CEA) is broad and reiterates the CFTC’s 2015 determination that bitcoin and other virtual currencies are properly defined as commodities.1 Under the CEA, the CFTC has jurisdiction over futures, options and derivatives contracts. The CFTC believes that its jurisdiction is implicated when a virtual currency is used in a derivatives contract or if there is fraud or manipulation involving a virtual currency traded in interstate commerce. As noted in the Primer, the CFTC staff does not claim general jurisdiction over “spot” or cash-market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing. The CFTC staff does, however, claim jurisdiction over instances of fraud or manipulation involving virtual currencies, even in the case of spot or cash-market exchanges and transactions involving virtual currencies that do not utilize margin, leverage or financing. This may include an ICO, as the CFTC’s definition of “virtual currency” remains unclear.2
With respect to ICOs, the Primer briefly reviews the facts of The DAO Report, which concluded that tokens sold through ICOs could fall under the federal definition of a “security” (thus triggering a host of regulatory implications), and states that “[t]here is no inconsistency between the SEC’s analysis and the CFTC’s determination that virtual currencies are commodities and that virtual tokens may be commodities or derivatives contracts depending on the particular facts and circumstances. The CFTC looks beyond form and considers the actual substance and purpose of an activity when applying the federal commodities laws and CFTC regulations.” ICOs would not be the first instrument that the SEC and CFTC dually-regulate (see, e.g., futures on single securities and narrow-based securities indices).
As with prior SEC releases and guidance, the Primer also addresses a number of risks associated with virtual currencies including operational risks, cybersecurity risks, speculative risks and fraud and manipulation risks.
The Primer – along with recent CFTC enforcement actions related to virtual currencies, including recently filed charges against two entities alleging a Ponzi scheme in Bitcoin itself rather than Bitcoin derivatives3 – makes it clear that the CFTC is looking closely at virtual currencies, including ICOs, that implicate its jurisdiction.
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LabCFTC is a CFTC initiative “aimed at promoting responsible FinTech innovation to improve the quality, resiliency, and competitiveness” of the various derivatives markets over which the CFTC has jurisdiction. The CFTC has recognized that its regulation and operations have not kept pace with the digitalization of the derivatives trading markets.4 With LabCFTC, the CFTC would like to achieve two goals: (1) “to provide greater regulatory certainty that encourages market-enhancing FinTech innovation to improve the quality, resiliency, and competitiveness of our markets,” and (2) “to identify and utilize emerging technologies that can enable the CFTC to carry out its mission more effectively and efficiently in the new digital world.”5