Last week, the Commodity Futures Trading Commission’s LabCFTC issued a helpful overview of digital currencies, discussing what a virtual currency is and how digital currencies and distributed ledger technology might be used; the role of the CFTC in the oversight of virtual currencies; and risks of transacting in digital currencies as well as suggestions to mitigate such risks.
Among other things, the Commission noted that, under relevant law, the definition of commodity “is broad” and it has previously determined (since 2015) that virtual currencies constitute commodities. As a result, said the Commission, the CFTC’s jurisdiction is implicated when a virtual currency underlies a derivatives contract or when there is fraud or manipulation in connection with a virtual currency traded in interstate commerce.
The CFTC acknowledged that the Securities and Exchange Commission has said that certain digital tokens may be securities under federal securities laws, but observed “[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 facts and circumstances.”
The CFTC noted that one of the purported advantages of the distributed ledger – that it is immutable – may not be true, and that persons transacting in virtual currencies could lose their assets should the digital wallet holding their private key (i.e., the private digital code used to access owned cryptocurrency) be compromised by illicit access.
LabCFTC is the recently established CFTC function meant to promote “responsible financial technology innovation” and serve as the agency’s focal point for interactions with the FinTech community.
Last week, LedgerX commenced trading as a CFTC-approved swap execution facility and derivatives clearing organization transacting swap contracts referencing and settling in Bitcoin (click here for details).
Legal Weeds: For those just beginning their knowledge quest regarding virtual currencies, digital tokens and distributed ledger technology, the publication “A CFTC Primer on Virtual Currencies” published last week by the Commission is a very helpful first read. However, the primer should just be the starting point for persons endeavoring to gain knowledge
Structurally, virtual currencies are just one type of digital token; the other types are, as noted by the SEC in its DAO order, securities, and utility tokens that provide the holder access to a particular project as a user or developer with certain predefined rights. (Click here for background on the SEC’s views regarding certain digital tokens in the article “SEC Warns That Digital Tokens May Be Securities” in an August 3 Advisory by Katten Muchin Rosenman LLP.)
The nature of a digital token could also morph over time, functioning as a security at birth (e.g., to reward investors for funding a project) and a virtual currency later. A derivative based on such a digital token might be deemed to be a security future under law and potentially be subject to oversight by both the SEC and CFTC.
Likewise, it is important to recognize that the CFTC and SEC are not the only ones interested in regulating cryptocurrencies. The Financial Crimes Enforcement Network of the US Department of Treasury as well as states may impose obligations on persons who exchange or keep custody of cryptocurrencies for customers. At least one state currently has express obligations on such persons separate and distinct from regulations aimed at so-called money transmitters. (Click here to access an applicable 2013 FinCEN Guidance, and here to access the article “New York BitLicense Regulations Virtually Certain to Significantly Impact Transactions in Virtual Currencies” in a July 8, 2015 Katten Advisory.)
Moreover, a model state code has recently been finalized that may be adopted by individual states, adding more potential regulation to this area. (Click here to access the article “Model State Virtual Currency Law Finalized Finally” in the October 15, 2017 edition of Bridging the Week.) International regulators are also considering the application of their own laws in this space. (Click here to access the article “Singapore Regulator Joins Other Regulators in Warning Initial Coin Offerings May Impact Local Laws” in the October 8, 2017 edition of Bridging the Week.)
(Click here for a more detailed but basic overview of cryptocurrencies and distributed ledger technology in the chapter “Distributed Ledger Technologies” in the February 27 IOSCO Research Report on Financial Technologies (pages 47 – 64).)