Bitcoin derivatives are coming to mainstream exchanges. CME Group, one of the world’s largest operators of futures exchanges, recently announced that it intends to offer a Bitcoin futures contract by year-end and publicly released the related contract specifications.[1] This announcement was presaged, earlier this year, by the CBOE announcing that it plans to list Bitcoin-based derivatives contracts and LedgerX[2] commencing trading of a Bitcoin option contract.[3]

As a result of these developments, many asset managers may consider increasing their clients’ exposure to Bitcoin. These managers should, however, first evaluate whether and how increased trading in Bitcoin derivatives will affect their relationship with the Commodity Futures Trading Commission.

Effect on the 4.13(a)(3) Exemption

Investment managers that rely on the CFTC Rule 4.13(a)(3) exemption from commodity pool operator registration and that trade digital currency derivatives (whether or not listed) for client accounts should be aware that these derivatives likely need to be included in their “de minimis” calculations.[4] It may be particularly difficult for investment managers attempting to rely on the “initial margin” prong of the test to continue to do so with digital currency derivatives exposure in their portfolios, as many Bitcoin derivatives are fully collateralized (or will presumably require a significant level of initial margin).

Expanding CFTC Digital Currency Jurisdiction

The CFTC generally asserts jurisdiction over commodity (and similar) derivatives contracts but not over the commodities themselves.[5] At times, however, the CFTC has asserted jurisdiction over trading in commodity spot markets under its general anti-manipulation and anti-fraud authority.[6] These interventions have generally been limited to situations where manipulative trading in the spot market affected the associated derivatives market; however, in September, the CFTC took a step beyond that traditional limit by filing a complaint against the alleged masterminds of a Bitcoin-based Ponzi scheme[7] prior to any Bitcoin-based derivative contracts being traded on a U.S. exchange.

These developments indicate that the direct and indirect influence of the CFTC on managers that trade in exposure to digital currencies is likely to increase. Private fund managers and other advisers that are currently, or expect to begin, trading in these instruments should ensure that they have a firm understanding of how their relationship with the CFTC, both as an overseer of registrants and as an arbiter of marketplace conduct, will affect their investment programs.