On July 6, 2017, the Commodity Futures Trading Commission (CFTC) issued an Order of Registration (SEF Order) to LedgerX LLC (LedgerX), granting it registration as a Swap Execution Facility (SEF).1 On July 24, 2017, the CFTC issued an Order of Registration (DCO Order, and together with the SEF Order, Orders) to LedgerX, granting it registration as a Derivatives Clearing Organization (DCO).2 With the Orders, LedgerX will become the first federally regulated bitcoin options exchange and clearinghouse to list and clear fully collateralized, physically settled bitcoin options.3
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and the Commodity Exchange Act (CEA) require that any person who offers a trading system or platform in which multiple market participants have the ability to execute or trade swaps on the system or platform apply to the CFTC to register as a SEF or be classified as a designated contract market. The CEA also requires that any clearinghouse that seeks to provide clearing services with respect to futures contracts, options on futures contracts, or swaps must register with the CFTC as a DCO before it can begin providing such services. The CFTC has previously found in a settled enforcement action that virtual currencies such as bitcoin are “commodities” under the CEA, and therefore, options on virtual currencies are commodity options which, since Dodd-Frank, are regulated as swaps that, if transacted on a facility for the trading of swaps, may only be traded on a CFTC-regulated SEF or designated contract market.4
LedgerX’s Orders of Registration
LedgerX has indicated that it intends to offer a “multi-to-multi” trading and clearing platform for bitcoin options, and accordingly, LedgerX applied for registration as both a SEF and a DCO. A bitcoin option contract provides the option holder with the right to buy or sell bitcoin at a fixed price at a future date. With LedgerX’s SEF registration, LedgerX became the 25th SEF registered with the CFTC, and the first to list bitcoin options.
The CFTC’s grant of SEF and DCO registration to LedgerX should be viewed in the context of the CFTC’s recent policy goal of making the agency more hospitable to innovators. For example, the CFTC created LabCFTC, which seeks to promote FinTech innovation and fair competition by making the CFTC more accessible to FinTech innovators.
Contrast to Recent SEC Orders
The Orders also are notable because they contrast with the Securities and Exchange Commission’s (SEC) recent rejection of the public listing and trading of bitcoin trusts. On March 10, 2017, the SEC issued an order disapproving a rule change of an exchange that had sought to list and trade shares issued by a bitcoin trust,5 and on March 28, 2017, the SEC issued another order disapproving a rule change that another exchange had filed proposing to list and trade shares of a bitcoin trust.6 Both of these trusts had planned to hold bitcoin as their primary underlying asset and their shares would track either the price of bitcoin traded on a separate bitcoin exchange or the price of bitcoin as measured by an index. These SEC orders effectively prevent the listing and trading of securities with bitcoin as the underlying asset on national exchanges.
The SEC indicated that the rule changes were inconsistent with Section 6(b)(5) of the Securities Exchange Act of 1934 (Exchange Act) which requires that rules of national securities exchanges be designed to (a) prevent fraudulent and manipulative acts and practices and (b) protect investors and the public interest. The SEC stated that the significant markets for bitcoin were unregulated and the listing and trading of bitcoin trusts on exchanges would be susceptible to manipulation. As such, the exchanges had not entered, nor would they be able to enter into, the type of surveillance-sharing agreements with significant, regulated markets that have been in place with respect to all previously approved commodity-based exchange-traded products. Such agreements would have helped address the SEC’s concerns about the potential for fraudulent or manipulative acts and practices in the market. The exchanges have subsequently filed written notice of their intention to petition the SEC for review of these rejection orders.
The SEC’s rationale for denying the bitcoin trusts is noteworthy because in order for LedgerX to list swaps for trading and begin operations, it was required to demonstrate to the CFTC that its swaps are not “readily susceptible to manipulation” within the meaning of SEF core principle 3 under the CEA. The CFTC’s grant of SEF and DCO registration to LedgerX, which is being launched solely to trade and clear bitcoin options, may indicate that the CFTC’s views on the manipulability of bitcoin prices differ from those of the SEC.