CFTC Commissioner Calls for Creation of Cryptocurrency SRO

CFTC Commissioner Brian Quintenz advocated for the creation of a self-regulatory organization (“SRO”) focused on the oversight of cryptocurrency platforms.

In remarks delivered at the DC Blockchain Summit, Mr. Quintenz addressed the issue of the proliferation of cryptocurrencies and initial coin offerings. He described various oversight and regulatory challenges including jurisdictional limitations that restrict CFTC authority over spot markets.

Mr. Quintenz advocated for the creation of a private, independent organization aimed at developing standards and policing cryptocurrency platforms. Citing the success of SROs such as FINRA, the NFA and the MSRB, Mr. Quintenz suggested that a similar organization could be established in order to (i) set best practices and industry standards for cryptocurrency platforms and (ii) eventually enforce rules and supervise members for compliance. He pointed to independent bodies that had been established in other countries, and said that creating such an organization could help to “create uniform standards for these trading platforms, reduce the possibility of regulatory arbitrage, and avoid duplicative regulation.”

Mr. Quintenz also highlighted what he sees as several advantages over federal regulators, including that SROs: (i) do not require new legislation in order to quickly establish oversight, (ii) are funded by members as opposed to the federal government, and (iii) have the ability to expediently create or amend rules. He said that the IOSCO Principles for Self-Regulation could be used as a framework to establish a self-regulatory group for cryptocurrency. While SROs must be subject to the oversight of a government regulator, Mr. Quintenz said, an “SRO-like” entity could begin to establish a framework for standard-setting as Congress considers potential federal action.

Lofchie Comment: While there is a growing consensus that there should be a federal system of regulation of cryptocurrencies and ICOs, it seems unlikely that the development of such a system can be accelerated by reliance on a system of “self-regulation.” Such systems succeed because members interact extensively with each other and share a mutual interest in the development of the industry and the product as a whole.

These are not the characteristics of the crypto industry. To a good extent, one may even question whether crypto firms are issuing a common product. Further, Mr. Quintenz may overestimate the degree to which the U.S. self-regulatory organizations are genuinely self-regulatory; in fact, at least on the securities side, SROs are very much under the authority of the SEC, and function less as “self-regulatory” organizations than as extensions of the government.

CFTC Advisory Committee Examines Emerging Technology

The CFTC Technology Advisory Committee (“TAC”) considered challenges posed by new technologies. Officials from both inside and outside the CFTC and non-government financial and technology executives discussed (i) blockchain and the potential application of distributed ledger technology to the derivatives markets; (ii) virtual currencies and related futures products; (iii) the future of machine learning, artificial intelligence and computing power; (iv) developments in automated trading technologies; and (v) cybersecurity developments and best practices.

CFTC Commissioner Brian Quintenz, the sponsor of TAC, commented that while there is a need to rationalize the current regulatory framework for virtual currencies, there should be further investigation before adopting any new regulation. He described the potential application of distributed ledger technology (“DLT”) in the derivatives markets and the benefits exhibited by a trial version. Noting the challenges posed by DLT – including scalability issues, the digitalization of derivatives contracts, and DLT’s compatibility with existing CFTC regulations – he urged further discussion before taking any action. He cautioned that the CFTC “should not attempt to make value judgments about which new products are worthwhile,” and urged the cryptocurrency sector to set up a self-regulatory organization to set standards for its activities.

CFTC Commissioner Rostin Behnam recommended the CFTC take more immediate steps. While applauding TAC’s plans to reintroduce some of the Regulation Automated Trading (“Reg. AT”), he urged the CFTC to take immediate action “before an automated trading system run amok causes harm to market participants.” He asserted that “the question of a market event, flash crash or otherwise, is not if, but when.” Mr. Quintenz, speaking separately on the matter, encouraged the Committee to discuss and identify the specific risks associated with automated trading, how those risks are being addressed through the market’s incentive structure, and then to determine if regulation can effectively alleviate those risks.

CFTC Chair J. Christopher Giancarlo stated the CFTC’s first duty was to learn everything about the emerging FinTech industry before adopting regulations. LabCFTC, according to Mr. Giancarlo, will lead their efforts to learn and communicate with those in the technology industries. Since its launch, LabCFTC has conducted over 150 meetings with relevant entities and plans to continue fostering open communication.

Lofchie Comment: Mr. Behnam is right, of course, in predicting that something bad will eventually happen. More difficult is predicting what specific bad thing might happen and proposing rules that are reasonably tailored to prevent or deal with it. The alternative is to propose rules that don’t prevent problems, to have problems in spite of those ineffectual rules, and then to “find” that government wasn’t “tough enough” and so to adopt more expensive and futile rules. Put differently, the question is not, should there be rules; the question is whether there are specific rules that can forestall reasonably likely specific problems at a reasonable expense.

SEC and CFTC Leaders Vow to Cooperate on Virtual Currency Regulation

Chair of the SEC Jay Clayton and Chair of the CFTC J. Christopher Giancarlo described their agencies’ approaches to the regulation of virtual currency and pledged to collaborate to provide investor protection.

In testimony before the U.S. Senate Banking Committee, Mr. Giancarlo noted that some observers tout the transformative potential of distributed ledger technology, while others characterize it as overblown hype with no real utility. He emphasized the importance of perspective, saying that virtual currencies receive media attention that is disproportionate to their small market size. The novel nature of virtual currencies presents a unique set of challenges for regulators, he said. With regard to CFTC authority and oversight, Mr. Giancarlo said that the CFTC does not have regulatory jurisdiction over cash or spot transactions in virtual currency, but does have regulatory jurisdiction over derivatives on virtual currencies. He highlighted several recent efforts by the CFTC to communicate its authority over virtual currencies and enforce federal commodities regulations against bad actors in the virtual currency markets.

Mr. Giancarlo also stressed the importance of perspective when considering the impact of the exchange trading of Bitcoin futures, again emphasizing the small size of the market. He addressed concerns about the self-certification process employed by exchanges to list virtual currency futures products, and reiterated that the CFTC has developed a heightened review process to ensure that virtual currency futures were not susceptible to manipulation. In the interest of facilitating transparency, he stated, the CFTC is requesting that exchanges disclose to the CFTC which steps were taken to solicit public input with regard to particular virtual currency product listings.

Mr. Giancarlo asserted that broadening CFTC authority to include virtual currency spot markets would represent a “dramatic expansion of the CFTC’s regulatory mission.” Considering the retail investor-oriented nature of virtual currencies, he said that they may require closer regulatory oversight, and encouraged Congressional consideration of exploring policy solutions to facilitate more effective federal regulation of virtual currencies. He acknowledged the many potential benefits of virtual currencies and distributed ledger technology, and encouraged a “proper balance of sound policy, regulatory oversight, and private sector innovation.”

SEC Chair Clayton emphasized that initial coin offerings (“ICOs”) often contain the hallmarks of securities and should be subject to federal securities laws. As the virtual currency and ICO markets experience exponential growth, Mr. Clayton expressed optimism for the potential financial benefits, but stressed that retail investors deserve an appropriate degree of investor protection. He pointed to the global nature of the product, the widespread lack of regulation, and cybersecurity deficiencies as significant red flags surrounding many ICOs, and said that no ICO has registered with the SEC. Mr. Clayton underscored the risks associated with ICOs, and warned that naming conventions do not absolve ICO issuers of their SEC-registration obligations.

Mr. Clayton further stated that the SEC has not approved any exchange-trade products holding virtual currencies, and also expressed concern about trading platforms that are not federally regulated and may not afford investors with an appropriate level of protection. He emphasized that the SEC does not have direct oversight over currency or commodity transactions, including trading platforms. He highlighted SEC enforcement efforts in the virtual currency space, and vowed to take a collaborative approach with the CFTC and other regulators to oversee the virtual currency markets.

SEC Shuts Down ICO

The SEC obtained a court order freezing the assets of an allegedly fraudulent initial coin offering claiming to use cryptocurrency to “revolutionize banking.”

According to the SEC’s Complaint, Jared Rice Sr., Stanley Ford and their company, AriseBank (collectively, the “Defendants”), offered investors the “AriseCoin” cryptocurrency, which they claimed would fund the world’s first decentralized bank. The SEC alleged that AriseCoin was an improperly unregistered security, and that Defendants made various fraudulent misrepresentations to solicit investments from retail investors. Among the misrepresentations was the claim that AriseBank was FDIC-insured and had raised over $600 million in two months. In addition, the SEC contended that Defendants failed to disclose AriseBank executives’ relevant criminal histories to investors.

In addition to freezing the Defendants’ assets, the court appointed a digital receiver over AriseBank.

The SEC charged Defendants with violating Securities Act Sections 5(a), 5(c) and 17(a)(2), and Exchange Act Section 10(b) and Rule 10b-5.

SEC and CFTC Chairs Vow Careful Regulation of Cryptocurrency Markets

SEC Chair Jay Clayton and CFTC Chair J. Christopher Giancarlo vowed to support and scrutinize distributed ledger technology (“DLT”) and cryptocurrency-related market activity. In a joint op-ed published in The Wall Street Journal, the agency heads cautioned investors on the risks of investing in cryptocurrencies, given limited regulation and “substantial DLT-related market activity that shows little or no regard to our proven regulatory approach.” Mr. Clayton and Mr. Giancarlo also signaled support for efforts by Congress and others to revisit the existing regulatory structures to provide more effective regulation of cryptocurrencies, particularly spot market trading.

In the op-ed, Mr. Clayton and Mr. Giancarlo acknowledged that advances in DLT are driving important innovations in various areas, such as cryptocurrencies and digital payment systems. They argued that history has shown that the transparency, investor protection and market integrity that come from appropriate regulation are critical for innovation to continue as well as to prevent abuse. They noted widespread retail investor participation in cryptocurrency-related investments, and warned that the risk to all investors in the current environment is high.

Mr. Giancarlo and Mr. Clayton also explained that cryptocurrencies were initially promoted as payment facilitation alternatives to traditional currencies but are now primarily investment assets. Much DLT-related market activity in today’s markets operates outside of regulated venues. They underscored the prevalence of unregistered, offshore “spot market” platforms outside of the SEC and CFTC regulatory umbrellas.

In response to these developments, Mr. Clayton and Mr. Giancarlo called for reconsideration of current regulatory frameworks, and highlighted the activities of their respective Commissions to police cryptocurrency markets where they have authority. With respect to initial coin offerings (“ICOs”), the agency leaders also warned that coins that have the characteristics of securities will be regulated as such, and that the SEC “will vigorously pursue those who seek to evade the registration, disclosure and antifraud requirements of our securities laws.”

CFTC Chair Giancarlo Details Risks of Virtual Currency

CFTC Chair J. Christopher Giancarlo reasserted the “obligation of futures exchanges to ensure that virtual currency futures are not susceptible to manipulation, and of futures clearinghouses to ensure that such products are adequately risk managed.” In remarks at the ABA Derivatives and Futures Section Conference in Naples, Florida, CFTC Chair J. Christopher Giancarlo described the impact of virtual currencies on the U.S. derivatives markets and reiterated his support for a deference-based approach to the U.S. and European Union cross-border regulation of swaps.

Chair Giancarlo said that virtual currencies have already had significant effects on the markets. He raised questions about their actual value, given their high volatility and instability as a store of value. He also argued that virtual currencies represent a small asset class that receives outsized media attention, but warned that they present serious risks.

While acknowledging that the CFTC has been criticized for not holding public hearings prior to self-certification of Bitcoin futures, Chair Giancarlo argued that there is no provision in the statute for public input on CFTC staff reviews of such new product actions. Mr. Giancarlo declared that the CFTC is attentive to these concerns, and offered an eight-point checklist of objectives that the CFTC will undertake in future reviews of such certifications.

As to the appropriateness of trading Bitcoin or other cryptocurrencies, Chair Giancarlo reported that the CFTC reached an agreement with two of the primary exchanges for additional measures to be taken with respect to exchange trading of these products. These measures include:

  • Designated contract markets (“DCMs”) setting exchange large-trader reporting thresholds at five Bitcoins or less;
  • DCMs entering direct or indirect information-sharing agreements with spot market platforms to allow access to trade and trader data;
  • DCMs agreeing to engage in the monitoring of price settlement data from cash markets, and in identifying anomalies and disproportionate moves;
  • DCMs agreeing to conduct inquiries, including at the trade settlement and trader level, when anomalies or disproportionate moves are identified;
  • DCMs agreeing to regular communications with CFTC surveillance staff on trade activities that include providing trade settlement and trader data upon request;
  • DCMs agreeing to coordinate product launches to enable the CFTC’s market surveillance branch to monitor minute-by-minute developments; and
  • DCOs setting substantially high initial and maintenance margin for cash-settled instruments.

With regard to cross-border derivatives regulation, Chair Giancarlo affirmed his support of the recent CFTC margin comparability determination with the European Commission. He said that the comparability determination constitutes complete substituted compliance, meaning that the CFTC will defer to European regulators when market participants follow EU margin rules, even if this means certain non-financial counterparties are not subjected to variation margin rules when they would be under the CFTC framework.

Lofchie Comment: The SEC and the CFTC have taken philosophically opposing views with respect to the ability of investors to trade in cryptocurrencies. The SEC Division of Investment Management previously announced that it would not allow the registration of an investment company to go forward if the company were to be significantly involved in trading cryptocurrencies. By contrast, Chair Giancarlo has acknowledged the risks of these products, but determined not to prevent trading in them.

To some extent, the different conclusions reached by the regulators may reflect the differing investor bases. Investment companies are likely to attract a retail investor base, while futures traders are more likely to be institutions. Further, through his negotiations with the exchanges, Chair Giancarlo was actually in a better position than the SEC would have been to impose additional prudential requirements on the trading of cryptocurrencies. Still, Chair Giancarlo leaves himself vulnerable to second-guessing if there are material negative developments with trading cryptocurrencies, while the SEC has taken the politically safer path. In so doing, Chair Giancarlo should be respected for his willingness to take some political risk on the basis of the view that the Government can not, and should not, prevent individuals from deciding to take economic risk.

Chair Giancarlo Outlines CFTC Approach to Virtual Currency Regulation

CFTC Chair J. Christopher Giancarlo asserted the CFTC’s commitment to regulating virtual currency trading effectively. In a public statement, he highlighted the agency’s scrutiny of new launches of virtual currency futures markets in light of recent launches of bitcoin futures under “self-certification procedures.” He announced a meeting of the CFTC’s market risk advisory committee to consider the efficacy of the self-certification process. He reiterated the CFTC view that virtual currency is a “commodity” as that term is defined in the CEA, and thus is subject to CFTC regulation. Chair Giancarlo contended that the CFTC is delivering a regulatory response centered on “consumer education, asserting CFTC authority, surveilling trading in derivative and spot markets, prosecuting fraud, abuse, manipulation and false solicitation and active coordination with fellow regulators.”

Chair Giancarlo also highlighted an upcoming meeting of the CFTC Technology Advisory Committee to consider challenges, opportunities, and market developments of virtual currencies. He said that virtual currency and virtual currency derivatives offer potential benefits, but market participants must be vigilant, as they also present certain heightened risks.

The CFTC also published a document providing information on CFTC oversight of and approach to virtual currency futures markets. The document includes an explanation of the self-certification process as applied to virtual currency futures products.

Lofchie Comment: The SEC also recently issued a statement asserting jurisdiction over certain transactions involving blockchain products. (See SEC Chair Jay Clayton Urges Caution regarding ICOs and Cryptocurrencies.) This raises the possibility of a regulatory dispute over jurisdiction. Each agency is perfectly correct in interpreting the relevant statutes to the effect that at least some transactions involving virtual currency or other blockchain products will fall within the ambit of that agency, and perhaps within the ambit of both. What is significant in the regulatory pronouncements is not the possibility for regulatory disagreement, but rather that both regulators are seeking to exercise their consumer protection functions.

Global Markets into 2018

The Center for Financial Stability (CFS) hosted a small private workshop for leaders in finance to delve into issues that will shape the future of asset values and investment management on December 6.

CFS Special Counselor Jack Malvey set the stage with an essay “Toward the Mid-21 st Century Global Financial System” –

Workshop topics included:

– Geopolitics and Big Picture Challenges through 2020 – AI, cyber, etc;
– Global Macro, Quantitative Tightening, and Financial Stability;
– Financial Industry Transitions – Active versus Passive Management, etc; and
– Opportunities and Risks (a selection follows).


– Buy cash today – the rate of return will be extraordinarily high.
– Central banks will more actively incorporate financial stability into actions and mandates.
– Emerging markets will outperform.
– The Fed desires to move further away from the zero lower bound.
– NPLs in China are overstated / bank earnings mitigate and neutralize risks.
– Global macro investment opportunities via uneven tightening.


– I will buy cash – but tomorrow.
– Bitcoin correction.
– Limited attractive equity names based on valuation / similar to Tokyo in 1989.
– Geopolitical tensions will increase with North Korea, China, Russia, and Saudi Arabia.
– Inflation surprise / data may be misread.
– Artificial intelligence channeled for ill.

Best wishes into the Holiday Season and 2018!

CFTC Requests Comment on Proposed Interpretation of “Actual Delivery” in Virtual Currency Transactions

The CFTC requested comment on a Proposed Interpretation of the term “actual delivery” in the context of virtual currency retail transactions. The CFTC describes the “actual delivery” exception to regulation of leveraged transactions in virtual currencies as retail commodity transactions.

The CFTC restated the position that a virtual currency is a commodity, which means that leveraged, margined or financed transactions in virtual currencies with non-eligible contract participants (“non-ECPs”) are “retail commodity transactions” subject to CFTC oversight under Section 2(c)(2)(D) of the Commodity Exchange Act. Regulation of retail commodity transactions is subject to a statutory exemption for transactions in which actual delivery of the commodity occurs within 28 days of the transaction. In connection with virtual currency, the CFTC pointed to an Eleventh Circuit decision finding a virtual currency trading platform liable for failing to register with the CFTC on the grounds that the platform “did not actually deliver bitcoins purchased from them,” but instead “held the purchased bitcoins in bitcoin deposit wallets that it owned and controlled.”

The CFTC’s Proposed Interpretation includes a “broad” interpretation of the term “virtual currency.” In the CFTC’s view, virtual currency “encompasses any digital representation of value (a ‘digital asset’) that functions as a medium of exchange, and any other digital unit of account that is used as a form of a currency (i.e., transferred from one party to another as a medium of exchange); may be manifested through units, tokens, or coins, among other things; and may be distributed by way of digital ‘smart contracts,’ among other structures.”

In order to prove “actual delivery” of virtual currency in connection with retail commodity transactions, the proposal would establish that a market participant would be required to be able to demonstrate:

  • that a customer has the ability to (i) take possession and control of the entire quantity of the commodity, whether it was purchased on margin, or using leverage, or any other financing arrangement, and (ii) use it freely in commerce (both within and away from any particular platform) no later than 28 days from the date of the transaction; and
  • the offeror and counterparty seller (including any of their respective affiliates or other persons acting in concert with the offeror or counterparty seller on a similar basis) does not retain any interest in or control over any of the commodity purchased on margin, leverage, or other financing arrangement at the expiration of 28 days from the date of the transaction.

The Proposed Interpretation provides several examples to illustrate practical applications.

Comments will be due 90 days after publication in the Federal Register.

In addition, the CFTC launched a resource page on virtual currency. The page includes a new Customer Advisory on understanding the risks associated with trading in virtual currency.

SEC Chair Jay Clayton Urges Caution regarding ICOs and Cryptocurrencies

SEC Chair Jay Clayton asserted that initial coin offerings (“ICOs”) are likely to involve the sale of assets that qualify as securities, and urged investors to proceed with caution when considering ICO or cryptocurrency-related investments. His formal statement is directed at investors and market professionals acting as gatekeepers, and warns the latter group to focus on their responsibilities under the securities laws.

Chair Clayton urged market professionals to review the SEC report on the application of securities laws to initial coin offerings. In the report, the SEC applied longstanding securities law principles to determine that particular ICO tokens qualified as securities and, thus, were subject to relevant federal securities laws. Chair Clayton asserted that tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others bear the hallmarks of securities. He warned professionals that they cannot avoid regulatory requirements simply by representing that a particular token or coin provides utility or “structuring it to provide some utility.” He said that such representations “elevate form over substance.” While Chair Clayton acknowledged the possibility that certain cryptocurrencies and ICO tokens may not comprise securities, he urged regulators and other market participants to fulfill their responsibilities in order to ensure investor protection. He also noted that he has instructed the SEC Division of Enforcement to police ICO offerings vigorously, and warned that in addition to securities registration, promoters should consider broker-dealer and exchange registration requirements.

Chair Clayton also urged market professionals to act with particular vigilance when dealing with cryptocurrency transactions. He encouraged broker-dealers and other market participants that allow for payments in cryptocurrencies to ensure that cryptocurrency transactions do not interfere with their ability to meet anti-money laundering and know-your customer obligations. While cryptocurrencies may or may not ultimately be considered as securities, Chair Clayton added, the SEC will closely monitor their impact on and interaction with the securities markets.

CFTC Chair J. Christopher Giancarlo praised Chair Clayton for his statement, noting that virtual currency markets are still largely unregulated and present challenges for regulatory agencies. According to Chair Giancarlo, “CFTC and SEC staff are in regular communication on these issues,” and investors should be aware of associated volatility and risk.