On September 17th, the Commodity Futures Trading Commission (“CFTC”) announced an enforcement order and settlement against an unregistered bitcoin options trading platform. The order is notable for six reasons:
1) It is the first official pronouncement from the CFTC that, “Bitcoin and other virtual currencies are encompassed in the definition [of a commodity under the Commodity Exchange Act] and properly defined as commodities”. This is significant since it confirms what many market participants have assumed. It also opens up the possibility for CFTC-initiated market manipulation enforcement actions in the Bitcoin space, broadly defined to cover the Bitcoin derivatives and spot markets or other activity that affects the price of a Bitcoin derivative.
2) It is the first enforcement against a Bitcoin derivatives trading platform for failure to register as a swap execution facility or a designated contract market. In fact, it is the first enforcement action for failure to register as a swap execution facility.
3) According to the order, the platform operator advertised that its platform “connects buyers and sellers of standardized Bitcoin options and futures contracts”. The order states that, the platform operator –
listed Bitcoin as the asset underlying the option and denominated the strike and delivery prices in US Dollars…Premiums and payments of settlement of the option contracts were to be paid using Bitcoin at a spot rate determined by a designated third-party Bitcoin currency exchange
The order also indicated that while Bitcoin futures contracts were advertised as being available for trading, no such contracts were actually ever offered over the platform.
4) The order underscored the distinction under the commodities laws between “retail” derivatives, on the one hand, and “commercial” derivatives, on the other hand. As a general rule, the Commodity Exchange Act (“CEA”) imposes the highest regulatory burdens on businesses that offer derivatives to retail participants or facilitate trading by such participants. In short, the laws are designed to “protect Mom & Pop” (our words, not the CFTC’s) from being taken advantage of in the derivatives markets. In the order, the CFTC observed that the platform users were not limited to sophisticated, large, institutional market participants using Bitcoin for commercial purposes. As a result, a “commercial” oriented exemption from full-blown CFTC regulation – known as the “trade option” exemption – was not applicable.
5) The order did not address “OTC Bitcoin Forward Contracts” that were available for trading over the platform. The order describes these forwards in the following manner:
A [trading platform] user would be matched through competitive bidding with a counterparty to execute a contract to exchange US Dollars for Bitcoins at a predetermined price and date…Although the price would be expressed as an exchange rate between US Dollars and Bitcoins, [the platform provider] required all settlements and margin payments to be transacted in Bitcoins.
According to the order, the platform provider calculated and held initial and maintenance margin payments and determined the settlement due upon termination of these fowards. The order further indicates that:
No bids or offers were posted by [Platform providers] for these contracts. Although these activities may have violated, or led to violations, of the Commodity Exchange Act, the [CFTC] does not address this conduct here.
In other words, the regulatory status of forward contracts settled in Bitcoin under the CEA appears to remain unsettled. This is an important issue to keep a proverbial “eye on” since some forward contracts may be excluded from regulation by the CFTC under the CEA altogether. That said, the CFTC remarked that the forward activities “may have violated, or led to violations of” the CEA. That is a very broad and general statement and, given that the CFTC expressly stated that it did not address forwards, it does not seem practical to conclude anything about the status of Bitcoin forwards under the CEA, other than they may lead to a violation of the CEA.
6) Finally, in the press release that accompanied the order, the CFTC’s Director of Enforcement noted that:
While there is a lot of excitement surrounding Bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.
The press release and enforcement order are available here.
Good day. Good opportunity to learn more about the regulatory status of Bitcoin derivatives. DR2.