On March 24, the Commodity Futures Trading Commission (CFTC) issued final interpretive guidance (the Guidance) regarding retail commodity transactions involving virtual currency. In short, this Guidance clarifies when “actual delivery” of virtual currency (such as bitcoin and ether) occurs under the test determining whether a leveraged arrangement is exempt from regulation by the CFTC as, effectively, a futures contract. This important Guidance demonstrates the proactive and leading role that the CFTC has taken in connection with understanding and addressing developments in the fintech sector. In the Guidance, the CFTC explains the exemption clearly and places it in the context of the CFTC’s regulatory mandate, its somewhat tortured history in obtaining jurisdiction over leveraged retail transactions in commodities, and its interest in preventing abusive practices. As part of its commitment to assisting the industry in adjusting to the evolving interpretations, the CFTC also announced that it would impose a 90-day moratorium on initiating enforcement actions that address aspects of the Guidance that, according to Chairman Tarbert’s accompanying statement, “were not plainly evident from prior CFTC guidance, enforcement actions, and case law.”
The Guidance in effect enables those transacting in leveraged virtual currency (often referred to as “cryptocurrency”) to understand whether they are subject to CFTC jurisdiction. As noted in the release, the CFTC has exclusive jurisdiction over commodity futures, options and swaps – which encompasses a broad range of derivatives – and has broad anti-fraud and anti-manipulation authority over any contract of sale of any commodity in interstate commerce, as well as swaps and futures. This jurisdiction includes certain speculative commodity transactions involving leverage or margin, which are also treated by the CFTC as futures. The CFTC’s jurisdiction over leveraged retail transactions remained uncertain until passage of the Dodd-Frank Act in 2010.
Before the Dodd-Frank Act, it was possible that a retail transaction in a commodity entered on a leveraged or margined basis, or financed by the counterparty, could avoid regulation by the CFTC even though it was economically indistinguishable from a futures contract. In his statement, Chairman Tarbert offers this example: suppose that someone decides to purchase a commodity with some money down, with delivery and final payment to be made at some future date, but is also able to trade out of the position at any time to lock in any gains or losses incurred to date; “that starts to look an awful lot like a futures contract—with identical economics but without any regulation.” The Dodd-Frank Act addressed this regulatory gap, with a particular application to abusive sales practices involving foreign currency and precious metals, and now the Guidance provides interpretation to apply the same principles to virtual currency.
The important exception to the CFTC’s jurisdiction over leveraged retail commodity transactions is for a contract of sale that “results in actual delivery within 28 days…” The determinative factor as to whether a transaction in virtual currency is subject to CFTC jurisdiction is whether actual delivery occurs within 28 days of trade execution. (Note that, for retail foreign currency transactions, the delivery period is only two days.) In its 2015 Coinflip Order, the CFTC clarified that virtual currency constitutes a “commodity” under the Commodity Exchange Act. Although virtual currency is an intangible commodity, the CFTC has jurisdiction over other types of intangible commodities, including rate indices and renewable energy credits. Multiple federal courts have also held that virtual currencies are commodities under the Commodity Exchange Act. The CFTC broadly defines virtual currencies as follows:
a digital asset that encompasses any digital representation of value or unit of account that is or can be used as a form of 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 the Guidance, the Commission interprets “actual delivery” in the context of virtual currency as taking place when (a) a customer (i) secures 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) has ability to use the entire quantity of the commodity freely in commerce, no later than 28 days from the date of the transaction; and (b) the offeror and counterparty seller do not retain any interest in, legal right, or control over any of the purchased commodity after 28 days from the date of the transaction. While this interpretation is carefully drafted to avoid permitting any “sham delivery” to qualify, the Guidance states that the simplest definition of actual delivery is the ability of a purchaser to use the virtual currency immediately as a unit of exchange. And while the 28-day period is provided as the outside time limit to constitute actual delivery, as a practical matter, it typically takes much fewer than 28 days for a virtual currency transfer to complete. To determine whether the seller no longer retains any interest in the virtual currency, the CFTC may look to whether the seller retains any ability to access or withdraw any quantity of the virtual currency from the purchaser’s account or virtual wallet. The Guidance essentially reaffirms guidance that the CFTC provided in 2013, in a non-virtual currency context, as to the “functional approach” that the CFTC would apply in determining whether actual delivery had occurred.
In the Guidance, the CFTC emphasizes the importance of virtual currencies and their underlying blockchain technologies, and highlights its efforts to take a “deliberative and measured approach” in this area, to avoid stifling technological innovation. The CFTC points to its efforts in this area, including the LabCFTC initiative, which seeks to promote market-enhancing innovation. It also notes that several derivatives contracts based on virtual currency are listed on CFTC registered entities. The Guidance also reports that the CFTC continues to follow the evolution of the cash market for virtual currencies, since cash markets affect related derivatives markets. It is because the technology, market structures and law are evolving so quickly that, as discussed by several Commissioners in their accompanying statements, issuing interpretive guidance is more appropriate than rulemaking at this time. We encourage readers to refer to the CFTC’s full Guidance, which is clearly written with helpful examples.