Derivatives regulators continue to take actions that pull virtual currencies – also known as digital currency or cryptocurrency, the best known of which is bitcoin – into their regulatory schemes. In December, the National Futures Association (NFA), the futures industry’s self-regulatory organization, issued three Notices to Members that expand the notification and reporting requirements for futures commission merchants (FCMs), introducing brokers (IBs), commodity pool operators (CPOs) and commodity trading advisers (CTAs) trading in virtual currencies and related derivatives. In issuing these directives, the NFA cited the fact that a number of CFTC-regulated trading venues were in the process of offering derivatives on virtual currency products and stated that it was expanding the notification and reporting requirements due to the volatility in the underlying virtual currency markets.
Specifically, the NFA’s notices:
- direct each FCM for which NFA is the DSRO to immediately notify NFA if the firm decides to offer its customers or non-customers the ability to trade any virtual currency futures product. NFA also requires each FCM to report on its daily segregation reports the number of customers who traded a virtual currency futures contract (including closed out positions), the number of non-customers who traded a virtual currency futures contract (including closed out positions), and the gross open virtual currency futures positions (i.e. total open long positions, total open short positions);
- direct each IB to immediately notify NFA if it solicits or accepts any orders in virtual currency derivatives. NFA also requires each IB that solicits or accepts orders for one or more virtual currency derivatives to notify NFA by amending its annual questionnaire, by answering this question: Does your firm solicit or accept orders involving a virtual currency derivative (e.g. a bitcoin future, option or swap)? In addition, starting with the current quarter, IBs that solicit or accept orders for virtual currency derivatives will also be required to report the number of accounts they introduced that executed one or more trades in a virtual currency derivative during each calendar quarter;
- direct each CPO and CTA to immediately notify NFA if it executes a transaction involving any virtual currency (such as bitcoin) or virtual currency derivative (such as a bitcoin future, options or swap) on behalf of a pool or managed account. NFA’s Notice requires that CPOs and CTAs provide such notice by amending their annual questionnaire, to which NFA added questions that inquired, for CPOs, whether the firm operates a pool that has executed a transaction involving a virtual currency or virtual currency derivative and, for CTAs, whether the firm offers a trading program for managed account clients that have transacted in a virtual currency, or managed an account that transacted in a virtual currency derivative. In addition, beginning with the current quarter, the NFA is requiring CPOs and CTAs to report on a quarterly basis the number of their pools or managed accounts that executed at least one transaction involving a virtual currency or virtual currency derivative.
On October 12, 2017, the United States Securities and Exchange Commission’s Investor Advisory Committee met to discuss Blockchain technology and its impact on the securities industry. While Blockchain is best known as the decentralized accounting system that make transactions in Bitcoin and other cryptocurrencies possible, the panel of industry professionals and academics emphasized its potential to transform “mainstream” financial recordkeeping in a way that makes executing and recording all financial transactions more secure and efficient.
SEC Chairman Jay Clayton, who oversaw the proceedings, explained that the Commission seeks to explore the ways in which Blockchain can promote robust and competitive markets, while ensuring that investors are protected and federal securities laws are applied to transactions in cryptocurrencies made possible by the technology.
Cryptocurrencies, including Bitcoin, have been in the news a lot lately, but many people still don’t know what they are—or whether they’re regulated. Here’s a quick rundown.
What Are Cryptocurrencies?
Cryptocurrencies are decentralized digital cash systems. Eschewing centralized control, such as a bank or government, cryptocurrencies instead rely on pseudonymous peer-to-peer networks—think Napster of yore—in which all actors in the network must recognize and reflect a transaction. To illustrate how this works, if Person A has an apple and trades it to Person B for her orange, Person A cannot thereafter trade that apple to Person C because everyone knows from a public ledger that Person A has already traded his one apple.
The security of the public ledger is then of paramount importance—so how do cryptocurrencies ensure ledger security? They rely on people called miners. Miners are basically the bookkeepers of the public ledger, and anyone with the time, energy, and equipment can be a miner. When a transaction occurs, it is not immediately added to the public ledger; instead, a miner must first confirm it. To do so, miners generate a complicated code that: (1) memorializes the data relating to the transaction; (2) refers to the previous confirmed transaction in the system (a sequential timestamp of sorts); and (3) complies with the particular cryptocurrency’s specific requirements. This is a challenging and necessary task that protects the public ledger—a transaction won’t be confirmed if a code can’t be generated that aligns with previous ledger entries. Using the earlier example, once Person A’s apple-orange trade has been confirmed, he can’t trade the apple again because any code generated after that reflects that he has already traded his apple. Without an acceptable code, no new transaction can be confirmed.
On the eve of the much anticipated release of Star Wars: The Force Awakens, the SEC approved Overstock Inc.’s plan to issue digital shares. The online retailer plans to issue company stock via bitcoin blockchain–an enormous database running across a global network of independent computers that tracks the exchange of money. Just as the original Star Wars movies released in the late 1970s and early 1980s signaled a monumental shift in special effects in film, Overstock’s plan to issue digital shares may herald a significant shift in the way securities are distributed and traded in the future.