December 23, 2020
by Brian M. Walsh

On December 17, 2020, the Commodity Futures Trading Commission (CFTC) released a "Digital Assets Primer" (the "Primer") to "provide updated information to the public about emerging concepts in digital assets."  The Primer follows on the CFTC’s "Primer on Virtual Currencies," released in 2017.  The CFTC states that the Primer’s focus is broader than the 2017 piece and includes "smart contracts and other digitized representations of value or ownership" in addition to virtual currencies. 

The Primer also offers a differentiation between virtual currencies and "digital tokens," which it describes as a digital asset that requires another blockchain network to operate and may serve a variety of functions beyond virtual currency (e.g., utility tokens).  The Primer points out that Bitcoin dominates the digital asset marketplace in terms of market capitalization, that the number of digital assets is growing, and that digital asset markets remain small relative to traditional asset markets. 

The Primer identifies four elements that it asserts may contribute to a "robust regulatory framework," namely:

  1. Native Governance
    • Described by the CFTC as mechanisms that determine how digital assets operate, including the coding process and the transaction verification process.
  2. Community Standards and Best Practices
    • As established by the user community.
  3. Legal Agreements
    • The CFTC notes that legally enforceable agreements between two or more parties can facilitate the adoption and use of digital assets.
  4. Government Regulation
    • Described by the CFTC as principles, rules, and regulatory practices created and enforced by government authorities.  The Primer identifies the SEC, CFTC, FinCEN, OCC, and the Federal Reserve as examples of federal authorities contributing to the regulatory framework for digital assets. 
    • The Primer notes that non-governmental stakeholders are also contributing to the framework, including developers, businesses, users, market participants, and SROs. 

The Primer posits that regulatory coordination is necessary for effective oversight of digital assets and provides an overview of the CFTC’s potential jurisdiction over certain digital assets.  On a slide titled "CFTC’s Jurisdiction," the Primer cites two settled administrative actions in which the agency took the view that Bitcoin and other virtual currencies are commodities, as well as two federal district court decisions that the Primer asserts  "affirmed" the CFTC’s jurisdiction over the digital assets at issue.  Lastly, the slide cites CFTC Chairman Tarbert’s view that Ether is a commodity. 

The Primer offers the CFTC’s view that digital asset markets should be transparent, safe, and resilient and that market integrity should be a focus of digital asset governance.  It references the October 2019 Joint Statement on Activities Involving Digital Assets issued by leaders of the CFTC, SEC, and FinCEN, which emphasized the AML/BSA responsibilities attendant to digital asset transactions.  The Primer also references the March 2020 CFTC guidance regarding "actual delivery" of virtual currency transactions in connection with leveraged retail transactions.[1]

The Primer describes the development of CFTC-registered digital asset derivatives markets and references the product certification and review process involved with CFTC-registered entities seeking to list or clear virtual currency derivatives products.[2]  Additionally, it details the self-certification process whereby designated contract markets and swap execution facilities may offer new products by self-certifying that the offering complies with the Commodity Exchange Act and CFTC regulations.  The Primer notes that CFTC staff review of listed digital asset derivatives focuses on (for cash-settled products): (1) the quality and liquidity of the underlying market and pricing data; (2) the extent to which  there are safeguards in place to ensure fraud and manipulation risk is mitigated; and (3) the robustness of the methodology for calculating the settlement price.  For physically-settled digital asset derivatives, the review focuses on: (1) custody protocols, safeguards, and security, and rules related to the delivery process; (2) for cleared products, the role of the clearinghouse in the delivery process; (3) what the impact may be of delivery on underlying cash markets, and whether traders could engage in squeezes, corners, or other manipulative behavior; and (3) what protocols are in place to ensure fraud and manipulation risk is mitigated.

Lastly, the primer offers topics for further consideration.  Most notably, it asks "What does an effective regulatory framework look like?" and "How can regulators support transparent, liquid markets and help ensure their integrity?"

Our takeaway:  the Primer is an informational piece rather than a policy statement, but it is helpful to know that the CFTC, specifically LabCFTC, is interested in engaging with the public regarding the regulator’s role in evolving products and marketplaces.

 

[1] Leveraged retail commodity transactions entered into with, or offered to, parties that are not Eligible Contract Participants (ECPs) are treated as futures, except with respect to any contract of sale that results in "actual delivery" within 28 days – meaning actual transfer of possession of control and the ability to use the virtual currency freely, not simply a book entry or position roll or offset. 

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Blockchain technology utilizes a distributed digital ledger to record and track information, and can be leveraged to gain transparency and certainty in transactions ranging from cryptocurrency to supply chain tracking.  This blog provides information on the legal developments surrounding implementation of blockchain technology, with an initial focus on the financial services sector.