On March 6, 2018, in a decision on the CFTC’s motion for a preliminary injunction and the pro se defendant’s motion to dismiss, United States District Court Judge Jack Weinstein in the Eastern District of New York ruled that virtual currencies are “commodities” as that term is used in the Commodity Exchange Act and CFTC Regulations. Moreover, the court confirmed that a provision added to the CEA by the Dodd Frank Act, and regulations promulgated thereafter, provide the CFTC with jurisdiction over fraudulent transactions in the cash market for virtual currency even if the activity does not involve a futures or swap trade.
On January 18, 2018, the CFTC filed an enforcement action against Patrick McDonnell and his company Cabbagetech Corp. d/b/a Coin Drop Markets. The CFTC alleges the defendants operated a deceptive and fraudulent virtual currency scheme for purported virtual currency trading advice and virtual currency trading on behalf of investors, and instead simply misappropriated the investors’ funds.
Following an evidentiary hearing on the CFTC’s motion for a preliminary injunction, the court found that McDonnell, CabbageTech and Coin Drop sold customers “memberships” in virtual currency trading groups which would provide the customers exit prices and profits of up to 300% per week. In addition, “investors” transferred virtual currency to the defendants for day trading by the defendants on the investors’ behalf. Among other things, McDonnell claimed that $1,000 in Litecoin “should be earning $200 to $250 per day through trading.”
After receiving membership payments or virtual currency investments, the defendants deleted their social media accounts and websites. They provided minimal if any virtual currency trading advice. The defendants refused to return the membership payments or the virtual currency investments and misappropriated the funds.
From the founding of the CFTC in 1975, the CEA has given the CFTC jurisdiction over contracts of sale of a commodity for future delivery. The Dodd Frank Act expanded the CFTC’s jurisdiction to include commodity swaps. Historically, the CFTC had little jurisdiction over the underlying cash commodity markets.
Another provision of the Dodd Frank Act changed that. Section 753(a)(1) added Section 6(1) to the CEA mandating that the CFTC promulgate regulations making it unlawful for any person “to use or employ, in connection with any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery . . . any manipulative or deceptive device or contrivance.” This expanded the CFTC’s jurisdiction to include fraudulent transactions in a cash commodity market even if there are no futures or swaps transactions involved in the fraud.
The regulation that CFTC promulgated pursuant to Section 6(1), Regulation § 180.1, is the provision that the CFTC relied upon in bringing its enforcement action against McDonnell and CabbageTech as the defendants’ conduct did not involve futures or swap transactions.
In considering whether the CFTC had standing, the court looked to multiple definitions of the term “commodity.” It considered common definitions of “commodity,” citing Black’s Law Dictionary, Merriam Webster and various scholars and commentators. The court found these to be consistent with the conclusion that virtual currencies are commodities.
The court considered the definition of the term “commodity” set forth CEA Section 1a(9). That reads:
The term “commodity” means [an extensive list of agricultural products not relevant here], and all other goods and articles, . . . and all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.
The court noted that the CEA covers intangible commodities. The reference in the CEA’s definition of “commodity” to “all other goods and articles . . . services, rights and interests” probably does capture virtual currencies. The court did not address, however, how the virtual currencies McDonnell and CabageTech took in from customers or investors met the definition’s requirement that they be “goods . . . in which contracts for future delivery are presently or in the future dealt in.” Currently, the only virtual currency with a futures contract on it is Bitcoin.
The court also considered the CFTC’s interpretation of the term “commodity.” It noted that in a 2015 administrative proceeding, In re Coinflip, the CFTC found that “Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.” The court also noted that in various public statements since the Coinflip case, the CFTC has asserted that virtual currencies constitute a “commodity” under the CEA. The court did not comment, however, on the fact that the Coinflip case involved illegal Bitcoin options contracts, so Bitcoin was a good in which contracts for future delivery were dealt in (albeit illegally).
The court concluded that Section 6(1)’s delegation of authority over “any contract of sale of any commodity in interstate commerce” allowed the CFTC to enforce its antifraud mandate against the defendants.
The court, however, does not expressly explain how all of the virtual currencies involved are commodities under the CEA’s definition of “all other goods and articles, . . . and all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.” Although there are now futures contracts listed for trading in Bitcoin, there are not futures contracts listed for trading on any other virtual currency. McDonnell specifically solicited Litecoin investments among apparently other virtual currencies.
On the one hand, it seems the Court read out of the definition of the term “commodity” under the CEA the requirement that the commodity have contracts for future delivery that “are presently or in the future dealt in.” Or, the court could be interpreting the term “commodity” for the purposes of Section 6(1) differently from how the term is interpreted under the CEA’s definition of “commodity” found in CEA Section 1a(9).
On the other hand, the court did write:
Where a futures market exists for a good, service, right or interest, it may be regulated by the CFTC, as a commodity, without regard to whether the dispute involves futures contracts.
By this, the court appears to acknowledge the requirement that, for the CFTC to exercise its antifraud authority over a cash commodity market, there must be a futures contract listed for trading on the commodity. But this appears inconsistent with the court’s reliance on the definition of “commodity” in everyday usage.
Perhaps the best explanation for the apparent inconsistency is that the court is reasoning that if one virtual currency has a futures contract trading on it, then all other virtual currencies are “goods . . . . in which contracts for future delivery are presently or in the future dealt in.”
McDonnell represented himself pro se. Accordingly, the court did not benefit from a defense counsel’s rigorous testing of the CFTC’s theory that all virtual currencies are commodities. It remains to be seen, then, how a court would rule if it had the benefit of a robust, critical analysis of the CFTC’s theory proffered on behalf of a defendant.
Bipartisan Senators Propose Regulatory Overhaul of Crypto Markets
Blockchain Law Center | (06/09/2022)
Wyoming Crypto Bank Sues Federal Reserve Over Delay in Application For a Master Account
Blockchain Law Center | (06/09/2022)
SEC Announces Charges in Cryptomining and Trading Scheme
Blockchain Law Center | (05/06/2022)
SEC Nearly Doubles Size of Enforcement’s Crypto Assets and Cyber Unit
Blockchain Law Center | (05/04/2022)
Comptroller of the Currency Advocates for Uniform Standards for Stablecoins
Blockchain Law Center | (04/28/2022)
About Blockchain Law Center
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.