July 30, 2018
by Katherine Cooper


Concerned that virtual currencies and related products “may be attracting customers that do not fully understand their nature, the substantial risk of loss that could arise from trading them and the limitations of NFA’s oversight role,” the National Futures Association (“NFA”) is implementing new disclosure requirements for NFA Members engaging in virtual currency activities with customers. 

Under NFA’s Interpretative Notice implementing these new disclosure requirements, futures commission merchants (“FCMs”) and introducing brokers (“IBs”) must provide each customer with the NFA Investor Advisory – Futures on Virtual Currencies Including Bitcoin and the CFTC Customer Advisory: Understand the Risks of Virtual Currency Trading before or when the customer engages in a virtual currency derivative transaction with or through the FCM or IB.  For customers who have traded in a virtual currency derivative prior to the effective date of the Interpretative Notice, the FCM or IB must furnish the advisories to those customers within 30 days of the effective date of the Interpretative Notice.

FCMs and IBs that solicit customers to engage, or engage in, spot virtual currency transactions with customers must provide the customer or counterparty with specifically- worded mandatory disclosure language which provides that, although the FCM or IB is subject to NFA’s regulatory oversight of its derivatives activities, NFA does not have regulatory oversight authority over “spot virtual currency products or transactions or virtual currency exchanges, custodians or markets.”

For institutional customers that are eligible contract participants, FCMs and IBs can provide these advisories and disclosures through website postings.  For retail customers, FCMs and IBs must provide the advisories and disclosures “in writing or electronically in a prominent manner designed to ensure a customer is aware of them.”

Commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) offering pools, exempt pools, or trading programs that trade in virtual currencies or virtual currency derivatives must customize their disclosure documents, offering memoranda, and promotional material to address the unique risks related to their specific activities.  Specifically, the Interpretative Notice mandates that a CPO or CTA address in those materials the following areas, if applicable:

  • Unique Features of Virtual Currencies: Virtual currencies are not legal tender in the United States and many question whether they have intrinsic value.
  • Price Volatility: Certain virtual currencies have seen a daily price volatility of more than 20%.
  • Valuation and Liquidity: The difficulties in valuing virtual currencies due to the lack of centralized pricing sources and the dispersed liquidity may make it difficult to exit a position, especially during times of market stress.
  • Cybersecurity:  Virtual currency wallets and exchanges are subject to being hacked causing immediate and irreversible losses and downward price pressure.
  • Opaque Spot Market: The pseudonymous nature of the blockchain may lead to “an increased risk of manipulation and fraud, including the potential for Ponzi schemes, bucket shops and pump and dump schemes.”
  • Unregulated Service Providers: Virtual currency exchanges, intermediaries and custodians are largely unregulated.  This creates the risk that they may not hold sufficient virtual currencies and funds to meet customer obligations.
  • Regulatory Landscape: One or more jurisdictions may adopt laws or regulations in the future that could adversely impact the usefulness of virtual currencies to merchants, service providers, and customers, which in turn could cause the price of virtual currencies to fall.
  • Technology: The technology underlying virtual currencies is new and rapidly evolving.  Forks unsupported by an exchange or wallet provider could adversely impact an investor holding virtual currency through that provider.
  • Transaction Fees: Several virtual currencies allow market participants to pay miners fees to process their transactions promptly.  During periods of market stress, these fees could become exorbitant.

In addition to these disclosures which can, and should, be customized to the CPO’s and CTA’s specific product or service offerings, a CPO or CTA must include two sets of specifically-worded mandatory disclosures.  The first, which must be included in its disclosure document, offering memorandum, and promotional materials, discloses that, although NFA has regulatory oversight over the CPO or CTA, NFA does not have regulatory oversight over the spot market for virtual currencies, exchanges, and custodians.  In addition, the disclosure warns customers of the opaqueness of the underlying markets and the lack of acceptable practices for NFA to verify the ownership or control of virtual currencies or their valuations.  The second specifically-worded mandatory disclosure must be provided before or when the CPO or CTA engages in any underlying spot virtual currency activity with the customer.  The disclosure advises that, although the CPO or CTA is a member of NFA and subject to NFA’s regulatory oversight, NFA does not have “regulatory oversight authority over underlying spot virtual currency products or transactions or virtual currency exchanges, custodians or markets.”

Clients with questions about the Interpretative Notice should contact Katherine Cooper at (212) 880-3630 or kcooper@mmlawus.com, Elizabeth Davis at (202) 220-1933 or edavis@mmlawus.com, or Brian Walsh at (202) 661-7030 or bwalsh@mmlawus.com.

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.