Crypto Land of Confusion

This is the time,
This is the place,
So we look for the future,
But… Tell me why, this is the Land of Confusion.
-Land of Confusion,  Genesis, 1986

At a recent panel in London regarding cryptocurrencies, Blockchain, and initial coin offerings (ICOs), the experience from individuals (and/or their organizations) that had completed ICOs was that confusion reigned supreme around the regulatory and legal requirements of the ICO process and, generally, around the nascent “cryptoverse,” (see “Cryptoverse skinny,” p. 41).

They stated that great sums of money had been spent on expensive attorneys to receive confusing and often contradictory advice about how to conduct an ICO and not end up in jail. Furthermore, as the only American on the panel (other than the moderator), I was pressed as to why the regulatory landscape in the United States was particularly challenging.

The answer to the U.S. regulatory question lies, at least partially, with the multiple regulator system that we have in the United States. Each regulator has carved up the regulatory crypto pie based on its respective mandate (i.e., securities vs. derivatives) and issued rulings, opinions and/or guidance from its unique perspective and precedents. Unfortunately, while correct legally, this approach does not always yield perfectly clear regulation. Market participants are sometimes left to struggle with contradictory and confusing rules. So, they do what most rational people do and avoid the jurisdiction while looking for countries that have either favorable, or at least not confusing, regulations. In the meantime, the United States loses out on potential business as market participants seek shelter away from the Land of Confusion.

Dual Regulation Strikes Again
Two of the most powerful financial regulators in the United States (actually, one could persuasively argue that their power extends to the world), the Commodity Futures Trading Commission (CFTC) and the Securities & Exchange Commission (SEC) have been going back-and-forth since 2014 with rulings and guidance on the cryptoverse. For example, in September 2014, the CFTC granted TeraExchange, a swap execution facility (SEF), approval of a Bitcoin Swap. Around this time, various CFTC Commissioners, as well as former Chairman Tim Massad, stated that because bitcoin and all digital currencies were commodities, the CFTC had jurisdiction over these products.

Chairman Massad, in testimony before the Senate Agriculture Committee in December 2014 said that, “Derivative contracts based on a virtual currency represent one area within our responsibility.”

He went on to say that the CFTC defines commodities “very broadly,” which is consistent with the Commodity Exchange Act (CEA) – the CFTC’s guiding statute.

When the calendar rolled over to 2015, the CFTC’s docket was still busy with issues arising from the cryptoverse. Among other things, a new crypto-entity, LedgerX, submitted a SEF and an adjoining Derivatives Clearing Organization (DCO) application. LedgerX touted itself as “a new derivatives exchange and clearinghouse that will serve the digital currency market by offering physically settled swaps and options contracts.” LedgerX went on to point out that it would be the first exchange to offer physically settled bitcoin derivatives in the United States.

While the CFTC issued a few straight-forward Orders in connection with crypto-businesses during 2015 and 2016 (e.g., TaraExchange agreed to cease and desist failing to enforce its wash trading and prearranged trading rules on the SEF platform), the bulk of the interaction between the CFTC and the SEC began in the summer of 2017. After a two-year application process, the CFTC granted SEF status to LedgerX on July 6, 2017 and, a couple of weeks later, DCO status on July 24, 2017.

Additionally, the futures exchange associated with the Cboe Global Markets known as “CBOE Futures Exchange (CFE)” issued a statement around this time stating that it had entered into an agreement with the Gemini cryptocurrency exchange, owned and operated in part by the Winklevoss twins of Facebook fame, to launch cryptocurrency derivatives trading (see “Bitcoin futures are coming”). CFE has targeted a Q4 or early 2018 launch, but is waiting on CFTC approval.   

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