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U.S. Law Roundup: Part Two

5 December 2018
U.S. Law Roundup: Part Two

Bitcoin futures: Regulation of virtual currency derivatives in the U.S.

In this four-part series, New York attorney Bryan Hollmann explains the multifaceted approach to the regulation of virtual currencies in the United States. Previously, Bryan explained the Howey test and how initial coin offerings may be subject to U.S. federal securities law. The second part of this series, provided below, covers the regulation of virtual currencies as commodities by the U.S. Commodity Futures Trading Commission. Part three will discuss anti-money laundering and know-your-customer compliance under the Bank Secrecy Act and FinCEN, and part four will provide an overview of virtual currency taxation by the U.S. Internal Revenue Service.

In December 2017, the virtual currency industry took a big step toward institutional adoption with the launch of bitcoin futures products by the Chicago Mercantile Exchange and the CBOE Futures Exchange. Other projects, such as Intercontinental Exchange's Bakkt platform, also plan to offer virtual currency derivatives products in the near future. The U.S. Commodity Futures Trading Commission (CFTC), the regulator that oversees the futures and swaps markets, will play a large role in shaping the industry moving forward.

The CFTC was a relatively early mover in the race to assert jurisdiction over bitcoin and other virtual currencies. In late 2014, Timothy Massad, then Chairman of the CFTC, stated that "derivative contracts based on a virtual currency" are within the regulatory purview of the CFTC. In 2015, the CFTC declared that bitcoin and other virtual currencies are commodities.

Generally, the CFTC oversees futures, options and derivatives contracts. Its authority stems from the Commodity Exchange Act and extends to transactions involving commodities. The definition of 'commodity' under the Commodity Exchange Act is exceedingly broad, and includes agricultural products as well as all goods, services, rights, and interests (except, oddly, for onions and motion picture box office receipts) in which contracts for future delivery are presently or in the future dealt in. The CFTC has claimed that bitcoin and other virtual currencies are properly defined as commodities.

According to the CFTC, bitcoin and other virtual currencies are subject to its jurisdiction when a virtual currency is used in a derivatives contract, or if there is fraud or manipulation involving virtual currency in interstate commerce. With few exceptions, persons offering virtual currency derivatives must be registered with the CFTC.

So far, the CFTC's expansive view has been supported by at least two federal courts. On 6 March 2018, Judge Jack B. Weinstein of the U.S. District Court for the Eastern District of New York concluded that virtual currencies fall well within the definition of commodities under the Commodity Exchange Act and can be regulated by the CFTC as such. Even more recently, on 26 September 2018, another federal judge opined that, since futures contracts for virtual currencies exists (i.e. Bitcoin futures), all digital tokens within the class of virtual currencies are commodities subject to the anti-manipulation and anti-fraud provisions of the Commodity Exchange Act.

Where the jurisdiction of the CFTC ends and the jurisdiction of another agency begins is unclear. Also unclear is whether virtual currencies can mutate over time from one classification to another. Ether, for example, likely was a security in 2014 when it was sold to the public; however, the Director of the SEC's Division of Corporation Finance, William Hinman, stated in June 2018 that he considers Ether to no longer be a security because of "the state of the Ethereum network and its decentralized structure". The implications of that assessment—whether Ether today is regulated by the SEC as a security, by the CFTC as a commodity, or by both—is anybody's guess. Companies offering virtual currencies that resemble both securities and commodities may find themselves under scrutiny by multiple regulators. Moving forward, it will be worth observing how these regulators interact with each other when their jurisdictions overlap.

Disclaimer: This article does not constitute legal advice and does not establish an attorney-client relationship. If you need legal advice, please contact an attorney directly.

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