By Todd Zerega and Tom Watterson
In the past week, Bitcoin derivatives have been making news. A Bloomberg article highlighted Bitcoin derivatives and platforms for such products, and in an interview on February 28, the CME Group chairman and president, Terry Duffy, announced that the CME Group is beginning to take a preliminary look into Bitcoins.
As mentioned in our previous post, the CFTC would have a colorable claim to regulate derivative products of Bitcoins (i.e., Bitcoin futures, swaps, rolling spot Bitcoin transactions, etc.). But what about the standard, everyday exchanges of Bitcoins for money, goods or services (for the ease of reference, we will refer to these exchanges as “Bitcoin Transactions”)? This post explores the jurisdictional hooks the CFTC could have over these Bitcoin Transactions.
Future, Swap or Spot Transaction?
The CFTC has broad jurisdiction over derivative products of commodities, such as swaps and futures, and has limited (but not zero) jurisdiction over spot transactions in the underlying commodities. Both the swap and future definitions under the Commodity Exchange Act (“CEA”) are extremely broadly worded, and therefore, the CFTC could attempt to treat Bitcoins Transactions as a swap or future. However, it may be more likely that the CFTC will consider Bitcoin Transactions to be more akin to spot transactions than a future or swap.
One method to distinguish between spot and future transactions was laid out by the Seventh Circuit in CFTC v. Zelener (373 F.3d 861 (7th Cir. 2004)). In Zelener, the court determined that certain rolling spot commodity transactions were not “futures” by looking at whether the transaction was a sale of a “contract” or a sale of the commodity itself. Additionally, in the context of foreign exchange, the CFTC looked at whether a transaction is being settled within the “customary timeline of the relevant spot market” to distinguish between spot and forward foreign exchange transactions. (See Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 FR 48,207, 48,256-258 (Aug. 13, 2012)).
With respect to Bitcoin Transactions, the analogy to the CFTC’s interpretation of spot foreign exchange transaction seems more appropriate because Bitcoins share characteristics with currencies in their use and exchange. However, given the early development of the Bitcoin market, the “customary timeline” for settlement of Bitcoin Transactions is not as settled as it is for foreign exchange. Moreover, Bitcoin Transactions are currently processed by miners who receive new Bitcoins for their work; eventually, these miners will no longer receive new Bitcoins. As a result, a transaction fee that can be set by the counterparties will likely become a more important source of income for processing Bitcoin Transactions. If the counterparties set a very low fee, miners may never process the Bitcoin Transaction or it may take a very long time to process and could turn into a method for speculating on the future price of Bitcoins. Although the spot foreign exchange analysis appears to be an appropriate analogy to Bitcoin Transactions, it remains to be seen whether or not the unique aspects of how Bitcoin Transactions are processed could cause certain Bitcoin Transactions to fall outside of the “spot” transaction analysis for purposes of the CFTC jurisdiction.
Bitcoin as a “Commodity”
Even if the CFTC does not treat Bitcoin Transactions as swaps or futures, a Bitcoin would likely be a “commodity” under the CEA. Specifically, a “commodity” as defined by Section 1a(9) of the CEA and CFTC Rule 1.3(e) includes “all services, rights and interests . . . in which contracts for future delivery are presently or in the future dealt in”. In other words, anything that futures are traded on. Currently, according to media reports, there appear to be two active platforms for trading Bitcoin derivatives, including futures.
As a commodity, Bitcoin Transactions would not be completely removed from CFTC jurisdiction. “Spot” Bitcoin Transactions would be subject to the CFTC’s anti-manipulation rules because manipulation in the spot market can affect the prices in the derivatives market. Moreover, the CFTC has historically limited the exercise of its jurisdiction of the spot market toward manipulations that affect futures prices, but the agency does have enforcement authority with respect to market manipulation in spot market transactions. Indeed, the CFTC’s first enforcement action under its new market manipulation rules arising out of Dodd-Frank was in relation to a Ponzi scheme involving spot market silver contracts. (See CFTC v. Atlantic Bullion & Coin, Inc., C.A. No. 8:12-1503-JMC (D. S.C., June 6, 2010) (CFTC Press Release here)). This jurisdictional hook could become more important as the Bitcoin derivatives market evolves and more Bitcoin derivatives products are traded by persons in the US.
Moreover, the Dodd-Frank Act added Section 2(c)(2)(D) to the CEA which gives the CFTC anti-fraud authority over leveraged or margined commodity transactions with retail customers (i.e., non-ECP customers – see our prior post for a practical guide to the ECP definition) and would require those transactions to be entered into on an exchange. However Section 2(c)(2)(D)(ii)(III) exempts: (1) transactions where actual delivery takes place within 28 days; and (2) contracts that create an enforceable obligation to deliver, the buyer and seller have the ability to deliver and accept delivery in connection with a line of business.
As the Bitcoin market develops, we expect to see a large amount of product innovation and transactions, and we expect that, in some instances those products could come under CFTC regulatory authority. However, following the CFTC’s previous guidance on “spot” transactions, the average user’s purchases and sales of Bitcoins should remain mostly, but not completely, outside of the CFTC’s jurisdiction.
Good day. Good “spot”. TSR