Recent turbulence in the cryptocurrency industry has enlivened an ongoing debate about which agency should be the lead federal regulator of crypto going forward: the Commodity Futures Trading Commission or the Securities and Exchange Commission.
The answer: Both agencies should continue to exercise their regulatory authority over crypto assets and activities provided by existing law, and any new legislation should grant exclusive authority to the CFTC regarding spot market crypto assets—those that are traded for immediate delivery.
Complex Web
Unfortunately, today US crypto regulation involves many regulators including the CFTC and SEC, as well as the Financial Crimes Network of the Department of the Treasury and many states. It is likely that this complex web, as well as gaps in the web, contributed not only to the recent collapse of FTX, but of many other crypto players, too, including Celsius, BlockFi, and Voyager.
US regulation of traditional securities—such as equities and debt instruments, as well as investment contracts—is under the oversight of the SEC. The CFTC, on the other hand, has plenary jurisdiction over derivatives—such as futures or swaps—involving commodities, except to the extent such commodities constitute securities.
The CFTC also has the authority to bring enforcement actions against persons who commit fraud in connection with commodity transactions even when they don’t involve derivatives.
The CFTC, as supported by courts, has claimed that crypto constituting virtual currencies are just another commodity—like wheat, gold, and certain financial products—and that the CFTC’s rules apply equally to derivatives transactions in such crypto.
The SEC, also as supported by courts, has claimed that investment contracts that involve crypto are under its jurisdiction, and persons transacting in such products must comply with applicable securities laws and SEC rules, just as they must comply if they were transacting in non-investment contract securities.
FinCEN and the states often regulate persons who are in the business of transacting with the public in spot virtual currencies, or purchases and sales of bitcoin.
The lines among the regulators, however, are sometimes unclear. As a result, for example, four crypto assets recently were listed as digital asset securities on an alternative trading system regulated by the SEC, while the same crypto assets are contemporaneously trading on multiple trading platforms subject to state regulation as virtual currencies.
The SEC has a well-publicized lawsuit pending against Ripple and its founders related to a crypto asset XRP, which it terms a security, while in 2015 the Department of Justice settled an enforcement action with the same company, claiming the same XRP was a virtual currency and never terming the crypto asset a security.
Even earlier this year, the SEC brought an action against three individuals claiming they benefited from illegally front-running 25 crypto assets newly listed on a trading platform, of which it termed at least nine crypto assets as securities. The SEC did not suggest in its complaint what the other 16 crypto assets might be.
There are many examples of the same crypto asset receiving different regulatory treatment from different US regulators.
CFTC Should Lead
Fortunately, three bipartisan-sponsored bills are pending in Congress that provide a path for the CFTC to be the principal federal regulator in the spot crypto space—to the extent relevant crypto transactions are virtual currencies and do not involve securities.
Some have argued that the SEC is a tougher regulator when it comes to customer protection and enforcement and should be the lead regulator in any new legislation. Even before SEC staff penned the agency’s first interpretation of any kind involving crypto assets in 2017.
However, the CFTC had already brought three enforcement actions against persons it alleged were violating applicable laws and its rules regarding transactions in crypto assets.
Since then, the CFTC has further demonstrated its aggressiveness in the crypto arena by bringing enforcement actions against many household names among crypto enterprises for various alleged offenses, including Coinbase, Gemini, Bitfinex/Tether, BitMEX, and Kraken.
Moreover, the practice of crypto trading platforms globally is to combine the trading of spot crypto assets with derivatives on such assets. To the extent the CFTC already has plenary jurisdiction over the derivatives trading involving virtual currencies, it is more efficient to add authority to the CFTC over spot trading, too.
Finally, the crypto industry has rapidly evolved since publication of the Satoshi Nakamoto white paper in 2008, in which the author laid out the bitcoin concept. There is little doubt it will continue to morph rapidly going forward as new use cases for blockchain technology are developed. As a principles-based regulator, the CFTC is well-situated to respond most rapidly to changes in technology and practices to ensure maximum customer protection.
Both the CFTC and SEC are tough regulators. However, given the CFTC’s history, it seems preferable for the CFTC to be given additional authority over spot virtual currency activities in any new proposed legislation.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Gary DeWaal is special counsel to Katten Muchin Rosenman.
