Among the virtual currency transactions that are within the scope of CFTC regulation are leveraged, margined, or financed transactions in virtual currencies offered to retail customers. These retail commodity transactions are illegal unless traded on a regulated futures exchange and cleared through a futures commission merchant. They include any transaction: in a commodity (including virtual currencies but not foreign currency or securities); with a customer that is not an eligible contract participant; and that is offered on a leveraged, margined, or financed basis.
The CEA exempts from this treatment any transaction that “results in actual delivery [of the underlying commodity] within 28 days” (emphasis added). Today the CFTC proposed an interpretation of “actual delivery” for purposes of this exemption in the context of virtual currency transactions. Comments on the proposal are due 90 days after its publication in the Federal Register.
A brief background. Although not specifically referenced in the CFTC’s release, the proposal may be, at least in part, a response to a petition for rulemaking submitted to the CFTC in 2016. That petition was spurred by a position taken by the CFTC in its enforcement order against Bitfinex, a virtual currency exchange, which involved the offering of illegal off-exchange retail commodity transactions in bitcoin. In that enforcement order, the CFTC asserted that actual delivery of bitcoin will not have occurred where delivery of bitcoin is evidenced by accounting entries in an exchange’s own database, whether the delivered bitcoin is held for individual customers in an omnibus digital currency wallet or in individual customer digital wallets, if the exchange retains control over the private keys for those wallets. The petition argues against the CFTC conditioning actual delivery of a virtual currency on the recipient having control over the private key to the digital currency wallet to which the virtual currency was delivered.
The proposal. In its proposal, the CFTC sets out two key conditions for a virtual currency transaction to satisfy the actual delivery requirement under the exemption. These conditions, quoted in full, are:
- A customer having the ability to: (i) take possession and control of the entire quantity of the commodity, whether it was purchased on margin, or using leverage, or any other financing arrangement, and (ii) use it freely in commerce (both within and away from any particular platform) no later than 28 days from the date of the transaction; and
- The offeror and counterparty seller (including their respective affiliates or other persons acting in concert with the offeror or counterparty seller on a similar basis) not retaining any interest in or control over any of the commodity purchased on margin, leverage, or other financing arrangement at the expiration of 28 days from the date of the transaction.
The CFTC would consider the offeror of a virtual currency transaction to include “a virtual currency platform that makes the transaction available to the retail customer or otherwise facilitates the transaction.”
The proposal includes two examples of transactions that the CFTC would view as actual delivery and two examples that would not satisfy that requirement. It also sets out nine questions (with subparts) on which the CFTC is specifically seeking feedback.
Initial observations. The proposal represents an important step by the CFTC to clarify the treatment of many types of retail virtual currency transactions and should be of great interest to virtual currency exchanges and retail participants of those exchanges.
- Continuation of Bitfinex. The proposal represents the same general view expressed by the CFTC in the Bitfinex enforcement order. As made clear by the examples provided in the release, the CFTC would not view actual delivery of a virtual currency to have occurred unless a virtual currency transaction is both reflected on the blockchain for that virtual currency (not only on a separate ledger maintained by a virtual currency exchange) and where the full amount of the currency is delivered to a virtual currency wallet under the full control of the intended recipient and with no control asserted by the offeror or seller.
- The role of agents recognized. The proposal specifically recognizes the possible role of an agent in holding virtual currency for a purchaser. The agent, according to example 2 in the release, would need to have an agreement with the purchaser to hold virtual currency for the purchaser without regard to any asserted interest of the offeror or seller in that virtual currency and who is not the offeror or seller. The release asks whether the agent should be subject to specific regulatory or licensing requirements.
- Multi-sig solutions? The proposal states that, for a virtual currency transaction to have resulted in actual delivery, the offeror or seller of the virtual currency may not retain any interest or control over any of the virtual currency purchased. This position raises questions about whether multi-sig solutions can be modified or developed to ensure actual delivery for purposes of CFTC regulations.
- Fostering innovation. A theme of the release is the CFTC’s desire to not stifle innovation in the virtual currency markets, in recognition that “certain virtual currencies and their underlying blockchain technologies have the potential to yield notable advancements in applications of financial technology.” The CFTC asks for comment on the factors that may be relevant in exercising its authority under the CEA to exempt retail commodity transactions in virtual currencies from the requirement that they be treated as futures contracts.
As the CFTC considers a final interpretation of actual delivery for virtual currencies, those who operate virtual currency businesses or transact in these markets should consider providing thoughtful and constructive input on the proposal. Given the rapid development of these markets and technologies underlying virtual currencies, the market should assist the CFTC in establishing interpretation that is sufficiently flexible to appropriately accommodate new activities and technologies as they emerge.