It could be said that 2023 has been a year of setbacks in crypto for the U.S. Securities and Exchange Commission (SEC) — or at least, a very bad summer
With adverse outcomes in some high-profile crypto cases, the SEC’s crypto enforcement efforts are in a tailspin. These include the Ripple Labs crypto-asset securities case in July, in which the Southern District of New York (SDNY) held that sales of Ripple’s XRP coin on crypto exchanges were not unregistered offers and sales of securities as the SEC had asserted (and the SEC’s application to appeal denied).
A month later, the agency received a fairly harsh rebuke by the same court in the Grayscale case, in which the DC Circuit Court found the SEC’s rejection of crypto-asset manager Grayscale’s spot-bitcoin exchange-traded fund (ETF) application to be arbitrary and capricious.
The same cannot be said, however, of the US Commodity Futures Trading Commission (CFTC), which, in the crypto regulatory space, appears to be hitting its stride.
Historically, it has been the SEC spearheading crypto regulation in the US, particularly regulation by enforcement and seemingly inserting itself everywhere possible in the crypto-universe, shaping markets and — as many critics assert — driving business and innovation offshore.
Meanwhile, the CFTC has taken a more measured approach. After some early court victories affirming its jurisdiction over certain elements of the crypto markets — specifically in crypto derivatives and certain types of fraud in the underlying spot markets — the CFTC issued a series of releases. These included a 2018 customer advisory noting that some digital coins may be securities but also may be commodities, and a March 2020 release on the actual delivery of virtual currency under the Commodity Exchange Act (CEA), setting out the so-called “28-day rule.”
The CFTC has not shied away from tough cases that raise novel legal issues.
Fast-forward to 2023, and the CFTC is on a crypto bender. Following up on fairly low-profile enforcement actions over the past few years against many major crypto players, including Binance, Bitfinex, Tether, Kraken, and Coinbase, among others, the CFTC has lately turned its attention to the world of decentralized finance (DeFi).
In so doing, the CFTC has not shied away from tough cases that raise novel legal issues. In June, the CFTC obtained a default judgment against a decentralized blockchain-based platform, Ooki DAO — or decentralized autonomous organization — which permitted market participants to take positions on the difference in the prices of two digital assets from the time the position was established until the time it was closed. The CFTC found these to be retail commodity transactions subject to its jurisdiction, requiring Ooki to register under the CEA.
As industry and academic speculation ran amok, the US District Court for the Northern District of California ruled in favor of the CFTC, holding that Ooki DAO is a person under the CEA and can be held liable for violations — the first time a US court has ruled that a DAO is a legal person subject to federal jurisdiction.
Going after DeFi platforms
Building off this momentum, the CFTC issued orders in early September, settling charges against three DeFi platforms. The CFTC found that two of the platforms — Opyn, which developed and deployed a blockchain-based platform for trading digital-asset derivatives in the US and abroad based in part on the price of Ether; and Deridex, which developed a blockchain-based digital asset trading protocol and website for trading perpetual contracts — offered leveraged or margined retail commodity transactions to US customers who were not eligible contract participants (ECPs) without registering with the CFTC as a futures commission merchant (FCM), swap execution facility (SEF), or designated contract market (DCM), among other violations of the CEA.
The third platform, ZeroEx, developed and deployed a blockchain-based digital asset protocol, the 0x protocol, offering retail and institutional users in the US and abroad the ability to trade digital assets through the use of various blockchains. Additionally, ZeroEx created and operated a front-end user interface called “Matcha,” which utilized the 0x protocol to enable users to exchange digital assets and execute trades on the platform on a peer-to-peer basis in various digital assets. Some of the digital assets traded on Matcha were leveraged digital assets developed and issued by unaffiliated third parties. According to the CFTC, ZeroEx did not take steps to prevent non-ECPs from accessing these leveraged tokens.
CFTC continues to look like the favorite to helm a proposed US crypto regulatory framework.
As the DeFi Education Fund advocacy group pointed out, the CFTC alleged no malfeasance by ZeroEx or its operators, but rather by third-party bad actors, which appears inconsistent with a ruling by the US Court of Appeals for the Fifth Circuit earlier in the Uniswap case (Risley v. Universal Navigation Inc. et al, 2023 WL 5609200).
CFTC Commissioner Summer K. Mersinger also issued a dissenting statement protesting the use of CFTC enforcement in DeFi registration failures. Mersinger pointed out that the enforcement actions against the three DeFi developers did not include any allegations of fraud or abuse and questioned whether the CFTC even had jurisdiction in the ZeroEx case.
Building a regulatory framework for crypto
Nonetheless, despite some internal wrangling, the CFTC continues to look like the favorite to helm a proposed US crypto regulatory framework. While there have been hundreds of crypto bills introduced in Congress, many of the major pieces of proposed crypto legislation would appoint the CFTC as lead regulator, including:
The Digital Commodity Exchange Act of 2022, introduced by US Representatives Glenn Thompson (R-Pa.), Ro Khanna (D-Calif.), Darren Soto (D-Fla.), and Tom Emmer (R-Minn.), which would, among other things, authorize the CFTC to register and regulate trading venues that offering spot or cash digital commodity markets as digital commodity exchanges (DCEs) and require DCEs to register with the CFTC if they offer leveraged trading or list for sale digital commodities that were distributed to individuals before being available to the public.
The Responsible Financial Innovation Act (RFIA), reintroduced in 2023 by US Senators Kirsten Gillibrand (D-N.Y.) and Cynthia Lummis (R-Wyo.), which would require all crypto-asset exchanges to register with the CFTC.
The Digital Commodities Consumer Protection Act of 2022 (DCCPA), introduced by US Senators Debbie Stabenow (D-Mich.), John Boozman (R-Ark.), Cory Booker (D-N.J.), and John Thune (R-S.D.), which would authorize the CFTC to regulate “digital commodity platforms” and “digital commodity” trading. The DCCPA would effectively give the CFTC primary oversight over most crypto trading platforms in the US.
The Financial Innovation and Technology for the 21st Century (FITC) Act, sponsored by Glenn Thompson (R-Pa.) and co-sponsored by J. French Hill (R-Ark.), Dusty Johnson (R-S.D.), Warren Davidson (R-Ohio), Tom Emmer (R-Minn.), and Marcus J. Molinaro (R-N.Y.), which would designate similar registration steps for digital commodity exchanges, digital commodity brokers, and digital commodity dealers, as well as establish requirements for these entities. FITC also includes certain SEC registration requirements.
In a hastily scheduled Senate banking committee hearing in the wake of the FTX collapse late last year, CFTC Chair Rostin Behnam focused on DCCPA, which would include CFTC requirements covering crypto platform registration, liquidity, disclosure, customer protection, segregation of customer funds, and prohibition on conflicts of interest. Chair Behnam testified that a framework like the one proposed under DCCPA would have gone a long way toward giving the CFTC a clearer picture of FTX in real time, as well as the tools to mitigate the likelihood of an adverse result.
Chair Behnam provided the example of LedgerX, which was an FTX-affiliated CFTC-registered derivatives exchange. Chair Behnam noted that he remained in contact with LedgerX daily, and that, due in large part to this oversight, LedgerX was not a party to the FTX bankruptcy. LedgerX was sold by FTX in April 2023.
In early October, speaking at the Futures Industry Association Expo 2023, Chair Behnam shared his view that approximately 70% of cryptocurrencies are commodities. This view seems to have energized the CFTC as latest US federal crypto cop, which has firmly established itself as the clear choice — with a bullet.
This article was written for Forum magazine by Eric Berman, Senior Legal Editor for Thomson Reuters.
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