CFTC asserts its regulatory powers in the Cryptocurrency realm

In the latest chapter of the very active regulatory activity on cryptocurrency, on March 27th the CFTC issued a complaint for injuctive and other equitable relief against Binance, alleging the company offered crypto derivatives, such as futures or options contracts, with leverage for assets such as bitcoin, ether, and litecoin to U.S. persons without registering as a futures commodity merchant. Even though Binance is not based in the U.S., if it services U.S. customers it must comply with the Commodity Exchange Act (CEA). Binance operates the world’s largest centralized digital asset exchange.

The complaint also named Changpeng Zhao, the Binance founder and CEO, and former Chief Compliance Officer Samuel Lim, who is charged as having orchestrated much of the bad acts. The agency is seeking disgorgement of profits, civil monetary penalties, registration bans and a permanent injunction against further violations.

“Today’s enforcement action demonstrates that there is no location, or claimed lack of location, that will prevent the CFTC from protecting American investors. I have been clear that the CFTC will continue to use all of its authority to find and stop misconduct in the volatile and risky digital asset market,” said CFTC Chairman Rostin Behnam. “For years, Binance knew they were violating CFTC rules, working actively to both keep the money flowing and avoid compliance. This should be a warning to anyone in the digital asset world that the CFTC will not tolerate willful avoidance of U.S. law. I applaud the diligent and dedicated work of the CFTC’s Enforcement team in bringing this action, and for their hard work in addressing illegal operations in the digital asset space.” See https://www.cftc.gov/PressRoom/PressReleases/8680-23

The CFTC has complete regulatory authority over derivatives transactions (inclusive of swaps, futures, and options), and greater restricted authority to adjust fraud and manipulation in commodities markets. The CFTC made its first respectable declaration on its jurisdiction over virtual belongings in 2015. Later, in 2016, the CFTC cemented its role in an enforcement action: ?it issued an Order filing and simultaneously settling charges against Hong Kong-based bitcoin exchange,?BFXNA Inc. d/b/a?Bitfinex?(Bitfinex), for offering illegal off-exchange financed retail commodity transactions in bitcoin and other cryptocurrencies, and for failing to register as a Futures Commission Merchant (FCM) as required by the Commodity Exchange Act (CEA).? See In re BFXNA INC. d/b/a BITFINEX, CFTC Docket No. 16-19 (June 2, 2016).

A major step by the CFTC in exercising its regulatory authority came in 2021 in the Southern District of New York. Pursuant to Section 2(c)(2)(D) of the Act, 7 U.S.C. § 2(c)(2)(D) (2018), any agreement, contract, or transaction in any commodity that is entered into with or offered to (even if not entered into with) non-ECPs on a leveraged or margined basis or financed by the offeror, counterparty, or a person acting in concert with the offeror or counterparty is, subject to certain exceptions, subject to Section 4(a) of the Act, 7 U.S.C. § 6(a) (2018), “as if the agreement, contract, or transaction was a contract of sale of a commodity for future delivery.” Section 4(a) of the Act makes it unlawful for any person to offer to enter into, enter into, execute, confirm the execution of, or conduct an office or business in the United States for the purpose of soliciting, or accepting any order for, or otherwise dealing in any transaction in, or in connection with, a commodity futures contract, unless such transaction is made on or subject to the rules of a board of trade that has been designated or registered by the CFTC as a contract market for the specific commodity.

“During the Relevant Period, Respondents offered to enter into, entered into, executed, and/or confirmed the execution of margined or leveraged retail commodity transactions with non-ECP U.S. persons on the Bitfinex platform. These retail commodity transactions were not conducted on or subject to the rules of a board of trade that has been designated or registered by the CFTC as a contract market and therefore violated Section 4(a) of the Act.” Order, In Re Ifinex Inc., CFTC Docket No. 22-05 (Oct. 15, 2021) at n.2,?https://www.cftc.gov/media/6651/enfbfxnaincorder101521.

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It is clear that widely decentralized digital currencies, like Bitcoin and Ether, are “commodities” and not currencies. Efforts to categorize those cryptocurrencies or others as “currencies” commonly will not withstand regulatory scrutiny under the commonplace definition of commodity and the Commodity Exchange Act`s (CEA) definition of commodity. It is essential to be aware that the “jurisdictional authority of CFTC to adjust digital currencies as commodities does now no longer prevent different groups from exercise their regulatory strength whilst digital currencies characteristic otherwise than spinoff commodities.”

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Even though the CFTC has decided that digital currencies are commodities, the CFTC`s jurisdiction over digital forex markets is restricted to policing fraudulent and manipulative practices in interstate commerce. Beyond this kind of enforcement authority, the CFTC does not commonly oversee digital forex transactions. A spot cryptocurrency product is generally a product that results in actual delivery of the cryptocurrency within a particular market’s spot delivery period.

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Despite the CFTC`s lack of registration jurisdiction over spot markets, the futures contract be suject to CFTC jurisdiction. “The Commission has long held that certain speculative commodity transactions involving leverage or margin are futures contracts subject to Commission oversight…”See Interpretive Guidance and Policy Statement Regarding Retail Commodity Transactions Involving Certain Digital Assets, 85 Fed. Reg. 37,734 (June 24, 2020).

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Additionally, CEA section 2(c)(2)(D)(i) captures “any retail transaction entered into, or offered on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis.” See Interpretive Guidance and Policy Statement Regarding Retail Commodity Transactions Involving Certain Digital Assets, 85 Fed. Reg. 37,734 (June 24, 2020). In 2021, then CFTC acting Director of Enforcement Vincent McGonagle said, “In the virtual asset space, we`ve added numerous movements in opposition to entities wherein they`re providing virtual belongings, Bitcoin or others on a margin or finance basis…and people merchandise have to be on an alternate.” See?Stewart Bishop, Top Enforcement Officials Eye Individual Prosecutions, LAW360 (Oct. 27, 2021),?https://www.law360.com/fintech/articles/1435304/top-enforcement-officials-eye-individual-prosecutions-crypto?nl_pk=471280e2-a0ff-4fd3-878d-aba5130bfb59&utm_source=newsletter&utm_medium=email&utm_campaign=fintech.

?The Binance case may be just the tip of the regulatory spear in 2023.?In early February of this year ?the CFTC Chairman Rostin Behnam said in remarks at an American Bar Association (ABA) Business Law Section Derivatives & Futures Law Committee Winter Meeting event that the agency is looking toward a big year of crypto enforcement actions: “The CFTC has brought important, precedent-setting cases against those who illegally offer derivatives or leveraged, margined or financed digital asset products to US customers or operate within the United States,” he said. He promised to use “the full breadth of the commission’s authority” in going after illegal transactions in digital assets. See https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam31