Episode 113:

 

Sasha Hodder

Discussing CFTC’s Guidance on Retail Commodity Transactions in Virtual Currency

“Who do you want as your regulator, the CFTC or FinCEN?”

Transcript:

 

Sasha:

Hello and welcome to the HODLCast! Today is April 27th and today’s podcast is just me. And we’re going to focus on the CFTC guidance issued March 24th titled, “Retail Commodity Transactions in Virtual Currency.” So as a short summary, the reason I am interested in this, and that I thought it might be a good topic for a podcast is that, if a company is registered with FinCEN as a money service business, they may consider switching over to be registered with the CFTC, which would then have supremacy over the state-by-state money transmission licenses. So that’s why this is important. And the guidance that just came out, it says that the CFTC regulates Bitcoin, and if the transaction is paid out in the same virtual currency as the contract was entered into, and it qualifies for actual delivery that takes place 28 days in the future, then the CFTC regulation can apply.

So this interpretive guidance, it really focused in on the actual delivery factors and it described two factors that demonstrate this actual delivery. And that is; (1) “If a customer is securing the possession and control of the entire quantity of the commodity whether it was purchased on margin using leverage or any other financing arrangement. And to the ability to use the entire quantity of the commodity freely and commerce away from any particular execution venue no later than 28 days from the date of the transaction, and at all times thereafter”; And (2) “The offer and counter party seller, including any of their respective affiliates or other person acting in concert with the offer or a counter party. They do not retain any interest, legal right or control over any of the commodity purchased on margin leverage or any other financing arrangement at the expiration of 28 days from the date of the transaction.”

So what that looks like for an OTC seller of Bitcoin is that, on day one you enter the transaction, you either receive money in the form of bank wire, or you receive a promissory note. Then on day 28, you deliver the Bitcoin or the commodity. It can be any type of cryptocurrency, but you deliver the commodity and its entire quantity to a non-custodial wallet that the counter-party has full ownership rights to. And that should satisfy these CFTC requirements here for an exemption to registration. So the CFTC, they’re an independent us federal agency. They were established in 1974 and their goals include the promotion of competitive and efficient futures markets and protection of investors against manipulation, abuse of trade practices and fraud. And they deemed virtual currency as a commodity just simply because Bitcoin is the subject of futures trading.

So there was a case, the CFTC versus My Big Coin Pay, Inc. And that happened in the District of Massachusetts on September 26, 2018, and in the memorandum of decision, the court went through why the CFTC has exclusive jurisdiction over futures contracts and exchanges where they’re traded. That’s written out in the commodities exchange act, and also the CFTC has general powers of anti-fraud, anti-manipulation authority over any contract of sale of any commodity and interstate commerce. And the term commodity, it’s an enumerated term, so basically it starts off by wheat, cotton, rice, corn, oats, barley, rye, flax seed grain, and several other similar commodities that are either now or in the future delivered. So that’s part of the section 1.A of the Commodities Exchange Act. And then this defendant in My Big Coin was charged with not registering with the Commodities Exchange Act, and selling a commodity. And his argument, which he went pro se, so he did not have a lawyer with him. His argument was that, My Big Coin (MBG) was distinct from Bitcoin because it doesn’t trade in futures contracts or delivery. But the government or the CFTC argued and the court agreed that the CEA’s definition of a commodity is broader and it does not distinguish between any particular type or brand of that commodity. So basically they’re saying that MBG complete shitcoin is a type of Bitcoin or a type of brand of Bitcoin. And because of that, it also is regulated by the CFTC. So they said basically, other cases have looked at distinguishing livestock by its type, grade, brand, producer, manufacturer or form.

And the CFTC has said that those types of distinctions don’t count. If something is traded in futures, if one type of it is traded, it doesn’t matter what grade, brand, or producer, or manufacturer makes the other type of it. It’s all considered a commodity. And the court also drew on a series of cases involving natural gas, which is interesting because this natural gas seems to be something that we can compare Bitcoin to, quite a bit. And in terms of its fungibility, I suppose, natural gas was used as an example as well as to how the UCC can take jurisdiction over Bitcoin if it’s similar to natural gas. They can find a way to get it under the property rights of the UCC, the Uniform Commercial Code. But here, we’re looking at natural gases as the link to getting Bitcoin regulated by the CFTC, or that’s what the courts are using as the link.

So in natural gas cases, the courts have rejected arguments that a certain type of natural gas is not a commodity because that specific type of gas wasn’t a subject of a futures contract. But the courts have held that natural gas is fungible, and it may move freely through a national pipeline system. And because of that, that makes it a commodity. And it doesn’t matter if just one type is traded. So they say if it’s fungible and it can move on the pipeline system, it’s a commodity even if that certain brand isn’t settled in futures contracts. And then a quote from a case in the fifth circuit in 2012, United States vs Brooks says, “The CEA only requires the existence of futures trading within a certain class.” For example, natural gas, in order for all items within that class, like West coast natural gas to be considered as a commodity.

So the CEA requires the certain firms or individuals that conduct business in the derivatives industry must register with the CFTC. And in order to register, first, the company must become a member of the National Futures Association, and the costs for this type of registration really ranges. Like if you become a tier one swap dealer, it’s some million dollar annual fee, and then you have to pay a million dollar registration fee, like an initial million dollars, and then a million dollars every year, payable quarterly. But then some other ones cost much less. For example, the National Futures Association, if you register as a swaps futures commission merchant with the NFA as your SRO, your self regulatory organization, then the membership due is 7,000 annually. So it depends which you’re looking at getting registered for.

So the next question that I had anyway was, if you did register with the CFTC, can you de-register yourself as a FinCEN money service business? And if you look in the May 9th guidance for virtual currencies that FinCEN put out, it says, “The term money service business does not include, and there’s several things that doesn’t include, but one of them is a person registered with and functionally regulated or examined by the US Securities and Exchange Commission (SEC) or the US Commodities Futures Trading Commission.” So that’s pretty clear guidance that if you are functionally regulated by the CFTC, you are not regulated by FinCEN. So the FinCEN registration will become redundant and unnecessary.

So to recap, you can become regulated by the CFTC through an exemption to registration, so you don’t have to pay one of these million dollar registration fees if you’re doing OTC trading where you make the contract, you sell the Bitcoin, and you get a promissory note for the price of the Bitcoin that you’re going to sell, and then you give full delivery 28 days after the date of the sale.

Thank you! I hope everyone’s doing well!

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