Last Thursday the United States Commodities Futures Trading Commission (CFTC) settled charges against a small and now-defunct operation in San Francisco called Coinflip, which marketed bitcoin derivatives. In the process, the CFTC asserted for the first time that bitcoin is a “commodity”.
What does that determination mean for the bitcoin ecosystem and what does this new kind of enforcement action portend for the future?
First, before getting to the nitty-gritty, recall that in the crazy mixed-up world of overlapping American regulation, this determination means almost nothing for how other regulators treat bitcoin. The BitLicense, for example, will soldier on unaffected, as will other state regulators and FinCEN.
The formal classification probably does put to final rest the idea that ordinary bitcoins are securities, as Prof. Shadab told to CoinDesk last week, but the SEC has been acting that way for a long time.
What the classification tells us about the CFTC
As an initial matter, it comes as no surprise that the CFTC is calling bitcoin a commodity. The CFTC had signaled its views on the subject nearly a year ago, and I wrote about its potential implications around the same time. Companies like TerraExchange have been working with the CFTC under the same presumption for even longer.
TerraExchange and others have taken to heart the most obvious upshot of the CFTC’s classification, which is that, to legally run a market for bitcoin derivatives for US users, a company must first jump through a bunch of hoops with the CFTC. (For financial newbies, a financial derivative is essentially a contract to buy, sell, or pay, contingent upon the price of a something else.) Coinflip didn’t do this and the result was this recent enforcement action.
More broadly, the classification also now means it is more likely the CFTC could, under its market manipulation authority, police fraudulent activities on exchanges where bitcoins – and not just bitcoin derivatives – are traded.
However, the CFTC has suggested it is not particularly interested in going down that path, and in fact there may be some limits on its ability to do so without a specific connection to commodities derivatives markets.
This leaves the primary impact of the enforcement action itself to be felt by companies like Coinflip, which offer bitcoin derivatives to users in the US.
Before getting to that, though, keep in mind the importance of bitcoin derivatives themselves.
The importance of bitcoin derivatives
Bitcoin derivatives provide the primary vehicle by which a holder can stabilize the fiat value of their bitcoins even when markets remain turbulent – if you’re not familiar with the concept, check out how you do this using a “costless collar”.
That’s a big deal when many complain bitcoin is not a dependable store of value. Using derivatives to stabilize value is awkward on a one-off basis, but commercialized and regularized through smart contracts, it gives holders the experience of owning bitcoins with a stable price, even when the market price for bitcoins continues to fluctuate.
“The CFTC’s action is exactly the sum of its parts. Bitcoin is now officially a commodity.”
As for legal implications, the most pertinent message from the enforcement action itself is the CFTC’s signal that it will expend resources to shut down unregistered platforms, including very small ones.
The CFTC didn’t make any money on this settlement, as Coinflip didn’t have to pay a fine, and likely could not have afforded to pay a big one anyway. Likewise, Coinflip’s platform, Derivabit, apparently never had more than 400 users, which, even in the world of bitcoin, is still very small.
It is worth pointing out, as I’ve mentioned before, that non-US based companies who sell derivatives to US persons are subject to this same enforcement risk – though whether the CFTC will go so far as to conduct extraterritorial enforcement actions in this area is not obvious.
Likewise, violation of any CFTC rule is, somewhat amazingly, punishable with jail time.
Here, Coinflip cooperated with the CFTC, and the fact that they didn’t even pay a fine likely reflects this. (Recall, though, that while cooperation with an investigation is sometimes a good strategy, willy-nilly and lawyer-less discussion with government investigators almost never is.)
Still, this enforcement action suggests that, without something more flagrant, criminal punishment for these types of offenses is not especially likely.
In the end, the takeaway is that the CFTC’s action is exactly the sum of its parts. Bitcoin is now officially a commodity.
Even small unregistered sellers of bitcoin derivatives are wise to make plans to deal with potential enforcement actions.