Bates News, Bates Research | 07-26-18
Eight Recent Developments on Cryptocurrency
Activity around the regulation of cryptocurrency continues apace. Only a short time ago, we reported on Operation Cryptosweep, a coordinated effort by NASAA and state securities regulators to crackdown on fraudulent cryptocurrency-related investment products. Today, we review a number of newsworthy developments that may affect the regulation of a technology that has defied easy categorization and oversight. Here’s a roundup:
1. Russian Agents, Bitcoin and the 2016 Presidential Campaign
The revelation contained in the Special Counsel’s indictment of Russian intelligence agents, that Bitcoin was used to finance and obscure an operation intended to undermine the 2016 U.S. elections, has begun to reverberate in policy debates. It served as the backdrop to recent congressional hearings and prompted a letter by Representative Emanuel Cleaver to FinCEN to “initiate an investigation of the cryptocurrency industry and articulate further guidance to help prevent financial crimes” such as those implicated in the Russia probe.
2. Congressional Hearings on Digital Currency and Policy
Meanwhile, in two separate hearings, representatives debated fundamental questions about the government’s role in the development of the digital currency markets and whether the Federal Reserve should issue its own form of cryptocurrency. At a July 18th hearing before the House Financial Services Subcommittee on Monetary Policy and Trade, academics and experts debated the viability and security of digital currencies, the pros and cons of a "widely accessible, retail-oriented central bank digital currency that could be used by the public for person-to-person and retail transactions," and the potential effects of such currencies on traditional banking structures.
At a House Committee on Agriculture hearing on the same day, Daniel Gorfine, Director, LabCFTC and Chief Innovation Officer, warned against "hasty regulatory pronouncements" that might “miss the mark, have unintended consequences, or fail to capture important nuance regarding the structure of new products or models." Former CFTC Chair Gary Gensler expressed an alternative concern that failure to enact reasonable regulation would “trigger a brain drain of crypto entrepreneurs from the US.” Witnesses testified uniformly that digital assets did not fit neatly into existing regulatory frameworks. (1)
3. Executive Order Establishing a Task Force on Market Integrity
On July 11th, President Trump signed an Executive Order establishing a Task Force on Market Integrity and Consumer Fraud. The Task Force, under the direction of the Attorney General, will be made up of regulators and cabinet secretaries who will provide guidance and coordination in fighting financial fraud, specifically—and for the first time—including cyber fraud.
4. CFA Institute Introduces Crypto Into Exam Curriculum
The CFA Institute, the global association of investment professionals that administers industry certifications, just added cryptocurrency and blockchain as a new subject category to its Chartered Financial Analyst Exams. The new subject matter, named “Fintech in Investment Management,” falls under the Level I and II Exam categories. As one report noted, this development “might be the definitive sign that cryptocurrencies have arrived on Wall Street.”
5. CFTC Issues Guidance on Cryptocurrency Futures Trading
Since our last review of federal regulatory activity, the CFTC issued guidance for exchanges and clearinghouses to list virtual currency products. The guidance is intended to help with the design of management programs that address risks associated with virtual currency derivative products. Specifically, the guidance provides for (i) enhanced market surveillance, (ii) close coordination with the CFTC, (iii) the application of the large trader reporting threshold for any virtual currency derivative contract, (iv) a mandatory request for comment on issues relating to a proposed listing, and (v) a required CFTC staff governance review concerning adherence to internal governance procedures for new contract approval.
6. CFTC Warns Customers on Purchasing Digital Coins
On July 16th, the CFTC issued a customer advisory on Initial Coin Offerings and other crypto-related transactions. The agency warned virtual currency customers “to use caution and do extensive research before purchasing virtual coins or tokens.” Specifically, the CFTC urged customers to treat any coin or token that includes “any promises or guarantees of future value as a ‘red flag.’” The CFTC recommended customers “conduct extensive due diligence on any individuals and entities listed as affiliates of a digital coin or token offering,…ask whether the digital coins or tokens are securities and if the offering is registered” with the SEC, and find out “what rights the digital coin or token provides.”
7. FINRA Asks Firms to Report Cryptocurrency Activities
On July 6th, FINRA issued a regulatory notice encouraging each member firm “to promptly notify FINRA if it, or its associated persons or affiliates, currently engages, or intends to engage, in any activities related to digital assets, such as cryptocurrencies and other virtual coins and tokens.” The notice requires member firms to provide updates to their regulatory coordinator about any crypto related activities until July 31, 2019.Among other activities firms must disclose are “purchases, sales or executions of transactions in digital assets, pooled funds that invest in digital assets; or derivatives tied to digital assets.” The FINRA notice also recommends “disclosure regarding custody of digital assets; acceptance of cryptocurrencies from customers; mining of cryptocurrencies; the acceptance of orders in cryptocurrencies and/or other virtual coins and tokens; quotations in cryptocurrencies and other virtual coins and tokens.” Lastly, FINRA expects firms to disclose any provision or facilitation of “clearance and settlement services for cryptocurrencies” or “recording cryptocurrencies and other virtual coins and tokens using distributed ledger technology or any other use of blockchain technology.”
8. International Developments
The Financial Stability Board, ("FSB") the international organization established by the G20 to monitor and make recommendations about the global financial system, published a framework to monitor the financial stability implications of developments in crypto-asset markets. The framework sets out the metrics that the FSB will use to monitor developments in crypto-asset markets as part of the FSB’s ongoing assessment of vulnerabilities in the financial system. The metrics include the use of data on liquidity, trading volumes, pricing, clearing and margining for crypto-asset derivatives. As stated in the framework, “the use of leverage, and financial institution exposures to crypto-asset markets are important metrics of transmission of crypto-asset risks to the broader financial system.” The report also recaps the work of other international standards-setting bodies such as the Committee on Payments and Market Infrastructures, IOSCO and the Basel Committee on Banking Supervision.
Certain developments, both small and large, domestic and international, feed the sense that the forward march of blockchain is inevitable. Regulators seem attuned to the complexities and the challenges that cryptocurrency presents. It is not yet clear, however, how the pieces will fit together, or if an intervening political event will cause disruption. Bates Group will continue to monitor the regulatory landscape and keep you apprised of these fast moving developments.
(1) For additional discussion on regulatory classification of digital currency as commodities at the hearing see here. For a recent analysis about the classification of certain products as a security see here.