CFTC Stump questions charges against Kraken: “How would it have been expected to operate?”

Rick Steves

The CFTC Commissioner concluded that the application of the Commission’s FCM rules to an exchange on which retail commodity transactions are traded is uncharted territory at this time.

The CFTC has yesterday settled charges with San Francisco-based cryptocurrency exchange Kraken, which has agreed to pay a $1.25 million civil penalty.

The venue has allegedly illegally hosted leveraged cryptocurrency trades and failed to register as a futures commission merchant (FCM) and served as the sole margin provider and maintained physical custody of all clients’ assets.

As such, the platform operated a facility to trade cryptocurrencies without being approved as a Designated Contract Market and acted as an Eligible Contract Participants (ECP), without registering as such with the CFTC.

The CFTC found that Kraken violated CEA Section 4 because it engaged in retail commodity transactions that are prohibited by the CEA unless traded on or subject to the rules of a DCM – a registration designation that has neither been requested by nor granted to Kraken. But it also finds that Kraken operated as an unregistered FCM with respect to those transactions.

CFTC Commissioner Dawn Stump has issued a concurring statement on the matter to further explain why Kraken violated U.S. regulations and called for regulatory clarity.

The Commission’s finding that Kraken engaged in prohibited retail commodity transactions is informed by its Final Interpretive Guidance on retail commodity transactions involving certain digital assets issued in 2020, she said.

“However, as the Guidance becomes increasingly relevant to the Commission’s enforcement program, I believe it is incumbent upon the Commission to undertake a rulemaking proceeding to supersede the Guidance by adopting binding and enforceable rules that will provide certainty to the marketplace and a shared understanding of the “rules of the road”.

“I agree with his observation that “[i]n the rapidly developing world of digital assets, two years is a lifetime” – and yet now we are an additional year-and-a-half later still. I believe, therefore, that the Commission should act to replace the Guidance with rules that are based on current input from market participants and members of the public”.

In regard to the unregistered FCM finding, the Commission has long held that certain speculative commodity transactions involving leverage are futures contracts that must be traded on a designated contract market that is subject to Commission oversight.

“However, court decisions called that view into question with respect to certain leveraged transactions involving retail participants”, the CFTC Commissioner continued.

If Kraken had sought to register with the Commission as an FCM, how would it have been expected to operate?

“Absent these transactions occurring on a DCM, they would continue to be illegal even if Kraken had an FCM registration”, Commissioner Stump pointed out. ”

“Furthermore, how Kraken would be regulated as an FCM is not entirely clear, because many of the Commission’s rules governing its regulation of traditional FCMs do not fit Kraken’s role as an exchange. It also would be unprecedented for an entity to register as both a DCM and an FCM.”

The CFTC Commissioner concluded that the application of the Commission’s FCM rules to an exchange on which retail commodity transactions are traded is uncharted territory at this time.

“I believe that if the Commission is going to hold an exchange liable for operating as an unregistered FCM with respect to retail commodity transactions, it is incumbent upon the Commission to explain in a transparent manner the relevant legal requirements for such an entity that seeks to register as an FCM and how the Commission will apply them in enabling the entity to conduct business with U.S. customers”.

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