CFTC wants to oversee crypto cash markets: BTC, ETH….XRP?

Rick Steves

While the SEC v. Ripple lawsuit lingers, CFTC’s Behnam positions himself as a critic of the regulation-by-enforcement practice as “it cannot be viewed as a viable substitute for a functional regulatory oversight regime”. 

CFTC Chairman Rostin Behnam has spoken before the U.S. Senate to share his views on digital assets with a speech titled “Examining Digital Assets: Risks, Regulation, and Innovation”.

The Commodity Futures Trading Commission is the primary regulator of the U.S. derivatives markets in which commodity futures, swaps and options are traded.

The agency ensures the integrity of derivatives markets, which requires its officials to understand a great deal about underlying reference cash markets, where producers and institutional investors directly exchange products, which include digital assets such as XRP, BTC, and ETH.

The potential for fraud or manipulation in these underlying markets often poses the most immediate threat to the integrity of derivatives markets, said the CFTC Chair, adding that while the CFTC does not have direct statutory authority to regulate cash markets, it does have fraud and manipulation enforcement authority.

Regulation by enforcement is not a viable substitute

CFTC’s Rostin Behnam started out by saying that enforcement authority through judicial interpretation has proven an effective means of uncovering and addressing some of the regulatory gaps presented by innovation, but it cannot be viewed as a viable substitute for a functional regulatory oversight regime for the cash digital asset market.

The digital asset market is unique and presents many novel issues for the CFTC. There is no one regulator, either state or federal, with sufficient visibility into digital asset commodity trading activity to fully police conflicts of interest and deceptive trading practices impacting retail customers, he continued.

Chair Behnam then explained why the digital asset commodity cash market would benefit greatly from CFTC oversight:

  • Unlike most cash commodity markets, which are dominated by wholesalers and large financial institutions facilitating the transfer of commodities for commercial use and consumption, the cash market for digital assets is currently characterized by a high number of retail investors mostly engaged in price speculation;
  • The speculative fervor around digital assets, frequently feeling like a modern gold rush, has led many investors to regularly take on high levels of leverage when trading, leading to heightened price volatility, often exacerbated by cascading liquidations during price downturns;
  • Most investors in the cash market entrust their digital assets to the platforms upon which they trade, failing to differentiate this type of custody arrangement from that offered by the traditional regulated banking industry. The technical complexities around securing and transacting in digital assets, particularly issues around custody, have resulted in numerous platforms losing funds to hacks, exploits, and poor cyber security;

As the digital asset industry in the U.S. does not fall under a single comprehensive regulatory regime, the CFTC has been agressive tackling fraud and manipulation since 2014, having brought nearly 50 enforcement actions and overseing an increasing number of registrants offering digital asset based derivative products.

Challenges remain and “we are past the stage where digital assets and decentralized financial technologies are a research project, sandboxing what may come in the future”.

On that, the CFTC Chairman pledges to continue to use the existing enforcement authority to its fullest extent but also recognizes the need to go beyond the confines of the Commodity Exchange Act.

“We are seeing several government agencies consider how this technology impacts federal policy related to payments, custody, illicit activity, national security and a host of other issues.”

SEC’s pressured as XRP lawsuit unfolds

The Securities and Exchange Commission has been actively trying to be the number one financial watchdog in the cryptocurrency space, but many critics fear that the agency’s regulation-by-enforcement practice could destroy innovation and the country’s leading position in the emerging asset class.

In his speech, CFTC’s Behnam clearly positions himself as a critic of that practice as “it cannot be viewed as a viable substitute for a functional regulatory oversight regime”. 

The digital asset industry and regulators are tuning in to the SEC v. Ripple case as the precedent setting lawsuit heats up with upcoming rulings on the SEC’s motion to strike the fair notice defense and the motion to dismiss charges against Garlinghouse and Larsen.

Ripple has most recently filed a sur-reply on the fair notice issue that argues the SEC’s prior 75 enforcement actions do not serve as fair notice. In fact, they support Ripple’s defense. The document includes an exhibit that analyzes each SEC crypto litigation.

In a Twitter exchange a few days ago, attorney Jeremy Hogan agreed with the prediction that the fair notice defense will be allowed by the court, while charges against Brag Garlinghouse and Chris Larsen won’t be dismissed.

In the meantime, a JP Morgan report made a claim on why XRP is so correlated with Bitcoin, namely the lack of partners on the Ripple network using XRP for cross border payments. Critics have argued the data is outdated.

CFTC’s Stump: Crypto cash markets “beyond our expertise”

CFTC Commissioner Dawn Stump has addressed the confusion regarding the role of regulators in the digital asset space again.

Ms. Stump has been making efforts to explain the regulators’ scope as something that must be dealt with before government agencies engage in a jurisdictional power-grab.

“Until we remedy that confusion, we cannot have an honest conversation about whether any agency needs new authorities. And only then can informed stakeholders contribute to designing a workable regulatory structure”.

Before expanding the CFTC’s authority into the cash markets, Commissioner Stump called for careful consideration “to whether the market infrastructure we oversee today can logically benefit the cash markets, which have historically been beyond our expertise”.

Stump has previsouly cleared up the “commodity vs security” fallacy. The 10 concise points laid out by the CFTC Commissioner include the definition of “commodity” and the CFTC’s authority which does not include the oversight of cash commodities (instead of futures contracts and other derivatives).

In other wocashrds, the CFTC does not regulate commodities but their derivatives. “Therefore, even if a digital asset is a commodity, it is not regulated by the CFTC”. But the trading of futures contracts on Bitcoin or Ether fall under its scope.

A point that is well established is that the CFTC does not regulate securities, the SEC does. However, the trading of derivatives on a security could fall under the scope of either the SEC or CFTC or both.

Is XRP a security?

The trouble with the present situation in the cryptocurrency space is that the SEC claims that many of the tokens listed on the U.S. exchanges may be in fact digital asset securities.

The SEC v. Ripple may also clarify both the SEC’s stance on that matter as well as create jurisprudence for future enforcement actions. The Securities and Exchange Commission hasn’t been explicit as to whether XRP is a security, but it seems that it is trying to make that point.

The infamous Hinman’s 2018 speech on Ether and its non-security nature may serve as premise as to what is the SEC’s (un)official position, which might also clarify if Ripple’s digital asset fits in the commodity or security category.

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