Cryptocurrency Derivatives, Funds and Advisers: Key Considerations Under U.S. Commodity Laws (Part 2: The Regulation of Commodities — Quite Substantial, Even If Not Substantive)

By Andrew Cross

This story is the second in a series that outlines key considerations for investment funds and their advisers regarding the application of the U.S. commodity laws to cryptocurrency derivatives. This posting is intended to be a primer on the topic and is not legal advice. You should consult with your counsel regarding the application of the U.S. commodity laws to your particular facts and circumstances.

In Part 1, we focused on the status of cryptocurrencies as commodities and how that status relates to the jurisdiction of the U.S. Commodity Futures Trading Commission (the “CFTC”). Here, in Part 2, we provide an overview of the regulation of commodities and the commodity markets under the Commodity Exchange Act (the “CEA”).

The Regulation of Commodities — Quite Substantial, Even If Not Substantive

A primary purpose of the CEA and a primary mission of the CFTC is to prevent the manipulation of commodity prices (see Section 5 of the CEA); however, as will be explored in greater detail in the remainder of this series, the CEA does not substantively regulate every transaction that involves a commodity.

Note: As used in this series, the term “substantive regulation” means that a party to certain types of transactions involving commodities could be required to (1) register with the CFTC as a type of regulated market participant or (2) qualify for an exemption from such registration. In certain contexts, “substantive regulation” may also refer to the fact that the CEA and related CFTC regulations may place limitations on the transaction itself (e.g., restricting the types of market participants that can enter into the transaction, or whether the transaction can be entered into on a bi-lateral basis).

In light of the primary purpose of the CEA, U.S. commodity laws give the CFTC substantial anti-fraud and anti-manipulation jurisdiction over transactions in interstate commerce that involve a commodity (see Sections 6(c) and 9(a)(2) of the CEA and CFTC Regulations 180.1 and 180.2). It is worth emphasizing that a transaction does not have to involve a derivative (e.g., a swap or a futures contract), or even be entered into by the parties on a leveraged, margined or financed basis, for that transaction to be subject to the CFTC’s anti-fraud and market manipulation oversight. Further, based on several recent CFTC enforcement actions, it appears to be well established that the CFTC’s anti-fraud jurisdiction extends to the crypto asset class (see CFTC v. Gelfman Blueprint, Inc. and Nicholas Gelfman, №1:17-cv-07181 (S.D.N.Y. Sept. 21, 2017); CFTC v. My Big Coin Pay, Inc., Randall Crater, and Mark Gillespie, №18–10077-RWZ (D. Mass, Jan 16, 2018); CFTC v. Patrick K. McDonnell, and CabbageTech Corp. d/b/a Coin Drop Markets, №18-cv-0361, (E.D.N.Y. Jan 18, 2018)).

Funds and advisers should be aware of the CFTC’s anti-fraud authority, given the substantial potential scope of that authority. Practically speaking, in light of this authority, funds and advisers should design their crypto compliance trading policies based on the assumption that a fully funded purchase or sale of crypto for immediate delivery to the buyer (i.e., a spot transaction) falls within the anti-fraud and anti-manipulation enforcement authority of the CFTC.

However, as a conceptual matter, for investment funds and advisers to more fully understand the federal regulation of commodities and commodity markets in the U.S., it is helpful to distinguish between the following:

  • The CFTC’s substantial anti-fraud enforcement authority; and
  • The authority of the CFTC to substantively regulate aspects of certain types of transactions and the counterparties to those transactions (i.e., funds and advisers).

In sum, while the authority to prevent fraud and manipulation may apply to any transaction in interstate commerce that involves a commodity (including a spot transaction), the CFTC’s “substantive regulation” applies only if a transaction involves a “commodity interest“. We will explore both of these concepts in greater detail in the posts that follow.

Good day. Good Part 2, we hope. DR2