Two important events occurred in the cryptocurrency space last week.1 The Chairman of the US Commodity Futures Trading Commission (CFTC) gave a speech regarding regulators’ role in effectively supervising markets in the era of digitization, and the US Securities and Exchange Commission (SEC) brought its first enforcement action against an individual for operating an unregistered crypto-exchange. These events signify the continuing transformation of cryptoasset markets from the “Wild West” to a fully—and highly—regulated market sector, at least in the United States.
CFTC Chairman’s Speech
Regulators are increasingly looking to technology to help keep pace with digitization. On November 7, 2018, CFTC Chairman Christopher Giancarlo spoke at the Georgetown Law FinTech Conference regarding regulators’ own need to “keep pace with digitization and execute [their] missions in the most effective and efficient ways possible.”2 For example, as blockchain technology moves transactions away from more easily regulated centralized markets, Giancarlo called for “new machine-learning based surveillance tools,” which could “sniff out patterns of likely illegal trading activity or attempts to manipulate markets for enforcement analysis.” To help accomplish this goal, he promoted his “belief and vision that the CFTC should establish a new office of data and analytics as a stand-alone department ready and capable of serving the needs of the Commission and the operating divisions.”
Takeaways: Chairman Giancarlo recognizes that blockchain technology may be poised to disrupt traditional commodities and securities markets, and their oversight. As such, he is looking to make sure that the CFTC embraces technology to ensure that it is not left behind. Further, the CFTC may soon have a stand-alone division dedicated to integrating economic and data analytics into its mission to protect commodities and futures markets, similar to the SEC’s Division of Economics and Risk Analysis.
In the Matter of Zachary Coburn
On November 8, 2018, the SEC settled its first enforcement action against an individual for operating a digital token trading platform, finding that the platform operated as an unregistered securities exchange.3 The platform executed trades of digital tokens using blockchain “smart contracts,” which the SEC determined effectively operated as an exchange, thus falling under its purview.
The SEC found that throughout an 18-month period, the platform executed more than 3.6 million orders for digital tokens that it classified as securities under federal securities laws. The SEC found that the platform at issue had a “user-friendly interface” and the underlying functionality of an online “national securities exchange” and was therefore required to register with the SEC or operate under an exemption. The respondent agreed to pay $388,000 in penalties, disgorgement, and interest. The SEC did not bar the respondent from the securities industry, noting his cooperation with the staff.
Takeaways: This latest development likely indicates that the SEC is continuing its transition to a more holistic regulatory regime of cryptoassets. As recently as late 2017 and early 2018, the SEC was still dipping its toes in this space, mostly bringing enforcement actions relating to initial coin offerings and alleged fraud. Here, there were no allegations of sales of unregistered securities or fraud. Rather, it appears that the SEC is moving to the next logical area of regulation: exchanges. To the extent that exchanges permit trading of cryptoassets that can potentially be viewed as securities, such exchanges must register with the SEC. Indeed, the SEC foreshadowed this next step in the “DAO Report” issued in July 2017 indicating that exchanges providing for trading in cryptoassets must register unless they are exempt.4 This latest enforcement action should put additional actors in the cryptoasset industry on notice that they could be subject to SEC regulation.
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Last week’s developments make clear that the CFTC and SEC are continuing their push to bring cryptoassets to the world of highly-regulated commodities and securities, respectively. The CFTC appears to understand the need to keep pace with the evolving technology to execute its mission. Meanwhile the SEC has fully expanded its scope of cryptoasset regulation from the securities themselves to the exchanges. Although the cryptoasset market is far from being as highly regulated as traditional commodities or securities, its “Wild West” days of operating relatively free of regulator scrutiny may be nearing the end, at least in the United States.
1 The term “cryptocurrency” is commonly used to describe all virtual currencies and digital tokens created on distributed ledgers using blockchain technology. Because all digital tokens do not function as a medium of exchange—nor are intended to—we suggest using “cryptoasset” instead. We thus use “cryptoasset” herein as an umbrella term covering all digital assets based on distributed ledger and blockchain technologies with cryptocurrencies being one type of cryptoasset.
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