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LabCFTC Issues Primer on Digital Assets
Practical Law Legal Update w-028-9621 (Approx. 4 pages)
LabCFTC Issues Primer on Digital Assets
by Practical Law Finance
| Published on 23 Dec 2020 • USA (National/Federal) |
The CFTC released a primer on digital assets, the latest in a series of blockchain-related primers, which sets out the CFTC's position regarding its oversight of these instruments and provides an educational overview of digital assets, including CFTC regulation of digital asset derivatives. The primer was produced by LabCFTC, designed to be the hub for the agency’s engagement with the fintech community.
The CFTC released a primer on digital assets, the latest in a series of blockchain-related primers, which sets out the CFTC's position regarding its oversight of these instruments and provides an educational overview of digital assets. The primer, a 36-slide deck, was produced by LabCFTC, which the CFTC launched in May 2017 to encourage fintech innovation in markets subject to CFTC oversight and to aid the CFTC's engagement with new fintech solutions and innovation opportunities (see Legal Update, CFTC Launches LabCFTC Fintech Initiative).
The primer reiterates the CFTC's basic definitions of virtual currency (VC) and explains the distinction (including Venn diagram) between types of digital assets such as VC and digital tokens. The primer then provides high-level overviews of regulatory engagement and coordination on digital assets, as well as the current market, and the environment for regulation of digital assets. The primer also incudes a review of the CFTC's digital asset regulatory history, including relevant statutory authority and case citations, in underscoring its now well-established regulatory jurisdiction over VC.
The primer includes the following sections:
- Overview of Digital Assets
- Digital Asset Markets
- Regulatory Response
- Digital Assets and the CFTC
- CFTC-Regulated Digital Asset Derivatives
- Digital Assets Moving Forward
CFTC and Digital Asset Derivatives
The primer includes certain information on CFTC regulation of digital asset derivatives.
Certification and Review Process for Virtual Currency Derivatives: 2018 Staff Advisory
The CFTC notes in the primer that it released a staff advisory in 2018 (2018 advisory) that set out guidance for CFTC-registered entities seeking to list or clear virtual currency derivatives products (see Legal Update, CFTC Issues Advisory on Virtual Currency ICOs). The 2018 advisory recommended that trading platforms and clearinghouses:
- Partner with spot market platforms that follow KYC/AML rules.
- Have in place information-sharing agreements with spot-market platforms.
- Monitor price settlement data from spot markets and identify/investigate anomalies and disproportionate moves.
- Set large-trader reporting thresholds at five bitcoins or less.
- Regularly coordinate with CFTC surveillance staff and provide trade data.
- Allow CFTC staff to review initial margin and maintenance margin for virtual currency futures.
Self-Certification Process for Virtual Currency Derivatives
The primer notes that the Commodity Exchange Act (CEA) provides designated contract markets (DCMs) and swap execution facilities (SEFs) with the option to either:
- Submit a certification to the CFTC, or
- Submit the contract for CFTC approval.
The primer notes further that:
- DCMs/SEFs bring the vast majority of new products to market through the certification process.
- When a DCM/SEF certifies a new contract it must determine that the offering complies with the CEA and CFTC regulations, including that the new contract is not readily susceptible to manipulation (DCM/SEF Core Principle 3).
- To date, all VC derivatives have been self-certified by trading venues.
CFTC Staff Review of Listed Digital Asset Derivatives
For cash-settled digital asset derivatives, according to the primer, the CFTC's primary focus is to ensure that the contract settlement prices are reliable. Among the issues the CFTC staff considers in making this determination are:
- What is the quality and liquidity of the underlying market and pricing data?
- Are there safeguards in place to ensure fraud and manipulation risk is mitigated?
- How robust is the methodology for calculating the settlement price?
For physically-settled digital asset derivatives, according to the primer, the CFTC staff considers:
- Physical transfer and storage (custody). Are there appropriate protocols, safeguards, and security? Does the exchange have clear rules around the delivery process? Is it consistent with prevailing cash market practices?
- For cleared products, what is the role of the clearinghouse in the delivery process? What may be the impact of delivery on underlying cash markets? Could traders engage in squeezes, corners or other manipulative behavior? What protocols are in place to ensure fraud and manipulation risk is mitigated?