[Federal Register Volume 82, Number 243 (Wednesday, December 20, 2017)]

[Proposed Rules]

[Pages 60335-60341]

From the Federal Register Online via the Government Publishing Office [www.gpo.gov]

[FR Doc No: 2017-27421]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AE62

Retail Commodity Transactions Involving Virtual Currency

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed interpretation; request for comment.

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SUMMARY: The Commodity Futures Trading Commission (the “Commission”

or “CFTC”) is issuing this proposed interpretation of the term

“actual delivery” as set forth in a certain provision of the

Commodity Exchange Act (“CEA”) pursuant to the Dodd-Frank Wall Street

Reform and Consumer Protection Act (the “Dodd-Frank Act”).

Specifically, this proposed interpretation is being issued to inform

the public of the Commission’s views as to the meaning of actual

delivery within the specific context of retail commodity transactions

in virtual currency. The Commission requests comment on this proposed

interpretation and further invites comment on specific questions

related to the Commission’s treatment of virtual currency transactions.

DATES: Comments must be received on or before March 20, 2018.

ADDRESSES: You may submit comments, identified by RIN 3038-AE62, by any

of the following methods:

CFTC website: http://comments.cftc.gov. Follow the

instructions for submitting comments through the Comments Online

process on the website.

Mail: Christopher Kirkpatrick, Secretary of the

Commission,

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Commodity Futures Trading Commission, Three Lafayette Center, 1155 21st

Street NW, Washington, DC 20581.

Hand Delivery/Courier: Same as Mail, above.

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one method.

All comments must be submitted in English or, if not, accompanied

by an English translation. Comments will be posted as received to

http://www.cftc.gov. You should submit only information that you wish

to make available publicly. If you wish the Commission to consider

information that you believe is exempt from disclosure under the

Freedom of Information Act (“FOIA”),1 a petition for confidential

treatment of the exempt information may be submitted according to the

procedures established in Commission Regulation 145.9.2

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1 5 U.S.C. 552.

2 17 CFR 145.9. Commission regulations referred to herein are

found at 17 CFR chapter I.

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The Commission reserves the right, but shall have no obligation, to

review, pre-screen, filter, redact, refuse or remove any or all of your

submission from http://www.cftc.gov that it may deem to be

inappropriate for publication, such as obscene language. All

submissions that have been redacted or removed that contain comments on

the merits of the interpretation will be retained in the public comment

file and will be considered as required under the Administrative

Procedure Act and other applicable laws, and may be accessible under

FOIA.

FOR FURTHER INFORMATION CONTACT: Philip W. Raimondi, Special Counsel,

(202) 418-5717, [email protected]; or David P. Van Wagner, Chief

Counsel, (202) 418-5481, [email protected]; Office of the Chief

Counsel, Division of Market Oversight, Commodity Futures Trading

Commission, 1155 21st Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

With certain exceptions, the CFTC has been granted exclusive

jurisdiction over commodity futures, options, and all other derivatives

that fall within the definition of a swap.3 Further, the Commission

has been granted general anti-fraud and anti-manipulation authority

over “any swap, or a contract of sale of any commodity in interstate

commerce, or for future delivery on or subject to the rules of any

registered entity.” 4 The Commission’s mission is to foster open,

transparent, competitive and financially sound markets; and protect the

American public from fraudulent schemes and abusive practices in those

markets and products over which it has been granted jurisdiction.

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3 7 U.S.C. 2(a)(1)(A). The CFTC shares its swap jurisdiction

in certain aspects with the Securities and Exchange Commission

(“SEC”). See 7 U.S.C. 2(a)(1)(C).

4 7 U.S.C. 9(1).

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Pursuant to CEA section 2(c)(2)(D),5 the marketplace for “retail

commodity transactions” is one such area over which the Commission has

been granted explicit oversight authority.6 CEA section 2(c)(2)(D)

applies to any agreement, contract or transaction in any commodity that

is entered into with, or offered to (even if not entered into with), a

person that is neither an eligible contract participant 7 nor an

eligible commercial entity 8 (“retail”) on a leveraged or margined

basis, or financed by the offeror, the counterparty or a person acting

in concert with the offeror or counterparty on a similar basis.9 CEA

section 2(c)(2)(D) further provides that such an agreement, contract or

transaction is subject to CEA sections 4(a),10 4(b),11 and 4b 12

“as if the agreement, contract or transaction was a contract of sale

of a commodity for future delivery.” 13 The statute, however,

excepts certain transactions from its application. In particular, CEA

section 2(c)(2)(D)(ii)(III)(aa) 14 excepts a contract of sale that

“results in actual delivery within 28 days or such other longer period

as the Commission may determine by rule or regulation based upon the

typical commercial practice in cash or spot markets for the commodity

involved.” 15 If no exception is applicable, these retail

transactions are “commodity interests” subject to Commission

regulations together with futures, options, and swaps.16 Under this

authority, the Commission regulates retail commodity transactions, with

the exception of contracts of sale that result in actual delivery

within 28 days.17

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5 7 U.S.C. 2(c)(2)(D).

6 The authority provided to the Commission by CEA section

2(c)(2)(D) is in addition to, and independent from, the jurisdiction

over contracts of sale of a commodity for future delivery and

transactions subject to regulation pursuant to CEA section 19 that

the CEA has historically granted to the Commission. It is also in

addition to, and independent from, the jurisdiction over swaps

granted to the Commission by the Dodd-Frank Act. Further, the

authority granted under CEA section 2(c)(2)(D) is in addition to,

and independent of, the Commission’s ability to bring enforcement

actions for fraud or manipulation in connection with swaps,

contracts of sale of any commodity in interstate commerce, or for

future delivery on or subject to the rules of any registered entity.

7 U.S.C. 9(1), 9(3), 13(a)(2); 17 CFR 180.1, 180.2.

7 7 U.S.C. 1a(18).

8 7 U.S.C. 1a(17); see also 7 U.S.C. 2(c)(2)(D)(iv).

9 7 U.S.C. 2(c)(2)(D)(i).

10 7 U.S.C. 6(a) (prohibiting the off-exchange trading of

futures transactions by U.S. persons unless the transaction is

conducted on or subject to the rules of a designated contract

market).

11 7 U.S.C. 6(b) (permitting foreign boards of trade

registered with the Commission with the ability to provide direct

access to U.S. persons).

12 7 U.S.C. 6b (prohibiting fraudulent conduct in connection

with any contract of sale of any commodity in interstate commerce,

among other things).

13 7 U.S.C. 2(c)(2)(D)(iii).

14 7 U.S.C. 2(c)(2)(D)(ii)(III)(aa).

15 The Commission has not adopted any regulations permitting a

longer actual delivery period for any commodity pursuant to this

statute. Accordingly, the 28-day actual delivery period remains

applicable to all commodities, while retail foreign currency

transactions remain subject to a 2-day actual delivery period

pursuant to CEA section 2(c)(2)(C).

16 17 CFR 1.3(yy).

17 In addition, certain commercial transactions and securities

are excepted pursuant to CEA section 2(c)(2)(D)(ii).

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The Dodd-Frank Act added CEA section 2(c)(2)(D) to address certain

judicial uncertainty involving the Commission’s regulatory oversight

capabilities. The Commission has long held that certain speculative

commodity transactions involving leverage or margin may have indicia of

futures contracts, subjecting them to Commission oversight.18

However, judicial decisions emerged that called into question the

Commission’s oversight over certain leveraged retail transactions in

currencies and other commodities.19 In 2008, Congress addressed this

judicial uncertainty by providing the Commission with more explicit

authority over retail foreign currency transactions in CEA section

2(c)(2)(C).20 These new statutory provisions established a two-day

actual delivery exception for such transactions.21 Two years later,

Congress provided the Commission with explicit oversight authority over

all other “retail commodity transactions” in CEA section

2(c)(2)(D).22 As noted,

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these new statutory provisions established an exception for instances

when actual delivery of the commodity occurs within 28 days.23

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18 See In re Stovall, CFTC Docket No. 75-7 [1977-1980 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ] 20,941, at 23,777 (CFTC Dec. 6,

1979) (applying traditional elements of a futures contract to a

purported cash transaction).

19 See, e.g., CFTC v. Zelener, 373 F.3d 861 (7th Cir. 2004);

CFTC v. Erskine, 512 F.3d 309 (6th Cir. 2008).

20 See Food, Conservation and Energy Act of 2008, Public Law

110-246, 122 Stat. 1651 (2008).

21 7 U.S.C. 2(c)(2)(C)(i)(II)(bb)(AA).

22 See Dodd-Frank Wall Street Reform and Consumer Protection

Act of 2010, Public Law 111-203, 124 Stat. 1376 (2010); see also

Hearing to Review Implications of the CFTC v. Zelener Case Before

the Subcomm. on General Farm Commodities and Risk Management of the

H. Comm. on Agriculture, 111th Cong. 52-664 (2009) (statement of

Rep. Marshall, Member, H. Comm. on Agriculture) (“If in substance

it is a futures contract, it is going to be regulated. It doesn’t

matter how clever your draftsmanship is.”); 156 Cong. Rec. S5,924

(daily ed. July 15, 2010) (statement of Sen. Lincoln) (“Section 742

corrects [any regulatory uncertainty] by extending the Farm Bill’s

“Zelener fraud fix” to retail off-exchange transactions in all

commodities.”) (emphasis added).

23 7 U.S.C. 2(c)(2)(D)(ii)(III)(aa).

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In connection with its retail commodity transaction oversight, the

Commission previously issued a proposed interpretation of the term

“actual delivery” in the context of CEA section 2(c)(2)(D),

accompanied by a request for comment.24 In that interpretation, the

Commission provided several examples of what may and may not satisfy

the actual delivery exception. After reviewing public comments, the

Commission issued a final interpretation in 2013 (the “2013

Guidance”).25

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24 Retail Commodity Transactions Under Commodity Exchange Act,

76 FR 77670 (Dec. 14, 2011).

25 Retail Commodity Transactions Under Commodity Exchange Act,

78 FR 52426 (Aug. 23, 2013).

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The 2013 Guidance explained that the Commission will consider

evidence “beyond the four corners of contract documents” to assess

whether actual delivery of the commodity occurred.26 The Commission

further noted that it will “employ a functional approach and examine

how the agreement, contract, or transaction is marketed, managed, and

performed, instead of relying solely on language used by the parties in

the agreement, contract, or transaction.” 27 The 2013 Guidance also

included a list of relevant factors the Commission will consider in an

actual delivery determination 28 and again provided examples 29 of

what may and may not constitute actual delivery. As per the 2013

Guidance, the only satisfactory examples of actual delivery involve

transfer of title and possession of the commodity to the purchaser or a

depository acting on the purchaser’s behalf.30 Among other things,

mere book entries and certain instances where a purchase is “rolled,

offset, or otherwise netted with another transaction” do not

constitute actual delivery.31

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26 Id. at 52,428.

27 Id.

28 “Relevant factors in this determination include the

following: Ownership, possession, title, and physical location of

the commodity purchased or sold, both before and after execution of

the agreement, contract, or transaction, including all related

documentation; the nature of the relationship between the buyer,

seller, and possessor of the commodity purchased or sold; and the

manner in which the purchase or sale is recorded and completed.” 78

FR at 52428.

29 In the 2013 Guidance, Examples 1 and 2 illustrate

circumstances where actual delivery is made, while Examples 3, 4 and

5 illustrate circumstances where actual delivery is not made. In

setting forth the examples, the Commission made clear that they are

non-exclusive and were intended to provide the public with guidance

on how the Commission would apply the interpretation. 78 FR at

52427-28.

30 Id.

31 Id.

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Within a year after the 2013 Guidance was released, the Eleventh

Circuit issued an opinion affirming a preliminary injunction obtained

by the Commission in CFTC v. Hunter Wise Commodities, LLC.32 Hunter

Wise further reinforced the Commission’s interpretation of actual

delivery in the 2013 Guidance. Specifically, the Eleventh Circuit

recognized that delivery “denotes a transfer of possession and

control.” 33 Indeed, “[i]f `actual delivery’ means anything, it

means something other than simply `delivery,’ for we must attach

meaning to Congress’s use of the modifier `actual.’ ” 34

Accordingly, the Court stated that actual delivery “denotes `[t]he act

of giving real and immediate possession to the buyer or the buyer’s

agent” and constructive delivery does not suffice.35 Notably, the

Eleventh Circuit found that its own holding harmonized with the 2013

Guidance and recognized that the legislative history behind CEA section

2(c)(2)(D) also “complements” its decision.36

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32 CFTC v. Hunter Wise Commodities, LLC, et al., 749 F.3d 967

(11th Cir. 2014) (hereinafter, Hunter Wise).

33 749 F.3d at 978-79, (citing Black’s Law Dictionary 494 (9th

ed. 2009)).

34 749 F.3d at 979.

35 Id.

36 749 F.3d at 977.

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Soon after the Hunter Wise decision, the Commission established

that virtual currency is a commodity as that term is defined by CEA

section 1a(9).37 Subsequently, the Commission brought its first

enforcement action against a platform that offered virtual currency

transactions to retail customers on a leveraged, margined, or financed

basis without registering with the Commission.38 In the Bitfinex

settlement order, the Commission found that the virtual currency

platform violated CEA sections 4(a) and 4d because the unregistered

entity “did not actually deliver bitcoins purchased from them” as

prescribed within the actual delivery exception.39 Rather, the entity

“held the purchased bitcoins in bitcoin deposit wallets that it owned

and controlled.” 40

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37 In re Coinflip, Inc., d/b/a Derivabit, and Francisco

Riordan, CFTC Docket No. 15-29, 2015 WL 5535736, [Current Transfer

Binder] Comm. Fut. L. Rep. (CCH) ] 33,538 (CFTC Sept. 17, 2015)

(consent order); In re TeraExchange LLC, CFTC Docket No. 15-33, 2015

WL 5658082, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ]

33,546 (CFTC Sept. 24, 2015) (consent order).

38 In re BFXNA INC. d/b/a BITFINEX, CFTC Docket No. 16-19

(June 2, 2016) (consent order) (hereinafter, Bitfinex).

39 Id.

40 Id.

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After Bitfinex, the Commission received requests for guidance with

regard to the meaning of the actual delivery exception in the specific

context of virtual currency transactions. Accordingly, the Commission

has decided to issue this proposed interpretation and seek public

comment. The Commission is issuing this proposed interpretation to

inform the public of the Commission’s views as to the meaning of the

term “actual delivery” in the context of virtual currency and to

provide the public with guidance on how the Commission intends to

assess whether any given retail commodity transaction in virtual

currency (whereby an entity or platform offers margin trading or

otherwise facilitates 41 the use of margin, leverage, or financing

arrangements for their retail market participants) results in actual

delivery, as the term is used in CEA section

2(c)(2)(D)(ii)(III)(aa).42 The Commission requests comment generally

on this proposed interpretation and further invites comment on specific

questions, as outlined within this release.

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41 Specifically, CEA section 2(c)(2)(D)(i) captures any such

retail commodity transaction “entered into, or offered . . . on a

leveraged or margined basis, or financed by the offeror, the

counterparty, or a person acting in concert with the offeror or

counterparty on a similar basis.”

42 7 U.S.C. 2(c)(2)(D)(ii)(III)(aa).

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II. Commission Interpretation of Actual Delivery for Virtual Currency

A. Virtual Currency as a Commodity

As noted previously, the Commission considers virtual currency to

be a commodity,43 like many other intangible commodities that the

Commission has recognized over the course of its existence (e.g.,

renewable energy credits and emission allowances, certain indices, and

certain debt instruments, among others).44 Indeed, since their

inception, virtual currency

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structures were proposed as digital alternatives to gold and other

precious metals.45 As a commodity, virtual currency is subject to

applicable provisions of the CEA and Commission regulations.

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43 In re Coinflip, Inc., d/b/a Derivabit, and Francisco

Riordan, CFTC Docket No. 15-29, 2015 WL 5535736, [Current Transfer

Binder] Comm. Fut. L. Rep. (CCH) ] 33,538 (CFTC Sept. 17, 2015)

(consent order); In re TeraExchange LLC, CFTC Docket No. 15-33, 2015

WL 5658082, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ]

33,546 (CFTC Sept. 24, 2015) (consent order).

44 See generally Further Definition of “Swap,” “Security-

Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps;

Security-Based Swap Agreement Recordkeeping, 77 FR 48208 at 48233

(Aug. 13, 2012) (discussing application of the swap forward

exclusion to intangible commodities).

45 Nick Szabo, Bit gold, Unenumerated (Dec. 27, 2008), http://unenumerated.blogspot.com/2005/12/bit-gold.html.

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The Commission interprets the term virtual currency broadly. In the

context of this interpretation, virtual or digital currency: 46

Encompasses any digital representation of value (a “digital asset”)

that functions as a medium of exchange, and any other digital unit of

account that is used as a form of a currency (i.e., transferred from

one party to another as a medium of exchange); may be manifested

through units, tokens, or coins, among other things; and may be

distributed by way of digital “smart contracts,” among other

structures.47 However, the Commission notes that it does not intend

to create a bright line definition at this time given the evolving

nature of the commodity and, in some instances, its underlying public

distributed ledger technology (“DLT” or “blockchain”).

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46 The Commission uses the term “virtual currency” and

“digital currency” interchangeably for purposes of this proposed

interpretation. However, the Commission acknowledges that the two

terms may have certain practical differences in other contexts. For

example, one view is that “digital currency” includes fiat

currencies, while “virtual currency” does not. See The Financial

Action Task Force [FATF], Virtual Currencies: Key Definitions and

Potential AML/CFT Risks, at 4 (June 27, 2014), http://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions-and-potential-aml-cft-risks.pdf. Further, this

interpretation is not intended to encompass transactions otherwise

covered by CEA section 2(c)(2)(C) and related Commission

regulations.

47 One prominent type of virtual currency is cryptocurrency.

Cryptocurrency is described as “an electronic payment system based

on cryptographic proof instead of trust, allowing any two willing

parties to transact directly with each other without the need for a

trusted third party.” Satoshi Nakamoto, Bitcoin: A Peer-to-Peer

Electronic Cash System (Oct. 31, 2008), https://bitcoin.org/bitcoin.pdf. Transactions are represented by a hash or “chain of

digital signatures,” which takes into account the previous owner

and the next owner. Given the lack of a centralized authority,

transaction verification is “publicly announced” in a transparent

ledger “system for participants to agree on a single history” of

transactions. Id. Each transaction moves from one digital wallet to

another, recognized as “nodes” on a distributed ledger network.

This structure represents one form of DLT or blockchain technology,

which underlies bitcoin–a widely traded virtual currency.

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B. The Commission’s Interest in Virtual Currency

The Commission recognizes that certain virtual currencies and their

underlying blockchain technologies have the potential to yield notable

advancements in applications of financial technology (“FinTech”).

Indeed, as part of its efforts to facilitate beneficial FinTech

innovation and help ensure market integrity, the Commission launched

the LabCFTC initiative.48 This initiative provides the Commission

with a platform to engage the FinTech community and promote market-

enhancing innovation in furtherance of improving the quality,

resiliency, and competitiveness of the markets overseen by the

Commission. As such, the Commission is closely following the

development and continuing evolution of blockchain technologies and

virtual currencies.

—————————————————————————

48 See Press Release, Commodity Futures Trading Commission,

CFTC Launches LabCFTC as Major FinTech Initiative (May 17, 2017),

http://www.cftc.gov/PressRoom/PressReleases/pr7558-17.

—————————————————————————

Moreover, since virtual currency can serve as an underlying

component of derivatives transactions, the Commission maintains a close

interest in the development of the virtual currency marketplace

generally. As a practical matter, virtual currency, by virtue of its

name, represents a digital medium of exchange for goods and services,

similar to fiat currency.49 Over time, numerous centralized platforms

have emerged as markets to convert virtual currency into fiat currency

or other virtual currencies. These platforms provide a place to

immediately exchange one commodity for another “on the spot.”

—————————————————————————

49 Michael J. Casey and Paul Vigna, Bitcoin and the Digital-

Currency Revolution, The Wall Street Journal (Jan. 23, 2015),

https://www.wsj.com/articles/the-revolutionary-power-of-digital-currency-1422035061 (“Once inside the coffee shop, you will open

your wallet’s smartphone app and hold its QR code reader up to the

coffee shop’s device” to buy a cup of coffee).

—————————————————————————

Some of these centralized platforms also attempt to cater to those

that wish to speculate on the price movements of a virtual currency

against other currencies. For example, a speculator may purchase

virtual currency using borrowed money in the hopes of covering any

outstanding balance owed through profits from favorable price movements

in the future. This interpretation is specifically focused on such

“retail commodity transactions,” whereby an entity or platform: (i)

Offers margin trading or otherwise facilitates 50 the use of margin,

leverage, or financing arrangements for their retail market

participants; (ii) typically to enable such participants to speculate

or capitalize on price movements of the commodity–two hallmarks of a

regulated futures marketplace.51

—————————————————————————

50 As noted earlier, CEA section 2(c)(2)(D)(i) captures any

such retail transaction “entered into, or offered . . . on a

leveraged or margined basis, or financed by the offeror, the

counterparty, or a person acting in concert with the offeror or

counterparty on a similar basis.” The Commission views any

financing arrangements facilitated, arranged, or otherwise endorsed

by the offeror or counterparty to satisfy this statutory definition

for purposes of this interpretation.

51 See, e.g., CFTC v. Int’l Foreign Currency, Inc., 334 F.

Supp. 2d 305, 310 (E.D.N.Y. 2004) (listing elements typically found

in a futures contract); In re Stovall, CFTC Docket No. 75-7 [1977-

1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 20,941, at 23,777

(CFTC Dec. 6, 1979) (describing how futures contracts, being traded

on margin, “are entered into primarily for the purpose of assuming

or shifting the risk of change in value of commodities, rather than

for transferring ownership of the actual commodities.”); David J.

Gilberg, Regulation of New Financial Instruments Under the Federal

Securities and Commodities Laws, 39 Vand. L. Rev. 1599, 1603-04,

n.14 (1986) (typically, futures “traders are interested only in

obtaining cash payments of price differentials, not actual

commodities”).

—————————————————————————

Beyond their practical and speculative functions, the emergence of

these nascent markets has also been negatively marked by a variety of

retail customer harm that warrants the Commission’s attention,

including, among other things, flash crashes and other market

disruptions,52 delayed settlements,53 alleged spoofing,54

hacks,55 alleged internal theft,56 alleged manipulation,57 smart

contract coding vulnerabilities,58 bucket shop

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arrangements and other conflicts of interest.59 These types of

activities perpetrated by bad actors can inhibit market-enhancing

innovation, undermine market integrity, and stunt further market

development.

—————————————————————————

52 See, e.g., Paul Vigna, Virtual Currencies Bitcoin and Ether

Wrap Up a Wild Quarter, The Wall Street Journal, Jul. 3, 2017, at B6

(describing a recent flash crash affecting the price of virtual

currency Ether, caused by “a multimillion-dollar sell order” that

subsequently “sparked a cascade of stop-loss orders”); Paul Vigna,

BitBeat: Bitcoin Price Drops on Block-Size Debate, `Flash Crash,’

The Wall Street Journal (Aug. 20, 2015), http://blogs.wsj.com/moneybeat/2015/08/20/bitbeat-bitcoin-price-drops-on-block-size-debate-flash-crash/ (“bitcoin’s speculative traders love this kind

of stuff [margin trading]; these guys could easily give Wall

Street’s casino hotshots a run for their money”).

53 Paul Vigna, Virtual Currencies Bitcoin and Ether Wrap Up a

Wild Quarter, The Wall Street Journal, Jul. 3, 2017, at B6

(“[t]here were delays of hours and even days.”).

54 Lionel Laurent, Bitcoin Wrestles With Spoofy the Trader,

Bloomberg Gadfly (Aug. 7, 2017), https://www.bloomberg.com/gadfly/articles/2017-08-07/bitcoin-has-a-spoofy-problem.

55 See, e.g., Paul Vigna and Gregor Stuart Hunter, Bitcoin

Sinks After Exchange Reports Hack, The Wall Street Journal (Aug. 3,

2016), http://www.wsj.com/articles/bitcoin-sinks-after-exchange-reports-hack-1470195727; Nathaniel Popper and Rachel Abrams,

Apparent Theft Rattles the Bitcoin World, N.Y. Times, Feb. 25, 2014,

at B1; Alex Hern, A History of Bitcoin Hacks, The Guardian (Mar. 18,

2014), http://www.theguardian.com/technology/2014/mar/18/history-of-bitcoin-hacks-alternative-currency.

56 Jessica Lipscomb, Cryptsy Founder Paul Vernon Disappeared,

Along With Millions of His Customers’ Cash, Miami New Times (Jun.

28, 2016), http://www.miaminewtimes.com/news/cryptsy-founder-paul-vernon-disappeared-along-with-millions-of-his-customers-cash-8557571.

57 Izabella Kaminska, When OTC markets backfire, bitcoin

edition, Financial Times–Alphaville (Mar. 8, 2017), https://ftalphaville.ft.com/2017/03/08/2185731/when-otc-markets-backfire-bitcoin-edition.

58 Matthew Leising, The Ether Thief, Bloomberg Markets

Magazine (Jun. 13, 2017), https://www.bloomberg.com/features/2017-the-ether-thief/ (while not technically an event specific to any one

platform, this hack illustrates an event that dramatically affected

the price and status of a virtual currency traded on such

platforms).

59 See, e.g., Vitalik Buterin, Bitfinex: Bitcoinica Rises From

The Grave, Bitcoin Magazine (Nov. 22, 2012), http://bitcoinmagazine.com/articles/bitfinex-bitcoinica-rises-from-the-grave-1353644122; Matt Levine, How A Bank Should Be?, Bloomberg View

(Mar. 11, 2015), https://www.bloomberg.com/view/articles/2015-03-11/how-should-a-bank-be- (“Just because you mumble the word

`blockchain’ doesn’t make otherwise illegal things legal”); Matt

Levine, Bitcoin Bucket Shop Kicks Bucket, Bloomberg View (Jun. 19,

2015), https://www.bloomberg.com/view/articles/2015-06-19/bitcoin-bucket-shop-kicks-bucket.

—————————————————————————

C. Actual Delivery of Virtual Currency

As underscored by its efforts to engage the FinTech community, the

Commission emphasizes that it does not intend to impede market-

enhancing innovation or otherwise harm the evolving virtual currency

marketplace with this interpretation. To the contrary, the Commission

believes this interpretation can help advance a healthy ecosystem and

support further market-enhancing innovation. Additionally, the

Commission takes seriously its goal of protecting U.S. retail market

participants engaged in the virtual currency marketplace that falls

within the Commission’s jurisdiction–as it would with respect to

retail market participants trading in any other retail commodity

marketplace that falls within its jurisdiction. The Commission drafted

this interpretation with such a balance in mind.

As discussed above, a retail commodity transaction may be excepted

from CEA section 2(c)(2)(D) (and thus not subject to CEA sections 4(a),

4(b), and 4b) if actual delivery of the commodity occurs within 28 days

of the transaction.60 The longstanding Model State Commodity Code

also contains an exception from its “commodity contract” regulation

when physical settlement occurs within 28 days.61 However, the Model

State Commodity Code provides for the ability to lengthen or shorten

its 28-day physical delivery exception time period, while CEA section

2(c)(2)(D) only provides the Commission with the ability to lengthen

its actual delivery exception time period.62 Therefore, absent

Congressional action, the Commission is unable to reduce the actual

delivery exception period for speculative, leverage-based retail

commodity transactions in virtual currency. The one-size-fits-all 28

day delivery period in CEA section 2(c)(2)(D) may not properly account

for innovation or customary practice in certain cash markets, such as

virtual currency transactions that would presumably take much less than

28 days to deliver to a purchaser in a typical spot transaction.63

Without the application of CEA section 2(c)(2)(D), retail market

participants that transact on platforms offering speculative

transactions in virtual currency (involving margin, leverage, or other

financing) will not be afforded many of the protections that flow from

registration under the CEA. Despite the statutory limitations, the

Commission will utilize its current statutory authority as best it can

to prevent fraud in retail commodity transactions involving virtual

currency.

—————————————————————————

60 7 U.S.C. 2(c)(2)(D)(ii)(III)(aa).

61 See Model State Commodity Code section 1.01(e), [1984-1986

Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 22,568 (Apr. 5, 1985).

62 To date, the Commission has not chosen to extend the 28-day

actual delivery period in any instance.

63 Notably, Congress provided a 2-day actual delivery

exception for retail foreign currency transactions. See 7 U.S.C.

2(c)(2)(C)(i)(II)(bb)(AA).

—————————————————————————

The Commission, in interpreting the term actual delivery for the

purposes of CEA section 2(c)(2)(D)(ii)(III)(aa), will continue to

follow the 2013 Guidance and “employ a functional approach and examine

how the agreement, contract, or transaction is marketed, managed, and

performed, instead of relying solely on language used by the parties in

the agreement, contract, or transaction.” 64

—————————————————————————

64 78 FR at 52428.

—————————————————————————

Further, the Commission will continue to assess all relevant

factors 65 to aid in such an actual delivery determination. More

specifically, the Commission’s view of when “actual delivery” has

occurred within the context of virtual currency requires:

—————————————————————————

65 This list includes, but is not limited to “[o]wnership,

possession, title, and physical location of the commodity purchased

or sold, both before and after execution of the agreement, contract,

or transaction, including all related documentation; the nature of

the relationship between the buyer, seller, and possessor of the

commodity purchased or sold; and the manner in which the purchase or

sale is recorded and completed.” Id.

—————————————————————————

(1) A customer having the ability to: (i) Take possession and

control of the entire quantity of the commodity, whether it was

purchased on margin, or using leverage, or any other financing

arrangement, and (ii) use it freely in commerce (both within and away

from any particular platform) no later than 28 days from the date of

the transaction; and

(2) The offeror and counterparty seller (including any of their

respective affiliates or other persons acting in concert with the

offeror or counterparty seller on a similar basis) 66 not retaining

any interest in or control over any of the commodity purchased on

margin, leverage, or other financing arrangement at the expiration of

28 days from the date of the transaction.67

—————————————————————————

66 The Commission recognizes that the offeror of the

transaction and the ultimate counterparty may be two separate

entities or may be the same. For example, the Commission would

consider as the offeror of the transaction a virtual currency

platform that makes the transaction available to the retail customer

or otherwise facilitates the transaction. That virtual currency

platform could also be considered a counterparty to the transaction

if, for example, the platform itself took the opposite side of the

transaction or the purchaser of the virtual currency enjoyed privity

of contract solely with the platform rather than the seller.

Additionally, the Commission recognizes that some virtual currency

platforms may provide a purchaser with the ability to source

financing or leverage from other users or third parties. The

Commission would consider such third parties or other users to be

acting in concert with the offeror or counterparty seller on a

similar basis.

67 Among other things, the Commission may look at whether the

offeror or seller retain any ability to access or withdraw any

quantity of the commodity purchased from the purchaser’s account or

wallet.

—————————————————————————

Consistent with the 2013 Guidance, a sham delivery does not

constitute actual delivery for purposes of this interpretation. The

offeror and counterparty seller, including their agents, must retain no

interest or control whatsoever in the virtual currency acquired by the

purchaser at the expiration of 28 days from the date of entering into

the transaction. Indeed, in its simplest form, actual delivery of

virtual currency connotes the ability of a purchaser to utilize the

virtual currency purchased “on the spot” to immediately purchase

goods or services with the currency elsewhere.

In the context of an “actual delivery” determination in virtual

currency, physical settlement of the commodity must occur. A cash

settlement or offset mechanism, as described in Example 4 below, will

not satisfy the actual delivery exception of CEA section 2(c)(2)(D).

The distinction between physical settlement and cash settlement in this

context is akin to settlement of a spot foreign currency transaction at

a commercial bank or hotel in a foreign nation–the customer receives

physical foreign currency, not U.S. dollars. As mentioned, such

physical settlement must occur within 28 days from the date on which

the “agreement, contract, or transaction is entered into” to

constitute “actual delivery.” 68

—————————————————————————

68 78 FR at 52427.

—————————————————————————

Consistent with the interpretation above, the Commission provides

the following non-exclusive examples to further clarify the meaning of

actual delivery in the virtual currency context:

[[Page 60340]]

Example 1: Actual delivery of virtual currency will have occurred

if, within 28 days of entering into an agreement, contract, or

transaction, there is a record on the relevant public distributed

ledger network or blockchain of the transfer of virtual currency,

whereby the entire quantity of the purchased virtual currency,

including any portion of the purchase made using leverage, margin, or

other financing, is transferred from the counterparty seller’s

blockchain wallet 69 to the purchaser’s blockchain wallet, the

counterparty seller retains no interest in or control over the

transferred commodity, and the counterparty seller has transferred

title 70 of the commodity to the purchaser. When a matching platform

or other third party offeror acts as an intermediary, the virtual

currency’s public distributed ledger must reflect the purchased virtual

currency transferring from the counterparty seller’s blockchain wallet

to the third party offeror’s blockchain wallet and, separately, from

the third party offeror’s blockchain wallet to the purchaser’s

blockchain wallet, provided that the purchaser’s wallet is not

affiliated with or controlled by the counterparty seller or third party

offeror in any manner.

—————————————————————————

69 The source of the virtual currency is provided for purposes

of this example. However, the focus of this analysis remains on the

actions that would constitute actual delivery of the virtual

currency to the purchaser.

70 For purposes of this interpretation, title may be reflected

by linking an individual purchaser with proof of ownership of the

particular wallet or wallets that contain the purchased virtual

currency.

—————————————————————————

Example 2: Actual delivery will have occurred if, within 28 days of

entering into a transaction: (1) The counterparty seller has delivered

the entire quantity of the virtual currency purchased, including any

portion of the purchase made using leverage, margin, or financing, into

the possession of a depository (i.e., wallet or other relevant storage

system) other than one owned, controlled, or operated by the

counterparty seller (including any parent companies, partners, agents,

affiliates, and others acting in concert with the counterparty seller)

71 that has entered into an agreement with the purchaser to hold

virtual currency as agent for the purchaser without regard to any

asserted interest of the offeror, the counterparty seller, or persons

acting in concert with the offeror or counterparty seller on a similar

basis; (2) the counterparty seller has transferred title of the

commodity to the purchaser; (3) the purchaser has secured full control

over the virtual currency (i.e., the ability to immediately remove the

full amount of purchased commodity from the depository); and (4) no

liens (or other interests of the offeror, counterparty seller, or

persons acting in concert with the offeror or counterparty seller on a

similar basis) resulting from the use of margin, leverage, or financing

used to obtain the entire quantity of the commodity purchased will

continue forward at the expiration of 28 days from the date of the

transaction.

—————————————————————————

71 The Commission recognizes that an offeror could act in

concert with both the purchaser and the counterparty seller in the

ordinary course of business if it intermediates a transaction. It is

not intended that such activity would prevent an offeror from

associating with a depository, as otherwise allowed by this example.

—————————————————————————

Example 3: Actual delivery will not have occurred if, within 28

days of entering into a transaction, a book entry is made by the

offeror or counterparty seller purporting to show that delivery of the

virtual currency has been made to the purchaser, but the counterparty

seller or offeror has not, in accordance with the methods described in

Example 1 or Example 2, actually delivered the entire quantity of the

virtual currency purchased, including any portion of the purchase made

using leverage, margin, or financing, and transferred title to that

quantity of the virtual currency to the purchaser, regardless of

whether the agreement, contract, or transaction between the purchaser

and offeror or counterparty seller purports to create an enforceable

obligation 72 to deliver the commodity to the purchaser.

—————————————————————————

72 This “enforceable obligation” language is provided in

reference to an exception to CEA section 2(c)(2)(D) that is limited

by its terms to a commercial transaction involving two commercial

entities with a pre-existing line of business in the commodity at

issue that is separate and distinct from the business of engaging in

a retail commodity transaction. See 7 U.S.C.

2(c)(2)(D)(ii)(III)(bb).

—————————————————————————

Example 4: Actual delivery will not have occurred if, within 28

days of entering into a transaction, the agreement, contract, or

transaction for the purchase or sale of virtual currency is rolled,

offset against, netted out, or settled in cash or virtual currency

(other than the purchased virtual currency) between the purchaser and

the offeror or counterparty seller (or persons acting in concert with

the offeror or counterparty seller).

III. Request for Comment

The Commission requests comment from the public regarding the

Commission’s proposed interpretation of “actual delivery” in the

context of virtual currency and further invites comments on specific

questions related to the Commission’s treatment of virtual currency

transactions. The Commission encourages all comments including

background information, actual market examples, best practice

principles, expectations for the possible impact on further innovation,

and estimates of any asserted costs and expenses. Specifically, the

Commission requests comment on the following questions:

Question 1: As noted in this proposed interpretation, the

Commission is limited in its ability to shorten the length of the

actual delivery exception period for retail commodity transactions in

virtual currency–which presumably take much less than 28 days to

deliver to a purchaser. Would a 2-day actual delivery period, such as

the actual delivery exception in CEA section 2(c)(2)(C), more

accurately apply to such transactions in virtual currency? Would

another actual delivery period be more appropriate? What additional

information should the Commission consider in determining an

appropriate actual delivery exception period for retail commodity

transactions in virtual currency? If the Commission were to decide that

a shorter actual delivery exception period would be more appropriate in

the context of virtual currency, should the Commission engage Congress

to consider an adjustment to CEA section 2(c)(2)(D)’s the actual

delivery exception? For example, should the Commission seek that

Congress amend CEA section 2(c)(2)(D)’s actual delivery exception to be

more aligned with the broader delivery period adjustment language in

the Model State Commodity Code?

Question 2: With respect to the Commission’s proposed

interpretation, are there additional examples the Commission should

consider in satisfaction of the “actual delivery” exception to CEA

section 2(c)(2)(D)?

Question 3: The Commission is concerned about offerors of virtual

currency retail commodity transactions that may be subject to conflicts

of interest, including situations such as an offeror or its principals

taking the opposite side of a customer transaction, either directly or

through an affiliated liquidity provider or market maker. These

arrangements may, in certain circumstances, resemble bucket shops.73

How should the Commission evaluate such circumstances if a platform

seeks to avail itself of the actual delivery exception? Are there any

additional factors that the Commission should consider in its

determination of whether

[[Page 60341]]

the “actual delivery” exception is available?

—————————————————————————

73 Vitalik Buterin, Bitfinex: Bitcoinica Rises From The Grave,

Bitcoin Magazine (Nov. 22, 2012), http://bitcoinmagazine.com/articles/bitfinex-bitcoinica-rises-from-the-grave-1353644122

(describing a bucket shop arrangement whereby a platform “steps in

and acts as the counterparty to some of its users,” creating

“perverse incentives”).

—————————————————————————

Question 4: As noted above, CEA sections 4(a), 4(b), and 4b apply

to retail commodity transactions “as if” the transaction was a

futures contract.74 Therefore, absent an exception, a retail

commodity transaction must be offered on or subject to the rules of a

designated contract market (“DCM”).75 Separately, an entity

soliciting or accepting orders for retail commodity transactions and

accepting money, securities, or property (or extending credit in lieu

thereof) to margin, guarantee, or secure such transactions must

register with the Commission as a futures commission merchant

(“FCM”).76 As a result of these requirements, the Commission

recognizes that certain entities or platforms will choose not to offer

virtual currency retail commodity transactions. This business decision

is not unique to any particular commodity. However, as noted earlier,

the Commission does not intend to stifle innovation. Rather, it is

acting to protect U.S. retail customers regarding transactions that

fall within its jurisdiction. Therefore, the Commission requests

comments as to what factors may be relevant to consider regarding the

Commission’s potential use of its exemptive authority under CEA section

4(c) 77 in this regard. For example, please note any advantages and

disadvantages regarding the potential to establish a distinct

registration and compliance regime for entities that seek to offer

retail commodity transactions in virtual currency. Why would such

treatment be uniquely warranted 78 in the context of virtual

currency? Please also note any other issues that the Commission should

consider regarding such an analysis. What other alternatives should the

Commission consider instead of establishing a distinct registration and

compliance regime?

—————————————————————————

74 7 U.S.C. 2(c)(2)(D)(iii).

75 7 U.S.C. 6(a).

76 7 U.S.C. 1a(28); 7 U.S.C. 6d(a).

77 7 U.S.C. 6(c).

78 Arguably, beyond the distributed ledger technologies,

entities offering virtual currency retail commodity transactions

operate in a similar manner to any other entity offering retail

commodity transactions online.

—————————————————————————

Question 5: In Example 2, the Commission sets forth a proposed set

of facts that permits actual delivery to a depository instead of the

purchaser. What should the Commission consider in further clarifying

the meaning of “depository” for purposes of this interpretation? For

example, could the depository maintain certain licenses or

registrations in order to qualify for this example? In addition, should

the Commission further prohibit the depository from being owned or

operated by the offeror (including any offeror parent company, partner,

agent, and other affiliates)? Please note any factors the Commission

should consider in making this determination (such as the effect of

contractual agreements between the depository and the offeror).

Question 6: Example 2 also requires the purchaser to secure full

control over the virtual currency once it is deposited in a depository

in order for the fact pattern to constitute actual delivery. The

Commission requests comment regarding what types of circumstances would

ensure a purchaser has obtained “full control” of the commodity. For

example, is possession of a unique key or other credentials that allow

full access and ability to transfer virtual currency sufficient to

provide full control? Similarly, how should the Commission view full

control by a user in light of commonly used cybersecurity techniques

and money transmitter procedures otherwise required by law?

Question 7: Example 2 also requires that no liens resulting from

the use of margin, leverage, or financing used to obtain the entire

quantity of the commodity purchased by the buyer continue forward at

the expiration of 28 days from the date of the transaction. The

Commission requests comment regarding circumstances under which a lien

would be considered terminated for purposes of this interpretation. For

example, are there circumstances where the Commission should consider

allowing “forced sale” scenarios, whereby the purchased virtual

currency is used to satisfy any resulting liens from the retail

commodity transaction, while still interpreting the transaction as

having resulted in actual delivery to the purchaser? Should the

Commission consider other types of lien scenarios or interests, such as

those liens that would not provide a right to repossession of the

commodity?

Question 8: As noted above, the status of “title” is one of the

factors the Commission considers in an actual delivery determination

for retail commodity transactions.79 In Examples 1 and 2, this

interpretation notes that “title” may be reflected by linking an

individual purchaser with proof of ownership of the particular wallet

or wallets that contain the purchased virtual currency. What additional

examples, if any, should the Commission consider to address the status

of “title” for the purposes of an actual delivery determination?

—————————————————————————

79 See 78 FR at 52428.

—————————————————————————

Question 9: While this interpretation is solely focused on the

actual delivery exception to CEA section 2(c)(2)(D), the Commission

recognizes other exceptions may be available.80 Specifically, the

Commission recognizes that the SEC recently issued a statement

regarding the application of federal securities laws to certain initial

coin offerings (“ICOs”).81 Depending on their use, the tokens or

units issued in an ICO may be commodities, commodity options,

derivatives, or otherwise fall within the Commission’s virtual currency

definition described in this interpretation. However, any such tokens

that are deemed securities (and trade in a manner that qualifies as a

retail commodity transaction) would be excepted from the retail

commodity transaction definition pursuant to section 2(c)(2)(D)(ii)(II)

of the Act. Are there concerns with the scope of this exception with

regard to retail commodity transactions? What factors should the

Commission consider if it were to issue further guidance regarding this

exception?

—————————————————————————

80 See generally 7 U.S.C. 2(c)(2)(D)(ii).

81 Report of Investigation Pursuant to Section 21(a) of the

Securities Exchange Act of 1934: The DAO, Exchange Act Release No.

81207 (Jul. 25, 2017).

Issued in Washington, DC, on December 15, 2017 by the

Commission.

Christopher J. Kirkpatrick,

Secretary of the Commission.

Appendix to Retail Commodity Transactions Involving Virtual Currency–

Commission Voting Summary

On this matter, Chairman Giancarlo and Commissioners Quintenz

and Behnam voted in the affirmative. No Commissioner voted in the

negative.

[FR Doc. 2017-27421 Filed 12-19-17; 8:45 am]

BILLING CODE 6351-01-P

 

 

Last Updated: December 20, 2017