CFTC: The not-so friendly regulator

Does the CFTC deserve its reputation as the ‘favorable’ regulator? CoinGeek spoke to two former members of the CFTC for their take on the matter.

Digital asset regulation in the United States has a problem. There are too many chefs in the kitchen, and in confusion, some digital dishes are getting burned while others are being snuck out the back door.

Both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) claim regulatory authority over the digital asset sphere, and the boundaries between the two are unclear. The result has been a jurisdictional grey area.

As regulators vie for control and legislation to settle this debate makes is slow march through Congress, many within the industry hope to see the Commodity Futures Trading Commission (CFTC)—often perceived as the friendlier of the two—emerge as the industry’s primary regulator.

This wish looks set to be granted: under the proposed legislation, the CFTC will receive a boost to its mandate. Should the bills pass, it will surely delight those averse to heavy-handed regulation who perceive it as the ‘good cop‘ of digital asset enforcement.

Its reputation as the ‘crypto-friendly’ regulator has dogged the CFTC since the beginning of its interactions with digital assets, much to the chagrin of current Chairman Rostin Behnam, who said at New York University in September that he gets “very irritated when folks start to talk about the CFTC as a more favorable regulator.”

The legislation in Congress would offer an increased scope to the CFTC and the resources to put paid to this ‘favorable’ label – but how digital asset-friendly is the CFTC, really? Was this reputation ever justified to begin with?

What’s it based on, and is it justified?

Part of the CFTC’s reputation likely comes from its perceived openness toward the digital asset space.

For one, Chairman Behnam was recently quoted as “cautious to be a cheerleader” for ‘crypto,’ describing the industry’s growth as “exciting” and “fascinating.” He also said that the price of BTC could double under the CFTC rule.

Forman Chairman Christopher Giancarlo, now practicing at Wilke Farr & Gallagher, describes the agency’s approach as “market intelligence and openness to innovation.”

“I wouldn’t say the phrase ‘friendly’: the CFTC has got this long tradition now for new product innovation and being comfortable with market and product innovation,” said Giancarlo. “The CFTC enforcement record is second to none, but it also has this mandate for furthering financial and market innovation. That tradition displayed itself in our ability back in 2017 to get comfortable with a Bitcoin futures product.”

This last point refers to the CFTC’s approval of the Chicago Mercantile Exchange and Chicago Board Options Exchange to offer BTC futures in 2017, a move that successfully followed through and saw BTC prices soar.

Gary DeWaal, former CFTC Senior trial attorney now with Katten, agrees that the CFTC does not precisely suit this reputation.

“I think ‘friendly’ is a misnomer,” he told CoinGeek. “I find both the SEC and the CFTC to be equally friendly, but that’s not the issue. The CFTC is really a principles-based regulator. Instead of articulating lots of very specific rules for exchanges and clearing houses, the CFTC articulates principles.”

“A principles-based regulator is better than a very detailed rules-based regulator, like the SEC,” he added.

Perceptions of ‘friendliness’ aside, the two regulators differ in at least one other material respect: resourcing. While the SEC boasts a 4,500-strong bench of investigators, case workers, and prosecutors, the CFTC has a comparatively light 700-strong headcount.

“We are still feeling the wounds and scars from about five or six years of flat funding,” said CFTC Chairman Behnam, speaking in September at the New York University School of Law. “We don’t have the traditional surveillance tools, the market oversight tools to monitor trading platforms, to oversee broker-dealers or similarly-situated intermediaries.”

Despite this disparity in resources and a mandate to further market innovation, the CFTC has still proven itself to be no regulatory push-over.

“Historically in the crypto space, it’s actually been the CFTC that’s been the toughest regulator,” claims De Waal.

“In the enforcement space, they’re the ones who have brought actions, beginning in 2016, against household names in the industry. They brought cases against Tether, Kraken, Coinbase (NASDAQ: COIN), and Gemini, and then they actually brought in some creative theories in the Ooki Dao case recently, so they’re not easy on the enforcement side.”

This track record of actions seems to, at least partly, dispute the idea of the CFTC as a soft touch, but another key factor that must be considered when discussing the relative merits of the regulators is the jurisdictional confusion that exists in the digital asset space.

The jurisdictional gray area

As former CFTC chairman Giancarlo points out, “the United States is unique in having not one but two financial market regulators.”

In a fast-moving, ever-evolving space where regulators are already struggling to hit a moving target, this overcrowding has naturally led to some jurisdictional ambiguity.

Traditionally, the SEC is responsible for securities, within which there is disagreement about what qualifies as a security, with digital assets, including BTC and ETH, increasingly being thought of as such; while the CFTC, which focuses on commodity-based futures and derivatives markets, has claimed BTC and many other digital assets as commodities.

This lack of clarity has led to wrangling over who has authority in certain situations, and in the melee, some of the non-compliant or potentially criminals have naturally fallen through the cracks.

“It’s not always clear which regulations apply to different activities,” said DeWaal. “So it’s not that we’re not regulated, it’s just that there’s a lack of clarity. That probably has hurt the development of crypto within the United States.”

“This is the impetus for some of the upcoming legislation, not only to protect consumers but to ensure that this asset class can develop in the United States, without fear of uncertainty that exists in it.”

Fortunately, for clarity’s sake, one of the core driving forces behind the various bills currently working their way through Congress is to clear up some of this ambiguity.

The SEC comparison

With this jurisdictional tug-of-war going on in the background, it seems logical to ask whether the CFTC’s reputation for being a more hospitable regulator is due to unfavorable—depending on your perspective—comparisons with the regulator at the other end of the rope.

If the CTFC has been seen as the ‘friendlier’ regulator, this gives some indication of how its sister agency, the ‘regulation by enforcement’ SEC, is viewed in the market.

This reputation is no accident either. In the digital asset space, SEC Chairman Gary Gensler has made it a priority to seek out high-impact cases targeting emerging types of securities violations in digital engagement practices, ‘cryptocurrencies,’ and cybersecurity compliance.

This approach was meant to signal that the SEC would protect investors by cutting abusive practices in unfamiliar business models—and the agency wants to pull as many of these ‘unfamiliar business models’ under its umbrella as it can.

“Nothing about the crypto markets is incompatible with the securities laws,” said SEC Chairman Gary Gensler, speaking at the annual SEC conference hosted by the Practising Law Institute in September. “Make no mistake: if a lending platform is offering and selling securities, it too comes under SEC jurisdiction.”

Regarded as the more intrusive of the regulators, the SEC’s desire to pull more of the digital asset space within its remit has, unsurprisingly, not been universally welcomed amongst industry players.

However, perhaps sensing a change in the prevailing winds over Capitol Hill, Gensler did speak in April of increased cooperation between the agencies, saying: “I’ve asked staff to work with the CFTC on how we jointly might address such platforms that might trade both crypto-based security tokens and some commodity tokens, using our respective authorities.”

This talk of cooperation gives hope of a more harmonious relationship on the horizon for the two key regulators and, presumably, greater jurisdictional clarity will only further this aim.

Legislative changes

Though it’s very much a live debate when it comes to future regulatory primacy in the digital asset industry, the winds of change are blowing in the CFTC’s direction.

“All the legislation that’s moving through Congress right now expands the CFTC’s authority, and none of the legislation appears to extend the SEC authority,” says Giancarlo.

DeWaal agrees, saying, “Most of the common themes are really around three pieces of legislation that are out there. Folks do think that the DCCPA probably is the leading piece of legislation right now, but all the legislation envisions a more central role for the CFTC in the regulation of spot virtual assets.”

The three key pieces of legislation in question are the Responsible Financial Innovation Act (RFIA), Digital Commodity Exchange Act (DCEA), and the Digital Commodities Consumer Protection Act (DCCPA):

  • The RFIA outlines a comprehensive regulatory framework for digital assets, the key relevant points being: it makes a distinction between digital assets that are commodities or securities and would grant the CFTC exclusive spot market jurisdiction over all fungible digital assets which are not securities; it categorizes decentralized autonomous organizations (DAOs) as business entities for the purposes of the tax code; and it calls for a number of studies on distributed ledger technology, decentralized finance (DeFi), energy consumption, and self-regulation.
  • The DCEA bill allows for the regulation and registration of digital commodity exchanges subject to oversight by the CFTC, as well as establishing the conditions for the sale of digital commodities and the registration of exchanges.
  • The DCCPA increases the CFTC’s scope by laying out in law the regulator’s exclusive jurisdiction over digital commodities trading, which would include spot markets. It also gives the CFTC the ability to charge the ‘crypto’ industry fees to fund new oversight; and makes it mandatory for any entity acting as a digital commodity platform to register with the CFTC.

As for why the new legislation has leaned firmly in the direction of the CFTC as opposed to the SEC, Giancarlo looks toward the CFTC’s track record so far.

“In politics, effective use of power results in more power, and the CFTC showed it’s effectively been able to utilize its statute to oversee what is a very healthy, liquid, and well-functioning futures market.”

Current activity

The boost provided by the DCCPA and other legislation currently under review will be warmly received by the CFTC. At the same time, the Commission has increasingly been making strides towards expunging its ‘friendly’ reputation.

According to the federal regulator’s annual enforcement report published in October, the CFTC filed 82 enforcement actions in 2022 (fiscal year), more than 20% of which were brought against some of the biggest names in the digital asset industry, such as Tether and Coinbase.

This is a surprisingly high number considering that all of those actions, as well as the majority of ‘crypto-related’ enforcement actions brought by the CFTC dating back to 2014, have resulted from anonymous tips and whistleblowers.

At a New York panel discussion hosted by law firm Lowenstein Sandler in October, CFTC Chairman Behnam spoke to this point, suggesting that the regulator’s over-reliance on whistleblowers was out of necessity, and “if we had more funds, if we had more personnel, we could bring more of this fraud and manipulation to light.”

It’s a statement that lawmakers seem likely to put to the test soon.

Digital asset regulation going forward

When considering the flaws in current governance and what these likely legislative changes will mean for the digital asset space going forward, it’s worth remembering that regulators, lawmakers, and law enforcement have been scrambling to catch up with a sector that’s grown from a white-paper theory to a multi-billion-dollar global industry in just over a decade.

“We’re talking about an industry less than 14 years old,” said Gary DeWaal, who sees reason for optimism in the bills poised to enter into law. “I have no doubt that going forward, there will be clearer guidelines on what will fall under the CFTC as provided in this new legislation or will clearly fall within the ambit of the SEC. That will obviously be very helpful when people can actually pick up a piece of paper, apply some kind of real mathematical test and determine when something falls in one category or not.”

When it comes to the CFTC, some may still argue that it is the digital asset industry’s preferred choice of agency due to its ‘favorable’ disposition. However, it seems there is a strong argument to be made that its reputation as the friendly neighborhood regulator is a combination of: a misreading of its approach; a lack of recognition of its enforcement record; jurisdictional confusion; and inevitable comparisons with the larger, more aggressive SEC.

From the perspective of Christopher Giancarlo, at least, the CFTC is the right regulator for the job: “It has bipartisan support, and it’s earned that. The proof is there that the CFTC can handle this.”

It has not been afraid to throw its weight around when necessary, and with the various bills in Congress poised to further bulk it out, with a clearer jurisdictional mandate and deeper pockets, the more regulation averse in the digital asset space may find the CFTC less friendly than they remember.

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