CFTC Sets the Parameters for Which Virtual Currencies are Subject to Full CFTC Jurisdiction by Merit of How They are Bought and Delivered

The Commodity Futures Trading Commission published in the Federal Register on June 24, 2020 its final interpretive guidance concerning retail commodity transactions involving certain digital assets (2020 Guidance).¹ The 2020 Guidance clarifies the CFTC’s views regarding the “actual delivery” exception to Section 2(c)(2)(D) of the Commodity Exchange Act (CEA) in the context of digital assets that serve as a medium of exchange, colloquially known as “virtual currencies.” The actual delivery determination is important because it delineates the virtual currencies over which the CFTC has full regulatory jurisdiction and those over which the CFTC merely has anti-fraud and market manipulation jurisdiction.

The 2020 Guidance explains that transactions in virtual currencies with “retail customers” conducted with margin, leverage or other financing must be traded on a CFTC-licensed futures exchange, unless: the virtual currency is free of any liens, other interests or legal rights of the offeror or seller; and the purchaser has full control of the virtual currency within 28 days of the transaction.

The 2020 Guidance took effect as of the date of its publication in the Federal Register. However, CFTC Chairman Heath P. Tarbert noted in his statement in support of the 2020 Guidance at the CFTC open meeting where it was approved unanimously that, to help maintain orderly and liquid digital asset markets, he anticipated that for a period of 90 days after publication, the CFTC will forbear from initiating enforcement actions addressing aspects of the 2020 Guidance “that were not plainly evident from prior CFTC guidance, enforcement actions, and case law.”²

Background

With certain exceptions, the CFTC has been granted exclusive jurisdiction over the marketplace for “retail commodity transactions,” which entail any agreement, contract or transaction in any commodity that is: (i) entered into with, or offered to (even if not entered into with), a person that is neither an eligible contract participant nor an eligible commercial entity (i.e., a retail customer); and (ii) 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 CEA further provides that, subject to certain exceptions, for purposes of the CFTC’s jurisdiction over the U.S. futures market,³ such an agreement, contract, or transaction will be treated “as if the agreement, contract, or transaction was a contract of sale of a commodity for future delivery” (i.e., a futures contract). However, the CEA excepts from CFTC jurisdiction 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.”⁴

In 2013, the CFTC issued an interpretation of the term “actual delivery” in this context (2013 Guidance) in which the CFTC explained that, in determining whether actual delivery has occurred, the CEA “requires consideration of evidence regarding delivery beyond the four corners of contract documents.”⁵ The 2013 Guidance provided a list of relevant factors the CFTC may consider when determining whether actual delivery has occurred, and stated that the CFTC would “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.” The 2013 Guidance also provided a non-exclusive list of examples to further clarify the meaning of actual delivery in the virtual currency context.⁶

Following court decisions related to the 2013 Guidance, the CFTC determined that virtual currency is a commodity, as that term is defined by CEA section 1a(9),⁷ and thus the CEA provides the CFTC with anti-fraud and market manipulation jurisdiction over virtual currencies even when they are purchased on a cash basis (e.g., not purchased on margin and not for delivery beyond 28 days). Subsequently, the CFTC issued a proposed interpretation and request for comment in December 2017 regarding the actual delivery exception within the specific context of retail commodity transactions in virtual currency (2017 Guidance).⁸

2020 Guidance

The 2020 Guidance solidifies the 2017 Guidance and clarifies the CFTC’s views concerning whether actual delivery has occurred in the context of retail commodity transactions in virtual currencies. Under the 2020 Guidance, actual delivery occurs in retail virtual currency transactions when: (1) a customer secures (i) 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) the ability to use the entire quantity of the commodity freely in commerce (away from any particular execution venue) no later than 28 days from the date of the transaction and at all times thereafter; 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) do not retain any interest in, legal right to, 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.

Similar to the 2013 Guidance, the 2020 Guidance offers the following examples that provide further direction as to the CFTC’s position regarding what constitutes actual delivery of virtual currencies.

Example 1: Actual delivery of virtual currency will have occurred if, within 28 days after entering into an agreement, contract, or transaction, there is a record on the relevant public distributed ledger or blockchain address 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 address to the purchaser’s blockchain address, over which the purchaser maintains sole possession and control. When an execution venue or other third party offeror acts as an intermediary, the virtual currency’s public distributed ledger should reflect the purchased virtual currency transferring from the counterparty seller’s blockchain address to the third party offeror’s blockchain address and, separately, from the third party offeror’s blockchain address to the purchaser’s blockchain address, over which the purchaser maintains sole possession and control.

Example 2: Actual delivery will have occurred if, within 28 days after entering into a transaction:

(1) the counterparty seller or offeror 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, operated by, or affiliated with, the counterparty seller (including any parent companies, subsidiaries, partners, agents, affiliates, and others acting in concert with the counterparty seller) 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 purchaser has secured full control over the virtual currency (e.g., the ability to remove as soon as technologically practicable and use freely up to the full amount of purchased commodity from the depository at any time, including by transferring to another depository of the customer’s choosing); and

(3) with respect to the commodity being delivered, no liens (or other interests or legal rights of the offeror, counterparty seller, or persons acting in concert with the offeror or counterparty seller on a similar basis) resulting or relating to the use of margin, leverage, or financing used to obtain the entire quantity of the commodity delivered will continue after the 28-day period has elapsed. This scenario assumes that no portion of the purchased commodity could be subjected to a forced sale or otherwise removed from the customer’s control as a method of satisfying this example.

Example 3: Actual delivery will not have occurred if, within 28 days of entering into a transaction, the full amount of the purchased commodity is not transferred away from a digital account or ledger system owned or operated by, or affiliated with, the offeror or counterparty seller (or their respective execution venues) and received by a separate, independent, appropriately licensed, depository or blockchain address in which the customer maintains possession and control in accordance with Example 2.

Example 4: 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 customer, 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, regardless of whether the agreement, contract, or transaction between the purchaser and offeror or counterparty seller purports to create an enforceable obligation to deliver the commodity to the customer.

Example 5: 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 customer and the offeror or counterparty seller (or persons acting in concert with the offeror or counterparty seller).

Conclusion

The 2020 Guidance reflects a continued effort by the CFTC to provide greater clarity to parties to any retail commodity transactions in light of experience and increased understanding of the evolution of digital assets and related markets.

As noted above, participants in the digital asset markets now have 90 days from the publication of the 2020 Guidance in the Federal Register (until August 22, 2020) before the CFTC will bring enforcement actions. Participants in this space should review the applicability of the 2020 Guidance to their business model and ensure that their business aligns with the requirements of the 2020 Guidance prior to that time.

Footnotes

1) Retail Commodity Transactions Involving Certain Digital Assets, 85 Fed. Reg. 37734 (June 24, 2020). This OnPoint summarizes the 2020 Guidance, and at times tracks it without the use of quotation marks.

2) Statement of Chairman Heath P. Tarbert in Support of Interpretive Guidance on Actual Delivery for Digital Assets (Mar. 24, 2020).

3) The CFTC’s jurisdiction over the U.S. futures market includes the CFTC’s authority to: (i) prohibit 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 under Section 4(a) of the CEA; (ii) regulate the ability of foreign boards of trade registered with the CFTC to provide direct access to U.S. persons under Section 4(b) of the CEA; and (iii) prohibit fraudulent conduct in connection with any contract of sale of any commodity in interstate commerce, among other things under Section 4b of the CEA.

4) CEA Section 2(c)(2)(D)(ii)(III)(aa).

5) Retail Commodity Transactions Under Commodity Exchange Act, 78 Fed. Reg. 52426, 52428 (Aug. 23, 2013).  

6) For instance, Example 4 in the 2013 Guidance provides that “Actual delivery will not have occurred if, within 28 days, the seller has purported to physically deliver the entire quantity of the commodity purchased by the buyer, including any portion of the purchase made using leverage, margin, or financing, and transfer title to that quantity of the commodity to the buyer, but the title document fails to identify the specific financial institution, depository, or storage facility with possession of the commodity, the quality specifications of the commodity, the identity of the party transferring title to the commodity to the buyer, and the segregation or allocation status of the commodity” (emphasis added).

7) See, e.g., CFTC v. Hunter Wise Commodities, LLC, et. al., 749 F.3d 967 (11th Cir. 2014) (noting that delivery “denotes a transfer of possession and control”); see also 2020 Guidance at 5 (noting that “the Commission determined that virtual currency is a commodity as that term is defined by CEA section 1a(9)” and citing to 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) and 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)).

8) Retail Commodity Transactions Involving Virtual Currency, 82 Fed. Reg. 60335 (Dec. 20, 2017).