The recently introduced Digital Commodities Consumer Protection Act would hand substantial oversight over the cryptocurrency industry to the Commodity Futures Trading Commission (CFTC), defining certain digital assets as “digital commodities,” though the definition contains a number of ambiguities and potential interpretive quagmires.
The bipartisan bill was introduced by Sens. Debbie Stabenow, D-Mich., and John Boozman, R-Ariz., the top senators on the Committee of Agriculture, Nutrition and Forestry. (Sens. Cory Booker, D-N.J., and John Thune, R-S.D., are other backers.) As currently drafted, the bill would give the CFTC sole oversight over a newly created asset class termed “digital commodities,” which would expressly include bitcoin and ethereum along with certain other “fungible digital form[s] of personal property that can be possessed and transferred person-to-person without necessary reliance on an intermediary.” The bill would grant general authority to the CFTC to regulate spot markets for digital commodities and envisions a world where spot transactions in cryptocurrencies meeting the new definition of “digital commodity” will be subject to extensive regulation by the CFTC, roughly replicating the regulatory approach currently applicable to derivatives on commodities (including futures, options, swaps and so-called “retail commodity transactions”). In contrast, the CFTC’s current jurisdiction over spot commodity markets is limited to its general anti-fraud and anti-manipulation authority.
Thus, the bill would result in a major expansion of CFTC jurisdiction—one which the CFTC would apparently welcome. In his keynote address at the July 25, 2022, Brookings Institution webcast “The Future of Crypto Regulation,” CFTC Chairman Rostin Behnam stated,
The CFTC is ready and well situated to address the risks in the cash markets for digital assets through direct oversight. At its core, the CFTC is a markets-focused regulator that works to ensure market integrity and vibrancy through oversight of exchanges and clearinghouses that are required to comply with well-established core principles and regulations, as well as through oversight of market intermediaries and participants.
The implications for the cryptocurrency industry of this jurisdictional expansion would be far-reaching. Many centralized crypto-exchanges would come under strict regulation as digital commodity trading facilities and the transactions and cryptocurrencies they trade would require CFTC approval. Many crypto-funds would come under regulation as commodity pool operators and/or commodity trading advisers, subject to a variety of regulatory requirements. Many platforms that maintain cryptocurrency accounts for their customers could come under CFTC regulation as digital commodity custodians.
A glaring hole in the bill is that it does not resolve how jurisdiction over digital assets would be allocated between the CFTC and the SEC. At the heart of the matter is the definition of a “digital commodity.” On the one hand, the term explicitly includes: “property commonly known as cryptocurrency or virtual currency, such as Bitcoin and Ether” but, on the other hand, explicitly excludes securities. By carving out securities, the definition of digital commodity does nothing to clarify under what circumstances digital assets constitute securities, apparently leaving it to the discretion of the SEC and its application of the Howey test. This arrives at a moment when the two regulators appear to be jousting over the proper approach to regulation of the digital assets markets, with the CFTC apparently upset by the SEC’s proclivity for “regulation by enforcement” rather than joint rulemaking. The apparent conflict heated up recently when the SEC designated several digital currencies as securities as part of an insider trading case brought against a former product manager at the crypto-exchange Coinbase. After the SEC action was announced, CFTC Commissioner Caroline Pham stated:
The SEC complaint alleges that dozens of digital assets, including those that could be described as utility tokens and/or certain tokens relating to decentralized autonomous organizations (DAOs), are securities. The SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together. Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input—through notice-and-comment rulemaking pursuant to the Administrative Procedure Act. Regulatory clarity comes from being out in the open, not in the dark.
The bill also does not clearly address some of the other thorny legal issues raised by Commissioner Pham’s comments. For example, the status of “utility tokens” under the bill is unclear. The bill provides that the CFTC would not have any jurisdiction over transactions in which a merchant or consumer uses a digital commodity solely for the purchase or sale of either a good or service. It is hard to know whether or how this would apply to so-called “utility tokens.” Nor does the bill address the status of decentralized finance, or DeFi, transactions. By building on certain traditional definitions, the bill sidesteps the question of whether decentralized platforms and transactions are within its scope. For example, the term “digital commodity trading facility” is defined as “a trading facility that facilitates the execution or trading of digital commodity trades between persons.” A trading facility is defined in Section 1a(51), in part, as “a person or group of persons that constitutes, maintains, or provides a physical or electronic facility or system…” and “persons” are defined as individuals, partnerships, associations or corporations. Are DEXs, or “decentralized exchanges,” digital commodity trading facilities? If so, are all holders of governance tokens in the DEX responsible for compliance? Nor does the bill clearly address whether NFTs are within its scope. The definition of “digital commodity” is limited to “fungible digital forms of personal property,” which on the surface might lead one to believe that “non-fungible tokens” are excluded. However, “fungibility” is not defined in the Commodity Exchange Act. As the use of NFTs expands, including through NFT farming, is it clear that they would be excluded from the CFTC’s jurisdiction?
The bill also creates a funding instrument for CFTC oversight by requiring the regulator to impose user fees on digital commodity platforms meant to fully offset costs associated with the CFTC’s oversight of and actions related to digital commodity markets. Thus, all digital commodity platforms registered with the CFTC will be required to pay this fee annually.
The Agriculture Committee is expected to hold a hearing on the bill as early as September 2022, according to Senate Agriculture Committee Chairwoman Debbie Stabenow.
Provisions included in the proposed bill:
Definitions. The Act defines “digital commodity” to be a “fungible digital form of personal property that can be possessed and transferred person-to-person without necessary reliance on an intermediary.” Bitcoin and ether are specifically defined as digital commodities. Digital commodities expressly do not include interests in physical commodities, securities or digital currency backed by the United States government. As discussed above, the various characteristics delineating commodities and securities are not clarified in the text. The definition of “commodity” in the Commodity Exchange Act (the Act) is expanded to include “digital commodity.”
New categories of registration such “digital commodity broker,” “digital commodity custodian,” “digital commodity dealer” and “digital commodity trading facility” (collectively, “digital commodity platforms”) are added to the Act, with the associated persons of digital commodity brokers and digital commodity dealers also being referenced. Engaging solely in mining activity to validate transactions does not trigger registration as a digital commodity platform.
CFTC Jurisdiction. The CFTC is granted exclusive jurisdiction over digital commodity trades. Excluded from such jurisdiction are transactions in which a merchant or consumer uses a digital commodity for the sole purchase or sale of either a good or service.
Digital Commodity Platforms
Registration. Any entity acting as a digital commodity platform must register with the CFTC in one or more of the applicable categories, such as digital commodity broker, custodian, dealer or trading facility.
Core Principles for Digital Commodity Platform. Any digital commodity platform must comply with all applicable core principles under the Act. These principles are established to protect customers along with the integrity of the digital commodity marketplace.
Such principles include that digital commodity trading facilities can only transact when the trades are not readily susceptible to manipulation. Markets provided must be competitive, open and efficient, with ongoing monitoring. Market participants should be protected from abuse, and timely trading information should be made public.
Fair and objective pricing, with ongoing recordkeeping, is further required of those enabling trading, with this information subject to disclosure to the CFTC upon request. Risk management systems and business conduct standards are mandated for all digital commodity platforms, as is the maintenance of adequate financial resources. Also required are system safeguards to protect against cybersecurity and other operational risks. CFTC requirements for the treatment of customer assets must also be met.
Rules Governing Margined or Leveraged Trading. The CFTC is authorized to make rules governing margined, leveraged or financed digital commodity trades.
Contract Listings, Rules and Rule Amendments for Digital Commodity Trading Facilities. A set process under which a digital commodity trading facilities may list for trading any digital commodity, can contract and can implement new rules is to be established under the Act. The CFTC has the authority to disapprove or revoke a contract listing or rule if it is inconsistent with the guidelines under the Act. Certain information about digital commodity contracts listed for trading, including those with a fixed price, must be maintained by digital commodity trading facilities.
Product Listing for Digital Commodity Brokers and Digital Commodity Dealers. Digital commodity dealers and brokers cannot trade, or enable a trade, for a digital commodity readily susceptible to manipulation. Further, digital commodity brokers and dealers are subject to common listing and disclosure requirements also applicable to digital commodity trading facilities when implementing contracts on digital commodities.
Customer Protection. The CFTC is required to adopt customer protection rules, to communicate in a fair and balanced manner and to establish standards for the platform’s marketing and advertising.
Prohibition on Fraud, Deception and Manipulation. Digital commodity platforms are prohibited from fraudulent, deceptive or manipulative acts.
Self-Regulation. Digital commodity brokers, digital commodity custodians and digital commodity dealers must register as members of a registered futures association created by the CFTC, and to which the CFTC can delegate registration functions.
Dual Registration. Digital commodity platform registered with the CFTC can also register with the SEC.
Fees for Registration. All digital commodity platforms registered with the CFTC are required to pay a fee to fund annual costs of registration, oversight, education and outreach in the digital commodity markets. Annual fees will be set on an ongoing basis to offset appropriations determined by Congress. Fees are limited to those assessed on digital commodity platforms and may solely fund digital commodity activities.
Customer Education and Outreach. The CFTC is authorized under the Act to provide education and outreach to customers engaging in digital commodity markets.
Inspection. The CFTC has the authority to inspect and monitor digital commodity platforms.
Retail Commodity Transactions. A trade in a digital commodity will not be subject to the requirements of exchange trading applicable to retail, leveraged and non-spot commodity transactions under the Act.
Applicability. The Act covers actions occurring in the United States, along with those which have “a reasonably significant effect within the United States” or impact a United States person. This would immediately expand the CFTC’s ability to regulate digital commodities overseas. Pursuant to Dodd-Frank, Section 2(i) contains a provision stating that the “provisions of this Act relating to swaps,” as opposed to certain other assets, can “apply to activities outside the United States if they “have a direct and significant connection with activities in, or effect on, commerce of the United States.” Courts have made clear that this kind of “clear statement of extraterritorial application” is necessary to apply a provision of the CEA overseas. See, e.g., Prime Int’l Trading, Ltd. v. BP P.L.C., 937 F.3d 94, 103 (2d Cir. 2019) (quotations and citations omitted). However, today, the CFTC does not have this kind of regulatory authority regarding digital assets. The bill seeks to change that.
Registration of Association Persons. Associated persons of digital commodity brokers and digital commodity dealers must register with the CFTC.
Acceptable Business Practices under Core Principles. The CFTC is authorized to issue interpretations regarding acceptable business practices under digital commodity platform core principles.
Anti-money Laundering. Digital commodity platforms are designated financial institutions under the Bank Secrecy Act and are subject to the related laws and other legal requirements.
Registration of Commodity Dealers and Association Persons. The list of entities registered by the CFTC is expanded to include those covered under the Act.
Amendments to Title 11 of the Bankruptcy Code. The Act extends relevant provisions of the Bankruptcy Code to digital commodity trades, allowing for the same protections.
Examination and Publication of Energy Consumption in Digital Commodity Markets. The CFTC must complete a report detailing the energy consumption and sources of energy used in the creation and transfer of digital commodities. This information must be published on the CFTC website and timely updated.
Report on Historically Underserved Customers Participating in Digital Commodity Markets. The CFTC is directed to examine the racial, ethnic and gender demographics of customers engaging in digital commodity markets. The CFTC is instructed to then issue a follow up report addressing how such demographic information will influence rulemaking, education and outreach efforts.
Preemption of State Laws. The registration requirements under state law relating to money transmission, virtual currency and commodity brokers are preempted and given to the CFTC.
Regulations. The CFTC is authorized to write rules and regulations to implement the sections under the Act added to the Commodity Exchange Act.
Applicability. The Act will not be applicable until the date of effectiveness of the final rule requiring registration of digital commodity platforms under this Act.
The above points address the major provisions of the Act, though further detail in the bill as written provides more detailed guidance and requirements.
A few other bills proposing to regulate crypto assets have been released this year or are pending. They primarily include:
The Digital Commodity Exchange Act of 2022 (introduced April 2022) would give the CFTC the authority to directly regulate digital assets that meet the definition of a commodity. This proposal allows exchanges to register with the CFTC and get certain benefits for doing so but would not mandate such registration. The Lummis-Gillibrand Responsible Financial Innovation Act (introduced June 2022) is a more sweeping bill meant to establish broad rules for the crypto asset community. The House Financial Services Committee has also promised stablecoin legislation, but no proposal has been released to date.
The Digital Commodities Consumer Protection Act of 2022, if enacted as drafted, would give new broad powers to the CFTC to regulate certain digital assets, but the actual contours of its scope remain unclear.