The Future of a Commodity: Bitcoin Regulation and the CFTC

Mark Wetjen, a commissioner at the US Commodities Futures Trading Commission (CFTC), has made it known loud and clear recently that bitcoin fits the legal definition of a commodity and that the CFTC has authority to regulate the digital currency.

So what would the CFTC's regulation of bitcoin actually look like? For the average bitcoin user and business, probably not anything dramatic. For people who buy and sell bitcoins daily, though, there might be a new sheriff in town.

The history of futures trading

For starters, the CFTC is called the Commodities Futures Trading Commission for a reason. That’s because the CFTC’s core power is not to regulate commodities themselves, but to regulate commodities futures – though the CFTC might not be limited to this role, as we’ll see below. Prices for traditional commodities like wheat and corn fluctuate widely – not unlike bitcoin prices – so buyers and sellers long ago sought a way to lock in a good rate before harvest time.

This is the origin of commodities futures, which are standardized, tradable contracts to buy or sell commodities at a later date for a fixed price. As futures contracts grew in sophistication, so did traders . . . and cheaters. The CFTC (and its predecessors) were created to ensure the integrity of these futures markets in the US.

So the heaviest CFTC regulation of bitcoin would likely concern not the cryptocurrency itself, but derivative bitcoin hedging contracts. Issuers involved with bitcoin futures might have to register with the CFTC and consequently jump though a number of regulatory hoops.

The special case of bitcoin markets

In truth, that future is already partly here: Commissioner Wetjen’s comments on bitcoin coincided with the CFTC’s approval of the first swap pegged to the price of a bitcoin. Although a swap isn’t actually a futures contract (a futures contract contemplates purchase and delivery of a commodity; a swap only involves payments of money based on price movements), it serves a similar economic function.

But there’s also a way that the CFTC can do more than just regulate hedging contracts; it could regulate bitcoin directly through its power to police “market manipulation”.

In fact, if Commissioner Wetjen is right that bitcoin actually is a commodity, then people who manipulate its markets can even be sent to jail. So now we’re not just talking about regulating bitcoin futures or swaps, but regulating the trading of bitcoins themselves.

What constitutes market manipulation? There’s no universal agreement on this question, and some judges have opted for an “I know it when I see it” approach.

Generally, though, market manipulation usually involves making fraudulent or deceptive trades aimed at moving a commodity price away from its true value. Here’s a simplified example: one person sets up several separate accounts, and then makes numerous, large volume public trades to himself, each time making it look like someone paid well above the prevailing market price. Soon, others think that the market price for the commodity has genuinely risen, and the manipulator then sells his holdings to others at that higher artificial price.

Regulation to protect from fraud

The potential for fraud in the bitcoin markets only hurts uptake and investment. Some might conclude, then, that it might not be such a bad thing if the CFTC does deem bitcoin trading to fall under its jurisdiction.

Under this view, policing market manipulation is not the kind of full-fledged, invasive regulation that many fear squelches innovation. Instead, the function that the CFTC would serve would be to watch, investigate when things look fishy, and hopefully weed out fraud.

Rather than tinkering with fundamental concepts in bitcoin use, this regulation would presumably be aimed at making sure that people can buy or sell bitcoins without being ripped off. Ideally, the CFTC’s enforcement power would increase the public’s trust in the soundness of the market for bitcoins.

Of course, as a lawyer who represents people investigated for regulatory violations, I know that even the best-intentioned regulations can ensnare well-meaning individuals and businesses. It's also possible that the CFTC could take an overly-intrusive approach to enforcement, or require unreasonable amounts of information from market participants.

No matter what your view on this situation, if you’re a frequent bitcoin buyer and seller you’d be wise to keep a close eye on the new sheriff in town, and to have a plan in place to avoid becoming ensnared in costly regulatory disputes.

Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.

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