Rostin Behnam, chairman of the Commodity Futures Trading Commission, said the US patchwork of regulation over digital assets is proving to be increasingly inadequate.
Behnam gave the keynote address at the Brookings Institution on July 25 and highlighted that regulation has reached an inflection point as the digital asset industry in the US does not fall under a single comprehensive regulatory regime.
“Instead, the CFTC, other federal agencies, and state regulators are most often collectively compared to a patchwork blanket that is increasingly proving inadequate as temperatures drop and vulnerabilities lay bare,” he said.
The CFTC is responsible for regulating commodity derivatives while the SEC regulates securities, and there are also state regulators who have been setting their own rules. Behnam said the US multiple-regulator approach could best be described as “ad hoc.”
His speech came after the Securities and Exchange Commission announced insider trading charges against a former Coinbase product manager regarding certain crypto assets that would be made available for trading on the Coinbase platform and declared that nine crypto assets were securities, under the regulation of the SEC.
Caroline Pham, CFTC Commissioner, said in a statement that the case is a “striking example” of regulation by enforcement.
“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,” she said. “The SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together.
Paul Grewal, chief legal officer of Coinbase, also disagreed with the SEC and said in a blog: “Coinbase does not list securities on its platform. Period.”
5/ This is another example of regulation by enforcement on behalf of the SEC, which is not an effective or transparent approach to regulation. More in our blog -> https://t.co/SaacvrZEiU
— paulgrewal.eth (@iampaulgrewal) July 21, 2022
Grewal wrote: “We, respectfully, 100% disagree with the SEC’s decision to file these securities fraud charges and the substance of the charges themselves.”
Coinbase has also filed a petition for rule making with the SEC calling for actual rule making so the crypto securities market has a chance to develop.
Faryar Shirzad, chief policy officer of Coinbase, said in a blog that the crypto markets could be expanded to offer crypto securities, subject to SEC regulation and governance, thereby giving investors new ways to invest in crypto. Shirzad wrote: “And opening debt and equity securities to tokenization would promote efficiency and resiliency in traditional markets.”
Retail involvement
Behnam noted that one fifth of US adults are estimated to have invested in or otherwise used cryptocurrency and that each digital asset is empowered by the free, largely unfettered, flow of information and relatively low barriers to access as the market has developed in the absence of a firmly demarcated regulatory perimeter.
“The onset of the current ‘crypto winter’ now blanketing the streets from Main to Wall, is further invigorating the call for a technology-neutral regulatory approach, guided by the risks within the crypto ecosystem, and not by risks within the underlying technology that makes it possible,” he added.
The US relies on the development of cooperative arrangements between regulators but this has been made more difficult by the rapid emergence and development of the digital asset market outside the traditional financial market structures according to Behnam.
“Even the strongest cooperative relationships may not yield the efficiency we need to put hard and fast stops to misconduct that increasingly has impacts beyond individual investors,”he added.
The first derivatives with an underlying digital asset commodity came fully within the CFTC’s direct oversight in 2017. CME and Cboe self-certified the first bitcoin futures contracts for trading and the first bitcoin binary options were self-certified by the Cantor Exchange.
“At that time, I urged for greater action to provide legal certainty with respect to the process for evaluating new products,” Behnam said. “Innovators and regulators alike were dealing with an emerging asset class in what was, for the most part, a regulatory vacuum.”
He praised President Biden’s Executive Order on Ensuring Responsible Development of Digital Assets for pushing regulatory action as the number of digital assets in circulation has grown and monthly trading volumes on exchanges have exceeded $1 trillion, with the derivatives market growing even larger.
“The CFTC is ready and well situated to address the risks in the cash markets for digital assets through direct oversight,” Behnam said. “While the CFTC does not have direct statutory authority to regulate cash markets, the CFTC maintains anti-fraud, false reporting, and anti-manipulation enforcement authority over commodity cash markets in interstate commerce.”
For example in 2021 the CFTC filed more than 20 enforcement actions alleging digital asset-related misconduct and this has continued this year. Behnam argued that the level of retail participation in the digital asset commodity cash market means it would benefit from CFTC oversight. In addition, retail participation in bitcoin futures is more than double that in other futures markets.
Recent CFTC studies found that retail participants make up approximately 25% of long open interest in the Bitcoin futures market, while it is between 5% to 11% in other commodity futures markets.
Declining digital assets prices could mean significantly more severe losses for lower-income investors, with knock-on effects penetrating the greater economy. In addition, technical complexities around securing and transacting in digital assets, particularly issues around custody, have resulted in numerous platforms losing funds to hacks, exploits, and poor cyber security.
“The lack of a comprehensive regulatory regime applicable to businesses operating in the digital asset market has led to inconsistent practices around issues such as trade settlement, conflicts of interest, data reporting, and cyber security,” said Behnam. “All of this suggests that, as with any trading market, the digital asset market would benefit from uniform imposition of requirements focused on ensuring certain core principles, including market integrity, customer protection, and market stability.”
Behnam continued that many digital asset-related companies now operate CFTC-registered exchanges, and the regulator’s Division of Market Oversight is reviewing new products tied to digital assets both from these new and more traditional registrants.
“I have asked the staff to be proactive in considering the extent to which our authority can be leveraged to bring these novel products into the regulatory fold to ensure important protections for customers and market integrity provided by CFTC regulation“ he added.
CFTC’s division of clearing and risk has also been reviewing novel market structures.
“To that end, I would like to take the opportunity to announce that LabCFTC is evolving in new ways and will take on a new identity as the Office of Technology Innovation (OTI) with an updated operating model,” said Behnam.
