In a webinar titled Trading Bitcoin: Legal and Compliance Considerations for Trading and Facilitating Transactions in Bitcoin, a team of Katten Muchin Rosenman attorneys explored the vast, murky and ever-expanding terrain surrounding cryptocurrencies and CFTC, SEC, FinCen, and NY Department of Financial Services regulation. The Katten team also explored emerging litigation issues, as well as providing practical insights and advice to industry players dealing with these issues. Below are some highlights from the webinar:
Three types of cryptocurrencies. The webinar kicked off with a discussion of the three basic types of cryptocurrencies. First, there are those that serve as a medium of exchange and store of value, like Bitcoin. Second, there are those that reflect an interest in an enterprise that is generally be deemed to be a security and might be offered as part of an initial coin offering (ICO). Third there are utility tokens that are associated with the rights to use a product or service. These can also be deemed to be securities. A particular cryptocurrency may possess more than one of these qualities and can morph from one function to another during its lifetime.
CFTC regulation and potential manipulation. Gary DeWaal led the discussion regarding CFTC-regulated exchanges and the recently launched futures products related to Bitcoin at the CBOE Futures Exchange on December 10, as well as the CME product, which will launch on December 17. Two other futures exchanges also have Bitcoin related products in the pipeline. Two swap execution facilities (SEFs) currently host Bitcoin related swap products, although retail customers do not have access to the SEFs.
In response to a question about the potential for manipulating the settlement price for the Bitcoin futures contracts, DeWaal noted that both sets of exchange traded futures contracts were cash settled and that the underlying Bitcoin exchanges were not subject to functional regulation. He explained that these exchanges do not have trade practice requirements, nor is there an obligation to monitor for manipulation by those exchanges. He observed, though, that these exchanges might be subject to some forms of prudential regulation which would include anti-money laundering, capital, and cyber security requirements.
Practical concerns related to Bitcoin futures trading. DeWaal raised a number of practical considerations for firms trading in or facilitating trading in Bitcoin futures, including:
- How adequate are the firm's disclosures related to unusual characteristics of Bitcoin futures? (For example, a customer’s margin requirements may routinely increase when a customer's long positions increase in value)
- Do the firm's disclosures adequately describe unusual conditions the firm may have imposed on customers trading Bitcoin futures? (For example, naked short positions may not be allowed, no give-in trades be permitted, or a premium to exchange-minimum margin may be required).
- Has the firm considered highlighting exchanges' authority, if applicable, to set market prices unrelated to market activity under extraordinary circumstances?
- Is the firm's customer agreement adequately drafted to authorize the firm to take actions it may deem warranted should Bitcoin futures experience extraordinary volatility?
- How should an account be liquidated when a client defaults in a margin payment related to positions in Bitcoin futures or under other circumstances?
Similarly, in October 2017, the SEC encouraged two sponsors of exchange traded funds (ETFs) tied to Bitcoin to withdraw their applications. The webinar presenters noted, however, the SEC may be revisiting the Winklevoss Trust and other potential ETF Bitcoin related products sometime in the coming year.
Litigation. One of the webinar presenters observed that, while there has been some litigation related to cryptocurrencies, the activity has not been substantial. Looking ahead, he foresees much of the litigation will mirror regulatory enforcement actions. Additionally, significant market losses will also likely trigger an increase in litigation activity. Other particular areas he saw that will likely be subject of litigation might be related to the resale of unregistered securities, forced liquidations, trading and delivery issues, as well IPO related fraud and Ponzi related actions where investor funds have seemingly disappeared.