Fear and Loathing ‘24: Crypto and the Election Part Two
What goes on at the CFTC anyway?
(credit: Dall-E)
I started Brogan Law to provide top quality legal services to individuals and entities with legal and regulatory questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their start up mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
Welcome back to the Brogan Law Newsletter! Last week we discussed the levers that the next President could pull at the US Securities and Exchange Commission (“SEC”) and how that might affect the regulation of cryptocurrency. The SEC isn’t the only federal agency on the ballot this year, though, so this week we’ll talk about another—the Commodities Futures and Trading Commission (“CFTC”). How will the election change the crypto regulatory environment at the second best known financial agency? Let’s discuss below.
As a reminder Brogan Law is non-partisan and takes no position on the role of federal agencies, though our clients might.
The CFTC
The CFTC itself was created by the Commodities Futures Trading Commission Act of 1974, but its history goes back far further. Officially, the futures market in the United States began at the Chicago Board of Trade[1] in 1848 where traders began to exchange “forward or ‘to-arrive’ contracts.” A futures contract, broadly, is a financial instrument through which parties agree to buy or sell some asset at a certain price in the future. These instruments are highly valuable for hedging risk and smoothing incomes in price-sensitive commodity production industries like agriculture and mining, and are also popular for speculating.[2]
Because of this, futures contracts have long been highly regulated. The federal government has taken an interest at least since the Cotton Futures Act of 1914, and especially since the adoption of the Commodities Exchange Act of 1936 (the “CEA”). Initially, the CEA governed the trade of a delimited list of agricultural commodities, and this list expanded over the years.[3] By the 1980s, the CFTC’s authority expanded to include exchange trading of option contracts and stock futures, which continued to grow with e.g. the Commodities Futures Modernization Act of 2000, allowing the sale of OTC derivative financial products.
Today, the CFTC has quite broad regulatory authority over global trade of derivatives, financial products whose value is determined by some independent outcome.[4] Much like the SEC, it operates as a commission with five members, which can make rules and bring enforcement actions both in administrative courts and federal court. Also like the SEC, the CFTC commissioners serve staggered five year terms, are appointed by the President and confirmed by the Senate, and no more than three may be of the same political party at any given time. Last week’s newsletter analysis of the President’s power to influence the SEC all applies here too.
The CFTC’s mandate arguably covers much of DeFi (financial products often fall into a CEA category), and it has been an active regulator in the space. Enforcement actions settled with Tether and successfully prosecuted against OokiDao are among the most influential for practitioners evaluating crypto projects. A recent action against KuCoin suggests that the current CFTC might continue to oversee large segments of the industry, including unregistered exchanges.
What does the Next Administration Portend?
Despite its robust enforcement, the CFTC has been the object of significant political focus because of the perception of certain members of the cryptocurrency industry that it is a favorable regulator compared to the SEC. There is some support for this, as major crypto players like Coinbase have struggled to find a path to legitimacy at the SEC, but have nonetheless been able to register with the CFTC.
Because of the composition of the CFTC, always including members of both parties, it is generally possible to roughly guess what positions the Commission might take under a new administration. Past Republican commissioners have argued that a Trump administration might liberalize enforcement and “embrace [ ] innovation.”
In one stark example of party differences at the Commission, the CFTC recently issued a Notice of Proposed Rulemaking seeking to classify certain “event contracts”, including those concerning election outcomes and e.g. award show results, as “contrary to the public interest.” This is jargon, but the rulemaking is directed at prohibiting so-called prediction markets, which have gained popularity in recent years. Markets like PredicIt and Polymarket allow betting on the outcomes of various events, both to facilitate hedging and to produce high quality predictive information on public sentiment.[5] The current CFTC really does not like them, and is currently embroiled in litigation to shut down PredictIt.
It is very likely that a Republican led CFTC would treat these issues differently. We know this, because Republican commissioners have consistently publicly dissented to actions by the CFTC to limit prediction market activity. Most recently, Commissioner Summer Mersinger dissented to the proposed event contract rulemaking described above, arguing that “it is hard not to conclude [ ] that [the proposed rule] is motivated more by a seemingly visceral antipathy to event contracts than by reasoned analysis.”
That said, even a Democrat led CFTC has had a softer hand here than one might expect of the SEC. This year, the CFTC approved prediction market ForecastEx’s registration as a Designated Contract Market (“DCM”).[6] Many industry observers were surprised by this, as the previous designation of the prediction market Kalshi had come near the end of Trump’s term. This may signal greater openness of a Democrat-led CFTC to novel financial products like crypto in the future.
Ultimately, a Republican administrations changing priorities at the SEC will likely end up having a greater effect on the regulation of cryptocurrency than at the CFTC, however these changes could redound here if enforcement is shifted between the agencies as a result. Even if Vice President Harris wins, if she chooses to replace Gary Gensler as SEC Chair, CFTC enforcement may rise to the fore. The exact character of that downstream enforcement, however, is impossible to predict.
But what else?
The SEC and the CFTC are probably the most important federal regulators of the cryptocurrency industry, but the are far from the only ones. We’ll return to those other actors in a future edition. If you have any questions about how these laws may apply to your business, you can always reach us at aaron@broganlaw.xyz.
[1] If you ever find yourself in the Chicago Board of Trade Building in the Loop of downtown Chicago, I recommend stopping at Ceres. You’ll learn a lot about the city.
[2] After all, someone has to take the other side of the trade from the grain merchants and industrialists.
[3] But not to onions, because the trade of onion futures has been banned in the United States since the Onions Futures Act of 1958, following years of successful market manipulation by certain nefarious 1950s onion traders.
[4] The CFTC actually has reams of definitions of things it can regulate, but practically, assuming any financial product designed to speculate on future events is a good bet.
[5] Strictly, prediction markets are not “crypto” per se, but for somewhat idiosyncratic reasons the crypto industry has long found common cause with prediction markets. Polymarket, one of the largest and most influential prediction markets, operates on crypto rails, with other startups following its lead.
[6] Meaning that it essentially has a license to self-certify and legally list event contracts, provided they are not of a kind prohibited by CFTC Regulation 40.11.
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