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Can the CFTC Get a Piece of the Bitcoin Action?

4/7/2014

1 Comment

 
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By Sam Nadler

Sam Nadler is a junior at Vanderbilt University studying History.

On March 24, Tera Group Inc., a company based in Summit, NJ, announced the finalization of an agreement for the first platform for Bitcoin-linked swaps. This announcement comes on the heels of months of speculation about the regulation of Bitcoin by U.S. financial regulators. The pseudo-anonymous peer-to-peer digital currency has recently dominated news headlines. From volatile price swings to the bankruptcy of the leading exchange Mt. Gox, many have called for regulators to increase the transparency and stability of Bitcoin markets. Furthermore, Bitcoin's continual increase in popularity has hastened the efforts of Federal agencies to clarify legal questions surrounding regulatory jurisdiction over Bitcoin.  

While Federal Reserve Chairwoman Janet Yellen has publically stated that the Federal Reserve does not have the power to regulate Bitcoin "in any way," the Commodities Futures Trading Commission has undertaken preliminary steps that may lead to Bitcoin regulation. [1] The Commodities Futures Trading Commission (CFTC), in charge of preventing manipulation of commodities markets, has made public internal discussions regarding the legality and feasibility of Bitcoin market regulation. While the CFTC has yet to enact policy or determine if they have the legal authority to do so, current developments are clarifying the legality of Bitcoin-related regulations and may pave the way to regulation in the near future. 

On March 12, Mark Wetjen, acting chairman of the CTFC, said that Bitcoin is definitely a commodity but there is a "question about whether or not there is some derivative contract based on, or denominated in a virtual currency and whether that's listed on an exchange."[2] The answer to this question is crucial because the CFTC has authority to regulate commodities future contracts, not the physical commodities themselves.[3]

The 1974 Commodity Futures Trading Commission Act §2(a)(1)(A) gave the CFTC “exclusive jurisdiction” over all transactions that are substantially similar to, or commonly known as, an “option”, “bid”, “offer”, “put”, “call”, and “transactions involving contracts of sale of a commodity for future delivery.” These transactions are associated with options contracts. Options contracts give buyers and sellers the right to buy or sell a specified amount of commodity at a certain price (the strike price) within a range of dates. Options contracts do not obligate the seller to send nor the buyer to buy, they are often speculative vehicles or used for hedging transactions. The CFTC only has the legal ability to regulate these options contracts and not actual commodity contracts. Bitcoin contracts up to this point have not fit the Act's description and have failed to meet major criterion for options contracts established by U.S. courts.[4]

Many believe Tera's platform for buying and selling swaps linked to Bitcoin is the first step towards regulatory oversight by the CFTC.[5]  Swaps let investors, companies and institutions exchange one kind of payment for another. They can be used to speculate on prices or to hedge risk from trading.[6] Legal agreements like the one Tera Group created can spur derivatives trading by offering investors a template for structuring deals. Evidence of this derivatives trading would likely justify CFTC regulation. In fact, the Tera Group has already reached out to the CFTC to work on a regulated Bitcoin swap.[7]

Tera Group's announcement is sure to be one of many that increase the complexity of Bitcoin and Bitcoin trading. While the norm to this point has been simple exchanges of currency for Bitcoin, it is very likely that the Bitcoin-linked complex financial instruments will soon proliferate as the currency's popularity increases. At this point, the CFTC is still trying to determine its jurisdiction over Bitcoin, but if Tera's communication with them is any indication, these legal questions will soon become clearer. As this story continues to unfold, there is little doubt that CFTC will play an integral role in determining the future of emerging Bitcoin markets and Bitcoin-linked financial instruments.


[1] Ackerman, Andrew. "CFTC Studies Jurisdiction Over Bitcoin." The Wall Street Journal. WSJ.com, 11 Mar. 2014. Web 24 Mar. 2014.
<http://blogs.wsj.com/moneybeat/2014/03/11/cftc-studying-jurisdiction-over-bitcoin>
[2] Miedema, Douwe, "U.S. Swaps Watchdog Considering Bitcoin Regulation." Reuters. Reuters.com, 11 Mar. 2014. Web 24 Mar. 2014.  <http://www.reuters.com/article/2014/03/11/us-bitcoin-regulation-idUSBREA2A1W020140311>
[3] 7 U.S.C. § 2
[4] "What U.S. Regulations Apply to Bitcoin as Commodities?" Bitcoin and Trading Titan Blog. blog.bitcointitan.com, 2012, Web 25 Mar. 2014. <http://blog.bitcointitan.com/post/17789738826/what-u-s-regulations-apply-to-bitcoins-as-commodities>
[5]Miedema, Douwe, "Tera Exchange Announces First Bitcoin Derivative." Reuters. Reuters.com, 24 Mar. 2014. Web 24 Mar. 2014.
< http://www.reuters.com/article/2014/03/24/bitcoin-derivatives-idUSL1N0ML11320140324>
[6]Leising, Matthew and Brush, Silla, "Bitcoin Swaps Near Reality as Tera Creates Legal Framework." Bloomberg. Bloomberg.com, 24 Mar. 2014, Web 24 Mar 2014.  <http://www.bloomberg.com/news/2014-03-24/bitcoin-swaps-near-reality-as-tera-group-forms-legal-framework.html>
[7] Vaishampayan, Saumya, "Bitcoin Swap Agreement Could Lead to Regulated Derivatives." Wall Street Journal Marketwatch. blogs.marketwatch.com, 24 Mar 2014, Web 24 Mar. 2014. <http://blogs.marketwatch.com/thetell/2014/03/24/bitcoin-swap-agreement-could-lead-to-regulated-derivatives>


Photo Credit: Flickr user Antana
1 Comment
Barbara Friedel
4/29/2014 12:25:46 am

Helpful background for a growing and somewhat complex new turn in the global economy.

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