On March 24, the Commodity Futures Trading Commission (“CFTC”) released its Final Interpretive Guidance on Actual Delivery for Digital Assets (“Final Interpretation”), addressing longstanding questions regarding which digital asset transactions could be deemed “retail commodity transactions” under the Commodity Exchange Act (“CEA”). The Final Interpretation comes two years after the CFTC issued proposed interpretive guidance (“Proposed Interpretation”).
Under the CEA, the CFTC has jurisdiction over “retail commodity transactions,” which are defined to cover the offer or sale of any agreement, contract, or transaction in any commodity on a leveraged, margined or financed basis with any retail customer by any offeror, counterparty, or affiliated person acting in concert. No retail commodity transactions may be conducted off of a regulated futures exchange, unless the transaction fits within an exception.
One such exception exists where the transaction results in “actual delivery” of the entire commodity within 28 days. However, neither the CEA nor any CFTC regulation defines the term “actual delivery.” Instead, the CFTC first issued guidance on the meaning of the term in 2013 (the “2013 Guidance”).
The 2013 Guidance pre-dated the CFTC’s initial determination that virtual currencies met the CEA definition of a “commodity”, and thus did not address the idiosyncrasies of actual delivery of digital assets recorded using blockchain technology. Instead, the CFTC first confronted the issue in virtual currency markets via enforcement. Following this initial guidance by enforcement, the CFTC issued its Proposed Interpretation in December 2017.
The Final Interpretation
Pursuant to the Final Interpretation, the CFTC indicated that “actual delivery” has occurred in virtual currency transactions when the following two elements are met:
(1) No later than 28 days from the date of the transaction, a customer (i) secures possession and control of the entire quantity of the virtual currency, whether it was purchased on margin, or using leverage, or any other financing arrangement, and (ii) may use it freely in commerce (both within and away from any particular platform); and
(2) The offeror and counterparty seller (including any of their respective affiliates or other persons acting in concert with either of them) do not retain any interest in or control over any of the virtual currency purchased on margin, leverage, or other financing arrangement at the expiration of 28 days from the date of the transaction.
The Final Interpretation also included additional guidance in several key areas:
- What Constitutes “Virtual Currency”? Under the Final Interpretation, the term “virtual currency” encompasses “any digital representation of value…that functions as a medium of exchange, and any other digital unit of account that is used as a form of currency (e., transferred from one party to another as a medium of exchange); may be manifested through units, tokens, or coins, among other things; and may be distributed by way of digital ‘smart contracts,’ among other structures.” For those digital assets that do not serve as a medium of exchange or otherwise fall within scope of the Final Interpretation, market participants should instead look to the 2013 Guidance regarding “actual delivery” for other types of commodities.
- Who is an “Offeror” or “Counterparty Seller”? The CFTC acknowledged that some virtual currency trade execution platforms enable purchasers to source financing or leverage for a transaction from third parties. The CFTC cautioned that such third parties would be considered to be “acting in concert with the offeror or counterparty seller,” thus subjecting them to the retail commodity transaction prohibition.
Additionally, the CFTC interpreted the term “offeror” to extend to persons “presenting, soliciting, or otherwise facilitating ‘retail commodity transactions,’” including individuals or groups that have control over the blockchain protocol that is offering retail commodity transactions. This very broad conception seems likely to pose issues for parties operating unpermissioned blockchains that do not police the occurrence of retail commodity transactions over the blockchain. Such a position mirrors the similarly broad scope of jurisdiction that the SEC has taken towards control persons and creators of “decentralized” exchanges of securities tokens.
- What Constitutes Possession and Control? The CFTC clarified that full possession and control is demonstrated by physical settlement, where all of the virtual currency is transferred to a separate entity from the offeror and its trade execution venue, which is satisfied where either:
- The entire amount of virtual currency purchased is transferred to the purchaser’s blockchain address (over which the purchaser has sole possession and control); or
- The entire quantity of the of virtual currency is delivered into the possession of a third-party depository (which may only be affiliated with the execution venue subject to the conditions discussed below) under an agreement with the purchaser, who has also secured full control over the virtual currency, evidenced by the ability to remove and use the full amount of the purchased commodity at any time.
By contrast, actual delivery has not occurred if the purchaser or its depository has not received the full amount of virtual currency purchased in one of these manners. Further, mere book entry transfers on the books of the offeror, counterparty seller, or their respective execution venues will not suffice to demonstrate “actual delivery.”
- When Does Delivery to an Affiliated Depository Qualify? The CFTC further required that, in order for delivery to a depository that is affiliated with the offeror or counterparty seller to qualify as “actual delivery,” the depository must be:
- A “financial institution” under Section 1a(21) of the CEA;
- A separate line of business from the offeror not subject to its’ control (although they may be under common control);
- A separate legal entity from the offeror and any offeror execution venue;
- Predominantly operated for the purpose of providing custodial services;
- Appropriately licensed by state or federal authorities, or a self-regulatory organization authorized by state or federal authorities, to provide custodial services in the customer’s jurisdiction;
- An offeror of digital asset cold storage options to such customers; and
- Contractually authorized to act as the customer’s agent.
- What Is the Status of Principal Trading? The CFTC expressed concern for offerors acting as both principal to a trade and taking the opposite side of a retail commodity transaction, especially within a self-contained environment. In particular, the CFTC indicated this type of “bucket shop” structure may create situations in which actual delivery fails to occur. However, the CFTC also noted that as the CEA’s provisions on retail commodity transactions do not address these conflicts directly, the CFTC will consider their presence merely as “a factor weighing against demonstration of actual delivery,” as opposed to adopting an outright ban.
The CFTC’s analysis here is quite unsatisfying because it appears premised on the notion that all retail trading should occur on an exchange that does not take part in settlement of the transaction (i.e., where the offeror may not also be the counterparty seller). For example, what would be the CFTC’s view regarding over-the-counter (“OTC”) market makers and virtual currency exchanges that use a riskless principal model to reduce customers’ settlement risk? As the CFTC acknowledges, there is no clear statutory basis for the CFTC to prevent this business model.
- What Is the Relevance of Liens, Third-Party Leverage, and Forced Sales? Under the Final Interpretation, no purchases of virtual currency by retail customers with margin, leverage, or financing may satisfy actual delivery if after 28 days the virtual currency remains subject to a lien. (However, liens may continue to exist on collateral other than the purchased virtual currency.) In addition, where the lien is discharged via a “forced sale” of a portion of the virtual currency that was purchased equal to the margin, leverage, or financing provided, “actual delivery” is not
Additionally, the CFTC did not define what it means for a transaction to be margined, leveraged, or financed, including how it views short sales, where by definition there is no purchased virtual currency to be covered by a lien.
- Cash Settlement Arrangements Not Permitted. The CFTC confirmed that “actual delivery” has not occurred if, within 28 days of entering into an agreement, contract, or transaction, that transaction is merely rolled, offset against, netted out, or settled in cash or virtual currency (other than the purchased virtual currency) between the customer and the offeror or counterparty seller.
Addressing the application of the Final Interpretation, Chairman Tarbert indicated that the Commission will forbear from any enforcement relating to the guidance for 90 days, save for those violations that would be “plainly evident” from prior CFTC guidance, enforcement actions, and case law.
Even under the Final Interpretation, certain questions remain:
- When are virtual currency transactions considered to be “swaps”? Notably, the CFTC did not address the circumstances when a leveraged, margined, or financed virtual currency transaction might be considered a “swap” under the CEA. However, the CFTC did remind market participants that if a particular transaction were considered a “swap,” retail customers would only be able to enter into such transactions that were conducted on a CFTC-designated contract market.
- What will be the effect on digital assets not subject to the Final Interpretation? For digital assets that do not meet its prescribed “virtual currency” definition, the CFTC referred market participants back to its 2013 Guidance. Chairman Tarbert has opined that there are no digital assets the Commission currently has the authority to regulate that fall outside the Final Interpretation’s definition of a “virtual currency.” However, should that change in the future, this gap may leave open questions for market participants facilitating transactions for retail customers in digital assets that are not used as a medium of exchange as to the application of the CEA to their activities.
- What constitutes obtaining “title”? The CFTC requested comment in its Proposed Interpretation as to what it means to obtain “title” in the context of virtual currencies. Despite the comments received, the CFTC determined that the concept “has not fully developed in [this] context,” and that it would continue to follow how the term evolves in virtual currency markets before developing any firm opinion, leaving the question unanswered for now.
 For these purposes, a “retail customer” includes any person who is neither an “eligible contract participant” or an “eligible commercial entity” as defined by Sections 1a(18) and 1a(17) of the CEA, respectively.
 See In the Matter of Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15-29 (2015).
 See In the Matter of BFXNA Inc. d/b/a Bitfinex, CFTC Docket No. 16-19 (2016). In its Bitfinex order, the CFTC indicated that “actual delivery” had not occurred in virtual currency transactions where (1) purchasers’ bitcoin was initially held in an omnibus account; (2) the Bitfinex virtual currency exchange exclusively held control over all private keys necessary to transfer out the bitcoin assets; and (3) Bitfinex had not transferred possession and control to the purchasers until all liens were satisfied. As a result, the leveraged bitcoin transactions that Bitfinex permitted customers to engage in were found to be illegal, off-exchange retail commodity transactions.
 This Final Interpretation utilized nearly the same language as the Proposed Interpretation—with the sole difference being the requirement that the customer “secures” possession and control of the entire quantity of the virtual currency, as opposed to gaining the mere “ability” to take possession and control.
 CFTC Chairman Heath Tarbert indicated in a post-release interview with the Chamber of Digital Commerce that he currently does not know of any “tangible examples” of digital assets in markets the Commission regulates that do not meet the Final Interpretation’s “virtual currency” definition. Instead, he viewed this to be forward-looking guidance that might encompass digital assets that do not serve as a medium of exchange, but that still amount to something of value that is traded.
 Chairman Tarbert indicated in an interview with the Chamber of Digital Commerce that the CFTC’s decision to permit the use of an affiliated depository was based in part on the CFTC never previously requiring offerors or counterparty sellers to use unaffiliated depositories in the case of any other commodity.
 See 7 U.S.C. § 1a(21). The term “financial institution” means—(A) a corporation operating under the fifth undesignated paragraph of section 25 of the Federal Reserve Act (12 U.S.C. 603), commonly known as “an agreement corporation”; (B) a corporation organized under section 25A of the Federal Reserve Act (12 U.S.C. 611 et seq.), commonly known as an “Edge Act corporation”; (C) an institution that is regulated by the Farm Credit Administration; (D) a Federal credit union or State credit union (as defined in section 1752 of title 12); (E) a depository institution (as defined in section 1813 of title 12); (F) a foreign bank or a branch or agency of a foreign bank (each as defined in section 3101 of title 12); (G) any financial holding company (as defined in section 1841 of title 12); (H) a trust company; or (I) a similarly regulated subsidiary or affiliate of an entity described in any of subparagraphs (A) through (H).