Over the past five years, the market capitalization of virtual currencies has risen rapidly.[1] For example, the price of bitcoin has risen from $135 in April 2013 to $6,468.44 as of October 2018 (with a market cap of $112,173,455,380).[2] The substantial increase in the value of these digital assets (over the last year in particular) has triggered regulatory scrutiny in the United States.[3] Regulators, like the Commodities Futures Trading Commission (“CFTC”), have been working to incorporate virtual currencies under the current regulatory framework.[4] Recently, the CFTC has received its first judicial approval of its efforts.
What are Virtual Currencies?
Virtual currencies are digital assets that can be used “as a medium of exchange, a unit of account, and/or a store of value.”[5] Virtual currencies are not backed by a sovereign nation (i.e. it does not have the status of legal tender), but it can be converted into “real currency.”[6] An example of a convertible virtual currency is bitcoin.[7]
Bitcoin is the “first significant digital currency system that needs no centralized intermediary to maintain proper books.”[8] Bitcoin transactions take place on a distributed ledger (i.e. a blockchain) that is then recorded and distributed across a network of computers over the internet.[9] Each computer in the network is called a “node.”[10] When a user wants to send bitcoin, she sends a message to the network nodes to send bitcoin to another person.[11] The nodes, through incentives and code-based controls, update the ledger to reflect the transaction.[12] This process is unlike a transaction conducted through PayPal or a traditional bank, where there is a reliance on a trusted third-party to facilitate transactions.
Bitcoin (and Virtual Currencies) are a “Commodity”
While virtual currencies have been hailed as the next wave of tech innovation, there has been a significant incidence of fraud plaguing virtual currency issuance and trading. For example, in CFTC v. McDonnell,[13] the CFTC alleged that Coin Drop Markets (“CDM”) operated a deceptive and fraudulent virtual currency scheme to misappropriate investor funds. In particular, CDM promised that individuals who paid for membership in virtual currency trading groups (via two websites) would be provided profits of up to 300% per week.[14] After receiving membership payment or virtual currency investments, CDM deleted their social media accounts and websites, never provided the promised returns, and gave few, if any, trading advice.[15] The court acknowledged that Congress has yet to promulgate legislation to regulate virtual currencies and outlined the current multi-regulatory approach embraced by regulators in the U.S.[16]
The CFTC is one U.S. regulator that has asserted control over virtual currencies. Its jurisdiction comes from the definition of a “commodity” under the Commodity Exchange Act (“CEA”).[17] A “commodity” is broadly defined to include not only particular goods, such as wheat, cotton, or rice, but also “all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.”[18] The CFTC can assert jurisdiction if there is a “commodity interest” based upon a commodity.[19]
Since at least 2015, the CFTC has maintained that bitcoin, and other virtual currencies, fit the definition of a commodity primarily through administrative actions.[20] McDonnell was the first time the CFTC’s position was given judicial approval. The court noted that “[v]irtual currencies can be regulated by the CFTC as a commodity,” because virtual currencies can be exchanged in a market for a uniform quality and value.[21] The court’s reasoning makes clear that virtual commodities fall within both the common definition of commodity and the CEA’s definition of a commodity.
Virtual currencies are increasingly becoming recognized as a legitimate currency in its own right. The substantial amount of funding being committed to blockchain-related projects is evidence of this trend. While the technology holds tremendous promise, there is a risk that issuers like CDM will take advantage of this enthusiasm. To some observers, it may seem like this emerging technology cannot fit into our current framework. But CFTC action over the last few years is an indication that U.S. regulators are vigilantly policing fraud in the markets, even within blockchain-related technology. Thus, virtual currencies like bitcoin have inched closer to being properly characterized under the existing regulatory framework.
[1] See Bitcoin Historical Data, CoinMarketCap, https://coinmarketcap.com/currencies/bitcoin/historical-data/.
[2] Id.
[3] David Michaels & Paul Vigna, SEC Chief Fires Warning Shot Against Coin Offerings, Wall ST. J (Nov. 9, 2017, 5:31 PM), https://www.wsj.com/articles/sec-chief- fires-warning-shot-against-coin-offerings-1510247148.
[4] See Commodities Futures Trading Comm’n, Bitcoin, https://www.cftc.gov/Bitcoin/index.htm.
[5] I.R.S. Notice 14-21.
[6] Id.
[7] Id.
[8] Shaanan Cohney et al., Coin-Operated Capitalism, 12, Colum. L. Rev. (forthcoming 2018), https://ssrn.com/abstract=3215345.
[9] Id.
[10] Id. at 12-13.
[11] Id. at 13.
[12] Id.
[13] 287 F. Supp. 3d 213, 216 (E.D.N.Y 2018).
[14] Id. at 217.
[15] Id. at 218.
[16] Id. at 220-21.
[17] Matthew Kluchenek, Bitcoin and Virtual Currencies: Welcome to Your Regulator, Harv. Bus. L. Rev., at 2 (2016).
[18] 7 U.S.C. § 1(a)(9) (2012).
[19] Kluchenek, supra note 17, at 2-3.
[20] In re Coinflip, Inc., CFTC Docket No. 15-29, 2015 WL 5535736 at *3 (Sept. 17, 2015).
[21] CFTC v. McDonnell, 287 F. Supp. 3d 228.
