A foundational purpose of the Commodity Futures Trading Commission (CFTC) was to develop rules to prevent market manipulation and to manage price volatility risk for the producers and commercial users of agricultural commodities. This purpose was featured during the December 7 meeting of the CFTC’s Agricultural Advisory Committee in a Chicago Mercantile Exchange presentation on exchange-imposed price up/price down limits to extreme price volatility. However, the CFTC focus of congressional agriculture committees in 2022 has not been on extreme price volatility, but on legislating cryptocurrencies, such as Bitcoin™.
Cryptocurrencies were declared a “commodity” not as a result of an act of Congress or a CFTC Commission vote, but because of a 2018 federal court ruling involving a CFTC fraud investigation, in which exchange self-certification of Bitcoin™ futures contracts as consistent with CFTC rules was adduced as evidence. From this inauspicious legal origin, the congressional agriculture committees are proposing legislation to expand CFTC regulation of cryptocurrencies, despite their lack of commercial purpose, while leaving a long CFTC to-do list with little legislative direction and even less budget to do it.
In May, IATP wrote to the CFTC to oppose an application by FTX, the recently bankrupt cryptocurrency trading platform. FTX had proposed to be allowed to calculate at every second the margin collateral its “users” pay to trade and take user funds to cover collateral costs without informing those users who, so informed, might have wanted to dump their positions. As far as we know, there are no agricultural contracts denominated in any cryptocurrency. However, the FTX application indicated that this proposal for automated margining could eventually be applied to “all commodity classes.” We were among the commenters that advised the CFTC to start a rulemaking about automated margining and clearing (post-transaction documentation and payment), rather than vote for or against the FTX application as a mere technical amendment.
The vastly under-resourced CFTC faces enormous regulatory challenges, including having enough money to enforce CFTC rules, according to the chief of enforcement and compliance during the Obama administration. The agency, following its evisceration by the Trump administration, must focus on commodity markets crucial to the real economy and not on a “financial innovation,” whose best legal use case is to expedite cross-border payments using digital ledger technology. Whether cryptocurrency speculation, by mostly retail customers trading on their phones, is necessary to enable an encrypted payment system is a question that regulators and legislators, keen to support “innovation,” have not addressed.
On November 14, the CFTC very briefly announced that LedgerX, the only non-bankrupt FTX subsidiary, had withdrawn the FTX application. If the withdrawal makes automated margining a moot CFTC issue, why should IATP write about the post-bankruptcy call to regulate crypto markets? We are posting this letter on our website for the first time because congressional agricultural committees that oversee the CFTC may pass in 2023 the “Digital Commodities Consumer Protection Act of 2022,” strongly influenced if not co-authored by crypto lobbyists, including former CFTC officials. FTX lobbied hard to make the CFTC, and not the much larger and self-financed Securities and Exchange Commission (SEC), the primary crypto regulator. IATP is a member of Americans for Financial Reform, which has argued that the SEC’s extensive retail customer protections and the sale of equity shares in crypto “tokens” should make the SEC the primary crypto regulator.
(For this bipartisan bill, not surprisingly, FTX and other crypto firms doled out at least $80 million, about evenly divided, to both political parties. Rep. Tom Emmer (R-MN), the head of the “Blockchain Eight,” was among the members that wrote to the SEC in March to thwart initial inquiries of an SEC investigation into FTX.)
The bill would authorize the CFTC to regulate, and hence legitimate, this asset class even before the government has investigated possible criminality in the loss of billions of dollars of mostly of retail customer funds triggered by the FTX bankruptcy. At a December 1 hearing of the Senate agriculture committee hearing, CFTC Chair Rostin Behnam urged swift passage of the bill to enable the agency to prevent the crypto firms’ violations of law, rather than prosecute those violations after the financial damage had been done.
Will authorizing the CFTC to regulate crypto increase systemic financial risk?
There are several reasons to oppose this bill and others like it. The day before the hearing, Better Markets released a short analysis of the Senate bill, pointing out how the bill would legalize excessive speculation, currently forbidden in the Commodity Exchange Act that the bill modifies. Furthermore, the bill would allow cryptocurrency and traditional finance to interface in a way that would increase systemic financial risk. As Professor Hillary Allen wrote in the Financial Times, “Legitimization is not the only Trojan horse embedded in these crypto bills. Any legislation that creates a bespoke crypto regulatory framework will create opportunities for traditional financial assets to migrate into the new regime and so sidestep existing financial regulation. This problem is unavoidable because it’s impossible to define ‘crypto asset’ (or ‘digital asset’ or ‘digital commodity’) in a way that excludes traditional financial assets.” In addition to the opportunities for regulatory avoidance through asset migration, another political reality could undermine the agency’s ability to implement and enforce even the best designed bill. Senator Dick Durbin cautioned Chair Behnam at the December 1 hearing that the CFTC, as the only federal financial regulator dependent on Congress for its budget, might not get sufficient resources to implement whichever bill might be passed by Congress.
What could a CFTC reauthorized by Congress with a robust budget do?
Reauthorization is a process by which Congress can revise an agency’s statutory authorities and advocate for resources necessary to address problems not anticipated under prior authorization, e.g., investigating fraud in the underlying assets of greenhouse gas emissions offset futures contracts. Congress last reauthorized the agency in 2015. If the CFTC also must regulate additional crypto currencies — a new asset class and a new class of retail investors, very different from the institutional investors and companies that trade contracts in the asset classes it currently regulates — then its backlog of work that may require reauthorization might never get done.
A reauthorized CFTC, budgeted by Congress on par with the scale, complexity and variety of the contracts and markets it regulates, could undertake studies, data collection and rulemakings to repair the Trump administration CFTC “reforms.” For example, the Commission could start a rulemaking to replace the Trump era rule that allows exchanges to self-regulate the automated trading systems that conduct most transactions, including agricultural ones. The Commission could vote to delete a footnote in the cross border swaps (off exchange contract) trading rule that is a gateway for billions of dollars’ worth of regulatory evasion from U.S. originated contracts executed on foreign exchanges.
Such a CFTC could study the market impacts of exchange self-certification of novel contracts, such as greenhouse gas emissions offset futures, as consistent with CFTC rules. The CFTC could investigate the causes of sustained and extreme price volatility in the physical commodity cash and futures markets. It is, of course, the obligation of the CFTC Chair and Commissioners to decide on the agency’s regulatory agenda within the authorities and budget provided by Congress.
The Senate delayed confirming a full slate of CFTC Commissioners until 18 months into the Biden administration, while the crypto lobbyists pressed the CFTC and Congress to make the CFTC the main crypto regulator. Without a full Commission, Chair Behnam’s opportunities to advocate for new rulemakings was very limited. The CFTC’s ambition in its Spring 2022 “Unified Regulatory Agenda” was understandably modest for a Commission without Senate-confirmed Commissioners. The regulatory agenda should become more ambitious now, but it may not absent reauthorization.
The crypto bills and CFTC reauthorization by Congress
Congress should strengthen the capacity of the CFTC to carry out its core mission of enabling market participants to manage price volatility risks for financial and physically backed commodity contracts that are critical to the real economy. During the December 1 hearing, no Senator presented a positive business case for the contribution of cryptocurrency trading to the real economy. At least two Senators questioned Chair Behnam about the national security risk posed by cryptocurrencies, without referencing the Department of Defense’s announcement in September of its study about the extent of cryptocurrency money laundering and financing of terrorism by state and non-state actors.
Congress must not pass a cryptocurrency bill, at least before it has studied the vectors of risk to the financial system and national security posed by cryptocurrencies. Legitimizing cryptocurrencies by fast-tracking legislation would serve no public interest and very few other interests. If the political price of congressional CFTC reauthorization in the Farm Bill is first to pass a bill to make the CFTC the main crypto regulator, that price is too high.
