This will take a short dive into the language behind this recent fine and consider what it could mean for the rest of the cryptocurrency community. Note: I'm not a lawyer but I could probably play one on television.
The United States Commodity Futures Trading Commission (CFTC) released a statement saying that they investigated, fined, and settled with Bitfinex for "offering illegal off-exchange financed retail commodity transactions in bitcoin and other cryptocurrencies, and for failing to register as a Futures Commission Merchant (FCM) as required by the Commodity Exchange Act (CEA)".
The specifics of their violations are included in the release from the CFTC and I personally found the language to be very 'interesting'. I have a strong feeling that this is an indicator of things to come in the future for cryptocurrency markets. So lets take a dive in and do some hip-pocket lawyering, shall we?
"The Order finds that from April 2013 to at least February 2016, Bitfinex permitted users to borrow funds from other users on the platform in order to trade bitcoins on a leveraged, margined, or financed basis. The Order also finds that Bitfinex did not actually deliver those bitcoins to the traders who purchased them. Instead, Bitfinex held the bitcoins in deposit wallets that it owned and controlled, the Order states."
This paragraph indicates that margined trading was the primary driver behind the fine. However, reading further suggests that there was an additional violation of Bitfinex holding the coins in a wallet rather than delivering them to the trader. For anyone who has spent any amount of time on a cryptocurrency exchange, its well known that the exchanges hold the keys to the funds in a cold wallet for storage and a hot wallet for deposits and withdrawals.
Whether this sentence indicates that any exchange holding the private keys to the cryptocurrencies is in violation is unclear, however it would create quite the predicament. Given that Bitfinex paid a fine and received a cease and desist to stop violating the Commodity Exchange Act, I would assume that they are back in compliance with this violation. However, I doubt their method of storing the funds in their controlled wallets will change. Uncertain result. There is further explanation in the next paragraph of the release ...
"As explained in the Order, under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), financed commodity transactions – including those in cryptocurrencies like bitcoin – must be conducted on an exchange, unless the entity offering the transactions – such as Bitfinex – can establish that actual delivery of the bitcoins results within 28 days. "
Given that a withdrawal from any bitcoin exchange can take place well within 28 minutes, much less 28 days, I'm not certain what this sentence is actually implying. By this metric, any cryptocurrency exchange would be in violation, particularly if the term "delivery" means anything other than a cryptographic transaction sent over a blockchain. Fortunately, the release goes on...
"As one federal court of appeals recognized, “actual delivery” requires a transfer of “possession and control” of the commodity and giving “real and immediate possession to the buyer or the buyer’s agent.” CFTC v. Hunter Wise Commodities LLC..."
The fact that this topic was so heavily highlighted in the release gives me a suspicion that the regulators were using this linguistic technicality to hammer the exchange, apply pressure and set up a legal precedent in the industry that cryptocurrency exchanges must comply with the CFTC or end up with teams of lawyers and regulators breathing down their neck. Anyone with even a basic working knowledge of bitcoin and blockchain technology would understand that 'real and immediate possession' occurs as a result of 'actual delivery' within a 10-30 minute timeframe.
The release goes on to point out some specific regulatory language that Bitfinex violated...
"The Order finds that by offering to enter into, executing, and/or confirming the execution of off-exchange financed retail commodity transactions, Bitfinex violated Section 4(a) of the CEA, which requires such transactions to be conducted on a designated contract market or derivatives transaction execution facility. The Order further states that because the transactions did not result in actual delivery of bitcoins, Bitfinex could not rely on the exception to the CFTC’s jurisdiction over such transactions, found in Section 2(c)(2)(D)(ii)(III)(aa) of the CEA."
Section 4(a) falls under the 'Restriction of Futures Trading to Contract Markets or Derivatives Transaction Execution Facilities' and states:
"Unless exempted by the Commission pursuant to subsection (c), it shall be unlawful for any person to offer to enter into, to enter into, to execute, to confirm the execution of, or to conduct any office or business anywhere in the United States, its territories or possessions, for the purpose of soliciting, or accepting any order for, or otherwise dealing in, any transaction in, or in connection with, a contract for the purchase or sale of a commodity for future delivery (other than a contract which is made on or subject to the rules of a board of trade, exchange, or market located outside the United States, its territories or possessions) unless— (1) such transaction is conducted on or subject to the rules of a board of trade which has been designated or registered by the Commission as a contract market or derivatives transaction execution facility for such commodity;"
What this tells me is that the CFTC is setting precedence for establishing a trading commission for cryptocurrencies and this is the first move of that domino. Given the US government track record of regulatory success, this will not go well. Granted, this is me speculating, but it's what I would be doing if I were them.
Section 2(c)(2)(D)(ii)(III)(aa) falls under the 'Exceptions' sub-paragraph and states:
"a contract of sale that— (aa) results in actual delivery within 28 days or such other longer period as the Commission may determine by rule or regulation based upon the typical commercial practice in cash or spot markets for the commodity involved;"*
Based on the typical commercial practice for this commodity, the method of the exchange holding the keys to the wallet of funds is extremely common. Not sure exactly how this effects the position of Bitfinex, but it appears that these regulators are using the language of the law as a battering ram, rather than the spirit of the law as intended.
"The Order further finds that Bitfinex accepted orders and received funds in connection with retail commodity transactions without being registered with the CFTC as an FCM, as required by Section 4d(a)."
This is for futures or margins, however one can only expect that other exchanges with margin functions and bitcoin are paying attention to this and scrambling their legal teams. I'm guessing that interesting times are ahead.
"In the Order, the CFTC recognizes Bitfinex’s cooperation with the Division of Enforcement’s investigation, and that Bitfinex voluntarily made a number of changes to its business practices in order to attempt to come into compliance with the CEA."
I would be very curious to know exactly what Bitfinex changed in their business practices to fall under compliance.
Bitfinex leads all exchanges in total bitcoin volume with 15.02% of BTC/USD volume in the past 24 hours. They were just effectively put in their place by the CFTC and they're not even on American soil. I cringe at the thought of regulators entering into the cryptocurrency fray, but my instincts tell me that all they'll accomplish is the acceleration of the development and adoption of peer-to-peer exchanges like OpenLedger and EtherEx... at least I hope.