US Regulator’s Confusion Around Bitcoin Is Exactly Why No One Wants Them Involved

Discussion around governmental regulation of bitcoin came to a furor over the last few days when one of the five commissioners of the US’s Commodity Futures Trading Commission (CFTC), Bart Chilton, commented on FT.com:

“It’s not monopoly money we’re talking about here – real people can have real risk in these instruments, and we need to ensure that we protect markets and consumers, even in what at first blush appear to be ‘out there’ transactions.”

The next day he stated on Bloomberg.tv:

“In essence, we’re talking about a type of shadow currency, and there is more than a colorable argument to be made that derivative products relating to Bitcoin falls squarely in our jurisdiction.”

To many people besides Mr. Chilton, bitcoin’s legal color is not as clear: bitcoin still lives in the grey area between a currency and a commodity; the derivatives market has been largely a non-factor; and the logistics of regulating an pseudo-anonymous currency seem insurmountable. Using bitcoins to gamble anonymously online offers privacy and security, as transactions don’t require personal information. Players can enjoy a more discreet gaming experience. Many platforms, including a 무료 홀덤사이트, allow users to deposit and withdraw in bitcoin, ensuring complete anonymity and protecting sensitive data from exposure.

Current Regulatory Environment

Derivatives

When the Commodity Futures Trading Commission was chartered in 1974, their mandate was to regulate the commodity futures and option markets in the United States. The definition of these according to the CFTC:

• Futures – “An agreement to purchase or sell a commodity for delivery in the future.. at a price that is determined at initiation of the contract”

• Options – A contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of a commodity or other instrument at a specific price within a specified period of time”

The key difference is that with a futures contract the transaction must occur, while with an Option the buyer may choose whether to exercise the contract. Both of these are classified under the umbrella of derivatives since their value is derived from an underlying asset.

When the CFTC was originally created, their scope was solely regulating the exchange of commodity derivatives. However, this scope was recently expanded to include the foreign exchange (forex) transactions and forex derivatives. Bitcoin clearly does not derive its value from the future purchase of an underlying asset. Therefore, if the CFTC plans to regulate bitcoin, they must consider bitcoin either a commodity or forex, with the intent to regulate bitcoin forex or bitcoin derivatives.

Foreign Currency

Foreign exchange (forex) trades are largely unregulated, with physical Forex exchanges distributed in many locations throughout the world. Globally there is no central authority that regulates the entire industry. The CFTC’s responsibility has expanded over the last decade, most notably through the Dodd-Frank Act, to include forex and forex futures. Within this bill, the definition of foreign exchange is explicitly defined as:

FOREIGN EXCHANGE.—The term ‘‘foreign exchange’’ means the exchange, for compensation, of currency of the United States or of a foreign government for currency of another government.

Since bitcoin is not the currency of a foreign government, but rather the first global currency, it would seem their power to regulate bitcoin as forex does not apply. Therefore, Mr. Chilton must be considering it a commodity when he stated “there is an argument that it is squarely in our jurisdiction”.

Commodity

Commodities are explicitly defined under US Code Chapter 7 Title 1:

“The term “commodity” means wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice, and all other goods and articles, except onions” [emphasis added]

Given the catch-all of “all other goods and articles” it is challenging to define anything that is not considered a commodity. In fact, one must wonder why they describe 29 agricultural products, including five types of fats and oil, if the list literally includes every other tangible and intangible good.

In the US, Commodities are usually traded as futures contracts under the purview of the CFTC. This has caused a vast majority of US Code 7 Chapter 1 – Commodity Exchanges – to regulate derivatives. Since few if any actual bitcoin transactions are related to derivatives, any CFTC regulations related to bitcoin are an unnatural and forced fit. During Mr Chilton’s Bloomberg interview he stated ”you certainly want a regulator to at least look at it,” so let’s investigate the feasibility and outcome of regulation.

Feasibility of CFTC Regulation

Bitcoin being declared a commodity would create an interesting contrast with FinCEN’s March guidance requiring bitcoin exchanges to be registered as Money Service Businesses (MSB). In the March guidance FinCEN stated:

The term “money transmission services” means “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.”

So it seems the US Government has no idea how to classify bitcoin: is it a currency or a commodity? Any CFTC ruling would likely declare bitcoin a commodity and put it in a Schrodinger’s Cat state – it would coexist as both a currency and a commodity until a case was taken to court for a judge to decide.

Extenuating information aside, it is extremely challenging to associate any bitcoin address with personal identity. Contrast this with bank accounts that require a significant amount of identification information, or physical commodities such as gold that undergo a significant amount of record-keeping and scrutiny. Regulators could attempt to create registered addresses, however there is no effective way to verify the identity of depositors to those addresses.

Outcome of Regulation

The Good

It appears a lot of VC funding is waiting on the sidelines for a good bitcoin opportunity. Coinbase just received the biggest round of funding for a bitcoin company with $5 million, and several VC have openly talked about a desire to add bitcoin-related companies to their portfolios. If there is one thing large investors hate it is a lack of regulatory clarity. The recent FinCEN ruling legitimized bitcoin exchanges, and it is possible that a CFTC ruling could add enough clarity for more VC money to enter the market.

Increased regulatory attention may finally bring more scrutiny to the DDoS attacks and attempts at trading lag that have been pervasive on bitcoin exchanges and related services. It’s been well documented that for weeks DDoS attempts influenced market crashes, and several companies were held for ransom with attacks. Given CFTC’s main purpose is to investigate market manipulation, there may be some good to be had with their involvement.

Increasing the bitcoin derivative products available would provide a valuable hedge for bitcoin-accepting companies. It would allow them to lock-in future exchange rates making them less susceptible to large fluctuations in the currency. This would allow merchants to accept bitcoin without have to quickly convert it to dollars.

The Bad

More regulations and the associate costs will drive businesses to where they can operate freely: outside the US. Bitcoin is a completely digital product, meaning there is no need to operate from within the US. US-based bitcoin exchanges have struggled; most recently bitfloor.com closed down when their bank assets were frozen and they cited US regulations as a contributing factor. Mt. Gox, by far the largest bitcoin exchange by volume, is located in Japan and would likely be less affected by CFTC regulation than any US-based competitors. Additional regulations by the CFTC will increase the cost of doing business for US companies, and make it even harder for burgeoning US exchanges to compete. We’ll see innovative companies take their locations offshore where the costs are lower.

CFTC regulation could significantly increase the volatility of bitcoin exchanges. With the CFTC clarifying the legal ambiguity surrounding bitcoin derivatives, bitcoin may mimic other commodities markets and move a lot of trade volume towards futures and options. It is likely (though unconfirmed) that a large amount of current exchange volume is investors and traders rather than merchants using the currency. A vast majority of exchange volume is unlevered, and adding derivatives would significantly increase the leverage these traders have.

The Future

Many people share Bill Gate’s concern that bitcoin will face impending legislation, and Mr. Chilton will certainly not be the last US regulator to begin exploring bitcoin. As long as these new rules don’t make bitcoin illegal, clarifying regulatory uncertainty only stands to legitimize this rapidly growing currency. FinCEN was forced to create a new definition for virtual currencies, and we expect the CFTC to do the same. However, those living in fear of what the CFTC’s decision may hold should have solace in the fact that any regulations will be largely unenforceable anyway.