CFTC guidance on digital asset 'delivery' went into effect last week — here's why it matters

Last week, regulatory guidance developed by the Commodity Futures Trading Commission (CFTC) for the 'actual delivery' of digital assets went into effect. 

The move closes a chapter in the CFTC's expanding oversight of digital asset activities within the U.S. It's one in particular that began in 2016 when the agency announced a settlement with crypto exchange Bitfinex over the exchange's alleged offering of illegal off-exchange financed retail commodities trading and failure to register as a futures commission merchant. What also drew the CFTC's ire was the contention that Bitfinex "did not actually deliver those bitcoins to the traders who purchased them," according to a statement at the time.

The CFTC is the chief oversight body for derivatives markets in the U.S. Futures, swaps, options – these products and the marketplaces that offer them to American customers all fall under the agency's remit, including those that allow margin trading. In recent years, the CFTC has moved to expand its oversight of markets that offer crypto-related services, and this effort gained significant steam when the agency declared bitcoin to be a commodity in September 2015.

The final draft of the guidance was unveiled in March, as The Block reported. Its purpose is to define what it means to achieve "actual delivery" of a commodity that is wholly digital. And it's a change that carries significant implications for companies looking to offer crypto-tied derivatives products in the U.S. market.

This definition ended up taking a long time to figure out. As this editor reported in October 2017, officials at the agency back then were already digging deep into the question of what "delivering" a cryptocurrency actually means.

"Would someone here like to tell me how to define the 'actual delivery' of a virtual commodity? The CFTC is working very hard to provide a suitable response to that question," CFTC Commissioner Brian Quintenz said at the time.

That December, the agency laid the first planks of the guidance, setting the stage for years of deliberation that culminated in March.

According to the CFTC, two main factors that determine whether "actual delivery" has occurred.

The guidance notes:

"(1) a customer securing: (i) possession and control of the entire quantity of the commodity, whether it was purchased on margin, or using leverage, or any other financing arrangement, and (ii) the ability to use the entire quantity of the commodity freely in commerce (away from any particular execution venue) no later than 28 days from the date of the transaction and at all times thereafter; and
(2) the offeror and counterparty seller (including any of their respective affiliates or other persons acting in concert with the offeror or counterparty seller on a similar basis) do not retain any interest in, legal right, or control over any of the commodity purchased on margin, leverage, or other financing arrangement at the expiration of 28 days from the date of the transaction."

In other words, "delivery" occurs when the customer in question can freely move and utilize the asset — in this case, a digital one — without relying on the party that handled the transaction. In this context, a crypto exchange would have up to 28 days to hand over complete control or face possible penalties.

Why it matters

The new guidance "will make it harder for crypto exchanges to offer margin products to U.S. customers, and will increase the CFTC's importance as a primary regulator of the crypto industry," Compound Labs' general counsel Jake Chervinsky told The Block. 

The CFTC has now officially closed a gap in its oversight of crypto-related derivatives. To put it simply, if exchanges want to offer crypto derivatives, now they need to play ball according to the CFTC's rules.

But because of the way that centralized crypto exchanges function today, staying in alignment with the CFTC guidance could prove trickier in practice.

"In this guidance, the CFTC says that actual delivery only occurs when the customer receives exclusive possession and control of the full amount of the trade," said Chervinsky. "Most crypto exchanges aren't set up to satisfy that standard because they use a centralized, custodial model; they maintain custody and control of their customers' assets until and unless customers request a withdrawal."

According to Chervinsky, those who would seem to benefit the most from these rules are those that actually fall outside of them:

"The winners coming out of this guidance are: (1) offshore derivatives platforms that can continue offering margin products to their customers without concern for the CFTC; (2) non-custodial DeFi margin trading protocols that are natively designed to satisfy the CFTC's actual delivery guidance because users maintain possession and control of their assets; and (3) the CFTC itself, by increasing the importance of its own licensing authority over crypto exchanges that want to offer margin products," Chervinsky wrote in an email, adding:

"The losers, of course, are the centralized U.S. exchanges."