Client Alert: VIRTUAL CURRENCIES – CFTC clarifies ‘actual delivery’ exception for digital assets - 26 March 2020

The CFTC’s interpretive guidance provides welcome clarity on when certain leveraged digital asset transactions qualify for an exception from many requirements under the Commodity Exchange Act.

The CFTC has issued interpretive guidance to clarify how the "actual delivery" exception applies to leveraged spot retail commodity transactions involving digital assets like bitcoin and ether. The guidance sets out two primary factors in determining if actual delivery has occurred, relating to control of the asset within 28 days. If the factors are met, the transaction will not be treated as a futures contract under the Commodity Exchange Act (CEA) for purposes of CFTC oversight.

"Providing clarity to market participants is one of the CFTC’s core values," said CFTC Chairman Heath P. Tarbert. "This interpretive guidance not only fulfills that commitment, but it reflects my belief that the U.S. must be a leader in the digital asset space."

The existing framework. Putting the guidance in context, Commissioner Brian Quintenz noted that platforms have existed for some time that allow retail customers to enter into margined or financed transactions in many commodities, like foreign currencies and precious metals. Platforms that offer digital assets to retail customers on a margined basis are just the latest iteration of this, said Quintenz.

Chairman Heath Tarbert explained that these financed transactions, sometimes called "look-alike contracts," have many features in common with futures contracts, and the CFTC historically treated them as such. However, some courts disagreed and held that the transactions were wholly outside the CEA. Looking to provide greater certainty in this area, Congress included a provision in the Dodd-Frank Act codifying Section 2(c)(2)(D) of the CEA to provide that these transactions are subject to certain enumerated provisions of the CEA "as if they were" futures contracts, unless they meet one of several exceptions. One key exception carves out transactions that result "in actual delivery within 28 days."

Providing further details, in 2013 the CFTC issued guidance that uses a functional, facts-and-circumstances approach to determine when "actual delivery" has occurred. But as the digital asset space continued to evolve and take hold, questions arose as to how the "actual delivery" exception applies to digital assets that function as a medium of exchange, like bitcoin and ether.

How does it apply to digital assets? An early indication of the CFTC’s view on the meaning of "actual delivery" in the context of digital assets came in a 2016 settled enforcement action. The CFTC ordered Bitfinex, a Hong Kong-based bitcoin trading platform, to pay a $75,000 civil penalty for violating, among other provisions, CEA Section 4(a), which requires that commodity futures contracts be conducted on a regulated exchange.

The CFTC determined that the Bitfinex transactions did not meet the "actual delivery" exception because of the way the platform was structured. Bitfinex allowed users to borrow funds from each other to trade bitcoins on a leveraged, margined, or financed basis. Bitfinex did not deliver the bitcoins to users, but rather held them in deposit wallets that it owned and controlled. Because Bitfinex controlled the bitcoin wallets, users did not meet the "control" aspect of the actual delivery exception.

Proposed interpretation. Questions remained after the Bitfinex matter, however. In July 2016, the law firm of Steptoe & Johnson filed a petition for rulemaking asking the CFTC to adopt a rule to provide clarity in the area. Specifically, the petition asked the CFTC to set forth the requirements for effectuating a transfer of an ownership interest in a commodity in the context of cryptocurrency markets using blockchain for executing transactions, including the elements necessary to satisfy the requirements of "actual delivery" under CEA Section 2(c)(2)(D)(ii)(III) as applied to leveraged or financed retail cryptocurrency transactions.

In December 2017, the CFTC proposed an interpretation to inform the public of the Commission’s views as to the meaning of actual delivery within the specific context of retail commodity transactions in virtual currency. The CFTC requested comment on the proposed interpretation and on specific questions related to the Commission’s treatment of virtual currency transactions.

Final interpretative guidance. After reviewing public comment from the 2017 proposal, the CFTC issued final interpretive guidance, Retail Commodity Transactions Involving Certain Digital Assets.

The final guidance discusses two primary factors demonstrating "actual delivery" of retail commodity transactions in virtual currency:

The guidance also provides several non-exclusive examples of what the Commission would view as satisfying the "actual delivery" exception.

"Essentially, the guidance looks to whether the customer has the ability to freely use the virtual currency purchased on margin in interstate commerce," said Quintenz.

Commissioner Rostin Behnam supported the guidance but said he would have preferred to reopen the comment period because "in the rapidly developing world of digital assets, two years is a lifetime."

The guidance will become effective 90 days after publication in the Federal Register.

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