CFTC Customer Advisory
On Monday, the Commodity Futures Trading Commission (“CFTC” or “Commission”) issued its fourth virtual currency customer advisory, Customer Advisory 7756-18, as part of its outreach effort to educate market participants. Titled, Use Caution When Buying Digital Coins or Tokens, the advisory warns customers of the risks of speculation of future value and fraud; it ultimately advises that the best protection is to exercise caution and to extensively research digital tokens and coins—and those who offer them for sale—prior to purchase.
Specifically, the Commission advises customers to (a) conduct due diligence on affiliated entities (and consider the lack of such information a red flag), (b) ask if the digital asset is a security and whether the offering is registered with the SEC, and (c) understand how their money will be used and the rights the investor acquires by owning the digital asset, which the Commission notes should be clearly explained and disclosed in a business plan, white paper, or development plan.
The Commission also reminds customers there is currently no widely-accepted standard of valuation and to be wary of promises of quick wealth or guaranteed returns. The Advisory sets forth the following factors that may impact the value of a particular digital asset:
- Potential for forks in open-source applications that could split away market participants, increase the number of digital coins, or make coins obsolete;
- Decreasing mining or validation costs (if price is tied to those factors);
- Acceptance of other currencies, coins, or tokens for offered goods and services;
- Link between the value of a digital coin or token and the offered product/service;
- Adoption of the digital coin/token as a broad medium of exchange/store of value;
- Future competitors/technological changes that could disrupt the business;
- Future demand or uses for an application, network, product, or service;
- Liquidity in the market for a specific digital coin or token;
- Changes to the underlying technology that could devalue digital coins/tokens; and
- Risk of theft from hacking.
On the same day the Commission issued Customer Advisory 7756-18, the Financial Stability Board (“FSB”) issued its report for the G20 Finance Ministers and Central Bank Governors meeting at the end of July. This report describes the current crypto-asset work of the FSB and various standard-setting bodies. In collaboration with the Committee on Payments and Market Infrastructures (“CPMI”), the FSB has developed a framework of metrics it will use to monitor the financial stability implications of crypto-asset market developments. The report also mentions CPMI’s work on distributed ledger technology applications and payment innovations as well as the crypto-asset work of the International Organization of Securities Commissions (“IOSCO”), including its initial coin offering (“ICO”) Consultation Network and Support Framework to address ICO issues.
Notably, the report revealed that the Basel Committee on Banking Supervision (“BCBS”), under its mandate to strengthen the regulation, supervision, and practices of banks worldwide to enhance financial stability, is currently focused on three initiatives: (1) quantifying the materiality of banks’ direct and indirect exposures to crypto-assets; (2) analyzing the prudential treatment of banks’ exposures to crypto-assets, including potentially formally clarifying the prudential treatment of crypto-assets across risk categories; and (3) monitoring crypto-asset and other FinTech developments to assess implications for banks and supervisors.
In addition, on Wednesday, July 18, witness testimony at a public U.S. House of Agriculture Committee hearing signaled that crypto-assets present novel challenges that will take time to analyze. The testimony indicated that crypto-assets can shift regulatory classifications at different stages of development and use and may require adept regulatory coverage.
In particular, Daniel Gorfine, the director of LabCFTC, warned against “hasty regulatory pronouncements”:
We all have the shared goal to bring clarity and certainty to the market but [we] also need to be sure that we are thoughtful in our approach and do not steer or impede the development of this area of innovation. Indeed, while some may seek the immediate establishment of bright lines, the reality is that hasty regulatory pronouncements are likely to miss the mark, have unintended consequences, or fail to capture important nuance regarding the structure of new products or models.
Regulatory authorities continue their path of education and observation of the digital markets, following the lead of regulators’ initial handling of the Internet. Industry groups are encouraging such a path of slow and careful analysis so as not to discourage innovation.