Who’s Regulating Bitcoin and Other Cryptocurrencies? No One.
The value of bitcoin and other cryptocurrencies has increased significantly in recent years, leading more institutional and retail investors to put money into these assets. CME Group, Nadex, and TeraExchange even offer cryptocurrency derivatives. Generally, however, cryptocurrencies are traded without the oversight of a third-party institution, and there is no central regulatory authority. Many transactions take place across territorial boundaries and are virtually impossible to trace.
Traditional regulatory bodies such as the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) face significant challenges protecting investors who seek to capitalize on cryptocurrencies and initial coin offerings (ICOs).
Is a cryptocurrency transaction the sale of a security, as defined by the Securities Act of 1933, 15 U.S.C. § 77a, et seq.? Or is cryptocurrency a commodity regulated by the Commodity Exchange Act, 7 U.S.C. § 1, et seq.? Do state financial regulations apply? Legal questions abound, but uniform answers are few.
What Is Cryptocurrency?
The Internal Revenue Service informally defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Some virtual currencies are convertible, meaning they can be exchanged for real currency. Cryptocurrency is “a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.”
The distributed ledger creates a system of trust between pseudonymous individuals engaging in transactions without the oversight of a regulator. Each transaction, or block, is logged in chronological order on the distributed ledger, which is copied in real time across a global network of peer-to-peer computers. Once a block is added to the ledger, it cannot be modified, and a consensus algorithm ensures the ledger’s accuracy and authenticity.
Individuals known as miners use specialized software to verify the authenticity of transactions. The first miner to come up with the correct 64-digit hexadecimal number, or hash, records the transaction and is paid a small sum of cryptocurrency.
The Securities Act
Enacted on May 27, 1933, in response to the stock market crash of 1929, the Securities Act is designed to prevent fraud and misrepresentation in the sale of securities by ensuring that investors receive adequate information. Also called the “truth in securities” law, it mandates registration of all securities offered for sale, with some exemptions, and disclosure of pertinent facts and certified financial statements. If a registration statement contains incomplete or inaccurate information, the Securities Act authorizes investors suffering losses to sue anyone directly or indirectly involved in the filing.
For any of this to apply, an offering must be a security. SEC Chairman Jay Clayton stated in his February 8, 2018, testimony before the U.S. Senate that most ICOs are securities but notes that “no ICOs have been registered with the SEC.” The SEC has brought enforcement actions against currency issuers and charged an unregistered bitcoin-denominated trading platform and its operator with fraud.
The Commodity Exchange Act
The Commodity Exchange Act was enacted June 15, 1936, to “prevent and remove obstructions and burdens upon interstate commerce in grains and other commodities” by requiring that all futures and options be traded on registered exchanges. It also prohibits certain kinds of transactions involving futures, options, and other derivatives. The Act was amended in 1974 to create the CFTC to regulate derivatives markets.
The definition of commodities includes agricultural products, natural resources, precious metals, currencies and interest rates, and “all services, rights, and interests … in which contracts for future delivery are presently or in the future dealt.” In a 2015 order, the CFTC found that this definition encompasses cryptocurrencies. However, CFTC Chairman J. Christopher Giancarlo noted in his February 15, 2018, testimony before the U.S. Senate that the agency does not have the authority to regulate spot or cash transactions involving cryptocurrencies.
The CFTC does have jurisdiction when cryptocurrencies are used in derivatives contracts, and the agency has taken action against unregistered cryptocurrency exchanges. Additionally, the CFTC has used the antifraud provision of the Commodity Exchange Act to fight fraudulent transactions and the manipulation of markets.
Other Federal and State Laws Related to Cryptocurrencies
The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued guidance in 2013 regarding the applicability of the Bank Secrecy Act (BSA), 84 Stat. 1114-2, to cryptocurrency. Also known as the Currency and Foreign Transactions Reporting Act, it requires financial institutions to keep records of cash transactions and report suspicious activity. It is designed to assist in the detection and prevention of money laundering and other crimes. The guidance notes that “accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter” and thus subject to BSA requirements.
The Uniform Regulation of Virtual-Currency Businesses Act, developed by the National Conference of Commissioners on Uniform State Laws, provides a statutory framework for the regulation of the exchange, transfer, and storing of cryptocurrency and its use as a medium of exchange. Although uniform laws have no legal effect, states are encouraged to adopt them to create consistency in legislation. Rhode Island has adopted the Uniform Regulation of Virtual-Currency Businesses Act, and California, Hawaii, and Oklahoma have introduced bills.
The Conference of State Bank Supervisors has drafted a model framework for state regulation of cryptocurrency activities. Unlike uniform laws, which are intended to be templates that jurisdictions can adopt, model acts are designed to serve as guidelines for legislation and regulations.
Proceed in the Cryptocurrency Market With Caution
Outside a handful of federally regulated exchanges, the cryptocurrency market is a Wild West fraught with risk. In his Senate testimony, SEC Chairman Clayton expressed concern that few investors really understand those risks.
The CFTC notes that unregulated cryptocurrency platforms lack operational safeguards and may commingle assets in shared accounts. The market is highly volatile with substantial price swings, leaving investors exposed to adverse conditions. Manipulative activities and Ponzi schemes are common. And cryptocurrency platforms and digital wallets may be vulnerable to cyberattacks that result in the theft or loss of cryptocurrency assets.
Existing laws limit the ability of the SEC and CFTC to regulate cryptocurrency markets, and the agencies have been left to determine what falls within the ambit of their authority on a case-by-case basis. Until Congress acts with legislation addressing the potential for fraud and speculation, investors should proceed with caution.
Learn More About Technology and the Law
There’s a growing need for legal professionals who understand technology. If you want to gain advanced knowledge of the law as it relates to cybersecurity and technology, learn more about the Executive Juris Doctor/Law and Technology Track offered by Purdue Global Law School. This degree is for those who wish to develop legal expertise but do not intend to become a practicing attorney.
You can also request more information today.