On September 24th, the U.S. Commodity Futures Trading Commission (CFTC) settled charges against TeraExchange LLC, a provisionally registered bitcoin swap execution facility (SEF). The charges stem from a non-deliverable forward (“NDF”) contract based on the relative value of the U.S. Dollar and Bitcoin (the Bitcoin swap) executed over that SEF.
Background: Forwards and NDFs
A forward contract is an agreement between one party (the “Buyer”) and another party (the “Seller”) whereby the Buyer agrees to purchase something in the future from the Seller for a price that is agreed to at the time the contract is entered into by the parties.
- A forward contract is deliverable if the Buyer delivers cash to the Seller at settlement in exchange for the “something” from the Seller – in the case of a Bitcoin forward, that “something” is BTC. To settle a Bitcoin forward, the Buyer would pay USD to the Seller and the Seller would deliver BTC to the Buyer.
- A Bitcoin forward contract is non-deliverable if, rather than settling by the exchange of USD-for-BTC on the settlement date, the parties agree to look at the change in the relative values of U.S. Dollars and Bitcoin and whoever owes pays the other an amount of USD. In other words, Buyer would receive USD in an amount equal to the appreciation in value of BTC and pay USD in an amount equal to the depreciation in value of BTC, in each case relative to USD over the life of forward.
Understanding the difference between deliverable forwards and NDFs is important, since the CFTC has regulatory jurisdiction over an NDF on a commodity. As we pointed out in a posting from last week (CFTC Brings First Enforcement Action Against Unregistered Bitcoin Options Trading Platform), the regulatory status of deliverable forward contracts on BTC remains unsettled although the CFTC certainly has indicated that such contracts may lead to a violation of the Commodity Exchange Act (the “CEA”).
The Trading Activity Involving BTC NDFs
The particular trading activity at issue occurred on October 8, 2014 and was described by the CFTC in the following manner:
On October 8, 2014, the only two market participants authorized at that time to trade on Tera’s SEF entered into two transactions in the Bitcoin Swap. The transactions were for the same notional amount, price, and tenor, and had the effect of completely offsetting each other. At the time, these were the only transactions on Tera’s SEF.
Tera arranged for the two market participants to enter into the transactions. Tera brought together the market participants, telling one that the trade would be “to test the pipes by doing a round-trip trade with the same price in, same price out, (i.e. no P/L [profit/loss] consequences) no custodian required,” according to the Order.
However, subsequent to the transactions, Tera issued a press release and made statements at a meeting of the CFTC’s Global Markets Advisory Committee (GMAC) [on October 9, 2014] announcing the transactions, creating the impression of actual trading interest in the Bitcoin swap. Neither Tera’s press release nor the statements at the GMAC meeting indicated that the October 8 transactions were pre-arranged wash sales executed for the purpose of testing Tera’s systems.
In sum, the September 24th order settled charges that TeraExchange failed to enforce rules on its SEF rule that prohibited wash trading and prearranged trading over the SEF in violation of the CEA.
The Significance of the Order
The issuance of the order on September 24th marks the third consecutive Thursday on which the CFTC has released some form of Bitcoin related guidance, which is a significant fact in and of itself for “CFTC watchers” and industry participants alike. At this point, it appears fair to say that that the CFTC is giving attention to the Bitcoin industry. And, as explained by the CFTC in last week’s enforcement action, the regulator expects industry participants to comply with the rules that apply to all participants in the commodity derivatives markets.
The Press Release and CFTC Order are available here.
Good day. Good to keep learning…always. DR2