In this multi-part posting, we outline key considerations for investment funds and their advisers regarding the application of the U.S commodity laws to cryptocurrency derivatives. This posting is intended to be a primer on the topic and is not legal advice. You should consult with your counsel regarding the application of the U.S. commodity laws to your particular facts and circumstances.
First, a few words about our use of the word “cryptocurrency”… In this series of postings, we use the word cryptocurrency (and often the term “crypto”) to refer to traditional virtual currencies, like BTC and ETH, as well as tokens related to a particular software product development initiative (i.e., “coins” sold in an initial coin offering or “ICO”). We recognize that there are different classifications of cryptos among different groups of market participants; however, when we say “crypto,” we mean cryptocurrency in the broadest sense (inclusive of virtual currencies and tokens).
Having dealt with the initial definitional matter, we now turn to the substance of this Part 1 – Cryptos are Commodities (Except When They Are Not).
Cryptos are Commodities (Except When They Are Not)
As a general rule, a good starting point for funds and advisers is to analyze whether a crypto investment constitutes a “commodity,” as defined by section 1a(9) of the Commodity Exchange Act (the “CEA”).
The U.S. Commodity Futures Trading Commission (“CFTC”) has expressed its view that a virtual currency is a commodity and, in so doing, defined a “virtual currency” to mean “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, but does not have legal tender status in any jurisdiction.” In the Matter of Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Dkt. No. 15-29 at n.2 (Sept. 17, 2015).
The analysis of whether a “token” is a commodity is not a well-developed area of law and will typically turn on the facts and circumstances of the token. The CEA broadly defines a “commodity” to include articles and goods, physical commodities (which range from agricultural commodities to non-financial, intangible commodities such as carbon allowances), various financial interests (such as currencies, interest rates and financial indices), as well as all services, rights and interests in which contracts for future delivery are presently or in the future dealt in.
Note: In the language of the CEA, a “contract of sale of a commodity for future delivery” is what most market participants would call a “futures contract”; although, ironically, the CEA does not actually define the term “futures” despite using it in several places, including the name of the CFTC itself.
Under the plain language of the statute, a “service, right or interest” would seem to be a commodity, if there is an actively traded, listed futures contract on that service, right or interest. But, there is little guidance as to when futures contracts “are presently or in the future dealt in”. Given that some tokens (particularly fully-developed “utility tokens”) may constitute a “service, right or interest,” this threshold consideration is an area of interest to practitioners and market participants alike.
It is worth emphasizing that a security is a type of commodity, although section 2(a)(1)(A) of the CEA provides the U.S. Securities and Exchange Commission (“SEC”) with exclusive jurisdiction over the regulation of securities transactions. An understanding of this jurisdictional consideration is particularly important to funds and their advisers – a crypto that is a security raises securities law concerns, while a crypto that is a commodity raises commodity law concerns.
For the remainder of this series, we will assume that we are in the realm of cryptos that are commodities (but not securities).