CBA Record January 2018

The CFTC’s Regulation of Cryptocurrencies and Related Futures Products under the Commodity Exchange Act The Commodity Exchange Act (“CEA”) governs transactions involving the future delivery of commodities. The CEA covers a wide array of “commodities,” such as agricultural products (e.g., wheat and cotton), natural resources (e.g., gold and oil), traditional currencies (e.g., yen, euros), and interest rates (e.g., LIBOR). It has a catch-all for “all services, rights, and interests…in which contracts for future delivery are presently or in the future dealt in.” 7 U.S.C. § 1a(9). Cryptocurrencies fell under the auspices of the CFTC in Sep- tember, 2015. The CFTC commenced an enforcement action against Coinflip, Inc., an entity that facilitated cryptocurrency swaps without having registered as a swap execution facility or designated contract market pursuant to the CEA. The CFTC referenced the catch-all and concluded that “Bitcoin and other virtual currencies are encompassed in the definition and are properly defined as commodities.” In the underlying spot market for cryptocurrencies, “[t]he CFTC’s jurisdic- tion is implicated . . . if there is fraud or manipulation involving a virtual currency traded in interstate commerce.” CFTC Primer onVirtual Currencies . In the futures markets (like those for CME and CBOE Bitcoin futures), and in the markets for swaps and other derivatives involving cryptocurrencies, the CFTC will regulate all transactions. Although the CFTC has determined that it will regulate cryptocurrencies as “com- modities,” the SEC is also overseeing vari- ous aspects of the cryptocurrency market. For example, 2017 brought an influx of initial coin offerings (“ICOs”). These are similar to initial public offerings (“IPOs”) for stocks. According to the SEC, an ICO is a fundraising event in which an entity offers participants a unique digital “coin” or “token” in exchange for consid- eration, such as other cryptocurrencies or government-backed currencies. The company issues the tokens using block- The SEC’s Regulation of ICOs and Cryptocurrency-Related Products

chain technology. These tokens are then often subsequently listed and traded on separate online platforms, called “virtual currency exchanges,” in exchange for other cryptocurrencies or government-backed securities such as U.S. Dollars. Rather than publishing a prospectus, ICO promoters generally publish a “white paper” that details what purchasers expect to receive for their investments in coins. On December 11, 2017, SEC Chair- man Jay Clayton issued a statement of caution on ICOs and cryptocurrencies generally. Statement on Cryptocurrencies and Initial Coin Offerings . The Statement emphasized that some cryptocurrencies and ICOs could constitute securities under the federal securities laws. Simply calling a cryptocurrency a “currency” or a “token” does not immunize it from the securities laws. Before launching a cryptocurrency, or cryptocurrency-related instrument, its pro- moters must either register the product as a security or be able to demonstrate that it is not a security. Many ICOs meet the defini- tion of a security pursuant to the “investment contract” test announced in the Supreme Court’s decision, S.E.C. v. W.J. Howey Co ., 328 U.S. 293, 298 (1946). Under Howey , an instrument is a security if it constitutes an investment of money in a common enter- prise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. In its July 25, 2017 report on Decentral- ized Autonomous Organization, the SEC concluded that the initial coin offerings at issue were securities. Similarly, on Decem- ber 11, 2017, the SEC ordered Munchee, Inc., a restaurant review company, to cease and desist for failing to register its ICO with the SEC. The company had issued 225 million “MUN” tokens using Ethereum blockchain technology. The SEC concluded that MUN tokens are investment contracts under the Howey test because ICO purchasers expected a profit on their interest in the restaurant review company based on the efforts of Munchee’s promoters. The SEC has not yet approved exchange traded instruments (such as ETFs) related to cryptocurrencies, although companies have filed applications unsuccessfully

with the SEC. Chairman Clayton also warned that cryptocurrency exchanges could be operating unregistered Securities Exchanges or could constitute unregistered broker-dealers in violation of the 1934 Securities Exchange Act. Finally, it should be noted that hedge funds and other enti- ties investing in portfolios of cryptocur- rencies or cryptocurrency-related products should consider registration under the Investment Company Act, also overseen by the SEC. The IDFPR’s Regulation of Cryptocurrency Transactions The IDFPR indicated that it will not regulate a transaction consisting exclusively of cryptocurrency (which it refers to as “digital currency”), such as the exchange of one cryptocurrency for another, or the exchange of a cryptocurrency for a good or service. If, however, the transaction also involves government-backed currency, the IDFPR will regulate the transaction pursuant to the Illinois Transmitters of Money Act (“TOMA”). IDFPR, Digital Currency Regulatory Guidance . TOMA- covered transactions include trading cryptocurrencies for U.S. dollars through a website or app that operates as a third party exchange, taking the cryptocurrency buyer’s government-backed currency and transmitting it to the cryptocurrency seller. Entities facilitating such transactions are required to register with the IDFPR if they meet certain net worth thresholds. IDFPR recommends that all such entities seek a licensure determination before participat- ing in a transaction that involves both government currency and cryptocurrency. In 2014, the IRS stated that cryptocur- rency constitutes property for tax purposes. Realized gains from the sale of cryptocur- rencies (such as those realized by many in 2017 from the meteoric rise in Bitcoin) are taxable. See IRS, Virtual Currency Guid- ance: Virtual Currency is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply . In addition, payments to employees and contractors in cryptocurrencies are taxable events. Fur- The IRS View: Realized Cryptocurrency Gains Are Taxable

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