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First Bitcoin-Related CFTC Enforcement Action Wins USD 2.5 Million Judgement

On 16 October 2018, a New York Federal Court ordered Gelfman Blueprint Inc., and the CEO Nicholas Gelfman, to pay USD 2.5 million restitution and fines. This is a successful end to the Commodity Future Trading Commission’s (CFTC) first Bitcoin-related anti-fraud enforcement action, an endeavor which began on 21 September 2017.

From 2014 through January 2016 Gelfman Blueprint Inc. solicited USD 600,000 of investments from at least 80 clients. This money supposedly went towards a fund for an in-house high-frequency trading algorithm named Jigsaw, which supposedly made consistent profits. However, the performance reports were fake, and payouts of profits to clients came from new investments from other clients, which makes this a classic Ponzi scheme. The period of 2014 through 2016 coincided with a Bitcoin bear market, and Gelfman Blueprint Inc. was overall unprofitable. The Ponzi scheme collapsed when a fake hack was staged to make it appear like all customer funds were stolen.

The CFTC charged Gelfman Blueprint Inc. and the CEO with fraud, misappropriation of client’s money, and issuing false accounting statements. The final judgement is USD 1.047 million of restitution to clients, and USD 2.031 million of civil monetary penalties. The CFTC warns that Gelfman Blueprint Inc and the CEO might have no money though, and therefore despite the judgement there may be no payout. Further, Gelfman is banned from participating in any future financial activity that falls under CFTC jurisdiction. Notably, there does not appear to be any criminal penalties or prison time for Gelfman, despite effectively stealing USD 600,000.

The CFTC Director of Enforcement, James McDonald, says “This case marks yet another victory for the Commission in the virtual currency enforcement arena. As this string of cases shows, the CFTC is determined to identify bad actors in these virtual currency markets and hold them accountable. I’m grateful to the members of Enforcement’s Virtual Currency Task Force for their tireless work on these matters”.

In the past, the Securities and Exchange Commission (SEC) was the primary enforcer in the crypto markets, but this landmark case shows that the CFTC is ready, willing, and able to perform similar enforcement actions. The CFTC considers Bitcoin and crypto to fall under their jurisdiction as commodities, while the SEC says most cryptos are securities and fall under their jurisdiction. Bitcoin is sufficiently decentralized not to be considered a security itself, but the Bitcoin market still sees regular enforcement action by the SEC since many Bitcoin investment products can be classified as securities.

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CFTC Discusses Possible Crackdown On Blockchain Powered Prediction Markets

Commodities Futures Trading Commission (CFTC) Commissioner Brian Quintez made a speech that was largely about blockchain smart contracts on 16 October 2018. Quintez concludes that prediction markets powered by blockchain smart contracts, such as Augur which is the #52 cryptocurrency with a market cap of USD 139 million, are under CFTC jurisdiction and can be classified as binary options.

Specifically, Quintez says “Let’s apply the general analytical framework I’ve described above to our earlier example of the “prediction market.”  In this hypothetical, after performing a facts and circumstances analysis, the CFTC has determined that the smart contracts executed on the blockchain are binary options, which are within its jurisdiction. Binary options are a type of option whose payoff is either a fixed amount or zero. For example, there could be a binary option that pays $100 if the price of gold is above $1,200 per ounce on a specified date or zero otherwise.

Moreover, the contracts in our scenario likely qualify as event contracts that are based upon the occurrence or non-occurrence of an event (as opposed to a price of a commodity).  Event contracts have a unique spot in CFTC jurisprudence because of the public policy concerns they raise. For example, event contracts based upon war, terrorism, assassination, or other similar incidents may be contrary to the public interest – in which case, the CFTC can prohibit an exchange from offering the contract”.

Indeed, the Augur prediction market has already been in the spotlight due to assassination bets being created. This opens up the possibility that any sort of bet can be created on Augur, no matter how immoral it is, especially since Augur burned the kill switch for the platform, making it decentralized and unstoppable. Clearly, the CFTC would consider immoral bets on Augur contrary to the public interest, and therefore illegal.

Quintez further explains who is responsible when smart contract powered prediction markets violate the law. “I think the appropriate question is whether these code developers could reasonably foresee, at the time they created the code, that it would likely be used by U.S. persons in a manner violative of CFTC regulations. In this particular hypothetical, the code was specifically designed to enable the precise type of activity regulated by the CFTC, and no effort was made to preclude its availability to U.S. persons. Under these facts, I think a strong case could be made that the code developers aided and abetted violations of CFTC regulations. As such, the CFTC could prosecute those individuals for wrongdoing”. This brings up the possibility that programmers who create blockchain prediction markets, such as the Augur developers, could end up in a legal battle with the United States government.

Quintez compares blockchain prediction market developers to someone who lends their keys to a bank robber. As a secondary layer of enforcement, Quintez speculates that the CFTC could sue individuals who use prediction markets, but he admits this would probably be ineffective due to the decentralized, anonymous, and global nature of blockchain prediction markets.

Apparently, LabCFTC has been created to engage with blockchain developers, to prevent blockchain platforms that violate the law from being created in the first place. However, Quintez says if engagement does not occur, then enforcement is the only option.

A final important note in Quintez’s speech is he does not consider code to be law, contrary to the thinking of many blockchain and crypto users who consider code to be a form of law. Quintez says “I have heard some say that “the code is law,” meaning that if the software code permits it, an action is allowed. I disagree with this fundamental premise. Case law, statutes, and regulations are the law. They apply to the code, just as they apply to other activities, contracts, or agreements”.

Essentially, just because something is coded into a blockchain or crypto platform, that does not make it law, and the laws of the land are definitely superior, at least in the CFTC’s opinion.

Quintez ends the speech on a somewhat positive note, saying “Smart contract applications on blockchain networks hold great promise. They have the potential to open up new markets and create efficiencies in existing ones. At the same time, they also raise novel issues of accountability that users and policymakers alike must consider”.

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US District Court Rules CFTC Has Jurisdiction over Crypto

On 26 September 2018, Judge Rya W. Zobel of the US District Court of Massachusetts ruled that the Commodities Futures Trading Commission (CFTC) has jurisdiction to regulate all cryptocurrencies as commodities. This critical ruling was issued in response to a motion by My Big Coin to dismiss a case against them by the CFTC, on the grounds that the My Big Coin cryptocurrency was not a commodity.

The US District Court used a relatively broad definition of commodities to reach this decision. It says that commodities are all goods, articles and service rights and interests for which there are contracts for future or present delivery. The court references how the fact that Bitcoin has future markets factored into this decision.

The Director of CFTC Enforcement, James McDonald, says, “This is an important ruling that confirms the authority of the CFTC to investigate and combat fraud in the virtual currency markets. This ruling, like the one in McDonnell from Judge Weinstein in the Eastern District of New York, recognizes the broad definition of commodity under the Commodity Exchange Act (CEA), and also that the CFTC has the power to prosecute fraud with respect to commodities including virtual currencies. We will continue to police these markets in close coordination with our sister agencies.”

Simultaneously, the Securities and Exchange Commission (SEC) has previously declared that almost all cryptocurrencies are securities. The SEC says that any crypto which an investor buys in expectation of future profit is a security, if profits go to a centralized organization. The SEC says that only Bitcoin and Ethereum are decentralized enough not to be considered securities.

The end result is a hostile situation where most crypto companies can be regulated by the SEC and CFTC, as both commodities and securities. The reality is Bitcoin and other cryptocurrencies are an exotic new hybrid of commodities and securities, and there are discrepancies and irregularities should states regulate cryptocurrencies like traditional financial assets. Some industry commentators feel it would be best if a new government agency were created to regulate the crypto space, with the power to override decisions by the SEC and CFTC to ensure fair treatment of crypto companies.

 

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US Spent Over $5 Million on Blockchain Espionage in 2018

The United States government has spent USD 5.7 million with blockchain analytics firms so far in 2018 and this spending is accelerating, according to a report by digital currency publication Diar. Blockchain analytics firms are paid to conduct blockchain espionage, for criminal prosecution, taxes, and to ensure crypto regulations are being followed.

Bitcoin has a public blockchain ledger, where every transaction and address can be viewed by anyone. Firms like Chainalysis, Elliptic, CipherTrace, Scorechain, Coinfirm, Blockchain Intelligence Group, Bloq, and DMG Blockchain Solutions have developed advanced software which can attach identities to Bitcoin transactions, and transactions for other cryptocurrencies as well. The biggest customers of these firms are banks and financial institutions, who use blockchain analytics to ensure no breach of know your customer (KYC) or anti-money laundering (AML) policies. Collectively, the major blockchain analytics firms listed have received USD 28.8 million of contracts.

The Internal Revenue Service (IRS) is the biggest spender relative to other US government agencies at USD 2.19 million. The IRS is in charge of taxes in the United States, and it seems it is using the most advanced blockchain tracing technology people to build cases against crypto users who are not paying taxes. This despite members of the United States congress requesting that the IRS make its crypto tax guidelines clearer, since at this point the crypto tax code issued by the IRS is so unclear, prohibitive, and arduous that most crypto users don’t know how to pay crypto taxes.

The second biggest government spender is Immigrations and Customs Enforcement (ICE) at USD 1.54 million. This is probably because the ICE seizes drugs and other illegal goods at customs, and sometimes these packages are linked to crypto payments done over the darkweb.

The Federal Bureau of Investigations (FBI) takes third place in spending with USD 1.14 million, and this is probably related to crypto activity associated with criminal suspects and crime organizations. The Drug Enforcement Agency (DEA), in fifth position with USD 0.22 million, probably uses blockchain analytics firms for the same reasons the FBI does. The FBI and DEA can actually use blockchain analytics data in court for criminal prosecution.

The Securities and Exchange Commission (SEC) is at sixth place at USD 0.18 million. The SEC is cracking down hard on initial coin offerings (ICOs) and other fraudulent crypto-related securities, so it makes sense they’re spending some money on blockchain analytics. The Commodity Futures Trading Commission (CFTC) spends USD 0.12 million, likely to ensure exchanges are maintaining regulatory compliance, since Bitcoin trading is regulated under commodity laws.

 

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CFTC Chair: Blockchain Innovation Stifled by Lack of US Regulations

At a United States Congressional hearing on Wednesday, 25 July, Christopher Giancarlo, Chairman of the Commodity Futures Trading Commission (CTFC), elaborated on the need for CFTC participation in blockchain innovation in the US.

“Because we’re falling behind”

At the “Examining the Upcoming Agenda for the CFTC” public hearing, Giancarlo explained the frustrations of the CFTC not being able to participate in Proof-of-Concept (PoC) or beta tests of new blockchain innovations, that of which can be boiled down to bureaucracy.

He says that the CFTC would love to take part and create a regulatory node in the blockchain to observe these developments. However, Giancarlo noted that the CFTC was unable to do so, owing to present laws which stifle efforts to appropriately regulate the blockchain with full understanding.

The issue is that the CFTC can’t freely exchange information between itself and a private startup as it is considered a “gift”, which is something that the agency is strictly prohibited from doing, or even a bank, even if it was by invitation.

Giancarlo also points out that paying a private company for information is redundant as it will need to go through a time-consuming appropriations process, by which time he says “this thing is already launched”.

Catching up

His words come in response to Representative Austin Scott’s question of how the CFTC Modernization Act would allow them to do their job better, a bill that was also proposed by the representative.

He noted that the Bank of England had recently managed to finalize a Distributed Ledger Technology (DLT) project through their four-year-long Project Innovate that allowed them to participate in blockchain beta tests, from which they created a new “bank-to-bank payment system” and that it is going to be “blockchain compliant”.

Giancarlo was also asked earlier by the representative to explain the future intentions of the CFTC’s hub for “engagement with the fintech innovation community” called LabCFTC. To which he responded, “LabCFTC is our front door into these new regulatory fintech developments in the marketplace, and it’s so important to us to be able to understand these innovations that are coming down the pike so fast.”

US developments

The commissioner of the CFTC Rostin Benham called cryptocurrency a “modern miracle” in early June, also believing that blockchain was a remedy to globally-recognized problems such as poverty, corruption, food and healthcare.

In July, the Chamber of Commerce created a Fintech Innovation Initiative that is urging the government to establish clearer regulations on cryptocurrencies and related activities. Furthermore, it sent a report to US financial regulators also relaying the message that the US could fall behind the rest of the world.

It appears as though the cogs are finally turning in the US, though the nation will have to certainly set a high pace should it wish to be in league with countries such as South Korea, Malta, or the United Kingdom.

 

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Ethereum Could Get Major Lift from Plasma, Sharding Developments, SEC Boost

Ethereum has currently created an environment for some positive movement due to current developments in hand and positive SEC rulings over the past few days, according to NewsBTC. Although the price of Ether continues to reflect the current market, there are some positive developments such as its Plasma updates and sharding solutions.

Sharding, also known as horizontal partitioning is a design principle whereby rows of a database table are held separately, rather than splitting by columns (as for normalization). Each partition forms part of a shard, which may, in turn, be located on a separate database server or physical location, explains Stackoverflow.

Plasma itself is a collection of standard smart contracts used to create a tree of side-chains aptly called Plasma chains. This collection of smart contracts includes a multitude of key innovations that together make up a powerful tool in the battle towards scaling Ethereum’s capacity, explains Coincentral.

If Plasma is successful, it will successfully help Ethereum scale to a whole new level, and there has been some talk regarding Plasma Debit, which has the potential of introducing payment channels to Plasma Cash.

Ethereum can also gain a lift up after US Commodity Futures Trading Commission (CFTC) commissioner Rostin Beham’s recent unexpected remarks that cryptocurrency is a “technological revolution” that will one day be a part of every national economy, tagging blockchain as life “transforming”.

Add to that the statement of director of division of corporation finance at SEC, William Hinman, which lifted market hopes considerably:

“And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value.”

Such views from the SEC are empowering for Ethereum, Bitcoin and the blockchain, clearly adding much-needed and long-awaited legitimacy to crypto space, and along with new projects in hand, are certainly a step in the right direction for Ethereum investors.

 

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US Regulators Subpoena Coinbase, Kraken and Bitstamp in Bitcoin Probe

The US Commodity Future Trading Commission (CFTC) has subpoenaed Coinbase, Kraken, Bitstamp, and ItBit in an ongoing Bitcoin manipulation probe started last month, reports Coingape.

It is thought that the investigation has been initiated due to the distorted prices in the futures market.

Coinbase is one of the world’s major cryptocurrency exchanges with Kraken in 24th position and a 24-hour trading volume of over 54 million. Bitstamp ranks 38th with 28 million daily trading volume, and ItBit is 62nd with a $9.6 million daily trading volume.

The investigation followed the launch of bitcoin futures on CME Group Inc.’s CME, -0.45%  exchange six months ago. CME’s bitcoin futures derive their final value from prices at these exchanges.  Any kind of manipulative trading in those markets is reported to be able to influence the price of bitcoin futures that the government directly regulates.

The exchanges have been requested to submit their trading data to the CFTC in an attempt to prevent distorted prices in the CME futures market. The Wall Street Journal has said that the problem with CME has existed since it launched Bitcoin futures, requesting data from the exchanges in order to base the bitcoin price for futures trading. CFTC officials had previously backed the launch of bitcoin futures, viewing the move as risky, but worthwhile.

Apparently, CME didn’t have the agreements that allowed trading data sharing, and they had to rely on third-party firms to calculate the index, according to Market Watch. On the regulators search into fake orders and spoofing, Jesse Powell, the Chief Executive of Kraken recently commented:

“If there is any kind of attempted manipulation, whoever is doing it is taking a huge amount of risk for very little possible upside.”

The company behind ItBit exchange, Paxos’ Chief Executive Charles Cascarilla stated that “We have definitely entered an unknown area where it is clear there is a desire for tightened oversight.”

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CFTC Commissioner: Crypto Will ‘Proliferate To Every Economy’

Rostin Benham, a commissioner at the United States Commodity Futures Trading Commission (CFTC), stated that “cryptocurrencies will proliferate to every economy and every part of the planet”, calling crypto a “modern miracle”.

He believed blockchain had the potential to address the world’s most pressing problems like poverty, corruption, food, and healthcare. He made these comments regarding cryptocurrency during a speech at the Blockchain for Impact Global Summit at the United Nations Plaza in New York City on 4 June 2018.

CFTC declared Bitcoin a commodity in 2015 and since then has been playing an active role in regulating cryptocurrency markets. Benham said that CFTC had been outspoken and upfront about cryptocurrency over the past few years, having engaged in notable enforcement actions to increase transparency and reduce fraud in cryptocurrency markets. Additionally, it had been educating citizens to help prevent them from becoming victims of cryptocurrency scams.

Benham discussed how the unbanked could now have cryptocurrency accounts, possibly helping them get out of poverty by restoring their financial freedom. He believed that some small economies could become dependent on cryptocurrency for survival, much like the village of Kolionov in Russia.

Benham further said that the healthcare sector could see some major improvements with the aid of blockchain technology, helping patients organize and keep control of their medical records as opposed to the fragmented record keeping that is the standard today. It could also help reduce medical waste and fraud, lowering health care costs.

CFTC is an agency which was created in 1974 to regulate the futures, options, and commodities markets. Its mission is to foster safe, competitive, transparent, and trustworthy market conditions by avoiding systemic risk and preventing fraud. CFTC is the chief regulator for trillions of dollars of assets in the United States.

While Benham embraced the technology, he also warned that CFTC must remain diligent so that blockchain and cryptocurrency are not exploited for criminal purposes.

 

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Why SEC Should Take a Close Look at an ICO Amnesty Plan

Daniel S Alter, former general counsel for the New York State Department of Financial Services (DFS) and writer for Coindesk has suggested that the SEC should consider an amnesty for illegal ICOs.

In his article, he points out that 2017 saw a monumental rise in the number of coin offerings (ICOs). At one point, up to 50 companies a month were raising funds, most of these unregistered.

This changed later in 2017 after the DAO report based on the Howey Test earlier that year in July, resulted in certain tokens being classified as “investment contracts”, thereby becoming liable for US Securities and Exchange Commission’s (SEC) registration.

It took precedent from the famous court case of the WJ Howey Co-owned Florida citrus groves, the fruits from which would typically be considered a commodity when sold on an exchange. However, the Howey Co also leased about half of its groves in order to finance future grove developments. Howey’s own fruit groves, therefore, were found to be tied to its leased groves, which qualified as an “investment contract” instrument – or a security.

According to Alter, 2018 saw a wave of “SEC subpoenas and enforcement actions targeting similar token offerings – many of which smacked of fraud”. The result is that many ICO tokens have seen a fall in value due to reduced liquidity, market instability for existing tokens, and US companies registering overseas where token sales are unrestricted.

Alter suggests that a model amnesty “clean up” plan should be forged between participating ICOs and the SEC in order to integrate the new asset class into the current structure and introduce a mechanism for protecting “legally flawed investments”. Reports suggest that this process may have begun already, with firms and their lobbyists meeting with the SEC to try and effect a regulatory exemption for unregistered security tokens.

Currently, there are five agencies involved in discussing and setting cryptocurrency regulation in the US, including the US Securities and Exchange Commission (SEC), FinCEN, the Commodity Futures Trading Commission (CFTC), the Department of Justice (DOJ), and the Internal Revenue Service (IRS).

This past February, the Commission’s enforcement division announced the Share Class Selection Disclosure Initiative (SCSD Initiative), self-described as a self-reporting initiative that seeks to protect advisory clients from undisclosed conflicts of interest and return money to investors. Those reporting illegal activity under the initiative would be free from penalty themselves.

Alter feels that a similar approach could work with the case of unregistered security tokens by offering an amnesty. He suggests a method of achieving this would be for issuers of unregistered tokens to make a formal presentation to the SEC to replace the “old” tokens for “new” tokens. This could be formulated under section 12 of the Securities Act of 1933 (establishing a cause of action for rescission or damages in connection with the sale of unregistered securities).

“As an incentive to exchange old tokens for new ones, issuers would probably need to offer some additional consideration – possibly paid in new tokens rather than cash in order to preserve the company’s operating capital,” says Alter.

Ethereum is now under regulatory scrutiny by the SEC, which is considering whether it should be classified as a commodity or a security, according to the New York Times. The SEC is likely to use the Howey Test to establish if Ethereum trading qualifies as an investment contract, thus becoming a security.

 

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Global Conference Fireworks Over Crypto

A recent panel discussion at the Milken Institute Global Conference in Beverly Hills became heated when panelists aired their conflicting views on the future of cryptocurrency.

Every seat in the conference auditorium was filled for the discussion which included United States Commodity Futures Trading Commission (CFTC) chairman Christopher Giancarlo, economist Nouriel Roubini, and Commissioner at the United States Securities and Exchange Commission (SEC) Michael Piwowar.

SEC’s commissioner Piwowar, issued an early warning, making reference to the current argument surrounding ICOs, which has occupied much debate recently, suggesting that if an ICO token is a security it falls into one of three categories:

“The first is the registered public offerings; this is the normal IPO, public offer. We’ve not had anybody register a public offering for an ICO. The next bucket is exempt offerings, so if you have an ICO, you have to fit into one of those types of exempted. And the third bucket is illegal […] if you are not falling into the first two buckets, we’ve said we’re coming after you.”

Piwowar added, “Bitcoin itself is not a security, but these customized tokens for these initial coin offering – most of them are.”

Christopher Giancarlo was upbeat,  suggesting that there should be more respect for the generation’s “new instrument”, referring to cryptocurrencies, and said that rather than derision, markets needed policy initiatives that were “thoughtful and forward-looking”. He continued:

“There is something going on here that is generational… Just as the baby boomer generation lost faith in the leaders that came before them and tried to seek a cultural change in those days through sex, drugs and rock and roll, I think there is a generation that also has lost faith in us that led them through the financial crisis and they see technology as a way of disintermediating institutions for which they don’t have a great deal of respect.”

He went on to explain the CFTC’s problems of applying outmoded regulations to completely new technology.

Nouriel Roubini, tagged as ‘Dr Doom’, an economist known for predicting the 2008 financial crisis, caused friction when describing blockchain as “a glorified Excel spreadsheet” and described investors entering the Bitcoin market “bubble” in 2017 as “suckers.”

His description of decentralization as bullsh*t provoked blockchain entrepreneur Alex Macshinsky to respond, “Everything you just said is irrelevant.”

Ex-CIA cryptographer Bill Barhydt, clearly bemused by Roubini’s comments, retorted with “I don’t even know where to begin”.

 

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