FTX Is Gone, but Its Memory Still Drives Federal Crypto Policy

Convicted fraudster Sam Bankman-Fried is serving a 25-year sentence in federal prison, but his now-defunct cryptocurrency exchange, FTX, remains top of mind for federal regulators. 

On Monday, the U.S. Commodity Futures Trading Commission (CFTC) released an advance notice of proposed rulemaking intended to clarify its regulatory approach to the cryptocurrency market. In a statement explaining the agency’s stance, CFTC Chairman Michael Selig attributed the agency’s expansively broad reading of its federal authority to the need to “prevent, rather than only prosecute after the fact, fraudulent schemes such as FTX.”

The proposal would create a “tailored subcategory” under futures exchanges—designated contract markets (which include prediction markets) already fall under the CFTC’s purview—with the cryptocurrency or digital asset as the commodity rather than the contract. This agency’s newly regulated category would allow retail customers to trade “on a margined, leveraged or financed basis,” according to Selig. 

The proposal only covers crypto platforms that offer customers financing for trades they can’t cover with their own funds, leaving most Americans who trade or own cryptocurrency unaffected unless their exchange offers leveraged trading.

Crypto platforms that offer leveraged, or borrowed-money, trading would also operate much the same way they do now, keeping listing, trading, settlement, and custody services in one company so long as they’re individually registered, rather than having the CFTC regulate each market segment separately, as it does with futures exchanges. The proposal effectively gives crypto exchanges a choice between operating within a patchwork of state licenses or under a “single federal regulatory scheme,” Selig wrote in The Wall Street Journal. 

However, the proposed rule would extend federal protections, and thus federal oversight, to every transaction on a crypto exchange if the platform chooses to lend customers money to trade. This includes financing offers from third parties if offered through the exchange. Once a crypto exchange offers customers the opportunity to make borrowed-money trades, the offer “attaches to all agreements, contracts, or transactions” on the platform, even when a customer turns down the offer and pays in full with their own money. 

As federally registered exchanges, the crypto platforms would be required to enforce rules regarding market manipulation and abusive trading. In a nod to the scandal that sank FTX, the agency is considering whether exchanges would also be required to keep customer money separate from the company’s account and provide proof of reserves showing they can cover what they owe. That raises legitimate questions about the CFTC’s view of liability if a broker goes bankrupt.

Under the CFTC’s interpretation of the Commodity Exchange Act, the law that regulates commodities trading in the U.S., the agency is authorized to regulate spot cryptocurrency trades—transactions immediately settled at the current asset price—if the crypto assets are purchased with borrowed money. In 2010, Congress gave the CFTC authority to regulate any retail commodity trade that is “entered into, or offered (even if not entered into), on a leveraged or margined basis, or financed by the offeror.” The statute doesn’t include a standard for what constitutes an offer, leaving it to the CFTC to create one. In its proposal, the agency uses a definition for offer broad enough to cover a wide swath of situations. This includes “standard customer documentation,” such as onboarding documents or terms and conditions agreed to when signing up for a platform. 

If a cryptocurrency exchange offers leveraged trading, it must use a CFTC-registered broker or sponsor a bank that agrees to follow the agency’s broker rules. However, the agency acknowledges this as a potential conflict of interest, since one company could act as a lender while also setting rules for borrowing and selling off borrowers’ positions. 

The proposal comes weeks after the Senate failed to advance the Clarity Act. That law would have given the CFTC explicit authority to regulate spot cryptocurrency markets irrespective of whether a platform offers leverage trading. 

Using a creative reading of federal law, the CFTC’s proposal effectively gives it a version of the authority outlined in the bill, without Congress’ blessing. It’s jurisdictional creep, although the alternative is the status quo: the federal government regulating crypto through case-by-case enforcement. Still, Congress could simply treat American crypto enthusiasts as adults willingly engaging in a credible financial market. 

The proposal is open to public comments, due 60 days after the notice appears in the Federal Register, after which the agency will likely draft a formal proposal.