Seven months into his term, and Brian Quintenz is making waves.
The hedge fund boss-turned-regulator, who became a Commodity Futures Trading Commission (CFTC) commissioner on August 15, 2017, has been no stranger to the press since he took on the job, commenting on a range of issues stretching from the leverage ratio and de minimis thresholds for swap dealers, through to Regulation AT.
His most recent proclamation, however—that the cryptocurrency industry should form a self-regulatory organization (SRO)—first made at a Yahoo conference on February 7 and repeated again during the CFTC’s Technology Advisory Committee (TAC) meeting on February 14, raised some eyebrows.
Some steps toward this model have already been taken. In the UK, a number of crypto market participants have formed a trade association, CryptoUK, that could serve as a precursor to some form of SRO.
WatersTechnology examines five key considerations related to the proposal, below:
The Crypto Industry Could Not Create its Own Finra Tomorrow
The natural example of a successful SRO is the Financial Industry Regulatory Authority (Finra), and most comment on Quintenz’s proposal has naturally suggested this as a model. It would not work in the same way.
Finra was formed from the merger of the National Association of Securities Dealers and the New York Stock Exchange’s regulation and enforcement operations in 2007, the latter having a heritage that stretches back to the early 1930s.
Digital currency exchanges, however, do not have such a lengthy heritage—indeed, bitcoin only came into existence just under a decade ago. While the major exchanges have invested heavily in their surveillance and oversight operations, the idea that a Finra-esque body could be assembled with an appropriate degree of sophistication in the short term is doubtful.
However, a standards-setting body of sorts, similar to the National Futures Association (NFA), may be practical. Indeed, in a media call held on February 13, ahead of the TAC meeting, Quintenz suggested such a route may be the ideal one, which in turn could inform regulatory direction if and when further powers are granted to federal agencies.
“Last week at Yahoo, I called for the crypto investment community as well as the advocacy community to think about how to form some type of NFA-like organization that could help start thinking about creating procedures on financial resources, insider trading, data reporting, recordkeeping obligations and things like that in advance of potential congressional action of giving any agency jurisdiction over that,” he said.
The Structure of the Market Is Still in Evolutionary Flux
Cryptocurrency markets have undergone tremendous change in the past 12 months, with an emerging derivatives layer, regulatory approvals for trading venues and clearinghouses, and moves toward establishing custody functions, but the market structure is still nowhere near mature.
Indeed, the lack of basic functions found in other markets, such as prime brokerage, and the lack of a legal support apparatus as is seen in modern derivatives markets with International Swaps and Derivatives Association (Isda) master agreements, demonstrates just how far crypto has to go before it can be considered a developed asset class.
While there is certainly an argument that an SRO could evolve along with the market, and tailor its approach to suit its evolution, any command-and-control entities must be able to act with legal surety and with the confidence to ensure that their actions will guarantee fair and orderly markets, and not cause their destabilization. Crypto markets, at present, are highly sensitive to any regulatory actions.
Also, it’s worth considering that despite great steps forward that were taken with the listing of futures contracts on established exchanges in December, the first three-month products have yet to even mature as of yet.
Direct Oversight by Established Regulators Is Still Crucial
There is no doubt that cryptocurrency markets are still rife with bad actors. At least a half dozen enforcement proceedings have been brought by the CFTC and the Securities and Exchange Commission (SEC) relating to virtual currencies, initial coin offerings and various scams in the past two months alone, while the heads of both agencies have released numerous joint statements on the potential perils of trading cryptocurrencies and investing in unregistered securities offerings.
Fragmented responses to incipient crises from the digital exchanges over the past year have also highlighted the need for effective oversight. For example, a flash crash in the price of ether earlier in 2017 resulted in GDAX, one of the largest exchanges, being forced to return money to traders and put circuit breakers in place—basic provisions that have been established in more traditional asset classes for years.
One of the problems facing established regulators, however, is that hard-charging agencies such as the CFTC do not appear to hold statutory authority over the whole market.
“The CFTC only has enforcement authority over spot commodity transactions,” Quintenz said on the call. “So think of that as after-the-fact jurisdiction or regulation. We can go in after we have seen either fraud or manipulation; we can go in and we can prosecute it. We don’t have oversight authority. Congress did not give us, through the [Commodities Exchange Act], oversight authority, over the spot market.”
Regulatory Opinion Is Still Being Formed
Most regulators are engaged in their own efforts to regulate bitcoin at the moment, and progress varies wildly by jurisdiction. Crucially, there is little international harmonization, let alone standards that can be followed through bodies such as the Committee on Payments and Market Infrastructures or the International Organization of Securities Commissions.
Indeed, the legal dimensions of what constitutes an investment, let alone a solid framework for prosecuting offenders, is still under consideration. During the February 14 TAC meeting, DRW Trading’s head of market structure, Richard Gorelick, pointed this out.
“While I concur that there’s been a lot of guidance and investor education in recent weeks and months from the CFTC and the SEC, there’s still room for improved clarity around what the rules are,” Gorelick said. “Particularly around the definition of what is a security, what is a commodity, what is an asset? What are the rules and how do we determine what is what?”
The TAC recommended that the CFTC establish subcommittees to further explore cryptocurrency, indicating the debate is still at a formative stage.
An Advisory Committee Would Be a Better Use of Resources
Much of the problem with cryptocurrency markets and regulation, as became apparent in the TAC meeting, is a lack of dialogue and education among market participants.
Rather than a body of pseudo-regulators drawn from companies that are still finding their feet, a more effective use of resources would be to convene an expert committee, drawing from the exchanges, lobby groups and trading firms active in crypto markets, which could be on hand to explain market developments and guide regulatory thinking on matters related to the idiosyncrasies of crypto trading.
Ideally, such a group could not only serve to inform Quintenz’s own agency, but also promote regulatory convergence among international regulators, also, reflecting the global nature of the crypto market.
Quintenz said the formation of any specific federal-level regulator would be “for Congress to decide,” but made it clear that he favors the advisory and SRO route on the media call.
“I do think that self-regulatory organizations have played a very important role in our marketplaces. The NFA was created only a couple years after the CFTC was formed and the CFTC relies heavily upon them. The exchanges themselves, when they were formed in Chicago in the 1860s, banned corners in the futures markets, 70 years before the first federal regulator did,” he said.
“And they have an incentive to do that. It gets back to the conversation around incentives. From a market integrity perspective, exchanges have an incentive to enhance market integrity for having procedures and protocols to address things like conflicts of interest, insider trading, corners and things like that,” he said.
Additional reporting by Dan DeFrancesco.
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