While in recent years, the CFTC has taken the position that it has the power to regulate cryptocurrencies under the Commodity Exchange Act (“CEA”) [see prior QuickStudy], the McDonnell decision is significant because it formally recognizes virtual currencies as commodities and crystalizes the CFTC’s authority to regulate not just future contracts involving these currencies, but the digital assets themselves when issues of misrepresentation or fraud are involved. Nevertheless, with this decision, the Court did not preclude other agencies (i.e., the Securities and Exchange Commission, the Internal Revenue Service, the Department of Justice, the Treasury Department, various state regulatory agencies) from exercising regulatory control over blockchain technologies when “virtual currencies function differently than derivative commodities.” McDonnell, p. 24.
In the decision, the Court designated virtual currency as “an important nationally and internally traded commodity” where “Congress has yet to authorize a system to regulate.” McDonnell, p. 1, 9. As a result, the Court surveyed the virtual currency market and outlined multiple regulatory structures proposed by various industry participants, including: (1) no regulation, (2) regulation through existing criminal law and civil actions, (3) regulation through private exchanges, and (4) regulation through a combination of federal and state regulatory agencies. McDonnell, p. 10-12. The Court appeared to understand the significance of setting legal precedent in this emerging area of commerce and law, and it accordingly issued a 28-page opinion with several appendices and a detailed order, citing to a multitude of sources, both legal and lay, to reach its conclusion. The Court in large part deferred to the CFTC to interpret the scope of its own statute, the CEA, when deciding on a regulatory scheme for virtual currencies. In the end, the Court determined that the CFTC has a significant role in regulating cryptocurrencies, while opening the door for other agencies to exercise their influence when warranted.
The Court’s ultimate conclusion – that cryptocurrencies should be treated as commodities – was based on the fact that they exhibit commodity-like qualities. The Court pointed out that commentators have argued that virtual currencies are commodities because: (1) commodities are generally defined as “as article[s] of trade or commerce,” which cryptocurrencies are; (2) common usage of “commodities” implies “goods sold in the market with a quality and value uniform throughout the world” similar to Bitcoin; (3) commodities can provide a “store of value,” which is a function for which cryptocurrencies can be utilized; and (4) commodities can be used as a medium of exchange, which digital currencies clearly are. McDonnell, p. 17-18. Based on these descriptions, the Court found that cryptocurrencies met the definition of “commodity” under the CEA.1
In McDonnell, the CFTC brought a complaint against Patrick McDonnell and his company, CabbageTech, Corp., doing business as Coin Drop Markets, for operating “a deceptive and fraudulent virtual currency scheme...for purported virtual currency trading advice” and “for virtual currency purchases and trading…and simply misappropriated [investor] funds.” McDonnell, p. 3 (citing the CFTC Complaint). The CFTC alleged that McDonnell collected cryptocurrencies from clients on the promise to day-trade the assets for profit, but then avoided and refused to respond to his clients’ demands for return of those currencies. The CFTC sought injunctive relief, monetary penalties, and restitution of funds received in violation of the CEA, specifically the anti-fraud provision, 7 U.S.C. § 9(1) and its accompanying regulation 17.CF.R. § 180.1. Defendants moved to dismiss, arguing that (i) the CFTC lacks standing to regulate cryptocurrencies; and (ii) the CEA does not permit the CFTC to exercise jurisdiction over fraud that does not directly involve the sale of futures or derivative contracts.
The Court rejected both arguments and granted the CFTC a preliminary injunction, finding that, without such relief, there is a reasonable likelihood that Defendants would continue to violate the CEA. In arriving at this decision, the Court held that the CFTC has (1) standing to exercise regulatory authority because cryptocurrencies are commodities and (2) jurisdiction because the CEA’s fraud provisions apply to all transactions involving commodities, not just future derivative contacts. While the Court noted that CFTC’s jurisdiction over “spot market transactions” is limited to the agency’s general anti-fraud and manipulation enforcement authority over interstate commerce, this decision clearly paves the way for the CFTC to take an increased interest in the regulation of cryptocurrency transactions as a whole.
1 CEA defines “commodities” as “wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice, and all other goods and articles . . . and all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.” McDonnell, p. 18 (citing Title 7 U.S.C. § 1(a)(9) (emphasis in original)).
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