Bitcoin is the most famous cryptocurrency, and its price has fluctuated a great deal in recent years. Because of that, American retail traders have been attracted to Bitcoin exchanges using leveraged trading and derivative products. However, those actions likely violate CFTC regulations for retail traders in the US.
In order to purchase leveraged, margin products on exchange, including Bitcoin derivatives, American retail traders must follow CFTC rules. The majority of retail Americans trade leveraged Bitcoin financial products off-exchange.
Retail traders are permitted, however, to buy leveraged off-exchange forex contracts, as long as they use a Retail Foreign Exchange Dealer (RFED) registered with the National Futures Association (NFA) or a U.S.-registered bank.
Cryptocurrencies, such as Bitcoin, are not considered foreign currencies under the Forex Exemption by the CFTC and the CFTC refers to Bitcoin as a “commodity.”
Until it discontinued the leveraged Bitcoin binary contracts at the end of 2016, North American Derivatives Exchange Inc. (Nadex) was a CFTC-regulated exchange focused on the U.S.
Bitcoin exchanges try to evade the jurisdiction of the CFTC
By transferring title into Bitcoin wallets, Bitcoin exchanges claim to be exempt from CFTC jurisdiction as they claim traders are in fact taking delivery of their trades on their exchange. A forward contract for delivery within 28 days is not regulated by the CFTC because private transactions are not regulated.
In addition to futures, options, derivatives, and “financed retail transactions” for future delivery, the CFTC has jurisdiction over these products. An American retail customer traded leveraged trades on the spot Bitcoin market with the CFTC as a “financed retail transaction” according to CFTC enforcement documents. It also disagreed that Bitfinex delivered Bitcoin fully to traders.
Bitcoin exchanges face two CFTC enforcement actions
There was a CFTC enforcement action against Bitfinex in June 2016, and one against Coinflip in September 2015. Here is some information from Clifford Chance’s client briefing that covers CFTC vs. BFXNA INC. d/b/a BITFINEX and CFTC Bitfinex Enforcement Action.
- “The Order expands the CFTC’s regulatory reach into the spot market for Bitcoin and other cryptocurrencies.”
- “Spot transactions that qualify as financed retail transactions will therefore be regulated in the same way as futures transactions.”
- “The Commission determined that Bitcoin delivery was not actual since Bitfinex held the private keys required to access the digital Bitcoin wallet at all times, so it didn’t qualify for the exception.”
A comparison of on-exchange and off-exchange
The term ‘on-exchange’ refers to futures, options or derivatives trading on a CFTC-approved exchange like the CME, CBOE, ICE, NYMEX and NADEX.
A foreign exchange may also be on-exchange if they have received a “Part 30 Letter” from the CFTC permitting them to solicit consumers in the United States. There are similar requirements for the exchange as they do for the U.S. as far as posting prices, setting margin requirements, ensuring capital adequacy, and so forth. (See the CFTC website for a list of CFTC Part 30 letters).
As part of its mission, the CFTC protects retail consumers
In order to protect the interests of American retail traders, the CFTC is urging the exchanges to act as counterparties in leveraged transactions so that both buyers and sellers are aware of each other. A RFED Forex Firm registered with the NFA serves as the counterparty in off-exchange forex.
The Dodd-Frank Act of 2010 required clearing of swaps on exchanges for American retail customers as a result of the credit-default swap meltdown in 2008. CDS that were highly leveraged back then were not cleared on exchanges.
Bitcoins can be bought by investors for speculation purposes
Off-exchange traders can buy Bitcoins, provided they do not take advantage of leverage and retain possession of the Bitcoin wallet’s private key.
Bitcoins should be distinguished from leveraged Bitcoin futures, options, binary contracts, and contracts-for-difference (CFDs) as well as swaps and contracts. Retail customers in the United States who obtain Bitcoins off-exchange are allowed to do so as long as they do not use leverage. Nevertheless, if you are buying Bitcoin using leverage as an American retail customer, then you need to do so on a CFTC-recognized exchange.
AEC and ECP exemptions
CFTC regulations for retail customers are not applicable to eligible contract participants that meet certain requirements for high net worth. ECP trades out-of-exchange derivatives involving Bitcoin, including derivatives based on the cryptocurrency. Republican officials are interested in reducing Dodd-Frank regulations. Eligible Commercial Entities (ECE) are exempt from trading off-exchange leveraged financial products, including Bitcoin derivatives.
GOP leaders in Congress and President Trump had both said they wanted to reduce elements of the Dodd-Frank Act. It was likely they would reduce CFTC rules that restrict American retail customers from trading leveraged financial products.
Reported tax amounts
In addition to reporting Bitcoin trading income and losses worldwide, whether it is legal or not under CFTC regulations, the IRS requires American residents to file their American tax returns when they trade Bitcoins. Irrespective of whether you repatriate the funds to the U.S., your capital gains should be reported to the IRS. (Read my related post: If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)
Do American retail customers have the right to trade Bitcoin?
The Commodity Futures Trading Commission (CFTC) makes it mandatory for brokers to register with the agency or another U.S. regulator in order for retail customers to trade cryptocurrencies. Both the National Futures Association (NFA) and the CFTC say American retail customers are not subject to CFTC regulations, so this is legal. It may be legal to trade Bitcoin and cryptocurrencies for American retail customers, but not for counterparties, right? Perhaps yes, but I am not sure.
An afterthought: CFTC regulations require counterparties offering “leveraged” and “financed” financial products, including derivatives, to register if they deal with American retail clients. Because Bitfinex of Hong Kong offered leveraged cryptocurrency swaps to retail customers in the United States, the CFTC has brought an enforcement action against it. The majority of Americans traded cryptocurrency on exchanges that don’t offer leveraged contracts, and that seemed okay to me. Several unregistered offshore exchanges offered leveraged cryptocurrency contracts to American retail customers.