Who Wants to Be Bitcoin’s Watchdog?

The U.S. Commodity Futures Trading Commission has raised its hand. Some think it’s going too fast.
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J. Christopher Giancarlo, chairman of U.S. Commodity Futures Trading Commission.

Photographer: Andrew Harrer/Bloomberg

At a meeting with staff of the U.S. Commodity Futures Trading Commission late last year, Chairman J. Christopher Giancarlo ticked off a list of the watchdog agency’s achievements. Among them: It emerged as the federal overseer of digital currencies like bitcoin. For better or worse, Giancarlo added.

That may have been meant as a humorous aside, according to people who were there, but some in the crowd saw it as an unusually frank assessment. Cryptocurrency gives regulators a lot to be nervous about. Bitcoin prices are swinging wildly but are still up about 1,500 percent over the past year. It and other virtual tokens have captured the imaginations of investors who hope to get in on the money of the future, even though it’s challenging to actually buy things with digital cash. It’s also been widely viewed as a haven for illicit money. On Jan. 12, U.S. Treasury Secretary Steven Mnuchin called on Group of 20 nations to make sure that cryptocurrencies don’t become the equivalent of an anonymous Swiss bank account. 

The CFTC, a government agency created in 1974 to monitor agricultural futures and less well-known than the U.S. Securities and Exchange Commission, has an opportunity to increase its profile by becoming a key regulator in this new market. That also means that any blowups will be on its watch.

Giancarlo, a former executive at a swaps brokerage firm who became an agency commissioner in 2014 and chairman last year, is fond of referring to the CFTC as a “21st century regulator.” In December he took the agency headlong into the cryptocurrency fray when he allowed two exchanges to offer futures contracts based on bitcoin—which will allow investors to bet on the price rising or falling without buying the cryptocurrency itself. This could clear the way for new investment products and make it easier for large institutional investors to get involved. “Ignoring bitcoin trading doesn’t make it go away,” Giancarlo says. “Technology is a given, and the agency needs to keep pace.”

The fast-tracking of bitcoin futures provoked a storm of criticism, including from the biggest banks, which are responsible for settling the trades, as well as some Democratic lawmakers. Both Mnuchin and Securities and Exchange Commission Chairman Jay Clayton privately questioned why the process was moving so quickly, according to people familiar with the discussions. SEC spokesman John Nester says “the characterization is inaccurate.” A Treasury spokeswoman who asked not to be named disputed that Mnuchin questioned the speed of the futures roll-out. 

The CFTC chairman maintains that he could do little to stop the two exchanges, CME Group Inc. and Cboe Global Markets Inc., from going forward. That’s because they used a process set up under U.S. commodities law known as self-certification. It lets regulated exchanges launch their own products and bypass any formal review as long as they pledge not to run afoul of the agency’s rules. Giancarlo, in an interview, took pains to point out that the CFTC “did not approve” the new futures products.

Indeed, one risk is that individual investors could interpret the emergence of a regulated futures market as a stamp of approval for a volatile and little-understood asset—at a time when some classic signs of a bubble are emerging. For example, in an echo of the 1990s dot-com boom and 1960s ’tronics craze, stocks with even the slightest connection to cryptocurrency or blockchain are suddenly shooting up in price.

Meanwhile, Congress has chronically underfunded the 700-person CFTC even as it has given it greater swaths of territory to police. This includes the $483 trillion market for financial derivatives called swaps. The agency’s $250 million budget hasn’t risen in step with the new authority, driving down employee morale and leading the agency’s workers to unionize. It even ran out of cash several years ago and was forced to borrow from the Treasury just to keep its doors open.

To critics, that’s not a recipe for successful oversight. “Ultimately regular investors are going to lose money,” says Lee Reiners, a former Federal Reserve Bank of New York supervisor who is now director of the Global Financial Markets Center at Duke School of Law. “The CFTC will end up having to bear some responsibility for that.”

Giancarlo says the agency was able to demand some tougher safeguards for bitcoin futures investors. For one, he says, traders will have to put up a much steeper amount of collateral than they would for a typical, much less risky futures trade in, say, oil or wheat. And in asserting its jurisdiction in futures trading, he adds, the CFTC will be in a better position to protect the public by gaining insight into the underlying cash markets where bitcoin and other cryptocurrencies are traded directly.

A CFTC advisory on its website warns consumers that many exchanges where virtual currency is traded are unsupervised by regulators and that prices may be manipulated, among other risks. Using its authority to go after fraud, the agency has brought enforcement cases against platforms offering bitcoin trading to retail customers and in September filed suit over an alleged bitcoin Ponzi scheme.

Giancarlo says that despite his inability to slow the new bitcoin futures markets, his agency is ready to watch over digital currencies. He’s asked Congress for a 13 percent budget increase to add three dozen workers and boost technology to monitor cryptocurrency derivatives. The CFTC first identified bitcoin as a commodity in 2014, Giancarlo says, before he was made chairman. The agency “has been well prepared,” he says. One of his first steps after being named chairman was to set up an office called LabCFTC, which focuses on digital markets.

The chairman’s embrace of new technology has been praised by some lawmakers and former CFTC members as necessary and forward-thinking. “It’s actually pretty gutsy of the CFTC to have taken this on in a full-throated way,” says Bart Chilton, a former Democratic commissioner who also has an interest in digital currency. Chilton is helping launch one backed by oil reserves.

Under Clayton, the SEC has refused to allow bitcoin exchange-traded funds, mostly because of concerns that the underlying markets for bitcoin are opaque and unregulated. In January, Clayton issued a statement on initial coin offerings, in which people raise money for projects or companies by selling their own virtual tokens. “There are tales of fortunes made and dreamed to be made,” Clayton wrote. “We are hearing the familiar refrain, ‘this time is different.’ ” He wrote that currencies issued in ICOs often fit the legal definition of securities and fall under the SEC’s jurisdiction. Next month, Clayton is slated to testify along with Giancarlo about their agencies’ oversight of digital currencies before the Senate Banking Committee.

Mnuchin heads a council of regulators that monitors risks to the financial system; it’s put cryptocurrencies on its agenda. He often quotes JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon on the subject. The banker has called bitcoin a “great product” for criminals and derided its investors as “stupid,” though he’s recently softened his stance. Mnuchin, in his speech to the Economic Club of Washington on Friday, said he wants to ensure “bad people cannot use these currencies to do bad things” and that the U.S. would work with the G-20 on  “making sure that this doesn’t become the Swiss bank account.” 

In the wake of the criticism over the futures markets, the CFTC has been working to deal with some concerns. It’s scheduled public meetings later this month that will address the CFTC’s oversight of digital currencies. It also issued a flurry of papers to explain bitcoin trading and its decision on the futures contracts. Among them was that advisory for consumers. One of its tips: “Do not invest in products or strategies you do not understand.”

Updates the second and 15th paragraphs with Mnuchin’s Jan. 12 comments. Adds comment from Treasury in the fifth paragraph. Adds to the 14th paragraph the scheduled Senate testimony of Clayton and Giancarlo.

    BOTTOM LINE - The CFTC has allowed futures trading in bitcoin to move forward. Its chairman says the agency is ready to handle the new market.
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