Virtual Currencies as Commodities?

J. Paul Forrester is partner and Matthew Bisanz is an associate at Mayer Brown LLP. This post is based on a Mayer Brown memorandum by Mr. Forrester, Mr. Bisanz, David L. Beam, and Jerome J. Roche.

On September 26, 2018, a US federal court found that virtual currency constitutes a class of items that are commodities under the Commodity Exchange Act (“CEA”) because one member of that class, Bitcoin, is the subject of futures trading. [1]  This is the first judicial opinion to directly address the question of whether virtual currencies other than Bitcoin are commodities under the CEA.

Background

In January 2018, the Commodity Futures Trading Commission (“CFTC”) filed a civil action against a virtual currency issuer and its promoters alleging that they committed “commodity fraud and misappropriation related to the ongoing solicitation of customers for a virtual currency known as My Big Coin (MBC).” [2] The CFTC alleged that the issuer and the promoters violated the CEA by soliciting customers to purchase MBC with false and misleading claims and omissions about (i) the virtual currency’s “value, usage, and trade status,” and (ii) whether the virtual currency was backed by gold. According to the CFTC, there was no active trading of the virtual currency, and customer payouts were derived from funds paid in by new customers. At least 28 customers paid in approximately $6 million to the issuer.

Motion to Dismiss

In May 2018, the defendants filed a motion to dismiss the CFTC’s complaint, arguing that MBC is not a commodity under the relevant portions of the statutory definition of that term and, therefore, is not subject to the CFTCs jurisdiction under the CEA. Specifically, the defendants focused on the following portions of the definition:

“The term ‘commodity’ means … 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.” [3]

The defendants argued that services, rights and interests are commodities only if contracts for future delivery in such services, rights or interests are dealt in (i.e., are underlying reference assets to futures contracts traded on the futures exchanges). MBC, because it is not a reference asset for futures contracts traded on futures exchanges, would not be a commodity under the CEA. Furthermore, the defendants argued that the “all other goods and articles” portion of the definition applies only to tangible commodities, not intangible items like MBC.

The CFTC argued in its response that MBC is a commodity because (i) it falls under the “other goods and articles” portion of the statutory definition, which is not limited to tangible commodities or by a “dealt in” requirement; (ii) the “dealt in” requirement of the statutory definition refers to classes of services, rights and interests and not to each type of item within a class of commodities; and (iii) prior to the creation of futures contracts on Bitcoin, the CFTC had already determined through settled enforcement actions that Bitcoin was a commodity. [4]

The court rejected the CFTC’s first argument by finding that the “other goods and articles” portion of the statutory definition is subject to the same “dealt in” requirement as the “services, rights, and interests” portion of the definition, and therefore, that argument would be subsumed into the second argument. [5] However, the court adopted the CFTC’s second argument, that the definition of a commodity is general, categorical and not limited by “type, grade, quality, brand, producer, manufacturer, or form.” The court noted as an example that the CEA explicitly includes “livestock” as a commodity without enumerating the particular species that are subject to futures trading.

The court recognized that there is little case law interpreting the “dealt in” requirement and therefore looked to cases involving natural gas to support its holding. In those cases, other courts determined that all varieties of natural gas are a single class of commodity, even if a particular variety is not processed through a hub that underlies a futures contract, because natural gas is fungible and moves freely through the national natural gas pipeline system. [6] The court in MBC did not address the issues of whether MBC and Bitcoin (or other virtual currencies) are fungible or how the term “fungible” should be applied to intangible items. However, the court in MBC interpreted the natural gas precedent to “align with” the CFTC’s argument that “the CEA only requires the existence of futures trading within a certain class (e.g., ‘natural gas’) in order for all items within that class (e.g., ‘West Coast’ natural gas) to be considered commodities.” Accordingly, the MBC court accepted the CFTC’s assertion that MBC and Bitcoin are both items in the class of virtual currencies and found that MBC is a commodity because Bitcoin is undisputedly traded in the futures markets.

Takeaways

The court in the MBC case was a district court ruling on a motion to dismiss, so it remains to be seen how persuasive other courts find its holding that “virtual currency” is a class of items that are commodities under the CEA. While the court found that it was sufficiently clear for purposes of a motion to dismiss that MBC and Bitcoin were of the same class of items, the lack of clear rules for defining “classes” leaves market participants in a somewhat uncomfortable and uncertain position.

Additionally, the decision in the MBC case also leaves unresolved the question of whether MBC would remain a commodity if trading in Bitcoin futures ceased. While there is no indication that futures exchanges will be de-listing Bitcoin futures contracts anytime soon, it remains an unsettled point of law that an item in a class of items could cease to be a commodity for regulatory purposes if all futures exchanges de-listed all futures contracts for items in that class. This ambiguity could have broader implications because it is not limited to the virtual currency class of commodities.

A virtual currency (or any other tangible or intangible item) being a commodity under the MBC court’s analysis begs the question of the extent of the CFTC’s antifraud authority over sales of such commodities. While the MBC court found the CFTC had sufficient authority and denied the defendant’s motion to dismiss under this line of argument, we note that there remains considerable debate regarding the effect of the Dodd-Frank Act’s amendments to the CFTC’s antifraud authority. [7]

Endnotes

1Memorandum of Decision, CFTC v. My Big Coin Pay, No. 18-CV-10077 (D. Mass., Sept. 26, 2018); see also CFTC, Federal Court Finds that Virtual Currencies Are Commodities (Oct. 3, 2018), https://www.cftc.gov/PressRoom/PressReleases/7820-18. (go back)

2CFTC, CFTC Charges Randall Crater, Mark Gillespie, and My Big Coin Pay, Inc. with Fraud and Misappropriation in Ongoing Virtual Currency Scam (Jan. 24, 2018), https://www.cftc.gov/PressRoom/PressReleases/pr7678-18.(go back)

3CEA § 1a(9), 7 U.S.C. § 1a(9).(go back)

4In the Matter of BFXNA, CFTC Dkt. No. 16-19 (June 2, 2016); In the Matter of Coinflip, Inc., CFTC Dkt. No. 15-29 (Sept. 17, 2015).(go back)

5The MBC court did not directly address the CFTC’s third argument but recognized in a footnote that the CFTC’s settled actions supported the court’s holding.(go back)

6See United States v. Brooks, 681 F.3d 678 (5th Cir. 2012); United States v. Futch, 278 F. App’x 387 (5th Cir. 2008); United States v. Valencia, No. H-03-024, 2003 WL 23174749 (S.D. Tex. Aug. 25, 2003) (sub. hist. omitted).(go back)

7See CEA § 6(c)(1), 7 U.S.C. § 9(1) (as amended by Section 753(a) of the Dodd-Frank Act); see also CFTC v. Monex Credit. Co., No. SACV 17-01868, 2018 WL 2306863 (C.D. Cal. May 1, 2018) (finding that CEA § 6(c)(1) prohibits only fraud-based market manipulation); but see CFTC v. S. Tr. Metals, Inc., No. 16-16544, 2018 WL 3384266 (11th Cir. July 12, 2018) (upholding a decision finding an antifraud violation in a case that “involves no allegation, in other words, that the Defendants manipulated the price of a commodity”); CFTC v. Hunter Wise Commodities, LLC, 21 F. Supp. 3d 1317 (S.D. Fla. 2014) (similar finding).(go back)

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