On March 29, 2023, the NFA issued Compliance Rule 2-51, Requirements for Members and Associates Engaged in Activities Involving Digital Asset Commodities,[1] to impose anti-fraud, just and equitable principles of trade, disclosure, and supervision requirements on NFA Members and Associates that engage in digital asset commodity activities, including spot or cash market activities.
I strongly support the NFA’s leadership in issuing this rule for NFA Member or Associate activity in spot digital asset commodities such as Bitcoin and Ether. This is a clear example of using existing authority to ensure that there are customer protections in place, because registration with the NFA requires that firms and individuals comply with NFA rules.[2]
The NFA, as the CFTC’s sole registered self-regulatory organization (SRO) that has delegated authority under the Commodity Exchange Act (CEA)[3]—similar to the SEC and FINRA—plays an essential role in safeguarding markets and the retail public. The NFA is an integral partner to the CFTC in our mandate to ensure market integrity and protect against fraud, manipulation, and abusive practices. The importance of the NFA and its commitment and dedication to the CFTC’s mission cannot be overstated.
I have repeatedly said that customer suitability requirements and education are critical to retail protection so that individuals trading digital assets understand the risks involved.[4] Among other things, NFA Compliance Rule 2-51 imposes detailed disclosure obligations on offering materials and promotional materials pursuant to NFA Interpretive Notice 9073, Disclosure Requirements for NFA Members Engaging in Virtual Currency Activities.[5] These obligations will require NFA Members and Associates to explicitly disclose the risks associated with trading spot Bitcoin and Ether, so that customers are fully informed before making any trading decisions.
In addition, requiring high standards of business conduct, just and equitable principles of trade, and supervision requirements for spot digital asset commodity markets is absolutely necessary. I am pleased that the NFA’s rule aligns with my longstanding position on regulating digital asset markets.[6] Last year, I introduced my Ten Fundamentals for Responsible Digital Asset Markets.[7] These fundamentals prioritize the protection of customers and the retail public as well as the vigorous enforcement of market conduct rules, which are the sixth and eighth fundamentals, respectively.[8]
Although NFA Compliance Rule 2-51 currently defines “digital asset commodities” as Bitcoin and Ether,[9] and applies only to activities involving these digital assets, the NFA can modify this rule in the future to include other digital asset commodities. As innovation continues in our markets, regulators must adapt and adopt appropriate measures to keep pace.
I would like to note that this is not the first time that the NFA has taken action to make sure that retail protections are in place for spot markets that have been rife with fraud. During the early 2000s (and still to this day), spot retail foreign exchange, or “forex,” markets have been targets of fraudsters and scammers.[10] In 2003, the NFA adopted rules that applied to NFA Members engaged in spot retail forex transactions, which included requirements for registration, disclosure, recordkeeping, and customer protection.[11] Many firms registered with the CFTC to become regulated as futures commission merchants (FCMs) and as NFA Forex Dealer Members.[12] Back then, the CFTC did not have explicit regulatory authority over the spot retail forex market, and would not be granted such authority until Congress amended the CEA in 2008.[13] The NFA’s forex rules in 2003 helped establish a framework for the oversight of retail forex markets, paving the way for eventual federal regulation and greater oversight over these spot markets by the CFTC.
That is why I have also repeatedly stated that the CFTC currently has direct authority to regulate certain retail, spot market activity: retail forex and retail leveraged commodity transactions.[14] There are many similarities between spot retail forex markets and spot crypto markets, including market structure[15] and the need for strong customer protections and regulatory oversight to prevent fraud and ensure that there are appropriate risk management and compliance programs. I believe it is common sense to start with what we have and what works in order to extend our regulatory framework over spot digital asset commodity markets.
It is critical to have an effective SRO like the NFA as a partner in carrying out the CFTC’s mission and mandate. I would like to commend the NFA for taking action now to regulate the spot digital asset commodity markets and protect the retail public.
[2] See Forbes Digital Assets, CFTC Commissioner Pushes Back Against Claims The Regulator Cannot Police Digital Markets (Aug. 1, 2022), available at https://www.forbes.com/sites/stevenehrlich/2022/08/01/cftc-commissioner-pushes-back-against-claims-the-regulator-cannot-police-digital-markets/?sh=4d50ee5e3d81; see also, Caroline D. Pham, Commissioner, CFTC, Keynote Address of Commissioner D. Pham at the 18th Nasdaq Technology of the Futures Conference, Reimagining Tomorrow’s Markets (June 28, 2022), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham3 and Caroline D. Pham, Commissioner, CFTC, Keynote Address by Commissioner Caroline D. Pham at CordaCon 2022, A Voice for the People: A Proposal for a New Office of the Retail Advocate (Sept. 27, 2022), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham5.
[3] See, e.g., 7 U.S.C. § 21 and 17 C.F.R. Part 3.
[9] At this time, Bitcoin and Ether are the only two digital assets that have related “commodity interests” (e.g., futures contracts) certified by a registered entity (e.g., a designated contract market (DCM) (futures exchange)) for listing under Part 40 of CFTC regulations. This does not preclude the listing of additional commodity interest contracts referencing other digital assets in the future. See 17 C.F.R. § 40.2 (Listing products for trading by certification) and 7 U.S.C. § 1a(9) (definition of commodity).
[11] See NFA Notice I-03-14 (Oct. 2, 2003), New Forex Rules Will Become Effective on December 1, 2003, available at https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=1169 (notice to NFA members announcing NFA Compliance Rule 2-36, Sections 11 and 12 of the NFA Financial Requirements, NFA Interpretive Notice 9053, and related rules applicable to forex dealer members).
[12] See Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries, 75 FR 3282, 3285 at fn. 33 (Jan. 20, 2010).
[13] See CFTC Release No. 5501-08 (May 23, 2008), CFTC Applauds Enactment of Agency Reauthorization Legislation, available at https://www.cftc.gov/PressRoom/PressReleases/5501-08 and Food, Conservation, and Energy Act of 2008, Public Law 110–246, 122 Stat. 1651. 2189–2204 (2008).
[14] See 7 U.S.C. §§ 2(c)(2)(C), 2(c)(2)(D) and supra at notes 6 and 7.
[15] I have noted that many so-called spot crypto “exchanges” do not operate trading on a central limit order book (CLOB) with anonymous all-to-all trade matching and execution. Rather, these “exchanges” are really dealers that are trading on a principal basis and have conflicts of interest without proper disclosures or mitigating controls or separation of activities, and are operating trading facilities that are more akin to single-dealer platforms, broker-dealer alternative trading systems (ATSs), or other liquidity aggregators. Accordingly, I believe that an appropriate spot crypto dealer registration and oversight regime is necessary for the operators of these crypto “exchanges.” See supra at note 6.
