Distributed Counsel 5: Tether, Big Coin, Commodities, and Why Turbulence is a Disease

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Sorry for the long hiatus . . . Won’t happen again.

Is Tether Unraveling?

Tether has lost its audit relationship.  If you are a cryptocurrency trader, Tether is one of two things: it is either (a) the convenient and curious token that allows for easy liquidity between exchanges or (b) a Destroyer of Worlds that will take down crypto and have the naysayers rolling in the aisles as they mock our frivolity.  A simple “tether” search on Twitter will tell you a lot about the current odds of each.  

On Saturday, Tether acknowledged that its relationship with its auditor, Friedman LLP, was “dissolved.”  Numerous observers, including me, have been calling for a third party audit for some time. Now there is no auditor in place, and no audit forthcoming.  So one of two things will happen: either the market will ignore this, and one Tether will continue to be valued at one dollar, or Tether will collapse.  In the latter case, look for diverging prices for between Coinbase’s GDAX exchange (which trades real USD), and exchanges like Poloniex and Bitfinex, which pair cryptocurrencies with Tether instead of genuine greenbacks.  The prices on the “tether-exchanges” likely will be higher, and may get much higher, as people dump their Tether holdings into whatever they can buy.  Ultimately, any collapse will show up here.  So far, the peg appears to be holding. 

It’s Where the Money Is

Coincheck, a cryptocurrency exchange based in Japan, reported on Friday that it lost over $500 million in cryptocurrency to an external hacker.  This represents the largest heist to date, dwarfing the DAO hack (then valued at $160 million).  Many are comparing the hack to the collapse of Mt. Gox, which reported losing almost 850,000 Bitcoins in 2014.

The market’s reaction to the hack has been remarkably staid.  The currency involved (NEM) fell only 10% on the day, and the broader markets were stable.  It is either a sign of maturity, a testament to the sheer size of the market, or an incredibly depressing acknowledgement, that a half-a-billion dollar hack has had such little effect.  Coincheck, for its part, intends to continue operating.  It remains to be seen whether NEM will execute a hardfork or take other measures to destroy or recover the hacked coins.  A similar measure was employed in 2016 when Ethereum hardforked in the wake of the DAO hack.

CFTC and SEC Write an Op-Ed to Warn Everyone Else

The CFTC and the SEC released an op-ed in the Wall Street Journal on Thursday.  The piece contained the following:  

Market participants, including lawyers, trading venues and financial services firms, should be aware that we are disturbed by many examples of form being elevated over substance, with form-based arguments depriving investors of mandatory protections.”  

This underscores once again the futility of calling a token one thing, when the reality is another.  Both regulators have repeatedly stated that they will emphasize substance over form in contemplating action.

CFTC Brings Enforcement Action Against My Big Coin

The CFTC filed a complaint and sought a preliminary injunction against the promoters of My Big Coin last week.  In the complaint, the CFTC alleges a fairly garden-variety fraud, in which valueless coins were sold to victims, and various misrepresentations were made by the promoters.  This appears, once again, to be “low-hanging fruit”–easy cases that will generate quick settlements and favorable precedent.  

To be sure, the larger token promoters have found themselves in court as well, but in investor class actions.  Tezos and now Bitconnect have both been the subject of suits in recent months.  So where will the law be made: is it better for the CFTC and SEC actions to be the first to wrestle with the myriad novel issues presented by the blockchain, or will investor lawsuits provide a better opportunity for courts to “get it right”?  No matter which courts first address these core, unresolved issues, it is clear regulators and investors are beyond “what is it” and onto “what are we going to do about it.”

Is Bitcoin a Commodity?

In the Big Coin complaint, the CFTC alleged once again that a cyrptocoin is a commodity.  This should not be a surprise-SEC Chairman Clayton previously stated as much regarding Bitcoin in his November 2017 statement on cryptocurrencies.  And the CFTC, way back in 2015, claimed that Bitcoin was a commodity, not a currency.  The Big Coin complaint cites to the definition of commodity found at 7 U.S.C. 1a(9).  

Here it is:

The term “commodity” means 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, except onions (as provided by section 13-1 of this title) and motion picture box office receipts (or any index, measure, value, or data related to such receipts), and all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in.

 

What immediately leaps out from this paragraph is, of course, the specificity.  Clearly, many vegetables and grains are commodities but not onions, and definitely not anything to do with a movie.  I’m sure there are interesting cases (or lobbying victories) associated with these exclusions.  There is also a catchall–namely, “all services, rights, and interests . . . in which contracts for future delivery are presently or in the future dealt in.”  A plain reading of this clause would suggest that any service, right, or interest for which a futures market might be made would qualify as a commodity.  Indeed, the CFTC offers this on the subject:

“Section 1a(9) of the Act defines “commodity” to include, among other things, “all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in.” 7 U.S.C. § 1a(9). The definition of a “commodity” is broad. See, e.g., Board of Trade of City of Chicago v. SEC, 677 F. 2d 1137, 1142 (7th Cir. 1982). Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.”

But, and here’s the point, no case has yet squarely endorsed this conclusion.  The status of Bitcoin and other currencies (which must be distinguished from ICOs) may be settling, but it is not settled.  The working regulatory assumption is that Bitcoin will be a commodity, and fall within the orbit of the CFTC, but the assumption has yet to be meaningfully challenged.  So even as the regulatory agencies themselves stake out their turf, no court has ratified the boundaries.  Agencies do not say what the law is, courts do (in this case federal courts), and settlements without court approval, generally speaking, don’t make law.  Billions continue to pour into this market and numerous futures markets with established exchanges are already here, all without clarity as to regulatory jurisdiction.  It is a fascinating study on the value or lack thereof assigned by markets to regulatory oversight.

Turbulence is a Disease

Finally, in one of the most interesting items so far this year, scientists have discovered that the math governing the spread of liquid turbulence (which apparently accounts for the consumption of 10% of all energy) and the math governing the spread of disease are the same!  This link is fascinating and, truth be told, a bit terrifying.  It turns out that the cure for turbulence might be more turbulence.  Let’s hope the cure for disease is not more disease.

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