Introduction

Good afternoon.  I am delighted to join you today.  Thank you to Brookings for hosting this event, to Aaron Klein for sitting down with me following my remarks, and to the distinguished panel participants.

In a 1984 New York Times article, astrophysicist Dr. Jeremiah P. Ostriker remarked, “The discrepancy between what was expected and what has been observed has grown over the years, and we’re straining harder and harder to fill the gap.”[1]  Ostriker was referring to findings that a vast majority of the mass in the universe is not detectable, but consists of “dark matter.”  While it is compelling to get into a discussion about the similarities between dark matter and digital assets—and indeed, at least one author has done so with respect to Bitcoin,[2] for me, the fact that I cannot actually see either is about as far down that rabbit hole as I want to go today.  What does resonate, since watching the cryptoverse develop and expand over the last several years, is that the space has not necessarily evolved in ways we may have anticipated.  Neither has our regulatory approach—and we are now straining harder and harder to fill that gap.

We are here today because digital assets are trending towards becoming a part of mainstream American portfolios, with surveys and polls demonstrating that as many as one in every five adults has invested in or otherwise used cryptocurrency.[3]  This market has developed in the absence of a firmly demarcated regulatory perimeter.  A massive influx of retail participants has further galvanized an industry eager to meet demand for products and services.  Each digital asset is empowered by the free, largely unfettered flow of information—the defining characteristic of the information age we are currently occupying—and relatively low barriers to access.

The onset of the current “crypto winter,” now blanketing the streets from Main to Wall, is further invigorating the call for a technology-neutral regulatory approach, guided by the risks within the crypto ecosystem, and not by risks within the underlying technology that makes it possible.[4]  The prior wintery mix of 2018 is attributed to a crypto mania bubble bursting, accelerated by the chilling effect of hacks, the failure of institutional support, and hard forks.  The current storm is brewing from macroeconomic factors, leverage built up by the emergence of new financial products, high risk investing, and contagion.

An Inflection Point

And so today marks yet another inflection point.  We find ourselves here largely because the digital asset industry in the U.S. does not fall under a single comprehensive regulatory regime.  Instead, the CFTC, other federal agencies, and state regulators are most often collectively compared to a patchwork blanket that is increasingly proving inadequate as temperatures drop and vulnerabilities lay bare.

While our oversight capabilities are generally complimentary, market regulation and financial supervision in the U.S. often relies on the development of cooperative arrangements between regulators—a challenge given jurisdictional inexactitudes and sometimes imprecise or nonexistent statutory authority.  This is made more difficult by the rapid emergence and development of the digital asset market which has largely taken place on the outskirts of the traditional financial market structures.  Each U.S. regulator is facing the challenge of melding mission, mandate, and monetary resources around products, processes, and participants, while preserving policy goals, risk principles, and avoidance of systemic risk.

The CFTC’s core responsibility is regulating the commodity derivatives markets.  Our focus is on how individuals and market participants use the derivatives markets as a means for managing and assuming price risks and exposures, discovering prices, and disseminating prices through trading in liquid, fair, and financially secure trading facilities.[5]  Our guiding statute, the Commodity Exchange Act (CEA), and regulations create a principles-based system aimed at accomplishing execution certainty by ensuring transparency, integrity, and security of transactions.  We facilitate customer protections through intermediary oversight and a robust disclosure regime aimed at informing customers about who they are dealing with and providing material information so that they understand the risks of participating in our markets and are prepared to accept that risk.

Today, our work is never done.  While there are a multitude of strategic decisions ahead, our policy goals are firm: reducing systemic risk, preserving market liquidity, and incentivizing market participants to use the derivatives markets to manage risk.

Crypto-Market Trajectory

Towards the end of 2017, the first bitcoin futures contracts were self-certified for trading by CME and the CBOE Futures Exchange, and the first bitcoin binary options were self-certified by the Cantor Exchange, bringing the first derivatives with an underlying digital asset commodity fully within the CFTC’s direct oversight.[6]  The increasingly rapid development of FinTech products like cryptocurrencies, and the corresponding demand for new and novel price discovery and risk management tools, meant that the Commission had to utilize its authority and expertise to ensure that the markets we oversee innovate responsibly within an appropriate oversight framework.  At that time, I urged for greater action to provide legal certainty with respect to the process for evaluating new products.[7]  Innovators and regulators alike were dealing with an emerging asset class in what was, for the most part, a regulatory vacuum.  For the CFTC, I believed it was critical that we engage with industry in addressing risk, provide legal and regulatory certainty to the market, and educate the general public.

With our highest priorities being the protection of customer property and promotion of safe, transparent derivatives markets, our engagement and vigilance could not wane in the face of criticism of bureaucratic stall, undermining innovation and the free market approach.

About 7 months later, I delivered remarks at the very first Blockchain for Impact global summit at the United Nations Headquarters.[8]  By then we were already seeing that further developments in the digital asset space were not necessarily going to progress positively in the straight line that optimists and early adopters had envisioned.  The debate on crypto was just beginning, but two points were already clear: (1) crypto assets respect no borders, and (2) regulation was already behind the curve.

While some countries had already outlawed crypto and others had swiftly adopted strict laws to oversee them, many just paused in bewilderment, avoidance, or in abeyance as other jurisdictions took the lead.  The U.S., with our multiple-regulator approach, could best be described as ad hoc.  Though there was no clear direction from the Administration or Congress at the time, there was no clear and present danger to the existing economic system to warrant a coordinated, collective strategy yet because the overall size and development of the digital asset markets were still in their nascent stage.

By 2019, we were deep in contemplation with regard to the greater FinTech agenda which resulted in a collective analysis paralysis.  After reflecting on the past success of coordinated frameworks to address technological inflection points,[9] possible solutions started emanating.  It took a few years, but I am pleased an initiative is now underway thanks to President Biden’s Executive Order on Ensuring Responsible Development of Digital Assets.[10] 

The Covid 19 global pandemic created an especially fertile ground for crypto-development.  By February of this year, as I testified before Congress,[11] there were hundreds of thousands of unique digital assets in circulation with a combined market capitalization of approximately $2 trillion.  At the center of this burgeoning industry are the trading platforms where most investors access this market.  Several of these platforms operate on a global scale and host marketplaces for trading both in the underlying digital assets and the derivative contracts referencing those assets.  According to public data, every month in 2021 except one saw over $1 trillion in monthly trading volume in the digital asset cash market, with a high of $2.23 trillion in trading volume in May 2021.[12]  And the derivatives market is even larger, with notional exchange volumes in just bitcoin futures surpassing those numbers.[13]

Since February—and perhaps a bit before, cryptocurrency prices have tumbled, with the price of bitcoin down 70% from highs in November.[14]  The market value of the top 500 crypto tokens has dropped to less than $1 trillion, down from a high of $3.2 trillion.[15]  The May collapse of TerraUSD (UST) stablecoin, the world’s fourth largest stablecoin at the time, rocked the cryptoverse, and since then we have witnessed events that demonstrate how technology alone cannot make this market failsafe and volatility, leverage, interconnections, and contagion manifest in the crypto-asset ecosystem through precisely the same channels and in response to the exact same macro-economic pressures as our traditional financial markets.

This crypto-winter is getting anything but an icy response, and, given what we have seen with the tech mania of the dot.com era or the subprime frenzy, there are no signs that the growth and progress to date will be frozen.[16]  Washington is finding itself in a flurry of calls to action for international engagement and inter-agency action to address the risks of digital assets.[17]

The CFTC: Same Risk Regulator, Same Regulatory Success

The CFTC is ready and well situated to address the risks in the cash markets for digital assets through direct oversight.  At its core, the CFTC is a markets-focused regulator that works to ensure market integrity and vibrancy through oversight of exchanges and clearinghouses that are required to comply with well-established core principles and regulations, as well as through oversight of market intermediaries and participants.  The CFTC’s focused principles-based approach to customer protection, market integrity, price discovery, transparency, competition and enforcement have proven effective throughout the evolution of our jurisdictional markets and related markets, even in times of volatility.

While the CFTC does not have direct statutory authority to regulate cash markets, the CFTC maintains anti-fraud, false reporting, and anti-manipulation enforcement authority over commodity cash markets in interstate commerce.  When the CFTC becomes aware of potential fraud or manipulation in an underlying market, we investigate and address misconduct through our enforcement authority.

In the digital asset space, since 2014, the CFTC has aggressively exercised its enforcement authority, bringing more than 50 enforcement actions.  As the digital asset markets have grown in size and retail participation, so has the number of CFTC enforcement actions.  In FY 2021, the CFTC filed more than 20 enforcement actions alleging digital asset-related misconduct, including numerous cases charging retail fraud involving digital assets[18] and cases charging platforms with illegally offering off-exchange trading in digital assets.[19]

Thus far in FY 2022, the CFTC has filed several enforcement matters involving digital assets, including an action for making untrue or misleading statements and omissions of material fact in connection with the U.S. dollar tether token (USDT) stablecoin.[20]  The Commission recently filed a complaint involving allegations for making false or misleading statements of material facts or omitting to state material facts to the CFTC in connection with the self-certification of a bitcoin futures product.[21]  Last month, the CFTC filed a complaint against a commodity pool fraudulently soliciting bitcoin from members of the public.[22]  The pool accepted more than $1.7 billion in bitcoin – the largest fraudulent scheme involving bitcoin charged in any CFTC case.  Just last week, the Commission announced the successful resolution of its first enforcement action alleging a digital asset “pump-and-dump” scheme. [23]

These numbers do not reflect the breadth and depth of tips, complaints, and referrals the CFTC receives daily relating to potential misconduct in the digital asset space.  Our approach from triage to filing is strategic, tactical, and involves a high degree of analytical work and cooperation with our fellow regulators.  But the truth is that the existing ambiguities force hard decisions at the CFTC—as they do with our fellow regulators.  Even the strongest cooperative relationships may not yield the efficiency we need to put hard and fast stops to misconduct that increasingly has impacts beyond individual investors.  Our guiding principle at the CFTC and throughout the government must be to stop fraudulent and manipulative conduct that harms our markets and those who participate in them.  This means that we must work closely with our local, state, and federal partners to ensure that the government uses its strongest authority to bring those who harm our markets to justice.

Where there is direct, unambiguous impact on the integrity of CFTC jurisdictional markets or members of the public, an immediate, comprehensive enforcement-driven response from the CFTC is warranted.  We will continue to use our enforcement authority to the fullest extent, and leverage our cash market expertise as a function of our historical mandate over the derivatives markets and assert essential oversight within our current statutory remit.

To be clear, the CFTC’s oversight authority over all cash markets for commodities in interstate commerce is not currently at issue.  However, there are several unique elements of the digital asset commodity cash market that distinguish it from other cash commodity markets, suggesting it would benefit greatly from CFTC oversight.  The most notable difference between the digital asset market and other commodity markets is the level of retail participation.  Most commodity derivative markets, such as the agriculture and energy markets, are dominated by wholesalers, end-users and institutional investors engaging in hedging and other risk management transactions.  However, the digital asset market is characterized by a high level of retail participants that are engaged in price speculation.

Recent CFTC studies find that trading indicative of retail participants makes up approximately 25% of long open interest in the Bitcoin futures market, which is significantly higher than is generally observed in other futures markets, such as corn, soybeans, wheat, WTI crude, gold, and S&P E-mini futures, where retail long open interest ranges from 5% to 11%.[24] These studies suggest the amount of retail participation in the digital asset futures market is more than double that in other futures markets.

The barrier to entry in the digital asset space is lower than traditional financial markets, and crypto presents an opportunity to build wealth by those who have found themselves shut out.  However, these same groups are less likely to have the financial resources to absorb losses.  Declining digital assets prices could mean significantly more severe losses for lower-income investors,[25] with knock-on effects penetrating the greater economy.

Most investors in the cash market entrust their digital assets to the platforms upon which they trade, failing to differentiate this type of custody arrangement from that offered by the traditional regulated banking industry.  The technical complexities around securing and transacting in digital assets, particularly issues around custody, have resulted in numerous platforms losing funds to hacks, exploits, and poor cyber security.

And, while participants in the digital asset market may seem to be interacting with exchanges and intermediaries structured like those seen in other financial markets, the lack of a comprehensive regulatory regime applicable to businesses operating in the digital asset market has led to inconsistent practices around issues such as trade settlement, conflicts of interest, data reporting, and cyber security.

All of this suggests that, as with any trading market, the digital asset market would benefit from uniform imposition of requirements focused on ensuring certain core principles, including market integrity, customer protection, and market stability.

In the Mean Time…

I am encouraged by the bipartisan and bicameral support for legislation that recognizes the need for guardrails around the burgeoning digital asset economy and calls for regulation to impart transparency, accountability, stability, customer protections, and oversight across the cryptoverse.  While we cannot predict any legislative outcomes, the CFTC will continue to aggressively and relentlessly press forward in the digital asset commodity space within its historical remit.  I will ensure that the CFTC continues to use our existing enforcement authority to its fullest extent in the digital asset commodity space to protect customers from fraud and manipulation.  In so doing, we will work with our domestic counterparts to ensure that no fraudulent or manipulative activity falls through a gap between regulators.  And I will ensure that the CFTC continues to share our experience and expertise in support of work with our domestic and international counterparts towards a comprehensive and coordinated oversight approach.

As the new technological era has embraced our markets, the power of social media, coupled with the ease and speed of access, has broken down barriers.  As new participants and infrastructure providers increasingly access, impact, and shape the automated aspects of our markets, there is greater concern that in this environment— which can be game-like— there are built in limits and supervision, or that there is constant monitoring for risky behaviors— and risk generally.

Regulators must be nimble, and new challenges may require us to dig deeper, take a different look into how our organic statutes promote our growth alongside the markets we regulate.  In the absence of new legislative authority, we at the CFTC continue to look at how we can work to protect markets and investors within the bounds of our existing authority.  We have (and will forcefully utilize) our fraud and manipulation enforcement authority.  But, given the regulatory vacuum, we are also thinking creatively about how else we can use our existing regulatory authority to protect retail commodity markets and investors.  Make no mistake: we will use all levers at our disposal, and all relevant authorities to continue rooting out fraud and manipulation.

Looking Forward

Many here may be familiar with our engagement with financial technology innovators through LabCFTC.  Although less public, the CFTC’s efforts related to digital assets have evolved with the market, and we are now engaged in a more proactive and comprehensive effort across the agency to regulate these markets with the tools currently available to us.

For example, many digital asset-related companies now operate CFTC-registered exchanges, and our Division of Market Oversight is regularly reviewing new products tied to digital assets both from these new entrants and from more traditional registrants.  I have asked the staff to be proactive in considering the extent to which our authority can be leveraged to bring these novel products into the regulatory fold to ensure important protections for customers and market integrity provided by CFTC regulation.

Also, the digital asset market has been at the center of numerous proposals around non-intermediated access to our markets, and the Division of Clearing and Risk and Markets Participants Division have been leading engagement with the public as well as with internal experts as to the impact of these novel market structures on the regulatory principles the CFTC upholds.

These and numerous other examples demonstrate that we have moved past the stage of digital assets as a research project.  Our core policy divisions are now directly addressing how the CFTC can leverage our existing authority to bring important regulatory protections to this market.  Through our work, we have developed a deep understanding of this novel market and the underlying innovations that fuel the market.

To that end, I would like to take the opportunity today to announce that LabCFTC is evolving in new ways and will take on a new identity as the Office of Technology Innovation (OTI) with an updated operating model.  There is now a real intersection between the financial innovations and our markets that did not exist even a few years ago when former Chairman Giancarlo ambitiously and appropriately established LabCFTC as a means to accelerate CFTC engagement with fintech innovators.  As I testified in February, we are past the incubator stage, and digital assets and decentralized financial technologies have outgrown their sandboxes.

The issues are at the front and center of our thinking at the Commission, and with a greater acceptance of the role of regulators, innovators need no invitation to office hours to engage directly with our operating divisions and senior leadership.  Our resources will be better utilized through an Office of Technology Innovation, reporting directly to the Chairman’s office and staffed by a Director, a FinTech Policy and Technology Specialist, a strategic Communications and Education leader, and rotational opportunities for all CFTC employees to gain exposure and expertise.

OTI will continue to lead the CFTC’s efforts in incorporating innovation and technology into our regulatory oversight and mission critical functions, and it will do so purposefully by supporting the operating divisions and the Commission’s participation in domestic and international coordination.  But OTI will also have an opportunity to evolve within its new structure and have flexibility to meet needs both internally at the Commission and externally in the regulatory space and in the markets.

Another change we are making is the realignment of the Office of Customer Education and Outreach within the Office of Public Affairs.  This strategic alignment will leverage resources and a broader understanding of the issues facing the general public towards addressing the most critical needs in the most vulnerable communities.  The importance and need for this critically important responsibility of educating and protecting the public cannot be overstated.  Indeed, according to the Federal Trade Commission, since the start of 2021, more than 46,000 people have reported losing over $1 billion in crypto to scams, with the median individual reported loss at $2,600.[26]  With the top cryptocurrencies used to pay scammers identified as Bitcoin (70%), Tether (10%), and Ether (9%),[27] our mandate is clear.

Conclusion

At this point, I fear these remarks may have expanded further than I had anticipated and have not only filled the gap, but have spilled over.  It’s the nature of the cryptoverse—there is always more to explore.

I chose to focus on what I believe is most pressing in terms of the CFTC’s mission and the risks on both sides of our streets.  As other government agencies consider how FinTech impacts federal policy related to payments, custody, illicit activity, national security and a host of other issues, I anticipate they too will advocate for greater authority.  Our individual missions should not diminish our efforts towards a coordinated federal approach in this area, and the CFTC will continue to be a proactive participant in the process.

Thank you for your generous time. I look forward to your questions.