Coinbase Inc.'s decision to halt margin trading highlights the tricky path for cryptocurrency exchanges to offer in-demand trading products without running afoul of federal regulators.
At issue is the Commodity Futures Trading Commission’s “actual delivery” guidance meant to clarify when spot-market crypto trades become futures contracts. Coinbase, one of the largest crypto exchanges, cited the guidance as the main reason for halting margin lending on its Coinbase Pro platform effective Wednesday at 5pm EST.
The March guidance could force other unregistered exchanges to follow Coinbase’s lead and drop leveraged or margin trading, said Gary DeWaal, special counsel and chair of Katten Muchin Rosenman LLP’s financial markets and regulation practice in New York.
Under the guidance, certain margin trades could be considered futures, which would require crypto exchanges to register with the CFTC and beholden to greater oversight.
Many crypto exchanges in the U.S. don’t do business with U.S. customers for margin trades “precisely because they don’t want to deal with this issue and the registration process,” DeWaal said.
The Commodity Exchange Act prohibits any leveraged, margined, or financed retail trading in a commodity unless the transaction is a futures contract traded on a registered exchange.
The law allows an unregistered exchange to conduct spot trades on margin if the transaction results in the actual delivery of the commodity within 28 days—the cutoff for when trades start to be considered futures contracts.
Actual delivery of digital assets occurs when the buyer takes physical possession and control, the CFTC’s guidance said.
Meeting that standard for commodities like Bitcoin or Ether, which exist only as code on blockchain ledgers, poses challenges for spot-market exchanges like Coinbase, Kraken and Gemini, especially if the customer hasn’t repaid their financing.
Margin trades with the financing still not repaid could mean the buyer would fall short of having actual delivery.
“The real tricky thing with the guidance is there can’t be any kind of lien or encumbrance extending beyond that 28-day period,” said Kari Larsen, partner at Perkins Coie LLP in New York.
No Path Forward
Even if spot crypto exchanges like Coinbase wanted to register with the CFTC to offer futures trading, there’s no clear path for them to do that, Larsen said.
Some registered derivatives exchanges or clearinghouses, such as the Chicago Mercantile Exchange (CME) or the Intercontinental Exchange (ICE), offer crypto futures contracts. But there’s no registration category for crypto spot markets under the Commodities Exchange Act, Larsen said.
Exchanges like Coinbase currently don’t “have access to the CFTC’s regime where their margin can be appropriately overseen,” she said.
Those hurdles come amid growing demand for more products like margin trading in the spot crypto markets.
“You’ve got a new product like margin trading that suddenly is in high demand and people want to know now whether they can launch a product to provide that service or whether the regulators are going to frown on it,” said Daniel Kahan, counsel with King & Spalding LLP’s corporate, finance and investments group.
The rapid pace of change is coming into tension with regulators’ typically measured and slow procedures for offering guidance or rulemaking to the crypto industry. The CFTC first categorized crypto assets like Bitcoin as a commodities in 2015.
“I don’t think the regulators have ever been in feedback cycles this tight ever before,” Kahan said.
That’s driving some traders to look to options like decentralized exchanges, or peer-to-peer trading platforms, that don’t involve a typical crypto exchange as a middleman, he said.
That could result in less effective regulation of a market where many traders are increasingly looking for trustworthy, regulated parties or platforms to trade with, Kahan said.