By: Charlene Osmanski

Bitcoin. Ethereum. Dogecoin. They dominate the news on a regular basis and people want in on the game. The Chicago Mercantile Exchange remade the game in late 2017 when they introduced the Bitcoin futures contract. While virtual currency futures are governed by the same rules as all futures contracts, there is the added challenge of creating rules for an unruly product—a formula for an ever-evolving space.

NFA recently released Interpretive Notice 1-21-18 as a supplement to its previous Interpretive Notice 9073 relating to disclosure requirements for NFA members engaging in virtual currency transactions. The supplement requires that any Futures Commission Merchant (“FCM”) or Introducing Broker (“IB”) who solicits or accepts orders for virtual currency derivatives must immediately amend their annual questionnaire to reflect this fact. Commodity Trading Advisors (“CTAs”) and Commodity Pool Operators (“CPOs”) must also amend their annual questionnaire if they execute transactions which involve virtual currencies or virtual currency derivatives. This comes in addition to the previous required disclosures to customers.

In a notable departure from most NFA notices or rules, NFA outlined their concerns when developing the notices and remarked that developments in regulation will be ongoing as the cryptocurrency markets continue to grow. Members wishing to engage in virtual currencies and their derivatives must therefore recognize and communicate to customers that 1) the market’s unique features may attract customers who do not fully understand its nature, 2) there are significant risks not present in fully regulated markets, and 3) there is limited regulatory oversight and recourse. Members must ensure their customers are fully cognizant of the uncertainties surrounding cryptocurrencies, potentially exceeding the disclosures to those areas identified by NFA.

CTAs and CPOs

Any CTAs or CPOs wishing to enter into the virtual currency space must address the unique risks of the market by customizing their offering materials, including but not limited to: disclosure documents, subscription documents, and promotional materials. While NFA has provided a non-exhaustive list of necessary disclosures, there is no standardized language for those disclosures available to the public. Turnkey Trading Partners has navigated the virtual currency regulations since they were first introduced and developed approved disclosures which address the various risks. It is imperative that firms first identify what type of virtual currency will be traded—virtual currencies and their derivatives or underlying and spot virtual currencies—as the necessary disclosures vary.

Spot Virtual Currencies

Underlying or spot virtual currencies bring the greatest degree of risk and, with it, comes the greatest need for copious disclosures. Regardless of whether a firm is exempt or non-exempt, it must display activity-based disclosures in their disclosure documents, offering documents, and promotional materials which address the following areas, as applicable:

  • Unique Features of Virtual Currencies
  • Price Volatility
  • Valuation and Liquidation
  • Cybersecurity
  • Opaque Spot Market
  • Virtual Currency Exchanges, Intermediaries, and Custodians
  • Regulatory Landscape
  • Technology
  • Transaction fees

Depending on the type of underlying or spot virtual currencies the firm engages in, NFA requires that customers be provided and promotional material contain one of two standardized disclosures.

Virtual Currency Derivatives

Virtual Currency Derivatives do not carry the same specific disclosure requirements as spot currencies, though firms are encouraged to consider the above-mentioned areas when discussing risk. The risks associated with derivatives are largely due to price volatility and other market participants. Firms should discuss with their FCMs what restrictions they place on customers trading virtual currency to properly tailor their disclosures. Firms can expect constrained position limits, prohibitions on naked shorting, and restricted give-up transactions. Notably, FCMs may require additional margin which may be set as a percentage of the underlying contract; to the effect that margin requirements for long positions can increase as price increases.

Some designated contract markets are governed by rules which may impose trading halts during periods of high volatility. This may impact a customer’s ability to exit a position and result in substantial losses. With many new investors seeking to enter the cryptocurrency space, it is vital that they understand all potential risks to better protect them and the firm.

FCMs and IBs

FCMs and IBs should consider their customer base before determining the proper avenue for delivering their required advisories and disclosures. For firms who only engage with Eligible Contract Participants, displaying the required advisories and disclosures on the Member’s website is suitable. However, any firms with retail clients must provide the information in writing or electronically in a prominent manner; the communication must be reasonably designed to attain customer awareness prior to trading. NFA has determined that a risk disclosure booklet and emailed links to the disclosures are appropriate examples of notice.

Any customer wishing to engage in virtual currency derivatives must be provided the NFA Investor Advisory – Futures on Virtual Currencies Including Bitcoin and the CFTC Customer Advisory: Understand the Risk of Virtual Currency Trading prior to trading. Any current customers who have not received the advisories must be notified at the earliest opportunity. FCMs and IBs soliciting or accepting orders for virtual currency derivatives should discuss with their intermediaries about providing the advisories. NFA requires that either the FCM or IB provide them, but it would be prudent to have any reliance on another party established in writing.

For firms involved with underlying or spot virtual currency transactions, it needs to be made abundantly clear to customers that NFA does not regulate any such activities. All customers or counterparties participating in this space must be provided with the NFA standardized risk disclosure. Likewise, any promotional material created for spot virtual currencies must display the disclosure.

About the Author

Charlene joined Turnkey Trading Partners after being accepted to the Illinois Bar. She previously worked at Turnkey as an intern during her law school tenure. Charlene has also interned at law offices focused on Entrepreneurship and Intellectual Property. She has a Juris Doctor from Chicago-Kent College of Law with a Certificate in Intellectual Property and dual Bachelor’s degrees in Business & Management and Psychology from Rensselaer Polytechnic Institute. During law school, Charlene was a member of the Intellectual Property Legal Society and the Student Animal Legal Defense Fund. While at Rensselaer, she was on the varsity softball team and served as secretary for the Business & Management Honor Society.