YEAR ONE: In his first year CFTC Chairman Heath Tarbert declared ether a commodity, allowed ether-based futures products to enter the market and approved actual delivery guidance. (CoinDesk archives)
Perfection shouldn’t be the enemy of good when it comes to regulating the cryptocurrency space, said Commodity Futures Trading Commission (CFTC) Chairman Heath Tarbert.
The nation’s top commodities regulator, who recently marked his first anniversary at the CFTC, detailed his approach to cryptocurrency in a wide-ranging interview with CoinDesk. Tarbert noted that many of crypto’s unique attributes – namely borderlessness and decentralization — require a thoughtful approach.
“Our entire financial and economic system outside the current system, the non-crypto system basically evolved since, one could argue, the Renaissance in Italy,” he said. “Whereas what people are doing in the digital asset space is effectively building within a decade or less an entire economic system based on human incentives and trust … I just find that fascinating.”
Tarbert specified that he is interested in the way developers are incorporating “hundreds of years of accumulated knowledge about human behavior and economic incentives” as well as cryptographic methods originally used in national security applications to build these digital commerce systems.
Tarbert said he is fascinated by decentralized finance (DeFi).
“When you think about the idea that at some point a large part of our financial system could very well exist in blockchain format, that’s also revolutionary,” he said.
Tarbert took office on July 15, 2019, coming to the regulatory agency from the U.S. Treasury Department, where he served as Assistant Secretary for International Markets. He said that while he was familiar with bitcoin and digital assets prior to joining the agency, “I quickly found out that this is such a rapidly changing environment that I needed to really bone up” on.
While many aspects of the crypto and fintech spaces aren’t currently under the CFTC’s jurisdiction, some new products might someday fall into the derivatives space. So Tarbert needs to learn about much more than just bitcoin.
“My view is that to be a successful CFTC chairman, meaning regulating the derivatives market, you have to have [a] keen understanding of the underlying market,” he said. “And so I’ve tried to learn as much as I can about the various agricultural sectors. I’ve gone out into fields and … gone to grain elevators, I’ve gone to a feedlot to learn about cattle and wheat. I’m learning about oil but I’m also learning a lot about crypto and in many ways, because it’s so revolutionary and so cutting edge, I’m spending a lot of time just learning how it all works in the ecosystem.”
Tarbert’s efforts are paying off. Tarbert pointed to the elevation of LabCFTC, the agency’s fintech wing, noting it had grown from being a small group within the CFTC’s general counsel’s office to becoming its own division.
In the months since, the CFTC has declared ether a commodity, allowed the first ether-based futures products to enter the market and approved actual delivery guidance that explains to exchanges when the CFTC has jurisdiction and brought numerous enforcement actions, Tarbert said.
The next challenge is building out a holistic regulatory framework for crypto and its derivatives markets in the coming years.
“I suspect some of it will be principles-based and some of it will be more specific rules … the right blend of each to allow for innovation and also flexibility both for market participants but also for ourselves because we don’t want a regulatory framework to be obsolete six months after it’s introduced, but at the same time, there may be customer protection and maybe some other issues that are so important that we want to provide very clear standards and rules to provide clarity,” he said.
Tarbert said the planned framework, announced earlier this month, won’t be a prescriptive one, but a holistic approach that looks at how the agency regulates derivatives markets. This will require the CFTC to evaluate how it looks at exchanges, clearinghouses and other market intermediaries, and how its core principles apply or should apply to the space.
“We have some things listed on exchanges, but most of those, they’re either cash-settled products or they are fully collateralized,” he said. “So we actually haven’t gotten into a system where we actually have physically delivered digital asset products that have the kind of margining and practices associated with them as we do other futures contracts and even swaps.”
The CFTC doesn’t want to over- or under-regulate the space, he said.
“We have rules regarding custody of assets, so how do we handle custody and settlement?” Tarbert said. “We know how to do it with traditional physical assets and with cash but how do we do that with digital assets?”
Capital requirements, segregating customer assets with broker assets, market intermediary reporting and bankruptcy are other issues that need to be addressed within this framework, he said.
Pricing risk for crypto asset derivatives sold on margin is another area the CFTC is examining.
“What about if there’s a failure?” he asked. “Non-default loss at the clearinghouse, meaning the clearinghouse loses money not because one of the members fails but, rather, it loses custody of these assets or it loses the keys or something, and then what role should insurance play?”
This extends to infrastructure and physical hardware questions, and whether the CFTC should replicate its current regulations for the digital asset market or try to fit digital assets into an already existing framework.
These issues illustrate the need for a flexible framework, Tarbert said, one which takes into account these major questions but can still be applied flexibly as different aspects of the crypto space evolve.
As an added wrinkle, the CFTC won’t know for sure if its framework is effective until it’s implemented.
“You’re dealing with a counterfactual, so you can’t say, well, ‘how would things have evolved if we didn’t have this framework in place?’ The answer is, it’s a really important process but it needs to happen,” he said.
The G20’s Financial Stability Board underwent a similar process and the U.S. Treasury Department had to create rules around capital controls after the 2008 financial crisis as well, so Tarbert’s not a stranger to this type of challenge.
“It’s a very difficult question, but I think we owe it both to ourselves as well as market participants that after a reasonable period of, let’s say five years, we take a look back and say, ‘what are we doing right, what did we do wrong and what changes need to be made,’” he said. “It’s easier said than done, but it does need to be done.”
The CFTC also has to contend with the fact that crypto is inherently borderless. Market participants and developers all hail from different jurisdictions, and many live outside the U.S.
The U.S. should harmonize its approach to crypto both across the 50 states and additional territories, as well as with how other nations are approaching it, Tarbert said, likening the new asset class to other commodities under its jurisdiction.
“Commodities are commodities all around the world, right? Wheat is wheat …and so the commodity prices and the derivatives prices based on those commodities around the world are all interconnected,” he said. “Well now we take digital assets, crypto assets … and there they are uniform. And … people are not thinking about regulatory and national boundaries, by definition, this stuff is outside of it.”
The CFTC joined the Global Financial Innovation Network as one step in this process, collaborating with regulators worldwide to share ideas about financial innovation. The agency is also part of the International Organization of Securities Commissions (IOSCO), where Tarbert is the current vice-chairman.
Other international efforts include the Financial Stability Board, which has a working group on stablecoins (cryptocurrencies which maintain price parity with a fiat currency or asset like the U.S. dollar) and the Financial Action Task Force, which published guidance on crypto exchanges last year.
In his view, future international standards around crypto “will be as important to this community” as the Basel Accords developed across the past 30 years are to the banking sector today.
That’s not to say there shouldn’t be a national regulatory regime, Tarbet said.
“But I think there’s a real acknowledgement from national regulators that there needs to be enhanced international cooperation and thinking, and to some extent if at all possible, some degree of convergence,” he said.
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