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Ep 2: Why the US needs a framework to regulate digital assets
83 Plays1 year ago
CFTC Commissioner Summer Mersinger joins Olta Andoni, General Counsel at Enclave Markets to discuss the future of digital asset regulation. The conversation illuminates the CFTC's role and the advantages of principles-based regulation in this dynamic sector. Tune in for essential insights from Commissioner Mersinger on the evolving landscape of financial technology.
Find out more in our explainers at owlexplains.com
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Transcript
Introduction to Owl Explains Hootenanny
00:00:06
Speaker
Hello and welcome to this Owl Explains Hootenanny, our podcast series where you can wise up on blockchain and web3 as we talk to the people seeking to build a better internet. Owl Explains is powered by Avalabs, a blockchain software company and participant in the avalanche ecosystem. My name is Silvia Sanchez, project manager of Owl Explains and with that I'll hand it over to today's amazing speakers.
Meet Commissioner Mercinger
00:00:33
Speaker
Hello, this is Al explains. We are recording our second podcast and we're very excited about this new sort of narrative that you're trying to build here with the podcast. I have here with me today, Commissioner Mercinger. Thank you so much Commissioner for being with me today.
00:00:53
Speaker
We would like to start with some simple questions and we're very excited to jump on in the narrative about what we're doing without our I'll explain and also to proceed with some other questions about the CFTC's role.
Role of CFTC in Digital Asset Regulation
00:01:10
Speaker
Commissioner Mercinger,
00:01:12
Speaker
You joined the CFTC, if I'm not mistaken, March of last year. Can you tell us a little bit more what it means to be a commissioner at CFTC and what is the organization mission and how does the CFTC role as market regulator impacts the digital assets markets?
00:01:31
Speaker
Yes, thank you. And happy to be on all all explains, especially because it is kind of my one year anniversary as a commissioner, I was sworn in on March 30 of 2022. So I've had a full year under my belt. And hopefully that
00:01:50
Speaker
has given me some insight into the various, what's going on in the markets and also kind of where we see regulation and legislation going in some of the spaces that your listeners are interested in.
00:02:09
Speaker
I do always have to start with a standard disclaimer that the views I share today are my own and they do not reflect the views of the entire commission or my fellow commissioners. So with that, I will explain a little bit about the commission. We're a five member bipartisan commission. All five commissioners are appointed by the president.
00:02:32
Speaker
and confirmed by the United States Senate, we have staggering terms, each five-year terms that they expire at different times so that we have some continuity. The chairman is always a member of the party of the president, so Chairman Benham, our current chairman, is a member of the president's party.
00:02:58
Speaker
And the commission is always three to two, three commissioners from the party of the president and two minority commissioners. And I'm one of two minority commissioners. But what's interesting about our work is it's very, it's not partisan work. As regulators in the markets we regulate, it's really not a partisan commission or the work we do is really not partisan.
00:03:27
Speaker
which is great. So we work very closely. We're an independent agency. And really, our regulatory remit is regulating the futures and derivatives markets. And these are really just secondary forward-looking markets that are mostly used for price discovery and risk management and hedging by
00:03:49
Speaker
a lot of institutional players, large businesses, banks, and some other people who are looking to hedge risks that they have in their business. And our mission is, to quote it, it's to promote the integrity
00:04:07
Speaker
resilience and the vibrancy of the U.S. derivatives markets through sound regulation. Our governing statute, which is the Commodity Exchange Act, actually has a list of some other purposes or goals that they set out, including, you know, deterring and preventing manipulation and market disruptions, ensuring financial integrity, protecting market participants. And one that I quote
00:04:37
Speaker
most often is that we were directed through our statute to promote responsible innovation and fair competition among markets and market participants. I think that is really an important goal that was put into our statute back when we started in the 70s. It's the foundation of our agency and one that I
00:05:02
Speaker
always say we can't lose sight of. We really need to always have that in the back of our mind with whatever we are doing or whatever we're thinking about.
CFTC's Market Protection Approach
00:05:13
Speaker
And with respect to digital assets, we're kind of involved in two ways. First, we're the
00:05:19
Speaker
market regulator over trading facilities, clearing houses, and market professionals that are trading in derivatives on digital assets. These are futures contracts on Bitcoin, Ether. We have a lot of physical commodities where there's also futures contracts as well.
00:05:43
Speaker
And really, we just need to make sure that the secondary markets are operating free of manipulation, that the price discovery or the pricing that is resulting from these markets reflects the underlying spot market and just make sure everyone follows the rules. Kind of a secondary role through the enforcement
00:06:10
Speaker
The Congress gave us additional enforcement authority in the Dodd-Frank Act to go after fraud and manipulation in commodity markets. So what that means is when a digital asset is considered a commodity, we have special enforcement authority where if we find fraud and manipulation in those markets, we can bring charges.
00:06:34
Speaker
for that fraud and manipulation. Now, the unfortunate side of that is that's after the fraud and manipulation has occurred. So by the time we're stepping in with enforcement, something bad has probably happened. There's been some bad behavior. People may have lost money, and we'll do our best to try to catch the bad actors and recover as much of the funds as we can.
00:07:01
Speaker
But again, it's not a forward-looking regulatory role. It really is an after-the-fact, after-something-bad-has-happened role. So that's kind of, that's a lot. It's more of overview and what our agency is about. But I just wanted to give you that background.
00:07:18
Speaker
No, super, super helpful, Commissioner Mursinger. And I think this probably is a perfect segue into our next question because the CFTC's ability to police the digital assets markets has been called into question by some members of the Congress. And I'm sure you're very much aware of that and others.
00:07:38
Speaker
Could you speak a little bit more on how the CFTC's role in supervising this complex actually financial products is going to enable or would enable CFTC to oversee digital assets markets right now? That's a great question. And I think it's an important point that I often bring up, but I think others bring up as well when
00:08:03
Speaker
when asked about why would the CFTC be an appropriate regulator over these markets. Anyone who has spent any time looking at derivatives products, swaps, they were very complex financial products in the markets that they trade in.
00:08:22
Speaker
are complex, and that's what we do. We oversee very complex markets and contracts, and that's just kind of our bread and butter. So certainly, we're used to seeing new and innovative trading in our markets where
00:08:49
Speaker
I think other agencies probably do as well, but not to the extent where ours is pretty fast moving. We also are a principles-based regulator, which means we set out broad-based principles for our market participants and registrants to follow, and they can kind of fill in the blanks on specifics as long as they meet those overarching goals.
00:09:13
Speaker
What that means is we're a little bit more flexible and nimble. So I think innovation is able to thrive in our markets, probably a little bit more so than in some of the more traditional markets because we don't have this bespoke regulations that you may see in other markets. And the other thing that we bring to the table that I often point out is all our markets are very global.
00:09:42
Speaker
Everything we do at the CFTC, we have to think and really interact with our global regulatory counterparts to make sure we're not somehow causing problems for the markets globally.
00:09:58
Speaker
Because digital assets are clearly global markets and there are so many global participants and it's something where it's crossing borders, you want a regulator that understands that dynamic and how to work within those associations with other regulators in other countries.
00:10:24
Speaker
I think that's what we bring to the table. I know some people say that
Framework for Digital Asset Classification
00:10:28
Speaker
maybe our rules aren't strong enough because they're principles-based, but I actually think that having more prescriptive regulation in space where there's new technology and innovation is actually not as good of regulation because the regulation's always going to lag behind the innovation. When you have principles-based regulation,
00:10:54
Speaker
you are more technology neutral. And so it can keep up because you are looking at the overall kind of purpose and principle versus a very specific way that something needs to be done. So that's kind of the way I view it and what I try to share with, whether I'm talking to folks on the Hill or speaking publicly, it's what I try to explain to folks as to why the CFTC is
00:11:21
Speaker
would be an appropriate regulator of the digital asset spot market.
00:11:27
Speaker
Absolutely. And I think this kind of brings us to our Alex Lanes. We have created our tree of Web3, which we just launched recently. And I'm very excited as one of the co-founders of this campaign. I'm very excited about our tree of Web3 wisdom. And we have included their five branches to kind of guide our policymakers.
00:11:52
Speaker
Thinking when approaching the regulation and we'll touch on this, I mean during the rest of the conversation, but I would like to start with branch three, which refers or encourages policymakers to classify tokens sensibly.
00:12:08
Speaker
And I think this is probably one of the big principles that we have, but I think it definitely gets to the heart of that war of jurisdiction that you kind of referred a little bit previously between the SCC and CFTC.
00:12:25
Speaker
If we were classifying this token sensibly according to the nature and according to the purpose of a token do you think that would be helpful in creating that sort of regulatory framework that is going to move our industry forward?
00:12:42
Speaker
Yeah, absolutely. I think it's absolutely essential that we do create some sort of framework. That is something I've been trying to, when I'm talking to the legislative branch as they're working through different ideas, you know, I often suggest we can't ignore that first piece of this puzzle, which is a framework to classify digital assets.
00:13:07
Speaker
whether it's requiring the various agencies to sit down and do a joint rulemaking or coming up with a framework through a working group, we really do need to give that market certainty to players in this space. What's so interesting to me about digital assets is people want to say that's cryptocurrency, but it's anything. Anything can be a digital asset.
00:13:37
Speaker
I think that the other kind of important piece of a framework is to make sure people understand that even at the regulatory structure, it's legislatively changed. And one federal regulator is appointed as kind of the main regulator of the digital asset spot market.
00:13:59
Speaker
I don't think that changes the fact that, you know, if say you register, but then you want to offer a security that's clearly a security as a digital asset, that's not going to get you out of oversight by the SEC or other regulators. So, you know, making sure people understand that, you know, because these assets can be anything, they can transform as well. Giving people the certainty to know that, you know, if this is the asset you were bringing to market,
00:14:29
Speaker
you know, here's how it's going to be regulated, or who here's who you're going to have to work with for regulation. And that's really step one, we could be doing that right now. I don't, I don't think it's going to happen organically, I do think that, you know, it might take Congress telling us we have to. But we can, we can certainly do that with the SEC. And we've done it before through joint rulemaking. So it wouldn't be a new concept where there might be some overlap between
00:14:59
Speaker
where an asset falls between the two regulators. So I hope that's kind of step one in this process that we come up with some sort of clear framework. Absolutely.
Regulation of DAOs
00:15:10
Speaker
And I know that there are so many questions about DAOs right now. And I'm curious to hear your thoughts on the UK DAO. I know you've been very vocal actually about this. And I always loved your feedback and everything you had to say about this case because it's such an important
00:15:28
Speaker
enforcement case. How do you seek to regulate DAOs in the future? Do you have any particular thoughts on whether or not developers should be liable, especially as members of DAOs and those that, as we have seen from the section so far, it seems like those
00:15:51
Speaker
that simply hold governance tokens. I mean, it seems that the court considered them liable. So I would love to hear your thoughts on this. Well, I'm not afraid to admit that I don't have the answer. But what I do know is not the answer is for an enforcement case to tell us how we're going to look at these organizations. That's not the proper way to do this.
00:16:21
Speaker
I've encouraged the chairman and I would hope that we go through a rulemaking process where we put out publicly asking how should we regulate a DAO. How should they be held liable? That gives us public input, allows us to go through notice and comment. It gives us a stronger legal standing.
00:16:46
Speaker
I always have to be careful when I'm talking about the Oogie Dowd case, because it's still active litigation. But I always, I can talk about what I said in my dissent. And my dissent was surrounding the fact that we were, we were using a state unincorporated association, you know, law that we kind of just decided fit. And that's how we were going to look at the liability moving forward. And to me,
00:17:16
Speaker
that's bypassing a lot of important steps that need to happen to provide proper public notice of how we're going to consider liability. What's very hard here is, especially in this case, is clearly they're violating our act. They're offering trades in
00:17:44
Speaker
In a product that was a violation of our act, the two gentlemen that we settled with initially who started this actually said they were going to create a DAO and transfer the governance so that
00:18:03
Speaker
It could be kind of CFTC enforcement proof. So it's a very uncomfortable situation because there's a violation, a clear violation, and clearly somebody intended to set this up in a way to try to avoid being held liable under our governing statute. But to me, that doesn't mean we just find a way to make it happen. We really do need to go back and say, okay,
00:18:32
Speaker
How are we going to consider, you know, DAOs under our statute? How are we going to hold them liable? And the best way to do that is through notice and comment rulemaking. And we can do that. We can use our current statute. We don't need legislative authority to do that. That's something we could do right now. And it's something I keep suggesting and pushing for, because I do think we're going to see more cases like this.
00:19:00
Speaker
We just need to make sure the public is on notice of how we're going to consider those who are involved with the DAO, whether it's token holders or those who are trading through that system. People deserve to understand their liability going forward.
00:19:21
Speaker
Absolutely.
Crypto Firms and CFTC Licensing
00:19:22
Speaker
And I mean, just to reemphasize again, I'm a big fan of your dissent. So thank you so much for all the knowledge that you drop in these descents as well. I think it's very important for our industry, especially for myself being general counsel of decentralized and centralized exchange. And I know that we have spoken and we're not against the regulation. So we appreciate the regulators just helping us out there.
00:19:48
Speaker
understanding these principles. I'm just curious to hear from your perspective. So do you think or I would be curious whether or not crypto firms are going to be able to get any CFTC licenses in the future? I mean, so far, I think it's LedgerX, but do you have any sort of prediction on that or what the CFTC is going to be looking for?
00:20:08
Speaker
Yeah, I think there was a lot of interest. And there's certainly a demand for derivatives products based on cryptocurrencies. And those contracts actually exist at a number of our current exchanges. But we are seeing
00:20:30
Speaker
crypto companies themselves come into our space, some of it's through acquisitions of existing registrants or new applications. So you know what it will look like, you know, there's kind of two ways to go. So one is the what we call the intermediated model where we have what's called a futures commission merchant at FCM.
00:20:54
Speaker
who really does a lot of the kind of front-end onboarding, making sure that the customer is able to go through the AML, KYC process, understands that these are risky markets, has the margin and the capital to really take positions in these markets, and has
00:21:21
Speaker
the disclosures that are appropriate to participate in the futures markets. And so that's one way that we'll see crypto come through kind of our door. So it'll be a very traditional model where they have, maybe they're going to be the exchange or the clearing house, but they're going to have these FCM players be the way that customers access that clearing house.
00:21:51
Speaker
And that right now is really the only option if they want to have margin transactions. Now, the other way we are seeing it is crypto companies, and this is what LedgerX has, you can have these crypto derivatives and you can have direct access to the customers, but it has to be fully collateralized. So you're holding the full amount of capital for that position.
00:22:20
Speaker
And that's, you know, that's hard. It's something that, you know, there's not as much demand as we are seeing for the leveraged transactions. And so that's why a lot of companies are looking at how can we do this through the intermediated model so we can provide leveraged transactions to our customers.
00:22:48
Speaker
But it brings up a lot of interesting issues because of our core principles and because they were created and based on a very different system, we see a lot of vertical integration now where you may have one entity that's the parent company that's running a crypto exchange who now has a
00:23:13
Speaker
DCM license wants to be a clearinghouse and also wants to be the intermediary. And we have to ask ourselves, how is that going to work? Because especially with the clearinghouse, they have some self-regulatory responsibilities. And so you have to ask, okay, how does that entity regulate itself, essentially, in the market? You know, what protections are in place and the current
00:23:43
Speaker
you know, guidelines really address that. And I think that's something you'll see us talk about a little bit more at CFTC. You'll see us probably put something out requesting some input publicly on this matter. Because it is a trend that we are we are definitely experiencing and it's it's new and and just not new is not bad. We like new, but it goes to that responsible side where you know, it's
00:24:13
Speaker
A new model is great as long as we are comfortable that it can work responsibly and that we can regulate it in a way that is protecting the customers and ensuring that they are not being harmed by this vertical integration.
00:24:31
Speaker
Absolutely. This makes perfect sense. And I appreciate the fact that you are going to consider also some comments from the public. And I know we're kind of running out of time, but I would love to hear your thoughts.
Global Regulatory Coordination
00:24:44
Speaker
Let's talk a little bit about global coordination because that's a big part of branch or element five or item five of the tree of wisdom for our
00:24:54
Speaker
uh explains which encourages and i think this is very important for all the policy makers all around the world you kind of to kind of think globally to uh i know some time we try to compare where we stand from uh innovation perspective here in united states but honestly i mean we're very happy to uh to to not only support innovation here but we appreciate all this efforts especially from cftc recently and
00:25:22
Speaker
and other regulators in order to support us in this march toward innovation. So what do you think about this firm or some of the first principles that you would have regulators in different countries to kind of concentrate on? Or are there any some sort of first principles that you would highlight or you'd like to highlight?
00:25:43
Speaker
Yeah, absolutely. And it has been very interesting. I've done some international travel and I've met with some regulators across the globe and crypto is what everybody is talking about. And everybody's kind of in the same boat where they're just trying to find the right regulatory structure to make sure that the markets can continue to thrive, but that people are protected and they're not going to lose their money
00:26:12
Speaker
and have it all disappear overnight. So it's definitely a global issue that everybody's looking at and trying to address in a way that allows these markets to continue to thrive. I think one thing I always try to encourage other regulators or that I've said works well for us is obviously principles-based regulation, as I mentioned before, having some
00:26:39
Speaker
you know, structure, but not prescriptive rules, because prescriptive rules just can't keep up with the innovation and the technology. And you're going to the rules are either going to fall behind creating gaps, or you're going to keep some of the best innovation out of the market, because the rules are too prescriptive. So principles based regulation, I think is an important principle.
00:27:07
Speaker
not regulating the technology, regulating the activity is another one. And this is something we deal with in the futures markets as well, but protectionist policies.
00:27:20
Speaker
Understanding that these are global markets, this money needs to be able to flow freely throughout the globe. And when one country puts regulations on these markets that are protectionists or trying to bolster the market within their home country, you end up with market fragmentation. And that, to me, is an unnecessary risk.
00:27:48
Speaker
Part of having global markets is understanding the global size and the impact. If you start fragmenting these markets, then you never truly understand the size of the market and the risk of the market. I think we have to be careful not to be too protectionist and cause market fragmentation. I think the last thing is just promoting responsible
00:28:18
Speaker
innovation that's free of fraud and manipulation. So as long as there are bad actors out there taking advantage of customers that continue to kind of give the industry a bad name, it's hard to move forward from that. So as much as possible trying to weed out the bad actors, the people who are trying to take advantage of people,
00:28:43
Speaker
going after those individuals working together, again, you know, coordinating as regulators to find and weed out the fraud and manipulation. That's going to be key to ensuring that we have kind of long standing success in the digital asset markets.
00:29:06
Speaker
Absolutely. Commissioner Mercinger, this has been amazing. Thank you so much. It's a real honor to have you on our second podcast actually for our explains and I really appreciate it. All your input, all your feedback, especially all your knowledge. I'm a big fan of yours as you already know, but thank you so much for joining us today. Thanks for having me. I love what you guys are doing. I love the tree of wisdom. So
00:29:32
Speaker
I'm happy to be a part of this, and I look forward to seeing what the third, fourth, and fifth, beyond podcasts, what they bring. Absolutely. Thank you so, so much.
00:29:49
Speaker
We hope you enjoyed our Hootenanny. Thank you for listening.
Conclusion and Resources
00:29:52
Speaker
For more Hootful and hype-free resources, visit www.owlexplanes.com. There, you will find articles, quizzes, practical explainers, suggested reading materials, and lots more. Also, follow us on Twitter and LinkedIn to continue wising up on Blockchain and Web3. That's all for now on Owl Explains. Until next time!