Kraken Case Contains Silver Lining In Crypto Enforcement

October 1, 2021
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A recent settlement of charges laid by a U.S. federal regulator against crypto-exchange Kraken strikes a note of hope for the crypto-industry, which has been the target of much regulatory animosity recently.

A recent settlement of charges laid by a U.S. federal regulator against crypto-exchange Kraken strikes a note of hope for the crypto-industry, which has been the target of much regulatory animosity recently.

As the crypto-asset industry has grown rapidly in recent years, so has the number of federal enforcement actions.

While members of Congress are hashing out plans to regulate the booming industry, federal financial regulators have stepped up their efforts to punish it for disobeying their existing rules.

Earlier this week (September 28), the Commodity Futures Trading Commission (CFTC) announced a settlement that it had reached with Kraken, the crypto-exchange. The company agreed to pay a $1.25m penalty, without admitting or denying anything, to deal with the regulator’s allegations that it had illegally offered to process margined retail commodity transactions in digital assets, including Bitcoin, on behalf of others and had failed to register as a futures commission merchant (FCM) with the CFTC.

This case shows that even though many in the crypto-world are concentrating on “big-picture regulatory issues” such as the future of stablecoins or the problem of exchanges that do not impose know your customer (KYC) controls, the government always wants to enforce existing rules that apply to firms in the sector, Jeffrey Newton, lawyer at Kobre & Kim, told VIXIO.

That is particularly so in the area of margin products, which regulators believe to be particularly risky, especially when retail or non-professional traders are involved, he added.

Another important highlight of the order is the CFTC’s acknowledgement of Kraken’s cooperation. The exchange capitulated to the agency in a timely manner, reached out to it for guidance about compliance and took steps to mend its ways.

Even though the company is one of the largest digital asset exchanges in the U.S., the $1.25m settlement seems relatively small compared with its estimated value of more than $10bn.

By contrast, earlier in August, the CFTC settled a similar case against BitMEX, a crypto-exchange that also failed to register as an FCM, for $50m.

“It is a welcome development to see the CFTC acknowledge Kraken’s cooperation in the investigation, given the narrative of animosity between regulators and the industry that has developed recently,” Newton noted.

In an accompanying statement, commissioner Dawn Stump pointed out that the CFTC’s regulation concerning FCMs, as applied in the Kraken case, “is not entirely clear” and urged the regulator to update its guidelines for retail commodity transactions involving certain digital assets.

The concurrence of commissioner Stump provides further reason for hope that these agencies will heed the voices within them seeking to create clear, public guidance for crypto-operators, Newton said.

Wyoming State-chartered Kraken allows its users to store and transfer cryptocurrencies on its exchange and deposit their gains in U.S. dollars.

It was the first crypto-exchange to receive a state banking license in the U.S. after Wyoming established a new kind of bank charter called the "special purpose depository institution".

This so-called “novel” charter inspired the Federal Reserve to review the rules that its banks must observe when assessing the applications of fintech firms to join its payment system.

Section 4(a) of the Commodity Exchange Act makes it unlawful for any person to run a business in the United States for the purpose of dealing in any transaction in a commodity futures contract, unless it is subject to the rules of a board of trade that the CFTC has designated as a contract market for the specific commodity.

Kraken offered to execute margined or leveraged retail commodity transactions with U.S. residents who were non-eligible contract participants that did not result in actual delivery within 28 days. These margined or leveraged retail commodity transactions were not subject to the rules of a board of trade that the CFTC had designated as a contract market, so the regulator argues that Kraken broke Section 4(a) of the act.

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