CFTC Chairman Heath Tarbert Talks Ethereum, DeFi and the Next BitMEX

The Takeaway

"Let me just basically say how impressed I am by Ethereum, full stop, period."

No, that's not a Silicon Valley investor. That was Heath Tarbert, chairman of the Commodity Futures Trading Commission (CFTC), who flexed a sophisticated understanding of blockchains during a live interview at CoinDesk’s invest: ethereum economy virtual conference Wednesday.

Chatting with CoinDesk Chief Content Officer Michael J. Casey, Tarbert discussed how Ethereum and decentralized finance (DeFi) fit into U.S. securities and commodity laws, as well as the agency's recent enforcement actions and the potential benefits and risks of migrating financial activities to distributed networks.

The "fireside chat" picked up where a similar conversation last year left off: How Ethereum and its expected shift to a proof-of-stake consensus mechanism might fit into U.S. commodities laws.

"I'm not willing to say necessarily that" governance by staking would definitely put Ethereum 2.0, the coming reboot of the world's second-largest blockchain, into a securities classification, he said. "It's still decentralized in a way that your typical company or even a cryptocurrency that really has a company standing behind it" isn't.

Ether (the blockchain's native cryptocurrency) right now is considered a commodity, similar to bitcoin, the only other cryptocurrency with a regulated derivatives market in the U.S. However, it's unclear whether a proof-of-stake network would be treated similarly under U.S. law or if it would more closely resemble a security.

"The more decentralized it becomes over time and the more that it effectively runs itself, the more likely it is it's going to fall within the commodity category and not the securities [group]," Tarbert said.

This issue is contingent on what the U.S. Securities and Exchange Commission (SEC) says, Tarbert said.

"We usually defer to the SEC's views on [what is] a security, so if the SEC says, 'This is not a security,' then we're generally confident we can come in at that point and say it's a commodity," he said.

Tarbert has been an outspoken supporter of the cryptocurrency space since his arrival at the CFTC in mid-2019. Under his tenure, the first Ethereum-based derivatives contracts entered the U.S., validating a view he expressed last year. More recently, he said that "a large part" of the financial system could end up existing in a blockchain format.

It was in that spirit Wednesday that he addressed the burgeoning decentralized finance (DeFi) field, where a dizzying array of complex products have presented novel challenges for regulators. On the one hand, he saw cause for optimism.

"The whole idea of DeFi really is, number one, it's obviously revolutionary, and I think at the end of the day could lead to a massive disintermediation of the financial system and the traditional players," Tarbert said. "And ultimately, [it] could potentially even reduce systemic risk in some ways because we don't have the finance system concentrated in these large globally, systemically important institutions."

Tarbert does not expect this shift to happen immediately, saying it could be "decades" away, but the potential for this sort of disintermediation does mean that involved parties should be asking questions about network resilience.

"If we think about [if] a large portion of our global financial system winds up on Ethereum, then we have real concerns about the theory ... what if Ethereum went down?" he asked.

Tarbert did not provide a firm answer about how assets involved in or issued by DeFi projects might fit into securities or commodities laws, noting it could depend on what the digital contracts do and how tokens are distributed.

When asked about Uniswap's airdropped UNI governance token, Tarbert said it "has some features" of a security but also "significant differences," not least of which is the fact the assets were distributed for free.

"If people didn't necessarily pay for it ... then it's hard to see at what point there would be an economic loss," he said. Again, however, the CFTC chairman said this would be something for the SEC to consider.

If regulators aren't bringing actions against potential violators of securities laws, private individuals can still bring their own lawsuits, at which point a court would have to decide, Tarbert said.

So-called fair token distributions like Yearn.Finance's, where tokens aren't set aside for the project's founding team, are also a tough call.

"The issue with fair launch, that takes the founders out of it," he said. But there are still concerns about market manipulation which the regulators might still have to evaluate.

Making Ethereum more environmentally friendly would be an additional benefit from shifting to proof-of-stake, Tarbert said during the chat, noting that proof-of-work, the consensus mechanism currently used by the blockchain (and pioneered by Bitcoin) requires energy-intensive machinery.

"There are issues with mining, of course, so number one [is] environmental issues," he said. "And so I think we were generally supportive as a larger matter in reducing ... the environmental footprint, and moving to proof-of-stake clearly does that."

He likened current transaction costs on Ethereum's congested network to the cost of flying across the country compared to buying a car in the 1930s.

"At some point, we've got to move in terms of scale and efficiency to deal with environmental issues but also to deal with the cost issue," he said. "I see proof-of-stake as being potentially helpful."

The CFTC recently brought an enforcement action against BitMEX, one of the world's largest crypto derivatives exchanges. In charges unveiled this month, BitMEX is accused of allowing U.S. residents to transact on its platform without registering as a futures commission merchant or obtaining other licenses.

BitMEX also failed to comply with the Bank Secrecy Act in conducting know-your-customer and anti-money-laundering procedures, the CFTC alleged alongside prosecutors with the U.S. Attorney's Office for the Southern District of New York.

"I want the U.S. to lead in digital assets," Tarbert said, explaining why the agency pursued BitMEX. "What we want, our desire is to create an environment where innovators in digital asset exchanges can grow up here in the United States, they can come to places like the CFTC and get a license and they can benefit from our regulatory regime. What we don't want to see are offshore exchanges that are effectively flouting U.S. laws."

The agency has an "obligation" to go after non-compliant exchanges, he said. When asked if the agency is looking at other platforms as well, he answered: "I'll say maybe."