On November 27, 2018, the Commodity Futures Trading Commission’s LabCFTC released, “A CFTC Primer on Smart Contracts.” This primer follows on a 2017 primer on virtual currencies and includes three parts: (1) Overview of Smart Contracts; (2) The Role of CFTC and (3) Risks, Challenges, and Governance of Smart Contracts.
1. Overview of Smart Contracts
In the Overview of Smart Contracts, LabCFTC tried to provide its definition of “Smart Contract” and explain the relationship between smart contracts and blockchain/distributed ledger technology, the underlying technology of virtual currencies. Because of the tension between the legal concept of a contract, or a contract with automated parts, and the programmer’s concept of a contract as an electronic agent, it leads to lots of confusion in defining the term “smart contract”. LabCFTC proposed to clear the confusions by going to the fundamentals: “Fundamentally, a ‘smart contract’ is a set of coded computer functions” and pointed out that “a ‘smart contract’ may not be a legally binding contract”. The connecting point of smart contract and blockchain technology is that smart contracts can be stored and executed on a distributed ledger or blockchain, whether public or private/permissioned.
2. The Role of CFTC With Respect to Smart Contracts
The primer went further to introduce the relevance of the CFTC to smart contracts. Depending on its structure, operation, and relevant facts and circumstances, a smart contract could be a commodity, forward contract, futures contract, option on future contract or swap, subject to the CFTC’s jurisdiction. The CFTC suggested that participants consult competent legal counsel when considering whether a smart contract may be a product subject to CFTC jurisdiction. This also echoes the remarks by CFTC commissioner, Brian Quintenz at the 38th Annual GITEX Technology Week Conference in Dubai on October 16, 2018 (“Quintenz’s remarks”). Quintenz’s remarks suggested that smart contracts could fall within the CFTC’s jurisdiction, either because they resemble products the CFTC regulates or because they offer functionality that would permit or facilitate trading of such products. For the smart contracts that would facilitate the trading of products the CFTC regulates, Quintenz went further to suggest that while developers of the underlying blockchain, miners and others play a role in the use of smart contracts, it is the smart contract code developer who could be held accountable, at least where they “could reasonably foresee, at the time they created the code, that it would be likely be used by U.S. persons in a manner violative of CFTC regulations.”1 If this is the case, both the developers and the CFTC will need to consider whether and to what extent Commodity Exchange Act provisions and CFTC rules apply to developing applications that facilitate the execution of contracts falling under the CFTC’s jurisdiction.
3. Risk Factors
Last but not the least, the third part of the primer listed various risk factors related to smart contracts, which include operational risks, technical risks, cybersecurity risks, risks related to fraud and manipulation, etc. Although the primer is intended to be educational, it provided some examples of prohibited activities related to derivatives contracts. The examples include that derivatives contracts, including those that are smart contracts deployed on a decentralized blockchain, must not be traded on or processed by a facility that is not appropriately registered or be traded or executed by individuals or firms that are required to be registered with the CFTC, but are not and do not have an exception or exemption from registration.
The CFTC recommended those employing smart contracts consult with legal counsel or an appropriate expert concerning the legal and regulatory requirements. If you have any questions concerning legal requirements on your specific activities on smart contracts, please speak with your S&K contact attorney or any member of our Blockchain and Cryptocurrency Group.
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1 Brian Quintenz, Commissioner, U.S. Commodity Futures Trading Commission, Remarks at the 38th Annual GITEX Technology Week Conference (Oct. 16, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/Opaquintenz16
