SBF’s Victory From Behind Bars

The cryptocurrency industry landed one of its most desired prizes last month when regulators at a small but potentially pivotal federal agency allowed a little-known cryptocurrency company to oversee all aspects of brokering, facilitating, and clearing trades of its digital assets. 

Regulators and experts say the move, which came after millions were spent in lobbying in 2023 alone, could endanger customer assets and stifle competition, as well as set a dangerous precedent that could set up this and other financial markets for spectacular collapse.

The Dec. 13 approval of the application from Bitnomial, a small Chicago-based crypto derivatives company, is the first time the Commodity Futures Trading Commission (CFTC) has approved any financial institution to vertically integrate as an exchange, broker, and clearinghouse, without doing so through company acquisitions.

In most financial markets, the responsibilities for different functions are handled by separate entities to prevent conflicts of interest and ensure market stability. One entity runs the exchange where financial instruments are traded; another is a broker which performs transactions on behalf of clients; and another clears, or validates, the transactions before they go through.

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The approval of Bitnomial’s application comes after years of cryptocurrency interests — most prominently, convicted financial fraudster Sam Bankman-Fried — cozying up to CFTC regulators and pushing to ensure all federal crypto regulations are handled by the commission. The CFTC’s limited size and funding could lead to laxer oversight, compared to regulations from the much more aggressive and powerful Securities and Exchange Commission (SEC).

Now, with the Bitnomial approval, experts told The Lever that a precedent has been set that could allow more companies under CFTC oversight to vertically integrate into massive financial firms that could be susceptible to collapse.

“It’s a pretty big deal that’s flying under the radar, and it came up as a surprise at year end,” Dennis Kelleher, president and CEO of consumer advocacy group Better Markets, told The Lever. “Although it’s no surprise that the crypto-friendly CFTC Chairman Rostin Behnam would do this without much advance notice — ramming something through that’s crypto friendly at year end, that’s not a surprise.”

One CFTC commissioner who voted against the approval criticized her colleagues for rushing through the five-member commission’s first-ever vertical integration approval.

“We are in the middle of a public consultation on vertical integration and concerns with vertical integration have been expressed by the White House… Treasury Secretary Janet Yellen and other banking regulators,” said CFTC Commissioner Christy Goldsmith Romero in a Dec. 13 press release. “I do not understand why the Commission would rush to register this small start-up company, thereby setting precedent, without completing the analysis that we are in the middle of right now.”

Bitnomial says it did not pursue its application to “create a vertically integrated entity,” and that it still plans on working with multiple brokers. Bitnomial also claims its application did not receive an expedited process.

“The application wasn’t rushed,” a Bitnomial spokesperson told The Lever. “As was pointed out by CFTC staff in the public meeting, the application was first recommended for approval in early 2023 and the commission contemplated it so long that their statutory [180-day] deadline lapsed, at which point Bitnomial agreed to extend the deadline. Bitnomial is seeking this approval to expand digital asset support and access given how nascent the regulated digital asset derivatives market is in the U.S.”

‘Crashes And Bailouts’

The CFTC, which was originally established in 1974 to oversee agricultural futures contracts, has been called the “Achilles Heel” of the 2010 Dodd-Frank Act because it was handed oversight of the massive U.S. derivatives market, including all financial options, swaps, and futures, after the 2008 financial crisis. 

In 2022, the CFTC had an operating budget of just $332 million and 743 full-time employees, compared to the SEC, which oversees the stocks and bonds markets and had a 2022 budget of nearly $2 billion dollars and more than 4,500 full-time employees. 

The crypto industry has worked diligently over the years to make the CFTC the sole regulator of digital assets. It’s why the fight over the definition of cryptocurrencies has become heated; some regulators view it as a security, similar to a stock or bond, which would likely bring it under the purview of the SEC, while others view it as a commodity, like grain or oil, which would place its regulation under the CFTC.

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The CFTC has developed a congenial relationship with the crypto industry — and in particular Bankman-Fried, the disgraced former CEO of the massive crypto exchange FTX, which collapsed in November 2022. Bankman-Fried played a pivotal role in glorifying crypto and lobbied the CFTC before he was arrested and ultimately found guilty on seven counts of felony fraud and money laundering in November.  His sentencing hearing is scheduled for March 28, where he faces more than 100 years in prison.

Before his criminal activity was discovered, Bankman-Fried and his associates were able to obtain same-day meetings with CFTC Chair Behnam, thanks to the connections and efforts of former CFTC regulators that FTX hired as top deputies. 

Behnam, a former equities trader and Congressional advisor, was appointed to the CFTC in 2017 by former President Donald Trump. He was reappointed to the position in 2021 by President Biden and elected chair by his co-commissioners.

Bitnomial’s application is similar to one that Bankman-Fried was pursuing for FTX, which was to allow the company to consolidate the exchange, broker and clearinghouse functions for the digital assets it managed. The FTX application sought to change how derivatives markets and clearinghouses operate; the Bitnomial application was less ambitious, Kelleher said. 

“[Bitnomial’s approval] not only allows crypto firms to get bigger, but it positions them to get connected to the core of the financial system, where when they get in trouble, like dominoes, they could have knock-on effects on the traditional banking and financial system, which could lead to crashes and bailouts,” Kelleher said. 

Bitnomial, founded in 2014, is a relatively small company with just $1.7 million in total assets, and its application was not given a public comment period, like the one FTX underwent, when it submitted its application in April 2022.

Instead, in June 2023, the CFTC issued a Request for Comment for an obscure process, called “Impact of Affiliations of Certain CFTC Registered Entities,” to consider the potential issues that may arise from vertical integration under CFTC regulation. The CFTC received over 160 comments during this process, many of which warned of the potential risks associated with vertically integrated financial institutions. 

“The CFTC should have put the Bitnomial application out for public comment and it should have taken that information and the information submitted in response to the ‘Impact of Affiliations of Certain CFTC Registered Entities’ all into account before it took action… and allowed the dangerous affiliations presented in the Bitnomial application,” Kelleher said.

CFTC Commissioner Goldsmith Romero expressed similar concerns.

“We received so many comments expressing serious concerns about conflicts of interest risk, risk of customer harm, anti-competitive risks, contagion risk, financial stability risks, and systemic risk,” she said in her Dec. 13 press release. “That means the stakes are high if we get this wrong.

Steven Adamske, a senior spokesperson for the CFTC, declined to comment on Commissioner Goldsmith Romero’s comments suggesting the application was rushed through. 

“The Bitnomial Application has been with the commission for over a year where we have a statutory deadline to act within a certain period of time,” he said. “I would point out, however, that the application has been under consideration for over a year and that in Commissioner Goldsmith Romero’s December 18 statement, she notes she was prepared to vote against the application in May.”

He also noted the Commodity Exchange Act and the Commission’s own recommendations do not require a public comment period for the type of application Bitnomial submitted.

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A “Big Christmas Present At Year End”

Although the company is small, Bitnomial has deep-pocketed investors, including investment firm Franklin Templeton and crypto exchange Coinbase. Both companies have spent more than $3.7 million combined lobbying Congress, the CFTC, the White House and other federal entities on crypto and additional issues in 2023 alone, disclosures show.

Kelleher, the President of Better Markets, said Bitnomial’s application would never have been approved by the SEC because securities law prevents this type of consolidation. He added that the consolidation is similar to the market structure that was allowed right before the stock market crash of 1929, preceding the Great Depression. 

Kelleher added that it was this structure — one entity acting as an exchange, broker, and clearinghouse — that also caused the collapse of FTX, even though the arrangement was illegal to do so at the time.

“They were technically separate entities, but they had common control, which was Sam Bankman-Fried,” Kelleher said. “It illustrates that when you have those conflicts of interest, the pressure to advantage different parts of your business for your own benefit and at the expense of others like investors and customers is overwhelming. And that’s effectively what the CFTC is approving here.”

CFTC commissioner Kristin N. Johnson also warned about the dangers of vertically integrated financial companies, but ultimately voted for the Bitnomial application after she said Bitnomial promised to put consumer protections in place to prevent conflicts of interest.

In a press release explaining his support of Bitnomial’s application, CFTC Chair Behnam made no mention of the possible dangers of vertical integration and praised Bitnomial for incorporating changes regarding concerns that arose from the public comments they received.

“Bitnomial has demonstrated compliance… [and] this demonstration of compliance is all that is required for registration,” Behnam said in a press release. “Bitnomial has also adopted rules that specifically address potential conflicts of interest associated with having [a vertically integrated company] and a separate, stand-alone policy that addresses potential affiliate conflicts.”

Behnam also said vertically integrated clearinghouses “are not novel structures,” that Bitnomial’s application was standard, and that the Commission should not hold them to a higher standard, “ nor should it require compliance with rules that have not yet been proposed or approved,” Behnam said in a Dec. 18 press release.

But for consumer advocates like Kelleher, the CFTC’s approval of this model represents a “big Christmas present at year end” for the industry.

“I think the bottom line of this crypto application approval is that the action really shows, again, what a weak crypto regulator the CFTC is,” Kelleher said. “And how ill-suited it is to properly regulate a largely lawless financial market like crypto.”

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