Regulation

Crypto Dad is leaving, the CFTC is still writing the rules, and applicants fall short: D.C. sources on what’s holding up ErisX and Bakkt approvals

Quick Take

  • Legal professionals and sources in Washington, D.C. break down the regulatory hoops exchanges like Bakkt and ErisX must jump through before getting the thumbs up for their intended licenses
  • They also outline why some exchanges got the golden ticket more quickly than others – and when we should expect the exchanges’ approvals to come through

It’s not easy being a crypto exchange. Especially when it comes to getting futures licenses from some of the world’s most stringent financial regulators.

Among them is Bakkt, which is currently seeking a trust license to launch its bitcoin futures platform, and ErisX, which is bidding to secure a Derivatives Clearing Organization (DCO) to launch its own futures platform. Both firms are optimistic they’ll have approval by year-end, but it won’t be easy — and it’s likely to take months to get any news about their progress.

To establish what’s going on behind the scenes, we spoke to lawyers and sources on the ground in Washington, D.C. They explained the main regulatory hurdles facing Bakkt and ErisX to launch their crypto derivatives products.

A blank canvas, and a lot of talking

As ever in crypto, regulators and exchanges are writing the rules as they go. “No one has written out the answer – no one has said ‘this is what you need to do to get the license'”, one person said. “Companies are going in guessing the approved architecture.”

And the Commodity Futures Trading Commission (CFTC) is taking no chances in writing its blueprint.

“The CFTC is going to do on-site examines and ask you to explain things. It is a major process of back and forth. Factor on top of that the fact that that this is something very new and novel to the agency. I think that adds in another layer of diligence. It is not as simple as submitting an application,” said Jeff Steiner, a partner at law firm Gibson Dunn. “It takes a really long time, the process is significant. To put it in perspective … if I am coming in and want to start my exchange. I have to have my own rule book.”

Indeed, the due diligence process is intensive, reportedly encompassing a comprehensive review of the exchanges in question, an inside source said.

“The reason for the delay is not because companies are waiting on the SEC or CFTC to make their mind up. It’s that the SEC is in dialogue with the companies, interviewing every single person and seeing every angle.” 

Arthur Long, another lawyer from Gibson Dunn, added: “Any bank or trust company is going to have to go through a substantial process so that the regulators understand the business,” speaking specifically on Bakkt’s plan to secure a trust license. As reported by The Wall Street Journal, the firm — which is backed by Intercontinental Exchange — has been in the process of applying for a trust, which could further delay the launch of its bitcoin futures product. Originally, Bakkt was planning to launch the product in 2018. The process of securing such a trust could take half a year, Long said.

“[Regulators] want to make sure the people are running it are capable, and have the right integrity,” he said. “These days with any charter they want to make sure you have the right policy, technology, make sure you can run the business in a safe manner.”

Application woes

Another issue is that crypto license-applications are reportedly paying insufficient attention to the regulators’ requests. “They’ve seen countless proposals from big names. And they’re saying ‘come back with something new.’ But [applicants] are coming back with the same thing or only a few amendments,” one DC source said. “They’re still looking for the innovation.”

They added:

“There’s two big hurdles. One, the lack of creativity in these firms. And two, that they’re fighting against themselves. The market is dragging them down, it’s not done enough maturing.”

“What these people want to see before approving is that the whole industry is ready for it,” the source added.

Another source noted that because of the limited resources, “one hiccup can add months” to the final timeline.

New management

The CFTC is also preparing for a leadership change as chairman J. Christopher Giancarlo, known affectionately as “Crypto Dad” for some of his crypto-friendly stances, wraps up his term. He can step down at any time between now and 2020 — likely in the summer, depending on when U.S. Senate Majority Leader Mitch McConnell puts a vote on the floor, with Heath Tarbert, a senior U.S. Treasury Dept. official, has been tipped as his successor.

One source noted that Giancarlo’s impending departure means he’s squeezing in final sweeping reforms — indirectly creating delays by diverting resources.

“The chairman has several things he wants to accomplish, so many have had to split their time with the new rulemaking. That has probably slowed the process,” they said.

Still, according to another source, the leadership upheaval is unlikely to be the most important variable for exchanges awaiting an answer. 

“In D.C., you have political appointees sitting at a certain level in the organisation. But those doing the actual groundwork, the people making the decisions are career staffers. So unless someone’s coming in [as chairman] with a totally different point of view, it’s not going to make much of difference,” they said. “In my opinion, the new chairman thing is low hanging fruit.”

*****

So what are the odds of getting approved then?

ErisX’s attempt to get a DCO license would pave the way for them to become a futures exchange like CME or ICE, where trading is done through a central limit order book. A DCO is a clearinghouse, which is necessary because any futures contract executed must be cleared through such an entity.

Already, ErisX has begun facilitating trading in spot cryptocurrency markets, a spokesperson noting in an email that the firm is “working with the CFTC on getting our DCO license and we are pleased with the progress we are making.”

Bakkt, for its part, is pursuing a license to operate as a trust rather than the famed BitLicense, a New York State license for crypto firms. This may be because this is “more expansive” according to Long, and also because trust companies can operate in broader swath of services in financial markets, such as financial advice. 

“I would put the likelihood of a Bakkt trust license very very high. Not within the next month – but after that, I couldn’t tell you,” one source said.

Again, there’s an acquisition route available, which Bakkt has opted for; propelled by its enormous treasury. “That’s why Bakkt acquired DACC [in Q2]- they’ve got a totally new custody solution,” the source explained.

This is also the route Coinbase took, acquiring a group with the South Dakota Trust license, with the logic being that “once you get South Dakota, you’re pretty much good for everything,” the source said. It took Coinbase less than a year to get approved, while Gemini took 18 months, having gone a “different way.” 

 

Editor’s note: An earlier version of this story incorrectly stated that ErisX was pursuing its DCM license, which ErisX has had since inception, a company spokesperson said.