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Cryptocurrency Derivatives Series: CFTC Reckons ‘Digital Assets and Blockchain Domain Needs Principles-based Regulation Over Rules’

We kept saying crypto-derivatives avenue has myriad interests especially after the recent trends in Bitcoin price sentiment. There has been a long waiting of cryptocurrency aspirants for institutional investors. Although the launch of bitcoin futures contracts on regulated exchanges in late 2017 made a bit of a buzz but didn’t gain a lot of traction, of late, Bakkt appears to be striking a chord in the space.

These are exciting times for our derivatives markets. From blockchain to digital assets, innovative FinTech arena are witnessing paradigm shift in the way derivatives markets functions.

The Commodity Futures Trading Commission (CFTC) has come up with an insight of important role to play in determining as to how these new products and technologies evolve. They have reiterated their mission statement to promote the integrity, resilience, and vibrancy of derivatives markets through sound regulation. The trick with digital assets is to foster the development of exciting new products while mitigating potential risks.

They reckon that one should be aware of how we regulate is just as important as what we regulate. That’s why a principles-based approach is the best way to govern this emerging market.

Principles-based regulation involves moving away from detailed, prescriptive rules and relying more on high-level, broadly-stated principles to set standards for regulated firms and products. Companies will then be responsible for finding the most efficient way of satisfying those standards. Such an approach affords greater flexibility to the tech sector. It will also enable the CFTC to stay ahead of the curve by reacting more quickly to changes in technology and the marketplace. 

A more principles-based approach can help reduce the need for volumes of regulations that seek to dictate every aspect of a firm’s behavior. As Winston Churchill put it, “If you make 10,000 regulations, you destroy all respect for the law.” Yet Titles 12 and 17 of the U.S. Code of Federal Regulations—which together cover banking, securities, and derivatives regulation—now total over 13,000 pages. 

It is important to recognize that principles-based regulation is not a euphemism for “deregulation” or a “light-touch” approach—far from it. Principles-based regulation is a different way of achieving the same regulatory outcomes as rules-based regulation. But it simply does so in what is, in many cases, a more efficient and flexible manner. That flexibility also prevents subversion of those outcomes through the kind of loopholes that revealed the inherent vulnerability of rules-based regulation in the run up to the financial crisis.

Of course, in practice, it is rare for to have either a purely principles-based or a purely rules-based regulation. Rather, they represent two ends of the regulatory spectrum. Every principles-based regulatory regime has some rules, and every rules-based regime has some element of principle. For this reason, we frequently see hybrid regulatory systems of principles and rules. The appropriate mix of each will depend on a number of factors, such as the regulatory objective, maturity of the market, the characteristics of market participants, and quality of the regulator.

Applying this analytic framework to digital assets and other fintech products leads me to conclude that we should take a predominantly principles-based approach in this area. Some issues that touch customer protection—the treatment of assets held by financial firms on behalf of customers, such as cash and securities held as margin, for instance—are generally more suited to a rules-based approach. But overall, CFTC staff is currently considering how the core principles applicable to exchanges (venues where derivatives trades are executed) and clearinghouses (entities that take on and manage the post-trade counterparty credit risk) can be better tailored for fintech. 

Crypto-derivatives avenues are evolving as Bitcoin and other digital assets are highly volatile investments. Many traders attempt to mitigate their risk simply by buying an asset when the price drops or selling it when the price goes up.

The downside of this tactic is that oftentimes money is left on the table after you leave the market. If the price continues to rise after you sell, for example, you’re missing out on profits you could’ve earned had you left your position open.  A key benefit of futures trading is that you can hedge existing spot positions without additional crypto - allowing you to be agile and prepared for any market environment.

Cryptocurrency futures allow us to maximize your returns by utilizing the power of leverage to multiply your profits and apply advanced trading strategies. Use futures to speculate on the direction of the market and minimize risk, all while holding less crypto than on a spot exchange.

By Niranjan Patil
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