Government is often thought of as being antithetical to cryptocurrencies. Even Bitcoin’s first block noted another round of a government bailout of the banking system. Yet regulation is still an important part of crypto and blockchain technology and few agencies are as important as the Commodity Futures Trading Commission. It has a hand in crypto in part because of its regulatory oversight on exchange-traded Bitcoin futures. Compared to the Securities Exchange Commission, the CFTC is seen by the community as more open to digital assets and the technologies behind them.
How the CFTC views crypto and distributed ledger technology will have significant impact on how these innovative technologies develop over the coming years. To get an idea of the CFTC’s approach, we met with Daniel Gorfine, the agency’s chief innovation officer and director of its “LabCFTC,” which is “designed to be the hub for the agency’s engagement with the FinTech innovation community.” Gorfine often travels from city to city for LabCFTC’s “office hours,” where innovators can come and meet with the agency to ask questions. We decided to ask some questions ourselves.
Gorfine, an attorney by training and an adjunct professor of law at Georgetown University, was energetic and articulate in his responses, methodically answering every question as if he had been preparing for days even though we were a couple of people meeting at a Starbucks in downtown Manhattan on a cold winter day.
MODERN CONSENSUS: What is LabCFTC and what are you hoping to accomplish? When did it start? How did it start?
DANIEL GORFINE: High-level overview: LabCFTC was launched in the summer of 2017, so we’ve been in operation for almost 18 months now. It really comes from the kind of repeated view and vision of our chairman Chris Giancarlo who’s talked about the increasing digitization of markets and the increasing role that technology is playing in our markets. This is a view that was shared by our chairman and our other commissioners as well. And so there was a thought that we really need to make sure we have the right types of understanding and, essentially, also the regulatory tools to keep up with changes in our market. So that’s why we launched LabCFTC.
The mission statement for LabCFTC is to facilitate market-enhancing innovation, help to inform policy, and again to make sure that we have the regulatory and technological tools and understanding to keep up with our markets.
There are three primary workstreams for LabCFTC. The first one is around engagement and we’ll talk more about that and that’s why I’m here in New York right now. It’s that underpinning of the engagement prong is to be doing office hours and meetings with innovators. The second piece is more around once we’ve identified promising technologies, how can we help stimulate them or incorporate them to make the agency more effective. The last prong is easiest to think of as an internal thinktank of sorts. We spend a lot of time seeking to educate and inform our staff, our colleagues, as well as our commissioners and then also use that as a platform to collaborate with other regulators, domestic and international. So we work closely with our peers in Washington and we also have these fintech cooperation arrangements with the SEA monetary authority of Singapore and ASIC, the Australian regulator.
But then really quickly back to the office hours: So, when I say we meet with innovators, to us, an innovator can be a startup or an established financial institution or a technology company—essentially, anybody who is using technology to do innovative things in our markets We want to talk to them. And we travel around the country and we’re willing to do these meetings in various cities as well as in Washington. But the reason we go outbound is to make sure that we’re actually meeting innovators where they are not requiring them to spend the time and money to come to Washington to meet with us. So over the last 18 months, we’ve been to Boston, Mass., Silicon Valley, Chicago, Austin, Tex., multiple times here in New York, and then again, meetings in D.C. as well.
I’ll leave you with one last point: in terms of the value proposition for those who meet with us, when they’re real startups, many times it’s that they’re trying to get some feedback as to how our rules may apply to particular activities. Other entities may come in and point out where there’s ambiguity or friction in rules and want to raise that with us. And obviously for us, it just allows us to learn what’s coming around the corner. So it can help us inform the commission as to what’s actually taking place in the market.
What’s the usual mix of companies that come before you (established versus startups)? And what kind of startups are you seeing?
It’s really quite a range. I would be hard-pressed to give you exact percentages. We get true startups that are a couple of graduate students who are starting it up as they finish graduate school. You’ll also have little bit more mature, established young companies that may be a few years old and actually have clients and customers. And then you’ll get some regulated entities, registrants that would come in as well to meet with us. The range of topics also varies, so I think maturity of the entities varies as well as the topics. And certainly since the launch of Bitcoin futures last year, the topic of crypto has been a pretty large one as well as broader DLT [distributed ledger technology], including permissioned DLT systems.
We get a fair amount in the machine learning space. That could be either machine learning applied in the reg-tech context—like can you aid compliance and make compliance more efficient by using computers and machines to identify problematic behavior—so that’s a big area. You can flip it around and say the supervisory technology side—how could regulators use machine learning tools and otherwise in order to enhance surveillance and be more effective in overseeing markets. So those are the largest areas—crypto, broader DLT, machine learning, and AI.
There have been conversations around smart contracts, cloud, and broader reg-tech.
Along the lines of DLT, are there any particular pieces of technology that you find interesting? Have you found that they focus on a specific aspect of the commodities markets?
DLT as a broad proposition stands for interoperable databases, standardizing data formats and fields, and all of this can elevate computing infrastructure which can have really positive efficiency benefits in a lot of different economic activity. It can be in commodities markets, it could be for farmers and agricultural producers who are thinking about supply chain tracking, you hear about it in the context of actual trading activity where maybe it enhances clearing and settlement processes.
One area that our chairman has also been pretty vocal about is the idea that DLT in the future could enhance regulatory reporting. If you imagine market participants adopting a system or some type of a DLT network where the regulators node within that system, you would have registrants being able to actually share real time standardized data with us as the regulator instead of the current process where they are manually batching data files, sending those and pushing those to us in forms that are not necessarily standardized. For us to consume it, it’s more difficult. For them pushing it and aggregating it, it’s expensive and not the most efficient. So there may be an opportunity where as a node, we’re seeing that information real time in a standardized format which would actually allow us to do a lot more with the data—because then it’s clean, structured, and you can build analytics tools on top of that in order to enhance your oversight capabilities.
Is anybody doing that now? Are you doing anything in-house?
There are groups working on these types of DLT systems. It’s worth a look at the FCA’s recent report on crypto. They talk about working with an industry consortium around mortgage disclosures and satisfying regulatory reporting requirements in that context.
Here in the States, U.S. regulators would have difficulty doing the same types of proof of concepts as what some international regulators are doing and that’s because there are two barriers. The first one is, if you work with an entity that’s providing even just a test to see whether the system can even satisfy regulatory requirements, if someone gives us something that someone deems to be of value, that’s a gift. So we can’t work in an iterative way with someone that is offering you access to a system that is deemed to be of value. Now the flip side is you wouldn’t go through a traditional procurement process buy capital markets infrastructure. It doesn’t really make sense. You’re actually working on a prototype to see if some new technology can assist in satisfying regulatory requirements. So we have a little bit of an issue there. There were bipartisan members of Congress who have created legislation that would give CTFC research and testing authority to be able to do some of these proofs of concepts… So right now it’s a bit of a challenge for us but it’s something that we’re really interested in figuring out—how can we get a better sense of whether the technology that can satisfy both regulatory interests and objectives as well as be something that market participants view as beneficial, at a lower coast, and a more efficient way to satisfy rules and reporting.
The CFTC doesn’t have a wish list
Do you have a wish list?
No, we’re not setting specifications or requirements. Right now, we would be in the phase of saying, “Let’s understand if it’s pie-in-the-sky or if the technology is capable of satisfying these types of use cases. Regulatory reporting is a potential source of friction or a pain point so if there are ways to use these technologies to do it more efficiently and effectively, we would be interested in that. But you have to start with small proofs of concepts to be able to understand whether it can do what it’s purporting to do. We’re not in a place where we’re saying this is what we want it to do in terms of setting specifications but we would like to be able to better understand whether it can live up to its potential.
With regard to smart contracts, are there any concerns that a lot of the hash power is done out of China, particularly a handful of players controlling more than 51 percent of the system and it could be subject to a takeover? Is there any concern at CFTC that a foreign power or a consortium of companies that reside outside the United States might have the ability to [influence blockchain data]?
I’ll answer you a little bit more broadly. We put out our second primer [on Nov. 28, 2018] on the topic of smart contracts. We’ve issued two primers. The first one was on the topic of virtual currencies that we released in the fall of last year. This one is now specifically on the topic of smart contracts. Both of those deal with potential challenges and risks around the technology and we certainly mention the potential for things like 51 percent attacks. That’s important because one of things out there is that ledgers are immutable. Well, they’re intended to be immutable. Of course, if someone does gain control of the network, they could potentially manipulate a ledger and undermine the integrity of the ledger. That is one of the risks that exists around these technologies. The same thing goes with smart contracts. We go through a series of risks and challenges surrounding smart contracts in addition to talking about how they could be beneficial and how they could be used. But certainly, the risk of actors either tampering with oracles and the information that is supposed to feed into the smart contract is a potential risk, risks to the integrity of the underlying blockchains that smart contracts run on is a real risk. Hard fork—how do you handle that if you’re relying on smart contracts for important functions? These are all things that we definitely think about.
Just to back up for a second on these primers, they go back to part of why we’re here as well. When we meet with innovators and when we meet with a range of firms, we hear either common questions or themes or threads. Part of our goal is to try to engage in an ongoing dialogue with the marketplace. One of the ways we can do that is through publishing these primers where we seek to provide some education guideposts as to how we’re thinking about various topics. Primers are set up the same way where talk about what is the technology in the first section. The second part is why does it matter to the CFTC, how is it potentially relevant to our jurisdiction and our markets. And the third piece is around risks and challenges that folks should be aware of. We’re trying to get that information out to the marketplace as to how we’re thinking about either risks and challenges or potential applications.
Are there any other things where you say, ‘Hey, you know, these guys [companies that engage with LabCFC] are missing an important factor’?
It’s never specific to one group coming in to talk to us but it’s an attempt to aggregate what are the common questions and topics. If we can efficiently aggregate into a public educational document, we think that’s valuable and we should offer that out to anybody so you don’t have to come meet with us. We can hopefully we can get information out there that may make things a little bit easier for an innovator trying to navigate not just the CFTC but multiple regulators and jurisdictions. To the extent that we can make it easier for people to understand, we’ll do it. Hopefully, it is helpful for those that are working on a business model concept and want to get an idea of how the CFTC might think about it.
Is there a demand for something that you see as a regulator that perhaps the general market might not see or there might not be an initiative for whatever reason?
That gets the second prong of what we’re doing, the idea that when we identify promising technologies, can we help stimulate activity or incorporate activity. The way we go about what you’re describing is through innovation competitions that U.S. regulators under the Science Prize Competition Act can host competitions similar to what the FCA has done. Essentially, what you’re doing there is you’re going to the public and saying, “Here is a public policy challenge. Here’s something that we think innovation might be able to help solve.” And then you would put out a public statement and encourage participation and competition. What we’ve done earlier [in 2018] is we put out a request for public feedback. We asked the public what are the substantive areas that you think would lend themselves to a competition. We also identified some areas that we thought were promising. Things that we flagged are around data visualization, for example. We publish a lot of data through the CFTC but there may be more effective ways for us to either take those data sets and combine them with other public data sets and maybe offer with new data visualization tools that help people make sense of how our markets impact the real world. That’s one potential area.
You talk about things like robo-rulebooks or machine-readable rulebooks. Are there ways for you to tag rules and regulations so that reg-tech compliance software systems can flag activity internally at the firm and indicate that there maybe regulatory around the activities that you are engaging in? These are the types of things that you could help foster through competitions. Regulatory reporting is another area that we’ve expressed interest and received some interest from the public. And then more broadly, on machine learning, the idea of using some of these technologies to enhance surveillance capabilities is another area that’s fairly topical. We will ultimately execute on one of these competitions [in 2019], but I think it’s a great way to identify a challenge, think about how technology might be able to solve for it, and then get the public and get innovators to compete to come up with those solutions.
Are there any specific commodities or futures or instruments that lend themselves to blockchain technology more than others?
I’m including in the conversation permissioned systems that of course have some attributes of public blockchains but not all of them; I think about them on a sliding scale and a lot of these permissioned DLT systems incorporate elements of public blockchains. You talk about supply chain management, you think about trade finance, bringing efficiencies to commodity markets and spot trading—there’s a lot of potential benefit that can come from these DLT solutions. They’re interoperable, they’re standardizing data formats and fields, which is really what allows computers and the internet to do what people hope they can do, which is enhance efficiencies in various types of economic transactions. In the ag [agricultural] context there’s a lot of application. In the commodity markets, there can be application. And as you move to the capital markets and trading activity in terms of efficiencies in terms of trades and post-trade costs and fees, I think you can see benefit as well.
Any success stories where the CFTC guided a particular startup or established firm?
The types of questions we get are really diverse [but] it’s not the role of the regulator…. We’re not offering business guidance and we’re very clear that we don’t offer legal advice to firms so we’re not going to be in a place where we’re going to claim great victory for having done something that allowed a business to get to the next level because they had a conversation with the CFTC. What we are trying to do is help them save time and resources in understanding the regulatory landscape, providing feedback and guideposts to how our rules apply to activities, and in terms of the demands that we’ve received from firms that have come to meet with us, we get a pretty good sense of: Is this adding value? Is this something that people are seeking? Do they want to sit down and talk to a regulator? And I think that for many of them, being able to front-end as they’re developing business models or new concepts, to be able to talk to us is a pretty valuable thing.
Sometimes we’ve met with folks who come in and ask a question and we say, “We don’t regulate, for example, specific technologies. Just because you’re a DLT company that creates a new permissioned system to enhance efficiencies for a particular part of the market, that’s not something that will inherently trigger CFTC regulation.” But even those types of basic questions can be valuable to someone who is trying to understand where this is going to fit in the regulatory landscape. So I would say they’re small victories. I don’t want to overstate what we’re trying to be.
Is there anything you want our readers to come away with from this discussion?
It’s a two-way street in terms of the value proposition. Be aware that it can be helpful hopefully for folks who meet with us to really understand early in the development of their business models how a regulator like the CFTC might think about its space. But the flip side is true: they help us understand where markets are going, what are common themes and threads and trends. And we can use that information to internalize at the agency, which is very, very valuable because you want a regulator to actually understand the space that they’re regulating. It drives better policymaking. It sounds like a pretty basic concept but these are fast-changing, fast changing technologies so to the extent that you could help inform us, that’s valuable as well.