CFTC Announcement RE: Abra Provides Significant Cause for Concern


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CFTC Announcement RE: Abra Provides Significant Cause for Concern

Just a few days ago from the time of writing, the CFTC published a public press release on its site, demanding that Abra cease and desist its operations immediately.

"Washington, D.C. — The Commodity Futures Trading Commission today issued an order filing and settling charges against respondents Plutus Financial, Inc. d/b/a Abra of California, and Plutus Technologies Philippines Corp. d/b/a Abra International of the Philippines for entering into illegal off-exchange swaps in digital assets and foreign currency with U.S. and overseas customers and registration violations. This case was brought in connection with the Division of Enforcement’s Digital Asset Task Force."

(source: https://www.cftc.gov/PressRoom/PressReleases/8201-20)

Penalties Assessed

According to the press release, the CFTC mandates that Abra:

  • Pay $150,000 in civil monetary penalty
  • Cease and Desist from committing further violations of the Commodity Exchange Act

This was done in conjunction with the SEC as part of a 'parallel enforcement action'.

Reason For Concern

The entire space has been in a craze over 'Decentralized Finance' for the past couple of months or so, resulting in a significant inflow of capital into related projects.

Where Things Could Get Sticky For the Blockchain Space

As we'll see in this brief overview, the CFTC's primary qualm with Abra was essentially their propagation of the exact same schemes that these DeFi projects are running.

If Abra is Targeted, Then What Makes Anyone Else Safe?

Although some may argue that Abra is a fundamentally different entity than other blockchain projects like Synthetix / Compound / etc., its worth noting that the CFTC got involved with this (versus just the SEC).

What's the Big Deal About the CFTC Being Involved?

Contrary to the SEC, the CFTC works in tandem with the Department of Justice to leverage criminal charges against certain entities whose behavior they deem egregious enough to warrant such.

Evidenced Below:

(source: https://www.wsj.com/articles/cftc-relying-more-heavily-on-coordination-with-criminal-prosecutors-11575027001)

Going Back to the Press Release (Briefly) Before Dipping Into the Actual 'Order'

One statement from the CFTC press release that deserves a lot of attention is the following:

"In soliciting and accepting orders for these contracts [swaps], the respondents illegally operated as an unregisterd futures commission merchant."

Will Current 'DeFi' Projects Fit Under This Definition?

The obvious counter argument here is that all of the transactions are executed via smart contract, thus, no one can be held at fault.

Au Contraire

In a series of orders (in 2019 / 2020) and decisions, the SEC made its stance clear on digital assets, essentially stating that:

A) They did not consider smart contracts to be autonomously functioning projects where no one can be held accountable for how users interact with them

B) They did view projects such as Bitcoin / Ethereum (among other blockchain projects) that leverage Proof of Work (versus 'Proof of Stake' or another blockchain itself), to be 'unpunishable', in essence.

References Evidencing This Interpretation Below:

  1. Director Hinman affirming Ethereum is not considered a security = https://www.sec.gov/news/speech/speech-hinman-061418
"Based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions."

2. SEC Chariman (Jay Clayton) confirms Hinman's statements, saying Ethereum is not considered a security = https://coincenter.org/link/sec-chairman-clayton-just-confirmed-commission-staff-analysis-that-ethereum-and-cryptos-like-it-are-not-securities

Accompanying Order

To be clear, what we have reviewed up to this point is only the public press release by the CFTC.

Now, we're going to take a closer look at the Order (demanding $150k payment + cease and desist of all operations by Abra / Plutus Financial).

Here's a Link to the Order: https://media.librehash.com/TEVO2/CUvUXOhI76.pdf

Starting Off With Some Quick Screenshots That Give Us a More Comprehensive Overview of the Order

Major Points of Interest

The timeline of events is something we should definitely play close attention to her.e

Specifically, it states that:

"Initially, Abra only offered contracts allowing customers to gain exposure to price movements of certain foreign currencies, including the Euro and the Mexican peso."
"Abra offered these contracts to retail customers beginning in or about December 2017."
"On or about March 15, 2018, Abra expanded its product offerings and began offering contracts allowing customers to gain exposure to price movements of certain virtual currencies
"In February 2019, Abra again expanded its offerings and began offering contracts allowing customers to gain exposure to price movements of certain U.S. stocks and ETF shares."

The Order then goes on to state that Abra was initially contacted by the SEC (and the CFTC) in early 2019.

Doing Some Quick Math

Based on the statements that we extracted above, it seems that the CFTC + SEC began speaking with Abra right around the time that theyhad "expanded its offerings and began offering contracts allowing customers to gain exposure to price movements of certain U.S. stocks and ETF shares."

Interpretation of This Information

Given the fact that the CFTC + SEC were aware of Abra's actions dating back to 2017, yet did not step in to demand that the activity stop until 2019 (essentially simultaneuosly with Abra's 'expansion'), it is possible that Abra's actions, while in breach of regulations, may not have been seen as egregious enough to grant them any priority on the SEC / CFTC's enforcement schedule.

However, it appears that once Abra started accelerating the rate at which it was introducing new derivative / synthetic options for users of their platform to trade with (specifically synthetic derivatives of the stock market itself), they inadvertently put themselves squarely within the 'scope' of both enforcement agencies.

Abra's Response to the Original 'Cease and Desist' Order by the CFTC + SEC Gives Us a Major Clue as to What Was Negotiated

While this cease and desist order (and subsequent fine) from both the CFTC + SEC are extremly public, the initial contact by the CFTC and SEC were not.

So we don't know exactly what was said / requested by the SEC (apart from what their press releases and respective court orders state).

Normally this would force us to remain in the limbo of speculation but...that may not be the case here.

Specifically, the Order States:

"After being contacted by the Commission and the Securities and Exchange Commission in early 2019 and coperating with their investigations, Abra voluntarily ceased offering its virtual currency and foreignc urrency-based swaps to U.S. customers and **undertook measures to ensure that these swaps were only offered to non-US customers through Plutus Tech."

Unpacking Abra's Response

It appears that after being contacted by the regulatory agencies, there was some implicit agreement between said regulatory bodies and 'Abra' that Abra would:

A) Refrain from offering certain products (period)

and

B) Abra would take necessary measures to ensure that it avoided soliciting U.S. citizens to participate in Abra's quasi-derivatives markets.

Why We're Focusing on This

The excerpt that we analyzed above re: Abra's response to the original investigation by the CFTC & SEC makes it implicitly clear that Abra's offering of virtual currencies was encompassed at least some of the activity that the CFTC + SEC took issue with (if this weren't the case, then Abra wouldn't have ceased these activities for the sole sake of appeasing these agencies).

If we look back at the beginning of the Order by the CFTC, we can see that they make explicit mention of the 'smart contract' quasi-derivative scheme Abra employed.

Missed it? Don't worry, we'll re-post the specific quote from the Order below for your edification (please note that this excerpt is rather lengthy!)

"Abra's product offerings evolved over time, but the basic structure of the financial transactions and contracts remained the same. First, customers would set up an Abra wallet and then fund their wallet via bank transfer, credit card, or virtual currency deposit. Abra would then convert those customer funds to Bitcoin, which were accounted for on the Bitcoin blockchain. When a customer decided to gain price exposure to one of the available assets (referred to as reference assets), the customer selected the reference asset, posted collateral (in Bitcoin) equal to the amount of exposure they wanted, and entered into a Bitcoin blockchain-settled 'smart contract' with Abra as the counterparty."

"But Bitcoin Doesn't Use Smart Contracts!

Not in a 'conventional' sense, yes (and we're pretty sure that the CFTC was not being nuanced and referring to the op_code, quasi-smart contracting system that Bitcoin uses)

So what did the CFTC mean here?

Possible Indictment of the Use of "WBTC"

Known as "Wrapped BTC", $WBTC is supposed to be a synthetic derivative for Bitcoin itself.

Trustnodes explained it best here, stating:

"The idea of a Wrapped BTC (WBTC) however is pretty much the same as that of a stable coin like USDT."
"You hand over your bitcoin to a custodian, and you receive an ERC20 token, WBTC, corresponding 1:1. At any time you can return this token and get bitcoin, with additional transparency here because there’s a blockchain auditable on both ends."

Hang on, let's rewind a sec.

Doesn't that sound exactly like what the CFTC described in their 'Order'?

We won't repost the entire paragraph again, but here's the bullet point version:

A) Customers deposit Bitcoin

B) Customers then used their credits (from their deposited Bitcoin) to gain exposure to a 'reference asset'

Quick Breakdown of a 'Reference Asset':

"A reference asset is an underlying asset used in credit derivatives to protect a debt holder against a potentially risky borrower. A reference asset is also known as a reference entity, a reference obligation or a covered obligation. A reference asset can be an asset such as a bond, note or other debt-backed security.Apr 11, 2018" (source: https://www.investopedia.com/terms/r/reference_asset.asp)

In laymen's terms, a 'reference asset' is essentially a synthetic derivative. Pure and simple.

To be clear, it is not an actual asset, but rather a promissory / debt note that can, itself, be redeemed for the the asset it was borrowed against.

(Sound confusing? Just know that this is a major confirmation of our theory that the CFTC is referring to WBTC [Wrapped Bitcoin] here).

Back to Where We Left Off

C) The CFTC specifically notes that this process was facilitated by a smart contract (WBTC is a smart contract by virtue of it being a token on the Etheruem blockchain)
D) "At the end of the contract term, settlement occurred on the Bitcoin blockchain. If the market price for the reference asset had increased, then the customer would receive the collateral plus a payment (in Bitcoin) equivalent to the increase. If the market has fallen, then the customer's collateral would be reduced by the equivalent amount."

What Would Be the Purpose of Such a Scheme?

This scheme essentially would allow users to seamlessly gain access to the Ethereum blockchain directly via Bitcoin - thus creating a quasi-DEC setup that has now expanded to allow for the inclusion of Bitcoin (before this concept was introduced, all 'DEX' platforms were limited to only transacting with tokens that belonged to the same native blockchain, exclusively).

Seeing if We Can Put Together the Dots (and the evidence)

Further research here into the activities of Abra shows that we were both right and wrong (you'll see).

Evidence All Here in This Announcement By Abra From 2018 (https://www.abra.com/blog/decentralized-investment-platform/):

The press release is surprisingly (and in hindsight, stupidly) bold.

Especially in its proclamation:

"How was Abra able to achieve something that no other company int he crypto space able to achieve? The answer lies in our new smart contract-based investment platform."

What We Actually Need to Focus On

That statement above is irrelevant.

What isn't though is the following from Abra's press release:

"Abra has developed a unique multi-sig smart contract-based investment platform that allows us to create synthetic digital assets (e.g. stablecoins) based on Litecoin or Bitcoin. Abra has been using stablecoins in USD, EUR, JPY, KRW, etc. and our platform has already seen hundreds of millions of dollars worth of transactions using the same technology. We are now extending this technology to create synthetic digital assets that include other cryptocurrencies. In other words, Abra gives you investment exposure to cryptocurrencies or fiat currencies without actually holding the physical currency."

Just As We Thought

It appears that Abra's decision to expand by introducing synthetic derivatives of cryptocurrencies (versus just fiat currencies), as a means of gaining access to alternative derivative markets is what accelerated their demise in this situation.

One Major Difference: Contract Structure

Remember earlier in this report where we remarked that its highly unlikely that the CFTC was being nuanced in characterizing Bitcoin's op_code (SCRIPT language) as a smart contract? The language / op_codes, while limited in comparison to Ethereum - do still meet ht definition of a 'smart contract' (conditional code execution [transaction] based on the fulfillment of conditions to spend a given transaction by a successful participant via PKI).

This Idea is Corroborated by the Fact That Abra Essentially Outlined Their Setup in the Exact Same Manner as What CFTC Described in Their Order

"These multi-sig contracts based on P2SH scripts on the Litecoin and Bitcoin blockchains simulate investment contracts the way a gold ETF is a contract based on USD. In the case of a gold contract, if the value of gold goes up, the user gets more USD, and if the value of gold goes down, the user loses USD."

Conclusion

We're going to leave this research right here and opt to use a follow up piece to provide greater

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