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Mango Storm a-Comin’

Avi Eisenberg, of Mango Markets incident fame, has been arrested and charged with “commodities fraud” and “commodities manipulation.” We previously wrote about this case suggesting that the exchange itself, Mango, was likely at more risk than Eisenberg if they wished to pursue him for the money.

Avi Eisenberg, of Mango Markets incident fame, has been arrested and charged with “commodities fraud” and “commodities manipulation.”

We previously wrote about this case suggesting that the exchange itself, Mango, was likely at more risk than Eisenberg if they wished to pursue him for the money. What has happened now is quite a bit different. Though the documents do also make plain that Mango Markets is likely committing the kinds of violations we discussed.

The US government is charging that Eisenberg was involved in manipulative and fraudulent commodities trades at least in part because they involved USDC. There is some reasonably-well-settled law that USDC, as a “virtual currency” is a “commodity” within the meaning of certain US laws prohibiting this sort of conduct.

This is kind of an odd one. But, as we are going to see, the legal argument appears strong. It is well established in the American legal system that prosecutors are supposed to consider which offenses to pursue and how aggressively based on a range of factors. This is perhaps best summed up in the famous Robert Jackson quote that “the citizen’s safety lies in the prosecutor who tempers zeal with human kindness…and who approaches his task with humility.” Given that person was both US Attorney General and Solicitor General, sat on the Supreme Court and was chief prosecutor at the Nuremberg Trials we can safely infer the sentiment is widespread in that community.

Related: Of Outlaws & Governance in a Decentralized System

So it means something they are deciding to prosecute this conduct in this way. You can have a conversation about the somewhat haphazard process that unfolded around the collapse of FTX and eventual arrest of SBF. But Mango Markets blew up over two months ago.

Virtual Currencies as Commodities

The government is charging crimes that clearly require some part of the underlying traded assets to be commodities. For this they rely on a 2018 CFTC settlement with Coin Drop Markets which resolves one question:

Virtual currencies can be regulated by CFTC as a commodity. Virtual currencies are “goods” exchanged in a market for a uniform quality and value…They fall well within the common definition of “commodity” as well as the CEA’s definition of “commodities” as “all other goods and articles…in which contracts for future delivery are presently or in the future dealt in.”

The judge does not sound particularly unsure on this one. Further, Coin Drop specifically challenged the CFTC on this point, got that ruling, and lost. It is of course possible to overturn precedent. But that ruling cites a laundry list of relevant documents including the CME’s opinion that these things are commodities. Eisenberg has a big fight ahead of himself if he wants to challenge that one.

Perps as Swaps

Now just because something is a commodity that does not mean someone is going to sue you for trading it. However, that same 2018 ruling tells us that:

CFTC does not have regulatory authority over simple quick cash or spot transactions that
do not involve fraud or manipulation.

So, aside from the fraud bit, the government needs to demonstrate we are not talking about “simple quick cash or spot transactions.” Well, the charging document does a pretty good job there as:

virtual currencies, such as USDC, are “commodities” under the Commodity Exchange Act…Accordingly, Perpetuals based on the relative value of MNGO and USDC are “swaps” under the CEA.

If we go ahead and trace down the definition of swap we get:

any agreement, contract, or transaction…that is a put, call, cap, floor, collar, or similar option of any kind … based on the value, of 1 or more… commodities… or other financial or economic interests or property of any kind;

Based on that definition it sounds the same as the description given on Wikipedia for financial derivatives:

In finance, a derivative is a contract that derives its value from the performance of an underlying entity.

So it looks like, legally, in the United States essentially any derivative contract is a swap. That feels ominous in quite a few ways. And we can now see how the prosecutors got here. These definitions and general rulemaking framework derive from the 1922 Grain Futures Act so there is a tremendous amount of precedent on precisely what the words mean. Challenges here look futile.

Eisenberg’s Defense

We already know what Eisenberg’s defense is going to be. He told us. We wrote about it. His argument is that the system worked precisely the way it was intended to. Again, commodities trading in the US has a long and rich history. In a 1982 CFTC case we find that for manipulation to have occured:

it must be proven that the accused acted ..with the purpose or conscious object of causing or effecting a price or price trend in the market that did not reflect the legitimate forces of supply and demand…Since proof of intent will most often be circumstantial in nature, manipulative intent must normally be shown inferentially from the conduct …once it is demonstrated that the alleged manipulator sought…to move the market away from the equilibrium…the mental element of manipulation may be inferred.

Eisenberg may have a chance here. Mango Markets made a big point of being, truly, mechanically controlled. As we wrote previously even their governance process is done in code and is mechanical.

The position that manipulation is impossible when all participants clearly state they want the system to behave precisely in the way the code is written is logically consistent. We will find out if the court, or a jury, buys that argument. But it does not sound crazy. It is also the only choice here.

Markets in General

The bigger overall issue looks to be that the US government is asserting that any derivative involving USDC (or presumably a different stablecoin) is a commodity swap and any manipulative conduct is prosecutable. Essentially all crypto trading is done against stablecoins. And all the big stablecoin issuers aside from USDT are based out of the US. So if you are onboarded with and trading Circle’s USDC or either Paxos stablecoin (USDP and BUSD), you are operating in the US.

It probably gets worse. Exchanges have long managed to avoid US regulatory problems for dealing with US residents by making efforts to block them. If a resident somehow gets through this process that seems to be ok-ish as long as your process was legitimate.

But prosecutors enforcing the Commodity Exchange Act are not bound by that largess. They may feel, to borrow justice Jackson’s words quoted above, that some people tempered their zeal a bit too much with human kindness and should have been a bit less humble. They may well decide to prosecute overseas exchanges that repeatedly offered commodity swaps to US folk, whether or not they made an attempt to stop it.

Let’s consider a completely different regulatory regime: illegal drugs. If you run an import/export business and find a mysterious bag of powder inside a shipment you are generally fine as long as you call the police immediately. But if it keeps happening, whether or not you are asking your supplier to “please confirm there are no drugs in this shipment” each time, you’re going to end up with a problem eventually.

It’s Criminal Prosecutors Here, Not Regulators

For those less familiar with the US system it is also worth noting that discussions with the CFTC, SEC and other regulatory agencies are different than those with prosecutors. Those agencies are fundamentally political operations that engage with industry, try to permit innovation, and generally talk about how they like maintaining an open dialog with major players. Their budgets are set by politicians and they are accountable to politicians via public hearings fairly often.

Not so federal prosecutors. These folks are generally not politicians and are not a big part of the political process in the US. They are not accountable to politicians except in the most basic of senses. Yes they are nominally under the control of the president. But firing them or telling them what to do absent a good reason tends to result in disaster for whoever gave that order. And New York’s Southern District (SDNY), which is the main area prosecuting markets crimes, has for decades been known as the “Sovereign District of New York” by politicians because of its’ fierce independence.

And for good reason. Surely everyone has watched some movie or series about the Mafia in New York. What many people do not realize is that organized crime was a serious problem there until the 1980s when then SDNY-head Rudy Giuliani vigorously pursued organized crime leaders and ultimately cleaned up the problem.

This was dangerous. Not “in theory” dangerous: the Mafia considered killing Giuliani, informants told the FBI, and he prosecuted them anyway. Say what you will of all of those photos of SBF posing with regulators who are now pursuing him. But you are not going to find pictures of a crypto exchange boss smiling and shaking hands with a US Attorney. And the threat of “stifling innovation” is not going to dissuade them.

Be Careful What You Wish For

One possible outcome here is that essentially all of crypto falls under the jurisdiction of criminal prosecutors in the US that have a longstanding reputation for being indifferent to the political winds. And this outcome came about at least in part because of a massive effort to muzzle the more traditional markets regulators through the political process. SBF’s massive political donations are probably the best known part of that effort.

The lesson here is that the industry should have taken a more rational approach to regulation — like, you know, accepting roughly the same limits as the rest of finance — rather than pushing for perpetual exemptions. And now is the time to start registering, apologizing, and regularizing as much as possible. Because the alternative looks like a world where nearly every entity lives and dies at the discretion of a small number of famously good prosecutors that do not care one bit about anything beyond enforcing the law as written.