Here's Why the CFTC Fined Kraken $1.25 million

Cryptocurrency exchange Kraken has been slapped with a big fine.

The Commodity Futures Trading Commission (CFTC) has hit popular cryptocurrency exchange Kraken with a $1.25 million fine for letting U.S. customers access leveraged trading products.

The fine comes as lawmakers consider new controls on cryptocurrencies and authorities use existing legislation to crack down on platforms that might be acting outside the law.

What did Kraken do?

The reason Kraken is in hot water with the CFTC has to do with its crypto margin trading products, which it withdrew from the American market earlier this year. According to the CFTC, from June 2020 to July 2021, Kraken offered crypto margin trading to U.S. customers who were not eligible.

The CFTC’s Acting Director of Enforcement Vincent McGonagle said, "Margined, leveraged or financed digital asset trading offered to retail U.S. customers must occur on properly registered and regulated exchanges in accordance with all applicable laws and regulations."

In a statement, Kraken said it appreciated that the CFTC had acknowledged the exchange's cooperation and stressed Kraken's commitment to working alongside regulators: "We are committed to working with regulators to try to ensure the rules governing digital assets create a level playing field globally -- one that allows the crypto space in the U.S. to flourish, while protecting the interests of individuals and the integrity of the industry."

What is margin trading?

Margin trading is a type of derivative. It's an advanced product that lets traders use borrowed funds to leverage their positions. For example, in crypto margin trading, you might use $500 at a 3:1 leverage to take a $1,500 position in Bitcoin (BTC). If the price of Bitcoin went up, you'd multiply your profits. But if it fell, you'd also multiply your losses.

It's risky because the crypto market is both volatile and unpredictable. Research by Carnegie Mellon University CyLab showed that less experienced traders often suffered significant losses using derivatives trading.

Is crypto margin trading illegal in the U.S.?

Margin trading is strictly controlled. It isn't illegal per se, but exchanges need to register and get permission from the CFTC. However, it is one reason many crypto exchanges are unavailable in the U.S. Both Kraken and Coinbase Pro disabled their margin trading products earlier this year.

Kraken pointed out that the firm was committed to following regulatory guidelines, but there had not been clear guidance about these products. "This enforcement action comes in the absence of a clearly articulated path to offering margin spot products to retail investors," its press statement said.

Recently, another big crypto exchange, FTX, acquired LedgerX, a U.S.-licensed derivatives exchange. The company hopes that the move will pave the way for its American site -- FTX.US -- to offer crypto derivatives products. This may be one reason Kraken is pushing for a level playing field. It would give FTX a significant advantage if it can offer products that other exchanges cannot.

U.S. crypto regulation currently falls between several bodies, including the CFTC and the Securities and Exchange Commission (SEC). The new SEC Chair, Gary Gensler, has said he believes many cryptocurrencies are unregistered securities that should come under the SEC's purview. The CFTC argues that as commodities, cryptocurrencies fall under its jurisdiction.

Right now, the industry is braced for a new policy framework that's expected from the Treasury, which is likely to propose stricter cryptocurrency oversight. While increased regulation seems inevitable, it remains to be seen what shape those changes will take and how it will impact the burgeoning cryptocurrency industry. In the meantime, exchanges like Kraken are not alone in hoping for what it calls "reasonable regulation."