May 1, 2023

Good morning and happy May. Despite some recent regulatory headwinds, passion and innovation in the crypto and Web3 space were alive and well in Austin last week. Today, we look at two Congressional hearings and a new bipartisan bill.

Top Points

• House Agriculture and House Financial Services Subcommittees held hearings focused on identifying regulatory gaps for digital assets. At a high-level, Members and witnesses primarily keyed in on the need to:

  • Authorize the Commodity Futures Trading Commission to oversee digital asset spot markets (not just futures)

  • Clarify definitions for digital asset securities and digital commodities.

• Senators Ted Budd (R-NC) and Kirsten Gillibrand (D-NY), and Reps. Zachary Nunn (R-IA) and Jim Himes (D-CT), introduced the Financial Technology Protection Act of 2023 - a bill to establish a working group to study and report to Congress on how new financial technologies, including digital assets, may be used for illicit uses and how to mitigate related risks.

House Agriculture ("Ag") and Financial Services ("HFSC") Subcommittees Hold Hearings on Identifying Regulatory Gaps for Digital Asset Spot Markets

On Thursday, the House Ag and HFSC subcommittees with jurisdiction over digital assets held concurrent hearings on identifying the regulatory gaps in digital asset spot markets.

Key Takeaways: At a high-level, both hearings evidenced bipartisan agreement that Congress will need to act to provide greater regulatory clarity and consumer protections. The challenge, as always, will be filling in the details.

The House Ag hearing keyed in on authorizing the CFTC to proactively oversee digital commodity spot markets and bolstering consumer education via disclosures, while HFSC focused more on defining which tokens are securities versus commodities and registration requirements for crypto intermediaries, though there was significant overlap in substance.

The HFSC subcommittee hearing was notably more partisan as Ranking Member Maxine Waters (D-CA) and Subcommittee Ranking Member Stephen Lynch (D-MA) disagreed with the hearing's premise that there are any significant regulatory gaps. Instead, they echoed SEC Chair Gensler's position that virtually all of crypto is subject to existing securities laws and that regulatory compliance, not clarity, is the problem.

So Where Are the Gaps?

Spot Market Regulation

The Securities Act of 1933 and Securities Exchange Act of 1934 authorize the SEC to oversee and regulate the offer and sale of securities as well as the intermediaries involved in facilitating the transfer of securities, including exchanges, brokers, and clearing agencies.

The Commodity Exchange Act ("CEA") authorizes the Commodity Futures Trading Commission to oversee and regulate the commodity futures markets.

The CEA also grants the CFTC broad enforcement authority which allows the agency to go after fraud and market manipulation in the commodities spot markets (on the basis that such activities may influence the futures markets). However, enforcement actions are brought after the bad acts have already occurred and the damage is done.

Thus, many Members and witnesses keyed in on the need to provide the CFTC clear authority to proactively oversee and regulate the crypto spot market. For example, Congress could direct the CFTC to require exchanges to comply with certain core principles, such as proactively monitoring for fraud and market manipulation, disclosing risks, eliminating conflicts of interest, and prohibiting commingling of customer and company funds. Members appeared particularly keen on filling in this regulatory gap because of the the large number of retail participants in the crypto spot market who would benefit from greater regulatory oversight.

Last Congress, the Digital Commodity Exchange Act (§ 2), the Digital Commodities and Consumer Protection Act (§ 3), and Lummis-Gillibrand (§ 403), all included language authorizing the CFTC to oversee the digital commodities spot market. All three bills were bipartisan.

Security v. Commodity

Even if the CFTC were given exclusive jurisdiction over the digital commodity spot market, an important question remains: what's a digital commodity?

Thus, not surprisingly, perhaps the most recurring issue debated at the hearings (and in crypto policy discussions generally) is which crypto assets are commodities or securities. With a few Democrat exceptions, the majority of policymakers and witnesses who weighed in on this issue believed Congress needs to provide greater definitional clarity.

Notably, Subcommittee Chairman French Hill (R-AR) and Rep. John Rose (R-TN) each posited that Congress may need to establish a new, third category of classification for collectible tokens like NFTs that are neither securities nor commodities.

So what if crypto assets are securities?

If crypto tokens are considered securities, they must be registered with the SEC and companies issuing those tokens must comply with corresponding reporting requirements. Further, those involved in the transfer of such securities (e.g., exchanges) may need to register with the SEC and comply with corresponding regulations.

Zachary Zweihorn of Davis Polk provided an illustrative example of how existing securities based registration requirements might prove incompatible with certain blockchain based assets, using Filecoin as an example:

• If Filecoin were a security..."Then everybody that touches Filecoin would need to be a regulated intermediary...so if you were to buy Filecoin because you want to use it, you want to store files, you could only buy it through a registered broker-dealer. The system through which it gets transferred to you would need to be a registered exchange to actually find the buyer and seller and a clearing agency in order to actually send it to you. And those basically make it impossible to use for its intended purpose because you are not going to have all the entities involved in facilitating the storage of data be SEC regulated for financial service activities."

• See full exchange with Rep. Byron Donalds (R-FL) starting at 1:47:24 here.

• (To be clear, both Zweihorn and Rep. Donalds opined that they did not believe Filecoin is actually a security.)

Members at each hearing also questioned witnesses on the differences between traditional securities and crypto assets—highlighting, for example, that unlike traditional securities, like stocks, which generally provide a right or claim to a centralized company, many blockchain based tokens may not carry such rights. Further, projects issuing tokens may become increasingly decentralized and less connected to such tokens over time, potentially resulting in their tokens' status as a security or commodity to morph over time.

Accordingly, a key challenge in drafting legislation will be ensuring the regulations are, in the closing words of Subcommittee Chairman French Hill, "fit for purpose."

So What?

While the hearings demonstrated there is bipartisan support at a high-level for crafting legislation authorizing the CFTC to oversee the crypto spot market and providing clear definitions, the next step will be drafting specific legislative provisions that can garner bipartisan support. To this end, Chairman McHenry announced the subcommittees will host a joint hearing later this month focused on addressing the gaps identified last week.

At Consensus, Chairman McHenry and Senator Cynthia Lummis emphasized their commitment to working on a bipartisan, bicameral basis to pass clear rules for digital assets. And as prospects for stablecoins legislation took a hit in recent weeks due to key Democrats announcing they will "start from scratch," perhaps a market structure bill addressing the issues outlined above will be the new area of focus.

Notably, if a market structure bill was narrowly crafted to stay within the confines of the House and Senate Ag Committees, it would be able to avoid the Senate Banking Committee with its crypto-skeptic Chairman Sherrod Brown (D-OH) (though note Brown also sits on Senate Ag). Further, the Ag committees must pass a farm bill this year (current farm bill expires 9/30)—offering a must-pass vehicle to which a targeted, bipartisan bill could potentially attach.

Senators Introduce the Bipartisan Financial Technology Protection Act of 2023

On Thursday, Senators Ted Budd (R-NC) and Kirsten Gillibrand (D-NY) introduced the Financial Technology Protection Act of 2023.

Reps. Zachary Nunn (R-IA) and Jim Himes (D-CT) introduced companion legislation (i.e., an identical version) in the House.

The bill would create a "Working Group" to study how new financial technologies, including digital assets, may be used for illicit purposes such as financing terrorism or evading sanctions, and to develop a strategy on how to mitigate such risks. See §§ 2-3.

Additionally, the bill tasks the Working Group with developing legislative and regulatory proposals to combat anti-money laundering and illicit financing efforts in the U.S. See § 2(b).

The Working Group would include representatives from federal agencies, including (among others) Treasury, State, the CIA, and five individuals to represent FinTech companies, blockchain intelligence companies, financial institutions, or research organizations. See § 2(a).

Here's the bill's full text.

Look Ahead

• Chairman Patrick McHenry (R-NC) announced HFSC and House Ag subcommittees will host a joint hearing later this month on addressing the regulatory gaps identified last week.

  • ​Press Release

• Senator Cynthia Lummis (R-WY) and Senator Kirsten Gillibrand (D-NY) are expected to introduce their revised Responsible Financial Innovation Act in the coming weeks.

  • According to Senator Lummis at Consensus, the bill is expected to include bolstered consumer protection and cybersecurity provisions.

Quick Hits

• HFSC Chairman Patrick McHenry (R-NC), Bill Huizenga (R-MI), and French Hill (R-AR) sent a letter to the heads of the FDIC, OCC, and Federal Reserve, demanding information from the agencies regarding a potential coordinated effort by the agencies to deny banking services to crypto-related businesses and the ecosystem as a whole (i.e. "Operation Chokepoint 2.0").

  • ​Press Release & Letters to Agency Heads​

• Senators Elizabeth Warren (D-MA) and Roger Marshall (R-KS) Delay Reintroducing Crypto Bill Due to Lack of Sponsors

  • ​Article (Casey Wagner; Blockworks)

• CoinCenter Submits Comments to SEC on Amendments Regarding the Definition of ‘Exchange’ and Alternative Trading Systems

  • ​Comments​

• Hamas Armed Wing Announces Suspension of Bitcoin Fundraising

  • ​Article (Nidal Al-Mughrabi; Reuters)

  • "[D]evelopments in technology that track the movement of crypto on the blockchain ledger have made it easier for authorities to identify those behind crypto transfers. Many major crypto exchanges now also run ID checks on clients."

  • "Hamas had endorsed crypto as a fundraising method for years, previously developing sophisticated tactics to solicit bitcoin donations."

Use Case of the Week

DOVU focuses on building a greener future by tokenizing carbon offsets and making them fully auditable by using distributed ledger technology.

Read more on DOVU's website here.

Trivia

Last Week:

• Q: In 2014, which NBA sports franchise became the first pro basketball team in the U.S. to accept Bitcoin as payment?

• A: Sacramento Kings.

This Week's Q: Last year, the Mayor of this Texas city proposed two initiatives directing the City Manager to (1) ensure the city maintains a blockchain and Web3 friendly environment and (2) study how the city could accept Bitcoin or other cryptocurrencies as payment for municipal taxes, fees, and penalties. What's the city? Bonus: What was the Mayor's name?

Thank you for reading and see you on Friday when we resume our regularly scheduled Friday morning delivery.

Sincerely,
GSL