CAP HILL CRYPTO

Week of April 29, 2022

Good morning, and thank you for subscribing. This week's newsletter is dedicated to those of us whose invites to Crypto Bahamas got lost in the mail.

Top Points

  • Rep. Glenn Thompson (R-PA) introduces the "Digital Commodity Exchange Act"—a bipartisan, comprehensive crypto package authorizing the CFTC to oversee digital commodities, digital commodities exchanges, and a new regulatory regime for stablecoins.

  • Rep. Patrick McHenry (R-NC)—a crypto advocate with a record of garnering bipartisan support for crypto legislation—announced he will likely keep his position as the top Republican on House Financial Services Committee, rather than run for House Whip, if the Republicans take back the House of Representatives in November.

    • Thus, if Republicans take back the House, Rep. McHenry would become Chairman of House Financial Services.

Digital Commodity Exchange Act Summary

  • On Thursday, Rep. Glenn Thompson, Ranking Member on the House Agriculture Committee, unveiled the Digital Commodity Exchange Act ("DCEA") along with Reps. Ro Khanna (D-CA), Tom Emmer (R-MN), and Darren Soto (D-FL).

  • The bipartisan DCEA builds on the Commodity Exchange Act, which has historically regulated the commodity derivatives markets.

  • Importantly, the bill provides clear definitions for digital commodities and digital commodity exchanges.

  • Specifically:

    • "Digital Commodity" is defined as: "any form of fungible intangible personal property that can be exclusively possessed and transferred person to person without necessary reliance on an intermediary."

    • "Digital Commodities Exchanges" or "DCEs" are defined as: "a trading facility that lists for trading at least one digital commodity."

  • The DCEA also excludes securities from the definition of digital commodities, thereby ensuring the SEC maintains jurisdiction over digital assets that are securities.

Regulation and Registration of DCEs

  • The DCEA authorizes the CFTC to register and regulate DCEs.

  • Under the DCEA, a registered DCE may generally offer a digital commodity so long as it is "not readily susceptible to manipulation."

  • Further, DCEs are prohibited from permitting trading of a digital commodity if:

    • (1) it is reasonably likely that any person or group of people acting collectively can fraudulently alter the digital commodity's transaction history; or

    • (2) it is reasonably likely that any person or group of people under common control can materially alter the digital commodity's functionality or operation.

  • Moreover, the DCEA requires registered DCEs to monitor trading activity, prohibit abusive trading practices, establish minimum capital requirements, avoid conflicts of interest, establish governance standards, and adopt security measures.

  • But Note:

    • The DCEA only requires Digital Commodity Exchanges to register with the CFTC if they want to offer leveraged trading or offer digital commodities distributed to the public before going public.

    • If the DCE does not offer such services, they are not required to register with the CFTC, but may continue to be subject to state based regulatory regimes.

Why does the DCEA matter?

  • By providing statutory definitions, the DCEA establishes a clear framework for determining whether a crypto will be subject to CFTC or SEC oversight.

    • According to Rep. Darren Soto's statement on the bill, "[i]nnovators are spending up to fifty percent of start-up costs on legal fees because of the current regulatory ambiguity between what is a security and what is a commodity[.]"

  • Further, the DCEA provides DCEs statutory guidance for determining when it is permissible to list a digital commodity on its exchange.

  • And crypto investors and traders would know that cryptos offered on a registered exchange have been subjected to the consumer protection provisions applying to those exchanges (e.g. anti-market manipulation protections).

  • The bill has bipartisan support out of the gate and is sponsored by the leading Republican on the House Agriculture Committee--both good signs for its prospects of gaining traction.

  • Senator Lummis and Senator Gillibrand are expected to unveil their own comprehensive bipartisan crypto legislation in the coming weeks. We will keep a close eye on the extent to which that proposal mirrors or conflicts with the DCEA.

Stablecoin Regulation Provisions

  • At a high level, the DCEA offers a regulatory regime whereby stablecoin issuers may register with the CFTC and provide public disclosures regarding the nature and extent to which assets back up the stablecoin, as well as their redemption policies.

  • Importantly, the DCEA permits—but does not require—stablecoin operators to register with the CFTC as "fixed-value digital commodity operators" or "FVDCOs."

    • FVDCO is defined, in relevant part, as any person "engaged in a business that solicits, accepts, or receives funds, property, or other assets from others for the purpose of issuing units of a fixed-value digital commodity [i.e. stablecoins]."

  • Stablecoins issued by FVDCOs are referred to as "fixed-value digital commodities" or "FVDCs."

    • A FVDC is defined as "a digital commodity which is redeemable for a fixed amount of fiat currency or another commodity, or the value thereof."

  • The DCEA incentivizes stablecoin providers to register with the CFTC by simplifying the pathway for their FVDCs to be listed and traded on registered Digital Commodity Exchanges.

    • Specifically, FVDCs issued by FVDCOs would be deemed "not readily susceptible to manipulation."

  • Fixed-Value Digital Commodity Operators would be subject to public disclosure and capital holding requirements.

  • Specifically, the DCEA requires the FVDCO to disclose:

    • their redemption processes

    • information about the risks associated with their FDVC

    • the total value of the outstanding units of the FVDC

    • the total value of funds and other property held by the operator for redemption

    • any conflicts of interest the FVDCO might have.

  • Further, the DCEA requires FVDCOs to maintain daily records of redemptions, and maintain books and records to be made available to the CFTC upon request.

  • As for capital requirements, the DCEA provides the CFTC discretion to set the specific requirements.

Comparison to Existing Stablecoin Bills

Like other stablecoin bills proposed this Congress (Stablecoin Transparency Act, Stablecoin TRUST Act of 2022), the DCEA provisions are aimed at increasing transparency around the assets backing stablecoins and the redemption processes of their providers.

Notably, whereas Sen. Toomey's Stablecoin TRUST Act of 2022 authorizes the Office of the Comptroller of the Currency ("OCC") to oversee federally registered stablecoin issuers, the DCEA gives that authority to the CFTC. Not surprisingly, the House Agriculture Committee, on which Rep. Thompson is the Ranking Member, has jurisdiction over the CFTC, and the Senate Banking Committee, on which Sen. Toomey is the Ranking Member, has jurisdiction over the OCC. It will be interesting to see how the jurisdictional battle shakes out should any stablecoin package gain traction this year.

Rep. Patrick McHenry as Chairman of Financial Services

  • On Monday, Rep. Patrick McHenry announced in a Punchbowl news interview that he will not seek a leadership position should the Republicans take back the House following this year's mid-term election.

  • Thus, assuming Republicans control the House in the 118th Congress, Rep. McHenry will likely become Chairman of the House Committee on Financial Services.

    • He is currently the Ranking Member and Rep. Maxine Waters (D-CA) is the current Chair.

Why It Matters:

  • Rep. McHenry has a history of engaging on important crypto issues and leading bipartisan pushes.

  • Most notably, following passage of last year's Infrastructure Investment and Jobs Act (the "Infrastructure Act"), Rep. McHenry, along with Rep. Tim Ryan (D-OH), introduced the "Keep Innovation In America Act," to clarify confusion stemming from the Infrastructure Act's vague definition of "broker" and newly created tax reporting requirements.

  • Specifically, the Keep Innovation in America Act:

    • Redefines "broker" so that only brokers hired to perform trades would be subject to the Infrastructure Act's new reporting requirements.

    • Clarifies that miners, delegators, validators, and developers would not be subject to the reporting requirements. See § 2, § 5.

    • Limits reporting requirements under the Infrastructure Act to information that is voluntarily supplied by customers to the broker. See §3(b).

    • Defines digital assets as: "any digital representation of value which is recorded on a cryptographically secured distributed ledger." § 3(a)(D).

    • Requires the IRS to study and report to Congress on the impact of imposing reporting requirements on digital assets transactions exceeding $10,000. See § 4; See also 26 U.S.C. 6050I.

    • Cosponsors include: Kevin Brady (R-TX), Ro Khanna (D-CA), Tom Emmer (R-MN), Eric Swalwell (D-CA), Warren Davidson (R-OH), Darren Soto (D-FL), Anthony Gonzalez (R-OH), Ted Budd (R-NC), Mike Bost (R-IL), David Schweikert (R-AZ), Byron Donalds (R-FL), Jake Auchincloss (D-MA), French Hill (R-AR), William Timmons (R-SC), Bryan Steil (R-WI), Gregory Murphy (R-NC), and Jackie Walorski (R-IN).

  • Rep. McHenry also introduced the "Eliminate Barriers to Innovation Act" along with Stephen Lynch (D-MA), which passed the House on April 20, 2021. It is currently awaiting action in the Senate Banking Committee.

  • The bill would:

    • Establish an SEC and CFTC working group to study and report on the regulation of digital assets.

      • The working group would consist of SEC and CFTC staff, as well private sector representatives from fintech companies, academic or advocacy institutions, investor protection organizations, and organizations that support investment in historically-underserved businesses. See § 2(b).

    • Require the working group to make recommendations for:

      • (i) improving fairness and efficiency in digital asset markets

      • (ii) creating standards concerning custody and cybersecurity relating to digital assets

      • (iii) best practices for reducing fraud and market manipulation, improving investor protections, and assisting in compliance with anti-money laundering and know your customer banking regulations. See § 2(c).

    • Cosponsors include: Glenn Thompson (R-PA), Ted Budd (R-NC), and Warren Davidson (R-OH).

  • Finally, Rep. McHenry remarked earlier this week that perhaps digital assets should be subject to their own regulator, rather than divided between the SEC and CFTC as securities or commodities. As discussed above, this is in direct tension with the DCEA's proposed framework.

Look Ahead

Though a few weeks away, mark your calendars for May 17 and May 25. House Agriculture Committee will host a hearing on May 17 to analyze FTX's proposal to offer derivatives directly to customers—rather than through the traditional route of using intermediaries. The May 17 hearing is expected to include witnesses from the Chicago Mercantile Exchange and the Intercontinental Exchange—the very intermediaries FTX proposes to cut out.

On May 25th, the CFTC will host a staff roundtable to discuss issues related to intermediation in derivatives trading and clearing.

Worth the Read

Trivia

Last Week's A: Joseph P. Kennedy, Sr.

This week, I've replaced a trivia question with, what else—a cryptogram. Each letter below corresponds to another single letter in the alphabet. Hint: L= O. First person to crack the code and message me the translation gets a s/o in next week's newsletter.

HZGLHSR MZPZNLGL

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Thank you for reading, and please enjoy your weekend.

Sincerely,

GSL