U.S. Senate And House Of Representatives Introduce Competing Crypto Regulation Bills – Fin Tech

On July 12, 2023, U.S. Senators Cynthia Lummis (R-WY) and
Kirsten Gillibrand (D-N.Y.) proposed a revised version of their previously introduced crypto regulation bill
to create better safeguards for the crypto industry generally while
adding new, stronger consumer protection provisions and AML
provisions. The Lummis-Gillibrand bill, also known as the
Responsible Financial Innovation Act (“RFIA”), identifies
the need for enhanced regulation of digital assets. The proposal
addresses this need, in part, by creating clearly defined
regulatory roles for the Securities and Exchange Commission
(“SEC”) and the Commodity Futures Trading Commission
(“CFTC”), which are two of the leading regulatory bodies
currently engaged in regulating the U.S. crypto market, as well as
creating a new Customer Protection and Market Integrity Authority
self-regulatory organization. The need for greater clarity in the
roles of the CFTC and the SEC and with respect to cryptocurrency
regulations generally is certainly timely, given the recent CFTC
actions against Blockratize, bZeroX (and its successor Ooki DAO), and others and recent high-profile SEC actions against major
crypto exchanges.

The revised RFIA draws a clearer distinction between digital
assets that are considered “securities,” which are
regulated by the SEC, and “commodities,” which fall under
the regulatory authority of the CFTC. The proposal affirms that
assets that do not represent debt or equity or that otherwise do
not give an investor a financial interest in a business are not
considered securities even if they “benefit from entrepreneurial and managerial
efforts that determine the value of the assets.” As most
digital assets, including Bitcoin and Ethereum, which comprise more
than half of digital asset market capitalization, would be considered commodities under this
distinction (according to the bill’s sponsors), the proposal,
in turn, grants primary regulatory authority of the digital asset
space to the CFTC. Under the RFIA, the CFTC would only exercise
jurisdiction over “an agreement, contract, or transaction
involving a contract of sale of a crypto asset that is commercially
fungible, which shall not include digital collectibles and other
unique crypto assets,” a definition which would seem to
exclude transactions of typical non-fungible tokens (or
“NFTs”).

The proposal establishes the CFTC as the main digital asset
regulator in several different ways. For example, the RFIA mandates
that crypto exchanges are to be overseen by the CFTC and would
require that U.S. “crypto asset exchanges” register
with the CTFC (whereas registration was merely optional in the
previous version of the bill); so-called “decentralized crypto
asset exchanges” or DeFi services are regulated separately in
the bill. The SEC is not completely without authority however, as
the RFIA still requires those issuing cryptocurrency to make twice-yearly disclosures to the SEC, but as
long as these issuers’ tokens are still considered
“commodities” using the aforementioned criteria,
cryptocurrency issuers will, for the most part, remain outside the
regulatory purview of the SEC. Moreover, under the bill, a
CFTC-regulated “crypto asset” would not include an asset
that “provides the holder of the asset with any of the
following rights in a business entity: (i) A debt or equity
interest in that entity; (ii) Liquidation rights with respect to
that entity; (iii) An entitlement to an interest or dividend
payment from that entity; (iv) Any other financial interest in that
entity.” These classes of digital assets would remain under
SEC jurisdiction.

On the consumer protection front, the RFIA includes several key provisions:

• Allocating enforcement authority for new crypto asset consumer
  protection requirements amongst the CFTC, SEC, banking agencies and
  a new self-regulatory organization, the Customer Protection and
  Market Integrity Authority.




• Requiring all crypto asset intermediaries to maintain proof of
  reserves and undergo an annual verification, which would be
  enforced by the Public Company Accounting Oversight Board.




• Specifying that customer agreements must be written in plain
  language and that these agreements, and subsequent changes, must be
  filed in a public database.




• Specifying mandatory notice requirements for customers.




• Imposing basic notice, risk management and segregation and
  third-party custody requirements, as well as standards for crypto
  asset lending and a ban on rehypothecation.




• Requiring customer agreements to specify the moment when a
  transaction is finally settled between an intermediary and a
  customer, as a matter of law.




• Creating advertising standards for crypto asset marketing,
  including a duty to be fair, balanced and not misleading, and
  requiring disclosures, including compensation.




• Requiring that crypto asset intermediaries report cybersecurity
  breaches in a timely manner and mandating the CFTC and the SEC, in
  consultation with other agencies, develop cybersecurity standards
  for brokers and other intermediaries.

The comprehensive list of consumer protection measures outlined
in the RFIA is a direct response to fraud and bad actors that exist
in the digital asset marketplace (which was one of the motivating factors behind the initial
introduction of the RFIA in 2022). Further, these measures dovetail
with the RFIA’s provisions to combat the use of digital assets
in illicit financial transactions which include increased criminal
penalties for willful violations of the Bank Secrecy Act relating
to digital assets, the adoption of robust anti-money laundering and
sanctions evasion measures, and increased Financial Crimes
Enforcement Network (“FinCEN”) reporting, which is
similar to a bill introduced by U.S. Senator Elizabeth Warren
(D-MA) in December 2022 (Digital Asset Anti-Money Laundering Act
(S.5267)).

In the wake of the revised RFIA’s introduction to the Senate
floor, a similar bipartisan effort was launched in the House of
Representatives on July 26, 2023. The House Financial Services
Committee approved a plan to advance the Financial Innovation and Technology for the 21st
Century Act, a bill that also attempts to define when a digital
asset is a security or a commodity while clarifying the regulatory jurisdiction of the
CFTC and the SEC in the U.S. crypto market. The House bill would
give the CFTC jurisdiction over digital assets traded on a
“functional” and “decentralized” exchange or
issued through an “end user distribution.” The SEC would
have jurisdiction over digital assets before the networks to which
the assets relate are “functional” and certified as
“decentralized.” The House bill also specifies that
neither the CFTC nor the SEC would have authority to regulate stablecoins. Depending on the stablecoin’s
characteristics, it would be regulated by the Federal Reserve
Board, Office of the Comptroller of the Currency or state
regulators. While the House bill did receive opposition as it made its way through
Committee, these recent legislative developments suggest that
regulatory clarity is a salient topic in this industry.

It remains to be seen whether the Lummis-Gillibrand bill, the
House bill, or a third proposal for digital asset regulation
becomes law, but these proposals underscore a significant
bipartisan effort to tackle underlying issues affecting the current
digital asset landscape.

U.S. Senate and House of Representatives Introduce
Competing Crypto Regulation Bills

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