On Thursday, the House Financial Services Committee (HFSC) and the House Agriculture Committee held hearings focusing on the future of digital assets. The former hearing focused primarily on how regulation should be crafted to balance consumer protection and much-needed innovation, while the latter focused on the significant gap in spot market regulation of digital assets that exists.
House Financial Services Subcommittee Hearing
The Subcommittee on Digital Assets, Financial Technology and Inclusion within the HFSC held a hearing titled The Future of Digital Assets: Identifying the Regulatory Gaps in Digital Asset Market Structure”. The hearing focused on regulatory gray areas, which regulatory regime should be applied to crypto assets, and—as per the Subcommittee’s statement released ahead of the hearing—striking “the appropriate balance to protect consumers without stifling responsible innovation.”
Though Ranking Member Stephen Lynch (MA-08) began the hearing by implying that existing financial and securities regulations provide ample regulators backdrop for digital assets, witnesses emphasized the dangers of regulating digital asset providers like financial services—emphasizing the need to provide proactive clarity on centralized crypto while preserving space for decentralized innovations to flourish. In discussing the possibilities that decentralized storage provides, for instance, Marta Belcher, President and Chair of the Filecoin Foundation, reminded the committee that “cryptocurrency is about so much more than financial services, and regulating cryptocurrency like financial services can undermine these use cases.”
Centralized intermediaries were flagged as a regulatory priority by witnesses over decentralized actors. For instance, Blockchain Capital’s General Counsel Joshua Rivera emphasized the need to focus on “regulating entities that we understand…intermediaries, exchanges, custodians, who provide services in a centralized way to the digital asset ecosystem, and making sure that that regulation is focused and not so broad that it stifles innovation for things we understand less…"
Finally, for a dose of realism regarding the role existing regulators have played thus far, Representative John Rose (TN-06) stated that “only about four crypto projects have been able to come into compliance as defined by the SEC.”
House Ag Committee Hearing
The Subcommittee on Commodity Markets, Digital Assets, and Rural Development within the House Ag Committee held a hearing titled The Future of Digital Assets: Identifying the Regulatory Gaps in Spot Market Regulation that was spearheaded by Subcommittee Chairman Dusty Johnson (SD-At Large) and shared a similar sentiment that “digital assets and blockchains can bring a tremendous amount of opportunity. In discussing regulatory vision, Rep. Johnson stated regulators ought to “craft a legislative framework that will allow the next Ethereum or Filecoin to emerge,” while still protecting consumers from fraud.
Witness testimony substantially focused on the tensions between the Commodities Futures Trading Commission’s (CFTC) and Securities and Exchange Commission’s (SEC) competing approaches to digital assets. Witnesses such as Daniel Davis, current partner at law firm Katten Munchin, Rosenman LLP and former General Counsel of the CFTC, expressed the view that digital assets actually form a significant gap in spot market regulation because they fall out of both the CFTC’s and SEC’s jurisdiction. More specifically, Davis expressed that though the CFTC has stated that seven of the top fifteen digital assets of commodities—a sentiment that the SEC has never explicitly challenged—the SEC has only asserted that one of the top fifteen (referring to XRP) are securities; as such, a large majority of digital assets are unanswered for, falling in the gray area of jurisdiction between the CFTC and SEC.
Timothy Massad, Former Chairman of the CFTC, proposed alternatives to provide regulatory clarity for this gap, such as requiring the CFTC and SEC to come together to engage in joint rulemaking, or relying on Congress to proactively regulate activity. Still, Massad emphasized the importance of pragmatic rulemaking, suggesting that overregulation in the digital assets markets looks like trying “too hard to clarify this issue of what is a security and what is a commodity in a way that will not practically solve any of the regulatory problems and investor protection risks that currently exist.”
What does this mean?
Both hearings shared similar sentiment concerning the lack of regulatory clarity and the need to protect innovation. The HSFC’s subcommittee hearing especially emphasized that regulating the DeFi ecosystem as if it were the traditional financial system would stifle significant societal progress that’s being made with decentralized innovation—innovation that, as Belcher of Filecoin pointed out, goes well beyond just financial services.
The House Ag Committee hearing was well-warranted in its concern over tension between the CFTC and SEC that has led to rampant enforcement without regulatory clarity. The SEC has especially been aggressive in its approach to regulate by enforcement and assume jurisdiction over the entire crypto ecosystem without Congressional approval. With that said, we implore Congress to set the regulatory landscape and prevent regulatory agencies from continuing their overreach on a market with no clear guidance—otherwise, the US could face a de facto ban on crypto innovation.
California Lawmaker Introduces DAO Bill
On Monday, California State Representative Matt Haney (D) introduced a bill that would create a legal framework for decentralized autonomous organizations (DAOs). The bill amends California’s Unincorporated Nonprofit Association (UNA) statutes, permitting DAOs to register as decentralized nonprofit associations in the state.
According to the bill’s text, decentralized nonprofit associations must have at least 100 members “with a primary common purpose other than to operate a business for profit.” Nonetheless, the bill allows the associations to engage in profitable business, provided that proceeds are applied to furthering the association's non-profit objectives. Also, the association is required to designate an agent who will serve as the recipient of any legal action taken against it.
Moreover, the bill allows the transfer of membership interest from one individual to another, which results in the automatic transfer of voting rights to the recipient. Importantly, the bill does not hold members of the association “liable for a debt, obligation, or liability of the association solely by reason of being a member.” However, the bill delineates certain circumstances where the members could be held liable.
Should the bill pass, California will become the fourth state to implement a registration framework designed for DAOs, following Wyoming, Tennessee, and Utah.
What does this mean?
We will soon publish a blog post that examines the bill’s potential effects on both DAOs and their members. In the meantime, check out a prior post that explores similar frameworks in other states. Stay tuned.
Coinbase Sues the SEC
On Monday, Coinbase filed a narrow action in the US Court of Appeals for the 3rd Circuit to compel the Securities and Exchange Commission (SEC) to respond to its July 2022 petition. The petition asked the agency to exercise its rulemaking authority to provide guidance to the digital asset ecosystem and the SEC is statutorily required by the Administrative Procedure Act (APA) to respond to petitions “within a reasonable time,” which Coinbase alleged the agency has failed to do by not responding.
In its brief, Coinbase argued that the “it’s important for the SEC and any other agency petitioned for rulemaking to respond to the petition once the agency has made up its mind, especially if the answer is no” because “otherwise the public can never exercise its right to ask a court if the agency’s decision was proper.” Put simply, to be able to challenge an agency decision, there needs to first be a decision.
In its press release, Coinbase noted that over 1,700 companies and individuals have submitted comments to its petition echoing the request for clarity through rulemaking. Coinbase and many others in the digital asset ecosystem have criticized the SEC’s general approach as an attempt to regulate through enforcement rather than through the collaborative process of notice and comment rulemaking. Despite this, SEC Chair Gary Gensler has maintained that “the law is clear” and no ambiguities or gaps need to be filled through the rulemaking process.
Additionally, on Thursday, Coinbase responded to the Wells Notice it had received from the SEC last month. In a video posted to Youtube, Coinbase CEO Brian Armstron and CLO Paul Grewal discuss their response. In the video, Grewal pushed back against the SEC’s action, saying, “Coinbase does not want to litigate against the SEC. And the SEC should not want to litigate this case either. Litigation will put the SEC's own actions on trial, erode public trust in the SEC's mission, undermine any incentive for market participants to engage with the SEC, and put at risk broad aspects of the SEC's enforcement program. So we are asking you directly to not waste the SEC's limited and important resources on unnecessary litigation that will only harm the very investors that the SEC is mission-bound to protect…”
What does this mean?
Coinbase’s action against the SEC has come as the agency has continuously targeted the digital asset ecosystem with enforcement actions while simultaneously avoiding guidance. As previously stated, the SEC has a legal obligation under the APA to respond to Coinbase’s initial July 2022 petition.
As suggested in our previous section, we implore Congress to step in to rein in this rogue agency and prevent it from unilaterally placing a de facto ban on crypto innovation in the United States. Otherwise, its strategy will continue to empower bad actors, punish good actors, and drive US consumers to off-shore businesses.