Federal Reserve Update
Chairman Powell’s Testimony
This week, Chair of the Federal Reserve, Jerome Powell, testified before the House Financial Services Committee for his semi-annual monetary policy report. While the discussion focused on inflation and interest rates, Powell briefly spoke of the potential for a central bank digital currency (CBDC) and provided new information for what that could look like in the future.
Chair Powell confirmed that the Fed has yet to make any decisions on issuing a CBDC and stated, “We’re not making any real decisions, we’re doing kind of early stage experimentation – how would this work? Does it work? What’s the best technology, what’s efficient – early stage, but we're making progress on technological issues.”
Further, the Chair expressed that the Fed has yet to decide if a CBDC is even needed in the United States, or if the private sector is better positioned to take on the task of digitizing the dollar. Despite indicating that the Fed isn’t close to making any near-term decisions, he did assure Congress that he “think[s] [the Fed] can get this into the hands of the public very quickly.”
When asked about whether the Fed would need more statutory authority to issue a CBDC, the Chair replied that it might not need it to establish a CBDC, “at least for financial institutions,” explaining that a “wholesale” CBDC for settling transfers between banks and other financial institutions could be feasible. With respect to a “retail CBDC,” Chair Powell said “that is something we would certainly need congressional approval for.”
Chairman of Supervision Michael Barr’s Speech
On Thursday, Vice Chair of the Federal Reserve for Supervision, Michael Barr, delivered a speech at the Peterson Institute for International Economics in Washington, D.C, which focused on the counterparty risks associated with stablecoin arrangements and their risks similar to traditional finance.
“There’s a critical role for Congress to play right now in establishing a framework for stablecoins because stablecoins in particular pose the potential for systemic risk if they’re not regulated appropriately. They are a form of private money that borrows the trust of the central bank.”
Vice Chair Barr added that stablecoin arrangements can be “quite explosive” and “potentially quite dangerous.” He went on to say, “[t]he banks we regulate, in contrast, are well protected from bank runs through a robust array of supervisory requirements.”
Further, Vice Chair Barr reiterated that banks should exercise caution when engaging with the digital asset industry, warning that its unregulated nature could present undue risk to depository institutions and the system at large. He concluded by ensuring that the Fed would exercise its supervisory authority to oversee crypto activity and that the agency plans on assembling a group of experts to monitor developments in the industry.
What does this mean?
Chair Powell’s comments were largely a continuation of the Fed’s past sentiments, with the exception of the distinction between “wholesale” and “retail” CBDCs, which we were encouraged to hear him make. While we do not support the issuance of any CBDC, a retail CBDC poses a much larger threat to the individual liberties and the ability of private market actors to compete in the payments industry.
It was also a relief for the Chair to clarify that the Fed does not have the authority under existing laws to issue a retail CBDC. In the absence of such authority, the Fed would need Congress and the President to enact a bill into law.
Given the developing events in the traditional banking system, Fed Vice Chair for Supervision Barr’s speech yesterday discussing crypto risks and the safety and soundness of “well-protected” banks subject to a “robust array of supervisory requirements” reminds us of the utility of DeFi and the need for a new way.
Capitol Hill Hearings
CFTC Chair Behnam Testifies
On March 8, the Senate Agriculture Committee held a hearing in which Commodity Futures Trading Commision (CFTC) Chair Rostin Behnam testified.
In his testimony, Chair Behnam stressed the limits of leveraging agency enforcement authority, stating that “By the time the CFTC is able to exercise its enforcement authority, it is generally too late for defrauded customers and too late to isolate and contain the fallout from attendant bankruptcies, failures, and flights to liquidity.”
Advocating for a move from reactionary enforcement to “comprehensive regulation,” Behnam emphasized that it “would enable [the CFTC] to establish market structures and regulatory barriers, guardrails, and guidance that would prevent fraud before it happens, and fully deploy transparency and surveillance tools to see fraud when it does occur.”
A key line of questioning concerned the clash between Securities and Exchange Commission (SEC) Chair Gensler’s recent informal suggestion that all tokens except for Bitcoin are securities and the CFTC’s position of allowing Ethereum futures to be listed on exchanges and designated contracts markets. In response, Behnam reiterated that he’s “made the argument that Ether is a commodity. It’s been listed on CFTC exchanges for quite some time. And for that reason, it creates a very direct jurisdictional hook for us to police, obviously, the derivatives market but also the underlying market as well.”
When probed about this “competition for oversight” and the tools available to the CFTC to respond to it, Chair Behnam stressed the analysis that goes into the CFTC’s approval of a listing via their self-certification process. Explaining its legal backing, Behnam stated, “We would not have allowed the product, in this case, the Ether futures product, to be listed on a CFTC exchange if we did not feel strongly that it was a commodity asset—because we have litigation risk, we have agency credibility risk if we do something like that, without serious legal defense or defenses to support our argument that our asset is a commodity.”
What does this mean?
Congress must put an end to agency jockeying that is inhibiting the implementation of CeFi regulations in the United States. And notwithstanding Gensler’s recent assertions that everything and anything is a security and that he has all the authority he needs, we point you to his remarks in late 2021 in which he said that the SEC “needs additional Congressional authorities to prevent transactions, products, and platforms from falling between regulatory cracks… In my view, the legislative priority should center on crypto trading…” (emphasis added).
HFSC Digital Asset Hearing
On Thursday, the House Financial Services Subcommittee on Digital Assets, Financial Technology and Inclusion held a hearing on crypto policy issues. The hearing touched on a variety of issues, including the risks involved, the potential to drive innovation offshore, and the benefits of the technology.
Representative Warren Davidson (R-OH) underscored the importance of self-custody and the security holding one’s own assets provides. Representative Byron Donalds (R-FL) also made remarks concerning the current regulatory approach by the SEC, asking
"Do the agencies that currently exist have the technical capacity to adequately regulate a digital assets space?... if they don't, wouldn't it be better for Congress to do something novel and actually create a regulatory sandbox so that the industry can actually prepare the… regulatory environment, since they have the technical capacity way past anybody over at the SEC...?"
What does this mean?
For the most part, the hearing positively illustrated the benefits of DeFi and cryptocurrency more broadly and demonstrated concern for driving innovation offshore due to US regulators’ approach to date. If regulatory agencies, like the SEC, continue to regulate by enforcement, the US will surely see innovation go offshores and be left behind in the new wave of revolutionary technology.
Utah Passes the DAO Act
On March 1, 2023, Utah passed the Utah Decentralized Autonomous Organizations Act, making it the third state after Wyoming and Tennessee to legally recognize DAOs. The Act comes into force in January 2024.
The Act functionally affords DAOs treatment as an LLD—akin to a limited liability company (LLC), where members will only be held liable when actually voting for non-compliant actions, as opposed to being included by merely holding governance tokens. Participants also have no implicit fiduciary duties unless they hold themselves out as fiduciaries.
Additionally, each DAO registered under the Act must adopt procedural rules and regulations, referred to as by-laws, that govern the DAO. DAOs can also choose to be classified as corporations for federal tax purposes; otherwise, a DAO registered under the Act will be classified as a partnership and be taxed as a pass-through entity.
Unlike its Wyoming counterpart, the Act does not use the “legal wrapper” approach by subsuming DAOs under a version of an LLC but rather introduces a legal personhood uniquely available to DAOs that avoids some of the pitfalls of the traditional entity offerings. For instance, it defines the DAO participant base in the abstract instead of treating them automatically like members.
What does this mean?
We welcome experimentation in DAO legislation on the state level. The Act represents an optimistic step forward and is based in large part on the COALA Model Law on DAOs. That being said, several of its requirements merit further investigation.
First, though the Act defines DAO participants in the abstract, it still revolves around one key incorporator: at least one organizer who files a certificate of organization with their personal information to the Utah Division of Corporations and Commercial Code. Fortunately, the Act states that “the organizer can request the redaction of personal information before public disclosure of the filing.” Although, some argue that this privacy may be preempted by the reporting requirements of the Corporate Transparency Act, which requires reporting of beneficial ownership information to FinCEN.
Second, the Act defines unique quality assurance requirements for DAOs that both encourage them to adopt best practices but act as barriers for early-stage organizations as well. For instance, DAOs must submit evidence that their smart contracts are viewable in a public forum, that these contracts have gone through security review, that the DAO leverages a decentralized governance system, and that the DAO operates on a permissionless blockchain.
Third, the DAO is also required to share a “publicly specified communication mechanism” to contact their registered agent to provide legally-recognized service of process in the event of litigation, and “describe or provide a dispute resolution mechanism that is binding and able to resolve disputes via settlement.” Though this acts as another burden, it does help clarify some of the practical challenges of serving DAO members (avoiding the concerns about notice present in cases such as CFTC v. Ooki DAO).
Illinois Considers Misguided Legislation on Blockchains
A comprehensive blockchain licensing act passed through a committee in the Illinois General Assembly that would severely chill blockchain and crypto activity within the state. The Digital Asset Regulation Act criminally punishes unlicensed “digital asset business activity” with or on behalf of any Illinois resident.
Unfortunately, the bill’s definition of what constitutes such an “activity” is all encompassing, potentially even capturing a person validating transactions (anywhere in the world) on a permissionless blockchain that could be used by an Illinoisan.
What does this mean?
Like Illinois’ recent Senate Bill SB887, compelling the impossible reversal of transactions without a private key, this proposed Act fundamentally misconstrues the nature of transacting in the digital asset space. In the name of consumer protection, this kind of legislation, built without the technical nuances of blockchains in mind—and by extension, developed in a way that is impossible to comply—would only chill innovation and deprive Illinoisans of the ability to participate in the crypto and blockchain industry altogether.
Crypto Mining Bill Reintroduced by U.S. Lawmakers
On Friday, March 3rd, U.S. Senator Edward Markey (D-Mass) and Representative Jared Huffman (CA-02) announced the ‘‘Crypto-Asset Environmental Transparency Act of 2023.’’ The bill, which was first introduced in December last year, requires crypto mining companies that consume more than five megawatts of power to disclose information about their emissions. It would also mandate the Environmental Protection Agency (EPA) to conduct a study on crypto mining’s environmental effects.
This week, Senator Markey chaired a Senate hearing titled, “Air, Climate, and Environmental Impacts of Crypto-Asset Mining.” “The crypto industry is growing, but so is the fight for climate justice. We will hold these companies accountable,” Markey said after the hearing.
What does this mean?
Crypto mining uses electricity just as every other industry uses electricity. Should Congress decide to establish emission transparency requirements via legislation, they should apply equally to all businesses that consume electricity. While certainly an “apples and oranges” comparison, we note that this proposed legislation would implement via statute for miners requirements that the SEC is considering adopting via rulemaking for all public companies.