1. The House Financial Services Committee Held Its Second Hearing on Stablecoins.
On Tuesday, the House Financial Services Committee (“HFSC”) held its second hearing on stablecoins. Nellie Liang, Under Secretary of the Treasury for Domestic Finance, testified regarding both the President’s Working Group on Financial Markets’ Report on Stablecoins” (“PWG Report”) and a potential regulatory framework for stablecoins in the United States.
Members of Congress on both sides of the aisle expressed interest in developing legislative solutions that provide regulatory clarity, ensure that centralized dollar stablecoins retain their pegs, and enhance transparency surrounding the reserve assets held by issuers. In addition, both Democratic and Republican members indicated that they believe stablecoins could be a useful tool in bolstering the dollar’s position as the world’s reserve currency of choice.
Published in November 2021, the PWG Report argued that stablecoins pose three broad types of risk to the financial system: (1) the risks of a run on stablecoins, (2) the risks accompanying stablecoins’ role in payments, and (3) the risks associated with the concentration of economic power in potentially-large stablecoin issuers. To address these risks, the PWG made a number of recommendations, notably the recommendation to limit the issuance of stablecoins to insured depository institutions (“IDIs”), i.e. traditional banks.
But while most members of Congress broadly concurred with the PWG Report’s statements concerning the potential risks associated with centralized stablecoins, they disagreed on the best approach to address them.
On the one hand, Rep. Ann Wagner (R-MO) questioned the need for federal regulation of stablecoins and argued that the state regulatory frameworks already in place sufficiently address the risks outlined in the PWG Report. She also emphasized that any federal regulation should fit the activities actually conducted by stablecoin issuers, rather than simply port over existing banking regulations that do not necessarily capture the types of risk centralized stablecoin issuance presents.
On the other hand, outspoken crypto and DeFi critic Rep. Brad Sherman (D-CA) argued that a lack of a federal regulatory framework could lead to a “race to the bottom” in which states lower regulatory standards to compete for stablecoin issuers to domicile in their states.
Where We Stand:
While centralized, reserve-backed stablecoins aren’t DeFi, they are instrumental to transacting in DeFi markets. As part of our education push in Congress, we are explaining the critical importance of allowing individuals to retain the right to self-custody their digital assets, including stablecoins. No self-custody = no DeFi. We disagree with the initial analysis put forward by the Federal Reserve, suggesting that a “potential U.S. CBDC… would best serve the needs of the United States by being… intermediated….”
At the same time, it may make sense to establish clear requirements for centralized stablecoin issuers. Consistent application of regulatory principles is key, though. We haven’t heard convincing arguments why the exact same reserve requirements are insufficient for centralized USD stablecoin issuers but sufficient for services like Venmo, PayPal, etc.
Bottom line: we are encouraged both by how productive this hearing was and by the content of many members’ statements and questions. The HFSC is clearly making progress towards understanding custodial stablecoins and the crypto ecosystem more broadly. Long may it continue.
2. Senate Committee on Agriculture Hearing on Digital Assets.
On Wednesday, the Senate Agriculture Committee, which oversees the Commodity Futures Trading Commission (“CFTC”), held a hearing to assess the role of the CFTC in regulating digital assets markets. Senators first heard from CFTC Chairman Rostin Benham and then from a panel of witnesses. The panel included: Sam Bankman-Fried, Founder and CEO of FTX; Sandra Ro, CEO of the Global Blockchain Business Council; Perianne Boring, Founder and CEO of The Chamber of Digital Commerce; and, Kevin Werbach, Professor at the Wharton School of Business.
The hearing was notable for its cooperative tone. Chairman Benham, committee members, and industry representatives all generally agreed on the need for further regulation of crypto spot markets. While each individual had different motivating concerns, there was nearly unanimous agreement that the CFTC’s jurisdiction should be expanded to include crypto spot markets. Chairman Benham specifically requested that Congress pass legislation both to expand the CFTC’s mandate to cover these markets and to allocate additional funding so the CFTC can conduct comprehensive market surveillance and keep up with technological developments and cybersecurity risks. He argued that the CFTC was the most well suited agency to cover these markets because of the CFTC’s long history of pursuing enforcement in the crypto markets and deep knowledge of markets.
There were a number of highlights in the hearing that evidenced policymakers' growing understanding of the crypto ecosystem. Senator Cory Booker (D-NJ) commented on the high hopes he has for cryptocurrencies to democratize the financial services industry and increase access to credit in minority and traditionally underserved communities. Chairman Benham explicitly stated that bitcoin and ether are commodities, which is good to hear given the lack of explicit clarity on this matter from the SEC. A number of senators indicated that they believed stablecoins are a key piece of ensuring the dollar remains the world’s reserve currency. Most tellingly, there was no anti-crypto grandstanding in this hearing. Broadly, this hearing was a well-intentioned conversation seeking to move towards a coherent and workable regulatory structure for spot markets.
The second panel unanimously called for further regulation of spot markets by the CFTC. Sam Bankman-Fried noted that the lack of regulatory clarity around the digital asset spot markets, stablecoins, and the path to registration for tokens make the US a non-competitive market and push most crypto business offshores. He called for the committee to bring much needed clarity to the markets by broadening the role of the CFTC and mentioned his willingness to contribute funding for the expanded CFTC role.
How does this impact DeFi?
The short answer is: TBD. DeFi was not specifically mentioned in the hearing. That being said, in a letter this week responding to a question about DeFi, Chairman Behnam wrote that LabCFTC, the CFTC’s innovation office has facilitated “an effort to ensure innovators are focusing on important issues such as customer protection and market integrity. LabCFTC has also worked to accelerate the CFTC’s research and consideration of novel approaches to accomplishing those same goal[s]. However… the technology has moved past the sandbox phase such that the CFTC is continuing to evolve to address these issues through new approaches” (emphasis added). We’ll be on the lookout for what “novel” and “new” approaches might be in the works.
While DeFi was not front and center at the hearing, we think it was positive for DeFi and crypto acceptance generally. Spot market regulation is likely coming, and the CFTC has a history of a market-driven approach that allows innovations to develop.
For a full rundown of the hearing, check out this thread by our Legal Intern, Jacob Hirshman.
3. Did the IRS Rule That Staking Rewards Are Not Taxable Income? No!
Last week, crypto twitter went a bit wild over the apparent news that the IRS had set a precedent that newly created staking reward tokens would not be considered taxable income by the IRS. This is NOT TRUE.
What’s really happening?
The debate is over whether staking rewards should be taxed as income when they are received by a staker or when they are sold by a staker.
Current IRS guidance states that staking rewards are taxed as income when they are received, which can over-represent the wealth gained via staking and is inconsistent with long-standing taxation principles. Making these arguments, a taxpayer sued the IRS for a refund on the overtaxation caused by the “when received” valuation method.
Last week, the IRS stopped defending their position and offered the taxpayer his requested refund, which is a positive signal because logically the IRS would keep litigating the case if they were confident in their position. Had the taxpayer agreed to the refund, the case would have “died” without any precedential value.
Instead, @nohardforks decided to keep litigating the case, which keeps open the possibility of legal precedent to establish that staking rewards should be taxed as income when they are sold, which would be great for the whole ecosystem. The question of how to tax unsold staking rewards is still very much an open question, but we may be getting closer to an answer.
There isn’t too much to report here, but we wanted to make sure all our stakoooooors consult their accountants on the tax treatment of any and all token rewards, whether or not you have sold those tokens.