U.S. House Republicans' Crypto Proposal: A Step Towards Clearer Regulatory Framework
Last Friday, in an unprecedented move aimed at providing regulatory clarity for the rapidly evolving crypto industry, key Republican chairs in the U.S. House of Representatives released a discussion draft for the Digital Asset Markets Structure. This proposed legislation offers a pathway for crypto assets to be classified as digital securities, commodities, or stablecoins, based on the level of decentralization in their respective blockchain systems, addressing one of the primary areas of contention in the crypto sphere: the classification of crypto assets
Additionally the proposed legislation would establish a new category of businesses, referred to as 'digital commodity exchanges.' These platforms, regulated by the U.S. Commodity Futures Trading Commission (CFTC), would facilitate the trading of certified crypto commodities while adhering to the regulatory protections of the CFTC, including measures against market manipulation. This proposition also extends to crypto exchanges registering with the U.S. Securities & Exchange Commission (SEC), enabling them to trade digital securities, commodities, & stablecoins all on a single platform
The draft bill outlines criteria to determine whether a crypto asset is a commodity or a security. Crypto firms claiming their assets as commodities must provide detailed explanations of their operations, proof of decentralization, & certify that no individual controls more than 20% of the assets. However, the SEC still retains the right to dispute this classification.
Importantly, the proposed legislation calls for a joint study by the SEC and CFTC to explore key aspects of DeFi. This includes the nature, operations, size, and role of DeFi protocols, along with the interoperability of smart contracts with blockchain technology and other software systems. The proposed study must also aim to examine the governance structures that manage DeFi, the potential benefits, and associated risks, as well as its impact on and integration with traditional finance markets.
Despite being predominantly a Republican initiative, there is optimism that it will receive bipartisan support. The draft is currently a discussion piece and awaits Democratic input.
What does it mean?
The introduction of this draft legislation signifies a significant shift towards institutional acceptance and recognition of cryptocurrencies and blockchain technology. It represents an effort to integrate digital assets into the current financial system by adapting existing regulatory principles, while also formulating new ones where necessary. This move could stimulate the growth of crypto businesses by offering legal clarity & protection, which could fuel the growth & adoption of digital assets.
However, the complexities of the bill, such as the criteria for assessing decentralization of a blockchain, indicate there's still significant groundwork to be done. Questions surrounding the evaluation of these criteria, the authority to verify decentralization claims, and the potential implications for different types of digital assets are yet to be resolved.
This proposed legislation also underscores the increasing political significance of crypto assets and underlines the growing divide between Republicans and Democrats on crypto regulation. This bill could potentially ignite a new era of regulatory clarity in the U.S. crypto industry, providing companies with much-needed guidance on operating within U.S. law and regulation. However, it's important to note that the path to comprehensive and effective crypto regulation in the U.S. is still long and filled with challenges.
Hearing on Digital Asset Spot Markets
On June 6th, 2023, the House of Representatives Committee on Agriculture held a hearing titled The Future of Digital Assets: Providing Clarity for Digital Asset Spot Markets, focusing on the discussion draft of the Digital Asset Market Structure bill. The list of witnesses included figures such as Chair Rostin Behnam of the Commodity Futures Trading Commission (CFTC) and Paul Grewal, Chief Legal Officer at Coinbase.
Beyond discussion of the bill, both members of Congress and the witnesses addressed some crucial areas including asset class determination, regulatory clarity, and decentralization.
Chair Behnam applauded the Market Structure Bill in its efforts to position the level of decentralization as the main distinguishing factor between securities and commodities. Chair Behnam also added that if the investor receives an asset directly from the issuer, this diverts the asset more towards security, while receiving an asset from a third party relates closer to commodities.
Furthermore, Chair Benham outlined that following the separation of the token issuer from the industry, digital assets can transition from securities to commodities, because “there wouldn't be that centralized body conducting business or operations that would impact the value of the token.”
During the second portion of the hearing, former Chair of the CFTC J. Christopher Giancarlo addressed the question of anonymity as a problem in the crypto space. Giancarlo stated that instead of the need for disclosure by the central authority, “There will be third parties stepping up providing very good analysis that people investing in digital commodities will look to."
What does this mean?
This hearing demonstrates good-faith efforts in Congress to bring much-needed regulatory clarity to the digital assets space. Although there is progress on reaching consensus on some items, such as the importance of the level of decentralization in the process of asset class determination, broad agreement is yet to be established on critical issues, such as the transition of the asset from a security to a commodity, regulatory overlap between the SEC and CFTC, and the role of third parties in disclosure.
SEC Enforcement Actions
This week, the U.S. Securities and Exchange Commission (SEC) brought enforcement actions against two of the world's largest cryptocurrency exchanges, Binance and Coinbase. The SEC alleges that both platforms have violated rules requiring them to register as securities exchanges and be overseen by the federal agency.
The SEC's complaint against Coinbase alleges that the platform, which services over 108 million customers and accounts for billions of dollars in daily trading volume, has been operating as an unregistered securities exchange since at least 2019. The SEC claims that Coinbase traded at least 13 crypto assets that are securities and should have been registered, including tokens such as Cardano, Polygon, and Solana. Following the lawsuit, Coinbase reportedly suffered about $1.28 billion in net customer outflows, according to blockchain analytics firm Nansen. This comes despite Coinbase's efforts to work with regulatory bodies and its proactive approach to compliance.
In response to the charges, Paul Grewal, Coinbase's General Counsel, stated that the company will continue operating as usual and has demonstrated a commitment to compliance. The company denies the SEC's allegations and pledged to vigorously defend itself in court.
The SEC accuses Binance and its CEO Changpeng Zhao of operating a "web of deception,"as well as offering12 cryptocurrency coins without registering them as securities. The lawsuit expands the overall number of cryptocurrencies that the SEC has explicitly identified as securities, raising questions about other exchanges that have also allowed U.S. investors to trade those tokens.
Binance has also pledged to defend itself against the lawsuit, which it says reflects the SEC's "misguided and conscious refusal" to provide clarity to the crypto industry. Following the lawsuit, customers reportedly pulled around $790 million from Binance and its U.S. affiliate, according to Nansen.
What does this mean?
These lawsuits represent a significant escalation in the SEC's efforts to regulate the cryptocurrency industry and signal a new era of regulatory scrutiny for even the largest of cryptocurrency exchanges.
The lawsuits also expand the overall number of cryptocurrencies that the SEC has explicitly identified as securities, raising questions about other exchanges that have allowed U.S. investors to trade these tokens. This could potentially serve as a precedent for future enforcement actions against other exchanges that have allowed trading of tokens now identified as securities by the SEC. If the SEC prevails, it could force crypto exchanges to comply with the same regulatory requirements as traditional securities exchanges, potentially leading to significant changes in how these platforms operate.
However, it is important to note that both Coinbase and Binance have denied the SEC's allegations and have pledged to vigorously defend themselves in court. The outcome of these lawsuits is far from certain, and the legal battles could take years to resolve.
The DEF submitted a comment letter in response to French agency ACPR’s request for comment around decentralized finance. In the letter, we argue that 1) ACPR should not directly regulate miners and validators by establishing standards for public blockchains; 2) private blockchains do not present novel regulatory concerns; 3) a framework for smart contract certification would require centralization and the inappropriate regulation of speech; 4) a policy that would “force centralization” would eliminate the core innovations of public blockchains; 5) so-called “front ends” that make it easier for users to interact with public blockchains are not akin to traditional financial intermediaries; and 6) permissioning access to blockchains likewise eliminates the characteristics that make them novel—and useful.