The Securities Clarity Act
On Thursday, House Majority Whip Tom Emmer (R-MI) and Representative Darren Soto (D-FL) introduced the Securities Clarity Act to provide regulatory clarity to cryptocurrencies and jurisdictional boundaries for regulators. The act provides a distinction between digital assets and security contracts by including the definition of “investment contract assets” into law. An investment contract asset is defined in the act as a tangible or intangible asset—including assets in digital form—“sold or otherwise transferred, or intended to be sold or otherwise transferred, pursuant to an investment contract.”
What does this mean?
The act compares the orange groves sold in the original court case that established the Howey test—SEC v. W.J. Howey Co.—with digital assets in the sense that the sale of an asset could be deemed a security but that does not make the underlying asset itself a security.
We applaud both Rep. Emmer and Rep. Soto in their effort and leadership with this bill, and fully support its enactment, as it will provide the regulatory clarity the crypto community needs and that the Securities and Exchange Commission (SEC) has neglected.
The SEC Moves to Dismiss to Coinbase’s Writ of Mandamus Petition—While the Chamber of Commerce Supports Coinbase’s Plea for Clarity
On April 24th, through a filing called a petition for writ of mandamus, Coinbase asked the Third Circuit Court of Appeals to force the Securities and Exchange Commission (SEC) to “act on Coinbase’s pending rulemaking petition to provide clarity for the crypto industry.”
This week, the Securities and Exchange Commission replied, arguing that Coinbase’s petition to the Court should be dismissed. Through its brief, the agency argues that “Coinbase has identified no such egregious delay warranting the extraordinary relief it seeks” (where relief entails an attempt to provide “regulatory certainty and a workable framework for digital asset securities”) from the agency.
The SEC cites the “complexity of Coinbase’s proposal” and the fact that “regulation of crypto assets raises ‘complex and novel issues’” (quoting the rulemaking petition) as a key reason for justifying the dismissal of Coinbase’s request—a far cry from the oversimplified come in and register tune of SEC Chair Gensler’s remarks made just last month.
The brief also discusses the agency’s “limited resources” in defense of its nonresponsiveness to Coinbase’s proposal—ironically, the agency nevertheless had time to file, as quoted in its own brief, an impressive “760 total enforcement actions in fiscal year 2022, a 9 percent increase over the prior year.”
In related news, Coinbase’s fight for clarity in lieu of regulation-by-enforcement has garnered widespread support from industry as amici, or third-party advocates who also submit argumentative briefs to the court for consideration. Notably, the U.S. Chamber of Commerce, the world’s largest business organization representing nearly three million companies, submitted its amicus brief just last week. Therein, it emphasized the economic harm and lack of due process involved in the agency’s actions.
Quoting SEC Chair Gary Gensler himself, the Chamber echoed that “[c]ompanies and investors alike … benefit from clear rules of the road,” and adds that the SEC’s “attendant refusal to engage in rulemaking specific to digital assets—is causing substantial economic harm to both Coinbase and the broader business community.”
Second, the Chamber emphasized the threat that regulation-by-enforcement poses to the checks-and-balances provided by judicial review, arguing that “[b]y eschewing all formal, prospective processes, the SEC has also largely disabled the federal courts from reviewing the extremely contestable legal arguments underlying its expansive claimed authority.” Ultimately, as the Chamber argues, the SEC’s lack of willingness to clarify stances proactively “puts businesses and their customers to a difficult choice: They can accept the risk of future litigation—and the associated financial burdens—or they can stop engaging in conduct that the agency might or might not ultimately target.”
What does this mean?
The SEC’s response does little to clarify its stance towards digital assets, but does demonstrate one thing: a continued embrace by the agency of its use of enforcement actions, rather than proactive rulemaking, to leave its mark on the industry. Noting the SEC’s penchant for regulation-by-enforcement and the language used in its response brief, Coinbase’s Chief Legal Officer Paul Grewal commented that through its brief, “[t]he SEC acknowledged that it will continue to use enforcement actions as a substitute for rulemaking for the foreseeable future, but not to worry — those enforcement actions may eventually ‘inform’ not-yet-planned rulemaking.”
Still, there is more to come. Coinbase will file a response to the SEC’s brief next week, after which the court will rule on the writ of mandamus petition, determining whether or not it can compel the SEC to act and provide further regulatory clarity. Either way, the SEC’s arguments regarding the complex issues implicated in regulating digital assets—inconsistent with its statements about how easily industry actors can comply with securities regulation via mere registration—may come in handy in defending against potential enforcement actions going forward. If drafting appropriate rulemaking involves “difficult and complex legal, policy, and technical considerations relating to the application of the existing federal securities law regime,” as the SEC states, then perhaps industry compliance with its existing, obfuscated regime defined by ex post facto enforcement actions is similarly burdensome.
Bank for International Settlements
This week, the Bank for International Settlements (BIS) published a “paper that provides an overview of policy measures by financial authorities in 19 jurisdictions and global [standard setting bodies]” (SSBs). The paper addresses policy measures in three categories: centrally managed crypto asset activities, community-managed crypto asset activities, and users’ direct exposure to crypto assets (DeFi), and related crypto asset activities.
The paper argues that DeFi presents four main risks: illicit activity, legal uncertainty from smart contracts, potential risk to traditional finance, and concentration of power. The paper then proceeds to provide examples of policy measures that claim to address said risks such as the US Treasury’s Office of Foreign Assets Control (OFAC) sanction of Tornado Cash (TC).
Furthermore, the paper provides “potential approaches to addressing the risks associated with DeFi protocols.” This includes considering miners and validators as intermediaries subject to registration and oversight—i.e., they would be “accountable for extractable value and market manipulation in cryptoasset activities built on public permissionless [distributed ledger technology].” The potential approaches also include developing a process for issuing credentials to entities that wish to participate in DeFi and a process for assessing and approving which DeFi protocols are fit for use. Lastly, the paper includes an approach that would “establish public-private collaboration for code regulation through ex ante guidelines or ex post code reviews and audits.”
What does this mean?
The paper serves as a high-level overview of a variety of policy measures to address the presumed risks of crypto assets. However, DeFi’s risks cannot be appropriately addressed with jurisdictions’ current approaches. For example, OFAC’s sanction of TC was clear government overreach. Sanctions are only applicable to individuals, entities, or countries that can challenge the sanctions and TC is open-source software that is not controlled by a person, entity, or country—i.e., it’s autonomous pursuant to deployment. Furthermore, TC was not developed for illicit activity; law-abiding citizens have a right to participate in private financial transactions.
Additionally, the potential approaches demonstrate a misunderstanding of distributed ledgers and suggest suppressive measures for DeFi protocols. First, miners and validators are not intermediaries— they neither custody assets nor control transactions. Their respective roles are to maintain the operations and security of a distributed ledger, and do so in a decentralized and consensus-driven manner. Second, the DeFi ecosystem is meant to be permissionless. Issuing credentials for participation and deciding which protocols are fit for use exposes DeFi to the risk of bias and abuse of power that could rupture competition and monopolize markets, hurting the consumer in the end. The paper itself does not dive into the details of these approaches but it’s safe to say we won’t support them.
MiCA: A New Era of Crypto Asset Regulation in the European Union What Happened?
The European Union (EU) has made a significant stride towards the governance of crypto-assets with this week’s official adoption of the Markets in Crypto Assets (MiCA) regulation. This unanimous decision by the Council, representing all 27 member states, ushers in the first comprehensive crypto licensing regime in a major global jurisdiction. The decision makes the EU the first major jurisdiction globally to establish a comprehensive crypto licensing regime.
What Does it Mean?
As we have previously noted, MiCA regulation marks a significant shift in the crypto-asset industry, laying the groundwork for a uniform regulatory framework for centralized crypto exchanges. Its implementation intends to foster innovation while ensuring consumer and investor protection within the digital finance landscape.
However, the legislation raises questions about transactions that involve self-hosted wallets. Transactions over €1000 involving hosted and centrally managed wallets will fall under regulatory scrutiny, while peer-to-peer transfers via unhosted wallets will be exempt.
Additionally, the law confers significant authority to the European Securities and Markets Authority (ESMA), sparking concerns about potential centralization in a market that typically thrives on decentralization. As MiCA begins its journey of implementation, these nuances underscore the ongoing need for scrutiny and refinement in the rapidly evolving crypto industry.
House Stablecoin Hearing
On Thursday, the House Financial Services Subcommittee on Digital Assets, Financial Technology, and Inclusion (HFSCDA) held a hearing titled Putting the “Stable” in “Stablecoins:” How Legislation Will Help Stablecoins Achieve Their Promise. Days earlier, Representative Maxine Waters (D-CA) circulated draft stablecoin legislation which aligns in part with the legislation drafted last month by House Financial Services Committee Chairman Patrick McHenry (R-NC).
In light of the overlaps between the two pieces of legislation, hearing participants expressed optimism around the prospect of passing bipartisan stablecoin legislation. HFSCDA Vice Chairman French Hill (R-AR) emphasized that the parties “agree on the basic protections that must be included in any stablecoin legislation” and that the existence of “two different legislative proposals” does not mean that the parties are “starting from scratch.”
Despite those overlaps, representatives remain divided on the balance of authority between state and federal regulatory bodies. Representative Waters noted that, as a key difference between the bills, her draft would provide the Federal Reserve Board with greater regulatory authority in order to prevent regulatory arbitrage at the state level. Representative Stephen Lynch (D-MA) echoed these concerns, stating that giving sole regulatory to the states risks the possibility of states “engaging in a race to the bottom.” Representative Ritchie Torres (D-NY), a fellow democrat, expressed a more balanced view, noting that while he supports establishing a federal floor to prevent regulatory arbitrage, state regulators have proven to be more effective at regulating crypto than has the federal government.
As a related issue, representatives also debated which federal regulator(s) are best suited to oversee stablecoin market participants. Representative Bryan Steil (R-WI) clarified his view that stablecoins are not securities and thus should not be regulated by the SEC. Representative Steil and others also questioned whether the Federal Reserve would be the appropriate regulator at the federal level, while Chairman Hill seemed open to the possibility of having the OCC serve as the primary regulator.
What does this mean?
The tone of Thursday’s hearing, coupled with the similarities between the draft stablecoin bills, may be indicative that progress is being made towards passing bipartisan stablecoin legislation. The drafts put forth by both parties are generally in alignment with respect to reserve requirements, disclosures and transparency, and other measures aimed at advancing consumer protection.
As noted above, the primary issue that remains is the respective power allocated to federal and state regulatory authorities. On its face, this issue appears to be partisan in nature. However, Representative Torres’s statements suggest that at least some on the left support granting meaningful authority to the states, provided that a federal floor is established. Greater consensus on this issue would drastically increase the likelihood that bipartisan stablecoin legislation will be passed in the coming months.