The Off-Chain Transaction Reporting Act
On September 28, U.S. Representative Don Beyer (D-VA) announced the introduction of the Off-Chain Digital Commodity Transaction Reporting Act.
The proposed legislation “would require that all off-chain digital asset transactions be reported within 24 hours to a CFTC-registered trade repository, similar to the requirements for virtually all securities and swaps transactions,” according to a press release announcing the bill. If a transaction is completed on a “trading platform,” the “trading platform” is responsible for reporting. For situations in which transactions “are not executed on or through a trading platform, such transactions shall be reported by the purchaser in real-time….”
What does this mean?
The bill is vague, largely duplicative of public blockchain records, and does not specify who falls within its scope of regulation. “Trading platforms,” for example, is undefined even though “trading platforms” are the primary target of the bill.
Practical considerations warrant caution as well. The real-time transaction reporting requirement represents one of the key issues of the bill, as it would mandate individual purchasers to report their transactions to a digital asset repository immediately after settlement. This would be incredibly burdensome, unnecessary, inappropriate, and technologically complex for individuals.
Further, a CFTC-registered repository of personal information tied to on-chain transactions effectively creates a centralized database of private financial information. The provisions in the bill that allow a broad spectrum of entities to access sensitive user data, such as domestic regulators and foreign authorities, further magnify our privacy concerns.
The inaptly named Off-chain Transaction Monitoring Act’s technology-biased requirements would chill innovation unnecessarily and should be scrapped.
CFTC Chair Rostin Behnam Commented on DeFi
On Monday, Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam addressed attendees at the Futures Industry Association Expo in Chicago. Chair Behnam mentioned the CFTC’s recent action in the Ooki Dao case and enforcement actions against three “DeFi operators” in September. He stressed that any entity operating within the U.S. market, whether registered or an unincorporated association, remains under the purview of the Commodity Exchange Act (CEA).
Chair Behnam highlighted the pressing need for Congressional intervention concerning the unregulated digital commodity landscape and recognized DeFi as a pivotal technology driving the current transformative phase characterized by “disintermediation.” According to Chair Behnam, the combination of increased electronification and DeFi’s potential scope is leading to a more vertically integrated marketplace, unhindered by geographical boundaries. Many existing regulations, which were crafted focusing on individual registrants, now appear inadequate, he said. In conclusion, Chair Behnam advocated for a proactive approach and additional authority for the CFTC in the crypto space, rather than a reactive stance post-market events.
What does this mean?
Chair Behnam's remarks displayed an interesting contradiction: he lauded the CFTC’s recent regulation by enforcement actions in DeFi while also suggesting in more general terms that just such an approach, one focused on finding purported intermediaries anywhere and everywhere, would not work. We agree.
Nevertheless, following the example of the SEC, the CFTC has decided to pursue its own impact litigation strategy designed not to regulate the novelly-functioning markets allegedly within its jurisdiction but rather to undermine and suppress them. In pursuit of this policy objective, the CFTC establishes novel “law” in settlements that maximize ambiguity with respect to the limits of the Commission’s authority and undermine market certainty.
Federal agencies entrusted by Congress with the power to not only create new law but also enforce the law should not engage in impact litigation: given enough time, it undermines their effectiveness, credibility, integrity, and power, while imposing immediate and irreparable harm on their targets.
SEC’s Response to Coinbase
This week, the Securities and Exchange Commission (SEC) filed its opposition to Coinbase’s motion for judgment on the pleadings, which sought to dismiss the SEC’s case against Coinbase. As a refresher, Coinbase was sued by the SEC in June of this year based on allegations that Coinbase is operating its trading platform as an unregistered national securities exchange, broker, and clearing agency. The SEC also alleged Coinbase failed to register the offer and sale of its crypto asset staking-as-a-service program.
The SEC makes four key arguments, listed below.
The complaint sufficiently alleges transactions in “securities” on Coinbase’s Platform. In support of this argument, the SEC argues that a formal contract or agreement between seller and purchaser of the token is not a required element of an investment contract, an investment contract does not require that an investor get a share in the income, profits, or assets of a business; and the Howey test applies as much to secondary market trading as it does to primary market offerings.
The Major Questions Doctrine — which declares that federal agencies lack the authority to issue regulations on significant policy matters unless Congress explicitly delegates that power to them – does not apply to this case because the SEC has not extended is power beyond that given to it by the securities laws;
The SEC sufficiently alleges that Coinbase conducts brokerage activity through its Wallet application. The SEC argues that because “Coinbase actively solicits investors (on its website, blog, and social media) to use Wallet’s trading features,” “effects transactions in crypto asset securities by making them ‘available’,” and routes “customer orders through third party… trading platforms… to access liquidity outside the Coinbase platform” that they are essentially acting as a broker.
The complaint sufficiently alleges that Coinbase engages in the unregistered offer and sale of securities through its Staking Program. Reiterating its arguments regarding the Howey test, the SEC argues that Coinbase marketed their staking program as “an investment opportunity and not a receipt of payments for validation services as Coinbase claims now in litigation.”
In its brief, the SEC also rejects Coinbase's assertions that it received approval for its non-compliant actions when it became publicly traded. Additionally, the SEC maintains that the remarks made by SEC Chair Gary Gensler during a Congressional hearing should not be construed as directly applicable to the court's interpretation of federal securities laws.
What does this mean?
In its brief, the SEC makes the same arguments it has been in recent public statements and enforcement actions: it is supposedly already equipped with the regulatory authority to oversee the crypto industry and therefore, its actions do not warrant the application of the major questions doctrine. Contrary to the SEC’s claims that its enforcement action against Coinbase “does not have the vast economic or political significance” that would warrant the application of the major questions doctrine, crypto is already a trillion dollar global market consisting of a novel technology that is unlike anything the 73rd Congress of the 1930’s could have possibly envisioned. Crypto laws are still evolving, and it is not for unelected bureaucrats to decide what is to be done about an emerging industry that involves 60 million Americans.
With regards to Coinbase’s Wallet application, DEF submitted an amicus brief in mid-August educating the court on the nature of the application. In our brief, we explain the technical details of how a digital asset wallet works and argue that developing and providing wallet application software does not constitute broker activity. In order to be a broker, a person or entity must act as an intermediary. And even according to the SEC’s sparse allegations regarding Wallet in the complaint, the Wallet application is truly passive software as Coinbase does not control users’ assets, handle customer funds, or commingle assets
Furthermore, the SEC’s assertion that Wallet “routes” orders is a stretch of the imagination, when in reality Wallet’s software facilitates communication to a blockchain network — much like when an email provider “translates” a message from human language into binary code that can be transmitted over the network.
DEF’s amicus also explained the nature of Coinbase’s Staking Program. The SEC, of course, argues that the Staking Program is based on “Coinbase’s efforts to generate the returns,” and that it is not ministerial. As we explain in our brief, Coinbase is not the “primary determiner” of stakers’ rewards — the consensus protocol is, which is simply software. Coinbase is simply administering a way for users to participate in the protocol’s consensus mechanism — Coinbase’s efforts in no way dictate whether or not users see a return. Importantly, users do not transfer their crypto or private keys to Coinbase when staking, which eliminates the SEC’s assertion that there is an “investment” of any sort.
Coinbase Chief Legal Officer, Paul Grewal, stated via X that Coinbase will file its reply to the SEC’s opposition on October 24th. It will then be up to Judge Failla to review both sides’ arguments and decide whether to grant Coinbase’s motion. If her opinion in Risley, et al. v. Universal Navigation Inc., et al. is any indication, Judge Failla will wrestle with the nuances of the technology and the SEC’s allegations determine whether the SEC’s arguments related to the Howey test and its own administrative powers have any merit.