On June 10, 2022, U.S. senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced S. 4356, their Responsible Financial Innovation Act, to transfer most regulation of cryptoproducts to the Commodity Futures Trading Commission (CFTC}, essentially ousting the SEC, presumably perceived to be a more aggressive regulator, from oversight of cryptoproducts that were securities.

The senators’ timing could not have been worse. Between November 2021 and June 21, 2022, global crypto capitalization fell 69 percent, led by Bitcoin, the industry leader, which declined 70 percent, Coinbase, the leading crypto exchange, which fell 86 percent, and Tether, a supposedly safe form of stablecoin that was based on a risky algorithm, which fell to as low as 10 cents on the dollar by May 13, 2021. Cryptomania had been succeeded by the great Crypto Crash.

In the declining world of crypto, President Biden, with a March 2022 executive order, initiated a federal government-wide review of digital assets after cases of crypto were identified as being involved in illegal transactions such as money laundering, tax evasion, or trading of illegal goods.  Crypto was further criticized in some forms for high volatility and Bitcoin miners’ mammoth energy consumption.

Facing similar problems, China had banned all crypto currency transactions in part in response to Bitcoin’s massive energy consumption.

The SEC had been successful in litigation establishing that some crypto products satisfied the Howey definition of a security and could be traded on a platform that would have to register as a security exchange. Through the end of 2021, the SEC had brought 97 crypto-related litigations and administrative actions, imposing approximately $2.35 billion in monetary penalties against digital asset participants.

The SEC was hardly alone in its attention to crypto. When a cryptoproduct did not satisfy the Howey test, the CFTC had also successfully characterized other cryptoproducts as commodities and had registered some crypto futures markets.

In January 2022, the Federal Reserve began what it anticipated would be a year-long discussion with stakeholders of whether it should create a Central Bank Digital Currency (CBDC), in part because China sought to do so as it banned most cryptocurrencies. There were concerns articulated in the Biden executive order whether the lack of a CBDC would hinder the United States in international payment system transactions.

Cutting the other way from these regulatory moves were the efforts of many states: 33 had enacted or had pending legislation by year-end 2021 to enable crypto transactions. States such as Wyoming and Texas were taking the lead in providing crypto providers with a welcome mat, in some instances enabling crypto mining.

In this context, the Lummis-Gillibrand bill not only tilts towards the CFTC to be the lead Federal regulator, but also tilts towards the enabling spirit of several states, notably including Wyoming.

S. 4356 covers a lot of issues.

Title II exempts individual sales of exchanges of virtual currency from federal income taxation of gross income with a $200 limit per transaction.  Digital asset mining income “shall be included in the gross income of the taxpayer until the taxable year of the disposition of the assets produced or received in connection with the mining or staking activities.”

Title III would amend the Securities Exchange Act to define investments included in the definition of security in Section 2(a)(l) of the Securities Act and other Federal Securities laws “to be a commodity consistent with section 2(c)(2)(F) of the Commodity Exchange Act.” A later provision in Title IV similarly states, “Notwithstanding any other provision of law, the Commodity Futures Trading Commission shall have exclusive jurisdiction over the regulation and all other activities of a registered digital asset exchange.”

Title IV goes further and addresses responsible commodities innovation, asserting the CFTC’s “exclusive jurisdiction over any agreement, contract, or transaction involving a contract of sale of a digital asset in interstate commerce,” except that the SEC could continue periodic disclosure requirements for securities within the meaning of Section 2(a)(l) of the 1933 Act and specified ancillary assets.

Much of the regulation of digital assets would be subject to the initial control of digital asset exchanges through provisions such as those addressing compliance with trading, trade processing and participation rules; the capacity to detect, investigate and enforce violation of these rules; decisions as to which assets are readily susceptible to manipulation; listing restrictions; and protection of the safety of customer money, assets, and property. There is no intermediate organization to help supervise compliance with the act in the way that FINRA, for example, helps the SEC police securities exchanges. There are numerous opportunities in the proposed act for a customer to opt out or waive a specific requirement. A digital asset exchange may begin operations by deeming itself in compliance with CFTC requirements for registration.

The act includes provisions to permit a host state to create interstate sandboxes for the development of new or existing technology involved in financial products, services, business models, or delivery mechanisms that have “no substantially comparable widely used analogues in common use in the United States.”

Title VI addresses consumer protection, including disclosure requirements that identify material source-code changes relating to the relevant digital assets. Title VI does address subsidiary proceeds that may accrue to a digital asset through forks, airdrops, and staking, but provides the digital asset provider the opportunity not to collect subsidiary proceeds.

Lending arrangements must be clearly disclosed to customers before any lending service takes place and be subject to the affirmative consent of the customer. Title VI then addresses the work of the Federal Reserve System and requires stablecoins under this section to “equal not less than 100 percent of the face amount of the liabilities of the institution on payment stablecoins issued by the institution.” Stablecoins are defined to include United States coins and currency, demand deposits at an insured depository institution, balances held at the Federal Reserve bank, foreign withdrawable reserves as defined in Section 249.3 of Title 12 of the Code of Federal Regulation, short term securities issued by or guaranteed by the Department of Treasury, related reserve requirements, or other high quality liquid assets determined by the appropriate federal or state banking agency to be consistent with safe and sound banking practices. The parity of state regulators in federal law is a pattern that recurs throughout the act. While limiting the national payment system to high quality stablecoins may prove to be wise – this is a topic the Federal Reserve is currently studying – allowing states to define as appropriate a class of stablecoins broader than the federal banking authorities are willing to approve appears to be inconsistent with the Constitution’s Supremacy Clause.

Title VI would provide authority to the Financial Crimes Enforcement Network to establish an Innovation Laboratory to assess potential changes in laws, rules, or policies to facilitate supervision of financial technology and the laws under the jurisdiction of the agency.

Title VII comes out strongly in favor of digital technology to reduce risk in depository institutions and includes the finding, “The Federal Reserve banks have, on occasion, provided services to non-depository, non-insured institutions without appropriate statutory authority,” not exactly language likely to win the bill’s sponsors many friends at the Fed and in any event a topic earlier addressed by the Dodd-Frank Act. Paradoxically, S. 4356 attempts to limit the ability of appropriate federal banking agencies to request a depository institution to terminate a specific customer account or group of customer accounts based on reputation risk. The appropriate federal banking agencies are given clear authority to terminate customers when they pose a threat to national security, are involved in terrorist financing, or are agencies of the governments of Iran, North Korea, Syria, or any country listed on the State Sponsors of Terrorism list.

Strikingly, the act is virtually silent on energy consumption, except for a requirement in Section 806 that each year the Federal Energy Regulatory Commission, in consultation with the CFTC and the SEC, provide an annual report on energy consumption for mining digital asset transactions.

There are many other studies proposed in the act, as well as an Advisory Committee on Financial Innovation with 10 members, including two appointed by the president from the financial technology industry, four appointed by the president with specializations in consumer protection, consumer education, financial literacy, or financial inclusion, one commissioner from the SEC, one from the CFTC, one member of the Federal Reserve Board of Governors, and one state financial regulator. A novel requirement states that, “Not more than 4 of the members of the Committee shall be from the same political party.”

S, 4356 and other bills that have been or will be introduced include one from Senator Debbie Stabenow that will provide for a larger or exclusive role for the CFTC in regulating cryptoproducts. Most of the sponsors of these bills are on the U.S. House or Senate agriculture committees and implicitly reflect the perennial challenge of dividing financial regulation between the SEC and CFTC, with each subject to separate congressional oversight.

While there is growing support for some form of new legislation to address cryptoproducts, the SEC, through comments of Chair Gary Gensler and environmentalists who favor more direct forms of regulation of crypto-mining energy consumption, are on record as opposing the approach of the Lummis­-Gillibrand bill.

Time also militates against enactment of anything like S. 4356 in this session of Congress. With a declining number of legislative days and the nation’s attention on several other issues, Congress has yet to initiate hearings on this bill and, given the ongoing Biden and Federal Reserve studies, may prove unwilling to do so. If the Republicans gain control of the House and the Senate in November, the reception for legislation such as S. 4356 likely will be warmer.

When Congress does address cryptoproducts, the need for clarification of jurisdiction of the relevant federal enforcement agency is wise, but likely there will be greater attention paid to the prevention of fraud and energy consumption.

This post comes to us from Joel Seligman, the dean emeritus of, and a professor at, Washington University School of Law and author of “The Rise and Fall of Cryptocurrency: The Three Paths Forward,” forthcoming in the NY.U. Journal of Law and Business (2022).