On June 2, the Chairs of the House Committees on Financial Services and Agriculture jointly released an ambitious discussion draft of new legislation aimed at filling the persistent gap in regulation of spot cryptoasset markets and to resolve lingering uncertainty regarding federal securities laws’ application in the cryptoasset arena. While the 162-page draft is complex and invites many questions, it represents an intriguing potential springboard for advancing the regulatory discussion in the United States beyond backward-looking, one-off enforcement actions, which have long been the overwhelming focal point. In the most recent and high-profile examples, the SEC has unveiled a sweeping complaint against the world’s largest cryptoasset exchange, its founder, and its U.S. arm, and separately a complaint against the largest cryptoasset exchange in the United States. In what has become a pattern, the SEC has chosen to use its enforcement action tool to launch new assertions that specific cryptoassets (even a particular stablecoin) are securities — without bringing enforcement actions against the relevant developers or issuers of the purported securities.
The cryptoasset industry has witnessed some pronounced failures meriting vigorous enforcement. But the SEC’s practice of issuing summary declarations about the status of widely traded digital assets through ad hoc civil litigation, while refusing to promulgate a tailored, navigable regime of appropriate disclosures and other rules, is not conducive to U.S. leadership in this industry or to the meaningful protection of investors. In stark relief, regulatory clarity is increasing abroad (notably in the European Union, with its adoption in May of new rules on markets in cryptoassets). In the limited circumstances that the SEC has engaged in focused cryptoasset-related rulemaking, it has largely sought to fit cryptoassets into the familiar rails that apply to traditional securities, such as in its April proposal to require decentralized software protocols to designate a specific entity with compliance responsibility, thereby calling into question the ability of these protocols to function in a decentralized manner.
The draft proposal (a more detailed summary of which can be found here) would resolve several fundamental regulatory questions about jurisdictional authority over cryptoasset markets — dividing authority between the CFTC and the SEC based on functional standards — and facilitate, through a tailored regime, compliant capital formation and trading activity. In particular, the bill would:
- provide the CFTC with jurisdiction to regulate spot markets in cryptoassets constituting commodities and establish requirements for registered digital commodity exchanges, including to prohibit market abuse and to meet cybersecurity requirements;
- create a framework for registration of digital commodity brokers and commodity dealers;
- set conditions for a cryptoasset to be deemed a commodity, including:
- assets issued through an “end user distribution” (such as through mining, staking or an “airdrop”) other than to an issuer, a related person or an affiliate; or
- assets held by a person other than an issuer where the applicable blockchain network is functional and is formally self-certified as decentralized;
- establish SEC jurisdiction over cryptoassets that are offered as part of an investment contract pending the cryptoassets meeting the definition of a commodity;
- exempt payment stablecoins from treatment as securities while reserving certain antifraud authority to the SEC;
- create a tailored disclosure regime for capital-raising transactions involving cryptoassets and periodic reporting for cryptoasset issuers (including filing of annual and semiannual reports, pending certification that the applicable network is decentralized);
- provide a mechanism for cryptoasset issuers (or other market participants) to certify to the SEC that the relevant network has become decentralized, providing a potential off-ramp from SEC reporting that remains subject to SEC rebuttal of such certification;
- establish an SEC registration exemption for an issuer’s sales of cryptoassets not involving equity or debt, subject to certain conditions (e.g., total sales by the issuer over the prior 12 months not exceeding $75 million, non-accredited investor’s purchases not exceeding a prescribed financial threshold and the purchaser not owning more than 10% of the post-transaction units);
- require that the SEC enable registration of cryptoasset trading platforms as ATSs;
- permit a path to secondary trading of commodity digital assets even after an initial offering by investment contract;
- allow broker-dealers to custody cryptoassets, subject to conditions; and
- establish a joint CFTC-SEC advisory committee on cryptoassets, including for the express purpose of jointly studying decentralized finance (DeFi).
The bill also raises many questions, including as to when a blockchain network would be sufficiently decentralized (as even under the objective criteria set out in the bill, this remains a heavily fact-intensive inquiry, leaving open how the SEC would attempt to wield its discretion). The bill also raises the specter of a particular cryptoasset simultaneously trading on a CFTC-registered exchange and an SEC-registered ATS (e.g., in the case of insiders’ tokens), posing potential market complexity. But at least as a starting point, the bill reflects a constructive approach to regulation by applying the substance of traditional rules designed to promote market integrity and protecting investors in a tailored manner that seeks to preserve the potential benefits of new technology. This stands in contrast to an enforcement-centric approach, or more caustic legislative approaches exemplified by a recent New York bill that could make cryptoasset-related activities in that jurisdiction prohibitively difficult.
This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “Congressional Bill Proposes Comprehensive Cryptoasset Legal Framework Amidst SEC’s Continued Regulation-By-Enforcement,” dated June 7, 2023.