Republican lawmakers have revealed a proposed digital asset framework that would clarify the responsibilities of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) in regulating the digital asset industry.
The bill was revealed Friday by the Republican chairs of the House Financial Services and Agriculture Committees, Patrick McHenry (R-NC) and Glenn Thompson (R-PA).
“This discussion draft is a critical first step toward much-needed clarity for the digital asset ecosystem,” tweeted Rep. McHenry.
This discussion draft is a critical first step toward much-needed clarity for the digital asset ecosystem.
I encourage the public to provide constructive feedback to help us get this right.
Thanks to @CongressmanGT, @RepFrenchHill, and @RepDustyJohnson for your partnership. https://t.co/aPKXAMwluJ
— Patrick McHenry (@PatrickMcHenry) June 2, 2023
The bill heavily emphasizes the status of a given digital asset project as ‘decentralized’ in determining whether it is a security (and thus under the umbrella of the SEC) or a commodity (which would place it within the jurisdiction of the CFTC).
Under the rules, token issuers can apply for securities exemptions to be treated as commodities only if they can prove that they are sufficiently decentralized.
The requirements for decentralization are rigorous and are defined in a way that almost certainly excludes the likes of BTC and ETH. For example, a blockchain network can only be considered decentralized if it can be shown that no issuer or affiliated person has had unilateral authority in the last 12 months to “control or materially alter the functionality or operation of the blockchain network.”
Nor can they have held more than 20% of all the relevant digital assets in circulation or held voting rights in excess of 20%.
A project will also fail to be decentralized if any issuer or affiliated person has, within the previous three months, implemented or contributed any intellectual property that materially alters the functionality or operation of the blockchain network.
Major ramifications for BTC, ETH
Though the bill is in its early stages and faces numerous competing drafts from both sides of the political aisle, the document unveiled Friday will greatly impact how centralization is currently viewed in the digital asset industry.
The thresholds that must be overcome for a project to claim it is decentralized are interesting in themselves. Decentralization has been the key question in any digital asset securities analysis, thanks to Howey, which is the test for determining whether a given asset offering is an investment contract and, therefore, a security. The most important prong of Howey in the digital assets context is that an investment has been made with the expectation of profits reliant on the efforts of others. This question has been interpreted by regulators—including the SEC—as turning on whether a digital asset project is ‘decentralized’—which is a highly nebulous concept, if the time it has taken for regulators to clock on to the fact that most digital asset projects are in fact centralized is anything to go by.
If adopted, the language in the proposed bill would be the clearest boundary lines for decentralization yet described. Under the language of the bill, it’s difficult to see how any digital asset project being continually developed and revised by identified individuals would ever escape classification as a securities offering.
The creation of the 12- and three-month exclusionary windows also appears designed to allow for digital assets to begin life as securities and then later pivot into a commodity if it becomes decentralized. In the same vein, however, the bill clarifies that the SEC can reclassify a ‘decentralized’ network should it become sufficiently centralized further down the line.
Though the bill is intended to provide clarity to the market, its provisions still betray signs of the tension created by having two regulators be responsible for different parts of the same market. For example, the bill stipulates that both the CFTC and the SEC should jointly issue rules that would exempt those companies registered as both a digital commodity exchange with the CFTC and an alternative trading system with the SEC from any ‘duplicative, conflicting or unduly burdensome provisions’ of the new law.
The SEC would also retain its oversight of digital asset trading platforms, and under the bill, this oversight would exist even in cases where the platform lists commodities.
Bill faces stiff competition
The bill is the latest attempt in a multi-pronged effort by U.S. legislators to close the regulatory gaps which still exist in the digital asset space.
In May, the same U.S. Financial Services-Agriculture Subcommittee held its first hearing on digital asset regulation, where both Republican and Democrat lawmakers emphasized the need to clarify the roles of the CFTC and the SEC. One of the key issues raised was the resourcing disparity between the two agencies and a recognition that any further allocation of responsibility to the CFTC would need to come with significant additional funding.
There is also pending legislation that seeks to address the regulation of stablecoins specifically. In May, the House Subcommittee on Digital Assets, Financial Technology convened to discuss two competing draft stablecoin bills—one by Democrat Maxine Waters and another by Republican Patrick McHenry—and highlighted divisions within the U.S. legislature about how best to address the stablecoin issue. Those bills were created after an earlier bipartisan attempt from 2022 failed.
Next steps
Though the next joint Subcommittee hearing has yet to be listed, the House Agriculture Committee is scheduled to meet on Tuesday at a hearing titled “The Future of Digital Assets: Providing Clarity for Digital Asset Spot Markets.” It is expected that McHenry’s new discussion draft will be addressed at that hearing, which begins at 10 am Eastern time.
Watch: US Congressman Patrick McHenry on Blockchain Policy Matters
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