In a significant development for the digital asset industry, Republican lawmakers from the U.S. House Committees on Financial Services and Agriculture have released a comprehensive discussion draft of proposed legislation aimed at establishing a regulatory framework for digital assets. This draft, which builds upon previous legislative efforts including the Financial Innovation and Technology for the 21st Century Act (FIT21), represents the latest attempt to provide regulatory clarity in the rapidly evolving digital asset space.
The draft bill has been released to set the table for stakeholder discussion and solicit feedback from affected industry participants, consumers, and regulatory bodies before formal introduction.
The draft bill introduces a new category of asset, a “digital commodity,” defined as “a commodity the value of which is, or is reasonably expected to be, derived from the relationship of the commodity with the blockchain system to which the commodity relates.” A digital commodity is considered to relate to a blockchain system if the digital commodity is “intrinsically linked to the blockchain system,” including:
Securities, certain stablecoins, and derivatives are excluded from the definition.
Under the draft legislation, both the SEC and CFTC would have a role regulating the digital assets industry. The CFTC would have primary responsibility over digital commodities exchanges, brokers, dealers, and custodians. Through oversight of digital commodity exchange listing standards, the CFTC would play a gatekeeping role in determining which digital commodities are appropriate for public markets.
The SEC would generally have jurisdiction over issuance of new digital assets and would oversee the process to certify “mature blockchain systems,” which would transition to primarily secondary market supervision. The SEC would also have jurisdiction over new rules limiting trading by digital asset issuers, related parties, and affiliates.
The two agencies share significant regulatory waterfront in secondary markets. SEC registrants would be permitted to offer digital asset commodities on their platforms alongside securities, and the SEC is given primary supervision over the digital commodity activities of SEC registrants.
Under the draft bill, the SEC would retain jurisdiction over securities transactions, and so the familiar Howey test to determine if an asset is offered or sold as an investment contract and Reves test to determine whether a “note” is a security would remain relevant in some circumstances. However, as described below, specific exemptive relief relevant to many transactions involving crypto assets would bring these transactions outside of the SEC’s purview or reduce compliance burdens, lowering the stakes of determining whether an asset is offered or sold in a securities transaction.
Four-Year Safe Harbor
The draft bill includes a four-year safe-harbor provision that would exempt tokens from the SEC’s registration requirements if:
During the safe harbor, an issuer will be subject to slimmed-down disclosure requirements, including filing an “offering statement” and any other documents the SEC prescribes, that include:
To make offers and sales during the safe harbor, an issuer must also disclose the following information:
Further, issuers taking advantage of the safe harbor will be required to file semi-annual reports that:
Issuers are also required to file current reports reflecting any material changes to information previously provided to the SEC. The SEC will also have the authority to issue additional rules to require disclosures comparable to those envisioned by the safe harbor for digital assets sold in reliance on other exemptions.
Secondary Trading
Under the draft bill, the offer or sale of a “digital commodity” by a person other than the issuer or its agent, that does not represent or give the purchaser and ownership or profit-sharing interest in the issuer or another business, shall not be considered a “investment contract” under existing federal securities laws. This provision should resolve the ongoing disagreement between federal courts regarding whether secondary trading in digital assets constitutes securities transactions; under the draft bill, they would not be.
Trading Restrictions
The draft bill allows a related or affiliated person to use units of a digital commodity in the programmatic functioning of the blockchain system. However, it imposes certain trading restrictions on related and affiliated persons both before and after the blockchain system is a mature blockchain system.
Before the blockchain system is certified as mature, a related or affiliated person may use units of the digital commodity in the programmatic functioning of the blockchain system. They may also offer or sell units of the digital commodity if:
After the blockchain system is certified as mature, a related or affiliated person may offer, sell, or transfer units of the digital commodity if:
These restrictions would also apply to any person “that asserts control of a blockchain system, together with its related digital commodity,” following certification as a mature blockchain system. The proposed bill would also require digital commodity exchanges to enforce these trading rules.
Mature Blockchain Certification
The bill provides a pathway for digital assets to transition from the SEC’s oversight to digital commodities under the CFTC’s purview through the “mature blockchain system” certification process, which will be overseen by the SEC. The certification must “include such information that is reasonably necessary to establish that the blockchain system is not controlled by any person or group of persons under common control,” which may include information regarding:
Under the draft bill, the SEC would publish the certification and may open a public comment period. The review period will be 60 days but the SEC can extend it an additional 120 days to allow additional consideration. The certification will become effective when the SEC publishes a notification that it does not object to the certification—or when the review period expires.
The draft bill lays out the following criteria for a blockchain system to be deemed mature, but notes that the SEC may issue further rules:
“The digital commodity has a market value that is substantially derived from the programmatic functioning of the blockchain system,” and any development plan describing how value will be derived from programmatic functioning of the blockchain system, which has published by the issuer, has been substantially completed.
The SEC is directed to issue rules covering disclosure requirements for blockchain systems that fail to mature within the four-year safe harbor.
New registration requirements would be established for digital commodity exchanges, brokers, and dealers with the CFTC.
Digital Commodity Exchanges
The definition of digital commodity exchange is drafted to capture entities engaged in the customary business of crypto exchanges, i.e. making available spot markets in digital commodities, which have historically not been subject to federal market regulation but rather regulated in a limited manner at the state level under rules governing money transmission or specialized state regimes such as New York’s BitLicense.
Digital Commodity Brokers and Dealers
The definitions of digital commodity broker and digital commodity dealer capture businesses that facilitate purchases and sales of digital commodities outside of exchanges—in the case of brokers as an agent by “soliciting or accepting orders from a customer,” and in the case of dealers as a principal by “acting as a counterparty to a person” for “the purchase or sale of a digital commodity,” where the digital commodity broker or dealer either accept and maintain control over customer funds or exercise discretion over the “quantity, quality, timing, routing counterparty, or other attribute or fulfilment requirement of the order.” Both definitions include exceptions for certain transactions with institutional parties, transactions that are principally in the nature of payments, and the operation of nodes withing blockchain systems.
Customer Protection
The draft bill would require CFTC registrants to hold customer digital commodities with a qualified digital commodity custodian. It would also require the new types of registrants to segregate customer assets and treat them as separate from all other assets held by the registrant unless the customer agreed to waive that requirement. With customer permission, registrants can pool customer assets in order “to provide a blockchain service,” such as pooled staking programs.
Listing Requirements for Exchanges
Digital commodity exchanges would be required to abide by listing standards in the draft bill, including permitting “trading only in a digital commodity that is not readily susceptible to manipulation.” Further, a digital commodity may be listed only if the following information is correct, current, and available to the public:
An exchange may rely on information disclosed to the SEC by the issuer of a digital commodity pursuant to the safe harbor provision described above.
Separate Regulation of Custody and Trading
The bill creates standards for “qualified digital commodity custodians” who must meet the supervision requirements of federal banking regulators, state authorities, or “an appropriate foreign governmental authority in the home country of the digital commodity custodian.” The CFTC may provide rules allowing registered entities to custody digital commodities.
Recordkeeping
Records requirements for brokers, dealers, and exchanges under the Securities Exchange Act of 1934 would be modernized to permit a person “to consider records from a blockchain.”
Airdrops, Staking, and Mining
The draft bill introduce the defined term “end user distribution:” “A distribution of a unit of a digital commodity that (i) does not involve an exchange of more than a nominal value of cash, property, or other assets; and (ii) is distributed in a broad and equitable manner based on conditions capable of being satisfied by any participant in a blockchain system, including as incentive-based rewards.”
The draft bill states that an end user distribution is not the offer or sale of a digital commodity and is not the offer or sale of a security.
DeFi
Decentralized finance activities are provided specific exemptions from both SEC and CFTC regulations while maintaining anti-fraud and anti-manipulation protections. The following activities are covered by this exclusion:
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Footnotes
1 The CFTC and SEC are directed to jointly issue rules to define the term “programmatic functioning.”
2 The draft bill defines “related person” with respect to a digital commodity issuer to mean ‘‘(A) a founder, promoter, employee, consultant, advisor, or person serving in a similar capacity; (B) any person that is or was in the previous 6-month period an executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity; or (C) any equity holder or other security holder.”
3 The draft bill defines an “affiliated person” as “a person (including a related person) that, with respect to any digital commodity—(A) acquires more than 1 percent or more of the total outstanding units of such digital commodity from a digital commodity issuer; or (B) was described under subparagraph (A) at any point in the previous 6-month period.”