Institutional clients are estimated to have traded $1.14 trillion worth of cryptocurrencies on Coinbase in 2021. Analysts warn the industry is so large that macroeconomic consequences may occur if these assets are mismanaged. Still, regulating cryptocurrency has been largely piecemeal.
Now, the Responsible Financial Innovation Act (RFIA), recently introduced by Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY), aims to change this by, as stated in the Senators’ joint press release, “integrat[ing] digital assets into existing law and to harness[ing] the efficiency and transparency of this asset class while addressing risk.”
The RFIA addresses significant issues which arise at the intersection of traditional financial regulation and digital asset innovation across taxation, securities, banking and consumer protection. Most notably, it would:
- create a clear standard for determining which digital assets are commodities and which assets are securities by looking at the purpose of the asset and the rights or powers it conveys to the consumer
- create definitions for such terms as digital asset, payment stablecoin, virtual currency, smart contract, distributed ledger technology, and digital asset intermediary
- give the CFTC clear authority over applicable digital asset spot markets, affecting digital assets that meet the definition of a commodity, such as bitcoin and ether, which comprise more than half of digital asset market capitalization, and
- remove an obligation to include gain or loss from the change of value in a virtual currency used for personal transactions under $200.
This article considers several implications for those active in digital asset markets if the CFTC becomes the primary regulator as proposed in the RFIA.
The RFIA would add “digital asset” and “digital asset exchange” to definitions contained in the Commodity Exchange Act (CEA), thereby making them subject to the CFTC’s jurisdiction. It also would exclude from the “digital asset” definition assets that provide the holder of the asset with a debt or equity interest, liquidation rights, entitlement to a dividend or payment, a profit or revenue sharing based on the entrepreneurial or management of others, or any financial interest in the entity that would traditionally be treated as a security.
Indeed, under the RFIA, “digital asset” would become incorporated into the CEA’s definition of “commodity.” This classification as a commodity and therefore subject to the CFTC’s regulation would not, however, excuse the digital asset from securities regulations entirely.
Under the RFIA, an asset would be able to satisfy the definition of “digital asset” for purposes of CFTC jurisdiction, but would still be subject to certain disclosure requirements of the SEC: for purposes of the SEC, digital assets which are not fully decentralized, and which benefit from entrepreneurial and managerial efforts that determine the value of the assets, but do not represent securities because they are not debt or equity or do not create rights to profits, liquidation preferences or other financial interests in a business are called “ancillary assets.” These ancillary assets will be required to furnish disclosures with the SEC twice a year. They would, however, be presumed to be treated as commodities for purposes of their classification by a court of the United States and the SEC.
Accordingly, through the way it uses definitions, the RFIA would give digital asset companies the ability to determine what their regulatory obligations would be, while also giving the CFTC and SEC clarity to enforce existing commodities and securities laws.
As proposed, the CFTC would have exclusive jurisdiction over any agreement, contract or transaction involving a contract of sale of a digital asset.
Through this jurisdiction, the CFTC could:
- prohibit persons from offering, executing, or conducting any business in the United States for the purpose of soliciting or accepting a contract for the purchase or sale of a commodity for future delivery unless (1) this transaction is conducted on or subject to the rules of a board of trade designated by the CFTC as a contract market or derivatives transaction execution facility for such commodity; (2) the transaction is executed or consummated by or through a contract market; and (3) the contract is evidenced by a record in writing which shows the date, parties to the contract and their addresses, the property covered and its price, and the terms of delivery
- require all registered entities to maintain daily trading records, in addition to any records required to be made or submitted for such entities’ registration classification, such as a futures commission merchant, swap dealer, or major swap participant, and
- subject transactions in digital assets to the CFTC’s antifraud regulations.
Additionally with respect to the CFTC, under RFIA:
- CFTC would have exclusive spot market jurisdiction over all fungible digital assets which are not securities, including ancillary assets, in addition to the agency’s current jurisdiction over leveraged transactions
- A pathway for digital asset exchanges to register with the CFTC to conduct trading activities would be created
- Digital asset exchanges would be established as “financial institutions” under the Bank Secrecy Act
- In an insolvency, digital assets would be treated similarly to the way commodities are treated, giving clarity to investors, creditors, digital asset exchanges and other financial institutions and ensuring that assets are appropriately safeguarded
- A payment stablecoin issued by a depository institution (bank or credit union) would be treated neither as a commodity nor a security and
- The CFTC could impose a small user fee on digital asset exchanges to cover increased costs to the agency.
Note, while the CFTC has authority to create speculative position limits of physically settled core future contracts, RFIA does not address whether digital asset contracts would become subject to such limits.
The press release issued by Senators Gillibrand and Lummis on the RFIA calls it “the most substantial and comprehensive bipartisan effort to provide certainty and clarity to the growing digital asset and blockchain industries.” While experts are skeptical that the RFIA will be enacted in its current form, many industry leaders applaud the bill, particularly its efforts to distinguish or better clearly define digital assets as commodities or securities.
Regardless, with the RFIA encouraging dialogue about digital assets as commodities, an understanding of the regulatory implications for the classification of digital assets is crucial. We will continue to monitor and report on this and similar legislation.