Regulation of cryptocurrencies by the Commodities and Futures Trading Commission (CFTC), tax exemptions for crypto transactions, and strict reserve requirements for stablecoin issuers are some of the proposals in a new bipartisan bill for cryptocurrency regulation from Senator Cynthia Lummis (R-Wy) and Sen. Kirsten Gillibrand (R-NY).
The bill, titled the Responsible Financial Innovation Act, is the first such attempt to regulate an industry with aspirations to become an important part of the financial ecosystem. It addresses some of the most important questions related to industry’s workings.
The regulation measures proposed are wide-ranging and generous in their appraisal of the industry. But critics say the bill is problematic because it eschews strict regulation in favor of a light touch on an ecosystem that has yet to prove value to society.
The Bill’s Contents
Perhaps the most important question answered in the bill relates to the agency responsible for regulating cryptocurrency. The question has become the moot point in most discussions around crypto lawmaking. Even as crypto enthusiasts called for the creation of a new agency or a self-regulatory organization to police the industry, the Securities and Exchange Commission (SEC) chief Gary Gensler is urging Congress to let him expand his authority over cryptocurrencies. The bill unveiled this morning tasks the Commodities and Futures Trading Commission (CFTC) with regulating the spot market for cryptocurrencies.
It defines a new asset class – called ancillary assets – that refers to digital assets which may not be ‘fully decentralized’ like Bitcoin and cannot be classified as debt or equity. The bill codifies application of the ‘Howey Test’, used to determine whether a given asset is a security, for ancillary assets. The idea may be to interpret the test to favor cryptocurrencies.
“According to the people familiar with the bill’s drafting—who asked not to be identified by name—the Howey test makes clear that cryptocurrencies are not securities, and that the SEC’s interpretation, which says they are, is incorrect,” writes online publication Decrypt. If the bill is made law, the move could end a rancorous and divisive debate about the regulatory status of cryptocurrencies.
Other measures in the bill are aimed at preventing crypto runs and boosting usage of cryptocurrencies for daily transactions. In the aftermath of a spectacular stablecoin collapse last month, the bill also requires all issuers of payment stablecoins to maintain ‘high-quality’ liquid assets equal to 100% of the face value of all outstanding stablecoins in the market and provide public disclosures. It provides exclusions of up to $200 per transaction from gross income for its use in payment of goods and services.
Decentralized Autonomous Organizations (DAOs), which some crypto advocates claim is a new form of decentralized governance, become taxable based on their registration status with the IRS under the bill’s provisions.
A Dangerous Dynamic
Rohan Grey, assistant professor of law at Willamette University and author of the STABLE Act to regulate stablecoins, says that the proposed bill is a ‘lot better’ than previous attempts but it is still problematic because it goes easy on regulating the industry. “It is a dangerous dynamic to leave off regulation [for the crypto industry] in the short term,” he says, adding that he doesn’t see any political value in ceding to [crypto] actors who don’t hold themselves accountable to society.
He also criticized the creation of a new asset class for cryptocurrencies. Ancillary assets are not meant to be profit-making entities. But Grey says the idea of earning profits will be ‘creatively interpreted’ by the cryptocurrency industry. “They are not charities,” he says, referring to crypto companies that issue tokens or coins without interest or tied to stakes in another system. “What’s going on here is that this is a categorical line to let some actors off the hook.”
There is no justification to provide tax exemptions for crypto transactions or to create regulatory sandboxes, he says. “There is no evidence that these [crypto] actors are doing any activity that requires a regulatory sandbox other than the kinds of activities that regulation is designed to protect against,” he says, referencing the numerous scams and accusations of fraud that have plagued the crypto ecosystem since its inception. According to Grey, most cryptocurrency actors are concerned only with making profits by breaking existing rules.
The clincher here is that when those rules finally come, they might not be strict. Assigning oversight of cryptocurrency markets to the CFTC, away from the SEC, is a ‘time-honored strategy’ to weaken regulatory hold on industries, says Grey.
There are two reasons for this. The first one is the difference in philosophical approaches to regulation at both agencies. Securities must justify their existence while commodities are presumed to exist in nature. The distinction is important because it lays the groundwork for disclosures and utility of assets in each ecosystem. Treating cryptocurrencies as commodities translates to fewer rules and disclosures for the asset class.
CFTC also does not have resources or funding to go after the bad guys. According to Grey, assigning cryptocurrency regulation to CFTC is “essentially trying to pick the shortest, weakest, and least-funded person to be the cop on the beat.”
[That may not be an entirely accurate description CFTC’s capabilities. The agency fashioned rules for the unregulated derivatives market and implemented provisions of the Dodd Frank Act under the chairmanship of current SEC Chair Gary Gensler.]
The Decrypt post states that CFTC will receive a major cash infusion from the crypto industry to perform its duties, if it is handed charge of crypto markets.