• Tue. Aug 2nd, 2022

How the Responsible Financial Innovation Act proposes to regulate cryptocurrencies and other digital assets – commodity perspective

ByHazel R. Lang

Jun 23, 2022

Institutional customers are estimated to have traded $1.14 trillion worth of cryptocurrencies on Coinbase in 2021. Analysts warn that the industry is so large that macroeconomic consequences can arise if these assets are mismanaged. Yet cryptocurrency regulation 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 that to, as noted in the joint press release of the senators, “integrat[ing] digital assets in existing legislation and to be exploited[ing] efficiency and transparency of this asset class while addressing risk.

The RFIA addresses important issues that arise at the intersection of traditional financial regulation and digital asset innovation in the areas of tax, securities, banking, and consumer protection. More specifically, it would be:

  • 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 confers on the consumer
  • create definitions for terms such as digital asset, stablecoin payment, 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 account for more than half of the market capitalization digital asset exchange, and
  • remove the requirement to include gain or loss resulting from the change in value of virtual currency used for personal transactions under $200.

This article examines several implications for participants in digital asset markets if the CFTC becomes the primary regulator, as proposed by the RFIA.

Classification

The RFIA would add “digital asset” and “digital asset exchange” to the definitions contained in the Commodity Exchange Act (CEA), bringing them under the jurisdiction of the CFTC. It would also exclude from the definition of “digital asset” assets that provide the holder of the asset with debt or equity, liquidation rights, right to a dividend or payment, share in profits or income based on the entrepreneurial spirit or management of others, or any financial interest in the entity that would traditionally be treated as a security.

Indeed, within the framework of the RFIA, a “digital asset” would be included in the definition of “goods” of the CEA. This classification as a commodity and therefore subject to CFTC regulation would not, however, entirely exempt the digital asset from securities regulation.

Under the RFIA, an asset could meet the definition of a “digital asset” for CFTC jurisdictional purposes, but would still be subject to certain SEC disclosure requirements: for SEC purposes, digital assets which are not fully decentralized, and which benefit from corporate and management efforts that determine the value of 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 referred to as “ancillary” assets.” These ancillary assets will be required to report to the SEC twice a year. They would, however, be presumed to be treated as commodities for purposes of classification by a United States court and the SEC.

As a result, through the way it uses the definitions, the RFIA would give digital asset companies the flexibility to determine what their regulatory obligations would be, while giving the CFTC and SEC clarity to enforce existing laws. on commodities and securities.

CFTC Registration

As proposed, the CFTC would have exclusive jurisdiction over any agreement, contract or transaction involving a contract for the sale of a digital asset.

Through this jurisdiction, the CFTC could:

  • prohibit persons from offering, performing, or conducting any activity in the United States for the purpose of soliciting or accepting a contract to buy or sell any commodity for future delivery unless (1) such transaction is conducted on or subject to the rules of any chamber of commerce designated by the CFTC as a contracts market or derivatives transaction execution facility for such commodity; (2) the transaction is executed or consummated by or through a contracted market; and (3) the contract is evidenced by minutes showing the date, the parties to the contract and their addresses, the goods covered and their price, and the terms of delivery.
  • requiring all registered entities to maintain daily records of transactions, in addition to any records required to be established or submitted for the registration classification of such entities, such as a futures commission agent, swap broker, or major participant in swap, and
  • subject digital asset transactions to CFTC anti-fraud regulations.

Additionally, with respect to the CFTC, under RFIA:

  • The CFTC would have exclusive spot market jurisdiction over all fungible digital assets that 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 the event of insolvency, digital assets would be treated the same as commodities, providing clarity to investors, creditors, digital asset exchanges and other financial institutions and ensuring that assets are properly protected
  • A payment stablecoin issued by a custodial institution (bank or credit union) would not be treated as a commodity or a security and
  • The CFTC could impose a small user fee on digital asset exchanges to cover increased costs for the agency.

Note that while the CFTC has the authority to create speculative position limits for physically settled commodity futures contracts, the RFIA does not specify whether digital asset contracts would be subject to such limits.

Conclusion

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 of enacting the RFIA in its current form, many industry leaders applaud the bill, especially its efforts to distinguish or better clearly define digital assets as commodities or securities. .

Either way, with the RFIA encouraging dialogue on digital assets as commodities, it is crucial to understand the regulatory implications for the classification of digital assets. We will continue to monitor and report on this and similar legislation.


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