Regulation
Taking Action for Federal Regulation of Blockchain and Cryptocurrencies | Sullivan & Worcester
[co-author: Karly Roux, Summer Associate]
On May 22, 2024, with bipartisan support, the U.S. House of Representatives passed H.R. 4763, the Financial Innovation and Technology for the 21st Century Act (“FIT21”), becoming the first major cryptocurrency bill to pass either chamber of Congress.
FIT21 Brief Summary
Overall, FIT21 aims to provide safeguards, comprehensive customer disclosure, and operational guidelines for digital activities.[1] If enacted, FIT21 would grant the U.S. Securities and Exchange Commission (“SEC”) jurisdiction to regulate restricted digital assets.[2] and grant the Commodity Futures Trading Commission (“CFTC”) jurisdiction to regulate digital commodities.[3] The bill distinguishes digital goods from restricted digital assets based on “decentralization” and “functionality.”
In general, a decentralized blockchain is a blockchain where:
- during the preceding 12-month period, no person had unilateral authority to control the blockchain or its use, and no issuer or affiliated person owned 20% or more of the digital asset or voting power of the digital asset, and all issuance of units of the digital asset through the operation of the blockchain system were for end-users, and
- in the preceding three-month period, the issuer and its affiliated persons have not contributed intellectual property to the source code of the blockchain system that has materially altered the functionality or operation of the system, except for certain technical corrections or modifications adopted through consensus or agreement of a decentralized governance system, and neither the issuer nor its affiliated persons have marketed the digital asset to the public as an investment.
The bill defines a functional blockchain system as a system that allows network participants to use a corresponding digital asset for an application on the blockchain system, transmission and storage of value, participation in services, or participation in the decentralized governance system on the blockchain.
Under the bill, a person may certify to the SEC that a blockchain system to which a digital asset relates is a decentralized system. In connection with this certification, the person would be required to provide detailed information to the SEC to substantiate the determination that the system is decentralized, including, among other things, regarding functionality, governance, ownership of the digital asset, and recent issuance. The blockchain system will be deemed certified as decentralized 60 days after the date of certification, unless the SEC provides notice within that period indicating that the person making the certification has provided an inadequate explanation or that there are new or complex issues that require additional time for consideration. The bill also provides for an appeals process if the SEC ultimately determines that a system is not decentralized.
Once a blockchain system to which a digital asset refers is a functional system and is certified as decentralized, the digital asset would fall within the definition of a digital commodity and be regulated by the CFTC. Excluded from the definition of a digital commodity are digital assets held by the issuer of the digital asset or owned by related persons.[4] and affiliates of the digital asset issuer[5] – these digital assets will be regulated by the SEC.
The bill also proposes amendments to the Securities Act of 1933 (the “Securities Act”), including a new Section 4(a)(8) under the Securities Act to include processes and procedures for issuers to offer and sell units of digital assets in transactions exempt from the full registration requirements of the Securities Act, and also proposes new SEC authority to register and regulate digital asset brokers, digital asset dealers, and digital asset trading systems.
Potential impact of FIT21
If enacted, FIT21 could potentially provide a clearer and more stable landscape for the U.S. digital asset market while also fostering technological innovation. The bill seeks to achieve this by imposing certain limited disclosure requirements aimed at preventing market manipulation and fraud, thereby increasing investor confidence in these investment opportunities. Consumer protections within FIT21 include requirements for brokers, dealers, and exchanges to register with the SEC or CFTC, disclose asset information, segregate customer funds, create lock-up periods for token insiders, and limit annual sales volume. Additionally, by defining the difference between a commodity and a security, the bill helps alleviate some of the regulatory ambiguity that has existed in the cryptocurrency industry. Given other countries’ efforts to develop their own regulatory guidelines, FIT21 could solidify the U.S. as a thought leader in the fintech space.
However, there are several critics of FIT21 who believe the bill will fall short of its goals and could cause more problems than it solves. Whether or not FIT21 is signed into law, at a minimum, it serves as an essential first step in Congress’ conversation about regulating digital tokens and a foundation for future legislative proposals.
Next steps for FIT21
The Biden administration issued a statement expressing concern over the bill’s lack of adequate investor and consumer protections, but it nonetheless expressed a willingness to work with Congress on the issue of regulating cryptocurrency market activity and did not threaten to veto the bill if it passed the Senate. The Senate now has the opportunity to amend the bill but has not yet scheduled a floor vote or committee hearing to discuss those changes as of late June 2024. In any case, while enacting FIT21 may be an uphill battle, the bill’s passage in the House underscores growing bipartisan support for clear and comprehensive cryptocurrency legislation.