Regulation
The House approves the cryptocurrency law which promises regulatory clarity | Manatt, Phelps & Phillips, LLP
After many iterations over the years in attempting to regulate the cryptocurrency industry, the House of Representatives passed the Financial Innovation and Technology for the 21st Century Act, or FIT21 Act, on May 22, 20241. The bipartisan vote was 279-136 .
This legislation marks a considerable milestone in the creation of a U.S. regulatory framework for the digital assets market and, compared to bipartisan and bicameral attempts in previous years, shows the most promise of becoming law. After years of industry complaints about the lack of a way to comply with the previous US framework, this step signals Congress’ commitment to bringing stability to the digital asset market.
The bill was sponsored by Glenn Thompson (R-PA) and co-sponsored by a politically diverse bipartisan coalition that includes several members who have long supported legislative solutions to many of the digital asset challenges: French Hill (R-AR ), Patrick McHenry (R-NC), Tom Emmer (R-MN), and Ritchie Torres (D-NY).
Key Provisions
First, the bill aims to clearly define cryptocurrencies by classifying them based on whether they are a currency, a commodity, a security, or another form of digital asset. The categorization is crucial as it describes how cryptocurrency is governed. FIT21 adds definitions to the Securities Act of 1933 for terms such as “Blockchain,” “Decentralized,” and “Digital Asset.” The Howey2 test for determining whether an item is a security has not been eliminated, however a new Howey “carve out” has been incorporated into the definition of “Digital Asset” which is clearly designed to give issuers greater clarity in executing their projections:
“(E) TREATMENT OF CERTAIN DIGITAL ASSETS SOLD UNDER AN INVESTMENT AGREEMENT.—A digital asset offered or sold or intended to be offered or sold under an investment agreement is not and does not become a security upon sale or otherwise transferred under such investment agreement.” (emphasis added)
But of course it could still be a security, so the SEC is still somewhat in the driver’s seat in determining the status of the security and pursuing enforcement cases. This is in response to litigation in which the judge ruled that tokens became securities based on the way they were offered.3 The FIT21 law is designed to send a message to the SEC that it should not pursue cases against decentralized blockchain tokens and Section (E ) above is a rather weak safe harbor.
The legislation also seeks to establish a structure that divides regulatory responsibility between the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). If the digital asset is classified as a “Security” or “Restricted Digital Asset,” the SEC will supervise it, while digital assets classified as commodities and derivatives will fall under the jurisdiction of the CFTC.
The allocation between regulatory bodies depends on factors such as how decentralized the digital asset is on the blockchain system, the process of acquiring the digital asset, and who holds the asset (for example, a developer or an exchange). While assigning separate regulatory responsibilities, the legislation also seeks to strengthen regulatory cooperation by mandating both agencies to formulate joint regulation. This framework allows entities to register with both agencies and alleviate compliance challenges.
In addition to establishing a classification process, the legislation also introduces a certification process that allows an individual to file a certification that a blockchain system has met the criteria required to qualify as a “Decentralized System.” If the SEC does not deny the request within the 60-day review period, the blockchain system will be certified as a decentralized system and therefore subject to CFTC-style regulations rather than the SEC.
Finally, the legislation includes consumer protection in its regulatory framework. For example, FIT21 requires both the SEC and the CFTC to establish additional anti-fraud rules on digital assets beyond the anti-fraud protections imposed under the existing regulatory framework under securities and commodity derivatives laws.
Collectively, the FIT21 Act seeks to bridge regulatory gaps between traditional regulatory frameworks and new emerging technologies. Not surprisingly, SEC Chairman Gary Gensler opposes the law, saying the bill would create additional regulatory loopholes, particularly by excluding investment contracts from the definition of “security” if created on a blockchain.4
Because matter?
- The FIT21 Act is designed to eliminate the SEC’s claws to some extent and provide legislative clarity to the status of digital assets. Much blood (and legal fees) has been shed over the past decade in deciphering exactly which regulatory regime applies to a particular offering by a digital asset company. Most professionals took it for granted that securities laws were enforced, but the new legislation, if passed, would improve this view somewhat.
- The SEC and CFTC have sometimes argued over jurisdiction in this area. This has been further complicated by separate enforcement proceedings by state attorneys general and state financial services and securities regulators. The FIT21 law outlines the division of labor between the two agencies.
- The FIT21 Act is the most ambitious legislative initiative to bring order and clarity to the digital asset space. As with many financial regulations, much is left to the agency’s discretion based on the facts and circumstances of a particular offering. However, the FIT21 law at least updates and modernizes the tools so that the laws do not seem almost a century old and apply to completely different technologies than those of companies today.
- Among the bill’s supporters were nearly all the Republicans who voted in the House and many Democrats. Most far-left Democrats voted no, but many moderates and Democrats from high-tech areas voted in support of the bill (anecdotally, Marjorie Taylor Greene and Adam Schiff both voted “Yes”).
What comes next?
While House approval is a significant achievement, the FIT21 bill will then go to the U.S. Senate for consideration and a vote and then, if it passes, to the White House. There may be upcoming revisions to the legislation, as it fails to specifically address some of the issues relating to decentralized finance.
1 The FIT21 law is called HR 4763 and the text of the law and procedural history can be found here: Text – HR4763 – 118th Congress (2023-2024): Financial Technology and Innovation for the 21st Century Act | Congress.gov | Library of Congress
2 See SEC v. W. J. Howey Co., 328 US 293 (1946).
3 See SEC v. Ripple Labs, Inc. et.al. (SDNY 2024). https://www.sdnyblog.com/files/2023/07/20-CIv.-10832-2013.07.13-Ripple-SJ-Ruling.pdf AND Both the SEC and Ripple claim victory in a major securities decision.