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Two weeks ago, we dipped a toe in a court decision in the case of SEC vs. Ripple. Here’s the ultra-fast recap. The U.S. District Court of Southern New York ruled that Ripple’s XRP token was a security when being sold to institutional investors, but not a security when being sold to everyday investors. 

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For those seeking clarity on the future of crypto regulation, this was the exact opposite. 

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Then, just this week, Judge Jed Rakoff ruled on a separate case for the same District Court, granting that the SEC had a right to proceed with a relatively lawsuit against stablecoin issuer, Terrarform Labs. 

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Rakoff ruled that the SEC was correct—that the issuer’s coin qualified as a security upon sale. In making this ruling, Rakoff also reversed the court’s previous (and widely criticized) Ripple decision. 

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In Rakoff’s view, “The Court rejects the approach recently adopted by another judge of this District in a similar case, SEC v. Ripple Labs Inc. […] Howey makes no such distinction between [primary and secondary] purchasers.” 

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In short, the SEC took a swing at Ripple. They fouled off the first attempt, but managed to get on base with the next swing. 

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Now, Congress steps to the plate. 

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Mr. Nakamoto Goes to Washington

As the courts wrangle to wrap precedents around something sort of unprecedented, we are faced with an important truth. We really don't yet have the regulatory regime or legal mechanisms needed to properly regulate this rapidly innovating space.

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But the last year has seen a buzz of Congressional activity around that very imperative. 

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Of course, this isn’t the parliamentary body’s first time at bat. Actually, their stat sheet is littered with singles, walks, and strikeouts. 

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(Apologies. We may or may not be watching a baseball game while writing this…)

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Anyway, according to Cointelegraph, Congress has proposed at least 50 legislative actions concerning cryptocurrency just since 2022, attempting to address issues like the rules defining stablecoins, the enforcement tools needed to confront money laundering, and which regulatory agency gets to be the new sheriff in the Wild West that is blockchain. 

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So the fact that there are a few major legislative packages winding their way through Congress right now isn’t particularly newsworthy. What’s newsworthy is that some of these bills actually have a chance of becoming law and, maybe even setting a clear path forward for the crypto industry.

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Four To the Floor

Cointelegraph says that there are four very credible pieces of legislation in the mix today that warrant serious consideration:

Financial Innovation and Technology for the 21st Century Act

Introduced: 7/20/23; 

Sponsored By: Rep. Glenn Thompson (R-PA), chair of the House Agriculture and Financial Services Committees

Aim: To create a solid process for determining whether digital assets are commodities or securities.

Responsible Financial Innovation Act (RFIA)

Introduced: June 2022; Updated July 2023

Sponsored By: Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY)

Aims: To clarify regulatory jurisdiction between the SEC and CFTC; to create stronger investor protections.

Digital Asset Market Structure Bill (DAMS)

Introduced: June 1, 2023

Sponsored By: House Reps Patrick McHenry (R-N.C.), chair of the House Financial Services Committee, and Glenn ‘G.T.’ Thompson (R-Pa.), head of the House Agriculture Committee.

Aims: To define the roles of the SEC and CFTC relating to crypto; and to set a regulatory framework for differentiating digital commodities from securities.

Digital Commodity Exchange Act (DCEA)

Introduced: September 2020; Updated April 2022.  

Sponsored by: House Rep. Glenn ‘G.T.’ Thompson (R-Pa.), head of the House Agriculture Committee; and Reps Ro Kanna (D-CA); Tom Emmer (R-MN); and Darren Soto (D-FL)

Aims: To define who can register to offer stablecoins; to establish CFTC jurisdiction for digital assets that are not identified as securities.

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Naturally, there’s a lot in there. And we are skeptical that any bills emerging from the House without bipartisan support will make meaningful progress in the Senate.

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So we’ll save the real dissection until such time as one or several of these bills actually becomes law. But for now, the collection of bills is a pretty good way to see which way the wind is blowing.

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Capitol Idea

We agree that an act of Congress is the likeliest way through all of this. Once again, the XRP reversal illustrated that we still lack the clear legal framework to regulate crypto. So it’s up to Congress to make that legal framework.

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Obviously, we always temper our expectations when faced with the specter of a Congressional Act. 

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This is complicated stuff and…well…there is no IQ test for Congressional eligibility.

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But there is actually a bipartisan desire to address the issue. This makes crypto a unicorn among policy issues. It's clear that both Congressional Democrats and Republicans support some action on crypto. There’s even some meaningful overlap on the subject, with both sides recognizing the need for a regulatory regime and the opportunity for innovation. 

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So if we’re being optimistic here, there is a bit of breathing room for compromise. But surely, there is no guarantee. Because despite the surface level harmony, the collected bills under consideration represent something of a regulatory turf war.

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Turf War

On one side, the SEC remains the preferred regulator among many Congressional Democrats. It is understood—especially under the comparatively proactive leadership of Chair Gensler—that the SEC would impose stricter regulatory oversight upon the crypto industry. This would include a strong emphasis on protections for individual investors.

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At the root of this assumption is the reality that the SEC is the far bigger regulatory agency in this tug of war, and that it possesses far more resources to address the full scope of this regulatory challenge.

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On the other side, The Commodities Futures Trade Commission (CFTC) is the preferred regulator among Congressional Republicans and players in the crypto industry itself. The view is that the CFTC would be more lenient and sympathetic to the priorities of said industry. 

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At least in part, that view extends from the CFTC’s relatively smaller size and lesser resources relative to the SEC. The assumption is that the CFTC would simply be less able to devote the same resources to enforcement.

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That said, if you speak to crypto industry insiders, you learn that to an extent, the preferred regulator is simply one who’s willing to actually take on the job. In spite of the SEC’s fervor in bringing legal action against crypto entities, there are some pretty loud rumors out there about the Commission’s unwillingness (or inability?) to provide meaningful guidance to those same entities as they have attempted to navigate registration. 

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This may well explain why, in spite of ongoing talks between the SEC and Coinbase for instance, conversation ultimately unraveled into a lawsuit. There is some speculation that the SEC has repeatedly declined industry requests for guidance. In other words, it’s possible that the SEC has done more to discredit its own role in regulating the blockchain industry than have any of its external critics.

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But the CFTC has proven more than willing to succeed where the Commission has failed. This is why, If you look at the thrust of the bills above, the legislative push clearly favors widening the CFTC’s authority. 

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We Could Be Royals

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Perhaps most consequential among these bills is the Lummis-Gillbrand bill. It would seem to have the edge on a few fronts. First and foremost, it is an ostensibly bipartisan bill—a legislative package that must pass through a Democratic Senate majority while carrying the support of a well-known crypto industry advocate. 

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Lummis is known in some circles as the Crypto Queen. The Republican lawmaker has a clearly-stated affinity for blockchain based entrepreneurs. We can’t confirm any actual royal lineage.

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By contrast, Gillibrand has expressed a particular interest in advancing investor protections in a space where these are lacking. Together, they are sponsoring a bill that is meant to satisfy both sides of this dichotomy.

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It is also the most comprehensive bill on the table. In its current form, the Lummis-Gillibrand bill is positioned to begin sewing up many of the holes that cryptocurrency bored into the existing regulatory regime. 

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Highlights of the 10-Point Plan include language designed to distinguish securities from commodities in the crypto space; specification of the regulatory roles to be played by the SEC and the CFTC in this space; and, prominently featured in the proposed legislation, enhanced conditions for consumer protections.

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In fact, during the year-long process of revising the original bill, a big area of focus was beefing up consumer safeguards in light of the FTX scheme that crashed crypto markets in 2022. Thus, the bill would also provide a framework for enforcement actions against those who act illicitly in the crypto space. 

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In producing the bill, Lummis and Gillibrand have also effectively voiced the concerns of their respective supporters.

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Senator Gillibrand asserts that "Congress has a duty to step in to protect consumers and root out bad actors, while also creating a transparent and accountable market. Our framework does that and we will make passing this bipartisan legislation a priority in this Congress,"

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Lummis agrees that “bad actors exist,” but also notes that “we cannot lose sight of the potential of crypto assets and distributed ledgers to modernize our financial industry.”

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They’re both right. This is why, at its very core, the viability of this regulatory regime–or any regulatory regime, really–should be greeted as good news.

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That said…

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SEC Ya!

Nobody will greet this news with greater enthusiasm than the crypto industry, which has long advocated for some regulatory direction while expressing general hostility toward the SEC.

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But for many lawmakers and regulators, the regulatory thrust of the collective bills is taking us down a path that could be dangerous for everyday investors. 

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A House Democrat, speaking anonymously, said of the Lummis-Gillibrand bill,“I was skeptical of the original bill, and I am skeptical of this one…This bill appears to be another effort to muzzle the SEC by the industry in favor of what it sees as an easier regulator in the form of the CFTC.”

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I’m Telling On You

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Democrats have even stiffer and more public doubts about the McHenry-Thompson DAMS Act. House Representative Maxine Waters (D-CA) recently called on Chair Gensler and Treasury Secretary Janet Yellen to take a closer look at the likely impact of the DAMS Act. She asked both to explain how the new legislation would impact the respective abilities of their Commission and Department to carry out their charges. 

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This follows the California Congresswoman’s laundry list of concerns upon the bill’s introduction in June. 

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Waters said “I am particularly worried that the Republican bill would allow crypto firms that are currently being sued for violating our securities laws to continue doing business through provisional registration. We witnessed last year when disgraced FTX CEO Sam Bankman-Fried defrauded millions of customers, and now the SEC is taking actions against firms like Binance and other firms for potentially similar behavior. The bill appears to halt any enforcement actions by the SEC against crypto firms, even when they have committed fraud. This provisional registration could reward bad actors with a ‘get out jail free’ card and allow them to continue harming consumers and investors.”

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By contrast, the crypto industry views the McHenry-Thompson bill favorably, particularly the provision that would “create an SEC exemption specifically tailored to the initial sale of digital assets in the same way that crowdfunding framework was specifically tailored for smaller businesses as a result of the JOBS Act.”

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This exemption could pave the way for more entrants, greater innovation, and a clear path forward for emergent crypto players. Speaking upon its release in early June, Chairman Thompson asserted that “Today’s release of the discussion draft brings us one step closer to bringing regulatory certainty to these novel and emerging technologies….This historic joint effort with the House Committee on Financial Services aims to close existing authority gaps between the CFTC and SEC and bolster U.S. leadership in financial and technological innovation.”

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Summer of Wildfires

On the surface, we have some concerns about the relative lack of disclosure requirements in the McHenry-Thompson Bill. For everyday investors, this may simply warrant a restatement of a lesson we should all have learned by now anyway. Proceed with extreme caution. 

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That said, we recognize the inherent value of creating a space for innovation. There is a tremendous opportunity to be had in the crypto space. This could represent a huge boon to U.S. markets and a chance to further democratize prosperity on a global scale. Many crypto industry advocates say these higher aspirations are simply not possible under the terms of the current U.S. securities regime. 

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It seems clear to us, and many on both sides of the aisle, that the current SEC approach to crypto is inadequate. And today, Congress is at least moving toward something resembling clarity. 

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Still, it will be a while before the smoke clears. There are a lot of logs on the fire, including additional bills relating to money laundering and consumer protections. When the smoke does clear, we wouldn’t be surprised to see the CFTC standing at the top of this regulatory hierarchy. 

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However, we also wouldn’t be surprised to see the CFTC get additional resources in order to cover this new remit. If this does happen, the CFTC might not be quite as lenient as some in the crypto industry hope.

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It remains to be seen how any or all of these bills will ultimately stand up the legislative process. But for now, there is at least some political will on both sides to get something done. We would cautiously describe this as a good thing for everybody. 

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