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Digital Asset Weekly | Regulation...that is, Innovation, in the Spotlight


Hugh Meyer

Friday Focus: Regulation…that is, Innovation, in the spotlight

As part of our ongoing coverage of the Lummis-Gillibrand Responsible Financial Innovation Act announced last week, we examine Titles III and IV of the bill which discuss “Responsible Securities Innovation” and “Responsible Commodities Innovation”.

Section III: Securities Innovation

Section III attempts to answer one of the biggest ongoing debates in the Crypto industry by defining which cryptocurrencies are securities under existing SEC definitions, which include the Howey test, and establishes a new category of crypto, “ancillary assets”. Ancillary assets are not fully decentralized, and benefit from “entrepreneurial and managerial efforts” that determine their value. This definition would currently capture the vast majority of cryptocurrencies that are not fully decentralized and are controlled by a software company or foundation. These assets will be required to make disclosures to the SEC twice a year. The bill provides an offramp for assets that become sufficiently decentralized to cease making disclosures.

Section IV:  Commodities Innovation

Digital assets which do not fall under the definition of a security under Section III will be classified as commodities, and subject to regulation by the Commodities Futures Trading Commission (CFTC). The bill provides an onramp for digital assets exchanges to register with the CFTC, permits futures commissions merchants (an existing classification of futures traders) to deal in digital assets, and defines how such assets will be treated in bankruptcy.  

Taken together, these two sections strongly imply that Bitcoin and Ethereum will be classified as ancillary assets, subject to CFTC oversight as commodities. This is primarily due to their high degree of decentralization, and practically it would be difficult to bring the two largest cryptocurrencies under SEC regulation. The majority of other cryptocurrencies may be classified as securities, subject to SEC disclosure requirements, unless they can prove that they fit the definition of ancillary assets.

In the power equation between the SEC and CFTC, this bill clearly leans toward the CFTC, perhaps because of their long and broad experience of regulating the US futures market since their establishment in 1975, just as the derivatives market was taking off.  We will see if this power sharing formula holds up as the bill winds its way through Congress.

Why this matters to you:

We recognize that for the digital assets markets to continue to grow, they must be subject to sensible investor protections. This must start with a clear distinction between what is a commodity versus what is a security.  While the bill has a long way to go, competing bills may be drafted, current and future investors in digital assets must have an awareness of the evolving regulatory landscape.

Please contact us today with any questions regarding this article or any parts of the Lummis/Gillibrand proposed legislation.


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