Cryptocurrency Regulation and the 118th Congress
The crypto industry endured much turmoil in 2022, ushering in close congressional scrutiny of the industry. Major bankruptcies included FTX, the Celsius Network, and BlockFi. The collapse of FTX was especially noteworthy and resulted in high-profile hearings in both the House and Senate, as well as criminal investigations.
While crypto proponents and skeptics are divided on the value of cryptocurrencies, policymakers from across the political spectrum have indicated their strong desire to act in some fashion. The 118th Congress, in just its first two months, has set a steady pace of activity. The Senate followed up on congressional hearings late last year on the implosion of FTX with a hearing focused on safeguards for digital assets. Meanwhile, the House set up the Digital Assets, Financial Technology and Inclusion Subcommittee and held its first hearing to investigate digital assets. While the path forward for Congress is unclear, any legislation will require bipartisan support given Republican control of the House and Democratic control of the Senate.
Some Major Issues and Relevant Legislation
Legislation from the previous Congress can be a helpful guide in determining what the Congress will do this year, and what issues they will focus on. Two major crypto bills from the last Congress were the Responsible Financial Innovation Act (RFIA) and the Digital Commodities Consumer Protection Act (DCCPA), but there were also several smaller bills introduced that are likely to be reintroduced again this Congress. Based on these bills, several issues seem likely to reemerge this Congress.
Regulation and the Security Versus Commodity Debate
Significant debates exist around whether a crypto asset should be classified as a security or commodity as well as the appropriate regulatory role of the SEC and CFTC. If a crypto asset is deemed a security, the SEC would have broad jurisdiction over its regulation. If a crypto asset is deemed a commodity, it would be regulated as a commodity and in part by the CFTC (more discussion on regulatory gaps later in this blog). The crypto industry generally prefers crypto assets to be deemed commodities and have the CFTC as a regulator, while crypto industry critics generally prefer crypto assets to be designated as securities and regulated by the SEC.
Under existing law, regulators and courts can use the Howey test (set by the Supreme Court) to determine if a crypto asset is a security. The test has been used by the SEC to make that determination, but critics have suggested the agency has provided the crypto industry with inadequate guidance on its interpretation of the Howey test.
Many debate whether existing law is well-designed for crypto assets or needs to be modified or clarified by Congress. For instance, former Senator Pat Toomey (R-PA) argues “Given the novel nature of these tokens, Congress ought to step in to provide clarity…. crypto tokens have varying degrees of decentralization, usually do not have a financial claim on the issuer, and typically can be settled in real-time without intermediaries. These are important differences from traditional securities. And they merit a clearly stated and tailored regulatory framework.” In contrast, former SEC Chair Jay Clayton argues “the problem is not a lack of clarity around regulation. The problem is that people engaged in the crypto ecosystem don’t like the existing regulations because compliance is costly. The claim of regulatory uncertainty is in many cases no more than a thinly veiled attempt to avoid these costs.” Several bills introduced last Congress, such as the Securities Clarity Act and Token Taxonomy Act, weigh into this debate.
Much debate also exists on the best approach to identifying and closing gaps in financial regulation for crypto assets. For instance, the Financial Stability Oversight Council (FSOC) has identified a gap in spot markets for crypto assets that are not securities. The Digital Commodities Consumer Protection Act, introduced last congress, attempted to address this gap by giving more regulatory authority to the CFTC in spot markets, but critics and supporters debated the bill’s approach.
FSOC has also raised concerns about regulatory arbitrage as another gap. Specifically, stating that “crypto-asset businesses do not have a consistent or comprehensive regulatory framework and can engage in regulatory arbitrage. Some crypto-asset businesses may have affiliates or subsidiaries operating under different regulatory frameworks, and no single regulator may have visibility into the risks across the entire business.”
Stablecoins, crypto assets pegged to a non-crypto asset such the U.S. dollar, have gained considerable regulatory attention in recent years. A major concern with stablecoins is that a large number of stablecoin owners might try to redeem the underlying asset at once and the stablecoin issuer will not have the reserves necessary to meet demand. While House Financial Services Committee Chairman Patrick McHenry (R-NC) and Ranking Member Maxine Waters (D-CA) have stated their desire to work on bipartisan stablecoin legislation, to our knowledge, nothing has been made public as of this writing.
Other Crypto Issues
Several other crypto issues have received considerable attention, including anti-money laundering rules, tax policy, and environmental disclosures. The Digital Asset Anti-Money Laundering Act of 2022 would have created stricter anti-money laundering requirements on the crypto industry. The Virtual Currency Tax Fairness Act would have put in place tax exemptions on certain small dollar crypto transactions. The Crypto-Asset Environmental Transparency Act of 2022 would have created more environmental study and reporting requirements for crypto miners and has been reintroduced this congress.
Finally, issues around blockchain, the underlying technology behind cryptocurrencies, are also being examined. For instance, last Congress, the Blockchain Promotion Act of 2021 would have created a working group within the Department of Commerce to study and recommend a definition for blockchain technology.
The crypto industry is facing considerable scrutiny by Congress. Crypto regulation questions are front and center, but policymakers have had trouble reaching compromise on a range of issues from stablecoins to commodity spot markets. In a divided government, legislation will require bipartisan support to pass so compromise will be necessary.
Note: This blog was written prior to the March 2023 bank failures and therefore does not analyze the policy implications of those events.
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