On April 27th 2023, the House Agriculture Committee Subcommittee on Commodity Markets, Digital Assets, and Rural Development held a hearing entitled “The Future of Digital Assets: Identifying the Regulatory Gaps in Spot Market Regulation.” The witnesses in the hearing were:
- Purvi Maniar, Deputy General Counsel, FalconX Holdings, LTD.
- Daniel Davis, Partner, Katten Muchin Rosenman
- Nilmini Rubin, Head of Global Policy, Hedera
- Timothy Massad, Former Chairman, Commodity Futures Trading Commission (CFTC)
- Joseph Hall, Partner, Davis Polk & Wardwell
Below is a summary of the hearing prepared by Delta Strategy Group. It includes several high-level takeaways from both panels, followed by summaries of opening statements and witness testimonies and a summary of the Q&A portion of the hearing.
Key Takeaways
The following is a summary of some of the topics explored in today’s hearing. Each is discussed in further detail in the Discussion section below.
- Chairman Dusty Johnson
- Regulatory gaps are harming innovators and investors alike. Principles-based regulations can help these markets to flourish.
- We are beginning an unprecedented process of working with the House Financial Services Committee to work on these issues together to create a clear regulatory framework.
- Ranking Member Yadira Caraveo
- Regulators have played an important role in regulating these markets in the capacity they have today, but it is time for Congress to act to create clear jurisdictional authorities for this space.
- With any additional Authority that Congress grants, we must also ensure that these regulators are appropriately funded.
- Committee Chairman GT Thompson
- I am excited to work with the House Financial Services Committee to ensure that we can create a bipartisan and cross-Committee framework that truly serves these markets and investors.
SUMMARY
Opening Statements and Testimony
Subcommittee Chairman Dusty Johnson (R-SD)
We need to study how the gaps in this regulatory framework are harming innovators and consumers alike. There has been an unprecedented level of cooperation and collaboration between this Committee and the House Financial Services Committee on these issues. The digital asset space has tremendous potential, but it also has a large amount of hype and failures. Today, we restart our work to help create a framework that will allow digital asset innovation to emerge in the U.S.
Ranking Member Yadira Caraveo (D-CO)
There has been tremendous volatility in cryptocurrency markets, and we have seen catastrophic failures. The CFTC has brought numerous enforcement actions in this space. Considering recent market events, we must examine regulations to ensure that investors are appropriately protected, and our agencies have the necessary authorities to oversee the industry.
A significant number of investors in this space are retail investors, meaning we should consider their lower risk tolerance when considering digital asset legislation. When we do consider legislation, we must also ensure that the CFTC is appropriately funded to carry out its mission to promote the integrity and resilience of derivatives markets.
Committee Chairman GT Thompson (R-PA)
No one group can solve the issues in this space alone, and we are conducting unprecedented work with the House Financial Services Committee to address these concerns.
Purvi Maniar, Deputy General Counsel, FalconX Holdings, LTD.
There is no single regulator of digital assets in the U.S., and each of the US regulators has their own authority and regulatory viewpoints. The lack of clear oversight and jurisdictional lines hinders global competitiveness and creates barriers to entry in a significant space. We are subject to rigorous CFTC regulations, and we have found this to be a benefit, not a negative, in our business. The SEC’s regulatory framework is ill-suited for digital assets, and many of its disclosures have no analogous versions in our space. We believe that legislation like the Digital Commodity Exchange Act, which takes some of the basic principles of CFTC regulation and applies them to digital asset spot markets, would have a significant benefit for our industry.
Daniel Davis, Partner, Katten Muchin Rosenman
There is a significant gap in regulatory jurisdictions, as the majority of activity in digital asset spot markets operates outside the jurisdiction of the CFTC and the SEC. The CFTC has enforcement oversight of the space, but it lacks regulatory authority to extend its best practices and regulations to the spot market space. While the CFTC has brought a number of significant enforcement actions in the space, there is a clear gap for digital asset spot markets.
It appears that the CFTC has asserted that seven of the top fifteen digital assets are commodities, accounting for over 75 percent of the digital asset market cap. The SEC has never challenged any of these claims. The SEC has only specifically claimed that one of the top fifteen digital assets is a security, which accounts for 2 percent of market cap.
Nilmini Rubin, Head of Global Policy, Hedera
Digital assets enable fast and cheap fuel for new networks to operate effectively. Public blockchain projects, such as carbon-reducing ag projects, need digital assets to operate. The current regulatory environment provides no clear path to compliance for digital asset projects. Congress should pass legislation that regulates digital assets based on the nature of the transactions. Congress should define digital commodities and securities. It should also empower the CFTC to regulate centralized spot marketplaces. We cannot remove Americans’ access to these new innovations that the rest of the world will be harnessing.
Timothy Massad, Former Chairman, CFTC
There is still no regulator for digital asset spot markets, which has resulted in significant failures and losses in these markets. One key issue is the disagreements and conflicts between the CFTC and SEC’s views on digital assets. We should fill this gap without rewriting laws or lowering the authorities of either agency. Any trading or lending platform should be required to comply with a core set of principles unless it has registered with the SEC and CFTC. This approach would greatly increase investor protections by bringing strong principles to centralized exchanges. Law should make clear that the SEC and CFTC should not lose any responsibility.
Joseph Hall, Partner, Davis Polk & Wardwell
The root of this problem is that digital assets are inherently different from the asset classes our regulatory structure is built for. Because they combine functionality with easy transferability, they are different from assets that come before them. Determining whether tokens are securities or commodities is a difficult and unclear process. It is not easy for businesses to plan and invest when the answer to their biggest questions is a maybe.
The problem is that today, registering with the SEC is not a practical option for companies. The SEC framework is built for passive instruments, but it is not built for activities such as facilitating payments. The SEC has taken no steps to adopt its framework to the digital asset space. If there were practical routes to registration, I am confident that more entities would register. It is time to move past the debate over whether digital assets are securities and create a new paradigm designed specifically for the characteristics of digital assets.
Discussion
Johnson (R-SD): What are the consequences of conflicting statements by the SEC and CFTC on these issues? What does it mean that these regulations are unpredictable? Davis: It is very hard to advise companies on how to act in the space. Bitcoin and ether have been trading on CFTC-regulated markets for years, and these are the strongest cases for assets not being securities; Hall: Regulators and the regulated need to be able to look at the facts of their assets and activities and draw a similar conclusion on whether or not they are subject to regulation. There must be a common language to create clarity on the rules for this space. We should not be relying on judgement calls for each asset based on the SEC’s current tests.
Thompson (R-PA): What are some use cases for companies that utilize blockchain networks to improve their businesses? Rubin: There are programs where farmers can tokenize carbon credits created from beneficial farm practices to monetize their conservation efforts. We have not even begun to explore all the possible use cases for this technology.
Thompson (R-PA): If all digital assets were deemed securities, how would it impact your customers? Maniar: It would deeply disrupt our clients. It would suddenly mean that the assets they hold have no practical use anymore.
Caraveo (D-CO): How did the CFTC first make determinations in this space? What is the potential effect of passing legislation to address regulatory gaps without increasing funding for regulators? Massad: The definition of a commodity does not predict digital assets, but we believe that derivatives contracts for future delivery on digital assets defined them as commodities. It is important to keep that concept in mind as we consider future assets. You would need to greatly increase resources for either the SEC or the CFTC to regulate these markets.
Davis (D-NC): Why do the CFTC or SEC matter to average Americans? What would be the impact of a CBDC be on the average American? Massad: Proper oversight could help protect investors from the illicit market practices that led to massive losses in recent months. The Fed is engaged in research on a CBDC, but it is years away from being created if we even decide that we need it.
Langworthy (R-NY): Are we seeing an innovation flight as other jurisdictions such as the EU create regulatory frameworks? Adversaries like Russia and China would love to usurp us as global financial leaders. What would be the risks if the U.S. allows adversaries to take the lead in these spaces? Maniar: It is critical for us to remain a leader in the future of finance. We have always been a leader in financial markets, and we need to continue with this asset class as well. If these markets do move overseas, Americans will continue to invest in them outside of U.S. jurisdiction; Rubin: Yes, people are fleeing to jurisdictions with greater clarity. This is bad for both innovators and consumers.
Budzinski (D-IL): How could we better educate consumers on the risks in this industry? Massad: Investors are aware that these assets have price risks, but they do not realize the risks of unregulated trading platforms. There is no insurance or regular disclosures or protections in bankruptcies for consumers.
Rose (R-TN): Are you concerned that if we do not take the lead in regulating other countries may seek to use this technology to exploit their citizens? Maniar: Yes, this is why the U.S. must be leader both in this industry and its regulation.
Chavez-Deremer (R-OR): Does the CFTC work well in tandem with the SEC? Massad: I worked closely with the SEC on Dodd-Frank requirements. That cooperation dates back to the founding of the SEC.
Rouzer (R-NC): What kind of overregulation would you avoid in this space? Massad: I am worried Congress will try too hard to try and define what is and is not a security. There are many different models for this decision and being overly prescriptive could limit markets; Hall: We need Congress to provide basic boxes to put these different assets in; Maniar: I would like to see principles-based regulations so that innovation can continue to occur.
Nunn (R-IA): Is ether a security? Massad: I do not have enough information for this. When the merge happened, it might have made ether a security; Where do you see innovation impacted by a lack of certainty? Maniar: Certainty keeps people from wanting to build and work in this industry. Congress can empower this space by providing certainty. I believe that there should be a system with clear rules of the road that we know will be the same tomorrow.
Molinaro (R-NY): How would you rank the New York state regulatory structure? Hall: The BitLicense works quite well for what it does, but some businesses have deliberately avoided operating in the state because of it. The states have a clear role to play in this regulation, but if you have a business operating across state lines on the internet, you need a federal framework; Maniar: This is why a principles-based approach is so useful. There should be federal principles that can be enforced at more local levels.