House Financial Services Committee Hearing

On June 13, the House Financial Services Committee held a hearing entitled “The Future of Digital Assets: Providing Clarity for the Digital Asset Ecosystem.  The witnesses in the hearing were: 

• Jeremy Allaire, CEO, Circle 

• Coy Garrison, Partner, Steptoe & Johnson LLP, Former Counsel to Securities and Exchange Commission (SEC) Commissioner Hester Peirce  

• Emin Sirer, CEO, Ava Labs 

• Thomas Sexton, President and CEO, National Futures Association (NFA) 

• Aaron Kaplan, Co-CEO, Prometheum, Inc. 

The hearing listed the Committees’ latest drafts of stablecoin and market structure legislation. 

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. 

The following is a summary of the main topics explored in today’s hearing.  Each is discussed in further detail in the Discussion section below.   

• Committee Chairman Patrick McHenry (R-NC) 
  • We are seeking input on these bills and welcome bipartisan discussions.  We plan to mark them up upon our return from the July 4 recess. 
  • The SEC’s regulation by enforcement has held this industry back and provided no meaningful clarity for investors or market participants.  This legislation addresses that. 
• Committee Ranking Member Maxine Waters 
  • There are particular concerns with the provisional registration provisions in this bill.  These could serve as a get-out-of-jail-free card for bad actors that allows them to get away with the exact activities we saw with the FTX collapse. 
• NFA President and CEO Tom Sexton 
  • This industry has clear similarities with retail foreign exchange (forex) platforms, and Congress should address it in a similar way by giving CFTC regulatory jurisdiction over trading platforms.   
  • NFA is capable of implementing the same investor protections that it does for futures and swaps markets for the digital asset industry. 
• Digital Asset Subcommittee Chairman French Hill (R-AR) 
  • Provisional registration was successful for swaps markets during the implementation of Dodd-Frank.  This could work for the digital asset space as well. 
• Representative Tom Emmer (R-MN) 
  • Just because something is sold through an investment contract does not mean that the token itself is a security.  This bill should clarify that distinction. 

Committee Chairman Patrick McHenry (R-NC) 

Digital assets are no longer a new technology, and the U.S. is at risk at falling behind the rest of the world at implementing this technology.  We need to modernize our regulatory framework so that digital assets are subject to the same regulation as any other financial market.  This should be a bipartisan process, and I intend it to be.  We will mark up this draft when we return from the July 4 recess. 

This bill would require trading platforms to adhere to strict customer asset segregation requirements similar to what is required by most traditional intermediaries.  It also addresses how issuers raise capital for projects.  We know that informative disclosures are critical for investors, and we have worked to create a fit-for-purpose disclosure regime for this space.  This framework provides clarity for both digital commodities and tokens issued as part of an investment framework.   

Committee Ranking Member Maxine Waters (D-CA) 

Committee Democrats have looked at this legislation, but the bill is highly complex and long.  Any bill that would seriously overhaul our nation’s capital markets must be worked on in a bipartisan way.  We also need the input of our regulators and stakeholders.  That said, I have some concerns with the bill. 

This bill would allow crypto firms that are being sued by the SEC to continue doing business through provisional registration.  The SEC has taken important action against firms like Coinbase and Binance for potentially the same behaviors we saw with FTX.  Halting enforcement actions when companies have committed fraud could reward bad actors with a get-out-of-jail-free card.  The SEC is bringing enforcement actions against funds for comingling customer assets, so it is unclear why this bill would allow these companies to continue these practices.  Companies are receiving approval to operate under our existing securities laws, showing crypto firms are not being truthful when they say they cannot operate under existing securities laws. 

I am encouraged by the bipartisan progress we have made on stablecoin legislation.  We need to include diversity and inclusion protections, stronger consumer protections, and wholly insufficient federal oversight of state-approved issuers. 

Representative French Hill (R-AR) 

This bill would prevent another FTX from happening through establishing clear and strong federal regulation for digital asset markets. 

Representative Stephen Lynch (D-MA) 

Both of the bills considered in this hearing would seriously undermine existing financial regulations and would hinder the SEC’s ability to carry out robust enforcement. 

Jeremy Allaire, CEO, Circle 

The steps the government takes now on stablecoins will impact the future of the dominance of the U.S. dollar.  Technological superiority is at the heart of this goal.  I appreciate the stablecoin legislation we are considering today, and I believe it must be a national priority.  We need to ensure that the U.S. is at the forefront of creating the rules for how dollar-denominated stablecoins are issued and regulated around the world.  We need standards for all stablecoin issuers that can be enforced by federal regulators when appropriate.  Issuers should only hold reserves that are even safer than fractional reserve banks.  We should also afford issuers limited rights to basic Fed services to improve their service to customers.  We need stronger protections around the custody of digital assets.  Stablecoin intermediaries should have to hold them with state registered qualified custodians. 

Coy Garrison, Former Counsel to Securities and Exchange Commission (SEC) Commissioner Hester Peirce 

Congress must act to bring sensible regulation to the digital asset space, and today’s proposal is thoughtful and measurable.  It would create vital consumer protections while also creating an environment where the industry can innovate and succeed.   

The application of the Howey test is not always straight forward and requires the consideration of as many as sixty categories.  There is also no case law for addressing the application of the Howey test to a secondary market transaction in an investment contract.  SEC staff has also taken the position that tokens can eventually no longer be a security, but there is no guidance on how or when this happens.  Congress must act on this issue because the SEC has refused to create a workable regulatory framework for this space.  Congress must act because inaction harms digital asset investors.  This bill would create the regulatory certainty that this industry needs to succeed. 

Emin Sirer, CEO, Ava Labs 

We are in a period of technological innovation that marks a pivotal shift in the nature of the internet.  Blockchain allows us to redefine trust, communication, ownership, and commerce transforming how we interact with digital systems and each other.  Any regulatory regime imposed by Congress must start and end with the functionality and features of digital assets, not the underlying blockchain technology.  Decentralized networks are a desirable outcome for this technology beyond any regulatory desires for their use cases.  Blockchain builders did not build technology to evade laws; they built blockchains to improve traditional systems and solve computing problems. 

The U.S. won the first wave of the internet revolution because it enabled the freedom to innovate responsibly, and it must do the same for blockchain technology.  It should sensibly regulate tokens based on their uses.  Blockchain platforms should not be regulated at the protocol level.  

Thomas Sexton, President and CEO, National Futures Association (NFA) 

We applaud the work on this draft, and we believe this draft contains the critical consumer protections that Congress should adopt as it goes forward with developing a regulatory framework for digital asset commodity spot trading.  NFA is solely a regulator, and we work closely with the CFTC to accomplish our mission.  One key oversight area of our oversight is the monitoring of consumer fund segregation and ensuring that customer funds are in the right place on a daily basis.  We also investigate any possible rule violations and vigorously enforce our rules. 

We believe that digital asset commodity trading platforms are comparable to retail forex trading platforms.  Congress prudently placed a fence around these platforms and created a separate registration regime for dealers in this space. 

NFA member firms are already within our registration regime.  We have created rules to install anti-fraud and market manipulation rules for bitcoin and ether already.  Only Congress can create a true registration and regulatory regime for digital asset commodities. 

Aaron Kaplan, Co-CEO, Prometheum, Inc. 

We are building a public market for digital asset securities within existing securities laws.  We are developing a fair and orderly market fully compliant with existing securities laws.  Properly regulating crypto trading settlement and custody under existing securities laws provides a proven mechanism to allow responsible participation and innovation while ensuring that consumer protections are in place.  

There has been much discussion about the need for greater regulatory clarity for digital assets.  The discussion today should not be about creating new regulations but applying the existing regulations to digital assets.  The SEC and FINRA perform vital functions for the markets they oversee, and they have proven to be the best regulators to promote retail markets.  Most digital assets offerings have violated securities laws and the SEC has responded accordingly.  Implementing new legislation will take years while the investing public will continue to operate on reckless, unlawful platforms. 

McHenry (R-NC):  How many foreign regulators have proposed new frameworks for digital assets?  How has regulation by enforcement held back progress in the U.S.?  Would the SEC and CFTC be able to serve as primary regulators for the digital asset commodity spot markets?  Sexton:  Between six and twelve including Europe.  European regulation has encouraged innovation and investment to leave the U.S. to move to this jurisdiction;  Sirer:  A lack of clarity regarding token issuance holds back many innovators from residing in the U.S. and pushes many outside of our jurisdiction;  Sexton:  If that is how Congress defines these terms, we would be able to regulate these spot markets.  We have strong consumer protections for commodities just as the SEC does for its markets. 

Waters (D-CA):  Should the comingling of customer funds be prohibited?  Are there activities that SEC-registered broker dealers are prohibited from that would be allowed under this bill?  Kaplan:  We believe that customer funds should not be allowed to be comingled.  We are capable of custodying digital asset securities with filings and disclosures.  These systems are the best way to protect the public.  The best way to protect investors is to establish the SEC and FINRA as the primary regulator for this space. 

Hill (R-AR):  How did the provisional registration period work during Dodd-Frank, and why is it needed for this space?  Would this framework allow for the conflicts of interest and comingling of funds that Democrats have voiced concerns over?  Garrison:  The provisional registration period acknowledges the reality that these markets exist now.  Customers use these platforms now, and they need to continue to function as these rules are written.  These rules would prevent all of the concerning activities that have been discussed today. 

Scott (D-GA):  Could this bill result in less protection for investors than is currently provided?  Kaplan:  I anticipate that it would.  Securities laws are tried and tested over generations and creating a new regulatory regime would create a void between what we have now and what could potentially exist.  Provisional registration provides a get-out-of-jail-free card that prevents the SEC from going after their previous actions. 

Lucas (R-OK):  Why should we not wait to pass this legislation?  How important is it for Congress to act to protect consumers?  Garrison:  The longer we wait on these issues, the more the trading public remains at risk of being abused.  It also creates more uncertainty for the industry and increases the risk of innovation moving offshore;  Allaire:  We are seeing governments around the world defining the rule for how digital dollars are issued in their markets.  The U.S. needs to be responsible for what happens with the dollar;  Sexton:  We saw the importance of Congressional action with retail forex.  We believe a similar framework needs to exist for digital assets.  There needs to be regulation along with enforcement authority for this space.  If this legislation were to pass, the NFA would amend its rules to accommodate bitcoin and ether and allow intermediaries to register with us.  Then, we would create consumer protection rules for this space. 

Velazquez (D-NY):  What are your views of the stablecoin bill as it exists today?  Allaire:  We believe this rule creates a strong framework for a federal floor for regulation and allowing states to create appropriate regulatory oversight for these requirements.  The bill stipulates core requirements for reserves, safety and soundness, and transparency.  This allows for dynamic markets and changing technology;  Kaplan:  There are issues with the state requirements.  States should not be able to expand the types of reserve assets acceptable under the law.  

Posey (R-FL):  How should investors consider liquidity risks with stablecoins as opposed to banks?  Allaire:  This bill sets out standards for stablecoin reserves that make them dramatically safer than bank deposits.   

Luetkemeyer (R-MO):  What percent of your company is owned by a Chinese company?  Kaplan:  20 percent.  They have the same rights as other shareholders, but they do not have access to intellectual property.  No customer data is exposed to these investors. 

Meeks (D-NY):  Who is currently your primary regulator?  Allaire:  We are regulated by almost every state in the country.  States have a vital role to play in regulating stablecoins.  A state path for stablecoin registration would not create a race to the bottom for regulatory requirements if there were a strong federal floor for regulations. 

Wagner (R-MO):  Do the bills we are considering today fix the problems we saw with FTX?  Does the SEC prevent companies from coming in and registering with the SEC?  Allaire:  Both of these bills address the comingling problem that was the primary issue with FTX;  Garrison:  The lack of a regulatory framework for digital assets makes it impossible for digital asset intermediaries to comply with current SEC requirements.  Secondary trading rules need to be updated to acknowledge that certain intermediaries are not necessary in digital asset markets. 

Lynch (D-MA):  What are the consequences of a bill that allows companies to choose jurisdictions with fewer requirements?  Kaplan:  Customers will be harmed.  The only way forward is to apply securities laws to these markets. 

Barr (R-KY):  Do existing securities laws apply clearly to digital assets?  Garrison:  Digital assets are not in the statute, so we determine whether they are investment contracts.  Digital assets can be sold in a way that constitutes an investment contract, but that does not mean that the tokens are investment contracts for all time.  They do not operate as equity securities.  They are purchased for a number of different reasons beyond simply investing.  Existing securities laws are a piece of this puzzle, but there are massive gaps in current regulations. 

Emmer (R-MN):  I am concerned that this bill would allow tokens to be both securities and commodities.  Just because tokens are sold through an investment contract, it does not mean that token is a security forever. 

Himes (D-CT):  Does this legislation prevent all comingling?  Garrison:  I believe that this bill would allow a specific exception to comingling;  Kaplan:  We have to apply securities laws to this entire industry to ensure that there is never comingling. 

Davidson (R-OH):  Should the SEC make it clear whether an asset is a security?  What is the importance of self-custody?  What are the requirements for comingling under Dodd-Frank?  Garrison:  It should be a bright line test for investors, innovators, and regulators.  There is nothing to stop the SEC from allowing tokens to register and be regulated as securities, but they have not done this;  Sirer:  The failure of FTX was not due to crypto but due to the failure of centralizes custodians;  Sexton:  In swaps markets, we have requirements surrounding sufficient funds to pay off all liabilities to customers. 

Foster (D-IL):  If we wish to prevent market abuses, is there an alternative to a regulator seeing the true identity behind every participant in every trade?  Sexton:  This has been handled by the trader id mechanism.  There needs to be a regulator with this information. 

Torres (D-NY):  Is there a contradiction between the lawsuit against Coinbase and its IPO filing?  If almost every token is a security, why does the SEC only flag thirteen in the Coinbase case?  Garrison:  Yes.  The SEC had to do a public interest filing, and it should have flagged any issue then.  It would be nice to have a full understanding of which tokens the SEC believes are securities. 

Nickel (D-NC):  What is the advantage of market structure legislation?  Garrison:  This provides critically needed protections for investors, so they are not just at the whim of a platform. 

Flood (R-NE):  Can Prometheum customers trade in any commonly used tokens?  Kaplan:  No.  Regulation and new ATSs are working slowly to add additional assets as time goes on. 

Nunn (R-IA):  How would a token be able to go from a security to a commodity?  What are your thoughts on the customer protections provided by this legislation?  Garrison:  It would provide an exemption for firms wanting to issue tokens via investment contract;  Sexton:  The customer protections provided in this proposal mirror the protections from the futures markets.  These have been in place for years.  The NFA would have the ability to work with the CFTC to implement all of these standards.