SENATE COMMITTEE ON AGRICULTURE, NUTRITION, & FORESTRY
HEARING ON FEDERAL OVERSIGHT OF DIGITAL COMMODITIES
For questions on the note below, please contact the Delta Strategy Group team.
On July 15, the Senate Committee on Agriculture, Nutrition, and Forestry held a hearing entitled “Stakeholder Perspectives on Federal Oversight of Digital Commodities.” Witnesses in the hearing were:
- Ji Kim, Chief Executive Officer, Crypto Council for Innovation
- Rostin Behnam, Distinguished Fellow, Psaros Center, Georgetown University
- Timothy Massad, Research Fellow and Director of Digital Assets Policy Project of the Mossavar-Rahmani Center for Business and Government, Kennedy School of Government at Harvard University
- Tom Sexton, President and Chief Executive Officer, National Futures Association
- Walt Lukken, President and Chief Executive Officer, Futures Industry Association
Below is a summary of the hearing prepared by Delta Strategy Group. It includes several high-level takeaways, followed by summaries of opening statements.
KEY TAKEAWAYS
- Chairman Boozman (R-AR) highlighted how the lack of a comprehensive federal framework for digital commodity markets has created a regulatory gap to the detriment of market and customer protections. He cited how the lack of regulatory certainty and clear guidance has offshored developers, market participants, and decentralized finance (DeFi) innovation. He called for the Committee’s expedient development of a framework that allows for liquid and resilient spot digital commodity markets, in conjunction with the Senate Banking Committee, regarding the trading of digital assets in securities transactions.
- Chairman Boozman emphasized that solely the Commodity Futures Trading Commission (CFTC) should regulate the spot trading of digital commodities, referencing its enforcement authority over such markets, and called for building on that authority instead of distributing it amongst regulators. He stated that entities that list or facilitate the trading of digital commodities should not be exempted from CFTC regulation simply because they are registered with another federal agency.
- Ranking Member Klobuchar (D-MN) discussed how the CFTC is well-positioned within its existing role in overseeing the digital commodity derivative markets and its enforcement authority exercised over the underlying spot market to oversee digital commodity spot markets.
- Discussion themes centered around the need to focus on clear lines of jurisdiction, strong customer protections, and flexibility to keep pace with innovation. Witnesses highlighted the CFTC’s significant experience with innovative products and called for retention of its core-principle regulatory approach. Sexton and Massad raised the importance of self-regulatory organizations (SROs) and the time-tested public-private oversight framework, highlighting the CFTC’s and NFA’s strong oversight partnership between frontline oversight of regulation and registered membership within derivatives markets.
- Witnesses recommended that Congress provide the CFTC with exclusive authority over digital commodities and the Securities and Exchange Commission (SEC) with authority over digital securities to avoid ambiguity for market participants and opportunities for regulatory arbitrage. Comments cautioned against a framework with blurred jurisdictional lines and two market regulators writing rules for the same activity.
- Discussions cited how digital asset firms in the U.S. are already subject to anti-money laundering (AML) compliance, sanctions screening, and suspicious activity reporting (SAR), with Kim raising that such requirements should be confirmed and codified. Behnam called for the SEC and CFTC to be provided with tools to hold increased authority on AML and know-your-customer (KYC).
- Behnam discussed how the definition section of any legislation this Committee puts out is arguably the most important part, stating that clarifying such between the CFTC and SEC is the first and most important step. He highlighted the importance of the Committee’s and Congress’s steering of the definitional and jurisdictional delineation, with Sexton in agreement on the need for definitional support from Congress in any legislation.
- Massad cited the principal reason for the lack of clarity as the fragmented regulatory system between the CFTC and SEC, neither with jurisdiction to regulate the spot market for digital assets that are not securities. He reiterated that the solution should bring the agencies closer together, discussing the role of joint rulemaking and that between the two, the CFTC would likely be taking the lead in implementing and enforcing rules with respect to the spot market. He also discussed the formation of a joint SRO.
- Democrats, led by Ranking Member Klobuchar, emphasized that any new framework must strengthen, not weaken, the existing system. They called for safeguards to be in place to prevent corruption by federal officials, criticizing the Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) and Digital Asset Market Clarity (CLARITY) Acts’ exclusion of such, alongside strengthened customer protections and statutory safeguards on the custody of customer funds. Several questioned the efficiencies, conflicts of interest, and subsequent risks due to the vertical integration of centralized exchanges.
SUMMARY
Opening Statements and Testimony
Chairman John Boozman (R-AR)
While approximately seventy percent of digital assets are trading digital commodities, the U.S. currently lacks comprehensive federal regulation of the digital commodity markets. A significant percentage of Americans trade with crypto with very limited federal customer and market risk protections, referred to as the digital commodity regulatory gap. While the regulatory gap has not stifled consumer interest in crypto, we know what can happen when crypto intermediaries operate outside of a regulated framework without clear, comprehensive digital commodity market regulation. The lack of such federal regulation in the U.S. has created significant regulatory uncertainty among innovators, developers, and market participants. Not knowing the rules of the road, U.S. businesses have moved overseas, leaving U.S. consumers vulnerable. We must act on digital assets legislation to protect customers and ensure innovation and growth remain in the U.S. The CFTC, and only the CFTC, should regulate the spot trading of digital commodities and it currently has enforcement authority over these markets. We should build upon that authority, not distribute it among different regulators. Entities that list or facilitate the trading of digital commodities should not be exempted from CFTC regulation simply because they are registered with another federal agency. This longstanding bifurcated approach to financial market regulation was at the core of the Dodd-Frank Act’s regulation of the swaps and security-based swaps market. This should be the foundation upon which we build a comprehensive regulatory framework. This is not to pit regulators against one another, but to entrust the CFTC and the SEC with the authority to collaboratively regulate the digital asset markets. We must support the Banking Committee as they work on a regulatory framework for the trading of digital assets in securities transactions. As with the CFTC and the SEC, there are clear lines of jurisdictions between our Committees and we are committed to working collaboratively to create a comprehensive bill that allows for liquid and resilient spot digital commodity markets, with strong retail protections and rules that provide confidence to continue to innovate and grow in the U.S.
Ranking Member Amy Klobuchar (D-MN)
Oversight and regulation of this market have not evolved to keep up with the growth. The CFTC has long played a vital role in ensuring the integrity of our financial and agricultural derivative markets. That includes protecting market participants from fraud and manipulation, maintaining orderly markets, and enabling farmers, ranchers, manufacturers, and small businesses to hedge against risk. As early as 2015, the CFTC determined that digital assets could be commodities and found that bitcoin, the largest such asset, was a commodity. Derivatives on bitcoin and other digital commodities have been listed on CFTC-regulated exchanges, and the CFTC has full regulatory authority over these products, but it only has anti-fraud and anti-manipulation authority over the underlying spot markets; a regulatory gap that has resulted in untold losses to customers and increasing risk of contagion to traditional financial markets as digital commodity markets grow in size and are integrated into the existing financial system. If Congress gives the CFTC the authority and the resources to step in and oversee these spot markets, it would be well positioned, given its existing role, in overseeing the digital commodity derivative markets and its enforcement authority exercised over the underlying spot market. Providing regulatory certainty and oversight to these markets can encourage responsible innovation and the adoption of new technologies. We must also ensure a level regulatory playing field so that crypto market participants are subject to standards as rigorous as those applied to traditional financial institutions. If Congress is to do this, it must do so without compromising crucial customer protections, with safeguards to prevent illicit finance and provisions to address market integrity concerns. It also means putting in place guardrails to address conflicts of interest in the digital asset sector, preventing exchanges and issuers from using their position to favor affiliated actors or exploit customers. If Congress is going to establish a new financial regulatory framework, it must strengthen our system, not weaken it, by putting safeguards in place to prevent corruption or self-dealing by federal officials, including those in positions of power who might sponsor, issue, or profit from digital tokens. Regulation of the digital commodities swap market can responsibly encourage innovation while ensuring our financial markets continue to be the safest in the world for market participants.
Ji Kim, Chief Executive Officer, Crypto Council for Innovation
Strengthening U.S. leadership and digital asset innovation is best accomplished through comprehensive federal oversight of digital commodities. It is critical to urgently pass legislation providing the CFTC with oversight over the trading of digital commodities to provide necessary regulatory clarity, reduce uncertainty, protect consumers, and ensure continued U.S. leadership over digital assets. For years, the digital asset industry has requested clear rules of the road and a coherent federal framework to operate within the U.S., preventing fragmentation and regulatory ambiguity. Tokenization of real-world assets, securities, real estate, and agricultural commodities has the potential to make markets more liquid, accessible, and inclusive. From a consumer protection standpoint, clear federal supervision of market activity is essential. And industry is committed to building necessary guardrails. A significant portion of the digital asset ecosystem functions like commodities rather than traditional securities. Assets like bitcoin and ether are not issued by centralized entities to raise capital and lack profit-sharing rights. Courts and regulators, including the CFTC, have affirmed that such assets fall under the Commodity Exchange Act (CEA) depending on their structure and use. Most digital asset trading volume occurs in secondary markets with assets treated as a store of value, not as equity stakes. Recognizing the commodity-like nature of these assets is essential to crafting a comprehensive regulatory framework to provide essential consumer protections, including business conduct standards, disclosures, segregation of customer funds, minimum capital requirements, trade surveillance, and more. Digital asset firms in the U.S. are already subject to AML compliance, sanctions screening, and SAR. These requirements should be confirmed and codified in any new comprehensive framework. The CFTC already has enforcement authority over spot commodity markets, but this must be matched by a broader federal framework that addresses how digital assets are used. The CFTC is well situated to play a central role in overseeing the spot digital asset commodity market as a principles-based regulator with a mandate to deter price manipulation, ensure financial integrity, protect market participants, and promote responsible innovation. It has extensive experience in supervising large and complex markets and maintains a robust enforcement capability. In the global race to the top for leadership in digital asset innovation, other jurisdictions, including the EU, UK, Japan, and Singapore, have recognized the importance of this technology by actively engaging with industry to consider and implement tailored regulatory regimes. We can further establish leadership through a comprehensive legislative framework, ensuring long-term stability and guarding against future policy volatility that may otherwise repeatedly shift the goalpost.
Rostin Behnam, Distinguished Fellow, Psaros Center, Georgetown University
Similar testimony to the June 24 hearing with Senate Banking; DSG summary available here. There is a gap in regulation for the digital asset commodity market, which must be filled with targeted legislation. The CFTC is the appropriate regulator to oversee the digital commodity asset market because of its expertise in regulating commodity markets, including digital asset derivatives since 2017, and its enforcement experience in the underlying digital commodity market. Carefully examine how the current unregulated digital asset market structure differs from traditional market structure and consider where there may be opportunities for change and where existing market structure requirements should be preserved. In a situation where a regulated digital asset market participant handles both security and non-security tokens in the underlying market, separate and exclusive jurisdiction for each agency is critical. Any regulatory system that includes deference or exempted authority will be an incomplete effort, and any framework where each agency does not retain its exhaustive, exclusive licensing authority foretells a future of blurred jurisdiction across digital assets and possibly physical commodities. The CFTC’s principles-based oversight model has served its regulated markets well, striking an appropriate balance between clear outcomes-based requirements and measured flexibility to meet those outcomes. Tailor rules to meet the risk and profile, leaving flexibility to adapt with a changing market landscape as the digital market itself evolves. Appropriate funding is necessary to meet the mandate of any regulatory program. A reliable self-regulatory organization has been critical to the success of the CFTC. An effective legislative effort must include a role for NFA. It is essential that legislation provide comprehensive authority for AML, KYC, and customer identification programs.
Timothy Massad, Research Fellow and Director of Digital Assets Policy Project
Similar testimony to Senate Banking hearing on July 9; DSG summary available here. We cannot define whether something in digital form is a security, a commodity, or neither with a few paragraphs in a statute. We should not lock in definitions that will fail to bring clarity, nor should we tie regulators’ hands. A different approach must establish regulation over the spot market without rewriting the securities laws and mandate that the SEC and CFTC work together, not just on a few rules, but overall. Classification issues can best be addressed by the agencies working together to implement general principles, not prescriptive rules provided by Congress. A joint rulemaking approach establishes jurisdiction over the market without debating the classification of each token or Congress pursuing tortured rewriting of existing definitions of securities and commodities. Rewriting existing law might fail to bring clarity and inadvertently undermine decades of regulation and jurisprudence as they apply to traditional markets. The CLARITY Act will not provide clarity, but will undermine regulation. It addresses classification with a tortured definition that rewrites existing law. It provides exemptions from securities laws, such as for raising funds if one has the intent to build a mature blockchain system, that are unnecessary and will be misused. It creates a broad exemption for DeFi activities, which will lead to the migration of regulated activity into an unregulated sphere. A large intermediary could operate a software protocol for the trading of tokenized securities that would then be exempt from the Securities Exchange Act. It will not require crypto trading platforms to own the digital assets their customers purchase, and it will permit them to engage in their own proprietary trading and have other conflicts of interest.
Tom Sexton, President and Chief Executive Officer, National Futures Association
The NFA’s and CFTC’s over forty-year public-private partnership overseeing the derivatives industry has been a tremendous success, and we recognize the CFTC’s commitment and significant efforts in promoting the integrity, resilience, and vibrancy of the derivatives markets. NFA has a critical role in protecting customers and ensuring the integrity of the derivatives markets with a clearly defined mission: to safeguard the integrity of the derivatives markets, protect investors, and ensure that NFA members meet their regulatory responsibilities. We optimize the “self” in self-regulation and leverage industry expertise. Our activities are closely overseen by the CFTC, with the CFTC providing frontline regulatory oversight of exchanges, clearinghouses, and swap execution facilities (SEFs). NFA provides frontline oversight of global membership of CFTC-registered market participants, including futures commission merchants (FCMs), swap dealers, IBs, RFEDs, CPOs, and CTAs. The CFTC is well equipped to take on effective oversight of digital commodities, given its core principles, regulatory approach, experience over the years integrating new asset classes into its oversight framework, and its current experience gained from having anti-fraud jurisdiction over spot digital commodities and supervisory oversight of related derivatives products, including bitcoin and ether futures. The Committee should focus on the following: clear lines of jurisdiction, strong customer protections, and flexibility to keep pace with innovation. Congress should provide the CFTC with exclusive authority over digital commodities and the SEC with authority over digital securities. Avoid a framework in which jurisdictional lines become blurred and two market regulators are writing rules for the same activity. This will be confusing for market participants, create blind spots in the oversight of this market, and lead to regulatory arbitrage. Look to the time-tested, robust customer protections that have served the derivatives industry extremely well, which include customer fund safeguards, customer disclosures, business conduct standards, and AML protections. Rely on the CFTC’s significant experience with innovative products and retain its core principles regulatory approach. Self-regulation provides many benefits to customers and the industry. As the derivatives markets have evolved over the years, Congress and the CFTC have entrusted NFA with additional responsibilities. Our coordination with the CFTC has resulted in a strong track record of protecting retail customers and prosecuting retail trading abuses and fraud. Customer complaints and single-event customer arbitrations filed at NFA, as well as the CFTC’s reparation cases, remain at all-time lows. NFA is adaptive and proactive, with numerous member firms engaged in spot digital commodity activities. To enhance oversight of these firms, we adopted a rule in early 2023 that imposes anti-fraud, just and equitable principles of trade, and supervision requirements. Fifty years ago, Congress had the wisdom to establish a public-private oversight framework, which the CFTC and NFA have effectuated to form a strong oversight partnership. We strongly recommend that Congress, in any market structure legislation, retain a significant role for an RFA to partner with the CFTC.
Walt Lukken, President and Chief Executive Officer, Futures Industry Association
The U.S. has two strong market regulators in the CFTC and the SEC, and collectively, they can bring digital commodities and digital securities into a proper regulatory framework. The CFTC is well-suited for the oversight of digital commodities, with five strengths within its regulatory framework that will enable the CFTC to take on increased responsibilities in digital commodities and provide these innovative markets with a sound regulatory framework. First is CFTC’s principles-based regulation, which ensures the agency can keep pace with technological changes and advancements in market dynamics. This will be key for the evolving digital commodity markets. Second is the agency’s support of innovation, as the CEA explicitly and uniquely requires the CFTC to promote responsible innovation in fulfilling its duties. It has done so for fifty years, allowing innovative new asset classes to be listed, including futures on cryptocurrencies eight years ago and more than sixty cryptocurrency futures and options currently trade on seven CFTC-registered exchanges. Third is the CFTC’s customer protections, which have safeguarded investors for years, requiring FCMs to segregate and confirm customer balances every day. This FCM model of protection has provided critical resilience and risk management. Fourth is strong enforcement in combination with robust customer protections as a powerful one-two punch for the agency. The CFTC has aggressively used its enforcement authority to bring actions against those who seek to swindle investors or manipulate prices. Fifth is the CFTC’s approach to cross-border trading, with the CFTC’s cross-border recognition framework, pioneered in the 1990s, striking the right balance of protecting U.S. participants while providing access to markets globally. Other key stakeholder recommendations involve recognizing the risk-reducing positions of customers for margin and capital. Farmers and other end users utilize markets to hedge the price risk of assets, whether it is corn, oil, or financial products. When these offsetting products are regulated by different agencies, customers may be forced to pay double margins because of a lack of recognition of these offsetting trades. FIA supports statutory language that instructs the CFTC and SEC to allow for cross-margining between offsetting positions in these respective markets. FIA also supports legislative language that instructs prudential regulators to recognize these offsetting risk positions through cross-product netting. These two actions will free up capacity for these growing markets and incentivize strong risk management. On the need for clear rules around managing conflicts of interest, we support legislative language that requires the CFTC to conduct a rulemaking on managing conflicts of interest when entities combine exchanges, clearinghouses, FCMs, and trading arms all within the same legal structure. We believe the development of consistent rules around conflicts will ensure customers can utilize innovative new structures without facing differing customer protections due to market structure design.
DISCUSSION
Chairman Boozman (R-AR): Why is the CFTC, and only the CFTC, is the right regulator for spot digital commodity trading? Can you address concerns about allowing entities to list or facilitate trading in digital commodities without full CFTC registration? Behnam: Over the last ten-year period and following the determination of bitcoin as a commodity, the CFTC has been at the forefront of enforcement, both on the fraud and manipulation side of crypto. Enforcement does not just mean an enforcement action as staff within the agency are conducting research and surveillance of derivatives markets and the underlying physical market. The CFTC has developed a distinct and unique expertise in the digital asset market. The CFTC, as an independent agency, understands commodity markets. It is extremely important the CFTC become the primary regulator of any commodity asset, and that we have two market regulators because they are independently very large, unique markets that demand different sets of regulations. If any agency starts to regulate commodity tokens, it becomes and potentially creates a blurred line of jurisdiction between the CFTC, commodity markets, potentially physical commodities themselves, and other regulators; Lukken: Three strengths give the CFTC a unique ability to oversee the commodity derivative or digital commodity markets: expertise, top-down mission, and flexibility. That expertise, whether it is surveillance, manipulation of those markets, or how best to ensure that those markets are not being taken advantage of by those trying to manipulate prices, is critical. The CFTC has experience in crypto and derivatives digital commodity space, currently regulating sixty products and all that goes with it, including the core principles that come with that regulatory expertise. Section III of the CEA is unique in stating the CFTC should be promoting responsible innovation, which allows these products, as they get listed, to be considered in terms of how to promote new, innovative technologies. That is an important top-down mission of the agency in helping these products evolve and develop. Flexibility in having principles-based regulation under the CEA allows it to carve out certain things that may not justly be in their jurisdiction through exemptive authority. The CFTC has the tools to exclusively oversee these markets, but also with flexibility that will allow these markets to evolve.
Chairman Boozman (R-AR): What is the importance of avoiding applying centralized intermediary regulatory requirements to decentralized software and technology? Kim: DeFi allows individuals to transact peer-to-peer by using software and code without reliance on centralized intermediaries. The software and code do not take control or custody of the funds. We regulate exchanges and brokers, not the matching engine or trading screens. We regulate decentralized intermediaries that take control and custody of the funds. The focus has been on centralized intermediaries taking control or custody of funds. There are no business conduct standards, conflicts of interest provisions, or consumer education. To cement U.S. leadership and best protect consumers, we must address the regulatory gap, with no federal framework for the supervision of digital commodities, by providing the CFTC with supervision.
Ranking Member Klobuchar (D-MN): How would dividing jurisdiction between the CFTC and SEC work in any legislation? Massad: Former Chair Clayton and I were trying to establish jurisdiction over the spot market without rewriting securities laws or the definition of security, which is why we argued for joint rules. We must recognize that this market is more retail than what the CFTC has regulated, and keep that in mind. This will be a very big exception, in that the CFTC does not regulate other spot markets, and we do not want that exception to grow. It is an unusual technology in which things can start out as securities and then become commodities. That is why they have to work together. It would involve some joint rulemaking and one of the agencies taking the lead. In terms of implementing and enforcing rules, that could certainly be the CFTC with respect to this spot market. It should also involve an SRO, and I have great respect for the work of the NFA. That could be jointly supervised, as the Lummis-Gillibrand proposal advocated. It would be a combination of joint rulemaking, perhaps a joint SRO. You could even have common Commissioners, but I am not advocating merger. This is a technology with multiple uses, and we must approach with consistency across the board.
Ranking Member Klobuchar (D-MN): What specific approaches would you recommend to ensure innovation does not come at the expense of basic safeguards and customer protections? Would there be specific marketing disclosure rules? Behnam: A lot of the market is retail-oriented, unlike the typical CFTC marke as institutionally oriented. We must look at the asset itself as opposed to the constituency that is investing. Securities are regulated in a way to bridge information gaps between an issuer of a security and investors, because you have centralized individuals and audited financial statements that need to be disclosed to investors. That is not the case with commodities, so I do not think you are going to need to build, or can build, an investor disclosure regime at the CFTC like you have one at the SEC, because you cannot simply disclose something about bitcoin that you can about a share of a stock. The CFTC has a very well-built-out customer education program that the Committee should think about investing more in to increase its abilities.
Ranking Member Klobuchar (D-MN): What effect do the President’s activities have on the crypto industry and efforts to regulate it? Massad: It is a black eye for the industry and gives the wrong impression. It must be addressed with rules on conflicts, divestment, and so forth. Memecoins are a perfect bribery tool. One can essentially provide money to the President, yet claim they are only speculating.
Ranking Member Klobuchar (D-MN): How important is it that Congress provides durable and sufficient funding for the CFTC to effectively regulate emerging digital asset markets? What will happen if resources are spread too thin? Behnam: If you authorize a regulatory program but do not have the funding, there are no teeth. We came up with about $130 million over the first few years to staff up, both on the tech side and the personnel side. It is zero-sum. When you have those people working on crypto matters, which are novel, unique, and do not have legal precedent, it pulls them away from traditional markets; Lukken: The CFTC deserves full funding, and especially if they are taking on the new responsibility of digital commodities, with more funding to make sure that they can administer an Act. That is something that has traditionally been done through an appropriations process. The CLARITY Act gives the ability for a transitional fee that happens for four years. That makes some sense, but once you start to put in a permanent tax on the industry, the concern is it may start to impact hedgers and end up taxing them instead of appropriating through an appropriations process. I have concerns about a permanent transaction tax. It is better suited through the appropriations process.
Ranking Member Klobuchar (D-MN): Are digital commodity market participants technologically capable of complying with financial laws, and should Congress tailor these laws to account for the unique features of these markets or technologies? Kim: The U.S. already has a robust AML/CFT program through FinCEN. It is appropriate for the CFTC to be the regulator for digital commodities. Once that framework is established, there could be additional protections as needed. What has been missing as part of the regulatory gap is that the CFTC does not have that substrate authority to look at centralized intermediaries.
Ranking Member Klobuchar (D-MN): What mechanisms would best guarantee the safety of digital assets even if collateralized digital assets collapse? How should Congress address the reusing customer assets or commingling funds for their own purposes? Behnam: It goes to the core principles and rules that the CFTC applies in regulated institutions. MFGlobal was unique in the sense that it was a regulated entity, and those funds were commingled outside in violation of the segregation rules. Some changes were made after, but segregation rules are sacrosanct to the CFTC, making sure customer money is protected and prioritized among house money and other customer money. If you replicate rules around what customers say or use for traditional CFTC markets in digital asset markets, we can protect customer money in digital assets.
Ranking Member Klobuchar (D-MN): How should Congress approach DeFi platforms in regulatory frameworks? Behnam: We had a couple of enforcement actions against DeFi protocols during my chairmanship. There should be and needs to be a unique look at how DeFi platforms function relative to centralized platforms, with some mechanism of regulation and oversight needed. DeFi platforms cannot live in a regulatory vacuum. There has to be some intersection with a regulator and a decentralized platform in order to have effective regulation. Otherwise, there will be a race to the bottom, essentially a race to circumvent regulations.
Ranking Member Klobuchar (D-MN): Does the CLARITY Act’s DeFi exemption raise concerns for you? Is it too broad? Sexton: There are concerns expressed about the DeFi exception in the CLARITY Act. Congress should give some instruction to the CFTC as to how to deal with these platforms going forward in legislation. The CFTC and SEC should also carefully examine together DeFi protocols and determine how best to look at protocols in the future, possibly to come up with some type of regulatory oversight over them; Massad: The DeFi exemption that is in the Act is one of its worst features. The first thing we have to do is define what we mean. People use the term DeFi, but it is not just an autonomous protocol and there are lots of touchpoints for regulation. DeFi should not get a regulatory pass. We may need different rules, but we need to achieve the same regulatory objectives. If we had a protocol that was for the Treasury market and that suddenly became the main way Treasuries were traded, we would not say we do not need to regulate or worry about it. The key things are to define what we mean, look at the touchpoints for regulation, because there are typically centralized actors acting in that space, and develop different rules if we need them.
Ranking Member Klobuchar (D-MN): How can we ensure customer funds are protected when trading occurs on offshore exchanges beyond U.S. oversight? Behnam: We have been behind other regulators, and that has created arbitrage opportunities. These international platforms, which do not feel they have a path to registration in the U.S. for several reasons, are circumventing through VPNs to get access to U.S. customers. A market structure bill, if drafted correctly and comprehensively, will bring the market within the regulatory fold, and that will provide customer protections and on a sort of outcomes basis. Regulation will resolve these issues in part, and hopefully comprehensively, with other global regulators.
Senator Marshall (R-KS): How can we stop black markets and illicit activities? How should we address potential deficiencies, such as how the crypto industry should be held to the same standards as banks? Behnam: Whatever efforts are made on AML and KYC should be grounded in existing law, and existing law around both Treasury mostly implements. But the agencies will also need increased authority around AML and KYC. Much of this industry is about anonymity, and why we are here today is to bring that anonymity into light and transparency around it. Comprehensive regulation around the entities and intermediaries serves that purpose and will provide the tools that Congress and law enforcement agencies need to prevent AML and KYC issues that support a lot of the illicit activity. This is a primary concern that needs to be top of mind in considering legislation, but I do not think it is reinventing the wheel. Much of AML and KYC law developed over time is a good framework to build off of.
Senator Marshall (R-KS): What specific guardrails could be implemented to ensure crypto markets are not a haven for bad actors? Kim: FinCEN, starting from 2013, has required digital asset exchanges to have SARs reporting, AML compliance, and sanctions screening. Providing the CFTC with oversight over the spot trading of digital commodities and allowing it to come up with additional necessary rules and guardrails to best protect the industry would benefit industry, consumers, and allow innovation to grow in the U.S. The only way for industry to keep growing is to best protect consumers.
Senator Smith (D-MN): What are your thoughts on the issue of disclosure? Massad: I agree with Behnam, generally, that we do not worry about a disclosure framework on commodities. In the context of commodity futures, we worry about whether the contract is susceptible to manipulation. But this is different. If you look at the CLARITY Act, Lummis-Gillibrand, or any of these proposals, they provide for disclosure regarding digital commodities. We will have to build out some kind of disclosure framework. I am fine with the CFTC being the lead authority on overseeing these markets, ideally through the work of an SRO. The development of the rules is going to require cooperation.
Senator Smith (D-MN): Would you agree that securities brokers are required to seek the best trade across exchanges but that crypto trading lacks this, and would the CLARITY Act address this? Massad: I agree, and no, it would not. Our markets are well regulated with respect to securities and commodities, but this is different. There is no best execution obligation. There is no prevention of conflicts of interest on the part of brokers or crypto exchanges.
Senator Smith (D-MN): Is there any reason a crypto broker could not or should not be required to execute trades in their customers’ best interest? Is there anything intrinsic in the technology that makes this unreasonable? Massad: No, not to my knowledge.
Senator Smith (D-MN): What risks would tokenized stocks pose? If one owns a tokenized stock, would they lack protections under the SEC that come with purchasing a traditional stock? Massad: There could be a lot of confusion and a failure to protect investors. It will not be clear exactly what this tokenized thing is. Does it pass through all the rights, or does it just represent trading on the price? There could be fragmented disclosure and less transparent trading. There is a big risk with DeFi exemptions in the CLARITY Act. That is why we need joint rulemaking and cooperative coordination between the agencies. It could represent something where it is a pass through, but it might not.
Senator Smith (D-MN): How could the CLARIRTY Act address the concern that companies might choose the regulatory structure best for themselves rather than for investors? Massad: We could not have exemptions that encourage that kind of migration of activity, but that is what we are seeing in the CLARITY Act and other proposals.
Senator Tuberville (R-AL): What risks will the U.S. face without urgency on this? Kim: It is a global race to the top, and other jurisdictions have not been waiting for the U.S. to lead. We need the U.S. to lead and despite the progress in other jurisdictions, everyone is watching the U.S. The UK had been taking a very modular, patient approach, but recently announced an all-at-once approach. This is an opportunity for the U.S. to cement its leadership and make sure innovation stays here. That starts with a comprehensive legislative framework; Sexton: I encourage this Committee and the House to continue to work on legislation. We have member firms already engaged in this activity. To the extent that the CFTC would be provided with anti-fraud and regulatory oversight over digital commodities, it would be very helpful to our own regulatory structure here.
Senator Tuberville (R-AL): Why do we need to clear up regulatory definition between the CFTC and SEC? Behnam: It is the first and most important step. From there, the two will be able to really start to develop rules, either distinctly and uniquely or in a joint fashion. It is important that the agencies get a bit of a steer from this Committee and Congress, because there are lines that you can draw to help the agencies start to really define the landscape of what tokens are securities and what tokens are commodities.
Senator Luján (D-CA): What are key differences in consumer protections between a commodity and a security? Massad: They are huge. We do not have any regulation of the spot market for digital commodities. We need to put that into place. On how to make that regime work, we are going to need things that are unusual for commodity markets, like disclosure rules, trading rules, and conflict rules. We need to have some coordination between the agencies.
Senator Luján (D-CA): Does customer confusion about the differences in protections when commodities and securities are listed together increase risks like rug pulls and pump-and-dump schemes? Massad: Absolutely. Under the CLARITY Act, it is not clear that memecoins would be regulated. They recently put out a revision that maybe they would be, but we should have a framework where anything that is traded is subject to the regulatory framework. They cannot just list something else that is not. Those rules have to be very clear so that customers are not confused, and we should not have securities trading on the same platform.
Senator Luján (D-CA): What does Congress need to do to protect consumers from fraudulent schemes while still allowing access to and benefits from cryptocurrencies? Massad: We need to put in a good, comprehensive framework. The measures proposed so far have some of those elements, but not sufficient ones. They are too lax in many requirements and do not address conflicts of interest sufficiently. They undermine securities laws by creating some exemptions. It requires a comprehensive framework that will create investor protection standards that are comparable to those in securities markets today; Behnam: Before we get to a point of deciding which agency has jurisdiction, if we can get lines drawn around definitions between commodities and securities. The whole premise on commodity tokens is that there may be an issuer at some point in the evolution of the token, but when it is trading on a CFTC exchange, it is decentralized enough, or at some point becomes sufficiently decentralized, where there is no central institution, group of individuals, or individual that is controlling or impacting the price of the asset. If it is sufficiently decentralized, you really would not have that issue of individuals pulling off manipulative trading activities that could hurt investors.
Senator Luján (D-CA): Does the definition section of the Act matter? Behnam: The definition section of any legislation this Committee puts out is arguably the most important part.
Senator Justice (R-WV): How can we pull off both innovation and protection? Kim: A comprehensive framework to allow for responsible innovation and a principles-based approach, while best protecting consumers. Now is the time to do so; Behnam: Start with our great capital and derivative markets as a foundation, and then figure it out; Massad: Do no harm to the existing markets. Keep it relatively simple in the legislation. Rely on the expertise of regulators, and not fight the last war when they were not doing enough, perhaps, to customize rules; Sexton: Use the time-tested structure already in place. Congress can give some definitional support to what is a security, what is a commodity, and then go from there. It has worked in the past, is simple, and will work again. There are SROs underneath that support the SEC and CFTC; Lukken: The CFTC is a natural home for these types of commodities that are dealing with volatility. Give exclusive jurisdiction over digital commodities to the CFTC and give digital securities to the SEC, with clear lines of jurisdiction to both agencies.
Senator Durbin (D-IL): What concerns, if any, do you have about an exception for collectibles? Massad: On the collectibles, I agree with you. The CLARITY Act does exclude those as commodities, and the rule should be that digital commodity exchanges cannot trade anything unless they are covered by these rules. If the Act is so clear as to what is a digital commodity, ask platform to tell you, of the hundreds of things they list, which ones are digital commodities, and see what answers you get; Sexton: We approach it from a slightly different angle, and that is we regulate the conflicts that may be embedded within our members.
Senator Booker (D-NY): With the CFTC’s budget and personnel cuts, combined with expanded crypto jurisdiction under the CLARITY Act without additional funding, threaten its ability to oversee existing markets and risk creating chaos for retail consumers in both crypto and traditional finance? Behnam: The short answer is yes. The number one priority, if we are going to authorize new authority the CFTC is funding and resources to execute those responsibilities.
Senator Bennet (D-CO): Should federal elected officials be prohibited from issuing or endorsing digital assets? What types of market manipulation could result if they are not? Massad: Absolutely. I agree that you should be prohibited from it and required to divest. There are no benefits to the American people from it whatsoever. We do not have rules in place to prevent it, but we need them now. Industry wants them but they are afraid to say it.
Senator Schiff (D-CA): How can we ensure consumers are protected? Lukken: Congress needs to fill this regulatory gap, and quickly. Make sure we have strong, clear lines between the CFTC and SEC on jurisdiction. Each brings unique customer protections and important market integrity to the problems identified; Behnam: Following the collapse of FTX, LedgerX, which was registered and regulated by the CFTC, was the sole entity that was viable, well-managed, and had value after that bankruptcy. It had regulation, supervision, oversight, and a future because of regulation. Regulation works, and it ultimately will protect customers; Sexton: There are longstanding safeguards in place to protect retail customers that the CFTC and NFA have adopted. Those should be applied also to the digital commodity markets to protect retail customers, such as safeguarding customer funds, market practice rules, business conduct rules, and disclosures. Look to those time-tested requirements and safeguards. They go a long way to accomplishing protection of retail customers in digital commodities.
Senator Warnock (D-GA): What risks, inefficiencies, or conflicts of interest arise when centralized exchanges routinely serve as custodians and handle listing, trading, clearing, and settling trades through vertical integration? What provisions should a Senate bill include to limit the risks that large, centralized firms pose to the digital asset market? Behnam: They have more vertical integration than that. Most trading is through those intermediaries, not on-chain. There are all sorts of conflicts that can arise. These trading platforms can do their own proprietary trading, and can front-run customer orders or misuse customer information. They can have interests in the tokens that they list as that is not prohibited either, and can have other business ventures. On custody, they can be charging separate fees and may not adhere to good custody rules. The Act does not require platforms to hold the bitcoin they say their customers own; Massad: We need a comprehensive regulatory framework that prohibits these kinds of conflicts of interest, like no proprietary trading, interest in the tokens they list, or other business ventures that can pose conflicts. We need to impose best execution requirements on brokers. We need to impose strict custody rules and either consider separate custodians or at least have rules that ensure they really are holding the bitcoin they claim, or the other assets that they claim their customers own, and that they are segregating it properly and not charging fees for that.