The Blockchain Association applauds the introduction of the bipartisan Digital Commodity Exchange Act and the Securities Clarity Act, led by Republicans Rep. Tom Emmer and Rep. Mike Conaway and Democrat Rep. Darren Soto. These bills address two fundamental questions regarding the regulation of digital assets: “When do the securities laws apply to digital assets?” and “How will digital assets be regulated when the securities laws don’t apply?”
Securities Clarity Act
In order to clarify when the securities laws apply, Rep. Tom Emmer and others have introduced the Securities Clarity Act. The introduction of this bill is timely given the recent SEC cases against two companies, Telegram and Kik Interactive. The SEC’s arguments in these cases conflated pre-sale investment contracts and tokens. The Securities Clarity Act attempts to resolve this ruling by maintaining that these tokens, which the bill considers to be “investment contract assets,” are not securities.
The test that is used to decide whether something is an investment contract was created in the 1946 Supreme Court case SEC v. W. J. Howey Co. According to Howey and subsequent cases, an investment contract is a “transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” If a transaction or scheme fits this definition of an investment contract, it is a security. However, courts have not endorsed the claim that an asset delivered pursuant to an investment contract is also considered a security merely as a result of it being transferred as part of the investment contract.
The Securities Clarity Act seeks to “clarify and codify that an asset sold pursuant to an investment contract, whether tangible or intangible (including an asset in digital form), that is not otherwise a security under the Act, does not become a security as a result of being sold or otherwise transferred pursuant to an investment contract.” As such, “investment contract assets” are not subject to the securities laws.
Digital Commodity Exchange Act
When securities laws do not apply to a digital asset, other regulatory mechanisms must be implemented to ensure that digital asset markets are safe and fair. Rep. Mike Conaway and others are looking to fill this regulatory gap with the Digital Commodity Exchange Act (DCEA).
Currently, there is no comprehensive federal regulation of digital commodity markets in the United States. To access the digital commodity marketplace, consumers rely on specialized trading platforms, often referred to as “exchanges,” to match buyers and sellers of assets. These exchanges perform functions similar to traditional commodity exchanges and private trading venues, yet they are not treated the same by regulators.
Unlike those legacy players, digital commodity exchanges often operate as money services businesses, which individual states and territories regulate. Because they fall under state and territory regulations, digital commodity exchanges must navigate a labyrinthine patchwork of 53 regulatory frameworks in order to operate across the United States. These state money transmission regulations are not designed to regulate trading venues and do not police exchanges’ trading practices.
The DCEA would address this complexity by creating a national framework with state law preemption for the regulation of digital commodity exchanges. The national framework is “opt-in,” meaning that digital commodity exchanges could continue to operate under the current system if they so choose, and state regulatory systems will remain intact. If the digital commodity exchanges do opt-in to the national framework, however, the bill designates the Commodity Futures Trading Commission (CFTC) as the primary regulator responsible for enforcing the framework.
The existing federal commodity market regulatory framework is well suited to regulate digital commodity markets. Commodity markets have developed robust methods of customer protection (core principles, segregation of assets, the bankruptcy regime) which should be extended to digital commodities. Moreover, a principles-based approach to regulation is appropriate for the quickly developing digital commodity markets, as a prescriptive approach could quickly become outdated.
The introduction of both the Securities Clarity Act and the DCEA are promising developments for the crypto ecosystem in that these two pieces of legislation demonstrate that crypto might finally get the time and attention it deserves on the Hill. And while each bill may need changes as they work through the process, both pieces of legislation legitimize the efforts of industry within the political sphere. Members of industry can find comfort in the fact that crypto is no longer viewed by Washington as simply “a plaything for nerds.” Instead, politicians, lawmakers, and regulators alike are beginning to see the industry for what it truly is: the future.