Introduction
On June 2, House Republicans on the Financial Services and Agriculture Committees jointly released a draft of the Digital Asset Market Structure Act, or “DAMS”. The bill represents one of the most serious attempts so far to create a new regime for digital assets regulation in the United States – and one that might clear the cloud of uncertainty that surrounds cryptocurrencies and other digital assets today. The bill’s introduction by the current House majority – led by Financial Services Committee Chair Patrick McHenry (R-NC) and Agriculture Committee Chair Glenn Thompson (R-PA) – is especially notable as it comes at a time when the SEC, under the Biden Administration, has adopted a much more aggressive enforcement posture.[1] Against this backdrop, leaders in the digital asset industry have expressed cautious optimism about the bill, with one calling DAMS “a good starting point for a sensible market structure bill”[2] and another saying that DAMS offers token issuers “a path to compliance.”[3] If passed, DAMS would expand regulatory exemptions, establish new legal definitions, and fill the regulatory and enforcement gap that currently exists between the SEC and the CFTC – the two federal agencies that have been most active in digital assets regulation albeit without clearly defined roles.
Expanded Exemptions For Early-Stage Projects
DAMS is intended to address the difficulty (and, according to many, impracticality) of requiring early-stage token projects to comply with SEC disclosure and registration requirements in connection with token issuing activities. The draft bill would exempt from the existing securities laws any initial coin offering for which total sales of the coin over the previous year were less than $75 million and as to which purchases by any non-accredited buyer were small as a percentage of token sales or the buyer’s net worth.[4] However, the issuer must meet a “securities lite” set of requirements such as filing certain information with the SEC, including annual and semiannual reports, until after the issuer’s network is “certified decentralized.”[5] Finally, the bill exempts from direct SEC regulation those who offer so-called “ancillary services” like providing a user interface for a blockchain network or, importantly, developing digital asset wallet applications.[6]
The New Middle Ground – Alternative Trading Systems
DAMS takes direct aim at what is considered one of the most vexing problems for digital asset platforms: how to regulate early-stage projects before they mature and become sufficiently decentralized. To solve this, the bill would allow certain platforms to register as Alternative Trading Systems (ATS). This designation – which the SEC could not deny to a platform that sought it solely on the basis that the assets traded are digital assets – would permit a platform to offer restricted digital assets, subject to certain informational disclosure requirements.
Through Decentralization, an Off-Ramp from SEC Regulation
The bill would allow digital asset issuers to demonstrate that a platform associated with a given token is both functional and sufficiently decentralized so as to render its token a commodity and not a security – and thus outside the ambit of SEC enforcement. This is meant to address what has been one of the biggest points of contention between the industry and the SEC: whether a project or platform is “far enough along,” i.e., operational and distributed such that its tokens are not investment contract securities. Thus, under DAMS, a platform is “functional” when (inter alia) the assets on the network are used for transmitting value, interacting with a network application, or participating in the network’s governance.[7] And it is “decentralized” when the initial backers of the project can show they are no longer primarily in control of it: no single entity has exerted unilateral control over the network for the past year; the token issuer (or affiliate) has not owned or exerted voting power in excess of 20% of issued tokens; the issuer has not substantially changed the network’s code or marketed the network in the past three months; and all tokens issued in the last year have been created by the system’s “programmatic functioning.”[8]
A More Robust Role for the CFTC
The bill envisions that the lifecycle of a successful blockchain project culminates in its tokens being traded and used by a widely-distributed network of people. Once a network can certify that it is functional and decentralized, DAMS generally exempts its tokens from SEC oversight (see discussion, supra) and would regulate them not as securities, but as digital commodities. It is at this point where the drafters have elevated the role of the CFTC in supervising blockchain networks and trading markets. The bill would confer “exclusive regulatory jurisdiction” on the CFTC to supervise a newly-defined class of token market participants: digital commodity exchanges (DCEs), digital commodity dealers (DCDs), and digital commodity brokers (DCBs).[9] And the bill would state that a payment stablecoin should be considered a digital commodity, and thus subject to CFTC jurisdiction.
Each of these entities would be required to register with the SEC and would have to comply with robust regulatory standards. Digital commodity exchanges would not only have to comply with a long list of CFTC “core principles”; they would only be permitted to list digital commodities that are “not susceptible to manipulation” and for which they have disclosed information about the token’s underlying “source code, transaction history, and digital asset economics.”[10] Similarly, digital commodity brokers and dealers would have to (inter alia) comply with business conduct, conflict-of-interest, and fair dealing standards, maintain minimum capital reserves, and segregate customer funds. These provisions, more than anything else, may help to establish a regime of disclosure in digital assets beyond what exists today.
Finally, where appropriate, the CFTC’s regulatory authority is intended to be consistent with that of the SEC. For example, the exemptions that shield “ancillary activities” from direct SEC regulation would be mirrored by exemptions from direct CFTC regulation.[11]
Improvements in Innovation
The draft bill lays out an ambitious plan for various agencies to conduct rulemaking and market studies and emphasize innovation in their internal processes. It would codify “FinHub” at the SEC and “LabCFTC” at the CFTC, and would charge both with keeping abreast of new fintech technologies, improving industry accessibility to their respective agencies, and providing expertise to agency leadership.[12] Further, the bill would require the two agencies to conduct a joint study on decentralized finance. And non-fungible assets, although not the focus of the legislation, are highlighted as an area of future interest. The draft provides for the Commerce Department, in conjunction with the White House Office of Science and Technology, the SEC, and the CFTC, to study non-fungible assets in preparation for future legislative efforts.[13]
Political Consensus Will Be Hard to Reach
This bill is expected to face pushback from SEC Chair Gary Gensler and House Democrats.[14] SEC Chair Gensler, for one, has repeatedly stated – including in hearings before the House Financial Services Committee itself – that the principal problem with digital assets regulation and enforcement is not a lack of clarity but rather non-compliance by industry players with rules that are already in place.[15] Consistent with this view, on June 5, 2023 – just three days after DAMS was first circulated – the SEC announced a lawsuit against digital currency exchange Binance, accusing it of mispresenting trading controls and oversight on its platform and engaging in the unregistered sale of securities.[16] It followed that with another suit against Coinbase the very next day, alleging that the company operates as an unregistered securities exchange, broker, and clearinghouse.[17] These lawsuits make clear that the SEC’s adversarial approach to the digital assets industry may be very different from that of DAMS’s sponsors.[18]
Perhaps unsurprisingly, congressional Democrats have expressed skepticism, if not outright hostility, to the DAMS proposal. Rep. Maxine Waters (D-CA), ranking member of the Financial Services Committee, criticized some of the bill’s provisional registration provisions as a “get out [of] jail free” card for firms engaging in illegal or unethical behavior.[19] Others, like Stephen Lynch (D-MA) and Brad Sherman (D-CA), both Financial Services Committee members, accused DAMS of undermining the SEC and a giveaway to the crypto industry.[20]
And other commentators have already begun raising substantive concerns. Pointing to the bill’s proposed requirements for decentralized networks, one firm points out that prohibiting software changes by a platform operator could have the effect of discouraging necessary changes.[21] An op-ed in widely-read crypto industry publication Cointelegraph describes the bill as “watershed draft legislation” but states that it “falls short of bringing regulatory clarity to the industry.”[22] It concludes that, given the bill’s standards for functionality and decentralization, “protocols with any level of centralized operations (read: most) remain under the jurisdiction of the Securities and Exchange Commission.”[23]
Looking Forward
With Democrats in control of the Senate, and with members like Sen. Elizabeth Warren (D-MA) widely recognized as “anti-crypto,”[24] it is unlikely that the DAMS draft will be passed into law in its current form. Nevertheless, it is the most serious attempt at regulatory reform in digital assets to date, and is likely to frame the debate over how digital assets should be governed under the securities laws.
END NOTES:
[1] Leo Schwartz, Key House committees team up on bill that would provide clarity to crypto markets, Fortune Crypto (June 2, 2023), https://fortune.com/crypto/2023/06/02/key-house-committees-team-up-bill-crypto-markets/.
[2] Billy Bambrough, Congress Introduces A Game-Changing Crypto Bill Amid $350 Billion Bitcoin, Ethereum, BNB And XRP Price Pump, Forbes (June 2, 2023), https://www.forbes.com/sites/digital-assets/2023/06/05/congress-introduces-a-game-changing-crypto-bill-amid-bitcoin-ethereum-bnb-and-xrp-price-pump/?sh=2d4bec7970f2.
[3] Brayden Lindrea, Republican Crypto Bill a ‘10x Improvement’ On All Others — Messari CEO, Cointelegraph (June 8, 2023), https://cointelegraph.com/news/republican-crypto-bill-10x-improvement-messari-ceo.
[4] Digital Asset Market Structure Discussion Draft, House Comm. on Fin. Services & House Comm. on Agric., at 2, https://docs.house.gov/meetings/AG/AG00/20230606/116051/HHRG-118-AG00-20230606-SD001.pdf.
[5] Id.
[6] Id. at 4.
[7] Digital Assets Market Structure Discussion Draft, House Comm. on Fin. Services & House Comm. on Agric., at 10-11, https://docs.house.gov/meetings/AG/AG00/20230606/116051/HHRG-118-AG00-20230606-SD003.pdf.
[8] Id. at 5-6.
[9] Digital Asset Market Structure Discussion Draft, supra n. 4 at 4.
[10] Id. at 5.
[11] Id.
[12] Id. at 6.
[13] Id. at 7.
[14] Allyson Versprille, Key House Republicans Unveil Crypto Market Structure Draft Bill, Bloomberg law (June 2, 2023), https://www.bloomberglaw.com/bloomberglawnews/crypto/X7CMG0IK000000?bna_news_filter=crypto#jcite.
[15] Oluwapelumi Adejumo, SEC Chair Gensler Highlights Crypto Firms Non-Compliance In House Committee Testimony, CryptoSlate (April 18, 2023), https://cryptoslate.com/sec-chair-gensler-highlights-crypto-firms-non-compliance-in-house-committee-testimony/.
[16] SEC Files 13 Charges Against Binance Entities and Founder Changpeng Zhao, Sec. & Exch. Comm’n (June 5, 2023), https://www.sec.gov/news/press-release/2023-101.
[17] SEC Charges Coinbase for Operating as an Unregistered Securities Exchange, Broker, and Clearing Agency, Sec. & Exch. Comm’n (June 6, 2023), https://www.sec.gov/news/press-release/2023-102.
[18] Zachary Warmbrodt, Eleanor Mueller and Declan Harty, Biden's crypto cop taunts Republicans, Politico (June 6, 2023), https://www.politico.com/news/2023/06/06/bidens-crypto-cop-taunts-republicans-00100412.
[19] Nicholas Morgan, Crypto Leaders Praise Draft GOP Bill, Dems Raise Concerns, Decrypt (June 14, 2023), https://decrypt.co/144663/crypto-leaders-praise-draft-gop-bill-dems-raise-concerns.
[20] Id.
[21] Jonathan E. Schmalfeld, Stephen A. Rutenberg, Majer Ma, Proposed Digital Asset Market Structure Bill Could Give Regulatory Clarity; But is it the Regulatory Clarity the Industry Wants?, Polsinelli (June 9, 2023), https://www.polsinellibitblog.com/new-blog/2023/6/9/proposed-digital-asset-market-structure-bill-could-give-regulatory-clarity-but-is-it-the-regulatory-clarity-the-industry-wants.
[22] Alex, O’Donnell, Opinion: GOP Crypto Maxis Almost As Bad As Dems’ ‘Anti-Crypto Army’, Mag. by Cointelegraph (June 15, 2023), https://cointelegraph.com/magazine/opinion-republican-crypto-maxis-democrat-anti-crypto-army-mchenry-warren/.
[23] Id.
[24] Zachary Warmbrodt, Elizabeth Warren Is Building An Anti-Crypto Army. Some Conservatives Are On Board, Politico (February 14, 2023), https://www.politico.com/news/2023/02/14/elizabeth-warren-anti-crypto-ftx-00082624.