Federal regulations on digital assets may be coming soon | Ballard Spahr LLP

The RFIA would have to go through several Senate committees before being put to a full House vote, then would need House approval and President Biden’s signature. Therefore, the proposed legislation is subject to change before becoming law. However, if passed, the RFIA would establish the most comprehensive regulatory framework yet for the digital asset industry in the United States.

Significant regulation may soon be coming in the area of ​​cryptocurrency, blockchain, and digital assets.

On June 6, 2022, U.S. Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced the Responsible Financial Innovation Act (RFIA), which aims to establish a comprehensive federal regulatory system for digital assets. The proposal comes at a time of significant instability in the crypto market – including the recent steep declines in the value of Bitcoin and Ether and the collapse of TerraUSD (UST), an algorithmic stablecoin – which could generate additional regulatory support.

The RFIA defines “digital assets” broadly to include “(i) virtual currency and ancillary assets. . . (ii) payout stablecoins. . . and (iii) other securities and commodities that meet the definition of digital assets.

The RFIA breaks down the regulation of each of these “digital assets” as follows: payment stablecoins to banking regulators; tokens that include voting, participation, and equity-like rights with the Securities and Exchange Commission (SEC); and ancillary assets, including spot or cash digital assets, as well as future and leveraged digital assets, to the Commodity Futures Trading Commission (CFTC). Note that the effect of the RFIA would be to assign most market regulation to the much smaller CFTC.

The RFIA seeks to create a basis for distinguishing digital assets as securities or commodities by analyzing the purpose of the digital asset and the rights it confers on its owner. The RFIA creates a new section in the Securities and Exchange Act of 1934 and adds a definition of “ancillary asset”. Under the RFIA, an “ancillary asset” is defined as “a fungible intangible asset that is offered, sold or otherwise provided to a person in connection with the purchase and sale of a security through an agreement or scheme that constitutes an investment contract.” If a digital asset is classified as an “ancillary asset”, the issuer of the investment contract under which the ancillary asset was sold could incur certain limited disclosure obligations. Further, the RFIA would create a rebuttable presumption that an “ancillary asset” is a commodity rather than a security. Notably, the RFIA would classify Bitcoin and Ether – the two cryptocurrencies with the highest market capitalization – as commodities under the jurisdiction of the CFTC.

Reading the RFIA, it is clear that the senators intend to regulate digital assets in the same way that traditional commodity futures and swaps have been regulated. Familiar concepts will include trade-registered exchanges, brokerage futures commission merchants, and other regulated intermediaries.

Highlights of the proposed bill include:

  • Regulate digital assets like commodities (unless they are securities or stablecoins issued by banks).
  • Granting jurisdiction to the CFTC over digital assets other than securities and stablecoin digital assets issued by banks, and excluding “digital collectibles”.
  • Create digital asset exchanges that must act according to general principles, much like existing designated contract markets or futures exchanges.
  • Enable futures commission merchants to hold digital asset client funds separately, with a regulated custodian.
  • Prohibit the mixing of digital asset client funds with the forward agent’s assets or the use of digital asset client funds to secure the accounts of other clients.
  • Limit the investment of client funds in digital assets to certain highly liquid and creditworthy assets.
  • Prohibit the forward broker from acting as a digital asset counterparty for the digital asset client.
  • Create a class of “digital asset service providers,” which includes digital asset intermediaries, financial institutions, and federal or state licensees.
  • Including a user fee to fund market regulation by the CFTC.
  • Define specific terms that must be addressed in digital asset customer agreements and notices that must be provided to digital asset customers
  • Resolve the issue of finality of settlement with respect to digital assets.

Customers should particularly note the obligations associated with being a digital asset service provider. Entities subject to these requirements would include futures traders, exchange intermediaries, commodity trading advisers, commodity pool operators, swap traders, state or federally registered investment advisers , investment companies, bond trustees, banks or other depository institutions or subsidiaries of a bank or depository institutions, trust companies, funds transfer companies, consumer credit providers, stock exchanges digital assets and brokers, among others. Once classified as a digital asset service provider, this entity would be responsible for consumer protection, including entering into a customer agreement containing specified terms of business and notices relating to the risk of engaging in digital assets. , including source code version changes.

Additionally, the RFIA includes provisions to enhance consumer protections for stablecoin holders by requiring all stablecoin issuers to have a 100% reserve for the stablecoin and disclose the composition of that reserve to the market. The RFIA would require stablecoin issuers to ensure that stablecoin holders retain the ability to redeem stablecoins at a 1:1 ratio in a recognized legal currency. The stablecoin regulations included in the RFIA appear to prohibit the use of algorithmic stablecoins such as TerraUSD (UST), which recently collapsed after failing to hold its peg at $1.

The RFIA would also create certain federal tax implications by providing an exclusion from a taxpayer’s gross income of up to $200 per transaction when the taxpayer uses digital assets to pay for goods and services, subject to certain conditions. Additionally, the RFIA would clarify that digital assets obtained from “staking” do not give rise to a taxable event prior to the disposition of those digital assets and their conversion into fiat currency.

The RFIA would have to go through several Senate committees before being put to a full House vote, then would need House approval and President Biden’s signature. Therefore, the proposed legislation is subject to change before becoming law. However, if passed, the RFIA would establish the most comprehensive regulatory framework yet for the digital asset industry in the United States.

This legislation would be a game-changer, as individuals and businesses in the digital asset industry have for years faced a lack of clarity from regulators, which has made it difficult for lawyers to provide legal advice on structuring products and compliance. SEC commissioners have, for years, knowledgeable lawyers that they shouldn’t help their customers evade regulators. Having structure will help, however, too much structure could stifle innovation, so finding the right balance will be key as this legislation moves through the process.