Crypto Regulatory Update

By: Morgan Holder, M.B.A candidate, Associate Consultant

Crypto Winter continues….. The industry is attempting to recover from numerous bankruptcies, hackings, and overall market decline. However, the legislative branch, in the U.S., continues to study and develop crypto currency regulations for the good of the industry. Globally, many regulators stand at a crossroads classifying the many different types of cryptocurrencies and digital assets. Arguably one of the biggest roadblocks toward acceptable regulation is whether to classify cryptocurrencies as commodities, payment tokens, or securities. The industry is in a grey area where regulators and investors want to maintain competitiveness but also guarantee some consumer protection.

There are many ways to approach crypto regulation. Regulators should look no further than the early 90’s for a regulatory framework. The Clinton administration took a thorough market-driven approach to regulating the internet. The “Framework For Global Electronic Commerce” was the platform for initial regulatory approaches to oversee the birth of the internet. There was similar dialogue when the internet itself was dubbed “the Wild West”.

The “Framework For Global Electronic Commerce” was a pre-text of five principles that:

a. Placed the private sector in the driver seat

b. Avoided undue restrictions

c. Enforce a predictable, minimalist, consistent and simple legal environment

d. Explored the unique qualities of the internet

e. Facilitation on a global basis.

These five principles closely mirror some sections of the bills discussed below. The U.S. can take these five principles and consolidate them to fit the current business environment in a push toward institutional adoption.

We have consolidated the five principles into five standards to approach digital asset regulatory policy:

1. Innovate consumer protection
2. Allow the private sector to lead.
3. Strategic review of the economic benefits of digital assets.
4. Prior regulatory frameworks do not fit Digital Assets
5. Highlight the risks to consumers

Two of the major bills before Congress now, The Digital Commodities Consumer Protection Act and The Lummis-Gillibrand Responsible Financial Innovation Act, adhere to these five standards while educating the public.

Below are the key takeaways from the Digital Commodities Consumer Protection Act.

Key Takeaways:

• Defines Bitcoin and Ether as commodities
• Requires a prohibition of abusive trading practice, eliminate and disclose conflicts of interests, maintains cyber security
• Requires digital commodity platforms (trading facilities, brokers, dealers, and custodians) to register with the CFTC
• Requires digital commodity platforms to adhere to advertising standards and disclose information about the risks of digital commodities
• Authorize the CFTC to impose fees on commodity platforms to fund regulatory oversight.
• Authorizes the CFTC to examine demographics of customers to inform on policymaking and outreach
• Outlines those other financial agencies regulate digital assets that are not commodities

This bill, while slightly vague, provides a good starting point to the regulatory approach. This bill essentially breaks out the commodities section of the Lummis-Gillibrand bill which outlines a broader regulatory framework. The primary focus of this legislation reads as consumer protection and transparency. The big win for consumers in this bill is arguably classifying Bitcoin and Ether as commodities. With over 15,000 digital assets, it is important to focus on addressing the largest and commonly held assets first. This bill also highlights the Commodity Futures Trading commission with oversight of Bitcoin Ether, and other assets classified as digital commodities.

The Lummis-Gillibrand bill is arguably the largest regulatory framework bill put forth to date. This bill incorporates all five standards with introductory regulatory proposals. The major part of this bill neutralizes a key roadblock for regulatory approach; The common definitions of securities, payment tokens, and or commodities.

The bill includes numerous subsections touching on different aspects of the industry. The key takeaways are below:

Taxation

The taxation section of the bill will bring clarity to consumers who want to avoid a detrimental tax obligation to the federal government. Below are the highlights:

• The bill moves to clarify the classification of certain DAOs as business entities — requiring proper incorporation of a jurisdiction
• As with securities lending transactions, the bill maintains Digital lending agreements aren’t taxable
• Requires the Government Accountability Office to research potential opportunities of retirement investing to diversify accounts and study the risks.
• Defines transactions of up to $200 per transaction are excluded from gross income for use of payment

Securities Innovation– This section allows the private sector to lead in defining which assets are commodities or securities. This gives the private sector discretion on what their regulatory obligations will be. For example: assets that are not securities will be defined as commodities and subject to SEC disclosure and CFTC registration. See above for more on the consumer protection bill.

Commodities — For the commodities section, payment tokens (stablecoins) issued by depository institutions are clarified neither commodities or securities. In addition, Digital asset exchanges (Coinbase & Binance) are now classified as financial institutions under the BSA Act.

Consumer Protection — The Lummis-Gillibrand Bill requires clear and concise legal disclosure in agreements relating to asset treatment in bankruptcy, risks of loss, applicable fees, and more. The major piece of this confirms a person’s right to ownership (Keep and control) their digital assets. This section of the bill contains overlap on the Digital Commodities Consumers Protections Act which can be used to create the standard for regulatory agencies. See above for a broader description.

Payments — To avoid another TerraLuna debacle, the bill requires all issuers of stable coins to maintain all assets at face value; provide public disclosures on what is backing said stablecoins; and provide the ability to redeem all outstanding payment stablecoins at par value. In addition, the bill will define how depository institutions can issue stablecoins.

Security — Security is at the forefront of any crypto regulation. Investors need to know that their funds are safe in any institution they choose. The bill calls for OFAC (Office of Foreign Assets Control) to establish new guidance on sanctions compliance and liabilities for all issuers of stablecoins. In addition to the creation of an “Innovation Laboratory” within FinCen (Financial Crimes Enforcement Network) to increase public and private dialogue to enhance supervision without stifling innovation. Numerous other committees are formed in this section of the bill revolving around examination standards, decentralized finance markets, self-regulation, and other cybersecurity standards. Overall, this section of the bill can give skeptical investors some breathing room to at least begin exploring adoption.

At this moment in time, the crypto industry stands where the Internet was in the 90’s. The United States must pursue a policy of innovation which incorporates safety and educates the public on risks. Older investors need clarity before risking capital and exposing their clients bottom line. As numerous banking institutions beginning to incorporate crypto platforms into their services, the private sector must remain in the driver’s seat to continue the explosive growth we have seen in the last two years. Innovation must not be stifled because regulators were behind the curve. Policy-Makers should undoubtedly pass both bills to:

1. Increase U.S. competitiveness in the Digital Asset Sector;

2. Protect consumers;

3. Keep the private sector out front

4. Kick off the adoption of an alternative asset class.

With respect to numerous crypto bankruptcies and downturns, there has never been a better time to push toward market-driven regulation and substantial innovation.

New to trading? Try crypto trading bots or copy trading