[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
THE FUTURE OF DIGITAL ASSETS:
IDENTIFYING THE REGULATORY GAPS
IN THE DIGITAL ASSET MARKET STRUCTURE
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HEARING
BEFORE THE
SUBCOMMITTEE ON DIGITAL ASSETS,
FINANCIAL TECHNOLOGY,
AND INCLUSION
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
__________
APRIL 27, 2023
__________
Printed for the use of the Committee on Financial Services
Serial No. 118-17
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
52-395 PDF WASHINGTON : 2023
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HOUSE COMMITTEE ON FINANCIAL SERVICES
PATRICK McHENRY, North Carolina, Chairman
FRANK D. LUCAS, Oklahoma MAXINE WATERS, California, Ranking
PETE SESSIONS, Texas Member
BILL POSEY, Florida NYDIA M. VELAZQUEZ, New York
BLAINE LUETKEMEYER, Missouri BRAD SHERMAN, California
BILL HUIZENGA, Michigan GREGORY W. MEEKS, New York
ANN WAGNER, Missouri DAVID SCOTT, Georgia
ANDY BARR, Kentucky STEPHEN F. LYNCH, Massachusetts
ROGER WILLIAMS, Texas AL GREEN, Texas
FRENCH HILL, Arkansas EMANUEL CLEAVER, Missouri
TOM EMMER, Minnesota JIM A. HIMES, Connecticut
BARRY LOUDERMILK, Georgia BILL FOSTER, Illinois
ALEXANDER X. MOONEY, West Virginia JOYCE BEATTY, Ohio
WARREN DAVIDSON, Ohio JUAN VARGAS, California
JOHN ROSE, Tennessee JOSH GOTTHEIMER, New Jersey
BRYAN STEIL, Wisconsin VICENTE GONZALEZ, Texas
WILLIAM TIMMONS, South Carolina SEAN CASTEN, Illinois
RALPH NORMAN, South Carolina AYANNA PRESSLEY, Massachusetts
DAN MEUSER, Pennsylvania STEVEN HORSFORD, Nevada
SCOTT FITZGERALD, Wisconsin RASHIDA TLAIB, Michigan
ANDREW GARBARINO, New York RITCHIE TORRES, New York
YOUNG KIM, California SYLVIA GARCIA, Texas
BYRON DONALDS, Florida NIKEMA WILLIAMS, Georgia
MIKE FLOOD, Nebraska WILEY NICKEL, North Carolina
MIKE LAWLER, New York BRITTANY PETTERSEN, Colorado
ZACH NUNN, Iowa
MONICA DE LA CRUZ, Texas
ERIN HOUCHIN, Indiana
ANDY OGLES, Tennessee
Matt Hoffmann, Staff Director
SUBCOMMITTEE ON DIGITAL ASSETS,
FINANCIAL TECHNOLOGY, AND INCLUSION
FRENCH HILL, Arkansas, Chairman
FRANK D. LUCAS, Oklahoma STEPHEN F. LYNCH, Massachusetts,
TOM EMMER, Minnesota Ranking Member
WARREN DAVIDSON, Ohio BILL FOSTER, Illinois
JOHN ROSE, Tennessee JOSH GOTTHEIMER, New Jersey
BRYAN STEIL, Wisconsin RITCHIE TORRES, New York
WILLIAM TIMMONS, South Carolina BRAD SHERMAN, California
BYRON DONALDS, Florida AL GREEN, Texas
MIKE FLOOD, Nebraska SEAN CASTEN, Illinois
ERIN HOUCHIN, Indiana WILEY NICKEL, North Carolina
C O N T E N T S
----------
Page
Hearing held on:
April 27, 2023............................................... 1
Appendix:
April 27, 2023............................................... 37
WITNESSES
Thursday, April 27, 2023
Allen, Hillary J., Professor of Law, American University
Washington College of Law...................................... 12
Belcher, Marta, President and Chair, Filecoin Foundation......... 5
Gorfine, Daniel S., Founder & CEO, Gattaca Horizons LLC; Adjunct
Professor of Law, Georgetown University Law Center; and former
Chief Innovation Officer and Director, LabCFTC, U.S. Commodity
Futures Trading Commission (CFTC).............................. 6
Rivera, H. Joshua, General Counsel, Blockchain Capital........... 8
Zweihorn, Zachary J., Partner, Davis Polk & Wardwell LLP......... 10
APPENDIX
Prepared statements:
Allen, Hillary J............................................. 38
Belcher, Marta............................................... 55
Gorfine, Daniel S............................................ 58
Rivera, H. Joshua............................................ 68
Zweihorn, Zachary J.......................................... 72
Additional Material Submitted for the Record
Hill, Hon. French:
Written statement of the Crypto Council for Innovation....... 83
Waters, Hon. Maxine:
Better Markets Fact Sheet: Crypto Regulation................. 87
Written statement of the Credit Union National Association
(CUNA)..................................................... 95
Written statement of the National Association of Federally-
Insured Credit Unions (NAFCU).............................. 99
Written statement of Public Citizen.......................... 100
Written responses to questions for the record from Marta
Belcher and Hillary Allen.................................. 120
THE FUTURE OF DIGITAL ASSETS:
IDENTIFYING THE REGULATORY
GAPS IN THE DIGITAL ASSET
MARKET STRUCTURE
----------
Thursday, April 27, 2023
U.S. House of Representatives,
Subcommittee on Digital Assets,
Financial Technology,
and Inclusion,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:02 p.m., in
room 2128, Rayburn House Office Building, Hon. French Hill
[chairman of the subcommittee] presiding.
Members present: Representatives Hill, Davidson, Rose,
Timmons, Donalds, Flood, Houchin; Lynch, Foster, Torres,
Sherman, Casten, and Nickel.
Ex officio present: Representatives McHenry and Waters.
Chairman Hill. The Subcommittee on Digital Assets,
Financial Technology, and Inclusion will come to order. Without
objection, the Chair is authorized to declare a recess of the
subcommittee at any time.
Today's hearing is entitled, ``The Future of Digital
Assets: Identifying the Regulatory Gaps in the Digital Asset
Market Structure.''
I now recognize myself for 4 minutes for an opening
statement.
Thank you for joining us at today's hearing. We have an
unique opportunity as members of this subcommittee to be on the
cutting edge of crafting an effective, functional regulatory
system for the digital assets ecosystem.
At this very moment, Chair Johnson and other members of the
House Agriculture Committee are also holding a similar hearing
discussing this same issue. That means that more than 40
Members of the U.S. House have an opportunity to work together
to ensure that our regulatory framework embodies the key
principles of the same activity, with the same risk, and the
same regulation.
Moreover, we will be holding a joint hearing next month
with the House Agriculture Committee to explore these issues
together. Two committees working hand in hand on a joint
legislative product like this is unprecedented, and I believe
it vastly increases our chances of getting it right.
Why is legislation needed? The U.S. Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission
(CFTC) have created an impossible situation where the same
firms are subject to competing enforcement actions by the two
different agencies. Asset legislation and our regulators are
only pushing entrepreneurs, developers, and job creators
offshore and out of the U.S. system.
We have a responsibility to protect our constituents. There
are glaring gaps in consumer and investor protections, and
regulation by enforcement does nothing to fill that gap. And
contrary to arguments by some that the problem is simply
nonconformity or noncompliance, it is much more complicated
than that. Also, money transmission licenses--as one of today's
witnesses, Mr. Gorfine, points out--are insufficient in scope.
So today, we are going to dive into the current rules that
govern our securities and commodity markets and assess how we
can address these potential gaps. First, we will examine the
current test to determine if a digital asset is offered as a
part of an investment contract and therefore a security.
Currently, the SEC and the CFTC disagree on the classification
of many digital assets, which is unworkable for entrepreneurs
and consumers. The agencies need direction from Congress.
Second, the current disclosure regime does not produce
information that a reasonable consumer would need to know
before considering the purchase of a digital asset. The
information that is relevant to the purchaser of a digital
asset is different from the information that is relevant when
an investor considers purchasing a stock of a public company.
Third, we will explore whether digital asset trading
platforms perfectly fit under existing laws and regulations and
the rules applicable to digital asset trading platforms.
We have a diverse, knowledgeable panel before us today.
Their experiences will help us understand how we can fill these
gaps and build a better, more-functioning framework. I implore
members of this subcommittee to be thoughtful and open-minded
with their questions as we seek to take a deep dive into the
current regulatory requirements.
I look forward to working together on both sides of the
aisle to craft a digital asset market structure framework and
to lead in the right way.
I now recognize the ranking member of the subcommittee, Mr.
Lynch, for a 4-minute opening statement.
Mr. Lynch. Thank you very much, Mr. Chairman.
And today is Take Your Child to Work Day, so some of our
staff--
Chairman Hill. Did you bring Bill Foster?
Mr. Lynch. No. He is much younger than my son. My dad was
an iron worker, so he did not take me to work, thankfully.
But anyway, I want to thank you, Mr. Chairman, for holding
this hearing. And I thank our witnesses for your willingness to
share your expertise and to help this committee with its work.
As we consider the future of digital assets, I believe that
this is an important opportunity to really understand the
intended and unintended impacts on our traditional financial
system that might come about as our collective efforts combine
to change the regulatory landscape for some of these digital
products.
This hearing focuses on possible gaps in regulation and the
need for legislation to fill those gaps, which is a fair and
legitimate topic. I do have some concerns, however, that we may
be feeding into a narrative that has been shaped by the digital
assets industry itself, and it will turn into a tax on the
regulatory structure and those individuals leading the
regulatory institutions.
Digital asset companies often claim that their technology
is incompatible with existing laws and regulations, when in
reality, it may be simply that their business models are
incompatible with existing law.
Over the last of couple of years, as the digital asset
space has matured, there have been ongoing questions about the
ways in which digital assets should be regulated. The industry
continues to claim that it lacks regulatory clarity and that
its products are so innovative that they require their own
regulatory regime.
The financial services industry has innovated for decades
and will likely continue to do so. The U.S. has a comprehensive
and long-standing framework of securities law and rules
designed to protect investors, promote market integrity, and
facilitate capital formation.
As I have stated before, I align with SEC Chair Gensler's
assertion that most crypto assets are indeed securities and
should be regulated as such. Chair Gensler has called for
cryptocurrency intermediaries to register with the SEC, warning
that they may be subject to enforcement action if they do not
do so. My hunch is that companies do not do so because they
know that they would not meet the standards required, and that
these rules are not compatible with their individual business
models.
Securities laws exist for a reason. They prevent many of
the issues we have seen from failed crypto companies, and they
cover a multitude of products and services. The SEC has
important requirements to protect investors in markets,
including the segregation of customer funds and voiding
commingling and capital requirements, customer protection
rules, Know Your Customer (KYC) supervision and compliance, and
transparency and disclosure.
Rather than complying with existing rules, various crypto
firms have engaged in legal battles against the SEC, and often
argue that they lack guidance on their products. Additional
criticism of the SEC appears to conflict. On one hand, the
industry and some of my Republican colleagues argue that the
SEC has not provided adequate guidance, but, on the other hand,
they complain that the SEC pursues too many rulemakings and
enforcement actions designed to remove that lack of clarity.
As we consider legislation, it is important to note that
neither the Administration, investors, the SEC, or financial
regulators have called for any. It seems unnecessary to
reinvent the rules when we already have a regulatory regime
that is indeed effective. Our financial system is the envy of
the world because of investor confidence, which comes from
these rules. And we could easily become the envy of the world
in the digital asset space if we simply had digital asset
companies comply with existing laws.
So, I look forward to the debate and discussion and to
learning more from our experts. And Mr. Chairman, I yield back.
Chairman Hill. I thank the ranking member.
And I now recognize the Chair of the full Financial
Services Committee, Mr. McHenry of North Carolina, for 1
minute.
Chairman McHenry. Thank you, Mr. Chairman. I want to thank
you for how you have conducted this subcommittee and the
collegial efforts you are trying to lead to build consensus
here.
Digital assets are here to stay. This ecosystem has been
denied legal clarity for too long, and both market participants
and consumers are worse off because of it. We have a market
that lacks clarity, and we have a duty to create a regulatory
environment that allows responsible innovation and responsible
consumer protection to sit side by side with appropriate legal
clarity. We need that innovation here in the United States.
If Congress doesn't act, the rest of the world will. The
Europeans are ahead of us in a market structure bill. The U.K.
regime is ahead of us. They have provided legal clarity, while
we have not. We need to do our work, and it starts here in this
subcommittee with these members.
And I want to thank this panel for their expertise in
bringing forward ideas on how to protect consumers and ensure
that innovation happens here.
I yield back.
Chairman Hill. Thank you, Chairman McHenry.
And now, it is my pleasure to call on the ranking member of
the Full Committee, Ms. Waters of California, for 1 minute.
Ms. Waters. Thank you very much.
Last week, I questioned SEC Chair Gensler about whether the
agency has the authorities it needs to bring crypto companies
and exchanges into compliance with our securities laws, which
have served investors and the markets for the past 90 years.
His response was unequivocally, yes, and the SEC's success in
the courts proves his point.
Despite what those across the aisle may say, we do not need
to create an entirely new and special framework for crypto; we
already have one. Rather, crypto firms, like other tech
companies before them, must recognize that they are not
exceptional. They need to comply with the laws of the land. To
the extent that there are actual gaps in our laws, such as
limitations on the SEC's reach overseas, we should focus on
those and not on creating more complexity through a whole new
regulatory framework.
Later on, I hope I will be able to ask some questions. I
yield back. And thank you very much.
Chairman Hill. I thank the ranking member.
Today, we welcome the testimony of a great panel of
witnesses. First, Ms. Marta Belcher is the president and chair
of the Filecoin Foundation, as well as the general counsel and
head of policy for Protocol Labs.
Second, Mr. Daniel Gorfine is an adjunct professor of law
at Georgetown Law School, as well as the founder and CEO of
Gattaca Horizons LLC. Previously, he was the CFTC's first Chief
Innovation Officer and the Director of LabCFTC.
Third, Mr. Joshua Rivera serves as general counsel of
Blockchain Capital, a leading venture capital firm in the
industry.
Fourth, Mr. Zachary Zweihorn is a partner at Davis Polk &
Wardwell LLP, where he specializes in financial institutions,
fintech, and digital assets.
And finally, Ms. Hillary Allen is a professor of law and
associate dean for scholarship at American University
Washington College of Law, where she teaches courses on
banking, securities regulation, and business associations.
We thank each of you for taking the time to be with us
today. Each of you will be recognized for 5 minutes to give an
oral presentation of your testimony. And without objection,
each of your written statements will be made a part of our
record.
Ms. Belcher, we will start with you. You are now recognized
for 5 minutes.
STATEMENT OF MARTA BELCHER, PRESIDENT AND CHAIR, FILECOIN
FOUNDATION
Ms. Belcher. Thank you, Subcommittee Chairman Hill,
Subcommittee Ranking Member Lynch, Full Committee Chairman
McHenry, and Full Committee Ranking Member Waters for inviting
me to testify today.
I am Marta Belcher, president and chair of Filecoin
Foundation, one of many organizations working on a
cryptocurrency called Filecoin.
While this hearing is being held by the Committee on
Financial Services, I want to emphasize today that
cryptocurrency is about so much more than finance.
Cryptocurrency is already creating a better internet, providing
an alternative to Big Tech that puts people in control of their
own data. This technology is also preserving some of the
world's most important information, including government data,
evidence of human rights abuses, and critical scientific
datasets. Today, I would like to explain how.
Today's internet is centralized. The vast majority of data
is stored by three companies: Amazon, Microsoft, and Google.
This creates single points of failure. When these companies
suffer blackouts, large swaths of the web go down for hours.
This also means that we live our lives through a handful of
corporations. We have no choice but to trust them with our
data, and they have unilateral control over what we can do and
say online.
Cryptocurrency provides an alternative. Cryptocurrency
creates the ability to program money, to send value across the
globe instantly and automatically with no intermediary when a
condition is met. For example, you can write a computer program
that says for every second of a song I play, automatically
transfer a millionth of a cent from me to the songwriter.
Filecoin uses programmable money to create a decentralized file
storage network.
It is like Airbnb for file storage. You can rent out your
digital storage space to people who pay you to store their
files or pieces of their files. A computer program regularly
checks that you are still storing the files, and you are
automatically paid in Filecoin. Using the Filecoin token
enables the network to operate in a way that is peer-to-peer,
instant, automatic, and trustless.
Filecoin is a foundational technology for the next
generation of the Web. Filecoin puts users in control of their
data, finally giving them an alternative to Big Tech. It also
allows users to store many copies of their files so that data
remains accessible even if some devices fail. There are
thousands of individuals and small businesses serving as
Filecoin storage providers, some of them in the audience today.
They are contributing more than 15 billion gigabytes of
capacity to the Filecoin network, which is enough to store all
written works since the beginning of recorded history 10 times
over. That storage space is being used to preserve humanity's
most-important information.
For example, Filecoin is storing copies of open datasets
created by NASA, NIH, and the National Weather Service.
Filecoin is also important for government documents because it
can solve the problem of link rot, the fact that over time,
many links and important documents like congressional records
no longer work. Harvard's Library Innovation Lab is exploring
how these technologies can ensure that links work permanently.
Human rights defenders leverage Filecoin to help collect,
verify, and preserve data. For example, Starling Lab, a project
of Stanford and USC, recently submitted evidence of Russian war
crimes in Ukraine. They submitted that to the International
Criminal Court, and used Filecoin to both preserve this digital
evidence and also verify that it was authentic and had not been
tampered with.
Filecoin also stores important scientific generation like
genomic, satellite, and climate datasets from institutions like
the ATLAS Experiment at CERN. Filecoin Foundation is also
working with Lockheed Martin on a satellite launch to
demonstrate how the technology underlying Filecoin can speed up
communications in space.
As these examples show, cryptocurrency is about so much
more than financial services, and regulating cryptocurrencies
like financial services could undermine these valuable use
cases. Regulations that insert intermediaries and add friction
are incompatible with these technologies.
It is critical that any cryptocurrency regulation protects
users' ability to transact directly with each other. It is
critical to recognize the open source decentralized nature of
this technology and to acknowledge our country's free speech
protections for writing computer code. And it is critical to
provide clarity, safe harbors, and compliance on-ramps so that
innovators can continue to operate in the United States.
In drafting cryptocurrency regulation, I urge the committee
to consider the many valuable use cases of cryptocurrency
beyond financial services to ensure this innovation can
continue to thrive. I look forward to your questions. Thank
you.
[The prepared statement of Ms. Belcher can be found on page
55 of the appendix.]
Chairman Hill. Thank you.
Mr. Gorfine, you are now recognized for 5 minutes.
STATEMENT OF DANIEL S. GORFINE, FOUNDER & CEO, GATTACA HORIZONS
LLC; ADJUNCT PROFESSOR OF LAW, GEORGETOWN UNIVERSITY LAW
CENTER; AND FORMER CHIEF INNOVATION OFFICER AND DIRECTOR,
LABCFTC, U.S. COMMODITY FUTURES TRADING COMMISSION (CFTC)
Mr. Gorfine. Thank you, Subcommittee Chairman Hill and
Ranking Member Lynch, Full Committee Chairman McHenry and
Ranking Member Waters, and members of the subcommittee for the
opportunity to testify before you today.
My name is Daniel Gorfine. I am the founder and CEO of
Gattaca Horizons, an adjunct professor at Georgetown Law, and
the former Chief Innovation Officer at the CFTC. The testimony
presented here today reflects my own views.
The topic of today's discussion has featured prominently
both during and after my time in government. Nevertheless, the
fundamental regulatory landscape for digital assets in the
U.S., especially at the Federal level, has not changed
significantly since the inception of Bitcoin in 2009.
The current landscape remains one where spot or cash
digital commodity trading activity, which means the buying and
selling of an asset for immediate delivery, is largely
regulated at the State level. Notably, under the status quo,
spot market digital commodity exchanges are not subject to
comprehensive Federal market oversight and supervision. This
would require new and explicit authorization from Congress.
But let me step back and unpack the current landscape a bit
further. The Financial Crimes Enforcement Network (FinCEN)
determined in 2013 that digital asset exchanges are money
services businesses. Following FinCEN, many States have
required exchanges to secure a money transmission license
pursuant to each State's respective laws. Some States have gone
further and created tailored crypto regulatory frameworks,
including, for example, the New York BitLicense.
State frameworks do impose meaningful requirements on
intermediaries. These frameworks do not, however, uniformly
impose the same types of markets and trading oversight as is
common with Federal market regulation. For example, State money
transmitter regulation would typically not impose market
surveillance requirements intended to detect fraudulent or
manipulative trading activity, including wash trading and
spoofing.
Beyond FinCEN and the States, the CFTC, the SEC, and the
Federal banking regulators apply their respective rules
depending on the type of digital asset intermediary and the
involved activity.
The CFTC's jurisdiction over digital assets was established
in 2015 when the Commission determined that Bitcoin met the
definition of, ``commodity.'' However, the CFTC's jurisdiction
over spot commodity markets is quite limited. While the CFTC
does have enforcement authority to police for fraud and
manipulation, this authority is backward-looking and is invoked
only when wrongdoing is suspected. And this authority is not
oversight authority, which entails rulemaking and the
registration and regular examination of intermediaries.
This key point is commonly confused because the CFTC does
have authority over derivatives products that may be predicated
on an underlying commodity, for example, oil, gold, or even
Bitcoin futures contracts. Involved intermediaries are then
subject to CFTC requirements, including with respect to
registration, trade surveillance, and customer education and
protection.
Since 2018, the CFTC has overseen well-regulated, robust,
and transparent Bitcoin futures in options markets. These
products were offered under the CFTC's tailored heightened
review framework in order to address unique digital commodity
characteristics, including their high degree of retail
participation and unique custody considerations.
The CFTC accordingly established the basis for differential
treatment of digital commodities and ensured that Americans
have access to well-regulated markets. This outcome is far
preferable to seeing investors lured to offshore, illegal
derivatives exchanges that are prone to fraud and financial
crime.
With respect to the SEC, it has broadly asserted its
enforcement authority and suggested that many cryptocurrencies
are securities. While many enforcement actions--especially
during the ICO mania--targeted clear cases of an issuer selling
tokens to raise capital or defraud investors, there remains a
lack of clarity in determining when an asset is a security.
This ambiguity has implications, since market participants and
regulators alike may struggle in determining which rules apply.
Looking ahead, while some States like New York have
developed mature regulatory frameworks, there is no current
Federal market regulator overseeing spot digital commodity
markets. By statute, the CFTC is a principles-based regulator
established by Congress to deter and prevent price
manipulation, uphold market integrity, protect market
participants, and promote responsible innovation. The CFTC,
however, would need specific statutory authority to oversee
spot digital commodity markets.
Additionally, even if the CFTC were granted such authority,
it would still be necessary to increase definitional clarity
regarding when a token is or is not a security. This is an area
where more work needs to be done, whether by the courts,
regulators, or Congress.
Today's panel, as well as many others before us, have
identified existing gaps and opportunities to create a more
efficient and comprehensive national regulatory framework.
Against this backdrop, I think there is a great opportunity for
policymakers to work collaboratively to craft that framework in
order to ensure the responsible development of digital assets
and markets in the United States.
Thank you, and I am happy to answer any questions you may
have.
[The prepared statement of Mr. Gorfine can be found on page
58 of the appendix.]
Chairman Hill. Thank you very much.
Mr. Rivera, you are now recognized for 5 minutes for your
oral presentation.
STATEMENT OF H. JOSHUA RIVERA, GENERAL COUNSEL, BLOCKCHAIN
CAPITAL
Mr. Rivera. Thank you, Subcommittee Chairman Hill and
Ranking Member Lynch, Full Committee Chairman McHenry and
Ranking Member Waters, and the members of the subcommittee for
inviting me to testify today.
My name is Joshua Rivera. I serve as general counsel of
Blockchain Capital, a venture capital firm focused on digital
assets technology. I am a lawyer by training and practice and
have represented traditional global financial institutions in
various financial transactions, including capital markets,
financings, mergers and acquisitions, and asset management.
I also have the great privilege of sitting on our
investment committee of Blockchain Capital and participating in
the critical investment decisions we make on behalf of our
limited partners.
Blockchain Capital manages approximately $2 billion in
assets and has invested in more than 100 portfolio companies,
protocol teams, and projects in the digital assets industry.
Our team fields approximately 1,500 proposal decks and pitches
each year from entrepreneurs building in the industry,
providing us with an unique macro perspective on industry
developments.
Thank you for allowing me to testify about the incredible
opportunities as well as the challenges the digital assets
industry presents to an innovative American marketplace. My
message for you today is that the industry wants to work with
you, the members of this subcommittee, other Members of
Congress, and regulators on developing appropriate market
structure regulation for addressing the novel challenges and
opportunities this technology presents.
First, I will explain pain points in our current financial
system and how blockchain technology can enhance our society.
The current financial system is overly-reliant on centralized
intermediaries. This is a paradigm that constrains innovation.
The U.S. consumer credit rating system provides a prime
example of the inefficient and flawed systems that can arise
out of overly-intermediated value systems. Monopolized by three
ratings bureaus, this system is often ineffective, and excludes
those who need safe and affordable access to credit, while also
creating immense privacy and security concerns.
It is not only legacy financial systems that suffer from
intermediaries. Social media enterprises like Facebook and
Twitter, as well as content platforms like Spotify and YouTube,
have all leveraged the free and instantaneous transfer of data
originally pioneered by the internet, not to democratize
participation in value creation, but rather to monopolize it.
They do this by commoditizing their own users and preventing
actual content creators from realizing more value from the
content they create. Blockchain technology creates alternative
solutions to the services and infrastructure controlled by
these intermediaries.
In the case of financial ecosystems, blockchain networks
can be accessed anywhere in the world by anyone with an
internet connection. Using these networks, participants can
transfer any amount of value to virtually any location in the
world 24 hours a day, 7 days a week, 365 days a year with
instantaneous settlement at much lower cost to the user.
So the question is, how should we engage with this
innovation? The fundamental innovation of blockchain networks
is to allow anyone, anywhere, to participate in commerce or
other systems of value without an intermediary. This is novel,
and a fundamental shift from the traditional ways in which
finance and commerce are both organized and regulated. It
requires a new approach.
There is an unfortunate perception that participants,
investors, and founders in the digital assets industry do not
want to be regulated. This is false. A great number of
participants, myself included, have sought over many years to
engage with regulators in a collaborative attempt to set out
clear and workable rules of the road. While there have been
some rulemaking efforts, these efforts have not come early or
often enough, and unfortunately have been made with almost no
meaningful industry engagement. The undesirable result has been
rule proposals that are largely unworkable, both in technical
implementation and policy outcomes. We should work with this
innovation, not against it.
According to data from PitchBook, the share of venture
capital funding from blockchain start-ups in the European Union
surpassed the allocation for U.S. firms for the first time ever
in the first quarter of this year. This may signal a
potentially devastating outcome, one from which the U.S. may
not be able to recover. It is something that every member of
this subcommittee should actively seek to correct.
In closing, the world-changing innovations introduced by
the digital assets industry have only scratched the surface of
their potential. We are on the cusp of the next wave of
technological change, but the United States must act quickly to
ensure it develops here and not abroad.
Tailored, fit-for-purpose rules for this nascent ecosystem
are critical, and must protect consumers, while also promoting
innovation. Industry stands ready to work with you on this
balanced approach to ensuring that the U.S. remains a leader,
as it often is, in all vanguard fields of innovation,
especially blockchain technology.
Thank you for the opportunity to testify. I look forward to
your questions.
[The prepared statement of Mr. Rivera can be found on page
68 of the appendix.]
Chairman Hill. Thank you very much.
Mr. Zweihorn, you are now recognized for 5 minutes for your
presentation.
STATEMENT OF ZACHARY J. ZWEIHORN, PARTNER, DAVIS POLK &
WARDWELL LLP
Mr. Zweihorn. Chairman Hill, Ranking Member Lynch, and
members of the subcommitte, thank you for inviting me to
testify today. My name is Zach Zweihorn, and I am a partner at
the law firm of Davis Polk & Wardwell. My legal practice
focuses on the regulation of the securities markets, and in
particular, laws and rules that govern the activity and conduct
of market intermediaries, such as securities exchanges and
broker-dealers.
I have worked with many industry members, both in
traditional finance as well as those that are crypto native, to
consider their digital asset activities and the potential
securities law compliance obligations.
It has been a challenging landscape to navigate due to the
regulatory uncertainty and some legal dead-ends. There is much
debate on the question of whether a particular digital asset is
or should be considered to be a security. This is a critical
question, and one that Congress needs to clarify.
What I would like to highlight today is that if a digital
asset is a security, not only is the initial sale subject to
registration, but secondary market trading must occur through a
web of registered and regulated market intermediaries: brokers,
dealers, exchanges, transfer agents, and clearing agencies.
We have all heard the siren's call that trading platforms
should come in and register. It sounds enticingly attractive,
but it is an oversimplification that conflates registration,
which may theoretically be possible, with compliance, which
really is not.
Registration is not simply a matter of filling out forms
and sending them in. Instead, it is a substantive exercise of
showing the regulator how a firm's proposed activities will
comply with the existing laws and rules. Because these existing
laws and rules were designed for traditional securities such as
debt and equity, compliance for trading in digital assets
securities is challenging or virtually impossible.
To point out a couple of examples, under current law and
rules, a registered exchange can generally only facilitate
trading in a security if that security is registered.
Similarly, broker-dealers are prohibited from facilitating
trade in a security unless the issuer has taken steps to
register it or otherwise make certain disclosures.
This results in a catch-22. The intermediary is required to
register with the SEC in order to facilitate trading, but if it
has registered with the SEC, it is prohibited from facilitating
trading unless the issuer--somebody different than the
intermediary that it can't control--has taken further steps and
actions.
As another example, in order for centralized trading
platforms to operate, someone needs to hold securities for
investors. But SEC accounting and custody guidance has made it
legally or economically infeasible for either banks or broker-
dealers to provide custody services for digital assets. So,
again, if a firm were to register, there would be no way for it
to facilitate trading, because there is nobody that can provide
custody.
In light of these and other challenges, and absent a litany
of exceptions or new guidance from the SEC, a digital asset
security that did seek to register with the SEC would have its
application rejected.
There are also differences in market structure that raise
unnecessary legal challenges. Digital asset trading platforms
operate under a model that allows end-users to directly trade
on a platform, with the platform maintaining custody of the
digital assets of the user, matching buyers and sellers and
settling transactions. This is different from how our
traditional securities markets work, where separate firms
provide exchange, broker services, and clearing.
Because the securities laws and rules were developed to
regulate the heavily-intermediated structures that are already
involved in the securities market, that model has been baked
into the laws. As a result, current law assumes that there
would be a high level of intermediation, and effectively
requires intermediation if an asset is a security, regardless
of whether new innovations mean that model is not necessarily
practical or better for investors.
It may be popular in the crypto community to blame the SEC
for bringing enforcement actions while failing to adopt a
regulatory regime that is compatible with digital assets, but
the SEC is a creature of statute, created by Congress in charge
of administrating the Federal securities laws that Congress has
adopted. While the SEC has authority to provide exemptions,
wholesale changes and entirely new regulatory regimes should
come from Congress and not from the Commission.
The only real solution is for Congress to establish a
regulatory framework under which digital asset market structure
can exist, giving the SEC a mandate to implement and facilitate
it. Congress has amended the laws to address changes to the
securities market before. Congress could and should take the
same approach today.
Thank you, again, for the opportunity to participate today,
and I look forward to your questions.
[The prepared statement of Mr. Zweihorn can be found on
page 72 of the appendix.]
Chairman Hill. Thank you very much.
And Professor Allen, you are now recognized for 5 minutes
for your oral presentation.
STATEMENT OF HILLARY J. ALLEN, PROFESSOR OF LAW, AMERICAN
UNIVERSITY WASHINGTON COLLEGE OF LAW
Ms. Allen. Thank you, Chairman Hill, Ranking Member Lynch,
and members of the subcommittee. Thank you for inviting me to
testify at today's hearing.
My name is Hillary Allen, and I am a professor of law at
the American University Washington College of Law, and the
author of the book, ``Driverless Finance: Fintech's Impact on
Financial Stability.''
We are here to talk about regulation of the digital asset
markets, and the other witnesses here have urged legislative
and regulatory reform in order to let crypto business models
thrive.
The main point I would like to make today is to urge you to
be very wary of peeling back laws designed to protect the
public from harm. In my research, I have explored in detail the
financial stability and investor harms associated with the
crypto markets. And in connection with the latter, I would like
to read you a quote from Congress in 1933.
``During the postwar decade, some $50 billion of new
securities were floated in the United States. Fully half or $25
billion worth of securities floated during this period have
been proved to be worthless. These cold figures spell tragedy
in the lives of thousands of individuals who invested their
life savings, accumulated after years of effort, in these
worthless securities. The flotation of such a mass of
essentially fraudulent securities was made possible because of
the complete abandonment by many underwriters and dealers in
securities of those standards of fair, honest, and prudent
dealing that should be basic to the encouragement of investment
in any enterprise.
``Alluring promises of easy wealth were freely made with
little or no attempt to bring to the investor's attention those
facts essential to estimating the worth of any security. High-
pressure salesmanship rather than careful counsel was the rule
in this most dangerous enterprise.''
I think this statement would resonate very much with those
who have lost money with Celsius or FTX or any of the other
failed crypto intermediaries. I believe it would also resonate
with those exposed to the DeFi platform, Terra LUNA, or any
number of other DeFi scams.
I read this statement here to illustrate that with crypto,
not much has changed since 1933. Of course, the technology used
is different now, but technology is only a tool, and the
impacts of any technology are inextricably intertwined with the
people who use it.
With crypto, the existence of blockchain technology does
nothing to change the economic incentives of those deploying
it, and those incentives have not changed significantly since
1933.
The crypto industry often demands that lawmakers and
regulators understand the intricacies of blockchain technology
before creating or enforcing law or rules. But I would submit
that the crypto industry needs to learn some basics about
economics and finance before they argue that the rules
shouldn't apply to them.
If they understood even a little bit about economics and
finance, they would understand that technological
decentralization and decentralized economic control are two
very different things. A system can have lots of nodes, but if
someone controls a lot of those nodes, they will control the
system.
Of course, it is possible that some members of the crypto
industry already do understand these things, and their rhetoric
about decentralization is entirely disingenuous because there
is nothing economically decentralized about the crypto markets
where we see concentrations of economic power that sometimes
rival or exceed what we would see in traditional finance. The
technological decentralization achieved through blockchain
technology, that is far less efficient than centralized
systems, has all been for naught.
While I see little of value in blockchain technology, I
want to make it clear that enforcement of existing law is not
incompatible with blockchain technology. It is entirely
possible for a business using blockchain technology to comply
with existing investor protection and financial stability
regulation.
However, for many crypto businesses, it may be true that
existing regulation is incompatible with the economics of their
business model, especially if their business model depends on
doing things that we have learned over the years tend to harm
people, like a hedge fund that profits by trading against the
customers of an affiliated exchange without those customers
knowing, or an exchange that profits by commingling its own
assets with customer assets and then using those commingled
assets to trade, or an issuer that profits by making up assets
out of thin air at almost zero cost engaging in some wash
trades to inflate their market price, hyping the assets on
social media, using them as collateral for loans, and then
dumping them on unsuspecting investors.
As my written testimony explains, existing financial law
and regulations are already well-suited to dealing with these
kinds of harms associated with crypto business models. We
shouldn't dispense with those protections lightly in any
circumstances, and we really shouldn't dispense with them for
the sake of letting business models based on speculation and
predation thrive and become too-big-to-fail.
Remember that laws make markets, and bespoke crypto
legislation could create a market for business models that
don't have enough utility to survive on their own. More robust
enforcement of existing laws and regulations would certainly be
desirable.
In particular, Congress should support the SEC's
enforcement in securities registration and broker-dealer
registration requirements with increased funding and with
increased political support, but the legal fundamentals are by
and large there.
I look forward to your questions.
[The prepared statement of Ms. Allen can be found on page
38 of the appendix.]
Chairman Hill. Thank you very much.
We will now turn to Member questions. And the Chair now
recognizes himself for 5 minutes for questioning.
I will just start out by saying that I appreciate,
Professor Allen, your talk about the securities markets, and I
think you have made many, many good points.
Let me say that between March of 2000 and October of 2002,
the insider regulatory framework, with all of their
surveillance and people involved in overseeing it, and
following every 1933 and 1934 Act, we lost $5.5 trillion from
investors in the United States. Silicon Valley Bank, just a few
weeks ago--super-regulated, over-regulated, massively-
regulated, inside the regulatory framework, but due to a lack
of supervision and a terrible business policy, people lost a
lot of money there.
So what we are talking about today is crafting a regulatory
framework that is fit for purpose and that fits the activity
and absolutely doesn't undercut any fraud or anything
whatsoever about consumer-investor compliance.
I don't think anybody here is suggesting that. No one on
this panel supports fraud and misbehavior, a lack of
compliance, not following the rules, et cetera. But we
definitely have the need for a regulatory framework that fits
the purpose and protects investors to the best that Federal
regulation can do so.
Although some digital assets will fall under the definition
of a security or a commodity--and we have heard testimony today
about both--there are digital assets like a digital sports card
or a digital collectible or maybe a token connected to an
activity like a game or Filecoin that we have had described
today pretty thoroughly, I think, that make a use case for
precisely what that company is doing that is distinguishable
from a security or a commodity. And these assets merit, in my
view, being classified in a third category altogether, which is
why the existing regulatory framework does not work.
So, Mr. Gorfine, would you agree that there is a third
bucket of digital assets that need oversight, need clarity,
need all of the investor and security protections, but they
don't fit in the bucket of either Mr. Rivera's background at
the CFTC or Chair Gensler's world at the SEC?
Mr. Gorfine. Yes. It is a good question. And I would
actually suggest that the problem with the term, ``digital
asset,'' is that it is incredibly broad. And I would say we
have even more than three buckets. The reason I say that is you
can effectively tokenize any asset, especially if you are
tokenizing the ownership interest in that asset. You could
tokenize a car title. You could tokenize a title to a home. You
could tokenize an actual item of digital art or ownership over
existing artwork.
So, I think we have to be careful because the reality is
that regulation looks at things through the lens of what type
of an asset or an instrument is it, and we apply certain rules
based on what the asset actually is. So in that sense, the
term, ``digital asset,'' is incredibly broad, and there
certainly may be items, collectibles, that fall outside of at
least the securities law definition, and potentially even the
way that the CFTC, for example, would view, ``commodity,''
because the term, ``commodity,'' under the Commodity Exchange
Act is incredibly broad. That doesn't mean that the CFTC is
seeking to at least police the spot market for every
conceivable commodity or instrument that can transact in
society. It is a broad topic.
Chairman Hill. Thank you. I like the idea of a gaming
company that raises money to create a new game; let's say they
have to raise $10 million to create a game. It is clearly a
security. It is a private placement to create the game. But if
you invest in the game, you also get some tokens that are going
to be used in the game, if the game ever works. If the game is
unveiled and nobody comes to play and it is a flop, then those
tokens are useless. But if the game is up and running a year
later, those tokens have value.
Are those tokens securities, or are those tokens just
things in the game?
Mr. Gorfine. That is where we are going to need some
clarity around the potential for something to transition from
being in one state, maybe down the line to something else. If
people purchase a token in order to help the company raise
money--
Chairman Hill. But that wasn't my example.
Mr. Gorfine. Right. This is something that is actually
being used functionally within the game.
Chairman Hill. Yes. We will dumb it down and make it for a
broader audience, perhaps.
So, $10 million to create a new musical. You are going to
star in it on Broadway. And if the musical goes from off-
Broadway to Broadway and is successful, everybody who put
$100,000 in my $10 million-offering gets 25 tickets to the show
that they could use for the whole run of the show.
So, it's clearly a security. The Broadway show is a
success. I am earning a return on my investment, I hope. But I
now have 25 tickets that are just a thing to go to this show. I
can keep them. I can give them to my kids. I can sell them. Are
those tickets a security?
Mr. Gorfine. It sounds like it is a perk as being part of
that--
Chairman Hill. A perk. Yes. It is an offshoot of it. And if
the play was a flop, then those tickets would have no value.
I think this is why we need to really carefully think about
this. I appreciate your responses.
Now, let me yield to my friend, the ranking member of the
subcommittee, Mr. Lynch, for 5 minutes.
Mr. Lynch. Thank you, Mr. Chairman.
Professor Allen, the SEC first warned investors of the
dangers of investing in crypto back in 2013, when the Office of
Investor Education and Advocacy issued an investor alert on,
``Ponzi schemes involving cryptocurrencies.'' Then in 2014, the
same office issued another investor alert on Bitcoin and other
virtual currency-related investments.
In 2019, the SEC issued a Framework for Investment Contract
Analysis of Digital Assets. And that was to provide clarity on
when a digital asset has the characteristic of a security and
when the sale of a digital asset is a securities transaction.
And in addition, there had been 130 enforcement actions
brought by the SEC against crypto firms that have engaged in
marketing securities without providing the necessary
disclosures, audited financials, or investor protections that
would allow investors to make a meaningful and informed
decision regarding the value of a crypto product or the
viability of the underlying business.
Two points are notable. One, the SEC has won every single
one of those 130 cases that they have brought under existing
law. And two, each of those cases went through a legal process
which culminated, in every case, in a written regulatory
decision, and many had judicial decisions or administrative
opinions written on appeal that actually do provide clear and
unambiguous guidance to the crypto industry and provide clarity
and lay out the rules of the road that should guide our crypto
firms.
So the claims that there is no direction, there is no
clarity, in at least that part of it, can you speak to that?
Ms. Allen. I do think it is quite clear. And it ties back
to the investor harms that I mentioned earlier. The Howey test
is all about protecting people who have invested their money in
a common enterprise with the expectation of profits to come
predominantly from the efforts of others.
That offers scope for harm, and I think that probably
accurately reflects why most people are investing in these
crypto things. I think there is the clarity. But if we wanted
more, Congress could pass legislation that inserted crypto
assets into the definition of security in both the 1933 Act and
the 1934 Act, and that would settle it for all time.
Mr. Lynch. Let me ask you, the fact that--and others have
said here this morning that you can basically tokenize
anything. If you did have a system for crypto that was--that
didn't--so all of those rules that apply to traditional finance
don't apply, okay? Because they are all acting right now in
noncompliance.
If there was another whole system that is set up where
there is no compliance requirements for disclosure or
commingling of funds, which is happening rampantly in the
crypto world, what would that do to the traditional finance
system where you have financial firms that are under the burden
and have to observe the protections that are provided to
investors and to the public?
Ms. Allen. This is really important. A bespoke crypto
regime would be a massive regulatory loophole for all of
financial services. I don't actually use the term, ``digital
assets,'' in this space because I think all our assets are
already digital, right? So, I talk about crypto as being
something that is associated with the blockchain, because all
of our assets are already digital.
It is very easy, as we have heard, to tokenize them and put
them on the blockchain. So if you create a special bespoke
crypto regime that has fewer protections than the existing
regulatory regime, it doesn't take a genius to see what is
going to happen to traditional finance. They are going to put
it all on the blockchain and take advantage of that lighter
touch regime.
Mr. Lynch. Right. And with the commingling of funds--many
of the crypto firms don't provide audited financials. They
don't make those necessary disclosures. If we held the crypto
industry to the same standards, would that be one way of
legitimatizing or protecting the public even in the crypto
realm?
Ms. Allen. Yes, that is right. We have to thread the needle
where we protect the public without giving special treatment to
crypto. And I think by applying existing registration
requirements for the securities themselves and also for the
broker-dealer regulation and exchange regulation--just to take
one example, that would mean that the current crypto exchange
model with all of the conflicts of interest that is just rife
in that model couldn't continue to exist. And so, customers
would be protected from all of those conflicts of interest by
requiring those exchanges to register.
Mr. Lynch. Thank you.
Mr. Chairman, I yield back.
Chairman Hill. I thank my friend.
I now turn to Mr. Rose of Tennessee for 5 minutes.
Mr. Rose. Thank you, Chairman Hill, and thank you, Ranking
Member Lynch, for holding this hearing.
And thank you to our distinguished witnesses for being here
and sharing your time with us.
Mr. Rivera, AI-linked blockchain products include payment
systems, trading, models, machine-generated nonfungible tokens,
and blockchain-based marketplaces for AI applications. As we
think through how to play catch-up in the broader crypto
regulatory landscape, what are some of the unique regulatory
gaps created by AI-linked crypto projects?
Mr. Rivera. The question on AI is a difficult one. It is
still a very burgeoning and growing industry. It is moving
extremely rapidly with the recent rise of ChatGPT. Its
application to crypto is something that we are looking at very
closely, and how that will be regulated, I think, is extremely
important.
But I think the focus needs to be on regulating entities
that we understand how they work, intermediaries--exchanges,
custodians--who provide services in a centralized way to the
digital asset ecosystem. And making sure that regulation is
focused, and not so broad that it stifles innovation for things
that we understand less, like how AI is going to interplay with
digital assets in the next 3 to 5 years.
There surely will be a large number of innovations that
will come from the interplay of those two things, and many of
them will be extremely useful. They will be extremely
beneficial to society, and we should give space for those
innovations to happen, and in the meantime, really focus on
providing targeted regulation for entities that we understand.
Mr. Rose. Thank you.
Shifting to Mr. Gorfine, SEC Chair Gensler has insisted
that digital assets' legal status depends on, ``individual
facts and circumstances,'' and that projects should, ``come in
and talk to the SEC,'' to identify a path towards compliance.
Only about four crypto projects have been able to come into
compliance as defined by the SEC.
Mr. Gorfine, at your former agency, the CFTC, is there a
path towards compliance, specifically for exchanges, and what
does that look like?
Mr. Gorfine. Yes. To level set, remember that spot
commodities are not directly regulated by the CFTC. So,
exchanges that are engaging in spot activity do not register
with the CFTC. But the CFTC has registered and oversees a
number of exchanges that do offer Bitcoin or ether futures and
options products, and those can be both physically settled and
cash settled.
So, there is a robust, well-regulated marketplace regulated
by the CFTC where registrants have been able to come in and
offer those types of products.
Mr. Rose. Thank you.
Mr. Zweihorn, Chair Gensler has said--and I am going to
give you about four of his quotes. In August of 2021, he said
that the SEC needs additional authorities to prevent
transactions, products, and platforms from falling between
regulatory cracks. In December of 2022, he said that he feels
that the SEC has enough authority in this space. In May of
2021, he said that, right now, there is not a market regulator
for crypto exchanges. And then, in December of 2022, he said
that exchanges can come into compliance by appropriately
working with the SEC.
So, Mr. Zweihorn, do you believe that these comments
provide regulatory clarity and promote stability in digital
markets?
Mr. Zweihorn. Thank you, Congressman Rose.
I think those comments, depending on whether he is
referring to a digital asset as a security or as not a
security, could mean different things. There is a lot of lack
of clarity about that. But the SEC admittedly, by its own
admission, doesn't regulate Bitcoin or Bitcoin exchanges. So, I
don't think he could mean that Bitcoin exchanges would need to
register.
But as he has said, he believes--and the market does not
agree with this--that many other digital assets are securities.
But there is certainly some lack of clarity in terms of which
ones and therefore what obligations they have.
Mr. Rose. Thank you.
Mr. Rivera, SEC Commissioner Peirce has noted that there
has been a reluctance on the part of the SEC to, ``provide
additional guidance about how to determine whether a token is
being sold as part of the securities offering or which tokens
are securities.''
In your view, would additional guidance from the SEC on
this issue be helpful?
Mr. Rivera. Yes. I think it is pretty telling when one of
the Commissioners of the SEC has directly stated that there is
reticence in the agency to provide guidance. We have been
asking for this with the SEC for a long time. As they say,
everything is facts and circumstances, so it is hard to say
that whether something is a security is based on facts and
circumstances, but everything is a security.
Mr. Rose. Thank you.
My time has expired. I yield back.
Chairman Hill. I thank the gentleman.
And I now recognize my friend from Illinois, Dr. Foster,
for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman.
Ms. Belcher, how does Filecoin handle anonymity and
censorship? For example, if someone steals the designs of
nuclear weapons and posts them on Filecoin, can you find out
who did it, remove the material, and take it down and identify
the person?
Ms. Belcher. Thank you so much for that question.
Filecoin is an open source technology, and many people are
building tools on top of the Filecoin network--
Mr. Foster. My question is, can you do it today? As it is
set up right now, if someone tomorrow posts the designs of
nuclear weapons, can you identify the person, haul them into
court, and remove the material?
Ms. Belcher. Yes. We have content moderation tools that are
built on top of the Filecoin network by--
Mr. Foster. And do you have a governing structure that
allows you--let's say that taking down material is disputed.
What court system do you go to to resolve that?
Ms. Belcher. The way that it works is basically the same
content moderation rules apply.
Mr. Foster. Which court system ultimately has jurisdiction?
Ms. Belcher. Again, the same rules that would apply to
content--
Mr. Foster. Are you saying no court system has jurisdiction
to ultimately decide if there is a disputed takedown of
material?
Ms. Belcher. I am saying the same rules apply to content
moderation on the Filecoin network that apply to Facebook or
any other protocol.
Mr. Foster. What jurisdiction are you registered in that
allows the court to say, I'm sorry, I order you to take that
down?
Ms. Belcher. Just like with Facebook, there isn't
registration for content moderation. The way that it works is
you can go to any individual node or storage provider, and we
actually have tools that provide for decentralized content
moderation.
Mr. Foster. Okay. That is an important question that we
have to think through, because it will happen and maybe already
has.
Mr. Gorfine, there are estimates from Forbes and other
places that more than 50 percent of all Bitcoin transactions
are fakes, mostly wash trades between anonymous participants.
So, how can you possibly have a well-regulated market in,
say, Bitcoin futures, when the majority of transactions in the
underlying assets are fraudulent?
Mr. Gorfine. When the CFTC allowed the self-certification
in Bitcoin futures, it did so under a heightened review
framework where there were requirements for the derivatives
exchanges to have information-sharing relationships with the
underlying exchanges being used to create--
Mr. Foster. But there are a lot of trades that are not on
underlying exchanges. How do you get the information to know
that this is a wash trade?
Mr. Gorfine. The underlying exchanges were U.S.-based
exchanges participating in the index formation. But to your
point, that is the gap in the underlying spot market, is there
is no Federal market supervision of spot trading activity as
you would typically see with market regulation.
Mr. Foster. Right. Yes, when trading derivatives, you need
a trader ID so you know exactly who--there is a regulator that
sees the true identity of both participants of all trades, and
they can identify wash trades and other market abuses.
Mr. Gorfine. That is right.
Mr. Foster. That is not present in Bitcoin, correct?
Mr. Gorfine. That is right. The same is the case, though,
for many other commodities. Precious metals like gold-based
futures, you don't have--spot markets tend to operate
differently than the regulated markets. But in the context of
digital commodities, there are these characteristics around the
trading activity, the retail facing aspect, which could warrant
this type of market--
Mr. Foster. Right. Which are much more surveilled than
Bitcoin, I guess is the point.
Mr. Rivera, one of the fundamental rules of the road is
that you cannot drive a car on the road without a license plate
and without a licensed driver. The automobile industry would
never have gone anywhere without that convention.
And for the same reason, it seems to me that all crypto
wallets must require a verifiable driver's license, that can be
anonymous under most circumstances, but when a crime has been
committed, you have to use that to deanonymize the true owner.
In addition, for commodities or any item which has a market
defined value, we have to prevent wash trades and other front-
running market abuses like that. So, is there any alternative
in this case to have a regulator somewhere that sees the true
identity between all participants of all crypto transactions?
Is there any alternative to that?
Mr. Rivera. We are investing in companies that are building
something called zero knowledge--
Mr. Foster. I understand there is a dream. Is there
anything that works today, that will allow you to prevent wash
trades, for example?
Mr. Rivera. Crypto networks are extremely transparent. And
Federal regulators actually--
Mr. Foster. But there are ones, like Monero and more
advanced ones, that have deliberate and very effective efforts
to make it impossible to identify the true participants.
My question is, does the technology exist today to prevent
wash trades unless there is a regulator that sees the true
identity?
And if you can respond. My time is up. If you can respond--
Mr. Rivera. Yes, it is developing, sir.
Mr. Foster. I understand. But this question is for
everyone, and I would like you all to respond for the record.
Does the technology exist today that does not require having a
regulator see the true identities behind both sides of any
crypto transaction if we wish to prevent wash trades and other
market abuses?
My time is up. I yield back.
Chairman Hill. Yes. You can respond in writing if you would
like to on that. Thank you very much.
The gentleman from Ohio, Mr. Davidson, who is the Vice
Chair of this subcommittee, and also the Chair of our Housing
and Insurance Subcommittee, is recognized for 5 minutes.
Mr. Davidson. I thank the chairman, and I thank our
witnesses. I also thank my colleagues who are taking the time
to continue to study this issue. As someone who has tried to
get regulatory clarity for this since I got on the committee in
2017, it has been painful. You just see people ask questions
that you explain over and over and over and over and over
again, and that is why it means a lot that people do take time
to understand the issue.
It seems that even then, you will have people who draw
different conclusions. For example, that the only reason you
would want to own these things is to evade the law.
The reality is people have been pleading for this ever
since I got here, ever since the Initial Coin Offering (ICO)
market. The people with good use cases have come here saying,
please solve this problem. They are asking to be regulated, and
not the way a lot of people are being asked to be regulated.
They are saying, basically, hey, could you protect our market
share by making it illegal for people to actually compete with
us? They are saying, let's compete.
I think the challenge is that people think of this space in
the same--if they can't get rid of Bitcoin altogether, they at
least want to make it account-based, because they don't
actually trust you with custody. Just like they haven't
actually outlawed cash, but almost, right?
Mr. Rivera, as you're aware, the European Union recently
passed the Markets in Crypto-Assets Regulation, which puts them
well ahead of us; they actually passed a law. But alongside
this proposal, the EU also passed a Transfer of Funds
Regulation, which imposes a strict Know Your Customer (KYC)
regime whenever more than 1,000 euros is transferred between
self-custody wallets.
If I move more than $1,000 of value to someone else in any
form, cash or something else of worth, you have to get a third
party. We don't trust our citizens. They can't do
permissionless transactions. Everything has to be permissioned.
It seems like some of my colleagues actually think that is
a good thing. I think it is kind of dystopian, personally, but
the reality is, how do you have DeFi without the, ``de'' part,
the ``decentralized?''
Mr. Rivera. Yes, the Transfer of Funds Regulation is the
European Union's effort to clarify the existing travel rule. I
think the rule itself is not perfect, but, importantly, what it
does is it limits the application of the rule to institutions
communicating with each other and making transfers of value to
each other. While doing so, it aims to protect the privacy of
individuals who want to self-custody their assets.
So, the objective of the rule is to actually allow
individuals to participate in decentralized systems without
having to divulge personal information about themselves and the
financial activities that they engage in, while still
regulating institutions that send that information, like our
travel rule.
It is unclear how it is going to be implemented, as it has
just been passed, but it does make the right efforts, at least
initially.
Mr. Davidson. That is encouraging, and it is a little more
narrow than I had understood it to be, if not in law, in
intent, maybe.
But how important is custody to the concept of market
structure? When some of the same people in the room helped in
2018 to craft what became the base text for the 100-percent
bipartisan Token Taxonomy Act, we wanted to define a bright-
line test that translates the Howey test into language that
people can understand, including the regulators. But it also
dealt with custody.
So, we have custody challenges in our T+2 trading of actual
securities, but since you have a real-time 24/7, in theory,
permissionless peer-to-peer transaction capability, how
important is custody to market structure? And I will open that
up to the panel.
Mr. Rivera. Custody is extremely important, and it is
extremely important to understand the differences between
traditional custody, which is paper-based and ledger-based and
relies on an intermediary that is keeping track, and digital
assets custody, which actually relies on a decentralized
blockchain to identify who has what. In order to ensure
protection of client funds under a custodial regime, digital
asset custodians have to have incredible technical expertise,
and it is technical expertise that they have developed over the
course of the last 10 years.
Mr. Davidson. Can more than one person have custody of
something at the same time?
Mr. Rivera. No. But someone can gain access to funds in the
same way that someone could kind of steal funds in a bank, but
the way you do that is very different.
Mr. Davidson. Right.
I think the important point when you look at some of the
markets where you will see asymmetry in naked short selling and
derivatives contracts and so on and so forth, is that the idea
is really solved with the custody rules here.
I wish I had more time to get into this. But my time has
expired, and I yield back.
Chairman Hill. I thank the gentleman.
The gentleman from New York, Mr. Torres, is now recognized
for 5 minutes.
Mr. Torres. Thank you, Mr. Chairman.
If the United States continues driving crypto offshore,
there will be more offshore companies, more companies in the
offshore deregulated mold of FTX, so it seems to me that it
would be in the interest of consumer and investor protection to
bring crypto into a workable but rigorous regulatory regime
here in the United States.
FTX fraud has no greater friend than the status quo, and no
greater friend than congressional inertia.
New York State has shown that it is possible to create a
rigorous regulatory regime for crypto without causing the
apocalypse for 9 decades of securities law. There is a question
of whether Congress should create a new regulatory framework
for crypto, as New York State has successfully done, or whether
Congress should seek to fit crypto within the existing Federal
framework for regulating financial assets, which strikes me as
the more-probable outcome.
If Congress elects to adapt the existing framework rather
than create an entirely new one, the question then becomes,
which digital assets qualify as securities and which qualify as
commodities or something else? But if an asset qualifies as a
security, then there is a question of registration, and that is
where blockchain technology has run into a buzz saw.
Even if Congress were to pass a law that provides perfect
regulatory clarity as to which assets are securities, none of
it matters if there is no workable path to registration and
compliance. And under the status quo, SEC registration is
little more than a mirage for blockchain businesses. The number
of blockchain businesses that have found a workable path to
registration is close to zero. One observer put it cogently:
``The SEC has created a world where project founders are
required to register as ice cream while making freezers
illegal. Good luck.''
Mr. Zweihorn, how can Congress best tailor registration to
accommodate blockchain technology without compromising investor
protection?
Mr. Zweihorn. Thank you, Congressman Torres. I think that
is a very good way of thinking about it.
My client, certainly, and nobody I know who is respectable
in the blockchain space believes that it should be unregulated,
that we need fewer regulations. They want a system that sort of
gives them an out. I think they want tailored regulations.
As I said in my testimony, there are a lot of SEC rules and
part of the Federal securities laws that are sort of round peg
and square hole when it comes to digital assets, because
digital assets are just different. And if you compare the White
Papers that came out during the ICO boom and compare them to a
prospectus, they are, obviously, a lot shorter. There is a lot
less information, but there is also a lot of information that
is not in SEC prospectuses because digital asset purchasers are
interested in other topics that are not ones that the SEC has
asked about in its forums.
Mr. Torres. And as I understand it, Chair Gensler himself
has said that the SEC has tailored disclosure requirements to
accommodate the particularities of industry. So, there is
nothing unprecedented about the notion of tailoring.
Mr. Zweihorn. That is correct. The SEC has adopted
particularized disclosure regimes for certain assets. But they
have not yet done so for digital asset securities.
Mr. Torres. The SEC, statutorily, is designed to be a
merit-neutral regulator, but it hardly requires a suspension of
disbelief to imagine a regulator who has a personal or
ideological antipathy for crypto and, therefore, seeks to
regulate the industry out of existence.
But even if you are a critic of crypto, the fact remains
that regulatory sabotage of crypto is the antithesis of merit-
neutral regulation, which is the kind of regulation that
Congress contemplated for the SEC.
So, how can Congress ensure that the SEC is, in fact, a
merit-neutral regulator? And how do you prevent the use of the
registration process to punish or sabotage an industry that has
fallen out of political favor?
Mr. Zweihorn. Thank you.
I don't want to impugn the motives of anybody at the SEC.
They are hardworking and well-meaning people, and I think they
are acting in good faith, but they are subject to the
securities laws. Congress has mandated that they apply the
securities laws as Congress has written them. I think their
incentive is to make sure that the securities laws are
followed, at least as they interpret them.
I think if Congress wanted to make it more likely that
there would be a workable path, Congress would need to mandate
that the SEC adopt something that is actually functional and
possible for the market to comply with.
Mr. Torres. A distinction has been drawn between regulating
financial activity and regulating the technology that underlies
the activity. Some people call it regulating applications
versus regulating protocols. When crafting a regulatory
framework, how should we think about that distinction? Should
financial regulators be limited to their core competency of
regulating financial activity rather than the underlying
technology?
Mr. Zweihorn. Of course. The one challenge with digital
assets, as I think Mr. Gorfine said earlier, is that you can
have a car title, or you can have a home title in NFT or a
security or a commodity, and they are all a digital asset of
some sort or another. And I think we, in this country, do
regulate different items and different assets differently
depending on what the risks are because the risks of buying a
house are different than the risks of buying a security.
So, there would need to be a way to differentiate in terms
of whether this asset is an investment product, it is--
Chairman Hill. The gentleman's time has expired.
The gentleman yields back.
Mr. Timmons is now recognized for 5 minutes.
Mr. Timmons. Thank you, Mr. Chairman.
And I want to thank all of our witnesses for taking the
time to come and testify before us here today.
In 1946, the Justices of the United States Supreme Court
could not have fathomed the internet, nevertheless digital
assets. It seems absurd that the future of digital assets will
be decided using such an archaic test. Nevertheless, the Howey
test has dominated the conversation around how to classify
digital assets.
Mr. Zweihorn, can you talk about any other classification
frameworks that exist?
Mr. Zweihorn. A case subsequent to Howey, the Forman case,
questioned whether a sheriff's stock in a co-op, a residential
apartment co-op, was a security, and the court said, well, a
co-op is used to live in. There is a functional purpose for it,
and if something has a functional purpose, and it is not just
an investment, then it is not a security.
So there is this tension there, particularly with digital
assets, of whether the asset is just an investment or it
actually has a functional purpose, such as Filecoin that the
other member of the panel has talked about.
Mr. Timmons. What suggestions would you have if we were to
create a test from scratch to classify digital assets?
Mr. Zweihorn. It is a challenging question, Congressman,
because a lot of these assets are dual purpose, and while
Filecoin, as an example, is useful and has utility to use for
purchasing storage space, there are plenty of people who
speculate on it. But that is true with lots of commodities. You
go buy gold as an investment. You go buy a property as an
investment.
I think there has to be some kind of threshold for utility
where if this thing actually is just a share of interest in a
company, and it is a claim on its debtor equity, then it is a
security, and if there is actual utility, then it is not a
security.
Mr. Timmons. Thank you for that.
Turning back to Howey, Mr. Rivera, can you talk about the
need for a definition for when a digital asset is or has become
sufficiently decentralized to fall out of Howey? How should we
think about this?
Mr. Rivera. Yes, that is a very good question. It is going
to take a lot of collaboration from Congress to think through
principle-based legislation that will allow regulators to make
specific applications for different assets. Facts and
circumstances isn't incorrect, like the SEC likes to say, but
it does mean that we need to have more principled legislative
approaches to make that determination.
There are thousands of digital assets. Some of them are
securities, but many of them are not, and understanding the
ways in which they are used, whether they have use case,
understanding both the technical and the economic
decentralization in the networks that they operate on, are key
principles that Congress really needs to understand well and
think about implementing.
So, it is going to take some time and require some
collaboration.
Mr. Timmons. Thank you.
Ms. Belcher, what about when blockchain technology is used,
say, in the business-to-business (B2B) process solution? I have
met with many companies which are utilizing blockchain
technology to trim hours, and in some cases days, off the B2B
processes in the financial services world. The efficiency and
cost savings presented by these companies is incredibly
compelling.
Are there any risks of getting in the way of blockchain
innovation by not considering this important use of blockchain
technology while we are working on the market structure
legislation?
Ms. Belcher. Absolutely. Filecoin is really just one
example of so many protocols that are enabling a huge number of
businesses, including small businesses, to thrive. For example,
many of our thousands of storage providers are small businesses
in the United States.
In fact, as one example, Lucky Storage converted a former
Lucky Strike tobacco factory in North Carolina into a data
storage facility. They are actually here today. They have 65
employees in North Carolina; and that is one of thousands of
storage providers on just one cryptocurrency network.
And, in addition, we have many applications that are built
on top of the Filecoin network that are business-to-business
and that also are themselves small businesses.
One example is Audius. I mentioned in my testimony the
ability to say, for every second of a song I play,
automatically transfer a millionth of a cent to the songwriter.
And they are actually doing that, building on top of the
Filecoin network.
These are things that are really revolutionizing the way
that small businesses work, and it is very important not to get
in the way of that innovation in order to ensure that these
businesses continue to thrive.
Mr. Timmons. Thank you for that.
One final question, Ms. Belcher. Just broadly speaking, do
you believe that blockchain technology can deliver on the
industry's promise of efficiency, decentralization, and
financial inclusion?
Ms. Belcher. Absolutely. All you have to do is think about
what happened within hours of Russia invading Ukraine. Within
hours, Ukraine had posted their wallet address and millions and
millions of dollars were donated via cryptocurrency. Why?
Because it was the most efficient way to do it.
Mr. Timmons. Thank you, Mr. Chairman. I yield back.
Chairman Hill. Thank you.
I now yield to the gentleman from California, Mr. Sherman,
for 5 minutes.
Mr. Sherman. Billions and billions of dollars have been
transferred to Ukraine using traditional currencies, and lots
of money has gone to Russia, evading our sanctions, using
cryptocurrency.
Fear of missing out. Somebody else may get ahead of us in
this technology. The Bahamas is ahead of us. Peru is ahead of
us in cocaine cultivation. China is ahead of us in organ
harvesting, and the Cayman Islands is ahead of us in financial
crime. We don't need to catch up.
Fentanyl is a new, innovative technology. We don't need a
regulatory system that rewards those who created that
innovation.
There are gaps in our regulatory system because Congress
fails to pass a law prohibiting Americans from buying
cryptocurrency. There are gaps in our law because we have not,
in the alternative, passed a law saying that cryptocurrency is
clearly a security. So, we are going to leave it to the courts
to decide, based on the Howey test.
And there are gaps because the crypto industry cannot
prosper unless much of it is underwater, immune from familiar
currency, familiar customer anti-money laundering statutes.
That doesn't mean everybody who invests in cryptocurrency is
trying to hide money, although, ``cryptocurrency,'' literally
means, ``hidden money.''
Sometimes, they think they can just make a profit investing
in cryptocurrency and selling it to someone else who needs to
hide their money, just as you can make money by investing in a
burglary tool factory without actually being a burglar.
Sam Bankman-Fried is out on bail, unfortunately, living in
my State, and living much better than most of my constituents,
but his ghost is still in this room. He haunts the halls of
Rayburn. But let's remember why he was here, for one reason: To
prevent the SEC from having jurisdiction over cryptocurrency
and to give cryptocurrency the baby regulation, the patina of
regulation that would be provided through the CFTC.
If you want to know whether crypto is a currency or whether
crypto is a security, just ask yourself: Are those in the
crypto business engaged in the financial services business or
the agriculture business? It is clear that they weren't the
Agriculture Committee regulator on this to provide a patina of
regulation.
All of the money and power in this town is in the crypto
side because crypto bros make money literally by making money,
and they have made over a trillion dollars out of thin air.
They will accuse the U.S. Government of making money out of
thin air. Maybe we do, but we are the U.S. Government. What we
are able to do benefits the American people in a democratic
system. Nobody elected Sam Bankman-Fried.
But I want to pursue one other area and that is taxation.
We have this capital gains allowance, very low tax or, if you
hold it until you die, no tax on your gain, and we justify that
on the basis that we are trying to encourage people to invest
in something that will create jobs and build the American
economy.
Professor Allen, can you think of a reason why we allow
gains on cryptocurrency, when they are reported, to be taxed
under a favorable rate, a lower tax rate than is paid by our
staff?
Ms. Allen. I think you have hit on something important in
your remarks, which is that we are talking about crypto as
something it actually isn't, so let me demystify the blockchain
a little bit. A blockchain is a database, right? That is what
it is. It has no magical powers. The thing that makes it a
blockchain is that there is no, ``centralized technological
node,'' that controls that database, who updates it, et cetera.
But there are economic forces that centralize control of that
database, so we have created something that is really
replicating what we already have.
Now, I am not an apologist for traditional finance. There
are a lot of problems with traditional finance, but what we
have here is all of those problems being replicated or
exacerbated. And when we talk about sort of giving capital
gains treatment or tailored regulation, et cetera, to this
space, we have to ask the question: Why are we doing this?
Traditional finance, with all of its flaws, facilitates
capital formation and credit allocation. Crypto does neither,
so I think we need to keep that in mind as we think about how
we regulate this space.
Mr. Sherman. Thank you.
Chairman Hill. I thank the gentleman. He yields back.
Mrs. Houchin is now recognized for 5 minutes.
Mrs. Houchin. Thank you, Chairman Hill, and Ranking Member
Lynch.
I appreciate the opportunity to talk to the witnesses, and
thank you for being here.
There has been talk today about FinHub's guidance. In 2019,
the SEC's FinHub released guidance regarding how an issuer of a
digital asset can determine whether it would fall under the
definition of an investment contract and, thus, be required to
comply with securities laws. The guidance consists of a list of
factors and subfactors that digital assets projects should
consider.
Mr. Zweihorn, in your view, is this guidance useful for
projects in determining whether or not they will be classified
as a security by the SEC?
Mr. Zweihorn. Thank you for the question.
I think when the guidance first came out, the industry was
very excited to have some guidance, and it was useful in terms
of showing what the SEC was thinking and was a good-faith
effort by the SEC to tell the industry.
But in time, it has turned out to not be all that helpful.
It consists of 50-plus factors, none of which is determinative.
It is a question of weighing and, therefore, resulting in how
likely something will be, so it leaves people sort of not with
a definitive answer on any particular token they are
considering.
Mrs. Houchin. As a follow-up to that, how does a purchaser
determine how many factors it needs to meet and how to weigh
the factors against each other under this current structure?
Mr. Zweihorn. It is a difficult question. A colleague of
mine referred to it as a ruler with no lines, so you can't
really tell where on the ruler you are. You kind of get a
feeling of how many factors and how important those factors
are, but there is not a way to answer that.
Mrs. Houchin. During Chairman Gensler's term, has the SEC
provided any other guidance on how the Commission will
determine whether a digital asset is offered as part of an
investment contract?
Mr. Zweihorn. I am not aware of them putting out further
guidance as such. Chairman Gensler obviously speaks his mind
openly before Congress and in other venues, and the SEC has
brought a number of enforcement actions where the SEC sets out
its view of whether particular assets are or are not securities
and explains it to some degree.
They haven't turned back to the framework in those
enforcement actions as far as I am aware to evaluate it against
the framework. And in some ways, some of the enforcement
actions of late have been inconsistent with the framework,
where the enforcement action says this asset was sold as a
security initially many, many years ago, whereas, the framework
looks to what is it today. What are its uses today? Is it
decentralized?
So, it looks like there has been a bit of a shift in
thinking.
Mrs. Houchin. What has been, in your opinion, the result of
the SEC's failure to provide guidance on this issue?
Mr. Zweihorn. It is very challenging for members of the
industry and clients of mine because they really are at the
whim of, are they going to get an enforcement action if they do
something here? They can have very strong views, very strong
legal views, opinions, or guidance from counsel, but at the end
of the day, if they are doing anything in this space, they have
to worry that the regulator may disagree with them.
Mrs. Houchin. Switching gears a little bit here, one of the
problems with the current regulatory framework is that digital
asset projects have a disincentive to register, as they are
less likely to be listed on a trading platform if they are
classified as a security.
Mr. Zweihorn, would you discuss the perverse incentives
that this dynamic creates and how our market structure
legislation can ensure that firms are not penalized for
complying with the law?
Mr. Zweihorn. Yes. I think the firms that are not listing
on exchanges are not doing so because they don't believe that
the asset involved is a security, and the disincentive is that
if the asset is a security, those exchanges, which are not
registered with the SEC, would not list it.
So if they want to have a liquid market for the asset, they
need to take steps to ensure that, in their view, they are
comfortable that it is not a security. The SEC may or may not
agree with that, because if it is a security, it won't be
listed.
I think market structure regulation would be to create a
viable market structure where if it finds that these are
securities, make it so that exchanges can actually list them,
which they really can't today. Or if it finds them as not
securities, create a market structure where exchanges can exist
that do list them and trade them in such a way that consumers
are protected.
Mrs. Houchin. Thank you.
From the financial sector to alternative uses and
applications, digital assets and the underlying technologies
are here to stay. It is important that we create clear rules of
the road to stop the threat of regulation by enforcement and
establish a field where anyone who wants to play by the rules
has the ability to do so.
Thank you, Mr. Chairman. I yield back.
Chairman Hill. The gentlewoman yields back.
The gentleman from Illinois, Mr. Casten, is recognized for
5 minutes.
Mr. Casten. Thank you, Mr. Chairman. And thanks to all of
our witnesses.
Ms. Belcher, I want to start with you. In your testimony,
you described some of your customers as being musicians who
have to put their music on Spotify or something like that and
get paid in fractions of a penny for every listen. And I want
to first say that I completely agree that there is an enormous
value of the blockchain technology, distributed ledger, as a
way to monetize the digital asset.
You said fractions of a cent, which is not a
cryptocurrency. For people who are engaging in that
transaction, is what they are putting on the blockchain,
essentially, an invoice to be repaid in U.S. currency? Or is it
an invoice to be repaid in a token that is separate from the
dollar? I just didn't quite follow from how you explained that
distinction.
Ms. Belcher. Thank you for the question.
It is a token, but the point I was trying to make is that
it can be micro, micro amounts.
Mr. Casten. No, no. Sure. Why? Why is it a token? Because I
don't have any need for rapid settlement of 3/10 of a penny.
Ms. Belcher. Sure. A couple of things. First of all, that
enables us to program money, to send it instantly and
automatically across the world with no intermediary, as though
I am handing a fraction of a cent to someone.
Mr. Casten. So, it is primarily a settlement time issue?
Ms. Belcher. No, it is a programmability issue.
Mr. Casten. No, but I could program an invoice. If you and
I have--if I want to have a legal contract that you owe me
money, I can program it and have a blockchain that you owe me
money, right?
Ms. Belcher. Yes. Basically, to give you an example from
Filecoin, it is important that we use a bespoke token, as
opposed to a stablecoin or the traditional financial system,
because that is actually what allows us to operate the way that
the Filecoin token does operate.
Mr. Casten. Okay. We are going to get wonkier here than we
have time for, but it seems to me that a token could be an
invoice that is dollar-denominated. I don't have to retokenize.
And the reason that I mention it is, Mr. Chairman, I would
like to enter for the record an article from last week's New
Yorker entitled, ``Crooks' Mistaken Bet on Encrypted Phones.''
Chairman Hill. Without objection, it is so ordered.
Mr. Casten. I would encourage everybody to read this
article because it is fascinating and has nothing and
everything to do with crypto. It is, essentially, a lot of our
international financial regulators hacked into the bad guys'
cell phones that they thought were encrypted and have unearthed
these massive financial fraud networks where you can go take a
picture of a low denomination $5 bill and then send that serial
number through an encrypted cell phone network to somebody in
the Netherlands or Mexico or wherever you are moving money.
Take it to the bank or the illicit bank. Get $30 million with a
cell phone.
Mr. Rivera, you mentioned that, sort of, rapid settlement
was an innovation of the crypto industry. I would submit to you
that encrypted tokenization was invented a long time before by
a lot of shady characters.
The value--
Mr. Rivera. You mean the U.S. Government.
Mr. Casten. The value--the U.S. Government is not trying to
break the law.
This has tremendous value for people who want to break the
law. I am not saying that every crypto user is trying to break
the law, but encrypted tokenization--because I really want to
separate the value proposition of the blockchain from the value
proposition of an encrypted token that can get around KYC laws.
Professor Allen, are you aware of anyone in the crypto
space, anywhere within the system, who is tracking enough
information about buyers and sellers on either side of the
trade so that they are capable of complying with Know Your
Customer/Anti-Money Laundering (KYC/AML) laws and are doing so?
Ms. Allen. I do not know if that is happening. I do know
that avoiding the anti-money laundering regulation is, in many
respects, a feature rather than a bug of this business model.
The problem with the blockchain is that it is actually
quite inefficient when compared with centralized alternatives
because if you think about it, if you have a database where you
have to create some kind of proof of work consensus or proof of
state to deter bad actors, that is going to be more
computationally expensive than just having a centralized person
add things to the blockchain.
So because it is more expensive, the way that you usually
see efficiency gains is from doing end runs around AML and
KYC--
Mr. Casten. I want to get into other things, because I do
think there is a case to be made. Again, if I am--people often
confuse me with Jay-Z. If I write a song, sell it to you, like
the digital transaction, that is a value for the blockchain
there because it is a digital thing that I can't get around.
I want to introduce one more thing for the record, but,
Professor Allen, you had mentioned I think in your testimony
that a lot of the profits in the crypto industry are made by
founders in Wales. We have had a tremendous number of people
here who say this is about closing the racial wealth gap.
Mr. Chairman, I would like to introduce a Washington Post
article, ``Crypto is not the key to Black generational
wealth,'' which notes that from 2017 to 2022, the median
cryptocurrency declined by 46 percent, and the average stock
market index rose by 56 percent, and that the losers are
disproportionately Black and Brown communities who got in late.
Chairman Hill. Without objection, that will be included in
the record.
Mr. Casten. Thank you. I will yield back to you, Chairman
Hill.
Chairman Hill. I thank my friend.
Mr. Flood is now recognized for 5 minutes.
Mr. Flood. Thank you, Mr. Chairman.
Let's briefly take a step back and identify why we are
here. The SEC and Chair Gary Gensler have forced this
committee's hand. There is simply no way that the digital
assets ecosystem within the United States will survive without
some kind of action from Congress to combat the regulatory
deluge we have seen in the past few months.
We have all heard from firms like Coinbase that they will
move offshore. The reality is that in this environment, it is
hard to blame them.
In February, the SEC issued a proposed rulemaking that
would severely restrict the ability of current custodians for
registered investment advisors to continue to hold custody of
those assets.
Mr. Rivera, I would like you to briefly speak to some of
the challenges associated with the proposed rulemaking from the
SEC for qualified custodians and how it would affect your firm.
Specifically, as it stands, how many options does your firm
have to custody digital assets, and would you expect this
rulemaking to reduce your firm's options for providing custody
services of digital assets?
Mr. Rivera. Our firm has a very limited number of digital
asset custodians. There are three, perhaps four; there are
three that we trust. This rulemaking effectively reduces that
to maybe zero. It seems like the intent is to make it extremely
difficult to comply with the rule as proposed, which would mean
that we could effectively be disenfranchised from being able to
invest in the ecosystem.
Mr. Flood. Thank you.
Next, I would like to pivot to how broker-dealers work in
the digital asset space and whether today's securities rules
could possibly apply to the digital asset space as written.
Broker-dealers that work with equities typically custody
securities for their customers. However, with the current SEC
custody rules, there is no way for a broker-dealer to directly
custody customer assets.
Mr. Zweihorn, can you describe what kinds of challenges
this presents for broker-dealers within the digital asset
space?
Mr. Zweihorn. Sure. Thank you for the question,
Congressman.
As you said, broker-dealers typically will custody their
investor securities on their behalf, and that is part of the
services they provide that facilitates the customer trading.
The SEC has a rule that regulates how broker-dealers do so in
order to protect customers, called the Customer Protection
Rule, to ensure that those brokers don't mishandle or lose or
steal those assets.
That rule was adopted in the 1970s originally, and it has
been amended over time, and, not surprisingly, it doesn't refer
to holding a crypto private key as one of the ways that a
broker-dealer can permissibly hold a customer's assets.
The SEC has struggled with determining what would be a safe
mechanism for broker-dealers to hold crypto assets for
customers, and the most recent step they took was to put out
guidance that was time-limited; it expires, actually, 3 years
from today. It would allow broker-dealers to hold custody if
they have reasonable policies and procedures, but then, there
is a list of other conditions that brokers, essentially, can't
meet because it would mean they couldn't do any other business.
Mr. Flood. Thank you.
Let's move on to clearing and settling. Within the
securities market, you need some sort of entity which ensures
that a trade placed by an investor is ultimately settled
between the buyer and the seller. The Depository Trust and
Clearing Corporation is the clearing agency that fills that
role for securities.
The current model, which requires a clearing agency to
clear and settle trades, just doesn't really make sense for
digital assets operated on a blockchain. Transactions clear in
real time, and there is no need for one centralized
intermediary.
Continuing with this question, you mentioned in your
testimony the perils of applying the definition of clearing
agency under the Securities Exchange Act to validators and
miners on a blockchain that participate in the settlement
process. Can you just elaborate on that a little bit for me?
Mr. Zweihorn. Sure. The definition of, ``clearing agency,''
under the Securities Exchange Act is very broad, and it
includes anyone that is facilitating a settlement of a
securities transaction without the physical delivery of paper
security certificates. That definition made sense in its
context where it was regulating the securities market, the
traditional securities market, and trying to bring a higher
level of safety and security to the market where paper
certificates were moving or where they were becoming
dematerialized.
Everyone in digital assets is facilitating the transfer of
the asset without physical delivery, whether they are
securities or not. But if they are securities, then, arguably,
the definition would encompass a lot of different parties.
Now, if a firm, like a digital asset trading platform,
holds all the assets itself so that it can update its books in
real time with every trade, it doesn't really seem like you
need a separate clearing agency to just add an intermediation
that is not actually technically necessary.
Mr. Flood. Thank you for your answer.
The final point I will make is this: Legislation is needed
to fix this.
Thank you.
Chairman Hill. Thank you.
Mr. Flood. I yield back.
Chairman Hill. Thank you, Mr. Flood.
And I will turn to my friend from North Carolina, Mr.
Nickel, for 5 minutes.
Mr. Nickel. Thank you. I would like to thank Chairman Hill
for holding today's hearing on digital asset market structure.
I am looking forward to working together in a bipartisan way to
learn more about this issue and pass meaningful legislation.
Mr. Rivera, you write in your testimony that you are
worried there is a growing sentiment that crypto technology
will, ``go away if we don't create new regulations.'' I am
concerned that if this is the case, and all the trading venues
were to exit the U.S. market, that any American looking to
trade digital assets would find themselves having to use an
offshore exchange.
As we learned with the failure of Bahamas-based FTX.com and
others, foreign firms are not always well-regulated.
It is my priority to protect my constituents.
Mr. Rivera, do you have any concerns that a decline in the
number of U.S. trading venues might produce new risks for
American consumers?
Mr. Rivera. I do. I think that this is an example of a
really unfortunate policy outcome resulting from the
enforcement actions that have happened from regulators,
particularly the SEC. If there are trading venues that move
offshore and U.S. persons want to trade in those venues, they
will probably try to find ways to trade them, and the U.S.
Government will have much less of an ability to regulate the
activity on those venues, and that would be unfortunate.
Mr. Nickel. And I have to apologize. I forgot to thank and
acknowledge Ranking Member Lynch for his outstanding leadership
on this subcommittee and, most specifically, thank him for
keeping us all fed last night on this side of the aisle, with
some very well-timed pizza. We were here until 11:30 last night
for a markup. So, I am grateful for your leadership on well-
timed pizza.
Back to Mr. Rivera. In March of 2022, the SEC released
Staff Accounting Bulletin (SAB) 121, which effectively
precludes banks from offering a digital asset custody at scale
by requiring them to include on their balance sheets crypto
assets that are custody on behalf of their clients. This is a
shift in historical practices. Custody assets have always been
treated as off-balance sheet assets. If crypto companies don't
have access to safe and security banking, U.S. investors will
be at risk.
Mr. Rivera, if banks can't provide this service, who would?
Are you concerned that some may turn to offshore solutions?
Mr. Rivera. Indeed. There should be meaningful engagement
with custodial providers in the ecosystem, and banks, to the
extent that they want to provide custody to digital assets,
they should have avenues that they can pursue to do that. SAB
121 effectively limits their ability to do that in any
meaningful way. It would be entirely too costly for them to
have to over-collateralize the digital assets they hold as
liabilities on their balance sheet.
Mr. Nickel. Thank you.
Ms. Belcher, some have claimed that digital asset market
structure legislation would only legitimize an industry seeking
to facilitate illicit activities. Some have also claimed that
digital assets are unnecessary and fail to add any new, real
value to our financial and technological systems.
I am doing my best to try to understand this issue and dig
in. Could you provide us with some background on the use cases
for Filecoin and the service that it is helping to provide?
Ms. Belcher. Absolutely. Thank you so much for the
question.
Filecoin is just one example of cryptocurrency, but it is
enabling hundreds of applications and use cases. Those include
human rights applications. In addition to Starling Lab's
international criminal court evidence verification, they are
also storing the USC Shoah Foundation's genocide survivor
testimony archives.
We also have with us here today the Prelinger Archives,
which is using decentralized technologies to store rare films.
We have the Freedom of the Press Foundation that is exploring
using decentralized technologies for secure document exchange
between journalists and anonymous sources. And the Guardian
Project, which is building a mobile app for eyewitnesses that
authenticates content captured on smartphones.
And the Human Rights Data Analysis Group, which is
exploring how this storage can be useful for accessing
sensitive human rights data. We also have investigative
journalists using this technology with enterprise use cases.
There is an organization called the Decentralized Storage
Alliance that uses these technologies, which includes EY,
Seagate, and AMD. Scientific data, not only stored by the ATLAS
Project at CERN, but also the University of Maryland, the
University of Utah, and Berkeley's Underground Physics Group.
And government datasets, an absolutely enormous amount of
open datasets, not just the ones that I mentioned, but also the
National Library of Medicine, the National Oceanic and
Atmospheric Administration, the National Center for Atmospheric
Research, et cetera, et cetera.
So, there are just an enormous number of use cases, and all
of those are enabled by the Filecoin network.
Mr. Nickel. Thank you so much.
And I yield back.
Chairman Hill. I appreciate that. The gentleman yields
back.
Mr. Donalds is now recognized for 5 minutes.
Mr. Donalds. Thank you, Mr. Chairman.
And I am actually glad I get to go last. I heard a lot in
today's hearing. Obviously, we have some serious questions that
Congress is going to need to address. And let's just be very
clear: The SEC, or the CFTC, or frankly, any other agency has
not been empowered by Congress to just decide this stuff on the
fly. Sorry, relative Commissioners and Chairmen that exist
around this town. We have not authorized you to do that yet.
A couple of things. One, I found it interesting that Sam
Bankman-Fried is now the ghost of Christmas past. What happened
at FTX is unconscionable, never tolerated, but that is
accounting fraud, which is something that was contemplated
under the Sarbanes-Oxley Act after the Enron scandal. So, you
have that.
If we are going to talk about Russia avoiding our sanctions
regime using cryptocurrency, then maybe the Administration
should have paid attention to Russia's military buildup on the
Ukrainian border after the debacle that was the withdrawal from
Afghanistan.
If we are going to talk about the fentanyl crisis, maybe
the Administration should actually secure the border, as
opposed to just complaining about fentanyl all the time.
And with respect to Filecoin or anything else, I think one
of the most fundamental problems we have in this building is
Members of Congress trying to justify why an American would
choose to buy a product that they want to acquire. We are not
talking about narcotics here. We are not talking about food
that you ingest. We are not talking about contact lenses that
go in your eye. We are talking about a digital currency or
assets or token that they might choose to buy with their own
U.S. dollars. I thought that was okay in the U.S., but I see
that not all is reality here on Capitol Hill.
Mr. Gorfine, is the CFTC, or the Federal Government, for
that matter, currently equipped to serve as a market regulator
for digital assets?
Mr. Gorfine. The CFTC, by virtue of overseeing futures,
swaps options that are predicated on commodities gains very
good understanding of commodities and the underlying markets
and the asset. They currently don't have that authority to
regulate the spot market, but as I noted earlier, there are
some unique characteristics of digital commodities that may
make it reasonable to say we need to have Federal market
supervision.
Mr. Donalds. I like your answer, but I am also under 2
minutes and 36 seconds.
I want to hone in on one thing. The operative word in your
sentence is, ``may.'' Does the CFTC, if this is the agency that
looks to be the closest to be able to do so, have the manpower,
the technical knowledge, and the expertise to adequately be a
market regulator of digital assets?
Mr. Gorfine. Yes. They already are, and they do have that
expertise. They do have that knowledge. Chairman Behnam has
been testifying as such, so this is something for which they
may need additional resources, given the size and scope of
digital commodity markets, but they do have that expertise, and
the professional staff there is well-equipped to understand the
underlying commodity market.
Mr. Donalds. Okay.
Mr. Zweihorn, can you elaborate on some of the
incompatibilities between the digital asset marketplace and the
traditional financial structure marketplaces?
Mr. Zweihorn. Sure. As we have talked about many times in
this hearing, there are lots of digital assets that have
functional uses. In order to use Filecoin, for example--I don't
believe Filecoin is a security, but if Congress was to say that
Filecoin is a security, then everybody who touches Filecoin
would need to be a regulated intermediary.
Mr. Donalds. Quickly, let me just say, as a Member of
Congress, that Filecoin is not a security. But go ahead.
Mr. Zweihorn. Better you than me.
If you were to buy Filecoin because you want to use it, you
want to store files, you can only buy it through a registered
broker-dealer. The system through which it gets transferred to
you would be through a registered exchange to actually find the
buyer and seller and a clearing agency in order to actually
send it to you. And those basically make it impossible to use
for its intended purpose, because you are not going to have all
of the entities involved in facilitating storage of data be
SEC-regulated for financial services activities.
Mr. Donalds. Okay.
Last question. Mr. Rivera, given that Congress is already
behind the curve regarding blockchain technology, how do we
ensure that what is proposed today applies down the road?
Mr. Rivera. Applies what?
Mr. Donalds. How do we ensure that some of the topics in
conversations that are being talked about today in this
committee can apply down the road? What do you think is the
best course of action for this?
Mr. Rivera. Yes, we want collaboration by Congress, and by
members of this committee, to take a very good look at the
industry and understand all of the different issues at play and
come up with constructive legislation that regulators can then
apply meaningfully to multiple different use cases and
different types of assets. So, we need principles-based
legislation that is bipartisan and effective.
Mr. Donalds. Okay.
I yield back. Thank you, Mr. Chairman.
And thank you, witnesses.
Chairman Hill. Thank you. Thank you, Mr. Donalds.
I want to thank the panel today. It has been a very
informative hearing. I look forward to comparing notes with our
colleagues over in the House Agriculture Committee's Digital
Assets Subcommittee today and see what they learned. Again, I
repeat, we have 40 Members of Congress engaging right now on
trying to understand the digital asset marketplace or the
cryptocurrency marketplace and understanding how best the U.S.
Government should be engaged.
What I heard today was that we have a real need for fit-
for-purpose regulatory tools at the SEC and the CFTC. I have
heard in the spot market, in dealing, in registering something
that is not a security, clarifying how the laws work and, of
course, custody. So it was a very good discussion.
I thank my friend, Mr. Lynch, the ranking member of the
subcommittee, for our collaboration in listening to your
testimony and working on potential legislation.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
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