[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
THE FUTURE OF DIGITAL ASSETS: PROVIDING
CLARITY FOR THE DIGITAL ASSET ECOSYSTEM
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HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
__________
JUNE 13, 2023
__________
Printed for the use of the Committee on Financial Services
Serial No. 118-31
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
53-179 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
C O N T E N T S
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Page
Hearing held on:
June 13, 2023................................................ 1
Appendix:
June 13, 2023................................................ 59
WITNESSES
Tuesday, June 13, 2023
Allaire, Jeremy, Co-Founder, Chairman, and CEO, Circle........... 5
Garrison, Coy, Partner, Steptoe and Johnson LLP, and former
Counsel to SEC Commissioner Hester M. Peirce................... 6
Kaplan, Aaron, Co-CEO and Founder, Prometheum, Inc............... 12
Sexton, Thomas W., President and CEO, National Futures
Association (NFA).............................................. 8
Sirer, Emin Gun, Founder and CEO, Ava Labs, Inc.................. 10
APPENDIX
Prepared statements:
Allaire, Jeremy.............................................. 60
Garrison, Coy................................................ 65
Kaplan, Aaron................................................ 72
Sexton, Thomas W............................................. 114
Sirer, Emin Gun.............................................. 124
Additional Material Submitted for the Record
Davidson, Hon. Warren:
Written responses to questions for the record submitted to
Aaron Kaplan............................................... 134
Waters, Hon. Maxine:
Written responses to questions for the record submitted to
Jeremy Allaire............................................. 135
Written responses to questions for the record submitted to
Coy Garrison............................................... 135
Written responses to questions for the record submitted to
Thomas W. Sexton........................................... 136
Written responses to questions for the record submitted to
Emin Gun Sirer............................................. 136
THE FUTURE OF DIGITAL ASSETS:
PROVIDING CLARITY FOR THE
DIGITAL ASSET ECOSYSTEM
----------
Tuesday, June 13, 2023
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 2:42 p.m., in
room 2128, Rayburn House Office Building, Hon. Patrick McHenry
[chairman of the committee] presiding.
Members present: Representatives McHenry, Lucas, Posey,
Luetkemeyer, Huizenga, Wagner, Barr, Williams of Texas, Hill,
Emmer, Loudermilk, Mooney, Davidson, Rose, Steil, Timmons,
Norman, Meuser, Fitzgerald, Kim, Donalds, Flood, Lawler, Nunn,
De La Cruz, Ogles; Waters, Velazquez, Sherman, Meeks, Scott,
Lynch, Green, Himes, Foster, Beatty, Vargas, Gonzalez,
Pressley, Horsford, Tlaib, Torres, Garcia, Williams of Georgia,
Nickel, and Pettersen.
Chairman McHenry. The Financial Services Committee will
come to order.
Without objection, the Chair is authorized to declare a
recess of the committee at any time.
Today's hearing is entitled, ``The Future of Digital
Assets: Providing Clarity for the Digital Asset Ecosystem.''
I will now recognize myself for 4 minutes for an opening
statement.
Nearly 15 years since the Bitcoin White Paper, an idea has
become the new internet architecture with ownership, digital
identity, and value storage native to technology. Digital
assets are no longer a new technology. They are used all over
the world, and America has always led technology invention, and
if not invention, implementation, and today we are at risk of
falling behind competitors around the globe.
This bipartisan hearing has been years in the making. Over
the past several months, this committee has engaged in an
unprecedented joint effort with our colleagues on the House
Agriculture Committee. Earlier this month, Agriculture
Committee Chairman Thompson and I, along with Subcommittee
Chairs, French Hill and Dusty Johnson, released a discussion
draft that would close the gaps between our securities and
commodities laws and provide much-needed clarity for digital
assets. We adhered to the time-tested principle of same risk/
same regulation, while modernizing our regulatory framework to
better match this innovative technology. In fact, requirements
set out in the draft bill are much more onerous than the
requirements for traditional financial intermediaries.
As I have said in all of our markups, I have an open door.
This should be a bipartisan process, and I intend it to be, so
please share your input. This is a draft bill. There is plenty
of time for Members to find common ground on how we legislate
here, but be advised that I intend for this committee to mark
up some form of this legislation when we return from the July
4th recess.
Let's start with where I know we all agree: consumer
protection. The draft bill would require trading platforms to
comply with strict requirements regarding the segregation of
customer assets, similar to most traditional intermediaries. We
also address how digital asset issuers raise capital for their
projects. The U.S. has the deepest and most-liquid capital
markets in the world, and we intend to keep it that way. We
want to keep that strategic advantage here in the United States
to the best of our ability.
We know informed disclosures are critical to helping
investors make informed decisions. By making disclosures fit
for purpose, the draft bill will ensure that issuers provide
users with necessary information, including the number of
tokens in circulation, the concentration of assets held by
affiliates, and much, much more.
Additionally, we enhance the SEC's ability to detect and
punish fraudulent actors and activity. Today, traditional
financial intermediaries are registered with a Federal
regulator. Digital asset trading platforms should be no
different. The draft legislation will establish requirements
for digital asset trading platforms to ensure that Americans
and their assets are protected. The draft bill will provide a
workable path for trading platforms to register with the SEC
and/or the CFTC. It will provide clarity to those assets that
are offered as part of an investment contract and, therefore,
security.
And I would submit that the central part of this bill is a
workable timeframe and a workable time period for assets,
started as part of an investment contract, to transition to a
digital commodity if the network is functional and
decentralized. I think that is the central piece of this
legislation on which our discussion should be focused.
Let me close with this: We are at a critical moment for
American dynamism. We can choose the side of financial freedom,
innovation, inclusion, and American competitiveness, and
important consumer protections at the same time, or we can let
this moment pass us by and surrender our leadership of the
global financial system to other countries. I hope we will
choose the former. I yield back.
I will now recognize the ranking member of the committee,
who as Chair last Congress, started this long arc for
stablecoin legislation and the discussion that we are centering
on today on this market structure bill. With that, I recognize
Ranking Member Waters for 4 minutes for her opening statement.
Ms. Waters. Thank you very much, Mr. Chairman. Good
afternoon. Last week, Republicans posted a bill that would
rewrite our nation's security and commodities laws. Committee
Democrats are taking a serious and thoughtful look at this
piece of legislation. However, the bill is 160 pages long,
highly complex and was only made public about a week ago. Any
bill that would so dramatically overhaul our nation's capital
markets must be worked on collaboratively with the Minority. We
also need the analysis and views of our independent regulators,
the Administration, and the stakeholders on the implications of
this legislation.
With that said, I have some initial concerns I would like
to discuss today. For starters, I am particularly worried that
the Republican bill would allow crypto firms that are currently
being sued for violating our securities laws to continue doing
business through provisional registration. We witnessed this
last year when disgraced FTX CEO, Sam Bankman-Fried, defrauded
millions of customers, and now the SEC has taken actions
against firms like Binance and other firms for potentially
similar behavior. This bill appears to halt any enforcement
actions by the SEC against crypto firms, even when they have
committed fraud. This provisional registration could reward bad
actors with a get-out-of-jail-free card and allow them to
continue harming consumers and investors.
We also know that FTX illegally commingled customers' funds
to make undisclosed investments and to trade against its own
customers. The SEC has ramped up its enforcement against other
crypto firms for the same misconduct. Broker-dealers today are
and have been for decades prohibited from commingling customer
assets, so I wonder why Republicans would legitimize this
illegal practice for crypto firms and allow customer funds to
be put at risk?
Another point I would like to raise is that three crypto
firms recently received approval to operate legitimately under
our securities laws. Franklin Templeton received approval to
offer a money market fund on the blockchain, OTC Markets
received approval to trade crypto securities, and Prometheum,
whose CEO is one of our witnesses today, received approval to
custody and trade crypto assets. As SEC Chair Gensler has
repeatedly said, the door is always open for crypto companies
to register with the SEC. Despite the claims of some in the
industry, our securities laws, which have worked for every
other industry for 90 years, can also work for crypto firms.
Turning to the stablecoin bill that was also noticed for
this hearing, I am encouraged by the legislative progress that
is being made. That said, while Republicans have heeded a few
of our concerns, there are still major red flags, including the
bill's lack of diversity and inclusion protections, weak
consumer protections, and wholly-insufficient oversight by the
Federal Reserve or State-chartered stablecoin issuers. So, I
look forward to returning to the negotiating table to finish
what we started last Congress.
I do believe that Mr. McHenry and I had gotten a long way
in dealing with stablecoins, and I am sorry that it got
interrupted somehow, but I am looking forward to getting back
and negotiating to see if we can move stablecoins forward.
Chairman McHenry. I look forward to those continued
conversations, and I appreciate you starting this long
discussion on digital assets under your leadership. And my
intention is to utilize those conversations we have had and
come to some reasonable conclusion that we both can support,
and I want to thank the former Chair and current Ranking Member
for that.
The Chair now recognizes the gentleman from Arkansas, Mr.
Hill, who is also the Chair of our Subcommittee on Digital
Assets, Financial Technology, and Inclusion, for 1 minute for
an opening statement.
Mr. Hill. I thank the chairman. Good afternoon. Thank you
all for joining us on our panel, particularly for the 6th
hearing that we have had in this committee on digital assets.
For months, the Digital Assets Subcommittees of the House
Financial Services and the House Agriculture Committees have
been working on legislation to establish a functional
regulatory framework with strong consumer protections. The two
proposals noticed at the hearing are the result of that good
work.
Importantly, the market structure bill would prevent
another FTX from happening by ensuring that customer assets are
protected, by providing robust guardrails to mitigate conflicts
of interest, and by establishing clear oversight and
supervisory authority for Federal regulators to ensure that
market participants like dealers, exchanges, and custodians are
compliant with our securities and related commodity laws. Like
then-Chair Waters said in November, after FTX, we need
legislative action to ensure that digital asset entities cannot
operate in the shadows, and that is exactly what we have done.
I want to be clear: We want feedback from our Members and
we look forward to that during the course of the hearing today.
I yield back.
Chairman McHenry. The Chair now recognizes the ranking
member of our Subcommittee on Digital Assets, Financial
Technology, and Inclusion, the gentleman from Massachusetts,
Mr. Lynch, for 1 minute.
Mr. Lynch. Thank you, Chairman McHenry, and Ranking Member
Waters. I must say I continue to have grave concerns with key
elements of both of these bills under consideration, which I
believe will serve to fundamentally undermine our broader
financial system. By creating a whole new regulatory carveout
dedicated to digital assets, these bills create a loophole that
will allow any non-bank security issuer to digitize or tokenize
its products so it will be able to avoid compliance with
existing investor protections and financial stability
regulations.
I am also deeply concerned about the new roles defined for
the SEC and the CFTC. These bills are both targeted at greatly
reducing the SEC's authority and would hinder its ability to
conduct adequate enforcement. Our financial system, which is
the envy of the world and the source of U.S. primacy in global
finance, is in its essence built on trust and the investor
protections afforded by the rule of law. I would urge my
colleagues to take a critical view of these bills and consider
how the insecurity and volatility that these changes will
inject into our traditional financial system will endanger the
trust and confidence in that system. Thank you, and I yield
back.
Chairman McHenry. The gentleman yields back. Today, we
welcome the testimony of a great panel: Jeremy Allaire, the co-
founder, chairman, and CEO of Circle; Coy Garrison, a partner
at Steptoe and Johnson, and a former Counsel to SEC
Commissioner Hester Peirce; Thomas Sexton III, the president
and CEO of the National Futures Association; Emin Gun Sirer,
the founder and CEO of Ava Labs, Incorporated; and Aaron
Kaplan, the founder and co-CEO of Prometheum, Incorporated.
We thank each of you for taking the time to be here. Each
of you will be recognized for 5 minutes to give an oral
presentation of your testimony. And without objection, your
written statements will be made a part of the record.
Mr. Allaire, you are now recognized for 5 minutes.
STATEMENT OF JEREMY ALLAIRE, CO-FOUNDER, CHAIRMAN, AND CEO,
CIRCLE
Mr. Allaire. Chairman McHenry, Ranking Member Waters, and
members of the committee, it is an honor to be here today. I am
Jeremy Allaire, chairman and CEO of Circle. I co-founded Circle
10 years ago with the vision that digital currency would
transform how value was exchanged. Five years ago, we launched
USDC. Today, USDC has grown to become one of the largest dollar
digital currencies in the world. USDC powers tens of thousands
of applications and has handled over $10 trillion in
transactions.
The core of Circle's day-to-day mission is expanding the
role of the dollar on the internet. The demand for safe and
secure dollars on the internet is real and growing. Stablecoins
and blockchain networks will likely become strategic
infrastructure for the future of the internet. It is a profound
moment for the dollar in the world today. Currency competition
is real and is increasingly defined by technological
competition. No nation understands this better than China with
its own state-controlled digital yuan, complete with embedded
surveillance. The steps the U.S. Government takes now will have
a significant impact on dollar competitiveness in the decades
that follow. Failing to take the appropriate steps could have
devastating consequences for America. As a nation, we need to
ensure that the dollar is the most-competitive currency on the
internet.
There also needs to be universal access to the safest and
most-secure digital dollars possible. These digital dollars
must be backed by the safest assets. The world must have the
safety and assurance needed to exchange value without fears of
bank runs. Access and safety are cornerstones of keeping the
dollar competitive, but at the heart of dollar competitiveness
must be technological superiority. That means unleashing the
innovation made possible by software, the internet, and free
market competition.
We are here today to consider and discuss proposed
stablecoin legislation. I appreciate the substantial and
bipartisan work you have all done. Delivering a stablecoin bill
to President Biden's desk should be a national priority.
Already, other major nations are enacting laws to regulate the
use of dollar stablecoins. Rather than let other countries
define our future, the United States needs to lead the
development of global rules that will determine how our
currency moves around the world. The broad parameters of this
bill are strong, providing for robust supervision, strict
reserve requirements, redemption, custody, and reporting
requirements that protect consumers. The bill also provides
roles for both State and Federal regulators and supports both
bank and non-bank issuers.
At the same time, there are several issues on which I would
like to comment. The first is the respective roles State and
Federal banking regulators should play. We need to ensure an
important and continuing role for States in the growth of well-
regulated stablecoin adoption. To start, we need nationally-
established standards that set a high bar for all issuers and
that can be enforced by Federal regulators where appropriate.
A second issue is related to reserves. Circle believes
issuers should only hold reserves that are even safer than for
banks, where fractional reserves put the safety of money used
for payments at risk. A simple solution would be to afford
issuers limited rights to basic Fed services, facilitating
more-timely redemptions, and protecting consumers and financial
stability, without needing to provide access to the discount
window.
Finally, are questions around custody and safekeeping. The
harsh lessons of 2022 teach us that we need stronger
protections around the custody of digital assets. A common-
ground solution would be to require that any stablecoin
intermediary be required to hold them with either a State- or
federally-chartered qualified custodian.
Back in the late 1990s and early 2000s, we went through an
intense hype cycle and then a dramatic crash in the development
of the web. There were total losses, scams, and frauds. A
combination of proactive policy and private-sector development
led to a period that made America the uncontested technology
leader. We are in a similar moment today, but we don't have the
luxury of time. The tech capability gap that existed then has
now been closed by China. The dollar is at a crossroads, and
currency competition is now technology competition.
I ask all of you as Members of Congress to consider this
moment. Ask what value system we want to enshrine in law and
how do we safely and deliberately unleash the creative forces
of U.S.-led technology innovation?
Thank you again for the opportunity to be here today. I
would happy to answer any questions you may have.
[The prepared statement of Mr. Allaire can be found on page
60 of the appendix.]
Chairman McHenry. Thank you. Mr. Garrison, you are now
recognized for 5 minutes.
STATEMENT OF COY GARRISON, PARTNER, STEPTOE AND JOHNSON LLP,
AND FORMER COUNSEL TO COMMISSIONER HESTER M. PEIRCE
Mr. Garrison. Thank you, Chairman McHenry, Ranking Member
Waters, and members of the committee, for inviting me here
today. My name is Coy Garrison. I am a partner at Steptoe and
Johnson where I advise participants across the digital asset
industry on securities laws compliance. Prior to a year ago, I
was an attorney at the SEC where I had the honor of serving as
Counsel to Commissioner Hester Peirce. I am testifying today on
my own behalf and not on behalf of my firm or any client of my
firm.
My message to you today is simple: Congress must act to
bring sensible regulation to the digital asset industry.
Today's discussion draft is thoughtful and measured. It would
create a workable regulatory framework for the industry with
much-needed investor protections. Before highlighting the
positive aspects of the draft, I would like to discuss why
congressional action is needed.
First, the application of securities laws to digital assets
is not always clear. Sweeping statements that nearly all
digital assets are securities or are not securities ignore the
complexity of the analysis and distract from finding a workable
solution to the issues at hand. Congress defined, ``security,''
in 1933 by referencing more than 30 instruments.
Unsurprisingly, digital assets are not included in this list.
Generally, the question becomes whether a digital asset is sold
pursuant to an investment contract.
Under the Howey case, an investment contract is a contract,
transaction, or scheme where you have an investment of money in
a common enterprise that leads to a reasonable expectation of
profit from the efforts of others. The application of this test
is not always straightforward. Indeed, the SEC staff issued
guidance on the subject in 2019, and it identified over 60
factors to consider. Additionally, even if a digital asset is
sold pursuant to an investment contract, the digital asset
itself is not the security. Rather, it is the digital asset
plus the promises of the third party that constitute the
transaction, the contract, or the scheme that is the security.
Further, as of today, there simply is no case law
addressing the application of the Howey Test to a secondary
market transaction in an investment contract. And if that is
not enough, adding to the complexity, the SEC staff has taken
the position that a digital asset that at one point in time may
represent a security, may over time no longer represent the
security if the network becomes sufficiently decentralized.
There is no clear guidance on how this happens.
Second, congressional action is needed because the SEC has
refused to create a workable regulatory framework. Digital
asset trading platforms cannot register under existing rules
because those rules are not designed with the realities of how
digital assets trade or operate. Existing equity market
structure rules do not contemplate concepts made possible, such
as instantaneous settlement, the potential for trading of
securities and non-securities on the same platform, and the
lack of a need for intermediaries for various functions.
The SEC has shown little interest in considering changes to
existing rules. The Commission is instead relying on
enforcement actions, some of which will take years of
litigation and appeals to result in any binding judicial
precedent. Absent a congressional directive to the SEC to
engage in rulemaking, the status quo will likely persist for
the foreseeable future.
Third, congressional action is needed because the lack of
regulation harms investors, responsible industry participants,
and the U.S. economy. The status quo fails to protect people
who are trading digital assets. While there are a number of
responsible platforms appropriately safeguarding customer
assets and monitoring against fraud and manipulation, some
platforms have notoriously put their customers' assets at
dramatic risk and caused significant loss. While enforcement
actions are important tools to hold wrongdoers accountable,
they simply cannot replace sensible market regulation that can
help deter, identify, and mitigate wrongdoing.
Fortunately, the market structure draft provides a
foundation for a responsible regulatory framework and addresses
a number of the regulatory uncertainties I have just
highlighted. The bill forces the SEC to turn its focus to
producing a more-workable regulatory regime and to also
responsibly divide responsibility of the digital asset spot
markets between the SEC and the CFTC.
First, the bill would create a new exemption where a
digital asset can be sold pursuant to an investment contract to
non-accredited investors with important investor protections in
place. Second, the bill would require the SEC to modernize its
secondary trading rules to permit the trading of digital
assets. Third, the bill would also provide the first framework
for how a network can become decentralized, and it creates a
formal process to transfer regulatory responsibility from the
SEC to the CFTC. Fourth, the bill gives the CFTC authority to
regulate the spot markets and digital asset commodities in a
responsible manner.
In conclusion, the discussion draft would provide the
regulatory certainty that is needed to ensure that the digital
asset industry can innovate and grow the U.S. economy. Thank
you for your tremendous work on this important legislation, and
I look forward to your questions.
[The prepared statement of Mr. Garrison can be found on
page 65 of the appendix.]
Chairman McHenry. Thank you, and I recommend to the panel
that you bring the microphones closer. This is the best
technology that we can bring to you from the 1940s.
[laughter]
Chairman McHenry. Mr. Sexton, you are now recognized.
STATEMENT OF THOMAS W. SEXTON, PRESIDENT AND CEO, NATIONAL
FUTURES ASSOCIATION (NFA)
Mr. Sexton. Thank you, Chairman McHenry, Ranking Member
Waters, and committee members for inviting the National Futures
Association (NFA) to appear before you today. My name is Tom
Sexton, and I am the president and CEO of NFA. We applaud this
committee's and the House Committee on Agriculture's joint
work. The committees' June 2nd discussion draft contains the
critical customer protections that Congress should adopt as it
moves forward with developing a statutory framework for spot
digital asset commodities.
Congress in 1974 authorized the creation of registered
futures associations. NFA is the only one. Congress and the
CFTC in 1982 gave us the responsibility to regulate firms
engaging in exchange-traded derivatives. Over the years,
Congress expanded the CFTC's jurisdiction, and we were
entrusted with additional responsibilities over spot retail
forex and swaps.
NFA is solely a regulator, and we partner closely with the
CFTC to perform our work. We currently have approximately 3,000
global member firms that the CFTC requires to be members of
NFA, and 42,000 individual associate members. We have
approximately 520 employees, and our budget is approximately
$140 million, all paid for by the industry. Our seven primary
areas of responsibility are described in my written testimony.
Let me highlight two.
First, we monitor and examine our members for compliance
with NFA's rules. One key oversight area relates to customer
funds. Futures Commission Merchants (FCMs), by rule, must hold
these funds in segregated accounts at qualified depositories,
which are separate from the FCM's proprietary and operational
funds. Each day, we receive reports directly from depositories
holding these funds to ensure that an FCM holds sufficient
money to cover the amount owed to customers.
Second, we investigate possible rule violations and
vigorously enforce our rules. Our enforcement efforts are
coordinated closely with the CFTC and, if necessary, law
enforcement. Over the past 10 years, nearly 25 individuals have
gone to prison due to criminal misconduct, many involving
retail customers initially investigated by NFA.
My written testimony describes our strong track record in
two areas and how we partner with the CFTC to protect retail
customers and prosecute retail trading abuses and fraud. In
both cases, our enforcement actions and customer-filed
arbitrations drop precipitously due to our actions.
Let me highlight how we tackle customer abuses in the spot
retail forex market. Forex dealers appear to function similar
to firms that offer digital asset commodities. They solicit
retail customers, accept customer funds, operate an electronic
trading platform, and may take the other side of the trade with
customers. In 2008, Congress gave the CFTC anti-fraud and
regulatory jurisdiction over spot retail forex transactions and
their dealers. Congress prudently placed a fence around these
spot forex transactions within the Commodity Exchange Act and
created a separate registration category for forex dealers,
whom Congress required to be members of a Regional Financing
Arrangement (RFA.) Today, NFA and the CFTC impose extensive
customer protection rules upon these dealers.
Let me now turn to our involvement with spot digital asset
commodities. Member firms engaging in spot digital asset
commodities are already within our doors. NFA has proactively
acted to oversee members engaged in this activity. In 2018, we
required members to provide enhanced disclosure requirements
and an investor advisory to customers. More recently, we filled
a jurisdictional hole by adopting a rule that imposes anti-
fraud and supervision requirements on members engaged in this
activity. NFA's rule currently covers Bitcoin and Ether.
Retail customers have suffered significant monetary harm in
schemes involving digital asset commodities and deserve
protection. Only Congress can create a Federal registration and
regulatory regime. Therefore, we encourage you to provide the
CFTC with the regulatory authority to complement its current
anti-fraud authority over spot digital asset commodities. Only
then, can the CFTC adopt the discussion draft's critical
customer protections, including those relating to customer
assets, business conduct and disclosures, minimum capital
requirements, and trade practices.
Finally, I want to voice our strong support for the
critical role as provided in the discussion draft that an RFA
should play to partner with the CFTC to regulate this area. NFA
has always been willing to take on the additional
responsibilities entrusted to it by Congress and the CFTC, and
we would do so again to the extent requested. Thank you, and I
am happy to answer any questions.
[The prepared statement of Mr. Sexton can be found on page
114 of the appendix.]
Chairman McHenry. Thank you. Dr. Sirer, you are now
recognized for 5 minutes.
STATEMENT OF EMIN GUN SIRER, FOUNDER AND CEO, AVA LABS, INC.
Mr. Sirer. Chairman McHenry, Ranking Member Waters, and
members of the committee, it is an honor to be here with you
today. I thank you for the opportunity to appear before you as
a computer scientist to discuss blockchain technology, its
innovative uses, why it is impactful to our economy, and why it
must thrive in the United States.
I am the founder and CEO of Ava Labs, a blockchain software
company headquartered in Brooklyn, with the mission to digitize
the world's assets. We have developed some of the most-
significant recent technological innovations in blockchain,
including the biggest breakthrough in consensus protocol since
Bitcoin. I was previously a professor of computer science at
Cornell University for almost 20 years. I consulted with
various U.S. Government agencies and made fundamental
contributions to distributed systems, operating systems, and
networking. I am also currently a member of the CFTC's
Technology Advisory Committee.
We are living through a period of unprecedented
technological progress and transformation. Computers initially
set the strand in motion with isolated mainframes and personal
computers that lacked network connectivity. The emergence of
the internet marked a pivotal shift from isolated local
computing to global-scale computing using what we call client-
server architectures. This new paradigm, which enabled us to
connect to services operated by others, gave rise to systems
that cater to the entire world, created millions of jobs, and
solidified the United States' position as a global economic
leader.
Blockchains represent the next phase of networked computer
systems. Whereas client service systems rely on point-to-point
communication, blockchains facilitate many-to-many
communication, allowing multiple computers to collaborate,
achieve consensus, act in unison, and share services under
adverse network conditions. This enables the development of
unique digital assets, more-efficient financial services,
programmable assets in computer games, and digital identity
solutions, among many other innovative applications. My full
written testimony contains examples of blockchain applications
that tangibly improve people's lives.
The implications of this breakthrough are far-reaching
because blockchain and the digital uniqueness it creates allows
us to redefine trust, ownership, commerce, recreation, and
communications, ultimately transforming how we interact with
digital systems and each other. The determination of the
regulatory regime for blockchains must start and end with the
functionality and features of the digital assets and not the
technology used to create them. At Ava Labs, we call this a
sensible token classification.
Blockchains have the ability to build into their
technological fabric any set of rules that are then
automatically applied to all relevant transactions. This
enables us to build efficient, self-enforcing networks. For
example, the Ava Labs software allows anyone to build custom
blockchains with creator-defined rule sets, including financial
regulations. Other blockchains are working on their own
equivalent solutions.
Now, let me be clear on three key points. First,
decentralized networks are a desirable goal for many reasons
that have nothing to do with regulations governing use cases.
In fact, they are more resilient, secure, auditable, and
available than traditional systems. Blockchain builders did not
set out to develop technology to evade loss. We set out to
solve hard computer science problems.
Second, tokenization also was not created to evade laws. It
is the natural product of blockchains and an improvement over
traditional systems, just like computer databases were an
improvement over paper filing cabinets.
Third, as we enter this new era, we must support this
revolutionary technology. By doing so, we can ensure that the
United States remains at the forefront of innovation,
propelling the next generation of internet technologies and
ushering in great economic growth.
The U.S won the first wave of internet revolution precisely
because it enabled the freedom to innovate responsibly. The
United States must follow the same path of enabling free but
responsible growth of blockchain technology through sensible
regulation of blockchain applications and tokens based on
implementation and use case. Otherwise, there are two critical
paths of failure for any regulatory framework.
First, the blockchain platforms themselves should not
become regulated at the protocol layer. This would be the
equivalent of regulating internet services and internet
routers, which would have doomed the vibrant internet we have
today.
Second, the tokens and smart contracts created with
blockchains should not be lumped into homogeneous and
incompatible categories. This would be the equivalent of
regulating a social media application the same way we regulate
a consumer healthcare application. Instead, tokens and smart
contracts must be regulated based on their function and
features.
Finally, it is essential to remember that just as good
people are committed to public service, there are also good
people committed to building technologies to improve lives. By
working together, we can lay the groundwork for trustworthy,
efficient, and self-enforcing systems that serve as the
foundation for our modern economy. I thank the committee for
the opportunity and look forward to your questions.
[The prepared statement of Dr. Sirer can be found on page
124 of the appendix.]
Chairman McHenry. Thank you, Dr. Sirer. And Mr. Kaplan, you
are recognized for 5 minutes.
STATEMENT OF AARON KAPLAN, CO-CEO AND FOUNDER, PROMETHEUM, INC.
Mr. Kaplan. Chairman McHenry, Ranking Member Waters, and
esteemed members of the committee, thank you for the
opportunity to testify at today's hearing on, ``The Future of
Digital Assets: Providing Clarity for the Digital Asset
Ecosystem.''
My name is Aaron Kaplan, and I am the founder and co-CEO of
Prometheum. As an attorney, my background is in securities
laws. Since 2013, I have dedicated my career to the application
of distributed ledger technology to the securities industry and
the related regulatory issues.
Prometheum and its subsidiaries are building a public
market and custodial infrastructure for digital asset
securities pursuant to the Federal securities laws. Prometheum
has developed proprietary technology in the United States,
integrating the requirements and investor protections of
securities regulation and the efficiencies of distributed
ledger technology. Prometheum's subsidiaries are Securities and
Exchange Commission registered broker-dealers and Financial
Industry Regulatory Authority (FINRA) members. Prometheum ATS
is an SEC-registered alternative trading system that matches
orders for buyers and sellers of digital asset securities under
the Federal securities laws. Prometheum Capital was recently
approved as the first Special Purpose Broker-Dealer, meaning it
is the first SEC-registered custodian for digital asset
securities under the Federal securities laws.
By operating under the SEC's established regulatory
frameworks through registered entities overseen by the SEC and
FINRA, Prometheum provides Americans participating in the
crypto and Web3 space with the investor protections of the
Federal securities laws. Through this, Prometheum is developing
a fair and orderly market, ensuring customers' assets are
properly segregated, secured, and custodied.
In the vast majority of cases, crypto is a financial
instrument offered to the public as an investment.
Intermediaries are required to be regulated by the SEC based on
the services they provide to the public. Properly regulating
crypto trading, clearing, settlement, and custody under the
securities laws provides a proven mechanism which allows and
encourages responsible participation and innovation, while at
the same time ensuring that investors are protected.
There has been much discussion lately about the need for
greater regulatory clarity for digital assets. The essential
point at hand is not about more or less regulation or even new
regulation, but rather, the application of the existing
regulatory frameworks to digital assets. The Federal securities
laws have been tried and tested for almost 90 years and have
allowed the United States to establish the world's most-trusted
and advanced financial markets.
The SEC is by far the most-capable financial markets
regulatory agency in the world. The SEC relies on FINRA, a
self-regulatory organization whose mission is market integrity
and investor protection, to regulate the securities markets.
Together, the SEC and FINRA employ approximately 8,000
employees to oversee these vital securities functions. Put
simply, the Federal securities laws and oversight from the SEC
and FINRA have proven to be the most-effective system to
protect investors, operate fair and orderly markets, and
protect customers' funds and assets.
As early as July 2017, the SEC put the industry in the DAO
Report, stating that digital assets and related financial
services could (and likely did) implicate the Federal
securities laws. Subsequently, the SEC created a marketplace
framework with the release of the four-step process on July 8,
2019, and the three-step process on September 25, 2020.
Thereafter, the SEC created the framework for the clearance,
settlement, and custody of digital asset securities through the
Special Purpose Broker-Dealer release on December 23, 2020.
These releases provide the framework for a compliant path
forward for crypto in the United States.
I want to stress that point: There is a compliant path
forward for crypto in the United States, that the SEC has
clearly laid out. Those who argue for new laws are simply not
willing to comply with existing applicable securities laws and
regulations. New legislation is not in the best interest of the
investing public or the blockchain industry. Legislative
efforts will take years to implement while the American public
will continue to operate on reckless, unlawful platforms.
In conclusion, the United States fosters innovation through
the vibrancy of our capital markets. U.S. capital markets
flourish under the established regulations of the Federal
securities laws overseen by the SEC and FINRA. In order for
innovation to continue to thrive in the digital asset space,
the protections afforded by the Federal securities laws need to
be in place. Proper regulation under the Federal securities
laws is not a hindrance to innovation, but rather, a
prerequisite that will allow innovation to flourish.
Thank you again for the opportunity to testify at this
hearing, and I look forward to answering any questions.
[The prepared statement of Mr. Kaplan can be found on page
72 of the appendix.]
Chairman McHenry. I will now recognize myself for 5 minutes
for questions.
Mr. Garrison, how many foreign regulators have proposed new
regulatory frameworks for digital assets?
Mr. Garrison. You are looking at about half a dozen to a
dozen.
Chairman McHenry. Okay. Including Europe?
Mr. Garrison. Including Europe.
Chairman McHenry. And Europe is far more advanced than we
are?
Mr. Garrison. Yes.
Chairman McHenry. Okay. We see venture capitalists now
deploying offices--American venture capital firms going there
to seek to invest. Are other countries implementing new
regulations around digital assets, specifically digital assets?
Mr. Garrison. They are. Whole cloth new regulations.
Chairman McHenry. Okay. And do you think consumers are
protected here in the United States by our lack of clear rules?
Mr. Garrison. No, they are not.
Chairman McHenry. Okay.
Dr. Sirer, how does the threat of enforcement action stymie
innovation and hold back developers from new projects here in
the United States?
Mr. Sirer. Lack of clarity around regulations involving the
issuance of tokens holds back quite a few innovators from
actually residing in the United States, and we are actually
seeing people who are active in this field move wholesale out
of our borders to other jurisdictions.
Chairman McHenry. And that is putting pressure on you to
develop your technology overseas, not here in the United
States?
Mr. Sirer. Well, I am very happy to be in the United States
myself, but I can see the pressure on other people.
Chairman McHenry. Okay.
Now, Mr. Garrison, in terms of the cost structure of
potential enforcement action by the SEC, what does that look
like for a firm? I don't want to get into what they charge, but
it is not cheap, right?
Mr. Garrison. It is not. Hundreds of thousands of dollars,
and into the millions, depending on the charges.
Chairman McHenry. Okay. As I said, we want a purpose-built
regime for digital assets, right? We want same risk/same
regulation, that is the focus.
Mr. Sexton, in the draft here, we have said that
decentralization is the key. If a digital asset is associated
with a decentralized and functional network, they would be
treated as commodities. Would the CFTC and your organization be
able to serve as primary regulators over the digital commodity
spot market?
Mr. Sexton. Chairman McHenry, if that is the definition as
far as a commodity is concerned, then the CFTC and NFA would be
able to implement that definition within and regulate that in
the spot market, yes.
Chairman McHenry. Okay. Over here in the Financial Services
Committee, we have securities law protections for consumers. We
have consumer protection. That is a key part of our
discussions. Is there similar consumer protection in the world
of commodities?
Mr. Sexton. Absolutely, everything from segregation,
capital requirements, risk disclosure. You monitor the trading
that occurs, the exchanges do on the exchanges. Very similar
type of customer protections are in place with regard to retail
participants.
Chairman McHenry. Dr. Sirer, about decentralization, what
are the features? What is the end goal state of a functional
decentralized network? What are the attributes of it? Give us
some sort of, not your 401 class, maybe your 201 class from
your college days?
Mr. Sirer. Simply put, a decentralized network aims to
provide a service wherein, even though some of the actors in
the system might be what we call, ``Byzantine,'' and they might
be acting in an adversarial fashion, the system is still able
to maintain its safety and integrity guarantees for all of its
users. These networks are more resilient than other computer
network systems.
Chairman McHenry. When we see the Securities and Exchange
Commission ramping up their enforcement action, it's time for
hearings. I would think there has to be some contemplation from
our friends over there. What we are trying to build is
consensus around changes in law, around a new object, a new
asset, a new digital architecture.
Mr. Garrison, if you have an innovator who wants to set up
shop here in the United States in the world of digital assets,
how would you advise them?
Mr. Garrison. I tell them that the laws, the regulations
are very uncertain, and often those conversations end with the
entrepreneur deciding to either launch offshore or to drop the
idea altogether.
Chairman McHenry. Let's pivot to stablecoins. Mr. Allaire,
where are you currently regulated? Where is Circle currently
regulated?
Mr. Allaire. Circle is regulated in a number of
jurisdictions. We are regulated across the United States by
State payments and banking supervisors. We are regulated in
Singapore as a major payment institution. We are in
registration with the French government, and we are also
regulated by the Financial Conduct Authority (FCA) in the UK.
Chairman McHenry. Do you comply with any money laundering
rules here in the United States?
Mr. Allaire. Yes, absolutely, comprehensive Bank Secrecy
Act/Anti-Money Laundering (BSA/AML) programs, which we have had
in place for a very long time.
Chairman McHenry. Okay. Are you licensed in the State of
New York?
Mr. Allaire. We have a BitLicense in New York, and we are
also licensed as a money transmitter in the State of New York.
Chairman McHenry. Okay. Thank you all for your testimony. I
appreciate the wide-ranging panel we have here.
I will now recognize the ranking member, Ms. Waters, for 5
minutes.
Ms. Waters. Thank you so much, Mr. Chairman. I did not I
anticipate that we would have such strong advocacy for the CFTC
and for the SEC, so this is interesting.
Mr. Kaplan, while Democrats are taking a serious look at
the Republicans' market structure bill, I am deeply concerned
that some of the most-basic investor protections are missing
from the bill. First, any commingling of investor funds must be
strictly prohibited. We saw with the collapse of FTX that much
of the fraud and investor harm came from the commingling of
customer funds, which enabled the CEO, Sam Bankman-Fried, to
steal his customers' property. The bill also seems to permit
trading facilities to trade against their own customers and
engage in other activities prohibited by today's security laws.
Do you agree that commingling of customer funds should be
prohibited? Will your firm commingle customer assets, Mr.
Kaplan?
Mr. Kaplan. Our firm will not commingle customer assets
with that of the firm. Our model does not have proprietary
trading or market-making activities. Thus, customer assets will
not be commingled with firm assets because, in that sense,
there are no firm assets. And customer assets will be properly
segregated as outlined by Securities Exchange Act Rule 15c3-3.
Now, when it comes to the investor protections of the
Federal securities laws, we saw the dangers with FTX, of what
happens when they are not in place. The Federal securities laws
would have done the most in terms of preventing an FTX-like
situation. They ensure fair and orderly markets. They ensure
that markets are not manipulated. They ensure that you can't
trade against your customers' accounts necessarily. They also
ensure proper segregation of customer funds and assets from
that of the firm.
These were major issues when it came to FTX, and they could
have been prevented had there been proper regulation and
oversight with the SEC. So, in order for the best route going
forward, I think the best way to protect the American public is
with the application of the Federal securities laws, which are
built to protect investors. There is literally no need to
recreate the wheel here.
Ms. Waters. Thank you very much. As a Special Purpose
Broker-Dealer (SPBD), are there activities you are prohibited
from doing but that are permitted for crypto brokers in the
Republican bill, and can you describe why the securities laws
prohibit those activities and how changing the prohibition
would affect investors?
Mr. Kaplan. The Special Purpose Broker-Dealer is capable of
custodying digital asset securities under the Federal
securities laws. Pursuant to the Federal securities laws, there
are filings and disclosures that must be submitted to the SEC,
and these disclosures and filings include firm financials,
possession and control reports, and it goes as far as requiring
disclosures about firms' affiliates. Having these systems in
place with the ongoing reporting, the proper oversight, and the
investor protections of the Federal securities laws will ensure
market participants are properly protected and are the best way
to protect the American public, going forward.
Ms. Waters. Mr. Kaplan, I also have concerns with what the
bill refers to as, ``provisional registration.'' Specifically,
I am concerned that this gives crypto firms that are violating
our securities laws a get-out-of-jail-free card. This provision
seems particularly harmful, because firms like Binance or even
FTX, which have both been accused of fraud, could effectively
block the SEC from continuing its investigation. Are you
concerned by this provision of the bill? What impact do you see
this having on investors?
Mr. Kaplan. I am very concerned by that provision of this
bill, as the provisional safe harbor would essentially prevent
a system where the American public is still exposed to the
dangers that they were previously exposed to while that safe
harbor goes to full registration. Furthermore, when you look at
the best way forward, the best way forward has to be to use the
most-robust system to protect the American public, and the
most-robust system to protect the American public is the
Federal securities laws.
I would like to point out that the American public was left
holding the bag when it came to the FTX violations, or the
alleged violations, when it comes to Binance and Coinbase. And
essentially, the best way to protect them going forward is to
establish the most-robust regulatory regime. The SEC and FINRA
combined have 8,000 employees. The CFTC and the NFA combined
have approximately 1,300 employees. The best way forward that
is pretty clear and logical is the application of the Federal
securities laws.
Ms. Waters. Thank you very much. I yield back.
Mr. Hill. [presiding]. The ranking member yields back. I
now recognize myself for 5 minutes.
Last week, the House Agriculture Committee heard testimony
from CFTC Chair Behnam and former SEC General Counsel
Berkovitz, who served under Chairman Gensler, and it was
striking to see how both of those witnesses called for
congressional action to address the gap in Federal regulation
of digital assets, and this mirrored the Financial Stability
Oversight Council's (FSOC's) report last October.
And this morning, for those of you who are not glued to C-
SPAN here at the House, we had Treasury Secretary Yellen here
for a very interesting morning, and she also suggested that she
stood by that FSOC report calling for a comprehensive
regulatory framework for digital assets. And she said, ``We
would like to see your regulatory framework over those markets
and their gaps and regulations. I would point out specifically
stablecoins, and I do believe we need a comprehensive Federal
prudential framework, and I would be pleased to work with you
and the Congress to develop such a framework.'' In my view, the
CFTC thinks that this is the right direction to take because
there are gaps in the system, notwithstanding the comments from
Mr. Kaplan, and our Treasury Secretary seems to agree as well.
Mr. Garrison, I want to start with you, because I think the
ranking member brought this subject up. She had a good
interchange with Mr. Kaplan about this provisional registration
issue. It is very important. This was also discussed in the
House Agriculture Committee hearing last week. It is a tricky
area to get right, and we want to make sure we draft it in the
best way possible. This is a temporary provision, as I
understand it, meant to bring digital asset firms into the
remit of the SEC and the CFTC before rules of this
comprehensive framework can be stood up, and this was similar
to how we approached swap dealers after Dodd-Frank. Is that
your understanding?
Mr. Garrison. Yes.
Mr. Hill. And we patterned this drafting based on that. The
last time the committee worked ably with the Agriculture
Committee was in the Dodd-Frank Act, on looking at swap rules,
which was a tough debate. I think Mr. Lucas and Ms. Waters
would agree with that. Why is a process like this needed, and
how it can be structured to provide actual customer protection
in the digital asset markets in the interim before those rules
are ready? Is it possible that we can do that?
Mr. Garrison. It certainly is. The provisional registration
or provisions, I think are designed to acknowledge the reality
that these markets exist now, that these trading platforms
exist now, and that customers, consumers are using them. And
until the new rules are written, there are no rules of the
road. So by requiring them to raise their hand, to signal an
indication of seeking full registration when the rules are
provided by committing to certain undertakings of meeting
certain standards----
Mr. Hill. Those standards might include books and
recordkeeping, customer disclosure, segregation of customer
funds, right? No one is letting somebody off the hook for those
responsibilities, even under provisional rules. Isn't that
right?
Mr. Garrison. Correct.
Mr. Hill. Do you have any suggestions on further refining
provisional registration that would be best for both the
regulators and the market participants?
Mr. Garrison. Sure. I think there is a provision exempting
any actions relating to fraud, and it sounds like there might
be some confusion on that point. So, I would recommend really
drilling down and making sure that during that provisional
period, obviously, that shouldn't cover any fraudulent acts
that would occur during that provisional period. So to the
extent there is uncertainty on that, It seems like a good area
on which to focus.
Mr. Hill. Good. Thank you. Last week, the Commission issued
an enforcement action against Binance for failing to register
as a national securities exchange broker-dealer or
clearinghouse. More concerning was also the allegation that
they were commingling customer assets with house assets and
misrepresenting the controls to investors. This absolutely
cannot be allowed to happen. We need clear rules of the road to
prevent that kind of thing or another FTX. You have looked at
our draft. Do you think that we have a good bill, with
provisions on prohibiting commingling?
Mr. Garrison. I think it does, both on the SEC side and the
CFTC side.
Mr. Hill. Would it allow conflicts of interest to persist
if we have the new framework in place?
Mr. Garrison. It would not.
Mr. Hill. Mr. Garrison, Mr. Kaplan made a very good comment
about his success in becoming a registrant of the Commission.
Are there things you saw that took place there that we should
change in our bill about registering broker-dealers?
Mr. Garrison. No. I believe the Special Purpose Broker-
Dealer is limited to a certain universe of digital assets.
Mr. Hill. My time has expired. You can answer in writing if
you would.
The gentleman from Georgia, Mr. Scott, is now recognized
for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman. Mr. Kaplan, 90 years
ago, Congress created our Federal securities laws to protect
our investors and to establish robust regulation against
misrepresentation and fraud in our securities market. However,
since then, we have seen decades of legal precedent established
that consistently yielded benefits to our consumers and our
investors in the long run. Unfortunately, I believe that under
this misguided digital asset market structure bill we are
dealing with now, the fundamental approach to securities laws
is effectively undermined, to the detriment of the American
investor.
I am particularly referencing sections of the bill which
give much of the authority over digital assets, previously with
the SEC, to the CFTC, and the bill would also exclude digital
commodities and payments stablecoins from the definition of a,
``security,'' under the securities laws. This is antithetical
to current law where an asset can be both a commodity and a
security. So by creating an entirely new regime for so-called
digital commodities, the bill eliminates the SEC's ability to
determine what is or is not a security.
Mr. Kaplan, what consequences may arise from this? Make it
plain to us. This is the heart of the matter. Could this
potentially result in less protection for our investors than is
currently provided?
Mr. Kaplan. I anticipate that it would. Essentially, as you
mentioned, the Federal securities laws are tried and tested
over generations. There is not just case law; there is follow-
on legal precedent, and additional regulations, and basically
continuing actions thereafter. And essentially, the concept of
creating a new regulatory regime that would make a
determination of whether a digital commodity will exist would
create sort of a void in between what we have now and when that
is fully in place. It would take maybe half a decade to a
decade for those laws to be flushed out such that they might be
viable. And in the meantime, we have an existing framework that
is purpose built, meant to protect investors, meant to ensure
there are proper disclosures, and meant to ensure that there
are fair and orderly markets, and basically, that customer
funds and assets are properly segregated and secured.
Essentially, in the meantime, while all of this is sort of
flushed out in the legal system, and basically the digital
commodity is operating in a semi-security capacity because it
has always arguably been a security, the investors
participating in that space will not have proper disclosures,
and proper protections, and also not proper oversight to ensure
they are properly protected.
I also want to circle back to the provisional registration.
The provisional registration really provides a get-out-of-jail-
free card because, essentially, when an entity registers or
provisionally registers, the SEC cannot go after their previous
actions. So in theory, if Binance, or if FTX was still around,
were registered, once they became provisionally registered,
those who suffered at the hands of the malfeasance of those
entities would not have legal recourse. How is that in the best
interest of the American public? It is not.
Mr. Scott. Mr. Kaplan, I agree with you 100 percent. What
do you think we should do about this?
Mr. Kaplan. Follow the existing Federal securities laws,
which have been tried and tested over generations and are
literally meant to protect the retail investing public. It is a
clear and logical pathway forward.
Mr. Scott. Thank you, Mr. Kaplan.
Mr. Hill. The gentleman from Georgia yields back.
The gentleman from Oklahoma, Mr. Lucas, is recognized for 5
minutes.
Mr. Lucas. Thank you, Mr. Chairman, for holding this
hearing and for your work, and I thank the Chairman McHenry for
his work on the digital market structure legislation. Both this
Financial Services Committee and the House Agriculture
Committee have had many hearings, and many roundtables in the
lead-up to this draft, and this hearing gives us another
opportunity to examine the underlying legislation and discuss
why it is important for Congress to provide a clear regulatory
framework.
And I will begin with this: If the United States wants to
be a leader in the future of digital assets, it is essential
that Congress act. Other jurisdictions, such as the European
Union and Japan, have frameworks for digital assets, and
countries like the U.K. are crafting their own rules. At the
same time, our regulators here in the U.S. are at odds. We have
the Chairman of the SEC telling Congress that legislation is
not needed, while the Chairman of the CFTC says legislation is
needed. Congress should settle this by passing much-needed
regulatory clarity for digital assets, not jurisdictions abroad
like the EU, and not the SEC through a chaotic enforcement
approach.
Mr. Garrison, could you discuss how it makes our job
passing meaningful legislation more difficult, the longer we
wait?
Mr. Garrison. The longer that it takes to get legislation
together, the more the trading public in digital assets are put
at risk, where there are no rules in place. The longer that
industry participants do not have certainty, the more difficult
it is for them to continue to operate, and the greater the risk
that they move offshore.
Mr. Lucas. Mr. Allaire, could you further underscore the
missed opportunity of allowing other countries to create a
workable digital asset environment, while here in the United
States we allow the SEC to take the lead?
Mr. Allaire. Thank you for the question, Congressman Lucas.
Very specifically, we are seeing governments around the world--
the EU, the U.K., Japan, Hong Kong, Singapore, and others--
actually defining the rules for how dollars, digital dollars,
are issued and operate in those markets, which is astounding.
The United States is responsible for the dollar, and the United
States does not yet have clear regulation for payment
stablecoins and digital dollar issuance. And with respect to
the different need for clarity, I think as recommended by
Secretary Yellen and the entire President's Working Group, who
have also led an effort internationally to establish stablecoin
rules, we need to adopt stablecoin rules so that other markets
are not actually regulating the dollar.
Mr. Lucas. Many of the consumer protection concerns that we
see today in the crypto market are reminiscent of the forex
markets of the 2000s, which were rife with get-rich-quick
schemes under an unclear regulatory framework. In 2008,
granting the CFTC jurisdiction over retail forex transactions
provided tangible consumer protection results.
Mr. Sexton, drawing upon your experience and tenure at the
NFA, how important is it for Congress to act if we truly want
to protect consumers?
Mr. Sexton. Mr. Lucas, thank you for the question and thank
you for meeting with us yesterday. As a member of the
Agriculture Committee, you worked with us on retail forex
issues, and it is extremely important in light of the similar
type of retail customer fraud that occurs with regard to spot
digital asset commodities that a similar framework be built.
We know that the CFTC has anti-fraud jurisdiction over
these products currently. We need to complement that with
regulatory jurisdiction, as we did in the retail forex space.
As we have often said, it is far better to prevent fraud than
to prosecute fraud because retail customers have been hurt
after that has occurred.
Mr. Lucas. Mr. Sexton, I understand you are still reviewing
applications of the market structure discussion draft, but
could you discuss broadly how the National Futures Association
would amend its compliance rules to account for Congress
creating a classification for digital commodities? What would
the process look like?
Mr. Sexton. The process would be very similar to what we
have done in the past when we have taken on additional
responsibilities in the retail forex and the swaps markets. The
first thing that we would do is--as I said, we currently have
an anti-fraud rule for digital asset commodities that covers
Bitcoin and Ether. Depending upon what Congress derives as far
the definition for those products, we would amend our rules to
cover those products. We also would amend our rules to permit
digital asset commodity brokers and dealers to be members of an
NFA if we are participating in this, and then afterwards, we
would adopt compliance rules in the areas that are identified
in the discussion draft, working closely with the CFTC in doing
so, from customer seg to capital disclosures, you go down the
line, as to the elements of the discussion draft.
Mr. Lucas. Thank you for those insights. My time is about
to expire, Mr. Chairman.
Mr. Hill. The gentleman yields back.
The gentlewoman from New York, Ms. Velazquez, is recognized
now for 5 minutes.
Ms. Velazquez. Thank you, Mr. Chairman.
Mr. Allaire, as you know, the New York Department of
Financial Services has developed its own regulatory regime
providing for the legal issuance of stablecoins in the State of
New York. There has been significant conversation on this
committee about whether the Federal Government or the States
should be the primary regulatory authority regarding stablecoin
issuance. What is your view? How do you view the role of the
Federal Reserve vis-a-vis the States?
Mr. Allaire. Thank you for the question, Congresswoman
Velazquez. This is a critical issue which I know is central to
ultimately getting stablecoin legislation done here in the
United States. We believe there needs to be a strong role for
both States and the Federal regulators. I think that the bill,
as noticed as of this Friday, makes very significant progress
in establishing the very strong Federal floors on the reserve
requirements, reporting requirements, redemption disclosures,
co-minglings, not allowing that. And then, very specifically,
it allows the Fed and the Federal banking regulators to deal
with the rules around capital advocacy, core risk management
rules, safety and soundness requirements, the kind of fitness
of management, many of the fundamental things, and that becomes
the floor that any State regulator needs to meet. But States
would be allowed to issue payment stablecoin licenses and to
supervise firms under that Federal floor, and I think that is a
good compromise for States like New York, which have really led
the way in stablecoin regulation in the United States.
Ms. Velazquez. Thank you for that answer.
Mr. Kaplan, what is your view? How do you view the role of
the Federal Government vis-a-vis the States when it comes to
regulation of stablecoin issuance?
Mr. Kaplan. Under the draft bill, I think there are
potential issues when it comes to the fragmentation and the
different regulatory regimes. Essentially, a stablecoin could
be licensed at a State level, but what happens if that
stablecoin is used outside the State? Isn't it used in
interstate commerce then, and therefore shouldn't there be
Federal oversight?
I think the most-appropriate way to ensure that investors
and the public are properly protected, particularly when it
comes to stablecoins, which arguably pose the largest and most
systemic risk, is to have proper Federal oversight that is
uniform, that would prevent any sort of regulatory arbitrage
where issuers would choose one State versus another because
they are more friendly towards the approval process.
Ms. Velazquez. Okay. Thank you for that answer.
Mr. Allaire, and Mr. Kaplan, if you both believe Federal
oversight is important, do you believe it is important to have
ongoing supervisory and examination authority for the State
license issuers at the Federal level?
Mr. Allaire. I believe that the Fed needs to be able to
continue to enhance rules over time. In particular, the bill
stipulates core areas around capital adequacy, risk management,
and safety and soundness. The importance of those is paramount,
and Federal regulators need to be able to look at what is
evolving in the market and evolving on the whole and be able to
make recommendations around that.
So, this is not a static, one-time thing. I think that
these are going to be dynamic markets and technology changes,
and that will require that we be able to look at those on an
ongoing basis.
Ms. Velazquez. Very short answer, Mr. Kaplan?
Mr. Kaplan. I think that there is specifically, on the
State level, potential issues when it comes to the idea that
the State can unilaterally expand the list of eligible reserve
assets without restriction at any time. Expanding the
underlying assets that could basically stabilize the
stablecoin, and to include and introduce additional risks which
will increase the chance of that stablecoin losing its peg.
Ms. Velazquez. Thank you. Mr. Kaplan, one of the central
tenets of our banking system is the separation of banking and
commercial activity. The Republican-led stablecoin legislation
we are discussing here today seems to fail to recognize this
separation for stablecoin issuers, which would allow non-
commercial businesses to own a stablecoin issuer. Can you
explain the harm to both consumers and perhaps financial
stability that could arise from failing to clearly define this
separation?
Mr. Kaplan. Consolidation of consumer and banking
activities can lead to conflicts of interest and potential
systemic risk. Essentially, the lack of a strong framework with
proper regulatory oversight for the entities involved,
particularly when they are comingling consumer- and financial-
based activities, presents additional levels of conflict and
potential exposure to the underlying customers either on the
consumer side or----
Mr. Hill. Thank you. The gentlewoman's time has expired.
Ms. Velazquez. Thank you. I yield back.
Mr. Hill. Thank you.
The gentleman from Florida, Mr. Posey, is now recognized
for 5 minutes.
Mr. Posey. Thank you, Mr. Chairman.
Mr. Allaire, you began your testimony today talking about
China's currency. Do you see any comparison between that and
the central bank digital currency that the President has
proposed in his Executive Order?
Mr. Allaire. I'm sorry. I could not hear the last part of
your question because the door opened.
Mr. Posey. I said, do you see any similarity between the
Chinese program and the central bank digital currency that
President Biden included in his Executive Order?
Mr. Allaire. Thank you for the question, Congressman Posey.
I think what the Chinese government has pushed forward with is
an entirely state-run and state-administered digital currency
program. It has with it significant embedded surveillance
capabilities, and it is clearly something that the Chinese
government seeks to export around the world as part of its
desire to grow the role of the yuan internationally.
I believe your reference to the Executive Order from
President Biden was around studying a central bank digital
currency in the United States. Our view is that a similarly-
designed retail government-run and government-administered
central bank digital currency is not needed in the United
States. But we do believe that there are critical improvements
to be made in the core infrastructure of the dollar itself,
within the Federal Reserve System, what people sometimes refer
to as wholesale infrastructure for this, and clearly, central
banks around the world are all exploring that.
But I think this separation between those institutions that
are delivering financial services directly to end customers and
the government is a kind of air gap that is important to
preserve for privacy, security, and market competition reasons.
Mr. Posey. You can understand the concern of some people
that if private digital is competing with government digital,
guess who is going to win? It is never going to be a level
playing field, and more levels of regulation is not going to
help. We know that for 10 years, the SEC was informed about the
biggest fraud in history. So, more regulation is not going to
fix the fraud that we endured.
And there is also concern that when you have a central bank
digital currency, like China has, the government knows every
penny that you spend. They can slow down your flow of funding,
they can cut it off, or they can take everything that you have.
And I can understand the legitimate concerns that some people
have about that.
How should investors evaluate the liquidity risk of digital
assets compared to banks?
Mr. Allaire. Specifically on stablecoins, what this bill
does is specify a very narrow base of important, high-quality
liquid assets that must be held on a fully-reserved basis, the
most-liquid dollar instruments in the world. And a digital
dollar that is held to those reserve standards is dramatically
safer than bank deposits. Bank deposits hold one-twelfth of the
deposits, and the remainder is lent out. We see risks from
fractional reserving. And the mixing of that lending behavior
and payment system behavior has, let's just say, bitten
American consumers and businesses many, many times
historically.
This bill, I think, helps to define and create the safest
digital dollar in the world, which is what the American
government should be getting behind and making that an
important export product on the internet.
Mr. Posey. How should the regulations for stablecoins
compare to the capital regulations for banks and money market
funds?
Mr. Allaire. In the stablecoin bill, there are
recommendations for Federal regulators to look at capital
adequacy, to evaluate key activities around the risks of an
issuer, and I think that is appropriate. There should be
capital buffers to deal with it. But unlike a bank, which is
rehypothecating and lending and fractionally reserving, these
are very, very narrowly held, so the liquidity requirements,
and therefore the capital buffer requirements, are likely going
to be significantly lower. That is left to regulators to
determine as opposed to being highly prescriptive in the bill,
but I think it is a very important and necessary piece for this
to ultimately go into effect.
Mr. Posey. Thank you. Mr. Chairman, my time has expired, so
I yield back.
Mr. Hill. The gentleman yields back.
The gentleman from California, Mr. Sherman, is recognized
now for 5 minutes.
Mr. Sherman. Thank you. This seems like the 12th hearing we
have had on crypto this year. I am still waiting for a hearing
on diversity, equity, and inclusion in this room this year. But
all of these hearings seem to start with the idea that we are
falling behind. But America is behind Peru in cocaine
cultivation, and we are behind the Cayman Islands in nefarious
hidden financial transactions; we do not always need to catch
up.
We are told that we now have a 160-page bill, and I am sure
a lot of work has gone into that bill, but it comes down to the
one sentence, and the one reason why Sam Bankman-Fried prowled
the halls of this building, and that was to get the SEC out and
put a patina of regulation in.
Then, there is the proposed stablecoin bill that goes to
the lowest State denominator. And what State, if they could
have $1 billion to provide health care for their own citizens
who might die, would not cut that deal and just provide
whatever patina of regulation the industry wanted? And if North
Dakota will not do it, South Dakota will.
So, we will have achieved Sam Bankman-Fried's objectives.
The least we could do is let him out of jail to come here and
celebrate this legislative success.
When billionaires tell you that they are working to hurt
your country, you should believe them. The head of Coinbase,
Brian Armstrong, tells us that he views crypto as a new global
reserve currency. And we see from others that this is the way
major figures in the crypto industry see crypto: as a way to
undermine American sanctions.
The role of the U.S. dollar allows us to have the, ``Know
Your Currency,'' rules. Crypto says it is hidden money. It is
in the name. Undermine our sanctions rules, provide a tool for
tax evaders, but most importantly is what Mr. Brian Armstrong,
CEO of Coinbase says, and that is to displace the dollar
partially or completely as a reserve currency.
We are told that we need clarity. We have clarity. The SEC
realizes it is a security, as Mr. Kaplan does as well. The
industry is here to: first, they are in court spending tens of
millions of dollars to undermine that clarity; and then, they
are in Congress spending God knows how much to undermine the
clarity that we could have with tough regulation from the SEC,
which is what is currently called for in our laws
I have a question for Ava Labs. Avalanche Labs attempts to
highlight their use of technology to focus on innovation, but
still peddles unregistered securities to retail investors. The
Avalanche token went from a market cap of $40 billion to $4
billion.
Mr. Sirer, did Ava Labs file a registration statement with
the SEC? Has Ava Labs sold unregistered Avalanche tokens or a
future right to Avalanche tokens in order to raise capital?
Mr. Sirer. Congressman, we have complied with every
regulation to the best of our abilities, and we are----
Mr. Sherman. Did you file a registration statement or not?
Mr. Sirer. When we did our token sale, we filed an
appropriate----
Mr. Sherman. Did you file a registration statement or not?
Mr. Sirer. I do not know the correct answer to that. I am a
technologist, so I do not know the answer to that. I don't
believe that we did.
Mr. Sherman. That would certainly surprise me. I mean,
Taylor Swift turned down millions of dollars and responded to
the community by saying that crypto is an unregistered
security, and she would turn down millions of dollars to not be
associated with it. Some people in this room are not willing to
make that statement.
Mr. Kaplan, are you able to comply with SEC regulation and
carry on your business?
Mr. Kaplan. Yes, sir.
Mr. Sherman. You filed a registration statement?
Mr. Kaplan. We filed through the licensing process.
Mr. Sherman. Through the licensing, so, you got a license
from the SEC?
I would just say that we have had a lot of witnesses come
before us, but I don't believe we have had one who came here to
talk about how, if this works, it undermines the power of the
American people.
Mr. Hill. The gentleman's time has expired.
Mr. Sherman. I yield back.
Mr. Hill. I thank the gentleman from California.
The gentleman from Missouri, Mr. Luetkemeyer, who is also
the Chair of our National Security Subcommittee, is recognized
for 5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
I want to quote from an article in the Wall Street Journal
last week entitled, ```Crypto communism' Has a New Meaning:
China seeks to infiltrate the U.S. financial system, and the
SEC and FINRA seem oblivious.'' In this article, it talks about
Prometheum as an American company, but according to SEC filings
it is a, ``strategic partner and joint venture with Shanghai
Wanxiang Blockchain Inc., and its affiliate, HashKey. The
former company is a spinoff of Wanxiang Group, which has deep
ties with the Chinese Communist Party.''
Wanxiang Group was founded in 1969, and the founder passed
away recently, and an official press release commented that,
``the comrade always listened to the party and followed the
party.'' That group is now led by that gentleman's son, Lu
Weiding, and the press release goes on to say that, ``he will
carry forward the practices of the deceased founder and always
listen to the party and follow the party.'' I can tell you from
being on the House Select Committee on the Chinese Communist
Party, that that is a chilling statement, when we have an
American company that is in bed with the Chinese.
Mr. Kaplan, what percentage of your company is owned by a
Chinese entity?
Mr. Kaplan. I think, approximately 20 percent.
Mr. Luetkemeyer. Twenty percent of it. How much influence
do they have over your company?
Mr. Kaplan. They have the same rights as other
shareholders.
Mr. Luetkemeyer. How much access do they have to
intellectual property?
Mr. Kaplan. Wanxiang has no access to any Prometheum code
or technology or systems service or customer data.
Mr. Luetkemeyer. If they are on the board of directors and
have access to all of your data, from the standpoint of being
an investor, how do you answer that question like that?
Mr. Kaplan. The bylaws were changed in the filing that was
filed with the SEC in November 2021, and they basically limit
who has access to data, including directors.
Mr. Luetkemeyer. Okay. Where is the data stored right now?
Mr. Kaplan. In the United States.
Mr. Luetkemeyer. So, your headquarters is here, and your
data is stored here. It is not stored anywhere in China?
Mr. Kaplan. Not at all, sir.
Mr. Luetkemeyer. Okay. You have a designation as a digital
asset security broker-dealer, and as such, you have a lot of
personally identifiable information on your clients, do you
not?
Mr. Kaplan. Correct.
Mr. Luetkemeyer. Okay. Do the Chinese have access to any of
that information or any other technology at this point?
Mr. Kaplan. Absolutely not, sir. I want to point out that
Prometheum is an American-born, American-bred, and American-
controlled company, and there is basically no foreign influence
or control over Prometheum or any of its systems, its code, its
servers, or its customers' data.
Mr. Luetkemeyer. I am glad you could read that, but that
does not impress me because I sit on the Committee, and I can
tell you any company that is either owned by or involved with
the Chinese Communist Party and/or government is influenced by
them. That is the only way they operate.
What safeguards do you have in place to make sure they do
not get access to anything in your company?
Mr. Kaplan. Sir, we have had both a Committee on Foreign
Investment in the United States (CFIUS) inquiry and an SEC
investigation where we were required to give all
communications----
Mr. Luetkemeyer. To what benefit do the Chinese then
involve themselves in your company? If they cannot access
information, if they cannot access your technology, what is the
benefit to them of investing in your company?
Mr. Kaplan. The belief in the business idea that digital
assets are securities and need to be properly regulated as such
and traded on intermediaries that are properly registered under
the securities laws.
Mr. Luetkemeyer. Do you think that perhaps they are getting
some information just by being around your business that could
be helpful to them?
Mr. Kaplan. I do not believe so, sir.
Mr. Luetkemeyer. Why did you take them on as a partner? Why
can you not have an American partner instead of a Chinese
partner? What is the benefit of having a Chinese partner in
this business?
Mr. Kaplan. As anyone who has started a startup knows, when
you are young and small as an entity and a large, established
entity seeks to have a relationship with you, you look for the
opportunity. If there had been an American opportunity, we
probably would have taken it.
Mr. Luetkemeyer. That is troubling because, you see, this
is exactly how the Chinese work their way into our various
companies in this country. They see an opening, because there
is a need there for the company to grow, for money, for
expertise, for technology, and they are standing there with
their hands out being willing to add that to the portfolio or
give to whatever you want to do here. And as a result, then
they have their hands on you. It is very disturbing to see that
is what is going on here.
I am just worried that this is a situation where we have
the SEC giving you one of the first digital asset security
broker-dealer's licenses, and where is the SEC on this, I
wonder?
But anyway, I see my time is getting short, so with that,
Mr. Chairman, I will yield back.
Mr. Hill. The gentleman yields back.
The gentleman from New York, Mr. Meeks, who is also the
ranking member of the House Foreign Affairs Committee, is
recognized for 5 minutes.
Mr. Meeks. Thank you, Mr. Chairman. I think most of you
know I am from New York, and I think you are all aware that the
New York Department of Financial Services (DFS) has created
what I believe is a best-in-class licensing regime for virtual
currency businesses, and I am very, very proud of that. The New
York DFS is the only prudential regulator with virtual asset-
specific authority in these United States of America. Under the
leadership of Superintendent Adrienne Harris, DFS ensures that
consumers and markets are protected, and New York continues to
be the financial center of the entire world. They have
assembled the largest team of expert virtual currency
regulators in the nation and have taken the strongest
supervisory and enforcement actions of any regulator.
Mr. Allaire, whom would you consider to be Circle's primary
regulator?
Mr. Allaire. Thank you for the question, Congressman Meeks.
We are regulated similarly to virtually every other major
electronic payment innovator in the United States. We are
regulated by many different State regulators throughout the
U.S., similar to PayPal, Apple Pay, Venmo, Cash App, and
others. So, we are an electronic stored value money
transmission application, which requires us to be licensed in a
filing with the Treasury Department, with Bank Secrecy Act
(BSA) and mail requirements with the U.S. Treasury, as well as
licensing and supervision throughout the United States. We also
have international supervisors that are central banks and
market supervisors.
We are also a BitLicense company. In fact, we were the very
first company in the world to receive the New York BitLicense.
In 2015, we contributed to the development of that licensing
regime. And we follow New York's reserve and disclosure
requirements for stablecoins, which we would agree are some of
the best available to the market today.
Mr. Meeks. I just want to make sure that I am clear--does
Circle currently possess any type of virtual currency license
in the domestic jurisdictions?
Mr. Allaire. Yes. We have a BitLicense, the New York
virtual currency license which they pioneered in 2015. Other
States also have specific enhancements to their money
transmission statutes that deal with virtual assets and
interactions between the banking system and virtual assets. A
number of large States do that already today. We are also
supervised by international banking regulators such as the
Monetary Authority of Singapore, the UK Financial Conduct
Authority (FCA), and others.
Mr. Meeks. So, you acknowledge that States like New York
have been leaders in this space, and you agree that they have a
vital role to play. Is that correct?
Mr. Allaire. I absolutely agree.
Mr. Meeks. Can you speak to why the existence of a State
pathway is not a race to the bottom?
Mr. Allaire. I believe payment stablecoins, as identified
by the Presidential Working Group and by the G20 as well, have
the potential to be very large scale, much larger scale in use
than many other payment technologies. And for that reason, it
has been recommended by the U.S. Treasury, the White House, and
others that there be national standards set for payment
stablecoins. And I think that is exactly what, on a bipartisan
basis, we are seeing happen here in Congress.
And what is really key there is that there is a federally-
defined floor, that we do have the ability for Federal
regulators to define what that floor is so that there cannot be
a race to the bottom. I believe the best States should be able
to issue licenses and supervise firms according to this Federal
floor. And I think that is exactly what the legislation in
front of us considers today.
Mr. Meeks. Thank you. Let me jump to Mr. Garrison. Mr.
Garrison, your assessment that the lack of clear rules of the
road puts the United States at a competitive disadvantage
deeply resonates with me. It is something that I have been
talking about a lot. Like you, I hear regularly from U.S.
companies that the lack of regulatory clarity at the Federal
level is causing them to consider moving out of the United
States and seek to be regulated in other jurisdictions around
the world.
So, I would like to give you an opportunity to expand on
this and share some of your observations in this area, and what
are some of the potential near-term and longer-terms impacts of
industry participants leaving the United States?
Mr. Garrison. The regulatory uncertainty is tremendously
difficult for people as they want to grow businesses. And when
they seek legal counsel and when they come to people like me,
they are willing to spend money to comply with the law. They
just simply need to know what the rules of the road are, so it
becomes incredibly frustrating when there are no clear rules of
the road, and all you know is that an enforcement action may be
hanging over your head, but there is no actual way to comply.
Mr. Hill. The gentleman's time has expired. I thank the
gentleman from New York.
The gentlewoman from Missouri, Mrs. Wagner, who is also the
Chair of our Capital Markets Subcommittee, is now recognized
for 5 minutes.
Mrs. Wagner. Thank you, and I want to thank Chairman
McHenry and our Chair of the Digital Asset Subcommittee, Mr.
Hill, for their efforts to develop a much-needed framework that
provides clarity to market participants, promotes innovation,
and protects investors.
This hearing is timely, and the legislation that we are
discussing today is critical to ensuring the United States
remains the leader in technological and financial innovation.
While Congress has been working toward developing a legislative
framework, SEC Chair Gensler continues to regulate by
enforcement. The SEC is actively policing digital asset markets
through enforcement without clear authority from Congress and
without providing a clear regulatory roadmap for digital asset
firms.
Meanwhile, the Commodity Futures Trading Commission (CFTC)
has brought enforcement actions as well, including with regard
to digital assets over which the SEC claims jurisdiction.
Mr. Allaire, although the collapse of FTX did not involve
payment stablecoins, one of the most-egregious stories to come
out of it was the co-mingling of customer and firm assets.
Following your review of the draft legislation, does this draft
fix the problems that we saw in FTX, so that we can provide
increased protections to Main Street investors?
Mr. Allaire. Thank you for the question, Congresswoman
Wagner. In both the payment stablecoin bill and in the draft
market structure bill, I do believe that those co-mingling
issues are absolutely addressed, and I think that is a critical
issue that you have identified, and obviously a core to whether
you are holding funds backing a stablecoin or you are holding
digital assets that are on behalf of investors and users.
Mrs. Wagner. Absolutely. Last week, the SEC issued an
enforcement action against Coinbase, alleging that they were
operating as an unregistered broker-dealer exchange and
clearinghouse. This action came after several requests from
Coinbase, including a petition for rulemaking to amend the
securities laws so that they could actually come in and
register with the agency.
Mr. Garrison, in your view, does this inaction on valid
requests from the SEC, followed by harsh penalties against
Coinbase, inhibit companies making good faith efforts to
register, thus preventing job creation and economic growth
within the stablecoin market, sir?
Mr. Garrison. It certainly does. The lack of a regulatory
framework makes operating a digital asset business in the U.S.
very difficult, so allowing digital asset markets to operate
within the acknowledgement of certain realities such as
instantaneous settlement of trading of digital assets that may
be represented by securities alongside non-securities at the
same time are important things to acknowledge, and I think this
bill does a good job of identifying that and telling the SEC to
start putting a regulatory framework in place.
Mrs. Wagner. Okay. Mr. Garrison, the proposed legislation
requires the SEC to modernize a number of its rules to account
for the realities of digital assets, including rules governing
alternative trading systems and broker-dealers. Would you
describe how these rules could be updated to accommodate
digital assets and what impact these modernizations will have
on the digital asset ecosystem?
Mr. Garrison. The secondary trading rules need to be
updated to acknowledge that not all intermediaries are
necessary, which is one thing that digital assets make
possible. So, those are rules that, by the way, even at the end
of these enforcement actions, if the SEC is successful, these
rules still have to be updated to allow for these realities of
the technology to occur.
So, it is something that the SEC can do now, and the good
thing about this bill is it requires them to act now as opposed
to waiting until after the enforcement action----
Mrs. Wagner. My time is short, Mr. Garrison. Development in
the blockchain space is accelerating rapidly, yet existing
regulations make it difficult for everyday investors to
participate in initial offerings. The new exemption in the bill
allows participation of non-accredited investors, up to a
certain limit. How will this access benefit retail investors?
Mr. Garrison. Improving investor choice is an important
part of investor protection, as well as the key characteristics
here of----
Mrs. Wagner. Are there protections too, sir?
Mr. Garrison. Yes. The disclosure requirements are included
in the bill, the individual investment limits, the aggregate
offering limits. There are limits on secondary trading from
insiders as well.
Mrs. Wagner. My time has expired, but I would be interested
in any other protections that you think should be added to the
legislation.
I thank the Chair, and I yield back.
Mr. Hill. The gentlewoman yields back.
The gentleman from Massachusetts, Mr. Lynch, who is also
the ranking member of our Digital Assets Subcommittee, is
recognized for 5 minutes.
Mr. Lynch. Thank you, Mr. Chairman.
Mr. Kaplan, I am going through the bill itself, and it is
remarkable that the Commodity Exchange Act actually reads out
of the law four major pieces of legislation that have been
intrinsic to strengthening our markets--the Securities Act of
1933, gone; the Securities Exchange Act of 1934, gone;
Investment Company Act of 1940, gone, does not apply; the
Investment Advisors Act of 1940, does not apply; the Sarbanes-
Oxley signoff of annual reports, gone. As a matter of fact,
annual reports are gone.
All of these bills were put in place right after the stock
market crash in 1929, and because we had 9,000 banks in this
country go out of business, fail, Congress, with the support of
Wall Street, amazingly, at the time, came back and said, how do
we restore the trust of investors in Wall Street, in the stock
market, in our banks? And we came up with this menu of bills
that tried to restore confidence, since our financial system is
built essentially on trust. And we got trust by providing
public information to those investors right up front, to build
confidence in their investments.
You have been able to follow those rules in establishing
Prometheum. What do you think the consequences will be if new
companies have the choice of either being regulated or, as SEC
Chair Gary Gensler has pointed out, operating like the Wild
West? And especially if it is a State-by-State model, where you
can go to a State like New York, which has an established
regime and somewhat of a regulatory framework, or you can go to
some other State that is very loosely regulated. What do you
think the consequences of those choices will be on the markets?
Mr. Kaplan. The American public will be harmed.
Essentially, what we have seen is that the Wild West crypto
financial services ecosystem focused on revenues at the expense
of customers' best interests. The way forward, the best way,
really, the only way forward is the application of the Federal
securities law to ensure that investors are protected.
As you mentioned, sir, the major Acts when it came to the
securities laws were passed after the 1919 crash. We learned
our lessons then. Regretfully, we did not understand them in
2022. But now, in hindsight, it is totally clear that the best
way forward and the best way to protect the public is literally
the application of the Federal securities laws.
I want to point out that there has been discussion about a
lack of regulatory clarity, and that is just not true. The SEC
put the industry on notice in July 2017, in the DAO Report. The
SEC has released compliant frameworks for the trading and
custody of digital assets. Those who argue that there is a lack
of regulatory clarity, need a lack of regulatory clarity
because they cannot be compliant under the existing clarified
regulations.
Mr. Lynch. Mr. Kaplan, the SEC has brought 130 enforcement
actions and has won every single one of them. After each and
every one of those enforcement actions, there is a written
decision as to why that individual company was found to be in
noncompliance. Is that instructive to the next company coming
along? Is that instructive to you as a new startup?
Mr. Kaplan. There has been clear indication, whether it is
on the release, the enforcement side, or the statements coming
out of the SEC, that the Federal securities laws applied and
that those seeking to operate compliantly in the space when it
comes to digital asset financial services need to comply with
them. Basically, there is no confusion here. Essentially, the
industry has chosen to ignore the clear statements, the
enforcement actions, and the releases by the SEC because they
were best-served by not being regulated under the Federal
securities laws.
Mr. Lynch. Thank you. We have a few seconds left. What are
the steps for registering and coming into compliance under
existing laws? Is it onerous or is it balanced?
Mr. Kaplan. The steps are difficult, they are a little
complex, and they take time, but they need to, because when you
are dealing with customer funds and assets----
Mr. Hill. The gentleman's time has expired. I thank the
witness. I appreciate my ranking member and his questions.
And I will now recognize the gentleman from Kentucky, Mr.
Barr, for 5 minutes.
Mr. Barr. Thank you, Mr. Chairman. Let me start with Mr.
Garrison and follow up with Mr. Kaplan's testimony. It seems
that Mr. Kaplan is making the argument that everything except
Bitcoin is a security. I want you to amplify your testimony in
reference to this, what I think is Mr. Kaplan's testimony. In
your written testimony, you talk about how the application of
existing security laws--which Mr. Kaplan says are perfectly
applicable in this new, innovative marketplace--to digital
assets is not always clear. And amplify your analysis of how
Howey does not really cover everything in the current modern
world.
Mr. Garrison. Yes. We always start with the statute on the
analysis of, what is a security? The statute is quite clear in
the list of instruments. Digital assets are not there. Then the
question becomes, is it an investment contract? The Supreme
Court, in the Howey case, put forth a test. It said a contract,
transaction, or a scheme where there is an investment of money
and a common enterprise with a reasonable expectation of profit
from the efforts of others is the security.
Now a digital asset, at times, can, in fact, be sold
pursuant to an investment contract, which does not mean that
the digital asset itself evidences the security for all of
time. That set of promises that may have been launched as a
project is getting off the ground and developing the network
for the first time, and raising money to do that, that is
selling a token pursuant to an investment contract. But over
time, tokens operate differently. They are not equity
securities. They are not your traditional stocks or bonds or
notes. People purchase them for a number of different reasons,
but one of the reasons is they want to use it on the platform
itself, on the network itself.
At some point in time, when the network is fully
decentralized and fully functioning, that digital asset does
not bear the characteristics of the security, and the
application of securities laws would be so overly burdensome
that it would render the use of the network moot.
Mr. Barr. In summary, what do you make of Mr. Kaplan's
argument that existing securities laws are all we need?
Mr. Garrison. I disagree with the position. I think
securities laws are a piece of the puzzle, but I think there is
a large piece of the puzzle that is missing.
Mr. Barr. Let me follow up with a question about custody.
It is essentially for any market structure legislation to set
rules for the custody of digital assets so that consumers can
have confidence that their digital assets actually are where an
intermediary says they are. Digital assets raise several novel
issues when it comes to custody that must be addressed.
Mr. Garrison, would you discuss some of the key questions
when it comes to the application of the SEC's requirements for
custody of digital assets?
Mr. Garrison. With respect to custody of digital assets and
the SEC, there are a number of different questions relating to
the intermediaries that may hold digital assets, typically
broker-dealers, sometimes investment advisors.
Generally, one of the questions that comes up, and the core
becomes, how do you demonstrate exclusive possession of a
digital asset? The way digital assets work is you have private
keys, and of course, the private key may be shared with others
and may be charted and put into different groups, so a lot of
the securities regulations or debates going on in securities
regulation is how do you actually show exclusive control.
Now, the industry has a number of solutions that they think
are sufficient, and the SEC has been talking about it and
refusing to come to a conclusion since, I want to say, about
2018, on the subject.
Mr. Barr. Here again, the status quo is unacceptable. It is
stifling innovation. The banks tell us that not just the SEC
but also the bank regulators are discouraging State custody of
digital assets, and that is stifling innovation here in the
United States. We have to fix that.
My final question to Mr. Allaire is related to China. Can
you touch on how the United States can build out our stablecoin
regime to elevate the United States' leadership in this space
without jeopardizing Americans' access to freedom, privacy, and
apolitical private capital, and talk about that in contrast to
what we see in China with the Chinese digital yuan, which has
embedded surveillance features?
Mr. Allaire. Thank you for the question, Congressman Barr.
Mr. Barr. And could you also touch on how a regulatory
framework for a dollar-denominated stablecoin is an effective
alternative to a CBDC or a digital dollar that would preserve
the dollar's dominance globally?
Mr. Allaire. My time is very short. In short, I believe
private sector innovation with strong regulation at the
national level for digital dollars, which is what this bill
provides, is the best path to compete with China right now.
Mr. Barr. Thank you. And it is a longer answer, but I
appreciate the answer. I yield back.
Mr. Hill. The gentleman's time has expired.
The gentleman from Texas, Mr. Green, is recognized for 5
minutes.
Mr. Green. Thank you, Mr. Chairman. I thank the ranking
member as well. And I thank the witnesses for appearing.
I think a good many topics have been covered quite
thoroughly, so I would like to go into another area that I am
interested in, and that is diversity. I believe that this
industry ought to have diversity, and I would like to ask you
if you agree with me. If you think that this industry should be
diversified in terms of people who are involved, at all levels,
if you think it should be diversified at all levels would you
kindly extend a hand into the air?
[Show of hands.]
Mr. Green. Okay. Let the record reflect that all of the
witnesses believe that we should have diversity at all levels.
Are there women who are capable, competent, and qualified
to testify at a hearing like this one today? If you think so,
raise your hand, please.
[Show of hands.]
Mr. Green. Let the record reflect that all of the witnesses
believe that there are women who are capable, competent, and
qualified to testify at a hearing such as this.
If you identify yourself as a person who is not--N-O-T--not
a male, raise your hand.
[Pause.]
Mr. Green. Let the record reflect that no hands have been
raised, so I assume that all of the witnesses identify
themselves as males.
I must tell you, I find it quite amazing that as far as we
have come, we still have a way to go. I do not fault you. I
really do not. But I do fault my colleagues. Not one female
among the persons who are on this panel, not one. I am amazed
because they know that I am going to point it out, because I do
this quite regularly.
I am also amazed because this could end if the news media
would make an issue of it, and just note that we are not
allowing women to have the opportunity to demonstrate that they
are capable, competent, and qualified.
Do any of you have children? If you have children, raise
your hand, please.
[Show of hands.]
Mr. Green. If you have a daughter, raise your hand, please.
[Show of hands.]
Mr. Green. Okay. Let's start with the gentleman at the far
end. Sir, would you like to see a female on this panel?
Mr. Allaire. Absolutely.
Mr. Green. Do you think your daughter would benefit from
having a female on this panel?
Mr. Allaire. I do.
Mr. Green. When you came in and noticed that you had all
what facially appear to be men, did it give you any degree of
consternation?
Mr. Allaire. I would like to see more diversity in all of
these panels.
Mr. Green. So would I. We have come so far, yet we have so
far to go, it seems.
Mr. Kaplan, do you have any women in your business?
Mr. Kaplan. Yes, sir.
Mr. Green. Are women as smart as men?
Mr. Kaplan. Arguably smarter.
Mr. Green. I agree.
What about you, Mr. Sexton? Any women in your business?
Mr. Sexton. Absolutely, sir. NFA is 40 percent women, 60
percent men. I have two women behind me who are fully capable
of testifying at this hearing, who helped prepare me for this
hearing. I also have a daughter who would, I am sure,
thoroughly enjoy testifying before you.
Mr. Green. Thank you. Just to validate what you said about
two women behind you, would you feel it an imposition to just
have them raise their hands? Would that be an imposition?
Mr. Sexton. I am certainly sure that they could raise their
hands, sir. Thank you.
Mr. Green. All right. Ladies, women, if you would, raise
your hands.
[Show of hands.]
Mr. Hill. I'm sorry. The gentleman's time has expired.
Mr. Green. Okay. My time always expires, but I will be
back.
Mr. Hill. Not always. The 5 minutes goes by fast.
The gentleman from Minnesota, Mr. Emmer, who is also the
Majority Whip of the House, is recognized for 5 minutes.
Mr. Emmer. Thank you, Mr. Chairman. I want to thank
Chairman McHenry for holding this important hearing today, and
I want to thank all of the witnesses for your testimony.
We are convening to discuss a remarkable piece of draft
legislation on digital asset market structure. It is a product
of joint committee collaboration, which, here in Congress, does
not happen often, and it is drafted thoughtfully and
intelligently. I want to commend Chairman McHenry, Chairman
Thompson of the Agriculture Committee, and both of their teams
for all of their hard work.
Crypto will thrive with or without the United States. What
we seek to do today in discussing this draft is to establish if
the next iteration of the internet is going to be designed by
Americans, and for Americans, or if it is going to emulate the
values of some other country. It must be the former, not the
latter.
American digital asset innovators and entrepreneurs
desperately need regulatory clarity, regulatory certainty,
regulatory confidence, and regulatory competitiveness, the four
C's. Instead, as a product of Congress ceding its power to the
administrative state since the mid-1990s, this Administration
has been able to abuse its regulatory powers toward the digital
asset ecosystem to the detriment of the American people.
We have an SEC Chair who flip-flips before Congress,
telling us last year that he needs legislation to regulate the
digital asset industry, and telling us this year that he has
changed his mind. He actually does have the authority, in his
own mind, the statutory authority to regulate this space. I
would disagree. But obviously this sends mixed signals.
The SEC and the CFTC, the two primary regulators, are
constantly at odds on whether digital assets are commodities or
securities. This sends, again, mixed signals to stakeholders.
This Administration weaponized the recent bank crisis to de-
bank the digital asset community, deploying an Operation Choke
Point-style assault on this legal industry.
We have enforcement actions almost every week alleging that
different tokens are securities or different actions fall under
SEC jurisdiction. Yet, the SEC has failed to produce a single
rule or regulation to help the unique digital asset industry
come into compliance, a failure of the administrative state.
Congress needs to step into the driver's seat and pass a
bill that provides regulatory clarity, certainty, confidence,
and competitiveness. I believe the McHenry-Thompson bill could
get us there. It would set up a dual registration framework
that would allow projects to crowdfund and give tokens a
mechanism to move from issuance to decentralization.
However, the way it is currently drafted conflicts
philosophically with how I consider this asset class.
Fundamentally, I do not believe digital assets themselves are
ever securities. Instead, I believe digital assets can be
obtained through a securities contract. The distinction between
an investment contract and the asset of the investment contract
underpins my 8 years of legislative work in this space, and it
is a basis of my bill, the Securities Clarity Act, which I was
fortunate to have Mr. Thompson on as a co-sponsor last
Congress.
Primarily, while I know this is not the author's intention,
my concern is that the McHenry-Thompson bill, as drafted,
currently sets up a framework where one fungible digital asset
can be both a security and a commodity at the same time. On its
face, that is not possible. For one thing to have two distinct
classifications, that is not possible. That is because the SEC
does not clearly distinguish the asset from the investment
contract. In current law, securities inherently include
commodities.
Let's go back to Howey. The orange groves themselves were
obviously a commodity, but they were obtained through a
securities contract. Nonetheless, the SEC considered those
orange groves a security rather than the asset of a security,
but it did not consider all other orange groves a security.
The SEC does this today with digital assets, which, if
continued, makes it impossible for digital assets to be in
compliance with the law and to be used for their utility. Chair
Gensler gave a speech just last week discussing his belief that
the asset of the investment contract is itself the investment
contract, which is completely bogus.
For the text to achieve what the authors wanted to achieve,
which is to enable a framework in which a project can crowdfund
and still create an asset that can be used for its utility,
then the text needs to clearly assert concepts established in
the Securities Clarity Act, that a token is separate and
distinct from an investment contract. This will allow the bill
to provide the necessary regulatory clarity, regulatory
certainty, regulatory confidence, and regulatory
competitiveness to ensure that the next iteration of the
internet is designed by Americans, for Americans.
Again, thanks to our witnesses for being here, and thanks
to Chairman McHenry and Chairman Thompson for your work in this
framework. I yield back.
Mr. Hill. The gentleman yields back.
The gentleman from Connecticut, Mr. Himes, who is also the
ranking member of the House Permanent Select Committee on
Intelligence, is recognized for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman, and thank you to our
witnesses. I would like to thank Chairman McHenry and Ranking
Member Waters for starting down this path. It is evident that
we have a bunch of work in here, and that we have a bunch of
work yet to do.
I am going to use my time just to try to elucidate one
issue that has come up a lot today and that is the issue of
comingling. There is a lot that needs to be done in this bill
but we are all pretty attuned to commingling, given the fact
pattern around FTX. I was told that the bill permitted
commingling.
Mr. Garrison, you said the bill did not permit commingling.
So, I went back to the language of the bill and what I find
when I look at it is on page 105, ``commingling prohibited.
Money, assets, and property of a customer described in Clause
One shall be separately accounted for and shall not be
commingled.''
Then, we move down a few lines to, ``Exceptions,'' where it
reads, ``Notwithstanding subparagraph (a), money, assets, and
property of customers of a digital commodity exchange described
in subparagraph (a) may for convenience, be commingled.''
Elsewhere in the bill there is an exactly parallel construction
where it says that all assets shall be segregated unless they
cannot be segregated if separately accounted for.
It would appear that as written, the language is that there
can be commingling provided that it is done for convenience. I
can't find anywhere in the bill that defines for whose
convenience or what convenience means.
Mr. Garrison, since you made the statement earlier, and
because of your experience, I am wondering, does that language
give you confidence that there will not be commingling?
Mr. Garrison. If I remember correctly, and I don't have the
exact language of the bill in front of me, I think there was a
specific carveout for a very limited activity. So, to the
extent that there was a carveout for a very specific activity
that it is very clear there is a purpose for, then I think that
would make sense.
Mr. Himes. I don't mean to provoke here, but I have read
this 10 times now and it says that, ``for convenience,'' is the
one condition that must be met for commingling to occur. That
is pretty clear here.
I am not a lawyer but that troubles me. You are a lawyer.
Does it trouble you?
Mr. Garrison. I would agree. ``For convenience,'' should be
tightened up.
Mr. Himes. Okay.
Mr. Kaplan, I wonder if you have any views on this, since
you have been seeing things slightly differently than Mr.
Garrison?
Mr. Kaplan. Commingling is a fundamental issue that is
necessary to deal with and to regulate properly in order for
crypto innovation to continue to occur in the United States.
The best way to prevent against commingling is the application
of the Federal securities laws, which have reporting
mechanisms, ongoing reporting mechanisms, proper oversight, and
a plethora of other devices to ensure that the entities that
are holding customers' assets do not commingle them with the
assets of the firm, particularly Rule 15c3-3, the customer
protection rule which has been established and has essentially
led to the capital markets on the custody side being able to
continue to thrive and grow.
Mr. Himes. Okay. Just to drive this point home, I think we
have agreed that perhaps the language as written is a bit broad
or the exceptions are a bit broad.
Do any of our witnesses have any objections if we use the
language associated with prohibitions on commingling and
custody accounts and that sort of thing to prevent commingling
inside this bill?
Would there be an objection to that as a concept?
[No response.]
Mr. Himes. Okay. I hear none. Thank you very much. And I
yield back, Mr. Chairman.
Mr. Hill. The gentleman yields back.
The gentleman from Georgia, Mr. Loudermilk, is recognized
for 5 minutes.
Mr. Loudermilk. Thank you, Mr. Chairman.
Mr. Garrison, in your written testimony you point out that
SEC staff has taken a position that digital assets may or may
not be securities, depending on the condition of their
underlying network, but do little more to clarify the
thresholds of which a network is decentralized enough for the
asset to be a digital commodity.
Given that almost every market participant has asked for
clarity as to when digital assets are commodities or
securities, why do you think it is important to look at the
underlying network as opposed to the digital asset itself?
Mr. Garrison. I believe that looking at the underlying
network is important because it will show the regulator, and it
will show anybody using the network, who actually is in charge.
If the network is decentralized and everybody comes on
equal terms and the rules are being built by a decentralized
group, a number of people outside of just a core number of
folks who started the program, then that should give you more
comfort that this is a decentralized network, not something
that is simply run by a centralized group of people.
Mr. Loudermilk. Okay. Thank you. Do you think it is
important that there are clear thresholds of decentralization
that could be used to make this security vs commodity
distinction?
Mr. Garrison. Yes, I do.
Mr. Loudermilk. What do you believe is a good measure of
network decentralization to help in making that distinction?
Mr. Garrison. I think there are a number of factors that
you can look at, one being, does any person or group of persons
have unilateral authority to change the code itself? I think
that is something that jumps out. Can they block or prohibit
people from interacting with the code on their own?
Another is concentration of ownership of tokens. If there
are governance rights associated with a token, and a central
group or a central entity can always decide the outcome, then
that would indicate centralization as well.
Mr. Loudermilk. Okay. Thank you for that.
Mr. Kaplan, your company recently received the first-ever
approval as a Special Purpose Broker-Dealer (SPBD) for digital
assets. Since then, you have publicly proclaimed that there is
obviously a way forward for crypto in the United States.
However, while your company was approved, most of your would-be
competitors are still waiting for their approval.
You have already begun discussing Prometheum as an, ``SEC-
registered platform,'' even though, respectfully, your firm
does not command the same recognition as countless other
platforms that are more familiar to consumers.
It seems that you are keenly anticipating the increase in
market share that will come with SPBD approval. Given that you
are the only SPBD for digital assets around, do you really
think experience can speak for market participants as a whole?
Mr. Kaplan. I do think it can. Previously, they were
frameworks for the compliant trading and custody of digital
assets under the securities laws. But until someone was
approved, you can argue that there was no pathway forward, that
there was no clear path.
But that argument is now moot, and essentially others, I
believe, in the industry can follow that example of compliance
under the securities laws, and understand that there can be
success at the end of that endeavor and basically put those
practices into place in order to achieve compliance.
Mr. Loudermilk. Okay. In your written statement for this
hearing you claimed that it was clear that a joint development
agreement with Shanghai, if I pronounce this right, the
Wanxiang Blockchain, a company that has known ties to the
Chinese Communist Party, was not viable as early as December of
2018.
You also claimed that after that realization, you began
independently developing your platform. However, in June of
2021 SEC filings, you claimed that you were still conducting
development activities with these Chinese strategic partners.
If you realized you needed to stop working with them in 2019,
why did it take you until October or November 2021 to formally
terminate the agreement?
Mr. Kaplan. I would have to check the exact statement, sir,
but my understanding is that the investment occurs at the end
of 2018 and maybe early 2019 and, therefore, the year time
period thereafter is not in 2019, in my understanding.
Mr. Loudermilk. Okay. As you know, an alternative trading
system cannot facilitate trading for unregistered securities
unless they have a valid exemption. To date, how many tokens
have received these exemptions and how many of these are major
tokens?
Mr. Kaplan. I believe a significant number of the top 50
market cap tokens have gone the exceptive route.
Mr. Loudermilk. Okay.
Mr. Chairman, I see that I am running out of time, so I
will submit my remaining questions for the record, and I yield
back.
Mr. Hill. The gentleman yields back.
The gentlewoman from Massachusetts, Ms. Pressley, is
recognized for 5 minutes.
Ms. Pressley. Thank you. This hearing is billed as a chance
to make progress on cryptocurrency but I would like to know,
progress for whom? In my opinion, Congress should not be doing
the work of wealthy investors in advancing toothless and feeble
legislation that can make the problem of an unregulated crypto
industry worse.
Mr. Kaplan, can you give an estimate of approximately how
many cryptocurrencies exist?
Mr. Kaplan. Thousands.
Ms. Pressley. Okay. According to a recent Forbes article,
there are over 22,000, and many more are bound to be created.
While there are differences among them, crypto tokens do share
similarities. For example, cryptocurrency generally has a low
barrier to entry. If someone has a smart phone, they can simply
download an app, connect a bank account, and become a crypto
investor. This helps explain why cryptocurrency has become so
popular, because it is so accessible.
While a lot of folks want to highlight the innovation and
opportunity that crypto offers, I am laser-focused on making
sure that the innovation and opportunity does not come at the
expense of financial ruin for those who do not have MBAs or
Wall Street experience or generational wealth to invest.
Data shows that low-income Black and Latino adults invest
in crypto at higher rates than White adults.
Mr. Kaplan, for years experts have warned of bad actors in
the crypto market. Do you agree a seemingly normal crypto
investment can really be nothing more than a scam?
Mr. Kaplan. I think that a lot of platforms utilize the
advantages of the internet with the association of innovation
in order to democratize scams to the general public because
they were not properly regulated and did not have proper
disclosures and often had nefarious----
Ms. Pressley. Reclaiming my time, I will take that as a,
yes.
Mr. Kaplan. Yes, ma'am.
Ms. Pressley. Okay. Congress has learned important lessons
on how to regulate our economy and complex investments to
protect investors from scams. When regulating something as
high-risk and volatile as cryptocurrency, we should be
comprehensive, not restrained. Public disclosure which clearly
establishes investor rights, and stringent administrative
oversight are critical aspects of our securities laws but they
are overwhelmingly lacking in proposals put forth by my
colleagues across the aisle.
Comprehensive regulation matters. Just look at the recent
economic turmoil. When FTX crashed late last year, billions of
dollars, not millions, not thousands, but billions of dollars
were lost, and earlier this year, Signature Bank, which had
deep ties to the crypto industry, collapsed, putting more than
$100 billion at risk.
In order to protect investors in crypto, it simply does not
make sense to start from scratch or create a weak regulatory
system. We need to use best practices and further empower the
SEC and Federal watchdogs to oversee this industry. If we
don't, the consequences can certainly go far beyond crypto.
Mr. Kaplan, in your opinion, if there is a loophole created
where non-crypto firms could take advantage of lax regulation
on a secondary market to sell stock under the guise of
blockchain, would they do it? Yes or no?
Mr. Kaplan. I anticipate they would.
Ms. Pressley. Okay. So if Congress is going to regulate
cryptocurrency, we must make sure the solution is not worse
than the problem. Thank you. I yield back.
Mr. Hill. I now recognize the gentleman from Ohio, Mr.
Davidson, who is also the Vice Chair of our Digital Assets
Subcommittee and the Chair of our Housing Subcommittee, for 5
minutes.
Mr. Davidson. Thank you, Mr. Chairman. Thank you to our
witnesses, and I am excited, because it took a long time to get
to this hearing. It has taken a long time to get to draft text
and I wish everyone could understand all of the legislation. We
can explain it to everybody, but we can't understand it for
everybody. But I appreciate that so much innovation is
happening in our country. I hope we can keep some of it here
and that we can get this legislation done.
I have had bipartisan legislation on this subject since
2018, the Token Taxonomy Act. It has been fully bipartisan for
years, and I just think how many of the calamities that people
point to could have been prevented or solved if we had done our
job as Congress and provided legal clarity.
Mr. Garrison, there is a saying that beauty is in the eye
of the beholder. But should whether something is a security or
not be in the eye of the beholder or should it be pretty clear
to everybody that this is a security, and that is not?
Mr. Garrison. It should be very clear and that would
provide certainty that would allow businesses to operate and
investors to do so in a protected manner.
Mr. Davidson. And I think the point of a bright-line test
is incredibly important and it should be clear for the
investors, for the innovators, it should be clear for the
regulators, too, and even SEC Chairman Gensler can't decide,
after all this time, whether or not it is a security. We just
had him here in April for hearings, and he couldn't answer the
question.
So if the existing framework and existing laws are fully
adequate, why can't the Chair of the SEC answer that? It will
tell you it is not clear enough, and we spend a lot of time
here talking about how things could be treated as not
securities. But could it be that somebody wants to create a
token that does represent a security?
Mr. Garrison. Yes, and that does occur today.
Mr. Davidson. Right. So, when you think about the framework
that we are putting together, even if, in the cases, oh, with
the existing law, you could possibly find a way to do it,
couldn't we create a market structure that would be more clear
for everybody? How would you register a token and make it a
security and be fully regulated as a security?
Mr. Garrison. Absolutely. There is nothing preventing the
SEC from updating the regulations to allow for tokenized equity
securities or stock or bonds.
Mr. Davidson. Yes. I would add there is nothing preventing
Congress from doing that either, so one of the things that we
talk about is the importance of self-custody.
Dr. Sirer, some of your observations that you have made
include that privacy is an important protection, but when you
look at the people who looked at FTX, there was clear fraud.
The people who had self-custody used the platform to be able to
conduct a transaction. Then, they offloaded the custody of
that. They were protected. So, could you highlight how
important self-custody is?
Mr. Sirer. Absolutely. The failure of FTX was a failure not
of crypto but of traditional custodians, and the decentralized
exchanges that performed much of the same functionality as FTX
did not fail and in fact survived quite well through market up
and downs.
Mr. Davidson. Thank you. I think it is just incredibly
important that we protect self-custody. The Keep Your Coins Act
does that, and I hope that we can get to that kind of principle
in both the stablecoin bill and the market structure bill.
I want to get to stablecoins, but I think it is important
to address something Mr. Himes said.
Mr. Sexton, the commingling limitations, I don't think he
actually applied correctly, because there are, in current law
due to Dodd-Frank, differences in how we treat futures versus
swaps in terms of funds; you can't commingle with house funds
but you can commingle with the funds of customers. When you
think about legally separate operating commingling frameworks
provided for swaps under Dodd-Frank, would you please explain
how that works?
Mr. Sexton. There are different frameworks with regard to
assets and the protections of those assets with regard to swaps
and the segregation accounts that we have in the futures world.
So, it is very complex. It is pursuant to the CFTC's
regulations, and when you have a customer segregated account on
the futures side, generally, we say that you cannot commingle
the house. But the house could top that off with sufficient
funds to have excess funds in that segregated account also to
make sure that they at all times have sufficient funds to pay
off liabilities to customers.
Mr. Davidson. Yes. That is existing law; it is not like
this is some loophole that creates some exception. It is just
meant to capture the existing law and existing framework.
And as much as I would love to get to the stablecoin market
and the importance of it, I will have to submit some questions
for the record on that.
My time has expired, and I thank you all.
Mr. Hill. The gentleman's time has expired. I appreciate
that.
The gentlewoman from Texas, Ms. Garcia, is now recognized
for 5 minutes.
Ms. Garcia. Thank you, Mr. Chairman, and thanks to all the
witnesses who are here today.
As we all know, then-Chairwoman Waters led meaningful,
productive, and truly bipartisan negotiations on stablecoin
legislation last Congress. I would like to start by
highlighting my frustration with the stripping of some very
important provisions from those earlier negotiations, working
against the bipartisan progress that then-Chairwoman Waters and
other Members of Congress worked on last year.
With that said, I am relieved that some of the more-radical
proposals by my Republican colleagues were not offered and are
no longer in play, and I hope that this hearing can lead to a
productive discussion on this very important issue.
I was just discussing with the ranking member when we all
got started, what, now 3 years ago, maybe 4, that this has been
a long journey, and it is great that we are here today to
hopefully put a ribbon on the whole thing.
Mr. Kaplan, I would like to begin by asking you about an
issue that I have been engaged on for a long time and have some
very strong concerns about. The Democratic compromise draft of
the stablecoin bill includes language preserving the separation
of banking and commerce, which protects from unhealthy
consolidation of economic power.
In simpler terms, it would prohibit non-financial
commercial businesses like Facebook or Wal-Mart from owning a
payment stablecoin issuer, which would ultimately prevent
massive private companies from being able to control even more
of their consumers' lives.
In the 116th Congress, I introduced a bill to address
exactly this problem because I believe that allowing private
companies to be stablecoin issuers is very dangerous. This
protection, however, is notably absent from the bill that the
Republicans are proposing today.
Mr. Kaplan, can you please highlight the kinds of customer
harm that could come from huge companies issuing their own
coins? Why is this separation important?
Mr. Kaplan. The potential for conflicts of interest when a
company has both commercial and financial interests both
offered to the same customers is significant. Furthermore, the
systemic risk and potential contagion risk associated with an
entity that has a stablecoin is significant. The potential
implications of a stablecoin losing its peg could have knock-on
effects and contagion risks that would affect the larger
financial market, and it is essential that we hold those who
are issuing stablecoins to the highest standards and that we
properly segregate those activities from other business
activities.
Ms. Garcia. Thank you.
In carrying on with important provisions that the
Republicans stripped from Chairwoman Waters' version of this
bill, I would like to touch on the importance of diversity and
financial inclusion in the crypto space, which this bill fails
to even mention. This nation has a long history of building
financial institutions and systems that are accessible and
exciting for the wealthy and mostly White consumer, and
inaccessible and exclusionary for everyone else.
This nation continues to deal with credit inequity, lending
inequity, banking inequity, and financial literacy inequity,
and as was clearly pointed out by my colleague and friend from
Houston, there is also witness inequity.
And still, in front of our eyes, it appears that we are
repeating our mistakes of the past and building a financial
system that only makes the rich and privileged richer and more
privileged.
Mr. Kaplan, can you please speak about the importance of
building financial inclusion language into regulatory
legislation?
Mr. Kaplan. It is essential for any industry to make sure
that it is able to be afforded and available to all segments of
society, and as such, it is important that there is diversity
and inclusion.
Ms. Garcia. Can you give us an example of what you think we
need to add to make sure that happens within this legislation?
Mr. Kaplan. I don't have a specific example off the top of
my head. I think that it is essential that there is a mention
such that the policy of diversity and inclusion is made sure to
be understood and integrated into the crypto industry and the
larger financial industry as a whole.
Ms. Garcia. Thank you. How can crypto-based companies work
to better include low-income and minority communities in the
crypto space? How can they best reap the benefits of a
functional, well-regulated crypto industry for which we are all
striving?
Again, Mr. Kaplan?
Mr. Kaplan. What we saw with FTX and the like was that they
used the internet under the guise of innovation in a
speculative new investment instrument in order to basically
allow the general public and certain segments of society on----
Mr. Hill. The gentlewoman's time has expired.
I recommend that the witness expand on his answer in
writing. And I now turn to the gentleman from Tennessee, Mr.
Rose, for 5 minutes.
Mr. Rose. Thank you, Mr. Chairman, and thanks to our
witnesses for taking the time to be with us today.
I want to dive right in. The Democratic talking point that
Chair Gensler's approval of this one Special Purpose Broker-
Dealer license does not mean that the current system is
working. Why? Because an alternative trading system (ATS)
cannot facilitate trading for any unregistered securities not
offered under a valid exemption.
Additionally, Chair Gensler, and the Democrats, and
apparently, Mr. Kaplan, allege that nearly all tokens are
unregistered securities. This approval does nothing for retail
investors and the general public.
Mr. Garrison, isn't it correct that there currently aren't
any registered digital asset securities with real customer
demand and liquidity? For example, can an ATS offer Solana or
Cardano, which the SEC has recently alleged are unregistered
securities, to retail non-accredited investors on its ATS
today?
Mr. Garrison. No, they cannot.
Mr. Rose. And, Mr. Garrison, would the outcome be different
under the market structure legislation that we have coming
forward?
Mr. Garrison. Yes. The legislation would allow an ATS to
list and trade structured digital assets alongside payment
stablecoins, alongside digital commodities. Each of those would
be regulated under different regimes but an ATS regulated by
the SEC would allow all those products to trade.
Mr. Rose. Thank you.
Mr. Garrison, can an ATS currently offer both digital asset
securities and digital asset commodities alongside each other
on the same platform for retail trading?
Mr. Garrison. No, they cannot.
Mr. Rose. And would the outcome be different under the
market structure legislation?
Mr. Garrison. Yes, it would be.
Mr. Rose. Thank you.
Mr. Garrison, Prometheum has been approved to custody
digital assets under a Special Purpose Broker-Dealer framework
that the SEC issued in 2020. Under current law, digital assets
may be classified as securities or commodities.
Can a Special Purpose Broker-Dealer custody both digital
asset securities and digital asset commodities on behalf of
retail investors?
Mr. Garrison. No.
Mr. Rose. Mr. Garrison, given this fact, what impact, if
any, does the SEC's approval of this Special Purpose Broker-
Dealer license have on retail traders?
Mr. Garrison. Not a significant impact.
Mr. Rose. And, Mr. Garrison, the SEC has indicated that
they expect digital assets to be registered by a promoter or,
``a promoter sponsor or other third party,'' that, ``provides
essential managerial efforts that affect the success of the
enterprise.''
The problem is that certain digital assets are open source
peer-to-peer digital currencies that are transferred through a
decentralized public ledger that is maintained by a network of
computers operated by individuals who, apart from possibly
transferring digital assets to one another at some point in
their lives, may never interact.
Take Dogecoin. Mr. Garrison, who exactly is the SEC
expecting would come in and register Dogecoin?
Mr. Garrison. I do not know.
Mr. Rose. Mr. Garrison, in 2021 SEC Chair Gensler said
regarding the regulation of digital assets, ``There are some
gaps in this space. We need additional congressional
authorities to prevent transactions, products, and platforms
from falling between regulatory cracks.''
He now says the securities laws are clear, that he doesn't
need additional authority from Congress.
Mr. Garrison, do you agree with Chair Gensler version one,
whom we might call, ``Dr. Jekyll,'' that he needs more
authority from Congress to regulate crypto?
Or do you agree with Chair Gensler version two, ``Mr.
Hyde,'' that the Federal securities laws are 100 percent clear
and no relief is necessary to regulate digital assets,
securities, and crypto platforms seeking to support them?
Mr. Garrison. I am not sure that I agree with either
version. I believe the SEC has the authority to regulate
digital assets that are sold pursuant to investment contracts
in a clearer way than they have. But I do also disagree that
the securities laws' application to the sale of digital assets
is certainly not clear.
Mr. Rose. And shifting gears, Mr. Allaire, given the
Federal Reserve's incompetence during the most-recent turmoil
in the banking sector, are you confident that they will be able
to regulate stablecoin issuers under this bill?
Mr. Allaire. Thank you for the question, Congressman Rose.
I believe that the bill does a very good job of very clearly
establishing the core standards that are important for a
stablecoin to function, so I believe Congress is doing its job
in identifying that and----
Mr. Hill. The gentleman's time has expired.
Mr. Rose. Thank you. I yield back.
Mr. Hill. The Chair now recognizes the gentleman from New
York, Mr. Torres, for 5 minutes.
Mr. Torres. Thank you, Mr. Chairman.
Before we get to the substantive question of what to do
with crypto, we as a country have to answer a more fundamental
question: Who among us should get to decide the future of
emerging technologies like crypto and blockchain? Should it be
Chair Gary Gensler, an unelected bureaucrat who answers only to
himself, or should it be the United States Congress, whose
Members are elected by and therefore accountable to the people?
Mr. Allaire, do you believe as I do that an Act of Congress
would be the most-democratic means by which to decide the
future of digital assets?
Mr. Allaire. Thank you for the question, Congressman
Torres.
I do agree, and in fact, the Presidential Working Group
specifically asked Congress to act urgently on this matter over
a year-and-a-half ago. So, I believe it is critical that
Congress does take control here.
Mr. Torres. There are crypto companies like Circle that
strive to be compliant with the law, and then there are crypto
companies that seem intent on willfully evading the law. And,
yet, Chair Gensler appears to see no difference at all between
the two. He treats them all as one and the same. His
enforcement has been indiscriminant in nature, which brings me
to the lawsuit against Coinbase.
Mr. Garrison, if the SEC sincerely thought that Coinbase
was operating an unregistered securities exchange, then why on
earth would the SEC approve Coinbase as a public company?
Why would the SEC not, at a minimum, require Coinbase to
disclose its status as an unregistered securities exchange as a
material risk to the investing public? Do you see a
contradiction between the SEC's 2021 approval of Coinbase as a
public company and the 2023 enforcement action against
Coinbase?
Mr. Garrison. I do see a contradiction. As part of the
filing review process, making a filing effective under the
securities rules requires a public interest finding. Typically,
a public interest finding is a very loosely defined term but
you might argue that an act by the company that is inconsistent
with securities laws might be not in the public interest.
Mr. Torres. And I want to interject. The SEC made the
following statement in the Coinbase lawsuit. It said that
declaring effective a Form S-1 registration statement does not
constitute an SEC staff opinion on endorsement of the legality
of an issue as underlying business. When it comes to S-1
registration, the SEC is asserting that it has no opinion on
whether an issuer is complying with the very laws that the SEC
is charged with enforcing.
That strikes me as strange. It is almost as if, suppose the
SEC would approve the Mafia as a public company, and then say,
but we have no opinion on the underlying legality of the
business. As a lay person, that just strikes me as absurd. So,
am I missing something or----
Mr. Garrison. No, I think that is where the public interest
finding comes in, and I think perhaps the other side of that
coin is that----
Mr. Torres. No pun intended, right?
Mr. Garrison. ----you don't want the SEC to take
responsibility for what is in any filing, which is what I think
some of that language is getting at as well.
Mr. Torres. In an interview with New York Magazine, Chair
Gensler said that everything but Bitcoin is a security. Of the
more than 200 listings on the Coinbase exchange, the SEC
lawsuit only identifies 13 as unregistered securities, and 13
out of more than 200 seems to contradict the Gensler doctrine
that everything but Bitcoin is a security.
Do you see a contradiction there?
Mr. Garrison. Yes. It would be nice to have clearer
insights into what tokens, what digital assets the SEC believes
are securities instead of seeing them piecemeal through
enforcement actions.
Mr. Torres. The digital market structure discussion draft
provides for a safe harbor and I see the need for a safe harbor
that protects good-faith crypto companies from arbitrary and
capricious enforcement actions.
But what about bad-faith crypto companies? How do we
prevent bad-faith crypto companies from exploiting the safe
harbor to prevent legitimate enforcement actions?
Mr. Garrison. Included in the market structure bill are the
typical anti-fraud protections that exist in both the
securities and commodities laws. So whether a digital asset is
sold through the new SEC exemption, the SEC's robust anti-fraud
authority would also apply there, and on the CFTC side, if a
digital commodity was sold or manipulated in a fraudulent way,
the anti-fraud provisions of the Commodity Exchange Act would
apply as well.
Mr. Torres. And then, a quick question about the
applicability of securities law to secondary market
transactions. Has there ever been a single statute or a single
rule or regulation or a single court case that expressly
affirms that the Howey Test applies to secondary market
transactions?
Mr. Garrison. No.
Mr. Torres. Are you sure?
Mr. Garrison. To the best of my knowledge, yes.
Mr. Torres. Are you positive?
Okay. My time has expired.
Mr. Hill. The gentleman's time has expired. As you can see,
there is a vote on the House Floor. It is the Chair's intention
to continue until there are approximately 200 on the non-voting
screen. We will then recess and reconvene immediately after
votes.
I now recognize the gentleman from South Carolina, Mr.
Timmons, for 5 minutes.
Mr. Timmons. Thank you, Mr. Chairman.
Mr. Garrison, getting back to the exemption that
Congresswoman Wagner covered earlier, the new exemption in the
bill allows participation of non-accredited investors in
primary issuances of digital assets.
You started talking about the protections that the market
structure bill provides for retail investors in primary
offerings. The exemption as I read it provides that a non-
accredited investor is permitted over a 12-month period to
purchase digital assets issued in a primary sale that equal 5
percent of the person's net worth or 5 percent of their annual
income. Rough math--for a person with $990,000 of net worth or
$190,000 in annual income would be $49,000 or $9,500 of annual
investment, depending which is greater.
My question is, in your view, is the exemption as laid out
in the discussion draft a good balance of retail investor
access to this new asset class and traditional consumer
protections?
Mr. Garrison. I believe it is a good balance. Personally, I
am opposed to individual limitations on investments generally,
but I recognize that reasonable people can disagree on that,
and I think this approach in the market structure bill really
borrows from Regulation Crowdfunding, which has these
individual investor limits, as does Regulation A, and I think
that has proven to be a protection that can be valuable in
these exemptions.
Mr. Timmons. Thank you for that. A common way for a project
to distribute digital assets to its users is through broad
distributions in order to support the development of its
network.
Mr. Garrison, again, how does this proposed legislation
treat digital assets distributed in this manner and why does
this treatment more accurately correspond to how the digital
asset markets operate?
Mr. Garrison. Sure. The market structure bill acknowledges
that some digital assets are created through the normal
functioning of the network itself, whether that is through a
validating transaction or staking or anything like that, and it
just makes clear that the securities laws are not needed to
protect those activities. Those activities are separate. They
are not securities transactions. And it more clearly separates
the transactions that are in need of consumer investor
protections from those that are not in need.
Mr. Timmons. Thank you for that.
Mr. Garrison, again, in the proposed legislation there are
tests for decentralization in functionality of the blockchain
network. Would you share your views on this construct in the
legislation?
Mr. Garrison. Yes. I think this is a really great first
effort in trying to put a construct around how decentralization
can occur. It is an issue that has really been difficult for
those in the industry to come to terms with because there are
no third-party standards that we can look at to say, this is
how networks are decentralized.
For example, when I worked for SEC Commissioner Peirce, and
she created her token safe harbor proposals, there were a lot
of ideas in there of, how do you show decentralization, and a
lot of different ideas came to the foreground. Some of them
include looking at the ownership of the tokens of the network,
are they concentrated in any one particular group or not?
Another is just the functionality of the network, who is
contributing to the code. I think in the early days of a lot of
networks, you see some key contributors that are responsible or
perhaps have a key they can write and change code as needed on
an emergency basis.
Over time, those things typically go away. Those are good
indicators of decentralization. What is the number of
participants in the network, both end users of validators,
miners, whatever the protocol may be?
There are a lot of different factors you can consider, and
I think this bill does a good job of really drilling down and
saying, what are the key ones that matter, and it really keeps
coming back to this idea of unilateral control: Does a person
or a group of persons have control over this network.
Mr. Timmons. Thank you. One last question, Mr. Garrison.
Some have alleged that the proposed legislation creates light
touch regulation for digital assets. However, the bill seeks to
apply the same rules for current SEC- and CFTC-registered
intermediaries with adjustments as needed for the unique
characteristics of digital assets.
In some instances, the requirements of digital asset firms
are more onerous than traditional intermediaries. Would you
discuss how the bill applies equal or stronger standards to
digital asset firms?
Mr. Garrison. The bill brings digital assets into the SEC-
and CFTC-regulated universes. Currently, digital asset
transactions are not covered here, so the SEC would oversee the
initial issuance in certain situations through the new
exemption, and the SEC would also oversee normal securities
trade through ATSs. So, all of the protections from an ATS
would also apply here.
Mr. Timmons. Thank you for that. Mr. Chairman, I yield
back.
Mr. Hill. The gentleman yields back.
It is a pleasure to recognize the gentleman from Illinois,
Dr. Foster, for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman, and thank you to our
witnesses.
I would like to start with what I consider the two
foundational questions in this that are not, I don't believe,
really addressed in this draft.
The first one is to answer the simple question, if we wish
to prevent ransomware and all kinds of illicit activities, is
there any way to do that if we allow self-custody of assets or
is it pretty much a binary thing? Either we are going to allow
self-custody and live in a world with ransomware and so on or
not. Is there any alternative to that third path?
Mr. Sirer. Congressman, it is entirely possible to control
these systems at the ingress and egress points. So, it is
entirely possible to preserve self-custody and all the benefits
that come with it.
Mr. Foster. But how does that work actually? If you go and
take your dollars and you put them into the systems you are
developing, then they go off and become self-custody. They are
used for human trafficking or you name it, ransomware, you name
it, and then someone comes back after having passed this
through anonymous currencies that are better than Bitcoin for
avoiding truly anonymous alternatives that are being developed
and actually exist to some degree today, and then they pass it
through these anonymizing techniques, and then they present
something that has been self-custodied to your system.
It seems like you are just the last leg in a complicated
money laundering scheme, and tell me why that is not really
technically the case?
Mr. Sirer. That is technically not the case because the
sets of tools we have for tracking and tracing money flows are
incredibly sophisticated. Chainalysis and TRM Labs-type
companies are quite able to trace even those anonymizing
transactions and trace the flow of funds. If you look at the
recoveries that law enforcement has done in recent years with
the aid of these increasing----
Mr. Foster. Yes, but those are Bitcoin-type things that
they are tracking. And you rapidly get into declassified
discussions in briefings that I have had on this.
But a bunch of smart people are working very hard and
effectively to really make these anonymous. I think they are
more likely to succeed than the mouse is likely to not survive
the cat in this case. And I don't think that today, you can
guarantee that won't be the case, so I think that's the first
thing, and we should continue this technical discussion
offline.
The second thing is that if we wish to prevent market
abuses, things like front-running or wash trades, there are
estimates that more than half of all Bitcoin transactions are
actually wash trades, for example.
If we wish to prevent that, is there any alternative to
having some regulator somewhere that sees the true identity
behind the participants on both sides of every trade? How do
you prevent wash trades if there is not such a regulator
somewhere?
Mr. Sexton, how this has been handled with the Trader ID
mechanism and the like?
Mr. Sexton. It has, and it is key that if you are going to
prevent those types of trading abuses, you have to know who is
on both sides of a trade.
Mr. Foster. A trusted regulator must know, must be able to
see who is on both sides of the trade?
Mr. Sexton. Correct.
Mr. Foster. Right. The traders don't need to know who is on
the other side. In fact, it is not good for them to know who is
on the other side in the typical instance.
But when you see something that looks abusive, you have to
go and, first off, know who the people are, and you also have
to make sure that the Trader ID is, for example, biometrically,
so you don't have one person operating multiple Trader IDs.
That is a major no-no in your industry.
Mr. Sexton. If you bring this into a regulated environment
under the National Futures Association (NFA) and the CFTC
intermediaries need to know who their customers are, and if you
have exchanges or trading platforms, they need to know who is
going to be on the opposite side of those trades. That is the
bedrock of the regulated environment that we have today under
the CFTC.
Mr. Foster. Yes. But if you have, for example, the ability
to make derivative bets and have a spot market over here, a
regulator has to see the True IDs of both the spot market
participants and everyone who is making derivative bets on the
basis of those spot prices. It seems as though this is
something that spans the current jurisdictions of the SEC and
the CFTC.
Mr. Sexton. You have to have cooperation between regulators
so that they know what a market user is doing in both the spot
markets and in the futures markets.
Mr. Foster. Right, and this actually has to work
internationally if you are talking about crypto assets that are
traded internationally as well. So, it is an even more
complicated thing. You have some sort of solution
internationally in the options market.
Mr. Sexton. International cooperation is also essential.
Mr. Steil. [presiding]. The gentleman's time has expired.
The witness can provide additional comments in writing for the
record. I now recognize myself for 5 minutes for questions.
Mr. Garrison, I want to follow up on Congressman Emmer's
comments earlier. According to SEC Commissioner Hester Peirce,
a digital asset may be offered and sold initially as a security
because it is wrapped in a transaction involving an investment
contract. But the asset may later be emphasized and sold
outside of an investment contract.
I think a key point is to think about how our legislation
should categorize different types of digital assets regardless
of their classification when first issued.
Can you elaborate on this principle and then comment on how
the proposed legislation addresses this?
Mr. Garrison. A digital asset, when it is sold pursuant to
an investment contract, does not constitute the security. Under
the Howey Test and 77 years of case law, courts have come up
with an analysis to determine when a transaction contract or
scheme may be sold in a manner that is, in fact, a securities
transaction.
This is very different than the test for what is an equity
security, what is a stock, what is a bond, and the case law
makes it quite clear that the object of the investment
contract, whether it be the orange groves in the original Howey
case or there are some fun exotic cases about chinchillas and
whiskey receipts.
The chinchillas themselves are not securities, so in
applying that logic to the digital asset space, the distinction
becomes even more important as one learns more about digital
assets and understands why one holds a digital asset to operate
or to function and participate on a network, and once those
functionalities are realized for the digital asset, you start
to realize that there is no actual central party that maybe was
making promises at the time of the initial sale for fundraising
but later in time a fully decentralized functioning network.
There is no central party. There is no one that would be
the equivalent of an issuer in a securities offering.
Mr. Steil. Thank you for providing that distinction. Let me
shift gears to you, if I can, Mr. Kaplan. There is a little bit
of confusion around the circumstances and disclosures
associated with Prometheum, their filings for the alternative
trading system and Special Purpose Broker-Dealers.
In your testimony, you noted that you terminated all co-
development work and strategic relationships with your Chinese
affiliate in late 2021. When did Prometheum take full control
of the product development?
Mr. Kaplan. Prometheum realized that its endeavors with
Wanxiang were not going to bear fruit, and that, in conjunction
with the ongoing decoupling that was occurring in the larger
geopolitical sphere, led to the decision to terminate that
relationship. I believe the termination agreement is October
2021.
Mr. Steil. October 2021. Thank you.
Did the SEC or FINRA at any point raise a concern about the
relationship between Prometheum and the Chinese firm?
Mr. Kaplan. We had both a CFIUS inquiry and an SEC
investigation where we were required to submit all
communications with any foreign entity for review to the SEC,
and basically, we were told that after a period of time, the
SEC closed the investigation.
Mr. Steil. Thank you.
Has Prometheum ever had to adjust its policies and
procedures at the request of HashKey or representatives of the
Chinese government?
Mr. Kaplan. No.
Mr. Steil. Okay. I appreciate your testimony there. I want
to just echo the concerns raised by some of my colleagues. Our
regulators have done everything in their power to push digital
asset business overseas. They seem to be quite comfortable
giving a stamp of approval to a firm with the relationships
back to China.
To me, this underscores the need for clarity and consistent
regulation in the industry structure. Cognizant of my time, I
am going to come back to you if I can, Mr. Garrison, just for a
second.
Mr. Rose brought this up a little bit, but I think it is
worth hitting the point home before we go into recess. There
has been some hyperbole in particular about how the bill is
described. Do the modifications upend securities law, as some
have suggested?
Mr. Garrison. No, it does not. It borrows from existing
provisions and securities laws.
Mr. Steil. Okay. And I have 40 seconds, so I am going to
jump back to Mr. Allaire.
Stablecoin legislation attached to this gives the Fed a
backstop authority over State-chartered payment stablecoin
issuers. Can you describe why the backstop is important and
what the Fed can and can't do with it?
Mr. Allaire. Thank you for the question, Congressman Steil.
I think it is critical. I think the first is really the
fundamental standards around what can be in reserves, the
reporting and disclosure requirements, the need to separate
these assets. Those are part of that kind of Federal framework.
Additionally, setting standards under Section 4 around
capital adequacy, risk management, safety and soundness, and
others they can, obviously, also enforce against those.
Mr. Steil. Thank you.
Cognizant of the time, and cognizant that we are now under
200 votes, pursuant to the Chair's previous announcement, the
committee will stand in recess until the conclusion of votes.
[recess]
Mr. Flood. [presiding]. The committee will come to order.
The Chair now recognizes Mr. Nickel for 5 minutes.
Mr. Nickel. Thank you so much to our chairman and ranking
member. Thank you so much, Congressman Flood, as well, for
being here today, and thank you to our witnesses. I know it has
been quite a long day, so thanks for joining us.
I am happy with the progress our committee is making on
stablecoin legislation. The most recent draft includes many of
my suggestions like protecting State regulators, adding
consumer protections, and ensuring banks can safely hold
digital assets in their custody.
I hope that we can all come together and put politics aside
and reach bipartisan agreement on this legislation. Not only is
passing a stablecoin bill essential to protecting consumers and
encouraging innovation, but it is also vital to providing much-
needed regulatory clarity.
The SEC's regulation by enforcement, which we have seen
ramp up in the last week, is going to send digital asset
companies offshore to places like the Bahamas, where Americans
will have no protections. Additionally, as I have said before,
stablecoin legislation can reinforce the dominance of the U.S.
dollar as the global reserve currency, all while making it
stronger, more accessible, and more competitive.
Mr. Allaire, my first question to you. Can you please
describe the privilege the U.S. is afforded because the dollar
is the dominant global reserve currency?
Mr. Allaire. Thank you for the question, Congressman
Nickel. As is often referenced, the dollar presents the United
States with an exorbitant privilege, and that is in many forms,
I think that privilege is around low borrowing costs for the
government, for households, and for businesses. I think strong
preference in commerce and trade internationally helps grow
opportunities for people and businesses here, as well as the
execution of soft power around the world. And in an environment
today, where that is being challenged, it is more important
than ever that the U.S. make every effort to strengthen dollar
competitiveness, and I would agree with you that the stablecoin
bill is a significant step towards increasing dollar
competitiveness.
Mr. Nickel. Thanks so much. And in your testimony you said,
``Currency competition is real and is increasingly defined by
technological competition. Perhaps, no nation understands this
better than China.''
Mr. Allaire, as we are designing stablecoin legislation,
how should we think about currency competition? Would the most-
recent draft of the stablecoin bill ensure that the U.S. dollar
remains competitive, safe, and accessible?
Mr. Allaire. I think it would be a huge step forward in
that. The United States competes with highly competitive
technology companies, financial companies, and open, free, and
fair markets in a rules-based system. That has served us
incredibly well in the development of the internet. It has
served us incredibly well in the realm of payment technology
innovation. And I think for an innovation like stablecoins, it
can also be the leader globally.
Critically, stablecoin legislation, as currently submitted
to the committee, does, in fact, create, I believe, the safest
digital dollar in the world. It creates a mechanism to ensure
that there is a competitive market for the issuance of that by
banks and nonbanks, and that those firms can compete in that
technological competition with constantly-upgradeable
blockchain infrastructure and be competing with state-driven
actors such as China.
Mr. Nickel. Thanks so much.
Mr. Garrison, moving on to you, I would like to talk about
the Majority's market structure bill, which I am still
reviewing. I am encouraged to see that we are making progress,
but I do have some concerns with this current version of the
bill, which I understand is just a starting point. Whether you
love crypto or hate crypto, you should support market structure
legislation. It is what safeguards consumers while updating our
securities laws to work with modern technological innovations.
And frankly, burying our heads in the sand just is not an
option here.
Mr. Garrison, can you please explain the dangers of
congressional inaction on digital asset market structure?
Specifically, how would consumers be harmed without clear
regulations that encourage companies to remain here in the
United States?
Mr. Garrison. If the status quo were to continue, I think
it would harm investors and consumers, it harms the
participants in the digital asset ecosystem, and it ends up
harming the U.S. economy. There is a lack of a Federal
regulator over the spot markets for digital assets right now,
as we speak, so anyone trading on a digital asset platform in
the U.S. is at the mercy of the platform's own controls and
procedures and processes and compliance with other laws----
Mr. Flood. The gentleman's time has expired.
Mr. Nickel. I yield back.
Mr. Flood. Thank you, Mr. Nickel.
I now recognize myself for 5 minutes.
I would like to start by reading a question from a comment
letter that Prometheum sent in response to the SEC's December
2020 Special Broker-Dealer Framework: ``The definition of a
digital asset security, as used in the proposal, is a digital
asset that meets the definition of a security under the Federal
securities laws. This definition puts a burden on the industry
to determine which digital assets are securities. As a result,
we believe that clarity is needed to understand the regulatory
framework they must comply with.''
That was in a letter dated April 26th, from Prometheum,
specifically signed by Benjamin S. Kaplan, co-CEO of the
company. I offer this into the record, without objection.
[This letter can be found as an appendix to the written
testimony of Mr. Aaron Kaplan, on page 00 of the appendix.]
This concern, which Prometheum themselves raised in 2020,
probably sounds familiar for those who track this committee
closely. It is the exact same concern we have heard from
witnesses in front of this committee before. Can a broker-
dealer register if they do not know which assets are a security
and which are not? Further, it makes the same argument that
other firms have made, that the lack of clarity from the SEC
puts an undue burden on the industry.
Mr. Kaplan, in your testimony you were very confident that
no new legislation is needed in the digital asset space to
clarify this question. What has changed between the date of
this letter, in 2021, when your firm called for clarity, and
now? What has changed?
Mr. Kaplan. Over the 2-plus years since that time, there
have been additional enforcement actions and statement by the
SEC, which have clarified any questions that we had in regard
to the designation of a digital asset as a security.
Mr. Flood. Mr. Kaplan, Prometheum's website says that
Prometheum's ATS supports, ``many tokens that mostly trade on
crypto exchanges.'' I would like to dig in on that just a
little bit. Can Prometheum customers trade in Ether? If your
answer is yes, please explain how?
Mr. Kaplan. Not currently.
Mr. Flood. Can Prometheum customers trade in Bitcoin? And
if your answer is yes, please explain how.
Mr. Kaplan. No.
Mr. Flood. Just for the audience at home's benefit, Ether
and Bitcoin make up more than 60 percent of the digital asset
market.
Mr. Kaplan, given that Ether and Bitcoin make up more than
60 percent of the digital asset market, if the current system
is working, why can't your customers trade the most-popular and
widely-used digital assets?
Mr. Kaplan. Regulation and new ATSs and custodians should
take a, ``crawl, walk, run,'' approach, and essentially they
will proceed to add additional assets and abilities as time
goes on. I would like to point out when the----
Mr. Flood. I am going to reclaim my time. Mr. Kaplan, did
Prometheum receive any additional exemptive relief from the SEC
that has not been publicly shared?
Mr. Kaplan. No.
Mr. Flood. Thank you, Mr. Kaplan.
Prometheum's Special Purpose Broker-Dealer license does not
address the core issue. There is not a consistent definition of
a digital asset security within current law. This point was
made obvious when Chair Gensler could not say definitively
whether Ether is a digital asset security, when asked by
Chairman McHenry in this very room a couple of months ago. In
other words, that same question that Prometheum themselves
raised in their 2021 comment letter is still unanswered. That
is why legislation is needed. That is the problem that the
chairman's bill works to solve.
To testify in front of our committee that your company's
charter, which only allows for trading in a very small subset
of assets, is evidence that no legislation is needed just does
not make sense. If anything, the fact that Prometheum's
customers cannot trade some of the most-popular digital assets
is an illustration of the broader problem, Mr. Kaplan.
I yield back.
With that, the gentleman from Iowa, Mr. Nunn, is recognized
for 5 minutes.
Mr. Nunn. Thank you, Mr. Chairman, and I think we are well
said on the rule of having clarity in this space, which is what
Chairman McHenry is aiming to do.
I want to thank the Chair for the comments here. I sit on a
second committee, the House Agriculture Committee, and it also
has oversight of digital assets. I had the pleasure of talking
with CFTC Chair Benham about his thoughts on market structure
and what we are discussing today. His thoughts on this
legislation were that a much-needed change was in order to give
clarity to the digital asset ecosystem.
Right before CFTC Chairman Benham testified, however, we
saw his counterpart, SEC Chair Gary Gensler, charge Coinbase
with listing digital tokens he deemed to be securities. Chair
Gensler went so far as to say that, ``We do not need more
digital currency. We already have digital currency. It is
called the U.S. dollar. It is called the euro. It is called the
yuan.''
Let's make one thing very clear, that the rest of the world
is already attuned to: Chair Gensler's blockchain innovation
and technology is here to stay. It is thriving, and the U.S.
market needs to be able to appreciate it. This lack of
consensus among our Federal regulators, however, on the
appropriate regulatory treatment of digital assets is what we
need to discover and why we are here today.
The inconsistent treatment by Federal regulators
underscores the urgent need for Congress to pave clear rules of
the road for both market participants and investors. If
Congress does not act, and lets Federal agencies continue to
engage in territorial disputes and empire building, this will
have a grave national impact, both on our trade as well as our
national security.
From this sentiment, Europe, the UK, and Singapore have all
marched out as leaders in this space. They have worked
effectively within their jurisdiction. In fact, the Markets in
Crypto-Assets Regulation (MiCA) is real. Venture capital
investment in Europe in crypto projects is up to 1,000 percent
in 1 year alone, investments that could have been happening in
U.S. markets. To my home State of Iowa, these represent real
tangibles. They are American jobs. They are future investment.
To America, it means innovation that is fleeing offshore. That
is why this legislation that the chairman has brought forward,
I believe, is highly important.
Mr. Garrison, your former boss, SEC Commissioner Hester
Peirce, explained how a digital asset may be offered as a sold
initial security based on the initial transactions offered in,
but the digital asset may later be offered outside this
investment contract. You spoke with my colleague here earlier
today. Highlight specifically how this proposed legislation
would address that?
Mr. Garrison. The market structure bill would address that
by providing a clear exemption for issuers that would like to
sell a digital asset pursuant to an investment contract. So if
you want to build a network and sell the digital asset that is
required for the network, this bill would allow an exempt
transaction for up to $75 million within a 12-month period. It
would allow for individual investment limitations for non-
accredited investors to purchase them. There would be robust
disclosure requirements. The disclosure requirements would be
tailored to the needs of token purchasers of digital asset
purchasers. And it would place restrictions around activities
that people want to engage in, in the U.S., but currently
cannot.
Mr. Nunn. This would provide a clear framework. Absent this
legislation, we would be like Coinbase, and have to come to
Chairman Gensler on a, ``come and register,'' approach, meaning
that everyone would have no clear guidance but would have to go
and have a sniff test done by the SEC, which at this point has
been only punishing--no carrot, no incentive, no guidance. Is
that correct?
Mr. Garrison. Yes.
Mr. Nunn. Mr. Sexton, the proposed legislation that we have
been discussing imposes significant consumer protections,
requirements that all digital commodities intermediaries
register with the CFTC would have to be met, most notably, the
segregation of customer assets. What are your thoughts on
customer protections provided for in this legislation?
Mr. Sexton. Thank you for your question. The customer
protections provided in this proposed legislation mirror the
customer protections that have been in place for years with
regard to the regulated futured markets. Customer assets,
capital disclosures, Congressman, you can go down the list
within the bill, but those have been in place for years.
Mr. Nunn. Would the NFA have the ability to implement these
new standards for the CFTC?
Mr. Sexton. We totally have that ability to work the CFTC
to do so.
Mr. Nunn. So for the consumer, for the process, for the
providers, and for the national security of the United States,
this legislation makes very good sense.
Mr. Flood. The gentleman's time has expired.
Mr. Nunn. Mr. Chairman, I yield back.
Mr. Flood. The gentleman yields back.
The gentleman from South Carolina, Mr. Norman, is now
recognized for 5 minutes.
Mr. Norman. I thank each of you for your testimony and for
a long day, so I will be brief.
Mr. Kaplan, in your testimony you state that, ``Prometheum
provides Americans participating in the crypto Web3 space with
the investor protections of the Federal securities laws.'' What
assets do you plan to offer?
Mr. Kaplan. Digital asset securities.
Mr. Norman. But you have a limited offering on that, do you
not?
Mr. Kaplan. I believe that a certain number of the top
tokens qualify as digital asset securities.
Mr. Norman. What percentage?
Mr. Kaplan. Thirty? Forty?
Mr. Norman. Which would be----
Mr. Kaplan. Possibly a lot more. And as Chairman Gensler
has said, the overwhelming majority of digital assets, arguably
everything besides Bitcoin, is potentially a security.
Mr. Norman. But you would have a pick of 60 percent that
would be not regulated under the----
Mr. Kaplan. Those numbers are guesses, at best. I would
have to look into it more deeply. It is my belief that almost
every smart contract-based network token was issued with the
intention to raise capital from the general public, with the
intention of the investor to make money in the common
enterprise from the efforts of that common enterprise.
Mr. Norman. I get that. I guess I just--your claims that
you are providing investor protections really would not be all-
inclusive, at all.
Now with your company, what bothers me about Prometheum is
the Chinese 25-percent ownership. I think I heard when you were
questioned by another Congressman that there is no Chinese
investor with 25 percent that sits on your board. Is that
right?
Mr. Kaplan. There is no Chinese investor in our company
that has 25 percent, sir. I said, 20 percent.
Mr. Norman. So, they have 20 percent.
Mr. Kaplan. Correct.
Mr. Norman. Currently?
Mr. Kaplan. Correct.
Mr. Norman. Is that not a problem for this country to open
up the type of information that you would be giving? It shocked
me that FINRA and the SEC approved this.
Mr. Kaplan. Prometheum went through a series of SEC
inquiries and CFIUS investigations. We changed our bylaws. We
terminated any agreement. There is no code, nothing done from
China that is involved in Prometheum in any capacity.
Mr. Norman. But they sit on your board, with a vote, that
owns 20 percent.
Mr. Kaplan. Sir, I believe there are many Chinese who sit
on boards of certain companies in America.
Mr. Norman. I am talking about Prometheum, that just got
approval from the SEC and from FINRA.
Mr. Kaplan. And there was a full examination by CFIUS into
our interactions, plus the SEC. We had to send all
communications in to any foreign investor. Essentially, they
examined everything we had previously done, and based on their
examination, they thought it was okay. They closed that
investigation.
Mr. Norman. Okay. Well, I doubt your claim is true. That
would not qualify for protection from the Federal securities
law that you are offering, with this type of an investment
group.
Mr. Garrison, you are, I think, an SEC alum?
Mr. Garrison. Yes.
Mr. Norman. Are you aware of the bicameral bill that
Senator Tillis has, and I think it is Senator Gillibrand, that
prohibits Chinese entities from acquiring U.S. digital asset
companies? You worked at the SEC. What is your opinion of this
bill?
Mr. Garrison. I am not familiar with that exact bill.
Mr. Norman. It stops Chinese companies from investing in
Prometheum.
Mr. Garrison. I believe the national security concerns
should be taken into account in any digital asset legislation
and regulation.
Mr. Norman. Do you agree with the bill or not? Is that
something you would----
Mr. Garrison. Yes, in general broad terms. Again, I have
not read the bill. But yes, that is----
Mr. Norman. Okay. It just prohibits Chinese----
My time is about up, but if we do not realize now what
China is doing to this country, and the information that is
divulged, being on a board of the size of this company and the
private information, for a company that is pretty much
overtaking this country, or attempting to, I think it is a sad
day in this country that this is what is happening. And the
protections are not there, and you basically know it.
I yield back.
Mr. Flood. I would like to thank all of our witnesses for
being here and for their testimony today.
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.
I will ask our witnesses to respond no later than July 10,
2023.
This hearing is adjourned.
[Whereas, at 6:46 p.m., the hearing was adjourned.]
A P P E N D I X
June 13, 2023
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