[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
THE FUTURE OF DIGITAL ASSETS:
IDENTIFYING THE REGULATORY GAPS IN
SPOT MARKET REGULATION
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON COMMODITY MARKETS, DIGITAL ASSETS, AND RURAL
DEVELOPMENT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
__________
APRIL 27, 2023
__________
Serial No. 118-9
__________
Part 1
__________
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Printed for the use of the Committee on Agriculture
agriculture.house.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
53-323 PDF WASHINGTON : 2023
COMMITTEE ON AGRICULTURE
GLENN THOMPSON, Pennsylvania, Chairman
FRANK D. LUCAS, Oklahoma DAVID SCOTT, Georgia, Ranking
AUSTIN SCOTT, Georgia, Vice Minority Member
Chairman JIM COSTA, California
ERIC A. ``RICK'' CRAWFORD, Arkansas JAMES P. McGOVERN, Massachusetts
SCOTT DesJARLAIS, Tennessee ALMA S. ADAMS, North Carolina
DOUG LaMALFA, California ABIGAIL DAVIS SPANBERGER, Virginia
DAVID ROUZER, North Carolina JAHANA HAYES, Connecticut
TRENT KELLY, Mississippi SHONTEL M. BROWN, Ohio
DON BACON, Nebraska SHARICE DAVIDS, Kansas
MIKE BOST, Illinois ELISSA SLOTKIN, Michigan
DUSTY JOHNSON, South Dakota YADIRA CARAVEO, Colorado
JAMES R. BAIRD, Indiana ANDREA SALINAS, Oregon
TRACEY MANN, Kansas MARIE GLUESENKAMP PEREZ,
RANDY FEENSTRA, Iowa Washington
MARY E. MILLER, Illinois DONALD G. DAVIS, North Carolina,
BARRY MOORE, Alabama Vice Ranking Minority Member
KAT CAMMACK, Florida JILL N. TOKUDA, Hawaii
BRAD FINSTAD, Minnesota NIKKI BUDZINSKI, Illinois
JOHN W. ROSE, Tennessee ERIC SORENSEN, Illinois
RONNY JACKSON, Texas GABE VASQUEZ, New Mexico
MARCUS J. MOLINARO, New York JASMINE CROCKETT, Texas
MONICA De La CRUZ, Texas JONATHAN L. JACKSON, Illinois
NICHOLAS A. LANGWORTHY, New York GREG CASAR, Texas
JOHN S. DUARTE, California CHELLIE PINGREE, Maine
ZACHARY NUNN, Iowa SALUD O. CARBAJAL, California
MARK ALFORD, Missouri ANGIE CRAIG, Minnesota
DERRICK VAN ORDEN, Wisconsin DARREN SOTO, Florida
LORI CHAVEZ-DeREMER, Oregon SANFORD D. BISHOP, Jr., Georgia
MAX L. MILLER, Ohio
______
Parish Braden, Staff Director
Anne Simmons, Minority Staff Director
______
Subcommittee on Commodity Markets, Digital Assets, and Rural
Development
DUSTY JOHNSON, South Dakota, Chairman
FRANK D. LUCAS, Oklahoma YADIRA CARAVEO, Colorado, Ranking
AUSTIN SCOTT, Georgia Minority Member
DAVID ROUZER, North Carolina DONALD G. DAVIS, North Carolina
DON BACON, Nebraska JIM COSTA, California
TRACEY MANN, Kansas ANDREA SALINAS, Oregon
JOHN W. ROSE, Tennessee MARIE GLUESENKAMP PEREZ,
MARCUS J. MOLINARO, New York Washington
NICHOLAS A. LANGWORTHY, New York NIKKI BUDZINSKI, Illinois
ZACHARY NUNN, Iowa JONATHAN L. JACKSON, Illinois
LORI CHAVEZ-DeREMER, Oregon GREG CASAR, Texas
MAX L. MILLER, Ohio ANGIE CRAIG, Minnesota
JASMINE CROCKETT, Texas
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(ii)
C O N T E N T S
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Page
Caraveo, Hon. Yadira, a Representative in Congress from Colorado,
opening statement.............................................. 3
Johnson, Hon. Dusty, a Representative in Congress from South
Dakota, opening statement...................................... 1
Prepared statement........................................... 2
Thompson, Hon. Glenn a Representative in Congress from
Pennsylvania, opening statement................................ 41
Prepared statement........................................... 4
Witnesses
Davis, J.D., Daniel J., Partner and Co-Chair, Financial Markets
and Regulation, Katten Muchin Rosenman LLP, Washington, D.C.... 5
Prepared statement........................................... 7
Maniar, J.D., Purvi R., Deputy General Counsel, FalconX Holdings
Ltd., San Mateo, CA............................................ 12
Prepared statement........................................... 13
Rubin, Nilmini, Chief of Staff and Head of Global Policy, Hedera
Hashgraph, LLC, Chevy Chase, MD................................ 16
Prepared statement........................................... 18
Massad, J.D., Hon. Timothy G., Research Fellow, Mossavar-Rahmani
Center for Business and Government, Kennedy School of
Government, Harvard University; Director, M-RCBG Digital Assets
Policy Project, Washington, D.C................................ 22
Prepared statement........................................... 23
Hall, J.D., Joseph A., Partner, Davis Polk & Wardwell LLP, New
York, NY....................................................... 31
Prepared statement........................................... 32
THE FUTURE OF DIGITAL ASSETS:
IDENTIFYING THE REGULATORY GAPS IN
SPOT MARKET REGULATION
----------
THURSDAY, APRIL 27, 2023
House of Representatives,
Subcommittee on Commodity Markets, Digital Assets, and
Rural Development,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 2:00 p.m., in
Room 1300 of the Longworth House Office Building, Hon. Dusty
Johnson [Chairman of the Subcommittee] presiding.
Members present: Johnson, Rouzer, Bacon, Mann, Rose,
Molinaro, Langworthy, Nunn, Thompson (ex officio), Caraveo,
Davis of North Carolina, Salinas, Budzinski, Jackson of
Illinois, and Craig.
Staff present: Paul Balzano, Caleb Crosswhite, Nick
Rockwell, Kevin Webb, John Konya, Emily German, Josh Lobert,
Ashley Smith, and Dana Sandman.
OPENING STATEMENT OF HON. DUSTY JOHNSON, A REPRESENTATIVE IN
CONGRESS FROM SOUTH DAKOTA
The Chairman. Well, we have an august panel of experts, so
we best start on time. I want to thank everybody for coming to
this hearing of the Subcommittee on Commodity Markets, Digital
Assets, and Rural Development. It has the rather clunky
abbreviation of CMDARD. Staff were instructed to find something
better, but I guess that is the best that we could do. So be
it.
We do have a lot of work to dig into this year, and I am
excited to get started. Of course, today's hearing is on
digital assets, but it is hardly the only thing that we are
collectively going to be working on together. I mean, clearly
rural development is going to be really important, particularly
in light of that title of the farm bill. We also have the
Commodity Futures Trading Commission, which is going to be
important, particularly given the fact that we have had both
the Chairman and the Ranking Member commit to doing
reauthorization of the CFTC this year. And I look forward to
working with Ranking Member Caraveo and others on the Committee
on that work.
But today, we are tasked with examining digital asset
markets and I think, most importantly, understanding what are
the gaps in this regulatory framework and how are those gaps
harming innovators and consumers alike. And as I mentioned, we
have an august panel to help walk us through that.
I think it would be an unfortunate deficiency if we didn't
take a moment to call out the nearly unprecedented level of
cooperation and collaboration that we have had with the House
Financial Services Committee. This is a town where people very
much like to fight over turf and where egos can sometimes get
in the way of progress, but that group is convening at this
exact same moment a complementary hearing dealing with the same
general topic: What are the gaps in the regulatory framework,
and how can we work together to address them? And in fact, next
month, the collaboration gets even closer insofar as we have a
joint hearing to examine these issues together, and those are
not typical in this town. And that cooperation is a testament
to the importance that both Chairman McHenry and Chairman
Thompson, as well as the teams on both sides of the aisle have
had to getting things done on digital assets this Congress.
A lot of ink has been spilled on digital assets, a lot of
it breathlessly positive, a lot of it angrily negative. I think
reasonable people understand that digital assets and the
underlying blockchains can bring a tremendous amount of
opportunity. They can also be filled with a fair amount of
hype. And we know that in this marketplace, as in every
marketplace, there are fraudsters and hucksters that seek to
make money while, unfortunately, giving the whole industry a
bad name. And the hits and misses are well-known to all of us.
You have hits like Ethereum, Hedera, Filecoin, and then you
have outfits like BananaCoin, KodakCoin, and MoonCoin. So those
are the highs and the lows.
The difficult task we are starting today--and we are really
not starting it. I know there have been lots of informal
conversations over the course of months and even some work done
in the last Congress. But the work that we begin anew today is
to craft a legislative framework that will allow the next
Ethereum or Filecoin to emerge, while at the same time
protecting the public from the hype, the scams, and the frauds
that we have seen all too much of in the last few years.
This task is bigger than any single person, committee, or
agency and in a town that so often prefers food fights to
collaboration, it is going to take a pretty substantial
collective effort on our part here to make sure that we get it
right.
In this effort, there is plenty of work for regulatory
agencies. It is not just Congress alone, we will be looking to
smart folks in industry, smart folks at the CFTC and the SEC,
as well as our state banking regulators, to make sure that we
hit the center of the bullseye.
So I am looking forward to today's hearing and the ongoing
collaboration with House Financial Services.
[The prepared statement of Mr. Johnson follows:]
Prepared Statement of Hon. Dusty Johnson, a Representative in Congress
from South Dakota
Good afternoon. I want to welcome everyone to our first hearing of
the Subcommittee on Commodity Markets, Digital Assets, and Rural
Development.
We have a lot of work to dig into this year and I'm excited to get
started. Today's hearing is on digital assets, but in the coming year,
we will also focus on rural development, oversight of the Commodity
Futures Trading Commission, and as the Chairman and Ranking Member
committed to last month, legislation to reauthorize the CFTC. I look
forward to working with Ranking Member Caraveo and the rest of the
Committee on these priorities.
Today, we are tasked with examining digital asset markets and
understanding how the gaps in the regulatory framework are harming
consumers and innovators alike.
I'm excited to note our unprecedented cooperation with the House
Financial Services Committee in this effort. As we meet here today,
their Digital Assets, Financial Technology, and Inclusion Subcommittee
is convening a complementary hearing, also looking at the gaps in
market structure regulation. And next month we will sit together in a
joint hearing to continue examining these issues.
This cooperation is a testament to the importance that both
Chairman Thompson and Chairman McHenry, as well as Chairman Hill and
me, place on getting digital asset legislation done this Congress.
A lot of ink has been spilled on digital assets, their value, their
purpose, and their ultimate benefit to society. For my part, I see the
potential for valuable tools to be created with digital assets, that
will enable Americans to solve some of life's tough problems and build
systems to better serve the needs of everyday people. Blockchains and
digital assets may not be as revolutionary as some claim, but I don't
believe that every digital asset is a scam or a waste of time.
There will be hits and misses with digital assets. For every
project like Ethereum, Hedera, and Filecoin, there will be projects
like BananaCoin, KodakCoin, and MoonCoin.
The difficult task we are starting today is to craft a legislative
framework that will allow the next Filecoin or Ethereum to emerge,
while protecting the public from the hype, scams, and frauds, which
have been so prevalent to crypto over the past 10 years.
This task is bigger than any single person, committee, or agency.
It will take a collective effort here in Congress and among our
regulators to craft a legal framework that will protect the public
while safeguarding opportunities for innovation.
In this effort, there's plenty of work for our regulatory agencies
to do, including the CFTC, the SEC, and our state and Federal banking
regulators. But it's up to Congress to divide that work between
regulators and ensure our public policy goals are effectively met.
I'm looking forward to today's hearing and our ongoing
collaboration with the House Financial Services Committee to craft
digital asset market structure legislation.
Thank you.
The Chairman. And without any further ado, I would turn to
Ranking Member Caraveo for her comments.
OPENING STATEMENT OF HON. YADIRA CARAVEO, A REPRESENTATIVE IN
CONGRESS FROM COLORADO
Ms. Caraveo. Well, thank you, Chairman Johnson, for
convening today's inaugural Subcommittee hearing on this
important topic. It is an honor to serve as Ranking Member of
the Commodity Markets, Digital Assets, and Rural Development
Subcommittee. I appreciate the opportunity to work with
Chairman Johnson as we identify regulatory gaps in the digital
assets industry and look for solutions, and in the future
opportunities, as our Subcommittee also works to improve the
livelihoods of our rural communities.
We have an impressive panel of witnesses before us, and I
look forward to hearing from all.
Over the past several years, there has been a tremendous
amount of volatility in the digital assets industry. In
February last year, the industry had a combined market
capitalization of approximately $2 trillion. Today, however,
that number is closer to $1 trillion with Bitcoin alone
accounting for about $500 billion. We have seen catastrophic
failures in this space, including the collapse of FTX, and
dramatic shifts in market capitalization over relatively short
periods of time.
Even with the Commodity Futures Trading Commission's
limited authorities to regulate digital commodity cash markets,
the CFTC has to date brought 70 enforcement actions involving
digital asset commodities, and such cases comprised more than
20 percent of all enforcement actions filed in the last fiscal
year.
Considering these events, it is vital we closely examine
current regulations to ensure investors are appropriately
protected and that our agencies have the necessary authorities
to oversee this new and evolving industry. Unlike most of the
typical commodity market investors under CFTC regulation, a
significant number of digital commodity cash market investments
are individual retail investors. That means volatility and
failures in these digital asset classes disproportionately
impact everyday people and families. For sufficient customer
protection, we must consider the everyday person's lower risk
tolerance and ensure that appropriate disclosures are readily
accessible and clearly communicated.
In considering any digital assets legislation, I would be
remiss not to emphasize that we must also include the
appropriate funding for the CFTC to continue carrying out its
mission of promoting the integrity, resilience, and vibrancy of
the U.S. derivatives markets through sound regulation. The CFTC
is the only Federal financial regulator that relies solely on
appropriations from Congress. It is therefore our
responsibility to ensure any additional authorities and
oversight of a technologically complex and unique industry
comes with additional resources. Failure to include the
appropriate funding would severely undercut any efforts to
reach a comprehensive and cohesive regulatory framework for the
digital asset industry that incentivizes innovation and
protects customers.
With that, I would like to thank our witnesses for agreeing
to testify today. I sincerely appreciate your willingness to be
here and the expertise that you all bring to this conversation,
and I look forward to a productive exchange.
Thank you, Mr. Chairman, and I yield back my time.
The Chairman. Thank you much. And if either Chairman
Thompson or Ranking Member Scott come and would like to make
some opening comments, of course we will provide them that
opportunity. Anybody else who would like to make opening
remarks, we would just ask that you submit those for the
record, and we will make sure that they are included.
[The prepared statement of Mr. Thompson follows:]
Prepared Statement of Hon. Glenn Thompson, a Representative in Congress
from Pennsylvania
Thank you, Mr. Chairman.
I also want to welcome all of the Members of the Subcommittee here
today.
There was a great demand to serve on this Subcommittee this
Congress, in no small part because of the opportunity to work on
digital asset issues.
I am excited about the work of the Subcommittee, and I want to
thank you all for your willingness to serve on it.
I think that there is great potential for digital assets to provide
significant value for the American public.
Not just in monetary terms, but as tools to solve real world
problems, as we'll hear about today.
But, as we'll also hear about today, digital asset developers,
users, and institutions need clear, thoughtful rules of the road to
create these solutions.
As Chairman Johnson said, we are working hand-in-glove with the
House Financial Services Committee to craft legislation that will do
just that.
This is perhaps unusual for Congress, but it's the right thing to
do to make good public policy.
No one can solve this issue alone. It will take the cooperation of
committees and regulators to build a workable framework to oversee
digital assets.
Finally, I want to thank our witnesses for coming today to share
their expertise with us.
I look forward to your testimony and the discussion that follows. I
yield back.
The Chairman. We have a panel which we will introduce. A
number of you are experienced testifiers, so I don't need to
tell you this, but you have the time in front of you. Each
Member will only be given 5 minutes to hopefully ask questions.
Sometimes they make speeches, and I guess that is okay, too. It
will remain green until I believe there is 1 minute left on the
clock, at which point it will turn yellow. When it hits zero,
you will get a red light. And if you are going on and on, you
will hear a very light tapping from me. At about 20 seconds it
will get more insistent. We do want you to have an opportunity
to at least answer the question a bit, understanding that you
will follow up afterwards to fill out the evidentiary record.
But if a Member with only 6 seconds left has tossed it to you,
we will give you 20 seconds to try to address their comments at
least a little bit. But we do want to keep it moving. We will
have lots of good questions and a lot of good discussion.
So unless there is anything else for the good of the order,
I will introduce each of our panelists and then provide them
each their time to make their remarks.
Okay. So our first witness today is Mr. Daniel Davis, who
is a Partner and the co-Chair of Financial Markets and
Regulation at the Katten Muchin Rosenman firm. Previously, he
was the General Counsel at the CFTC.
We also have Ms. Purvi Maniar, who is the Deputy General
Counsel at FalconX Holdings.
Our third witness is Nilmini Rubin, who is the Head of
Global Policy at Hedera.
Our fourth witness is Mr. Timothy Massad. Mr. Massad
currently serves as a Research Fellow at the Kennedy School of
Government at Harvard and is the Director of the M-RCBG Digital
Assets Policy Project. He was, as I suspect many of you know,
also a former Chairman of the CFTC.
Our fifth and final witness today is Mr. Joseph A. Hall,
who is a Partner at Davis Polk & Wardwell. He was formerly the
managing executive for policy at the SEC.
I want to thank all of our witnesses for joining us today.
And with that, Mr. Davis, you are on the clock.
STATEMENT OF DANIEL J. DAVIS, J.D., PARTNER AND CO-CHAIR,
FINANCIAL MARKETS AND REGULATION, KATTEN MUCHIN ROSENMAN LLP,
WASHINGTON, D.C.
Mr. Davis. Thank you, Chairman Johnson, Ranking Member
Caraveo, Chairman Thompson, Ranking Member Scott, and Members
of the Subcommittee. Thank you for the opportunity to speak
with you today. As Chairman Johnson mentioned, my name is Dan
Davis. I am co-Chair of the Financial Markets and Regulation
Practice at Katten. From 2017 to 2021, I had the honor of
serving as General Counsel at the CFTC. I would like to thank
my wife Liz and son Spencer for joining me today and say hello
to my daughters Catherine and Abigail, who will be watching
this hearing when they return home from school. My views
expressed today are in my personal capacity and not on behalf
of any person, private-sector, agency, or government agency.
Today's topic is identifying the regulatory gaps in spot
market regulation of digital assets. My view can be summarized
as this: There is a significant gap in Federal spot market
regulation because the large majority of digital assets spot
market activity falls outside the regulatory jurisdiction of
both the CFTC and the SEC. To explain how I reached this
conclusion, I will discuss the jurisdiction of both agencies
and how they have exercised their authority regarding the spot
market for digital assets.
The major dividing line between CFTC and SEC authority is
whether a product is a security or not. If a product is a
security or is based on a security, the SEC generally has
jurisdiction over that product, so this would include not only
securities themselves, but security futures and security-based
swaps. The SEC has regulatory jurisdiction, which means it can
require registration, require compliance with the securities
laws and regulations, and to conduct exams and reviews. It can
also bring enforcement actions.
If a product is not a security, then it likely is within
some level of CFTC jurisdiction. The CFTC has full regulatory
authority over a number of products such as futures, options on
futures, and swaps. These all have their counterparts of SEC
jurisdiction: futures, security futures, swaps, security-based
swaps. The CFTC has regulatory jurisdiction over a couple of
other products with a specific retail component, such as
certain retail foreign exchange transactions and certain
leveraged or margined retail commodity transactions. Over all
of these products, the CFTC can require registration, require
compliance with all applicable statutes and regulations,
including robust customer protection provisions, and conduct
exams and reviews.
So what CFTC jurisdiction remains? If there is a spot
product that is outside the CFTC regulatory authority for
leveraged or margined retail commodity products, the CFTC only
has enforcement authority for fraud, manipulation, or false
reporting regarding that product. This is a backwards-looking
authority to punish bad conduct after it has already occurred.
No registration, no exams by the CFTC.
Congress gave the CFTC this authority because the prices in
the spot market significantly impact the futures and swaps
products. And the CFTC has not hesitated to use its enforcement
authority in the digital asset space, bringing over 80
enforcement actions related to digital assets, including 20
percent of its enforcement activity in the past year.
Where does that leave us? If a digital asset activity
occurs on the spot market, it is not a security, it is not a
leveraged retail commodity product, then there is no CFTC or
SEC regulatory authority over that product. There is only CFTC
enforcement jurisdiction.
How large is that universe? It is large, and I base that on
two key assumptions. First, I looked at the top 15 digital
assets by market capitalization. Now, there are thousands of
digital assets, but the top 15 account for about 86 percent of
the market. Second, I look to what the Commissions themselves
have said about those 15 digital assets, not a Chairman, not a
Commissioner, but the Commission itself because only the
Commission can speak for itself. Based on my review, and
looking at CFTC and SEC enforcement actions, it appears that
the CFTC has asserted that seven of the top 15 digital assets
are commodities. These seven digital assets are some of the
largest, accounting for approximately 76 percent of the digital
asset market.
The SEC, as a Commission, has never challenged any of those
CFTC determinations, some of which have been around for years.
Instead, the SEC, in an enforcement action, has asserted that
only one of the top 15 digital assets is a security. And that
digital asset currently accounts for about two percent of the
market, 76 to 2, 76 percent of commodity, two percent of
security, and the rest of the top 15, about eight percent,
undetermined. I don't think that should be very surprising
because the market division between swaps, regulated by the
CFTC, and securities-based swaps, regulated by the SEC, is
about 90 percent swaps for the CFTC and ten percent security-
based swaps for the SEC.
So I conclude where I began. There is a significant
regulatory gap in Federal spot market regulation of digital
assets because the large majority of digital asset spot market
activity falls outside the regulatory jurisdiction of the CFTC
and the SEC. Thank you.
[The prepared statement of Mr. Davis follows:]
Prepared Statement of Daniel J. Davis, J.D., Partner and Co-Chair,
Financial Markets and Regulation, Katten Muchin Rosenman LLP,
Washington, D.C.
Chairman Johnson, Ranking Member Caraveo and Members of the
Subcommittee:
Thank you for the opportunity to appear before you today and share
my views about digital asset regulation, including the Commodity
Futures Trading Commission's (CFTC) role in digital asset regulation. I
had the honor of serving as the CFTC's General Counsel from 2017-2021
and currently advise clients about CFTC and digital asset regulation in
my role as partner with Katten Muchin Rosenman LLP. However, my
appearance before you today is in my own personal capacity; I am not
representing or speaking on behalf of any other person, private sector
agency or governmental agency.
I would like to address a few issues in my testimony today,
including the current jurisdiction that the CFTC has over the digital
asset market, including the spot market, the CFTC's substantial
experience regarding digital assets, and the protections that the
Commodity Exchange Act (CEA) and rules currently offer for investors,
particularly to retail customers.
CFTC Jurisdiction Regarding Digital Assets
As this Subcommittee is well aware, the CFTC is the primary
regulator of the futures, options on futures, and swaps markets. The
CFTC also regulates leveraged retail commodity transactions. The CFTC's
full ``regulatory'' authority includes the ability to require
registration and examine registered entities that offer these products.
The CFTC also has enforcement jurisdiction (or anti-fraud and anti-
manipulation jurisdiction) in the commodities markets at large. Thus,
if the CFTC thinks that there is manipulation or fraud in a spot market
for a commodity--such as gold or bitcoin--it can institute an
enforcement action to enjoin that activity and seek recompense of ill-
gotten gains from that activity.
Why is it important for the CFTC to have anti-fraud and anti-
manipulation authority over the spot markets? Quite simply, because the
spot markets highly influence the derivatives markets. Spot markets and
derivatives markets are highly correlated. Furthermore, derivatives
market prices are largely determined by prices in the spot market. If
somebody can manipulate the price of the spot market, they generally
also can influence the price of derivatives products based upon the
underlying asset.\1\
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\1\ See, e.g., In re Coinbase, Inc., CFTC No. 21-03 at 3-4 (Mar.
19, 2021).
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Former CFTC Commissioner Dawn Stump provided an excellent
explanation about the rationale and nature of the CFTC's anti-fraud and
anti-manipulation authority for the spot market:
The public should be aware that where cash commodity markets
are concerned, this limited authority (anti-fraud/manipulation/
false reporting, as opposed to day-to-day regulatory oversight)
is bestowed upon the CFTC as a tool to assist in its primary
function of regulating derivatives products, such as futures.
Futures contracts serve a price discovery function. Well-
functioning futures (and other derivatives products) rely upon
a sound underlying cash market and may reference cash market
indexes in their pricing. Therefore, cash market transactions
can potentially be part of a scheme to manipulate prices of
derivatives products that are regulated by the CFTC. Congress
has recognized these relationships between prices of cash
transactions and derivatives products, and thus the CEA
provides the CFTC with limited enforcement authorities with
respect to cash transactions.\2\
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\2\ Concurring Statement of Commissioner Dawn D. Stump Regarding
Enforcement Action against Coinbase, Inc., (Mar. 19, 2021), https://
www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement031921.
Thus, CFTC enforcement actions in the spot market are not primarily
focused on policing the spot market for its own sake. The CFTC
emphasizes, instead, its role in regulating the derivatives markets.
Chairman Behnam made these points in a Senate Agriculture Committee
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hearing last month:
As I discussed in December [2022], the CFTC does not have
direct statutory authority to comprehensively regulate cash
digital commodity markets. Its jurisdiction is limited to its
fraud and manipulation enforcement authority. In the absence of
direct regulatory and surveillance authority for digital
commodities in an underlying cash market, our enforcement
authority is by definition reactionary; we can only act after
fraud or manipulation has occurred or been uncovered.\3\
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\3\ Testimony of Chairman Rostin Behnam Before the U.S. Senate
Committee on Agriculture, Nutrition, & Forestry, Oversight of the
Commodity Futures Trading Commission, (Mar. 8, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam32.
The CFTC nevertheless has actively used its enforcement authority
in the digital assets space. It has brought at least 70 enforcement
actions involving digital asset commodities. In the last fiscal year,
more than 20 percent of the Commission's enforcement actions related to
digital asset commodities.\4\
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\4\ Id.
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The CFTC has a long history of involvement with digital assets. As
early as 2014, the first Bitcoin denominated cash-settled swaps,
options and non-deliverable forwards began trading on CFTC-registered
swap execution facilities.\5\ The next year the CFTC found that Bitcoin
and other virtual currencies were commodities.\6\ The first cash-
settled Bitcoin futures contracts began trading on CFTC-registered Cboe
Futures and CME in 2017.\7\ During the same year, the CFTC for the
first time designated a swap execution facility and derivatives
clearing organization to transact in physically deliverable Bitcoin
swaps contracts. Also in 2017, the CFTC's LabCFTC released a primer on
virtual currencies.\8\
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\5\ Stan Higgins, TeraExchange Receives US Approval to Launch First
Bitcoin Derivative, Coindesk (Sept. 12, 2014), https://
www.coindesk.com/tech/2014/09/12/teraexchange-receives-us-approval-to-
launch-first-bitcoin-derivative/; In re TeraExchange LLC, CFTC Docket
No. 15-33 at 3 (Sept. 24, 2015) (``On September 11, 2014, Tera filed
with [the CFTC Division of Market Oversight] a submission self-
certifying the Bitcoin swap for trading on its [swap execution
facility]. Tera began offering the Bitcoin swap for trading on
September 12, 2014.'').
\6\ See In re Coinflip, Inc., CFTC No. 15-29 (Sept. 17, 2015).
\7\ CFTC, Release No. 7654-17 (Dec. 1, 2017), https://www.cftc.gov/
PressRoom/PressReleases/7654-17.
\8\ LabCFTC, A Primer on Virtual Currencies (Oct. 17, 2017),
https://www.cftc.gov/sites/default/files/idc/groups/public/documents/
file/labcftc_primercurrencies100417.pdf.
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Since 2017, the CFTC has released additional backgrounders on
virtual currencies and related derivatives products.\9\ And CFTC Staff
in 2018 released an advisory regarding their priorities and
expectations when reviewing new virtual derivatives products to be
listed on CFTC regulated markets.\10\
---------------------------------------------------------------------------
\9\ See CFTC Backgrounder on Self-Certified Contracts for Bitcoin
Products, https://www.cftc.gov/sites/default/files/idc/groups/public/
@newsroom/documents/file/bitcoin_fact
sheet120117.pdf; CFTC Backgrounder on Oversight of and Approach to
Virtual Currency Futures Markets (Jan. 4, 2018), https://www.cftc.gov/
sites/default/files/idc/groups/public/%40custom
erprotection/documents/file/backgrounder_virtualcurrency01.pdf.
\10\ See CFTC Staff Advisory No. 18-14 (May 21, 2018), https://
www.cftc.gov/node/214951.
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Today, there are over a dozen actively trading futures and options
contracts on digital assets on CFTC-registered markets.\11\ These
contracts are based on the two most-traded digital assets, Bitcoin and
Ether. This long-standing and active oversight of digital asset
derivatives has given the CFTC unique insights, expertise, and
understanding of the operation of spot digital asset markets. As Dr.
Chris Brummer noted to a similar subcommittee last year, ``the CFTC
gained expertise in overseeing the institutionalization of significant
infrastructures intersecting directly with the digital asset commodity
spot market, something that the SEC, which has yet to approve a spot
Bitcoin or digital asset commodity ETF, has arguably only accomplished
in attenuated fashion through multiple Bitcoin Futures ETFs.'' \12\
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\11\ Products are ``self-certified'' by a CFTC-registered entity.
An entity self-certifying a product must provide to the CFTC ``[a]
concise explanation and analysis of the product and its compliance with
applicable provisions of the [Commodity Exchange] Act, including core
principles, and the Commission's regulations thereunder.'' 17 CFR
40.2(a)(3)(v). Furthermore, a registered entity must ``provide [to CFTC
staff] any additional evidence, information or data that demonstrates
that the contract meets, initially or on a continuing basis, the
requirements of the [Commodity Exchange] Act or the Commission's
regulations or policies thereunder.'' Id. 40.2(b). In certain
circumstances, the Commission can stay the trading of the contract. Id.
40.2(c).
\12\ Testimony of Chris Brummer before the Subcommittee on
Commodity Exchanges, Energy and Credit at 5 (June 23, 2022), https://
agriculture.house.gov/uploadedfiles/brum
mer_congressional_testimonythe_future_of_digital_asset_regulation.pdf.
Indeed, last year the CFTC voluntarily opened up to public comment
consideration of a registered entity's proposed changes to the market
structure for certain digital asset derivatives products. CFTC Seeks
Public Comment on FTX Request for Amended DCO Registration Order, CFTC
Release No. 8499-22 (Mar. 10, 2022), https://www.cftc.gov/PressRoom/
PressReleases/8499-22. The CFTC received 1,500 comments in response.
See https://comments.cftc.gov/PublicComments/Com
mentList.aspx?id=7254&ctl00_ctl00_cphContentMain_MainContent_gvCommentLi
stChangePage=
1_50. Although the request was ultimately withdrawn, the public comment
process provided the CFTC with valuable insight into a host of
questions regarding the market structure and operation of digital asset
exchanges.
---------------------------------------------------------------------------
Furthermore, the CFTC has clarified the scope of its authority to
regulate retail commodity transactions that involve leverage,
financing, or margin. A key statutory requirement for CFTC jurisdiction
is whether ``actual delivery'' of retail commodity transactions have
occurred within 28 days. The CFTC engaged in extensive rulemaking with
the digital asset community and provided thorough guidance about the
meaning of ``actual delivery'' as that phrase applied to digital
assets, with multiple examples of acceptable and non-acceptable
practices.\13\ With Commission-backed guidance on this issue in place
after receiving and incorporating extensive public feedback, the
Commission has used its enforcement authority to have market
participants follow the guidance.\14\
---------------------------------------------------------------------------
\13\ CFTC Final Interpretive Guidance, Retail Commodity
Transactions Involving Certain Digital Assets, 85 Fed. Reg. 37734 (June
24, 2020).
\14\ See, e.g., In re Payward Ventures, Inc., CFTC No. 21-20 (Sept.
28, 2021).
---------------------------------------------------------------------------
Current Regulatory Gap in the Spot Market at the Federal Level
Neither the CFTC nor any other Federal regulator has plenary
regulatory authority over the trading of digital assets that qualify as
commodities. If certain transactions involving a digital asset are
considered securities, then the SEC would have jurisdiction. To
evaluate the amount of the Federal regulatory gap for digital asset
transactions, the question then becomes the scope of the SEC's
jurisdiction in the digital asset space.
As you are all aware, there is currently a fair amount of
discussion about the regulatory oversight of the digital asset market
by the CFTC and the SEC, respectively. There have been discussions
about which digital assets are under the jurisdiction of the CFTC (as a
commodity) and of the SEC (as a security), and recently an apparent
dispute regarding the classification of at least one digital asset--
Ether--with the CFTC consistently stating that Ether is a commodity and
the SEC Chairman last week before the House Financial Services
Committee refusing to acknowledge that Ether is or is not a security.
This is an important debate, and one that I will not resolve during my
testimony today.\15\
---------------------------------------------------------------------------
\15\ I do note that both the CFTC and SEC have previously worked
together to provide extensive guidance on the lines between their
respective jurisdictions. For example, Section 712(d)(1) of the Dodd-
Frank Act required the CFTC and SEC jointly to further define the
difference between a ``swap'' (subject to the CFTC's jurisdiction) and
a ``security-based swap'' (subject to the SEC's jurisdiction). Within
the space of about 2 years, the CFTC and SEC: (1) issued an advance
notice of proposed rulemaking regarding the definitions; (2) published
a proposed rulemaking; (3) received and reviewed almost 100 comments to
the proposed rules; and (4) issued a final rule filling more than 150
pages in the Federal Register giving significant guidance, examples,
and applications of the difference between ``swaps'' and ``securities-
based swaps.'' Further Definition of ``Swap,'' ``Security-Based Swap,''
and ``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 77 Fed. Reg. 48208, 48209-211 (Aug. 13, 2012).
This joint effort has greatly reduced the uncertainty regarding the
differences between ``swaps'' and ``securities-based swaps.'' In
addition, both agencies worked together to establish quantitative
measures, later modified and adopted by Congress, to clarify the
jurisdictional lines between futures and security futures. See 7 U.S.C.
1a(35), 1a(44).
---------------------------------------------------------------------------
What I do want to point out is that, in terms of market
capitalization and looking at the activities of the Commissions
themselves (not the statements of a Chairman or a Commissioner),
``commodities'' have a much larger share of the spot digital asset
market than ``securities.'' \16\
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\16\ In a recent proposed rule regarding custody requirements for
investment advisors, the SEC asserted that ``most crypto assets are
likely to be funds or crypto asset securities covered by the current
[custody] rule.'' Safeguarding Advisory Client Assets, 88 Fed. Reg.
14672, 14676 (Mar. 9, 2023). The SEC, however, did not specifically
identify any particular digital asset as a security.
---------------------------------------------------------------------------
Let's take the top fifteen digital assets by market capitalization.
As of April 21, 2023, a popular crypto tracking website estimates that
digital assets have a global market capitalization of about $1.17
trillion.\17\ The top fifteen digital assets account for approximately
$1.01 trillion of market capitalization, or approximately 86 percent of
the market.\18\
---------------------------------------------------------------------------
\17\ See CoinMarketCap, https://coinmarketcap.com/ (last visited
April 21, 2023).
\18\ Id.
---------------------------------------------------------------------------
As described above, CFTC-registered derivatives products have been
trading on the top two digital assets in market capitalization--Bitcoin
and Ether--for several years now. Bitcoin (45.3 percent of market cap)
and Ether (19.0 percent of market cap) collectively account for
approximately 64.3 percent of the total digital asset market
capitalization. If Bitcoin and Ether were securities, they should not
be trading on CFTC-registered exchanges, and the SEC has never
challenged the trading of these products. So, right off the bat, almost
\2/3\ of the spot digital asset market appear to be outside the SEC's
jurisdiction.
One can also evaluate enforcement filings to determine which
specific digital assets the CFTC and SEC have formally regarded as a
security or a commodity. The numbers point to an even larger share of
the spot digital asset market being outside the SEC's jurisdiction.
The CFTC in enforcement filings has alleged that seven of the top
fifteen digital assets are commodities (with estimated market
capitalization as of April 21, 2023):
Bitcoin (BTC) \19\ (45.3 percent)
---------------------------------------------------------------------------
\19\ Complaint at 2, CFTC v. Binance, No. 1:23-cv-01887 (N.D.
Ill. Mar. 27, 2023).
Ether (ETH) \20\ (19.0 percent)
---------------------------------------------------------------------------
\20\ Id.
Tether (USDt) \21\ (7.0 percent)
---------------------------------------------------------------------------
\21\ Id. at 24.
USD Coin (USDC) \22\ (2.6 percent)
---------------------------------------------------------------------------
\22\ Complaint at 2, CFTC v. Eisenberg, No. 1:23-cv-00173
(S.D.N.Y. Jan. 9, 2023).
Dogecoin (DOGE) \23\ (1.0 percent)
---------------------------------------------------------------------------
\23\ Complaint at 1, CFTC v. McAfee, No. 1:21-cv-01919 (S.D.N.Y.
Mar. 5, 2021).
Binance USD (BUSD) \24\ (0.6 percent)
---------------------------------------------------------------------------
\24\ Supra note 19 at 24.
Litecoin (LTC) \25\ (0.5 percent)
---------------------------------------------------------------------------
\25\ Id.
Collectively, these seven digital assets account for approximately
76 percent of the total market capitalization of spot digital assets.
The SEC has never asserted in either an enforcement action or a
rulemaking that any of the above seven digital assets was or is a
security. Of the top fifteen digital assets in terms of market
capitalization, the SEC appears to have asserted that only XRP, with a
market capitalization of approximately two percent of the market, is a
security.\26\ For the other seven digital assets in the top fifteen--
accounting for approximately 8.5 percent of market capitalization
\27\--neither agency has specifically asserted that the digital asset
is a security or commodity.\28\
---------------------------------------------------------------------------
\26\ Complaint at 1, SEC v. Ripple Labs Inc., No. 1:20-cv-10832
(S.D.N.Y. Dec. 22, 2020).
\27\ Those seven are BNB (BNB) (4.3 percent); Cardano (ADA) (1.1
percent); Polygon (MATIC) (0.8 percent); Solana (SOL) (0.7 percent);
Polkadot (DOT) (0.6 percent); Shiba Inu (SHIB) (0.5 percent); and Tron
(TRX) (0.5 percent).
\28\ Over time it would be likely that the digital asset market
would trend away from securities and toward commodities. That is
because, as a digital asset either becomes more decentralized or
becomes used for a consumptive purpose, it is less likely to be
considered a security. In addition, if Congress or a court agree that
secondary transactions in digital markets do not constitute an
``investment contract'' under the securities laws, then an even smaller
portion of activity in the digital markets would fall within the
jurisdiction of the SEC. See, e.g., Motion to Dismiss in SEC v. Wahi,
et al., Case No. 2:22-cv-01009, Doc. 33 at 13-27 (W.D. Wash. Feb. 6,
2023) (advancing the argument that secondary transactions in digital
assets do not fall within the definition of an ``investment
contract'').
---------------------------------------------------------------------------
Indeed, the SEC recently brought an enforcement action against
digital asset trading platform Bittrex, Inc. (Bittrex) and related
parties for, among other things, failure to register as a national
securities exchange.\29\ The SEC alleges that from 2014 to the present,
Bittrex ``made available more than 300 crypto assets for trading,''
\30\ including what appears to be most of the top fifteen digital
assets by market capitalization. The SEC, however, did not assert in
that complaint that any of the top fifteen digital assets were a
security. Instead, the SEC relied primarily upon six digital assets
with a total of less than 0.18 percent of the total spot digital market
capitalization to buttress its claim that Bittrex should have
registered with the SEC.\31\
---------------------------------------------------------------------------
\29\ Complaint at 3, SEC v. Bittrex, Inc., No. 2:23-cv-00580
(W.D. Wash. Apr. 17, 2023).
\30\ Id. at 67.
\31\ The six digital assets (and their percentage of market
capitalization as of April 21, 2023) are: Algorand (ALGO) (0.1142
percent); Dash (DASH) (0.0472 percent); OMG Network (OMG) (0.0144
percent); Naga (NGC) (0.0007 percent); Monolith (TKN) (0.0002 percent);
and I-House Token (IHT) (0.0000001 percent).
---------------------------------------------------------------------------
Customer Protections Provided in the CFTC Regime
Entities subject to CFTC jurisdiction must provide extensive
protections to customers purchasing CFTC-regulated products. And the
CFTC and the National Futures Association (NFA) \32\ have not hesitated
to enforce these customer protections. In addition to the anti-fraud
and anti-manipulation authority described above, there are significant
rules regarding the segregation and protection of customer funds. CFTC-
registered futures commission merchants (FCMs) must provide general
written disclosures regarding the risks of futures trading and specific
disclosure regarding their own circumstances.\33\ FCMs and introducing
brokers must have privacy policies and have procedures in place to
protect customer information.\34\
---------------------------------------------------------------------------
\32\ The NFA has been designated by the CFTC as a registered
futures association.
\33\ 17 CFR 1.55; NFA Rule 2-30.
\34\ See 17 CFR Parts 160 and 162.
---------------------------------------------------------------------------
The CFTC also has extensive rules to protect retail customers
engaging in certain foreign exchange transactions.\35\ Entities engaged
in retail foreign transactions must register,\36\ meet minimum
financial requirements,\37\ and comply with various recordkeeping and
reporting requirements.\38\ These entities must also provide
appropriate disclosures to retail customers about the risks of engaging
in these types of transactions, noting, among other things, that the
customer can ``rapidly lose all of the funds [they] deposit for such
trading and [they] may lose more than [they] deposit.'' \39\
---------------------------------------------------------------------------
\35\ See generally 17 CFR Part 5.
\36\ Id. 5.3.
\37\ Id. 5.6-5.7.
\38\ Id. 5.10-5.11.
\39\ Id. 5.5(a)(2)(b).
---------------------------------------------------------------------------
The NFA has additional rules that protect customers. For example,
NFA members and associates must observe high standards of commercial
honor and just and equitable principles of trade. This includes dealing
fairly with customers and others at all times.\40\ NFA members must
also comply with express standards in all communications with the
public generally and promotional literature specifically.\41\
---------------------------------------------------------------------------
\40\ NFA Rule 2-4.
\41\ NFA Rule 2-28.
---------------------------------------------------------------------------
The NFA additionally requires members to provide specific
disclosures regarding their digital asset activities and comply with
certain conduct standards regarding their activities involving the
digital assets Bitcoin and Ether.\42\
---------------------------------------------------------------------------
\42\ NFA Rule 2-51; see also NFA Interpretive Notice 9073.
---------------------------------------------------------------------------
Conclusion
There appears to be a significant gap at the Federal level in the
regulation of spot digital assets. Assertions of jurisdiction by both
the CFTC and SEC in enforcement actions suggest that most of the market
capitalization of spot digital assets falls outside SEC jurisdiction.
The CFTC has extensive experience in the digital asset space
through both its (1) overseeing of trading of digital asset-based
derivatives on CFTC-regulated exchanges and (2) asserting its anti-
fraud and anti-manipulation enforcement authorities over the spot
markets. The CFTC and NFA also have significant experience in providing
protections to customers participating in these markets.
Thank you for the opportunity to appear before the Subcommittee. I
look forward to answering any questions you may have.
The Chairman. And even before the insistent knocking began,
very good. You should be proud of your father, our guests. He
did a great job.
Ma'am, you are up and on the clock.
STATEMENT OF PURVI R. MANIAR, J.D., DEPUTY GENERAL COUNSEL,
FalconX HOLDINGS LTD., SAN MATEO, CA
Ms. Maniar. Chairman Johnson, Chairman Thompson, Ranking
Member Caraveo, and Members of the Subcommittee, thank you for
this opportunity to testify before you today. In my testimony,
I will endeavor to provide FalconX's perspective on the current
regulatory landscape for digital assets and the benefits of
coordinated regulation and responsible innovation in this
realm.
FalconX is a prime broker in the digital asset space for
the world's leading institutions, and FalconX Bravo is proud to
be a CFTC-registered swap dealer. Our mission is to provide
secure, efficient, and regulatory-compliant access to these
markets for our clients. Our institutional-only business
includes regulated, over-the-counter derivatives with digital
asset underliers. By employing time-tested OTC market
structures and state-of-the-art technology, we enable our
customers to hedge risk or gain financial exposure in this
space. We are committed to orderly, fair, and liquid markets
for all market participants.
We are happy and eager to engage with policymakers and
regulators to provide industry insights on this critical issue
and recommend potential areas for further legislative clarity.
Digital asset technology is underpinned by the blockchain
and paves the way for innovative growth while offering more
secure, transparent, and decentralized alternatives to
traditional structures. That technology can better facilitate
control over the sharing and storing of information. An example
of this innovation can be seen in the blockchain networks such
as Ethereum, which have multiple significant use-cases and
benefits. Ethereum's groundbreaking feature is smart contracts,
which have the ability to execute contracts without
intermediaries.
It is evident that the existing rules and tools at our
disposal are insufficient to address the unique challenges
presented by this dynamic technology. I go into more detail
regarding the real-world utility and use-cases of such digital
asset commodities in my written testimony.
As the digital asset industry has evolved, different U.S.
regulators have issued their respective rules and guidance,
oftentimes resulting in inconsistent enforcement and an opaque
and sometimes conflicting regulatory regime. There is no clear
single regulator of digital assets in the U.S., and many
regulators have claimed some form of jurisdiction, each with
their own authorities and regulatory objectives. While it is
not uncommon for an industry to be subject to multiple
regulators, a lack of clear oversight and jurisdictional lines
creates barriers to entry and confusion for a nascent industry.
The absence of regulatory clarity in the U.S. has hindered our
global competitiveness in this dynamic but still emerging
industry. This moment calls for the United States to take
resolute action and to assert leadership in the development of
an unambiguous digital asset regulation.
We believe that the majority of digital assets are used and
traded like commodities. In part, this is why FalconX decided
to actively pursue CFTC registration as the best-suited,
available regulatory framework for digital assets in which
FalconX makes markets and trades. It should be noted that CFTC-
registered swap dealers are subject to very robust regulatory
requirements, many of which I have set out in more detail in my
written testimony.
While some digital assets may be securities, the securities
regulatory structure is ill-suited for most digital assets.
SEC-mandated disclosures designed for factors like earnings,
cash flow, or material events have no analogy for digital asset
commodities and would prevent many of their benefits such as
peer-to-peer transactions.
The current U.S. regulatory framework is fragmented. And
until this is addressed, it will continue to lead to a loss of
economic opportunity and technological advancement for the U.S.
We believe that spot markets would benefit from the application
of some of the CFTC's business conduct standards, in particular
those focused on registration, reporting, and disclosure. At
FalconX, we have found that these rules greatly enhance our
ability to foster a transparent and orderly market for digital
asset derivatives. Tailored to the unique characteristics of a
digital assets spot market, we believe they could greatly
enhance market integrity and promote market participation,
confidence, and protection while facilitating innovation.
We firmly believe that Congress and market regulators
should work together to establish a framework for the digital
asset ecosystem so that we can ensure that digital asset market
participants and markets are safe, transparent, and orderly for
all participants. Legislation like the Digital Commodity
Exchange Act of 2022 (H.R. 7614, 117th Congress) achieves just
this, and we applaud Chairman Thompson, Chairman Johnson, and
the rest of this Committee for their leadership in this regard
in the last Congress. We look forward to this Committee's
efforts to advance legislation and cooperation and coordination
with the House Financial Services Committee.
Let me reiterate FalconX's appreciation for this
opportunity to testify in front of you this afternoon, and I
look forward to answering any questions you have. Thank you.
[The prepared statement of Ms. Maniar follows:]
Prepared Statement of Purvi R. Maniar, J.D., Deputy General Counsel,
FalconX Holdings Ltd., San Mateo, CA
Chairman Johnson, Chairman Thompson, Ranking Member Caraveo, and
Members of the Subcommittee, thank you for this opportunity to testify
before you today. In my testimony, I will endeavor to provide FalconX's
perspective on the current regulatory landscape for digital assets and
the benefits of coordinated regulation and responsible innovation in
this realm.
My name is Purvi Maniar, and I currently serve as the Deputy
General Counsel of FalconX. In this role, I am responsible for
providing legal guidance to FalconX regarding the development of
products meeting the needs of our institutional clients in a manner
that is compliant with governing regulations.
FalconX provides a platform for institutional clients to hedge risk
or gain financial exposure to digital assets, through a variety of
products and services. We are committed to orderly, fair markets in
this arena for all market participants.
We are happy and eager to engage with policymakers and regulators
to provide industry insights on this critical issue and recommend
potential areas for further legislative clarity.
I. Background
A. FalconX
FalconX is a prime broker in the digital assets space for the
world's leading institutions. FalconX Bravo is a Commodity Futures
Trading Commission (CFTC)-registered swap dealer, and it is our mission
to provide secure, efficient, and regulatory-compliant access for our
clients. Our business includes regulated, over-the-counter (OTC)
derivatives with digital asset underliers. Designed specifically for
institutional clients, FalconX utilizes a market-risk-neutral approach.
By leveraging our extensive expertise in this arena, state-of-the-art
technology, and by employing time-tested OTC market structures, FalconX
provides institutional-grade products that enable our customers to
hedge risk or gain financial exposure within this space.
B. Digital Assets
Digital asset technology is underpinned by the blockchain and paves
the way for innovative growth while offering more secure, transparent,
and decentralized alternatives to traditional structures. The priority
remains user privacy and control over personal information.
Blockchain is a transformative technology. The potential
applications of this technology are vast and varied, and the industries
that can benefit from their far-reaching power are numerous. By
enabling decentralization, efficiency, and programmability, these
technologies pave the way for innovation and growth while promoting
security and transparency.
Blockchain technology enables individuals to control their data by
storing it in a decentralized network of computers rather than a
centralized server controlled by a single entity, such as a
corporation. This means that users can access and manage their data
using their private keys and grant permission for third-party access on
a case-by-case basis, rather than granting unrestricted access to a
central authority.
An example of this innovation can be seen in blockchain networks
such as Ethereum, which have multiple significant uses and benefits.
Ethereum's groundbreaking feature is smart contracts that operate on
its blockchain. The Ethereum chain's ability to execute contracts
automatically without intermediaries offers a more secure, efficient,
and transparent alternative to traditional intermediated contract-based
processes. By enabling developers to build decentralized applications,
Ethereum offers limitless potential for entrepreneurs to create
innovative solutions in diverse industries. The flexibility and
programmability of the Ethereum blockchain allow for a wide range of
possible use cases, and as the technology continues to mature and
evolve, we can expect to see new and innovative applications emerge.
The platform's ability to enhance transparency and efficiency could
transform sectors such as finance and technology, where a few prominent
intermediaries have traditionally played a significant role. As
Ethereum's use cases continue to evolve, it is evident that the
existing rules and tools at our disposal are insufficient to address
the unique challenges presented by this dynamic technology.
II. Current Regulatory Landscape
As the digital asset industry has evolved, different U.S.
regulators have issued their own respective rules and regulations,
oftentimes resulting in inconsistent enforcement and an opaque and
sometimes conflicting regulatory regime.
There is no clear single regulator of digital assets in the United
States. A constellation of regulators, including the Commodity Futures
Trading Commission (CFTC), Federal Trade Commission (FTC), Securities
and Exchange Commission (SEC), Office of the Comptroller of the
Currency (OCC), Federal Deposit Insurance Corporation (FDIC), along
with the Federal Reserve Board, the U.S. Treasury Department, and its
Internal Revenue Service (IRS) and Financial Crime Enforcement Network
(FinCEN), along with others have all claimed and asserted some form of
jurisdiction.
Each regulator views the industry through its own unique lens and
in the context of its own existing authority and enforcement
priorities, oftentimes against the backdrop of competing jurisdiction.
While multi-pronged regulation is common across industries, given the
nascency of this sector, the absence of clear oversight and
jurisdictional lines has created confusing outcomes for industry
participants and regulators alike.
A common sentiment in policy and media discussions around digital
assets is that entities in this arena are trying to skirt regulatory
oversight or sufficiently robust risk management and governance
practices. The reality is that legitimate digital asset businesses do
not want to circumvent regulation; they want clear rules of the road so
that they can successfully grow their business. FalconX and other
industry leaders have sought to foster policy discussions and serve as
a resource to lawmakers on the technology, current market structure,
and emerging risks in support of digital asset-specific regulation as
the regulatory landscape continues to evolve in the United States.
Globally, major economies, including those of the UK, Japan, China,
and the EU, have achieved significant strides toward adopting
regulatory frameworks tailored to digital assets. These frameworks not
only evidence an increasing appreciation for the potential benefits of
these technologies but also enable the industry to expand, resulting in
substantial job growth, revenue generation, and tax receipts in these
regions.
The absence of regulatory clarity in the U.S. has hindered its
global competitiveness in this dynamic but still emerging sector. This
moment calls for the United States to take resolute action.
Despite the current challenges, there remains continued interest
for the United States to lead by enacting digital asset-specific
regulation. We are a leader in global markets and policymaking.
Blockchain technology presents an opportunity for our nation to, once
again, forge clear, comprehensive, and forward-looking regulations.
We believe now is the right time for the United States to assert
leadership in the development of unambiguous digital asset regulation.
Clear legislation and accompanying regulation are necessary to keep
existing companies from leaving the U.S. or to prevent startups from
choosing to launch in other jurisdictions where the rules are clearer,
and their businesses are welcomed. We should foster and attract
innovation and aim to be leaders in the development of new
technologies.
III. Many Digital Assets Are Commodities, Not Securities
Many digital assets are used and traded like commodities.
Commodities have independent utility; their value is not typically tied
to a revenue stream or annual earnings. Instead, commodities have a
specific use (e.g., oil is used to power machinery, Ethereum is used as
a building block for smart contract applications). Commodities usually
are bought and sold according to certain specifications tied to their
use. Their prices typically fluctuate based on their use and
macroeconomic factors such as interest rates and inflation, not any
disclosed event like quarterly earnings. It is for this reason that the
CFTC regulatory architecture is better suited to regulating digital
assets.
While some digital assets are undoubtedly securities, the
securities regulatory architecture, in contrast, is ill-suited for most
digital assets. Securities have no independent utility other than
profit participation. As a result, securities regulations focus on
robust disclosure of facts affecting that profit movement, such as
earnings, cash flow, or material events affecting earnings. However,
most securities law-mandated financial disclosures have little
applicability to digital assets. Moreover, the requirement under
securities laws that spot securities must be traded on a regulated
exchange using third-party intermediaries eliminates the benefits of
peer-to-peer transactions. The ability to transfer spot assets
instantly and safely on a peer-to-peer basis, one of the key benefits
of digital assets, does not exist if one is required to place an order
with a broker-dealer intermediary on a third-party exchange subject to
a multi-day settlement cycle. As a result, few digital asset companies
have sought registration or exemption under the securities laws;
presumably, it is why few of those applications have been granted,
given the difficulties of shoehorning digital assets into the
securities law framework.
In part, this is why FalconX decided to actively pursue CFTC
registration as the best-suited available regulatory framework for
digital assets in which FalconX makes markets and trades.
CFTC registration comes with significant regulation, oversight, and
compliance tailored to the derivative products it regulates. The CFTC
also has fraud and manipulation authority over the spot markets
underlying those derivatives. As a registered swap dealer, FalconX is
subject to business conduct standards that require compliance with
policies and procedures designed to ensure our clients are treated
fairly and undertake obligations with us in an informed and prudent
manner. Those standards require fair dealing, robust disclosure, and
confidential handling of client information. CFTC swap dealer
registration also obligates FalconX to maintain sufficient regulatory
capital, implement margin and market risk policies, and provide
complete, robust transaction reporting to the CFTC through a swap data
repository. Registration also involves regular regulatory examinations
through oversight by an SRO, the National Futures Association, as well
as regular reviews and interactions with the CFTC. We undertook this
registration voluntarily and at great expense because we believe a
properly regulated industry will thrive in the United States and we
want to be an active participant in its development.
IV. A Path Forward
The current U.S. regulatory framework is fragmented, and the risks
to the U.S. from this lack of a cohesive regulatory approach already
have pushed some companies founded in the U.S. to other jurisdictions
with greater regulatory clarity. We believe that regulatory uncertainty
constitutes a major impediment to U.S. innovation and investment. Until
it is addressed, it will continue to lead to a loss of economic
opportunity and technological advancement for the U.S.
As discussed above, FalconX has seen great benefits from the
application of CFTC rules to its swap dealing business. There are
aspects of the CFTC regime that can be applied to spot market trading
of digital assets that would provide a regulatory framework to protect
customers without stifling innovation.
FalconX believes that there are numerous benefits to applying
certain rules from the CFTC's regulatory approach for derivatives
markets to digital asset spot markets. The CFTC's rules are clear,
tough, and fair. Spot markets would benefit from the application of
some of the CFTC business conduct standards, in particular those
focused on registration, reporting, and disclosure. At FalconX, we have
found that these rules greatly enhance our ability to foster a
transparent and orderly market for digital asset derivatives. Tailored
to the unique characteristics of digital asset spot markets, they could
greatly enhance market integrity, promote investor confidence, ensure
investor protection, and facilitate innovation.
V. Conclusion
Many companies in the digital asset space, like FalconX, are
voluntarily and eagerly seeking to conduct business in a compliant and
transparent manner. We firmly believe that Congress and market
regulators should work together to establish a framework for the
digital asset ecosystem so that we can both ensure that digital asset
markets are safe, transparent, and orderly for all participants.
Legislation like the Digital Commodity Exchange Act achieves just
this. We applaud Chairman GT Thompson and the rest of the Committee for
their leadership in this regard in the last Congress.
We look forward to this Committee's efforts to progress legislation
in cooperation and coordination with the House Financial Services
Committee. Chairman Thompson, Chairman Johnson, and Madam Ranking
Member, let me reiterate FalconX's appreciation for this opportunity to
testify in front of you this afternoon.
I look forward to answering any questions that you might have.
The Chairman. We are two for two on time. Mrs. Rubin, the
pressure mounts. You are up.
STATEMENT OF NILMINI RUBIN, CHIEF OF STAFF AND HEAD OF GLOBAL
POLICY, HEDERA HASHGRAPH, LLC, CHEVY CHASE, MD
Mrs. Rubin. Thank you, Chairman Johnson, Ranking Member
Caraveo, Members of the Subcommittee for inviting me to
testify. As today is take-your-child-to-work day, my husband
has brought two of our three daughters here today.
I am Nilmini Rubin, Head of Global Policy for the Hedera
Governing Council, a decentralized multi-stakeholder governing
body that establishes policies for the open-source Hedera
network.
Hedera is a fast and green distributed ledger or public
blockchain. Essentially, Hedera provides a layer of trusted
internet infrastructure for applications with real-world
impact. What we call the internet is a set of computers talking
to each other through open protocols. These protocols have
evolved over time to enable additional features and
capabilities that benefit society.
Initially, protocols enabled only read-only text or Web1.
Then, they enabled posting content and conducting commerce, or
Web2. And now, they enable personal control of data, or Web3.
Public blockchains are web-through platforms for other
applications and are operated by a network of independent
computers, or nodes. Now, these nodes do not fund their
operations by showing advertisements or selling subscriptions.
Instead, nodes are paid by users directly through fees like
water or electricity. Node fees are typically tiny and
frequent, with hundreds or thousands of transactions processed
per second. It is not possible to use the traditional financial
system to send fractions of a penny quickly, efficiently, and
globally.
To solve this problem, public blockchains use a digital
asset or cryptocurrency to rapidly transfer value between users
and node operators. The cryptocurrency serves as a fuel on
which the network runs. For example, in March, the Hedera
network processed over one billion transactions. Each
transaction costs between \1/10\ and \1/100\ of a penny and was
paid in the Hedera network's cryptocurrency called HBAR.
The key takeaway here is that public blockchains need
digital assets to operate. The ability of blockchains to
provide trusted and timestamped records enables people to
store, track, and monitor data in new and powerful ways. Three
examples of products running on the Hedera network include the
DOVU marketplace that allows farmers to generate additional
income from actions like changing farming techniques and
planting additional crops. Their actions are tokenized as
carbon credits to fund carbon-reducing projects.
The second one is atma.io built by Avery Dennison. It helps
brands reduce waste across the supply chain for over 28 billion
items, and it has both economic and environmental benefits.
And the third, Everyware. It monitors vaccine cold chain
storage across the supply chain and picks up on any
irregularities before administering those vaccines to patients,
keeping patients safe.
U.S. network and market infrastructure providers need a
complete roadmap towards compliance. The current U.S.
regulatory environment provides no clear path to compliance for
digital assets, leaving blockchains with two choices either
stop operating in the U.S. or hope U.S. policy will come
through before the enforcement of misaligned regulations.
To protect consumers, enable innovation, and promote
competition, we recommend Congress pass legislation creating an
activities-based framework to regulate digital assets based on
the nature of the transaction. First, Congress should provide a
definition of and delineation between digital commodity and
digital security or state when a digital asset is neither.
Second, Congress should empower the CFTC to regulate certain
digital commodity activities, such as operating a centralized
spot marketplace.
To extend U.S. leadership and competitiveness, Congress
should establish digital asset policy that supports the use of
public blockchains. The rest of the world is recognizing the
potential of blockchains. Other jurisdictions such as Dubai,
Europe, Singapore, and the United Kingdom, are creating digital
asset regulatory certainty. The United States risks shutting
out businesses that rely on digital assets to operate, risks
shutting out the ability to regulate the industry, and most
importantly, risks removing the American people's access to the
efficiency, transparency, and data-storage tools that the rest
of the world will be using to their competitive advantage.
Thank you for focusing on policy for the next wave of
digital innovation.
[The prepared statement of Mrs. Rubin follows:]
Prepared Statement of Nilmini Rubin, Chief of Staff and Head of Global
Policy, Hedera Hashgraph, LLC, Chevy Chase, MD
Thank you, Chairman Johnson, Ranking Member Caraveo, and Members of
the Subcommittee on Commodity Markets, Digital Assets, and Rural
Development for inviting me to testify today.
I am Nilmini Rubin, Head of Global Policy for the Hedera Governing
Council, a decentralized, multi-stakeholder governing body that
establishes policies for the open-source Hedera Network. Having spent
about twelve years as a House Foreign Affairs Committee and Senate
Foreign Relations Committee professional staff member, I am honored to
testify before Congress.
The Hedera Governing Council is one of many organizations working
on the Hedera network, a public blockchain launched in September of
2019, built on top of the open-source hashgraph technology. The Hedera
Network is a fast and green public blockchain whose general purpose
applications go well beyond financial services.
I speak today on behalf of only one part of the decentralized
Hedera network ecosystem--Hedera Hashgraph, LLC, a U.S. company, whose
members consist of twenty-eight leading global companies and
universities that comprise the Hedera Governing Council: abrdn, Avery
Dennison, Boeing, Chainlink Labs, DBS Bank, Dell Technologies, Dentons,
Deutsche Telekom, DLA Piper, EDF (Electricite de France), eftpos, FIS
(WorldPay), Google, IBM, the Indian Institute of Technology (IIT), LG
Electronics, The London School of Economics (LSE), Magalu, Nomura
Holdings, ServiceNow, Shinhan Bank, Standard Bank Group, Swirlds, Tata
Communications, Ubisoft, University College London (UCL), Wipro, and
Zain Group. My remarks do not necessarily reflect the views of any
particular Hedera member.
Why Public Blockchains Need Digital Assets
What we call ``the internet'' is essentially a decentralized set of
computers talking to each other through open protocols on a public
network. Each protocol was created by a multi-stakeholder governing
body. Those protocols, like TCP/IP, DNS, HTTPS, etc., have never
stopped evolving to enable additional features and capabilities that
benefit society. Initially, internet protocols just enabled a handful
of institutions to share information and send direct messages (the
`read-only' web or ``web1''). Protocol innovations enabled people
around the world to self-publish and securely message anyone (read and
write web or ``web2'')--unlocking the information revolution. Those
web2 protocol innovations enabled the secure sharing of images and
videos; secure credit card transactions--unlocking e-commerce; and
mobile apps connectivity--unlocking ubiquitous use of the internet
anywhere.
Public blockchains are often referred to as ``web3'' because they
deliver the next major protocol innovation. Public blockchains enable
unprecedented personal control--the ability to read, write, and own
your data and assets--without dependency on centralized intermediaries.
Unlike in web2, where a user account only exists on a single company's
servers, in web3 the entire blockchain network records account
ownership. Individuals hold cryptographic keys that enable access to
the account. This means that in web3 user accounts are persistent
across an unlimited array of services that exist on top of blockchain
networks, without requiring users to perpetually create new accounts
and passwords.
These web3 protocols, and cryptographically provable individual
ownership, allow major innovations including decentralized digital
identity. Decentralized identity allows an individual to control what
personal information is shared, and with whom it is shared, rather than
relying upon an ``identity provider'' to manage this for them, often
under a terms of service agreement the user doesn't fully understand.
So, if I need to prove that I am over 21, I could use my digital ID and
choose not to share additional information like my address which helps
me protect my safety.
Fundamentally, there are two ways to run a blockchain: (1) private
blockchains used for internal operations or with a consortium of
partners; and (2) public blockchains that anyone can build applications
on.
Public blockchains are operated by a network of independent
computers, or ``nodes.'' Since public blockchain nodes act as the
platform on which other applications are built, they cannot fund their
operations by showing advertisements or selling subscriptions like web2
intermediaries. Instead, nodes must be compensated by users directly
through fees, like water and electricity charges. The node fees are
typically tiny and frequent, with hundreds or thousands of messages or
transactions processed per second. It is not possible to use the
existing financial system to send fractions of a penny so quickly,
efficiently and globally.
To solve this problem, public blockchains use a digital asset, or
cryptocurrency, to transfer value directly between users and operators.
The nodes process these transfers in seconds. As there is no
intermediary, they go through an automated consensus-generating process
to ensure all computers agree on the amount of cryptocurrency in each
network account. The cryptocurrency serves as the fuel on which the
network runs. For example, during the previous month, the Hedera
Network processed over 600 transactions per second--in total over 1.5
billion transactions. Each transaction cost between a tenth ($0.001)
and hundredth ($0.0001) of a penny, paid in the network's native
cryptocurrency called ``hbar.''
Public Blockchains Advance the Economy and Humanity
The ability of blockchains to provide immutable, auditable, and
order-based records, enables businesses and organizations to store,
track and monitor data in new and powerful ways. Products running now
on Hedera store, track, and monitor data to reduce waste, fraud, and
abuse, and provide economic, social, and environmental benefits, for
example:
Data storage and provenance--supporting human rights:
Starling Lab, co-founded by Stanford University's School of
Engineering and the University of Southern California's Shoah
Foundation, built a framework on Hedera and other blockchains
to verify, and preserve the authenticity of photos and other
evidence.
Starling Labs is preserving the USC Shoah Foundation's
Holocaust archive and testimonies from tampering,
effectively storing, distributing, and verifying the
testimonials through sophisticated automated tracking and
tracing.\1\
---------------------------------------------------------------------------
\1\ https://www.jpost.com/diaspora/antisemitism/how-blockchain-can-
preserve-holocaust-testimonies-from-manipulation-657308.
Starling Lab and Hala Systems submitted a digital
evidence package to the Office of the Prosecutor of the
International Criminal Court documenting possible war
crimes in Kharkiv, Ukraine. The package was an unbroken
chain of digital evidence establishing data provenance,
proving it had not been tampered with from the field to the
courtroom--a first for any court submission in the
world.\2\
---------------------------------------------------------------------------
\2\ https://dornsife.usc.edu/cagr-news/news/2022/06/33571-starling-
lab-and-hala-systems-file-cryptographic-submission-evidence-war-crimes.
Value exchange--supporting rural development: DOVU is a
marketplace, built on Hedera, to inexpensively issue tokenized
carbon credits in order to fund projects that remove, capture,
or sequester carbon from the environment. This presents an
opportunity for participating farmers to generate additional
income by unlocking carbon sequestered in soil; increase the
amount of carbon sequestered, and selling the carbon to buyers
looking for offsets. The entire audit trail technology is built
on top of Hedera's Guardian open-source framework, and verifies
the entire journey for any carbon project from onboarding to
retirement, with simple visualizations and documentation.\3\
---------------------------------------------------------------------------
\3\ https://dovu.earth/en/news/.
Transparent platforms--supporting the environment: CYNK,
Africa's first verified carbon emissions reduction platform,
built a product on Hedera to track and trade emission reduction
tokens generated by Tamuwa, Kenya's largest biomass company.
CYNK provides an immutable audit trail for all of Tamuwa's
carbon credits, bringing trust and transparency to the
emissions reduction platform.\4\
---------------------------------------------------------------------------
\4\ https://furtherafrica.com/2022/10/05/first-african-emissions-
reduction-platform-to-begin-trading/.
Supply chain traceability--supporting waste reduction:
atma.io, built by Avery Dennison, utilizes Hedera and helps
brands meet net-zero targets and reduce waste across the supply
chain. As more than 28 billion items across apparel, retail,
food and healthcare move through the supply chain, their
movements are recorded as transactions, timestamped and stored
on Hedera. This allows atma.io to provide a granular view of
carbon emissions and enables targeted carbon reductions.\5\
---------------------------------------------------------------------------
\5\ https://www.labelsandlabeling.com/news/sustainability/atmaio-
utilize-hedera-network-co2-emissions.
Supply chain monitoring--supporting vaccine safety:
Everyware built a product on Hedera to monitor vaccine cold-
chain storage and pick up on any irregularities before
administering those vaccines to patients. Everyware's sensors
monitor the temperature of refrigerators storing the
temperature-sensitive vaccines in real-time, and transmit the
data to its cloud platform, which is encrypted and then saved
on to Hedera's blockchain network.\6\
---------------------------------------------------------------------------
\6\ https://www.cnbc.com/2021/01/19/uk-hospitals-use-blockchain-to-
track-coronavirus-vaccine-temperature.html.
Supply chain tracking--supporting pharmaceutical safety: AVC
Global and Medical Value Chain (MVC), built a product on Hedera
and another blockchain to track all pharmaceuticals coming into
the Kingdom of Bahrain. Their SmartPass technology
cryptographically tracks the entire supply chain to allow users
to authenticate pharmaceuticals and avoid dangerous
counterfeits.\7\
---------------------------------------------------------------------------
\7\ https://www.unlock-bc.com/news/2021-05-25/bahrain-based-
medical-value-chain-fully-integrated-with-blockchain-hedera-hashgraph/.
In addition, establishing strong digital asset policy frameworks
and regulation advances American values. Before hosting the Summit for
Democracy in March, the U.S. government issued a call to the private
sector to address global democratic challenges. Hedera was proud to
respond and committed to convening a roundtable on how blockchain
technologies can support democracy. Hedera will invite companies, trade
associations, advocacy groups, academics and government officials,
publicly share a summary of the discussion, and make recommendations
for next steps.\8\
---------------------------------------------------------------------------
\8\ https://www.state.gov/private-sector-commitments-to-advance-
democracy/.
---------------------------------------------------------------------------
Recommendations for Congress
The sale of digital assets to raise money for the creation of a
network or application is fundamentally different from the use of
digital assets as a fuel to pay for network activity costs or obtain
access to other goods or services, and regulations should be tailored
to address the unique characteristics of each. Participants in each
transaction should be able to have a clear understanding of how the
regulations apply and what their obligations are.
Built on the premise that digital asset regulation should protect
consumers, enable innovation, and promote competition, we recommend
passage of legislation to create an activities-based framework that
regulates the use of digital assets based on the nature of the
transaction:
First, Congress should provide a clear definition of and
delineation between ``Digital Commodity'' and ``Digital
Security,'' or when a digital asset is neither. Currently, it
is not clear whether the Commodity Futures Trading Commission
(CFTC) or the Securities and Exchange Commission (SEC) is the
primary regulator for any given digital asset or transaction.
Second, Congress should empower the CFTC to regulate certain
Digital Commodity activities, such as operating a centralized
spot marketplace. Network and market infrastructure providers
in the U.S. today do not have a complete roadmap toward
compliance and appropriate regulatory oversight. For example,
if trading platforms must register as a designated contract
market (DCM) and intermediaries must register as a futures
commission merchant (FCM), how can businesses be brought into
the existing regulatory perimeter without friction or harm to
purchasers and users? Clarity here will greatly improve
consumer safety as adoption of these technologies and their
benefits accelerate.
In the same way not all assets are securities, not all digital
assets are securities. Not all digital assets are securities because
not all digital assets have the same purpose, characteristics, and
historical facts and circumstances. Applying existing securities law to
all cryptocurrencies severely limits--if not prohibits--the actual use
of public blockchains. For example, a supply chain application for the
manufacturing process of a food item to ensure accurate tracking of
expiration dates for consumer safety may require the use of an SEC-
registered broker-dealer just to pay a 1 transaction fee in
cryptocurrency to log a supply chain event.
Legislative clarity for innovative products has been done before.
The 2010 Dodd-Frank Wall Street Consumer Protection Act allocated
rulemaking authority for swaps to more than one Federal agency. In
Title VII of the Dodd-Frank Act, Congress recognized that derivatives
contracts differed meaningfully and allocated authority for swaps
involving a commodity interest to the CFTC, while at the same time
granting rulemaking and oversight of swaps involving an underlying
security to the SEC. Today, swaps market regulation is largely viewed
as an example of successful allocation of regulatory authority between
two agencies. The same approach could be taken to digital assets.
Digital asset use is inherently international and it is important
that any regulation takes that into account. The CFTC has an
established process for permitted substituted compliance with non-U.S.
regulatory regimes. Known as Comparability Determinations, the CFTC has
the authority to determine that a foreign jurisdiction's regulatory
requirements are comparable to the CFTC's requirements under U.S.
law.\9\
---------------------------------------------------------------------------
\9\ See Comparability Determination for Substituted Compliance
Purposes at https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/
index.htm.
To regulate fast-developing innovations like digital assets, the
CFTC is a more appropriate regulator than the SEC because the CFTC
adheres to the concept of ``principles-based regulation'' while the SEC
---------------------------------------------------------------------------
follows a prescriptive rules based approach.
As former CFTC Chair Heath Tarbert noted, ``It is important to
recognize that principles-based regulation is not a euphemism for
`deregulation' or a `light-touch' approach--far from it. Principles-
based regulation is a different way of achieving the same regulatory
outcomes as rules-based regulation. But it simply does so in what is,
in many cases, a more efficient and flexible manner.'' \10\ The current
regulatory environment in the U.S. provides no clear path to
compliance, leaving two choices: (1) find that path overseas; or (2)
continue hoping regulation will catch up before enforcement punishes
another innovator for being a square peg they cannot fit into their
round hole of prescriptive rules designed for very different
activities, decades before these innovative activities were ever
considered.
---------------------------------------------------------------------------
\10\ See Fintech Regulation Needs More Principles, Not More Rules
at https://fortune.com/2019/11/19/bitcoin-blockchain-fintech-
regulation-ctfc/.
---------------------------------------------------------------------------
Conclusion
The internet is global but it was invented here in the U.S.,
allowing American values to underpin fundamental internet protocols.
Congress must define rules in the U.S. to allow public blockchains to
thrive so that the next wave of internet value creation continues to
echo the U.S.' commitment to markets and democracy. Other countries and
regions, including China, the European Union, Singapore, the United
Arab Emirates and the United Kingdom, are swiftly moving forward with
their own digital asset regulations. The resulting regulatory certainty
may give companies currently based in those locations an advantage over
U.S. companies; it may encourage companies to move to some of those
locations; and it may present national security risks.
Thank you for your focus on digital assets and setting the rules
that will enable American innovators to continue to play a leading role
in crafting the future of the internet.
The Chairman. Very well said.
Mr. Massad, you are up, three for three.
STATEMENT OF HON. TIMOTHY G. MASSAD, J.D., RESEARCH FELLOW,
MOSSAVAR-RAHMANI CENTER FOR BUSINESS AND GOVERNMENT, KENNEDY
SCHOOL OF GOVERNMENT,
HARVARD UNIVERSITY; DIRECTOR; M-RCBG DIGITAL
ASSETS POLICY PROJECT, WASHINGTON, D.C.
Mr. Massad. Chairman Thompson, Chairman Johnson, Ranking
Member Caraveo, Members of the Committee and staff, I am
honored to be testifying before you today. It is almost a
decade since I first testified before this Committee about the
lack of a comprehensive regulatory framework for crypto. Four
years ago, I wrote a paper on the need to strengthen
regulation, which began with the following sentence: ``There is
a gap in the regulation of crypto assets that Congress needs to
fix.'' That gap still exists today, of course, and it is the
absence of a Federal regulator for the spot market and crypto
tokens that are not securities, as has been explained. And it
is a principal reason why investor protection in the crypto
market is extremely weak, and that was made painfully obvious
by the failures of several crypto firms last year such as FTX,
which resulted in hundreds of thousands of people suffering
losses.
Now, there are other gaps. I have noted some of those in my
written testimony, but I will focus on this one.
For years now, I have said that either the SEC or the CFTC
needs to be given the authority and the resources to regulate
that spot market. Today, I want to suggest to you that there is
another path forward, an easier path forward, and it addresses
the fact that the lack of investor protection is also related
to this debate about whether crypto tokens should be considered
securities or commodities or something else. Industry
participants complained about the lack of regulatory clarity,
but trading and lending platforms also claim they are dealing
only in tokens that are securities, thereby avoiding direct
Federal oversight. SEC Chair Gensler, on the other hand, says
most tokens are securities, and the problem is a lack of
compliance with existing requirements.
While the SEC has brought enforcement actions on this
issue, that path could take a long time to reach sufficient
clarity. And while there are legislative proposals to address
this issue, by revising regulatory categories, I am concerned
those could generate as much confusion as clarity
There is an alternative path forward. It would increase
investor protection quickly, without rewriting decades of law
or diminishing the existing authority of either the SEC or the
CFTC. The investor protection standards we need are largely the
same, regardless of whether a token falls in the securities or
commodities bucket. Therefore, Congress would pass a law
mandating that any trading or lending platform that trades
Bitcoin or Ethereum must comply with a core set of principles
unless that platform has already registered with the SEC or the
CFTC. The principles would include protection of customer
assets, prevention of fraud and manipulation, prohibition of
conflicts of interest, and others as I have set forth in my
written statement. Congress would direct the SEC and the CFTC
to develop joint rules implementing these principles or create
a self-regulatory organization, SRO, to do so.
This approach has several advantages. First, it is simple.
The requirements would apply to any trading or lending platform
that trades Bitcoin or Ethereum. That captures almost all of
the market, if not the entire market.
Second, it focuses on the core of the problem. Over 90
percent of spot trading volume takes place on centralized
intermediaries. This approach would dramatically raise the
level of investor protection on those platforms. Simply
eliminating wash trading where someone trades with themselves
or an affiliate to inflate the price or trading volume of an
asset and which has been estimated to represent 50 to 90
percent of the volume on many platforms would be a huge
improvement. And of course, the rules can also be customized to
apply to decentralized platforms.
Third, it is practical. It is based on the market as it
exists today. It would not require a bifurcation of trading
into one platform for security tokens and one for commodity
tokens. And that is useful because actual trading takes place
in pairs of tokens that can often be in different buckets.
In addition, by using an SRO, the industry could be
required to pay for the cost of the approach. You would not
have to allocate money. The approach would not involve
rewriting existing securities or commodities laws, and such
proposals might not only fail to bring clarity to crypto, they
might unintentionally undermine decades of regulation and
jurisprudence. In particular, the law should make clear that
the CFTC and SEC would retain their existing authority. The SEC
could still contend that any particular token is a security,
and if it prevailed, the intermediary would have to stop
dealing in that token or move it to a registered platform, but
the intermediary would not be shut down. That would assure
platforms and their customers that operations will continue on
a far more responsible basis.
The approach finally is incremental. While
comprehensiveness is desirable, it can take a long time to
build consensus. I believe it is better to do something
incremental that can protect millions of investors and serve as
a foundation which can be improved over time. This is
essentially the same thing that former SEC Chair Jay Clayton
and I proposed in a Wall Street Journal op-ed. And the point is
that this is a proposal that can be supported by people,
regardless of one's view of the value of crypto, whether you
are breathlessly positive or angrily negative I believe you
said, Mr. Chairman, and it is a proposal people on both sides
of the political aisle can support.
Thank you.
[The prepared statement of Mr. Massad follows:]
Prepared Statement of Hon. Timothy G. Massad, J.D.,* Research Fellow,
Mossavar-Rahmani Center for Business and Government, Kennedy School of
Government, Harvard University; Director; M-RCBG Digital Assets Policy
Project, Washington, D.C.
---------------------------------------------------------------------------
* Research Fellow and Director, Digital Assets Policy Project,
Harvard Kennedy School Mossavar-Rahmani Center for Business and
Government; Chairman of the Commodity Futures Trading Commission (2014-
2017); Assistant Secretary for Financial Stability of the U.S. Treasury
(2010-2014).
---------------------------------------------------------------------------
Chairman Thompson, Ranking Member Scott, Subcommittee Chairman
Johnson, Subcommittee Ranking Member Caraveo, Members of the Committee
and staff, I am honored to be testifying before you today. It is almost
a decade since I first testified before this Committee about the lack
of a comprehensive regulatory framework for crypto in the United
States. Four years ago, I wrote a paper published by the Brookings
Institute on the need to strengthen crypto asset regulation. It began
with the following sentence: ``There is a gap in the regulation of
crypto assets that Congress needs to fix.'' \1\ While I am pleased this
hearing is being held, it is unfortunate that there are still
significant gaps in crypto asset regulation.
---------------------------------------------------------------------------
\1\ Timothy Massad, It's Time to Strengthen the Regulation of
Crypto-Assets, The Brookings Institute, p. 2 (Mar. 2019), https://
www.brookings.edu/research/its-time-to-strengthen-the-regulation-of-
crypto-assets/ (hereinafter ``Massad 2019'').
---------------------------------------------------------------------------
The gap I talked about then was the absence of a Federal regulator
for the spot market in crypto tokens that are not securities, such as
bitcoin. It was during my tenure as Chairman of the Commodity Futures
Trading Commission (CFTC) that the agency declared bitcoin and other
virtual currencies to be commodities, which gave the agency authority
to regulate derivatives based on such commodities, but its authority
over the spot market for any commodity is quite limited.\2\
---------------------------------------------------------------------------
\2\ The CFTC has authority to bring enforcement actions for fraud
and manipulation in the spot market and to regulate certain retail
leveraged transactions, but it does not have the authority to prescribe
standards under which trading platforms or other intermediaries must
operate. For a discussion of the CFTC's authority, see ibid, pp. 32-33
as well as Timothy Massad and Howell Jackson, How to improve regulation
of crypto today--without Congressional action--and make the industry
pay for it, The Brookings Institute, pp. 8-9 (October, 2022), https://
www.brookings.edu/research/how-to-improve-regulation-of-crypto-today-
without-congressional-action-and-make-the-industry-pay-for-it/
(hereinafter ``Massad-Jackson 2022'').
---------------------------------------------------------------------------
Because of this and other reasons, investor protection is woefully
inadequate on crypto trading and lending platforms. These platforms do
not observe standards common in our financial markets that ensure
protection of customer assets, prohibition of conflicts of interest,
prevention of fraud and manipulation, and adequate transparency, among
other things. That was made painfully obvious last year by the failures
of trading platform FTX, crypto lender Celsius, the Terra/Luna
stablecoin and others, resulting in hundreds of thousands of investors
sufferinglosses.
There are other gaps in crypto-asset regulation. One is the lack of
a Federal regulatory framework for stablecoins. The report of the
Financial Stability Oversight Council issued last fall identified
additional gaps consisting of the opportunities for regulatory
arbitrage and ``whether vertically integrated market structures can or
should be accommodated under existing laws and regulations.'' \3\ While
I agree with these findings and share the concerns in the FSOC report,
I will focus on the gap in oversight of the spot market and make some
brief comments about the absence of a Federal regulatory framework for
stablecoins.
---------------------------------------------------------------------------
\3\ Financial Stability Oversight Council, Report on Digital Asset
Financial Stability Risks and Regulation, p. 5 (October 2022), https://
home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf
(hereinafter the ``FSOC Report'').
---------------------------------------------------------------------------
In my 2019 paper, I proposed that either the Securities and
Exchange Commission or the Commodity Futures Trading Commission be
given authority to regulate the spot market for crypto assets that are
not securities. Either agency is capable of doing so provided it is
given sufficient resources. I know first hand the challenges faced by
the CFTC because of its limited budget, and the task of regulating the
crypto asset (non-security) spot market would require significant
resources.
Today, I want to suggest that there is another path forward as
well. It addresses the fact that spot market regulation is very
challenging because of the question of how to classify digital assets:
are they securities or commodities or something else? Should we create
a new regulatory category for them? The debate over this issue is a
major reason why crypto trading and lending platforms do not observe
standards that are common in other financial markets. Industry
participants complain about a lack of clarity in the rules for
resolving this issue and have called for regulators to create a new set
of rules specifically for crypto. But meanwhile trading and lending
platforms claim they are only dealing in tokens that are not
securities--thereby avoiding direct Federal oversight. Chair Gary
Gensler of the Securities and Exchange Commission (SEC) says most
tokens are securities and the problem is a lack of compliance with
existing legal requirements.\4\ There is no need to write new rules
just because of a new technology, and doing so might undermine decades
of precedents that have contributed to the strength of our capital
markets generally.
---------------------------------------------------------------------------
\4\ See, for example, Chair Gensler's testimony before the U.S.
House of Representatives Financial Services Committee on April 18,
2023, at https://financialservices.house.gov/calendar/
eventsingle.aspx?EventID=408690.
---------------------------------------------------------------------------
The SEC has some pending enforcement actions that may bring greater
clarity to this question. But that is uncertain and could take time,
during which investors will continue to be at risk. Moreover, even if
the SEC prevails in particular cases, it may face a game of whack-a-
mole, where proponents of other tokens and the trading and lending
platforms themselves argue that other tokens are different from the
particular facts of an SEC victory, triggering further litigation.
Meanwhile, Members of Congress have proposed legislation that would
create new regulatory categories meant to resolve this issue, often in
conjunction with giving new authority to the CFTC for the spot market.
While admirable in intent, the risk is creating new regulatory
categories of assets might generate more confusion than clarity, and
lead to disputes over their own meaning that could take years to
resolve. They could also have unintended adverse ancillary effects with
respect to regulation of capital markets generally.
There is an alternative path forward. It would increase investor
protection quickly without rewriting decades of law in one bill. It
would not diminish the existing authority of either the SEC or the
CFTC.
The idea is to create a baseline of investor protection by
recognizing that many of the standards we need are the same regardless
of whether a token falls in the securities or commodities bucket.
Congress would pass a law mandating that any trading or lending
platform that trades bitcoin or ethereum must comply with a set of core
principles, unless the platform has already registered with the SEC or
CFTC as a securities or derivatives intermediary. The principles would
include protection of customer assets, prevention of fraud and
manipulation, prohibition of conflicts of interest, adequate disclosure
to investors, regular reporting, pre and post trade transparency, risk
management and governance standards, among others.
Congress would direct the SEC and the CFTC to develop joint rules
implementing these principles (and the principles could also be made
applicable pending issuance of such rules). Rules could also be
developed by creating a new self-regulatory organization (SRO) jointly
supervised by the SEC and the CFTC. SROs have been critical to the
regulation of our securities and derivatives markets for decades, and
there is precedent for SROs registered with both the SEC and the
CFTC.\5\ The SRO could also be charged with enforcing the rules.
---------------------------------------------------------------------------
\5\ See Massad-Jackson 2022, supra note 2.
---------------------------------------------------------------------------
I believe this approach has several advantages. It is simple. It
focuses on the core of the problem. It is practical and feasible. It
can be implemented quickly and efficiently. It does not rewrite
existing law in ways that may create more confusion than clarity. And
it is incremental. Let me explain each of these aspects and then
provide some greater detail and background.
First, simplicity: the approach is based on a clear definition of
jurisdiction. The requirements would apply to any trading or lending
platform that trades bitcoin or ethereum, which are chosen because they
represent so much of the market. There would not be confusion as to
what entities must comply, though one could add other tokens to the
list or include a minimum volume threshold to exclude insignificant
activity. It would also be based on principles that are already
wellknown in financial market regulation, the desirability of which
should command wide support.
Second, it focuses on the core of the problem. Over 90% of spot
market trading is estimated to occur through centralized
intermediaries.\6\ If we can raise the level of investor protection on
those intermediaries, that will help prevent the kinds of losses we
have seen recently. It may also take some of the speculative air out of
the sails of this industry. For example, wash trading--where someone
trades with themselves or an affiliate to inflate the price or trading
volume of an asset--has been estimated to represent 50% or more of the
trading on crypto platforms.\7\ If we simply prevented that, it would
be a huge improvement. The proposal can also cover decentralized
platforms, as the agencies or SRO can be directed to develop
appropriate adjustments to rules for those as well.
---------------------------------------------------------------------------
\6\ See Coingecko, 2022 Annual Crypto Industry Report which
estimated that as of the end of 2022, centralized exchanges had 93% of
market share.
\7\ See Lin William Cong, et al., Crypto Wash Trading (July 2021),
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3530220 (estimating
that wash trades account for 70 percent of volume on unregulated
cryptocurrency exchanges); see also Jialan, Chen et al., Do
Cryptocurrency Exchanges Fake Trading Volume? 586 Physica A. 126405
(Jan. 15, 2022); Matthew Hougan, et al., Economic and Non-Economic
Trading In Bitcoin: Exploring the Real Spot Market For The World's
First Digital Commodity, Bitwise Asset Management (May 24, 2019),
https://www.sec.gov/comments/sr-nysearca-2019-01/srnysearca201901-
5574233-185408.pdf (study demonstrating that ``95% of reported trading
volume in bitcoin is fake or non-economic in nature''); Javier Paz,
More Than Half of All Bitcoin Trades are Fake, Forbes (Aug. 26, 2022),
https://www.forbes.com/sites/javierpaz/2022/08/26/more-than-half-of-
all-bitcoin-trades-are-fake/?sh=
11ea350b6681; see also Steve Inskeep, et al., How ``wash trading'' is
perpetuating crypto fraud, NPR (Sept. 23, 2022), https://www.npr.org/
2022/09/23/1124662811/how-wash-trading-is-perpetuating-crypto-fraud.
---------------------------------------------------------------------------
Third, it is practical and feasible. It is practical because it is
based on the market as it exists today. The subject platforms would be
required to implement the principles regardless of arguments about what
is a security and what is a commodity. It would not require a
bifurcation of trading into one platform for security tokens and one
for commodity tokens. This is particularly useful because crypto
trading involves pairs of tokens that might be classified into
different buckets. It is feasible because the SEC and the CFTC have the
experience to implement the principles and there are precedents for
them working together. By forming an SRO, they could draw on the
expertise of existing SROs such as the Financial Industry Regulatory
Association (FINRA) and the National Futures Association (NFA).
Finally, the cost of the SRO's activities could be imposed on the
industry through membership fees, consistent with existing practice.
The approach would not involve rewriting existing securities or
commodities law. There would be no changes to the definition of
security, which might not only fail to bring clarity to crypto; that
might unintentionally undermine decades of regulation and jurisprudence
as it applies to traditional securities and derivatives markets.
In particular, the law should not diminish the existing authority
of either the SEC or the CFTC. It should make clear that the SEC would
retain its authority to contend that any particular token is a
security. If, for example, it prevailed in any particular case, an
intermediary would still have to comply--by ceasing to deal in that
token, or only doing so on a registered platform--but it would not be
shut down as long as it was complying with these basic standards. This
would assure the platforms, and their customers, that operations will
continue--on a far more responsible basis--while classification and
other issues are resolved.
Finally, the approach is incremental in several ways. It does not
seek to regulate all crypto transactions or all players in the crypto
world from the get-go or resolve the classification questions. It does
not rewrite the law as noted. While comprehensiveness is desirable, it
can take a long time to build consensus, and it is much harder to get
it right. It is better to do something incremental now that can protect
millions of investors and serve as a foundation which can be added to
and improved over time.
How Did We Get Here?
Former SEC Chairman Jay Clayton and I have advocated essentially
this approach in a Wall Street Journal op-ed late last year. We wrote
about how ``the unique genesis of crypto assets . . . complicated the
regulatory challenge.''
Unlike other financial innovations, bitcoin was launched
globally and directly to retail consumers, with a claim that it
would make traditional intermediaries obsolete. Because
financial regulation is implemented on a national basis and
largely through intermediaries, this ``global retail'' path of
emergence has challenged regulators as traditional tools are
less effective.'' \8\
---------------------------------------------------------------------------
\8\ Jay Clayton and Timothy Massad, ``How to Start Regulating the
Crypto Markets--Immediately,'' The Wall Street Journal, (Dec. 4, 2022),
https://www.wsj.com/articles/how-regulate-cryptocurrency-markets-
11670110885.
It is ironic that an innovation that claimed it would make
traditional intermediaries obsolete actually created a whole new
category of intermediaries--crypto trading and lending platforms. These
new intermediaries are also less accountable than the traditional ones
that the creator of bitcoin and many crypto proponents complain about.
Former Chair Clayton and I went on to say that other complicating
factors have been the fact that ``the use case of many crypto assets is
often cloudy''--it is not always clear whether a particular token
offers an investment opportunity, access to goods or services, or a
bank-like product. In addition, the U.S. has a fragmented financial
regulatory system with multiple regulators responsible for different
product areas.\9\ These factors have all contributed to the lack of a
strong investor protection framework.
---------------------------------------------------------------------------
\9\ Id.
---------------------------------------------------------------------------
Achieving Investor Protection Now, While Classification Arguments
Continue
A key virtue of this approach is that it will allow us to improve
investor protection without having first to resolve questions of which
tokens are securities and which are commodities. Crypto trading
platforms are all quick to say they do not trade or list any tokens
that are securities, but there is significant variation in what they do
actually list, which should make us ask why that is the case.
For example, as of a recent date, the four largest U.S. platforms--
Binance U.S., Coinbase, Gemini and Kraken, listed approximately 60
tokens in common, such as bitcoin and ethereum.\10\ Each platform,
however, lists a lot more tokens. The number ranges from over 250
(Coinbase) to about half that amount (Gemini). Collectively, the four
platforms list a total of around 400 different tokens, and each one
lists many tokens that none of the others list.
---------------------------------------------------------------------------
\10\ These numbers are based on a manual comparison of listings
noted on their respective websites.
---------------------------------------------------------------------------
If each platform is confident that all the tokens it lists are not
securities, why don't they list more tokens in common? Would they say
all 400 tokens are not securities and claim their selection is based on
other factors?
There are surely other factors that are considered, but it seems
unlikely these would account for the degree of difference. For example,
Coinbase says it considers other factors such as ``customer demand
(i.e., trading volume, market cap), traction of token/application
(i.e., token holders) and anticipated liquidity.'' \11\ Changpeng
(C.Z.) Zhao, the co-founder and chief executive officer of Binance.com,
once put it more bluntly: ``If a coin has a large number of users, then
we will list it. That's the overwhelming significant attribute.'' \12\
---------------------------------------------------------------------------
\11\ Coinbase Exchange, ``Listing Prioritization Process &
Standards,'' (Oct. 2022), https://assets.ctfassets.net/c5bd0wqjc7v0/
1DqPApt37t3uBHAMFUxPyI/4fa9169f9a8d90191d322635e597b
fda/Coinbase_Exchange_Listing_Prioritization_Process_and_Standards.pdf
\12\ Helen Partz, ``Binance CEO reveals one key factor for token
listings,'' Cointelegraph, (Nov. 30, 2021), https://cointelegraph.com/
news/binance-ceo-reveals-one-key-factor-for-token-listings.
---------------------------------------------------------------------------
While it would seem reasonable for platforms to consider consumer
demand, one would expect that criteria to lead to platforms listing the
same tokens, not different tokens. And if instead selections reflect
the platforms' different judgements about technical or security issues,
that would suggest a need for better disclosure about tokens that are
listed.
As I noted earlier, there are pending cases that may provide
further light on these classification issues, and my approach does not
interfere with the exercise of the SEC or CFTC's authority or the
proper role of the courts in resolving those questions. Indeed, if the
SEC succeeds in establishing that a token is a security, then trading
in that token would need to be on an SEC registered exchange. But we do
not need to wait for any such case to be resolved.
The Principles
The principles that Congress would articulate would be familiar
ones used in our securities and derivatives markets. The list could
include the following:
governance standards (including fitness standards for
directors and officers);
protection of customer assets, including segregation and
protection in bankruptcy;
conflicts of interest (including prohibitions or limitations
on the ability of trading platforms to engage in proprietary
trading or having financial interests in listed assets);
having adequate financial resources, including capital and
margin;
recordkeeping and periodic public disclosures;
execution and settlement of transactions in a competitive,
open, efficient and timely manner[;]
pre- and post-trade transparency requirements;
prevention of fraud, manipulation and abusive practices
(including prevention of wash trading);
disclosures to customers, including regarding fees,
recourse, and dispute resolution; \13\
---------------------------------------------------------------------------
\13\ Howell Jackson and I noted in our SRO paper (see note 2) that
some have been critical of FINRA's arbitration proceedings for investor
disputes involving securities transactions. See, e.g., Mark Egan, et
al., Arbitration with Uninformed Consumers, Harvard Business School
Finance Working Paper No. 19-046 (May 11, 2021), https://
papers.ssrn.com/sol3/papers.cfm?abstract_id=3260442. Whatever concerns
one might have about FINRA arbitration proceedings as currently
implemented, the point to recognize is that consumers investing in
crypto-asset markets now have no mechanism for supervised dispute
resolution. Moreover, the most stringent system of oversight currently
under debate for crypto-assets--full compliance with SEC requirements--
implicitly contemplates the application of FINRA arbitration
requirements. Conceivably a crypto-asset SRO might adopt better
arbitration rules, but whatever rules they adopt would most likely be
an improvement upon the status quo.
---------------------------------------------------------------------------
risk management practices;
operational resilience, cybersecurity standards and business
continuity and disaster recovery policies; and
know your customer (KYC), anti-money laundering (AML) and
combating financial terrorism (CFT) standards.\14\
---------------------------------------------------------------------------
\14\ See also Massad and Jackson (2022), supra, note 2.
There could also be a requirement that a platform must make sure
there is disclosure regarding a token, whether provided by a person
seeking admission of a token to trading or otherwise. This is the
approach taken in the new Regulation of the European Parliament and of
the Council on Markets in Crypto-assets (MiCA), which provides that a
crypto token cannot be listed unless there is a white paper on file
that provides basic information.\15\ The disclosure requirements need
not mirror existing securities law requirements. Georgetown Law
Professor Chris Brummer has argued that Regulation S-K, the SEC's
primary disclosure regulation, is both ``over-inclusive and under-
inclusive'' with respect to crypto: ``it fails in some instances to
account for critical aspects of the digital assets ecosystem, and in
others imposes obligations with little to no relevance, creating both a
lack of clarity and inefficiency in compliance.'' \16\ The approach
suggested here allows for development of disclosure requirements
without undercutting existing securities law which would continue to
apply to any token ultimately deemed a security.
---------------------------------------------------------------------------
\15\ The white paper must contain ``(a) information about the
offeror or the person seeking admission to trading; (b) information
about the issuer, if different from the offeror or person seeking
admission to trading; (c) information about the operator of the trading
platform in cases where it draws up the crypto-asset white paper; (d)
information about the crypto-asset project; (e) information about the
offer to the public of the crypto-asset or its admission to trading;
(f) information about the crypto-asset; (g) information on the rights
and obligations attached to the crypto asset; (h) information on the
underlying technology; (i) information on the risks; (j) information on
the principal adverse impacts on the climate and other environment-
related adverse impacts of the consensus mechanism used to issue the
crypto-asset.''
These requirements are spelled out in further detail in an
appendix. There is also a requirement that the paper not contain any
material omission. See European Parliament, ``Position of the European
Parliament adopted at first reading on 20 April 2023 with a view to the
adoption of Regulation (EU) 2023/ . . . of the European Parliament and
of the Council on markets in crypto-assets, and amending Regulations
(EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and
(EU) 2019/1937'' (April 24, 2023), Procedure: 2020/0265(COD), available
at https://www.europarl.europa.eu/doceo/document/TA-9-2023-
0117_EN.html#title2.
\16\ Georgetown Law Professor Chris Brummer has argued that
Regulation S-K, the SEC's primary disclosure regulation, is both
``over-inclusive and under-inclusive'' with respect to crypto: ``it
fails in some instances to account for critical aspects of the digital
assets ecosystem, and in others imposes obligations with little to no
relevance, creating both a lack of clarity and inefficiency in
compliance.'' Chris Brummer, Georgetown Law School, Testimony before
the Agriculture Committee of the U.S. House of Representatives,
Subcommittee on Commodity Exchanges, Energy, and Credit (June 23,
2002), https://docs.house.gov/meetings/AG/AG22/20220623/114931/HHRG-
117-AG22-Wstate-BrummerC-20220623-U1.pdf.
---------------------------------------------------------------------------
In addition to improving investor protection, requiring
intermediaries to observe these principles will serve some broader
policy goals. It will strengthen our ability to prevent crypto markets
from being used for illicit activity. It will give regulators greater
information that can help prevent any potential risks to financial
stability. Requiring crypto intermediaries to have stronger resiliency
standards and cybersecurity protections--which is critical given how
common hacks and outages have been--can also help reduce the risk that
such hacks and attacks result in collateral damage to other parts of
the financial system.
Implementing the Approach Through a Self-Regulatory Organization
While Congress could direct the SEC and the CFTC to jointly develop
and enforce rules implementing the principles, a more efficient
approach may be to have the two agencies create and supervise a self-
regulatory organization that would do so. Professor Howell Jackson of
Harvard Law School and I have written about how such an approach could
work in a recent paper.
The ``self-regulatory'' aspect of an SRO does not mean lax
standards, as long as the SRO is properly supervised by the SEC and
CFTC. On the contrary, our country's SROs have been important
components of the regulation of our securities and derivatives markets
for decades. They have been central to the development and
implementation of strong standards, as well as enforcement of those
standards against industry participants.
Although the SEC and CFTC have authority to create an SRO without
legislation, and there are precedents for joint SROs,\17\ having
Congress direct the agencies to do so would make clear the importance
of and authority for such an approach. A jointly supervised SRO is also
appropriate given the fact that both the SEC and CFTC have some
jurisdiction over crypto. To the extent there are some differences in
existing law with respect to an agency's authority over or relationship
to an SRO (such as in the process for approving rules), those could be
harmonized or resolved in favor of one approach over another.\18\ An
SRO could make it easier to conduct supervision and enforcement,
because those activities could be conducted by SRO staff rather than
joint teams of the two agencies. The Congress could also make clear
that the SRO would be financed from industry member dues, as is the
practice with existing SROs.
---------------------------------------------------------------------------
\17\ See Massad-Jackson 2022, at note 2.
\18\ For example, under current law, the SEC must approve an SRO's
proposed rules; if the CFTC does not object to a proposed rule, it is
deemed approved.
---------------------------------------------------------------------------
State Law Cannot Fill the Gaps
We cannot rely on state law to address the gaps in crypto
regulation. The state law requirements that are imposed today on crypto
trading firms are minimal, arising primarily from state money
transmitter laws. Those laws have their origins in the telegraph era,
and generally impose only minimal requirements pertaining to net worth,
security and permissible investments. They do not provide a regulatory
framework comparable to that created by the Federal laws and
regulations governing the securities and derivatives markets. (They do
trigger a requirement to register as a money service business with the
Treasury Department and the application of the Bank Secrecy Act, which
imposes anti-money laundering and other requirements.) Relying on state
law would be analogous to relying on state blue sky laws to regulate
the securities market after the crash of 1929, rather than what we
actually did--which was to pass the Securities Act, the Securities
Exchange Act and the other laws that are the foundation of the
strongest capital markets in the world. Moreover, even to the extent
that a few states have strengthened their laws or might choose to do so
in the future to address the obvious lack of investor protection in the
crypto sector, there would still be inconsistency as between different
states' requirements. This creates opportunities for regulatory
arbitrage that the FSOC report highlighted.\19\
---------------------------------------------------------------------------
\19\ See supra note 3.
---------------------------------------------------------------------------
The Path Forward Should Not Depend on Consensus on the Value of Crypto
A recent Economic Report to the President issued by the White House
takes a very negative view on the value of crypto to date:
``In addition to the decentralized custody and control of
money, it has been argued that crypto assets may provide other
benefits, such as improving payment systems, increasing
financial inclusion, and creating mechanisms for the
distribution of intellectual property and financial value that
bypass intermediaries that extract value from both the provider
and recipient . . . So far, crypto assets have brought none of
these benefits . . . Indeed, crypto assets to date do not
appear to offer investments with any fundamental value . . .
instead, their innovation has been mostly about creating
artificial scarcity in order to support crypto assets' prices--
and many of them have no fundamental value.'' \20\
---------------------------------------------------------------------------
\20\ The White House, Economic Report of the President, p. 238
(March 2023), https://www.whitehouse.gov/wp-content/uploads/2023/03/
ERP-2023.pdf.
Those who question the fundamental value of the crypto sector may
believe that regulating crypto trading and lending firms will tend to
legitimize or encourage more investment in a sector we should prefer to
see decline, move offshore or at least not grow. By contrast, there are
those who will argue that the United States is failing to create a
regulatory framework that encourages the development of technology they
believe is transformative and is deserving of a dedicated regulatory
regime. They worry that important innovation will move overseas.
I continue to hold the views expressed in my 2019 paper:
``. . . whether [crypto assets] are the next big thing or
modern-day Dutch tulips should not determine whether or how we
regulate them. There is nothing so exceptional about crypto
assets that justifies giving them a regulatory pass. Nor should
they be taxed or regulated out of existence. A traditional
principle of financial market regulation in the United States
has been to refrain from normative judgements about
investments, require transparency and integrity in markets and
let investors make their own decisions. We should follow that
same principle here.'' \21\
---------------------------------------------------------------------------
\21\ Massad 2019 supra at note 1, p. 6.
This is important also as other jurisdictions work to clarify their
crypto regulatory regimes. The possibility that activity moves abroad
may not reduce risk to our markets or our citizens; it could simply
make it harder for regulators to monitor and regulate that risk.
The approach I am suggesting can find support on both sides of the
political aisle. Former SEC Chair Jay Clayton and I advocated
essentially this same approach in our Wall Street Journal op-ed late
last year. We began by noting that ``only someone who has been living
under a rock could think cryptocurrency markets don't need stronger
regulation.'' \22\ We proposed that the SEC and CFTC develop a set of
common, basic investor protection requirements and require platforms to
adopt them if they haven't already registered with the SEC as a
securities intermediary or with the CFTC as a derivatives intermediary.
This would strengthen investor protection without either agency
relinquishing any authority while classification and other issues are
resolved.
---------------------------------------------------------------------------
\22\ See supra, at note 8.
---------------------------------------------------------------------------
In short, this is a proposal that people on both sides of the
aisle, and people with different views on the merits of crypto, can
support.
Another Critical Gap: The Lack of a Federal Regulatory Framework for
Stablecoins
I wish to discuss briefly another critical gap, which is the lack
of a Federal regulatory framework for stablecoins, which are used
extensively in the crypto spot market. Stablecoin market capitalization
has grown quickly in the last few years, and has not declined
dramatically despite the fact that the crypto market has generally lost
\2/3\ of its value since late 2021. The risks posed by stablecoins have
been described in detail in two recent government reports--the report
of the President's Working Group on Financial Markets, the Federal
Deposit Insurance Corporation and the Office of the Comptroller of the
Currency,\23\ and the report of the FSOC previously noted.\24\ I will
therefore not summarize those risks, nor the inadequacies of present
regulation which are also described in those reports. Both those
reports call on Congress to pass new legislation to provide specific
authority to regulate stablecoins.
---------------------------------------------------------------------------
\23\ President's Working Group on Financial Markets, the Federal
Deposit Insurance Corporation, and the Office of the Comptroller of the
Currency, Report on Stablecoins (Nov. 1, 2021), https://
home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf
(hereinafter the ``PWG Report'').
\24\ FSOC report, supra at note 3.
---------------------------------------------------------------------------
I believe we need to bring stablecoin activity within the Federal
regulatory perimeter rather than attempt to keep it outside. I believe
that is a better way to oversee and manage the risks that stablecoins
pose, both to consumers and to the traditional financial system and
financial stability generally. Limiting interconnections between crypto
and the traditional banking sector generally, which appears to be the
current policy of our bank regulators, may slow the growth of certain
crypto activities, but it risks pushing the activity overseas, or to
less-regulated or non-regulated areas of financial activity. That could
ultimately make it harder to oversee and manage the risk. Bringing the
activity within the regulatory perimeter is also the best way to
realize any positive potential that stablecoins might offer. Although
stablecoins are used mostly within the crypto sector today, they might
have potential to improve payments in other areas.\25\
---------------------------------------------------------------------------
\25\ In the interests of full disclosure, I note that I am a member
of PayPal's Advisory Council on Blockchain, Crypto and Digital
Currencies. I am testifying in my personal capacity and the views I
express are entirely my own.
---------------------------------------------------------------------------
Professors Jackson of Harvard Law School and Dan Awrey of Cornell
Law School and I wrote a paper recently outlining how such a regulatory
framework could be created today by our financial regulators (primarily
our banking regulators) under existing law without new legislation.
However, our bank regulators appear reluctant or unwilling to do so
unless given specific authority by Congress.
Therefore, I support legislation that would create a framework for
stablecoin regulation based on principles followed primarily in our
regulation of banks. As long as stablecoins are used as a payment
mechanism, and do not pay interest or a return to their holders, I
believe it is best to regulate them as payment instruments. There need
to be prudential requirements on the issuer, including that stablecoins
be fully backed by reserves in the form of cash or high quality liquid
assets as well as capital and liquidity requirements. Operational
requirements on the stablecoin issuer are necessary as well, such as
KYC and AML requirements, risk management standards, cybersecurity, and
restrictions on use of customer data. There should be standards on the
issuer's selection and oversight of decentralized blockchains on which
stablecoins are transferred. There also need to be standards requiring
interoperability of stablecoins and prevention of concentration of
power, as well as limitations on certain commercial affiliations.
The Digital Assets Policy Project at the Harvard Kennedy School,
which I direct, held a roundtable on stablecoin regulation last
November attended by senior leaders from government, the stablecoin
industry, traditional financial institutions, academia and others.
Although the event was conducted under Chatham House rules, a summary
of the discussion and other materials, including comparisons of
different legislative proposals on stablecoins, can be found at the
Digital Assets Policy Project website.
I would be happy to answer any questions. Thank you.
The Chairman. Thank you very much, sir.
Mr. Hall, you are recognized for 5 minutes.
STATEMENT OF JOSEPH A. HALL, J.D., PARTNER, DAVIS POLK &
WARDWELL LLP, NEW YORK, NY
Mr. Hall. Chairman Johnson, Ranking Member Caraveo, and
Members of the Subcommittee, I am Joe Hall, and I am a Partner
in the law firm Davis Polk & Wardwell.
The question of where blockchain-based digital assets fit
in our regulatory framework frustrates businesses and continues
to divide regulators. I believe the lack of certainty has had
real costs in terms of consumer confidence in protection, lost
economic activity, and unnecessary hurdles to competing with
foreign markets. And so when I hear that blockchain technology
has not lived up to the hype, I sometimes wonder how we would
even know.
At the root of the problem is a simple observation. Many
kinds of digital assets are inherently different from the
stocks, bonds, options, and futures that our existing
regulatory structures were built for. Digital assets may not
represent a claim on the revenues or assets of a business or
look much like the agricultural products, natural resources, or
financial commodities with prices that need to be hedged.
Instead, digital assets might be deployed to verify a
transaction between two strangers or to facilitate decision-
making by a dispersed network of coders or to encourage honest
behavior in the fulfillment of an obligation.
Because they combine functionality with easy traceability,
one can say that digital assets are in fact different in kind
from what preceded them. Now, our system of financial market
regulation depends on the ability to distinguish securities
from commodities, and so we have to determine whether digital
assets are securities under SEC jurisdiction or commodities
under CFTC jurisdiction. And as it turns out, it is not so
clear. The Supreme Court says that, quote, ``When a purchaser
is motivated by a desire to use or consume the item purchased,
the securities laws do not apply.
And now different Federal and state regulators, including
the SEC and the CFTC, have taken conflicting positions on
whether some of the most common digital assets are securities.
And the SEC suggests market participants should consider a list
of 50 or 60 different characteristics, none of which is
necessarily determinative on the understanding that when their
presence is stronger, then it is more likely that the digital
asset is a security. And now that is not a recipe for
predictability. It is not easy for businesses to plan and
invest when the answer to their most pressing question is,
maybe what you want to do is okay, but maybe it is not.
Given this uncertainty, a couple of questions naturally
arise. Why not just register with the SEC? And given how well-
trod the path of SEC registration is, are people who take the
position that their digital assets are commodities simply
behaving as scofflaws? That has not been my experience.
The problem is, today, registering with the SEC is not a
practical alternative. First, the obligations that attach to
securities make it impractical to use them in everyday
transactions, and that is because the securities framework was
built for passive investment instruments, and virtually
everyone who touches them is subject to extensive regulation by
the SEC in ways that, frankly, make sense for debt and equity
securities. This framework wasn't built to govern commercial
activities like sending a payment. And despite the rise of
blockchain technology over the last 10 years, the SEC has taken
no apparent action to adapt its rulebook to facilitate
activities involving digital assets.
Second, even if the SEC did adapt its rules, market
participants would continue to face insurmountable barriers to
conducting business across state lines, and that is because
each state regulates the sale of securities, each with its own
registration process, and digital assets are not exempt. There
is no coordination among states on digital assets, and
businesses who try to register will find themselves quickly
facing a gauntlet of 50 different state securities
commissioners.
If there were practical routes to registration, I am
confident that many businesses would in fact register. But
today, the security-or-not question means that if a digital
asset is a security, then we regulate it out of existence or at
least out of the United States, but if it isn't, then consumers
lack reliable information in the protection of Federal market
oversight.
I don't believe it is practical to task the regulators with
sorting this out. Our approach to financial regulation relies
on competition, and it relies on our Federal financial
regulators pushing against the boundaries of their
jurisdiction. I believe that competition among the regulators
is a feature, not a bug of our system.
So I believe it is time to move past the tired debate over
whether digital assets are securities under existing law.
Congress should instead step in with a new regulatory approach
tailored to this asset class. Concepts drawn from the Federal
securities and commodities laws can inform our new paradigm,
but regulators will need clear direction from Congress on how
these precedents should apply.
I appreciate the Committee's time today and look forward to
answering your questions. Thank you.
[The prepared statement of Mr. Hall follows:]
Prepared Statement of Joseph A. Hall, J.D.,* Partner, Davis Polk &
Wardwell LLP, New York, NY
---------------------------------------------------------------------------
* I am a Partner in the law firm of Davis Polk & Wardwell LLP in
New York City, where I began my career in 1989. As a member of the
firm's capital markets group, I advise public and private companies,
asset managers and financial intermediaries on transactional, corporate
governance and securities compliance and enforcement matters. In the
last decade my practice has focused increasingly on the intersection of
federal securities law with cryptoassets and participants in the
digital asset industry.
From 2003 to 2005, I served on the staff of the Securities and
Exchange Commission, ultimately as managing executive for policy under
Chairman William H. Donaldson. From 1988 to 1989 I served as a law
clerk for the Hon. Phyllis A. Kravitch of the U.S. Court of Appeals for
the 11th Circuit in Savannah and Atlanta, Ga. I am a graduate of the
University of North Carolina at Chapel Hill and Columbia Law School.
Today I am presenting my own views, and not those of my firm or any
client of the firm.
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Chairman Johnson, Ranking Member Caraveo, and Members of the
Committee:
Thank you for the privilege to speak before you today.
My name is Joe Hall and I am a Partner in the law firm of Davis
Polk & Wardwell, where I have practiced securities law for the last 3
decades. Earlier in my career--a few years before anyone had heard of
Satoshi Nakamoto--I served as a senior staff member of the Securities
and Exchange Commission.
The question of where blockchain-based digital assets fit into our
regulatory framework frustrates and bewilders entrepreneurs, small
businesses and large public companies, and continues to divide
regulators \1\ and experts in financial services regulation.\2\ I
believe the persistent lack of certainty and workable rules has had
real costs in terms of consumer confidence and protection, foregone
investment, lost economic activity, and unnecessary hurdles to our
ability to compete with foreign markets. And so when I hear that
blockchain technology ``hasn't lived up to the hype,'' \3\ I sometimes
wonder how we would even know.
---------------------------------------------------------------------------
\1\ E.g., CFTC, Statement of Commissioner Caroline D. Pham on SEC
v. Wahi (Jul. 21, 2022), https://www.cftc.gov/PressRoom/
SpeechesTestimony/phamstatement072122.
\2\ See generally Davis Polk & Wardwell, Client Update: Bipartisan
crypto bills could clarify current regulatory confusion--if they tackle
Howey (Aug. 10, 2022), https://www.davispolk.com/insights/client-
update/bipartisan-crypto-bills-could-clarify-current-regulatory-
confusion-if-they.
\3\ E.g., 12 Examples of ``Revolutionary'' Tech That's Not Living
up to the Hype, Forbes (Aug. 24, 2022), https://www.forbes.com/sites/
forbestechcouncil/2022/08/24/12-examples-of-revolutionary-tech-thats-
not-living-up-to-the-hype/?sh=233e56663d22.
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I would like to focus my remarks on a pair of questions:
Is the regulatory environment really uncertain?
Even if it is, why not simply go ahead and register with the
SEC--just to be careful?
Regulatory uncertainty is real
I acknowledge that there are well-informed and thoughtful people
who hold the view that claims of regulatory uncertainty are overblown
at best,\4\ but from my perspective as a practitioner having advised
clients on a wide range of digital asset matters, I respectfully
disagree.
---------------------------------------------------------------------------
\4\ See, e.g., Gary Gensler, Getting Crypto Firms to Do Their Work
Within the Bounds of the Law, The Hill (Mar. 9, 2023), https://
thehill.com/opinion/congress-blog/3891970-getting-crypto-firms-to-do-
their-work-within-the-bounds-of-the-law/.
---------------------------------------------------------------------------
At the root of the problem lies this simple observation: Many kinds
of digital assets are qualitatively different from the stocks, bonds,
options and futures that we have experience with and that our existing
market regulatory structures were purpose-built for. These new assets
may not represent a claim on the revenues or properties of a business,
or look much like useful resources with fluctuating prices that
producers, manufacturers and consumers need to hedge. Instead, digital
assets might be deployed to verify the details of a transaction between
two strangers, or to facilitate decisionmaking by a dispersed and ever-
changing network of coders, or to encourage honest behavior in the
fulfillment of a bargained-for obligation. Because they combine
inherent functionality with qualities of an easily tradable and
storable instrument, one could say that digital assets are different in
kind from what preceded them.\5\
---------------------------------------------------------------------------
\5\ Elsewhere I've argued that because the digital asset class is
far from monolithic, a variety of regulatory approaches may be needed
to protect consumer interests and foster competition and innovation.
Regulating Crypto: A Guide to the Unfolding Debate, Bloomberg Law (Dec.
2022), https://www.davispolk.com/sites/default/files/2022-12/
Joe%20Hall%20-%20Bloomberg
%20Law%20-%20Regulating_Crypto.pdf. This in turn suggests the need for
a statutory taxonomy based on the describable characteristics of major
groupings of digital assets, rather than an approach that builds on
generic ``investment contract'' terminology, as discussed in note 30
below. E.g., Lee A. Schneider, Introduction: A ``Sensible'' Token
Classification System, Chambers Global Practice Guides: Fintech 2022,
https://drive.google.com/file/d/1v4JM8Dk4R8pi1
LvZYU4pILNlIXl1jdQ1/view.
---------------------------------------------------------------------------
And just as digital assets are different from traditional assets,
their trading markets--shaped by economic and business decisions made
over time by a growing industry--are structured differently from the
markets for traditional stocks, bonds, options and futures. For
example, some functions that are split between intermediaries in
traditional asset markets are often combined within a single firm in
digital asset markets.
As the Committee knows well, our Federal system of financial market
regulation depends on the ability to distinguish securities from
commodities.\6\ If a particular asset is a security, then trading of
the asset in both the spot and derivatives markets is subject to
comprehensive oversight by the SEC under the Federal securities laws.
On the other hand, if the asset is a commodity, then we do not impose
comprehensive Federal regulation over the spot market for that
asset,\7\ but trading in the derivatives market is subject to
comprehensive oversight by the Commodity Futures Trading Commission
under the Federal commodities laws.
---------------------------------------------------------------------------
\6\ As a technical matter, securities are also commodities. The
Commodity Exchange Act definition of ``commodity'' is broad and
encompasses securities along with substantially ``all other goods and
articles,'' but Section 2 of that Act allocates regulatory authority
over securities to the SEC. See 7 U.S.C. 1a(9), 2(a)(1)(A)
(``nothing contained in this section shall . supersede or limit the
jurisdiction at any time conferred on the Securities and Exchange
Commission'').
\7\ Although the CFTC does not have comprehensive regulatory
authority over commodity spot markets, in 2010 Congress granted the
CFTC anti-fraud, false reporting, and anti-manipulation enforcement
authority over commodity spot markets in interstate commerce, including
digital asset spot markets. See Section 6(c)(1) of the Commodity
Exchange Act, 7 U.S.C. 9(1)(A); Cong. Research Svc., Crypto-Asset
Exchanges: Current Practices and Policy Issues (Jul. 23, 2021), at 2,
https://crsreports.congress.gov/product/pdf/IN/IN11708.
---------------------------------------------------------------------------
If a digital asset is a security, it cannot be offered and sold
into the public markets without Federal registration, a regulatory
review process and a prospectus containing prescribed business,
management and financial information. After the security has been sold
and begins to trade in the secondary markets, virtually all
intermediaries who touch it--exchanges, broker-dealers, clearinghouses,
transfer agents, custodians--are themselves subject to pervasive SEC
registration and oversight, and the issuer remains subject to ongoing
reporting requirements. But if the digital asset is a commodity, none
of these advance and ongoing requirements apply.
And so--and not for the first time in the history of Federal
financial market oversight \8\--we have to determine whether these new
assets are securities under the jurisdiction of the SEC, or commodities
under the jurisdiction of the CFTC.
---------------------------------------------------------------------------
\8\ The CFTC and SEC reached an agreement in 1981 known as the
``Shad-Johnson Jurisdictional Accord'' to resolve a dispute between the
agencies over the regulation of single-stock and stock-index futures;
futures on single stocks and ``narrow-based'' stock indices were
thereafter agreed to be regulated as securities, while futures on
``broad-based'' stock indices were to be regulated as commodity
futures. Congress codified the accord into law in 1983. See GAO,
Report: CFTC and SEC: Issues Related to the Shad-Johnson Jurisdictional
Accord (2000), at 1, https://www.gao.gov/products/ggd-00-89.
---------------------------------------------------------------------------
As it turns out, making this call is not so clear-cut.
The point is often made that the Federal securities laws are
flexible enough to encompass digital assets, and indeed Justice
Thurgood Marshall once observed that ``Congress's purpose in enacting
the securities laws was to regulate investments, in whatever form they
are made and by whatever name they are called.'' \9\ But as Justice
Powell pointed out a few years earlier in an opinion that Justice
Marshall joined, ``when a purchaser is motivated by a desire to use or
consume the item purchased . . . the securities laws do not apply.''
\10\
---------------------------------------------------------------------------
\9\ Reves v. Ernst & Young, 494 U.S. 56, 60-61 (1990).
\10\ United Housing Found., Inc. v. Forman, 421 U.S. 837, 852-853
(1975).
---------------------------------------------------------------------------
Determining whether a particular digital asset is a commodity and
not a security can thus turn on its consumptive uses, and as I noted
earlier, many digital assets offer a use case separate and apart from
any investment appeal. Because of this, serious arguments can usually
be made on both sides of the question of whether any widely traded
digital asset is a security, even if some dealings in the asset share
hallmarks of a securities transaction.
The SEC has emphasized that the question of whether a particular
digital asset is a security is a facts-and-circumstances determination
\11\--and that the answer can change over time.\12\ When analyzing a
digital asset transaction, the SEC suggests market participants should
consider a non-exclusive list of 50 or 60 ``characteristics,'' none of
which is ``necessarily determinative,'' on the understanding that when
their ``presence'' is ``stronger'' it is ``more likely'' that the
digital asset, or the transaction in which it is offered and sold,
involves a security.
---------------------------------------------------------------------------
\11\ See SEC, Framework for ``Investment Contract'' Analysis Of
Digital Assets (Apr. 3, 2019), at 2, https://www.sec.gov/files/dlt-
framework.pdf (``Whether a particular digital asset at the time of its
offer or sale satisfies the Howey test depends on the specific facts
and circumstances.'').
\12\ Id. at 5 and 8 (discussing considerations for ``evaluating
whether a digital asset previously sold as a security should be
reevaluated at the time of later offers or sales'').
---------------------------------------------------------------------------
This is not a recipe for predictability and regulatory certainty.
The CFTC has determined that both Bitcoin and Ether are
commodities.\13\ The SEC agrees that Bitcoin, the Ur-digital asset, is
not a security, though unfortunately it has never published its
analysis and so we don't know how the SEC weighed the dozens of
relevant characteristics in arriving at this conclusion.\14\ In the
past, SEC officials have indicated that Ether was not a security,\15\
though today there is some question whether the agency continues to
hold this view.\16\
---------------------------------------------------------------------------
\13\ See, e.g., CFTC, In re Coinflip, Inc., No. 15-29 (Sept. 17,
2015), https://www.cftc.gov/sites/default/files/idc/groups/public/
@lrenforcementactions/documents/legalpleading/enfcoinflipr
order09172015.pdf (``Bitcoin and other virtual currencies are . . .
properly defined as commodities.''); CFTC, In Case You Missed It:
Chairman Tarbert Comments on Cryptocurrency Regulation at Yahoo!
Finance All Markets Summit, Press Release Number 8051-19 (Oct. 10,
2019), https://www.cftc.gov/PressRoom/PressReleases/8051-19 (``It is my
view as Chairman of the CFTC that ether is a commodity, and therefore
it will be regulated under the CEA.'').
\14\ E.g., Letter from Brent J. Fields, Assoc. Dir., Div. of Inv.
Mgt., SEC, to Jacob E. Comer (Oct. 1, 2019), https://www.sec.gov/
Archives/edgar/data/1776589/999999999719007180/filename1.pdf (``[W]e
disagree with your conclusion that bitcoin is a security. We think that
conclusion is incorrect under both the reasoning of SEC v. Howey and
the framework that the staff applies in analyzing digital assets.'').
\15\ William Hinman, Dir., Div. of Corp. Fin., SEC, Remarks at the
Yahoo Finance All Markets Summit: Digital Asset Transactions: When
Howey Met Gary (Plastic) (Jun. 14, 2018), https://www.sec.gov/news/
speech/speech-hinman-061418 (``And putting aside the fundraising that
accompanied the creation of Ether, based on my understanding of the
present state of Ether, the Ethereum network and its decentralized
structure, current offers and sales of Ether are not securities
transactions.'').
\16\ See, e.g., Paul Kieran and Vicky Ge, Ether's New ``Staking''
Model Could Draw SEC Attention, Wall St. J. (Sept. 15, 2022), https://
www.wsj.com/articles/ethers-new-staking-model-could-draw-sec-attention-
11663266224.
---------------------------------------------------------------------------
The SEC has never affirmatively stated that any other popularly
traded digital asset is not a security, and senior officials have often
expressed the view that the ``vast majority'' of digital assets are in
fact securities.\17\ Of course, with more than 23,000 digital assets
estimated to have been created,\18\ but only a handful making up the
bulk of the market's value,\19\ two propositions can simultaneously be
true: (1) the vast majority of digital assets are securities, but (2)
the digital assets that people most commonly use, trade and hold are
not.
---------------------------------------------------------------------------
\17\ See, e.g., SEC, Testimony of Chair Gary Gensler Before the
United States House of Representatives Committee on Financial Services
(Apr. 18, 2023), https://www.sec.gov/news/testimony/gensler-testimony-
house-financial-services-041823.
\18\ See CoinMarketCap, https://coinmarketcap.com (last visited
Apr. 25, 2023).
\19\ Id. According to CoinMarketCap, on April 25, 2023 the market
capitalization of all traded digital assets was in excess of $1
trillion. Bitcoin accounted for approximately 45% of this total, and
the ten digital assets with the largest market capitalizations
(including Bitcoin) accounted for approximately 85%.
---------------------------------------------------------------------------
Perhaps an understatement, but it's not easy for businesses to plan
and invest when the answer to their most pressing question is: ``Maybe
what you want to do is OK, but maybe it's not.''
SEC registration is not currently practical
Given the uncertainty over whether any particular digital asset is
a security, and the risk of severe and costly consequences for the
organization that created it, any investor who buys and resells it
within a short period of time, and any entity who facilitates trading,
custodying or clearing it,\20\ a couple of questions naturally arise:
---------------------------------------------------------------------------
\20\ These consequences include SEC fines and sanctions for conduct
(including that which is neither fraudulent nor manipulative) in
violation of any registration requirement under the Federal securities
laws, as well as private causes of action for participation in an
unregistered public offering of securities. See, e.g., 15 U.S.C. 77k
,77l 78ff. Willful violations of the Federal securities laws are also
subject to criminal penalties. See, e.g., 15 U.S.C. 77x, 78ff(a).
---------------------------------------------------------------------------
Why not just register with the SEC?
Sure, it might take longer and be more expensive, but isn't
it just completing some paperwork and paying a fee? After all,
people have been registering with the SEC for nearly a century!
And given how well-trod the path of SEC registration is, are people
who take the position that their digital assets are commodities simply
scofflaws trying to evade compliance?
That has not been my experience.
Let me pause to acknowledge the obvious: there has been plenty of
fraud in the digital asset market. This does not come as a surprise;
there are always bad actors in the financial sector, and no asset class
in our financial markets is exempt from fraud, manipulation and
misrepresentation--indeed, this is one of the primary reasons we have
financial services regulation and strong regulators like the CFTC and
SEC to begin with. But just as we do not impute the conduct of Bernie
Madoff to all asset managers, so we should not impute the conduct of
Sam Bankman-Fried to all participants in the digital asset industry.
The problem is that simply registering with the SEC in order to
avoid the potential risk that the regulator will later say that your
digital asset is a security is not, today, a practical alternative.
There are two principal reasons.
First, the regulatory obligations that attach to transactions in
securities make it impractical to use them for everyday commercial
purposes--as a means of payment or transmission of value, or for uses
like peer-to-peer lending, file storage or gaming. This is because
secondary-market transactions in securities occur within a framework in
which intermediaries who trade or facilitate trading in securities,\21\
clear transactions in securities, effect transfers of securities or
custody securities for third parties, are subject to extensive
regulation and supervision by the SEC and self-regulatory organizations
under SEC oversight. This framework was not built to govern simple
commercial activities like a consumer's sending a payment with a widely
available medium of exchange.\22\
---------------------------------------------------------------------------
\21\ The SEC recently reopened for public comment a proposal to
require exchange registration when ``the activities of any combination
of actors constitute, maintain, or provide, together, a market place or
facilities for bringing together buyers and sellers for securities.''
See SEC, Supplemental Information and Reopening of Comment Period for
Amendments to Exchange Act Rule 3b-16 Regarding the Definition of
``Exchange,'' Rel. No. 34-97309 (Apr. 14, 2023), at 29, https://
www.sec.gov/rules/proposed/2023/34-97309.pdf. For a discussion of some
of the interpretive questions this could raise in the digital asset
marketplace, see Statement of Hester M. Peirce, Comm'r, SEC, Rendering
Innovation Kaput: Statement on Amending the Definition of Exchange
(Apr. 14, 2023), https://www.sec.gov/news/statement/peirce-rendering-
inovation-2023-04-12.
\22\ My colleague Zach Zweihorn describes the consequences of this
framework for the digital asset markets in testimony today before the
Financial Services Committee. See Testimony of Zachary J. Zweihorn
Before the United States House of Representatives Committee on
Financial Services, Subcommittee on Digital Assets, Financial
Technology, and Inclusion (Apr. 27, 2023), https://www.davispolk.com/
sites/default/files/2023-04/written-statement-zachary-zweihorn.
pdf.
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But despite our experience with blockchain technology over the past
decade, the SEC has taken little apparent action--no rule proposal, no
concept release--to adapt its rulebook to facilitate secondary-market
activities involving digital assets.\23\ Indeed, the SEC has not
broached questions as basic as whether a blockchain would itself
somehow need to be registered as a securities clearinghouse.\24\
---------------------------------------------------------------------------
\23\ And far from seeking to avoid regulation, industry
participants have repeatedly sought SEC engagement and guidance,
including calling on the SEC for rulemaking. E.g., Letter from Paul
Grewal, Chief Legal Officer, Coinbase Global Inc., to Vanessa
Countryman, Sec'y, SEC, Petition for Rulemaking-Digital Asset
Securities Regulation (Jul. 21, 2022), https://www.sec.gov/rules/
petitions/2022/petn4-789.pdf.
\24\ Congress has given the SEC broad authority under Section 28 of
the Securities Act of 1933, 15 U.S.C. 77z-3, and Section 36 of the
Securities Exchange Act of 1934, 15 U.S.C. 78m, to tailor the Federal
securities laws to transactions in digital asset securities upon a
finding that doing so is consistent with the public interest and the
protection of investors.
---------------------------------------------------------------------------
I have a sense as to why the SEC may not have acted, and I
certainly do not believe it is because the agency has been ignoring the
issues or somehow favors enforcement over rulemaking--this agency never
hesitates to use all available tools in its kit.
Instead, it would be extremely difficult--some would say
impermissible \25\--for the SEC to architect a regulatory framework for
a new industry without express Congressional authority. And, as we know
from past efforts to introduce significant market structure
changes,\26\ the sort of effort that would be required could rapidly
become all-consuming for an agency that already has many important
priorities on its plate.
---------------------------------------------------------------------------
\25\ It is easy to predict challenges to such an administrative
effort based on the ``major questions'' doctrine. See West Virginia v.
EPA, 142 S. Ct. 2587, 2609 (2022) (holding that an agency cannot bring
about a major policy absent `` `clear Congressional authorization' for
the authority it claims'' (quoting Utility Air Reg. Grp. v. EPA, 573
U.S. 302, 324 (2014)); Alabama Ass'n of Realtors v. Dep't of Health &
Hum. Servs., 141 S. Ct. 2485, 2489 (2021) (per curiam) (counseling
courts against accepting an agency's interpretation if it would result
in a sweeping claim of new authority, even if the statutory text is
ambiguous or the agency's interpretation is plausible); Utility Air,
573 U.S. at 324 (an agency may not ``discover'' ``unheralded power'' in
a ``long extant-statute'' that it has never relied on to regulate a
business in the manner it seeks in a new, major policy).
\26\ For an example, the Committee could revisit the contentious
history behind the 2005 adoption of Regulation NMS, which introduced
changes to the national market system for equities. See, e.g., Comment
Letters of Rep. Peter King, Member of Congress, et al. (Jan. 25, 2005),
https://www.sec.gov/rules/proposed/s71004/s71004-727.pdf; Rep. Paul E.
Kanjorski, Member of Congress (Jan. 25, 2005), https://www.sec.gov/
rules/proposed/s71004/s71004-730.pdf; Reps. Deborah Pryce and Eric
Cantor, Members of Congress (Feb. 7, 2005), https://www.sec.gov/rules/
proposed/s71004/s71004-775.pdf.
---------------------------------------------------------------------------
Second, even if the SEC did adapt the rulebook to facilitate
secondary-market activities involving digital assets, market
participants would continue to face near-insurmountable barriers to
conducting business across state lines. This is because each state has
``blue sky'' laws governing the offer and sale of securities, each with
its own registration, review and approval process.\27\ Unlike the
disclosure-based Federal regime, the state process is ``merit based,''
with each regulator exercising broad power to forbid the offer and sale
of securities within its state's borders if it concludes that a
security is too speculative, too expensive or otherwise not suitable
for the public.
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\27\ Although it might be possible for the SEC to preempt blue sky
laws through rulemaking, this would be unprecedented and controversial.
The SEC could use its authority under Section 18(b)(3) of the
Securities Act of 1933, 15 U.S.C. 77r(b)(3), in order to provide that
any purchaser of a digital asset security sold in a transaction meeting
specified conditions, which could include the availability of SEC-
prescribed disclosure, is a ``qualified purchaser'' of that security,
which would result in it being a ``covered security'' and therefore
exempt from blue sky registration requirements (though not from state
anti-fraud authority). The SEC would be required to conclude that the
qualified-purchaser designation for these digital asset securities was
consistent with the public interest and the protection of investors.
---------------------------------------------------------------------------
The blue sky process varies widely from state to state and can be
slow and inscrutable. There is no coordination among the states on an
approach to standardize or harmonize the review and approval of digital
asset securities, and Congress has already recognized the practical
problems that even well-administered blue sky laws pose for businesses
who, having successfully negotiated the SEC registration process,
nevertheless find themselves hamstrung by the gauntlet of 50 state
securities commissions. Indeed, this is why in 1996 Congress preempted
blue sky registration requirements for any security listed on the New
York Stock Exchange or Nasdaq Stock Market.\28\
---------------------------------------------------------------------------
\28\ National Securities Markets Improvement Act of 1996, Pub. L.
No. 104-290, 110 Stat. 3416.
---------------------------------------------------------------------------
And so if there were practical routes and predictable consequences
to registration, then I am highly confident that many responsible
businesses would eagerly register despite the well-grounded position
that their activities are not subject to regulation under Federal
securities law. But the net impact of the two consequences I have
described means that today, treating a digital asset as a security
generally means that it loses all ability to trade and function.
Consumers and businesses need Congress to weigh in
I believe consumers want and deserve better comparative information
about digital assets, given their complexity and variety, than they do
about traditional agricultural, mineral and industrial commodities.
This suggests that our historic approach to the regulation of commodity
markets is no more appropriate to the digital asset class than our
historic approach to the regulation of securities markets.
But responsible businesses are effectively compelled to rely on the
position that their digital assets are commodities and not securities,
even though this yields a situation in which consumers and the market
as a whole lack consistent information about specific digital assets,
and intermediaries in the spot market are not subject to sensible,
fairly applied standards for handling customer assets and orders. It is
not wrong to wonder whether standards like these, enforced by an
energetic regulator like the CFTC or SEC, could have prevented the FTX
debacle.
And so I have described a quandary which yields a status quo that
is not acceptable. The binary ``security-or-not'' question means that
if a digital asset is a security then it is regulated out of existence,
but if it isn't a security then consumers lack both reliable
information and the protection of Federal market oversight.\29\
---------------------------------------------------------------------------
\29\ See Financial Stability Oversight Council, Report on Digital
Asset Financial Stability Risks and Regulation (2022), at 112-114,
https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-
2022.pdf.
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How then to address this quandary?
I do not believe tasking the regulators with sorting it out among
themselves is a practical solution. The genius behind our Federal
approach to financial services regulation is competition. We want our
Federal financial services regulators to push at the boundaries of
their jurisdiction; to guard their turf. That is how we make sure
things don't fall through the cracks in our massive and endlessly
changing economy. A unified financial services regulator may be fine
for a less dynamic economy, but not for ours: Competition among
regulators is a feature of our system, not a bug. Hoping the regulators
can resolve these thorny jurisdictional issues among themselves is
therefore not the answer.
It's my belief that we should move past the tired debate over
whether digital assets are securities under existing law. Instead,
Congress should step in with a new regulatory approach tailored to this
asset class, with a clear allocation of authority over both the primary
and secondary markets. Although concepts drawn from both Federal
commodities and securities law can inform a new regulatory paradigm,
the appropriate regulators will need clear direction from Congress on
how these precedents should apply.\30\ For example, Congress may direct
the regulators not to impose structural changes on the market simply
because functional activities in the securities or commodities markets
have historically been carried out with different organizational forms.
Or Congress may direct the regulators not to impose financial statement
requirements on a digital asset creator whose digital asset does not
represent a debt or equity interest in the creator itself.
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\30\ I believe any new legislation should avoid terminology drawn
from investment-contract jurisprudence developed under SEC v. W.J.
Howey Co., 328 U.S. 293 (1946) and succeeding cases. The ``Howey
test,'' as it is known, is essential to the SEC's regulatory and
enforcement program because it enables the agency to police activities
that are squarely within the zone of Federal securities law, regardless
of what they are called or how they are structured. This is illustrated
by the facts of the Howey case itself, in which Mr. Howey offered his
investors passive equity-like returns from a citrus fruit business,
albeit not in the form of common stock--and was therefore judged to
have sold an ``investment contract,'' which is a security. Of course
the oranges, tangerines and grapefruits produced by the business were
not themselves securities.
Or were they? The seemingly obvious distinction between a
transaction (the investment contract) and a valuable product or object
of the transaction (the orange) has proven exceedingly difficult to pin
down in the digital asset context, as others have pointed out. E.g.,
Jai Massari, Why Cryptoassets Are Not Securities, Harvard L. Sch. Forum
on Corp. Governance (Dec. 6, 2022), https://corpgov.law.harvard.edu/
2022/12/06/why-cryptoassets-are-not-securities/, in which the author
discusses Lewis Rinaudo Cohen, Gregory Strong, Freeman Lewin and Sarah
Chen, The Ineluctable Modality of Securities Law: Why Fungible Crypto
Assets Are Not Securities (discussion draft Nov. 10, 2022), https://
dlxlaw.com/wp-content/uploads/2022/11/The-Ineluctable-Modality-of-
Securities-Law-DLx-Law-Discussion-Draft-Nov.-10-2022.pdf.
Part of the difficulty is attributable to encrustations from nearly
80 years of wielding Howey in all manner of factual circumstances, many
involving questionable conduct or even outright fraud. As the maxim
goes, bad facts make bad law. Writing on a clean slate and steering
clear of the term ``investment contract'' and hoary concepts like
``investment of money,'' ``common enterprise,'' ``expectation of
profits'' and ``entrepreneurial or managerial efforts of others,''
Congress has the opportunity to liberate the digital asset industry
once and for all from worn-out and obfuscating analogies to
chinchillas, whiskey warehouse receipts, New York City co-ops--and yes,
Mr. Howey's oranges.
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All of these decisions can and should be on the table when Congress
decides to act.
I appreciate the Committee's time today and look forward to
addressing any questions you may have. Thank you.
The Chairman. Excellent job, panelists. Thank you very
much. And for the families of Mrs. Rubin and Mr. Davis who are
around it, at the conclusion of the hearing if you would like
to get a picture with your parents up here with Ranking Member
Caraveo and I or without me, just with her, we can certainly
make that happen as a commemorative photo.
I will recognize myself for 5 minutes.
Mr. Davis, I want to start with you. Well, I think every
panelist talked about a lack of certainty impairing the
marketplace. They talked about it in different ways, but I
think they all hit on it. And so in your testimony, you
mentioned that the CFTC and the SEC have had some disagreements
about classification. And we need look no further than Ether,
where we have had the CFTC routinely state that it is a
commodity. The SEC agreed for a time, but now we have Chair
Gensler, who has hinted around the margins that perhaps the
change in their validation status might change their
classification as a commodity.
So, Mr. Davis, tell us, those kinds of conflicting
statements, what impact do they have on the market and product
development?
Mr. Davis. Well, as someone who practices in this space, it
is very difficult to give advice to clients who come to us,
very diligent citizens who very much want to follow the law.
They are very interested in technology, they are fascinated
with the possibilities that technology creates, and they are
not lawyers, and they come to us and they say, ``Look, we want
to follow the law, we want to do what is right, tell us how to
do it.'' And so when you have those conflicting statements
regarding any type of a digital asset, it creates uncertainty.
Now, as I noted in my testimony, I think the case for
Bitcoin and Ether being non-securities is strongest, right? The
CFTC has been saying with respect to Bitcoin for almost 10
years now that it is a commodity, and with respect to Ether,
not nearly as long but for at least 5 years. And the other
thing that has happened with Bitcoin and Ether is both of those
products had been trading on CFTC-regulated markets for years
now.
And so what I like to tell people is, look, Bitcoin and
Ether are the clearest cases for something not being a
security. And as has been alluded to, those two digital assets
accounted for roughly \2/3\ of the market capitalization. And
so even if you just square away the categorization of simply
those two digital assets, you have given clarity to \2/3\ of
the market.
The Chairman. Yes, very well said. And, Mr. Hall, I didn't
hear it in your verbal testimony, but in your written
testimony, you talked about a non-exclusive list of 50 to 60
characteristics that the SEC can rely upon, none of which is
necessarily determinative, and they may result in regulatory
outcomes which are not reproducible, predictable, or certain. I
think I know what each of those words mean, but I guess I would
like a little more meat on the bone, sir. What do they mean in
this context, and why is that problematic?
Mr. Davis. Sure. Thank you. Look, regulators and the
private bar or the regulated need to be able to look at the
facts of their asset, they need to be able to look at the facts
of their activities, and they need to be able to draw a
conclusion about whether their proposed activity is subject to
regulation. If so, how is it subject to regulation? So we have
to speak a common language, and a common language that needs to
have rules that we all understand, that we all understand the
consequences of it. If the question is, is this digital asset a
security--and that is the basic question that we face in any
digital asset activity. If the answer is here is a list of 50
factors that you need to consider and none of them is
determinative and so, therefore, no matter how many you tote up
in that list, ultimately, you may or may not have a security,
you are just asking people to make a judgment call. And if the
regulator weighs those factors in one way and the regulated
party weighs it in a different way, we will just come up with a
different conclusion.
And so I said in my testimony that the SEC's test does not
produce or does not lead to reproducible results. I have to be
able to look at the facts and come to the same conclusion about
whether an asset is a security as the regulator will do. And,
it is not helped by the fact that the one digital asset that
the SEC seems to be pretty clear is not a security, which is
Bitcoin, the SEC has frankly never showed us how they weighed
those 50 factors on Bitcoin alone. So we end up stabbing in the
dark and not surprisingly coming to conclusions that the
regulator may disagree with.
The Chairman. Very good. It looks like it is time for
Congress to get our act together to help with some of these
clarities. Thank you very much.
With that, I would--well, before we recognize the Ranking
Member, the order is Mr. Thompson will go after Ms. Caraveo and
then, Mr. Davis, you are on deck thereafter.
The Ranking Member is recognized.
Ms. Caraveo. Thank you again, Mr. Chairman, and thank you
to the panel for your testimony.
Colorado actually just recently became the first state
where residents have the opportunity to pay their taxes in
cryptocurrency, so I especially appreciate the opportunity to
discuss digital assets because as more and more Americans
invest, it is important, as I said earlier, that we recognize
these regulatory gaps so that we continue to spur innovation,
but also protect customers.
So, Mr. Massad, under your leadership, the CFTC began this
conversation regarding virtual currencies and potential CFTC
oversight as early as 2014. And the agency determined that
virtual currencies can be commodities and began to take
enforcement actions. Could you discuss the process through
which those initial determinations were made by the Commission
and the resources that were necessary to support that work?
Mr. Massad. Certainly. Thank you for the question. The
definition of commodity obviously doesn't contemplate digital
assets, but it does refer to language that was included several
decades ago that said all services, rights, and interests in
which contracts for future delivery are presently or in the
future dealt in. Market participants were coming into my office
saying we are thinking about doing a Bitcoin swap or a Bitcoin
future. What do you think? And we thought about it, and we
said, we think that means they are commodities because they
were talking about contracts for future delivery. So that is
the action we took in a settlement first with an entity called
CoinFlip, and then another one with Terra exchange, and that
was then built on. But it is important then to keep that
concept in mind that it was because market participants were
contemplating or engaging in derivatives on those commodities.
Now, there are arguments that it should even be interpreted
more broadly, but that is where we started.
As far as the resources question, at that time, that was a
fairly small part of our activity. But now the market is huge.
And neither agency really has the resources it needs to police
this market, given what we have seen particularly from the
recent failures is evidence of failure to protect customer
assets, fraud and manipulation, conflicts of interest, lack of
governance, and so forth.
Ms. Caraveo. You really are leading directly into my second
question is what is the potential effect of Congress passing
legislation to address those gaps but not providing additional
funding or resources?
Mr. Massad. Well, I think that would be a real mistake.
Now, you are going to have to give the agencies funding if you
expect them to really police this market. Now, I have noted
that if you create an SRO, that could impose a lot of the
burden of the cost on the industry, just the way we do with all
our SROs. But clearly, this is a huge market, and it will
require additional resources.
Ms. Caraveo. Great. In the last year, the CFTC has brought
a number of major enforcement actions against major players in
the digital asset industry, including FTX, and recent actions
taken against Binance. While we are here today discussing
regulatory gaps, many of these enforcement actions really seem
to be the result of fraud or misrepresentation. For example, in
the months following the FTX collapse, many suggestions were
made by Commissioners and stakeholders on how to prevent
similar future collapses.
So for anyone on the panel, in addition to providing
authority to regulate swap digital commodity markets, what
other authorities or disclosures should be considered providing
for the CFTC? And that is open to anyone.
Mr. Massad. Well, again, as I have said, what I would like
to see is a way to provide authority and resources to raise the
level of investor protection without rewriting the law just
yet. We may want to create new definitions. There are lots of
them that have been proposed in various proposals of Congress,
including the Chairman's and others. And those have a lot to be
said for them. But they are all different if you look at them.
And the danger is, I think we don't have enough information
even about the tokens. We don't have a disclosure regime for
the tokens to know whether, in fact, there is an enterprise
with people involved who are doing things to enhance the value
of that token, which is the basis for whether it is a security.
So I don't know how anyone can say that is not a security when
you don't even have the information about the token. So again,
my proposal is let's elevate investor protection first. Let's
get a little more disclosure, and then come back and revisit
how we should define this.
Ms. Caraveo. Thank you. With that, I yield back my time.
The Chairman. Ladies and gentlemen, the legend of Howard,
Pennsylvania, the Chairman of the full Committee, Mr. GT
Thompson.
OPENING STATEMENT OF HON. GLENN THOMPSON, A REPRESENTATIVE IN
CONGRESS FROM PENNSYLVANIA
Mr. Thompson. That was a good walk-on. Couldn't you put
some music to that, too? That would be even better. Yes,
Howard, Pennsylvania, 600 people, one red light.
Hey, good afternoon, everybody, and thank you to all the
witnesses that are here today for lending your expertise to
this incredibly important hearing. And thank you to the
Chairman and Ranking Member for your leadership and your
commitment, your passion in this area. And to all the folks,
all of our Members who are serving on this Subcommittee, there
was a great demand to serve on this Subcommittee this Congress
in no small part because of the opportunity to work on digital
asset issues, a critical issue going forward.
And I am excited about the work of the Subcommittee. I want
to thank you all for your willingness to serve on this
Subcommittee. I think that there is a great potential for
digital assets to provide significant value to the American
public, Web3.0, not just in monetary terms, but also as tools
to solve real-world problems, as have been reflected on that
today.
But, digital asset developers, users, institutions need
clear, thoughtful rules of the road to create the solutions. As
Chairman Johnson said, we are working hand-in-glove with the
House Financial Services Committee to craft legislation that
will do just that. This is perhaps unusual for Congress, but it
is the right thing to do to make good public policy. No one can
solve this issue alone. It will take the cooperation of
committees and regulators to build a workable framework to
oversee digital assets. And I am so thankful for all the
witnesses for sharing their expertise.
I will start my questions with Mrs. Rubin. I would like to
further explore with you the practical uses of digital assets
and blockchain technology. In your testimony, you talk about
how several organizations are using the Hedera network to
improve their businesses. Can you elaborate on a project or two
who utilize your network to accomplish daily or commercial
activities?
Mrs. Rubin. Thank you, Mr. Chairman, for this question. I
included a few use cases in the testimony. One was DOVU, which
allows farmers to tokenize the work that they are doing. So
let's say they have a regular crop and they plant additional
flowers around the edge that has different environmental
benefits and carbon benefits. They can tokenize that and sell
it as an offset. If they decide to drill instead of tilling,
they can tokenize that changed farming technique and make money
on it. It is really fascinating. Another one that I thought was
fun was Tune.FM. And it is kind of like Spotify but on the
blockchain, so it will allows artists to get paid immediately.
Like, as soon as someone is listening to it, then that tiny
amount of money goes to them. They don't have to like wait.
They don't have to prove there are a certain number of
listeners. It is clearly on the blockchain, this number of
people listen to your song and this is how much you get per
amount of time that the song was played.
Another that really moved me was with AVC Global and
medical value chain. And what it does is it allows--it uses
Hedera to authenticate pharmaceuticals so you can track and
make sure that that pharmaceutical is legitimate. It turns out
that counterfeit pharmaceuticals, it doesn't just cost
companies money when they are used. It endangers people's lives
because these pharmaceuticals are not real. So these are just
amazing use cases that we haven't even begun to explore.
Mr. Thompson. Well, thank you for that.
Ms. Maniar, as you know, there has been much debate in the
U.S. on whether digital assets are considered commodities or
securities. We heard that discussion today. Some Federal
regulators have claimed that all digital assets except Bitcoin
are securities. If all digital assets were deemed securities
tomorrow, how would that affect the customers of FalconX?
Ms. Maniar. Thank you for your question, Mr. Chairman. It
would certainly mean that our customers would be disrupted.
They would have an asset that they are holding that they would
have no clear avenue to be able to transfer, which really gets
at what the heart of the technology is for, which is the ease
of transfer and being able to control the terms in which you do
it in a disintermediated fashion. It would be extremely
disruptive to their businesses.
Mr. Thompson. Yes. Well, thank you to each of you for your
expertise, your testimony, your oral and your written
testimony, is much appreciated.
Mr. Chairman, I yield back.
The Chairman. We will have Davis, Langworthy, Budzinski.
Mr. Davis, you are recognized for 5 minutes.
Mr. Davis of North Carolina. Thank you so much, Mr.
Chairman, and to our Ranking Member. And thank you to the
witnesses who are here. It is always good to see--I think I
would concur that the music was absent. We need that.
But to all the witnesses again, thank you for joining us
today.
Most people in my district in eastern North Carolina very
likely have never heard, I would imagine, of this, CFTC or the
SEC. I am just keeping it real today. Most Americans probably
haven't either. But more and more Americans have heard of
cryptocurrencies and have either purchased them themselves or
have raised concerns about how they will affect the traditional
economic markets. So my question is, what would you tell people
in my district why the CFTC or the SEC matters to them or how
these agencies would impact them on a day-to-day basis?
Mr. Massad. Thank you for the question, Congressman. It is
estimated that about 17 percent of Americans have purchased
cryptocurrency. A lot of those--and that is also scaled toward
younger generations, and it is scaled somewhat toward lower-
income people. And a lot of those people have suffered
significant losses. A lot of them bought after prices had gone
up quite a bit, and then prices fell dramatically, and we had
failures of some big firms. A lot of them lost retirement
savings, college savings, other assets very important to them.
Having a regulatory framework is no guarantee against
failure, but it can certainly help prevent it. And particularly
because the types of things that have come out as to what the
failed institutions did in terms of using customer assets
improperly, using them through affiliates that had conflicts of
interest, failures to prevent fraud and manipulation, I think
those are the kinds of things that a good regulatory framework
can prevent.
My own view is we shouldn't be basing policy on a judgment
about the merits of cryptocurrencies. They are obviously out
there, and people are investing. But we do need to set up a
framework that gives people some assurance that there is
integrity and transparency and protection of customer assets.
Mr. Davis of North Carolina. There has been more and more
talk about officials and those in the public about a central
bank digital currency in the U.S.. Can you speak then on if you
have heard from the Federal Government pursuing this policy?
And, if so, what would that mean for, again, the average
consumer and how they conduct business?
Mr. Massad. Well, I think the Federal Reserve is engaged in
research on a CBDC, but I think that is years away at best, 5,
10 years away if we decide to have one. It is not clear that we
need one. There are a lot of policy issues both ways.
Cryptocurrencies are here today, and there are stablecoins,
which effectively--the value of those are tied to the dollar,
and those could be significant in payments. But again, we lack
a regulatory framework for those as well.
So my own view is we need to create the proper regulatory
frameworks for the unbacked crypto tokens, as well as a proper
regulatory framework for stablecoins. We need to be pursuing
research on CBDCs and how to improve our payment systems, but I
see those things as happening on a longer track.
Mr. Davis of North Carolina. Yes. Well, I would just end
today by saying I have heard so much from residents back home.
And at the same time, there appears to be so much of an
opportunity here to educate the public, common, everyday people
on this whole topic and why we are here. And I can't say
enough. When I think about fraud, scams that are taking place,
the complexity of this, I can't say enough to our leadership,
to our Ranking Member and above to our Chairman for having us
here today and also for the Financial Services. I yield back.
The Chairman. Thank you, Mr. Davis. The lineup is Mr.
Langworthy, Ms. Budzinski, and then Mr. Rouzer unless somebody
else comes back in.
Mr. Langworthy from New York, you are recognized for 5
minutes.
Mr. Langworthy. Thank you, Mr. Chairman, Ranking Member.
Mrs. Rubin, last week, the European Parliament passed their
crypto asset legislative framework known as MiCA (Markets in
Crypto-assets). I heard from several crypto companies that, due
to the lack of regulatory clarity, that many firms are choosing
to domicile their companies in jurisdictions that do have
clarity. In addition, a recent study published by the Developer
Report reported that the U.S. is continuing to lose its lead in
blockchain going from 40 percent of the developers globally to
29 percent. Mrs. Rubin, are you seeing this innovation flight
as well? If you are seeing that, how can we reverse that?
Mrs. Rubin. Thank you, Mr. Langworthy, for that question.
Yes, the flight that you are discussing is real, and it is
happening. People are fleeing to jurisdictions with regulatory
clarity because they want to know that their businesses are
operating within the law and that they can operate fully and
that they can make investments that will stand. So it is kind
of this shocking situation where the United States, which is
usually at the forefront of every technology, is now standing
back and allowing other jurisdictions to run ahead. And this is
not just bad for the businesses themselves, but it is a bad for
the American consumers because we won't have access to these
transformative technologies.
Hedera was created by U.S. veterans, people who were
teaching at the Air Force Academy. Like we launched Hedera here
in the United States as a global platform. Our firm desires to
make this be a platform from here, but it is very scary and
fearful to be working in an environment without regulatory
clarity, so the number one thing that you could do is help
provide that regulatory clarity.
Mr. Langworthy. Thank you very much.
And, Ms. Maniar, pivoting here to China, we know that
adversaries like China and Russia, they are exploring ways to
undermine the U.S. dollar and our position as the world leader
in finance. As you know, markets have thrived under U.S.
leadership as our values of economic freedom, capital
formation, and consumer protection. They have shaped the global
economy. Many are calling crypto the next wave of financial
innovation. So what are the risks if the U.S. stands idly by
while our adversaries take the lead in this area in the future
of finance?
Ms. Maniar. Thank you, Congressman, for your question. I
certainly agree. I think it is incredibly important that we
remain relevant and a leader in developing what this technology
looks like. If the technology is developed offshore and we are
going to see U.S. market participants not being interested in
engaging in the technology, but they are going to receive what
is developed overseas. And the U.S. has always been a leader in
technology and financial markets, as you pointed out, and we
really look to see that we continue to do that for this asset
class as well.
Mr. Langworthy. Okay. Would any of the other panelists wish
to weigh in on that question?
Mr. Massad. Sure, I think it is very important for the U.S.
to be focused on the technology of payments generally. I think
we are still a ways away from the dollar really being
threatened. The dollar's dominance is related, as you know, to
a number of factors, the strength of our economy, the rule of
law, the stability of our government. But I think the
technology of payments is important. And, it is possible that
countries could move away from using the dollar as a payment
mechanism, even if they continue to invest in our Treasury
securities. So that is why I have supported research not just
on CBDCs, but improving payments in other ways, a stablecoin
framework, and so forth.
Mr. Langworthy. Thank you very much. And I yield back, Mr.
Chairman.
The Chairman. Thank you very much. We will go Budzinski and
then Nunn--I am sorry, Rose, Mr. Rose, and then we will go Ms.
Salinas. All right. You are recognized for 5 minutes.
Ms. Budzinski. Thank you, Mr. Chairman, and thank you,
Ranking Member. And thank you to the panelists. I really
appreciate your expertise and your testimony as it relates to
this topic.
I share a lot of the sentiment that Congressman Davis just
shared with you as it relates to his district and kind of from
the consumer end-user perspective and constituents that might
not all be as up to speed on the financial services sector and
all the ins and outs of cryptocurrency. And so as I think
everyone is looking for new opportunities to take advantage of
making a little bit more money, but we want to make sure that
consumers are also obviously protected.
Just to kind of piggyback a little bit on what Congressman
Davis was asking is could you give some ideas of like maybe
some better communication that we might be able to have with
consumers around the risks that they are taking on in this new
industry but that I think settling some of that risk and
getting people more comfortable with it also could have them
make more calculated decisions that financially could benefit
them. I think communication is really key and something that we
haven't really been able to tackle in a good way. So I am just
curious what you might think about that.
Mr. Massad. Well, sure, I would be happy to address that. I
mean, I think one of the challenges is that I think even with
people who have gotten into this space investing, they may be
aware that the crypto assets themselves have risk because they
are volatile. But what they don't appreciate sometimes is these
trading platforms have a lot of risk because they are
unregulated. And that is exemplified by, again, the studies
that show how much wash trading there are where basically
someone is trading with themselves to inflate the price or
inflate the volume. And there are holders of Bitcoin, the so-
called whales, people who hold a lot of Bitcoin who potentially
can easily manipulate that price.
The same is true with protection of customer assets. They
don't realize that their customer assets are not protected in
the same way that they are if you buy a share of stock or if
you deposit money in a bank. There is no insurance scheme, of
course, and there is not even what we have for securities where
we at least have a regime on brokers or even in commodity
futures, we have better protections in bankruptcy. There is no
protections in bankruptcy for consumers. I think if we had a
stronger regulatory regime, part of that would also be an
education campaign so people are aware of these risks.
Ms. Budzinski. That is a great idea. Any other thoughts?
Mr. Davis. I am most familiar with the CFTC, but there are
robust consumer protection mechanisms under CFTC rules and
regulations. And, CFTC does cover a significant retail base.
There are retail foreign exchange transactions that are subject
to CFTC, and there is also leveraged retail commodity
transactions. So if I buy Bitcoin and I want to leverage up and
buy five times or six times or seven times Bitcoin, that is a
product that is currently regulated by the CFTC.
And so, that agency has already been wrestling with that
question about, ``Okay, we know we are dealing with retail, we
know it is a product that has some differences than other
products they may be dealing with. How do we get proper
disclosures? What types of requirements do we give to the
exchanges or the people who operate in this space so we limit
or avoid wash trading?'' And I think one of the benefits of a
CFTC style of regulation is that the exchange itself obtains
responsibilities for implementing core principles and having an
effective rulebook that is reviewed by the CFTC and agreed upon
by the CFTC that they have to follow and impose and enforce.
And that can include those types of provisions, customer
disclosures that are common sense that can be understood by the
regular retail investor, understanding of the risks that you
take. This wash training problem that the former Chairman has
talked about, I mean, the CFTC has brought enforcement actions
against wash trading in some of the biggest digital assets out
there. So I think a lot of the ingredients are there to be able
to give your retail investor the type of information and
protection and information so they can make an informed choice.
Ms. Budzinski. Thank you. I will ask one really quick
question, too. And your testimony has touched on a lot of this,
but if we could just kind of go back to a new regulatory
framework for digital assets, if you could just topline go
through for me really quick what are the guiding principles do
you believe should be at the core of any regulation? I know you
have talked about this a little bit but if we could review it
again one more time.
Mr. Massad. Sure, I think they are very similar to the
principles we have in our securities and derivatives markets
today, the protection of customer assets, systems to prevent
fraud and manipulation, governance measures, including fitness
of directors, regular reporting, both publicly pre- and post-
trade transparency, as well as reporting to regulators. Risk
management, cybersecurity, and that is a big one, because there
could be a hack of a platform that has consequential collateral
damage to other parts of our financial system. And also just
making sure they do a good job on know-your-customer and money
laundering because that is important for preventing illicit
activity.
Ms. Budzinski. Thank you. Thank you. Thank you, Mr.
Chairman. I yield back.
The Chairman. Let's go to Mr. Rose and then Ms. Salinas.
Mr. Rose. Thank you, Chairman Johnson and Ranking Member
Caraveo, for holding this hearing, and thank you to our
witnesses for being with us today and taking time.
Mr. Massad, given the uncertainty created by the
regulators, I think it is important that Congress helps clarify
the line between digital assets that are commodities and those
that are securities. However, it seems there is a third bucket
of digital assets like digital collectibles, so-called non-
fungible tokens I guess we might say, or digital sports cards
that are unique and not like traditional CFTC-regulated
commodity products. How would you suggest Congress approach
this group of digital assets?
Mr. Massad. It is an excellent question, Congressman. I
have focused on the fungible tokens, as have many of the pieces
of legislation. You are right that there are issues on the non-
fungible tokens, too. I would consider those separately. You
could consider having the CFPB issue rules on that because they
don't create quite the same issues that we have with kind of
the securities/commodities world. But I think it is important
that we do create a framework, and generally, those are sort of
traded on different platforms. They are not the coin bases of
the world so much. They are other platforms. So that would be
my view, but I agree with you that that is an area that needs
examination also.
Mr. Rose. Thank you. An article published in Forbes late
last year and written by George Calhoun, who is the
quantitative finance program director at the Stevens Institute
of Technology, noted that, according to a report by the
European Union Institute for Security Studies, the Chinese
Government has leveraged the traceability and immutability
offered by blockchain technology in the field of policing, has
explored the use of blockchain for the dissemination of
propaganda, and is already using blockchain to gather evidence
against dissidents. As Congress considers clarifying the
regulatory scope of the SEC and CFTC's jurisdiction over
digital assets, I would like to ask each of you if you feel
that Congress should use this opportunity to consider
guardrails to ensure that bad actors like the Chinese Communist
Party can't utilize digital assets that are developed and/or
supported in the United States to assist in repression of their
citizens? And I will let any of you that would like to comment.
Mr. Davis. I will just say I think everyone recognizes that
privacy is something that we all value, that it is important to
us. It is part of our culture. And certainly, when I think in
terms of CFTC regulation and the way that the CFTC regulates,
you think about core principles, right? So you can imagine a
world where one of the core principles an exchange or a
regulated entity has to wrestle with and figure out how to
implement is how to have proper privacy protections for the way
it operates and the way the digital assets that trade under it
operate. And so I think it is an important concept, and I think
it is one that we are perfectly capable of looking into and
figuring out and make sure that we are properly factoring into
the way that this industry continues to develop.
Ms. Maniar. I would say certainly. I would reference back
to my earlier point, too, about the fact that this is why it is
crucial for the U.S. to be leading on the development of this
technology so that we can set the standards for what it should
look like.
Mrs. Rubin. I would agree, yes. We absolutely need to take
this opportunity to put up guardrails against repression. And I
would add only that the U.S. leadership vacuum gives China an
opportunity for influence, and we need to fill it.
Mr. Massad. And I would just add that I think that is
another reason why it is important for us to be a leader in
regulation, not just obviously of cryptocurrencies but of
things like stablecoins and looking into a CBDC, not that we
should decide to have one. We may not need one. But we need to
be at the table as some of these issues are talked about so
that we make sure payment systems develop in ways that are
consistent with western values, protection of privacy.
Mr. Hall. And I would just add that the lack of a clear
regulatory framework at the moment means that we don't have the
kind of corporate and institutional investment in this sector
that would allow our country and entrepreneurs and brilliant
people in our country to be developing and exploring the kinds
of use-cases that, frankly, other governments, including
repressive governments, are doing right now. So I think we are
hamstringing ourselves by not providing clear rules of the road
for American businesses to try to solve problems.
Mr. Rose. Thank you. I see my time has expired. I yield
back, Chairman Johnson.
The Chairman. Ms. Salinas will be recognized for 5 minutes,
and next up on deck would be Mr. Rouzer.
Ms. Salinas. Thank you, Chairman Johnson and Ranking Member
Caraveo, for this really important discussion today.
As the country grapples with questions on how to regulate
cryptocurrency and what role it plays in our financial markets
or otherwise, the states have really had to step up in the
interim to try to protect consumers and identify some paths
forward. My own State of Oregon was the first state to give
control of digital assets to a fiduciary. And currently, Oregon
law requires companies that transfer digital currency from one
person to another to be licensed as money transmitters.
However, Oregon law does not have any requirement on companies
that only take cash and turn it into digital currency.
And this is for anyone on the panel who wishes to respond.
From your individual perspectives, does licensing money
transmitters help protect consumers, and what are the
shortfalls in doing so?
Mr. Massad. Certainly, the money transmitter laws do help
protect consumers, but I think for this sector, for this
industry, they are simply woefully inadequate as a regulatory
framework. They basically impose very minimal net worth
requirements, very minimal security like posted bond
requirements, and some of them have permitted investment
requirements. They don't create the kind of framework that we
need to regulate this sector and protect the public.
It is kind of like, if you imagine that after the 1929
crash, Roosevelt had said, you know what, I think the states
can take care of this, we don't need a securities law. The blue
sky laws we had would not have been adequate. So the same is
true here. Now, some states have tried to build on that, and
that is great. I encourage that kind of activity.
And one of the things that should be done at the state
level is to clarify, essentially, property rights and transfers
of digital assets, the Uniform Commercial Code issues, and some
states are working on that. That is extremely important for
states to take up.
Ms. Salinas. Thank you. Does anyone else wish to respond?
All right. I will move on.
So, Mr. Massad, during your tenure as chair of the CFTC,
were there instances in which the CFTC worked with the SEC to
actually resolve regulatory disagreements, and what were the
results in those instances? And would it be helpful to
establish a clear process by which Federal agencies regulating
digital assets could actually work in tandem?
Mr. Massad. Yes, we did. Mary Jo White was the chair then,
and we worked very closely together on the implementation of
the Dodd-Frank requirements for over-the-counter swaps. And
that was critical because both agencies did have
responsibilities. And that type of cooperation dates back to
the founding of the SEC. The Shad-Johnson accord was one of the
main examples. It doesn't come easily sometimes. It does depend
sometimes on people's personalities and the time and so forth.
But, I think if Congress sets an expectation that they expect
the agencies to do that, that it can happen, and clearly it is
needed in this space.
Ms. Salinas. Thank you. Mr. Davis, despite their limited
authorities, the CFTC has brought at least 70 enforcement
actions involving digital asset commodities, as you note in
your testimony. Are there some common themes within those
enforcement actions?
Mr. Davis. I mean, I remember one person telling me, it
doesn't matter the asset class, fraud and schemes to get people
separated from their money are always the same right?
Ms. Salinas. Right.
Mr. Davis. And so you have the same types of fraudulent
schemes that you get with other asset classes. You have a
classic pump-and-dump scheme, right? You tout the benefits of a
particular cryptocurrency, you didn't tell people that you own
it, you pump up the price, and then you sell out from
underneath it. As the former Chairman has referred to, wash
sales is active in a host of markets where you are acting on
both sides of the ledger to beef up what appears to be the
activity in a particular asset, right? And so that the types of
activities that are fraudulent aren't unique to digital assets,
right, but they are also occurring in the digital asset market.
And to the CFTC's credit, during my tenure there, there was an
active engagement to learn more about how the digital asset
space operated, how those markets work, how fraudsters were
taking the tools that they would use elsewhere and how they
were applying it to digital assets. And so I think the CFTC has
really done an excellent job through its enforcement actions
and other activities that it is doing to really get a better
understanding of how these underlying digital asset markets
work because it is very important for them with the role that
they have with futures and derivatives to understand how those
spot markets work.
Ms. Salinas. Thank you all for your time today. I yield
back.
The Chairman. Mr. Rouzer is recognized for 5 minutes, and
he will be followed thereafter by Mr. Jackson.
Mr. Rouzer. Well, thank you, Mr. Chairman. I appreciate our
panelists being here today. This is an incredibly important
topic.
My experience is Congress either over-prescribes or under-
prescribes. It is kind of hard to get it right. So my question
to each of you, I will give you an opportunity to share with
the Subcommittee, what does over-regulation look like? What are
you worried that we are going to do? I always like to know what
not to do first, that way it helps get me on the right path,
whoever wants to start.
Mr. Massad. I am happy to answer that. I am actually
worried that you will try too hard to clarify this issue about
what is a security, what is a commodity. I respect the intent.
I respect the desire to do so. But when you look at the
legislation out there, there has been several proposals made.
They all do it differently. They all will provoke a lot of
questions. I can find problems and loopholes in each one of
them. I think any of those things are going to lead to a lot of
questions of interpretation, potential litigation. I just don't
think we know enough in part it is because we don't have enough
disclosure about these tokens, and that is why I am kind of
suggesting something incremental. Require the two agencies to
set some standards for the platforms that elevate investor
protection, that provide a little more disclosure, and then
come back and look at how should we really define this
permanently. That is the essence of what I am suggesting.
Mr. Hall. I would be concerned about that approach. I
understand some of the practical reasons why former Chairman
Massad is proposing it, but I would be concerned about an
approach where Congress simply acted on Bitcoin and Ether and
didn't address the other 23,000 assets that are out there. And
I don't think that there is a way for Congress, frankly, to
avoid this very difficult question of drawing the line between
securities and commodities because the agencies are at
loggerheads right now, and the SEC, I believe, is at
loggerheads with the industry right now about what these things
are. And so from my perspective, as somebody who advises a lot
of different clients in the industry, I think we do need
Congress to come in and give us some basic line drawing, some
basic boxes that we can put these different assets in.
Now, I don't think all digital assets are the same. I think
that they are endlessly mutable, but I think that there are
some basic categories that we could begin to work with. I have
read a lot of the legislation and the drafts that have been out
there so far. I am not entirely sure that any of them kind of
gets this question just right yet. But I think that hard work
does need to be done by Congress. And I, unfortunately, don't
have a lot of confidence that if it is left to the regulators
to sort out amongst themselves, that we will be in any
different situation from the situation that we are in today,
which I don't believe is tenable for the industry.
Mr. Massad. Can I just clarify? I am not suggesting that we
act only on Bitcoin or Ether. What I was suggesting was that
Congress pass a law which mandates that any platform trading
Bitcoin or Ether be subject to these principles, but that would
be for everything that trades. That is just a definitional way
of defining which platforms you want. There is no platform out
there of any relevance that is not trading Bitcoin or Ether.
They are 70 percent of the market, and often, trading is in
pairs. So you are going to capture the whole market, and you
are going to set standards that then apply to all of the
tokens. The fact is 23,000 are not listed. If you take the four
largest exchanges, they list a total of about 400. And what is
quite interesting, actually, is they don't list the same
securities. So if it is so clear to them--or the same tokens, I
should say. If it is so clear to them that they are only
listing commodities, why are they all different?
Mr. Rouzer. I got 22 seconds real quick.
Mrs. Rubin. I would briefly add that one thing that
Congress could do wrong is to think about regulating the
technology. Instead, think about regulating the activity, and
that is what we are seeing in other jurisdictions around the
world.
Mr. Rouzer. Yes, ma'am?
Ms. Maniar. I would just add that this is a very
entrepreneurial space, so I would like to see principles-based
regulation that allows that innovation to continue to grow.
Mr. Davis. I would say don't let the perfect be the enemy
of the good. Adding better guardrails about the line between
securities and commodities will greatly enhance the ability of
us to give advice and for businesses to know what to do.
Mr. Rouzer. You all are incredible, 5 seconds left,
amazing.
Mr. Chairman, I yield back.
The Chairman. And there is a lot of good stuff there at the
end, really, really good stuff.
All right. We will go Mr. Jackson, and that will be
followed by Mr. Nunn. Mr. Jackson, you are recognized for 5
minutes.
Mr. Jackson of Illinois. Thank you, Mr. Johnson. Thank you
for your participation today.
I think to follow up on my colleague's question on defining
this as the commodity versus the stock, I am very familiar with
it. But in simple layman's term for those that are watching us,
stock is a piece of ownership in the actual corporation, and
this commodity can be an asset before it has actually been
delivered, evolved, or even planted. So in your honest and
humble opinion, shall I say, what would you like to see it
described as? I do not believe the regulators know your
business better than you, and I am concerned that we are behind
the ball as to--we can see an implosion. We saw something with
a hard asset stock if you will in the SVB that were the assets
and the balance sheet and swollen, then contracted from
macroeconomic circumstances beyond their control, raising of
the interest rates. They couldn't rein it in, and I take it
most of you up there are old enough like me to know of long-
term capital and other things. So where is this? Is it a stock
as an asset or is it a commodity or an asset to be realized in
the future that is in its creation? And that is open to the
panel.
Mr. Davis. Now, I will go to my testimony. If you look at
what the Commissions themselves have said, right, not a
Chairman, not a Commissioner, if you look at what the CFTC as a
Commission have said and what the SEC as a Commission have
said, the CFTC has identified seven of the top traded digital
assets as securities, and that is 76 percent of the market. The
Securities and Exchange Commission has identified one of the
top 15 digital assets as a security, and that is two percent of
the market, right? And so you can look at those seven that the
CFTC have identified through enforcement actions, and you can
see some characteristics about them. They tend to be
decentralized, people tend to use them for consumptive purpose
and not for an investment purpose, so there are some
characteristics there.
And so, I agree that each digital asset is a bit different,
but certainly, the actions at the Commission level with the
most heavily traded digital assets is at least giving us some
additional clarity--there can always be more; there definitely
needs to be more--but they have given us some level of clarity
about where some of the lines might be between security and
commodity.
And the other thing that I would note is that, over time,
one would expect that a digital asset becomes more of a
commodity than a security because, in theory, with most digital
assets the idea it is going to be widely accepted, widely used,
widely dispersed, those are much more the characteristics of a
commodity than a security.
Mr. Hall. And, Mr. Jackson, I think you have put your
finger right on it. An asset that represents a claim on the
assets or revenues or properties of a business or a business
enterprise, that is a security. And even if it is issued on a
blockchain, it should be regulated like a security. And so if I
were going to draw lines and create boxes for these things, I
would put those in a category by themselves.
But then I would go to the things like Mr. Davis is talking
about and say, okay, this particular asset doesn't represent a
claim on a business or a promise from a business. This is an
asset that I can use to send a payment or an asset that I can
use to purchase file storage space or something like that.
I do believe that users need good information about it, and
this goes back to one of the questions that came earlier about
why should a retail person, why should an ordinary person
trading these things, why should they have that information? I
think it is different from a commodity. People have an
intuitive idea about what an orange is, but they are not
necessarily going to have an intuitive idea about what a
digital asset is. So I do think we should have standards and
information that needs to be provided and back that up with
liability for the person providing that information.
And that is where a digital asset is just different from
what we customarily think of as a security and what we
customarily think of as a commodity. And again, the reason why
I think Congress needs to come in and begin to draw these lines
and begin to say how we want these assets to be regulated
rather than this tired debate over whether it is a commodity or
a security.
Mr. Jackson of Illinois. And let me ask just one follow-up
on that, and please take it, it is an opaque industry, so at
what point do you declare this asset, this commodity to be
decentralized?
Mr. Hall. Well, I wouldn't have decentralization as being
all that important because I think whether the asset is
decentralized or not, consumers still need the information
about it. And I also think that we still want to have strong
market oversight and market regulation. So I personally would
not focus on decentralization because I think we need to be
able to cover decentralized assets as well.
Mr. Massad. The decentralized point also goes to the fact
that we don't have enough information about a lot of these
tokens. We don't even know sometimes is there a foundation
behind it? Are there people with administrative keys? And that
is why, again, I am pushing for more information, more
disclosure, more consumer protection first, and then come back
and define exactly where the lines are drawn because we are
talking about thousands and thousands of digital assets.
Mr. Jackson of Illinois. Thank you. And I yield my time
back, Mr. Johnson.
The Chairman. Very good. Thank you, Mr. Jackson.
We will go to the gentleman from Ohio. Mr. Nunn, you are
recognized for 5 minutes. Thereafter, we will go to Mr.
Molinaro.
Mr. Nunn. Thank you, Mr. Chairman.
And I want to compliment both the chairs of the digital
asset on the Financial Services side, as well as the
Agriculture Committee for working so well on this, both
bipartisan, bicameral, and we are going to get into--for those
folks at home playing the government bingo card on acronyms
here, an SEC and a CFTC. Now under the SEC, we are talking
about all things that are securities. Under the CFTC, we are
talking about all things that would be commodities. In my home
State of Iowa, we know commodities very well.
But we do hear from Chair Gensler on the Financial Services
Committee that all tokens are securities. And we heard here in
the Agriculture Committee not only a month ago from the CFTC's
Chairman Behnam who said pretty much the opposite, that all
commodities are where they should be.
So if we can, I do think, Mr. Hall, with respect, it is
important that we provide some guidance for those who are in
this space.
Mr. Massad, you are former CFTC Chairman. Simple question,
right? Ethereum, commodity, security?
Mr. Massad. I don't have enough information. I think the
concern about Ether, Ethereum was in the merge where they
changed the system of validating transactions, there seemed to
be a foundation, a group of people involved in that. Is that
under the Howey Test, a common enterprise from which if I hold
Ethereum, I am expecting to receive a return? I don't know. And
that is the problem with all these. I don't have enough
information.
Mr. Nunn. And I think that there are a lot of Americans who
are in the same situation. What is the challenge of having
these conflicting messages out there coming from both the CFTC
and the SEC?
Mr. Massad. Well, it confuses people, obviously. And I
think, obviously, we are in a stalemate where we are not
improving investor protection because of it.
Mr. Nunn. Right.
Mr. Massad. And the risk is, if we try to rewrite it
without having enough information, not only could we get it
wrong, but there could be unintended consequences in our
broader markets. That is why, again, I am not against coming up
with a new definition. I am just saying take a little more
time.
Mr. Nunn. Well, let me push back on that just a moment.
Mr. Massad. Sure.
Mr. Nunn. I think Mrs. Rubin actually had a very good
argument here from Hedera, which is an Air Force guy, Air Force
creation. Compliments, by the way. Industries do want clarity
in the law. And I am going to go to Ms. Maniar on this. We have
seen the last few days a couple of other countries and other
regions have moved out in this space. The European Union has
moved forward with the markets and crypto asset, kind of a
space in between the CFTC and SEC called MiCA. The United
Kingdom is finalizing its own digital asset regulatory
proposal.
What I think was highlighted here is we don't necessarily
want to regulate the commodity. We want to provide the
framework, right? So could you speak to us from FalconX's
perspective where you guys are seeing innovations thrive when
there is a structure and where innovation is being stymied
because there is no structure?
Ms. Maniar. Absolutely. Thank you for your question.
Certainty in any industry gives the ability for those who want
to get involved, who want to build, who want to grow, want to
create businesses to do so, right? And having no certainty
makes it very hard to do. When you employ people, you can't
employ people with the assumption that your company might be
here today but may not be here tomorrow. You have an obligation
to those employees. That certainty is necessary in the U.S.
right now, and we are seeing that the jurisdictions where there
is certainty--and I want to make clear, where there is
certainty, not lack of regulation--is getting the benefit of
those companies being founded there.
Mr. Nunn. You are the first and only--if I have this
correct--CFTC-registered cryptocurrency focus where you are a
swap dealer, which is a great thing. How is the CFTC as a
principle-based regulator in comparison to the SEC in this form
of regulation? Do they have it right?
Ms. Maniar. Yes, we have had a very robust and effective
dialogue with the CFTC. It is nuanced. They have been very
interested in learning about our space and understanding our
business. There is certainly not an easy regulator, and that is
okay. That is not what we are looking for. Nobody in the
industry is looking for that, right? So they have been very
eager to learn about our business, eager to learn about the
space, eager to understand how the existing framework that they
have is one that we have been able to comply with. And that has
made it incredibly easy for us to be able to build in that
space because of that certainty.
Mr. Nunn. So let's go back to our bingo card. On the SEC
and the CFTC, let's take this away from the unelected
bureaucrats and put it squarely in the court where I have \3/4\
million bosses back home. What can we be doing in Congress to
make this space a better frame for businesses like yours?
Ms. Maniar. Certainty, taking Congressional action to
create some certainty in this space so that we can keep doing
this here in the U.S.
Mr. Nunn. I am going to push you one deeper. What does
certainty look like to you?
Ms. Maniar. To me, it looks like a system where there are
rules of the road, there is a framework that you know that you
can operate in, that you know will be the same tomorrow so that
you can invest in this space and build a company in this space.
Mr. Nunn. Nothing worse than D.C. whiplash. I get it. Copy.
Mr. Chairman, thank you very much. I yield back my time.
The Chairman. As much as it may pain me to say it, I think
Mr. Nunn hit it out of the park with his description of the
need to close the gap here, well said.
Mr. Molinaro, you are recognized for 5 minutes.
Mr. Molinaro. Is that now the standard, Mr. Chairman? Are
you are going to grade our lines of questioning?
The Chairman. Yes, sure. Yes. You are either better than
Nunn or not quite as good as Nunn.
Mr. Molinaro. Well, bingo. Mr. Chairman, thank you.
I am excited to be in Congress in this moment in time. And
I have said this many times. I represent a rural part of
upstate New York. Digital assets provide I think one of the
greatest opportunities to harness innovation but also to
provide access to capital in places and to people where the
traditional banking institutions frankly, I don't want to say
fail them but are outside of their reach at times.
And so, interestingly enough, right, this is an entire
industry that is seeking to be regulated to a degree. The
golden question for us, what are the guiderails that we think
are appropriate to both harness but also support the innovation
while establishing the basic tenets of regulation to protect
people and the industry? And that is the challenge, right? What
is the right mix?
Many of my colleagues often speak about American regulation
if we were to impose, how would that compare to China or the EU
or Great Britain? I often go back to local because, right now,
absent Federal action, states are filling the field. And that
worries me to a degree. But for better or worse, New York State
has been one of the states that has taken sort of initial
action to develop a regulatory structure. There are good points
and bad points in the state's regulatory structure.
And I think only because, Mr. Hall, you are somewhat a New
Yorker--are you a New Yorker? I thought I would start with you.
And perhaps just for our benefit, could you just speak to what
perhaps are the strengths and weaknesses of a New York system
and, if you would like, some of those other tenets that other
states have imposed?
Mr. Hall. Sure, and thank you very much. New York has an
excellent regulator. DFS is an excellent regulator. They were
out well ahead of the Federal Government and well ahead of many
other governments in terms of coming up with a bit license back
in, now 2016 or 2017, that a lot of our clients have obtained,
and I think it works quite well for what it does. I will say
that I am aware of businesses that have deliberately avoided
serving New York customers because of it.
But look, I think with anything that operates over the
internet, honestly, while there is a huge room for the state
regulators to play, particularly in anti-fraud enforcement and
payment services, money transmission, and things like that, I
think when you have a business in the United States that is
operating a storefront on the internet, we need Federal
legislation. We need legislation that is going to apply
consistently across the country and not have a situation where
somebody who is a New York resident, maybe using a VPN to get
around firewalls so that they can trade with somebody who maybe
hasn't obtained that----
Mr. Molinaro. So I agree with you. The question that I have
is can we, should we have a system that has--obviously not--I
mean, not obviously, but perhaps not Federal supremacy, but
rather sort of the dual banking model that exists now, Fed
guiderails, state structure as well or----
Mr. Hall. Yes, I think we should, and I think you have to
look at different kinds of digital assets in order to see where
that works and where that is actually an improvement. For
example, if you are a stablecoin issuer, I think that you ought
to be able to elect whether to have a Federal charter or a
state charter. I think there is definitely room for state
regulation like that.
Mr. Molinaro. Okay. So one of the challenges in creating
the structure for digital assets is that, as we understand,
many tokens vary widely in function and underlying value. In
New York, there is a trust that offers what essentially is
tokenized gold. It is a digital asset that has value. It is
pinned to real allocated underlying gold bars in London vault,
which was of interest to me, not ETFs or futures. So purchasing
the token is equivalent of buying an ounce of physical gold.
To any of you, perhaps could you speak to the tenets that
would help in balancing a regulatory structure that is clear
and defined but also flexible enough to consider the actual
underlying value of tokens? Anyone jump in my last 30 seconds.
But I heard the Chairman say he would give you 20 extra.
Mr. Davis. So, I mean, CFTC background, the CFTC deals with
those types of things, right, where you have an underlying
commodity, then you do something on top of it, right? The way
you do the something-on-top-of-it impacts from a CFTC
perspective under current law how it is regulated, right? I
think the same principle applies, right? When you are engaging
in that type of asset, you want the same type of protections,
and so you need a regime that allows you to define that asset
in a way that people can understand and then you know what
regulatory regime applies to it.
Mr. Molinaro. Well, my time----
Ms. Maniar. If I may just add----
Mr. Molinaro. I am not sure. Mr. Chairman? Okay. Go ahead.
Ms. Maniar. Very quickly. This is where the principles
versus prescriptive method I think really comes in. It allows
the principles to apply to the technology without restricting
what the technology can do.
Mr. Molinaro. Thank you. And, Mr. Chairman, I appreciate--
not for your benefit, but the leadership of this Subcommittee
and the relationship with Financial Services. This is truly an
exciting time if this country embraces the innovation. Thanks.
The Chairman. Thank you.
If the Ranking Member has any closing comments, we will
turn to her at this time.
Ms. Caraveo. Thank you again, Mr. Chairman, and thank you
to the panel for really what was a fascinating and enlightening
discussion.
I think it has been very clear, there has been a lot of
evolution since the start of Bitcoin in 2009. There is
volatility in part because of this lack of a Federal regulatory
regime, and it has caused harm to customers because we haven't
had appropriate regulation and oversight. Since 2014, the CFTC
has played a role and should continue to play a role to ensure
the safety, soundness, and orderly operation of these markets,
but it is clear that Congress needs to enact appropriate
legislative solutions.
First, we need to address this regulatory gap that exists
in digital commodity spot markets. Second, we need strong
customer protections that involve disclosures that are clear
and material to the products in which customers are investing.
And third, any legislative solution cannot succeed without
providing these agencies with the sufficient funding resources
that they need.
I think this is a little bit of a simplistic summary, and
no doubt there is going to need to be many, complicated
decisions as part of a legislative solution that are going to
take significant effort and focus and additional conversations,
but I think that this is a great start for this Committee, and
I appreciate the Majority's convening of the hearing today.
Thank you so much, once again, for your expertise and your
valuable insights, and I look forward to future conversations.
Thank you, Mr. Chairman, and I yield back.
The Chairman. Very well said, Ms. Caraveo. I agree about
the importance of closing the regulatory gap. You said that
very well. The importance of disclosure being a part of that,
you are exactly right.
And I just want to thank the panelists. Each of you brought
forth some real wisdom today. I agree, we can't let the perfect
be the enemy of good. I agree that principles-based regulation
will allow innovation to flourish. We certainly don't want to
stifle the marketplace as we work to protect consumers.
Mr. Hall, though, I think you really nailed it in your
testimony. You mentioned that the lack of certainty, which is
in no small part Congress' fault, has had real costs in
consumer confidence and protection. It has caused foregone
investment, lost economic activity, and it has reduced our
ability to compete with foreign markets.
This is why we have to do our work, ladies and gentlemen.
It will not be easy. There will be bickering over the contours
of what actual legislation will look like. But I think the time
is ripe for us to find something that strikes the right
balance, and I look forward to doing this in a bipartisan and
bi-subcommittee way. And I think we are headed in the right
direction.
With that, the record of this hearing will be open for 10
days as Members and our panelists are able to submit additional
information. And unless anyone has anything else for the good
of the order, this Subcommittee will stand adjourned.
[Whereupon, at 3:45 p.m., the Subcommittee was adjourned.]