WASHINGTON —
The House last month voted to pass a bill establishing a regulatory regime for cryptocurrencies, and the bill notably passed with uncommon bipartisan support. Seventy-one Democrats voted for the bill, including senior party members like former House speaker Rep. Nancy Pelosi of California.
The bill faces tougher odds in the Senate, where Senate Banking Committee Chairman Sherrod Brown, D-Ohio, has been skeptical of crypto legislation that he sees as being too favorable to the crypto industry.
But the vote in the House was a turning point for crypto in Washington, as more Democratic lawmakers seem to be interested in considering some kind of bill.
Going forward, a key element of the forthcoming debate on the crypto bill — known as the "Financial Innovation and Technology for the 21st Century Act," or FIT21 — will be the implications of the bill not just on crypto, but traditional financial institutions, including banks.
Some Democratic House members have argued that the bill could make it easier for banks — typically larger banks with established trading desks — and asset managers to create assets that would be overseen by the Commodity and Futures Trading Commission rather than the Securities and Exchange Commission, which is typically seen to have a lighter regulatory touch.
Specifically, much of the concern centers around a section titled "Clarity for assets offered as part of an investment contract." Democrats on the House floor argued that this section was added in only the most recent iteration of the legislation and after the bill went through the House Financial Services Committee markup.
"Language was added to the bill after it was marked up by the committees of jurisdiction that would allow even some traditional securities to also exist in this regulatory no-man's-land," said Rep. Maxine Waters, D-Calif., on the House floor.
The section outlines the ways in which an "investment contract asset" — normally something that would fall under the SEC's purview — would not be regulated by the SEC if it meets certain decentralization criteria, including that transaction of the asset is recorded on a cryptographically secured public ledger.
Graham Steele, a fellow at the Roosevelt Institute and until recently the assistant secretary for financial institutions at the Treasury Department, said that under the bill, banks and other financial institutions could set up a blockchain system, outsource that operation or spin it out, and then whatever is listed on that platform would be outside the realm of SEC regulation.
"There are ways you could have a bank stand up a blockchain network," he said. "Any person can self-certify to the SEC that the network and its related digital assets are decentralized. And then, assuming the SEC … doesn't challenge that, it moves to the digital commodity space and has CFTC oversight."
The risk of larger institutional players getting into this market are twofold, Steele said. The CFTC requires fewer disclosures and offers consumers less protection than the SEC, which could result in consumer harm, and the entry of large traditional firms could create financial bubbles that threaten financial stability.
"So there's the micro consumer harm being caused by investing in products and services and not necessarily having all the information to understand the risks," he said. "And then, number two, you could have large incumbent financial institutions making these markets larger and larger, that could turn it into a financial stability problem."
Lee Reiners, a lecturing fellow at Duke Law who studies fintech and crypto policy, said that, in theory, a large nonbank financial firm like BlackRock — which already has a tokenized fund — could make a few tweaks to that offering to satisfy the bill's definition of what can be classified as a commodity. Reiners, along with a number of financial policy law academics and consumer groups,
"If you give Wall Street the opportunity to game the system and opt into a lighter touch regulatory regime, they will do so," he said. "You can imagine someone saying, 'OK, if you don't want to register with the SEC, you just put it on the blockchain.'"
Republicans, meanwhile, argue that their bill doesn't set up this dilemma. Rep. French Hill, R-Ark., one of the primary sponsors of the legislation, said that the bill specifically defines assets offered as part of an investment contract as securities, unless it would be otherwise defined as a security. That's part of a complex legal criteria called
"The minority has charged time and time again that somehow a great securities loophole is being offered and opened in this bill," he said. "That's just not true — it's just not a factual statement."
Hill said that the term "investment contract" is a "fungible, digital representation," and that the bill specifically defines digital assets as not including notes, stock, treasuries and security-based swaps.
"So it does not open the loophole that the ranking member of the Financial Services Committee charges," he said.
That assessment has gained purchase with other experts as well. Zachary Zweihorn, a partner at Davis Polk, said that the idea that financial institutions "can just slap a blockchain label on something" and therefore get out from the regulatory structure for securities isn't "realistic under the text of the bill."
"The way I read it is that it says an asset that was sold pursuant to an investment contract is not automatically a security as a result," said Zachary Zweihorn, a partner at Davis Polk. "Unless it is otherwise a security, which is kind of circular."
If a large bank or another financial institution creates an asset that meets the definition of a digital asset that should be regulated by the CFTC under the Republicans' crypto bill, Zweihorn said that the CFTC might be the best place for that asset to be regulated.
"It's hard to imagine a bank creating this kind of asset that would meet this definition," he said. "And you know, if they do, then it's probably not the worst idea for it to go [to the CFTC]."
