The 118th Congress on Fintech Legislation | Poyner Spruill LLP
14 February 2023, 118th Congress held its first hearing on cryptocurrency after the volatile events of 2022. Several issues were discussed, including proper regulatory authority, property rights, financial stability, regulation without stifling innovation, among others. These issues are discussed in detail below. Upcoming customer alerts will discuss summaries of the introduced bills from 117th Congress to provide a comprehensive picture of what has been contemplated regarding digital asset legislation.
Who is the right regulator?
In his testimony, Mr. Lee Reiners[1] made several recommendations to Congress regarding the appropriate regulatory authorities for digital assets. These recommendations included: (1) closing the CFTC’s regulatory loophole over commodity spot markets; (2) to separate cryptocurrency from the definition of commodity and recognize cryptocurrencies as securities under a special definition to the securities laws; (3) empower the SEC to regulate stablecoins as money market funds with strict reserve and disclosure requirements, among other things. Additionally, if Congress does not want to endow the SEC with exclusive powers, Reiners recommended imposing consumer protection requirements and assigning joint rulemaking authority to the SEC and CFTC. Conversely, Professor Linda Jeng[2] expressed concern about giving the SEC jurisdiction over cryptocurrency. She stated that cryptocurrency works similarly to a medium of exchange. In the case of transactions, there is no other claim on interest or property, which is similar to cash transactions. Placing it under the SEC’s jurisdiction would be problematic for this way of doing business. Professor Yesha Yadav[3] argued that the focus should be on regulating cryptocurrency exchanges. She suggested that these stock exchanges should adopt a self-regulating organizational structure to supplement future regulations.
Ownership and property rights
Another topic that was discussed was ownership and property rights to digital assets. Professor Yadav expressed concern about the current lack of instructions on custody and property rights. Using the FTX bankruptcy as an example, she stated that in that case the customers would likely become unsecured creditors. The court is faced with the consequence of a lack of legal instructions, and the decisions about property rights and custody are decided by probate courts instead of digital asset experts. Professor Jeng later elaborated on the importance of requiring white papers to disclose how tokens are created, custodial rules and explanations of who holds private keys in a custodial scheme.
Financial stability
Financial stability was a significant focus of the consultation. Two issues that were discussed were the connection between cryptocurrency and traditional markets, and the consequences of creating a two-part financial system. Regarding the first issue, Reiners said the lack of contagion to traditional markets in the events of 2022 was due to minimal overlap between traditional and cryptocurrency markets. However, he stated that cryptocurrency entities are working to increase this overlap. Professor Jeng elaborated on the second point, explaining that regulatory uncertainty will lead to market uncertainty. Cryptocurrency firms will shift to jurisdictions with clearer regulatory certainty or to “shadow banking”. In either case, this can lead to a two-part market and reduce the ability of regulators to maintain control over the financial system.
Regulate but encourage innovation
A question on many senators’ minds during the hearing was how to regulate effectively without stifling innovation. Professor Jeng advocated clear consumer protection, consumer rights and consumer power. In addition, she said it is important to create and maintain open and interoperable standards for blockchain technology to prevent monopolies from moving forward. The basic guardrails needed for regulation are consumer and investor protection and clear legal rights for the ownership of digital assets. She further emphasized the importance of clear regulation created with the help of public feedback. Use of the formal rulemaking process is important, rather than operating only under a “regulation by enforcement” approach.
Upcoming legislation
Throughout the hearing, three senators referred to potential upcoming legislation. Senator Tillis referred to a proof of reserve bill prepared by his office. The witnesses said that independent third-party audits may be a more worthwhile methodology, but to ensure that any approach taken must be clear and comprehensive. Senator Warren announced the reintroduction of her anti-money laundering bill from the previous Congress. Senator Hagerty referenced a bill he introduced last year on stablecoins, but did not explicitly announce a reintroduction.
[1] Mr. Lee Reiners is the Policy Director of the Duke Financial Economics Center.
[2] Professor Linda Jeng is a Visiting Fellow in Financial Technology and Assistant Professor of Law at the Institute of International Economic Law at the Georgetown University Law Center.
[3] Professor Yesha Yadav is the Milton R. Underwood Chair Professor of Law and Associate Dean at Vanderbilt Law School.
