Congress Creates A Storm Of Crypto Legislation

What Happened

A flurry of activity took place in Congress from July 26 to July 28 as lawmakers worked on first-of-their-kind stand-alone crypto bills before the legislature’s August recess. The House returns from recess on September 12th to vote on this legislation.

Topics include a formal process to determine when digital assets will be treated as either securities to be regulated by the Securities and Exchange Commission or commodities under the purview of themCommodity Futures Trading Commission (CFTC), what type of federal/state regulatory regime will exist for payment stablecoins and the how the Bank Secrecy Act (BSA) will apply to cryptocurrency providers.

Key Pieces of Legislation

Setting Boundaries Between the SEC and CFTC

Whether the SEC or CFTC should be the primary regulator for crypto spot markets has been a subject of debate for years. The contention is largely definitional: there is no clear guidance on when a token is a security or commodity. While the SEC has taken the position that virtually every asset with the exception of bitcoin is a security, the crypto community and a large cadre of friendly legislators in Congress disagree. Therefore many efforts have been made to craft a piece of crypto-specific legislation that will provide a set of conditions to determine when an asset is a commodity or a security. These bills would also formally place commodity digital assets under the Commodities Exchange Act for the first time.

The latest chapter in this saga took place July 26, when a historic markup hearing saw the advancement of the Financial Innovation and Technology for the 21st Century Act (FIT for the 21st Century Act) as introduced by Congressman French Hill (R-Ark.), Congressman Dusty Johnson (R-S.D.) and Congressman Glenn G.T. Thompson (R-Pa.) out of the House Financial Services Committee on July 26 and out of the House Agriculture Committee on July 27 in a vote along bi-partisan lines. On the following day, the House Agriculture Committee similarly held a markup hearing for the same bill passed by voice vote in a very organized fashion.

Stablecoins

Stablecoin legislation has become a hot button in Washington because of concerns that a mature token could threaten the ability of the U.S. government to oversee monetary policy. There also are questions about the safety of today’s largest issuers, Tether and Circle, in what is today a $120+ billion industry. Legislative efforts have focused on setting criteria for who can issue stablecoins and what rules will govern redeemability and collateral. The House Financial Services Committee continued its markups of two additional bills, including the Clarity for Payment Stablecoins Act of 2023 as introduced by Hill, which involved the Democrats on the panel walking out of the hearing a.

Anti-Money Laundering

Some key crypto skeptics on the hill, headlined by Elizabeth Warren (D-Mass.), contend that crypto is good for little else than as a payment gateway for illicit activity. While the industry has pushed back on that narrative, it needs to find a way to protect itself from being misused without falling afoul of rights to privacy. In the U.S. this typically means coming into compliance with the Bank Secrecy Act, which is overseen by the Treasury’s Financial Crimes Enforcement Network (FinCEN). A prerequisite is determining when an entity constitutes a money-services business that is subject to regulation.

With that context, on July 26 a bill called the Blockchain Regulatory Clarity Act from Congressman Tom Emmer (R-Minn.) also advanced to the House floor. Also, the Financial Technology Protection Act, a bipartisan measure sponsored by Congressman Zach Nunn (R-Iowa) and Congressman Jim Himes (D-Conn.) that would set up an independent Financial Technology Working Group to combat terrorism and illicit financing in cryptocurrency made it to the same stage.

But that is not all, on July 26, two parts of Senate Amendment 712 (S.A. 712) impacting BSA requirements for cryptocurrency sponsored by Senators Cynthia Lummis (R-Wyo.), Kirsten Gillibrand (D-N.Y.), Warren and Roger Marshall (R-Kans.) were added to the National Defense Authorization Act (NDAA) for Fiscal Year 2024. The amendment requires the Treasury’s Office of Foreign Assets Control (OFAC) to begin risk-focused examinations for money-services businesses with respect to cryptocurrency and for reports on anonymity enhanced cryptocurrencies and tools. The Senate passed the NDAA on July 28.

On July 28, came the reintroduction of a bill by Senators Warren (R-Wyo.), Marshall, Joe Manchin (W. Va.), and Lindsey Graham (S.C.) called the Digital Asset Anti-Money Laundering Act of 2023. The bill calls for extreme measures that the crypto industry would need to adhere to regarding its BSA and Anti Money-Laundering Act (AML) requirements. Meanwhile, a bill that had been introduced in the previous week called the CANSEE Act Crypto-Asset National Security Enhancement and Enforcement Act by Senators Jack Reed (R-R.I.) , Warner, Mike Rounds (R-S.D.) and Mitt Romney (R-Utah) also focused on BSA and AML and sanctions requirements with a narrow concentration on just the decentralized finance (DeFi) subset of the crypto industry.

Keep Your Coins and Regulatory Certainty for Blockchains

In addition, the Keep Your Coins Act sponsored by Congressman Warren Davidson (R-Ohio) that sought to protect the ability of individuals to self-custody their cryptocurrency advanced to the House floor. This bill as written prohibits federal agencies “from restricting the use of convertible virtual currency by a person to purchase goods or services for the person’s own use.” The Blockchain Regulatory Certainty Act aims to protect certain blockchain platforms from being designated as money-services businesses. Both acts advanced through the Republican-dominated House with support from Democrats. The Financial Technology Protection Act, however, was passed unanimously by both sides of the aisle.

Key Table

Outlook and Implications

Now the jockeying begins, since any bill must pass both houses of Congress and be signed by the president to become law. The outlook is unclear.

For instance, the AML/KYC amendment to the NDAA passed in the Senate will need to be reconciled with that of the House, which passed its version of the act on July 14, This is by no means a done deal, but its chances appear to be better and the debate more collegial than the frantic and ugly discussions on the floor of the Senate in 2021 over a crypto tax reporting provision in an infrastructure bill that could have defined entities such as bitcoin miners as securities broker-dealers and thus forced them to produce 1099 forms tax for customers, something that would have been unfeasible. In that case though, while the bill did pass with the controversial provision, expected implementation guidance from the Treasury is likely to save the industry from some of those impractical expectations.

The NDAA from the Senate will now head to a conference with the House to discuss what issues end up in the final package. In that the Lummis-Gillibrand and Warren-Marshall alignment also represents a key alliance between Lummis, a pro-crypto Senator, and Warren, who recently discussing raising her ‘anti-crypto army’. This is the most likely of all the legislation that saw movement last week to become law. The implications are far-reaching and wide for three main areas of crypto: whether tokens are securities vs. commodities, whether stablecoins are regulated at either the federal or state level, and the level of examinations that will be required for BSA / AML and OFAC requirement that touch on broadly the proliferation of finance, terrorism finance and money laundering (ML) issues that speak to the national security of the U.S. Expect to see further battle lines drawn in these as the big three crypto policy questions.

It also appears that the White House is starting to exert its influence in some of these bills. For instance, the administration seemed to be far away from any kind of agreement on the stablecoin bill, and according to the House Finance Committee Chair Patrick McHenry (R-N.C.), actually helped to disrupt what was a productive pathway to a bill. The main debate is whether just the federal regulators should oversee the industry or whether a combination with state officials on equal footing is appropriate. Similar to the turf wars that the market structure FIT Act hopes to fix between the SEC and CFTC, it appears there is now a divide between the Adrienne Harris, superintendent of the New York State Department of Financial Services and Federal Reserve Chair Jay Powell over whether the regulation of stablecoins should be at the federal or state leves, which according to people familiar with the matter, seem to lie at the heart of this divide.

The FIT Act now heads to the House Rules Committee, where the versions from the Financial Services and Agriculture committees will be combined into one before officially heading to the House floor for a vote. You can expect a much larger discussion across the entire chamber as all 435 representatives–not just those on the two committees—will need to be educated on and understand the implications of this bill before the vote. Similarly, the stablecoin bill, which is already moved for consideration to the floor, will also require a far-reaching educational effort for the entire chamber before the final vote. The real question then becomes whether either of these bills can garner support from Democrats to be taken seriously when they are received in the Senate.

All three components will be critical in cementing the future of the crypto industry in the U.S. Watching the number of Democrats that agree to vote yes on both the FIT and stablecoin legislation will help investors gauge just how close this type of policy is to impacting the crypto ecosystem.

On the national security front, the industry and its practitioners are at a point of no return where powerful senators are asking for a Know Your Customer regime to exist for the entire cryptocurrency marketplace, specifically with an aim at the DeFi sector. Between two bipartisan bills that have just been introduced in the senate focusing on these issues, the requirement for crypto to succeed in the U.S. will likely need to be mandatory compliance with these issues. That threatens the outlook for DeFi, which if it were forced to meet the same requirements as banks and other financial institutions, would probably become untenable.

Decision Points

With many of these proposed pieces of legislation still in their early innings, it is difficult for investors to paint a clear picture forward. Perhaps the most consequential bill would be the passage of the FIT for the 21st Century Act, which would add certainty to the number and types of tokens available for sale on crypto exchanges. Clarity in this realm would be seen as bullish for digital asset prices. Additionally, passage of a stablecoin bill could also lead to a jump in market capitalization for those tokens, currently sitting at $127 billion, by easing investor unease in the U.S. Given that stablecoins are involved in more than 50% of all crypto trading worldwide, this could add needed liquidity to a market that has seen the tide go out with the collapse of major firms such as FTX. Regarding the AML/KYC legislation, a key focus point for investors should be the impact on DeFi exchanges and lending platforms. Onerous requirements would almost necessarily reduce demand for those platforms.