Regulating digital currencies: US Congress debates SEC vs. CFTC, enforcement, and digital identities
On Wednesday, the Joint Financial Services-Agriculture Subcommittee held its first scheduled hearing on “The Future of Digital Assets: Measuring the Regulatory Gaps in the Digital Asset Markets” in Washington, D.C., where lawmakers from both parties discussed the future of digital asset regulation in the United States, in particular the roles that the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) should play.
Rep. Dusty Johnson (R-SD), who serves as Chair of the Subcommittee, set the stage for the hearing by stating that digital asset technology holds’real promise’ in a variety of fields, but that legislation in the United States has not kept pace.
“Current federal laws and regulations offer few guidelines for those who wish to utilize these emerging technologies,” he said. “I believe we can all agree that the current state of uncertainty is detrimental to the market.”
CFTC vs. SEC
The question of which regulator is best-suited to oversee the digital asset industry (and in what contexts) between the SEC and the CFTC, the former being concerned with securities and the latter with commodity-based futures and derivatives markets, has received a great deal of attention recently and was raised repeatedly during today’s hearing. Even among the witnesses called to testify, including the former chairman of the CFTC, Timothy Massad, there was disagreement over whether something could be both a security and a commodity.
“Something can be considered a commodity under our laws, such as ETH, if a futures contract is traded on it,” Massad explained.
“This does not necessarily imply that the item is not a security. You may possess something that is both. And the question for many of these tokens is, “Is there still an enterprise that affects its value?” he asked.
The CFTC is frequently portrayed as the industry-friendly regulator. Simultaneously, the regulator has requested additional resources to fulfill its current mandate over commodity-based futures and derivatives markets and to assume additional responsibilities over digital assets.
Rep. Yadira Caraveo addressed the CFTC’s recent request for additional resources to fulfill its expanding regulatory role over digital assets.
“We must respect those who perform work for taxpayers. In her opening remarks, she expressed her conviction that any digital asset legislation passed by Congress must include a funding mechanism for the CFTC.
Rep. Sean Casten (D-IL) questioned the digital asset industry’s ostensible preference for the CFTC based on the fact that the CFTC has far fewer resources than the SEC.
“The CFTC is the smallest regulatory agency. “But to state the obvious, it is never easy to raise the necessary resources,” Casten said, before asking the New York Stock Exchange’s chief operating officer, Michael Blaugrund, “If this industry is so important, could you speculate as to why the industry would like to be regulated by the smallest, least-resourced organization?”
Blaugrund refused to speculate, but it was evident that the question was rhetorical.
However, not every committee member appeared to concur with the SEC versus CFTC question’s preeminence.
Rep. Stephen Lynch (D-Massachusetts) remarked, “I fear we may be asking the wrong questions and risk feeding into an industry-fueled narrative of a turf war between the SEC and CFTC.” “The issue is not regulatory ambiguity, but rather widespread noncompliance with existing laws.”
The United States lags behind the rest of the world.
Regardless of differing perspectives on this uncertainty, it is evident that it is a major factor motivating legislators, not least because other jurisdictions around the world have made significant progress toward designing and implementing their own comprehensive legal frameworks in 2023. Due to this, the topic was discussed frequently throughout the hearing.
Johnson stated that the United States had fallen behind the G20 nations in this area and alluded to a lack of U.S. leadership.
Rep. Frank Lucas (R-OK) asked Marco Santori, who testified at the hearing in his capacity as Chief Legal Officer of Kraken, how the progress of jurisdictions such as the European Union and the United Kingdom makes the jobs of U.S. lawmakers more difficult.
“It is important that we get it right, not necessarily first, but I can assure you that we have plans to invest in Europe. We intend to invest in the United Kingdom,” replied Santori.
“In terms of our plans to invest in the United States, we are constrained. Without a comprehensive federal plan, it is quite difficult for us to determine how many resources to deploy in this region, he continued.
Where to begin with new laws?
The subcommittee discussed several potential approaches to regulating digital assets, including fitting digital assets into existing laws, modifying existing frameworks, and establishing an entirely new, industry-specific regime.
Former CFTC chairman Timothy Massad, for instance, questioned whether tinkering with current definitions would actually provide a solution to the current ambiguity.
“I believe it will generate its own interpretation questions, leading to litigation and confusion,” he said.
“I believe an alternative approach would be to pass a law mandating that any trading platform or lending platform that uses or trades Bitcoin or Ethereum must adhere to a set of principles in everything it does, for every token and activity. This includes safeguarding customer assets, preventing fraud and manipulation, requiring reporting, and mandating trade transparency, he explained.
Congress would direct the CFTC and SEC to develop these rules and standards jointly, or it would establish a Self-Regulatory organization to do so on their behalf.
When asked to describe this SRO, he cited FinRA as an example.
The current laws regarding disclosure to investors and regulators have been cited as one of the reasons why they are not suitable for digital assets. This is due in part to the fact that they do not account for a number of factors unique to digital assets that are essential for investors to comprehend but are not captured by current disclosure regimes.
Offered Kraken’s Santori: “Items such as the number of nodes operating on the network, the number of developers actually developing on this network, whether they are associated or operating independently, and the location from which these nodes operate. These are incredibly technical and digital asset-specific characteristics that I could list until the end of time.”
Andrew Durgee, the head of Republic Crypto at Republic and a witness, testified as follows: “The disclosure requirements simply do not work within an industry attempting to decentralize. For instance, once a certain number of token-holding investors is reached, the issuer is required to register under section 12 (g) of the Exchange Act, limiting access and inclusion for other eager participants. It is almost impossible for a business to pursue decentralization without triggering this requirement.”
Lynch proposes mandating that both parties in every transaction have a digital identity.
Bill Foster (D-Illinois) made perhaps the most radical recommendation of the Subcommittee.
“If we wish to prevent wash trades, insider trading, front running, money laundering, ransomware, and everything else, is there any alternative to having both sides of every crypto transaction associated with a digital identity, and have that digital identity issued by a government with which we have extradition treaties and a common concept of financial fraud?” he questioned.
Kraken’s Santori resisted this notion and, when asked for an alternative, began to describe how Kraken monitors its own exchange. However, Foster interrupted him and pointed out that Kraken’s monitoring cannot possibly capture every transaction. He stated that it is more difficult to detect wash trading with certain assets than with others.
“In my opinion, the place we must go is…The issuance of license plates to registered drivers has been crucial to the development of the automobile industry, if one considers the automobile industry as a whole. It would be unacceptable for unlicensed vehicles to drive through your neighborhood or cross your borders, he said.