U.S. Congressional Leaders Introduce Two Landmark Bills to Create a Digital Assets Regulatory Scheme

This week, two committees in the House of Representatives will mark up legislation intended to clarify the regulatory framework applicable to digital assets in the United States. Earlier this month, leaders in the U.S. Senate also introduced legislation to establish a comprehensive and unified regulatory scheme for digital assets and digital asset derivatives.¹ Both the House and Senate bills seek to integrate the regulation of digital assets and digital asset derivatives into the existing U.S. regulatory framework — primarily that of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) — rather than create a standalone framework, but both bills face significant barriers to enactment.

On July 20, Rep. Glenn “GT” Thompson (R-Pennsylvania), Chairman of the House Committee on Agriculture; Rep. French Hill (R-Arkansas), Chairman of the Subcommittee on Digital Assets, Financial Technology, and Inclusion; and  Rep. Dusty Johnson (R-South Dakota), Chairman of the Subcommittee on Commodity Markets, Digital Assets, and Rural Development introduced the Financial Innovation and Technology for the 21st Century Act (an updated version of the Digital Asset Market Structure discussion draft released by Rep. Patrick McHenry (R-North Carolina), Chairman of the House Financial Services Committee on June 2) (as updated, the McHenry-Thompson Bill).² On July 12, Sen. Cynthia Lummis (R-Wyoming) and Sen. Kirsten Gillibrand (D-New York) introduced an updated version of their Responsible Financial Innovation Act (Lummis-Gillibrand Bill), which was originally introduced June 7, 2022.³

The following summary highlights certain key provisions in each bill, along with a discussion of some political considerations. This is not intended to be comprehensive, so we encourage readers to review the full text and accompanying summaries of each bill.

McHenry-Thompson Financial Innovation and Technology for the 21st Century Act

Regulatory Characterization of Digital Assets

The McHenry-Thompson Bill gives the CFTC primary jurisdiction over digital asset markets but details a process for market participants and regulators to follow in allocating oversight of digital assets between the SEC and CFTC.

Digital Commodities and End User Distributions — CFTC

• A digital asset is classified as a “Digital Commodity” and is regulated by the CFTC if the blockchain network to which a digital asset relates is both “functional” and certified as “decentralized” (each as defined in the bill and proposed to be incorporated into the securities laws and Commodity Exchange Act) — unless the digital asset is a “Restricted Digital Asset,” defined below.
  • If the network is (1) not functional or (2) not decentralized, the digital asset is regulated by the SEC until such time as both are true (if ever).
  • Any person (whether or not related to the network’s development) may certify an asset’s status as a Digital Commodity. Networks are presumed decentralized unless the SEC objects within 30 days of the certification and provides a detailed analysis of its reasons for doing so.
• If a digital asset is issued through an “end user distribution,” the digital asset is regulated by the CFTC — unless the digital asset is a Restricted Digital Asset.
  • An “end user distribution” is defined as an issuance of digital assets that does not involve an exchange of cash or other assets and is distributed in a broad, nondiscretionary manner based on satisfied conditions, including incentive-based awards (i) to users of a digital asset in its native blockchain network and (ii) for validating, mining, staking, and interacting with a functional blockchain system.

Restricted Digital Assets — SEC

• “Restricted Digital Assets” are regulated by the SEC and include:
  • digital assets held by the issuer of the digital asset, related persons, or affiliates of the issuer before the networks to which the assets relate are functional and certified as decentralized; and
  • digital assets held by persons other than issuers, their related persons, and their affiliates before the networks to which the assets relate are functional and certified as decentralized unless the digital assets are distributed through an “end user distribution” or acquired on a CFTC-regulated exchange.

Payment Stablecoins — Neither CFTC Nor SEC

• “Payment Stablecoins” are excluded from the definition of both “Digital Commodity” and “Restricted Digital Asset.”
  • Payment Stablecoins are permitted to trade on both SEC and CFTC regulated venues; however, neither the SEC nor CFTC is given authority to regulate the operations (issuance, redemption, collateral, etc.) of permitted stablecoins or their issuers.
    • Chairman McHenry’s proposal to regulate payment stablecoins (The Future of Digital Assets: Providing Clarity for the Digital Asset Ecosystem) assigns regulatory jurisdiction to the Federal Reserve Board, the Office of the Comptroller of the Currency, or state regulators, depending on the payment stablecoin issuer’s characteristics.
  • Still, the SEC and CFTC retain antifraud and antimanipulation authority over permitted stablecoins trading on venues subject to their respective jurisdiction.

Securities Offerings Involving Digital Assets

The bill creates a new exemption from the registration requirement under the Securities Act for offers and sales of digital assets by issuers. The exemption is available if all the following conditions are met:

• The aggregate amount of digital assets sold by the issuer in reliance on the exemption in the previous 12-month period is not more than $75,000,000,
• Purchases by non-accredited investors (i.e., “retail” investors), within a 12-month period, must not exceed the greater of (i) 10% of that person’s annual income or (ii) 10% of that person’s net worth,
• No transaction will result in the purchaser’s owning more than 10% of the total amount of digital assets sold in reliance of the exemption,
• The transaction does not involve the offer or sale of any digital asset not offered as part of an investment contract, and
• The issuer meets certain other requirements, including that it is a U.S. company and not an Investment Company under the Investment Company Act.

Issuers relying on the new exemption are required to file disclosures with the SEC and must continue to file periodic reports until after the blockchain network to which the digital asset relates is functional and certified as decentralized. Issuers must also separately make prescribed disclosures focused on the nature of the risks surrounding digital assets, including source code, project economics, development plan, related and affiliated persons, and material risk factors available to purchasers on a freely accessible website.

Regulation of Intermediaries

• The bill defines and provides for the regulation of “Digital Commodity Exchanges,” “Digital Commodity Brokers,” and “Digital Commodity Dealers” and requires such entities to register with the CFTC.
  • These new registrant types expand the CFTC’s regulatory jurisdiction to spot markets for digital assets that are not securities, filling an existing regulatory gap. The bill imposes numerous regulatory requirements on the new CFTC registrants aimed at providing customer protections, including requirements pertaining to business conduct standards, fair dealing, customer disclosures, segregation of customer funds, conflicts of interest, minimum capital requirements, reporting and recordkeeping, and more.
• Similarly, the bill defines “Digital Asset Trading Systems,” “Digital Asset Brokers,” and “Digital Asset Dealers” and requires such entities to register with the SEC.
  • These definitions distinguish “Restricted Digital Assets” from “securities” while still giving the SEC authority over activities related to Restricted Digital Assets. The bill establishes specified regulatory requirements such as capital requirements, recordkeeping, and segregation of customer funds.
• SEC-registered intermediaries offering at least one digital commodity must dually register with the CFTC. “Mixed” transactions involving both Digital Commodities and Restricted Digital Assets are subject to the SEC’s jurisdiction unless occurring on a dually registered exchange.
• “Ancillary Activities” do not trigger either SEC or CFTC registration requirements.
  • Ancillary Activities are activities related to the operation of a blockchain system and are defined to include various activities related to validating transactions; operating a node; providing interfaces to interact with a blockchain network; developing, maintaining, or administering a blockchain system; and developing software to allow for self-custody of private keys.

Lummis-Gillibrand Responsible Financial Innovation Act

Regulatory Characterization of Digital Assets

The Lummis-Gillibrand Bill grants the CFTC spot market jurisdiction over all fungible crypto assets that it does not define as securities, in addition to the agency’s current jurisdiction over derivatives and leveraged transactions. As such, the CFTC is the primary digital asset market regulator, as exchanges listing digital assets are required to register with — and are overseen by — the CFTC. (Note that under the Lummis-Gillibrand Bill, all stablecoins issuers are regulated as depository institutions under federal banking agency supervision.)

The bill divides digital assets into “ancillary assets” (presumed to be commodities and not securities) and other assets:

• “Ancillary assets” are intangible, fungible assets offered, sold, or otherwise provided in connection with the purchase of a security through an arrangement or scheme that constitutes an investment contract and are regulated by the CFTC.
  • Notwithstanding ancillary assets’ status as commodities, if any person owning not less than 10% of any class of equity securities of the issuer engages in entrepreneurial or managerial efforts that primarily determine the value of the ancillary asset, the issuer must file certain mandatory disclosures prescribed by the bill with the SEC.
• By contrast, assets that provide the holder with debt or equity interests in a business entity, liquidation rights with respect to a business entity, entitlements to an interest or dividend payment from a business entity, or any other financial interest in a business entity are excluded from the definition of ancillary assets and are regulated by the SEC.

The bill grants the DC Circuit Court of Appeals authority to find that an asset represents a financial interest in a business entity and thus is a security, not an ancillary asset. While this proposal appears more streamlined than the McHenry-Thompson bill, the Lummis-Gillibrand bill still relies on the DC Circuit to make key determinations, where the McHenry-Thompson approach relies on the SEC to challenge a certification by market participants.

Regulation of Intermediaries

CFTC-regulated exchanges are required to follow prescribed custody, customer protection, anti-market-manipulation, information-sharing, and risk management standards. The bill grants the CFTC further rulemaking authority with respect to digital asset exchanges.

Consumer Protection

The bill emphasizes consumer protection throughout. Notably, the consumer protection title has nearly doubled since the 2022 version. Key consumer protection provisions include:

• requiring intermediaries to provide clear notice to each customer of asset segregation methods, treatment of customer assets in the case of bankruptcy or insolvency, the time and manner in which the intermediary is obligated to return crypto assets upon customer request, fees, and the dispute resolution process; and
• imposing mandatory proof of reserves on intermediaries, which are required to maintain a system, policies, and procedures — subject to regular financial audits — to “demonstrate cryptographically verifiable possession or control of all crypto assets” under their custody. Such system is protected against disclosure of customer data, proprietary intermediary information, and other data that may lead to operational cybersecurity risk.

Anti-Money-Laundering (AML)/Sanctions

The bill includes provisions designed to combat illicit finance risks, which has been a priority for Sen. Elizabeth Warren (D-Massachusetts) and other Democrats.

• The Lummis-Gillibrand bill requires the CEO of any crypto asset intermediary — under criminal penalty of perjury — to certify compliance with applicable anti-money-laundering, customer identification, prevention of terrorist financing, and sanction laws, applicable custodial and safekeeping laws (including proof of reserve requirements), and the notices required by the bill.
• The bill directs multiple federal agencies to increase efforts related to combatting the use of digital assets in illicit finance, including requiring the Treasury Department, SEC, and CFTC to adopt examination standards and requiring the Office of Foreign Assets Control to develop guidance on sanctions compliance applicable to issuers of stablecoins.

Additional Matters

The Lummis-Gillibrand Bill is more comprehensive than the McHenry-Thompson Bill. In addition to addressing the oversight of digital asset markets by the SEC and CFTC and providing prescriptive consumer protection requirements, this bill includes detailed provisions addressing the issuance of stablecoins, illicit finance, taxation of digital assets, agency appropriations, and more.

Political Considerations and Timing

Although both Reps. McHenry and Thompson are chairs of House committees and can ensure that their committees debate and consider their bill, House Democrats (including Financial Services Committee Ranking Member Maxine Waters (D-California)) announced concerns with it but agreed to negotiate on a path forward for stablecoin legislation. Consumer groups have publicly expressed their opposition to the original draft of the McHenry-Thompson Bill as well. After Chairman Thompson introduced the updated McHenry-Thompson Bill on July 20, it is scheduled for markup in the Financial Services Committee on July 26 and Agriculture Committee on July 27.

Given its high-profile sponsors in leadership positions, the McHenry-Thompson Bill will maintain an important role in shaping conversations in the House. But with no public Democratic support in either chamber at this time, even if it passes by party-line vote in the House, it is doubtful the bill would receive 60 votes in the Senate in its current form.

In the Senate, the Banking Committee and Agriculture Committee have jurisdiction over this legislation. Senate Banking Committee Chair Sen. Sherrod Brown (D-Ohio) indicated he was not inclined to support their bill, and Sen. Debbie Stabenow (D-Michigan), who cosponsored a version of the bill last Congress, has not commented publicly this year about the legislation. However, it is notable that the Lummis-Gillibrand Bill has bipartisan support — unlike the McHenry-Thompson Bill.

Republicans and Democrats in the House are optimistic that they can achieve a stablecoin compromise, but it is unclear how the ultimate stablecoin legislation coming out of the House can or will align with priorities of key senators.

CFTC Chairman Rostin Benham has testified before the House Agriculture Committee that he “generally support[s]” legislation giving the CFTC additional authority to regulate digital asset markets. In contrast, SEC Chair Gary Gensler has recently stated that the SEC is the appropriate regulator for the digital asset market and that the SEC has all the legislative authority it needs. To date, many Democrats have deferred to Chair Gensler’s views. However, litigation between the SEC and digital asset market participants may influence the legislative process. Recently, an issuer of digital assets prevailed over the SEC for the first time in a federal district court, obtaining partial summary judgment in its favor.⁴ In response, both Republican and Democratic members of the House (separately) sent letters to the SEC, urging the agency to reassess its strategy.⁵ If the courts rule against the SEC in other cases, as occurred in Ripple, Congress might feel more urgency to enact legislation to resolve legal ambiguities.

Knowledge management lawyer Daniel Engoren contributed to this Sidley Update.