On April 28, 2022, a bipartisan group of legislators in the House of Representatives re-introduced and updated a bill regarding proposed regulatory oversight by the CFTC of crypto exchanges on which digital commodities are traded (the “Bill”). The Bill was introduced by Republican Representatives Glenn Thompson of Pennsylvania and Tom Emmer of Minnesota and by Democratic Representatives Darren Soto of Florida and Ro Khanna of California.
Digital Commodity Exchanges. If the Bill is adopted in its current form, the new law would be entitled the Digital Commodity Exchange Act of 2022 and would authorize the CFTC to register and regulate crypto exchanges offering spot and cash transactions in Digital Commodities (“Digital Commodity Exchanges”). (The CFTC already has oversight over futures and other derivatives transactions involving digital assets.)
Generally, registration of such an exchange with the CFTC would be voluntary and would be an alternative to current state-by-state money transmitter licensing regimes. However, registration of an exchange would be mandatory if the exchange offers leveraged trading of Digital Commodities or lists for sale Digital Commodities that were distributed to certain persons before being made available to the public (i.e., tokens distributed in presales).
A registered Digital Commodity Exchange would be subject to regulatory oversight by the CFTC and would be required to implement certain procedures, including procedures designed to monitor trading activity, prohibit abusive trading practices and address cybersecurity risks. A registered Digital Commodity Exchange would also be required to segregate customer assets and hold customer Digital Commodities only in qualified Digital Commodity custodians that are recognized by the CFTC and regulated and supervised by state, federal or international banking regulators.
The new law would also establish a self-certification process for Digital Commodity Exchanges to list new Digital Commodities for trading. Among other things, a Digital Commodity Exchange would need to analyze the mechanics of the new Digital Commodity and conclude that it is not readily susceptible to manipulation. The Digital Commodity Exchange would be permitted to list the new Digital Commodity for trading if the CFTC does not act to deny the self-certification within a set period of time.
Digital Commodities. If adopted, the new law would define a “Digital Commodity” to include any form of fungible intangible personal property that can be exclusively possessed and transferred person to person without necessary reliance on an intermediary. However, the definition expressly excludes an asset that conveys (i) an equity or debt interest in a company, partnership or fund, (ii) a profit or revenue share derived solely from the managerial efforts of others, or (iii) an entitlement to any interest or dividend payment.
If the Bill advances, additional guidance through legislative history or the rulemaking process may provide additional clarity on whether the definition is intended to narrow the range of digital assets that would be treated as securities under current law. (However, the exception for an asset that conveys a profit or revenue share derived solely from the managerial efforts of others may be intended to incorporate, and not necessarily alter, existing “investment contract” concepts under the federal securities laws.)
Based on the Bill and an available summary prepared for the House Committee on Agriculture, it is clear that presales of a Digital Commodity to raise funds for development of the Digital Commodity would still be subject to the securities laws. However, in addition to other options for resales of presold Digital Commodities based on existing securities regulations, the new law would provide for resales on a regulated Digital Commodity Exchange as a further alternative.
Other Provisions. The Bill incorporates a number of additional proposed provisions. For example, in addition to requiring that a Digital Commodity Exchange be registered if it permits Digital Commodities issued in presales to be listed and sold, the law would also expressly permit off-exchange resales of presold Digital Commodities through a registered (or exempt) securities offering, or to an accredited investor.
Developers of Digital Commodities would also be permitted (but not required) to register with the CFTC and make certain disclosures, which could help to facilitate an eventual listing of a Digital Commodity on a registered Digital Commodity Exchange.
The new law would also adopt a new regulatory regime for certain stablecoins. In particular, it would permit an operator of an asset-backed stablecoin to register with the CFTC as a fixed-value digital commodity operator. Registration would require the operator to meet certain obligations pertaining to disclosure of operational information, protection of the assets backing the stablecoin, and retention of certain books and records that would be available for examination by the CFTC. Registration by a stablecoin operator is not mandatory but could facilitate the utilization of such stablecoins on registered Digital Commodity Exchanges.
Observations. The proposing legislators view the proposed law as filling a gap in regulatory oversight of the spot market for trading in Digital Commodities. SEC Chair Gary Gensler has suggested in recent statements that he believes it may be appropriate for crypto exchanges to be regulated by the SEC. Although the Bill in some form has been proposed previously, the current iteration might be seen in part as addressing industry concerns about potential SEC oversight of the spot market for Digital Commodities.
From the viewpoint of an existing or planned Digital Commodity Exchange, with certain exceptions where the exchange will support leveraged trading of Digital Commodities or resales of presold Digital Commodities, registration with the CFTC will not be mandatory. However, exchanges may have an incentive to register in order to avoid multi-state regulation under money transmitter licensing laws, which can be inconsistent and burdensome, and to build increased trust with the public.
Whereas registration with the CFTC would involve significant regulatory oversight and the implementation of various policies and procedures, exchanges are already subject to many of these procedures under state money transmitter laws and the New York BitLicense regulations. In addition, when compared to the potential burdens of registering with the SEC as a securities exchange (or, in certain cases, as an Alternative Trading System), industry participants generally view potential CFTC regulation and oversight as less burdensome.
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