On July 12, 2023, Senators Kristen Gillibrand (D-NY) and Cynthia Lummis (R-WY) reintroduced their Responsible Financial Innovation Act (RFIA) to the Senate in an attempt to provide a regulatory framework to allow legal clarity to digital asset entrepreneurs and investors. Other nations are racing to provide clear sets of rules to attract these borderless new tools while the United States has been slow off the mark.

First introduced in June of 2022, this iteration of the proposal increases consumer protection mechanisms and tightens regulations for private cryptocurrency exchanges. These are the biggest points of public discourse surrounding the crypto industry, particularly in the aftermath of the highly-publicized FTX collapse, and more recently an SEC lawsuit against Coinbase. With timely legislative coherence on the standards for the exchange of digital assets being of great importance, the revamped RFIA joins another piece of digital asset legislation in the House drafted by Representatives Patrick McHenry (R-NC-10) and Glenn Thompson (R-PA-15) titled the Digital Asset Market Structure Act (DAMS).

The big question that the bills seek to answer is which government agency should be granted the authority to enforce the proposed regulations. Prior to the invention of digital assets, the regulatory regime was relatively simple; the Securities and Exchange Commission (SEC) was responsible for regulating the issuance and trading of securities. The Commodities Futures Trading Commission (CFTC) was responsible for regulating the issuance and trading of commodities and futures. The advent of digital assets threw a wrench in that regime: it is unclear which of these legislative bodies should be responsible for digital assets whose asset classification within the old framework.  

This recent flurry of legislative focus on the digital asset marketplace shows that Congress sees crypto regulation as a priority. There is a lot of nuance to the differences between the two bills and their potential impact, so let’s break down the bills’ core positions and their significance with regards to current developments in the crypto industry.

A Primer: What Does All of This Even Mean?

Putting it mildly, the RFIA and DAMS bills are dense pieces of legislation. The crypto jargon and interdependent delineators make it difficult to parse out exactly how the congresspersons hope to regulate the complex market for digital assets. To ensure that you can understand the implications of the respective bills, here are some definitions of terms often used in discussion of regulation in the crypto industry. 

1. Digital Asset: Anything created and stored digitally that has value. This could range from a video on YouTube to a cryptocurrency. That said, not all assets hold the same classification, and the classification of an asset determines which government agency regulates that asset’s trade. 
2. Security: One classification of an asset in which the investment is made with the expectation that someone other than the investor will generate profit. In the traditional financial marketplace, securities are things like stocks, where one person buys equity in a company in the hopes that the company will generate a return on the initial investment. If classified as a security, the SEC assumes authority over the regulation of the asset. Notably, the SEC has the authority to regulate the spot trading (trade of an asset at a market price point in exchange for fiat currency) of all securities, regardless of the size of the enterprise and the number of interested investors. 
3. The Howey Test: The test used by the SEC for several decades to determine whether an asset will be classified as a security. The test asks three questions: 
   1. Is there an investment of money with the expectation of future profit?
   2. Is there investment of money in a common enterprise (such as a company, government, etc.)?
   3. Do the profits come from the efforts of someone other than the investor?If the answer to all three of these questions is yes, then the asset is deemed a security.
4.  Commodity: The other main classification of an asset in which goods, services, or rights are bought and sold. This definition is far more broad than that of a security, and commodities generally encompass the majority of what is bought and sold in the economy as a whole, such as food or clothing. In the realm of digital assets, commodities are assets that are bought and sold according to current market values, with no expectation to derive profits from anything other than the sale of the asset, such as Bitcoin. The CFTC oversees this asset class, but unlike the SEC, does not have the authority to regulate spot trading if the transaction does not explicitly involve the exchange of a commodity.
5. Decentralization: The transfer of supervision and decision-making over an asset from a central entity (a company, individual, or government) to a widely distributed network of stakeholders. Essentially, decentralization means separating the asset from its issuer. In the digital asset market, decentralized assets fall under the classification of commodities, whereas centralized assets are securities.

How and why do the RFIA and DAMS want to divvy up authority?

These bills were brought to the Senate and House floors out of necessity. The collapse of FTX illustrated just how vulnerable American investors were in the hands of an unregulated crypto intermediary. As such, it is crucial that the US holds issuers, brokers, and custodians of digital assets accountable to high standards for their handling of investments to limit the volatility of the ever growing market and protect Americans from fraud.

Gillibrand and Lummis use a relatively straightforward criteria to distinguish between securities and commodities in the RFIA. In an interview with Yahoo! News, Senator Gillibrand stated that most of the 15,000 cryptocurrencies on the market satisfied the Howey Test, qualifying as securities, meaning that authority over these assets belongs with the SEC. One big exception is Bitcoin, which experts have determined is decentralized to an extent that it is a commodity, meaning that the CFTC would still oversee the trade of the world’s most valuable cryptocurrency. 

The RFIA makes the distinction between securities and commodities pretty black and white, but the DAMS Act offers a more fluid proposition. McHenry and Thompson propose that all cryptocurrencies ought to be considered securities upon issuance, and once they reach a certain threshold of decentralization, they become commodities. With either bill, short term authority over the digital asset market would go to the SEC, as most cryptocurrencies currently fall short of the decentralization threshold proposed by the DAMS Act. 

Both bills plan to create a self-regulatory organization (SRO) composed of crypto asset intermediaries (crypto exchange services such as Binance and Coinbase) chosen by a committee made up of representatives from both the SEC and CFTC, among others. These new organizations would oversee the industry, review asset classifications and enforce rules around customer protection. The SRO approach would allow the industry to grow in currently unexpected ways while still ensuring that the most qualified people are being tasked with oversight. 

So why do these bills matter?

It may seem counterintuitive, but many people, including Senators Gillibrand and Lummis, believe that increasing the regulatory framework will actually attract crypto organizations to register their business in the US, rather than driving them away to more loosely regulated territories. Gillibrand notes that as Europe has rolled out its early digital asset legislation, the continent has seen an increase in its activity in digital asset marketplaces, as issuers feel more comfortable operating in an environment with clear guidelines and less risk of inadvertently committing a violation. Industry leaders also echoed this sentiment. ​​Coinbase CEO Brian Armstrong expressed support for Congress’s efforts to draft digital asset legislation, emphasizing the need for the clear delegation of authority and definition of assets to help fuel US innovation in digital asset protocols.

In principle, the exchange of digital assets over relatively new marketplaces like Coinbase, Binance, and (once upon a time) FTX offers a chance for investors to express more autonomy over their investment decisions, free from some of the restrictions imposed by traditional assets like stocks and bonds. There is a fundamental purity to allowing people to engage in more transparent, efficient transactions, no longer reliant on an intermediary to broker their investments. However, without the support and flexibility of the existing financial and legislative institutions, the marketplace for digital assets has been an unstable, even destabilizing force in the American economy in the past several years.

 Currently, the US government regulates digital asset marketplaces through the enforcement of laws that are, frankly, not fit to consider the complexity and irregularity of digital assets. This unpredictable enforcement leads to confusion amongst exchange platforms about how they can act in accordance with the law. The government has no ability to stop the development of this global financial movement, so its best and safest bet is to help clarify how these new assets can interact with our current society without compromising the values of either system. These bills are essential to making the digital asset marketplace a safer, more accessible outlet for investment for all Americans. 

Further Reading: 

Some more insight into the FTX collapse: Investopedia FTX Collapse

A law firm’s interpretation of the DAMS Act: Quinn Emanuel DAMS

Jason Brett’s summary of the RFIA’s revisions and path to ratification: Forbes RFIA article

The SEC’s formal statement about their filing of a lawsuit against Coinbase: SEC Press Release

Coinbase CEO Brian Armstrong’s tweet after the SEC announced their allegations against Coinbase: ​​Armstrong’s tweet

Some more clarity on the difference between securities and commodities:

1. 1. What is a security in crypto?. 
   2. Tennessee Chamber of Commerce’s traditional definitions of the asset classes. 
   3. More insight into the distinction in the crypto space and why it matters 
   4. Further explanation of spot trading and its relevance to the distinction between securities and commodities trading

More insight into the delegation of authority between the SEC and CFTC: BCS News CFTC vs. SEC 

A very interesting op-ed suggesting that the SEC’s legal action against Coinbase could be infringing upon the authority of Congress: Coindesk Op-Ed 

Why experts classify Bitcoin as a commodity: Digital Chamber of Commerce Explanation 

An interview with Senators Gillibrand and Lummis discussing the basic implications and structure of the revised RFIA: Yahoo! News interview

The complete drafts of the RFIA and DAMS:

1. 1. RFIA Draft
   2. DAMS Act Draft 

The basic goals and responsibilities of the CFTC and SEC: 

1. 1. SEC
   2. CFTC