Congress takes a serious swing at crypto legislation

This crypto bill is the most serious and comprehensive to date – but finding that balance between innovation and market integrity remains elusive

OPINION
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In early June, Congress made another attempt to draft legislation to regulate the on-again, off-again crypto asset industry in the US.  

The bill, Digital Asset Market Structure, or “DAMS,” is the latest among several dozen introduced in the US Congress over recent months to find the right balance between advancing financial market innovation while ensuring adequate market and investor protection. 

This bill is the most serious and comprehensive to date, but finding that balance between innovation and market integrity remains elusive. 

Let the DAMS discussion begin

Fashioned as a discussion draft, DAMS presents an interesting compare and contrast with regulatory and policy actions around the world as several jurisdictions compete to be the domicile that embraces financial technology and the innovators that make it possible. 

The competition for new markets often tends to err on the side of less regulation and more freedoms to attract the innovators. That may be good for competition, but is far more challenging for the crypto asset sector — one that has encountered many growing pains and gaps as to safety and soundness, transparency and investor protection. 

As the FTX implosion aptly demonstrated, fortune did not favor the bold, but will favor the markets that assess and design rules that ensure proper trade execution, clearing and custody.  

In our view, DAMS clearly has good intentions by aiming for simplicity and straightforwardness — i.e., not creating an entirely new securities law framework. That framework simply needs to accommodate crypto, while adapting to certain specifics of digital finance. 

In so doing, DAMS specifies which crypto assets will be deemed securities (thus overseen by the US Securities and Exchange Commission) and which will be likened to commodities (thus overseen by the US Commodity Futures Trading Commission), simplifying the problem to one of registration, exemption and effective use of existing regulatory agencies. This achieves greater regulatory clarity and legal certainty, both currently missing in the US market.

At the same time, however, the DAMS framework may be underestimating the complexity of the technological factors by assuming that the same disclosure and business conduct standards that apply to traditional IPO can also apply to initial coin offerings (ICOs).

It is not yet clear if this is the right approach for investor protection, or whether it will frustrate the needs of the digital finance industry. 

Key points to consider for crypto rules 

At CFA Institute, we believe that there are several key points that policymakers should keep in mind as they design new rules in this emerging sector. 

US Market Jurisdiction of Digital Assets. The starting point of the proposed legislation is resolving the thorny issue of regulatory classification and authority over various digital assets. 

There are important stakes for the industry, because they had been trading at least some digital assets on their platforms without a clear understanding of expected disclosures and required registration requirements.  

The industry and the SEC have regularly disagreed on the applicability of the Howey test (SCOTUS, 1946) to determine disclosure and registration requirements of digital tokens and other digital assets admitted to trading on digital platforms. (Note: Howey set forth a three-part test to determine whether a financial instrument is an investment contract). 

The key challenge here is to determine the central actor or the issuing entity responsible for such disclosures. As proposed, DAMS resolves this issue with certainty, including the regulatory jurisdiction issues that go with it.

Crypto Intermediaries.The definition of digital assets, while fairly aligned in spirit with other international frameworks, is keen to set the focus on the notion of an intermediary, which is paramount to the determination of whether a token is decentralized or centralized. 

In turn, the authors also astutely clarify the notion of the issuing entity, which can be related to the entity deploying the source code of an unbacked cryptocurrency, or its initial distribution, or its sponsor. In this context, DAMS clarifies who the responsible entity should be. 

Jurisdictional Issues Between US Regulators. To its credit, DAMS makes it clear which regulator regulates depending upon the level of intermediation. A network in charge of a particular token issuance would be considered decentralized if it meets a number of requirements, including that no single entity has had unilateral control over operations and no affiliated person owned more than 20% of the tokens for the past year.  

The SEC will retain jurisdiction over any token offered as part of an investment contract, as per the Howey test, deeming these as securities with an identifiable issuer. The CFTC will be assigned jurisdiction over tokens issued by a decentralized network, as these tokens would be deemed equivalent to commodities.

Custody and Safekeeping.The draft legislation rightly recognizes the issue of digital asset custody. It proposes to allow broker-dealers to custody digital assets and would require that the CFTC establish proper business standards for Digital Commodity Exchanges to guarantee the segregation of client assets. 

Global Cooperation. It is important to keep in mind the proposed approach of the US in comparison to approaches being taken in other jurisdictions.  

In short, DAMS can be seen as middle way between the entirely new framework proposed in the EU (MiCA) and the approach proposed in the UK by HM Treasury with its Future of Financial Services Regulatory Regime for crypto assets, which aims to simply add crypto assets to its existing lists of designated investments. 

Read more from our opinion section: Raise your hand if you fully trust your bank

The philosophy underpinning each of the three frameworks (EU, US, UK) is actually quite different and unfortunately, far from being collaborative.  Meanwhile, the International Organization of Securities Commissions (IOSCO) has published its own set of policy recommendations to address market integrity and investor protection issues concerning crypto asset markets as another baseline approach to regulatory oversight.  

Avoiding chaos and systemic disruption 

Seldom do investment practitioners and market regulators witness the advent of completely new market instruments in the way crypto has burst into the mainstream.  

Whatever the cultural or economic impetus for a new breed of financial assets, when they saturate investor interest and participation, regulators and policy makers are compelled to investigate. 

Clearly, many markets aim to lead and emerge as the crypto leader. Yet, when such markets and technologies pose unknown dangers due to their virtual, instantaneous, borderless and opaque nature, overseers cannot remain idle. 

We support efforts like DAMS and other global approaches to crypto regulation but urge serious collaboration — if for no other reason to minimize market fragmentation and thus regulatory arbitrage.  Without a global approach and coordination, these limitless market technologies may pose serious challenges to economic stability. 

The crypto derby has begun, and the horses are moving fast.


Andrews oversees the strategic direction and leadership of the Research, Advocacy, and Standards function at CFA Institute, where he seeks to position the organization as an innovator and thought leader in investment management. Previously, he served as Secretary General of the International Organization of Securities Commissions (IOSCO) for two terms. Mr. Andrews revamped the strategic direction of IOSCO and oversaw the development of numerous global standards, recommendations, and principles. Mr. Andrews also served as vice president and managing director, international affairs, at the Financial Industry Regulatory Authority (FINRA), where he directed the organization’s international engagements and worked closely with key regulators and regulatory bodies worldwide, including IOSCO. In addition, he worked at the US Securities and Exchange Commission, where he worked in the Division of Market Regulation and the Office of the General Counsel. Mr. Andrews has also worked in private legal practice. He is a graduate of the Catholic University School of Law and Villanova University.

Olivier Fines, CFA, is head of advocacy and capital markets policy research for the Europe, Middle East, and Africa (EMEA) region at CFA Institute. With teams based in London and Brussels, he leads the effort in researching and commenting on the major trends that affect the investment management industry, changes to the profession, and policy and regulatory developments. The positions taken on these issues and the research pieces that are published are meant to promote the fundamental principles upheld by CFA Institute: investor protection, professional ethics, and market integrity. Previously, Mr. Fines spent 15 years in investment management—spanning research, portfolio management, product management, and regulatory compliance work—at firms based in Paris and London. Prior to joining CFA Institute, he was head of risk and compliance at Rothschild & Co for the private equity and private debt division.


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