Digital Assets hearing latest – sufficiently decentralized tokens may still avoid security label

The House Financial Services hearing on “The Future of Digital Assets” contained a wealth of information on the potential future of the digital asset space in the United States.

Following the recent SEC lawsuits against Binance and Coinbase, the industry has feared for the future of web3 within the U.S. due to the listing of several top crypto projects, including Cardano, Solana, and Polygon, in the cases against the crypto exchanges.

The recent release of the Hinman emails suggests that such clarification would be impactful for Ethereum, which has been previously assessed to be ‘sufficiently decentralized.’

“Nearly 15 years since the Bitcoin whitepaper, an idea has become the new internet architecture, with ownership, digital identity, and value storage native to technology.

Digital assets are now no longer a new technology, they are used all over the world, and America has always led technology invention and, if not invention, implementation, and today we’re at risk of falling behind competitors around the globe… “

This was the opening statement of the hearing, chaired by Representative Mr. McHenry. He further stated the intention for a version of the 160-page  draft bill by July this year and highlighted the proposed directive on the registration of digital assets as securities.

Notably, “sufficient decentralization” appears to be being retained as a key factor in whether to define a digital asset as a security or not.

The hearing also contained testimony talking about the potential for a digital asset to have the security label removed if it were to become sufficiently decentralized.

Hearing testimony

Other testimony compared the SEC lawsuits against Coinbase and Binance to the collapse of FTX, a company that has yet to be served any formal action by the SEC.  There were also fears aired of digital assets undermining the current financial system through carve-outs.

Mr. Scott argued that the current draft of the proposed bill could “potentially result in less protection for our investors than is currently provided.”

The CEO of Circle, Jeremy Allaire, argued strongly for the need for digital asset regulation to stop the U.S. from falling behind China and devaluing of the Dollar. Allaire also stated that crypto reserves should be safer than banks by limiting fractional reserve practices by limiting of rights to FED services.

Additionally, he called for stronger protections in the realm of digital custody suggesting all stablecoin issuers should be required to use registered “qualified custodians.”

However, Benjamin Kaplan, the Co-CEO of Prometheum Capital, a company claiming to be “building Wall Street 2.0,” commented that discussion on the need for more or less regulation is flawed as the “application of the existing regulatory frameworks to digital assets” is needed as “the federal securities laws have been tried and tested for almost 90 years.”

Kaplan’s company states it is “among the very first to provide investors with a [sic] SEC-registered, full-service market ecosystem for digital asset securities.” Prometheum Chairman, Martin Kaplan, has long been a proponent of SEC regulation of digital assets. In 2018 he stated,

“A new industry like cryptocurrency only needs to follow the established regulatory treaty, and there is no need to worry that the United States will introduce more stringent laws to limit the development of the new industry.”

Aaron Kaplan, also Co-CEO, added that “the US cryptocurrency industry should actively cater to the SEC’s regulation,” supporting the current framework and believes no change is needed.

Sufficiently decentralized

Coy Garrison, a partner at legal firm Steptoe & Johnson, stated that the current draft of the bill works and is needed to support innovation. Garrison argued that sweeping statements that all digital assets are securities miss the complexity of the assets. Currently, there is no clear guidance on what “sufficient decentralization” means, and therefore, there is confusion within the industry, holding back innovation, according to Garrison.

There is no case law to give guidance on how the Howey test, used to assess whether an asset is a security, should be applied to assets traded on secondary markets, according to Garrison.

Digital assets are traded on multiple internationally decentralized secondary markets, thus posing a clear gap in regulatory guidance. A “more workable regulatory regime” that would give guidance on how a security could become sufficiently decentralized, as well as how to apply the guidance to the secondary market, was requested by Garrison in his closing remarks.

Allaire also commented on the absurdity of other nations defining regulation on U.S.-denominated digital assets, notably stablecoins, so that other countries “aren’t regulating the Dollar.”

The CEO of the National Futures Association, Thomas Sexton III, called for NFA to regulate “Bitcoin and Ether” spot markets with the support of the CFTC.

Critics of the crypto industry

Ms. Waters “did not expect” there to be a desire to work with the CFTC or SEC from the crypto industry. Waters repeatedly referred to FTX and the alleged crimes of Sam Bankman-Fried when discussing the subject of digital assets asking if the industry supports the “comingling” of funds akin to FTX’s alleged crimes.

Mr. Sherman claimed that the goal of the crypto industry, invoking SBF, was to “get the SEC out and put a patina of regulation in.” His statements came after several members of the crypto community made statements calling for a regulatory regime that took into consideration the complexity of digital assets compared to the types of securities available for review when the Howey test was created in 1933.

Sherman stated that Ava Labs “peddled unregistered securities” and asked if Ava Labs CEO, Emin Gün Sire, had sold unregistered security tokens. Sire responded, stating that “we have complied with every regulation to the best of our abilities.” After repeatedly being asked to confirm if Ava Labs had filed a registration statement for an ICO, he added, “I do not know the correct answer to that; I believe that we did not.”

Sherman concluded his time by stating that”Taylor Swift turned down millions of dollars to be associated with it.”

Continued discussion

The hearing continued to discuss the risk of exposure to China from such as Representative Mr. Luetkemeyer, who was strongly concerned that U.S. companies are trading with Chinese companies in any form.

This is an ongoing story, and further information will be reported separately. The hearing can be viewed in full on the GOPFinanceServices YouTube channel.