The Crucial Cryptocurrency Legislation Awaiting Congressional Approval
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The cryptocurrency sector has faced considerable challenges in recent years. Major failures, such as FTX led by Samuel Bankman-Fried and Terraform Labs under Do Kwon, coupled with lawsuits from the US Securities and Exchange Commission (SEC) against Ripple, Coinbase, and Binance, have left the industry in a precarious situation. Scams and failed ventures, including Logan Paul’s CryptoZoo, have further complicated the landscape. Bitcoin, which peaked at $67,567 in November 2021, is now struggling below $30,000. Although some analysts foresee a surge in prices, many potential investors remain hesitant to dive into the market.
The core issue lies in the absence of clear regulatory guidance in the US. Different countries have adopted varying stances on cryptocurrencies—some have outright bans, others recognize Bitcoin as an official currency, while many have specific regulations for mining and exchanges. In the US, however, lawmakers have been slow to act, fostering confusion among stakeholders.
Fortunately, several proposed bills in Congress may finally provide the legal framework necessary for the cryptocurrency industry to mature.
HR 4763: Financial Innovation and Technology for the 21st Century Act
On July 20, 2023, Republican Representative Glenn Thompson from Pennsylvania presented House Resolution 4763. This extensive proposal aims to:
- Establish clear definitions for cryptocurrencies and associated entities, including exchanges and developers.
- Differentiate between digital commodities and securities.
- Clearly delineate the roles of the SEC and the Commodity Futures Trading Commission (CFTC).
- Outline a pathway for registration and compliance.
- Form a joint task force between the SEC and CFTC to study and advise on digital assets, decentralized finance, NFTs, and more.
These measures are critical. The SEC has recently initiated numerous lawsuits against perceived wrongdoers in an attempt to curb rampant misconduct. Many of these legal actions assert that various tokens and coins qualify as securities, which requires sellers to register as brokers. The SEC previously targeted Ripple for selling XRP, labeling it an unregistered security. Although Ripple recently achieved a partial victory in this case, the SEC continues to pursue similar actions against others. Alarmingly, the SEC has asserted that all cryptocurrencies except Bitcoin and Ethereum are securities, despite most failing to meet the criteria established by the Howey Test.
The Howey Test, originating from a 1946 Supreme Court ruling, defines what constitutes a security: 1. an investment of money, 2. a shared enterprise, 3. an expectation of profit, and 4. reliance on the efforts of others. Traditional stocks are the clearest examples, as investors expect returns based on company performance.
In the case of cryptocurrencies, applying the Howey Test is more complex. Bitcoin is decentralized, meaning it does not operate as a common enterprise, and investors cannot rely on any organization for profits. XRP's classification has been contested due to Ripple's significant ownership and usage in cross-border payments and central bank digital currencies (CBDCs). Thankfully, Judge Torres ruled that the Howey Test's criteria were not sufficiently met in secondary market sales, allowing XRP (in this context) to be classified as a non-security. As of now, only Bitcoin, Ethereum, and XRP (in secondary market transactions) have been officially recognized as non-securities, although this status may change due to appeals.
Further complicating the situation, Judge Rakoff has contested the SEC's Ripple verdict, arguing that the method of sale should not affect XRP's classification. If this perspective prevails, it could result in many other cryptocurrencies being categorized as securities, hindering transactions and undermining the industry. Nevertheless, Judge Rakoff also acknowledged the confusion in current laws, emphasizing the need for legislation like HR 4763 that offers straightforward regulations.
The SEC has also hindered the crypto industry with its inconsistent approvals and rejections of exchange-traded funds (ETFs). ETFs mimic mutual funds, tracking specific assets or collections of assets. While crypto ETFs are thriving in Canada and Latin America, they have struggled to gain traction in the US, with the SEC rejecting over 30 applications since 2021, citing insufficient fraud protections.
> "Firms have been applying for spot bitcoin ETFs for more than two years, but so far, the SEC has denied more than 30 proposals since 2021 — a 100% rejection rate." > > Sigalos & Macheel, CNBC
The SEC's rationale often lacks clarity, but the US Court of Appeals for the D.C. Circuit recently sided with Grayscale, which sued the SEC for its ETF rejection, asserting that the SEC failed to provide adequate justification for its decision. The ruling may pave the way for other companies, like Blackrock and Fidelity, to have their ETF applications approved.
If HR 4763 is enacted, it would clarify numerous issues surrounding the SEC's current overreach, allowing it to focus on genuine fraud and provide clear guidance for cryptocurrency firms while protecting investors as intended.
HR 1747: Blockchain Regulatory Certainty Act
Critics of cryptocurrency often label it as a facilitator for money laundering, a claim that holds some truth. According to Chainalysis, illicit funds transmitted through crypto have been on the rise since tracking began in 2015. In 2022, criminals funneled nearly $24 billion in various digital assets to obscure the origins and destinations of the funds. Techniques include utilizing privacy coins, multiple wallets, small transactions, and mixers, which obscure the source of funds by pooling them with others and converting them into different tokens before redistributing them.
Due to the ongoing money laundering dilemma, US regulators are grappling with how to legislate the various crypto services. Some politicians, like Massachusetts Senator Elizabeth Warren, advocate for sweeping, blunt measures against the entire crypto sector, seeking to subject all crypto companies to the Bank Secrecy Act (BSA). Enacted in 1970, the BSA mandates financial institutions to assist in combating money laundering by documenting transactions and reporting suspicious activities. While there is a consensus on applying the BSA to exchanges, which are the primary gateways to fiat currency, debates linger regarding other crypto services.
To address this uncertainty and introduce necessary regulations, Republican Representative Tom Emmer introduced the “Blockchain Regulatory Certainty Act” on March 23, 2023. This concise bill stipulates that crypto services are exempt from the same regulations as financial institutions and money transmitters, provided they do not control customer funds.
> "This bill exempts from certain financial reporting and licensing requirements blockchain developers and providers of blockchain services that do not take control of consumer funds." > > HR 1747
Should this legislation pass, it would accomplish two objectives: relieving most crypto services from burdensome regulations and ensuring that entities handling customer funds maintain protections akin to those of traditional banks.
HR 4766: Clarity for Payment Stablecoins Act of 2023
Stablecoins are a familiar concept for anyone engaged with cryptocurrency. Designed to maintain a stable value of $1, stablecoins facilitate trading among various cryptocurrencies and between crypto and fiat. They achieve this stability through algorithmic trading or by maintaining reserve assets. However, the lack of regulation has led to significant fraud and market instability.
For instance, on May 7, 2022, the stablecoin UST lost its $1 peg and plummeted to $0.35 within two days. Its value continued to decline, resulting in an $18 billion loss. LUNA, associated with UST, fell from over $100 to a mere $0.000065. The debacle is linked to the actions of Do Kwon, head of Terraform Labs, who has since been arrested and faces charges in both Japan and the US.
The most prominent stablecoin, USDT, owned by Tether, has faced scrutiny regarding its reserve backing. Although Tether claims that USDT is fully backed by USD and other assets, they have not provided an audit confirming their reserves. Previous attempts to release an audit fell through when the hired firm, Friedman LLP, abandoned the project. Adding to the controversy, Tether has faced multiple fines from the SEC and CFTC for misleading investors, and its founders are under investigation for bank fraud.
While there are several stablecoins with better reputations, the crypto market requires stricter and more intelligent regulations regarding them. To address these issues, Representative Patrick T. Henry from North Carolina introduced the “Clarity for Payment Stablecoins Act of 2023” on July 20, 2023. Key provisions of the bill mandate that stablecoin issuers must:
- Maintain adequate reserves.
- Regularly verify reserves.
- Establish clear rules for redeeming reserves.
- Operate as part of an insured, federally or state-qualified institution.
> "Permitted issuers must be a subsidiary of an insured depository institution, a federal-qualified nonbank payment stablecoin issuer, or a state-qualified payment stablecoin issuer." > > HR 4766
With such oversight, investors would gain greater assurance that stablecoins will fulfill their intended role: providing stability in a notoriously volatile market.
HR 4841: Keep Your Coins Act of 2023
On July 25, 2023, Representative Warren Davidson introduced the “Keep Your Coins Act of 2023,” which succinctly states that no federal agency can prohibit the storage or use of virtual currencies for personal purchases or other purposes. The strength of this bill lies in its broad language: it firmly asserts that crypto cannot be banned outright. Although it's uncertain whether the US government would attempt a blanket ban on cryptocurrencies, the actions of other nations indicate it remains a possibility.
Countries such as Qatar, China, and Saudi Arabia have imposed total bans on cryptocurrencies, while others, including Russia, Algeria, and India, have enacted strict regulations. Conversely, only El Salvador has fully embraced cryptocurrency, declaring Bitcoin as legal tender in 2021 to enhance financial inclusion and provide greater economic freedom. The Central African Republic attempted a similar approach in 2022 but rescinded its decision within a year due to backlash.
While this bill may seem unnecessary, it provides a safeguard against potential legislative overreach, especially given the vocal opponents of cryptocurrency in both the House and Senate. Senator Warren has been described as leading a bipartisan "anti-crypto army," although her efforts have been tempered by pro-crypto legislators. HR 4841 would serve as a protective measure if the political landscape shifts.
Conclusion
The cryptocurrency landscape is fraught with challenges, from frivolous NFTs to unprecedented levels of fraud. Both individual and institutional investors are understandably wary, having witnessed significant losses in recent years. It is crucial for the US government to take decisive action. The proposed bills outlined above represent a positive step toward establishing the necessary regulations, although their future remains uncertain as they are currently stalled in the Committee on Financial Services (with HR 4763 also trapped in the Committee on Agriculture) and have yet to be presented for a formal vote in the House of Representatives.
If you are invested in the future of cryptocurrency and its legitimate applications, consider reaching out to your representatives to express your support for these bills.
Originally published at https://thehappyneuron.com on August 31, 2023.