Key Highlights from the Responsible Financial Innovation Act

Key Highlights from the Responsible Financial Innovation Act

Key Highlights from the Responsible Financial Innovation Act

1000 648 David Hoppe

As cryptocurrencies and other digital assets continue to establish themselves as economic powerhouses and enter into mainstream acceptance, the call for regulation has grown louder. In an effort to protect consumers and investors, Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) introduced bipartisan legislation that would create a regulatory framework for cryptocurrency markets and classify the majority of digital assets as commodities. The 69-page Responsible Financial Innovation Act (RFIA) would empower the Commodity Futures Trading Commission (CTFC) to regulate crypto markets and set new legal definitions for digital assets. The bill would also establish new federal law governing stablecoins, implement taxes on small-scale crypto payments, and codify regulatory jurisdictions. If successfully implemented, the bill would go a long way toward dispelling legal uncertainties that have plagued the cryptocurrency space and further establishing its legitimacy.

One of the most glaring holes in the digital asset space is the lack of legal definitions in the US Code. RFIA would regulate cryptocurrencies as commodities under the purview of the CTFC, which would treat them as raw commodities such as corn, coffee, gold, soybeans, and crude oil. The bill proposes to endow the CTFC with new regulatory powers to oversee cryptocurrencies, making it the primary regulator of the digital asset spot market as well as creating a new registration category for digital asset exchanges. The proposed legislation adds “digital asset” and “digital asset exchange” to definitions contained within the Commodity Exchange Act as well as definitions for “virtual currency,“ “payment stablecoins,” “smart contracts,” “decentralized autonomous organizations (DAOs),” and other related terms.

Cryptocurrencies Regulated as Commodities

Under RFIA, digital assets will be brought into the regulatory sphere, bringing some semblance of order where little currently exists. The text of the legislation distinguishes between digital assets that perform as commodities or securities and those comprising tangible, fungible assets that are offered or sold concurrently with the purchase and sale of a security. The determination of the category into which an asset falls would be made by examining the rights or powers they convey to the owner. The bill provides that digital asset companies will play the primary role in determining and carrying out their regulatory obligations while providing further clarification to regulators so they can enforce the commodities and securities laws where applicable.

Digital assets would be defined as “ancillary” if they are offered in conjunction with securities unless they behave like securities that a corporation would issue to investors for the purpose of accruing capital. The Securities and Exchange Commission’s Howey Test holds that an asset should be considered a security if four conditions exist:

  1. There is an investment of money.
  2. The asset represents a common enterprise.
  3. Contributors invest with the expectation of earning profits.
  4. Those profits would accrue solely from the efforts of others.

Organizations can avoid categorization as a “security” by satisfying specified periodic disclosure requirements. RFIA would also direct the SEC not to treat cryptocurrencies and other digital tokens like traditional securities unless the holder is entitled to privileges enjoyed by corporate investors, such as dividends, liquidation rights, and financial interest in the issuer, as outlined in the Howey Test.

If passed, the legislation would give the CFTC wider power by extending its reach into the crypto spot market in addition to creating a process whereby crypto trading platforms such as Coinbase must register their businesses. The CFTC would be authorized to generate revenue by levying fees on the companies it oversees.

Taxation Reforms for Digital Assets

RFIA also introduces changes that would define and clarify the taxation of digital assets.

Currently, any time a cryptocurrency holder sells a digital asset, he or she may be required to pay capital gains tax on the profits. Even if the digital currency is used only to buy a good or service, the transaction constitutes a disposition of that asset. If the holder makes money on the cryptocurrency because it has appreciated in value, they would be liable for the tax. RFIA will potentially eliminate this tax for small transactions.

As more merchants come to accept cryptocurrency as a form of payment, tax reform is needed so consumers will not be taxed every time they spend their Bitcoin or Ethereum. Under specified conditions, RFIA would provide a de minimis exclusion of up to $200 per transaction using virtual currency for the payment of goods and services. In other words, consumers would be able to buy products and services totaling less than $200 without incurring capital gains tax.

Avoiding the Terra-ble Problem

Even before the TerraUSD (UST) meltdown, regulators were concerned with the risk that stablecoins present in the financial system. The Federal Reserve maintains that they are “vulnerable to runs” and lack sufficient transparency about the assets that purportedly support them. The legislation seeks to implement regulations that would help avoid situations such as Terracoin arising again. Issuers of stablecoins—which are cryptocurrencies pegged to a traditional financial asset such as the dollar—would have to maintain cash or cash-equivalent reserves that would fully back their digital assets. This reserve requirement for 100 percent of the face value of all outstanding payment stablecoins is intended to eliminate the collapse of the digital asset. They would also have to complete detailed public disclosure requirements for all stablecoin issuers.

What’s Next For RFIA?

RFIA still must overcome several hurdles before it can be enacted into law. The legislation will be heard in the Senate Committee on Banking, Housing, and Urban Development, which oversees the Securities Exchange Commission, and the Senate Committee on Agriculture, Nutrition, and Forestry, which regulates commodities and the CTFC. Lummis is a member of the Banking Committee, and Gillibrand sits on the Agriculture panel. The bill is unlikely to become law before the congressional session adjourns on January 23, 2023. It would then be taken up when the new Congress convenes after the election. Even if it fails to become law, the legislation can serve as a benchmark for future bills and offer a game plan for wider crypto industry integration.

Overall, the legislation intends to clarify the legal uncertainty surrounding digital assets in the marketplace to create a new regulatory framework. Together, the CTFC and the SEC are powerful regulators who will be given more authority to oversee virtual currencies and digital assets in the US. The latter would regulate digital assets as a commodity and the former would police companies, executives, and securities for greater investor protection.

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David Hoppe

All stories by: David Hoppe

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