A U.S. Crypto Regulatory Primer

The recent passage of U.S. crypto regulatory policies follows on the heels of a long, convoluted path to bringing categorization and frameworks to digital assets in the U.S. With more legislation currently before Senate, the implications for digital assets and asset managers are wide ranging.

The Winding Path to Now

For years, the SEC skirted the creation of digital asset regulation, citing the unique risks of digital assets to investors. Instead, the regulatory body’s crypto rulemaking arrived in the form of crackdowns, whack-a-mole style. Firms and asset managers learned the hard way what wasn’t allowed in regards to digital asset investing in the U.S., without ever really understanding what, if anything, was permissible.

Congress attempted to pass the Financial Innovation and Technology for the 21^st Century Act (FIT21) in 2021. The regulation sought to better define which agencies have jurisdiction over specific digital assets (SEC versus CFTC). Additionally, it worked to cement what digital assets were classified as commodities and which were securities. Notably, stablecoins would only fall under SEC and CFTC oversight in very narrow instances.

FIT21 also created new requirements that brokers and dealers of digital assets, clearing agencies, and platforms must register as intermediaries with the SEC or CFTC. While it passed with bipartisan support in the House, it later fizzled in the Senate.

Signs of Changing Crypto Tides in the U.S.

The SEC’s Commissioner Hester Peirce has long been an advocate for SEC crypto regulation, and a vocal critic of the inertia the regulatory body demonstrated for years. It’s likely this advocacy that landed Commissioner Pierce as the lead for the newly formed SEC Crypto Task Force early this year. The Crypto Task Force MO, according to Commissioner Peirce, seeks to provide regulatory clarity in regards to digital assets as well as encourage ongoing innovations.

The Commission staff oversaw the rescission of Staff Accounting Bulletin 121 (SAB 121) early this year. Passed in 2022, SAB 121 required financial institutions to report any crypto custodied by customers as a liability on their balance sheets. In addition, companies must provide full, public disclosures of the type and amount of crypto held for customers.

SAB 121 proved massively unpopular with businesses. The addition of more assets on balance sheets could force greater capital reserve requirements for companies, thereby limiting other business practices such as lending. It made holding crypto a non-starter for many companies and banks. The rescission of these requirements opens the door once more for banks and businesses to provide custody services to rapidly growing crypto ETFs.

A Flurry of Regulatory Activity After Years of Silence

The new administration brought with it a rapid about-face in regards to digital assets and the crypto economy. Following close on the heels of establishing the Crypto Task Force, the creation of the Strategic Bitcoin Reserve and U.S. Digital Asset Stockpile set a new precedent for U.S. government investment in digital assets.

July brought the landmark passage and signing into law of the GENIUS Act. The Act marks the first piece of crypto regulation in the U.S. and goes into effect in January 2027. The GENIUS Act specifically deals with establishing U.S. dollar-backed stablecoins, a type of digital asset pegged to reserve assets. In this case, stablecoin issuers must back their supply with either cash or short-term Treasuries in a 1:1 ratio.

As seen previously with FIT21, the GENIUS Act establishes stablecoins outside of the security or commodity categories. Instead, regulation falls to whichever agency pertains to the permitted issuer, with specific definitions given for relevant agencies. It also requires monthly reporting and transparency for stablecoin issuers, which may be banking or nonbanking entities.

It’s difficult to quantify what the GENIUS Act means for cryptocurrencies as a whole. While the legislation does not apply specifically to these digital assets, they stand to benefit from broadening investor adoption within the crypto ecosystem. Here is an added layer of legitimacy, with clearly defined guardrails in an ecosystem with a reputation for risk.

Notably, the passage of any piece of pro-crypto legislation within the U.S. marks a significant turning point for digital assets. The GENIUS Act is likely to have a more immediate effect on tokenization efforts and adoption. However, it’s very much a matter of a rising tide lifting all boats, with the crypto economy set to benefit as a whole.

CLARITY on the Horizon

Alongside the GENIUS Act, the CLARITY Act also passed in the House with bipartisan support, although it still sits in the Senate. It is the legislation that evolved from the frameworks FIT21 sought to establish. The Act creates a regulatory framework for the classification of digital assets and establishes jurisdiction between the SEC and CFTC.

The CLARITY Act divides digital assets into two categories, security and commodity, with all digital assets defaulting to security initially. In order to establish a digital asset as a commodity, the issuer must prove to the SEC that it part of the newly classified “mature blockchain system."

In essence, a digital asset that is intrinsically linked to blockchain must also be sufficiently decentralized, including from its issuer, in order to qualify as a commodity. These would fall under the CFTC’s oversight and jurisdiction, including spot digital commodities. The Act also establishes digital commodity brokers, dealers, and exchanges who would all also register with the CFTC.

The SEC will hold jurisdiction over stablecoins and fraud that relates to stablecoins and specific digital commodities. It will not be allowed to prevent unregistered exchanges from obtaining covered exemptions because they trade in digital commodities or stablecoins as well as securities. The CLARITY Act also prevents the SEC from regulating decentralized finance activities. Furthermore, the SEC and CFTC must work together to resolve any conflicts that arise from the new regulations, such as dual-registered digital exchanges.

Overlooked Implications for Crypto Fund Managers

Implications for the CLARITY Act are broad and far-reaching. Definitive classification of digital assets would bring stability and investment transparency to a currently muddled asset class in the U.S. It also would work to create real guardrails for U.S. investors, with digital assets adhering to traditional investment legislation.

The broadening of digital commodities could prove a boon for some of the largest cryptocurrencies beyond bitcoin. However, dual-registration requirements and revisions to CPO and CTA definitions could catch some managers unaware, according to Jonathan Ammons, partner at ReedSmith. Under these new definitions, some advisors and fund managers that trade in or advise about digital commodities would find themselves needing to register with the CFTC. While there are some exceptions, the potential net is wide and the implications large.

The RFIA and CBDC Anti-Surveillance State Act

Alongside the CLARITY Act is the Responsible Financial Innovation Act (RFIA). It carries many similarities to the CLARITY Act. However, it discards the digital commodities definition in favor of “ancillary asset,” a potentially broader reaching classification. Notable differences include empowering the SEC to a much greater extent as well as requiring more transparency from issuers who self-certify. Under the RFIA, the SEC can engage in a broad range of rulemaking. It will also be able to determine if a digital asset qualifies as a security or ancillary asset.

The last piece of major legislation, the CBDC Anti-Surveillance State Act, prevents the Federal Reserve from establishing or issuing a central bank digital currency without Congress authorization. It also prevents the Fed from providing financial services or products directly to individuals, or keeping accounts on their behalf. The Act will allow the creation for a dollar-denominated digital currency that retains privacy protections similar to existing fiat currency but that is permissionless and open.

Originally published by ETF Trends on the CoinShares Crypto ETF Hub.

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