DeFi Hearing & Agency Updates
Weekly Crypto Policy Brief: 9.13.24
September 13, 2024
Presented by the DC Privacy Summit
Good morning and happy Friday. This week we dive into a DeFi hearing, agency updates, and a new legislative proposal.
Top Points
A House Financial Services subcommittee held a hearing squarely focused on DeFi, where Members explored potential benefits and ways to enhance consumer protections and mitigate illicit finance risks.
Rep. John Rose (R-TN) introduced a bill to establish a joint advisory committee on digital assets dedicated to advising the CFTC and SEC on digital asset regulations and harmonizing agency policies.
Twelve Republicans sent a letter to SEC Enforcement Director Gurbir Grewal, urging the SEC to reconsider its enforcement approach and focus on fair and transparent rulemaking.
The SEC approved tZERO Digital Asset Securities as a special purpose broker dealer, clarified the staff's views on SAB 121 remain unchanged, settled securities registration violation charges against eToro, and stated crypto assets themselves are not securities in its amended complaint against Binance.
The IRS published instructions for how brokers should fill out the 1099-DA tax form when reporting certain digital asset transactions that take place beginning in 2025.
House DeFi Hearing
On Tuesday, the House Financial Services Subcommittee on Digital Assets, Financial Technology and Inclusion hosted a hearing exclusively focused on DeFi: “Decoding DeFi: Breaking Down the Future of Decentralized Finance.”
Full hearing, committee memo, and witness statements here.
Key Takeaways
Republicans & Rep. Wiley Nickel (D-NC) painted DeFi as a nonpartisan tech issue, largely focusing on the technology’s potential to empower individuals, eliminate middlemen, expand access to financial services, and drive economic growth, while also looking for ways to mitigate risks related to hacks, scams, and illicit finance.
Democrats, including Ranking Member Maxine Waters (D-CA) and Subcommittee Ranking Member Stephen Lynch (D-MA), were more skeptical, often focusing on illicit finance and consumer protection risks rather than benefits, and at times questioning whether DeFi was truly decentralized and warranted tailored rules.
Many Members showed a nuanced understanding and interest in DeFi, with questions covering wide-ranging issues, from information asymmetries between DeFi project leads and protocol users, to DAO governance, quantum computing, use cases, and more.
Closer Look
Here's a closer look at some of the key recurring issues.
Risks: Consumer Protection & Illicit Finance
In general, both Republicans and Democrats wanted to know how to address risks relating to hacks, scams, and security vulnerabilities.
Throughout the hearing, witnesses responded by highlighting ongoing industry efforts to:
Partner with law enforcement to identify and stop bad actors
Incentivize reporting of incidents, vulnerabilities, or other security issues (see, e.g., Security Alliance)
Improve consumer education efforts
Train developers how to build safer ecosystems & appropriate systems management.
Rep. Stephen Lynch (D-MA) (Subcommittee Ranking Member), Rep. Bill Foster (D-IL), and Rep. Sean Casten (D-IL) all drilled down on illicit finance risks.
For example, after flagging the billions of dollars in crypto assets that were lost on DeFi platforms over the last few years due to “hacks, theft, or exploits,” Rep. Lynch (D-MA) questioned how bad actors would benefit if KYC/AML requirements did not apply to DeFi, and whether projects were actually decentralized.
In response, witness Mark Hays (Americans for Financial Reform) suggested that bad actors would likely seek to exploit any regulatory gaps between TradFi and DeFi, while agreeing with the notion that not all DeFi projects are truly decentralized.
Hays also advocated for improving disclosures and avoiding rug pulls (e.g., by standardizing white papers and making it so retail doesn't have to read code to understand project vulnerabilities).
Rep. Foster (D-IL) raised concerns that law enforcement is unable to identify and capture every bad actor who accesses DeFi through anonymous self-hosted wallets.
Rebecca Rettig (Polygon Labs) explained that law enforcement can often trace illicit funds on a public blockchain faster than funds moving through traditional financial institutions, and that illicit finance detection in TradFi is also less than 100%.
Later in the hearing, Rep. Warren Davidson (R-OH) & Peter Van Valkenburgh (Coin Center) pushed back against the notion that the government should have 100% surveillance and control capabilities over individuals' financial transactions, arguing financial privacy is an American value - and a Constitutional right.
Rep. Casten (D-IL) argued there should be legal liability for people who create and maintain DeFi protocols, if the protocols are found to be violating AML laws.
Amanda Tuminelli (DeFi Education Fund) countered that bad actors should be liable, not the developers, adding: “If I make a neutral tool that somebody uses to commit a crime, I should not be held liable for that person's conduct.”
Rep. Casten wasn't happy with the response, calling it “bizarre” and characterizing developing a tool used to commit a crime as “aiding and abetting the commission of a felony.”
See clip of exchange here.
Use Cases
Blockchain based use cases – particularly non-financial ones - were top of mind for several members, including Reps. Frank Lucas (R-OK), Brian Steil (R-WI), and Mike Flood (R-NE).
At a high-level, industry witnesses highlighted ways DeFi empowers individuals by mitigating or eliminating the need to trust or rely on third-parties, bolsters transparency via public blockchains, and expands financial inclusion through permissionless networks.
As specific examples, industry witnesses cited the California DMV digitizing 43 million car tiles to smooth the title transfer process, the delivery of humanitarian aid to Venezuela and Ukraine, and how decentralized blockchains can help content creators own their own data and IP without having to rely on a Big Tech third-party.
Rettig also directed lawmakers to a use case database: “The Value Prop.”
Global Competitiveness
Several Members - including, Reps. Wiley Nickel (D-NC), William Timmons (R-SC), and Mike Flood (R-NE) - voiced concern that the current state of regulatory uncertainty is causing the U.S. to lose talent, entrepreneurs, and economic growth to foreign jurisdictions.
On this point, industry witnesses urged lawmakers to look to the examples of foreign jurisdictions, like the EU and Singapore, which have established rules for centralized crypto actors, while carving out DeFi to allow more time to study the issue and develop fit-for-purpose rules.
Legislation
There were two pieces of draft legislation noticed for the hearing.
First, the Evaluating DeFi Opportunities Act would direct the SEC, CFTC, Treasury, and the GAO to jointly study the potential benefits and risks of DeFi and report back to Congress.
Text.
Second, another draft bill would direct Treasury to study privacy-preserving technologies used in connection with digital asset transactions and report back to Congress.
Text.
Look Ahead
A message from the Coinbase Institute
Join us for the DC Privacy Summit!
Explore the future of privacy online with leading technologists, privacy advocates, and policy-minded professionals.
Thursday - October 24, 2024
USC Capital Campus - Washington, D.C.
 |
|---|
Please note registration is required!
Learn more about this groundbreaking event exploring the intersection of decentralized networks, advanced cryptography, and the law here.
Hearings
House
House Financial Services Digital Assets Subcomm.:
Weds. - 10AM - Dazed & Confused: Breaking Down the SEC's Politicized Approach to Digital Assets - 2128 Rayburn.
HFS Nat. Security, Illicit Finance, and International Financial. Inst. Subcomm:
Weds. - 2PM - Protecting Americans' Savings: Examining the Economics of Multi-Billion Dollar Romance Confidence Scam Industry - 2128 Rayburn.
Senate
Senate Judiciary Privacy, Tech, & Law Subcomm:
Tuesday - 2PM - An oversight hearing to examine AI, focusing on insiders' perspectives - 226 Dirksen.
Senate Banking (not yet confirmed, per Politico):
Tuesday - Committee vote on FDIC Chair nominee Christi Goldsmith Romero.
Quick Hits
Congress
Legislation
Rep. John Rose (R-TN) introduced a bill to direct the SEC and CFTC to establish a “Joint Advisory Committee on Digital Assets” to advise the commissions on digital asset regulations and harmonize agency policies.
The joint committee would include at least 20 nongovernmental stakeholders (issuers, registrants, academics, and users).
Text: BRIDGE Digital Assets Act.
Letter
12 Republicans sent a letter to the SEC's Director of Enforcement, Gurbir Grewal, urging him to reconsider his current enforcement approach and the agency to refocus efforts towards fair and transparent rulemaking.
Letter.
SEC
New SPBD License
tZERO Group announced the SEC and FINRA approved tZERO Digital Asset Securities as a new Special Purpose Broker-Dealer for digital asset securities custody, making it the second regulated broker-dealer digital asset security custodian (Prometheum being the first).
tZERO Press Release.
Look ahead: Keeping eyes out for how Congress and industry respond given the difficulty other market participants have faced when attempting to register with the SEC and uncertainty around which digital assets are considered securities and when.
SAB 121
The SEC's Chief Accountant, Paul Munter, delivered remarks on “Accounting for Crypto-Asset Safeguarding Obligations” in which he clarified the staff's views in SAB 121 remain unchanged.
“In summary, the staff’s views in SAB 121 remain unchanged, and absent particular mitigating facts and circumstances, the staff believes an entity should record a liability on its balance sheet to reflect its obligation to safeguard crypto-assets held for others. I believe that such financial reporting provides relevant, timely information that investors need to assess the unique risks and uncertainties related to safeguarding crypto-assets for others.”
However, the remarks did offer specific fact patterns where the SEC has found an entity's safeguarding arrangements not within SAB 121's scope.
Fact patterns included cases involving a bank holding company, certain registered broker-dealers, and where entities used blockchain to facilitate certain types of tokenized transactions.
Enforcement
eToro and the SEC settled charges that the firm operated as an unregistered securities broker and clearing agency.
eToro will pay $1.5 million to settle and remove most crypto assets from its platform, but the SEC will allow eToro to continue listing Bitcoin, Bitcoin Cash, and Ether.
In its amended complaint against Binance, the SEC said it's arguing that crypto assets are the subject of an investment contract, not the investment contract itself, despite having used the term “crypto asset securities” throughout its original complaint.
CFTC
The CFTC's Office of Customer Outreach & Education is partnering with federal agencies (e.g., SEC, FBI, DHS), FINRA, and the American Bankers Association Foundation to combat pig-butchering scams, which they describe as “cryptocurrency relationship investment scams.”
The groups will distribute infographics outlining warning signs, protection methods, and what to do if you've been victimized.
Tax
The IRS published instructions for filling out Form 1099-DA - the form for brokers to report certain sale and exchange transactions of digital assets that take place beginning in 2025.
2024 Presidential
VP candidate JD Vance cites crypto & AI as potential drivers of economic growth while appearing on the “All In” podcast:
“I think you could get a lot more growth...just by massively reducing the amount of regulatory burden in the real economy. And again, I'm an optimist, I'm fundamentally an optimist on both crypto, blockchain, web3 stuff, but also on AI. And you know, the way out of this may very well be to radically open up the way technological innovation drives things in the United States.”
See clip.
Op-Ed
Former Senator Pat Toomey pens Op-Ed in The Hill:
Stablecoins
Castle Island Ventures and Brevan Howard Digital published a whitepaper investigating stablecoin usage in five emerging markets.
Trivia
Last Week's A: President Grover Cleveland signed a law establishing Labor Day as a federal holiday.
This Week's Q: Which five Presidents have won the electoral college despite losing the popular vote?
Thank you for reading and enjoy your weekend.
-GSL
