In early June, Patrick McHenry, Chairman of the House Financial Services Committee, and Glenn Thompson, Chairman of the House Committee on Agriculture, released a landmark draft digital asset market structure bill.

The release of this proposed legislation has been overshadowed in the mainstream press by SEC enforcement actions, but I believe it deserves ample attention - because this bill would not merely protect Coinbase, Ethereum, and the other digital asset service providers and issuers facing existential uncertainty in the US; it would lay the groundwork for a new wave of decentralized businesses and projects to create tremendous economic value that will be shared with their users.

New Technology Necessitates Smart Regulation

The bill would accomplish what the 1933 Securities Act, which was initially known as the “Truth in Securities” Law, did – not merely protecting ordinary folks from losses, but also enabling a trustworthy and vibrant capital market that has been a keystone in building America’s extraordinary economic engine. If the US is to maintain its position at the center of the world’s capital markets, at a time when Europe, the UK, and Hong Kong are all creating more favorable climates for digital asset businesses, we will need to update our ~90-year-old securities laws for this new technology.

It is a prototypical example of “smart regulation,” which does not merely balance the interests of capital formation with investor protections, but rather implements the sort of protections that encourages capital formation – and, in this case, the creation of decentralized products and services that generate widely shared economic benefits. More specifically, the McHenry-Thompson regime would enforce transparency and nudge projects towards true decentralization, where the benefits of crypto accrue more to end users and network participants.

The Bill’s Key Provisions

The bill’s most important provisions clearly defines and makes a distinction between digital asset securities and digital asset commodities, and provides a set of criteria by which tokens can transition from the former to the latter. This is all based on the guiding concept of “sufficient decentralization,” which was initially invoked by then SEC commissioner William Hinman.

The core principle is that while a protocol is more centrally controlled, via ownership of the token supply or authority over code changes, the development team behind it should be subject to disclosure requirements and insider sale restrictions – because there are legitimate concerns about information asymmetries between insiders and outsiders (as with a traditional corporation). Once a protocol is more decentralized in ownership and control (like Bitcoin is today), the risks of information asymmetries are diminished, and private companies can provide the data and insights that investors and users need to make decisions (as is the case in the energy and food commodities markets) - thus strict disclosure requirements are unnecessary.

The bill also allows protocol developers to distribute tokens more broadly. Right now, most pre-launch tokens are only sold to accredited investors using the Reg D exemption, and most protocols refrain from issuing airdrops to US users. Under the proposed legislation, US-based token issuers could sell registered tokens to the public, within limitations that are more sensible than current accredited investor laws – instead of barring people from investing if they don’t hit minimum wealth or income thresholds, anybody could invest up to 5% of their net worth or income in a given offering. Protocols could also make “end-user distributions,” via airdrops and staking rewards, from the outset. This would provide much broader access to the growth potential of these new assets.

Additionally, the bill provides a clear framework for companies to register both digital asset securities exchanges and digital commodities exchanges. The former would be subject to SEC jurisdiction, while the latter would be subject to CFTC oversight. Today, it is essentially impossible to register a digital asset securities exchange, nor is there a framework for federally registering a digital asset commodities exchange. These exchanges would be subject to both time-tested and sensibly tailored customer protection rules – a huge improvement on the status quo.

The Bill Would Have Broad and Positive Economic Ramifications

Some casual observers wonder if crypto is worth preserving in the US given the “lack of use cases.” Real world adoption of crypto is underappreciated and often understated, but it is also limited by the lack of a clear and reasonable regulatory framework in the US.

If a bill with these principles were to become law, I believe we would see radical improvements in the most well-known crypto use cases (DeFi, NFTs, and stablecoins), and still nascent use cases that could thrive under a new framework. These include (1) decentralized social media, as new US-based startups and established incumbents could issue tokens that allow creators to better share in the economic value they create, (2) decentralized physical infrastructure, as protocols offering decentralized cloud storage or telecom networks could more easily integrate their products into legacy systems, (3) regenerative finance, as the tokenized carbon credit market could take off under this framework, and (4) decentralized science, which is a movement primarily based on the ability to crowdfund and coordinate important research in biology and beyond.

This bill would not only allow crypto to thrive, but potentially fuel the US economy more broadly. Most US industries have become increasingly concentrated and monopolistic over the past few decades – exacerbating inequality, crimping growth, and kicking off a vicious cycle of increasing political capture. The bill would enhance competition in our economy by enabling new entrants to build innovative decentralized solutions for a wide variety of industries.

The Bill’s Path Forward

This ambitious bill is not perfect, and there are areas that will need be better addressed within the bill and perhaps with separate legislation over time – including DeFi (which has very different considerations from the centralized exchanges that the bill explicitly regulates), NFTs (the bill should ensure that collectibles and in-game assets are not unreasonably deemed securities), and stablecoins (which are defined in the bill, but will need its own federal framework to ensure that regulated US-based companies can compete with unregulated offshore issuers to proliferate dollars around the world). And there are still ambiguities or gaps around insiders’ ability to contribute to protocol governance, legal liability of DAO participants, and other topics.

But all-in-all, the basic tenets of this bill have the potential to enable a maturation of the industry that both crypto enthusiasts and crypto skeptics should support. Importantly. the shady behavior of companies like FTX and others would not be possible under this new framework.

If and when a market structure bill like this passes, it will have some meaningful changes based on industry feedback and compromises within Congress. Hardcore crypto enthusiasts and haters will each find elements they dislike. But if the final law embodies this version’s principles, it will represent a dramatic improvement upon the status quo – not just for crypto, but for the US economy as a whole.

The recent controversy around Ledger’s firmware update highlights a major tension between the preferences of crypto’s risk tolerant early adopters, and the needs of the masses who must drive crypto’s next wave of adoption. The ostensible problem is seed phrase management, but, at a more fundamental level, the problem is transaction irreversibly

Background for the uninitiated: the game theory embedded in blockchain consensus algorithms guarantees that executed transactions cannot be undone. We call this feature “immutability,” and it is central to crypto’s value proposition. But this solution to the double-spending problem is a double-edged sword, as it makes crypto scary for ordinary users - particularly because transactions must be sent to brutally unreadable 64-character, 256-bit hexadecimal addresses. If one mistakenly sends crypto to an address with just one wrong character, there is nobody to call for help and the funds are likely lost forever.

Hacks are an even bigger problem than mistakes, and the main reason that guarding one’s seed phrase is so important (though loss of seed phrases is a separate problem, which enabling reversibility does not solve). In fact, hacks are arguably the biggest problem in crypto - over $2B was lost to exploits in 2022 and NFTs worth hundreds of millions have been stolen. In response, many companies are building crypto loss prevention solutions, including human readable addresses, seed phrase recovery services, MPC wallets, account abstraction, advanced auditing tools, smart contract monitoring systems, blockchain forensics, and bug bounty marketplaces. These products have made crypto safer, but they cannot fully defeat software bugs or human error.

Mistakes and crime have also led to large losses in traditional payments and trading, but TradFi has more systems, including fraud protection and legal mechanisms, that protect users. In any case, the crypto industry should learn from the hard won insights of the last few centuries in finance, and then use crypto rails to create a more transparent and efficient system - rather than aiming for some decentralized utopian vision and falling into a chaotic dystopia.

Thus, I believe more should be done to directly address irreversibility, and I’ll highlight a few possible approaches below. I recognize that variations of some of these ideas are being tried, that there are probably better ideas out there, and that there are big challenges – technical, economic, regulatory, and design – to implementing these ideas at scale. I am also aware that many in the blockchain space are ideologically opposed to centralized products and services, and believe the better path is to educate users on best practices and solve security problems in other ways. Nonetheless, I believe irreversibility is one of the greatest barriers to mainstream adoption of crypto and DeFi, and that offering optional systems that increase users’ margin for error must exist over the long-term for true mass adoption. Here are the ideas, from most centralized to most decentralized:

• More protocols and token issuers could explore actively managing a mechanism for freezing funds, so users have somebody to contact when they’ve lost their funds. These mechanisms should be transparently disclosed and procedures should be scrupulously followed. This might require users to register and KYC unhosted wallets (as with the recent Ledger firmware update), or for protocol “managers” to get money transmitter licenses and build specialized fraud prevention teams. Additionally, we may need special enabling legislation to allow protocols developers or licensed third-party recovery services to do this without running afoul of any existing laws. Some stablecoin issuers have taken half steps in this direction – USDC, for example, notes in its terms and conditions that it may freeze any account it determines to be responsible for illegal activity, but also forces users to acknowledge that transactions are irreversible and accept all responsibility for mistakes.

• Custodians and new entrants might build payments layer on top of base chains that allow the senders themselves to reverse transactions within some specified time-period. This would require the introduction of a trusted or (preferably) trustless escrow service, mean that the recipients cannot access the funds during some holding period, and indeed slow down on-chain settlement times. But this is no problem at all for some use cases - if you are selling a valuable piece of art, who cares if it sits in a smart contract escrow for a few days?

• More companies should experiment with decentralized on-chain, third-party arbitration systems, such as Kleros, that can undo fraudulent transactions, without requiring the intervention of a single trusted entity.

• A group of Stanford researchers proposed a reversible token standard last year, but as far as I can tell, there has been no pickup. Perhaps this is due to a lack of demand for such tokens, lack of awareness around these ideas, or the failure of early crypto adopters and developers to build for the next generation of users.

• Non-custodial and MPC wallets should allow users to setup rules so they can cancel certain transactions within some time frame. A wallet’s primary job is to protect users from losses, and in my opinion, they are mostly failing. The wallets could offer pre-set parameters for cancellation and/or allow for customization based on transaction size or type. Once a transaction within such parameters is initiated, the wallet owners should receive a notification via an app, text, or email, and have the chance to pause the transaction. If the user believes their account has been compromised, they should be able to retake control off the wallet and send their assets to a special backup address (either one that they control or an omnibus account specially managed by a trusted backup custodial service) that have previously specified.

The systems described would introduce more centralization and “trust” into crypto. But they would all be opt-in, and the base layers could and should remain completely trustless, leaving the option of using tokens and protocols that are unfreezable and irreversible. Furthermore, the entities that provide these services could use the blockchain itself to provide transparency.

The introduction and proliferation of these systems will be challenging, and undoubtedly entails some major trade-offs. But I am optimistic that by tackling these problems head-on, crypto can deliver a next-generation financial system that provides different types of users with the sort of security that they value, while unlocking the benefits of global, interoperable, decentralized settlement networks. In the meantime, we cannot expect ordinary people to put their life savings on chain if they fear that their funds can be disappear, instantly and irreversibly.