The Future of Digital Asset Regulation (U.S. House Committee on Agriculture, Subcommittee on Commodity Exchanges, Energy, and Credit)

Hearing	The Future of Digital Asset Regulation
Committee	U.S. House Committee on Agriculture, Subcommittee on Commodity Exchanges, Energy, and Credit
Date	June 23, 2022

 

Hearing Takeaways:

• Regulation of Digital Assets: Subcommittee Members and the hearing’s witnesses remarked that the growing popularity and increasing volatility of digital assets necessitated that the assets receive more robust regulation. The hearing specifically focused on the role that the U.S. Commodity Futures Trading Commission (CFTC) could play in overseeing digital assets. Mr. McGonagle noted that digital assets were commodities and remarked that the CFTC possessed “broad” regulatory oversight over any derivatives products listed by designated contract markets. He highlighted how the CFTC did possess anti-fraud, false reporting, and anti-manipulation enforcement authority over commodity cash markets in interstate commerce. He testified that the CFTC had brought more than 50 enforcement actions since 2014 involving digital assets. Dr. Brummer commented that the CFTC was capable of regulating cash markets so long as it was properly financed and resourced.
  • Classification of Digital Assets as Commodities or Securities: A key area of discussion during the hearing involved whether digital assets ought to be classified as commodities, securities, or something else. This classification was important as it would largely determine whether the CFTC, the U.S. Securities and Exchange Commission (SEC), or a different agency would serve as the primary regulatory of a given digital asset. Mr. McGonagle remarked that digital assets were broadly defined to be commodities. He noted however that the SEC could determine a digital asset to be a security, which would bring the digital asset outside of the CFTC’s jurisdiction. He stated that there did not currently exist a framework that would enable such a digital asset to return to the CFTC’s jurisdiction as it matured. Dr. Brummer also remarked that the U.S. Supreme Court’s test for determining whether an asset was a commodity or security in SEC v. W.J. Howey Co. (known as the Howey test) was not always straightforward. Mr. Hoskinson remarked that cryptocurrencies were more fundamental in nature and did not neatly adhere to existing categories (such as currencies or commodities). He stated that the categorization of cryptocurrencies should depend on the markets that they traded on and their uses and utilities. He remarked that policymakers would need to consider their policy objectives when determining their regulatory approaches to digital assets.
  • Disclosure Challenges: Dr. Brummer stated that deeming digital assets as either commodities or securities would not solve disclosure challenges within the digital assets space. He noted how commodities were subject to grading and quality requirements and how spot commodities were not automatically subject to any particular disclosure regime. He also contended that U.S. securities laws were simultaneously underinclusive and overinclusive and highlighted how these laws demanded disclosure on corporate board governance (but not blockchain governance). He further asserted that U.S. securities laws were premised on the idea of disclosures being filed and not read.
  • Comparison Between CFTC and State Regulation and Oversight of Digital Assets Markets: Mr. McGonagle and Dr. Brummer remarked that the CFTC’s regulatory regime was fundamentally different from state money transmitter licensing regimes. Dr. Brummer acknowledged that there did exist some overlap with state money transmitter licenses and CFTC regulation.
  • The Digital Commodity Exchange Act of 2022 (DCEA): Full Committee Ranking Member GT Thompson (R-PA) mentioned how he had introduced the bipartisan DCEA to bring regulatory clarity to digital assets markets, protect market participants, and establish “clear jurisdictional lines” between financial regulators. He emphasized that the DCEA would provide a “clear pathway” for compliance for digital asset innovators and provide regulators with tools to hold bad actors accountable. He noted that this legislation would create a new registered entity, which would be known as a digital commodity exchange (DCE). He commented that DCEs would be similar to existing futures exchanges and swap execution facilities (SEFs).
  • Role of Self-Regulatory Organizations (SROs) in the Digital Assets Space: Rep. Austin Scott (R-GA), Mr. McGonagle, and Mr. Hoskinson highlighted the important role that SROs played in providing oversight of the digital assets market. They asserted that it would be impossible for the CFTC to directly regulate all of the cryptocurrencies currently in circulation given their limited staff and other responsibilities. They noted how SROs and private organizations were currently responsible for financial regulation in many instances.
  • Use of Algorithms to Regulate Digital Assets: Rep. Michael Cloud (R-TX) expressed concerns that the use of algorithms to regulate digital assets could eventually encroach on the privacy rights of Americans. Mr. Hoskinson suggested that any U.S. government algorithms ought to be built out in an open source process and stated that people ought to opt-in to having their data used in these algorithms (rather than having people proactively opt-out of having their data used in the algorithms).
  • Current Safety of Digital Asset Exchanges: Rep. Ann Kuster (D-NH) expressed interest in whether digital asset exchanges were currently operating in compliance with existing laws and rules and in a secure fashion. Mr. Levin how the U.S. Office of Foreign Assets Control (OFAC) had taken actions to designate certain cryptocurrency exchanges as facilitators of illicit activity. He also highlighted how the U.S. Department of the Treasury had taken actions to enforce anti-money laundering (AML) rules internationally.
• Other Policy Topics: In addition to the topic of digital assets regulation, Subcommittee Members and the hearing’s witnesses expressed interest in other digital asset policy topics.
  • Use of Digital Assets to Promote Financial Inclusion: Rep. Bobby Rush (D-IL) expressed interest in working to ensure that traditionally underserved communities (such as those in his Congressional District) could partake in blockchain technology-enabled wealth creation opportunities. Dr. Brummer asserted that the policy debate surrounding digital assets should focus on ensuring that underserved communities could meaningfully participate in wealth generation opportunities (rather than on specific asset classes). He further stated that the narrow focus of digital assets as investments diverted attention away from exploring whether there existed parts of the technology stacks underlying these assets that could be leveraged to promote economic opportunities for underserved Americans. He also remarked that the cryptocurrency industry would need to obtain input from a more diverse set of stakeholders as it scaled.
  • Use of Digital Assets in Illicit Activities: Mr. Levin remarked that the transparent nature of blockchains enhanced the ability of policymakers and government agencies to detect, disrupt, and ultimately deter illicit activity and abuse within cryptocurrency markets. He noted how examinations of blockchains enabled policymakers and government agencies to gain insights into entire criminal networks behind illicit activity. He commented that such examinations were more difficult to conduct in traditional criminal financial investigations.

Hearing Witnesses:

1. Mr. Vincent McGonagle, Director of the Division of Market Oversight, U.S. Commodity Futures Trading Commission
2. Dr. Christopher Brummer, Agnes N. Williams Professor of Law, Georgetown University Law Center
3. Mr. Jonathan Levin, Co-Founder and Chief Strategy Officer, Chainalysis, Inc.
4. Mr. Charles Hoskinson, Chief Executive Officer, Input Output Global

Member Opening Statements:

Subcommittee Chairman Sean Patrick Maloney (D-NY):

• He discussed how there had occurred “rapid and expansive” growth and innovation in the diversity and volume of available digital asset products since Bitcoin’s launch and the creation of the Ethereum blockchain.
• He noted how digital assets had come to encompass virtual currencies, investment opportunities, and exchange-traded assets.
• He remarked that the novel nature, complexity, and consumer uses of digital assets should dictate their regulation.
  • He expressed the Subcommittee’s interest in the oversight of digital commodity products available for trade in the derivatives and underlying spot markets.
• He called digital assets “very popular but volatile” and highlighted how the market capitalization of digital assets had decreased from approximately $3 trillion in November 2021 to $1 trillion today.
  • He mentioned how approximately 20 percent of U.S. adults had invested in, traded, or used cryptocurrencies.
• He asserted that it was therefore important for Congress to establish the “rules of the road” for digital assets to ensure that U.S. retail investors would be informed and protected.
  • He noted that while the CFTC had “dutifully” exercised its role as a regulator and enforcement authority in digital asset markets, he emphasized that this authority was limited.
• He remarked that the recent digital asset volatility coupled with high retail investor participation within digital asset spot markets posed concerns over the gap in oversight and regulation of the digital asset markets.
  • He also expressed interest in working to foster digital asset innovation domestically.
• He then remarked that while digital assets presented opportunities for promoting financial inclusion, he contended that the absence of strong consumer protections, consumer education, and regulatory certainty could imperil digital asset market participants.
  • He stated that mandatory disclosures for market participants might help retail investors to understand the volatility of the assets and facilitate “smart digital entrepreneurship.”
• He expressed interest in having the Subcommittee consider policies to address the aforementioned issues and expressed his hope that these policies could be bipartisan in nature.

Subcommittee Ranking Member Michelle Fischbach (R-MN):

• She noted how roughly half of U.S. adults own or have owned some form of cryptocurrency and indicated that the U.S.’s cryptocurrency ownership rate was similar to the U.S.’s traditional security ownership rate.
  • She added that more than 74 percent of Americans that owned cryptocurrencies had purchased them for the first time within the previous two years.
• She highlighted how there now existed nearly 20,000 cryptocurrencies spread across numerous blockchain platforms.
• She remarked however that cryptocurrencies often did not always neatly comport with the U.S.’s financial regulatory framework.
• She discussed how the U.S. traditionally protected investors through disclosure requirements and the segregation of their assets.
  • She also stated that the U.S. promoted market integrity through regulatory oversight, intermediaries, and enforcement actions.
• She noted however that the rules applicable to a given asset depended on the nature of the asset and the specific types of risks that market participants face.
  • She commented that regulations had struggled to provide guidance to market participants on how and when their activities require registration and compliance.
• She noted how Committee Members had proposed legislation to establish clear parameters for the roles of both the SEC and the CFTC within digital asset markets.
• She mentioned how Full Committee Ranking Member GT Thompson (R-PA) and Rep. Ro Khanna (D-CA) had recently introduced the DCEA.
  • She explained that this legislation would provide the CFTC with expanded oversight of digital asset trading activity involving digital assets deemed to be commodities.
• She expressed appreciation for the efforts from the CFTC and the SEC to apply existing regulatory frameworks to digital assets.
  • She stated however that existing law was often ill-equipped to address certain types of digital asset transactions (including spot digital commodity transactions).
• She called it incumbent on Congress to articulate a regulatory framework for digital assets in light of the growing popularity of these assets.

 Full Committee Ranking Member Glenn “GT” Thompson (R-PA):

• He discussed how the digital asset sector had faced numerous challenges in recent months, including falling prices, the implosion of several projects, and customer funds being lost or frozen.
  • He stated however that the public’s interest in digital assets technology remains consistent, despite the aforementioned challenges.
• He remarked that “clearly defined guardrails” for digital assets could provide more certainty to developers, investors, and the public and mentioned how he had introduced the DCEA to provide such guardrails.
  • He commented that this legislation would provide a framework to bring regulatory clarity to digital assets markets, protect market participants, and establish “clear jurisdictional lines” between financial regulators.
• He emphasized that the DCEA would provide a “clear pathway” for compliance for digital asset innovators and provide regulators with tools to hold bad actors accountable.
• He remarked that the DCEA’s focus on core principles would lead to a well-understood and flexible framework that would support the creation of new products and meet evolving market demands.

Witness Opening Statements:

Mr. Vincent McGonagle (Division of Market Oversight, U.S. Commodity Futures Trading Commission):

• He discussed how the CFTC served as the primary regulator of the futures, options, and swaps markets. 
  • He stated that the CFTC’s regulatory framework sought to ensure market integrity, the protection of customer funds, the avoidance of systemic risk, the policing of derivatives markets for abuses, and the fostering of innovation and fair competition.
• He noted how trading facilities for market participants (including retail customers) interested in listing and trading futures needed to apply to the CFTC in order to be designated as a contract market.
  • He indicated that this market then must comply with 23 statutory core principles, which involved the protection of customer funds, protection of market participants and markets from abusive practices, and the promotion of fair and equitable trading.
• He mentioned how contract markets needed to establish and maintain programs to identify and minimize sources of operational risk (including cybersecurity and disaster recovery).
• He also highlighted how designated contract markets were SROs, which necessitated that these markets establish and maintain effective oversight programs (including the monitoring and enforcement of their own rules).
  • He indicated that these markets must submit all of their new product terms and conditions to the CFTC.
• He testified that the CFTC’s staff conducted rule enforcement reviews and system safeguard examinations in order to ensure designated contract market compliance with the CFTC’s core principles.
  • He noted that CFTC staff could request that these markets provide detailed justifications of their continued compliance with core principles at any time.
  • He further mentioned that the CFTC conducted direct surveillance of trading on these markets.
• He then noted that digital assets were commodities and remarked that the CFTC had “broad” regulatory oversight over any derivatives products listed by designated contract markets.
• He mentioned how five contract markets currently listed futures and options contracts for Bitcoin and Ethereum products and indicated that the CFTC currently lacked regulatory authority over cash markets.
• He noted however that the CFTC did possess anti-fraud, false reporting, and anti-manipulation enforcement authority over commodity cash markets in interstate commerce.
  • He testified that the CFTC had brought more than 50 enforcement actions since 2014 involving digital assets and indicated that the CFTC had filed 25 enforcement actions that have included digital asset-related allegations within the previous 18 months.

Dr. Christopher Brummer (Georgetown University Law Center):

• He remarked that the U.S. would need to revisit long standing assumptions regarding market infrastructures for digital assets, as well as adapt its regulatory system for these assets in “creative” ways.
• He stated that deeming digital assets as either commodities or securities would not resolve the disclosure challenges within the digital assets space.
  • He noted how commodities were subject to grading and quality requirements and how spot commodities were not automatically subject to any particular disclosure regime.
• He also contended that U.S. securities laws were simultaneously underinclusive and overinclusive and highlighted how these laws demanded disclosure on corporate board governance (but not on blockchain governance).
  • He further asserted that U.S. securities laws were premised on the idea of disclosures being filed and not read.
• He remarked that the ultimate regulator in charge of overseeing digital assets would need to proactively work to identify and address potential problems.
  • He also commented that this regulator would require auditors of blockchain source code and better delivery systems for information.
• He contended that while both the SEC and the CFTC could oversee the digital assets space, he stated that each regulator had its own strengths.
• He highlighted how the CFTC did have significant experience in substantively regulating digital asset infrastructure.
• He also stated that the CFTC had gained expertise in overseeing the institutionalization of significant infrastructures intersecting directly with spot markets for digital asset commodities.
  • He asserted that the SEC’s expertise in this area was more limited and commented that this expertise mainly involved oversight of Bitcoin futures exchange-traded funds (ETFs).
• He remarked however that the SEC had more experience with maintaining disclosure regimes as compared with the CFTC.
  • He also highlighted how the SEC had significantly more resources than the CFTC.
• He then noted that while the policy debate surrounding digital assets had brought attention to the issue of financial inclusion for underserved populations, he asserted that this debate should focus on ensuring that these communities could meaningfully participate in wealth generation opportunities (rather than on specific asset classes).
  • He further stated that the narrow focus of digital assets as investments diverted attention away from exploring whether there existed parts of the technology stacks underlying these assets that could be leveraged to promote economic opportunities for underserved Americans.

Mr. Jonathan Levin (Chainalysis, Inc.):

• He remarked that the internet had not provided equitable economic opportunities to all people globally and asserted that the cryptocurrency industry could create such global economic opportunities.
  • He commented that the entrepreneurial dynamism present in cryptocurrencies enabled innovators and builders to create universal access to financial products that better serve consumers and their data.
• He stated that cryptocurrency technology could support the U.S.’s global competitiveness in the coming decades.
• He remarked that the transparent nature of blockchains enhanced the ability of policymakers and government agencies to detect, disrupt, and ultimately deter illicit activity and abuse within cryptocurrency markets.
• He noted how examinations of blockchains enabled policymakers and government agencies to gain insights into entire criminal networks behind illicit activity.
  • He commented that such examinations were much harder to conduct in traditional criminal financial investigations.
• He remarked that cryptocurrency technology could be used for both positive and negative purposes and contended that the U.S. was in a unique position to mitigate the risks associated with this technology.
• He stated that the transparency enabled through cryptocurrencies provides unique insights into cryptocurrency markets, including an understanding of market risks.
  • He commented that there existed a “great deal” of data and information available to government agencies looking to understand the cryptocurrency space.
• He discussed how his company, Chainalysis, and other similar blockchain analytics companies surveilled and obtained insights from blockchain transactions and stated that there also existed off-chain data that could provide insight into market manipulation trends.
• He remarked that the U.S. should aim to create a stable and regulated market for digital assets that would provide asset-referenced cryptocurrency prices for the world.
  • He also asserted that the clarification of cryptocurrency market regulator responsibilities would support the U.S.’s global leadership within the digital assets space.

Mr. Charles Hoskinson (Input Output Global):

• He noted that while the growth of the blockchain industry yielded significant opportunities (including infrastructure security, metaverses, and non-fungible tokens (NFTs), he remarked that this growth also presents new challenges and amplifies existing problems.
  • He elaborated that legacy systems cannot handle the rapid movement of value without counterparty risk and require centralized middlemen.
• He stated that current regulatory tools, risk management systems, and oversight processes were never designed for such speed, scale, and rapid evolution.
  • He highlighted how the blockchain industry had evolved to encompass concepts like initial public offerings (IPOs), intellectual property (IP), and decentralized autonomous organizations (DAOs).
• He remarked that the U.S.’s global dominance had traditionally rested upon its financial services, technology companies, and manufacturing capabilities.
• He asserted that these industries were “rapidly” transforming under the demands of globalization, increased competition, new technologies, and demands for environmental, social, and governance (ESG) considerations.
• He stated that the blockchain industry’s technology was fundamentally focused on creating distributed ledgers to store information that needs to be transparent, auditable, time-stamped, and immutable.
  • He commented that this process enabled records of social and economic concerns to be reliable and programmable.
• He discussed how he had to deal with numerous records as a rancher and stated that the lack of digitization and fragmentation of these records resulted in inefficiencies and replications of work.
  • He asserted that the digitization of these records could enable entrepreneurs and innovators to build new products and services that would reduce costs and improve efficiencies for all stakeholders.
• He remarked that blockchain technology’s power came from its universality and permissionless model for innovation and noted how his company, Input Output, had never needed to pay a royalty, file a patent application, or acquire a license to engage in business in foreign countries.
• He asserted that categories-based regulation that was jurisdiction-based and that relied upon centralized actors for reporting and disclosure was unlikely to be effective within the blockchain context.
• He contended that the U.S. should take a principles-based approach to regulating digital assets given the rapid nature of innovation within the blockchain space.
  • He commented that blockchains enabled the liquidity of value, thought, and commerce at an unprecedented and unknowable scale and speed.
• He stated that the U.S. digital assets policy should focus on identifying the risks that would be guarded against, determining fundamental rights for consumers, and making use of tools for “the greatest possible good.”
  • He further asserted that the U.S. should focus on measuring decentralization, information asymmetries, data accessibility, and access rather than determining the appropriate jurisdictional bodies and asset categorizations.

Congressional Question Period:

Subcommittee Chairman Sean Patrick Maloney (D-NY):

• Chairman Maloney asked Dr. Brummer to indicate whether the CFTC should have direct statutory authority to regulate cash markets.
  • Dr. Brummer remarked that the CFTC was capable of regulating cash markets so long as it was properly financed and resourced. He also asserted that all regulatory agencies would need to change how they approach digital assets to account for the unique infrastructures underlying the digital assets market. He further stated that the CFTC’s disclosure capabilities would need to be bolstered if the CFTC were to become the main regulator of the digital assets market.
• Chairman Maloney asked Dr. Brummer to elaborate on his testimony’s statement that the U.S. would need to revisit its long-standing assumptions about market infrastructures embedded in securities and derivatives laws in order to provide better oversight of digital assets.
  • Dr. Brummer remarked that the disclosure system under U.S. securities law was based on an assumption that issuers exclusively possessed non-public information and that this non-public information must therefore be disclosed. He noted that while this resulted in issuers filing disclosures about their securities, he expressed doubts as to whether investors were actually reading these disclosures. He then discussed how blockchains contained material information and noted that only expert actors could make sense of this information. He elaborated that retail investors could not comprehend the source code underlying this information. He stated that this dynamic meant that the disclosure system for securities was likely ill-suited for digital assets. He suggested that the disclosure system for digital assets ought to involve more consumer protection principles and should consider how exactly the disclosures would be made to consumers.
• Chairman Maloney asked Dr. Brummer to indicate whether the CFTC was capable of regulating cash markets for digital assets.
  • Dr. Brummer remarked that the CFTC was capable of regulating cash markets for digital assets and stated that the CFTC had the most experience among government agencies in terms of dealing with these issues. He commented however that the CFTC needed to be properly resourced in order to provide such regulation.
• Chairman Maloney asked Mr. McGonagle to address whether the CFTC should have direct statutory authority to regulate cash markets.
  • Mr. McGonagle remarked that the CFTC was a markets regulator and considered how all individual market participants used CFTC-regulated markets to hedge risks or manage risk exposure. He stated that the CFTC was primarily interested in how individuals viewed a commodity or digital asset’s change in value (rather than how individuals used the commodity or digital asset).
• Chairman Maloney asked Mr. McGonagle to indicate whether digital asset spot markets differed from traditional commodity spot markets in that digital asset spot markets were more prone to speculation. He also asked Mr. McGonagle to indicate whether the CFTC was well-equipped to address such speculation.
  • Mr. McGonagle noted how there was speculative interest in commodity spot markets and indicated that this speculation often involved leverage. He remarked that the CFTC could impose disclosure obligations in regulated markets in order to facilitate customer protections. He further noted that the CFTC could impose additional safeguards to protect assets.

Subcommittee Ranking Member Michelle Fischbach (R-MN):

• Ranking Member Fischbach noted how the CFTC was often referred to as a principles-based regulator. She asked Mr. McGonagle to explain this phrase and to discuss how the CFTC had taken a principles-based approach to regulation.
  • Mr. McGonagle discussed how the CFTC maintained 23 core principles for governing designated contract markets. He noted how these core principles related to subjects like system safeguard standards, product susceptibility to manipulation, customer protections, transaction execution certainty, and minimized counterparty risk. He elaborated that the CFTC minimized counterparty risks through requiring the use of clearing organizations. He also stated that these designated contract markets were expected to engage in self-regulation to ensure that their market participants were complying with rules. He further remarked that the CFTC possessed broad enforcement authority to ensure that market participants were complying with the Commodity Exchange Act (CEA) and its regulations.
• Ranking Member Fischbach asked Mr. McGonagle to respond to the criticism that the CFTC was a permissive and “light touch” regulator.
  • Mr. McGonagle remarked that the CFTC maintained a strong enforcement program and commented that this program supported market integrity and customer protection. He mentioned how the CFTC had filed 50 cases since 2014 related to digital assets and noted how these cases involved fraud, manipulation, and illegal contracts. He stated that the CFTC employed its enforcement authority to address violations of the CEA and related regulations and worked with the U.S. Department of Justice (DoJ) on cases involving criminal violations.
• Ranking Member Fischbach then asked Mr. Hoskinson to discuss the benefits and drawbacks associated with regulating cryptocurrencies as commodities (rather than as securities).
  • Mr. Hoskinson remarked that cryptocurrencies were more fundamental in nature and did not neatly adhere to existing categories (such as currencies or commodities). He stated that the categorization of cryptocurrencies should depend on the markets that they traded on and their uses and utilities. He remarked that policymakers would need to consider their policy objectives when determining their regulatory approaches to digital assets. He elaborated that these objectives could involve sanctions compliance, consumer protection, or market stability. He called the current debate surrounding disclosure regimes for cryptocurrencies ironic given how cryptocurrencies were very transparent by nature. He recommended that policymakers be less focused on precisely categorizing the asset classes of cryptocurrencies and should be more focused on identifying their policy objectives when regulating cryptocurrencies. He noted how the cryptocurrency industry had now been in existence for more than ten years and stated that policymakers could study this history to develop a regulatory framework for digital assets. He remarked that there currently existed strong policy proposals related to digital assets and expressed optimism that policymakers could use these proposals as a basis for a compromise policy framework for digital assets.

 Full Committee Ranking Member Glenn “GT” Thompson (R-PA):

• Ranking Member Thompson mentioned how he had recently introduced the bipartisan DCEA and highlighted how the legislation would create a new registered entity, which would be known as a DCE. He commented that DCEs would be similar to existing futures exchanges and SEFs. He asked Mr. McGonagle to discuss the requirements that the CFTC currently imposed on futures exchanges and SEFs.
  • Mr. McGonagle noted how designated contract markets and SEFs were responsible for establishing SROs. He highlighted how designated contract markets and SEFs will establish trading protocols and prohibitions concerning market abuse and indicated that the SROs are tasked with enforcing these rules. He stated that these SROs also had responsibilities to the CFTC and Congress. He elaborated that these SROs needed to ensure that their trading platforms were cyber resilient and had the capacity to rollover to another trading platform to enable trading to continue in the event of a disruption.
• Ranking Member Thompson then discussed how there existed uncertainty as to whether a given digital asset constituted a commodity or a security. He asked Dr. Brummer to address whether U.S. law currently provided a clear answer as to whether a given digital asset constituted a commodity or a security.
  • Dr. Brummer asserted that U.S. law was not clear as to whether a given digital asset constituted a commodity or a security. He stated that the U.S. Supreme Court’s test for determining whether an asset was a commodity or security in SEC v. W.J. Howey Co. (known as the Howey test) was not always straightforward. He discussed how each of the prongs of the Howey test were context-based in nature and commented that this nature made it difficult to apply in certain instances. He specifically highlighted how there existed ambiguity around the test’s prong related to reliance on the efforts of others and the test’s use of the term “common enterprise.” He asserted however that all digital assets were not securities and stated that many digital assets (including certain digital assets with large market capitalizations) were commodities.
• Ranking Member Thompson noted how Dr. Brummer had asserted that the SEC and the CFTC had different strengths. He remarked that the DCEA would recognize this dynamic through providing each of the agencies with regulatory authority over certain areas of the digital assets landscape. He asked Dr. Brummer to provide additional recommendations for Congress as it worked to develop a regulatory regime for digital assets.
  • Dr. Brummer discussed how new actors would begin using blockchains as blockchain technology grows and scales. He stated that this dynamic would likely result in more complicated situations in which there were more centralized systems with opaque off chain activities. He also commented that policymakers would need to consider situations where digital markets intersect with the non-blockchain economy. He stated that the aforementioned situations would require policymakers to consider disclosure and market infrastructure policy questions.

Rep. Bobby Rush (D-IL):

• Rep. Rush discussed how cryptocurrency markets had experienced significant volatility in recent months, including a “meltdown” in recent weeks. He expressed concerns that the cryptocurrency industry did not adequately disclose its risks and volatility because such disclosures might impede the industry’s efforts to attract new investments. He commented that these transparency concerns applied to both cryptocurrency exchanges and certain digital assets, including stablecoins. He raised concerns that the failure to provide disclosures around stablecoins could lead to stablecoin failures, which could in turn pose risks to the broader market. He further raised concerns over the energy consumption involved in cryptocurrency mining and stated that this energy consumption might lead to blackouts in certain areas. He lastly expressed concerns over the growing political power of cryptocurrency companies and warned that the cryptocurrency industry could achieve regulatory capture. He then expressed interest in working to ensure that traditionally underserved communities (such as those in his Congressional District) could partake in blockchain technology-enabled wealth creation opportunities. He asked Dr. Brummer to discuss how the U.S. could ensure that the cryptocurrency industry would not exploit vulnerable and overlooked communities.
  • Dr. Brummer remarked that complexity in financial instruments presented the opportunity for vulnerability and stated that regulators would need to reconsider disclosure requirements in light of this complexity. He also asserted that the cryptocurrency industry would need to obtain input from a more diverse set of stakeholders as it scaled. He remarked that increased adoption and familiarity of cryptocurrencies by consumers and policymakers would lead to more practical use cases and better policies.

Rep. Troy Balderson (R-OH):

• Rep. Balderson remarked that most stakeholders that he had met with believed that the CFTC was the best-positioned agency to oversee digital asset spot markets. He asked Mr. McGonagle to answer whether the CFTC was well-suited to oversee digital asset spot markets. He also asked the witnesses to identify the authorities that the CFTC would need in order to regulate these spot markets.
  • Mr. McGonagle remarked that the current trading of digital assets in the cash markets strongly reassembled the trading of digital assets as derivatives. He discussed how the CFTC had a “comprehensive oversight” with respect to applications for contract markets, compliance for contract markets, and surveillance for activities on contract markets. He asserted that all of these aspects related to digital asset spot market trading. He then highlighted how the CFTC had received statutory authority to oversee SEFs under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). He recounted how the CFTC had engaged in an extensive public comment process to implement Dodd-Frank’s SEF provisions and stated that this experience would help to inform any future oversight of digital assets.
  • Mr. Hoskinson remarked that commodities were intrinsically decentralized. He noted how people could grow, extract, and sell commodities without requiring permission and that these commodities were sold into regulated marketplaces. He asserted that the decentralized nature of cryptocurrencies suggested that cryptocurrencies ought to be regulated like commodities. He also stated that the U.S.’s regulatory approach to cryptocurrencies would need to account for cartels, market manipulation, and anti-competitive behavior from foreign governments. He recommended that the U.S. focus on defining decentralization over the next 12 to 24 months and commented that this definition would inform whether digital assets should be regulated as either commodities or securities.

Rep. Angie Craig (D-MN):

• Rep. Craig asked Mr. McGonagle to discuss how federal regulation of cryptocurrency trading platforms under the CEA was ultimately related to market transparency. She also asked McGonagle to address how this regulation would ensure that retail investors had access to necessary information so that they could evaluate cryptocurrency risks.
  • Mr. McGonagle expressed the CFTC’s interest in ensuring that market participants (particularly retail investors) were cognizant of the risks associated with trading using leverage. He remarked that the CFTC was focused on both market integrity and intermediary oversight. He stated that the CFTC’s intermediary oversight system focused on retail market participants and provided these participants with disclosures regarding trading strategies, fees, and customer protections. He concluded that the CFTC’s regulatory regime considered both execution certainty and customer protection.
• Rep. Craig asked Mr. McGonagle to indicate whether the CFTC had the capacity and the expertise to assume additional regulatory responsibilities within the digital assets space.
  • Mr. McGonagle remarked that the CFTC possessed the “intellectual expertise” to oversee the digital assets space. He mentioned how the CFTC currently was responsible for implementing and ensuring regulatory compliance with new market participants seeking designation as contract markets. He stated that the CFTC could take this skill set and apply it to the digital assets space. He remarked however that the CFTC would need to make a resource determination based on the number of applicants and the scope of its responsibility. He highlighted how CFTC Chairman Rostin Behnam had initiated an effort to accurately quantify the resources that would be needed in the event that Congress granted the CFTC with additional authority to oversee the digital assets space.
• Rep. Craig then asked Dr. Brummer to provide an assessment of whether the CFTC’s principles-based approach was compatible with the dynamic nature of digital assets space.
  • Dr. Brummer remarked that the CFTC’s regulatory framework enabled it to exercise oversight over designated contract markets at a granular level while also leveraging the self-regulatory capabilities of these markets. He asserted that this dynamic would help the CFTC to keep pace with the constantly evolving digital assets space and commented that the CFTC’s rulemaking in this space would need to be “very agile.”

Rep. Kat Cammack (R-FL):

• Rep. Cammack highlighted how the CFTC has been regulating cryptocurrency derivatives since 2014 and had exercised its anti-fraud and anti-manipulation enforcement authority over digital asset spot markets. She asked Dr. Brummer to confirm that several CFTC-registered exchanges currently allowed for retail traders to directly access exchanges without a broker.
  • Dr. Brummer confirmed that there were CFTC-registered exchanges that allowed for retail traders to directly access exchanges without a broker.
• Rep. Cammack asked Dr. Brummer and Mr. McGonagle to indicate whether federal regulation of cryptocurrency exchanges under the CEA would lead to higher baseline standards for reporting requirements and investor protections relative to current state-based money transmitter licensing regimes.
  • Mr. McGonagle remarked that the CFTC’s regulation of cryptocurrency exchanges would establish baseline standards for reporting requirements and investor protections. He stated however that the CFTC’s regulatory regime was fundamentally different from state money transmitter licensing regimes. He emphasized that the CFTC maintained a system for managing risk.
  • Dr. Brummer expressed agreement with Mr. McGonagle that state money transmitter licenses had different purposes than CFTC regulation. He acknowledged that there did exist some overlap with state money transmitter licenses and CFTC regulation.
• Rep. Cammack asked Mr. McGonagle to address how the CFTC’s expertise and experience regulating complex derivatives markets would translate to cryptocurrency markets.
  • Mr. McGonagle remarked that the CFTC provided an opportunity for multiple market participants to come together to execute transactions in a venue with price transparency. He also mentioned how the CFTC maintained rules governing how customers would enter their transactions on the market through intermediaries. He elaborated that retail market customers that used intermediaries received additional protections, including risk disclosures and the segregation and protection of their assets. He noted that these transactions ultimately went to a clearing facility and commented that the centralization of clearing facilities would minimize the risk currently present in spot platforms with counterparty exposure.
• Rep. Cammack then mentioned how the CFTC had been working “closely” with the SEC on exchange regulations within the cryptocurrency space. She asked Mr. McGonagle to provide the Subcommittee with an update on this collaboration between the CFTC and the SEC. She also asked Mr. McGonagle to indicate whether there existed any concerns or gaps in the current conversations between the two regulatory agencies that still needed to be addressed.
  • Mr. McGonagle remarked that the CFTC and the SEC had a longstanding relationship regarding enforcement issues and regulatory matters. He stated that the conversations between the two regulatory agencies were “always productive” and that the two agencies worked together on areas where they had overlapping jurisdictions. He indicated that the CFTC currently did not have regulatory authority over digital assets.

Rep. Ann Kuster (D-NH):

• Rep. Kuster highlighted how the value of Bitcoin had fallen sharply in recent weeks and stated that the U.S. needed to ensure that digital asset markets were operating above board and securely. She further stated that the U.S. needed to ensure that digital asset investors had access to necessary information so that they could fully understand the risks that they are assuming. She asked Mr. Levin to address whether risky cryptocurrency exchanges were prevalent. She commented that risky cryptocurrency exchanges included those that lacked Know Your Customer (KYC) rules, possessed ties to criminal actors, and were connected to the dark web.
  • Mr. Levin discussed how Chainalysis focused on mapping all of the different participants that actually facilitate transactions in cryptocurrencies. He mentioned how illicit actors had used exchanges in offshore jurisdictions to launder the proceeds of their illicit activities (such as ransomware). He noted how OFAC had taken actions to designate certain cryptocurrency exchanges as facilitators of illicit activity. He stated that policymakers ought to consider ways to appropriately equip a market regulator to oversee the venues that form the reference prices for digital asset commodities and to ensure the orderly functioning of markets. He also highlighted how the U.S. Department of the Treasury had taken actions to enforce AML rules internationally.
• Rep. Kuster then noted how the CFTC had brought more than 50 enforcement actions against digital asset markets since 2014. She indicated that these enforcement actions related to issues like fraud, manipulation, and false reporting. She asked Mr. McGonagle to discuss the CFTC’s investigation process and to indicate whether the CFTC required more authority and/or financial support from Congress in order to strengthen the agency’s enforcement role.
  • Mr. McGonagle remarked that the CFTC had “very broad and strong” enforcement authority. He noted how the CFTC’s anti-fraud and anti-manipulation authority extended into the physical markets. He mentioned how the CFTC had brought enforcement cases involving entities that failed to register with the CFTC and that violated AML provisions. He further noted how the CFTC looked into issues of fraud relating to illegal contracts.
• Rep. Kuster asked Mr. McGonagle to discuss the emerging trends in illicit activity related to digital assets.
  • Mr. McGonagle remarked that the use of leverage within the digital assets space was a “significant risk concern” for the CFTC. He also noted that while digital assets might not be the subject of a given fraud, he indicated that digital assets might serve as the payment mechanism for the fraud. He commented that digital assets were often used in foreign exchange (forex) fraud schemes.

Rep. Austin Scott (R-GA):

• Rep. Scott noted how there existed approximately 20,000 cryptocurrencies globally that were worth around $3 trillion in total. He asked Mr. McGonagle to indicate how many people currently worked at the CFTC.
  • Mr. McGonagle stated that “several hundred” people currently worked at the CFTC.
• Rep. Scott asserted that it would be impossible for the CFTC to regulate all of the outstanding cryptocurrencies given their limited staff and other responsibilities. He asked the witnesses to address how the U.S. ought to determine which cryptocurrencies it would regulate given current resource constraints.
  • Mr. Hoskinson remarked that cryptocurrency regulation could become algorithmic. He noted how cryptocurrency transactions carried metadata and identity and stated that policymakers could use this information to block the settlements of transactions that did not meet certain conditions. He also remarked that technologists could create self-certification systems for most types of cryptocurrencies. He stated that the CFTC and other regulatory agencies could be brought in to address anomalous situations involving cryptocurrencies.
• Rep. Scott commented that self-certification was different from agency regulation.
  • Mr. Hoskinson remarked that self-certification and agency regulation were interconnected. He noted how SROs and private organizations were currently responsible for financial regulation in many instances. He highlighted how banks were responsible for most of the compliance work involving AML and KYC requirements. He remarked that the U.S. would need to establish parameters for the relationships between regulatory agencies and private organizations, which would enable innovators to support these regulatory efforts.
• Rep. Scott asserted that the U.S. could not regulate all of the cryptocurrencies in existence and stated that the U.S. would need to rely upon a self-certification system in order to oversee cryptocurrencies. He then stated that cryptocurrencies should not compose a significant portion of the portfolios of average investors. He expressed concerns that regulation of cryptocurrencies might lead investors to falsely perceive cryptocurrencies as more stable and secure. He commented that this false perception could result in unnecessary risks to investors.

Rep. Randy Feenstra (R-IA):

• Rep. Feenstra asked Mr. McGonagle to indicate whether the CFTC would require new authority from Congress to promulgate additional cryptocurrency-specific requirements if the CFTC were to be given primary regulatory authority over digital asset trading platforms.
  • Mr. McGonagle answered affirmatively. He noted how the CFTC currently maintained a system of core principles for overseeing designated contract markets and SEFs. He highlighted how the CFTC had engaged in an “extensive” public comment process to develop rules around SEFs and their clearing processes.
• Rep. Feenstra asked Mr. McGonagle to indicate whether the maturation of a digital asset and its underlying network had the potential to remove security-like characteristics over time.
  • Mr. McGonagle remarked that digital assets were broadly defined to be commodities. He noted however that the SEC could determine a digital asset to be a security, which would bring the digital asset outside of the SEC’s jurisdiction. He stated that there did not currently exist a framework that would enable such a digital asset to return to the CFTC’s jurisdiction as it matured.
• Rep. Feenstra asked Mr. McGonagle to indicate whether the CFTC’s experience with swaps had any parallels to the current digital assets situation.
  • Mr. McGonagle stated that the CFTC and the SEC had coordinated in their efforts to oversee different parts of the swaps market. He noted how the two regulatory agencies had worked together on swaps rules that impacted both of their jurisdictions.
• Rep. Feenstra asked Mr. McGonagle to address how the notion of “fully decentralized” be defined or determined. He also asked Mr. McGonagle to identify when such a determination should be made. He further asked Mr. McGonagle to suggest a process for making such a determination.
  • Mr. McGonagle remarked that the CFTC focused more on whether a digital asset had a trading interest from multiple market participants than on whether a digital asset presented itself as decentralized. He stated that the CFTC would thus not be as interested in developing a precise definition of the term “decentralized” and more interested in determining whether the underlying asset ought to fall under the CFTC’s regulation.
• Rep. Feenstra asked Mr. McGonagle to indicate whether the CFTC would require more clarification from Congress for determining whether a given asset ought to fall under the CFTC’s jurisdiction.
  • Mr. McGonagle remarked that Congressional clarification of the CFTC’s jurisdiction would be appropriate. He noted that digital assets were currently viewed as commodities.

Rep. Michael Cloud (R-TX):

• Rep. Cloud remarked that one of the main appeals of cryptocurrencies was its absence of intermediaries. He asked the witnesses to identify the market failures that cryptocurrencies were meant to address and to discuss how cryptocurrency regulation could be narrowly tailored to address these specific market failures.
  • Mr. McGonagle remarked that cryptocurrency exchanges could only certify digital asset products that adhered to certain core principles. He highlighted that one of these core principles involved ensuring that a digital asset product was not readily susceptible to manipulation. He stated that the U.S.’s regulatory approach sought to identify which parties were interested in trading a given digital asset product and the reason for this interest. He elaborated that this interest was key to determining whether the digital asset would have sufficient liquidity that would enable the trading of risk. He remarked that the U.S.’s current regulatory approach enabled it to winnow out activity or contracts that failed to provide a market value.
  • Mr. Hoskinson remarked that no entities were adequately ensuring compliance with KYC and AML requirements and commented that no one wanted to be a data broker. He then remarked that private companies (particularly large technology companies) were obtaining power and control over “foundational resources.” He stated that cryptocurrencies and the blockchain industry sought to decentralize this control of such resources away from private companies.
• Rep. Cloud interjected to note how Mr. Hoskinson had previously suggested that algorithms could be used to support the U.S.’s regulatory efforts. He stated that large technology companies were currently employing algorithms to engage in nefarious activities and raised concerns that the U.S. government’s use of algorithms could eventually encroach on the privacy rights of Americans. He asked Mr. Hoskinson to address how the U.S. could remain globally competitive within the digital assets space without undermining the privacy rights of Americans.
  • Mr. Hoskinson expressed agreement with Rep. Cloud’s concerns. He remarked that any U.S. government algorithms ought to be built out in an open source process and stated that people ought to opt-in to having their data used in these algorithms (rather than having people proactively opt-out of having their data used in the algorithms). He asserted that the U.S. ought to work to preserve the benefits stemming from the decentralized nature of digital assets.