The Future of Digital Assets: Identifying the Regulatory Gaps in Digital Asset Market Structure (U.S. House Committee on Financial Services, Subcommittee on Digital Assets, Financial Technology, and Inclusion)

Hearing	The Future of Digital Assets: Identifying the Regulatory Gaps in Digital Asset Market Structure
Committee	U.S. House Committee on Financial Services, Subcommittee on Digital Assets, Financial Technology, and Inclusion
Date	April 27, 2023

 

Hearing Takeaways:

• Regulatory and Legal Uncertainty for Digital Assets: Subcommittee Republicans, some Subcommittee Democrats, Ms. Belcher, Mr. Gorfine, Mr. Rivera, and Mr. Zweihorn argued that the U.S. is not providing sufficient regulatory and legal certainty for digital asset firms and users. Subcommittee Ranking Member Stephen Lynch (D-MA) and Ms. Allen argued however that the digital assets industry is claiming that there is regulatory and legal uncertainty so that Congress will establish more favorable regulatory regime for digital assets.
  • U.S. Securities and Exchange Commission (SEC) Digital Asset Enforcement Actions: Subcommittee Chairman French Hill (R-AR), Rep. Erin Houchin (R-IN), Mr. Grofine, and Mr. Zweihorn expressed concerns that the SEC is pursuing enforcement cases against digital asset firms without providing clear guidance as to what is legal. They stated that this approach does not foster legal certainty for the digital assets industry. Full Committee Ranking Member Maxine Waters (D-CA), Subcommittee Ranking Member Lynch and Ms. Allen asserted however that the SEC’s 100 percent success rate in pursuing these enforcement cases against digital asset firms indicates that the SEC’s actions are warranted. They also stated how the decisions stemming from these enforcement cases provide digital asset stakeholders with clear guidance.
  • SEC Digital Asset Guidance: Rep. John Rose (R-TN), Rep. Houchin, Mr. Rivera, and Mr. Zweihorn argued that the guidances that the SEC has thus far released on the application of federal securities laws to digital assets, including their 2019 Strategic Hub for Innovation and Financial Technology (FinHub) guidance, have been unclear. They requested that the SEC provide additional guidance on this subject. Subcommittee Ranking Member Lynch and Ms. Allen argued however that the SEC has provided multiple guidances to the digital assets industry as to whether digital assets constitute securities under the test established in the U.S. Supreme Court’s SEC v. W.J. Howey Co. decision (known as the Howey test). Subcommittee Ranking Member Lynch, Rep. Brad Sherman (D-CA) and Ms. Allen called on Congress to provide the SEC with the authority to oversee all cryptocurrencies.
  • Impact on the U.S.’s International Competitiveness and Innovation: Subcommittee Republicans, some Subcommittee Democrats, Ms. Belcher, and Mr. Rivera expressed concerns that the U.S.’s lack of regulatory and legal clarity for digital assets is driving digital assets activity outside of the U.S.’s jurisdiction. They warned that this trend will reduce the U.S.’s international competitive and innovation, as well as leave U.S. consumers vulnerable to bad actors in less regulated jurisdictions. Rep. Sherman and Ms. Allen however questioned the merits of having the U.S. become a global leader in digital assets given how digital assets can be used to evade know your customer (KYC) and anti-money laundering (AML) laws.
• Existing Laws, Rules, and Issues for Digital Assets: The hearing also examined the current laws and rules that govern the digital assets space, as well as some policy issues impacting the space.
  • U.S. Securities Laws: Subcommittee Ranking Member Stephen Lynch (D-MA) and Ms. Allen argued that digital asset firms can comply with existing securities laws. They noted that these laws require the segregation of customer funds, establish capital standards, create customer protections, impose KYC rules, and provide compliance, transparency, and disclosure standards. Mr. Zweihorn remarked however that U.S. securities laws and rules had been developed to regulate heavily intermediated structures and commented that these laws and rules effectively require intermediation if an asset is a security. He stated that this expectation of intermediation for new innovations might not be practical or beneficial for investors.
  • SEC Registration: A key area of contention during the hearing involved the feasibility of having digital asset firms register with the SEC. Rep. Erin Houchin (R-IN), Rep. Ritchie Torres (D-NY) and Mr. Zweihorn argued that SEC registration is impractical for many digital asset firms and suggested that the SEC is purposefully making this registration process difficult. Rep. Houchin asserted that current SEC rules discourage registration because digital assets are less likely to be listed on trading platforms if they are classified as securities. Subcommittee Ranking Member Lynch stated however that many cryptocurrency intermediaries are likely refusing to register with the SEC because they know that they could not adhere to the relevant requirements. 
  • U.S. Commodities Laws: Mr. Gorfine discussed how the U.S. Commodity Futures Trading Commission’s (CFTC) jurisdiction over digital assets had been established in 2015 when it had determined that Bitcoin met the definition of a commodity. He noted however that the CFTC has limited jurisdiction over spot commodity markets and only has authority to police for fraud and manipulation. He highlighted how this authority is “backward looking” and invoked only when wrongdoing is suspected. He stated that while the CFTC has some experience overseeing the digital assets market, he asserted that the CFTC might require additional resources to oversee the digital assets space if Congress were to provide it with more responsibility.
  • State Regulatory Systems and Money Transmitter Licenses: Subcommittee Chairman French Hill (R-AR), Rep. Torres, and Mr. Gorfine discussed how states currently play a key role in overseeing the digital assets space. They noted how some states have used their money transmitter license systems to oversee this space. Subcommittee Chairman Hill argued that money transmitter licenses are insufficient for overseeing digital assets.
  • Custody Services for Digital Assets: Subcommittee Vice Chairman Warren Davidson (R-OH), Rep. Mike Flood (R-NE), Rep. Wiley Nickel (D-NC), Mr. Rivera, and Mr. Zweihorn expressed concerns that recent proposed rules and guidances from the SEC make it legally and economically infeasible for either banks or broker-dealers to provide custody services for digital assets. They specifically raised concerns over how the SEC’s February 2023 proposed Enhanced Safeguarding Rule for Registered Investment Advisers (RIAs) and March 2022 Staff Accounting Bulletin No. 121 (SAB 121) will impact the availability of custody services for digital assets.
  • Clearing Services for Digital Assets: Rep. Flood and Mr. Zweihorn expressed concerns that the current clearing model (which requires a clearing agency to clear and settle trades) does not make sense for digital assets that operate on blockchains. They stated that if a digital asset firm (such as a digital asset trading platform) holds all of its digital assets itself so that it can provide real-time recordkeeping for every trade, then a separate clearing agency might add unnecessary intermediation.
  • The European Union’s (EU) Transfer of Funds Regulation (TFR): Vice Chairman Vice Chairman Davidson raised concerns that the EU’s TFR will impose strict KYC requirements for digital asset transfers. Mr. Rivera remarked that the EU is attempting to clarify the Financial Action Task Force’s (FATF) Travel Rule through its TFR. He commented that while the EU’s TFR is not perfect, he stated that this Rule is beneficial in limiting its applications to institutions. He also stated that the EU’s TFR seeks to protect the privacy of individuals wishing to self-custody their digital assets.
  • Artificial Intelligence (AI) Blockchain Applications: Rep. John Rose (R-TN) expressed interest in AI applications for blockchain technology. Mr. Rivera discussed how the AI industry remains very nascent and is rapidly growing. He predicted that AI-linked crypto projects will result in very useful innovations and that policymakers should focus on regulating entities that are currently understood.
• Potential Digital Assets Policy Reforms: Subcommittee Republicans, some Subcommittee Democrats, Ms. Belcher, Mr. Gorfine, Mr. Rivera, and Mr. Zweihorn called on Congress and regulators to pursue new policies that would provide more legal and regulatory clarity for the digital assets space. Full Committee Ranking Member Maxine Waters (D-CA), Subcommittee Ranking Member Stephen Lynch (D-MA), and Ms. Allen contended however that the U.S. does not need to create a new and special legal framework for digital assets and stated that cryptocurrency firms should instead comply with existing laws. Ms. Allen further warned that a bespoke cryptocurrency regulatory regime would constitute a “massive regulatory loophole” for the financial services system.
  • Classification of Digital Assets: Subcommittee Vice Chairman Warren Davidson (R-OH), Rep. William Timmons (R-SC), Rep. Ritchie Torres (D-NY), Rep. Erin Houchin (R-IN), Mr. Rivera, and Mr. Zweihorn expressed interest in developing legislation to clarify how digital assets are classified. They elaborated that legislation could provide guidance as to whether digital assets should be considered securities, commodities, or another type of asset. Rep. Timmons and Mr. Rivera added that legislation could clarify when a digital asset becomes sufficiently decentralized to change its asset type.
  • Digital Asset Disclosures: Subcommittee Chairman French Hill (R-AR), Rep. Torres, and Mr. Zweihorn called on the U.S. to adopt a disclosure regime for digital assets that is tailored to the unique characteristics of digital assets. Subcommittee Ranking Member Lynch and Ms. Allen argued that digital asset firms should be held to the same disclosure standards as traditional financial firms.
  • Treatment of Non-Financial Digital Assets: Subcommittee Chairman Hill, Rep. Torres, Ms. Belcher, Mr. Gorfine, and Mr. Zweihorn expressed interest in providing regulatory and legal certainty to digital assets that are not financial in nature. They stated that digital assets can encompass a broad array of items beyond securities and commodities, including digital collectables and tokens. They argued that applying traditional financial regulatory frameworks to non-financial digital assets might make it impossible to use these assets for their intended purposes. Ms. Allen expressed concerns however that the establishment of a bespoke cryptocurrency regulatory regime would lead many financial services firms to tokenize their assets so that they can evade traditional financial services laws and regulations.
  • Treatment of Illegal Materials on Decentralized Networks: Rep. Bill Foster (D-IL) expressed concerns that decentralized networks may be used to host illegal information and stated that policymakers must consider developing a process for removing such illegal information from decentralized networks. Ms. Belcher testified that the Filecoin network has content moderation tools that are built on top of its network. She indicated that the Filecoin network’s content moderation system would adjudicate claims on its network.
  • Proposals to Tie Identity Information to Digital Asset Transactions: Rep. Foster also expressed interest in requiring cryptocurrency wallets to have a unique identifier that can remain anonymous unless an alleged crime has been committed. He stated that law enforcement agencies should be able to obtain warrants to unlock the identity behind the wallets when they believe illicit activity is occurring. He asserted that this capability is key to combating wash trades and other market abuses within the cryptocurrency space. Mr. Rivera stated however that technology is being developed to prevent wash trades within the cryptocurrency space.

Hearing Witnesses:

1. Ms. Marta Belcher, President and Chair, Filecoin Foundation
2.  Mr. Daniel Gorfine, Founder & CEO, Gattaca Horizons, LLC; Adjunct Professor of Law, Georgetown University; former Chief Innovation Officer, U.S. Commodity Futures Trading Commission
3. Mr. Joshua Rivera, General Counsel, Blockchain Capital
4. Mr. Zachary Zweihorn, Partner, Davis Polk
5. Ms. Hillary Allen, Professor of Law, American University Washington College of Law

Member Opening Statements:

Subcommittee Chairman French Hill (R-AR):

• He mentioned how the Subcommittee’s hearing is being held simultaneously with a U.S. House Committee on Agriculture hearing on digital assets.
  • He further indicated that the U.S. House Committee on Financial Services and the U.S. House Committee on Agriculture will be holding a joint-hearing next month to further explore digital asset issues.
• He then remarked that the SEC and the CFTC have created an “impossible situation” where firms are subject to competing enforcement actions from both regulatory agencies.
  • He asserted that these regulators are causing entrepreneurs, developers, and job creators to move outside of the U.S.’s jurisdiction.
• He stated that there exist “glaring” gaps in consumer and investor protections around digital assets and argued that a “regulation by enforcement” approach fails to address these gaps.
  • He also contended that money transmitter licenses are insufficient for addressing these regulatory gaps.
• He then discussed how the SEC and the CFTC disagree about the asset type classifications of many digital assets and called this situation “unworkable” for entrepreneurs and consumers.
  • He asserted that these agencies need direction from Congress on how to classify digital assets.
• He also stated that the U.S.’s current disclosure regime for digital assets does not produce information that a reasonable consumer would need to know when considering the purchase of a given digital asset.
  • He commented that the information that is relevant to a purchaser of a digital asset is different from the information that is relevant to an investor involved in the stock of a public company.
• He further expressed interest in exploring whether digital asset trading platforms perfectly fit under existing laws and regulations and the rules applicable to these platforms.

Subcommittee Ranking Member Stephen Lynch (D-MA):

• He raised concerns that the hearing might perpetuate the digital asset industry’s preferred narrative that digital assets technology is incompatible with existing laws and regulations.
  • He asserted that the business models of digital asset technology companies are often incompatible with existing laws.
• He noted how the digital asset industry often claims that it lacks regulatory clarity and that the unique nature of digital assets necessitates the creation of a special regulatory regime.
• He remarked that the U.S. maintains a comprehensive and longstanding framework of securities laws and rules designed to protect investors, promote market integrity, and facilitate capital formation.
  • He expressed agreement with SEC Chairman Gary Gensler’s assertion that most digital assets constitute securities and should be regulated as such.
• He noted how SEC Chairman Gary Gensler has called for cryptocurrency intermediaries to register with the SEC and has warned that the failure of these intermediaries to pursue such registration could subject them to enforcement actions.
  • He commented that many cryptocurrency intermediaries are likely refusing to register with the SEC because they know that they cannot adhere to the relevant requirements.
• He remarked that U.S. securities laws are key to protecting investors and markets.
  • He emphasized that these laws require the segregation of customer funds, establish capital standards, provide customer protections, impose KYC rules, and provide compliance, transparency, and disclosure standards.
• He stated that several cryptocurrency firms are engaging in litigation against the SEC to avoid compliance with the SEC’s policies.
  • He noted how these firms have argued that they lack guidance from the SEC regarding their digital asset products.
• He contended that much of the current criticism of the SEC from the digital asset industry and Congressional Republicans is conflicting.
  • He commented that some critics allege that the SEC has not provided enough guidance to the digital asset industry while other critics allege that the SEC is pursuing too many rulemaking and enforcement actions.
• He called it unnecessary for the U.S. to reinvent digital asset rules when the U.S. already maintains an effective regulatory regime for digital assets.
  • He argued that the U.S. could “easily” become the global leader in digital assets if the U.S. were to require digital asset companies to comply with existing securities laws.

Full Committee Chairman Patrick McHenry (R-NC):

• He asserted that digital assets are not a fad and stated that the U.S.’s failure to provide legal clarity for digital assets has harmed market participants and consumers.
  • He called on the U.S. to create a regulatory environment for digital assets that supports responsible innovation and responsible consumer protection.
• He warned that Congress’s failure to address digital assets will cause other countries to become the leaders in digital asset technology.
  • He noted how the EU and the United Kingdom (UK) have more advanced regulatory frameworks for digital assets than the U.S. has.

Full Committee Ranking Member Maxine Waters (D-CA):

• She mentioned how SEC Chairman Gary Gensler had recently told the Committee that the SEC has the necessary authorities to bring cryptocurrency companies and exchanges into compliance with U.S. securities laws.
  • She commented that the SEC’s previous litigation success supports SEC Chairman Gary Gensler’s claim.
• She stated that the U.S. does not need to create a new and special legal framework for digital assets and contended that cryptocurrency firms must comply with existing laws.
• She remarked that Congress should focus on addressing gaps in U.S. securities laws, such as limitations on the SEC’s ability to address overseas activities.

Witness Opening Statements:

Ms. Marta Belcher (Filecoin Foundation):

• She remarked that cryptocurrencies have purposes beyond finance and stated that cryptocurrencies are supporting improvements to the internet and providing alternatives to large technology companies.
  • She also mentioned that cryptocurrency technology is preserving some of the world’s most important information, including government data, evidence of human rights abuses, and scientific data sets.
• She discussed how the internet is currently very centralized and noted how three companies (Amazon, Microsoft, and Google) store most online data.
  • She commented that this situation creates single points of failure and that blackouts at these companies can cause large parts of the internet to go down for hours.
• She also stated that Americans must trust these three companies with their data and that these companies have unilateral control over internet activities and speech.
• She remarked that cryptocurrencies provide an alternative to these companies and explained that cryptocurrencies enable the instant transfer of value across the internet without intermediaries when a condition is met. 
  • She posited an example in which cryptocurrencies could enable a computer program in which a music listener could automatically pay a music creator based on how much of the creator’s music had been listened to.
• She discussed how her foundation’s cryptocurrency, Filecoin, uses programmable money to create a decentralized file storage network.
  • She explained that the Filecoin network allows users to rent out their excess storage space to other users.
• She stated that the Filecoin token enables the network to operate in a manner that is peer-to-peer, instant, automatic, and trustless.
  • She commented that Filecoin gives its users an alternative to the incumbent large companies and allows for users to store multiple copies of their files so that their files will remain accessible in the event of device failure.
• She indicated that there are thousands of individuals and small businesses serving as Filecoin storage providers and testified that these storage providers are contributing over 15 billion gigabytes of capacity to the Filecoin network.
  • She highlighted how the Filecoin network is storing copies of open datasets created by the U.S. National Aeronautics and Space Administration (NASA), the U.S. National Institutes of Health (NIH), and the U.S. National Weather Service (NWS).
• She stated that Filecoin is important for government documents because it can address the problem of “link rot,” which refers to how many important links will become inactive over time.
• She highlighted how researchers and organizations are already using the Filecoin network to support their activities.
  • She mentioned how human rights organizations are leveraging the Filecoin network to collect, verify, and preserve data.
  • She also mentioned the Filecoin network stores important scientific information, including genomic, satellite, and climate datasets.
  • She further testified that the Filecoin Foundation is working with Lockheed Martin on a satellite launch to demonstrate how the technology underlying Filecoin can speed up communications in space.
• She remarked that cryptocurrencies have applications beyond financial services and warned that regulating cryptocurrencies like financial services can undermine these practical applications.
  • She asserted that regulations that insert intermediaries and add friction are incompatible with cryptocurrency-related technologies.
• She called it critical for cryptocurrency regulations to protect the ability of users to transact directly with each other and to recognize the open source and decentralized nature of cryptocurrency technologies.
  • She also asserted that the U.S. must recognize the free speech protections associated with computer code.
• She further stated that the U.S. must provide clarity, safe harbors, and compliance on ramps so that cryptocurrency innovators can continue to operate within the U.S.

Mr. Daniel Gorfine (Gattaca Horizons, LLC; Georgetown University; former Chief Innovation Officer, U.S. Commodity Futures Trading Commission):

• He remarked that the fundamental regulatory landscape for digital assets in the U.S. (especially at the federal level) has not changed significantly since the inception of Bitcoin in 2009.
  • He noted that the current regulatory landscape for digital assets remains one where spot digital commodity trading activity is largely regulated at the state level.
• He highlighted how spot market digital commodity exchanges are not subject to comprehensive federal market oversight and supervision.
  • He indicated that Congress would need to provide new and explicit authorization for these exchanges to be subject to federal market oversight and supervision.
• He mentioned how the U.S. Financial Crimes Enforcement Network (FinCEN) had determined in 2013 that digital asset exchanges are money service businesses.
• He noted how many states have used this FinCEN determination to require these exchanges to pursue money transmitter licenses.
  • He indicated that some states have taken additional actions to create tailored regulatory frameworks for cryptocurrencies and highlighted New York’s BitLicense Program as an example of this.
• He commented that while state regulatory frameworks for digital assets do impose meaningful requirements on cryptocurrency intermediaries, he emphasized that these frameworks do not uniformly impose the same types of market and trading oversight as is common with federal market regulation.
  • He noted that state money transmitter regulation typically does not impose market surveillance requirements intended to detect fraudulent or manipulative trading activity (such as wash trading and spoofing).
• He also discussed how the CFTC, the SEC, and federal banking regulators apply their respective rules to digital assets and intermediaries.
  • He indicated that the CFTC’s jurisdiction over digital assets had been established in 2015 when it had determined that Bitcoin met the definition of a commodity.
• He noted however that the CFTC’s jurisdiction over spot commodity markets is “quite limited” and indicated that the CFTC only has authority to police for fraud and manipulation.
  • He highlighted how this authority is “backward looking” and invoked only when wrongdoing is suspected.
• He emphasized that the CFTC’s authority does not constitute oversight authority, which entails rulemaking and the registration and regular examination of intermediaries.
  • He noted however that the CFTC does have oversight authority over derivatives products that might be predicated on an underlying commodity.
  • He indicated that involved intermediaries are subject to CFTC requirements, including with respect to registration, trade surveillance, and customer education requirements.
• He discussed how the CFTC has overseen well-regulated, robust, and transparent Bitcoin futures and options markets since 2018.
  • He explained that these products had been offered under the CFTC’s tailored heightened review framework in order to address unique digital commodity characteristics.
  • He indicated that these unique characteristics include their high degree of retail participation and their unique custody considerations.
• He stated that the CFTC has established the basis for differential treatment of digital commodities and ensured that Americans have access to well-regulated markets.
  • He asserted that this outcome is “far preferable” to having investors lured to offshore illegal derivatives exchanges that are prone to fraud and financial crime.
• He then discussed how the SEC has “broadly” asserted its enforcement authority and has suggested that many cryptocurrencies constitute securities.
• He stated that while many of the SEC’s enforcement actions had targeted clear cases of an issuer selling tokens to raise capital or defraud investors, he asserted that there remains a lack of clarity for determining when an asset is a security.
  • He commented that this ambiguity has implications since market participants and regulators may struggle with determining which rules apply.
• He mentioned that while some states (such as New York) have developed mature regulatory frameworks for digital assets, he noted how there do not exist any market regulators overseeing spot digital commodity markets.
• He explained that the CFTC is a principles-based regulator by statute that aims to deter and prevent price manipulation, uphold market integrity, protect market participants, and promote responsible authority.
  • He indicated that the CFTC would need specific statutory authority to oversee spot digital asset commodity markets.
• He also called it necessary for federal courts, regulators, and/or Congress to increase definitional clarity for when a digital asset token constitutes a security.

Mr. Joshua Rivera (Blockchain Capital):

• He remarked that the blockchain industry wants to work with Congress and regulators to develop appropriate market structure regulation for addressing the novel challenges and opportunities that digital asset technology presents.
• He discussed how the current financial system is overly reliant on centralized intermediaries and stated that this overreliance constrains innovation.
  • He asserted that the U.S. consumer credit rating system demonstrates the problems associated with overly intermediated value systems and commented that this system can be ineffective and poses immense privacy and security concerns.
• He stated that intermediaries do not just harm legacy financial systems and asserted that social media companies and content platforms have leveraged the free and instantaneous transfer of data to monopolize participation and value creation.
  • He commented that these companies and platforms are commoditizing their own users and preventing actual content creators from realizing more value from their created content.
• He remarked that blockchain technology creates alternative solutions to the services and infrastructure controlled by incumbent intermediaries.
• He discussed how blockchain networks can be accessed anywhere in the world by anyone with an internet connection.
  • He noted how these networks enable participants to transfer any amount of value to virtually any location in the world on a 24/7 basis.
  • He added that these value transfers have instantaneous settlements and much lower costs for participants.
• He stated that the fundamental innovation of blockchain networks is to permit parties to participate in commerce or other systems of value without an intermediary.
• He remarked that there exists a false perception that participants, investors, and founders in the digital asset industry do not wish to be regulated.
  • He testified that many digital asset industry participants (including himself) have sought for years to engage with federal regulators on establishing clear and workable rules for digital assets.
• He asserted that digital asset rulemaking efforts have not come early or often enough and stated that these efforts have been made with almost no meaningful industry engagement.
  • He commented that this has resulted in unworkable rule proposals in terms of their technical implementation and policy outcomes.
• He mentioned how PitchBook had found that the share of venture capital funding for blockchain technology startup companies in the EU had surpassed the funding allocation for blockchain technology startup companies in the U.S. in the first quarter of 2023.
  • He warned that this development might signal a “potentially devastating” outcome and called on the Subcommittee to work to rectify this development.
• He asserted that the U.S. must work to ensure that digital asset technology improvements will develop domestically (rather than abroad).

Mr. Zachary Zweihorn (Davis Polk):

• He remarked that his clients have faced challenges navigating the digital assets landscape due to regulatory uncertainty and some “legal dead ends.”
  • He stated that there remains significant debate surrounding how to determine whether a given digital asset constitutes a security and called on Congress to clarify this issue.
• He noted that if a digital asset constitutes a security, then the initial sale of the digital asset is subject to registration requirements and the secondary trading of that asset must occur through a web of registered and regulated market intermediaries.
  • He indicated that these registered and regulated market intermediaries include brokers, dealers, exchanges, transfer agents, and clearing agencies.
• He contended that that it is currently impractical for digital asset trading platforms to register with the SEC and noted how registration requires these platforms to prove that their activities will comply with existing laws and rules.
  • He stated that these existing laws and rules had been designed for traditional securities (such as debt and equity) and cannot be easily applied to novel digital assets.
• He mentioned how a registered exchange under current law and rules can generally only facilitate trading in a security if that security is registered.
  • He also noted how broker-dealers are similarly prohibited from facilitating trading in a security unless the issuer has taken steps to register the security or make certain disclosures.
• He stated that this situation results in a “Catch 22” in that intermediaries must register with the SEC to facilitate trading and that this registration prohibits the intermediary from facilitating trading unless a third-party issuer has taken further steps and actions.
• He also discussed how centralized trading platforms require someone to hold securities for investors.
  • He asserted however that SEC accounting and custody guidance has made it legally and economically infeasible for either banks or broker-dealers to provide custody services for digital assets.
  • He stated that this situation means that a firm that has pursued registration with the SEC cannot facilitate the trading of digital assets because there is no one that can provide custody for digital assets.
• He remarked that there would need to exist a litany of exemptions or new SEC guidance to enable digital asset securities to register with the SEC.
• He then discussed how differences in market structures raise unnecessary legal challenges for digital assets and noted how digital asset trading platforms enable end-users to trade directly on their platforms.
  • He indicated that digital asset trading platforms maintain custody of the user’s digital assets, match buyers and sellers, and settle transactions.
  • He indicated that traditional securities markets by contrast involve separate firms providing exchange, brokerage services, and clearing.
• He stated that U.S. securities laws and rules had been developed to regulate heavily intermediated structures and commented that these laws and rules effectively require intermediation if an asset is a security.
  • He commented that this expectation of intermediation for new innovations might not be practical or beneficial for investors.
• He remarked that the SEC’s enforcement actions against digital asset firms are merely enforcing federal securities laws and asserted that Congress is better positioned to reform the U.S.’s regulatory regime for digital assets.

Ms. Hillary Allen (American University Washington College of Law):

• She cautioned the Subcommittee against pursuing digital asset legislative proposals that would weaken consumer protections.
• She mentioned how the U.S. had recently experienced the failure of several digital asset companies (including Celsius, FTX, and Terra Luna) and asserted that these failures share several similarities with securities failures throughout U.S. history.
  • She commented that the existence of blockchain technology does nothing to change the economic incentives of those deploying the technology.
  • She added that these incentives have remained stable throughout the 90-year history of federal securities law.
• She emphasized that technological decentralization is very different from decentralized economic control.
  • She explained that a system can have a large number of nodes and that a single party controlling many of these nodes will result in the single party controlling the system.
• She disputed the assertion that the cryptocurrency markets are decentralized and stated that these markets often have significant concentrations of economic power.
• She then contended that blockchain technology companies can comply with existing investor protection and financial stability regulations.
  • She commented however that this compliance might be incompatible with the business models of these companies.
• She stated that existing financial laws and rules are already well-suited to address the harms associated with cryptocurrency company business models and called on the U.S. to maintain these existing laws and rules.
  • She warned that bespoke cryptocurrency legislation could create a market for business models that lack enough utility to survive on their own.
• She recommended that Congress provide increased funding and political support for the SEC’s enforcement activities and SEC’s securities registration and broker-dealer registration requirements.

Congressional Question Period:

Subcommittee Chairman French Hill (R-AR):

• Chairman Hill noted how U.S. investors had lost $5.5 trillion between March 2000 and October 2002 because of insider trading, despite the U.S. maintaining a robust regulatory framework for policing insider trading activity. He also mentioned how Silicon Valley Bank had recently experienced a failure, despite being subject to robust federal regulations. He remarked that the Subcommittee is working to develop a regulatory framework for digital assets that is tailored to this particular asset class and that does not undercut consumer and investor protections. He then discussed how there are some digital assets, such as digital collectables and tokens connected to activities, that are distinguishable from securities and commodities. He stated that these digital assets should be categorized separately from securities and commodities and asserted that the U.S.’s existing regulatory framework for digital assets fails to address these assets. He asked Mr. Gorfine to indicate whether there exists a third category of digital assets that needs its own oversight and regulatory framework.
  • Mr. Gorfine remarked that the term “digital asset” is problematic because it is too broad. He asserted that there exist more than three categories of digital assets. He stated that any asset can be effectively tokenized and that the ownership interest of the assets can be separately tokenized. He commented that many assets might therefore fall outside of the legal definitions of securities or commodities.
• Chairman Hill posited a scenario where a video game company provides their investors with tokens that can be used in their soon-to-be-released video games. He commented that the value of these in-game tokens will depend largely on the popularity of the video games. He asked Mr. Gorfine to indicate whether the in-game tokens in this proposed scenario should be considered securities or something else.
  • Mr. Gorfine remarked that Congress might need to provide clarity for how a given asset can change its asset type over time.
• Chairman Hill interjected to posit another scenario in which a musical raises money from investors. He indicated that the investors in this scenario will receive 25 tickets to the musical (in addition to their returns from the musical itself). He stated that the musical in this scenario is clearly a security. He asked Mr. Gorfine to indicate whether the tickets that the investors receive in this scenario should be considered securities.
  • Mr. Gorfine commented that the 25 tickets in Chairman Hill’s scenario appear to be a perk that is separate from the investment in the musical.
• Chairman Hill interjected to express agreement with Mr. Gorfine’s answer. He also stated that these tickets would have no value if the musical is not successful. He remarked that Congress must work to clarify definitions for digital assets.

Subcommittee Ranking Member Stephen Lynch (D-MA):

• Ranking Member Lynch noted how the SEC had first warned investors about the dangers of investing in cryptocurrencies in 2013 through an Office of Investor Education and Advocacy investor alert. He also noted how this Office had issued a 2014 investor alert regarding Bitcoin and other virtual currency-related investments. He further noted how the SEC had published its Framework for “Investment Contract” Analysis of Digital Asset in 2019, which provides clarity on when digital assets constitute securities. He added that the SEC has brought 130 enforcement actions against cryptocurrency firms for the marketing of securities without the provision of the necessary disclosures, audited financial statements, or investor protections. He highlighted how the SEC has been successful in all of these enforcement actions. He noted that these cases involved written judicial and regulatory decisions and commented that these decisions provide clear and unambiguous guidance to the cryptocurrency industry. He asked Ms. Allen to respond to the claims that the cryptocurrency industry has not received policy clarity from the SEC regarding whether digital assets constitute securities.
  • Ms. Allen remarked that the SEC has provided the cryptocurrency industry with clear guidance on whether digital assets constitute securities. She noted how the U.S. Supreme Court’s SEC v. W.J. Howey Co. decision had established a test for determining whether an asset constitutes a security. She commented that this test seeks to protect people who have invested their money in a common enterprise with the expectation of profits to come predominantly from the efforts of others. She asserted that most cryptocurrency investments should satisfy the criteria of the Howey Test for constituting securities. She stated however that Congress could provide even more certainty for cryptocurrencies through passing legislation to explicitly define cryptocurrencies as securities under both the Securities Act of 1933 and the Securities Exchange Act of 1934.
• Ranking Member Lynch the mentioned how there has been assertions made during the hearing that anything can be tokenized.  He posited a scenario in which there existed a separate regulatory regime for non-security and non-commodity digital assets that did not contain disclosure requirements and prohibitions on the co-mingling of funds. He asked Ms. Allen to address how this separate regulatory regime for non-security and non-commodity digital assets would impact the traditional financial system. He commented that traditional financial firms would be subject to more robust regulations under this scenario.
  • Ms. Allen remarked that a bespoke cryptocurrency regulatory regime would constitute a “massive regulatory loophole” for the financial services system. She stated that it is very easy to tokenize assets and put them on blockchains. She warned that the establishment of a bespoke cryptocurrency regulatory regime would lead many financial services firms to tokenize their assets so that they can evade traditional financial services laws and regulations.
• Ranking Member Lynch then stated that many cryptocurrency firms do not provide audited financial information and financial disclosures to investors. He asked Ms. Allen to indicate whether holding cryptocurrency firms to the same standards as traditional financial firms would help to protect retail cryptocurrency investors.
  • Ms. Allen remarked that the U.S. must protect retail cryptocurrency investors and not provide special regulatory treatment to cryptocurrencies. She stated that applying existing registration requirements, broker-dealer regulations, and exchange regulations to cryptocurrency firms would protect customers from potential conflicts of interest.

Rep. John Rose (R-TN):

• Rep. Rose discussed how there exist AI linked blockchain products, including payment systems, trading models, machine generated non-fungible tokens (NFTs), and blockchain-based marketplaces for AI applications. He asked Mr. Rivera to discuss the unique regulatory gaps created by AI-linked crypto projects.
  • Mr. Rivera discussed how the AI industry remains very nascent and is rapidly growing. He testified that Blockchain Capital is closely examining AI applications for cryptocurrencies and commented that the regulation of these applications will be “extremely important.” He stated however that policymakers should focus on regulating entities that they already understand, such as financial intermediaries, exchanges, and custodians. He also stated that policymakers should work to ensure that this regulation is focused so that it does not unintentionally stifle innovation. He predicted that AI-linked crypto projects will result in very useful innovations and reiterated that policymakers should focus on regulating entities that are currently understood.
• Rep. Rose then noted how SEC Chairman Gary Gensler has insisted that the legal status of digital assets depends on “individual facts and circumstances.” He also noted how SEC Chairman Gary Gensler has stated that digital asset projects should engage with the SEC on identifying a path toward regulatory compliance. He indicated that only four digital asset projects have been able to achieve regulatory compliance as defined by the SEC. He asked Mr. Gorfine to discuss whether the CFTC provides a path for digital asset exchanges to achieve regulatory compliance with the Agency.
  • Mr. Gorfine first noted how the CFTC does not directly regulate spot commodities and indicated that exchanges that engage in spot trading activities do not register with the CFTC. He stated however that the CFTC has registered and oversees various digital asset exchanges that offer Bitcoin and/or Ether futures and option products. He indicated that these products may be either physically settled or fast settled. He stated that the CFTC thus oversees a robust and well-regulated marketplace where registrants are able to offer Bitcoin and Ether futures and option products.
• Rep. Rose then mentioned how SEC Chairman Gary Gensler has stated in August 2021 that the SEC requires additional authorities to prevent transactions, products, and platforms from “falling between regulatory cracks.” He noted however that SEC Chairman Gensler had stated in December 2022 that the SEC possesses sufficient authority to oversee the digital assets space. He then mentioned that SEC Chairman Gensler had stated in May 2021 that there did not exist a market regulator for cryptocurrency exchanges. He noted however that SEC Chairman Gensler had stated in December 2022 that cryptocurrency exchanges could come into compliance with the SEC through working with the Agency. He asked Mr. Zweihorn to indicate whether these comments from SEC Chairman Gensler provide regulatory clarity and promote stability in digital asset markets.
  • Mr. Zweihorn remarked that SEC Chairman Gary Gensler’s comments can mean many different things depending on whether SEC Chairman Gensler is referring to a digital asset that is a security. He highlighted how the SEC does not regulate Bitcoin or Bitcoin exchanges. He noted however that SEC Chairman Gensler believes that many digital assets constitute securities and are thus subject to SEC regulation. He commented that there exists a lack of clarity around which digital assets constitute securities.
• Rep. Rose then noted how SEC Commissioner Hester Peirce has stated that the SEC has been reluctant to provide additional guidance for determining whether a token is being sold as part of a securities offering or which tokens are securities. He asked Mr. Rivera to indicate whether additional regulatory guidance from the SEC on the status of digital assets be helpful.
  • Mr. Rivera answered affirmatively. He noted how the blockchain industry has long requested additional guidance from the SEC on this topic.

Rep. Bill Foster (D-IL):

• Rep. Foster asked Ms. Belcher to discuss how Filecoin addresses issues of anonymity and censorship. He posited a scenario in which a person has stolen secrets about nuclear weapons and posted these secrets on the Filecoin network. He asked Ms. Belcher to indicate whether the Filecoin Foundation can identify the thief in this scenario and take down the secrets from the Filecoin network.
  • Ms. Belcher stated that Filecoin is an open-source technology and indicated that many parties are building tools on top of this network.
• Rep. Foster interjected to asked Ms. Belcher to indicate whether the Filecoin Foundation has the capability to identify parties that post illegal information on their network and remove the illegal information.
  • Ms. Belcher testified that Filecoin has content moderation tools that are built on top of the Filecoin network.
• Rep. Foster interjected to posit a scenario where a party disputes the removal of information from the Filecoin network. He asked Ms. Belcher to address whether this type of dispute can be resolved through the court system.
  • Ms. Belcher stated that Filecoin’s content moderation system would adjudicate claims on the Filecoin network.
• Rep. Foster interjected to ask Ms. Belcher to indicate whether any court system could serve as the ultimate arbiter of disputes regarding the removal of material from the Filecoin network.
  • Ms. Belcher stated that the Filecoin network follows the same rules for addressing content moderation issues as other protocols (such as Facebook).
• Rep. Foster asked Ms. Belcher to identify the jurisdiction that the Filecoin network is registered in.
  • Ms. Belcher stated that there is no registration for content moderation. She indicated that parties requesting the removal of material from the Filecoin network can make their request to any node or storage provider. She also noted how the Filecoin network has tools that provide for decentralized content moderation.
• Rep. Foster commented that policymakers must consider the process for removing illegal information from decentralized networks as part of future legislation on the topic. He then mentioned how there are estimates that more than half of all Bitcoin transactions are fraudulent. He indicated that many of these fraudulent Bitcoin transactions involve wash trades. He asked Mr. Gorfine to address how there can exist a well-regulated market for Bitcoin futures when the majority of the transactions in the underlying assets are fraudulent.
  • Mr. Gorfine noted how the CFTC had permitted the self-certification of Bitcoin futures under a heightened review framework. He indicated that this framework requires derivatives exchanges to have information sharing agreements with the underlying exchanges being used to support the derivatives.
• Rep. Foster noted how many trades do not take place on underlying exchanges. He asked Mr. Gorfine to explain how derivatives exchanges can determine whether wash trades are occurring.
  • Mr. Gorfine first indicated that the underlying exchanges that participate in information sharing with derivatives exchanges are U.S.-based exchanges participating in the index formation. He then noted how there is no federal market supervision of spot trading activity. He commented that this situation constitutes a regulatory gap.
• Rep. Foster stated that derivatives trading requires users to have a Trader ID and indicated that this Trader ID system enables market regulators to know the true identities of the market participants involved in trades. He commented that this system enables market regulators to identify wash trades and other market abuses. He asked Mr. Gorfine to confirm that this Trader ID system is not present within the Bitcoin trading space.
  • Mr. Gorfine confirmed that Bitcoin trading does not use the Trader ID system. He stated that Bitcoin trading is similar to other commodities trading (such as precious metals and gold-based futures). He elaborated that spot markets tend to operate differently from regulated markets. He stated however that digital commodities have interesting characteristics around trading activity and retail-facing nature that can warrant additional surveillance.
• Rep. Foster interjected to contend that cryptocurrency wallets ought to require a unique identifier that can remain anonymous unless an alleged crime has been committed. He stated that the U.S. must work to prevent wash trades and other market abuses within the digital asset trading space. He asked Mr. Rivera to indicate whether the U.S. must have a regulator that can observe the true identities of market participants involved in cryptocurrency transactions.
  • Mr. Rivera stated that cryptocurrency networks are extremely transparent and that federal regulators can observe these networks.
• Rep. Foster interjected to note that there do exist cryptocurrency networks (such as Monero) that seek to obscure the true identities of their network participants. He asked Mr. Rivera to indicate whether it is possible to prevent wash trades within the cryptocurrency space without having a regulator that knows the true identities of market participants.
  • Mr. Rivera stated that technology is being developed to prevent wash trades within the cryptocurrency space.
• Rep. Foster interjected to ask the witnesses to indicate whether there currently exists technology that can prevent wash trading and other market abuses and that does not require regulators to see the true identities involved in cryptocurrency transactions. He acknowledged that his question period time had expired and asked the witnesses to provide their responses to this question for the hearing’s record.

Subcommittee Vice Chairman Warren Davidson (R-OH):

• Vice Chairman Davidson remarked that he has been working to provide regulatory clarity for digital assets since joining the Committee in 2017 and lamented the U.S.’s lack of progress on this issue. He disputed the assertion that digital assets are only meant for illicit purposes and stated that there exist legitimate use cases for digital assets. He then raised concerns that Bitcoin opponents are attempting to make the asset account-based. He asserted that these opponents do not trust people in their ability to custody their own digital assets. He highlighted how the EU had recently passed the Markets in Crypto-Assets (MiCA) regulation and commented that this regulation provides the EU with a more advanced regulatory framework for digital assets than the U.S. He also mentioned how the EU had passed their TFR, which imposes strict KYC requirements whenever more than 1,000 Euros is transferred between self-custodied cryptocurrency wallets. He called this regulation “dystopian.” He asked Mr. Rivera to address how the U.S. could promote decentralized finance (DeFi) systems without permitting the systems to be decentralized.
  • Mr. Rivera remarked that the EU is attempting to clarify FATF’s Travel Rule through its TFR. He commented that while the EU’s TFR is not perfect, he stated that this Rule is beneficial in limiting its applications to institutions. He also stated that the EU’s TFR seeks to protect the privacy of individuals wishing to self-custody their digital assets. He explained that the objective of the EU’s TFR is to allow individuals to participate in decentralized systems without having to divulge personal information about themselves and their financial activities. He indicated that this Rule pursues this goal while still regulating financial institutions that send personal information. He expressed uncertainty as to how the EU’s TFR will be implemented given the fact that it had just been passed. He asserted however that this Rule does appear to be beneficial thus far on a net basis.
• Vice Chairman Davidson called Mr. Rivera’s description of the EU’s TFR encouraging. He commented that the EU’s TFR appears to be narrower in scope than he had previously believed (at least in intent). He then mentioned how he had developed the Token Taxonomy Act to provide a “bright line test” for determining the asset type of a given digital asset. He also noted how the legislation had sought to address custody issues within the digital asset space. He highlighted how digital assets have a real time 24/7 permissionless peer-to-peer transaction capability. He asked the witnesses to discuss the importance of custody for market structures.
  • Mr. Rivera remarked that custody for market structures is “extremely important.” He called it important to understand the differences between traditional custody (which is paper and ledger based and relies upon intermediaries) and digital asset custody (which relies upon a decentralized blockchain). He stated that digital asset custodians must have “incredible” technical expertise to ensure protection of client funds. He indicated that this technical expertise has been developed over the previous decade.
• Vice Chairman Davidson asked Mr. Rivera to indicate whether it is possible for multiple people to have custody of the same thing at the same time.
  • Mr. Rivera answered no. He stated however that someone can gain access to funds in the same way that someone could steal funds from a bank.
• Vice Chairman Davidson stated that custody rules could address market problems involving asymmetries and naked short selling in derivatives contracts.

Rep. Ritchie Torres (D-NY):

• Rep. Torres stated that if the U.S. continues to drive cryptocurrency activity offshore, then there will exist more companies that are not subject to U.S. laws and rules. He asserted that it would therefore be beneficial for the U.S. to provide cryptocurrency companies with a “workable but rigorous” regulatory regime. He commented that such a regime would promote consumer and investor protections. He remarked that his state of New York had created a rigorous regulatory regime for cryptocurrencies that did not threaten the functioning of securities laws. He stated that if Congress elects to adapt its existing legal frameworks to digital assets, then Congress must develop a framework for classifying digital assets as securities, commodities, or another type of asset. He noted that digital assets that qualify as securities can trigger SEC registration requirements and described these requirements as unworkable in their current form. He noted that very few blockchain businesses have been able to successfully register with the SEC. He asked Mr. Zweihorn to address how Congress can best tailor the SEC’s registration process to accommodate blockchain technology without compromising investor protections.
  • Mr. Zweihorn remarked that his blockchain legal clients (and most blockchain industry stakeholders) do not believe that blockchain technology should go unregulated or receive less regulatory oversight. He stated that the blockchain industry instead desires tailored regulations. He commented that many securities laws and policies are not designed for the unique characteristics of digital assets. He noted how digital asset white papers tend to be much shorter and contain less information than traditional investor prospectuses. He noted however that these digital asset white papers tend to provide information not found in traditional investor prospectuses because digital asset purchasers have interests in other types of information that is not demanded from the SEC.
• Rep. Torres noted how SEC Chairman Gary Gensler has indicated that the SEC has previously tailored its disclosure requirements to accommodate the particular needs of certain industries. He asserted that providing a tailored disclosure regime for digital asset firms would therefore have precedent.
  • Mr. Zweihorn interjected to confirm that that the SEC has particularized disclosure regimes for certain assets. He also noted that the SEC has not provided a particularized disclosure regime for digital asset securities.
• Rep. Torres then stated that the SEC is statutorily designed to be a merit neutral regulator. He raised concerns however that regulators might still have antipathy toward cryptocurrencies and attempt to make it impractical for cryptocurrency firms to operate within the U.S. He asked the witnesses to address how the U.S. could ensure that the SEC is a merit neutral regulator. He also asked the witnesses to address how the U.S. could prevent the SEC from using its registration process to punish or sabotage politically disfavored industries.
  • Mr. Zweihorn noted how the SEC is required to implement federal securities laws as written. He stated that Congress could require that the SEC adopt a registration pathway for digital asset firms that would be functional and possible to comply with.
• Rep. Torres then noted how there is a difference between regulating financial activity and regulating the technology that underlies the financial activity. He asked the witnesses to address how policymakers should approach this difference when developing a regulatory framework for digital assets.
  • Mr. Zweihorn noted how digital assets can encompass a broad array of items, including car titles, home titles, NFTs, securities, and commodities. He stated that the U.S. can regulate items based on the risks that the items pose. He asserted that the U.S. will therefore need to differentiate how different types of digital assets are being used as part of its regulatory approach.
• Note: Rep. Torres’s question period time expired here.

Rep. William Timmons (R-SC):

• Rep. Timmons remarked that the U.S. Supreme Court could not have fathomed digital assets when it had rendered its decision in SEC v. W.J. Howey Co. in 1946. He called it “absurd” that the future of digital assets will be decided using the “archaic” Howey test. He asked Mr. Zweihorn to address whether there exist any other types of classification frameworks for digital assets beyond the Howey Test.
  • Mr. Zweihorn mentioned how the U.S. Supreme Court had considered whether a share of stock in a residential housing cooperative (co-op) should constitute a security in United Housing Foundation, Inc. v. Forman. He noted that the U.S. Supreme Court had found that a residential housing co-op has a functional purpose (i.e., a person can live in the co-op) and that this functional purpose means that the share of stock in this co-op should not constitute a security. He stated that there remains debate surrounding whether digital assets are solely investments or have functional purposes.
• Rep. Timmons asked Mr. Zweihorn to provide recommendations for the development of a brand new test for classifying digital assets.
  • Mr. Zweihorn stated that it is difficult to classify assets that have multiple purposes. He provided the example of Filecoin, which can be used for purchasing storage space and for speculation purposes. He commented however that many traditional assets (such as gold and properties) can be used for both utility and investment purposes. He suggested that policymakers establish a threshold for utility that can be used to help determine whether a given asset constitutes a security.
• Rep. Timmons then asked Mr. Rivera to discuss the need for the U.S. to define when a digital asset is or has become sufficiently decentralized to no longer be considered a security under the Howey test.
  • Mr. Rivera remarked that Congress will need to develop principles-based legislation that will enable regulators to make determinations regarding different types of digital assets. He stated that the SEC will still need to consider facts and circumstances when making such determinations. He elaborated that regulators will need to understand the ways in which digital assets are used and the level of economic and technical decentralization in digital asset networks.
• Rep. Timmons then mentioned how he had met with several companies that are using blockchain technology to improve the speed of business-to-business processes in the financial services space. He commented that these companies could potentially realize significant efficiencies and cost savings through using blockchain technology. He asked Ms. Belcher to indicate whether Congress could impede these blockchain technology innovations through failing to consider innovative blockchain technology use cases when developing market structure legislation.
  • Ms. Belcher answered affirmatively. She stated that Filecoin is just one of many blockchain protocols that are enabling businesses of all sizes to thrive. She mentioned how many of Filecoin’s storage providers are U.S. small businesses. She highlighted how Lucky Storage had converted a former Lucky Strike tobacco factory in North Carolina into a data storage facility. He stated that Lucky Storage is just one of thousands of storage providers on just one cryptocurrency network. She further discussed how many business-to-business applications have been built on top of the Filecoin network and indicated that these applications are small businesses themselves. She highlighted how Audius is one such application and explained that Audius provides compensation to artists based on how much of their music has been streamed. She remarked that Congress should not impede these blockchain innovations.
• Rep. Timmons lastly asked Ms. Belcher to indicate whether blockchain technology can deliver on blockchain industry’s promise of efficiency, decentralization, and financial inclusion.
  • Ms. Belcher answered affirmatively. She recounted how blockchain technology had enabled Ukraine to quickly receive donations following their invasion by Russia.

Rep. Brad Sherman (D-CA):

• Rep. Sherman mentioned how tens of billions of dollars have been transferred to Ukraine using traditional currencies. He also noted how Russia has been able to evade U.S. sanctions through cryptocurrencies. He then discussed how many cryptocurrency advocates have argued that the U.S.’s failure to embrace cryptocurrencies could lead other countries to become the global leaders in this space. He asserted however that the U.S. should not strive to become the global leader in the cryptocurrency space given the dangers associated with these assets. He stated that the cryptocurrency industry desires regulatory gaps because these gaps enable the industry to evade federal KYC and AML statutes. He also asserted that many cryptocurrency investors are attempting to indirectly profit from the tendency of other cryptocurrency users to engage in illicit activities. He then noted how former FTX CEO Sam Bankman-Fried had sought to prevent the SEC from regulating cryptocurrencies and to have the CFTC regulate cryptocurrencies. He contended that CFTC regulation of cryptocurrencies would be much weaker than SEC regulation of cryptocurrencies. He argued that the SEC should oversee the cryptocurrency space. He further asserted that the cryptocurrency industry has outsized political influence and stated that the cryptocurrency industry is powerful because its business involves creating new money. He then discussed how the U.S. taxes capital gains at a lower rate than ordinary income as a way to encourage people to make investments. He asked Ms. Allen to provide justifications for why gains from cryptocurrency investments should receive preferential tax treatment.
  • Ms. Allen stated that a blockchain is simply a database without a centralized administrator. She asserted however that there exist economic forces that centralize control over blockchains. She stated that blockchain-based assets are thus effectively replicating existing financial assets (which have centralized control). She further asserted that blockchain technology can exacerbate the problems within traditional finance. She questioned the wisdom of developing a special regulatory framework for cryptocurrencies and extending capital gains preferential tax treatment to cryptocurrencies. She stated that traditional finance facilitates capital formation and credit allocation. She asserted however that cryptocurrencies facilitate neither of these aforementioned benefits.

Rep. Erin Houchin (R-IN):

• Rep. Houchin mentioned how the SEC’s FinHub had released 2019 guidance for how an issuer of a digital asset can determine whether their digital asset will fall under the definition of an investment contract. She noted that a digital asset found to be an investment contract would be subject to securities laws. She indicated that this 2019 guidance consists of a list of factors and subfactors that digital asset projects should consider. She asked Mr. Zweihorn to indicate whether this guidance is useful for projects in determining whether they will be classified as securities by the SEC.
  • Mr. Zweihorn remarked that the 2019 SEC FinHub guidance had provided the digital asset industry with some clarity regarding the SEC’s approach to digital assets. He also called this guidance a “good faith effort” on the part of the SEC. He stated however that this guidance has not proven that helpful to the digital asset industry. He noted how this guidance consists of over 50 factors and highlighted how none of these factors is considered determinative of an asset’s status. He commented that this guidance thus does not provide the digital asset industry with definitive answers.
• Rep. Houchin asked Mr. Zweihorn to address how a party determines how many factors a digital asset must meet under the 2019 SEC FinHub guidance for the asset to be considered a security. She also asked Mr. Zweihorn to address how a party should weigh factors against each other in this structure.
  • Mr. Zweihorn described the 2019 SEC FinHub guidance as a “rule with no lines.” He elaborated that this guidance provides the general sentiment of the SEC without providing specific details as to whether a given digital asset should be considered a security.
• Rep. Houchin asked Mr. Zweihorn to indicate whether the SEC has provided any additional guidance regarding how the SEC will determine whether a digital asset constitutes an investment contract during SEC Chairman Gary Gensler’s tenure.
  • Mr. Zweihorn testified that he was not aware of either SEC Chairman Gary Gensler or the SEC releasing any additional guidance on the asset type status of digital assets during Chairman Gensler’s current tenure at the SEC. He noted however that SEC Chairman Gensler has made public statements on digital assets before Congress and other venues. He also mentioned how the SEC has taken various enforcement actions in which the Agency had articulated its view on whether a given digital asset constitutes a security. He stated that these enforcement actions did not cite the 2019 SEC FinHub guidance for determining whether a digital asset constitutes a security. He further asserted that some recent SEC enforcement actions have been inconsistent with the 2019 SEC FinHub guidance. He elaborated that the 2019 SEC FinHub guidance calls for digital assets to be evaluated based on their current uses while some SEC enforcement actions have focused on previous uses of digital assets.
• Rep. Houchin asked Mr. Zweihorn to discuss the consequences of the SEC’s failure to provide guidance regarding whether digital assets constitute securities.
  • Mr. Zweihorn remarked that the SEC’s lack of guidance on digital assets subjects many digital asset companies (including his legal clients) to the prospect of an SEC enforcement action. He commented that these companies may seek out legal counsel and that legal counsel may still be insufficient for protecting against an SEC enforcement action.
• Rep. Houchin then remarked that the current regulatory framework for digital assets is problematic in that it creates a disincentive for digital asset projects to register as securities with the SEC. She explained that digital assets are less likely to be listed on trading platforms if they are classified as securities. She asked Mr. Zweihorn to discuss how this dynamic creates perverse incentives and to address how market structure legislation could ensure that firms are not penalized for complying with the law.
  • Mr. Zweihorn stated that many firms do not list their digital assets on exchanges because the firms do not believe that their digital assets constitute securities. He noted that digital assets deemed to be securities cannot be listed on exchanges not registered with the SEC. He stated that firms that want liquid markets for their digital assets will need to ensure that their digital assets do not constitute securities. He remarked that market structure legislation should create a viable market structure that enables digital asset securities to be listed on exchanges. He also stated that this legislation should create a market structure where non-security digital assets can be traded on exchanges in a manner that offers consumer protections.
• Rep. Houchin remarked that digital assets and their underlying technologies will remain an element of the U.S. financial system moving forward. She called on the U.S. to create clear rules for digital assets and to address the threat of “regulation by enforcement.”

Rep. Sean Casten (D-IL):

• Rep. Casten first remarked that blockchain technology and distributed ledger technology (DLT) can help to monetize digital assets. He noted how Ms. Belcher had discussed an application where artists could be paid based on how much of their music had been streamed and that these payments could be fractions of 1 cent. He asked Ms. Belcher to clarify whether the payments made in this music streaming application will be repaid in U.S. currency or in tokens that are separate from the U.S. dollar.
  • Ms. Belcher indicated that the payments in this music streaming application will be made in tokens that are separate from the U.S. dollar. She emphasized that these payments can be made in very small amounts.
• Rep. Casten asked Ms. Belcher to explain why the payments made in this music streaming application are made in tokens. He commented that there is limited utility in being able to rapidly settle very small transactions.
  • Ms. Belcher remarked that the use of tokens enables Filecoin network to program money so that it can be sent instantly, automatically, and globally with no intermediaries. She called it important for the Filecoin network to use a bespoke token (as opposed to a stablecoin or the traditional financial system) because this bespoke token is optimized for the Filecoin network.
• Rep. Casten stated that a token could be an invoice that is U.S. dollar-denominated. He discussed a recent New Yorker article that detailed how international regulators had hacked into the cellular phones of bad actors and uncovered “massive” financial fraud networks. He explained that these fraud networks enabled bad actors to send the serial numbers of U.S. currency to banks in other countries for redemption. He remarked that encrypted tokenization has “tremendous value” for bad actors seeking to evade KYC laws. He asked Ms. Allen to indicate whether there exist any parties within the cryptocurrency space that are tracking enough information about cryptocurrency buyers and sellers to sufficiently comply with KYC and AML laws.
  • Ms.  Allen stated that she did not know whether any parties within the cryptocurrency spare are sufficiently tracking cryptocurrency transactions. She asserted however that the cryptocurrency business model deliberately seeks to evade AML rules. She stated that blockchains are less efficient than centralized systems because blockchains require computationally expensive consensus mechanisms. She remarked that bad actors will often evade KYC and AML rules to compensate for the reduced efficiencies of blockchains.
• Rep. Casten then noted how much of the profits made within the cryptocurrency industry are concentrated amongst founders and large parties. He highlighted how many cryptocurrency advocates claim that cryptocurrencies can help to reduce the U.S.’s racial wealth gap. He noted however that the median cryptocurrency had declined by 46 percent between 2017 and 2022. He indicated that the average stock market index had risen by 56 percent during this same period. He stated that African American and Hispanic communities have disproportionately lost money in the cryptocurrency space.

Rep. Mike Flood (R-NE):

• Rep. Flood remarked that Congress must act to combat the recent “regulatory deluge” on digital assets from the SEC. He noted how many cryptocurrency firms (including Coinbase) have stated that they will move abroad if the U.S. does not provide regulatory clarity for digital assets. He called these statements understandable given the U.S.’s current regulatory environment for digital assets. He mentioned how the SEC had issued a proposed rulemaking in February 2023 that would “severely” restrict the ability of current custodians and RIAs to continue to provide custody services for digital assets. He asked Mr. Rivera to discuss the challenges associated with the SEC’s proposed rulemaking for qualified custodians and how this proposed rulemaking would impact his firm. He specifically asked Mr. Rivera to indicate how many options his firm has to custody digital assets and to indicate whether this rulemaking would reduce his firm’s options for providing custody services for digital assets.
  • Mr. Rivera testified that his firm has three digital asset custodians that it trusts. He remarked that the SEC’s February 2023 proposed rulemaking could eliminate these custodian options and commented that it is “extremely” difficult for his firm to comply with the rulemaking. He stated that this proposed rulemaking could prevent his firm from investing within the digital asset ecosystem.
• Rep. Flood then discussed how broker-dealers that work with equities typically custody securities for their customers. He noted however that there does not exist any way for a broker-dealer to directly custody customer assets under current SEC custody rules. He asked Mr. Zweihorn to describe the challenges that this current situation presents for broker-dealers within the digital assets space.
  • Mr. Zweihorn discussed how broker-dealers will typically custody securities for their investors and commented that these custody services facilitate customer trading. He noted how the SEC has its Customer Protection Rule to ensure that broker-dealers do not mishandle or steal customer assets. He mentioned that this Rule had been first adopted during the 1970s and has been subsequently amended during the ensuing decades. He indicated that this Rule does not refer to holding a cryptocurrency private key as a permissible way for broker-dealers to hold customer assets. He stated that the SEC has struggled in determining what would constitute a safe mechanism for broker-dealers to hold cryptocurrencies for customers. He mentioned how the SEC had issued time-limited guidance (which expires in three years) that would allow for broker-dealers to provide custody services if they have reasonable policies and procedures. He contended however that this time-limited guidance is unworkable because it includes other conditions that would prevent broker-dealers from engaging in additional forms of business.
• Rep. Flood then discussed the necessity of entities that ensure that trades placed by investors are ultimately settled between the buyers and sellers. He indicated that the Depository Trust & Clearing Corporation fills this clearing role for securities. He stated that the current clearing model (which requires a clearing agency to clear and settle trades) does not make sense for digital assets that operate on blockchains. He highlighted how digital asset transactions clear in real-time and commented that there is no need for a central intermediary. He noted how Mr. Zweihorn’s testimony had discussed the perils of applying the definition of clearing agency under the Securities Exchange Act of 1934 to validators and miners on a blockchain that participate in the settlement process. He asked Mr. Zweihorn to elaborate on these perils.
  • Mr. Zweihorn remarked that the definition of clearing agency under the Securities Exchange Act of 1934 is very broad. He noted that this definition includes anyone that is facilitating a settlement of a securities transaction without the physical delivery of paper security certificates. He stated that this definition makes sense for the traditional securities market. He noted how all parties within the digital asset ecosystem are facilitating the transfer of the digital asset without physical delivery, regardless of whether the digital asset is a security. He stated that if digital assets are considered securities, then the definition of clearing agency might encompass many different parties. He also stated that if a digital asset firm (such as a digital asset trading platform) holds all of its digital assets itself so that it can provide real-time recordkeeping for every trade, then a separate clearing agency might add unnecessary intermediation.
• Rep. Flood concluded that federal legislation is needed to fix the regulatory gaps within the digital assets space.

Rep. Wiley Nickel (D-NC):

• Rep. Nickel noted how Mr. Rivera had expressed concerns that the U.S.’s failure to develop a new regulatory framework for digital assets will cause domestic cryptocurrency innovation to cease. He raised concerns that the elimination of domestic cryptocurrency innovation will lead Americans to use offshore exchanges to trade cryptocurrencies. He commented that the recent failure of Bahamas-based FTX demonstrates how foreign cryptocurrency exchanges may be poorly regulated. He asked Mr. Rivera to indicate whether a decline in the number of U.S. cryptocurrency trading venues might produce new risks for U.S. consumers.
  • Mr. Rivera raised concerns that a decline in the number of U.S. cryptocurrency trading platforms might produce new risks for U.S. consumers. He attributed the decline in the number of U.S. cryptocurrency trading platforms to recent regulatory enforcement actions (particularly from the SEC). He stated that Americans interested in trading cryptocurrencies on offshore venues will likely find ways to trade on these venues. He commented that the U.S. government is less able to regulate activities on offshore cryptocurrency trading platforms than on domestic cryptocurrency trading platforms.
• Rep. Nickel then mentioned how the SEC had released SAB 121 in March 2022. He stated that SAB 121 effectively precludes banks from offering digital asset custody at scale through requiring banks to include cryptocurrencies on their balance sheets that are custodied on behalf of their clients. He called SAB 121 a “shift in historical practice” and commented that custodied assets have always been treated as off balance sheet assets. He stated that if cryptocurrency companies do not have access to safe and secure banking services, then U.S. investors will be put at risk. He asked Mr. Rivera to identify who would offer cryptocurrency custody services if banks are unable to provide the services. He also asked Mr. Rivera to indicate whether the inability of banks to provide cryptocurrency custody services could lead U.S. customers to pursue offshore custody solutions.
  • Mr. Rivera remarked that interested banks should have avenues for providing custody services for cryptocurrencies. He stated that SAB 121 effectively limits the ability of banks to offer custody services for cryptocurrencies. He commented that SAB 121 would force banks to overcollateralize the cryptocurrencies held as liabilities on their balance sheets, which would be very expensive.
• Rep. Nickel then noted how digital asset market structure legislation opponents have claimed that such legislation would only legitimize efforts to pursue illicit activities. He also noted how digital asset critics have claimed that digital assets are unnecessary and do not provide any new value to financial or technological systems. He asked Ms. Belcher to discuss Filecoin’s use cases and to address the service that it is attempting to provide.
  • Ms. Belcher stated that Filecoin is enabling hundreds of applications and use cases. He mentioned how Filecoin has human rights applications and highlighted how the Filecoin network is being used to store International Criminal Court (ICC) evidence and USC Shoah Foundation’s genocide survivor testimony archives. She also mentioned how the Filecoin network is being used to store the Prelinger Archives for rare films. She further noted how the Freedom of the Press Foundation is exploring the use of decentralized technologies to facilitate secure document exchanges between journalists and anonymous sources. She also mentioned how the Guardian Project is using blockchain technology to build a mobile application for eyewitnesses that authenticates content captured on smartphones. She then discussed how there are enterprise use cases for decentralized technologies and noted how the Decentralized Storage Alliance is currently exploring this area. She further mentioned how there are scientific and government projects that are using blockchain technology to store important information. She remarked that the Filecoin network enables the aforementioned use cases.

Rep. Byron Donalds (R-FL):

• Rep. Donalds remarked that Congress has not yet authorized the SEC, the CFTC, or other federal agencies to address cryptocurrencies. He also stated that FTX’s collapse had been the result of accounting fraud rather than digital assets. He also remarked that Russia’s military buildup and the trafficking of fentanyl should not be attributed to the use of digital assets and should instead be attributed to the failure of U.S. policymakers to directly address the issues. He contended that Americans should be free to purchase digital assets as they please. He then asked Mr. Gorfine to indicate whether the CFTC (or the U.S. government more broadly) is currently equipped to serve as a market regulator for digital assets.
  • Mr. Gorfine noted that the CFTC has experience overseeing futures, swaps, and options that are predicated on commodities. He stated that this experience provides the CFTC with a strong understanding of commodities and their underlying markets. He noted that while the CFTC currently lacks the authority to regulate spot markets, he contended that there exist unique characteristics of digital commodities that might warrant the provision of federal market supervision over these commodities.
• Rep. Donalds asked Mr. Gorfine to indicate whether the CFTC has the manpower, the technical knowledge, and the expertise needed to be an adequate regulator of digital assets.
  • Mr. Gorfine answered affirmatively. He stated however that the CFTC might require additional resources to oversee the digital assets space given the size and scope of digital commodity markets.
• Rep. Donalds then asked Mr. Zweihorn to elaborate on some of the incompatibility between the digital asset marketplace and traditional financial structure marketplaces.
  • Mr. Zweihorn noted how many digital assets have functional uses. He stated that if Filecoin is to be classified as a security, then every party that touches Filecoin will need to be regulated intermediaries (e.g., broker-dealers, registered exchanges, clearing agencies).
• Rep. Donalds interjected to assert that Filecoin should not be classified as a security.
  • Mr. Zweihorn remarked that requiring all parties using Filecoin to be regulated intermediaries would make it impossible to use Filecoin for its intended purpose. He commented that entities involved in data storage are unlikely to register with SEC and subject themselves to financial services regulation.
• Rep. Donalds lastly asked Mr. Rivera to address how Congress could ensure that any digital asset legislation would be relevant to future developments within the digital asset space.
  • Mr. Rivera remarked that Congress should develop constructive digital asset legislation that regulators could then apply to multiple digital asset use cases. He called for principles-based legislation that is bipartisan and effective.

Subcommittee Chairman French Hill (R-AR):

• Chairman Hill remarked that the U.S. needs “fit-for-purpose” regulatory tools at the SEC and the CFTC for addressing digital assets. He stated that Congress needs to address digital asset spot market oversight, registration for digital asset non-securities, and digital asset custody issues.