A Second Round of the Lummis-Gillibrand Crypto Bill Elevates CFTC, Defines DeFi

The U.S. Securities and Exchange Commission (SEC) would take a back seat in a crypto oversight bill re-launched by Sens. Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.), which would require that crypto exchanges be overseen by the Commodity Futures Trading Commission (CFTC) and all stablecoin issuers be regulated depository institutions.

The crypto industry needs the U.S. Senate if it’s going to get U.S. regulation, and this bill represents the widest-reaching effort to yet emerge from that body. Last year’s inaugural bill from the bipartisan duo failed to make significant progress, and the wishes of key figures such as Sen. Sherrod Brown (D-Ohio), the chairman of the Senate Banking Committee, remain murky this year.

The bill’s big-ticket item is the border it draws between securities oversight and everything else – the long-awaited division that would give the SEC and CFTC their crypto marching orders. Broadly, it says that assets that don’t give the investor a financial interest in a business shouldn’t be considered securities, even if they “benefit from entrepreneurial and managerial efforts that determine the value of the assets.” Those issuing cryptocurrencies would make twice-yearly disclosures to the SEC, but as long as their tokens don’t represent debt or equity or tick other ownership boxes, they’d stay outside SEC reach – unless the agency wins a court challenge also outlined in the bill.

Most of the progress so far in this legislative session has been in the House, where Republicans have been keen on a pair of bills – one to address rules of the road for stablecoins and another to define how crypto markets would be regulated. Before those recent efforts, though, Lummis and Gillibrand had carried the legislative hopes of much of the crypto industry when they’d introduced the first version of their bill in 2022, some of which found echoes in later legislation. Now the sector gets Lummis-Gillibrand 2.0, which broadly pushes in the same direction as the House proposals while taking some of its own detours.

As it stands, the bill would put most crypto tokens within the CFTC’s commodities space and would grant that agency power over crypto trading. Still, the same amount of funding would be directed to both agencies – $500 million – and they’d both have an equal hand in a new self-regulatory organization (SRO) for crypto.

Setting up such a go-between entity, like the National Futures Association or the Financial Industry Regulatory Authority in the securities sector, remains controversial. Basically, Lummis and Gillibrand are suggesting a separate organization to govern industry standards and impose penalties for violations. In this case, it’s described as the “consumer protection and market integrity authority.”

The legislation would also demand customers’ assets are fully segregated and impose new risk-management standards for crypto lending, outright banning “rehypothecation,” in which crypto firms use customer’s assets to stretch their own credit. Several crypto platforms declared bankruptcy over the past year, revealing that they had loaned out or otherwise used customer funds and could no longer honor withdrawal requests.

And stablecoins – typically dollar-based tokens like Tether’s USDT and Circle Internet Financial’s USDC – could only be issued by banks or credit unions regulated by the federal government or the states, but it would let existing issuers jump in line first to get newly established licensing for that role. It would set up a new kind of charter through the U.S. Comptroller of the Currency, for instance, to be a stablecoin issuer.

Lummis and Gillibrand are additionally pushing a definition for decentralized finance (DeFi) that sets strict rules for when a software project strays into a more centralized business effort and then needs to be registered as an exchange. Previous proposals for regulation hadn’t managed to rope in DeFi.

About a month ago, the senators met with Lael Brainard, director of the White House’s National Economic Council and a former Federal Reserve governor who oversaw its research into central bank digital currency (CBDC), going over the details of the legislation for about an hour, said people familiar with the effort behind the new bill. The lawmakers’ staffs have also had regular contact with the relevant financial agencies, the people said. They said this bill was designed to find a middle road between the parties, and many of its provisions were drawn directly from proposals from other lawmakers, such as Sen. Elizabeth Warren (D-Mass.), a dedicated crypto critic.

While the industry waits for this and other bills to make real progress, such as approval by one of the involved committees in the House or Senate, the SEC under Chair Gary Gensler has moved aggressively to pin prominent crypto companies to existing securities laws. The agency’s most recent enforcement campaign targeted both Binance and Coinbase with accusations that the businesses are operating illegally.

While Lummis and Gillibrand, together, occupy seats in the Senate committees that will be evaluating their bill, they haven’t yet signed other senators onto the effort. The Senate’s 50-50 party divide will require legislation that can draw a wide range of bipartisan support. The lessons of recent history suggest that committee chairs need to get directly involved in financial legislation for it to become law – such as the Dodd-Frank Act of 2010 or the 2018 banking overhaul pushed by Sen. Mike Crapo, then chairman of the Senate Banking Committee.

This effort could potentially get chopped into smaller pieces or absorbed into other bills, though every month that speeds the U.S. closer to the next presidential election puts increased political weight on major moves from an already sluggish U.S. Congress. While crypto has been a priority for both parties this year – judging from the number of hearings in both the House and Senate – it’s unclear when a crypto bill might be put to floor votes and sent to the president’s desk.

"While the Lummis-Gillibrand proposal is a major step forward from the Senate, we will also be watching the House for any movement on stablecoin and market structure bills,” said Georgia Quinn, general counsel of Anchorage Digital, which occupies an unusual role as the sole digital asset bank with an OCC charter.

Another potential hotbed of debate in Lummis-Gillibrand is the $1.4 billion in funding it offers over five years. It raises that money by holding crypto to the same wash-sales tax restrictions that are held over securities, meaning a taxpayer can’t benefit from crypto losses if they happened from a sale that’s quickly followed by the repurchase of the same assets. The bill would also require crypto intermediaries to account for their assets by annually assessing the actual market value of their holdings and paying taxes on gains – a “mark to market” approach.

But it also includes some significant tax benefits for crypto investors, including that they don’t have to be taxed on crypto they get from mining, staking, forks or airdrops until they pocket the new assets. And any crypto payment buying goods or services for less than $200 gets a tax exemption – an idea that could pave the way for cryptocurrencies to be used as actual currencies without incurring tax complications.

Read More: SEC Chair Gensler Suggests Lummis-Gillibrand Bill May ‘Undermine’ Market Protections

UPDATE (July 12, 2023, 14:41 UTC): Adds comment from Anchorage Digital.

UPDATE (July 12, 2023, 20:09 UTC): Adds link to full text of the bill.