While FIT21 would provide various exemptions from securities registration, it would also require certain digital asset issuers and market participants, such as exchanges and broker-dealers, to register with the SEC or CFTC, as applicable, in newly-defined registration categories and provide certain disclosures to customers.2
While we do not expect that FIT21 will be passed by the Senate, it importantly did pass in the House with the support of 71 Democrats, which makes this Bill the first crypto-related legislation to pass one of the chambers of Congress. This demonstrates that Republicans and a meaningful number of Democrats see the need for a clear regulatory framework around crypto.
Before becoming law, FIT21 would require a vote of the U.S. Senate and signature by President Biden. As of publication, the U.S. Senate has not indicated that it would vote on the Bill. Further, the Biden Administration has issued a Statement of Administration Policy in response to the House’s passage of the Bill, noting that it “lacks sufficient protections for consumers and investors.” 3 SEC Chair Gary Gensler also issued a statement in response to the House’s passage of the Bill, noting that it would put the capital markets “at immeasurable risk” due to regulatory gaps.4 The Statement of Administration Policy, however, did state that the Biden Administration is “eager to work with Congress” on the regulatory structure for digital assets.5
Key Takeaways From FIT21
- SEC and CFTC Jurisdiction: A critical component of FIT21 would be a framework for the classification of whether a digital asset falls under the jurisdiction of the CFTC or the SEC. FIT21 would create two categories of digital assets: “digital commodities”6 and “restricted digital assets”7 (sometimes referred to as “digital assets”). The question of whether a digital asset is a digital commodity, and under the jurisdiction of the CFTC, or a restricted digital asset, and under the jurisdiction of the SEC, would turn on the decentralization and functionality analysis, further described below.
- Decentralization Analysis: Under FIT21, the CFTC would have regulatory authority if the digital assets were on a blockchain that is both functional and decentralized, and the SEC would have regulatory authority if the digital assets were on a blockchain that is non-functional or functional but not decentralized. Whether a blockchain is decentralized turns on a number of factors, including: (i) who has authority to control or materially alter the blockchain; (ii) who beneficially owns the digital assets that can be distributed in such blockchain system; and (iii) whether the digital assets that can be distributed in such blockchain system were marketed as investments.8
- Functionality Analysis: FIT21 would provide that a blockchain system to which a digital asset relates is a functional system if it allows network participants to use that digital asset for: (i) the transmission and storage of value on the blockchain system; (ii) the participation in services provided by or an application running on the blockchain system; or (iii) the participation in the governance system of the blockchain system.9
- Exemption from Securities Registration: FIT21 would also provide numerous exemptions from registration under the U.S. Securities Act of 1933, as amended, for certain offers and sales of digital assets, including an exemption for end users, a transactional exemption, and an exemption for a decentralized blockchain through a certification process. Issuers who seek to rely on the transactional exemption would still be required to file information statements with the SEC and provide certain disclosures to investors on a freely accessible public website.10
- Regulation of Certain Intermediaries: FIT21 would require digital asset trading systems,11 digital asset brokers,12 and digital asset dealers13 to register with the SEC as new registration categories, and digital commodity brokers,14 digital commodity dealers,15 and digital commodity exchanges16 to register with the CFTC. However, until a registration process is fully developed by the CFTC and SEC, FIT21 would allow such intermediaries to file a “notice of intent to register.”
- Treatment of Stablecoins: Permitted payment stablecoins17 would be excluded from the definitions of digital commodities and restricted digital assets, and neither the SEC nor CFTC would have regulatory authority over such products. However, digital commodity exchanges would be permitted to list permitted payment stablecoins, and digital commodity brokers and a digital commodity dealers would be permitted to trade them.
FIT21 Explained
SEC and CFTC Jurisdiction
The question of whether a digital asset is a digital commodity, and under the jurisdiction of the CFTC, or a restricted digital asset, and under the jurisdiction of the SEC,18 would turn on the decentralization analysis below, which contains four factors:
- Who holds the digital asset;
- The extent to which the blockchain system is controlled;
- The functionality of digital assets within that system; and
- How the assets were distributed to the persons who hold them.
Under FIT21, the CFTC would regulate digital assets if the blockchain is both functional and decentralized.19 The SEC would regulate digital assets if the blockchain is non-functional or functional but not decentralized.20 However, there may be instances when an industry participant needs to register with both the CFTC and the SEC. In that scenario, FIT21 would require the CFTC and the SEC to jointly issue rules exempting those participants from duplicative, conflicting, or unduly burdensome provisions to the extent that such exemption would foster the development of fair and orderly markets.21
FIT21 further recognized that while restricted digital assets would initially be treated as securities and regulated by the SEC, such asset could evolve to become a CFTC-regulated digital commodity if its corresponding blockchain was later deemed to be decentralized and functional.22 In particular, the Bill provides that investment contract assets, defined to mean “fungible digital representations of value that can be exclusively possessed and transferred, person to person, without necessary reliance on an intermediary, and is recorded on a cryptographically secured public distributed ledger; sold or otherwise transferred, or intended to be sold or otherwise transferred, pursuant to an investment contract; and is not otherwise a security,” are excluded from the definition of security.23 Further, market participants would be permitted to trade in secondary sales even if such assets were initially sold as an investment contract, as long as certain conditions are met, such as there being certified and publicly available enhanced disclosure regarding the digital asset’s blockchain network.24
Decentralized System
Perhaps the most significant factor in the decentralization analysis is the extent to which the blockchain system is controlled. FIT21 would provide that a blockchain system is decentralized if all of the following conditions are met.
- During the previous twelve months, no person had the unilateral authority, directly or indirectly, to control or materially alter the functionality of the blockchain system or had the authority to restrict or prohibit any person who is not a digital asset issuer,25 related person,26 or affiliated person27 from engaging with the blockchain system.28
- During the previous twelve months, no digital asset issuer or affiliated person beneficially owned more than 20% of the total amount of units of the digital asset distributed on that blockchain.29
- During the previous three months, no digital asset issuer, affiliated person, or any related person has added any intellectual property to the source code of the blockchain system that alters the blockchain system unless done so to address cybersecurity issues or unless such intellectual property was added through the consensus of a decentralized governance system.30
- During the previous three months, neither a digital asset issuer nor an affiliated person marketed the digital asset to which the blockchain system relates as an investment.31
- During the previous twelve months, all issuances of digital assets through the programmatic functioning of the blockchain system were end user distributions.32
Functionality
FIT21 would also consider the functionality of digital assets within the blockchain system. FIT21 would provide that a blockchain system to which a digital asset relates is a functional system if it allows network participants to use that digital asset for: (i) the transmission and storage of value on the blockchain system; (ii) the participation in services provided by or an application running on the blockchain system; or (iii) the participation in the governance system of the blockchain system.33
Exemptions from SEC Registration
As noted above, FIT21 would provide numerous exemptions from securities registration with the SEC, including an exemption for end users, a transactional exemption, and an exemption for a decentralized blockchain through a certification process, each described below.
An end user distribution would not be deemed to be security, and thus would not be required to be registered with the SEC. End user distributions include distributions made for activities directly related to the operation of the blockchain system, including mining, validating, or staking.34
Further, a transaction involving the offer or sale of units of a digital asset by a digital asset issuer would be exempt from registration if it satisfies all of the following requirements: (i) the aggregate amount of units to be sold would be no more than $75,000,000;35(ii) when the purchase of units of a digital asset by a person (who is not an accredited investor) would be less than either 10% of the person’s annual income or 10% of the person’s net worth;36 (iii) the purchaser would not own more than 10% of the total amount of units;37 (iv) the transaction would involve a digital asset offered as part of an investment contract;38 and (v) the transaction does not involve a digital asset issuer that is not organized in the U.S., or is a specific type of entity such as an investment company.39 While such transactions are exempt from registration, FIT21 would nonetheless require the digital asset issuer to have filed information statements with the SEC and provided certain disclosures to investors on a freely accessible public website.40 Even with such disclosures, SEC Chairman Gensler noted that this exemption would lead to “a lot of risk for ordinary investors.”41
A digital asset issuer that believes its corresponding blockchain is decentralized, and therefore not required to be registered with the SEC, would be required to file a certification with the SEC stating that the blockchain system to which the digital asset relates is a decentralized system. Such a certification requires information about the person making the certification as well as description of the blockchain system and the digital asset itself.42 Information regarding the blockchain system and the digital asset must describe the blockchain’s operation and the functionality of the digital asset.43 The SEC would have 60 days to rebut a certification filed with it. As discussed above, the CFTC, rather than the SEC, would have jurisdiction over digital assets on a blockchain that is functional and decentralized. For this reason, if the SEC does not rebut the certification, then the digital asset would be treated as a digital commodity and fall under the CFTC’s regulation.
Regulation of Certain Intermediaries and Notice of Intent to Register
FIT21 would delegate regulatory authority to the SEC over digital asset brokers, digital asset dealers, and digital asset trading systems44 and to the CFTC over digital commodity brokers, digital commodity dealers and digital commodity exchanges. For those participants who need to register in such newly-defined categories, but where such a process has not yet been developed by the SEC or CFTC, FIT21 provides that such participant could instead file a notice of intent to register until further rulemaking can be completed by the SEC or CFTC. Any person who files a notice of intent to register with the SEC must also make certain disclosures, which includes information regarding the management of the entity, their financial condition, affiliated entities and potential conflicts of interest, and information regarding their operations.45
Under FIT21 any person may file a notice of intent to register with the CFTC as a digital commodity exchange, broker, or dealer46 or with the SEC as a digital asset broker, dealer, or trading system.47 Any such person who will file a notice of intent to register with the CFTC must provide certain disclosures as set forth in FIT2148 and would not be subject to SEC requirements with respect to registering as a national securities exchange.49
The Bill further provides that any person who has filed a notice of intent to register is exempt from SEC “rules and regulations pertaining to registering as a national securities exchange, broker, dealer, or clearing agency, for activities related to a digital asset,” although the Bill does not limit any fraud, anti-manipulation, or false reporting authority of the SEC or CFTC.50
As noted above, there may be instances when the same entity may need to register in multiple capacities with both the SEC and CFTC if transacting in both restricted digital assets and digital commodities. The Bill would require the CFTC and the SEC to jointly issue rules exempting those participants from duplicative, conflicting, or unduly burdensome provisions to the extent that such exemption would foster the development of fair and orderly markets.51
Treatment of Stablecoins
The Bill expressly excludes permitted payment stablecoin from the definition of both a restricted digital asset52 and a digital commodity.53 However, digital commodity exchanges would be allowed to list permitted payment stablecoins, and digital commodity brokers and digital commodity dealers would be permitted to trade them.54 FIT further provides that if a transaction in permitted payment stablecoin is executed either on or by an entity registered with the CFTC, the CFTC will have jurisdiction over that transaction.55
Although FIT21 excludes permitted payment stablecoins from the definition of a restricted digital asset, transactions in permitted payment stablecoins may nonetheless be subject to the SEC’s rules that prohibit fraud and manipulation if those transactions were engaged in by a broker, dealer, or through an alternative trading system.56
Implementation Process
FIT21 would require the SEC and CFTC to: (i) establish a Joint Advisory Committee on Digital Assets, to, among other actions, discuss the implementation by the SEC and CFTC of the Bill; (ii) jointly conduct a study on decentralized finance or “DeFi”; (iii) jointly conduct a study on financial literacy among digital asset holders; and (iv) jointly conduct a study on financial market infrastructure improvements to help facilitate the development of fair and orderly financial markets.57 The Comptroller General of the United States would also be required to conduct a study on non-fungible digital assets. Reports on such studies would be required to be submitted to certain relevant Congressional committees, including the Committee of Financial Services.
Looking Ahead
As the U.S. Senate has not indicated that it would vote on the Bill and given the impact of the Statement of Administration Policy, it does not seem likely that the Bill will be enacted into law.
Nonetheless, the Bill represents a significant milestone and establishes an important foundation on which future legislative efforts to establish a regulatory framework for digital assets could be built, particularly as the Biden Administration’s Statement of Administration Policy notes that it is “eager to work with Congress to ensure a comprehensive and balanced regulatory framework for digital assets.”58 In particular, legislators may build upon the proposed framework by creating registration processes for digital asset or digital commodity brokers or dealers, digital asset trading systems or digital commodity exchanges. Additionally, the passage of FIT21 with such significant bipartisan House support should be viewed by market participants as a notable step towards possible regulatory clarity for digital assets.
A&O Shearman’s cross-disciplinary team, which includes members of our Financial Services Advisory and Regulatory, Litigation, Corporate, M&A, Employment and Benefits, Tax, and Capital Markets teams have extensive experience in advising clients on digital assets globally and are available to discuss any questions you may have.
Footnotes
1 H.R. 4763, Financial Innovation and Technology for the 21st Century Act (May 22, 2024), (“FIT21”). The House Financial Services Committee and the House Agricultural Committee passed FIT21 for consideration in the House on July 26, 2023. Note that the U.S. Senators Gillibrand and Lummis also introduced a bill in July 2023 that would create a regulatory framework for “crypto assets,” which has not been voted on. S. 2281, Lummis-Gillibrand Responsible Financial Innovation Act (July 12, 2023)
2 Fin. Servs. Comm., House Passes Financial Innovation and Technology for the 21st Century Act with Overwhelming Bipartisan Support, (May 22, 2024)
3 Exec. Off. of the President, Statement of Administration Policy, H.R. 4763 – Financial Innovation and Technology for the 21st Century Act, (May 22, 2024)
4 Gary Gensler, Statement on the Financial Innovation and Technology for the 21st Century Act, U.S. Sec. And Exch. Comm’n, (May 22, 2024), While the SEC advocates for crypto-market participants to “come in and register,” certain commenters, including Commissioner Hester Pierce, note that there is a lack of “a coherent legal framework.” SEC Commissioner Hester Peirce has further called for a move beyond this regime of “regulation by enforcement” and urged the SEC to work collaboratively with Congress to provide clear guidance for crypto-market participants. See Outdated: Remarks before the Digital Assets at Duke Conference, Comm’r Hester M. Pierce, U.S. Sec. And Exch. Comm’n, (Jan. 20, 2023)
5 Supra note 3.
6 “Digital Commodity” would be defined to mean:
“(i) any unit of a digital asset held by a person, other than the digital asset issuer, a related person, or an affiliated person, before the first date on which each blockchain system to which the digital asset relates is a functional system and certified to be a decentralized system under section 44 of the Securities Exchange Act of 1934, that was—
(I) issued to the person through an end user distribution described under section 42(d)(1) of the Securities Exchange Act of 1934; or
(II) acquired by such person in a transaction that was executed on a digital commodity exchange;
(ii) any unit of a digital asset held by a person, other than the digital asset issuer, a related person, or an affiliated person, after the first date on which each blockchain system to which the digital asset relates is a functional system and certified to be a decentralized system under section 44 of the Securities Exchange Act of 1934; and
(iii) any unit of a digital asset held by a related person or an affiliated person during any period when any blockchain system to which the digital asset relates is a functional system and certified to be a decentralized system under section 44 of the Securities Exchange Act of 1934.” FIT21 at §102(55).
7 “Restricted Digital Asset” would be defined to mean:
“(i) prior to the first date on which each blockchain system to which a digital asset relates is a functional system and certified to be a decentralized system under section 44 of the Securities Exchange Act of 1934, any unit of the digital asset held by a person, other than the digital asset issuer, a related person, or an affiliated person, that was—
(I) issued to such person through a distribution, other than an end user distribution described under section 42(d)(1) of the Securities Exchange Act of 1934; or
(II) acquired by such person in a transaction that was not executed on a digital commodity exchange;
(ii) during any period when any blockchain system to which a digital asset relates is not a functional system or not certified to be a decentralized system under section 44 of the Securities Exchange Act of 1934, any digital asset held by a related person or an affiliated person; and
(iii) any unit of a digital asset held by the digital asset issuer.” Id. at §101(34).
8 Id. at §101(25). Note that FIT21 does not further specify what types of investments it is referring to here.
9 Id. at §101(31).
10 Id. at §301.
11 “Digital Asset Trading System” would be defined to mean:
“(A) any organization, association, person, or group of persons, whether incorporated or unincorporated, that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of restricted digital assets or for otherwise performing with respect to restricted digital assets the functions commonly performed by a stock exchange within the meaning of section 240.3b–16 of title 17, Code of Federal Regulations, as in effect on the date of enactment of this paragraph; and
(B) does not include a blockchain protocol or a person or group of persons solely because of their development of a blockchain protocol.” Id. at §102(86).
12 “Digital Asset Broker” would be defined to mean, subject to certain exceptions, “any person engaged in the business of effecting transactions in restricted digital assets for the account of others.” Id. at §102(83).
13 “Digital Asset Dealer” would be defined to mean, subject to certain exceptions, “any person engaged in the business of buying and selling restricted digital assets for such person’s own account through a broker or otherwise.” Id. at §102(85).
14 “Digital Commodity Broker” would be defined to mean “any person who, in a digital commodity cash or spot market, is—
(i) engaged in soliciting or accepting orders for the purchase or sale of a unit of a digital commodity from a person that is not an eligible contract participant;
(ii) engaged in soliciting or accepting orders for the purchase or sale of a unit of a digital commodity from a person on or subject to the rules of a registered entity; or
(iii) registered with the Commission as a digital commodity broker.” Id. at §103(56).
15 “Digital Commodity Dealer” would be defined to mean any person who
“(i) in digital commodity cash or spot markets—
(I) holds itself out as a dealer in a digital commodity;
(II) makes a market in a digital commodity;
(III) has an identifiable business of dealing in a digital commodity as principal for its own account; or
(IV) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in a digital commodity;
(ii) has an identifiable business of entering into any agreement, contract, or transaction described in subsection (c)(2)(D)(i) involving a digital commodity; or
(iii) is registered with the Commission as a digital commodity dealer.” Id. at §103(58).
16 “Digital Commodity Exchange” would be defined to mean “a trading facility that offers or seeks to offer a cash or spot market in at least 1 digital commodity.” Id. at §103(59).
17 “Permitted payment stablecoin” would be defined to mean a digital asset—
“(i) that is or is designed to be used as a means of payment or settlement;
(ii) the issuer of which—
(I) is obligated to convert, redeem, or repurchase for a fixed amount of monetary value; or
(II) represents will maintain or creates the reasonable expectation that it will maintain a stable value relative to the value of a fixed amount of monetary value;
(iii) the issuer of which is subject to regulation by a Federal or State regulator with authority over entities that issue payment stablecoins; and
(iv) that is not—
(I) a national currency; or
(II) a security issued by an investment company registered under section 8(a) of the Investment Company Act of 1940.”
18 Cong. Rsch. Serv., An Overview of H.R. 4763, Financial Innovation and Technology for the 21st Century Act, (May 17, 2024)
19 FIT21 at §101(29).
20 Id. at §101(34)(A)(i)–(iii).
21 Id. at §105(b).
22 Note that William Hinman, former Director of the Division of Corporation Finance at the SEC previously stated that the analysis of whether a token is a security is “not static and does not strictly inhere to the instrument.” William Hinman, Digital Asset Transactions: When Howey Met Gary (Plastic), U.S. Sec. And Exch. Comm’n, (June 14, 2018)
23 FIT21 at §202.
24 Id. at §303. Note that the digital asset issuer, an affiliated person, a decentralized governance system, or a digital commodity exchange, as applicable, would need to certify these disclosures to the CFTC and SEC on a quarterly basis.
25 Digital asset issuers issue digital assets or sell the rights to future issuances of digital assets. Id. at §107(b)(1)–(2).
26 A related person works for a digital asset issuer or stands to benefit from a digital asset on account of their relationship to the digital asset issuer. Id. at §107(b)(1)–(2).
27 An affiliated person, directly or indirectly, controls, is controlled by or is under common control with a digital asset issuer (either currently or within the last three months) or owns (or beneficially owns) at least 5% or more of the units of a digital asset. Id. at §107(b)(1)–(2).
28 Id. at §101(25)(A)(i)–(ii).
29 Id. at §101(25)(B)(i)–(iii).
30 Id. at §101(25)(C).
31 Id. at §101(25)(D).
32 Id. at §101(25)(E).
33 Id. at §101(31).
34 Id. at §101(30)(A)–(B).
35 Id. at §301(a)(1)(8)(A).
36 Id. at §301(a)(1)(8)(B)(i)–(ii).
37 Id. at §301(a)(1)(8)(C).
38 Id. at §301(a)(1)(8)(D).
39 Id. at §301(a)(1)(8)(E)(i)–(vi).
40 Id. at §301.
41 Gensler, supra note 4.
42 FIT21 at §304(44)(b).
43 Id.
44 FIT21 would require that all digital asset dealers and brokers segregate any funds that accrue (or are received) on behalf of the customer and bars the comingling of any such funds as well as establishing capital requirements to fulfill any potential obligations. Id. at §406(a)(f)(3)(A)–(B).
45 Id. at §107(b)(1)–(2).
46 Id. at §106(a)(1)(A)–(B).
47 Id. at §107 (a)(1)–(2).
48 Id. at §106(b).
49 See Cong. Rsch. Serv., supra note 18.
50 FIT21 at §106(e) and §107(e).
51 Id. at §105(b).
52 Id. at §101(34)(B).
53 Id. at §103(55)(B).
54 Id. at §6c(a).
55 Id. at §501(G)(i)(I)–(II).
56 Id. at §402(e)(1).
57 See FIT21 at §§604–608. Note that the Bill otherwise did not address the status of non-fungible digital assets or “NFTs” or provide clarity around DeFi.
58 Exec. Off. of the President, supra note 3
