Regulatory clarity in the crypto industry in U.S. has taken front stage for much of 2023, as jurisdictions across the globe put frameworks in place to regulate the nascent industry, while the U.S. lags behind.
Last month, the U.S. House Financial Services Committee issued a bill aimed at regulating the industry; however, not much progress has been made on the bill. (Remember, this is the same bill that failed to gain bipartisan support back in September 2022.)
Last week, House Majority Whip Tom Emmer (R-MN) and Representative Darren Soto (D-FL) announced the introduction of their bipartisan Securities Clarity Act to clear up one of the main sticking points in cryptocurrency regulation: the question of whether cryptocurrencies are classified as securities.
It’s an important question to answer, since much of the uncertainty surrounding cryptocurrencies in the U.S. has stemmed from the actions taken by the Securities and Exchange Commission over the past years.
The bill is intended to provide clarity in the regulatory classification of digital assets, providing market certainty for innovators and clear jurisdictional boundaries for regulators.
This is key, since one of the chief complaints in the U.S. is that blockchain innovation is being stifled by a lack of clarity around the classification of digital assets.
Much of that uncertainty is being created by the SEC. The Commission has been increasingly active in bringing actions against a number of crypto industry businesses; however, there has been a lack of guidelines from the SEC, leading to uncertainty in the industry.
In some cases, it seems the SEC has implicitly approved of a crypto business model, yet it still brings action against the project, again without providing any details or guidelines to the project to inform them on how they might rectify any alleged violations.
The most visible action has been the serving of a Wells Notice to crypto exchange Coinbase earlier this year. Even before receiving the Wells Notice, Coinbase was seeking clarity from the SEC.
According to statements from Coinbase CLO Paul Grewal, the company has repeatedly approached the SEC over the past nine months to seek clarity on its business activities, but the SEC has repeatedly failed to provide a straight answer on which digital assets the Commission considers to be securities.
The current environment in which enforcement comes before regulation needs to change. Currently there is little guidance for crypto companies, and despite the SEC saying they will work with those projects that register properly, currently there is no process in place to complete such a registration. The Securities Clarity Act seeks to resolve that Catch-22.
The Securities Clarity Act Explained
The Securities Clarity Act is a short bill, just 5 pages long. That’s because it seeks to address one failing of current securities law in regard to digital assets. According to the bill, “existing securities law does not distinguish between an asset and the securities contract it may or may not be part of.”
Congressman Emmer introduced this same bill previously in September 2020, when he was serving as the Ranking Member of the House Financial Services Committee’s Task Force on Financial Technology. In addition, Congressman Emmer became co-chair of the Congressional Blockchain Caucus in 2018.
The Securities Clarity Act, if drafted into law, will provide clarity for digital assets by setting a distinction between the digital asset (cryptocurrencies) and the securities contract that it may or may not be part of.
The bill also seeks to clarify that an investment contract asset is separate from the investment contract under which it was sold.
Simply stated, a crypto project can have a securities contract, but it is possible that the token of this contract is not classified as a security.
We are all aware that many cryptocurrencies are issued as part of a securities contract, however once the project develops and becomes decentralized, these tokens might not be classified as securities any longer. Instead, they might be considered as a commodity or as property.
Currently, without a defined distinction between the cryptocurrency and the securities contract it was issued under, projects that need to issue tokens to fund development in early stages find it impossible for these tokens to move out of the securities framework, which is preventing the tokens from being used for their intended utility.
“So long as we lack a clear definition under the law for what is a commodity and what is a security, American innovation will suffer.”
– House Representative Thomas Emmer
The Securities Clarity Act will amend the 1933 Securities Act to separate “investment contracts” from the underlying assets sold pursuant to the investment contract.
In essence, the bill says that assets sold as part of an investment contract do not become securities merely by being sold as part of that investment contract.
Also key to understanding of securities law and the definition of securities is the Howey Test. (See our Guide to SEC Regulation on Tokens, Explained with Cat Photos.)
The Howey Test Explained
The Howey Test was created in 1946 by the U.S. Supreme Court to determine if an asset is a security, and thus under the purview of the Securities and Exchange Commission. It has four parts, all of which must be true for an asset to be classified as a security:
- There is an investment of money. This means you give money or something else of value to someone else.
- There is a common enterprise. This means you and other investors are pooling your money together for a shared goal.
- There is an expectation of profit. This means you hope to make more money than you invested.
- The profit is derived from the efforts of others. This means you rely on someone else’s work or skill to make money, not your own.
By placing an asset into the framework of the Howey Test, it is possible to determine whether or not it should be classified as a security.
However, as you’ll see in the video below, even Gary Gensler, the chairman of the SEC, has difficulty in answering a question about whether Ethereum is a security.
Getting clarity on the classification of digital assets is key to opening up the blockchain economy in the U.S. Business and consumers both need this clarity to allow them to invest in the space without fearing prosecution.
The Securities Clarity Act would provide that certainty for businesses, investors, and consumers by legally establishing the difference between an investment contract and the digital assets that are sold under these contracts.
This will allow companies to create great products and services, while also maintaining consumer protections. The bill is one of the smartest approaches brought forward for providing clarity regarding the application of securities law to digital assets.
If the U.S. wants to remain a leader in the blockchain space, and reap the economic benefits of that leadership, then such legislation is a requirement. The sooner we can define digital assets, the sooner we will be able to create a strong digital asset market.
Without it, we will rapidly fall even further behind the European Union and Hong Kong, both of which have been working diligently to provide the clarity that U.S. investors and businesses have been asking for over the past several years of regulatory limbo.
As stated on Emmer’s website, “The Securities Clarity Act offers a key distinction that will enable crypto projects to reach their full potential in a compliant way, enabling the United States to compete globally in this next iteration of the internet.”