House Passes Digital Asset Market Structure Legislation: Financial Innovation and Technology for the 21st Century Act (FIT21)

On May 22, 2024, the US House of Representatives passed H.R. 4763, the Financial Innovation and Technology for the 21st Century Act (FIT21), which would amend existing securities and commodity regulatory statutes to facilitate the use of digital assets, by a vote of 279 – 136. The passage of FIT21 marks an important milestone in the development of a federal regulatory regime for digital assets in the United States as it is the first time a chamber of Congress has passed major digital asset legislation.

In addition, the strong bipartisan vote for FIT21 demonstrates significant support in Congress for digital asset legislation despite the opposition of federal regulators, particularly the Securities and Exchange Commission (SEC). On the day of House’s vote on FIT21, SEC Chairman Gary Gensler released a statement expressing his concerns about the legislation’s potential to undermine investor protection and rejecting the need for new digital asset regulations. Nevertheless, 71 Democratic House members—including former Speaker of the House Rep. Nancy Pelosi and current House Minority Whip Rep. Katherine Clark, along with 208 Republican members—voted for FIT21.

Even with the strong support for FIT21 in the House, however, its future in the Senate is very uncertain. Most importantly, President Joe Biden does not support the legislation in its current form. Prior to the House vote, the White House released a Statement of Administrative Policy (SAP) stating that the Administration opposed passage of FIT21. The SAP stated that the “Administration is eager to work with Congress to ensure a comprehensive and balanced regulatory framework for digital assets, building on existing authorities,” but that FIT21 “lacks sufficient protections for consumers and investors.” As a result, it is highly unlikely that the Democratic-controlled Senate would bring up FIT21 for a vote unless the bill was amended to secure President Biden’s support. However, if FIT21 is considered by the Senate, the Senate’s recent 60 – 38 vote to pass the joint resolution of disapproval of the SEC’s Staff Accounting Bulletin No. 121 (which imposes high regulatory requirements on public companies, including publicly traded banks, to custody digital assets) under the Congressional Review Act suggests that the 60-vote majority needed to overcome a Senate filibuster may exist in the Senate.

In this Legal Update, we provide a summary of FIT21 and its key provisions.

Summary of FIT21

FIT21 would establish a federal digital asset regulatory framework by clarifying the regulatory responsibilities of the SEC and CFTC over digital asset products and transactions, as well as update existing securities and commodity laws to account for various blockchain technology applications, including decentralized protocols. 

Digital Assets Categories Based on Characteristics and Regulatory Jurisdiction

The bill would create three categories of digital assets, which would determine whether a digital asset falls under SEC or CFTC jurisdiction; i.e., as a:

• “restricted digital asset” subject to SEC jurisdiction;
• “digital commodity” subject to CFTC jurisdiction; or
• ”permitted payment stablecoin” subject to either SEC or CFTC jurisdiction, depending on the nature of the intermediary involved in a transaction.

Under the bill, a digital asset would generally be considered a “restricted digital asset” unless it meets the definition of a “permitted payment stablecoin,” or is self-certified as a “digital commodity.” The bill would establish criteria for determining whether a digital asset can be considered a “digital commodity” or a “restricted digital asset” based on:

(1) the level of decentralization and functionality of the digital asset’s underlying blockchain system;
(2) the method of acquisition of the digital asset by an end user; and
(3) the party holding the digital asset (e.g., issuer or unaffiliated third party).

For illustration, it would be likely that a digital asset would meet the criteria for being a “digital commodity” if it (1) is issued through a distribution that is not used for fundraising (i.e., involves only an exchange of nominal value for the digital asset) and is open to all participants equally (i.e., a rewards program) or acquired through a digital commodity exchange; and (2) relates to a blockchain protocol that is functionally decentralized. On the other hand and in contrast, a digital asset would likely to be considered a “restricted digital asset” if it is not related to a functionally decentralized network and is obtained through an issuer distribution in exchange for meaningful value.

The bill would create a self-certification process for “digital commodities,” under which any person could file a certification with the SEC (not the CFTC) that the blockchain system to which a digital asset relates is a decentralized system (while the SEC oversees self-certification, both the SEC and CFTC are directed to engage in joint rulemaking on the self-certification criteria).

The SEC would have 60 days to reject the certification before the assets on such a system would be considered “digital commodities” subject to CFTC jurisdiction. Under this determination by the SEC, a “restricted digital asset” could initially be issued as a security—subject to SEC disclosure and offering requirements similar to those that apply to traditional securities, but specific to digital assets—and later become a “digital commodity” through self-certification. Importantly, a digital asset certified as a “digital commodity” may still be considered a “restricted digital asset” at the same time and is determined based on the holder (e.g., the units held by the issuer, an affiliate of the issuer, or who beneficially owns 5% or more of the outstanding units).

Stablecoins

The bill would define “permitted payment stablecoins” as digital assets issued by an issuer subject to regulation by a federal or state regulator (with authority over issuers of payment stablecoins) which:

(1) are used or designed to be used as means of payment or settlement;
(2) the issuer of which (a) is obligated to redeem for a fixed monetary value or (b) represents the asset will maintain or creates the reasonable expectation that it will maintain stable value relative to a fixes amount of monetary value; and
(3) excludes (a) national currency or (b) securities issued by a registered investment company.

Digital Asset Intermediaries and Registration Requirements

The bill would require digital asset intermediaries (i.e., those who trade, transfer, facilitate trading, clear or custody these assets) to register with the SEC or the CFTC, based on the type of digital asset in which it transacts (i.e., “restricted digital assets” with the SEC or “digital commodities” with the CFTC).

• The SEC would have oversight of “qualified digital asset custodians” for “restricted digital assets” and digital asset brokers, digital asset dealers and digital asset trading systems.
• The CFTC would have oversight of “qualified digital asset custodians” for “digital commodities” and digital commodity exchanges, brokers, or dealers.
• The bill directs the SEC and CFTC to issue joint rulemaking for dual registration by intermediaries with each agency.
• Digital asset intermediaries would be subject to anti-money laundering (AML) laws and must comply as “financial institutions” under the Bank Secrecy Act (BSA).

CFTC-SEC Joint Committee and Additional Rulemaking

The bill would establish a CFTC-SEC Joint Advisory Committee on Digital Assets, a group of 20 nongovernmental stakeholders (10 appointed by each of the CFTC and SEC), which would provide advice on digital asset rules, regulations, and policies to the CFTC and SEC, including on how to the agencies should measure and quantify decentralization, functionality, information asymmetries, and transaction and network security of digital assets. 

The bill directs the CFTC and SEC to jointly conduct a study to assess whether additional guidance or rules are necessary to facilitate the development of tokenized securities and derivatives products (which would represent application of blockchain technology to the broader financial market).

Noteworthy Safe Harbors

The bill would create a safe harbor for “decentralized finance activities,” which would largely exempt certain users from compliance with FIT21 who participate in or provide services for the operations and maintenance of blockchain networks or decentralized finance (DeFi) systems (e.g., operating or participating in a liquidity pool, participating in network operations or computational services, hosting end-user interfaces for DeFi, or writing or publishing DeFi software).

New SEC Authority

• The SEC would have authority over new categories of securities: “restricted digital assets” and, depending on the type of transaction, “permitted payment stablecoins.”
• The SEC would have authority to register and regulate digital asset brokers, digital asset dealers and digital asset trading systems. 
• The SEC would have authority to register and regulate digital asset clearing agencies.
• The SEC would have authority over digital assets activities by federally regulated intermediaries, such as broker-dealers, investment advisers, and investment companies, and to establish rules for the custody, valuation, and reporting of such assets.

New CFTC Authority

• The CFTC would have exclusive jurisdiction over spot “digital commodity” transactions, regardless of whether they are subject to the jurisdiction of any other federal or state agency.
• This jurisdiction would be in addition to the CFTC’s traditional exclusive jurisdiction over commodity derivatives and retail commodity transactions.

Mandated Rulemakings

Joint SEC-CFTC Rulemakings
The SEC, in conjunction with the CFTC, would be required to issue rules to:

• Establish rules to exempt dually registered intermediaries from duplicative, conflicting, or unduly burdensome requirements.
• Establish rules applicable to “mixed digital asset transactions”, which are transactions involving both a “digital commodity” and a security or “restricted digital asset.”

SEC Mandated Rulemakings
The SEC would be required to engage in rulemaking to:

• Establish rules to oversee exempted transactions in digital assets, including setting the aggregate amount limit for digital asset issuers, establishing enhanced disclosure requirements, and creating a certification process for certain digital assets. 
• Establish rules to distinguish between digital assets sold as part of an investment contract and other types of securities, and to determine the treatment of investment contract assets.
• Establish rules to set requirements for digital asset trading systems, such as fair access, order execution, market surveillance, and recordkeeping.
• Establish rules to address conflicts of interest for digital asset intermediaries, such as trading on a proprietary basis, engaging in market manipulation, or favoring certain customers over others. 
• Establish rules to register and regulate notice-registered digital asset clearing agencies, such as setting standards for risk management, governance, and transparency.

CFTC Mandated Rulemakings
The CFTC would be required to engage in rulemaking to:

• Establish a fee schedule and collect filing fees from entities filing a notice of intent to register as digital commodity exchanges, brokers, or dealers.
• Register and regulate digital commodity exchanges under new section 5i of the Commodity Exchange Act, which includes requirements for trading, customer asset protection, market access, and governance, among others.
• Establish rules for qualified digital commodity custodians, which are entities that hold or store digital commodities on behalf of customers or exchanges.
• Register and regulate digital commodity brokers and dealers, which are entities that engage in the business of buying or selling digital commodities for their own account or for the account of others. 

Other Provisions of Interest

• The bill would effectively repeal SEC Staff Accounting Bulletin No. 121 for banks and trust companies, but not for other public companies.
• The bill would codify the SEC's FinHub and CFTC’s LabCFTC.
• The bill would direct the Comptroller General of the United States to conduct a study on non-fungible digital assets, examining their nature, use, storage, interoperability, benefits, risks, and levels of illicit activity.
• The bill would direct the SEC and CFTC to jointly conduct studies to:
• Analyze the nature, size, role, use, benefits, risks, and potential for integration of decentralized finance with traditional financial markets.
• Identify the current level of financial literacy among retail digital asset holders and methods to improve financial literacy materials and dissemination, and
• Assess whether additional guidance or rules are necessary to facilitate the development of tokenized securities and derivatives products.