28 - Unpacking The Responsible Financial Innovation Act
If you ask an American born in the 70’s, 80’s, and 90’s how they learned about the US government, many of them will give you similar answers: Schoolhouse Rock. The classic cartoon education series was a popular way to explain the complex inner workings of our country's governing process. One of the most well known clips titled “I'm just a bill” describes the law making process. It starts with the first phase whereby a member of Congress in either the House of Representatives or the Senate drafts a bill. That bill then gets discussed, voted on, and eventually might land on the President’s desk for signing. Last week the crypto industry was buzzing about a new bill called The Responsible Financial Innovation Act (RFIA) which was introduced by Sen. Cynthia Lummis and Kirsten Gillibrand. The bill outlined some sorely needed regulatory guidance around the treatment of digital assets by the federal government. Overall, the bill was received positively. Many industry experts are hoping that it does eventually become law and its important to understand why.
Many in the digital asset space have long complained that governments, especially the United States, have not taken the time to understand the industry. The lack of interest has led to few laws being issued. Those that have are often written with a clear misunderstanding of many of the technical nuances that make the digital asset space unique. The result has led to questions about what governing body has domain over the industry, how digital assets should be taxed, and what legal framework digital assets should be assessed within. Traditional financial institutions often cite the lack of regulatory clarity as a reason not to get involved in this emerging market.
Calls for regulatory clarity were finally heard by Senators Lummis and Gilibrand who on June 6, 2022 released a proposed bill to answer some of these questions. Lummis is a Republican senator from Wyoming and a longtime friend of the digital asset industry. On October 7, 2021, Lummis disclosed that she had purchased somewhere between $50,000 and $100,000 worth of bitcoin (BTC) in August of the same year. Gillibrand, a democrat from New York was not exactly an obvious ally. In fact, her home state has long been hostile towards the digital asset industry starting with its BitLicience and most recently with its desire to ban Proof of Work mining from being conducted within the state. These two unlikely allies have produced one of the most well-written pieces of bipartisan legislation to date.
As some readers have probably guessed by its name, the bill is focused on harboring innovation not stifling a growing industry. The bill does an excellent job of addressing some of the most unclear areas of the space starting with which governing body has oversight over the industry. It also touches on all the way to how institutions should approach holding stablecoins and outlines a path for decentralized autonomous organizations (DAO) to operate in a legally compliant manner. Let’s take a look at some of these topics and how the bill addresses them.
Governing agency - Historically, the Securities and Exchange Commission (SEC) has been the governing body most actively engaged in regulatory enforcement within the digital asset industry. At the helm is Gary Gensler who has proven to be somewhat cold toward the industry. The new RFIA outlines that instead of the SEC, the Commodities and Trading Commission (CFTC) should have majority jurisdiction over digital asset regulation. Selecting the CFTC as the primary regulator means that the senators are acknowledging that most digital assets are more like a commodity than security. The bill does address the fact that digital assets are nuanced, and no two assets are exactly the same, meaning that some of them may fall under other agencies' jurisdictions such as the SEC. In an effort to spur inner agency cooperation and education, the bill also requires that the SEC and CFTC conduct a joint agency study on the industry as well as the formation of an advisory committee. The advisory committee would be made up of industry organizations, federal and state regulators among others to develop guiding principles for self regulation and advise lawmakers.
Stablecoins - Stablecoins are one of the most talked about innovations in the blockchain space. The TLDR is that they are digital assets that are designed to maintain their value as they relate to another asset, usually the US dollar. A popular form of stable coin is one where an individual can deposit US dollars into a bank account, and the institution managing that account issues a digital asset that represents each dollar. These stablecoins are called “dollar backed stablecoins” and the two most well known are USDT and USDC. The RFIA outlines clear guidelines for how traditional financial institutions interested in issuing a stablecoin should approach doing so. Guidelines of this nature would give institutions clear rules by which they can play in hopefully encouraging more players to enter the industry. The bill would also require institutions issuing these assets to undergo a financial audit to ensure that every stablecoin is backed 1:1 in US dollars.
De minimis tax rule - When you travel abroad and exchange your US dollars for a local currency, you don’t often think about taxes; but if your exchange value is large enough, it could be a taxable event. Most people wouldn’t have this issue because of something called “the de minimis rule.” The rule allows an average person to make an foriegn currency exchange without needing to pay taxes on that transaction. The RFIA suggests a similar treatment be employed for digital assets used to pay for goods and services. The bill states that if the gain from the transaction is below the $200 threshold, then an individual will not need to pay taxes on that gain. Industry veterans will tell you that a digital asset de minimis rule has been a long time request and seeing it included in the bill is encouraging.
Decentralized Autonomous Organizations (DAO) - In Decentralized finance, we discussed the concept of a DAO as a “smart contract based investment vehicle.” Since the first DAO on Ethereum, DAO’s have become much more than investment vehicles. The smart contracts that underpin the modern DAO do more than help to allocate resources. Many of them now operate much like distributed businesses in which participants work together to accomplish a specific goal. In the RFIA, the bill categorizes these organizations as “a business entity which is not a disregarded entity.” Describing a DAO in such a manner means that the government wants to view them the same way they do a traditional corporation. This would provide state governments with a means by which to create their own legislation directly addressing DAO’s created in their jurisdiction.
Despite the positive reaction the bill has garnered, there are also some critics who think it’s not as well thought out as it first appears. Political experts worry that oversight being shifted from the SEC to the CFTC is a bad idea. The digital asset industry needs significant attention and the CFTC is perceived to be more underfunded and less aggressive than the SEC. On the crypto side, some believe that the way in which the bill addresses stablecoins and DAO’s shows a misunderstanding about the technology. How can a distributed autonomous organization be categorized the same way as a corporation? How could a DAO reside in any state or country? By definition it is distributed across many jurisdictions, and those involved are not only autonomous but also anonymous, often intentionally so. Despite these shortcomings many in the industry believe the bill is positive and will, at the very least, start the conversation about robust regulation on the right foot.