A group of US Senators have introduced a bill recently, titled Digital Commodities Consumer Protection Act of 2022, which gives teeth to the Commodity Futures Trading Commission (CFTC) to regulate trading of digital commodities. The framework can be looked at as a safeguard for US customers who are currently exposed to markets which are not regulated. You can read the entire draft of the bill here.
“These rules hold digital commodity platforms to the same standards as traditional financial institutions,” read a document summarising the draft of the bill.
The bill would allow the CFTC to regulate two of the most popular cryptocurrencies— Bitcoin and Ethereum— and other crypto assets which are not classified as securities by the Securities and Exchange Commission (American equivalent of the SEBI).
The bill was backed by the following senators:
- Debbie Stabenow,
- John Boozman,
- Cory Booker,
- and John Thune.
“One in five Americans have used or traded digital assets— but these markets lack the transparency and accountability that they expect from our financial system. Too often, this puts Americans’ hard-earned money at risk,” Stabenow said in a statement.
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Why it matters: The bill is notable because it will provide clear governmental oversight to digital asset commodity markets. The crypto markets have been facing a series of hacks of late leaving investors in a bind who wish to seek recourse.
- It is also important to note that many countries, including India, around the world are looking to regulate digital assets. The cross-border nature of these assets make it all the more pertinent for countries to join hands in order to bring effective regulation.
1/ Really pleased to see the introduction of the Digital Commodities Consumer Protection Act from @SenStabenow, @JohnBoozman, @CoryBooker, and @SenJohnThune. This bill will ensure the @CFTC has the authority it needs to regulate the digital asset commodity markets.
— Faryar Shirzad (@faryarshirzad) August 3, 2022
Key highlights from the bill
Definition: The bill defines digital commodity as “a fungible digital form of personal property that can be possessed and transferred person-to-person without necessary reliance on an intermediary”. The draft also lists the following exclusions to the definition—
- an interest in a physical commodity;
- a security;
- a digital form of currency backed by the US;
- any other instrument not classified as a digital commodity by the CFTC.
The draft, however, steers clear of defining which token constitutes a commodity or a security.
Jurisdiction: One of the key provisions in the bill grants the CFTC “exclusive jurisdiction” over digital commodity trades. The CFTC will be tasked with prohibiting fraud with respect to any digital commodity trade.
- It means that every trade will now come under the purview of the CFTC “except for transactions in which a merchant or consumer is using a digital commodity solely for the purchase or sale of a good or service”.
- The CFTC also has the power to inspect and monitor digital commodity platforms in real time for the purpose of ensuring compliance with the Act.
Registration: The law mandates that it would be illegal for an entity to conduct business without registration. It is that any entity acting as a digital commodity platform must register with the CFTC in one of the following categories:
- Digital commodity broker: They are a person who is engaged in soliciting or accepting orders on
behalf of another person for a digital commodity trade and arranging digital commodity trades on behalf of another person.
- Digital commodity custodian: It means a person who maintains possession, custody, or control over digital commodities on behalf of another person as their business.
- Digital commodity dealer: A person who has an identifiable business of dealing in a digital commodity as principal for its own account and of buying or selling digital commodities for conversion into other digital commodities, currency, or other considerations.
- Digital commodity trading facility: It means a trading facility that facilitates the execution or trading of digital commodity trades between persons.
Core Principles: All entities must permit trading only in transactions that are not readily susceptible to manipulation. They must also provide a “competitive, open, and efficient market and mechanism for executing transactions that protects the price discovery process” of trading on the platform.
- Principles for trading facilities: A digital commodity trading facility needs to establish rules to protect markets and market participants from abusive practices committed by any party.
- Monitoring activity: A digital commodity trading facility shall monitor transactions to prevent manipulation, price distortion, and disruptions through “surveillance, and disciplinary practices which include investigations, sanctions, and methods for conducting real-time monitoring of trading”.
- Disciplinary Procedures: An entity will have to put in place disciplinary procedures that authorise the digital commodity trading facility to discipline, suspend, or expel market participants that violate the rules of the platform.
- Dispute resolution: A trading facility also has to have a mechanism for dispute resolution for market participants and market intermediaries.
- For dealers and brokers: The draft directs them to ensure fair and objective prices; keep records of all digital commodity transactions and provide information to the CFTC upon request; conform with business conduct standards; and establish risk management systems.
- Core principles for all stakeholders: Every platform has been asked to preserve records for a period of five years which includes an audit trail.
- Antitrust concerns: A platform has been asked to refrain from adopting any rules that result in any unreasonable restraint of trade or impose anticompetitive burden on trading.
- Conflict of interest: The CFTC will require platforms to develop conflict of interest systems and procedures that offer “structural and institutional safeguards” such as information partitions, disclosures of material incentives or conflicts of interest.
- Cybersecurity: A platform must have a program of risk analysis and oversight to identify and minimise sources of operational risk with appropriate controls and procedures, and automated systems.
- Chief Compliance Officer: A platform has to designate an individual to serve as a chief compliance officer who will report directly to the board or to a senior officer. They will ensure that the company complies with provisions under the law.
- They also have to prepare an annual report that contains details about compliance of the platform with the Act, and its policies and procedures.
Customer protections: The CFTC has been asked to incorporate customer protection requirements which require disclosure by a digital commodity platform to a customer about the following:
- Information about material risks;
- Characteristics of any applicable digital commodity contracts;
- Material incentives or conflicts of interest of the platform;
- Standards governing platforms’ marketing and advertising including testimonials and endorsements.
Self-regulation: The law has mandated that everyone from a digital commodity broker, digital commodity dealer, or digital commodity custodian shall be a member of a registered futures association. The CFTC has the power under the law to ask an association to perform the function of registering entities dealing with digital commodities.
Fees charged by CFTC: The CFTC can assess and collect fees from entities to be used for recovering annual costs of the following:
- Registering digital commodity platforms;
- Conducting oversight of digital commodity trades;
- Carrying out education and outreach activities
- The rate will be determined on the basis of the volume of business of the digital commodity platform; and the category of the digital commodity platform.
- The law forbids digital commodity platforms from imposing a per-transaction fee for each digital commodity trade to pay the fees to CFTC.
Preparation of reports: The CFTC has been asked to examine the energy consumption and sources of energy used in connection with the creation and transfer of the most widely-traded digital commodities.
- They have to prepare a report within 180 days providing an estimate of the energy consumption. The CFTC has also been asked to publish the estimate on its website, and update the dashboard periodically on a timely basis.
- The CFTC must also prepare a report to examine the racial, ethnic, and gender demographics of customers participating in digital commodity markets; and submit the report in the US Senate.
- The report should propose ways in which the CFTC can provide outreach to historically under-served customers participating in digital commodity markets. The report will have to be prepared within 180 days once the law comes into force.
1/ Four members of the Senate Agriculture Committee just introduced the Digital Commodities Consumer Protection Act, the third bill this year making the CFTC primary regulator for crypto spot markets.
It's a good bill overall & confirms a growing consensus for CFTC regulation.
— Jake Chervinsky (@jchervinsky) August 3, 2022
Not the first legislation to regulate crypto assets in the US Senate
The Digital Commodities Consumer Protection Act is not the first bill to be introduced in the US Senate to regulate crypto assets. It comes on the heels of the Responsible Financial Innovation Act which was introduced in June 2022 by US senators Kirsten Gillibrand and Cynthia Lummis which develops a framework to regulate digital assets in the US.
Moreover, the bill by Gillibrand and Lummis also proposes to designate the Commodity Futures Trading Commission with authority to regulate digital asset spot markets. The draft had said that the mandate “aligns well with their [the CFTC’s] current purview over other commodity markets.”
The scope of the Lummis-Gillibrand bill is more expansive than the one proposed by Stablenow. The draft dealt with issues of taxation including a de minimis exclusion of $200, definitions, stablecoins, central bank digital currencies, innovation, among others.
The bill also dealt with customer protections mandating intermediaries to ensure that the “scope of permissible transactions that may be undertaken with customer digital assets is disclosed clearly in a customer agreement.”
It also directs them to acknowledge:
- Material source code version changes relating to digital assets before any updates,
- Manner of segregation of customer’s digital assets,
- Treatment of customer assets in a bankruptcy or insolvency scenario and the risks of loss,
- Time period and the manner in which it is obligated to return the digital asset of the customer upon their request,
- Applicable fees,
- Dispute resolution process.
You can read our summary of the bill here.
When will India come up with its own bill to regulate crypto assets?
The Lummis-Gillibrand bill, along with the one by Stablenow, can serve as a blueprint for India’s own law regarding digital assets which is currently under deliberation. There is no clarity on when the bill will be tabled in the Parliament after having been listed twice for introduction.
The government had announced recently that it was working on releasing a consultation paper which covers a wide range of issues thrown up by crypto assets. The paper is likely to reveal the government’s position on crypto assets and how it intends to regulate them. It does suggest that a law might still be a few months away from promulgation.
The path to regulation is littered with treacherous turns as India’s central bank is gunning for a ban. Finance Minister Nirmala Sitharaman recently revealed that RBI wants to bring back the ban on cryptocurrencies it had first introduced in 2018.
Note: The headline was updated on August 8, 12.28 PM for greater clarity
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