Presented by the DC Privacy Summit

Good morning and happy Friday. This week, we dive into a new stablecoin bill and lawsuit against the SEC.

Top Points

Senator Bill Hagerty (R-TN) unveiled a draft bill to establish a regulatory framework for stablecoin issuers, drawing heavily on Chairman McHenry's Clarity for Payment Stablecoins Act.
Crypto.com is asking a federal district court in Texas to set aside the SEC's “de facto rule” that treats virtually all digital assets sales as securities, and declare the platform is not acting as an unregistered securities broker-dealer or clearing agency.

Clarity for Payment Stablecoins Act of 2024

On Thursday, Senator Bill Hagerty (R-TN) unveiled a discussion draft for the Clarity for Payment Stablecoins Act of 2024.

Text.

Similar to Chair Patrick McHenry's bill, Senator Hagerty's bill would establish reserve, disclosure, and redemption requirements for issuers, create pathways for bank and nonbank issuers, and delineate supervisory and enforcement roles for federal and state regulators.

Here's a high-level overview of key provisions:

Who may issue?

Subsidiaries of insured depository institutions
Nonbank entities
State-qualified issuers, if:
- Approved by a state regulator,
- Issues stablecoins in compliance with minimum federal regulatory requirements, and
- Has a market cap of $10 billion or less (though the issuer may ask for a waiver) See §§ 1, 3, 14.

More specifically, an issuer may opt for a state-level regulatory regime if:

What are the regulatory requirements?

In general, all issuers must:

Back stablecoins on a 1:1 basis with certain reserve assets (e.g., U.S. coins and currency; funds held as demand deposits at banks; Treasury bills, notes, or bonds with a maturity of 93 days or less; certain money market funds; and more) (See full list in § 4(a)(1)(A)).
Establish procedures for timely redemption and publicly disclose redemption policies.
Disclose monthly composition of reserve assets on their website, and have this information examined by a registered public accounting firm & certified by the issuer’s CEO and CFO.
Not rehypothecate reserve assets.
Limit activities to those directly supporting the work of issuing and redeeming stablecoins.
Comply with the Bank Secrecy Act. § 4.

In addition, all issuers must comply with capital, liquidity, and risk-management rules to be issued jointly by federal regulators. State regulators may also issue rules. § 4(a)(4).

How does an issuer get approved?

In the case of subsidiaries of insured depository institutions and nonbank issuers, the OCC would evaluate applicants based on the following factors:

The ability of the applicant to meet the regulatory requirements outlined above based on the applicant's financial condition and resources.
The general character and fitness of the applicant’s management.
The risks presented by the applicant and benefits provided to consumers. § 5.

In general, the OCC would have 120 days to render a decision on a completed application or the application would be deemed approved. Id.

Denial of an application would require a written explanation and an opportunity for hearing. Id.

Who gets supervisory and enforcement authority?

For federally-approved issuers, federal banking regulators would have supervisory and enforcement authority, with the OCC having supervisory authority over nonbank entities. See § 6.

For state-qualified issuers, state regulators would have supervisory, examination, and enforcement authority. § 7(a).

However, in exigent circumstances (to be defined by rulemaking), the Fed could bring certain enforcement actions against a state-qualified issuer. See § 7(e).

Other Noteworthy Provisions

Customer Protection:

Any person providing custodial or safekeeping services for stablecoins or private keys of stablecoins must: (a) be subject to Federal or state regulatory supervision, (b) segregate customer property, and (c) submit information to the Fed on their business operations and how they protect customer assets. § 8.
- Note: Persons providing hardware or software to facilitate a customer’s self-custody are excluded from this section. § 8(e).
Commingling of customer property with funds of the issuer or a custodian would also be generally prohibited. § 8(c).

Interoperability: Section 9 would direct federal stablecoin regulators to prescribe standards for issuers to promote interoperability.

Algos: Section 10 would place a 2-year moratorium on issuing “endogenously collateralized” (i.e. algorithmic) stablecoins that are not in existences on the date of enactment. During this period, Treasury would study endogenously collateralized stablecoins and report back to Congress.

Not Securities: Section 13 would clarify that payment stablecoins are not securities.

What's Next?

In a press release announcing the draft, Senator Hagerty asks for feedback on the bill by November 1st.

It remains to be seen whether Congressional Democrats, Republicans, and the White House can reach an agreement in the lame duck. But as further evidence there's interest in finalizing a deal, Axios reported earlier this week that Rep. Maxine Waters (D-CA) floated her own updated stablecoin proposal to HFSC Chairman Patrick McHenry (R-NC).

Crypto.Com Sues SEC

On Tuesday, Crypto.Com filed suit against the SEC in the Eastern District of Texas.

In short, Crypto.com is asking the court to:

Set aside the SEC’s “unlawful de facto rule” of treating nearly all digital assets as “crypto asset securities;”
Stop the SEC from enforcing this de facto rule against Crypto.com;
Declare that secondary-market transactions in digital assets on its platform are not securities transactions, and that Crypto.com is not required to register as a securities broker-dealer or clearing agency. See Complaint at 45.

The SEC sent Crypto.com a Wells notice in September. Id. at 15.

Crypto.com's preemptive suit allows the trading platform to frame the narrative first and choose a preferred venue (i.e., the Fifth Circuit).

De Facto Rule

Crypto.Com’s argues the SEC's asserted authority over secondary-market sales of crypto assets relies on an “unlawful de facto rule:” namely, that nearly all crypto assets and transactions involving them are securities (the “Rule”). Id. at 1.

Crypto.com points to various enforcement actions, proposed rules, final rules, orders, and statements by Chair Gensler advancing this theory as proof the SEC has, in effect, adopted the Rule. See id. at 27-29.

According to Crypto.com, the court must set aside the Rule under the Declaratory Judgement Act and/or the Administrative Procedures Act because the Rule:

(i) is unlawful and exceeds the SEC's statutory authority,
(ii) is arbitrary and capricious, and
(iii) didn't go through the APA’s notice-and-comment process.

Here’s a closer look:

(i) The Rule is Unlawful

Crypto.com argues the Rule is outside of the SEC's statutory authority because secondary-market sales of digital asset tokens are not investment contract securities under the Securities Act of 1933 or Securities Exchange Act of 1934.

Note: Crypto.com keys its analysis on “Targeted Network Tokens”: SOL, ADA, BNB, FIL, FLOW, ICP, ATOM, ALGO, NEAR, and DASH (tokens the SEC has designated as “Crypto Asset Securities” in prior actions).

For example, Crypto.com argues Targeted Network Token sales on Crypto.com are not securities under the Howey test because:

Targeted Network Tokens do not appear in any statutory definition of security and do not share characteristics commonly associated with securities (e.g., profit-sharing, dividends, risk of loss).
There’s no relationship between Crypto.com and issuers of Targeted Network Tokens.
Crypto.com makes no representations and has no ongoing obligations to deliver future value or commitments to buyers.
The buyer from Crypto.com does not invest in a common enterprise. See Complaint at 19-21.

Additionally, Crypto.com cites cases like SEC v. Binance and SEC v. Ripple Labs where courts have held that digital assets were not themselves investment contracts and certain secondary-market sales were not investment contracts. In particular, the Complaint drills down on the Binance court's rejection of the SEC's “embodiment theory” (i.e., that a digital asset is an investment contract because it can “embody” the promises and obligations made by the issuer to the initial buyer). Id. at 33-35.

The Complaint also flags recent bipartisan Congressional efforts (e.g., FIT 21, DCCPA) to regulate crypto markets as proof Congress has not granted the SEC the authority it asserts. See id. at 35-38.

(ii) The Rule is Arbitrary and Capricious

Crypto.com argues the Rule must be invalidated as arbitrary and capricious because the SEC treats Targeted Network Tokens differently than similarly situated assets: bitcoin and ether.

“[T]he Targeted Network Tokens are similarly situated to bitcoin and ether because they are functionally identical and sold in the secondary-market to customers in an identical manner on the Platform.” See id. at 41-43.

Yet, “the SEC has never provided a reasoned explanation” as to why bitcoin and ether sales are not treated as securities transactions, but sales of Targeted Network Tokens are. Id. at 41-43.

(iii) The Rule Violated the APA’s Notice and Comment Requirements

Crypto.com also argues the Rule must be set aside because the SEC adopted the Rule without following the APA’s required process for notice-and-comment. Id. at 43-44.

What's Next?

Awaiting an SEC response in the form of an answer or motion to dismiss.

Joint Rulemaking Request

Crypto.com also filed a petition asking the SEC and CFTC to confirm that certain crypto derivative products are solely regulated by the CFTC.

The petition was filed pursuant to joint rules issued under the Dodd-Frank Act, which allow market participants to ask the CFTC and SEC whether a product is a “swap,” “security-based swap,” or “mixed swap.”

See Joint Rules.
See also Crypto.Com Press Release.

Look Ahead

A Message from the Coinbase Institute

Join us for the DC Privacy Summit!

Explore the future of privacy online with leading technologists, privacy advocates, and policy-minded professionals.

Thursday - October 24, 2024

USC Capital Campus - Washington, D.C.

Please note: RSVP Required!

Quick Hits

Courts

SEC v. Ripple Labs

Ripple Labs files cross-appeal.

Docket.

SEC v. Cumberland

The SEC charged Cumberland DRW LLC with operating as an unregistered dealer in more than $2 billion of crypto assets offered and sold as securities.
- SEC Press Release & Complaint.
- Cumberland responds:

Operation Token Mirror

U.S. Attorneys in the District of Massachusetts and the SEC charged individuals and market makers with criminal and civil charges related to allegations of widespread fraud and securities market manipulation via wash trading.
- USAO Massachusetts Press Release.
- SEC Press Release.

Tornado Cash

Coin Center analyzes Judge Failla's recent decision to allow charges against Roman Storm to go to trial:
- “The disappointing denial of Tornado dev's motion to dismiss.”

Tax

Josh Jarret is challenging the IRS's taxation of block rewards.
- Complaint & Coin Center Blog.

Administration

Operation ChokePoint 2.0

In an article for Unchained, Veronica Irwin explores reports that the Fed and FDIC have told banks to cap deposits from crypto companies, and examines whether these charges violate the APA.

Trivia

Last Week's A: The first vice-presidential debate was held on Oct. 15, 1976 between Walter Mondale and Bob Dole.

This Week's Q: When was the last time Congress passed all 12 appropriations bills via regular order on time?

Thanks for reading,

-GSL

Senator Hagerty's Stablecoin Bill - 10.11.24