House Crypto Bill Won’t Restrain SEC and Could Threaten DeFi, Legal Experts Say

U.S. lawmakers rolled out a much anticipated digital assets bill yesterday, raising hopes that it will end what the crypto industry sees as an unfairly hostile regulatory environment. 

But some experts say the bill’s vague language, and in particular a provision that could threaten the DeFi market, won’t do much to hold back the SEC and its enforcement approach to crypto.

"I think that we're working backwards if we're bringing more ambiguity to what's going on," Billy Sebell, executive director of the XDC Foundation, told Decrypt.

Gabriel Shapiro, general counsel for Delphi Labs, said via Twitter that the House bill still leaves many assets used in DeFi exposed to being labeled a security by the SEC. 

It now includes a number of exemptions for what qualifies as a digital asset, but Shapiro said the language around the exemptions for what counts as security leaves many DeFi assets like liquidity staked tokens unprotected.

"It's a backdoor DeFi prohibition,"he wrote.

The bill, called the Financial Innovation and Technology for the 21st Century Act, aims to redress what the sponsors say are the many shortcomings of the current regulatory regime. Its main sponsors are all Republicans, including House Agriculture Committee Chairman Glenn Thompson (R-PA), Rep. French Hill (R-AR), and Rep. Dusty Johnson (SD-AL). 

In the 212-page piece of legislation, lawmakers included new definitions around digital assets, carved out certain exemptions, and set up lanes for registering cryptocurrency exchanges with both the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC).

Jack Solowey, a policy analyst at D.C.-based libertarian think tank Cato Institute, said that the recent draft contains a few "notable changes" from the previous version released by House Republicans in June, particularly with regard to when a token is considered a security or commodity.

In the text of the new bill, a digital token sold as part of an investment contract does not itself immediately qualify as a security. In other words, the bill separates tokens from the manner in which they are sold. In the previous version, digital tokens themselves were still counted as securities if offered as part of an investment contract between parties.

Solowey suspects the update is an effort to harmonize the bill with a recent ruling by a federal judge in favor of Ripple Labs. In the partial ruling, the judge wrote that the XRP token had not been sold as a security in most cases—except when it had been sold to institutions. The XRP token "is not necessarily a security on its face," the judge said.

"I think this provision that excludes the aspects around programmatic sales from the definition of a restricted digital asset is meant to take the Ripple decision into account," Solowey told Decrypt.

Another area that left some observers concerned relates to the requirements around registering with regulators. SEC Chairman Gary Gensler claims most crypto projects are likely in violation and most companies have simply refused to register with the agency. The industry rejects this argument, countering that no clear path for registration exists. 

The House bill attempts to address this by setting a registration standard based on a legal definition of "decentralization," thereby codifying into law what it means for a crypto project to be "sufficiently decentralized" and therefore exempt from SEC registration.

Elizabeth Boison, a partner at law firm Hogan Lovells in Washington, said that the path offers a better strategy than "launch and find out later" whether the SEC considers a project sufficiently decentralized. Boison cautioned, however, that the bill leaves "the same gray area" on the SEC to make this determination.

This may not land well with many in crypto who have complained that the SEC has refused to issue any rules to clarify how to avoid enforcement actions for alleged violations. 

Ultimately, the bill is still viewed as much too favorable to the crypto industry by House Agriculture Committee Democrats. And it still has to overcome steep political obstacles, said Jeffrey Blockinger, chief legal counsel at decentralized exchange Vertex Protocol. 

In the last hearing on the bill in June, Democrats expressed concern over any perceived undercutting of the SEC. They also frequently invoked the failed crypto exchange FTX, whose collapse was accompanied by heightened scrutiny of donations made to lawmakers by its disgraced founder Sam Bankman-Fried.

"It remains to be seen whether this Congress will be able to muster the bipartisan support needed to pass any comprehensive digital asset legislation," Blockinger told Decrypt. "Ultimately, I don’t expect that Congress will step in front of the SEC in a way that is perceived to help the industry."