Crypto Regulation Is Coming – Here’s What You Need to Do

After years of getting nowhere, Congress finally has before it comprehensive legislation that would go a long way to bringing common sense regulation to crypto.

The bill, the Responsible Financial Innovation Act, is a bipartisan effort from Senators Cynthia Lummis, R-WY, and Kirsten Gillibrand, D-NY.

Initial reactions to the bill from the crypto community have been almost universally positive.

“We’re really excited about this bill, and we think it landed in a really, really great place,” Michelle Bond, CEO of the Association of Digital Asset Markets, crypto-industry trade group, told The Wall Street Journal.

Some libertarian-minded crypto fans have long opposed regulation. But it’s a necessary and vital step that will make crypto investing much safer – which in turn will set the stage for higher prices.

Today, I want to go over the salient points of the bill, explain why it opens up the potential for huge profits for crypto investors, and talk about what comes next…

Why the Crypto Market Needs Legislation

Two recent incidents show how a lack of regulation leaves investors vulnerable to damaging blowups that cause painful losses and trigger sharp declines in the crypto markets.

The first was the collapse of the TerraLuna ecosystem last month. When the TerraUSD (UST) algorithmic stablecoin lost its peg to the U.S. dollar, the LUNA token intended to maintain the peg plunged to near-worthlessness. Some $68 billion of investor value was lost.

On the heel of that crisis, crypto lender Celsius froze all customer withdrawals as it struggled to stay solvent. Celsius had a large position in a crypto asset called staked ether (stETH), a sort of proxy crypto that allows investors to trade ETH that would otherwise be locked up via staking.

A rush on redemptions (investors converting stETH back to ETH) that started when an stETH staking service lost its keys caused the peg between stETH and ETH to break, with stETH trading at a 5% to 6% discount to ETH. Every redemption became a loss.

As a result, companies with millions of dollars of exposure to stETH – like Celsius and hedge fund Three Arrows Capital – are now teetering on insolvency.

It’s obvious that crypto desperately needs more oversight if it is to become a trusted component of the financial world – both for institutional investors and small investors like you and me.

Crypto regulation is long overdue – I’ve been talking about it since 2014 – but the Lummis-Gillibrand bill is the first legislation to have a real chance of becoming law.

Here are the key points of the bill…

What You Need to Know About the New Crypto Bill

The first thing to know about the Responsible Financial Innovation Act is that Sens. Lummis and Gillibrand definitely did their research.

“We tried to do our due diligence by talking to lots of members of the SEC, members of CFTC, lots of staff from all the committees of jurisdiction, stakeholders, advocacy organizations, and industry players throughout the country,” Sen. Gillibrand told CoinDesk’s “The Breakdown” podcast. “And so we tried to get as much information as we could. It’s not necessarily going to be perfect, but we’re committed to working hard to get it right.”

While the bill covers a lot of ground, these provisions most directly affect retail investors:

  • Securities or commodities: This question has dogged crypto for years and delayed regulation because the SEC regulates securities and the CFTC regulates commodities. The Lummis-Gillibrand bill draws a clear distinction. Fully decentralized cryptocurrencies, such as Bitcoin and Ethereum, are classified as commodities. Digital assets that match the requirements of the Howey test are securities. But the bill adds a new type of commodity it calls “ancillary assets.” While these assets are not fully decentralized and benefit from the managerial efforts of a team, they are not equity and do not create rights to profits or other financial interests. The bill requires the issuers of ancillary assets (such as ICOs) to make tailored disclosures to the SEC twice a year to retain the “commodity” classification. If they become fully decentralized, the assets can graduate to full commodity status without making the twice-yearly reports.
  • Exchange regulation: Crypto exchanges will fall under the jurisdiction of the CFTC. The CFTC will be allowed to charge the exchanges a fee to help pay for the costs of oversight.
  • Stablecoins: The bill would require stablecoins to be fully backed and the issuers required to disclose the holdings used to back them. The failed TerraUSD was an algorithmic stablecoin that was not backed by U.S. dollar assets. The bill would also allow banks and credit unions to issue stablecoins. Stablecoins are classified as commodities.
  • Taxation: After years without clarity on whether staking and mining rewards are taxable events, the bill makes a welcome call. Digital assets acquired through mining or staking are not taxable until sold. The bill also says crypto lending transactions are not taxable events. Unfortunately, the bill does not set the taxable status of crypto acquired via events like forks and airdrops. Instead it charges the IRS to study the issue and make a determination. The tax status of interest-bearing accounts was not addressed, but as an interest payment received you can assume it’s taxable income.
  • A de minimis exclusion: Calculating taxable gains and losses for small crypto transactions is a huge stumbling block to the use of cryptocurrencies for daily spending. The bill exempts gains on crypto transactions of up to $200. While substantially lower than the $600 de minimis exclusion proposed in 2017 in the initial version of a bill called Cryptocurrency Fairness Act, it’s a welcome change.
  • Consumer protections: The bill requires crypto companies that hold customer assets “clearly disclose” information in their customer agreements. It also ensures that “assets are appropriately safeguarded in an insolvency” and that customers have the right to retain control of their digital assets. To prevent crypto companies from “borrowing” customer funds for risky investment schemes, the bill requires a company get customer consent before it uses their digital assets as collateral for any other financial transaction.
  • Retirement accounts: Many investors want to add crypto to their retirement accounts, but lack of regulation has made such opportunities scarce. The Lummis-Gillibrand bill doesn’t settle this, but instructs the General Accounting Office (GAO) to analyze the “potential opportunities and risks of retirement investing in digital assets” and report on its findings.

This bill is far from the final word on crypto regulation. It calls for a number of studies to be done, including one by the Federal Energy Regulatory Commission to analyze crypto energy consumption for such activities as mining and staking. The bill also instructs the SEC and CFTC to work together to develop guidance for crypto firms “around topics such as security operations, risk identification and mitigation, sanctions avoidance, and money laundering.”

What Happens Now

The Lummis-Gillibrand bill has a long way to go to become law. Past efforts have made little progress.

But this bill’s authors both carry significant clout and serve on key committees that greatly improves their chances of shepherding the legislation forward.

Sen. Gillibrand is a former securities lawyer who practiced law for about 15 years and serves on the Senate’s Agriculture Committee (which oversees the CFTC and holds hearings on crypto). Sen. Lummis serves on the powerful Senate Banking Committee.

With midterm elections only a few months away, no one expects the crypto bill to become law during the current session of Congress. But it has a good chance of advancing in 2023. Even then, because it has to go through four different committees (banking, agriculture, intelligence, and financial services), it will be a slow and piecemeal process.

But it represents real progress on U.S. crypto regulation.

“We expect this bill will be the starting point for debate next year regardless of which party controls the House or the Senate,” Jaret Seiberg, an analyst with Cowen Washington Research Group, wrote in a note. “What does matter is that there is a bipartisan effort to bring crypto into the existing regulatory regime even if the details are likely to change.”

In the meantime, the strategy for prospective investors is simple: Now’s the time to establish a position in crypto, especially while so many tokens are available “on the dip.”

— David Zeiler

He’s the richest man in the world. He has 47 million Twitter followers. And his genius is on par with Einstein, Jobs, and Nikola Tesla himself. Best of all, he can make investors millions with a single tweet. In fact, a new “big tweet” could come any day now. Full story here.

Source: Money Morning