Responsible Financial Innovation Act

Yesterday, a leaked draft of the much-anticipated Lummis-Gillibrand Responsible Financial Innovation Act was dropped on Twitter:

here you go

(plz RT) pic.twitter.com/UOVhIUiUBu
— slam (@bot_slam) June 7, 2022

It is important to remember: if this leak is authentic (and it does seem to be), the language here may not be final, and there will still be plenty of time for comments and further changes.

So with that in mind, we wanted to take a look at the leaked draft and, at the very least, use it to start a discussion about crypto regulatory frameworks in the United States. The draft bill is 67 pages long so we can’t cover every line item, but we’ll provide a broad overview.

We’ve also compiled the leaked images into a PDF for easier reading:

crypto-draft-leak Download

What is the Responsible Financial Innovation Act?

The Responsible Financial Innovation Act is a bipartisan bill in the process of being drafted by Sen. Cynthia Lummis (R-WY) and Sen. Kirsten Gillibrand (D-NY). The intent is to provide a thorough regulatory framework for digital assets, blockchain technology, and providers of those services. Blockchain industry voices including the Chamber of Digital Commerce were active in drafting the proposed legislation.

According to the leaked draft, the bill is broken up into eight main sections:

Definitions
Responsible Taxation of Digital Assets
Responsible Securities Innovation
Responsible Commodities Innovation
Responsible Consumer Protection
Responsible Payments Innovation
Responsible Banking Innovation
Responsible Interagency Coordination

Here’s a quick TL;DR of the bill (more detail below):

Better tax clarity for daily users and miners/stakers
Bitcoin and many digital assets would be considered a commodity and under the CFTC’s jurisdiction
However, many DeFi tokens would still likely be securities under the SEC, and DAOs are now considered legal entities for tax purposes
Stablecoin issuance is allowed, but with strict guidelines
Tougher exchange compliance requirements mean better user protections but may be onerous for smaller players
Prescriptions for areas of further study and interagency coordination

“Blockchain doesn’t need to be regulated”

Given that the blockchain community has largely run free up until now (and given the general resistance to government/centralized intervention), some of the points in this bill may seem onerous or even impossible for blockchain purists.

But, try to keep in mind:

In order for cryptocurrency to truly become the foundation of a future financial system, it must be widely accepted by local authorities. Regulation simply must happen; the trick is to make sure that centralized entities don’t mess it up when it does.

This is where the political process and you, the consumer come in. This bill is a working draft that will eventually be open for public comment. If you have concerns about language in the bill, you can reach out to your legislators and let them know. This is especially important if you live in Wyoming or New York. We will be creating a page to let you quickly contact your legislators about this specific issue when the full draft is released.

So with that in mind, here’s an overview of some of the main points in the bill.

Digital Asset Tax Clarity

Daily Transactions

For starters, gains on transactions where digital assets are used to buy goods or services under $200 would not have to be reported to the IRS. As it currently stands, if you want to buy your $5 cup of morning coffee with crypto, you have to log the transaction and account for profit or loss. This makes it awfully hard to use cryptocurrency as an actual currency.

This provision of the Responsible Financial Innovation Act would make day-to-day transactions feasible for most users.

Mining, Staking, Forks, and Airdrops

Currently, digital assets earned by mining, staking, forks, and airdrops are all counted as income at the time you receive the assets. This creates more unintended tax complications for many individuals who didn’t ask to receive a fork or airdrop, or for miners and stakers who receive rewards periodically.

The new guidance would be to tax assets earned through these methods when you spend them, giving consumers much more control over their own taxes and simplifying the process significantly. Another big win for consumers.

Exchanges & Service Providers

DeFi and DAOs

DAOs must now register as legal entities in the United States, which means they must comply with local regulations and pay US taxes.

This is one of the tougher pieces in the leaked draft and would place a burden on decentralized startups that want to operate within the US market, and possibly even on those that don’t. Overseas DAOs can always ignore compliance (US regulators have no power to actually shut down operations or stop DAPPs), but as long as US users can buy and hold their tokens, there’s a surface for regulation.

Which opens up an interesting precedent… what if other countries all require DAOs to register and pay taxes as well? It would get incredibly muddy trying to figure out where a DAO’s users are located, and then having to comply with all the relevant local regulations. Death by a thousand cuts.

Furthermore, most DAO governance tokens and many DeFi tokens would likely be classified as securities (more on this later).

Centralized Exchanges

Centralized exchanges don’t exactly get off easy, either. There are a variety of regulations that place requirements on asset security, appropriate use of customer funds, standards for listing and approving digital assets, monitoring transactions, providing reasonable uptime, and recordkeeping. There’s even a clause requiring that funds be returned to users first in the event of bankruptcy.

This is a large burden for digital asset exchanges to bear, but not so much as to be unreasonable. And, much of this will likely result in a better, safer experience for the end-user. The one caveat being that the cost of compliance is going to be huge. Large exchanges and big players will have no problem beefing up their compliance dept and there is a provision allowing for offsetting regulatory costs onto the end-user, but these requirements may prove challenging for smaller or newer startups, and it’s already an incredibly expensive industry for newcomers to enter.

It’s a delicate balancing act and we like a lot of these suggestions generally speaking. More analysis will have to be done on the actual implementation of these suggested policies.

Stablecoins

Stablecoins are generally allowed. That is, depository institutions may issue and conduct activities related to stablecoin operations. There are fairly strict oversight requirements (no doubt thanks to the recent UST fiasco), and a clear requirement for:

“A depository institution shall maintain high-quality liquid assets… equal to not less than 100 percent of the face amount of the liabilities of the institution on payment stablecoins issued by the institution.”

This means that algorithmic (non-backed) stablecoins are expressly not allowed, while overcollateralized stablecoins like DAI should be allowed (although the language was clearly written with centralized exchanges in mind).

In general, this section feels pretty fair. Given how long crypto investors have had to endure the “Tether FUD,” having a clear system of regulation and oversight for centralized stablecoin issuers can only help. We just hope there’s room to include asset-backed DeFi stablecoins as well.

Bitcoin is a Commodity… but Everything Else?

As it was in the actual wild west, in the digital wild west, jurisdictions can be a little murky. With the absence of a regulatory framework, it’s currently unclear whether many digital assets are commodities, securities, or something else entirely. As such, agencies like the SEC and CFTC have both made claims that they have the right to regulate digital assets. The SEC has historically handed out more judgments and enforcements, many of which the border crypto community has been critical of.

This new bill would aim to generally classify digital assets as commodities, cementing the CFTC’s jurisdiction over much of the market.

However, there is a stipulation that a digital asset is likely a security if it confers any of the following:

Voting rights with respect to that entity.
Rights to interest, dividend payments, or profits with respect to that entity.
A debt or equity interest in that entity.
Liquidation rights with respect to that entity.

This clause affects many, if not all, DeFi and DAO tokens, although is much less likely to impact utility or payment tokens. This is fairly restrictive for a lot of tokens and use cases, and is something the wider community will likely want to address. There is also a clause excluding nonfungible assets from CFTC jurisdiction, meaning NFTs may be considered their own asset class.

The Crypto Rating Council has some great further reading on possible classifications of some digital assets on their site (based on the Howey test which is not exactly the same as this new framework).

Further Study and Agency Coordination

Lastly, there are some provisions for further study and development of various committees to further blockchain research, applications, and implementation. Specifically, the draft called for:

Using blockchain technology for reducing risk in depository institutions
A study about the possible benefits (and risks) of decentralized finance for a variety of industries
A study on the effects of PoW mining on the environment and renewable energy use
Developing an advisory committee on financial innovation

There are also several sections devoted to standardizing interagency coordination between the FED, department of the Treasury, FDIC, SEC, FinCEN, and more. There are the expected anti money laundering requirements to track illicit transactions, but there are also sections pertaining to money transmission laws and also general information sharing between the agencies. This is the sort of bureaucratic red tape that’s generally to be expected, and necessary for government adoption.

Conclusion

In general, we like the direction this bill is headed, although in its current form there are some thorny points that will need to be addressed. That said, what we like the most is that this is a comprehensive, well-thought-out framework for beginning the discussion with legislators.

Currently, users and service providers have to play guessing games on what is allowable and what isn’t based on vague guidance and sporadic judgments. This framework shows that the United States is looking to embrace digital assets and to be a global thought leader in this field over the next decade. More importantly, it also shows that legislators on both sides of the aisle are taking blockchain technology and digital assets seriously, and they’re talking to industry leaders about how best to implement it.

But legislators haven’t yet heard from YOU, the consumer. Once the final draft is released we’ll put together a page that makes it easy to find and contact your local representatives about this specific issue and why it’s important to you as their constituent.