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The unintended consequences of the FIT21 Cryptocurrency Market Structure Law
There is no doubt that the bipartisan passage of the Financial Innovation and Technology for the 21st Century Act (FIT21) from the Chamber represents a monumental development for the US cryptocurrency industry, bringing much-needed regulatory clarity into view. However, despite its good intentions, FIT21 is fundamentally flawed from a market structure perspective and introduces issues that could have far-reaching unintended consequences if not addressed in future Senate negotiations.
Joshua Riezman is deputy general counsel of GSR.
Note: The opinions expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.
One of the most problematic aspects of the bill is the creation of a bifurcated market for crypto tokens. By distinguishing between “limited digital assets” and “digital goods” in parallel trading markets, the bill sets the stage for a fragmented landscape that is ill-suited to the inherently global and fungible nature of crypto tokens and creates the first of its own kind complications of compliance.
This legislative initiative arises from long-standing debates over the application of US federal securities laws to crypto tokens and the difference between bitcoin, which is considered a non-security, and almost all other tokens. US Securities and Exchange Commission (SEC) guidance on whether a crypto token is a security is generally based on whether the associated blockchain project is “sufficiently decentralized” and therefore is not an investment contract “security” as defined by the Howey test.
FIT21 attempts to codify this impractical test by dividing regulatory oversight of spot cryptocurrency markets between the Commodity Futures Trading Commission (CFTC) and the SEC, based on, among other things, the degree of decentralization.
While the bill appears to helpfully clarify that cryptographic tokens transferred or sold pursuant to an investment contract do not themselves become securities, it unfortunately contradicts itself by still giving the SEC plenary authority over such investment contract assets when sold to investors (or issued to developers). ) for the period of time before a project reaches decentralized Valhalla. Only tokens distributed or earned by end users are initially “digital products” subject to the jurisdiction of the CFTC.
Most confusingly, FIT21 allows simultaneous trading of limited digital assets and digital commodities for the same token in separate and distinct markets during this period (as shown in the graph below). It is likely that many projects would do this Never meet the law’s prescriptive definition of decentralization and thus trade in disconnected markets in the United States indefinitely.
The bill’s proposed bifurcated market for limited and unlimited digital assets ignores fungibility as a key feature of cryptographic tokens. By creating categories of tied and untied goods, the bill disrupts this principle, leading to confusion and market fragmentation. This could compromise liquidity, complicate transactions and risk management mechanisms such as derivatives, reduce the overall utility of crypto tokens, and ultimately stifle innovation in a nascent industry.
Implementing such distinctions would likely require technological changes to crypto tokens to allow buyers to know what type of crypto asset they are receiving so they can meet specific market requirements. Imposing such a technology stamp on restricted digital assets, even if possible, would create an “American-only” cryptocurrency market separate from global digital asset markets, reducing the utility and value of any relevant project.
As shown in the chart above, tokens could transit back and forth between the SEC and CFTC markets in the event that decentralized projects recentralize. The complexity and compliance costs created by such a scheme applied to the many thousands of future crypto tokens are dramatically underestimated and would undermine the credibility and predictability of US financial markets. There are precious few examples of financial products transitioning between SEC and CFTC jurisdiction, and it’s almost always a tire fire (for examplethe 2020 transition of KOSPI 200 futures contracts from CFTC jurisdiction to joint CFTC/SEC jurisdiction).
The bill further underestimates the international nature of crypto token markets. Crypto tokens are global assets that are traded as the same instrument globally. Attempting to restrict certain assets in the United States would likely lead to regulatory arbitrage, where the flow back from international markets would undermine the intent of the bill while eroding the competitiveness of the U.S. cryptocurrency industry.
Developers and investors outside the United States are unlikely to impose similar restrictions on restricted digital assets. Therefore, new projects and investors will be incentivized to move development and investment outside of the United States to avoid these requirements. This would make it extremely difficult to prevent the US digital commodities market from being flooded with non-US tokens that would have been restricted digital assets if they had been “issued” in the US
Finally, ironically, the bill designed to protect US consumers may end up hurting them due to poor market structure. The first CFTC-regulated markets for end users will be full of sellers who typically received tokens for free. This unbalanced market dynamic will most likely lead to low prices and greater volatility than both restricted and international markets, with professional arbitrageurs benefiting at the expense of US retail.
This system will be further manipulated by insiders and professional investors as arbitrageurs capitalize on disjoint pricing and price jump discontinuities caused by the transition between centralized and decentralized designations. At best, US retail markets will be a noisy signal of fundamental value and end users will be the last to receive institutional liquidity.
While FIT21 represents a crucial step in addressing the regulatory challenges posed by crypto tokens, the current proposed market structure may have unintended consequences. To protect customers and ensure the smooth functioning of U.S. digital asset markets, lawmakers must refine the bill to unify spot markets for fungible crypto tokens that would otherwise not be securities under a coherent regulatory framework.