OK, So What the Hell is In this Lummis-Gillibrand 'Responsible Financial Innovation Act'?

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Introduction

According to Senator Kirsten Gillibrand (D-NY), co-author of the 'Responsible Financial Innovation Act', "To maintain America as the financial capital of the world, the federal government needs to encourage innovation in the digital assets markets and protect consumers through thoughtful regulation" [Gillibrand, K. The Responsible Financial Innovation Act. (Accessed June 9, 2022)]. Senator Cynthia Lummis (R-WY) added:

The United States is the global financial leader, and to ensure the next generation of Americans enjoys greater opportunity, it is critical to integrate digital assets into existing law and to harness the efficiency and transparency of this asset class while addressing risk. My home state of Wyoming has gone to great lengths to lead the nation in digital asset regulation, and I want to bring that success to the federal level. As this industry continues to grow, it is critical that Congress carefully crafts legislation that promotes innovation while protecting the consumer against bad actors.

[Id].

Lummis and Gillibrand have worked for months to craft the bipartisan package, first announcing the effort in March 2022. Their respective committee assignments laid the groundwork for the partnership: Gillibrand serves on the Agriculture Committee, which has oversight over the Commodity Futures Trading Commission (CFTC), which regulates commodities markets. Lummis serves on the Banking Committee, which has oversight over the U.S. Securities and Exchange Commission (SEC), which regulates securities.

[Gillibrand, K. Press Release-Lummis, Gillibrand Introduce Landmark Legislation To Create Regulatory Framework For Digital Assets. (Accessed June 9, 2022)].

Regarding this proposed legislation, Senator Gillibrand reasoned: "As with any new technology, there are real risks to consumers, businesses, national security, and our financial system. These risks make sound regulation key. Furthermore, without a clear and defined regulatory framework to guide their businesses practices, digital asset companies could be compelled to take their operations overseas. The bottom line is that it is absolutely critical that the U.S. plays a leading role in this new frontier" [Gillibrand-The Responsible Financial Innovation Act. Supra].

There is an awful lot covered within this proposed legislation. For this article we will be investigating highlighted key provisions contained therein (quoting from the proposed legislation whenever possible). Should you wish to read the entire text of this proposed bill, you may click here.

Key Provisions Contained Within the Responsible Financial Innovation Act (hereinafter the 'Act')

Definitions for Key Terms

The Act includes a number of definitions for key terms, including but not limited to: DIGITAL ASSET, DIGITAL ASSET INTERMEDIARY, DISTRIBUTED LEDGER TECHNOLOGY, PAYMENT STABLECOIN, SECURITY, and VIRTUAL CURRENCY. "If codified into law, these definitions alone would go a long way towards establishing a framework for understanding some admittedly complex concepts" [Staples, C. Breaking Down the New Bitcoin Bill: An Overview of the Lummis-Gillibrand Responsible Financial Innovation Act. (Accessed June 9, 2022)].

Responsible Taxation of Digital Assets

Highlights from this Section of the proposed legislation are:

Gain or Loss From Disposition of Digital Currency

" (a) In General.—Gross income shall not include gain or loss from the disposition of virtual currency in a personal transaction (as such term is defined in section 988(e)) for the purchase of goods or services.
(b) Limitation.—
(1) IN GENERAL.—The amount of gain or loss excluded from gross income under subsection (a) with respect to a disposition shall not exceed $200.
(2) AGGREGATION RULE.—For purposes of this subsection, all dispositions which are part of the same transaction (or a series of related transactions) shall be treated as one disposition
(3) OTHER DISPOSITIONS.—For purposes of this subsection, subsection (a) shall not include dispositions in which virtual currency is sold or exchanged for cash, cash equivalents, digital assets (as defined in section 9801, title 31, United States Code), or other securities or commodities" [Lummis, C. and Gillibrand, K. Lummis-Gillibrand Responsible Financial Innovation Act. (Accessed June 9, 2022)].

These provisions provide for the greater usage of cryptocurrency as an alternative payment and exchange of value medium. The Act further provides a taxpayer gross income exclusion of up to $200 for the payment of goods or services, subject to aggregation. Interestingly, for the acts of 'mining' or 'staking' cryptocurrency, the Act provides "that digital assets obtained from these activities do not form a part of a taxpayer’s gross income until the eventual disposition of those assets and conversion to fiat currency" [Staples. Supra.].

Classification of the 'Decentralized Autonomous Organization'

The Act provides: "DECENTRALIZED AUTONOMOUS ORGANIZATION.—The term ‘decentralized autonomous organization’ means an organization—
(i) which utilizes smart contracts (as defined in section 9801 of title 31, United States Code) to effectuate collective action for a business, commercial, charitable, or similar entity,
(ii) governance of which is achieved primarily on a distributed basis, and
(iii) which is properly incorporated or organized under the laws of a State or foreign jurisdiction as a decentralized autonomous organization, cooperative, foundation or any similar entity" [Lummis and Gillibrand. Supra].

This section is very important as it now defines a DAO as a business entity for tax purposes under the Code. Furthermore, under the proposed legislation all DAOs will be required to be incorporated or otherwise organized under the laws of an identifiable jurisdiction.

Commodity Futures Trading Commission Jurisdiction Over Digital Asset Transactions

The Act provides:

"(I) JURISDICTION.—Subject to sections 6d, 12(e) and section 403 of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27a), the Commission shall have exclusive jurisdiction over any agreement, contract, or transaction involving a contract of sale of a digital asset in interstate commerce, including ancillary assets (consistent with section 41(b)(4) of the Securities Exchange Act of 1934), except that specified periodic reporting requirements made by an issuer which provided the holder of the security with an ancillary asset under that section, and the security that constitutes an investment contract (within the meaning of section 2(a)(1) of the Securities Act of 1933 (15 U.S.C. 77b(a)(1))), shall remain within the jurisdiction of the Securities and Exchange Commission.
(II) FUNGIBILITY REQUIREMENT.—The Commission shall only exercise
jurisdiction over an agreement, contract, or transaction involving a contract of sale of a digital asset that is fungible, which shall not include digital collectibles and other unique digital assets" [Lummis and Gillibrand. Supra].

Here the Act finally settles the issue as to who should regulate cryptocurrency and other digital assets. A review of the Act gives to the CFTC exclusive spot market jurisdiction over all fungible digital assets which are not securities. "Digital assets that meet the definition of a commodity, such as bitcoin or ether, which comprise more than half of digital asset market capitalization, will be regulated by the CFTC" [Gillibrand-The Responsible Financial Innovation Act. Supra]. And the Act requires CFTC registration by digital asset exchanges to conduct asset trading and "further classifies those exchanges as financial institutions subject to other existing laws" [Staples. Supra].

To determine whether the CFTC or SEC has jurisdiction over a particular digital asset, the Act codifies the existing legal precedent in SEC v. WJ Howey Co., 328 U.S. 293 (1946). The Howey test determines

whether a transaction qualifies as an “investment contract” and is therefore, deemed a security subject to disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934. The determination requires an examination of the rights or powers given to the holder of the digital asset, as well as the asset’s inherent purpose. In order to be classified as a security, the digital asset must provide the holder with a debt or equity interest in a business entity, liquidation rights or entitlement to interest or dividend payments from a business entity, a profit or revenue share in a business entity derived 'solely from the entrepreneurial or managerial efforts of others,' or any other financial interest in the entity.

[Id].

Regarding the implementation of the codified Howey test, Senator Gillibrand remarked: "Most cryptocurrencies go to the SEC [...] Bitcoin and Ether would be certainly commodities, and that's agreed upon. That’s agreed with Chairman Gensler as well as the chairman of the CFTC" [Ng, F. Gillibrand and Lummis state that most altcoins are securities. (Accessed June 9, 2022). Clarifying this, she added: "I don’t think CFTC is the primary regulator.... They just have the obligation to regulate Bitcoin and Ether, the majority of cryptocurrencies today [Id].

Payment Stablecoins

Regarding 'payment stablecoins', the Act provides:

(a) In General.—A depository institution may issue, redeem and conduct all incidental activities relating to payment stablecoins, as provided by this section.
(b) Required Payment Stablecoin Assets.—A depository institution shall maintain high quality liquid assets under this section equal to not less than 100 percent of the face amount of the liabilities of the institution on payment stablecoins issued by the institution. In the case of an insured depository institution described in subsection (m)(1)(A) that engages in on-balance sheet lending activities, assets under this subsection shall equal not less than 100 percent of the face amount of the liabilities of the institution on payment stablecoins issued by the institution, with the assets held in balances at a Federal Reserve bank (including a segregated balance account), or in the case of foreign withdrawable reserves, at a foreign central bank, in a special, custodial or trust account, other off-balance sheet account, or in another equivalent manner that ensures the segregation of the assets in the event of receivership. An insured depository institution may segregate the issuance and management of payment stablecoins into a separate depository institution affiliate under the same holding company structure. Eligible high-quality liquid assets under this section shall be comprised of the following:
(1) United States coins and currency and any other instrument defined as legal tender (as defined by 31 U.S.C. 5103);
(2) Demand deposits at a depository institution, except that deposits in an insured depository institution shall not exceed the limit of deposit or share insurance available for that account, which may include passthrough insurance, or shall be maintained in a special, custodial or trust account or other off-balance sheet account held by the insured depository institution;
(3) Balances held at a Federal Reserve bank, which may be held in a master account or segregated balance account;
(4) Foreign withdrawable reserves, as defined in 12 C.F.R. 249.3, consistent with any foreign unit of account in which the payment stablecoin is denominated or pegged.
(5) A security that is issued by, or unconditionally guaranteed as to the timely payment of principal and interest by, the Department of the Treasury, with an original maturity of 1-
5 year or less.
(6) A reserve repurchase agreement relating to a security specified by paragraph (5);
(7) Any other high-quality, liquid asset determined to be consistent with safe and sound banking practices, as determined by the appropriate Federal banking agency or State bank supervisor. [Lummis and Gillibrand. Supra].

It should be noted that the Act defines 'payment stablecoins' as "neither commodities nor securities, but would still be subject to significant regulation under the Act, which regulation is much needed following the recent collapse of the TerraUSD stablecoin and the reliance on stablecoins in many parts of the developing world as an alternative store of value and a hedge against inflation" [Staples. Supra]. Many of the Acts provisions in this regard concern consumer protection in the areas of reserve funds and reporting.

Final Thoughts

Although it may seem that this article is voluminous, it does not scratch the surface of the full contents of this proposed legislation. In fact the text of the full proposed legislation is 69 pages in length.

The Act contains many other procedural and operational consumer protection provisions. Please remember, only this author's perceived highlights were addressed herein.

If you are interested in this topic, avail yourself of the link to the full text of the Act as provided above.

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