Shawn Zhang, MJLST Staffer
Cryptocurrency has experienced rapid growth over the past few years. Retail investors rushed into this market in hopes of amassing wealth. However, the current price of Bitcoin is sitting at roughly 30% of the all-time high. Investors dub this current state of the market as the “Crypto Winter”, where the entire crypto market is underperforming. This term signifies the current negative sentiment held by a large portion of the market towards cryptocurrency.
Cryptocurrency is a relatively new class of assets, bearing similarities to both currency and securities. Regulators are not quite sure of how to regulate this volatile market, and with the lack of regulations investors are more prone to risk. Nevertheless, legislators are still seeking to protect retail investors and the general public from risky investments, as they did with the 1933 Securities Act and 1934 Securities Exchange Act. The question is how? Well, the answer may be The Lummis-Gillibrand Responsible Financial Innovation Act which has recently been introduced into Congress. This bill seeks to “provide for responsible financial innovation and to bring digital assets within the regulatory perimeter.” If passed, this bill would address those concerns investors currently have with investing in the volatile crypto market.
Summary of the Bill
This legislation would set up the regulatory landscape by granting the Commodity Futures Trading Commission (CFTC) exclusive jurisdiction over digital assets, subject to several exclusions. One of the exclusions being that when the asset is deemed a security, the Securities and Exchange Commission (SEC) will gain jurisdiction and providers of digital asset services will then be required to provide disclosures. The bill would also require the Internal Revenue Service to issue regulations clarifying issues of digital assets and eliminate capital gains taxes through a de minimis exclusion for cryptocurrencies used to buy up to $200 of goods and services per transaction. Moreover, it would also allow crypto miners to defer income taxes on digital assets earned while mining or staking until they dispose of the assets.
Commodity vs Security
So, what’s the difference between CFTC and SEC? The CFTC governs commodities and derivatives market transactions, while the SEC governs securities. The key difference that these classifications make are the laws under which they operate. The CFTC was created under the 1936 Commodities Exchange Act, while the SEC was created under the 1933 Securities Act and 1934 Securities Exchange Act. Hence, giving the CFTC primary jurisdiction means that cryptocurrency will primarily be governed under the 1936 Commodity Exchange Act. The biggest advantage (or what one may think of as a disadvantage) of this Act is that commodities are generally more lightly regulated than securities. Under the 33’ act and 34’ act, securities are thoroughly regulated via disclosures and reports to protect the public. Issuers of securities must comply with a large set of regulations (which is why IPOs are expensive). This could be a win for crypto, as crypto was intended to be “decentralized” rather than heavily regulated. Though having some regulations may help invoke public trust in this class of assets and potentially increase the total number of investors, which may be a bigger win.
The question ends up being what level of regulation and protection is appropriate? On the one hand, applying heavy handed regulations may not be effective, and in fact might encourage black market activity. This may lead to tech savvy investors detaching their real life identity from the world of crypto and using their money elsewhere through the blockchain networks. On the other hand, investors hate uncertainty. Markets react badly when there is “fear, uncertainty, and doubt.” By solidifying the jurisdiction of CFTC on cryptocurrency, both investors and issuers may feel more at ease rather than wonder what regulations they must follow. As a comparison, oil, gold, and futures are also regulated by the CFTC rather than the SEC, and they seem to be doing fine on the exchanges.
Tax Clarifications & Incentives
Clarifications are always welcome in the complex world of federal taxes. Uncertainty can result in investors avoiding a class of assets purely due to the complexity of its tax consequences. Moreover, investors may be unexpectedly hit with a tax bill that was different from what they expected due to ambiguity or lack of clarity in the statutes. Thus, clarifications under the proposed Act would likely make lives easier for investors in this space.
Tax often incentivizes certain investor actions. For example, capital gains tax incentivizes investors to hold their investments for longer than a year in order to reduce their taxes. Tax incentives also often have policy rationales behind them, like the capital gain tax incentive aims to promote long term investment rather than short term speculation. This indirectly protects investors from short term fluctuations in the market, and also keeps more money in the economy for longer.
The proposed Act would eliminate capital gains tax for crypto used to purchase goods and services up to $200. That’s $200 of untaxed money that could be spent without increasing an investor’s tax liability. This would likely encourage people to conduct at least some transactions in crypto, and thus further legitimize the asset class. People often doubt the real world use of cryptocurrencies, but if this Act can encourage people to utilize and accept cryptocurrencies in everyday transactions, it may increase confidence in the asset class.
Conclusion
The Lummis-Gillibrand Responsible Financial Innovation Act could be a big step towards further adoption and legitimization of crypto. Congress giving primary jurisdiction to the CFTC is likely the better choice, as it strikes a balance between protecting consumers while not having too much regulation. Regardless of whether this will have a positive impact on the current market or not, Congress is at least finally signaling that they do see Crypto as a legitimate class of asset.