SharkTeam: Interpretation of the U.S. House FIT21 Act
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SharkTeam: Interpretation of the U.S. House FIT21 Act
President Biden announced he would not veto the bill and called on Congress to collaborate on a "comprehensive, balanced regulatory framework for digital assets."
Navigating Web3 tides with focused insightsAuthor: SharkTeam
On May 23, 2024, the U.S. House of Representatives passed the FIT21 crypto bill (Financial Innovation and Technology for the 21st Century Act) by a vote of 279 in favor and 136 opposed. U.S. President Biden announced he would not veto the bill and called on Congress to cooperate on a "comprehensive, balanced regulatory framework for digital assets."
FIT21 aims to provide a pathway for blockchain projects to launch safely and effectively in the United States, clarify the jurisdictional boundaries between the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), distinguish whether digital assets are securities or commodities, strengthen oversight of cryptocurrency exchanges, and better protect American consumers.
I. Key Provisions of the FIT21 Bill
1. Definition of Digital Asset
Bill text: IN GENERAL.—The term “digital asset” means any fungible digital representation of value that can be exclusively possessed and transferred, person to person, without necessary reliance on an intermediary, and is recorded on a cryptographically secured public distributed ledger.
The bill defines a “digital asset” as a fungible digital representation that can be transferred peer-to-peer without relying on intermediaries and is recorded on a cryptographically secured public distributed ledger. This definition encompasses a broad range of digital forms, from cryptocurrencies to tokenized real-world assets.
2. Classification of Digital Assets
The bill introduces several key criteria to determine whether a digital asset is classified as a security or a commodity:
(1) Investment Contract (The Howey Test)
If purchasing a digital asset is considered an investment where investors expect profits through entrepreneurial or third-party efforts, it is typically treated as a security. This follows the standard established by the U.S. Supreme Court in SEC v. W.J. Howey Co., commonly known as the Howey Test.
(2) Use and Consumption
If a digital asset is primarily used as a medium for goods or services rather than as an investment expecting capital appreciation—for example, tokens used to purchase specific products or services—it may not be classified as a security but instead as a commodity or other non-security asset, based on its design and primary use case. Although such assets may still be subject to speculative trading in practice, their classification hinges on intended utility.
(3) Degree of Decentralization
The bill emphasizes the level of decentralization of the underlying blockchain network. If a digital asset operates on a highly decentralized network with no centralized authority controlling the network or the asset, it is more likely to be considered a commodity. This distinction is critical because the regulatory treatment differs significantly between “commodities” and “securities.”
The Commodity Futures Trading Commission (CFTC) will regulate digital assets as commodities “if the blockchain or digital ledger on which it operates is functional and decentralized.”
The Securities and Exchange Commission (SEC) will regulate digital assets as securities “if the associated blockchain is functional but not strictly decentralized.”
The bill defines decentralization as requiring, among other things, that no person has unilateral control over the blockchain or its usage, and no issuer or affiliate holds 20% or more ownership or voting rights in the digital asset.
Specific criteria for determining decentralization include:
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Control and Influence: No individual or entity has had unilateral power, directly or through contracts, arrangements, or other means, to control or materially alter the functionality or operation of the blockchain system within the past 12 months.
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Ownership Distribution: No person or entity affiliated with the digital asset issuer has collectively held more than 20% of the total issued supply of the digital asset within the past 12 months.
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Voting Rights and Governance: No person or entity affiliated with the issuer has been able to unilaterally direct or influence more than 20% of the voting power related to the digital asset or its decentralized governance system within the past 12 months.
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Code Contributions and Modifications: The issuer or related parties have not made material, unilateral changes to the source code of the blockchain system within the past three months, unless such changes were necessary to address security vulnerabilities, routine maintenance, cybersecurity risks, or other technical improvements.
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Marketing and Promotion: Within the past three months, the issuer and its affiliates have not marketed the digital asset to the public as an investment.
Among these criteria, the distribution of ownership and governance rights—specifically the 20% threshold—is a hard benchmark that significantly influences whether a digital asset is classified as a security or commodity. Thanks to the transparency, traceability, and immutability of blockchain technology, this quantitative criterion becomes clearer and fairer in application.
(4) Functionality and Technical Characteristics
The relationship between a digital asset and its underlying blockchain technology is another key factor in determining regulatory treatment. This includes how the asset is created, issued, traded, and managed:
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Asset Issuance: Many digital assets are issued through programmable mechanisms on blockchains, meaning their creation and distribution follow predefined algorithms and rules rather than manual intervention.
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Transaction Validation: Transactions involving digital assets must be validated and recorded via consensus mechanisms on the blockchain network, ensuring correctness and immutability.
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Decentralized Governance: Some digital asset projects implement decentralized governance models, allowing token holders to participate in decision-making processes, such as voting on future development directions.
These characteristics directly affect how an asset is regulated. If a digital asset primarily provides economic returns through automated blockchain programs or allows participation in governance votes, it may be deemed a security, indicating investor expectations of profit derived from managerial or entrepreneurial efforts. Conversely, if its main function is as a medium of exchange or direct access to goods and services, it is more likely to be classified as a commodity.
3. Marketing and Sale of Digital Assets
How digital assets are marketed and sold is also a central component of FIT21. If a digital asset is primarily promoted based on expected investment returns, it may be classified as a security. This aspect is particularly significant as it shapes the regulatory framework and could influence which digital assets might qualify for spot ETF approval next.
(1) Registration and Regulatory Responsibility
Digital assets fall into two categories: digital commodities and securities. Depending on the classification, regulation is shared between two primary agencies:
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Commodity Futures Trading Commission (CFTC): Oversees trading of digital commodities and related market participants.
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Securities and Exchange Commission (SEC): Regulates digital assets deemed securities and their trading platforms.
(2) Lock-up Period for Insider Tokens
Bill text: "A restricted digital asset owned by a related person or an affiliated person may only be offered or sold after 12 months after the later of— (A) the date on which such restricted digital asset was acquired; or (B) the digital asset maturity date."
This provision mandates that insiders must lock up their tokens for at least 12 months from the acquisition date or from the defined “digital asset maturity date,” whichever occurs later.
This delayed selling mechanism helps prevent insiders from profiting using non-public information or unfairly influencing market prices. By aligning insider incentives with long-term project goals, it discourages speculation and market manipulation, contributing to a more stable and fair market environment.
(3) Sales Restrictions for Affiliated Persons
Bill text: "Digital assets may be sold by an affiliated person under the following conditions: (1) The total volume of digital assets sold by the person does not exceed 1% of the outstanding volume in any three-month period; (2) the affiliated person must immediately report to the Commodity Futures Trading Commission or the Securities and Exchange Commission any order to sell more than 1% of the outstanding volume."
An affiliated person may sell digital assets only if:
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The total volume sold does not exceed 1% of the outstanding supply in any three-month period;
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The affiliated person immediately reports any sale order exceeding 1% of the outstanding supply to the CFTC or SEC.
This measure prevents market manipulation and excessive speculation by limiting the volume affiliates can sell within short timeframes, thereby ensuring market stability and health.
(4) Project Disclosure Requirements
Bill text: "Digital asset issuers must disclose the information described in Section 43 on a public website prior to selling digital assets under Section 4(a)(8)."
While the specific disclosure requirements are not detailed in the provided excerpt, they typically include:
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Nature of the Digital Asset: What the digital asset represents (e.g., equity in a company, rights to future earnings, etc.);
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Risks Involved: Potential risks associated with investing in the digital asset;
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Development Status: Current state of the project or platform linked to the digital asset, including milestones achieved or market readiness;
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Financial Information: Any financial details or projections related to the digital asset;
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Management Team: Information about the individuals behind the project or issuing entity.
The bill requires digital asset issuers to provide detailed project information—including the nature of the asset, associated risks, and development status—to enable investors to make informed decisions. This enhances market transparency and protects investor interests.
(5) Customer Fund Safety and Segregation Principle
Bill text: "Digital commodity exchanges shall hold customer funds, assets, and property in a manner that minimizes the risk of loss or unreasonable delay in access by customers to their funds, assets, and property."
This provision requires digital asset service providers to implement measures ensuring the safety of customer funds, preventing losses or delays in access due to operational failures.
(6) Separation of Customer Funds and Operational Funds
Bill text: "Funds, assets, and property of a customer shall not be commingled with the funds of the digital commodity exchange or be used to secure or guarantee the trades or balances of any other customer or person."
This means service providers must strictly separate customer funds from their own operational funds, ensuring independence and preventing unauthorized use of customer assets, thus enhancing fund security and transparency.
In certain cases, such as for settlement convenience, customer funds may be held in the same account with other institutional funds, provided that separation is maintained through proper accounting and recordkeeping to ensure each customer’s funds and property remain secure.
II. Encouraging and Supporting Innovation
FIT21 also includes numerous provisions designed to encourage and support innovation.
(1) Establishment of a CFTC-SEC Joint Advisory Committee
The bill proposes creating a CFTC-SEC Digital Assets Joint Advisory Committee with the purpose of:
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Advising both commissions on rules, regulations, and policies related to digital assets;
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Promoting further coordination between the commissions on digital asset regulation;
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Researching and disseminating methods for describing, measuring, and quantifying digital assets;
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Studying the potential of digital assets, blockchain systems, and distributed ledger technologies to improve the efficiency of financial market infrastructure and better protect market participants;
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Discussing implementation of this Act and its amendments by the commissions.
The committee's goal is to promote cooperation and information sharing between the two major regulatory bodies on digital asset regulation.
(2) Strengthening and Expanding SEC’s Innovation and FinTech Strategic Center (FinHub)
The bill proposes strengthening and expanding the SEC’s Innovation and FinTech Strategic Center (FinHub) to:
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Assist in developing the commission’s approach to technological advancements;
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Examine financial technology innovations by market participants;
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Coordinate the commission’s response to emerging technologies in finance, regulation, and supervision.
Its responsibilities include:
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Promoting responsible technological innovation and fair competition within the commission, particularly in fintech, regtech, and suptech;
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Providing internal education and training on fintech to the commission;
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Advising the commission on fintech matters relevant to its functions;
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Analyzing the impact of technological advances and regulatory requirements on fintech companies;
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Providing recommendations to the commission on fintech rulemaking or actions by other agencies or staff;
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Providing information to emerging fintech enterprises about the commission, its rules, and regulations;
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Encouraging companies working in emerging technologies to collaborate with the commission and receive feedback on potential regulatory issues.
FinHub’s primary mission is to advance fintech-related policymaking and provide guidance and resources to market participants. It must submit an annual report to Congress detailing its activities in the prior fiscal year. Additionally, it must have full access to commission and self-regulatory organization documents and information, supported by a detailed recordkeeping system (as defined under Section 552a of Title 5, U.S. Code) to facilitate communication.
(3) Creation of CFTC’s LabCFTC
The bill proposes establishing LabCFTC with the purpose of:
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Promoting responsible financial innovation and fair competition for the benefit of the American public;
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Serving as an information platform to inform the commission about new fintech innovations;
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Engaging with innovators to discuss their technologies and the regulatory framework established by this Act and related regulations.
Its responsibilities include:
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Providing recommendations to the commission on fintech rulemaking or actions by other agencies or staff;
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Providing internal education and training on fintech to the commission;
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Advising the commission on fintech to strengthen its supervisory functions;
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Engaging with academia, students, and professionals on fintech topics, ideas, and technologies related to the Act;
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Providing information to personnel in emerging tech fields about the commission, its rules, regulations, and the role of registered futures associations;
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Encouraging personnel in emerging tech fields to engage with the commission and obtain feedback on potential regulatory concerns.
Like FinHub, LabCFTC’s mission is to support policy development and provide technical guidance and outreach. LabCFTC must also submit an annual report to Congress and be granted full access to commission and self-regulatory or registered futures association documents and information, supported by a detailed recordkeeping system.
(4) Emphasis on Research into DeFi, NFTs, Derivatives, and Other Innovations
The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) should jointly conduct research on innovative areas such as decentralized finance (DeFi), non-fungible digital assets (NFTs), and derivatives, studying their development trends and assessing their impact on traditional financial markets and potential regulatory strategies.
This section establishes a clear stance toward crypto compliance, particularly highlighting DeFi and NFT research, signaling that these areas may soon face clearer regulatory frameworks.
III. Significance of the FIT21 Bill
Although the crypto industry has existed for over a decade, there remains no comprehensive global regulatory framework for digital assets. Existing regulations are fragmented, incomplete, and lack clarity. This regulatory uncertainty not only hinders the growth of legitimate businesses but also creates opportunities for bad actors.
Therefore, the passage of FIT21 is highly significant.
Its passage plays a crucial positive role in establishing a regulatory environment supportive of blockchain technology development, while setting clear requirements for protecting crypto markets and consumer safety. Specific provisions include clearly assigning regulatory authority over different types of digital assets to either the CFTC or SEC; implementing consumer protections such as segregation of customer funds, insider token lock-up periods, annual sales volume limits, and disclosure requirements.
Blockchain technology and digital assets represent another epoch-defining invention following the internet, holding immense potential and promise. Embracing regulation while fostering innovation, we are all pioneers of this new era.
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