Forward the Original Title ‘解读 FIT21 法案影响加密世界下一个10年’

On May 22, 2024, the FIT21 bill passed the House of Representatives with a vote of 279 to 136. This landmark legislation establishes a comprehensive regulatory framework for digital assets and is poised to have one of the most significant impacts on the cryptocurrency landscape to date.

This article mainly explains how to define digital assets in the regulatory framework proposed by FIT21 and the boundaries between commodities and securities.On May 22, 2024 (🍕), the FIT21 bill was passed in the House of Representatives with a vote of 279 to 136. This bill establishes a regulatory framework for digital assets and may become one of the bills with the most far-reaching impact on Crypto currently.

The Financial Innovation and Technology Act of the 21st Century (FIT21) marks a pivotal moment in the evolution of cryptocurrency regulation. Coinciding with the approval of the ETH spot ETF application (Form 19b-4), FIT21 establishes a comprehensive regulatory framework for digital assets, paving the way for more cryptocurrencies to seek spot ETFs and embrace regulatory compliance. This landmark development signifies the end of a decade-long gray area for cryptocurrencies and heralds the dawn of a new era.

1/9 · Registration and Regulatory Responsibilities

Digital assets are defined in two directions: digital commodities and securities. The bill stipulates that based on different definition directions, the supervision of digital assets is jointly responsible by two main institutions:

• Commodity Futures Trading Commission (CFTC): Responsible for supervising the trading of digital commodities and related market participants.
• Securities and Exchange Commission (SEC): Responsible for supervising digital assets considered securities and their trading platforms.

2/9 ·Definition of Digital Assets

The bill defines “digital asset” as an exchangeable digital representation that can be transferred from person to person without relying on intermediaries and is recorded on a cryptographically protected public distributed ledger. This definition encompasses a wide range of digital forms, from cryptocurrencies to tokenized real assets.

3/9 · Commodity or Security (Classification of Digital Assets)

The bill proposes several key factors to distinguish whether a digital asset belongs to a security or a commodity:

1. Investment Contract (The Howey Test): If the purchase of a digital asset is considered an investment and investors expect to profit through the efforts of promoters or third parties, the asset is generally considered a security. This is based on the standard set forth 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, such as tokens that can be used to purchase specific services or products, it may not be classified as a security but rather as a commodity or other non-security asset.
3. Decentralization: The bill specifically emphasizes the decentralization of blockchain networks. If the network behind a digital asset is highly decentralized and there is no central authority to control the network or asset’s functionality, such an asset may be more likely to be considered a commodity.
4. Function and Technical Characteristics: The technical construction and implementation of a digital asset are also the basis for classification.
5. Market Activity: How an asset is promoted and sold in the market is also an important factor. If an asset is primarily marketed through the expectation of investment returns, it may be considered a security.

This content is extremely important because it defines the regulatory framework for digital assets and will affect what digital asset might be the next one to pass through a spot ETF.

4/9 · Standard 1: Use and Consumption, Not Investment for Capital Appreciation

From the current perspective, public blockchains, PoW tokens, and functional tokens are more compliant with the standard. (Note that this is just an example from the perspective of use and consumption, and the definition of securities/commodities needs to be considered from multiple dimensions, and does not mean that these assets fully comply with the standard).

The common feature of these digital assets is that they are primarily used as a medium of exchange or payment method, rather than as an investment to expect capital appreciation. Although in the actual market, these assets may also be purchased and held for speculative purposes, but from the perspective of design and main purpose, they are more inclined to be considered commodities.

5/9 · Standard 2: Definition of Decentralization

• Control and Influence: In the past 12 months, no individual or entity has had the unilateral power, directly or through contracts, arrangements, or other means, to control or materially change the function or operation of the blockchain system.
• Ownership Distribution: In the past 12 months, no individuals or entities associated with the issuer of the digital asset have, in aggregate, owned more than 20% of the total issuance of the digital asset.
• Voting Rights and Governance: In the past 12 months, no individuals or entities associated with the issuer of the digital asset have been able to unilaterally direct or influence more than 20% of the voting rights of the digital asset or related decentralized governance system.
• Code Contribution and Modification: In the past 3 months, the issuer of the digital asset or its affiliates have not made substantive, unilateral modifications to the source code of the blockchain system, unless such modifications are to address security vulnerabilities, maintain routine operations, prevent cybersecurity risks, or other technical improvements.
• Marketing and Promotion: In the past 3 months, the issuer of the digital asset and its affiliates have not marketed the digital asset to the public market as an investment.

Among these definition standards, the more rigid standards are ownership distribution and governance rights, and the 20% boundary line is of great significance for defining a digital asset as a security or commodity. At the same time, because of the public transparency, traceability, and immutability of blockchain, the quantification of this definition standard will become more clear and fair.

6/9 · Standard 3: Function and Technical Characteristics

The bill’s definition of digital assets and how they connect to the underlying blockchain technology is the basis for determining how these assets are regulated. We have already discussed the definition of digital assets above. Here, we will specifically discuss how the connection between digital assets within the scope of the definition of digital assets determines the regulatory direction. This connection usually includes how assets are created, issued, traded, and managed:

1. Asset Issuance: Many digital assets are issued through the programmatic mechanisms of the blockchain, which means that their creation and distribution are based on predetermined algorithms and rules, rather than human intervention.
2. Transaction Validation: Transactions of digital assets need to be verified and recorded through the consensus mechanism in the blockchain network to ensure the correctness and immutability of each transaction.
3. Decentralized Governance: Some digital asset projects implement decentralized governance, and users who hold specific tokens can participate in the project’s decision-making process, such as voting on the future development direction of the project.

These characteristics directly affect how assets are regulated. Specifically:

• If digital assets primarily provide economic returns or allow voting participation in governance through the automated processes of the blockchain, they may be considered securities, as this indicates that investors are expecting to profit through management or the efforts of the enterprise.
• If the primary function of digital assets is to serve as a medium of exchange or to be used directly for the acquisition of goods or services, they may be more likely to be classified as commodities.

7/9 · Key Issue 1: Programmatic Issuance Characteristics of Assets Tend to Define Them as Commodities

This section is about how to define whether certain digital assets issued through blockchain technology, especially through smart contracts or decentralized applications (DApps), constitute securities.

In the traditional sense, securities typically involve investors investing funds and expecting to profit through the efforts of an enterprise or third party. However, in the world of blockchain and cryptocurrencies, many assets are issued and managed through automated processes or algorithms, and the characteristics and purposes of these assets may differ from traditional securities.

According to the bill’s explanation, even if a digital asset is sold or transferred under the terms of some investment contract, if these assets are automatically issued by a programmatic blockchain system, they do not automatically become securities as a result. This is because:

1. Programmatic Operation: Blockchain technology allows the issuance and management of assets to be automatically executed through code, without relying on traditional corporate structures or intervention from external managers. This automation reduces the direct control of individuals or groups over the operation of assets.
2. Decentralized Characteristics: Many blockchain-based asset issuances utilize decentralized characteristics, such as smart contracts and DApps. These tools ensure that the operation and management of assets follow predetermined rules, rather than the decisions of a single management entity.
3. Programming Transparency: Assets issued through methods such as smart contracts typically have their rules and logic open and transparent. Investors can directly access these rules and make investment decisions based on this programmatic logic.

8/9 · Key Issue 2: How to Handle Digital Assets with Governance and Voting Functions

The bill mentions that if a digital asset or its related decentralized governance system does not have any related personnel individually owning or controlling more than 20% of the voting rights in the past 12 months, this may indicate that the asset has decentralized characteristics. However, in the relationship between digital assets and blockchain systems, it is also mentioned that if digital assets primarily provide economic returns or allow voting participation in governance through the automated processes of the blockchain, they may be considered securities, as this indicates that investors are expecting to profit through management or the efforts of the enterprise.

There is a contradiction here. If a digital asset has voting rights and no related personnel have individually owned or controlled more than 20% of the voting rights through related personnel in the past 12 months, is this asset more likely to be defined as a commodity or a security?

It touches on a complex area of digital asset regulation, which is how to handle assets with governance and voting functions. Understanding this requires distinguishing between two key concepts: the decentralization of the asset and the control or economic return expectations that the asset provides to investors.

(1) Decentralization and Voting Rights

The bill mentions that if no related personnel have individually owned or controlled more than 20% of the voting rights in the past 12 months, this indicates that the digital asset has a high degree of decentralization. This usually means that no single entity or small group can control the operation or decision-making of the asset. From this perspective, high decentralization is a factor that drives assets to be considered commodities, as it reduces the control of a single entity over the value and operation of the asset, which is in line with the characteristics of commodities, namely being used primarily for exchange or use rather than for investment returns.

(2) Voting Rights and Security Attributes

On the other hand, if a digital asset allows holders to participate in governance through voting rights, especially governance with a significant influence on economic decisions, this could lead to the asset being considered a security. This is because voting rights and participation in governance typically mean that holders are expecting to profit through management or the efforts of the enterprise (including the efforts of other holders), which aligns with the basic definition of a security.

(3) Understanding the Contradiction

The potential contradiction here lies in the fact that, on the one hand, a high degree of decentralization of an asset usually aligns with commodity attributes, while on the other hand, the governance and voting functions of an asset could make it be considered a security. The key to resolving this contradiction lies in evaluating:

1. Substantive Impact of Voting Rights: Does voting have a substantial direct impact on the value and operation of the asset? If voting primarily affects technical settings or non-core economic decisions, the asset might still lean towards being a commodity.
2. Economic Return Expectations: Is the primary reason for holders to own the asset to gain economic returns (e.g., through asset appreciation or dividends), or is it to use the asset for transactions and other activities on the platform or network?

In the context of the approval of the ETH spot ETF application (Form 19b-4), the definition of ETH leans more towards functional use. Its staking and governance functionalities are more for maintaining network operation rather than economic returns. Therefore, in theory, future digital assets similar to ETH could potentially rely on this approval as a precedent, provided they meet the preconditions like a high degree of decentralization.

From this perspective, DeFi protocols governed by DAOs are more likely to be defined as securities if their governance direction leans towards acquiring economic returns or dividends. Conversely, the probability of being defined as commodities is higher if their governance direction focuses on functionality and technical upgrades.

9/9 ·Support for Technology and Innovation

• The bill proposes solidifying and expanding the SEC’s Strategic Hub for Innovation and Financial Technology (FinHub) and the CFTC’s LabCFTC. Their mission is to promote policy development related to financial technology and provide market participants with guidance and resources on emerging technologies.
• Establishment of a Joint Advisory Committee for CFTC and SEC: This committee will specifically focus on digital asset issues. Its goal is to promote cooperation and information sharing between the two major regulatory bodies regarding digital asset regulation.
• Research on Decentralized Finance (DeFi): The bill requires the SEC and CFTC to research the development of DeFi, assess its impact on traditional financial markets, and explore potential regulatory strategies.
• Research on Non-Fungible Tokens (NFTs): This section explores NFTs and their role and regulatory needs within the financial market.

This section essentially lays the groundwork for a compliant cryptocurrency landscape. The clear direction is research into DeFi and NFTs, suggesting that these areas might also see the emergence of clearer regulatory strategies in the future.

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