The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law.
In the wake of the summary judgment decision in SEC v. Ripple, legislators and litigants have rushed to clarify what the SEC’s first loss against a digital asset issuer means for the larger Web3 industry in the United States.
This Ripple decision spurred congressional calls for an updated digital asset regulatory framework. Multiple legislative efforts are underway, including reintroducing the Responsible Financial Innovation Act in the Senate, to bring financial innovations under consumer protection norms. Senators also proposed the Crypto-Asset National Security Enhancement and Enforcement Act to extend the Bank Secrecy Act to certain digital asset transactions, stirring debates on its potential to criminalize software publishing. Lastly, the House introduced the Financial Innovation and Technology for the 21st Century Act, a comprehensive law proposal developed after extensive hearings, marking significant legislative progress in the digital asset space.
These developments and a few other brief notes are discussed below.
Summary Judgment in SEC v. Ripple Sends Shockwaves Through Industry: July 13, 2023
Background: On June 13, a Motion for Summary Judgment Order in the SEC v. Ripple case was released, with a ruling many in the industry have been advocating for: “XRP, as a digital token, is not in and of itself a contract, transaction, or scheme that embodies the Howey requirements of an investment contract.” (internal quotes omitted). This wasn’t a complete win for Ripple, as over $700 million in contractual sales to institutional investors were ruled to be unregistered securities transactions. But for “programmatic sales” through digital asset exchanges, the Court ruled that buyers did not understand objectively that their funds would go to Ripple to increase the price of XRP, so those were not deemed to be securities transactions.
Summary: We provided a full breakdown of the case and the Court’s Order in an article on the BitBlog, which you can read here. The Court rejected the Ripple “essential elements” arguments and fair notice defense (for institutional sales). However, the Court went on to apply the Howey transaction-by-transaction analysis and reached a determination that some transactions involving the XRP token were securities sales in their totality, and some were not. This ruling has led members of Congress to call for renewed efforts toward creating a workable digital asset regulatory framework in the United States.
Senate Digital Asset Legislation Reintroduced: July 14, 2023
Background: On July 14, the Lummis-Gillibrand Responsible Financial Innovation Act (“RFIA”) was re-introduced into the Senate, after failing to get past committee last Congressional session. Senator Lummis tweeted an infographic describing what is new in this version of the legislation. The revised RFIA maintains much of the broad scope of the 2022 version but is updated to reflect developments since then, like the collapse of FTX.
Summary: This bill has not received the same level of industry support as the Digital Asset Market Structure bill in the House, but this is a bipartisan effort with seemingly some support in the Senate. While most of the momentum is on the House’s bill, it would not be surprising to see features of the RFIA make their way into any final legislation on the topic. Especially the aspects regarding consumer protection, which may hit home with legislators who saw a lack of consumer protections lead to the implosion of FTX and other prominent digital asset service providers.
Senate Introduced Legislation Aimed at DeFi AML Compliance: July 18, 2023
Background: On July 18, Senators Reed, Rounds, Warner, and Romney introduced the Crypto-Asset National Security Enhancement and Enforcement (“CANSEE”) Act in the Senate. The legislation seeks to extend obligations and penalties under the Bank Secrecy Act to persons who (1) “makes available an application designed to facilitate transactions using a digital asset protocol”; and (2) who “control a digital asset protocol, as determined by the Secretary of the Treasury.”
Summary: This bill is an attempt to find a way to apply traditional finance’s protections for anti-money laundering (“AML”) and know your customer (“KYC”) to decentralized finance as those rules apply to traditional finance. Coin Center has alleged that the bill is unconstitutional because it creates potential for criminal prosecution against individuals for merely publishing software and failing to register with FinCEN. Any regulation for the space will create pain points for digital asset services providers who have developed those services largely without regulatory burdens thus far.
House Introduced the Financial Innovation and Technology for the 21st Century Act: July 20, 2023
Background: On July 20, after a process that included hearings in both the Agriculture and Financial Services Committees in the House, the proposed digital asset market structure law, titled the Financial Innovation and Technology for the 21st Century Act, is finally here. While the Discussion Draft was a comprehensive 162 pages, this checks in at 212 pages. The Agriculture Committee’s press release and all associated documents (including a fact vs. myth breakdown) are available here.
Summary: As stated above, the House is seemingly much further along with its legislation than the Senate, with months of hearings on a discussion draft bill leading up to this proposed legislation. Additionally, as Chair of the House Financial Services Committee, Patrick McHenry may have more power to push the House’s bill past committee. However, the House’s bill will need to gain support from across the aisle, potentially from industry proponents like Representative Ritchie Torres, to get this bill to a point where it can pass in the Senate and be signed into law by the President.
Senators Propose Digital Asset Amendments to National Security Legislation: Senators Warren/Marshall (generally anti-crypto), and Lummis/Gillibrand (generally pro-crypto) proposed a crypto-focused amendment to pending national security legislation. It puts AML reporting burdens on crypto kiosks and some obligations on FinCEN and Treasury to come up with compliance regimes for stablecoins/mixers.
Coinbase Litigation Against SEC Update: Coinbase filed its letter response to the SEC’s intent to strike Coinbase’s affirmative defenses, and the parties had a hearing with the Court for over 2 hours as well.
Polsinelli Blockchain+ Team Updates: The Blockchain+ team got a big upgrade with the hire of Albert “Bert” W. Stemmler as a shareholder in the firm’s growing Nashville office. Prior to joining Polsinelli, Bert served as Head of Legal and Compliance at a VC fund manager and operator of an accelerator for early-stage companies in crypto/digital assets.
The ruling in Ripple finding that digital assets are not securities in certain circumstances underscores the need for legislative and regulatory clarity. It shows that a reasonable court could find that there are regulatory gaps in the sale of these instruments, which supports the renewed push from all sides of the issue to put clarifying legislation into place.
While Congress traditionally moves slowly on issues of major significance, such as the regulation of a completely new industry, it is possible that the Ripple decision and other developments in the courts could spur legislators to move quickly instead of allowing these issues to be decided piecemeal by the judicial branch rather than through lawmaking from the legislative branch.