Review: Senate Crypto Market Structure Discussion Draft

Some significant daylight between House and Senate positions

Following closely on the heel’s of the House's passage of CLARITY last week, the Senate Banking Committee released a discussion draft of its crypto market structure bill yesterday. Given the Banking Committee’s oversight of the SEC, this draft primarily focuses on securities-related issues, with the Senate Ag Committee anticipated to address CFTC-related legislation shortly.

This review highlights several significant discrepancies between the securities-related aspects of CLARITY and the Senate's draft. While differences are considerable at this stage, we are still early in the Senate process and further alignment may occur as discussions evolve.

Definitions: Digital Commodity (House) vs Ancillary Asset (Senate)

Intrinsic linkage

• House: Digital commodities require intrinsic linkage to a blockchain system, deriving their value from it.
• Senate: Omits intrinsic linkage from the definition of ancillary asset. However, the Senate's proposed Reg DA (Sec 102) includes a reference to reliance on a network in connection with an originator’s (issuer’s) requirement to dilute control within four years. This shift in placement of the intrinsic linkage concept from the asset-level definition to the offering exemption condition could incentivize token designs under the Senate version that would not otherwise qualify as digital commodities under CLARITY. We can dig in to some examples if this framework stays in.

Decentralized Securities

• House: Decentralized securities are included within the term “digital commodity.” By decentralized securities I mean: “[a] note, an investment contract, or a certificate of interest or participation in any profit-sharing agreement that represents or gives the holder an ownership interest or other interest in the revenues, profits, obligations, debts, assets, or assets or debts of [a decentralized governance system]” (from CLARITY).
• Senate: No inclusion of decentralized securities. I.e. decentralized securities cannot be ancillary assets, which is a significant variation from CLARITY.

Definition: Foreign Originator

The Senate draft’s definition of a Foreign Originator appears problematic. It confusingly defines Foreign Originator (essentially a foreign private issuer in the securities context) “as a an ancillary asset originator incorporated or organized outside of the United States… or [the draft then proceeds to lay out conditions similar to a reverse or negative version of the shareholder and business contacts tests under Regulation S]. In other words, it defines, as a Foreign Originator, actors with predominant US touchpoints and principally US-administered businesses.

Primary Sale Exemption Conditions

Exemption Amount

• House: $50mil per 12 month period
• Senate: $75mil per calendar year

Issuer domicile

• House: Issuer required to be “organized under the laws of a State, a territory of the United States, or the District of Columbia.”
• Senate: Lacks a clear domicile requirement, potentially widening eligibility.

Codification of Howey

Interestingly, the Senate draft contains a SEC required rulemaking provision completely absent in CLARITY relating to the codification of Howey. Specifically, it directs the SEC to adopt a rule expressing that an investment contract requires the follow elements:

1. An investment of money by an investor, which shall include more than a de minimis amount of cash (or its equivalent) or services.
2. An investment described in paragraph (1) is made in a business entity, whether incorporated, unincorporated, organized, or unorganized.
3. An express or implied agreement is required whereby the issuer makes, directly or indirectly, certain promises to perform essential managerial efforts on behalf of the enterprise.
4. The investor reasonably expects profits based on the terms of the agreement itself and statements by the counterparty and its agents, when it is clear from the context that such statements :
   1. are made by or authorized by the enterprise; and
   2. are accessible to the investor.
5. Profits under paragraph (4) are derived from the entrepreneurial or managerial efforts of the counterparty or its agents on behalf of the enterprise, where such efforts
   1. are post-sale and essential to the operation or success of the enterprise; and
   2. do not include ministerial, technical, or administrative activities.

This could profoundly reshape crypto regulation by potentially exempting certain yield-bearing or revenue-sharing tokens, particularly those driven by decentralized or minimally- managerial activities, from securities laws.

Absence of Protections for DeFi Activities

Significantly, the Senate draft omits securities-related protections for DeFi-related activities (through it does include money transmission protection for devs). In contrast, CLARITY explicitly exempts certain blockchain and DeFi functions from SEC oversight, including transaction validation, node operation, software development, liquidity pool participation, and the provision of wallets or custody solutions (with certain protections limited to decentralized spot activity).

No GENIUS Limitations

Unlike CLARITY, which prohibits permitted payment stablecoin issuers from engaging “non-financial” activities (relative to the definition of financial activities in section 4(k) of the Bank Holding Company Act), the Senate draft does not directly reference GENIUS. It does however, expand the notion of financial activity under section 4(k) to include (among other basic items like custody and digital asset payment services):

• making loans collateralized by digital assets;
• operating a node on a distributed ledger;
• providing self-custodial wallet software;
• engaging in derivatives transactions;
• providing brokerage services; and
• underwriting, dealing in, or making a market in digital assets.

Conclusion

Given these not insubstantial differences, stakeholders should anticipate continued debate as the Senate and House attempt to reconcile their positions. The ultimate shape of crypto market regulation will likely hinge on how legislators navigate these divergent frameworks, balancing innovation, investor protection, and regulatory clarity. Continued engagement and close monitoring of these developments will be crucial for industry participants aiming to navigate this evolving landscape effectively.