Crypto Market Integrity as a Key for Consumer Protection in Digital Commodities - Unpacking the Senate Ag Committee Bill

The bill pushes the legislative conversation another step forward. While legislation can take years and it is likely to change, it further clarifies that both individual firms and the industry as a whole need to increase efforts to provide demonstrable market integrity, prevent market manipulation or prove its absence, and provide stronger consumer protection.

The Digital Commodity Consumer Protection Act dropped today by the Senate Agriculture Committee is another important development in the intensifying journey towards constructive crypto regulation, and a safe and regulated digital asset industry. As bills do, it includes a lot of details, but these are the bottom line takeaways for me: [1] Another strong signal of the regulatory focus shifting to market integrity and preventing trade manipulation as a key to consumer protection; [2] clear definitions of digital commodity platforms and digital commodities;  [3] unlike other bills, a mandatory registration requirement with the CFTC for almost any digital asset service platform, which would also potentially preempt the necessity of state money transmitter licenses; and [4] a foundation to give the CFTC tools and resources (through platform fees) in order to regulate and enforce against violations. More analysis below, but first -

What's in the Bill?

There are a lot of summaries flying around, but in my view it’s always best to hear things from the horse’s mouth - here a link to the section-by-section summary published by the Ag Committee, and here’s the summary of the bill from the press release:

• U.S. Senators Debbie Stabenow (D-MI), Chairwoman of the Senate Committee on Agriculture, Nutrition, and Forestry, and John Boozman (R-AR), Ranking Member, along with Senators Cory Booker (D-NJ) and John Thune (R-SD) today introduced the Digital Commodities Consumer Protection Act of 2022, with the stated goal of giving the Commodity Futures Trading Commission new tools and authorities to regulate digital commodities.
• Closes regulatory gaps by requiring all digital commodity platforms—including trading facilities, brokers, dealers, and custodians—to register with the CFTC. 
• Requires digital commodity platforms to prohibit abusive trading practices, eliminate or disclose conflicts of interest, maintain sufficient financial resources, have strong cybersecurity programs, protect customer assets, and report suspicious transactions - essentially porting the 1936 Commodity Exchange Act’s core principles to digital commodity platforms.    
• Requires digital commodity platforms to adhere to advertising standards and disclose information about digital commodities and their risks, bringing greater transparency and accountability to the marketplace. 
• Authorizes the CFTC to impose user fees on digital commodity platforms to fully fund its oversight of the digital commodity market. 
• Directs the CFTC to examine racial, ethnic, and gender demographics of customers participating in digital commodity markets and use that information to inform its rulemaking and provide outreach to customers. 
• Recognizes that other financial agencies have a role in regulating digital assets that are not commodities, but function more like securities or forms of payment.

Key takeaways: What does all of this mean, and why is it important and interesting?

1. Emphasis on market integrity as a form of consumer protection, and the prevention of manipulation and abuse. The bill continues and expands the global trend of making market integrity requirements explicit in regulation, vs. the earlier regulatory focus on AML. Though the full draft has not yet been released, the section-by-section breakdown released today mentions market integrity, market manipulation and abuse throughout, with these specific examples:

• Subsection (b) - Proposes core principles centered focused on “protecting customers and the integrity of the digital commodity marketplace.” It then goes to specifically state platforms “must only permit transactions in digital commodities that are not readily susceptible to manipulation,” as well as “monitor digital commodity trading and protect market participants from abuse.” This essentially lays to ground for market surveillance requirements which exist in other CFTC-regulated markets.
• Subsection (e) - provides another layer of protection from manipulation by forbidding the offering of any services relating to assets that could be manipulated. It clarifies that “digital commodity dealers and digital commodity brokers may not trade, or arrange a trade, in a contract for a digital commodity that is readily susceptible to manipulation.” This is interesting, as it presents a challenge of demonstrable integrity - will each asset need to be proven as not susceptible to manipulation? With decentralized assets like Bitcoin, that may mean the industry will need to promote data sharing agreements that remove concerns of cross-market manipulation, especially considering the SEC’s concerns about bitcoin manipulation expressed in ETF rejection documents.
• Subsection (h) - Provides an additional layer of protection, by simply clarifying that manipulation, abuse and fraud will not be tolerated. Sounds trivial, but it never hurts to clarify, if anyone still had doubts.

2. The first proposed bill in the US to suggest mandatory federal registration requirements for a broad range of crypto service providers - potentially preempting state licenses. While other proposed legislation like the Lummis-Gillibrand bill included option or less comprehensive registration requirements, today’s introduced bill proposes a mandatory requirement “that any entity acting as a digital commodity platform must register with the Commission.“ Together with a broad list of definitions for digital commodity platforms including brokers, custodians, trading facilities and dealers, if implemented this would apply to most crypto firms in America. It’s important to note that this may serve as a way to preempt the need for many crypto firms to register with each individual state for money transmitter licenses, and potentially replace it with one federal registration.

3. This is another bill pushing for CFTC oversight of crypto as a baseline - which the industry favors. Proposed by the Senate Ag Committee, which oversees the CFTC, this bill aligns with the Lummis-Gillibrand bill in making the CFTC the supervisor of spot market activity, without affecting the pre-existing authorities of other agencies - namely the SEC for digital securities. That’s also aligned with the industry stance - most of the crypto industry believes it will be better off with the CFTC as the primary markets regulator, since the agency is more hands off, a tenth of the size of the SEC in terms of resources and staff, and more adapted to regulating markets of decentralized assets (like wheat or gold). This bill adds some of the necessary elements to include non-physical decentralized assets like bitcoin and other crypto’s under its supervision and existing principles of the commodity exchange act.

4. The politics of it - this is an important bipartisan bill proposed by very influential senators in key roles, and therefore is very relevant, but it’s a long way from becoming law. The fact that the bill is proposed by the influential senators leading the Senate Agriculture Committee - which oversees the CFTC and has jurisdiction over traditional commodity markets -  as well as the fact that it’s bipartisan, makes it a very important bill. That being said, despite the headlines, buzz and news chatter any bill generates, the first thing to keep in mind is that legislation takes A LOT of time, and goes through many changes before it becomes law. Especially in an election year. Legislative news often carries an air of ``let's hurry and wait.”

5. This bill vs. the Lummis-Gillibrand bill from earlier this year and the Commodity Exchange Act from 2020 - generally aligned on CFTC jurisdiction, provides more detailed criteria, and proposes mandatory, vs. optional, registration of crypto firms. This Bill focuses on CFTC jurisdiction rather than seeking to address more comprehensive policy gaps that are included in Lummis-Gilbrand (prudential, tax, securities, commodities). Both bills provide the baseline jurisdiction over digital commodities (broadly defined as nonsecurities) to the CFTC. In both cases, it’s clear the bill was developed through a lot of dialogue with the industry. Today’s Senate Ag bill also seems to build on the House proposed Digital Commodity Exchange Act (2020 and 2022), but, as Coincenter writes, with one key difference - it defines with more details a set of digital asset platforms, and makes registration with the CFTC mandatory, not an option.

Additional Resources:

• The Solidus Labs Global Crypto Regulation Index - a great resource to compare the US legislative action with what's going on globally.
• DACOM Summit (recording available for free here), which took place on July 28, 2022, included many conversations that touched the Senate Ag bill, and US crypto regulation in general - specifically the keynote session with CFTC Commissioner Caroline Pham and former CFTC Chair Chris Giancarlo.