About the FIT21 Bill: Background, Content, and Impact
Author | TaxDAO-Ray
On May 22, 2024, the U.S. House of Representatives passed the Financial Innovation and Technology for the 21st Century Act (FIT21) by a vote of 279 to 136. This bill, led by the Republican Party, aims to amend existing securities and commodities regulations to establish a regulatory framework for digital assets, thereby promoting the development of the cryptocurrency industry. Once officially enacted, the FIT21 bill will mark a significant milestone in the federal regulation of digital assets in the United States. This article will interpret the FIT21 bill from the perspectives of legislative background, bill content, and potential impacts.
1. Legislative Background of the FIT21 Bill
Since the genesis block of Bitcoin was mined, cryptocurrency digital assets have existed and developed for fifteen years, currently entering a vibrant and increasingly mature stage. However, neither the United States nor other countries have established a comprehensive regulatory framework for digital assets, only conducting fragmented and partial regulation. This not only fails to create a stable and predictable legal environment for the cryptocurrency industry but also allows various illegal and criminal activities to flourish within the digital asset sector, severely hindering innovation and progress. Critics argue that under the existing regulatory framework in the U.S., startups in the cryptocurrency industry suffer from "enforcement-based regulation," which leads relevant companies to operate in other countries, detrimental to both U.S. technological innovation and overall economic development. Therefore, there is an urgent need for the U.S. to create a supportive environment for innovation through legislation, fully tapping into the future potential of the cryptocurrency industry while avoiding a monopoly by a few large tech companies reminiscent of the Web 2.0 era.
In September 2022, the White House released the First-Ever Comprehensive Framework for Responsible Development of Digital Assets, urging the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to develop specific rules governing digital assets. The legal draft of FIT21 can be traced back to March 2023, when the Digital Assets, Financial Technology, and Inclusion Subcommittee, led by U.S. Congressman French Hill, planned to collaborate with the House Agriculture Committee to formulate a regulatory framework for digital assets. In July of the same year, the House Financial Services Committee and the House Agriculture Committee successively passed the FIT21 bill, and it wasn't until May 2024 that the House completed the voting process for the bill. The FIT21 bill will soon be submitted for a vote in the Senate, and after passing in the Senate, it will be sent to the President for signature and official release.
Recent developments regarding SAB 121 (Staff Accounting Bulletin No.121) have also led both chambers of Congress and the cryptocurrency industry to place high hopes on the FIT21 bill. The SEC issued SAB 121 in 2022, which requires digital asset custodians to treat digital assets as liabilities and hold them at fair value on their balance sheets. Based on this, if banks wish to hold digital assets, they must hold cash equivalent to the fair value of those assets, a regulation considered an excessive intervention by the SEC into the banking industry, effectively excluding banks from the cryptocurrency sector. In mid-May 2024, prior to the SEC's shift in attitude towards ETH spot ETFs, both chambers of Congress took action to pass a bill to overturn SAB 121. However, this was short-lived, as President Biden ultimately vetoed the bill on May 31, leaving both chambers and the cryptocurrency industry disappointed and placing more hope on the pending FIT21 bill awaiting Senate vote and presidential signature.
2. Overview of the FIT21 Bill Content
The FIT21 bill consists of multiple chapters, each addressing different aspects of digital asset regulation and innovation systems. This section will categorize and summarize the content of each chapter of the FIT21 bill and outline the main regulatory framework it establishes.
2.1 Overview of the Chapters of the FIT21 Bill
The first chapter of the FIT21 bill is titled "Definitions; Rulemaking; Notice of Intent to Register." This section defines key terms under various laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, and the Commodity Exchange Act. These definitions cover terms such as "digital asset," "blockchain," and "decentralized system," clarifying the scope of the bill.
The second chapter primarily clarifies digital assets as part of investment contracts. Section 202 describes digital assets as a part of investment contracts, defining them as interchangeable digital representations of value, while stipulating how they should be classified and regulated, distinguishing them from traditional securities.
The third chapter mainly regulates the provision and sale of digital assets. Specifically, Section 301 outlines exemptions for trading digital assets, Section 302 specifies requirements for the provision and sale of certain digital assets, and Section 303 mandates enhanced disclosure requirements for any digital asset and its related blockchain systems.
Chapters four and five address the registration of digital asset intermediaries under the jurisdiction of the SEC and CFTC. Digital asset intermediaries include digital asset exchanges, brokers, dealers, and custodians. Relevant regulations cover business requirements such as trading certification and licensing, general and specific conditions for different registration entities, methods and exemptions, and rules regarding conflicts of interest.
Chapter six is titled "Innovation and Technology Improvements," which serves as both a title and a conclusion, indicating the drafters' and Congress's assessment of cryptocurrency technology. Relatedly, the SEC will establish an Innovation and Financial Technology Strategic Center (FinHub), while the CFTC will establish LabCFTC. According to FIT21, the main internal functions of these two centers are to shape how the SEC and CFTC examine financial technology innovations and analyze the impact of regulations on fintech companies. Although both research centers engage with stakeholders and provide information about rules and regulations to those working with emerging technologies, given the wording of FIT21, Congress does not seem to view them as active regulatory sandboxes, as the SEC and CFTC have not been granted specific discretionary powers in regulation.
2.2 Overview of the Regulatory Framework of the FIT21 Bill
Overall, FIT21 will establish a federal regulatory framework for digital assets by clarifying the regulatory responsibilities of the SEC and CFTC regarding digital assets and transactions, as well as updating existing securities and commodities laws to regulate various blockchain technologies, including decentralized protocols. Some argue that the protective measures for technology and innovation in FIT21 are somewhat similar to those implemented in the U.S. after the Great Depression of the 1920s, which led to unprecedented economic growth and an era of innovation.
The regulatory framework established by the FIT21 bill for U.S. digital assets mainly includes the following four aspects. First, the CFTC must regulate digital assets as commodities, provided that the underlying blockchain or digital ledger is functional and decentralized. Additionally, the bill grants the CFTC exclusive regulatory authority over crypto commodities and spot markets. Second, in cases where the relevant blockchain is functional but not decentralized, the SEC must regulate digital assets as securities. The FIT21 bill specifies some exceptions for SEC regulation of digital assets, involving annual sales, qualified investors, and stipulates requirements for primary and secondary market transactions. Third, the CFTC and SEC must jointly issue rules to formulate relevant provisions and avoid duplicative regulatory rules faced by exchanges. Fourth, the bill excludes approved stablecoins from the regulation of the CFTC and SEC, except for specific transactions involving anti-fraud agencies and registered entities.
3. Interpretation of Sections 101 and 103 of the FIT21 Bill
Clarifying the subjects is a prerequisite for taking action. Sections 101 and 103 of the FIT21 bill provide detailed definitions of restricted digital assets (securities), digital commodities, and permitted payment stablecoins, along with specific criteria for judgment. This allows the SEC and CFTC to clarify their respective responsibilities, regulating restricted digital assets and digital commodities accordingly, while permitted payment stablecoins fall outside their jurisdiction. This forms the basis for subsequent regulatory and guiding measures, enabling the cryptocurrency industry to benefit from a more orderly regulatory framework and a more stable development space. Overall, the FIT21 bill categorizes digital assets into three major types: restricted digital assets, digital commodities, and permitted payment stablecoins. The relationship among them is that digital assets are generally restricted digital assets unless they self-certify as digital commodities or meet the definition of permitted payment stablecoins.
3.1 Digital Assets
Section 101, item 26, first defines "digital asset" and lists exclusions. This section states that a digital asset "is any interchangeable digital representation of value that can be fully owned and transferred by individuals without reliance on intermediaries and is recorded on a cryptographically secure public distributed ledger." However, digital assets do not include any notes, stocks, shares, securities futures, securities swaps, bonds, debt certificates, debt proofs… any puts, calls, straddles, options, privileges" and assets equivalent to options, futures, swaps, etc.
It is important to note that Section 101 also emphasizes two points: first, "nothing in this section shall be construed to imply that a digital asset is a representative of any type of security not excluded from the definition of digital assets," indicating that FIT21 adheres to a strict definitional approach to digital assets, clearly distinguishing them from other types of securities. Second, "digital assets sold or intended to be sold under an investment contract shall not become securities by virtue of being sold or otherwise transferred under that investment contract." To understand this, one must first grasp the Howey Test. The concept of securities in U.S. law originally developed from the term "investment contract" in the Howey Test, one of the four conditions of which is that the profits come solely from the efforts of others. Under this condition, the efforts of the project party and related parties are key to the investor's profits, while the investor only needs to pay specified fees and costs without actually participating in the project's operation and management. However, the issuance and management of digital assets often rely on smart contracts and other automated programs, where there is no traditional project party and related party effort. The relevant provisions of the FIT21 bill exclude digital assets from being classified as securities primarily to promote technological innovation while also considering investor protection.
3.2 Restricted Digital Assets
Item 34 defines "restricted digital assets" and proposes three criteria for determining "restricted digital assets": (1) the degree of decentralization and functionality of the underlying blockchain system; (2) the method by which users ultimately acquire the digital assets; and (3) the identity of the party holding the digital assets. Clarifying the specific meanings of these criteria will help distinguish restricted digital assets from other digital assets. It should be noted in advance that "restricted digital assets" here refer to digital assets that possess characteristics similar to "securities," although the legislators did not use the term "security"; for example, Section 405 explicitly states that securities include restricted digital assets.
According to item 25, the judgment of decentralization and functionality includes the following aspects: (1) in terms of control and influence, no individual or entity has had unilateral power to control or substantially change the functionality or operation of the blockchain system in the past 12 months, either directly or indirectly. (2) In terms of the distribution of ownership and governance rights of digital assets, no digital asset issuer or related party has owned more than 20% of the total issued digital assets in the past 12 months, nor has any digital asset issuer or related party controlled 20% or more of the circulating voting rights of that digital asset or related decentralized governance system. (3) In terms of code modification, no digital asset issuer or related party has substantially or unilaterally modified the source code of the blockchain system in the past three months in a way that materially changes the functionality or operation of the blockchain system, unless such modifications are made to address vulnerabilities and misalignments, for routine maintenance, to prevent cybersecurity risks, or to improve blockchain technology. (4) In terms of marketing, no digital asset issuer or related party has marketed digital assets to the public as investments in the past three months. (5) The units of the digital asset issued through the programmatic functionality of the blockchain system are all issued to end users. It should be noted that according to item 30, "end user distribution" refers to a broad, fair, and non-discretionary distribution that does not involve asset exchange, typical examples being mining and staking rewards for blockchain users.
Among the above criteria, the important standards are "12 months" and "20%." The 12 months serve as a vertical judgment standard for decentralization, while 20% serves as a horizontal judgment standard for decentralization. Whether it is 12 months or 15 months, 20% or 30%, the specific values themselves are not the most important; what matters is that they provide clear, quantifiable standards, making the judgment of decentralization more objective.
Regarding the method by which users acquire digital assets, this provision requires that restricted digital assets are issued to users in a non-end-user distribution manner or obtained by users in non-digital commodity exchanges.
For the last criterion, restricted digital assets must be all digital assets held by the issuer and related parties during the period when the blockchain system lacks functionality or has not become a decentralized system. Additionally, permitted payment stablecoins are exempt from being classified as restricted digital assets.
3.3 Permitted Payment Stablecoins
Item 32 of Section 101 defines permitted payment stablecoins. This section states that permitted payment stablecoins are those used or designed to be used as means of payment or settlement, whose issuers are obligated to convert, redeem, or repurchase to obtain a fixed amount of monetary value, or represent a stable value that is maintained or reasonably expected to be maintained relative to a fixed amount of monetary value, while the issuer is subject to regulation by authorized federal or state regulatory agencies, and the stablecoin is not a national currency or security. The aforementioned monetary value refers to domestic currency, deposits, or equivalent notes denominated in domestic currency. From this definition, it is evident that the FIT21 bill emphasizes the significance of a licensing system for payment stablecoins while indicating that only fiat or note-backed stablecoins have the opportunity to be licensed, excluding algorithmic stablecoins from the licensing scope.
3.4 Digital Commodities
Item 55 of Section 103 defines "digital commodities." Digital commodities involve three situations. First, any unit of digital asset held by individuals other than the digital asset issuer or related parties before the relevant blockchain system becomes a functional system and is certified as a decentralized system, and that unit of digital asset is obtained through final issuance or in a digital commodity exchange. Second, any unit of digital asset held by individuals other than the digital asset issuer or related parties after the relevant blockchain system becomes a functional system and is certified as a decentralized system. Third, any unit of digital asset held by related parties during the period when the relevant blockchain system becomes a functional system and is certified as a decentralized system. Digital commodities also do not include permitted payment stablecoins. There is also a special provision stating that if a federal court has already ruled that a digital asset is not a security before the enactment of the FIT21 bill, then that digital asset should be recognized as a digital commodity, reflecting the FIT21 bill's attitude of effectively dividing digital assets into securities and commodities after excluding permitted payment stablecoins.
4. Potential Impacts of the FIT21 Bill After Passage
4.1 Impact of the FIT21 Bill on Cryptocurrency Taxation
According to IRS Notice 2014-21, all cryptocurrency assets are treated as property rather than currency, thus subject to the general tax principles applicable to property transactions. However, the IRS has a broad definition of cryptocurrency assets, considering "any digital representation of value recorded on a cryptographically secure distributed ledger or any similar technology" as cryptocurrency assets. The FIT21 bill provides detailed criteria and standards for the IRS to determine the scope of cryptocurrency assets and whether specific cryptocurrency assets are classified as digital commodities or securities, which will assist the IRS in taxing cryptocurrency asset holders based on the distinction between general investment income and capital gains.
At the same time, it is important to emphasize that the FIT21 bill does not use the term "securities" to refer to restricted digital assets that are similar to securities, meaning that some strictly limited tax rules do not apply to restricted digital assets. For example, U.S. tax law allows investment losses to offset taxes but strictly prohibits wash sales, meaning investors cannot sell an asset at a loss and then buy the same or similar security within a short period. The term "securities" includes stocks, bonds, mutual funds, ETFs, options, futures, and warrants, while the term "restricted digital assets" continues to exclude cryptocurrency assets from wash sale rules.
4.2 Impact of the FIT21 Bill on Cryptocurrency Regulation
In terms of regulatory subjects and objects, the FIT21 bill attempts to delineate clear regulatory subjects and scopes for the two major regulatory agencies, the SEC and CFTC, by distinguishing between restricted digital assets, digital commodities, and exempting permitted payment stablecoins, ensuring the orderly regulation of digital assets and preventing negative impacts caused by unclear and conflicting regulatory powers.
In terms of regulatory content, the FIT21 bill not only requires the SEC and CFTC to be responsible for the registration and management of digital assets but also enhances the information disclosure requirements for digital assets, and mandates the SEC and CFTC to implement anti-money laundering (AML) systems and anti-fraud mechanisms, contributing to further enriching the regulatory content for cryptocurrency assets.
In terms of regulatory style, overall, the FIT21 bill adopts a flexible and inclusive regulatory policy while emphasizing the protection of small and medium investors and consumers, providing orderly and ample space for innovation and development in the cryptocurrency industry in the U.S. This will attract more cryptocurrency talent and companies to the U.S., further invigorating the U.S. cryptocurrency industry and ultimately enhancing the country's financial competitiveness globally.
5. Conclusion
Although there remains some uncertainty about whether the FIT21 bill will be ultimately passed, the House of Representatives' approval of the FIT21 bill itself indicates that legislators' attitudes toward cryptocurrency assets have become more favorable. Favorable does not mean permissive; on the contrary, the U.S. hopes to create a stable and effective regulatory environment for the healthy growth of the cryptocurrency asset market through the FIT21 bill. In the future, the SEC and CFTC will work together to further focus on the integration of DeFi and financial markets, NFTs and traditional markets, and enhance the financial literacy of cryptocurrency asset investors, strengthening the infrastructure of the blockchain financial market, while maximizing the role of cryptocurrency assets and blockchain technology in promoting economic development while protecting investor rights.
