Late last month, the House passed the Financial Innovation and Technology for the 21st Century Act (FIT21)—the first comprehensive cryptocurrency regulatory procedure legislation that could become law. It marks a dramatic first step to bring the emergent crypto market under the enormous weight of the U.S. regulatory regime. The legislation requires federal agencies and commissions to produce two studies on decentralized finance (DeFi), which is crypto-world slang for transactions without human mediums of exchange. Lawmakers have historically struggled to understand this novel technology. The legislation is 256 pages, so here are the good, the bad, and ACI’s proposed changes for the FIT21.

The Good

  • Scam Protection: Prohibits co-mingling of customer and firm funds, unless explicitly allowed by the customer in certain circumstances. This protects user funds from risky business investments since firms will no longer be able to mix its investment pools with its user pools. Co-mingling exposes user funds to risks undertaken by firms, a risk that makes the entire project less secure, as seen in the FTX collapse.
  • De Jure Regulation: Provides asset classification clarity by legally codifying de facto regulations. More clarity means safer business and consumer investments. No longer will regulatory asset classification interpretations be left to the machinations of courts.
  • Regulatory Clarity: Establishes long-needed regulatory clarity in a field devoid of it. Increased certainty promotes investment and new innovations.
  • Delineates Networks: Centralized and decentralized networks are functionally distinct and require different contextual rules. FIT21 enshrines that needed distinction.
  • Exemptions: Provides exceptions for digital assets from securities regulation if they meet requirements, such as “restrictions on transaction amount, non-accredited investor access caps, purchaser limits, and requirements for issuer disclosure and compliance.”
  • Studies: Requires two, year-long DeFi studies. One was conducted jointly by the Security and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), and another by the Government Accountability Office. DeFi is rarely understood by the legislature or the regulatory bodies that seek to micromanage it. Measures to increase understanding are welcomed.

The Bad

  • DeFi: Agencies should not regulate technologies without understanding them. FIT21 seeks to understand how these markets operate but wrongly allows agencies to regulate DeFi before the findings of these proposed studies are finalized. The legislation avoids making rules on DeFi due to a lack of understanding but then fails to prohibit agency rulemaking during the study process.
  • Clarity: Due to a lack of a definition for “decentralized” in the context of cryptocurrency, definitions for commodities and securities will be a host to issues. Namely, it will be up to the agencies to determine what is and is not sufficiently decentralized. Agencies will begin creating rules with no objective standard to measure the level of decentralization needed to determine “sufficient” amounts.

The Proposed Changes

  • Definitions: Policymakers should amend FIT21 to include a “sufficiently decentralized” network definition. If that objective remains elusive, the legislation should consist of a research period and enough time to determine what this would mean. There is currently no definition of DeFi, as admitted by the Department of the Treasury, making enforcement along this line fraught with potential error.
  • Moratorium on DeFi Rulemaking: DeFi should be exempt from agency rulemaking until both studies are complete. Providing enough time for public debate of the findings before new rules are created, administered, and enforced is crucial.

Isaac Schick is with the American Consumer Institute, a nonprofit education and research organization. For more information about the Institute, visit www.TheAmericanConsumer.Org or follow us on X @ConsumerPal.