Can These 4 Factions Stop Fighting Over a Crypto Market Structure Bill?

The other day I was talking to a lobbyist about what their clients wanted to see in a market structure bill. It’s a type of call I’ve been having a lot lately with lobbyists, lawyers, investors and some of the more policy-engaged crypto entrepreneurs. 

I pointed out to them that I was hearing a lot of different wish lists. I also pointed out that the White House had made it known that it wanted to deliver on its “promises” of a bill by August recess — a statement I was struggling to square with the reality of the situation. 

Before I was even able to ask the obvious question that would follow, they cut me off: “I know. I guess sometimes you just have to will this into existence.” 

Willing a market structure bill into existence does, in fact, seem exactly like what this White House is keen to do. But if the industry can’t get on the same page, all but the loudest voices may go unaccounted for. Worst-case scenario, risky crypto projects could be permitted to operate unabated, or beneficial projects prevented from growing. 

Can These 4 Factions Stop Fighting Over a Crypto Market Structure Bill?

Congress wants to pass a long-awaited piece of legislation. But the industry is speaking with four different voices about what should be in the law. 

President Donald Trump, who received at least $13 million from crypto companies and executives for his inauguration, is urging a busy Congress to get a bill that enshrines clear rules for the crypto industry passed into law before it leaves for August recess. 

The problem is, the industry isn’t sure what it wants. 

Insiders have developed multiple pathways to regulate the industry, ranging from slight tweaks of existing securities laws to those which take the majority of the crypto industry out of the Securities and Exchange Commission’s jurisdiction. It has spent months circulating research papers and pitching its ideas to regulators. 

The most popular theories utilize interpretations of the Howey Test and how it should be applied to crypto, if at all. The Howey Test is the product of a Supreme Court decision made in 1946, decades before the invention of cryptocurrencies, to determine which transactions should be subject to securities laws. It says an asset is a security if there is an investment of money in a common enterprise with the expectation of profit derived by the efforts of others.

The SEC previously used the Howey Test as justification for its wave of enforcement actions against the industry. However, the industry felt that it was overzealous in calling digital assets securities under this legal precedent.

Securities laws, which could still apply to early-stage crypto tokens, require various reporting and audits that are seen by many in the crypto industry as too complex and expensive for early-stage entrepreneurs. That is why most of the theories devise different ways for at least some crypto projects to exist outside of their purview. 

But as time goes on, the disagreement between crypto’s different factions on specific rules has only grown more entrenched, and a once-organized crypto industry has found itself in an academic, legalese-laden conflict over the details. 

The dynamics have left members of Congress and the president, who in January may have thought that crafting crypto legislation would be simple, having to pick winners and losers in this horse race. And if the industry makes things too difficult, it could fumble its best chances to get the “regulatory clarity” it’s worked so hard for at all. 

Arguments over the following legal theories will likely consume much of the policy conversation for the next three months. Here is how the battle lines are currently drawn.

Read More: Coinbase Aims to Jointly Pass Market Structure and Stablecoin Legislation in Congress 

Change Nothing

First, there is the possibility that the Howey Test remains a “facts and circumstances” case — i.e., its application to crypto isn’t codified in law, and is applied on a case by case basis. This could best be described as codifying the status quo.

Take John Reed Stark, former chief of the SEC Office of Internet Enforcement, at the first SEC Crypto Task Force roundtable earlier this year. “While it is an interesting academic exercise to debate the Howey Test, the reality is that the SEC is granted tremendous latitude with respect to its jurisdiction,” he said. Democratic SEC Commissioner Caroline Crenshaw seems to agree, as do many more securities lawyers whom the industry calls “anti crypto.” 

However, SEC Chairman Paul Atkins and Republican members of Congress in charge of the relevant committees for creating a market structure bill seem distinctly against this approach. Atkins said at a SEC Task Force Roundtable last week that the existing framework “badly needs attention.”

This approach seems highly unlikely to win.

Nothing Is a Securities Transaction Without an Express Written Contract

A small but outspoken contingent of crypto lawyers argues that most crypto transactions are not securities transactions because they involve activity that falls outside of the realm of a typical securities contract. This first iteration of this argument surfaced in the context of the 2020 Ripple case, where Ripple said there were “essential ingredients” for a transaction to be considered an investment contract that were not met, such as post-sale obligations that the token promoter owes the investor in order for the buyer to share in the profits.

Though the “essential ingredients” theory, a term created by Ripple, was not successful in court, a similar argument made by many crypto lawyers in favor of the most light-touch regulations says that the Howey Test should not apply to most cryptocurrency transactions because they do not mimic transactions similar to those seen in traditional securities. 

Part of what is innovative about crypto, these lawyers argue, is the unique relationships formed between various types of token holders, like custodianship or staking. And because these types of transactions possibly lie outside of what the Supreme Court could have imagined when creating the Howey Test, or Congress could have imagined when creating the Securities and Exchange Act, they should not apply. “Considering the uncertain basis for such inclusion, it is probable that Congress did not intend to include cryptocurrencies in the class of securities requiring registration with the SEC,” George Mason University professor J.W. Verret explained in a paper published last year. 

Read More: How Did Ripple Sell Trump on XRP in a Crypto Reserve? By Pushing for Solana

Token Issuance Is a Securities Contract; Secondary Market Transactions Are Not

There are also lawyers who argue that token issuance is a securities transaction, but that almost all other transactions are not subject to securities laws. Lewis Cohen, in his testimony before the Senate Banking Committee in February, described this as an “ancillary asset framework.”

This argument, like the prior, has considerable popularity because it doesn’t require crypto-specific amendments to the Securities Act or Exchange Act but rather interprets existing laws for application to the crypto industry. It is also a fairly light-touch method of regulation because it classifies nearly any cryptocurrency transaction outside of issuances as non-securities transactions, and thus not something that triggers arduous reporting or auditing requirements.

All Transactions on Decentralized Blockchains Are Not Subject to Securities Law 

The fourth camp, around which some of the industry’s most powerful players like a16z Crypto, Coinbase, Aave, EigenLayer, Optimism, and many others are coalescing, argues that any transactions taking place on decentralized networks are not securities. 

Part of why these organizations are gaining ground with their legal theory is because it’s a way of thinking that was first proposed in a famous 2018 speech by the regulator’s former director of corporate finance, William Hinman, who is currently an advisory partner at Andreessen Horowitz, when he declared that Ethereum was sufficiently decentralized to fall outside of the SEC’s jurisdiction. It was subsequently adopted by Hester Peirce in 2019, so it already has momentum at the nation’s primary securities regulator. 

Moving back to the present, this current theory is “inspired” by the Howey Test, explains Delphi Ventures General Counsel Sarah Brennan, who recently co-authored a paper articulating her version of the framework with the Decentralization Research Center — one similar to a framework two sources said a16z Crypto has circulated on the Hill. The paper itself does not mention Howey by name, but a new law centered around this new principle would have the practical effect of replacing Howey, particularly the part dictating that investors in a security rely on the efforts of others for profits.

The framework, these sources said, has been influential with the members of Congress writing a market structure bill. 

“Think what you might have thought of years ago, with this open source community, cypherpunk vision where at the infrastructure layer you have privately created permissionless tech. That’s a public good, and the only value accrual center is the token,” explains Brennan. “Then there’s Web 2 businesses with a token….that kinda looks like a regular, vanilla, securities-type thing.” 

However, while this approach may seem attractive in a vacuum, the line of delineation between a centralized and decentralized network continues to be a moving target. 

Read More: Is the SEC About to Reverse Its Position on Howey?

Next Steps

Sources have said that at least the House Financial Services Committee — one of four congressional committees involved in shaping market structure legislation — plans to release a draft bill any time between now and early June. After that, the SEC and, if given some jurisdiction over crypto, the CFTC would go through a rulemaking process to fine-tune how they will interpret and apply the law. These regulators have not yet been given a strict timeline by which to act, though SEC Chair Atkins and incoming CFTC Chair Brian Quintenz have signaled an eagerness to provide clarity for the crypto industry. 

The release of a draft market structure bill will inevitably bring many of the differences between crypto lawyers out into the open. The general counsels for most major crypto projects and industry associations in the space will be submitting comment letters, writing tweet threads, perhaps even making their case on crypto conference stages and D.C. 

If legislation adopts a framework some see as too restrictive, certain projects could struggle to comply with regulation. If legislation takes a more light-touch approach, problematic projects could be allowed to infiltrate the crypto market, causing broad instability and reputational damage. 

“We need to have a decentralization test that is effective and sufficiently robust so that we don’t end up with a bunch more FTTs and a bunch more Terras,” said Decentralization Research Center Executive Director Connor Spelliscy, a member of the fourth camp. “Not only will that hurt a lot of people, but we will probably never recover reputationally as an industry.” 

Related content: 

• A Draft Crypto Market Structure Bill Could Come as Soon as This Week

• Newly Revealed Crypto Majors Solana, Yuga Labs, and Uniswap’s Hayden Adams Gave to Trump’s Inauguration

• A Market Structure Bill by August? Why Some Crypto Traders Want Congress to Slow Down