The United States of America maintains a considerable sway over global financial markets, including the emerging realm of digital assets. Whether it is attributed to the vast scale of the US economy, the hegemony of the US dollar, or its influence over global institutions, this impact is undeniable and extends to the cryptocurrency market.

A recent illustration of U.S. policy shaping market sentiment is seen in the passage of the FIT21 bill in the House of Representatives. On May 22, 2024, the House approved H.R. 4763, known as FIT21, with a vote of 279 to 136. This bill aims to modify existing securities and commodity regulations to accommodate digital assets. Its passage signifies a significant advancement in establishing a federal regulatory framework for digital assets, marking the inaugural instance of major digital asset legislation being passed by a Congressional chamber. The bill introduces a federal regulatory framework that clarifies the roles of regulatory bodies such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) in overseeing digital asset products and transactions.

Before delving into the FIT21 bill and what makes it pivotal in digital asset regulation, it would be helpful to understand the current regulatory landscape in the U.S. as it applies to digital assets. Unlike in Europe, which has enacted the Markets in Crypto-Assets (MiCA) Regulation to govern digital assets, the U.S. currently does not have a regulatory framework for digital assets. In the U.S, the SEC and the CFTC have both previously claimed jurisdiction over digital assets as these assets have some traits that resemble that of a security and others that are more similar to a commodity. However, due to the idiosyncratic nature of digital assets, this jurisdictional debate has not been resolved. The digital asset industry has been left seeking regulatory clarity for a few years now, but that has largely fallen on deaf ears. During this period, the SEC has been the more aggressive of the two agencies and it has repeatedly insisted that most digital assets should be classified as securities under the age-old Howey Test.

The Howey Test classifies an asset as a security if it can be an investment with expectation of profits, and if the investment is in a common enterprise. The Howey Test provides a clear demarcation between an investment contract and an asset of pure utility such as a commodity. However, in the digital world, this line of distinction is actually blurred and a cryptocurrency can be both at the same time, or neither. For instance, not only can Ethereum be purchased by investors with the expectation of profits but also by users of the Ethereum network to pay for transaction fees. Another example would be memecoins which are largely purchased by retail users with the expectation of profits but can at times be purchased with a more nonchalant view to simply participate in a movement of digital culture. And memecoins certainly have no utility so far. It is tricky to apply the Howey Test to both native tokens of smart contract networks and memecoins.

The SEC has not only refused to provide crypto projects and exchanges clear guidelines to operate within, it has gone a step further and retrospectively attempted to take enforcement action against a number of top tier projects for violating securities regulations, when it is not clear that the regulations should apply. The SEC has already lost multiple cases in different US courts and been heavily criticized for its aggressive approach, which is hindering crypto innovation in the US.

FIT21 aims to sidestep the outdated Howey Test and provide new, more suitable labels to digital assets of different kinds. A key aspect of FIT21 is the creation of three categories of digital assets, each subject to distinct regulatory jurisdictions. These categories include "restricted digital assets," "digital commodities," and "permitted payment stablecoins." FIT21 establishes clear criteria for determining the classification of digital assets:

Restricted Digital Assets: These are digital assets subject to SEC jurisdiction. They are typically acquired through issuer distributions in exchange for significant value and are not related to functionally decentralized networks. Examples of restricted digital assets include security tokens issued by companies conducting public token launches to raise capital.

Digital Commodities: Digital assets falling under this category are subject to CFTC jurisdiction. They are often issued through distributions not used for fundraising and are open to all participants equally. Examples of digital commodities include Bitcoin and Ethereum, which are decentralized cryptocurrencies used as mediums of exchange and store of value. Well distributed airdrops, tokens with low ownership concentration, and deemed sufficiently decentralized by having a rigorous governance structure in place fall into this category. A set of five criteria covering token distribution, project code updates, token emissions, and accessibility is used to determine if an asset is a digital commodity or not.

Permitted Payment Stablecoins: These digital assets are subject to either SEC or CFTC jurisdiction, depending on the nature of the intermediary involved in the transaction. Permitted payment stablecoins are issued by regulated issuers and designed for use as means of payment or settlement. Examples of permitted payment stablecoins include USD Coin (USDC) and Tether (USDT), which are backed by fiat currencies and widely used for remittances and payments.

FIT21 states that it is possible for cryptocurrency to launch as a restricted digital asset and later evolve into a digital commodity.

FIT21, if passed, will potentially strengthen the market by protecting digital asset projects. Digital asset developers will have a pathway to raise funds; and participants will have a clear process to determine which digital asset transactions are subject to the SEC’s jurisdiction and the CFTC’s jurisdiction. FIT21 will also help create comprehensive registration regimes to permit financial institutions to lawfully serve customers in digital asset markets.

It remains to be seen how FIT21 evolves, and what its overall impact is on the crypto space. Market participants were fatigued by the lack of clarity on digital asset regulation in the US and deemed FIT21 as a positive development. There are, however, several criticisms of FIT21. The White House, in their Statement of Administrative Policy said that the bill fails to provide sufficient protection for consumers and investors, as did SEC chairman Gary Gensler. Projects aiming to have their tokens classified as digital commodities might find it challenging as the bill could lead to unwanted over-regulation involving not one, but two slow moving regulatory bodies – the SEC and CFTC. Also, the bill fails to address one of the major challenges facing digital assets buyers – their susceptibility to fraud.

The Biden administration could intervene to prevent FIT21 from becoming law as is has adopted a fairly hostile stance towards crypto in its current term. Biden’s office recently vetoed a repeal of Staff Accounting Bulletin 121 (SAB121). SAB121 requires publicly traded banks to place custodied digital assets on their balance sheet. SAB121 imposes burdensome capital requirements on institutions that custody crypto on behalf of customers. SAB121 got overwhelming pushback from both the banking and crypto sector and was repealed by the House and the Senate. President Biden overturned the repeal and defended his decision by arguing that repealing the SEC’s custody and accounting guidelines would undermine the commission’s authority over accounting practices. Biden further emphasized that he would not support measures that could jeopardize the well-being of consumers and investors, although he did not specify what overturning SAB121 has to do with consumer well-being.

Although the Biden administration’s stance towards crypto has been consistently unfriendly, US politicians are starting to recognize that crypto is growing in importance. SAB121’s repeal received a bipartisan response in favour, as did FIT21 in the House. The voter base that represents crypto might not be large enough to impose direct electoral costs on hostile parties but the donor base has continued to grow in size. Republican candidate Donald Trump has recognized this and vocally stated his support for Bitcoin and the cryptocurrency sector at large. Key industry figures such as Messari founder Ryan Selkis are actively aiding the Trump campaign solely to push for crypto regulation and innovation. It is worth closely monitoring how FIT21 progresses through the Senate and eventually evolves to attract projects to the US without stifling innovation. If it gets passed into law, any project that can be formally regulated in the US will have an edge in tapping into large otherwise currently inaccessible institutional pools of capital.