Interpreting the FIT21 Act: Impact on the Crypto World in the Next 10 Years

05-24

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Author: Chen Mo cmDeFi

This article mainly explains how to define digital assets and divide the boundaries between commodities and securities in the regulatory framework proposed by FIT21.

On May 22, 2024 ( 🍕 ), the FIT21 bill was passed by the House of Representatives with 279 votes to 136. The bill establishes a regulatory framework for digital assets and may become one of the most far-reaching bills on Crypto to date.

FIT21, the full name is - Financial Innovation and Technology Act for the 21st Century. The key point of this bill is that it coincides with the approval of the ETH spot ETF application (Form 19b-4), standardizes the regulatory framework of digital assets, and provides guidance for more crypto assets to apply for spot ETFs and the compliance path in the future. It can almost be announced that the gray era of more than ten years since the birth of Crypto has ended and officially entered a new world.

1/9 · Registration and regulatory responsibilities

There are two definitions of digital assets: digital commodities and securities. The bill stipulates that the supervision of digital assets will be jointly responsible by two main agencies, depending on the definition:

2/9 · Definition of digital assets

The bill defines "digital assets" as an exchangeable digital representation that can be transferred from person to person without relying on an intermediary and recorded on a cryptographically protected public distributed ledger. This definition includes a wide range of digital forms, from cryptocurrencies to tokenized physical assets.

3/9 Commodity or Security (Classification of Digital Assets)

The bill proposes several key elements to distinguish whether digital assets are securities or commodities:

The content here is extremely important because its significance lies in standardizing the regulatory framework for digital assets and will affect what the next digital asset may be through a spot ETF.

4/9 · Criterion 1: Use and consumption, rather than investment in the expectation of capital appreciation

From this perspective, public chains, PoW tokens, and functional tokens are more in line with the standards. (Note that this is only an example from the perspective of use and consumption. The definition of securities/commodities needs to be considered from multiple dimensions, and it does not mean that such assets fully meet the standards.)

The common feature of these digital assets is that they are primarily used as a medium of exchange or payment method, rather than as an investment in the hope of capital appreciation. Although in the real market, these assets may also be purchased and held speculatively, from the perspective of design and primary use, they are more likely to be regarded as commodities.

5/9 · Criterion 2: Determination of the degree of decentralization

Among these definition criteria, the more rigid ones are ownership distribution and governance rights. The 20% boundary line is of great significance for the definition of digital assets as securities or commodities . At the same time, because of the openness, transparency, traceability and non-tamperability of blockchain, the quantification of this definition standard will become clearer and fairer.

6/9 · Criterion 3: Functionality and technical characteristics

The definition of digital assets in the bill and how they are connected to the underlying blockchain technology are the basis for determining how these assets are regulated. We have already explained the definition of digital assets above. Here we will specifically explain how their connection with the underlying blockchain technology determines the direction of regulation within the scope of the definition of digital assets. This connection usually includes how assets are created, issued, traded and managed:

These characteristics directly affect how assets are regulated. Specifically:

7/9 · Key Issue 1: The programmatic distribution characteristics of assets tend to be defined as commodities

This section provides important guidance on how to define whether certain digital assets issued through blockchain technology, especially through smart contracts or decentralized applications (DApps), constitute securities.

In the traditional sense, securities usually involve investors investing money in the expectation of receiving benefits through the efforts of a business or third party. However, in the world of blockchain and cryptocurrency, many assets are issued and managed through automated programs or algorithms, and the characteristics and purpose of these assets may be different from traditional securities.

According to the bill, even if a digital asset is sold or transferred pursuant to the terms of an investment contract, if these assets are automatically issued through a programmed blockchain system, they do not automatically become securities. This is because:

8/9 · Key Question 2: How to deal with digital assets with governance and voting functions

The bill mentions that if no relevant person in a digital asset or its related decentralized governance system has owned or controlled more than 20% of the voting rights in the past 12 months, this may indicate that the asset has decentralized characteristics. However, in the relationship between digital assets and blockchain systems, it is mentioned that if digital assets mainly provide economic returns or allow voting to participate in governance through automated procedures of blockchain, they may be regarded as securities because this indicates that investors are expecting to gain benefits through management or corporate efforts.

There is a contradiction here. If a digital asset has voting rights and no relevant person has owned or controlled more than 20% of the voting rights alone in the past 12 months, is this asset more likely to be defined as a commodity or a security?

It touches on a complex area of digital asset regulation, namely how to treat assets with governance and voting features. Understanding this requires distinguishing between two key concepts: the degree of decentralization of an asset and the expectation of control or economic benefits that the asset provides to investors.

(1) Decentralization and voting rights

The bill mentions that if no relevant person has owned or controlled more than 20% of the voting rights alone in the past 12 months, this indicates that the digital asset has a high degree of decentralization. This usually means that no single entity or small group can control the operation or decision-making of the asset. From this perspective, a high degree of decentralization is a factor that drives assets to be considered commodities, because it reduces the control of a single entity over the value and operation of the asset, which is consistent with the characteristics of commodities, that is, they are mainly used for exchange or use, rather than for investment returns.

(2) Voting rights and securities attributes

On the other hand, if a digital asset allows holders to participate in governance through voting rights, especially governance that has a significant impact on economic decisions, this may cause the asset to be considered a security. This is because voting rights and governance participation generally mean that holders expect to gain benefits through the efforts of management or the enterprise (including the efforts of other holders), which meets the basic definition of a security.

(3) Understanding contradictions

The potential contradiction here is that on the one hand, the high degree of decentralization of assets is usually consistent with commodity attributes, while on the other hand, the governance and voting rights functions of assets may make them be considered securities. The key to resolving this contradiction lies in evaluating:

In the context of the approval of the ETH spot ETF application (Form 19b-4), the definition of ETH is more inclined towards functional use. The nature of its pledge and governance is more to maintain network operation rather than economic returns. Therefore, in the future, digital assets similar to ETH can theoretically rely on this approval as a template if they meet preconditions such as the degree of decentralization.

From this perspective, if the governance direction of the DeFi protocol governed by DAO is closer to obtaining economic returns or dividends, then its positioning is more likely to be defined as a security. If the governance direction tends to be functional, technological upgrades, etc., then it is more likely to be defined as a commodity.

9/9 · Technical and innovation support

In this part, the attitude towards Crypto compliance is basically established. The clearer direction is the research on DeFi and NFTs, which means that DeFi and NFTs may also usher in gradually clear regulatory strategies in the future.

Sector:

Layer 1

Smart Contracts

Disclaimer: The content above is only the author's opinion which does not represent any position of Followin, and is not intended as, and shall not be understood or construed as, investment advice from Followin.

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