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House Ag Committee leader talks new bills to treat more cryptos like commodities

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Two bills introduced last week looked to solidify the roles of the Securities and Exchange Commission and the Commodity Futures Trading Commission — respectively the regulators for securities and commodities in the United States. The bills featured many of the usual suspects in legislation touching on crypto but one less familiar face was U.S. Representative Mike Conaway (R-TX). 

Currently serving as the ranking member of the House Agriculture Committee, Conaway has been in Congress since 2005, predating Bitcoin’s whitepaper. His tenure has not been especially crypto-heavy. Nonetheless, he’s behind a bill that could transform how the U.S. handles crypto exchanges, which is important because it’s the Ag Committee that governs the CFTC.

Federal licensing for crypto exchanges

The Digital Commodity Exchange Act looks to give crypto exchanges the option to register with the CFTC, a national regulator, rather than going state-by-state to get money transmitter or money service provider licensing. “We got the patchwork of state-based regulations that are really hard to comply with,” Conaway explained to Cointelegraph.

The reason that crypto exchanges have had such a time getting licensing is due to general uncertainty as to what exactly to call cryptocurrencies themselves. The Digital Commodity Exchange act would move the standards more in the direction of calling them commodities.

New definitions for new assets

Moreover, the bill, alongside the Securities Clarity Act that Rep. Tom Emmer (R-MN) has introduced to the House Financial Services Committee, would put together a framework that assumes that certain new crypto assets are treated as commodities once they are distributed. Conaway explained to Cointelegraph:

“If it meets our definition, it would automatically fall into the category of commodity. […] We have no idea what kind of assets are going to develop over time. When you put new rules in place they’re never dynamic enough to accommodate what’s going on.”

The specifics of that definition may well get murky. The bill defines a “digital commodity” as:

“Any form of fungible intangible personal property that can be exclusively possessed and transferred person to person without necessary reliance on an intermediary, and which does not represent a financial interest in a company, partnership, or investment vehicle.”

Concepts similar to “representing a financial interest in a company” are critical to existing securities law and are, consequently, the subject of their fair share of debate.

The bill, according to Conaway, saw its impetus in 2018, around the time that LabCFTC founder Daniel Gorfine testified before the Agriculture Committee. “We did it the old-fashioned way, we had the hearing before we had the legislation,” Conaway joked.

Commodities vs. securities

But why does it matter if the CFTC runs the show? The CFTC is more of a principles-based regulator, Conaway noted. The idea is that commodities operate independent of a third party who could potentially run a swindle on investors. If you invest in oil futures, the price might tank — as it famously did in April — but you can’t blame that on BP.

The role of the SEC in crypto has been controversial, especially following the commission’s clampdown on Telegram’s GRAM distribution. “We’re trying to distinguish between what looks like a securities offering, which is clearly the SEC’s deal, and the ongoing trading of assets,” Conaway said. Effectively, that would mean reinforcing the SAFT Framework of dividing initial securities offerings from tokens, a format that many saw to be a thing of the past.

Outlook for the bill in the Ag Committee

Currently, Conaway’s bill has co-sponsorship from two other Republicans on the Agriculture Committee, as well as several members of the Blockchain Caucus. But what does that mean for getting the committee’s democrats on-board?

“We’ve had a couple of members of the committee that were really close to wanting to sign onto the bill,” Conaway said “We think that we’ll wind up with good bipartisan support.” He did not specify what stopped initial support, but things have been contentious around Congress lately.

Regardless, the bill will live on past Conaway’s time on the committee. This Congress is ending and he, at 72, is not running again. “It’s beyond the pale. My replacement is already in place,” he said.

Kristin Smith, head of the Blockchain Association, noted that the new legislation is a major step, but certainly will see updates before possibly becoming law. She nonetheless described it as:

“The first time we’ve seen a proposal of a regulatory framework for how we can ensure that the markets are strong and also carve out a regulated space for these digital commodities. So these are obviously first proposals. And at the end of the Congress, we don’t expect any immediate action.”

Earlier today, the CFTC filed charges against a trading platform that was offering futures in Bitcoin, Ether and Litecoin to U.S. investors without registering in the country. While regulators have acknowledged Bitcoin to be a commodity for several years, Ether and Litecoin have operated with less certainty.



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Tech developments challenge legal community

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Smart contracts are an important element of the blockchain revolution, although they predate blockchain. According to most sources, it was Nick Szabo who coined the term “smart contract” in the 1990s. The mechanism of a vending machine has since been frequently given as an example of a basic smart contract based on if-then logic. The payment into a vending machine triggers an irrevocable automated action from when money is retained to when an item is supplied.

The emergence of blockchain technology enabled the implementation of such if-then logic on decentralized networks to facilitate autonomous self-executing, self-performing smart contracts, also called computerized scripts, smart code, computerized protocols or decentralized business logic. Ever since they gained popularity, it has been debated and questioned whether they are at all smart or contracts.

The basics of smart contracts

Setting this debate aside for the moment, smart contracts offer many benefits. One of them is efficiency brought mainly by automation, their streamlined formation, unambiguous interpretation and efficient performance. Efficiency gains bring forth cost savings, achieved through the removal of intermediary layers and the reduction of ambiguities and opportunistic behavior.

Transparency of smart contracts provides auditability and enhances trust. Technology-guaranteed performance facilitates transacting not only between parties that do not know each other but also between parties that would be reluctant to transact with each other without guaranteed performance. Ex-ante guarantee of performance through automation and self-execution of smart contracts also helps to avoid institutional enforcement and costly contract breaches. Smart contracts can enable more efficient, cheaper business processes, supply chain management, corporate governance and much more. We are only starting to explore their potential use.

However, it has to be said that smart contracts also require a certain degree of technical literacy to code, implement and understand them, and outside of the blockchain community, such skills remain relatively low. Smart contracts are also not free from technical challenges and vulnerabilities throughout all stages of their lifecycle, from creation through to deployment, execution and completion. There are also ex-ante costs of smart contract implementation and costs of switching to smart contract networks, which should not outweigh the benefits to realize any efficiency gains.

Related: The promise of smart contract adoption is held back by crypto silos

Technology and law

Smart contracts represent the intersection of technology and law, and therefore challenge practitioners, scholars and legislators — many legal issues have been debated. Smart contracts have been called out as neither smart nor a contract. First, there is neither a commonly agreed-upon definition nor a unified, structured and systematic classification of smart contracts. There is no common agreement or understanding about the relationship between smart contracts and traditional legal contracts. Some scholars question the ability to create valid, binding legal contracts through a smart contract.

Related: Hybrid smart contracts will replace the legal system

Discussions are ongoing in regard to applicable legal frameworks and how to reconcile the immutability of blockchain records with contractual mistakes or contractual deficiencies. Similar concerns have been raised about amending smart contracts’ terms recorded on an immutable ledger. Also governing law and applicable jurisdiction are particularly relevant issues for borderless, decentralized blockchain networks on which smart contracts are being deployed. Consumer protection and duty of information issues are also being raised.

Increasingly, there are also considerable concerns related to Anti-Money Laundering (AML)/Combating the Financing of Terrorism (CFT) requirements, as well as privacy and confidentiality issues. Immutability and automated, unstoppable execution are also potential legal pitfalls for smart contract use.

This analysis is made more difficult since there are different types and models of smart contracts, depending on their legal relevance (if any), context and technical properties. They vary from simple, straightforward and standardized payment instructions, to sophisticated instruments capable of the autonomous performance of a complicated sequence of actions. The emergence of blockchain-based smart contracts also brought a new dimension to the notion of cyberspace self-regulation. Moreover, discussions about “code is law” and “Lex Cryptographia” ensued.

However, when it comes to legislators and regulators, they have been largely silent on smart contracts. Despite vigorous scholarly debate about the legal status, recognition and enforceability of smart contracts, their normative legitimacy and legal implications, legislators do not seem to be alarmed nor are they rushing into any prohibitive action. Even though there is some legislative activity in selected jurisdictions, thus far only a handful of countries have formulated a regulatory response and enacted legislation, which has usually been modest.

Smart contracts vs. United States

For example, the majority of the legislative initiatives on smart contracts in the United States are relatively narrow and govern only a select number of issues mostly limited to defining smart contracts, recognition of their electronic form and signatures, and sometimes their admissibility as evidence. This includes states like Arizona, Tennessee, North Dakota, Nevada, Wyoming and Illinois. Some critics have claimed that such legislative initiatives are premature and incomplete, and amount to no more than a promotion of a particular jurisdiction. This creates the risk of regulatory fragmentation among the U.S. states and piecemeal smart contract legislation, potentially complicating the harmonization at the federal level in the future.

The U.S. federal regulatory and supervisory agencies, such as the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), addressed smart contracts through their investigations, statements and guidance, which clarify some legal implications of smart contract use in the United States. The CFTC issued a primer on smart contracts in which it claims that a smart contract could be a binding legal contract, depending on the facts and circumstances, and could be subject to a variety of existing legal frameworks. The CFTC also highlighted several risks stemming from smart contract use including operational risks, technical risks, cybersecurity risks, risks of fraud and manipulation, and risks arising out of governance protocols.

Similar to the CFTC, the SEC applies existing legal frameworks in its enforcement actions related to blockchain and smart contracts. As a sign of increasing regulatory scrutiny, the SEC recently announced procurement for smart contract analysis tools to analyze and detail code within blockchains and other distributed ledgers, in support of its efforts to monitor risk, improve compliance and inform SEC policy concerning digital assets.

Smart contracts vs. the world

In other parts of the world, countries like Belarus, Italy and Russia have addressed smart contracts to a limited extent. The United Kingdom Jurisdiction Taskforce issued an important legal statement, concluding that smart contracts are capable of forming valid, binding and enforceable contracts between parties, emphasizing the adaptability and flexibility of common law that is capable of catering to technological advancements such as smart contracts. The European Union has also expressed consumer protection concerns related to the use of smart contracts, but so far there has been no regulatory action taken at the EU level.

The existing legislative initiatives seem to align when it comes to the recognition of smart contracts within existing legal frameworks; however, they differ on defining smart contracts. It is just a matter of time before issues related to smart contracts reach the courts, allowing the judiciary to address legal questions, particularly in common law jurisdictions.

Conclusion

In the meantime, the proliferation of diverging definitions and potentially legal treatment of smart contracts may give rise to legal uncertainties and regulatory arbitrage. Legislators should therefore closely follow developments in smart contracts and step in only when necessary to provide legal certainty, mitigate risks and protect vulnerable contracting parties. Such a measured and risk-based regulatory approach would support innovation, harness opportunities and integrate smart contracts innovation within existing legal systems. Adequate regulatory guidance could also help to remove legal uncertainties and uplift market confidence for the industry, investors and consumers.

The market size of global smart contracts is rapidly growing. It is predicted to gain a compound annual market growth rate of 17.4% in the forecast period of 2020 to 2025, and is expected to reach $208.3 million by 2025. Smart contracts are increasingly being deployed across a broad range of sectors, including the financial sector, public sector, supply chain management, and the automobile, real estate, insurance and healthcare industries. They are also the backbone of a growing decentralized finance (DeFi) space. Regulators will be increasingly challenged to respond to and address smart contracts, but legislative initiatives so far indicate that there are no major obstacles for smart contract use; it does not seem that any substantial legal reforms are necessary to embrace them.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph, nor the Warsaw University of Technology or its affiliates.

This article is for general information purposes and is not intended to be and should not be taken as legal advice.

Agata Ferreira is an assistant professor at the Warsaw University of Technology and a guest professor at a number of other academic institutions. She studied law in four different jurisdictions, under common and civil law systems. Agata practiced law in the U.K. financial sector for over a decade in a leading law firm and in an investment bank. She is a member of a panel of experts at the EU Blockchain Observatory and Forum and a member of an advisory council for Blockchain for Europe.