On Reg

A Deep Dive on New U.S. Crypto Legislation

• Dechert LLP • Episode 15

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How will the recently adopted GENIUS Act, the pending CLARITY Act and other recent regulatory developments affect the crypto market in the U.S.? In this installment of Dechert On Reg, host Angelo Lercara is joined by Dechert partners Brenden Carroll and Neel Maitra to highlight what these new developments mean for crypto traders and asset managers, the role of the SEC and banking agencies and the potential for tokenization of securities. The discussion also explores the challenges of regulating decentralized finance and the prospect for harmonization between U.S. and EU regulations. 

Show Notes

Dechert's Leading on Crypto

Angelo Lercara:

Hello everyone, and welcome to Dechert On Reg, the podcast where we explore the ever-changing landscape of financial regulations and the key issues that are shaping the future of asset management. I'm Angelo Lercara a partner at Dechert and co-head of our regulatory product line, and in each episode, we'll be joined by expert colleagues and guests to explore the most pressing issues in financial regulation. In today's episode, we dig into Washington's new crypto rules, the GENIUS Act, the pending CLARITY Act and fresh SEC guidance and why these shifts matter. So, whether you're an industry insider or simply interested in the world of financial regulation, you don't want to miss this episode of Dechert On Reg. I'm excited to have two experts joining us. My colleagues, Neel Maitra and Brenden Carroll, are here today to discuss with us. Let's dive in. Hi Neel. Hi Brenden, good to see you.

Neel Maitra:

Good to see you, and thanks for having us.

Brenden Carroll:

Yes, Angelo. Always a pleasure.

Angelo Lercara:

After years of regulation by enforcement, Washington is finally writing clear crypto rules. The GENIUS Act is the first federal framework for payment stablecoins. Issuers must be licensed, hold high-quality liquid reserves, give investors redemption rights and meet ongoing disclosure and supervision requirements. The CLARITY Act, still pending, would set the broader market structure and divide responsibilities between the SEC and CFDS. In the meantime, guidance from the SEC and the banking agencies on custody, staking stablecoins and even memecoins is filling the gap, probably only until Congress finishes the full regime. These are all interesting, if not exciting, developments that we want to understand better today. Neel, let's start with the GENIUS Act, the new U.S. law on payment stablecoins. What exactly are payment stablecoins, and what does this mean for crypto traders and asset managers and in particular, can non-U.S. issuers get involved as well?

Neel Maitra:

Great questions, Angelo. Thank you. And so, the central concept of a payment stablecoin is basically a digital asset that's designed to be or used as a means of payment and settlement, and the issuer of which is doing one of two things, either it's obligated to convert, redeem or repurchase the coin for a fixed amount of monetary value, or it represents that the issuer will maintain or create the reasonable expectation that there is going to be a stable value relative to a fixed amount of monetary value. So for example, if you've got a token that says, }"this token is always going to be worth $1" or "this token is always going to be worth $10" that, for example, would be a payment stablecoin. So, it's a fairly sort of clear definition in that sense. Now, what the GENIUS Act does is that it creates a prudential regulatory framework for stablecoins generally. You asked about foreign issuers of stablecoin and I think, as a general matter, the GENIUS Act prohibits a digital asset service provider, from offering, selling or otherwise making available in the U.S. a payment stablecoin issued by a foreign stablecoin issuer. However, this prohibition doesn't apply to payment stablecoins if they're issued by a foreign payment stablecoin issuer that's from a qualifying non-U.S. jurisdiction with a comparable regulatory and supervisory framework as determined by the Secretary of the Treasury and that issuer can demonstrate capability of complying with U.S. lawful orders. So, compliance with regulatory asset freezes, seizures, blocks, anti-money laundering, economic sanctions, derivatives, all of that. So basically, what we've got here is generally a prohibition on foreign payment stablecoin issuers, but also a loophole, or rather an exception, that allows foreign payment stablecoin issuers to issue stablecoins as long as it's been found by the Secretary of Treasury to belong to a jurisdiction that has a comparable regulatory and supervisory framework and the issuer can demonstrate capability of complying with U.S. economic laws such as anti-money laundering laws or sanctions laws. But even after you have this determination of comparability, foreign issuers can only issue payment stablecoins in the U.S. if they register with the Office of the Comptroller of the Currency and they hold reserves in a U.S. financial institution that's sufficient to meet the liquidity demands of U.S. customers, and those reserves have to be in the form of specific assets, such as, for example, U.S. dollars, treasuries, all of that. So, these may be fairly significant requirements for foreign payment to reach stablecoin issuers, not to say that they can't do it,

Angelo Lercara:

So, would MiCA be a comparable regime or an but there are stringent conditions. acceptable regime?

Neel Maitra:

I'll let Brenden get a word in edgeways on that first. Did you want to add something, Brenden?

Brenden Carroll:

Yeah, I wanted to emphasize one point you made, right? These are payment stablecoins. They're not intended to be investments. And one of the important features of GENIUS Act, and in fact, like, a core prohibition, is that a payment stablecoin issuer cannot pay yield or interest. So, these are non-yield bearing instruments designed as a mechanism for payment and settlement. I think that, you know, these payment stablecoins could really revolutionize the payment infrastructure within the United States and will definitely have an impact outside of the United States. I also wanted to highlight one other feature that Neel mentioned, and that is the eligible reserve requirements. I mean, this is this is also an important feature of this legislation. These stablecoins have to be backed on a one-to-one basis by incredibly short maturity, high-quality investments, including cash and U.S. Treasury securities that mature within 93 days or less. There is some permission to invest outside of that limitation but, you know, it can include things like overnight repos. So, those types of requirements are even more stringent than what a registered money market fund can invest in. And you know, this legislation, you know, had it permitted yield, it might have had more of a competitive impact on some of the fund products out there that also seek to maintain a $1 stable net asset value per share.

Angelo Lercara:

Right, right. The other act, which we want to discuss, the CLARITY Act, which is another big piece of U.S. crypto legislation. It's passed the House, but isn't law yet, I believe. And if it does become law, how would it change the way crypto markets are regulated in the U.S., and what's the big shift from how things work today?

Neel Maitra:

I think that the CLARITY Act would be a much more significant development than GENIUS. Not to suggest that GENIUS is not a significant development. It certainly is. But the GENIUS Act and the bipartisan support with which it passed really indicate the fact that stablecoins are a fairly easy crypto idea for everybody to get behind. Everybody likes them. People can see the case for stablecoins. People can kind of see the utility for stablecoins easily. It's clear that they would make things much easier from a payment rails and a perspective. And so it's a relatively small, discrete part of the crypto market that, I think, has gotten clear congressional support. The CLARITY Act, I think, is a much more wide- ranging kind of legislative initiative, and for that reason, I suspect it's going to get a lot more debate and a lot more discussion before it makes it to law. And so, what the CLARITY Act really does is, among other things, it kind of seeks to create a completely new structure for the crypto markets altogether. And to do that, it allocates jurisdiction between the SEC and the CFTC. As you know, the United States is relatively unusual in the sense that it has separate regulators for securities and for commodity futures, which is not always the case for many developed economy regulators. And so the question of which regulator has jurisdiction is an important question for U.S. Law. The CLARITY Act seeks to give the CFTC much more jurisdiction over digital assets in the sense that, for the first time, it gives the CFTC plenary jurisdiction over the stock trading of digital asset commodities. So the CFTC has historically largely regulated Commodity Futures Trading. They do have some anti-fraud, anti-manipulation, you know, jurisdiction over spot trading, but they have much more extensive jurisdiction over derivatives than they do over spot, What CLARITY really does is that it invests the CFTC with much greater jurisdiction over spot trading of derivatives, over the intermediaries that would trade spot digital commodities such as exchanges, such as broker dealers, and even over custodians. So, that's kind of one of the big things that CLARITY does. There are several other things that CLARITY does, but one other that I think is probably worth mentioning is that it creates some parts, or some regulated parts, towards the offering of digital assets in the United States. And so these are both things that the digital asset industry has long asked for. It's kind of asked for a regulated path forward to offer digital assets, particularly to retail investors in the U.S. And it has basically said there has to be some sort of market structure regulation that is not the same as traditional securities regulation. So, CLARITY Act seeks to address both of those questions.

Angelo Lercara:

OK.

Brenden Carroll:

And I think most people would agree that the CLARITY Act, it's not perfect. You know, even the President's Working Group on Digital Assets released a report, you know, two days ago, and they called the CLARITY Act an excellent foundation for the digital asset markets, but they are recommending some additional features as that bill works its way through Congress. So, I do think there will be some changes to be made in that legislation. I do think it's more complicated than the GENIUS Act. It touches more parts of some of the plumbing in the United States, in some of the weighty jurisdictional issues that have been lingering in Congress for a long time,

Angelo Lercara:

And it seems that the regulators have been pretty active as well, because while Congress has been debating these laws, the SEC and some banking agencies have put out a bunch of statements on things like stablecoin staking and also memecoins. Some say this guidance has been pretty crypto friendly. Is that true? And do you think any of it could be rolled back if these new laws come in?

Brenden Carroll:

Well, I'd almost say that's an understatement, Angelo, compared to what we were dealing with last year. The pace of guidance that has been put out by the agencies under this administration has just been astounding compared to the prior administration. The agencies are trying to work in long step to implement President Trump's policy to create a, you know, sort of the crypto first, or to be the crypto capital of the world, as I believe he had said. You know, fairly recently, the U.S. banking regulators had put out a joint statement addressing safe-keeping activities for crypto assets. And that was really important from the banking community from an asset management perspective, right? A lot of our regulations require that custody of client assets be maintained with a bank or another eligible custodian. I think this recent guidance that came out really can encourage some of these more institutional banks to provide those types of safe-keeping services for crypto asset securities, which could give managers more options to custody client assets. The legislation will always take priority over agency guidance, and so it's possible that some of this guidance may need to be, you know, rethought as new legislation comes out. I think we do expect a bit more, you know, concrete rule making that would address some of what has been included within these statements, including the statement on stablecoins. I think that, you know, the GENIUS Act, essentially, just, you know, codified that. The more interesting question that I think you allude to is like, how everlasting is this guidance? You know, we've seen a bit of a turn from the prior presidential administration to the Trump administration. I think time will tell how everlasting this will be. But I do emphasize Neel's earlier point that the GENIUS Act passed with broad bipartisan support, which would suggest some level of comfort on both sides of the aisle with at least some aspects of the wider crypto universe or ecosystem.

Angelo Lercara:

OK, thank you. We will continue our conversation after a short break.

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Angelo Lercara:

I guess tokenized versions of traditional securities is another interesting topic. SEC Commissioner Hester Peirce recently hinted that the SEC might support trading in tokenized versions of traditional securities. What do you think? How real is that idea? And do you think we could see large -scale trading of tokenized stocks in the near future? What's standing in the way? Why don't we see it already?

Neel Maitra:

I think we could, and I think we've seen the first steps towards it. I mean, the most important thing to note is that there seems to be significant support at the top. And in fact, SEC Chair Atkins gave a speech yesterday, which was very, very supportive of the idea of sort of tokenization. And I think he sees it as being a critical move towards continued U.S. innovation and leadership on finance. And so I think he's very much looking to work with the industry on ideas of tokenizing securities. That's not to say that with all that regulatory goodwill that we necessarily have solved that problem. There are real questions around regulation NMS, which sort of governs most of the publicly traded, exchange traded securities in the United States, which is obviously the bulk of the market. So, there are questions around regulation NMS that still need to sort of be thought through. But there's definitely interest in doing this, and interest in finding a way to do this, and the SEC has already indicated, to the extent you've got a question, or to the extent you're seeking some kind of relief to get this done, the SEC is kind of going to be open to that, or is going to be receptive to granting such relief, you know, within, obviously, legal parameters. So, I think it's very much something that's on the cards. One thing I would note is that, you know, a number of firms have already tried to tokenize securities. They've largely done that outside of the United States, those initiatives have met with a mixed reception in the sense that they're obviously innovative. But I think, you know, people have asked questions about whether a new security is being created, whether a new derivative is being created. Who's the issuer? Who are the intermediaries who are making them available? Are they made available to U.S. persons? I think all these questions have kind of arisen, and they will need to continue to be confronted as we go down the tokenization route.

Brenden Carroll:

Just to pick up on that theme, I mean, that speech that Chairman Atkins gave yesterday really announced what he dubbed the "Project Crypto" within the SEC, where it's really a policy vision, where he is committing to really pull all the levers within the SEC available to him to help implement some of the recommendations from the President's Working Group on Digital Assets. I think at no other time have we had this type of, you know, tone at the top and support at the top to implement a number of these sort of crypto DeFi ideas. So, there's a lot of work to be done, of course, as Neel would suggest but, you know, you certainly have a chairman that is committed to pushing through rulemaking to help make this an everlasting feature of our, you know, financial marketplace. And in the interim, he said that they would consider no action, exemptive or any other type of guidance or relief that may be necessary.

Angelo Lercara:

Interesting. Neel, you have alluded to it already, so, a lot of tokenization so far has been happening in private funds that tend to be more innovative. Do you think that's where innovation will stay, actually, or could we start seeing more action in the regulated fund space as well?

Neel Maitra:

I'll defer to Brenden on this, who's really the guru on regulated funds. So, Brenden, take it away. And tokenized money market funds

Brenden Carroll:

I mean, we've already seen it, so I expect a number of our clients to be interested in tokenizing their regulated funds. I mean, we already have tokenized regulated funds in the United States. I think there were some constraints. I think, very helpfully, the SEC staff provided some guidance to help facilitate the tokenization. But I think this is only going to gain, you know, more and more traction as the industry comes up with potential use cases where one can use tokenized funds for a number of different means, including for investment, or not just for investment, I So, this fund, who, you know, may have to should say. You know, recently, there was a big announcement from both Goldman Sachs and Bank of New York Mellon on making available money market funds through Bank of New York Mellon's money market fund portal, where the shares would be tokenized. I mean, that, I think, is an important development, and I think it's only a matter of time before we see more adoption of this within our markets. maintain more cash on hand to satisfy those redemption requests. The idea that an investor can use those shares and post it for margin purposes, I think, has the potential to really grow that market. I think. in theory, some of this could be done now. CFTC rules do permit certain types of money market funds to be, you know, eligible collateral. But as with any other technology, I think it's going to take time before adoption, right? There's concerns about how it would be respected in bankruptcy, how one can sort of demonstrate, you know, control. I think all of that will take time, but I think it's a matter of when and not if.

Angelo Lercara:

You've mentioned DeFi. Regulators have, surprisingly, mostly stayed quiet on decentralized finance and decentralizationas a whole. The CLARITY Act suggests that code and algorithms themselves wouldn't be regulated. But what about how they are used? Do you have any thoughts on how DeFi might get regulated in the U.S. or maybe Europe going forward? I mean, if you if you look at MiCA, the European regulation, it barely touches DeFi. There are a few review clauses but,you know, nothing more than that. So, the regulators seem to be stalling still. What are your views on that?

Neel Maitra:

It's an excellent question. And I think that we all agree that there are aspects of DeFi that are not suitable for regulation. I mean, for example, just the provision of code. But then the question really is, for DeFi, where do we draw the line, and how do we draw the line? How thickly should that line be drawn? So I think there, you know, Commissioner Peirce, again, has kind of been a pioneer in this space by sort of saying, "Well, you know, if you're just publishing code, then perhaps that's not subject to regulation. But if you're doing more, then you may be subject to regulation." But what is that more? There is another thing there, which was discussed in the report that the president's working group put out yesterday, which suggests the idea of an innovation exemption from typical regulated categories. So, we might be seeing a situation where, for example, if you are a DeFi-automated market maker or a decentralized exchange, then you may meet the definition of an exchange or a broker dealer. You may. I mean, I think that that's debatable in itself, because I think there are a lot of people who would say we don't meet the definition. But even if you did, a lot of people would say the existing rules are not suitable for you, or are not appropriate for you, because there is really no one in charge in the way that there is in the sense of a centralized exchange, or, for example, you're not taking custody of funds and securities in the way that a centralized exchange or a traditional broker dealer is. So given that, I think the likely direction of travel here on DeFi is that we're almost certainly going to see some kind of exception being created for DeFi products. Now, the question there will be, how onerous is that exception? Is it just going to be sort of having to make a couple of notice filings, or is there going to be more than that? Is it something that is going to be debated, discussed and possibly contested in the months to come? One thing I will say is that obviously there is a great deal of interest in pushing this forward from, you know, the DeFi enthusiasts within the crypto industry. But the more aggressively they push it, or the more maximal the position they take, the more likely they are to sort of get some degree of debate or some degree of difference from traditional finance operators who are in the space and who may start asking, "Why is it that two essentially similar functions are being subject to different levels of review and regulation?" So that's where I think the real debate is.

Angelo Lercara: :

et's look ahead. Crypto runs 24/7, but regulation doesn't. What do you think? Are we moving toward more alignment or even harmonization between the U.S. and the EU on crypto rules or or not at all.

Neel Maitra:

Brenden, do you want to take a first crack at that? It's a big question.

Brenden Carroll:

Yeah, let me just look into my crystal ball here. You know, I guess, one could never be wrong here. Look, perhaps we can see some harmonization. I think there are a lot of areas where we could have done that in the past, even outside of crypto. And our markets are never completely harmonized. I mean, each country has its own philosophy on regulation, so there's never going to be perfect harmony here. I would say that, like, as one jurisdiction begins to adopt a framework and if there are benefits and if it's attracting capital, it's more likely that the other jurisdiction will perhaps conform, at least to some degree, if they see those benefits and maybe they address some of the bugs in the system. But countries are just inherently philosophically different. I mean, you take the Central Bank Digital Currency. I mean, we have a bill that was passed in House that would essentially prohibit our government from ever issuing one of those. And that's driven by, sort of our sensitivities on privacy. You know, in China, that is a feature, not a bug. So perhaps we'll see some more harmonization. But I think there are some limits about exactly how close these regulatory regimes will look.

Neel Maitra:

I think that that's right. The one thing I would add there is that in terms of the major developing regime that I'm thinking primarily about MiCA, but also the fast-developing U.S. crypto regime, we're going to see a significant amount of pressure from significant industry participants such as, for example, centralized exchanges, but also asset managers and others highlighting the areas where compliance with the two regimes is duplicative or onerous, or conflicting. I think those will probably be the low-hanging fruit that will first yield some benefits in terms of harmonization. I think I can see, particularly in this administration, receptivity to the claims that it's very difficult to comply with multiple overlapping regimes. I think there we're going to see some movement. So. I think a long road ahead but, you know, a journey over 1000 miles starts with a single step, so those steps will, I think, be happening soon.

Angelo Lercara:

Yeah. And this is a good point, Neel, and we saw it with MiFID for instance, with the overlapping regimes and double burden. Yeah. Neel, Brenden, a big thank you for joining us and sharing your insights with us. We really appreciate your expertise, and it's been great having you in this conversation. Thank you very much.

Neel Maitra:

Thank you.

Brenden Carroll:

Thank you for having us

Angelo Lercara:

As we wrap up today's episode, I'd like to extend my thanks to our incredible production team. It is their dedication and hard work behind the scenes that make this podcast possible. So., here's to our talented producers, sound engineers and everyone else involved in bringing this show to life. To our listeners, thank you for tuning in to our financial regulatory podcast. We hope that you found today's episode informative and engaging. If you enjoyed the show, please consider subscribing, rating and reviewing us on your favorite podcast platform. See you next time.