What is the Clarity Act?

For all the talk surrounding the Clarity Act, not many people can pinpoint what the bill actually does, nor what it aims to change. Hard to blame them; 250 pages of impenetrable legal jargon is not for everyone. Nevertheless, behind the walls of text lies a fundamental rewriting of how cryptocurrencies are to be treated in the future. The impact of the bill cannot be overstated; the existent legal framework is about to be burnt to the ground.

Out with the old

Cryptocurrencies have had a rough few years. Former SEC Chairman Gary Gensler was notoriously harsh on the emerging industry, providing little in terms of guidance but plenty in terms of punishment. Rules were unclear, inconsistent and selectively enforced. Companies did not know what was allowed and what was not. In the absence of clear regulations, attempts at innovation were often met with fines, de-listings, injunctions, forced shutdowns and years of costly legal battles. In one instance, the SEC’s overreach was so bad that a federal judge sanctioned the commission, leading Gensler himself to admit that the case in question was “not well handled”. There are many, many more examples of poor conduct on behalf of the agency.

The situation was a bit like pinning someone down, grabbing their hand and going through the “why are you punching yourself” routine. Not particularly conducive to technological progress. Fortunately, the current US administration has adopted a more lenient stance on the matter, as exemplified by the Clarity Act itself. Time to stop the bullying.

In with the new

The Clarity Act establishes a clear regulatory path that would allow cryptocurrencies to escape the wrath of the SEC and instead move over to the protective umbrella of the CFTC. As a reminder, the Securities and Exchange Commission deals with, as the name suggests, securities. Meanwhile, the Commodity Futures Trading Commission deals with, drum roll, commodities. In the US, securities face far more regulatory scrutiny than commodities, so classifying cryptocurrencies as digital commodities immediately solves many problems.

Unfortunately, the US government cannot simply declare all cryptocurrencies to be commodities overnight, because doing so would open the door to massive fundraising fraud. There has to be a well-defined mechanism allowing cryptocurrencies to earn the title of digital commodity. To do this, the Clarity Act introduces the notion of blockchain maturity, which demands of each project a certain level of decentralisation, dilution and utility.

The path can be summarised as follows:

•   ●  Define “blockchain maturity”.
•   ●  Classify mature blockchains as digital commodities.
•   ●  Place digital commodities under the jurisdiction of the CFTC.

Blockchain maturity

In order to qualify as mature, the blockchain must:

•   ●  Have a value that is substantially derived from the use of the blockchain system.
•   ●  Allow network participants to engage in blockchain activities (e.g. transacting, accessing services, operating a node, voting, etc.).
•   ●  Be composed of source code that is open source.
•   ●  Operate exclusively according to pre-established rules encoded directly within the source code, which may not be altered at a later date.
•   ●  Allow no person or group of persons to unilaterally modify the functionality or consensus mechanism of the blockchain.
•   ●  Allow no team or person to own more than 20% of the total amount of units of the digital commodity, nor control more than 20% of the voting power.

On top of the above, all currently operational blockchains must have at least 50% of their coins/tokens in circulation, i.e. away from the founding team.

As reasonable as they are, many blockchains would struggle to meet the above criteria. Some chains, such as BNB, would likely fail on the decentralisation front, while others, such as HYPE or SUI, would probably fail due to their token supplies being insufficiently diluted.

SEC versus CFTC

Upon launch, a blockchain falls under the remit of the SEC by default, as a restricted digital asset. Later, once the development team can prove its technology to be sufficiently mature, it can submit a formal application to the SEC, with supporting evidence. The commission then has 60 days to review the application before delivering a verdict. If successful, the blockchain in question gains the coveted maturity status, thereby placing it under the jurisdiction of the CFTC.

The process is not permanent. Should the development team renege on any given requirement, the blockchain will be stripped of its digital commodity status and be dragged back under the authority of the SEC. As with any legal text, there is room for interpretation. It is up to each company to defend itself and its actions within the regulatory framework provided.

Commodity perks

As mentioned above, digital commodities face much less regulatory scrutiny than their SEC-sanctioned counterparts. The reduced legal hurdles do not just affect the founding team, they also make life easier for exchanges and investors.

As far as the founding team is concerned, the shift means that regular financial audits and corporate risk assessments are no longer necessary. A digital commodity is not considered the legal property of a company; it is instead recognised as a public utility driven by supply and demand. It is simply a decentralised network, free for anyone to use, unable to be fined or forced into compliance.

As far as exchanges are concerned, hosting unregistered securities can cause huge problems, often incurring fines and even SEC enforcement lawsuits. The shift towards digital commodities mostly does away with such concerns, as there are almost no legal barriers to listing digital commodities on trading platforms.

The biggest shift of all lies with investors. Institutional asset managers are subject to strict rules about what they can and cannot do. Blackrock or Fidelity cannot simply ape into the latest ICO craze, nor can they accumulate vast wallets of unregistered cryptocurrencies; strict legal barriers prevent them from doing so. On the other hand, there is very little to stop them from acquiring huge balance sheets of commodities, digital or otherwise.

Institutional money is coming

It used to be a bit of a meme back in the day, but institutional money is indeed waiting for regulatory clarity before entering crypto in earnest. The relentless buying of crypto ETFs is proof enough that the appetite is there; all that is left is for the Clarity Act to be signed into law. The scope of the bill is in fact quite large and includes elements that are not particularly relevant to the average crypto user, such as those prohibiting the Federal Reserve from issuing Central Bank Digital Currencies (CBDCs), those relating to Know Your Customer and Anti-Money Laundering standards, as well as other, equally dull clauses. Frustratingly, it was precisely these clauses that held up the bill for so long.

It matters little now. At long last, the wait is over. Traditional and decentralised finance finally have the regulatory clarity they fought so long and so hard to obtain. Make no mistake, the Clarity Act represents one of the most monumental shifts in financial law since the Securities Act of 1933. A new chapter begins.