Interpretation of the FIT21 Act: Defining digital assets and regulatory framework

On May 22, 2024, the FIT21 Act was passed in the U.S. House of Representatives with a vote of 279 to 136. The full name of the Act is "21st Century Financial Innovation and Technology Act," which establishes a regulatory framework for digital assets and could become one of the most far-reaching pieces of legislation affecting the cryptocurrency industry.

The bill clarifies the definition of digital assets, categorizing them into two types: digital commodities and securities. The Commodity Futures Trading Commission ( CFTC ) is responsible for regulating digital commodity trading and related market participants, while the Securities and Exchange Commission ( SEC ) is responsible for regulating digital assets deemed to be securities and their trading platforms.

Digital assets are defined as a form of exchangeable digital representation that can be transferred peer-to-peer without relying on intermediaries and recorded on a cryptographically secured public distributed ledger. This encompasses a wide range of digital forms, from cryptocurrencies to tokenized physical assets.

The bill proposes several key elements to distinguish whether a digital asset is a security or a commodity:

1. Investment Contract ( Howey Test ): If the purchase of a digital asset is considered an investment, and the investor expects to profit from the efforts of a third party, it is typically regarded as a security.

2. Use and Consumption: If digital assets are primarily used as a medium for goods or services, they may be classified as commodities or non-securities.

3. Degree of Decentralization: Digital assets behind a highly decentralized network are more likely to be regarded as commodities.

4. Functions and Technical Features: The technical construction and functional implementation methods of digital assets are also classification criteria.

5. Market Activities: If assets are primarily marketed based on expected returns from investments, they may be considered securities.

From the perspective of use and consumption, public chains, PoW tokens, and functional tokens are more in line with commodity standards. The definition of decentralization includes multiple aspects such as control, ownership distribution, voting rights, etc., among which the 20% boundary line is of significant importance for asset definition.

The relationship between digital assets and underlying blockchain technology in terms of functionality and technical characteristics determines the regulatory direction. This includes aspects such as asset issuance, transaction verification, and decentralized governance.

It is worth noting that even if digital assets are sold according to the terms of an investment contract, they do not automatically become securities if they are issued automatically through a programmatic blockchain system. This is because programmatic operations, decentralized characteristics, and programming transparency reduce the direct control of individuals or groups over the operation of the assets.

The definition of digital assets with governance and voting functions has certain contradictions. High decentralization often corresponds with commodity attributes, but governance and voting rights functions may cause them to be viewed as securities. The key to resolving this contradiction lies in assessing the substantive impact of voting rights and the economic return expectations of the holders.

The bill also proposes to strengthen the technical and innovation support of regulatory agencies, including expanding the SEC's Innovation and Financial Technology Strategic Center and the CFTC's Lab. At the same time, a joint advisory committee between the CFTC and SEC will be established, focusing on digital asset issues. The bill also calls for research on the development of decentralized finance ( DeFi ) and non-fungible tokens ( NFTs ) and their regulatory needs.

These measures indicate an attitude towards the compliance of the cryptocurrency industry and lay the foundation for future regulatory strategies for DeFi and NFTs.