FIT21 is a PsyOp

Known as the Financial Innovation and Technology for the 21st Century Act, or FIT21, the bill passed by lawmakers in the House of Representatives would provide a pathway for cryptocurrencies to become certified as digital asset commodities under new rules.

But according to speakers, this is a "psyop" (psychological operation) that will end DeFi as we know it in the US.

In fact, FIT21 introduces a labyrinth of legal traps and ambiguities designed to maintain traditional control. It threatens to dismantle DeFi by imposing mandatory intermediation, carving out essential definitions, and leaving tokens in a legal limbo.

Dive into FIT21

FIT21 review (6:00)

Positive aspects of FIT21 :

• It represents a step in the right direction politically by addressing the need for a regulatory framework for digital assets.
• It recognizes the importance of legally defining decentralization
• It supports the idea of exempting truly decentralized projects from CFTC and SEC regulation

Negative aspects of FIT21 :

• The CFTC seems even more aggressive and damaging than the SEC, likening the SEC to "a nice little Pomeranian" in comparison.
• The CFTC's enforcement actions in the past, particularly against forex brokers, have been excessively harsh
• FIT21 is granting more power to the CFTC and SEC, when the focus should be on stripping power from these agencies and clearly delineating their roles.

Suggested improvements for FIT21 :

• Clarify and strengthen the definition of decentralization, specifically regarding front-ends and user access to smart contracts.
• Explicitly state that running a front-end that allows user access to a smart contract should not be subject to CFTC or SEC regulation and is a part of DeFi that should be left unregulated.

The proposed definition on decentralization (12:00)

The bill outlines a five-point system for defining a decentralized system :

1. Lack of unilateral control
2. Distribution of voting power
3. Lack of code changes by an issuer
4. Lack of marketing as an investment
5. Distribution of digital assets directly to end-users.

The definition is seen as potentially difficult for projects to meet, which may be the intention behind including it.

It recognizes that tokens can be initially issued to raise capital (potentially as securities) but later become part of a decentralized system, allowing for a "cleansing" of the securities status over time.

That said, there are "blanks" in the definition that will need to be filled in through regulations by the SEC or CFTC, which raises concerns about trusting these agencies given their track record in the crypto space.

The definition may need to be more restrictive in terms of the leeway given to regulatory agencies, given the lack of good faith demonstrated by agencies like the SEC.

Two categories of digital assets (18:00)

The bill creates two categories of digital assets, digital commodities and restricted digital assets :

• Digital commodities are those deemed sufficiently decentralized, which would fall under CFTC regulation
• Restricted digital assets would fall under SEC regulation, similar to securities

On the positive aspects, it creates a legal pathway for token sales/issuances to raise capital (up to $75 million). It enshrines a token exemption for relatively small token raises, which is seen as long overdue, and it establishes a non-security status for airdrops

On the other hand, the process of certifying something as sufficiently decentralized (a digital commodity) could get messy under the proposed rule. Furthermore, regulators can do overreach or misinterpretation

The concerns

Certifying an asset (22:00)

The process for certifying an asset as decentralized (and thus a digital commodity) raises questions :

• Who can initiate the certification process ?
• How disputes over the SEC's determination would be resolved ?

Another concern is about granting the CFTC authority over digital commodities. It gives the CFTC new powers beyond its traditional jurisdiction over futures markets, and CFTC did overreach before in regulating forex markets

CFTC overreach (28:00)

The CFTC has traditionally regulated derivative markets (futures), not spot commodity markets, but the intangible nature of digital assets blurs the distinction between spot and derivative transactions, complicating the CFTC's jurisdiction

For physical commodities like oil, a spot transaction involves the actual delivery of the commodity, and futures/derivative contracts is based on the price movement of the commodity, not the delivery itself

With digital assets, the line between spot transactions and derivative transactions is blurred since the "delivery" is just a transfer of data

So CFTC would try to assert authority over DEXs by claiming traded tokens represent futures/leveraged transactions

That would mean registration requirements with the CFTC for activities like offering digital commodities for sale

Concerns about Commodity Exchange Act, aka CEA (32:00)

The CEA requires non-eligible contract participants (non-ECPs) to trade commodity interests/derivatives through regulated intermediaries (futures commission merchants) and exchanges

This mandatory intermediation requirement is fundamentally incompatible with DeFi protocols, as they undermine DeFi innovations and benefits

To comply with intermediation, DeFi platforms may create "walled gardens" accessible only to ECPs. This would fragment liquidity, preventing non-ECPs from accessing certain trading pools

Liquidity fragmentation is already a problem in DeFi as a whole, intermediation would break everything

Although FIT21 includes an exemption stating its provisions do not apply to DeFi, there are concerns about how "DeFi" is defined, particularly regarding front-ends and DAOs

Legal precedent & Websites

The Ooki DAO legal precedent (39:20)

In 2023, Ooki DAO has been taken to court by the CFTC for violations of the Commodity Exchange Act (CEA)

Allegations included unlawful off-exchange leveraged retail commodity transactions, engaging in activities only for registered futures commission merchants (FCMs), and failing to implement AML/KYC procedures

Ooki DAO did not respond to the CFTC's complaint or appear in court, so the CFTC obtained a default judgment and Ooki DAO was ordered to shut down the website/frontend, pay $650,000 in penalties

The court held that Ooki DAO is a "person" under the CEA and can be held liable.

Classifying a DAO as a "person" and an "unincorporated association" opens a "Pandora's box" of potential litigation, as individuals participating in DAO governance could be identified as "persons" and held personally liable

Improvements for frontends (43:00)

Operating a website/front-end for user access to DeFi protocols should not alone subject entities to CFTC regulation

The CFTC has historically asserted jurisdiction by claiming websites "accept offers", so CFTC regulating websites is an overreach

In this regard, FIT21 would be improved :

• Bolstering the "DeFi exemption" section to explicitly cover websites and front-ends
• Clarifying that operating a front-end for user access to smart contracts alone does not constitute regulated activity
• Addressing the ambiguity around what constitutes "soliciting and accepting offers" for digital commodities