Senate market structure negotiations must not sacrifice hard won developer protections

For months, Coin Center has advocated for two critical parts of the market structure legislation being debated in the Senate. The House crafted a non-partisan bill, Clarity, that was carefully calibrated with feedback from advocates like Coin Center and technical assistance from the Treasury to prevent illicit finance loopholes. Ultimately, those carefully calibrated sections were passed by an overwhelming majority in the House and also got the endorsement of the administration in the President’s Working Group report.

Those two sections of Clarity are:

1. the inclusion of the BRCA, which codifies FinCEN 2019 guidance on money transmission and would stem inappropriate prosecutions of software developers for unlicensed money transmission liability.
2. the “developer protections” that narrow otherwise sweeping definitions of digital commodity broker and dealer to appropriately scope the CFTC’s authority. These ensure that software developers who are saved from money transmission licensing liability by the BRCA don’t fall out of the frying pan but into the fire of inappropriate CFTC liability.

Not enough has been written about these “developer protections” as we have been calling them in the Senate or the “Exclusion for decentralized finance activities” as they were passed in the House. As the Senate debates these provisions, we don’t want anyone to have the wrong idea: this is not special treatment for the “DeFi industry” or sweeping loopholes for trusted entities who are truly deserving of regulatory licensing obligations. That is not what the developer protections are.

The way these protections were negotiated in the House is as follows: a drafting choice was made to make the definition of Digital Commodity Broker and Digital Commodity Dealer very broad and then to selectively exclude software developers and other neutral infrastructure providers from the registration requirement for brokers and dealers. That’s a reasonable approach: a broad definition prevents regulatory arbitrage and selective carve-outs from registration requirements protect specific persons who are not appropriate to force to register.

Those exclusions are at §409 in the Clarity Act:

SEC. 409. Exclusion for decentralized finance activities.

The Commodity Exchange Act (7 U.S.C. 1 et seq.), as amended by the preceding provisions of this Act, is amended by inserting after section 4u the following:

“SEC. 4v. Decentralized finance activities not subject to this Act.

“(a) In general.—Notwithstanding any other provision of this Act, a person shall not be subject to this Act and the regulations promulgated under this Act based on the person directly or indirectly engaging in any of the following activities, whether singly or in combination, in relation to the operation of a blockchain system or in relation to decentralized finance trading protocol:

“(1) Compiling network transactions or relaying, searching, sequencing, validating, or acting in a similar capacity.

“(2) Providing computational work, operating a node or oracle service, or procuring, offering, or utilizing network bandwidth, or other similar incidental services.

“(3) Providing a user-interface that enables a user to read, and access data about a blockchain system.

“(4) Developing, publishing, or otherwise distributing a blockchain system or a decentralized finance messaging system.

“(5) Constituting, administering, or maintaining a decentralized finance messaging system or decentralized finance trading protocol, or operating or participating in a liquidity pool with respect thereto, for the purpose of executing a spot transaction for the purchase or sale of a digital commodity.

“(6) Developing, publishing, constituting, administering, maintaining, or otherwise distributing software or systems that create or deploy hardware or software, including wallets or other systems, facilitating an individual user’s own personal ability to keep, safeguard, or custody the user’s digital assets or related private keys.

“(b) Exceptions.—Subsection (a) shall not be interpreted to apply to the anti-fraud, anti-manipulation, or false reporting enforcement authorities of the Commission.”

Notice that these are not sweeping carve-outs or favors for industry. These are fundamental and reasonable limitations on who should have an obligation to go get permission before they engage in certain activities relating to digital commodities.

Nobody wants a bitcoin miner in America to need to get approval from the CFTC before they participate in the public good of maintaining the bitcoin network (§409(1)-(2)). Nobody wants a mere internet communications intermediary (a node or relayer) to be treated as a financial institution (§409(1)). Nobody wants the operator of a website that merely lets visitors view and utilize already public blockchain data to be barred from providing that information service unless they first get permission (§409(3)). Nobody wants the publishers of mere wallet software to be treated as if they hold the financial assets of those who use their software to hold their own assets (§409(6)). Nobody wants the core developers of Bitcoin or Ethereum to have to get permission before they suggest and publish new versions of the protocol code (§409(4)).

These carefully drafted and ultimately non-partisan exclusions from the definition of a broker are part and parcel of the excellent work done in the House. Those excluded are not secretly centralized powerful businesses; they are participants on these networks who are not in a position of trust with their users and who, in many cases, would also have First Amendment protections from prior restraints like registration requirements.

If we lose those protections for developers and infrastructure, the broad definitions of broker and dealer would sweep all manner of software developer and communications provider into a registration regime. Many applications of that registration requirement would be per se violations of the First Amendment rights of software and website publishers. On these issues, the Senate should follow the approach in Clarity; if the developer protections are dropped we’d need to go back to the drawing board with the broad definitions of brokers and dealers and that’s a renegotiation from which no one will likely benefit.

None of this means that specific concerns about illicit finance or consumer protection in DeFi cannot be addressed, potentially even with new legislative approaches. It just means we shouldn’t be treating developers and infrastructure providers as brokers and dealers, and therefore shouldn’t unsettle the carefully drafted definitions and exclusions in Clarity.