FIT21: Impact on the crypto market and investors

The Financial Innovation and Technology for the 21st Century Act (H.R. 4763), or FIT21, represents a comprehensive effort to establish a regulatory framework for digital assets in the United States. Approved by the House of Representatives on May 22, 2024, it aims to delineate authority between key regulators and introduce clear criteria for classifying crypto assets, thereby reducing legal uncertainty for market participants.

Key Takeaways (TL;DR):

• Division of Jurisdictions: FIT21 grants oversight of "digital commodities" to the Commodity Futures Trading Commission (CFTC) and crypto-securities to the Securities and Exchange Commission (SEC). This creates a more predictable regulatory environment.
• Enhanced Oversight: An increase in compliance requirements is expected. Centralized exchanges (CEX) and stablecoin issuers will cooperate more actively with authorities, raising the risk of asset freezes associated with high-risk transactions.
• Required Actions: Investors should implement proactive risk management, including AML counterparty checks, portfolio audits for regulatory risks, and asset diversification across platforms in different jurisdictions.

1. Key Provisions of the FIT21 Bill

Bill H.R. 4763 was introduced in the House of Representatives on July 20, 2023. Its current status and full text are available on the official U.S. Congress website 1.

Main Innovations:

1. Separation of SEC and CFTC Authority. The law defines the jurisdiction of the Securities and Exchange Commission (SEC) over digital assets offered as part of an investment contract, and the Commodity Futures Trading Commission (CFTC) over assets functioning as digital commodities.
2. New Asset Classification Criterion. Instead of relying exclusively on the Howey Test [2], which defines a security as an investment in a common enterprise with an expectation of profits from the efforts of others, FIT21 introduces the concept of network decentralization.
3. Definition of "Digital Commodity." According to Section 101 of the bill [3], a digital asset can be classified as a commodity if its associated blockchain is functional and decentralized. A network is considered decentralized if no single person or affiliated group owns more than 20% of the voting tokens or has the unilateral ability to change the network's rules. This allows tokens initially issued as securities (e.g., via an ICO) to transition into the commodity category over time.

2. Implications for Market Participants

• Exchanges and Custodians. Platforms dealing with both types of assets will need to undergo dual registration with the SEC and CFTC, leading to stricter compliance and reporting procedures.
• Investors. Private investors will gain greater legal protection but will face the widespread implementation of strict Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures. The risk of asset freezes due to transactions flagged as suspicious will increase.
• DeFi Protocols. The decentralized finance (DeFi) sector remains in a high-risk zone. Regulators are shaping enforcement practices targeting participants and developers:
  • Liability for DAO Participants: In the case against Ooki DAO, the court held governance token holders liable as members of an "unincorporated association" [4].
  • Pressure on Developers: The SEC's Wells notice to Uniswap Labs demonstrates an intent to hold creators of interfaces for DeFi protocols accountable [5].
  • Sanctions Against Smart Contracts: The blocking of the Tornado Cash mixer by the U.S. Office of Foreign Assets Control (OFAC) set a precedent where software code itself can be sanctioned, creating risks for all its users [6].

3. Investor Risk Analysis

Probability and timeline estimates are based on a qualitative analysis of public statements by regulators, enforcement practices, and the technical capabilities of AML systems.

4. Alternative Scenarios

• Optimistic (25% probability). The Senate quickly passes the bill with minimal changes. Clear rules attract institutional capital, leading to market growth. Regulators take a constructive stance, focusing on major violators rather than average users.
• Neutral/Base (50% probability). The bill passes the Senate with amendments during 2025. Regulatory clarity arrives but is accompanied by stricter compliance. The market adapts, but some DeFi projects and anonymous assets come under pressure.
• Pessimistic (25% probability). The bill gets "stuck" in the Senate due to political disagreements. The SEC continues an aggressive enforcement-by-litigation policy, maintaining a state of uncertainty and stifling innovation in the US.

5. Practical Guide to Asset Protection

1. Implement Transactional Compliance Hygiene.

   • Tools: Before conducting a transaction, check the counterparty's address using AML services (e.g., Chainalysis, Crystal Blockchain, GetBlock).
   • Thresholds: Avoid transactions with addresses having a high "risk score" (e.g., above 70–80%), as this may indicate a link to illegal activity and result in your funds being flagged as high-risk.

2. Diversify Jurisdictions and Platforms.

   • Actions: Distribute assets across multiple centralized (CEX) and decentralized (DEX) platforms.
   • Jurisdiction Criteria: Favor countries with clear legal regimes (e.g., EU countries with MiCA regulation, UAE, Singapore) that provide clear legal protection mechanisms. When choosing a CEX, evaluate the presence of licenses, insurance coverage, and public Proof-of-Reserves audits.

3. Conduct a Portfolio Audit for Regulatory Risks.

   • Evaluate assets based on the following criteria:
     • Howey Test: Was the token sale conducted with promises of profit from the team's efforts? This increases the risk of being classified as a security.
     • Decentralization (FIT21 criteria): Do developers or affiliated funds control more than 20% of the tokens? Can they unilaterally change the protocol?
     • Functionality: Does the token have real utility in a working network beyond speculation? The presence of a utility function reduces regulatory risks.

6. Outlook for Senate Consideration

The bill is not final. Its consideration in the Senate, where members of the Banking Committee play a key role, may take a significant amount of time. During discussions, substantial amendments may be introduced regarding:

• Stablecoin Regulation: Integration of provisions from other bills to establish strict requirements for reserves and the operational activities of issuers is possible.
• Decentralization Criteria: The 20% threshold may be revised.
• Investor Protection: Stricter disclosure rules for issuers may be added.

7. Conclusion

The passage of FIT21 will end the early stage of legal regulation for the crypto industry in the US, replacing it with a structured regulatory framework. For investors, this means a shift to a new paradigm: evaluating jurisdictional and compliance risks becomes just as important as analyzing technology and tokenomics. Proactive management of these risks is a key condition for preserving assets in the changing legal landscape.

Sources:
[1] H.R.4763 — Financial Innovation and Technology for the 21st Century Act. Congress.gov.
[2] SEC v. W.J. Howey Co., 328 U.S. 293 (1946). U.S. Supreme Court.
[3] Text of Bill H.R.4763, Section 101. Congress.gov.
[4] CFTC v. Ooki DAO. CFTC Press Release.
[5] "Fighting for DeFi". Uniswap Labs Blog.
[6] "Treasury Sanctions Notorious Virtual Currency Mixer Tornado Cash". U.S. Department of the Treasury (OFAC).

Disclaimer: This article is for informational purposes only and does not constitute legal or financial advice. For decisions regarding your assets, it is recommended to consult a qualified lawyer specializing in U.S. regulatory law and digital asset compliance.