The RFIA would set consumer protection standards for digital assets and introduce new requirements regarding the use of digital assets in interstate money transfers.
Latham & Watkins presents a blog series on the Responsible Financial Innovation Act, which was introduced in the US Senate on June 10, 2022, to create a framework for digital assets, cryptocurrency and blockchain technology. This second article in the series covers consumer protection and state money transmission laws.
Consumer Protection: Disclosures
Consumer protection issues are covered by Bill Title V (Responsible Consumer Protections) of the Responsible Financial Innovation Act (RFIA). The RFIA’s Client Protection Standards must be enforced by the federal or state authority licensing, registering, or chartering a digital asset intermediary, or by the appropriate state or federal banking supervisor whether it is a depository institution or another financial institution.
The RFIA would add a new Section 9802 to Chapter 98 of Title 31 of the United States Code, which would define consumer protection standards for digital assets. A client agreement should be provided whereby the person or protocol providing digital asset services (i.e. intermediaries, financial institutions and other authorized service providers) must disclose the scope of transactions permissions that can be made with the Customer’s digital assets. A digital asset service provider should inform a client of the following:
- Hardware updates or changes to the source code version of a digital asset that may include security vulnerabilities
- If a customer’s digital assets are segregated from other customer assets
- How the Client’s assets would be treated in a bankruptcy or insolvency proceeding of the Service Provider, and the risk of loss
- The process (including time and manner) for the return of digital assets at the request of a customer
- Dispute resolution process
Further, the RFIA would require a digital asset service provider that provides lending services to clearly disclose the terms of those services to the customer prior to the lending. (Disclosed loan agreements include terms and risks, yield and how yield is calculated, collateral requirements and policies, and mark-to-market and monitoring agreements.) Likewise, a digital asset service provider that engages in the re-mortgaging of customer assets should clearly disclose such arrangements to the customer before doing so and receive the customer’s affirmative consent.
Customers can elect to self-custody any digital assets that they legally own, possess or control. Customers would not be required to use third-party intermediaries for custody, although they would be free to enter into an agreement to do so.
Forks, Purpose of Settlement and Custody
The RFIA would require digital asset service providers to agree in writing with their customers on the source code version of each digital asset. It would also require vendors to adopt and maintain standards for changes to the supported version of a digital asset should the validation rules associated with that digital asset change. The bill states that these standards must include the customer’s opinion and approval “according to the circumstances”. This customer review and consent guidance is likely designed for situations such as the much-discussed change of the Ethereum network from proof-of-work to proof-of-stake, but service providers may need more guidance regarding the circumstances that would actually require such notice. and approval.
The bill also states that digital asset service providers cannot “capriciously redefine a digital asset or the corresponding source code.” However, the bill does not address what happens when a digital asset service provider stops supporting a particular digital asset or version of it. The customer notification requirements described above could also include the digital asset service provider’s process for the return of such digital assets.
Digital asset service providers should also agree with customers on settlement finality terms for all transactions, including the terms under which a digital asset is deemed to be fully transferred, the exact time of transfer, the discharge of any obligations upon transfer; and compliance with the Uniform Commercial Code. Such agreements would be an important step towards resolving the settlement finality issue on distributed networks, but of course do not resolve the larger issue of what constitutes on-chain final settlement between pseudonymous counterparties.
State Laws on the Transmission of Digital Funds and Assets
Title VIII of the RFIA (Responsible Interagency Coordination) contains a section that addresses the use of digital assets in interstate monetary transfers. Section 803 of the RFIA would require that within two years from the date of enactment, state bank supervisors adopt standards relating to the handling of digital assets under money transmission laws of the State which are “substantially consistent” with each other. Standards should address topics such as:
- potential licenses for digital assets;
- payment stablecoin processing;
- the extent to which these standards would apply to persons or software that engage in transaction validation, noncustodial wallet providers, or software or hardware development;
- tangible net worth and permitted investment requirements;
- disclosures, reports and record keeping; and
- common examination and examiner training standards (including common best practices for customer identification, anti-money laundering and sanctions developed in consultation with the Financial Crimes Enforcement Network and the Office of Foreign Assets control)
If a state has not adopted uniform money transmission standards, the Consumer Financial Protection Bureau (CFPB) is authorized to adopt the prevailing uniform standards for that state. However, the CFPB may grant a State more time to meet the Uniform Standard if the State demonstrates a good faith effort toward implementation. The CFPB may also promulgate regulations to monitor state compliance with the objectives of this section of the RFIA.
Consistency between state regulators could certainly be helpful for digital asset service providers nationwide, but it’s unclear if states would be happy to provide such consistency or if some states would like to continue to apply a strict licensing regime while others would prefer to attract business. by being less rigorous. It remains to be seen whether such harmonization would be a first step towards a federal licensing regime or if, on the contrary, state-by-state registrations would become more burdensome for digital asset service providers.