An Open Letter on HB3479

Calling for Inclusive Legislation and Prudence in the Regulation of Blockchain and Digital Assets

       The cryptocurrency and blockchain industry is building the next generation of internet-enabled products and services, financial and non-financial, creating tens of thousands of American jobs, and providing lawful business opportunities for millions. We represent a diverse group of actors in the blockchain and digital assets community, including legal professionals, technologists, entrepreneurs, and end-users. Unfortunately, we believe that HB3479, in its current form, does not represent “Robust and nimble financial regulation…” (Bill Press Release - IDFPR Regulatory Innovation Officer David DeCarlo) nor does it have broad industry support. In reality, it threatens to have disastrous consequences on the digital asset ecosystem in Illinois, and the use of Blockchain technology more generally.

        As such, we urge caution, inclusivity, and prudence to ensure the enactment of a sensible, fair, effective, and balanced bill that protect consumers and fosters innovation. As concerned citizens and stakeholders, we stand ready and willing to assist the legislature in its efforts to craft sensible and effective policies, and welcome the opportunity to collaborate to this end. As a long-time hub of Blockchain innovation, we believe Illinois can do better to encourage and enable the entrepreneurial business and people within this industry while still protecting citizens.

The Issues

        We believe that this legislative effort, and specifically the Digital Asset Regulation Act (DARA) is problematic and overbroad as follows:

        I. Broadly defining “digital asset business activity” as the “exchanging, transferring or storing of a digital asset” captures any foreseeable asset on a blockchain, including utility tokens, NFTs, Stablecoins, sufficiently decentralized commodity blockchains such as Bitcoin and Ethereum, and all transferable, or indeed, non-transferable tokens on any blockchain, regardless of its similarity to securities, equities, or other conventional financial assets. Even more critically, DARA, which will replace the traditional approach by applying to all transfers of digital assets, and its scope extends beyond intermediary digital asset businesses. This overly-broad definition would even include non-crypto businesses merely using digital assets internally, or using wallets for the self-custody of their own digital assets, and even IL residents, who can be subject to up to $100,000 per day plus $25,000 per specific provision violation with no maximum in fines simply for transferring digital assets without a license.

        II. The Act in its current state would grant the Illinois Department of Financial and Professional Regulation (IDFPR), an unelected body, unprecedented powers to draft rules and oversee enforcement of this business activity. Currently, the IDFPR is given full mandate to subjectively reject or allow applications for licences. They are further enabled with investigative and subpoena powers against any business or individuals that the IDFPR, in its sole determination, finds to be a licensee or a person potentially required to become a licensee. DARA goes even farther in giving the agency the “nonexclusive oversight and enforcement under any federal law applicable to digital asset business activity”, and in doing so deputizing it to enforce SEC rules. Given the current permissionless nature of decentralized protocols, this DARA oversight and enforcement could make developers, DAO members, and users of these systems liable. The bill sponsors may have looked to New York’s BitLicense regime for inspiration—a regime already considered the most restrictive in the nation—but the DARA licensing regime is practically punitive to digital asset activity. In contrast to the DARA licensel, which applies to both transfers and transmissions of digital assets, BitLicense applies only to transmissions of digital assets done on behalf of others for a fee and involving more than a nominal amount of value. Moreover, BitLicense defines (23 CRR-NY 200.2(q)) "Virtual Currency (VC) Business Activity" (VCBA) as:

                • Receiving VC for transmission or transmitting VC (except for nonfinancial purposes and not involving more than a nominal amount of VC);

                • Storing, holding, or maintaining custody or control of VC on behalf of others;

                • Buying and selling VC as a customer business;

                • Controlling, administering, or issuing a VC (but the development and dissemination of software itself does not constitute VCBA).

As per the explicit provisions of DARA and the MTMA, the IDFPR is now in a position to regulate for-profit companies that deal with the actual fiat money of Illinois customers with comparatively lesser oversight and compliance requirements than not-for-profit individuals in Illinois who only deal with digital assets that are not yet recognized as payment and hence are not considered as monetary value.

        III. Compliance with DARA’s requirements is technically and operationally impossible for decentralized protocols, organizations, and groups, effectively destroying any DAO operations, DeFi protocols, or blockchain innovation within the state Licensees must designate individuals responsible for monitoring compliance with the regime, who must be approved by an executive officer or board of directors. We believe such requirements are indicative of a fundamental misunderstanding of the infrastructure, technology, and innovation enabled by decentralized ledger technologies. This is illustrated by archaic provisions, such as those requiring that a record of a digital transaction be communicated to residents. It is self-evident that this information is public record to anyone at anytime by simply searching the transaction ID on whatever blockchain was used to enable the transaction to begin with. Furthermore, DARA handicaps the ability for startups and crypto-native firms to compete in IL by allowing traditional finance exemptions to corporate fiduciaries, such as large hedge funds and registered exchanges, essentially granting a regulatory moat to incumbents and chilling any innovation that may occur.

        IV. In the wake of the FTX collapse and other high-profile crypto frauds, support may be widespread for a more robust regulatory approach, but this bill critically fails to effectively address the prevention of such fraudulent activities. Notably, if the bill had been in place when FTX sought licensure, it would not have prevented the consumer harm that ensued. FTX, an unregulated offshore entity, had the financial means to develop exceptional policies, programs, and hire regulatory professionals, giving the appearance of an ideal digital asset business. The current provisions in DARA inadvertently make it challenging for honest, early-stage innovators to develop their ideas within Illinois under proper supervision, as they face substantial upfront costs associated with licensure before they can legally test their product's feasibility. Consequently, well-intentioned innovators may be pushed towards less regulated markets, increasing the likelihood of fraudulent activities and driving innovation away from Illinois, either to other states or completely offshore.

        V. The bill alleges that its primary purpose is consumer protection, when the money from fines and licensing from its consumer protection fund would be used for State employee salaries, and for State funds, as opposed to making consumers whole, in contrast to existing money transmitter consumer protection funds. This bill sends a clear signal that IL is hostile to tech innovations and blockchain technologies. It is difficult to see how this bill benefits anyone except a very small number of centralized businesses already operating under a variety of licences and regulations in other states.

Recommendations

        We respectfully request that the General Assembly consider the following concerns and recommendations:

        I. Collaborative and Inclusive Approach: Engage in an open dialogue with a diverse range of stakeholders, including legal professionals, technologists, entrepreneurs, and end-users, to ensure a comprehensive understanding of the technology and its implications. Collaboration is essential to crafting regulations that strike the right balance between protecting consumers and fostering innovation. Concrete measures embodying this recommendation include such things as safe harbor provisions, sandboxes for crypto organizations where they can engage directly with the IDFPR to craft processes that allow for consumer protections while still allowing for innovation, and more generally liaisons from the IDFPR or other regulators embedded directly with organizations in this industry.

        II. Gradual and Adaptive Regulation: Adopt a gradual and adaptive approach to regulation, allowing for incremental adjustments as the technology evolves and new use-cases emerge. This approach will prevent overly burdensome regulations that may stifle innovation and hinder the growth of the digital assets ecosystem in Illinois. The industry has already seen the effect of overly burdensome regulations in states like New York, where licensing requirements which were arguably even more permissive to IL’s own, led to a total chilling effect for firms operating in that state, and a mass exodus of businesses and regulators as a result. California’s Governor Newsom seems to have understood this requirement for gradual regulation, given his veto of burdensome and premature regulations in his state.

        III. Interoperability and Harmonization: Strive for regulatory harmonization and interoperability with existing federal regulations and guidelines, as well as with regulations in other states. This will ensure a consistent regulatory environment, reducing compliance burdens for businesses and fostering interstate and international cooperation in the digital asset space.

        IV. Privacy and Anonymity: Balance the need for transparency and consumer protection with the fundamental right to free speech and rights of privacy. In particular, we urge the General Assembly to consider the implications of HB3479 on privacy-centric digital assets and decentralized technologies, ensuring that any regulations do not infringe upon individual privacy rights.

        V. Education and Public Awareness: Encourage education and public awareness initiatives to ensure that consumers, businesses, and regulators have a clear understanding of the benefits and risks associated with digital assets and blockchain technology. This will help create a more informed and responsible digital asset ecosystem in Illinois.

        Should DARA be enacted in its current form, it would impede innovation and economic growth, foster fraudulent behavior, obstruct equitable competition in favor of established players, and elevate the likelihood of harm to consumers in Illinois.

        In conclusion, we urge the Illinois General Assembly to consider the concerns and recommendations outlined in this letter as they deliberate on HB3479. By adopting a measured, inclusive, and adaptive approach to the regulation of digital assets and blockchain technology, the General Assembly can ensure that Illinois remains at the forefront of technological innovation while protecting the interests of its citizens.

Sincerely,
LexDAO Study Group, drafting collaborators and all petition signers herein