On June 7, 2022, senators Cynthia Lummis (R‑WY) and Kirsten Gillibrand (D‑NY) unveiled their highly anticipated crypto bill. The bipartisan Lummis-Gillibrand Responsible Financial Innovation Act covers some of the most contested issues in crypto regulation, including taxation, stablecoins, digital asset exchanges, interoperability with the banking system, and compliance with anti-money laundering laws and sanctions. Notably, the bill seeks to clarify the extent to which digital assets ought to be regulated as securities by the Securities and Exchange Commission (SEC) or commodities by the Commodity Futures Trading Commission (CFTC). Some reactions to the bill have couched the Lummis-Gillibrand solution as handing the reins to the CFTC. However, this characterization glosses over key features of the bill, under which commodities or securities regulations may apply to crypto projects, depending on the circumstances. The question that the Lummis-Gillibrand bill seeks to answer is less “whether” it is the SEC or the CFTC that has a role to play in crypto regulation so much as “when” each agency does.

Under the bill, while a digital asset itself may be a CFTC-regulated commodity, where that asset is sold in connection with a type of security known as an “investment contract,” the contract still will be considered an SEC-regulated security. The SEC has found investment contracts to exist when, for example, crypto tokens are sold during so-called initial coin offerings (ICOs), which raise money for early-stage crypto projects. The Lummis-Gillibrand bill recognizes that digital assets will continue to be sold like this. Therefore, the bill introduces the concept of an “ancillary asset.” Under this framework, where a crypto token is, for instance, sold alongside an investment-like opportunity that helps to finance a crypto project, the token itself may be presumed to be a commodity while the contract documenting the investment remains a security. In such cases, the bill would require the token seller to make applicable disclosures to the SEC.

There are a few important details to unpack in this framework. First, in the scenario just laid out, the crypto token, a.k.a. the ancillary asset, is “presumed” to be a commodity. Under the bill, this presumption can be rebutted in federal court. If the court finds that there isn’t a substantial basis to presume that the ancillary asset is a commodity, then the asset will not be exempt from securities laws generally.

Second, there are key exceptions through which a crypto token would be treated as a security. Where a crypto token grants its holder certain financial rights in a business—including rights to debt or equity, an interest or dividend payment, a profit or revenue share derived solely from the entrepreneurial or managerial efforts of others, or any other financial interest—such a token would end up being treated as a security in practice.

Finally, and most importantly, there is the overarching idea of separating the ancillary asset from the investment contract. To understand this concept, it is helpful to look at SEC v. W.J. Howey Co., the Supreme Court case that defined what it means to be an investment contract. The facts of the case are important here. Howey sold orange groves in Florida; he also offered purchasers a contract selling a service that would manage the groves on the purchasers’ behalf and give them a cut of the profits from the orange sales. The Supreme Court famously found this arrangement to be an investment contract and therefore a security.

Peter Van Valkenburgh, director of research at Coin Center, offers an instructive twist on the Howey facts: suppose that “instead of promising to pay investors profits from selling the oranges at market, [Howey] promises to give them the oranges.” While this would not get rid of the investment contract, as Van Valkenburgh notes, people intuitively understand that the oranges themselves are not securities.

Through the concept of the ancillary asset, the Lummis-Gillibrand bill conceives of certain tokens that are sold alongside investment-like opportunities as the oranges: a commodity provided in connection with a security. While the overall arrangement may include a security in the form of an investment contract, the output of the contract is to be considered separately and may itself not be a security. Here, critically, the exceptions in the Lummis-Gillibrand bill discussed above come into play.

Under Howey, a scheme is a security where a person (1) invests money in a (2) common enterprise and is led to (3) expect profits (4) solely from the efforts of a promoter or third party. The relevant exceptions in the bill that end up treating crypto tokens as securities codify this test (and its successive development by courts).

Taking a step out of the weeds (orange grove?), the critical element from the Howey line of cases when thinking about crypto is that an investment contract involves reliance on the efforts of others. The promise of a crypto project is that in achieving a functional, decentralized network, the crypto token no longer will rely on the efforts of others, but rather a protocol running on distributed computers, in which case the token should not be considered a security. One of the challenges in regulating crypto projects is that it can take time to achieve decentralization. Therefore, an investment of money that begins with a security reliant on the efforts of developers may end with an ancillary asset that in itself would not be a security under the Howey test. For this reason, the Lummis-Gillibrand bill addresses when the SEC and CFTC each might have jurisdiction over crypto projects. Where a piece of crypto legislation takes into account what makes the technology truly novel—its capacity for decentralization—and seeks to rationally integrate that innovation with longstanding precedent, so much the better.