Securities, Commodities, and Crypto — Oh My!
Fitting a square Blockchain peg into a round regulatory hole
Congress is in a panic.
We’ve seen Bitcoin’s price hit a peak of ~$20k with a ~$325B (billion, with a capital B) market cap; only to drop to below ~$7k six weeks later. And we’ve seen over 1,500 ICOs raising upwards of $6.5B (again, billion with a B) — of which, 500 ICOs and $1.5B have been in the first few weeks of 2018 alone!
This is causing congressional pandemonium for two reasons:
The first would be funny if it weren’t so sad. People are so convinced that Cryptocurrencies & ICOs are the next gold rush, that they are investing their life savings in these digital artifacts in the hopes of striking it rich. Instead, tragedy strikes when the price of Bitcoin crashes; or the developers from that ICO last week seem to have absconded with all of the money they just raised. The sooner that congress can put in consumer protections, the harder it will be for Main Street investors to make terrible, terrible financial decisions.
The second reason that congress is in a panic is due to pretty much the same problem governments have been dealing with for millennia: it’s really difficult to control and tax what they can’t understand and regulate. So the sooner that they can figure out how to classify these new technologies, and which agency should be in charge of regulating them, the sooner they can resume business as usual. (see also: Net Neutrality)
The Great Debate
In a hearing today on Capitol Hill entitled “Examining the Cryptocurrencies and ICO Markets”, congress and industry experts discussed how we can make Blockchain technologies fit with our existing legal paradigms, and which existing regulatory agencies should be in charge of enforcing those laws.
The reason that they still don’t have the answer for that is because Blockchain technologies really span two different regulatory paradigms overseen by two different agencies:
Some people think that Blockchain technologies should be regulated by the CFTC (Commodity Futures Trading Commission) which is in charge of commodities— actual physical goods whose prices rise or fall with supply and demand — like gold, oil, or corn. The thinking goes that, just like other commodities, cryptocurrencies (like Bitcoin) derive their value from scarcity. Gold would not be as valuable if you could find it while walking down the street, or if the alchemist’s stone could actually transmute lead into gold. Same with Bitcoin. Only 21M Bitcoins will ever be “mined”. Ever. Add to that the fact that you can exchange Bitcoins for goods & services (just like gold) and it makes for a pretty compelling argument that Blockchain technologies fall squarely within the CETC’s wheelhouse.
Or do they…?
See, other people think that Blockchain technologies should be regulated by the SEC (Securities and Exchange Commission) which is in charge of securities — promises of future value that depend largely on how well a company performs — like a stock, or a bond. The thinking goes that, just like other securities, ICOs are really a promise of future value. Invest in us today, “get in on the ground floor” so to speak, and we’ll give you a whole bunch of digital “tokens”. One day, after we build this product that we are promising to build, and people start using it like we promise that they will, then these tokens will have value. It’s kind of a Kickstarter meets Venture Capitalism way of crowdsourcing startups. You are investing in them not only because you want to use the thing they say they are going to make, but because you also want to make money one day when they are profitable.
Both of these arguments are equally valid. But both are also equally flawed, because the nature of a given Blockchain technology evolves over time.
Evolution of a Blockchain Technology
What starts out as a speculative investment in an ICO; classified as a “security”; and regulated by the SEC — will one day, (if they are successful), become an integral part of the building block of the distributed web; classified as a “commodity”; and thus regulated by the CETC.
Three case studies prove the point: Bitcoin, Etherium, and Filecoin. They each represent the financial, computation, and storage aspects of Web 3.0. Speculation and news headlines aside, today they are traded more for their utility than for a promise of future value. Bitcoin can be used to make transactions on a distributed financial ledger; Ether can be used to fuel computation on the Etherium compute network; and Filecoin can be used to store files on the distributed storage network.
But when they started, they were much more akin to today’s ICOs than people care to remember. If you can believe it, Bitcoin was even more poorly understood and volatile than it is today. When Etherium was just a lowly white paper, there had been no real examples of “me too” Blockchain technologies, and therefore it was highly academic, and highly speculative. And actually, Filecoin is new as of the last six months or so, and technically hasn’t even hit the “commodity” stage yet. But it will, one day. Because that’s the nature of these Blockchain technologies:
First they ignore you. Then they ridicule you. And then they attack you and want to burn you. And then they build monuments to you.
— Nicholas Klein
Nearly everyone at the congressional hearing today agreed that, be they securities or commodities, it is in everyone’s best interests to ensure that the market surrounding Blockchain technologies simultaneously inspires confidence in investors, as well as promotes innovations. The risk being that if we under-regulate, scammy ICOs will ruin the fun for everyone (except themselves, of course, when they make off with millions). And if we over-regulate, then we will just encourage these investors to go overseas.
So remember, folks — just like many Kickstarter campaigns never come to fruition; and many VC investments never make any money; and stock markets crash; so we should also expect the same of ICOs and other Cryptocurrency “investments”. The same common sense rules apply as always — don’t invest any money you are not prepared to lose completely.
As in, gone.
So don’t be an idiot.
P.S. It strikes me that the irony of an ICOs is that — in an industry promising to build technologies to eliminate the need for trust — you sure do need a lot of trust that these companies are going to deliver on their promises. Maybe someone should make a new ICO around solving that problem…