US Congress Bill Seeking to Redefine Securities Laws for Tokens and Cryptos (Part I)
Governments around the world — such as the US and Switzerland — are doing their best to regulate and define cryptocurrencies within their existing laws.
In this two part article we will go over a bill introduced to change the legal framework within the US. The first part will discuss the securities aspect and the latter will go over changes on a taxation level.
In the US, laws — enacted from 1933 and 1934, after the great depression — are being used to classify tokens and cryptocurrencies as securities. This is with the exception of cryptocurrencies like Bitcoin, which due to their nature are not considered as a security. As a result, Bitcoin falls under the supervision of the US Commodity Futures Trading Commission (CFTC).
Now, a recent bill introduced by two congressmen aims to amend existing federal laws — by defining tokens and cryptocurrencies in such a way as to exclude them from what they believe are outdated laws.
The text of the bill is not yet available on the official site, but can be found elsewhere on the web.
On November, 2018, CoinDesk organized a conference titled “Consensus: Invest”. At the conference, US Securities and Exchange Commission (SEC) Chairman Jay Clayton was invited to participate in a live discussion.
During this conversation he was asked to differentiate between a security and a commodity, something that has been on the mind of many people including those hosting and investing in ICO’s within the US:
“An asset like bitcoin, where decentralized, no one is creating it for their own control of bitcoin, it’s designed to be a payment system replacement, we’ve determined that that doesn’t have the attributes of a security… It’s not centrally created or distributed…” — Jay Clayton, SEC, Consensus: Invest, 2018
As for broker-dealers, banks or other companies dealing with Bitcoin, Clayton noted that “I expect them to treat that as if they were accepting cash”, thus applying the required Anti Money Laundering (AML) and Know Your Customer (KYC) regulations.
What about securities? The Howey test — which was formulated in 1946 as a result of a Supreme Court case — allows the SEC to determine which assets may fall under this category. During the live conversation, Clayton said that an asset is a security when “I as an investor give you my money with the expectation of a return based on your effort”.
Furthermore, if an asset is classified as a security, then the operators matching the buys and sells must register as an exchange or “file for an exemption”.
“As in Howey — where interests in the groves were sold to hotel guests, not farmers — tokens and coins typically are sold to a wide audience rather than to persons who are likely to use them on the network. Simply labeling a digital asset a “utility token” does not turn the asset into something that is not a security… the economic substance of the transaction always determines the legal analysis, not the labels.” — William Hinman, SEC, 2018
Changes to Securities Laws
As a result of the regulations mentioned, a majority of tokens would fall under the category of a security. This has made the US regulations fall behind those of more dynamic markets, such as Switzerland.
The “Token Taxonomy Act” bill, introduced on December 20, 2018, by representatives Warren Davidson (press release) and Darren Soto (press release), is an attempt to clarify the situation for people to feel confident in the sales and trades of crypto assets.
The bill seeks to “amend the Securities Act of 1933 and the Securities Exchange Act of 1934 to exclude digital tokens from the definition of a security”. The bills define digital tokens as:
- Mine-able (like Bitcoin), pre-mined (like Ripple), or partially pre-mined (like Ethereum) digital units whose creation and supply cannot be altered by a person or a group of people “under common control” (referring to the mathematical laws governing the creation and/or supply of cryptocurrencies).
- Transparency: digital units with a transaction history that is recorded on a digital ledger — like a blockchain in “which consensus is achieved through a mathematically verifiable process”.
- Immutability: digital units that, once consensus has been reached, cannot be “materially altered by a single person or group of persons under common control”.
- Decentralised: digital units that can be transferred between two wallets “without an intermediate custodian”.
- Digital units that do not represent company shares.
Should a digital token fail these requirements and be considered as a security by the Commission, the promoter will have 90 days to return all funds raised from the sale, with the exclusion of funds “reasonably” spent on development.
This aspect of the proposed bill seems to oppose Clayton’s thoughts on modifying existing laws. As mentioned in an article by CNBC published in June (2018):
“We are not going to do any violence to the traditional definition of a security that has worked for a long time… we’ve been doing this a long time, there’s no need to change the definition.” — Jay Clayton, CNBC, 2018
This bill would likely introduce a great deal of oversight, risk and extra work for the SEC to monitor each digital token in order to determine whether it is a security or not. Essentially it would be opening up the gates and letting everyone come through the front-door. Whether that is something they would want to be involved with is yet to decided.
A dynamic framework like that of Switzerland seems better than an inflexible black and white approach that limits innovation in the crypto space.
In the next article we will discuss the bill with a focus on taxation requirements.
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