Token Taxonomy Act of 2019: The Digital Token Exclusion
A Brief Summary of §§ 2(a) & 2(b) of H.R. 2411
Background
On April 9, 2019, H.R. 2411, a bill widely referred to as “The Token Taxonomy Act,” was reintroduced by U.S. Representative Warren Davidson of Ohio. This was the second iteration of the bill, which had previously been introduced on December 20, 2018.
Scope of this Article
The 2019 version of the bill proposes changes to several U.S. securities laws and regulations as well as the taxable treatment of virtual currency under the Internal Revenue Code. This article focuses solely on the bill’s exclusion of “digital token” from the definition of a “security” under the Securities Act of 1933, and is really not much more than an annotated version of the bill, with attempts to simplify and clarify where practicable.
I hope to provide analysis as well as present and discuss other parts of the bill in subsequent articles, but this is designed to be a starting point for discussion among lawyers and non-lawyers in the crypto and blockchain space as I believe this bill will have an enormous impact if passed in its current form. I have included the entirety of §§ 2(a) & 2(b) of the Act at the end of the article for reference.
Definition of a Digital Token
Section 2(a) of the bill proposes a definition for digital token,” to be added at the end of 15 U.S.C. 77b(a) (which currently goes up to subsection 19 — the definition of an “emerging growth company”). This new subsection 20 states that a “digital token” is a “digital unit” (defined later in the article) which has all four of the following characteristics:
First, it must be created for at least one of the following reasons —
- in response to the verification or collection of proposed transactions [e.g., bitcoins released as block rewards]; or
- pursuant to rules for the digital unit’s creation and supply that cannot be altered by any single person or persons under common control [e.g., coins or tokens that are pre-mined pursuant to a smart contract that cannot be altered by any centralized authority]; or
- as an initial allocation of digital units that will otherwise be created in accordance with 1. or 2. above [e.g., to cover something like the “Simple Agreement for Future Tokens,” or “SAFT”].
Second, it must have a transaction history that is—
- recorded in a distributed, digital ledger or digital data structure in which consensus is achieved through a mathematically verifiable process [i.e., transactions must be recorded in a distributed ledger]; and
- after consensus is reached, resists modification or tampering by any single person or group of persons under common control [i.e., it must be immutable and decentralized].
Third, it must be capable of being transferred between persons without an intermediate custodian
[i.e., it must allow for purely peer-to-peer transacting]
Fourth, it must NOT be a representation of a financial interest in a company or partnership, including an ownership interest or revenue share.
[i.e., it cannot be like what most people consider to be securities, like a share of stock, a partnership interest, an interest in a revenue-sharing arrangement, etc.]
Definition of a Digital Unit
Section 2(a) of the bill also proposes a definition for what it calls a “digital unit,” to be added at the end of 15 U.S.C. 77b(a) as subsection 21. As you will recall above, this definition is of critical importance as every digital token must be a digital unit. A “digital unit” is defined as follows:
The term ‘digital unit’ means a representation of economic, proprietary, or access rights that is stored in a computer-readable format.
[I leave it to the reader to arrive at your own conclusion, but please think about what sorts of things might qualify as a “digital unit” given that definition]
Definition of a Security
Section 2(b) of the bill modifies the definition of “security” under subsection 1 of 15 U.S.C. 77b(a), specifically, it states that:
The term ‘security’ does not include a digital token.
[i.e., if something qualifies as a ‘digital token’ under the Act, it is not a security, full stop. That means no Howey Test, no having to sift through 85 years of cases or SEC opinions to figure out whether it is a security]
Conclusion
Although not especially precise, I have tried to distill the essence of §§ 2(a) & 2(b) of the bill to the following key points:
A computer-readable representation of current or future economic, proprietary, or access rights…
created in a decentralized manner…
recorded to an immutable distributed ledger…
transferable peer-to-peer…
that does not represent a financial interest in a company or partnership…
is NOT a security.
For this article I simply wanted to present the bill as objectively as possible without including any positive or negative commentary, but please share your thoughts about it in the comments below. Do you like the bill as written? Should it be changed? If so, what would you change? Below you will find the original language from §§ 2(a) & 2(b) of the proposed Act:
A BILL to amend the Securities Act of 1933 …
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,
SECTION 1. SHORT TITLE.
This Act may be cited as the ‘‘Token Taxonomy Act of 2019’’.
SEC. 2. SECURITIES ACT OF 1933.
(a) DEFINITION OF DIGITAL TOKEN. — Section 2(a) of the Securities Act of 1933 (15 U.S.C. 77b(a)) is amended by adding at the end the following:
‘‘(20) DIGITAL TOKEN. — The term ‘digital token’ means a digital unit —
‘‘…(A) that is created —
‘‘……(i) in response to the verification or collection of proposed transactions;
‘‘……(ii) pursuant to rules for the digital unit’s creation and supply that cannot be altered by any single person or persons under common control; or
‘‘……(iii) as an initial allocation of digital units that will otherwise be created in accordance with clause (i) or (ii);
‘‘…(B) that has a transaction history that —
‘‘……(i) is recorded in a distributed, digital ledger or digital data structure in which consensus is achieved through a mathematically verifiable process; and
‘‘……(ii) after consensus is reached, resists modification or tampering by any single person or group of persons under common control;
‘‘…(C) that is capable of being transferred between persons without an intermediate custodian; and
‘‘…(D) that is not a representation of a financial interest in a company or partnership, including an ownership interest or revenue share.
‘‘(21) DIGITAL UNIT. — The term ‘digital unit’ means a representation of economic, proprietary, or access rights that is stored in a computer-readable format.’’.
(b) DEFINITION OF SECURITY. — Section 2(a)(1) of the Securities Act of 1933 (15 U.S.C. 77b(a)(1)) is amended —
…(1) by inserting ‘‘(A)’’ after ‘‘(1)’’; and
…(2) by adding at the end the following:
‘‘……(B) Such term does not include a digital token.’’.
Grant Gulovsen 高伟明 is a licensed U.S.-based intellectual property attorney whose practice focuses on advising individuals and businesses in the blockchain and cryptocurrency space. You can find him online at Gulovsen Law Office.
This article was kindly shared with ValueTokenized publication by Grant Gulovsen.
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