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On Thursday, two U.S. congressmen introduced a bill that would seemingly put to rest any question over whether cryptocurrency or blockchain-based tokens could be legally considered “securities.” And there was much (embarrassingly premature) rejoicing.
The Token Taxonomy Act aims to strictly define “digital tokens” as a “a new term for cryptocurrencies and other network tokens, and explicitly excludes them from the definition of a security,” according to a statement from the Blockchain Association—the lobbyist group throwing its weight behind the bill.
The idea is to shift cryptocurrencies and tokens away from the jurisdiction of the SEC and into the hands of the regulators that deal in commodities and consumptive goods—like the Federal Trade Commission or the Commodity Futures Trading Commission—Blockchain Association head Kristin Smith told CNBC.
The problem is it might not actually do any of that, and could potentially harm crypto innovation more than it helps, says Lewis Cohen, an attorney who specializes in blockchain-related legal matters at the New York-based firm DLx Law LLP. (Strap in, this gets complicated.)
“The moment you try to put pen to paper, especially with something as slippery and evolving and innovative as blockchain and tokens, and try to say in the law ‘you can do this, you can’t do that,’ that actually becomes a negative for innovation, not a positive,” Cohen says. The definition of a “digital token” penned by U.S. Congressmen Darren Soto (D-Fla) and Warren Davidson (R-Ohio) in their bill isn’t necessarily a “terrible” one, he says. The issue is that “almost any definition is going to suffer from a lack of future proof” once its written into federal statute. If it turns out that this now legally codified definition of crypto is lacking down the road, “amending it later then becomes extra difficult,” Cohen warns.
Worse yet, aside from potentially stifling future innovation, Cohen says the Token Taxonomy Act may not actually do the thing it’s setting out to do. “When you create a blockchain-based token that is potentially going to be part of a decentralized system, that token itself is just not a security,” he says. Rather, it is the public offering of that token as investment opportunity, Cohen explains, that constitutes an “investment scheme” and therefore a securities transaction. “We don’t need legislation to tell us that,” he says. That’s already the way it is.
In other words, legally defining a “digital token” as decidedly “not a security” doesn’t do a blessed thing to prevent the SEC from seeking to protect investors who participate in “securities offerings”—whether they be tokens in an ICO or tickets to a Broadway play.
SEC Chairman Jay Clayton infamously told the Consensus: Invest Conference in New York last November that even Broadway tickets could be considered “securities” under the right set of circumstances. If you give investors “tickets in exchange for their interest in the play, those tickets are securities,” Clayton said. But that isn’t quite right, Cohen argues.
“I would strongly assert that a stiff piece of paper—with a name of a show, a date and seat number—at no point in time is that stiff piece of paper (which you might otherwise call a ‘ticket’) a security,” he says. “However, if I go and solicit you and say, ‘Look, I’ve got an idea. I need a million dollars. I’m going to put on this production. And I’ll tell you what, I’ll give you big, sick stack of these tickets, if you give me a million dollars. If I do this publicly, that’s an investment scheme, and that needs to be registered [as a securities offering].”
Cohen insists this distinction is far from trivial. It’s the reason, he claims, that SAFT and Regulation D private placements currently aren’t safe from SEC scrutiny. You could have done all the right things and ticked all the right boxes during your token offering—even going so far as only dealing with accredited investors—and that still may not be enough. After you’ve closed your sale and distributed your token, “Who’s going to tell you that the token itself isn’t a security?” he posits.
“Once you go down the path, and you don’t separate clearly and distinctly the token from the scheme, the SEC’s attitude is that the token and scheme have fused into one thing.” And that spells bad news for the crypto startups who thought they were going out of their way to stay on the right side of securities laws during their ICO, and something that this legislation does nothing to address.
Cohen suggests the way forward is to continue to insist that the SEC properly separate investment schemes from the object of those schemes (digital tokens) and begin issuing the sort of “affirmative, no-action guidance” that William Hinman, the SEC’s director of the Division of Corporate Finance, promised more than six months ago. If the SEC were to say, “XYZ coin launched this way, and these are the reasons we think you’re OK,” it would begin to provide positive examples for other startups to follow, he says.
While the Token Taxonomy Act stands little chance of making any significant headway in D.C., it may serve to get the wheels turning, if nothing else. “It kind of creates some dialogue and in that respect it’s definitely a good thing that folks know that this is an important legislative agenda,” says Cohen. “If we don’t find a way to get better clarity from the applicable regulators, [it shows] Congress at least has the potential willingness and interest to act.” And if that isn’t reason enough to seek clarity from the SEC sooner rather than later, we don’t know what is.