There is a saying in French, "Le mieux est l'ennemi du bien," which loosely translates to "perfect is the enemy of good enough." Perhaps US legislators would be wise to remember this aphorism after hearing testimony on cryptocurrencies and initial coin offerings (ICOs) on March 14, 2018.
Congressmen repeatedly expressed a desire to "get it right," but that will be difficult amid the rough seas of cryptocurrency regulation. Who possesses jurisdiction over virtual assets? At times, it would appear that the Commodity Futures Trading Commission (CFTC) is in charge, and at other times, the Securities and Exchange Commission (SEC) has claimed authority.
The answer? Well, it just depends.
It's hard to expect clear answers to emerge from these hearings, but today, witnesses provided critical insight into the sometimes-murky distinction between commodities and securities. They each tried to explain to legislators which areas the CFTC oversees and which issues seem to reside with the SEC.
But, it appears that cryptocurrency regulation remains a moving target. In all, the witnesses seemed to agree, it's important for legislators to understand what authority has been established by state and federal regulators before making any rash decisions.
According to Mike Lempres, chief legal risk officer of Coinbase, the US-based exchange supports trading of four different virtual currencies: bitcoin (BTC), bitcoin cash (BCH), Litecoin (LTC), and Ether (ETH). Coinbase, he said, determined that these digital assets qualify as a "virtual currencies" based on 1) the CFTC's 2015 guidance that bitcoin and other virtual currencies are commodities, 2) a recent ruling that supported the CFTC's classification of bitcoin as a commodity, and 3) the SEC's July 2017 DAO report, which referred to Ether as a virtual currency.
Note: BCH and LTC are both based on bitcoin core, so it was assumed that they are subject to the same standards that apply to bitcoin.
If correct, Coinbase's assessment of the facts, is intriguing, because that would mean that enforcement authority over the Ether spot market would appropriately belong with the CFTC. It's important to remember that the agency does not have regulatory oversight authority over spot virtual currency platforms; in fact, no US Federal regulator has such authority.
Of course, assuming that Ether is a virtual currency, the CFTC would also have regulatory jurisdiction over the potential Ether derivatives market in the US and that would likely mean that Ether (like bitcoin) qualifies as property based on the Internal Revenue Service's 2014 guidance.
However, all of this paints over a very significant nuance. For all intents and purposes, public mining of bitcoin, bitcoin cash, and Litecoin were immediately possible. There was no "pre-mine," an opportunity for developers to create their own reserves of digital tokens before a wider release, and there was no "sale" or ICO associated with BTC, BCH, or LTC.
By comparison, Ether did have a sale and the Foundation allocated a sizeable portion of the digital tokens for a development fund among other uses. At least in the early going, it would appear that Ether was a security.
It's impossible to say if or when Ether made the transition from security to commodity, but perhaps that occurred at the moment when public mining became possible. One could also argue that the value of ETH continues to depend on the management efforts of the Ethereum Foundation and various developers, so it's hard to make any sort of determination about a security versus commodity classification.
Ultimately, it looks like regulators just don't know what to do with Ethereum, in large part because of the potential opportunities afforded by the platform and its associated tokens.
Ahead of today's hearing, Coinbase published its written testimony for the House Financial Services Committee's subcommittee on Capital Markets, Securities, and Investment.
During the hearing, Dr. Chris Brummer, a professor of law at Georgetown University Law Center, called for improved disclosure practices in whitepapers, the documents that have frequently revealed the details – however sparse – of initial coin offerings (ICOs).
One day before the hearing, he published "What Should Be in an ICO White Paper? Expert Take." Brummer suggested that whitepapers should include the following basic information:
- Promoter's location
- Problem and proposed technology solution in plain English
- Description of the token (avoiding hyperbole)
- Blockchain governance
- Qualifications of the technical team
- Risk factors.
Meanwhile, Robert Rosenblum, partner at law firm Wilson Sonsini Goodrich & Rosati said that Congress should authorize federal regulators (i.e., the CFTC and SEC) to oversee the ICO markets as appropriate, but called legislation "premature."
Rosenblum also said that the focus on the distinction between a security and a commodity was near-sighted, because it's very difficult to determine when the efforts of a promoter have ended and when a token's value is primarily derived from its use on a network rather than its alleged investment proposition. Crypto-regulation is also arriving very early relative to functional use cases. To put it another way, designing a regulatory treatment for tokens today is like trying to design regulations for Uber when Apple launched the iPhone.
Peter Van Valkenburgh, director of research at Coin Center, continued his call for a streamlined regulatory environment, acknowledging the patchwork of rules that exist at the federal and state levels. Van Valkenburgh told legislators he worries that technologists will move abroad if the US is inhospitable to FinTech and virtual currency development.
Congressman Brad Sherman (D-CA) raised some curious points about cryptocurrency, essentially questioning the value of the ecosystem beyond terrorist financing and illicit purchases. He asked what great social purpose is being fulfilled, but seemed more dismissive than accepting of the uncertainties.
That being said, Sherman specifically asked about seigniorage, the profits that are derived by a government by printing money that is excess of the value of its production. Essentially, this is the value that the government generates just by minting dollars and coins. The congressman worried that cryptocurrencies could eventually damage the financial mechanisms of the United States insofar as the Federal Reserve and the Internal Revenue Service are concerned.
In all, these Congressional hearings continue to be both educational opportunities for legislators and painful procedures for cryptocurrency stakeholders, who are repeatedly reminded of bureaucratic failings. The bad news is that it's taking a very long time to hammer out the appropriate standards for digital assets. This risks hesitation by American technologists and the possible loss of US innovation. It also means that speculators may continue to throw money at overhyped projects that remain unchecked by federal authorities.
Fortunately, the good news is that Congress is engaging with the cryptocurrency experts in meaningful dialogue, and relevant parties from both industry and government are helping to shape legislative attitudes. The perfect solution may elude us, but for now, this is good enough.