Crypto (Un)Certainty and Unfolding Regulatory Policy

Summary: Regulatory Action in Crypto is Fragmented–and Facing Increasing Legislative Interest   


J.C. Boggs, Jennifer DePalma, Matt Hanson and Ana Buling are attorneys in King & Spalding’s FinTech, Blockchain and Cryptocurrency practice

In its latest effort to provide clarity for digital asset markets, the Securities and Exchange Commission announced plans earlier this month to release a “plain English instrument” to help entrepreneurs and other crypto market participants understand the Commission’s lens for evaluating whether particular crypto tokens are “securities.” While the crypto markets took news of the promised guidance as a step toward certainty, the SEC is just one of many federal regulators in the process of defining their approach to crypto tokens.

On November 5, William Hinman, head of the SEC’s Division of Corporation Finance, told attendees of Washington’s Fintech Week that the guidance will draw on his widely quoted speech from June, in which Hinman said he does not view offers and sales of Ether to be securities transactions. His June comments pointed to the level of decentralization in the use of Ether, as well as to the lack of central control over Ether. Hinman said the forthcoming guidance will also explain how to register initial coin offerings with the SEC or, in the alternative, how to conduct an exempt offering.

Other U.S. regulators have taken different positions on how crypto tokens should be treated, each based on their particular perspectives and the types of crypto tokens on which the agency is focused. For example, the Commodity Futures Trading Commission views certain virtual currencies as commodities. The Internal Revenue Service says that convertible virtual currencies are property.

The different approaches bring to mind the ancient parable of the Blind Men and the Elephant. In that parable a group of blind men encountered an elephant for the first time and were asked to describe it. Each man felt a different part of the elephant’s body and described the elephant based on his interaction with that one part, resulting in each man’s description of the elephant being different from that of the others. 

Unlike the men in the parable, regulators are encountering a variety of truly distinct digital objects. Given the significant differences in what any given crypto token represents, it would be difficult, if not impossible, to agree on a consensus definition of a term like cryptocurrency or virtual currency. To subject all crypto tokens to a one-size-fits-all legislative or regulatory regime would miss the mark.

Using the existing frameworks, it is often difficult to determine whether regulators would classify a particular crypto token as a commodity, a security, another form of asset, such as a derivative or payment mechanism, or perhaps all of the above. Further complicating the analysis, some crypto tokens are used in ways not easily analogized to one financial instrument. A number of tokens may be used both as a means of payment within a network and also as a security traded on an exchange. Such dual-use tokens potentially implicate both money-transmitter and securities laws. 

For companies with crypto-related business plans, the resulting inconsistencies and ambiguity leave them guessing at what is required under the law. And that creates risk. What an entrepreneur today views as a novel step into an area lacking official guidance may later be seen (in hindsight) as an obvious step onto the wrong side of the law.

U.S. financial regulators are working on harmonizing the regulatory approach to digital assets across agencies. While regulators will no doubt continue evaluating how to apply existing rules and regulations, both the crypto community and U.S. financial regulators are waiting to see if Congress will act to provide clarity. 

Congress has gotten into the action, studying new developments, and hosting meetings with industry players and regulators. Committees both in the House of Representatives and in the Senate have held public hearings to solicit views on where legislative action might be best focused. Those hearings have produced a substantial record, and some members of Congress have now shifted to framing potential legislation.

Two recent House resolutions express support for the new industry — H. Res. 1108, sponsored by Rep. David Schweikert (R-AZ), and H. Res. 1102, sponsored by Rep. Tom Emmer (R-MN). Reps. Schweikert and Emmer, who help co-chair the Congressional Blockchain Caucus, are sponsoring more than half of the crypto-related legislation proposed in recent months. 

One recent bill would address setting standard definitions for terms like “blockchain” in order to facilitate a cohesive regulatory scheme. (H.R. 6913 ‒ Rep. Doris Matsui (D-CA) and Rep. Brett Guthrie (R-KY)).

Other bills are geared toward granting industry participants relief in the absence of certain regulatory guidance. One would exempt de minimis transactions in cryptocurrencies (initially those under $600, tied to inflation going forward) from IRS reporting requirements. (H.R. 3708 ‒ Rep. Schweikert (R-AZ)). Another would provide a temporary safe harbor for the tax treatment of convertible virtual currency received when a blockchain forks, aiming to address what the sponsors view as a present lack of clear IRS guidance on forks. (H.R. 6973 ‒ Rep. Emmer). A third bill would provide a safe harbor from money transmitter licensing and registration for certain blockchain developers and providers of blockchain services that do not, in the regular course of business, “control” users’ crypto tokens. (H.R. 6974 – Rep. Emmer). 

The newly proposed legislation, like the SEC’s efforts to provide additional guidance, are emblematic of the balancing act Congress and regulators are trying to strike between regulating crypto tokens and blockchain technology, while not restricting their utility or hampering innovation. To reach and maintain this balance, legislators and regulators must continue learning about these new technologies.  

Current uncertainty surrounding the treatment of offers, sales, and other transfers and uses of crypto tokens is hindering innovation in the United States and could ultimately drive business elsewhere. In addition to legislative clarification, the U.S. Department of Treasury or National Economic Council could also play more of a coordinating role among the various financial regulators in an effort to better harmonize federal regulations, increase legal certainty and predictability, and generally make the United States a more competitive and attractive ecosystem for blockchain innovation and investment. It is incumbent upon market participants to share their knowledge and expertise with policymakers in Congress and the executive branch who are trying to better understand blockchain technology and determine whether or how crypto tokens should be regulated.

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