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0/ Sorry to say, I'm not a fan of the new Token Taxonomy Act.
I do think we need legislation to clarify whether & how digital tokens should be regulated, but this bill doesn't cut it. Here's my take on why it would create *more* regulatory uncertainty, not less.
Thread. 👇
I do think we need legislation to clarify whether & how digital tokens should be regulated, but this bill doesn't cut it. Here's my take on why it would create *more* regulatory uncertainty, not less.
Thread. 👇
1/ The draft Token Taxonomy Act ("TTA") proposes to amend the definition of a "security" under the Securities Act of 1933 & the Securities Exchange Act of 1934. These are the laws requiring securities issuers to register with the SEC before a public sale.
scribd.com/document/40563…
scribd.com/document/40563…
2/ Under existing law, if a company issues a security without registering it first (or satisfying an exemption from registration), the company has violated Securities Act §§ 5 & 12.
The company could then be prosecuted by the SEC & forced to pay fines & refunds to investors.
The company could then be prosecuted by the SEC & forced to pay fines & refunds to investors.
3/ This matters because digital tokens may qualify as "investment contracts," a type of security.
Under the Howey test, assets are investment contracts if they involve "an investment of money in a common enterprise with the expectation of profit based on the efforts of others."
Under the Howey test, assets are investment contracts if they involve "an investment of money in a common enterprise with the expectation of profit based on the efforts of others."
4/ The problem is, there's no way to be sure if a particular token will pass the Howey test. Reasonable minds can differ on the test's outcome.
As a result, the crypto industry has been plagued by regulatory uncertainty, left to guess what the SEC or a judge & jury will decide.
As a result, the crypto industry has been plagued by regulatory uncertainty, left to guess what the SEC or a judge & jury will decide.
5/ The TTA tries to resolve this problem by defining a new class of "digital tokens" & then explicitly removing them from the scope of the securities laws.
That means crypto companies wouldn't have to worry about Howey so long as they satisfy the TTA's digital token definition.
That means crypto companies wouldn't have to worry about Howey so long as they satisfy the TTA's digital token definition.
6/ But the TTA's proposal only works--that is, only provides regulatory clarity--if it's easier for companies to satisfy the digital token definition than it is to satisfy the Howey test.
In my view, that's not the case: the digital token definition is *less* clear than Howey.
In my view, that's not the case: the digital token definition is *less* clear than Howey.
7/ The big issue with Howey has been figuring out whether a token purchaser's expectation of profit is "based on the efforts of others."
That's what the whole "sufficiently decentralized" thing was about last year & what the SEC focused much of its ICO guidance on last week.
That's what the whole "sufficiently decentralized" thing was about last year & what the SEC focused much of its ICO guidance on last week.
8/ But even though the "based on the efforts of others" element is hard to apply to crypto, it's also an old standard that lawyers have worked on for decades.
There's a wealth of case law & commentary on what this means. It's not perfect, but at least we have something to go on.
There's a wealth of case law & commentary on what this means. It's not perfect, but at least we have something to go on.
9/ On the other hand, the TTA's digital token definition has a number of new elements that are just as hard to apply (if not more so) & lack a solid basis in existing jurisprudence. This isn't the best recipe for statutory clarity.
I'll give you a few examples of what I mean.
I'll give you a few examples of what I mean.
10/ The definition applies to tokens created "pursuant to rules for...creation and supply that cannot be altered by...persons under common control."
What distinguishes "control" from mere influence? What type of relationship makes control "common?" What about rules for utility?
What distinguishes "control" from mere influence? What type of relationship makes control "common?" What about rules for utility?
11/ The definition also requires that tokens be recorded on a data structure that "resists modification or tampering[.]"
But don't even the most centralized non-blockchain databases "resist tampering" in some way? Do we want to include tokens on private servers with passwords?
But don't even the most centralized non-blockchain databases "resist tampering" in some way? Do we want to include tokens on private servers with passwords?
12/ The definition excludes tokens that represent "a financial interest in a company or partnership[.]"
I assume the goal is to exclude tokens that function like equity shares, but this language is broad. Can't a "financial interest" in a "partnership" mean just about anything?
I assume the goal is to exclude tokens that function like equity shares, but this language is broad. Can't a "financial interest" in a "partnership" mean just about anything?
13/ These are just a few issues I see at first glance, but you get the idea.
Bottom line: I don't think this draft of the TTA resolves any of the uncertainty around the Howey test. It just replaces that uncertainty with different elements requiring years of litigation to unpack.
Bottom line: I don't think this draft of the TTA resolves any of the uncertainty around the Howey test. It just replaces that uncertainty with different elements requiring years of litigation to unpack.
14/ I'm not the only lawyer who thinks so. Many others who care deeply about the crypto industry have criticized the TTA this week.
To start, you have Caitlin Long (@CaitlinLong_), who's done more work on crypto legislation than anyone. Like, actually.
To start, you have Caitlin Long (@CaitlinLong_), who's done more work on crypto legislation than anyone. Like, actually.
15/ Then you have a pair from top crypto boutique DLx Law, Lewis Cohen (@NYcryptolawyer) and Gabriel Shapiro (@lex_node).
Lewis explains why folks are "up in arms" over the TTA ().
Gabe cuts to the point, calling it "pure nonsense."
Lewis explains why folks are "up in arms" over the TTA ().
Gabe cuts to the point, calling it "pure nonsense."
16/ And some of our pseudonymous colleagues are weighing in too. @MeatTC_ dives into the TTA's tax provisions--which I'll leave to the tax lawyers to analyze--calling some of them "ridiculously broad and bad, like, someone should get fired bad[.]"
17/ Let's be clear: the existing federal securities laws aren't well-equipped to address the unique challenges posed by digital assets.
We *do* need action from Congress to move this industry forward, and revamping the securities laws is just the start. This is a huge project.
We *do* need action from Congress to move this industry forward, and revamping the securities laws is just the start. This is a huge project.
18/ That's why we have to make sure we get it right.
No doubt, this is a tough problem & nobody has a perfect answer. But we can't afford to trade one unclear standard for another, just for the sake of doing something. As it stands, that's what I think the TTA would do.
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No doubt, this is a tough problem & nobody has a perfect answer. But we can't afford to trade one unclear standard for another, just for the sake of doing something. As it stands, that's what I think the TTA would do.
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