I’ve been speaking a lot the last two years about how the blockchain industry tends to misunderstand regulation. This goes beyond whether or a particular token is a security or a commodity. The problem we have is in defining tokens.
Alexandra Damsker is an attorney and strategic consultant, advising on legal and operational issues. She was previously an attorney with the US Securities and Exchange Commission and Mayer Brown, and is an exited founder.
Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.
It really doesn’t matter which agency regulates tokens, because all of them are premised on the same thing: the regulated item is static. A stock is a stock from the day it’s created until the day it is voided or the company is dissolved. Fiat is currency from the day it is minted until the day it is destroyed.
But not tokens. Tokens are dynamic – they can have multiple different functions to different holders, or even to the same holder, simultaneously. And there is no regulatory system in the world that can account for that.
Let’s look at some of the things tokens can do, and the regulatory consequences of each:
Move transactions along a chain. This is purely functional and unregulated.
Incentivize people who contribute effort to secure and manage the blockchain. This is an exchange for labor or services, and does not rely on any presumed value for the token, so is unregulated.
Represent value, either physical or digital. This is only regulated when the underlying represented thing is regulated (e.g., a token representing a television is not regulated, but a token representing a share of stock in Tesla is regulated).
Represent a physical or digital product or group of rights. This is just a product, and unregulated other than any intellectual property rights that may attach.
Payment for goods or services OTHER than transactional fees (i.e., gas fees). This is tricky: unless it’s a stablecoin, it’s similar to a currency, but not quite the same. (Remember that currencies are intended to be a store of value that stays within a narrow range to a key targeted or exchange rate. Assets, on the other hand, are designed to fluctuate in value – that’s how your tiny investment in something suddenly becomes worth so much, or your huge investment in something else plummets to nothing.) Currencies are regulated by the U.S. Department of Treasury, including FinCEN and the IRS.
Payment for transactional fees (gas fees). These are service fees, and generally unregulated.
Represent partial value. (This is great – you can’t own a partial stock or partial painting, but you can get fractional value of pretty much anything if you tokenize it.) This one is tricky, too: generally, If you break an asset into part-interests where everyone shares interest in the whole, it’s a security, regulated by the SEC. But if you break things up in a way that you own something distinct and individual, rather than a piece of a whole, it’s generally NOT a security. It could be a commodity, however, like bitcoin (BTC).
Represent rewards for taking on risk or offering a good or service, like staking on chains without providing validation work, or payment for tokens loaned to a liquidity pool, borrower platform or application. This is regulated by a combination of securities and Treasury regulators.
Represent voting rights. Regulated by the SEC in public companies only.
Represent perceived or speculative market value. A security or commodity, and regulated by the SEC or CFTC, accordingly.
You can see how many things a token can be – and the buyer doesn’t know what a specific token will end up. If I buy ether (ETH) in January, February and March, then in June stake some with a validator, purchase a one-of-one NFT (a product) in July, and a meme coin (likely a security) in August, paying gas for each transaction, which ETH specifically was used for which transaction? I, the buyer, don’t even know – I won’t know which ETH was used to buy the meme coin until I apply my jurisdiction’s accounting method. So we only find out in retrospect which regulatory system to look at for any particular ETH until after I spend it and apply professional accounting methods.
Now we throw in the fact that there is a person on the other side of the transaction – who may then shift the ETH into something else, just like I did. I took ETH I purchased on the marketplace (likely a security) to buy a product (the NFT) and service fees (gas fees). The person who sold me the NFT could have taken the ETH (payment/ currency) and then placed some of it on the market (currency), voted on an Ethereum Improvement Proposal (EIP) with some (voting), and purchased an NFT in a major fine art piece (security) and paid service fees (gas fees).
See also: Is the House’s FIT21 Bill Really the Legislation That Crypto Needs? | Opinion
Do we see how confusing this is, and artificial? The current regulatory structure assumes anything that falls within it will remain there permanently. But that is not only unlikely, it is impossible with respect to tokens. It does not work for dynamic systems.
Trying to squeeze tokens into old frameworks can only give us marginally useful protection at best, and limits incentive to innovate at worst. We can do better than this. And considering the fact that quantum computing and other technologies with greater likelihood of simultaneous shifting of character are coming into mass use faster and faster, we have no time to waste.
UPDATE 5/30/24; 19:25: The headline and summary for this op-ed have been amended to more accurately reflect the argument.
