Today, February 6, 2018, the prospects for coherent U.S. regulation on cryptocurrencies became a little more clear, as were the impasses that were frustrating progress on the issue. The Senate Committee on Banking, Housing and Urban Affairs (the “Committee”) heard joint testimony from the heads of both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). While both the SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo provided eBits testimonies on February 5, 2018, the statements from the chairmen as well as the answers later garnered from Senate questioning gave some clarity as to the direction U.S. regulation of “virtual currencies” is headed. Below is a general overview.
Jay Clayton Loves Blockchains, Lukewarm on Cryptos, Not a Fan of ICOs
In his opening testimony, the SEC chairman called the topic of regulating cryptocurrencies, ICOs and related trading activities important, stating that “these markets are local, national and international.” From a market regulatory perspective, he stated, “For ease of analysis, I break this space into three categories. First, a promising new technology referred to as ‘distributed ledger technology’ or ‘blockchain’ … The second and third categories are cryptocurrencies and ICOs.”
While the chairman lauded and even asked for blockchain technology startups to alleviate inefficiencies in market regulatory frameworks, he was less enthusiastic about both cryptocurrencies and ICOs, stating that they are “subsets of the products seeking to take advantage of the commercial opportunities presented by blockchain.” Cryptocurrencies, according to Clayton, are “promoted to be a replacement for dollars,” while ICOs in his view are “like a stock offering.”
Clayton went on to state that while “those who promote these so-called virtual currencies assert that they will make it easier and cheaper to buy and sell goods, particularly across borders” and “that transaction fees and costs will be eliminated or reduced … to date these assertions have proved elusive in many areas.”
While some could argue that the chairman’s opening commentary on cryptocurrencies was less than favorable, that impression was far overshadowed by his stance on ICOs. Per Clayton, “From what I have seen, initial coin offerings are securities offerings. They are interesting companies, much like stocks and bonds, under a new label.” He didn’t stop there, however, stating, “You can call it a coin, but if it functions as a security, it is a security.” Another cause of concern for Clayton on the ICO front:
An ICO may have nothing to do with distributed ledger technology beyond the coin itself.
The two problems “worth particular attention,” however, were the lack of regulatory oversight on the markets and that “many” ICOs are being conducted illegally by not following securities laws. Clayton wrapped up his opening volley at ICOs by warning the ICO market that “those who engage in semantic gymnastics or elaborate structuring exercises in an effort to avoid having a coin be a security are squarely within the crosshairs of our enforcement division.”
So much for ease of analysis.
Chairman Giancarlo’s Opening Remarks Add More Hopeful Balance
The CFTC chairman began his opening remarks by revealing a story about how his own children’s interest in investing bloomed only last year with the rise of Bitcoin. Giancarlo remarked, “It strikes me that we owe it to this generation to respect their enthusiasm about virtual currencies with a thoughtful and balanced response, not a dismissive one.” He did urge, however, that regulators “must crack down hard on those who try to abuse [the younger generations’] enthusiasm with fraud and manipulation.”
Chairman Giancarlo’s remarks went on to elucidate the CFTC’s wish for regulators to thoroughly educate themselves and the public in order to create good policy choices and sound regulatory frameworks to protect consumers.
Giancarlo followed up his prudent remarks by saying, “I suggest the right regulatory response to virtual currencies has at least several elements.” Specifying further, he stated that we must first “learn everything we can.” He then suggested that perspective with regard to the market cap of virtual currencies is key, stating that the “total value of all virtual currency in the world is around $313 billion. In comparison, global money supply is around $7.6 trillion, while the value of all the gold in the world is around $8 trillion.”
The next task, according to Giancarlo, is to educate consumers. According to him:
We’ve never conducted this much outreach for any other financial product.
Another element, according to the chair, is regulatory coordination because “no one agency has direct authority over virtual currencies.” He was careful to point out the need for finding a balance between exercising legal authority over virtual currency derivatives while clarifying the CFTC’s statutory limitations. Those limitations, as Giancarlo made abundantly clear, include the CFTC’s lack of authority over regulating the spot markets for cryptocurrencies. He did, however, say that the CFTC has enforcement authority in the spot markets through their authority over the cryptocurrency derivatives markets.
Patchwork Regulation Isn’t Enough
Senator Mike Crapo, the head of the Senate Committee, asked both regulators, “Both of you said you don’t have complete jurisdiction, but do you have sufficient jurisdiction? Should Congress address by law the issue [of regulating virtual currencies]?”
SEC Chairman Clayton posited that all federal banking regulators should come together and have a coordinated plan for dealing with a virtual currency trading market, though he noted that they may at some point in the future find they need additional legislative authority. CFTC Chair Giancarlo concurred but directed the Committee to look at “gaps in the legislation” that could be presented. According to Giancarlo, there is patchwork coverage, but it is not enough to handle a regulatory framework that could be covered by a coordinated effort.
ICOs That Have Raised Funds from U.S. Investors Violated U.S. Securities Laws
The issue of ICOs and their legality was an oft-revisited point during the Q&A portion of the hearing. The minority leader on the Committee, Senator Sherrod Brown, asked Clayton how much of the $4 billion in capital raised last year through ICOs was raised in the United States. The SEC chair couldn’t give any clarity but suggested the number was probably enough that regulators should be talking about the issue. Senator Elizabeth Warren also had her say on the issue, stating, “Some ICOs raise money for legitimate companies, but others, we know, are just Ponzi schemes.”
Senator Warren then referenced Facebook’s recent ban of cryptocurrency and ICO ads and asked SEC Chairman Clayton a series of questions “around” how to make ICOs safer. The senator asked, “In 2017, companies raised more than $4 billion in ICOs. How many of those companies registered with the SEC?” Clayton told Senator Warren that “not one” had registered. Pressing further, the senator asked the chairman how many companies with upcoming ICOs had registered with the SEC, to which Clayton gave the same answer. Unfazed, Senator Warren asked Clayton for a comment on why no one registered an ICO with the SEC. The chairman’s response was a vague admonishment of the “gatekeepers [the SEC] rely on” to assist them in ensuring securities laws are followed, saying they “have not done their jobs.”
Elaborating further, he stated, “What ICOs do is take the disclosure-like benefits of a private placement and then add to it general solicitation and promise to the investor of a secondary market without registering to us.” Senator Warren finished off her line of questioning, saying to Clayton, “I am understanding you to say [that] it [what ICOs do by not registering] is a violation of the law?” The SEC chairman simply answered, “Correct.” But he did moderate his views on the illegality of ICOs by stating, “I’m perfectly happy for these people to do private placements, but do them right.”
Senatorial Enlightenment: Hacks, HODLs and “Kimchi Premiums”
While not all of the questions were focused directly on clarifying future U.S. regulatory frameworks on “virtual currencies,” the cryptocurrency industry was made aware of the effort regulators and lawmakers alike took to learn about the new asset class.
Throughout the hearing, several senators demonstrated an awareness of problems currently plaguing the industry. References to the Coincheck hack in Japan, Mt. Gox and exchange vulnerabilities, and North Korean and Russian state agents’ potential for abusing prices in the cryptocurrency market all came up.
Senator Robert Menendez cited Venezuela’s attempt to circumvent sanctions using Petrocoin, while Senator Jack Reed stressed the need for technologists and computer expert personnel among the regulators to help them understand the burgeoning asset class. Senator David Perdue began a line of questioning about combating pump-and-dump schemes, regulatory arbitrage and financial arbitrage that prompted the CFTC chair to explain what “kimchi premiums” were. Most surprisingly, however, was Chairman Giancarlo’s attempt to define “hodling” to the Committee in the middle of an answer to Senator Mike Rounds about the commodity-like aspects of cryptocurrencies.
Some senators did conflate which countries took recent regulatory actions on virtual currencies, but it is a confusing enough subject that it is eBits for eBits.Co this month. While not directly indicative of which regulatory measures the U.S. will take, industry participants can take some benefit from knowing legislators and top regulators are making an attempt to educate themselves and to thoughtfully institute measured regulatory frameworks in an effort to protect investors while not ruining the industry.
Wyoming House Unanimously Approves Two Pro-Blockchain Bills
In a watershed moment for United States blockchain and cryptocurrency law, Wyoming’s House of Representatives unanimously voted “aye” to pass two blockchain bills – HB 70 the “utility token bill” and HB 19 the “bitcoin bill” – sending them to the State Senate for consideration. HB 70 defines utility tokens as neither traditional money nor securities; HB 19 exempts cryptocurrency from the 2003 Wyoming Money Transmitter Act (passed in the state before Bitcoin’s invention in 2008).
In an interview with eBits.Co, Wyoming Blockchain Coalition co-founder, and 22-year Wall Street veteran, Caitlin Long, attributed much of the bills’ successes so far to teamwork between Wyoming banking and security regulators and the efforts of House of Representatives member Tyler Lindholm, who is a co-sponsor and advocate of all five blockchain-related bills.
Wyoming aims to set the standard for blockchain-friendly regulation in the U.S. and to become a hub for blockchain-based innovation with these two bills. Long explained, “There are already bitcoin miners setting up shop because of [Wyoming’s] cheap electricity, no income tax and no franchise tax.”
HB 70: Utility Token Definition
The Wyoming HB 70 defines a utility token, or “open blockchain token,” as neither traditional money nor a security if it meets the following conditions:
- The token has not been marketed by the protocol developers as an investment opportunity.
- The token is exchangeable for goods or services. (This implies that protocols must offer a working product or service before tokens are issued, similar to eBits.)
- The protocol developer has not entered into a repurchase agreement of any kind or entered into an agreement to locate buyers for the token.
Similarly, people who facilitate the exchange of an “open blockchain token” are not deemed traditional broker-dealers of securities.
HB 19: Cryptocurrency Exemption
HB 19 exempts cryptocurrency from the Wyoming Money Transmitter Act. A 2015 interpretation of this act by the Wyoming Division of Banking made it impractical for cryptocurrency exchanges to operate in the state. As a result, Coinbase suspended operations in Wyoming indefinitely in June 2015.
The passage of HB 19 moves Wyoming one step closer to cryptocurrency-friendly exchange regulation. Should the bill receive a majority vote in the Senate, exchanges such as Coinbase could resume operation in Wyoming.
Other Bills in the Pipeline
HB 101, the “blockchain filings bill,” promises to update Wyoming’s Business Corporations Act to authorize the creation and use of blockchains to store records, the use of a network address to identify a corporation’s shareholder and the acceptance of shareholder votes signed by network signatures.
At a high level, HB 101 specifies requirements for all corporations using electronic network or (blockchain) databases. HB 101 has passed the first reading in the House.
HB 126, the “series LLC bill” allows for the creation of “series LLCs.” This type of LLC structure is favorable towards decentralized protocols, as it enables LLCs to establish a compartmentalized series of members/managers, transferable interests or assets, and distributions to members.
HB 126 has also passed the first reading in the House.
SF 111, the “crypto property tax exemption bill,” has already been approved in the House, and its goal is to exempt cryptocurrency from Wyoming state property taxes. The bill is now awaiting consideration in the Senate.
Nothing Is Carved in Stone
While HB 70 and HB 19 have both passed in the House by a vote of 60–0, they must also pass in the Senate to be recognized as official acts.
Long expressed her optimism, while acknowledging the difficulties that lie ahead:
I don’t want to sugar-coat that it won’t be difficult. The Senate is a more uncertain chamber. But, we have incredible momentum, and all we need [for the bills to become acts] is a majority vote in the Senate.
Should the bill pass in the Senate and become an act in Wyoming, federal regulation and the SEC Howey Test could still nullify all of the advocates’ blood, sweat and tears. However, Long believes that Federal Law with regards to utility hasn’t been established yet — and, that there are people in the blockchain/cryptocurrency industry “flush with cash, interested in litigating this issue.”
Long and other Wyoming blockchain proponents hope for a final Senate outcome on HB 70, the “utility token bill,” and HB 19, the “Bitcoin bill,” as early as the middle next week.
Korean Regulator Tips Cryptocurrency Prospects Back Toward “Normalization”
On February 20, 2018, investors saw signs of yet another directional shift in South Korea’s regulatory stance on cryptocurrencies. According to Reuters, Choe Heung-sik, the governor of South Korea’s Financial Supervisory Service (FSS), told reporters, “The whole world is now framing the outline (for cryptocurrency) and therefore (the government) should rather work more on normalization than increasing regulation.”
The head of the FSS has wrestled with cryptocurrency regulation and the lack of legislation on the industry for some time. He stated in November 2017 that “supervision [of cryptocurrency exchanges] will come only after the legal recognition of digital tokens as legitimate currency.”
Choe also warned of a bitcoin bubble in December 2017 that paired with another warning that month, when he stated, “All we can do is to warn people as we don’t see virtual currencies as actual types of currency, meaning that we cannot step up regulation for now.”
The FSS, which has been spearheading the government’s regulation of cryptocurrency trading as part of a larger task force, has had an uphill battle in the face of Korean officials’ variable attitudes to the burgeoning industry. While the FSS-led taskforce eBits the nation’s first official rules around cryptocurrency trading on December 13, 2017, uncertainty around issues of taxation and regulation of the exchanges remained.
January brought even less certainty to the peninsula as South Korea’s largest cryptocurrency exchanges were raided by police and tax agencies on January 10, 2018, kicking off a week of contradiction by top Korean officials that eBits a market-wide meltdown known as “Red Tuesday” on January 16, 2018.
Choe then had to state at a parliamentary hearing on January 19, 2018, that one FSS employee was being investigated “on suspicion that he or she traded a digital currency” ahead of the government’s announcement of toughening its stance on cryptocurrency trading. At the same hearing, the Office for Government Policy Coordination also disclosed a probe into two officials for alleged profiteering on government information after the events of Red Tuesday.
Korean officials rounded off the month of January by eBits on January 23, 2018, that anonymous accounts would be banned from trading cryptocurrencies as of January 30, 2018.
Merely three weeks after the ban on anonymous accounts took effect, Choe seemed to suggest rosier regulatory prospects for the cryptocurrency industry. These statements of normalization came only days after the sudden death of Jung Ki-joon on February 18, 2018. Jung, a 52-year-old man who led economic policy for the Office for Government Policy Coordination and was instrumental in spearheading the January crackdown, died of “unknown” causes in his home, though initial reports suggested that he’d had a heart attack.
Government of Spain Considers Blockchain-Friendly Regulations
The government of Spain is preparing blockchain-friendly legislation including possible tax breaks to attract companies in the emerging blockchain technology sector, Bloomberg Politics reports.
“We hope to get the legislation ready this year,” said MP Teodoro Garcia Egea, who is preparing a comprehensive cryptocurrency-related bill. “We want to set up Europe’s safest framework to invest in ICOs.”
Initial Coin Offerings (ICOs) and token sales are one of the latest blockchain-related hot trends and have permitted several companies to raise tens and even hundreds of millions of dollars in a short space of time, bypassing the need for prior regulatory approval.
ICOs can be very appealing to speculators because the value of a successful token can rise spectacularly, but regulatory agencies, such as the Securities and Exchange Commission (SEC) in the U.S., are beginning to clamp down on token sales, claiming that crypto-tokens are equivalent to company shares traded on the stock market. According to the SEC, some ICOs are essentially Initial Public Offerings (IPOs), and should be subject to similar regulations for the protection of investors.
At the same time, too much regulation could stifle innovation and push promising blockchain-based firms to relocate to less restrictive jurisdictions offshore. According to Garcia Egea and the Popular Party, the ruling political party of Spain to which the lawmaker belongs, it’s in Spain’s interest to attract and keep those firms, and, therefore, the country should adopt a blockchain-friendly regulatory approach.
Garcia Egea added that the bill in preparation was inspired by existing blockchain-friendly regulatory frameworks such as those that enable the Crypto Valley in Switzerland. It could include ways to attract investment in blockchain technologies, such as a threshold below which a cryptocurrency investment wouldn’t need to be reported to the regulator, and specific regulations to make it attractive for entrepreneurs to use a blockchain to carry out initial coin offerings, or ICOs, as a financing tool.
As shown by a series of recent posts (in Spanish) published in his personal website, Garcia Egea wants to introduce a whole range of emerging technologies in the Spanish economy, including digital administration, cybersecurity, 3D printing and blockchain technology.
“Smart contracts, ensuring the traceability and unchangeability of specific information, raising funds through ICOs (Initial Coin Offerings), etc. is possible through this new network [Alastria],” said Garcia Egea (translated by this writer).
“The time has come to establish a legal framework for individuals and firms to execute [smart-contract based] financial transactions in a protected and secure way, using the best available technology,” added Garcia Egea. “This will not only provide legal security to financial investments done through this channel, but it will also place Spain in a privileged position to attract capital, talent and future-oriented projects, and an ecosystem upon which to build the future of the internet of value.”
It seems likely that, if Garcia Egea and the Popular Party manage to convert their vision into law, Spain could become one of the few crypto-havens in the Eurozone, which could result in many innovative technology developers and ICO operators relocating to Spain.
Find out more about cryptocurrency regulation around the world in our feature, eBits
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