Lawmakers look to change SEC’s 72-year old securities definition to exclude cryptocurrencies


Aaron P. Bernstein | Reuters
The Capitol building in Washington, DC.

Congress may finally bring the cryptocurrency industry what it has been loudly calling for: regulatory clarity.

Two congressmen are introducing a bill Thursday that would exclude digital currencies from the decades-old definition of a security. The legal definition might seem like an insignificant change, but it has become a heated issue for those in the industry who say the law is outdated for a digital asset class.

The “Token Taxonomy Act” — a bipartisan effort by Reps. Warren Davidson, R-Ohio and Darren Soto, D-Fla. — defines a “digital token” and clarifies that securities laws would not apply to cryptocurrencies once they become a fully functioning network.

“In the early days of the internet, Congress passed legislation that provided certainty and resisted the temptation to over-regulate the market. Our intent is to achieve a similar win for America’s economy and for American leadership in this innovative space,” Davidson said in a statement.

A major concern for lawmakers and regulators has been consumer protection. Retail investors made speculative bets on bitcoin and other cryptocurrencies last year, and many lost big as the crypto bubble burst. Bitcoin is down 71 percent this year while XRP, the second largest, is down 85 percent this year, according to data from CoinDesk.

WATCH: When Bitcoin hit $100 for the first time in 2013

Square peg, round hole

A recurring complaint from cryptocurrency participants is the idea of applying a 72-year-old securities law to digital currencies. The Securities and Exchange Commission uses what’s known as the “Howey Test,” which comes from a 1946 U.S. Supreme Court decision involving a Floridian citrus farmer to determine whether or not a cryptocurrency is a security.

The Supreme Court determined that any transactions that qualify as “investment contracts” are considered securities. According to the SEC, an investment contract exists if “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”

But experts say those standards should be more nuanced for digital assets.

Many of these cryptocurrencies are also blockchain software platforms, meaning you can build on top of them. They are also capable of being traded without an intermediary, making them far different from your average stock on the Nasdaq.

“These decentralized networks don’t fit neatly within the existing regulatory structure,” said Kristin Smith, head of the Blockchain Association, the first group in Washington to lobby for the technology behind bitcoin. “This is a step forward in finding the right way to regulate them.”

SEC Chairman Jay Clayton has made it clear he does not intend to update those standards to cater to crypto. The chairman said at a Senate hearing earlier this year that every initial coin offering he has “seen is a security.” The only two they agency has explicitly said are not securities are bitcoin and ether, which are regulated as commodities by the Commodities Futures Trade Commission.

William Hinman, head of the Division of Corporation Finance at the SEC, said in June that bitcoin and ether are not securities because they are decentralized — meaning there is no central party whose efforts are a key determining factor in the enterprise. Initial coin offerings, or ICOs, he said are securities because of the expectation of a return by a third party.

While the SEC has clarified existing laws and made exemptions, it would take moves by Congress to actually change any statutes the agency is required to follow.

The bill looks to amend the Securities Act of 1933 and the Securities Exchange Act of 1934, which established the current structure for what a security is, by adding a new definition for “digital tokens.”

Smith, who was an aide to former Sen. Olympia J. Snowe, R-Maine, and lobbied blockchain issues for, said this bill does not mean that these digital tokens will go unregulated. If the bill passes, they will instead likely fall under the purview of the Federal Trade Commission or the CFTC.

Thursday’s bill also directs the IRS to adjust taxation of virtual currencies, create a tax exemption for exchanges of one virtual currency for another and to create a de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency.

How did we get here?

The bill was months in the making, and was largely a result of a roundtable hosted by Davidson in September. More than 50 industry participants including experts from Fidelity, Nasdaq, State Street, Andreessen Horowitz and the U.S. Chamber of Commerce gathered on Capitol Hill to discuss regulatory shortcomings.

At the Washington roundtable, advocates claimed that until regulation is crystal clear and updated for the modern digital asset class, the crypto industry can’t flourish or mature. If regulators don’t keep up, founders warned that innovation in these emerging markets will flee overseas.

The group told stories of companies scrambling to interpret whether their ICOs are compliant. Because some have a “utility” use case, founders argued they should be exempt from securities laws, and instead be considered a commodity regulated by the CFTC.

The SEC has cracked down numerous cryptocurrency projects this year. Some ICOs have been proven to be outright frauds, others have been prosecuted for less egregious violations, like not registering with the agency.

The issue has slowly gained some momentum in Congress. Earlier this month, Soto and other members of the House are introduced two bills that could bring more oversight and less opacity to the cryptocurrency industry.

This week’s bill is largely symbolic. Friday is likely the last day Congress is in session and the bill will need to be reintroduced next year, when Democrats are in control of the House.

“It shows that there’s momentum on both sides,” Smith said. “There’s interest among bipartisan members, and lays groundwork for the next Congress.”

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