At 10AM EST on May 31, 2018, Coindesk held a virtual panel called ICOs: the State of Global Regulation. The four panelists were:
Martin Bartlam: Partner with DLA Piper (London)
DLA Piper: www.dlapiper.com
Amy Davine Kim: General Counsel, Chamber of Digital Commerce
CDC: www.digitalchamber.org
Caitlin Long: Co-founder of Wyoming Blockchain Coalition
Blog: www.caitlin-long.com
WBC: http://wyomingblockchain.io
Mark Radcliffe, Partner with DLA Piper (Silicon Valley)
DLA Piper: www.dlapiper.com
After brief introductions, the panels got into the current state of the regulatory climate in the USA and, to a slightly lesser extent (likely because Americans were 75% of the panel) Europe. Some really interesting commentary came out of the discussion, and the following is a relatively high-level overview of some of the key takeaways. One disclaimer: the panel was fairly fast-paced, and while I did my best to faithfully capture an accurate picture of what was said, there will undoubtedly be mistakes in here. This is NOT intended to be legal or financial (or other) advice as any kind, and is best read as an opinion piece on this panel. I will be happy to correct any errors, and those who would like to hear firsthand discussion on any of these topics should view the primary source. The panel is slated to be released on Coindesk’s website within the next few days, and I will be sure to update this with a link when available!
The Regulator’s Dilemma
A big topic of early discussion was why this regulation (or, often, just the threat of regulation) was even an issue. At heart, blockchain technology is about avoiding centralization, and a lot of us were originally attracted to the “Bitcoin Model” specifically because it was able to operate without government intervention. But the panel provided a not-often-talked-about perspective: that of the regulators. The narrative can often swing to extremes like, “the US government is trying to destroy Bitcoin!”, but what’s missing is the idea that regulation doesn’t always have to have destructive intentions. The government is, in a lot of ways, stuck between wanting to promote industry and growth, and regulating/reducing things that most people would agree are bad: money laundering, fraud, etc.
The challenges to the regulators are to somehow protect the retail investor by dealing with the pressing issue of fraud, while not stifling innovation.
While it was not explicitly mentioned in the panel, it’s plausible that this is why the SEC has been so slow to pass down clear regulations. As noted by the panel, guidance seems to be the appropriate level of action thus far. While not as clear-cut as regulations, guidance definitely helps provide clarity, and has several other advantages: it’s faster to push out to the public, it’s more readily updated or amended when circumstances warrant, and it avoids coming down hard and fast on a nascent industry. In some ways, this slower approach is, while currently frustrating, better in the long run. It will lead to more nuanced regulations if and when they get formally codified.
Adding to this are the additional challenges of regulators often not knowing where they themselves stand. For example, much was made of the FinCEN letter regarding money transmission. This panel provided an alternative viewpoint, in which FinCEN was simply stating what the law is, and reminding the country where their jurisdiction starts and ends. Ultimately, this is important to keep in mind: ICOs may be engaged in money transmission under traditional rules. The determination will likely be on a case-by-case basis.
How, then, will this clarity arrive? All seemed in agreement that the most likely method would be through the SEC, or through litigation. The SEC could offer clarity in two ways: they could offer affirmative guidance or even regulation, or individual project can push for themselves to a certain extent through ‘no-action letters’. These no-action letters are interesting—the SEC essentially reads a letter describing the facts of your use case, and returns a decision. The hope is to get a favorable decision, but this may be unlikely in the current climate. Another issue may be one of scalability: this is a one-off decision, and if regulation never materializes, how many letters can the SEC deal with? In any event, these letters provide further guidance.
As a last note, one of the best ways to work towards clarity would be to team up with a larger group… good choices include the Chamber of Digital Commerce, or the Wyoming Blockchain Coalition!
Looking Forward
At the end of the day, we all want to know when this regulation might be handed down, and where it might come from. However, when dealing with such a novel, global technology, there aren’t always clean answers. The panelists all agreed that one of the major sticking points for digestible regulations are the multiple sovereign jurisdictions at play. They specifically pointed to the range of actions taken by various countries to further highlight how far we may be from global regulation: we’ve seen China talking about outright bans, while countries such as Gibraltar and Switzerland have been more friendly.
This country-by-country approach makes things quite sticky — if tokens aren’t geographically limited, how can the rules governing them be?
One solution, which is currently being explored, is for a globally recognized body to set out umbrella guidance (as opposed to umbrella regulation). This would give a standard for individual regulatory bodies, and perhaps pull the extremes closer to the mean. Each country would ultimately have autonomy, but this guidance would act as a universal baseline.
The United States in particular poses a unique challenge in that we have a federal government, and then independent states that are capable of creating their own legislation. One of the most striking examples of this is Wyoming, and Caitlin Long was able to speak at length about HB70. Wyoming House Bill 70 was the first bill that recognized “utility tokens” under a law voted on by elected officials, essentially carving out “safe havens” for certain classes of blockchain tokens. HB70 essentially takes what we typically think of as “utility tokens” and classifies them as property (rather than securities), effectively creating a new class of property to do so. There are certain requirements that need to be met (for example, you need to register with the Secretary of State, can’t market them as financial instruments, etc), but the path to registration is clear and reasonable. But federal law is still a big hurdle. Many of the tokens carved out under Wyoming law could be classified as securities by the SEC (for example), and what happens when these bodies conflict is not clear. Long is optimist, suggesting that the ‘property’ classification removes any federal jurisdiction (property has historically been the domain of the states).
In Europe, a similar approach may work. But, as Martin points out, a lot still needs to be developed. Europe is not immune to the jurisdictional issues facing the U.S., and there are still worldwide points of friction that need to be smoothed out before any kind of meaningful regulation can be handed down.
Raising Capital
Regulatory ambiguity has been troubling for many projects, especially in terms of raising capital. Mark suggested that, despite all the hype about ICOs and grassroots fundraising, the lack of clarity is pushing most projects back into seeking and getting funding from more traditional sources. One option that he thinks may be making a return is the Simple Agreement for Future Tokens (SAFT), which is, essentially, somewhat of a mix in that it’s an ICO round run by venture capitalists. He points to Telegram is a potential reason for the shifting funding model, rightfully noting that people are going to want to emulate the businesses that they see raising the most capital.
But Amy was quick to remind the panel that, bad press and changing models notwithstanding, ICOs are a real market. As evidence, she cites a recent paper by Boston College scholars in which ICO investments were examined in-depth. Ultimately, the average ICO investor sees returns of around 82%. This is pretty amazing, and does a lot to change the narrative. We think of ICOs as rife with fraud, but this just isn’t the case.
Most ICOs are a positive funding model, and it may be better to adjust our thinking to more accurately frame things as if frauds are in the minority.
This is a real industry despite the presence of fraud. True, there are millions of dollars in scam ICOs every year, but there are charlatans in every sector. The small proportion of scam ICOs shouldn’t cause us to throw the baby out with the bathwater — something the SEC almost did when they stated (various iterations of) “we’ve never seen a token that’s not a security” (a position they’ve, thankfully, walked back).
Utility Tokens vs. Security Tokens
This brings up one of the enduring questions in blockchain: where is the line between a utility token and a security token? Martin believes that this is the heart of the issue. This technology, especially in the form of utility tokens, has such huge potential to catalyze a seismic shift our world economy, bringing about huge gains in efficiency, wealth distribution, and truly opening up the free markets. Confusing these utility tokens with security tokens will be, in his eyes, quite damaging — not least of all because it undermines a lot of what the creators are trying to achieve. However, there are some concessions that need to be made. One is to recognize that regulation (especially in its current state) is not intended to be anti-token or anti-ICO, but rather to ensure that people understand the application of existing laws to things like tokens.
Another is that, just like not all tokens are security tokens, not all tokens are true utility tokens.
And to distinguish between the two, Martin proposes that a simple common-sense test is, in most (if not all) cases, incredibly accurate. To illustrate this, he starts with the premise that tokens used to raise money in order to build a business should probably be classified as security tokens, and uses a cinema as an example. If your business model is to tokenize cinema tickets, and you sell them at the same price as a paper ticket to people who will use them to watch movies, this is clearly a utility token. If, on the other hand, you (pre-)sell a bunch of cinema-ticket tokens in order to raise money to build the cinema, and you sell primarily to people who won’t use them to gain access to the movies, but instead are mostly interested in the building development angle and will likely sell the tokens for a profit later…. This is probably a security. When put this way, the commonsense approach is actually pretty useful. Eventually, he says, we will want something more like a universal taxonomy or language to talk about these tokens. He’s working with a group to do just that, and suspects that this will help regulators frame the issues at hand with greater precision.
Questions? Please feel free to reach out!
-VEVA
t.me/vevaone