I think most of my thoughts are eloquently summed up in the antithesis of Chairman Clayton's closing gaffe found in his written testimony:
" Being faithful to each part of our mission not in isolation, but collectively, has served us well. Said simply, we should embrace the pursuit of technological advancement, as well as new and innovative techniques for capital raising, but not at the expense of the principles undermining our well-founded and proven approach to protecting investors and markets."
Yes, Chairman Clayton, clearly your principles are taking steps to destroy well-founded and proven approaches to protecting investors and markets. Whatever the intent, they're functionally forcing legitimate businesses to flee the US and any protection you can provide investors for foreign shores with almost no investor protections. That, in large part, is why crypto has been so popular with political dissidents. I suggest you not embrace your principles so zealously in changing times.
However conveniently stated, clearly this was not the intent of his remark. The testimonies of Clayton and Giancarlo read like an Oliver Twist bit. "Please sirs, may I have some more." The tone is remarkably pointless ultimately. I think everyone in the Virtual Currency industry and outside of it agree that something has to be done, the question should be specifically what. It is to you, sirs, that this responsibility falls. And moreover, I think it should fall to you.
Chairman Giancarlo's testimony paints a fairly accurate picture. I hope you take his statements to heart, largely, in describing the general landscape of the moment we're in. So called Virtual Currencies are in their infancy. The total "market cap" of all virtual currencies is paltry in comparison to even a single large company on the US Stock exchange. Adoption really hasn't even started yet. And it's true that the press, as ever, is blowing Virtual Currency market influence way out of proportion.
He's also right to point out that there is promising and real efficiency that these systems create over their more traditional counterparts. In fact, the much of this efficiency comes from the ability to provide strict community governance that cannot be corrupted. This particular feature is the feature your guidance is so desperately needed on.
The tone from the US Federal Government has set the tone for lawmaking around the world for more than a century now. Please don't hesitate to use that mandate wisely, as there are those who seek to usurp it. In the case of Virtual Currencies this is in the form of enabling innovation. If the US doesn't invite healthy Virtual Currency start-ups to its shores they have, and will continue to move outside of US jurisdiction and any positive effect the CFTC or SEC oversight could have had will become viewed, instead, as heavy handed draconian legislation. The choices you make regarding this issue will decide if Virtual Currencies become lawless actors outside of US jurisdiction, or key parts of industries leading the world from US shores. That's the gravity of the issue. Virtual Currencies are poised to disrupt everything from Youtube, (http://d.tube) to Shipping (Shipchain and many others), to financial markets (bitshares and the obvious currency markets), real estate, produce markets, commodity markets, the exchange of goods, and even notary, contract, and law. I'm sure I've missed a good deal but I hope you realize the brush is broad.
From this perspective you can see that Virtual Currencies have a bit of a name problem. There's not anything quite like them which is why, in law they become unwieldy. They are not quite like other organizations so calling them Virtual Currencies is over-simplistic as a definition. Virtual Currencies are hard to define with terms that precede them. They can be seen as tokens (think car wash), as stock, as real estate, as currency, or even as companies. The reality is that the token, or coin, or ticker is just a tiny part of a "Virtual Currency". To be sure Chairman Clayton's three "categories" are called overly simplistic, because, they are. Particularly, his naive and seemingly uneducated perspective on ICOs and Virtual Currencies. Trying to cram all ICOs under the moniker of a security offering is like trying to call a bake sale or a kickstarter a stock offering. Not only is he grossly oversimplifying the discussion, he's doing actual harm to any Virtual Currency or blockchain industry that might exist in the US with this forced analogy. Let me remind you this is demonstrably true now. He's actively screwing things up by saying things like this.
Virtual currency systems generally act like autonomous companies. There are rules to participate, actions that promote the system or "company" are given incentives. Actions that negatively affect the company are discouraged or their risks are mitigated. The incentive/disincentive system often takes the form of a token exchange. Tokens then are both exchanged for use of a service, and rendered as payment to those that help enable the service. And, at the core of it, yes,
often speculated. In many ways it's like working for a company that pays in the form of a token instead of dollars.
Imagine you work for a car wash that pays you to clean up and maintain the car wash in exchange for tokens to use that very same car wash. The caveat is that you are allowed to sell these tokens for whatever you wish to people wanting to use the car wash. If the car wash is packed with dirty cars you might demand more for the tokens you sell than you would on a day of little to no business. That being the case people may stock up on car wash tokens on slow days so they can make use of the car wash on busy days for less.
In this analogy the ICO might be a community fundraiser to fund the building of the car wash, where, you are given tokens in exchange for your contribution to the car wash. You have no ownership of the car wash. You have no right to additional tokens as payment unless you do some work for the car wash. You may sell your tokens for whatever you wish but there's no profit expected directly from it. All the token will ever be good for is the wash of a single car. If someone else values that car wash more than you then that's their decision.
To elaborate a bit more perhaps there is a committee voted in by those contributors to the fundraiser who's job is to address complaints about the car wash, fund and render repairs, and hire the maintenance man (you). These committee members would be paid in tokens for their service to the car wash.
And to add the quantum leap. Nothing of value other than washing cars can be obtained from this carwash. No one, single person or group, owns the car wash thus it cannot be sold or bought only built. If this version is corrupted somehow by a fraudster committee or a maintenance man who slacks off then a new one can be rebuilt with very little effort. Tokens can only be issued as payment by the car wash machine itself using mechanisms created during its construction and they can't be used in any other way except as a store of value for the washing of a single car.
Although this is at risk of oversimplification it's still yards better than Chairman Clayton's explanation. As outlandish and wild as this may appear this is what's happening. Not what will happen, what's happening with or without your approval. The question to you is, do you want this kind of activity to be nurtured safely on US shores or forced to go abroad well out of your control?
ICOs have evolved as a way to fund the development of these systems. They're simply pre-payment in exchange for a piece of software that, in and of itself, has no inherit value.
If this letter gains any traction whatsoever I'll elaborate, but suffice to say that any of these "coins" or "tokens" actually operate as incentives to a greater automatic system. You'll hear variations of this idea described as DAC (decentralized automated companies) or "smart contracts" or blockchain platforms. It's my understanding that your staff was debriefed by Jerry Brito from coincenter.org. I have faith that any detailed questions on the matter can be directed his way for an appropriate response. The point is sticking to a currency narrative that the term "virtual currencies" invites is misleading. Before you make strong opinions we need to agree on what we're actually talking about, so please research on your own outside of the CFTC and SEC. The CFTC and SEC for their parts are acting as any enforcement agency should I suppose, they're seeking to prevent scams ultimately. The trouble is that some of what they're doing is shooing away the seeds of innovation. Blockchain companies and business models are so frightened of uncertain regulation that they'd rather attempt to start up in the Cayman Islands or Puerto Rico than risk starting here.
This is not the America I was born into. We oughtn't be plowing up the garden for weeds before the seeds have taken.
The SEC is a case in point and the problem comes down to clarity. Of the top ICOs and fundrasing campaigns, and among the top 20 cryptocurrencies fully 1/4 to as much as 1/2 of them have been concerned enough by an overly broad and unclear reach from the SEC to move their headquarters out of US jurisdiction and/or to fully exclude Americans from investing in their products. Not just some Americans, all of us! Ironically, these seem to be the projects often least associated with scams and therefore most likely to succeed. They do this because there is no certainty on how their product will be regulated by the US Government and currently the SEC's statements (or lack thereof) have been fueling legal speculation that's driving innovation away from our shores. With respect to Chairman Clayton, it doesn't matter how clear he thinks the regulations are, the industry being birthed into existence is fleeing America like a beaten refugee. It's hard to overstate how antagonistic the US government is viewed in this revolution. From the Virtual Currency side, and especially the perspective of legitimate and savy Virtual Currency innovators, the US is looked at like an enemy.
Although, I'll agree that so far the actions against scams by the SEC are laudable, again I point to the lack of certainty as the core issue. The fact is that it's not ironic that they're concerned about enforcement over international boundaries because by all accounts it certainly seems like they're all but chasing legitimate business out of the country. Since 1946 the Howey test has been the general standard for deciding what a security is. As a reminder the basic tenants are as follows:
1.) It must be an investment of money.
2.) The money must be held in a common enterprise.
3.) There must be an expectation of profit.
4.) The profits must come solely from the efforts of others.
The problem is that many virtual currencies don't cleanly fall into or out of any of these categories. Lets review Bitshares recently rated by Weiss as a B- investment:
1.) It's an exchange platform so certainly there is investor money involved.
2.) Bitshares has a token, BTS, so all money is held in a common "enterprise" of sorts in the form of this token.
3.) Profits are hoped for, you could argue this either way. But certainly no one is expecting losses.
4.) This can also be true for a common investor. Someone having no interest in taking part in Bitshares would ride completely on the work of others.
At the same time:
1.) What about the users of the Bitshares service? For them buying BTS is just a means to trade one thing for something else. They use Bitshares as a service. From their perspective the BTS token is no more a security than a penny.
2.) The money is held in a common ledger but no one entity has control over it. No single or even very large group of people have control of the money in Bitshares at any given time. At least no more than shoppers in a supermarket. Metaphorically, in the case of Virtual Currencies often the "supermarket" is simply run by robots. The only human workers are those that are absolutely necessary and even they have tepid involvement.
3.) Again, some participants in the ICO of Bitshares surely just wanted to use their tokens in exchange for the service of safely exchanging one thing of value for another. From this perspective they cared little about the profitability of holding BTS. It is a means of paying for safe exchange of value.
4.) At the same time that others are just taking profits, there are still block producers, witnesses, committee members, programmers and community projects, and they all earn the same token but for specific work they do. From their perspective BTS is payment.
This is just a single example. Briefly, I roundly disagree with Chairman Clayton in that our 80 year precedent of security law can be implemented with few hitches. This is a different animal and if you can't see that you haven't been paying attention. Moreover, and again, doing that is pushing a burgeoning, potentially revolutionizing industry cleanly out of our country. I can't say this enough. The SEC is running businesses (potentially revolutionary businesses) out of the US. The hope of blockchain havens is increasingly resting in the hands of, to use the president's vernacular, "shithole" countries like Venezuela, which recently started its own Oil Blockchain.
Please ask yourself if this is the way it ought to be.
The SEC seems to also fall, as Senator Brown mentioned, into a category of being lackadaisical about Wall Street regulation. "Repeat offenders" indeed, Senator Brown. I doubt you need to be reminded, but the entire Cryptocurrency industry was spawned from frustration and disillusionment with the banking industry following the 2008 Wall Street scandals. Do not forget the original motivation that brings this situation to your doorstep. Many Americans, but especially early Virtual Currency adopters see government regulators as colluding with the Big Banks and Wall Street. If you want to show the people you're on their side here's your chance. There is a general sentiment in the Virtual Currency industry that the SEC, CFTC, and traditional legislation will (if it hasn't already) be used as a weapon by companies wishing to hold sway in a market that will be disrupted by these technologies. The fear is too tempting to ignore as current rhetoric seems to imply that's exactly what's happening. I see no way to quell that fear without actually addressing the Virtual Currency industry innovators and leaders in America rather than institutions of law that, by definition, have close and intimate contact with traditional Wall Street business.
My strongest criticism of the hearing is one that seems echoed by you both. Great, so there's work to be done. But what are your suggestions?
Chairman Clayton and Chairman Giancarlo may have to go back to the drawing board but I have a few suggestions.
First and foremost, regulation second. You can't do anything useful until you know what really needs to be done. Right now the SEC and CFTC are rightfully worried about consumers but their story is only a small part. If you accept only their testimony as to what laws and regulations they see fit to implement, you're cutting corners on the bigger issues and we Americans will suffer for it.
Instead, invite a collection of industry leaders to Washington to help you work out the details. The EEA (Enterprise Ethereum Alliance), BITA (Blockchain in the transport alliance), Blockchain Alliance, CoinCenter, and many others already exist to educate and collaborate within their industries and with Washington. Ask them to do a little brainstorming for America. Figure out what would encourage them to use their solutions here in the US safely. Push them to sell you on what would be best for the average American citizen so that as many Americans as possible can take advantage of their solutions and benefit from them.
Just meeting with these leaders would have a profound impact on virtual currencies in general. Legitimizing some claims to realistic new business, and, more importantly, encouraging that new business to come here by virtue of the fact that our national leaders are willing to discuss fair law with them.
Once you've gathered information from that then involve the SEC and CFTC and ask them to poke holes in your ideas.
Overall I'd like to close with a few bits of guidance I hope will be taken to heart.
- Virtual Currencies are never currencies, securities, tokens, futures, or derivatives in whole. Most of the time they're a little part of each and sometimes none of those things.
- The efficiency of these systems can be quickly mitigated by overly litigious process. Lengthy form filing, superfluous audits, extensive and multifaceted licensing. Whatever decisions are made they must be relatively easy for a collection of people to follow or you'll be effectively excluding whole business models from the country. This is always a worst case scenario because then the (presumably) desirable business model will exist, but only outside of US Jurisdiction. This is usually the layman's hallmark of a scam. Forcing legitimate business to only exist outside the US not only excludes positive actors but muddies the water for determining which systems are ultimately unsafe. Any participants will have to deliberately forego US law to take part and this is in no one's best interest.
- When in doubt wait and see is an appropriate measure to take. South Korea shows a good example. They realize they can prevent money laundering and a whole host of scams by just associating a person with an account. At the same time they don't outright ban anything. Bad actors can be understood this way because they can be tracked, after they're studied, effective law can be rendered to deal with them.
- Consider having banking, securities, and commodity agencies research and promote certain systems and contract code as safe from fraud. Like a USDA grade on produce certifications like this could act as additional incentive for legitimate businesses to seek US licensing while, at the same time, conveying and reporting useful indicators to potential investors concerning the use of any particular Virtual Currency as a vehicle of fraud. Examples might include consensus mechanisms known to have anti-fraud capability, incentive systems and disincentive systems that promote the use of the Virtual Currency legitimately, systems that protect investors from price manipulation, and so on.
In conclusion, although I intend to reprint and send these concerns to you both by mail I have very little hope that anyone meaningful will read them, understand them, or use them. If only for the sheer volume of correspondence you must receive daily. I've taken considerable time and effort to try to express my thoughts in a meaningful way so I hope if they find their target they're considered carefully in tune with the time it took to compile them.
Any return comment, even trivial will be dutifully cited and reposted here and elsewhere so I can show the people in my community that their senators are paying attention.
I hope your judgments on this matter are just and that any resulting legislation invokes the best principles of the American spirit.
Sincerely,
A Fellow American.