Van Valkenburgh’s opening 5 minute statement is an excellent summary. I highly suggest that readers listen to it.
I will make one quibble with Valkenburgh’s opening statement and please feel free to pass a link to this comment along to him. He seems to insinuate that once a token is issued, then it’s no longer a future promise and thus no longer a security. That is not correct. If the common enterprise that is responsible for that token’s future value is not significantly decentralized, then the token owner is dependent on those humans in the common enterprise and thus those humans are securing the future value and thus the tokens are securities. You will note at the time in the video provided by your link, the Congressman made essentially the same rebuttal to him. Also his notion that the SAFT tokens aren’t securities has been debunked as an obfuscation that doesn’t side-step Howey, c.f. §Utility tokens are securities if issued bound to an investment contract in this blog above. Attorney Robert Rosenblum explains (c.f. also) that at this hearing.
Tokens become commodities when the free market is primarily in control of the future value as explained in IS BITCOIN A SECURITY? by Jeffery E. Alberts & Bertrand Fry on page 20:
If the expectation of economic return from an instrument is based solely on market forces, and not on the efforts of the sponsor, then the instrument does not satisfy this prong of the Howey test. (Noa v. Key Futures, Inc., 638 F.2d. 77 (9th Cir. 1980).)
The only other way for a token to not be a security is if the token owner is significantly in control of the common enterprise so that he/she is not relying on the efforts of others for securing the value of his tokens. This is why for example that that issuing shares to directors and officers of a corporation are usually exempt from securities registration requirements. Yet those shares can’t be transferred to others without registering them, unless those others are also directors or officers.
Lempres from Coinbase stated that the CFTC had declared that BTC, ETH, and LTC are not securities. He also references the SEC’s DAO report which refers to ETH as a cryptocurrency (and by implication not a security). Note Israel has recently declared that Bitcoin and cryptocurrencies like it are not securities. Lempres also admitted that Coinbase has appointed itself as a judge and jury w.r.t. to morality and they scan the blockchain to violate privacy on such matters! Whoa!
At the 1:06 mark in the hearing, one Congresswoman is advocating adding even more stringent tests of what is a security than what is already in the Howey test! However Congressman Tom Emmer argued against this. And Valkenburgh clarified that SEC Chair Clayton didn’t ask for regulation of “pure cryptocurrencies” which aren’t securities. Chris Blummer opinines that even pure cryptocurrencies may need regulations requiring more disclosure!
Congressman Bill Foster is proposing using the force of law to by implication essentially blacklisting any tokens which will not release their owner’s identity. So the tokens essentially become illegal in any nation which doesn’t give the U.S.A. the middle finger.
Congressman David Scott stated that SEC Chair Clayton told him that even digital wallets trading tokens which are securities are subject to broker dealer registration requirements! Coinomi developers are you paying attention?
One of key questions raised at the hearing is what can be done with decentralized ledgers that can’t be done with fiat currencies. Unfortunately nobody articulated the key distinction which is the combination of:
The record and acceptance of transactions on a decentralized ledger can’t controlled nor made opaque by anyone.
A fiat currency can’t be recorded on a decentralized ledger. I had gone into great technical detail in some of my past writings about why value can be tracked by pegging. All pegs eventually fail.
So if the thing in the ledger is a security, then bitcoin does not change that. It operates like any other financial ledger, but without needing a trusted authority to maintain the ledger.
Agreed. The ledger though can enable protocol driven organization which enables us to issue shares which can be proven to not be securities because their owners are actively acting as directors and officers of the entity by participating in all decisions of the entity such as by recording votes on the ledgers.
So you agree that a ledger can only contain tokens which are securities, and then you say that a protocol on the ledger enables you to issue shares which can be proven not to be securities... I find that a contradiction as per the definition of security (which applies specially to shares)
I never stated that all ledger tokens are securities. I stated that a utility token is a unicorn, meaning I have not seen one yet that was not a security. But tokens issued by proof-of-work are not securities because by definition the invested funds are not transferred to the issuer.
What makes a security by USA law as codified in the Howey test, is that the owner of the security is dependent on the issuer for securing the future profit. If instead the owner of the shares is actively managing the corporation, he is not relying on the issuer for his future profit, thus the shares are not a security. Yet as I said, if they are transferred to someone who is not actively managing, then they become securities.
In short, securitization means someone other than the investor or the free market, insuring the outcome of the investment.
I sent an email to the Chair of the hearing:
Palmer Rafferty,
Hello sir, I spoke with you briefly on the phone today and you suggested I may email my concise comments to you. I presume you'll decide if any of these comments merit the attention of the Honorable Congressman Bill Huizenga who I understand to be the Chair on the House subcommittee on securities and investments. I'm sure you all are quite busy so I will try to make my comments concise. If you require any follow-ups please feel free to email me a request. I am a U.S. citizen.
My comments are motivated by the recent hearing discussing regulation of distributed ledger tokens aka virtual currencies, cryptocurrencies, and in some cases ICOs:
https://www.c-span.org/video/?442556-1/hearing-focuses-cryptocurrency-markets
Rep. Huizenga stated to a reporter at the end of the hearing that one of the key questions which the committee is not yet clear about is whether distributed ledgers in general and crypto tokens specifically have any use case that can't be provided by existing paradigms such as fiat currency and virtual payment services such as Apple Pay.
The key point that was not made at that hearing is that unlike centralized databases which power Apple Pay and Paypal, in theory a decentralized ledger can't be controlled by any party, i.e. it is transparent, objective, and tamper-proof. By definition a fiat currency can't be put on a decentralized ledger otherwise it would not longer be a fiat. Via math and game theory it can be shown that tokenized pegs (proxies) on a ledger representing the value of a fiat currency (e.g. BitUSD) must eventually fail. The transparency, objectivity, and tamper-proof attributes of a distributed ledger can't be obtained with centralized databases. Those attributes are crucial for empowering a more level playing field for just about everything that humanity does. But without a token to pay for the transaction fees, then distributed ledgers can't function. So that is the succinct answer he needs.
Please make a distinction between decentralized and distributed ledgers. Decentralization means in theory no group has sufficient 50% control to take control of the ledger. The 50% safety threshold is a property of Byzantine Fault Tolerance in the permissionless context. In a permissioned context the safety threshold increases to ~67% (exactly ⅔) and the liveness threshold deteriorates from 0% to 33%. Distributed means the nodes are spread out but it doesn't mean the ledger is not controlled by a centralized party. This rabbit hole goes quite deep and a very interesting discussion can be had about the fact that no one has design a decentralized ledger yet. The technical details are beyond what I can summarize concisely here. So if Bitcoin is really centralized but who controls it is obfuscated, what does that tell you about who might have invented it considering that Bitcoin subjugates all the nations' jurisdictions to a global jurisdiction which does not yet exist.
Not all distributed ledgers are block chains. For example, some are based on other technologies such as directed acyclic graphs aka DAGs.
Those who argue that the investment contract can be separated from the issued tokens via for example a SAFT, are incorrect. A report issued by the Cardozo Law School in New York explains that SAFTs essentially subvert the substance of the definition of the investment contract security type, because the jurisprudence of a SAFT asserts that—a bright-line rule requiring presence of utility such as consumptive use, combined with irrelevant timing—supersedes or subsumes the economic reality of a securitized investment. I wrote a document which more fully summarizes this which can be provided if you ask for it.
Sincerely,
Shelby H. Moore III
https://www.linkedin.com/in/shelby-moore-iii-b31488b0/
After writing that I realized a decentralized ledger could have a protocol which enabled a fiat controller to sign for certain actions such as the increase in the money supply. So I guess it is theoretically possible that a fiat currency could be hosted on a decentralized ledger in the future. But that still wouldn't invalidate my point that decentralized ledgers offer the unique attributes of objectivity, transparency, and tamper-proof which aren't guaranteed with centralized ledgers. And my point that the fiat token would have to exist on the decentralized ledger, because pegs are not viable.
RE: A Utility Token is a Unicorn