Hot Takes

ESMA issued their final DLT report but continues to underestimate open networks.

Our previous comment to the European Securities Markets Authority was referenced in the final report; it looks like we were the only commenter sticking up for permissionless blockchain networks:

For many respondents, appropriate governance frameworks will play a key role to ensure trust and provide legal certainty to market participants. Many of them agreed that permissioned-based DLT networks would be the most appropriate for financial markets. One respondent however disagreed that permissioned-based DLT networks were more appropriate. According to this respondent, all permissioned-based systems remain in the proof-of-concept stage of development. In contrast, permissionless systems have been running in public for almost ten years and are battle-tested.

But unfortunately the bulk of the report continues to prematurely identify permissioned systems as the only viable technological architecture for building-out future financial systems:

Importantly, ESMA understands that the DLT that would be used for financial services would differ from the Blockchain designed for Bitcoins in a number of ways. In particular, while the Bitcoin Blockchain is an open system where all can contribute to the validation process (‘permissionless’ system), the DLT that is likely to be used in financial markets would be a permissioned system with authorised participants only. Permissioned DLTs have a number of advantages compared to permissionless systems when it comes to governance issues, scale or the risk of illicit activities, which makes them more suitable for securities markets. Yet, some of the benefits attached to permissionless frameworks, e.g. ‘openness’, may be lost in a permissioned framework. In line with current market initiatives in securities markets, the rest of the report deliberately focuses on permissioned DLT.

As we point out in our recent report, the "benefits attached to permissionless frameworks" (e.g. privacy, security, and interoperability) shouldn't be underestimated. Even in the securities settlement process, "openness" may matter in the end.

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The Human Rights Foundation has published a guide to stablecoins for people living in at-risk economies.

In the latest installment of their multi-part series meant to help those who may need to transact privately in the course of their sensitive work, security expert Eric Wall details compares the properties of several popular stablecoins.

Stablecoins are designed to maintain a peg to an existing currency, usually the dollar. These are similarly experimental yet promising technologies for those who need censorship resistance but prefer to be insulated from the volatility that comes with using something like Bitcoin.

Eric explains why permissionless dollars are interesting:

Most digital dollars exist as entries in central databases, where your access to them as a user is at the mercy of the system owners. To provide you with this service, the system owners will almost always demand that you provide identifying information. Examples of such systems include banks, PayPal, Wechat Pay, Venmo, and Skrill. These operators in turn fall under the regulatory purview of the jurisdictions they operate in. As such, they provide little to no help in regions where usage of the dollar is not permitted or blocked by sanctions.

Stablecoins, by virtue of existing on cryptocurrency ledgers, are — perhaps to some amount of surprise — different. The entire purpose of cryptocurrency ledgers is to be without central system owners. As such, these coins can to varying extent slip through the cracks and into the hands of people who can use them without the blessing of their government. Because cryptocurrency ledgers do not typically embed the notion of people’s real-world identities in them, stablecoins can often be held by completely unknown users.

He goes on to explain the relevant risks and benefits of various stablecoin system designs. You can read the full piece here.

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Save the Date: The 2020 Coin Center Annual Dinner will be on May 11, 2020.

The Blockchain community’s night out is coming back to New York City during Consensus 2020. We hope you will join us once again to rub shoulders with some of the best and brightest in the industry, all while supporting Coin Center’s critical policy advocacy mission.

Monday, May 11, 2020

Reception: 7:00 PM

Dinner: 8:00 PM

Ziegfeld Ballroom

141 W 54th Street, New York, NY 10019

Tickets will be on sale in early 2020. For sponsorship information please contact antonie@coincenter.org.

Check out these photos from last year’s dinner.

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China intends to launch a national digital currency that will let the government easily surveil spending. Following in their footsteps would be a mistake.

A recent New York Times report highlights that Facebook’s Libra project has led Beijing to accelerate its cryptocurrency effort:

A state-issued e-currency would help China’s government know more — much, much more — about how its citizens spend their money, giving it sweeping new powers to fight crime and manage the economy while also raising privacy concerns.

“It’s extraordinary power and visibility into the financial system, more than any central bank has today,” said Martin Chorzempa, a research fellow at the Peterson Institute for International Economics in Washington.

Yet some in the U.S., including members of Congress, have been pointing precisely to China's pursuit of a state digital currency as a reason why the U.S. should consider its own corporate-led or central bank digital currency. As policymakers look at the issue they should make sure not to fall into the trap of undermining American values--like freedom of speech and assembly and rights to privacy and due process--in the haste of competing with China. Such values are absent in China's planned system, according to the Times:

Chinese officials use something of an oxymoron to describe what their new currency will offer: “controllable anonymity.”

“As long as you aren’t committing any crimes and you want to make purchases that you don’t want others to know about, we still want to protect this kind of privacy,” Mr. Mu, the deputy director of the central bank’s payments department, said in another recent online lecture on China’s cryptocurrency plans.

The capacity to perfectly surveil and control transactions on a payments or currency network is possible when intermediaries--whether banks, or companies, or consortia of either--operate a network. Any such American-led effort must forswear that kind of power by making anonymity and censorship-resistance core network features. To do otherwise would be to import authoritarian values out of fear when it is the liberal values enshrined in the U.S. Constitution that are the basis of our global leadership.

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Coin Center has published a new plain English explainer on forks and airdrops to highlight ambiguities in recent IRS guidance.

Last week we published our analysis of the recently released IRS guidance. Our biggest concern with that guidance was that it incorrectly described how forks and airdrops occur, and therefore failed to provide much needed clarity with respect to how these events will be taxed.

Today we published an updated explainer on forks and airdrops to provide policymakers with a plain english description of how these events actually unfold. We hope this material will help to underscore how inappropriate it would be to hold taxpayers liable for forked or airdropped assets that they have taken no affirmative steps to claim and of which they may not even be aware. We are working closely with tax professionals, members of Congress, and other policymakers to ensure that this ambiguity is quickly resolved in a manner that does not leave cryptocurrency users with unreasonable obligations.

Read the explainer here.

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This week’s EOS and Sia settlements with the SEC reinforce Coin Center’s 2016 policy recommendations.

Block.one has settled and is paying a fine for doing a pre-sale of EOS as ERC20 tokens, and Nebulous has settled and is paying a fine for selling Sianotes, a profit share in the returns from their network’s decentralized storage system. In both cases, the cryptocurrency on each project’s running network has not been deemed a security in their respective settlements: EOS (the tokens on the now functional EOS network) is not deemed a security, and Siacoin (the tokens on the now functional Siacoin network) is also not deemed a security in their settlement.

In our Framework for Securities Regulation of Cryptocurrencies we explained why this exact type of outcome strikes an ideal policy balance. Tokens providing some use-value from a decentralized network are not a good fit for securities regulation, while heavily marketed and pre-sold tokens (as in trading before the network is live) are a good fit for securities regulation.

In a 2018 update to our Framework we stressed that two separate inquiries should be performed regarding security classification if a network’s token was presold but later successfully launched and now provides functionality. First, an inquiry about the pre-sale agreement (and any tokens representing it, e.g. EOS’s original ERC20 token) will likely find them to be a security and investors could benefit from appropriate disclosures and controls. Second, a separate inquiry should look at the resultant decentralized token (once distributed) and if the network is powered by open source software and running with an open consensus mechanism the token is not a security, current purchasers have less need for a disclosure regime focused on the original issuer.

This division between pre-sold token and resultant token is sometimes referred to as a transmutation of a security into a non-security or commodity. We don’t like this framing. Nothing, in our opinion, ever transmutes. The agreement for future tokens was (and always will be) a security, and the tokens that get delivered are the fruits of that agreement. The resultant assets are not tainted by their being part of an earlier crowdfund any more than the Floridian land sold in the Howey case is tainted today. Yes the land and the tokens were involved in investment contracts that were rightly regulated as securities, but these assets are not securities when they trade on secondary markets amongst persons who did not participate in the prior investment schemes. With regard to functional and decentralized cryptocurrencies, there is no original sin and there is no transubstantiation.

While some may be vexed by the size of the fines involved, the policy here is sound. We are very gratified that the SEC continues to take a reasonable approach to providing investor protection in this space.

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There is hidden tax guidance between the lines of recent IRS educational letters to cryptocurrency users.

On July 26, the IRS announced it was sending “educational” letters to more than 10,000 taxpayers that the agency suspects “failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.” Commissioner Charles P. Rettig added that taxpayers “should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties.”

This initiative is somewhat surprising. Commissioner Rettig acknowledged in May that the agency has not yet provided taxpayers with “clarity on basic issues related to the taxation of virtual currency transactions," including fundamental questions such as how taxpayers should calculate the tax basis of their cryptocurrencies and how they should assign those bases to cryptocurrency dispositions. Commissioner Rettig has assured Congress and other stakeholders that substantive guidance will be coming “soon,” although there continues to be no mention of it in the agency’s “Priority Guidance Plan,” which lists “guidance items that are most important to taxpayers and tax administration.”

More surprisingly, perhaps, is that the threelettertemplates the agency released seem to contain answers to some of the open questions about the tax treatment of cryptocurrency transactions that it has failed to articulate in guidance. Two key examples:

  1. Notice 2014-21 says that “taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.” We have previously noted that requiring fair market value calculations to be conducted using a daily exchange rate, rather than allowing for more precise methodologies, often doesn’t make sense, particularly for virtual currencies that have significant intraday exchange rate movements. The recently released Letters 6174 and 6174-A, however, instruct taxpayers to “report the virtual currency received at its fair market value, measured in U.S. dollars, as of the date and time of the transaction.” (Emphasis added.)

  2. Section 1031 of the Internal Revenue Code stipulates that no gain or loss need be recognized when certain types of property of “like kind” are exchanged. The Tax Cuts and Jobs Act of 2017 narrowed this exception to only apply to real estate exchanges starting in 2018, but it has been an open question whether or not certain virtual currency transactions that occurred before then would qualify. However, all three of the letters the IRS released—which address tax years 2013 to 2017–state that “an exchange of a virtual currency (such as Bitcoin, Ether, etc.) includes the use of the virtual currency to pay for goods, services, or other property, including another virtual currency such as exchanging Bitcoin for Ether.” The implication is that the IRS does not recognize the “like kind” exemption for cryptocurrencies.

Generally, the letters hint at positive changes in the IRS’ approach to the taxation of virtual currency transactions, albeit changes that should come in the form of formal guidance rather than ominous letters alleging noncompliance.

(For a more in-depth look at what the open questions are as well as suggestions of common-sense clarifying guidance the IRS could provide, please see our report “A Duty to Answer.”)

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Coin Center submitted comments to Her Majesty’s Treasury defending UK citizens’ right to develop and publish open-source software.

As outlined in its consultation paper, “Transposition of the Fifth Money Laundering Directive”, HM Treasury is currently considering broadening the scope of the UK’s anti-money laundering/countering the financing of terrorism (AML/CFT) regulations to impose data collection and reporting requirements on not only cryptocurrency developers, but all open-source software developers and others who facilitate the peer-to-peer exchange of cryptoassets.

In our comment letter, we urge HM Treasury to refrain from such an over-broadening of its AML/CFT regulations. We argue that such an expansion would violate UK citizens’ free speech and privacy rights, as codified in the International Covenant on Civil and Political Rights (ICCPR) and in the European Convention on Human Rights (ECHR). Those arguments, which are more fully laid out in the comment, are briefly summarized below.

Regarding privacy rights, both the ICCPR and the ECHR prohibit intrusions upon the privacy of persons unless those intrusions are made in accordance with law that is sufficiently clear in its terms to give citizens an adequate indication as to the circumstances in which and the conditions on which public authorities are empowered to resort to this secret and potentially dangerous interference with the right to respect for private life and correspondence. The imposition of financial surveillance upon every user of cryptocurrency, regardless of their particular circumstances, would fail to meet this standard and would, therefore, not be in keeping with the ICCPR and the ECHR.

Regarding speech rights, any law or regulation attempting to ban, require licensing for, or compel the altered publication (e.g. backdoors) of open-source cryptocurrency software would be unconstitutional under First Amendment-like protections for speech afforded to UK citizens by the ICCPR and ECHR.

These arguments, and their underlying principles—the right to free speech and to privacy—hew closely to our recent report on how the First and Fourth Amendments to the US Constitution protect open-source software developers and users here in the United States.

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Based in Washington, D.C., Coin Center is the leading non-profit research and advocacy center focused on the public policy issues facing cryptocurrency and decentralized computing technologies like Bitcoin and Ethereum. Our mission is to build a better understanding of these technologies and to promote a regulatory climate that preserves the freedom to innovate using permissionless blockchain technologies.