Hot Takes

Good news: Ethereum’s CryptoKitties are probably not securities.

Ethereum just got overrun with cats; the cats are literally slowing down the network with their feline machinations, their idiosyncratic personalities, and yes, their breeding… lots of cat breeding… on Ethereum. The cats are called CryptoKitties. Just like bitcoins or ether, CryptoKitties are peer-to-peer tradeable, provably scarce digital items that are accounted for by an open blockchain network. Unlike those cryptocurrencies, each item (each kitty) is unique with its own set of attributes: striped, droopy-eyed, slow (yes, slow is one), and many more.

Rather like some of the ICOs you might have read about, there is a company that is selling some of these digital items and financing its operation from those sales. From their FAQ:

The CryptoKitties team releases a new “Gen 0” CryptoKitty every fifteen minutes (up until November 2018). The starting price of “Gen 0” CryptoKitties is determined by the average price of the last five CryptoKitties that were sold, plus 50%.

There are complicated and controversial legal arguments about why some ICOs might be unregistered securities issuance while other might not be. The SEC has yet to offer a bright line test but has identified a few specific projects as securities and indicated that it looks to the flexible test for an “investment contract,” the so-called Howey Test, in order to determine whether any particular token sale is securities issuance. Our framework for securities regulation of cryptocurrencies has outlined the nuts and bolts of that standard and advocated for an innovation friendly approach since 2015.

CryptoKitties look less like securities under that flexible test for a few reasons. One important prong of the test is whether buyers are relying on the managerial efforts of others for profits. First of all, CryptoKitties aren’t marketed as profit-making investments, and ownership of a Cryptokitty doesn’t give you a right to dividends or revenue streams from the Cryptokitty team or anyone else for that matter. Sure people might hope that they can flip a kitty for a profit but people feel that way about other non-securities like real estate, gold, or (appropriately) beanie babies. And sure you can breed two kitties to get more cats which you could of course sell, but that alone certainly doesn’t make them securities any more than real life purebred pets.

This is starting to sound a bit like an actual case about securities law and real life animals, the case was SEC vs. Weaver Beaver (yes, that’s the actual name). Here’s Bob Davenport, a regional director of the SEC back in the 1970s:

The beaver case was a case called SEC versus Weaver’s Beaver Association. One defendant appealed to the U.S. Supreme Court, which denied cert. A fellow in the Salt Lake area started a company called Weaver’s Beaver Association. They sold pairs of beaver, all over the United States and in foreign countries. These were purportedly domesticated beaver. You would buy a pair of beaver for several thousand dollars, and these beaver would have little beavers, called kits. Then these little kits would grow up, and they’d have more kits. And you would end up with this large herd of beaver. The beaver were to be sold to other purchasers. They had a marketing arm, where they would sell your pairs of beaver. There was going to be a tremendous demand for beaver pelts in coats, beaver hats, and everything—it’s coming back. So they sold millions and millions of dollars of these beaver. The salesmen represented that you could take possession of your beaver, and you can raise them in your own backyard, but if you don’t have the capabilities, we have beaver ranches all through the West—Montana, Wyoming, et cetera.

It didn’t end well:

We’ll take care of your beaver for you for a hundred and fifty or a hundred seventy-five dollars per beaver per year, until you can sell it. Nobody could take care of beaver; you can’t put it in your bathtub. The purchasers would have to leave the beaver on the ranches. What happened was that all these beaver and their kits that was being sold to people could not be re-sold, because the Association was too busy selling their own beaver to take time to sell your beaver.

So these people ended up with a large number of beaver, and they’re paying all these ranching fees. It was just a disaster. They really weren’t selling domesticated beaver; instead they were flying the beaver down from Canada and purchasing them from trappers in Canada at approximately twenty dollars a beaver. They’d fly them into Salt Lake, put tattoos in their back foot, in the web, and start selling them. They’d sell them for three thousand a pair and up.

The SEC came after Weaver Beaver because it was clear that the economic reality of the scheme wasn’t just beaver sales! Weaver was selling shares of a “profitable” beaver farm. You weren’t buying a beaver to take it home with you; you were buying it to get rich, and you relied on Weaver to take care of your beavers, breed them, sell the kits and give you the profits. Nobody actually took delivery of their beaver (you are shocked, I know).

So why are CryptoKitties different? Because you can and do actually take delivery of your CryptoKitty. You don’t have to keep them in your bathtub, you just connect to the open Ethereum network and check up on the blockchain to find your cats. You don’t have to rely on the CryptoKitty team to take care of your cats or breed them for you, the cats don’t eat and “breeding” is just an ethereum transaction that you (and only you) can make by using any free and compatible Ethereum software client and by signing the transaction with your Ethereum private keys. And you don’t rely on the CryptoKitty team to find buyers for your cats, or buy them back from you, all sales are peer-to-peer and any ethereum user in the world can find you and offer to buy your little bundles of kitty joy (or breed with it!). Also there’s no sad beaver relocation, caging, and tattooing, just happy little bits of digital fur ball coursing over the world’s increasingly renowned global computer, Ethereum. That last one isn’t part of the Howie Test but it makes me happy to live in the future we got.

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Keeping track of the cryptocurrency bills in Congress.

As part of our work to keep cryptocurrency networks open, decentralized, and permissionless, Coin Center tracks the introduction and current status of federal legislation that mentions, or relates to, cryptocurrencies. During the first months of the 116th Congress, we have identified 11 such bills as having been introduced in either the House of Representatives or the Senate.

As a resource to those interested in public policy and the regulation of cryptocurrencies, we have decided to make our “Crypto Bills Tracker” publicly available. We will be periodically updating it as bills are introduced and move through the legislative process, and hope it will serve as a useful resource for the cryptocurrency community.

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Coin Center files comment in CFTC proceeding on Ethereum

A few months ago LabCFTC, the division of the agency dealing with innovative financial products, put out a request for information to better understand the Ethereum network and ecosystem that has developed around it. We have submitted a formal comment explaining what Ethereum is and how it works relative to other public blockchain networks like Bitcoin. Issues covered include smart contracts, consensus mechanisms (current and planned), governance, etc.

You can read the full comment here.

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We demonstrated the Bitcoin Lightning Network in Congress.

Earlier today, Coin Center hosted a briefing in Congress in conjunction with the Congressional Blockchain Caucus. We covered the basics of cryptocurrency, why it’s exciting, and went through some the policy issues the technology raises, including questions of scaling, privacy, consumer protection, and tax.

One of the things made uniquely possible by cryptocurrency is microtransactions--tiny transactions without a middleman. To visualize this concept, we used a lightning enabled candy dispenser. We were able to show the process of sending tiny amounts of bitcoin from our phones to the vending machine and watch it dispense candy in real time. The network fees were 1 satoshi per transaction.

Real time demonstrations like these are always better than simply describing a process. We are grateful to Swiss developer David Knezić for generously donating the dispenser to Coin Center.

The well-attended briefing was the first of many that the Congressional Blockchain Caucus plans to hold in 2019. We are excited to continue helping them and their colleagues better understand and appreciate this technology.

Here are the slides from our presentation:

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New York is creating a cryptocurrency task force. We encourage them to reevaluate the BitLicense as part of their work.

As any cryptocurrency entrepreneur will tell you, getting a BitLicense is difficult and costly. Not only that, but as written the regulation has grey areas relating to custody, requires state approval before a company can add new products or services, and very few licenses have been issued.

The result of this is that many cryptocurrency businesses are choosing to simply forgo doing business with customers in New York.

We are glad to see the New York legislature taking the step of creating a task force to better evaluate the cryptocurrency landscape and its own regulatory stance toward the technology, which is well overdue. As Assemblyman Clyde Vanel noted, “It has been nearly four years since the implementation of the BitLicense. In the cryptocurrency space and technology in general, a few months is equivalent to years.”

We look forward engaging with the task force on this important mission.

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A bill that would clarify securities law for tokens and improve the tax treatment of cryptocurrencies was just introduced in Congress.

Today, Reps. Warren Davidson and Darren Soto introduced the Token Taxonomy Act, which includes several common-sense changes to federal law.

First, the bill would amend the definition of “security” in the Securities Act of 1933 and the Securities Exchange Act of 1934 to exclude decentralized cryptocurrencies such as Bitcoin, thereby making clear that such cryptocurrencies are not subject to the rules and regulations of the U.S. Securities and Exchange Commission. We have longargued that classifying decentralized cryptocurrencies as securities would be both impractical and harmful to innovation, a view that the SEC has, to its great credit, also recently taken. Although the SEC has put forth sensible guidance on this question, codifying that decentralized cryptocurrencies are not securities would mitigate any lingering uncertainty.

The bill would also make several changes to the tax treatment of cryptocurrencies. One such change that we have long argued for is a de minimis exemption for cryptocurrency transactions for goods and services. Today, if you buy a cup of coffee with bitcoins and the price of bitcoin has increased since you acquired it, you would have to calculate, report, and pay taxes on any capital gains that you realized as a result of the transaction, no matter how small they might be. The Token Taxonomy Act would create an exemption from this requirement for any gains under $600, similar to the de minimis exemption that foreign currency transactions enjoy today, which we think is a simple and fair way to avoid unfairly discouraging the use of cryptocurrency as a means of payment.

We are happy to see continued action from Congress to implement common-sense clarifications and adjustments to the regulatory treatment of cryptocurrencies. We are looking forward to continued engagement with policymakers on these issues to ensure that the fruits of cryptocurrency innovation are not lost to ill-considered policy.

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The next Coin Center Annual Dinner will be on May 13, 2019

Save the date! Blockchain’s night out is back. We will be returning the the magnificent ballroom of the Plaza Hotel in New York City after the first night of Consensus 2019.

Join us for a evening of food and drink with the best of the cryptocurrency industry, all while supporting Coin Center’s critical policy advocacy mission.

Monday, May 13, 2018 - 7:00 PM

The Plaza Hotel

768 5th Avenue, New York, NY 10019

Individual tickets will be available in early 2019.

You can see pictures from past dinners here.

For table sponsorship opportunities contact antonie@coincenter.org.

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Two new digital asset associations launch to advance cryptocurrency professionalization.

Over the last week, The Association for Digital Asset Markets and Mexican Blockchain Association both launched. Their goals are to develop industry standards, codes of conduct, and best practices among companies working with public blockchain networks.

You can read ADAM’s founding principles here and about the Mexican Blockchain Association (in Spanish) here.

It is great to see cryptocurrency industry participants increasingly work together to improve their standards and build an orderly cryptocurrency ecosystem. We are looking forward to working with both organizations.

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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.