Two new bills in Congress would clarify agency jurisdiction over cryptocurrency
Pre-sale agreements would fall under SEC jurisdiction, CFTC would oversee decentralized network tokens
Three longstanding policy issues facing cryptocurrency technology are being addressed by two new bi-partisian bills introduced in the House today: (1) the patchwork of state-by-state licensing of exchanges, (2) the limits of SEC jurisdiction, and (3) alleged price manipulation. How can two bills address all three of these issues? Before we get to that, let’s quickly review those issues in a bit more detail.
State Patchwork. For years Coin Center has analyzed the complicated and inefficient patchwork of state by state licensing for crypto exchanges: it’s costly for businesses to become licensed in every state and varying state standards offer inconsistent and sometimes insufficient protections for consumers. A single federal license could be preferable, and giving exchanges the choice to remain state-regulated or seek the federal license as an alternative would offer improved regulatory outcomes while preserving state sovereignty and regulatory choice.
SEC Jurisdiction. For years Coin Center has described and critiqued the fuzzy line delimiting SEC oversight of cryptocurrencies and the markets where they trade. The SEC regulates tokens that qualify as securities and any organized secondary markets where those tokens might trade; that much is clear. However, the definition of a security is flexible and its application to various token projects is uncertain and often determined in a case-by-case fashion. Consistent with our advocacy, the SEC has generally made those determinations in a commonsense manner: clearly announcing that running decentralized cryptocurrencies like Bitcoin are not securities, and clearly specifying that pre-sale agreements for future cryptocurrencies are securities. Where things remain convoluted is the launch of a decentralized cryptocurrency that was originally financed through a token pre-sale. Where does the pre-sale agreement (a security) end and the running token (not a security) begin?
Manipulation. Increasingly Coin Center has been fielding concerns over price manipulation of cryptocurrencies. Another issue with state-by-state money transmission licensing is that these regulations only deal with custody risks to customers, as regulatory structures licensing requirements and examinations are not intended to provide for market supervision or to detect and prevent manipulation. The CFTC is an expert agency with respect to manipulation but it only has supervisory jurisdiction over commodities derivatives markets, not commodities spot markets (including cryptocurrency spot markets) where it has only investigative and policing powers.
Here’s how the two bills address these issues:
Digital Commodities Exchange Act
Ranking Member Conaway’s bill would empower the CFTC to offer an optional registration for crypto exchanges. Importantly, exchanges are free to continue relying on state money transmission licenses or state bank and trust charters; choosing CFTC regulation would be an optional alternative path. If an exchange applied and was approved, then it would no longer be subject to state-by-state money transmission licensing requirements. The registration would require the exchange to keep customer cryptocurrency with qualified custodians and share market surveillance data with the CFTC so that they can detect and police manipulation.
The bill also defines a subset of digital tokens as “pre-sold” tokens: tokens that are now running on decentralized networks but were originally promised to investors in pre-sale agreements. Pre-sold tokens, according to the bill, can only be traded on these CFTC registered exchanges in an orderly fashion not subject to manipulation. That should help guarantee that original investors are not dumping initial allocations of the token onto the general public. Once a pre-sold token is sold to the general public through a CFTC registered exchange it loses the pre-sold token designation and can trade on traditional state regulated exchanges. This pre-sold wrinkle should help to better define the line between SEC and CFTC jurisdiction: pre-sale agreements will continue to be regulated by the SEC, but there will be less need for continued SEC wariness once the tokens are delivered and the network is live because the CFTC will be picking up the regulatory slack and supervising sales to the public upon network launch. This one bill addresses all three of these policy issues: the need for a federal alternative to state licensing, the need for clarity over SEC jurisdiction, and the issue of cryptocurrency price manipulation and the need for spot-market supervision.
Securities Clarity Act
Representative Emmer’s bill explicitly clarifies SEC jurisdiction with regard to token presales. The SEC has jurisdiction over pre-sales because the existing securities laws include “investment contracts” within the definition of a security. Courts have interpreted “investment contract” to mean an investment of money in a common enterprise with an expectation of profits dependent on the efforts of a third party promoter. The formative court case was Howey v. SEC, and in that case a sale of land was combined with a promise to grow oranges on the land and give the landowners the profits. This combination of a non-security (land) sale, and ongoing contractual promises of profits (the orange grove returns), was deemed to be an investment contract. Token pre-sales are similar. A non-security is being sold (the future decentralized token), but it comes with a contractual promise from the issuer (the promise to build the token network as specified so that the tokens will actually do something of value in the future).
Representative Emmer’s bill does not abrogate or alter the existing court-derived Howey test for an investment contract, it simply clarifies that outside of the investment contract, the associated asset is not a security. So if you bought the land in Florida without signing a contract for orange grove profits, the land is not a security. And if you bought the Ethereum token after the original promise to build the network had been fulfilled, then the token itself is not a security. This may seem like a commonsense interpretation, but sometimes it’s helpful to have common sense spelled out in law because unfortunately, as they say, commonsense ain’t that common.
We’re thrilled that these two bills, which enjoy the support from members of both parties, are taking reasonable approaches toward solving longstanding cryptocurrency policy issues.