Are cryptoassets alternatives to traditional safe-haven assets like gold and silver? Or are they, in the words of Warren Buffett, “probably rat poison squared”? Do they facilitate exchange between free individuals? Or are they stalking horses for central bank digital currencies (CBDCs)? These debates are now intensifying. Brummer’s collection of 28 essays could serve as a standard reference for these topics.
Challenging longstanding models / A basic description of cryptoassets is that they rely on cryptography and technologies such as blockchain (a ledger shared on a digital network) to provide both security and proof of ownership. These assets range from cryptocurrencies like Bitcoin and Ethereum to initial coin offerings (ICOs) and CBDCs. One example of cryptoassets’ emergence: In 2016, Delaware law was amended to allow blockchain technology for stock ledger administration. Overstock.com later became the first public company to issue stock via blockchain. In a 2016 Securities and Exchange Commission filing, the firm explained its issuance of preferred stock consisted “of 126,565 shares of Series A Preferred…. Series A Preferred are digital securities.”
Cryptoassets can serve as mediums of exchange, devices for accessing an online service, investments, or all three at once, according to Brummer, who is a member of the Commodity Futures Trading Commission’s Subcommittee on Virtual Currencies. The assets’ reliance on blockchain reduces the need for intermediaries, but that worries regulators because of alleged volatility, financial instability, and potential for money laundering. In sum, Brummer notes that cryptoassets “challenge longstanding economic models and regulatory strategies.”
The book covers a wide range of topics: cryptoassets’ potential effect on commercial banks, legal issues such as whether they are securities or commodities, methods of valuation and potential roles as mediums of exchange, taxation, and how to integrate blockchain into derivatives markets to achieve market transparency under the Securities Act of 1933.
Book contributor Benjamin Geva of the international law firm Torys traces payment intermediation’s evolution from ancient Mesopotamia to the current era. In the cyber-age, new forms have emerged: electronic payments, e‑money, and access to central bank balances. “Ultimately,” Geva observes, “efficiency is bound either to turn payment institutions into banks or for banks to take over payment institutions, either directly or as subsidiaries, so as to eliminate this unnecessary layer of intermediation.” The broader regulatory question is whether new forms of intermediation will supersede commercial banks.
In SEC v. W.J. Howey, Co. (1946), the U.S. Supreme Court found a financial instrument qualifies as an “investment contract” when an individual invests money “in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” In 2018, SEC official William Hinman stated that Bitcoin and Ethereum are not “securities transactions” because of their “sufficiently decentralized” structure. Yet, SEC chair Gary Gensler said in 2021 the agency considers many cryptocurrencies to be securities under Howey. The pending case SEC v. Ripple Labs, Inc. et al. may resolve this issue.
St. Mary’s University law professor Angela Walch, in her contribution to the book, notes legal implications are inescapable in technology discussions, yet decentralization’s “uncertain meaning makes it ill-suited for a legal standard.” The term “decentralization” has ideological undertones rooted in “the cypher-punk, crypto-anarchist roots of Bitcoin.” Scholars grapple with “appropriate legal treatment” for “people acting together” in a blockchain. Regulators face a complex and undefined environment. One example: “hashing” is cryptography that converts data into a unique text string. How can regulators address concentration in the hashing market?
21st century currency / Should cryptoassets be separated into different asset classes? Finance writer Nic Carter argues that “the jury is out” on whether the value of these assets derives from network usage demand, speculation, or even their “commodity-like cost of production.” Can a virtual, non-sovereign currency achieve stable valuation without managed exchange rates or a state to support it? Can value accretion be forecast or does it simply emerge, and if so, what discount rates are appropriate? Academics are still wrestling with these issues and tend to lag technological developments. But they have “begun to reckon with cryptoassets and virtual currencies as assets in their own right rather than … passing manias,” writes Carter.
Fiat currencies “are not well suited to 21st century commerce … (because of) high handling and exchange costs,” argues MIT mathematician and finance scholar Alexander Lipton. Regulators may soon “allow competition between various business banking models[:] … hotly contested races between fractional reserve banks and narrow banks, digital cash and physical cash, fiat currencies and asset-backed cryptocurrencies, and, most important, centralized payment systems and distributed payment systems.” Lipton concludes “only regulatory compliant fiat-backed tokens” are likely viable in the long run.
An ICO involves issuance of a cryptoasset token. The issuer does not necessarily receive money for the coin, as with stocks and bonds. Instead, Bitcoin or Ethereum could be exchanged on a ledger. There are differences between ICOs and other financing sources such as IPOs, crowdfunding, and venture capital. A regulatory sandbox framework would allow regulators to work with issuers to develop applicable law as technology evolves in this lightly regulated market. Singapore Management University professors Aurelio Gurrea-Martinez and Nydia Remolina Leon note in their chapter that China and South Korea ban ICOs while the United States, Singapore, and Switzerland allow them with the caveat that issuers must comply with securities laws if the token is classified as a security. In Mexico, regulators authorize ICOs after a review.
Regulatory discovery / A contractual model is one possible way to exclude tokens from the scope of regulators while protecting tokenholders who wish to participate in an ICO. Publicly disclosed white papers would explain the tokens to buyers and make their issuance subject exclusively to the law of contracts. The model could reduce regulatory costs associated with the tokens’ issuance. By contrast, a ban model would empower regulators to decide whether “to prohibit the participation of retail investors due to higher asymmetries of information.” One possible outcome of such a regulatory regime is that commercial banks and pension funds would not be allowed to purchase tokens because any potential failure could have consequences for the financial system and taxpayers.
“Ventures succeed and fail in a capitalist system,” write Brummer, Digital Investment Group lawyer Trevor Kiviat, and Davis Polk attorney Jai Massari. “It is not the job of regulators to play favorites, or to ensure that any one investment succeeds. What is problematic is the lack of quality information available (to investors).” U.S. regulators are trying to bring ICOs within the regulatory perimeter of the Securities Act of 1933 by requiring “promoters to undertake the same extensive disclosures that other issuers do when offering securities to the public.” They argue ICO tokens fit the definition of an “investment contract” under Howey: the coins are transactions where an individual “invests his money in a common enterprise and is led to expect profits (primarily) from the efforts of the promoter or a third party.” Howey, they contend, stands “for the proposition that when such asymmetric information and power imbalances arise, U.S. securities law will step in to fill the void, and allow investors to better price and evaluate investment opportunities.”
The general securities disclosure document, Form S‑1, dates to the New Deal. Yet the S‑1 is built on “assumptions about securities issuances that are not always applicable to emerging ICO tokens,” they write. Merely recognizing ICO tokens as “securities” will not necessarily improve the disclosures made to investors. Instead, they conclude, “such decisions comprise, at best, the initiation of a long-term process of regulatory upgrades that will be needed to fine-tune protections for the retail public and preserve the efficiency of capital formation in global financial markets.”
This idea of a long-term process of regulatory discovery is evident throughout the book. Government regulators face technology and new markets that they do not always understand.
Fundamental regulatory changes will be needed to integrate blockchain into derivatives markets to achieve transparency. Noting the absence of CFTC expertise, Deloitte managing director Petal Walker writes that the current regulatory infrastructure will have to change in order to not inhibit “the great promise that blockchain has for market efficiency and transparency.” Blockchain transparency allows for real-time analyses. A blockchain-based derivatives market would include interoperable ledgers, smart contracts, and automation visible to all participants, including the CFTC, in near-real time. Such a “golden record” could reduce risk. One obstacle: a language gap between coders and legal professionals.
How should tax authorities treat cryptoassets? The United States, Ireland, and Singapore are among nations “generally supportive of—or at least neutral toward—the crypto industry,” argues Walker. Most jurisdictions treat cryptoassets as property versus money for income and capital gains purposes, even when they are used as means of exchange. To date, the Internal Revenue Service has released limited guidance.
U.S. regulators may look elsewhere for answers. In Venezuela, individuals use cryptocurrency to preserve their assets in a hyperinflation. The Maduro government created the petro, a CBDC backed by commodity reserves including oil. In China, citizens were once allowed to trade in Bitcoin while warned of the risks, though that ended in 2021 when the government banned non-state-approved cryptocurrencies. Today, China classifies them as “virtual commodities,” not currencies.
Cryptoassets are nascent in terms of regulation. In mid-2022 the combined market cap of the world’s 20 top cryptocurrencies exceeded $800 billion. This fact alone suggests they will continue to attract regulatory attention. Brummer’s book makes it clear that U.S. regulators have more questions than answers.
