Two congressmen are introducing a bill that would exclude digital currencies from securities classification and substantially improve the tax treatment for cryptocurrencies. The new definition could benefit current cryptocurrency projects—such as Ripple’s XRP—and allow for ICOs and STOs to fundraise with more clarity.
Today, CNBC reported that a bipartisan bill, the “Token Taxonomy Act” would clarify how cryptocurrencies fit within the U.S. Securities and Exchange Commission’s regulatory framework.
The new law would more precisely define a “digital token” and clarifies that securities laws would not apply to a cryptocurrency once it becomes a “fully functioning network,” as stated by CNBC.
The bill would also introduce more favorable tax treatments for cryptocurrencies. Currently, trading one crypto for another triggers capital gains or losses, and often produces a large amount of record keeping. Another issue is that when someone purchases a small item with cryptocurrency, like a coffee, that transaction would also incur those same gains or losses.
The proposed bill would address these issues, creating an exemption for crypto-to-crypto exchanges (‘like kind’ exchanges), such as trading Bitcoin for Ethereum. Moreover, the bill would create an exemption for small (de minimis) transactions below a certain threshold, allowing users to more easily use crypto as a medium of exchange.
Current Securities Laws
The basis for current U.S. securities laws stem from the Securities Act of 1933, and the Securities Exchange Act of 1934. Another court ruling, SEC. v. W.J. Howey Co., produced an often used standard, the ‘Howey Test’ to determine whether an investment qualifies as a security.
The Howey Test, as defined by FindLaw, has four distinct parts:
- It is an investment of money;
- There is an expectation of profits from the investment;
- The investment of money is in a common enterprise;
- Any profit comes from the efforts of a promoter or third party.
If an investment meets these four criteria, then it is likely classified as a security.
So far, the SEC has only levied a few enforcement actions against blockchain-related projects, even for those operating within the United States.
The reasoning has been a hotbed of controversy for the crypto-community. Since 2017, the SEC has issued actions against the DAO, Munchee, EtherDelta, Paragon and Airfox, and DJ Khaled and Floyd Mayweather.
These enforcement actions have clarified some, but not all, of the issues surrounding securities classification for cryptocurrencies.
Statements From Those in the SEC
“…issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies.”
And for the treatment of exchanges:
“…securities exchanges providing for trading in these [cryptocurrency] securities must register unless they are exempt.”
There are a number of different exemptions that crypto companies can take advantage of. The most common being Regulation D, which allows companies to raise funds from accredited investors. Two other more recent offerings include Regulation Crowdfunding, which allows a project to raise up to $1,040,000 and Regulation A, which allows a company to sell securities up to $50 million.
However, ICOs have still proven alluring to companies looking to raise large amounts of cash quickly, especially during the boom of late 2017. That said, the choice of conducting an ICO has left many companies in potential legal jeopardy.
Finally, to iterate the SEC’s stance:
“U.S. federal securities law may apply to various activities, including distributed ledger technology, depending on the particular facts and circumstances, without regard to the form of the organization or technology used to effectuate a particular offer or sale.”
Although these statements—along with the SEC’s enforcement actions—indicate the Commission will take action against those who do not comply with securities regulations, the SEC has also offered projects some leeway.
In enforcement against Paragon and AirFox, both companies were offered routes to rectify their offering.
“…these orders provide a model for companies that have issued tokens in ICOs and seek to comply with the federal securities laws,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division.
By offering to return investor funds (recision), agreeing to regularly file reports with the SEC, and by improving disclosures to investors, projects can then potentially become compliant with securities laws, even if they previously held an ICO.
SEC Chairman Jay Clayton had also made some resounding statements about cryptocurrency:
“You should start with the assumption that you’re starting with a securities offering.”
For his reasoning, Clayton cites the lack of oversight and the potential for market manipulation:
“Those kinds of safeguards do not exist currently in all of the exchange venues where digital currencies trade. . . When you see an asset trade on [the] Nasdaq or NYSE, there’s a great deal of surveillance preventing you and me from teaming up and pretending we’re decentralized. Those sort of safeguards do not exist in a lot of markets where digital currencies trade.”
These are only a few statements from the SEC which indicate the Commission intends to regulate and enforce securities laws, even for companies that take advantage of distributed ledger technology.
Potential Exceptions through Decentralization
Although the SEC seems firm about regulation, there have also been some notable statements which indicate that some projects could fall under a different classification. William Hinman, the SEC’s Director of Division of Corporation Finance, had this to say in a speech:
“If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract.”
Hinman goes on to say that Bitcoin and Ethereum do not appear to be securities:
“The network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value. And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.”
Impact on the Cryptocurrency Markets
The introduced bill has the potential to provide new guidance to the SEC and improve the situation of many projects that have already conducted ICOs. Furthermore, the bill will make the trading and everyday use of cryptocurrency even more attractive through improved tax treatment.
However, crypto enthusiasts shouldn’t get their hopes up too soon. The bill still has a long way to go before it becomes law.
That said, should the Token Taxonomy Act get passed by Congress, it would have profound ramifications; The law could potentially kickstart a new stage of innovation and adoption for both blockchain and cryptocurrency.Posted In: Adoption, Cryptocurrency Taxes, Regulation