Cryptocurrencies cannot be regulated by current US regulators

Over the last couple of years I’ve talked a lot about how the blockchain industry tends to misunderstand regulation. This goes beyond whether a particular token is a security or a commodity. The problem we have is in the definition of tokens.

Alexandra Damsker is a lawyer and strategic consultant, advising on legal and operational matters. She previously served as an attorney at the U.S. Securities and Exchange Commission and Mayer Brown, and is a departing founder.

Note: The opinions expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.

It doesn’t really matter Which The agency regulates tokens, because they all rely on the same thing: the regulated element is static. A stock is an equity security from the day it is created until the day it is canceled or the company is dissolved. Fiat is money from the day it is minted until the day it is destroyed.

But not tokens. Tokens are dynamic – they can have several different functions for different owners, or even for the same owner, at the same time. And there is no regulatory system in the world that can take this into account.

Let’s look at some of the things tokens can do and the regulatory consequences of each:

• Move transactions along a chain. This is purely functional and unregulated.

• Incentivize people who help protect and manage the blockchain. This is an exchange of work or services and is not based on any assumed value for the token, so it is unregulated.

• Represent value, physical or digital. This is only regulated when the underlying object represented is regulated (for example, a token representing a television is unregulated, but a token representing a share of Tesla stock is regulated).

• Represent a physical or digital product or group of rights. This is a product only and not regulated, other than any intellectual property rights it may attach.

• Payment for goods or services OTHER than transaction fees (for example, gas fees). This is tricky: unless it’s a stablecoin, it is similar to a currency, but not quite the same thing. (Remember that currencies are intended to be a store of value that remains within a narrow range relative to a key target or exchange rate. Assets, on the other hand, are designed to fluctuate in value—that’s how your little investment in something suddenly becomes worth so much, otherwise your huge investment in something else plummets to zero.) Currencies are regulated by the US Treasury Department, including FinCEN and the IRS.

• Payment of transaction fees (gas fees). These are service fees and generally unregulated.

• To represent partial value. (This is great: you can’t own a partial title or a partial painting, but you can get a fractional value of pretty much anything if you tokenize it.) This is tricky, too: generally, if you split an asset into part-interests in which everyone shares interests overall, is a security, regulated by the SEC. But if you divide things so that you have something distinct and individual, rather than a piece of a whole, it is generally NOT a security. It could be a commodity, however, like bitcoin {{BTC}}.

• They represent rewards for taking risks or offering goods or services, such as staking on chains without providing validation work or paying for tokens lent to a borrower’s liquidity pool, platform, or application. This is regulated by a combination of securities and Treasury regulators.

• Represent voting rights. Regulated by the SEC only in public companies.

• Represent perceived or speculative market value. A security or commodity is regulated accordingly by the SEC or the CFTC.

The story continues

You can see how many things a token can be – and the buyer it doesn’t know what a specific token will end up with. If I buy ether {{ETH}} in January, February and March, stake it with a validator in June, buy a one-of-one NFT (a product) in July, and a meme coin (probably a stock) in August, paying gas for each transaction, which ETH was used specifically for which transaction? I, the buyer, don’t even know: I won’t know what ETH was used to purchase the meme coin until I apply my jurisdiction’s accounting method. So we’ll just find out in retrospective which regulatory system to consider for a particular ETH until I spend it and apply professional accounting methods.

Now let’s add the fact that there is a person on the other side of the transaction – who could then move the ETH into something else, just like I did. I took the ETH purchased on the market (probably a stock) to purchase a product (NFT) and service fees (gas fees). The person who sold me the NFT could have taken the ETH (payment/currency) and then put some of it into the market (currency), voted with some (vote) on a proposal to improve Ethereum (EIP), and bought a NFT in an important work of art (security) and paid service fees (gas fees).

See also: Is House Bill FIT21 Really the Legislation Cryptocurrencies Need? | Opinion

Do we see how confusing and artificial all this is? The current regulatory structure assumes that everything that falls under it remains there permanently. But this is not only unlikely, it is also impossible when it comes to tokens. It doesn’t work for dynamic systems.

Trying to fit tokens into old frameworks can only give us marginally useful protection at best and limit incentives to innovate at worst. We can do better than this. And considering the fact that quantum computing and other technologies with increased probability of simultaneous change of character are entering mass use faster and faster, we have no time to waste.

UPDATE 5/30/24; 7.25pm: The title and summary of this editorial have been changed to more accurately reflect the topic.

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