A recurring complaint from cryptocurrency participants is the idea of applying a 72-year-old securities law to digital currencies. The Securities and Exchange Commission uses what’s known as the “Howey Test,” which comes from a 1946 U.S. Supreme Court decision involving a Floridian citrus farmer to determine whether or not a cryptocurrency is a security.
The Supreme Court determined that any transactions that qualify as “investment contracts” are considered securities. According to the SEC, an investment contract exists if “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
But experts say those standards should be more nuanced for digital assets.
Many of these cryptocurrencies are also blockchain software platforms, meaning you can build on top of them. They are also capable of being traded without an intermediary, making them far different from your average stock on the Nasdaq.
“These decentralized networks don’t fit neatly within the existing regulatory structure,” said Kristin Smith, head of the Blockchain Association, the first group in Washington to lobby for the technology behind bitcoin. “This is a step forward in finding the right way to regulate them.”
SEC Chairman Jay Clayton has made it clear he does not intend to update those standards to cater to crypto. The chairman said at a Senate hearing earlier this year that every initial coin offering he has “seen is a security.” The only two they agency has explicitly said are not securities are bitcoin and ether, which are regulated as commodities by the Commodities Futures Trade Commission.
William Hinman, head of the Division of Corporation Finance at the SEC, said in June that bitcoin and ether are not securities because they are decentralized — meaning there is no central party whose efforts are a key determining factor in the enterprise. Initial coin offerings, or ICOs, he said are securities because of the expectation of a return by a third party.
While the SEC has clarified existing laws and made exemptions, it would take moves by Congress to actually change any statutes the agency is required to follow.
The bill looks to amend the Securities Act of 1933 and the Securities Exchange Act of 1934, which established the current structure for what a security is, by adding a new definition for “digital tokens.”
Smith, who was an aide to former Sen. Olympia J. Snowe, R-Maine, and lobbied blockchain issues for Overstock.com, said this bill does not mean that these digital tokens will go unregulated. If the bill passes, they will instead likely fall under the purview of the Federal Trade Commission or the CFTC.
Thursday’s bill also directs the IRS to adjust taxation of virtual currencies, create a tax exemption for exchanges of one virtual currency for another and to create a de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency.