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DFS Crypto “Coin Listing” Proposal Represents A Dramatic Expansion of the NY BitLicense

The comments below are in response to the New York DFS’s new proposed Coin Listing Policy Framework (the “Proposal” or the “Framework”) extension to the DFS Part 200 (the “BitLicense”) regulation, released on 12/11/2019 (available here. The DFS has provided only until January 27, 2020 to get comments in to innovation@dfs.ny.gov, so please read the Proposal and this post, and send them your thoughts ASAP).  The proposal consists, in main, of two prongs:

  1. A provision for DFS “listed” coins which will automatically be permitted to be used by BitLicense grantees (“Licensees”).
  2. A provision for self-certification of coins by Licensees which aren’t permitted under prong 1.

Little detail has been provided at this point, so the below comments reflect on the apparent main concepts of the Proposal, as well as interpret its general contextual and explanatory language.

As a reminder, the scope of the BitLicense is coverage only of those engaged in a “virtual currency customer business,” and so, the Proposal would apparently not effect either (a) non-business or (b) non-customer uses of cryptocurrencies (however, it’s worth noting that both limiting concepts could use more clarity in the context of the BitLicense).

  1. Issues with The First Prong.

The first (and main) prong of the Proposal uses the foundational language “list of all coins that are permitted for the Virtual Currency Business Activities of the VC licensees, without the prior approval of DFS.”

However, neither the BitLicense regulation itself nor the language of the Proposal makes it clear whether it will be permitted to utilize coins which aren’t expressly approved by the DFS (or aren’t approved under Prong 2: self-certification).  The alternative interpretation would be that of a “safe habor”: i.e., under which a Licensee could make use of non-approved coins in business, but would potentially receive less regulatory deference for them (or face some statutory limits under the safe harbor; e.g., limits in manner of use, type of customer, or scale).

My belief is that, on the wording of the Proposal, the DFS does intend to entirely prohibit dealings by Licensees in coins not approved under Prong 1 or Prong 2, rather than to create a new safe harbor.

If true, this would be striking, because it would represent a whole new dimension of the BitLicense: a ban on individual (non-approved) coins.  This requirement (which seems material to the BitLicense as a whole) is not spelled out in Part 200, nor, even, in the language of the BitLicense application materials (i.e., the language of the forms – which may typically go beyond the letter of the law, albeit, in a less-binding and more guidance-like capacity).

It appears, then, that ad hoc interactions between Licensees and the DFS regarding permissiveness of activities with respect to specific coins (by understandably-cautious regulated crypto financial companies) has been taken “to the next level” in a regulatory sense with this proposal.

The confusion is compounded by the use of the term “listing” in almost every place in the Proposal –except the one sentence quoted above, which seems to contemplate any type of virtual currency business activity.  The BitLicense itself does not define “listing”.  Thus, it is not clear if the Proposal is intended to encompass public listing activities of Licensees (i.e., by exchanges, such as Coinbase), or any dealings in coins (e.g., private custodial holdings,  private trading, payment processing, participating in a “utility token” ecosystem, etc.).

I believe this apparent quantum leap in the scope of the BitLicense deserves more public attention and scrutiny than it has thus far received.

To illustrate the impact of the regulatory shift, imagine you are a well-meaning crypto project starting up outside the U.S. — let’s say, Estonia.  You “do everything right” in terms of your project team, governance, and financing — and may explicitly follow applicable cryptocurrency or other regulations in your home country of Estonia, as well as potentially on cryptocurrency exchanges in other countries (which may themselves be licensed and have an explicit regulatory status — e.g., as Gibraltar provides).  You may even have what is on it’s face a “security token” – or choose to treat your coin as such, for regulatory certainty.

However, none of that “good citizenship” will result in your coin being listable – or perhaps even commercially-usable (i.e., in a custodial arrangement) by New York BitLicense holders.  This will simply not be possible unless your coin or token is explicitly permitted under the Proposal – either under Prong 1 (DFS listing), or more likely, Prong 2: Licensee self-certification of the coin.

And despite  the availability of Prong 2,   getting certified under it is one-off process, company by company (discussed further in the next section).  There are not a lot of parallels to this situation.  It would be as if every non-public stock had to be re-certified by every broker-dealer or exchange that wished to deal in it – and mind you, many of these crypto tokens will be regulatory securities, just like stocks.  This new Proposal, then, would represent a redundant layer of regulation for such instruments.

As for mainly “unit of exchange” crypto coins, these are more like currencies in view of the forex sector (which counts as its participants banks, speculative trading houses, and forex brokers).  Yet, none of the regulated players in the forex space are required to get approval for every single currency they deal in.

Note that, in both the cases of stocks and foreign currencies, the traded instruments may very well “implode”, despite all assurances, and best hopes. They also might suffer from varying levels of money laundering risk (something explicitly cited as a review factor in the Proposal with respect to crypto coins). But one of the core functions of the market is to “price risk” with respect to all manner of bad outcomes, including that fraud, insolvency, or some other form of risk (i.e., cybersecurity) might lurk within an instrument.

Thus, it is far from clear that a more restrictive, crypto coin-specific regime is appropriate – and such might even hinder the market in its risk-pricing function (which is also a risk-surfacing and mitigating function).

RECOMMENDATIONS:

  • Clarify the permissiveness of non-approved coins under the BitLicense (under either prong of the Proposal)
  • Create (or clarify) a safe harbor for one or both prongs (preferably covering both).
  • Clarify whether the coin use restriction is with respective to public trading listings, or any “virtual currency business” use of a coin.
  • Limit the coin use restriction to public trading listings, or at least, tailor the safe harbor in a manner respecting “public vs. private” use (one might follow securities exemptions/safe harbors in this respect – and for similar reasons).
  • Clarify which factors would trigger the DFS to even review a coin for the general list in the first place, and if under consideration, what the criteria would be (presumably, all the company self-certification criteria, plus some additional ones).
  • Exempt coins which are securities in entirety (with a foreign reciprocation regime).
  • Exempt coins which have any regulated status under any qualifying foreign recognized regulatory regime.
  • Require the DFS to consider coins for listing by any paying applicant, fully subject to administrative and judicial review (just as with the BitLicense itself).
  1. Second Prong Issues

The second set of issues I see is with Prong 2 in specific.  This is the self-certification provision.  The DFS has suggested numerous factors to be examined in a self-certification framework.  Though the factors mentioned are not definitive, at least the DFS plans to release a “model” framework, and certainly, having this means of  coin  approval at all somewhat counterbalances the “bottleneck” that would exist if requiring DFS approval for every single coin.  We can naturally expect that this will be the go-to provision for newer coins that haven’t yet garnered universal attention or acceptance, and therefore would not be under consideration for general listing under Prong 1.

However, the effectiveness of this prong seems limited by its “one-off” status.  I.e., a Licensee that self-certifies a coin hasn’t done anything to make that coin usable by any other Licensee.  So, each Licensee will have to “reinvent the wheel” in onboarding a new coin.

Or, alternatively, the onus will be on the progenitor of the coin to advocate for its self-certification by individual New York Licensees.  It’s not clear why our Estonian (or any other foreign token-issuing) venture should have to be this concerned with individual companies in New York — particularly if they have followed all local  regulations and those of major crypto-coin trading venues.  In a sense, it’s a sort of “non-fungibility” rule for crypto assets that (almost by definition) doesn’t really exist in the broader financial sector — or in a free market property system, for that matter (imagine, e.g., pawn brokers not only having to themselves be licensed, but being required to “certify” every single type of asset they took in).

From the perspective of our Estonian applicant, it’s probably not worth the effort to shepherd their coin through possibly dozens of prospective Licensees.  This will provide a competitive disadvantage to smaller or upstart projects, which will inevitably make New York less competitive.

RECOMMENDATIONS:

  • Make the Prong 2 prohibition a safe harbor (again).
  • Allow self-regulatory organizations to approve coins (this will presumably require some approval process in turn for the SRO – however, crypto SROs are indeed now in existence, such as the Association for Digital Asset Markets,  or ADAM).

III.  General Issues and Comments

  • Non-licensees who can still deal in crypto without a BitLicense under the DFS regulation; e.g., banks.  Apparently, these entities will have a unique advantage under this regime, as it appears they will not have to get coin-specific certifications.

    RECOMMENDATION: Clarify this (and preferably, do not establish this kind of differential treatment).

  • Regulatory Phase-ins. The BitLicense generally has no initial coverage threshold or “phase-in,” i.e., for small businesses or startups.  I view this as one of the most damaging shortcomings of the BitLicense broadly (and know of numerous clients and prospects who have avoided or pulled out of New York entirely because of it).  This has clearly created a preference for larger companies to deal in crypto in New York, and dramatically limited the choices of New York consumers and business.  Now, with coin-specific qualification, the lack of BitLicense phase-ins will be even more damaging.

    RECOMMENDATION: Allow businesses – subject to reasonable phase-in parameters (i.e., such as number of customers or revenue) – to be excluded from the BitLicense entirely, or subject to a general safe harbor.  Coincidentally, one doesn’t need to look far to find reasonably-tailored regulation in this sense effectively covering crypto companies in New York: the New York SHIELD privacy and data security law, which goes into effect in 2020 (indeed, most privacy and data security laws in the U.S. and worldwide phase-in thusly, so they don’t apply from dollar (or customer) number 1, and which would badly squelch commerce and innovation.  And arguably, crypto should have even more generous phase-ins, as most crypto clients make an affirmative choice and “know what they are getting themselves into” — unlike consumers generally using digital services).

  1. CONCLUSION

I am a big fan of the increased securing and professionalization of the crypto sector, of which government regulation is a major (though not the only) part. However, the Proposal, and the BitLicense generally, could use significant fine-tuning to make it more friendly to innovation, including small businesses and startups.  Until this is done, I believe New York is missing out on playing a larger and more constructive role in this important new sector, and this new coin-permitting Proposal (as initially-posed) will make the situation worse rather than better.

 

 

 

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A Tale of Two Token Offerings: Lessons from Blockstack (Reg A+) And Telegram (Reg D)

Telegram and Blockstack logos juxtaposed. See footer for rights and source attribution.

(*) Some of the biggest news of the past half-year on the US crypto regulatory front has been (1) Blockstack’s successful (qualified) “Reg A+” filing with the SEC and associated offering, and (2) the SEC’s lawsuit and injunction against Telegram, blocking distribution of their “Grams” tokens, sold pursuant to earlier “SAFTs” (Simple Agreements for Future Tokens, similar to SAFE notes).   Surprisingly, the latter came even though Telegram had filed a Form D for ostensibly-exempt private, accredited investor-only sales of the Grams/SAFTs under Regulation D, Rule 506(c).

It seems to me that neither event — let alone comparative lessons of the two — has been fully appreciated by the crypto community.   Thus, in this post, I wanted to highlight some main points of interest in each, and possible lessons in comparing and contrasting the two cases.

I. OVERVIEW OF “REG A+” AND BLOCKSTACK’S OFFERING

Blockstack was (in the US) a Regulation A (so-called “Reg A+”, since being expanded with the 2012  JOBS Act reforms) offering in the US which was qualified (“approved”) by the SEC on July 10, 2019 (see the offering circular here; filing index here).  Reg A+ allows for up to $50 million to be raised by an issuer per 12 months, not limited to accredited investors, in exchange for following somewhat scaled-back public company-like disclosures (thus, it is often called a “mini-IPO”).

In fact, a Reg A+ offering is, for most purposes, considered “registered” by the SEC (which will become key later in this post).  This is in contrast to offering exemptions, like the popular “private offering” (accredited investor-only) through Regulation D – Rule 506(c) offering.   Such exempt offerings are expressly not “registered”, and therefore, every subsequent transaction (i.e., resale) of the issued securities are presumed unlawful in the US, lacking any further exemption (or, simply, a registration, as in an IPO or Reg A+ filing).

This “all subsequent transactions presumed illegal” status is of course a heavy cross to bear, and many, many blockchain token issuers over the past few years (actual, and would-be; ICO and otherwise) have expended considerable resources (and incurred considerable brain damage) attempting to deal with this situation, and square it with their structure and plans (our clients, of course, have at least had some of their pain mitigated, and many have — in spite of the lack of bespoke regulations — had successful token raises).

Critically, this consideration has been front-and-center even for ostensible “utility token”-selling projects, because (1) “pre-sales” of utility tokens, or rights to them, prior to developing the promised network utility, are statutory sales of securities in the US under the Howey “investment contract” doctrine, and (2) even when network utility is created, it is almost never 100% clear if “sufficient utility” — not only in an absolute sense, but also relative to subjective purchaser (and SEC) expectations — has been established to mitigate any possibility of being deemed a security.

Add on top of that the fluid nature of blockchains and their coins/tokens globally, and the result is that a heck of a lot more ventures are worrying about US securities law than either their globally-facing posture or the nature of their blockchain tokens and networks might suggest.

Thus, a major blockchain token issuer that could “safely” permit general public token purchases and sales in the US (including resales) while still offering what is effectively a “utility token” would be a major breakthrough.

Enter Blockstack.   They were the first Reg A+ blockchain token offering of any kind to get approved by the SEC, and, quite fascinatingly, this was for a de facto utility token — not a security token, as nearly all observers had expected for the first approved Reg A+ project.  A security token would have been the “safe bet”.  But Blockstack (by all appearances) apparently really believed in the underlying model they had originally-envisioned, centered around the utility of their “Stacks” token, and its free-flowing role as critical to their network and constituent ecosystem — so they pushed to maintain their offering notwithstanding the token not really resembling a classical “security” on its fundamentals.

Now, I say “de facto” utility token because, what a Reg A+ offering (as with any securities exemption or registration) is expressly for is a security instrument.   Thus, technically, what Blockstack has done is file as a provisional security (in a “mini-IPO”), while fully-disclosing their plans to foster an evolution of the token to a pure “utility status” — at some indeterminate point in the future (implicitly, to the satisfaction of the SEC).  Their pathway to do doing such is moving the network to a “sufficiently decentralized” status.   (As far as a specific threshold condition, we don’t really know what “sufficiently decentralized” means in the SEC’s eyes in any precision yet — but Blockstack could very well be the first case wherein we find out.  On a related note, we’ve also argued here that being “sufficiently decentralized” shouldn’t be the only way for a blockchain token to become a non-security).

This indeterminate timing of the expected utility token status plus provisional treatment of the token as a security in the US is likely pretty important to the SEC’s approval of the offering.  Basically, Blockstack didn’t design their offering like a “ticking time bomb” — i.e., one which is (presumptively) a security now, but will “explode” at some specific point in the future (that is, explicitly circulate contrary to securities regulations) —  leaving the lawful securities trade status of potentially millions of (US) transactions in question.

When (and if) the Stacks token is ever deemed a non-security in the US, there will have already been a legal general public trading market for it in the US — as that is precisely what Reg A+ establishes.    In my read, this is the central concern of the SEC, much less so than whether the securities trading market infrastructure and associated panoply of compliance becomes redundant at some point in the future (because the token “is suddenly a utility token”).

Don’t get me wrong; it’s not as if Blockstack took a “no-brainer” option in undertaking a blockchain token offering this way — by their own recounting, they spent $5 million in legal and professional fees on getting this offering through (plus a 9-month review timeline — which likely doesn’t account for pre-filing lead-time during which internal discussions, legal and accounting advisory consultations, and informal interactions with the SEC were surely taking place).  (For comparison, $1-2 million for a traditional IPO is typical, so this was not “cheap” by virtually any standard).

But it was still a watershed accomplishment, and it will likely dramatically lower the cost for subsequent  Reg A+ blockchain token offerings (and simpler, plain-vanilla security token offerings, or STOs, will likely be even cheaper than offerings hewing closer to the Blockstack “model”).

Also, the offering did raise $23 million under Reg A+ (i.e., in the US), so it did “pay for itself”, and thus, was “rewarded” in the marketplace.  (Further, Crunchbase reports Blockstack raised a total of $93.8 million in 10 rounds, at least some of which was likely from Regulation S “offshore” sales, and so would not be counted along with the Reg A+ raised amount).

II. OVERVIEW OF TELEGRAM’S OFFERING AND SEC ENFORCEMENT

Telegram, the popular messaging app, went another direction with their blockchain token offering.  They did go to market well after the SEC’s July 2017 “DAO Report” (essentially warning the ICO sector that it was presumed-regulated, and that enforcement was coming).  And like many projects, Telegram responded by going the  path of performing their “pre-sale” of tokens (that is, their sale of presumptive utility tokens — but before the network and companion utility was developed) within the US in a manner meant to mollify the SEC, by (1) limiting the sales to accredited investors, (2) filing a Form D declaration pursuant to Regulation D Rule 506(c), and (3) requiring US purchasers (and to some extent, offshore purchasers) to agree to contractual resale restrictions and lock-ups for an initial period.

After this initial phase — specifically, upon a hard deadline of October 31, 2019 (if not postponed under certain conditions), Telegram was to deliver its “grams” tokens to all pre-sale investors and the general public, worldwide.

(A general note: Telegram — thanks to Regulation S of the Securities Act — was not generally restricted in pre-selling such token interests to non-US persons — and itself enjoys somewhat-limited SEC jurisdictional reach, given its status as a non-US company.  But in many ways, it clearly entered into US SEC jurisdiction.  I’ll touch on jurisdictional considerations again below).

By hopes, and at first-blush appearances, this plan was expected to insulate Telegram from charges of violating securities laws in the US with its pre-sale agreements — in particular, with respect to US purchasers of the SAFT interests (all of whom were limited to being accredited).  But as you probably can guess if you’re aware of the SEC’s lawsuit and injunction against Telegram of DATE, things did not go quite as planned.

The SEC took extraordinary action against Telegram with its suit filed on October 11, 2019 (complaint here ; cited as “Complaint” hereunder), seeking a TRO to completely enjoin (halt) Telegram’s distribution of Grams tokens worldwide until the merits of the offering were adjudicated.

(As a point of procedural detail, the court technically never granted the SEC’s requested TRO; on October 21 , Telegram and the SEC agreed to a stipulation and consent order that Telegram would voluntarily not “not offer, sell, deliver, or distribute ‘Grams’ to any person or entity” until the conclusion of a Feb. 18 & 19 2020 court hearing in the case.  I think it’s safe to assume that the SEC would have obtained the TRO even if it relied upon the unilateral power of the court — but perhaps not in time for the October 31st planned Grams distribution date.  Telegram’s SAFT purchasers also agreed to voluntarily postpone the distribution of Grams until after this hearing — sidestepping both questions of whom, if anyone, could still receive Grams, as well as whether the postponement could be unilaterally invoked by Telegram.)

(Please note that in all of the below, I am relying upon the SEC’s complaint for a recounting of the facts; which may not precisely hold.  Telegram has not yet filed a full answer which might dispute some material facts.  However, if even most of the facts are accurate, I believe the analysis and comments below are still on-point).

The SEC’s suit, at its core, is based upon two key concerns, which (in my own terms) boil down to:

  1. the Grams token has virtually no way to be a full “utility token” by the October 31, 2019 delivery deadline, relative to how Grams was promoted and the offering was conducted (and probably also in any absolute sense; i.e., of meeting some basic threshold of utility); and
  2. Telegram promoted and positioned the offering in such a way as to encourage — if not effectively guarantee — that many purchasers would act as mere “underwriters” for the initial offering; i.e., quickly “flipping” the tokens for a transnational profit, rather than as an investment in the inherent value of the token.

Addressing the first, and (I’d say) threshold concern: Telegram seems to have badly fumbled in making a strong “utility token” case, in both their communications and actual steps taken.  This left them “wide open” to the SEC’s charges.  See, e.g.,:

  • “Grams are not a currency because they have no realistic currency uses at this time” (Complaint, p. 14);
  • “Telegram sold and will deliver Grams in amounts that far exceed any anticipated ‘use’ on the TON Blockchain. For example, all but three of the United States Grams Initial Purchasers bought more than 2.5 million Grams each. Nor did or will Telegram restrict sales only to individuals who would actually “use” Grams (Complaint, p. 14);
  • “The Whitepaper .. contained a detailed list of projects and steps that Telegram and its principals would take to make TON a reality. This included describing at length Telegram’s plans for the TON Blockchain … [it] also described a long list of services that Telegram would develop to improve the functionality of Messenger and of the TON Blockchain after its launch, but that … Telegram had no reasonable prospect for completion in advance of the delivery of Grams.” (emphasis mine; Complaint, p. 18);
  • “The Whitepaper spoke of potential future products and services that investors could use in connection with Grams, but also made clear that these products were not available at the time the Offering began and would not be available by the time Defendants delivered Grams to Initial Purchasers.” (emphasis mine; Complaint, p. 24);
  • “Like other Offering Documents, the Primers made clear that that Telegram’s work would continue for some years after delivery of Grams on the new TON Blockchain and would remain critical for the foreseeable future. Both documents, for example, included a timeline specifying that the ‘[l]aunch of TON Services, TON Storage, and TON Proxy’ would occur in the year after the ‘[l]aunch of Telegram Wallet.’ The 2017 Primer explained that Telegram’s vision will not be ‘implemented and deployed’ until ‘2021,‘ and that even then ‘the continuous evolution of the TON Blockchain will be maintained by the TON Foundation.'” (emphasis mine, Complaint, p. 19; see also p. 24);

As we always reiterate around here, if you do one thing in pitching a utility token offering, don’t state that you won’t get the utility done by the time you distribute the tokens (at least, if its to, or within reach of US purchasers).

Also fairly damning, the SEC observed that far more money was raised than even Telegram itself claimed it needed to develop the blockchain per se, and indeed, Telegram was completely open about the fact that a very large portion of the money would go to other purposes, e.g.:

  • that Telegram would spend a large chunk of the raise on the core (non-blockchain) Messenger app which already exists: “… the $1.7 billion raised in the Offering so far exceeds what Defendants project they will need to develop the TON Blockchain… Defendants stated in offering documents … that Telegram would spend $520 million—or one-third of the funds raised—on Messenger alone between 2019 and 2021.” (Complaint, p. 14);
  • “The 2017 Primer described Telegram’s need for ‘about $620 million to support continuing organic user growth’ for Messenger … ” (Complaint, p. 16);
  • “The 2018 Primer similarly explained that Telegram intends ‘to use the proceeds raised from the offering for the development of the TON Blockchain, for the continued development and maintenance of Telegram Messenger, and for general corporate purposes.'” (Complaint, pp. 16-17)

This represents a significant tactical error, as funds not going to bringing about the initial core “utility” of the constructed blockchain network and token must inherently be a part of some long-term, generalized investment.

(For what it’s worth, I do not place great weight on many of the other “common enterprise” — as well as reliance upon “managerial and entrepreneurial efforts” — points made by the SEC; just because a venture is clearly a common enterprise per se managed by an inside team, it doesn’t mean that a token-purchaser is not purchasing for the sheer utility of that instrument.  This, and related points, are discussed further in this post. But the damage is clearly done with the above complaint points, most based upon express admissions of Telegram itself.)

Even assuming Telegram hadn’t made any of the missteps discussed above, it would still have a problem with respect to delivering grams tokens in an unrestricted, global public offering.  This would be based upon the reality that even if they assert the token was at the time of public delivery a utility token, any doubt as to such (especially in the mind of the SEC) would mean they are potentially unlawfully issuing a security publicly.  And if such is done globally, that means the US general public could be included (and, giving the regulators the benefit of the doubt, therein harmed).

As the SEC put it : “Defendants have committed to flood the U.S. capital markets with billions of Grams by October 31, 2019 … without filing a registration statement for the Grams as they are required to do under the Securities Act of 1933… [selling] billions of securities that will quickly come to rest in the hands of U.S. investors” (Complaint, pp. 1-2).

This is where it becomes apparent that having an exempt US offering of securities, i.e., which is a one-time, non-public event — and/or ostensibly restricted to non-US purchasers — falls short of what is needed to properly enable  US general public transactions (including resales).

III. COMPARATIVE DISCUSSION

Rule 144 under the Securities Act sets forth the holding period of “restricted securities” (most commonly, 1 year), and conditions for their permitted resales.   Rule 144 dovetails with the all-important Section 5 general prohibition on unregulated securities sales, combined with Section 4‘s carve-out of “transactions by any person other than an issuer, underwriter, or dealer,” to create an avenue for allowable resales for un-registered, “private” issuance securities,  as would presumptively be the case for the SAFTs sold by Telegram (and also, potentially, for the subsequently-distributed Grams tokens).

Further, after the 1 year restricted period, one would think these rules imply that restricted securities could trade freely in a “secondary market” (i.e., one consisting of resales, and resales of those resales, etc.)  — and, ignoring for a moment individual US state/territorial securities laws, they can — in principle.

The biggest catch, however (which was roundly invoked in the enforcement against Telegram), is the “underwriter or dealer” part.  If, in actuality, some of the private accredited purchasers (or the offshore purchasers) intend to re-sell their interests in grams to general-public US individuals, they are clearly falling outside the exemptions set up by Rule 144 and Section 4.   Worse, because there is no benefit of the doubt (and no safe harbor) as to not being an underwriter, the burden of proof is on the issuer as to whether every single sale instance is not to a de facto underwriter.  That means (1) it requires litigation (or exhaustive administrative back-and-forth) to prove this to the SEC, and (2) the only practical way to do so is to have procedural protections in place that make it impossible, or at least, vanishingly unlikely, for any purchaser to act as an “underwriter”.

This is where the SEC’s invocation of Telegram’s manner of sale is so devastating in its operation against them, especially that:

  • The lock-ups didn’t run the entire 1 year in any instance (“Round One purchasers agreed that they could not, without Telegram’s prior written consent, offer, sell, or contract to sell Grams that they purchased except in a series of 25% tranches starting three months, six months, twelve months, and eighteen months after they received Grams. Round Two Gram Purchase Agreements included no such restrictions”; Complaint, p. 14);
  • “Telegram also led the Initial Purchasers to expect profits by selling Grams to them at deep discounts from the price Telegram told them to expect on the day of launch, thereby encouraging those purchasers to immediately distribute Grams to the public… Under Telegram’s Formula, Defendants would price the first Gram at $0.10, and every subsequent Gram at an amount one-billionth higher than the prior sales price. As such, Telegram designed the price of Grams to increase ‘exponential[ly].’ Indeed, Telegram sold Grams to Initial Purchasers at a deep discount to an expected market price of $3.62 at launch.” (Complaint, p. 21);
  • On at least one instance of pitching to a prospective purchaser in early 2018, “Telegram spoke of the ‘chance for 0x-50x’ returns on the investments,” a prospect which was explicitly cited by the investor in agreeing to purchase $27.5 million worth of Grams “that had no use and would have no use at the time of launch, demonstrating its intent to profit from the potential increase in value of Grams.” (Complaint, p. 23);
  • “Telegram touted a readily available trading market for Grams, including one leveraging its hundreds of millions of Messenger users; sold Grams to Initial Purchasers at deeply discounted prices from its own projected secondary market price at launch; and promoted the future transferability of Grams into a liquid market”  and”[Telegram] told investors to expect a listing of Grams ‘at the major cryptocurrency exchanges’ in ‘January – March 2019,’ immediately after the ‘December 2018 [p]rojected date for [Grams] to be issued to all investors,’ making Grams almost immediately sellable in open markets, including to United States investors…” (Complaint, pp. 19-20);
  • Many sales to offshore individuals lacked any meaningful tracking of the buyer’s identity, let alone their positioning with respect to the purchase; and grams trading activity was to be allowed — and indeed, promoted as being available on — offshore on run-of-the-mill cryptocurrency exchanges, complete with inadequate KYC of buyers (including, in some cases, not even blocking US individuals!) (see Complaint, p. 3, see also p. 28).

Even worse, the SEC argues (based in part upon the points above) that Telegram affirmatively launched the issuance as an underwriter issuance — in which case, purchasers subjectively not seeing themselves as underwriters is no defense!  (I think, when the SEC cites Telegram’s secondary market listings and touts of such (as well as its hyping of resales), it is at its strongest in making this argument.  But when it claims (as it does on page 26) that the Grams token cannot even become decentralized without underwriter-like resales, I think its case is on the weakest footing.  Similarly, I am also skeptical when it argues that lock-ups are actually evidence of users’ desires to resell, as it does on page 14 — this seems a bit like “having it both ways”).

(And, for what it’s worth, I do not believe the SEC’s repeated complaints of Telegram’s having 170 million users at the outset — and even criticisms of Telegram observing such explicitly as driving “value” or “demand” — are particularly strong.   One could just as easily argue that having such an established user base, scale, and experience of practice imply that the issuer is a mature business, and hence, token purchasers won’t need securities protections.  Compare to how a contract for a new cloud service by Google or its peers is not treated like a security, even if the service is novel.  Nevertheless, there were plenty of other defects, as discussed above).

In theory, all of the above issues would be nullified by the gram’s being, without a shadow of a doubt, a non-security, as of the planned release date of October 23, 2019.  But with any doubt as to its being a pure “utility token”, the above issues compounded the damage for Telegram, and in effect, handed the SEC justification to call for a worldwide halt to the grams distribution — even though the SEC can generally only enforce with respect to securities activity within the US!

These defects render in stark relief the securities compliance pathway taken by Blockstack.  With a Reg A+ filing, Blockstack nullified the temporal question of Stacks’ security status, while simultaneously “sterilizing” the US market with respect to all secondary market resales (whether originating within the US, or offshore — i.e., from run-of-the-mill cryptocurrency exchanges listing Stacks).

Having done a Reg A+ filing, secondary market resales of Stacks are simply allowed;  explicitly, what is issued in the original sale are not considered “restricted securities”.  As a result, the SEC (in my read) essentially doesn’t care whether the Stacks tokens trade on crypto exchanges overseas, because that is clearly not a public market in the US — and if US residents happen to be able to access these exchanges, that is no different than the same persons acquiring the tokens on the secondary market within the US (which, again, is allowed, under Reg A+).

The “catch” is that any organized, formal market-based trading of Stacks taking place in the US will have to be on a regulated securities exchange (at least, until such time as the SEC gives clear guidance that the Stacks token is no longer a security).   No such exchange exists and carries Stacks as of this writing, so only informal trading is allowed in the US in the meantime.  (A related, apparently-prophylactic practice I’m aware of, is that while Blockstack is indeed engaging professional crypto market-makers overseas, they are contractually-agreeing to terminate such relationships the moment a regulated securities exchange becomes available for Stacks tokens in the US.  My guess is that this eliminates potential claims that the issuer is unlawfully “conditioning the market” for the subject security in the US).

IV. CONCLUSION

All in all, for the amounts of money we are looking at being at stake in these two offerings, Reg A+ seems to be an overwhelmingly attractive pathway to address the Securities Act as applied by the SEC to the issuance of a pre-network, but prospective utility blockchain token.  While one can argue that the non-US company Telegram “shouldn’t have to care” about some obscure, untested (again, as applied) US regulatory election to their planned global blockchain token offering, the economics of the situation argues otherwise (particularly after initial funds were raised from US accredited and offshore investors to the tune of tens of millions of dollars).

Indeed, perhaps now that Blockstack has “blazed the way”, the SEC will work out a deal with Telegram that involves wrapping the (now-paused) Grams issuance in a Reg A+ offering (likely plus a fine).

Reg A+ as an affirmative “ICO” pathway aside, the cases of Telegram and Blockstack certainly have made vastly more apparent some important areas of SEC concern having to do with the “market-conditioning” aspects of global blockchain token offerings, as discussed above.

(* Article images courtesy of Wikimedia Commons; CC-by-SA 4.0.  Links here and here).

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Initial Impressions On The SEC’s Big “Digital Asset Framework” and Token No-Action Letter Releases

Important note: While I have read both of the releases discussed below in full, the following still represents a “first take”, and in any case, does not constitute legal advice.

Yesterday was a big day in blockchain legal news, as the SEC put out two releases (combined here) that arguably constitute the biggest advances in token-sale securities law policy since the DAO Report in 2017.

The two releases were a “Framework for ‘Investment Contract’ Analysis of Digital Assets” by the SEC’s new FinHub (providing a guide for determining if a proposed token sale is a security), and a no-action letter (NAL) granted to TurnKey Jet, Inc., for its sale of non-security tokens (i.e., “utility tokens”).

These releases do represent a major categorical step forward, as the SEC is showing it wants to “move the needle” in this area and be of use to entrepreneurs attempting to develop in the space, and because the SEC has not previously granted any blockchain-related no-action letter requests (and I am aware that many have been submitted since 2017).   It is particularly good that the SEC is signaling that they will look at specific projects and give a “yes or no” regulatory coverage answer (presuming the request is formulated clearly and there aren’t too many unknowns, and of course, subject to the SEC’s workload).

However, when looking at the details, the degree of advancement is quite modest, as the substance of the releases doesn’t add much to the state of thinking of counsel working actively in the space (if my experience is typical).

Taking the two releases in turn, starting with the Framework:

1. The Digital Asset Framework

The framework represents an incremental step forward in the process of determining whether a token is a security in that it makes explicit various points mentioned in SEC staff speeches over the past 1-2 years, and considerations close followers in the industry had been hypothesizing about, but it’s not revolutionary.  Mainly this is because, even while introducing some “new” useful factors to the analysis and formalizing some prior proposed ones,  it introduces a lot of implicit uncertainty about the weighting of factors.  Indeed, the FinHub staff explicitly disclaim any binding or specific aspect of the analysis (from footnote 1):

This framework represents the views of the Strategic Hub for Innovation and Financial Technology (“FinHub,” the “Staff,” or “we”) of the Securities and Exchange Commission (the “Commission”). It is not a rule, regulation, or statement of the Commission, and the Commission has neither approved nor disapproved its content.

and footnote 4:

It is not an exhaustive treatment of the legal and regulatory issues relevant to conducting an analysis of whether a product is a security, including an investment contract analysis with respect to digital assets generally. We expect that analysis concerning digital assets as securities may evolve over time as the digital asset market matures. Also, no one factor is necessarily dispositive as to whether or not an investment contract exists.

Thus, despite being the first “end-to-end” compilation of factors by the SEC, it is really still more a tool for it discussion and understanding the SEC’s thinking, rather than providing any sort of determinative yardstick, and thus raises almost as many questions as it answers.

That said, here’s a sample of some of the positive detail of the framework:

Although no one of the following characteristics of use or consumption is necessarily determinative, the stronger their presence, the less likely the Howey test is met:

The distributed ledger network and digital asset are fully developed and operational.

Holders of the digital asset are immediately able to use it for its intended functionality on the network, particularly where there are built-in incentives to encourage such use.

The digital assets’ creation and structure is designed and implemented to meet the needs of its users, rather than to feed speculation as to its value or development of its network. For example, the digital asset can only be used on the network and generally can be held or transferred only in amounts that correspond to a purchaser’s expected use.

Prospects for appreciation in the value of the digital asset are limited. For example, the design of the digital asset provides that its value will remain constant or even degrade over time, and, therefore, a reasonable purchaser would not be expected to hold the digital asset for extended periods as an investment.

Verbiage like that seems almost tailor-made for projects that have very carefully considered how to separate “utility” token sales from “security” aspects and roles, and to take proactive measures to limit unwanted speculative behavior towards tokens (as some of my clients have, including in discussions with the SEC).

A major thematic downside, in my view, was that the SEC reiterated repeatedly points such as that continued “development” of an blockchain network was a factor counting towards a security.  I hope that gets clarified more, because  a factor like this could be taken to effectively mandate that a blockchain digital service provider can’t keep improving their network/service offering in the usual course, which would place such efforts below standard non-blockchain enterprises.

Other mentioned factors of concern include (where “AP” means the project or associated persons):

The digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future.

Purchasers reasonably would expect that an AP’s efforts will result in capital appreciation of the digital asset and therefore be able to earn a return on their purchase.

Purchasers would reasonably expect the AP to undertake efforts to promote its own interests and enhance the value of the network or digital asset, such as where […] AP retains a stake or interest in the digital asset. […] or the AP’s compensation is tied to the price of the digital asset in the secondary market.

These are very broad and open-ended, and the SEC did not make clear to what extent disclaimers might be adequate to dispel such expectations or notions of purchasers (as generally), or whether technical measures would be required, or whether it would require active preventative measures or outright prohibitions of related conduct or features to avoid any of these factors rendering a token sale a security.

An overriding legal concern is that — while it seems reasonable to introduce “new” legal factors in a sector as novel as blockchain — many of the SEC’s suggested factors are not traditional securities law analysis factors, and have little to no basis in statute or case law, so it’s not clear how well they will hold up (but for now, those that don’t plan on challenging them in court have to treat them with the same deference as traditional factors).

Of course, as the SEC said, no one factor is dispositive, but no weighting was provided — explicitly.  This is the sort of lingering ambiguity that makes it clear that even with such a “Framework”, at this stage, token sellers will still be left with no option but to request a NAL in every single case of “utility” token sale.

Finally, here’s an example of a specific non-security token example given by the SEC in the Framework that is, in my view, quite a bit less helpful than at first glance:

… Digital assets with these types of use or consumption characteristics are less likely to be investment contracts. For example, take the case of an online retailer with a fully-developed operating business. The retailer creates a digital asset to be used by consumers to purchase products only on the retailer’s network, offers the digital asset for sale in exchange for real currency, and the digital asset is redeemable for products commensurately priced in that real currency. The retailer continues to market its products to its existing customer base, advertises its digital asset payment method as part of those efforts, and may “reward” customers with digital assets based on product purchases. Upon receipt of the digital asset, consumers immediately are able to purchase products on the network using the digital asset. The digital assets are not transferable; rather, consumers can only use them to purchase products from the retailer or sell them back to the retailer at a discount to the original purchase price. Under these facts, the digital asset would not be an investment contract.

This seems good at first blush, but all the SEC is doing here is describing an internal loyalty points system with blockchain factors stripped out.  But not only does such eliminate most of the innovative elements we have questions about, this is answering a question that really wasn’t asked — which is “are loyalty points systems with no transfers permitted securities.”  The operative question is  more like: “to what extent can you add blockchain transferability to a consumer points system without the digital asset becoming a security?”

Unfortunately, until some of the avowedly-helpful factors that the SEC introduced and reiterated in this Framework receive something closer to a bright-line (or really any line) rule, most of the uncertainty in the space bearing on the “security vs. utility” question will remain (and even worse, the introduction of new factors to “watch out for” might have a chilling effect).  That is because — as the guidance repeatedly makes clear — the final determination integrating all of the factors is just an overall balancing analysis.   In other words, until there is more on-point legislation or judicial opinion, it is simply about the comfort level of the SEC.  And that is not a terribly comfortable place for most entrepreneurs to be.

2. The TurnKey Jet NAL

It represents great progress that the SEC has now granted a NAL to a token seller — and even better that it is for a “utility” token.

However, it is my sense after going through the TurnKey Jet NAL request and response that it was actually a very limited-scope NAL.  In essence, it just requests no enforcement action for a locked-in points platform that happens to be based on a blockchain instead of some other shared database technology (amongst the private network partners).  True, it also has the attributes of (1) a 1-1 token “soft peg” to USD, and (2) a “secondary market” whereby users can resell tokens to each other on the platform, so it goes a little beyond most (but not all) proprietary consumer points systems.  However, because the “lock-in” is rather extensive, namely:

  • tokens cannot be removed from the private network’s wallets (to say nothing of being listed on 3rd party exchanges)
  • tokens may only be re-purchased by the company at a discount
  • tokens will correspond to literal USD balance on deposit
  • token proceeds will not be used for any development or for general purposes (i.e., “overhead” or otherwise)

it’s not clear how much this advances regulatory clarity for a wide swathe of the utility token sector.  Importantly, the SEC explicitly hit on all of the above limiting points in their NAL response, showing that they “cared” about them quite significantly.

Thus, I find this to be a “conservative” grant on the part of the SEC — they are doing little more than assenting to a closed consumer points system that happens to be implemented with blockchain.  They arguably have to do that, because of the “economic reality” dictum of securities law.  Still, such a conservative move as a first step on the NAL front is probably to be expected, and isn’t much of a surprise.

Indeed, the biggest point of substantive regulatory progress the NAL represents may be that it validates that something like a non-security “stablecoin” — at least in the utility token (rather than financial product) context — can be a non-security.

In sum, the SEC releases yesterday are more of a “small step” than “a giant leap”, which raise the question of what the next big foray of the SEC in the token space will be — and likely more immediately, what will become of Kik’s Wells Notice response and prospective litigation with the SEC.  The latter will inevitably answer some of the factor-“dividing line” questions implicated by the releases and discussed above.

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No, Airdrops Weren’t Just “Legalized” in the U.S.

Airdroppin’: Maintain extreme caution when doing this with blockchain tokens in the U.S. (Source: U.S. Air Force photo/Staff Sgt. Brian Ferguson via Wikimedia Commons).

A November 27, 2018 order in the case of ICO-gone-wrong SEC v. BlockVest, LLC (SoCal U.S. District Court), caused quite a buzz, for the ostensible holding that it (tentatively, of course, as this was not a final order) deemed the “airdrop” method of token distribution (i.e., free giveaways) permissible in the U.S.  The order denied an asset freeze that had been requested by the SEC as part of a preliminary injunction.

Undoubtedly, the SEC not being granted the asset freeze was a little bit of fresh air for the beleaguered blockchain fundraising space.  But I have now had a chance to review the BlockVest order of 11/27, and I have to say, there seems to be almost no basis to read into the decision that it is an “approval of airdrops,” or anything even remotely similar.

Indeed, I find it hard to glean from the order anything other than a recognition that substantive, evidence-based objections were raised to the SEC’s allegations of reliance on BlockVest representations by the buyers/token recipients, and against the offer as a de facto security, and consequently, the court was merely denying the SEC the privilege of having its allegations carry for the purposes of a preliminary injunction (which is a very high standard).

In other words, for an injunction which includes an asset freeze, and thus impinges upon the accused’s ability to hire counsel to defend itself, the SEC isn’t entitled to have its view of the facts, and associated legal conclusions, mechanically adopted by the court.

Unfortunately,  it is likely that the presumptions on the same questions will swing the other way for overall case disposition on the merits (assuming no new facts are unearthed), as courts will give a wide berth to a regulatory organization within its own subject domain.  So don’t get out the champagne just yet.

Further, I don’t even see much basis for the construction of the actions underlying the case as “airdrops,” or really, very comparable to them at all.  Many of the alleged investors actually did pay something to BlockVest, and indeed wrote checks (with annotations indicating that these funds were for token purchases); others deposited funds (in the form of major cryptocurrencies) on the platform in exchange for “test tokens.” So not only was monetary consideration provided by many buyers (unlike in actual airdrops), but the tokens weren’t even “live” tokens intended for eventual general public circulation — clouding the basis for the “airdrop” interpretation on two additional counts (and take heed: a future, inchoate issuance of securities can be the basis for application of securities regulation; [1]).

There are other facts that undermine the “airdrops permissible” interpretation of this decision, such as BlockVest’s claim that it knew all the token recipients personally and invited them directly to test the platform (hardly a “general distribution” of tokens, for sure).

Perhaps this order is another brick in the wall in the trend against asset forfeiture, but at the end of the day, it may reflect little more than standard jurisprudence of a court that, refreshingly, didn’t allow itself to get caught up in anti-ICO hysteria.

Footnotes.

[1] Under § 2(4) of the Securities Act (15 USC § 77b(4)) (which refers to “one who proposes to issue any security”), a person is an “issuer” when such person promotes the sale of shares in to-be-created ventures. E.g.  publishers of “Mining Truth” were “issuers” of securities, where magazine included a paper to be signed by interested parties, labeled “indication of possible acceptance,” indicating that the signer may accept shares of stock in the proposed corporation;  SEC v Starmont (1939, DC Wash) 31 F Supp 264.

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House Financial Services – Monetary Policy and Trade Subcommittee Hearing (7/18/18): “The Future of Money: Digital Currency”

Below is a rough auto-transcript of a hearing held last week entitled “The Future of Money: Digital Currency” (video available at previous link).

The witnesses were:

  • Dr. Rodney J. Garratt, Maxwell C. and Mary Pellish Chair, Professor of Economics, University of California Santa Barbara
  • Dr. Norbert J. Michel, Director, Center for Data Analysis, The Heritage Foundation
  • Dr. Eswar S. Prasad, Nandlal P. Tolani Senior Professor of Trade Policy, Cornell University
  • Mr. Alex J. Pollock, Distinguished Senior Fellow, R Street Institute

We have not yet gone through the hearing record exhaustively and produced a selection of “pull quotes” of interest. However, the transcript with links to the hearing video is reproduced here anyway, as it might be useful to some.  (Watch this space for further excerpts and comments, once we analyze the record fully).

TRANSCRIPT GUIDE  AND ADVISORY:

  • The transcript was produced by a text-to-speech process performed automatically by a third party service outside of our control.
  • KrowneLaw does not vouch for its accuracy; indeed, we guarantee it is inaccurate.
  • As such, each snippet of translated text is linked directly to the point in the video at which it occurs (popup in separate window/tab).   Please use this functionality to confirm exactly what was said in each case.
  • The hearing may cover a wide variety of topics; thus, cryptocurrency/blockchain-related terms have been highlighted to assist in quick location of the relevant passages (this highlighting is by no means exhaustive, however).
  • The breaks in the text coincide roughly with changes in topic/changes in Congressperson leading the questioning.  They do not correspond to changes in speaker; thus, each block usually represents multiple speakers, including those on “opposing sides.”  You must listen to each particular segment in the video to determine who is speaking and to get the full context (and therefore, meaning).

Scroll box with transcript follows:

[00:16:01] objection the chair is authorized to declare a recess of the committee at any time and all members will have five legislative days within which to submit extraneous materials to the chair for inclusion in the record this hearing is entitled the future of money digital currency and now recognize myself for five minutes to give an opening statement today we will discuss the future of money and how digital currency may feature in it when discussing the future of money it is pertinent to have a firm understanding of its defining characteristics and history economists define money as anything that acts as a store of value a unit of account and a medium of exchange various objects have been used as money such as seashells giant stone tablets and cigarettes in prisoner-of-war camps commodities such as furs rice whiskey tobacco and corresponding warehouse receipts circulated as money on the american continent in the colonial period prior to america's independence americans imported gold and silver coins from European countries to use in trade and the colonies issued their own species before they and the Continental Congress began experimenting with paper money even the US dollar has evolved since it was declared the standard unit of currency with the passage of the coinage Act in 1792 it has undergone changes in dimensions design denominations issuer and backing notably with the implementation and subsequent abandonment of the gold standard in recent decades money has been electronically stored in bank deposits and transferred with credit cards mobile phones and the Internet cryptocurrency however was designed to be something different cryptocurrency allows users to potentially store value in unlinked store value unlinked from fiat currency on a decentralized ledger and securely transact directly from person to person across a peer-to-peer network of computers apart from a commercial or central bank the central question before us today is this our digital currencies simply a new way to hold and transfer value that will have a limited impact and nisha appeal or will it or derivative of it have a far-reaching transformative effect that will change our economy forever cryptocurrency has existed for a decade since the appearance of Bitcoin in 2009 but has flown under the radar for most of its history four years after its creation it was worth little had few users and garnered sparse mainstream media attention however the media and consumers have been taking note with a stark rise in value in 2017 Bitcoin grabbed headlines as it reached a valuation of around 20,000 u.s. dollars last December also reported our controversies such as bitcoins involvement in purchases on the online black market the Silk Road and donations funding WikiLeaks the theft of hundreds of thousands of bitcoins from the exchange mount GOx and reports that hackers have stolen 1.6 billion dollars from cryptocurrency accounts over the last seven years Congress must pay close attention to the developments in this space the capital markets securities and investment subcommittee held a hearing examining the crypto currencies and initial coin offering markets in March of this year and the Terrorism and illicit finance subcommittee held a hearing to discuss illicit use of virtual currency and the law enforcement response last month as chairman of the monetary policy and trade subcommittee I am particularly interested in any impact digital currency may have on monetary policy and the international financial system we will discuss its use both in the United States and abroad thus far some countries like Vietnam and China have banned or restricted it altogether others such as Switzerland and Malta have fostered it with a mostly hands-off approach and regulatory guidance and others have adopted it including Tunisia and Ecuador by issuing their own central bank digital currencies how odd the United States government approach this new technology is of great importance some believe as former Fed Chairman Ben Bernanke highlighted in a 2013 letter to Congress that digital currency innovations quote may hold long term promised particularly if the innovations promote a faster more secure and more efficient payment system unquote some have suggested that cryptocurrency may be a catalyst for the elimination of physical currency and a foundation for a move to a purely cashless society others say that cryptocurrencies are not suitable replacements for coins and banknotes such as European Central Bank executive board member Benoist been away coy in the chair of the Bank for International Settlements market committee Jacqueline Lowe who in a joint article in The Financial Times entitled Bitcoin not the answer to a cash flow society called crypto currencies quote something of a mirage unquote cryptocurrency has attracted advocates critics sceptics entrepreneurs investors and attention from media government agencies and law enforcement today there are well over a thousand different crypto currencies with various characteristics together comprising over 250 billion dollars of total market capitalization well cryptocurrency be the future of money are they in a bubble that will burst or even just a passing fad these are the sorts of questions we will attempt to address today with our witnesses the the chair now recognizes

[00:21:45] mr. foster that for five minutes for an opening statement Thank You mr. chairman

[00:21:52] and thank you to our witnesses I'll be brief because I am actually very interested in this topic have been for a while and I'd look forward to the testimony of the witnesses and hope to hear about currencies that are not only pure crypto but asset-backed crypto and potentially digital fiat currencies and most significantly digital fiat currencies I'm concerned that if a significant central bank could issue a digital currency that it would have the potential to supplant the United States dollar now for many transactions and even for as the reserve currency around the world and despite the reports that they're exploring at countries like Russia or Venezuela are not really credible economies that could issue fiat currencies that would supplant the dollar but if however the ECB no weird issue digital euros then I think the entire world would very rapidly adopt that for many digital transactions now which should have benefits to consumers and a number of risks associated with that as well and if there is really a credible threat that a digital foreign currency would supplant the dollar we have to be prepared to respond to that threat I look forward to hearing from witnesses on the economic feasibility of another currency supplanting the dollar and whether digitization could be a catalyst in such a transition I also look forward to any thoughts the witnesses might have on some of the decision points that have to be made when you decide to create them for example a fiat currency the currencies could be traceable or not they could be traceable only with a court order whether or not trades could be busted in the same sense that a credit card purchase can be broken if you convince some entity that the that the transaction was fraudulent and who makes that call under what circumstances these are what I see the really important decisions that cannot be evaded when we when we design a digital currency and so the issue of anonymity is is really crucial and at the heart of this as well as what sort of authentication a person will have to present to transact that anything so I look forward to this hearing very much and to yield back gentleman yields back

[00:24:13] and the chair recognizes for the

[00:24:16] remainder of the time mr. shermin for opening statement two-and-a-half minutes blockchain is a good technology but it can be used to track and transfer sovereign currency there is nothing that can be done with cryptocurrency that cannot be done with sovereign currency that is meritorious and helpful to society the role of the US dollar in an international financial system is a critical component of us power it brought Iran to the negotiating table then we argue about whether we got a good enough deal or not in the jcpoa we would have nothing had it not been for the role of the dollar we should prohibit us persons from buying or mining crypto currencies Mining alone uses electricity which takes away from other needs and/or adds to the carbon footprint as a store as a medium of exchange cryptocurrency accomplishes nothing except facilitating narcotics trafficking terrorism and tax evasion some of its supporters delight in that that if you can disempower the US government from being able to prevent terrorism narcotics trafficking and tax evasion you have somehow struck a blow for liberty that is reason enough to ban it but its role as an investment is at least as bad we have certain animal spirits in our culture or willingness to take a risk to place a bet this can be harnessed by gambling casinos which at least pay very high local taxes and created a city of Las Vegas out of a desert we can better yet harness those animal spirits to get people to invest in risky stocks startup enterprises and provide the technologies and jobs of the future or we can see those animal spirits spent doing nothing but helping create a market for tax evaders narco terrorists and others who find that the US dollar is not to their liking at a very minimum we need investor protection if we're going to have people invest in crypto currencies and crypto offering memoranda and crypto registrations are not would be considered outright fraud and reason for incarceration if they were issued by somebody selling stocks bonds or any other investment and finally there is sin I sin your age the money that we make as a country because we're the reserve currency because we can issue a greenback that does not yield interest there are people who are

[00:27:08] alive today because of the profits the US government makes on that whether it be our to fund defense or medical research all of that gets diminished with cryptocurrency I yield back

[00:27:19] the gentleman's time has expired today we welcome the testimony of dr. Rodney Garrett who holds the Maxwell Sea and mareep Elish chair on economics at the University of California Santa Barbara he has served as a technical adviser to the Bank for International Settlements a research adviser to the Bank of England and as a former vice-president of the Federal Reserve Bank of New York during his time at the Federal Reserve Bank of New York he Co led the virtual currency working group for the Federal Reserve System after leaving the the Federal Reserve Bank he consulted for payments Canada and r3 on project Jasper a proof of concept for a wholesale interbank payment system mr. Garrett received his PhD from Cornell dr. Norbert Michele who is the director of the Center for data analysis at the Heritage Foundation where he studies and writes about financial markets crypto currencies and monetary policy before rejoining Heritage in 2013 Michele was a tenured professor professor at Nicholls State University's College of Business teaching finance economics and statistics dr. Michele holds a doctoral degree in financial economics from the University of New Orleans dr. Ezra Prasad is the t'lani senior professor of trade policy and professor of economics at Cornell University he is also a senior fellow at the Brookings Institution where he holds the new century chair in international trade in economics and a research associate at the National Bureau of Economic Research he is a former head of the imf's China division his extensive publication record includes articles and numerous collected volumes as well as top academic journals he has co-authored and edited numerous books including on financial regulation and on China and India finally mr. Alex Pollock is distinguished senior fellow with the R Street Institute welcome back to the committee mr. Pollock providing thought and policy leadership on fine natural systems cycles of booms and busts financial crises risk and uncertainty central banking and the politics of Finance Alex joined our street in January 2016 from the American Enterprise Institute where he was a resident fellow from 2004 to 2015 previously he was president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004 Alex received his master's in philosophy from the University of Chicago and a master's of Public Administration degree in international affairs from Princeton University each of you will be recognized for five minutes to give an

[00:29:51] oral presentation of your testimony without objection each of your written statements will be made part of the record dr. Rodney Garrett you are now recognized for five

[00:30:00] minutes if you can just push the button there to turn on your mic thank you

[00:30:10] Thank You chair bar ranking member Moore and members of the subcommittee the convenience of electronic transfers has led to a decline worldwide in the use of cash this is particularly true in countries where systems for transferring commercial bank deposits are more advanced Sweden's mobile payment systems wish has been adopted by over 60% of the population and cashews and transactions has fallen below 2% by value countries around the world are introducing their own faster payment systems including the recently launched real-time payments platform in the United States at the same time PayPal venmo and other private mobile payment platforms continue to improve convenience and speed of person-to-person and retail payments by leveraging conventional financial market infrastructures it seems likely that the use of cash will continue to fall and it's worth noting that there is a tipping point at which even if consumers seek to use cash businesses and banks will not want to deal with it what happens then one possibility is that people will be content to transact primarily and commercial bank deposits and things will be business as usual with a much smaller cash component to the monetary base another possibility is that people will demand direct access to some form of digital central bank issued money as a replacement for cash and the third possibility is that well people people will turn to privately issued crypto currencies like Bitcoin these options are not mutually exclusive nor are they independent the adoption rate of Bitcoin will depend not only on its performance as a money but also on the alternative forms of digital money that the central bank provides if consumers perceive that they have inadequate access to a cash like medium of exchange then they may then they may be more inclined to turn to alternatives on the other hand if the central bank offers a digital form of central bank money to the public with sufficient cash light properties then perhaps this will appease those who miss cash central banks are currently evaluating numerous options for digital currencies not just in response to the shift away from cash but also for meeting core objectives and the enhancement of financial market infrastructures ongoing proofs of concept by central banks and private partners consider the use of central bank crip central bank crypto currencies in wholesale systems only these applications are driven by efficiency and cost considerations and have minimal monetary policy implications in these opening remarks I will focus on the merits of a widely accessible retail oriented central bank cryptocurrency that could be used for person-to-person and retail transactions as suggested in blogger JP Kony fed coin proposal a retail central bank cryptocurrency could transact like Bitcoin however instead of having a fixed money supply rule the Federal Reserve would control the creation and destruction of these coins crucially there would be one-to-one convertibility with cash and reserves and hence a retail central bank cryptocurrency would not suffer from the high price volatility that undermines the usefulness of Bitcoin is a store in value and medium of exchange the Fed could also choose to implement a cryptocurrency on a per mission blockchain which means transaction validation could be performed by vetted actors who are accountable for their actions without costly proof-of-work proposals to increase access to digital central bank money have been made before Nobel laureate James Tobin proposed giving the public access to deposited currency accounts at Federal Reserve Bank's over three decades ago a number of things have changed since Tobin's proposal as I mentioned the use of cash has declined a major financial crisis may have changed some people's attitude towards commercial bank deposits and technological advancements offer the potential for issuing digital central bank money in a new way with enhanced features I offer two examples first the peer-to-peer aspect of cryptocurrencies could allow central banks to provide a digital money with anonymity property similar to those of cash whether or not the central bank would want to do this is a complicated issue that requires balancing legitimate demands for individual privacy against concerns related to tax evasion and other criminal activities second there is the potential to approve upon cash by creating what advocates of cryptocurrencies call programmable money programmable money allows trading partners to hardwire the terms and conditions of trades into their transactions so that they may be executed upon fulfilment of these conditions without relying on third parties this is particularly useful for transactions that span multiple legal jurisdictions any decision to implement a retail oriented central bank cryptocurrency would have to balance potential benefits against potential risks a common objection to expanding access to central bank money is that it could disintermediate banks however it is also plausible that it could produce healthy competition the risk of excessive dissident or mediation would be mitigated by making any new form of central bank money more like cash and less like deposits thank you and I would be happy to answer any questions thank you dr. Norbert Michelle you are now recognized for five minutes

[00:34:59] chairman bar rep for members of the committee thank you for the opportunity to testify today my name is Norbert Michele I'm the director of center the director of the Center for data analysis at the Heritage Foundation and the views that I expressed today are my own they should not be construed as representing any official position of the Heritage Foundation cryptocurrencies have rapidly expanded since the introduction of Bitcoin in 2008 and their underlying technology a distributed database that allows digital assets to be transferred without a third party intermediary holds the potential to transform the financial industry this innovation should be fostered not smothered my remarks today will provide four specific points relating to the use of cryptocurrencies cash and other alternative forms of money first electronic means a payment have become more widespread as technology has changed but paper currency cash is still widely a still a widely you form of payment the demise of cash has been widely and steadily predicted since at least the 1970s yet it remains a preferred method of payment for many people Federal Reserve reports show that cash is still the most frequently used form of payment in the US and that it plays a dominant role for small value transactions it also remains the leading payment instrument for expenditure categories such as person-to-person gift transfers food and personal care supplies and entertainment and transportation expenditures as the charts in my written testimonies show both the volume and value of currency in circulation in denominations including one all the way from one to one hundred dollar bills have steadily increased since the 1990s that's increased so retail establishments that prohibit customers from using cash as was recently reported in a Washington Post story do so at their own peril but this danger this this threat of consumers using an alternative form of payment possibly at an alternative place of business is exactly as it should be competitive processes should take place so that businesses and consumers can discover the best means of payment the fact that cryptocurrency is a new option for making payments though it is in its infant stages should be embraced that brings me to my second point which is that the federal government should not step in and tilt the playing field it should treat cryptocurrency in all other forms of money neutrally this means that it should not be so any particular legal advantage on any particular alternative form of money and that it should remove all legal barriers to using alternative forms of money removing capital gains taxes from purchases with alternative currencies including crypto currencies and foreign currencies would be a major step towards leveling that playing field between alternative forms of payment to further level the playing field Congress should even consider allowing the US Postal Service and other government agencies to accept these alternatives my third point is that these competitive forces are the forces that push entrepreneurs to innovate and improve products specifically to satisfy their customers they also expose weaknesses and inefficiencies in existing products the same comported the same competitive forces can and should be used to improve money the federal government's partial monopoly on money limits the extent to which competitive processes can strengthen money and it exposes our money to the mistakes of a single government entity nothing can provide as powerful a check against the federal debasement of money as a threat of competition from a viable from viable alternative forms of payment my final point is that centralizing cryptocurrencies within any government agency makes little sense the technology promises potential benefits because of its decentralized nature centralizing the technology at a central bank offers no particular advantage over a more traditional electronic database furthermore Congress and the administration should do all they possibly can to ensure that our central bank never offers retail bank accounts to the public whether via a central bank backed cryptocurrency or via a more traditional digital form of money implementing such a policy would give the federal government a complete monopoly of money and effectively nationalize all private credit markets no private entity would be able to compete with the federal government for funds even Ken Rogoff a staunch advocate for phasing out cash and forcing people to use only one type of digital money admits that the biggest threat to the value of currency is often the government itself that Rogoff quote is quite frankly an understatement giving the federal government the power to directly take money from its citizens with a few computer keystrokes in the name of some vague goal of stabilizing the economy simply amounts to the death of economic freedom is a terrible idea and it's Congress's duty to protect Americans from those sorts of tyrannical acts thank you thank you and now dr.

[00:39:56] Prasad you're recognized for five

[00:39:56] minutes Shimon bar and members of the committee thank you for the opportunity to testify in front of you on the implications of digital currency broadly defined for the US economy and financial system I should note that two years ago I faced an important choice one afternoon whether it is spend that afternoon buying Bitcoin which is not a trivial process or to start working on a paper about Bitcoin and digital currency for better or worse I chose the latter so today I have no Bitcoin but I do have a paper about the implications of digital currency it's useful to frame our discussion around three questions one should the government or the Federal Reserve provide services that the private sector can provide more efficiently and that is something that a cryptocurrency for instance could provide second what are the implications for the Fed in terms of its monetary policy objectives of low inflation high employment and most importantly financial stability if digital currencies become widely prevalent and third what are the implications for the u.s. role in the global financial system as when looks at the landscape of cryptocurrencies it's useful to keep one distinction in mind that is the distinction between central bank digital currencies which could use the same cryptographic technology as something like Bitcoin and then non official crypto currencies which are essentially created in the ether or a digital asset with no backing behind them unlike the US dollar which does have backing now there are many proponents of the US and other economies moving to digital forms of fiat currencies and I think there are some legitimate arguments about how that could reduce activity in the shadow economy reduce illicit activities improve the tax base and in some ways even make monetary policy more efficient even at the lower bound where the Fed may not be able to use interest rate policy anymore if all of us were to have non-interest bearing deposit accounts with the Fed which is fast becoming technologically feasible and this is what Professor Tobin had had suggested this would make a certain aspect of monetary policy implementation a lot easier but it's worth thinking about money in a broader sense money is created by the central bank but also to a much greater extent by commercial banks and I think this is going to have a serious implication for money creation in the economy because as new technologies new financial technologies more broadly eat away at the standard business model of banks and its non-bank financial intermediaries start playing a major role in the financial system the question remains what role banks play because those are the institutions that the Fed has direct control over and that are responsible for creating loans and therefore for creating deposits and a very important part of money the other aspect in terms of thinking about Fed the Federal Reserve's digital currency or any central banks digital currencies what it does to the payment systems right now the Fed has no role in retail payment systems it has a very important role in intermediating financial transactions among the major financial institutions in terms of clearing and settlement of their transactions with non-interest bearing deposit accounts one could well end up in a scenario where the Fed essentially starts managing a retail payment system as well it's not obvious that this is the ideal solution but it's worth thinking about the alternative if in fact we had a situation where both the retail payment systems and also the wholesale payment systems among banks are managed through distributed ledger technology which might become feasible then what happens in a time of crisis of confidence in normal times is actually might lead to significant gains in efficiency again the private sector might do far more efficiently under the government the management of these payment systems but the issue of trust in the central bank especially at a moment of crisis of confidence becomes really important so if you look around the world and think about central banks like Sweden that are thinking about introducing a digital version of the fiat currency the objective they have in mind is not to intrude or reduce innovation but basically to provide a backstop to the payment system to make sure that is not all in the private sector and subject to a crisis of confidence there are other concerns related to regulatory arbitrage and the possibility of cross-border capital flows again illicit as well as licit that could be facilitated which would certainly improve efficiency but also potentially also make underground activities easier to execute and finally on the issue of the u.s. dollars role as a global reserve currency there I worry less I think it's possible that if other countries were to issue their own currencies in digital form you could have the medium of exchange shifting towards non official crypto currencies towards other currencies but what preserves the US Dollars role as the ultimate global safe haven is not just the its role as a medium of exchange but its ability to serve as a safe haven and that requires us institutions which I think are still pretty strong and are going to retain foreign investors stress so I think as a store of value the US dollars will remain secure for now thank you thank you mr. Park you're recognized for five

[00:45:14] minutes thanks mr. chairman and mr. foster members of the subcommittee this hearing poses really interesting questions which to answer require some speculation and guessing along with thinking we hope among the intriguing question is whether Bitcoin or another cryptocurrency could become a successfully privately issued fiat currency that would mean being widely accepted it constantly used in payments and settlements used to denominator and other enforceable contracts and people going around and not asking what's the price of Bitcoin but what's the price of this in Bitcoin we're way away from that but it's imaginable as the chairman said the history of money demonstrates a wide variety of monies that have been used there have been numerous historical examples of private currencies but to my knowledge there's never been a private fiat currency those are reserved for the power of governments for private currency is an example circulating notes of state chartered banks were common in the 19th century you might have carried in those days in your wallet a five-dollar bill from the third state bank of Scone Creek for example or hundreds of others but all such notes were banked by the loans and investments in capital of the issuing bank they were not fiat money the dominant historical trend in money has been to create ever more central bank monopoly of currency over several centuries of development will the new and ubiquitous computing power of our time reverse this trend and create more competition and currency with dr. Michelle and the famous economist Friedrich Hayek think it might be a good idea but I don't think it will happen Bitcoin theorists imagine it will but I believe it's easier to imagine moving in exactly the opposite direction that is toward even greater monopolies by the central bank through digital money mr. foster made the point it's not only our own central bank but other powerful central banks we might think about in this context and many central banks are indeed interested in having their own digital currency so the general public not only banks could have deposit accounts with the central bank in addition to carrying around its paper currency and the appeal of this idea to central banks is natural it would greatly increase their size role and power with current technology this would clearly be possible the central bank could have tens of millions of accounts with individuals businesses associations invicible governments and anybody else and there's not much standing in the way of that in terms of pure financial technique but would it be a good idea no it wouldn't in such a scheme the Federal Reserve would be in direct competition with all private banks it would be a highly advantage to government competitor and it would be regulating its competitors that's what central bank evolution tried to develop out of in the American banking system they're about twelve trillion dollars and domestic deposits could a Federal Reserve digital deposit account system grab say half of them why not and it'd be six trillion dollars which would expand its balance sheet to ten trillion dollars now what's key in this is to remember that on if you have deposits on one side of your balance sheet you have something else on the other side so what would the Fed do with this mountain of deposits and as as my friend Norbert said well it would have to have to make investments and loans it would become by this means the overwhelming credit allocator of the American economic and financial system I think we can safely predict its credit allocation would unavoidably we politicized and the taxpayers would be on the hook for its credit losses the risk would be directly in the central bank as opposed to central bank support of somebody else so as as norbert said i think to have a central bank digital currency is one of the worst financial ideas of recent times still it's quite conceivable to think of as a possibility and it's good for us to think about it in conclusion I think if we look at the money of the future digitalization will continue but I don't think the fundamental nature of money will change it will surely be the monopoly issuance play it by a central bank it might be a private currency backed by reliable assets I don't think it will be a private fiat currency like Bitcoin and as we consider all this an increase in the monopoly power of central banks which already have too much should be avoided and thanks a lot for being able to share these views thank you for your testimony in the chair now recognizes himself for five

[00:50:33] minutes for questioning let me just start with this idea of cryptocurrency potentially supplanting or displacing US Federal Reserve notes as though as a as the world's reserve currency and this is for anyone who wants to chime in with greater use of electronic payments and the advent of digital currencies do you think demand for US Federal Reserve notes will decrease and what what implications does that have for the US dollar I think if you look at why the US dollar is as strong as it is and is in demand as it is you have to look beyond just the fact that we have a Federal Reserve that prints Federal Reserve notes we have an economy with strong property rights especially relative to many other countries in the world we have incredibly developed well developed industrialized infrastructure here and as long as you combine those things and have a dynamic economy then the the assets of that kind of that economy including the money that's predominantly used in that economy are going to be sought-after so that's what you should focus on if you want people to want our money if you want people to want to use our money and there's also a downside to being the the world's reserve currency and that's that we can basically sort of continue the fiction that we can print as much as we want and lend as much as we want and that's frankly not a good idea so I that's just not the way that I would think of those things anybody else want to comment on that mr. Paulk another way to think about that is that the United States does have has had and continues to have as my old friend John Macon used to say a competitive advantage in wealth storage services and that's a an advantage it arises out of social infrastructure all the things that Norbert said rule of law enforcement of a contract a strong financial system and of course a powerful government enforcing all of that and I think that will continue but we talked about bank notes and US dollar paper currency does circulate around the world as we know nonetheless I think the electronic forms of money certainly in the wholesale markets will become ever more dominant in spite of the advantages in some situations that paper currency has like privacy dr. Prasad do you want to it is difficult to see an asset that has no intrinsic value and no backing by the government maintaining value as a store of value the initial promise of something like Bitcoin is said me it might become an effective medium of exchange and that promise hasn't quite panned out because it turns out that it is very inefficient and very costly to transact using Bitcoin so in fact many of the non official crypto currencies that are gaining more traction as mediums of exchange are in fact ones that are backed by fiat currencies or other other forms of backing so there is one called tether for instance which is backed one for one with the US dollar and that is beginning to get a traction as a medium of exchange so ultimately the US dollars were just pointed out is maintained in its dominant role through u.s. institutions and the trust in the Federal Reserve let me follow up by basically well by starting with a more kind of fundamental question you talked about the volatility of digital currency and maybe that is the principal reason why it's not the best medium of exchange right now or store value but and it's very core is our crypto currencies money and and and by anyone to chime in on this and if not if crypto currencies are not money do they substitute as money do they function as money substitutes dr. Garrett yeah on that point I would point to Hayek who who didn't you like the word money as much as he liked the word currency are youing that that's a property so I think can have currency it's a different extent and so is Bitcoin money well you know I you know for regulatory purposes I mean we may not want it different to define that way the IRS CFTC has defined it as a commodity because that's necessary for for regulatory purposes but in terms of the conceptual idea of is it money it is to some extent but it's not currently a very good one for the reasons that have been articulated it's not very good as a medium of exchange because the price is so volatile that means that or a store value but as a medium of exchange it's not good because if the price is if we think the price is going to go down I don't want to receive it and if I think the price is going to go up I don't want to spend it so this volatility undermines its features both as a store of value and my time is about ready to expire but it would would what is properties as money improve what is quality as money improve when its volatility declined based on adoption rate is adoption rate all that is required to improve its qualities to get to money yeah I mean people have to start using it for transactions I mean I mean if that happens then the price volatility might start to decline the adoption rate has a lot to do with the way Bitcoin itself is set up has a lot to do with its own volatility but that's only one cryptocurrency but yes so I would just in general say yes the adoption rate has a lot to do with it my time is more than expired I will now recognize dr. Foster for five minutes thank you and thank our witnesses again um you know recently there were reports in the press the estimates of a about 20% of all Bitcoin had been lost which strikes me as implying that whatever government or central bank issues digital fiat currency if that was a representative numbers it would be a tremendously profitable enterprise to be a if if 20% of your cash never you know came back to be redeemed and that's in addition to the interest expense if there is no interest paid on these digital instruments and so it strikes me that whatever country starts doing this and becomes a de facto standard is going to have a permanent cash cow and do you see anything wrong with that analysis and Iverson and I'd say for any issuer of currency you like to have your currency lost or put away someplace you remember American Express checks which were kind of currently used to used to encourage you to put them in your attic and save them for the future which was tremendously profitable for American Express and you know and the other there have been some concern here that somehow there'd be a big evil government monopoly taking all over all banking functions it seems to me it would be pretty self limiting if there was no interest paid on these things yeah average person would maintain just a convenience level amount of this and not have all of their net worth in something that paid no interest and so it seems like you just have a reasonable fraction of everyone's net worth usable for short-term transactions and and then they would separately in a very competitive banking and investment environment allocate the main bulk of their of their investments elsewhere do you see anything wrong with that analysis Yes Doctor yes I do I think the Fed would pay interest just as they do I'm sorry yeah well as they don't on cash yeah just to be clear the notion that is being floated right now is of non-interest bearing deposit accounts right now this is not clear proposal there are different ways of thinking about how to set up a central bank digital currency but the notion of deposit accounts is of non-interest bearing deposit accounts so the concerns that you could have this asset superseding other assets is highly unlikely because again it will be a zero nominal interest rate yield instrument

[00:58:28] just like cash currently is in regard to your concern about potential technological malfeasance this goes back to the 7th century when paper currency was printed when counterfeiting was a prior concern and that's remain to this day one could argue that digital forms of fiat currency could reduce the concern about counterfeiting of paper currency but they are on the flip side and in most issues here there is a one side on the other side but the flipside here is that certainly they would make them very vulnerable to technological hacks and this is why I think most central banks are very concerned about moving forward very aggressively with this because of technological vulnerabilities that are potentially out there you know and so the the promise of blockchain is that it provides essentially a non falsifiable ledger that that would prevent a lot of malfeasance I think the kind that you still will I think forever be worried about is the business of authenticating the person who has access to move these balances around and and operate that system and that's remains an unsolved problem in the digital world is you know how you really oughta get yourself for different levels of transactions dr. Garrett I'm what how does actually Sweden handle this issue in their proposal you know for example in the Swedish proposal do swipe fees just disappear and that you can you can pay and how do you deal out of Sweden deal with a problem if someone steals your cell phone or your identity somehow and proceeds to spend a bunch of money you know is there a mechanism to get your money back when a fraudulent transaction has taken it away from you I think if you're regarding to the to the current switch system this is a system that's run by the central bank in cooperation with private banks so these are these are still centralized accounts so in the event that your your cellphone was was lost you would still have access to to go to the bank reveal your identity and and and get your account reinstated or you could probably just do that online so that the sweet sweden has has has issued as something called an e Crona report where they're considering alternative new technologies to deal with the replacement of cash but those are still just proposals okay and among those technologies that they're considering is a store value technology and in China which has just massively apparently adopted digital transactions for consumers at least that is that essentially a on account of the two big players whose name I forget to only pay and whatever the other one is so these are essentially everyone has a balance on their and I pay you by transferring some of my balance in all II paid to you or is there some government operation behind it or central bank operation behind in Li Chen essentially is based on using the WeChat platform and the Ali pay platform but with balances that are already at your bank account so you can link it to your bank account what Sweden is considering is two options say they register based system where you have this electronic deposit accounts like I mentioned or a value based system are essentially a download digital cash onto your electronic wallet which could be like a credit card so those are the two options in Sweden that are being considered thank you Yeomans time has expired the chair recognizes the vice chairman of the subcommittee mr. Williams from Texas Thank You mr. chairman and thank all of you for today's hearing we're in the exciting first stages of the digital currency movements adaption by mainstream stakeholders and it's become apparent to many that blockchain and other new technologies is the digital currency space offer solutions have the potential drastically alter the financial sector that does business as as Congress and regulars determine how best to treat these emerging products we must be mindful of the impact our actions have on innovation and the free enterprise at the same time however it's important that policymakers keep in mind the legitimate governmental interest in preventing the use of anonymous digital currency by those who wish to do us harm I look forward to discussing with the experts today on the best path forward so my first question dr. Michele is you state in your testimony that Congress had worked diligently to eliminate tax and other legal impediments to the development of alternative currencies as well as new applications for blockchain technology what are the impediments to development of alternative currencies new applications for blockchain technologies and what can Congress do about them I think the main one honestly I do believe is capital gains tax the fact that you have to contain keep track of basis in every single transaction you would make that's a that's a major impediment to using anything other than the US dollar for your transactions so that's the biggest one otherwise regulator on a regulatory side I think if we look at ESA Bank Secrecy Act any money laundering laws ensuring that nothing is treated differently yes it is true that criminals have used Bitcoin but criminals also have used airplanes computers and automobiles we shouldn't criminalize any of those instruments simply because criminals use them those components I believe are the main barriers to using tutto a more widespread adoption of these things in the u.s. thank you my next question is dr. Garrett your testimony presents three offices for consumers in the event that cash is no longer available to them number one used commercial bank deposits for everyday transactions number two demand direct access to gentles digital central bank issued money and thirdly turn to privately issued cryptocurrencies so what would cause consumers to choose options 2 and 3 when option 1 is an existing from major technology that has already become an increasingly convenient as a payment method so so first of all let me say that I I agree with what you said at the end there I mean there's this there's nothing wrong with our current banking system and people have been very and as I mentioned in my testimony new means for transferring commercial bank deposits are constantly arising it's increasing the ease with which we make not only person to business payments but particularly peer-to-peer of payments person-to-person payments so in those scenarios all I outlined the first scenario is probably the most likely but as cash actually disappears that starts to create problems in a society Sweden is currently dealing with this and the governor of the rich Bank recently wrote an opinion piece where he talked about some of the pain points that are that occur when casual and physical cash really starts to disappear and when stop receiving it and so what I'm really talking about is that that future scenario and at that point the central bank has to decide if it wants to withdraw completely from providing a payment device for the general public or whether it wants to offer some sort of digital alternative and one of those digital alternatives could be possibly down the road some form of crypto currency that's it's offered by the central bank and the primary reasons for doing that I think one would be if you wanted to allow some type of privacy component within transactions of this currency like it's currently possible with cash subject to limits and as I said balanced against the risks of tax evasion and criminal activity these are the options that the central bank will ultimately face and and and my argument is that these are something that we should be prepared for okay let me stay with you dr. Garrett with the dozens of digital currencies out there all the different attributes that make classifications difficult what is the appropriate framework for us to use if Congress approaches legislation addressing the digital currency well that's a very difficult question that's why I ask you to you well there's people have the ability to issue these private currencies and they and they're going to exist and I think just like dr. Michael said one can't make something illegal just because it might be used for illegal purposes what I'm arguing is that the is that you know I believe that the central bank does a good job at providing payment services and not only just at the interbank level but also for small payments by the public and I think the central bank should continue to provide the best possible product along those lines and what I'm arguing is is that in a future date that best possible product might involve some of these new technologies but but issued by the central bank's to me remain competitive with those payment devices as opposed to some of these private currencies which which you know our less able we're less able to monitor and and less able to tell men's time has expired that the chair recognizes the gentleman from California mr. Sherman it seems like some think tanks demand that every turn that we do things that make the federal government less able to meet its financial obligations and then they demand that we have a extensive and expensive foreign policy that costs well over a trillion dollars there's no way to square that unless we abolish Social Security and Medicare we have moved from a gold from 2,000 years ago to drafts and paper currency symbolizing gold to wear the paper currency itself has value and now for many decades what has value is paper that represents the paper I pay my rent with a check which represents paper dollars which as recently as the 1930s could be converted into gold but can no longer be and we now have an opportunity to disempower the federal government and to move that power to those a hostile to it the we need a medium exchange we need a unit of value the witnesses have demonstrated that the dollar is much better at that for honest citizens but crypto currencies offer unparalleled advantages to nations that the US government wants to sanctioned for their terrorist activities to tax evaders and criminals mr. pollak what is the this seems to be a solution looking for a problem what can an honest citizen not do to store value to effectuate a transaction I can be in the smallest hamlet in rural India and use my Visa card I've never had a problem paying somebody unless they didn't have the money so it's a good we have pretty efficient mostly digital transfers of dollars every day what's the problem we're trying to solve except for the problem that the narcotics dealers have the I think the proposal being made for private fiat currencies which as I said congressman strikes me as an unlikely outcome a private fiat currency as opposed to a convertible currency is to give optional ways of settlement for anybody but I mean I've got a means of settlement called the dollar what is the great failure and you have another one called the euro and I have many many choice you 100 views you have leases of gold so so what problem do I have that they're trying to solve unless I'm a tax evader or a narco-terrorist I don't think we can go first of all I'm not pushing I'm not pushing as you know this solution I am trying to illustrate that it is a solution only to the problems of tax evaders criminals and terrorists but I you might and it offers an opportunity for profit by speculators speculating on a currency whose sole value is to help by the aforementioned near do Wells go ahead you might argue that people should deserve just as I think dr. Michel did and in my written testimony there's a quote from Friedrich Hayek on this the freedom to choose the denomination of the transactions they want to they want we should allow people to own guns in many circumstances but if the sole advantage of a particular gun is that it has a special tape on it to prevent finger prints from adhering and you would say the honest citizen who wants to hunt wants to make sure that the deer cannot identify the finger prints of the hunter I would say the sole benefit of that particular tape on that particular gun is to facilitate criminals what other than facilitating criminals and allow people place bets on the value of some of a of a criminal tool I mean who can speculate the value of burglars tools what does this do what problem does it solve can you identify one because I can't I I don't know the extent to which crypto currencies are used in this criminal way I suspect they are some to some extent but so is cash yes rifles are chiefly used for hunting rifles with design not to have fingerprints on them or prey usually predominantly used for crime the gentleman's time has expired and the the bells signal that boats have been called on the House floor we will recess for votes in a moment but we will go to mr. Hill for five minutes of questioning then we will recess and we will return and for members who have not had an opportunity we will reconvene for the remainder of the hearing for your questions after votes at this time we will ask mr. Hill for his five minutes of questioning Thank You chairman bar appreciate the time to a very interesting panel I was at the u.s. chamber this morning talking about FinTech and the advantages of exploring how blockchain can change business economics and accounting and logistics very interesting topic today we're talking about something that is the the headline which is constantly chatter about currencies and when I listen to the your testimony I just have flashbacks not personally of course to the 1830s I'm thinking about Wildcat banking when we had no central bank thanks to President Jackson's insistence that we didn't need that and every state in every business and every town issued script or currency I have a book in my at my house of obsolete script and currency that's a collector's guide and it's very thick so help me mr. Pollock understand that that why is this any different I mean I can't imagine that anyone privately issued cryptocurrency could be any more accepted than another you know big picture since why is it not like Wildcat banking of the 1830s congressman I think it's exactly the same as I tried to suggest in my testimony I I said in my written testimony I have in my collection maybe my book isn't as fat as yours a nice copy of a $3 bill issued by the Wisconsin Marine and Fire Insurance Company which acted as a bank in the 1840s in this period you're talking about I think it's exactly the same except those currencies did have a claim on the assets of the bank if the bank had good assets thank you for that and dr. Michele you know the I think if I remember article one right coining money is a enumerated power of the of the Congress not the Federal Reserve System yet I'm always in fact chairman of power got the question this morning like chairman Powell can decide to do crypto currencies at the Fed where is all this this would still be pursuant obviously to Congress directing that we do this and so tell me your views on on that legally legally I mean I I hate to venture a guess because they they seem to be able to do quite a bit without legislation this is no surprise from your testimony yes thank you but I and then dr. Prasad a question for you you talked about potentially because of blockchain truly an innovative area that potentially you would make some forms of money or credit I'd say obsolete like an account payable receivables for example people wouldn't necessarily have as big a line of credit so you're concerned about future credit creation and open market operations I assume that's where you were coming from and your testimony artifact about the previous congressman's question about what is the point of crypto currencies there are many inefficiencies and that lurk in the financial system including ones that result in crisis but also if you think about payments either using your visa or if you think about cross-border settlement of transactions those are painfully slow sometimes quite expensive and these technologies in principle provide a way of getting around those issues they in principle again I as emphasized that could make transactions much easier to verify to follow through they could ensure finality of settlement of transactions and bring down the cost you're not quite there yet but that's the prospect and that could affect the traditional model of banking especially as non-bank financial intermediaries we talked about Alipay and Alibaba and China they take over and that could affect how the Fed thinks about financial stability and the transmission of monetary policy as well thank you very much in my in my time remaining mr. chairman since this is the monetary policy committee I have to come in to our viewing audience and to my colleagues mr. Pollock's recent writings on the 40th anniversary of the humphrey-hawkins Act one of my personal favorite laws and we celebrated today quietly here as we had Trimble tamarin pal testifying and I've always always find the goals of humphrey-hawkins odd you have full employment and price stability so I didn't get to ask my question and I'll let you have the last word mr. pollak how is price stability consistent with perpetual inflation setting an inflation target it is not that's one of the great mysteries of the Federal Reserve how stable prices which is actually the term in act is consistent with their announced strategy of perpetual inflation thank you that's one of the great mysteries of Finance I yield back a

[01:18:11] gentleman yields back

[01:18:13] from those good questions and I am informed that because this is going to be an extraordinary lay long vote series on the House floor we may be losing members and so our reverse course and call on our colleague from Ohio for the last set of questions for the hearing and that is Warren Davidson who is now recognized for five minutes

[01:18:37] for the final question of the hearing thanks for the bonus time chairman and

[01:18:42] thank you all for being here I assume you're relieved a bit so you won't be waiting for us for an hour and a half or two to get back over here so thank you for your expertise in this and I think just beginning with the nature of currency what is our currency and part of the stability of the US dollar lies not just in the resources of the United States but in the resources of the world the petro dollar everyone has to settle their current account at some level in u.s. dollars because everyone uses crude oil and so we have an effective monopoly on settlement there and it dealt somewhat effectively with the problem of mercantilism involved in gold so prevented hoarding because the oil isn't hoarded of course Congress continues to tap the Strategic Petroleum Reserve so I assume eventually maybe we can find find an end but in the background of that what creates the stability of money and I and I guess I want to get at in crypto currency we use the word for everything we use it for crypto securities that are really nothing more than you know non-voting shares and companies in some cases this is what the SEC is trying to regulate we've established that that numerous of these crypto commodities or effectively commodities but we're not quite sure that their currencies mr. pollak you summed it up well by saying there's a big gap between how much is this in Bitcoin and and so I guess that's the question I'd like the panel to explore maybe mister Michelle would you like to pursue dr. Michelle the question specifically being the nature of money in in crypto so what makes it what makes it what would make a cryptocurrency a currency not just a commodity not an asset how do you move from whether it's Bitcoin or petrol coin or Michelle coin we're in coin I like the sound of that one that's good if if we're talking about a medium of exchange then what we have is either a currency or a substitute for currency or a substitute for money if it's all digital maybe we shouldn't call it currency but the idea is a is what is the medium of exchange and my whole point is that people should be allowed to use whatever medium of exchange that they want to use the the fact that many people think that the Fed is great and the Fed is fine and we should just stick to the central bank that we have that's that's wonderful if nobody else ever believes that way and hardly anybody adopts any alternative form of money then there's no problem nobody's going to use one but if somebody comes up with something better then we should allow that to take place because you highlighted earlier you had it earlier that the government shouldn't shouldn't favor one or the other well we clearly do we coined the money and we have the official money we have the legal tender in the United States mr. pollak how do you see migrating that path for something to really become a currency to be a currency as I tried to suggest in my remarks be readily accepted in settlement of payments and debts and to be a unit which is used to denominator acts and that and that means that people in general believe that that currency is going to be available and accepted by other people and they have to believe that other people accept that and and everybody else has to believe that other people will accept that as well it's a strange social creation money that comes out of out of belief backed up by sets of enforcement of the great history history of money high garius to think about yeah I'll just build on that I mean I think I think what you're what you're really getting at with your question is you know why it is Bitcoin have any value at all and as mr. Pollock just said for a currency to have value and to function as a currency it simply has to be the case that you accept it from someone on the belief that someone down the road will accept it from you one of the interesting things that that makes that work apparently with something like Bitcoin is the is the currency supply rule there's a fixed rule for how the money increases over time but that's known and fixed and so you don't have to worry that the issuer of the currency will behavior responsibly and devalue it so that's sort of a fundamental aspect that gives Bitcoin dial you once once somehow that process has started where people have started to believe in it but it also is is it can be problematic because it means that you you have a fixed role and you are not able to provide currency in a way that might be beneficial in general for the economy thank you so much I'm sorry I couldn't get to everyone and Frank they couldn't get to nearly all my questions but nearly universal liquidity I think is the defining characteristic and then we can't get to the store of value related to petrol but thank you so much for your

[01:23:57] time and thanks for your indulgence

[01:23:59] chairman thank you for your questions

[01:24:01] and thank you for yielding back your time and I'd like to thank all of our witnesses for their testimony today again I apologize for the brevity of the hearing I think we had a lot of members with a lot of interest but because of the interruption of votes we will have to end this hearing a little bit early but given the fact that digital currencies and crypto currencies will continue to have a greater and greater impact on our financial system and the broader economy I'm sure we'll be revisiting this issue and exploring this topic further in the future without objection all members while five legislative days within which to submit additional written questions for the witnesses to the chair which will forded - the witness for the response asked our witnesses to please respond as promptly as you are able this hearing is adjourned you
Posted on

House Agricultural Committee Hearing (7/18/18): “Cryptocurrencies: Oversight of New Assets in the Digital Age”

Below is a rough auto-transcript of a hearing held last week entitled “Cryptocurrencies: Oversight of New Assets in the Digital Age” (video available at link).

The witnesses were:

  • Mr. Joshua Fairfield, William Donald Bain Family Professor of Law, Washington and Lee University School of Law, Staunton, VA
  • Ms. Amber Baldet, Co-Founder and CEO, Clovyr, New York, NY
  • Mr. Scott Kupor, Managing Partner, Andreessen Horowitz, Menlo Park, CA
  • Mr. Daniel Gorfine, Director, LabCFTC and Chief Innovation Officer, CFTC, Washington, DC
  • The Honorable Gary Gensler, Senior Lecturer, MIT Sloan School of Management, Brooklandville, MD
  • Mr. Lowell Ness, Managing Partner, Perkins Coie LLP, Palo Alto, CA

Here are a few “pull quotes” and exchanges of interest (this is by no means exhaustive):

    • Rep. Soto (@1:42:08): “I’m more concerned though about being able to avoid money laundering for terrorism, drug trafficking, human trafficking, tax evasion — so I’d love to hear from each of you in one sentence on what we could do to stop money laundering and having Bitcoin and other cryptocurrencies be the choice of terrorists, drug traffickers, and those evading taxes.”

      Mr. Fairfield: “Trust FinCEN to do their job.”

      Ms. Baldet: “Rely on other law enforcement mechanisms that work around strong cryptography — we do not weaken roads to add potholes to them.”

      Mr. Kupor: “Bitcoin is actually the worst tool to money launderer because every transaction is registered and fully recordable so it’s actually law enforcement’s best friend”.

      Mr. Gorfine: “While the technology can be peer-to-peer, most activity takes place through a new type of intermediary where you can apply AML and KYC rules.”

      Mr. Gensler: “On top of that, rigorously require crypto exchanges to register — and you may need to pass a law to do that — but to make sure they register and that all the AML, anti-money laundering and know-your-customer is being done there.”

      Mr. Ness: “The alleged Russian hackers were caught because they used Bitcoin.”

    • Rep. Faso (@1:45:01): “I’m wondering if for the benefit of our viewers at home across the country who are watching this hearing and are trying to understand the impact of the crypto currencies and what the future holds if if perhaps miss Baldet and Mr. Kupor could tell us where you think from a five to ten year view point where this is going to be the role that these currencies are going to have in our economy and how might this affect average consumers — right now it’s the market participants are mostly very sophisticated people do you see this insinuating itself into the broader economy?”

      Mr. Kupor: “Thank you yes so we believe that this really is gonna create a whole new set of of infrastructure on which all kinds of new applications are going to be built — some which we may not even know about today. So if you think about all the benefits we’ve reaped from you know Facebook and Google and all the kind of you know internet properties have been built today.”

      Rep. Faso: “… and negatives …”

      Mr. Kupor: “… and negatives — I think what the beauty of this technology is is it gives us a new set of platforms and again very critically those platforms are not controlled or governed by centralized corporations; they’re controlled and governed by community, and so you can imagine all the utility that we have today but where the consumer actually has ownership of data the consumer has the ability to actually ensure that data is shared in a manner in which they want to be shared and the consumer also can capture the economic rents from use of that data; so we think the opportunity in that respect is endless.”

    • Rep. LaMalfa (@1:51:30): “Would you touch upon what what would look like if that token is determined to be a security?…”

      Mr. Ness: “Yeah I think the issue really comes down to friction and while we can get to a status of free trading securities by registering them, even when you do get to that status there are all sorts of ancillary friction[s] in and around the transfer of a security — you need to have broker dealers involved, and you need to have suitability requirements met and other potential disclosure issues and so forth that are ongoing; and so when we’re talking about trying to create the next generation of decentralized protocol layer kind of apps on top that are all interoperably-interacting with each other and transferring value at the speed of software to deliver a service to a consumer — it may it may be all transparent to the consumer that this is all happening under the hood –but you can’t have fundamentally the transfer of value at the speed of software if it’s a security.

      Rep. LaMalfa: “Please touch on the importance of increasing the access to the speediness of those types of trans transactions — why is that important?

      Mr. Ness: “Well I mean, to get a little philosophical I suppose I mean you know ledger technology is fundamental to Commerce, right, and double-entry accounting was an amazing innovation and ledger technology that, you know, pulled Europe out of the … Dark Ages, and the same thing can happen in in in a amazingly more robust way when we start to literally not just allow parties to trust each other through standard mechanisms of reconciliation, but when we remove the reconciliation or the need for it all together… and that is simply a philosophical point of view I suppose but it goes to this issue that we’re at early stages of this, we don’t know where it’s gonna, go but speed is probably a good thing.

      Mr. Gensler: “Could I just say I’m an optimist I agree with what mr. Ness says, but maybe it’s the MIT in me now, I think that the beneficial ownerships will be able to be tracked in a matter of milliseconds and nanoseconds — not yet, it might take five years — but we’ll get there; technology’s pretty neat how it grows and helps us.”

    • Rep. Davis (@2:01:54): “I want to ask you a quick question sir; based on the way current law is written, it’s not cut and dry whether cryptocurrency should be regulated by the SEC or the CFTC.  If Congress attempts to come up with a workable definition for cryptocurrencies that are more similar to commodities — you know call them as we’ve heard blockchain commodities — what should we be looking at to guide us?”

      Mr. Gorfine: “You know I the one thing I would say is that — and I mentioned this in my opening statement — that it’s important that we’re not hasty in terms of figuring out what the right contours are of applying… securities laws and then the the commodities framework. I do think that the SEC has in due course been providing additional clarity — there was recently Mr. Hinman over at the SEC, gave a well-received speech kind of outlining some of the SEC’s thinking as to how they would apply the securities law framework — and some of the things that I think you’ve heard are factors around decentralization, you know are their expectations of return based on meaningful work of others… Rhese are important elements that — of course are not you know I’m not saying that these are the only elements — but these are some of the things that you start to look at in terms of figuring out well when does it make sense to be applying the securities laws framework that includes things like required disclosures, it requires regulations around you know the offering of securities, and the intermediaries involved in securities, and when does that perhaps not fit the product. So I think that this discussion is ongoing, and I think that in due course, and being thoughtful you’re starting to see additional clarity and uncertainty coming out. But certainly those are some of the factors that we’ve we’ve heard talked about a fair amount.”
      …
      Ms. Baldet: “To tag on to kind of the last question but also the the concern about regulatory framework, you know what I was mentioning is about a need for clarity more so than the, not so much the bright lines that we’re talking about with security versus commodity, as much as more interest in safe harbors for innovators; especially because we’re seeing the market adapt to this in that new disruptors are at an advantage versus incumbent institutions who are waiting for regulatory clarity to engage. And so in a way, in the absence of that, it’s not it’s not necessarily that incumbents are incapable of innovating or they don’t understand the technology, but they have to take a sidelines approach because they have traditional businesses to lose.”
      …
      Rep. Davis: “Well thank you… We want to make sure that we devise a regulatory structure that allows this industry to continue to grow, but allows to us to address many of the law enforcement problems that have been brought up here by many of my colleagues — so I can’t wait to continue to work with you; thanks for your time.”

Again, we have not yet gone through the hearing record exhaustively. However, the transcript with links to the hearing video is reproduced here anyway, as it might be useful to some.  (Watch this space for further excerpts and comments, once we analyze the record fully).

TRANSCRIPT GUIDE  AND ADVISORY:

  • The transcript was produced by a text-to-speech process performed automatically by a third party service outside of our control.
  • KrowneLaw does not vouch for its accuracy; indeed, we guarantee it is inaccurate.
  • As such, each snippet of translated text is linked directly to the point in the video at which it occurs (popup in separate window/tab).   Please use this functionality to confirm exactly what was said in each case.
  • The hearing may cover a wide variety of topics; thus, cryptocurrency/blockchain-related terms have been highlighted to assist in quick location of the relevant passages (this highlighting is by no means exhaustive, however).
  • The breaks in the text coincide roughly with changes in topic/changes in Congressperson leading the questioning.  They do not correspond to changes in speaker; thus, each block usually represents multiple speakers, including those on “opposing sides.”  You must listen to each particular segment in the video to determine who is speaking and to get the full context (and therefore, meaning).

Scroll box with full transcript follows:

[00:16:06] well good morning everyone hearing on committee of Agriculture and title crypto currencies oversight of new assets and the digital age will come to order please join me in a quick prayer never really father we ask you Lord for blessings on this meeting this morning we've got some things to understand that are new and different and we've got a great panel that's here to visit with us this morning I also want to lift lift up Collin Peterson his family during these times bittersweet and your thoughts and prayers with him as well help us to to do your will and to be the kinds of people that that will honor you we ask these things in Jesus name Amen just a quick word caller Peterson's not 8 half year old father passed this week and so our bittersweet but he was telling me a wonderful story that his dad was apparently had his faculties right up to the very end which is pretty darn good so our thoughts are with you go he's hanging in there he could remember the crop prices from 1952 you know I mean II knew everything yeah all right so well good morning we've got a terrific panel this morning I see a lot of new faces as in the audience today for the big questions up on a lot of folks Minds is what's the Agriculture Committee doing with cryptocurrency and and the distributive ledger technology but we're here to find that out this morning so for those of you that not joined us before welcome we're happy to have you as we discuss an emerging policy area that is of deep interest to our members to the emerging into crypto industry and we hope to all Americans of all stripes Digital SS like Bitcoin and ether but also hundreds of other token-based projects that are being developed represent a new way for people to interact and exchange in commerce with one another while digital assets are often thought of as payment systems or digital gold I believe the promise that token networks hold is more Universal and more exciting quite frankly than that for the first time we have a tool that enables individuals to reliably exchange value and a digital realm without an intermediary we could have assets that exists can be created exchange consumed at digital form the promise of being able to secure property rights in a digital in digital space may fundamentally change how people in people interact with one another this technology holds the potential to bring enormous benefits to each of us if we're willing to give us the space to grow provided providing a strong clear legal regulatory framework for digital the SS is essential to that end there are several questions before us about how law should govern the issuance trade and utilization of these digital assets perhaps no question is generating greater uncertainty than how to determine if a particular token is a security we generally know that it would what to do if a commonly traded asset is in fact deemed of security we simply apply the securities laws if it's not a security there's a good chance it's a commodity which will be subject to the requirements of the Commodity Exchange Act the problem seems to be in making that determination how we test which concerns the sale of orange groves and service contracts to the 1940s as offered presented as a standard test to determine if the securities laws govern a token yet they have provided they prove to be challenging in the analysis under this as an analysis under this test a related question is whether or not current laws are appropriate for these new digital assets if a token is derm is determined to be a security or a commodity or something else a regulatory regime need not be static if it's necessary Congress or regulators may want to consider developing a new framework that takes into account the diverse characteristics and unique economic relationships and Bennett in many of the types of digital assets that can be represented by tokens providing clear guidance to enable developers to determine the nature of their token and then suitable rules will enable them to develop their project is essential to both project protecting the public and promoting innovation how we regulate these products and those who develop them won't determine if they're developed or used but it will determine where they're developed in use and we want them that innovation done in our country as we consider changes to the laws or new regulations the Committee on agriculture will be part of that conversation within the house we have a vested interest in the definition of a security because it directly impacts the definition of a commodity similar to our work in agricultural commodities as well as futures and swaps markets the committee has a strong interest in promoting safe efficient transparent markets for those who use these new toá-- Marcus properly regulated Marcus promote innovation and foster economic growth and I don't believe there will be any different with respect to digital assets of course proper regulation does not mean intrusive regulation that means regulation appropriate to the nature of the activities and the participants and in some cases it might mean no regulation at all before watcher narake you remember I want to thank all of our witnesses for making time to prepare testify we have an incredibly qualified panel to present all sides of a fascinating and complex set of issues I welcome to please each one of you here today for this conversation and with that color I'll turn to you for any comments that you might want to have Thank You mr. chairman and thank all of you for joining us here today and I'm happy that we have a chance to review this new net new technology and our role is to oversee via CFTC regulation of it if that's appropriate as a CPA and someone who's found a career helping folks run numbers on their finances I still am having a hard time getting my hands around this and I have some real concerns one crate cryptocurrency that we need to pay special attention to is its volatility there are some of you that will tell us that the fluctuations in cryptocurrency are a good thing and part of its appeal but the increased speculation and the fact that regular investors stand to lose their shirts give me a great deal of concern as one study found over 80% of the initial coin offerings are scams while regular investors stand to lose a very small amount Santa Lou is a very small amount stand to gain for example 97% of Bitcoin is held by just 4% of the participants and cryptocurrency there's a lot of things here that don't make much sense to me and who knows maybe some type of this technology will come along and really make a difference after these starts and fits but as it stands right now I'm skeptical it's our jobs to be the adults in the room and to ensure that in these early days there's enough oversight of this new frontier to ensure that it can grow responsibly that I look forward to your testimony and I yield back

[00:22:32] thank you mr. Peterson so chair would request other members submit their opening statements for the record so that our witnesses may begin their testimony and to assure there's ample time for questions I'd now like to welcome our witnesses to our table first off we have Joshua Fairfield dr. mr. Joshua Fairfield the William Donald Bain family professor of law William Utley University the University School of Law in Staunton Virginia we have miss amber bald a co-founder and CEO of clover in New York New York we have Scott Cooper managing partner of andreessen horowitz midlow Park California we have mr. Daniel Gore fine director lab CFTC and chief innovation officer at the CFTC here in Washington DC we've got welcoming back for another round of conversations of the Honorable Gary Gensler who currently is a senior lecturer MIT Sloan School of Management and then we've got mr. Lowell Ness managing partner Perkins Kui Palo Alto California so we've got a terrific panel and with that we'll go to mr. Ferrell you what everybody have five minutes to pitch your wares and we've also got your opening statements for the record so with that mr. Fairfield your fair feel you're recognized talk come on Thank You mr. chairman Conway ranking member Peterson and members of the committee for the opportunity to address you today my remarks are going to try to set some context and they're organized around two questions we've heard a lot about Securities and commodities but how are people actually using cryptocurrency tokens and given that how should regulators proceed on the first question blockchain which is the technology underlying the current rash of cryptocurrency and tokens is a new decentralized database technology many communities have formed just to see what the technology can do and they're trying different experiments the potential value in these experiments is considerable collaborative communities of artists new forms of corporations fast and low-cost check settlement digitization of securities open and low-cost electronic mortgage and secured transactions filing systems secure international remittances voting systems and many more are possible applications of the technology my testimony today will focus on potential for blockchain technology to expand personal property rights online this is my primary area of research and my conclusions are and I'll continue them below that first citizens need and want an expansion of personal property rights online the cryptocurrency tokens are helping them do that by solving important problems in building markets for digital property and that we need to be cautious when regulating overlapping spaces and use cases such as systems in which most people hold a token to use it or consume it and a few hold it to speculate on the price on the second question how do we go about conducting oversight common-sense construction of how groups are using the technology a so-called duct test will help regulators begin to sort out whether and where to engage rough agency consensus can handle these conflicts and hearing such as this one are critically important for regulators to start working out the overlaps because many many more applications of this technology are coming so in the body of my remarks I'd like to discuss how this technology represents a badly needed expansion for personal property rights online we should really care about good property rules for intangible electronic digital assets good property rules preserve citizen independence property institutions build individual wealth and social welfare by reducing transaction costs and property permits us to express ourselves by changing and arranging our environment to reflect what we want here you might think of your own home or your wedding ring for example but personal property rights like this have had serious trouble coming online we just don't own that much personal property online consider that people used to have record collections now they have a subscription to Spotify people used to have bookshelves now they have Kindle accounts this is because early in the history of the internet intellectual property holders were worried about illegal copying it took several decades to develop a technology blockchain the database technology underneath cryptocurrency tokens that can be traded held bought and sold but not duplicated so far until now property institutions haven't really gotten the benefit of internet technologies because it's too costly to record all the transactions we can't have a database of ownership for every Barbie doll in the entire country right it's too costly however token systems can and will reshape all of these ways of owning if they push price points low enough the way the internet did for basic internet communication in some blockchain technology is not just used as a security it's not just used as a commodity it's used as a way to unstick personal property law for all of us online but it's only going to do it if we let it so what's the path to successful oversight responsible regulation has to rest on a frank and common-sense determination of how people are using this technology working out the jurisdictional questions is going to be time-consuming but it's not particularly harder than for network communications technology generally we've just had to hand these things out and figure it out tokens do present some challenge specifically they may be used in different ways by different members of a community they may be used at different times in different ways but most importantly the nature of the use by a community can shift a community can be trying to do something entirely legitimate and have speculators come in and begin to disrupt the purpose of the original community the current hot characterization debate is whether token sales ought to be deemed regulable unto the Howey test I believe instead the Howey test represents the outer bound of where we should look we should look inside that outer bound to figure out what the beneficial and damaging uses of the technology are if a community is using cryptocurrency tokens like securities then they should be regulated as securities but if they're not they shouldn't and that's the most important edition in conclusion blockchain technology has enabled new communities and new business forms it has also provided the technological basis for a badly needed expansion of personal property rights line and for purposes of regular regulatory jurisdiction a rough common source common sense sorting into buckets will do more good in the near term than precise definitions of what a cryptocurrency token is that is a lost cause a cryptocurrency token wears as many hats as humans give it it is an entry in a database it is a technological entry and nothing more in the current characterization debate what this means is that a token should be deemed a security when it operates like the collective security a commodity when it operates like a commodity a currency when it operates as a currency and as a simple property interest when it operates as a simple property interest thank you so much thank you for

[00:30:05] spare feel ms bell day 5 minutes chairman Conway ranking member Peterson and members of the committee thank you for the opportunity to be here this morning I'm amber Baldy co-founder and CEO of clover a company building tools that make it easier to build decentralized applications on top of both publicly accessible blockchain networks and access control distributed Ledger's previously I led the blockchain program at JPMorgan though I'd like to note that my comments today do not represent my former employer I also currently sit on the board of the Z cash Foundation a nonprofit organization seeking to advance the state of the art for privacy technology as applied to Internet infrastructure and privacy preserving cryptocurrencies these are a variety of disparate hats all of which lead me to the same message my commentary today concerns the importance of a cautious and thoughtful regulatory approach to innovative technologies even and especially those that might disrupt business as usual or add to the complexity of regulating the Internet as both critical infrastructure and a shared public good we must determine how to balance the enormous potential value of this technology with the need for consumer protections and national security and how to achieve this while respecting human and constitutionally protected rights so far money seems to be the killer app for blockchain much as the early Internet killer app email continues to be a cornerstone for how we communicate online peer-to-peer payments will likely grow into and persist as a ubiquitous part of our personal and professional daily lives in fact the ability to spend trade rent or license other sorts of unique digital bearer assets could be applicable to many things we own mortgages securities collectibles intellectual property rights personal data etc imagining this mature interconnected global ecosystem of such markets feels like standing in the 90s and imagining Netflix streaming on your phone and yet my concern is not the speed with which we reach that end state it's the choices that we make along the way which stands to be as hotly contested and impactful as net neutrality the DMCA FASTA cesta or the on-again off-again discussion of state mandate mandated week cryptography continues to be while we struggle to overlay existing regulatory frameworks onto new technology that is useful precisely for its fluidity other areas of the world are embracing that ambiguity and learning by doing in Afghanistan for example code to inspire helps train young women for technical careers and pays them in Bitcoin which they can use in local shops as well as global marketplaces in a place where women's banking and even physical agency is limited financial autonomy and Digital Inclusion is a powerful force for equality and democracy in some African countries and places with less legacy financial infrastructure companies are using crypto assets to enable farmers to properly track and register their commodities and increase their bargaining power in downstream market pricing not only can end consumers tip their farmer in support of fair and sustainable working conditions but every other factory or wholesale retailer along the way can make more informed decisions about the provenance of inputs to their products in the United States square whose business strategy is already based on disrupting traditional payments processors has added the ability to buy sell and transfer Bitcoin into its mobile app and there are many products targeting cryptocurrency investors and early adopters there's also several more experimental projects that are interesting for example using economic incentives to battle fake news cryptocurrency micropayments as an alternative business model to data hungry online advertising and fluid marketplaces for unused disk space on your home computer as a disruptive force too centralized cloud storage these projects all launched as initial coin offerings icos either on a new single purpose blockchain network or as a token on top of an existing network like aetherium are often compared to the internet startup boom of the 90s the ability to quote unquote code oneself out of business is a novel property of these decentralized blockchain applications but most experiments today invoke a variety of human controlled workflow checkpoints and escape hatches to allow intervention if necessary along with understanding who controls access to the network and who can modify the rules of the system identifying who controls these escape hatches might be helpful in sorting tokens into various asset classes once the sensible taxonomy has been established as a counterpoint blockchain is not the answer to every problem for example I recommend extreme caution with exploration of blockchain based Evo ting ensuring one-person one-vote while keeping ballot selections private is an incredibly complex computer science and human coordination problem that we are not ready to tackle yet internationally it's no surprise that some of the central bank's most aggressively investigating cryptocurrency as an alternative or enhancement to their existing currencies are in Venezuela Russia and China going forward as there is inevitably more discussion of the potential for a digital dollar I encourage strongly encrypted privacy preserving design choices coupled with opt in selective disclosure as opposed to options like mandatory cryptographic backdoors or golden keys which could make the US financial system a very attractive target for nation state sponsored cyberattacks and hackers as that conversation matures you must clarify how FinCEN oh fak and other relevant rules can be applied modified or interpreted to balance many competing interests so in conclusion and hopefully even and hopefully if this committees guidance is simply a strong commitment to non-interventionism safe harbors for innovators and work towards resolution of the patchwork fabric of state laws the time it takes to come to such a commitment have the unfortunate effect of eroding America's early mover advantage in technical innovation and entrepreneurialism thank you thank you

[00:36:05]

[00:36:06] mr. Baldev mr. Cooper Thank You chairman Conway and ranking member Peterson for the opportunity to be here today to talk about this very important new technology my name is Scott Cooper I'm the managing partner for a firm called a H capital management which manages about seven billion dollars worth of venture capital assets and very recently also for a group called cnk capital management which is a 300 million dollar registered investment advisor fund focused exclusively on investing in crypto related assets I'd like to spend my time today to focus on why we believe as investors that crypto technologies make a very compelling investment opportunity particularly for members of the venture capital community and I want to start with a definition that's different from the definition I think that we often hear about so if you focus on a lot of the public narrative today around crypto technologies there are two kind of dominating narratives one is certainly around Bitcoin and price fluctuations and volatilities which we heard certainly from the ranking member today as well as well as what are called initial coin offerings I see owes for capital fundraising as investors though we're interested in the broader ecosystem and we use the term crypto networks to describe what we think about as that ecosystem very specifically crypto networks for us means a new way to build digital services and by digital services we mean any internet application that obviously may exist today so ride-sharing applications social media applications and probably a whole host of things of course that we haven't even thought about but where those digital services are owned and operated by a community of network participants rather than by a centralized corporation now I realize at first blush that when you think about community ownership and management of an asset that may seem odd but in fact if you look at the technology industry there's actually a significant precedent for the existence and success of community based networks in the development of a significant portion of technology first is what is known as the open source software movement this started back in 1983 actually at MIT by a professor named Richard Stallman and at the time it was a very very radical notion the idea was that a community of developers would publish and then freely offer their software to others who could modify that software who can incorporate it into various other projects it was really in many respects a very liberal movement around opening up and reducing kind of copyright initiatives and software if you fast-forward to today the open source is the predominant method of software development and software utilization today in the world for any data center you go to which is obviously where major corporations run their internet applications Linux which is a major operating system is by far the dominant operating system in play and for all of you who like myself who walk around with your cell phones all day long the vast majority of components in your cell phones are what are called Android and the centrally open-source software so the history of open-source software I think is relevant for how we think about the potential for what bit coin and crypto networks can be the second important historical analogy is around what we call open protocols which really form the foundation of the modern internet that we all use today an example of this is something called SMTP which is the protocol that we all use for email transmission it's an open protocol it was governed in many cases by open communities by networks by academics and in many cases with government funding and many people built applications on top of these open networks precisely because they knew that the nature of that protocol would not change they could rely on the steadiness and the consistency of that protocol on which to build applications so if we look at technology open protocols that are well developed and well maintained can become the building blocks on which massive customer utility and economic growth can be built it's also the case however if you look at the startup world that many startup companies have failed by relying on what we called platform risk which is building on other platforms that are governed by centralized corporations and then finding that the rules of the road change over time and that really does significantly handicap their efforts as a result of this what we now see in our business is many developers are hesitant to take on this platform risk and are instead looking at things like crypto networks as a new and innovative way for developers to create new digital services without the Intendant risk that comes from depending upon centralized platforms in many ways crypto networks borrowed from the nearly 50 years of history in the technology industry which shows that communities of developers can share their work openly and properly govenor network without centralized authority but crypto networks also introduce a very powerful economic incentive that didn't exist in these prior generations the presence of what we call touken which creates a direct financial incentives for members of the communities to in fact develop and govern the networks appropriately the token really in a sense is the glue that binds the various players in the ecosystem and provides the appropriate economic incentives for all market participants understandably so this creates a whole new set of challenges for regulators consistent with recent statements that we've heard from the director of corporate finance at the SEC we believe that the regulatory nature of crypto networks varies with the stage and development of a particular project briefly when a centralized sponsor is seeking to raise capital from investors prior to the functional development of the network this is probably and what is known as an investment contract and therefore properly regulated as the security however the nature of the tokens that are delivered on that contract can ultimately be regulated as commodities once the fulfilment of that investment contract has occurred as stated by the CFTC some tokens are not securities once the network is functional and in particular in cases where the network is decentralized from an ownership perspective we believe the nature of the tokens looks more like commodities and securities and therefore probably rightly should be governed by the CFTC this is precisely because there's no centralized sponsor on which the efforts of the value of the token are largely depend instead the tokens have value based upon the utility of the service to participants this actually looks much more like the way commodities trade in conclusion the US has long enjoyed the fruits of an age innovation in the form of economic growth job growth and consumer utilities stemming from many of the great technology companies of our time and we believe that crypto networks present a new and exciting opportunity for us to continue on that trajectory doing so however will require that we develop a regulatory framework that encourages risk-taking and capital formation provides clarity and certainty to market participants and of course protects individual investors and the integrity of the markets thank you for the opportunity to be here today Thank You mr. Cooper mr. gore fine five

[00:42:10] minutes Thank You chairman Conaway ranking member Peterson and members of the committee for the opportunity to testify before you today I'm chief innovation officer and director of lab CFTC at the US Commodity Futures Trading Commission the testimony presented here reflects my own views and does not necessarily reflect the opinions or the views of the Chairman or the Commission in May of last year chairman giancarlo announced with bipartisan Commission support the launch of lab CFTC the agency's effort to help create a model for regulatory engagement and modernization in light of the ongoing digitization of our markets its mission is to facilitate market enhancing innovation inform policy and ensure that we have the technological and regulatory tools and understanding to keep pace with inevitable change the building blocks of our effort our engagement testing and experimentation and education shifting to the primary topic of today's hearing we are interested both in private or permission distributed ledger technologies that can improve market infrastructure and in public block chains that require the use of a virtual currency developments across this spectrum have society rethinking the nature of money how people transact and how we can more efficiently engage in regulatory economic and market activity with respect to public blockchains proponents note that they unlock digital scarcity enable efficient transfer of ownership and power the execution of applications and all of this can be done without the need for a trusted central intermediary that was traditionally needed to verify that each party has and does what it promises many however appropriately worry that virtual currencies and tokens may be used for illegal activities and are prone to fraud manias and bubbles driven by potential misunderstandings and myths regarding their scalability utility and intrinsic value with recent hype around this space there has also been a proliferation of icos which may be intended to raise capital for a venture and may bear the hallmarks of a securities offering our colleagues at the SEC have been thoughtfully addressing related challenges and providing additional clarity to the marketplace and from the CFTC's perspective given the potential to tokenize a broad range of economic assets it is important to remind the public that digital assets can also be commodities or derivatives depending on their terms and how they are structured given the potential and the challenges of this space chairman Giancarlo has made clear that the proper response by regulators is not to dismiss the entire movement as misguided or foolish but rather to take the time to learn facilitate the promise guard against risks and bad actors as part of this effort lab CFTC published its first FinTech primer on the topic of virtual currencies in October 2017 the primer explains that the agency determined in 2015 that certain virtual currencies such as Bitcoin are commodities and therefore implicate our jurisdiction the CFTC has regulatory oversight authority over futures and swaps markets based on commodities and that has anti fraud and manipulation enforcement authority over these and the underlying commodity markets it is important to note however that we do not have oversight authority over these underlying markets additional details regarding CFTC oversight of crypto related markets and enforcement and education efforts since the self-certification of Bitcoin futures in December 2017 can be found in my written testimony moving forward one thing is certain none of us are able to predict exactly where this innovation is heading it is accordingly incumbent upon us as a 21st century regulator to continue studying learning and keeping pace with change we look forward to ongoing close collaboration with our regulatory peers including through the eff Sauk digital asset working group we all have the shared goal to educate market participants target bad actors and ensure an efficient and effective regulatory framework we are also focused on bringing clarity and certainty to the market but need to be sure that we are thoughtful in our approach and do not steer or impede the development of this area of innovation while some may seek the immediate establishment of bright lines the reality is that hasty regulatory pronouncements are likely to miss the mark have unintended consequences or fail to capture important nuance regarding the structure of new products in the late 1990s during the early days of the internet senior government advisor policy advisor IRA Magaziner made the following observation that given quote the breakneck speed of change in technology government attempts to regulate are likely to be outmoded by the time they are finally enacted end quote given this dynamic the government largely avoided a prescriptive approach in favor of principles focused on educating and empowering law enforcement and allowed the this area of innovation time and space to develop all while maintaining the ability and careful vigilance to act to ensure market integrity this approach generally seems like the right one when dealing with new technologies which are largely agnostic as to how they are used the role of the regulators to facilitate use of new technologies that can benefit markets and the public more broadly while deterring and pursuing those who seek to use technology to do harm thank you and I'm happy to answer any questions you may have thank you where's Korra find mr.

[00:47:28] Gibbs our five minutes thank you good morning chairman Conaway ranking member Peterson my condolences on your dad's passing it's good to be with you all here today I think I've testified in front of you a dozen or two dozen times and some previous capacities but since I was last with you I took on a new role at MIT where I am engaged yes in researching teaching lecturing and advising on digital currency and blockchain technology now I say that but for those who don't know because some are new I also chaired the Commodity Futures Trading Commission for four or five years and before that long ago I was 18 years ago Minh sax so I bring from my years in finance my years in public policy and now I guess as an academic some perspective of what I've learned and with the chairs permission one thing I've learned as an academic is to ask the audience a little bit about their engagement in Bitcoin so again with the chairs permission if I could just see us how many members of this committee have invested in crypto currencies and I'm going to ask the audience to so we've got the show line in the audience Bob Cheryl the audience yeah we've got about half the audience that's an interesting split there we go I would say the other thing that splits the community in my discussions usually as if this is not a community that splits normally like right and left Republican Democrat this is a community that splits more about Bitcoin maximalist and Bitcoin pessimist or you know skeptics or one and and by the way some of those skeptics and pessimists or Republican and some are Democrats some are Nobel laureates some are in finance whether it's Jamie Dimon or Warren Buffett and then some of the max les can be a venture capitalist like an andreessen horowitz and elsewhere so it's interesting this wit in the community I'm probably a little bit center maximalist if I can say that you know I am an optimist on the underlying technology you'll also hear some people say well not that Bitcoin but the blockchain technology is good and they kind of split their their views that way so again what have I learned blockchain technology I believe has a real potential to transform the world of finance because it is about money it's about moving value on the Internet this new technology could lower costs and risk in the financial sector second to reach its potential I feel strongly that and for public confidence to reach its potential we need to bring it inside the world that we know the long-held public policy frameworks know what are those frameworks Congress has a role to play to tinker about these frameworks I've just say what are our historical frameworks about technology and finance we guard against illicit activity like tax evasion or money laundering we insure for financial stability and we protect investors and consumers those are the three big ones we protect against illicit activity we insure for financial stability and we protect investors everything else is debatable and you we need to adjust the details underneath that third the SEC and CFTC do have a role to play both of them have roles to play they've released numerous notices and enforcement actions and so forth however there's a lot of non-compliance I mean there are thousands of entrepreneurs out there they're probably right now are not complying with SEC guidance and they're fewer that are not complying with CFTC guidance but that's just because the CFTC doesn't have ever cited this thing called the initial coin offering market and and that's where there's a lot going on and this thing's going large and big it's about two hundred and fifty billion dollar market quarter of a trillion is getting some size I mean the overall capital markets in the world are about 250 trillion they're 300 trillion so it's not threatening that but thousands of eyes cos have been raised twenty billion dollars of capital formation I'm here to say nearly all of them I don't know if it's 98% or 97% but nearly all of them are probably securities under our securities laws because they're being offered in a pre functional time this IC o---- markets rife with scams and frauds forth bad actors have figured out how to use this new currency sometimes it's state actors we learned last Friday was the the alleged I should say with the alleged 12 Russians spies Venezuela tries to raise it off of their oil and outrun US sanctions policy v while federal agencies are engaged current laws apply to this activity there are gaps so if I convention a few of the gaps first I think that there's gaps around the crypto exchanges themselves either where you can buy and sell why because they're being right now regulated through state money transmission laws this approach regulating them like Western Union or money grams just not satisfactory because crypto activity is more complex and it's harder to trace and it doesn't build on top of the traditional banking system it's built on something that we can't see that's out there in other countries like in China and Russia so second the crypto exchange is lack broker to access they don't have brokers so there's no brokers by the way sending 1099 bees and my detailed testimony says you know maybe the IRS should do something about that so you can just have reporting of the gains third the issuers of securities the crypto space are only slowly coming into the SEC Rimet I think this is going to take two three four years before the SEC really cleans up this space and so there's gonna be a lot of caught can they go faster can we do it right but it's gonna take take some time forthe crypto derivatives are being handled by the CFTC I think they're doing it well but there's two things that worry me about the technology and one is that the under ret unregulated underlying crypto cash market is a mess so the corn and wheat markets that you ever see the the gold and the oil markets we have some we have a lot of history we have some confidence of that about that and then the CFTC can do their job layering over those underlying commodities the CFTC is regulating derivatives but they're referencing an underlying market where it's just at best the Wild West and at worst it's a it's it's pretty bad so about that underlying market the CFTC has general anti-fraud and any manipulation authorities with regard to it but I think the Congress will be debating it probably not in this Congress but I suspect in the next session the next Congress you all will be debating should you give the CFTC additional authority or maybe some other agency you know maybe it will be the SEC somebody else but I think the CFTC to have additional authorities about that underlying what I would call cash crypto market it's 70% of the market the SEC has securities the CFTC had derivatives I think you want to debate whether to do something about the underlying market and lastly I think you'll need to give them resources along with your friends over at the Appropriations Committee because I think these agencies will need that thank you

[00:55:03] thanks mister mr. Ness five minutes

[00:55:06] thank you all for inviting me to testify this morning I certainly agree with everybody that's gone before me that this technology does have the potential to be transformative one of the questions I get asked a lot is why don't we just call these things securities we have securities regulations we could create a scenario where these things get registered and then become quote unquote freely tradable so why not just call them securities deal with existing laws and I think the the problem with that is they exhibit some characteristics of securities during certain phases and not in others and especially when we get to full functionality when it's a truly completed product that is being sold the intention of that product is to be used in a network and that really can't happen at least not at the speed of software which is really the the fundamental principle here behind these decentralized protocols is to allow for value transfers truly at the speed of software you can't do that if everybody's got to be a broker dealer and all the intermediaries have to interact in a way that that would be appropriate for securities so we need to come up with a fairly novel and and you know pragmatic approach to dealing with the fact that there needs to be some investor protections particularly in the early stages while the thing is a PowerPoint deck and an idea in somebody's mind but find ways to create some clarity around how and when it goes from being sold as a security to being sold as a commodity and that is a very important imperative right now because we are seeing so much activity frankly and the the threat of sort of people going offshore for lack of clarity is a very real one I say in my 25 years in Silicon Valley I have not seen circumstances where you go to a meet-up in places like you know Palo Alto or even San Jose and you see regulators from zhuge Switzerland and Singapore and Hong Kong and Bermuda and and an end and so to avoid any kind of race to the bottom I do think that there's a serious imperative about getting something done before we have a situation where we're trying to entice people back into the country because then the standards would really have to be lowered to do that so I think we have an opportunity now if we get ahead of the truth light but that's an important idea around why we need some of the bright lines to that end I did in in some of my written testimony include some materials and a proposed regulatory framework that both talk about what the existing laws say and how the existing laws treat these so-called utility tokens and you know there's sort of a 50 page memo on how the existing laws work to avoid having to go through that 50 page memo type analysis with each and every one of these I think the bright lines are really what's necessary so there's a regulatory framework that we've been thinking a lot about too that would create that that set of bright lines that would enable the regulators and the regular you know the companies going out there to really know how to sort the good ones from the bad ones and and I do think that starts with kind of this test around how we and the investment contract analysis for you know regulating securities as securities in the in the primary offering in you know if they're being sold sort of pre functionality before they're before they're fully functional but coming up with ways to say that once they are fully functional how do we let them now trade as commodities effectively and the trading is important because as I said this is the movement of value to have value it needs a price and the markets really are a necessary part of this so the fact that there are secondary markets is is a key part of this they need to be able to trade in those markets to establish price they also need to be able to you to be used in their networks as non securities and so we need to come up with ways to say when they're being sold to investors as investments let's treat them like securities when they're being used in the network or they're being traded in the secondary markets let's call them commodities thank you well thank you mr. Ness the

[01:00:15] chair remind members that they'll be recognized for questioning in the order

[01:00:19] seniority for members who were here at the start of the hearing after that members will be recognized in order

[01:00:24] arrival I appreciate my colleagues understanding and I'll recognize myself for five minutes yes I agree with you that if we don't get this right and we flush the innovators offshore into other countries that getting it back is a lot more difficult so hopefully we at least this start of the the process with this hearing that we can get to an answer that doesn't do that mr. Baldev mr. Cooper you each noted that tokens and crypto networks had the potential to create next-generation open Internet protocols can you flush that out a little bit for the layman and myself that understand the words but if you could think that tell us what those actually mean it'd be a little helpful sure thank you so when we say open open means a couple things in this case we mostly mean open access when we say public blockchains which means that anyone can join the network it has to do with the degree of gatekeeping which is not necessarily an all-or-nothing kind of a decision but we can if we start thinking of public blockchains as being more like a public Commons it's a lot more like the Internet where and you have a lot of choice as how you how you access that sort of network we also usually mean open source as mr. Cooper mentioned so that we're allowing auditing of that code which increases trust of the code and most of the the core technology that powers the backbone of the internet is open source I agree with all that I would just just to give you maybe a very specific example imagine in the future you know a social network today right you have as users of social networks of course you have an intermediary in many cases a company like a Facebook who obviously is taking and utilizing the consumer data and then obviously developing relations with advertisers and others as a way to monetize that data that's their business model in the future utilizing a crypto network you can imagine a world where you as the user own your data that data is cryptographically secured and you choose which data you want to expose to various advertisers or other promoters and the flow of economic value in that case as opposed to going through an intermediary might be going directly from an advertiser or a promoter of products to you as an individual as you've kind of governed the use of that data so that would be kind of in very broad terms the way to think about kind of expansive view of what this could look like alright mr. penafiel you talked about the Howey test which seems to be the gold standard among securities lawyers who can spell that last night can you you talk about that be maybe the outer edges just where one of our questions were trying to answer is are these securities are the commodities and where does that transition occur and is it you know where could you talk to us better about this how he test and why do you think that's the outer agent and just how should it apply to to distinguishing between commodities and securities certainly there are two questions the first is lawyers are inventive they can rework the formal form of a transaction to make it into anything how he describes the outer limit of the kinds of legal forms that can be turned into investment contracts that can be turned into this sort of exchange I give you money now and I wait and I reap the benefit of your labor on the other end but the difficulty with that is that while courts must be able to look to the economic realities of the transaction look underneath the form because if we just look at the form if we just look at what it's called then anyone can just title it can title the asset whatever they want at the top of the piece of paper and escape whatever regulation they want so courts have to look past the formal titling of the asset to the economic realities of it however they also have to understand that the very flexibility of these tools both the flexibility of legal forms and the flexibility of this database technology means that it is very possible for people to be using a product for one entirely legitimate purpose and have other people begin to use it for different purposes an example of this from outside of the cryptocurrency area entirely would be the discussion we had several decades ago on VCRs right the question was some people use them to make illegal copies many people don't how far are we willing to go in rooting out bad uses that are beginning to cut away a healthy tissue and that's why I believe Howie is the outer circle it's it's it's necessary that it be there so that SEC in this particular case can reach cases in which people are labeling something one formal legal form but are actually engaging in an investment contract that's what it's there for but it doesn't really tell us anything about what the regulatory landscape should actually look like at the end of the day in fact the regulatory landscape in my estimation should and will look like something substantially different it will look like a bit of a handoff like a relay race in which for certain functions and under certain conditions one one overseer may have authority under so I lost your mic Thank You mr. Fairfield ranking member five minutes Thank You mr. chairman um I don't know where to start you know I'm somebody that believes we should still be on the gold standard and that I think we should honor the Fed because I don't really trust them you know so what worries me about this is that you know you say there's 250 billion dollars of capitalization here or whatever how much money is actually here I mean I just this is just seems like a Ponzi scheme to me it's um you know I mean I think the stock market is is a casino you know that's where I'm coming from so I mean so if I you know I'm gonna send a hundred thousand dollars to somebody through one of these deals who's gonna stand behind it you know where's the you know so I give the money I guess to one of you guys and then you turn around create these things and send it to somebody else for what in the meantime what if you went broke I mean I was involved when we found out about credit default swaps and figured out that everybody was trading these things and there was nothing there and and if we're gonna stop them the whole time what a collapse you know and I don't know if we got a similar situation going on here with this but you know I just what is behind this I mean what if there's no money at the end of the day who's gonna make up for this can anybody explain that to me good night should I take a shot I think that I'd split it into two buckets in this field where venture capitalist entrepreneurs are developing an idea and asking people for money they publish a white paper they build a following reddit post and these are different communities social network posts medium and so forth and they build a following and then they sell it and raise money and sometimes it's small just like a crowdfunding on Kickstarter but most of them aren't there's been 3,800 of them today over 50% of them fail within four months and and there's different estimates how many are scams and frauds there are good-faith actors in the middle of it too a lot of good faith actors but there's a lot of fraud and scams if if right now if they fail you've only way you could do is try under the securities laws to say they were an unregistered non compliant security and try to under the private rights of action senator securities law try to get something back nothing in the second category its digital gold the digital gold which is Bitcoin and while there's nothing behind it I would say mr. ranking member there's really nothing behind gold either you might all of us we have what's behind it is a cultural norm that for thousands of years we like gold the value of gold the worldwide value of gold is seven trillion dollars by the way just to give you a little sense but only about ten percent of the annual production of gold is used in manufacturing the rest of it is because we think it's kind of nice to have gold necklaces and jewelry or we do it as a store of value so bitcoin is a is a modern form of digital gold and it's a social construct but the money they are there just creating this money out of nowhere I mean the the in the in the first category the the the investor type that would be understated but in the second category you're right which was under this committee I mean you're you're gonna be grappling with this for a while I think I mean in the first category I mean I assume most of people are sophisticated enough to realize they're gonna get fleeced potentially you know I mean it are they or I mean I think there's people get into that area that don't realize what they're getting into they think some are no they're gonna get rich and they're gonna you know get into this deal ahead of everything else and it's going to go up and they're gonna make ten thousand percent on their money and whatever else and some guy is selling them you know on on this I mean I don't know where the protection is here there there's some are very sophisticated like andreessen horowitz and they manage seven billion dollars there there's there many like that but there are others that aren't but you're right I think this Securities and Exchange Commission has a lot of work ahead of them to sort of bring this market into the first part of the market that 70% of the market is commodities but the first part this ICO marketplace is the SCC's they're working at it but they've got a lot of work ahead if I could if I could just add mr. ranking member you know you raise this concept of kind of almost trust right which is who do I trust what's the trusted intermediary the the beauty at least certainly from the perspective of an investor and as a consumer the beauty of these crypto networks is what you're trusting is you're trusting kind of cryptography you're trusting math you're trusting software as opposed to a centralized intermediary and you have a community that's governing the interest there so in other words if the community tries to do something that is inappropriate all of this software is open-source all this software can be basically what's called forked and literally taken over and you know recreated in a new community so there is a norm of community governance that exists in these areas that really substitutes trust from a centralized intermediary to trust to a community that's responsible for government thank you but I'm still skeptical mr. Lucas 5ms Thank You mr. chairman and along with the gentleman from Georgia mr. Scott I have the privilege of setting both on this committee and financial services so I work on this discussion by the panel when it comes to the next regulatory frontier as it impacts the two committees first mr. Cooper how should regulators think about the function of the token when choosing to apply regulatory requirements should regulators look to the functioning of the token at all or only the issuing activity and for example say there's a cryptocurrency we'll call it for the sake of discussion Bitcoin 2.0 and say it functions identically to Bitcoin in every way except that a small portion of the total tokens were pre mined and distributed in token sale is it possible to issue Bitcoin 2.0 through ICO and not have it be a security or is the functioning of the token irrelevant because of the manner in which its issued so I'm asking what my folks back home would define as geek questions but this is where we are yes sir let's say you so yes a couple a couple things so the issuance of those tokens and the sale of those tokens in exchange for money before a network exists I do believe is a what's called an investment contract and should be regulated as such so if I offer if I develop a white paper and I tell you I'm gonna build this thing and you give me money for it before it exists if I fleece you absolutely the SEC has jurisdiction to you know bring me up on securities fraud charges you have private cause of action no no question about there once the network is functional and therefore the tokens are doing what they were intended to do whether that's storage or other things the value of that token now really is not a function of the efforts of the developer it's the really the question of what's the utility of that token much like any other commodity and so therefore you know certainly my view is that in that case the underlying token itself should be regulated as if it were a commodity because that's actually kind of the nature of what it's actually doing thank you mr. Ness the last prong of the Howey test identifies as an investment contract or transaction in which an individual expects profits solely from the efforts of the promoter or the third party yet for almost every token project there are multiple avenues for a holder to come into possession of token when a net works fully functional token can be purchased through promoter traded on a secondary mark exchange within a network are earned by performing work to support the network in each of these cases the efforts of the holder vary and can implicate the how detest differently how should regulators think of an asset that has multiple methods of delivery an asset that can be both purchased and earn or should the method of delivery determine the regulatory regime governing an asset fortunately I think it's a relatively simple answer which is that it really comes down to the same test which is pre functionality versus post functionality or whatever we end up deciding is the trigger point for determining the different status it seems to me that however you come by this I mean I suppose there are two two fundamentally different ways one is to get it from the issuer directly the other is to get it from some third party and if it is in pre functional the pre functional stage and you are getting it obtaining it from the issuer I would argue that is a primary offering of an investment contract even if it's essentially earned on a network because at that point there's a lot of case law out there that you know if you do work for a security you know you've paid for the security there's consideration there in the services so I wouldn't say that there's a difference between earning it versus buying it it's going to be a security depending on its characteristics as you know as we end up defining them pre functionality versus post functionality mr. gore fine in your testimony you mentioned the new working group set up by F sock and the Commission's work with the SEC and other regulators this committee cares a lot about coordination between financial regulators when it comes to these sorts of matters so can you talk more about how the regulator's including the CFTC and working together are working together I should say to understand and clarify their overlapping jurisdictions and how it affects the virtual currencies yes thank you it's a great question and we agree that that coordination in collaboration with our sister agencies is very important on this type of a topic you know one thing about this space that's common across a lot of areas of financial technology is that it inherently cuts across Geographic and jurisdictional boundaries so it's very important to make sure that we are coordinated and sharing information with each other so certainly on the topic of crypto currencies we are working closely with the SEC to make sure that we are coordinated and just to step back and explain how we view our rule set the definition of commodity under our statute is very broad so a lot of things are commodities and we're soon after the World Cup so think about soccer balls those are commodities just because something is necessarily a commodity doesn't mean that we have a direct regulatory interest it's only when we start to see the rise of futures or swaps products built on those commodities that we have kind of direct oversight but when the SEC applies the Howey test and determines whether something fits within a securities law framework that certainly matters to us because then that's something that would fall under their jurisdiction hence the need for us to be in close communication with the SEC mr. chairman if you'd indulge me for one last thought for a number of years I sat next to Ron Paul on the Financial Services Committee so when mr. Peterson brought up his observations about gold standard I can't help but think about mr. Ron mr. Paul's story noting that when the Roosevelt administration took us off the gold standard in 33 they sealed every safe deposit box in every financial institution in America and before you could open it you had to have a federal official of appropriate nature or state designee to be with you so they could make sure you didn't have any gold coins gold bars or gold certificates in those safe-deposit boxes so I think the ranking member brings up some interesting observations even gold wasn't safe in 33 you'll back mr. long reserve of government so thank you David

[01:17:45] Scott five minutes Thank You mr. chairman you know there is a good amount of very serious and legitimate concern about coins that are being offered I mean I'm not sure we realize it but there are over one thousand six hundred coins currently and growing every day and and we've got to look closely and watch how these coins are being used and if it is appropriate for them to be regulated to make sure that they're not being used improperly I'm not sure that the panelists or the audience or those who may be watching via television know but I find it very concerning that in the indictment of the twelve Russian hackers that hacked the DNC's servers did you know that they included in those charges within the indictment was the fact that the Russian hackers used principally Bitcoin when purchasing the service when registering the domains and otherwise making payments in furtherance of illegal hacking activity on the United States elections so what I'm saying is that with every new tool our technology is moving fast it's going at a rapid rate and we've got to grab hold on what we're doing to make sure that we do everything we can to ensure that these new coins are not being used illegally or for illicit activities like when the Russians attacked our election system now I also have read in some news coverage of studies studies that are out that think that not all of these icos are a positive thing there's a lot of debate on that and I think our ranking member mr. Peterson expressed it you at a customer advisory that we published through our office of customer education and outreach where we're tackling exactly this issue which is that it's a very speculative risky space for especially retail participants to be participating and we encourage them to really do their research and ask themselves important questions about the value of a lot of the different types of offerings that are out there it's an area that we think education is a key component I'll also add that from an enforcement perspective the CFTC is a well as well as a lot of other agencies are looking to target bad actors that are trying to take advantage of a lot of the enthusiasm around this space so the combination of Education enforcement and then proactive engagement as lab CFTC is doing are important regulatory tools for us to deploy yo cyber smart Austin Scott five minutes Thank You mr. chairman and well we are a long way from the peanut fields in Sycamore Georgia and I can't help but wonder if somebody who prior to getting elected to Congress actually had a series seven what would a prospectus on a coin offering look like it I don't know if it would be one page or or 10,000 pages or more but one thing that it's clear to me is that you can certainly create a coin for anything you can create a coin for any color you can create a coin for any opposite color so there's an infinite number of coins that can be that could be created I see no way to regulate every coin offering that's out there but I would also tell you that when you turn on CNBC and they show the Dow the SP and the Nasdaq on one side of the screen and on the other side of the screen is a value for Bitcoin then certainly it's reached the level where we need to have some type of regulatory certainty in this in this area most of my questions are for mr. cork or fine you run lab CFTC and you have held office hours around the country where you've met with with many people in the industry can you tell us about the interesting concerns of the developers who are working on token-based projects and how sensitive they are to the regulatory environment yeah thank you for the question and in fact I'm heading this afternoon up to New York to have another round of office hours with innovators we've had an incredible opportunity to go to various cities and and meet with folks that are heavily involved in a lot of projects across the spectrum that you've heard about today and you know it strikes me that it is a new generation that is really looking through a technology lens as to how we can transform markets make markets more efficient and effective but there are a lot of questions that they have and that's the reason we have the engagement function of lab cftc a lot of folks are trying to get a lay of the land and start to understand the alphabet soup of regulators in DC so through labs CFTC we do try to establish some guideposts and educate as to how our framework applies and in some situations will explain well this is where the CFTC fits and then there are questions that you may need to look at securities laws to understand the interplay there but in response to a lot of common questions we were getting that's why we published the FinTech primer it's our way of kind of facilitating conversation with the community to make sure we are being responsive and where possible providing as much clarity as we can other efforts of CFTC have been around things like actual delivery is a question that comes up a lot in the cryptocurrency realm so our division of markets and oversight has put out a draft interpretation that deals with actual delivery all of these are efforts to start enhancing and providing as much clarity as we can mr. Goren you suggest in your testimony that the Commission has an interest in this technology being used for capital markets infrastructure many of us on this committee include myself have introduced a piece of legislation the CFTC research Modernization Act have you had a chance to review that legislation and do you think it could help the Commission understand the emerging financial technologies and and help us better understand how we need to regulate or in some cases not regulate certain areas yeah thank you I mean one of the things that we're really focused on doing is making sure that we're engaging with technologies and fully understanding them so what you're raising is you know the ability to give the CFTC authority to research and test new technologies I'll give one example of how that may work in this space we talked a little bit about private and permission to distributed ledger technologies which could impact and improve capital markets infrastructure there's a lot of interest from market participants who are saying there may be more efficient ways for us to do for example regulatory reporting in a lower-cost way for them and in a way that for the regulator is is more consumable we can receive standardized data without kind of the traditional push process that could be very valuable what what you're pointing out congressman is that authority that that's proposed in your legislation would allow us to actually work with a consortium that type of infrastructure and that way from a CFTC perspective we could better understand how can this technology benefit our markets how would regulatory reporting be facilitated and really kind of lift the hood and really understand the technology instead of having kind of a high-level conversation so those types of authorities would be very very helpful to us thank you very much Gemma sorceress custard - thank you very

[01:28:24] much mr. chair and thank you this has been a very enlightening hearing and I appreciate all the wisdom mr. gore fine picking up on the CFTC regulations such as it is do you have sufficient resources at the CFTC or what would you recommend that you need from Congress going forward thank you well harness that the Chairman on this our Chairman's been very vocal about the need for the CFTC to have the right resources to be able to keep pace with our markets and regulate our markets most effectively I believe he's asked for 281 million dollars for our budget and a lot of those resources would be utilized not only with bringing in economists but also making sure we have the technologists in-house to be able to keep pace I'm I'm a lawyer I know multiple layers deep of the onion when you're talking about technologies but we really need to be able to get to the core of technology to make sure that we're ascertaining where new risks are arising so certainly with greater resources our agency would be able to even scale up some of those activities so I would just say for the record one obvious place to look for those resources would be to get the IRS on top of how a to tax the benefits and the gains that are being made because one of the most troubling comments today is that the IRS is not on top of how to how to capture those gains and I think that's something that we need to look at but it's also something on your side with some conversations with your counterparts at the IRS I want to quickly turn to the two professors and get a sense of a very troublesome aspect of this and if anyone else wants to comment so Credit Suisse analysts last year identified that 4% of the addresses hold 97% of the Bitcoin in the world and the philosophical goal of Bitcoin is to replace governmental backed fiat currency but if that goal is achieved you'd have an unprecedented amount of wealth and power concentrated in the hands of a very small number of people is this concerning to you and and what should lawmakers be doing with in this regard and there's a couple minutes left in some extent it's not surprising because most economic small economics ends up with some central is so an irony is that the technology is supposed to be a dis decentralized that was easier this struck me because all the commentary has been this and so it's one of the natural ironies because we all humans tend towards clusters and clumps and centralization and taking into account with the indictment that some of these addresses are in Russia with people that wanna do harm to our so more specifically to your question some of that concentration is because it's the large exchanges the crypto exchanges like coinbase has 20 million accounts they may not all be active and they hold 20 billion dollars of crypto funds and the market I should have said the market went up in the last day so it's now about 290 billion but just one exchange has a big chunk of it so I don't know if that is that then owned by multiple parties well so it's it's I'll speak a little bit like an accountant which I know the Chairman can appreciate but is that coinbase has a several accounts but they're only there coinbase and then if I wanted to trade I don't but if I wanted to trade then I have an account at coinbase these addresses would be in coin basis name not in my name so I only have a right to coinbase coin basis actually has whatever you want to call a right on this ledger in Florida my question is that not very many people end up controlling that is influencing and and if if the long-term goal is to cut out state-sponsored currency that is problematic in my view yeah I I think you're right to be concerned about the centralization of power but it when it's not necessarily so that a single address equates to a single legal entity in any way any one person can generate any number of addresses that have smaller or larger amounts and we don't really have a proper way to put it what do you think the percentage would how would you describe to the public watching today the distribution of influence there certainly are loci of power but also if you look at the movement in some of those earlier addresses or larger addresses it's commonly accepted that about 25% of something on a network like Bitcoin have not moved or have basically been lost at this point and so you'll see funds sitting in places and simply not moving and the the common consensus is that the private keys are the access to those wallets have simply are those addresses have simply been been lost what my time is up and I'll yield back

[01:33:57] but just to make a plea for democracy somewhere in this process I I appreciate the Chairman for scheduling the hearing thank you yeah Julian's back mr. Allen

[01:34:14] five minutes Thank You mr. chairman and this has been very interesting the gig economy is moving at light speed and the rest of us are just kind of dragging us along but but it is exciting you know I guess the the problem that we're having is from a regulatory standpoint is is through throughout the gig economy is obviously the reason it's doing so well is because there's lots of freedom and very little regulation but we do know that there are lots of problems people are you know I mean as far as connectivity as far as security and that sort of thing how do we reach a balance with this a in you know what we're doing is we're creating another money supply here is that as I see it in other words you disc its global I mean it's a global currency you know I just don't know how that works we you know we're like we have our basis our dollar I believe kind of sets the mark for the world right now explain how this how this is gonna work across the world yeah I mean you mentioned Afghanistan I don't what their currency base there is but I'm just gonna open it up I mean handle I don't I can't visualize how this could possibly work okay can I give it one real quick shot is government's sound governments like the US I mean if we maintain you have to maintain ur fiscal discipline and all the things we need to do if you can keep it right yeah but sound government's have certain advantages I think because of the stability and also because we allow our currency fiat currency to be used for all its legal tender for all debts public and private and you can use it to pay taxes and so there's some just natural advantages I think that how this might play out I could see a country that's in distress the Venezuela's of the world where in the future one of these currencies will be a better thing for their public than in that their individual citizens for the individuals for the mirga's they're not dealing through their government they're dealing through this global currency yeah I could see that I secondly think even in a stable economy like ours that our Federal Reserve with our respect has a little bit of competition for the payment system we Americans spend between a hundred billion and two hundred billion dollars a year for our payment system that's only a half a percent to one percent of our economy but it's still a hundred billion to two hundred billion dollars a year and so startups and entrepreneurs have a chance to chip away at that and get inside of that that's competition to the commercial banks and and the central bank when our payment system other feedback we got about two minutes yeah I just wanted to add to that around the Venezuela point that there was an some interesting usage of Z cash in Venezuela over the last year as a sort of bridge currency to the dollar so that citizens that could not have traditional access to get to the dollar we're using a crypto currency as an intermediary given the volatility of crypto currencies you wouldn't necessarily want to stay there but as a bridge and a sensor censorship resistant bridge at that it's somewhat important so all that censorship resistance can be seen as a double-edged sword we might not necessarily like the way that people are doing bad things quote-unquote with the network the ability to project into places where they also would prefer people to not be doing things should not be underestimated I can see where like a business located in a country where the government is is unstable the business community could really benefit from this what nation would I mean so then you got this competition between you know right now I guess the biggest competition is between the United States and China I mean you know there at the end seems to want to be the basis how do you I mean which nation would run this thing and ultimately be responsible for it was see that's the thing it's actually so it's it's it's decentralized so no nation does but you mentioned China I don't know there's been public reports but there's a lot of people in the community that say that though China the government has said we're clamping down the reality the reality is there's a lot of activity the Bitcoin is mined this is how its developed two of the biggest mining poles two of the three largest mining holes are in China the third ones in Russia and that combined is about 50 percent of the mining pools but beyond that the Bank of China is very actively engaged but the government is not fond of this well they're there of two mines yeah they say publicly they're not fond of it because they don't want their current their currencies not convertible so they're worried about people running around their currency that's the public face of it but underneath it they're doing a lot of work on at the Bank of China particularly is looking at it very closely because they're worried they wouldn't get their payment system right and they want to use it maybe there's also a bit of a land grab going on when it comes to enterprise distributed ledger projects where countries like China can go into emerging economies and do essentially free work for them using their technology which is impacting the adoption of specific protocols backed by various country in those regions yeah all right I'll yield back mr. buddy thank you very much

[01:40:03] god Darren five minutes Thank You mr. chairman cryptocurrency blockchain technology all have tremendous potential and I'm bullish on the prospect but we're in kind of a bizarre position here on Satoshi Nakamoto an unknown person or people who developed Bitcoin and this person or persons has nine hundred eighty thousand bitcoins and an estimated worth between nineteen point four billion to seventeen point nine billion so can any of you today and just raise your hand verify that mr. Satoshi Nakamoto is in fact a person or persons I don't believe it we've all agreed that it's a male all I asked okay Satoshi is female Satoshi's female grapes so none of you can verify who founded our own Bitcoin is my point which puts us in a strange position because normally we have industries and new currencies where we'd know who created it so that puts us in a weird position in addition you mind to develop new currency a process by which transactions are verified and you add it to the public ledger you compile recent transactions into blocks and try solving computationally difficult puzzles and you get a reward either a a guess a transaction for your newly released Bitcoin have we ever I guess gold is the only thing that we could even parallel to where we've mined in such a way have we ever had a currency online like this where you mine via transaction algorithms and solving puzzles on the Internet this that's that's the novel creation of yes somebody we don't know who she is Satoshi Nakamoto or he or collection but that that's the novel thing and when the internet was created my time is limited so we have an unknown person and a bizarre way of mining Bitcoin to get it together I'm more concerned though about being able to avoid money laundering for terrorism drug trafficking human trafficking tax evasion so I'd love to hear from each of you in one sentence on what we could do to stop money laundering and having Bitcoin and other cryptocurrencies be the choice of terrorists drug traffickers and those evading taxes we'll start from the left and going back one sentence because I've my times limited trust Vinson to do their job rely on other law enforcement mechanisms that work around strong cryptography we do not weaken two sentences bowls to them my time is limited I apologize Bitcoin is actually the worst tool to money launderer because every transaction is registered and fully recordable so it's actually law enforcement best friend okay while the technology can be peer-to-peer most activity takes place through a new type of intermediary where you can apply AML kyc rules okay on top of that rigorously require crypto exchanges to register and you may need to pass a law to do that but to make sure they register and that all the AML any money laundering know your customers being done there run-on sentence but helpful thank you the alleged Russian hackers were caught because they used Bitcoin thank you also concerned about two practices spoofing and wash Trading spoofing being flooding markets with fake orders to trick other traders into buying or selling and wash trading which is where cheaters trade with his or her self to give a false impression of market demand that lures others to dive into so can anybody give us any insight into how to stop spoofing and wash trading and we'll start from the right to the left now you know that's a tough one I don't have a good answer guess next register the exchanges and cops on the beat yeah we're a markets regulator that's something that we're able to police for within our regulated futures and swaps markets so worth a look at the underlying market to ensure that the right types of regulations are in place and are you all doing that right now the CFTC does not have direct oversight authority over underlying mark so we would have to give you jurisdiction to help with spoofing and wash trading it would be something Congress would have to look at in terms of authorities next mr. Kapoor yeah I agree either between the SEC or the CFTC you'd have to grant appropriate authority agreed broker dealers need to be treated like broker dealers I'd agree with that all right thanks and I yield back

[01:44:59] yep Jemma's Rebekah's Oh five minutes Thank You mr. chairman I'm wondering if for the benefit of our viewers at home across the country who are watching this hearing and are trying to understand the impact of the crypto currencies and what the future holds if if perhaps miss ball day and mr. Cooper could tell us where you think from a five to ten year view point where this is going to be the role that these currencies are going to have in our economy and how might this affect average consumers right now it's the market participants are mostly very sophisticated people do you see this insinuating itself into the broader economy sure thank you yes so we believe that this really is gonna create a whole new set of of infrastructure on which all kinds of new applications are built some which we may not even know about today so if you think about all the benefits we've reaped from you know Facebook and Google and all the kind of you know internet properties have been built today and negatives and negative - I think what the beauty of this technology is is it gives us a new set of platforms and again very critically those platforms are not controlled or governed by centralized corporations they're controlled and governed by community and so you can imagine all the utility that we have today but where the consumer actually has ownership of data the consumer has the ability to actually ensure that data is shared in a manner in which they want to be shared and consumer also can capture the economic rents from use of that data so we think the opportunity in that respect is endless mm-hmm sure I would say that there's two very different sides of the spectrum on the enterprise blockchain and distributed ledger side we're seeing mutualization of workflows kind of come to pass and that's a way for companies who kind of trust each other to do things in a more coordinated way that drives down operating cost on the the public side we can see to tag onto the gig economy statement earlier we can see a further kind of micro gig economy's happening wherein if people were to have more access and control over their own data this goes to for businesses as well we might be able to monetize that in new way so alternative business mechanisms to the current kind of data hungry surveillance capitalism that we see arising from centralized companies we might be able to challenge that kind of hegemony and and mr. Fairfield you referenced personal privacy issues how how do you see that coming into play here well there are a few the first would be if we were to follow through on the suggestion that KYC naml that has no your customer and anti money laundering requirements be imposed on many more actors in this space the initial reaction of many people who held cryptocurrency was that they did not particularly want those data revealed and they built products to try to keep that data from being revealed at least as far as the major exchanges and I've heard exchanges used a few different ways today but here I'm talking about the way you onboard you spend dollars you get Bitcoin for example I think that giving those exchanges the requirement under the Bank Secrecy Act to have kyc and AML requirements at the same time that they have fairly strict financial privacy requirements was a moderately decent fit for national security purposes we need to know when people can make a couple million dollars disappear in one country and reappear in another but at the same time there is some degree of constraint over what where that information can go once it's kept within financial institutions I think that's a good example of a mix that seems to work and maybe that would be a model we could spread out from and and just generally mr. Gensler or mr. gore fine as we look at the development of this it does seem that there is a issue that's going to affect government which is right now we know because we have paper trail we have electronic trails and documentation of transactions for which taxation applies for which government oversight and reporting applies how does government address this from the standpoint of its interest to try to make sure that taxation and other compliance issues are resolved that currently with our existing trim financial transactions we have mechanisms to have that reporting but I think it's it's really about knowing all the accounts this technology has what's called public keys and private keys and Z cash which miss bull debts involved in is even more secret than that but it's really knowing who owns the accounts behind that so it's know your customer beneficial ownership and then trying to do that through some of these central mechanisms like crypto exchanges it's not going to be perfect this is gonna be like a wacom all that it's going to be you know it's the IRS and the CFTC will work hard and then three years from now the technologists will have a new way to get around it mr. chairman could mr. Gore fly and respond to that as well yeah very quickly yeah if I may I mean you know one observation too is remember the most anonymous form of transaction is actual cash right people transact in cash there's very little record of that taking place most virtual currencies crypto currencies are pseudonymous so there is actually the ledger which is a fairly transparent mechanism to be able to pursue potential law enforcement as well as AML q I see so I just want to point that out but it is something that needs to be figured out by government thank you mr. Mishler boffo fabulous

[01:50:58] Thank You mr. chairman sorry I missed part of this hearing here but it might be well I'm a flip phone guy in a Bitcoin world anyhow all does you know no pretense here but mr. Ness they come from the flip phone part of North Cal as you down there in the Bay Area just a question I'll try and narrow down to it was talked about earlier in the committee about crypto networks and the internet protocols on tokens so would you touch upon what what would look like if that token is determined to be a security indium can you hit that for us yeah I think the issue really comes down to friction and while we can get to a status of free trading securities by registering them even when you do get to that status there are all sorts of ancillary friction they in and around the transfer of security you you need to have broker dealers involved and you need to have suitability requirements met and other potential disclosure issues and so forth that are ongoing and so when we're talking about trying to create the next generation of decentralized protocol layer kind of apps on top that are all interoperable interacting with each other and transferring value at the speed of software to deliver a service to a consumer it may it may be all transparent to the consumer that this is all happening under the hood but you can't have fundamentally the transfer of value at the speed of software if it's a security you're talking mean with the middleman of a typical financial institution right that's right yeah all right and again what please touch on the importance of increasing the access to the speediness of those types of trans transactions why why is that important well I mean to get a little philosophical I suppose I mean you know ledger technology is fundamental to Commerce right and double-entry accounting was an amazing innovation and ledger technology that you know pulled Europe out of the you know Dark Ages and the same thing can happen in in in a amazingly more robust way when we start to literally not just allow parties to trust each other through standard mechanisms of reconciliation but when we remove the reconciliation were the need for it all together and that is simply a philosophical point of view I suppose but it goes to this issue that we're at early stages of this we don't know where it's gonna go but speed is probably a good thing could I just say I'm an optimist I agree with what mr. Ness says but maybe it's the MIT and me now I think that the beneficial ownerships will be able to be tracked in a matter of milliseconds in nanoseconds not yet it might take five years but we'll get there technology's pretty neat how it grows and helps us well it's amazing thank you and as chairman appear at the risk of looking senatorial at a Zuckerberg Harry and I'm going to yield the rest my time Thank

[01:54:34] You mr. both of us Plaskett five minutes good good morning gentlemen and gentlewoman thank you all for being here of course this is you know something that we're all really learning about I try and say that I'm woke but you know that always doesn't work and this is one area where I think that my my 20-something year old children would find me really out of date so I'm happy mr. chair that we're having this because I think there and I think you all are correct there's a balance right we don't want to over restrict something that we don't even really understand or that's still developing but at the same time ensuring that that development while it's developing bad actors are not utilizing and gaming the system so that really terrible things can go on one of the main things that I'm concerned about people think of the Virgin Islands is really just being a beautiful paradise but we have enormous amount of drug trafficking that goes through the Virgin Islands and we also along with other Caribbean islands on other islands more so than ours have the ability to be used as a filter for hiding money and particularly ill-gotten gains and so I was wondering if anyone on the committee can really talk about how we can or law enforcement can really act as a deterrent for the use of bitcoins the marriage now between bitcoins and blockchain to be able to really accelerate the use of these types of currencies in a manner that does not you know cause individuals in other places to really take advantage of this it's ultimately a bit of an arms race because technology's new love it we're having an arms race with electronic money right we are we are it but the arms race and this is basically against societal norms and bad actors mm-hmm so technology I mean there's always gonna be crime and technology's just a new form of way to do it I think one thing that the panel's all set is Bitcoin actually is more traceable than the public thanks it's not anonymous it's what's called su nonnamous but we need ways to connect those public keys which are like 24 or 32 digits that nobody you know to real people and real companies and that's why I've recommended I think you need to have gatekeepers or gateways gateways to do that the exchanges the crypto exchanges are one set of gateways for law enforcement then detract the way that law enforcement now it uses banks the rack thing that would be one way out mhm I saw some others limiters if I could also respond the the way we catch criminals often is through traffic analysis blockchains are quite good sources for traffic analysis uh huh there are tumblr can you tell me how does the black channel facilitate that sure one thing to do would be to go online and simply google the blockchain right you'll find a website that will list each transaction as it comes across and if you spend 30 seconds sort of watching every transaction in the world that happens in blockchain and you think to yourself if I were a police officer I would find this flow of money around the world very interesting we also have computer programs though that require that don't require person set there but can comb these databases find patterns and kick bad patterns up to somebody to take a look at it there are ways of circumventing this block chains are pseudonymous I don't put too much stock in it because tumblers and dark wallets can essentially you and I might agree I'll pay your debts you pay mine that way your debts aren't traceable to you and my debts aren't traceable to me that's essentially what a tumbler does we pay each other's debts and so we hide where the money's come right but but I think that with traffic analysis standard artificial intelligence runs a combing across the database we can do a pretty good job of kicking up where bad actors are stirring the water mr. Gorn fine what do you think the role we talk about law enforcement doing this there's a all of us here concerned with what is our role what do you see CFTC in dealing with this as well yeah and I want to kind of step back and compliment the way I think you framed this this initial set of questions because I think you know it's exactly right that when I mentioned earlier my testimony about thinking about principles and making sure we're giving a you can you can regulate based on principles and then as you identify areas where there are particular harms to solve for that's where more prescriptive rules might fit in and certainly in this area of anti-money laundering you know your customer that's an area where you would want to make sure you're enforcing rules but to your more specific question you know the CFTC has now had a lot of experience dealing with some of these markets and the technologies but again we're our role is as a primary regulator of futures and swaps markets and then we do have that enforcement authority that's a look back authority to police for fraud and manipulation either in our futures and swaps markets or in the underlying market as well but because of our experience I think we have a lot to offer at this stage in terms of informing the discussion around this space given our enforcement experience the the role of our division of market and oversight in regulating the the actual exchanges monitoring some of the clearing and risk issues associated with crypto currencies customer education and then lab CFTC outreach so I think we're playing a very important role and then hopefully can help inform these efforts thank you and I yield back

[02:00:31] I just want to make sure that the regulations that we're doing while we give time for these this is to grow we also make sure we don't end up like Facebook where it has outpaced us in terms of being able to do damage in in the general good jump jalisa expired mr. Davison Thank You mr. chairman mr. Griffin I'm gonna go right back to you obviously we've talked a lot about jurisdictional issues and how to set up the proper regulatory structure that many in the industry are asking us to do you know there's obviously with many of the commodities and different products we have a SEC portion that is regulated in many cases and then we have the CFTC which falls under our jurisdiction and you get to to see some of the humorous anecdotes from members of Congress here who I'm sure had many maybe have had similar things to say when that new thing the internet was taking place and how are you ever gonna buy things off of the internet well Jeff Bezos has told us how I showed us a very well that anyone can do that now and as crypto currencies continue to grow in usage they're going to become less and less in intriguing and more and more used I am going to get into the demographics of many of the crypto users but I want to ask you a quick question sir based on the way current law is written not cut and dry whether cryptocurrency should be regulated by the SEC or the CFTC if Congress attempts to come up with a workable definition for crypto currencies that are more similar to commodities you know call them as we've heard blockchain commodities what should we be looking to guide us yeah thank you for the question you know I the one thing I would say is that and I said that mentioned this in my opening statement that it's important that we're not hasty in terms of figuring out what the right contours are of applying you know securities laws and then the the commodities framework I do think that the SEC has in due course been providing additional clarity there was recently mr. Hinman over at the SEC gave a well-received speech kind of outlining some of the SE c--'s thinking as to how they would apply the securities law framework and some of the things that I think you've heard are factors around decentralization you know are their expectations of return based on meaningful work of others I mean that these are important elements that of course are not you know I'm not saying that these are the only elements but these are some of the things that you start to look at in terms of figuring out well when does it make sense to be applying the securities laws framework that includes things like required disclosures it requires regulations around you know the offering of securities and the intermediaries involved in securities and when does that perhaps not fit the product so I think that this discussion is ongoing and I think that in due course and being thoughtful you're starting to see additional clarity and uncertainty coming out but certainly those are some of the factors that we've we've heard talked about a fair amount Thank You mr. Baldi and mr. Cooper and I'm sorry I wasn't here at the beginning of the hearings if I mispronounced a name forgive me I always try to mispronounce my colleague Ted's on purpose but not yours now Ms baoddai this is an industry that you are getting into in the infancy and you've actually done something that we don't see a lot around here you've come to us to actually ask for a stricter regulatory environment to stop some of the fraud and abuse that that was mentioned by some of my other colleagues today I want to ask for those of you who are in this business what demographic usually utilizes Bitcoin here in the United States what age it's Souda nonnamous so based on based on Twitter it's probably few people in there you know 20s to 40s Millennials its Millennials sure but you know institutionally there's a very different skew towards the size of transactions and the types of people that are playing and the larger dollar values so and there's also as you know there's a developing institutional market in this as well right so yes I think it started certainly there but if you look at some of the major financial institutions there there are institutional markets and you know large private equity groups there that are heavily transacting this as well yeah and to tag on to kind of the last question but also the the concern about regulatory framework you know what I was mentioning is about a need for clarity more so than the not so much that the bright lines that we're talking about security versus commodity as much as more interest in safe harbors for innovators especially because we're seeing the market adapt to this in that new disruptors arm are at an advantage versus incumbent institutions who are waiting for regulatory clarity to engage and so in a way in absence of that it's not it's not necessarily that incumbents are incapable of innovating or they don't understand the technology but they have to take a sidelines approach because they have traditional businesses to lose well thank you and mr. chairman my time is about ready to expire but we want to make sure that we devise a regulatory structure that allows this industry to continue to grow but allows to us to address many of the law enforcement problems that have been brought up here by many of my colleagues so can't wait to continue to work with you thanks for your time thank you of a

[02:06:10] show for five minutes Thank You mr. chairman I appreciate you all having the patience be here this is something that's really confusing to me my wife and I we watched a documentary on bitcoins and when we got done we were more confused and I have not invested in any as you asked with that said mr. Gensler in your testimony you mentioned the recent SEC staff determination that ether is not a security although it might have been at its issuance if the SEC had determined ether it was a security in 2015 what regulatory requirements would either be subject to today and I've got two follow-ups and anybody else that wants to weigh in on if they had determine that way back in 2015 at the time they would have had to give some full and fair disclosure I think the SEC at that time would have probably said well it's probably not three years of financials and things like that because it was a new startup and this is something the SEC is grappling with even now for current initial point offerings what is full and fair disclosure I think director Hinman at the SEC said it right it's about information asymmetry give an investor enough information so they can take the risk the government shouldn't it's not a nanny government we're not you know but the investors can take their risk as long as they get enough information okay and how might security I might such a regulatory regime affect the functionality of the ether 'im Network I think that and mr. Ness raised this question earlier there's friction right now because we don't have the beneficial ownership securities laws say we have to have full and fair disclosure and we have to keep track of anybody who owns the security it's that second one that's the friction mr. Ness mentioned I'm an optimist I think technology can solve for this it's not going to be in 2018 so it would slow down some of these token economies but I believe that it's important to track beneficial ownership for all the reasons about illicit activity and taxing and I agree with that anybody else at the risk of confusing you more about aetherium oh well I was going to say that named aetherium is apropos because it's just out there yeah it looks like where is it yeah so whereas some systems like Bitcoin were initially meant for peer-to-peer value transfer transfer the etherium Network does what's called well it's kind of more like a distributed world computer in a way don't think about it too much but what you can do is you can use the native token of the system this ether which may or may not have been a security issue and says you mentioned to pay for what's called gas in that network and that gas is used to by computational cycles on a shared computer so if something like gas ends up looking a lot like a security it that's generating PNL just as you're running a general computer it would be incredibly cumbersome if not impossible for normal humans to figure out what their their balance sheet should look like so we need to be be careful and not just applying a you know one-size-fits-all solution on them well I think the important thing is you know we don't want to stifle the imagination the entrepreneurialship the development of this but yet we want to have the safeguards in place whether it's a CFTC or the SEC we just want to make sure that when people get involved in it that their monies or their investment are protected you were gonna add something I was going to make a rough analogy because these are databases it's like the database in your computer and applying securities regulation to these databases would have the same impact as having the SEC regulate your computer at the internal level which is it's just simply going to gum up the works right yeah we don't want that I mean but we want the safeguards there my other question is I sit on foreign affairs and we deal a lot with North Korea and the sanctions and all that and we see countries changing companies funneling money breaking sanctions or skirting sanctions and a lot of it we see is being done over electronic currency like this what are the safeguards that you guys can help us with on that so that we can follow it you know when that's cash transfers it's easier to track that we can block and sanction those banks or those entities but when they're transferring things like this or any other nefarious activity drug deals and things like that what are the safeguards that you guys can put in place that we know we can follow that stuff yeah we we talked a little bit about this earlier but the the idea behind these networks is all the transactions are in fact traceable in beautiful and so in fact in most cases that you've seen for example in the recent Russian you know hacking investigation they really create a trail at a presence that actually really is a date of mind for many respects law enforcement so I think there's I think there's actually quite I think if you fast forward a few years I think this will look at many respects like GPS and cell phones have to come for law enforcement as well which is it really creates an immutable record that I agree benefit I appreciate your time I'm out of my time and thank you mr. chairman well thank the panel mr. gore filed I think you may have to slip out gets a play but I'd like to give each of you probably no more than a minute kind of closing comments think you wish you have said there you're opening there there a question that didn't get answered you thought about it be helpful for the for the record to have it so we'll start mr. Fairfield any any closing comment quickly only that I think it's a wonderful idea to begin with these kinds of conversations because it is here that we're able to look at the different communities that are using the technology in different ways and perhaps craft legislation or other rules that will permit us to not only capture the bad guys not only get them cleaned out of the system but to leave intact what is good behind sure thank you for for having me I would say that it's certainly important that we're having these conversations and moving towards some right size frameworks at the same time I think and possibly this is just our general American sensibility we're focusing on the private sector kind of business how does this look like a business how does this look like a financial system angle whereas there's a whole other conversation to be had about how what does this look like if it becomes systemic infrastructure similar to the internet and what does that mean globally so at the same time it's it should not be an either/or conversation we need to be thinking about how rather than just defensively we regulate how we can proactively make sure that we are frontline innovators in the way that we were for the Internet as well globally yeah I just want to echo a little bit mr. Yoho what you said which is to be very clear I speak myself none of us is suggesting here that there shouldn't be appropriate regulation in this market I think the there is actually a very good framework between definitions of security laws that apply to the SEC and then things that actually you know rightly so look more like commodities there's also FinCEN as we've talked about right in terms of KYC @ml so there is a there is quite a patchwork out there and I think you know for certainly in our business where we sit a lot of what we're seeking is quite frankly just regulatory clarity so that we ensure that companies who are good actors actually understand what the rules the road are and we fully support obviously the activities the SEC and CFTC and others are doing to make sure that the bad actors are routed out of the system yeah thank you I just want to thank the committee for taking an interest in this area and allowing us and as CFTC to help inform and support the effort to strike the right balance it's a it's a promising and very new area of innovation that you know as I said earlier we don't know where a lot of these different threads will lead but it's important for us to be vigilant and make sure that we're targeting kind of bad actors and making sure there are appropriate guardrails in place and that we have an efficient effective regulatory framework in place and look forward to helping support that effort first it's just so good to be with your chair and this committee again after five years - I think promoting innovation and promoting competition means also bringing this inside the public policy sphere I don't think they compete I think it's together I think that if you recall as this committee that there's the issuer based crypto which is kind of the SEC in these I cos there's derivative crypto which the CFTC has but it's going to have some challenges and then there's the whole cash commodity crypto which is 70% of this world that's where I think Congress has a role a real role and and to think about is there more authorities I say incumbents versus startups startups feel that they can beg for forgiveness after they sort of mess up with the law enforcement incumbents feel they've got to ask for permission and so right now there's an imbalance right now where incumbents aren't in this space and startups or and you might want to address that MIT and I are available any time if you need any help with any of this thank you I guess I'll echo that you know I think probably Eber taught us all that for better for worse if you build something that is incredibly popular the laws will change to conform to to that new technology technology is moving at a very very fast pace we've heard today about some of the pitfalls of these new technologies that get out ahead of the legislators and so I want to compliment you guys for for being on top of this and I think the SEC as well has been you know incredibly you know on top of it and and working closely with us and open to dialog and that and that's what I think is really needed is a kind of free flow of information and communication between those of us who are sort of on the front lines dealing with the day to day fact patterns and and you guys who need to think about the actual policy-making aspects well thank you it's been a terrific couple hours well spent for us I hope you consider it the same clearly elucidated some issues not all just with regulation of these issues but also the tangential impact of taxable transactions being captured in a way that that folks can comply with our tax code and and the revenues there the law enforcement piece is ball day I think you may be involved with a group that's trying to find a way to create a currency that is not synonymous but would be anonymous that's perfectly within that's what these market is that's what innovators do is they see something that that needs to get changed and they'll do that and so that just speaks to how dynamic the process as so long as the stupid criminals keep using Bitcoin will be great but then the support was no pivot to to something that allows them to hide better behind this so it's been a terrific i opening session and will not be the last because our folks at the CFTC who are our part and no bacon has happened and their partners at the SEC really want to do the same thing and that is regulate where it needs to and you have a certainty so that the incumbents don't have to worry about you know asking for permission while the innovators are asking for forgiveness that's an unlevel playing field and we also want this action going on it within the United States so thank you all very much under the rules of the committee that's at the record of today's hearing will remain open for 10 calendar days to receive additional material and supplementary written responses from the witnesses or any question posed by a member this hearing of the communitive agriculture is adjourned thank you [Music]
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Doubts Emerge Regarding SEC Director Hinman’s “Decentralization” Token Security-Criteria

On June 14th, 2018,  at the Yahoo! Finance All Markets Summit, the SEC’s Director of the Corporate Finance Division, William Hinman, made a “speech heard ’round the world” — best known for its bombshell conclusion that Ether coin (or “ETH”, of the Ethereum blockchain network) should not be considered a security [1].  While this sort of speech  is (surprisingly, to most) not an official pronouncement of the SEC [2], the blockchain world nonetheless breathed a sigh of relief, as the fate of a huge swathe of the sector could be in legal peril if present, day-to-day transactions involving Ether were deemed unlawful, and Director Hinman is the head of the SEC division responsible for making such determinations proactively.  Direct to point, Hinman stated:

… 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. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required. And of course there will continue to be systems that rely on central actors whose efforts are a key to the success of the enterprise. In those cases, application of the securities laws protects the investors who purchase the tokens or coins.

That statement is pretty clear regarding Ether, and the market’s jubilation on that particular aspect is likely justified.  Indeed, Hinman also stated:

… this also points the way to when a digital asset transaction may no longer represent a security offering. 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. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.

which fairly-directly addresses the separate, but related burning question of whether transition from a security (token) to non-security status is really possible — and does so in the affirmative.

However, look a little beyond the Ether-specific application of these remarks, and additional, thorny questions quickly arise.

For one, Hinman seems to hinge the Ethereum de facto determination on the fact that Ethereum is (now) “decentralized;” even generalizing this criterion, where he says “there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required” and “where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts ,” and, conversely, that “systems that rely on central actors whose efforts are a key to the success of the enterprise” are protected by “application of the securities laws.”

These portions of Hinman’s remarks did not seem to stir many feathers in the blockchain nest, likely because the blockchain world is “all about” decentralization of social and entrepreneurial functions (preferably, as “disruptively” as possible).

However, from a securities law perspective, the remarks are somewhat unorthodox, because “decentralization” does not exist as concept in the existing main body of law.  Now, new criteria are not entirely alarming when taking into account that so much about blockchain and ICOs is new, and intuition has it that the decentralization aspect should factor into the legal analysis somehow — but then the questions become: (1) is such a neologism really appropriate, and (2) if so, is it being delineated and applied correctly?

There are already hints of trouble in blockchain-land in attempting to make use of the “Hinman criteria” (as preliminarily sketched thus far) — i.e., cries have already gone up that “if Ether is not a security, shouldn’t Ripple also not be?”; or “if Ether is not a security because it is sufficiently-decentralized, shouldn’t Ripple, conversely, be a security, because it is not?”

And, more generally, what is sufficiently decentralized, anyways, for the purposes of “not being a security”?

These sorts of concerns in light of the state of extreme diversity of the blockchain ecosystem lead us to question whether the SEC might be headed down the wrong path if intending to weigh decentralization of blockchain tokens/coins qua securities in a manner embodied by Hinman‘s June 14th remarks.

Specifically, the expressed concern is the extent to which a centralized group or body is managing or controlling the network and its development, i.e., exerting “managerial or entrepreneurial efforts” that predominate over other activities in the network.

However, that is not what we take “managerial or entrepreneurial efforts” to mean in the broad body of securities law: it is evidently less of a determinative factor or characterization of the nature of the overall regulated-investment relationship than a dicta providing a broad qualitative descriptor of the sort of things promoters of a venture are doing when investors entrust capital with them to bring a venture to first fruition.

Indeed, the term “managerial or entrepreneurial efforts” didn’t appear in the touchstone SEC vs. W.J. Howey case (“Howey”) [3] — it actually appeared first in United Housing Found., Inc. v. Forman [4] (to be discussed below).  In Howey, rather, the court stated (emphasis added):

Thus all the elements of a profit-seeking business venture are present here. The investors provide the capital and share in the earnings and profits; the promoters manage, control and operate the enterprise. It follows that the  arrangements whereby the investors’ interests are made manifest involve investment contracts, regardless of the legal terminology in which such contracts are clothed. [5]

The first bolded passage parallels Hinman’s emphasis.  However, it appears to us that the stress on “making the investor’s interests manifest” in the second bolded passage has been lost in Hinman’s focus on decentralization of the “management, control” and/or “operation.”  I.e., it seems that a critical part of the investment contract-securities determination should be (and has always been) whether promises made to investors by contract have been made manifest.  In other words, whether the initial, commercially-viable version of the project or enterprise has been delivered.

It is not clear how decentralization of management, control or operation has any relevance after this point: dozens of times a day, all of us make use of commercial services that are managed, controlled or operated by a single entity, without this arrangement constituting “a security” or otherwise invoking securities regulation (indeed, they aren’t even un-regulated — they are the purview of state consumer protection agencies and the Federal Trade Commission).  Thus, it isn’t clear how simply recasting such relationships into “token form” could render them “investment contracts” for securities  law purposes.  At least, that outcome seems like it could not possibly be the desired result.

To illustrate the looming paradox here, consider other commonplace arrangements that do not strike one as (or are typically considered not to be) a regulated securities “investment contract” arrangement:

  • A Microsoft Office 365 subscription (whereby continued access, ongoing updates, and cloud services are provided exclusively by one company, Microsoft);
  • A subscription to any software-as-a-service (“SaaS”) delivered entirely by a cloud services company (with no decentralization);
  • More conceptually, a coin-op (or internal credit-based) laundromat under service contract from the company that built it, financed originally by selling to investors pre-paid laundry “tokens” (or house credits) (A hypothetical scenario from SEC Chairman Clayton’s recent public remarks [6]).

In any of these scenarios, clearly, the arrangement prior to delivery of the initial commercial service is one of a regulated securities investment. But after first viability and public release of the service, it seems evident that this status should be reversed, and new, or even continued contracts, or the transaction of “tokens” or “house credits,” should be treated as commercial services sales in lieu of regulated securities issuances.

That proposition per se (i.e., evolving from security-investment to utility-purchase) seems significantly less controversial after Hinman’s remarks. But why, then, should it matter whether the provision of the commercial service is “decentralized” after that point? It is in none of the above examples.

We contend that the ultimate standard for deeming blockchain token sales to be regulated sales of securities should instead involve how decentralized the efforts of producing the initial commercially-viable version of the blockchain network (and associated services) are, with respect to those who invested by buying tokens.  That is, the proper concern is whether those individuals are protected members of the investing public, or are instead sophisticated co-venturers (i.e., better associated with the venture/promoter group itself), and hence, are not protected as being on the “other side” of an investment contract which is subject to the “information asymmetries” Hinman mentions.

A further, (ostensibly) confounding aspect of the blockchain token-sale/ICO/utility token situation is that the arrangement may evolve from one of clear passive investment to one of direct use by the same original purchaser (indeed, in the blockchain case, often ultimately involving functional use of the actual instrument of sale itself, i.e. the blockchain token).

But, this situation of some fluidity between the two roles turns out to not be unprecedented in securities law and practice.

For example, SEC Notice 33-5347 [7] (which is actually cited by Hinman in his June 14th written remarks) deals with the question of when real-estate contracts are securities versus non-securities.  This is germane to the present discussion because you can either profit from real estate (i.e., passively, with other parties managing the arrangement) , or live in it (i.e., glean utility), and the status of the sale contract (or lease) as a security depends on the details.  Relevantly, Notice 33-5347 states (emphasis here):

If the condominiums are not offered and sold with emphasis on the economic benefits to the purchaser to be derived from the managerial efforts of others, and assuming that no plan to avoid the registration requirements of the Securities Act is involved, an owner of a condominium unit may, after purchasing his unit, enter into a non-pooled rental arrangement with an agent not designated or required to be used as a condition to the purchase, whether or not such agent is affiliated with the offeror, without causing a sale of a security to be involved in the sale of the unit. Further, a continuing affiliation between the developers or promoters of a project and the project by reason of maintenance arrangements does not make the unit a security. [8]

The first bolded segment supports the argument that a “consumptive” purpose in acquiring a token can override hallmarks of a (passive) investment contract (even if, as in this example, the contract’s “maturing” into a security was also a possibility), to end up with a “utility”-type transaction (here, the vending of real estate for direct use/enjoyment).  So “going from security to utility” is not as legally “revolutionary” as might be assumed at first blush.

The second bolded segment harks back to a the marquee question raised by Hinman’s June 14th proposal (as discussed above), and seems to contradict it:  here, a continuing “service-type” relationship — managed by the very promoters themselves — has no per se bearing  on whether the original transaction contract was a security.

This brings us back to Forman.  Hinman in fact cites Forman, for the proposition that whether a sale transaction is a securities-regulated investment contract hinges on the expectation of functional use by the purchasers (“Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers. When someone buys a housing unit to live in, it is probably not a security.” [9]).  Yet, let us trace further.  The Forman Supreme Court, in interpreting and applying Howey, stated (emphasis added),

This test, in shorthand form, embodies the essential attributes that run through all of the Court’s decisions defining a security. The touchstone is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. By profits, the Court has meant either capital appreciation resulting from the development of the initial investment, as in Joiner, supra (sale of oil leases conditioned on promoters’ agreement to drill exploratory
well), or a participation in earnings resulting from the use of investors’ funds, as in Tcherepnin v. Knight,  supra (dividends on the investment based on savings and loan association’s profits). [10]

This is where that handy phrase “entrepreneurial or managerial efforts” comes from.  But notice how the court then bifurcates the application of this criteria into (a) capital appreciation from the development of the initial investment, or (b) participation in earnings.  Nowhere present in this rubric is incidental capital appreciation, or any other forms of value gleaned from ongoing entrepreneurial or managerial (or any other sorts of) efforts by the contractual counterparties.

This is all in the context of a discussion of shares giving the right to use housing, i.e., a “utility versus security” discussion, and the above passage immediate precedes the Forman court’s more well-known rule (internal quotes and citations removed and emphasis added):

… when a purchaser is motivated by a desire to or consume the item purchased — to occupy the land or to develop it themselves — the securities laws do not apply. [11]

Immediately at the conclusion of the above passage, the court cites SEC Release No. 33-5347 (discussed above) as support, bringing this discussion neatly full-circle.

So it appears that when the SEC and Supreme Court together last looked at an analogous situation (i.e., a contract that can “mature” into either economic returns or direct “personal use”), they came to much the same conclusion that we have regarding decentralization vis-a-vis continued management/control/servicing.  That is, the import of “the degree decentralized” of management has on the securities status of ongoing or even vested purchases is categorically limited; what matters far more is whether people are buying the instruments under a bargain whereby a separate group of promoters promises to turn the buyers’ principal into an ongoing economic return, or from an inchoate idea into a viable commercial product or service.  We hope the SEC does not lose sight of that when advancing in this sector.

-AK

Citations

  1. William Hinman, “Digital Asset Transactions: When Howey Met Gary (Plastic),” Securities Exchange Commission, June 14, 2018 (hereinafter, “Hinman0618”), available at https://www.sec.gov/news/speech/speech-hinman-061418.
  2. I.e., the first footnote of of the written version of Hinman’s remarks reads: “The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners or other members of the staff”; id, Fn 1.
  3. SEC vs. W.J. Howey,  328 U.S. 293 (1946).
  4. Id. at at 300.
  5. United Housing Found., Inc. v. Forman, 421 U.S. 837 (1975).
  6. The SEC has posted no transcript or official written remarks of these speeches, but see, e.g., Nikhilesh De and Mahishan Gnanaseharan , “SEC Chief Touts Benefits of Crypto Regulation,” CoinDesk.com, Apr 5, 2018 , available at https://www.coindesk.com/sec-chief-not-icos-bad/; or Erin Arvedlund, “SEC chair Clayton promotes ‘harmonizing’ conflicting rules over brokers, advisors,” Philly.com, May 2, 2018, available at http://www.philly.com/philly/news/breaking/sec-chair-clayton-promotes-harmonizing-conflicting-rules-brokers-advisors-20180502.html.
  7. SEC Notice 33-5347, GUIDELINES AS TO THE APPLICABILITY QF THE FEDERAL SECURITIES LAWS TO OFFERS AND SALES OF CONDOMINIUMS OR UNITS IN A REAL ESTATE DEVELOPMENT, Jan. 4, 1973, available at https://www.sec.gov/rules/interp/1973/33-5347.pdf.
  8. Id at 4.
  9. Hinman0618, at citation of fn. 6.
  10. Forman at 852.
  11. Id. At 852-853.
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Congress Members Push Back Against SEC; Promise To Introduce Utility Token/SAFT-friendly U.S. Legislation

A routine House Financial Services Committee hearing held on May 16th, 2018, turned eventful when a number of U.S. Congressional representatives sprung “initial coin offering” (ICO-related) questions on SEC officials — most of them from a more positive and supportive perspective than the SEC’s Chairman Jay Clayton has evinced in his comments directed at the ICO sector for most of the past year.

At the hearing, Ms. Avakian  and Mr. Peikin, co-directors of the SEC’s Division of Enforcement, testified for the SEC.

Notable statements and exchanges included (emphasis added):

  • Rep. Sherman (28:21): “I hope you shut it all down” (in reference specifically to ICOs; Sherman goes on to contrast the supposedly-lax SEC treatment of ICOs with a perceived harshness faced by conventional filers merely “misstating a footnote”.)
  • Rep. Maloney (42:30): ” … there [has] been a strong debate about whether a token that is offered as an ICO can be a security when it is first issued to investors and then later evolved into something that is not a security; some people think that once it’s a security it’s always a security and the others think that the token status as a security can change over time. As far as I know this is not a decision that’s been decided by the SEC or the court, so I’d like to ask both of you do you believe it’s possible for a token to start as a security but then evolve to something that is not a security?”
    Ms. Avakian: “I think it’s always going to be a facts and circumstances test as to whether something meets the definition of a security, and if the substance of something changes over time that analysis is going to have to continue to happen — but we really do look at the substance of the transaction, not the name of it, not what it’s called, and look at, you know, does it fit the test for a security…”
    Rep. Maloney: “… have you seen any situations where [a coin going from a security to ‘utility’ status] has actually happened?”
    Mr. Peikin: “I mean we have dozens of investigations that are ongoing and one of the subjects of many of these investigations is evaluating whether or not a particular instrument is or isn’t a security. I don’t think I can speak to… the outcome of those because some of that work is ongoing. A lot of what we’ve seen though in these ICOs obviously looks and… meets the definition of securities.”
  • Rep. Maloney (44:14): “… chairman [Clayton] has stated, and I quote, ‘I believe every ICO I’ve seen is a security’ — do you agree with that statement?”
    Mr. Peikin: “I can’t speak to whether he’s seen the broad… gamut of instruments that our division is is investigating, so I certainly don’t dispute that what he’s seen he he believes is a security; the question… is whether some of the things that we’re looking at now, do they actually meet that definition, and I think… some more needs to be written on that.”
  • Rep. Emmer (01:10:10): “… as I’ve listened today, clearly I must have a different point of view when it comes to some of my colleagues on cryptocurrencies, and I will say that you just testified that these initial coin offerings present real risks to investors — but let’s not forget they also present real opportunities and we’re talking about a technology blockchain technology that has an amazing potential … “
  • Rep. Emmer (01:10:51): “… secretary Clayton has said ‘every initial coin offering is a security’ — that’s not what I heard you say; you’re reviewing these and you’re developing what your view is of the different types of cryptocurrency… problem is, a lot of people up here with white hair without hair or people that have been around for a while don’t even understand what they’re talking about and we worry that too much government could actually kill this thing before it can grow into something that’s very good for our economy…”
  • Rep. Emmer (01:12:46): ” … how does the SEC distinguish between an ICO and the sale of a token for use on a blockchain platform?”
    Ms. Avakian: “That’s always going to be a real facts and circumstances question, and again, we’re gonna take a step back and look at exactly what the substance of that particular transaction or token is not the name of it…”
    Rep. Emmer: “Is that [determination] evolving , because it could be a security, it could be a commodity, it could be a currency — there have to be some delineated lines so that people understand where they’re at and… who has jurisdiction over them, because we want to make sure that they’re continuing to explore the opportunity, and not just going out of business.”
    Ms. Avakian: “Yeah, I think that’s right — and we’ve spoken a lot publicly about it, certainly the Chairman’s spoken a lot publicly about it, you know to the extent something is a pure currency, pure medium of exchange, that’s not a security. I think we’re relying on the experts in the marketplace — the gatekeepers, the lawyers, others like that — to really take a step back and take a true look at what is the underlying substance of a transaction, and that’s really going to be I think what guides someone.  But we are… open in terms of having folks come to us and help work through that analysis.”
  • Rep. Davidson (01:19:00): “What do you make of these folks that are clearly cryptocurrency today, yet if they had raised capital, might be seen as security at the time —  how do you resolve that?”
    Mr. Peikin: “… we’re obviously… encountering [a] kind of new area with new products and changing technology, and some of these issues are being worked out in in the courts… as we speak… We’ve been focused on the tokens and crypto assets that fit the definition of a security, and the CFTC has been focused… on currencies and mediums of exchange, but you know I’m not sure I’m an expert to say… where that exact line is drawn, and I think some of this is going to be worked out… over time.”

And, the coup de grâce:

  • Rep. Davidson (01:20:02): “… Our office is working on an initial coin offering bill that would provide certainty about how a security is…  fundamentally, is the Howey test still relevant, what’s the role of SAFTs, is a white paper paper gonna cut it, or do you to use SEC forms that already exist — how do you advise proceeding forward with your office? …”

There is more discussion on ICOs, throughout — check out the full hearing record to get a complete picture.

We will not attempt to handicap the likelihood of this legislation coming to pass, but the comments do speak revealing to the presence of genuine advocates of ICOs and the new blockchain token asset economy in Congress.  As such, we find the exchange that transpired distinctly encouraging.

(No official transcript of the hearing has been released; however, video of the full session can be accessed here, and KrowneLaw has provided an approximate, marked-up automatic transcript of the entire hearing, below.)

TRANSCRIPT GUIDE  AND ADVISORY:

  • The transcript was produced by a text-to-speech process performed automatically by a third party service outside of our control.
  • KrowneLaw does not vouch for its accuracy; indeed, we guarantee it is inaccurate.
  • As such, each snippet of translated text is linked directly to the point in the video at which it occurs (popup in separate window/tab).   Please use this functionality to confirm exactly what was said in each case.
  • The hearing covers a wide variety of topics; thus, ICO-related terms have been highlighted to assist in quick location of the relevant passages (this highlighting is by no means exhaustive, however).
  • The breaks in the text coincide roughly with changes in topic/changes in Congressperson leading the questioning.  They do not correspond to changes in speaker; thus, each block usually represents multiple speakers, including those on “opposing sides.”  You must listen to each particular segment in the video to determine who is speaking and to get the full context (and therefore, meaning).

Scroll box with transcript follows:

[00:18:41] it's just a minute ready to roll let's go committee will come to order and without objection the chair is authorized to declare a recess at of the committee at any time this hearing is entitled oversight of the FCC's division of enforcement now recognize myself for four minutes to give an opening statement as we all know the Securities and Exchange Commission has a three-part mission to protect investors maintain fair orderly and efficient markets and to facilitate capital formation today's hearing will focus on the policies and procedures of the SCC's division of enforcement the Enforcement Division investigates potential violations of the federal securities laws and prosecutes these cases in the federal courts or in administrative proceedings before the SEC zone administrative law judges the SEC is a civil enforcement agency it cannot bring criminal charges itself although it can refer cases for criminal prosecution to the Justice Department that pursues civil money penalties disgorgement of illicit profits and injunctions to prohibit future violations however the division has broad authority to subpoena documents and testimony from individuals and entities of violating the federal securities laws or who may have information relevant to a fraud investigation in November of 2017 the SEC enforcement division released their annual report highlighting their enforcement priorities which are guarded guided by five core principles first focus on the Main Street investor to focus on individual accountability three keep pace with technological change four impose sanctions that most effectively and further enforcement goals and five consistently as assess the allocation of SEC resources in the fiscal year of 2017 the SEC brought 754 enforcement actions and obtained almost 3.7 billion in in disgorgement and civil penalties resulting from those actions additionally 1.07 billion was distributed to harmed investors which was a dramatic increase from the previous year's 140 million dollars while this increase is significant the SEC noted that much of the effort that resulted in the FY 17 numbers occurred in years however focusing on the number of enforcement actions and total amount of penalties uses used to measure quote-unquote success can be misleading in my opinion I believe in this instance that these statistics only provide a very limited picture of the quality nature and effectiveness of a successful enforcement program for example violations that are prevented or deterred cannot accurately be measured by that particular statistic I'm pleased to see the enforcement division under chairman Clayton's leadership has redirected its focus away from the broken windows enforcement philosophy ie targeting a high number of minor infractions in order to discourage larger securities violations which was championed by former chair Mary Jo white in a 2013 speech then chair white characterized this approach as quote the theory is that when a window is broken and someone fixes it it's a signal that disorder will not be tolerated but when a broken-winged window is not fixed it is signaled that no one cares and so breaking more windows costs nothing the same theory can be applied to our securities markets minor violations that are overlooked or ignored can feed bigger ones and perhaps more importantly can foster a culture where laws are increasingly treated as toothless guidelines of close quote in a speech last week the SEC Commissioner Hester Pearce purse stated that by quote following the broken windows approach perhaps the SEC should have changed its name to the sanctions and Exchange Commission because it acted like a branch of the US Attorney's Office for the Southern District of New York close quote I couldn't agree more with a commissioner purse in my mind I believe that this is this misguided approach to enforcement appears to have only been successful at boosting statistics versus meaningfully improving investor protections I'm pleased to see that the division is shifting away from minor violations of securities laws instead taking a more selective approach to enforcement after all we should not evaluate the true effectiveness of a regulatory agency or its enforcement program solely based on how many headlines it can generate I look forward to hearing from our code directors of enforcement and how on how well the rules are working and if there are regulatory gaps that need to be filled to allow you do your jobs more closely and more carefully with that the chair now recognizes the ranking member of the subcommittee the gentlelady from New York mrs. Maloney for three minutes for an opening statement I thank the chairman for yielding and

[00:23:48] two of my minutes are going to mr. Sherman III thank you for holding this hearing the division of enforcement's job is to investigate and punish people who violate the securities law and it is the largest division in the SEC because its job is so very important the Enforcement Division makes all of the other divisions at the SEC matter after all if you don't enforce your regulations and rules then you might as well not have them but if it's a job that the Enforcement Division can't do alone the divisions budget actually decreased slightly in fiscal year 2018 and it is still badly outspent by the financial industry and the white color defense bar the SEC is responsible for overseeing over 8,000 public companies and more than 26 thousand registered market participants such as investment advisers and brokers and there are tens of thousands of retail investors who rely on vigorous enforcement of the securities laws to get a fair shake to cover all of this the Enforcement Division has a staff of around 1,200 less than 4% of the number of companies the SEC oversees and easily less than 1/10 of 1% of the employees of those companies given this huge disparity there's simply no way that the Enforcement Division can catch and punish every single violation of the securities laws that's why Congress gave investors the right to sue companies if they invest in for violations this private right of action allows investors who have been harmed to recover their losses without relying on the SEC enforcement division to do all the work this is one of the reasons why investors have so much confidence in US markets they know they can hold companies they invest in accountable when they violate the law even if the SEC enforcement digit division doesn't have the time or the resources so if you care about enforcing this Security's law and punishing bad actors who take advantage of retail investors which I know are our panelists do then you should support private enforcement of the securities law through investor lawsuits I also want to mention that the SEC has been very active recently in cracking down on fraud and virtual currencies and so called initial coin offerings or icos this is important because retail investors are getting killed in virtual currencies which are being treated like speculative investments rather than currencies this is a problem that we need to address and the SEC enforcement division has been at the forefront of this effort so I want to thank both of our panelists I look forward to hearing from you and I yield

[00:26:38] back my time o gentleman yields back well I've got

[00:26:47] one more minute remaining on my side where we will I will recognize the vice

[00:26:50] chairman of the committee for one-minutes an opening statement and then we'll be going to mr. shermin for his two minutes thank you for convening this hearing chairman huizinga thank you to our witnesses enforcement of our securities laws is a critical part of achieving orderly and efficient markets and the SEC s division of enforcement is critical to providing investors the confidence to participate in our markets this is especially true for retail investors who may not have a strong understanding of sophisticated financial products and services additionally the market participants should be reasonably informed about the expectations of the commission for following our securities laws transparency in this respect is of the utmost importance enforcement practices should be about ensuring the law is followed enforcement proceedings should not result from miscommunication or misunderstanding of the law finally I'm pleased to see that the Commission's enforcement approach has prioritized protecting retail investors I want to ensure they maintain the confidence to invest especially given the historic opportunities for investment and ongoing growth of our economy with that mr. Chairman I yield back gentleman yields

[00:27:53] back the chair recognizes gentleman

[00:27:55] California mr. Sherman for two minutes for an opening standing the purpose of the SEC often the focuses on the fairness to the market participants but the real focus has got to be funding American business it is we you deal with the people who participate in the markets but it is those entrepreneurs and companies that get funded that really affect the economy as the ranking member pointed out you're beginning to do something on initial coin offerings I hope I would have hoped you've done more I hope you shut it all down and we'll be interesting to find out what barriers you face in doing that because if someone's trying to fund an operating business that might employ thousands of people and they tried to comply with the securities laws and they screw up footnote 27 you might be on them like a ton of bricks but if somebody just builds on the image of the securities laws has an unregistered offering of quote coins calls it an initial coin offering to be similar to an initial public offering and is selling an investment with no investor protection something like in every Ponzi scheme is valuable only because another sucker might be found and furthermore isn't funding operating businesses now it's true somebody selling an initial coin offering might give a small donation to the Red Cross every scoundrel does something good in their life but when somebody's trying to fund creation of jobs they've got to do it very carefully or you're on them for a misstatement in footnote 27 when somebody is selling crypto currencies to investors it's taking you a while to shut them down you're still under a there's still there's still delay and I hope that you will be as tough on them or tougher on them than those who comply try to comply with the securities laws gentleman's time has expired today we welcome the testimony of Miss Stephanie Avakian and mr. Steven pekin who are the co-directors of the SCC's division of enforcement I'm going to recognize you

[00:30:20] collectively for a generous five minutes that will save us a few minutes actually rather than each of you being recognized and without objection your written statements will be made part of the record so with that about Ms Avakian you are recognized thank you thank you good

[00:30:37] morning chairman Huizenga ranking member Maloney and members of the subcommittee my name is Stephanie Avakian and along with my colleague Stephen Pekin who will address you next I serve as co-director of the United States Securities and Exchange Commission's division of enforcement thank you for inviting us here to testify today on behalf of the Commission about the Enforcement Division the Enforcement Division plays an essential role in carrying out the SCC's mission to protect investors maintain fair orderly and efficient markets and facilitate capital formation our vigorous enforcement of the federal securities laws in order to detect deter and punish wrongdoing and compensate harmed investors enables the Commission to promote confidence in our markets which is critical to encouraging capital formation our efforts are aided by our regular coordination with the Commission's other divisions and offices and our partners at the Department of Justice and other federal state and foreign regulators since our appointment almost a year ago in June 2017 the Enforcement Division has remained focused on its core mission of strong and effective enforcement of the federal securities laws the cases we have investigated and recommended to the Commission over the past year are a product of the hard work professionalism and expertise of our career staff in Washington and our 11 regional offices in November of last year we issued a report in which we outlined five key principles that guide our decision-making these are focus on the interests of Main Street investors focus on individual accountability keep pace with technological change impose sanctions that most effectively further enforcement and constantly assess the allocation of our resources today we would like to briefly explain how we are applying several of these principles protecting retail investors has always been at the heart of the enforcement divisions mission we've enhanced these efforts by forming a retail strategy task force which is focused on identifying punishing and deterring misconduct that affects everyday investors this increased retail focus does not mean that we are allocating fewer resources to financial fraud investigations or to policing Wall Street since we were appointed co-directors the Commission has continued to pursue cases against large corporations financial institutions Wall Street firms and other market participants who violate the federal securities laws focusing on individual accountability has also long been a priority and the enforcement divisions recent efforts show that our commitment to holding individuals accountable for misconduct in the securities markets has not diminished since we assumed our roles more than 80 percent of enforcement actions have included charges against one or more individuals at all levels of the corporate hierarchy including CEOs CFOs and other high-ranking executives and going forward we will continue to hold individuals accountable where warranted thank you very much for the opportunity to testify today before the subcommittee I would be happy to answer any questions you may have and my co-director Stephen Pekin will address you next good morning mr. chairman ranking member Maloney and members of the subcommittee my name is Stephen pekin along with my colleague Stephanie and I serve as co-director of the division of enforcement and I want to touch on two additional points our efforts to address technological change and the issue of remedies and relief in an effort to keep pace with technological change were focusing the enforcement divisions efforts and resources on emerging cyber related threats and issues including issues relating to hacking data breaches virtual currencies and initial coin offerings we think these are among the greatest risks facing investors in the financial markets today and we recently formed a cyber unit to focus on these sorts of issues cyber related matters are an area where we've sought to utilize the full range of tools and remedies that are available in an effort to balance protecting investors and allow for real innovation in some cases we recommend enforcement actions against wrongdoers in others we've acted on an emergency basis to recommend the Commission suspend trading in stocks the Commission and the Enforcement Division have also issued a number of public statements and alerts to focus investors and others on the risks relating to IC OS including for example the risks associated with celebrity endorsements of these products the sanctions the enforcement division seeks in its actions are critical to influencing the behavior of market participants and we have a wide array of tools available to us disgorgement penalties industry suspensions and bars and other relief in every case we consider the facts and circumstances and we seek the package of available remedies that's most appropriate enforcement division is also focused on compensating harmed investors for losses stemming from violations of the federal securities laws we place great importance on putting money back into the pockets of harmed investors in the last fiscal year the Commission returned to record 1.07 billion dollars to harmed investors now despite our successes in recovering funds a recent development threatens our ability to do so for long-running frauds in a case called khopesh versus SEC the Supreme Court held that claims for disgorgement are subject to a five-year statute of limitations and as you would expect many fraudsters try to conceal their schemes some are successful and defraud investors for years before they're discovered we appreciate the need for clear statutes of limitations and we're redoubling our efforts to uncover investigate and bring cases as quickly as possible but no matter how quickly we work it's likely that the coke cash decision will impact our ability to obtain recovery for harmed investors and long-running frauds so thank you for inviting us here today to discuss the division of enforcement and Stephanie and I are happy to answer any questions you have thank you very much we appreciate that I'm going to recognize

[00:36:33] myself for five minutes at this time for questioning and as I mentioned in my opening statement I believe that lawmakers should never necessarily evaluate the efficacy of regulatory agency or rule or enforcement program solely based on number of headlines or press releases that it can generate but there have been some recent news articles criticizing the drop of enforcement actions by the SEC under the new administration from 868 and 2016 to 754 in 2017 and so the joint question to you both as a and Mis Avakian you had talked about a focus on protecting the retail investors which i think is it's great and it needs to be done but does the statistic this drop in in actual cases beg the question of whether the SEC division of enforcement is has gotten soft on Wall Street as some are accusing and are you really trying to protect that retail investor thank you for the question you know we really when we think about whether we're protecting and to what degree we're protecting the retail investor and when we think about our effectiveness we really think it's most important to look at the nature and the quality of our actions the actions were taking and what it is we're doing so while statistics like you know how many actions the Commission's filed over a given period of time or you know the total amount of financial remedies ordered over a given period of time can be some measure of activity we don't think that that's the way to really look at the effectiveness of our program and instead we take a step back and look more meaningfully at you know what are the actions we're bringing are we making a difference for investors are we focused is our program focused on the worst conduct on the fraudulent conduct are we stopping ongoing frauds are we stopping inappropriate print inappropriate practices or sales of inappropriate products at financial institutions are we focused on those cases that are most likely to get money back into the pockets of harmed investors are we getting bad actors out of the securities markets those kinds of things are we deterring wrongdoing and that's what we think can well so with an enforcement program can it be evaluated solely on those number of enforcement's and and penalties and those kinds of things I mean it's what we're really trying to get out of then is what should be the evaluation of of the effectiveness of your particular division I mean how should you be measured we should be measured on you know are we creating deterrence against wrongdoing are we getting bad actors out of the marketplace some of these things are measurable by statistics but many are not are we stopping fraud on retail investors are we covering a broader range of retail investors or a broader range of practices so not all of these things are amenable to using statistics to measure them but if you look at for example what we've done in the ico space in a very short period of time and I think the effect that what our program is done in that time period is sort of a good way to look at it in a very short period of time the Commission has issued a report of investigation we've brought a number of cases the commissioners issued has issued a number of trading suspensions we've made of a number of statements to the marketplace I think we've gotten response to that so it's it's a more qualitative analysis I've got about a minute and a half here and I want to move on to another issue but I may follow up with a written looking at number of complaints and those kinds of things just to get a better handle on that in June 2017 the Supreme Court held in khopesh versus the SEC that the five-year statute of limitations apply to disgorgement claims that the SEC seeks an enforcement actions by clarifying that the remedy of disgorgement is a quote penalty and your testimony you noted that the co-coach decision has already had significant impact across many parts of the division can you please explain the effects of it and what you've seen so far and do you believe that investors ultimately will have to shoulder additional losses while fraudulent actors are able to keep billed gotten gains due to this decision it's a it's a very significant decision that's having meaningful impact on our ability to recover funds and return them to investors particularly in cases of long-running frauds where they're not discovered until time has passed we can't reach back beyond five years and pull money out of the pockets of the wrongdoers who and turn them to investors we've been keeping track of in our litigated and settled cases of how much money we've had to forego seeking recovery of and the latest numbers are over 800 million dollars just in the last year or so alone in our litigated and that was out of a total and total enforcement it was three something four billion it was last year it's a very meaningful percentage and I think you know we don't know what the ultimate impact will be but this is going to have a significant you know impact on the recovery that we achieve for investors my times expired and expiring but at what I want to know and we'll follow up in writing is what we as Congress can do to ensure that bad actors aren't able to profit from from from their misbehavior and their and their fraudulent actions and and then get get that remedy back to those investors so I think this is going to be a very significant thing and look forward to continuing that conversation with that I recognize the ranking member

[00:42:20] for a generous five minutes thank you and I look forward to working with you on on the point that you made I'd like to ask both you about initial coin offerings and virtual currencies there have been a strong debate about whether a token that is offered as an ICO can be a security when it is first issued to investors and then later evolved into something that is not a security some people think that once it's a security it's always a security and the others think that the token status as a security can change over time as far as I know this is not a decision that's been decided by the SEC or or the court so I'd like to ask both of you do you believe it's possible for a token to start as a security but then involved is something that is not a security that's really a question that's primarily within the expertise of our division of corporation finance not us as much that said I think it's always going to be a facts and circumstances test as to whether something meets the definition of a security and if the substance of something changes over time that analysis is going to have to continue to happen but we really do look at the substance of the transaction not the name of it not what it's called and look at you know does it fit the test for a security is it an investment in an enterprise in order to generate a profit based upon the efforts of others and that's really the test that's going to be applied well have you seen any situations where this has actually happened yeah I think I mean we have dozens of investigations that are ongoing and one of the subjects of many of these investigations is evaluating whether or not a particular instrument is or is in a security I don't think I can speak to you know the outcome of those because some of that work is ongoing a lot of what we've seen though in these icos obviously looks and is you know meets the definition of securities well building on that statement chairman Clayman is stated and I quote I believe every IC o---- I've seen is a security do you agree with that statement I can't speak to whether he's seen the broad you know gamut of instruments that our division is is investigating so I certainly don't dispute that what he's seen he he believes is a security the question I guess is whether some of the things that we're looking at now do they actually meet that definition and I think the you know some more needs to be written on that well I I know that you brought a number of enforcement actions on icos and I'm pleased to see that you're taking this issue seriously a great number of retail investors are getting hurt with cryptocurrencies but there been so many ICS over the past few years and none of them none of them have been registered with the SEC securities offerings so when your division is looking at all these IPOs how do you decide which cases to bring enforcement actions on we have as you noted there are a number of ICS and we have a number of investigations in the pipeline I think just speaking very broadly in terms of how we prioritize things that require emergency action are going to come to the front of the priority list so there are some cases we've brought in the last months like the Sentra I see which was a large ICO that involved celebrity promotion the founders of that were arrested assets were seized think roughly 60 million dollars in digital assets were frozen there are other cases the arise Bank case and there have been others long thin where you know I think those ones that that really do require an asset freezer emergency actually are gonna come to the top but there are others and you know like many other things the investigations take time so some of this is going to be when the actions are ready we'll bring them well do you believe that private lawsuits by investors can help supplement the enforcement divisions work by deterring bad behavior that the SEC might not catch so our main intersection with Private Securities Litigation is that we often will use Private Securities Litigation as a source for you know to start an investigation of our own I think our assessment of whether or not to conduct an investigation on our own isn't impacted by whether or not there's a private civil litigation because if we think it's worth devoting our resources to the remedies that we can get at the end of the day often are much broader than what a private litigant can achieve so in addition to just getting money back for investors we can also bar wrongdoers from the industry but that's our principle intersection with the Private Securities Bar well I think that sounds helpful to me so I believe it's important that the SEC not take the unprecedented step of allowing public companies to use forced arbitration clauses to prohibit their investors from ever suing them under the securities laws in court even for securities fraud so no matter how good a job the SEC enforcement or Enforcement Division does it will never be enough to catch all of the bad actors that are out there in our markets so I just want to say that while the SEC enforcement division is necessary I don't think it will ever be sufficient by itself it's so underfunded and understaffed compared to the challenge before you and that's why it's important that investors keep their ability to sue public companies in putting those class actions for securities fraud in court so I just my time is long past and I yield back

[00:48:03] thank you the chair was being generous since I had been a little loose on my own time so with that the vice chair of our committee mr. Hultgren from Illinois is recognized Thanks chairman thank you

[00:48:15] again both for being here in your written testimony regarding the Supreme Court's recent ruling on Co Koosh versus the SEC I wonder if you could explain and I'll let you decide whose best to respond if you could explain this decision how this rescission could decision could restrict the Commission's ability to enforce our securities laws what does this mean for retail investors and then also want to ensure our securities laws are enforced we need to have enforceable rules in order to encourage effective markets for companies seeking access to capital investors and the brokers that facilitate these markets so what steps do you believe Congress should take if any in light of the Supreme Court's recent decision so as I said the co cash decision is significant and is gonna have far-reaching impact on our ability to recover funds that have been stolen from victimized investors I think that we don't come with a specific proposal for a legislative fix if one's appropriate for Co cash but we I think would be interested in working with this committee and and with the members and their staff in fashioning a proposal or responding to anything that might come forward because this will have a significant impact on investors you know please let us know your thoughts as we move forward on that we had floated an amendment actually took Japan in general would you support a process within your office I'm sorry if I'm jumping on my notes here let me go back we had floated an amendment to choice act that would expand the reforms proposed for the SEC enforcement ajiz division to the CFTC and wonder if you could respond to would you support a process within your office for closing investigations during this time say 180 days could you make a determination to institute an administrative or judicial action refer the matter to DOJ for potential criminal prosecution or inform the parties that investigations are closed I think we're not familiar with the details of the legislation but but broadly speaking the investigations typically take some amount of time what I'll say is one of the things Steve and I have really message to the staff and I think folks have taken quite seriously is the importance of first moving quickly in our investigations but also really once we make a determination that perhaps we shouldn't proceed there's not a securities law violation you know to close the matter if it's more appropriately referred to someone else to do that quickly but we do take quite seriously prompt prompt movement of our cases and decision making that's great I think that's you know the issue for us is obviously this is disruptive and to get answers or information as quickly as possible when these investigations are going on or when they can be closed that's what we want to see happen obviously not changing the process making sure the process can work but expediting where possible let me move on a little bit to cyber security expectations in general wonder if you could speak to your expectations for public companies to protect themselves from cyber security threats for example after a breach would you be able to reach conclusion that a company was negligent in protecting itself and therefore its investors from cyber security threats and would you look at something like NIST standards to inform this thinking so we look at the question of cyber security through the lens of disclosure and you know the Commission has issued guidance to public companies about what they should be thinking about in terms of disclosing cyber risks and how they should be thinking about the issue of disclosing a cyber or then I think we're cautious in this area that we don't want to second-guess the good faith disclosure decisions that companies have been victimized by sophisticated actors including even nation-states have to face and we've said before that while we don't want to second-guess those kinds of judgments there could be circumstances that are so egregious failures of disclosure that we would bring enforcement action and we recommend it and the Commission brought enforcement action against the company formerly known as Yahoo just a couple of weeks ago for what we considered to be a case that had crossed over that line from good faith to to an abdication of responsibility Thanks my last seconds just the beginning of your testimony mentioned in fiscal year 2017 the Commission brought 750 for enforcement actions and obtained 3.8 billion dollars in penalties and disgorgement I'll return a record of 1.07 billion to harmed investors in awarding nearly 50 million dollars in payments to whistleblowers critics of your office may point out that the Commission brought fewer cases since the change in leadership at the Commission however could you please explain how you were able to return a record amount to harmed investors in general what does this mean for how your office is approaching enforcement we've taken the issue of both collections and distributions quite seriously we have a very they're both within our trial unit in the division and the collections folks have been incredibly aggressive about going out and collecting money and our distributions area is an area where we've put additional resources and where we've put a serious focus on doing our best to quickly move to get money back into the pockets of harmed investors as quickly as possible great thank you again thanks both for being here yield back gentleman yields

[00:53:34] back with with that the chair recognizes

[00:53:35] the gentleman from Massachusetts mr. Lynch for five minutes thank you very

[00:53:41] much mr. chairman and thank you for having this hearing I want to go back to the Yahoo hack now it's called Altha book I guess that's the new company and you're right he just settled for 35 million with with Al Tabo formerly Yahoo that hack affected several hundred million users alpha boy I'll go back yahoo sold their digital and email services for about four point four eight billion to Verizon I did the math on this so the thirty-five million represents about 8 cents per user that was hacked and you're very very correct when you say that that case was as you described it an abdication of responsibility I think it was worse than that they hid that disclosure of that hack for two years the only reason they disclosed it was because they were for sale so you know I think that that was the worst possible behavior to deceive investors they eventually had to discount the sale because they had neglected to disclose that information to the buyer but eight cents eight cents per user a hacked do you think that's that's fair I thought 35 million for a company that solve a four point four eight billion I thought 35 million was really you know selling short the the damage that was done to users and I I think it was a slap on the wrist to be honest with you because it really didn't didn't affect anybody other than the users having their their information compromised yeah I I think it's a great question and fashioning you know the the appropriate recommended penalty in a case like this where there'd never been a case brought before against a company for failing to make a disclosure like this obviously is a difficult situation you're trying to weigh the costs and benefits and burdens of any corporate penalty the penalty itself was never going to go back to compensate the people who were whose information was was hacked all fairness was going to the how about fairness you know III know they weren't gonna be compensated but you know you're also telling me now that that we're not going to do dozens of cyber hacking cases in the future we're gonna want to shift gears so I just see a lot of this we serve on another subcommittee that deals with you know cyber issues and I just think it was the case of first impression I agree with that but I think you fell far short or the SEC fell far short of holding anybody account here I think if there had been a meaningful penalty here other companies would look at that and say hey we got to get our act together here not only should we not allow this hacking to go forward and and you know redouble our efforts to protect data but you know there's also the backend the reputational damage that to the company when that happens and also the example to others in the future because this any company out there doing a sizable business in in you know digital conduct is is really gonna blow this off because thirty five million is laughable to be honest with you for a company that you know is about five billion dollars in value and and and and these people as I said before intentionally concealed this information from investors and and its customers so you know it was especially egregious behavior and I just think that that example coupled with your your new policy where you're not going to go after cyber hackers as you have in the past so we're going from week to week or I don't know how much weaker you can get them thirty five million dollars for a company of that value now you're going to do less I just think you're going in the wrong direction to be honest with you and and I think that some of this was a Russian hack some of these entities are getting even more sophisticated so your your example or your the lesson that you are teaching is that the fines aren't that bad compared to the cost of stiffening your system strengthening your system so why spend money on it I mean that's that's the message I'm getting from you well you know I hope that the industry reads this case in a different way and that I don't know why they would honestly you know I'm trying to be failed with you yeah and I would say that you know there there certainly is no intent or plan on our pot on our part to abandon bring cases against the perpetrators of these intrusions which continues to be of significant priority for us we see intrusions for the purpose of stealing information for insider trading and we have cases and investigations that have been there were gone going and then have been brought against the perpetrators of that kind of misconduct and I expect that will continue to be a high priority for the Enforcement Division thank you I yield

[00:59:10]

[00:59:11] back mr. chairman thank you gentleman yields back the gentleman from Missouri

[00:59:14] the chairman Wegener is recognized for

[00:59:14] five minutes I thank the Chairman I think our witnesses for being here I want to talk about a trend that occurred at the SEC in the last administration that is very concerning to me and that I hope is being addressed with our new leadership under the leadership of former chairman Mary Jo white the SEC increasingly turned to its own administrative law judges LJ's rather than the federal courts to adjudicate enforcement actions and in fact a 2014 Wall Street Journal article found that for 12 months straight every case the SEC steered towards the agencies appointed ALJ ALJ's was quote successful for the SEC in contrast according to the same article the SEC fared far worse when they brought cases before the federal court trials winning approximately I think half of the time at the time former enforcement director Andrew surest me I think was his name stated quote were using administrative proceedings more extensively because they offer a streamlined process with sophisticated fact finders let me start off by asking this our SEC administrative law judges the same as judges with lifetime tenure appointed under article 3 of the Constitution the judges are appointed in a different fashion I'm not sure of the exact mechanism but they're different so they are they are not appointed under article 3 of the Constitution should suc administrative law judges be interpreting and developing federal securities laws for at for example insider trading laws even though they aren't article 3 judges there are I think some sorts of cases that make sense for administrative law judges to consider given their securities background and the fact that the appellate rights are to the Commission of the end of the circuit courts but I should step back and make it clear that since we've been in this job which has now been just about a year the circumstances in which we've filed litigated actions as administrative proceedings have been fairly limited and I would say broadly they've been limited to circumstances where either the charges that we're pursuing are only available in the administrative forum so think failure to supervise of a broker dealer or something like that or where the principal relief we're seeking is only available in the administrative forum so barring someone from being in the securities business or where the person involves is a registered person like a registered broker-dealer investment advisor so I think we have filed a far fewer number of litigated actions as administrative proceedings Senate many of them our settlement maybe things have changed and I want to reclaim my time because I have several other questions it's very clear the SEC has lately been using these administrative judges for complicated cases including several involving insider trading how's their performance evaluated quickly the administrative law judge yes I'm not sure how their performance is evaluated doesn't this create a potential for conflicts of interest or undue bias in favor of the Commission in administrative proceedings probably worth noting that in the last year we fared much better in litigation in district court than we did in our administrative forum I think our success rate was fewer than less than 60 percent I am very concerned about the bias so what steps are being taken to prevent bias or at least the appearance of bias in all ALJ proceedings can the administrative law judges or are pointed in a unrelated to anything we do in an independent fashion but I will say that the appellate rights are initially to the Commission but after that to the US Circuit Court of Appeals which is the same appellate path that a case takes if it goes through the district court so I think you know if there's concern ultimately there is a path for peel that's very similar to the defendant have a choice about which path he can take know as the plaintiff says you know that's of concern to me does the SEC bring similar cases for example insider trading cases in both federal district court and administrative proceedings we have not filed it I understand the question yes have not filed an insider trading case as an administrative proceeding does this create the potential for different legal interpretations of the same or similar laws and potentially inconsistent enforcement actions I don't think any differently than you get by being in front of any number of district court judges who decide the same set of facts in a different fashion I understand the question yeah and these are complicated these are complicated issues and I have great concerns of this overreach of authority especially given the fact that these are not article 3 judges and I look forward to working with you and the agency as we go forward to get the most proper outcome concerning these issues so I think I've run out of time I yield

[01:04:32] back Jim gentleman yields back gentleman

[01:04:34] from Georgia congressman Scott is recognized for five minutes

[01:04:39] thank you very much mr. chairman mr. bacon and mr. Abba Khan let me ask you this you listed in your testimony the recent Supreme Court decision of I think was kokeshi versus the SEC and you said that that along with the president Trump's administration's hiring freeze put had ones before you and could very well severe affect the effectiveness of your enforcement duties would you share with us why you've come to that conclusion and how serious would these impediments be so mr. Scott um I appreciate the question I think really a couple points in response the first is the Co cache decision is is going if not change is going to limit our ability to recover funds that have still been stolen from investors as part of long-running frauds in some cases like Ponzi schemes for example are sort of self covering and so they often go on for many years before they're discovered and then we can't reach back and get money that's that's been stolen from investors the the question of hiring is one that we you know think about a lot and and we've been operating under a hiring freeze we think we're adequately resourced to do our jobs and you know we've asked in the current budget request for an additional 17 slots for enforcement which we'll use for our cyber efforts and our trial unit and and other key areas but we're working we're trying to use the resources we have to make decisions about how to allocate scarce resources like every other law enforcement agency we have a broad area to cover and we're doing things like using data analytics and trying to leverage our investigations to work smarter to try to to make the biggest impact with the resources that we have yeah and there was a case I believe in Dallas with this company who's running a scam operation you may remember that and my information is that they were trying to develop a false federally insured bank could you tell us about that so we could see the ingenuity of folks doing that it was AVS Bank Epperly I know it starts with and I think I think um that you're talking about a case called a rise Bank where yeah I rise a an initial coin offering that was supposed to fund a some kind of banking operation and this is one of the cases that Avakian referred to where we acted to obtain emergency relief it turned out that it was a total scam as we allege the individuals were ultimately arrested and we seized digital assets so I think it's a great illustration of how these initial coin offerings can present real risks to investors and how we've been trying to work quickly to stop this kind of fraud from from going on all right now in my in my last minute and a half here we are now in the grips of dealing with Russia and China and their use of their very sophisticated technology of really breaking into our security systems what I'd like to get from you is how serious is this nation-states threats and who would be the leaders that we have to worry about the most and how so so I'm not sure that I'm in a position to really answer that question fully but I will tell you that you know our cyber unit which is focused you know in large part on addressing securities law violations that are perpetrated by cyber criminals including nation-states you know sees you know actors in the Russian Federation and other places that you've mentioned trying to steal non-public information to trade forcing trading by breaking into people's brokerage accounts and the like and the Yahoo case which I mentioned before is one in which actors which I think we allege were associated with the Russian Federation were involved in in stealing the information from Yahoo so you you have actually saved Russian operatives who are acting physically correct well I believed in the Yahoo case the allegation is that the people who were identified as having broken into Yahoo and stolen user information were associated with the Russian Federation so yes and in your enforcement capacities what has been the disposition of these Russian operatives well as you can imagine for you know for a civil investigative agency that police's the securities markets where we're often looking at people who trade on that kind of information or benefit from the theft of that information so you know whether we can actually bring action against the perpetrators you know depends on the case thank you very much gentleman time has expired with that gentleman from Minnesota mr. Emmer is recognized for five minutes

[01:10:06] I want to thank the chair again for convening this hearing and the co-directors for joining us today and for the job that you're doing as I've listened today clearly I must have a different point of view when it comes to some of my colleagues on crypto currencies and I will say that you just testified that these initial coin offerings present real risks to investors but let's not forget they also present real opportunities and we're talking about a technology blockchain technology that has a an amazing potential I'd like to go back to some of the questions earlier and ask them a little bit differently and I want to thank you before I start because I think it was represent Maloney that started the hearing this morning by suggesting that secretary Clayton has said every initial coin offering is a security that's not what I heard you say you're you're reviewing these and you're developing what your view is of the different types of cryptocurrency problem is a lot of people up here with white hair without hair or people that have been around for a while don't even understand what they're talking about and we worried that too much government could actually kill this thing before it can grow into something that's very good for our economy so I'd like to know since you've been getting involved in some of these enforcement actions in investigations what has been your level of engagement with cryptocurrency exchanges with the actual exchanges about their decision process around listings are you actually communicating with them in having it back and forth we as an agency broadly speaking are engaging with the marketplace I think to some degree the exchanges although we're not necessarily in the best position to answer that particular question the reason is as an agency we've really worked together across divisions and across offices so we've got a distributed ledger technology working group that's an interagency group we've got a FinTech working group that's an interagency group those groups particularly the FinTech group have been working closely with the marketplace with folks who are coming to us with folks we're doing outreach to I would say the division of corporation finance is probably on the frontline of a lot of it the division of trading and markets is going to be on the frontline of the exchange issue but we are working with industry and we encourage market participants to come to us whether it's through the FinTech email box which we've set up FinTech at sec gov or whether it's to reach out directly to a particular division or office I would go the next step then how does the SEC distinguish between an IC o---- in the sale of a token for use on a blockchain platform that's always going to be a real facts and circumstances question and again we're gonna take a step back and look at exactly what the substance of that particular transaction or token is not the name of it and so is it something that someone's you know investing something of value in is it an enterprise someone's investing something of value in in order to generate a profit at the expense of others that's the basic definition of what's a security it is that evolving ru because it could be a security it could be a commodity it could be a currency there have to be some delineated lines so that people understand where they're at and who is who has jurisdiction over them because we want to make sure that they're continuing to explore the opportunity and not just going out of business yeah I think that's right and we've spoken a lot publicly about it certainly the Chairman's spoken a lot publicly about it you know to the extent something is a pure currency sure medium of exchange that's not a security I think we're relying on the experts in the marketplace the gatekeepers the lawyers others like that to really take a step back and take a true look at what is the underlying substance of a transaction and that's really going to be I think what guides someone but we are as I said before we are open in terms of having folks come to us and help work through that analysis what let me ask you this last one when looking at potential enforcement actions what specific factors are used by the division to determine which token pre-sales will be targeted when we think about enforcement action and what we're going to look at we are working together with our division of corporation finance to a large degree to analyze what it is we know about the substance of an underlying product is it as security is it potentially as security and and that will guide sort of how we think about it okay well I look forward to working with you as this evolves and I want to thank you again for the work that you're doing and your light touch policies is so far thank you my yield back gentleman yields

[01:15:13] back at this time all right at this time we're going to stay on the Republican side and the chair will recognize mr.

[01:15:27] Davidson from Ohio for five minutes Thank You chairman I thank you both for

[01:15:32] your for your testimony and for the work you're doing to protect our markets and to make sure that America remains the world's best place to raise capital and and see it grow I will spend a fair bit of time on icos and crypto currencies but I want to pick up where miss Wagner left off on due process with administrative law judges I couldn't have used five minutes better and for that reason I introduced HR 2128 the Due Process Restoration Act which seeks to give defendants the option of federal court versus a no option path to an administrative law judge proceeding I have some of the concerns about a near 100% batting average for the ALJ's and I think over time about a 67 670 batting average for the courts which says that the SEC is good about picking their cases but it does raise some concerns about the path of ALJ's director pinkie bacon you can yes speaking my apologies I guess are you concerned that SEC administrative proceedings have fewer due process rights than in the courts so let me just make a couple of reactions to that so one I think as Stephanie said earlier you know we've been much more restrained in the use of administrative proceedings in the last year um and really using them in only the limited categories for litigated cases that she outlined when you look broadly at you know the the success rate of our litigated cases in over a broad period of time in the administrative form versus federal court they actually are pretty close now don't get me wrong when we bring a case we're we're looking to win them all we don't we win about seventy five percent of our cases in federal court and about eighty five percent in an administrative form so you know the roughly equivalent success rates there are protections there obviously different processes in administrative proceedings from in federal court but the rules around administrative proceedings have been modernized in recent years to for example allow for depositions you know each side and there are some protections in the administrative form that aren't even available in federal court so we have to turn over our entire file immediately in an administrative form we don't have to do that in federal court we have to turn over information Brady or jiggly Oh information which is exculpatory or helpful to write your side and we don't have to do that in federal court so you know there is a balance there obviously different rights and procedures in both forums well as you know there's a case pending before the Supreme Court so we look forward to that out come and and we look forward to vote on the on the due process Restoration Act here but we also look forward to regulatory certainty around initial coin offerings in particular and you know is is is you're all aware the CFTC also has claimed some jurisdiction you've got a working group as you know you referenced earlier is it clear where the CFTC's jurisdiction is because we do have you know court proceedings and we have CFTC who staked out claims on crypto currencies since 2015 what do you make of these folks that are clearly cryptocurrency today yet if they had raised capital might be seen as security at the time how do you resolve that yeah I mean I think some of this you know we're obviously um you know encountering kind of new area with new products and changing technology and some of these issues are being worked out in in the courts you know as we speak you know we've obviously operated our financial system has operated for a long time with you know regulators with differing jurisdictions the CFTC regulating derivatives and commodities and SEC focused on securities I think the way you know things have fallen out recently where we've been focused on the tokens and crypto assets that fit the definition of a security and the CFTC has been focused its jurisdiction on you know currencies and mediums of exchange but you know I'm not sure I'm an expert to say you know where that exact line is drawn and I think some of this is going to be worked out you know over time yeah okay so our office is working on an initial point offering bill that would provide certainty about how a security is it's fundamentally is the Howey test still relevant what's the role of staffs is a white paydirt paper gonna cut it order you to use SEC forms that already exist how do you advise proceeding forward with your office so I mean that obviously would be interested in providing technical assistance and working with you and your staff on any proposal and our division of corporation finance is probably a critical participant in in that because some of this is beyond the expertise of the Enforcement Division all right thank you my time is expired challenge time how you look inspired seeing no for their Witnesses on the Democrat or sorry questioners on the Democrat side we will move to mr. Poliquin from Maine for five minutes thank you very much mr. Chairman

[01:21:00] I appreciate it thank you both for being here today I am represent the great state of Maine and I know you folks are new at your job you've been there for a year you'll probably have a very stressful situation at the SEC so I want to remind everybody that Maine is vacation land if you haven't booked your vacation remain you should do it we don't have any air conditioning with a lot of moose a lot of critters everywhere a lot of blueberry pie and lobster so with that let's get right into it I'm concerned about small investors because rural Maine is like the most beautiful part of the world the hardest-working people I don't worry as much about folks who have you know big fat you know accounts but I worry about small investors in in particular when you look at small investors who are starting out to build a nest egg maybe the first time through a mutual fund and you know they mark the market every day in its public and it's one portfolio for the asset manager and I don't worry as much about that but what happens if one of our small investors builds up that nest egg to a point where they might want a separate account from an investment advisor well maybe they participate in a 401k planner to find a benefit pension plan and that account is managed by an asset manager in a separate account now I used to be in the asset management business and you know what you're providing for your investors for your accounts if you're in that business is trust and security and the product you're selling in great extent is is your rate of return your performance record over time so what I worry about and when I want to ask you folks is how you deal with this when you go look at an asset manager it's time for their review and you're trying to make sure that the rate of return that they are showing their prospective clients how do you make sure there is accuracy in the performance data that they're submitting because that's what people are buying Pass perform it's no guarantee of future performance but that's what they're selling so for example if you walk into an asset managers firm and they have a hundred different accounts how do you know number one they're all fully discretionary how do you know there are no restrictions on on tobacco or alcohol or gambling how do you know about the size of the account are they diversified enough that you're getting a true reflection of what the performance is such that investors are able to make the decisions with confidence that the data is accurate tell us how you do that sure I think the the first line of defense on the kind of potential problems you're worried about really is our office of compliance inspections and examinations OSI they are the ones that go in and do the examinations they do risk-based examinations they do other sorts of examinations and this is one of the things they're looking at is what an investment advisor is representing to its clientele is it accurate is it true is their performance what they say it is so that is one of the things that we look at that OSI looks at I would note that we've done some risk-based proactive work within the division of enforcement asset management unit and one thing we've looked at is performance reporting our economic folks in our indira the division of economic resource and research and analysis have also spent time looking at this issue broadly and so this it's a it's a very potentially real concern that you raise and it's a very good question but it is one that I think our examination folks take seriously and mr. beacon have you found these wonderful examination folks that work over at the SEC that there this is a problem or is the oversight enforcement the audits that you perform on behalf of the investors and savers in Maine and beyond is enough to keep folks in line or have you seen there been problems here so the issue of valuation is it has been a problem in the number instances and we brought a number of enforcement actions against you know wrongdoers for you know giving investors false information about the true value of and performance returns we have a very close relationship with our with our office of compliance inspections and examinations and they refer to enforcement results from their examination so if they go in and they find something that's sufficiently serious that they don't just issue a corrective letter they'll refer it over to enforcement and we open investigations and some of our most significant cases have been brought based on these examinations and what type of penalties are common with an asset manager who might be cooking the books so it could be the whole gamut um there could be you know disgorgement and return of money to victims penalties barring them from participating in the investment advisory business altogether so you know anything up to and including you know being being kicked out of the business please keep working at what you're doing make sure your vacation in Maine but don't forget about the small investors or small savers we need to make sure they have confidence when they turn over their hard-earned savings to an investment manager thank you very much

[01:26:12] thank you mr. chairman the gentleman's time has expired and if it is fine with our co directors we're gonna do a quick second round of questioning which at this point we think will be rather limited we might not decide whether its Laurel or yani but let's at least continue the conversation I'm going to turn to my friend and gentleman from Georgia for five minutes sure let me get to what I think is really the gist of the matter here I have recently read a Wall Street Journal report and it says this it says that US regulators have repeatedly put cryptocurrency companies and their advisers on notice in recent months about what officials say are widespread violations of security rules designed to protect investors could you share with us what these widespread violations are so I think when we look at these crypto asset related issues they really fall into two buckets so on the one hand we have the out-and-out frauds like the one that you were talking about with the Dallas bank company and these are people who are trying to just trade on whatever newsworthy event there is and make money you know in the past it's been in the marijuana industry or hurricane relief and this just happens to be a newsworthy thing this technology so they're trying to take advantage of investors by trading on that so we see those kinds of out and out frauds and then we also see in another bucket the failure to register offerings broad offerings of what we think meets the definition of a security and if you're gonna sell make a general solicitation of a security offering broadly to investors if you're not subject to an exemption from registration that's got to be registered with the Securities Exchange you have to comply with the various rules and requirements and if you don't meet an exception then investors are presented with an investment opportunity without the information that the Commission has decided they're entitled to have so those are the two sort of real buckets that we see these issues falling into yeah this whole enders is is so moving our technology the crypto currencies all of this seems to be moving at warp speed and with some variation that what we're doing isn't enough just just to carry this point further in the same article your chairman Jake Clayton said this he said many promoters of ICL's and crypto currencies are not complying with our current security laws and then he also said that he has urged his staff meaning you the enforcers to be on high alert for protests to icos that may be contrary to the spirit of these laws however with all these warnings from you and from your chairman it goes on this article very good I hope more people will read this Wall Street Journal article it says such warnings have failed to chill the booming market for digital tokens coin offerings have already raised about one point six six billion dollars this year in our own pace to even top last year's six point five billion dollar tally according to research and data from token report and then he went on say we're just dealing with the tip of the iceberg and as we all know when you just deal with the tip of the iceberg you have problems with the ship below all we have to do is look at the great sinkings of the Titanic there's if we just reached the tip the real serious part of this iceberg is down below as it was with the Titanic and if that happens our nation's gonna be in serious trouble is this article accurate are they sounding the necessary norm you agree with it so you raise you raise a great point and I think if you look at the work that the staff has done there have been a couple of you know there have been cases that we've brought already enforcement actions that we brought there are many investigations that are ongoing and those will take time but they will many of them will likely lead to enforcement actions I don't know how many but many of them will we've also seen people we've we've communicated with people they've stopped a token offering because they hadn't told that you know they were about to violate the federal securities laws so no violation occurred lemansky I got 10 seconds yeah is there anything that we in this committee we in Congress can do to help you with your farm progress in this great challenge well I mean I think we have adequate statutory tools but obviously we'd be willing and interested in working with your staff and the staff of any members here on any proposed legislation all right thank you gentleman's time has expired and we are going to go back for the PSA for pure Maine with mr. Poliquin remain for five minutes thank you very much mr. chairman appreciate it folks if one of you could take a stab this miss miss Avakian my prancing out right in February you folks made an announcement about your shear class selection disclosure initiative and I believe it deals with investment advisers and reporting and self reporting and so forth so on could you explain that program to us and how it might help investors absolutely I'm happy to explain it and we we do expect it to directly impact and help retail investors in particular so one of the problems we've seen over the years both our office of examinations and an enforcement are problems where investment advisors are recommending higher higher fee mutual fund share classes for which they're being compensated when there are lower or no fee share classes of the exact same products available is this only apply to if I may to to fund companies in other words it doesn't deal with managers who me in a separate account you're just talking about mutual fund companies that correct the share classes or share classes and mutual fund companies the self reporting initiative is targeted to investment advisor got it and so we've brought OSI has identified this problem in a number of exams over the years we have brought in the Enforcement Division a number of cases for failure of investment advisors to identify this this conflict of interest for their clients the fact that there's a higher fee share class for which they're being compensated is this apply to no loads as well as load funds or you just talking eh two bees that are nutty should be the you know the fees that are charged and so the self-reported and we've brought a number of cases in each of which against financial institutions in each of which the Commission assessed penalties in connection with the resolution of those cases the self reporting initiative provides a defined period of time for months for investment advisors who have this problem have identified this problem to come forward and self-report and in exchange for that we will recommend to the Commission standard settlement terms those standard settlement terms require these investment advisors to disgorge the monies and to repay them back to investors and in exchange for that we'll have standard settlement terms that will not include a financial penalty ultimately what we're trying to do here is take a problem we identified on a broad scale investigations that take a substantial amount of time to complete and instead say all of you who have this problem come forward identify it to us and hopefully attract and get a much larger universe with way fewer staff resources invested in it and money back into the pocket of investors you find in doing your work do you find there's a common thread among the asset manager community that participates in these practices that they're not no there's no common we've seen it from the smallest advisors to the biggest financial services firms on Wall Street okay good Thank You mr. chairman I yield back my

[01:35:20]

[01:35:23] time thank you gentleman yields back we'll give the ranking member of opportunity as well I apologize I have another hearing taking place there just many many hearings today with a lot of work to cover I want to go back to the kokeshi decision I want to understand how you got a 9-0 ruling that that's very rare in the Supreme Court yet there seem to be a concern on both the Republican and Democratic side and from you that this would limit very much the Securities Exchange Commission in your mission to protect investors can you give me some insights on the khopesh case and ruling and and then secondly what do we do about it you identified it as a problem as did many of my colleagues on both sides of the aisle would it take legislation to correct it but what were the circumstances of this case that's so overwhelmingly came out in a 9-0 ruling I don't know of any other 9-0 ruling this Court's easing so if you could give me some more understanding of the khopesh case and responding really to both of your testimony that this is a big challenge for the Securities SEC um yeah so the khopesh decision a couple things so first of all the case itself involved a pretty egregious fraud in which khopesh stole think like thirty five million dollars from investors and that took place over a 10-year period and by the time you know he was prosecuted enough time had elapsed that in the end as a result of Supreme Court's decision he was allowed to keep all but I think about five million dollars of that thirty five million dollars that was you know misappropriated from investors the Supreme Court's decision as you know was unanimous and we obviously accepted and it's the law of the land and so you know the issue is not with the decision but rather with the effect of it which is that going forward you know if it was a huge crime where they abused investors you would think that the court would be sympathetic to investors being reimbursed in other words they cut off their ability to be reimbursed there's got to be a reason why well I think they were addressing a you know technical legal question of how did the statute of limitations apply to the remedy of disgorgement so I think absent a a you know some kind of extension of the statute of limitations you know that's we're going to live with this and that's what we'll have to act faster but there will be cases where there's a mom going fraud for years we don't discover it until you know some of that money is out of our reach and I just would note that you know we respect the fact that satchel limitations are important you know they put limits on the government in appropriate cases but there are many statute of limitations that apply to financial fraud cases that are much longer than five years for example the Justice Department has the ability to use the financial institutions recovery and Reform Act which has a 10-year statute of limitations so it's not without precedent for there to be a longer statute of limitations available but the the way Congress could react is by legislating correct absolutely we constantly legislate after Supreme Court decisions that we disagree with most notably that when I was involved in was a little allowed better act that allowed people to sue when they've been discriminated against but in any event I just want to thank you for for your testimony today it's a very difficult job and we want to help you in any way we can I yield back

[01:39:18] generally to yields back and I'm gonna

[01:39:21] take a couple of moments here as well for a quick question on explore maybe a little bit of the differences between corporate and individual penalties and in what that might how that might affect things and former SEC chair Mary Jo white emphasized the need to seek more admissions of wrongdoing from defendants as a condition of really settling the enforcement cases and mr. mr. peak in the you have noted that for people they're resolved cases with the Commission without admitting wrongdoing I'm sorry I'm not sure where that hum is coming from helps without admitting wrongdoing but still agreeing to all points of relief that most people don't particularly view that as hey I got away with one here but can you explain how other tools such as obtaining disgorgement monetary penalties mandatory business reform compared with the admission of guilt in settling I mean is there something more significant that it comes with that admission and and does settling help obtain relief more promptly rather than going on and risking you know the trial and in that time and effort and costs of that Thank You mr. chairman um we continue to consider whether seeking admissions is an appropriate part of the resolution of any case obviously though we have to balance as you note that against the possibility that by demanding admissions rather than getting all the other remedies that we might seek like disgorgement and the ability to return money to investors today so the SEC still can go for these admissions of yield and we do you do but

[01:41:11] you know if there's a case where you know a respondent says I'm willing to give you everything except those admissions we have to make a cost-benefit analysis about whether it's worth you know going through what could be years of litigation in some cases that might well be worth it in others maybe not and so you know we evaluate the full package of potential remedies in relief as part of every resolution do you mind addressing briefly maybe individual versus corporate penalties and how that may affect people's actions I mean I think as some you know the chairman Clayton has said individual liability in his view and I agree with this drives behavior more even so than organizational liability so we put a high premium on bringing I think I think at one point he said we'll look at it is it is shareholders that then are paying part of that penalty correct yeah and I look I think that what we the way we look at it is in every case that we recommend to the Commission we're seeking where appropriate to recommend action against an individual in some cases that's not that's not possible but over the last year it's been possible in about 80 percent of all the cases that we bring there's charges against an individual as well as potentially against an institution so we're looking at both there is a place for corporate liability and you know corporate penalties and there are places for individual responsibility and individual penalties and including getting bad actors out of the out of the markets so some of the individuals that we come across in our investigations our recidivist sort of engaged in serious wrongdoing and they have no place being in our in our markets and so we'll recommend as part of our proposal that we seek to bar them or suspend them or bar them entirely from participating in the in the industry and previously we had had bill inmon here from corporate finance division and talked a lot about icos and and and those kinds of things and it's been pretty clear that most of these seem to be birthed as a security and then some migrated into a futures and and so is it oh I've been describing is it fish or is it fowl and it turns out this these are sort of platypuses you know somehow or another they're where they they they don't quite fit in into categories so I appreciate the you know the opportunity to explore that a bit more we certainly are working on on that issue and needing some clarification and again how that works for you all to then enforce what what what is being laid out so with that I just want to say thank you I appreciate the time think and I think both of you for your efforts on behalf of the SEC and and that retail investor as well and without objection I would like to submit the following statements for the record I think and then without objection all members will have five legislative days within which to submit additional written questions for the witnesses to the chair I will then pass those questions along to you we ask for as timely a response as possible please and without objection all members will have five legislative days within which to submit extraneous materials to the chair for inclusion in the or as well so again mr. Pekin MS Avakian thank you for your for your time today here and our hearing is adjourned thank you you
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CFTC Commissioner Quintenz Drops Hints of More “Bespoke” US Crypto Regulatory Approach

(KrowneLaw Reports from Consensus 2018 in Manhattan)

Speaking to the Consensus conference in New York on May 14, 2018, Commodities Futures Trading Commission (CFTC) Commissioner Brian Quintenz revealed that US regulators are actively working on a legal framework to treat blockchain tokens and ICOs, in particular, addressing the question of if and when they are securities.   The remarks are intriguing for crypto market players, as Quintenz specifically addressed the unique nature of crypto tokens in various respects, including that they can “evolve” from security to non-security (“utility”) tokens.

Some highlights of Quintenz’s remarks:

  • The CFTC is actively working with the SEC on the question of crypto token securities status, and a decision on treatment is “imminent” (suggesting, specifically, that it would occur this year).  Quintenz suggested regulatory harmony was a goal, saying “the last thing that we want is for our agencies to take different views publicly.”
  • Quintenz said “Crypto-assets can evolve, or actually change,” and the status determination partly hinges on whether a token (even if originally a security) has a use, e.g., blockchain-based smart contracts, at which point it could cease being a security.   Quintenz also picked up on and re-emphasized previous comments by SEC Chairman Jay Clayton and Commissioner Hester Peirce suggesting that cryptos might be able to evolve away from securities status.
  • Quintenz suggested that governance of updates over blockchain software and “forks” are part of the question regarding securities status.
  • Quintenz encouraged the industry to create a self-regulatory entity – “Because of the lack of any federal oversight authority… I’ve called for these platforms to come together and establish some kind of self-regulatory group.”
  • Quintenz rejected the idea that the Financial Stability Oversight Council take up the charge in leading the crypto regulatory effort, saying “I can really think of no worse approach than regulating fintech by viewing it solely through the lens of its downside risk.”

On balance, this is tremendously positive.  While we don’t know the specifics yet, and the “devil may yet be in the details”, Quintenz’s remarks signal an accommodating regulatory approach that recognizes the unique attributes and usage scenarios of cryptocurrencies and ICO, rather than continuing to try to cram them into a legal framework that never contemplated them.

Quintenz’s overtures continue a burgeoning trend within the US of recognition of crypto token status beyond traditional securities.  In a notable recent example, back in March 2018, Wyoming passed HB-70, a bill which creates a “utility token” asset class as distinct from securities (it also passed four other associated bills carving cryptos out from money-transmittal licensing and creating other blockchain benefits).  These moves have sparked a wave of interest in the US in Wyoming as a blockchain venture setup location.  Perhaps more significantly, they created a new opening in US law for the treatment of cryptos differently than traditional assets and arrangements, in particular, as some level of federal deference must be given to state law determinations.

Other global jurisdictions, e.g., Gibraltar and Bermuda, have in recent months announced ICO and crypto regulatory frameworks that acknowledge the unique properties of blockchain and associated services and fundraising scenarios, and generally seek to accommodate them, while still applying sensible regulation.

Such developments may have been on the CFTC and SEC commissioners’ minds of late, as they have approached the question of how to create a unified and well-fitting approach to cryptos.

KrowneLaw helps venturers set up and grow their blockchain enterprises in the US and globally (more). Contact us if you have any questions.