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Why It Matters Whether the CFTC Versus the SEC Regulates Crypto

May 29, 2024

As a crypto investor with a background in law, I’ve been expressing my concerns about the industry’s misunderstanding of regulation for the past two years. The problem isn’t which agency regulates tokens; it’s the fact that tokens are dynamic by nature, and no regulatory system can account for that.

As a seasoned analyst, I’ve frequently addressed the misconceptions surrounding regulation in the blockchain sector over the past two years. It’s not just about labeling a specific token as a security or a commodity, but rather addressing the root cause of our confusion: the lack of clarity in defining tokens themselves.

Alexandra Damsker serves as both a lawyer and strategic advisor, providing counsel on legal and operational matters. Her professional background includes tenure as an attorney with the United States Securities and Exchange Commission and law firm Mayer Brown. Additionally, she is the founder of a successfully exited business.

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

Regulating agencies for tokens are interchangeable, as they all share a common foundation: the regulated entity remains unchanged. A stock represents an unalterable financial asset since its inception until it’s either cancelled or the company ceases to exist. Similarly, fiat currency retains its identity from the moment of minting until it is destroyed.

As an analyst, I would put it this way: I’d like to clarify that I’m not referring to tokens as static entities. Instead, they possess the ability to serve multiple functions for various holders or even for a single holder concurrently. Unfortunately, no existing regulatory framework is equipped to handle such versatility.

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

    Move transactions along a chain. This is purely functional and unregulated.Incentivize people who contribute effort to secure and manage the blockchain. This is an exchange for labor or services, and does not rely on any presumed value for the token, so is unregulated.Represent value, either physical or digital. This is only regulated when the underlying represented thing is regulated (e.g., a token representing a television is not regulated, but a token representing a share of stock in Tesla is regulated).Represent a physical or digital product or group of rights. This is just a product, and unregulated other than any intellectual property rights that may attach.Payment for goods or services OTHER than transactional fees (i.e., gas fees). This is tricky: unless it’s a stablecoin, it’s similar to a currency, but not quite the same. (Remember that currencies are intended to be a store of value that stays within a narrow range to a key targeted or exchange rate. Assets, on the other hand, are designed to fluctuate in value – that’s how your tiny investment in something suddenly becomes worth so much, or your huge investment in something else plummets to nothing.) Currencies are regulated by the U.S. Department of Treasury, including FinCEN and the IRS.Payment for transactional fees (gas fees). These are service fees, and generally unregulated.Represent partial value. (This is great – you can’t own a partial stock or partial painting, but you can get fractional value of pretty much anything if you tokenize it.) This one is tricky, too: generally, If you break an asset into part-interests where everyone shares interest in the whole, it’s a security, regulated by the SEC. But if you break things up in a way that you own something distinct and individual, rather than a piece of a whole, it’s generally NOT a security. It could be a commodity, however, like bitcoin (BTC).Represent rewards for taking on risk or offering a good or service, like staking on chains without providing validation work, or payment for tokens loaned to a liquidity pool, borrower platform or application. This is regulated by a combination of securities and Treasury regulators.Represent voting rights. Regulated by the SEC in public companies only.Represent perceived or speculative market value. A security or commodity, and regulated by the SEC or CFTC, accordingly.
When purchasing tokens like ether (ETH), a buyer may not be aware of its final use or destination. For instance, if someone buys ETH in January, February, and March, then stakes some with a validator in June, purchases a unique NFT in July, and acquires a meme coin in August, each transaction requiring gas payments, it becomes unclear which specific ETH transaction led to the purchase of the meme coin. The buyer’s lack of knowledge is due to the complex nature of crypto assets and accounting methods; only after applying professional accounting principles can one determine which regulatory system should be consulted for a particular ETH transaction – a process that occurs in retrospect.
We need to consider that someone else is involved in the exchange, who could have converted the ETH they received for the NFT into something else. For instance, I bought an NFT using ETH I acquired from the marketplace, which was most likely a security. However, the person selling me the NFT might have used their ETH to invest in other areas, such as voting on Ethereum Improvement Proposals (EIPs), buying more securities like NFTs of fine art pieces, and paying gas fees for these transactions.

See also: Is the House’s FIT21 Bill Really the Legislation That Crypto Needs? | Opinion

I acknowledge the complexity and artificiality of the current regulatory framework when applied to tokens. This framework presumes that anything falling under its jurisdiction will be static and unchanging. However, such a assumption is both improbable and impossible in the context of dynamic systems like tokens.

Attempting to force fit tokens into outdated structures may provide minimal security benefits at most, while stifling the drive for innovation in the long run. We deserve more than that. Moreover, given the increasing prevalence of quantum computing and other advanced technologies capable of instantaneous transformation, it is crucial that we act swiftly to adapt and improve.

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2024-05-30 21:47