Regulatory Update and Look Ahead

my name is Jerry burrito I'm the executive director of coin Center and first just want to say how grateful we are to the etherion foundation for having us here today to give you a little regulatory update I think the first thing I'm gonna do is tell you about coin Center what we are so Point Center is an independent nonprofit based in Washington DC that's focused on the public policy issues that affect crypto currencies and open blockchain networks like Dario and Bitcoin Z cash and we really do three things we engage in education public policy research and advocacy education stories spend a lot of our time and what that means is we seek to educate policymakers whether they're members of Congress their staff folks at different agencies so they understand the technology so much of what can go wrong with regulation is not out of malice but out of ignorance we want to make sure they have a good understanding the second thing we do is policy research so we engage in the policy thinking to develop what regulatory frameworks could exist that help regulators meet their ends because they're gonna you know find a way to do what they want to do hope to meet their ends while preserving as much as possible the freedom to innovate and to avoid unintended consequences and then the last thing we do is we advocate for the solutions we try to get them into law or we try to get laws not passed so I guess I should get the clicker from you Peter so today I'm gonna give you a little year in review of what we've done over the past year so the first thing I'm going to talk about is state money transmission licensing which really is one of the biggest regulatory hurdles or impediments for the growth of this ecosystem and that's for two reasons number one it's looking at these laws which are written in the 50s and 60s it's really difficult to know whether you need to get a license in each state or not and number two if you need to get a license it's very difficult to comply with those rules and so we're very happy that over the past two years we've worked with the Uniform Law Commission to develop a model state act for regulation of virtual currency businesses and so this would supplant the existing money transmission licenses in the states this would supplant something like the bit license and we're excited about is that we've been able to include in the Scindia model act a definition of control which is very important only if you have control only if you take control of others cryptocurrency do you need to get a license if you never take control of somebody's cryptocurrency you don't need to get a license under this act and we define control as the power to execute unilaterally or prevent and definitely in virtual currency transaction and the next thing that we're excited about is we're able to get a bunch of exemptions into the act and among them is something that is a personal exemption so anybody who is using virtual currency on their own behalf or for personal family or household purposes or as for academic purposes are completely excluded from any kind of licensing requirements and so what does that get you if you do not have control you don't need to get licensed that means that wallet developers validators de channel notes exchanges are non-custodial all excluded and with the personal exemption it means that if you're an individual holder of course but also of your corporate institutional investor and academic or even if you are creating and selling a new token and so they're your tokens that you're selling you would be excluded from licensing this was not clear at all under the existing law so now our job over the next coming year is to try to get this model Act passed there's many states this makes sense and what you mean think to yourself look this is just parochial us stuff it actually has a global implication this definition of control which creates a line about who is regulated or who is not is going to be valuable going forward so if you think about as Europe looks to amend its fourth anti-money laundering directive they're going to need a definition of was an intermediary that should be regulated who was not and our definition of control helps you get there when China is looking to regulate exchanges it's gonna help there as well the next thing I wanna talk to you about is tax so we worked with the blockchain caucus over the past year to develop and introduce a bill in Congress that will create a de minimis exemption for capital gains tax of cryptocurrency so as you might know if you buy a cup of coffee with Bitcoin or even potentially if you use some ether to run a smart contract those events are taxable dispositions of cryptocurrency and technically you're required to keep track of each of those dispositions report it to the IRS and pay taxes on that which obviously creates a lot of friction so this bill that we helped introduce creates a de minimis exemption of $600 any transaction below $600 you don't have to report it you don't have to keep track of it you don't have to pay taxes on and so we're hoping we can get this attribute passed as law it's gonna be difficult but we're optimistic next thing we talked about is securities so last year at this conference Peter explained to you our framework for securities regulation of crypto currencies and we think that having produced that and having spent a lot of time with the SEC explaining to them what our framework is how we think tokens how some tokens are and how many tokens are not securities and having spent a lot of time with them explaining the technology and how it works has borne fruit so recently they produced a dau report which you all may have seen and we think that it was a very thoughtful and very deliberate approach that didn't bring an enforcement action and it really echoes a lot of the policy thinking that we've been advocating over the past year and again this isn't just it sounds seems like this is just us based but what we see is that once the us Act once the Securities and Exchange Commission in the United States acts other countries follow on so we saw immediately after the Dow report the UK FCA issues a advisory on tokens that echoed the sec and we've seen other places with even tougher language the final thing I'm going to talk about is terrorists use of cryptocurrency sort of potential for that so over the summer there was just this really strange surge of interest in this potential there were a couple of reports published one by the Center for a New American Security there are a couple of convenings and most importantly there was there's a nuke subcommittee in Congress called the illicit financing to terrorism and illicit financing subcommittee of the House Financial Services Committee and they decided that their first thing they were going to really work on was the potential for terrorists using cryptocurrency because we have built over the past three years strong relationships with Congress we were invited to help them with that investigation and so we navigated them through the space we brought experts to town to talk to them we put on a demo day where we showed them technology and demoed it we put on a full member briefing for the members of Congress and the committee and finally we had a hearing they had a hearing which I was asked to testify and I testified at that hearing and the conclusion at this point they're satisfied that this is a serious you know potential threat but one that at the moment there's only anecdotal evidence of it's something that law enforcement has the tools to address it and I think we may see legislation at some point soon related to this but it's going to be focused on fact more fact-finding so that's the state of that and funny thing while I was testifying at that hearing across the hallway in a different hearing and this never happens at the same time Peter was testifying and much happier subject about how open blockchains can help the economy and he was asked by a member of Congress what was the most exciting thing that he'd seen since the last time that we had been in Congress testifying and Peter said well it was the launch of new networks like aetherium and Z cash heeey you should go look up this video if you haven't done so in two minutes explained a theorem and Z cache master for later so it's really remarkable so with that I'm going to turn it over to Peter who is going to talk to you about some issues thanks Jerry so I just want to I just want to generally characterize some big issues on the horizon and of course that means most of this second half is gonna be about tokens because that's where a lot of the regulatory attention and maybe attention in general is right now so there are two regulatory hotspots to look out for with respect to tokens one is securities regulation of course which I talked about in Def Con last year and the second is anti money laundering or financial surveillance regulation so AML in a nutshell boils down to two questions first does AML law applied to your token or your cryptocurrency well the question that answers that in the US and this will be echoed elsewhere is is the token being used as a currency substitute not is it designed as a currency substitute is it being used as currency somewhere in the world then AML law is something you have to think about then the second question says okay if it's used as a currency substitute who's regulated this gets to our definition of control but right now the question with tokens is is there an issuer who can also withdraw the the tokens from circulation so it's centralized it's like eagled or Liberty Reserve if there is an issue or who can also call them back out of the network because they keep the ledger well then that issuer is a money services business if there's no issuer because it's a proper decentralized cryptocurrency like aetherium or Bitcoin well then there is no issue or for there to be an MSB as an issuer so it's the exchanges companies like coinbase with G Dax or Polonia X those are the MSBs those are the entities who need to effectively surveil their customers who need to do anti-money laundering compliance suspicious activity reporting and things like this it's very important to coin Center that we draw this line clearly between decentralized cryptocurrency and centralized ones securities law I'm to far from my device securities law boils down to two questions as well the first question is is the thing being sold as an investment and the second question is is there a person upon whom investors rely for the profits of their investments this is a simplification of the Howey test i presented last year but this is pretty dead-on I'd say now you can think about this like this gold is sold as an investment of course but there's no one person re rely on to create the value of gold it's a network of buyers and sellers miners and people using gold there is someone we rely on if you're buying a share of Apple stock his name's Tim Cook and his management team a share of Apple stock is a security gold that you actually take delivery of is not and so we can have this two question classification exercise to figure out dimensions in order to categorize any token is it more of a utility or a useful commercial item or is it sold more as an investment and what's backing up that token is it a decentralized network like gold or is it somebody like Tim Cook and this is how we present this to regulators this is far too pedantic and descriptive you understand this money goes in more money comes out it's an investment money goes in a service comes out could be cloud storage compute cycles could be a number of things that's something that's more useful a vote to decide where the cumulative funds should be invested is not a use that's that has to do with profit making and pooling money and growing it but cloud storage or something like that makes sense as something that's useful and then this issuer versus Network distinction again this is how we explain it to regulators so I'm gonna rush because you understand if you have PayPal as the service provider money goes in you get a service PayPal's doing a few things they're checking passwords they're keeping a record of transactions and there's a corporate oversight role that makes sure the other functions are being performed well that's how PayPal works what if we want to decentralize PayPal have an electronic cash for the Internet well we have a network of computers we network them together we use public key cryptography so that every node can verify passwords effectively we use a distributed lead like a blockchain so that every nodes keeping track of valid transactions but where's the oversight there is no corporation so who's doing this nobody every participant in the network is directly incentivized because they're awarded tokens for doing their job well to actually help provide the service that's how mining works that's how Bitcoin works this is still pretty radical although everyone in the room is pretty comfortable with it at this point that's more of a networked token rather than an issuer backed token and we can do the same thing with something else like cloud storage again this is how we explain it to Congress the only difference is now every node is adding their spare hard drive capacity so something like swarm or file point or SIA or all the effort projects trying to make this work and every node is incentivized to behave honestly because of the tokens so now that we have these two dimensions we can graph them maybe to get a geometric handle on the issues at hand with respect to tokens will put useful tokens on the bottom of the graph and we'll put investment tokens on the top will put Network backed tokens on the left and we'll put issue or back tokens on the right now I'm not going to put specific projects on this graph because that's none of my business really what I am going to do is show you the background case law so here's Tim Cook this is a security we know that upper right quadrant backed by an issuer and sold as an investment shares of Apple stock here's where gold would be some people use it some people want it to invest but it's a decentralized network that makes gold valuable here's real estate oil gas things that are valuable commodities where there's a decentralized network and markets effectively that create the value up here our member managed LLC's so corporations that could be for-profit where every individual shareholder is actually deciding the ultimate fate fate of the enterprise here we have loyalty cards Country Club memberships things like that we're relying on the person who built the golf course to make it valuable but it really is something you use you go in your golf usually these have restrictions on transferability as well though two two put a put a stop into speculation about their value and here we could have theater tickets where there's a group of artists that provide the value and here this is kind of interesting and I put this here because there's a line of cases that talk about this fact pattern where somebody sold someone something like a barrel of whiskey and said we'll store it for you and it's really good whiskey don't worry about it and we'll find people who will want to buy it in 20 years when it ages and it's sold as an investment and all you get is a receipt for the warehouse and it's always claimed like oh well you can get it take it and drink your whiskey at any point but nobody does that and everybody knows what's going on here the whiskey distillery is selling shares of its profit-making whiskey enterprise and now we have tokens that basically do all of these different things we definitely have electronic gold tokens we definitely have electronic gas tokens we have real estate tokens that are digital which would be digital real estate or gigabytes we have member run enterprises for profit that may be member run or may actually have centralized control and here basically is the SCC's possible jurisdiction the security is regulated in the u.s. they have a flexible test so this is an amorphous geometry it could be like this now what's interesting about this well if you sell a token that is actually a revenue stream from a corporation like a share of Apple stock the tokens of security it doesn't matter if it's a token rather than a stock certificate if you are selling warehouse receipts for a speculative good that that is being sold as an investment and no one's actually taking delivery of it or the functionality is never realized that's probably a security now where things get really tricky and interesting is the upper left quadrant and the lower right quadrant you have a member run for profit organization if it's really run by the members it's out here if there's a few centralized parties that are really promoting it and making it function it's in the securities area I think you all know what I'm talking about and this area is interesting if you pre sell golf course memberships before people can go in golf then it starts to become more of a speculative investment because people can't realize the utility right away and it creeps up into the securities realm so this edge is very interesting and very dangerous with respect to token projects that are analogues of these old cases and that's all I'm gonna say about securities law other than the fact that the SEC has a flexible test so that could be their jurisdiction that could be their jurisdiction but coin Center advocates for this to be their jurisdiction where we really have an issuer that people are relying on for the profit of their investment if we can help them get comfortable with this I think we can have a much freer and more open and innovative community but we worry about investor protection so where this line gets drawn is very important and that's why coin Center has spent time working on frameworks for security regulation which I presented last year but also on consumer protection and also on any money laundering and we appreciate all the support we get from your wonderful community we'll be here all week so please come and see us and please consider supporting coin Center and thanks again to the theory founders for having us [Applause] [Music]