The Virtual World: Regulation of Virtual Currency, Ethereum & ICOs

Topics: Artificial Intelligence, bitcoin, blockchain, cryptocurrency, Government, Law Firms, Leadership, Legal Innovation, Midsize Law Firms Blog Posts

ICOs

This past year has seen a proliferation of Initial Coin Offerings (ICOs), prompting legislators around the world to sit up and take notice of this new financial instrument. We’ve seen reactions run the gamut, including the People’s Bank of China’s extreme ban of ICO activity. It seems Pandora’s box has been opened, and regulators, such as the US Securities and Exchange Commission (SEC), must catch up with this blindingly fast-moving new technology.

At this year’s Devcon3 — the annual Ethereum foundation developers conference, which was held earlier this month in Cancún, Mexico — the issue of regulation of these techno-securities was widely discussed.

Jerry Brito, the Executive Director, and Peter Van Valkenburgh, the Research Director, of Coin Center — a non-profit research and advocacy center focused on public policy issues surrounding cryptocurrencies like Bitcoin and Ethereum — gave a regulatory update, summarizing some recent activity relevant to virtual currency regulation. The pair focused on US policy, mentioning that decisions made by the US Congress may have global implications. Earlier this year, Brito appeared before Congress, consulting on the status quo of virtual currency; while on the same day, Van Valkenburgh also appeared before Congress to help describe how technologies like Ethereum can have positive economic implications.

blockchain

Taxation

Under current tax law, buying a cup of coffee with Bitcoin should be reported to the IRS as a taxable event for the person who used the Bitcoin. If virtual currencies are to behave like currencies rather than securities, there will need to be some supporting legislation. One such bill, H.R. 3708, was introduced to in the US House of Representatives in September by Rep. David Schweikert (R-Ariz.). The bill seeks to introduce a de minimis exemption of $600 when selling or exchanging a virtual currency asset.

Under this proposed law, buying the proverbial cup of coffee (or anything under $600) with a virtual currency would no longer be a taxable event. This would have a big impact on cryptocurrency if it passes, so it’s worth keeping an eye on. (The bill is currently under consideration by the House Ways & Means Committee.)

SEC Regulation: Security, Asset or Commodity?

Of all the questions raised by the rise of cryptocurrencies and related technology, it is perhaps ICOs and the Ethereum Token Standard, commonly called ERC20, which are the most provocative and difficult to regulate. Tokens are used in the virtual currency world as a sort of coin or claim on ownership of certain goods, which may themselves be virtual. Because of this, each type of token comes with its own set of rules; so, it’s not really fitting to quantify them all as securities.

For example, a token for Etheroll (an online dice game) offers its owner a percentage of the application’s profits for life. This is clearly a stake in the company and would most likely fall within the SEC’s jurisdiction. However, other tokens may entitle the owner to an asset; for example, a Filecoin’s token serves as a credit to use the network’s distributed data storage services at some point in the future. Doesn’t sound like a security, does it? But wait, there’s more. Since the tokens are transferrable and have a fixed supply, the Filecoin tokens can be (and most certainly have been) bought and sold as a speculative investment.

This is where things get a little hairy, regulatory-wise, as the intent of the purchaser may play a part in the token’s classification. Legislators are considering this carefully before making any decisions, as any choices made now may have broad implications for the budding technologies.

Indeed, there are a multitude of decisions to be made, and regulation can still make or break this new asset class. With regard to regulation, I think Brito said it best in his June testimony before Congress:

“This technology can’t be put back in the bottle,” he testified. “Encouraging its legitimate use gives us more and better visibility into the network while discouraging its use only cedes the network to bad actors.”