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A blockchain bill, backed by industry, may tie SEC’s hands

The bill would provide a safe harbor from federal securities regulations for digital currencies and other blockchain-based products

Rep. Warren Davidson, R-Ohio, leaves the House Republican Conference meeting at the Capitol Hill Club in Washington on Wednesday morning, June 13, 2018. (Bill Clark/CQ Roll Call file photo)
Rep. Warren Davidson, R-Ohio, leaves the House Republican Conference meeting at the Capitol Hill Club in Washington on Wednesday morning, June 13, 2018. (Bill Clark/CQ Roll Call file photo)

Even as the nation’s infant blockchain industry lines up in support of a new bipartisan bill to exempt digital tokens from Securities and Exchange Commission oversight, others warn about the dangers of Congress making the situation worse.

The bill from Reps. Warren Davidson, an Ohio Republican, and Darren Soto, a Florida Democrat, would provide a safe harbor from federal securities regulations for digital currencies and other blockchain-based products. But outside of the young sector’s backers, some worry that the bill goes too far in its current form.

“I think it’s a laudable approach to try to provide some certainty and level the playing field. So, credit goes to the representatives for trying to do that,” said Matt Kluchenek, a partner at the law firm Mayer Brown who advises fintech and cryptocurrency companies on securities law. “But it’s a large, large task.”

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“It really tries to level the playing field in one fell swoop, and my concern is that the devil is in the details, and the law of unintended consequences,” he added. By creating a broad exemption for digital tokens, Kluchenek said, the bill may provide regulatory certainty, but may also end up making it unclear whether the SEC can go after the bad actors behind a fraudulent initial coin offering.

“We’ve seen, over the past decade, very time-intensive, costly fights about whether or not an agency has jurisdiction,” said Kluchenek. “What we want any bill to do is to clarify — not muddle — the responsibilities.”

He noted that the SEC and the Commodity Futures Trading Commission have been working to clarify their stance on the matter, and urged lawmakers to work with the regulators on workshopping the bill’s language.

The bill would exempt a digital token from the definition of a security.

Davidson said it would allow the young industry to experiment with new digital tokens, which may have more utility as vehicles for data sharing and self-executing contracts than as cryptocurrencies, without unintentionally running afoul of the SEC’s registration requirements. But the bill’s text wouldn’t include securities offerings using blockchain technology — initial coin offerings — in the safe harbor, and that’s important, Davidson said.

In early April, a week before the bill’s introduction, the SEC issued 13 pages of guidance on when it would consider digital coins to be securities. At four pages, the bill is significantly simpler and more sweeping. The SEC guidance essentially walks through securities case law since the landmark 1946 Supreme Court case, SEC v. W.J. Howey Co., and applies the Howey analysis to cryptocurrencies.

As guidance, the memo lacks the legal weight of a formal rulemaking, offering limited comfort to blockchain companies. The Blockchain Association lamented the guidance, saying it “raises more questions than it answers.”

“We are concerned that this guidance alone does not provide the regulatory certainty that the industry needs, which will further harm innovation and stifle investment in open blockchain networks in the United States,” the trade group wrote.

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SEC and certainty

When asked why Congress should intercede when the SEC was working on the issue, Davidson echoed the trade group’s complaint. “Well, first of all, they haven’t done the greatest of job at it,” Davidson said. “Their guidance has not produced certainty in the market.”

And if blockchain entrepreneurs can’t find that certainty here, Davidson said, they’ll go elsewhere, building their companies in foreign jurisdictions that have already built regulatory frameworks for the new technology.

Recognizing that urgency, Kluchenek still urged caution.

“It’s a wholesale attempt to really define important concepts,” Kluchenek said. “If that’s the case, you got to get it right.”

The wild gyrations of bitcoin’s price have received the most media attention in the nascent industry, but it’s the underlying blockchain technology that Davidson thinks has the most potential.

“Blockchain is the architecture,” Davidson said, comparing bitcoin to a single website and blockchain to the internet. While didn’t last, firms like Amazon have proven that online retail is here to stay, he said, adding that the same goes for blockchain’s decentralized ledger technology. Davidson and industry insiders say it will lead to new applications barely imagined.

Blockchain backers like Davidson’s approach. The bill “clarifies when a digital token is a security and when it is not,” said Jerry Brito, executive director of Coin Center, a digital currency research and advocacy group. “It largely mirrors the SEC’s approach to date but creates a sharper line in legislative language that should reduce uncertainty.”

In a blog post, the Blockchain Association, an industry lobbying group, praised the reintroduction of the bill, which Soto and Davidson first introduced in December during the last Congress. “This provision provides much needed regulatory certainty so that the token economy can grow.”

“[W]e are doubling down on our efforts to get lawmakers and their staff the knowledge they need to make informed decisions about this policy,” the group wrote. “We are committed to seeing this legislation move forward.”

There are a handful of other blockchain bills working their way through Congress — Soto and Davidson are signed on as cosponsors to many of them — but besides a handful of narrower bills to direct federal agencies to study the underlying issues that passed the House in January, Davidson and Soto’s bill has attracted the most initial support, with Reps. Josh Gottheimer, D-N.J., Ted Budd, R-N.C., Tulsi Gabbard, D-Hawaii, and Scott Perry, R-Pa., joining as original cosponsors.

Other than Perry and Soto, all of the bill’s cosponsors sit on the House Financial Services Committee, raising its chances of getting to a markup.

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