The Token Taxonomy Act May Not Be a Bullseye, But It’s Progress

There’s a bill coming to the newly sworn in 116th Congress that could change the way cryptocurrencies are taxed and traded. The Token Taxonomy Act currently sits on the desk of Florida Democratic Representative Darren Soto, and is based on a previous bill that he floated late last year.

The previous bill, which was cosponsored by Republican Ohio Representative Warren Davidson, attempted to update the Securities Act of 1933 and the Securities Exchange Act of 1934. It proposed changing the definition of a security to specifically exclude digital tokens.

The Need to Define a New Asset Class

Digital tokens are a new asset class, and we need to define them in order to regulate a market that can “compete with Singapore, Switzerland, and others who are aggressively growing their blockchain economies,” according to Rep. Davidson. He adds that “early attempts to regulate digital currencies have frustrated entrepreneur’s dreams with complex regulation and costly compliance,” citing the universally maligned New York BitLicense as an extreme example.

Davidson says the Token Taxonomy Act proposes “a simple but clear ‘light-touch’ approach” to regulation “that protects consumers, advances free market solutions, and defines safe-harbors for the earliest stage innovators” in order to “send a powerful message around the world that the U.S. is the best destination for ICO markets.”

What the Bill Says About Tokens

As it stands now, a ‘security’ has a broad legal definition, but must pass the Howey Test to qualify. The test’s nickname comes from the 1946 case SEC v. Howey. Here are the criteria it uses to define a transaction as a security:

  1. It must be an investment of money or assets
  2. Profits are expected
  3. The investment goes into a ‘common enterprise’
  4. Profit is the result of the efforts of a third party or promoter

At first glance, it’s easy to see how most crypto transactions would qualify. Representatives Soto and Davidson would change the criteria to draw an exemption for digital tokens, saying they should be categorically excluded from the definition of securities. It’s an effort to keep cryptos from being over-regulated—a worthy cause, most crypto users will agree. And according to Rep. Soto, they’re eve doing the SEC a favor.

“Providing this much needed certainty frees the SEC to perform its vital and much needed consumer protection duties,” he says, “of enforcement on those who have engaged in securities fraud by making false claims or simply attempting to engage in regulatory arbitrage to circumvent securities law.”

The bill also attempts to modify the IRS code to exclude the trading and acquisition of virtual currencies from taxable gains, treating them instead as real property.

No one wants their cryptos taxed, and protecting people from fraud is an important impetus to crypto regulation. But there’s some problems with the bill.

Objections to the Bill

The Token Taxonomy Act considers all tokens as eligible to be considered securities in the first place, instead of treating certain token transactions as securities exchanges. This is a fundamental flaw, according to Anthony Zeoli, a transactional attorney who specializes in securities.

Right now, an ICO is generally viewed as a security exchange. But that doesn’t make the token itself a security. This distinction could have major repercussions. Under the Token Taxonomy Act, ICOs would be unregulated by the SEC.

But Zeoli points out that “the majority of the fraudulent activities we have seen in this industry have been at the ICO level and specifically exempting these transactions from securities regulations is extremely dangerous.”

Of course, the bill would change the facts and circumstances surrounding a crypto transaction, with the idea of simplifying transactions and lowering costs for everyone. If successful, this could cut securities attorneys like Zeoli out of the loop, and it’s no wonder such an attorney would frown on the bill. Securities regulations are not protecting consumers and investors of ICOs, they are raising costs of transactions while only serving to remove confidence from the market. These are the opposite of the SEC’s mission statement.

Will the Bill Become Law?

In short, the Token Taxonomy Act alone likely wouldn’t accomplish the worthy goals it sets out to achieve, as currently written, but it can follow a path similar to Wyoming’s 2018 ‘Utility Token’ Act, which also exempted certain crypto assets and transactions from state securities laws. After carving the exemptions, Wyoming passed follow-up laws already in 2019 to further establish a framework and distinct new asset class that the industry can use. The nearly unanimous votes in passing holistic pro-crypto bills in Wyoming serve as inspiration for representatives in US Congress, compared to other states that circumvented the legislative process, unilaterally creating heavy handed crypto policy.

We do need a “light-touch” framework to establish crypto regulation and the industry can’t grow without it. But according to Zeoli, the Token Taxonomy Act simply doesn’t make enough sense to be green-lit into law.

Not everyone agrees. Lobbyist Kristen Smith, who is head of the Blockchain Association, calls the token bill “a step forward in finding the right way to regulate them.”

SEC Chairman Jay Clayton has no intention of updating the definition of securities. “We are not going to do any violence to the traditional definition of a security that has worked for a long time,” he said. “We’ve been doing this a long time, there’s no need to change the definition.”

The bill may not be the cure-all for ease of operating in the crypto industry, but its proposal is getting the conversation moving. That itself is a step, and one that will undoubtedly lead to further progress.

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Eric Lamison-White
Eric is the co-founder and CEO of Pareto Network, a platform for intelligent cryptocurrency investment information. An early adopter and ambassador for blockchain technology, Lamison-White began developing in 2013, and filed for his first cryptocurrency patent aimed at stabilizing digital currencies shortly thereafter. His background with a federal financial regulator (FDIC) alongside a career in software development enabled him to bring a seasoned and nuanced perspective to the volatile cryptocurrency space. He’s a sought-after writer and speaker on digital currency security and valuation—he’s written for Nulltx (formerly The Merkle), and he’s been featured in Forbes, The Street, and Inc, among other publications.

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