Does the Token Taxonomy Act Offer “Security” for Blockchain?

Blockchain and cryptocurrency, which some call the most innovative technology since the internet, should be dominating America’s tech industry. But it isn’t. A lack of regulatory certainty combined with inconsistent guidance from the SEC and the courts has crypto-startups flourishing overseas instead of right here at home. As a result, the Token Taxonomy Act (“TTA”) has been reintroduced in the House of Representatives in an attempt to steer investment back to the U.S. with some much needed regulatory improvements.  Although a good start, the bill is far from a comprehensive fix-all and may create more problems than it intends to solve.

Largely similar to the bill introduced in 2018, the new and improved TTA aims to stabilize many of the contradictory-regulatory rulings which have plagued an already complicated framework. Currently, the Securities and Exchange Commission (SEC) treats digital assets as securities, the Commodity Futures Trading Commission (CFTC) treats them as commodities, and the Internal Revenue Service (IRS) treats them as property. To make matters worse, many states have enacted regulations that conflict with other state laws and, in some cases, federal regulation.

To streamline regulation, the bill seeks to exempt “digital tokens” from the securities laws and amend both the Securities Act of 1933 and the Securities Exchange Act of 1934.  This will, in effect, create a new asset class for blockchain-based investments. For the first time in the technology’s history, Congress is providing guidance to determine whether a token is a security.  Instead of relying on the Supreme Court’s Howey Test, the 4-part analysis currently used to determine whether a transaction is an “investment contract,” and thereby a security under the 1933 and 1934 Acts, the TTA sets out its own classification. This new test is rather technical as it mandates, among other things, a “verification or collection of proposed transactions” and a “transaction history that is recorded in a distributed, digital ledger or digit data structure in which consensus is achieved through a mathematically verifiable process.” Predictably, since its announcement, several analysts have pointed out the semantic confusion this legislation guarantees and warns against the abandonment of decades of Howey Test interpretative precedent. These issues will certainly be at the top of the House committee’s priority list before a vote is taken.

To complicate matters even further, the TTA also contains a state preemption, which largely eliminates the states’ rights to regulate digital assets.  In a scenario where state regulations conflict with the provisions specified in the Act, the latter would supersede the former.  This effectively prohibits states from exercising independent regulatory authority over digital assets.  As expected, this ceding of power and “level playing field” approach is already receiving mixed reactions from investors and states alike.  While the bill would bring a much needed degree of crypto-regulation to states where there is little to no regulation in place, it would, in effect, nullify any actions taken by crypto-friendly states like Wyoming, Arizona, Colorado, and Montana that have already passed regulations. The TTA does, however, preserve the right of the states to enforce their own laws to prosecute criminal activity associated with digital tokens. The bill also empowers the SEC to stop any transactions or coin offerings it determines involve the sale of securities.

Thankfully, it’s not all bad. The TTA does contain a few universally lauded changes to the current tax treatment. Most importantly, transactions that convert cryptocurrency to fiat-currency would become tax exempt for transactions under $600.  This is a major step forward for micro- and P2P- systems that utilize blockchain to exchange cryptocurrency between its users for payment.  Additionally, the Act creates a tax exemption for non-fiat gains realized through the sale or exchange of cryptocurrencies. And probably the most exciting news for commercial investors and accountants, the TTA also exempts the exchange of one cryptocurrency to another.

So, what’s the verdict?  It’s clear that blockchain technology has landed firmly on Congress’ radar and the industry is one step closer to mass adoption.  It’s also clear that if the TTA replaces the Howey test, many new legal elements will be introduced which could take years of litigation to unwrap.  But regardless of the consequences, Congress seems poised to pass this bill.  Months of industry-insider discussion and public input have been incorporated to bolster bipartisan support. And for once, it appears, Congress has found a genuine opportunity to reach across the aisle.  While passing the bill in its entirety seems unlikely, the approval of the tax exemptions alone would be a major win for investors and enthusiasts.  For now, it sits in committee to be edited or scrapped altogether, but, in any form, this bill represents a giant step in the right direction to attract and maintain blockchain development on American soil.  Let’s hope the second time’s a charm.