In the accompanying press release, CDC member Paul Atkins, CEO of Patomak Global Partners and former U.S. Securities and Exchange Commission (SEC) Commissioner, argued that guidelines are needed for the smart regulation that “strikes the right balance between protecting investors while allowing for innovation in this new technological frontier.”
The CDC is a U.S.-based advocacy group that promotes the industry behind virtual currencies and underlying technologies like blockchain. It was founded in July 2014 by Perianne Boring, who previously worked as a legislative analyst in the U.S. House of Representatives and a television anchor of an unspecified “international finance program,” according to her bio aon the CDC’s website.
Being established as a public education outlet, as well as a tool for influencing lawmakers and regulators about digital currencies, the Chamber started to build up its credibility with authorities from the very start: In August 2014, it registered a political action committee (PAC) with the U.S. Federal Election Commission (FEC). Two months after that, in October, the CDC received a nonprofit status from the Internal Revenue Service (IRS).
At this point, the CDC is comprised of approximately 350 participants — ranging from technologists and economists, to token experts, lawyers, former regulators and membership companies as large as Microsoft, Deloitte and IBM.
The CDC report is dubbed “Understanding Digital Tokens.” It is the first installment of what is supposed to become a series, and it focuses upon a particular type of coin — tokens that are not designed to represent securities or commodities, meaning that they should be situated in a grey zone not controlled by the SEC and U.S. Commodity Futures Trading Commission (CFTC) respectively.
In the introduction of the paper, the authors argue that the industry has come to a point where digital tokens do not necessarily fall into one precise category, a sentiment similar to the one voiced by experts at a recent U.S. Congressional hearing, which argued that a digital token’s legal status is fluid these days:
“Some tokens may serve as a virtual currency, others may represent or track physical assets in the real world, some may explicitly represent a security and others may have a utility function. These functionalities are not necessarily mutually exclusive, and a token’s legal treatment may depend on the manner in which the token was marketed.”
The CDC then lists examples of U.S. regulatory bodies’ various approaches toward virtual currencies, outlining the uncertainty of the current regulatory landscape. “In such a volatile regulatory regime (not to mention economic market), reasonable guidelines are imperative,” the paper argues.
The first part of the report is a regulatory overview of five different jurisdictions: namely, the U.S., Canada, the U.K., Australia and Gibraltar. The CDC goes over various legal aspects like taxation of tokens, Know Your Customer (KYC) and Anti-Money Laundering (AML) compliance, investors protection, etc.
In every reviewed case, a specific regulatory framework for generation and distribution of digital tokens is absent. Therefore, such actions tend to fall on the periphery of the law and are defined on a case-to-case basis, where certain aspects of a token are studied by regulators. Even in Gibraltar, where a DLT framework was brought into effect in January 2018 and aimed to help facilitate DLT-backed businesses, it “does not extend to the generation and sale of digital tokens,” albeit with some exceptions, the paper concludes.
Based on the assumption that digital tokens “can take a variety of forms and serve many purposes” that was supported by the aforementioned examples, the paper then attempts to outline principles and guidelines for ‘Token Sponsors’ — defined as an individual or group that either “generates or distributes” or “undertakes to lead or control the development, adoption, or distribution of a digital token” — to manage the risk that the offering and distribution of a digital token may entail, considering certain securities and commodity laws.
Significantly, tokens mentioned in this report are not securities or CFTC-regulated instruments, and the paper itself does not contain legal advice.
The CDC suggests risk management based on the broad definition of what might be deemed as “securities” along with the Howey Test, as well as stating the cases in which the CFTC may exercise general anti-fraud and anti-manipulation authority over any digital token.
The next section in the report focuses on what should and what should not be included in the token’s white paper:
“Thus, the Token Sponsor should provide clear explanation of the project, along with the underlying technology, include descriptive or illustrative case studies of the application, disclose potential risks and employ utility-oriented promotion that does not ‘encourage interest in acquiring the token based solely on investment expectations or a fear of missing out on an investment,’ as it would constitute securities.”
The authors then argue that the white paper should not, however, describe the process of token distribution — as those details can be disclosed in additional materials, if needed:
“If a Token Sponsor’s digital token will be distributed in private sales, a limited public sale or auction, airdrop or a similarly limited event, it may be more appropriate to describe the event in separate materials that can be superseded when the event is completed, rather than in the Token Sponsor’s white paper.”
Moreover, the white paper should stay away from making misleading statements, promising financial returns, discussing strictly investor-oriented details and mentioning prior investments or major projects completed by the development team, its advisors and consultants.
The CDC stresses that following these guidelines “provides no guarantee that a federal or state regulator will not take issue with the digital token issuance, sale or other distribution” as they are intended to assist a Token Sponsor when thinking through critical issues related to “its digital token issuance, sale and distribution.”
Due diligence is the number one priority for platforms trading tokens
Further, the Chamber report focuses on token trading platforms, “entities that allow the trading of digital tokens.” The paper first warns that “responsible” platforms “should do more than merely avoid regulation by the SEC or the CFTC”:
“They should voluntarily conduct business in a manner that protects token consumers, protects the integrity of secondary markets and builds public confidence in the broader blockchain industry.”
Then, the section discusses how token trading platforms may manage risks that arise when a regulator or a court contends that a digital token trading on their platform is a security or a CFTC-regulated instrument “notwithstanding the Token Sponsor’s claims to the contrary.” Essentially, the report suggests the platform to do due diligence, keep the Howey Test in mind and review the token’s present utility before listing it on their service.
The report comes to a close by noting that the “concept of digital tokens is complex” and by citing SEC Commissioner Hester Peirce, who declared that she “used to know what a token was,” while its present state is much more perplexing — which, in turn, shouldn’t “breed anxiety and therefore bad regulation.”
The subsequent CDC reports will highlight topics including AML/KYC potential regulatory adjustments; promoting the concept of a “utility token” among policymakers; and how the industry might play a role in self-regulation, among others.