In the fall of 2018, Republican congressman Warren Davidson was meeting with a cryptocurrency entrepreneur in Massachusetts. The CEO was deciding where to locate his startup, and they were discussing the regulatory uncertainties surrounding digital currencies and initial coin offerings (ICOs).
The entrepreneur told Davidson, “Look, it’s nothing personal. We just don’t trust that you guys are gonna get this done right. So we’re feeling kind of Swiss,” implying he might move to Switzerland, a country with an arguably more business-friendly approach to crypto regulation.
Over the past few years, most companies that created digital tokens and sold them through ICOs assumed they wouldn’t be deemed securities. But when regulators think otherwise, startups can face major legal trouble, as we’ve seen recently with the cases of Airfox, Paragon and Basis. In December, Warren Davidson introduced a new digital token bill, aiming to kill the uncertainty and keep innovation inside U.S. borders.
“The SEC’s stance has caused a massive flight of startups to offshore jurisdictions,” says Caitlin Long, a former managing director at Morgan Stanley who helped Wyoming pass new blockchain legislation last year. “Lawyers right and left were telling clients, ‘Don’t issue tokens to U.S. investors and don’t domicile in the U.S.’”
Marco Santori, former head of the financial technology group at law firm Cooly and current president of crypto company Blockchain, says the present regulatory environment has spawned “mostly a state of confusion among entrepreneurs. … That is not a good place for American innovation.” Crypto investors also point to regulatory uncertainty as a cause of the crypto bear market in 2018, a period when bitcoin lost nearly 75% of its value.
In February 2018, Switzerland declared that some ICOs are not securities, drawing applause from industry veterans. Today about 420 crypto and blockchain startups are domiciled there, according to research by PwC and Swiss blockchain investment firm CV VC. Although the U.S. population is 40 times larger, it has just 2,100 such startups, AngelList reports.
In other words, for every 100,000 residents of each country, Switzerland has five crypto startups, while the U.S. has only one.
Tezos, a blockchain platform founded in 2016 by two New York-based entrepreneurs, has its governing foundation headquartered in Switzerland. Dfinity, a high-profile crypto startup whose CEO is based in San Francisco, is incorporated in Switzerland.
Media-focused blockchain startup Singular DTV chose Switzerland as its home because “it was the only jurisdiction in the world at that time—early 2016—that was actively working to understand blockchain technology and classify ICOs … within its regulatory framework,” CEO Zach LeBeau says. He adds that, since then, Switzerland has adopted “a more U.S.-centric approach” that has “slowed blockchain development there.”
Warren Davidson is trying to make the U.S. more attractive to crypto startups. Before becoming a congressman in Ohio in 2016, the 48-year-old was an entrepreneur and owned a group of manufacturing companies. After he arrived in D.C., he noticed that ICOs were an often-discussed problem without a solution. A self-described tech geek, Davidson joined forces with Florida Democratic congressman Darren Soto to release a bipartisan bill in December 2018, the Token Taxonomy Act. Just a few weeks earlier, Davidson had created a stir by releasing a bill to fund President Trump’s proposed border wall with public donations.
With the Token Taxonomy Act, Davidson aims to amend the Securities Act of 1933 and the Securities and Exchange Act of 1934—the laws the government uses to define securities—“to get the regulatory certainty that I feel like the market needs.” The bill’s primary goal is to define the criteria for when a cryptocurrency initial coin offering (ICO) is a security, in an attempt to exempt some of them from the maligned designation.
Under the new bill, some of the criteria for exemption from security status are: the blockchain platform the token runs on has already launched; the token’s supply can’t be controlled by a single person or group of people; once finalized, transactions can’t be altered by a single person or group of people; and the token “is not a representation of a financial interest in a company, including an ownership or debt interest or revenue share.”
The stipulation about having already launched a product is important. “If you want to raise money to sell oranges, and you don’t own any oranges or an orange grove, that’s a security,” Davidson says, using a business example that served as the basis for the Howey Test, a Supreme Court precedent the government also uses to help define securities. “But if now the oranges have grown and are in barrels, the oranges are no longer securities.” That means, if the bill moves forward, crypto startups would need to pursue traditional funding models like angel or venture investment to support operations before they’ve launched a product.
The Token Taxonomy Act would be “a significant advance if it were to pass,” says blockchain legislation advocate Caitlin Long. She sees defining a digital security as critical and says the proposed bill follows the models set forth in Switzerland and Wyoming. “It would provide a lot of clarity and ensure that blockchain innovation stays in the U.S.,” says Kyle Samani, managing partner of crypto fund Multicoin Capital. “This is designed to precisely help prevent things like Basis shutting down.” Hoboken, New Jersey-based Basis closed its doors in December 2018 due to concerns its product would be deemed a security.
Ari Lewis, a cofounder of crypto fund Grasshopper Capital who also consulted Ohio on its project to let businesses pay taxes in crypto, says, “This bill doesn’t change the fact that many of these tokens don’t have a utility purpose today [outside of speculation] … but one of the problems with the government is that they study everything to death. Kudos to Warren Davidson for trying to make policy change and make a difference.”
At nine pages, Davidson’s bill is short and narrow in scope, focusing primarily on the definition of a security. “This could turn into a bill that would be very long, that would involve three or more committees in Congress,” he says. “By taking slices, not only do we make it easier to create regulatory certainty and go light-touch on the regulation, we make it easier to actually move through Congress.”
The next step is for him to reintroduce the bill, a requirement given that a new Congress started on January 3. He expects to do that in a few weeks or a couple months, and then the bill will go to the Financial Services Committee for review.
What are the chances it will become law, and how long might that take? Davidson expects it to pass but declined to predict when. And Caitlin Long isn’t banking on it. “We’re not holding our breath,” she says. “It could take years.”
Date: January 18, 2019