[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]








   
    CRYPTOCURRENCIES: OVERSIGHT OF NEW ASSETS IN THE DIGITAL AGE

=======================================================================

                                HEARING

                               BEFORE THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED FIFTEENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 18, 2018

                               __________

                           Serial No. 115-14




[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]








          Printed for the use of the Committee on Agriculture
                         agriculture.house.gov






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                        COMMITTEE ON AGRICULTURE

                  K. MICHAEL CONAWAY, Texas, Chairman

GLENN THOMPSON, Pennsylvania         COLLIN C. PETERSON, Minnesota, 
    Vice Chairman                    Ranking Minority Member
BOB GOODLATTE, Virginia,             DAVID SCOTT, Georgia
FRANK D. LUCAS, Oklahoma             JIM COSTA, California
STEVE KING, Iowa                     TIMOTHY J. WALZ, Minnesota
MIKE ROGERS, Alabama                 MARCIA L. FUDGE, Ohio
BOB GIBBS, Ohio                      JAMES P. McGOVERN, Massachusetts
AUSTIN SCOTT, Georgia                FILEMON VELA, Texas, Vice Ranking 
ERIC A. ``RICK'' CRAWFORD, Arkansas  Minority Member
SCOTT DesJARLAIS, Tennessee          MICHELLE LUJAN GRISHAM, New Mexico
VICKY HARTZLER, Missouri             ANN M. KUSTER, New Hampshire
JEFF DENHAM, California              RICHARD M. NOLAN, Minnesota
DOUG LaMALFA, California             CHERI BUSTOS, Illinois
RODNEY DAVIS, Illinois               SEAN PATRICK MALONEY, New York
TED S. YOHO, Florida                 STACEY E. PLASKETT, Virgin Islands
RICK W. ALLEN, Georgia               ALMA S. ADAMS, North Carolina
MIKE BOST, Illinois                  DWIGHT EVANS, Pennsylvania
DAVID ROUZER, North Carolina         AL LAWSON, Jr., Florida
RALPH LEE ABRAHAM, Louisiana         TOM O'HALLERAN, Arizona
TRENT KELLY, Mississippi             JIMMY PANETTA, California
JAMES COMER, Kentucky                DARREN SOTO, Florida
ROGER W. MARSHALL, Kansas            LISA BLUNT ROCHESTER, Delaware
DON BACON, Nebraska
JOHN J. FASO, New York
NEAL P. DUNN, Florida
JODEY C. ARRINGTON, Texas

                                 ______

                   Matthew S. Schertz, Staff Director

                 Anne Simmons, Minority Staff Director

                                  (ii)
































                             C O N T E N T S

                              ----------                              
                                                                   Page
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, opening statement.......................................     1
    Prepared statement...........................................     3
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     4

                               Witnesses

Fairfield, J.D., Joshua A.T., William Donald Bain Family 
  Professor of Law, Washington and Lee University School of Law, 
  Staunton, VA...................................................     5
    Prepared statement...........................................     7
Baldet, Amber, Co-Founder and Chief Executive Officer, Clovyr, 
  New York, NY...................................................    11
    Prepared statement...........................................    13
    Submitted questions..........................................    97
Kupor, J.D., Scott, Managing Partner, Andreessen Horowitz, Menlo 
  Park, CA.......................................................    15
    Prepared statement...........................................    18
Gorfine, J.D., Daniel, Director and Chief Innovation Officer, 
  LabCFTC, Commodity Futures Trading Commission, Washington, D.C.    20
    Prepared statement...........................................    22
    Submitted questions..........................................    97
Gensler, Hon. Gary, Senior Lecturer, Sloan School of Management, 
  Massachusetts Institute of Technology; Senior Advisor to the 
  Director, MIT Media Lab, Brooklandville, MD....................    27
    Prepared statement...........................................    30
Ness, J.D., Lowell D., Managing Partner, Palo Alto Office, 
  Perkins Coie LLP, Palo Alto, CA................................    47
    Prepared statement...........................................    48 
 
      CRYPTOCURRENCIES: OVERSIGHT OF NEW ASSETS IN THE DIGITAL AGE

                              ----------                              


                        WEDNESDAY, JULY 18, 2018

                          House of Representatives,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 10:01 a.m., in Room 
1300 of the Longworth House Office Building, Hon. K. Michael 
Conaway [Chairman of the Committee] presiding.
    Members present: Representatives Conaway, Thompson, 
Goodlatte, Lucas, King, Gibbs, Austin Scott of Georgia, 
Hartzler, LaMalfa, Davis, Yoho, Allen, Bost, Rouzer, Abraham, 
Kelly, Comer, Marshall, Bacon, Faso, Arrington, Peterson, David 
Scott of Georgia, Costa, McGovern, Vela, Lujan Grisham, Kuster, 
Nolan, Plaskett, Adams, Evans, Lawson, O'Halleran, Panetta, 
Soto, and Blunt Rochester.
    Staff present: Darryl Blakey, Mindi Brookhart, Paul 
Balzano, Rachel Millard, Matthew MacKenzie, Patrick Delaney, 
Troy Phillips, Nicole Scott, and Carly Reedholm.

OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE 
                     IN CONGRESS FROM TEXAS

    The Chairman. Good morning, everyone. This hearing of the 
Committee on Agriculture entitled, Cryptocurrencies: Oversight 
of New Assets in the Digital Age, will come to order. Please 
join me in a quick prayer.
    Heavenly Father, we ask you, Lord, for blessings on this 
meeting this morning. We have some things to understand that 
are new and different, and we have great panelists to visit 
with us this morning. I also want to lift up Collin Peterson 
and his family during these times, bittersweet, and your 
thoughts and prayers with him as well. Help us to do your will 
and be the kind of people that will honor you. We ask these 
things in Jesus' name. Amen.
    Just a quick word. Collin Peterson's 98\1/2\ year old 
father passed this week, and this is bittersweet. But he was 
telling me a wonderful story that his dad apparently had his 
faculties right up until the very end, which is pretty darn 
good. Our thoughts are with you, Collin.
    Mr. Peterson. He was hanging in there. He could remember 
the crop prices from 1952. He knew everything.
    The Chairman. Yes, all right.
    Well good morning. We have a terrific panel this morning. I 
see a lot of new faces in the audience today. One of the big 
questions on a lot of folks' mind is what is the Agriculture 
Committee doing with cryptocurrency, and the distributive 
ledger technology, but we are here to find that out this 
morning.
    For those of you who have not joined us before, welcome. We 
are happy to have you as we discuss an emerging policy area 
that is of deep interest to our Members, to the emerging 
crypto-industry, and, we hope, to Americans of all stripes.
    Digital assets like Bitcoin and Ether, but also hundreds of 
other token-based projects that are being developed, represent 
a new way for people to interact and exchange in commerce with 
one another. While digital assets are often thought of as 
payment systems or digital gold, I believe the promise that 
token networks hold is more universal and more exciting, quite 
frankly, than that.
    For the first time, we have a tool that enables individuals 
to reliably exchange value in a digital realm without an 
intermediary. We can have assets that exist and can be created, 
exchanged, and consumed in digital form. The promise of being 
able to secure property rights in a digital space may 
fundamentally change how people interact with one another. This 
technology holds the potential to bring enormous benefits to 
each of us, if we are willing to give it the space to grow.
    Providing a strong, clear, legal and regulatory framework 
for digital assets is essential. To that end, there are several 
questions before us about how laws should govern the issuance, 
trade, and utilization of these digital assets.
    Perhaps no question has generated greater uncertainty than 
how to determine if a particular token is a security. What to 
do if a commonly traded asset is, in fact, deemed a security. 
We simply apply the securities laws. If it is not a security, 
there is a good chance it is a commodity, which would be 
subject to the requirements of the Commodity Exchange Act.
    The problem seems to be in making that determination. The 
Howey Test, which concerns the sale of orange groves and 
service contracts in the 1940s, is often presented as the 
standard test to determine if the securities laws govern a 
token, yet they have proved challenging to analyze under this 
test.
    A related question is whether or not current laws are 
appropriate for these new digital assets. If a token is 
determined to be a security or a commodity or something else, 
our regulatory regime need not be static. If it is necessary, 
Congress and regulators may want to consider developing a new 
framework that takes into account the diverse characteristics 
and unique economic relationships embedded in many of the types 
of digital assets that can be represented by tokens.
    Providing clear guidance to enable developers to determine 
the nature of their token and then suitable rules to enable 
them to develop their project, is essential to both protecting 
the public and promoting innovation. How we regulate these 
products and those who develop them won't determine if they are 
developed or used, but it will determine where they are 
developed and used, and we want that innovation done in our 
country.
    As we consider changes to the laws or new regulations, the 
Committee on Agriculture will be a part of that conversation. 
Within the House, we have a vested interest in the definition 
of a security, because it directly impacts the definition of a 
commodity.
    Similar to our work in agricultural commodities, as well as 
futures and swaps markets, the Committee has a strong interest 
in promoting safe, efficient and transparent markets for those 
who use these new token markets. Properly regulated markets 
promote innovation and foster economic growth, and I don't 
believe that will be any different with respect to digital 
assets. Of course, proper regulation does not mean intrusive 
regulation. It means regulation appropriate to the nature of 
the activities and the participants, and in some cases, it 
might mean no regulation at all.
    Before I turn to our Ranking Member, I want to thank all of 
our witnesses for making the time to prepare and testify. We 
have an incredibly qualified panel to present all sides of a 
fascinating and complex set of issues. I am pleased to welcome 
each one of you here today for this conversation.
    [The prepared statement of Mr. Conaway follows:]

  Prepared Statement of Hon. K. Michael Conaway, a Representative in 
                          Congress from Texas
    Good morning. I see a lot of new faces today as we tackle a 
cutting-edge topic for the Committee: digital assets.
    For those of you who have not joined us before, welcome. We are 
happy to have you as we discuss an emerging policy area that is of deep 
interest to our Members, to the emerging cryptocurrency industry, and . 
. . we hope . . . to Americans of all stripes.
    Digital assets like Bitcoin and Ether, but also like hundreds of 
other token-based projects that are being developed, represent a new 
way for people to interact and engage in commerce with one another. 
While digital assets are often thought of as ``payment systems'' or 
``digital gold'' I believe the promise that token networks hold is more 
universal--and more exciting--than that.
    For the first time, we have a tool that enables individuals to 
reliably exchange value in the digital realm, without an intermediary. 
We can have assets that exist--and can be created, exchanged, and 
consumed--in digital form. The promise of being able to secure property 
rights in a digital space may fundamentally change how people interact 
with one another. This technology holds the potential to bring enormous 
benefits to each of us, if we are willing to give it the space to grow.
    Providing a strong, clear legal and regulatory framework for 
digital assets is essential. To that end, there are several questions 
before us about how laws should govern the issuance, trade, and 
utilization of digital assets.
    Perhaps no question has generated greater uncertainty than how to 
determine if a particular token is a security. We generally know what 
to do if a commonly traded asset is deemed a security--we apply the 
securities laws. And if it is not a security, there is a good chance 
it's a commodity and subject to the requirements of the Commodity 
Exchange Act.
    The problem seems to be in making that determination. The Howey 
Test, which concerns the sale of orange groves and service contracts in 
the 1940s, is often presented as the standard test to determine if the 
securities laws govern a token, yet they have proved challenging to 
analyze under the test.
    A related question is whether or not the current laws are 
appropriate for these new digital assets. If a token is determined to 
be a security or a commodity or something else, our regulatory regime 
need not be static. If it's necessary, Congress and regulators may want 
to consider developing a new framework that takes into account the 
diverse characteristics and unique economic relationships embedded in 
the many types of digital assets that can be represented by tokens.
    Providing clear guidance to enable developers to determine the 
nature of their token and then suitable rules to enable them to develop 
their project, is essential to both protecting the public and promoting 
innovation. How we regulate these products and those who develop them 
won't determine if they are developed and used, but it will determine 
if they are developed and used in our country.
    As we consider changes to the law or new regulations, the Committee 
on Agriculture will be a part of the conversation. Within the House, we 
have a vested interest in the definition of a security, because it 
directly impacts the definition of a commodity.
    Similar to our work in agricultural commodities, as well as futures 
and swaps markets, the Committee has a strong interest in promoting 
safe, efficient, and transparent markets for those who use these new 
token markets. Properly regulated markets promote innovation and foster 
economic growth, and I don't believe that will be any different with 
digital assets. Of course, ``proper regulation'' does not mean 
``intrusive regulation.'' It means, regulation appropriate to the 
nature of the activities and the participants, and in some cases, it 
might even mean no regulation at all.
    Before I turn to our Ranking Member, I want to thank all of our 
witnesses for making the time to prepare and testify. We have an 
incredibly qualified panel to present all sides of a fascinating and 
complex set of issues. I am pleased to welcome you all, and I look 
forward to our conversation today.

    The Chairman. With that, Collin, I will turn to you for any 
comments that you might want to add.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE 
                   IN CONGRESS FROM MINNESOTA

    Mr. Peterson. Thank you, Mr. Chairman, and thanks to all of 
you for joining us here today.
    I am happy that we have a chance to review this new 
technology in our role to oversee the CFTC regulation of it, if 
appropriate.
    As a CPA and someone who spent a career helping folks run 
the numbers on their finances, I am still having a hard time 
getting my hands around this, and I have some real concerns.
    One aspect of cryptocurrency that we need to pay special 
attention to is its volatility. There are some of you that will 
tell us that the fluctuations in cryptocurrency are a good 
thing, and part of its appeal. But the increased speculation 
and the fact that regular investors stand to lose their shirts 
gives me a great deal of concern.
    As one study found, over 80 percent of the initial coin 
offerings are scams. While regular investors stand to lose, a 
very small amount stand to gain. For example, 97 percent of 
Bitcoin is held by just four percent of addresses.
    There are a lot of things here that don't make much sense 
to me, and who knows? Maybe some type of this technology will 
come along and really make a difference after these starts and 
fits, but as it stands right now, I am skeptical. It is our job 
to be the adults in the room and to ensure that in these early 
days, there is enough oversight of this new frontier to ensure 
that it can grow responsibly.
    With that, I look forward to your testimony, and I yield 
back.
    The Chairman. Thank you, Mr. Peterson.
    The chair would request other Members submit their opening 
statements for the record so that our witnesses may begin their 
testimony, and to ensure there is ample time for questions.
    I now would like to welcome our witnesses to our table. 
First off we have Mr. Joshua Fairfield, the William Donald Bain 
Family Professor of Law, Washington and Lee University School 
of Law in Staunton, Virginia.
    We have Ms. Amber Baldet, Co-Founder and CEO of Clovyr in 
New York, New York.
    We have Scott Kupor, Managing Partner of Andreessen 
Horowitz, Menlo Park, California.
    We have Mr. Daniel Gorfine, Director, LabCFTC and Chief 
Innovation Officer at the CFTC here in Washington, D.C.
    We are welcoming back for another round of conversations 
the Honorable Gary Gensler, who currently is a Senior Lecturer, 
MIT Sloan School of Management, and then we have Mr. Lowell 
Ness, Managing Partner, Perkins Coie, Palo Alto, California.
    We have a terrific panel, and with that, we will go to Mr. 
Fairfield.
    Everybody will have 5 minutes to pitch your wares, and we 
also have your full statements for the record.
    So with that, Mr. Fairfield, you are recognized.

       STATEMENT OF JOSHUA A.T. FAIRFIELD, J.D., WILLIAM
    DONALD BAIN FAMILY PROFESSOR OF LAW, WASHINGTON AND LEE 
             UNIVERSITY SCHOOL OF LAW, STAUNTON, VA

    Mr. Fairfield. Thank you, Chairman Conaway, Ranking Member 
Peterson, and Members of the Committee for the opportunity to 
address you today.
    My remarks are going to try to set some context, and they 
are organized around two questions. We have heard a lot about 
securities and commodities, but how are people actually using 
cryptocurrency tokens? And given that, how should regulators 
proceed?
    On the first question, blockchain, which is the technology 
underlying the current rash of cryptocurrency and tokens, is a 
new decentralized database technology. Many communities have 
formed just to see what the technology can do, and they are 
trying different experiments. The potential value in these 
experiments is considerable. Collaborative communities of 
artists, new forms of corporations, fast and low cost check 
settlement, digitization of securities, open and low cost 
electronic mortgage and secured transactions filing systems, 
secure international remittances, voting systems, and many more 
are possible applications of the technology.
    My testimony today will focus on potential for blockchain 
technology to expand personal property rights online. This is 
my primary area of research, and my conclusions are--and I will 
continue them below--that first, citizens need and want an 
expansion of personal property rights online. The 
cryptocurrency tokens are helping them do that by solving 
important problems in building markets for digital property and 
that we need to be cautious when regulating overlapping spaces 
and use cases, such as systems in which most people hold a 
token to use it or consume it, and that few hold it to 
speculate on the price.
    On the second question, how do we go about conducting 
oversight? Common sense construction of how groups are using 
the technology, a so-called duck test, will help regulators 
begin to sort out whether and where to engage. Rough agency 
consensus can handle these conflicts, and hearings such as this 
one are critically important for regulators to start working 
out the overlaps because many, many more applications of this 
technology are coming.
    In the body of my remarks, I would like to discuss how this 
technology represents a badly needed expansion for personal 
property rights online. We should really care about good 
property rules for intangible electronic digital assets. Good 
property rules preserve citizen independence. Property 
institutions build individual wealth and social welfare by 
reducing transaction costs, and property permits us to express 
ourselves by changing and arranging our environment to reflect 
what we want. Here you might think of your own home or your 
wedding ring, for example.
    But personal property rights like this have had serious 
trouble coming online. We just don't own that much personal 
property online. Consider that people used to have record 
collections. Now they have a subscription to Spotify. People 
used to have bookshelves. Now they have Kindle accounts. This 
is because early in the history of the Internet, intellectual 
property holders were worried about illegal copying. It took 
several decades to develop a technology, blockchain, the 
database technology underneath cryptocurrency tokens, that can 
be traded, held, bought, and sold but not duplicated. So far 
until now, property institutions haven't really gotten the 
benefit of Internet technologies because it is too costly to 
record all the transactions. We can't have a database of 
ownership for every Barbie doll in the entire country, right? 
It is too costly. However, token systems can and will reshape 
all of these ways of owning if they push price points low 
enough the way the Internet did for basic Internet 
communications.
    In sum, blockchain technology is not just used as a 
security. It is not just used as a commodity. It is used as a 
way to unstick personal property law for all of us online. But 
it is only going to do it if we let it.
    What is the path to successful oversight? Responsible 
regulation has to rest on a frank and common sense 
determination of how people are using this technology. Working 
out the jurisdictional questions is going to be time consuming, 
but it is not particularly harder than for network 
communications technology. Generally we have just had to hand 
these things out and figure it out.
    Tokens do present some challenge. Specifically, they may be 
used in different ways by different members of a community. 
They may be used at different times in different ways, but most 
importantly, the nature of the use by a community can shift. A 
community can be trying to do something entirely legitimate and 
have speculators come in and begin to disrupt the purpose of 
the original community.
    The current hot characterization debate is whether token 
sales ought to be deemed regulable under the Howey test. I 
believe instead the Howey test represents the outer bound of 
where we should look. We should look inside that outer bound to 
figure out what the beneficial and damaging uses of the 
technology are. If a community is using cryptocurrency tokens 
like securities, then they should be regulated as securities. 
But if they are not, they shouldn't, and that is the most 
important addition.
    In conclusion, blockchain technology has enabled new 
communities and new business forms. It has also provided the 
technological basis for a badly needed expansion of personal 
property rights online, and for purposes of regulatory 
jurisdiction, a rough common sense sorting into buckets will do 
more good in the near term than precise definitions of what a 
cryptocurrency token is. That is a lost cause. A cryptocurrency 
token wears as many hats as humans give it. It is an entry in a 
database. It is a technological entry and nothing more.
    In the current characterization debate, what this means is 
that a token should be deemed a security when it operates like 
a security, a commodity when it operates like a commodity, a 
currency when it operates as a currency, and as a simple 
property interest when it operates as a simple property 
interest.
    Thank you so much.
    [The prepared statement of Mr. Fairfield follows:]

 Prepared Statement of Joshua A.T. Fairfield, J.D., William Donald Bain
 Family Professor of Law, Washington and Lee University School of Law, 
                              Staunton, VA
    Mr. Chairman Conaway, Ranking Member Peterson, and Members of the 
Committee. Thank you for the opportunity to address you today.
Introduction
    My remarks are organized around two questions:
    How are people actually using this new technology? And: How should 
a regulator best proceed in light of how the technology is being used? 
I will briefly summarize my conclusions before returning to the body of 
my testimony.
    First, blockchain, the technology underlying the current rash of 
cryptocurrencies, is a relatively new database technology that permits 
communities to self-organize and build trustworthy decentralized 
databases. Many communities have formed just to see what the technology 
can do, and are attempting different experiments, often with each 
offering its own ``coin.'' (To be sure, scam artists have also flocked 
to the development scene.) The potential value in these experiments is 
considerable: collaborative communities of artists, new corporate 
forms, distributed autonomous organizations, fast and low-cost check 
settlement, digitization of securities, open and low-cost electronic 
mortgage and secured transactions systems, secure international 
remittances, voting systems, and many more are possible applications of 
the technology.
    The Committee will hear about a range of these applications today. 
The specific area in which I would like to focus is the potential for 
blockchain technology to act as a catalyst for expansion of online and 
electronic personal property rights. This is my primary area of 
research. My conclusions, as below, are that citizens need and want an 
expansion of personal property rights online; that cryptocurrencies and 
cryptocurrency tokens can help solve important problems in building 
markets for digital property; and that caution may be advisable when 
regulating overlapping spaces and use cases, such as systems in which 
most people hold an asset to consume it, and a few hold it to speculate 
on the price.
    On to the second question, how to best proceed? Agencies have 
already for several years found themselves faced with the potential for 
overlapping jurisdiction over blockchain-based businesses, products, 
and services, precisely because the technology can support so many 
different uses. Because blockchains are just databases, their use must 
determine the oversight response.
    Uses of cryptocurrency tokens can be complex. Not all people who 
hold a cryptocurrency token do so for the same reasons. Some people 
hold cryptocurrency tokens to consume, some simply to possess, some to 
speculate, some to trade, and some change their minds from time to 
time. Thus, tokens have a fundamentally multi-use nature. There is also 
a time component. Until the owner takes action (consume or trade), the 
owner's reason for holding the token may not be knowable. The use and 
holding of the token as personal property should be generally 
unproblematic, at least by default. Only the trade and speculation 
components should trigger regulatory concern, and even then, only if 
the structure of the transaction looks like an attempt to circumvent 
some established regulatory mandate.
    There are solid paths forward that can protect investors from fraud 
and permit entrepreneurs and communities to develop new business 
models. Common sense construction of how groups are using the 
technology--a ``duck test''--will help begin to sort out whether a 
regulatory structure is needed at all, and if so, which law governs. 
Rough agency consensus and even active and agile cooperation between 
regulators can handle these conflicts, and are good for regulators to 
start working out: more applications of this technology are coming. 
There is indeed every reason to believe this is how regulation in this 
space will actually evolve. More concerning is the risk of chilling 
innovation through incautious overlapping or conflicting regulation. 
Carefully overlapping jurisdictional claims need not cause 
contradiction, but it may take time until the contours of how people 
use the technology become clear. And when those contours do become 
clear, good rules can draw workably clean lines between shifting uses 
of a product or service within a community that weaves across a legal 
boundary.
B. Cryptocurrencies and the Future of Property *
---------------------------------------------------------------------------
    * Editor's note: the testimony is published as submitted, there was 
no section labeled A.
---------------------------------------------------------------------------
    In the body of my remarks I would like to discuss how this 
technology represents a badly needed expansion of personal property 
rights online. We should care about good property rules for electronic 
assets. Good property rules contribute to human thriving, or as Nobel 
Laureate Amartya Sen expressed it, good property rules expand the range 
of human capabilities. Property matters because it lets people do 
things. Thus, good property rules are those that expand what people can 
do. There are three primary ways good property institutions positively 
impact society.\1\ First, good property rules can preserve citizen 
independence. Property draws an important line between private and 
state power.\2\ Second, property institutions build individual and 
social welfare by reducing transaction costs, permitting resources to 
flow to higher-valuing users.\3\ And third, property permits humans to 
express themselves by changing and arranging their environment to 
reflect themselves.\4\ Here, examples might be the property interest in 
a home, wedding band, detailed automobile, and so on.
---------------------------------------------------------------------------
    \1\ See Jedediah Purdy, The Meaning of Property: Freedom, 
Community, and the Legal Imagination 19 (Yale University Press 2010).
    \2\ Joshua A.T. Fairfield, Owned: Property, Privacy, and the New 
Digital Serfdom 18 (Cambridge University Press 2017) (``His first 
stream is `libertarianism,' or negative liberty: the idea that property 
means a kind of liberty from government interference.'') (citing 
Jedediah Purdy, supra, at 19).
    \3\ Id. (``His second stream is efficiency, or what he calls 
`welfarism': property is an institution that helps to ensure the free 
flow of goods for minimum transaction costs, such that it allows people 
to get what they want at the lowest price.'') (citing Jedediah Purdy, 
supra, at 20).
    \4\ Id. (``Purdy identifies a stream of human personhood, or 
identity. The identity view of property requires that we have some 
stability in our environment so that we can build a home, a family, an 
identity. Property allows us to surround ourselves with reminders of 
who we are or wish to be.'') (citing Jedediah Purdy, supra, at 20); see 
also Margaret Jane Radin, Property and Personhood, 34 Stan. L. Rev. 
957, 957 (1982) (``The premise underlying the personhood perspective is 
that to achieve proper self-development--to be a person--an individual 
needs some control over resources in the external environment. The 
necessary assurances of control take the form of property rights.'').
---------------------------------------------------------------------------
    Despite these advantages, personal property rights have had serious 
trouble transitioning from offline to the online environment. We don't 
own much personal property online. Instead, we license everything.\5\ 
If you question whether this is true, consider that people used to own 
record collections; now they license iTunes, or simply have a 
subscription to Spotify. People used to have bookshelves; now they have 
Kindle collections. This modern license framework is in place because, 
early in the history of the Internet, intellectual property holders 
were worried about illegal copying. It took several decades to develop 
a technology, blockchain, which operated like a digital object. Slots 
in a blockchain--cryptographic tokens--can be traded, held, bought, and 
sold, but not duplicated. Cryptocurrency tokens cannot be double-spent, 
because they would be rejected by both the protocol and the other 
``players.'' \6\
---------------------------------------------------------------------------
    \5\ See Aaron Perzanowski & Jason Schultz, The End of Ownership: 
Personal Property in the Digital Economy (MIT Press 2016).
    \6\ Joshua A.T. Fairfield, BitProperty, 88 S. Cal. L. Rev. 805, 841 
(2015).
---------------------------------------------------------------------------
    As a result, cryptocurrency tokens let us own an intangible 
electronic asset just like we own a hat. Blockchain technology appears 
poised to un-stick personal property law online by strongly reducing 
transaction costs for tracking transactions in digital property rights, 
and by creating rivalrous (that is, non-copyable) digital assets. 
Already, cryptocurrency tokens are appearing in court decisions on 
inheritance, wills and trusts, and other routine treatment of personal 
property under the common law. It may soon become as routine to own 
digital tokens as it is to own dollars in a bank account.
    Property institutions will deeply benefit from this technology-
driven drop in transaction costs. Carol Rose notes: ``It costs 
something to define rights, to monitor trespasses, and to expel 
intruders.'' \7\ As property rights become more complex and harder to 
define, property systems cost even more. The difference in expense is 
why we currently have title registries for big items like houses, cars, 
boats, and airplanes, but not for smaller pieces of personal property. 
Cryptocurrency tokens can keep track of minute changes in ownership of 
property interests at strongly reduced costs. Rose predicted that 
``when there are changes in the technological or administrative costs 
of establishing, monitoring and trading property, there may well be 
changes in property regimes as well.'' \8\ Her advice: look for drops 
in those costs. There we will find the future of property. And this is 
precisely what cryptocurrency tokens represent.
---------------------------------------------------------------------------
    \7\ Carol M. Rose, The Several Futures of Property: Of Cyberspace 
and Folk Tales, Emission Trades and Ecosystems, 83 Minn. L. Rev. 133 
(1998).
    \8\ Id. at 139.
---------------------------------------------------------------------------
    These cost drops can fuel further innovation. Just as 
communications technologies proliferated when the cost of communication 
went nearly to zero, so a range of property interests will flourish 
when the costs of transfer go nearly to zero. This is, after all, the 
model of the broader Internet, which, for all of its ``free'' price 
points, is extraordinarily expensive to maintain.\9\ Internet 
technologies scale most disruptively at near-zero transaction 
costs.\10\ For each drop in transaction costs, a new range of widely 
scaled and potentially disruptive uses becomes possible.
---------------------------------------------------------------------------
    \9\ See Joshua A.T. Fairfield, BitProperty, supra, at 815.
    \10\ See Kevin Werbach, The Centripetal Network: How the Internet 
Holds Itself together, and the Forces Tearing It Apart, 42 U.C. Davis 
L. Rev. 343, 347-48 (2008) (``The Internet fosters innovation by 
eliminating transaction costs, enabling new services to emerge.'').
---------------------------------------------------------------------------
    So far, property institutions have not yet fully realized the 
benefits of the last 3 decades' advances in information technology 
because of the cost needed to record transactions and vet trusted 
intermediaries to maintain and protect records.\11\ Token systems can 
and will reshape property law if they push price points low enough to 
unleash disruptive and scalable applications.
---------------------------------------------------------------------------
    \11\ See Joshua A.T. Fairfield, BitProperty, supra, at 813.
---------------------------------------------------------------------------
C. A Path to Successful Oversight
    In this section, I turn to the second question, and discuss 
features of a successful oversight strategy. I derive these principles 
from experience with several prior analogous regulatory moments: the 
IRS determination as to when to tax financial gains on virtual objects; 
the IRS determination as to whether cryptocurrency ought to be taxed as 
currency or commodity; and the deliberations by FinCEN, CSBC, and other 
stakeholders in the state and Federal banking systems over whether 
cryptocurrency exchanges ought to be deemed money transmitters under 
the Bank Secrecy Act.
    Responsible regulation must rest on a frank and common-sense 
determination of how people are using the technology. A primary benefit 
of close attention to how the technology is actually being used will be 
to reduce the number of overlapping oversight claims. Almost every 
regulator will soon be able to claim jurisdiction over some application 
of blockchain technology, but of course they will not have jurisdiction 
over all uses.
    Working out jurisdiction over actions or business models that cross 
several different regulatory boundaries will be time-consuming, but no 
harder for blockchains than they were for network communications 
technology generally. SEC, CFTC, FinCEN, IRS, and state banking 
regulators have spent several years sorting out their various roles in 
regulating the various uses of cryptocurrency, and there has been 
measurable progress in determining which regimes and what terms govern.
    Tokens do present some interesting problems. First, tokens may be 
used in different ways by different members of a community. Second, 
even a single owner may buy, hold, consume, sell, trade, or destroy 
tokens for different reasons at different times. A community may shift 
to use products or services in illicit ways that the product creator or 
service provider did not predict. Illicit uses may make use of a licit 
support layer. This is precisely what happened when the SEC warned in 
July of 2017 that The DAO, an Ethereum-based investment and governance 
platform had likely violated securities regulations.\12\ Contrast this 
with SEC Division of Corporation Finance Director William Hinman's 
recent announcement that transactions in Ether are unlikely to be 
deemed securities transactions.\13\ Agencies are already beginning to 
sketch out the important distinctions that will help preserve 
beneficial applications of the technology (investors in Ether were 
justifiably relieved by the announcement) while permitting oversight of 
bad practices at the application layer (such as another DAO).
---------------------------------------------------------------------------
    \12\ See generally SEC, 81207, Report of Investigation Pursuant to 
Section 21(a) of the Securities Exchange Act of 1934: The DAO (2017).
    \13\ See Trevor M. Dodge, SEC Director William Hinman: ``Current 
offers and sales of Ether are not securities transactions,'' The 
National Law Review, June 18, 2018, at 1.
---------------------------------------------------------------------------
    The currently hot characterization debate is whether token sales 
ought to be deemed regulable under the Howey test.\14\ I find that 
discussion unhelpful. Howey marks in a sense one of the deepest reaches 
of the SEC into regular ownership behavior. The case is a placeholder, 
there to preserve SEC's right to make further and more in-depth 
determinations. As such, it is not a particularly good guide to how 
things should end up. Instead of the rule of Howey, a better approach 
is to look at how the technology is actually being used. If a community 
uses cryptocurrency tokens functionally like securities, then they 
ought to be regulated as such. But if not, they shouldn't. There should 
be a well-regulated market for blockchain-traded securities. Companies 
are working now to legally list and trade securities through blockchain 
databases, and Delaware has been working to make that possible. There 
is a legal path for companies wishing to list and trade securities on a 
blockchain, and some companies are moving to do so. This is the duck 
test as applied to securities: ``if it quacks like a security,'' and 
everyone knows the rest.
---------------------------------------------------------------------------
    \14\ SEC v. Howey Co., 328 U.S. 293 (1946).
---------------------------------------------------------------------------
    The harder question is how to characterize token sales when the 
issuer and majority of purchasers can credibly show that their purpose 
in buying, holding, selling, and consuming cryptocurrency tokens is not 
to profit from the efforts of others, but in fact to order rights and 
relationships in some new way. For example, most community members 
might use a given token system for clearly non-securities related 
purposes, but some tokens may be bought, held, and traded by 
speculators. Further, different actors within the community may take on 
different positions at different times, and the community as a whole 
may shift its use of the token. In these cases, the trick is to catch 
the fraudulent ducks without killing a goose who may lay the golden 
egg--new and powerful communities and business models. Only a deeper 
dive into how the asset is promoted, used, and traded can begin to 
provide an answer.
    Entities charged with oversight should be cautious not to squash 
new arrangements of rights merely because there is an arguable 
conceptual overlap with the broad language of cases such as Howey. 
However, they must not fail to recognize systems that walk, quack, and 
waddle like ducks merely because of some shiny new cryptocurrency 
feathers. Many token sales transparently attempt to bilk the public by 
selling and supporting junk tokens.\15\ Some token sales are a 
transparent attempt to raise money for business ventures that wish to 
circumvent securities regulation. But just as clearly, many companies 
and communities are building communities that have nothing to do with 
securities, although some users may speculate with the tokens. Part of 
this is unavoidable. Entities tasked with oversight are reasonably 
reluctant to overcommit to the legality of some cryptocurrency business 
models, because they are concerned with lending a false sense of 
credibility to business practices that may turn out in the end to be 
fraud. But reasonable common-sense guidance is necessary so that 
innovators can move plans for businesses from the kitchen table to the 
garage.
---------------------------------------------------------------------------
    \15\ See, e.g., Nathaniel Popper, In the World of Cryptocurrency, 
Even Good Projects Can Go Bad, New York Times (May 30, 2018), available 
at https://www.nytimes.com/2018/05/31/technology/envion-initial-coin-
offering.html (last visited on July 13, 2018).
---------------------------------------------------------------------------
    During this shakedown period in token technology, regulators will 
best be able to decide jurisdictional questions, and citizens will best 
be able to predict how the law will respond to their attempt to create 
new business models and new communities, by reasoning from past 
business practices. This new technology permits us to do new things 
technologically, not legally. This is not a permanent state of affairs, 
however. The demand for cryptocurrency tokens also demonstrates that 
there is serious untapped demand for new and cheaper ways to manage and 
trade certain kinds of rights, and that people want to be able to 
directly invest by making cryptocurrency purchase decisions--whether 
this is wise or not. In the end, regulators may determine that certain 
kinds of transactions simply cost us all too much in terms of defrauded 
investors, broken promises, emptied bank accounts, and subsequent 
claims that regulators should have better insulated consumers from 
harm. But they should not do so lightly, and should take every 
precaution to avoid stepping on legitimate novel forms of organizing 
human productivity while they make a determination of how people are 
using this technology, and what to do about it.
Conclusion
    Blockchain technology has enabled new communities and new business 
forms. It has also provided the technological basis for a badly needed 
expansion of personal property rights online. An agency exercising 
oversight must therefore be sure that the use it observes fits in its 
regulatory wheelhouse--many new uses will not. In determining what law 
applies to blockchain technology, the legal regulatory regime must rest 
on an informed and common-sense determination of how the technology is 
being used. That simple test has some advanced wrinkles, because 
cryptocurrency tokens are built for overlapping, shifting, and multiple 
uses. As a result, regulatory agencies have done best with 
cryptocurrency technologies when they use a common-sense functional 
analysis, followed by engagement with the industry or community.
    In considering regulatory jurisdiction, common-sense sorting into 
rough buckets will do more good in the near term, as applications begin 
to come online, and regulators see which applications are likely to 
impact society the most. In the current characterization debate, a 
token should be deemed a security when it operates like a security, a 
commodity when it operates as a commodity, a currency when it operates 
as a currency, and a simple property interest when it operates as a 
simple property interest.

    The Chairman. Thank you, Mr. Fairfield.
    Ms. Baldet, 5 minutes.

   STATEMENT OF AMBER BALDET, CO-FOUNDER AND CHIEF EXECUTIVE 
                 OFFICER, CLOVYR, NEW YORK, NY

    Ms. Baldet. Chairman Conaway, Ranking Member Peterson, and 
Members of the Committee, thank you for the opportunity to be 
here this morning. I am Amber Baldet, Co-Founder and CEO of 
Clovyr, a company building tools that make it easier to build 
decentralized applications on top of both publicly accessible 
blockchain networks, and access-controlled distributed ledgers.
    Previously, I led the blockchain program at JPMorgan, 
though I would like to note that my comments today do not 
represent my former employer. I also currently sit on the Board 
of the Zcash Foundation, a nonprofit organization seeking to 
advance the state of the art for privacy technology as applied 
to Internet infrastructure and privacy preserving 
cryptocurrencies.
    These are a variety of disparate hats, all of which lead me 
to the same message. My commentary today concerns the 
importance of a cautious and thoughtful regulatory approach to 
innovative technologies, even--and especially--those that might 
disrupt business as usual or add to the complexity of 
regulating the Internet, as both critical infrastructure and a 
shared public good.
    We must determine how to balance the enormous potential 
value of this technology with the need for consumer protections 
and national security, and how to achieve this while respecting 
human and constitutionally protected rights.
    So far, money seems to be the killer app for blockchain. 
Much as the early Internet's killer app, e-mail, continues to 
be a cornerstone for how we communicate online, peer-to-peer 
payments will likely grow into and persist as a ubiquitous part 
of our personal and professional daily lives. In fact, the 
ability to spend, trade, rent, or license other sorts of unique 
digital bearer assets could be applicable to many things we 
own, mortgages, securities, collectibles, intellectual property 
rights, personal data, et cetera.
    Imagining this mature, interconnected global ecosystem of 
such markets feels like standing in the 1990s and imagining 
Netflix streaming on your phone; and yet, my concern is not the 
speed with which we reach that end stage, it is the choices 
that we make along the way, which stand to be as hotly 
contested and impactful as net neutrality, the DMCA, FOSTA/
SESTA, or the on again, off again discussion of state-mandated 
weak cryptography continues to be.
    While we struggle to overlay existing regulatory frameworks 
onto new technology that is useful precisely for its fluidity, 
other areas of the world are embracing that ambiguity and 
learning by doing. In Afghanistan, for example, Code to Inspire 
helps train young women for technical careers and pays them in 
Bitcoin, which they can use in local shops as well as global 
marketplaces. In a place where women's banking and even 
physical agency is limited, financial autonomy and digital 
inclusion is a powerful force for equality and democracy.
    In some African countries and places with less legacy 
financial infrastructure, companies are using crypto-assets to 
enable farmers to properly track and register their 
commodities, and increase their bargaining power in downstream 
market pricing. Not only can end consumers tip their farmer in 
support of fair and sustainable working conditions, but every 
other factory or wholesale retailer along the way can make more 
informed decisions about the providence of inputs to their 
products.
    In the United States, Square, whose business strategy is 
already based on disrupting traditional payments processors, 
has added the ability to buy, sell, and transfer Bitcoin into 
its mobile app, and there are many products targeting 
cryptocurrency investors and early adopters.
    There are also several more experimental projects that are 
interesting. For example, using economic incentives to battle 
fake news, cryptocurrency micropayments as an alternative 
business model to data-hungry online advertising, and fluid 
marketplaces for unused disk space on your home computer as a 
disruptive force to centralized Cloud storage. These projects, 
all launched as initial coin offerings, ICOs, either on a new 
single purpose blockchain network or as a token on top of an 
existing network, like Ethereum, are often compared to the 
Internet startup boom of the 1990s.
    The ability to ``code oneself out of business'' is a novel 
property of these decentralized blockchain applications, but 
most experiments today invoke a variety of human-controlled 
workflow checkpoints and escape hatches to allow intervention 
if necessary.
    Along with understanding who controls access to the network 
and who can modify the rules of the system, identifying who 
controls these escape hatches might be helpful in sorting 
tokens into various asset classes once a sensible taxonomy has 
been established.
    As a counterpoint, blockchain is not the answer to every 
problem. For example, I recommend extreme caution with 
exploration of blockchain-based e-voting. Ensuring one person 
one vote while keeping ballot selections private is an 
incredibly complex computer science and human coordination 
problem that we are not ready to tackle yet. Internationally, 
it is no surprise that some of the central banks most 
aggressively investigating cryptocurrency as an alternative or 
enhancement to their existing currencies are in Venezuela, 
Russia, and China.
    Going forward, as there is inevitably more discussion of 
the potential for a digital dollar, I encourage strongly 
encrypted, privacy-preserving design choices coupled with opt-
in selective disclosure, as opposed to options like mandatory 
cryptographic back doors or golden keys, which could make the 
U.S. financial system a very attractive target for nation-state 
sponsored cyberattacks and hackers. As that conversation 
matures, we must clarify how FinCEN, OFAC, and other relevant 
rules can be applied, modified, or interpreted to balance many 
competing interests.
    In conclusion, even--and hopefully if--this Committee's 
guidance is simply a strong commitment to non-interventionism, 
safe harbors for innovators, and work towards resolution of the 
patchwork fabric of state laws, the time it takes to come to 
such a commitment may have the unfortunate effect of eroding 
America's early mover advantage in technical innovation and 
entrepreneurism.
    Thank you.
    [The prepared statement of Ms. Baldet follows:]

  Prepared Statement of Amber Baldet, Co-Founder and Chief Executive 
                     Officer, Clovyr, New York, NY
    Chairman Conaway, Ranking Member Peterson, and Members of the 
Committee, thank you for the opportunity to be here this morning. I'm 
Amber Baldet, co-founder and CEO of Clovyr, a company building tools 
that make it easier to build decentralized applications on top of both 
publicly accessible blockchain networks and access-controlled 
distributed ledgers.
    From 2015 to April of this year, I led the blockchain program for 
JPMorgan's Corporate & Investment Bank, though I'd like to note that my 
comments today do not represent my former employer. I also currently 
sit on the Board of the Zcash Foundation, a nonprofit organization 
seeking to advance the state of the art for privacy technology as 
applied to Internet infrastructure and privacy-preserving 
cryptocurrencies.
    Technical tooling, corporate and financial industry transformation, 
digital privacy and public cryptocurrency advocacy: these various hats 
might sound incongruous, but I see them as interconnected pieces of a 
larger puzzle. The puzzle we are trying to solve is the design for the 
next-generation fabric of both macro and micro-economies.
    E-mail allows you to send a digital version of a birthday card to a 
grandchild instantly. Cryptocurrency like Bitcoin gives you the ability 
to put the digital equivalent of $10 inside that card. No need to 
attach a code for a gift card redeemable at a single retailer or buy a 
clunky prepaid cash card from a credit card company. Whereas you might 
attach the same family photo to three different birthday cards, you 
can't send the same $10 more than once. The revolutionary proposition 
of cryptocurrency--or more broadly, crypto-assets--is the ability to 
send something you own across the Internet and then irrefutably not 
have it anymore, without relying on a third party to intermediate or 
otherwise witness the event. So far, money seems to be the killer app 
for blockchain, but you can imagine that the ability to spend, trade, 
rent, or license unique digital bearer assets could be applicable to 
many things we own: mortgages, securities, collectibles, intellectual 
property rights, unused disk space on your home computer, personal 
data, etc.
    Imagining a mature, interconnected global ecosystem of such markets 
feels like standing in the 90s, looking at a pre-World Wide Web 
electronic bulletin board system and trying to imagine Netflix 
streaming on your phone. The prospect seems so fanciful as to be 
impossible, but here we are. And yet, my concern is not getting to that 
end state, it's the choices that we make along the way. As evidenced by 
the debate around, and impact of, legislation like the DMCA (Digital 
Millennium Copyright Act), Net Neutrality, FOSTA/SESTA (Fight Online 
Sex Trafficking Act/Stop Enabling Sex Traffickers Act), or sporadic 
discussion of state-mandated weak cryptography since the 1990s (e.g., 
Compliance with Court Orders Act of 2016), the government greatly 
impacts how we are all able to use Internet and communications 
utilities which are inexorably woven into the vast majority of 
Americans' daily lives.
    The peer-to-peer protocols which underpin crypto-asset networks are 
not much different than those that underpin the Internet; they are just 
rules for how to route bits and bytes. They do not care about the 
legality or morality of what crosses the wire and can be used in 
service of business as usual, political action, commission of crimes, 
facilitating human rights, or sharing funny photos of cats.
    Everything old is new again, and we are at the precipice of the 
same choices for crypto-asset networks as for the Internet. The 
difference, of course, is that we did not previously need to decide if 
every email was possibly a security with taxable profit and loss. The 
discussion today concerns the financial classification of the assets 
that cross the wires, which is important, but cannot be completely 
decoupled from the treatment of the Internet any more than litigation 
about a car crash can be divorced from observations about the condition 
of the road, timing of traffic lights, speed limit signage, and driver 
compliance with traffic laws.
    It's not just about our banking sector, not just corporate supply 
chains, not just consumer payment rails, but how all these things might 
be connected both here and abroad to reduce friction and open new 
possibilities for economic growth. It is recognition that we are 
building next-generation systemically important infrastructure for the 
American economy. It's also about learning how to balance the enormous 
potential business value of this technology with the need for consumer 
protections and national security, and how to achieve this while 
respecting human and Constitutionally-protected rights.
    There are many stakeholders in this emerging universe who sometimes 
have fundamentally divergent philosophies. Yet, they are in near 
unanimous agreement that when it comes to cryptographically unique 
digital bearer assets, the genie is out of the bottle. As science 
fiction author William Gibson said, ``The future is already here, it's 
just not very evenly distributed.'' While we struggle to overlay 
existing regulatory frameworks onto new technology that is useful 
precisely for its fluidity--sometimes it may act like a medium of 
exchange, sometimes a store of value, a commodity, a security, etc.--
while we wrestle with that flexibility, other areas of the world are 
embracing the ambiguity and learning by doing.
    In Afghanistan, for example, Code to Inspire helps train young 
women for technical careers and pays them in Bitcoin, which they can 
use in local shops as well as global marketplaces. In a place where 
women's banking and even physical agency is limited, financial autonomy 
and digital inclusion is a powerful force for equality and Democracy.
    Another example is that in places with less legacy financial 
infrastructure, companies are using crypto-assets to enable farmers to 
properly track and register their commodities, enhance supply chain 
transparency and increase their bargaining power in downstream 
commodities market pricing. Not only can end consumers ``tip their 
farmer'' in support of fair and sustainable working conditions, but 
every other factory or wholesale retailer along the way can make more 
informed decisions about the provenance of inputs to their products.
    The sticking point in such registries might be the perfection of 
these crypto-assets, in that while we can represent a real-world good 
on a blockchain, processing of claims in the case of a default requires 
enforcement practices external to the network. Relatedly, while 
tokenized physical assets have been proposed as a response to 
government corruption (for example, forced re-allocation of land rights 
during a change in leadership), credible threat or use of physical 
violence still holds more sway over allocation of resources than any 
ledger ever will. Ironically, then, these sorts of token registries 
might work best in places that want to leapfrog a generation of banking 
technology, but already have well-functioning rule of law.
    In the United States, several more experimental projects are also 
interesting, whether it's using economic incentives to battle fake 
news, cryptocurrency micropayments as an alternative business model to 
data-hungry online advertising, or fluid marketplaces for unused disk 
space on home computers as a disruptive force to centralized cloud 
storage. These projects, all launched as initial coin offerings (ICOs) 
either on a new single-purpose blockchain network or as a token on top 
of an existing network like Ethereum, are often compared to the 
Internet startup boom of the 1990s. Because these are ``blockchain 
native'' assets rather than tokenized representations of real-world 
assets, it may be possible to more closely approximate today's dispute 
resolution frameworks entirely as programmatic rules within ``smart 
contracts,'' but only if explicitly coded to do so, and only assuming 
there are no bugs in the code which cause unintended and possibly 
irreversible outcomes.
    The ability to ``code oneself out of business'' is a novel property 
of decentralized blockchains, but most experiments today invoke a 
variety of human-controlled workflow checkpoints or escape hatches to 
allow intervention if necessary. Along with understanding who controls 
access to the network and who can modify the rules of the system, 
identifying these escape hatches and who controls them might be helpful 
in sorting tokens into various asset classes once a sensible taxonomy 
has been established.
    Of the myriad applications currently under development, it's hard 
to tell what's going to take off and what will be most transformative. 
Nonetheless, the sheer number of people globally working on these 
projects make it likely that it's only a matter of time until they are 
no longer considered experimental. The question is how long it will 
take for distributed ledgers of various incarnations to be considered a 
legal system of record in enough places that interacting with them is 
the norm rather than a novelty. Clarity around legal and regulatory 
treatment in various jurisdictions is, perhaps, the most important 
factor in the speed of that evolution.
    As a counterpoint, and to temper what might sound like unbridled 
enthusiasm, I recommend extreme caution on engaging with blockchain 
based e-voting for real-world ballot measures. Ensuring one-person-one-
vote while keeping ballot selections private, is both a non-trivial 
computer science and human coordination problem we're not ready to 
tackle yet. It is one thing to experiment with making decisions about a 
blockchain network's governance processes using the network itself, it 
is quite another to talk about electronic voting processes for 
something like U.S. elections, where even traditional electronic voting 
machines are continually demonstrated to be vulnerable to being hacked.
    But when it comes to more promising near-term use cases, the oft-
referenced regulatory position of Do No Harm is a helpful signal but is 
perhaps not strong enough. Recently, new entrants Coinbase and Gemini 
launched cryptocurrency custody solutions for retail and institutional 
investors, and this week Coinbase made further strides in SEC approval 
to list on its exchange tokens which are considered securities. As more 
traditional assets become tokenized, they may be able to challenge 
incumbents not because the incumbents are too outdated to understand 
the technology or unable to develop new products and services quickly 
enough, but because they are held back from competing due to regulatory 
uncertainty.
    Similarly, as the Federal Reserve and commercial banks take a wait-
and-see approach to exploring tokenized representations of the U.S. 
Dollar, we risk missing the larger picture of what a next-generation 
Internet of Value means for geopolitics and the future of nation-state 
economic competition and power projection. It's no surprise that some 
of the central banks most aggressively investigating cryptocurrency as 
an alternative or enhancement to their existing currencies are in 
Venezuela, Russia, and China. As we begin to explore domestic strategy 
in this area, it will be important to clarify how existing FinCEN, 
OFAC, and other relevant rules can be applied, modified, or interpreted 
to not stifle innovation.
    Interestingly, the anonymous, censorship resistant features of open 
blockchain currencies may not prove to be a threat to U.S. financial 
system at all, but rather turn out to be foundational to creation of a 
digital U.S. Dollar equivalent that is as well regarded around the 
world as the physical dollar is today. Going forward, I encourage more 
discussion of strongly encrypted, privacy-preserving digital currencies 
coupled with opt-in selective disclosure, as opposed to more naive 
options like so-called cryptographic backdoors or ``golden keys,'' 
which are attractive targets for nation-state sponsored cyberattacks 
and hackers.
    In conclusion, even--and hopefully if--this Committee's guidance is 
simply a strong commitment to non-interventionism, safe harbors for 
innovators, and work toward resolution of the patchwork fabric of state 
laws, the time it takes to come to such a commitment may have the 
unfortunate effect of eroding America's early mover advantage in 
technical innovation and entrepreneurism. We take for granted that much 
of the Internet as we know it was developed here at home, and the 
immense benefits accrued to us because of it. I appreciate your ongoing 
work to come to consensus on a way to repeat the successes of the early 
Internet era while learning from the things we could have done better. 
Thank you for your time.

    The Chairman. Thank you, Ms. Baldet.
    Mr. Kupor?

 STATEMENT OF SCOTT KUPOR, J.D., MANAGING PARTNER, ANDREESSEN 
                    HOROWITZ, MENLO PARK, CA

    Mr. Kupor. Thank you, Chairman Conaway and Ranking Member 
Peterson for the opportunity to be here today to talk about 
this very important new technology. My name is Scott Kupor. I 
am the managing partner for a firm called AH Capital 
Management, which manages about $7 billion worth of venture 
capital assets, and very recently also for a group called CNK 
Capital Management, which is a $300 million registered 
investment advisor fund focused exclusively on investing in 
crypto-related assets.
    I would like to spend my time today to focus on why we 
believe as investors that crypto-technologies make a very 
compelling investment opportunity, particularly for members of 
the venture capital community, and I want to start with a 
definition that is different from the definition that we often 
hear about. If you focus on a lot of the public narrative today 
about crypto-technologies, there are two kind of dominating 
narratives. One is certainly around Bitcoin and price 
fluctuations and volatilities, which we heard certainly from 
the Ranking Member today as well, as well as what are called 
initial coin offerings, ICOs, for capital fundraising.
    As investors, though, we are interested in the broader 
ecosystem and we use the term crypto-networks to describe what 
we think about as that ecosystem. Very specifically, crypto-
networks for us means a new way to build digital services, and 
by digital services, we mean any Internet application that 
obviously may exist today, so ridesharing applications, social 
media applications, and probably a whole host of things, of 
course, that we haven't even thought about, but where those 
digital services are owned and operated by a community of 
network participants rather than by a centralized corporation.
    Now, I realize at first blush that when you think about 
community ownership and management of an asset, that may seem 
odd, but in fact, if you look at the technology industry, there 
is actually significant precedent for the existence and success 
of community-based networks in the development of a significant 
portion of technology.
    First is what is known as the open source software 
movement. This started back in 1983 actually at MIT by a 
professor named Richard Stallman, and at the time, it was a 
very, very radical notion. The idea was that a community of 
developers would publish and then freely offer their software 
to others who could modify that software, who could incorporate 
it into various other projects. It was really, in many 
respects, a very liberal movement around opening up and 
reducing copyright initiatives in software.
    If you fast forward to today, though, open source is the 
predominant method of software development and software 
utilization today in the world. For any data center you go to, 
which is obviously where major corporations run their Internet 
applications, Linux, which is a major operating system, is by 
far the dominant operating system in play, and for all of you, 
like myself, who walk around with your cell phones all day 
long, the vast majority of components in your cell phones are 
what are called android and essentially open source software. 
The history of open source software is relevant for how we 
think about the potential for what Bitcoin and crypto-networks 
can be.
    The second important historical analogy is around what we 
call open protocols, which really form the foundation of the 
modern Internet that we all use today. An example of this is 
something called SMTP, which is the protocol that we all use 
for e-mail transmission. It is an open protocol. It was 
governed, in many cases, by open communities, by networks, by 
academics, and in many cases, with government funding, and many 
people built applications on top of these open networks 
precisely because they knew that the nature of that protocol 
would not change. They could rely on the steadiness and the 
consistency of that protocol on which to build applications.
    If we look at technology, the open protocols that are well-
developed and well-maintained can become the building blocks on 
which massive customer utility and economic growth can be 
built. It is also the case, however, as you look at the start 
up world that many start up companies have failed by relying on 
what we call platform risk, which is building on other 
platforms that are governed by centralized corporations and 
then finding that the rules of the road change over time, and 
that really does significantly handicap their efforts.
    As a result of this, what we now see in our business is 
many developers are hesitant to take on this platform risk and 
are instead looking at things like crypto-networks as a new and 
innovative way for developers to create new digital services 
without the attendant risk that comes from depending upon 
centralized platforms. In many ways, crypto-networks borrow it 
from the nearly 50 years of history in the technology industry, 
which shows that communities of developers can share their work 
openly and properly govern a network without centralized 
authority.
    But crypto-networks also introduce a very powerful economic 
incentive that didn't exist in these prior generations. The 
presence of what we call a token, which creates a direct 
financial incentive for members of the communities to, in fact, 
develop and govern the network appropriately. The token really, 
in a sense, is the glue that binds the various players in the 
ecosystem and provides the appropriate economic incentives for 
all market participants.
    Understandably so, this creates a whole new set of 
challenges for regulators. Consistent with recent statements 
that we have heard from the director of corporate finance at 
the SEC, we believe that the regulatory nature of crypto-
networks varies with the stage of development of a particular 
project. Briefly, when a centralized sponsor is seeking to 
raise capital from investors prior to the functional 
development of the network, this is probably what is known as 
an investment contract and therefore properly regulated as a 
security. However, the nature of the tokens that are delivered 
on that contract can ultimately be regulated as commodities 
once the fulfillment of that investment contract has occurred.
    As stated by the CFTC, some tokens are not securities. Once 
the network is functional, and in particular cases where the 
network is decentralized from an ownership perspective, we 
believe the nature of the tokens looks more like commodities 
than securities, and therefore probably rightly should be 
governed by the CFTC. This is precisely because there is no 
centralized sponsor on which the efforts of the value of the 
token are largely dependent. Instead, the tokens have value 
based upon the utility of the service to participants. This 
actually looks much more like the way commodities trade.
    In conclusion, the U.S. has long enjoyed the fruits of 
innovation in the form of economic growth, job growth, and 
consumer utilities stemming from many of the great technology 
companies of our time, and we believe that crypto-networks 
present a new and exciting opportunity for us to continue on 
that trajectory. Doing so, however, will require that we 
develop a regulatory framework that encourages risk taking and 
capital formation, provides clarity and certainty to market 
participants, and of course protects individual investors and 
the integrity of the markets.
    Thank you for the opportunity to be here today.
    [The prepared statement of Mr. Kupor follows:]

 Prepared Statement of Scott Kupor, J.D., Managing Partner, Andreessen 
                        Horowitz, Menlo Park, CA
    Chairman Conaway and Ranking Member Peterson, thank you very much 
for the opportunity to speak with the Committee regarding crypto-
technology and its implications for American technology innovation. I 
applaud this Committee for your efforts to take a closer look at what 
we believe is a foundational area of technology development, one that 
is critical to the health of our capital markets, entrepreneurship and 
the American economy.
    By way of background, I am the Managing Partner for AH Capital 
Management, which manages approximately $7 billion in venture capital 
funds focused principally on early-stage IT-related investments. We 
have been operating this business for just over 9 years and some of the 
companies in which we have invested and with which you may be familiar 
include Facebook, Lyft, AirBnB, Instacart, Pinterest and Github. I am 
also the Managing Partner for CNK Capital Management, a registered 
investment adviser that manages a $300 million venture capital fund 
dedicated solely to investing in crypto-related technologies.
Background on Crypto-networks
    I'd like to focus my time here today on what we believe is the 
foundational importance of crypto-related technologies and why we 
believe they make a compelling investment opportunity for the venture 
capital community.
    In doing so, I think it's important to define the space precisely.
    The public narrative around crypto-related technologies tends to 
focus primarily on two areas: (i) Bitcoin itself as a potential store 
of value and the high levels of volatility inherent in the price of 
Bitcoin and (ii) the proliferation of initial coin offerings (ICOs) to 
unaccredited, retail investors, many of which have been rightly 
criticized by the SEC as inconsistent with U.S. securities laws. While 
these are no doubt currently significant aspects of the industry, the 
almost exclusive public focus on these areas obscures the exciting 
technological innovation that drives our interest in crypto-networks.
    Specifically, we define the term ``crypto-networks'' as:

   a new way to build ``digital services,''

   where those services are ``owned and operated'' by a 
        ``community of network participants,'' rather than by a 
        centralized corporation, and

   where the repository of activity on the network (i.e., the 
        database) is decentralized and maintained by the community.

    What are ``digital services''? They are simply Internet-based 
applications, such as many of the ones we enjoy today--ride sharing, 
messaging, grocery delivery, enterprise applications, to name a few. We 
believe that developers will create a whole new set of digital services 
utilizing the principles of crypto-networks, many of which are likely 
beyond our imagination today but will also yield enormous consumer 
utility.
    And what are those principles of crypto-networks? That they are 
both owned and managed by the community that develops, maintains and 
utilizes the networks. This is distinct from the large digital services 
that we utilize today, where the ownership and management of those 
services are governed by a centralized corporation.
    At first blush, this may sound crazy--that there may be value in 
community ownership and management of an asset that exceeds that of 
centralized corporate control? But, in fact, there is well-established 
precedent for this in the history of the technology industry.
    First, is the open source software movement. This started in 1983 
as a movement to create free software, led by an MIT researcher named 
Richard Stallman. Understandably, this was a radical concept at the 
time--that a community of developers would publish their software 
freely for others to modify and incorporate into various other open 
projects. But over time, this work morphed into the mainstream 
development of open source software, which today is the predominant 
method by which software is developed. Examples of open source software 
that have experienced widespread adoption include Linux, an operating 
system that governs most data center servers today and is a major 
component in virtually all smartphones and tablets, and Git, an open 
source software development system used by millions of software 
engineers globally.
    Second, is the development of the very Internet protocols that have 
given rise to the tremendous job and economic growth and consumer 
utility that we all currently enjoy from existing digital services. 
These protocols--which include, for example, SMTP (the protocol for 
email transmission), HTTP (the protocol to exchange structured text on 
the Internet) and TCP/IP (the protocol for end-to-end data 
communication)--derived largely from academic or government-funded 
efforts and have been maintained in most cases by communities of 
academics and developers. They are ``open'' protocols in the sense that 
they are the well-established foundations on which many very exciting 
for-profit businesses have been built (e.g., Facebook, Amazon, Google), 
knowing that the protocols themselves cannot be changed by a 
centralized corporation.
Why should we care about this?
    Because as the history of the Internet has shown us, open protocols 
that are well-built and well-maintained can become the building blocks 
on which massive consumer utility and economic growth can be built.
    And why is that? Because for-profit enterprises are willing to take 
on all of the market risks of building a new company--and venture 
capitalists are willing to provide the funding for such endeavors--when 
they know that the foundations on which they are taking that risk 
cannot be changed at the whim of a centralized corporation.
    In contrast, the technology world is also riddled with startup 
companies that have failed as a result of having taken on platform risk 
that depends on the rules of the road as defined by centralized, for-
profit platforms (in contrast to open protocols). That's not because 
centralized, for-profit platforms are inherently bad, but rather 
because over time their economic incentives require that to remain 
viable as independent businesses they capture more of the gains 
associated with their proprietary platforms, often causing them to 
change the nature of the relationships they once encouraged with other 
companies who were in fact building on and improving their platform.
What does any of this have to do with crypto-networks?
    As we noted previously, crypto-networks enable a new way for 
innovative developers to create new digital services without the 
attendant risk of building on centralized platforms. In many ways, 
crypto-networks borrow from the nearly fifty years of history in the 
technology industry that enabled the initial Internet protocol 
development and the open source movement; that is, the idea that 
communities of developers can share their work openly and properly 
govern a network without centralized authority. As my partner, Chris 
Dixon, has written about, crypto-networks essentially replace the 
requirement to rely on trust from a centralized corporation with the 
requirement only that you trust the software itself to do what it has 
been built to do (and for which the fundamental code is open sourced 
for you to confirm on your own).
    But, at the same time, crypto-networks introduce a very powerful 
economic incentive that did not previously exist in the development of 
prior technologies--the presence of a token that creates a direct 
financial incentive for the community members to in fact develop and 
govern the networks appropriately. ``Tokens'' in the crypto-networks 
world perform a series of functions: (i) they are the method of value 
exchange between network participants--that is, consumers ``pay'' for 
services using the token and sellers ``receive'' tokens in exchange for 
the services and (ii) they provide the financial incentive to reward 
developers and other maintainers of the network--that is, people may 
receive tokens for ensuring the authenticity of the transactions 
completed on the network.
The Importance of Regulation in Crypto-networks
    Thus, the token plays a very important role in the functioning of 
crypto-networks--it is the glue that binds the various players and 
provides the appropriate economic incentives for all market 
participants. And, recall that because all of the software in these 
networks is open sourced, meaning that anyone who wants to create a 
competing network can simply take all of the existing software and 
stand-up a rival network, the competitive incentives for the market 
participants are designed to be fair and responsive to the user 
community.
    But, the token itself and the decentralized nature of many of these 
networks create a new set of challenges for regulators.
    I want to first be very clear that we believe appropriate 
regulation in crypto-networks is very important and we welcome the 
opportunity to work with you, other Members of the House and Senate and 
the various agencies who are interested in creating a regulatory 
framework that both encourages innovation and protects consumers and 
well-functioning capital markets. There is an important role for the 
regulatory community to play and we believe that role is one of the 
reasons why the U.S. has long been a leader in the commercial 
development of so many breakthrough technologies.
    In fact, the work that CFTC Chairman Giancarlo has done in setting 
up LabCFTC is a great example of how the regulatory community is trying 
hard to balance the needs of encouraging technological innovation with 
those of protecting consumers. Such collaborative engagement between 
regulators and innovators is precisely the type of activity that is 
required in such fastmoving markets as are crypto-network-related 
activities. Thank you as a Committee for your support and sponsorship 
in these initiatives.
    Consistent with recent statements from the Director of Corporate 
Finance at the SEC, we believe that the regulatory nature of crypto-
networks varies with the stage of development of a particular project. 
Briefly, if a centralized sponsor is seeking to raise capital from 
investors prior to the functional realization of the network itself, 
the contract between the sponsor and investor is likely an ``investment 
contract'' and thus properly regulated under the U.S. securities laws 
by the SEC. The nature of the to-be-delivered tokens under that 
contract, however, may not be securities; they need to be evaluated 
using the same Howey test as do all potential securities.
    As stated by the CFTC, some tokens are not securities. Once the 
network is functional and, in particular in cases where the network is 
decentralized, we believe that the nature of the tokens looks more like 
commodities than securities. This is because there is no centralized 
sponsor on whose efforts the value of the token is largely dependent. 
Rather, the tokens will have value that represents the utility of the 
service to its participants; the value will not be derived from the 
coordinated activities of a centralized sponsor.
    Obviously, these are not easy determinations and will require the 
efforts of this Committee, among others, and the various regulatory 
agencies. But, we believe this framework is consistent with early 
pronouncements from both the SEC and the CFTC.
    Regardless of the jurisdictional boundaries, we believe that 
investor protection, well-functioning capital markets and support for 
innovation should be the hallmark of the regulatory focus.
Summary
    In summary, I would offer the Committee the following observations:

   The U.S. has long been a leader in technology, in large part 
        due to a favorable regulatory and financial environment that 
        has fostered risk taking and innovation.

   While we have enjoyed the fruits of this innovation in the 
        form of economic growth, job growth and consumer utility 
        stemming from many of the great technology companies of our 
        time, we believe that crypto-networks presents a new and 
        exciting opportunity for us to continue on that trajectory.

   This is why you see venture capitalists and other financial 
        professionals increasing their investment focus in this area. 
        Just like other areas of technology development, our job is to 
        provide risk capital to the areas of innovation that we believe 
        can support long-term, self-sustaining enterprises. We believe 
        crypto-networks is one such area.

   But, to ensure that the U.S. continues to be the favored 
        haven for such technological innovation, we need to develop a 
        regulatory framework that encourages risk-taking and capital 
        formation, provides clarity and certainty to market 
        participants and protects individual investors and the 
        integrity of the markets.

    I thank you for your time and look forward to the opportunity to 
work with the Committee on this important topic.

    The Chairman. Thank you, Mr. Kupor.
    Mr. Gorfine, 5 minutes.

     STATEMENT OF DANIEL GORFINE, J.D., DIRECTOR AND CHIEF 
    INNOVATION OFFICER, LabCFTC, COMMODITY FUTURES TRADING 
                  COMMISSION, WASHINGTON, D.C.

    Mr. Gorfine. Thank you, Chairman Conaway, Ranking Member 
Peterson, and Members of the Committee for the opportunity to 
testify before you today. I am Chief Innovation Officer and 
Director of LabCFTC at the U.S. Commodity Futures Trading 
Commission. The testimony presented here reflects my own views 
and does not necessarily reflect the opinions or the view of 
the Chairman or the Commission.
    In May of last year, Chairman Giancarlo announced with 
bipartisan Commission support the launch of LabCFTC, the 
agency's effort to help create a model for regulatory 
engagement and modernization in light of the ongoing 
digitization of our markets. Its mission is to facilitate 
market enhancing innovation, inform policy, and ensure that we 
have the technological and regulatory tools and understanding 
to keep pace with inevitable change. The building blocks of our 
effort are engagement, testing and experimentation, and 
education.
    Shifting to the primary topic of today's hearing, we are 
interested in both private or permission-distributed ledger 
technologies that can improve market infrastructure and in 
public blockchains that require the use of a virtual currency. 
Developments across this spectrum have society rethinking the 
nature of money, how people transact, and how we can more 
efficiently engage in regulatory, economic, and market 
activity.
    With respect to public blockchains, proponents note that 
they unlock digital scarcity, enable efficient transfer of 
ownership, and power the execution of applications, and all of 
this can be done without the need for a trusted central 
intermediary that was traditionally needed to verify that each 
party has and does what it promises. Many, however, 
appropriately worry that virtual currencies and tokens may be 
used for illegal activities and are prone to fraud, manias, and 
bubbles driven by potential misunderstandings and myths 
regarding their scalability, utility, and intrinsic value.
    With recent hype around this space, there has also been a 
proliferation of ICOs, which may be intended to raise capital 
for a venture and may bear the hallmarks of a securities 
offering. Our colleagues at the SEC have been thoughtfully 
addressing related challenges, and providing additional clarity 
to the marketplace. And from the CFTC's perspective, given the 
potential to tokenize a broad range of economic assets, it is 
important to remind the public that digital assets can also be 
commodities or derivatives, depending on their terms and how 
they are structured.
    Given the potential and the challenges of this space, 
Chairman Giancarlo has made clear that the proper response by 
regulators is not to dismiss the entire movement as misguided 
or foolish, but rather, to take the time to learn, facilitate 
the promise, and guard against risks and bad actors. As part of 
this effort, LabCFTC published its first FinTech primer on the 
topic of virtual currencies in October 2017. The primer 
explains that the agency determined in 2015 that certain 
virtual currencies, such as Bitcoin, are commodities and 
therefore implicate our jurisdiction. The CFTC has regulatory 
oversight authority over futures and swaps markets based on 
commodities, and then has anti-fraud and manipulation 
enforcement authority over these and the underlying commodity 
markets. It is important to note, however, that we do not have 
oversight authority over these underlying markets. Additional 
details regarding CFTC oversight of crypto-related markets and 
enforcement and education efforts since the self-certification 
of Bitcoin futures in December 2017 can be found in my written 
testimony.
    Moving forward, one thing is certain. None of us are able 
to predict exactly where this innovation is heading. It is 
accordingly incumbent upon us as a 21st century regulator to 
continue studying, learning, and keeping pace with change. We 
look forward to ongoing close collaboration with our regulatory 
peers, including through the FSOC digital asset working group. 
We all have the shared goal to educate market participants, 
target bad actors, and ensure an efficient and effective 
regulatory framework. We are also focused on bringing clarity 
and certainty to the market, but need to be sure that we are 
thoughtful in our approach and do not steer or impede the 
development of this area of innovation.
    While some may seek the immediate establishment of bright 
lines, the reality is that hasty regulatory pronouncements are 
likely to miss the mark, have unintended consequences, or fail 
to capture important nuance regarding the structure of new 
products.
    In the late 1990s during the early days of the Internet, 
senior government policy advisor Ira Magaziner made the 
following observation, that given ``the breakneck speed of 
change and technology, the government attempts to regulate are 
likely to be outmoded by the time they are finally enacted.'' 
Given this dynamic, the government largely avoided a 
prescriptive approach in favor of principles, focused on 
educating and empowering law enforcement, and allowed this area 
of innovation time and space to develop all while maintaining 
the ability and careful vigilance to act to ensure market 
integrity. This approach generally seems like the right one 
when dealing with new technologies, which are largely agnostic 
as to how they are used. The role of the regulator is to 
facilitate use of new technologies that can benefit markets and 
the public more broadly, while deterring and pursuing those who 
seek to use technology to do harm.
    Thank you, and I am happy to answer any questions you may 
have.
    [The prepared statement of Mr. Gorfine follows:]

    Prepared Statement of Daniel Gorfine, J.D., Director and Chief 
  Innovation Officer, LabCFTC, Commodity Futures Trading Commission, 
                            Washington, D.C.
    Thank you Chairman Conaway, Ranking Member Peterson, and Members of 
the Committee for the opportunity to testify before you today on 
FinTech innovation, Blockchain, and new assets in the digital age. I am 
Chief Innovation Officer and Director of LabCFTC at the U.S. Commodity 
Futures Trading Commission (CFTC). The testimony presented here 
reflects my own views and does not necessarily reflect the opinions or 
views of the Chairman, Commissioners, or the Commission.
    The mission of the CFTC is to foster open, transparent, 
competitive, and financially sound markets.\1\ The agency oversees 
markets vital to supporting the transfer of risk between market 
participants and by extension to the stability and reliability of real-
world economic activity, ranging from the production and provision of 
gasoline for our cars, to the availability of credit for our purchases, 
and the offering of produce in our grocery stores.\2\
---------------------------------------------------------------------------
    \1\ See CFTC Mission Statement, Commodity Futures Trading 
Commission http://www.cftc.gov/About/MissionResponsibilities/index.htm 
(last visited July 16, 2018).
    \2\ Many of my introductory remarks here derive from my prior 
publication: See Daniel Gorfine, FinTech Innovation: Building a 21st 
Century Regulator, Georgetown University Law Center Institute for 
International Economic Law (IIEL), Issue Brief 11/2017 (November 2017), 
https://www.law.georgetown.edu/iiel/wp-content/uploads/sites/8/2018/01/
LabCFTC-Chris-Brummer-Dan-Gorfine-IIEL-Issue-Brief-November-2017-
Accessible.pdf; see generally, Bruce Tuckman, Derivatives: 
Understanding Their Usefulness and Their Role in the Financial Crisis, 
J. of Applied Corp. Fin. Vol. 28, No. 1 (Winter 2016).
---------------------------------------------------------------------------
    As one might expect, the agency's work has always included a focus 
on agricultural products like wheat and corn, and even precious metals. 
It is worth asking how do we now find ourselves here making the jump 
from traditional commodities and risk transfer to FinTech topics like 
DLT and Bitcoin?
    The answer is that our financial markets are fast-evolving due to 
technology-driven innovation and this has changed the way market 
participants interact, trades are formulated and processed, risk is 
assessed and hedged, and business operations are executed. No longer do 
market participants rely on face to face interactions and telephones. 
Instead, markets have become increasingly electronic, digital, and 
interconnected. This new world in turn creates new market and 
regulatory opportunities, challenges, and risks.
    Much of this dynamic derives from three identifiable threads around 
FinTech innovation. The first centers on speed, both in terms of 
innovation and subsequent adoption. The speed phenomenon derives from 
the profound impact of increased computing power in the development of 
products, services, and markets, and the Internet in their adoption. 
The concept of Moore's Law \3\--which roughly suggests that computing 
power will expand exponentially over time--has allowed for the 
development of increasingly powerful, and low cost, computer systems 
that enable rapid iteration and development of new business models, as 
well as the capability to do more with increasingly available data. 
This means that markets and regulators are faced with a constant 
barrage of innovations and not much time to grasp their implications 
before interconnected computers permit their ready adoption.
---------------------------------------------------------------------------
    \3\ See Harald Bauer, et al., Moore's Law: Repeal or Renewal?, 
McKinsey & Company (December 2013), http://www.mckinsey.com/insights/
high_tech_telecoms_internet/moores_law_repeal_or_
renewal.
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    The second is that innovation largely seeks to either 
disintermediate traditional gatekeepers or change the way they operate. 
Current financial regulatory frameworks are centered on the 
intermediaries or gatekeepers that manage the access to our markets or 
financial services activity. To the extent that innovators are seeking 
to disintermediate or substantially transform traditional models in 
order to increase efficiencies, regulators will need to proactively 
identify how rules and regulations conform or will need to change.
    Finally, the increasing complexity of technology-driven business 
models requires significantly more focus on technological literacy at 
all levels of leadership, including within business and government. It 
is simply not enough to all agree to high level platitudes that items 
like cybersecurity are of great importance--instead it is imperative 
that we have deep understanding of the details of security protection 
in order to avoid bad outcomes, including cyber breaches. Indeed, I 
would suggest that a key emerging risk in our markets is a potential 
lack of required literacy in the face of increasingly technology-driven 
business models and processes.
LabCFTC: Building a 21st Century Regulator
    Given these market dynamics, and related emerging regulatory 
challenges, we believe thoughtful 21st century regulatory approaches 
are needed. This is why last summer, CFTC Chairman Chris Giancarlo 
announced with bipartisan Commission support the launch of LabCFTC.\4\
---------------------------------------------------------------------------
    \4\ Address of J. Christopher Giancarlo to the New York FinTech 
Innovation Lab, ``LabCFTC: Engaging Innovators in Digital Financial 
Markets,'' (May 17, 2017) Commodity Futures Trading Commission, http://
www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-23.
---------------------------------------------------------------------------
    LabCFTC is the CFTC's effort to help create a replicable model for 
regulatory engagement and modernization. The mission of LabCFTC is to 
facilitate market-enhancing innovation, inform policy, and ensure we 
have the technological and regulatory tools and understanding to keep 
pace with changes to our markets. LabCFTC was launched out of our 
Office of General Counsel so that it can leverage its deep bench of 
expertise to help manage the interface between technological engagement 
and innovation, regulatory modernization, and existing rules and 
regulations.
    The building blocks of the effort are engagement, testing and 
experimentation, education, and collaboration. The core LabCFTC team 
works closely with subject matter experts from the Agency's operating 
divisions, who form the LabCFTC liaison network. Through this approach, 
we can gain a better understanding of emerging risks, technologies, and 
trends, modernize our regulatory tools and operations, engage with 
innovators early in the development of new business models, and support 
better informed policymaking that facilitates market-enhancing 
innovation.
    The effort seeks to involve both internal and external stakeholders 
through three primary work streams. First, `Guide Point' provides a 
dedicated point of contact for FinTech innovators to engage with the 
CFTC, learn about the CFTC's regulatory framework, and obtain feedback. 
Such feedback and discourse may provide innovators with valuable 
information that can help them save time and resources, or allow for 
the identification of potential friction or uncertainty in existing 
rules.
    Since the beginning of its formation, LabCFTC has met with 
approximately 200 organizations and discussed a range of technology-
related issues, including those involving machine learning and 
artificial intelligence, DLT and capital markets infrastructure, 
virtual currencies, smart contracts, RegTech, cloud, and algorithmic 
trading. LabCFTC `office hour' meetings have been held in Silicon 
Valley, Chicago, New York, Boston, and Washington, D.C. And in response 
to common questions raised through these sessions, LabCFTC published 
its first FinTech educational primer in October 2017. The primer, 
leveraging a format which will be applied to a range of innovations 
going forward, involved discussion of technology use-cases, CFTC 
jurisdiction, and potential risks and challenges.
    Second, `CFTC 2.0' fosters the testing, understanding, and 
potential adoption of new technologies that can improve markets or make 
the Commission a more effective and efficient regulator. We are 
currently crowdsourcing ideas for future innovation competitions,\5\ 
which may involve, for example, novel ways to visualize CFTC published 
data, develop market surveillance tools, make our rules more readily 
machine-readable, or build a more dynamic, digital, and ``smart'' 
notice-and-comment platform.
---------------------------------------------------------------------------
    \5\ CFTC Asks Innovators for Competition Ideas to Advance FinTech 
Solutions, (Apr. 24, 2018) Commodity Futures Trading Commission, 
https://cftc.gov/PressRoom/PressReleases/7717-18.
---------------------------------------------------------------------------
    We further believe that it is through developing proofs of concept 
and truly kicking the tires on new innovations that agency staff can 
properly understand the application of new technologies, which will 
subsequently drive more informed policymaking and technology 
strategies. In some instances, existing law may be an obstacle to 
participation in this type of testing, research, and proofs of concept. 
For this reason, the Chairman appreciates the current efforts of 
Members of this Committee to suggest ways to provide the CFTC with the 
authority to fully engage with, research, and test emerging 
technologies.\6\
---------------------------------------------------------------------------
    \6\ See, e.g., Commodity Futures Trading Commission Research and 
Development Modernization, H.R. 6121, 115th Cong. (2018), https://
www.congress.gov/bill/115th-congress/house-bill/6121/text?r=1.
---------------------------------------------------------------------------
    Finally, `DigitalReg' is designed to support the Commission's 
effort to build a 21st century regulator and regulatory approach. 
Internally, DigitalReg serves as a CFTC-wide resource to help inform 
the Commission and staff on FinTech-related developments. Externally, 
DigitalReg acts as a hub to help the Commission collaborate with other 
U.S. and international regulatory authorities in order to share best 
practices around FinTech engagement. We were accordingly pleased 
earlier this year to enter into a CFTC-first FinTech cooperation 
arrangement with the UK's Financial Conduct Authority (FCA),\7\ and 
look forward to ongoing constructive engagement with our domestic and 
international regulatory peers.
---------------------------------------------------------------------------
    \7\ U.S. CFTC and UK FCA Sign Arrangement to Collaborate on FinTech 
Innovation, Commodity Futures Trading Commission, (Feb. 19, 2018) 
https://www.cftc.gov/PressRoom/PressReleases/pr7698-18.
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DLT, Blockchain, and Digital Assets
    The topics of DLT, blockchain, and digital assets \8\ have been 
prominent areas of engagement and exploration for the CFTC over the 
past year. When LabCFTC views the space, we are interested both in 
private or permissioned ledger networks (also sometimes considered 
``blockchain-inspired'' technologies) that can be deployed by market 
participants to improve market infrastructure and in public blockchains 
that require use of a virtual currency to incentivize participation in 
maintaining the ledger system.
---------------------------------------------------------------------------
    \8\ `Digital assets' is a broad category that includes `virtual 
currencies' or `cryptocurrencies.' For purposes of this testimony and 
consistent with CFTC past use, I use the term `virtual currencies.'
---------------------------------------------------------------------------
    Developments across this spectrum have society re-thinking the 
nature of money, how people transact, and how we can more efficiently 
engage in regulatory, economic, and market activity.
    On the private or permissioned side of the spectrum, new 
innovations hold promise in improving clearing and settlement 
processes, facilitating regulatory reporting and compliance, and even 
transforming information capture, delivery, and analytics capabilities. 
The CFTC is also very interested in better understanding their 
potential ability to power smart (or self-executing) contracts, which 
can incorporate compliance provisions and potentially decrease 
execution risks. To be clear, however, this area of innovation is quite 
distinct from the realm of public distributed ledgers and virtual 
currencies, and has its own unique set of challenges including around 
security, scalability, and broader adoption.\9\
---------------------------------------------------------------------------
    \9\ CFTC Primer on Virtual Currencies. Commodities Future Trading 
Commission, (Oct. 17, 2017), http://www.cftc.gov/idc/groups/public/
documents/file/labcftc_primercurrencies
100417.pdf (hereinafter ``LabCFTC Primer'').
---------------------------------------------------------------------------
    On the public distributed ledger side of the spectrum, it may be 
helpful to level-set. Virtual currencies are a digital representation 
of value and may function as a medium of exchange, a unit of account, 
and/or a store of value. Virtual currencies generally run on a 
decentralized peer-to-peer network of computers, which rely on certain 
network participants to validate and log transactions on a permanent 
public distributed ledger visible to all. The virtual currency serves 
as the required incentive for miners or validators.\10\
---------------------------------------------------------------------------
    \10\ See generally LabCFTC Primer.
---------------------------------------------------------------------------
    Proponents note that these virtual ecosystems unlock digital 
scarcity, enable the efficient transfer of ownership, and power the 
execution of relatively autonomous application platforms all without 
the need for a trusted, central party that was traditionally needed to 
verify that each party to a transaction has--and does--what it 
promises.\11\ In addition to providing new ways to transact over the 
Internet, these advancements could allow for decentralized platforms or 
applications that provide consumers with desired goods and services 
absent a central gatekeeper.\12\ Some further note the potential 
inspiration that virtual currencies may provide Central Banks in the 
future creation of digital fiat currencies.\13\
---------------------------------------------------------------------------
    \11\ See Jerry Brito, Executive Director, Coin Center before the 
New Jersey Assembly Financial Institutions and Insurance Committee 
Hearing on digital Currency, Coin Center (Feb. 5, 2015) https://
coincenter.org/wp-content/uploads/2015/02/
NewJerseyLegislatureWrittenTestimony.pdf.
    \12\ Steven Johnson, Beyond the Bitcoin Bubble, New York Times, 
(Jan. 16, 2018) https://www.nytimes.com/2018/01/16/magazine/beyond-the-
bitcoin-bubble.html.
    \13\ Qin Chen, Next Stop in the Cryptocurrency Craze: A Government-
Backed Coin, Consumer News and Business Channel, (Dec. 29, 2017) 
https://www.cnbc.com/2017/11/29/federal-reserve-starting-to-think-
about-its-own-digital-currency-dudley-says.html.
---------------------------------------------------------------------------
    Many, however, appropriately worry that virtual currencies and 
tokens are prone to fraud, manias, and bubbles driven by 
misunderstandings and myths regarding their scalability, utility, and 
intrinsic value.\14\ Indeed, over time bad actors have commonly invoked 
the concept of innovation in order to engage in fraudulent activities 
that target the general public.\15\ Additionally, as we are reminded by 
recent events,\16\ concerns regarding the use of cryptocurrencies to 
facilitate illegal activity are well-founded and require government 
efforts to ensure that Anti-Money Laundering (AML) and Know Your 
Customer (KYC) requirements are effectively applied.
---------------------------------------------------------------------------
    \14\ CFTC Customer Advisory: Use Caution When Buying Digital Coins 
or Tokens, Commodity Futures Trading Commission, (July 16, 2018), 
https://www.cftc.gov/PressRoom/PressReleases/; see also Shane Shifflett 
& Coulter Jones, Buyer Beware: Hundreds of Bitcoin Wannabes Show 
Hallmarks of Fraud, Wall Street Journal (May 17, 2018) https://
www.wsj.com/articles/buyer-beware-hundreds-of-bitcoin-wannabes-show-
hallmarks-of-fraud-1526573115; Angela Monaghan, Bitcoin Biggest Bubble 
in History, says Economist who Predicted 2008 Crash, The Guardian, 
(Feb. 2, 2018) https://www.theguardian.com/technology/2018/feb/02/
bitcoin-biggest-bubble-in-history-says-economist-who-predicted-2008-
crash.
    \15\ CFTC Charges Nicholas Gelfman and Gelfman Blueprint, Inc. with 
Fraudulent Solicitation, Misappropriation, and Issuing False Account 
Statements in Bitcoin Ponzi Scheme, Commodities Futures Trading 
Commission (Sept. 21, 2017) https://www.cftc.gov/PressRoom/
PressReleases/pr7614-17.
    \16\ Gabriel T. Rubin, How Bitcoin Fueled Russian Hacks, Wall 
Street Journal (July 13, 2018), https://www.wsj.com/articles/how-
bitcoin-fueled-alleged-russian-hacks-1531517907.
---------------------------------------------------------------------------
    With recent hype around virtual coins and tokens there has also 
been a proliferation of so-called ``Initial Coin Offerings'' or ICOs, 
which frequently refers to the sale of virtual tokens to the public 
that are intended to raise capital for a venture and may bear the 
hallmarks of a securities offering.\17\ Our colleagues at the 
Securities and Exchange Commission (SEC) have been thoughtfully 
addressing related challenges,\18\ and providing additional clarity to 
the marketplace.\19\ And from the CFTC's perspective, given the 
potential to tokenize a broad range of economic assets, it is important 
to remind the public that digital assets can also be derivatives or 
commodities, depending on their terms and how they are structured.
---------------------------------------------------------------------------
    \17\ Jay Clayton & J. Christopher Giancarlo, Regulators Are Looking 
at Cryptocurrency, Wall Street Journal, (Jan. 24, 2018). https://
www.wsj.com/articles/regulators-are-looking-at-cryptocurrency-
1516836363.
    \18\ The SEC Has an Opportunity You Won't Want to Miss: Act Now!, 
(May 16, 2018) Securities And Exchange Commission, https://www.sec.gov/
news/press-release/2018-88; see also Pre-ICO Sale is Live, Howeycoins 
(2018), available at https://www.howeycoins.com/index.html; Investor 
Bulletin: Initial Coin Offerings, Securities and Exchange Commission 
(July 25, 2017). https://www.sec.gov/oiea/investor-alerts-and-
bulletins/ib_coinofferings.
    \19\ William Hinman, Director of the Division of Corporation 
Finance, Director Digital Asset Transactions: When Howey Met Gary 
(Plastic), Yahoo Finance All Markets Summit: Crypto, San Francisco, CA, 
Securities and Exchange Commission (June 14, 2018) https://www.sec.gov/
news/speech/speech-hinman-061418.
---------------------------------------------------------------------------
    Given the potential and challenges of this space, CFTC Chairman 
Giancarlo has made clear that the proper response by regulators and 
policymakers is not to dismiss the entire movement as misguided or 
foolish, but rather to take the time to learn, facilitate the promise, 
and guard against risks and bad actors.\20\
---------------------------------------------------------------------------
    \20\ Written Testimony of Chairman J. Christopher Giancarlo before 
the Senate Banking Committee, Washington, D.C., Commodity Futures 
Trading Commission (Feb. 6, 2018) https://www.cftc.gov/PressRoom/
SpeechesTestimony/opagiancarlo37; see also Testimony of Chairman J. 
Christopher Giancarlo before the Senate Committee On Appropriations 
Subcommittee on Financial Services and General Government, Washington, 
D.C. Commodity Futures Trading Commission (June 5, 2018) https://
www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo47.
---------------------------------------------------------------------------
    As part of this effort, LabCFTC published its first FinTech primer 
on the topic of virtual currencies in October 2017.\21\ The goal of the 
primer was to help educate the public about potential use-cases of the 
technology, CFTC jurisdictional considerations, and relevant risks, 
including around investment speculation, cybersecurity, and platform 
operations.
---------------------------------------------------------------------------
    \21\ CFTC's LabCFTC Releases Primer on Virtual Currencies Commodity 
Futures Trading Commission (Oct. 17, 2017), https://www.cftc.gov/
PressRoom/PressReleases/7631-17.
---------------------------------------------------------------------------
    After the self-certification and launch of Bitcoin futures in 
December 2017, LabCFTC was then able to continue providing support in 
the areas outlined below to the Commission and operating divisions 
based on our engagement and study of DLT and virtual currencies.
Digital Assets and CFTC Jurisdiction
    In 2015, the Commission determined that certain virtual currencies, 
such as Bitcoin, met the definition of ``commodity'' under the 
Commodity Exchange Act (CEA). This means that the CFTC's jurisdiction 
is implicated from an oversight perspective if a commodity-based future 
or swaps product is offered to the market and from an enforcement 
perspective if there is fraud or manipulation involving such products 
or their underlying commodity markets.
    In December 2017, two CFTC regulated futures exchanges self-
certified and launched Bitcoin futures products.\22\ Under the CEA and 
Commission regulations and related guidance, futures exchanges may 
self-certify new products on twenty-four hour notice prior to trading. 
This type of framework encourages market-driven innovation and has made 
America's listed futures markets the envy of the world. Both CME and 
CBOE worked with the CFTC for months before launching Bitcoin futures 
in December 2017. As detailed in our Chairman's prior Congressional 
testimony, due to the complexity of issue, the CFTC conducted a 
``heightened review'' of CME's and CBOE's responsibilities.
---------------------------------------------------------------------------
    \22\ The following discussion is largely based on: J. Christopher 
Giancarlo Testimony Before the U.S. Senate Agriculture, Nutrition, and 
Forestry Committee (Feb. 15, 2018), Commodity Futures Trading 
Commission https://www.cftc.gov/PressRoom/SpeechesTestimony/
opagiancarlo38.
---------------------------------------------------------------------------
    Chairman Giancarlo has outlined six elements regarding CFTC 
oversight of the virtual currency-related futures and swaps markets. 
These elements include: (1) staff competency; (2) consumer education 
through our Office of Customer Education and Outreach; (3) interagency 
cooperation including with the SEC, the Department of Treasury's 
Financial Crimes Enforcement Network known as FinCEN, and through the 
Financial Services Oversight Council (FSOC); (4) CFTC exercise of its 
regulatory oversight authority; (5) strong enforcement efforts to deter 
and prevent fraud and manipulation; and (6) heightened review of 
virtual currency-related product self-certifications.
    With respect to heightened review, in May of this year, our 
Division of Market Oversight and Division of Clearing and Risk issued a 
joint staff advisory that gives exchanges and clearinghouses registered 
with the CFTC guidance for listing virtual currency derivative 
products. The advisory highlights key areas that require particular 
attention in the context of listing a new virtual currency derivatives 
contract, including: enhanced market surveillance; close coordination 
with CFTC staff; large trader reporting; outreach to member and market 
participants; and, Derivatives Clearing Organization risk management 
and governance.
    Commission staff further noted at the time that since the Agency 
found virtual currencies such as Bitcoin to be commodities in 2015, it 
has taken action against unregistered Bitcoin futures exchanges; 
enforced the laws prohibiting wash trading and prearranged trades on a 
derivatives platform; issued proposed guidance on what is a derivative 
market and what is a spot market in the virtual currency context 
through an interpretation of `actual delivery' \23\; issued warnings 
about valuations and volatility in spot virtual currency markets; and, 
addressed a virtual currency Ponzi scheme.
---------------------------------------------------------------------------
    \23\ CFTC Issues Proposed Interpretation on Virtual Currency 
``Actual Delivery'' in Retail Transactions, Commodity Futures Trading 
Commission (Dec. 15, 2017), https://www.cftc.gov/PressRoom/
PressReleases/7664-17.
---------------------------------------------------------------------------
    On the topic of enforcement, it is worth mentioning that the CFTC 
is working closely with the SEC and other fellow financial enforcement 
agencies to aggressively prosecute bad actors that engage in fraud and 
manipulation regarding virtual currencies. The more cops we can have on 
the beat, the better.
Moving Forward
    One thing is certain: none of us are able to predict exactly where 
innovation is heading, and, accordingly, it is incumbent on us as a 
21st century regulator to continue studying, learning, and keeping pace 
with change. For our part, LabCFTC looks forward to ongoing engagement 
with a broad range of innovators, including the likes of those on 
today's panel, to be sure we are skating to where the puck is heading. 
We can best facilitate market-enhancing innovation and ensure sound 
policy through sound understanding.
    Additionally, we look forward to ongoing close collaboration with 
our regulatory peers, including through the FSOC digital asset working 
group spearheaded by our colleagues at the Treasury Department. We all 
have the shared goal to bring clarity and certainty to the market, but 
also need to be sure that we are thoughtful in our approach and do not 
steer or impede the development of this area of innovation. Indeed, 
while some may seek the immediate establishment of bright lines, the 
reality is that hasty regulatory pronouncements are likely to miss the 
mark, have unintended consequences, or fail to capture important nuance 
regarding the structure of new products or models.
    In thinking about the future of a broad range of emerging 
technologies, it is perhaps informative to harken back to the policy 
approach that helped facilitate the development of the Internet and the 
rise of new Internet-based business models. Noting the rapid pace of 
innovation and technological transformation, then senior policy adviser 
Ira Magaziner stated in 1997 that given ``the breakneck speed of change 
in [] technology . . . [g]overnment attempts to regulate are likely to 
be outmoded by the time they are finally enacted.'' \24\
---------------------------------------------------------------------------
    \24\ Steve Lohr, Policing the Internet: Anyone But Government, New 
York Times (Feb. 20, 2000), https://www.nytimes.com/2000/02/20/
weekinreview/ideas-trends-policing-the-Internet-anyone-but-
government.html?nytmobile=0&pagewanted=print&src=pm&referer=.
---------------------------------------------------------------------------
    Given this dynamic, the government largely avoided a prescriptive 
approach in favor of principles, focused on educating and empowering 
law enforcement to target bad actors, and allowed this area of 
innovation time and space to develop, all while maintaining the ability 
and vigilance to act to ensure market integrity. While particular areas 
of innovation may require different treatment, generally this approach 
seems like the right one when dealing with new technologies, which are, 
of course, agnostic as to their use. The role of the regulator is to 
facilitate the use of new technologies that benefit markets and the 
public more broadly, while deterring and pursuing those who seek to use 
technology to do harm.
    Thank you. I am happy to answer any questions that you have.

    The Chairman. Thank you, Mr. Gorfine.
    Mr. Gensler, 5 minutes.

 STATEMENT OF HON. GARY GENSLER, SENIOR LECTURER, SLOAN SCHOOL 
                  OF MANAGEMENT, MASSACHUSETTS
         INSTITUTE OF TECHNOLOGY; SENIOR ADVISOR TO THE
          DIRECTOR, MIT MEDIA LAB, BROOKLANDVILLE, MD

    Mr. Gensler. Thank you. Good morning, Chairman Conaway, 
Ranking Member Peterson. My condolences on your dad's passing. 
It is good to be with you all here today. I have testified in 
front of you a dozen or two dozen times in some previous 
capacities, but since I was last with you, I took on a new role 
at MIT where I am engaged, yes, in researching, teaching, 
lecturing, and advising on digital currency and blockchain 
technology. Now I say that, but for those who don't know 
because some are new, I also chaired the Commodity Futures 
Trading Commission for 4 or 5 years, and before that, long ago, 
I was 18 years at Goldman Sachs. I bring from my years in 
finance, my years in public policy, and now, I guess, as an 
academic, some perspective of what I have learned. And with the 
Chairman's permission, one thing I have learned as an academic 
is to ask the audience a little bit about their engagement in 
Bitcoin. Again, with the Chairman's permission, if I could just 
ask, how many Members of this Committee have invested in 
cryptocurrencies? And I am going to ask the audience, too.
    The Chairman. By show of hands?
    Mr. Gensler. We have one. The audience, show of hands?
    The Chairman. Same with the audience.
    Mr. Gensler. Yes, we have about half the audience. That is 
an interesting split. There we go.
    I would say the other thing that splits the community in my 
discussions usually is this is not a community that splits 
normally like right and left, Republican, Democratic. This is a 
community that splits more about Bitcoin maximalist and Bitcoin 
pessimist, or skeptics on one end and by the way, some of those 
skeptics and pessimists are Republicans and some are Democrats. 
Some are Nobel laureates, some are in finance. Whether it is 
Jamie Diamond or Warren Buffett, and then some of the 
maximalists can be adventure capitalists like at Andreessen 
Horowitz and elsewhere. It is interesting the split in the 
community.
    I am probably a little bit center maximalist, if I can say 
that. I am an optimist on the underlying technology. You will 
also hear some people say, ``Well, not that Bitcoin but the 
blockchain technology is good,'' and they kind of split their 
views that way.
    Again, what have I learned? Blockchain technology, I 
believe, has a real potential to transform the world of finance 
because it is about money. It is about moving value on the 
Internet. This new technology could lower costs and risks in 
the financial sector. Second, to reach its potential, I feel 
strongly that for public confidence to reach its potential, we 
need to bring it inside the world that we know, the long held 
public policy frameworks. Now what are those frameworks? 
Congress has a role to play to tinker about with these 
frameworks. I will just say what are our historical frameworks 
about technology and finance: We guard against illicit activity 
like tax evasion or money laundering. We insure for financial 
stability, and we protect investors and consumers. Those are 
the three big ones. We protect against illicit activity, we 
insure for financial stability, and we protect investors. 
Everything else is debatable and we need to adjust the details 
underneath that.
    Third, the SEC and CFTC do have a role to play. Both of 
them have roles to play. They have released numerous notices 
and enforcement actions and so forth; however, there is a lot 
of noncompliance. I mean, there are thousands of entrepreneurs 
out there that probably right now are not complying with SEC 
guidance, and there are fewer that are not complying with CFTC 
guidance, but that is just because the CFTC doesn't have 
oversight of this thing called the initial coin offering 
market, and that is where there is a lot going on. And this 
thing is going large and big. It is about a $250 billion 
market, $\1/4\ trillion is getting some size. I mean, the 
overall capital markets in the world are about $250 trillion or 
$300 trillion, so it is not threatening that. But thousands of 
ICOs have been raised, $20 billion of capital formation. I am 
here to say nearly all of them, I don't know if it is 98 
percent or 97 percent, but nearly all of them are probably 
securities under our securities laws because they are being 
offered in a pre-functional time. This ICO market is rife with 
scams and frauds.
    Fourth, bad actors have figured out how to use this new 
currency. Sometimes it is state actors. We learned last Friday 
it was the alleged, I should say, but the alleged 12 Russian 
spies. Venezuela tried to raise it off of their oil and outrun 
U.S. sanctions policy.
    Fifth, while Federal agencies are engaged, current laws 
apply to this activity, there are gaps. If I can mention a few 
of the gaps. First, I think that there are gaps around the 
crypto-exchanges themselves, either where you can buy and sell. 
Why? Because they are right now being regulated through state 
money transmission laws. This approach, regulating them like 
Western Union or MoneyGram is not satisfactory because crypto-
activity is more complex and it is harder to trace, and it 
doesn't build on top of the traditional banking system. It is 
built on something that we can't see that is out there in other 
countries, like in China and Russia. Second, the crypto-
exchanges lack brokered access. They don't have brokers, so 
there are no brokers, by the way, sending 1099-Bs and my 
detailed testimony says that maybe the IRS should do something 
about that so you can just have reporting of the gains. Third, 
the issuers of securities, the crypto-space, are only slowly 
coming into the SEC remit. This is going to take 2, 3, 4 years 
before the SEC really cleans up this space, can they go faster, 
can we do it right, but it is going to take some time. Fourth, 
crypto-derivatives are being handled by the CFTC. They are 
doing it well, but there are two things that worry me about the 
technology, and one is that the unregulated underlying crypto-
cash market is a mess.
    The corn and wheat markets that you oversee, the gold and 
the oil markets, we have a lot of history. We have some 
confidence about that, and then the CFTC can do their job 
layering over those underlying commodities. The CFTC is 
regulating derivatives, but they are referencing an underlying 
market where it is just, at best, the Wild West and at worst, 
it is pretty bad.
    About that underlying market: The CFTC has general anti-
fraud and anti-manipulation authorities with regard to it, but 
I think that Congress will be debating it. Probably not in this 
Congress, but I suspect in the next session, the next Congress, 
you all will be debating should you give the CFTC additional 
authority, or maybe some other agency. Maybe it will be the 
SEC, somebody else, but the CFTC needs to have additional 
authorities about that underlying what I would call cash 
crypto-market, it is 70 percent of the market. The SEC has 
securities. The CFTC has derivatives. You will want to debate 
whether to do something about the underlying market. And last, 
I think you will need to give them resources along with your 
friends over at the Appropriations Committee, because these 
agencies will need that.
    Thank you.
    [The prepared statement of Mr. Gensler follows:]

Prepared Statement of Hon. Gary Gensler, Senior Lecturer, Sloan School 
of Management, Massachusetts Institute of Technology; Senior Advisor to 
            the Director, MIT Media Lab, Brooklandville, MD
    Good morning, Chairman Conaway, Ranking Member Peterson, and 
Members of the Committee. I thank you for inviting me to testify 
regarding the world of crypto-finance birthed by blockchain technology. 
As is often the case when innovations in finance occur, this 
Committee's oversight of commodities and derivatives markets is 
implicated.
    On a personal note, it is good to be with you once again.
    I'm honored to be testifying in my new role at Massachusetts 
Institute of Technology (MIT), where I am engaged with a talented team 
researching, writing and teaching about digital currency, blockchain 
technology, and the ethics and governance of artificial intelligence. 
As Senior Advisor to the Director, MIT Media Lab and Senior Lecturer, 
MIT Sloan School of Management, I have spoken at numerous regulatory, 
research, or investor conferences related to blockchain technology and 
will be teaching a graduate course this fall entitled `Blockchain & 
Money.' I coauthored of an upcoming Center for Economic Policy 
Research-Geneva Report entitled `The impact of blockchain technology on 
finance: a catalyst for change' (Casey, Crane, Gensler, Johnson, and 
Narula, 2018)
    I also am honored to be Chairman of the Maryland Financial Consumer 
Protection Commission which reports to the General Assembly, Governor 
and Congressional delegation of Maryland about matters related to 
financial consumer protection. We held a public hearing in Annapolis 
last month on cryptocurrencies, initial coin offerings, crypto-
exchanges and other blockchain technologies.\1\
---------------------------------------------------------------------------
    \1\ Maryland Financial Consumer Protection Commission; http://
dls.maryland.gov/policyareas/maryland-financial-consumer-protection-
commission#.
---------------------------------------------------------------------------
    With the benefit of this experience, I would like to share some 
thoughts about blockchain technology and more particularly the public 
policy issues raised by the burgeoning markets for the trading of 
cryptocurrencies, initial coin offerings and other related crypto-
tokens.\2\
---------------------------------------------------------------------------
    \2\ Though the research herein builds upon joint work with 
colleagues, the views expressed are mine alone, and do not represent 
the views of any of my academic colleagues or fellow MD Commissioners. 
I have no financial interest in any digital currency, or any blockchain 
related business.
---------------------------------------------------------------------------
Executive Summary
    Blockchain technology has real potential to transform the world of 
finance. Though there are many technical and commercial challenges yet 
to overcome, I'm an optimist and want to see this new technology 
succeed. It could lower costs, risks and economic rents in the 
financial system.
    To reach this potential and for public confidence, blockchain 
technology and the world of crypto-finance it has birthed has to come 
within the norms of long-established public policy frameworks.
    As with other aspects of finance or other emerging technologies, we 
must guard against illicit activities, such as tax evasion, money 
laundering, terrorism finance and avoiding sanctions regimes. We must 
continue to ensure financial stability. And we must ensure investors 
and consumers are protected.
    As things currently are, though, there is significant non-
compliance with respect to many initial coin offerings (ICOs), other 
crypto-assets and crypto-exchanges.
    The question then is how do the crypto-finance markets, this new 
technology, Congress and regulators go forward? While many U.S. 
agencies are engaged, and current laws clearly cover much of this new 
activity, there may be gaps to consider.
    To date, crypto-exchanges and digital wallet providers generally 
have not been registering as banks, exchanges, broker dealers or 
futures commission merchants. This leaves the only regulatory 
safeguards--to guard against illicit activity and protect investors--to 
state-administered money transmission regulations. This approach--
regulating exchanges' duties in the same manner that Western Union and 
MoneyGram are regulated--is not satisfactory. Illicit activity is hard 
to track, billions of dollars have been lost to hacks, and manipulative 
behavior is unchecked.
    Crypto activities are more complex, inherently harder to monitor 
and less traceable than straightforward money transfers. Crypto 
exchanges and digital wallet providers lack the same natural 
connections to the regulated banking system that money transmission 
companies have when transferring fiat currencies. Regulated banks help 
protect customers funds by compliance with the bank secrecy act. As 
crypto-exchanges lack intermediated access, tax compliance is also 
compromised as there are not brokers to regularly report crypto-
transactions through form 1099-Bs.
    Furthermore, though both the Securities and Exchange Commission 
(SEC) and Commodity Futures Trading Commission (CFTC) have released 
numerous public advisories, notices and enforcement actions, most 
crypto-exchanges remain unregistered and operate with limited investors 
protections. Thousands of ICOs have occurred, most being investment 
contracts under the securities laws, but only a fraction have recently 
started complying. Studies repeatedly report that the ICO market and 
crypto-exchanges are rife with scams, frauds and manipulative 
practices.
    The current patchwork approach to addressing these issues--to guard 
against illicit activities, protect investors & their funds, and 
promote market integrity--would be better accomplished through 
application of commodities and securities laws. As outlined below, 
while issuer based crypto is slowly being brought under securities laws 
and crypto-derivatives are clearly under the CFTC and commodities laws, 
there may be a gap Congress considers filling related to 
cryptocurrencies not subject to securities laws, such as Bitcoin, 
herein called `crypto-cash commodities.'
    While the CFTC has general anti-fraud and anti-manipulation 
authorities with regard to spot transactions in crypto-cash 
commodities, such as Bitcoin or Ether, the agency does not currently 
have express registration or plenary rule writing authorities with 
regard to cash commodities. Furthermore, as the CFTC staff recently 
said in an advisory letter, ``virtual currencies are unlike any 
commodity that the CFTC has dealt with in the past.'' \3\
---------------------------------------------------------------------------
    \3\ CFTC Staff Advisory No. 18-14 (May 21, 2018) https://
www.cftc.gov/sites/default/files/idc/groups/public/%40lrlettergeneral/
documents/letter/2018-05/18-14_0.pdf.
---------------------------------------------------------------------------
    Congress may wish to consider providing the CFTC--or another 
agency--with general authorities to write rules for these markets, 
including possibly requiring registration for trading on crypto-
exchanges solely dealing in cryptocurrencies, aka crypto-cash 
commodities. Doing so may best protect investors, limit illicit 
activity and enhance underlying reference markets for crypto-
derivatives and exchange traded funds (ETF). It also is critical that 
the CFTC, SEC and other agencies have sufficient budgetary resources to 
adequately oversee crypto-markets, especially as these markets have 
continued to grow.
    Clear rules of the road also would allow firms--both incumbents and 
start-ups--to more fully explore investing in blockchain technology or 
crypto-assets. Start-ups have had an advantage over incumbents as they 
generally differ on how they evaluate taking reputational and 
regulatory risks regarding uncertain regulatory treatment.
    Bringing the crypto-world within the long-established public policy 
frameworks, though, will promote greater innovation and competition, 
allowing blockchain technologies to be explored to their fullest 
potential.
Comprehensive Review
Blockchain Technology Potential
    Blockchain technology and cryptocurrencies are an innovative tool 
for creating and moving value on the Internet (digital assets) using 
blockchains, distributed consensus algorithms, cryptography, and peer 
to peer networking. Regardless of whether Bitcoin and other 
cryptocurrencies adequately exhibit the three classic characteristics 
of money--a store of value, a medium of exchange and a unit of 
account--they do provide a means to move value and run computer code on 
the Internet without relying upon a central intermediary such as a 
bank.
    That ties blockchain technology and cryptocurrencies directly to 
the essential plumbing of the financial sector, which at its core 
performs the role of efficiently moving and allocating money and risk 
within the economy.
    Though there are many technical and commercial challenges yet to 
overcome, blockchain technology has the potential to transform the 
world of finance by creating open protocols to which everyone has 
access, but nobody has control--to do for finance what the web did for 
information.
    The technology could reduce the ``cost of trust''--the costs borne 
by transacting parties because they have to rely on their 
counterparties or a trusted intermediary to honestly record completion 
of the transaction. These costs range widely--from those associated 
with vault doors, cybersecurity, settlement procedures, user 
identification, compliance teams, security guards, and anti-fraud 
regimes, to the excess amounts that centralized institutions can charge 
customers.
    Potential use cases include cross-border payments, clearing and 
settlement for financial transactions, digital identities, trade 
finance and supply chain management. Open permissionless blockchain 
applications such as Bitcoin have also inspired permissioned or private 
blockchains. The term ``distributed ledger technology,'' or DLT, is 
often used to describe this field in broader, generic terms.
    With increased competition and innovation in the financial system, 
DLT--both permissionless and permissioned--offers a catalyst for change 
by incumbents or as an opportunity for entrepreneurial start-ups, 
potentially lowering costs, risks and economic rents in the financial 
sector which represents 7.5% of the U.S. economy.\4\
---------------------------------------------------------------------------
    \4\ Value added by private industries: Finance, insurance, real 
estate, rental, and leasing: Finance and insurance as a percentage of 
GDP; Federal Reserve Bank of St. Louis (reviewed on July 15, 2018) 
https://fred.stlouisfed.org/series/VAPGDPFI.
---------------------------------------------------------------------------
    To reach its potential, though, blockchain technology and the world 
of crypto-finance, must come fully within long established public 
policy frameworks.
Crypto Finance
    Blockchain technology has given rise to the latest addition to an 
ever-evolving global financial system. The world of crypto-finance--
with total market capitalization of $250 billion,\5\ its innovative 
forms of crowdfunding and trading on crypto-exchanges--has so far 
operated largely outside established investor protection frameworks.
---------------------------------------------------------------------------
    \5\ CoinMarketCap (as of July 14, 2018) https://coinmarketcap.com.
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    To date, 3800 ICOs have launched \6\ and 200 crypto-exchanges are 
operating \7\ with tens of millions of customers worldwide. About 55 
percent of the crypto-market value is now in tokens other than 
Bitcoin.\8\
---------------------------------------------------------------------------
    \6\ Stats and Facts; ICO Bench (as of July 13, 2018) https://
icobench.com/stats.
    \7\ 24 Hour Volume Rankings (Exchange); CoinMarketCap (as of July 
13, 2018) https://coinmarketcap.com/exchanges/volume/24-hour/.
    \8\ Market Cap by Cryptocurrency (as of July 13, 2018); Coin Dance; 
https://coin.dance/stats.
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Cryptocurrencies by Market Cap
coin.dance

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    The market is volatile but has grown significantly over the years 
as shown in the following figure of historical market capitalization.
Cryptocurrency Market Caps (Historical)
coin.dance

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Tokens and Initial Coin Offerings
    Burgeoning investor interest in crypto-assets along with the 
potential for token-based economies, has led to a new means of raising 
capital for blockchain-based projects: initial coin offerings (ICOs) 
and similar token sales.
    By their very nature and design, ICOs and similar token offerings 
mix economic attributes of both investment and potential consumption. 
Marketing documents describe utility-like qualities for the token's 
stated purpose on a decentralized network, but there is almost always a 
strong investment component to token sales as they fund development of 
underlying software and a network. Thus, ICOs are quite different from 
tokens for a neighborhood laundromat, tickets to the theatre or 
donation-based crowdfunding platforms such as Kickstarter or GoFundMe.
    ICO investors bear economic risk related to the success or failure 
of the network in which the token is to potentially circulate. 
Investors lose if the network isn't completed or falls short of hoped 
for public adoption, but they may gain if the network widely succeeds. 
ICOs are typically marketed online with the release of a whitepaper 
prior to the launch of a new blockchain-based decentralized 
application.
    ICO tokens are structured with attributes to promote marketability 
and potential appreciation. They usually include a so-called `monetary 
policy' which is encoded in the software, defining the future supply of 
tokens and introducing an element of scarcity. They are fungible or 
interchangeable which enhances liquidity. They are often listed on 
crypto-exchanges, boosting marketability and transferability.
    Development and support of the network, though often open-sourced, 
tends to be largely concentrated around the issuing company or 
foundation and other closely aligned developers. The selling company, 
related foundation and founders usually retain a meaningful portion of 
pre-issued tokens and are motivated to increase the value of the 
tokens.
    Nearly every ICO token's economic realities--its risks, expectation 
of profits, monetary policies, manner of marketing, and capital 
formation--are attributes of investment schemes.
    Issuance has ballooned in the last 12 months, with CoinDesk 
reporting total ICO issuance of nearly $20 billion through June 30. 
There are no authoritative data sources, however, and most data 
aggregators are relying on ICO issuers to self-report the amount they 
raised. EOS raised $4.2 billion through a year-long ICO and Telegram 
Group raised $1.7 billion in two private offerings. CoinDesk reports 
$14 billion raised so far in 2018 versus just over $5 billion in all of 
2017.\9\
---------------------------------------------------------------------------
    \9\ All-Time Cumulative ICO Funding; CoinDesk (as of July 13, 2018) 
https://www.coindesk.com/ico-tracker/.
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All-Time Cumulative ICO Funding

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    Many start-ups are turning to this market to raise capital as there 
are significant valuation differences versus traditional venture 
capital funding. The valuation disparity may be due, amongst other 
things, to the public's speculative interest, the potential to share in 
the network effects of token economies, the token's greater liquidity, 
reduced transactions costs or regulatory arbitrage.
    There is a high failure rate for ICOs. One study in February of 
2018 found that 59% of a sample of 2017 ICOs had already failed or 
semi-failed.\10\ There also is a considerable amount of fraud and scams 
in this field, with numerous ICOs targeting retail investors, using 
celebrity endorsers, and promising short-term gains. Estimates vary 
considerably with 25 percent \11\ to 81 percent as scams.\12\ A recent 
Wall Street Journal analysis of over 1400 ICOs found ``rampant 
plagiarism, identity theft and promises of improbable returns.'' \13\
---------------------------------------------------------------------------
    \10\ Nearly Half of 2017 Cryptocurrency `ICO' Projects Have Already 
Died; Forbes (February 25, 2018) http://fortune.com/2018/02/25/
cryptocurrency-ico-collapse/.
    \11\ Initial Coin Offerings: Can Regulators Curb the Risks? How 
Many ICOs Are Scams?; ValueWalk (March 30, 2018) https://
www.valuewalk.com/2018/03/initial-coin-offerings-regulators-curb-risks/
 
    \12\ ICO Quality: Development & Trading; Sherwin Dowlat & Michael 
Hodapp of Satis Group (March 21, 2018) https://medium.com/satis-group/
ico-quality-development-trading-e4fef28df04f.
    \13\ Hundreds of Bitcoin Wannabes Show Hallmarks of Fraud; Wall 
Street Journal (May 17, 2018) https://www.wsj.com/articles/buyer-
beware-hundreds-of-bitcoin-wannabes-show-hallmarks-of-fraud-1526573115.
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    As cheap money, though, will always displace expensive money (from 
an entrepreneur's perspective), if valuation disparities continue, it 
is possible that ICO funding will grow further to displace a 
significant portion of the $160 billion venture capital raised annually 
around the globe.\14\ This changing venture funding landscape 
highlights the need for investor protection to keep pace with market 
developments.
---------------------------------------------------------------------------
    \14\ Venture Capital Funding Report 2017; CB Insights https://
www.cbinsights.com/research/report/venture-capital-q4-2017/.
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Crypto-Exchanges
    Once Bitcoin developed as the first cryptocurrency, it was only 
natural that secondary markets and exchange trading would develop.
    In aggregate, crypto-exchanges now have tens of millions of 
customers. Coinbase, alone, has over 20 million accounts, almost as 
many as Fidelity Investments, more than twice brokerage firm Charles 
Schwab and nearly as many as Vanguard has investors.\15\
---------------------------------------------------------------------------
    \15\ Move deliberately, fix things: How Coinbase is building a 
cryptocurrency empire; Washington Post (May 17, 2018) https://
www.washingtonpost.com/business/economy/move-deliberately-fix-things-
how-coinbase-is-building-a-cryptocurrency-empire/2018/05/17/623d950c-
587c-11e8-858f-12becb4d6067_story.html?utm_term=.a18c45536e2b.
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    Trading appears to be significant, with over $12 billion in daily 
volume reported last week.\16\ There are now approximately 200 crypto-
exchanges and many others have failed. By 2015, one list already had at 
least 36 failures.\17\ In 2018, after the Japanese Financial Services 
Agency (JFSA) conducted business reviews of exchanges, at least nine 
suspended their operations.\18\
---------------------------------------------------------------------------
    \16\ 24 Hour Volume Rankings (Exchange); CoinMarketCap (as of July 
13, 2018) https://coinmarketcap.com/exchanges/volume/24-hour/.
    \17\ 36 bitcoin exchanges that are no longer with us, Brave New 
Coin (October 23, 2015) https://bravenewcoin.com/news/36-bitcoin-
exchanges-that-are-no-longer-with-us/.
    \18\ Nine Japanese Crypto Exchanges Have Suspended Operations So 
Far, Bitcoin.com (April 13, 2018) https://news.bitcoin.com/nine-
japanese-crypto-exchanges-have-suspended-operations-so-far/.
---------------------------------------------------------------------------
    In reviewing exchange volume figures, some caution is in order as 
market data from crypto-exchanges generally is not audited or 
regulated. Furthermore, exchanges may use wash sales (i.e., trading 
involving no change in beneficial ownership that is intended to produce 
the false appearance of trading) to inflate their volume statistics in 
an effort to report greater market share. One recent study suggests up 
to 95% of OKex's reported volume may be nonexistent and 82% of Huobi's 
may be as well.\19\
---------------------------------------------------------------------------
    \19\ Chasing fake volume: a crypto-plague; Sylvain Ribes (March 10, 
2018) https://medium.com/@sylvainartplayribes/chasing-fake-volume-a-
crypto-plague-ea1a3c1e0b5e.
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    These exchanges also have some significant differences from 
traditional securities, derivatives and retail fiat currency exchanges. 
Crypto exchanges offer direct access to customers rather than access 
through regulated intermediaries, such as broker dealers or future 
commission merchants. Centralized crypto-exchanges also take custody of 
customers crypto and some fiat funds. For instance, Coinbase reports to 
have custody of over $20 billion in customer crypto-funds.\20\
---------------------------------------------------------------------------
    \20\ Announcing the Coinbase Suite of Institutional Products; The 
Coinbase Blog (May 15, 2018) https://blog.coinbase.com/coinbase-
institutional-deea317d23af.
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    Crypto-exchanges have had significant problems protecting 
customers' funds held in custody, usually in digital wallets rather 
than at a bank, broker dealer, or future commission merchants. Numerous 
hacks have led to significant stolen customer funds. Mt. Gox lost $473 
million in Bitcoin in 2014.\21\ Coincheck lost $530 million in NEM 
tokens in 2018.\22\ A South Korean exchange, Coinrail, was hacked in 
June of 2018, losing $40 million, or fully 30% of customer tokens held 
in custody.\23\
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    \21\ 12 Biggest Cryptocurrency Hacks In History, Benzinga (November 
24, 2017) https://www.benzinga.com/fintech/17/11/10824764/12-biggest-
cryptocurrency-hacks-in-history.
    \22\ Coincheck: NEM Foundation Stops Tracing Stolen Coins, Hackers' 
Account At Zero, CoinTelegraph (March 23, 2018) https://
cointelegraph.com/news/coincheck-nem-foundation-stops-tracing-stolen-
coins-hackers-account-at-zero.
    \23\ South Korean Exchange Coinrail Hacked, $40 Million in Crypto 
Reported Stolen; Bitcoin Magazine (June 11, 2018) https://
bitcoinmagazine.com/articles/south-korean-exchange-coinrail-hacked-40-
million-crypto-reported-stolen/.
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    Also acting as counterparties to their customers, crypto-exchanges 
currently have limited guardrails against front running, fraud, or 
other manipulative practices. For instance, there are no assurances 
that order book or sales price information posted on these exchanges 
are current or accurate or that the cryptocurrency held by exchanges in 
custodial wallets is fully backed with coins on the relevant 
blockchain.
    There are no rules for best execution or order routing amongst 
crypto-exchanges. There are no rules limiting conflicts of interest or 
for fair and orderly markets. There are no standards for price 
transparency--either pre-trade or post-trade. There are no cops on the 
beat to protect against manipulative practices. In summary, investors 
have little basis for confidence in crypto-exchanges' order books or 
price discovery function.
    There have been repeated reports of manipulative behavior on these 
exchanges. A study last year reviewed how a trader using two trading 
bots on the Mt. Gox exchange may have manipulated the price of Bitcoin 
up eight-fold in 2013.\24\ In January of 2018, there were reports of an 
investigation into whether Bitcoin might have been manipulated on the 
Bitfinex exchange in a scheme using the token Tether.\25\
---------------------------------------------------------------------------
    \24\ Price Manipulation in the Bitcoin Ecosystem; Neil Gandal, J.T. 
Hamrick, Tyler Moore, and TaliOberman (June 22, 2017) https://
tylermoore.utulsa.edu/jme17.pdf.
    \25\ Worries Grow That the Price of Bitcoin Is Being Propped Up; 
New York Times (January 31, 2018) https://www.nytimes.com/2018/01/31/
technology/bitfinex-bitcoin-price.html?dlbk.
---------------------------------------------------------------------------
    The Futures Industry Association (FIA) expressed its apprehension 
about the reference markets for Bitcoin futures. As it stated: ``We 
remain apprehensive with the lack of transparency and regulation of the 
underlying reference products on which these futures contracts are 
based and whether exchanges have the proper oversight to ensure the 
reference products are not susceptible to manipulation, fraud, and 
operational risk.'' \26\
---------------------------------------------------------------------------
    \26\ Open letter to CFTC Chairman Giancarlo regarding the listing 
of cryptocurrency derivatives; Futures Industry Association (December 
7, 2017) https://fia.org/articles/open-letter-cftc-chairman-giancarlo-
regarding-listing-cryptocurrency-derivatives.
---------------------------------------------------------------------------
    The volumes, millions of customers, repeated hacks and ample 
potential for manipulative behavior, suggest that oversight is worthy 
by securities, commodities and derivatives regulators around the globe. 
To date, however, this trading activity has largely taken place outside 
of investor protection and market integrity regimes.
Public Policy Frameworks
    As with the emergence of new technologies in the past, from 
railroads in the 19th century to the Internet in the late 20th century, 
there have been debates on how blockchain technology and crypto-finance 
might best fit within existing public policy and legal frameworks.
    Operating within policy frameworks, though, has helped foster 
traditional capital markets for decades and are just as important for 
crypto-finance, even if the details for achieving the goals may be 
adapted to accommodate new technologies.
    The public broadly benefits when we:

   Ensure tax compliance.

   Guard against money laundering or terrorism financing.

   Enforce sanctions regimes.

   Promote financial stability.

   Protect investors and consumers.

   Promote market integrity and efficient capital markets.

   Foster economic inclusion and growth.

    Achieving these broad public policy goals fosters economic growth 
and is consistent with promoting innovation.
    When investing in any form of financing, whether initial coin 
offerings, other crypto-assets, or in traditional forms, such as stocks 
or bonds, the public benefits from full and fair disclosure from 
issuers.
    The investing and hedging public benefits from prohibitions against 
fraud and deceptive sales practices.
    Investors, hedgers, and issuers all benefit from secondary market 
trading that promote transparency and prohibit manipulative practices 
such as price manipulation, front running, wash sales, and spoofing 
(i.e., bidding or offering with the intent to cancel the bid or offer 
before execution.)
    The investing and hedging public benefits when conflicts of 
interest are disclosed and minimized.
    Such core principals of investor protection and market integrity 
are embodied in U.S. securities and commodities laws regardless of the 
form of investment. Such common-sense rules of the road bolster 
confidence in markets and enhances our economy.
Securities Laws, Howey Test & Duck Test
    Despite issuers' claims that the intended utility function of their 
tokens should place them in a different category from securities, 
there's no getting away from ICOs' investment contract attributes which 
means they should be subject to securities laws.
    In essence, as Indiana poet James Whitcomb Riley wrote over 100 
years ago: ``When I see a bird that walks like a duck and swims like a 
duck and quacks like a duck, I call that bird a duck.''
    An important early test of securities laws' statutory construct 
related to the Florida orange groves of William Howey, whose company 
sold land with an option to lease the land to an affiliated service 
company and participate in the profits of the crop. Even though not 
stocks or bonds, the U.S. Supreme Court in 1946 ruled that Howey's land 
sale agreements satisfied the definition of `investment contracts' 
under the 1933 Securities Act and thus should be regulated as 
securities.
    The so-called `Howey Test' from this case states that: ``an 
investment contract for purposes of the Securities Act means a 
contract, transaction or scheme whereby a person invests his money in a 
common enterprise and is led to expect profits solely from the efforts 
of the promoter or a third party.'' SEC v. W.J. Howey Co., 328 U.S. 
293, 299 (1946).
    The Securities and Exchange Commission (SEC) has now repeatedly 
spoken out about the application of securities laws to initial coin 
offerings and crypto-exchanges offering ICOs for sale. Sounding like 
poet Riley, SEC Chairman Clayton stated in February that ``I believe 
every ICO I've seen is a security. You can call it a coin but if it 
functions as a security, it is a security.''
    At a Congressional hearing on April 26, 2018, Chair Clayton divided 
crypto-assets into two areas, those which represent ``a pure medium of 
exchange'' and ``tokens, which are used to finance projects.'' He said 
that a ``pure medium of exchange . . . as a replacement for currency'' 
such as Bitcoin would not be regulated as a security.
    As for tokens, Chair Clayton said: ``Then there are tokens, which 
are used to finance projects. I've been on the record saying there are 
very few, there's none that I've seen, tokens that aren't securities.'' 
He added ``To the extent something is a security, we should regulate it 
as a security, and our securities regulations are disclosure-based, and 
people should follow those and provide the information that we 
require.'' \27\
---------------------------------------------------------------------------
    \27\ Bitcoin is Not a Security SEC Chairman; BlockExplorer News 
(April 27, 2018) https://blockexplorer.com/news/bitcoin-is-not-a-
security-sec-chairman/.
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Commodities Laws & Crypto Derivatives
    The CFTC has exclusive jurisdiction over the trading of crypto-
derivatives on exchanges, i.e., ``designated contract markets'' (DCMs) 
and ``swap execution facilities'' (SEFs) for both futures contracts and 
swaps as well as the trading of over-the-counter crypto-swaps. The CFTC 
also has general anti-fraud and manipulation authority for spot 
transactions in commodities traded in interstate commerce.
    Thus, the CFTC has direct jurisdiction for crypto-derivatives. If 
an exchange offers derivatives on cryptocurrencies, then that exchange 
must register with the CFTC. Crypto-exchanges that offer to U.S. 
persons `retail commodity transactions' as defined in statute, could 
also be subject to the authority of the CFTC.
    The CME Group and CBOE Global Markets started trading Bitcoin 
futures in December 2017. Nasdaq \28\ and Intercontinental Exchange 
\29\ have both said that they are investigating offering cryptocurrency 
or crypto-derivative trading. Overseas, Germany's largest exchange, 
Deutsche Borse, has said it is considering offering Bitcoin futures on 
its Eurex derivatives exchange.\30\ A UK start-up, Crypto Facilities, 
launched an Ether futures contract in May 2018.\31\
---------------------------------------------------------------------------
    \28\ After Nasdaq CEO Blesses Cryptocurrency, Investors See Bigger 
Future for Bitcoin, Others; Forbes (April 25, 2018) https://
www.forbes.com/sites/kenrapoza/2018/04/25/nasdaq-ceo-bitcoin-trading-
cryptocurrency/#556c526613f4.
    \29\ Bitcoin Sees Wall Street Warm to Trading Virtual Currency; New 
York Times (May 7, 2018) https://www.nytimes.com/2018/05/07/technology/
bitcoin-new-york-stock-exchange.html.
    \30\ German market weighs Bitcoin futures, Handelsblatt Global 
(December 13, 2017) https://global.handelsblatt.com/finance/german-
market-weighs-bitcoin-futures-865045.
    \31\ Ethereum Futures Go Live on UK Trading Platform; CoinDesk (May 
11, 2018) https://www.coindesk.com/ethereum-futures-go-live-uk-trading-
platform/.
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    The CFTC in its ``Coinflip Order'' determined that Bitcoin and 
other virtual currencies are commodities under the CEA in 2015.\32\ A 
U.S. District court subsequently concurred with a latter similar 
determination.\33\ Accordingly, the CFTC has general anti-fraud and 
anti-manipulation authority for spot transactions in the underlying 
reference cryptocurrencies, whether traded on exchanges or over the 
counter. The CFTC has brought a number of actions under this authority, 
one related to the trading of Bitcoin and Litecoin \34\ and another 
with regards to the trading of My Big Coin.\35\ My Big Coin, though, is 
challenging the jurisdiction of the CFTC contending that their token is 
not a commodity.\36\
---------------------------------------------------------------------------
    \32\ In the Matter of Coinflip, Inc., d/b/a Derivabit, and 
Francisco Riordan; (Sept. 17, 2015), https://www.cftc.gov/sites/
default/files/idc/groups/public/@lrenforcementactions/documents/
legalpleading/enfcoinfliprorder09172015.pdf.
    \33\ Bitcoin and Cryptocurrencies Are Commodities, Federal Court 
Rules, Bitcoin.com (March 7, 2018) https://news.bitcoin.com/bitcoin-
cryptocurrencies-commodities-federal-court-rules/.
    \34\ Federal Court in NY Enters Preliminary Injunction Order 
Against Patrick K. McDonnell and his Company CabbageTech, Corp. d/b/a 
Coin Drop Markets in Connection with Fraudulent Virtual Currency 
Scheme; CFTC (March 6, 2018) https://www.cftc.gov/PressRoom/
PressReleases/pr7702-18.
    \35\ CFTC Sues Obscure Crypto Scheme for Fraud; CoinDesk (January 
24, 2018) https://www.coindesk.com/cftc-sues-crypto-scheme-big-coin-
fraud/.
    \36\ My Big Coin Tells Court Tokens aren't Regulated by CFTC 
Because they are Not Commodities; Crowdfund Insider (April 5, 2018) 
https://www.crowdfundinsider.com/2018/04/131518-my-big-coin-tells-
court-tokens-arent-regulated-by-cftc-because-they-are-not-commodities/.
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The Path Forward
    How do the markets, this new technology, Congress and regulators 
move forward?
    I will review some considerations organized around the three broad 
public policy goals of: (1) guarding against illicit activity; (2) 
ensuring for financial stability[;] and (3) protecting the investing 
public.
Guarding Against Illicit Activity
    On balance, though, blockchain technology and cryptocurrencies have 
given the official sector new challenges in guarding against illicit 
activities. The crimes aren't generally new. The means and methods, 
though, particularly of payment, may be.
    The pseudonymous nature of blockchain-based records obscures the 
identity of actors, raising concerns for law enforcement authorities 
tasked with guarding against illicit activities. At the same time, the 
private sector has had legitimate concerns about the privacy of data 
shared on Bitcoin and other open permissionless blockchain 
applications.
    Interestingly, Bitcoin and other blockchain applications while 
often referred to anonymous, are more accurately what security experts 
would call pseudonymous. Bitcoin transactions do not include names of 
individuals or companies, but they do provide Bitcoin addresses, which 
if found to be linked to any personal data, such as your e-mail or ISP 
address, may allow for some transparency. Thus, blockchain technology 
allows some information about participants to be gleaned from patterns 
in the transaction records, balances in the unspent transactions 
outstanding and blockchain forensics.\37\
---------------------------------------------------------------------------
    \37\ Stealing bitcoins with badges: How Silk Road's dirty cops got 
caught; arsTechnica (August 17, 2016) https://arstechnica.com/tech-
policy/2016/08/stealing-bitcoins-with-badges-how-silk-roads-dirty-cops-
got-caught/. Also see: A Fistful of Bitcoins: Characterizing Payments 
Among Men with No Names; Meiklejohn, Pomarole, Jordon, Levchenko, 
McCoy, Voekler, & Savage (2013) https://cseweb.ucsd.edu/smeiklejohn/
files/imc13.pdf.
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    Given the pseudonymous nature of Bitcoin, it was only a matter of 
time and technological innovation before a number of cryptocurrencies 
would be developed promoting more anonymity. These anonymity-focused-
crypto-assets have specific designs that make their transactions harder 
to track on their underlying blockchains. Monero, Dash and Zcash are 
the three with the largest market capitalization, totaling about $5 
billion, but many more exist and are marketed to the public.\38\ It has 
been reported that Japan this spring has been encouraging crypto-
exchanges to halt listings of trading anonymity-focused-crypto-
assets.\39\ On the other hand, it has been recently reported that 
Coinbase is considering listing Zcash for the first time.\40\
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    \38\ 9 Anonymous Cryptocurrencies You Should Know About; Coinsutra 
(February 2, 2018) https://coinsutra.com/anonymous-cryptocurrencies/.
    \39\ Japan's Financial Regulator Is Pushing Crypto Exchanges To 
Drop `Altcoins' Favored By Criminals; Forbes (April 30, 2018) https://
www.forbes.com/sites/adelsteinjake/2018/04/30/japans-financial-
regulator-is-pushing-crypto-exchanges-to-drop-altcoins-favored-by-
criminals/#22d47e3e1b8a.
    \40\ Coinbase Considering Cardano, Stellar Lumens, Zcash, 0x & BAT 
Token Listings; Bitcoin Exchange Guide News (July 13, 2018) https://
bitcoinexchangeguide.com/coinbase-considering-cardano-stellar-lumens-
zcash0x-bat-token-listings/.

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    Dark Markets

    One of the most harmful activities has been on so-called dark 
markets. These markets operate with anonymous communications through 
the Tor network, a free and open network which provides users anonymous 
and censorship resistant means of communicating on the Internet.\41\ 
Dark markets have generally used Bitcoin for escrowed payments. They 
list for sale illegal drugs, weapons, stolen credit card details, and 
forged documents offered by hundreds or sometimes thousands of vendors.
---------------------------------------------------------------------------
    \41\ Tor https://www.torproject.org.
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    U.S. and international enforcement authorities have successfully 
taken down a number of dark markets trafficking in illegal activities, 
but other markets keep popping up in their place. When the U.S. 
Department of Justice shut down AlphaBay in July of 2017, it was 
estimated to be ten times larger than the notorious Silk Road web site 
which was shut down in 2013. Dutch authorities, working along with U.S. 
authorities successfully shut down another large dark market, Hansa, 
just 2 weeks later.\42\
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    \42\ Forget Silk Road, Cops Just Scored Their Biggest Victory 
Against The Dark Web Drug Trade; Forbes (July 20, 2017) https://
www.forbes.com/sites/thomasbrewster/2017/07/20/alphabay-hansa-dark-web-
markets-taken-down-in-massive-drug-bust-operation/#72702fd15b4b.
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    Beyond use on the darknet, there are those around the globe who 
seek to use these new technologies to thwart government oversight of 
money laundering, tax evasion, terrorism financing, or evading 
sanctions regimes.

    State Actors

    Two high profile uses of cryptocurrencies in efforts to thwart U.S. 
policy were by foreign government actors. In January of 2018, Venezuela 
announced a $5 billion oil-backed ICO called Petro. In response, 
augmenting previously established sanctions, the President signed an 
Executive Order in March prohibiting U.S. persons from purchasing or 
dealing in any digital currency, coin or token of the Government of 
Venezuela.\43\
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    \43\ Executive Order on Taking Additional Steps to Address the 
Situation in Venezuela; White House (March 19, 2018) https://
www.whitehouse.gov/presidential-actions/executive-order-taking-
additional-steps-address-situation-venezuela/.
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    On July 13, 2018, the U.S. charged 12 Russian military intelligence 
officers with conspiracy to interfere with the 2016 elections. Amongst 
the charges, count ten alleges conspiracy to launder money. It reads, 
in part: ``the defendants conspired to launder the equivalent of more 
than $95,000 through a web of transactions structured to capitalize on 
the perceived anonymity of cryptocurrencies such as bitcoin.'' It is 
alleged that: ``they principally used bitcoin when purchasing servers, 
registering domains, and otherwise making payments in furtherance of 
hacking activity.'' The indictment states that: ``The use of bitcoin 
allowed the Conspirators to avoid direct relationships with traditional 
financial institutions, allowing them to evade greater scrutiny of 
their identities and sources of funds.'' \44\
---------------------------------------------------------------------------
    \44\ U.S. v. Netyksho, et al., Indictment; Count ten, paragraph 57 
(July 13, 2018) https://assets.bwbx.io/documents/users/iqjWHBFdfxIU/
rs96.XUFx2Gw/v0.

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    Tax Compliance

    The U.S. Internal Revenue Service issued guidance in 2014 on the 
use of what they called `virtual currencies', such as Bitcoin and other 
crypto-assets. In determining that all virtual currencies are treated 
as property for U.S. tax purposes, the IRS said that general tax 
principals applicable to property transactions apply to virtual 
currencies. Taxpayers receiving virtual currencies for payment of goods 
and services must include their fair market value in their reported 
gross income.
    Taxpayers also are required to include in income any gains or 
losses upon a sale or exchange of virtual currencies.\45\
---------------------------------------------------------------------------
    \45\ IRS virtual currency guidance: Virtual currency is treated as 
property for U.S. Federal tax purposes; General rules for property 
transactions apply; IR-2014-36; IRS (March 25, 2014) https://
www.irs.gov/newsroom/irs-virtual-currency-guidance.
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    One open question that investors and tax practitioners had had was 
the appropriate treatment under the tax laws of crypto to crypto-
exchanges. The law was clear that tax could be deferred by treating 
these trades as so-called `like-kind exchanges' under IRS section 1031. 
If that was even possible prior to 2018, it no longer is now, with 
amendments to Section 1031 included in the Tax Cut and Jobs Act to make 
like-kind exchanges only applicable to real estate transactions.\46\
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    \46\ The Truth About Cryptocurrency And Like-Kind Exchanges; Forbes 
(February 19, 2018) https://www.forbes.com/sites/tysoncross/2018/02/19/
the-truth-about-cryptocurrency-and-like-kind-exchanges/#33c7cdc26fd1.
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    One challenge for tax compliance is that crypto-exchanges have not 
yet been sending form 1099-B, reporting on transactions, to their 
customers and the IRS. The IRS requires brokers to do so with regard to 
all broker or barter exchange transactions.\47\ As discussed elsewhere, 
though, the current model for crypto-exchanges does not generally 
include brokers, leaving a significant gap in tax reporting. The U.S. 
Internal Revenue Service had to win in Federal court before the crypto-
exchange Coinbase was willing to share information on their most active 
customer accounts--approximately 13,000 accounts--with the IRS.\48\
---------------------------------------------------------------------------
    \47\ 2018 Instructions for form 1099-B; IRS https://www.irs.gov/
pub/irs-pdf/i1099b.pdf.
    \48\ Coinbase Notifies Customers That It Will Turn Over Court-
Ordered Data; Forbes (February 28, 2018) https://www.forbes.com/sites/
kellyphillipserb/2018/02/28/coinbase-notifies-customers-that-it-will-
turn-over-court-ordered-data/#390113ca1431.
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    The IRS, if need be working with Congress, should close this gap 
and require crypto-exchanges lacking intermediated brokered access to 
provide customers and the IRS with form 1099-B for their crypto and 
other property transactions. In addition, the IRS should close gaps 
with regard to requirements for taxpayers with offshore crypto-accounts 
on filing a report of foreign bank and financial accounts (FBAR).\49\ 
This has been a gray area which could undermine tax compliance.\50\
---------------------------------------------------------------------------
    \49\ Report of Foreign Bank and Financial Accounts (FBAR); IRS 
https://www.irs.gov/businesses/small-businesses-self-employed/report-
of-foreign-bank-and-financial-accounts-fbar
    \50\ Bitcoin, FBAR, and the Offshore Voluntary Disclosure Program: 
A Primer for Expats; Greenback Expat Tax Services (March 22, 2018) 
https://www.greenbacktaxservices.com/blog/expat-taxes-on-bitcoin-fbar/.

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    First Line of Defense--Money Transmission Laws

    There is a widely held view amongst most policy officials globally 
that we must guard against such threats--whether by state actors or 
private-sector actors--though how best to do so has been up for debate.
    The first line of defense has been through money transmission laws 
and bank secrecy laws requiring compliance with anti-money laundering 
(AML), combating financing of terrorism (CFT), and know your customer 
(KYC) laws. The U.S. Treasury's Financial Crime Enforcement Network 
(FinCEN) put out guidance on this regard starting in 2013 \51\ and most 
recently in a letter to Congress.\52\
---------------------------------------------------------------------------
    \51\ FIN-2013-G001; Application of FinCEN's Regulations to Persons 
Administering, Exchanging, or Using Virtual Currencies; Department of 
Treasury (March 18, 2013) https://www.fincen.gov/sites/default/files/
shared/FIN-2013-G001.pdf.
    \52\ Letter to Senator Ron Wyden, FinCEN (February 13, 2018) 
https://coincenter.org/files/2018-03/fincen-ico-letter-march-2018-coin-
center.pdf.
---------------------------------------------------------------------------
    More could be done, though, directly overseeing the crypto-
ecosystem and at the intersections of the traditional financial 
sectors, e.g., banking and payments networks, to perform KYC and to 
minimize the risk of the illicit use of blockchain networks.

    Crypto-Exchanges and Wallets--Critical Gateways

    Crypto-exchanges and digital wallet companies, if properly 
regulated, may provide one of the most critical gateways to protect 
against such illicit transmissions of value. Both crypto-exchanges and 
digital wallets provide customers the ability to store crypto-assets 
and transact electronically. (Many provide fiat currency services as 
well.)
    This gateway to effect public policy is particularly important as 
crypto-exchanges allow for direct public access. In contrast, 
traditional securities and derivatives exchanges are accessed through 
intermediaries such as banks, broker-dealers or futures commission 
merchants (FCM), giving authorities important gateways to monitor and 
enforce the law. Thus, in the crypto-world, tax authorities and 
financial crimes enforcement will have to look to exchanges, 
custodians, investors or blockchain forensics companies, for reporting 
on crypto-transactions, taxable gains or losses, and any illicit 
activity.
    In the U.S., in the absence of Federal registration, crypto-
exchanges are required to comply with money transmission laws and to 
register in each state according to those individual state laws. This 
is a cumbersome and inconsistent process even for those well-meaning 
companies seeking to comply. Few exchanges have done so in all 
jurisdictions, raising questions of possible noncompliance. New York 
State, through its BitLicense, has acted to bring exchanges within 
enhanced money transmission laws.\53\ Federal registration and 
oversight--through commodities and securities laws--would be a better 
public policy solution than this current patchwork approach.
---------------------------------------------------------------------------
    \53\ Department of Financial Services BitLicense Regulatory 
Framework; New York State (June 24, 2015) https://www.dfs.ny.gov/legal/
regulations/bitlicense_reg_framework.htm.
---------------------------------------------------------------------------
    Japan moved in 2017 to regulate crypto-exchanges primarily for 
money transmission and their custodial duties. Korean authorities 
banned exchanges from trading for anonymous accounts \54\ and 
subsequently began investigating numerous exchanges for fraud and other 
misconduct.
---------------------------------------------------------------------------
    \54\ S Korea bans anonymous cryptocurrency trades; BBC News 
(January 23, 2018) http://www.bbc.com/news/business-42784384.
---------------------------------------------------------------------------
    As many jurisdictions around the globe, however, do not yet have 
specific regulatory regimes governing crypto-exchanges it puts an even 
greater burden on U.S. authorities, financial sector and laws. ``There 
are significant challenges to investigating foreign virtual currency 
businesses, because most jurisdictions do not regulate and supervise 
virtual currency businesses,'' a Treasury official wrote in the letter 
FinCEN sent to Congress in February 2018.

    Decentralized Crypto-Exchanges--Challenges Ahead

    Decentralized crypto-exchanges, still only a modest portion of the 
crypto-markets, may present even greater challenges. These exchanges 
provide for peer-to-peer trading based upon open-source algorithms with 
no centralized platform and no custody of funds. Thus, decentralized 
exchange protocols, might help provide a solution for the security of 
customer funds, if they truly don't hold those digital assets. On the 
other hand, though, they may pose additional challenges to authorities 
trying to guard against illicit activities, particularly for crypto-to-
crypto trading.
    If decentralized exchanges facilitate trading of fiat currency vs. 
cryptocurrency, regulators might be able to implement policy by 
restricting regulated intermediaries or their customers in transacting 
with such platforms.
Ensuring for Financial Stability
    It is important to ensure that blockchain technology, 
cryptocurrencies and crypto-exchanges do not undermine financial 
stability, in normal times or in stressful economic times.

    Financial Stability Board--Initial Assessment

    The Financial Stability Board (FSB), an international group that 
makes recommendations about the global financial system, stated in its 
open letter in March 2018 to the G20 heads of state, that ``The FSB's 
initial assessment is that crypto-assets do not pose risks to global 
financial stability at this time.'' \55\ They noted that even at their 
peak earlier this year, the overall market value was less than 1% of 
global GDP.
---------------------------------------------------------------------------
    \55\ To G20 Finance Ministers and Central Bank Governors; Financial 
Stability Board (March 13, 2018) http://www.fsb.org/wp-content/uploads/
P180318.pdf.
---------------------------------------------------------------------------
    The current market value of all crypto-assets is approximately $250 
billion relative to global equity markets of approximately $80 trillion 
as of 2017 year-end \56\ and global debt outstanding as of March 31, 
2018 of approximately $250 trillion.\57\ The world's 190,000 tons of 
gold \58\ are worth about $7 trillion in aggregate at recent market 
prices of $1,243 per ounce.
---------------------------------------------------------------------------
    \56\ Market capitalization of listed domestic companies; The World 
Bank (as of December 31, 2017) https://data.worldbank.org/indicator/
CM.MKT.LCAP.CD.
    \57\ Global debt monitor; Institute of International Finance (July 
9, 2018) https://www.iif.com/publication/global-debt-monitor/global-
debt-monitor-july-2018.
    \58\ World Gold Council (as of July 13, 2018) https://www.gold.org/
about-gold/gold-supply/gold-mining/how-much-gold-has-been-mined.
---------------------------------------------------------------------------
    The FSB noted, however, that their assessment could change if 
crypto-finance became more interconnected with the core of the 
regulated financial sector. In that regard, it is worthwhile to 
consider three areas worthy of monitoring: (1) leverage in crypto-
markets; (2) market infrastructure blockchain initiatives; and (3) 
central bank digital currencies.

    Leverage in Crypto-Markets

    Given the high volatility of crypto-assets, significant leverage 
could add to instability and stress, particularly during down markets. 
While Bitcoin futures listed at CME and CBOE require nearly 50% margin, 
most crypto-exchanges allow for much lower margin (and thus higher 
leverage) when trading Bitcoin and many other crypto-assets. BitMEX 
provides 100:1 leverage (only 1% margin) for Bitcoin trading. Many 
other exchanges allow offer leverage above 10:1.\59\ Furthermore, given 
that many exchanges lack transparency and remain unregulated, it may be 
challenging for central banks and others responsible for financial 
stability to influence the amount of leverage in crypto-markets or get 
an accurate window into these markets.
---------------------------------------------------------------------------
    \59\ The Best Bitcoin and Cryptocurrency Trading Platforms; 
BitReview (as of July 12, 2018) https://bitreview.com/trade/bitmex/.

---------------------------------------------------------------------------
    Market Infrastructure--Blockchain Initiatives

    Blockchain technology and other forms of distributed ledger 
technology raise the possibility of replacing various centralized 
market infrastructures. This could lower costs, limit counterparty 
risks, promote innovation and economic inclusion. It may also lower the 
systemic risks associated with centralized market infrastructures for 
payments, clearing, settlement and other shared functions. Though 
Bitcoin is now nearly 10 years old, these technologies are still 
untested in any economy-wide (or even enterprise-wide) production. Any 
widescale use of blockchain technology within the financial sector will 
need to be considered in light of their potential resilience to various 
risk vectors--economic, cyber, operating and otherwise.
    Possibly most relevant to this Committee's work, there are efforts 
underway to use blockchain smart contracts to help automate post trade 
event management for uncleared swaps. The International Swaps and 
Derivatives Association (ISDA) is working with Regnosys to produce a 
digital version of ISDA's Common Domain Model for numerous swap 
transaction and life cycle processes. The goal is to provide the market 
with a standard set of digital definitions and smart contracts to 
reduce costs and counterparty risk.\60\
---------------------------------------------------------------------------
    \60\ ISDA Publishes Digital Iteration of the Common Domain Model; 
ISDA (June 5, 2018) https://www.isda.org/2018/06/05/isda-publishes-
digital-iteration-of-the-common-domain-model/.
---------------------------------------------------------------------------
    There are other clearing and settlement use cases of note, though 
as stated, none are live at this time. The Depository Trust and 
Clearing Corporation's (DTCC) has delayed its initiative, working with 
IBM, to implement a permissioned blockchain for credit default swap 
clearing and record keeping at its Trade Information Warehouse.\61\ 
Nasdaq, partnering with blockchain startup Chain, is experimenting with 
a number of blockchain applications, including for clearing and 
settlement for private securities transactions for non-listed 
companies.\62\ Overseas, the most noted initiative is that of the 
Australian Stock Exchange which announced last year that it would 
replace its entire clearing and settlement infrastructure with a 
permissioned distributed ledger-based solution developed by Digital 
Asset Holdings.\63\
---------------------------------------------------------------------------
    \61\ Enterprises Building Blockchain Confront Early Tech 
Limitations; CoinDesk (March 23, 2018) https://www.coindesk.com/
enterprises-building-blockchain-confront-tech-limitations/.
    \62\ Nasdaq Exec: Exchange Is `All-In' on Using Blockchain 
Technology; TheStreet (April 23, 2018) https://www.thestreet.com/
investing/nasdaq-all-in-on-blockchain-technology-14551134.
    \63\ CHESS Replacement, ASX is replacing CHESS with distributed 
ledger technology (DLT) developed by Digital Asset; ASX (December 2017) 
https://www.asx.com.au/services/chessreplacement.htm.

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    Central Bank Digital Currencies

    Last, Bitcoin and cryptocurrencies has led to healthy debates 
within the central banking and economics communities on the pros and 
cons of central banks issuing retail central bank digital currencies 
(CBDC) and if so, the effects that might have on payment systems and 
the commercial banking system.\64\ Central banks already issue digital 
currency, but only to commercial banks, in the form of bank reserves. 
The public--merchants and consumers alike--can only access paper 
currency or bank deposits. In the U.S. that is in the paper form is 
Federal Reserve Notes.
---------------------------------------------------------------------------
    \64\ Central bank digital currencies; Bank for International 
Settlements, Committee on Payments and Market Infrastructures (March 
2018) https://www.bis.org/cpmi/publ/d174.pdf.
---------------------------------------------------------------------------
    The debate is whether to utilize blockchain technology to give 
greater access to either central bank payment systems and/or reserves 
to merchants or the wider public. In part this is being considered by 
central banks in an effort to stay abreast of rapid changes in payment 
methods and means of commerce, such as mobile payments, digital wallets 
and in some countries, the decline in the use of paper notes. In 
addition, central banks may find that they will be reacting to private-
sector initiatives to issue so-called `stable value' tokens designed to 
have stable prices or values and tied to or backed by fiat currency. 
Though stable value tokens to date, such as Tether, have had many 
challenges, some observers think that such an effort has potential.\65\
---------------------------------------------------------------------------
    \65\ Stable Coins Analysis: Is There A Viable Solution For The 
Future?; Cointelegraph (May 14, 2018) https://cointelegraph.com/news/
stable-coins-analysis-is-there-a-viable-solution-for-the-future.
---------------------------------------------------------------------------
    Thus, the question CBDC raises for financial stability is with 
direct access to central bank digital currencies what portion of 
consumer deposits would move away from commercial banks and what 
effects would such migration have on lending and the overall economy? 
Furthermore, in times of stress or financial uncertainty, the public 
might move a significant portion of their money away from commercial 
banks to the central bank, potentially aggravating instability in the 
financial sector.
Protecting the Investing Public
    As noted above, the $250 billion crypto-markets currently operate 
largely outside of traditional investor protection norms. This is in 
spite of the SEC repeatedly publishing advisories and making public 
statements that most ICOs and the crypto-exchanges trading in such 
tokens must comply with U.S. securities laws.
    Thus, it is not surprising that the crypto-markets are now known 
for high levels of fraud, scams and manipulative behavior. I will now 
review the need for investor protection in each of the three segments 
of the crypto-markets: (1) crypto-tokens--ICOs or issuer or based, (2) 
crypto-derivatives[;] and (3) cryptocurrencies (aka crypto-cash 
commodities). Following this, I will touch upon the critical need to 
address crypto-custodial functions.

    Crypto-Tokens--ICOs or Issuer-Based

    The burgeoning market and the economic realities of ICOs or issuer-
based tokens has led to robust debates around the globe over the 
appropriate regulations to apply to their issuance and trading. The 
International Organization of Securities Commissions (IOSCO) board 
expressed its concerns in a statement stating that: ``ICOs are highly 
speculative investments in which investors are putting their entire 
invested capital at risk. . . . the increased targeting of ICOs to 
retail investors through online distribution channels . . .--raises 
investor protection concerns. There have also been instances of fraud, 
and as a result, investors are reminded to be very careful in deciding 
whether to invest in ICOs.'' \66\
---------------------------------------------------------------------------
    \66\ AIOSCO Board Communication on Concerns Related to Initial Coin 
Offerings (ICOs); IOSCO (January 18, 2018) http://www.iosco.org/news/
pdf/IOSCONEWS485.pdf.
---------------------------------------------------------------------------
    Individual countries' securities regulators have also been active 
in releasing statements regarding ICOs, cryptocurrencies, and 
exchanges. IOSCO lists statements from 40 countries regarding ICOs.\67\
---------------------------------------------------------------------------
    \67\ Regulators' Statements on Initial Coin Offerings; IOSCO 
https://www.iosco.org/publications/?subsection=ico-statements.
---------------------------------------------------------------------------
    In the U.S., it is now the case that most ICO related tokens, and 
the crypto-exchanges that list them must comply with securities laws. 
Unfortunately, though, most are not yet doing so. The SEC's effort to 
date has yet to bring this market into compliance.
    We've already seen high levels of fraud and loss of funds in these 
markets. Currently, a growing and potentially significant portion of 
the capital markets--crypto-finance--is not benefiting from basic 
investor protections.
    When determining what is an investment contract under their 
securities laws, Canada has a similar approach to that of the U.S. 
Howey Test.\68\ Provincial regulators from Canada joined with state 
regulators in the U.S. in May 2018, in a coordinated action against 
ICOs named ``Operation Cryptosweep'' with nearly 70 open investigations 
and 35 enforcement actions.\69\
---------------------------------------------------------------------------
    \68\ CSA Staff Notice 46-307, Cryptocurrency Offerings; Ontario 
Securities Commission (August 27, 2017) http://www.osc.gov.on.ca/en/
SecuritiesLaw_csa_20170824_cryptocurrency-offerings.htm.
    \69\ State and Provincial Regulators in U.S. and Canada Target 
Initial Coin Offerings; the Wall Street Journal (May 21, 2018) https://
www.wsj.com/articles/state-and-provincial-regulators-in-us-and-canada-
target-initial-coin-offerings-1526918512.
---------------------------------------------------------------------------
    The SEC to date has used public advisory statements, speeches, 
testimony and enforcement actions against some of the most obvious 
offenders but has a great deal of work ahead of them to bring the 
issuer-based crypto-market into compliance.
    The SEC's Director of the Division of Corporate Finance, William 
Hinman, sought to give additional direction in a speech on June 14, 
2018. He noted that ``a digital asset transaction may no longer 
represent a security offering [where] the network on which the token or 
coin is to function is sufficiently decentralized--where purchasers 
would no longer reasonably expect a person or group to carry out 
essential managerial or entrepreneurial efforts.'' In explaining that 
decentralization may reduce information asymmetries, he said: ``[W]hen 
the efforts of the third party are no longer a key factor for 
determining the enterprise's success, material information asymmetries 
recede.'' Moreover, ``[a]s a network becomes truly decentralized, the 
ability to identify an issuer or promoter to make the requisite 
disclosures becomes difficult, and less meaningful.'' \70\
---------------------------------------------------------------------------
    \70\ Digital Asset Transactions: When Howey Met Gary (Plastic); 
William Hinman, SEC (June 14, 2018) https://www.sec.gov/news/speech/
speech-hinman-061418.
---------------------------------------------------------------------------
    While the number of ICOs being sold under exempt securities 
offerings (i.e., Reg D filings) is increasing, many ICOs are still 
sidestepping these requirements. Furthermore, while there are reports 
that a number of crypto-exchanges are in discussions with the SEC about 
registering as broker dealers and complying with Reg ATS, none have yet 
fully done so. That means that these exchanges are currently likely 
operating in the breach.
    To bring greater clarity to these markets, the SEC must also 
determine how best to bring into compliance the over 1000 ICOs and 
numerous crypto-exchanges still in operation in the U.S. What 
remediation and possible penalties are appropriate? One petitioner 
recommended retroactive registration along with investor rescission 
rights. Some requirements, such as satisfying requirements to track 
beneficial ownership may be difficult for these past ICOs.
    Another challenge is that though SEC Chair Clayton has been clear 
that nearly all of the ICO market need comply with securities laws, 
until more enforcement actions are brought, potentially litigated and 
upheld in court, many issuers and exchanges will possibly continue to 
skirt their obligations. As the SEC stated in its Munchee Order, it 
will take more than semantics and more than a token being functional on 
a network to be exempt from securities regulation.\71\
---------------------------------------------------------------------------
    \71\ Order Instituting Cease-and-desist Proceedings Pursuant to 
Section 8A of the Securities Act of 1933, making Findings, and Imposing 
a Cease-and-desist Order (Release No. 10445) (December 11, 2017) 
https://www.sec.gov/litigation/admin/2017/33-10445.pdf.
---------------------------------------------------------------------------
    The crypto-markets have gotten some clarity with the SEC stating 
that the two largest coins, Bitcoin and Ether are not currently 
securities. There are strong cases to be made, though, that a number of 
the other large market cap tokens are noncompliant securities. If large 
market cap tokens, such as XRP (sold by Ripple) or EOS (sold by 
Block.one), are concluded to be non-compliant securities--there are 
strong arguments that they pass the Howey Test and are--exchanges 
offering trading in these tokens will need to comply with SEC 
regulatory requirements or cease offering these products.
    Also, the SEC will need to decide if they might issue rules and 
interpretations specific to the crypto-space. To date, they have chosen 
not to do so, but with the advent of the Internet and electronic 
trading in the 1990s, the SEC issued a number of new regulations for 
those novel market developments. A similar approach could be adopted 
here.

    Crypto-Derivatives

    If an exchange offers derivatives on cryptocurrencies, then that 
exchange must register with the CFTC either as a DCM or as a SEF. 
Exchanges that offer leverage or margin for the purchase of 
cryptocurrencies may come under the definition of offering `retail 
commodity transactions' and thus also be required to register.
    The CFTC has yet to finalize a proposed interpretation that may 
help determine the breadth of crypto-exchanges that will need to 
register.\72\ Under the CEA, the CFTC has jurisdiction over any retail 
commodity transaction entered into on a leveraged or margined basis 
that does not result in actual delivery of the underlying commodity 
within 28 days. Under a proposed CFTC interpretation, ``actual 
delivery'' occurs if within 28 days of execution, only if a full 
transfer of the cryptocurrency is transferred between the seller and 
buyer as recorded on the relevant blockchain (not merely on the 
exchange's data base or wallet), whether it is reflected on the 
recipient's private wallet and whether the recipient has control of the 
private key.
---------------------------------------------------------------------------
    \72\ Retail Commodity Transactions Involving Virtual Currency--80 
FR 60335.
---------------------------------------------------------------------------
    Given how crypto-exchanges' transactions are currently being 
conducted for levered or margined cryptocurrency, many exchanges may be 
holding cryptocurrencies for retail customers that do not satisfy the 
``actual delivery'' exemption. These crypto-exchanges therefore might 
be offering trading of a form of a retail commodity transaction subject 
to CFTC regulations.
    Thus, the CFTC's final interpretation with regard to the definition 
of `actual delivery' will be important. At one end--nearly all of the 
crypto-exchanges offering margin to the retail public would need 
register with the CFTC. At the other end for the final interpretation--
gaps in crypto-exchange market integrity and custodial duties oversight 
will persist.
    The CFTC issued an advisory in May 2018 with respect to crypto-
derivatives listings. The CFTC staff expressed guidance on enhanced 
procedures for exchanges and clearinghouses listing derivatives 
contracts on virtual currency. These enhancements include an 
expectation that exchanges, and clearinghouses enter into information 
sharing arrangements with the underlying crypto-spot market(s).\73\
---------------------------------------------------------------------------
    \73\ CFTC Staff Advisory No. 18-14 (May 21, 2018).
---------------------------------------------------------------------------
    Another challenge for regulators is that blockchain technology 
provides for new algorithmic means to structure binary options and 
contracts for differences, all of which are derivatives under the 
jurisdiction of the CFTC. The bitcoin scripting language and smart 
contracts used on other networks provide ways to structure peer-to-peer 
derivatives which execute and settle automatically based upon pre-
arranged conditions. These blockchain based derivatives could reference 
any commodity--agricultural, metals, energy or financial. The CFTC and 
other regulators will want to ensure that this new technology does not 
presage a new and growing unregulated or dark swaps market.

    Cryptocurrencies (aka Crypto-Cash Commodities)

    Gaps in investor protection also have developed for crypto-
exchanges solely trading cash cryptocurrencies. As previously 
discussed, crypto-exchanges currently have limited guardrails against 
front running, fraud, or other manipulative practices. There have been 
repeated reports of manipulative behavior on these exchanges. There 
have been repeated reports of stolen customer funds through cyber 
hacks. As mentioned, the FIA expressed its apprehension about the lack 
of transparency and regulation of the crypto-cash commodities markets 
underlying Bitcoin futures.
    Currently nearly 70% of the crypto-markets' $250 billion total 
capitalization is represented by the five cryptocurrencies which have 
either been designated by the SEC as not securities (Bitcoin and Ether) 
\74\ or were forks off of Bitcoin or Ether (Bitcoin Cash in 2017, 
Litecoin in 2011, Ethereum Classic in 2016).
---------------------------------------------------------------------------
    \74\ Digital Asset Transactions: When Howey Met Gary (Plastic); 
William Hinman, SEC (June 14, 2018) https://www.sec.gov/news/speech/
speech-hinman-061418.
---------------------------------------------------------------------------
    The CFTC has general anti-fraud and anti-manipulation authorities 
with regard to spot transactions in these crypto-cash commodities, such 
as Bitcoin or Ether. This authority is critical for cryptocurrencies 
referenced in the derivatives markets but may be increasingly important 
as well for retail investors in crypto-cash commodities. The agency, 
though, does not currently have express registration or plenary rule 
writing authorities with regard to cash commodities.
    One troubling recent development highlights the need for such 
authorities. The CME was unable to get underlying transaction data from 
the four crypto-exchanges upon which they rely for the Bitcoin index 
referenced by their Bitcoin futures contract. It's been reported that 
these four exchanges (Bitstamp, Coinbase, Itbit, and Kraken) refused to 
provide the data until the CFTC stepped in with subpoenas.\75\ It is 
critical to the functioning of any crypto-derivatives markets that both 
self-regulatory organizations and government regulators have ready 
access to trading data for the underlying referenced crypto-cash 
commodities.
---------------------------------------------------------------------------
    \75\ What Do We Know About the CFTC Price Manipulation Probe; 
Cointelegraph (June 15, 2018) https://cointelegraph.com/news/what-do-
we-know-about-the-cftc-price-manipulation-probe.
---------------------------------------------------------------------------
    The SEC is grabbling with similar issues with regard to its review 
of possible crypto-related ETFs and crypto-investing by mutual funds. 
The SEC has rejected a number of filings for Bitcoin ETFs, starting 
with the Winklevoss Bitcoin Trust (COIN ETF) in March 2017. The SEC 
stated two requirements that the exchanges had not must satisfied in 
order to list a Bitcoin ETF: ``the exchange must have surveillance-
sharing agreements with significant markets for trading the underlying 
commodity or derivatives on that commodity. And second, those markets 
must be regulated.'' It further cited ``concerns about the potential 
for fraudulent or manipulative acts and practices in this market.'' 
\76\
---------------------------------------------------------------------------
    \76\ SEC Release No. 34-80206; File No. SR-BatsBZX-2016-30; March 
10, 2017 https://www.sec.gov/rules/sro/batsbzx/2017/34-80206.pdf.
---------------------------------------------------------------------------
    In a subsequent staff letter published in January 2018, the SEC 
raised a series of questions regarding, amongst other things, 
appropriate valuation methods available for crypto-assets, liquidity of 
crypto-markets, custody of crypto-funds and potential manipulation in 
these markets.\77\
---------------------------------------------------------------------------
    \77\ Staff Letter: Engaging on Fund Innovation and Cryptocurrency-
related Holdings; SEC (January 18, 2018) https://www.sec.gov/divisions/
investment/noaction/2018/cryptocurrency-011818.htm.
---------------------------------------------------------------------------
    Failing to better oversee the crypto-cash commodities markets also 
leaves investors vulnerable, illicit activity hard to control and 
custodial responsibilities to vagaries of state enforcement of money 
transmitter laws. The volumes, millions of customers, repeated hacks 
and reports of manipulative behavior, suggest that oversight of crypto-
exchanges trading solely in crypto-cash commodities is worthy of 
consideration.
    Furthermore, as the CFTC staff discussed in their recent advisory, 
there are differences between crypto-cash commodities and other 
commodities. They said:

          ``To date, virtual currencies have gained prominence as they 
        are bought and sold for investment, speculative, or financial 
        purposes. Those transactions greatly predominate over 
        commercial uses of virtual currency--such as to purchase goods 
        and services--which are still developing. Thus, virtual 
        currencies differ from commodities like oil and gold where 
        commercial uses predominate or at least provide points of 
        comparison. At the same time, virtual currencies differ from 
        financial indices and other commodities for which robustly-
        regulated markets facilitate price verification and provide 
        insight into the reasons for price changes.'' \78\
---------------------------------------------------------------------------
    \78\ CFTC Staff Advisory No. 18-14 (May 21, 2018).

    Gemini Trust Company (Gemini), the crypto-exchange founded by 
Cameron and Tyler Winklevoss, recently proposed setting up a self-
regulatory organization (SRO) for crypto-exchanges dealing in crypto-
cash commodities or what they call `virtual commodities.' In the medium 
post calling for the SRO, Cameron and Tyler Winklevoss articulate a 
view that virtual commodities should have an additional layer of 
oversight beyond that which other cash commodities have stating: ``Cash 
markets for virtual commodities, however, are unique inasmuch as: (a) 
the commercial use-cases for virtual commodities are still developing, 
(b) there is strong speculative interest, (c) these marketplaces 
involve a large number of individual participants, and (d) technology 
makes individual transaction costs exceptionally low (on a relative 
basis) as compared to other physical commodity spot markets.'' \79\
---------------------------------------------------------------------------
    \79\ Proposal for a Self-Regulatory Organization for the U.S. 
Virtual Currency Industry; Cameron Winklevoss (March 12, 2018) https://
medium.com/gemini/a-proposal-for-a-self-regulatory-organization-for-
the-u-s-virtual-currency-industry-79e4d7891cfc.
---------------------------------------------------------------------------
    It is a logic for additional oversight of crypto-cash commodities 
somewhat consistent with the recent CFTC staff advisory discussion. 
Though the logic is directional sound, I believe that a Federal 
oversight regime is appropriate if we are to achieve the public policy 
goals for crypto-exchanges of guarding against illicit activity, 
ensuring stability, protecting investors and promoting market 
integrity, with SROs playing an important supportive role as they do in 
securities and derivatives markets.
    Given frauds and other concerns in the retail foreign exchange 
markets, Congress, in the 2008 Farm bill, included provisions for the 
first time for CFTC registration and regulation of retail foreign 
exchange dealers (RFEDs). Similarly, the CFTC and Congress might wish 
to consider allowing retail cryptocurrency exchanges to register as 
RFEDs, though cryptocurrencies are not foreign currency, and while 
ensuring that cryptocurrencies remain distinct from fiat currencies for 
other parts of the commodities law.
    Or Congress may wish to consider if it would be more appropriate to 
provide the CFTC--or another agency--with general authorities to write 
rules for crypto-cash commodities markets, including possibly requiring 
registration for trading on crypto-exchanges solely dealing in 
cryptocurrencies, aka crypto-cash commodities.

    Custodial Functions

    The Wall Street Journal reported this week: ``Regulatory gaps and 
insufficient levels of defense have made some exchanges simple to 
breach.'' \80\ Seven hacks to date in 2018 have led to $800 million in 
customer funds being stolen from crypto-exchanges. Over $1.6 billion 
has been stolen in 56 reported hacks since 2011. No doubt, more has 
been lost to unreported thefts and cyber-attacks.
---------------------------------------------------------------------------
    \80\ Cryptocurrency Exchanges Are Getting Hacked Because It's Easy; 
Wall Street Journal (July 16, 2018) https://www.wsj.com/articles/why-
cryptocurrency-exchange-hacks-keep-happening-1531656000.
---------------------------------------------------------------------------
    Though Bitcoin and many blockchains themselves have been generally 
resistant to hacks, with the integrity of their ledgers preserved, 
there are significant weaknesses in other areas and layers within the 
crypto-ecosystem.
    Unlike traditional exchanges, crypto-exchanges hold significant 
customer funds in digital wallets--a state of affairs that directly 
contradicts the principles of decentralized user-based control of 
digital assets upon which Bitcoin was initially built. The aggregate of 
these customer crypto-assets is then represented on a particular 
token's blockchain associated with the public keys of the exchange, not 
the individual customers. As mentioned previously, Coinbase reports to 
have custody of over $20 billion in customer crypto-funds.
    In contrast, customers trading on traditional securities exchanges 
with intermediated access have their securities recorded at a transfer 
agent, and held by a broker or dealer, not the exchange. Customers 
trading on derivatives platforms, have their trades recorded and margin 
posted at regulated clearing houses and FCMs.
    Exchanges are exploring whether new approaches, such as multi-
signature wallets, might aid in protecting the security of customer 
funds.\81\ But for now, the existing system is operating with a glaring 
gap in investor protection. With well over 90% of daily trading volume 
in Bitcoin occurring through crypto-exchanges rather than being 
recorded as a transaction directly within the blockchain, and with the 
public accessing these exchanges without the benefit of regulated 
intermediaries, it is critical to put in place Federal requirements for 
the custody of crypto-assets.
---------------------------------------------------------------------------
    \81\ The sad state of crypto custody; Techcrunch (February 1, 2018) 
https://techcrunch.com/2018/02/01/the-sad-state-of-crypto-custody/.
---------------------------------------------------------------------------
    In the U.S. to date, the only regulatory safeguards have been 
through state-administered money transmission regulations. This 
approach--regulating exchanges' custodial duties in the same manner 
that Western Union and MoneyGram are regulated--is not satisfactory.
    In some countries, particularly Japan, authorities have required 
crypto-exchanges to register and meet certain custodial duties to 
protect customer funds stored in an exchange's digital wallets.
    The public policy goals should be the same, whether the asset is 
crypto in nature or a more traditional security or derivative. 
Exchanges should fully segregate customer funds and ensure that they 
not lose those funds and not use those funds.
    When considering existing custodial rules, the specifics of 
blockchain technology, public keys and cryptography will need to be 
considered. New technologies, such as multi-signature controls might 
protect customers or fulfill certain custodial responsibilities. Added 
safeguards, need be considered for the private keys associated with 
exchanges', asset managers', banks' or regulated intermediaries' public 
keys. Additional cyber-security and other safeguards might be 
appropriate, particularly given the numerous losses and hacks that have 
occurred in the past.
Conclusion
    In conclusion, blockchain technology has a real potential to 
transform the world of finance. Though there are many technical and 
commercial challenges yet to overcome, I'm an optimist and want to see 
this new technology succeed. It could lower costs, risks and economic 
rents in the financial system.
    For broad adoption--both as a technology solution and as part of 
the capital markets--the technology and its various applications need 
to come within existing public policy frameworks. Basic norms and 
principles to guard against illicit activity, ensure for financial 
stability, and protect investors and market integrity, while promoting 
innovation, should consistently guide public policy.
    Clear rules of the road also will allow firms--both incumbents and 
start-ups--to more fully explore investing in crypto-assets or 
blockchain technology. Today, start-ups have an advantage as incumbents 
do not take the same reputational and regulatory risks that startups 
generally are willing to take. Startups, so to speak, are more willing 
to beg for forgiveness while incumbents more often need ask for 
permission.
    Bringing clarity and compliance will have its challenges. There are 
numerous crypto-exchanges and thousands of ICO launched tokens in 
significant non-compliance. Congress and this Committee have a role to 
play as well, monitoring developments, overseeing compliance, and, when 
appropriate, updating laws. It also will be critical that sufficient 
resources be provided the CFTC, SEC and other agencies to adequately 
oversee crypto-markets, especially as these markets have continued to 
grow.
    Market participants, the investing public, entrepreneurs, 
technology developers, regulators and Congress all will play a role. In 
particular, crypto-exchanges and ICOs should now seek to comply with 
the law to fullest extent possible.
    The public, blockchain technology, and the financial system will 
all reap the benefits.
    Thank you again for inviting me today, and I look forward to your 
questions.

    The Chairman. Thanks, Mr. Gensler.
    Mr. Ness, 5 minutes.

STATEMENT OF LOWELL D. NESS, J.D., MANAGING PARTNER, PALO ALTO 
            OFFICE, PERKINS COIE LLP, PALO ALTO, CA

    Mr. Ness. Thank you all for inviting me to testify this 
morning.
    I certainly agree with everybody that has gone before me 
that this technology does have the potential to be 
transformative.
    One of the questions I get asked a lot is why don't we just 
call these things securities? We have securities regulations. 
We could create a scenario where these things get registered 
and then become freely tradable, so why not just call them 
securities, deal with the existing laws? The problem with that 
is they exhibit some characteristics of securities during 
certain phases and not in others; especially when we get to 
full functionality when it is a truly completed product that is 
being sold, the intention of that product is to be used in a 
network, and that really can't happen--at least not at the 
speed of software, which is really the fundamental principle 
here behind these decentralized protocols is to allow for value 
transfers truly at the speed of software. You can't do that if 
everybody has to be a broker-dealer and all the intermediaries 
have to interact in a way that would be appropriate for 
securities.
    We need to come up with a fairly novel and pragmatic 
approach to dealing with the fact that there needs to be some 
investor protections, particularly in the early stages while 
the things are a PowerPoint deck and an idea in somebody's 
mind. But find ways to create some clarity around how and when 
it goes from being sold as a security to being sold as a 
commodity. And that is a very important imperative right now 
because we are seeing so much activity, frankly, and the threat 
of people going offshore for lack of clarity is a very real 
one.
    I will say in my 25 years in Silicon Valley, I have not 
seen circumstances where you go to a meet-up in places like 
Palo Alto or even San Jose and you see regulators from Zug, 
Switzerland; Singapore; Hong Kong; and Bermuda et cetera. To 
avoid any kind of race to the bottom, I do think that there is 
a serious imperative about getting something done before we 
have a situation where we are trying to entice people back into 
the country, because then the standards would really have to be 
lowered to do that. I think we have an opportunity now if we 
get ahead of the true flight, but that is an important idea 
around why we need some of the bright lines.
    To that end, I did in some of my written testimony include 
some materials and a proposed regulatory framework that both 
talk about what the existing laws and how the existing laws 
treat these so-called utility tokens, and there is a 50-page 
memo on how the existing laws work. To avoid having to go 
through that 50-page memo type analysis with each and every one 
of these, I think the bright lines are really what is 
necessary.
    There is a regulatory framework that we have been thinking 
a lot about how that would create that set of bright lines that 
would enable the regulators and the companies going out there 
to really know how to sort the good ones from the bad ones. I 
do think that starts with this test around how we in the 
investment contract analysis for regulating securities as 
securities in the primary offering, if they are being sold pre-
functional--before they are fully functional. But coming up 
with ways to say that once they are fully functional, how do we 
let them now trade as commodities effectively, and the trading 
is important because as I said, this is the movement of value. 
To have value, it needs a price and the markets really are a 
necessary part of this. The fact that there are secondary 
markets is a key part of this. They need to be able to trade in 
those markets to establish price. They also need to be able to 
be used in their networks as non-securities, and so we need to 
come up with ways to say when they are being sold to investors 
as investments, let's treat them like securities. When they are 
being used in the network or they are being traded in the 
secondary markets, let's call them commodities.
    Thank you.
    [The prepared statement of Mr. Ness follows:]

Prepared Statement of Lowell D. Ness, J.D., Managing Partner, Palo Alto 
                Office, Perkins Coie LLP, Palo Alto, CA
U.S. Regulatory Framework for Digital Assets
Introduction
    We support the regulatory mission of investor protection and full 
and fair disclosure. We also support aggressively dealing with 
fraudulent actors in the blockchain technology industry. We believe it 
is essential to both market participants and the regulatory community 
that bad actors are dealt with through targeted strikes and regulatory 
action. We also believe it is equally essential to provide clear 
guidance beyond enforcement actions to allow continued development and 
innovation around what many believe to be potentially transformational 
technology development. It is in that spirit that we welcome this 
engagement with the regulatory community toward defining a regulatory 
framework that best addresses market participant protection and 
continued growth and development of blockchain technologies.
    Blockchain technology (also called ``distributed ledger 
technology'') allows the creation of a software ledger that is 
distributed, meaning many copies of the ledger exist and are 
automatically kept in sync such that no one actor can alter the ledger 
without employing a defined consensus mechanism among the actors. This 
technology allows assets to be traded on a ledger that is not 
maintained by a centralized ``trusted'' actor. Blockchain technology 
allows ledger transactions to occur immediately, immutably and 
transparently, without the need for reconciliation of multiple 
proprietary ledgers. This is, arguably, the most fundamental change to 
ledger technology since double-entry accounting. Double-entry 
accounting helped trading counterparties trust each other. Blockchain 
technology removes the need for centralized trusted intermediaries to 
act as the go between for trading counterparties. While the Internet 
enables the free flow of information, blockchain technology enables the 
free flow of value. More specifically, blockchain technology enables 
the creation of many types of digital assets, including digital 
currencies, digital goods and services, software tokens and digital 
securities (e.g., tokenized debt or equity).
    This memorandum addresses the regulatory framework for the 
application of U.S. securities laws and commodities laws to these 
various types of digital assets, with a focus on the treatment of 
utility tokens. Tokenized goods and services are non-fungible tokens 
that are merely intended to represent specific goods or services, so 
their regulatory status should simply follow from the regulatory status 
of the good or service they represent. Other digital assets require 
somewhat more complicated analysis to determine their regulatory 
status.
Digital Currencies, Digital Securities & Utility Tokens
    At one end of the spectrum, digital currencies are fungible tokens 
that have no other marketed functionality than use as a medium of 
exchange or stored value. These types of tokens (e.g., Bitcoin) are 
subject to various U.S. Federal and state as well as foreign money 
transmission laws, are treated as property under U.S. tax laws, and are 
treated as commodities under U.S. commodities laws. Offers and sales of 
digital currencies should not be viewed as securities under the Howey 
test, absent unusual facts (such as promising efforts to maintain 
secondary market liquidity or token architectural features like burning 
tokens intended to reduce supply and increase the value).
    At the other end of the spectrum, digital securities are tokenized 
traditional securities (e.g., debt or equity) or investment contract 
type securities that offer a direct financial return from an 
identifiable issuer. These types of tokens would clearly be securities 
and would generally not be subject to commodities laws or money 
transmission laws per se.
    Utility tokens are intended to be used by users of a software 
network and do not represent an equity interest (or any other corporate 
obligation), but they do attract speculative resellers, which 
implicates the Howey test. The Howey case law is highly nuanced and, 
therefore, challenging to interpret, leading to uncertainty. As a 
general matter, U.S. Federal securities laws were developed and have 
evolved primarily for and around equity securities (and other corporate 
obligations). There is much less clarity around investment contract 
type securities, particularly investment contract type securities that 
offer no direct financial return, but nevertheless enjoy robust 
secondary markets.
    The Howey test requires a reasonable expectation of profits. A 
purchaser may be led to expect profits either from a direct financial 
return (e.g., an ownership interest in a business or a promise of 
payment) or from a rising price in secondary markets. Ordinarily, if 
there is no direct financial return, and the object being sold has 
never been sold before, there would be no reasonable expectation of 
profits. This is because a reasonable purchaser would not expect a 
novel product to have any secondary market liquidity. The fact that 
every team, every time, seems to be able to general an immediate 
secondary market for its newly minted utility token, is astonishing, 
but has become a fact of life. At this point, the expectation of 
profits from secondary market activity has become a given. It would be 
difficult to point to another phenomenon where this was the case. This 
is the first factor in the utility token analysis that is arguably 
unique.
    An expectation of profits is not, however, sufficient to form an 
investment contract. The expectation of profits must be based on the 
efforts of others. Most investment contracts, including Howey itself, 
involve the promise of direct financial returns. When a promoter offers 
a financial return to the purchaser, the efforts of others continue for 
the life of the financial return, which would mean indefinitely in the 
case of an ownership interest in a going concern. When no direct 
financial return is offered, however, and the only expectation of 
profits comes from the hope of a rise in price in secondary markets, 
the efforts of the promoter are only relevant so long as the product is 
being developed by the promoter. This temporal qualification is the 
second factor in the utility token analysis that is unique and leads to 
the concept of mutability, discussed in our memorandum to the SEC dated 
March 26, 2018 regarding the Investment Contract Analysis of Utility 
Tokens. As discussed in that memorandum, the token itself is never a 
security, but the facts and circumstances surrounding the sale of the 
token likely constitute an investment contract while the token is in 
the development stage because the buyer's expectation of profits are 
based on the seller's efforts to complete development of the token. 
Once the token has been fully developed and the facts and circumstances 
no longer support an investment contract conclusion, the offer and sale 
of the token should be treated as the sale of any other commodity 
trading in spot markets. As a result, under the Howey test, token sale 
agreements could constitute investment contracts under some 
circumstances but not others.
    Some would prefer to resist the implications of mutability by 
simply treating all tokens as securities forever. Treating all tokens 
as immutable securities, however, (i) would not be analytically 
consistent with existing law and (ii) would not allow tokens to be used 
for their intended purpose--access to products and services on a 
network, which would inevitably cause development to relocate 
abroad.\1\ China, whose securities laws arguably are not as nuanced, 
took a binary approach to regulation and banned all token sales in 
China instead of adopting tailored protections that would enable the 
development of the technology to continue in China. We believe the law 
and guidance around what constitutes an investment contract should be 
clarified. We believe that the industry's and the regulators' interests 
are aligned in establishing clear rules and appropriate investor 
protections so that capital formation in blockchain technology is not 
derailed and development can continue to flourish in the United States.
---------------------------------------------------------------------------
    \1\ For example, a social network that uses a token as a micro 
payment for a micro task like submitting a blog post, would be engaged 
in the unregistered and, presumably, non-exempt sale of a security if 
the token were a security.
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Proposed Regulatory Framework for Utility Tokens
    To remedy the uncertainty and confusion in this space, we are part 
of a group of academics, venture capital firms and law firms practicing 
in this area that has proposed the following regulatory framework to 
serve as the basis for a more detailed non-exclusive safe harbor that 
would help provide guidance to the industry on what constitutes an 
``investment contract'' and how the investment contract law and 
guidance should apply to utility tokens with respect to primary sales, 
resales and use of the tokens for their intended purposes. Similar to 
the steps the SEC took by putting in place Regulation D, a non-
exclusive safe harbor to address the uncertainty caused by SEC v. 
Ralston Purina in the private placement arena, we believe the proposed 
framework outlined below could be codified in a no-action letter or 
series of no-action letters that could ultimately lead to a rulemaking 
around a safe harbor that will assist in relieving the regulatory 
uncertainty around utility tokens. The goals of the proposed framework 
are to (i) establish clarity for the industry, (ii) permit use of 
tokens for their intended purposes (i.e., on their software platform) 
and (iii) establish appropriate investor protections for both primary 
sales and resales of tokens, with emphasis on eliminating trading 
manipulation.
    The industry's need for clarity is obvious. Currently, the vast 
majority of token sales are smaller token sales that have not been 
reviewed by counsel or that are merely attempting to follow precedent 
transactions in a highly nuanced area with varying models and no bright 
line rules. The regulators would also benefit from clarity. The 
proposed framework would require affirmative consent to jurisdiction, 
which has been challenging in light of the global and distributed 
nature of token sales. The proposed framework allows regulators to (i) 
define the contours of jurisdiction (and therefore responsibility), 
(ii) avoid the incongruent result of defining all tokens as securities 
(while tokens have security-like characteristics at one stage, the 
regulatory scheme must also permit use of tokens for their intended 
purposes) and (iii) provide an efficient structure for continued 
capital formation.
    The proposed framework is largely based on the application of 
existing case law and regulatory principles, such as Rule 144 and Rule 
701, to tokens, but proposes bright lines to clarify existing case law 
and regulation in a way that is practical and useful for all 
constituents. The proposed framework has been vetted by, and has the 
support of, many of the key players in the industry. We believe the 
proposed framework works well from the perspective of both industry and 
the regulators by balancing market participant protections and capital 
formation.
    In general, offers and sales of tokens meeting the specified 
conditions would not be deemed securities transactions (except for 
purposes of application of general anti-fraud and manipulation rules, 
such as Rule 10b-5) once the tokens have achieved either full 
functionality or full decentralization (as described below) and may be 
exchanged as non-securities in secondary markets subject to the general 
anti-fraud and manipulation rules of each of the CFTC and the SEC. 
Token sellers would, however, impose certain investor protection 
requirements tailored to each stage. The no-action letter(s) and any 
eventual safe harbor would be non-exclusive as there will be tokens 
clearly purchased for consumptive purposes, such as non-fungible 
tokenized goods and services. The principles of the proposed framework 
are as follows:
    Pre-Functionality--Until the token achieves full functionality, 
offers and sales of tokens would generally constitute investment 
contract type securities under Howey, unless a reasonable purchaser is 
purchasing with consumptive intent.\2\ In this case, the token should 
generally be treated as a security unless use of the token (as opposed 
to resale) is reasonably certain. As such, this stage would include the 
following features:
---------------------------------------------------------------------------
    \2\ Consumptive intent, as opposed to investment intent, would 
generally be established if the purchaser is only able to use the token 
for its intended purpose and is not able to resell the token for 
profit. The existence of consumptive intent was a key determinant, for 
example, in United Housing Foundation, Inc. v. Forman, 421 U.S. 837 
(1975).
---------------------------------------------------------------------------
    Primary sales--Existing securities laws would apply to primary 
sales of the token. Primary token sale agreements would continue to be 
generally treated as securities based on the investment contract 
analysis under Howey. Primary sellers of tokens would be able to rely 
on available exemptions from registration (e.g., Rule 506(b), Rule 
506(c), Regulation S, Rule 701) and the SEC would retain full 
regulatory authority to enforce violations under existing Federal 
securities laws.
    Resales--Any resales or assignments of the primary token purchase 
agreement, which is the security under Howey, by purchasers or 
affiliates of the token creator would also need to rely on existing 
resale exemptions under the securities laws. Resales of the token would 
also be subject to the special resale lockup and resale volume 
restrictions described below.
    Use for Intended Purpose--Tokens would be able to be earned or used 
as intended through the network, so long as either (i) resale is not 
possible,\3\ or (ii) the network on which the tokens can be used will 
be shut down within some reasonably finite period, say 6 months (i.e., 
these are testnet tokens that have no resale value).
---------------------------------------------------------------------------
    \3\ During this stage of token development, we believe that resale 
should either be extremely unlikely (i.e., in the case of testnet 
tokens) or effectively impossible. More practical (i.e., less 
stringent) resale lockup mechanics may be more appropriate for tokens 
that achieve full functionality.
---------------------------------------------------------------------------
    Full Functionality--Once the token achieves full functionality, 
offers and sales of tokens would generally not constitute investment 
contracts under Howey. Software networks, however, generally require 
ongoing updates and upgrades, so it may be appropriate to create 
limited but ongoing investor protections.\4\ As such, this stage would 
include the following features:
---------------------------------------------------------------------------
    \4\ Ongoing software updates and upgrades constitute ongoing 
efforts of others under Howey, but they are not likely to rise to the 
requisite level of efforts to form an investment contract. The case law 
is particularly challenging to apply to the facts in this area, which 
makes it difficult to determine whether investor protections should 
apply. Nevertheless, we believe that limited ongoing investor 
protections, even at this stage of token functionality, are essential 
in ensuring that capital raising is not derailed in this industry by 
pump and dump or get rich quick schemes taking advantage of immediate 
liquidity in secondary trading markets for tokens.
---------------------------------------------------------------------------
    Primary Sales--Primary sales of tokens below the Per Purchaser 
Limit (described below) would be able to be made without being subject 
to lockup or volume restrictions. Larger purchasers, however, would 
need to be accredited investors and are subject to the special resale 
lockup and resale volume restrictions described below. Tokens would be 
able to be gifted or otherwise distributed to users, service providers, 
strategic partners and other participants without an exchange of money, 
including mining, also without being subject to lockup or volume 
restrictions.\5\
---------------------------------------------------------------------------
    \5\ For equity securities, we would typically consider many of 
these non-monetary issuances of stock to be ``sales.'' For tokens, 
there are strong policy objectives around bolstering the use of the 
tokens for their intended purposes. As such, non-monetary transfers of 
tokens for the purpose of seeding potential users to drive network 
adoption or for purposes otherwise related to the token's usage should 
be permitted. To the extent a so-called ``airdrop'' is announced in 
advance as a way to drive up the trading price of the token associated 
with the blockchain on which a new token is being airdropped, we would 
consider this a marketing practice inconsistent with the safe harbor.
---------------------------------------------------------------------------
    Resales--Tokens would be able to be traded on exchanges or resale 
platforms as non-securities, other than for purposes of the general 
anti-fraud and manipulation rules, such as Rule 10b-5.\6\
---------------------------------------------------------------------------
    \6\ There are many variations in the market on token trading 
platforms, from true peer-to-peer to decentralized exchanges that 
provide information supporting peer-to-peer trading or, in some cases, 
matching engines, but that do not take custody of tokens, to hosted-
wallet exchanges running full services as an exchange. How to handle 
exchanges and the mechanics of our proposal will need significant 
further discussion with the Staff. We do not believe, however, that it 
would be appropriate to require all exchanges trading fully functional 
tokens to be registered as Alternative Trading Systems. We believe it 
is essential to apply general anti-fraud and manipulation rules to 
these open exchanges, but it would be counterproductive to treat them 
as ATS's with inapposite rules developed around equity securities and 
other corporate obligations.
---------------------------------------------------------------------------
    Use for Intended Purpose--The token would be able to be earned or 
used on the network for its intended purpose (i.e., on their software 
platform) without being subject to lockup or volume restrictions.
    Full Decentralization (Protocol Tokens) \7\--If a token achieves 
full decentralization (not all will), the token would fall entirely 
outside of Howey since there is no longer an issuer or promoter 
delivering ongoing software updates or upgrades that could potentially 
constitute the requisite efforts of others under Howey. As such, a 
token that achieves full decentralization would be not be deemed a 
security for any purposes other than the general anti-fraud and 
manipulation rules, such as Rule 10b-5.
---------------------------------------------------------------------------
    \7\ ETH is a good example of this type of protocol token that has 
become so decentralized it should not be deemed a security. For 
clarity, ETH is the protocol token for the Ethereum network, so this 
safe harbor provision would apply to ETH, but not necessarily to all 
ERC20 tokens running on top of the Ethereum network unless an ERC20 
token is itself a protocol token. Also, for clarity, a protocol token 
may qualify as a token with full functionality irrespective of whether 
it has achieved full decentralization.
---------------------------------------------------------------------------
Key Defined Terms
    Full Functionality--A token achieves full functionality when a 
token holder can use the token for its intended purpose (marketing 
test), or a token holder can use the token in some meaningful way 
(qualitative use test), or the network in which the token is to be used 
is fully functional in accordance with its whitepaper (operational 
test), or the token's consensus mechanism is working and blocks are 
being published (layer 1 protocol token test). The foregoing are 
examples of functionality criteria, but there may be other indicia of 
functionality that require further discussion in the context of a 
specific no-action letter. Protocol tokens (i.e., tokens that allow 
other developers to build application tokens on top of the protocol 
token network) should be deemed to have immediate full functionality 
when the protocol tokens can be used for their intended purpose by 
developers even if the applications have not been developed yet, while 
application tokens would require their marketed features to be built 
before achieving full functionality.
    Per Purchaser Limit--This could be a dollar limit akin to 
crowdfunding concepts, but would make more sense under Howey as a limit 
that indicates consumptive intent. Each primary token seller could 
establish a limit based, for example, on the number of tokens a user 
might use within a given period of time. In some cases, tokens are 
meant to be purchased by developers who are building other applications 
that will make use of the tokens and will need a larger quantity of 
tokens for their separate development project than would a typical 
user.
    Full Decentralization--A token achieves full decentralization when 
the token creator no longer has control of the network based on its 
ability to make unilateral changes to the functionality of the tokens, 
or based on the number of network nodes controlled by the broader 
community, or based on the code being forkable and open source, or 
based on it being a permissionless network (any node can join), or 
based on affiliated hashpower (proof of work), or based on affiliated 
holdings (proof of stake). Again, these are just examples of indicia of 
control criteria that require further discussion in the context of a 
specific no-action letter.
Primary Token Seller Conditions for Safe Harbor
    Special Resale Lockup and Resale Volume Restrictions--Primary sales 
other than for fully decentralized protocol tokens (i.e., for either 
Pre-Functionality or Full Functionality tokens), would need to include 
a lockup that permits use but not resale for the period ending on the 
later of (i) 6 months following purchase, and (ii) achievement of full 
functionality. In addition, purchasers and affiliates of the token 
creator would need to agree to resale volume limitations.
    Consent to Jurisdiction--Primary token sellers would need to 
consent to jurisdiction of the applicable regulators.
    Consent to Anti-Fraud Rules--The primary token seller would need to 
also agree to the application of the general anti-fraud and 
manipulation rules, such as Rule 10b-5 under Federal securities laws 
with respect to any tokens sold under all circumstances.
    Public Disclosure--Any information that the primary token seller 
provides regarding features and use of the network would need to be 
made publicly available. To achieve full functionality, a white paper, 
superseding any prior white paper, would need to be published detailing 
present functionality and would need to focus on present features with 
only limited and very generalized discussion of future features, if 
any. Other disclosures may be appropriate and would need to be 
discussed in the context of a specific no-action letter.
    Public Marketing--The token seller would not be permitted to market 
the token as an investment, but would be able to provide disclosures 
consistent with Rule 506(c) and Rule 134. Any marketing materials made 
public would only be able to relate to the token's functionality, not 
its resale value.
    Legends/Smart Contracts--Primary token seller would need to enforce 
lockups.
    Token Features--The tokens would not (i) have one or more features 
that make them a ``security'' under one of the other concepts in the 
definitions under the 1933 Act or 1934 Act, or (ii) constitute an (a) 
ownership interest, (b) equity interest, (c) a share of revenue, profit 
and/or loss, or assets and/or liabilities, (d) status as a creditor or 
lender, (e) claim in bankruptcy, (f) holders of repayment obligations, 
or (g) right to convert into an investment interest, all with respect 
to the token project or network application, or any legal entity.
Exchange Conditions for Safe Harbor
    The conditions for an exchange to list a utility token as a non-
security requires further discussion in the context of a specific no-
action letter, including with respect to (i) the exchange's role 
regarding FinCEN KYC/AML regulations; (ii) the exchange's role relating 
to resale limitations on tokens; and (iii) consent to jurisdiction for 
enforcement of general anti-fraud and manipulation rules.
Reseller Conditions for Safe Harbor
    Resellers would need to comply with any lockup and volume 
limitations.
    Resellers would need to be subject to the general anti-fraud and 
manipulation rules, such as Rule 10b-5.
Conclusion
    We believe that the above regulatory framework ensures the goals of 
investor protection, clarity for market participants and support for 
blockchain technology. While the SEC retains significant jurisdiction 
under the proposal, the CFTC would also retain the ability to regulate 
fraud and market manipulation in the token spot markets, in addition to 
its full authority to regulate any derivative token markets. FinCEN 
remains the primary regulator with respect to all KYC/AML requirements, 
and the FTC would also have jurisdiction for any consumer protection 
actions associated with misleading advertising.
                               Attachment
March 26, 2018

 
 
 
      To:    William Hinman, Director, Division of Corporation Finance
             Amy Starr, Chief, Office of Capital Markets Trends
             Valerie Szczepanik, Assistant Director, Head of the SEC
              Distributed Ledger Technology Working Group
    From:    Perkins Coie LLP
      Re:    Investment Contract Analysis of Utility Tokens
 

    This memorandum discusses whether and under what circumstances so-
called ``utility tokens'' would be securities as defined under the 
Securities Act of 1933, as amended (the ``Securities Act'').\1\
---------------------------------------------------------------------------
    \1\ While other U.S. securities laws have slightly different, and 
in some cases broader, definitions of a security, the most immediate 
concern for utility tokens is whether a token sale to the general 
public may constitute a violation of Section 5 of the Securities Act. 
Outside the United States, except for Canada, we have not run into a 
jurisdiction where the securities laws would apply the investment 
contract test discussed in this memorandum according to local counsel. 
So far, utility tokens have been deemed non-securities in places like 
Switzerland, Singapore, Hong Kong, Bermuda, the Cayman Islands, and the 
British Virgin Islands, among others.
---------------------------------------------------------------------------
Executive Summary
    In Howey \2\ and its progeny, including the cases discussed in the 
DAO Report,\3\ the Securities and Exchange Commission (the ``SEC'') and 
the courts have laid out the characteristics of an ``investment 
contract,'' emphasizing that the analysis of what is and is not an 
investment contract can be based on the facts and circumstances 
surrounding each offer and sale. Inherent in any analysis based on 
facts and circumstances is the reality that the analysis may yield a 
different conclusion at different points in time as circumstances 
change. In the case of tokens, and the underlying blockchain 
technology, the market dynamics have, in fact, changed over time, as 
market participants have adjusted to a better understanding of both the 
technology and the applicable regulatory requirements. Currently, it is 
widely accepted that a pre-functionality sale of tokens may well 
constitute an ``investment contract,'' and hence a security, within the 
meaning of Section 2(a)(1) of the Securities Act. This conclusion flows 
from the likelihood that a reasonable purchaser expects to profit in 
the secondary market for the tokens based on the efforts of the token 
seller to build the network or application in which the token is used. 
Accordingly, most market participants are initially purchasing a pre-
functionality token sale agreement, which is offered and sold in 
accordance with Rule 506(b), Rule 506(c) or Regulation S, and which 
represents a right, at a future time, to delivery of utility tokens. In 
this context, the pre-functionality token sale agreement is the 
security, and it is subject to the resale restrictions imposed by 
Regulation D or other applicable exemptions, under the Securities Act. 
At the point at which the utility tokens achieve a sufficient level of 
functionality, such that their value is no longer dependent on the 
efforts of others, the pre-functionality token sale agreement is 
effectively extinguished and the holder thereof receives delivery of 
the tokens. A token by--itself is never an investment contract--
Dogecoin \4\ is simply a meme that can be transferred via blockchain 
operations. The investment contract arises from the understanding as to 
how the token will be developed into something of useful value. In this 
memorandum we discuss the legal analysis supporting our views with 
respect to the legality of these transactions and the legal status of 
the tokens, both pre- and post-functionality. We also discuss more 
broadly the legal framework in which token sales take place.
---------------------------------------------------------------------------
    \2\ SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (hereinafter, 
``Howey'').
    \3\ Report of Investigation Pursuant to Section 21(a) of The 
Securities Exchange Act of 1934 (Exchange Act Rel. No. 81207) (July 25, 
2017) https://www.sec.gov/litigation/investreport/34-81207.pdf 
(hereinafter the ``DAO Report'').
    \4\ http://dogecoin.com/.
---------------------------------------------------------------------------
    The key difference between (i) an equity offering or the forward 
sale of an extant commodity and (ii) an offering of utility tokens is 
the fact that equity is inherently a security by its nature and extant 
commodities are non-securities by their nature and that nature never 
changes. Equity fundamentally represents a right to a share of the 
profits of the issuer, so equity securities never ``transform'' from a 
security to a non-security because their fundamental nature does not 
change. The treatment of a contract as an investment contract, and 
hence as a security, however, is entirely based on a test that is 
driven by the facts and circumstances at the time of the offer and 
sale. Thus, it is possible for a contract for the sale of tokens to be 
an investment contract under one set of circumstances, while a 
subsequent contract for the sale of the same tokens is not an 
investment contract when sold under different circumstances. In this 
case, the transformation is not de jure, but arises from a change in 
the facts and circumstances, i.e., ipso facto. Since one of the key 
facts underpinning the efforts of others element set out in Howey is 
the promoter's efforts to build functionality, there may well be a 
different result with respect to an offer and sale made at a time when 
functionality exists, versus at a time when it does not. Indeed, if 
tokens are delivered to the pre-functionality token purchasers after 
full functionality has been created, the efforts of others element 
would no longer be met under Howey, and any subsequent resale of the 
tokens should not constitute an investment contract.
    If we assume that the expectation of profits prong under Howey is 
always met based on today's frothy secondary markets, and if we ignore 
the other prongs of the test, the only remaining question is whether 
the expectation of profits is sufficiently based on the efforts of 
others. The courts use objective criteria to determine when a 
reasonable purchaser expects to profit on the efforts of others, not 
the subjective mind set of each purchaser. Thus, even if token 
purchasers currently may be described as irrationally exuberant, 
meeting the Howey test is within the control of the token seller 
because the test is objective not subjective. It follows that there is 
a ``right way'' for token sellers to construct tokens and conduct token 
sales, initially as a security, but once the token has achieved full 
functionality, it should be treated as a non-security that will 
ultimately trade on spot markets regulated under the anti-fraud rules 
administered by the CFTC.
    In addition to being analytically inconsistent with existing law, 
categorizing tokens immutably as securities will mean that tokens 
cannot be used for their intended purposes in the United States. 
Securities cannot be used in the way utility tokens are intended to be 
used (e.g., as micro payments for micro tasks on a social network). 
From a policy perspective, it is important that we apply our securities 
laws in such a way that inapposite regulation does not cause today's 
highly mobile workforce to develop these technologies abroad (as many 
already have) if utility tokens cannot be used for their intended 
purposes in the United States. While regulators must be mindful of 
containing the highly speculative and frothy market that currently 
exists, in which resale motives may predominate, use motives are 
gaining traction. As use of tokens grows, and as the novelty wears off, 
we expect that circumstances may well change again to the point where 
the irrational exuberance has subsided and there is a more balanced 
view of tokens as merely tools for interacting with various software 
platforms and applications.
    Policy objectives aside, and whether or not a less frothy future 
state comes to pass, this memorandum addresses the analytical basis for 
the appropriate treatment of token sales under existing law.
Detailed Analysis
A. Definition of Utility Token
    In October 2008, the Bitcoin whitepaper \5\ introduced a new 
currency based on distributed ledger technology, also known as the 
Bitcoin Blockchain. Currency was the first use case for this underlying 
technology. Other use cases include using cryptographically secure 
distributed ledgers to track and trade traditional debt and equity 
securities, or any other tangible or intangible asset, good or service. 
This memorandum does not cover:
---------------------------------------------------------------------------
    \5\ Satoshi, Nakamoto, Bitcoin; A Peer-to-Peer Electronic Cash 
System, www.Bitcoin.org, available at https://bitcoin.org/bitcoin.pdf. 
(last visited March 22, 2018).

  (1)  Digital Securities--meaning (i) any token that represents or 
            otherwise enables a blockchain transfer of a share of 
            stock, note or other type of security explicitly included 
            in the definition of ``security'' in the Securities Act and 
            (ii) any token that would constitute an (a) ownership 
            interest, (b) equity interest, (c) a share of revenue, 
            profit and/or loss, or assets and/or liabilities, (d) 
            status as a creditor or lender, (e) claim in bankruptcy, 
            (f) holders of repayment obligations, or (g) right to 
            convert into an investment interest, all with respect to 
            the token project or network application, or any legal 
---------------------------------------------------------------------------
            entity;

  (2)  Digital Currencies--meaning fungible tokens that have no other 
            marketed functionality than use as a medium of exchange or 
            stored value; \6\ or
---------------------------------------------------------------------------
    \6\ Digital currencies, like Bitcoin, would generally not be 
securities unless there are somewhat unusual facts and circumstances 
causing the coin to fall within the definition of a security (e.g., if 
the coin's promoter builds certain features into the coin like 
diminishing supply or promises significant actions that would make the 
coin more valuable in the future). Typically, digital currencies are 
complete and useful as currency immediately upon creation of the first 
coin and do not promise any further development of features or 
functionality or actions to make them more valuable in the future. Even 
if the coin is marketed as an investment (as physical gold coins often 
are, for example), it would not be a security unless the expectation of 
profits is based on the efforts of others.

  (3)  Tokenized Goods and Services--meaning each token represents the 
            right to a specific good or service that would often not be 
            perfectly fungible with any other token.\7\
---------------------------------------------------------------------------
    \7\ Non-fungible (or less fungible) tokenized goods and services do 
not pose the same trading issues and easy resale profit opportunities 
as fungible utility tokens. By definition, the consumptive intent of 
the purchaser is patently obvious with respect to this type of token. 
In this case, the token can be abstracted away and its status as a non-
security simply follows the non-security status of the underlying good 
or service. If the presale of a Tesla, for example, had used 
distributed ledger technology to track the identity of holders of the 
presale rights to the Tesla, the token purchasers would have had such 
clear consumptive intent that the tokens should not have been deemed 
securities even if such rights had been traded on an exchange while the 
car was under development. In this case, the token could either 
represent a customized car (i.e., a nonfungible token), or it could 
represent a fungible currency value only redeemable for a car to be 
selected by the token holder in the future (akin to a gift card). 
Either way, the consumptive intent is clear. Tokenized concert tickets 
would be another example of this type of token, where there is a fixed 
supply of tickets and initial sales are likely to be virtually 
exclusively to and between resellers, but the tickets will ultimately 
be purchased, for the most part, by the end users who go to the 
concert. In the case of concert tickets, of course, it is also possible 
for the tokens to be perfectly fungible if the concert is all open 
seating, for example, so the touchstone for this type of token is the 
clarity of the consumptive intent of the ultimate end use purchasers. 
Of course, as with digital currencies, the offer and sale of this type 
of token could still meet the investment contract test if, for example, 
the tokens are coupled with a management contract like the one present 
in the Howey case.

    This memorandum covers utility tokens, defined as fungible tokens 
that have some software-based functionality beyond mere use as a medium 
of exchange or stored value, although typically the tokens also have 
those currency-like properties. The value of these utility tokens 
should be derived from their use in a smart contract or other 
application automating the payment and delivery of goods or services, 
including access to decentralized networks.
B. Token Sale History and Evolving Model
    A large number of token sales of so-called ``alt coins'' occurred 
in 2014 and 2015. These were typically coins, based on the software 
code for Bitcoin, which is open-source software accessible to anyone. 
Many of these early tokens were digital currencies, although over time 
these tokens were used in more novel ways as part of a software network 
or application and became utility tokens (as defined for purposes of 
this memorandum). In 2014 and 2015, market participants believed that 
as long as these alt coins did not pay any sort of financial return, 
and did not represent a share of any company, similar to Bitcoin, they 
should not be treated as securities. Over time, the market cooled as 
appetite faded for new tokens that offered little in true functionality 
other than use as a currency, and use began to rise for the alt coins 
that included significant functionality in addition to use as a 
currency. In 2017, there was a resurgence of token sales based on the 
advent of more capable token technology. The ERC20 token protocol, as 
well as several others, now embed executable code into each token 
(often referred to as smart contracts), which allows developers to 
tokenize anything that software can create. These second-generation 
tokens can be said to be tokenized software products or APIs 
(application programming interfaces) that perform a function in 
addition to acting as a medium of exchange or stored value.
    Initially, these new utility tokens were thought of by market 
participants as the sale of products in development that could follow 
the Kickstarter crowd sale model, so long as they continued to avoid 
paying any sort of financial return or share of ownership of a company 
or project. The offers and sales were made at a time when the market 
for tokens was untested and it could not be said that there was a 
built-in reasonable expectation of profits associated with resale 
because secondary markets were not assured.\8\ Participants in the 
offers and sales tended to be technologists, developers, software 
users, and innovators. A reasonable amount of technological know-how 
was required just to be able to participate in a token sale. Means of 
holding tokens became more user friendly, including in online wallets, 
and means of exchanging one token for another, including on token 
exchanges, were made more reliable and simplified.
---------------------------------------------------------------------------
    \8\ Generally, when a new team markets a new product or service, it 
is extremely unlikely for any sort of secondary market to develop on 
its own. It normally requires promotional efforts over a long period of 
time to gain any sort of traction and most projects fail to ever get a 
secondary market to develop. It cannot be said that a reasonable 
purchaser was expecting to profit in secondary markets at this point in 
the history of token sales.
---------------------------------------------------------------------------
    Over time, as the development of robust secondary markets became 
more and more of a given, market participants began to evolve the model 
to take into account the changing market conditions. Specifically, it 
became apparent that the offer and sale of tokens potentially 
implicated the Federal and state securities laws and market 
participants started to apply the Howey test to determine whether the 
tokens might properly be viewed as securities. This in turn led to 
delivering increasingly functional tokens at the time of a public token 
sale to offset the increasingly apparent expectation of profits 
associated with secondary trading (as opposed to use of the token) that 
began to emerge.
    Today, as discussed below, while there are many token sales that do 
not follow best practices, market participants seeking to follow best 
practices generally follow a model where, before the tokens are fully 
functional, the sale of the tokens is conducted under an exemption from 
the registration requirements of the Securities Act and the proceeds 
are used to build functionality into tokens that will later be 
distributed to the pre-functionality purchasers. Typically, this is 
effected through the use of a pre-functionality token sale agreement 
that is not transferable and must be held indefinitely. The tokens are 
not delivered to the pre-functionality purchasers (and, therefore, do 
not begin trading on any exchanges or in peer-to-peer wallets) until 
the system for using the tokens becomes fully functional. Once full 
functionality is achieved, the token seller delivers the tokens to the 
pre-functionality purchasers and often conducts a second sale of the 
fully functional utility tokens to the public as a non-security.
C. Overview of Securities Law Analysis
    The Securities Act regulates the offer and sale of securities. Once 
it is established that an instrument is a security within the meaning 
of the Securities Act, this transactional regulatory regime requires 
that each offer and sale of a security be registered or exempt from the 
registration requirements of the Securities Act. For current purposes, 
the threshold question is whether the instrument or arrangement meets 
the Securities Act's wide-ranging definition of ``security.'' As 
discussed in the Dao Report, the applicable test then is whether the 
instrument or arrangement by which the offers and sales of utility 
tokens are made would constitute an ``investment contract'' under 
Howey. This is a multi-factor test based on facts and circumstances 
that must be analyzed with respect to the instrument or arrangement as 
of the time of each offer and sale. Facts and circumstances can and do 
change over time, so the results may be different, even for the same 
token, depending on when the offer and sale is made.
    In most cases, under present market conditions,\9\ the pre-
functionality sale of tokens may well be a securities transaction under 
the Securities Act based on the investment contract analysis under 
Howey.\10\ Once full functionality has been incorporated into the 
technology underlying the token, the token is a commodity trading on 
spot markets accessible to the public, which are subject to the anti-
fraud rules enforced by the CFTC described below. For these purposes, 
``full functionality'' is not intended to mean that merely some utility 
exists but rather that the requisite quantum of functionality exists 
such that the efforts of the promoter or others to deliver additional 
functionality do not form the basis for a reasonable purchaser's 
expectation of profits in purchasing the token. The requisite quantum 
of functionality is further discussed below.
---------------------------------------------------------------------------
    \9\ Present market conditions for utility tokens include the 
presence of robust secondary markets trading the rights to the tokens 
being developed primarily among resellers with speculative intent 
rather than users with consumptive intent. To continue the analogy to 
event ticket sales, the market for utility tokens is still in the early 
days after initial launch of ticket sales where resale is the primary 
intent of buyers who are attempting to gauge the ultimate price the 
end-user will be willing to pay for this fixed-supply good.
    \10\ The Kickstarter pre-functionality crowd sale model likely 
doesn't apply under present market conditions for utility tokens. 
Kickstarter campaigns do not have secondary markets trading the rights 
to the goods being developed, which calls into question consumptive 
intent.
---------------------------------------------------------------------------
    Of course, the circumstances could change again in the future, as 
the novelty wears off, and a pre-functionality crowd sale structure 
could work again, if and when it becomes clear that purchasers have 
switched back to purchasing primarily for consumptive purposes rather 
than resale (as is the case with Kickstarter campaigns). In addition, 
even under present market conditions, token sellers may decide to take 
certain steps to ensure use rather than resale, which would also change 
the analysis. In such a case, the Howey test would arguably not be met 
if either there is not sufficient expectation of profits because the 
token is generally being purchased for consumptive purposes or the 
expectation of profits is predominantly based on variables exogenous to 
the efforts of the promoter(s) of the token.
D. Description of the Pre-Functionality Token Sale Agreement
    Although pre-functionality token sale agreements may be executed 
with differing characteristics, for purposes of this memorandum, we 
assume the pre-functionality token sale agreements will have the 
following common characteristics:

   The purchaser pays to the seller the purchase amount (which 
        may be denominated in fiat currency, such as U.S. dollars, or 
        digital currency, such as Bitcoin) on or about the date on 
        which the pre-functionality token sale agreement is executed.

   In consideration of the purchase amount, the seller agrees 
        to deliver to the purchaser a number of tokens equal to the 
        purchase amount divided by a certain price on or about the time 
        the seller conducts a public sale of the tokens or otherwise 
        publicly launches the system or application on which the token 
        may be used. In either case, the delivery does not occur until 
        full functionality is achieved.

     The pre-functionality price may be stated as a fixed 
            value, in which case the quantity of tokens to be delivered 
            can be determined at the time the pre-functionality token 
            sale agreement is executed. This is always the case when 
            the trigger for token delivery is network launch.

     Alternatively, the pre-functionality price may be 
            stated in terms of a percentage of the eventual public sale 
            price.

   The pre-functionality token sale agreement is a separate 
        instrument from the tokens and terminates upon the seller's 
        delivery of tokens to the purchaser.

   The pre-functionality token sale agreement generally 
        contains certain other standard representations, including, for 
        instance, representations from the purchaser that it is an 
        accredited investor purchasing the rights to the token embodied 
        in the agreement for its own account and not with a view to 
        distribution.

    A pre-functionality token sale agreement frequently will not define 
the specific function of the token or the timeframe for its development 
and completion, or require the seller to conduct a sale before a 
specified time or at all. The seller's whitepaper and other information 
provided to the pre-functionality purchasers typically addresses such 
matters, often in very general terms. When analyzing a potential 
investment contract, the ``[d]ecision will necessarily turn on the 
totality of the circumstances, not on any single one.'' SEC v. Aqua-
Sonic Products Corp., 687 F.2d 577 (2nd Cir. 1982), cert. denied, sub 
nom Hecht v. SEC, 459 U.S. 1086 (1982). Thus, it would be the totality 
of the circumstances relating to the use of the proceeds from pre-
functionality token sale agreements to develop and launch a token that 
may give rise to an investment contract under Howey, rather than the 
pre-functionality token sale agreement itself. Nevertheless, to 
facilitate the discussion, this memorandum will analyze a pre-
functionality token sale agreement as though it incorporated all of the 
reasonable understandings and expectations of the purchaser that would 
arise under the total circumstances.
    Because of the risk that a pre-functionality token sale agreement 
may be deemed to constitute an investment contract, as discussed below, 
pre-functionality token sale agreements are frequently sold in 
compliance with an exemption from the registration requirements of the 
Securities Act. This would include provisions prohibiting any transfer 
of the pre-functionality token sale agreement except in compliance with 
such exemption, or more typically, a standard prohibition on transfer 
or assignment of the agreement without consent.
E. Circumstances in Which a Pre-Functionality Token Sale Agreement May 
        Create an Investment Contract
    A pre-functionality token sale agreement to deliver a specified 
amount of an asset at a specified price on a future date has many of 
the characteristics of a forward contract for the underlying future 
tokens. It is established that a forward or futures contract for non-
securities, in fact any type of sales contract, normally does not 
entail an investment contract. For example, in SEC v. Commodity Options 
Intern., Inc., 553 F.2d 628, 632 (9th Cir. 1977), the Ninth Circuit 
stated that:

          Commodity futures contracts are considered not to be 
        securities per se. [Citation omitted] They are investments to 
        be sure. The investment, however, is not in an enterprise but 
        is in the underlying commodity, and we may assume, arguendo, 
        that a conventional option to buy or sell a futures contract 
        takes on the character of the contract that is the subject of 
        the option and is no more a security than is that underlying 
        contract.\11\
---------------------------------------------------------------------------
    \11\ The court distinguished standard commodity futures and options 
from the ``naked double options'' that were offered by the defendant. 
Defendant collected and pooled the premiums for these options ``and put 
out to speculation with the expectation that the seller's expertise in 
speculation will produce a profit in which the buyer and seller will 
share,'' thus creating an investment contract. Commodity Options 
Intern, 553 F.2d at 633. See also, cases cited at  15[a] of Stephen G. 
Christianson, What is ``Investment Contract'' within Meaning of  2(1) 
of Securities Act of 1933 (15 U.S.C.A.  77b(1)) and  3(a)(10) of 
Securities Exchange Act of 1934 (15 U.S.C.A.  78c(a)(10)), Both 
Defining Term ``Security'' as Including Investment Contract, 134 A.L.R. 
Fed. 289 (1996).

A pre-functionality token sale agreement differs from conventional 
forward contracts in an important respect: it typically involves a to-
be-created novel product or service with no established market or 
value. In the words of the Ninth Circuit, such agreements are often 
``investments in the enterprise'' of creating an operating token rather 
than an investment in just the token.
    Most other products and services have a market value determined by 
general supply and demand where prices are bounded by the price of 
competing goods or services. Even if the seller in a typical forward 
contract engages in significant promotional efforts, such efforts 
should be expected to have only a marginal impact on the product's 
price and any resulting profits from the forward contract. Such 
promotional efforts would not be ``undeniably significant [efforts], 
those essential managerial efforts which affect the failure or success 
of the enterprise.'' SEC v. Glenn W. Turner Enters., Inc., 474 F.2d 
476, 482 (9th Cir. 1973); see e.g., Bender v. Continental Towers Ltd. 
P'ship, 632 F. Supp. 497, 501 (S.D.N.Y. 1986) (``Here, plaintiffs 
allege that Continental influenced the value of the condominium units 
through its marketing efforts and its own buying and selling 
strategies. But these efforts by Continental would have at most only a 
marginal effect on the value of the condominium units''). Thus, 
expected profits from any appreciation in the value of the asset 
underlying a typical forward contract should not be derived from the 
efforts of the seller.
    In contrast, the future tokens underlying a pre-functionality token 
sale agreement have yet to be fully developed or to demonstrate their 
functionality and typically are associated with an entirely novel 
application where the ultimate ranges of prices to be paid by end users 
is speculative. Any eventual profits from the pre-functionality token 
sale agreement may therefore depend on the successful development of 
the application using the tokens and on the seller's success in 
launching the application. In some circumstances, this may elevate the 
seller's efforts to the ``undeniably significant'' level required under 
Glenn W. Turner.
    Real estate provides an example of circumstances in which an asset 
not generally regarded as a security may become the basis of an 
investment contract based on promises of future development. Although 
the SEC has stated that ``[t]he offer of real estate as such, without 
any collateral arrangements with the seller or others, does not involve 
the offer of a security,'' Guidelines as to the Applicability of the 
Federal Securities Laws to Offers and Sales of Condominiums or Units in 
a Real Estate Development, Securities Act Release No. 5382, 38 FR 9587 
(1973), courts have found allegations ``that defendants encouraged 
investment purchases by promising the lots would increase in value 
because of defendants' activities in developing and providing 
amenities, and that defendants led purchasers to believe a trust would 
be established to construct and operate facilities for their common 
benefit,'' sufficient to establish an investment contract. Aldrich v. 
McCulloch Properties, Inc., 627 F.2d 1036, 1039 (10th Cir. 1980); see 
also, Fogel v. Sellamerica, Ltd., 445 F. Supp. 1269, 1277-78 
(S.D.N.Y.1978) (``the developers did represent that a variety of 
residential services and recreational facilities would be developed so 
as to increase the value of plaintiffs' property along with all of the 
lots in the development''); Anderson v. Grand Bahama Dev. Co., 384 
N.E.2d 981, 985 (Ill. App. Ct. 1978) (``[P]laintiffs allege that the 
land will become `valuable and salable to tourists' and others solely 
[original emphasis] by virtue of defendants' efforts. They also allege 
that purchasers of the land could not, nor were they expected to, do 
anything to increase the value of their investments. These allegations 
fulfill the final two requirements for an investment contract as stated 
in Howey.''). Similarly, an undertaking to develop and launch an 
application for a token may create a collateral arrangement that would 
cause an agreement to buy a utility token to qualify as an investment 
contract, even though the token itself will be a commodity.
    As more fully discussed in Section I.1 below, the manner in which a 
token is offered is also relevant to its status as an investment 
contract. Offering materials that emphasize the potential profits from 
purchasing a token may create an expectation of profit that satisfies 
the third prong of the Howey test. Because the purchasers of the pre-
functionality token sale agreement will not receive tokens until 
completion of the project, and many purchasers may not intend to use 
the tokens, there is pressure on the seller to discuss the potential 
market value of the tokens in its offering materials. The materials 
also commonly explain the anticipated timeframe for development, the 
development team and their relevant experience. Under these 
circumstances, the offering materials could be viewed as ``emphasizing 
the economic benefits to the purchaser to be derived from the 
managerial efforts of'' the seller which, according to the Munchee 
Order, could factor into finding that the pre-functionality token sale 
agreements are investment contracts.
    The purchasers of the pre-sale functionality token sale agreement 
may also require assurances that the seller intends to conduct a public 
sale of the future tokens at a higher offering price than the pre-
functionality price, reflecting the fact that the early money is being 
paid to take the risk that functionality may not be achieved or that 
the expected use may command a lower price than anticipated. Although 
the purchasers do not generally offer their tokens in the public sale, 
and may not receive unrestricted access to the tokens until the sale is 
completed, their ability to profit from the sale of their tokens 
generally depends on the success of the public sale. In the case of a 
token used for a new or unique software application, the public sale 
will establish the initial value of the token, so the seller's efforts 
may have more than a marginal effect on the potential profits of the 
purchasers who decide to sell their tokens.
    Under such circumstances, which are different from those of a 
typical forward contract, the SEC or a court may find that the efforts 
of a seller are ``undeniably significant'' with respect to the expected 
profits of the purchasers. The development of a successful application 
for a token may be comparable to the efforts required to develop the 
infrastructure and amenities of a resort, which courts have found to 
satisfy the final element of an investment contract. Moreover, unlike 
an asset (such as a commodity or condominium) with an established 
market, the developer of a new or unique application may have 
significant influence over the related token's initial market value. 
Consequently, the seller's efforts in conducting the public token sale 
and launching the network application may have a significant impact on 
the purchaser's expected profits from selling, rather than using, the 
tokens. Circumstances such as these create a heightened risk that the 
pre-functionality token sale agreements may be classified as investment 
contracts.
    Different circumstances may reduce the risk of a pre-functionality 
token sale agreement being considered an investment contract. For 
example, a seller may be converting an already developed application 
into a blockchain format using the future tokens. This might be the 
case for a video game which already has an ``in-game'' token that can 
be earned by playing the game and spent to acquire virtual assets used 
in the game. The game developer may want to convert the in-game token 
to a blockchain token so as to allow players to purchase tokens rather 
than earn them (saving hours of game playing), and to permit other 
games to incorporate the tokens, so players can move their virtual 
wealth from game to game. In this instance, the token's ``ecosystem'' 
is largely developed; the developer only needs to pay for the 
programing and other costs of moving the in-game token to a blockchain. 
To fund this cost, the developer may offer pre-functionality token sale 
agreements for the blockchain tokens to current players of its game who 
would benefit from the ability to acquire and transfer the tokens 
outside of the game. The materials marketing these pre-functionality 
token sale agreements could emphasize the established functionality of 
the future tokens, the value of which would depend on the appeal of the 
gaming community created by the players (including the purchasers), 
rather than the entrepreneurial or managerial efforts of the seller. 
These purchasers would resemble someone buying a condominium in a 
nearly completed resort, which ``is not under normal circumstances 
treated as purchasing a `security.' '' Rodriguez v. Banco Cent. Corp., 
990 F.2d 7, 10 (1st Cir. 1993); see also, cases cited in Christianson, 
supra note 2, 134 A.L.R. Fed. at  12[c]. Under circumstances such as 
these, a pre-functionality token sale agreement may resemble a standard 
forward contract more closely than an investment contract.
F. Why Tokens Delivered Pursuant to an Investment Contract May Not 
        Qualify as Investment Contracts
    The foregoing analysis shows how a pre-functionality token sale 
agreement might be regarded as an investment contract due to 
circumstances unrelated to whether the future tokens are securities. If 
the circumstances have changed materially by the time of the delivery 
of tokens to the pre-functionality purchasers (which is often 
accompanied by a public sale of the utility tokens), any new offer or 
sale of those same tokens should not necessarily be construed to 
represent investment contracts. This would be the case if development 
of the token's functionality is completed by the time of the public 
sale. So long as there are no other efforts of others involved either--
i.e., (i) marketing materials are focused primarily on present 
functionality and use of the token, (ii) the seller has not built 
features into the token intended to provide an investment return or 
support the price of the token in secondary markets, and (iii) the 
seller does not promise to take steps to support secondary trading of 
the token--then, at this stage, the seller's efforts would be limited 
to supporting the use of the tokens with the network or software 
application and any further increase in the value of the token should 
not be derived from the efforts of the seller. Once the tokens are 
delivered to the purchasers, each purchaser would have unfettered 
control over the tokens, and would have no reasonable expectation that 
the seller will take future steps intended to increase the market value 
of the tokens. Generally, ``[T]the courts will find a security is not 
present where the investor retains unfettered discretion over the 
distribution and marketing of the product.'' Wabash Valley Power 
Ass'n., Inc. v. Public Service Co. of Ind., Inc., 678 F. Supp. 757, 767 
(1988) (added emphasis). At this point, unlike the DAO Token, which 
promised returns from projects undertaken by the DAO, any reasonable 
expectation of profits the purchaser might have should depend primarily 
on the market's demand for the functioning application and the 
purchaser's own efforts to find buyers and negotiate a favorable price 
for the tokens (akin to general expectations of appreciation in the 
demand for a commodity or real estate).
    Such changing circumstances--the completion of the full 
functionality of the token--also allow the seller to take a different 
approach to marketing its network or software application at the time 
of the public token sale. The completion of the network or software 
application allows the seller to focus on selling the tokens to 
potential users, so any marketing materials would emphasize the value 
in using the goods and services accessible through the token. In 
addition, unlike pre-functionality purchasers, the purchasers in a 
public sale do not expect the seller to hold a future sale of the 
tokens at a higher price. In fact, if the public sale is conducted to 
distribute the tokens at approximately their market clearing price, 
purchasers should not have a reasonable basis to anticipate any future 
appreciation in their value.
    These circumstances: (i) completion of the network or software 
application in which the token is used, (ii) a corresponding emphasis 
on selling the token based on its use and the value of its application 
and (iii) a public sale price that approximates such value, all serve 
to separate the public sale of the tokens from the circumstances 
existing at the time the pre-functionality token sale agreements are 
privately placed. These changed circumstances should prevail at the 
time the pre-functionality purchasers receive delivery of their tokens 
and have an opportunity to sell them. If the tokens are not digital 
securities by design, and if all the other facts and circumstances 
support the conclusion that the token sale agreements entered into at 
the time of the public sale should no longer be viewed as investment 
contracts, then tokens received and, if applicable, sold by pre-
functionality purchasers under those same circumstances should not be 
viewed as investment contracts either. The characteristics of the pre-
functionality token sale agreement by which the tokens were originally 
purchased should not be determinative of the status of the tokens as 
``investment contracts'' with respect to the subsequent offer and sale 
transaction occurring under changed facts and circumstances.
    Instead, we would argue that the pre-functionality token sale 
agreement was the instrument that was deemed a security under the Howey 
test, but that it is distinguishable from the underlying token. The 
pre-functionality token sale agreement is subject to the applicable 
private placement restrictions for the duration of its existence and 
may not be offered or sold except pursuant to appropriate registration 
or exemption. At the point of full functionality, however, and delivery 
of the tokens, the tokens take on a separate regulatory existence and 
their status as securities should be independently determined at that 
time.
    From Howey (oranges) to Edwards (pay phones),\12\ the case law is 
replete with products that provide the basis for an investment contract 
without qualifying as securities themselves. See, Christianson, supra 
note 2, 134 A.L.R. Fed. at  10[b] (citing cases involving dental care 
products, foxes, beavers and master tapes) and 14[a] (citing cases 
involving whisky, personal and home care products, oil, chinchillas and 
earthworms). In these cases, a critical element was the promoter's 
promise to either purchase or arrange for the sale of the underlying 
product at a profit, regardless of its current market value. A seller's 
undertaking to conduct a public sale of future tokens at a price above 
the pre-functionality price might be considered analogous to the 
promoters' promises in these cases. In that context, the promise of an 
opportunity to sell the tokens at a profit after delivery makes the 
pre-functionality token sale agreement an investment contract, not the 
character of the tokens (or any of the products in the cited cases).
---------------------------------------------------------------------------
    \12\ SEC v. W.J. Howey Co., 328 U.S. 293 (1946); SEC v. Edwards, 
540 U.S. 389 (2004).
---------------------------------------------------------------------------
    Critical, and unique to tokens and this analysis, is the mutability 
of the token--it can be both initially representative of an investment 
opportunity and subsequently a functional tool for use on the 
blockchain application. Thus, one of the reasons it may seem 
appropriate to treat both pre-functionality token sale agreements and 
their underlying tokens as investment contracts may stem from the fact 
that a token directly issued and marketed under the same circumstances 
as a pre-functionality token sale agreement may be considered an 
investment contract for the same reasons as a pre-functionality token 
sale agreement. A pre-functionality token in this sense, has the same 
security-like characteristics as a pre-functionality token sale 
agreement. This was the case in the Munchee Order, where the utility 
tokens were created and delivered to purchasers prior to full 
functionality. The Munchee Order involved several practices (such as an 
undeveloped application) commonly associated with pre-functionality 
token offerings.
    So long as utility tokens are not created or delivered to the pre-
functionality purchasers prior to full functionality, the financial 
instrument that is the proper subject of the analysis is the pre-
functionality token sale agreement itself, not the future token, which 
does not yet exist.
G. Deemed Underwriter Status and ``Coming to Rest'' Analysis
    The adage ``once a security, always a security'' is alive and well, 
in light of the fact that the ``security'' is the investment contract 
(or, more precisely, the right to future tokens evidenced by that 
contract) not the asset underlying the investment contract. The pre-
functionality token sale agreement never loses its character as a 
security and in practice these contracts are non-transferable on the 
part of the purchaser. Thus, the right to future tokens represented by 
the pre-functionality token sale agreement, which is a security, stays 
a security, and comes to rest in the hands of that initial purchaser. 
The best way to think about this is to change one fact from the Howey 
case itself--suppose the purchasers were paid in oranges instead of 
cash. If all the other facts remained the same, we would undoubtedly 
still consider the contract to be an investment contract (it would 
still be a contract to share profits, just denominated in oranges), but 
we would never conclude that the oranges, once fully grown and 
delivered, had somehow transformed into a security that could not be 
immediately sold by the purchasers upon receipt.
H. Jurisdiction Over Hybrid Instrument
    When a contract involves an asset that is a commodity being sold 
under circumstances that cause the transaction to be a securities 
transaction under the Securities Act, Section 2(f) of the Commodity 
Exchange Act (the ``Hybrid Instrument Exclusion'') guides the analysis 
of jurisdictional boundaries.\13\ By acknowledging and relying on the 
distinctions outlined within that provision, the SEC retains its 
inherent discretion and latitude to address potential security law 
violations at the point of token issuance, in addition to, and 
potentially independent of, pre-functionality token sale violations. 
This has the systemic benefit of maintaining clarity for responsible 
actors within the industry, ensuring utility tokens are treated in 
accordance with their inherent fungible characteristic, not negatively 
impacting the wider pre-funding model for the rest of the industry, and 
maintaining consistency with existing law designed to address these 
dilemmas. A pre-functionality token sale would need to satisfy the 
enumerated requirements of the Hybrid Instrument Exclusion in order to 
meet the definition, although such requirements could be met through 
appropriate documentation and marketing restrictions, for example a 
legend that confirms the pre-functionality token sale agreement is 
subject to SEC oversight and not an instrument subject to the 
provisions of the Commodity Exchange Act.
---------------------------------------------------------------------------
    \13\ Section 2(f) Exclusion for qualifying hybrid instruments of 
the Commodity Exchange Act provides:

      (1) In general

        Nothing in this chapter (other than section 16(e)(2)(B) of this 
title) governs or is applica-
    ble to a hybrid instrument that is predominantly a security.

      (2) Predominance

        A hybrid instrument shall be considered to be predominantly a 
security if--
          (A) the issuer of the hybrid instrument receives payment in 
full of the purchase price
      of the hybrid instrument, substantially contemporaneously with 
delivery of the hybrid in-
      strument;
          (B) the purchaser or holder of the hybrid instrument is not 
required to make any pay-
      ment to the issuer in addition to the purchase price paid under 
subparagraph (A), wheth-
      er as margin, settlement payment, or otherwise, during the life 
of the hybrid instrument
      or at maturity;
          (C) the issuer of the hybrid instrument is not subject by the 
terms of the instrument
      to mark-to-market margining requirements; and
          (D) the hybrid instrument is not marketed as a contract of 
sale of a commodity for fu-
      ture delivery (or option on such a contract) subject to this 
chapter.

      (3) Mark-to-market margining requirements

        For the purposes of paragraph (2)(c), mark-to-market margining 
requirements do not in-
    clude the obligation of an issuer of a secured debt instrument to 
increase the amount of
    collateral held in pledge for the benefit of the purchaser of the 
secured debt instrument to
    secure the repayment obligations of the issuer under the secured 
debt instrument.
---------------------------------------------------------------------------
    Section 1(a)(29) of the Commodity Exchange Act defines a ``hybrid 
instrument'' as ``a security having one or more payments indexed to the 
value, level, or rate of, or providing for the delivery of, one or more 
commodities.'' Section 1(a)(31) of the Commodity Exchange Act defines a 
``security'' by reference to Section 2(a)(1) of the Securities Act of 
1933 and Section 3(a)(10) of the Securities Exchange Act of 1934, both 
of which in turn define a security to mean, in pertinent part, an 
investment contract.
    The guidance provided by the Hybrid Instrument Exclusion is 
agnostic as to what is ultimately delivered pursuant to the pre-
functionality token sale agreement in question:

   in the event that the ultimate utility token delivered does 
        not bear the hallmarks of a security and thus can be properly 
        categorized as a commodity the SEC retains jurisdiction and 
        regulatory oversight of the pre-functionality token sale 
        agreement qua an investment contract, with the CFTC taking over 
        jurisdiction and enforcement oversight of the delivered utility 
        token in the spot market, as outlined in Section I.1 below.

   in the event that the ultimate utility token delivered does 
        bear the hallmarks of a security and thus can be properly 
        categorized as a security the SEC retains jurisdiction and 
        regulatory oversight of the pre-functionality token sale 
        agreement qua an investment contract, and also retains 
        jurisdiction and enforcement oversight of the delivered utility 
        token as a security qua a commodity. This result, although 
        slightly counter-intuitive, arises because under the 
        definitions applicable to the Commodity Exchange Act, a 
        security is a type of commodity, albeit an excluded commodity 
        which is subject to exclusive SEC oversight.

    The history and interaction between the SEC and the CFTC on shared 
instruments is consistent with this result, and the Hybrid Instrument 
Exclusion is a direct result of consideration of products that escaped 
clear classification. The SEC and the CFTC have considered questions 
relating to hybrid instruments since the 1980s (of particular note is 
the report of the President's Working Group on Financial Markets in 
1999).\14\ Since that time, the Hybrid Instrument Exclusion (formerly 
the hybrid instrument exemption) has been an appropriate method of 
determining which agency should have appropriate oversight over a 
legally awkward instrument.
---------------------------------------------------------------------------
    \14\ Report of the President's Working Group on Financial Markets, 
Over-the-Counter Derivatives Markets and the Commodity Exchange Act, 
November 9, 1999. Available at: https://www.treasury.gov/resource-
center/fin-mkts/Documents/otcact.pdf.
---------------------------------------------------------------------------
    Given the unique and novel nature of utility tokens, conceiving a 
pre-functionality token sale agreement as a hybrid instrument is a 
pragmatic and common-sense approach to a scenario that can exhibit the 
characteristics of both a security and a commodity for all the reasons 
discussed above in Section E. This position is also consistent with the 
legislative history and general position of both the SEC and CFTC that 
products should generally be regulated by a single agency. It also 
results in the maintenance of the inherent fungibility of the utility 
tokens in question--an outcome that from a commodity law perspective is 
sensible (the characteristics of a commodity should not be affected by 
its means of delivery), as well as from a securities law perspective 
(the utility token can be assessed on its own merits as a potentially 
distinct security).
    On balance, treating the underlying token as a `commodity' is an 
outcome consistent with the fundamental legislative intent of the 
Hybrid Instrument Exclusion (bearing in mind that for these purposes, a 
security can also be a type of commodity) and is also consistent with 
statements of CFTC Commissioner Brian Quintenz that [digital 
currencies] ``may actually transform at some point from something that 
starts off as a security and transforms into a commodity'' and that 
``they may start their life as a security from a capital-raising 
perspective but then at some point--maybe possibly quickly or even 
immediately--turn into a commodity''.\15\
---------------------------------------------------------------------------
    \15\ Coincenter.org, CFTC commissioner: tokens that start as 
securities may ``transform'' into commodities. October 20, 2017. 
Available at: https://coincenter.org/link/cftc-commissioner-tokens-
that-start-as-securities-may-transform-into-commodities.
---------------------------------------------------------------------------
I. Quantum of Functionality
    The real question we need to address is not about transformation, 
it is whether a utility token can ever achieve the status of a 
commodity that is not also a security. This goes to the issue of the 
quantum of functionality required and whether and when variables 
exogenous to the promoter become predominant as the reason for the 
purchaser's expectation of profits.
    Since utility tokens do not represent a share of the promoter, the 
main ties back to the promoter once full functionality has been 
achieved would seem to be any residual belief that the promoter is 
likely to continue to support and update the software underlying the 
tokens and/or the network on which the tokens can be used. Of course, 
all software products have updates and upgrades, so it would be 
surprising indeed if tokenized software must always be treated like a 
security while non-tokenized software is not. Tokenized software is a 
novelty but the analytical framework underlying the case law requires a 
determination of what predominates as the underlying driver of price 
changes that a reasonable purchaser would expect. In a post-
functionality trading market for a fully completed piece of tokenized 
software, the ongoing updates and upgrades from the promoter would only 
represent a very small driver of price changes, if any. The state of 
the industry, competing novel trends, competing goods and services, and 
fundamental supply and demand issues that drive the price of the access 
or service provided by the token should predominate the value 
attributed to a token. The recent volatility in the digital currency 
markets demonstrates this very clearly. It cannot be said that 
someone's promises of updates to the Bitcoin protocol, for example, had 
anything to do with the recent price swings. The real price swings 
occurred after the fork to the protocol was completed. These market 
moves were unrelated to any promises by a promoter to update the 
software as a driver of price, but instead reflected exogenous views of 
the market as to the value of Bitcoin.
1. Whose Perspective Counts?
    In Teague v. Bakker, the Fourth Circuit affirmed that ``[t]he 
subjective intention of a given purchaser cannot control whether 
something is a `security' '' for purposes of the Howey test, otherwise 
``some might have purchased securities while others did not.'' 139 F.3d 
892, 892 (4th Cir. 1998). Rather, ``[t]he proper focuses of the inquiry 
are on the transaction itself and the manner in which it is offered.'' 
which would tend to place emphasis on objective evidence and 
considerations such as marketing materials, communications and 
transaction documents. Id.
    The manner of offering was paramount in the recent Administrative 
Order against Munchee, Inc., Sec. Act Release No. 10445 (Dec. 11, 2017) 
(the ``Munchee Order''), which found an investment contract based on 
the promoter ``emphasiz[ing] the economic benefits to the purchaser [of 
a token] to be derived from the managerial efforts of the [token's] 
promoter.'' The tokens in the Munchee Order (``MUN'') were intended for 
use in an application to advertise, review and buy meals from 
restaurants, although ``no one was able to buy any good or service with 
MUN'' at the time of their sale. Munchee Order at 10. ``In the MUN 
White Paper, on the Munchee Website and elsewhere, Munchee and its 
agents . . . emphasized that the company would run its business in ways 
that would cause MUN tokens to rise in value.'' Id. at 12. The SEC also 
found that ``Munchee primed purchasers' reasonable expectations of 
profit through statements on blogs, podcasts, and Facebook that talked 
about profits.'' Id. at 14. Munchee also undertook to list MUN on 
exchanges, so that purchasers could realize profits through secondary 
trading, regardless of whether they ever used MUN in the application. 
Id. at 13. These findings led the SEC to conclude that MUN tokens were 
investment contracts, id. at 30, insofar as, ``[b]ecause of the conduct 
and marketing materials of Munchee and its agents, investors would have 
had a reasonable belief that Munchee and its agents could be relied on 
to provide the significant entrepreneurial and managerial efforts 
required to make MUN tokens a success.'' Id. at 34 (added emphasis).
    Notwithstanding its emphasis on the manner of offering, Teague 
allowed that in some cases, ``where most intended purchasers share a 
common understanding of, and have similar motives stoked by, an 
offering, the `subjective' understanding and motives are powerful 
evidence of the objective intent and effect of the offering.'' Teague, 
139 F.3d at 892. Teague set a high bar for reaching this conclusion: it 
looked to ``the subjective feeling of the vast majority of 
purchasers,'' and not merely the particular plaintiffs in question, as 
likely indicative of the seller's objective intention despite other 
evidence. Id. It should also be noted that the motives must still be 
``stoked by the offering,'' rather than a general enthusiasm for all 
things associated with a blockchain. It follows that a token seller 
that implements safeguards and constructs a token and conducts a token 
sale the ``right way'' will ultimately be able to sell a utility token 
as a non-security even if some purchasers have wildly unrealistic 
expectations of profit akin to beanie baby mania.
2. Who are the ``Others'' in Efforts of Others?
    The original formulation of the Howey test stated that the profits 
must have been expected ``solely from the efforts of the promoter or a 
third party.'' This test has been subsequently modified with respect to 
the requisite amount of efforts as discussed below. Some courts \16\ 
have focused on the efforts of the promoter as satisfying the common 
enterprise prong of the Howey test as discussed below, with other 
courts noting that this treatment would conflate the common enterprise 
prong with the efforts of others prong. Putting aside the common 
enterprise conflation and focusing again on the efforts of others 
prong, most cases focus on either the promoter's efforts or the 
purchaser's efforts. It would appear from the original formulation that 
reliance must be placed on the efforts of some identifiable person or 
persons. The clause would be overbroad if ``others'' were interpreted 
to include anyone other than the purchaser. All investment assets would 
be securities if efforts of others included the efforts of unspecified 
persons contributing to market dynamics and supply and demand. This 
element of the test will be relevant to many utility token sales since, 
unlike traditional enterprises, typically, the projects involve the 
development of open-source software that can be maintained by anyone 
and not just the original promoter of the project. Even for those who 
subscribe to the broad vertical commonality interpretation of the 
common enterprise prong of the Howey test, however, that interpretation 
has focused on the efforts of the promoter, so the entire community of 
open source software developers would need to be considered part of the 
promoter in order to satisfy that interpretation. While the original 
promoter is the most likely party to provide updates and upgrades to 
the code, the fact that there is a large community of developers who 
could easily decide to step in and do so further minimizes the amount 
of reliance a reasonable purchaser would objectively have on the 
efforts of the promoter as compared to the far weightier price drivers 
in a trading market that have nothing to do with the original token 
seller.
---------------------------------------------------------------------------
    \16\ Revak v. SEC Realty Corp., 18 F.3d 81, 87-88 (2d Cir. 1994), 
relying on Long v. Shultz Cattle Co. Inc., 881 F.2d 129, 140-41 (5th 
Cir. 1989); SEC v. Comcoa, Ltd., 855 F. Supp. 1258 (S.D. Fla. 1994) 
(finding vertical commonality with regard to service to assist 
application and development of FCC licenses). These courts can be said 
to subscribe to the broad vertical commonality interpretation of the 
common enterprise prong of the Howey test.
---------------------------------------------------------------------------
3. Requisite Amount of Efforts of Others
    As discussed, the original Howey formulation was modified by 
subsequent case law that recognized the word ``solely'' was too narrow. 
It is clear that at one end of the spectrum, if either the purchaser's 
efforts are significant in the success of the enterprise,\17\ or the 
promoter's efforts are de minimis in assuring the success of the 
investment, the Howey test is not satisfied. Beyond that, courts have 
stated the requirement as ``primarily'' or ``substantially'' from the 
efforts of others.\18\ As discussed above, in Glenn W. Turner, the 
court stated the test as ``whether the efforts made by those other than 
the investor are the undeniably significant ones, those essential 
managerial efforts which affect the failure or success of the 
enterprise.'' The context for this test was a business enterprise that 
included both efforts of the promoter and efforts of the purchaser. The 
court was clearly focused on ensuring that promoters could not avoid 
the securities laws by merely building in some perfunctory efforts of 
the purchaser into their business schemes. When the context is about 
determining when the promoter's efforts are displaced by variables 
entirely exogenous to (and beyond the control of) both the promoter and 
purchaser, the test is better understood to be a simple predominance 
test. For that reason, we have used predominance as the test throughout 
this memorandum, but we would also expect that if a court applied a 
test more like the Glenn W. Turner test, the efforts associated with 
software updates and upgrades would still not rise to the level 
described by that test. It can hardly be said that providing ongoing 
software updates and upgrades constitute those essential managerial 
efforts which affect the failure or success of the secondary market 
price,\19\ particularly compared to the other market dynamics affecting 
price in the trading market post-functionality.
---------------------------------------------------------------------------
    \17\ E.g., Steinhardt Group v. Citicorp, 126 F.3d 144 (3dCir. 1997) 
(limited partnership interest in a securitization transaction was not a 
security where limited partner's retention of ``pervasive control'' 
meant that he was relying extensively on his own efforts).
    \18\ See, e.g., United States v. Leonard, 529 F.3d 83 (2d Cir. 
2008) (the court considered whether, under all the circumstances, the 
scheme was being promoted primarily as an investment).
    \19\ This illustrates the problem with applying Glenn W. Turner to 
tokens. There is no enterprise on whose success or failure the token 
holder's investment depends. The closest analog might be to substitute 
the secondary market for the ``enterprise'' in that test.
---------------------------------------------------------------------------
    Since the test is objective, and because use of tokens for their 
intended purpose is gaining traction, some courts might well conclude 
that purchasers are not merely passive and that the purchaser's 
collective efforts are significant because use of the token for its 
intended purpose is a strong driver of demand for the token and, 
therefore, the price of the token. Many applications permit, and some 
require, token holders to participate in the operation of the 
application. A crowdsourcing application will not work unless enough 
users vote or otherwise record a view on the crowdsourced question. 
These applications frequently use tokens to regulate the crowdsourcing 
process, assign and weight votes and reward the most accurate 
predictions. Networked services are another common example of 
applications that require active participation by token holders. 
Network participants must download the service application on their 
computers and accept tokens in exchange for performing the service. 
Holders of tokens for such applications may be active contributors to 
the token's success, rather than passive investors. Many courts have 
found that an arrangement does not constitute an investment contract 
when it involves significant efforts of the purchaser. See Cordas v. 
Specialty Restaurants, Inc., 470 F. Supp. 780, 788 (D. Ore. 1979) 
(``[i]t is undeniable here that the plaintiff's managerial efforts were 
intended to have an important effect on her own success. Her efforts 
would also have some effect, however slight, [added emphasis] on the 
success of the enterprise as a whole. [Citation omitted.] These factors 
are sufficient to preclude her from coverage under the Howey 
analysis.'' ``To hold otherwise would put the courts in the position of 
judging where along the continuum a manager's efforts become 
`significant' in the success of a larger enterprise.'') Id. at 788. The 
Cordas court chose to apply Howey based on the quality of the 
plaintiff's participation, rather than its impact on the broader 
enterprise. Other courts have also taken this approach to the final 
prong of the Howey test, particularly in cases involving franchises. 
For example, Boldy v. McConnell's Fine Ice Creams, Inc., 904 F.2d 710 
(9th Cri. 1990) (``In focusing on `the extent of participation the 
franchisee has under the franchise agreement' in this case, it is clear 
that `each franchisee's active management was essential to the success 
of his retail restaurant.' '' [Citation omitted.]); see also, cases 
discussed in What is an ``Investment Contract'' within Meaning of  
2(1) of Securities Act of 1933 (15 U.S.C.A.  77b(1)) and  3(a)(10) of 
Securities Exchange Act of 1934 (15 U.S.C.A.  78c(a)(10)), Both 
Defining Term ``Security'' as Including Investment Contract, 134 A.L.R. 
Fed. 289,  17[a]-[c] (Cum Supp. 2017).
    Whether or not a court finds substantial efforts of token holders 
are involved, it seems likely that once full functionality has been 
achieved, the efforts of the promoter would not rise to the level 
required by the efforts of others element of the Howey test to consider 
post-functionality sales of the token to constitute investment 
contracts.
4. Gary Plastic
    The Gary Plastic case has special relevance to utility tokens given 
the robust secondary markets that have developed. In an ordinary case, 
most of the elements of Gary Plastic can be distinguished--token 
exchanges do not negotiate the terms of the tokens, do not promise to 
find buyers for the tokens and are not exclusive venues for purchase 
and sale of the tokens. The key element, however, that would be 
applicable is any promise by the promoter to establish or maintain a 
trading market for the tokens. This can be described as a special type 
of ``efforts of others'' that obviates the need for analysis of trading 
dynamics as the driver of price since the expectation that the market 
will exist in the first place is based on the promised efforts of the 
promoter. It follows that any promises by the promoter to support an 
active trading market for the token would, by itself, be sufficient to 
satisfy the efforts of others prong of the Howey test. The same would 
not be true, however, if the token seller were to cooperate with token 
exchanges in the qualification process without publicizing in advance 
any promise of such cooperation. Without a promise of supporting 
trading in advance of a purchase, the purchaser cannot reasonably 
expect it, as token exchange qualification requirements are significant 
and evolving rapidly. While outside the scope of this paper, we note 
that some exchanges are currently requiring token sellers to provide a 
securities law analysis and some token creators are declining to 
provide this for fear of being seen as facilitating exchange activity. 
As a result, many tokens perversely wind up being traded only on the 
less rigorous (often foreign) exchanges that do not require 
interaction. Discouraging cooperation with the qualification process, 
may negatively impact the ability of exchanges to properly discriminate 
between tokens that are securities, which the exchange is not licensed 
to list, and utility tokens. Similarly, merely providing links to token 
exchanges contained on a token seller's website should not be viewed as 
efforts of the promoter to support an active trading market, so long as 
these links are merely included to assist users of the platform in 
obtaining tokens for use on the platform.
5. Full Functionality
    In light of the above, it is clear that merely some utility is not 
sufficient under present market conditions. A reasonable approach to 
defining how much functionality is sufficient under present market 
conditions would be to say that the token must have at least as much 
functionality as any other non-tokenized good or service being sold. To 
that end, we would propose an 80/20 rule of thumb whereby the marketing 
materials focus on the present functionality of the token with much 
less attention paid to the potential future upgrades or additional 
features (i.e., 80% focused on present functionality and 20% on future 
functionality). This roughly approximates what other sellers of non-
tokenized goods and services have historically put into their marketing 
materials. While virtually all products with embedded software come 
with free updates, the seller will focus on the present functionality 
of the product to entice the purchaser with the features the purchase 
can presently enjoy. The seller might also mention planned future 
enhancements that will be delivered for free to induce the purchaser to 
buy now rather than wait because the purchaser will get the update for 
free when available without having to wait to enjoy all the present 
features of the product. Stereo equipment is a good example of this 
where the marketing materials will focus on the present features, but 
will also include some mention of the ``future proof'' nature of the 
purchase by discussing other codecs (i.e., digital music formats) that 
will be supported on the equipment after a firmware update that will be 
provided for free when available.
    Once a token has achieved its full functionality under this 
proposed standard, any purchaser that purchases the token with an 
expectation of profits is relying primarily on market dynamics 
affecting the value of the goods and services accessible through the 
token (not the promoter) for price changes. So long as the token seller 
did not promise to support secondary trading on any exchanges, the sale 
of a utility token with full functionality should not be the sale of a 
security.
J. Consumptive Intent vs. Resale
    As discussed, the Teague court focused on objective criteria in 
determining the purchasers' intent. Other Federal courts have expanded 
on Teague, concluding that marketing materials indicating an actual 
subjective investment-related purpose established by the plaintiff 
could not override a contractual representation and merger clause 
affirming that a purchase was for consumption.\20\ As such, even under 
current market conditions where resale intent appears to be more 
prevalent than consumptive intent, there are certain practices that 
could be employed by token sellers to establish sufficient consumptive 
intent, although these are not common features of a token sale. Here 
are a few examples:
---------------------------------------------------------------------------
    \20\ Demarco v. LaPay, No. 2:09-CV-190 TS, 2009 WL 3855704, *8-*9 
(D. Utah Nov. 17, 2009) (holding that plaintiffs could not ``disclaim 
the contents of the contract which were clearly laid out and duly 
acknowledged by them'' in real estate transaction); see also Alunni v. 
Dev. Res. Group, LLC, No. 6:08-cv-1349-Orl-31DAB, 2009 WL 2579319, *8 
n. 12 (M.D. Fla. Aug. 18, 2009) (same).

   Establish limits on the number of tokens any individual 
        purchaser may purchase to approximate the number likely to be 
---------------------------------------------------------------------------
        used in a reasonable amount of time;

   Exclude purchasers who fit the profile of an investor (e.g., 
        venture funds or hedge funds);

   Include lockups on the tokens that preclude resale but 
        permit use for some period of time;

   Include representations as to intended use of the token; and

   Include covenants of the purchaser to login and use the 
        tokens in the network on some prescribed periodic basis.

Since an offering must meet each prong of the Howey test to be 
considered an investment contract, if sufficient consumptive intent 
were to be established, the token sale would not be an investment 
contract even if the sale occurred prior to the development of full 
functionality.
    It is also important to consider when the appropriate time to 
measure consumptive intent vs. resale intent is. In the case of event 
tickets, resale intent predominates the first few days following ticket 
launch as resellers attempt to speculate on the ultimate price that 
users will be willing to pay. This is because the tickets are generally 
not released until shortly before the event takes place. Because there 
is a fixed date for use, the seller is able to ensure that the time for 
resale is arbitrarily short. With utility tokens, there is no fixed 
date for use so it is possible that resale will go on for a relatively 
long time and only gradually shift to use as the project gains adoption 
and traction among users. As that happens, the price would be expected 
to converge on the ultimate price that end users are willing to 
pay.\21\ If we measure consumptive intent today for a utility token 
launched last week, it is likely we will conclude that resale intent 
predominates over consumptive intent presently. That doesn't mean there 
never will be consumptive intent or that the utility tokens have no 
inherent consumptive purpose. The same would be true of event tickets 
if measured at a time when resale was prevalent. Anecdotal evidence 
suggests that there have been a number of earlier token offerings from 
the 2014 and 2015 vintage with respect to tokens that are now routinely 
used for their intended purpose. This is why the Kickstarter model was 
considered best practices for the early utility token sales in 2017. 
This inevitable change in circumstances, i.e., mutability, at least for 
those tokens with truly useful functionality, is also why it makes 
sense under existing case law to only consider pre-functionality token 
sale agreements to be securities, and not the tokens themselves in 
perpetuity.
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    \21\ In many cases, the use price of a utility token is entirely 
independent of the secondary market price, in which case the secondary 
market speculation is really about currency value which is commodity 
speculation having nothing to do with the project or promoter. These 
types of utility tokens are much more akin to digital currencies in 
their relationship to securities laws.
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K. Characteristics of a ``Compliant'' Token Sale
    As the DAO Report found, and as many commentators and regulators 
have observed, many token sales are currently running afoul of U.S. 
securities laws. In this sense, the DAO Report sounded an important 
cautionary alarm to the market. However, the offer and sale of tokens 
can be affected in a manner that complies with the requirements of the 
Federal and state securities laws. Here are the key characteristics 
that must be present in a token sale that complies with the 
requirements of the U.S. securities laws:

   The token cannot offer or be packaged with a financial 
        return or share of ownership;

   Prior to achieving full functionality, the offer and sale of 
        tokens will almost always be deemed to be the offer and sale of 
        an investment contract that must be registered or exempt under 
        U.S. securities laws;

   Once full functionality is achieved, there should be no 
        expectation of profit from the efforts of others, and value 
        should instead be driven by exogenous market factors. At such a 
        point, the token should no longer be deemed an investment 
        contract, as the transaction no longer meets the Howey test, 
        and the offer and sale of tokens should no longer be subject to 
        the requirements of the Securities Act;

   The requisite amount of functionality needed is fact-based, 
        with marketing being an important determinant--if buyers would 
        not buy the token for its present functionality, the token 
        seller must build more present functionality before 
        distributing the token to the public as a non-security;

   Marketing materials must focus on present functionality and 
        use of the token, not on future features or resale 
        opportunities, although a short description of any planned 
        upgrades is permissible; and

   The token seller cannot promise to support secondary market 
        trading of the token on any exchanges.

    We believe the following facts tend to push the securities analysis 
one way or the other but are not by themselves dispositive (good facts 
push the analysis toward a non-security):

   Fixed or automatically increasing supply of tokens is 
        generally a good fact. A fixed or automatically increasing 
        supply is not characteristic of most traditional product sales, 
        but it is also not characteristic of most securities offerings 
        either.\22\ It is a currency-like characteristic and generally 
        stems from the Bitcoin model and the fact that most utility 
        tokens are used as currencies even if they have additional 
        functions and features. A fixed or automatically increasing 
        supply also helps the analysis around efforts of others in the 
        sense that the promoter has no control over supply, which is a 
        key element of price in the trading market.
---------------------------------------------------------------------------
    \22\ Once again, event tickets are an example of a traditional good 
that does have a fixed supply.

   Diminishing token supply, either automatic or periodic, 
        tends to indicate an intent on the part of the token seller to 
        drive up the price of the token in the secondary markets. If 
        this feature exists, there should be important structural 
        reasons for this feature having nothing to do with the desire 
        to influence price. This feature represents efforts of the 
        promoter in structuring the token that not all courts would 
        recognize as satisfying the Howey test to the extent the court 
        applies the Life Partners test focusing on post-sale efforts 
        rather than pre-sale efforts, but since this conclusion is in 
        question, it is still considered to be a bad fact for purposes 
---------------------------------------------------------------------------
        of utility token sales.

   Publicly announced discounts that diminish over a set 
        schedule are problematic during a post-functionality token 
        sale, especially if not accompanied by resale lockups. While 
        this may be a practice used by conventional sellers of goods 
        and services, in the context of utility tokens, it does tend to 
        create an expectation of profits based on the efforts of the 
        promoter to structure the token sale in this manner. Once 
        again, these would be pre-sale efforts of the promoter, but it 
        would still be considered a bad fact for a utility token sale. 
        Also, the same practice would be appropriate during the pre-
        functionality token sale, because the purchasers are investors 
        with a profit motive participating in a securities offering 
        with the requisite protections in place.

   Allocations of a substantial number of tokens to the token 
        seller team as well as to advisors, strategic partners and 
        others for compensatory purposes, especially without any 
        significant resale lockups in place, clearly puts tokens in the 
        hands of persons with resale intent, not consumptive intent. 
        This may not matter to the extent we have already assumed that 
        most purchasers are purchasing with resale intent. At a 
        minimum, if these allocations are granted pre-functionality, 
        the grant must comply with Rule 701 or Regulation D or 
        otherwise comply with U.S. securities laws. The real reason 
        this could be a bad fact is that this practice may result in 
        fraudulent ``pump and dump'' Ponzi-like schemes on the part of 
        the persons receiving the allocations.

   Each of the factors discussed above in Section J that tend 
        to establish consumptive intent rather than resale intent are 
        good facts, particularly lockups that prohibit resale but not 
        use for a significant period of time after purchase, which are 
        an excellent way to curb ``pump and dump'' tendencies and to 
        emphasize intent to use rather than resell.
L. Existing Regulations Applicable to Token Exchanges--CFTC Anti-Fraud 
        Rules
    The CFTC is responsible for enforcement actions against wrongful 
conduct in spot markets for digital currencies.\23\ Historically, the 
CFTC has exercised that enforcement authority when there is a nexus to 
an actively traded commodity interest,\24\ and, consistent with that 
approach, since the recent launch of digital currency-related 
derivative products, the CFTC has stepped up its enforcement actions 
against spot market abuses, although its initial digital currency-
related actions began in 2015.\25\ ``Bitcoin and other virtual 
currencies'' have already been deemed within the scope of `commodities' 
under CFTC enforcement jurisdiction, and given the wide scope of the 
definition (the term commodity means ``all other goods and articles [. 
. .] and all services, rights and interests [. . .] in which contracts 
for future delivery are presently or in the future dealt in''), any 
utility token with fungible characteristics falls within this 
scope.\26\
---------------------------------------------------------------------------
    \23\ The term digital currency means the same thing as virtual 
currency for purposes of this memorandum. In its enforcement order 
against Derivabit in September 2015, the CFTC confirmed that ``Bitcoin 
and other virtual currencies are encompassed in the definition and 
properly defined as commodities.'' United States of America Before the 
Commodity Futures Trading Commission In the Matter of Coinflip Inc., d/
b/a Derivabit, and Francisco Riordan, Respondents. Order Instituting 
Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity 
Exchange Act, Making Findings and Imposing Remedial Sanctions. CFTC 
Docket No. 15-29, September 17, 2015. Available at: http://
www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/
legalpleading/enfcoinfliprorder09172015.pdf.
    \24\ CEA Sections 6c, 9a(2) and Part 180 of the CFTC's regulations 
give the CFTC the authority, in relevant part, over violations with 
respect to ``any commodity in interstate commerce.'' 7 U.S. Code  9, 
13, and 17 CFR  180, 76 FR 41398. There are two particular provisions 
of the CEA that grant the CFTC broad authority to take action against 
persons engaged in forms of market abuse, including manipulation and 
fraud, or attempted manipulation and fraud, Sections 6(c) and 9(a)2. 
Commission Regulation 180 (i.e., Part 180) codifies Section 6(c).
    \25\ In addition to the Derivabit action outlined above, the CFTC 
has also taken action against TeraExchange in 2015, and the spot 
exchange Bitfinex in 2016, for CEA violations associated with virtual 
currencies. See United States of America Before the Commodity Futures 
Trading Commission In the Matter of TeraExchange LLC Respondent. Order 
Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the 
Commodity Exchange Act, as amended, Making Findings and Imposing 
Remedial Sanctions. CFTC Docket No. 15-33, September 24, 2015. 
Available at: http://www.cftc.gov/idc/groups/public/
@lrenforcementactions/documents/legalpleading/
enfteraexchangeorder92415.pdf. See also United States of America Before 
the Commodity Futures Trading Commission In the Matter of BFXNA Inc. d/
b/a BITFINEX, Respondent. Order Instituting Proceedings Pursuant to 
Sections 6(c) and 6(d) of the Commodity Exchange Act, as amended, 
Making Findings and Imposing Remedial Sanctions. CFTC Docket No. 16-19, 
June 2, 2016. Available at: http://www.cftc.gov/idc/groups/public/
@lrenforcementactions/documents/legalpleading/enfbfxnaorder060216.pdf.
    \26\ CEA Section 1a(9), 7 U.S. Code  1.
---------------------------------------------------------------------------
    In September 2017, in its complaint against Gelfman, the CFTC took 
action against alleged abuses in the Bitcoin spot market and charged 
operators of an alleged Ponzi scheme with fraud, misappropriation and 
issuing false account statements in violation of Section 6(c) of the 
CEA.\27\ In January 2018, the CFTC brought three digital currency 
enforcement actions: (i) My Big Coin Pay Inc., which charged the 
defendants with commodity fraud and misappropriation related to the 
ongoing solicitation of customers for a digital currency known as My 
Big Coin; \28\ (ii) The Entrepreneurs Headquarters Limited, which 
charged the defendants with a fraudulent scheme to solicit Bitcoin from 
members of the public, misrepresenting that customers' funds would be 
pooled and invested in products including binary options, making Ponzi-
style payments to commodity pool participants from other participants' 
funds, misappropriating pool participants' funds, and failing to 
register as a Commodity Pool Operator; \29\ and (iii) CabbageTech, 
Corp., which charged the defendants with fraud and misappropriation in 
connection with purchases and trading of Bitcoin and Litecoin.\30\
---------------------------------------------------------------------------
    \27\ Commodity Futures Trading Commission v. Gelfman Blueprint, 
Inc. and Nicholas Gelfman, Case Number 17-7181, United States District 
Court, Southern District of New York. Complaint filed September 21, 
2017. Available at: http://www.cftc.gov/idc/groups/public/
@lrenforcementactions/documents/legalpleading/
enfgelfmancomplaint09212017.pdf.
    \28\ Commodity Futures Trading Commission v. My Big Coin Pay, Inc., 
Randall Crater, and Mark Gillespie, Case Number 18-10077-RWZ, United 
States District Court, District of Massachusetts. Complaint filed 
January 16, 2018. Available at: http://www.cftc.gov/idc/groups/public/
@lrenforcementactions/documents/legalpleading/
enfmybigcoinpaycomplt011618.pdf.
    \29\ Commodity Futures Trading Commission v. Dillon Michael Dean 
and the Entrep[r]eneurs Headquarters Limited, Case Number 18-cv-00345, 
United States District Court, Eastern District of New York. Complaint 
filed January 18, 2018. Available at: http://www.cftc.gov/idc/groups/
public/@lrenforcementactions/documents/legalpleading/
enfentrepreneurscomplt01
1818.pdf.
    \30\ Commodity Futures Trading Commission v. Patrick K. McDonnell, 
and CabbageTech Corp. d/b/a Coin Drop Markets, Case Number 18-cv-0361, 
United States District Court, Eastern District of New York. Complaint 
filed January 18, 2018. Available at: http://www.cftc.gov/idc/groups/
public/@lrenforcementactions/documents/legalpleading/
enfcdmcomplaint011818.pdf.
---------------------------------------------------------------------------
    The CFTC also appears to be closely monitoring digital currency 
spot exchanges as part of these efforts. As part of the self-
certification process for Bitcoin futures products by certain 
Designated Contract Markets (``DCMs''), the CFTC expects information 
sharing agreements to be in place with underlying spot exchanges in 
accordance with the second core principle for DCMs.\31\ On February 15, 
2018, the CFTC once again reminded market participants in a customer 
protection action that it ``maintains general anti-fraud and 
manipulation enforcement authority over virtual currency cash markets 
as a commodity in interstate commerce.'' \32\ It has also apparently 
(i) requested information from GDAX in relation to an alleged `flash 
crash' which occurred on June 21, 2017,\33\ and (ii) issued subpoenas 
regarding alleged conduct at the Hong Kong-based exchange Bitfinex.\34\
---------------------------------------------------------------------------
    \31\ See CFTC Backgrounder on Self-Certified Contracts for Bitcoin 
Products, December 1, 2017. Available at: http://www.cftc.gov/idc/
groups/public/@newsroom/documents/file/bitcoin_fact
sheet120117.pdf. See also CFTC Statement on Self-Certification of 
Bitcoin Products by CME, CFE and Cantor Exchange, December 1, 2017. 
Available at: http://www.cftc.gov/PressRoom/PressReleases/pr7654-17.
    \32\ CFTC Customer Advisory: Beware Virtual Currency Pump-and-Dump 
Schemes, February 15, 2018. Available at: http://www.cftc.gov/idc/
groups/public/@customerprotection/documents/file/
customeradvisory_pumpdump0218.pdf.
    \33\ Lily Katz and Matt Robinson, Cryptocurrency Flash Crash Draws 
Scrutiny from Watchdog, Bloomberg.com, October 2, 2017. Available at: 
https://www.bloomberg.com/news/articles/2017-10-02/cryptocurrency-
flash-crash-is-said-to-draw-scrutiny-from-cftc.
    \34\ Matthew Leising, U.S. Regulators Subpoena Crypto Exchange 
Bitfinex, Tether, Bloomberg.com, January 30, 2018. Available at: 
https://www.bloomberg.com/news/articles/2018-01-30/crypto-exchange-
bitfinex-tether-said-to-get-subpoenaed-by-cftc.
---------------------------------------------------------------------------
    Reinforcing the inherent scope of the CFTC's enforcement authority 
is the possibility of aiding and abetting violations that act to 
restrain certain industry service providers or other market 
participants associated with any alleged violations.\35\ The efficacy 
of this regulation by proscription is further reinforced by the ability 
of private litigants to take actions under the above provisions, 
subject to certain additional requirements.\36\ For a private actor to 
make a claim, they must demonstrate, inter alia, that they purchased or 
sold a derivative contract referencing a digital currency and prove 
actual damages resulting from the proscribed conduct. Although this 
right of action therefore relies on a nexus to the digital currency 
derivative market, as the number and diversity of digital currency 
based derivative products continues to grow so too does the number of 
potential plaintiffs.
---------------------------------------------------------------------------
    \35\ To prove an aiding and abetting violation under the CEA (7 
U.S. Code  25(a)(1)), it must be shown that the defendant ``in some 
sort associate himself with the venture, that he participate in it as 
in something that he wishes to bring about, that he seek by his action 
to make it succeed.'' CFTC v. Amaranth Advisors, L.L.C., 554 F. Supp. 
2d 523 (2008) stating the appropriate standard for aiding and abetting 
under the CEA, quoting Learned Hand J. in United States v. Peoni, 100 
F.2d 401, 402 (2d Cir.1938).
    \36\ 7 U.S. Code  25(a)1(D) provides that a private litigant can 
take action for fraud, attempted fraud or if the violation constitutes 
``a manipulation of the price of any such contract or swap or the price 
of the commodity underlying such contract or swap.''
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M. Conclusion
    The Howey test is fundamentally based on facts and circumstances--
the economic realities--of the offer and sale of the underlying product 
or service.\37\ As circumstances change, the results of the test should 
change as well. Specifically, when the circumstances under which 
parties agree to enter into a pre-functionality token sale agreement 
have changed by the time the underlying tokens are delivered, an 
analysis which concluded that the pre-functionality token sale 
agreement constituted an investment contract may no longer apply to the 
tokens. On the other hand, if circumstances have not changed 
materially, new token sale agreements may constitute investment 
contracts in their own right, even after delivery under the initial 
pre-functionality token sale agreement.
---------------------------------------------------------------------------
    \37\ Howey, supra note 2 at 299. (The Howey test ``embodies a 
flexible rather than a static principle, one that is capable of 
adaptation to meet the countless and variable schemes devised by those 
who seek the use of the money of others on the promise of profits.'')
---------------------------------------------------------------------------
    A pre-functionality token sale agreement may be found to constitute 
an investment contract even if the future tokens will not qualify as 
investment contracts or other securities at the time of their delivery. 
When a seller offers and sells the pre-functionality token sale 
agreements by emphasizing the potential value of the future tokens, 
uses the proceeds of the pre-functionality token sale agreements to 
complete development of an application for the tokens and undertakes to 
conduct a public sale of the tokens with a target price above the pre-
functionality price, these circumstances may provide a basis for the 
SEC or a court to conclude that the pre-functionality token sale 
agreements are investment contracts. Once the network or software 
application for the tokens is developed, these circumstances would no 
longer apply and, thus, could no longer provide a basis for concluding 
that further sales of tokens would constitute investment contracts. 
Even if the pre-functionality purchasers reasonably anticipate that a 
token will appreciate above its public sale price, any such 
appreciation should result from general market forces rather than the 
efforts of the seller. Therefore, once the investment contract implied 
by the pre-functionality token sale agreement has been completed (i.e., 
at the time of tokens are delivered), the tokens should no longer 
involve a common enterprise in which the seller's efforts are 
reasonably expected to produce profits for the token purchasers.
N. Epilogue
    While not directly related to the above conclusion, here are some 
additional thoughts worth considering.
1. Relevant Disclosure
    Ultimately, the Securities Act is a disclosure regime. One 
important way to look at this situation is to ask what the relevant 
disclosure would be post-functionality. Existing disclosure rules 
assume the security represents either equity or debt, neither of which 
would be appropriate disclosure rules for utility tokens. It would not 
be wise, for example, to include disclosure about the token seller, or 
we would confuse the purchasers into believing they have some interest 
in the token seller, which they do not. Perhaps some disclosure would 
be appropriate about the real risk here, namely that the market price 
is extremely volatile, but that is now patently obvious to anyone 
sitting in front of a computer and is not something about which the 
token seller has any special information or expertise to provide. Maybe 
some disclosure about overhang would make sense, especially if the 
token seller happens to be aware of any large purchasers, but this 
disclosure again risks providing false comfort to the market since the 
token seller, unlike an equity issuer, has no way of knowing who holds 
any particular percentage of the tokens from time to time. We have to 
ask ourselves, if there is no relevant disclosure that could possibly 
be provided by the token seller post-functionality, are we really 
dealing with a securities transaction that is appropriately regulated 
under a disclosure regime, or are the regulatory concerns really about 
trading price manipulation covered by the CFTC's anti-fraud rules for 
spot trading?
2. Common Enterprise
    We have not considered the common enterprise prong of the Howey 
test in the above discussion because the courts are fractured over the 
best way to interpret this prong of the test. This fact, however, cuts 
both ways. It is not prudent for a token seller to rely on this test as 
the sole prong to hang its hat on, or for regulators to assume it will 
be easy to prove (and the regulator must prove it to win in court).
    Indeed, the most commonly applied interpretation of this prong 
involves horizontal commonality, which doesn't appear to be the case 
once tokens have achieved full functionality and are sold to purchasers 
as a product. There are no contractual commitments on the part of the 
token seller surviving the post-functionality token sale. The proceeds 
of a post-functionality token sale cannot be said to be pooled in any 
enterprise of which the token holders own a share or interest. It is 
true that narrow vertical commonality will often exist in the sense 
that the token seller's fortunes are often tied to the same market 
dynamics as the token holders to the extent the price of tokens rises 
and the token seller has retained an inventory of tokens for future 
sale. Perhaps for the very reason that this type of commonality would 
apply to every seller of a good or service that is hoping for the 
prices of its goods to go up, very few courts have held that narrow 
vertical commonality is sufficient by itself to satisfy the common 
enterprise prong. Broad vertical commonality, meaning that the fortunes 
of the token holder are tied to the efforts of the token seller would 
be subsumed within the efforts of others prong, so it would not be 
sufficient for merely some efforts of the promoter to satisfy the Howey 
test for all the reasons described above with respect to the efforts of 
others prong showing that those efforts must predominate the 
expectation of profits. From the regulator's perspective, at best, the 
common enterprise prong adds nothing to the analysis, but in all 
likelihood, it represents a very significant hurdle to overcome in 
court.
3. Fraudulent Sales Tactics--Pump and Dump
    We have pointed out in several instances above that, if we apply 
existing case law with analytical consistency, the mere marketing of a 
post-functionality token (or any commodity, such as gold coins) as an 
investment should not, by itself, cause the offering to satisfy the 
Howey test. Nevertheless, we leave open the possibility that the 
presence of abusive marketing tactics or running a so-called ``pump and 
dump'' scheme can satisfy the efforts of others prong in that 
purchasers would expect to profit on the continuation of those abusive 
promotional efforts. In any market environment, that would be 
sufficient basis for satisfying Howey if the other prongs were also 
satisfied. Moreover, token sellers would be unwise to ever refer to the 
token as an investment, whether pre- or post-functionality, because 
those statements will live on and be discoverable with an Internet 
search even at some future time when the token seller would like to be 
able to conclude that the efforts of others prong is no longer the only 
prong available to avoid satisfying the Howey test (e.g., if the token 
seller wants to market future features after the market has cooled down 
and the tokens are being used instead of resold for the most part). As 
such, we do not expect this technical point--that commodities may be 
marketed as investments--to lead to problematic behavior in the context 
of token sales.
4. Reves Test
    It is important not to confuse the Reves test with the Howey test. 
Some of the Reves factors are similar to some of the Howey prongs. The 
first Reves factor examines the transaction in order to assess the 
motivations that would prompt a reasonable lender (buyer) and creditor 
(seller) to enter into it. For example, was the transaction in question 
an investment transaction or a commercial or consumer transaction? This 
factor might be confused with the expectation of profits element of the 
Howey test. In Reves the satisfaction of any one factor, if strong 
enough, can cause the note to qualify as a security. This confusion may 
lead to the incorrect application of Howey which requires every prong 
to be satisfied, regardless of how clearly any one factor may be 
satisfied, for the arrangement to qualify as an investment contract. 
Again, it is not sufficient for an expectation of profits to exist with 
respect to an asset that may even be marketed as an investment, if the 
expectation is not based on the efforts of others. Analytically, it 
just doesn't matter in how many ways and how clearly the expectation of 
profits prong is satisfied if those expectations are not based on the 
efforts of others.
    In addition, some of the Reves factors would appear relevant to 
utility tokens, especially the second factor, which is the plan of 
distribution used in the offering and selling the instrument--for 
example, is the instrument commonly traded for investment or 
speculation? While it may be tempting to consider the trading markets 
for utility tokens to be dispositive of the issue of whether a utility 
token is a security, that is not the case. As discussed above, it is 
merely one more fact tending to establish the expectation of profits 
element of the Howey test, which may be overridden by the other prongs.
5. Policy Considerations
    Blockchain technology is as transformative as the Internet. While 
the Internet was about the movement of information (and set off lots of 
new legal concerns around privacy and data security), blockchain 
technology is about the movement of value. The key innovation, as with 
the Internet, is found in the frictionless nature of the movement. It 
has already led to important new business models never seen before. It 
will ultimately lead to rapid frictionless liquidity for every asset 
class and every good and service. Wherever possible, it will be 
important to regulate based on looking through the token to the thing 
being tokenized for the right regulatory treatment. But, it will mean 
things like novel software applications suddenly have unprecedented 
trading characteristics that need to be evaluated under existing law. 
Fortunately, the Howey test is based on facts and circumstances and 
focuses on the economic substance of the transaction, so it should 
stand the test of time as this disruptive technology changes our daily 
norms.
    Blockchain technology is expanding at a rapid pace. Other 
jurisdictions like China have taken a very stilted binary approach to 
regulating token sales by simply banning them because their laws are 
not developed enough to be useful as a means of preventing bad actors 
while permitting good actors. Other jurisdictions have aggressively 
embraced blockchain technology and have instantly become magnets for 
blockchain entrepreneurs as today's workforce is more mobile than ever.
    Over time, this recent spate of irrational exuberance associated 
with this novel technology will subside and consumptive intent will 
predominate once again. In that future state, it would not make any 
sense to have taken a position that all tokens are securities in 
perpetuity. This would be tantamount to following China's lead as this 
would shut down the entire ecosystem, at least here in the United 
States. Fundamentally, utility tokens are intended to be used as non-
securities in a network or application. They could not be used for 
their intended purpose (e.g., micro payments for micro tasks, or 
loyalty rewards) if they are categorized as securities under U.S. law, 
so all of this innovation would need to move offshore and the United 
States would be one more jurisdiction added to the list of disqualified 
jurisdictions along with China and New York (because of the overbroad 
BitLicense). It makes more sense to draw a line today that is grounded 
in intellectual rigor and analytical consistency, which uses the 
flexibility of Howey to regulate the bad actors while permitting the 
good actors to continue to innovate with Blockchain technology here in 
the United States.

    The Chairman. Thank you, Mr. Ness.
    The chair reminds Members that they will be recognized for 
questioning in the order of seniority for Members who were here 
at the start of the hearing. After that, Members will be 
recognized in the order of arrival. I appreciate Members' 
understanding, and I will recognize myself for 5 minutes.
    Mr. Ness, I agree with you that if we don't get this right 
and we flush the innovators offshore into other countries, that 
getting them back is a lot more difficult. We are at the start 
of the process with this hearing so that we can get to an 
answer that doesn't do that.
    Ms. Baldet and Mr. Kupor, you each noted that tokens in 
crypto-networks have the potential to create next generation 
open Internet protocols. Can you flesh that out a little bit 
for the laymen and myself that understand the words, but if you 
can tell us what those actually mean, that would be a little 
helpful.
    Ms. Baldet. Sure, thank you.
    When we say open, open means a couple things. In this case, 
we mostly mean open access when we say public blockchains, 
which means that anyone can join the network. It has to do with 
the degree of gatekeeping, which is not necessarily an all or 
nothing kind of a decision. If we start thinking of public 
blockchains as being more like a public commons, it is a lot 
more like the Internet wherein you have a lot of choice as to 
how you access that sort of network.
    We also usually mean open source, as Mr. Kupor mentioned, 
so that we are allowing auditing of that code which increases 
trust of the code, and most of the core technology that powers 
the backbone of the Internet is open source.
    Mr. Kupor. I agree with all that. I would just to give you 
a very specific example, imagine in the future a social 
network. Today, as users of social networks, of course, you 
have an intermediary, in many cases, a company like Facebook 
who obviously is taking and utilizing the consumer data, and 
then obviously developing relations with advertisers and others 
as a way to monetize that data. That is their business model.
    In the future, utilizing a crypto-network, you can imagine 
a world where you as the user own your data. That data is 
cryptographically secured, and you choose which data you want 
to expose to various advertisers or other promoters, and the 
flow of economic value in that case, as opposed to going 
through an intermediary, might be going directly from an 
advertiser or a promoter of products to you as an individual as 
you have kind of governed the use of that data. That would be, 
in very broad terms, a kind of expansive view of what this 
could look like.
    The Chairman. All right. Mr. Fairfield, you talked about 
the Howey test, which seems to be the gold standard among 
securities lawyers who can spell that last name. Can you talk 
about that being maybe the outer edges?
    One of the questions we are trying to answer is are they 
securities or commodities, and where does that transition 
occur? Can you talk to us better about this Howey test and why 
you think that is the outer edge, and just how should it apply 
to distinguishing between commodities and securities?
    Mr. Fairfield. Certainly. There are two questions. The 
first is lawyers are inventive. They can rework the formal form 
of a transaction to make it into anything. Howey describes the 
outer limit of the kinds of legal forms that can be turned into 
investment contracts, that can be turned into this sort of 
exchange. I give you money now, and I wait and I reap the 
benefit of your labor on the other end.
    But the difficulty with that is that while courts must be 
able to look to the economic realities of the transaction, look 
underneath the form because if we just look at the form, if we 
just look at what it is called, then anyone can title the asset 
whatever they want at the top of a piece of paper and escape 
whatever regulation they want.
    Courts have to look past the formal titling of the asset to 
the economic realities of it; however, they also have to 
understand that the very flexibility of these tools, both the 
flexibility of legal forms and the flexibility of this database 
technology means that it is very possible for people to be 
using a product for one entirely legitimate purpose and have 
other people begin to use it for different purposes.
    An example of this from outside of the cryptocurrency area 
entirely would be the discussion we had several decades ago on 
VCRs. The question was some people use them to make illegal 
copies. Many people don't. How far are we willing to go in 
rooting out bad uses that we are beginning to cut away healthy 
tissue? And that is why I believe Howey is the outer circle. It 
is necessary that it be there so that SEC, in this particular 
case, can reach cases in which people are labeling something 
one formal legal form, but are actually engaging in an 
investment contract. That is what it is there for, but it 
doesn't really tell us anything about what the regulatory 
landscape should actually look like at the end of the day. In 
fact, the regulatory landscape, in my estimation, should and 
will look like something substantially different. It will look 
like a bit of a handoff, like a relay race in which for certain 
functions and for certain conditions, one overseer may have 
authority. Under [audio malfunction in hearing room].
    The Chairman. Sorry, I lost your microphone. Thank you, Mr. 
Fairfield.
    Ranking Member Peterson, 5 minutes.
    Mr. Peterson. Thank you, Mr. Chairman. I don't know where 
to start.
    I am somebody that believes we should still be on the gold 
standard, and we should audit the Fed because I don't really 
trust them.
    What worries me about this is that you say there are $250 
billion of capitalization here or whatever, how much money is 
actually here. This just seems like a Ponzi scheme to me. I 
think the stock market is a casino, so that is where I am 
coming from.
    If I am going to send $100,000 to somebody through one of 
these deals, who is going to stand behind it? I give the money 
to one of you guys and then you turn around and create these 
things and send it to somebody else. Well, in the meantime, 
what if you went broke? I was involved when we found out about 
credit default swaps and figured out that everybody was trading 
these things and there was nothing there, and if we wouldn't 
have stopped them the whole economy would have collapsed. I 
don't know if we have a similar situation going on here with 
this, but what is behind this? If there is no money at the end 
of the day, who is going to make up for this? Can anybody 
explain that to me? Mr. Gensler?
    Mr. Gensler. Could I take a shot?
    I think that I would split it in two buckets. In this field 
where venture capitalists, entrepreneurs are developing an idea 
and asking people for money, they publish a White Paper, they 
build up a following, Reddit posts--these are different 
communities, social network posts, a medium and so forth--and 
they build a following and then they sell it and raise money. 
And sometimes it is small, just like a crowdfunding on 
Kickstarter. But most of them aren't. There have been 3,800 of 
them to date. Over 50 percent of them fail within 4 months, and 
there are different estimates how many are scams and frauds. 
There are good faith actors in the middle of it, too, a lot of 
good faith actors, but there are a lot of frauds and scams.
    Right now, if they fail, the only thing you could do is try 
under the securities laws to say they were an unregistered, 
noncompliant security and try--under the private rights of 
actions under securities law--to get something back; or do 
nothing.
    And the second category is digital gold. The digital gold, 
which is Bitcoin, and while there is nothing behind it, I would 
say, Mr. Ranking Member, there is really nothing behind gold 
either. All of this, we have what is behind it is a cultural 
norm that for thousands of years we like gold. The worldwide 
value of gold is $7 trillion, by the way, just to give you a 
little sense, but only about ten percent of the annual 
production of gold is used in manufacturing. The rest of it is 
because we think it is kind of nice to have gold necklaces and 
jewelry, or we do it as a store value. Bitcoin is a modern form 
of digital gold and it is a social construct.
    Mr. Peterson. They are just creating this money out of 
nowhere.
    Mr. Gensler. In the first category, the investor type that 
would be under the SEC.
    Mr. Peterson. No, I get that.
    Mr. Gensler. But in the second category, you are right, 
which was under this Committee. You are going to be grappling 
with this for a while.
    Mr. Peterson. No, I know.
    Mr. Gensler. It is digital gold.
    Mr. Peterson. In the first category, I assume those people 
are sophisticated enough to realize they are going to get 
fleeced potentially?
    There are people that get into that area that don't realize 
what they are getting into. They think they are going to get 
rich and they are going to get into this deal ahead of 
everything else and they are going to make 10,000 percent on 
their money and whatever else, and some guy is selling them on 
this. I don't know where the protection is here for people.
    Mr. Gensler. Some are very sophisticated like Andreessen 
Horowitz and they manage $7 billion. There are many like that, 
but there are others that aren't. But you are right. The 
Securities and Exchange Commission has a lot of work ahead of 
them to sort of bring this market into--the first part of the 
market. Seventy percent of the market is commodities, but the 
first part, this ICO marketplace, is the SEC's--they are 
working at it, but they have a lot of work ahead.
    Mr. Kupor. If I could just add, Mr. Ranking Member, you 
raise this concept of a kind of trust, right, which is who do I 
trust? What is the trusted intermediary?
    The beauty, at least, certainly from the perspective of an 
investor and as a consumer, the beauty of these crypto-networks 
is what you are trusting is you are trusting cryptography, you 
are trusting math, you are trusting software as opposed to a 
centralized intermediary, and you have a community that is 
governing the interest there. In other words, if the community 
tries to do something that is inappropriate, all of the 
software is open source. All of the software can be basically 
what is called forked and literally taken over and recreated in 
a new community. There is a norm of community governance that 
exists in these areas that really substitutes trust from a 
centralized intermediary to trust to a community that is 
responsible for government.
    Mr. Peterson. Thank you, but I am still skeptical.
    The Chairman. Mr. Lucas, 5 minutes.
    Mr. Lucas. Thank you, Mr. Chairman, and along with the 
gentleman from Georgia, Mr. Scott, I have the privilege of 
sitting both on this Committee and the Financial Services 
Committee, so I welcome this discussion by the panel when it 
comes to the next regulatory frontier as it impacts the two 
Committees.
    First, Mr. Kupor, how should regulators think about the 
function of the token when choosing to apply regulatory 
requirements? Should regulators look to the functioning of the 
token at all, or only the issuing activity?
    For example, say there is a cryptocurrency. We will call 
it, for the sake of discussion, Bitcoin 2.0, and say it 
functions identically to Bitcoin in every way except that a 
small portion of the total tokens were pre-mined and 
distributed in token sale. It is possible to issue Bitcoin 2.0 
through ICO and not have it be a security, or is the 
functioning of the token irrelevant because of the manner in 
which it is issued?
    I am asking what my folks back home would define as geek 
questions, but this is where we are.
    Mr. Kupor. Yes, sir.
    Mr. Lucas. What say you?
    Mr. Kupor. Yes, to a couple of things.
    The issuance of those tokens and the sale of those tokens 
in exchange for money before a network exists, I do believe is 
what is called an investment contract and should be regulated 
as such.
    If I develop a white paper and I tell you I am going to 
build this thing and you give me money for it before it exists, 
if I fleece you, absolutely the SEC has jurisdiction to bring 
me up on securities fraud charges. You have private cause of 
action. No question about it there.
    Once the network is functional and therefore, the tokens 
are doing what they were intended to do, whether that is 
storage or other things, the value of that token now really is 
not a function of the efforts of the developer, it is really 
the question of what is the utility of that token, much like 
any other commodity. Therefore, certainly my view is that in 
that case, the underlying token itself should be regulated as 
if it were a commodity because that is actually kind of the 
nature of what it is actually doing.
    Mr. Lucas. Thank you.
    Mr. Ness, the last prong of the Howey test identifies an 
investment contractor transaction in which an individual 
expects profits solely from the efforts of the promoter or the 
third party. Yet, for almost every token project, there are 
multiple avenues for a holder to come into possession of a 
token. When a network is fully functional, tokens can be 
purchased through promoter, traded on a secondary market 
exchange within a network, or earned by performing work to 
support the network. In each of these cases, the efforts of the 
holder vary and can implicate the Howey test differently. How 
should regulators think of an asset that has multiple methods 
of delivery, an asset that can be both purchased and earned, or 
should the method of delivery determine the regulatory regime 
governing an asset?
    Mr. Ness. Fortunately, it is a relatively simple answer, 
which is that it really comes down to the same test, which is 
pre-functionality versus post-functionality, or whatever we end 
up deciding is the trigger point for determining the different 
status.
    It seems to me that however you come by this, I suppose 
there are two fundamentally different ways. One is to get it 
from the issuer directly, the other is to get it from some 
third party. And if it is in pre-functional--the pre-functional 
stage and you are obtaining it from the issuer, I would argue 
that is a primary offering of an investment contract, even if 
it is essentially earned on a network, because at that point 
there is a lot of case law out there if you do work for a 
security, you have paid for the security. There is 
consideration there in the services.
    I wouldn't say that there is a difference between earning 
it versus buying it. It going to be a security, based on its 
characteristics as we end up defining them, pre-functionality 
versus post-functionality.
    Mr. Lucas. Mr. Gorfine, in your testimony you mentioned the 
new working group set up by FSOC and the Commission's work with 
the SEC and other regulators. This Committee cares a lot about 
coordination between financial regulators when it comes to 
these sorts of matters. Can you talk more about how the 
regulators, including the CFTC, are working together, I should 
say, to understand and clarify their overlapping jurisdictions 
and how it affects the virtual currencies?
    Mr. Gorfine. Yes, thank you. It is a great question and we 
agree that coordination and collaboration with our sister 
agencies is very important on this type of a topic.
    One thing about this space that is common across a lot of 
areas of financial technology is that it inherently cuts across 
geographic and jurisdictional boundaries. It is very important 
to make sure that we are coordinated in sharing information 
with each other.
    Certainly, on the topic of cryptocurrencies, we are working 
closely with the SEC to make sure that we are coordinated. And 
just to step back and explain how we view our rule set, the 
definition of commodity under our statute is very broad. A lot 
of things are commodities and we are soon after the World Cup, 
so think about soccer balls. Those are commodities. Just 
because something is necessarily a commodity doesn't mean that 
we have a direct regulatory interest. It is only when we start 
to see the rise of futures or swaps products built on those 
commodities that we have direct oversight.
    But when the SEC applies the Howey test and determines 
whether something fits within a securities law framework, that 
certainly matters to us because then that is something that 
would fall under their jurisdiction. Hence the need for us to 
be in close communication with the SEC.
    Mr. Lucas. Mr. Chairman, if you would indulge me for one 
last thought.
    For a number of years, I sat next to Ron Paul on the 
Financial Services Committee, so when Mr. Peterson brought up 
his observations about gold standard, I can't help but think 
about Mr. Paul's story noting that when the Roosevelt 
Administration took us off the gold standard in 1933, they 
sealed every safe deposit box in every financial institution in 
America and before you could open it, you had to have Federal 
official of appropriate nature or state designee to be with you 
so they could make sure you didn't have any gold coins, gold 
bars, or gold certificates in those safe deposit boxes. The 
Ranking Member brings up some interesting observations. Even 
gold wasn't safe in 1933.
    I yield back, Mr. Chairman.
    The Chairman. The long reach of government. Thank you.
    David Scott, 5 minutes.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman.
    There is a good amount of very serious and legitimate 
concerns about coins that are being offered. I am not sure we 
realize it, but there are over 1,600 coins currently and 
growing every day. And we have to look closely and watch how 
these coins are being used, and if it is appropriate for them 
to be regulated, to make sure that they are not being used 
improperly. I am not sure that the panelists or the audience or 
those who may be watching via television know, but I find it 
very concerning that in the indictment of the 12 Russian 
hackers that hacked the DNC's servers, did you know that they 
included in those charges within the indictment was the fact 
that the Russian hackers used principally Bitcoin when 
purchasing the servers, when registering the domains, and 
otherwise making payments in furtherance of illegal hacking 
activity on the United States elections?
    What I am saying is that with every new tool, our 
technology is moving fast. It is growing at a rapid rate, and 
we have to grab hold on what we are doing to make sure that we 
do everything we can to ensure that these new coins are not 
being used illegally or for illicit activities, like when the 
Russians attacked our election system.
    Now, I also have read in some news coverage studies that 
are out there that think that not all of these ICOs are a 
positive thing. There is a lot of debate on that, and our 
Ranking Member, Mr. Peterson, expressed it best of all.
    For example, a recent Statis group study found that over 80 
percent of initial coin offerings are scams. In fact, they 
broke ICOs into six groups, scam ICOs, failed ICOs, gone dead 
ICOs, dwindling ICOs, promising ICOs, and then successful ICOs. 
And on the basis of these above six classifications, they wrote 
that they found that approximately 81 percent of our ICOs were 
scams. Six percent were failed. Five percent had gone dead, and 
eight percent went on to trade on the exchange.
    I want to ask the panel, with this evidence, does this seem 
right to you? Is 80 percent high? Are the risks being blown out 
of proportion for these studies?
    Let's start with Mr. Gorfine. You mentioned in your 
testimony that LabCFTC published in its first FinTech primer on 
virtual currency late last year. What more can we do to protect 
investors? And I want to get each of you in my last minute 
here. Just say yes or no, are we in trouble? Is this thing 
serving us or are we serving it?
    Mr. Gorfine. I will try to be brief, and we share your 
concern. And you mentioned the LabCFTC primer which we 
published in October of last year, and the way that the primer 
is structured is that it concludes with a discussion of risks 
and challenges that we believe market participants need to be 
aware of. Just this week on Monday, and I would encourage the 
public that is viewing this today to take a look at a customer 
advisory that we published through our Office of Customer 
Education and Outreach where we are tackling exactly this 
issue, which is that it is a very speculative, risky space, 
especially for retail participants to be participating, and we 
encourage them to really do their research and ask themselves 
important questions about the value of a lot of the different 
types of offerings that are out there. It is an area that we 
think education is a key component. I will also add that from 
an enforcement perspective, the CFTC, as well as a lot of other 
agencies, are looking to target bad actors that are trying to 
take advantage of a lot of the enthusiasm around this space.
    The combination of education, enforcement, and then 
proactive engagement as LabCFTC is doing are important 
regulatory tools for us to deploy.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired.
    Austin Scott, 5 minutes.
    Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
    We are a long way away from peanut fields in Sycamore, 
Georgia, and I can't help but wonder if somebody who, prior to 
getting elected to Congress, actually had a series 7, what 
would a prospectus on coin offering look like? I don't know if 
it would be one page or 10,000 pages or more, but one thing 
that is clear to me is that you can certainly create a coin for 
anything. You can create a coin for any color. You can create a 
coin for any opposite color. There is an infinite number of 
coins that can be created.
    I see no way to regulate every coin offering that is out 
there, but I would also tell you that when you turn on CNBC and 
they show the Dow, the S&P, and the Nasdaq on one side of the 
screen and on the other side of the screen is a value for 
Bitcoin, then certainly it has reached the level where we need 
to have some sort of regulatory certainty in this area.
    Most of my questions are for Mr. Gorfine. You run LabCFTC, 
and you have held office hours around the country where you 
have met with many people in the industry. Can you tell us 
about the interesting concerns of the developers who are 
working on token-based projects, and how sensitive they are to 
the regulatory environment?
    Mr. Gorfine. Yes, thank you for the question, and in fact, 
I am heading this afternoon up to New York to have another 
round of office hours with innovators.
    We have had an incredible opportunity to go to various 
cities and meet with folks that are heavily involved in a lot 
of projects across the spectrum that you have heard about 
today, and it strikes me that it is a new generation that is 
really looking through a technology lens as to how we can 
transform markets, make markets more efficient and effective. 
But there are a lot of questions that they have, and that is 
the reason we have the engagement function of LabCFTC. A lot of 
folks are trying to get a lay of the land and start to 
understand the alphabet soup of regulators in D.C., so through 
LabCFTC, we do try to establish some guideposts and educate as 
to how our framework applies. And in some situations, we will 
explain, ``Well, this is where the CFTC fits and then there are 
questions that you may need to look at securities laws to 
understand the interplay there.''
    But in response to a lot of common questions we were 
getting, that is why we published the FinTech primer. It is our 
way of facilitating conversation with the community to make 
sure we are being responsive, and where possible, providing as 
much clarity as we can.
    Other efforts of CFTC have been around things like actual 
delivery is a question that comes up a lot in the 
cryptocurrency realm, so our Division of Markets and Oversight 
has put out a draft interpretation that deals with actual 
delivery. All of these are efforts to start enhancing and 
providing as much clarity as we can.
    Mr. Austin Scott of Georgia. Mr. Gorfine, you suggest in 
your testimony that the Commission has an interest in this 
technology being used for capital markets infrastructure. Many 
of us on this Committee, including myself, have introduced a 
piece of legislation, the CFTC Research Modernization Act. Have 
you had a chance to review that legislation, and do you think 
it could help the Commission understand the emerging financial 
technologies and help us better understand how we need to 
regulate, or in some cases, not regulate certain areas?
    Mr. Gorfine. Yes, thank you. One of the things that we are 
really focused on doing is making sure that we are engaging 
with technologies and fully understanding them. What you are 
raising is the ability to give the CFTC authority to research 
and test new technologies.
    I will give one example of how that may work in this space. 
We talked a little bit about private and permissioned 
distributed ledger technologies, which could impact and improve 
capital markets infrastructure. There is a lot of interest for 
market participants who are saying there may be more efficient 
ways for us to do, for example, regulatory reporting, in a 
lower cost way for them and in a way that for the regulator is 
more consumable. If we can receive standardized data without 
the traditional push process, that could be very valuable. What 
you are pointing out, Congressman, is that authority that is 
proposed in your legislation would allow us to actually work 
with a consortia of folks that are trying to create that type 
of infrastructure, and that way from a CFTC perspective we 
could better understand how can this technology benefit our 
markets? How would regulatory reporting be facilitated, and 
lift the hood and really understand the technology instead of 
having the high level conversation.
    Those types of authorities would be very, very helpful to 
us.
    Mr. Austin Scott of Georgia. Thank you very much.
    The Chairman. The gentleman's time has expired.
    Ms. Kuster, 5 minutes.
    Ms. Kuster. Thank you very much, Mr. Chairman, and thank 
you witnesses. This has been a very enlightening hearing, and I 
appreciate all the wisdom.
    Mr. Gorfine, picking up on the CFTC regulation, such as it 
is; do you have sufficient resources at the CFTC, or what would 
you recommend that you need from Congress, going forward?
    Mr. Gorfine. Thank you. Well, I will harness the Chairman 
on this. Our Chairman has been very vocal about the need for 
the CFTC to have the right resources to be able to keep pace 
with our markets and regulate our markets most effectively. I 
believe he has asked for $281 million for our budget, and a lot 
of those resources would be utilized, not only with bringing in 
economists, but also making sure we have the technologists in 
house to be able to keep pace.
    I am a lawyer. I know a couple layers deep of the onion 
when you are talking about technologies, but we really need to 
be able to get to the core of technology to make sure that we 
are ascertaining where new risks are arising. Certainly, with 
greater resources, our agency would be able to even scale up 
some of those activities.
    Ms. Kuster. I would just say for the record one obvious 
place to look for those resources would be to get the IRS on 
top of how to tax the benefits and the gains that are being 
made, because one of the most troubling comments today is that 
the IRS is not on top of how to capture those gains. That is 
something that we need to look at, but it is also something on 
your side with some conversations with your counterparts at the 
IRS.
    I want to quickly turn to the two professors and get a 
sense of a very troublesome aspect of this, and if anyone else 
wants to comment. Analysts last year identified that four 
percent of the addresses hold 97 percent of the Bitcoin in the 
world, and the philosophical goal of Bitcoin is to replace 
government-backed fiat currency. But if that goal is achieved, 
you would have an unprecedented amount of wealth and power 
concentrated in the hands of a very small number of people. Is 
this concerning to you, and what should lawmakers be doing in 
this regard?
    There are couple of minutes left, and----
    Mr. Gensler. To some extent it is not surprising, because 
most small economics ends up with some centralization. An irony 
is that the technology is supposed to be a decentralized peer-
to-peer----
    Ms. Kuster. That was why the statistic struck me, because 
all the commentary has been this is all----
    Mr. Gensler. And so it is one of the natural ironies, 
because all humans tend towards clusters and clumps and 
centralization.
    Ms. Kuster. And taking into account with the indictment 
that some of these addresses are in Russia with people that 
want to do harm to our country.
    Mr. Gensler. More specifically to your question, some of 
that concentration is because it is the large exchanges, the 
crypto-exchanges, like Coin Base has 20 million accounts. They 
may not all be active, and they hold $20 billion of crypto-
funds. I should have said the market went up in the last day, 
so it is now about $290 billion. But just one exchange has a 
big chunk of it. I don't know if that----
    Ms. Kuster. Is that then owned by multiple parties?
    Mr. Gensler. I will speak a little bit like an accountant, 
which I know the Chairman can appreciate, but it is that Coin 
Base has several accounts, but they are only there at Coin 
Base. But if I wanted to trade, then I have an account at Coin 
Base. These addresses would be in Coin Base's name, not in my 
name. I only have a right to Coin Base. Coin Base has whatever 
you want to call a right on this ledger. And part of----
    Ms. Kuster. Part of my question is that not very many 
people end up controlling and influencing, and if the long-term 
goal is to cut out state-sponsored currency, that is 
problematic in my view.
    Ms. Baldet. Yes, you are right to be concerned about the 
centralization of power, but when it is not necessarily so that 
a single address equates to a single legal entity in any way. 
Any one person can generate any number of addresses that have 
smaller or larger amounts, and we don't really have a proper 
way to be able to tie that----
    Ms. Kuster. How would you describe to the public watching 
today the distribution of influence?
    Ms. Baldet. There certainly are loci of power, but also if 
you look at the movement in some of those earlier addresses or 
larger addresses, it is commonly accepted that about 25 percent 
of something on a network like Bitcoin have not moved or 
basically been lost at this point, and so you will see funds 
sitting in places and simply not moving, and the common 
consensus is that the private keys or the access to those 
addresses have simply been lost.
    Ms. Kuster. My time is up and I will yield back, but just 
to make a plea for democracy somewhere in this process. I 
appreciate the Chairman for scheduling the hearing. Thank you.
    The Chairman. The gentlelady yields back.
    Mr. Allen, 5 minutes.
    Mr. Allen. Thank you, Mr. Chairman, and this has been very 
interesting. The gig economy is moving at light speed, and the 
rest of us are just kind of dragging us along. But it is 
exciting.
    I guess the problem that we are having, from a regulatory 
standpoint is throughout the gig economy is obviously the 
reason it is doing so well is because there is lots of freedom 
and very little regulation, but we do know that there are lots 
of problems, as far as connectivity, as far as security, and 
that sort of thing.
    How do we reach a balance with this, what we are doing is 
we are creating another money supply here as I see it. In other 
words, it is global. It is a global currency. I just don't know 
how that works, like where we have our basis. Our dollar, I 
believe, kind of sets the mark for the world right now.
    Explain how this is going to work across the world. I mean, 
you mentioned Afghanistan. I don't know what their currency 
base there is, but I am just going to open it up. I can't 
visualize how this could possibly work.
    Mr. Gensler. Can I get one real quick shot?
    Mr. Allen. Yes.
    Mr. Gensler. Sound governments like the U.S., if we have to 
maintain our fiscal discipline and all the things we need to 
do----
    Mr. Allen. Yes, if you can keep it, right.
    Mr. Gensler. But sound governments have certain advantages, 
because of the stability, and also because we allow our 
currency, fiat currency, it is legal tender for all debts 
public and private, and you can use it to pay taxes. And so 
there are some just natural advantages.
    I think that how this might play out, I could see a country 
that is in distress, the Venezuela's of the world, where in the 
future one of these currencies will be a better thing for their 
public than in that----
    Mr. Allen. For the individual citizen?
    Mr. Gensler. For the individuals, for the merchants----
    Mr. Allen. Because they are not dealing through their 
government, they are dealing through this global currency?
    Mr. Gensler. Yes, I could see that.
    Second, even in a stable economy like ours, that our 
Federal reserve, with all respect, has a little bit of 
competition for the payment system. We Americans spend between 
$100 billion and $200 billion a year for our payment system. 
That is only \1/2\ percent to one percent of our economy, but 
it is still $100 billion to $200 billion a year. And so 
startups and entrepreneurs have a chance to chip away at that 
and get inside of that. That is competition to the commercial 
banks and the central bank on our payment system.
    Mr. Allen. Other feedback? We have about 2 minutes.
    Ms. Baldet. Yes, I just wanted to add to that around the 
Venezuela point, that there was some interesting usage of Zcash 
in Venezuela over the last year as a sort of bridge currency to 
the dollar so that citizens that could not have traditional 
access to get to the dollar were using a cryptocurrency as an 
intermediary. Given the volatility of cryptocurrency, you 
wouldn't necessarily want to stay there, but as a bridge and a 
censorship resistant bridge at that, it is somewhat important. 
While censorship resistance can be seen as a double-edged 
sword, we might not necessarily like the way that people are 
doing bad things with the network, the ability to project into 
places where they also would prefer people to not be doing 
things should not be underestimated.
    Mr. Allen. I can see where like a business located in a 
country where the government is unstable, the business 
community could really benefit from this.
    Then you have this competition between nations, right now 
the biggest competition is between United States and China. The 
end seems to want to be the basis. Which nation would run this 
thing and ultimately be responsible for it?
    Mr. Gensler. See that is the thing. It is decentralized so 
no nation does, but you mentioned China. I don't know that 
there has been public reports, but there are a lot of people in 
the community that say that though China, the government, has 
said we are clamping down, the reality is there is a lot of 
activity. The Bitcoin, this is how it is developed. Two of the 
three largest mining pools are in China. The third one is in 
Russia, and that combined is about 50 percent of the mining 
pools.
    But beyond that, the Bank of China is very actively engaged 
to do research----
    Mr. Allen. But the government is not fond of this?
    Mr. Gensler. Well, they are of two minds.
    Mr. Allen. Yes.
    Mr. Gensler. They say publicly they are not fond of it 
because their currency is not convertible, so they are worried 
about people running around their currency. That is the public 
face of it, but underneath it, they are doing a lot of work on 
it. The Bank of China particularly is looking at it very 
closely because they are worried. They want to get their 
payment system right and they want to use it maybe.
    Mr. Allen. Okay.
    Ms. Baldet. There is also a bit of a land grab going on 
when it comes to enterprise distributed ledger projects where 
countries, like China, can go into emerging economies and do 
essentially free work for them using their technology, which is 
impacting the adoption of specific protocols backed by various 
countries in those regions.
    Mr. Allen. Okay. All right, I yield back, Mr. Chairman.
    The Chairman. The gentleman yields.
    Mr. Allen. Thank you very much.
    The Chairman. Mr. Soto, 5 minutes.
    Mr. Soto. Thank you, Mr. Chairman.
    Cryptocurrency, blockchain technology all have tremendous 
potential, and I am bullish on the prospect. But we are in a 
bizarre position here. Satoshi Nakamoto, an unknown person or 
people who developed Bitcoin, and this person or persons has 
980,000 Bitcoins and an estimated worth between $19.4 billion 
to $17.9 billion. Can any of you today, and just raise your 
hand, verify that Mr. Satoshi Nakamoto is, in fact, a person or 
persons?
    Ms. Baldet. I don't believe that we have all agreed that it 
is a male.
    Mr. Soto. All I asked--okay.
    Ms. Baldet. Satoshi is female.
    Mr. Soto. Satoshi is female, great. None of you can verify 
who founded or owned Bitcoin is my point, which puts us in a 
strange position, because normally we have industries and new 
currencies where we know who created it. That puts us in a 
weird position.
    In addition, you mine to develop new currency, a process by 
which transactions are verified and you add it to the public 
ledger. You compile recent transactions into blocks and try 
solving computationally difficult puzzles, and you get a 
reward, either a transaction fee or newly released Bitcoin. I 
guess gold is the only thing that we could even parallel to 
where we have mined in such a way. Have we ever had a currency 
online like this where you mine via transaction algorithms and 
solving puzzles on the Internet?
    Mr. Gensler. That is the novel creation of--yes, somebody 
we don't know who she is--Satoshi Nakamoto, or he or 
collection. But that is the novel thing. When the Internet was 
created----
    Mr. Soto. My time is limited, so we have an unknown person 
and a bizarre way of mining Bitcoin to get it together.
    I am more concerned, though, about being able to void money 
laundering for terrorism, drug trafficking, human trafficking, 
tax evasion. I would love to hear from each of you in one 
sentence on what we could do to stop money laundering and 
having Bitcoin and other cryptocurrencies be the choice of 
terrorists, drug traffickers, and those evading taxes. We will 
start from the left and go on back. One sentence, because my 
time is limited.
    Mr. Fairfield. Trust FinCEN to do their job.
    Ms. Baldet. Rely on other law enforcement mechanisms that 
work around strong cryptography. We do not weaken roads and add 
potholes to them.
    Mr. Soto. That is two sentences, but thank you. My time is 
limited. I apologize.
    Mr. Kupor. Bitcoin is actually the worst tool to money 
launder because every transaction is registered and fully 
reportable, so it is actually law enforcement's best friend.
    Mr. Soto. Okay.
    Mr. Gorfine. While the technology can be peer-to-peer, most 
activity takes place through a new type of intermediary where 
you can apply AML/KYC rules.
    Mr. Soto. Okay.
    Mr. Gensler. On top of that, rigorously require crypto-
exchanges to register, and you may need to pass a law to do 
that, but to make sure they register and that all the AML, 
anti-money laundering and know your customer is being done 
there.
    Mr. Soto. Run-on sentence, but helpful. Thank you.
    Mr. Ness. The alleged Russian hackers were caught because 
they used Bitcoin.
    Mr. Soto. Thank you.
    I am also concerned about two practices, spoofing and wash 
trading. Spoofing being flooding markets with fake orders to 
trick other traders into buying or selling, and wash trading, 
which is where cheaters trade with his or herself to give a 
false impression of market demand that lures others to dive in, 
too. Can anybody give us any insight into how to stop spoofing 
and wash trading? We will start from the right to the left now.
    Mr. Ness. That is a tough one. I don't have a good answer.
    Mr. Soto. Okay, next.
    Mr. Gensler. Register the exchanges and cops on the beat.
    Mr. Gorfine. We are a markets regulator. That is something 
that we are able to police for within our regulated futures and 
swaps markets, and so worth a look at the underlying market to 
ensure that the right types of regulations are in place.
    Mr. Soto. And are you all doing that right now?
    Mr. Gorfine. The CFTC does not have direct oversight 
authority over underlying markets.
    Mr. Soto. We would have to give you jurisdiction to help 
with spoofing and wash trading?
    Mr. Gorfine. It would be something Congress would have to 
look at in terms of authorities.
    Mr. Soto. Okay. Next, Mr. Kupor?
    Mr. Kupor. Yes, I agree. Either between the SEC or the CFTC 
you would have to grant appropriate authority.
    Ms. Baldet. Agree, broker dealers need to be treated like 
broker dealers.
    Mr. Fairfield. I would agree with that.
    Mr. Soto. All right, thanks, and I yield back.
    The Chairman. The gentleman yields back.
    Mr. Faso, 5 minutes.
    Mr. Faso. Thank you, Mr. Chairman.
    I am wondering if, for the benefit of our viewers at home 
across the country who are watching this hearing and are trying 
to understand the impact of the cryptocurrencies and what the 
future holds, if perhaps Ms. Baldet and Mr. Kupor could tell us 
where you think from a 5 to 10 year viewpoint where this is 
going to be, the role that these currencies are going to have 
in our economy, and how might this affect average consumers? 
Right now the market participants are mostly very sophisticated 
people. Do you see this insinuating itself into the broader 
economy?
    Mr. Kupor. Sure, thank you. Yes, we believe that this 
really is going to create a whole new set of infrastructure on 
which all kinds of new applications are going to be built, some 
of which we don't even know about today. If you think about all 
the benefits we have reaped from Facebook and Google and all 
the Internet properties----
    Mr. Faso. And negatives from----
    Mr. Kupor. And negatives, too. What the beauty of this 
technology is, is it gives us a new set of platforms, and 
again, very critically those platforms are not controlled or 
governed by centralized corporations, they are controlled and 
governed by a community. And so you can imagine all the utility 
that we have today, but where the consumer actually has 
ownership of data. The consumer has the ability to actually 
ensure that data is shared in a manner in which they want to be 
shared, and a consumer can also capture the economic rents from 
use of that data, so we think the opportunity in that respect 
is endless.
    Mr. Faso. Yes.
    Ms. Baldet. Sure, I would say that there are two very 
different sides of the spectrum.
    On the enterprise blockchain and distributed ledger side, 
we are seeing mutualization of work flow come to pass, and that 
is a way for companies who trust each other to do things in a 
more coordinated way that drives down operating costs.
    On the public side, to tag onto the gig economy statement 
earlier, we can see a further kind of micro-gig economy is 
happening wherein if people were to have more access and 
control over their own data--this goes for businesses as well--
we might be able to monetize that in new ways.
    Alternative business mechanisms to the current data hungry 
surveillance capitalism that we see arising from centralized 
companies, we might be able to challenge that kind of hegemony.
    Mr. Faso. And Mr. Fairfield, you referenced personal 
privacy issues. How do you see that coming into play here?
    Mr. Fairfield. Well there are a few. The first would be if 
we were to follow through on the suggestion that KYC and AML, 
that is Know Your Customer and Anti-Money Laundering, 
requirements be imposed on many more actors in this space. The 
initial reaction of many people who held cryptocurrency was 
that they did not particularly want those data revealed, and 
they built products to try to keep that data from being 
revealed.
    At least as far as the major exchanges, and I have heard 
exchanges used a few different ways today, but here I am 
talking about the way you onboard. You spend dollars, you get 
Bitcoin, for example.
    I think that giving those exchanges the requirement under 
the Bank Secrecy Act to have KYC and AML requirements at the 
same time that they have fairly strict financial privacy 
requirements was a moderately decent fit. For national security 
purposes, we need to know when people can make a couple million 
dollars disappear in one country and reappear in another. But 
at the same time, there is some degree of constraint over where 
that information can go once it is kept within financial 
institutions. That is a good example of a mix that seems to 
work, and maybe that would be a model we could spread out from.
    Mr. Faso. And just generally, Mr. Gensler or Mr. Gorfine, 
as we look at the development of this, it does seem that there 
is an issue that is going to affect government, which is right 
now we know, because we have a paper trail, we have electronic 
trails and documentation of transactions for which taxation 
applies, for which government oversight and reporting applies. 
How does government address this from the standpoint of its 
interest to try to make sure that taxation and other compliance 
issues are resolved that currently, with our existing financial 
transactions we have mechanisms to have that reporting?
    Mr. Gensler. It is really about knowing all the accounts. 
This technology has what is called public keys and private keys 
and Zcash, which Ms. Baldet is involved in is even more secret 
than that, but it is really knowing who owns the accounts 
behind that. It is know your customer, beneficial ownership, 
and then trying to do that through some of the central 
mechanisms like crypto-exchanges.
    It is not going to be perfect. This is going to be like a 
whack-a-mole, the IRS and the CFTC will work hard and then 3 
years from now the technologists will have a new way to get 
around it.
    Mr. Faso. Mr. Chairman, could Mr. Gorfine respond to that 
as well?
    The Chairman. Yes, very quickly.
    Mr. Gorfine. Yes, if I may. One observation, too, is 
remember the most anonymous form of transaction is actual cash, 
right, people transacting cash. There is very little record of 
that taking place. Most virtual currencies, cryptocurrencies, 
are pseudonymous, so there is actually the ledger, which is a 
fairly transparent mechanism to be able to pursue potential law 
enforcement, as well as AML and KYC, so I just want to point 
that out, but it is something that needs to be figured out by 
government.
    Mr. Faso. Thank you, Mr. Chairman.
    The Chairman. Mr. LaMalfa, 5 minutes.
    Mr. LaMalfa. Thank you, Mr. Chairman. I am a little sorry I 
missed part of this hearing here, but it might be--well, I am a 
flip phone guy in a Bitcoin world anyhow, there is no pretense 
here.
    But, Mr. Ness, I come from the flip phone part of NorCal, 
as you say down there in the Bay area. I will ask a question 
and I will try and narrow down to, it was talked about earlier 
in the Committee about crypto-networks and the Internet 
protocols on tokens, so would you touch upon what it would look 
like if that token is determined to be a security? Can you hit 
that for us?
    Mr. Ness. Yes. The issue really comes down to friction, and 
while we can get to a status of free trading securities by 
registering them, even when you do get to that status, there 
are all sorts of ancillary friction in and around the transfer 
of a security. You need to have broker dealers involved, and 
you need to have suitability requirements met, and other 
potential disclosure issues and so forth that are ongoing.
    And so when we are talking about trying to create the next 
generation of decentralized protocol layer kind of apps on top 
that are all interoperable and interacting with each other and 
transferring value at the speed of software to deliver a 
service to a consumer. It may be all transparent to the 
consumer. This is all happening under the hood, but you can't 
have fundamentally the transfer of value at the speed of 
software if it is a security.
    Mr. LaMalfa. You are talking with the middle man of a 
typical financial institution, right?
    Mr. Ness. That is right.
    Mr. LaMalfa. All right, and again, please touch on the 
importance of increasing the access to the speediness of those 
types of transactions. Why is that important?
    Mr. Ness. Well, to get a little philosophical, ledger 
technology is fundamental to commerce, right, and double entry 
accounting was an amazing innovation in ledger technology that 
pulled Europe out of the Dark Ages. And the same thing can 
happen in an amazingly more robust way when we start to 
literally not just allow parties to trust each other through 
standard mechanisms of reconciliation, but when we remove the 
reconciliation or the need for it altogether, and that is 
simply a philosophical point of view, I suppose, but it goes to 
this issue that we are at early stages of this. We don't know 
where it is going to go, but speed is probably a good thing.
    Mr. Gensler. Can I just say, I am an optimist. I agree with 
what Mr. Ness says, but maybe it is the MIT in me now. I think 
that the beneficial ownerships will be able to be tracked in a 
matter of milliseconds and nanoseconds. Not yet, it might take 
5 years, but we will get there. Technology is pretty neat, how 
it grows and helps us.
    Mr. LaMalfa. Well, it is amazing. Thank you, and Mr. 
Chairman, at the risk of looking senatorial at a Zuckerberg 
hearing, I am going to yield the rest of my time.
    The Chairman. Thank you, Mr. LaMalfa.
    Ms. Plaskett, 5 minutes.
    Ms. Plaskett. Good morning, gentlemen and gentlewoman. 
Thank you all for being here.
    Of course, this is something that we are all really 
learning about. I try and say that I am woke, but you know, 
that always doesn't work and this is one area where my 20+ year 
old children would find me really out of date. I am happy, Mr. 
Chairman, that we are having this because you all are correct. 
There is a balance, right? We don't want to over-restrict 
something that we don't even really understand or that is still 
developing, but at the same time, ensuring that that 
development, while it is developing, bad actors are not 
utilizing and gaming the system so that really terrible things 
can go on.
    One of the main things that I am concerned about, people 
think of the Virgin Islands as really just being a beautiful 
paradise, but we have an enormous amount of drug trafficking 
that goes through the Virgin Islands, and we also, along with 
other Caribbean islands--other islands more so than ours--have 
the ability to be used as a filter for hiding money, and 
particularly ill-gotten gains. And so I was wondering if anyone 
on the panel can really talk about how we can or law 
enforcement can really act as a deterrent for the use of 
Bitcoins, the marriage now between Bitcoins and blockchain to 
be able to really accelerate the use of these types of 
currencies in a manner that does not cause individuals in other 
places to really take advantage of this.
    Mr. Gensler. It is ultimately a bit of an arms race because 
technology is new----
    Ms. Plaskett. I love it. We are having an arms race with 
electronic money, right?
    Mr. Gensler. We are, we are. But the arms race in this is 
basically against societal norms and bad actors. There is 
always going to be crime and technology is just a new way to do 
it.
    One thing that the panel has all said is Bitcoin actually 
is more traceable than the public thinks. It is not anonymous. 
It is what is called pseudonymous, but we need ways to connect 
those public keys, which are like 24 or 32 digits to real 
people and real companies, and that is why I have recommended 
you need to have gatekeepers or gateways to do that, the 
exchanges, the crypto-exchanges or one set of gateways for law 
enforcement then to track the way that law enforcement now uses 
banks to track things. That would be one way I would say.
    Ms. Plaskett. Right. I saw some others wanted to respond.
    Mr. Fairfield. If I could also respond.
    The way we catch criminals often is through traffic 
analysis. Blockchains are quite good sources for traffic 
analysis.
    Ms. Plaskett. Yes.
    Mr. Fairfield. There are----
    Ms. Plaskett. Can you tell me, how does the blockchain 
facilitate that?
    Mr. Fairfield. Sure. One thing to do would be to go online 
and simply Google the blockchain.
    Ms. Plaskett. Right.
    Mr. Fairfield. You will find a website that will list each 
transaction as it comes across, and if you spend 30 seconds 
watching every transaction in the world that happens in 
blockchain and you think to yourself if I were a police 
officer, I would find this flow of money around the world very 
interesting. We also have computer programs, though, that don't 
require a person sit there but can comb these databases, find 
patterns, and kick bad patterns up to somebody to take a look 
at it.
    There are ways of circumventing this. Blockchains are 
pseudonymous. I don't put too much stock in it because tumblers 
and dark wallets can essentially--you and I might agree I will 
pay your debts, you pay mine, that way your debts aren't 
traceable to you and my debts aren't traceable to me. That is 
essentially what a tumbler does. We pay each other's debts, and 
so we hide where the money is coming from.
    Ms. Plaskett. Right.
    Mr. Fairfield. But, with traffic analysis and standard 
artificial intelligence runs combing across the database, we 
can do a pretty good job of kicking up where bad actors are 
stirring the water.
    Ms. Plaskett. Mr. Gorfine, we talk about law enforcement 
doing this. All of us here are concerned with what is our role. 
What do you see CFTC in dealing with this as well?
    Mr. Gorfine. Yes, and I want to kind of step back and 
compliment the way you framed this initial set of questions 
because it is exactly right that when I mentioned earlier in my 
testimony about thinking about principles and making sure we 
are giving--you can regulate based on principles, and then as 
you identify areas where there are particular harms to solve 
for, that is where more prescriptive rules might fit in. 
Certainly, in this area of anti-money laundering and know your 
customer, that is an area where you would want to make sure you 
are enforcing rules.
    But to your more specific question, the CFTC has now had a 
lot of experience dealing with some of these markets and the 
technologies, but again, our role is as a primary regulator of 
futures and swaps markets, and then we do have that enforcement 
authority that is a look-back authority to police for fraud and 
manipulation, either in our futures and swaps markets or in the 
underlying market as well.
    But because of our experience, we have a lot to offer at 
this stage in terms of informing the discussion around this 
space, given our enforcement experience, the role of our 
division and market and oversight in regulating the actual 
exchanges, monitoring some of the clearing and risk issues 
associated with cryptocurrencies, customer education, and then 
LabCFTC outreach. I think we are playing a very important role, 
and then hopefully can help inform these efforts.
    Ms. Plaskett. Thank you, and I yield back. I just want to 
make sure that the regulations that we are doing, while we give 
time for this to grow, we also make sure we don't end up like 
Facebook where it has outpaced us in terms of being able to do 
damage in the general good.
    The Chairman. The gentlelady's time has expired.
    Mr. Davis?
    Mr. Davis. Thank you, Mr. Chairman.
    Mr. Gorfine, I am going to go right back to you. Obviously 
we have talked a lot about jurisdictional issues and how to set 
up the proper regulatory structure that many in the industry 
are asking us to do. Obviously, with many of the commodities 
and different products, we have an SEC portion that is 
regulated in many cases, and then we have the CFTC which falls 
under our jurisdiction, and you get to see some of the humorous 
anecdotes from Members of Congress here who I am sure have had 
similar things to say when that new thing the Internet was 
taking place, and how are you ever going to buy things off of 
the Internet? Well Jeff Bezos showed us very well that anyone 
can do that now. And as cryptocurrencies continue to grow in 
usage, they are going to become less and less intriguing and 
more and more used.
    I am going to get into the demographics of many of the 
crypto-users, but I am want to ask you a quick question, sir. 
Based on the way current law is written, it is not cut and dry 
whether cryptocurrency should be regulated by the SEC or the 
CFTC. If Congress attempts to come up with a workable 
definition for cryptocurrencies that are more similar to 
commodities, call them, as we have heard, blockchain 
commodities, what should we be looking to guide us?
    Mr. Gorfine. Yes, thank you for the question. You know 
what? The one thing I would say is, and I mentioned this in my 
opening statement, that it is important that we are not hasty 
in terms of figuring out what the right contours are of 
applying securities laws and then the commodities framework. I 
do think that the SEC has in due course been providing 
additional clarity. Mr. Hinman over at the SEC gave a well-
received speech outlining some of the SEC's thinking as to how 
they would apply the securities law framework, and some of the 
things that you have heard are factors around decentralization, 
are there expectations of return based on meaningful work of 
others? These are important elements that, of course, I am not 
saying that these are the only elements, but these are some of 
the things that you start to look at in terms of figuring out 
well, when does it make sense to be applying the securities 
laws framework that includes things like required disclosures, 
it requires regulations around the offering of securities and 
the intermediaries involved in securities, and when does that 
perhaps not fit the product?
    This discussion is ongoing, and in due course and being 
thoughtful, you are starting to see additional clarity and 
certainty coming out. But certainly those are some of the 
factors that we have heard talked about a fair amount.
    Mr. Davis. Thank you.
    Ms. Baldet and Mr. Kupor, and I am sorry I wasn't here at 
the beginning of the hearing so if I mispronounced a name, 
forgive me. I always try to mispronounce my colleague, Ted's, 
on purpose, but not yours.
    Now Ms. Baldet, this is an industry that you are getting 
into in the infancy, and you have actually done something that 
we don't see a lot around here. You have come to us to actually 
ask for a stricter regulatory environment to stop some of the 
fraud and abuse that was mentioned by some of my other 
colleagues today.
    But I want to ask for those of you who are in this 
business, what demographic usually utilizes Bitcoin here in the 
United States, what age?
    Ms. Baldet. It is pseudonymous, so----
    Mr. Davis. What----
    Ms. Baldet. Based on Twitter, it is probably people in 
their 20s to 40s.
    Mr. Davis. The millennials?
    Ms. Baldet. It is millennials.
    Mr. Kupor. Institutionally there is a very different skew 
towards the size of transactions and the types of people that 
are playing and the larger dollar values. And there is a 
developing institutional market as well, right, so yes, it 
started there, but if you look at some of the major financial 
institutions, there are institutional markets and large private 
equity groups that are heavily transacting in this as well.
    Ms. Baldet. Yes, and to tie on to the last question, but 
also the concern about regulatory framework. What I was 
mentioning is about a need for more clarity, not so much the 
bright lines that we are talking about security versus 
commodity as much as more interest in safe harbors for 
innovators, especially because we are seeing the market adapt 
to this in that new disruptors are at an advantage versus 
incumbent institutions who are waiting for regulatory clarity 
to engage. And so in a way, in absence of that, it is not 
necessarily that incumbents are incapable of innovating or they 
don't understand the technology, but they have to take a 
sidelines approach because they have traditional businesses to 
lose.
    Mr. Davis. Well thank you, and Mr. Chairman, my time is 
about ready to expire, but we want to make sure that we devise 
a regulatory structure that allows this industry to continue to 
grow, but allows us to address many of the law enforcement 
problems that have been brought up here by many of my 
colleagues.
    I can't wait to continue to work with you. Thanks for your 
time.
    The Chairman. Mr. Yoho for 5 minutes.
    Mr. Yoho. Thank you, Mr. Chairman. I appreciate you all 
having the patience to be here. This is something that is 
really confusing to me. My wife and I, we watched a documentary 
on Bitcoins and when we were done, we were more confused. I 
have not invested in any, as you asked.
    With that said, Mr. Gensler, in your testimony you 
mentioned recent SEC staff determination that Ether is not a 
security, although it might have been at its issuance. If the 
SEC had determined Ether was a security in 2015, what 
regulatory requirements would Ether be subject to today? And I 
have two follow-ups, and anybody else that wants to weigh in on 
this.
    Mr. Gensler. If they had determined that way back in 2015, 
at the time they would have had to give some full and fair 
disclosure. The SEC at that time would have probably said, 
``Well, it is probably not 3 years of financials and things 
like that because it was a new startup,'' and this is something 
the SEC is grappling with even now for current initial coin 
offerings. What is full and fair disclosure? Director Hinman at 
the SEC said it right. It is about information asymmetry. Give 
an investor enough information so they can take the risk. It is 
not a nanny government. The investors can take the risk as long 
as they get enough information.
    Mr. Yoho. Okay, and how might such a regulatory regime 
affect the functionality of the Ethereum network?
    Mr. Gensler. Mr. Ness raised this question earlier. There 
is friction right now because we don't have the beneficial 
ownership. Securities laws say we have to have full and fair 
disclosure and we have to keep track of anybody who owns the 
security. It is that second one that is the friction Mr. Ness 
mentioned. I am an optimist. I think technology can solve for 
this. It is not going to be in 2018. It would slow down some of 
these token economies, but I believe that it is important to 
track beneficial ownership for all the reasons about illicit 
activity and taxing.
    Mr. Yoho. I agree with that. Anybody else?
    Ms. Baldet. At the risk of confusing you more about 
Ethereum----
    Mr. Yoho. I was going to say, that name Ethereum is apropos 
because it is just out there.
    Ms. Baldet. In the Ether, yes.
    Mr. Yoho. It is like where is it?
    Ms. Baldet. Yes. Whereas some systems like Bitcoin were 
initially meant for peer-to-peer value transfer, the Ethereum 
network does, well it is more like a distributed world 
computer, in a way. Don't think about it too much. But what you 
can do is you can use the native token of the system, this 
Ether, which may or may not have been a security issuance as 
you mentioned, to pay for what is called gas in that network. 
And that gas is used to buy computational cycles on a shared 
computer. If something like gas ends up looking a lot like a 
security, that is generating PNL just as you are running a 
general computer, it would be incredibly cumbersome, if not 
impossible, for normal humans to figure out what their balance 
sheet should look like. We need to be careful in not just 
applying a one size fits all solution on that.
    Mr. Yoho. Well, the important thing is that we don't want 
to stifle the imagination, the entrepreneurship, the 
development of this, but yet we want to have the safeguards in 
place. Whether it is the CFTC or the SEC, we just want to make 
sure that when people get involved in it, that their monies or 
their investments are protected.
    You were going to add something?
    Mr. Fairfield. I was going to make a rough analogy. Because 
these are databases, it is like the database in your computer, 
and applying securities regulation to these databases would 
have the same impact as having the SEC regulate your computer 
at the internal level, which is just simply going to gum up the 
works.
    Mr. Yoho. Right. We don't want that, but I mean, we want 
the safeguards there.
    My other question is, and I sit on the Foreign Affairs 
Committee, and we deal a lot with North Korea and the sanctions 
and all that, and we see countries changing companies, 
funneling money, breaking sanctions or skirting sanctions, and 
a lot of we see is being done over electronic currency like 
this.
    What are the safeguards that you guys can help us with on 
that so that we can follow it? When that cash transfers, it is 
easier to track that. We can block and sanction those banks or 
those entities, but when they are transferring things like this 
or any other nefarious activity, drug deals and things like 
that, what are the safeguards that you guys can put in place 
that we know we can follow that stuff?
    Mr. Kupor. We talked a little bit about this earlier, but 
the idea behind these networks is all the transactions are, in 
fact, traceable and immutable, and so in fact, in most cases 
that you have seen, for example, in the recent Russian hacking 
investigation, they really create a trail and a presence that 
actually really is a data mine for, in many respects, law 
enforcement. If you fast forward a few years, this will look, 
in many respects, like GPS and cell phones have become for law 
enforcement as well, which is it really creates an immutable 
record that----
    Mr. Yoho. I appreciate your time. I am out of my time, and 
thank you, Mr. Chairman.
    The Chairman. Well I want to thank the panel.
    Mr. Gorfine, you may have to slip out to catch a plane, but 
I would like to give each of you probably no more than a minute 
for any closing comments you think you wish you would have said 
during your opening or a question that didn't get asked that 
you thought would be helpful for the record to have it.
    So we will start with Mr. Fairfield. Any closing comment 
quickly?
    Mr. Fairfield. Only that it is a wonderful idea to begin 
with these kinds of conversations because it is here that we 
are able to look at the different communities that are using 
the technology in different ways, and perhaps craft legislation 
or other rules that will permit us to not only capture the bad 
guys, not only get them cleaned out of the system, but to leave 
intact what is good behind.
    Ms. Baldet. Sure. Thank you for having me.
    I would say that it is certainly important that we are 
having these conversations and moving towards some right-sized 
frameworks. At the same time, and possibly this is just our 
general American sensibility. We are focusing on the private-
sector kind of business. How does this look like a business? 
How does this look like a financial system angle, whereas there 
is a whole other conversation to be had about what does this 
look like if it becomes systemic infrastructure similar to the 
Internet, and what does that mean globally?
    At the same time, it should not be an either/or 
conversation. We need to be thinking about how rather than just 
defensively we regulate, how we can proactively make sure that 
we are frontline innovators in the way that we were for the 
Internet as well globally.
    Mr. Kupor. Yes, I just want to echo a little bit, Mr. Yoho, 
what you said, which is to be very clear, I speak for myself. 
None of us are suggesting here that there shouldn't be 
appropriate regulation in this market. There is actually a very 
good framework between definitions of security laws that apply 
to the SEC, and then things that actually, rightly so look more 
like commodities. There is also FinCEN as we have talked about, 
right, in terms of KYC and AML, so there is quite a patchwork 
out there, certainly in our business were we sit, a lot of what 
we are seeking is, quite frankly, just regulatory clarity so 
that we ensure that companies who are good actors actually 
understand what the rules of the road are, and we fully 
support, obviously, the activity that the SEC and CFTC and 
others are doing to make sure that the bad actors are rooted 
out of the system.
    Mr. Gorfine. Yes, thank you. I just want to thank the 
Committee for taking an interest in this area and allowing us 
and the CFTC to help inform and support the effort to strike 
the right balance. It is a promising and very new area of 
innovation that, as I said earlier, we don't know where a lot 
of these different threads will lead. But it is important for 
us to be vigilant and make sure that we are targeting bad 
actors and making sure there are appropriate guardrails in 
place, and that we have an efficient, effective regulatory 
framework in place and look forward to helping support that 
effort.
    Mr. Gensler. First, it is just so good to be with you, Mr. 
Chairman, and this Committee again after 5 years.
    Two, promoting innovation and promoting competition means 
also bringing this inside the public policy sphere. I don't 
think they compete. I think it is together. If you recall, in 
this Committee that there is the issuer-based crypto, which is 
kind of the SEC and these ICOs. There is derivative crypto, 
which the CFTC has but it is going to have some challenges. And 
then there is the whole cash commodity crypto, which is 70 
percent of this world. That is where Congress has a role, a 
real role to think about is there more authorities?
    I say incumbents versus startups. Startups feel that they 
can beg for forgiveness after they mess up with the law 
enforcement. Incumbents feel they have to ask for permission. 
And so right now there is an imbalance right now where 
incumbents aren't in this space and startups are, and you might 
want to address that. MIT and I are available any time if you 
need any help on any of this.
    Thank you.
    Mr. Ness. I guess I will echo that. I think probably Uber 
taught us all that for better or for worse, if you build 
something that is incredibly popular, the laws will change to 
conform to that new technology.
    Technology is moving at a very, very fast pace. We have 
heard today about some of the pitfalls of these new 
technologies that get out ahead of the legislators, and so I 
want to compliment you guys for being on top of this, and the 
SEC as well has been incredibly on top of it and working 
closely with us and open to dialogue, and that is what is 
really needed is a kind of free flow of information and 
communication between those of us who are on the frontlines 
dealing with the day-to-day fact patterns and you guys who need 
to think about the actual policymaking aspects.
    The Chairman. Well thank you. It has been a terrific couple 
of hours. It was well spent for us. I hope you consider it the 
same. You clearly elucidated some issues, not only just with 
regulation of these issues, but also the tangential impact of 
taxable transactions being captured in a way that folks can 
comply with our Tax Code and the revenues there, the law 
enforcement piece. Ms. Baldet, you may be involved with a group 
that is trying to find a way to create a currency that is not 
pseudonymous but would be anonymous. That is what innovators do 
is they see something that needs to get changed, and they will 
do that. And so that just speaks to how dynamic the process is. 
As long as the stupid criminals keep using Bitcoin would be 
great, but then the smart ones will pivot to something that 
allows them to hide better behind that.
    It has been a terrific eye-opening session, and will not be 
the last because our folks at the CFTC who are our partners in 
making this happen, and their partners at the SEC really want 
to do the same thing, and that is regulate where it needs to 
and give the certainty so that the incumbents don't have to 
worry about asking for permission while the innovators are 
asking for forgiveness. That is an unlevel playing field. And 
we also want this action going on within the United States.
    Thank you all very much. Under the Rules of the Committee, 
the record of today's hearing will remain open for 10 calendar 
days to receive additional material and supplementary written 
responses from the witnesses to any question posed by a Member.
    This hearing of the Committee on Agriculture is adjourned. 
Thank you all.
    [Whereupon, at 12:03 p.m., the Committee was adjourned.]
    [Material submitted for inclusion in the record follows:]
                          Submitted Questions
Response from Amber Baldet, Co-Founder and Chief Executive Officer, 
        Clovyr *
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    * There was no response from the witness by the time this hearing 
was published.
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Submitted Questions by Hon. Vicky Hartzler, a Representative in 
        Congress from Missouri
    Question 1. Illicit Activity--Over the past few years, one of the 
things that's caused me and my constituents a great deal of concern is 
the rise of illicit activities being facilitated by the dark web, such 
as drug and sex trafficking. Congress is continuing to address the 
opioid epidemic, and I've turned my attention to sex trafficking as 
well. Last year, I sponsored a bill, known as the Empowering Law 
Enforcement to Fight Sex Trafficking Demand Act, that passed the House 
to address this issue.
    Ms. Baldet, Mr. Gensler brought up the use of certain 
cryptocurrencies to purchase illegal goods and facilitate criminal 
activity. As you sit on the board of the Zcash Foundation, which is a 
non-for-profit dedicated to enhancing financial privacy, I'd like to 
get your perspective on how we can fight against illegal activities 
being facilitated through cryptocurrency.
    How should we weigh the value of financial privacy against the 
value of law enforcement access to financial information?
    Answer.

    Question 2. Is it possible to have a truly anonymous cryptocurrency 
and still protecting against bad actors using it to launder money, 
purchase illegal goods, or evade taxes, or does the public have to 
choose one or the other?
    Answer.
Response from Daniel Gorfine, J.D., Director and Chief Innovation 
        Officer, LabCFTC, Commodity Futures Trading Commission
Submitted Questions by Hon. John J. Faso, a Representative in Congress 
        from New York
    Question 1. Commissioner Brian Quintenz has stated that a virtual 
currency can start as a security and become a commodity. What is that 
transition point in your mind?
    Answer. The Securities and Exchange Commission (SEC) interprets and 
applies the securities laws, and has been providing further guidance on 
how it would apply the ``Howey Test'' to crypto-asset offerings. To the 
extent that a crypto-asset is a security, the CFTC would generally not 
exercise regulatory authority over the instrument.
    Within the above context, it is conceivable that an enterprise 
would seek to raise capital through an investment contract and help to 
build a decentralized network predicated on a crypto-coin or token that 
takes on attributes similar to Bitcoin or Ether. In this case, the 
crypto-coin or token may be a commodity, akin to oranges or Bitcoin, 
while the initial investment contract is deemed a security. Of course, 
whether a particular offering or crypto-asset is a security or 
commodity is subject to a facts and circumstances legal test and 
accordingly is highly dependent on the details of the offering.

    Question 2. In the hearing you cited SEC Director Hinman's comments 
on decentralization. At what point are a central actor's efforts no 
longer key to the success of an enterprise, or sufficiently 
decentralized, to no longer be classified as a security?
    Answer. I defer to the proper jurisdiction of the SEC in 
determining the outer boundaries of the securities laws, but given our 
ongoing collaboration with the SEC and observation of its public 
comments the factors of decentralization, control, public expectations 
of profits from ongoing work of others, information asymmetries, and 
crypto-asset use cases all appear to be relevant to the analysis. 
Again, the securities and commodities laws are subject to facts and 
circumstances tests that eschew over-simplified definitions in order to 
accommodate evolving markets and offerings.
    With respect to decentralization, one might consider how many 
nonaffiliated individuals or entities contribute to the success of the 
network and whether the network remains significantly reliant on a 
founding team of creators or developers. As crypto-asset fact patterns 
continue to evolve, we at the CFTC will strive to continue providing 
clarity to market participants, as appropriate.

    Question 3. How many independent users confirming transactions or 
changes to a blockchain are sufficient for effective decentralization?
    Answer. I do not believe a bright-line number of users or 
transactions should be dispositive as to the classification of a 
crypto-asset. Instead, the CFTC utilizes a facts and circumstances test 
in determining application of the CEA. To be sure, the number of users 
confirming transactions and breadth of participation are likely 
relevant to such a test, but not dispositive. As noted above, a 
relevant consideration may be whether the network remains significantly 
reliant on the work or efforts of a core team or group of developers as 
compared to gaining such widespread adoption that it can continue to 
run largely autonomously.

                                  [all]