[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
EXAMINING THE CRYPTOCURRENCIES
AND ICO MARKETS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS,
SECURITIES, AND INVESTMENT
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
__________
MARCH 14, 2018
__________
Printed for the use of the Committee on Financial Services
Serial No. 115-79
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
31-384 PDF WASHINGTON : 2018
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PATRICK T. McHENRY, North Carolina, MAXINE WATERS, California, Ranking
Vice Chairman Member
PETER T. KING, New York CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma BRAD SHERMAN, California
STEVAN PEARCE, New Mexico GREGORY W. MEEKS, New York
BILL POSEY, Florida MICHAEL E. CAPUANO, Massachusetts
BLAINE LUETKEMEYER, Missouri WM. LACY CLAY, Missouri
BILL HUIZENGA, Michigan STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin DAVID SCOTT, Georgia
STEVE STIVERS, Ohio AL GREEN, Texas
RANDY HULTGREN, Illinois EMANUEL CLEAVER, Missouri
DENNIS A. ROSS, Florida GWEN MOORE, Wisconsin
ROBERT PITTENGER, North Carolina KEITH ELLISON, Minnesota
ANN WAGNER, Missouri ED PERLMUTTER, Colorado
ANDY BARR, Kentucky JAMES A. HIMES, Connecticut
KEITH J. ROTHFUS, Pennsylvania BILL FOSTER, Illinois
LUKE MESSER, Indiana DANIEL T. KILDEE, Michigan
SCOTT TIPTON, Colorado JOHN K. DELANEY, Maryland
ROGER WILLIAMS, Texas KYRSTEN SINEMA, Arizona
BRUCE POLIQUIN, Maine JOYCE BEATTY, Ohio
MIA LOVE, Utah DENNY HECK, Washington
FRENCH HILL, Arkansas JUAN VARGAS, California
TOM EMMER, Minnesota JOSH GOTTHEIMER, New Jersey
LEE M. ZELDIN, New York VICENTE GONZALEZ, Texas
DAVID A. TROTT, Michigan CHARLIE CRIST, Florida
BARRY LOUDERMILK, Georgia RUBEN KIHUEN, Nevada
ALEXANDER X. MOONEY, West Virginia
THOMAS MacARTHUR, New Jersey
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana
Shannon McGahn, Staff Director
Subcommittee on Capital Markets, Securities, and Investment
BILL HUIZENGA, Michigan, Chairman
RANDY HULTGREN, Illinois, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
PETER T. KING, New York BRAD SHERMAN, California
PATRICK T. McHENRY, North Carolina STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin DAVID SCOTT, Georgia
STEVE STIVERS, Ohio JAMES A. HIMES, Connecticut
ANN WAGNER, Missouri KEITH ELLISON, Minnesota
LUKE MESSER, Indiana BILL FOSTER, Illinois
BRUCE POLIQUIN, Maine GREGORY W. MEEKS, New York
FRENCH HILL, Arkansas KYRSTEN SINEMA, Arizona
TOM EMMER, Minnesota JUAN VARGAS, California
ALEXANDER X. MOONEY, West Virginia JOSH GOTTHEIMER, New Jersey
THOMAS MacARTHUR, New Jersey VICENTE GONZALEZ, Texas
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
TREY HOLLINGSWORTH, Indiana
C O N T E N T S
----------
Page
Hearing held on:
March 14, 2018............................................... 1
Appendix:
March 14, 2018............................................... 41
WITNESSES
Wednesday, March 14, 2018
Brummer, Chris, Professor of Law, Georgetown University Law
Center......................................................... 7
Lempres, Mike, Chief Legal and Risk Officer, Coinbase............ 5
Rosenblum, Robert, Partner, Wilson Sonsini Goodrich & Rosati..... 8
Van Valkenburgh, Peter, Director of Research, Coin Center........ 10
APPENDIX
Prepared statements:
Brummer, Chris............................................... 42
Lempres, Mike................................................ 48
Rosenblum, Robert............................................ 55
Van Valkenburgh, Peter....................................... 76
Additional Material Submitted for the Record
Huizenga, Hon. Bill:
Statement for the record from Liquid M Capital, Inc.......... 86
Foster, Hon. Bill:
Statement for the record from Sweetbridge.................... 92
Lempres, Mike:
Responses to questions for the record from Representatives
Emmer and Hultgren......................................... 94
Rosenblum, Robert:
Responses to questions for the record from Representative
Hultgren................................................... 100
Van Valkenburgh, Peter:
Responses to questions for the record from Representative
Emmer...................................................... 106
EXAMINING THE CRYPTOCURRENCIES
AND ICO MARKETS
----------
Wednesday, March 14, 2018
U.S. House of Representatives,
Subcommittee on Capital Markets,
Securities, and Investment,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:06 a.m., in
room 2128, Rayburn House Office Building, Hon. Bill Huizenga
[chairman of the subcommittee] presiding.
Present: Representatives Huizenga, Hultgren, Stivers,
Wagner, Hill, Emmer, MacArthur, Davidson, Budd, Hollingsworth,
Maloney, Sherman, Scott, Himes, Ellison, Foster, Sinema,
Vargas, and Gottheimer.
Also present: Representative Hensarling.
Chairman Huizenga. The committee will come to order. And
without objection, the Chair is authorized to declare a recess
of the committee at any time. The hearing is entitled
``Examining the Cryptocurrencies and ICO Markets.''
I now recognize myself for 4 minutes to give an opening
statement.
The cryptocurrency and initial coin offering (ICO) markets
have grown rapidly in recent years, and actually it is more
like recent months. Specifically ICOs have been increasingly
used by companies to raise capital for their business and
products. To that end, people often equate them with a new type
of initial public offering or an IPO; however, an ICO is not an
IPO.
ICOs, whether they represent offerings of securities or
not, offer potential for entrepreneurs to raise more effective,
transformative, and efficient funding for an innovative project
as opposed to a traditional IPO.
Although an ICO has the same characteristics of raising
capital and accessing new sources of investment, it does not
involve an investment in some amount of equity in a company,
which is afforded under an IPO, nor does it offer the same
amount of investor protections.
The size of the ICO market has grown exponentially in this
past year and the Token Report estimates that approximately
$6.6 billion was raised in coin offerings. In 2018 alone, just
in the first few months, 480 ICOs are estimated to have raised
$1.66 billion.
Cryptocurrencies and ICOs provide an innovative vehicle for
startups to potentially access capital and grow their
businesses. Early investors in some cryptocurrencies have
experienced massive gains, and the ever-increasing number of
ICOs has created opportunities for investors to diversify their
portfolios in cryptocurrencies.
Since the surge in popularity or crypto craze, there has
been considerable attention attracted both by investors seeking
to diversify their portfolios and startup enterprises in search
of additional access to capital and to grow their businesses.
This is also rightly garnered attention of the regulators.
Additional scrutiny has surrounded the cryptocurrency and IPO
markets due to the number of fraudulent IPOs that have raised
money with no intention of ever providing a product or a return
to the ICO purchasers.
A soon to be published MIT study of the ICO market
estimates that $270 million to $317 million of the money raised
by coin offerings has, quote, ``likely gone to fraud or
scams,'' end quote, according to MIT Professor Christian
Catalani.
The SEC (U.S. Securities and Exchange Commission) has the
authority to bring enforcement actions against ICOs for any
violation of the Federal securities laws. As part of this
increased scrutiny of the ICOs, the SEC recently announced
actions against two virtual currency organizations for engaging
in unregistered securities offerings.
Additionally, the SEC suspended trading in three issuers
claiming involvement in cryptocurrency and blockchain
technology. The Wall Street Journal also recently reported that
the SEC has issued, quote, ``dozens of subpoenas and
information requests to technology companies and advisors
involved in ICOs,'' closed quote, including, quote, ``demands
for information about the structure for sales and presales of
the ICOs,'' closed quote.
Further, on March 7 of this year, the SEC broadened its
series of notice statements to exchange-type activity, warning
that online trading platforms may also be violating the Federal
securities laws.
According to the statement, ``If a platform is providing a
mechanism for trading assets that are classified as securities
under the Federal securities laws, then the platform is
operating as an exchange and must register with the SEC as a
national securities exchange.''
Today's hearing will examine the economic efficiencies and
potential capital formation opportunities that cryptocurrencies
and ICOs potentially offer to businesses and investors, and
review the adherence to applicable laws so that investors
receive the full protections afforded by the Federal securities
laws.
Additionally, the hearing will consider the current
regulatory approach that regulators such as the SEC are using
to monitor and oversee cryptocurrencies and ICOs and how to
achieve further regulatory clarity in these markets.
As further action on how to regulate cryptocurrency and ICO
markets is considered, it is important that innovation in the
area of digital currencies and capital formation are not
stifled while ensuring that consumers are protected, fraud is
prevented, and securities laws are followed.
The Chair now recognizes the gentleman from Minnesota, Mr.
Ellison, for 2-1/2 minutes for an opening statement.
Mr. Ellison. Mr. Chairman, thank you for calling this
important hearing today. As important as it is, there are some
other things happening that I want to address.
The Senate is voting today to roll back some of the rules
for the biggest banks in the country. Think about that for a
minute. Just 10 years after big banks crashed the economy,
Senate Republicans and some Dems want to roll back the rules
that we put in place to prevent the next crash.
My colleagues may have forgotten about how bad the crash
was, but I haven't. Millions of people lost their jobs. One in
54 homes was in foreclosure. $2.6 trillion vanished from
America's retirement accounts. So why on earth are we going
back there? Supporters of the bill say this is just about
helping out the small community banks. No, no, not buying it.
Community banks are doing pretty well. We are not saying
they don't need some attention, but this is not about them. The
FDIC (Federal Deposit Insurance Corporation) says that 96
percent of them are profitable and these profits are higher
than ever.
Again, I want to be attentive and responsive to community
banks, but this is not about the small banks. The banks that
are going to benefit here, these are banks that got close to
$50 billion in bailout money during the crisis and banks that
can put their name on a football stadium.
Some of these provisions in this bill roll back the rules
for the very largest banks like Citigroup and JPMorgan Chase.
This bill increases the chance of another crash and the
nonpartisan Congressional Budget Office says the bill will
increase the likelihood of another bailout.
I am disappointed that the Senate is likely to pass this
bill today, and I can promise this committee that I will do
everything in my power to stop it when it comes over to the
House.
And I yield back. Thank you.
Chairman Huizenga. The gentleman yields back.
The gentleman from Illinois, the Vice Chairman of the
committee, Mr. Hultgren is recognized for 1 minute.
Mr. Hultgren. Thanks, Chairman Huizenga. Thank you all for
being here.
According to CoinMarketCap.com, there are over 1,500
different cryptocurrencies for capitalization estimated at $350
billion. That is a staggering amount of money.
As this market develops, Congress has a responsibility to
ensure that investors are protected without unduly limiting
opportunities for growth. Some of our most respected technology
companies have expressed at least some uncertainty regarding
cryptocurrencies. This is a complicated topic.
For example, Google just announced it is banning ads
promoting cryptocurrencies, exchanges, wallets, initial coin
offerings, and firms providing advice. Congress needs a strong
understanding of the technology and its application before we
can understand how it fits into our existing regulations and
how the laws we have on the books may encourage or inhibit an
efficient market.
For example, do we need clarification of what a
cryptocurrency exchange is and if this word implies any
investor protections? The SEC staff made this point the other
day when noting, and I quote, ``many online trading platforms
appear to investors as SEC registered and regulated
marketplaces when they are not,'' end quote.
Similarly, Chairman Clayton has expressed skepticism about
no initial coin offerings being registered. There are a lot of
questions in this. I think it important that we are having this
hearing today.
My time has expired, and I yield back.
Chairman Huizenga. The gentleman's time has expired.
The Chair now recognizes the gentleman from California, Mr.
Sherman for 2-1/2 minutes.
Mr. Sherman. Unfortunately, our colleague, distinguished
Ranking Member was unable to be here this morning, and I ask
unanimous consent to enter into the record the statement of the
gentlelady from New York.
Chairman Huizenga. Without objection.
Mr. Sherman. Cryptocurrencies are a crock. What social
benefit do they provide? They allow a few dozen men in my
district to sit in their pajamas on the couch all day and tell
their wives they are going to be millionaires.
They help terrorists and criminals move money around the
world. They help tax evaders. They help startup companies
commit fraud, take the money and 1 percent of the time they
actually create a useful business. But then again, I daresay
that some tiny percent of all larceny and crime helps finance
something that turns out to be useful.
It hurts the U.S. Government in two ways. Our ability to
have the dollar be the chief means of international finance is
what has underpinned our ability to impose sanctions and stop
tax cheating. And furthermore, when we have people take risk we
don't encourage gambling. We encourage investment in the real
economy.
But when you buy a Bitcoin are you financing a new factory?
No. You are gambling on its value for no social benefit. Now, I
know that these cryptocurrencies are popular. They are popular
with guys who want to sit in their pajamas and tell their wives
they are going to be millionaires.
And they are popular with those who have read ``Atlas
Shrugged'' and ``Fountainhead'' and believe that these are the
new canons, the new divinely inspired documents of our age.
But they are harmful and they are harmful in one other way,
and that is--and I am going to mispronounce the word,
seigniorage is the benefit that the U.S. Government gets by
issuing currency. It is the float. It is the fact that we do
not pay interest on newly created dollars.
We lose that as well. And the Fed was able to return well
over $50 billion to our Treasury in many of the recent years.
We undercut that.
And then finally, we have these initial coin offerings
deliberately naming themselves to lie to the public and convey
the image that it is like an initial public offering. They
stole the intellectual property and trademark of legitimate
investing and applied it to a fixed fraudulent gambling scheme
of no social benefit.
Aside from that, I think it is a good idea. I yield back.
Chairman Huizenga. The gentleman yields back.
And gentlemen on our panel, you are in for a lively
conversation. No, this is not a Senate hearing about Dodd-Frank
reform. You are in the right place. We are here to talk about
cryptocurrencies and blockchain technologies. But we are here
to welcome today a great panel.
And Mr. Mike Lempres, who is the Chief Legal and Risk
Officer for Coinbase; Dr. Chris Brummer, who is a Professor of
Law from Georgetown University Law Center; Mr. Robert
Rosenblum, Partner at Wilson Sonsini Goodrich & Rosati; and
Peter Van Valkenburgh, Director of Research for Coin Center.
Each of you will be recognized for 5 minutes to give an
oral presentation of your testimony. Having read the testimony,
there is far more than 5 minutes of information in each one of
yours, so good luck as you consolidate that down.
We will then have a question period and we will without
objection put your written testimony into the permanent record
and part of the record as well.
So with that, Mr. Lempres, you are recognized for 5
minutes.
STATEMENT OF MIKE LEMPRES
Mr. Lempres. Thank you and good morning, Chairman Huizenga,
Ranking Member Maloney, and members of the subcommittee. Thank
you for the opportunity to address this important topic at a
significant time.
My name is Mike Lempres and I am the Chief Legal and Risk
Officer at Coinbase, the Nation's leading digital currency
exchange and wallet service.
I commend you for holding this hearing on a technology that
could transform capital formation, innovation, and our economy.
It has tremendous potential.
To fulfill that potential, we believe that responsible
regulation is required, but the technology's incredible
benefits could also be stifled by regulatory or legal missteps.
I am pleased to testify this morning on behalf of Coinbase. We
view ourselves a as leader in the legitimatization and
maturation of the crypto economy.
We provide an onramp for acquiring, trading, and holding
digital currencies. Through our strategy of operating the most
trusted and easiest-to-use digital exchange and wallet, we have
grown dramatically. We have very strong cybersecurity
protections and compliance practices to ensure that we remain
the most trusted company in this space.
Our cybersecurity program is state-of-the-art and remains
the critical core of our business.
Similarly, our compliance program is designed to build upon
the highest levels of compliance in our industry. In addition
to our formal regulatory role, Coinbase continuously shares its
expertise to make sure that our ecosystem is clean and
compliant. We train more law enforcement agencies globally than
anyone.
I plan to discuss three items today: The model of the
Coinbase exchange; our view on ICOs; and the broader regulatory
environment. The Coinbase exchange operates a spot exchange
that offers the ability to buy and sell four digital
currencies.
We do not offer margin or derivatives trading. There are
more than 1,400 currencies and tokens available, and we limit
our trading to four that have regulatory clarity: Bitcoin,
Ether, Litecoin, and Bitcoin Cash. Part of the reason we trade
only those four assets is that each has been determined by
regulators to be a virtual currency and therefore we believe
not a security.
One of today's questions is how to approach ICOs. Coinbase
currently does not trade ICOs or any other security tokens.
Despite that, we believe that ICOs are inevitable and full of
tremendous potential.
We believe they can unlock the ability of entrepreneurs
anywhere in the United States to raise money on a level playing
field. Entrepreneurs won't need to know funders in Silicon
Valley or New York to access vibrant sources of capital.
At the same time, there is a need for responsible
regulation to ensure investor protection. We welcome that
regulation.
In order to fully enable ICOs, investors must have
confidence in the integrity of the market. For this reason, we
support enforcement actions where they are necessary to weed
out bad actors and to protect investors.
At the same time, we need to be sure that we are not
chilling good innovation brought about by new technology and
good actors.
We believe there is no need for Congress to create a new
regulator or a new regulatory scheme because Federal regulators
already have sufficient authority to oversee this space
effectively. There are at least four Federal regulatory
agencies that can effectively protect investors and the
markets: The SEC, the CFTC (Commodity Futures Trading
Commission), FinCEN (Financial Crimes Enforcement Network), and
the Federal Trade Commission.
In addition, this Federal regulatory regime exists
alongside vibrant State regulations.
With respect to the U.S. regulatory environment, it is
important to stress that not all tokens are alike and
regulators need to be able to distinguish between various
tokens to enable innovation. This requires regulators to
coordinate and provide clear guidance to market participants.
For example, some tokens may be a commodity and others a
security. The SEC and CFTC should be able to draw a line to
determine whether a token should be treated as a commodity or a
security for compliance purposes.
The agencies have done this before when new asset classes
emerge, for example, in addressing stock indices and swaps. As
mentioned in the beginning, we operate the most trusted and
easiest-to-use platform to access digital currencies. We
believe that trust is enhanced through partnership with
regulators.
At Coinbase, we are committed to working with you, the SEC,
the CFTC, and other regulators to help shape a responsibly
regulated market. We believe the decisions you are making now
will help determine the future of innovation and capital
formation. That future is not 20 years away. It is almost here
today.
Thank you for this opportunity to discuss these issues, and
I look forward to answering your questions.
[The prepared statement of Mr. Lempres can be found on page
48 of the appendix.]
Chairman Huizenga. Thank you.
With that, we go to Dr. Brummer, who is recognized for 5
minutes.
STATEMENT OF CHRIS BRUMMER
Dr. Brummer. Chairman Huizenga, members of the subcommittee
thank you so much for inviting me here to testify at this
hearing. My name is Chris Brummer and I am the Agnes and
Williams Research Professor at Georgetown University Law
Center. And I am here today solely in my capacity as an
academic and I am not testifying on behalf of any entity.
We are blessed in the United States to have one of the
safest, deepest, and most liquid capital markets in the world.
One of the reasons for this success is our system of
information sharing and dissemination to investors.
The disclosure system embodied in the Securities Act of
1933 is largely one where promoters share among other things
material information publicly about the company, the management
and the securities being offered, as well as the intended use
of the proceeds. This information is then filed with the
Securities and Exchange Commission where it is vetted,
scrubbed, and analyzed.
Most ICO disclosures, by contrast, are facilitated by
unregulated white papers focusing largely on the existing
technology or technology under development to be financed via
an offering.
There is, as a result, a large gap between the disclosures
and many of the registered filings such as an S-1, and the
information provided in most white papers. And this raises a
number of red flags, to say the least.
For our purposes today, I would like to highlight briefly
some of the key disclosures one would expect and likely need in
order for buyers of ICO tokens, whether they are investors
seeking to profit or technology users seeking to support and
participate in an innovative product, in order to make a
purchase in an informed manner.
These disclosures are relevant, especially relevant, I
believe, as ICOs transition from technical expert ecosystems to
the disruption of instruments that are ever more likely to
attract everyday investors and the retail public.
Disclosure number one, promoter's location. At least one
study has noted that in roughly 32 percent of ICOs, it is not
possible to identify the issuing entities' or promoters'
origin. This creates serious information asymmetries on the
part of the investor.
Without knowing the issuing entities' or promoters' origins
it becomes impossible to know or identify what rules and legal
protections might be afforded to investors. Further, investors
have few means by which to contact relevant public authorities
in the case of fraud, theft, or loss.
ICO white papers should therefore set out a detailed
statement beyond a simple P.O. Box of where the issuer, as well
as its key management, are located.
Disclosure number two, problem in proposed technology
solution. For most of the history of U.S. securities laws, no
information was more important for investors than an issuer's
financial statements. But ICOs tend to serve a different
purpose from IPOs of the 1930's.
Instead of funding industrial companies transitioning to a
more mature cycle of development, ICOs involve products
developed by startups identifying technology-based problems and
proposing the sale or financing of technology-based solutions.
And in return for financing, promoters offer coins of varying
currency, utility, or securities features.
For most of these offerings, as a rule, is not the
company's past performance or even financial statements that is
most important. Instead, it is the ventures technology
proposition. Consequently, ensuring that investors, including
retail buyers, understand the basic contours of the underlying
technology solution is paramount as ICOs become a more popular
means of fundraising.
To that end, you can envision a number of important
reforms. An optimal disclosure system for IPOs would require,
to the extent possible, a plain English description of the
technology problem and solution.
Furthermore for larger fundraises, more technical parts of
the white paper would ideally be subject to a system of third-
party validation, what could be termed a technology audit.
And meanwhile, all code, regardless of the size of the
fundraise, would be posted to a public code repository such as
GitHub so potential buyers can either diligence the code itself
or other proxies for the strength of the code.
Promoters should avoid hyperbole when describing their
solutions, an endemic problem in many white papers, and should
be required to identify an objective basis for all forward-
looking statements.
Along these lines, disclosures should be made as to whether
post-ICO financial statements will be provided to token
holders. A description of the token is also useful.
Promoters should be able to disclose whether or not and how
the IPO ownership of the company's protocol, as well as to
detail with specificity, what legal rights holders of the
tokens will enjoy, as well as how the tokens will be traded and
on what system.
They should also be required to provide disclosures for
blockchain governance and the basic risk factors impacting not
only the token itself but the industry at large. Thank you.
[The prepared statement of Dr. Brummer can be found on page
42 of the appendix.]
Chairman Huizenga. Thank you.
Mr. Rosenblum, you are recognized for 5 minutes.
STATEMENT OF ROBERT ROSENBLUM
Mr. Rosenblum. Chairman Huizenga, honorable members, first
of all, let me thank all of you for holding this hearing. I
think it is timely. I think it is very, very important and I
think many people in the industry, those who want to get things
right, will very much welcome your participation and your
interest in the topic. So again, thank you for holding the
hearing.
I am a partner at the law firm of Wilson Sonsini Goodrich &
Rosati, a Palo Alto law firm that is generally recognized as
being a leading advisor to technology firms, to life sciences
firms, and the like. I am the head of the firm's blockchain and
cryptocurrency practice.
Now, I do need to say that I am appearing here on my own
behalf, not on behalf of my law firm, not on behalf of any
client. However, thank you for having me anyway.
In our capacity as being among if not the leading tech
firm, we obviously handle a great number of initial coin
offering and similar transactions. We represent a large number
of ICO issuers, we represent a large number of funds that
invest in initial coin offerings, we represent a large number
of entities, often very sophisticated entities, that are
investing in initial coin offerings.
I will give you a quick observation that, about 9 months
ago or so, the ICO market really started to become significant
in the United States. I was concerned, as some of the comments
we have already heard, as to whether there was really a there
there.
As I will talk about in a couple of moments, I think there
really are some very important things happening in this market
and again I think that is why it is so important for this
subcommittee to be focusing on these issues.
I actually have two basic proposals or two basic
suggestions for this subcommittee: First, I think in the near
term, Congress could greatly help the markets, the ICO markets,
to facilitate good ICOs and to help guard against fraud.
By authorizing the SEC or by authorizing and encouraging
the SEC and other appropriate Federal regulators to both modify
and amend their rules to better assist ICO issuers in meeting
the requirements of the Federal securities laws.
As Dr. Brummer says, there are already a number of
disclosure issues, there are already a number of registration
requirements to securities issuers. They don't work well. They
are not geared toward ICOs and to tokens and so the SEC can be
doing a lot more. Although they are trying very hard, they can
do a lot more to amend their rules and modify their rules and I
think this committee can help.
I think in the longer term, this committee can lead the way
toward having a more unified disclosure approach, registration
approach, overall legislative approach to how we handle ICOs
and token use in the United States.
Truthfully, I think it is too early to know exactly what
the contours of that legislation are going to look like at this
point. Again, we are only 9 months in really to ICOs.
The industry is so dynamic and changing so quickly that I
think it would be premature at this point to try to actually
craft that legislation, but I do think that there are basic
principles that can help us inform what that legislation will
look like when you are able to get to it.
I think there are three things though that in all of your
legislative activities that we should be keeping in mind. One
is there is tremendous innovation in the blockchain and
cryptocurrency community. And by the way, cryptocurrency is a
bit of a misnomer.
There are some tokens, Bitcoin, Ether, for example, that
really are cryptocurrencies. There are a number of other
tokens, and those are most of those that we will probably be
talking about today that have very specific purposes on very
specific platforms, designed to do very special things.
Second, there are tremendous capital-raising techniques and
I hope during this hearing we will be able to discuss why those
capital-raising techniques or opportunities are so significant
and potentially so valuable to the U.S. economy.
Third, there is no getting around the fact that there is
significant fraud, significant opportunities for market
manipulation, significant opportunities for loss of privacy and
data breaches. And those need to be part of and considered in
any regulatory and legislative response. With that, let me end
my remarks and thank you so much.
[The prepared statement of Mr. Rosenblum can be found on
page 55 of the appendix.]
Chairman Huizenga. Thank you.
Mr. Van Valkenburgh, you are recognized for 5 minutes.
STATEMENT OF PETER VAN VALKENBURGH
Mr. Van Valkenburgh. Thank you, Chairman Huizenga and
members of the committee. I am Peter Van Valkenburgh, Director
of Research at Coin Center, an independent non-profit that is
focused on the cryptocurrency public policy space. Today, I
will start by describing the fundamental innovation of Bitcoin,
then discuss the differences between cryptocurrencies and ICOs,
and finally describe the regulatory landscape for these
technologies.
The fundamental innovation of Bitcoin is digital scarcity.
So in the physical world a thing like gold is scarce because
you can hold it in your hand. You can ask a lab to tell you
that it is real and when you hand it to somebody else they have
it and you don't. But in the digital world, how can we know
that a Bitcoin is scarce?
We know that there are only 16.9 million Bitcoins in the
world right now because their distribution and movements are
described with perfect accuracy on a public ledger called the
Bitcoin Blockchain. Anyone can independently read and
mathematically authenticate the data in the blockchain just
like anyone can independently verify the scarcity of gold.
Now that digital scarcity can then be employed by
innovative people for a variety of innovative purposes. A token
that is scarce and transferrable from person to person can be
used as money just like any other portable and transferable
good throughout history from gold to seashells. That, in a
nutshell, is Bitcoin.
But a scarce token can also be automatically redeemable for
a digital good or computing service provided by the same
network of participants who verify the blockchain. And these
are projects like Ethereum, Filecoin, and Blockstack and they
are beginning to compete with incumbent service providers like
Amazon, Facebook, and Google.
A scarce token can also represent a legal agreement or a
financial asset. So a public company or investment fund could
issue and track its shares as tokens on a blockchain.
Now, these blockchains are just records. Whether they are
about money, assets, or computation, but rather than relying on
a handful of corporations running vulnerable datacenters to
keep the record, a blockchain version of the record relies on
an open network of thousands, potentially millions of
participants who have skin in the game and independently verify
and secure that data.
Those records will always be available until every last
participant goes offline. In other words, they will likely
always be available.
And those records will be accurate unless every participant
has their individual computer hacked. In other words, they will
likely always be accurate. It is this revolutionary-
decentralized architecture that makes these systems effectively
unhackable, at least using traditional methods of attack.
Especially pertinent to today's hearing, these technologies
are also employed for capital formation. Scarce tokens like
Bitcoin and Ether already exist in the world and they are in
use. But other coins and tokens are merely theoretical because
the software that will enable them has yet to be designed and
built.
Recently, various developers have raised money to fund the
development of new blockchain software projects by selling a
promise of future tokens to willing investors in so-called
initial coin offerings or ICOs.
From a regulatory standpoint, there is a fundamental
distinction that must be made between, on the one hand, scarce
tokens that exist on a blockchain and are used for payment or
to obtain computing services, and, on the other hand, promises
of future tokens representing the hopefully profitable efforts
of a developer.
The former, things like Bitcoin and Ethereum, they are
effectively digital commodities. They are scarce items that may
have value on open markets as money, as investments, or as
inputs for valuable commercial and industrial processes. They
are commodities, just digital.
The latter, promises of future tokens, are securities.
Promises from issuers to investors that efforts will be put
forward to create profits. Now, both have investor protection
risks, but they are distinct risks that are best addressed in
different ways. A commodity-like token has no issuers upon whom
investors rely.
But the token does trade on speculative commodities
markets. Policing these markets for fraud and manipulation is
critical for investor protection. A promise of future tokens is
a security with an issuer upon whom investors rely. Mandating
accurate disclosure from these issuers is, as we have said,
critical for investor protection.
So the sensible and emerging investor protection regime is
nothing new even though the underlying assets may seem like
science fiction. The CFTC should use its existing authority to
police commodities, spot markets for fraud and manipulation and
the SEC should manage and mandate disclosures from issuers
making securities offerings.
But if policymakers get the line between commodity tokens
and securities offerings wrong or if it isn't made clear by
regulators, it will destroy the viability of these innovations
and cede leadership in this technology to the rest of the
world. Thank you and I look forward to your questions.
[The prepared statement of Mr. Van Valkenburgh can be found
on page 76 of the appendix.]
Chairman Huizenga. Thank you, and I appreciate all of your
input.
We are going to start with a 5-minute question period for
myself. I recognize myself here. I want to try to cover a
couple of quick things. Investor protections, first and
foremost, the SEC versus the CFTC, and then use of blockchain
technologies.
So on that investor protections part, maybe Dr. Brummer you
could illuminate for us here a little bit on what current
protections you see or lack of current protections that are in
place to really protect Mr. and Mrs. 401(k). We have
institutional investors, sophisticated investors, and then we
have more retail investors.
So if you could address that quickly please?
Dr. Brummer. At this point in time, the SEC is working on
really operationalizing some of its own powers and authority
under the 33 Act, 34 Act, and the 40 Act for the mom-and-pops,
for the investors who are increasingly having exposure to
cryptocurrency markets, for the better in some instances, and
for ill in others.
There is a regulatory vacuum currently. That regulatory
vacuum extends, to some extent, to the spot market in
cryptocurrency. I think that where there are financial products
that under traditional analyses would tend to be identified as
commodities there are questions about disclosure that are
required to be asked.
I think that even in the securities law space the
infrastructure on which many of these tokens are currently
being traded are not entirely subject to the SEC's oversight.
So there are rules that are in place but it is a mishmash.
Chairman Huizenga. I am going to get to Mr. Rosenblum here
because you had said that, here is how I have encapsulated it
here.
The SEC is trying to do its job to protect investors and
you say it needs to modify the rules to help facilitate ICOs
but you say it is premature to draft legislation.
Now, both Chairmen Clayton and Giancarlo had said, along
with their current counterparts from the Department of Treasury
and Federal Reserve and others, that they may come to Congress
here in the coming months and we know that this has moved very
quickly.
In the last 9, 10 months we have seen this explosion of it.
This panel, this Congress is not going to sit by idly with a
lack of protection for investors and you have heard some of my
colleagues express some skepticism of the legitimacy of
cryptocurrencies and certainly ICOs.
So I want to look at what, very quickly, what the role
Congress may be to play in this and what chilling effect it may
have from your opinion quickly.
Mr. Rosenblum. Yes, thank you, sir. First, I think that
there are, in particular, two parts of the legislation. I think
there is an immediate set of legislation that needs to happen
to authorize the SEC and other regulators to amend modified
rules consistent with investor protection but also to
facilitate capital development or capital investment.
That is not to say there won't also be additional grants of
power or additional protections that Congress adds but what my
other point is, this industry is moving so very rapidly.
It is very difficult to know, here is one example, if you
take blockchain, which has a tremendous capacity to store,
record, and retain information and you mix that with artificial
intelligence which is certainly something people are trying to
do today. The capacity of artificial intelligence combined with
the blockchain to potentially lead to tremendous new marketing,
tremendous new business opportunities, tremendous scientific
and sociological advances is tremendous.
However, the opportunity to advance our agility to use that
same technology for a manipulative conduct or a data breach,
and for all sorts of other, what I will refer to as nefarious
conduct, is really hard to predict right now. And so what I
don't want to do is lock us into a system too early.
And I will give you one more--
Chairman Huizenga. And I don't disagree, and unfortunately
I am running out of time. We will be able to hopefully explore
this with some other questions.
Mr. Lempres, I would like to get to you very quickly. Do
you believe that there are any certain instances where initial
coin offerings should not be regulated as an offering of
securities?
Mr. Lempres. Thank you for the question. It is difficult to
answer because it is hard to imagine all the circumstances
under which ICOs might be offered. I think that speaking on
behalf of Coinbase, we do not support any initial coin
offerings at the current time because we are not sure the way
the regulatory structure is and inventory treatment is.
It would be appropriate--
Chairman Huizenga. In your written testimony you talked
about the CFTC quite a bit, the SEC not so much, and I have had
some express that they believe the CFTC has been more flexible
and open and receptive to ICOs and in blockchain. I don't know
if that has been your experience as you have viewed it.
Mr. Lempres. Yes. Let me say, our experience is we are
waiting for the dust to settle between the CFTC and the SEC
before we will actively engage in supporting ICOs.
Chairman Huizenga. OK.
Mr. Lempres. And once the rules are clear we will move in.
We think there is tremendous potential. We want to be there to
support it. I will say that there is an important distinction
between what is a security and what is a commodity. They
perform different functions and they do deserve to be treated
differently.
Chairman Huizenga. Yes. I am well over my time. There is no
doubt though a token is not gold and a commodity as such, so I
think that is some of the struggle that we have. So with that
the Chair recognizes the gentleman from Georgia, Mr. Scott, for
5 minutes.
Mr. Scott. Thank you, Mr. Chairman. And Chairman Huizenga
you have opened up a line of discussion here that I would like
to follow up on.
Mr. Lempres, in your testimony, you said that you believed
there is no need for Congress to create a new regulatory
regime. You have said you felt that the Federal authorities
already had that authority and that it was basically just a
lack of coordination.
But Mr. Lempres, both the SEC's Chairman Clayton and the
CFTC Chairman Giancarlo have told me that neither one of them,
the SEC nor the CFTC, have any regulatory authority. And, as a
matter of fact, they said what regulation there is at the State
level they are regulating these entities as if what they refer
to as money transmitters.
So it seems to me that there is some type of regulatory
shortfall here and if you ask me it is a little bit of that and
not just a lack of coordination. So you see my point there?
Mr. Lempres. Yes, Congressman, thank you, I do. What I
would say is that there are sufficient authorities in place
today. And I would point out that there is a long--
Mr. Scott. So you are saying that the Chairman of the SEC
and the Chairman of the CFTC are wrong?
Mr. Lempres. Of course not--
Mr. Scott. They say that that is not so.
Mr. Lempres. No. What I am saying, though, is I think in
context what is happening is when you talk about money
transmission licenses, that covers a portion of our activity as
a business. We are in many ways an integrated business, a
portion of which is licensed by the States for money
transmission purposes.
Mr. Scott. Yes, but it is done at the State level. There is
none at the Federal level.
Mr. Lempres. Well, respectfully, Congressman, I would also
point out that, again staying at the State level, we have a
BitLicense with New York State, which is indeed a comprehensive
consumer protection license that covers crypto activity within
the State of New York.
On the Federal level, I would respectfully say there is
regulation of commodity markets just the way there is
regulation of commodity markets everywhere else and that this
new asset, which is not a physical thing that you hold in your
hand, still has many of the characteristics of a commodity.
Mr. Scott. Well, my time is getting short, I want to--there
is so much here. This is an exciting new area, and we are
discovering a lot here but let me switch to the ICO issue.
Now Mr. Rosenblum, in your testimony, you said you believe
it is too early for Congress and the Federal regulators to
enact a comprehensive legislative or regulatory scheme
governing cryptocurrency.
Now, I can assure you I am the Co-chairman of the FinTech
Caucus and I can assure you that none of us on that caucus or
on this committee want to be killing good innovation,
especially one that is raising, as this is, billions of dollars
of capital because it is very important for everyone to know
and as CSPAN is broadcasting this, but it is important to know
that as of February 2018 individuals and businesses raised
$1.66 billion through initial coin offerings or ICOs.
So I agree with you, Mr. Rosenblum. However, going back to
the SEC and the CFTC, they have not proposed rules regarding
the regulations of cryptocurrency and other digital assets and
instead have relied on informal rulemaking or enforcement
actions.
So I want to ask you in particular Mr. Rosenblum, and
others on the panel, what in your minds could the Federal
regulators be doing better and do you believe that enforcement
actions and other formal guidance are sufficient to regulating
these emerging and exciting digital assets?
Mr. Rosenblum. Congressman Scott, thank you for the
question. I agree with the point that you are moving toward or
that you are suggesting here, which is regulation by
enforcement in an area that is as complicated and dynamic as
this, is not the appropriate way to regulate.
Enforcement is necessary, of course, however, I do agree
with you entirely that we need clearer guidelines, a clearer
understanding of how the SEC's registration rules, its market
trading rules, its exchange rules, its investment company and
investment advisor rules should apply and do apply. And that is
not something you can do by regulation through enforcement.
And that is again one of the reasons I think this
subcommittee and this hearing is so important to this process
because we do need more guidance on precisely those areas.
Mr. Scott. Thank you, Mr. Rosenblum.
Chairman Huizenga. The gentleman's time has expired.
With that, the Vice Chairman of the committee, Mr. Hultgren
for 5 minutes.
Mr. Hultgren. Thank you, Chairman Huizenga.
Thank you all for being here. I appreciate your work and
this is something that we are all interested in learning as
much as we can.
I want to address my first question to Mr. Lempres if I
could? Your testimony mentions that you store more than $20
billion worth of digital currency and have traded over $150
billion in assets.
In light of the January 2018 hack of the Coincheck
cryptocurrency exchange wherein $534 million was stolen, I have
a few questions for you related to that cybersecurity side of
this. I wonder what cybersecurity standards does Coinbase
adhere to?
Mr. Lempres. So thank you for the question. And the reason
I am hesitating, this is not my area of expertise, and I
apologize when we get into this stuff. But I will say that our
cybersecurity protocols are, I believe, state-of-the-art.
That we have an entire team, obviously, that does nothing
but work with cybersecurity. Approximately 99 percent of the
assets that we hold are held offline in what is known as cold
storage, which makes them virtually immune to hack.
We do have a hot wallet process for, in effect, if you
think about it, the cold storage is akin to a vault, the hot
wallet is akin to a teller window at a bank. The hot wallet is
online obviously and we have that amount fully insured to
protect the consumers and investors as to that.
Mr. Hultgren. Are there any, if you know about it and we
can follow up in writing, too, or you can let us know who the
person is that you recommend with Coinbase that we talk to, but
is Coinbase legally required to follow any Federal
cybersecurity laws and regulations, for example, financial
institutions and some service providers are subject to Gramm-
Leach-Bliley?
Securities exchange and other SROs are subject to SEC's Reg
SCI (Regulation Systems Compliance and Integrity). Are there
any other Federal cybersecurity laws or regulations that
already apply to Coinbase and others like you?
Mr. Lempres. Yes, first off, I am more than happy to get
you the name--
Mr. Hultgren. That would be great.
Mr. Lempres. --Of the head of our security. And second, I
believe the cybersecurity standard that we most adhere to is
New York State's standard through their BitLicense, which takes
quite a lot of work.
Now, we are also working with a few of the big four
accounting firms to develop appropriate standards to make sure
everything is SOC 2 and other standards.
Mr. Hultgren. OK. I think you answered this, but maybe just
for clarification? In the event of a hack of your platform that
results in the loss of assets, is there a guarantee that is
provided to the purchasers of the assets through your platform?
Do you have any legal responsibility for safekeeping of
client's assets? And what other protections are afforded for
your customers in the event that the hot wallet is hacked? You
mentioned that but I--maybe just go into a little bit more
detail on that if you have any?
Mr. Lempres. Sure. So again, we do hold a little bit of
fiat currency, USD--United States dollars. Those are held in
banks which do have FDIC insurance as to those dollars.
As to our cryptocurrencies, there is no Federal insurance
program to which we belong. We have attempted to create a
degree of comfort amongst our customers by insuring the hot
wallet amount. I will note that to date we have not been
hacked. We have never had to make a payment out under those
insurance policies.
Mr. Hultgren. OK. Hope it continues that way. Your
testimony also mentions that the exchange only support four
assets because each has been determined by regulators to be a
virtual currency and therefore not a security. However, you go
on to note that regulators are not providing enough clarity for
other cryptocurrencies.
How did you establish the regulatory and legal certainty
for those four currencies that you currently support or have;
do the SEC or the CFTC individually provide guidance for those
four currencies? Or did Coinbase make a determination about
these four currencies based on the SEC-CFTC guidance?
Mr. Lempres. Yes. We have received some guidance certainly
as to those four examples. The CFTC has explicitly found and in
fact published a primer that listed three of those assets as
cryptocurrencies. The fourth, Bitcoin Cash is a hard fork which
is in effect a derivative of Bitcoin. It would be covered by
the same reasoning.
Mr. Hultgren. OK.
Mr. Lempres. There are some court cases that refer to them
as cryptocurrencies and the SEC itself has distinguished
between cryptocurrencies and securities. Specifically in the
DAO Report they referred to Ether as a cryptocurrency in the
context of discussing securities.
Mr. Hultgren. OK. You also mentioned in your statement, and
I am out of time, so we will--if that is OK if I can follow up?
And I have questions for others. Sorry 5 minutes goes way too
fast, but thank you all for being here. Again, we want to
understand this as much as we can, but grateful for your
testimony. And we will follow up with other questions if that
is all right.
With that, I will yield back.
Chairman Huizenga. The gentleman yields back.
And it may behoove the Chair at this time to note that we
will be having an opportunity to forward questions through the
Chair to the panel. And depending on our time, as well, and
participation we may be able to get to a second round of some
questioning so--with your indulgence.
So we will continue to move along. And with that, Mr.
Ellison from Minnesota is recognized for 5 minutes.
Mr. Ellison. Thank you.
And now let us talk about cryptocurrencies a little bit. In
my meetings with constituents over the last several months, I
have had many of them say, ``hey, what is going on with this
cryptocurrency? I heard that it started at really low
valuation; now it is really high and it is up and down. Should
I get into it?''
I am like, ``well, look, I am no investor. I can't tell you
what you should do,'' but it did occur to me that I should ask
you experts. If somebody who is not sophisticated in this area
wants to invest, what should they know in advance? Could you
all talk about what the hazards might be for an unsophisticated
investor in this area?
Dr. Brummer. So that is a great question. It is an
important question. And I would certainly say that given the
complexity of many of these instruments it is very dangerous.
One of the disclosures that I had suggested would be really
critical, particularly as retail investors become more
interested in this space, is to understand what the risks are
when it comes to investing. It is not only that they can lose a
lot of their money but they can lose all of it, and that it is
not just the specific venture itself that creates risk.
It is not even the cyber risks or the potential for
hacking. But it is a very dynamic ecosystem, that there are
certain kinds of changes in the nature of the technology where,
say, Internet-based principles become embedded in the
blockchain and leave some of the blockchain technologies that
we are depending on now rather obsolete where the tokens tied
to them then become ultimately worthless.
That these are the kinds of risks that retail investors
themselves may not necessarily understand even where they may
have some basic--and if not only hazy understanding--of the
technology itself. And as a result, because just like you, I
will sometimes go to the gym and people will ask me, so tell me
about bitcoin.
I think that that is always the sign of trouble, of
sometimes either a potential for investors to not be properly
informed about where they are putting their hard-earned savings
and, as a result, there is a need for much more fulsome
communications with those who are seeking or who may be
interested in participating in those markets.
Mr. Ellison. So over the course of 2017 we saw some
precipitous increase in value. We saw some drop. We exchanged a
lot. What do you think is driving some of those swings? Is it
regulation or the threat or the possibility of it?
Dr. Brummer. I think it is a product of speculation. I
think it is a product of--
Mr. Ellison. Bubble?
Dr. Brummer. --Yes, of a bubble certainly. It is a product
of investors who are money chasing investments instead of
investors chasing money. It is a product of inadequate
disclosure. And as a result, I think, just to echo some of the
comments here on the panel, that regulation can be very healthy
for those markets.
It can help to address some of the spikes in volatility and
the patterns of fear, the bubbles. But that action is needed
now.
Mr. Ellison. So we are--yes sir?
Mr. Van Valkenburgh. I would only add that we have had a
long history of technology bubbles. I think a lot of what is
happening in blockchain technology looks rather like the dot
com bubble of the late 1990's, early 2000's.
And I think that is important for Main Street investors to
understand, and educational programs from the CFTC like LabCFTC
and educational advisories from the SEC are critical because in
the late 1990's it would have been extremely correct to say
that Pets.com is overvalued, extraordinarily overvalued and
they are going to blow all their money on a Super Bowl ad. And
there are some projects in our space that look like that.
But it would also be incorrect to say that Amazon.com was
overvalued. And I think that is why we see the froth in these
markets because a lot of these projects, say Filecoin or
Ethereum or Zcash, are challenging major multinational
corporations.
And if any of them succeed they will be in the future as
valuable and as critical as the infrastructure that those
corporations created. But that is a highly speculative bet.
Mr. Ellison. I only have time for one last question from
one last person. So we are talking about regulation here in the
United States the discussion is on, but what about other
countries and how does that impact this conversation? Anybody?
Dr. Brummer. So we have been looking particularly over at
Georgetown, some of my colleagues and other people certainly on
the panel, at how interoperable are rules and approaches? The
CFTC I know has been very interested in terms of information
transfers, information exchanges between regulators.
I think that one important component to these projects--
LabCFTC was mentioned; I think that is certainly an important
and healthy program, but to think through also how do we
include more than just a market access component to those
agreements and to push our regulators to also incorporate in
the FinTech space questions of a coordinated regulatory design,
information sharing, and enforcement?
And I think that that would help to make sure that we can
export some of our best values and approaches abroad and to
take best lessons learned overseas and to incorporate them
here.
Chairman Huizenga. The gentleman's time has expired.
With that, the Chair recognizes the gentleman from Ohio,
Mr. Stivers, for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman. I really appreciate
you holding this very important hearing on a topic that has a
lot of people's attention.
The first question I have, and I am going to try to ask
three questions, we will see how it goes--is to Dr. Brummer.
Can you talk a little bit about the promise of blockchain
technology?
Let us take a couple steps backward and talk about the
promise of blockchain technology to make our financial system
more transparent and efficient and--well, not transparent--
efficient. And what blockchain technology can mean, both for
financial transactions and other things in our economy?
Dr. Brummer. I think that the value in blockchain
technology, and it is very useful for us all to remember that
blockchain technology has its applications not only in the
financial space but in other ecosystems, everything from
pharmaceuticals and health and real estate and property.
But it provides a platform whereby, in a very decentralized
format, you can create a systems, a ledger, a methodology, and
mechanism for tracking things and transactions in a way that is
extraordinarily difficult to tamper with. And it allows for the
disintermediation of certain kinds of folks in the middle that
allow for a cheaper transaction experience.
I think that precisely because it is embedded in online
technologies the ability to fully lever--or right now I am
going to talk about the upside for just a moment, because I
have certainly been emphasizing that there are--
Mr. Stivers. And I would like you to wrap this up in about
15 seconds.
Dr. Brummer. In 15 seconds.
Mr. Stivers. Keep going, but--
Dr. Brummer. Yes. The difficulty is that to the extent to
which you are operating online there is more that the Federal
regulators can do in terms of investor protection, but it also
then raises questions. Someone had mentioned money transmitter
laws as to how do you coordinate--
Mr. Stivers. That is my third question. We will get to that
in a second. So--
Dr. Brummer. All right.
Mr. Stivers. So my second question is for Mr. Van
Valkenburgh. Can you help us understand the difference between
a token that is used as a commodity and the promise of tokens
that becomes a security? And if you can do it in about 2
minutes that would be great because we have 5.
Mr. Van Valkenburgh. It is a great challenge and happy to
try and answer. Thank you for having me. So we have a flexible
test in the U.S. for what is a security. It is derived from a
case called the Howey case. And that test can be applied for
promises of future tokens.
What you are really looking for are two things, an
expectation of profits--I am simplifying--reliant on the
efforts of an issuer or third-party promoter.
So that is why this promise of future tokens is critical to
thinking about why an ICO is a security even though other
things might not be because we have a definable or discernible
issuer who is promising to build something of profound economic
value, but we are relying on them to actually keep that
promise. And that is why it fits the test for an investment
contract or a security.
Now, a digital commodity might be a digital commodity for a
number of reasons. We use commodities for money. We use
commodities as investments. We use commodities as inputs for
commercial industrial processes. And the same thing is true of
digital commodities like Bitcoin or Ethereum or Filecoin, once
Filecoin is built.
Now, it is important to note that Filecoin is raising money
to build itself, but once it is built it will be a commodity.
And I will just quickly go through those three because they
are great examples of what I mean by digital commodity. Bitcoin
is nothing but something that is scarce and transferrable
person-to-person. And that is why I make the metaphor to gold.
It is very different than gold, but like gold I could hand it
to another person and if that is valuable on markets that may
be valuable and used as a medium of exchange or a store of
value.
Now--
Mr. Stivers. And I want to do one more question and I have
58 seconds, so if you could--
Mr. Van Valkenburgh. Yep, yep.
Mr. Stivers. --Give me the other two quickly?
Mr. Van Valkenburgh. Ethereum is a computing system on the
Internet and in order to get access to that computing system to
get useful results you use Ether as a fuel to power that engine
on the Internet. It is a commodity like oil.
Mr. Stivers. And the last one?
Mr. Van Valkenburgh. And Filecoin, the last one, is rather
like digital real estate. So you use Filecoin to get storage on
the Internet. So it is a commodity like real estate, if you
want to think of real estate as a commodity, measured in
gigabytes instead of square feet.
Mr. Stivers. Great, thank you.
And one last question for the whole panel, and I know this
is slightly off topic but because it has come up, if folks
could comment on whether they feel like FinCEN's 2013 guidance
on the appropriate level of anti-money laundering and Know Your
Customer safeguards are appropriate. Or do you think that they
are being abused out in the system? Do you think there is more
information needed on those issues?
If we could just go down the panel, anybody that is
interested in answering that one?
Mr. Van Valkenburgh. I think it is a very sensible piece of
guidance. It was written early on in the space and it created a
lot of clarity, especially for exchanges. And that is why all
U.S. exchanges that I am aware of are collecting information on
their customers and filing suspicious activity reports and
keeping the financial system transparent even if it is
cryptocurrency.
Mr. Stivers. Thank you.
I yield back, Mr. Chairman.
Chairman Huizenga. With that, the Chair recognizes the
Ranking Member of the committee, Mrs. Maloney, for 5 minutes.
Mrs. Maloney. Thank you. My apologies. I had to Chair for
the Democrats another meeting, but this is an incredibly
important issue. Thank you, Mr. Chairman, for calling it.
Mr. Lempres, as you know, my good friend and colleague Mr.
Cleaver sent letters last month to the Bitcoin Foundation and
the digital Chamber of Commerce asking what they are doing to
prevent extremist groups like those involved in the White
Nationalist Movement from using cryptocurrencies to fund their
campaigns of hate?
And I have also seen evidence that cryptocurrencies are
used heavily by sex traffickers to sell women. So this is a big
problem and one that Ann Wagner and I have been working on.
As Coinbase is one of the largest cryptocurrency exchanges
in the world, what are you doing to prevent these extremists
from using your exchange to fund their activities? Do you have
a set of standards or--thank you.
Mr. Lempres. Yes, thank you for the question. Let me first
off say that we take that very seriously. Specifically with
regard to hate groups, for example, we have a specific section
of our terms of use that we rely on and we kick people off the
platform anytime we see anything that constitutes--
Mrs. Maloney. Thank you.
Mr. Lempres. --Either encouraging or facilitating hate on
there, through our network.
Speaking more broadly on bad actors and the things we do to
track them down, one of the nice things about this technology
is it actually gives you insights that you can't get in any
other financial instrument currently because of the nature of
the blockchain, which is an immutable permanent record that is
publicly available.
We use both internally developed and commercially available
blockchain analytic tools which actually give us quite a bit of
insight into connections between individuals. If, for example,
we identify some kind of bad node or some bad activity, we can
track to see who has touched that and what relationship they
would have with anybody else who might have touched that.
I should mention that we are members of the Bank Secrecy
Act Advisory Group. We work very closely with FinCEN. We file
an awful lot of SARs. We have, just to show how important we
view this space, nearly 20 percent of our total employees are
dedicated toward compliance.
Mrs. Maloney. Thank you. And as I have said before, I am
extremely concerned about virtual currencies because a lot of
average people are using it and believing that it is an
investment tool. They are pouring their life savings into
virtual currencies and they stand to lose a lot of money when
this bubble eventually bursts.
Some people are treating these things as investments, not
as currencies. And that is a huge problem because there are no
investor protections like we have for stocks and bonds.
So I am working on a bill that would regulate virtual
currencies but not the technology, that have the
characteristics of an investment like we have always regulated
investments with robust investor protections, including
disclosures, which will be regulated by the SEC.
So Professor Brummer, let me start by asking you a
question. Do you believe that the definition of a security in
current law encompasses all virtual currencies?
Dr. Brummer. No, I don't believe so. The Howey test, which
is long the standard for evaluating nontraditional financial
products in determining whether or not they fall within the
SEC's regulatory perimeter, establishes several key
characteristics and benchmarks that have to be satisfied.
And I think that when you apply them to some of these
virtual currencies like Bitcoin you get less than fulsome
results according to those benchmarks.
Mrs. Maloney. So if we wanted to regulate virtual
currencies that are being treated as investments and to require
adequate disclosures to investors would Congress need to expand
the SEC's authority, in your opinion?
Dr. Brummer. They would need to expand the SEC's authority,
yes.
Mrs. Maloney. And I liked the part of your testimony where
you describe what kinds of disclosures should be made to people
who invest in initial coin offerings. And I agree that the SEC
can tailor the required disclosures so that they are
appropriate for digital tokens and virtual currencies, which
are different from traditional securities.
Do you think that requiring these kinds of basic
disclosures would stifle innovation in this space or harm the
development of the blockchain technology?
Dr. Brummer. I really don't think so. The kinds of things
like I outlined, adding mailing addresses--
Mrs. Maloney. And I have 15 seconds left. Professor
Brummer--
Chairman Huizenga. I am being generous with the time.
Mrs. Maloney. Oh, no, I know my colleagues need time, too.
What do you think of the idea of subjecting virtual currency
exchanges to minimum cybersecurity standards? Do you think this
is necessary in light of the huge cybersecurity risks that
virtual currency exchanges face?
Dr. Brummer. I think that would be extremely helpful.
Cyber-security is perhaps the number one challenge facing our
financial markets infrastructure providers and, to the extent
to which you want to provide those financial services, you
should be subject to certain kinds of high expectations about
the cybersecurity of your operations.
Mrs. Maloney. My time is more than expired. Thank you so
very much.
Thank all of you. Thank you.
Chairman Huizenga. With that, the Chair recognizes the
gentleman from Minnesota, Mr. Emmer, for 5 minutes.
Mr. Emmer. Thank you, Mr. Chair, appreciate it.
Appreciate all of you being here. This is a huge topic that
cannot possibly be even scratched, in my mind, in 5 minutes
with each of the people that are up here. I have a whole litany
of questions, which I know my office will follow up through the
Chair with each of you.
I think where I want to go this morning after listening to
you, because I find myself maybe not with my colleagues on some
of this. I have a problem with, ``Government is here to help us
and we need more Government. We are going to have to go into
this new frontier and we have to have more regulation.''
I heard at the beginning we have a regulatory vacuum. That
scares me to death. I tend to trust people before I distrust
them. I tend to believe that people are in these things for
good, that they are trying to improve their own lives and
hopefully the lives of people around them, that old adage of
``A rising tide lifts all boats.''
And yet I hear elected officials who don't have any concept
of what we are dealing with here and how exciting it is talking
about oh, my gosh, we have to run in. We have to regulate. We
have to create more Government infrastructure. And by the way,
I respectfully disagree with the idea that that won't act as a
wet blanket on this amazing new technology.
What we are talking about here is blockchain. Blockchain
technology applies all over the place. It can solve some of our
cybersecurity issues.
These are open transactions where--and Milton Friedman, of
all people, predicted this back in 1999 when he said there will
come a day in the financial services space where you will be
able to do this over the Internet where A will have a
transaction with B and it will be entirely open for people to
see. But A won't know B and B won't know A.
You can know that and you can see things. I think Mr.
Lempres was talking about how you can see things through the
blockchain that are going on.
I love the fact that Mr. Rosenblum talked about examples of
blockchain technology outside of this space. And I will tell
you in Minnesota we have a company called BanQu that is using
blockchain to provide digital identities to unbanked and
underbanked individuals in order to build a credit history and
access capital.
That is something that Democrats and Republicans should be
celebrating here in Congress, not going, ``oh, my gosh, this is
terrible. We don't understand it. We need a new policeman or we
have to take the policemen we already have and give them even
more powers to start to invade this space and perhaps frustrate
the development.''
I have concerns. I realize there has to be some regulation,
but it is the balance. And I have heard from the panel that we
have regulation already in place; we just need clarity.
Mr. Lempres, why don't I start with you? You talked about
we have to be able to say what is a security in this space?
What is a commodity? I would add what is currency because these
are all important definitions to whether or not certain
agencies are within their jurisdiction.
And to have you say two things, really scared me. One, that
you haven't made any offerings because you don't have the
certainty you need to know whether or not you can start to work
in this space and second, to say that 20 percent of your
workforce is working on compliance, that is nothing to be
celebrating from this side of the table in my mind.
So I would just ask you what about clarity in this area and
what about the balance that I am concerned with?
Mr. Lempres. Yes, thank you for raising it. It is obviously
a very, very important issue. I can tell you that from our
standpoint what we really need more than any particular
approach is to know what that approach is going to be from the
Government so we can plan and we can move.
This system innovates very quickly and just knowing where
the lanes are is extremely helpful for us.
Mr. Emmer. If I can interrupt real quick?
Mr. Lempres. Yes.
Mr. Emmer. I am sorry because I am thinking of a conference
that I was at last week, one of our very important and
respected secretaries made a statement about everybody needs to
register.
There is no clarity around the law so all of a sudden
people who are looking at being in this space or getting into
this space, I heard from more people there after that comment
that we can't start our business in the United States. We are
going to have to go somewhere else to start it. Does that
concern you?
Mr. Lempres. It does, although I will say that the entire
world is struggling with these same issues. And with regard to
the percentage of our team that is focused on compliance, the
biggest piece of that is focused on Bank Secrecy Act and Know
Your Customer obligations, these people are concerned about
money laundering and counterterrorism and things like that.
And that is an important element no matter which country we
are operating in, and certainly in any developed country we
will have those expectations.
Mr. Emmer. And we should work with all of you to understand
better those things that would work. I would just leave you
with this. Right now this system gives advantage to the
individual and not to the Government, and I am worried about
giving advantage to the Government and taking away liberty from
the individual. So hopefully we will be able to meet that
balance as we go forward.
Thank you, Mr. Chair.
Chairman Huizenga. The gentleman's time has expired.
With that, the Chair recognizes the gentleman from
Illinois, Mr. Foster, for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman. And before I begin my
testimony I would like to ask unanimous consent to enter into
the record a letter on behalf of Congresswoman Sinema from an
Arizona-based blockchain company in support of this committee's
investigation into this area.
Chairman Huizenga. Without objection.
Mr. Foster. Thank you. Distributive ledger technology has
tremendous promise and the value of a non-falsifiable ledger
will have broad applicability to financial and non-financial
transactions. It could reduce transaction cost, increase
transparency, and provide for instant and final settlement in
the areas ranging from cash transactions to real property
records to securities.
It also provides a platform for more speculative
transactions, such as Bitcoin, that are backed by nothing more
than perhaps their scarcity and the belief that there will, at
some point, be a greater fool to take them off their hands at
some unknown price in the future.
But nonetheless, much of our daily lives will soon involve
something like blockchain, so I think it is past time that
Governments around the world have a look at these digital
tokens and figure out where and how they should be used.
And it strikes me there are three fundamental questions
that I would like your reaction to that we have to face. The
first is will there be a mechanism to bust trades or not? In
the case of the Flash Crash, for example, the CFTC had very
clear rules in place under which case market gyrations would
result in trades being broken. There is no such mechanism, for
example, in Bitcoin where if someone steals your Bitcoin codes
they have it and you cannot get it back.
Similar questions arise if a hacker absconds with the
contents of your vault. Is there a higher authority that you
can go to to break that trade? So that is the fundamental
design question that I think you face and that we face as
regulators.
Second, is there a need for something equivalent to a
consolidated audit trail? In the securities space we have
learned by bitter experience of the need, if we are going to
detect and prevent market manipulation, we need to have an
electronic record of the timing and the beneficial owner behind
every transaction. That could be designed into digital entities
like this or it could not be.
And third, related, is the authentication of participants.
Will there be a mechanism if necessary an order of the
regulator to unveil the identity of counterparties and issuers?
That is something that could be present or could not be in any
of these.
And so I was wondering if you have a reaction to you think
we should address those three issues: Busting trade,
consolidated audit trail, and authentication of participants. I
am just happy to go down the line here.
Mr. Lempres. Sure, I am happy to start with that. Busting
trades is tough--there are technological challenges to that.
Once these trades occur or a transaction occurs, it has
occurred. There is no opportunity for settlement 24 hours later
or something else where you can look at it and pull it back. So
that is a challenge.
Mr. Foster. Yes, but there are technological means of doing
that where every transaction would be conditional on the fact
that some trusted set of entities haven't publicized a code
that invalidates the trade.
Mr. Lempres. Yes, it--
Mr. Foster. There are technologic ways of doing that but
everyone has to understand that it is not like cash. If you
steal cash it is yours, all right? And, with the exception of
serial numbers and so on, you pretty much own that cash. But it
could be designed differently and--all right. Then--
Mr. Lempres. No, it absolutely could be. It absolutely
could be.
Mr. Foster. Right, so the consolidated audit trail?
Mr. Lempres. Yes, unless those two items are put together
the authentication of participants and any consolidated audit
trail issue--certainly if you are trading on our platform we
have information on it.
We have your bank account information. Typically we have a
lot of Know Your Customer information so we know the
individuals. We know where they are. We verify their identity.
We know the source of funds. We know quite a lot about them.
And there is an immutable record once it is created.
So in many ways we have--while it is not a consolidated
audit trail in exactly the terms you are looking at, we have
much of that information gathered on our platform that we are
able to reconstitute it if it becomes necessary.
Mr. Foster. OK. All right.
Dr. Brummer, you want to take a swing at those?
Dr. Brummer. Other than saying that I am sympathetic with
your objectives, I would have to defer to Mr. Lempres as to how
the internal operations work on it.
Mr. Foster. OK.
Mr. Rosenblum?
Mr. Rosenblum. Sir, I think to take all of your questions
we have to step back and look at a couple things. There are a
number of different currencies and there are a number of
different items being traded here. And there are a number of
different places in which they get traded.
So if you are talking about Bitcoin or other things that we
will view as pure currencies, which is probably where this
question starts from, I think there are one set of answers to
those questions. I promise to get to those.
But the second thing, though, is when we are talking about
the new tokens and things that are being developed for
particular platforms, those are very different. And there are
at least two places where those can be traded, one is on the
platform itself, second is on exchanges, most likely exchanges
registered with the SEC.
When we talk about exchanges registered with the SEC, I
think your notion of having all three of those things exist
will absolutely happen. I think the question of if we move--and
I think with well-regulated, well-thought out platforms, that
type of, at least to a large extent, all three things that you
are talking about, identifying customers, having a consolidated
audit trail, and being able to bust trades can happen on those
platforms.
I think when we move to something like Bitcoin, there I
think you have a much more difficult problem with this because
that genie is already way out of the bottle. And the ability to
trade Bitcoin throughout the world is very difficult to put in
at least to Know Your Customer rule or an identification rule.
For example, you have a wonderful consolidated audit trail.
You can follow Bitcoin throughout the trail. You just don't
know who it was who held it. So that one, I think, is the one
that is going to be much more challenging for this
subcommittee.
Chairman Huizenga. The gentleman's time has expired.
With that, the gentleman from Ohio, Mr. Davidson, is
recognized for 5 minutes.
Mr. Davidson. Thank you, Chairman, and I thank you all for
your expertise on the topic in the rapid expiration of 5
minutes has been duly noted. So I will try to crank through
this.
I really appreciate the dialog that has been had about the
differentiation between commodities and securities, and Mr. Van
Valkenburgh, I wanted to spend a little bit of energy on that
because as these securities are offered, in a way, I think you
did a good job of highlighting what might look like a commodity
with a test.
But many times when people go to market, these aren't
shares in a company. If you think of them as an equity they are
non-voting shares and some of them aren't even committed to a
dividend. And those that are committed to have some return in
their structure, how is it that I make money for it, in some
ways it looks almost like a bond.
So could you say, look, if we were filing for securities,
which people haven't done yet, part A plus part D, part S, what
does that look like to treat it as a security in common frame
of reference for folks?
Mr. Van Valkenburgh. Thank you, Congressman. I would first
start out by saying that there are several developers who have
sold their tokens through Reg D filings and they are not
selling the tokens in that case. They are selling a promise, an
investment contract in the true meaning and spirit of the Howey
test wherein they are going to make efforts, people will rely
on those efforts and the outcome will be something profitable.
But the outcome in many of these cases is a brand new
decentralized computing system that has baked into it tokens
which can achieve some functionality.
Once that system is built and the investors who bought in,
say, a Reg D offering, is given the tokens, those tokens to me,
assuming the network is functioning, that people are now
relying on the blockchain instead of the issuer. They are
relying on a blockchain the issuer created for proof of
ownership for the functionality that that blockchain creates.
At that point, it looks more like a commodity. At that
point, maybe you can do something useful with the token like
use it in an engine for cloud storage or use it in an engine
for computation or hold it as a valuable and scarce commodity
like gold or salt or things like that.
Mr. Davidson. Thank you. And in that sense shares have many
of the same features, and, of course, they are treated as
securities.
Mr. Rosenblum, I want to spend a little bit of time talking
about a lot of the companies that raise this capital are early-
stage companies. And historically one of the paths to capital
for early-stage venture.
Venture is often considered smart money. You get the
benefit of lots of experience helping small, early-stage
companies navigate to scale up. ICOs don't always have those
features. Last year it was estimated that startups raised about
$4 billion in ICOs. Can you talk a little bit about the
concerns with respect to venture versus ICOs?
Mr. Rosenblum. Thank you, Congressman. Actually let me say
one quick thing. I am the only one on the panel who has not
been asked about security versus commodity, so if somebody at
some point wants to ask me, you are going to get a very
different answer from me on that question than the other
panelists.
To answer your question, sir, one of the things we have
seen in the ICO market to date has been a large number of
people, a large number of companies raising money in ways that
any securities lawyer would have told you, and truthfully did
tell you, that you shouldn't do.
So for example, Dr. Brummer's suggestions about how to
improve a white paper to me make--I understand the notion, but
no rational securities lawyer will advise their client to sell
off a white paper. We always sell off of a private placement
memo--
Mr. Davidson. Right.
Mr. Rosenblum. --Or a disclosure document. We always have
risk factors. We always take all the steps you need to for an
ICO in exactly the same way that we do in a private placement
for any other security.
And so one of the things we have seen, and then I will--and
I know time is short, sir, but one of the things we have seen
are market practices that have been detrimental to the long-
term development of the ICO market.
Mr. Davidson. Yes, thank you for that. And I think a very
good distinction, and I like that you hooked back in this
notion, of a white paper and how soft that is versus a private
placement memorandum. And I guess to your point, if I could
hear your perspective on commodities versus securities, I would
appreciate that as we close.
Mr. Rosenblum. Oh, thank you. Thank you so much for the
invitation. So I think that the notion of trying to decide what
is a security and what isn't a security is something that would
lead the market to distraction.
To take the notion that once something becomes functional,
once a platform becomes functional you no longer have a
security that has to be wrong. You can be still relying very
extensively on the efforts of the promoters. Trying to draw a
line on when it is that you are no longer significantly relying
on the efforts of promoters is so very difficult and so
convoluted and so open to second guessing.
My suggestion is don't even bother. Come up with a simple,
easy system to use eventually that is going to apply to all of
these things regardless of whether they are a security or not.
Mr. Davidson. Thank you.
And thank you, Chairman, for the additional seconds, and I
yield.
Chairman Huizenga. The gentleman's time has expired.
With that, the gentlelady from Missouri is recognized, Mrs.
Wagner, for 5 minutes.
Mrs. Wagner. I thank the Chairman very much.
Mr. Lempres, in your testimony you stated, and I quote,
``we need to be sure that we are not killing good innovation
brought about by new technology and good actors. For example,
the State of New York requires a BitLicense, which has been
unpopular causing companies to end their business relationships
in the State.''
Mr. Lempres, let me start off by asking you two questions.
Since Coinbase is one of four companies who have received a
BitLicense, do you believe New York's model was appropriate for
all industry participants? And second, what lessons can we
learn from New York's attempt to regulate the virtual currency
market?
Mr. Lempres. Yes. Thank you for asking, and we are one of
four companies that has received it. I think an obvious lesson
is New York made a very ambitious effort by the State to
regulate in this space.
The fact that they have only issued four licenses answers
the question to a certain extent. They have chilled activity in
the State of New York.
Having said that, when you are at the scale that we are at
now and the number of individuals and institutions that we are
dealing with now, we do benefit from the comprehensive
regulatory scheme the State of New York has put in so that
people do trust more.
We are doing the kinds of things they want to see when we
have people who are used to dealing with financial
institutions, and the State of New York is in effect treating,
through its BitLicense, us and other companies the way they
treat financial institutions. I think that sends a message to
the market.
So for a company of our size and again, there are four that
have this license, we have found benefits in dealing with the
State of New York on this. I would note that there are hundreds
or thousands of companies in our space and obviously only four
of them are operating in New York under that authority.
Mrs. Wagner. What are other State laws that regulate
cryptocurrencies?
Mr. Lempres. So we have 40 licenses in 38 States so they
are primarily money transmission licenses that we deal with but
they lead to full exams. We have, I believe had 28 exams to
current various States coming into our offices.
Mrs. Wagner. OK. Switching topics somewhat, I wanted to
talk about compliance a little bit. As a registered MSB,
Coinbase is required to submit suspicious activity reports, or
SARs, to FinCEN. Mr. Lempres, I understand that Coinbase
includes blockchain analytics when filing their SARs. Can you
explain to the committee how including this information allows
FinCEN to get a more complete picture of what is going on?
Mr. Lempres. Yes, and thank you. So you are correct in all
of your parts there. Yes, we do file SARs with FinCEN and that
we do include blockchain analytic information where it is
helpful in that SAR.
And the reason we do that is simply to do everything we can
to put into context the information--we have access to
information, that many Federal agencies don't see on a day-to-
day basis. We see it all the time. We try to tie it together to
present as accurate and complete a picture we can so that if
further investigation is warranted they at least have the
broader context in which it is operated.
Mrs. Wagner. And to follow up, can you talk about how
Coinbase coordinates with law enforcement and how your Know
Your Customer program was developed?
Mr. Lempres. Sure. So we are quite proud of our involvement
with law enforcement. We have a group, our global intelligence
unit, it's focus is exclusively on law enforcement coordination
and education. We train, I believe, more law enforcement
agencies globally than anyone.
We have trained hundreds of State and local agencies. And
when I was talking about training, it is essentially how the
blockchain works, how cryptocurrencies work.
Mrs. Wagner. Right.
Mr. Lempres. What information is there and how a case can
be put together if they need to put a case together.
Mrs. Wagner. Mr. Van Valkenburgh, in your testimony you
mentioned that there is friction and mismatch between new
technology and old regulatory structures when it comes to
State-by-State money transmission regulation. Can you explain,
sir, how the current State regulatory approach poses issues
with regard to cryptocurrency exchanges?
Mr. Van Valkenburgh. Yes, thank you. The first thing I
would say is these are naturally global technologies. They work
on the Internet so when people use them they necessarily cross
borders. And a company like, say, Coinbase, will have customers
not only in every State but probably across the world. And that
means that compliance, when it is done at a more local level,
is very burdensome and often redundant.
The 40th background check that your company gets will
probably not make you more likely to be secure or to have a
good reputation. It is just extra.
Now, the other friction or mismatch between State money
transmission licensing and these technologies, especially at
the exchange level, is that money transmission licensing
relatively exclusively focuses on this idea of transmission
from A to B, not on the idea of custody as clearly defined but
on the idea of transmission.
And there are all sorts of people in the world who are
developing these technologies who facilitate transmission
because they write highly innovative software that help power
these new blockchain technologies. They are critical to this
innovation. And they don't take custody of consumer funds, so
they don't actually put customers in risk.
But depending on how a various State money transmission
licensing statute is drafted, you could interpret it to say
that that software writing activity is included as money
transmission. And the penalties for being an unlicensed money
transmitter are very grave.
So if we could cleanup that statutory language State-by-
State to make it clear, folks that hold people's Bitcoin, like
my colleagues' company Coinbase, are licensed.
But people who don't actually hold it are not subject to a
licensing requirement. That would be a very positive signal
from the U.S. that we are willing to protect innovation where
it doesn't endanger consumers.
Mrs. Wagner. I thank you all for your testimony. My time is
way expired. Thank you for your indulgence--
Chairman Huizenga. We have been somewhat generous today on
that, knowing how do you unravel this in 5 minutes is very
difficult.
And still while we are in this first round, welcome back
Mr. Sherman, who is recognized for 5 minutes.
Mr. Sherman. Thank you.
The currency is both a store, a value, one you hope
appreciates, and a medium of exchange. So let us focus on the
medium of exchange. Is there any reason why I would need a
cryptocurrency to pay for my groceries or anything else? Why
wouldn't that be adequately served by using dollars?
Yes, Mr. Van--yes.
Mr. Van Valkenburgh. Thank you, Congressman. No, not
yourself I believe, sir, because you and I are--
Mr. Sherman. You are assuming I am not a terrorist or a
criminal and I thank you for that.
Mr. Van Valkenburgh. No, I am assuming you are an American
citizen, which I think is a pretty safe assumption.
Mr. Sherman. Oh, that one is safe. The other two are
questionable. Go ahead.
Mr. Van Valkenburgh. You and I have the benefit of a well-
functioning and extremely important financial infrastructure
that surrounds us every day of credit cards, of bank accounts
and most Americans do find it not too difficult to become
banked. We have an unbanked problem in this country but it is
not nearly as profound as other parts of the world.
In other parts of the world--
Mr. Sherman. Now, is there any part of the world where the
unbanked couldn't just as easily have access to transactions in
real currencies rather than cryptocurrencies?
Mr. Van Valkenburgh. So there are parts of the world where
real currencies in those countries are being basically debased
by their Governments or hyperinflated or they just don't have
actual purchasing power because of--
Mr. Sherman. Right. So you could use dollars, euros, Swiss
francs. Why are those not the adequate substitute?
Mr. Van Valkenburgh. If you can find access to cash in your
region of the world, U.S. dollars, that might be a very good
means of exchange, but those will trade at extreme premiums. My
only point is that cryptocurrencies are accessible. They are
accessible financial tools only on the basic precondition that
someone has a smartphone and an Internet connection.
And I think there are regions of the world where people
will sooner have smartphones and Internet connections than they
will have access to a valuable and secure financial services
from companies.
Mr. Sherman. I wonder if someone else can comment on that?
I don't think on the tallest mountain of Tibet there is
somebody with a $100 bill that they are holding onto. And on
every cellphone there is a way to use dollars or euros, so does
someone else have a comment?
Mr. Rosenblum. Mr. Sherman, thank you for the questions. I
want to divide your question into two different parts. One part
relates to things like Bitcoin and other currencies, which is
really what you are discussing.
Second part is going to relate to tokens and similar types
of things that have--instruments that have specific purposes on
specific platforms that people can earn and generate in ways
that you could not do with cash.
Mr. Sherman. I have limited time--focus on what can't you
do with cash?
Mr. Rosenblum. In a platform, for example, where we have a
buyer of property, sellers, and then we have third parties who
are performing important services to the platform to help the
platform run, to help validate services, to help do other
functions that are--
Mr. Sherman. And why can't these platforms use dollars?
Mr. Rosenblum. Because there is nobody who is going to pay
them. What happens on these platforms is that the platform
itself--
Mr. Sherman. Wait a minute. I have a bank. I pay them one
way or another.
Mr. Rosenblum. No, no, see, you have to find a source. You
have to find somebody who would have or who would be in the
business of paying them and that costs money. So what you see
in these platforms, what you see--
Mr. Sherman. Sir, I have lived my whole life. I am as old
as almost anybody in the room.
Mr. Rosenblum. Oh, sir, that is very kind of you to say,
but--
Mr. Sherman. And various intermediaries have handled my
financial transactions my entire life and none of them have
gone hungry.
Mr. Rosenblum. We are talking about a very different
business model. And that is one of the things that is so
important about this and what is so important about this--
Mr. Sherman. --We know that this is a good method for
terrorists, criminals, and tax evaders. So the question is, is
there some great social purpose that cannot be met in any other
way? And I will want to hear from a different witness, and I
don't see one volunteering.
Dr. Brummer. Honestly I think it is an important question
because you are getting ultimately to this question as to
whether or not many of these cryptocurrencies, and I think the
vast majority of the cryptocurrencies tied to ICOs are really
just means by which you are raising capital as opposed to
currency.
I will say--
Mr. Sherman. Raising capital but unregulated--
Dr. Brummer. Oh, absolutely.
Mr. Sherman. --Doing an IPO but calling it an ICO--
Dr. Brummer. One of the key responses I was trying to mark
for Mr. Rosenblum when discussing the adequate disclosures or
the kinds of disclosures that one would like to see in a white
paper is precisely in order to beef up those white papers so
that they become more compliant with the expectations of our
securities law, which I think is an expectation that all
securities lawyers would enjoy.
But I am very sympathetic to that.
Mr. Sherman. But if I buy an ICO and the company sells
great pizza and eventually makes billions, I don't get any of
that. I am not a stockholder?
Mr. Rosenblum. But sir, the important thing on those tokens
is the company that creates the platform may not have any
financial success on the platform. And the fact that the
platform becomes very successful may not redound to the benefit
of the entity that created the platform.
Mr. Sherman. OK. Perhaps we will have another hearing after
some major terrorist event financed by cryptocurrencies, and I
yield back.
Chairman Huizenga. The gentleman yields back.
With that, the gentleman from Connecticut, Mr. Himes, is
recognized for 5 minutes. Currently pass, OK.
We have some people potentially in transit, but if it is OK
with my colleagues we would like to go on to a second round,
which basically means I get to ask another question finally
after having a number of them.
And Mr. Rosenblum, you asked for it. So differences between
a commodity and a security?
Mr. Rosenblum. So in this case, as I said before, it is
very difficult to know where one begins and one ends. The
notion of saying, something has usage if we go back to the
citrus groves that were at issue in the Howey test, there is no
doubt that the citrus groves had usage. They really produced
citrus fruit that people really sold. Didn't mean that the
participation interest in those were anything other than
securities.
The problem that we face is that I can draw a line for you
that says when the promoter's efforts on the platform become
less important than the commercial usage of the platform in
driving the token value, probably it is no longer security
under Howey.
What I cannot tell you is a good test or a good set of
factors to look at that tell you with any great certainty when
you get to that point. So the thing that I keep suggesting to
people on this is I think that in the long run we shouldn't
worry about that issue.
We shouldn't worry about the distinction between this is a
commodity, this is a security, and how they travel back and
forth between each other. But instead have a simple system,
move to an environment where you have a simple system that
works for both and we don't have to have lawyers like me argue
with other lawyers and argue with the courts and argue with the
SEC over which side of the line it is.
Dr. Brummer. So can I just jump in for one quick
observation in response to something that you said, which I
think is really quite useful? When you think about the citrus
groves in the Howey case, this famous Howey case, you had
oranges. The oranges themselves were commodities.
It was the combination of the oranges of a service contract
basically with an opportunity to invest in them. It is the
combination of it all where the whole is greater than the sum
of its parts. And then you end up in the world of a security.
However, I would say that there is a difference in terms of
how commodities are regulated under the CEA. And how securities
are regulated. And securities regulators, for example, tend to
put a little bit more of an emphasis on disclosure, the
relationship that the SEC has with infrastructure providers and
other market participants. There is a different level of
reliance in the commodities world versus the securities world.
And these are things that I think that you, as a committee,
really ought to take into consideration when you are drafting
any potential legislative response.
And I would like to also emphasize that when we think about
a commodity, one of the commonalities between the commodities
world and securities world is an awareness that digital things
tend to be more abstract and therefore they tend to be a little
bit harder to understand and as a result there is a bit more
attention that is focused and placed on those products.
Gold is the quintessential commodity because it is finite.
People tend to like shiny objects. And it is universally
identified as something that has value. Here we are debating a
lot of that, and as a result our regulatory authorities and you
as a--
Chairman Huizenga. And so based on those regulatory
authorities, and we saw my colleague, Mr. Emmer, talk a little
bit about this, and I see the natural tension. You have people
saying there is no way I want any Governmental regulation on
this. In fact, we came up with it. Get out of it. This is a
fire free zone and we like it that way.
Government bureaucracies and agencies tend not to view the
world through those lenses and I think there is a certain
Governmental responsibility to protect those investors versus a
known investor or a unique investor that is sophisticated in
that.
And I have a minute left here, and I am going to be tight
on this 5 minutes here, but I am curious, and anybody can
answer this, will a Governmental central bank in any system
recognize and utilize a cryptocurrency? Because I think until
that point, this is going to be a bit of an outlier.
And whether it would be some small country or some others,
it seems to me the only way that there is going to be an
ultimate legitimization of cryptocurrencies is whether a
central bank somehow recognizes it. Anybody?
Mr. Rosenblum. Mr. Chairman, I think several countries in
Europe, for example, and in Latin America have already thought
about and are already considering digitizing their currency. So
I think that that is something that may very well happen.
I wonder though whether to at least--
Chairman Huizenga. But that is a little bit different. That
is a Governmental-created currency versus a non-Governmental
currency at this point, right?
Mr. Rosenblum. That is right, but I wonder what the
difference is. Once we have moved away from the Bretton Woods
Treaty, and once we have currencies floating freely around with
each other. I think in one sense what we are worried about is
that Bitcoin isn't backed by a state actor and that is about
it.
Chairman Huizenga. OK.
With that, the gentleman from Georgia is recognized for 5
minutes.
Mr. Scott. Thank you very much, Mr. Chairman. And, again, I
am so excited about this new cutting edge, what I call the new
frontier of our financial service industry and it is an
exciting time for us.
But let me give you all this scenario. We have millions of
new investors who are literally pouring their savings into
virtual currencies here, and it is a wonderful thing. As I said
before, it is burgeoning up. It is billions of dollars in
capital being raised.
But then these facilities in this virtual currency are
facilities that store and they transfer these digital assets
for investors which are known as digital wallets. But here is
the problem. These digital wallets have become targets for
hackers.
And hackers are using social media, phone calls, and ads on
search engines to fool investors into providing them with
sensitive personal information that they can use to gain access
to accounts at digital wallet providers and steal literally
thousands of dollars' worth of virtual currencies. Hackers have
also targeted the digital wallets themselves, exploiting the
vulnerabilities in their cybersecurity systems.
This was brought to my attention by SEC Chairman Clayton.
He has pointed out that digital wallets storing or transacting
digital assets that are securities, can trigger other
registration requirements under the Federal security laws,
including broker-dealer, transfer agents, or clearing agency
registration.
So panel, what I want to ask you is what are the benefits
to investors of digital wallets registering with the SEC? Would
that help to defer? These are the kinds of technical and
complex questions that present us as Members of Congress
because it all falls on our shoulders. And most certainly we
want to be responsive.
And as I said before, Co-chairman of the FinTech Caucus I
am very proud of this industry. But I also know, for example,
the OCC may come there. They are flirting from one position to
the other of doing a special order charter for FinTechs. And
then you have all these regulators boxing around how to
identify them.
But all this comes to our lap, and if they are registered
with the SEC should these digital wallets be subject to
enhanced cybersecurity protocols such as Chairman Clayton said,
as the SEC's regulatory systems compliance and integrity of Reg
SCI? We are dealing here with an opportunity to get it right
before we get it wrong.
So tell me, Mr. Van Valkenburgh?
Mr. Van Valkenburgh. Thank you, Congressman. I think the
testimony of both Chairman Clayton and Chairman Giancarlo
before the Senate Banking Committee is extremely important to
take a look at, to think about how those two regulators are
construing the space.
Chairman Clayton, as you rightly said, talked about tokens
that are securities either because the token does represent a
legal agreement, it is a company saying these are shares of our
stock, or because the token is a speculative promise of future
efforts, fits the Howey test.
But Chairman Clayton also talked about what he called pure
cryptocurrencies. He used the term on several occasions. And
the Chairman suggested that those are outside of SEC
jurisdiction and if you look at one of his responses to the
questions he said, ``Do not misconstrue me saying that is
outside of our jurisdiction as asking for more jurisdiction.''
And I think that is probably because the colleague sitting
to his left was Chairman Giancarlo of the CFTC, an organization
that has expertise in policing markets for scarce commodities,
which pure cryptocurrencies, I would argue, very much are. So I
think we want to look to the institutional competencies of
these two different agencies to protect investors.
And that means the CFTC will continue to use its existing
authority to police spot markets for fraud and manipulation if
the spot market is trading commodities and the SEC will ensure
that only tokens that are securities are traded only on ATSes
or national securities exchanges, which will have to go through
all of those cybersecurity requirements.
Now, where there might be a gap, if there is any gap, is
the fact that the spot markets for cryptocurrencies are policed
by the CFTC ex post, not supervised by the CFTC ex ante, for
things like transparency, cybersecurity standards, and the
like. Instead, they are supervised by the States in a patchwork
approach that includes the BitLicense and others.
It might be time to rationalize and Federalize that
supervision of cryptocurrency markets.
Mr. Scott. And so if you saw those two agents--
Chairman Huizenga. I am sorry. The gentleman's time has
expired.
Mr. Scott. All right. Thank you, sir.
Chairman Huizenga. With that, the gentleman from North
Carolina, Mr. Budd, is recognized for 5 minutes.
Mr. Budd. Thank you, Mr. Chairman. And again, thanks to
each of you for being here today.
Peter, I want to publicly thank you for the private
briefing that you and Jerry gave several weeks back and just
say how helpful that was and just to encourage any other
members, staff on either side of the aisle just to reach out.
You guys have been very helpful in bringing us up to speed on
this, so thank you again.
Mr. Van Valkenburgh. Thank you.
Mr. Budd. So I want to make a statement and then ask a few
questions. One, regulation in this space is something that the
U.S. we have to get right because poor or rushed policy with
respect to cryptocurrency and tokens, in my opinion, it really
threatens America's leadership in finance and in technology.
So we have to be careful to avoid missteps. This technology
has potential to become something great, so I just think that
we should move with caution here.
And on that note, I am curious about an idea that I have
heard and being floated around as a potential regulation scheme
for cryptocurrencies. So this idea would divide
cryptocurrencies into securities and non-securities with
security coins being regulated as securities and non-security
coins being regulated as commodities.
So the obvious difference between the two being the
security coins would offer dividends or equity or anything that
did not, again, be on the other side, would be on the commodity
side. So I am curious, Peter, to get your thoughts on this idea
first.
And then Dr. Brummer, if you have any thoughts if you could
answer that as well?
Mr. Van Valkenburgh. Thank you, Congressman. The first
thing I would point out is that this is a global technology,
and U.S. laws are not a good fit for both the innovators and
the investors as far as protecting them but also enabling
markets, these technologies will move to other jurisdictions.
The Congressman is, I think, correct that a sensible way of
dividing these markets is between things that are more
commodity-like and more security-like. And in the U.S. the
flexible test for a security, the Howey test, is the tool for
doing that.
But it is not the tool globally. In Europe, for example
there is more of a black letter law approach than a flexible
test. Certain things have been identified in various European
jurisdictions as securities and they are more of what you
suggested, things that clearly offer a dividend or capital
return on investment.
Finding a more bright line test may be useful, although the
SEC's flexibility with the Howey test can be very helpful in
going after schemes that pretend to not be securities by not
offering those formal things.
So finding a way forward is not easy, but probably worth
considering because at the moment you see many more of these
truly innovative capital formation opportunities moving over to
Europe. You see a lot in Switzerland. You see a lot in Germany.
And these are not countries with lax securities regulations.
These are just countries with a more certain legal test.
So I think guidance from the SEC as to how they will
interpret the Howey test with respect to token sales, they have
already had a lot of very deliberate statements that have been
very helpful, but further guidance might be helpful, especially
with respect to exactly how you draw the line. And it might
look more like what Europe is doing these days.
Dr. Brummer. So I guess my first response is that Europe's
approach on this is very much uncertain, number one.
Number two, they don't have a definition in place firmly
for virtual currencies under MiFID and other European Union
regulations and rules. And they are grappling with these same
issues just as we are today. And there is an enormous amount of
uncertainty as to how that is going to just play out.
I think when it comes to the commodity securities question,
I agree with Peter. Maybe there is a little bit more of a
difference of tone. Institutional competence is extremely
important when thinking about who should be regulating
different financial products.
My testimony today emphasized the question of disclosure.
And I think that even when it comes--I think that Bitcoin is
not the same as gold and I think that people intuitively
understand it a lot less.
And so this creates very important questions as to what
kinds of disclosures should be related to pure cryptocurrencies
that may legally, under current law, resemble a commodity or be
classified as as a commodity as opposed to a security because
the disclosure process available under the CEA is more or less
of a buyer beware approach versus a much more fulsome approach
adopted under the SEC.
And so a decision has to be made as to not just the
competence but even under existing rules no matter which,
excuse the pun, side of the coin you may fall, there will be
subsequent rulemaking required in order to adopt and to adapt
your existing regulatory processes to a virtual currency. And I
think that it is important that people recognize this, that
there is going to be work that will have to be done, both on
the SECs and as well as under the CFTCs in order get it right.
Mr. Budd. Thank you both.
I yield back.
Chairman Huizenga. The gentleman's time has expired.
The gentleman from Connecticut is recognized for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman. I will yield my time to
Mr. Scott.
Mr. Scott. Thank you very much, Mr. Himes. I appreciate
that.
Mr. Van Valkenburgh, you hit it on the head as to what I
think we have an obligation both to this burgeoning industry
here, as well as to the safety of the American people. All this
technology that we have being applied in very sensitive areas
makes us become almost a servant of the machine technology that
was created to serve us.
And we have to get this right in terms of what I think is a
delicate balance of the right regulation that really helps to
solve the problem. We have hackers out there that are at work
and damaging great careers and jobs and just the lives of the
American people. And they look to us here in Congress to try to
solve that.
And so when I brought that issue you brought up how the
CFTC and the SEC would work together in working with this,
which presents another problem that we have. And let me ask you
in that situation the great need for harmonization because that
is the problem we have.
When we have these regulators involved and you have several
regulatory agencies, it puts your industry in somewhat of an
awkward position trying to figure out and try to make sure that
they are both coming at it the same way. So would you recommend
that whatever we do, knowing these different agencies, that
Congress put in whatever we do a rule for harmonization?
Mr. Van Valkenburgh. Yes. I do think harmonization is
critical. Chairman Giancarlo, when he talks about policing
authority over these spot markets for commodities, emphasizes
that they don't have any ex-ante authority. They don't have the
ability to supervise beforehand. They are not the regulator on
point.
And as I was briefly saying earlier, the regulator on point
is largely the States, whether it is through the BitLicense or
through money transmission licensing. And so it is not just
anarchic as between Federal agencies potentially. It is
anarchic as between Federal agencies and various State
regulators.
I think State-by-State money transmission licensing is both
the biggest impediment to the technology because of the
profound and redundant and nonproductive costs that it imposes
on the industry and on the ecosystem. And it also is not an
adequate way to protect consumers or investors.
I think we need to start a conversation in Congress about
Federal pre-emption of State money transmission licensing law
that would also include sensible investor protections for those
who become licensed by a Federal authority.
And Chairman Giancarlo, in his testimony before the--I
believe it was before the Ag Committee not Banking Committee in
the Senate said what that will look like will be data
reporting, capital requirements, cybersecurity standards,
measures to prevent fraud and price manipulation and anti-money
laundering and Know Your Customer protections.
That is a sensible package to require from intermediaries
in our cryptocurrency space, and it is the low-hanging fruit
from a harmonization standpoint of what Congress can do soon.
Mr. Scott. Thank you very much, Chairman.
Chairman Huizenga. The gentleman yields back the time.
So I would like to thank our witnesses for today. I thought
this was illuminating in so many various areas and completely
befuddling in others, which--welcome to Congress I guess. But
it was very helpful and thank you for this.
I believe that this is probably hello not good-bye. We are
going to be continuing to have this conversation.
I do have--without objection, I would like to submit the
following statement for the record, a statement from Liquid M
Capital, Inc. without objection, so moved.
Without objection, all members will have 5 legislative days
within which to submit additional written questions for the
witnesses to the Chair, which I will then forward on to you
all. And I would just ask our witnesses to please respond as
promptly as possible.
And without objection, all members will have 5 legislative
days within which to submit extraneous materials for the Chair
for inclusion into the record as well.
So again, thank you very much for your time and your
attention to this and your insights. And this hearing is
adjourned.
[Whereupon, at 12:07 p.m., the subcommittee was adjourned.]
A P P E N D I X
March 14, 2018
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