This post is part of CoinDesk’s 2019 Year in Review, a collection of 100 op-eds, interviews and takes on the state of blockchain and the world. Daniel Gorfine is the founder of fintech advisory firm Gattaca Horizons LLC. He currently serves as an adjunct professor at the Georgetown University Law Center, and is former chief innovation officer of the U.S. Commodity Futures Trading Commission.
Sometimes I imagine the advent of bitcoin as akin to the sudden appearance of the monolith in Stanley Kubrick’s 2001: A Space Odyssey that triggers curiosity, suspicion, euphoria and then ultimately evolution across a band of interested primates. Satoshi Nakamoto’s now more than 10-year-old white paper has elicited a broad range of human emotions, reactions, and responses ranging from those who believe this is all nothing more than digital smoke and mirrors, to those who argue blockchain is the biggest innovation since the development of the internet.
Regardless of your view, it is clear that bitcoin has driven society to think more broadly about the nature of money, the way we engage in economic activity, and the role of financial intermediaries and technology infrastructure in our markets. As we head into the year 2020, and wrap-up over a decade of experience with cryptocurrency, it is worth taking stock of five key market and regulatory topics that are likely to drive the crypto agenda heading into the new year.
The first topic is a remnant of the global ICO mania of 2018, which catalyzed fierce debate on the definition of a security in the crypto-context. Some within the crypto community have argued that tokens will serve a utility or consumption function in powering new decentralized economic models, and therefore should not be viewed through the lens of a securities offering. Global regulators have looked through the promise to argue that in reality many pre-sales of tokens bear the hallmarks of a traditional capital raise, and, therefore, are the proper focus of securities laws.
Much of the mania over ICOs dissipated in 2019, but it remains the case that there is still existing ambiguity at the margins of when a token may be a security as compared to – or “morph” into – a decentralized utility or consumption coin. Absent (unlikely) legislation to clarify this perimeter, 2020 may be the year that the judiciary more fully applies doctrines such as the “Howey Test” in the crypto context, including in cases like U.S. Securities and Exchange Commission v. Kik Interactive Inc.
To the extent that further clarity allows certain token projects to move forward outside of the securities law context, 2020 may also be the year that we begin to learn more about the viability, value, and economics of such projects (an area where I have previously expressed skepticism that we will see thousands or even hundreds of successful standalone tokens).
A second topic, derivative of the first, is looking at how regulation will evolve in the U.S. to the extent that a token falls outside of the securities laws. Platforms that facilitate the trade of digital commodities are currently subject to a patchwork of state regulation that largely treats the exchange of virtual currencies as money transmission (although some states, such as New York, have tailored specific crypto-regimes). With the exception of FinCEN registration, there is no coherent federal framework that provides oversight of a digital commodity exchange (also known as the cash, spot, or underlying market). While the CFTC may have backward-looking fraud and manipulation enforcement jurisdiction, this is not a federal framework to oversee spot digital commodity trading as with securities, or futures and derivatives markets.
The above-regulatory landscape seems to poorly serve both innovators and regulators. Digital asset market participants and innovators would benefit from a more efficient, rationalized, and mature regulatory framework that recognizes crypto-trading from a markets perspective instead of simply as money transmission. And regulators would better be able to satisfy regulatory interests – including investor protection and policing for trading manipulation – if the regulatory framework provided for direct market oversight.
For the above reasons, 2020 may be the year that policymakers at the state and federal level begin more robust consideration of a rationalized digital commodity regulatory framework.
At the federal level, an opt-in federal licensing option for cash-market digital commodity platforms could hold promise. At the state level, I would expect leaders to emerge in creating more streamlined, coordinated, and market-oriented licensing frameworks. These regimes would need to create properly tailored platform requirements, while leveraging appropriate market and trading oversight capabilities. The private sector, for its part, should continue to develop and deploy crypto-market surveillance and compliance tools, including through potential industry or self-regulatory bodies. All of these developments could help to enhance the integrity of underlying crypto markets.
A third topic will be further exploration (and ideally clarity) around the application of the securities laws to digital assets that are deemed to be securities or that are involved in a registered offering. In other words – whether the token represents a registered or legal form of an ICO, the mere tokenization of a traditional securities offering, or the underlying basket of assets in an investment fund – how can blockchain technology or blockchain-based assets satisfy regulatory expectations and requirements?
Let’s drill down on a few examples to highlight what I mean. If we assume an asset is in fact a security, the way the security is marketed, transferred, cleared, and custodied must all satisfy securities laws. These laws, for example, impose requirements on SEC registrants to ensure that customer assets are not lost, misused, or misappropriated. While this may sound straightforward, satisfying such standards poses unique challenges when the involved asset is secured with cryptographic keys, which can be lost or potentially shared with third parties.
A second related example of unique securities law considerations in the crypto context arises with respect to applications for a crypto-based ETF. The SEC has made clear successful applications will ultimately have to demonstrate how the fund can “prevent fraudulent and manipulative acts and practices.” A core challenge here derives from the regulatory framework outlined above – one which does not systemically surveil the underlying crypto-market for potential fraud and abusive trading practices.
My view is that efforts to further ensure the integrity of the underlying market – whether through application of more coherent regulatory frameworks or industry self-regulation – will be critical in enhancing requisite market integrity from a securities law perspective. CFTC oversight of evolving crypto futures markets may also advance these efforts.
A fourth topic for 2020 will be ongoing developments around stable coins and digital fiat currency, including the Libra initiative, global CBDC efforts (including in China), or a U.S. hybrid model I have advocated for that recognizes a role for the government, but in partnership with private sector dynamism and ingenuity. The truth is that, despite bitcoin’s longevity, we have not yet seen the mainstream adoption and success at scale of a tokenized medium of exchange powered by decentralized blockchain rails. We know the potential benefits – including efficiency, speed, transparency, and inclusion – but we need to test the merits as compared to traditional payment rails. This testing and evolution will inevitably happen, and 2020 may prove to be a catalyzing year.
A final topic moves beyond crypto as an asset and instead focuses on the many ancillary benefits that may arise from renewed focus on the technology infrastructure that underpins our broader markets and provision of financial services. I have frequently suggested that one of the positive outgrowths of the launch of bitcoin is that it has made the topic of interoperable databases and smart-contract-based automation a ‘hot’ area in the context of middle and back-office systems. Although existing infrastructure may be Scotch-taped and bubble-gummed together to serve its purpose, there is little question that new systems, which promote interoperability, data standardization, open architecture, and ready application of machine learning tools are the next generation of enterprise-level fintech. 2020 may be the year that we begin to see the value proposition of such infrastructure justify the up-front investment cost.
It’s hard to believe it has been more than a decade since Satoshi Nakamoto released the bitcoin white paper. We still do not know who Satoshi Nakamoto is and how cryptocurrency-based innovation will evolve. But, as one of the earliest popular articles I could find on bitcoin noted back in 2010 (when one bitcoin traded for 20¢): “purely as an intriguing idea that might indicate a possible future . . . Bitcoins are worth taking a look at.” Indeed, this intriguing idea promises to continue to drive our march into a 2020 cyberspace odyssey.
Happy New Year!
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