The blockchain community has been discussing the finer points of the Howey test and related matters to try to determine when a blockchain token (or its sale) meets the definition of “security” under the federal securities laws. Because a token can be the digitization of any asset (or of information or other items that have not traditionally been considered “assets”), we have cautioned that other regulatory schemes should be considered when evaluating how a blockchain project and its associated token should be regulated. Blockchain is a technology, not an industry, and its usage needs to be regulated in accordance with the context in which it is implemented.
As a timely reminder of this thesis, the Uniform Law Commission (ULC) recently promulgated a proposed uniform state law for virtual currency activities, in an attempt to encourage predictability and promote assurance among virtual currency users. The proposed statute can be found here. If adopted in any state, the law will create a new type of regulated activity requiring state licensure: entities and individuals that engage in “virtual business activities.” Virtual business activities include “exchanging, transferring, or storing virtual currency or engaging in virtual-currency administration, whether directly or through an agreement with a virtual-currency control-service vendor. . .” This definition is aimed to require licensure of providers of products and services related to Bitcoin.
But, not exclusively Bitcoin. Under the proposal, the licensure requirement stems from engaging in “virtual business activity” with respect to “virtual currency.” For these purposes, virtual currency means a “digital representation of value that: (1) is used as a medium of exchange, unit of account, or store of value and (2) is not legal tender, whether or not denominated in legal tender.” Legal tender is defined as “a medium of exchange or unit of value, including the coin or paper money of the United States, issued by the United States or by another government.” The proposed ULC statute notes that the purpose of the definition is to encompass blockchain assets “. . .used as a substitute for ‘money’ between an obligor and obligee that have agreed to transact business as if a barter transaction is occurring, that is, where the transaction is not subject to laws that specify when the discharge of ‘debt’ occurs.”
Whether an entity or individual will be able to continue business operations without a license, therefore, turns on this definition of “virtual currency.” This article discusses the adequacy of ULC’s definition and compares it to other definitions of the same terminology as a way to remind the community that blockchain tokens are not a homogeneous asset class capable of sustaining a bright-line definition like that of “virtual currency” proposed by the ULC.
The Internal Revenue Service (IRS) and the Financial Crimes Enforcement Network (FinCEN) have provided guidance on virtual currency under their regulations. The IRS defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like ‘real’ currency—i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance -- but it does not have legal tender status in any jurisdiction.”
FinCEN defines the term virtual currency to be “a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.” The guidance addresses “convertible” virtual currency, defined to “either [have] an equivalent value in real currency, or [act] as a substitute for real currency.”
In one respect, the ULC, IRS and FinCEN definitions are identical: a virtual currency is characterized by its function as a digitized “medium of exchange.” This idea seems to mean that the virtual currency does what fiat currency or legal tender does—function as a unit that people can use to pay for things.
But the IRS and ULC definitions also include concepts of a digitized “unit of account” or “store of value.” These definitions are much less straightforward. One may reasonably argue that a token representing any collectible in the world, like artwork, baseball cards or jewelry, is a store of value. More interestingly, any tokenized personal information transferable on a blockchain ledger (e.g., health records, identity cards, internet browsing history) could represent a store of value, and indeed certain blockchain projects seek to treat them as such. Moreover, the concept of “unit of account” becomes confusing when applied to those same examples. There are plenty of other illustrations that would apparently constitute a store of value or unit of account but certainly do not immediately lend themselves to treatment as a currency. The ULC idea that any digitized asset used for barter constitutes virtual currency therefore seems overbroad. Blockchain tokens engender this kind of confusion because digitization and appearance on a ledger gives “liquidity” (that is, easy transferability) to the underlying asset, information or other item. With liquidity, apparently, comes the temptation to classify the token as some type of financial instrument.
While financial assets are important to the world, they are not the only types of assets. More to the point, lawmakers have not intended financial regulation to apply to every commercial transaction or even to every investment transaction. Regulators and blockchain users alike should resist the temptation to apply financial services regulations to every digital asset. A digital cigar is still just a cigar.