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CRYPTOCURRENCIES: OVERSIGHT OF NEW 

ASSETS IN THE DIGITAL AGE 

HEARING 

BEFORE THE

COMMITTEE ON AGRICULTURE 

HOUSE OF REPRESENTATIVES 

ONE HUNDRED FIFTEENTH CONGRESS 

SECOND SESSION 

JULY 18, 2018 

Serial No. 115–14 

( 

Printed for the use of the Committee on Agriculture 

agriculture.house.gov 

COMMITTEE ON AGRICULTURE 

K. MICHAEL CONAWAY, Texas, Chairman 

GLENN THOMPSON, Pennsylvania 

Vice Chairman 

BOB GOODLATTE, Virginia, 

FRANK D. LUCAS, Oklahoma 

STEVE KING, Iowa 

MIKE ROGERS, Alabama 

BOB GIBBS, Ohio 

AUSTIN SCOTT, Georgia 

ERIC A. ‘‘RICK’’ CRAWFORD, Arkansas 

SCOTT DESJARLAIS, Tennessee 

VICKY HARTZLER, Missouri 

JEFF DENHAM, California 

DOUG LAMALFA, California 

RODNEY DAVIS, Illinois 

TED S. YOHO, Florida 

RICK W. ALLEN, Georgia 

MIKE BOST, Illinois 

DAVID ROUZER, North Carolina 

RALPH LEE ABRAHAM, Louisiana 

TRENT KELLY, Mississippi 

JAMES COMER, Kentucky 

ROGER W. MARSHALL, Kansas 

DON BACON, Nebraska 

JOHN J. FASO, New York 

NEAL P. DUNN, Florida 

JODEY C. ARRINGTON, Texas 

COLLIN C. PETERSON, Minnesota, Ranking 

Minority Member 

DAVID SCOTT, Georgia 

JIM COSTA, California 

TIMOTHY J. WALZ, Minnesota 

MARCIA L. FUDGE, Ohio 

JAMES P. MCGOVERN, Massachusetts 

FILEMON VELA, Texas, Vice Ranking 

Minority Member 

MICHELLE LUJAN GRISHAM, New Mexico 

ANN M. KUSTER, New Hampshire 

RICHARD M. NOLAN, Minnesota 

CHERI BUSTOS, Illinois 

SEAN PATRICK MALONEY, New York 

STACEY E. PLASKETT, Virgin Islands 

ALMA S. ADAMS, North Carolina 

DWIGHT EVANS, Pennsylvania 

AL LAWSON, JR., Florida 

TOM O’HALLERAN, Arizona 

JIMMY PANETTA, California 

DARREN SOTO, Florida 

LISA BLUNT ROCHESTER, Delaware 

MATTHEW S. SCHERTZ, Staff Director 

ANNE SIMMONS, Minority Staff Director 

(II) 

(III) 

C O N T E N T S 

Page 

Conaway, Hon. K. Michael, a Representative in Congress from Texas, opening 

statement .............................................................................................................. 1 

Prepared statement .......................................................................................... 3 

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, opening statement ........................................................................................................ 4 

WITNESSES

Fairfield, J.D., Joshua A.T., William Donald Bain Family Professor of Law, 

Washington and Lee University School of Law, Staunton, VA ........................ 5 

Prepared statement .......................................................................................... 7 

Baldet, Amber, Co-Founder and Chief Executive Officer, Clovyr, New York, 

NY ......................................................................................................................... 11 

Prepared statement .......................................................................................... 13 

Submitted questions ......................................................................................... 97 

Kupor, J.D., Scott, Managing Partner, Andreessen Horowitz, Menlo Park, 

CA .......................................................................................................................... 15

Prepared statement .......................................................................................... 18 

Gorfine, J.D., Daniel, Director and Chief Innovation Officer, LabCFTC, Commodity Futures Trading Commission, Washington, D.C. ................................. 20 

Prepared statement .......................................................................................... 22 

Submitted questions ......................................................................................... 97 

Gensler, Hon. Gary, Senior Lecturer, Sloan School of Management, Massachusetts Institute of Technology; Senior Advisor to the Director, MIT Media 

Lab, Brooklandville, MD ...................................................................................... 27 

Prepared statement .......................................................................................... 30 

Ness, J.D., Lowell D., Managing Partner, Palo Alto Office, Perkins Coie 

LLP, Palo Alto, CA ............................................................................................... 47 

Prepared statement .......................................................................................... 48 

(1) 

CRYPTOCURRENCIES: OVERSIGHT OF NEW 

ASSETS IN THE DIGITAL AGE 

WEDNESDAY, JULY 18, 2018 

HOUSE OF REPRESENTATIVES, COMMITTEE ON AGRICULTURE, Washington, D.C. 

The Committee met, pursuant to call, at 10:01 a.m., in Room 

1300 of the Longworth House Office Building, Hon. K. Michael 

Conaway [Chairman of the Committee] presiding. 

Members present: Representatives Conaway, Thompson, Goodlatte, Lucas, King, Gibbs, Austin Scott of Georgia, Hartzler, 

LaMalfa, Davis, Yoho, Allen, Bost, Rouzer, Abraham, Kelly, Comer, 

Marshall, Bacon, Faso, Arrington, Peterson, David Scott of Georgia, 

Costa, McGovern, Vela, Lujan Grisham, Kuster, Nolan, Plaskett, 

Adams, Evans, Lawson, O’Halleran, Panetta, Soto, and Blunt Rochester. 

Staff present: Darryl Blakey, Mindi Brookhart, Paul Balzano, Rachel Millard, Matthew MacKenzie, Patrick Delaney, Troy Phillips, 

Nicole Scott, and Carly Reedholm. 

OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A 

REPRESENTATIVE IN CONGRESS FROM TEXAS 

The CHAIRMAN. Good morning, everyone. This hearing of the 

Committee on Agriculture entitled, Cryptocurrencies: Oversight of 

New Assets in the Digital Age, will come to order. Please join me 

in a quick prayer. 

Heavenly Father, we ask you, Lord, for blessings on this meeting 

this morning. We have some things to understand that are new 

and different, and we have great panelists to visit with us this 

morning. I also want to lift up Collin Peterson and his family during these times, bittersweet, and your thoughts and prayers with 

him as well. Help us to do your will and be the kind of people that 

will honor you. We ask these things in Jesus’ name. Amen. 

Just a quick word. Collin Peterson’s 981⁄2 year old father passed 

this week, and this is bittersweet. But he was telling me a wonderful story that his dad apparently had his faculties right up until 

the very end, which is pretty darn good. Our thoughts are with 

you, Collin. 

Mr. PETERSON. He was hanging in there. He could remember the 

crop prices from 1952. He knew everything. 

The CHAIRMAN. Yes, all right. 

Well good morning. We have a terrific panel this morning. I see 

a lot of new faces in the audience today. One of the big questions 

on a lot of folks’ mind is what is the Agriculture Committee doing 

2 

with cryptocurrency, and the distributive ledger technology, but we 

are here to find that out this morning. 

For those of you who have not joined us before, welcome. We are 

happy to have you as we discuss an emerging policy area that is 

of deep interest to our Members, to the emerging crypto-industry, 

and, we hope, to Americans of all stripes. 

Digital assets like Bitcoin and Ether, but also hundreds of other 

token-based projects that are being developed, represent a new way 

for people to interact and exchange in commerce with one another. 

While digital assets are often thought of as payment systems or digital gold, I believe the promise that token networks hold is more 

universal and more exciting, quite frankly, than that. 

For the first time, we have a tool that enables individuals to reliably exchange value in a digital realm without an intermediary. 

We can have assets that exist and can be created, exchanged, and 

consumed in digital form. The promise of being able to secure property rights in a digital space may fundamentally change how people interact with one another. This technology holds the potential 

to bring enormous benefits to each of us, if we are willing to give 

it the space to grow. 

Providing a strong, clear, legal and regulatory framework for digital assets is essential. To that end, there are several questions before us about how laws should govern the issuance, trade, and utilization of these digital assets. 

Perhaps no question has generated greater uncertainty than how 

to determine if a particular token is a security. What to do if a 

commonly traded asset is, in fact, deemed a security. We simply 

apply the securities laws. If it is not a security, there is a good 

chance it is a commodity, which would be subject to the requirements of the Commodity Exchange Act. 

The problem seems to be in making that determination. The 

Howey Test, which concerns the sale of orange groves and service 

contracts in the 1940s, is often presented as the standard test to 

determine if the securities laws govern a token, yet they have 

proved challenging to analyze under this test. 

A related question is whether or not current laws are appropriate 

for these new digital assets. If a token is determined to be a security or a commodity or something else, our regulatory regime need 

not be static. If it is necessary, Congress and regulators may want 

to consider developing a new framework that takes into account the 

diverse characteristics and unique economic relationships embedded in many of the types of digital assets that can be represented 

by tokens. 

Providing clear guidance to enable developers to determine the 

nature of their token and then suitable rules to enable them to develop their project, is essential to both protecting the public and 

promoting innovation. How we regulate these products and those 

who develop them won’t determine if they are developed or used, 

but it will determine where they are developed and used, and we 

want that innovation done in our country. 

As we consider changes to the laws or new regulations, the Committee on Agriculture will be a part of that conversation. Within 

the House, we have a vested interest in the definition of a security, 

because it directly impacts the definition of a commodity. 

3 

Similar to our work in agricultural commodities, as well as futures and swaps markets, the Committee has a strong interest in 

promoting safe, efficient and transparent markets for those who 

use these new token markets. Properly regulated markets promote 

innovation and foster economic growth, and I don’t believe that will 

be any different with respect to digital assets. Of course, proper 

regulation does not mean intrusive regulation. It means regulation 

appropriate to the nature of the activities and the participants, and 

in some cases, it might mean no regulation at all. 

Before I turn to our Ranking Member, I want to thank all of our 

witnesses for making the time to prepare and testify. We have an 

incredibly qualified panel to present all sides of a fascinating and 

complex set of issues. I am pleased to welcome each one of you here 

today for this conversation. 

[The prepared statement of Mr. Conaway follows:] 

PREPARED STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE IN

CONGRESS FROM TEXAS

Good morning. I see a lot of new faces today as we tackle a cutting-edge topic 

for the Committee: digital assets. 

For those of you who have not joined us before, welcome. We are happy to have 

you as we discuss an emerging policy area that is of deep interest to our Members, 

to the emerging cryptocurrency industry, and . . . we hope . . . to Americans of all 

stripes. 

Digital assets like Bitcoin and Ether, but also like hundreds of other token-based 

projects that are being developed, represent a new way for people to interact and 

engage in commerce with one another. While digital assets are often thought of as 

‘‘payment systems’’ or ‘‘digital gold’’ I believe the promise that token networks hold 

is more universal—and more exciting—than that. 

For the first time, we have a tool that enables individuals to reliably exchange 

value in the digital realm, without an intermediary. We can have assets that exist— 

and can be created, exchanged, and consumed—in digital form. The promise of being 

able to secure property rights in a digital space may fundamentally change how people interact with one another. This technology holds the potential to bring enormous 

benefits to each of us, if we are willing to give it the space to grow. 

Providing a strong, clear legal and regulatory framework for digital assets is essential. To that end, there are several questions before us about how laws should 

govern the issuance, trade, and utilization of digital assets. 

Perhaps no question has generated greater uncertainty than how to determine if 

a particular token is a security. We generally know what to do if a commonly traded 

asset is deemed a security—we apply the securities laws. And if it is not a security, 

there is a good chance it’s a commodity and subject to the requirements of the Commodity Exchange Act. 

The problem seems to be in making that determination. The Howey Test, which 

concerns the sale of orange groves and service contracts in the 1940s, is often presented as the standard test to determine if the securities laws govern a token, yet 

they have proved challenging to analyze under the test. 

A related question is whether or not the current laws are appropriate for these 

new digital assets. If a token is determined to be a security or a commodity or something else, our regulatory regime need not be static. If it’s necessary, Congress and 

regulators may want to consider developing a new framework that takes into account the diverse characteristics and unique economic relationships embedded in 

the many types of digital assets that can be represented by tokens. 

Providing clear guidance to enable developers to determine the nature of their 

token and then suitable rules to enable them to develop their project, is essential 

to both protecting the public and promoting innovation. How we regulate these 

products and those who develop them won’t determine if they are developed and 

used, but it will determine if they are developed and used in our country. 

As we consider changes to the law or new regulations, the Committee on Agriculture will be a part of the conversation. Within the House, we have a vested interest in the definition of a security, because it directly impacts the definition of a commodity. 

4 

Similar to our work in agricultural commodities, as well as futures and swaps 

markets, the Committee has a strong interest in promoting safe, efficient, and 

transparent markets for those who use these new token markets. Properly regulated 

markets promote innovation and foster economic growth, and I don’t believe that 

will be any different with digital assets. Of course, ‘‘proper regulation’’ does not 

mean ‘‘intrusive regulation.’’ It means, regulation appropriate to the nature of the 

activities and the participants, and in some cases, it might even mean no regulation 

at all. 

Before I turn to our Ranking Member, I want to thank all of our witnesses for 

making the time to prepare and testify. We have an incredibly qualified panel to 

present all sides of a fascinating and complex set of issues. I am pleased to welcome 

you all, and I look forward to our conversation today. 

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

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A 

REPRESENTATIVE IN CONGRESS FROM MINNESOTA 

Mr. PETERSON. Thank you, Mr. Chairman, and thanks to all of 

you for joining us here today. 

I am happy that we have a chance to review this new technology 

in our role to oversee the CFTC regulation of it, if appropriate. 

As a CPA and someone who spent a career helping folks run the 

numbers on their finances, I am still having a hard time getting 

my hands around this, and I have some real concerns. 

One aspect of cryptocurrency that we need to pay special attention to is its volatility. There are some of you that will tell us that 

the fluctuations in cryptocurrency are a good thing, and part of its 

appeal. But the increased speculation and the fact that regular investors stand to lose their shirts gives me a great deal of concern. 

As one study found, over 80 percent of the initial coin offerings 

are scams. While regular investors stand to lose, a very small 

amount stand to gain. For example, 97 percent of Bitcoin is held 

by just four percent of addresses. 

There are a lot of things here that don’t make much sense to me, 

and who knows? Maybe some type of this technology will come 

along and really make a difference after these starts and fits, but 

as it stands right now, I am skeptical. It is our job to be the adults 

in the room and to ensure that in these early days, there is enough 

oversight of this new frontier to ensure that it can grow responsibly. 

With that, I look forward to your testimony, and I yield back. 

The CHAIRMAN. Thank you, Mr. Peterson. 

The chair would request other Members submit their opening 

statements for the record so that our witnesses may begin their 

testimony, and to ensure there is ample time for questions. 

I now would like to welcome our witnesses to our table. First off 

we have Mr. Joshua Fairfield, the William Donald Bain Family 

Professor of Law, Washington and Lee University School of Law in 

Staunton, Virginia. 

We have Ms. Amber Baldet, Co-Founder and CEO of Clovyr in 

New York, New York. 

We have Scott Kupor, Managing Partner of Andreessen Horowitz, Menlo Park, California. 

We have Mr. Daniel Gorfine, Director, LabCFTC and Chief Innovation Officer at the CFTC here in Washington, D.C. 

5 

We are welcoming back for another round of conversations the 

Honorable Gary Gensler, who currently is a Senior Lecturer, MIT 

Sloan School of Management, and then we have Mr. Lowell Ness, 

Managing Partner, Perkins Coie, Palo Alto, California. 

We have a terrific panel, and with that, we will go to Mr. Fairfield. 

Everybody will have 5 minutes to pitch your wares, and we also 

have your full statements for the record. 

So with that, Mr. Fairfield, you are recognized. 

STATEMENT OF JOSHUA A.T. FAIRFIELD, J.D., WILLIAM 

DONALD BAIN FAMILY PROFESSOR OF LAW, WASHINGTON 

AND LEE UNIVERSITY SCHOOL OF LAW, STAUNTON, VA 

Mr. FAIRFIELD. Thank you, Chairman Conaway, Ranking Member Peterson, and Members of the Committee for the opportunity 

to address you today. 

My remarks are going to try to set some context, and they are 

organized around two questions. We have heard a lot about securities and commodities, but how are people actually using 

cryptocurrency tokens? And given that, how should regulators proceed? 

On the first question, blockchain, which is the technology underlying the current rash of cryptocurrency and tokens, is a new decentralized database technology. Many communities have formed 

just to see what the technology can do, and they are trying different experiments. The potential value in these experiments is 

considerable. Collaborative communities of artists, new forms of 

corporations, fast and low cost check settlement, digitization of securities, open and low cost electronic mortgage and secured transactions filing systems, secure international remittances, voting systems, and many more are possible applications of the technology. 

My testimony today will focus on potential for blockchain technology to expand personal property rights online. This is my primary area of research, and my conclusions are—and I will continue 

them below—that first, citizens need and want an expansion of personal property rights online. The cryptocurrency tokens are helping 

them do that by solving important problems in building markets 

for digital property and that we need to be cautious when regulating overlapping spaces and use cases, such as systems in which 

most people hold a token to use it or consume it, and that few hold 

it to speculate on the price. 

On the second question, how do we go about conducting oversight? Common sense construction of how groups are using the 

technology, a so-called duck test, will help regulators begin to sort 

out whether and where to engage. Rough agency consensus can 

handle these conflicts, and hearings such as this one are critically 

important for regulators to start working out the overlaps because 

many, many more applications of this technology are coming. 

In the body of my remarks, I would like to discuss how this technology represents a badly needed expansion for personal property 

rights online. We should really care about good property rules for 

intangible electronic digital assets. Good property rules preserve 

citizen independence. Property institutions build individual wealth 

and social welfare by reducing transaction costs, and property perVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00009 Fmt 6633 Sfmt 6601 P:\DOCS\115-14\30893.TXT BRIAN
6 

mits us to express ourselves by changing and arranging our environment to reflect what we want. Here you might think of your 

own home or your wedding ring, for example. 

But personal property rights like this have had serious trouble 

coming online. We just don’t own that much personal property online. Consider that people used to have record collections. Now they 

have a subscription to Spotify. People used to have bookshelves. 

Now they have Kindle accounts. This is because early in the history of the Internet, intellectual property holders were worried 

about illegal copying. It took several decades to develop a technology, blockchain, the database technology underneath 

cryptocurrency tokens, that can be traded, held, bought, and sold 

but not duplicated. So far until now, property institutions haven’t 

really gotten the benefit of Internet technologies because it is too 

costly to record all the transactions. We can’t have a database of 

ownership for every Barbie doll in the entire country, right? It is 

too costly. However, token systems can and will reshape all of 

these ways of owning if they push price points low enough the way 

the Internet did for basic Internet communications. 

In sum, blockchain technology is not just used as a security. It 

is not just used as a commodity. It is used as a way to unstick personal property law for all of us online. But it is only going to do 

it if we let it. 

What is the path to successful oversight? Responsible regulation 

has to rest on a frank and common sense determination of how 

people are using this technology. Working out the jurisdictional 

questions is going to be time consuming, but it is not particularly 

harder than for network communications technology. Generally we 

have just had to hand these things out and figure it out. 

Tokens do present some challenge. Specifically, they may be used 

in different ways by different members of a community. They may 

be used at different times in different ways, but most importantly, 

the nature of the use by a community can shift. A community can 

be trying to do something entirely legitimate and have speculators 

come in and begin to disrupt the purpose of the original community. 

The current hot characterization debate is whether token sales 

ought to be deemed regulable under the Howey test. I believe instead the Howey test represents the outer bound of where we 

should look. We should look inside that outer bound to figure out 

what the beneficial and damaging uses of the technology are. If a 

community is using cryptocurrency tokens like securities, then they 

should be regulated as securities. But if they are not, they 

shouldn’t, and that is the most important addition. 

In conclusion, blockchain technology has enabled new communities and new business forms. It has also provided the technological basis for a badly needed expansion of personal property 

rights online, and for purposes of regulatory jurisdiction, a rough 

common sense sorting into buckets will do more good in the near 

term than precise definitions of what a cryptocurrency token is. 

That is a lost cause. A cryptocurrency token wears as many hats 

as humans give it. It is an entry in a database. It is a technological 

entry and nothing more. 

7 

In the current characterization debate, what this means is that 

a token should be deemed a security when it operates like a security, a commodity when it operates like a commodity, a currency 

when it operates as a currency, and as a simple property interest 

when it operates as a simple property interest. 

Thank you so much. 

[The prepared statement of Mr. Fairfield follows:] 

PREPARED STATEMENT OF JOSHUA A.T. FAIRFIELD, J.D., WILLIAM DONALD BAIN

FAMILY PROFESSOR OF LAW, WASHINGTON AND LEE UNIVERSITY SCHOOL OF LAW, STAUNTON, VA 

Mr. Chairman Conaway, Ranking Member Peterson, and Members of the Committee. Thank you for the opportunity to address you today. 

Introduction 

My remarks are organized around two questions: 

How are people actually using this new technology? And: How should a regulator 

best proceed in light of how the technology is being used? I will briefly summarize 

my conclusions before returning to the body of my testimony. 

First, blockchain, the technology underlying the current rash of cryptocurrencies, 

is a relatively new database technology that permits communities to self-organize 

and build trustworthy decentralized databases. Many communities have formed just 

to see what the technology can do, and are attempting different experiments, often 

with each offering its own ‘‘coin.’’ (To be sure, scam artists have also flocked to the 

development scene.) The potential value in these experiments is considerable: collaborative communities of artists, new corporate forms, distributed autonomous organizations, fast and low-cost check settlement, digitization of securities, open and 

low-cost electronic mortgage and secured transactions systems, secure international 

remittances, voting systems, and many more are possible applications of the technology. 

The Committee will hear about a range of these applications today. The specific 

area in which I would like to focus is the potential for blockchain technology to act 

as a catalyst for expansion of online and electronic personal property rights. This 

is my primary area of research. My conclusions, as below, are that citizens need and 

want an expansion of personal property rights online; that cryptocurrencies and 

cryptocurrency tokens can help solve important problems in building markets for 

digital property; and that caution may be advisable when regulating overlapping 

spaces and use cases, such as systems in which most people hold an asset to consume it, and a few hold it to speculate on the price. 

On to the second question, how to best proceed? Agencies have already for several 

years found themselves faced with the potential for overlapping jurisdiction over 

blockchain-based businesses, products, and services, precisely because the technology can support so many different uses. Because blockchains are just databases, 

their use must determine the oversight response. 

Uses of cryptocurrency tokens can be complex. Not all people who hold a 

cryptocurrency token do so for the same reasons. Some people hold cryptocurrency 

tokens to consume, some simply to possess, some to speculate, some to trade, and 

some change their minds from time to time. Thus, tokens have a fundamentally 

multi-use nature. There is also a time component. Until the owner takes action (consume or trade), the owner’s reason for holding the token may not be knowable. The 

use and holding of the token as personal property should be generally 

unproblematic, at least by default. Only the trade and speculation components 

should trigger regulatory concern, and even then, only if the structure of the transaction looks like an attempt to circumvent some established regulatory mandate. 

There are solid paths forward that can protect investors from fraud and permit 

entrepreneurs and communities to develop new business models. Common sense 

construction of how groups are using the technology—a ‘‘duck test’’—will help begin 

to sort out whether a regulatory structure is needed at all, and if so, which law governs. Rough agency consensus and even active and agile cooperation between regulators can handle these conflicts, and are good for regulators to start working out: 

more applications of this technology are coming. There is indeed every reason to believe this is how regulation in this space will actually evolve. More concerning is 

the risk of chilling innovation through incautious overlapping or conflicting regulation. Carefully overlapping jurisdictional claims need not cause contradiction, but it 

may take time until the contours of how people use the technology become clear. 

8 

* Editor’s note: the testimony is published as submitted, there was no section labeled A. 1See Jedediah Purdy, The Meaning of Property: Freedom, Community, and the Legal Imagination 19 (Yale University Press 2010). 2 Joshua A.T. Fairfield, Owned: Property, Privacy, and the New Digital Serfdom 18 (Cambridge University Press 2017) (‘‘His first stream is ‘libertarianism,’ or negative liberty: the idea 

that property means a kind of liberty from government interference.’’) (citing Jedediah Purdy, 

supra, at 19). 3 Id. (‘‘His second stream is efficiency, or what he calls ‘welfarism’: property is an institution 

that helps to ensure the free flow of goods for minimum transaction costs, such that it allows 

people to get what they want at the lowest price.’’) (citing Jedediah Purdy, supra, at 20). 4 Id. (‘‘Purdy identifies a stream of human personhood, or identity. The identity view of property requires that we have some stability in our environment so that we can build a home, a 

family, an identity. Property allows us to surround ourselves with reminders of who we are or 

wish to be.’’) (citing Jedediah Purdy, supra, at 20); see also Margaret Jane Radin, Property 

and Personhood, 34 STAN. L. REV. 957, 957 (1982) (‘‘The premise underlying the personhood perspective is that to achieve proper self-development—to be a person—an individual needs some 

control over resources in the external environment. The necessary assurances of control take the 

form of property rights.’’). 5See Aaron Perzanowski & Jason Schultz, The End of Ownership: Personal Property in the 

Digital Economy (MIT Press 2016). 6 Joshua A.T. Fairfield, BitProperty, 88 S. CAL. L. REV. 805, 841 (2015). 7 Carol M. Rose, The Several Futures of Property: Of Cyberspace and Folk Tales, Emission 

Trades and Ecosystems, 83 MINN. L. REV. 133 (1998). 

And when those contours do become clear, good rules can draw workably clean lines 

between shifting uses of a product or service within a community that weaves across 

a legal boundary. 

B. Cryptocurrencies and the Future of Property * 

In the body of my remarks I would like to discuss how this technology represents 

a badly needed expansion of personal property rights online. We should care about 

good property rules for electronic assets. Good property rules contribute to human 

thriving, or as Nobel Laureate Amartya Sen expressed it, good property rules expand the range of human capabilities. Property matters because it lets people do 

things. Thus, good property rules are those that expand what people can do. There 

are three primary ways good property institutions positively impact society.1 First, 

good property rules can preserve citizen independence. Property draws an important 

line between private and state power.2 Second, property institutions build individual 

and social welfare by reducing transaction costs, permitting resources to flow to 

higher-valuing users.3 And third, property permits humans to express themselves 

by changing and arranging their environment to reflect themselves.4 Here, examples 

might be the property interest in a home, wedding band, detailed automobile, and 

so on. Despite these advantages, personal property rights have had serious trouble 

transitioning from offline to the online environment. We don’t own much personal 

property online. Instead, we license everything.5 If you question whether this is 

true, consider that people used to own record collections; now they license iTunes, 

or simply have a subscription to Spotify. People used to have bookshelves; now they 

have Kindle collections. This modern license framework is in place because, early 

in the history of the Internet, intellectual property holders were worried about illegal copying. It took several decades to develop a technology, blockchain, which operated like a digital object. Slots in a blockchain—cryptographic tokens—can be traded, held, bought, and sold, but not duplicated. Cryptocurrency tokens cannot be double-spent, because they would be rejected by both the protocol and the other ‘‘players.’’ 6

As a result, cryptocurrency tokens let us own an intangible electronic asset just 

like we own a hat. Blockchain technology appears poised to un-stick personal property law online by strongly reducing transaction costs for tracking transactions in 

digital property rights, and by creating rivalrous (that is, non-copyable) digital assets. Already, cryptocurrency tokens are appearing in court decisions on inheritance, 

wills and trusts, and other routine treatment of personal property under the common law. It may soon become as routine to own digital tokens as it is to own dollars 

in a bank account. 

Property institutions will deeply benefit from this technology-driven drop in transaction costs. Carol Rose notes: ‘‘It costs something to define rights, to monitor trespasses, and to expel intruders.’’ 7 As property rights become more complex and harder to define, property systems cost even more. The difference in expense is why we 

currently have title registries for big items like houses, cars, boats, and airplanes, 

but not for smaller pieces of personal property. Cryptocurrency tokens can keep 

track of minute changes in ownership of property interests at strongly reduced 

costs. Rose predicted that ‘‘when there are changes in the technological or adminisVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00012 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
9 

8 Id. at 139. 9See Joshua A.T. Fairfield, BitProperty, supra, at 815. 10See Kevin Werbach, The Centripetal Network: How the Internet Holds Itself together, and 

the Forces Tearing It Apart, 42 U.C. DAVIS L. REV. 343, 347–48 (2008) (‘‘The Internet fosters 

innovation by eliminating transaction costs, enabling new services to emerge.’’). 11See Joshua A.T. Fairfield, BitProperty, supra, at 813. 12See generally SEC, 81207, Report of Investigation Pursuant to Section 21(a) of the Securities 

Exchange Act of 1934: The DAO (2017). 13See Trevor M. Dodge, SEC Director William Hinman: ‘‘Current offers and sales of Ether are 

not securities transactions,’’ The National Law Review, June 18, 2018, at 1. 14SEC v. Howey Co., 328 U.S. 293 (1946). 

trative costs of establishing, monitoring and trading property, there may well be 

changes in property regimes as well.’’ 8 Her advice: look for drops in those costs. 

There we will find the future of property. And this is precisely what cryptocurrency 

tokens represent. 

These cost drops can fuel further innovation. Just as communications technologies 

proliferated when the cost of communication went nearly to zero, so a range of property interests will flourish when the costs of transfer go nearly to zero. This is, after 

all, the model of the broader Internet, which, for all of its ‘‘free’’ price points, is extraordinarily expensive to maintain.9 Internet technologies scale most disruptively 

at near-zero transaction costs.10 For each drop in transaction costs, a new range of 

widely scaled and potentially disruptive uses becomes possible. 

So far, property institutions have not yet fully realized the benefits of the last 3 

decades’ advances in information technology because of the cost needed to record 

transactions and vet trusted intermediaries to maintain and protect records.11

Token systems can and will reshape property law if they push price points low 

enough to unleash disruptive and scalable applications. 

C. A Path to Successful Oversight 

In this section, I turn to the second question, and discuss features of a successful 

oversight strategy. I derive these principles from experience with several prior analogous regulatory moments: the IRS determination as to when to tax financial gains 

on virtual objects; the IRS determination as to whether cryptocurrency ought to be 

taxed as currency or commodity; and the deliberations by FinCEN, CSBC, and other 

stakeholders in the state and Federal banking systems over whether cryptocurrency 

exchanges ought to be deemed money transmitters under the Bank Secrecy Act. 

Responsible regulation must rest on a frank and common-sense determination of 

how people are using the technology. A primary benefit of close attention to how 

the technology is actually being used will be to reduce the number of overlapping 

oversight claims. Almost every regulator will soon be able to claim jurisdiction over 

some application of blockchain technology, but of course they will not have jurisdiction over all uses. 

Working out jurisdiction over actions or business models that cross several different regulatory boundaries will be time-consuming, but no harder for blockchains 

than they were for network communications technology generally. SEC, CFTC, 

FinCEN, IRS, and state banking regulators have spent several years sorting out 

their various roles in regulating the various uses of cryptocurrency, and there has 

been measurable progress in determining which regimes and what terms govern. 

Tokens do present some interesting problems. First, tokens may be used in different ways by different members of a community. Second, even a single owner may 

buy, hold, consume, sell, trade, or destroy tokens for different reasons at different 

times. A community may shift to use products or services in illicit ways that the 

product creator or service provider did not predict. Illicit uses may make use of a 

licit support layer. This is precisely what happened when the SEC warned in July 

of 2017 that The DAO, an Ethereum-based investment and governance platform had 

likely violated securities regulations.12 Contrast this with SEC Division of Corporation Finance Director William Hinman’s recent announcement that transactions in 

Ether are unlikely to be deemed securities transactions.13 Agencies are already beginning to sketch out the important distinctions that will help preserve beneficial 

applications of the technology (investors in Ether were justifiably relieved by the announcement) while permitting oversight of bad practices at the application layer 

(such as another DAO). 

The currently hot characterization debate is whether token sales ought to be 

deemed regulable under the Howey test.14 I find that discussion unhelpful. Howey 

marks in a sense one of the deepest reaches of the SEC into regular ownership behavior. The case is a placeholder, there to preserve SEC’s right to make further and 

more in-depth determinations. As such, it is not a particularly good guide to how 

things should end up. Instead of the rule of Howey, a better approach is to look at 

10 

15See, e.g., Nathaniel Popper, In the World of Cryptocurrency, Even Good Projects Can Go 

Bad, NEW YORK TIMES (May 30, 2018), available at https://www.nytimes.com/2018/05/31/ 

technology/envion-initial-coin-offering.html (last visited on July 13, 2018). 

how the technology is actually being used. If a community uses cryptocurrency tokens functionally like securities, then they ought to be regulated as such. But if not, 

they shouldn’t. There should be a well-regulated market for blockchain-traded securities. Companies are working now to legally list and trade securities through 

blockchain databases, and Delaware has been working to make that possible. There 

is a legal path for companies wishing to list and trade securities on a blockchain, 

and some companies are moving to do so. This is the duck test as applied to securities: ‘‘if it quacks like a security,’’ and everyone knows the rest. 

The harder question is how to characterize token sales when the issuer and majority of purchasers can credibly show that their purpose in buying, holding, selling, 

and consuming cryptocurrency tokens is not to profit from the efforts of others, but 

in fact to order rights and relationships in some new way. For example, most community members might use a given token system for clearly non-securities related 

purposes, but some tokens may be bought, held, and traded by speculators. Further, 

different actors within the community may take on different positions at different 

times, and the community as a whole may shift its use of the token. In these cases, 

the trick is to catch the fraudulent ducks without killing a goose who may lay the 

golden egg—new and powerful communities and business models. Only a deeper 

dive into how the asset is promoted, used, and traded can begin to provide an answer. Entities charged with oversight should be cautious not to squash new arrangements of rights merely because there is an arguable conceptual overlap with the 

broad language of cases such as Howey. However, they must not fail to recognize 

systems that walk, quack, and waddle like ducks merely because of some shiny new 

cryptocurrency feathers. Many token sales transparently attempt to bilk the public 

by selling and supporting junk tokens.15 Some token sales are a transparent attempt to raise money for business ventures that wish to circumvent securities regulation. But just as clearly, many companies and communities are building communities that have nothing to do with securities, although some users may speculate 

with the tokens. Part of this is unavoidable. Entities tasked with oversight are reasonably reluctant to overcommit to the legality of some cryptocurrency business 

models, because they are concerned with lending a false sense of credibility to business practices that may turn out in the end to be fraud. But reasonable commonsense guidance is necessary so that innovators can move plans for businesses from 

the kitchen table to the garage. 

During this shakedown period in token technology, regulators will best be able to 

decide jurisdictional questions, and citizens will best be able to predict how the law 

will respond to their attempt to create new business models and new communities, 

by reasoning from past business practices. This new technology permits us to do 

new things technologically, not legally. This is not a permanent state of affairs, however. The demand for cryptocurrency tokens also demonstrates that there is serious 

untapped demand for new and cheaper ways to manage and trade certain kinds of 

rights, and that people want to be able to directly invest by making cryptocurrency 

purchase decisions—whether this is wise or not. In the end, regulators may determine that certain kinds of transactions simply cost us all too much in terms of defrauded investors, broken promises, emptied bank accounts, and subsequent claims 

that regulators should have better insulated consumers from harm. But they should 

not do so lightly, and should take every precaution to avoid stepping on legitimate 

novel forms of organizing human productivity while they make a determination of 

how people are using this technology, and what to do about it. 

Conclusion 

Blockchain technology has enabled new communities and new business forms. It 

has also provided the technological basis for a badly needed expansion of personal 

property rights online. An agency exercising oversight must therefore be sure that 

the use it observes fits in its regulatory wheelhouse—many new uses will not. In 

determining what law applies to blockchain technology, the legal regulatory regime 

must rest on an informed and common-sense determination of how the technology 

is being used. That simple test has some advanced wrinkles, because cryptocurrency 

tokens are built for overlapping, shifting, and multiple uses. As a result, regulatory 

agencies have done best with cryptocurrency technologies when they use a commonsense functional analysis, followed by engagement with the industry or community. 

In considering regulatory jurisdiction, common-sense sorting into rough buckets 

will do more good in the near term, as applications begin to come online, and reguVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00014 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
11 

lators see which applications are likely to impact society the most. In the current 

characterization debate, a token should be deemed a security when it operates like 

a security, a commodity when it operates as a commodity, a currency when it operates as a currency, and a simple property interest when it operates as a simple 

property interest. 

The CHAIRMAN. Thank you, Mr. Fairfield. 

Ms. Baldet, 5 minutes. 

STATEMENT OF AMBER BALDET, CO-FOUNDER AND CHIEF 

EXECUTIVE OFFICER, CLOVYR, NEW YORK, NY 

Ms. BALDET. Chairman Conaway, Ranking Member Peterson, 

and Members of the Committee, thank you for the opportunity to 

be here this morning. I am Amber Baldet, Co-Founder and CEO of 

Clovyr, a company building tools that make it easier to build decentralized applications on top of both publicly accessible 

blockchain networks, and access-controlled distributed ledgers. 

Previously, I led the blockchain program at JPMorgan, though I 

would like to note that my comments today do not represent my 

former employer. I also currently sit on the Board of the Zcash 

Foundation, a nonprofit organization seeking to advance the state 

of the art for privacy technology as applied to Internet infrastructure and privacy preserving cryptocurrencies. 

These are a variety of disparate hats, all of which lead me to the 

same message. My commentary today concerns the importance of 

a cautious and thoughtful regulatory approach to innovative technologies, even—and especially—those that might disrupt business 

as usual or add to the complexity of regulating the Internet, as 

both critical infrastructure and a shared public good. 

We must determine how to balance the enormous potential value 

of this technology with the need for consumer protections and national security, and how to achieve this while respecting human 

and constitutionally protected rights. 

So far, money seems to be the killer app for blockchain. Much as 

the early Internet’s killer app, e-mail, continues to be a cornerstone 

for how we communicate online, peer-to-peer payments will likely 

grow into and persist as a ubiquitous part of our personal and professional daily lives. In fact, the ability to spend, trade, rent, or license other sorts of unique digital bearer assets could be applicable 

to many things we own, mortgages, securities, collectibles, intellectual property rights, personal data, et cetera. 

Imagining this mature, interconnected global ecosystem of such 

markets feels like standing in the 1990s and imagining Netflix 

streaming on your phone; and yet, my concern is not the speed 

with which we reach that end stage, it is the choices that we make 

along the way, which stand to be as hotly contested and impactful 

as net neutrality, the DMCA, FOSTA/SESTA, or the on again, off 

again discussion of state-mandated weak cryptography continues to 

be. 

While we struggle to overlay existing regulatory frameworks onto 

new technology that is useful precisely for its fluidity, other areas 

of the world are embracing that ambiguity and learning by doing. 

In Afghanistan, for example, Code to Inspire helps train young 

women for technical careers and pays them in Bitcoin, which they 

can use in local shops as well as global marketplaces. In a place 

where women’s banking and even physical agency is limited, finanVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00015 Fmt 6633 Sfmt 6601 P:\DOCS\115-14\30893.TXT BRIAN
12 

cial autonomy and digital inclusion is a powerful force for equality 

and democracy. 

In some African countries and places with less legacy financial 

infrastructure, companies are using crypto-assets to enable farmers 

to properly track and register their commodities, and increase their 

bargaining power in downstream market pricing. Not only can end 

consumers tip their farmer in support of fair and sustainable working conditions, but every other factory or wholesale retailer along 

the way can make more informed decisions about the providence of 

inputs to their products. 

In the United States, Square, whose business strategy is already 

based on disrupting traditional payments processors, has added the 

ability to buy, sell, and transfer Bitcoin into its mobile app, and 

there are many products targeting cryptocurrency investors and 

early adopters. 

There are also several more experimental projects that are interesting. For example, using economic incentives to battle fake news, 

cryptocurrency micropayments as an alternative business model to 

data-hungry online advertising, and fluid marketplaces for unused 

disk space on your home computer as a disruptive force to centralized Cloud storage. These projects, all launched as initial coin offerings, ICOs, either on a new single purpose blockchain network or 

as a token on top of an existing network, like Ethereum, are often 

compared to the Internet startup boom of the 1990s. 

The ability to ‘‘code oneself out of business’’ is a novel property 

of these decentralized blockchain applications, but most experiments today invoke a variety of human-controlled workflow checkpoints and escape hatches to allow intervention if necessary. 

Along with understanding who controls access to the network 

and who can modify the rules of the system, identifying who controls these escape hatches might be helpful in sorting tokens into 

various asset classes once a sensible taxonomy has been established. 

As a counterpoint, blockchain is not the answer to every problem. 

For example, I recommend extreme caution with exploration of 

blockchain-based e-voting. Ensuring one person one vote while 

keeping ballot selections private is an incredibly complex computer 

science and human coordination problem that we are not ready to 

tackle yet. Internationally, it is no surprise that some of the central 

banks most aggressively investigating cryptocurrency as an alternative or enhancement to their existing currencies are in Venezuela, Russia, and China. 

Going forward, as there is inevitably more discussion of the potential for a digital dollar, I encourage strongly encrypted, privacypreserving design choices coupled with opt-in selective disclosure, 

as opposed to options like mandatory cryptographic back doors or 

golden keys, which could make the U.S. financial system a very attractive target for nation-state sponsored cyberattacks and hackers. 

As that conversation matures, we must clarify how FinCEN, 

OFAC, and other relevant rules can be applied, modified, or interpreted to balance many competing interests. 

In conclusion, even—and hopefully if—this Committee’s guidance 

is simply a strong commitment to non-interventionism, safe harbors for innovators, and work towards resolution of the patchwork 

13 

fabric of state laws, the time it takes to come to such a commitment may have the unfortunate effect of eroding America’s early 

mover advantage in technical innovation and entrepreneurism. 

Thank you. 

[The prepared statement of Ms. Baldet follows:] 

PREPARED STATEMENT OF AMBER BALDET, CO-FOUNDER AND CHIEF EXECUTIVE

OFFICER, CLOVYR, NEW YORK, NY 

Chairman Conaway, Ranking Member Peterson, and Members of the Committee, 

thank you for the opportunity to be here this morning. I’m Amber Baldet, co-founder 

and CEO of Clovyr, a company building tools that make it easier to build decentralized applications on top of both publicly accessible blockchain networks and accesscontrolled distributed ledgers. 

From 2015 to April of this year, I led the blockchain program for JPMorgan’s Corporate & Investment Bank, though I’d like to note that my comments today do not 

represent my former employer. I also currently sit on the Board of the Zcash Foundation, a nonprofit organization seeking to advance the state of the art for privacy 

technology as applied to Internet infrastructure and privacy-preserving 

cryptocurrencies. 

Technical tooling, corporate and financial industry transformation, digital privacy 

and public cryptocurrency advocacy: these various hats might sound incongruous, 

but I see them as interconnected pieces of a larger puzzle. The puzzle we are trying 

to solve is the design for the next-generation fabric of both macro and micro-economies. 

E-mail allows you to send a digital version of a birthday card to a grandchild instantly. Cryptocurrency like Bitcoin gives you the ability to put the digital equivalent of $10 inside that card. No need to attach a code for a gift card redeemable 

at a single retailer or buy a clunky prepaid cash card from a credit card company. 

Whereas you might attach the same family photo to three different birthday cards, 

you can’t send the same $10 more than once. The revolutionary proposition of 

cryptocurrency—or more broadly, crypto-assets—is the ability to send something you 

own across the Internet and then irrefutably not have it anymore, without relying 

on a third party to intermediate or otherwise witness the event. So far, money 

seems to be the killer app for blockchain, but you can imagine that the ability to 

spend, trade, rent, or license unique digital bearer assets could be applicable to 

many things we own: mortgages, securities, collectibles, intellectual property rights, 

unused disk space on your home computer, personal data, etc. 

Imagining a mature, interconnected global ecosystem of such markets feels like 

standing in the 90s, looking at a pre-World Wide Web electronic bulletin board system and trying to imagine Netflix streaming on your phone. The prospect seems so 

fanciful as to be impossible, but here we are. And yet, my concern is not getting 

to that end state, it’s the choices that we make along the way. As evidenced by the 

debate around, and impact of, legislation like the DMCA (Digital Millennium Copyright Act), Net Neutrality, FOSTA/SESTA (Fight Online Sex Trafficking Act/Stop 

Enabling Sex Traffickers Act), or sporadic discussion of state-mandated weak cryptography since the 1990s (e.g., Compliance with Court Orders Act of 2016), the government greatly impacts how we are all able to use Internet and communications 

utilities which are inexorably woven into the vast majority of Americans’ daily lives. 

The peer-to-peer protocols which underpin crypto-asset networks are not much 

different than those that underpin the Internet; they are just rules for how to route 

bits and bytes. They do not care about the legality or morality of what crosses the 

wire and can be used in service of business as usual, political action, commission 

of crimes, facilitating human rights, or sharing funny photos of cats. 

Everything old is new again, and we are at the precipice of the same choices for 

crypto-asset networks as for the Internet. The difference, of course, is that we did 

not previously need to decide if every email was possibly a security with taxable 

profit and loss. The discussion today concerns the financial classification of the assets that cross the wires, which is important, but cannot be completely decoupled 

from the treatment of the Internet any more than litigation about a car crash can 

be divorced from observations about the condition of the road, timing of traffic 

lights, speed limit signage, and driver compliance with traffic laws. 

It’s not just about our banking sector, not just corporate supply chains, not just 

consumer payment rails, but how all these things might be connected both here and 

abroad to reduce friction and open new possibilities for economic growth. It is recognition that we are building next-generation systemically important infrastructure 

14 

for the American economy. It’s also about learning how to balance the enormous potential business value of this technology with the need for consumer protections and 

national security, and how to achieve this while respecting human and Constitutionally-protected rights. 

There are many stakeholders in this emerging universe who sometimes have fundamentally divergent philosophies. Yet, they are in near unanimous agreement that 

when it comes to cryptographically unique digital bearer assets, the genie is out of 

the bottle. As science fiction author William Gibson said, ‘‘The future is already 

here, it’s just not very evenly distributed.’’ While we struggle to overlay existing regulatory frameworks onto new technology that is useful precisely for its fluidity— 

sometimes it may act like a medium of exchange, sometimes a store of value, a commodity, a security, etc.—while we wrestle with that flexibility, other areas of the 

world are embracing the ambiguity and learning by doing. 

In Afghanistan, for example, Code to Inspire helps train young women for technical careers and pays them in Bitcoin, which they can use in local shops as well 

as global marketplaces. In a place where women’s banking and even physical agency 

is limited, financial autonomy and digital inclusion is a powerful force for equality 

and Democracy. 

Another example is that in places with less legacy financial infrastructure, companies are using crypto-assets to enable farmers to properly track and register their 

commodities, enhance supply chain transparency and increase their bargaining 

power in downstream commodities market pricing. Not only can end consumers ‘‘tip 

their farmer’’ in support of fair and sustainable working conditions, but every other 

factory or wholesale retailer along the way can make more informed decisions about 

the provenance of inputs to their products. 

The sticking point in such registries might be the perfection of these crypto-assets, 

in that while we can represent a real-world good on a blockchain, processing of 

claims in the case of a default requires enforcement practices external to the network. Relatedly, while tokenized physical assets have been proposed as a response 

to government corruption (for example, forced re-allocation of land rights during a 

change in leadership), credible threat or use of physical violence still holds more 

sway over allocation of resources than any ledger ever will. Ironically, then, these 

sorts of token registries might work best in places that want to leapfrog a generation of banking technology, but already have well-functioning rule of law. 

In the United States, several more experimental projects are also interesting, 

whether it’s using economic incentives to battle fake news, cryptocurrency micropayments as an alternative business model to data-hungry online advertising, or fluid 

marketplaces for unused disk space on home computers as a disruptive force to centralized cloud storage. These projects, all launched as initial coin offerings (ICOs) 

either on a new single-purpose blockchain network or as a token on top of an existing network like Ethereum, are often compared to the Internet startup boom of the 

1990s. Because these are ‘‘blockchain native’’ assets rather than tokenized representations of real-world assets, it may be possible to more closely approximate today’s 

dispute resolution frameworks entirely as programmatic rules within ‘‘smart contracts,’’ but only if explicitly coded to do so, and only assuming there are no bugs 

in the code which cause unintended and possibly irreversible outcomes. 

The ability to ‘‘code oneself out of business’’ is a novel property of decentralized 

blockchains, but most experiments today invoke a variety of human-controlled 

workflow checkpoints or escape hatches to allow intervention if necessary. Along 

with understanding who controls access to the network and who can modify the 

rules of the system, identifying these escape hatches and who controls them might 

be helpful in sorting tokens into various asset classes once a sensible taxonomy has 

been established. 

Of the myriad applications currently under development, it’s hard to tell what’s 

going to take off and what will be most transformative. Nonetheless, the sheer number of people globally working on these projects make it likely that it’s only a matter 

of time until they are no longer considered experimental. The question is how long 

it will take for distributed ledgers of various incarnations to be considered a legal 

system of record in enough places that interacting with them is the norm rather 

than a novelty. Clarity around legal and regulatory treatment in various jurisdictions is, perhaps, the most important factor in the speed of that evolution. 

As a counterpoint, and to temper what might sound like unbridled enthusiasm, 

I recommend extreme caution on engaging with blockchain based e-voting for realworld ballot measures. Ensuring one-person-one-vote while keeping ballot selections 

private, is both a non-trivial computer science and human coordination problem 

we’re not ready to tackle yet. It is one thing to experiment with making decisions 

about a blockchain network’s governance processes using the network itself, it is 

quite another to talk about electronic voting processes for something like U.S. elecVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00018 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
15 

tions, where even traditional electronic voting machines are continually demonstrated to be vulnerable to being hacked. 

But when it comes to more promising near-term use cases, the oft-referenced regulatory position of Do No Harm is a helpful signal but is perhaps not strong enough. 

Recently, new entrants Coinbase and Gemini launched cryptocurrency custody solutions for retail and institutional investors, and this week Coinbase made further 

strides in SEC approval to list on its exchange tokens which are considered securities. As more traditional assets become tokenized, they may be able to challenge incumbents not because the incumbents are too outdated to understand the technology or unable to develop new products and services quickly enough, but because 

they are held back from competing due to regulatory uncertainty. 

Similarly, as the Federal Reserve and commercial banks take a wait-and-see approach to exploring tokenized representations of the U.S. Dollar, we risk missing the 

larger picture of what a next-generation Internet of Value means for geopolitics and 

the future of nation-state economic competition and power projection. It’s no surprise that some of the central banks most aggressively investigating cryptocurrency 

as an alternative or enhancement to their existing currencies are in Venezuela, Russia, and China. As we begin to explore domestic strategy in this area, it will be important to clarify how existing FinCEN, OFAC, and other relevant rules can be applied, modified, or interpreted to not stifle innovation. 

Interestingly, the anonymous, censorship resistant features of open blockchain 

currencies may not prove to be a threat to U.S. financial system at all, but rather 

turn out to be foundational to creation of a digital U.S. Dollar equivalent that is 

as well regarded around the world as the physical dollar is today. Going forward, 

I encourage more discussion of strongly encrypted, privacy-preserving digital currencies coupled with opt-in selective disclosure, as opposed to more naive options 

like so-called cryptographic backdoors or ‘‘golden keys,’’ which are attractive targets 

for nation-state sponsored cyberattacks and hackers. 

In conclusion, even—and hopefully if—this Committee’s guidance is simply a 

strong commitment to non-interventionism, safe harbors for innovators, and work 

toward resolution of the patchwork fabric of state laws, the time it takes to come 

to such a commitment may have the unfortunate effect of eroding America’s early 

mover advantage in technical innovation and entrepreneurism. We take for granted 

that much of the Internet as we know it was developed here at home, and the immense benefits accrued to us because of it. I appreciate your ongoing work to come 

to consensus on a way to repeat the successes of the early Internet era while learning from the things we could have done better. Thank you for your time. 

The CHAIRMAN. Thank you, Ms. Baldet. 

Mr. Kupor? 

STATEMENT OF SCOTT KUPOR, J.D., MANAGING PARTNER, 

ANDREESSEN HOROWITZ, MENLO PARK, CA 

Mr. KUPOR. Thank you, Chairman Conaway and Ranking Member Peterson for the opportunity to be here today to talk about this 

very important new technology. My name is Scott Kupor. I am the 

managing partner for a firm called AH Capital Management, which 

manages about $7 billion worth of venture capital assets, and very 

recently also for a group called CNK Capital Management, which 

is a $300 million registered investment advisor fund focused exclusively on investing in crypto-related assets. 

I would like to spend my time today to focus on why we believe 

as investors that crypto-technologies make a very compelling investment opportunity, particularly for members of the venture capital community, and I want to start with a definition that is different from the definition that we often hear about. If you focus on 

a lot of the public narrative today about crypto-technologies, there 

are two kind of dominating narratives. One is certainly around 

Bitcoin and price fluctuations and volatilities, which we heard certainly from the Ranking Member today as well, as well as what are 

called initial coin offerings, ICOs, for capital fundraising. 

16 

As investors, though, we are interested in the broader ecosystem 

and we use the term crypto-networks to describe what we think 

about as that ecosystem. Very specifically, crypto-networks for us 

means a new way to build digital services, and by digital services, 

we mean any Internet application that obviously may exist today, 

so ridesharing applications, social media applications, and probably 

a whole host of things, of course, that we haven’t even thought 

about, but where those digital services are owned and operated by 

a community of network participants rather than by a centralized 

corporation. 

Now, I realize at first blush that when you think about community ownership and management of an asset, that may seem odd, 

but in fact, if you look at the technology industry, there is actually 

significant precedent for the existence and success of communitybased networks in the development of a significant portion of technology. 

First is what is known as the open source software movement. 

This started back in 1983 actually at MIT by a professor named 

Richard Stallman, and at the time, it was a very, very radical notion. The idea was that a community of developers would publish 

and then freely offer their software to others who could modify that 

software, who could incorporate it into various other projects. It 

was really, in many respects, a very liberal movement around 

opening up and reducing copyright initiatives in software. 

If you fast forward to today, though, open source is the predominant method of software development and software utilization 

today in the world. For any data center you go to, which is obviously where major corporations run their Internet applications, 

Linux, which is a major operating system, is by far the dominant 

operating system in play, and for all of you, like myself, who walk 

around with your cell phones all day long, the vast majority of components in your cell phones are what are called android and essentially open source software. The history of open source software is 

relevant for how we think about the potential for what Bitcoin and 

crypto-networks can be. 

The second important historical analogy is around what we call 

open protocols, which really form the foundation of the modern 

Internet that we all use today. An example of this is something 

called SMTP, which is the protocol that we all use for e-mail transmission. It is an open protocol. It was governed, in many cases, by 

open communities, by networks, by academics, and in many cases, 

with government funding, and many people built applications on 

top of these open networks precisely because they knew that the 

nature of that protocol would not change. They could rely on the 

steadiness and the consistency of that protocol on which to build 

applications. 

If we look at technology, the open protocols that are well-developed and well-maintained can become the building blocks on which 

massive customer utility and economic growth can be built. It is 

also the case, however, as you look at the start up world that many 

start up companies have failed by relying on what we call platform 

risk, which is building on other platforms that are governed by centralized corporations and then finding that the rules of the road 

17 

change over time, and that really does significantly handicap their 

efforts. 

As a result of this, what we now see in our business is many developers are hesitant to take on this platform risk and are instead 

looking at things like crypto-networks as a new and innovative way 

for developers to create new digital services without the attendant 

risk that comes from depending upon centralized platforms. In 

many ways, crypto-networks borrow it from the nearly 50 years of 

history in the technology industry, which shows that communities 

of developers can share their work openly and properly govern a 

network without centralized authority. 

But crypto-networks also introduce a very powerful economic incentive that didn’t exist in these prior generations. The presence of 

what we call a token, which creates a direct financial incentive for 

members of the communities to, in fact, develop and govern the 

network appropriately. The token really, in a sense, is the glue that 

binds the various players in the ecosystem and provides the appropriate economic incentives for all market participants. 

Understandably so, this creates a whole new set of challenges for 

regulators. Consistent with recent statements that we have heard 

from the director of corporate finance at the SEC, we believe that 

the regulatory nature of crypto-networks varies with the stage of 

development of a particular project. Briefly, when a centralized 

sponsor is seeking to raise capital from investors prior to the functional development of the network, this is probably what is known 

as an investment contract and therefore properly regulated as a security. However, the nature of the tokens that are delivered on that 

contract can ultimately be regulated as commodities once the fulfillment of that investment contract has occurred. 

As stated by the CFTC, some tokens are not securities. Once the 

network is functional, and in particular cases where the network 

is decentralized from an ownership perspective, we believe the nature of the tokens looks more like commodities than securities, and 

therefore probably rightly should be governed by the CFTC. This 

is precisely because there is no centralized sponsor on which the 

efforts of the value of the token are largely dependent. Instead, the 

tokens have value based upon the utility of the service to participants. This actually looks much more like the way commodities 

trade. 

In conclusion, the U.S. has long enjoyed the fruits of innovation 

in the form of economic growth, job growth, and consumer utilities 

stemming from many of the great technology companies of our 

time, and we believe that crypto-networks present a new and exciting opportunity for us to continue on that trajectory. Doing so, however, will require that we develop a regulatory framework that encourages risk taking and capital formation, provides clarity and 

certainty to market participants, and of course protects individual 

investors and the integrity of the markets. 

Thank you for the opportunity to be here today. 

[The prepared statement of Mr. Kupor follows:] 

18 

PREPARED STATEMENT OF SCOTT KUPOR, J.D., MANAGING PARTNER, ANDREESSEN

HOROWITZ, MENLO PARK, CA 

Chairman Conaway and Ranking Member Peterson, thank you very much for the 

opportunity to speak with the Committee regarding crypto-technology and its implications for American technology innovation. I applaud this Committee for your efforts to take a closer look at what we believe is a foundational area of technology 

development, one that is critical to the health of our capital markets, entrepreneurship and the American economy. 

By way of background, I am the Managing Partner for AH Capital Management, which manages approximately $7 billion in venture capital funds focused principally 

on early-stage IT-related investments. We have been operating this business for just 

over 9 years and some of the companies in which we have invested and with which 

you may be familiar include Facebook, Lyft, AirBnB, Instacart, Pinterest and 

Github. I am also the Managing Partner for CNK Capital Management, a registered 

investment adviser that manages a $300 million venture capital fund dedicated solely to investing in crypto-related technologies. 

Background on Crypto-networks 

I’d like to focus my time here today on what we believe is the foundational importance of crypto-related technologies and why we believe they make a compelling investment opportunity for the venture capital community. 

In doing so, I think it’s important to define the space precisely. 

The public narrative around crypto-related technologies tends to focus primarily 

on two areas: (i) Bitcoin itself as a potential store of value and the high levels of 

volatility inherent in the price of Bitcoin and (ii) the proliferation of initial coin offerings (ICOs) to unaccredited, retail investors, many of which have been rightly 

criticized by the SEC as inconsistent with U.S. securities laws. While these are no 

doubt currently significant aspects of the industry, the almost exclusive public focus 

on these areas obscures the exciting technological innovation that drives our interest in crypto-networks. 

Specifically, we define the term ‘‘crypto-networks’’ as: 

• a new way to build ‘‘digital services,’’ 

• where those services are ‘‘owned and operated’’ by a ‘‘community of network 

participants,’’ rather than by a centralized corporation, and 

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

What are ‘‘digital services’’? They are simply Internet-based applications, such as 

many of the ones we enjoy today—ride sharing, messaging, grocery delivery, enterprise applications, to name a few. We believe that developers will create a whole 

new set of digital services utilizing the principles of crypto-networks, many of which 

are likely beyond our imagination today but will also yield enormous consumer utility. 

And what are those principles of crypto-networks? That they are both owned and 

managed by the community that develops, maintains and utilizes the networks. 

This is distinct from the large digital services that we utilize today, where the ownership and management of those services are governed by a centralized corporation. 

At first blush, this may sound crazy—that there may be value in community ownership and management of an asset that exceeds that of centralized corporate control? But, in fact, there is well-established precedent for this in the history of the 

technology industry. 

First, is the open source software movement. This started in 1983 as a movement 

to create free software, led by an MIT researcher named Richard Stallman. Understandably, this was a radical concept at the time—that a community of developers 

would publish their software freely for others to modify and incorporate into various 

other open projects. But over time, this work morphed into the mainstream development of open source software, which today is the predominant method by which 

software is developed. Examples of open source software that have experienced 

widespread adoption include Linux, an operating system that governs most data 

center servers today and is a major component in virtually all smartphones and tablets, and Git, an open source software development system used by millions of software engineers globally. 

Second, is the development of the very Internet protocols that have given rise to 

the tremendous job and economic growth and consumer utility that we all currently 

enjoy from existing digital services. These protocols—which include, for example, 

SMTP (the protocol for email transmission), HTTP (the protocol to exchange structured text on the Internet) and TCP/IP (the protocol for end-to-end data communicaVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00022 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
19 

tion)—derived largely from academic or government-funded efforts and have been 

maintained in most cases by communities of academics and developers. They are 

‘‘open’’ protocols in the sense that they are the well-established foundations on 

which many very exciting for-profit businesses have been built (e.g., Facebook, Amazon, Google), knowing that the protocols themselves cannot be changed by a centralized corporation. 

Why should we care about this? 

Because as the history of the Internet has shown us, open protocols that are wellbuilt and well-maintained can become the building blocks on which massive consumer utility and economic growth can be built. 

And why is that? Because for-profit enterprises are willing to take on all of the 

market risks of building a new company—and venture capitalists are willing to provide the funding for such endeavors—when they know that the foundations on 

which they are taking that risk cannot be changed at the whim of a centralized corporation. 

In contrast, the technology world is also riddled with startup companies that have 

failed as a result of having taken on platform risk that depends on the rules of the 

road as defined by centralized, for-profit platforms (in contrast to open protocols). 

That’s not because centralized, for-profit platforms are inherently bad, but rather 

because over time their economic incentives require that to remain viable as independent businesses they capture more of the gains associated with their proprietary 

platforms, often causing them to change the nature of the relationships they once 

encouraged with other companies who were in fact building on and improving their 

platform. 

What does any of this have to do with crypto-networks? 

As we noted previously, crypto-networks enable a new way for innovative developers to create new digital services without the attendant risk of building on centralized platforms. In many ways, crypto-networks borrow from the nearly fifty 

years of history in the technology industry that enabled the initial Internet protocol 

development and the open source movement; that is, the idea that communities of 

developers can share their work openly and properly govern a network without centralized authority. As my partner, Chris Dixon, has written about, crypto-networks 

essentially replace the requirement to rely on trust from a centralized corporation 

with the requirement only that you trust the software itself to do what it has been 

built to do (and for which the fundamental code is open sourced for you to confirm 

on your own). 

But, at the same time, crypto-networks introduce a very powerful economic incentive that did not previously exist in the development of prior technologies—the presence of a token that creates a direct financial incentive for the community members 

to in fact develop and govern the networks appropriately. ‘‘Tokens’’ in the cryptonetworks world perform a series of functions: (i) they are the method of value exchange between network participants—that is, consumers ‘‘pay’’ for services using 

the token and sellers ‘‘receive’’ tokens in exchange for the services and (ii) they provide the financial incentive to reward developers and other maintainers of the network—that is, people may receive tokens for ensuring the authenticity of the transactions completed on the network. 

The Importance of Regulation in Crypto-networks 

Thus, the token plays a very important role in the functioning of crypto-networks—it is the glue that binds the various players and provides the appropriate 

economic incentives for all market participants. And, recall that because all of the 

software in these networks is open sourced, meaning that anyone who wants to create a competing network can simply take all of the existing software and stand-up 

a rival network, the competitive incentives for the market participants are designed 

to be fair and responsive to the user community. 

But, the token itself and the decentralized nature of many of these networks create a new set of challenges for regulators. 

I want to first be very clear that we believe appropriate regulation in crypto-networks is very important and we welcome the opportunity to work with you, other 

Members of the House and Senate and the various agencies who are interested in 

creating a regulatory framework that both encourages innovation and protects consumers and well-functioning capital markets. There is an important role for the regulatory community to play and we believe that role is one of the reasons why the 

U.S. has long been a leader in the commercial development of so many breakthrough technologies. 

In fact, the work that CFTC Chairman Giancarlo has done in setting up LabCFTC 

is a great example of how the regulatory community is trying hard to balance the 

20 

needs of encouraging technological innovation with those of protecting consumers. 

Such collaborative engagement between regulators and innovators is precisely the 

type of activity that is required in such fastmoving markets as are crypto-networkrelated activities. Thank you as a Committee for your support and sponsorship in 

these initiatives. 

Consistent with recent statements from the Director of Corporate Finance at the 

SEC, we believe that the regulatory nature of crypto-networks varies with the stage 

of development of a particular project. Briefly, if a centralized sponsor is seeking to 

raise capital from investors prior to the functional realization of the network itself, 

the contract between the sponsor and investor is likely an ‘‘investment contract’’ and 

thus properly regulated under the U.S. securities laws by the SEC. The nature of 

the to-be-delivered tokens under that contract, however, may not be securities; they 

need to be evaluated using the same Howey test as do all potential securities. 

As stated by the CFTC, some tokens are not securities. Once the network is functional and, in particular in cases where the network is decentralized, we believe 

that the nature of the tokens looks more like commodities than securities. This is 

because there is no centralized sponsor on whose efforts the value of the token is 

largely dependent. Rather, the tokens will have value that represents the utility of 

the service to its participants; the value will not be derived from the coordinated 

activities of a centralized sponsor. 

Obviously, these are not easy determinations and will require the efforts of this 

Committee, among others, and the various regulatory agencies. But, we believe this 

framework is consistent with early pronouncements from both the SEC and the 

CFTC. 

Regardless of the jurisdictional boundaries, we believe that investor protection, 

well-functioning capital markets and support for innovation should be the hallmark 

of the regulatory focus. 

Summary 

In summary, I would offer the Committee the following observations: 

• The U.S. has long been a leader in technology, in large part due to a favorable 

regulatory and financial environment that has fostered risk taking and innovation. 

• While we have enjoyed the fruits of this innovation in the form of economic 

growth, job growth and consumer utility stemming from many of the great technology companies of our time, we believe that crypto-networks presents a new 

and exciting opportunity for us to continue on that trajectory. 

• This is why you see venture capitalists and other financial professionals increasing their investment focus in this area. Just like other areas of technology 

development, our job is to provide risk capital to the areas of innovation that 

we believe can support long-term, self-sustaining enterprises. We believe cryptonetworks is one such area. 

• But, to ensure that the U.S. continues to be the favored haven for such technological innovation, we need to develop a regulatory framework that encourages 

risk-taking and capital formation, provides clarity and certainty to market participants and protects individual investors and the integrity of the markets. 

I thank you for your time and look forward to the opportunity to work with the 

Committee on this important topic. 

The CHAIRMAN. Thank you, Mr. Kupor. 

Mr. Gorfine, 5 minutes. 

STATEMENT OF DANIEL GORFINE, J.D., DIRECTOR AND CHIEF 

INNOVATION OFFICER, LABCFTC, COMMODITY FUTURES 

TRADING COMMISSION, WASHINGTON, D.C. 

Mr. GORFINE. Thank you, Chairman Conaway, Ranking Member 

Peterson, and Members of the Committee for the opportunity to 

testify before you today. I am Chief Innovation Officer and Director 

of LabCFTC at the U.S. Commodity Futures Trading Commission. 

The testimony presented here reflects my own views and does not 

necessarily reflect the opinions or the view of the Chairman or the 

Commission. 

21 

In May of last year, Chairman Giancarlo announced with bipartisan Commission support the launch of LabCFTC, the agency’s effort to help create a model for regulatory engagement and modernization in light of the ongoing digitization of our markets. Its 

mission is to facilitate market enhancing innovation, inform policy, 

and ensure that we have the technological and regulatory tools and 

understanding to keep pace with inevitable change. The building 

blocks of our effort are engagement, testing and experimentation, 

and education. 

Shifting to the primary topic of today’s hearing, we are interested 

in both private or permission-distributed ledger technologies that 

can improve market infrastructure and in public blockchains that 

require the use of a virtual currency. Developments across this 

spectrum have society rethinking the nature of money, how people 

transact, and how we can more efficiently engage in regulatory, 

economic, and market activity. 

With respect to public blockchains, proponents note that they 

unlock digital scarcity, enable efficient transfer of ownership, and 

power the execution of applications, and all of this can be done 

without the need for a trusted central intermediary that was traditionally needed to verify that each party has and does what it 

promises. Many, however, appropriately worry that virtual currencies and tokens may be used for illegal activities and are prone 

to fraud, manias, and bubbles driven by potential misunderstandings and myths regarding their scalability, utility, and intrinsic value. 

With recent hype around this space, there has also been a proliferation of ICOs, which may be intended to raise capital for a venture and may bear the hallmarks of a securities offering. Our colleagues at the SEC have been thoughtfully addressing related challenges, and providing additional clarity to the marketplace. And 

from the CFTC’s perspective, given the potential to tokenize a 

broad range of economic assets, it is important to remind the public 

that digital assets can also be commodities or derivatives, depending on their terms and how they are structured. 

Given the potential and the challenges of this space, Chairman 

Giancarlo has made clear that the proper response by regulators is 

not to dismiss the entire movement as misguided or foolish, but 

rather, to take the time to learn, facilitate the promise, and guard 

against risks and bad actors. As part of this effort, LabCFTC published its first FinTech primer on the topic of virtual currencies in 

October 2017. The primer explains that the agency determined in 

2015 that certain virtual currencies, such as Bitcoin, are commodities and therefore implicate our jurisdiction. The CFTC has regulatory oversight authority over futures and swaps markets based 

on commodities, and then has anti-fraud and manipulation enforcement authority over these and the underlying commodity markets. 

It is important to note, however, that we do not have oversight authority over these underlying markets. Additional details regarding 

CFTC oversight of crypto-related markets and enforcement and 

education efforts since the self-certification of Bitcoin futures in December 2017 can be found in my written testimony. 

Moving forward, one thing is certain. None of us are able to predict exactly where this innovation is heading. It is accordingly inVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00025 Fmt 6633 Sfmt 6601 P:\DOCS\115-14\30893.TXT BRIAN
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1See CFTC Mission Statement, Commodity Futures Trading Commission http:// 

www.cftc.gov/About/MissionResponsibilities/index.htm (last visited July 16, 2018). 2Many of my introductory remarks here derive from my prior publication: See Daniel Gorfine, 

FinTech Innovation: Building a 21st Century Regulator, Georgetown University Law Center Institute for International Economic Law (IIEL), Issue Brief 11/2017 (November 2017), https:// 

www.law.georgetown.edu/iiel/wp-content/uploads/sites/8/2018/01/LabCFTC-Chris-BrummerDan-Gorfine-IIEL-Issue-Brief-November-2017-Accessible.pdf; see generally, Bruce Tuckman, Derivatives: Understanding Their Usefulness and Their Role in the Financial Crisis, J. OF APPLIED

CORP. FIN. Vol. 28, No. 1 (Winter 2016). 

cumbent upon us as a 21st century regulator to continue studying, 

learning, and keeping pace with change. We look forward to ongoing close collaboration with our regulatory peers, including through 

the FSOC digital asset working group. We all have the shared goal 

to educate market participants, target bad actors, and ensure an 

efficient and effective regulatory framework. We are also focused on 

bringing clarity and certainty to the market, but need to be sure 

that we are thoughtful in our approach and do not steer or impede 

the development of this area of innovation. 

While some may seek the immediate establishment of bright 

lines, the reality is that hasty regulatory pronouncements are likely to miss the mark, have unintended consequences, or fail to capture important nuance regarding the structure of new products. 

In the late 1990s during the early days of the Internet, senior 

government policy advisor Ira Magaziner made the following observation, that given ‘‘the breakneck speed of change and technology, 

the government attempts to regulate are likely to be outmoded by 

the time they are finally enacted.’’ Given this dynamic, the government largely avoided a prescriptive approach in favor of principles, 

focused on educating and empowering law enforcement, and allowed this area of innovation time and space to develop all while 

maintaining the ability and careful vigilance to act to ensure market integrity. This approach generally seems like the right one 

when dealing with new technologies, which are largely agnostic as 

to how they are used. The role of the regulator is to facilitate use 

of new technologies that can benefit markets and the public more 

broadly, while deterring and pursuing those who seek to use technology to do harm. 

Thank you, and I am happy to answer any questions you may 

have. 

[The prepared statement of Mr. Gorfine follows:] 

PREPARED STATEMENT OF DANIEL GORFINE, J.D., DIRECTOR AND CHIEF INNOVATION

OFFICER, LABCFTC, COMMODITY FUTURES TRADING COMMISSION, WASHINGTON, D.C. 

Thank you Chairman Conaway, Ranking Member Peterson, and Members of the 

Committee for the opportunity to testify before you today on FinTech innovation, 

Blockchain, and new assets in the digital age. I am Chief Innovation Officer and 

Director of LabCFTC at the U.S. Commodity Futures Trading Commission (CFTC). 

The testimony presented here reflects my own views and does not necessarily reflect 

the opinions or views of the Chairman, Commissioners, or the Commission. 

The mission of the CFTC is to foster open, transparent, competitive, and financially sound markets.1 The agency oversees markets vital to supporting the transfer 

of risk between market participants and by extension to the stability and reliability 

of real-world economic activity, ranging from the production and provision of gasoline for our cars, to the availability of credit for our purchases, and the offering of 

produce in our grocery stores.2

As one might expect, the agency’s work has always included a focus on agricultural products like wheat and corn, and even precious metals. It is worth asking 

how do we now find ourselves here making the jump from traditional commodities 

and risk transfer to FinTech topics like DLT and Bitcoin? 

23 

3See Harald Bauer, et al., Moore’s Law: Repeal or Renewal?, McKinsey & Company (December 

2013), http://www.mckinsey.com/insights/high_tech_telecoms_internet/moores_law_repeal_or_ 

renewal. 4 Address of J. Christopher Giancarlo to the New York FinTech Innovation Lab, ‘‘LabCFTC: 

Engaging Innovators in Digital Financial Markets,’’ (May 17, 2017) Commodity Futures Trading 

Commission, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-23. 

The answer is that our financial markets are fast-evolving due to technology-driven innovation and this has changed the way market participants interact, trades are 

formulated and processed, risk is assessed and hedged, and business operations are 

executed. No longer do market participants rely on face to face interactions and telephones. Instead, markets have become increasingly electronic, digital, and interconnected. This new world in turn creates new market and regulatory opportunities, 

challenges, and risks. 

Much of this dynamic derives from three identifiable threads around FinTech innovation. The first centers on speed, both in terms of innovation and subsequent 

adoption. The speed phenomenon derives from the profound impact of increased 

computing power in the development of products, services, and markets, and the 

Internet in their adoption. The concept of Moore’s Law 3—which roughly suggests 

that computing power will expand exponentially over time—has allowed for the development of increasingly powerful, and low cost, computer systems that enable 

rapid iteration and development of new business models, as well as the capability 

to do more with increasingly available data. This means that markets and regulators are faced with a constant barrage of innovations and not much time to grasp 

their implications before interconnected computers permit their ready adoption. 

The second is that innovation largely seeks to either disintermediate traditional 

gatekeepers or change the way they operate. Current financial regulatory frameworks are centered on the intermediaries or gatekeepers that manage the access to 

our markets or financial services activity. To the extent that innovators are seeking 

to disintermediate or substantially transform traditional models in order to increase 

efficiencies, regulators will need to proactively identify how rules and regulations 

conform or will need to change. 

Finally, the increasing complexity of technology-driven business models requires 

significantly more focus on technological literacy at all levels of leadership, including within business and government. It is simply not enough to all agree to high 

level platitudes that items like cybersecurity are of great importance—instead it is 

imperative that we have deep understanding of the details of security protection in 

order to avoid bad outcomes, including cyber breaches. Indeed, I would suggest that 

a key emerging risk in our markets is a potential lack of required literacy in the 

face of increasingly technology-driven business models and processes. 

LabCFTC: Building a 21st Century Regulator 

Given these market dynamics, and related emerging regulatory challenges, we believe thoughtful 21st century regulatory approaches are needed. This is why last 

summer, CFTC Chairman Chris Giancarlo announced with bipartisan Commission 

support the launch of LabCFTC.4

LabCFTC is the CFTC’s effort to help create a replicable model for regulatory engagement and modernization. The mission of LabCFTC is to facilitate market-enhancing innovation, inform policy, and ensure we have the technological and regulatory tools and understanding to keep pace with changes to our markets. LabCFTC 

was launched out of our Office of General Counsel so that it can leverage its deep 

bench of expertise to help manage the interface between technological engagement 

and innovation, regulatory modernization, and existing rules and regulations. 

The building blocks of the effort are engagement, testing and experimentation, 

education, and collaboration. The core LabCFTC team works closely with subject 

matter experts from the Agency’s operating divisions, who form the LabCFTC liaison network. Through this approach, we can gain a better understanding of emerging risks, technologies, and trends, modernize our regulatory tools and operations, 

engage with innovators early in the development of new business models, and support better informed policymaking that facilitates market-enhancing innovation. 

The effort seeks to involve both internal and external stakeholders through three 

primary work streams. First, ‘Guide Point’ provides a dedicated point of contact for 

FinTech innovators to engage with the CFTC, learn about the CFTC’s regulatory 

framework, and obtain feedback. Such feedback and discourse may provide 

innovators with valuable information that can help them save time and resources, 

or allow for the identification of potential friction or uncertainty in existing rules. 

Since the beginning of its formation, LabCFTC has met with approximately 200 

organizations and discussed a range of technology-related issues, including those inVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00027 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
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5 CFTC Asks Innovators for Competition Ideas to Advance FinTech Solutions, (Apr. 24, 2018) 

Commodity Futures Trading Commission, https://cftc.gov/PressRoom/PressReleases/7717-18. 6See, e.g., Commodity Futures Trading Commission Research and Development Modernization, 

H.R. 6121, 115th Cong. (2018), https://www.congress.gov/bill/115th-congress/house-bill/6121/ 

text?r=1. 7 U.S. CFTC and UK FCA Sign Arrangement to Collaborate on FinTech Innovation, Commodity Futures Trading Commission, (Feb. 19, 2018) https://www.cftc.gov/PressRoom/ 

PressReleases/pr7698-18. 8 ‘Digital assets’ is a broad category that includes ‘virtual currencies’ or ‘cryptocurrencies.’ For 

purposes of this testimony and consistent with CFTC past use, I use the term ‘virtual currencies.’ 9 CFTC Primer on Virtual Currencies. Commodities Future Trading Commission, (Oct. 17, 

2017), http://www.cftc.gov/idc/groups/public/documents/file/labcftc_primercurrencies 

100417.pdf (hereinafter ‘‘LabCFTC Primer’’). 

volving machine learning and artificial intelligence, DLT and capital markets infrastructure, virtual currencies, smart contracts, RegTech, cloud, and algorithmic trading. LabCFTC ‘office hour’ meetings have been held in Silicon Valley, Chicago, New 

York, Boston, and Washington, D.C. And in response to common questions raised 

through these sessions, LabCFTC published its first FinTech educational primer in 

October 2017. The primer, leveraging a format which will be applied to a range of 

innovations going forward, involved discussion of technology use-cases, CFTC jurisdiction, and potential risks and challenges. 

Second, ‘CFTC 2.0’ fosters the testing, understanding, and potential adoption of 

new technologies that can improve markets or make the Commission a more effective and efficient regulator. We are currently crowdsourcing ideas for future innovation competitions,5 which may involve, for example, novel ways to visualize CFTC 

published data, develop market surveillance tools, make our rules more readily machine-readable, or build a more dynamic, digital, and ‘‘smart’’ notice-and-comment 

platform. 

We further believe that it is through developing proofs of concept and truly kicking the tires on new innovations that agency staff can properly understand the application of new technologies, which will subsequently drive more informed policymaking and technology strategies. In some instances, existing law may be an obstacle to participation in this type of testing, research, and proofs of concept. For this 

reason, the Chairman appreciates the current efforts of Members of this Committee 

to suggest ways to provide the CFTC with the authority to fully engage with, research, and test emerging technologies.6

Finally, ‘DigitalReg’ is designed to support the Commission’s effort to build a 21st 

century regulator and regulatory approach. Internally, DigitalReg serves as a CFTCwide resource to help inform the Commission and staff on FinTech-related developments. Externally, DigitalReg acts as a hub to help the Commission collaborate with 

other U.S. and international regulatory authorities in order to share best practices 

around FinTech engagement. We were accordingly pleased earlier this year to enter 

into a CFTC-first FinTech cooperation arrangement with the UK’s Financial Conduct Authority (FCA),7 and look forward to ongoing constructive engagement with 

our domestic and international regulatory peers. 

DLT, Blockchain, and Digital Assets 

The topics of DLT, blockchain, and digital assets 8 have been prominent areas of 

engagement and exploration for the CFTC over the past year. When LabCFTC views 

the space, we are interested both in private or permissioned ledger networks (also 

sometimes considered ‘‘blockchain-inspired’’ technologies) that can be deployed by 

market participants to improve market infrastructure and in public blockchains that 

require use of a virtual currency to incentivize participation in maintaining the 

ledger system. 

Developments across this spectrum have society re-thinking the nature of money, 

how people transact, and how we can more efficiently engage in regulatory, economic, and market activity. 

On the private or permissioned side of the spectrum, new innovations hold promise in improving clearing and settlement processes, facilitating regulatory reporting 

and compliance, and even transforming information capture, delivery, and analytics 

capabilities. The CFTC is also very interested in better understanding their potential ability to power smart (or self-executing) contracts, which can incorporate compliance provisions and potentially decrease execution risks. To be clear, however, 

this area of innovation is quite distinct from the realm of public distributed ledgers 

and virtual currencies, and has its own unique set of challenges including around 

security, scalability, and broader adoption.9

25 

10See generally LabCFTC Primer. 11See Jerry Brito, Executive Director, Coin Center before the New Jersey Assembly Financial 

Institutions and Insurance Committee Hearing on digital Currency, Coin Center (Feb. 5, 2015) 

https://coincenter.org/wp-content/uploads/2015/02/ 

NewJerseyLegislatureWrittenTestimony.pdf. 12Steven Johnson, Beyond the Bitcoin Bubble, NEW YORK TIMES, (Jan. 16, 2018) https:// 

www.nytimes.com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html. 13Qin Chen, Next Stop in the Cryptocurrency Craze: A Government-Backed Coin, CONSUMER

NEWS AND BUSINESS CHANNEL, (Dec. 29, 2017) https://www.cnbc.com/2017/11/29/federal-reserve-starting-to-think-about-its-own-digital-currency-dudley-says.html. 14 CFTC Customer Advisory: Use Caution When Buying Digital Coins or Tokens, Commodity 

Futures Trading Commission, (July 16, 2018), https://www.cftc.gov/PressRoom/PressReleases/ 

; see also Shane Shifflett & Coulter Jones, Buyer Beware: Hundreds of Bitcoin Wannabes Show 

Hallmarks of Fraud, WALL STREET JOURNAL (May 17, 2018) https://www.wsj.com/articles/ 

buyer-beware-hundreds-of-bitcoin-wannabes-show-hallmarks-of-fraud-1526573115; Angela 

Monaghan, Bitcoin Biggest Bubble in History, says Economist who Predicted 2008 Crash, THE

GUARDIAN, (Feb. 2, 2018) https://www.theguardian.com/technology/2018/feb/02/bitcoin-biggest-bubble-in-history-says-economist-who-predicted-2008-crash. 15 CFTC Charges Nicholas Gelfman and Gelfman Blueprint, Inc. with Fraudulent Solicitation, 

Misappropriation, and Issuing False Account Statements in Bitcoin Ponzi Scheme, Commodities 

Futures Trading Commission (Sept. 21, 2017) https://www.cftc.gov/PressRoom/PressReleases/ 

pr7614-17. 16Gabriel T. Rubin, How Bitcoin Fueled Russian Hacks, WALL STREET JOURNAL (July 13, 

2018), https://www.wsj.com/articles/how-bitcoin-fueled-alleged-russian-hacks-1531517907. 17 Jay Clayton & J. Christopher Giancarlo, Regulators Are Looking at Cryptocurrency, WALL

STREET JOURNAL, (Jan. 24, 2018). https://www.wsj.com/articles/regulators-are-looking-atcryptocurrency-1516836363. 18The SEC Has an Opportunity You Won’t Want to Miss: Act Now!, (May 16, 2018) Securities 

And Exchange Commission, https://www.sec.gov/news/press-release/2018-88; see also Pre-ICO 

Sale is Live, Howeycoins (2018), available at https://www.howeycoins.com/index.html; Investor 

Bulletin: Initial Coin Offerings, Securities and Exchange Commission (July 25, 2017). https:// 

www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings. 19William Hinman, Director of the Division of Corporation Finance, Director Digital Asset 

Transactions: When Howey Met Gary (Plastic), Yahoo Finance All Markets Summit: Crypto, 

San Francisco, CA, Securities and Exchange Commission (June 14, 2018) https://www.sec.gov/ 

news/speech/speech-hinman-061418. 

On the public distributed ledger side of the spectrum, it may be helpful to levelset. Virtual currencies are a digital representation of value and may function as a 

medium of exchange, a unit of account, and/or a store of value. Virtual currencies 

generally run on a decentralized peer-to-peer network of computers, which rely on 

certain network participants to validate and log transactions on a permanent public 

distributed ledger visible to all. The virtual currency serves as the required incentive for miners or validators.10

Proponents note that these virtual ecosystems unlock digital scarcity, enable the 

efficient transfer of ownership, and power the execution of relatively autonomous 

application platforms all without the need for a trusted, central party that was traditionally needed to verify that each party to a transaction has—and does—what it 

promises.11 In addition to providing new ways to transact over the Internet, these 

advancements could allow for decentralized platforms or applications that provide 

consumers with desired goods and services absent a central gatekeeper.12 Some further note the potential inspiration that virtual currencies may provide Central 

Banks in the future creation of digital fiat currencies.13

Many, however, appropriately worry that virtual currencies and tokens are prone 

to fraud, manias, and bubbles driven by misunderstandings and myths regarding 

their scalability, utility, and intrinsic value.14 Indeed, over time bad actors have 

commonly invoked the concept of innovation in order to engage in fraudulent activities that target the general public.15 Additionally, as we are reminded by recent 

events,16 concerns regarding the use of cryptocurrencies to facilitate illegal activity 

are well-founded and require government efforts to ensure that Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements are effectively applied. 

With recent hype around virtual coins and tokens there has also been a proliferation of so-called ‘‘Initial Coin Offerings’’ or ICOs, which frequently refers to the sale 

of virtual tokens to the public that are intended to raise capital for a venture and 

may bear the hallmarks of a securities offering.17 Our colleagues at the Securities 

and Exchange Commission (SEC) have been thoughtfully addressing related challenges,18 and providing additional clarity to the marketplace.19 And from the 

CFTC’s perspective, given the potential to tokenize a broad range of economic assets, it is important to remind the public that digital assets can also be derivatives 

or commodities, depending on their terms and how they are structured. 

Given the potential and challenges of this space, CFTC Chairman Giancarlo has 

made clear that the proper response by regulators and policymakers is not to disVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00029 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
26 

20Written Testimony of Chairman J. Christopher Giancarlo before the Senate Banking Committee, Washington, D.C., Commodity Futures Trading Commission (Feb. 6, 2018) https:// 

www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo37; see also Testimony of Chairman 

J. Christopher Giancarlo before the Senate Committee On Appropriations Subcommittee on Financial Services and General Government, Washington, D.C. Commodity Futures Trading Commission (June 5, 2018) https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo47. 21 CFTC’s LabCFTC Releases Primer on Virtual Currencies Commodity Futures Trading Commission (Oct. 17, 2017), https://www.cftc.gov/PressRoom/PressReleases/7631-17. 22The following discussion is largely based on: J. Christopher Giancarlo Testimony Before the 

U.S. Senate Agriculture, Nutrition, and Forestry Committee (Feb. 15, 2018), Commodity Futures 

Trading Commission https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo38. 23 CFTC Issues Proposed Interpretation on Virtual Currency ‘‘Actual Delivery’’ in Retail Transactions, Commodity Futures Trading Commission (Dec. 15, 2017), https://www.cftc.gov/PressRoom/PressReleases/7664-17. 

miss the entire movement as misguided or foolish, but rather to take the time to 

learn, facilitate the promise, and guard against risks and bad actors.20

As part of this effort, LabCFTC published its first FinTech primer on the topic 

of virtual currencies in October 2017.21 The goal of the primer was to help educate 

the public about potential use-cases of the technology, CFTC jurisdictional considerations, and relevant risks, including around investment speculation, cybersecurity, 

and platform operations. 

After the self-certification and launch of Bitcoin futures in December 2017, 

LabCFTC was then able to continue providing support in the areas outlined below 

to the Commission and operating divisions based on our engagement and study of 

DLT and virtual currencies. 

Digital Assets and CFTC Jurisdiction 

In 2015, the Commission determined that certain virtual currencies, such as 

Bitcoin, met the definition of ‘‘commodity’’ under the Commodity Exchange Act 

(CEA). This means that the CFTC’s jurisdiction is implicated from an oversight perspective if a commodity-based future or swaps product is offered to the market and 

from an enforcement perspective if there is fraud or manipulation involving such 

products or their underlying commodity markets. 

In December 2017, two CFTC regulated futures exchanges self-certified and 

launched Bitcoin futures products.22 Under the CEA and Commission regulations 

and related guidance, futures exchanges may self-certify new products on twentyfour hour notice prior to trading. This type of framework encourages market-driven 

innovation and has made America’s listed futures markets the envy of the world. 

Both CME and CBOE worked with the CFTC for months before launching Bitcoin 

futures in December 2017. As detailed in our Chairman’s prior Congressional testimony, due to the complexity of issue, the CFTC conducted a ‘‘heightened review’’ 

of CME’s and CBOE’s responsibilities. 

Chairman Giancarlo has outlined six elements regarding CFTC oversight of the 

virtual currency-related futures and swaps markets. These elements include: (1) 

staff competency; (2) consumer education through our Office of Customer Education 

and Outreach; (3) interagency cooperation including with the SEC, the Department 

of Treasury’s Financial Crimes Enforcement Network known as FinCEN, and 

through the Financial Services Oversight Council (FSOC); (4) CFTC exercise of its 

regulatory oversight authority; (5) strong enforcement efforts to deter and prevent 

fraud and manipulation; and (6) heightened review of virtual currency-related product self-certifications. 

With respect to heightened review, in May of this year, our Division of Market 

Oversight and Division of Clearing and Risk issued a joint staff advisory that gives 

exchanges and clearinghouses registered with the CFTC guidance for listing virtual 

currency derivative products. The advisory highlights key areas that require particular attention in the context of listing a new virtual currency derivatives contract, 

including: enhanced market surveillance; close coordination with CFTC staff; large 

trader reporting; outreach to member and market participants; and, Derivatives 

Clearing Organization risk management and governance. 

Commission staff further noted at the time that since the Agency found virtual 

currencies such as Bitcoin to be commodities in 2015, it has taken action against 

unregistered Bitcoin futures exchanges; enforced the laws prohibiting wash trading 

and prearranged trades on a derivatives platform; issued proposed guidance on what 

is a derivative market and what is a spot market in the virtual currency context 

through an interpretation of ‘actual delivery’ 23; issued warnings about valuations 

and volatility in spot virtual currency markets; and, addressed a virtual currency 

Ponzi scheme. 

27 

24Steve Lohr, Policing the Internet: Anyone But Government, NEW YORK TIMES (Feb. 20, 

2000), https://www.nytimes.com/2000/02/20/weekinreview/ideas-trends-policing-the-Internetanyone-but-government.html?nytmobile=0&pagewanted=print&src=pm&referer=. 

On the topic of enforcement, it is worth mentioning that the CFTC is working 

closely with the SEC and other fellow financial enforcement agencies to aggressively 

prosecute bad actors that engage in fraud and manipulation regarding virtual currencies. The more cops we can have on the beat, the better. 

Moving Forward 

One thing is certain: none of us are able to predict exactly where innovation is 

heading, and, accordingly, it is incumbent on us as a 21st century regulator to continue studying, learning, and keeping pace with change. For our part, LabCFTC 

looks forward to ongoing engagement with a broad range of innovators, including 

the likes of those on today’s panel, to be sure we are skating to where the puck is 

heading. We can best facilitate market-enhancing innovation and ensure sound policy through sound understanding. 

Additionally, we look forward to ongoing close collaboration with our regulatory 

peers, including through the FSOC digital asset working group spearheaded by our 

colleagues at the Treasury Department. We all have the shared goal to bring clarity 

and certainty to the market, but also need to be sure that we are thoughtful in our 

approach and do not steer or impede the development of this area of innovation. Indeed, while some may seek the immediate establishment of bright lines, the reality 

is that hasty regulatory pronouncements are likely to miss the mark, have unintended consequences, or fail to capture important nuance regarding the structure 

of new products or models. 

In thinking about the future of a broad range of emerging technologies, it is perhaps informative to harken back to the policy approach that helped facilitate the 

development of the Internet and the rise of new Internet-based business models. 

Noting the rapid pace of innovation and technological transformation, then senior 

policy adviser Ira Magaziner stated in 1997 that given ‘‘the breakneck speed of 

change in [] technology . . . [g]overnment attempts to regulate are likely to be outmoded by the time they are finally enacted.’’ 24

Given this dynamic, the government largely avoided a prescriptive approach in 

favor of principles, focused on educating and empowering law enforcement to target 

bad actors, and allowed this area of innovation time and space to develop, all while 

maintaining the ability and vigilance to act to ensure market integrity. While particular areas of innovation may require different treatment, generally this approach 

seems like the right one when dealing with new technologies, which are, of course, 

agnostic as to their use. The role of the regulator is to facilitate the use of new technologies that benefit markets and the public more broadly, while deterring and pursuing those who seek to use technology to do harm. 

Thank you. I am happy to answer any questions that you have. 

The CHAIRMAN. Thank you, Mr. Gorfine. 

Mr. Gensler, 5 minutes. 

STATEMENT OF HON. GARY GENSLER, SENIOR LECTURER, 

SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS 

INSTITUTE OF TECHNOLOGY; SENIOR ADVISOR TO THE 

DIRECTOR, MIT MEDIA LAB, BROOKLANDVILLE, MD 

Mr. GENSLER. Thank you. Good morning, Chairman Conaway, 

Ranking Member Peterson. My condolences on your dad’s passing. 

It is good to be with you all here today. I have testified in front 

of you a dozen or two dozen times in some previous capacities, but 

since I was last with you, I took on a new role at MIT where I am 

engaged, yes, in researching, teaching, lecturing, and advising on 

digital currency and blockchain technology. Now I say that, but for 

those who don’t know because some are new, I also chaired the 

Commodity Futures Trading Commission for 4 or 5 years, and before that, long ago, I was 18 years at Goldman Sachs. I bring from 

my years in finance, my years in public policy, and now, I guess, 

as an academic, some perspective of what I have learned. And with 

28 

the Chairman’s permission, one thing I have learned as an academic is to ask the audience a little bit about their engagement in 

Bitcoin. Again, with the Chairman’s permission, if I could just ask, 

how many Members of this Committee have invested in 

cryptocurrencies? And I am going to ask the audience, too. 

The CHAIRMAN. By show of hands? 

Mr. GENSLER. We have one. The audience, show of hands? 

The CHAIRMAN. Same with the audience. 

Mr. GENSLER. Yes, we have about half the audience. That is an 

interesting split. There we go. 

I would say the other thing that splits the community in my discussions usually is this is not a community that splits normally 

like right and left, Republican, Democratic. This is a community 

that splits more about Bitcoin maximalist and Bitcoin pessimist, or 

skeptics on one end and by the way, some of those skeptics and 

pessimists are Republicans and some are Democrats. Some are 

Nobel laureates, some are in finance. Whether it is Jamie Diamond 

or Warren Buffett, and then some of the maximalists can be adventure capitalists like at Andreessen Horowitz and elsewhere. It is interesting the split in the community. 

I am probably a little bit center maximalist, if I can say that. I 

am an optimist on the underlying technology. You will also hear 

some people say, ‘‘Well, not that Bitcoin but the blockchain technology is good,’’ and they kind of split their views that way. 

Again, what have I learned? Blockchain technology, I believe, has 

a real potential to transform the world of finance because it is 

about money. It is about moving value on the Internet. This new 

technology could lower costs and risks in the financial sector. Second, to reach its potential, I feel strongly that for public confidence 

to reach its potential, we need to bring it inside the world that we 

know, the long held public policy frameworks. Now what are those 

frameworks? Congress has a role to play to tinker about with these 

frameworks. I will just say what are our historical frameworks 

about technology and finance: We guard against illicit activity like 

tax evasion or money laundering. We insure for financial stability, 

and we protect investors and consumers. Those are the three big 

ones. We protect against illicit activity, we insure for financial stability, and we protect investors. Everything else is debatable and 

we need to adjust the details underneath that. 

Third, the SEC and CFTC do have a role to play. Both of them 

have roles to play. They have released numerous notices and enforcement actions and so forth; however, there is a lot of noncompliance. I mean, there are thousands of entrepreneurs out there 

that probably right now are not complying with SEC guidance, and 

there are fewer that are not complying with CFTC guidance, but 

that is just because the CFTC doesn’t have oversight of this thing 

called the initial coin offering market, and that is where there is 

a lot going on. And this thing is going large and big. It is about 

a $250 billion market, $1⁄4 trillion is getting some size. I mean, the overall capital markets in the world are about $250 trillion or $300 

trillion, so it is not threatening that. But thousands of ICOs have 

been raised, $20 billion of capital formation. I am here to say nearly all of them, I don’t know if it is 98 percent or 97 percent, but 

nearly all of them are probably securities under our securities laws 

29 

because they are being offered in a pre-functional time. This ICO 

market is rife with scams and frauds. 

Fourth, bad actors have figured out how to use this new currency. Sometimes it is state actors. We learned last Friday it was 

the alleged, I should say, but the alleged 12 Russian spies. Venezuela tried to raise it off of their oil and outrun U.S. sanctions policy. 

Fifth, while Federal agencies are engaged, current laws apply to 

this activity, there are gaps. If I can mention a few of the gaps. 

First, I think that there are gaps around the crypto-exchanges 

themselves, either where you can buy and sell. Why? Because they 

are right now being regulated through state money transmission 

laws. This approach, regulating them like Western Union or 

MoneyGram is not satisfactory because crypto-activity is more complex and it is harder to trace, and it doesn’t build on top of the traditional banking system. It is built on something that we can’t see 

that is out there in other countries, like in China and Russia. Second, the crypto-exchanges lack brokered access. They don’t have 

brokers, so there are no brokers, by the way, sending 1099–Bs and 

my detailed testimony says that maybe the IRS should do something about that so you can just have reporting of the gains. Third, 

the issuers of securities, the crypto-space, are only slowly coming 

into the SEC remit. This is going to take 2, 3, 4 years before the 

SEC really cleans up this space, can they go faster, can we do it 

right, but it is going to take some time. Fourth, crypto-derivatives 

are being handled by the CFTC. They are doing it well, but there 

are two things that worry me about the technology, and one is that 

the unregulated underlying crypto-cash market is a mess. 

The corn and wheat markets that you oversee, the gold and the 

oil markets, we have a lot of history. We have some confidence 

about that, and then the CFTC can do their job layering over those 

underlying commodities. The CFTC is regulating derivatives, but 

they are referencing an underlying market where it is just, at best, 

the Wild West and at worst, it is pretty bad. 

About that underlying market: The CFTC has general anti-fraud 

and anti-manipulation authorities with regard to it, but I think 

that Congress will be debating it. Probably not in this Congress, 

but I suspect in the next session, the next Congress, you all will 

be debating should you give the CFTC additional authority, or 

maybe some other agency. Maybe it will be the SEC, somebody 

else, but the CFTC needs to have additional authorities about that 

underlying what I would call cash crypto-market, it is 70 percent 

of the market. The SEC has securities. The CFTC has derivatives. 

You will want to debate whether to do something about the underlying market. And last, I think you will need to give them resources along with your friends over at the Appropriations Committee, because these agencies will need that. 

Thank you. 

[The prepared statement of Mr. Gensler follows:] 

30 

1Maryland Financial Consumer Protection Commission; http://dls.maryland.gov/policyareas/ 

maryland-financial-consumer-protection-commission#. 2Though the research herein builds upon joint work with colleagues, the views expressed are 

mine alone, and do not represent the views of any of my academic colleagues or fellow MD Commissioners. I have no financial interest in any digital currency, or any blockchain related business. 

PREPARED STATEMENT OF HON. GARY GENSLER, SENIOR LECTURER, SLOAN SCHOOL

OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY; SENIOR ADVISOR

TO THE DIRECTOR, MIT MEDIA LAB, BROOKLANDVILLE, MD 

Good morning, Chairman Conaway, Ranking Member Peterson, and Members of 

the Committee. I thank you for inviting me to testify regarding the world of cryptofinance birthed by blockchain technology. As is often the case when innovations in 

finance occur, this Committee’s oversight of commodities and derivatives markets is 

implicated. 

On a personal note, it is good to be with you once again. 

I’m honored to be testifying in my new role at Massachusetts Institute of Technology (MIT), where I am engaged with a talented team researching, writing and 

teaching about digital currency, blockchain technology, and the ethics and governance of artificial intelligence. As Senior Advisor to the Director, MIT Media Lab and 

Senior Lecturer, MIT Sloan School of Management, I have spoken at numerous regulatory, research, or investor conferences related to blockchain technology and will 

be teaching a graduate course this fall entitled ‘Blockchain & Money.’ I coauthored 

of an upcoming Center for Economic Policy Research-Geneva Report entitled ‘The 

impact of blockchain technology on finance: a catalyst for change’ (Casey, Crane, 

Gensler, Johnson, and Narula, 2018) 

I also am honored to be Chairman of the Maryland Financial Consumer Protection Commission which reports to the General Assembly, Governor and Congressional delegation of Maryland about matters related to financial consumer protection. We held a public hearing in Annapolis last month on cryptocurrencies, initial 

coin offerings, crypto-exchanges and other blockchain technologies.1

With the benefit of this experience, I would like to share some thoughts about 

blockchain technology and more particularly the public policy issues raised by the 

burgeoning markets for the trading of cryptocurrencies, initial coin offerings and 

other related crypto-tokens.2

Executive Summary 

Blockchain technology has real potential to transform the world of finance. 

Though there are many technical and commercial challenges yet to overcome, I’m 

an optimist and want to see this new technology succeed. It could lower costs, risks 

and economic rents in the financial system. 

To reach this potential and for public confidence, blockchain technology and the 

world of crypto-finance it has birthed has to come within the norms of long-established public policy frameworks. 

As with other aspects of finance or other emerging technologies, we must guard 

against illicit activities, such as tax evasion, money laundering, terrorism finance 

and avoiding sanctions regimes. We must continue to ensure financial stability. And 

we must ensure investors and consumers are protected. 

As things currently are, though, there is significant non-compliance with respect 

to many initial coin offerings (ICOs), other crypto-assets and crypto-exchanges. 

The question then is how do the crypto-finance markets, this new technology, 

Congress and regulators go forward? While many U.S. agencies are engaged, and 

current laws clearly cover much of this new activity, there may be gaps to consider. 

To date, crypto-exchanges and digital wallet providers generally have not been 

registering as banks, exchanges, broker dealers or futures commission merchants. 

This leaves the only regulatory safeguards—to guard against illicit activity and protect investors—to state-administered money transmission regulations. This approach—regulating exchanges’ duties in the same manner that Western Union and 

MoneyGram are regulated—is not satisfactory. Illicit activity is hard to track, billions of dollars have been lost to hacks, and manipulative behavior is unchecked. 

Crypto activities are more complex, inherently harder to monitor and less traceable than straightforward money transfers. Crypto exchanges and digital wallet providers lack the same natural connections to the regulated banking system that 

money transmission companies have when transferring fiat currencies. Regulated 

banks help protect customers funds by compliance with the bank secrecy act. As 

crypto-exchanges lack intermediated access, tax compliance is also compromised as 

there are not brokers to regularly report crypto-transactions through form 1099–Bs. 

31 

3 CFTC Staff Advisory No. 18–14 (May 21, 2018) https://www.cftc.gov/sites/default/files/ 

idc/groups/public/%40lrlettergeneral/documents/letter/2018-05/18-14_0.pdf. 

Furthermore, though both the Securities and Exchange Commission (SEC) and 

Commodity Futures Trading Commission (CFTC) have released numerous public 

advisories, notices and enforcement actions, most crypto-exchanges remain unregistered and operate with limited investors protections. Thousands of ICOs have occurred, most being investment contracts under the securities laws, but only a fraction have recently started complying. Studies repeatedly report that the ICO market 

and crypto-exchanges are rife with scams, frauds and manipulative practices. 

The current patchwork approach to addressing these issues—to guard against illicit activities, protect investors & their funds, and promote market integrity—would 

be better accomplished through application of commodities and securities laws. As 

outlined below, while issuer based crypto is slowly being brought under securities 

laws and crypto-derivatives are clearly under the CFTC and commodities laws, 

there may be a gap Congress considers filling related to cryptocurrencies not subject 

to securities laws, such as Bitcoin, herein called ‘crypto-cash commodities.’ 

While the CFTC has general anti-fraud and anti-manipulation authorities with 

regard to spot transactions in crypto-cash commodities, such as Bitcoin or Ether, the 

agency does not currently have express registration or plenary rule writing authorities with regard to cash commodities. Furthermore, as the CFTC staff recently said 

in an advisory letter, ‘‘virtual currencies are unlike any commodity that the CFTC 

has dealt with in the past.’’ 3

Congress may wish to consider providing the CFTC—or another agency—with 

general authorities to write rules for these markets, including possibly requiring 

registration for trading on crypto-exchanges solely dealing in cryptocurrencies, aka 

crypto-cash commodities. Doing so may best protect investors, limit illicit activity 

and enhance underlying reference markets for crypto-derivatives and exchange traded funds (ETF). It also is critical that the CFTC, SEC and other agencies have sufficient budgetary resources to adequately oversee crypto-markets, especially as these 

markets have continued to grow. 

Clear rules of the road also would allow firms—both incumbents and start-ups— 

to more fully explore investing in blockchain technology or crypto-assets. Start-ups 

have had an advantage over incumbents as they generally differ on how they evaluate taking reputational and regulatory risks regarding uncertain regulatory treatment. 

Bringing the crypto-world within the long-established public policy frameworks, 

though, will promote greater innovation and competition, allowing blockchain technologies to be explored to their fullest potential. 

Comprehensive Review 

Blockchain Technology Potential 

Blockchain technology and cryptocurrencies are an innovative tool for creating 

and moving value on the Internet (digital assets) using blockchains, distributed consensus algorithms, cryptography, and peer to peer networking. Regardless of whether Bitcoin and other cryptocurrencies adequately exhibit the three classic characteristics of money—a store of value, a medium of exchange and a unit of account—they 

do provide a means to move value and run computer code on the Internet without 

relying upon a central intermediary such as a bank. 

That ties blockchain technology and cryptocurrencies directly to the essential 

plumbing of the financial sector, which at its core performs the role of efficiently 

moving and allocating money and risk within the economy. 

Though there are many technical and commercial challenges yet to overcome, 

blockchain technology has the potential to transform the world of finance by creating open protocols to which everyone has access, but nobody has control—to do 

for finance what the web did for information. 

The technology could reduce the ‘‘cost of trust’’—the costs borne by transacting 

parties because they have to rely on their counterparties or a trusted intermediary 

to honestly record completion of the transaction. These costs range widely—from 

those associated with vault doors, cybersecurity, settlement procedures, user identification, compliance teams, security guards, and anti-fraud regimes, to the excess 

amounts that centralized institutions can charge customers. 

Potential use cases include cross-border payments, clearing and settlement for financial transactions, digital identities, trade finance and supply chain management. 

Open permissionless blockchain applications such as Bitcoin have also inspired 

permissioned or private blockchains. The term ‘‘distributed ledger technology,’’ or 

DLT, is often used to describe this field in broader, generic terms. 

32 

4 Value added by private industries: Finance, insurance, real estate, rental, and leasing: Finance and insurance as a percentage of GDP; Federal Reserve Bank of St. Louis (reviewed on 

July 15, 2018) https://fred.stlouisfed.org/series/VAPGDPFI. 5 CoinMarketCap (as of July 14, 2018) https://coinmarketcap.com. 6Stats and Facts; ICO Bench (as of July 13, 2018) https://icobench.com/stats. 7 24 Hour Volume Rankings (Exchange); CoinMarketCap (as of July 13, 2018) https:// 

coinmarketcap.com/exchanges/volume/24-hour/. 8Market Cap by Cryptocurrency (as of July 13, 2018); Coin Dance; https://coin.dance/stats. 

With increased competition and innovation in the financial system, DLT—both 

permissionless and permissioned—offers a catalyst for change by incumbents or as 

an opportunity for entrepreneurial start-ups, potentially lowering costs, risks and 

economic rents in the financial sector which represents 7.5% of the U.S. economy.4

To reach its potential, though, blockchain technology and the world of crypto-finance, must come fully within long established public policy frameworks. 

Crypto Finance 

Blockchain technology has given rise to the latest addition to an ever-evolving 

global financial system. The world of crypto-finance—with total market capitalization of $250 billion,5 its innovative forms of crowdfunding and trading on cryptoexchanges—has so far operated largely outside established investor protection 

frameworks. 

To date, 3800 ICOs have launched 6 and 200 crypto-exchanges are operating 7 with 

tens of millions of customers worldwide. About 55 percent of the crypto-market 

value is now in tokens other than Bitcoin.8

Cryptocurrencies by Market Cap 

coin.dance 

The market is volatile but has grown significantly over the years as shown in the 

following figure of historical market capitalization. 


11514001.eps
33 

9 All-Time Cumulative ICO Funding; CoinDesk (as of July 13, 2018) https:// 

www.coindesk.com/ico-tracker/. 

Cryptocurrency Market Caps (Historical) 

coin.dance 

Tokens and Initial Coin Offerings 

Burgeoning investor interest in crypto-assets along with the potential for tokenbased economies, has led to a new means of raising capital for blockchain-based 

projects: initial coin offerings (ICOs) and similar token sales. 

By their very nature and design, ICOs and similar token offerings mix economic 

attributes of both investment and potential consumption. Marketing documents describe utility-like qualities for the token’s stated purpose on a decentralized network, but there is almost always a strong investment component to token sales as 

they fund development of underlying software and a network. Thus, ICOs are quite 

different from tokens for a neighborhood laundromat, tickets to the theatre or donation-based crowdfunding platforms such as Kickstarter or GoFundMe. 

ICO investors bear economic risk related to the success or failure of the network 

in which the token is to potentially circulate. Investors lose if the network isn’t completed or falls short of hoped for public adoption, but they may gain if the network 

widely succeeds. ICOs are typically marketed online with the release of a 

whitepaper prior to the launch of a new blockchain-based decentralized application. 

ICO tokens are structured with attributes to promote marketability and potential 

appreciation. They usually include a so-called ‘monetary policy’ which is encoded in 

the software, defining the future supply of tokens and introducing an element of 

scarcity. They are fungible or interchangeable which enhances liquidity. They are 

often listed on crypto-exchanges, boosting marketability and transferability. 

Development and support of the network, though often open-sourced, tends to be 

largely concentrated around the issuing company or foundation and other closely 

aligned developers. The selling company, related foundation and founders usually 

retain a meaningful portion of pre-issued tokens and are motivated to increase the 

value of the tokens. 

Nearly every ICO token’s economic realities—its risks, expectation of profits, monetary policies, manner of marketing, and capital formation—are attributes of investment schemes. 

Issuance has ballooned in the last 12 months, with CoinDesk reporting total ICO 

issuance of nearly $20 billion through June 30. There are no authoritative data 

sources, however, and most data aggregators are relying on ICO issuers to self-report the amount they raised. EOS raised $4.2 billion through a year-long ICO and 

Telegram Group raised $1.7 billion in two private offerings. CoinDesk reports $14 

billion raised so far in 2018 versus just over $5 billion in all of 2017.9


11514002.eps
34 

10 Nearly Half of 2017 Cryptocurrency ‘ICO’ Projects Have Already Died; FORBES (February 25, 

2018) http://fortune.com/2018/02/25/cryptocurrency-ico-collapse/. 11 Initial Coin Offerings: Can Regulators Curb the Risks? How Many ICOs Are Scams?; 

VALUEWALK (March 30, 2018) https://www.valuewalk.com/2018/03/initial-coin-offerings-regulators-curb-risks/. 12 ICO Quality: Development & Trading; Sherwin Dowlat & Michael Hodapp of Satis Group 

(March 21, 2018) https://medium.com/satis-group/ico-quality-development-trading-e4fef28df04f. 13 Hundreds of Bitcoin Wannabes Show Hallmarks of Fraud; WALL STREET JOURNAL (May 17, 

2018) https://www.wsj.com/articles/buyer-beware-hundreds-of-bitcoin-wannabes-show-hallmarks-of-fraud-1526573115. 14 Venture Capital Funding Report 2017; CB Insights https://www.cbinsights.com/research/ 

report/venture-capital-q4-2017/. 15Move deliberately, fix things: How Coinbase is building a cryptocurrency empire; WASHINGTON POST (May 17, 2018) https://www.washingtonpost.com/business/economy/move-deliberately-fix-things-how-coinbase-is-building-a-cryptocurrency-empire/2018/05/17/623d950c-587c11e8-858f-12becb4d6067_story.html?utm_term=.a18c45536e2b. 

All-Time Cumulative ICO Funding 

Many start-ups are turning to this market to raise capital as there are significant 

valuation differences versus traditional venture capital funding. The valuation disparity may be due, amongst other things, to the public’s speculative interest, the 

potential to share in the network effects of token economies, the token’s greater liquidity, reduced transactions costs or regulatory arbitrage. 

There is a high failure rate for ICOs. One study in February of 2018 found that 

59% of a sample of 2017 ICOs had already failed or semi-failed.10 There also is a 

considerable amount of fraud and scams in this field, with numerous ICOs targeting 

retail investors, using celebrity endorsers, and promising short-term gains. Estimates vary considerably with 25 percent 11 to 81 percent as scams.12 A recent Wall 

Street Journal analysis of over 1400 ICOs found ‘‘rampant plagiarism, identity theft 

and promises of improbable returns.’’ 13

As cheap money, though, will always displace expensive money (from an entrepreneur’s perspective), if valuation disparities continue, it is possible that ICO funding will grow further to displace a significant portion of the $160 billion venture 

capital raised annually around the globe.14 This changing venture funding landscape highlights the need for investor protection to keep pace with market developments. 

Crypto-Exchanges 

Once Bitcoin developed as the first cryptocurrency, it was only natural that secondary markets and exchange trading would develop. 

In aggregate, crypto-exchanges now have tens of millions of customers. Coinbase, 

alone, has over 20 million accounts, almost as many as Fidelity Investments, more 

than twice brokerage firm Charles Schwab and nearly as many as Vanguard has 

investors.15


11514003.eps
35 

16 24 Hour Volume Rankings (Exchange); CoinMarketCap (as of July 13, 2018) https:// 

coinmarketcap.com/exchanges/volume/24-hour/. 17 36 bitcoin exchanges that are no longer with us, Brave New Coin (October 23, 2015) https:// 

bravenewcoin.com/news/36-bitcoin-exchanges-that-are-no-longer-with-us/. 18 Nine Japanese Crypto Exchanges Have Suspended Operations So Far, Bitcoin.com (April 13, 

2018) https://news.bitcoin.com/nine-japanese-crypto-exchanges-have-suspended-operations-sofar/. 19 Chasing fake volume: a crypto-plague; Sylvain Ribes (March 10, 2018) https://medium.com/ 

@sylvainartplayribes/chasing-fake-volume-a-crypto-plague-ea1a3c1e0b5e. 20 Announcing the Coinbase Suite of Institutional Products; THE COINBASE BLOG (May 15, 

2018) https://blog.coinbase.com/coinbase-institutional-deea317d23af. 21 12 Biggest Cryptocurrency Hacks In History, Benzinga (November 24, 2017) https:// 

www.benzinga.com/fintech/17/11/10824764/12-biggest-cryptocurrency-hacks-in-history. 22 Coincheck: NEM Foundation Stops Tracing Stolen Coins, Hackers’ Account At Zero, 

COINTELEGRAPH (March 23, 2018) https://cointelegraph.com/news/coincheck-nem-foundationstops-tracing-stolen-coins-hackers-account-at-zero. 23South Korean Exchange Coinrail Hacked, $40 Million in Crypto Reported Stolen; BITCOIN

MAGAZINE (June 11, 2018) https://bitcoinmagazine.com/articles/south-korean-exchange-coinrailhacked-40-million-crypto-reported-stolen/. 24Price Manipulation in the Bitcoin Ecosystem; Neil Gandal, J.T. Hamrick, Tyler Moore, and 

TaliOberman (June 22, 2017) https://tylermoore.utulsa.edu/jme17.pdf. 25Worries Grow That the Price of Bitcoin Is Being Propped Up; NEW YORK TIMES (January 

31, 2018) https://www.nytimes.com/2018/01/31/technology/bitfinex-bitcoin-price.html?dlbk. 

Trading appears to be significant, with over $12 billion in daily volume reported 

last week.16 There are now approximately 200 crypto-exchanges and many others 

have failed. By 2015, one list already had at least 36 failures.17 In 2018, after the 

Japanese Financial Services Agency (JFSA) conducted business reviews of exchanges, at least nine suspended their operations.18

In reviewing exchange volume figures, some caution is in order as market data 

from crypto-exchanges generally is not audited or regulated. Furthermore, exchanges may use wash sales (i.e., trading involving no change in beneficial ownership that is intended to produce the false appearance of trading) to inflate their volume statistics in an effort to report greater market share. One recent study suggests 

up to 95% of OKex’s reported volume may be nonexistent and 82% of Huobi’s may 

be as well.19

These exchanges also have some significant differences from traditional securities, 

derivatives and retail fiat currency exchanges. Crypto exchanges offer direct access 

to customers rather than access through regulated intermediaries, such as broker 

dealers or future commission merchants. Centralized crypto-exchanges also take 

custody of customers crypto and some fiat funds. For instance, Coinbase reports to 

have custody of over $20 billion in customer crypto-funds.20

Crypto-exchanges have had significant problems protecting customers’ funds held 

in custody, usually in digital wallets rather than at a bank, broker dealer, or future 

commission merchants. Numerous hacks have led to significant stolen customer 

funds. Mt. Gox lost $473 million in Bitcoin in 2014.21 Coincheck lost $530 million 

in NEM tokens in 2018.22 A South Korean exchange, Coinrail, was hacked in June 

of 2018, losing $40 million, or fully 30% of customer tokens held in custody.23

Also acting as counterparties to their customers, crypto-exchanges currently have 

limited guardrails against front running, fraud, or other manipulative practices. For 

instance, there are no assurances that order book or sales price information posted 

on these exchanges are current or accurate or that the cryptocurrency held by exchanges in custodial wallets is fully backed with coins on the relevant blockchain. 

There are no rules for best execution or order routing amongst crypto-exchanges. 

There are no rules limiting conflicts of interest or for fair and orderly markets. 

There are no standards for price transparency—either pre-trade or post-trade. There 

are no cops on the beat to protect against manipulative practices. In summary, investors have little basis for confidence in crypto-exchanges’ order books or price discovery function. 

There have been repeated reports of manipulative behavior on these exchanges. 

A study last year reviewed how a trader using two trading bots on the Mt. Gox exchange may have manipulated the price of Bitcoin up eight-fold in 2013.24 In January of 2018, there were reports of an investigation into whether Bitcoin might have 

been manipulated on the Bitfinex exchange in a scheme using the token Tether.25

The Futures Industry Association (FIA) expressed its apprehension about the reference markets for Bitcoin futures. As it stated: ‘‘We remain apprehensive with the 

lack of transparency and regulation of the underlying reference products on which 

these futures contracts are based and whether exchanges have the proper oversight 

36 

26Open letter to CFTC Chairman Giancarlo regarding the listing of cryptocurrency derivatives; Futures Industry Association (December 7, 2017) https://fia.org/articles/open-letter-cftcchairman-giancarlo-regarding-listing-cryptocurrency-derivatives. 

to ensure the reference products are not susceptible to manipulation, fraud, and 

operational risk.’’ 26

The volumes, millions of customers, repeated hacks and ample potential for manipulative behavior, suggest that oversight is worthy by securities, commodities and 

derivatives regulators around the globe. To date, however, this trading activity has 

largely taken place outside of investor protection and market integrity regimes. 

Public Policy Frameworks 

As with the emergence of new technologies in the past, from railroads in the 19th 

century to the Internet in the late 20th century, there have been debates on how 

blockchain technology and crypto-finance might best fit within existing public policy 

and legal frameworks. 

Operating within policy frameworks, though, has helped foster traditional capital 

markets for decades and are just as important for crypto-finance, even if the details 

for achieving the goals may be adapted to accommodate new technologies. 

The public broadly benefits when we: 

• Ensure tax compliance. 

• Guard against money laundering or terrorism financing. 

• Enforce sanctions regimes. 

• Promote financial stability. 

• Protect investors and consumers. 

• Promote market integrity and efficient capital markets. 

• Foster economic inclusion and growth. 

Achieving these broad public policy goals fosters economic growth and is consistent with promoting innovation. 

When investing in any form of financing, whether initial coin offerings, other 

crypto-assets, or in traditional forms, such as stocks or bonds, the public benefits 

from full and fair disclosure from issuers. 

The investing and hedging public benefits from prohibitions against fraud and deceptive sales practices. 

Investors, hedgers, and issuers all benefit from secondary market trading that 

promote transparency and prohibit manipulative practices such as price manipulation, front running, wash sales, and spoofing (i.e., bidding or offering with the intent 

to cancel the bid or offer before execution.) 

The investing and hedging public benefits when conflicts of interest are disclosed 

and minimized. 

Such core principals of investor protection and market integrity are embodied in 

U.S. securities and commodities laws regardless of the form of investment. Such 

common-sense rules of the road bolster confidence in markets and enhances our 

economy. 

Securities Laws, Howey Test & Duck Test 

Despite issuers’ claims that the intended utility function of their tokens should 

place them in a different category from securities, there’s no getting away from 

ICOs’ investment contract attributes which means they should be subject to securities laws. 

In essence, as Indiana poet James Whitcomb Riley wrote over 100 years ago: 

‘‘When I see a bird that walks like a duck and swims like a duck and quacks like 

a duck, I call that bird a duck.’’ 

An important early test of securities laws’ statutory construct related to the Florida orange groves of William Howey, whose company sold land with an option to 

lease the land to an affiliated service company and participate in the profits of the 

crop. Even though not stocks or bonds, the U.S. Supreme Court in 1946 ruled that 

Howey’s land sale agreements satisfied the definition of ‘investment contracts’ under 

the 1933 Securities Act and thus should be regulated as securities. 

The so-called ‘Howey Test’ from this case states that: ‘‘an investment contract for 

purposes of the Securities Act means a contract, transaction or scheme whereby a 

person invests his money in a common enterprise and is led to expect profits solely 

from the efforts of the promoter or a third party.’’ SEC v. W.J. Howey Co., 328 U.S. 

293, 299 (1946). 

The Securities and Exchange Commission (SEC) has now repeatedly spoken out 

about the application of securities laws to initial coin offerings and crypto-exchanges 

37 

27 Bitcoin is Not a Security SEC Chairman; BLOCKEXPLORER NEWS (April 27, 2018) https:// 

blockexplorer.com/news/bitcoin-is-not-a-security-sec-chairman/. 28 After Nasdaq CEO Blesses Cryptocurrency, Investors See Bigger Future for Bitcoin, Others; 

FORBES (April 25, 2018) https://www.forbes.com/sites/kenrapoza/2018/04/25/nasdaq-ceobitcoin-trading-cryptocurrency/#556c526613f4. 29 Bitcoin Sees Wall Street Warm to Trading Virtual Currency; NEW YORK TIMES (May 7, 2018) 

https://www.nytimes.com/2018/05/07/technology/bitcoin-new-york-stock-exchange.html. 30German market weighs Bitcoin futures, HANDELSBLATT GLOBAL (December 13, 2017) 

https://global.handelsblatt.com/finance/german-market-weighs-bitcoin-futures-865045. 31 Ethereum Futures Go Live on UK Trading Platform; COINDESK (May 11, 2018) https:// 

www.coindesk.com/ethereum-futures-go-live-uk-trading-platform/. 32 In the Matter of Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan; (Sept. 17, 2015), 

https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/ 

legalpleading/enfcoinfliprorder09172015.pdf. 33 Bitcoin and Cryptocurrencies Are Commodities, Federal Court Rules, Bitcoin.com (March 7, 

2018) https://news.bitcoin.com/bitcoin-cryptocurrencies-commodities-federal-court-rules/. 34Federal Court in NY Enters Preliminary Injunction Order Against Patrick K. McDonnell and 

his Company CabbageTech, Corp. d/b/a Coin Drop Markets in Connection with Fraudulent Virtual Currency Scheme; CFTC (March 6, 2018) https://www.cftc.gov/PressRoom/PressReleases/ 

pr7702-18. 35 CFTC Sues Obscure Crypto Scheme for Fraud; COINDESK (January 24, 2018) https:// 

www.coindesk.com/cftc-sues-crypto-scheme-big-coin-fraud/. 36My Big Coin Tells Court Tokens aren’t Regulated by CFTC Because they are Not Commodities; CROWDFUND INSIDER (April 5, 2018) https://www.crowdfundinsider.com/2018/04/131518- 

my-big-coin-tells-court-tokens-arent-regulated-by-cftc-because-they-are-not-commodities/. 

offering ICOs for sale. Sounding like poet Riley, SEC Chairman Clayton stated in 

February that ‘‘I believe every ICO I’ve seen is a security. You can call it a coin 

but if it functions as a security, it is a security.’’ 

At a Congressional hearing on April 26, 2018, Chair Clayton divided crypto-assets 

into two areas, those which represent ‘‘a pure medium of exchange’’ and ‘‘tokens, 

which are used to finance projects.’’ He said that a ‘‘pure medium of exchange . . . 

as a replacement for currency’’ such as Bitcoin would not be regulated as a security. 

As for tokens, Chair Clayton said: ‘‘Then there are tokens, which are used to finance projects. I’ve been on the record saying there are very few, there’s none that 

I’ve seen, tokens that aren’t securities.’’ He added ‘‘To the extent something is a security, we should regulate it as a security, and our securities regulations are disclosure-based, and people should follow those and provide the information that we require.’’ 27

Commodities Laws & Crypto Derivatives 

The CFTC has exclusive jurisdiction over the trading of crypto-derivatives on exchanges, i.e., ‘‘designated contract markets’’ (DCMs) and ‘‘swap execution facilities’’ 

(SEFs) for both futures contracts and swaps as well as the trading of over-thecounter crypto-swaps. The CFTC also has general anti-fraud and manipulation authority for spot transactions in commodities traded in interstate commerce. 

Thus, the CFTC has direct jurisdiction for crypto-derivatives. If an exchange offers derivatives on cryptocurrencies, then that exchange must register with the 

CFTC. Crypto-exchanges that offer to U.S. persons ‘retail commodity transactions’ 

as defined in statute, could also be subject to the authority of the CFTC. 

The CME Group and CBOE Global Markets started trading Bitcoin futures in December 2017. Nasdaq 28 and Intercontinental Exchange 29 have both said that they 

are investigating offering cryptocurrency or crypto-derivative trading. Overseas, 

Germany’s largest exchange, Deutsche Bo ̈rse, has said it is considering offering 

Bitcoin futures on its Eurex derivatives exchange.30 A UK start-up, Crypto Facilities, launched an Ether futures contract in May 2018.31

The CFTC in its ‘‘Coinflip Order’’ determined that Bitcoin and other virtual currencies are commodities under the CEA in 2015.32 A U.S. District court subsequently concurred with a latter similar determination.33 Accordingly, the CFTC has 

general anti-fraud and anti-manipulation authority for spot transactions in the underlying reference cryptocurrencies, whether traded on exchanges or over the 

counter. The CFTC has brought a number of actions under this authority, one related to the trading of Bitcoin and Litecoin 34 and another with regards to the trading of My Big Coin.35 My Big Coin, though, is challenging the jurisdiction of the 

CFTC contending that their token is not a commodity.36

The Path Forward 

How do the markets, this new technology, Congress and regulators move forward? 

I will review some considerations organized around the three broad public policy 

goals of: (1) guarding against illicit activity; (2) ensuring for financial stability[;] and 

(3) protecting the investing public. 

38 

37Stealing bitcoins with badges: How Silk Road’s dirty cops got caught; arsTechnica (August 

17, 2016) https://arstechnica.com/tech-policy/2016/08/stealing-bitcoins-with-badges-how-silkroads-dirty-cops-got-caught/. Also see: A Fistful of Bitcoins: Characterizing Payments Among 

Men with No Names; Meiklejohn, Pomarole, Jordon, Levchenko, McCoy, Voekler, & Savage 

(2013) https://cseweb.ucsd.edu/∼smeiklejohn/files/imc13.pdf. 38 9 Anonymous Cryptocurrencies You Should Know About; Coinsutra (February 2, 2018) 

https://coinsutra.com/anonymous-cryptocurrencies/. 39Japan’s Financial Regulator Is Pushing Crypto Exchanges To Drop ‘Altcoins’ Favored By 

Criminals; FORBES (April 30, 2018) https://www.forbes.com/sites/adelsteinjake/2018/04/30/japans-financial-regulator-is-pushing-crypto-exchanges-to-drop-altcoins-favored-by-criminals/ 

#22d47e3e1b8a. 40 Coinbase Considering Cardano, Stellar Lumens, Zcash, 0x & BAT Token Listings; BITCOIN

EXCHANGE GUIDE NEWS (July 13, 2018) https://bitcoinexchangeguide.com/coinbase-consideringcardano-stellar-lumens-zcash0x-bat-token-listings/. 41Tor https://www.torproject.org. 42Forget Silk Road, Cops Just Scored Their Biggest Victory Against The Dark Web Drug 

Trade; FORBES (July 20, 2017) https://www.forbes.com/sites/thomasbrewster/2017/07/20/ 

alphabay-hansa-dark-web-markets-taken-down-in-massive-drug-bust-operation/#72702fd15b4b. 

Guarding Against Illicit Activity 

On balance, though, blockchain technology and cryptocurrencies have given the official sector new challenges in guarding against illicit activities. The crimes aren’t 

generally new. The means and methods, though, particularly of payment, may be. 

The pseudonymous nature of blockchain-based records obscures the identity of actors, raising concerns for law enforcement authorities tasked with guarding against 

illicit activities. At the same time, the private sector has had legitimate concerns 

about the privacy of data shared on Bitcoin and other open permissionless 

blockchain applications. 

Interestingly, Bitcoin and other blockchain applications while often referred to 

anonymous, are more accurately what security experts would call pseudonymous. 

Bitcoin transactions do not include names of individuals or companies, but they do 

provide Bitcoin addresses, which if found to be linked to any personal data, such 

as your e-mail or ISP address, may allow for some transparency. Thus, blockchain 

technology allows some information about participants to be gleaned from patterns 

in the transaction records, balances in the unspent transactions outstanding and 

blockchain forensics.37

Given the pseudonymous nature of Bitcoin, it was only a matter of time and technological innovation before a number of cryptocurrencies would be developed promoting more anonymity. These anonymity-focused-crypto-assets have specific designs that make their transactions harder to track on their underlying blockchains. 

Monero, Dash and Zcash are the three with the largest market capitalization, totaling about $5 billion, but many more exist and are marketed to the public.38 It has 

been reported that Japan this spring has been encouraging crypto-exchanges to halt 

listings of trading anonymity-focused-crypto-assets.39 On the other hand, it has been 

recently reported that Coinbase is considering listing Zcash for the first time.40

Dark Markets 

One of the most harmful activities has been on so-called dark markets. These 

markets operate with anonymous communications through the Tor network, a free 

and open network which provides users anonymous and censorship resistant means 

of communicating on the Internet.41 Dark markets have generally used Bitcoin for 

escrowed payments. They list for sale illegal drugs, weapons, stolen credit card details, and forged documents offered by hundreds or sometimes thousands of vendors. 

U.S. and international enforcement authorities have successfully taken down a 

number of dark markets trafficking in illegal activities, but other markets keep popping up in their place. When the U.S. Department of Justice shut down AlphaBay 

in July of 2017, it was estimated to be ten times larger than the notorious Silk Road 

web site which was shut down in 2013. Dutch authorities, working along with U.S. 

authorities successfully shut down another large dark market, Hansa, just 2 weeks 

later.42

Beyond use on the darknet, there are those around the globe who seek to use 

these new technologies to thwart government oversight of money laundering, tax 

evasion, terrorism financing, or evading sanctions regimes. 

State Actors 

Two high profile uses of cryptocurrencies in efforts to thwart U.S. policy were by 

foreign government actors. In January of 2018, Venezuela announced a $5 billion 

oil-backed ICO called Petro. In response, augmenting previously established sanctions, the President signed an Executive Order in March prohibiting U.S. persons 

39 

43 Executive Order on Taking Additional Steps to Address the Situation in Venezuela; White 

House (March 19, 2018) https://www.whitehouse.gov/presidential-actions/executive-order-taking-additional-steps-address-situation-venezuela/. 44 U.S. v. Netyksho, et al., Indictment; Count ten, paragraph 57 (July 13, 2018) https://assets.bwbx.io/documents/users/iqjWHBFdfxIU/rs96.XUFx2Gw/v0. 45 IRS virtual currency guidance: Virtual currency is treated as property for U.S. Federal tax 

purposes; General rules for property transactions apply; IR–2014–36; IRS (March 25, 2014) 

https://www.irs.gov/newsroom/irs-virtual-currency-guidance. 46The Truth About Cryptocurrency And Like-Kind Exchanges; FORBES (February 19, 2018) 

https://www.forbes.com/sites/tysoncross/2018/02/19/the-truth-about-cryptocurrency-and-likekind-exchanges/#33c7cdc26fd1. 47 2018 Instructions for form 1099–B; IRS https://www.irs.gov/pub/irs-pdf/i1099b.pdf. 48 Coinbase Notifies Customers That It Will Turn Over Court-Ordered Data; FORBES (February 

28, 2018) https://www.forbes.com/sites/kellyphillipserb/2018/02/28/coinbase-notifies-customers-that-it-will-turn-over-court-ordered-data/#390113ca1431. 49 Report of Foreign Bank and Financial Accounts (FBAR); IRS https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar 50 Bitcoin, FBAR, and the Offshore Voluntary Disclosure Program: A Primer for Expats; Greenback Expat Tax Services (March 22, 2018) https://www.greenbacktaxservices.com/blog/expattaxes-on-bitcoin-fbar/. 

from purchasing or dealing in any digital currency, coin or token of the Government 

of Venezuela.43

On July 13, 2018, the U.S. charged 12 Russian military intelligence officers with 

conspiracy to interfere with the 2016 elections. Amongst the charges, count ten alleges conspiracy to launder money. It reads, in part: ‘‘the defendants conspired to 

launder the equivalent of more than $95,000 through a web of transactions structured to capitalize on the perceived anonymity of cryptocurrencies such as bitcoin.’’ 

It is alleged that: ‘‘they principally used bitcoin when purchasing servers, registering domains, and otherwise making payments in furtherance of hacking activity.’’ The indictment states that: ‘‘The use of bitcoin allowed the Conspirators to 

avoid direct relationships with traditional financial institutions, allowing them to 

evade greater scrutiny of their identities and sources of funds.’’ 44

Tax Compliance 

The U.S. Internal Revenue Service issued guidance in 2014 on the use of what 

they called ‘virtual currencies’, such as Bitcoin and other crypto-assets. In determining that all virtual currencies are treated as property for U.S. tax purposes, the 

IRS said that general tax principals applicable to property transactions apply to virtual currencies. Taxpayers receiving virtual currencies for payment of goods and 

services must include their fair market value in their reported gross income. 

Taxpayers also are required to include in income any gains or losses upon a sale 

or exchange of virtual currencies.45

One open question that investors and tax practitioners had had was the appropriate treatment under the tax laws of crypto to crypto-exchanges. The law was 

clear that tax could be deferred by treating these trades as so-called ‘like-kind exchanges’ under IRS section 1031. If that was even possible prior to 2018, it no 

longer is now, with amendments to Section 1031 included in the Tax Cut and Jobs 

Act to make like-kind exchanges only applicable to real estate transactions.46

One challenge for tax compliance is that crypto-exchanges have not yet been sending form 1099–B, reporting on transactions, to their customers and the IRS. The 

IRS requires brokers to do so with regard to all broker or barter exchange transactions.47 As discussed elsewhere, though, the current model for crypto-exchanges 

does not generally include brokers, leaving a significant gap in tax reporting. The 

U.S. Internal Revenue Service had to win in Federal court before the crypto-exchange Coinbase was willing to share information on their most active customer accounts—approximately 13,000 accounts—with the IRS.48

The IRS, if need be working with Congress, should close this gap and require 

crypto-exchanges lacking intermediated brokered access to provide customers and 

the IRS with form 1099–B for their crypto and other property transactions. In addition, the IRS should close gaps with regard to requirements for taxpayers with offshore crypto-accounts on filing a report of foreign bank and financial accounts 

(FBAR).49 This has been a gray area which could undermine tax compliance.50

First Line of Defense—Money Transmission Laws 

There is a widely held view amongst most policy officials globally that we must 

guard against such threats—whether by state actors or private-sector actors— 

though how best to do so has been up for debate. 

The first line of defense has been through money transmission laws and bank secrecy laws requiring compliance with anti-money laundering (AML), combating financing of terrorism (CFT), and know your customer (KYC) laws. The U.S. TreasVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00043 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
40 

51FIN–2013–G001; Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies; Department of Treasury (March 18, 2013) https:// 

www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf. 52Letter to Senator Ron Wyden, FinCEN (February 13, 2018) https://coincenter.org/files/ 

2018-03/fincen-ico-letter-march-2018-coin-center.pdf. 53Department of Financial Services BitLicense Regulatory Framework; New York State (June 

24, 2015) https://www.dfs.ny.gov/legal/regulations/bitlicense_reg_framework.htm. 54S Korea bans anonymous cryptocurrency trades; BBC NEWS (January 23, 2018) http:// 

www.bbc.com/news/business-42784384. 

ury’s Financial Crime Enforcement Network (FinCEN) put out guidance on this regard starting in 2013 51 and most recently in a letter to Congress.52

More could be done, though, directly overseeing the crypto-ecosystem and at the 

intersections of the traditional financial sectors, e.g., banking and payments networks, to perform KYC and to minimize the risk of the illicit use of blockchain networks. 

Crypto-Exchanges and Wallets—Critical Gateways 

Crypto-exchanges and digital wallet companies, if properly regulated, may provide 

one of the most critical gateways to protect against such illicit transmissions of 

value. Both crypto-exchanges and digital wallets provide customers the ability to 

store crypto-assets and transact electronically. (Many provide fiat currency services 

as well.) 

This gateway to effect public policy is particularly important as crypto-exchanges 

allow for direct public access. In contrast, traditional securities and derivatives exchanges are accessed through intermediaries such as banks, broker-dealers or futures commission merchants (FCM), giving authorities important gateways to monitor and enforce the law. Thus, in the crypto-world, tax authorities and financial 

crimes enforcement will have to look to exchanges, custodians, investors or 

blockchain forensics companies, for reporting on crypto-transactions, taxable gains 

or losses, and any illicit activity. 

In the U.S., in the absence of Federal registration, crypto-exchanges are required 

to comply with money transmission laws and to register in each state according to 

those individual state laws. This is a cumbersome and inconsistent process even for 

those well-meaning companies seeking to comply. Few exchanges have done so in 

all jurisdictions, raising questions of possible noncompliance. New York State, 

through its BitLicense, has acted to bring exchanges within enhanced money transmission laws.53 Federal registration and oversight—through commodities and securities laws—would be a better public policy solution than this current patchwork approach. 

Japan moved in 2017 to regulate crypto-exchanges primarily for money transmission and their custodial duties. Korean authorities banned exchanges from trading for anonymous accounts 54 and subsequently began investigating numerous exchanges for fraud and other misconduct. 

As many jurisdictions around the globe, however, do not yet have specific regulatory regimes governing crypto-exchanges it puts an even greater burden on U.S. 

authorities, financial sector and laws. ‘‘There are significant challenges to investigating foreign virtual currency businesses, because most jurisdictions do not regulate and supervise virtual currency businesses,’’ a Treasury official wrote in the letter FinCEN sent to Congress in February 2018. 

Decentralized Crypto-Exchanges—Challenges Ahead 

Decentralized crypto-exchanges, still only a modest portion of the crypto-markets, 

may present even greater challenges. These exchanges provide for peer-to-peer trading based upon open-source algorithms with no centralized platform and no custody 

of funds. Thus, decentralized exchange protocols, might help provide a solution for 

the security of customer funds, if they truly don’t hold those digital assets. On the 

other hand, though, they may pose additional challenges to authorities trying to 

guard against illicit activities, particularly for crypto-to-crypto trading. 

If decentralized exchanges facilitate trading of fiat currency vs. cryptocurrency, 

regulators might be able to implement policy by restricting regulated intermediaries 

or their customers in transacting with such platforms. 

Ensuring for Financial Stability 

It is important to ensure that blockchain technology, cryptocurrencies and cryptoexchanges do not undermine financial stability, in normal times or in stressful economic times. 

Financial Stability Board—Initial Assessment 

41 

55To G20 Finance Ministers and Central Bank Governors; Financial Stability Board (March 

13, 2018) http://www.fsb.org/wp-content/uploads/P180318.pdf. 56Market capitalization of listed domestic companies; The World Bank (as of December 31, 

2017) https://data.worldbank.org/indicator/CM.MKT.LCAP.CD. 57Global debt monitor; Institute of International Finance (July 9, 2018) https://www.iif.com/ 

publication/global-debt-monitor/global-debt-monitor-july-2018. 58World Gold Council (as of July 13, 2018) https://www.gold.org/about-gold/gold-supply/ 

gold-mining/how-much-gold-has-been-mined. 59The Best Bitcoin and Cryptocurrency Trading Platforms; BITREVIEW (as of July 12, 2018) 

https://bitreview.com/trade/bitmex/. 60 ISDA Publishes Digital Iteration of the Common Domain Model; ISDA (June 5, 2018) 

https://www.isda.org/2018/06/05/isda-publishes-digital-iteration-of-the-common-domainmodel/. 61 Enterprises Building Blockchain Confront Early Tech Limitations; COINDESK (March 23, 

2018) https://www.coindesk.com/enterprises-building-blockchain-confront-tech-limitations/. 

The Financial Stability Board (FSB), an international group that makes recommendations about the global financial system, stated in its open letter in March 

2018 to the G20 heads of state, that ‘‘The FSB’s initial assessment is that cryptoassets do not pose risks to global financial stability at this time.’’ 55 They noted that 

even at their peak earlier this year, the overall market value was less than 1% of 

global GDP. 

The current market value of all crypto-assets is approximately $250 billion relative to global equity markets of approximately $80 trillion as of 2017 year-end 56

and global debt outstanding as of March 31, 2018 of approximately $250 trillion.57

The world’s 190,000 tons of gold 58 are worth about $7 trillion in aggregate at recent 

market prices of $1,243 per ounce. 

The FSB noted, however, that their assessment could change if crypto-finance became more interconnected with the core of the regulated financial sector. In that 

regard, it is worthwhile to consider three areas worthy of monitoring: (1) leverage 

in crypto-markets; (2) market infrastructure blockchain initiatives; and (3) central 

bank digital currencies. 

Leverage in Crypto-Markets 

Given the high volatility of crypto-assets, significant leverage could add to instability and stress, particularly during down markets. While Bitcoin futures listed at 

CME and CBOE require nearly 50% margin, most crypto-exchanges allow for much 

lower margin (and thus higher leverage) when trading Bitcoin and many other 

crypto-assets. BitMEX provides 100:1 leverage (only 1% margin) for Bitcoin trading. 

Many other exchanges allow offer leverage above 10:1.59 Furthermore, given that 

many exchanges lack transparency and remain unregulated, it may be challenging 

for central banks and others responsible for financial stability to influence the 

amount of leverage in crypto-markets or get an accurate window into these markets. 

Market Infrastructure—Blockchain Initiatives 

Blockchain technology and other forms of distributed ledger technology raise the 

possibility of replacing various centralized market infrastructures. This could lower 

costs, limit counterparty risks, promote innovation and economic inclusion. It may 

also lower the systemic risks associated with centralized market infrastructures for 

payments, clearing, settlement and other shared functions. Though Bitcoin is now 

nearly 10 years old, these technologies are still untested in any economy-wide (or 

even enterprise-wide) production. Any widescale use of blockchain technology within 

the financial sector will need to be considered in light of their potential resilience 

to various risk vectors—economic, cyber, operating and otherwise. 

Possibly most relevant to this Committee’s work, there are efforts underway to 

use blockchain smart contracts to help automate post trade event management for 

uncleared swaps. The International Swaps and Derivatives Association (ISDA) is 

working with Regnosys to produce a digital version of ISDA’s Common Domain 

Model for numerous swap transaction and life cycle processes. The goal is to provide 

the market with a standard set of digital definitions and smart contracts to reduce 

costs and counterparty risk.60

There are other clearing and settlement use cases of note, though as stated, none 

are live at this time. The Depository Trust and Clearing Corporation’s (DTCC) has 

delayed its initiative, working with IBM, to implement a permissioned blockchain 

for credit default swap clearing and record keeping at its Trade Information Warehouse.61 Nasdaq, partnering with blockchain startup Chain, is experimenting with 

a number of blockchain applications, including for clearing and settlement for priVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00045 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
42 

62 Nasdaq Exec: Exchange Is ‘All-In’ on Using Blockchain Technology; THESTREET (April 23, 

2018) https://www.thestreet.com/investing/nasdaq-all-in-on-blockchain-technology-14551134. 63 CHESS Replacement, ASX is replacing CHESS with distributed ledger technology (DLT) developed by Digital Asset; ASX (December 2017) https://www.asx.com.au/services/ 

chessreplacement.htm. 64 Central bank digital currencies; Bank for International Settlements, Committee on Payments and Market Infrastructures (March 2018) https://www.bis.org/cpmi/publ/d174.pdf. 65Stable Coins Analysis: Is There A Viable Solution For The Future?; COINTELEGRAPH (May 

14, 2018) https://cointelegraph.com/news/stable-coins-analysis-is-there-a-viable-solution-for-thefuture. 66 AIOSCO Board Communication on Concerns Related to Initial Coin Offerings (ICOs); 

IOSCO (January 18, 2018) http://www.iosco.org/news/pdf/IOSCONEWS485.pdf. 67 Regulators’ Statements on Initial Coin Offerings; IOSCO https://www.iosco.org/publications/?subsection=ico-statements. 

vate securities transactions for non-listed companies.62 Overseas, the most noted initiative is that of the Australian Stock Exchange which announced last year that it 

would replace its entire clearing and settlement infrastructure with a permissioned 

distributed ledger-based solution developed by Digital Asset Holdings.63

Central Bank Digital Currencies 

Last, Bitcoin and cryptocurrencies has led to healthy debates within the central 

banking and economics communities on the pros and cons of central banks issuing 

retail central bank digital currencies (CBDC) and if so, the effects that might have 

on payment systems and the commercial banking system.64 Central banks already 

issue digital currency, but only to commercial banks, in the form of bank reserves. 

The public—merchants and consumers alike—can only access paper currency or 

bank deposits. In the U.S. that is in the paper form is Federal Reserve Notes. 

The debate is whether to utilize blockchain technology to give greater access to 

either central bank payment systems and/or reserves to merchants or the wider 

public. In part this is being considered by central banks in an effort to stay abreast 

of rapid changes in payment methods and means of commerce, such as mobile payments, digital wallets and in some countries, the decline in the use of paper notes. 

In addition, central banks may find that they will be reacting to private-sector initiatives to issue so-called ‘stable value’ tokens designed to have stable prices or values and tied to or backed by fiat currency. Though stable value tokens to date, such 

as Tether, have had many challenges, some observers think that such an effort has 

potential.65

Thus, the question CBDC raises for financial stability is with direct access to central bank digital currencies what portion of consumer deposits would move away 

from commercial banks and what effects would such migration have on lending and 

the overall economy? Furthermore, in times of stress or financial uncertainty, the 

public might move a significant portion of their money away from commercial banks 

to the central bank, potentially aggravating instability in the financial sector. 

Protecting the Investing Public 

As noted above, the $250 billion crypto-markets currently operate largely outside 

of traditional investor protection norms. This is in spite of the SEC repeatedly publishing advisories and making public statements that most ICOs and the crypto-exchanges trading in such tokens must comply with U.S. securities laws. 

Thus, it is not surprising that the crypto-markets are now known for high levels 

of fraud, scams and manipulative behavior. I will now review the need for investor 

protection in each of the three segments of the crypto-markets: (1) crypto-tokens— 

ICOs or issuer or based, (2) crypto-derivatives[;] and (3) cryptocurrencies (aka 

crypto-cash commodities). Following this, I will touch upon the critical need to address crypto-custodial functions. 

Crypto-Tokens—ICOs or Issuer-Based 

The burgeoning market and the economic realities of ICOs or issuer-based tokens 

has led to robust debates around the globe over the appropriate regulations to apply 

to their issuance and trading. The International Organization of Securities Commissions (IOSCO) board expressed its concerns in a statement stating that: ‘‘ICOs are 

highly speculative investments in which investors are putting their entire invested 

capital at risk. . . . the increased targeting of ICOs to retail investors through online distribution channels . . .—raises investor protection concerns. There have also 

been instances of fraud, and as a result, investors are reminded to be very careful 

in deciding whether to invest in ICOs.’’ 66

Individual countries’ securities regulators have also been active in releasing statements regarding ICOs, cryptocurrencies, and exchanges. IOSCO lists statements 

from 40 countries regarding ICOs.67

43 

68 CSA Staff Notice 46–307, Cryptocurrency Offerings; Ontario Securities Commission (August 

27, 2017) http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20170824_cryptocurrency-offerings.htm. 69State and Provincial Regulators in U.S. and Canada Target Initial Coin Offerings; the 

WALL STREET JOURNAL (May 21, 2018) https://www.wsj.com/articles/state-and-provincial-regulators-in-us-and-canada-target-initial-coin-offerings-1526918512. 70Digital Asset Transactions: When Howey Met Gary (Plastic); William Hinman, SEC (June 

14, 2018) https://www.sec.gov/news/speech/speech-hinman-061418. 71Order Instituting Cease-and-desist Proceedings Pursuant to Section 8A of the Securities Act 

of 1933, making Findings, and Imposing a Cease-and-desist Order (Release No. 10445) (December 11, 2017) https://www.sec.gov/litigation/admin/2017/33-10445.pdf. 

In the U.S., it is now the case that most ICO related tokens, and the crypto-exchanges that list them must comply with securities laws. Unfortunately, though, 

most are not yet doing so. The SEC’s effort to date has yet to bring this market 

into compliance. 

We’ve already seen high levels of fraud and loss of funds in these markets. Currently, a growing and potentially significant portion of the capital markets—cryptofinance—is not benefiting from basic investor protections. 

When determining what is an investment contract under their securities laws, 

Canada has a similar approach to that of the U.S. Howey Test.68 Provincial regulators from Canada joined with state regulators in the U.S. in May 2018, in a coordinated action against ICOs named ‘‘Operation Cryptosweep’’ with nearly 70 open 

investigations and 35 enforcement actions.69

The SEC to date has used public advisory statements, speeches, testimony and 

enforcement actions against some of the most obvious offenders but has a great deal 

of work ahead of them to bring the issuer-based crypto-market into compliance. 

The SEC’s Director of the Division of Corporate Finance, William Hinman, sought 

to give additional direction in a speech on June 14, 2018. He noted that ‘‘a digital 

asset transaction may no longer represent a security offering [where] the network 

on which the token or coin is to function is sufficiently decentralized—where purchasers would no longer reasonably expect a person or group to carry out essential 

managerial or entrepreneurial efforts.’’ In explaining that decentralization may reduce information asymmetries, he said: ‘‘[W]hen the efforts of the third party are 

no longer a key factor for determining the enterprise’s success, material information 

asymmetries recede.’’ Moreover, ‘‘[a]s a network becomes truly decentralized, the 

ability to identify an issuer or promoter to make the requisite disclosures becomes 

difficult, and less meaningful.’’ 70

While the number of ICOs being sold under exempt securities offerings (i.e., Reg 

D filings) is increasing, many ICOs are still sidestepping these requirements. Furthermore, while there are reports that a number of crypto-exchanges are in discussions with the SEC about registering as broker dealers and complying with Reg 

ATS, none have yet fully done so. That means that these exchanges are currently 

likely operating in the breach. 

To bring greater clarity to these markets, the SEC must also determine how best 

to bring into compliance the over 1000 ICOs and numerous crypto-exchanges still 

in operation in the U.S. What remediation and possible penalties are appropriate? 

One petitioner recommended retroactive registration along with investor rescission 

rights. Some requirements, such as satisfying requirements to track beneficial ownership may be difficult for these past ICOs. 

Another challenge is that though SEC Chair Clayton has been clear that nearly 

all of the ICO market need comply with securities laws, until more enforcement actions are brought, potentially litigated and upheld in court, many issuers and exchanges will possibly continue to skirt their obligations. As the SEC stated in its 

Munchee Order, it will take more than semantics and more than a token being functional on a network to be exempt from securities regulation.71

The crypto-markets have gotten some clarity with the SEC stating that the two 

largest coins, Bitcoin and Ether are not currently securities. There are strong cases 

to be made, though, that a number of the other large market cap tokens are noncompliant securities. If large market cap tokens, such as XRP (sold by Ripple) or 

EOS (sold by Block.one), are concluded to be non-compliant securities—there are 

strong arguments that they pass the Howey Test and are—exchanges offering trading in these tokens will need to comply with SEC regulatory requirements or cease 

offering these products. 

Also, the SEC will need to decide if they might issue rules and interpretations 

specific to the crypto-space. To date, they have chosen not to do so, but with the 

advent of the Internet and electronic trading in the 1990s, the SEC issued a number 

of new regulations for those novel market developments. A similar approach could 

be adopted here. 

44 

72 Retail Commodity Transactions Involving Virtual Currency—80 FR 60335. 73 CFTC Staff Advisory No. 18–14 (May 21, 2018). 74Digital Asset Transactions: When Howey Met Gary (Plastic); William Hinman, SEC (June 

14, 2018) https://www.sec.gov/news/speech/speech-hinman-061418. 

Crypto-Derivatives 

If an exchange offers derivatives on cryptocurrencies, then that exchange must 

register with the CFTC either as a DCM or as a SEF. Exchanges that offer leverage 

or margin for the purchase of cryptocurrencies may come under the definition of offering ‘retail commodity transactions’ and thus also be required to register. 

The CFTC has yet to finalize a proposed interpretation that may help determine 

the breadth of crypto-exchanges that will need to register.72 Under the CEA, the 

CFTC has jurisdiction over any retail commodity transaction entered into on a leveraged or margined basis that does not result in actual delivery of the underlying 

commodity within 28 days. Under a proposed CFTC interpretation, ‘‘actual delivery’’ 

occurs if within 28 days of execution, only if a full transfer of the cryptocurrency 

is transferred between the seller and buyer as recorded on the relevant blockchain 

(not merely on the exchange’s data base or wallet), whether it is reflected on the 

recipient’s private wallet and whether the recipient has control of the private key. 

Given how crypto-exchanges’ transactions are currently being conducted for 

levered or margined cryptocurrency, many exchanges may be holding 

cryptocurrencies for retail customers that do not satisfy the ‘‘actual delivery’’ exemption. These crypto-exchanges therefore might be offering trading of a form of a retail 

commodity transaction subject to CFTC regulations. 

Thus, the CFTC’s final interpretation with regard to the definition of ‘actual delivery’ will be important. At one end—nearly all of the crypto-exchanges offering margin to the retail public would need register with the CFTC. At the other end for 

the final interpretation—gaps in crypto-exchange market integrity and custodial duties oversight will persist. 

The CFTC issued an advisory in May 2018 with respect to crypto-derivatives listings. The CFTC staff expressed guidance on enhanced procedures for exchanges and 

clearinghouses listing derivatives contracts on virtual currency. These enhancements include an expectation that exchanges, and clearinghouses enter into information sharing arrangements with the underlying crypto-spot market(s).73

Another challenge for regulators is that blockchain technology provides for new 

algorithmic means to structure binary options and contracts for differences, all of 

which are derivatives under the jurisdiction of the CFTC. The bitcoin scripting language and smart contracts used on other networks provide ways to structure peerto-peer derivatives which execute and settle automatically based upon pre-arranged 

conditions. These blockchain based derivatives could reference any commodity—agricultural, metals, energy or financial. The CFTC and other regulators will want to 

ensure that this new technology does not presage a new and growing unregulated 

or dark swaps market. 

Cryptocurrencies (aka Crypto-Cash Commodities) 

Gaps in investor protection also have developed for crypto-exchanges solely trading cash cryptocurrencies. As previously discussed, crypto-exchanges currently have 

limited guardrails against front running, fraud, or other manipulative practices. 

There have been repeated reports of manipulative behavior on these exchanges. 

There have been repeated reports of stolen customer funds through cyber hacks. As 

mentioned, the FIA expressed its apprehension about the lack of transparency and 

regulation of the crypto-cash commodities markets underlying Bitcoin futures. 

Currently nearly 70% of the crypto-markets’ $250 billion total capitalization is 

represented by the five cryptocurrencies which have either been designated by the 

SEC as not securities (Bitcoin and Ether) 74 or were forks off of Bitcoin or Ether 

(Bitcoin Cash in 2017, Litecoin in 2011, Ethereum Classic in 2016). 

The CFTC has general anti-fraud and anti-manipulation authorities with regard 

to spot transactions in these crypto-cash commodities, such as Bitcoin or Ether. This 

authority is critical for cryptocurrencies referenced in the derivatives markets but 

may be increasingly important as well for retail investors in crypto-cash commodities. The agency, though, does not currently have express registration or plenary 

rule writing authorities with regard to cash commodities. 

One troubling recent development highlights the need for such authorities. The 

CME was unable to get underlying transaction data from the four crypto-exchanges 

upon which they rely for the Bitcoin index referenced by their Bitcoin futures contract. It’s been reported that these four exchanges (Bitstamp, Coinbase, Itbit, and 

45 

75What Do We Know About the CFTC Price Manipulation Probe; COINTELEGRAPH (June 15, 

2018) https://cointelegraph.com/news/what-do-we-know-about-the-cftc-price-manipulationprobe. 76SEC Release No. 34–80206; File No. SR–BatsBZX–2016–30; March 10, 2017 https:// 

www.sec.gov/rules/sro/batsbzx/2017/34-80206.pdf. 77Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings; SEC (January 18, 2018) https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency011818.htm. 78 CFTC Staff Advisory No. 18–14 (May 21, 2018). 79Proposal for a Self-Regulatory Organization for the U.S. Virtual Currency Industry; Cameron Winklevoss (March 12, 2018) https://medium.com/gemini/a-proposal-for-a-self-regulatoryorganization-for-the-u-s-virtual-currency-industry-79e4d7891cfc. 

Kraken) refused to provide the data until the CFTC stepped in with subpoenas.75

It is critical to the functioning of any crypto-derivatives markets that both self-regulatory organizations and government regulators have ready access to trading data 

for the underlying referenced crypto-cash commodities. 

The SEC is grabbling with similar issues with regard to its review of possible 

crypto-related ETFs and crypto-investing by mutual funds. The SEC has rejected a 

number of filings for Bitcoin ETFs, starting with the Winklevoss Bitcoin Trust 

(COIN ETF) in March 2017. The SEC stated two requirements that the exchanges 

had not must satisfied in order to list a Bitcoin ETF: ‘‘the exchange must have surveillance-sharing agreements with significant markets for trading the underlying 

commodity or derivatives on that commodity. And second, those markets must be 

regulated.’’ It further cited ‘‘concerns about the potential for fraudulent or manipulative acts and practices in this market.’’ 76

In a subsequent staff letter published in January 2018, the SEC raised a series 

of questions regarding, amongst other things, appropriate valuation methods available for crypto-assets, liquidity of crypto-markets, custody of crypto-funds and potential manipulation in these markets.77

Failing to better oversee the crypto-cash commodities markets also leaves investors vulnerable, illicit activity hard to control and custodial responsibilities to vagaries of state enforcement of money transmitter laws. The volumes, millions of customers, repeated hacks and reports of manipulative behavior, suggest that oversight 

of crypto-exchanges trading solely in crypto-cash commodities is worthy of consideration. 

Furthermore, as the CFTC staff discussed in their recent advisory, there are differences between crypto-cash commodities and other commodities. They said: 

‘‘To date, virtual currencies have gained prominence as they are bought and 

sold for investment, speculative, or financial purposes. Those transactions greatly predominate over commercial uses of virtual currency—such as to purchase 

goods and services—which are still developing. Thus, virtual currencies differ 

from commodities like oil and gold where commercial uses predominate or at 

least provide points of comparison. At the same time, virtual currencies differ 

from financial indices and other commodities for which robustly-regulated markets facilitate price verification and provide insight into the reasons for price 

changes.’’ 78

Gemini Trust Company (Gemini), the crypto-exchange founded by Cameron and 

Tyler Winklevoss, recently proposed setting up a self-regulatory organization (SRO) 

for crypto-exchanges dealing in crypto-cash commodities or what they call ‘virtual 

commodities.’ In the medium post calling for the SRO, Cameron and Tyler 

Winklevoss articulate a view that virtual commodities should have an additional 

layer of oversight beyond that which other cash commodities have stating: ‘‘Cash 

markets for virtual commodities, however, are unique inasmuch as: (a) the commercial use-cases for virtual commodities are still developing, (b) there is strong speculative interest, (c) these marketplaces involve a large number of individual participants, and (d) technology makes individual transaction costs exceptionally low (on 

a relative basis) as compared to other physical commodity spot markets.’’ 79

It is a logic for additional oversight of crypto-cash commodities somewhat consistent with the recent CFTC staff advisory discussion. Though the logic is directional sound, I believe that a Federal oversight regime is appropriate if we are to 

achieve the public policy goals for crypto-exchanges of guarding against illicit activity, ensuring stability, protecting investors and promoting market integrity, with 

SROs playing an important supportive role as they do in securities and derivatives 

markets. 

Given frauds and other concerns in the retail foreign exchange markets, Congress, 

in the 2008 Farm bill, included provisions for the first time for CFTC registration 

and regulation of retail foreign exchange dealers (RFEDs). Similarly, the CFTC and 

46 

80 Cryptocurrency Exchanges Are Getting Hacked Because It’s Easy; WALL STREET JOURNAL

(July 16, 2018) https://www.wsj.com/articles/why-cryptocurrency-exchange-hacks-keep-happening-1531656000. 81The sad state of crypto custody; TECHCRUNCH (February 1, 2018) https://techcrunch.com/ 

2018/02/01/the-sad-state-of-crypto-custody/. 

Congress might wish to consider allowing retail cryptocurrency exchanges to register as RFEDs, though cryptocurrencies are not foreign currency, and while ensuring that cryptocurrencies remain distinct from fiat currencies for other parts of the 

commodities law. 

Or Congress may wish to consider if it would be more appropriate to provide the 

CFTC—or another agency—with general authorities to write rules for crypto-cash 

commodities markets, including possibly requiring registration for trading on cryptoexchanges solely dealing in cryptocurrencies, aka crypto-cash commodities. 

Custodial Functions 

The Wall Street Journal reported this week: ‘‘Regulatory gaps and insufficient levels of defense have made some exchanges simple to breach.’’ 80 Seven hacks to date 

in 2018 have led to $800 million in customer funds being stolen from crypto-exchanges. Over $1.6 billion has been stolen in 56 reported hacks since 2011. No 

doubt, more has been lost to unreported thefts and cyber-attacks. 

Though Bitcoin and many blockchains themselves have been generally resistant 

to hacks, with the integrity of their ledgers preserved, there are significant weaknesses in other areas and layers within the crypto-ecosystem. 

Unlike traditional exchanges, crypto-exchanges hold significant customer funds in 

digital wallets—a state of affairs that directly contradicts the principles of decentralized user-based control of digital assets upon which Bitcoin was initially built. 

The aggregate of these customer crypto-assets is then represented on a particular 

token’s blockchain associated with the public keys of the exchange, not the individual customers. As mentioned previously, Coinbase reports to have custody of over 

$20 billion in customer crypto-funds. 

In contrast, customers trading on traditional securities exchanges with intermediated access have their securities recorded at a transfer agent, and held by a broker 

or dealer, not the exchange. Customers trading on derivatives platforms, have their 

trades recorded and margin posted at regulated clearing houses and FCMs. 

Exchanges are exploring whether new approaches, such as multi-signature wallets, might aid in protecting the security of customer funds.81 But for now, the existing system is operating with a glaring gap in investor protection. With well over 

90% of daily trading volume in Bitcoin occurring through crypto-exchanges rather 

than being recorded as a transaction directly within the blockchain, and with the 

public accessing these exchanges without the benefit of regulated intermediaries, it 

is critical to put in place Federal requirements for the custody of crypto-assets. 

In the U.S. to date, the only regulatory safeguards have been through state-administered money transmission regulations. This approach—regulating exchanges’ 

custodial duties in the same manner that Western Union and MoneyGram are regulated—is not satisfactory. 

In some countries, particularly Japan, authorities have required crypto-exchanges 

to register and meet certain custodial duties to protect customer funds stored in an 

exchange’s digital wallets. 

The public policy goals should be the same, whether the asset is crypto in nature 

or a more traditional security or derivative. Exchanges should fully segregate customer funds and ensure that they not lose those funds and not use those funds. 

When considering existing custodial rules, the specifics of blockchain technology, 

public keys and cryptography will need to be considered. New technologies, such as 

multi-signature controls might protect customers or fulfill certain custodial responsibilities. Added safeguards, need be considered for the private keys associated with 

exchanges’, asset managers’, banks’ or regulated intermediaries’ public keys. Additional cyber-security and other safeguards might be appropriate, particularly given 

the numerous losses and hacks that have occurred in the past. 

Conclusion 

In conclusion, blockchain technology has a real potential to transform the world 

of finance. Though there are many technical and commercial challenges yet to overcome, I’m an optimist and want to see this new technology succeed. It could lower 

costs, risks and economic rents in the financial system. 

For broad adoption—both as a technology solution and as part of the capital markets—the technology and its various applications need to come within existing public policy frameworks. Basic norms and principles to guard against illicit activity, 

47 

ensure for financial stability, and protect investors and market integrity, while promoting innovation, should consistently guide public policy. 

Clear rules of the road also will allow firms—both incumbents and start-ups—to 

more fully explore investing in crypto-assets or blockchain technology. Today, startups have an advantage as incumbents do not take the same reputational and regulatory risks that startups generally are willing to take. Startups, so to speak, are 

more willing to beg for forgiveness while incumbents more often need ask for permission. 

Bringing clarity and compliance will have its challenges. There are numerous 

crypto-exchanges and thousands of ICO launched tokens in significant non-compliance. Congress and this Committee have a role to play as well, monitoring developments, overseeing compliance, and, when appropriate, updating laws. It also will be 

critical that sufficient resources be provided the CFTC, SEC and other agencies to 

adequately oversee crypto-markets, especially as these markets have continued to 

grow. 

Market participants, the investing public, entrepreneurs, technology developers, 

regulators and Congress all will play a role. In particular, crypto-exchanges and 

ICOs should now seek to comply with the law to fullest extent possible. 

The public, blockchain technology, and the financial system will all reap the benefits. 

Thank you again for inviting me today, and I look forward to your questions. 

The CHAIRMAN. Thanks, Mr. Gensler. 

Mr. Ness, 5 minutes. 

STATEMENT OF LOWELL D. NESS, J.D., MANAGING PARTNER, 

PALO ALTO OFFICE, PERKINS COIE LLP, PALO ALTO, CA 

Mr. NESS. Thank you all for inviting me to testify this morning. 

I certainly agree with everybody that has gone before me that 

this technology does have the potential to be transformative. 

One of the questions I get asked a lot is why don’t we just call 

these things securities? We have securities regulations. We could 

create a scenario where these things get registered and then become freely tradable, so why not just call them securities, deal with 

the existing laws? The problem with that is they exhibit some characteristics of securities during certain phases and not in others; especially when we get to full functionality when it is a truly completed product that is being sold, the intention of that product is 

to be used in a network, and that really can’t happen—at least not 

at the speed of software, which is really the fundamental principle 

here behind these decentralized protocols is to allow for value 

transfers truly at the speed of software. You can’t do that if everybody has to be a broker-dealer and all the intermediaries have to 

interact in a way that would be appropriate for securities. 

We need to come up with a fairly novel and pragmatic approach 

to dealing with the fact that there needs to be some investor protections, particularly in the early stages while the things are a 

PowerPoint deck and an idea in somebody’s mind. But find ways 

to create some clarity around how and when it goes from being sold 

as a security to being sold as a commodity. And that is a very important imperative right now because we are seeing so much activity, frankly, and the threat of people going offshore for lack of clarity is a very real one. 

I will say in my 25 years in Silicon Valley, I have not seen circumstances where you go to a meet-up in places like Palo Alto or 

even San Jose and you see regulators from Zug, Switzerland; 

Singapore; Hong Kong; and Bermuda et cetera. To avoid any kind 

of race to the bottom, I do think that there is a serious imperative 

about getting something done before we have a situation where we 

48 

are trying to entice people back into the country, because then the 

standards would really have to be lowered to do that. I think we 

have an opportunity now if we get ahead of the true flight, but that 

is an important idea around why we need some of the bright lines. 

To that end, I did in some of my written testimony include some 

materials and a proposed regulatory framework that both talk 

about what the existing laws and how the existing laws treat these 

so-called utility tokens, and there is a 50-page memo on how the 

existing laws work. To avoid having to go through that 50-page 

memo type analysis with each and every one of these, I think the 

bright lines are really what is necessary. 

There is a regulatory framework that we have been thinking a 

lot about how that would create that set of bright lines that would 

enable the regulators and the companies going out there to really 

know how to sort the good ones from the bad ones. I do think that 

starts with this test around how we in the investment contract 

analysis for regulating securities as securities in the primary offering, if they are being sold pre-functional—before they are fully 

functional. But coming up with ways to say that once they are fully 

functional, how do we let them now trade as commodities effectively, and the trading is important because as I said, this is the 

movement of value. To have value, it needs a price and the markets really are a necessary part of this. The fact that there are secondary markets is a key part of this. They need to be able to trade 

in those markets to establish price. They also need to be able to 

be used in their networks as non-securities, and so we need to 

come up with ways to say when they are being sold to investors 

as investments, let’s treat them like securities. When they are 

being used in the network or they are being traded in the secondary markets, let’s call them commodities. 

Thank you. 

[The prepared statement of Mr. Ness follows:] 

PREPARED STATEMENT OF LOWELL D. NESS, J.D., MANAGING PARTNER, PALO ALTO

OFFICE, PERKINS COIE LLP, PALO ALTO, CA 

U.S. Regulatory Framework for Digital Assets 

Introduction 

We support the regulatory mission of investor protection and full and fair disclosure. We also support aggressively dealing with fraudulent actors in the blockchain 

technology industry. We believe it is essential to both market participants and the 

regulatory community that bad actors are dealt with through targeted strikes and 

regulatory action. We also believe it is equally essential to provide clear guidance 

beyond enforcement actions to allow continued development and innovation around 

what many believe to be potentially transformational technology development. It is 

in that spirit that we welcome this engagement with the regulatory community toward defining a regulatory framework that best addresses market participant protection and continued growth and development of blockchain technologies. 

Blockchain technology (also called ‘‘distributed ledger technology’’) allows the creation of a software ledger that is distributed, meaning many copies of the ledger 

exist and are automatically kept in sync such that no one actor can alter the ledger 

without employing a defined consensus mechanism among the actors. This technology allows assets to be traded on a ledger that is not maintained by a centralized 

‘‘trusted’’ actor. Blockchain technology allows ledger transactions to occur immediately, immutably and transparently, without the need for reconciliation of multiple proprietary ledgers. This is, arguably, the most fundamental change to ledger 

technology since double-entry accounting. Double-entry accounting helped trading 

counterparties trust each other. Blockchain technology removes the need for centralized trusted intermediaries to act as the go between for trading counterparties. 

49 

While the Internet enables the free flow of information, blockchain technology enables the free flow of value. More specifically, blockchain technology enables the creation of many types of digital assets, including digital currencies, digital goods and 

services, software tokens and digital securities (e.g., tokenized debt or equity). 

This memorandum addresses the regulatory framework for the application of U.S. 

securities laws and commodities laws to these various types of digital assets, with 

a focus on the treatment of utility tokens. Tokenized goods and services are nonfungible tokens that are merely intended to represent specific goods or services, so 

their regulatory status should simply follow from the regulatory status of the good 

or service they represent. Other digital assets require somewhat more complicated 

analysis to determine their regulatory status. 

Digital Currencies, Digital Securities & Utility Tokens 

At one end of the spectrum, digital currencies are fungible tokens that have no 

other marketed functionality than use as a medium of exchange or stored value. 

These types of tokens (e.g., Bitcoin) are subject to various U.S. Federal and state 

as well as foreign money transmission laws, are treated as property under U.S. tax 

laws, and are treated as commodities under U.S. commodities laws. Offers and sales 

of digital currencies should not be viewed as securities under the Howey test, absent 

unusual facts (such as promising efforts to maintain secondary market liquidity or 

token architectural features like burning tokens intended to reduce supply and increase the value). 

At the other end of the spectrum, digital securities are tokenized traditional securities (e.g., debt or equity) or investment contract type securities that offer a direct 

financial return from an identifiable issuer. These types of tokens would clearly be 

securities and would generally not be subject to commodities laws or money transmission laws per se. 

Utility tokens are intended to be used by users of a software network and do not 

represent an equity interest (or any other corporate obligation), but they do attract 

speculative resellers, which implicates the Howey test. The Howey case law is highly 

nuanced and, therefore, challenging to interpret, leading to uncertainty. As a general matter, U.S. Federal securities laws were developed and have evolved primarily 

for and around equity securities (and other corporate obligations). There is much 

less clarity around investment contract type securities, particularly investment contract type securities that offer no direct financial return, but nevertheless enjoy robust secondary markets. 

The Howey test requires a reasonable expectation of profits. A purchaser may be 

led to expect profits either from a direct financial return (e.g., an ownership interest 

in a business or a promise of payment) or from a rising price in secondary markets. 

Ordinarily, if there is no direct financial return, and the object being sold has never 

been sold before, there would be no reasonable expectation of profits. This is because 

a reasonable purchaser would not expect a novel product to have any secondary 

market liquidity. The fact that every team, every time, seems to be able to general 

an immediate secondary market for its newly minted utility token, is astonishing, 

but has become a fact of life. At this point, the expectation of profits from secondary 

market activity has become a given. It would be difficult to point to another phenomenon where this was the case. This is the first factor in the utility token analysis that is arguably unique. 

An expectation of profits is not, however, sufficient to form an investment contract. The expectation of profits must be based on the efforts of others. Most investment contracts, including Howey itself, involve the promise of direct financial returns. When a promoter offers a financial return to the purchaser, the efforts of others continue for the life of the financial return, which would mean indefinitely in 

the case of an ownership interest in a going concern. When no direct financial return is offered, however, and the only expectation of profits comes from the hope 

of a rise in price in secondary markets, the efforts of the promoter are only relevant 

so long as the product is being developed by the promoter. This temporal qualification is the second factor in the utility token analysis that is unique and leads to 

the concept of mutability, discussed in our memorandum to the SEC dated March 

26, 2018 regarding the Investment Contract Analysis of Utility Tokens. As discussed 

in that memorandum, the token itself is never a security, but the facts and circumstances surrounding the sale of the token likely constitute an investment contract while the token is in the development stage because the buyer’s expectation 

of profits are based on the seller’s efforts to complete development of the token. 

Once the token has been fully developed and the facts and circumstances no longer 

support an investment contract conclusion, the offer and sale of the token should 

be treated as the sale of any other commodity trading in spot markets. As a result, 

50 

1For example, a social network that uses a token as a micro payment for a micro task like 

submitting a blog post, would be engaged in the unregistered and, presumably, non-exempt sale 

of a security if the token were a security. 

under the Howey test, token sale agreements could constitute investment contracts 

under some circumstances but not others. 

Some would prefer to resist the implications of mutability by simply treating all 

tokens as securities forever. Treating all tokens as immutable securities, however, 

(i) would not be analytically consistent with existing law and (ii) would not allow 

tokens to be used for their intended purpose—access to products and services on a 

network, which would inevitably cause development to relocate abroad.1 China, 

whose securities laws arguably are not as nuanced, took a binary approach to regulation and banned all token sales in China instead of adopting tailored protections 

that would enable the development of the technology to continue in China. We believe the law and guidance around what constitutes an investment contract should 

be clarified. We believe that the industry’s and the regulators’ interests are aligned 

in establishing clear rules and appropriate investor protections so that capital formation in blockchain technology is not derailed and development can continue to 

flourish in the United States. 

Proposed Regulatory Framework for Utility Tokens 

To remedy the uncertainty and confusion in this space, we are part of a group 

of academics, venture capital firms and law firms practicing in this area that has 

proposed the following regulatory framework to serve as the basis for a more detailed non-exclusive safe harbor that would help provide guidance to the industry 

on what constitutes an ‘‘investment contract’’ and how the investment contract law 

and guidance should apply to utility tokens with respect to primary sales, resales 

and use of the tokens for their intended purposes. Similar to the steps the SEC took 

by putting in place Regulation D, a non-exclusive safe harbor to address the uncertainty caused by SEC v. Ralston Purina in the private placement arena, we believe 

the proposed framework outlined below could be codified in a no-action letter or series of no-action letters that could ultimately lead to a rulemaking around a safe 

harbor that will assist in relieving the regulatory uncertainty around utility tokens. 

The goals of the proposed framework are to (i) establish clarity for the industry, (ii) 

permit use of tokens for their intended purposes (i.e., on their software platform) 

and (iii) establish appropriate investor protections for both primary sales and resales of tokens, with emphasis on eliminating trading manipulation. 

The industry’s need for clarity is obvious. Currently, the vast majority of token 

sales are smaller token sales that have not been reviewed by counsel or that are 

merely attempting to follow precedent transactions in a highly nuanced area with 

varying models and no bright line rules. The regulators would also benefit from clarity. The proposed framework would require affirmative consent to jurisdiction, 

which has been challenging in light of the global and distributed nature of token 

sales. The proposed framework allows regulators to (i) define the contours of jurisdiction (and therefore responsibility), (ii) avoid the incongruent result of defining all 

tokens as securities (while tokens have security-like characteristics at one stage, the 

regulatory scheme must also permit use of tokens for their intended purposes) and 

(iii) provide an efficient structure for continued capital formation. 

The proposed framework is largely based on the application of existing case law 

and regulatory principles, such as Rule 144 and Rule 701, to tokens, but proposes 

bright lines to clarify existing case law and regulation in a way that is practical and 

useful for all constituents. The proposed framework has been vetted by, and has the 

support of, many of the key players in the industry. We believe the proposed framework works well from the perspective of both industry and the regulators by balancing market participant protections and capital formation. 

In general, offers and sales of tokens meeting the specified conditions would not 

be deemed securities transactions (except for purposes of application of general antifraud and manipulation rules, such as Rule 10b–5) once the tokens have achieved 

either full functionality or full decentralization (as described below) and may be exchanged as non-securities in secondary markets subject to the general anti-fraud 

and manipulation rules of each of the CFTC and the SEC. Token sellers would, however, impose certain investor protection requirements tailored to each stage. The noaction letter(s) and any eventual safe harbor would be non-exclusive as there will 

be tokens clearly purchased for consumptive purposes, such as non-fungible 

tokenized goods and services. The principles of the proposed framework are as follows: 

Pre-Functionality—Until the token achieves full functionality, offers and sales 

of tokens would generally constitute investment contract type securities under 

51 

2 Consumptive intent, as opposed to investment intent, would generally be established if the 

purchaser is only able to use the token for its intended purpose and is not able to resell the 

token for profit. The existence of consumptive intent was a key determinant, for example, in 

United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975). 3During this stage of token development, we believe that resale should either be extremely 

unlikely (i.e., in the case of testnet tokens) or effectively impossible. More practical (i.e., less 

stringent) resale lockup mechanics may be more appropriate for tokens that achieve full 

functionality. 4Ongoing software updates and upgrades constitute ongoing efforts of others under Howey, 

but they are not likely to rise to the requisite level of efforts to form an investment contract. 

The case law is particularly challenging to apply to the facts in this area, which makes it difficult to determine whether investor protections should apply. Nevertheless, we believe that limited ongoing investor protections, even at this stage of token functionality, are essential in ensuring that capital raising is not derailed in this industry by pump and dump or get rich quick 

schemes taking advantage of immediate liquidity in secondary trading markets for tokens. 5For equity securities, we would typically consider many of these non-monetary issuances of 

stock to be ‘‘sales.’’ For tokens, there are strong policy objectives around bolstering the use of 

the tokens for their intended purposes. As such, non-monetary transfers of tokens for the purpose of seeding potential users to drive network adoption or for purposes otherwise related to 

the token’s usage should be permitted. To the extent a so-called ‘‘airdrop’’ is announced in advance as a way to drive up the trading price of the token associated with the blockchain on 

which a new token is being airdropped, we would consider this a marketing practice inconsistent 

with the safe harbor. 6There are many variations in the market on token trading platforms, from true peer-to-peer 

to decentralized exchanges that provide information supporting peer-to-peer trading or, in some 

cases, matching engines, but that do not take custody of tokens, to hosted-wallet exchanges running full services as an exchange. How to handle exchanges and the mechanics of our proposal 

will need significant further discussion with the Staff. We do not believe, however, that it would 

be appropriate to require all exchanges trading fully functional tokens to be registered as Alternative Trading Systems. We believe it is essential to apply general anti-fraud and manipulation 

rules to these open exchanges, but it would be counterproductive to treat them as ATS’s with 

inapposite rules developed around equity securities and other corporate obligations. 

Howey, unless a reasonable purchaser is purchasing with consumptive intent.2 In 

this case, the token should generally be treated as a security unless use of the token 

(as opposed to resale) is reasonably certain. As such, this stage would include the 

following features: 

Primary sales—Existing securities laws would apply to primary sales of the token. 

Primary token sale agreements would continue to be generally treated as securities 

based on the investment contract analysis under Howey. Primary sellers of tokens 

would be able to rely on available exemptions from registration (e.g., Rule 506(b), 

Rule 506(c), Regulation S, Rule 701) and the SEC would retain full regulatory authority to enforce violations under existing Federal securities laws. 

Resales—Any resales or assignments of the primary token purchase agreement, 

which is the security under Howey, by purchasers or affiliates of the token creator 

would also need to rely on existing resale exemptions under the securities laws. Resales of the token would also be subject to the special resale lockup and resale volume restrictions described below. 

Use for Intended Purpose—Tokens would be able to be earned or used as intended 

through the network, so long as either (i) resale is not possible,3 or (ii) the network 

on which the tokens can be used will be shut down within some reasonably finite 

period, say 6 months (i.e., these are testnet tokens that have no resale value). 

Full Functionality—Once the token achieves full functionality, offers and sales 

of tokens would generally not constitute investment contracts under Howey. Software networks, however, generally require ongoing updates and upgrades, so it may 

be appropriate to create limited but ongoing investor protections.4 As such, this 

stage would include the following features: 

Primary Sales—Primary sales of tokens below the Per Purchaser Limit (described 

below) would be able to be made without being subject to lockup or volume restrictions. Larger purchasers, however, would need to be accredited investors and are 

subject to the special resale lockup and resale volume restrictions described below. 

Tokens would be able to be gifted or otherwise distributed to users, service providers, strategic partners and other participants without an exchange of money, including mining, also without being subject to lockup or volume restrictions.5

Resales—Tokens would be able to be traded on exchanges or resale platforms as 

non-securities, other than for purposes of the general anti-fraud and manipulation 

rules, such as Rule 10b–5.6

Use for Intended Purpose—The token would be able to be earned or used on the 

network for its intended purpose (i.e., on their software platform) without being subject to lockup or volume restrictions. 

52 

7 ETH is a good example of this type of protocol token that has become so decentralized it 

should not be deemed a security. For clarity, ETH is the protocol token for the Ethereum network, so this safe harbor provision would apply to ETH, but not necessarily to all ERC20 tokens 

running on top of the Ethereum network unless an ERC20 token is itself a protocol token. Also, 

for clarity, a protocol token may qualify as a token with full functionality irrespective of whether 

it has achieved full decentralization. 

Full Decentralization (Protocol Tokens) 7—If a token achieves full decentralization (not all will), the token would fall entirely outside of Howey since there is no 

longer an issuer or promoter delivering ongoing software updates or upgrades that 

could potentially constitute the requisite efforts of others under Howey. As such, a 

token that achieves full decentralization would be not be deemed a security for any 

purposes other than the general anti-fraud and manipulation rules, such as Rule 

10b–5. 

Key Defined Terms 

Full Functionality—A token achieves full functionality when a token holder can 

use the token for its intended purpose (marketing test), or a token holder can use 

the token in some meaningful way (qualitative use test), or the network in which 

the token is to be used is fully functional in accordance with its whitepaper (operational test), or the token’s consensus mechanism is working and blocks are being 

published (layer 1 protocol token test). The foregoing are examples of functionality 

criteria, but there may be other indicia of functionality that require further discussion in the context of a specific no-action letter. Protocol tokens (i.e., tokens that 

allow other developers to build application tokens on top of the protocol token network) should be deemed to have immediate full functionality when the protocol tokens can be used for their intended purpose by developers even if the applications 

have not been developed yet, while application tokens would require their marketed 

features to be built before achieving full functionality. 

Per Purchaser Limit—This could be a dollar limit akin to crowdfunding concepts, 

but would make more sense under Howey as a limit that indicates consumptive intent. Each primary token seller could establish a limit based, for example, on the 

number of tokens a user might use within a given period of time. In some cases, 

tokens are meant to be purchased by developers who are building other applications 

that will make use of the tokens and will need a larger quantity of tokens for their 

separate development project than would a typical user. 

Full Decentralization—A token achieves full decentralization when the token creator no longer has control of the network based on its ability to make unilateral 

changes to the functionality of the tokens, or based on the number of network nodes 

controlled by the broader community, or based on the code being forkable and open 

source, or based on it being a permissionless network (any node can join), or based 

on affiliated hashpower (proof of work), or based on affiliated holdings (proof of 

stake). Again, these are just examples of indicia of control criteria that require further discussion in the context of a specific no-action letter. 

Primary Token Seller Conditions for Safe Harbor 

Special Resale Lockup and Resale Volume Restrictions—Primary sales other than 

for fully decentralized protocol tokens (i.e., for either Pre-Functionality or Full 

Functionality tokens), would need to include a lockup that permits use but not resale for the period ending on the later of (i) 6 months following purchase, and (ii) 

achievement of full functionality. In addition, purchasers and affiliates of the token 

creator would need to agree to resale volume limitations. 

Consent to Jurisdiction—Primary token sellers would need to consent to jurisdiction of the applicable regulators. 

Consent to Anti-Fraud Rules—The primary token seller would need to also agree 

to the application of the general anti-fraud and manipulation rules, such as Rule 

10b–5 under Federal securities laws with respect to any tokens sold under all circumstances. 

Public Disclosure—Any information that the primary token seller provides regarding features and use of the network would need to be made publicly available. To 

achieve full functionality, a white paper, superseding any prior white paper, would 

need to be published detailing present functionality and would need to focus on 

present features with only limited and very generalized discussion of future features, if any. Other disclosures may be appropriate and would need to be discussed 

in the context of a specific no-action letter. 

Public Marketing—The token seller would not be permitted to market the token 

as an investment, but would be able to provide disclosures consistent with Rule 

506(c) and Rule 134. Any marketing materials made public would only be able to 

relate to the token’s functionality, not its resale value. 

53 

1While other U.S. securities laws have slightly different, and in some cases broader, definitions of a security, the most immediate concern for utility tokens is whether a token sale to 

the general public may constitute a violation of Section 5 of the Securities Act. Outside the 

United States, except for Canada, we have not run into a jurisdiction where the securities laws 

would apply the investment contract test discussed in this memorandum according to local counsel. So far, utility tokens have been deemed non-securities in places like Switzerland, Singapore, 

Hong Kong, Bermuda, the Cayman Islands, and the British Virgin Islands, among others. 2SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (hereinafter, ‘‘Howey’’). 3 Report of Investigation Pursuant to Section 21(a) of The Securities Exchange Act of 1934 (Exchange Act Rel. No. 81207) (July 25, 2017) https://www.sec.gov/litigation/investreport/34- 

81207.pdf (hereinafter the ‘‘DAO Report’’). 

Legends/Smart Contracts—Primary token seller would need to enforce lockups. 

Token Features—The tokens would not (i) have one or more features that make 

them a ‘‘security’’ under one of the other concepts in the definitions under the 1933 

Act or 1934 Act, or (ii) constitute an (a) ownership interest, (b) equity interest, (c) 

a share of revenue, profit and/or loss, or assets and/or liabilities, (d) status as a 

creditor or lender, (e) claim in bankruptcy, (f) holders of repayment obligations, or 

(g) right to convert into an investment interest, all with respect to the token project 

or network application, or any legal entity. 

Exchange Conditions for Safe Harbor 

The conditions for an exchange to list a utility token as a non-security requires 

further discussion in the context of a specific no-action letter, including with respect 

to (i) the exchange’s role regarding FinCEN KYC/AML regulations; (ii) the exchange’s role relating to resale limitations on tokens; and (iii) consent to jurisdiction 

for enforcement of general anti-fraud and manipulation rules. 

Reseller Conditions for Safe Harbor 

Resellers would need to comply with any lockup and volume limitations. 

Resellers would need to be subject to the general anti-fraud and manipulation 

rules, such as Rule 10b–5. 

Conclusion 

We believe that the above regulatory framework ensures the goals of investor protection, clarity for market participants and support for blockchain technology. While 

the SEC retains significant jurisdiction under the proposal, the CFTC would also 

retain the ability to regulate fraud and market manipulation in the token spot markets, in addition to its full authority to regulate any derivative token markets. 

FinCEN remains the primary regulator with respect to all KYC/AML requirements, 

and the FTC would also have jurisdiction for any consumer protection actions associated with misleading advertising. 

ATTACHMENT

March 26, 2018 

To: WILLIAM HINMAN, Director, Division of Corporation Finance 

AMY STARR, CHIEF, Office of Capital Markets Trends 

VALERIE SZCZEPANIK, Assistant Director, Head of the SEC Distributed 

Ledger Technology Working Group 

From: Perkins Coie LLP 

Re: Investment Contract Analysis of Utility Tokens 

This memorandum discusses whether and under what circumstances so-called 

‘‘utility tokens’’ would be securities as defined under the Securities Act of 1933, as 

amended (the ‘‘Securities Act’’).1

Executive Summary 

In Howey 2 and its progeny, including the cases discussed in the DAO Report,3 the 

Securities and Exchange Commission (the ‘‘SEC’’) and the courts have laid out the 

characteristics of an ‘‘investment contract,’’ emphasizing that the analysis of what 

is and is not an investment contract can be based on the facts and circumstances 

surrounding each offer and sale. Inherent in any analysis based on facts and circumstances is the reality that the analysis may yield a different conclusion at different points in time as circumstances change. In the case of tokens, and the underlying blockchain technology, the market dynamics have, in fact, changed over time, 

as market participants have adjusted to a better understanding of both the technology and the applicable regulatory requirements. Currently, it is widely accepted 

that a pre-functionality sale of tokens may well constitute an ‘‘investment contract,’’ 

54 

4http://dogecoin.com/. 

and hence a security, within the meaning of Section 2(a)(1) of the Securities Act. 

This conclusion flows from the likelihood that a reasonable purchaser expects to 

profit in the secondary market for the tokens based on the efforts of the token seller 

to build the network or application in which the token is used. Accordingly, most 

market participants are initially purchasing a pre-functionality token sale agreement, which is offered and sold in accordance with Rule 506(b), Rule 506(c) or Regulation S, and which represents a right, at a future time, to delivery of utility tokens. 

In this context, the pre-functionality token sale agreement is the security, and it is 

subject to the resale restrictions imposed by Regulation D or other applicable exemptions, under the Securities Act. At the point at which the utility tokens achieve 

a sufficient level of functionality, such that their value is no longer dependent on 

the efforts of others, the pre-functionality token sale agreement is effectively extinguished and the holder thereof receives delivery of the tokens. A token by—itself 

is never an investment contract—Dogecoin 4 is simply a meme that can be transferred via blockchain operations. The investment contract arises from the understanding as to how the token will be developed into something of useful value. In 

this memorandum we discuss the legal analysis supporting our views with respect 

to the legality of these transactions and the legal status of the tokens, both pre- and 

post-functionality. We also discuss more broadly the legal framework in which token 

sales take place. 

The key difference between (i) an equity offering or the forward sale of an extant 

commodity and (ii) an offering of utility tokens is the fact that equity is inherently 

a security by its nature and extant commodities are non-securities by their nature 

and that nature never changes. Equity fundamentally represents a right to a share 

of the profits of the issuer, so equity securities never ‘‘transform’’ from a security 

to a non-security because their fundamental nature does not change. The treatment 

of a contract as an investment contract, and hence as a security, however, is entirely 

based on a test that is driven by the facts and circumstances at the time of the offer 

and sale. Thus, it is possible for a contract for the sale of tokens to be an investment 

contract under one set of circumstances, while a subsequent contract for the sale 

of the same tokens is not an investment contract when sold under different circumstances. In this case, the transformation is not de jure, but arises from a change 

in the facts and circumstances, i.e., ipso facto. Since one of the key facts underpinning the efforts of others element set out in Howey is the promoter’s efforts to build 

functionality, there may well be a different result with respect to an offer and sale 

made at a time when functionality exists, versus at a time when it does not. Indeed, 

if tokens are delivered to the pre-functionality token purchasers after full 

functionality has been created, the efforts of others element would no longer be 

met under Howey, and any subsequent resale of the tokens should not constitute 

an investment contract. 

If we assume that the expectation of profits prong under Howey is always met 

based on today’s frothy secondary markets, and if we ignore the other prongs of the 

test, the only remaining question is whether the expectation of profits is sufficiently 

based on the efforts of others. The courts use objective criteria to determine when 

a reasonable purchaser expects to profit on the efforts of others, not the subjective 

mind set of each purchaser. Thus, even if token purchasers currently may be described as irrationally exuberant, meeting the Howey test is within the control of 

the token seller because the test is objective not subjective. It follows that there is 

a ‘‘right way’’ for token sellers to construct tokens and conduct token sales, initially 

as a security, but once the token has achieved full functionality, it should be treated 

as a non-security that will ultimately trade on spot markets regulated under the 

anti-fraud rules administered by the CFTC. 

In addition to being analytically inconsistent with existing law, categorizing tokens immutably as securities will mean that tokens cannot be used for their intended purposes in the United States. Securities cannot be used in the way utility 

tokens are intended to be used (e.g., as micro payments for micro tasks on a social 

network). From a policy perspective, it is important that we apply our securities 

laws in such a way that inapposite regulation does not cause today’s highly mobile 

workforce to develop these technologies abroad (as many already have) if utility tokens cannot be used for their intended purposes in the United States. While regulators must be mindful of containing the highly speculative and frothy market that 

currently exists, in which resale motives may predominate, use motives are gaining 

traction. As use of tokens grows, and as the novelty wears off, we expect that circumstances may well change again to the point where the irrational exuberance has 

subsided and there is a more balanced view of tokens as merely tools for interacting 

with various software platforms and applications. 

55 

5Satoshi, Nakamoto, Bitcoin; A Peer-to-Peer Electronic Cash System, www.Bitcoin.org, available at https://bitcoin.org/bitcoin.pdf. (last visited March 22, 2018). 6Digital currencies, like Bitcoin, would generally not be securities unless there are somewhat 

unusual facts and circumstances causing the coin to fall within the definition of a security (e.g., 

if the coin’s promoter builds certain features into the coin like diminishing supply or promises 

significant actions that would make the coin more valuable in the future). Typically, digital currencies are complete and useful as currency immediately upon creation of the first coin and do 

not promise any further development of features or functionality or actions to make them more 

valuable in the future. Even if the coin is marketed as an investment (as physical gold coins 

often are, for example), it would not be a security unless the expectation of profits is based on 

the efforts of others. 7 Non-fungible (or less fungible) tokenized goods and services do not pose the same trading 

issues and easy resale profit opportunities as fungible utility tokens. By definition, the consumptive intent of the purchaser is patently obvious with respect to this type of token. In this case, 

the token can be abstracted away and its status as a non-security simply follows the non-security status of the underlying good or service. If the presale of a Tesla, for example, had used 

distributed ledger technology to track the identity of holders of the presale rights to the Tesla, 

the token purchasers would have had such clear consumptive intent that the tokens should not 

have been deemed securities even if such rights had been traded on an exchange while the car 

was under development. In this case, the token could either represent a customized car (i.e., 

a nonfungible token), or it could represent a fungible currency value only redeemable for a car 

to be selected by the token holder in the future (akin to a gift card). Either way, the consumptive intent is clear. Tokenized concert tickets would be another example of this type of token, 

where there is a fixed supply of tickets and initial sales are likely to be virtually exclusively 

to and between resellers, but the tickets will ultimately be purchased, for the most part, by the 

end users who go to the concert. In the case of concert tickets, of course, it is also possible for 

the tokens to be perfectly fungible if the concert is all open seating, for example, so the touchstone for this type of token is the clarity of the consumptive intent of the ultimate end use purchasers. Of course, as with digital currencies, the offer and sale of this type of token could still 

meet the investment contract test if, for example, the tokens are coupled with a management 

contract like the one present in the Howey case. 

Policy objectives aside, and whether or not a less frothy future state comes to 

pass, this memorandum addresses the analytical basis for the appropriate treatment 

of token sales under existing law. 

Detailed Analysis 

A. Definition of Utility Token 

In October 2008, the Bitcoin whitepaper 5 introduced a new currency based on distributed ledger technology, also known as the Bitcoin Blockchain. Currency was the 

first use case for this underlying technology. Other use cases include using cryptographically secure distributed ledgers to track and trade traditional debt and equity securities, or any other tangible or intangible asset, good or service. This memorandum does not cover: 

(1) Digital Securities—meaning (i) any token that represents or otherwise enables a blockchain transfer of a share of stock, note or other type of security 

explicitly included in the definition of ‘‘security’’ in the Securities Act and (ii) 

any token that would constitute an (a) ownership interest, (b) equity interest, 

(c) a share of revenue, profit and/or loss, or assets and/or liabilities, (d) status 

as a creditor or lender, (e) claim in bankruptcy, (f) holders of repayment obligations, or (g) right to convert into an investment interest, all with respect 

to the token project or network application, or any legal entity; 

(2) Digital Currencies—meaning fungible tokens that have no other marketed 

functionality than use as a medium of exchange or stored value; 6 or 

(3) Tokenized Goods and Services—meaning each token represents the right to 

a specific good or service that would often not be perfectly fungible with any 

other token.7

This memorandum covers utility tokens, defined as fungible tokens that have 

some software-based functionality beyond mere use as a medium of exchange or 

stored value, although typically the tokens also have those currency-like properties. 

The value of these utility tokens should be derived from their use in a smart contract or other application automating the payment and delivery of goods or services, 

including access to decentralized networks. 

B. Token Sale History and Evolving Model 

A large number of token sales of so-called ‘‘alt coins’’ occurred in 2014 and 2015. 

These were typically coins, based on the software code for Bitcoin, which is opensource software accessible to anyone. Many of these early tokens were digital currencies, although over time these tokens were used in more novel ways as part of 

a software network or application and became utility tokens (as defined for purposes 

56 

8Generally, when a new team markets a new product or service, it is extremely unlikely for 

any sort of secondary market to develop on its own. It normally requires promotional efforts over 

a long period of time to gain any sort of traction and most projects fail to ever get a secondary 

market to develop. It cannot be said that a reasonable purchaser was expecting to profit in secondary markets at this point in the history of token sales. 

of this memorandum). In 2014 and 2015, market participants believed that as long 

as these alt coins did not pay any sort of financial return, and did not represent 

a share of any company, similar to Bitcoin, they should not be treated as securities. 

Over time, the market cooled as appetite faded for new tokens that offered little in 

true functionality other than use as a currency, and use began to rise for the alt 

coins that included significant functionality in addition to use as a currency. In 

2017, there was a resurgence of token sales based on the advent of more capable 

token technology. The ERC20 token protocol, as well as several others, now embed 

executable code into each token (often referred to as smart contracts), which allows 

developers to tokenize anything that software can create. These second-generation 

tokens can be said to be tokenized software products or APIs (application programming interfaces) that perform a function in addition to acting as a medium of exchange or stored value. 

Initially, these new utility tokens were thought of by market participants as the 

sale of products in development that could follow the Kickstarter crowd sale model, 

so long as they continued to avoid paying any sort of financial return or share of 

ownership of a company or project. The offers and sales were made at a time when 

the market for tokens was untested and it could not be said that there was a builtin reasonable expectation of profits associated with resale because secondary markets were not assured.8 Participants in the offers and sales tended to be technologists, developers, software users, and innovators. A reasonable amount of technological know-how was required just to be able to participate in a token sale. 

Means of holding tokens became more user friendly, including in online wallets, and 

means of exchanging one token for another, including on token exchanges, were 

made more reliable and simplified. 

Over time, as the development of robust secondary markets became more and 

more of a given, market participants began to evolve the model to take into account 

the changing market conditions. Specifically, it became apparent that the offer and 

sale of tokens potentially implicated the Federal and state securities laws and market participants started to apply the Howey test to determine whether the tokens 

might properly be viewed as securities. This in turn led to delivering increasingly 

functional tokens at the time of a public token sale to offset the increasingly apparent expectation of profits associated with secondary trading (as opposed to use of 

the token) that began to emerge. 

Today, as discussed below, while there are many token sales that do not follow 

best practices, market participants seeking to follow best practices generally follow 

a model where, before the tokens are fully functional, the sale of the tokens is conducted under an exemption from the registration requirements of the Securities Act 

and the proceeds are used to build functionality into tokens that will later be distributed to the pre-functionality purchasers. Typically, this is effected through the 

use of a pre-functionality token sale agreement that is not transferable and must 

be held indefinitely. The tokens are not delivered to the pre-functionality purchasers 

(and, therefore, do not begin trading on any exchanges or in peer-to-peer wallets) 

until the system for using the tokens becomes fully functional. Once full 

functionality is achieved, the token seller delivers the tokens to the pre-functionality 

purchasers and often conducts a second sale of the fully functional utility tokens to 

the public as a non-security. 

C. Overview of Securities Law Analysis 

The Securities Act regulates the offer and sale of securities. Once it is established that an instrument is a security within the meaning of the Securities Act, 

this transactional regulatory regime requires that each offer and sale of a security 

be registered or exempt from the registration requirements of the Securities Act. For 

current purposes, the threshold question is whether the instrument or arrangement 

meets the Securities Act’s wide-ranging definition of ‘‘security.’’ As discussed in the 

Dao Report, the applicable test then is whether the instrument or arrangement by 

which the offers and sales of utility tokens are made would constitute an ‘‘investment contract’’ under Howey. This is a multi-factor test based on facts and circumstances that must be analyzed with respect to the instrument or arrangement 

as of the time of each offer and sale. Facts and circumstances can and do change 

over time, so the results may be different, even for the same token, depending on 

when the offer and sale is made. 

57 

9Present market conditions for utility tokens include the presence of robust secondary markets trading the rights to the tokens being developed primarily among resellers with speculative 

intent rather than users with consumptive intent. To continue the analogy to event ticket sales, 

the market for utility tokens is still in the early days after initial launch of ticket sales where 

resale is the primary intent of buyers who are attempting to gauge the ultimate price the enduser will be willing to pay for this fixed-supply good. 10The Kickstarter pre-functionality crowd sale model likely doesn’t apply under present market conditions for utility tokens. Kickstarter campaigns do not have secondary markets trading 

the rights to the goods being developed, which calls into question consumptive intent. 

In most cases, under present market conditions,9 the pre-functionality sale of tokens may well be a securities transaction under the Securities Act based on the investment contract analysis under Howey.10 Once full functionality has been incorporated into the technology underlying the token, the token is a commodity trading 

on spot markets accessible to the public, which are subject to the anti-fraud rules 

enforced by the CFTC described below. For these purposes, ‘‘full functionality’’ is not 

intended to mean that merely some utility exists but rather that the requisite quantum of functionality exists such that the efforts of the promoter or others to deliver 

additional functionality do not form the basis for a reasonable purchaser’s expectation of profits in purchasing the token. The requisite quantum of functionality is 

further discussed below. 

Of course, the circumstances could change again in the future, as the novelty 

wears off, and a pre-functionality crowd sale structure could work again, if and 

when it becomes clear that purchasers have switched back to purchasing primarily 

for consumptive purposes rather than resale (as is the case with Kickstarter campaigns). In addition, even under present market conditions, token sellers may decide 

to take certain steps to ensure use rather than resale, which would also change the 

analysis. In such a case, the Howey test would arguably not be met if either there 

is not sufficient expectation of profits because the token is generally being purchased for consumptive purposes or the expectation of profits is predominantly 

based on variables exogenous to the efforts of the promoter(s) of the token. 

D. Description of the Pre-Functionality Token Sale Agreement 

Although pre-functionality token sale agreements may be executed with differing 

characteristics, for purposes of this memorandum, we assume the pre-functionality 

token sale agreements will have the following common characteristics: 

• The purchaser pays to the seller the purchase amount (which may be denominated in fiat currency, such as U.S. dollars, or digital currency, such as Bitcoin) 

on or about the date on which the pre-functionality token sale agreement is executed. 

• In consideration of the purchase amount, the seller agrees to deliver to the purchaser a number of tokens equal to the purchase amount divided by a certain 

price on or about the time the seller conducts a public sale of the tokens or otherwise publicly launches the system or application on which the token may be 

used. In either case, the delivery does not occur until full functionality is 

achieved. 

» The pre-functionality price may be stated as a fixed value, in which case the 

quantity of tokens to be delivered can be determined at the time the prefunctionality token sale agreement is executed. This is always the case when 

the trigger for token delivery is network launch. 

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

• The pre-functionality token sale agreement is a separate instrument from the 

tokens and terminates upon the seller’s delivery of tokens to the purchaser. 

• The pre-functionality token sale agreement generally contains certain other 

standard representations, including, for instance, representations from the purchaser that it is an accredited investor purchasing the rights to the token embodied in the agreement for its own account and not with a view to distribution. 

A pre-functionality token sale agreement frequently will not define the specific 

function of the token or the timeframe for its development and completion, or require the seller to conduct a sale before a specified time or at all. The seller’s 

whitepaper and other information provided to the pre-functionality purchasers typically addresses such matters, often in very general terms. When analyzing a potential investment contract, the ‘‘[d]ecision will necessarily turn on the totality of the 

circumstances, not on any single one.’’ SEC v. Aqua-Sonic Products Corp., 687 F.2d 

577 (2nd Cir. 1982), cert. denied, sub nom Hecht v. SEC, 459 U.S. 1086 (1982). 

58 

11The court distinguished standard commodity futures and options from the ‘‘naked double 

options’’ that were offered by the defendant. Defendant collected and pooled the premiums for 

these options ‘‘and put out to speculation with the expectation that the seller’s expertise in speculation will produce a profit in which the buyer and seller will share,’’ thus creating an investment contract. Commodity Options Intern, 553 F.2d at 633. See also, cases cited at § 15[a] of 

Stephen G. Christianson, What is ‘‘Investment Contract’’ within Meaning of § 2(1) of Securities 

Act of 1933 (15 U.S.C.A. § 77b(1)) and § 3(a)(10) of Securities Exchange Act of 1934 (15 U.S.C.A. 

§ 78c(a)(10)), Both Defining Term ‘‘Security’’ as Including Investment Contract, 134 A.L.R. Fed. 

289 (1996). 

Thus, it would be the totality of the circumstances relating to the use of the proceeds from pre-functionality token sale agreements to develop and launch a token 

that may give rise to an investment contract under Howey, rather than the prefunctionality token sale agreement itself. Nevertheless, to facilitate the discussion, 

this memorandum will analyze a pre-functionality token sale agreement as though 

it incorporated all of the reasonable understandings and expectations of the purchaser that would arise under the total circumstances. 

Because of the risk that a pre-functionality token sale agreement may be deemed 

to constitute an investment contract, as discussed below, pre-functionality token 

sale agreements are frequently sold in compliance with an exemption from the registration requirements of the Securities Act. This would include provisions prohibiting any transfer of the pre-functionality token sale agreement except in compliance 

with such exemption, or more typically, a standard prohibition on transfer or assignment of the agreement without consent. 

E. Circumstances in Which a Pre-Functionality Token Sale Agreement May Create 

an Investment Contract 

A pre-functionality token sale agreement to deliver a specified amount of an asset 

at a specified price on a future date has many of the characteristics of a forward 

contract for the underlying future tokens. It is established that a forward or futures 

contract for non-securities, in fact any type of sales contract, normally does not entail an investment contract. For example, in SEC v. Commodity Options Intern., 

Inc., 553 F.2d 628, 632 (9th Cir. 1977), the Ninth Circuit stated that: 

Commodity futures contracts are considered not to be securities per se. [Citation omitted] They are investments to be sure. The investment, however, is not 

in an enterprise but is in the underlying commodity, and we may assume, 

arguendo, that a conventional option to buy or sell a futures contract takes on 

the character of the contract that is the subject of the option and is no more 

a security than is that underlying contract.11

A pre-functionality token sale agreement differs from conventional forward contracts 

in an important respect: it typically involves a to-be-created novel product or service 

with no established market or value. In the words of the Ninth Circuit, such agreements are often ‘‘investments in the enterprise’’ of creating an operating token rather than an investment in just the token. 

Most other products and services have a market value determined by general supply and demand where prices are bounded by the price of competing goods or services. Even if the seller in a typical forward contract engages in significant promotional efforts, such efforts should be expected to have only a marginal impact on 

the product’s price and any resulting profits from the forward contract. Such promotional efforts would not be ‘‘undeniably significant [efforts], those essential managerial efforts which affect the failure or success of the enterprise.’’ SEC v. Glenn W. 

Turner Enters., Inc., 474 F.2d 476, 482 (9th Cir. 1973); see e.g., Bender v. Continental Towers Ltd. P’ship, 632 F. Supp. 497, 501 (S.D.N.Y. 1986) (‘‘Here, plaintiffs 

allege that Continental influenced the value of the condominium units through its 

marketing efforts and its own buying and selling strategies. But these efforts by 

Continental would have at most only a marginal effect on the value of the condominium units’’). Thus, expected profits from any appreciation in the value of the 

asset underlying a typical forward contract should not be derived from the efforts 

of the seller. 

In contrast, the future tokens underlying a pre-functionality token sale agreement 

have yet to be fully developed or to demonstrate their functionality and typically are 

associated with an entirely novel application where the ultimate ranges of prices to 

be paid by end users is speculative. Any eventual profits from the pre-functionality 

token sale agreement may therefore depend on the successful development of the 

application using the tokens and on the seller’s success in launching the application. 

In some circumstances, this may elevate the seller’s efforts to the ‘‘undeniably significant’’ level required under Glenn W. Turner. 

59 

Real estate provides an example of circumstances in which an asset not generally 

regarded as a security may become the basis of an investment contract based on 

promises of future development. Although the SEC has stated that ‘‘[t]he offer of 

real estate as such, without any collateral arrangements with the seller or others, 

does not involve the offer of a security,’’ Guidelines as to the Applicability of the Federal Securities Laws to Offers and Sales of Condominiums or Units in a Real Estate 

Development, Securities Act Release No. 5382, 38 FR 9587 (1973), courts have found 

allegations ‘‘that defendants encouraged investment purchases by promising the lots 

would increase in value because of defendants’ activities in developing and providing 

amenities, and that defendants led purchasers to believe a trust would be established to construct and operate facilities for their common benefit,’’ sufficient to establish an investment contract. Aldrich v. McCulloch Properties, Inc., 627 F.2d 1036, 

1039 (10th Cir. 1980); see also, Fogel v. Sellamerica, Ltd., 445 F. Supp. 1269, 1277– 

78 (S.D.N.Y.1978) (‘‘the developers did represent that a variety of residential services and recreational facilities would be developed so as to increase the value of 

plaintiffs’ property along with all of the lots in the development’’); Anderson v. Grand Bahama Dev. Co., 384 N.E.2d 981, 985 (Ill. App. Ct. 1978) (‘‘[P]laintiffs allege 

that the land will become ‘valuable and salable to tourists’ and others solely [original emphasis] by virtue of defendants’ efforts. They also allege that purchasers of 

the land could not, nor were they expected to, do anything to increase the value of 

their investments. These allegations fulfill the final two requirements for an investment contract as stated in Howey.’’). Similarly, an undertaking to develop and 

launch an application for a token may create a collateral arrangement that would 

cause an agreement to buy a utility token to qualify as an investment contract, even 

though the token itself will be a commodity. 

As more fully discussed in Section I.1 below, the manner in which a token is offered is also relevant to its status as an investment contract. Offering materials that 

emphasize the potential profits from purchasing a token may create an expectation 

of profit that satisfies the third prong of the Howey test. Because the purchasers 

of the pre-functionality token sale agreement will not receive tokens until completion of the project, and many purchasers may not intend to use the tokens, there 

is pressure on the seller to discuss the potential market value of the tokens in its 

offering materials. The materials also commonly explain the anticipated timeframe 

for development, the development team and their relevant experience. Under these 

circumstances, the offering materials could be viewed as ‘‘emphasizing the economic 

benefits to the purchaser to be derived from the managerial efforts of’’ the seller 

which, according to the Munchee Order, could factor into finding that the prefunctionality token sale agreements are investment contracts. 

The purchasers of the pre-sale functionality token sale agreement may also require assurances that the seller intends to conduct a public sale of the future tokens 

at a higher offering price than the pre-functionality price, reflecting the fact that 

the early money is being paid to take the risk that functionality may not be 

achieved or that the expected use may command a lower price than anticipated. Although the purchasers do not generally offer their tokens in the public sale, and 

may not receive unrestricted access to the tokens until the sale is completed, their 

ability to profit from the sale of their tokens generally depends on the success of 

the public sale. In the case of a token used for a new or unique software application, 

the public sale will establish the initial value of the token, so the seller’s efforts may 

have more than a marginal effect on the potential profits of the purchasers who decide to sell their tokens. 

Under such circumstances, which are different from those of a typical forward 

contract, the SEC or a court may find that the efforts of a seller are ‘‘undeniably 

significant’’ with respect to the expected profits of the purchasers. The development 

of a successful application for a token may be comparable to the efforts required to 

develop the infrastructure and amenities of a resort, which courts have found to satisfy the final element of an investment contract. Moreover, unlike an asset (such 

as a commodity or condominium) with an established market, the developer of a 

new or unique application may have significant influence over the related token’s 

initial market value. Consequently, the seller’s efforts in conducting the public token 

sale and launching the network application may have a significant impact on the 

purchaser’s expected profits from selling, rather than using, the tokens. Circumstances such as these create a heightened risk that the pre-functionality token 

sale agreements may be classified as investment contracts. 

Different circumstances may reduce the risk of a pre-functionality token sale 

agreement being considered an investment contract. For example, a seller may be 

converting an already developed application into a blockchain format using the future tokens. This might be the case for a video game which already has an ‘‘ingame’’ token that can be earned by playing the game and spent to acquire virtual 

60 

assets used in the game. The game developer may want to convert the in-game 

token to a blockchain token so as to allow players to purchase tokens rather than 

earn them (saving hours of game playing), and to permit other games to incorporate 

the tokens, so players can move their virtual wealth from game to game. In this 

instance, the token’s ‘‘ecosystem’’ is largely developed; the developer only needs to 

pay for the programing and other costs of moving the in-game token to a blockchain. 

To fund this cost, the developer may offer pre-functionality token sale agreements 

for the blockchain tokens to current players of its game who would benefit from the 

ability to acquire and transfer the tokens outside of the game. The materials marketing these pre-functionality token sale agreements could emphasize the established functionality of the future tokens, the value of which would depend on the 

appeal of the gaming community created by the players (including the purchasers), 

rather than the entrepreneurial or managerial efforts of the seller. These purchasers 

would resemble someone buying a condominium in a nearly completed resort, which 

‘‘is not under normal circumstances treated as purchasing a ‘security.’ ’’ Rodriguez v. Banco Cent. Corp., 990 F.2d 7, 10 (1st Cir. 1993); see also, cases cited in 

Christianson, supra note 2, 134 A.L.R. Fed. at § 12[c]. Under circumstances such as 

these, a pre-functionality token sale agreement may resemble a standard forward 

contract more closely than an investment contract. 

F. Why Tokens Delivered Pursuant to an Investment Contract May Not Qualify as 

Investment Contracts 

The foregoing analysis shows how a pre-functionality token sale agreement might 

be regarded as an investment contract due to circumstances unrelated to whether 

the future tokens are securities. If the circumstances have changed materially by 

the time of the delivery of tokens to the pre-functionality purchasers (which is often 

accompanied by a public sale of the utility tokens), any new offer or sale of those 

same tokens should not necessarily be construed to represent investment contracts. 

This would be the case if development of the token’s functionality is completed by 

the time of the public sale. So long as there are no other efforts of others involved 

either—i.e., (i) marketing materials are focused primarily on present functionality 

and use of the token, (ii) the seller has not built features into the token intended 

to provide an investment return or support the price of the token in secondary markets, and (iii) the seller does not promise to take steps to support secondary trading 

of the token—then, at this stage, the seller’s efforts would be limited to supporting 

the use of the tokens with the network or software application and any further increase in the value of the token should not be derived from the efforts of the seller. 

Once the tokens are delivered to the purchasers, each purchaser would have unfettered control over the tokens, and would have no reasonable expectation that the 

seller will take future steps intended to increase the market value of the tokens. 

Generally, ‘‘[T]the courts will find a security is not present where the investor retains unfettered discretion over the distribution and marketing of the product.’’ Wabash Valley Power Ass’n., Inc. v. Public Service Co. of Ind., Inc., 678 F. Supp. 757, 

767 (1988) (added emphasis). At this point, unlike the DAO Token, which promised 

returns from projects undertaken by the DAO, any reasonable expectation of profits 

the purchaser might have should depend primarily on the market’s demand for the 

functioning application and the purchaser’s own efforts to find buyers and negotiate 

a favorable price for the tokens (akin to general expectations of appreciation in the 

demand for a commodity or real estate). 

Such changing circumstances—the completion of the full functionality of the 

token—also allow the seller to take a different approach to marketing its network 

or software application at the time of the public token sale. The completion of the 

network or software application allows the seller to focus on selling the tokens to 

potential users, so any marketing materials would emphasize the value in using the 

goods and services accessible through the token. In addition, unlike prefunctionality purchasers, the purchasers in a public sale do not expect the seller to 

hold a future sale of the tokens at a higher price. In fact, if the public sale is conducted to distribute the tokens at approximately their market clearing price, purchasers should not have a reasonable basis to anticipate any future appreciation in 

their value. 

These circumstances: (i) completion of the network or software application in 

which the token is used, (ii) a corresponding emphasis on selling the token based 

on its use and the value of its application and (iii) a public sale price that approximates such value, all serve to separate the public sale of the tokens from the circumstances existing at the time the pre-functionality token sale agreements are privately placed. These changed circumstances should prevail at the time the prefunctionality purchasers receive delivery of their tokens and have an opportunity to 

sell them. If the tokens are not digital securities by design, and if all the other facts 

61 

12SEC v. W.J. Howey Co., 328 U.S. 293 (1946); SEC v. Edwards, 540 U.S. 389 (2004). 

and circumstances support the conclusion that the token sale agreements entered 

into at the time of the public sale should no longer be viewed as investment contracts, then tokens received and, if applicable, sold by pre-functionality purchasers 

under those same circumstances should not be viewed as investment contracts either. The characteristics of the pre-functionality token sale agreement by which the 

tokens were originally purchased should not be determinative of the status of the 

tokens as ‘‘investment contracts’’ with respect to the subsequent offer and sale 

transaction occurring under changed facts and circumstances. 

Instead, we would argue that the pre-functionality token sale agreement was the 

instrument that was deemed a security under the Howey test, but that it is distinguishable from the underlying token. The pre-functionality token sale agreement is 

subject to the applicable private placement restrictions for the duration of its existence and may not be offered or sold except pursuant to appropriate registration or 

exemption. At the point of full functionality, however, and delivery of the tokens, 

the tokens take on a separate regulatory existence and their status as securities 

should be independently determined at that time. 

From Howey (oranges) to Edwards (pay phones),12 the case law is replete with 

products that provide the basis for an investment contract without qualifying as securities themselves. See, Christianson, supra note 2, 134 A.L.R. Fed. at §§ 10[b] (citing cases involving dental care products, foxes, beavers and master tapes) and 14[a] 

(citing cases involving whisky, personal and home care products, oil, chinchillas and 

earthworms). In these cases, a critical element was the promoter’s promise to either 

purchase or arrange for the sale of the underlying product at a profit, regardless 

of its current market value. A seller’s undertaking to conduct a public sale of future 

tokens at a price above the pre-functionality price might be considered analogous 

to the promoters’ promises in these cases. In that context, the promise of an opportunity to sell the tokens at a profit after delivery makes the pre-functionality token 

sale agreement an investment contract, not the character of the tokens (or any of 

the products in the cited cases). 

Critical, and unique to tokens and this analysis, is the mutability of the token— 

it can be both initially representative of an investment opportunity and subsequently a functional tool for use on the blockchain application. Thus, one of the reasons it may seem appropriate to treat both pre-functionality token sale agreements 

and their underlying tokens as investment contracts may stem from the fact that 

a token directly issued and marketed under the same circumstances as a prefunctionality token sale agreement may be considered an investment contract for 

the same reasons as a pre-functionality token sale agreement. A pre-functionality 

token in this sense, has the same security-like characteristics as a pre-functionality 

token sale agreement. This was the case in the Munchee Order, where the utility 

tokens were created and delivered to purchasers prior to full functionality. The 

Munchee Order involved several practices (such as an undeveloped application) commonly associated with pre-functionality token offerings. 

So long as utility tokens are not created or delivered to the pre-functionality purchasers prior to full functionality, the financial instrument that is the proper subject 

of the analysis is the pre-functionality token sale agreement itself, not the future 

token, which does not yet exist. 

G. Deemed Underwriter Status and ‘‘Coming to Rest’’ Analysis 

The adage ‘‘once a security, always a security’’ is alive and well, in light of the 

fact that the ‘‘security’’ is the investment contract (or, more precisely, the right to 

future tokens evidenced by that contract) not the asset underlying the investment 

contract. The pre-functionality token sale agreement never loses its character as a 

security and in practice these contracts are non-transferable on the part of the purchaser. Thus, the right to future tokens represented by the pre-functionality token 

sale agreement, which is a security, stays a security, and comes to rest in the hands 

of that initial purchaser. The best way to think about this is to change one fact from 

the Howey case itself—suppose the purchasers were paid in oranges instead of cash. 

If all the other facts remained the same, we would undoubtedly still consider the 

contract to be an investment contract (it would still be a contract to share profits, 

just denominated in oranges), but we would never conclude that the oranges, once 

fully grown and delivered, had somehow transformed into a security that could not 

be immediately sold by the purchasers upon receipt. 

H. Jurisdiction Over Hybrid Instrument 

When a contract involves an asset that is a commodity being sold under circumstances that cause the transaction to be a securities transaction under the SecuVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00065 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
62 

13Section 2(f) Exclusion for qualifying hybrid instruments of the Commodity Exchange Act 

provides: 

(1) In general 

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

(2) Predominance 

A hybrid instrument shall be considered to be predominantly a security if— 

(A) the issuer of the hybrid instrument receives payment in full of the purchase price 

of the hybrid instrument, substantially contemporaneously with delivery of the hybrid instrument; 

(B) the purchaser or holder of the hybrid instrument is not required to make any payment to the issuer in addition to the purchase price paid under subparagraph (A), whether as margin, settlement payment, or otherwise, during the life of the hybrid instrument 

or at maturity; 

(C) the issuer of the hybrid instrument is not subject by the terms of the instrument 

to mark-to-market margining requirements; and 

(D) the hybrid instrument is not marketed as a contract of sale of a commodity for future delivery (or option on such a contract) subject to this chapter. 

(3) Mark-to-market margining requirements 

For the purposes of paragraph (2)(c), mark-to-market margining requirements do not include the obligation of an issuer of a secured debt instrument to increase the amount of 

collateral held in pledge for the benefit of the purchaser of the secured debt instrument to 

secure the repayment obligations of the issuer under the secured debt instrument. 

rities Act, Section 2(f) of the Commodity Exchange Act (the ‘‘Hybrid Instrument 

Exclusion’’) guides the analysis of jurisdictional boundaries.13 By acknowledging 

and relying on the distinctions outlined within that provision, the SEC retains its 

inherent discretion and latitude to address potential security law violations at the 

point of token issuance, in addition to, and potentially independent of, prefunctionality token sale violations. This has the systemic benefit of maintaining 

clarity for responsible actors within the industry, ensuring utility tokens are treated 

in accordance with their inherent fungible characteristic, not negatively impacting 

the wider pre-funding model for the rest of the industry, and maintaining consistency with existing law designed to address these dilemmas. A pre-functionality 

token sale would need to satisfy the enumerated requirements of the Hybrid Instrument Exclusion in order to meet the definition, although such requirements could 

be met through appropriate documentation and marketing restrictions, for example 

a legend that confirms the pre-functionality token sale agreement is subject to SEC 

oversight and not an instrument subject to the provisions of the Commodity Exchange Act. 

Section 1(a)(29) of the Commodity Exchange Act defines a ‘‘hybrid instrument’’ as 

‘‘a security having one or more payments indexed to the value, level, or rate of, or 

providing for the delivery of, one or more commodities.’’ Section 1(a)(31) of the Commodity Exchange Act defines a ‘‘security’’ by reference to Section 2(a)(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities Exchange Act of 1934, both 

of which in turn define a security to mean, in pertinent part, an investment contract. 

The guidance provided by the Hybrid Instrument Exclusion is agnostic as to what 

is ultimately delivered pursuant to the pre-functionality token sale agreement in 

question: 

• in the event that the ultimate utility token delivered does not bear the hallmarks of a security and thus can be properly categorized as a commodity the 

SEC retains jurisdiction and regulatory oversight of the pre-functionality token 

sale agreement qua an investment contract, with the CFTC taking over jurisdiction and enforcement oversight of the delivered utility token in the spot market, 

as outlined in Section I.1 below. 

• in the event that the ultimate utility token delivered does bear the hallmarks 

of a security and thus can be properly categorized as a security the SEC retains 

jurisdiction and regulatory oversight of the pre-functionality token sale agreement qua an investment contract, and also retains jurisdiction and enforcement 

oversight of the delivered utility token as a security qua a commodity. This result, although slightly counter-intuitive, arises because under the definitions applicable to the Commodity Exchange Act, a security is a type of commodity, albeit an excluded commodity which is subject to exclusive SEC oversight. 

The history and interaction between the SEC and the CFTC on shared instruments is consistent with this result, and the Hybrid Instrument Exclusion is a direct result of consideration of products that escaped clear classification. The SEC 

63 

14 Report of the President’s Working Group on Financial Markets, Over-the-Counter Derivatives Markets and the Commodity Exchange Act, November 9, 1999. Available at: https:// 

www.treasury.gov/resource-center/fin-mkts/Documents/otcact.pdf. 15 COINCENTER.ORG, CFTC commissioner: tokens that start as securities may ‘‘transform’’ into 

commodities. October 20, 2017. Available at: https://coincenter.org/link/cftc-commissioner-tokens-that-start-as-securities-may-transform-into-commodities. 

and the CFTC have considered questions relating to hybrid instruments since the 

1980s (of particular note is the report of the President’s Working Group on Financial Markets in 1999).14 Since that time, the Hybrid Instrument Exclusion (formerly 

the hybrid instrument exemption) has been an appropriate method of determining 

which agency should have appropriate oversight over a legally awkward instrument. 

Given the unique and novel nature of utility tokens, conceiving a pre-functionality 

token sale agreement as a hybrid instrument is a pragmatic and common-sense approach to a scenario that can exhibit the characteristics of both a security and a 

commodity for all the reasons discussed above in Section E. This position is also consistent with the legislative history and general position of both the SEC and CFTC 

that products should generally be regulated by a single agency. It also results in 

the maintenance of the inherent fungibility of the utility tokens in question—an outcome that from a commodity law perspective is sensible (the characteristics of a 

commodity should not be affected by its means of delivery), as well as from a securities law perspective (the utility token can be assessed on its own merits as a potentially distinct security). 

On balance, treating the underlying token as a ‘commodity’ is an outcome consistent with the fundamental legislative intent of the Hybrid Instrument Exclusion 

(bearing in mind that for these purposes, a security can also be a type of commodity) 

and is also consistent with statements of CFTC Commissioner Brian Quintenz that 

[digital currencies] ‘‘may actually transform at some point from something that 

starts off as a security and transforms into a commodity’’ and that ‘‘they may start 

their life as a security from a capital-raising perspective but then at some point— 

maybe possibly quickly or even immediately—turn into a commodity’’.15

I. Quantum of Functionality 

The real question we need to address is not about transformation, it is whether 

a utility token can ever achieve the status of a commodity that is not also a security. 

This goes to the issue of the quantum of functionality required and whether and 

when variables exogenous to the promoter become predominant as the reason for 

the purchaser’s expectation of profits. 

Since utility tokens do not represent a share of the promoter, the main ties back 

to the promoter once full functionality has been achieved would seem to be any residual belief that the promoter is likely to continue to support and update the software underlying the tokens and/or the network on which the tokens can be used. 

Of course, all software products have updates and upgrades, so it would be surprising indeed if tokenized software must always be treated like a security while 

non-tokenized software is not. Tokenized software is a novelty but the analytical 

framework underlying the case law requires a determination of what predominates 

as the underlying driver of price changes that a reasonable purchaser would expect. 

In a post-functionality trading market for a fully completed piece of tokenized software, the ongoing updates and upgrades from the promoter would only represent 

a very small driver of price changes, if any. The state of the industry, competing 

novel trends, competing goods and services, and fundamental supply and demand 

issues that drive the price of the access or service provided by the token should predominate the value attributed to a token. The recent volatility in the digital currency markets demonstrates this very clearly. It cannot be said that someone’s 

promises of updates to the Bitcoin protocol, for example, had anything to do with 

the recent price swings. The real price swings occurred after the fork to the protocol 

was completed. These market moves were unrelated to any promises by a promoter 

to update the software as a driver of price, but instead reflected exogenous views 

of the market as to the value of Bitcoin. 

1. Whose Perspective Counts? 

In Teague v. Bakker, the Fourth Circuit affirmed that ‘‘[t]he subjective intention 

of a given purchaser cannot control whether something is a ‘security’ ’’ for purposes 

of the Howey test, otherwise ‘‘some might have purchased securities while others did 

not.’’ 139 F.3d 892, 892 (4th Cir. 1998). Rather, ‘‘[t]he proper focuses of the inquiry 

are on the transaction itself and the manner in which it is offered.’’ which would 

tend to place emphasis on objective evidence and considerations such as marketing 

materials, communications and transaction documents. Id. 

64 

16 Revak v. SEC Realty Corp., 18 F.3d 81, 87–88 (2d Cir. 1994), relying on Long v. Shultz Cattle Co. Inc., 881 F.2d 129, 140–41 (5th Cir. 1989); SEC v. Comcoa, Ltd., 855 F. Supp. 1258 (S.D. 

Fla. 1994) (finding vertical commonality with regard to service to assist application and development of FCC licenses). These courts can be said to subscribe to the broad vertical commonality 

interpretation of the common enterprise prong of the Howey test. 

The manner of offering was paramount in the recent Administrative Order 

against Munchee, Inc., Sec. Act Release No. 10445 (Dec. 11, 2017) (the ‘‘Munchee 

Order’’), which found an investment contract based on the promoter ‘‘emphasiz[ing] 

the economic benefits to the purchaser [of a token] to be derived from the managerial efforts of the [token’s] promoter.’’ The tokens in the Munchee Order (‘‘MUN’’) 

were intended for use in an application to advertise, review and buy meals from restaurants, although ‘‘no one was able to buy any good or service with MUN’’ at the 

time of their sale. Munchee Order at 10. ‘‘In the MUN White Paper, on the Munchee 

Website and elsewhere, Munchee and its agents . . . emphasized that the company 

would run its business in ways that would cause MUN tokens to rise in value.’’ Id. 

at 12. The SEC also found that ‘‘Munchee primed purchasers’ reasonable expectations of profit through statements on blogs, podcasts, and Facebook that talked 

about profits.’’ Id. at 14. Munchee also undertook to list MUN on exchanges, so that 

purchasers could realize profits through secondary trading, regardless of whether 

they ever used MUN in the application. Id. at 13. These findings led the SEC to 

conclude that MUN tokens were investment contracts, id. at 30, insofar as, 

‘‘[b]ecause of the conduct and marketing materials of Munchee and its agents, investors would have had a reasonable belief that Munchee and its agents could be relied 

on to provide the significant entrepreneurial and managerial efforts required to 

make MUN tokens a success.’’ Id. at 34 (added emphasis). 

Notwithstanding its emphasis on the manner of offering, Teague allowed that in 

some cases, ‘‘where most intended purchasers share a common understanding of, 

and have similar motives stoked by, an offering, the ‘subjective’ understanding and 

motives are powerful evidence of the objective intent and effect of the offering.’’ 

Teague, 139 F.3d at 892. Teague set a high bar for reaching this conclusion: it 

looked to ‘‘the subjective feeling of the vast majority of purchasers,’’ and not merely 

the particular plaintiffs in question, as likely indicative of the seller’s objective intention despite other evidence. Id. It should also be noted that the motives must 

still be ‘‘stoked by the offering,’’ rather than a general enthusiasm for all things associated with a blockchain. It follows that a token seller that implements safeguards 

and constructs a token and conducts a token sale the ‘‘right way’’ will ultimately 

be able to sell a utility token as a non-security even if some purchasers have wildly 

unrealistic expectations of profit akin to beanie baby mania. 

2. Who are the ‘‘Others’’ in Efforts of Others? 

The original formulation of the Howey test stated that the profits must have been 

expected ‘‘solely from the efforts of the promoter or a third party.’’ This test has 

been subsequently modified with respect to the requisite amount of efforts as discussed below. Some courts 16 have focused on the efforts of the promoter as satisfying the common enterprise prong of the Howey test as discussed below, with other 

courts noting that this treatment would conflate the common enterprise prong with 

the efforts of others prong. Putting aside the common enterprise conflation and focusing again on the efforts of others prong, most cases focus on either the promoter’s 

efforts or the purchaser’s efforts. It would appear from the original formulation that 

reliance must be placed on the efforts of some identifiable person or persons. The 

clause would be overbroad if ‘‘others’’ were interpreted to include anyone other than 

the purchaser. All investment assets would be securities if efforts of others included 

the efforts of unspecified persons contributing to market dynamics and supply and 

demand. This element of the test will be relevant to many utility token sales since, 

unlike traditional enterprises, typically, the projects involve the development of 

open-source software that can be maintained by anyone and not just the original 

promoter of the project. Even for those who subscribe to the broad vertical commonality interpretation of the common enterprise prong of the Howey test, however, 

that interpretation has focused on the efforts of the promoter, so the entire community of open source software developers would need to be considered part of the promoter in order to satisfy that interpretation. While the original promoter is the most 

likely party to provide updates and upgrades to the code, the fact that there is a 

large community of developers who could easily decide to step in and do so further 

minimizes the amount of reliance a reasonable purchaser would objectively have on 

the efforts of the promoter as compared to the far weightier price drivers in a trading market that have nothing to do with the original token seller. 

65 

17 E.g., Steinhardt Group v. Citicorp, 126 F.3d 144 (3dCir. 1997) (limited partnership interest 

in a securitization transaction was not a security where limited partner’s retention of ‘‘pervasive 

control’’ meant that he was relying extensively on his own efforts). 18See, e.g., United States v. Leonard, 529 F.3d 83 (2d Cir. 2008) (the court considered whether, 

under all the circumstances, the scheme was being promoted primarily as an investment). 19This illustrates the problem with applying Glenn W. Turner to tokens. There is no enterprise on whose success or failure the token holder’s investment depends. The closest analog 

might be to substitute the secondary market for the ‘‘enterprise’’ in that test. 

3. Requisite Amount of Efforts of Others 

As discussed, the original Howey formulation was modified by subsequent case 

law that recognized the word ‘‘solely’’ was too narrow. It is clear that at one end 

of the spectrum, if either the purchaser’s efforts are significant in the success of the 

enterprise,17 or the promoter’s efforts are de minimis in assuring the success of the 

investment, the Howey test is not satisfied. Beyond that, courts have stated the requirement as ‘‘primarily’’ or ‘‘substantially’’ from the efforts of others.18 As discussed 

above, in Glenn W. Turner, the court stated the test as ‘‘whether the efforts made 

by those other than the investor are the undeniably significant ones, those essential 

managerial efforts which affect the failure or success of the enterprise.’’ The context 

for this test was a business enterprise that included both efforts of the promoter 

and efforts of the purchaser. The court was clearly focused on ensuring that promoters could not avoid the securities laws by merely building in some perfunctory 

efforts of the purchaser into their business schemes. When the context is about determining when the promoter’s efforts are displaced by variables entirely exogenous 

to (and beyond the control of) both the promoter and purchaser, the test is better 

understood to be a simple predominance test. For that reason, we have used predominance as the test throughout this memorandum, but we would also expect that 

if a court applied a test more like the Glenn W. Turner test, the efforts associated 

with software updates and upgrades would still not rise to the level described by 

that test. It can hardly be said that providing ongoing software updates and upgrades constitute those essential managerial efforts which affect the failure or success of the secondary market price,19 particularly compared to the other market dynamics affecting price in the trading market post-functionality. 

Since the test is objective, and because use of tokens for their intended purpose 

is gaining traction, some courts might well conclude that purchasers are not merely 

passive and that the purchaser’s collective efforts are significant because use of the 

token for its intended purpose is a strong driver of demand for the token and, therefore, the price of the token. Many applications permit, and some require, token holders to participate in the operation of the application. A crowdsourcing application 

will not work unless enough users vote or otherwise record a view on the 

crowdsourced question. These applications frequently use tokens to regulate the 

crowdsourcing process, assign and weight votes and reward the most accurate predictions. Networked services are another common example of applications that require active participation by token holders. Network participants must download the 

service application on their computers and accept tokens in exchange for performing 

the service. Holders of tokens for such applications may be active contributors to 

the token’s success, rather than passive investors. Many courts have found that an 

arrangement does not constitute an investment contract when it involves significant 

efforts of the purchaser. See Cordas v. Specialty Restaurants, Inc., 470 F. Supp. 780, 

788 (D. Ore. 1979) (‘‘[i]t is undeniable here that the plaintiff’s managerial efforts 

were intended to have an important effect on her own success. Her efforts would 

also have some effect, however slight, [added emphasis] on the success of the enterprise as a whole. [Citation omitted.] These factors are sufficient to preclude her from 

coverage under the Howey analysis.’’ ‘‘To hold otherwise would put the courts in the 

position of judging where along the continuum a manager’s efforts become ‘significant’ in the success of a larger enterprise.’’) Id. at 788. The Cordas court chose to 

apply Howey based on the quality of the plaintiff’s participation, rather than its impact on the broader enterprise. Other courts have also taken this approach to the 

final prong of the Howey test, particularly in cases involving franchises. For example, Boldy v. McConnell’s Fine Ice Creams, Inc., 904 F.2d 710 (9th Cri. 1990) (‘‘In 

focusing on ‘the extent of participation the franchisee has under the franchise agreement’ in this case, it is clear that ‘each franchisee’s active management was essential to the success of his retail restaurant.’ ’’ [Citation omitted.]); see also, cases discussed in What is an ‘‘Investment Contract’’ within Meaning of § 2(1) of Securities 

Act of 1933 (15 U.S.C.A. § 77b(1)) and § 3(a)(10) of Securities Exchange Act of 1934 

(15 U.S.C.A. § 78c(a)(10)), Both Defining Term ‘‘Security’’ as Including Investment 

Contract, 134 A.L.R. Fed. 289, § 17[a]–[c] (Cum Supp. 2017). 

66 

Whether or not a court finds substantial efforts of token holders are involved, it 

seems likely that once full functionality has been achieved, the efforts of the promoter would not rise to the level required by the efforts of others element of the 

Howey test to consider post-functionality sales of the token to constitute investment 

contracts. 

4. Gary Plastic 

The Gary Plastic case has special relevance to utility tokens given the robust secondary markets that have developed. In an ordinary case, most of the elements of 

Gary Plastic can be distinguished—token exchanges do not negotiate the terms of 

the tokens, do not promise to find buyers for the tokens and are not exclusive 

venues for purchase and sale of the tokens. The key element, however, that would 

be applicable is any promise by the promoter to establish or maintain a trading 

market for the tokens. This can be described as a special type of ‘‘efforts of others’’ 

that obviates the need for analysis of trading dynamics as the driver of price since 

the expectation that the market will exist in the first place is based on the promised 

efforts of the promoter. It follows that any promises by the promoter to support an 

active trading market for the token would, by itself, be sufficient to satisfy the efforts of others prong of the Howey test. The same would not be true, however, if 

the token seller were to cooperate with token exchanges in the qualification process 

without publicizing in advance any promise of such cooperation. Without a promise 

of supporting trading in advance of a purchase, the purchaser cannot reasonably expect it, as token exchange qualification requirements are significant and evolving 

rapidly. While outside the scope of this paper, we note that some exchanges are currently requiring token sellers to provide a securities law analysis and some token 

creators are declining to provide this for fear of being seen as facilitating exchange 

activity. As a result, many tokens perversely wind up being traded only on the less 

rigorous (often foreign) exchanges that do not require interaction. Discouraging cooperation with the qualification process, may negatively impact the ability of exchanges to properly discriminate between tokens that are securities, which the exchange is not licensed to list, and utility tokens. Similarly, merely providing links 

to token exchanges contained on a token seller’s website should not be viewed as 

efforts of the promoter to support an active trading market, so long as these links 

are merely included to assist users of the platform in obtaining tokens for use on 

the platform. 

5. Full Functionality 

In light of the above, it is clear that merely some utility is not sufficient under 

present market conditions. A reasonable approach to defining how much 

functionality is sufficient under present market conditions would be to say that the 

token must have at least as much functionality as any other non-tokenized good or 

service being sold. To that end, we would propose an 80/20 rule of thumb whereby 

the marketing materials focus on the present functionality of the token with much 

less attention paid to the potential future upgrades or additional features (i.e., 80% 

focused on present functionality and 20% on future functionality). This roughly approximates what other sellers of non-tokenized goods and services have historically 

put into their marketing materials. While virtually all products with embedded software come with free updates, the seller will focus on the present functionality of 

the product to entice the purchaser with the features the purchase can presently 

enjoy. The seller might also mention planned future enhancements that will be delivered for free to induce the purchaser to buy now rather than wait because the 

purchaser will get the update for free when available without having to wait to 

enjoy all the present features of the product. Stereo equipment is a good example 

of this where the marketing materials will focus on the present features, but will 

also include some mention of the ‘‘future proof’’ nature of the purchase by discussing 

other codecs (i.e., digital music formats) that will be supported on the equipment 

after a firmware update that will be provided for free when available. 

Once a token has achieved its full functionality under this proposed standard, any 

purchaser that purchases the token with an expectation of profits is relying primarily on market dynamics affecting the value of the goods and services accessible 

through the token (not the promoter) for price changes. So long as the token seller 

did not promise to support secondary trading on any exchanges, the sale of a utility 

token with full functionality should not be the sale of a security. 

J. Consumptive Intent vs. Resale 

As discussed, the Teague court focused on objective criteria in determining the 

purchasers’ intent. Other Federal courts have expanded on Teague, concluding that 

marketing materials indicating an actual subjective investment-related purpose established by the plaintiff could not override a contractual representation and merger 

67 

20Demarco v. LaPay, No. 2:09–CV–190 TS, 2009 WL 3855704, *8–*9 (D. Utah Nov. 17, 2009) 

(holding that plaintiffs could not ‘‘disclaim the contents of the contract which were clearly laid 

out and duly acknowledged by them’’ in real estate transaction); see also Alunni v. Dev. Res. 

Group, LLC, No. 6:08–cv–1349–Orl–31DAB, 2009 WL 2579319, *8 n. 12 (M.D. Fla. Aug. 18, 

2009) (same). 21 In many cases, the use price of a utility token is entirely independent of the secondary market price, in which case the secondary market speculation is really about currency value which 

is commodity speculation having nothing to do with the project or promoter. These types of utility tokens are much more akin to digital currencies in their relationship to securities laws. 

clause affirming that a purchase was for consumption.20 As such, even under current market conditions where resale intent appears to be more prevalent than consumptive intent, there are certain practices that could be employed by token sellers 

to establish sufficient consumptive intent, although these are not common features 

of a token sale. Here are a few examples: 

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

time; 

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

hedge funds); 

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

• Include representations as to intended use of the token; and 

• Include covenants of the purchaser to login and use the tokens in the network 

on some prescribed periodic basis. 

Since an offering must meet each prong of the Howey test to be considered an investment contract, if sufficient consumptive intent were to be established, the token 

sale would not be an investment contract even if the sale occurred prior to the development of full functionality. 

It is also important to consider when the appropriate time to measure consumptive intent vs. resale intent is. In the case of event tickets, resale intent predominates the first few days following ticket launch as resellers attempt to speculate on 

the ultimate price that users will be willing to pay. This is because the tickets are 

generally not released until shortly before the event takes place. Because there is 

a fixed date for use, the seller is able to ensure that the time for resale is arbitrarily 

short. With utility tokens, there is no fixed date for use so it is possible that resale 

will go on for a relatively long time and only gradually shift to use as the project 

gains adoption and traction among users. As that happens, the price would be expected to converge on the ultimate price that end users are willing to pay.21 If we 

measure consumptive intent today for a utility token launched last week, it is likely 

we will conclude that resale intent predominates over consumptive intent presently. 

That doesn’t mean there never will be consumptive intent or that the utility tokens 

have no inherent consumptive purpose. The same would be true of event tickets if 

measured at a time when resale was prevalent. Anecdotal evidence suggests that 

there have been a number of earlier token offerings from the 2014 and 2015 vintage 

with respect to tokens that are now routinely used for their intended purpose. This 

is why the Kickstarter model was considered best practices for the early utility 

token sales in 2017. This inevitable change in circumstances, i.e., mutability, at 

least for those tokens with truly useful functionality, is also why it makes sense 

under existing case law to only consider pre-functionality token sale agreements to 

be securities, and not the tokens themselves in perpetuity. 

K. Characteristics of a ‘‘Compliant’’ Token Sale 

As the DAO Report found, and as many commentators and regulators have observed, many token sales are currently running afoul of U.S. securities laws. In this 

sense, the DAO Report sounded an important cautionary alarm to the market. However, the offer and sale of tokens can be affected in a manner that complies with 

the requirements of the Federal and state securities laws. Here are the key characteristics that must be present in a token sale that complies with the requirements 

of the U.S. securities laws: 

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

• Prior to achieving full functionality, the offer and sale of tokens will almost always be deemed to be the offer and sale of an investment contract that must 

be registered or exempt under U.S. securities laws; 

68 

22Once again, event tickets are an example of a traditional good that does have a fixed supply. 

• Once full functionality is achieved, there should be no expectation of profit from 

the efforts of others, and value should instead be driven by exogenous market 

factors. At such a point, the token should no longer be deemed an investment 

contract, as the transaction no longer meets the Howey test, and the offer and 

sale of tokens should no longer be subject to the requirements of the Securities 

Act; 

• The requisite amount of functionality needed is fact-based, with marketing 

being an important determinant—if buyers would not buy the token for its 

present functionality, the token seller must build more present functionality before distributing the token to the public as a non-security; 

• Marketing materials must focus on present functionality and use of the token, 

not on future features or resale opportunities, although a short description of 

any planned upgrades is permissible; and 

• The token seller cannot promise to support secondary market trading of the 

token on any exchanges. 

We believe the following facts tend to push the securities analysis one way or the 

other but are not by themselves dispositive (good facts push the analysis toward a 

non-security): 

• Fixed or automatically increasing supply of tokens is generally a good fact. A 

fixed or automatically increasing supply is not characteristic of most traditional 

product sales, but it is also not characteristic of most securities offerings either.22 It is a currency-like characteristic and generally stems from the Bitcoin 

model and the fact that most utility tokens are used as currencies even if they 

have additional functions and features. A fixed or automatically increasing supply also helps the analysis around efforts of others in the sense that the promoter has no control over supply, which is a key element of price in the trading 

market. 

• Diminishing token supply, either automatic or periodic, tends to indicate an intent on the part of the token seller to drive up the price of the token in the 

secondary markets. If this feature exists, there should be important structural 

reasons for this feature having nothing to do with the desire to influence price. 

This feature represents efforts of the promoter in structuring the token that not 

all courts would recognize as satisfying the Howey test to the extent the court 

applies the Life Partners test focusing on post-sale efforts rather than pre-sale 

efforts, but since this conclusion is in question, it is still considered to be a bad 

fact for purposes of utility token sales. 

• Publicly announced discounts that diminish over a set schedule are problematic 

during a post-functionality token sale, especially if not accompanied by resale 

lockups. While this may be a practice used by conventional sellers of goods and 

services, in the context of utility tokens, it does tend to create an expectation 

of profits based on the efforts of the promoter to structure the token sale in this 

manner. Once again, these would be pre-sale efforts of the promoter, but it 

would still be considered a bad fact for a utility token sale. Also, the same practice would be appropriate during the pre-functionality token sale, because the 

purchasers are investors with a profit motive participating in a securities offering with the requisite protections in place. 

• Allocations of a substantial number of tokens to the token seller team as well 

as to advisors, strategic partners and others for compensatory purposes, especially without any significant resale lockups in place, clearly puts tokens in the 

hands of persons with resale intent, not consumptive intent. This may not matter to the extent we have already assumed that most purchasers are purchasing 

with resale intent. At a minimum, if these allocations are granted prefunctionality, the grant must comply with Rule 701 or Regulation D or otherwise comply with U.S. securities laws. The real reason this could be a bad fact 

is that this practice may result in fraudulent ‘‘pump and dump’’ Ponzi-like 

schemes on the part of the persons receiving the allocations. 

• Each of the factors discussed above in Section J that tend to establish consumptive intent rather than resale intent are good facts, particularly lockups that 

prohibit resale but not use for a significant period of time after purchase, which 

are an excellent way to curb ‘‘pump and dump’’ tendencies and to emphasize 

intent to use rather than resell. 

69 

23The term digital currency means the same thing as virtual currency for purposes of this 

memorandum. In its enforcement order against Derivabit in September 2015, the CFTC confirmed that ‘‘Bitcoin and other virtual currencies are encompassed in the definition and properly 

defined as commodities.’’ United States of America Before the Commodity Futures Trading Commission In the Matter of Coinflip Inc., d/b/a Derivabit, and Francisco Riordan, Respondents. 

Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange 

Act, Making Findings and Imposing Remedial Sanctions. CFTC Docket No. 15–29, September 

17, 2015. Available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder09172015.pdf. 24 CEA Sections 6c, 9a(2) and Part 180 of the CFTC’s regulations give the CFTC the authority, 

in relevant part, over violations with respect to ‘‘any commodity in interstate commerce.’’ 7 U.S. 

Code §§ 9, 13, and 17 CFR § 180, 76 FR 41398. There are two particular provisions of the CEA 

that grant the CFTC broad authority to take action against persons engaged in forms of market 

abuse, including manipulation and fraud, or attempted manipulation and fraud, Sections 6(c) 

and 9(a)2. Commission Regulation 180 (i.e., Part 180) codifies Section 6(c). 25 In addition to the Derivabit action outlined above, the CFTC has also taken action against 

TeraExchange in 2015, and the spot exchange Bitfinex in 2016, for CEA violations associated 

with virtual currencies. See United States of America Before the Commodity Futures Trading 

Commission In the Matter of TeraExchange LLC Respondent. Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange Act, as amended, Making Findings 

and Imposing Remedial Sanctions. CFTC Docket No. 15–33, September 24, 2015. Available at: 

http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/ 

enfteraexchangeorder92415.pdf. See also United States of America Before the Commodity Futures 

Trading Commission In the Matter of BFXNA Inc. d/b/a BITFINEX, Respondent. Order Instituting Proceedings Pursuant to Sections 6(c) and 6(d) of the Commodity Exchange Act, as 

amended, Making Findings and Imposing Remedial Sanctions. CFTC Docket No. 16–19, June 

2, 2016. Available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfbfxnaorder060216.pdf. 26 CEA Section 1a(9), 7 U.S. Code § 1. 27 Commodity Futures Trading Commission v. Gelfman Blueprint, Inc. and Nicholas Gelfman, 

Case Number 17–7181, United States District Court, Southern District of New York. Complaint 

filed September 21, 2017. Available at: http://www.cftc.gov/idc/groups/public/ 

@lrenforcementactions/documents/legalpleading/enfgelfmancomplaint09212017.pdf. 28 Commodity Futures Trading Commission v. My Big Coin Pay, Inc., Randall Crater, and 

Mark Gillespie, Case Number 18–10077–RWZ, United States District Court, District of Massachusetts. Complaint filed January 16, 2018. Available at: http://www.cftc.gov/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfmybigcoinpaycomplt011618.pdf. 29 Commodity Futures Trading Commission v. Dillon Michael Dean and the Entrep[r]eneurs 

Headquarters Limited, Case Number 18–cv–00345, United States District Court, Eastern District of New York. Complaint filed January 18, 2018. Available at: http://www.cftc.gov/idc/ 

groups/public/@lrenforcementactions/documents/legalpleading/enfentrepreneurscomplt01 

1818.pdf. 

L. Existing Regulations Applicable to Token Exchanges—CFTC Anti-Fraud Rules 

The CFTC is responsible for enforcement actions against wrongful conduct in spot 

markets for digital currencies.23 Historically, the CFTC has exercised that enforcement authority when there is a nexus to an actively traded commodity interest,24

and, consistent with that approach, since the recent launch of digital currency-related derivative products, the CFTC has stepped up its enforcement actions against 

spot market abuses, although its initial digital currency-related actions began in 

2015.25 ‘‘Bitcoin and other virtual currencies’’ have already been deemed within the 

scope of ‘commodities’ under CFTC enforcement jurisdiction, and given the wide 

scope of the definition (the term commodity means ‘‘all other goods and articles 

[. . .] and all services, rights and interests [. . .] in which contracts for future delivery are presently or in the future dealt in’’), any utility token with fungible characteristics falls within this scope.26

In September 2017, in its complaint against Gelfman, the CFTC took action 

against alleged abuses in the Bitcoin spot market and charged operators of an alleged Ponzi scheme with fraud, misappropriation and issuing false account statements in violation of Section 6(c) of the CEA.27 In January 2018, the CFTC brought 

three digital currency enforcement actions: (i) My Big Coin Pay Inc., which charged 

the defendants with commodity fraud and misappropriation related to the ongoing 

solicitation of customers for a digital currency known as My Big Coin; 28 (ii) The Entrepreneurs Headquarters Limited, which charged the defendants with a fraudulent 

scheme to solicit Bitcoin from members of the public, misrepresenting that customers’ funds would be pooled and invested in products including binary options, 

making Ponzi-style payments to commodity pool participants from other participants’ funds, misappropriating pool participants’ funds, and failing to register as a 

Commodity Pool Operator; 29 and (iii) CabbageTech, Corp., which charged the deVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00073 Fmt 6633 Sfmt 6621 P:\DOCS\115-14\30893.TXT BRIAN
70 

30 Commodity Futures Trading Commission v. Patrick K. McDonnell, and CabbageTech Corp. 

d/b/a Coin Drop Markets, Case Number 18–cv–0361, United States District Court, Eastern District of New York. Complaint filed January 18, 2018. Available at: http://www.cftc.gov/idc/ 

groups/public/@lrenforcementactions/documents/legalpleading/enfcdmcomplaint011818.pdf. 31See CFTC Backgrounder on Self-Certified Contracts for Bitcoin Products, December 1, 2017. 

Available at: http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/bitcoin_fact 

sheet120117.pdf. See also CFTC Statement on Self-Certification of Bitcoin Products by CME, 

CFE and Cantor Exchange, December 1, 2017. Available at: http://www.cftc.gov/PressRoom/ 

PressReleases/pr7654-17. 32 CFTC Customer Advisory: Beware Virtual Currency Pump-and-Dump Schemes, February 

15, 2018. Available at: http://www.cftc.gov/idc/groups/public/@customerprotection/documents/file/customeradvisory_pumpdump0218.pdf. 33Lily Katz and Matt Robinson, Cryptocurrency Flash Crash Draws Scrutiny from Watchdog, 

BLOOMBERG.COM, October 2, 2017. Available at: https://www.bloomberg.com/news/articles/ 

2017-10-02/cryptocurrency-flash-crash-is-said-to-draw-scrutiny-from-cftc. 34Matthew Leising, U.S. Regulators Subpoena Crypto Exchange Bitfinex, Tether, 

BLOOMBERG.COM, January 30, 2018. Available at: https://www.bloomberg.com/news/articles/ 

2018-01-30/crypto-exchange-bitfinex-tether-said-to-get-subpoenaed-by-cftc. 35To prove an aiding and abetting violation under the CEA (7 U.S. Code § 25(a)(1)), it must 

be shown that the defendant ‘‘in some sort associate himself with the venture, that he participate in it as in something that he wishes to bring about, that he seek by his action to make 

it succeed.’’ CFTC v. Amaranth Advisors, L.L.C., 554 F. Supp. 2d 523 (2008) stating the appropriate standard for aiding and abetting under the CEA, quoting Learned Hand J. in United 

States v. Peoni, 100 F.2d 401, 402 (2d Cir.1938). 36 7 U.S. Code § 25(a)1(D) provides that a private litigant can take action for fraud, attempted 

fraud or if the violation constitutes ‘‘a manipulation of the price of any such contract or swap 

or the price of the commodity underlying such contract or swap.’’ 37 Howey, supra note 2 at 299. (The Howey test ‘‘embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by 

those who seek the use of the money of others on the promise of profits.’’) 

fendants with fraud and misappropriation in connection with purchases and trading 

of Bitcoin and Litecoin.30

The CFTC also appears to be closely monitoring digital currency spot exchanges 

as part of these efforts. As part of the self-certification process for Bitcoin futures 

products by certain Designated Contract Markets (‘‘DCMs’’), the CFTC expects information sharing agreements to be in place with underlying spot exchanges in accordance with the second core principle for DCMs.31 On February 15, 2018, the 

CFTC once again reminded market participants in a customer protection action that 

it ‘‘maintains general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity in interstate commerce.’’ 32 It has also 

apparently (i) requested information from GDAX in relation to an alleged ‘flash 

crash’ which occurred on June 21, 2017,33 and (ii) issued subpoenas regarding alleged conduct at the Hong Kong-based exchange Bitfinex.34

Reinforcing the inherent scope of the CFTC’s enforcement authority is the possibility of aiding and abetting violations that act to restrain certain industry service 

providers or other market participants associated with any alleged violations.35 The 

efficacy of this regulation by proscription is further reinforced by the ability of private litigants to take actions under the above provisions, subject to certain additional requirements.36 For a private actor to make a claim, they must demonstrate, 

inter alia, that they purchased or sold a derivative contract referencing a digital currency and prove actual damages resulting from the proscribed conduct. Although 

this right of action therefore relies on a nexus to the digital currency derivative 

market, as the number and diversity of digital currency based derivative products 

continues to grow so too does the number of potential plaintiffs. 

M. Conclusion 

The Howey test is fundamentally based on facts and circumstances—the economic 

realities—of the offer and sale of the underlying product or service.37 As circumstances change, the results of the test should change as well. Specifically, when 

the circumstances under which parties agree to enter into a pre-functionality token 

sale agreement have changed by the time the underlying tokens are delivered, an 

analysis which concluded that the pre-functionality token sale agreement constituted an investment contract may no longer apply to the tokens. On the other 

hand, if circumstances have not changed materially, new token sale agreements 

may constitute investment contracts in their own right, even after delivery under 

the initial pre-functionality token sale agreement. 

A pre-functionality token sale agreement may be found to constitute an investment contract even if the future tokens will not qualify as investment contracts or 

other securities at the time of their delivery. When a seller offers and sells the prefunctionality token sale agreements by emphasizing the potential value of the future 

71 

tokens, uses the proceeds of the pre-functionality token sale agreements to complete 

development of an application for the tokens and undertakes to conduct a public 

sale of the tokens with a target price above the pre-functionality price, these circumstances may provide a basis for the SEC or a court to conclude that the prefunctionality token sale agreements are investment contracts. Once the network or 

software application for the tokens is developed, these circumstances would no 

longer apply and, thus, could no longer provide a basis for concluding that further 

sales of tokens would constitute investment contracts. Even if the pre-functionality 

purchasers reasonably anticipate that a token will appreciate above its public sale 

price, any such appreciation should result from general market forces rather than 

the efforts of the seller. Therefore, once the investment contract implied by the prefunctionality token sale agreement has been completed (i.e., at the time of tokens 

are delivered), the tokens should no longer involve a common enterprise in which 

the seller’s efforts are reasonably expected to produce profits for the token purchasers. 

N. Epilogue 

While not directly related to the above conclusion, here are some additional 

thoughts worth considering. 

1. Relevant Disclosure 

Ultimately, the Securities Act is a disclosure regime. One important way to look 

at this situation is to ask what the relevant disclosure would be post-functionality. 

Existing disclosure rules assume the security represents either equity or debt, neither of which would be appropriate disclosure rules for utility tokens. It would not 

be wise, for example, to include disclosure about the token seller, or we would confuse the purchasers into believing they have some interest in the token seller, which 

they do not. Perhaps some disclosure would be appropriate about the real risk here, 

namely that the market price is extremely volatile, but that is now patently obvious 

to anyone sitting in front of a computer and is not something about which the token 

seller has any special information or expertise to provide. Maybe some disclosure 

about overhang would make sense, especially if the token seller happens to be 

aware of any large purchasers, but this disclosure again risks providing false comfort to the market since the token seller, unlike an equity issuer, has no way of 

knowing who holds any particular percentage of the tokens from time to time. We 

have to ask ourselves, if there is no relevant disclosure that could possibly be provided by the token seller post-functionality, are we really dealing with a securities 

transaction that is appropriately regulated under a disclosure regime, or are the 

regulatory concerns really about trading price manipulation covered by the CFTC’s 

anti-fraud rules for spot trading? 

2. Common Enterprise 

We have not considered the common enterprise prong of the Howey test in the 

above discussion because the courts are fractured over the best way to interpret this 

prong of the test. This fact, however, cuts both ways. It is not prudent for a token 

seller to rely on this test as the sole prong to hang its hat on, or for regulators to 

assume it will be easy to prove (and the regulator must prove it to win in court). 

Indeed, the most commonly applied interpretation of this prong involves horizontal commonality, which doesn’t appear to be the case once tokens have achieved 

full functionality and are sold to purchasers as a product. There are no contractual 

commitments on the part of the token seller surviving the post-functionality token 

sale. The proceeds of a post-functionality token sale cannot be said to be pooled in 

any enterprise of which the token holders own a share or interest. It is true that 

narrow vertical commonality will often exist in the sense that the token seller’s fortunes are often tied to the same market dynamics as the token holders to the extent 

the price of tokens rises and the token seller has retained an inventory of tokens 

for future sale. Perhaps for the very reason that this type of commonality would 

apply to every seller of a good or service that is hoping for the prices of its goods 

to go up, very few courts have held that narrow vertical commonality is sufficient 

by itself to satisfy the common enterprise prong. Broad vertical commonality, meaning that the fortunes of the token holder are tied to the efforts of the token seller 

would be subsumed within the efforts of others prong, so it would not be sufficient 

for merely some efforts of the promoter to satisfy the Howey test for all the reasons 

described above with respect to the efforts of others prong showing that those efforts 

must predominate the expectation of profits. From the regulator’s perspective, at 

best, the common enterprise prong adds nothing to the analysis, but in all likelihood, it represents a very significant hurdle to overcome in court. 

72 

3. Fraudulent Sales Tactics—Pump and Dump 

We have pointed out in several instances above that, if we apply existing case law 

with analytical consistency, the mere marketing of a post-functionality token (or any 

commodity, such as gold coins) as an investment should not, by itself, cause the offering to satisfy the Howey test. Nevertheless, we leave open the possibility that the 

presence of abusive marketing tactics or running a so-called ‘‘pump and dump’’ 

scheme can satisfy the efforts of others prong in that purchasers would expect to 

profit on the continuation of those abusive promotional efforts. In any market environment, that would be sufficient basis for satisfying Howey if the other prongs were 

also satisfied. Moreover, token sellers would be unwise to ever refer to the token 

as an investment, whether pre- or post-functionality, because those statements will 

live on and be discoverable with an Internet search even at some future time when 

the token seller would like to be able to conclude that the efforts of others prong 

is no longer the only prong available to avoid satisfying the Howey test (e.g., if the 

token seller wants to market future features after the market has cooled down and 

the tokens are being used instead of resold for the most part). As such, we do not 

expect this technical point—that commodities may be marketed as investments—to 

lead to problematic behavior in the context of token sales. 

4. Reves Test 

It is important not to confuse the Reves test with the Howey test. Some of the 

Reves factors are similar to some of the Howey prongs. The first Reves factor examines the transaction in order to assess the motivations that would prompt a reasonable lender (buyer) and creditor (seller) to enter into it. For example, was the transaction in question an investment transaction or a commercial or consumer transaction? This factor might be confused with the expectation of profits element of the 

Howey test. In Reves the satisfaction of any one factor, if strong enough, can cause 

the note to qualify as a security. This confusion may lead to the incorrect application of Howey which requires every prong to be satisfied, regardless of how clearly 

any one factor may be satisfied, for the arrangement to qualify as an investment 

contract. Again, it is not sufficient for an expectation of profits to exist with respect 

to an asset that may even be marketed as an investment, if the expectation is not 

based on the efforts of others. Analytically, it just doesn’t matter in how many ways 

and how clearly the expectation of profits prong is satisfied if those expectations are 

not based on the efforts of others. 

In addition, some of the Reves factors would appear relevant to utility tokens, especially the second factor, which is the plan of distribution used in the offering and 

selling the instrument—for example, is the instrument commonly traded for investment or speculation? While it may be tempting to consider the trading markets for 

utility tokens to be dispositive of the issue of whether a utility token is a security, 

that is not the case. As discussed above, it is merely one more fact tending to establish the expectation of profits element of the Howey test, which may be overridden 

by the other prongs. 

5. Policy Considerations 

Blockchain technology is as transformative as the Internet. While the Internet 

was about the movement of information (and set off lots of new legal concerns 

around privacy and data security), blockchain technology is about the movement of 

value. The key innovation, as with the Internet, is found in the frictionless nature 

of the movement. It has already led to important new business models never seen 

before. It will ultimately lead to rapid frictionless liquidity for every asset class and 

every good and service. Wherever possible, it will be important to regulate based 

on looking through the token to the thing being tokenized for the right regulatory 

treatment. But, it will mean things like novel software applications suddenly have 

unprecedented trading characteristics that need to be evaluated under existing law. 

Fortunately, the Howey test is based on facts and circumstances and focuses on the 

economic substance of the transaction, so it should stand the test of time as this 

disruptive technology changes our daily norms. 

Blockchain technology is expanding at a rapid pace. Other jurisdictions like China 

have taken a very stilted binary approach to regulating token sales by simply banning them because their laws are not developed enough to be useful as a means of 

preventing bad actors while permitting good actors. Other jurisdictions have aggressively embraced blockchain technology and have instantly become magnets for 

blockchain entrepreneurs as today’s workforce is more mobile than ever. 

Over time, this recent spate of irrational exuberance associated with this novel 

technology will subside and consumptive intent will predominate once again. In that 

future state, it would not make any sense to have taken a position that all tokens 

are securities in perpetuity. This would be tantamount to following China’s lead as 

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this would shut down the entire ecosystem, at least here in the United States. Fundamentally, utility tokens are intended to be used as non-securities in a network 

or application. They could not be used for their intended purpose (e.g., micro payments for micro tasks, or loyalty rewards) if they are categorized as securities under 

U.S. law, so all of this innovation would need to move offshore and the United 

States would be one more jurisdiction added to the list of disqualified jurisdictions 

along with China and New York (because of the overbroad BitLicense). It makes 

more sense to draw a line today that is grounded in intellectual rigor and analytical 

consistency, which uses the flexibility of Howey to regulate the bad actors while permitting the good actors to continue to innovate with Blockchain technology here in 

the United States. 

The CHAIRMAN. Thank you, Mr. Ness. 

The chair reminds Members that they will be recognized for 

questioning in the order of seniority for Members who were here 

at the start of the hearing. After that, Members will be recognized 

in the order of arrival. I appreciate Members’ understanding, and 

I will recognize myself for 5 minutes. 

Mr. Ness, I agree with you that if we don’t get this right and we 

flush the innovators offshore into other countries, that getting 

them back is a lot more difficult. We are at the start of the process 

with this hearing so that we can get to an answer that doesn’t do 

that. 

Ms. Baldet and Mr. Kupor, you each noted that tokens in cryptonetworks have the potential to create next generation open Internet protocols. Can you flesh that out a little bit for the laymen and 

myself that understand the words, but if you can tell us what those 

actually mean, that would be a little helpful. 

Ms. BALDET. Sure, thank you. 

When we say open, open means a couple things. In this case, we 

mostly mean open access when we say public blockchains, which 

means that anyone can join the network. It has to do with the degree of gatekeeping, which is not necessarily an all or nothing kind 

of a decision. If we start thinking of public blockchains as being 

more like a public commons, it is a lot more like the Internet 

wherein you have a lot of choice as to how you access that sort of 

network. 

We also usually mean open source, as Mr. Kupor mentioned, so 

that we are allowing auditing of that code which increases trust of 

the code, and most of the core technology that powers the backbone 

of the Internet is open source. 

Mr. KUPOR. I agree with all that. I would just to give you a very 

specific example, imagine in the future a social network. Today, as 

users of social networks, of course, you have an intermediary, in 

many cases, a company like Facebook who obviously is taking and 

utilizing the consumer data, and then obviously developing relations with advertisers and others as a way to monetize that data. 

That is their business model. 

In the future, utilizing a crypto-network, you can imagine a 

world where you as the user own your data. That data is cryptographically secured, and you choose which data you want to expose to various advertisers or other promoters, and the flow of economic value in that case, as opposed to going through an intermediary, might be going directly from an advertiser or a promoter 

of products to you as an individual as you have kind of governed 

the use of that data. That would be, in very broad terms, a kind 

of expansive view of what this could look like. 

74 

The CHAIRMAN. All right. Mr. Fairfield, you talked about the 

Howey test, which seems to be the gold standard among securities 

lawyers who can spell that last name. Can you talk about that 

being maybe the outer edges? 

One of the questions we are trying to answer is are they securities or commodities, and where does that transition occur? Can you 

talk to us better about this Howey test and why you think that is 

the outer edge, and just how should it apply to distinguishing between commodities and securities? 

Mr. FAIRFIELD. Certainly. There are two questions. The first is 

lawyers are inventive. They can rework the formal form of a transaction to make it into anything. Howey describes the outer limit of 

the kinds of legal forms that can be turned into investment contracts, that can be turned into this sort of exchange. I give you 

money now, and I wait and I reap the benefit of your labor on the 

other end. 

But the difficulty with that is that while courts must be able to 

look to the economic realities of the transaction, look underneath 

the form because if we just look at the form, if we just look at what 

it is called, then anyone can title the asset whatever they want at 

the top of a piece of paper and escape whatever regulation they 

want. 

Courts have to look past the formal titling of the asset to the economic realities of it; however, they also have to understand that 

the very flexibility of these tools, both the flexibility of legal forms 

and the flexibility of this database technology means that it is very 

possible for people to be using a product for one entirely legitimate 

purpose and have other people begin to use it for different purposes. 

An example of this from outside of the cryptocurrency area entirely would be the discussion we had several decades ago on VCRs. 

The question was some people use them to make illegal copies. 

Many people don’t. How far are we willing to go in rooting out bad 

uses that we are beginning to cut away healthy tissue? And that 

is why I believe Howey is the outer circle. It is necessary that it 

be there so that SEC, in this particular case, can reach cases in 

which people are labeling something one formal legal form, but are 

actually engaging in an investment contract. That is what it is 

there for, but it doesn’t really tell us anything about what the regulatory landscape should actually look like at the end of the day. In 

fact, the regulatory landscape, in my estimation, should and will 

look like something substantially different. It will look like a bit of 

a handoff, like a relay race in which for certain functions and for 

certain conditions, one overseer may have authority. Under [audio 

malfunction in hearing room]. 

The CHAIRMAN. Sorry, I lost your microphone. Thank you, Mr. 

Fairfield. 

Ranking Member Peterson, 5 minutes. 

Mr. PETERSON. Thank you, Mr. Chairman. I don’t know where to 

start. 

I am somebody that believes we should still be on the gold standard, and we should audit the Fed because I don’t really trust them. What worries me about this is that you say there are $250 billion 

of capitalization here or whatever, how much money is actually 

75 

here. This just seems like a Ponzi scheme to me. I think the stock 

market is a casino, so that is where I am coming from. If I am going to send $100,000 to somebody through one of these 

deals, who is going to stand behind it? I give the money to one of 

you guys and then you turn around and create these things and 

send it to somebody else. Well, in the meantime, what if you went 

broke? I was involved when we found out about credit default 

swaps and figured out that everybody was trading these things and 

there was nothing there, and if we wouldn’t have stopped them the 

whole economy would have collapsed. I don’t know if we have a 

similar situation going on here with this, but what is behind this? 

If there is no money at the end of the day, who is going to make 

up for this? Can anybody explain that to me? Mr. Gensler? 

Mr. GENSLER. Could I take a shot? 

I think that I would split it in two buckets. In this field where 

venture capitalists, entrepreneurs are developing an idea and asking people for money, they publish a White Paper, they build up 

a following, Reddit posts—these are different communities, social 

network posts, a medium and so forth—and they build a following 

and then they sell it and raise money. And sometimes it is small, 

just like a crowdfunding on Kickstarter. But most of them aren’t. 

There have been 3,800 of them to date. Over 50 percent of them 

fail within 4 months, and there are different estimates how many 

are scams and frauds. There are good faith actors in the middle of 

it, too, a lot of good faith actors, but there are a lot of frauds and 

scams. 

Right now, if they fail, the only thing you could do is try under 

the securities laws to say they were an unregistered, noncompliant 

security and try—under the private rights of actions under securities law—to get something back; or do nothing. 

And the second category is digital gold. The digital gold, which 

is Bitcoin, and while there is nothing behind it, I would say, Mr. 

Ranking Member, there is really nothing behind gold either. All of 

this, we have what is behind it is a cultural norm that for thousands of years we like gold. The worldwide value of gold is $7 trillion, by the way, just to give you a little sense, but only about ten 

percent of the annual production of gold is used in manufacturing. 

The rest of it is because we think it is kind of nice to have gold 

necklaces and jewelry, or we do it as a store value. Bitcoin is a 

modern form of digital gold and it is a social construct. 

Mr. PETERSON. They are just creating this money out of nowhere. 

Mr. GENSLER. In the first category, the investor type that would 

be under the SEC. 

Mr. PETERSON. No, I get that. 

Mr. GENSLER. But in the second category, you are right, which 

was under this Committee. You are going to be grappling with this 

for a while. 

Mr. PETERSON. No, I know. 

Mr. GENSLER. It is digital gold. 

Mr. PETERSON. In the first category, I assume those people are 

sophisticated enough to realize they are going to get fleeced potentially? 

There are people that get into that area that don’t realize what 

they are getting into. They think they are going to get rich and 

76 

they are going to get into this deal ahead of everything else and 

they are going to make 10,000 percent on their money and whatever else, and some guy is selling them on this. I don’t know where 

the protection is here for people. 

Mr. GENSLER. Some are very sophisticated like Andreessen Horowitz and they manage $7 billion. There are many like that, but 

there are others that aren’t. But you are right. The Securities and 

Exchange Commission has a lot of work ahead of them to sort of 

bring this market into—the first part of the market. Seventy percent of the market is commodities, but the first part, this ICO marketplace, is the SEC’s—they are working at it, but they have a lot 

of work ahead. 

Mr. KUPOR. If I could just add, Mr. Ranking Member, you raise 

this concept of a kind of trust, right, which is who do I trust? What 

is the trusted intermediary? 

The beauty, at least, certainly from the perspective of an investor 

and as a consumer, the beauty of these crypto-networks is what 

you are trusting is you are trusting cryptography, you are trusting 

math, you are trusting software as opposed to a centralized intermediary, and you have a community that is governing the interest 

there. In other words, if the community tries to do something that 

is inappropriate, all of the software is open source. All of the software can be basically what is called forked and literally taken over 

and recreated in a new community. There is a norm of community 

governance that exists in these areas that really substitutes trust 

from a centralized intermediary to trust to a community that is responsible for government. 

Mr. PETERSON. Thank you, but I am still skeptical. 

The CHAIRMAN. Mr. Lucas, 5 minutes. 

Mr. LUCAS. Thank you, Mr. Chairman, and along with the gentleman from Georgia, Mr. Scott, I have the privilege of sitting both 

on this Committee and the Financial Services Committee, so I welcome this discussion by the panel when it comes to the next regulatory frontier as it impacts the two Committees. 

First, Mr. Kupor, how should regulators think about the function 

of the token when choosing to apply regulatory requirements? 

Should regulators look to the functioning of the token at all, or only 

the issuing activity? 

For example, say there is a cryptocurrency. We will call it, for 

the sake of discussion, Bitcoin 2.0, and say it functions identically 

to Bitcoin in every way except that a small portion of the total tokens were pre-mined and distributed in token sale. It is possible 

to issue Bitcoin 2.0 through ICO and not have it be a security, or 

is the functioning of the token irrelevant because of the manner in 

which it is issued? 

I am asking what my folks back home would define as geek questions, but this is where we are. 

Mr. KUPOR. Yes, sir. 

Mr. LUCAS. What say you? 

Mr. KUPOR. Yes, to a couple of things. 

The issuance of those tokens and the sale of those tokens in exchange for money before a network exists, I do believe is what is 

called an investment contract and should be regulated as such. 

77 

If I develop a white paper and I tell you I am going to build this 

thing and you give me money for it before it exists, if I fleece you, 

absolutely the SEC has jurisdiction to bring me up on securities 

fraud charges. You have private cause of action. No question about 

it there. 

Once the network is functional and therefore, the tokens are 

doing what they were intended to do, whether that is storage or 

other things, the value of that token now really is not a function 

of the efforts of the developer, it is really the question of what is 

the utility of that token, much like any other commodity. Therefore, certainly my view is that in that case, the underlying token 

itself should be regulated as if it were a commodity because that 

is actually kind of the nature of what it is actually doing. 

Mr. LUCAS. Thank you. 

Mr. Ness, the last prong of the Howey test identifies an investment contractor transaction in which an individual expects profits 

solely from the efforts of the promoter or the third party. Yet, for 

almost every token project, there are multiple avenues for a holder 

to come into possession of a token. When a network is fully functional, tokens can be purchased through promoter, traded on a secondary market exchange within a network, or earned by performing work to support the network. In each of these cases, the 

efforts of the holder vary and can implicate the Howey test differently. How should regulators think of an asset that has multiple 

methods of delivery, an asset that can be both purchased and 

earned, or should the method of delivery determine the regulatory 

regime governing an asset? 

Mr. NESS. Fortunately, it is a relatively simple answer, which is 

that it really comes down to the same test, which is prefunctionality versus post-functionality, or whatever we end up deciding is the trigger point for determining the different status. 

It seems to me that however you come by this, I suppose there 

are two fundamentally different ways. One is to get it from the 

issuer directly, the other is to get it from some third party. And if 

it is in pre-functional—the pre-functional stage and you are obtaining it from the issuer, I would argue that is a primary offering of 

an investment contract, even if it is essentially earned on a network, because at that point there is a lot of case law out there if 

you do work for a security, you have paid for the security. There 

is consideration there in the services. 

I wouldn’t say that there is a difference between earning it 

versus buying it. It going to be a security, based on its characteristics as we end up defining them, pre-functionality versus postfunctionality. 

Mr. LUCAS. Mr. Gorfine, in your testimony you mentioned the 

new working group set up by FSOC and the Commission’s work 

with the SEC and other regulators. This Committee cares a lot 

about coordination between financial regulators when it comes to 

these sorts of matters. Can you talk more about how the regulators, including the CFTC, are working together, I should say, to 

understand and clarify their overlapping jurisdictions and how it 

affects the virtual currencies? 

78 

Mr. GORFINE. Yes, thank you. It is a great question and we agree 

that coordination and collaboration with our sister agencies is very 

important on this type of a topic. 

One thing about this space that is common across a lot of areas 

of financial technology is that it inherently cuts across geographic 

and jurisdictional boundaries. It is very important to make sure 

that we are coordinated in sharing information with each other. 

Certainly, on the topic of cryptocurrencies, we are working closely with the SEC to make sure that we are coordinated. And just 

to step back and explain how we view our rule set, the definition 

of commodity under our statute is very broad. A lot of things are 

commodities and we are soon after the World Cup, so think about 

soccer balls. Those are commodities. Just because something is necessarily a commodity doesn’t mean that we have a direct regulatory 

interest. It is only when we start to see the rise of futures or swaps 

products built on those commodities that we have direct oversight. 

But when the SEC applies the Howey test and determines 

whether something fits within a securities law framework, that certainly matters to us because then that is something that would fall 

under their jurisdiction. Hence the need for us to be in close communication with the SEC. 

Mr. LUCAS. Mr. Chairman, if you would indulge me for one last 

thought. 

For a number of years, I sat next to Ron Paul on the Financial 

Services Committee, so when Mr. Peterson brought up his observations about gold standard, I can’t help but think about Mr. Paul’s 

story noting that when the Roosevelt Administration took us off the 

gold standard in 1933, they sealed every safe deposit box in every 

financial institution in America and before you could open it, you 

had to have Federal official of appropriate nature or state designee 

to be with you so they could make sure you didn’t have any gold 

coins, gold bars, or gold certificates in those safe deposit boxes. The 

Ranking Member brings up some interesting observations. Even 

gold wasn’t safe in 1933. 

I yield back, Mr. Chairman. 

The CHAIRMAN. The long reach of government. Thank you. 

David Scott, 5 minutes. 

Mr. DAVID SCOTT of Georgia. Thank you, Mr. Chairman. 

There is a good amount of very serious and legitimate concerns 

about coins that are being offered. I am not sure we realize it, but 

there are over 1,600 coins currently and growing every day. And 

we have to look closely and watch how these coins are being used, 

and if it is appropriate for them to be regulated, to make sure that 

they are not being used improperly. I am not sure that the panelists or the audience or those who may be watching via television 

know, but I find it very concerning that in the indictment of the 

12 Russian hackers that hacked the DNC’s servers, did you know 

that they included in those charges within the indictment was the 

fact that the Russian hackers used principally Bitcoin when purchasing the servers, when registering the domains, and otherwise 

making payments in furtherance of illegal hacking activity on the 

United States elections? 

What I am saying is that with every new tool, our technology is 

moving fast. It is growing at a rapid rate, and we have to grab hold 

79 

on what we are doing to make sure that we do everything we can 

to ensure that these new coins are not being used illegally or for 

illicit activities, like when the Russians attacked our election system. 

Now, I also have read in some news coverage studies that are out 

there that think that not all of these ICOs are a positive thing. 

There is a lot of debate on that, and our Ranking Member, Mr. 

Peterson, expressed it best of all. 

For example, a recent Statis group study found that over 80 percent of initial coin offerings are scams. In fact, they broke ICOs 

into six groups, scam ICOs, failed ICOs, gone dead ICOs, dwindling 

ICOs, promising ICOs, and then successful ICOs. And on the basis 

of these above six classifications, they wrote that they found that 

approximately 81 percent of our ICOs were scams. Six percent were 

failed. Five percent had gone dead, and eight percent went on to 

trade on the exchange. 

I want to ask the panel, with this evidence, does this seem right 

to you? Is 80 percent high? Are the risks being blown out of proportion for these studies? 

Let’s start with Mr. Gorfine. You mentioned in your testimony 

that LabCFTC published in its first FinTech primer on virtual currency late last year. What more can we do to protect investors? 

And I want to get each of you in my last minute here. Just say yes 

or no, are we in trouble? Is this thing serving us or are we serving 

it? 

Mr. GORFINE. I will try to be brief, and we share your concern. 

And you mentioned the LabCFTC primer which we published in 

October of last year, and the way that the primer is structured is 

that it concludes with a discussion of risks and challenges that we 

believe market participants need to be aware of. Just this week on 

Monday, and I would encourage the public that is viewing this 

today to take a look at a customer advisory that we published 

through our Office of Customer Education and Outreach where we 

are tackling exactly this issue, which is that it is a very speculative, risky space, especially for retail participants to be participating, and we encourage them to really do their research and ask 

themselves important questions about the value of a lot of the different types of offerings that are out there. It is an area that we 

think education is a key component. I will also add that from an 

enforcement perspective, the CFTC, as well as a lot of other agencies, are looking to target bad actors that are trying to take advantage of a lot of the enthusiasm around this space. 

The combination of education, enforcement, and then proactive 

engagement as LabCFTC is doing are important regulatory tools 

for us to deploy. 

Mr. DAVID SCOTT of Georgia. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman’s time has expired. 

Austin Scott, 5 minutes. 

Mr. AUSTIN SCOTT of Georgia. Thank you, Mr. Chairman. 

We are a long way away from peanut fields in Sycamore, Georgia, and I can’t help but wonder if somebody who, prior to getting 

elected to Congress, actually had a series 7, what would a prospectus on coin offering look like? I don’t know if it would be one 

page or 10,000 pages or more, but one thing that is clear to me is 

80 

that you can certainly create a coin for anything. You can create 

a coin for any color. You can create a coin for any opposite color. 

There is an infinite number of coins that can be created. 

I see no way to regulate every coin offering that is out there, but 

I would also tell you that when you turn on CNBC and they show 

the Dow, the S&P, and the Nasdaq on one side of the screen and 

on the other side of the screen is a value for Bitcoin, then certainly 

it has reached the level where we need to have some sort of regulatory certainty in this area. 

Most of my questions are for Mr. Gorfine. You run LabCFTC, 

and you have held office hours around the country where you have 

met with many people in the industry. Can you tell us about the 

interesting concerns of the developers who are working on tokenbased projects, and how sensitive they are to the regulatory environment? 

Mr. GORFINE. Yes, thank you for the question, and in fact, I am 

heading this afternoon up to New York to have another round of 

office hours with innovators. 

We have had an incredible opportunity to go to various cities and 

meet with folks that are heavily involved in a lot of projects across 

the spectrum that you have heard about today, and it strikes me 

that it is a new generation that is really looking through a technology lens as to how we can transform markets, make markets 

more efficient and effective. But there are a lot of questions that 

they have, and that is the reason we have the engagement function 

of LabCFTC. A lot of folks are trying to get a lay of the land and 

start to understand the alphabet soup of regulators in D.C., so 

through LabCFTC, we do try to establish some guideposts and educate as to how our framework applies. And in some situations, we 

will explain, ‘‘Well, this is where the CFTC fits and then there are 

questions that you may need to look at securities laws to understand the interplay there.’’ 

But in response to a lot of common questions we were getting, 

that is why we published the FinTech primer. It is our way of facilitating conversation with the community to make sure we are 

being responsive, and where possible, providing as much clarity as 

we can. 

Other efforts of CFTC have been around things like actual delivery is a question that comes up a lot in the cryptocurrency realm, 

so our Division of Markets and Oversight has put out a draft interpretation that deals with actual delivery. All of these are efforts to 

start enhancing and providing as much clarity as we can. 

Mr. AUSTIN SCOTT of Georgia. Mr. Gorfine, you suggest in your 

testimony that the Commission has an interest in this technology 

being used for capital markets infrastructure. Many of us on this 

Committee, including myself, have introduced a piece of legislation, 

the CFTC Research Modernization Act. Have you had a chance to 

review that legislation, and do you think it could help the Commission understand the emerging financial technologies and help us 

better understand how we need to regulate, or in some cases, not 

regulate certain areas? 

Mr. GORFINE. Yes, thank you. One of the things that we are really focused on doing is making sure that we are engaging with technologies and fully understanding them. What you are raising is the 

81 

ability to give the CFTC authority to research and test new technologies. 

I will give one example of how that may work in this space. We 

talked a little bit about private and permissioned distributed ledger 

technologies, which could impact and improve capital markets infrastructure. There is a lot of interest for market participants who 

are saying there may be more efficient ways for us to do, for example, regulatory reporting, in a lower cost way for them and in a 

way that for the regulator is more consumable. If we can receive 

standardized data without the traditional push process, that could 

be very valuable. What you are pointing out, Congressman, is that 

authority that is proposed in your legislation would allow us to actually work with a consortia of folks that are trying to create that 

type of infrastructure, and that way from a CFTC perspective we 

could better understand how can this technology benefit our markets? How would regulatory reporting be facilitated, and lift the 

hood and really understand the technology instead of having the 

high level conversation. 

Those types of authorities would be very, very helpful to us. 

Mr. AUSTIN SCOTT of Georgia. Thank you very much. 

The CHAIRMAN. The gentleman’s time has expired. 

Ms. Kuster, 5 minutes. 

Ms. KUSTER. Thank you very much, Mr. Chairman, and thank 

you witnesses. This has been a very enlightening hearing, and I appreciate all the wisdom. 

Mr. Gorfine, picking up on the CFTC regulation, such as it is; do 

you have sufficient resources at the CFTC, or what would you recommend that you need from Congress, going forward? 

Mr. GORFINE. Thank you. Well, I will harness the Chairman on 

this. Our Chairman has been very vocal about the need for the 

CFTC to have the right resources to be able to keep pace with our 

markets and regulate our markets most effectively. I believe he has 

asked for $281 million for our budget, and a lot of those resources 

would be utilized, not only with bringing in economists, but also 

making sure we have the technologists in house to be able to keep 

pace. 

I am a lawyer. I know a couple layers deep of the onion when 

you are talking about technologies, but we really need to be able 

to get to the core of technology to make sure that we are 

ascertaining where new risks are arising. Certainly, with greater 

resources, our agency would be able to even scale up some of those 

activities. 

Ms. KUSTER. I would just say for the record one obvious place to 

look for those resources would be to get the IRS on top of how to 

tax the benefits and the gains that are being made, because one 

of the most troubling comments today is that the IRS is not on top 

of how to capture those gains. That is something that we need to 

look at, but it is also something on your side with some conversations with your counterparts at the IRS. 

I want to quickly turn to the two professors and get a sense of 

a very troublesome aspect of this, and if anyone else wants to comment. Analysts last year identified that four percent of the addresses hold 97 percent of the Bitcoin in the world, and the philosophical 

goal of Bitcoin is to replace government-backed fiat currency. But 

82 

if that goal is achieved, you would have an unprecedented amount 

of wealth and power concentrated in the hands of a very small 

number of people. Is this concerning to you, and what should lawmakers be doing in this regard? 

There are couple of minutes left, and—— 

Mr. GENSLER. To some extent it is not surprising, because most 

small economics ends up with some centralization. An irony is that 

the technology is supposed to be a decentralized peer-to-peer—— 

Ms. KUSTER. That was why the statistic struck me, because all 

the commentary has been this is all—— 

Mr. GENSLER. And so it is one of the natural ironies, because all 

humans tend towards clusters and clumps and centralization. 

Ms. KUSTER. And taking into account with the indictment that 

some of these addresses are in Russia with people that want to do 

harm to our country. 

Mr. GENSLER. More specifically to your question, some of that 

concentration is because it is the large exchanges, the crypto-exchanges, like Coin Base has 20 million accounts. They may not all 

be active, and they hold $20 billion of crypto-funds. I should have 

said the market went up in the last day, so it is now about $290 

billion. But just one exchange has a big chunk of it. I don’t know 

if that—— 

Ms. KUSTER. Is that then owned by multiple parties? 

Mr. GENSLER. I will speak a little bit like an accountant, which 

I know the Chairman can appreciate, but it is that Coin Base has 

several accounts, but they are only there at Coin Base. But if I 

wanted to trade, then I have an account at Coin Base. These addresses would be in Coin Base’s name, not in my name. I only have 

a right to Coin Base. Coin Base has whatever you want to call a 

right on this ledger. And part of—— 

Ms. KUSTER. Part of my question is that not very many people 

end up controlling and influencing, and if the long-term goal is to 

cut out state-sponsored currency, that is problematic in my view. 

Ms. BALDET. Yes, you are right to be concerned about the centralization of power, but when it is not necessarily so that a single 

address equates to a single legal entity in any way. Any one person 

can generate any number of addresses that have smaller or larger 

amounts, and we don’t really have a proper way to be able to tie 

that—— 

Ms. KUSTER. How would you describe to the public watching 

today the distribution of influence? 

Ms. BALDET. There certainly are loci of power, but also if you 

look at the movement in some of those earlier addresses or larger 

addresses, it is commonly accepted that about 25 percent of something on a network like Bitcoin have not moved or basically been 

lost at this point, and so you will see funds sitting in places and 

simply not moving, and the common consensus is that the private 

keys or the access to those addresses have simply been lost. 

Ms. KUSTER. My time is up and I will yield back, but just to 

make a plea for democracy somewhere in this process. I appreciate 

the Chairman for scheduling the hearing. Thank you. 

The CHAIRMAN. The gentlelady yields back. 

Mr. Allen, 5 minutes. 

83 

Mr. ALLEN. Thank you, Mr. Chairman, and this has been very 

interesting. The gig economy is moving at light speed, and the rest 

of us are just kind of dragging us along. But it is exciting. 

I guess the problem that we are having, from a regulatory standpoint is throughout the gig economy is obviously the reason it is 

doing so well is because there is lots of freedom and very little regulation, but we do know that there are lots of problems, as far as 

connectivity, as far as security, and that sort of thing. 

How do we reach a balance with this, what we are doing is we 

are creating another money supply here as I see it. In other words, 

it is global. It is a global currency. I just don’t know how that 

works, like where we have our basis. Our dollar, I believe, kind of 

sets the mark for the world right now. 

Explain how this is going to work across the world. I mean, you 

mentioned Afghanistan. I don’t know what their currency base 

there is, but I am just going to open it up. I can’t visualize how 

this could possibly work. 

Mr. GENSLER. Can I get one real quick shot? 

Mr. ALLEN. Yes. 

Mr. GENSLER. Sound governments like the U.S., if we have to 

maintain our fiscal discipline and all the things we need to do—— 

Mr. ALLEN. Yes, if you can keep it, right. 

Mr. GENSLER. But sound governments have certain advantages, 

because of the stability, and also because we allow our currency, 

fiat currency, it is legal tender for all debts public and private, and 

you can use it to pay taxes. And so there are some just natural advantages. 

I think that how this might play out, I could see a country that 

is in distress, the Venezuela’s of the world, where in the future one 

of these currencies will be a better thing for their public than in 

that—— 

Mr. ALLEN. For the individual citizen? 

Mr. GENSLER. For the individuals, for the merchants—— 

Mr. ALLEN. Because they are not dealing through their government, they are dealing through this global currency? 

Mr. GENSLER. Yes, I could see that. 

Second, even in a stable economy like ours, that our Federal reserve, with all respect, has a little bit of competition for the payment system. We Americans spend between $100 billion and $200 

billion a year for our payment system. That is only 1⁄2 percent to 

one percent of our economy, but it is still $100 billion to $200 billion a year. And so startups and entrepreneurs have a chance to 

chip away at that and get inside of that. That is competition to the 

commercial banks and the central bank on our payment system. 

Mr. ALLEN. Other feedback? We have about 2 minutes. 

Ms. BALDET. Yes, I just wanted to add to that around the Venezuela point, that there was some interesting usage of Zcash in 

Venezuela over the last year as a sort of bridge currency to the dollar so that citizens that could not have traditional access to get to 

the dollar were using a cryptocurrency as an intermediary. Given 

the volatility of cryptocurrency, you wouldn’t necessarily want to 

stay there, but as a bridge and a censorship resistant bridge at 

that, it is somewhat important. While censorship resistance can be 

seen as a double-edged sword, we might not necessarily like the 

84 

way that people are doing bad things with the network, the ability 

to project into places where they also would prefer people to not be 

doing things should not be underestimated. 

Mr. ALLEN. I can see where like a business located in a country 

where the government is unstable, the business community could 

really benefit from this. 

Then you have this competition between nations, right now the 

biggest competition is between United States and China. The end 

seems to want to be the basis. Which nation would run this thing 

and ultimately be responsible for it? 

Mr. GENSLER. See that is the thing. It is decentralized so no nation does, but you mentioned China. I don’t know that there has 

been public reports, but there are a lot of people in the community 

that say that though China, the government, has said we are 

clamping down, the reality is there is a lot of activity. The Bitcoin, 

this is how it is developed. Two of the three largest mining pools 

are in China. The third one is in Russia, and that combined is 

about 50 percent of the mining pools. 

But beyond that, the Bank of China is very actively engaged to 

do research—— 

Mr. ALLEN. But the government is not fond of this? 

Mr. GENSLER. Well, they are of two minds. 

Mr. ALLEN. Yes. 

Mr. GENSLER. They say publicly they are not fond of it because 

their currency is not convertible, so they are worried about people 

running around their currency. That is the public face of it, but underneath it, they are doing a lot of work on it. The Bank of China 

particularly is looking at it very closely because they are worried. 

They want to get their payment system right and they want to use 

it maybe. 

Mr. ALLEN. Okay. 

Ms. BALDET. There is also a bit of a land grab going on when it 

comes to enterprise distributed ledger projects where countries, like 

China, can go into emerging economies and do essentially free work 

for them using their technology, which is impacting the adoption 

of specific protocols backed by various countries in those regions. 

Mr. ALLEN. Okay. All right, I yield back, Mr. Chairman. 

The CHAIRMAN. The gentleman yields. 

Mr. ALLEN. Thank you very much. 

The CHAIRMAN. Mr. Soto, 5 minutes. 

Mr. SOTO. Thank you, Mr. Chairman. 

Cryptocurrency, blockchain technology all have tremendous potential, and I am bullish on the prospect. But we are in a bizarre 

position here. Satoshi Nakamoto, an unknown person or people 

who developed Bitcoin, and this person or persons has 980,000 

Bitcoins and an estimated worth between $19.4 billion to $17.9 billion. Can any of you today, and just raise your hand, verify that 

Mr. Satoshi Nakamoto is, in fact, a person or persons? 

Ms. BALDET. I don’t believe that we have all agreed that it is a 

male. 

Mr. SOTO. All I asked—okay. 

Ms. BALDET. Satoshi is female. 

Mr. SOTO. Satoshi is female, great. None of you can verify who 

founded or owned Bitcoin is my point, which puts us in a strange 

85 

position, because normally we have industries and new currencies 

where we know who created it. That puts us in a weird position. 

In addition, you mine to develop new currency, a process by 

which transactions are verified and you add it to the public ledger. 

You compile recent transactions into blocks and try solving 

computationally difficult puzzles, and you get a reward, either a 

transaction fee or newly released Bitcoin. I guess gold is the only 

thing that we could even parallel to where we have mined in such 

a way. Have we ever had a currency online like this where you 

mine via transaction algorithms and solving puzzles on the Internet? 

Mr. GENSLER. That is the novel creation of—yes, somebody we 

don’t know who she is—Satoshi Nakamoto, or he or collection. But 

that is the novel thing. When the Internet was created—— 

Mr. SOTO. My time is limited, so we have an unknown person 

and a bizarre way of mining Bitcoin to get it together. 

I am more concerned, though, about being able to void money 

laundering for terrorism, drug trafficking, human trafficking, tax 

evasion. I would love to hear from each of you in one sentence on 

what we could do to stop money laundering and having Bitcoin and 

other cryptocurrencies be the choice of terrorists, drug traffickers, 

and those evading taxes. We will start from the left and go on back. 

One sentence, because my time is limited. 

Mr. FAIRFIELD. Trust FinCEN to do their job. 

Ms. BALDET. Rely on other law enforcement mechanisms that 

work around strong cryptography. We do not weaken roads and 

add potholes to them. 

Mr. SOTO. That is two sentences, but thank you. My time is limited. I apologize. 

Mr. KUPOR. Bitcoin is actually the worst tool to money launder 

because every transaction is registered and fully reportable, so it 

is actually law enforcement’s best friend. 

Mr. SOTO. Okay. 

Mr. GORFINE. While the technology can be peer-to-peer, most activity takes place through a new type of intermediary where you 

can apply AML/KYC rules. 

Mr. SOTO. Okay. 

Mr. GENSLER. On top of that, rigorously require crypto-exchanges 

to register, and you may need to pass a law to do that, but to make 

sure they register and that all the AML, anti-money laundering 

and know your customer is being done there. 

Mr. SOTO. Run-on sentence, but helpful. Thank you. 

Mr. NESS. The alleged Russian hackers were caught because they 

used Bitcoin. 

Mr. SOTO. Thank you. 

I am also concerned about two practices, spoofing and wash trading. Spoofing being flooding markets with fake orders to trick other 

traders into buying or selling, and wash trading, which is where 

cheaters trade with his or herself to give a false impression of market demand that lures others to dive in, too. Can anybody give us 

any insight into how to stop spoofing and wash trading? We will 

start from the right to the left now. 

Mr. NESS. That is a tough one. I don’t have a good answer. 

Mr. SOTO. Okay, next. 

86 

Mr. GENSLER. Register the exchanges and cops on the beat. 

Mr. GORFINE. We are a markets regulator. That is something 

that we are able to police for within our regulated futures and 

swaps markets, and so worth a look at the underlying market to 

ensure that the right types of regulations are in place. 

Mr. SOTO. And are you all doing that right now? 

Mr. GORFINE. The CFTC does not have direct oversight authority 

over underlying markets. 

Mr. SOTO. We would have to give you jurisdiction to help with 

spoofing and wash trading? 

Mr. GORFINE. It would be something Congress would have to look 

at in terms of authorities. 

Mr. SOTO. Okay. Next, Mr. Kupor? 

Mr. KUPOR. Yes, I agree. Either between the SEC or the CFTC 

you would have to grant appropriate authority. 

Ms. BALDET. Agree, broker dealers need to be treated like broker 

dealers. 

Mr. FAIRFIELD. I would agree with that. 

Mr. SOTO. All right, thanks, and I yield back. 

The CHAIRMAN. The gentleman yields back. 

Mr. Faso, 5 minutes. 

Mr. FASO. Thank you, Mr. Chairman. 

I am wondering if, for the benefit of our viewers at home across 

the country who are watching this hearing and are trying to understand the impact of the cryptocurrencies and what the future holds, 

if perhaps Ms. Baldet and Mr. Kupor could tell us where you think 

from a 5 to 10 year viewpoint where this is going to be, the role 

that these currencies are going to have in our economy, and how 

might this affect average consumers? Right now the market participants are mostly very sophisticated people. Do you see this insinuating itself into the broader economy? 

Mr. KUPOR. Sure, thank you. Yes, we believe that this really is 

going to create a whole new set of infrastructure on which all kinds 

of new applications are going to be built, some of which we don’t 

even know about today. If you think about all the benefits we have 

reaped from Facebook and Google and all the Internet properties—— 

Mr. FASO. And negatives from—— 

Mr. KUPOR. And negatives, too. What the beauty of this technology is, is it gives us a new set of platforms, and again, very 

critically those platforms are not controlled or governed by centralized corporations, they are controlled and governed by a community. And so you can imagine all the utility that we have today, but 

where the consumer actually has ownership of data. The consumer 

has the ability to actually ensure that data is shared in a manner 

in which they want to be shared, and a consumer can also capture 

the economic rents from use of that data, so we think the opportunity in that respect is endless. 

Mr. FASO. Yes. 

Ms. BALDET. Sure, I would say that there are two very different 

sides of the spectrum. 

On the enterprise blockchain and distributed ledger side, we are 

seeing mutualization of work flow come to pass, and that is a way 

87 

for companies who trust each other to do things in a more coordinated way that drives down operating costs. 

On the public side, to tag onto the gig economy statement earlier, 

we can see a further kind of micro-gig economy is happening 

wherein if people were to have more access and control over their 

own data—this goes for businesses as well—we might be able to 

monetize that in new ways. 

Alternative business mechanisms to the current data hungry surveillance capitalism that we see arising from centralized companies, we might be able to challenge that kind of hegemony. 

Mr. FASO. And Mr. Fairfield, you referenced personal privacy 

issues. How do you see that coming into play here? 

Mr. FAIRFIELD. Well there are a few. The first would be if we 

were to follow through on the suggestion that KYC and AML, that 

is Know Your Customer and Anti-Money Laundering, requirements 

be imposed on many more actors in this space. The initial reaction 

of many people who held cryptocurrency was that they did not particularly want those data revealed, and they built products to try 

to keep that data from being revealed. 

At least as far as the major exchanges, and I have heard exchanges used a few different ways today, but here I am talking 

about the way you onboard. You spend dollars, you get Bitcoin, for 

example. 

I think that giving those exchanges the requirement under the 

Bank Secrecy Act to have KYC and AML requirements at the same 

time that they have fairly strict financial privacy requirements was 

a moderately decent fit. For national security purposes, we need to 

know when people can make a couple million dollars disappear in 

one country and reappear in another. But at the same time, there 

is some degree of constraint over where that information can go 

once it is kept within financial institutions. That is a good example 

of a mix that seems to work, and maybe that would be a model we 

could spread out from. 

Mr. FASO. And just generally, Mr. Gensler or Mr. Gorfine, as we 

look at the development of this, it does seem that there is an issue 

that is going to affect government, which is right now we know, because we have a paper trail, we have electronic trails and documentation of transactions for which taxation applies, for which government oversight and reporting applies. How does government address this from the standpoint of its interest to try to make sure 

that taxation and other compliance issues are resolved that currently, with our existing financial transactions we have mechanisms to have that reporting? 

Mr. GENSLER. It is really about knowing all the accounts. This 

technology has what is called public keys and private keys and 

Zcash, which Ms. Baldet is involved in is even more secret than 

that, but it is really knowing who owns the accounts behind that. 

It is know your customer, beneficial ownership, and then trying to 

do that through some of the central mechanisms like crypto-exchanges. 

It is not going to be perfect. This is going to be like a whack-amole, the IRS and the CFTC will work hard and then 3 years from 

now the technologists will have a new way to get around it. 

88 

Mr. FASO. Mr. Chairman, could Mr. Gorfine respond to that as 

well? 

The CHAIRMAN. Yes, very quickly. 

Mr. GORFINE. Yes, if I may. One observation, too, is remember 

the most anonymous form of transaction is actual cash, right, people transacting cash. There is very little record of that taking place. 

Most virtual currencies, cryptocurrencies, are pseudonymous, so 

there is actually the ledger, which is a fairly transparent mechanism to be able to pursue potential law enforcement, as well as 

AML and KYC, so I just want to point that out, but it is something 

that needs to be figured out by government. 

Mr. FASO. Thank you, Mr. Chairman. 

The CHAIRMAN. Mr. LaMalfa, 5 minutes. 

Mr. LAMALFA. Thank you, Mr. Chairman. I am a little sorry I 

missed part of this hearing here, but it might be—well, I am a flip 

phone guy in a Bitcoin world anyhow, there is no pretense here. 

But, Mr. Ness, I come from the flip phone part of NorCal, as you 

say down there in the Bay area. I will ask a question and I will 

try and narrow down to, it was talked about earlier in the Committee about crypto-networks and the Internet protocols on tokens, 

so would you touch upon what it would look like if that token is 

determined to be a security? Can you hit that for us? 

Mr. NESS. Yes. The issue really comes down to friction, and while 

we can get to a status of free trading securities by registering 

them, even when you do get to that status, there are all sorts of 

ancillary friction in and around the transfer of a security. You need 

to have broker dealers involved, and you need to have suitability 

requirements met, and other potential disclosure issues and so 

forth that are ongoing. 

And so when we are talking about trying to create the next generation of decentralized protocol layer kind of apps on top that are 

all interoperable and interacting with each other and transferring 

value at the speed of software to deliver a service to a consumer. 

It may be all transparent to the consumer. This is all happening 

under the hood, but you can’t have fundamentally the transfer of 

value at the speed of software if it is a security. 

Mr. LAMALFA. You are talking with the middle man of a typical 

financial institution, right? 

Mr. NESS. That is right. 

Mr. LAMALFA. All right, and again, please touch on the importance of increasing the access to the speediness of those types of 

transactions. Why is that important? 

Mr. NESS. Well, to get a little philosophical, ledger technology is 

fundamental to commerce, right, and double entry accounting was 

an amazing innovation in ledger technology that pulled Europe out 

of the Dark Ages. And the same thing can happen in an amazingly 

more robust way when we start to literally not just allow parties 

to trust each other through standard mechanisms of reconciliation, 

but when we remove the reconciliation or the need for it altogether, 

and that is simply a philosophical point of view, I suppose, but it 

goes to this issue that we are at early stages of this. We don’t know 

where it is going to go, but speed is probably a good thing. 

Mr. GENSLER. Can I just say, I am an optimist. I agree with 

what Mr. Ness says, but maybe it is the MIT in me now. I think 

89 

that the beneficial ownerships will be able to be tracked in a matter of milliseconds and nanoseconds. Not yet, it might take 5 years, 

but we will get there. Technology is pretty neat, how it grows and 

helps us. 

Mr. LAMALFA. Well, it is amazing. Thank you, and Mr. Chairman, at the risk of looking senatorial at a Zuckerberg hearing, I 

am going to yield the rest of my time. 

The CHAIRMAN. Thank you, Mr. LaMalfa. 

Ms. Plaskett, 5 minutes. 

Ms. PLASKETT. Good morning, gentlemen and gentlewoman. 

Thank you all for being here. 

Of course, this is something that we are all really learning about. 

I try and say that I am woke, but you know, that always doesn’t 

work and this is one area where my 20+ year old children would 

find me really out of date. I am happy, Mr. Chairman, that we are 

having this because you all are correct. There is a balance, right? 

We don’t want to over-restrict something that we don’t even really 

understand or that is still developing, but at the same time, ensuring that that development, while it is developing, bad actors are 

not utilizing and gaming the system so that really terrible things 

can go on. 

One of the main things that I am concerned about, people think 

of the Virgin Islands as really just being a beautiful paradise, but 

we have an enormous amount of drug trafficking that goes through 

the Virgin Islands, and we also, along with other Caribbean islands—other islands more so than ours—have the ability to be 

used as a filter for hiding money, and particularly ill-gotten gains. 

And so I was wondering if anyone on the panel can really talk 

about how we can or law enforcement can really act as a deterrent 

for the use of Bitcoins, the marriage now between Bitcoins and 

blockchain to be able to really accelerate the use of these types of 

currencies in a manner that does not cause individuals in other 

places to really take advantage of this. 

Mr. GENSLER. It is ultimately a bit of an arms race because technology is new—— 

Ms. PLASKETT. I love it. We are having an arms race with electronic money, right? 

Mr. GENSLER. We are, we are. But the arms race in this is basically against societal norms and bad actors. There is always going 

to be crime and technology is just a new way to do it. 

One thing that the panel has all said is Bitcoin actually is more 

traceable than the public thinks. It is not anonymous. It is what 

is called pseudonymous, but we need ways to connect those public 

keys, which are like 24 or 32 digits to real people and real companies, and that is why I have recommended you need to have gatekeepers or gateways to do that, the exchanges, the crypto-exchanges or one set of gateways for law enforcement then to track 

the way that law enforcement now uses banks to track things. That 

would be one way I would say. 

Ms. PLASKETT. Right. I saw some others wanted to respond. 

Mr. FAIRFIELD. If I could also respond. 

The way we catch criminals often is through traffic analysis. 

Blockchains are quite good sources for traffic analysis. 

Ms. PLASKETT. Yes. 

90 

Mr. FAIRFIELD. There are—— 

Ms. PLASKETT. Can you tell me, how does the blockchain facilitate that? 

Mr. FAIRFIELD. Sure. One thing to do would be to go online and 

simply Google the blockchain. 

Ms. PLASKETT. Right. 

Mr. FAIRFIELD. You will find a website that will list each transaction as it comes across, and if you spend 30 seconds watching 

every transaction in the world that happens in blockchain and you 

think to yourself if I were a police officer, I would find this flow 

of money around the world very interesting. We also have computer programs, though, that don’t require a person sit there but 

can comb these databases, find patterns, and kick bad patterns up 

to somebody to take a look at it. 

There are ways of circumventing this. Blockchains are pseudonymous. I don’t put too much stock in it because tumblers and dark 

wallets can essentially—you and I might agree I will pay your 

debts, you pay mine, that way your debts aren’t traceable to you 

and my debts aren’t traceable to me. That is essentially what a 

tumbler does. We pay each other’s debts, and so we hide where the 

money is coming from. 

Ms. PLASKETT. Right. 

Mr. FAIRFIELD. But, with traffic analysis and standard artificial 

intelligence runs combing across the database, we can do a pretty 

good job of kicking up where bad actors are stirring the water. 

Ms. PLASKETT. Mr. Gorfine, we talk about law enforcement doing 

this. All of us here are concerned with what is our role. What do 

you see CFTC in dealing with this as well? 

Mr. GORFINE. Yes, and I want to kind of step back and compliment the way you framed this initial set of questions because it 

is exactly right that when I mentioned earlier in my testimony 

about thinking about principles and making sure we are giving— 

you can regulate based on principles, and then as you identify 

areas where there are particular harms to solve for, that is where 

more prescriptive rules might fit in. Certainly, in this area of antimoney laundering and know your customer, that is an area where 

you would want to make sure you are enforcing rules. 

But to your more specific question, the CFTC has now had a lot 

of experience dealing with some of these markets and the technologies, but again, our role is as a primary regulator of futures 

and swaps markets, and then we do have that enforcement authority that is a look-back authority to police for fraud and manipulation, either in our futures and swaps markets or in the underlying 

market as well. 

But because of our experience, we have a lot to offer at this stage 

in terms of informing the discussion around this space, given our 

enforcement experience, the role of our division and market and 

oversight in regulating the actual exchanges, monitoring some of 

the clearing and risk issues associated with cryptocurrencies, customer education, and then LabCFTC outreach. I think we are playing a very important role, and then hopefully can help inform these 

efforts. 

Ms. PLASKETT. Thank you, and I yield back. I just want to make 

sure that the regulations that we are doing, while we give time for 

91 

this to grow, we also make sure we don’t end up like Facebook 

where it has outpaced us in terms of being able to do damage in 

the general good. 

The CHAIRMAN. The gentlelady’s time has expired. 

Mr. Davis? 

Mr. DAVIS. Thank you, Mr. Chairman. 

Mr. Gorfine, I am going to go right back to you. Obviously we 

have talked a lot about jurisdictional issues and how to set up the 

proper regulatory structure that many in the industry are asking 

us to do. Obviously, with many of the commodities and different 

products, we have an SEC portion that is regulated in many cases, 

and then we have the CFTC which falls under our jurisdiction, and 

you get to see some of the humorous anecdotes from Members of 

Congress here who I am sure have had similar things to say when 

that new thing the Internet was taking place, and how are you 

ever going to buy things off of the Internet? Well Jeff Bezos showed 

us very well that anyone can do that now. And as cryptocurrencies 

continue to grow in usage, they are going to become less and less 

intriguing and more and more used. 

I am going to get into the demographics of many of the cryptousers, but I am want to ask you a quick question, sir. Based on the 

way current law is written, it is not cut and dry whether 

cryptocurrency should be regulated by the SEC or the CFTC. If 

Congress attempts to come up with a workable definition for 

cryptocurrencies that are more similar to commodities, call them, as 

we have heard, blockchain commodities, what should we be looking 

to guide us? 

Mr. GORFINE. Yes, thank you for the question. You know what? 

The one thing I would say is, and I mentioned this in my opening 

statement, that it is important that we are not hasty in terms of 

figuring out what the right contours are of applying securities laws 

and then the commodities framework. I do think that the SEC has 

in due course been providing additional clarity. Mr. Hinman over 

at the SEC gave a well-received speech outlining some of the SEC’s 

thinking as to how they would apply the securities law framework, 

and some of the things that you have heard are factors around decentralization, are there expectations of return based on meaningful work of others? These are important elements that, of course, 

I am not saying that these are the only elements, but these are 

some of the things that you start to look at in terms of figuring out 

well, when does it make sense to be applying the securities laws 

framework that includes things like required disclosures, it requires regulations around the offering of securities and the intermediaries involved in securities, and when does that perhaps not 

fit the product? 

This discussion is ongoing, and in due course and being thoughtful, you are starting to see additional clarity and certainty coming 

out. But certainly those are some of the factors that we have heard 

talked about a fair amount. 

Mr. DAVIS. Thank you. 

Ms. Baldet and Mr. Kupor, and I am sorry I wasn’t here at the 

beginning of the hearing so if I mispronounced a name, forgive me. 

I always try to mispronounce my colleague, Ted’s, on purpose, but 

not yours. 

92 

Now Ms. Baldet, this is an industry that you are getting into in 

the infancy, and you have actually done something that we don’t 

see a lot around here. You have come to us to actually ask for a 

stricter regulatory environment to stop some of the fraud and 

abuse that was mentioned by some of my other colleagues today. 

But I want to ask for those of you who are in this business, what 

demographic usually utilizes Bitcoin here in the United States, 

what age? 

Ms. BALDET. It is pseudonymous, so—— 

Mr. DAVIS. What—— 

Ms. BALDET. Based on Twitter, it is probably people in their 20s 

to 40s. 

Mr. DAVIS. The millennials? 

Ms. BALDET. It is millennials. 

Mr. KUPOR. Institutionally there is a very different skew towards 

the size of transactions and the types of people that are playing 

and the larger dollar values. And there is a developing institutional 

market as well, right, so yes, it started there, but if you look at 

some of the major financial institutions, there are institutional 

markets and large private equity groups that are heavily 

transacting in this as well. 

Ms. BALDET. Yes, and to tie on to the last question, but also the 

concern about regulatory framework. What I was mentioning is 

about a need for more clarity, not so much the bright lines that we 

are talking about security versus commodity as much as more interest in safe harbors for innovators, especially because we are seeing the market adapt to this in that new disruptors are at an advantage versus incumbent institutions who are waiting for regulatory clarity to engage. And so in a way, in absence of that, it is 

not necessarily that incumbents are incapable of innovating or they 

don’t understand the technology, but they have to take a sidelines 

approach because they have traditional businesses to lose. 

Mr. DAVIS. Well thank you, and Mr. Chairman, my time is about 

ready to expire, but we want to make sure that we devise a regulatory structure that allows this industry to continue to grow, but 

allows us to address many of the law enforcement problems that 

have been brought up here by many of my colleagues. 

I can’t wait to continue to work with you. Thanks for your time. 

The CHAIRMAN. Mr. Yoho for 5 minutes. 

Mr. YOHO. Thank you, Mr. Chairman. I appreciate you all having 

the patience to be here. This is something that is really confusing 

to me. My wife and I, we watched a documentary on Bitcoins and 

when we were done, we were more confused. I have not invested 

in any, as you asked. 

With that said, Mr. Gensler, in your testimony you mentioned recent SEC staff determination that Ether is not a security, although 

it might have been at its issuance. If the SEC had determined 

Ether was a security in 2015, what regulatory requirements would 

Ether be subject to today? And I have two follow-ups, and anybody 

else that wants to weigh in on this. 

Mr. GENSLER. If they had determined that way back in 2015, at 

the time they would have had to give some full and fair disclosure. 

The SEC at that time would have probably said, ‘‘Well, it is probably not 3 years of financials and things like that because it was 

93 

a new startup,’’ and this is something the SEC is grappling with 

even now for current initial coin offerings. What is full and fair disclosure? Director Hinman at the SEC said it right. It is about information asymmetry. Give an investor enough information so they 

can take the risk. It is not a nanny government. The investors can 

take the risk as long as they get enough information. 

Mr. YOHO. Okay, and how might such a regulatory regime affect 

the functionality of the Ethereum network? 

Mr. GENSLER. Mr. Ness raised this question earlier. There is friction right now because we don’t have the beneficial ownership. Securities laws say we have to have full and fair disclosure and we 

have to keep track of anybody who owns the security. It is that second one that is the friction Mr. Ness mentioned. I am an optimist. 

I think technology can solve for this. It is not going to be in 2018. 

It would slow down some of these token economies, but I believe 

that it is important to track beneficial ownership for all the reasons 

about illicit activity and taxing. 

Mr. YOHO. I agree with that. Anybody else? 

Ms. BALDET. At the risk of confusing you more about 

Ethereum—— 

Mr. YOHO. I was going to say, that name Ethereum is apropos 

because it is just out there. 

Ms. BALDET. In the Ether, yes. 

Mr. YOHO. It is like where is it? 

Ms. BALDET. Yes. Whereas some systems like Bitcoin were initially meant for peer-to-peer value transfer, the Ethereum network 

does, well it is more like a distributed world computer, in a way. 

Don’t think about it too much. But what you can do is you can use 

the native token of the system, this Ether, which may or may not 

have been a security issuance as you mentioned, to pay for what 

is called gas in that network. And that gas is used to buy computational cycles on a shared computer. If something like gas ends up 

looking a lot like a security, that is generating PNL just as you are 

running a general computer, it would be incredibly cumbersome, if 

not impossible, for normal humans to figure out what their balance 

sheet should look like. We need to be careful in not just applying 

a one size fits all solution on that. 

Mr. YOHO. Well, the important thing is that we don’t want to stifle the imagination, the entrepreneurship, the development of this, 

but yet we want to have the safeguards in place. Whether it is the 

CFTC or the SEC, we just want to make sure that when people get 

involved in it, that their monies or their investments are protected. 

You were going to add something? 

Mr. FAIRFIELD. I was going to make a rough analogy. Because 

these are databases, it is like the database in your computer, and 

applying securities regulation to these databases would have the 

same impact as having the SEC regulate your computer at the internal level, which is just simply going to gum up the works. 

Mr. YOHO. Right. We don’t want that, but I mean, we want the 

safeguards there. 

My other question is, and I sit on the Foreign Affairs Committee, 

and we deal a lot with North Korea and the sanctions and all that, 

and we see countries changing companies, funneling money, breakVerDate Aug 31 2005 10:15 Nov 01, 2018 Jkt 041481 PO 00000 Frm 00097 Fmt 6633 Sfmt 6601 P:\DOCS\115-14\30893.TXT BRIAN
94 

ing sanctions or skirting sanctions, and a lot of we see is being 

done over electronic currency like this. 

What are the safeguards that you guys can help us with on that 

so that we can follow it? When that cash transfers, it is easier to 

track that. We can block and sanction those banks or those entities, but when they are transferring things like this or any other 

nefarious activity, drug deals and things like that, what are the 

safeguards that you guys can put in place that we know we can follow that stuff? 

Mr. KUPOR. We talked a little bit about this earlier, but the idea 

behind these networks is all the transactions are, in fact, traceable 

and immutable, and so in fact, in most cases that you have seen, 

for example, in the recent Russian hacking investigation, they really create a trail and a presence that actually really is a data mine 

for, in many respects, law enforcement. If you fast forward a few 

years, this will look, in many respects, like GPS and cell phones 

have become for law enforcement as well, which is it really creates 

an immutable record that—— 

Mr. YOHO. I appreciate your time. I am out of my time, and 

thank you, Mr. Chairman. 

The CHAIRMAN. Well I want to thank the panel. 

Mr. Gorfine, you may have to slip out to catch a plane, but I 

would like to give each of you probably no more than a minute for 

any closing comments you think you wish you would have said during your opening or a question that didn’t get asked that you 

thought would be helpful for the record to have it. 

So we will start with Mr. Fairfield. Any closing comment quickly? 

Mr. FAIRFIELD. Only that it is a wonderful idea to begin with 

these kinds of conversations because it is here that we are able to 

look at the different communities that are using the technology in 

different ways, and perhaps craft legislation or other rules that will 

permit us to not only capture the bad guys, not only get them 

cleaned out of the system, but to leave intact what is good behind. 

Ms. BALDET. Sure. Thank you for having me. 

I would say that it is certainly important that we are having 

these conversations and moving towards some right-sized frameworks. At the same time, and possibly this is just our general 

American sensibility. We are focusing on the private-sector kind of 

business. How does this look like a business? How does this look 

like a financial system angle, whereas there is a whole other conversation to be had about what does this look like if it becomes systemic infrastructure similar to the Internet, and what does that 

mean globally? 

At the same time, it should not be an either/or conversation. We 

need to be thinking about how rather than just defensively we regulate, how we can proactively make sure that we are frontline 

innovators in the way that we were for the Internet as well globally. 

Mr. KUPOR. Yes, I just want to echo a little bit, Mr. Yoho, what 

you said, which is to be very clear, I speak for myself. None of us 

are suggesting here that there shouldn’t be appropriate regulation 

in this market. There is actually a very good framework between 

definitions of security laws that apply to the SEC, and then things 

95 

that actually, rightly so look more like commodities. There is also 

FinCEN as we have talked about, right, in terms of KYC and AML, 

so there is quite a patchwork out there, certainly in our business 

were we sit, a lot of what we are seeking is, quite frankly, just regulatory clarity so that we ensure that companies who are good actors actually understand what the rules of the road are, and we 

fully support, obviously, the activity that the SEC and CFTC and 

others are doing to make sure that the bad actors are rooted out 

of the system. 

Mr. GORFINE. Yes, thank you. I just want to thank the Committee for taking an interest in this area and allowing us and the 

CFTC to help inform and support the effort to strike the right balance. It is a promising and very new area of innovation that, as 

I said earlier, we don’t know where a lot of these different threads 

will lead. But it is important for us to be vigilant and make sure 

that we are targeting bad actors and making sure there are appropriate guardrails in place, and that we have an efficient, effective 

regulatory framework in place and look forward to helping support 

that effort. 

Mr. GENSLER. First, it is just so good to be with you, Mr. Chairman, and this Committee again after 5 years. 

Two, promoting innovation and promoting competition means 

also bringing this inside the public policy sphere. I don’t think they 

compete. I think it is together. If you recall, in this Committee that 

there is the issuer-based crypto, which is kind of the SEC and 

these ICOs. There is derivative crypto, which the CFTC has but it 

is going to have some challenges. And then there is the whole cash 

commodity crypto, which is 70 percent of this world. That is where 

Congress has a role, a real role to think about is there more authorities? 

I say incumbents versus startups. Startups feel that they can beg 

for forgiveness after they mess up with the law enforcement. Incumbents feel they have to ask for permission. And so right now 

there is an imbalance right now where incumbents aren’t in this 

space and startups are, and you might want to address that. MIT 

and I are available any time if you need any help on any of this. 

Thank you. 

Mr. NESS. I guess I will echo that. I think probably Uber taught 

us all that for better or for worse, if you build something that is 

incredibly popular, the laws will change to conform to that new 

technology. 

Technology is moving at a very, very fast pace. We have heard 

today about some of the pitfalls of these new technologies that get 

out ahead of the legislators, and so I want to compliment you guys 

for being on top of this, and the SEC as well has been incredibly 

on top of it and working closely with us and open to dialogue, and 

that is what is really needed is a kind of free flow of information 

and communication between those of us who are on the frontlines 

dealing with the day-to-day fact patterns and you guys who need 

to think about the actual policymaking aspects. 

The CHAIRMAN. Well thank you. It has been a terrific couple of 

hours. It was well spent for us. I hope you consider it the same. 

You clearly elucidated some issues, not only just with regulation of 

these issues, but also the tangential impact of taxable transactions 

96 

being captured in a way that folks can comply with our Tax Code 

and the revenues there, the law enforcement piece. Ms. Baldet, you 

may be involved with a group that is trying to find a way to create 

a currency that is not pseudonymous but would be anonymous. 

That is what innovators do is they see something that needs to get 

changed, and they will do that. And so that just speaks to how dynamic the process is. As long as the stupid criminals keep using 

Bitcoin would be great, but then the smart ones will pivot to something that allows them to hide better behind that. 

It has been a terrific eye-opening session, and will not be the last 

because our folks at the CFTC who are our partners in making this 

happen, and their partners at the SEC really want to do the same 

thing, and that is regulate where it needs to and give the certainty 

so that the incumbents don’t have to worry about asking for permission while the innovators are asking for forgiveness. That is an 

unlevel playing field. And we also want this action going on within 

the United States. 

Thank you all very much. Under the Rules of the Committee, the 

record of today’s hearing will remain open for 10 calendar days to 

receive additional material and supplementary written responses 

from the witnesses to any question posed by a Member. 

This hearing of the Committee on Agriculture is adjourned. 

Thank you all. 

[Whereupon, at 12:03 p.m., the Committee was adjourned.] 

[Material submitted for inclusion in the record follows:] 

97 

* There was no response from the witness by the time this hearing was published. 

SUBMITTED QUESTIONS

Response from Amber Baldet, Co-Founder and Chief Executive Officer, 

Clovyr * 

Submitted Questions by Hon. Vicky Hartzler, a Representative in Congress from Missouri 

Question 1. Illicit Activity—Over the past few years, one of the things that’s 

caused me and my constituents a great deal of concern is the rise of illicit activities 

being facilitated by the dark web, such as drug and sex trafficking. Congress is continuing to address the opioid epidemic, and I’ve turned my attention to sex trafficking as well. Last year, I sponsored a bill, known as the Empowering Law Enforcement to Fight Sex Trafficking Demand Act, that passed the House to address 

this issue. 

Ms. Baldet, Mr. Gensler brought up the use of certain cryptocurrencies to purchase illegal goods and facilitate criminal activity. As you sit on the board of the 

Zcash Foundation, which is a non-for-profit dedicated to enhancing financial privacy, I’d like to get your perspective on how we can fight against illegal activities 

being facilitated through cryptocurrency. 

How should we weigh the value of financial privacy against the value of law enforcement access to financial information? 

Answer. 

Question 2. Is it possible to have a truly anonymous cryptocurrency and still protecting against bad actors using it to launder money, purchase illegal goods, or 

evade taxes, or does the public have to choose one or the other? 

Answer. 

Response from Daniel Gorfine, J.D., Director and Chief Innovation Officer, 

LabCFTC, Commodity Futures Trading Commission 

Submitted Questions by Hon. John J. Faso, a Representative in Congress from New 

York 

Question 1. Commissioner Brian Quintenz has stated that a virtual currency can 

start as a security and become a commodity. What is that transition point in your 

mind? 

Answer. The Securities and Exchange Commission (SEC) interprets and applies 

the securities laws, and has been providing further guidance on how it would apply 

the ‘‘Howey Test’’ to crypto-asset offerings. To the extent that a crypto-asset is a security, the CFTC would generally not exercise regulatory authority over the instrument. 

Within the above context, it is conceivable that an enterprise would seek to raise 

capital through an investment contract and help to build a decentralized network 

predicated on a crypto-coin or token that takes on attributes similar to Bitcoin or 

Ether. In this case, the crypto-coin or token may be a commodity, akin to oranges 

or Bitcoin, while the initial investment contract is deemed a security. Of course, 

whether a particular offering or crypto-asset is a security or commodity is subject 

to a facts and circumstances legal test and accordingly is highly dependent on the 

details of the offering. 

Question 2. In the hearing you cited SEC Director Hinman’s comments on decentralization. At what point are a central actor’s efforts no longer key to the success 

of an enterprise, or sufficiently decentralized, to no longer be classified as a security? 

Answer. I defer to the proper jurisdiction of the SEC in determining the outer 

boundaries of the securities laws, but given our ongoing collaboration with the SEC 

and observation of its public comments the factors of decentralization, control, public expectations of profits from ongoing work of others, information asymmetries, 

and crypto-asset use cases all appear to be relevant to the analysis. Again, the securities and commodities laws are subject to facts and circumstances tests that eschew 

over-simplified definitions in order to accommodate evolving markets and offerings. 

With respect to decentralization, one might consider how many nonaffiliated individuals or entities contribute to the success of the network and whether the network 

remains significantly reliant on a founding team of creators or developers. As 

crypto-asset fact patterns continue to evolve, we at the CFTC will strive to continue 

providing clarity to market participants, as appropriate. 

Question 3. How many independent users confirming transactions or changes to 

a blockchain are sufficient for effective decentralization? 

98 

Answer. I do not believe a bright-line number of users or transactions should be 

dispositive as to the classification of a crypto-asset. Instead, the CFTC utilizes a 

facts and circumstances test in determining application of the CEA. To be sure, the 

number of users confirming transactions and breadth of participation are likely relevant to such a test, but not dispositive. As noted above, a relevant consideration 

may be whether the network remains significantly reliant on the work or efforts of 

a core team or group of developers as compared to gaining such widespread adoption 

that it can continue to run largely autonomously. 

Æ