Regulatory Challenges of Blockchain-Based Token Sales
In recent months, readers of financial news have been inundated with stories about the wild price fluctuations of the cryptocurrency “Bitcoin.” While it is easy to follow the shifting valuations of Bitcoin, understanding the regulatory issues raised by such digital assets is far more difficult. As with many Internet-related subjects, the problem is not too little information available online, but is far too much that is inaccurate, outdated or overhyped.
Bitcoin is just one of many kinds of digital tokens that can be generated through the newly emerging technology called “blockchain.” Blockchains have been described as fundamentally “decentralized databases maintained by a network of computers.” Through the use of “public-private key cryptography” and “strict code-based rules” blockchains are able to “store tamper-resistant, resilient and authenticated data” which permits digital assets to be transferred cheaply, efficiently and relatively safely throughout the world without the need for a centralized intermediary, like a bank or transfer agent. Moreover, transfers can be made pseudonymously. Blockchains also facilitate the use of “smart contracts.” These are programs that can be initiated by anyone who satisfies the requirements of the protocol (the smart contract’s “terms”) and thereby generate a result (the contract’s “performance”), such as the sale of a digital token to an online purchaser. These transactions thereby occur autonomously (and frequently anonymously) with no opportunity for interference by financial intermediaries or governments. The use of blockchain technology to offer digital assets for sale through “smart contracts” has made it an attractive vehicle for many internet firms seeking to raise capital. Virtually any internet business, utilizing readily available code (usually provided by the Ethereum network) can offer tokens for sale to the public. These “ICOs” or initial coin offerings can be used to fund future projects or maintain or improve existing networks. The tokens generated by the offering can provide various rights to assets (digital and non-digital) and access to various forms of income streams. In 2017, it has been estimated that over $2.2 billion was raised through the sale of blockchain-based digital tokens.
The availability of such new and unusual financing opportunities raise important regulatory issues for businesses, governments, financial regulators, corporate lawyers and corporate law academics. I look forward to presenting and discussing some of these issues at a presentation I will be giving at CFRED on Tuesday, January 30. The presentation will consist in part of my analysis and commentary on an important recent paper written by two of my colleagues at Cardozo Law School, Aaron Wright and Jonathan Rohr. The paper, which is available on the Social Science Research Network, was the most frequently downloaded paper on that network last month.
Most internet discussions of the appropriate regulation of cryptocurrencies and other digital tokens tend to be one-sided and simplistic. They are portrayed either as anarchic instruments designed to enable crackpots, criminals and terrorists to evade legitimate governmental oversight or as revolutionary technological innovations that will make capital available easily and cheaply to entrepreneurs around the world while avoiding unnecessary and burdensome regulation. Such vastly differing views clearly imply rather different regulatory prescriptions. A small but growing number of countries have actually banned Bitcoin and similar currencies, along with businesses that are based on their sales or networks on which they are traded. Others have condemned such actions as regressive and futile, since digital token trading can occur fairly easily anywhere in the world.
The paper by Professors Wright and Rohr takes a far more careful and nuanced view of the issues presented by digital token offerings. It focuses primarily on the law of the United States, a country generally seen as fairly open to online capital formation. Professors Wright and Rohr point out, however, that such openness is not the result of any express government policy, but is created by legal uncertainty regarding the scope of American securities laws. They argue that many existing token offerings could be prosecuted as violations of American securities law and that uncertainty regarding that issue is detrimental to the development of such tokens as a useful and efficient method of capital formation. I look forward to discussing their arguments and suggestions for reform, as well as broader issues concerning appropriate regulation of blockchain-based assets at my talk on January 30.
Charles Yablon, New York