The Token Taxonomy Act and the Future of Ethereum Tokens

Last week, a bipartisan bill was introduced by Warren Davidson, R-Ohio and Darren Soto, D-Fla. I think it's a positive step to providing some much needed regulatory clarity to crypto tokens and blockchain projects.

Disclaimer: Nothing here should be considered legal or investment advice.

“This bill provides the certainty American markets need to compete with Singapore, Switzerland, and others who are aggressively growing their blockchain economies.” (from the joint press release).

The bill itself is a relatively easy read (10 pages or so, double spaced). There’s interesting ideas about taxes, banks, and SEC regulation in there, but I’d like to focus on the most interesting thing to me: the token definition.

A Clear Definition of a New Asset Class

Many people share the opinion that digital tokens on blockchains represent a new asset class. So far when trying to determine what the definition of this new asset class might be, the community largely relies on what it might not be — namely what tokens are unlikely to be classified as securities by applying the 1946 Howey Test. In contrast, the Token Taxonomy Act contains a clear definition of a Digital Token (which is then excluded from the Definition of a Security).

It seems to me that the definition in this bill is based around 4 criteria: How it’s created, how the ledger works, how transactions work, and what it represents.

Creation

  1. A Digital Token is created “in response to the verification or collection of proposed transactions” -or-
  2. “pursuant to rules for the [token’s] creation and supply that cannot be altered by a single person or group of persons under common control” -or-
  3. “as an initial allocation of [tokens] that will otherwise be created in accordance with” 1 or 2 above.

Ledger

“A Digital Token has a transaction history that is recorded in a distributed, digital ledger or digital data structure in which consensus is achieved through a mathematically verifiable process; and after consensus is reached, cannot be materially altered by a single person or group of persons under common control.”

Transactions

“A Digital Token is capable of being traded or transferred between persons without an intermediate custodian.”

Representation

“A Digital Token is not a representation of a financial interest in a company, including an ownership or debt interest or revenue share.”

Examining the Criteria

Creation

The most interesting part to me is the “creation” criteria. It first clearly identifies tokens that are mined (verification or collection of transactions). It gets more interesting from there:

The key idea of the the second point is that something can be classified as a Digital Token if the rules of “creation and supply” can’t be altered by a central person or team.

This calls to mind a couple examples: When Augur released on main net, the team assigned the ownership of the REP smart contract to a null address. At that point the Augur team can no longer simply create new REP… meaning the “rules of creation and supply” have been set and are no longer controlled by them. This is often planned by acentric projects and it’s a sign that the network has truly become decentralized in nature. On the other hand, Oyster never did this, leaving control in the hands of the founder (who later unexpectedly issued a big pile of PRL token and wreaked havoc on the project and its supporters).

The third point is also really interesting — allowing for an “initial allocation” of tokens. This seems to carve out room for pre-sales. I interpret the language to mean that pre-sold tokens are classified as “Digital Tokens” as long as any tokens other than the initial allocation are created according to rules that can’t be changed. In addition, the ledger and transaction criteria must be functioning to meet the definition. The joint press release for the bill further speaks to the vision:

“This bipartisan legislation draws a bright line for businesses and regulators by defining a “digital token” and clarifies that securities laws do not apply to companies that use blockchain once they reach their goal of becoming a functional network.”

Examining Transaction Criteria

The ledger and transaction criteria are pretty straightforward and describe most crypto projects. A distributed ledger with decentralized consensus — secured by crypto. Transactions and trades that can take place directly wallet-to-wallet with no middleman or custodian. Oh hey, this bill explicitly calls out DEXs. Interesting 🙂

Examining Token Representation Criteria

The final criteria appears to me to simply state that the token shouldn’t represent a share of stock in a company.

Themes of Decentralization and Functionality

So a digital token can be mined or issued as long as the rules aren’t controlled centrally; It must have a crypto-consensus ledger, and transactions and trades should be possible wallet-to-wallet with no custodian or middleman; finally it can’t represent ownership in a central company. One common theme that all the criteria have is Decentralization — the more decentralized a token, the more it fits this proposed definition.

Furthermore, even though pre-sales seem to be allowed, the network must be functional — the ledger must be working, and wallet-to-wallet transactions/trades must be operational.

I might be biased as part of the Ethex.market team — we're a decentralized exchange that only lists useful (functional) tokens for wallet-to-wallet zero-custody trading — but I applaud this bill. I think it's a good step, and I hope to see it, or something similar re-introduced in 2019 (it can't be acted upon in 2018… shutdown or no shutdown).

Submitted December 23, 2018 at 06:35AM }
via reddit http://bit.ly/2AnCxlB

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