Alexandra Damsker, the author of Understanding DeFi published a superb article about the regulatory challenges of the crypto assets, where she argues that regulatory frameworks should consider the unique capabilities of tokens.
„Over the past two years, I’ve noticed a significant misunderstanding in the blockchain industry regarding regulation. The issue extends beyond categorizing a token as a security or a commodity. The primary challenge lies in defining tokens themselves.”
As she highlight the most important factor, the specific regulatory body overseeing tokens—whether it’s the CFTC or SEC—might seem secondary because both agencies operate under the assumption that the regulated items are static.
Stocks and fiat currencies maintain their identity from creation until they are voided or destroyed. But regulators are in trouble because tokens aren’t like this.
They are dynamic, performing various functions for different holders, or even for the same holder at different times.
No existing regulatory framework can fully accommodate this versatility, the vast number of functions.
Tokens are currencies, or items?
Tokens can facilitate transactions on a blockchain, a purely functional and unregulated role.
They can incentivize contributions to secure and manage the blockchain, which involves exchanging labor or services and remains unregulated as it does not depend on the token’s presumed value.
When tokens represent value, regulation is contingent on whether the underlying asset is regulated—tokens representing real world items are unregulated, but those representing for example Tesla shares are.
Tokens can also represent products or groups of rights, unregulated apart from intellectual property concerns.
Their use as payment for goods or services (excluding transactional fees like gas fees) presents a rather complex situation.
Unlike stablecoins, non-stablecoin tokens act more like assets, which are designed to fluctuate in value and thus fall under the jurisdiction of the U.S. Department of Treasury, including FinCEN and the IRS. There are already five regulators for one asset class.
Ownership, but what if it’s only partial?
Transactional fees, akin to service fees, are typically unregulated. Fractional ownership through tokenization allows individuals to hold fractional interests in assets, a scenario that blurs regulatory lines.
If fractional ownership shares interest in the whole, it’s a security regulated by the SEC. If it confers distinct individual ownership, it might be classified as a commodity, like bitcoin.
Tokens representing rewards for risk-taking or services, such as staking without providing validation or participating in liquidity pools, fall under a mix of securities and Treasury regulations.
Voting rights linked to tokens are regulated by the SEC in public companies. Tokens reflecting perceived or
speculative market value can be categorized as securities or commodities, thus falling under SEC or CFTC regulation respectively.
The dynamic nature of tokens, combined with their varied use cases is a clear sign of the need for a nuanced regulatory approach. A new approach, actually, because the current one isn’t applicable.
The implications of how these tokens are regulated are significant, because if regulators fail to account for the unique aspects of tokens, there could be stifling effects on innovation and development within the blockchain and DeFi sectors, risking the country remain left behind.
On the other hand, a well-tailored regulatory framework could support growth, ensuring that tokens’ multifaceted roles are acknowledged and appropriately governed.
Money in the morning, product at lunch, and security at noon
Tokens can serve many functions, making it difficult for buyers to predict their ultimate use in advance.
„If I buy ether in January, February and March, then in June stake some with a validator, purchase a one-of-one NFT (a product) in July, and a meme coin (likely a security) in August, paying gas for each transaction, which ETH specifically was used for which transaction? I, the buyer, don’t even know – I won’t know which ETH was used to buy the meme coin until I apply my jurisdiction’s accounting method.”
This depict the confusion very well, while one trying to fit tokens into current regulatory frameworks, which frameworks assume a static nature for regulated items. But again, tokens are dynamic and their regulatory status can change depending on how they are used.
Using outdated frameworks to regulate tokens offers limited protection and supress innovation.
Damsker argues the US must develop better regulatory approaches as soon as possible, especially as technologies like quantum computing, which can shift the nature of assets even more rapidly, become more prevalent, day by day.
Have you read it yet? 10k ETH is in play by the end of the year
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