Section 230(c)(1) of the Communications Decency Act is very short – 26 words in length in total. It states that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”
These words are deceptively simple but they form the backbone of the social Internet as we understand it today, because the words render platforms like Reddit, Facebook, and Twitter more or less absolutely immune for the content their users post. This allowed them to grow; speech otherwise comes with a lot of liability (infringement, defamation) and Section 230 and other provisions like the (much-reviled) immunity, notice and takedown regime under the DMCA for copyright infringement have resulted in an Internet which can develop unhindered by lawsuits and local rules in the fifty states which, otherwise, would have tied it down.
For this reason, Jeff Kosseff called Section 230 “the twenty six words that created the Internet,” also the title of the book he wrote on the subject. The story behind Section 230 is convoluted and strange but suffice it to say, without the rule or something like it, the user-generated web would not be what it is today.
We may now be approaching something like this with crypto – a necessary but overdue legal innovation capable of blowing adoption off the charts – with today’s release of the draft text of the Financial Innovation and Technology for the 21st Century Act (hereinafter the FIT Act, “FIT for the 21st Century… see what they did there?) which proposes to amend the much-hated provisions of the Securities Act of 1933 and the Exchange Act of 1934 to regularize crypto business.
The FIT Act is huge and there’s a lot to consider, so this post confines itself to Section 301 and Section 301 alone. Let’s dive in.
1. Section 301 basically Nukes Howey for a lot of possible cryptoasset products
Everyone knows what the Howey test is. “Investment contracts” are securities as defined in Section 2(a)(1) of the Securities Act. Howey defines what an “investment contract” is. The FIT Act removes crypto – properly, “digital commodities” (more on that later – from the definition of an investment contract.
Section 2(a)(1) of the Securities Act of 1933 currently reads:
(1)The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
Section 301 of the Bill amends this to read:
The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. The term does not include a digital commodity or a permitted payment stablecoin.
This change, if enacted, would be absolutely titanic. At the moment, the language “investment contract” covers virtually anything anyone can invest in. The Act proposes to remove “digital commodities” (more on that later) or “permitted payment stablecoins” (which I’m going to mostly skip in this post for word count’s sake), and provides a pathway to determine with legal certainty whether an asset should be so categorized.
What I will say is that for the moment, informed legal opinion on stablecoins is that they may very well constitute securities – not qua investment contracts but qua evidence of indebtedness. Although we haven’t seen a ton of non-fraud enforcement in this area (keeping in mind one of the first stablecoins, 2014’s Paycoin, was dinged by the SEC and DOJ on fraud charges), regularizing stablecoins should be an industry priority.
2) Section 301 also neuters the Exchange Act vis a vis digital asset exchanges
Section 3(a)(1) of the Securities Exchange Act of 1934 reads:
(1)The term “exchange” means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.
The significance of this definition is that if you want to running an exchange that trades securities you need to be registered as a national securities exchange or operate something called an Alternative Trading System or ATS, neither of which is particularly easy to do (nor cheap) and both of which are really not fit for purpose for assets like Bitcoin which have no issuer and in relation to which users all self-custody.
The amendment proposes:
The term “exchange” means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange. The term ‘exchange’ does not include a digital asset trading system, blockchain protocol, or any person or group of persons solely because of their development of a blockchain protocol.
…followed by a number of consequential amendments to subsequent provisions of the Exchange Act which would honestly be a bit too long to reproduce in full here. The upshot of it is that if an asset is a digital commodity, venues that trade those assets will be outside of the Exchange Act regime. The Exchange Act has long been considered an inappropriate regime for the trading of cryptoassets. This bill takes “digital commodity” cryptoassets out of it.
3) Definitions introduced elsewhere in the bill provide Section 301 with a very precise way of defining a Digital Commodity
Broadly speaking, the assets that are sought to be carved out of the regime are so-called “digital commodities.” What are those? Well, there’s a definition! And unlike previous, shoot-from-the-hip attempts from e.g. Bill Hinman to provide a shortform test for whether an asset
The FIT Act proposes the following:
‘Digital commodity’ means…
(i) any unit of a digital asset held by a person, other than a digital asset issuer, a related person, or an affiliated person, before the first date on which each blockchain system to which the digital asset relates is a functional network and certified to be a decentralized network under section 44 of the Securities Exchange Act of 1934, that was— (I) issued to the person through an end user distribution described under section 42(d)(1) of the Securities Exchange Act of 1934; or (II) acquired by such person in a transaction that was executed on a digital commodity exchange; or
(ii) any unit of a digital asset held by a person, other than a digital asset issuer, a related person, or an affiliated person, after the first date on which each blockchain system to which the digital asset relates is a functional network and certified to be a decentralized network under section 44 of the Securities Exchange Act of 1934; and
(iii) any unit of a digital asset held by a related person or an affiliated person during any period when any blockchain system to which the digital asset relates is a functional network and certified to be a decentralized network under section 44 of the Securities Exchange Act of 1934.
So the network has to be functional and certified. How to we certify? Well a new Section 44 of the Securities Act of 1933 exists for that! And it basically says that you publicly file a bunch of disclosure documents with the Commission and self-certify that your coin is “decentralized,” there’s a rebuttable presumption that you’re right, and if the Commission disagrees they can attempt to rebut that presumption within thirty days of filing.
SEC. 44. CERTIFICATION OF CERTAIN DIGITAL ASSETS.
‘‘(a) CERTIFICATION.—Any person may certify to the Securities and Exchange Commission that the blockchain system to which a digital asset relates is a decentralized network.
‘‘(b) FILING REQUIREMENTS.—A certification described under subsection (a) shall be filed with the Commission, and include— ‘‘(1) information regarding the person making the certification; ‘(2) a description of the blockchain system and the digital asset which relates to such blockchain system, including— ‘‘(A) the operation of the blockchain system; ‘‘(B) the functionality of the related digital asset; ‘‘(C) any decentralized governance system which relates to the blockchain system; and ‘‘(D) the process to develop consensus or agreement within such decentralized governance system; (3) a description of the development of the blockchain system and the digital asset which relates to the blockchain system, including – ‘‘(A) a history of the development of the blockchain system and the digital asset which relates to such blockchain system; ‘‘(B) a description of the issuance process for the digital asset which relates to the blockchain system; ‘ (C) information identifying the digital asset issuer of the digital asset which relates to the blockchain system; and ‘‘(D) a list of any affiliated person related to the digital asset issuer; ‘‘(4) an analysis of the factors on which such person based the certification that the blockchain system is a decentralized network, including – ‘‘(A) an explanation of the protections and prohibitions available during the previous 12 months against any one person being able to ‘‘(i) control or materially alter the blockchain system; ‘‘(ii) exclude any other person from using or participating on the blockchain system; and ‘‘(iii) exclude any other person from participating in a decentralized governance system; ‘‘(B) information regarding the beneficial ownership of the digital asset which relates to such blockchain system and any the distribution of voting power in any decentralized governance system during the previous months; ‘‘(C) information regarding the history of upgrades to the source code for such blockchain system during the previous 3 months, including ‘‘(i) a description of any consensus or agreement process utilized to process or approve changes to the source code; ‘‘(ii) a list of any material changes to the source code, the purpose and effect of the changes, and the contributor of the changes, if known; and ‘‘(iii) any changes to the source code made by the digital asset issuer, a related person, or an affiliated person; ‘‘(D) information regarding any activities conducted to market the digital asset which relates to the blockchain system during the previous 3 months by the digital asset issuer or an affiliated person of the digital asset issuer; and ‘‘(E) information regarding any issuance of a unit of the digital asset which relates to such blockchain system during the previous 12 months; ‘‘(5) with respect to a blockchain system for which a certification has previously been rebutted or withdrawn under this section, specific information relating to the analysis provided in subsection (f)(2) or (g)(3), as applicable, in connection with such rebuttal or withdrawal.
‘‘(c) REBUTTABLE PRESUMPTION.—The Commission may rebut a certification described under subsection (a) with respect to a blockchain system if the Commission, within 30 days of receiving such certification, determines that the blockchain system is not a decentralized network.
OK, so what’s a “decentralized network” then? Right up on Page 6 of the bill, some new amendments to the 1933 Act are proposed:
The term ‘decentralized network’ means the following conditions are met:
‘(A) During the previous 12-month period, no person ‘‘(i) had the unilateral authority, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, to control or materially alter the functionality or operation of the blockchain system; or (ii) had the unilateral authority to restrict or prohibit any person who is not a digital asset issuer, related person, or an affiliated person from ‘(I) using, earning, or transmitting the digital asset; (II) deploying software that uses or integrates with the blockchain system; (III) participating in a decentralized governance system with respect to the blockchain system; or (IV) operating a node, validator, or other form of computational infrastructure with respect to the blockchain system.
(B) During the previous 12-month period (i) no digital asset issuer or affiliated person beneficially owned, in the aggregate, 20 percent or more of the total amount of units of such digital asset that (I) can be created, issued, or distributed in such blockchain system; and (II) were freely transferrable or otherwise used or available to be used for the purposes of such blockchain network; (ii) no digital asset issuer or affilated person had the unilateral authority to direct the voting, in the aggregate, of 20 percent or more of the outstanding voting power of such digital asset or related decentralized governance system; or (iii) the digital asset did not include voting power.
(C) During the previous 3-month period, the digital asset issuer, any affiliated person, or any related person has not implemented or contributed any intellectual property to the source code of the blockchain system that materially alters the functionality or operation of the blockchain system, unless such implementation or contribution to the source code (i) addressed vulnerabilities, errors, regular maintenance, cybersecurity risks, or other technical improvements to the blockchain system; or (ii) were adopted through the consensus or agreement of a decentralized governance system.
(D) During the previous 3-month period, neither any digital asset issuer nor any affiliated person described under paragraph (20)(A) has marketed to the public the digital assets as an investment.
(E) During the previous 12-month period, all issuances of units of such digital asset were end user distributions made through the programmatic functioning of the blockchain system.
So basically what is currently understood as a “fair launch where all coins in circulation are mined” would be “decentralized,” would be “digital commodities” and therefore would not be “securities” and thus not subject to the Securities Act or Exchange Act securities regimes. This here is extreme shorthand and I’m still chomping on the (212 page long) bill, so more to come on this front on this blog.
Conclusions: not perfect, but a lot better than what we have
Is this legislation perfect? No. It’s also enormous so there’s much more to digest in the bill which might temper my initial opinion of Section 301. There is some dissent over the current version carving out a lot of DeFi contracts and DAO stuff from the digital asset exclusions.
Would it, if passed, open the floodgates to legal and regulated cryptocurrency innovation in the United States within certain well-defined boundaries, both in terms of increasing the number of the cryptocurrencies available and the DeFi venues on which they can be traded, while having some restrictions in place that restrict possibilities for insiders to get unfairly enriched? Yes.
If Congress is looking to clear up the confusion created by the recent Ripple Labs litigation looking forward, this is certainly a good place to start.
