Token Taxonomy Bill: Crypto holidays are here

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The following article was provided by Mike Minihan, partner at BX3 Capital.

For crypto enthusiasts in the US, Christmas came a few days early this year. The industry’s thought leaders descended on Congress in September, pleading for legislation of any kind, to help stabilize a jittery industry that most feared “regulation by enforcement.” With but one day remaining before the Congressional holiday, it was suddenly clear that those pleas were heard!

The bipartisan bill introduced yesterday by Reps. Warren Davidson (R-OH) and Darren Soto (D-FL) made several extraordinary accomplishments. But first and foremost, it put the world on notice that the US recognizes the importance of emerging opportunities for digital currency, tokens, and blockchain-based tools. Is it a perfect solution? No. It is, however, a critical first step towards ensuring US leadership in emerging technology.

The opening salvo of this legislation is indeed its name: The Token Taxonomy Act of 2018, and a substantial portion of the legislation is devoted to adding definitional certainty to terms that have been vexing for the crypto industry. Eschewing the colloquial “utility” terminology, the bill defines a “digital token” as a digital unit that is created through, effectively, the operation of a blockchain-based consensus process, and which is not a “representation of a financial interest in a company, including an ownership or debt interest or revenue share.” The Securities Act of 1933 would thus be amended to exclude digital tokens from the definition of a security. Yes, this is huge. The legislation thus contemplates tokens that are indeed not securities.

The exclusion from the digital token definition for things that actually are securities is definitely a light touch, although it is unclear whether that is intentional. For example, a token offering that represented an ownership interest in an apartment building to be built looks like a digital token and not a security under the law as written, even though this type of token offering would clearly be a security in the absence of this bill. From a light-touch perspective, this is definitely mission accomplished. The bill should serve the purpose of ensuring that token offerings in lieu of equity are used to fund most any project or non-equity asset acquisition.

The bill also limits the penalty provisions for selling an unregistered security if the issuer of the token had a reasonable and good-faith belief it would meet the definition of a digital token—thus, did not believe it was a security—and the issuer complies with certain requirements after the SEC has provided notification to the issuer that it has determined the offering to be a security offering. Again, this looks like a light touch: It gives the issuer fair latitude, as long as it is operating in a reasonable manner and in good faith.

With regards to SEC enforcements as Airfox and Paragon, this provision could have been quite helpful. The Token Taxonomy Act requires the return of unused investor funds—to the extent not already spent in a reasonable manner on technological development—whereas those settlements only required the return of funds to investors who requested refunds.

Tax policy also gets its due in the new bill. First, it provides an exemption that allows IRAs to purchase virtual currency—defined as a digital representation of value that is used as a medium of exchange, and which is not otherwise a currency for purposes of Sec. 988—without triggering a taxable distribution from the IRA. Essentially the bill is equating a virtual currency such as Bitcoin, which would meet the definition, with gold bullion, which also a recognized store of value. Next, and perhaps most importantly, the bill revives Sec. 1031, in which one virtual currency is exchanged for another. These changes would apply retroactively to January 1, 2017.

 These provisions aren’t just light touch in terms of bolstering cryptocurrency as an asset class: they potentially beckon those looking to incorporate tax preference into their investing profile. The bill offers strong opportunity for long-term tax deferral.

 This being said however these sections could use some tidying. The “virtual currency” definition for the Internal Revenue Code bears no reference to the “digital token,” for one thing. In other words, it remains unclear whether a digital token, a security, or both would meet the definition of “virtual currency” that would allow preferential tax treatment under these amendments to the Internal Revenue Code. Finally, the bill adds a de minimis rule, which excludes $600 of gain per transaction when a virtual currency is exchanged for cash. The key takeaway? The Token Taxonomy Act grants a tax-free bridge from crypto to fiat for everyday transactions like buying a cup of coffee.

There are gaps, of course. Beyond the taxation implications, there also should be clarity around the role of the CFTC, if any, and steps toward regulating the things that will add liquidity to the crypto market, such as ETFs.

 This being said, from a top-down perspective, this bill is exactly what the cryptocurrency industry needs as we take crypto investment to the next level—and will prove to the world that the US is and will continue to be a home for innovation and transformative technologies.  

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