Although not Mount Olympus but rather Capitol Hill, one could be forgiven for mistaking the Facebook Libra co-creator and Calibra CEO, David Marcus’s July 17th, 2019 testimony before the House Committee on Financial Services as a page out of Greek mythology.
If one were to be dramatic, one could say that this was no more an exercise in regulatory oversight of Facebook’s digital currency plans, than a Gigantomachy, of similar historical importance, with our Capitol Hill overseers panic-struck, and technology and terminology confused, frantically trying to throw everything-and-the-kitchen-sink at Marcus and his Facebook overlords as they desperately try to defend the tech giants’ assault on their domain and preserve of power.
Marcus was there to take questions on Libra, the cryptocurrency which Facebook through its subsidiary Calibra, proposes to launch on the Libra Blockchain, to be ‘overseen’, as least initially by the Libra Association, an “independent, not-for-profit membership organization headquartered in Geneva, Switzerland…” whose members will “…consist of geographically distributed and diverse businesses, nonprofit and multilateral organizations, and academic institutions…”, which count tech giants Uber, Spotify, Paypal, and of course Facebook, among them. (see the Libra White Paper).
In this, and the previous days hearings before the Senate Banking Committee, the first formal skirmish, the composed Marcus was superb.
While Marcus seemed keen to reiterate that Facebook, or, instead, Calibra, a separate entity and project, would work with regulators and only launch Libra when the Libra Association had received regulatory approval, the Committee members, for the most part, seemed perplexed by the technology and Calibra’s proposed plans.
What started off with a request from Chairwoman Maxine Waters (D-CA) for Facebook to commit to put a hold on the project pending regulatory review, moved to questions on how exactly the Libra platform would work, its relationship with Facebook and whether the platform intended to operate as a bank.
Rep. Sean Duffy (R-WI) threw Louis Farrakhan and Milo Yiannopoulos into the fray asking Marcus whether they would be banned from Libra, a fate befallen them on Facebook, and, waving a $20 bill, asked what better access to financial systems could there be than the mighty United States Dollar. Rep. Jim Himes (D-CT) had further concerns regarding Libra’s stability and the potential for ordinary consumers assuming a “foreign currency risk” in using Libra for day-to-day expenses the likes of paying rent.
Marcus notched up his responses, forever concise, polite and deferential. Calibra is not a bank, but a payments tool, just like venmo or paypal. Facebook would not be in control of policy; it simply would be one of the initial members of the Libra Association, to number 100, at launch, with Libra then to be moved to a decentralized non-permissioned platform in time. Day-to-day expenses, Calibra does not see as the primary use case, but rather foreign remittances with no-or little fee, with which the existing financial infrastructure is, in any event, slow and costly. Calibra likely may not charge ordinary consumers a fee to transfer Libra on its platform, but it may charge businesses. And of course, Libra would be a stablecoin: each $ (or Peso, or Euro, or Pound, etc.) paid in exchange for Libra would be deposited into the reserve (to be custodied by one or more major banks), underpinning the digital currency’s stability. And so on.
What’s more is that Libra would not be backed only by currency. As the White Paper says, “[a] basket of bank deposits and short-term government securities will be held in the Libra Reserve for every Libra that is created, building trust in its intrinsic value. The Libra Reserve will be administered with the objective of preserving the value of Libra over time…”.
A very interesting detail indeed, and one that Rep. Himes latched on to when he said that Libra/Calibra looked like an Exchange Traded Fund, within the ambit of the Investment Company Act. Marcus replied that it is a payment tool, not an ETF, and believes that no one would buy Libra for investment as it is designed for stability, and that it does not fall within the ‘Howey Test’ as a ‘security’, with any underlying “product” being actively managed.
Further questions went into money transmission, and its accompanying know-your-customer (KYC), anti-money laundering (AML)and countering the financing of terrorism (CFT) compliance.
Marcus deftly explained how Libra wallets would operate, and that all on-and-off ramps to the Libra Platform as represented by the wallets would be subject to KYC, AML and CFT compliance, offering the sentiment that blockchain could enable more transparent oversight than existing financial services systems. Marcus, replying to Rep. Barry Loudermilk (R-Georgia), said that this, together with the platform structure proposed to be implemented, would help to mitigate risk of illicit use. Interestingly, Rep. Loudermilk touched on whether the Financial Stability Oversight Council (FSOC) should designate Libra as systemically important, to which Marcus replied that it was not for him to say who should be regulating Libra, but that Calibra had been engaged with FSOC and all of the FSOC-umbrella agencies.
Marcus reiterated that Calibra would work with FinCEN and other money services business regulators to ensure compliance before proceeding to Libra launch. The Swiss origination of Libra, is, according to Marcus (or the White Paper), motivated not by an attempt to avoid US regulation, but rather to be situated in neutral Switzerland, and in the same jurisdiction as other major NGO’s, for example the WHO, the WTO and the Bank of International Settlements.
But it was the questions centering on United States Securities compliance and the decentralized nature of the Libra platform that drew much needed insight into not only Facebook and certain Committee members’ views on Libra, but also how much within the consideration of, at least, some of them, is regulatory reform and the need to encourage, and keep blockchain innovation in the US.
And while it did so, it also highlighted the potential shortcomings in Federal (and at least one State’s) attempts so far to address this, and, how, arguably, Libra could hurt current reform attempts, and innovation in the long run. To follow this line of argument, one needs to take a closer look at the current legislative initiatives to allow for open blockchain or ‘utility’ tokens outside of the existing US Securities regime.
The Token Taxonomy Act (TTA), a bipartisan bill introduced by Rep. Warren Davidson (R-OH) proposes to tackle the distinction between a security token (subject to the existing Securities laws) and a ‘utility’ token by introducing into the Securities Act the definition of “Digital Token” (being, in essence a blockchain-originated digital asset, “…. a representation of economic, proprietary, or access rights that is stored in a computer-readable format…” (TTA, Section 2(a))) and which doesn’t represent a “… financial interest in a company or partnership, including an ownership interest or revenue share…” (TTA, Sections 2(a))), and by excluding ‘Digital Tokens’ from the definition of ‘Security’ in Section 2(a)(1) of the Securities Act (TTA, Section 2(b)).
The TTA then would exempt an “… offer, promotion, or sale of a digital unit…” believed reasonably and in good faith to be a Digital Token (TTA, Section 2(c)) from public offerings and the requirement to file a registration statement or rely on other traditional exemptions from this requirement, unless “…within ninety days following a written notification from the Commission to such person that such digital unit has been determined by the Commission to be a security…” (TTA, Section 2(c)). The TTA then goes on to propose that all Blue Sky, State securities laws, be preempted by precluding the States from requiring registration or qualification for Digital Token sales or offerings (Section 2(d)).
In essence, the digital token legislative initiative in the TTA appears to be a wholesale, preliminary exclusion of digital tokens from the Securities public offering regime, unless the SEC takes action to exclude it. This, in itself, provides little direct guidance or certainty as to where the line in the sand between ‘utility’ and ‘security’ lies.
Comparatively, Wyoming’s approach to the distinction is instructive, and ventures further into the detail of the distinction. Wyoming, taking the lead in State digital asset regulation, divides digital tokens into three classes: (i) “digital consumer assets”; (ii) “digital securities”; and (iii) “virtual currencies”.
From experience, we know that pure digital currencies of the likes of Bitcoin and Ether, each digital tokens, are not security tokens, having been developed on purely decentralized blockchains, with profits in the tokens being derived independently of the efforts of any promoter or third party controlling a common enterprise (see the Howey Test).
But where the unchartered territory, the interesting stuff, is, is in Wyoming’s distinction between (i) and (ii).
For Wyoming, a “digital consumer asset” is a digital token “…that is used or bought primarily for consumptive, personal or household purposes and includes…[a]n open blockchain token…”. “Digital securities”, on the other hand, are ‘securities’ as defined under the Wyoming securities statute, but which expressly exclude “digital consumer assets” (see, Wyoming, SF0125).
An earlier Wyoming Bill, HB 70, 2018, gives further insight to the criteria for an “open blockchain token”. This includes the primary consumptive purpose, that the token “…shall only be exchangeable for, or provided for the receipt of, goods, services or content, including rights of access to goods, services or content…”, and that the developer or seller of the token must not sell or market the token to the initial buyer as a financial investment (see HB70, Section 1(a)). To satisfy the last mentioned requirement, it would be sufficient that “…the seller or developer reasonably believed that it sold the token to the initial buyer for a consumptive purpose…” and that the token was not marketed as a financial investment (see HB70, Section 1(a)(iii)(B)(I)).
The Wyoming approach, it seems, cuts very close to the essence of the distinction. It recognizes the risk to blockchain innovation, and the regulatory burden that presents in not exempting token-driven blockchain startups from securities, tax and money transmission regulation in their issue and use of ‘utility’ or consumptive digital tokens. Its legislation tries to cut to the core of the issue, rather than adopt the apparent ‘blanket’ security/utility approach of the TTA , and attempts to formulate a definition for the distinction between security tokens, on the one hand, and ‘utility’ or ‘consumptive tokens on the other.
At the House Committee hearings, Rep. Davidson, the sponsor of the TTA, specifically asked Marcus whether he thought Libra would be a security, and touched on the extent, or possibility for Libra’s decentralization. Davidson, animated, quipped whether there was “…a special Facebook clause…” that exempted Libra. Marcus simply responded that it isn’t because it is designed as a payment tool.
As we have seen, a pure virtual currency would not be a security. There has been considerable debate regarding whether other what-could-be virtual currencies, like Ripple’s XRP, are true virtual currencies given what may be said to be an underlying common enterprise and independent promoter efforts.
Is Libra all that different?
The Libra Association, and its council would be run by Facebook/Calibra and co to develop the platform. The Libra White Paper specifically refers to the Libra Association as its “Governing Entity” and which would manage the Libra Reserve which, as the White Paper says, would be used to “…cover the cost of the system, ensure low transaction fees…[and]…pay dividends to investors who provided capital to jumpstart the ecosystem…”, with “…[t]he association…[being]…the only party able to create (mint) or destroy (burn) Libra…”.
Granted, the White Paper also points out that the objective is to move towards further decentralization “over time”, and “…to start this transition within five years…” and that “… [t]he challenge is that as of today …[the Libra Association Members]…do not believe that there is a proven solution that can deliver the scale, stability, and security needed to support billions of people and transactions across the globe through a permissionless network…”.
So, if and when it is launched, wouldn’t Libra be a security? After all, isn’t the fundamental ability to launch Libra in the first place, and accompanying Government frenetic response and outcry very much the reflection of the very entities that are trying to do it? Put differently, isn’t Libra’s success (and potential value, stable coined or not), at least in some part, dependent on the efforts, names and global aggregation of the Facebook and other tech giants behind the concept? Would you not want to hold Libra to speculate on its (and its constituent members’) success?
All of this may become moot if legislative reform is implemented Federally, ultimately along the lines of the express ‘consumptive’ or ‘utility’ rationale ala Wyoming. It could be argued that Facebook/Calibra’s consumptive intention for the token may carry the day, fitting squarely into the very concepts underpinning not only Wyoming, but, which, it seems, were at least somewhat inherent in the security/utility distinction rationale behind the SEC’s April 3rd, “Framework for ‘Investment Contract’ Analysis of Digital Assets”, and approaches taken by other jurisdictions to the distinction, for example Switzerland.
But this is where Libra may spoil the initiative. As Marcus was keen to repeat at the Committee hearings, Facebook is prepared to follow the rules and toe the line. But is following the rules of the existing or proposed blockchain regulation simply enough? Better put: is the proposed blockchain token legislative reform really relevant to the Committee’s problems with Libra?
In the House Committee hearings, Rep. Josh Gottheimer (D-NJ), a TTA co-sponsor, seemed to be leading Marcus to support blockchain token legislative reform in his statements that blockchain technology is inevitable and is a new frontier for growth and job creation.
Rep. Gottheimer reflected the concern for the absence in the US of regulatory “guardrails” or “rules of the road” for blockchain businesses, as we have seen in the utility token/security token debate. Marcus not only dutifully responded that he had heard “…from companies in this space that regulatory clarity would be helpful…” but went on to add that, “…the first thing we can do is ensure that projects that are within the right oversight and done responsibly actually see the light of day instead of losing our leadership to other nations that are ploughing ahead…”.
The point is that while the House Committee during the hearing spent a lot of time expressing its concerns with specific aspects of cryptocurrency regulation, including anti-money laundering and securities compliance, and privacy, access and cybersecurity, while at the same time bemoaning the potential for lost innovation opportunity, one could not help but feel that the elephant, or rather giant, in the room was largely left directly unexpressed or confronted.
The primary concern with Libra, one may think, should not be the proposed reform or Libra’s compliance with the regulatory regime, but rather whether Congress should allow what in essence may become a competing currency and competing central bank.
Facebook, Calibra et al , as Marcus took pains to repeat, will comply. But what may be argued is missed is that Libra would not just be a new payment tool. If it works it will be a currency (virtual at that) possibly competitive with or perhaps, ultimately, dominant to the dollar.
Members of the Committee only sporadically touched on this, among them Rep. Brad Sherman (CA-D) (not shy, himself, of a dose of drama, and in the process somewhat undermining the force of his own arguments by launching into Libra, dubbing it “ZuckBucks” and cautioning that it is potentially more dangerous to America than Osama bin Laden’s “idea” to fly two planes into towers, a means to give Mark Zuckerberg, already having billions, the authority to print more and an attempt to “…transfer enormous power from America to Facebook and a number of its allies…”) and Rep. Andy Barr (R-KY) questioning whether, given the potential for its wide adoption, Libra would undermine central banks and monetary policy, going so far as to ask whether Libra’s point was to do so. Marcus, in response, wanted to “…make it very clear…” that Libra does not want to compete with the dollar and sovereign currencies, never in their wildest dreams thinking that Libra would come close to the size of the dollar or other currencies.
And there is the real risk that in all this confusion and fear, the encouraging, and much needed innovation, regulatory reform of the likes of Wyoming and the TTA and the Blockchain Regulatory Certainty Act (BRCA) (dealing with money transmission) would be either delayed or frustrated, thrown out with the bathwater, so to speak, over concerns about letting the Giants in. Preserving US government currency control is, it seems, a wholly different concern than the question of innovation and passing regulatory reform.
After all, wasn’t blockchain’s point in the first place to rest control from centralized organizations and make it democratic? Why would we want to replace one Central Bank for another; the Federal Reserve with a consortium of Facebook and other tech giants?
This is a battle of gigantic proportions. Congress, perhaps, needs a Heracles of its own to cut through the issues, confusion and red herrings, neither losing sight of the opportunity for innovation and US market leadership, nor letting the fear of losing innovation guide it to a course of action which could potentially undo the very innovation for which blockchain was intended.
Absent a focus now on the real issues at hand, Congress may miss the forest from the trees, and with it the opportunities that blockchain innovation may bring for the US.
** This article is intended to be informational only, and does not constitute legal advice. Competent, specific legal advice from a suitable, licensed attorney, should always first be obtained before taking any action, and the information in this article should not be relied upon independently of that advice.