Footballs & Carpenters – How Commissioner Peirce Reinvigorated An Industry

February 28, 2020

This article was originally published in the “Off The Chain” newsletter. Subscribe to the newsletter here.

By Amy Davine Kim

One of the most difficult questions plaguing the digital asset industry is that of when is a digital asset a security, and when is it not? What are the rules? In some cases, this is obvious – for example, a digital representation of a physical equity or debt is itself a security. But in others, more consideration is needed. For example, when an investment contract is formed between a digital asset (token) provider and a buyer, and the buyer then receives the token, has been the subject of much discussion. In fact, the question is so thorny that the SEC has issued at least 17 pieces of guidance, and taken 48 enforcement actions, of which 26 have gone to court.

The questions surrounding this space are creating a chill in the United States for blockchain development projects. Having the perspective of our more than 220 members and almost six years of experience representing our industry, we can see a clear shift toward projects overseas. Anywhere overseas. And businesses are not just looking for friendlier regulatory regimes. They are looking for clear rules of the road, with goal posts and yard lines well-marked, points delineated for certain accomplishments, penalties spelled out for clearly defined violations. Imagine if you were a football player, and the referees may or may not acknowledge your touchdown or call a penalty. Would you reconsider your playbook? Would you play the game at all?

The Chamber has long taken the position that violations of law must incur penalties. Orderly application of laws creates a fair marketplace. It seems, however, that we have fully embraced this role, without the corresponding consideration of how to support innovative technologies to create new and better networks.

That’s why Commissioner Peirce’s safe harbor proposal is important. In it we see the Commissioner attempt to create a period of time in which developing companies can grow a network that is never intended to be a security or operate as one. Certain consumer protection principles must be met to comply with the requirements, and the platform must meet “Network Maturity” within three years to receive the full benefit of the safe harbor and, presumably, not be considered a security at the other end.

Notably, Network Maturity is reached when a platform is decentralized or functional. This is important because it demonstrates an evolution from Director Hinman’s speech, Digital Asset Transactions: When Howey Met Gary (Plastic) in June 2018, in which he determined that certain tokens, such as bitcoin and ether, have become so decentralized that they are no longer considered securities (if they ever were). Decentralization, if we are able to define it sufficiently, would eliminate the presence of one factor in the Howey test, reliance on the efforts of others. However, the safe harbor also allows for another option, functionality. These do not need to be achieved together, but are alternatives, either of which defeats the Howey analysis because, at functionality, the item has become a consumable good.

The achievement is also notable because it no longer forces companies into one business model – that of decentralization. While decentralization is one of the true transformations that Bitcoin and other protocols offer (allowing those who do not know or necessarily trust each other to interact), requiring this element as the only way to avoid the application of the securities laws forces businesses into one type of business model. Why should founders be forced to create something that must be released to a broad community and step back from the project, relying on smart contracts and a network of validators to continue to function? While Bitcoin and others like it are extraordinary, we have seen some projects that would greatly benefit from the founders’ continued involvement to enhance or evolve the protocol’s functionality. Businesses are not static; they adapt to changing environments, competition, customer needs, and demand. We should allow for the possibility of this dynamic environment for blockchain platforms as well.

Commissioner Peirce joined the Chamber for a private meeting last week to detail her views on this proposal and take questions from our members directly. While many of our members are supportive, some asked questions probing certain points. In my view, receiving critical views can sometimes be even more productive – causing creators to think carefully about proposals and enhance them to address all angles. While we have recommendations to help enhance Commissioner Peirce’s proposal, I appreciate her effort to develop such an innovative idea and create clear rules for players to follow.

One of my favorite quotes is by Sam Rayburn (for whom the Rayburn Building in the U.S. Capitol is named): “Any jackass can kick down a barn, but it takes a carpenter to build one.” Commissioner Peirce has not only proven herself an independent voice in the community, but also shown she is a budding carpenter and, as comments come in, a busy referee.

Want to hear directly from Commissioner Peirce? Join Pomp and CryptoMom on March 11-12 at the DC Blockchain Summit at Georgetown University. Use the code – POMP – to save 15% off. Register today here.

Commissioner Peirce’s Safe Harbor Proposal Could Create Path for Digital Token Innovators

February 6, 2020

Today, SEC Commissioner Hester Peirce announced a proposed safe harbor for certain tokens under the federal securities laws. The Chamber of Digital Commerce encourages efforts to create a path for innovators to create and circulate digital tokens as they develop their networks toward a decentralized or functional technology platform.

The proposal exempts transactions involving digital tokens from the Securities Act of 1933 if the token is intended to be decentralized or functional within 3 years, and also contains additional disclosure requirements for the digital token developers. The safe harbor would allow token developers to begin their projects with clear parameters and disclosure requirements as they ideate, define, and begin to develop their solutions.

We look forward to working with Commissioner Peirce and her team to develop this proposed Rule, which has the potential to provide a clear path forward for those creating new innovations and solutions leveraging digital tokens.

Tokenizing Professional Sports Franchises

By David M. Otto, CounterPointe Sports Group, Inc.

The National Basketball Association (“NBA”) is currently considering a proposal that could provide liquidity to minority owners in the league and enable a broader range of investors to secure an ownership interest in a professional sports team. This proposal, scheduled for discussion at the NBA’s upcoming board of governors meeting in April 2020, represents a timely and unique opportunity to design and implement a model for tokenizing economic interests in professional teams.

The concept of tokenization is simple: it is the process of creating a digital version of your interest in an asset such as a professional sports team. In other words, tokenization allows a traditional asset—such as commercial real estate, works of art, or rights held in a sports team—to be transformed into a liquid, tradable digital contract. These digital contracts are referred to as tokens, and are kept and transferred from user to user on a designated blockchain platform.

Creating a digital version of an interest in an asset effectively ‘pegs’ the value of the tokens to the value of the underlying asset—for example, a particular percentage of an NBA franchise. By ‘pegging’ the token value, the token becomes both a mechanism for securing liquidity and a ‘currency’ that enables the buyer/holder of the token to realize that value in actual currency at the buyer/holder’s discretion.

This approach addresses the concerns of many NBA minority owners regarding the illiquidity of their ownership. Currently, the team ownership model in many professional sports franchises is highly centralized, illiquid, and the province of a select few with the capital and net worth necessary to acquire some or all of a team. This model—as the NBA is currently experiencing—is inefficient, cost-prohibitive, and economically punitive to sellers, particularly with respect to the sale of minority interests.

Tokenization enables fans, sponsors, communities, and other interested parties to participate in the growth, development, and value derived from professional sports franchises. As the tokenization process gains mainstream acceptance, and interests in professional sports franchises become increasingly tokenized, both access to these tokenized assets and the liquidity associated with them will create new economic opportunities, re-write valuation models, and activate an increase in global wealth creation and distribution for all participants.

Tokenizing professional sports franchises, however, does more than enable a team’s fan base to participate in the economic benefits of their favorite sports team. Tokenizing team ownership democratizes access to economic benefits associated with alternative asset classes, and creates liquidity for both minority and majority owners by allowing market participants to buy and sell team tokens. From the franchise’s perspective, tokenization provides teams with a mechanism to reward a loyal local fan base by programming bonus features into their team tokens. These ‘reward tokens’ enable teams to extend their brand globally, as token buyers/holders in countries on the opposite side of the world will be able to participate in team activities, both economically and with regard to team governance.

Tokenization also represents a sustainable model for broadening economic access to and increasing levels of fan engagement in professional sports franchises. Given the economic concerns and realities the NBA seeks to address, the growing global interest in this asset class, and the technological capabilities available today, it is time that the ownership of, and economic benefits associated with, professional sports franchises become more readily accessible, affordable, and transferrable. The current exclusive ownership model and the corresponding illiquid asset is outdated. Professional sports franchises, starting with the NBA, can lead the way in decentralizing ownership and transferring over value to those who generate it, thereby enabling them to participate in its appreciation.

About the Author.

David M. Otto is the Co-Founder, President, and General Counsel of CounterPointe Sports Group, Inc. Mr. Otto has 33 years of experience in finance and corporate law, mergers & acquisitions, securities, and corporate governance.  He is currently the Founder and Managing Partner of the law firm Martin Davis, PLLC, the private equity firm Otto Capital, LLC, and the venture capital firm CounterPointe Ventures, LLC, and a thought leader on decentralized business models, token economics and, capital markets and securities regulatory compliance.  Mr. Otto holds a B.A. from Harvard University and a J.D. from Fordham University School of Law.

The Road to Implementing Blockchain for Recordkeeping Might Just Start with Vehicle Titling

By Shane McRann Bigelow, CEO, Ownum

Vehicle ownership is a massive market. Every vehicle sale requires a change of title — a record of ownership maintained by local government — and more than 272,480,000 vehicles were registered to their owners in the U.S. in 2017 alone using manual, paper-based records. This manual process is not only inefficient but costs between $50 and $90 on average to title and re-title vehicles. The status quo is an expensive, slow, and worse, a fraud-prone paper-based system.

Recognizing this issue, states have embraced efforts to migrate the vehicle titling process from paper to online computer systems. Storing information related to car titles in centralized databases allows for increased efficiency by reducing the time required to mail or hand-deliver documents.

However, this type of centralized, cloud-hosted database does not solve all of the issues. Firstly, it duplicates the information contained on paper titles. Secondly, a centralized database can still only be updated by the owner, meaning the same linear information-flow between stakeholders, which is a cause of inefficiency today. If law enforcement, car purchasers, and state governments long for a system in which real-time updates can inform all users of an unpaid tax, undisclosed lien, or lapsed insurance, there’s another technology that’s better placed to help.

Blockchain offers a far better solution.

The unique qualities of blockchain  — including distribution of data, implicit security, and the ability to encode updates to database record details automatically — can be applied to enhance numerous types of records such as liens, insurance, ownership transfers, tax payments, and of course the titling of vehicles. A true digital title in a transparent blockchain environment would dramatically increase the security and efficiency of processing the record while greatly reducing opportunities for fraud and mistakes, which can be made along the way.

At Ownum, for example, we’ve set forth to accomplish a new CHAMPtitles solution by utilizing a Blockchain Encrypted Ledger That’s Executable and Distributed, a BELTED system. Our aim is to create a trusted marketplace whereby all disparate parties are linked together in a secure and immutable way. This allows for the electronic verification of each party’s relevance and stake in the vehicle transaction.

In evaluating the goals of business, government, and consumers, a digital titling system on the blockchain could deliver many desired benefits. For a start, digital titles stored on the blockchain could cut total processing time from days or weeks to minutes or seconds. Indeed, consumer testing undertaken to date shows us that such a system has the capability of slashing total time spent at every stage of the titling process, including data entry, review, and approval, for every participant in the process.

States spend tens of millions of dollars per year on the current auto title process, a cost borne by taxpayers. A true digital title system will make our roads safer, reduce costs, and benefit business, government, and consumers.

Now just imagine the benefits applied to other industries and inefficiencies. The possibilities are endless.

U.S. Members of Congress Urge IRS to Further Clarify Virtual Currency Tax Policy

December 23, 2019

On Friday, a bipartisan group of Members of Congress sent a letter to IRS Commissioner Charles Rettig requesting that the agency further clarify its tax policy as it relates to virtual currencies, hard forks, and air drops. The letter is a follow-up to a letter sent by 21 Members of Congress, led by Congressman Emmer, requesting guidance on how to report virtual currency in tax filings.

The Chamber supports these Members in their efforts to create a predictable legal environment in the United States by requesting that the IRS clarify its guidance related to virtual currencies issued in October. As noted by Congressman Tom Emmer (R-MN), “Taxpayers deserve the certainty of clear rules of the road so that every American can use this transformative technology, and rest assured they are complying with their tax obligations.” We appreciate the work of Rep. Emmer and the Congressional Blockchain Caucus and its leadership in its pursuit of these important goals.

Specifically, the letter states that the guidance, as written, must be updated to accurately capture the issues virtual currency users face. To remedy this, the letter asks the IRS:

• • How it intends to update its hypothetical cases to more accurately reflect scenarios virtual currency users are currently facing;
  • Whether it will clarify the determination of exercising “dominion and control” over forked assets using recognized standards; and
  • That until clear guidance that is prospective in nature is issued, the agency will not use its authority to bring enforcement actions against taxpayers who are making a good-faith effort to comply.

The Chamber, through its Tax Task Force and Digital Assets Accounting Consortium, has coordinated industry stakeholders to engage with relevant policy makers to identifying areas within the tax code and U.S. GAAP that require further education and clarification to promote the development and use of digital assets.