In May of last year, FinCEN issued guidance on “virtual currency” that reiterated and explained its original 2014 guidance. It essentially articulates a general principle: a business is subject to regulation if it accepts and transmits virtual currency from one person or location to another. Acceptance and transmission implies “independent control” over the virtual currency being moved. We thought that was pretty good, especially because that clearly excludes miners, nodes, and other network infrastructure providers, as well as software developers and even (explicitly) decentralized exchange and non-custodial multi-sig participants.
Someone building a business on a cryptocurrency network should be able to use this general principle and see how it applies to what they’re doing: “Do I both accept and transmit? Do I have independent control over customer virtual currency?” And if they continue to have questions about the application of these general principles, they can ask folks at FinCEN. As a matter of fact, just last week FinCEN announced that it’s been a year since its “office hours” program started answering questions from virtual currency entrepreneurs and that they will now do meetings to answer questions virtually.
While it may be tempting to ask for further formal guidance from FinCEN, the result could be more specificity that does not improve on the general principle already articulated. General principles like FinCEN’s “independent control” standard can seem insufficient because they neglect to specify precisely how every iteration of a complex technology will be regulated. But asking for an agency to spell out every edge case will not result in a bright line test.
We have seen this before.
For a long time it was unclear how the SEC would apply the Howey test to cryptocurrencies, and people asked for clarity. In June of 2018, Director of the Division of Corporation Finance William Hinman gave a speech in which he outlined a general principle: “If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract.” We thought that was pretty good, especially because he used Bitcoin as an example of a “sufficiently decentralized” system that was clearly not a security.
Some folks took the general principle and looked to see how it applied to their projects. If they had questions about its application, they asked the SEC. After all, in the same speech, Hinman had said, “We are happy to help promoters and their counsel work through these issues. We stand prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use.”
Others were not so pleased. The principle was too general, they argued. How do you know when a network is “sufficiently decentralized”? And besides, this was just a speech by one official; was it really SEC policy? They demanded formal written guidance (not merely a speech), and specifics (not merely a general principle).
So, the SEC obliged. In April 2019 it published a “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which was the formal written guidance many in the crypto industry had been demanding. It took the general principle in Hinman’s speech and broke it down into dozens of questions that one could ask to determine whether a network was “sufficiently decentralized.” Instead of applying a general principle, projects developers now had to parse dozens of “sub-tests.” Although the industry got the written, specific guidance many had demanded, it’s fair to say they were not pleased.
A map must be an abstract representation of the world it depicts; add in too many details and it will become as difficult to understand and navigate as the world itself. Similarly, no law or regulation can completely describe every case of its own application without descending into complexity that no lawyer, let alone an entrepreneur or technologist, could manage. FinCEN has done laudable work articulating good policy and doing so in a general manner that isn’t technology-specific.
As with the SEC’s more detailed Framework, we should be wary of further “clarification” and the map growing to fill the territory.