July 16, 2023

by Stephen Stofka

This week’s letter is about the impact of the internet and digital technologies on our laws. New technologies introduce new connections between people and institutions. What was once separate when a law was written becomes joined under the new technology. Advocacy groups emerge to pressure policymakers to shape new laws and regulations that incorporate a recent technology.

Over twenty years ago, the increasing volume of internet sales not subject to sales tax challenged the meaning of tax nexus. This was a retailer’s physical presence within a state that required it to collect sales tax on purchases and remit those collections to the state. The Sales Tax Institute has a nice explainer on the various types of nexus and the history of court decisions on the topic. Several characteristics of cryptocurrency have challenged policymakers and legal interpretations.

On Thursday, the stock of the Coinbase exchange shot up 25% on the hope that it will prevail in its attempt to operate outside SEC regulations, those that govern conventional market exchanges and securities brokers. A month ago the agency had charged Coinbase for operating as an unregistered securities exchange. On Thursday, a district court judge in a case involving another blockchain ruled that crypto assets were not securities in many cases. The judge cited the Howey test, a 1946 Supreme Court decision that set forth characteristics that defined a security. This past March an article at Coin Telegraph explained the history of the Howey test.  The key phrase in the Howey decision is that an investment contract is “an investment of money in a common enterprise with profits to come solely from the efforts of others.” Is crypto a “common enterprise” whose profits come “solely” from the efforts of others?

The judge’s ruling strengthens the argument by some that crypto has many characteristics of a collectible, which is not considered a security. Classifications rely on shared as well as distinguishing characteristics. Anomalies challenge classification the way that the platypus challenged biologists’ definition of a mammal. Advocates of crypto claim that it is a trustless system of exchange but let’s examine that claim.

A barter transaction between two people is the only exchange that does not involve a third party in some way. Trust is an implied intermediary in an exchange between two parties. Crypto or cash, there is some third party involved in a transaction. Our cash money may read “In God We Trust” but our trust is really in the Federal Reserve, an agency of the U.S. Government. Crypto exchanges have a fiduciary duty to the owners of the crypto coin the exchange holds. That fiduciary duty invites government regulation and it will be a battle of advocacy groups to shape the laws that create those regulations. This week Coinbase may be confident that it will prevail against SEC regulation but there will be an ongoing effort to impose some regulation to protect owners of crypto. As policy is shaped over the coming years, crypto owners can expect that crypto exchanges will experience similar abrupt reevaluations.  

/////////////////

Photo by Earl Wilcox on Unsplash