Stirling and Rose responds to The Australian Government crypto token mapping exercise by cautioning the reliance on a token’s functions being static.
The desire to bring the 10,000+ tokens into some classification scheme is understandable. But labeling an asset that can constantly change state, it is a bit like trying to capture a cloud.
Digital assets are assets that are made of code.
They do not exist in the physical and (for now) they are not tangible. Digital assets are exponentially increasing in volume and complexity, with the digital economy predicted to account for 30% of value in the global economy by 2030. Although they only exist in cyberspace, digital assets are recognised by the law as real, and a large majority are already considered financial products because of what they do (not what you call them!).
Over the past year, the Australian Government has been preparing for a “token mapping” exercise to bring some order to the complexity of the current market in blockchain-based digital assets. The original plan was announced under the former Liberal government last December; last week, the new Treasurer announced
As the first step in a reform agenda, Treasury will prioritise ‘token mapping’ work in 2022, which will help identify how crypto assets and related services should be regulated. This hasn’t been done anywhere else in the world, so it will make Australia leaders in this work… The previous government dabbled in crypto asset regulation but prematurely jumped straight to options without first understanding what was being regulated. The Albanese Government is taking a more serious approach to work out what is in the ecosystem and what risks need to be looked at first
The desire to take stock of what is out there, to bring the 10,000+ (and daily growing) tokens into some classification scheme is understandable. But before embarking on such an exercise, it is important to consider what we can expect from such an exercise and how to get it right.
- The 2017 “Summer of the ICO” was a major driver of the current working taxonomy of digital tokens. This differs in the exact terminology in each jurisdiction, but generally boils down to a trichotomy of “payment”, “security/equity” and “utility” tokens.
- While a good heuristic starting point, this tri-partite scheme—which has been incorporated into significant regulations, such as the EU MiCAR—has limitations. In the US, for example, there is still high-level controversy over whether most tokens are digital “commodities” or “securities” under the Howey test (which focusses on investment for profit through the efforts of another). Jumping to the token’s economic function (i.e., payment or investment?) skips a step or two, including the important legal question of what rights and obligations (if any) the token is actually meant to represent. (This is a preliminary issue to the “security” question.)
- More problematically, the payment/security/utility schematic does not adequately address the problems of token (i) hybridity and (ii) dynamism. The very point of many tokens is that they are hybrids of existing financial instruments, for example. Even more importantly, such tokens can change over time as a result of (i) changes in their use and (ii) changes to the tokens themselves or the protocol (and social network) in which they exist.
Code is the ultimate potter’s clay
At first blush, a mapping exercise seems a good candidate for solving the “issue” of regulatory uncertainty, but it is a bit like trying to capture a cloud. Attempts to create static categories of digital assets with corresponding static legal responsibility is a fool’s errand.
With the possible exceptions of central bank digital currencies (and bitcoin), the prevailing clustering of digital assets into the categories of stablecoin, non-fungible token (‘NFT’), utility token, security token and payment token (just to name a few) is often no more than a marketing exercise loosely tethered to technical functionality.
The key thing to look at when understanding your legal position in respect of digital assets is what can the token do and who is responsible for it; that is, what rights and obligations sit in the belly of the token, and who (or, in a world of code-run autonomous platforms, “what”) has control of the token?
This brings us to the nub of the issue: when it comes to digital assets, the answers to these questions change (often rapidly) and can be obscured from legal oversight and audit in novel ways. Ways that our current regulatory approach of licensing entities (and prosecuting entities for non-compliance) has not been designed for.
If we shouldn’t be mapping, what should we be doing?
- Regulatory issues in respect of digital assets should first be examined through the lens of the three most pressing macro legal issues of how we integrate machines (algorithms) into the way we “do” jurisprudence going forward.
- A high-level regulatory analysis of the Responsible Machine Problem, the need for Just-In-Time Law, and lastly the advent and impact of Complex Money would ground the deeper investigative work required to make the legislative and regulatory changes required to integrate digital assets into the mainstream economic and financial system. These are the three most pressing legal issues that impact digital assets, and it is time to bring them squarely into the terms of the debate.
a. Just-In-Time Law
- Just-In-Time Law is the necessary response to the nature of the digital economy, which is characterised by high and rapid information flow, algorithmically driven behaviours, and unbounded automatable outcomes (which can be changed in real time with the click of a button). There is no pause for the law, or those applying it, to take stock and react (for example, to prosecute). Decisions need to be immediate and technologically enabled to address the rapidity and volatility. Just-In-Time Law is the jurisprudential grounding for the rise of RegTech and SupTech, as regulators increasingly cannot respond to the digital economy using conventional means.
b. Responsible Machine Problem
- Recently, the US Office of Foreign Assets Control sanctioned a smart contract, the Tornado Mixer. This may prove to be an effective approach, and it may be something we see more of in the future. But it raises a host of jurisprudential questions about the legal nature of machines and the legal treatment of algorithms that (appear to) “do” things.
c. Complex Money
- The idea that blockchain based digital assets are “money” is integral to the founding ethos of the crypto movement. Even though serious questions exist about whether bitcoin (or any other cryptoasset) is “really” money, blockchain has brought monetary theory into the limelight and is changing the way that we think and speak about the subject. Beneath the obvious developments around crypto-based remittances, stablecoins, and CBDCs, the deeper set of questions goes to the nature of the payment object itself. The money we use every day is a fairly simple, highly standardised contract—a debt contract with a central bank or a commercial bank. Digital assets are the product of an open-ended and malleable set of contractual arrangements, and blockchain enabled decentralised finance is providing ways to use all these assets to perform the classical functions of money like medium of exchange and store of value. This is arguably drawing us into a world of “hyper-barter”, where “money” fades into the thinner function of unit of account while “tokenised” contracts are exchanged for one another directly.
But, if we are going to map, how do we do it well?
- With these issues in mind, token mapping can still be a heuristically useful exercise and can bring clarity and certainty if done well.
- The most important thing is to avoid overly rigid categories, and to avoid static allocation of any given asset to any one category. Taxonomy itself—an exercise in “carving nature at the joints” (as Plato put it)—is always an exercise in reconciling bottom-up empirics with top-down general theories about what has been collected. Categories are always, to some extent at least, driven as much by what we want the taxonomy to do as by what is “out there”. In other words, it is important not to let the categories we devise ossify and obscure the hybrid and dynamic nature of the subject matter.
- The other essential thing to keep in mind is the way that technical function, economic function, legal function, and regulatory classification “stack”. In particular, the legal function of tokens is (still) not generally given the importance that it deserves. This blind spot is perhaps due, in part, to the crypto movement’s agnosticism towards law. But a token that is meant to “fractionalise” ownership of a condominium, for example, has an inherently “legal” function (transfer of the token is meant to cause transfer of legal rights). Analysis of the intended (or purported) private law function is often a preliminary issue to the question of its regulatory treatment. For example, in the US context, whether a token purports to grant rights against anyone (or to anything “off-chain”) is directly relevant to the question whether it is more “commodity-like” or “security-like”.
Conclusion
The current Australian project of token mapping is to be welcomed, if done properly:
(i) as a quick and largely heuristic exercise that;
(ii) takes account of all the relevant data points (technical function, economic function, legal function);
(iii) remains flexible in the face of asset hybridity and dynamism; and
(iv) is grounded in the deeper jurisprudential problems that frame the issues.
Otherwise, it is likely to create more confusion than clarification.