The Legal Revolution That Might Save Cryptocurrency
Writing for Real Clear Markets, partner James Burnham says that the future of digital asset regulation is being written right now and opponents of regulatory overreach currently hold the high ground.
The future of digital asset regulation is being written right now and we can all hope collaboration carries the day. But for those who believe that peace is best achieved through strength, contingent battle plans must be readied. And that means understanding the legal terrain on which any conflict would unfold. For now, opponents of regulatory overreach hold the high ground.
Over several years and three Supreme Court Justices, the law of federal regulation has changed dramatically and for the better. In a series of decisions about everything from veterans benefits to a nationwide eviction moratorium, the Supreme Court has curtailed the power of federal regulators in major ways. Here are two:
Major Questions are for Congress. The era of unelected administrators resolving major policy questions is over. Time and again, the Court has rejected attempts by agencies to do big things based on novel interpretations of old laws. Consider last summer's decision invalidating the CDC's so-called eviction moratorium in Alabama Association of Realtors v. HHS (2021). There, the Court rejected the CDC's unprecedented claim that an antiquated phrase from a decades-old health law empowered the agency to shut down the rental housing market nationwide. In the Court's words: "We expect Congress to speak clearly when authorizing an agency to exercise powers of 'vast economic and political significance.'"
Judges Decide the Law. Once upon a time, administrative agencies had broad latitude to interpret laws and regulations according to their preferred policy views. No longer. In a pair of recent decisions—Kisor v. Wilkie (2019) and Niz-Chavez v. Garland (2021)—the Supreme Court has made clear that judges must apply laws as Congress wrote them, according to "their ordinary meaning at the time Congress adopted them." Courts must confine agencies to their statutory limits rather than reflexively "defer to some conflicting reading the government might advance."
These principles weigh against interpreting old statutes to invest unelected agencies with broad authority over digital assets. Whether and how to regulate a $2 trillion (and growing) industry poised to revolutionize the internet is plainly a major economic and political question. And Congress has not addressed—much less clearly addressed—digital asset regulation. Rather, digital assets do not fit cleanly within any existing statutory regime, which is no surprise with laws that largely date to the Great Depression.
The Securities and Exchange Commission illustrates how these principles might apply on the ground. Under the Securities Act of 1933 and the Securities Exchange Act of 1934, the SEC has jurisdiction to regulate "securities." Federal law defines the word "security" with a laundry list of terms (e.g., "stock," "bond," "debenture"), and the vague, catch-all term "investment contract."
Whether the SEC has jurisdiction over a digital asset typically turns on whether the asset falls within the catch-all—whether it represents an "investment contract." Federal law does not define "investment contract." But in a 1946 case called SEC v. W.J. Howey Co.—arising from people buying land in Florida while leasing it back to the seller for operation as a profit-generating orange grove—the Supreme Court defined the term "investment contract" as any "contract, transaction or scheme whereby a person  invests his money in  a common enterprise and is led to  expect profits  solely from the efforts of the promoter or a third party."
Under Howey, an investor therefore must (among other things) expect to reap profits "solely from the efforts of the promoter or a third party" for an "investment contract" to arise. Taken literally, that is a very strict requirement—profits must derive "solely" from someone else's work.
Perhaps unsurprisingly, then, lower federal courts have held that "solely" cannot be taken literally, reading that passage from Howey to require only that profits derive "predominantly," "primarily," "substantially," etc. from the efforts of a third party. The SEC, for its part, has embraced the broad view of the U.S. Court of Appeals for the Ninth Circuit that an "investment contract" exists whenever profits depend on "undeniably significant" efforts from management. The Supreme Court has never endorsed these expansive glosses, though it has advised that "form should be disregarded for substance and the emphasis should be on economic reality" in construing the securities laws.
The Supreme Court's recent shifts in administrative law support taking Howey's terms seriously—even if not literally. If major questions are for Congress and courts must apply the laws as written rather than leave agencies to fill the gaps, then it makes sense to interpret Howey narrowly in the context of digital assets. Limiting current law to arrangements where profits come "predominantly" or even "nearly solely" from another's efforts—rather than expanding it to all arrangements in which another's efforts play an "undeniably significant" role—would restrict the SEC's domain in a novel area and let Congress take the lead in creating new regulatory schemes.
The word "solely" might seem like an esoteric basis for reining in the SEC, but here is why it matters. Bitcoin and Ethereum—the two largest cryptocurrencies in the world—are likely not "securities" under a stricter view of Howey and should thus be exempt from SEC oversight. Both currencies operate on largely "decentralized" networks that do not depend on a small group of developers to function. So when someone buys Bitcoin or Ethereum, the purchaser stands to profit mainly from market forces (like when one buys gold). Bitcoin and Ethereum investors are not expecting profits "solely" (or predominantly, or substantially) from the efforts of others.
Perhaps that's an easy case, so consider a harder one. Many tokens derive some value from the "efforts of others." Investors often buy tokens for a variety of reasons: because the tokens have intrinsic value; because they think others will want the tokens later; because the token supplies a stake in some broader organization; and because the token's creator is going to keep improving the network, enhancing the token's value. Taking Howey seriously, the relevance of intrinsic value, market forces, or purchaser participation in enhancing a token's value could prevent that token from being a "security"—even if the token's creator plays an "undeniably significant" role in returning profits to investors.
Similar arguments could be made about each of the acronym agencies currently circling digital assets. Statutes need not fossilize in a fast-changing world, but they cannot mutate either. As the Supreme Court has repeatedly reaffirmed, the choice about whether and how to regulate new innovations is one that Congress has to make. Should the administrative state come for digital assets without clear statutory authority to do so, it will be charging up a steep hill indeed.
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