Keeping it not so simple: What’s a crypto token?

Crypto has rightly been celebrating the news that tokens are not intrinsically securities.

So now we know what they're not — but Judge Torres, unfortunately, did not tell us what they?are.

For that, we may have to wait for legislation, and it may not be very edifying: The Securities Exchange Act of 1934 circularly defines “equity securities” to be any?“security which the?Commission ?shall deem … necessary or appropriate … to treat as an equity security.”

Not very helpful!

The coming legal definition of crypto tokens will presumably be less circular and more helpful, but it won’t be coming anytime soon: In a note out this morning, Brian Garner, Policy Analyst at Stifel Financial, wrote that it could be “a few more years” before crypto legislation is passed.

So, that is the amount of time that Judge Torres has gifted us to figure everything out.

And with that much time on our hands, we might as well start from the beginning.

What is a crypto token, anyway?

Gimmie not too high, not too low

Put that deceptively simple question to a crypto native and you probably won’t learn much: Asking them to define “token” is like asking a fish to define “water” — chances are, they’ve never thought about it!

But non-natives have.

In a 2020 ruling (SEC vs. Telegram), a Southern District of New York judge wrote that?“Cryptocurrencies (sometimes called tokens or digital assets) are a lawful means of storing or transferring value.”

That high-level definition doesn’t tell us much, though: There are lots of ways to lawfully store or transfer value and most of them have nothing to do with crypto.

Worse still, the judge conflates “cryptocurrency” with “tokens” and “digital assets,” three things that have different (sometimes overlapping) meaning to crypto natives.

Bitcoin, for example, is a cryptocurrency and a digital asset — but don’t ever call it a token!?

In the same ruling, the judge called the Telegram?token?“little more than [an] alphanumeric cryptographic sequence.”

But that?low-level definition isn’t any better than his high-level one: It’s too short to be useful.

A more fulsome definition was offered in?a recent report ?from the UK’s Law Commission, which found tokens to be “a data structure instantiated within a crypto-token system, such that the particular, individuated instance of a data structure takes on a specific, individual function by virtue of the operation of the socio-technical system in which it exists.2061”

Got that??

Me neither.?

(And footnote number 2,061 did not clear things up.)

Offering a definition as technical as that is a bit like defining “water” as a “polar inorganic solvent exhibiting hydrogen bonding and metastability within fluid phases.” — technically correct (according to ChatGPT) but functionally useless (especially to a fish).

Fortunately, we have a more functional definition from?a Bank of International Settlements report , which describes tokens as?“digital entries [that have] the ability to integrate the records of underlying assets with set rules.”

Descriptive, understandable, and concise: I’ll give it an 8 out of 10.

And Simon Taylor of?Fintech Brain Food ?expresses it even more concisely:?“A token is a programmable asset.”

That’s a 10 out of 10 definition, in my book.

But invoking the term “asset” opens up another can of worms.

This one goes to 11

“Asset” implies “investment” and “investment” implies “investors” — and where investors are involved, the government is likely to get involved, too.

To what degree depends on the nature of the asset: Are tokens commodities like gold or securities like stocks?

The Lummis-Gillibrand bill defines ‘crypto asset’ as “a natively electronic asset that confers economic, proprietary, or access rights or powers.”

That implies ownership rights, which, in the case of a protocol that earns revenue, makes tokens sound a lot like equities.

But what do you really own as a token holder? Can you “own” a protocol?

Ownership is easier to prove in TradFi, where it’s conferred by the legal system.

It’s more complicated in crypto, where ownership is conferred by private keys.

Fintech Brain Food again puts it most concisely: “With a natively digital token, access and ownership are the same thing.”

Von Mises would approve: Whoever controls the private keys owns the tokens.

But does that mean token holders own the protocols, too?

The UK Law Commission believes it can do: If?“the social consensus”?agrees that tokens?“can and should be held, used, exchanged and protected”?as if they confer ownership, then they really do confer ownership.

Said another way: If everyone thinks that a token has a claim on earnings, then owning that token is owning a claim on earnings.

Crypto tokens offer a?“factual concept of control”?that makes them akin to equities.?

Still, that doesn’t mean tokens are?exactly?like stocks.?

Some may be utility or governance tokens, which are nothing like stocks.

And even tokens that?are?like stocks can at the same time be like loyalty points or Kickstarter funding … or like something else that we haven’t even thought of yet.

The UK Law Commission recognizes the multifaceted and fluid nature of crypto tokens and thinks governments should adopt an all-new legal definition to accommodate it.?

Instead of being declared a security like equities or a commodity like gold, the Law Commission has asked that the UK government put crypto tokens into a legal category of its own:?“data objects.”?

Data objects! As an umbrella definition of crypto tokens, I give that an 11 out of 10.

Adopting it for legal purposes would be a welcome acknowledgment that the nature of crypto assets is complicated, nuanced, and fluid — and that we’re therefore going to need some time to work it all out.

Fortunately, Judge Torres appears to have given us a year or two to do so.

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