Bitcoin was only the first of many applications for blockchains with financial implications. Many projects now are tackling much more ambitious, finance-related structures with several types of coins or other assets, ways to convert between types, methods to buy and sell in certain pre-specified ways following smart contracts, and doing this in ways that are sure to at least pique the interest of regulators.

For example, suppose I want to create an organization that will run decentralized, such as on Ethereum. To get the money for this, suppose I create a blockchain asset, and sell it. Ownership of that asset might even grant the owner a stake in the decentralized entity. This crypto asset is starting to look suspiciously like a stock. And, subject to securities laws (including exemptions), the sale of unregistered securities is… uh… illegal.

This is by no means a condemnation of blockchain applications. You can use blockchain applications to do practically anything- therefore it stands to reason you could also use blockchains to do securities-like things, bank-like things, insurance-like things, and more. As an analogy, you can use a blank piece of paper to write down anything. A blockchain enables many individuals to achieve reliable consensus about almost any piece of information, quite unlike a piece of paper which is merely a single copy.

There is huge potential for legitimate finance applications for crypto assets. They could change everything about how our economy works, from lending to insurance to investment, dramatically increasing their efficiency and speed, and lowering costs and risk. But these applications involve boldly wading into a morass of heavily regulated industries, and in my opinion large institutions are better positioned to adapt their existing systems to take full advantage of the benefits of crypto assets in their respective fields. For current Crypto 2.0 projects, it really seems to me like it’s more headache than it may be worth to take that bull by the horns.

It seems to me that it ultimately boils down to the specific details of your blockchain application. A blockchain application which allows users to prove that a certain document was written at a certain time is clearly not a security. A messaging platform? Also obviously not a security. By contrast, a blockchain application which allows users to buy equity in a company probably should be classified as a security, since that is precisely the use case securities laws are designed and intended to cover. If it quacks like a duck, it’s probably a duck.

There are endless applications which do not involve securities, and it is likely to be important to step carefully to ensure that all participants and all regulators know how the system works to avoid misunderstanding the meaning and purpose of crypto assets, potentially drawing the ire of regulators who may not understand the technology at all.

The Ambiguities of Cryptocurrency Assets

Although it’s easy to identify obvious cases where a crypto asset either likely should be, or likely should not be a security, in practice many current blockchain applications seem to be occupying this grey zone where it is very ambiguous what will or should happen. For example, suppose a blockchain uses a blockchain asset as a counter to facilitate the transfer of some form of value, permission, cryptographic signature, or something else entirely is being transferred. That transfer may be monetarily valuable, and its value may change over time, such as to increase as the particular blockchain application expands in usage and acceptance.

Add to this grey zone the fact that laypeople often don’t know or don’t care about the intended significance or function of a crypto asset. There is a danger of crypto assets being confused by laypeople with being a “security-like” asset even if they aren’t. Bitcoin has a strong reputation following its tremendous growth in popularity, from being worth absolutely nothing to being worth hundreds of dollars per coin today. This reputation has encouraged a large amount of crypto-related speculation. Perversely, this is actually getting in the way of what a lot of applications are trying to do- for example Bitcoin was originally intended to serve as a currency, and a good currency is defined by having a stable value, not a value that wildly fluctuates. Speculators may be interested in Bitcoin, but they’re interested to try and make a profit, not to have Bitcoin be used as a currency except insofar as widespread adoption makes its value rise.

This grey zone plus widespread illiteracy about technology in general, and particularly about Crypto 2.0 (or even just encryption generally) leads to a potentially dangerous realm of confusion that education and formulating a simple framework for understanding may help mitigate. Regulators and the general public need to have an accurate understanding about what is happening, to avoid dangerous mistakes like having non-securities blockchain applications get put through the wringer by regulators.

For example, another major Crypto 2.0 application is Ethereum, a tremendously exciting platform for all kinds of wild applications. Ethereum contains, among other things, a crypto asset called Ether. Like Bitcoin, many people are most familiar with this type of asset based on the fact that its price changes, such as in charts. There seems to be some reasonable possibility that a layperson will mistake this for a stock-like asset based on looking at its current price and value-over-time charts, and make badly mistaken inferences about crypto assets as a result.

Moreover, there are also many people who think that Ethereum has huge potential and have the (likely correct) belief that the value of Ether is going to rise, and choose to buy it in order to make money. These people may be more savvy about Ethereum than the layperson likely to confuse it with a stock, but they are actually engaging with a crypto asset like it is an investment for profit rather than a technological tool used to actually do something productive like perform computations.

Is Ether a security? I think absolutely not, but I can definitely see the shape of the argument that Ether is a sort of security-ish asset that many people might be buying expecting its value to appreciate, and that therefore it ought to be subjected to similar regulations as other securities. There is a very dangerous possibility of a mistake here, both by laypeople and potentially by regulators, legislators, and tech policymakers.

A Possible Solution: The “Resource” Metaphor

A common thread among several blockchain applications seems to be the need to count things. For many different applications where the fundamental underlying purpose of that cryptocurrency asset is to keep track of an amount of some “stuff” I propose a unified approach which may simplify the issue of whether or not cryptocurrency assets are securities, at least for one type of asset.

A “resource” metaphor makes sense when an asset is necessary in order to facilitate transfer between nodes in a decentralized network. Basically, there is a finite amount of STUFF, and in order to keep an accurate account of that STUFF it is necessary to have some information about where it is, who controls it, and when and how they are allowed to do things with it.

In this respect a “resource” metaphor rather than an “equity” metaphor is a representation of the contents of the decentralized system. This sort of counting is fundamentally necessary for the system to work. As an analogous case, consider the telephone network which is similar in many respects, but traditionally a centralized system from the telephone company. Addresses in the system are tightly analogous to telephone numbers, and a count of cell phone minutes would be very analogous to this type of “resource” being counted by the network. The major difference for blockchains being that we don’t have a central, trusted managing entity like a phone company. Instead of a phone company who is centrally organized and trusted with accurately counting everyone’s minutes, on a blockchain system everyone has to be a participant in counting and verifying everyone else’s minutes.

This type of “resource” metaphor is a new concept, made somewhat complex by the realities of needing to buy this resource in order to consume it to do things, opening up the alternative possibility of people buying it because they expect its value to rise. Because there is no centralized entity standing in for the phone company who can set a fixed price for everyone, the price of this resource is variable. Additionally, it may be important for the proper functioning of the decentralized system that the price of such resources fluctuate based on usage. When everyone wants to max out the decentralized system’s resources at the same time, it can’t be done because there’s a finite amount of resources in the system, so it is necessary for the price to rise so that only the people with a sufficiently good reason to justify paying for that resource will still be interested in using those system resources at that higher price point.

Conclusion

Briefly stated, a “resource” asset in any blockchain application, in my opinion, does not make sense to treat as a security. Users should be buying the resource for the purpose of using it to keep track of, count, transfer, or to do the thing the resource is designed to represent or to enable, with the actual function and usage of the resource varying widely based on the specific application.

Certainly, some people are going to buy such assets to speculate. They think the price is going to go up. But some people collect postage stamps expecting their prices to go up, too. This doesn’t change the fact that one stamp’s primary function is to allow you to mail one envelope. The stamp exists because the postal service has finite capacity, and the stamp is a resource which represents a claim on those resources sufficient to mail a letter.

Blockchain resources seem to me to be extremely closely analogous to stamps, with the difference that there is no central postal service doing the system management, instead users manage all the system’s resources themselves.

Obviously nobody really knows what’s going to happen in this Wild West world of crypto assets. But I for one am concerned about the possibility that due to the complexity and novelty of these technologies, policymakers, regulators, and the general public are going to make very serious mistakes in how they interact with blockchain applications because they have no idea what they are.

I hope the technological and legal framework that is eventually developed is one that makes sense, that works well, and that ensures everyone knows what’s happening with no secrets or errors. There is tremendous potential for an unparalleled degree of transparency, autonomy, and liberty for everyone that is unprecedented in history, formerly the exclusive domain of centralized authorities making decisions and keeping information behind closed doors. But I suspect it is highly likely many mistakes will be made by the ignorant for many years to come.