How Cryptocurrencies Should Be Regulated as Non-Sovereign Fiat Currencies

By | February 18, 2020

Courtesy of J.S. Nelson

As Facebook’s Libra, despite hiccups, may have 2.4 billion users a month transacting for goods and services by later this year, the question of how cryptocurrencies should be regulated is taking on pressing importance.

My forthcoming article, “Cryptocommunity Currencies,” argues—first, that cryptocurrencies should be regulated; second, that they should be regulated as a new category of non-sovereign fiat currency; third, that the regulation should evaluate the institutional structures behind the currency as created and maintained by its community.

Cryptocurrencies are not securities or commodities, but something else. They are a new form of established currency―a non-sovereign fiat currency. Like other self-governing bodies, the communities that issue cryptocurrencies should be judged on how well they support their currencies. This analysis is not meaningfully different from how we have evaluated traditional sovereign issuers of currency. Indeed, as traditional-sovereign-issued currency becomes entirely digital, functional distinctions between traditionally sovereign-backed fiat currency and widely-accepted non-sovereign fiat currency start to disappear. The primary way to distinguish the value of such currencies from each other then becomes the quality of their institutional backing. Through that lens, some self-governing online communities are better-organized and more supportive of their currencies than traditional sovereigns.

Cryptocurrencies Are Fiat Currency

First, cryptocurrencies quacurrencies are neither securities nor commodities, but fiat currencies. (Here we are speaking of true cryptocurrencies, and not other forms of cryptoassets.) The distinguishing feature of cryptocurrencies as currencies is that they are intended to be traded directly for goods and services: they are not being offered by another party as a future investment nor are they valuable apart from being exchanged for something else.  Their primary use is as a method of payment.  This distinguishes cryptocurrencies from products that might be closer to a security, such as stock. Additionally, cryptocurrencies as currencies are not themselves intrinsically valuable, contrasting them with commodities such as wheat or pork bellies. (See more on the legal definitions here.)

For lay purposes, consider the distinction between the U.S. dollars (a fiat currency issued by a traditional sovereign) that you might use to buy tickets at a fair, and the tickets (or tokens) that you buy for use at the fair.  The U.S. dollars (the fiat currency) that you paid for the tickets have the backing of the U.S. government and can be used widely.  By contrast, the tickets you have purchased at the fair are valuable only by specific agreement within the fair for the goods and services offered by the promoters of the fair for only as long as the fair exists.  Perhaps the fair tickets may be exchanged for delineated value such as playing games, bidding on prizes, etc.  The tickets, however, have value solely while the fair is in operation for the explicit bargain made through the promoter, or insofar as they may be exchangeable by agreement back into U.S. dollars at the end of the fair.  The fair tickets are not general tender that can be broadly exchanged for goods or services outside of the limited efforts of the fair.  Thus, the terms and representations upon which those tickets are issued then become very important and specific to the tickets’ value.  By contrast, the terms upon which you individually trade five U.S. one-dollar bills for a U.S. five-dollar bill or for a certain number of euros, pounds, or other currencies, should not be the governing factor in those bills’ (euros, pounds, or other currencies) general applicability after your trade as tender.

As a programming note, this distinction between U.S. dollars (fiat currency) and fair tickets (tokens) maps well on the difference between cryptocurrencies and tokens. Cryptocurrencies (aka, “coins” with their own blockchain) typically have more extensive infrastructure than fair tickets (“tokens”), which run over the territory of their fairgrounds for limited application.  As one source summarizes: “The basic difference is relatively simple. [‘Coins’ and ‘tokens’] are both used to define a unit of blockchain value.”  Coins “are unique digital currencies which are based on their own, standalone blockchains, [while]. . . tokens are built and hosted on existing blockchains.” It is coins that are the form intended to be general currency: “[a]lthough there are some blurry lines between the definition of [‘coins’ and ‘tokens’], the crypto community generally agrees that coins function as a method of payment.”  By contrast, “[t]okens operate on top of a blockchain and give access to a DApp [decentralized application], enabling the functions of that [specific] project.”

Regulating Cryptocurrencies

Second, the SEC and other authorities have the test for whether cryptocurrencies should be subject to regulation backwards. The SEC’s Director of the Division of Corporation Finance, William Hinman, for example, would look to the importance of a centralized promoter’s role in distinguishing Initial Coin Offerings (ICOs) for regulation from cryptocurrencies that escape regulation such as Bitcoin. Under the so-called “Hinman paradox,” why should cryptocurrencies such as Bitcoin and Ether escape regulation merely because they are already in existence, and the SEC does not have to evaluate how their systems initially grow? Although Bitcoin and Ether are arguably decentralized systems, representations about how their codes work were made at some point by someone trying to encourage new people to adopt them. In fact, because the systems are arguably decentralized, such representations may have been made by more people in more places at more times for their own financial advantages. Having more potential misrepresentations in the market for a mature product would seem to argue for a greater need to regulate, not to support an argument against regulation.

Additional problems with Director Hinman’s analysis here stem from his focus on generational processes (with the perverse use of decentralization as a proxy for maturity), and not on the organizational qualities of the communities behind currencies. First, in the case of Bitcoin, for example, there was at one point a central person—the legendary Satoshi Nakamoto who invented the processes to create Bitcoin—who then involved a community around him to follow those uniting instructions. These people are, of course, still part of Director Hinman’s “person or group to carry out essential managerial or entrepreneurial efforts” necessary for a currency, but not to be permitted under his analysis.  Second, studies of Bitcoin are revealing Bitcoin to be not as decentralized in performance as advertised—even by the SEC.  Nonetheless, there is no serious talk of regulating Bitcoin as a security.

Corporations, Cryptocurrencies, and Regulation

Third, some cryptocurrencies now have better institutional support than some traditional sovereign-issued fiat currencies. What is so different from a government issuing currency for universal exchange than another entity issuing it? One may say that no other entity has the market power of the U.S. or Chinese governments, but some corporations, for example, have more revenue, and arguably sophistication, than governments. In 2016, consider that the single company Apple had more “cash . . . on hand . . . [than] the GDPs of two-thirds of the world’s countries.” By 2017, in terms of revenue collected, “Walmart exceed[ed] [both] Spain and Australia.” During that year, in fact, “[o]f the top 100 revenue generators [including both national governments and corporations],. . . 71 [were] corporations.”

But even self-governing communities may still need external regulation. The corporation is an excellent example. My article analysesFacebook’s Libra cryptocurrency initiative, which, “[g]iven Libra’s potential scale once Facebook links its massive client base via Messenger and WhatsApp to Libra, worldwide monetary and financial regulators will have no choice but to regulate.” Indeed, the emergence of cryptocurrencies such as Libra may be “the first real re-thinking of global monetary arrangements since the end of the link between the U.S. dollar and gold in the early 1970s and the beginning of the era of floating fiat currencies.”

Improving Cryptocurrency Regulation

Accordingly, we now need to develop our regulatory system further. Although U.S. regulators and politicians have been cautious about this expansion of Facebook’s power, the article notes that the major arguments for being cautious are actually arguments in favor of regulation.  In exploring the political objections to Facebook’s plans, national security concerns seem to fall into two broad categories of threats: first, concerns about more widespread money-laundering and transactions of illegal goods; and second, concerns about challenge to the hegemony of the U.S. dollar.  External regulation would help combat widespread money-laundering and transactions of illegal goods. Protecting the hegemony of the U.S. dollar may ultimately depend on the wisdom of the country’s foreign policy choices.  But insofar as other steps are helpful, we should regulate what we can of our financial system or lose that power because rival sovereign currencies are already becoming digital, and cryptocurrencies will be based around the world anyway—à la Libra in light-touch Switzerland.

A deeper concern specifically about Facebook launching its own cryptocurrency is adding even more financial data to the enormous amount of information that the company and its partners already collect on individuals. Ironically then, the wider-spread use of other cryptocurrencies, insofar as individuals are allowed to remain anonymous within those payment systems (which may not be what Facebook allows through its exchange platform Calibra), may help combat concerns about personal data abuse.


We have a significant hole in our regulatory system that cryptocurrencies fall into. By shooting across the bow of the securities-versus-commodities debate, the article calls on regulators and academics to rethink their assumptions about cryptocurrencies and the communities that develop them. We should recognize well-institutionalized cryptocommunity currencies as non-sovereign fiat currencies and regulate them accordingly.

This post summarizes an article that will be published in a forthcoming edition of The Cornell Law Review.  The article is a tribute to the late Professor Lynn A. Stout.

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