The lack of a common taxonomy for categorizing digital tokens is creating opportunities for regulatory arbitrage, according to technologists at Barclays. The UK bank is pushing a new taxonomy for describing and distinguishing between cryptocurrencies and other digital assets, outlined in a paper published on August 26, which it hopes can serve as the basis for a global standard.  

Existing taxonomies have failed to keep pace with the speed of development of new types of digital tokens, according to Shreepad Shukla, enterprise architect in Barclays’ chief technology office and author of the paper. “The space is evolving rapidly, which creates a risk that any definitions and classifications can become out-of-date relatively soon after they are published,” he says.

Regulators have had difficulty fitting digital tokens into current asset classifications. In the US, the Securities and Exchange Commission regards them as unregulated securities and has denied approval for exchange-traded funds linked to bitcoin. The Commodity Futures Trading Commission has been more accepting of crypto-assets, granting approval for several major exchanges to trade them as commodities. 

The task facing regulators will only become more complex as new forms of digital tokens become available. High-profile tokenization projects include a number of central bank digital currency proofs of concept, Facebook’s Libra for retail payments and the wholesale payment system Fnality, which is backed by 15 financial institutions, including Barclays.

A fragmented and stale set of regulatory definitions could lead to perverse outcomes – for instance, where a digital asset is treated as a currency in one jurisdiction and a security in another. “That means there may be an inappropriate opportunity to then perform regulatory arbitrage, where a party may select a jurisdiction in order to better meet their business goals,” says Lee Braine, director of research and engineering at Barclays. “This creates the risk of a race to the bottom in terms of oversight in order to attract that type of business.”

The Barclays paper, called Historical Context and Key Features of Digital Money Tokens, distinguishes between digital tokens and the traditional concept of money as account claims. It then presents a taxonomy for classifying digital tokens based on seven key features, such as the issuers, claims and asset linkages underpinning them (see table).

“We surveyed several existing taxonomies in our paper,” says Shukla. “Most efforts to date have identified a number of specific forms of digital money tokens and then created taxonomies to incorporate those instances, but ground-up approaches may prove more useful in the longer-term. We decided to go back to basics by exploring all features and potential options for digital money tokens in order to first identify the key ones.”

Taxonomy trouble

In the absence of a common taxonomy, various regulators, standard-setters and trade bodies have developed their own approaches to classifying different types of digital tokens. 

The European Central Bank has created a framework for classifying stablecoins based on the issuer responsible for satisfying the claim, the asset underpinning the coins and whether decision making is centralized or decentralized.

Another classification system for crypto-assets proposed by the Global Financial Markets Association is based on a different set of features: the issuer, mechanism or structure underlying the asset; the rights conferred; and the nature of the claim. 

Other taxonomies start with the intended purpose of the token and then classify it accordingly. The Swiss financial regulator, Finma, has a classification system that distinguishes between three types of tokens: payment tokens that transfer value; utility tokens that provide access to a digital service; and asset tokens that represent a debt or equity claim on the issuer.

“The idea of looking at the function the token performs, and then layering the regulatory treatment around that, is a well-established approach,” says Braine.

Finma’s framework has been referenced in reports produced by the European Securities and Markets Authority.  

The UK’s Financial Conduct Authority uses a different set of definitions that differentiate between security tokens, e-money tokens that act as a store of monetary value, and unregulated tokens that do not provide any rights or obligations. The latter includes cryptocurrencies such as bitcoin and utility coins.

Braine says the idea of cryptocurrencies as unregulated tokens or securities tokens might be adopted more broadly. “I think it’s interesting that the evolution of thought by regulators has resulted in a new category of unregulated tokens as a name,” he says. “The term cryptocurrency is at best vague and at worst misleading, and terms such as unregulated token or securities token can serve a better purpose.”

Nandini Sukumar, chief executive of the World Federation of Exchanges (WFE), says a global taxonomy may lead to a common understanding of where crypto-assets fit within existing regulatory frameworks—for example, whether they meet the definition of a security. “This would, in turn, reduce the variance in application of regulation to global stablecoins/crypto-assets between jurisdictions,” she says.

The Barclays taxonomy is being pitched as more comprehensive than existing ones. Shukla claims the seven features identified in the paper can be combined to describe more than 3,000 forms of digital money tokens.

Open for debate

The paper has already sparked some debate. Manmohan Singh, a senior financial economist at the International Monetary Fund, says it “provides some insights on how to organize one’s thoughts on digital currencies”. However, he questions whether redemption rates—one of the features identified in the paper—should apply to digital money tokens.

“The whole idea of money, at least in my mind, is that with sufficient confidence you don’t need a redemption concept at all,” he says. “Tokens which do duty as money don’t need redemption unless they lack confidence, which means they aren’t really money.”

Arjun Jayaram, chief executive of blockchain fintech Baton Systems, says the paper presents “solid work on trying to organize the various attributes of a token into distinct categories”.

The whole idea of money, at least in my mind, is that with sufficient confidence you don’t need a redemption concept at all

Manmohan Singh, International Monetary Fund

But he argues that tokens fit better into an ontology relationship than a taxonomy: “I think it is easier to think of the attributes as an ontology, or a graph, rather than as a taxonomy, or a tree. A tree is a restricted instance of a graph.”

He also suggests expanding the list of key features to include depository institutions and governance. 

Others are more critical of the effort. Rhomaios Ram, chief executive of Fnality, argues that most digital assets can fit within traditional asset classifications. Cryptocurrencies—tokens issued on distributed systems with no central owner—are the exception to the rule, as there is no owner or operator of the asset. “So, other than crypto, everything else can be categorized under existing categorizations.”

Alistair Milne, professor of financial economics at Loughborough University, questions the distinction made in the paper between tokens and account money. “Account money can actually be token money—money that can be directly transferred from one holder to another without settlement,” he says, citing the example of Paypal and Alipay accounts. 

Shukla says the term “token” refers to all forms of money that can be transferred directly from one party to another without relying on an intermediary.

But Milne says direct transfer without a role for intermediaries would cover only unpermissioned cryptocurrencies.

Shukla concedes there is more work to be done to develop a common taxonomy for digital assets. “We look forward to further international collaboration between the industry and regulators on digital money tokens. This will be needed to arrive at a standard taxonomy that could form the basis of a uniform regulatory regime,” he says.