SEC Telegram Fight Shows Government At Its Worst

The Telegram SEC fight over whether “Gram” tokens are securities progressed when Telegram ‘answered’ in federal court. The move foretells a lengthy battle, something Telegram surely hoped to avoid. Telegram’s Answer spotlights myriad government crypto failures. Among them, mixed signals by officials, selective enforcement, policymaking by staff, unclear rules, and bureaucrats protecting agency power. Regardless of the SEC Telegram outcome, without changes America’s tech advantage will shrink whilst sinecures rise.

Telegram’s two defenses against SEC enforcement   

Telegram has two defenses but only uses one lest they admit clandestine attempts to skirt rules. Officially Telegram complains SEC rules are vague, scattershot, and violate due process. “Plaintiff has engaged in improper ‘regulation by enforcement’ in this nascent area of the law, failed to provide clear guidance and fair notice of its views as to what conduct constitutes a violation of the federal securities laws, and has now adopted an ad hoc legal position that is contrary to judicial precedent and the publicly expressed views of its own high-ranking officials.”

Yes. Telegram’s Answer covers many ad hoc apparatchik games. The three horseman of reaction, Shallow-End Jay Clayton, Bill the Butcher Hinman, and NPC Valerie Szczepanik play hot potato whilst Crypto Mom Hester Peirce stares incensed. Risk-averseness, so common to our three million “public servants,” isn’t bad with nuclear policy, global warming, or Ukraine favors. But here, their actions matter. The future American economy and our place as world’s chief innovator is at stake. Whether a court accepts SEC buck passing given DAO and NPC Valerie’s Dreadful Guidance is unclear. But the government has good odds.

Telegram SEC fight centers on decentralization

Telegram’s unspoken defense is “decentralization.” Decentralization isn’t in any court case or statute. Corp Fin Director Bill the Butcher created it. And while it makes sense, it lacks the analytical rigor crypto entrepreneurs need.

Bill the Butcher announced this policy last year:

The digital asset itself is simply code. But the way it is sold [determines whether it is a security.] But this also points the way to when a digital asset transaction may no longer represent a security offering. If the network on which the token or coin is to function is sufficiently decentralized—where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts—the assets may not represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede” and “the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.”

Crypto entrepreneurs embraced this statement lacking much else, save NPC Valerie’s Dreadful Guidance. When Congress pressed, Shallow-End Jay backed Bill the Butcher without actually using the word.

Crypto startups see decentralization as the only way around SEC compliance

Lawyers have earned millions working Bill the Butcher’s statement into the current capital framework. Most use Reg D for SAFTs but whether this covers the actual tokens is unclear.

Blockstack is the only successful Reg A+ offer thus far. In its offering circular it stated it expects to be decentralized and leave securities compliance within a year. Kik took a different route. It claimed its “Kin” tokens were already decentralized. And thus, like Bitcoin or Ethereum could avoid SEC oversight.

Telegram chose the Kik route, arguing the potentially disbursed 220 billion Grams would be de facto decentralized, but the SEC stopped it. As one CoinDesk commentator stated: “Last year, messaging platform Telegram funded the construction of its TON blockchain with a private placement which guaranteed future allocation of Gram tokens, which of course would be decentralized enough to not need to go through a securities registration. The SEC was not convinced.”

SEC filed against Telegram before it could claim decentralization

And the SEC laid bare Telegram’s plan in its temporary restraining order: “Indeed, by definition, the TON Blockchain can only become truly decentralized (as contemplated and promoted in the Offering Documents) if Grams holders other than the original Grams purchasers actually stake Grams… Stated differently, if the original Grams purchasers alone all immediately staked their holdings, the TON Blockchain would be centralized rather than decentralized and, therefore, subject to misuse and majority attacks.” [original emphasis].

Thus, both sides skate decentralization. Telegram demurs because it would tacitly admit it tried to skirt SEC mandates. The SEC avoids it because it’s somewhat unofficial.

Telegram SEC fight shows problems with government crypto policy 

But whatever happens, the government’s inability to explain its policy is a fiasco.

  • Relying on outdated precedent: SEC Enforcement defines securities from the 1946 Howey case. That worked for orange groves, but the world has changed slightly since mid-20th Century. Judicial precedent restrains the SEC, but also empowers it. The SEC likes Howey because it yields broad discretion.
  • Guidance that confuses more than clarifies: Crypto entrepreneurs have clamored for clear rules beyond outdated cases. The SEC responded with NPC Valerie’s Dreadful Guidance. It took 6-months to complete. And likely cost taxpayers upwards of a quarter-million dollars. And it only worsened things adding more factors to the Howey Test, without any inkling of weight or even if that was all. Anyone outside “public service” would have been fired for such waste.
  • Insistence entrepreneurs get permission: Not only does the SEC not give clear rules but it insists entrepreneurs ask permission through lengthy negotiations or laborious no-action letters. These letters may take years or not come at all. And others can’t use them as precedent. It also favors insiders, those represented by major law firms or with staff relationships.
  • Bureaucrats make policy without responsibility: Every document, speech, or murmur by an SEC functionary comes with disclaimers. No one takes responsibility or accountability. Bill the Butcher has a doctrine named for him—heady stuff—but ask if his statements represent the SEC. NPC Valerie travels the country on taxpayer dimes, receives VIP treatment at conferences. Ask her to opine beyond NPC fashionHowey, Howey, Howey.’
  • Real guidance comes through enforcement: The SEC can bankrupt a startup. It has no shareholders, no timelines, no need for profit, subpoena power, and essentially an unlimited budget. Try and cross them. They dare you.

SEC functionaries have hijacked crypto regulation

NPC Valerie summed the government’s crypto stance in a short yet revealing comment. “The lack of bright-line rules allows regulators to be more flexible.”

Just so, as these pages have opined:

This is true but has other effects. It leaves regulators with massive discretion. This gives them enormous power over the economy with no responsibility for the results. It mandates entrepreneurs approach them hat-in-hand for permission. And it makes them sought after speakers on the conference circuit.

But it’s a zero-sum game. Every unit of power Ms. Szczepanik reserves for herself and her colleagues removes it from job producers. Indeed, every ambiguous pronouncement shunts billable hours to lawyers and compliance professionals instead of research or marketing. Those building tomorrow’s economy need the flexibility not bureaucrats. They will power our future long after Ms. Szczepanik takes her professorship or retires to a nonprofit. 

Too few call out dreadful SEC crypto policy

A few, but only that, recognize the absurdity. Most prominently is Commissioner Hester Peirce, aka Crypto Mom. As a lone voice, she has repeatedly warned about this path: 

The SEC staff recently issued a framework to assist issuers with conducting a Howey analysis of potential token offerings. The document is a thorough 14 pages. It points to features of an offering and actions by an issuer that could signal that the offering is likely a securities offering. If this framework helps issuers understand what the different Howey Factors might look like in an ICO context, it may be valuable. I am concerned, however, that it could raise more questions and concerns than it answers.

While Howey has four factors to consider, the framework lists 38 separate considerations, many of which include several sub-points. A seasoned securities lawyer might be able to infer which of these considerations will likely be controlling and might therefore be able to provide the appropriate weight to each. Whether the framework gives anything new to the seasoned securities lawyer used to operating in the facts and circumstances world of Howey is an open question. I worry that non-lawyers and lawyers not steeped in securities law and its attendant lore will not know what to make of the guidance.

Pages worth of factors, many of which seemingly apply to all decentralized networks, might contribute to the feeling that navigating the securities laws in this area is perilous business . . .

Congress could act to reign in SEC intransigence

Representative Warren Davidson (R-OH) stated:

Regulation by enforcement [has] all the charm and inefficiency of third-world power structures.

. . .

The SEC is doing a complete patchwork of regulation. No one knows where they’re going. They’re literally told if you want to launch a token, whatever you think you want to do with it, come check with the SEC first. . .. And you can grovel. If you grovel well enough, then we’ll give you a no-action letter. You have hundreds of companies waiting on no-action letters. They’ve approved two.

You can’t raise capital while you’re waiting for that.

And in the best exchange in a recent SEC Congressional hearing, Ted Budd (R-NC) mocked NPC Valerie’s Dreadful Guidance, which is a poster child for bureaucratic drivel.

Budd: In April Fin Hub published a framework for investment contract analysis of digital assets which included 60 plus factors for determining whether or not the SEC would consider a digital asset a security. In a statement released alongside your framework your colleagues Bill Hinman and Valerie Szczepanik indicated that the framework is not intended to be an exhaustive overview of the law. But rather an analytical tool to help market participants . . . [H]as the guidance helped resolve their most important questions?

Crypto Mom: [No]

Budd: So last question, when can market participants expect and exhaustive overview of the law so that they can get the regulatory certainty required to continue to innovate and create American jobs.

The world keeps spinning while the SEC ensures America falls behind

But sound bites won’t change Commission practice. The Telegram SEC fight is only a symptom. Indeed, the SEC embodies the administrative state run amok—the Machine whose highest priority is turf protection and DC cache. The political and judicial branches must cabin administrative agencies. Or future Americans will be tech colonized by those less concerned about Washington chatter or who retires to an Ivy League teaching post.

By Jossey PLLC via www.thecrowdfundinglawyers.com

Telegram SEC Fight Could Signal Turning Point for Crypto Law

The Telegram SEC fight over its proposed “Gram” release could mark a sea change for U.S. crypto law. Both sides have dug in amid rising tension. And given the stakes—$425 million in U.S. investment—a truce seems doubtful.

The SEC got an emergency order to stop Gram purchasers “flooding” the U.S. market by reselling Grams to retail investors. Because the commission argues Grams are securities, resales violate U.S. law. But Telegram says Grams are would-be commodities once disbursed via its TON Blockchain. And the fight has turned nasty with Telegram accusing the SEC of “steamrolling” and the commission demanding swift discovery. Without a resolution this case will go to trial and then appellate review. Indeed, this could clarify crypto law rules heretofore dictated only by SEC fiat.

Telegram SEC fight evolved from app’s jump from messaging to blockchain

Telegram’s Messenger is an encrypted app with 300 million monthly users worldwide. Privacy focus made it a crypto favorite with 84% of blockchain projects having channels. But it has also become a government target. Founder Pavel Durov left his native Russia in 2014 after clashing with its government. And Russia banned Messenger over concerns of use by state enemies.

Early last year Telegram raised capital for the Telegram Operation Network (TON), “designed to host a new generation of cryptocurrencies and decentralized applications, at a massive scale.” And Telegram sought to power TON through its huge user base and crypto popularity. Heavies scooped up Gram futures contracts deliverable after the blockchain buildout. As a result, Telegram raised $1.7 billion from investors discounted from projected market yields.

Are Telegram SAFTs the same as Telegrams Grams? SEC says Yes  

The legal issues embody the crypto conflict. Telegram sold Simple Agreements for Future Tokens (SAFT) to accredited investors using Regulation D. Both sides agree SAFTs are securities. But what of Grams themselves? The SEC claims the SAFT sale began an illegal offering. Under this theory, no separation exists between SAFTs and Grams. This is a regular capital raise because some money went to improve Messenger, the TON Blockchain wasn’t finished, and Grams can’t buy anything yet because would-be products don’t exist.

Thus, the SEC Howeys Grams as “investment contracts.” Thus, they are securities because of profit potential for resellers whose value depends on the skill of Telegram’s team.

Or in SEC speak:

A reasonable purchaser of Grams would view their investment as sharing a common interest with other purchasers of Grams as well as sharing a common interest with Defendants in profiting from the success of Grams. The fortunes of each Gram purchaser were tied to one another and to the success of the overall venture, including the development of a TON “ecosystem,” integration with Messenger, and implementation of the new TON Blockchain.

Telegram insists it followed the rules by only selling SAFTs to accredited investors. Grams themselves are a commodity like “gold, sliver, or sugar.” “SEC’s actions hinge on a fundamentally flawed theory that Grams constitute a ‘security’ subject to U.S. Securities laws—a theory that runs counter to longstanding Supreme Court precedent, the SEC’s own views relating to other Cryptocurrencies, and common sense.”

The SEC Telegram Emergency Injunction forestalls Telegram’s best argument

The preliminary injunction forestalled Telegram from arguing what it wanted. If initial purchasers resold Grams to “highly interested” retail purchasers, Telegram could say decentralized occurred via the ‘Hinman Doctrine.’ And like Ethereum is now beyond SEC reach. This doctrine is named after SEC Corp Fin Director ‘Bill the Butcher’ Hinman but has no judicial grounding.

Thus, the SEC Catch 22. To claim decentralization, tokens must be widely distributed and used. But users can’t distribute them unless an open market exists. And an open market can’t exist under securities law. Indeed, issuers can’t even give them away for the desired decentralization.

The SEC knows this:

Defendants knew, however, that to actually implement the TON Blockchain in the real world, the project would require “numerosity”: a widespread distribution and use of Grams across the globe. Indeed, by definition, the TON Blockchain can only become truly decentralized (as contemplated and promoted in the Offering Documents) if Grams holders other than the original Grams purchasers actually stake Grams and, thereby, act as “validators” of transactions on the TON Blockchain.  

SEC demands Issuers use Reg A+ . . . Or be Ethereum

The commission’s only apparent answer to this puzzle is to get Reg A+ qualified like Blockstack and wait it out (or be Ethereum).  But if the SEC enjoins the token release that’s it because absent court findings it has all the power. And as Crypto Czar NPC Valerie has stated, they like it that way.

Telegram claims it spent 18 months “voluntarily engaged with, and solicited feedback from, the SEC regarding development and planned launch of its decentralized blockchain platform . . .” And it produce thousands of documents and answered endless inquiries. But when the time came, it didn’t even get a warning an ex parte emergency injunction was coming.

SEC needs judicial oversight or more Crypto Moms

Without court findings this untenable situation will persist. Commissioner Hester Peirce aka Crypto Mom discussed a utility-token carve out in recent congressional testimony. But current commission makeup makes this unlikely.

Telegram has a better fact pattern than Kik having only sold to accredited investors. And it imbued its SAFT with a restrictive legend. Unlike Kik, however, it doesn’t seem to have the stomach for a long-term fight. But it may not have a choice short of rescinding a third of its raise and leaving the U.S. market.  Whatever happens here court clarity must happen. The SEC cannot always sit as judge, jury, and bankrupter.

By Jossey PLLC via www.thecrowdfundinglawyers.com

Block.one Spared SEC Chopping Block, But Why?

SEC bugles sounded retreat as Enforcement Division troops let Block.one escape an ICO fate that felled lesser transgressors like ICOBox and Munchee. Perhaps it was gearing for heavyweight battles against Kik and Telegram, perhaps Block.one’s lawyers had nude selfies of Chairman ‘Shallow-End Jay’ Clayton.

Whatever the reason, Block.one walked away from a $4 billion unregistered securities offer with a “stunning and historically significant” $24 million wrist slap. No disgorgement, no rescission, no nothing. It can even keep selling securities (they promise to follow the rules next time). Block.one and their China-heavy EOS blockchain, the seventh largest by market cap, celebrated. Others scratched their head.  Whether justified or not the SEC’s sudden soft touch raises questions about favoritism as yet another indecisive year for the token revolution starts to close.

Block.one’s settlement is either prudent or corrupt

We can view Block.one’s settlement two ways. The charitable view is the SEC kept its powder, fining an amount roughly equal to US investment in its raise. Block.one claims it tried to stymie US investors with IP blocking software and contractual disclaimers. Importantly though, Block.one marketed the raise here and more importantly the tokens became instantly tradeable in the U.S. in July 2017.

CoinDesk’s Michael J Casey sums the less charitable view:

One cynical conclusion to draw, then, is that the crypto startup community is now following the same norms as the Wall Street banks it seeks to dislodge. Here too, it seems, money buys protection, if not from the law per se but from the impediments to business that adverse rulings have on those of lesser means. It’s a melancholy thought for those who want this technology to lower barriers to entry and give scrappy garage-based startups a chance to change the world.

By this view the SEC’s dreaded storm troopers trade in swords for plowshares depending on the size of lawyer billables and zeros in the raise. (Think the crypto version of the government ignoring a presidential candidate’s official communications placed on a bathroom-based server).

At the least the SEC makes no secret it expects you to dance to its tune. As Shallow-End Jay stated in recent Congressional testimony: “Our doors are open to talk about these things and if somebody’s going to launch something without coming to see us first, I think that’s a bad idea.”

Flatter the bureaucrats and the ‘facts and circumstances’ fall your way. Fight it and plowshares sharpen and cannonades besiege your company. Unfortunately, without bright line rules the SEC leaves for its discretion who gets artillery and who gets paroled.  

The SEC treated other ICO raises much harsher than Block.one

Questions arise because of seemingly disparate treatment with Kik, Munchee, ICOBox, and the looming Telegram. The Kik-SEC battle is the marquee showdown. Commentators describe Kik as belligerent and “angry,” whilst Block.one was helpful and accommodating. But that confrontational stance may provide clarity on issues like decentralization that demurred cases like Block.one will never solve. As the SEC’s infamous token guidance indicates, clarity is not a commission priority.   

Unlike Block.one, Kik raised a comparatively paltry $100 million, half of which was an ostensibly legal Reg D and by its count only $16 million from its allegedly illegal token sale. Yet Kik hasn’t danced the SEC’s tune and is besieged. The stakes are high. An appellate court could weaken the SEC’s hand and force them into clearer rules.

The SEC also iced ICOBox. And it stopped Munchee on Day Two of its raise. Just last week it filed an emergency injunction to stop Telegram from flooding the U.S. market with what it deems unregistered securities. Block.one got none of this despite selling 900 million ERC-20 Tokens the commission deemed unregistered securities. These tokens were “traded and widely available for purchase on numerous online trading platforms open to U.S.-based purchasers throughout the duration of the ICO.” 

Ask LeBron James and Steve Kerr about kowtowing to China

Whatever underlies the settlement, the commission could have picked a more sympathetic startup. Block.one’s EOS blockchain is weighted with Chinese whales and fears of state intervention abound. The biggest EOS feature is delegated Proof of Stake allowing China-based nodes to control governance. There is also wide-spread vote buying.

Given ongoing controversies with Huawei, the NBA, and Hong Kong, killing Canadian-based Kik whilst nerfing Chinese-heavy Block.one was not politic. Russian-created Telegram will now amass even more scrutiny. 

By Jossey PLLC via www.thecrowdfundinglawyers.com

SEC Commissioners talk Crowdfunding, Crypto before Congress

The Securities and Exchange Commission’s (SEC) commissioners testified last week to the House Financial Services Committee. The otherwise nondescript 3.5-hour confab briefly surveyed the crowdfunding and crypto landscape. But Congress missed a huge chance to examine the commission’s scattershot guidance and arbitrary enforcement. Its desultory policymaking hinders the economy and harms those it seeks to help.

This hearing followed one on the supposed menace of private capital markets. But unlike there, Commissioners provided balanced testimony. And only Robert J. Jackson Jr.—who (*eye roll*) holds five Ivy League degrees—promoted extreme anti-capitalist views.

SEC progress on Reg CF crowdfunding could rescue drowning exemption

The hearing began well with Patrick McHenry (R-NC) chastising Reg CF’s shackling.

McHenry: One exemption that warrants modernization is the crowdfunding exemption. My original crowdfunding bill which was included in the JOBS Act was only a few pages long, 11 pages in fact. I appreciate the SEC and their hardworking staff creating 685 pages worth of regulations around those 11 pages. The absurdity of this I have pointed out a number of times since then. So, you’ve given me at least the rhetorical value of talking about the burden of SEC regulation of making an exemption and a public law completely meaningless because of the impact of the costs.

As the bill’s sponsor, however, his concern proved sadly unique as the hearing wandered about. Everyone knows Reg CF’s shortcomings. And the commission seems finally to be acting.

Chairman Shallow-End Jay Clayton:  You can get up to a million-dollar company going with Reg Crowdfunding and some of our other exemptions. It’s really hard to grow a business from say a $1M business to a $50M business . . . if there are things that we can do to facilitate capital formation in that gap so our small businesses can become larger I think that’s an area we should focus on.

The SEC recently sought public comment on reconciling and improving the private exemptions. Commenters sent many good ideas. Long awaited action is hopefully afoot.

SEC token and crypto guidance remains woeful

Less promising is token-sale progress. The SEC seems no closer to solving the crypto riddle than during the ICO craze, with one exception.  

Congressman McHenry mentioned the Blockstack Reg A+ token sale and several are irked by Mark Zuckerberg’s corporate crypto scheme. But commissioners couldn’t remove crypto uncertainty. Commissioner Hester Peirce, aka Crypto Mom stated such when discussing utility tokens and policy-by-enforcement that only seems to bother her.

Crypto Mom: I would like to see us be a little more forward thinking in ways that we might accommodate unique aspects of digital assets. For example, digital assets that are utility tokens I don’t know that the securities laws framework that we have right now is the appropriate framework for them and so I’d like for us to think about creating some kind of safe harbor.

Crypto Mom: But enforcement is a poor way to announce policy. We need to be clear in writing our rules and we need to make sure we provide the guidance that firms and individual need as necessary. We understand that our rule book is complicated, and we work with well-intentioned firms and individuals to help them comply with our rules.

The SEC’s April Digital Asset “guidance”: dazed and confused

This wantonness colored the hearing’s best exchange when Ted Budd (R-NC) mocked the SEC’s now-infamous token ‘guidance,’ which has become a poster child for bureaucratic drivel.

Budd: In April Fin Hub published a framework for investment contract analysis of digital assets which included 60 plus factors for determining whether or not the SEC would consider a digital asset a security. In a statement released alongside your framework your colleagues Bill Hinman and Valerie Szczepanik indicated that the framework is not intended to be an exhaustive overview of the law. But rather an analytical tool to help market participants . . . [H]as the guidance helped resolve their most important questions?

Crypto Mom: [No]

Budd: So last question, when can market participants expect and exhaustive overview of the law so that they can get the regulatory certainty required to continue to innovate and create American jobs.

The SEC plagues entrepreneurs with ambiguous and arbitrary enforcement

The Commission’s name brand, massive budget, and economic power incentives risk-averse, snails-pace progress on issues that won’t wait.

Indeed, the SEC abstains from the only recent securities success: Reg D. Onerous rules knifed Reg CF and Reg A+. And rules encourage companies to stay private rather than face the many IPO burdens.

All the while, former SEC staff and commissioners get massive paydays to interpret and cajole because no one can discern motives behind mountains of disclaimers and subpoenas. Staffers justify this as needed “flexibility.” As NPC Valerie Szczepanik noted, “The lack of bright-line rules allows regulators to be more flexible.”

Just so, as these pages have stated:

This is true but has other effects. It leaves regulators with massive discretion. And it gives them enormous power over the economy with no responsibility for the results. It mandates entrepreneurs approach them hat-in-hand for permission. And it makes them sought after speakers on the conference circuit.

But it’s a zero-sum game. Every unit of power Ms. Szczepanik reserves for herself and her colleagues removes it from job producers. Indeed, every ambiguous pronouncement shunts billable hours to lawyers and compliance professionals instead of research or marketing. Those building tomorrow’s economy need the flexibility not bureaucrats. They will power our future long after Ms. Szczepanik takes her professorship or retires to a nonprofit. 

Congress missed a chance to examine the SEC’s misguided de facto policymaking

Entrepreneurs facing intense market pressures need flexibility. Warren Davidson’s (R-OH) soliloquy struck the matter and is worth fully quoting:

Davidson: Recently director of corporation and finance Bill Hinman stated in a fireside chat that the SEC prefers an approach to digital assets through facts and circumstances rather than a bright line test. This company by company approach prevents regulatory clarity and it suffers from some of the charm and inefficiency of third world power structures. For this reason, although innovators are in America and innovation is still occurring in America capital is fleeing. Not to avoid our regulations to find efficient regulatory clarity. And they’re finding it elsewhere. We need a simple set of rules that apply equally and clearly to all. That is the premise of a bill I know you won’t talk about. But the framework that the market needs. Where is the capital going? Places like Singapore, the UK, Switzerland, have laid out clear frameworks for digital assets.

Meanwhile the US hundreds of companies await No Action Letters, with only two having been issued thus far by the SEC. Now I agree with you that the ICO situation represents bad outcomes, but the root issue remains. America does not have a clear regulatory framework. Consumer and investors are harmed by that status quo in fact Commissioner Peirce nailed the explanation, the SEC should not only be concerned about fraud but also about opportunity. Our failure to provide regulatory clarity fails Americans on both counts. We have become the world’s land of opportunity the best destination for goods, services, capital, intellectual property and more by anarchy or by inaction. With respect for digital assets it’s time for deeds not words.

Yet instead of forcing Shallow-End Jay’s hand, Davidson sought Crypto Mom who, of course, agreed.

The problem is the SEC’s results not intentions

The SEC undoubtedly tries.

But too often we get years-long dithering before eye-rolling guidance or subpoena floods. And people never subject to market forces live comfortable lives in prestige whilst hindering tomorrow’s economy.

By Jossey PLLC via www.thecrowdfundinglawyers.com

Kik Lawsuit must decide decentralization question

The Kik lawsuit vs the Securities and Exchange Commission (SEC) got even uglier with Kik’s latest reply. Indeed, the company accused the SEC of “playing dirty,” and claimed the dreaded Enforcement Division was seeking favorable “news cycles” not blind justice. 

Of course, in theory the elected and judicial branches police alleged agency abuses. Reality is a different story. And the SEC’s tortured path to token securities shows how.

But instead of Congress or courts setting borders to cabin the SEC, the Commission has played unsupervised. It has produced a mishmash of conference statements, enforcement actions, tea-leaf reading, and finally “guidance” that confused more than enlightened.

The SEC should have shunted token rules through a rulemaking where affected parties comment. And would-be issuers can immediately challenge without pain of enforcement processes. Instead emerged the SEC’s Horsemen of Reaction: Chairman ‘Shallow-End Jay’ Clayton, Senior Advisor for Digital Assets and Innovation ‘NPC Valerie’ Szczepanik, and Corp Fin Director ‘Bill the Butcher’ Hinman.

And that is why the Kik lawsuit is so important. Kik’s present resolve to fight through trial allows courts to review the Commission’s legal and policy bearings. And prime among them is where decentralization fits in the securities milieu.

Kik lawsuit enables court to judge decentralization as a Howey extension

The SEC and courts use the dated Howey test to determine what products are securities. The test has four parts: (1) a contract, transaction, or scheme (2) whereby a person invests money, (3) in a common enterprise, and (4) expects profits solely from the efforts of others.

But it’s not that simple. The courts urged by government enforcers have oft twisted the factors. For instance, the first part needn’t include a “contract,” the second needn’t include “money,” no one takes “solely” seriously and so on.

Decentralization ideally rids “efforts” from the fourth prong thereby removing the securities status from ‘investment contracts.’ But as the Competitive Enterprise Institute and others show, the Howey test doesn’t include decentralization.

Bill the Butcher announced decentralization at a San Francisco shindig 

How did it get there? In typical commission fashion, Bill the Butcher, a staff-level functionary exclaimed this new criterion at a fancy San Francisco conference where security (the kind with badges) block the hoi polloi. And the ruling class pay upwards of $1,000 to attend. While discussing the Ethereum network last year he remarked:

If the network on which the token or coin is to function is sufficiently decentralized — where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts — the assets may not represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.

. . .

Based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions, and, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.

The SEC Horsemen of Reaction stick together 

And when forced, Shallow-End Jay backed him in a public letter:

I agree with Director Hinman’s explanation of how a digital asset transaction may no longer represent an investment contract, if for example, purchasers would no longer reasonably expect a person or group to carry out the essential managerial or entrepreneurial efforts. Under those circumstances, the digital asset may not represent an investment contract under the Howey framework.

NPC Valerie then issued widely panned “guidance”:

There are essential tasks or responsibilities performed and expected to be performed by an AP [Active Participant, yet another SEC invention], rather than an unaffiliated, dispersed community of network users (commonly known as a “decentralized” network).

And just like that the Howey test expanded.

The Enforcement Division now cites “decentralization” in pleadings:

At the time of all these [token] sales, there was nothing to purchase using Kin, and critical elements of the decentralized economy that Kik had marketed – including a blockchain capable of processing transactions between buyers and sellers at the volume and speed necessary for running consumer applications, and a functioning rewards engine – did not exist.

Ultimately, Kik pursued the ICO without first achieving a decentralized economy for Kin, and without even ensuring that investors would be able to buy goods and services with the tokens upon their receipt.

Decentralization is good, clear rules applied evenly are better

Some applaud SEC willingness to provide a security-less token pathway absent attendant expense and rules.  

But the Commission has not answered decentralization questions. And perhaps it has not even considered them.

The theory behind the decentralization comes from blockchain features. Blockchain ecosystems don’t function like normal issuers. Indeed lots of parties play substantive roles including miners, nodes, developers, and users. Thus, onerous disclosures don’t make sense when issuers have scant control. In the Bill the Butcher’s words, it wouldn’t be “meaningful.”

Kik lawsuit should answer how SEC applies decentralization to blockchain issuers

But the theory invites lots of theoretical and real-world problems. And the SEC fallback of relying on individual “facts of circumstances” welcomes bias and arbitrary enforcement as the Kik lawsuit claims.

As Angela Walch asks:

When we talk about decentralization in context to the Hinman test, what do we refer to? Do we refer to the amount of developers involved in a project? To the amount of nodes? Amount of miners? Is it about the degree of influence the issuer has on the governance and future development of a project? Do we talk about the degree in which a token’s value is derived from businesses building on top of a protocol?

The system’s decentralization is in part a description of its governance [power] and part a description of the numerical, geographical, and ownership distribution of the computers within the network [physical attributes].

Hinman focuses on the network as the decentralizing factor: “if the network…is sufficiently decentralized,” “as a network becomes truly decentralized,” “[t]he network on which Bitcoin functions….appears to have been decentralized for some time,” “based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure,” and “there may be other sufficiently decentralized networks and systems”). As Walch explains Hinman conflates the physical network as a gateway to explain power structure.

In crisis Bitcoin and Ethereum centralize  

Adding to the confusion, Bill the Butcher seems not to consider Bitcoin and Ethereum crises that caused temporary but dramatic centralized moments. For instance, in the fall of 2018 programmers discovered a bug in Bitcoin’s software that could affect coin output and ultimately kill the network.

A select group patched the bug in secret and got major mining pools on board minutes later. But the public didn’t know for days. And a similar hard fork occurred in 2013.

Likewise, Ethereum forked after the infamous DAO fiasco to deny a hacker stolen tokens. And in 2018 an invitation-only meeting took place to discuss Ethereum changes.

In fact, Kik’s lawsuit argues under these metrics Kin was more decentralized than either Bitcoin or Ether at the time of sale (or introduction) and achieved higher trading volumes since.

Kik lawsuit argues it’s as decentralized as others without legal troubles

But there’s more. It is interesting to note similarities between Kik’s lawsuit pleadings and Blockstack and Brave statements, both devoid of legal troubles.  

Kik:

Kik sold Kik Points [precursor to Kin] to advertisers, who – rather than siphoning user data and using it to run targeted advertisements –would offer them as rewards to users who interacted with advertisers’ surveys or polls within Kik Messenger.

It envisioned a decentralized, widely adopted currency that would be used for earning and spending within a variety of digital services offered by developers.

[CEO Ted] Livingston reiterated that “the ultimate dream is for Kik to launch Kin, to launch this broader ecosystem, then for this broader ecosystem to not need Kik.”

In this vision, Kik would be just one of a vast number of participants in this new digital economy.

Blockstack:

Ultimately, Blockstack anticipates that the Blockstack network will become an independent, decentralized ecosystem, over which no one party, including Blockstack, will have control. Changes to the Blockstack Core will likely be proposed by third parties, without Blockstack’s approval

[A]s the Blockstack network becomes increasingly decentralized, core developers other than those employed by Blockstack may become primarily responsible for the development and future success of the network.

Brave (from Life After Google):

Into this breach [Brendan] Eich is hurling his one billion BATS—the unit of exchange for an ingenious new decentralized open-source and efficient digital advertising platform based on Vitalik Buterin’s Ethereum blockchain. Advertisers award BATS to publishers based on the attention of users measured by the pattern of their usage. Users too will be paid in BATS for acting ads that they want to see or choose to tolerate in exchange for micropayments. They can donate they BATS back to favored publishers or use them in exchange for content.

Kik Lawsuit should define rules everyone knows in advance

The easy answer is Brave is a closed system and Blockstack played by the rules and got Reg A+ qualified. But Ethereum did neither. And it’s hard tack to say as did Bill the Butcher did, “putting aside the fundraising.” The SEC’s problem with Kik is “the fundraising.”

From the outside it appears unelected bureaucrats with unlimited power deciding winners and losers based on obeisance, media coverage, or worse. But this not to say Kik has clean hands. It knew the risks by avoiding certain jurisdictions. Moreover, it could have stopped after its $50 million SAFT sale and sought a Reg A+ public sale. It took a risk and is now rolling the dice in court.

No one should oppose decentralization as a factor or perhaps the sole factor in when the magic transition happens. But it’s the government process that makes it distasteful. A court can better apply standards evenly and interpret rules openly and fairly. The Kik lawsuit should not leave Bill the Butcher, Shallow End Jay, and NPC Valerie to roam like unsupervised children in billion-dollar playgrounds.  

By Jossey PLLC via www.thecrowdfundinglawyers.com

How Token Rewards will Kill Social Media

The social media future is now and it’s glorious. Token rewards via blockchain-based decentralized apps (dApps) will kill the online oligarchy and enable a cleaner, user-powered version. Indeed, tokens, as dApp currency, will do what new laws and anti-trust suits cannot: remove Silicon Valley control of the web.

A casual look at the news shows no one likes the online present. Some fear censorship and the arbitrary way popular platforms suspend, demonetize, and deplatform. Yet others object to massive corporate power and the unceasing ambition to broach further domains. *Cough, Mark Zuckerberg, Cough.*

The concerns are legit. Indeed, the plan wasn’t for a few companies to aggregate and curate the net. But it’s also flawed thinking. It suffers from the common mistake of assuming things as they are will remain so without collective fixes. Unfortunately, lawmakers who grew up in the age of record-cassette tape-CD won’t see the world as it will soon be.

Yet this doesn’t mean everything will go right or that corporations with spare billions won’t try to seize the internet’s third wave before it crests. *Cough Mark Zuckerberg Cough.*

But current thinking shorts human ingenuity, super speedy adoption rates, and user fickleness. The pace of changing communication methods shows how. Email to text to social apps makes record-cassette tape-CD look like traversing the bronze to iron age.

Speedy adoption rates threaten Silicon Valley hegemony

According to a recent IMF report: “The adoption of WhatsApp was one-third faster than that of Gmail. And today, WhatsApp has surpassed Gmail in user-base and is well past the 1.5 billion users mark. The dominance of WhatsApp relative to standard text-messaging solutions is even more stark.”

But dApps and token rewards add a twist. What made previous acquisitions like YouTube, Instagram, and Whatsapp appealing to Google and Facebook respectively was not only their massive adoption but centralization. Thus the giants could add to their data silos, force more adverts, and make it even harder to leave.

And dApps don’t silo data and token rewards curtail the waste of conventional advertising.

Token rewards will fuel ‘the great unbundling’

What is coming is what George Gilder, author of Life After Google, dubs ‘the great unbundling.’ Adoption speed combined with cross-app functionality will kill the old data-hoarding and advert model.   

Instead of walling users in, dApps replace authority with collaboration and data hoarding with data requesting. Indeed, the future social-media app won’t silo user data and those requesting attention must bargain for it. And users will trade attention and personal information for tokens. Moreover, they can jump the silo with a click.

As Don and Alex Tapscott put it in Blockchain Revolution, How the Technology behind Bitcoin is Changing Money, Business, and the World, “Blockchain technology offers a credible and effective means not only of cutting out intermediaries, but  also of radically lowering transaction costs, turning firms into networks, distributing economic power, and enabling of wealth creation and a more prosperous future.”

The list of token rewarding dApps grows daily

Indeed, this happening now. Blockstack, a blockchain ecosystem, received the first ever Reg A+ token-sale qualification two weeks ago. Blockstack stores personal data on clouds and users float between dApps easily. Currently Blockstack offers 171 dApps from 100 developers. And it rewards developers in Stack Tokens. Presently, many of its current apps mimic legacy apps like Facebook and YouTube without concerns about data capture or censorship.

Brendan Eich’s Ethereum-based Brave browser works similarly. There users exchange token rewards for attention and spend them for content or donate them to preferred publishers. This tackles a huge web problem: the advert detritus we download to get “free” stuff. And according to Gilder, at popular publishers’ sites, as much as 79% of mobile data are ads. “On average, smartphone users pay twenty-three dollars per month for ads, trackers, scripts, and other diversionary chaff that bears malware, slow load times, piles on data plan costs, depletes battery life, and tramples privacy and property rights.”

And like-models arrive seemingly every day. Bitcoin.com recently listed “Blockchain Apps that pay you to post.” The most interesting are below, read the full article here.

  • Steemit: The first, it pays users in Steem. According to Bitcoin.com Steemit’s resistance to censorship set a mark others followed: “Neither the platform nor other users could deplatform anyone by reporting or flagging a post (a huge problem currently for many giants in the field.”)
  • Bitchute: A politically focused video-sharing platform juiced with token rewards.
  • Minds: Noted for its successful equity crowdfunds. Minds threatens the social-media oligarchy resisting censorship and providing token rewards to creators and users. Based on the Ethereum blockchain.
  • Bitbacker: Crypto free-speech donation platform for creators. Patreon without the moralizing.

No matter who wins, we all win

The market will decide which dApps win the adoption wars. But we all will share their victories. Every move away from the current data silo/forced advert model is step toward a faster, cleaner, user-focused internet. Token rewards are the key to making this new model go and we can all join the ride.

By Jossey PLLC via www.thecrowdfundinglawyers.com