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

SEC Ices ICOBox

The Securities and Exchange Commission (SEC) iced erstwhile token issuer ICOBox last week. Indeed, the complaint filed in a California court alleges ICOBox didn’t register its $14.6M token sale and thus should disgorge the money. The case will likely settle quickly as the alleged facts are damning and related Paragon Coin already surrendered. Unlike SEC vs. Kik, this case won’t color token law. Questions like “sufficient” decentralization and Howey test utility will resolve elsewhere. But the case offers lessons in timing, compliance, best approaches to contesting SEC rules. And none of the parties here garner much sympathy. ICOBox, investors, and the SEC all acted faulty.

ICOBox officers invited SEC scrutiny by promoting potential gains and downplaying risks  

Over 2,00 investors bought ICOBox tokens in 2017. Company officers raised lots of red flags with performance promises, discarded risks, and downplayed SEC moves that endangered the sale. Afterward ICOBox’s marketing and compliance shop supplied ICO issuers myriad services. But also allegedly performed broker-dealer services, taking “success fees,” and “transaction-based compensation.”

ICOBox didn’t register the sale or fully explain why it didn’t need to. When would-be investors asked about risk, officers blew off concerns. They described the sale as for “product tokens” and “discount cards.” They dismissed the just-out SEC DAO report and claimed without apparent legal backing the tokens’ “purpose” and “functions” dodged registration. Afterward their alleged broker-dealer moves practically begged for SEC enforcement.

Investors with ICO FOMO should think more clearly  

Investors who purchased the tokens and others through ICOBox fare no better in hindsight. Many knew of the DAO report, and those who invested apparently didn’t seek a clearing legal opinion.

ICOBox’s website lists no physical address, no phone number, not even an email address. (It does have a contact form). There are no real pictures or team bios. No location listing. It purports to offer legal opinions that assure potential clients of offering legality but name no lawyers or firms. The site invites the impression of lucky amateurs who caught a wave and ended up dazed with a $14.6M stash.

The site’s press releases also scream Stay Away! Officers constantly churn. The CEO for example lasted five months. Others notify readers of changing business models and shifting priorities. And some are contradictory like “It is clear that in 2019 investors will mostly be focused on the security token market, because this approach meets the regulatory requirements . . .” Okay but what of ICOBox’s listed previous and current clients that didn’t follow the rules, not to mention its own token sale.

In short, investors not heeding these warnings may need a hard lesson in due diligence and the dangers of FOMO.

The SEC’s token approach and guidance is a case study in bureaucratic malpractice

Finally, the SEC shouldn’t take any victory laps. It will likely get a quick win, but its posture deserves no praise. The complaint emphasizes ICOBox’s timing, selling tokens after the infamous DAO report. Just so. The SEC released the report on July 25. ICOBox announced its token sale on July 27 and started selling on August 7.  At the time confusion reigned about what the report meant and how vigorously the SEC would pursue errant issuers. The SEC did not even bring charges against DAO but instead left it as a warning.

Media now calls the DAO report a “line in the sand.” “The SEC has consistently taken legal action against any ICO issuer post-DAO report if they have been deemed as issuing unregistered securities or other acts of fraud.” But no one knew that then.

But what if ICOBox had sold its tokens six-month earlier? The ICO advent clearly flummoxed the commission. And its response: appointing career bureaucrat “NPC Valerie” Szczepanik Crypto Czar and flooding issuers with subpoenas in early 2018 seems reactive and benighted. And for all the amateurishness, ICOBox doesn’t look like an outright fraud where the SEC should focus. Since August 2017, it reportedly helped 30 token issuers raise over $650 million.

Unfortunately, the SEC’s policy-by-enforcement harmed the economy and prompted grousing about uneven prosecution and sparse direction. And latent corrective attempts only mucked it up more. For instance, the commission’s long-awaited token “guidance” released in April and signed by ‘NPC Valerie’ and ‘Bill the Butcher’ Hinman was lamentable. Indeed, it took six months, likely cost the American taxpayer upwards of a quarter-million dollars and clarified nothing. And everyone from Commissioners to securities lawyers to media lampooned it. 

ICOBox’s SEC trouble should guide future issuers, activists, and investors

Token issuers should learn from ICOBox’s missteps to avoid rescissions, lawsuits, and even criminal charges:

  • The law is fluid, play by the rules. This means hiring experienced counsel willing to sign opinions. Views from issuers that no legal obligations exist mean nothing.
  • Better rules come through advocacy. As inept as the government is, it’s the only arbiter. Both Congress and the SEC have input paths. The SEC sought public comment in its current reconciliation of private exemptions. The president appoints commissioners and good ones like Hester Peirce aka Crypto Mom move the needle. Finally, some lawmakers see the problems. RepsWarren Davidson (R-OH) and Darren Soto (D-FL) have sponsored the Token Taxonomy Act and the JOBS Act 3.0 passed last Congress although it’s now stalled. Packed rooms in hearings like one this week pressure Congress.  

Still, the token future is bright. Distracted lawmakers, inept regulators, sleazy issuers, and stulted FOMO investors won’t stop it. But technology won’t halt buck-seeking con men or turf-protecting governments guarding control over the populace and economy. Buyer should beware and those interested in the token economy should get involved.

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

It’s happening! The Blockstack Reg A+ token sale and a new internet

The years-long wait is over. The Securities and Exchange Commission (SEC) finally approved a Reg A+ token sale. Indeed, Blockstack is already publicly selling Stack Tokens. If it works, it will bring a new and better internet.

Heretofore, the SEC’s refusal to qualify a Reg A+ token sale long flummoxed crypto-philes. Reg A+ is ideal for crowdfunding crypto projects as it most aligns with the ‘Wild West’ ICO craze of 2017, while complying with securities laws. Reg A+’s benefits are straightforward. The $50 million maximum meets tech startup needs (although Congress will likely soon raise it to $75 million). Anyone can purchase Reg A+ securities. And buyers can trade them instantly. Thus startups prefer it to Reg CF ($1 million limit) or Reg D (accredited investors only).

SEC Reg A+ reluctance typified its stance toward shiny things under Chairman “Shallow-End Jay” Clayton. Mr. Clayton and his cohorts are the “Machine”: the credential-and-prestige obsessed cabal of East Coast lawyers and fancy-degreed personages that land each year at name-brand federal agencies to pilot the American economy while disclaiming responsibility for the results. In the SEC crypto-sphere, NPC Valerie leads the way. But critics panned her main effort, 13-pages of crypto “guidance,” as prolix and overreaching.

Crypto Mom gets a win

Commissioner Hester Peirce, aka Crypto Mom remains a contrary voice encouraging regulatory modesty. She has long criticized the SEC’s glacial pace and risk-averse jeremiads, including with Reg A+ token sales.

She won this round against the forces of Machine reaction. But the victory is incomplete. First, Blockstack represents one qualification, lots more languish. Some have waited years; others have given up.

Secondly, even this victory is limited. Blockstack restricted post-sale Stack Token releases. Buyers will get them piecemeal over 24 months. Instant liquidity is a major Reg A+ virtue. If all companies must concede it for qualification it will hurt the market.

Finally, the SEC leaves uncertain how these security tokens become utilities although all agree that is the plan. Blockstack says its board will decide and pegs a year out as sufficient. No one knows how this will work. Will SEC Enforcement ultimately decide when tokens are no longer securities? If so, that’s not progress.

Blockstack is the anti-Facebook

Blockstack’s vision makes its qualification huge. It wants to change the system by removing online power from oligarchs and return it to users. As stated in its circular, “The ultimate goal in creating the Blockstack network is to enable application developers to build and publish decentralized applications [Dapps] without the need to maintain central databases, and for users of these decentralized applications to retain control over their own data.”

Author George Gilder explained the downsides of the current model in Life After Google. Facebook, Twitter, Google/YouTube, and Amazon et al. control the web by capturing the top of the “stack” where internet power resides.

“Free” services force users to relinquish security, property rights, privacy, control of adverts etc. And they are vulnerable to oligarchical whims. “Walled gardens” censor the masses, capture their data, and make it painful to leave. In turn, the companies respond to various pressure points including governments, activists, internal politics, shaming culture etc.

As Blockstack co-founder Ryan Shea stated, “Apps were not responsive to customers so much as designed to lock them in, you go onto the net and Facebook or Google or Dropbox or Pinterest tor Amazon and all want you to move in, giving them all your documents, music providing storage for your life. Medical sites want to store all your health data. You have to petition to it went you want it.”

The Zuckerbergs will try to keep their power

Mark Zuckerberg is the poster child. He became a multi-billionaire by repackaging and selling user data to the highest bidder. All the while he conspired with governments and activists to censor speech. And he is trying to recreate this model with financial transfers.

Libra’s goal is the entrenchment of very rich, powerful institutions that have much to lose in a decentralized world. It is designed to kill blockchain’s future and retrench oligarchic power for decades hence; the sappy videos are PR. Whatever Congressional assurances, Libra’s “gold mine” is access to crypto wallets it creates and controls.

But the Blockstack model keeps control at the bottom of the stack

But within Blockstack’s network, users will move from Dapp to Dapp without separate logins or remitting personal information. They will store their data in encrypted clouds and release it when they want.  

Allowing users to control their own information keeps the power at the individual level—the bottom of the stack. In the future tokenized world, individuals will yield time and attention for token rewards. The oligarchs will adapt or die.

Qualification of Stack Tokens clears Blockstack’s last legal hurdle. The sale precedes building its blockchain. Next comes mining, Dapp development, and user rewards. The new internet is coming.  

The SEC should recognize what Gilder and the Blockstack community see. The online world is changing. Governments should fiercely protect against fraud but otherwise step back and marvel at what’s next.

By Jossey PLLC via www.thecrowdfundinglawyers.com