14th November 2019

Crypto fought the law and the law won

Colin Platt here again, time for another blog, exploring some of the topics that Zeth, Shaun and I found interesting.

It has been a year since we focused on the SEC’s settlements with Paragon Coin, DJ Khaled and Floyd Maywhether. How time flies.

Although it’s not something we’ve spent too much time on here, regulators haven’t lost interest in cryptocurrencies. Regulators around the globe have announced actions and settlements on a number of projects, large and small. Beyond these, after having been awakened from their slumber by Facebook and Libra, lawmakers have tasked regulatory bodies with getting to the bottom of what is happening with stablecoins. Investigations into risks, and rules of these projects have been hotly debated by the G7, Bank for International Settlements, IMF and more.

Perhaps the loudest story was that of Canadian texting application, Kik, which raised $100 in a SAFT offering. In June, the SEC announced that it was suing Kik for selling unregistered securities to US investors. Amongst the allegations were that Kin tokens traded at half of the value that they were sold to investors at, that they had been marketed as an investment opportunity, and had no functionality. The complaint included details about how Kik had developed basic “minimum viable products” which could be purchased for Kin tokens, including their famous “Let’s Jam” honey badger:

Let’s Jam honey badger

Immediately prior to the news of the lawsuit being made public, Kik announced plans to sponsor a “Defend Crypto” fund which sought to raise funds to support crypto projects from regulatory actions. Upon the news of the SEC lawsuit many early supporters quietly withdrew support for the initiative.

Kik has denied wrongdoing and is challenging the SEC’s complaint. In the meantime, Kik let their Tel Aviv based team go in September. Kik CEO, Ted Livingston was accused, in what was later found out to be a hoax, of having drunkenly texted a journalist with doubts about the project.

The autumn crypto legal action season kicked off with a bang on 30 September, as Block.one (the founders of EOS) announced a settlement with the SEC related to their $4bn, year-long ICO that ended in June 2018. The SEC’s complaint claimed that the EOS tokens, originally launched as ERC-20 tokens on the Ethereum network and sold to the general public, were unregistered securities. This is perhaps the main regulatory concern that projects conducting token sales have when raising capital from the public, so the news of SEC action was widely followed. Not only were onlookers surprised that the SEC was finally coming after larger ICOs, but the amount of the fine, $24 million, surprised many. While a significant number in absolute terms, this settlement, which did not require that Block.one admit guilt to the claims made by the SEC, was less than 1% of the total amount raised by the EOS token pre-sales. Many commented that this was a very light fine, while several legal professionals suggested that circumstances including cooperating with the investigation and relative values raised from Americans could have contributed to calculating the amount of the fine.

While the Block.one managed to snatch the headlines, just one day later, the SEC announced another settlement, this time with Boston-based Nebulous, the company behind the 2014 launch of Siacoin. The settlement, which also did not admit fault, resulted in disgorgement and penalties amounting to $225k. Though this number is significantly smaller, the 2014 raise amounted to approximately $120k (all of which was subject to disgorgement). Nebulous went on to raise a further $1.5 from investor in 2018 under a Reg D sale.

As September ended on a note of, “well it could have been worse”, October saw a much larger, more notable action. On 11 October, the SEC filed a complaint against Telegram’s TON token sale, requesting the court grant an Emergency action, preventing TON from converting SAFTs (Simple Agreements for Future Tokens) to Gram tokens available for resale to the general public. This action was particularly notable for a few reasons, first is that it was one of the largest, well known projects in the space, having raised $1.7 billion from sophisticated investors.

Many projects issuing SAFTs had hoped that by raising money from qualified investors, developing their project and only then releasing tokens for a functional project, they could avoid having their tokens classified as securities.

In early September of this year, Telegram released a basic testnet and blockchain explorer for TON. While this clearly demonstrated that progress had been made, this network is not currently at a state that the tokens could be considered to have any actual utility.

Perhaps sparked by the TON testnet announcement, and subsequent realisation that the SAFTs would be converted by the end of October, and potentially released to the general public –without appropriate filing for registration of such issuance of securities– the SEC sought to halt the conversion process.

Following this announcement and the granting of the restraining order by the court, Telegram asked SAFT holders to grant an extension of its 31 October 2019 deadline, which was accepted by SAFT holders. In addition, Telegram formally responded to the SEC allegations, in which it claimed to have been in regular communication with the SEC and to have been caught in the 11th hour by this emergency action. Additionally, they argued that Grams should not be considered as securities, comparing them with currencies or commodities, and asked the court to deny a preliminary injunction which would have the effect of halting their plans.

The Telegram news showed that regulators were not going to go lenient on all token sellers, and that the rule of law still applied.

Outside of token sales, Facebook and Libra have been in the headlines, not just the crypto ones but everywhere. The US Congress, central banks, the G7 and even the BIS have called them in to testify, speak, and make the case why they should be allowed to proceed with their plans. We won’t go into too much depth on these well publicised proceedings, except to note that one side-effect of this focus has been that regulators are looking at if and how rules and regulations should be adapted for stablecoins generally. Regulators have noted a number of risks from these products, and some have called for stablecoins to be regulated as securities.

As is often the case, this space continues to look incredibly exciting and innovative. Increased regulatory focus doesn’t change this, but does reinforce the importance of understanding the rules of operating in financial services, even if things are dramatically different from what came before.

As always, nothing here should be construed as financial advice, recommendation or endorsement of any project or cryptocurrency.