A generation of blockchain founders thought they’d beat the system by classifying their tokens as “utilities” (a consumer purchase) rather than “securities” (an investment). The great thing about saying you’re selling a consumer product is that you’re not subject to regulation by the Securities and Exchange Commission (SEC).
The not so great thing?
You can pick your regulators, but you can’t pick none.
Bad coins. Bad coins. Whatcha gonna do, Whatcha gonna do? When they come for you CHAPTER ONE
During the 2017-2018 Initial Coin Offering (ICO) boom, as billions began rushing in from flimsy white papers, lawyers around the world wondered what to make of this sea of garbage and scams. What would the consequences be for flagrant misrepresentations and wholesale theft? Would regulatory bodies step in?
According to attorney Steven Masur at MGA:
with regard to the things that were done during that time period, the chickens are coming home to roost.
Regulators talkin' the talk
The SEC, CFTC, FTC and FinCen have all come out with guidance about crypto asset regulation, and, while there is some overlap, it remains to be seen which agencies will move forward in earnest and which will pump fake.
In order to match your shitcoin with its applicable regulator(s), Masur recommends, “a fact based analysis to determine what the token does and what the token is.”
As of right now, if we truly look in our heart of hearts, we know that the vast majority of tokens resulting from the ICO craze function as securities. Unfortunately, the SEC has given some notoriously bad actors a pass, opening up new channels for retribution.
In this article, we’ll look at the ways these tokens have masqueraded as not-securities, and why, on the whole, that’s a losing proposition.
Where art thou, SEC?
Here’s basically the core of what securities law is designed to prevent: a bunch of folks create a company, make a gripload of false or misleading claims about its prospects, sell shares in it to the public, and walk away with the money, leaving the American middle class holding the bag.
We the people have made this illegal for two reasons: one, it’s theft, and two, the common investor’s confidence in the stock market not only creates wealth but enables capital formation for real businesses to grow and thrive.
We all know dealing with the SEC is burdensome. It requires a bunch of disclosures to solicit primary investors and many, many more to solicit investment on secondary markets (stock exchanges). It’s certainly not perfect, but, for the most part, we can expect the businesses that make the cut to have adequate managerial skill as well as products and services that are viable, useful, and needed.
That’s why, when cryptocurrency companies touting absurd, impossible-to-deliver products and services began listing their tokens on U.S. based exchanges, most attorneys figured the SEC would have a field day with these charlatans. I mean, these exchanges were listing highly speculative assets, using stock ticker symbols to represent them, and were somehow selling directly to the American public. How???
International Issuance:
On September 30th, the SEC fined Block.one (issuers of the Eos token) just 0.6% of their total $4.1B ICO raise even though they failed to register with the SEC or seek any formal exemptions. Many were understandably shocked and disappointed by this paltry payout.
After all, Block.one was featured by HBO’s John Oliver in a segment on fraud, deceit and flagrant misstatements in the cryptocurrency industry (See more here). That, along with allegations of wash trading during their token raise, made Block.one the LeBron James of securities fraud.
Yet somehow, Block.one and its ilk sold tokens directly to the public, filed zero disclosures, and claimed national exemption after the fact -- contending that they issued their tokens in a safe harbor abroad.
Many attorneys theorized that the the $24M payout constituted the portion of the tokens issued in the United States.
Will the international issuance dodge get companies off the hook?
Probably not. More likely, companies are in for a worser fate (orange jumpsuits??) as other agencies step in, and/ or promises of future compliance with the SEC have engendered lenience (more on that later).
What’s next?
The SEC will likely continue with what James Park and Howard Park, writing in Washington Journal of Law and Policy, have dubbed “selective enforcement.” They continue:
Rather than bringing many enforcement cases seeking penalties (as it could have, given the sheer number of noncompliant ICOs), the SEC has brought only a handful of carefully chosen significant actions.
Even with selective enforcement, what we’ve seen thus far is just the tip of the iceberg. On average it takes 25 months from inception to completion of an SEC claim, so we can expect to see many more prosecutions in the coming weeks, months and years.
“Utility Tokens”
Crypto companies avoided scrutiny by the SEC by selling tokens that they claimed weren’t securities, currencies, or investments. They labeled them “utility tokens” and insisted that they represented early sales of products and services.
Apparently, the wokest future imaginable involves THOUSANDS of tokens that you have to track and manage and use for every possible task.
Want cloud storage, a dentist, a plantain??? You guessed it! There’s a *different* utility token for each of those! Too many utility tokens? No worries! There are hundreds of different (tokenized!!) solutions to enable your thousands of tokens to interact with each other. Simple, right?
Crypto founders wrote white papers depicting a future state with a revolutionary new platform, upon which their utility token would be used to pay for much needed products and services.
Offering soon-to-be-valuable-and-useful tokens meant companies could fundraise without offering any equity. It also meant their tokens could be bought, sold, and traded on U.S. based exchange platforms without the due diligence required for securities
Will the utility token dodge be the silver bullet?
Oof. No. While it seemed to have fooled many a regulator initially, it has opened an entirely different can of worms.
Masquerading as consumer products brought consumer protection laws to ShitCoinTown. Muy problematico.