Regulation
Commissioner Hester Peirce Dissents on SEC Telegram Ruling and Settlement
Commissioner Hester M. Peirce of the Securities and Exchange Commission (SEC) delivered a June 21 speech at Blockchain Week in Singapore where she expressed her dissent regarding the recent settlement between the SEC and Telegram.
It is unsurprising to hear Commissioner Peirce disagree with the recent court ruling barring the release of Telegram tokens to all investors, and subsequent settlement with the SEC. Commissioner Peirce has made it clear that she did not agree with the originating October 2019 emergency order filed by the SEC against Telegram.
Timeline of Telegram Raise and Court Case
| February 2018 | Popular messaging app Telegram raises $850M using the SAFT (Simple Agreement for Future Tokens) structure |
| March 2018 | Telegram raises an additional $850M using SAFT structure |
| October 2019 | Distribution of Telegram Tokens to Investors scheduled for October 31, 2019 |
| October 2019 | SEC files an emergency action and temporary restraining order against Telegram to prevent the distribution of Telegram tokens to investors. |
| March 2020 | The court orders that Telegram may not distribute tokens to any investor, American and foreign |
| June 2020 | Telegram settles with the SEC and agrees to return $1.2Bn to investors, close operations, and pay $18.5M fine |
Synopsis of Telegram Raise
- $1.7Bn raised from investors ($424.5M from American investors)
- 171 investors (39 Americans)
- Accredited investors only
- A minimum investment of $1M per person or entity
- The invested money was to be used to develop the Telegram Open Network (TON) blockchain and grow and maintain Telegram Messenger.
What Issues Does Commissioner Peirce Raise?
The court sees “one single scheme”. Commissioner Peirce takes issue with the court treating the investment agreement between Telegram and the accredited investors, the delivery of the tokens to the investor, and the resale of the tokens, as one single scheme. She laments, “gone is the distinction between the investment contract (the agreement between Telegram and the accredited investors) and the token (the asset to be created and delivered under the agreement)”. Commissioner Peirce believes that the initial investments in the company are to raise capital to build the platform, and that those initial investments are separate from the resale of a functional token “… such tokens, once they have a consumptive use, should be able to be sold to purchasers outside of a securities transaction”. She believes the Howey test supports the idea that the resale of the tokens does not constitute as a security simply because the tokens were initially acquired as a part of a securities transaction.
What is a requirement for success, is deemed an illegal securities offering by the SEC. What the SEC sees as an illegal securities offering (widespread global distribution of the token), Commissioner Peirce sees as a necessary element for a successful blockchain. “I do not support the message that distributing tokens inherently involves a securities transaction…. I see [widespread distribution of tokens] as a necessary prerequisite for any successful blockchain network.”
The SEC is overreaching. Commissioner Peirce also takes issue with the fact that the SEC, asked and was granted, enforcement against a corporation that is not incorporated or based in the US, and only a quarter of the investors and total investment were US-based. She reminds us that the American way is not the only way in a global economy “This willingness of the SEC to ask for, and of the district court to grant, such sweeping injunctive relief against a non-US company, in a case where one-quarter of the funds came from US investors, reasonably might raise some concerns among our international colleagues… we would do well to recall that our way is not the only way. We should be cautious about asking for remedies that effectively impose our rules beyond our borders.”
At Your Own Risk – No Clear Path
Interestingly, Commissioner Peirce notes that Telegram employed sophisticated counsel, “made good faith efforts to comply with federal securities laws” and “engaged extensively with SEC staff”. It begs the question – what went wrong? Did the SEC give improper guidance? Did Telegram choose not to follow the SEC’s guidance? Did the SEC change its mind once Telegram was due to distribute tokens to investors? These questions do not have clear answers and continue to leave companies in risky and unknown waters when conducting token offerings in the United States and/or with American investors.
It is clear that Commissioner Peirce believes that the SEC is not doing enough to help guide companies in the right direction, she notes “rather than provide useful guidance on safety standards and functional braking technology… [leaving] the industry to guess at the path to compliance”. Companies should not have to assume the risk of guessing at the correct path to compliance.
Who Did the SEC Protect?
The case of SEC v Telegram Group Inc. and Ton Issuer Inc. was petitioned by three investors; seven investors are listed as interested parties. All the investors would have had to qualify as “accredited investors” under the federal definition to invest in the Telegram raise. The minimum threshold for investing in Telegram was USD$1,000,000.
At the end of her speech, Commissioner Peirce asks, “who did we protect by bringing this action?”. It is a good question – one would assume that an investor with the capital to invest $1M in the Telegram raise is a reasonably sophisticated person or entity that understands the inherent risks of investing in new technology and early stage start-ups. So, who did the SEC really protect in this case? It appears that the only people protected were a handful of sophisticated investors who were unhappy with the risk they knowingly took.
Moving Forward
Since 2018 the crypto industry has witnessed a growing trend of companies refusing to accept American investors. It is likely that this trend of barring American investors will continue until there is clear guidance from the SEC. Due to the SEC’s enforcement actions and lack of guidance, most companies simply deem it too risky to allow American citizens, residents, or entities to invest in capital (token) raises.
In February of this year, Commissioner Peirce announced her proposal to bridge the gap between regulation and decentralization. She calls this proposal a safe harbor that gives companies a three-year grace period to develop a functional network. At the end of the three years, the tokens would not be deemed securities providing there is a functioning network where the token can actively be used for goods and services. Additional details about Commissioner Peirce’s safe harbor proposal can be found in the link above.
While Commissioner Peirce’s safe harbor proposal is well thought out and appears to be a great way to move forward, unfortunately, it is still simply a proposal. Given the ongoing refusal of the SEC to provide clear written guidance, rules, or regulation, we do not expect that Commissioner Peirce’s safe harbor will be adopted any time soon by the SEC. We expect to see other global markets take the lead in decentralized projects if clear guidance or regulations are not set out by the SEC.
by Mara Schmiedt, Global Strategy and Business Development Lead, ConsenSys Codefi
This is a two part article. Part 1 can be found here.
Summary
- The emergence of delegate work entities present a critical development to drive broader end-user adoption and participation, simultaneously posing new challenges to decentralization and token distribution in the evolving chapter of on-chain governance
- Token distribution strategies, as a result of the above, have seen a proportional increase in use-focused distribution mechanisms including proof of use and interactive airdrops
Trend 3: The New Kids on the Block
THE EVOLVING ROLE OF VCS AND DELEGATE WORK ENTITIES
With the rise of Proof-of-Stake, on-chain governance and other protocol-native work functions, networks require active user groups that have both the expertise and/or technical resources required to provide network-specific services and infrastructure. At the same time, these productive crypto-assets present new value accrual opportunities for entities with crypto-native business models that play an active role in network participation and adoption.
On one hand, traditional venture models are increasingly evolving into crypto-native hybrids. Capital providers with long-term holding strategies such as Multicoin Capital and ConsenSys Labs recognize the opportunity to create additional alpha by supporting networks in their portfolio through the provision of infrastructure and performance of crypto-native operations. These entities are uniquely positioned to support teams that are building decentralized protocols to bootstrap and jumpstart network effects.
Well designed agreements and incentives can ensure that all token holders involved in early stage project funding in the protocol’s development lifecycle can be valuable supporters that earn rewards from their own and ongoing participation and contribution to the network.
On the other hand, there has been a proliferation of another stakeholder group – so called ‘delegate work entities’ (see article by Ben Sparango). Delegate work entities are network stakeholders elected by a token holder to perform network-native work functions, such as staking and voting, on their behalf.
The premise of earning rewards on productive crypto-assets in exchange for contributions to the network is an attractive one, yet not all token holders necessarily have the time, desire, or technical ability to perform the required tasks themselves. This is where delegate work entities come in. Today, delegate work entities including non-custodial (Staked, Stakefish) and custodial (e.g. Binance, Coinbase, Anchorage) providers are largely focused on providing staking services to both institutional and retail clients. I believe custodians, exchanges, funds and independent delegate work entities will play a critical role in driving broader institutional and retail adoption of productive crypto-assets.
Source: PoS Bakerz, 2020
Recent developments such as Katalyst, Kyber’s 2020 protocol upgrade, reveal the increasing relevance delegate work entities will play in the governance realm either as direct actors in the voting process or by offering proxy voting functions on a token holder’s behalf.
I expect to see further growth and diversification in delegate work entities and other service providers as the Proof-of-Stake landscape continues to expand and believe these entities will continue to play a critical role in driving broader adoption and maturation of the industry. A research study conducted by ConsenSys in March revealed that across almost 300 active token holders 41.4% would like to participate in on-chain governance directly while 28.2% would like to delegate their vote to a representative.
Source: ConsenSys Codefi
It is important to note, however, that delegate work entities, particularly custodians, exchanges and funds with large and accruing token allocations, could result in centralization risks particularly as Proof-of-Stake systems increasingly co-evolve into on-chain governance.
Trend 4: Evolving Token Distribution Strategies
THE FUTURE OF USE-FOCUSED TOKEN DISTRIBUTIONS
As network participation data indicates, having a broad distribution is not enough and it is critical that distribution aligns incentives amongst all network stakeholders. Healthy networks have a representative and actively engaged network of stakeholders.
How have the aforementioned trends manifested themselves as design considerations in more recent token distribution models?
There has been a proportional increase in public token distribution mechanisms focused on targeting actively contributing users.
Source: Smith & Crown, 2019
These have come in the form of both interactive airdrops, such as Livepeer or Edgeware, as well as different implementations of proof-of-use enabled token distributions such as NuCypher, Solana and SKALE that are focused on distributing tokens to actual users.
I believe that designing distribution models that factor in self-selected productive efforts beyond capital contributions in a sale or (pseudo)-random selection in a passive airdrop is essential to:
- Maximize regulatory compliance by ensuring that a token is being used for its intended purpose on the network, rather than a speculative holding.
- Filter for participants most likely to participate in the network to disincentive short-term speculation, price volatility and dumping.
- Effectively bootstrap the network at launch, whilst enabling early adopters to familiarize themselves with the network and earn token-based rewards for their efforts.
Conclusion
With the technical maturation of token-powered networks, particularly in the context of rising Proof-of-Stake adoption, the industry is leaving its adolescent, wild west years behind as it enters the chapter of ‘actual’ use and utility.
The chapter of use also creates a new window of opportunity for stakeholders with crypto-native business models, including VCs and delegate work entities, that play a critical role in the adoption and maturation of productive crypto-assets and the decentralized networks they are a part of.
While there is still a lack of formal regulatory guidance on the blueprint for compliant token launches, I believe the emerging discourse, setting of industry best-practices and increasing focus on use-focused token distributions are steps in the right direction.
Despite the financial uncertainty posed by 2020, the tumultuous year has represented something of a prosperous one for the stablecoin market. Since the beginning of the year, the cryptocurrencies that have their values pegged to existing assets like gold or the US Dollar have seen a heavy flow of funding as more traders look to buy into stable assets as a way of keeping their money from depreciating.
While stablecoins have become a useful store of finance that promises stronger protection against the disruption threatened by COVID-19 and subsequent recessions, there’s reasonable evidence to suggest that the currencies are actively evolving beyond their role as a trading asset and are increasingly being looked upon as a means of transferring value.
Over the coming years, we’re likely to see a range of central banks and large corporations start to tap into the stablecoin landscape, with global behemoths like Facebook already signalling their intent with the shelved Libra Project. With large scale investment into stablecoins looking like an inevitability, what will this mean for the crypto world’s smaller, un-tethered assets, like Ripple?
The Rise and Rise of Stablecoins
Tether entered the fray as the world’s first stablecoin. Launched in 2014, it took a matter of years before the US dollar-backed cryptocurrency started to receive widespread adoption.
As Bitcoin made its famous rally towards the end of 2017, more and more cryptocurrency exchanges started to make the switch from fiat currency-to-Bitcoin trading pairs to Tether-to-Bitcoin – thus enabling crypto-only exchanges to build on market share gains.
The late 2017 boom opened the door for more stablecoins to enter the market, with countless projects surfacing in a bid to emulate Tether’s purpose and success.
The subsequent year saw the arrival of several major players in the world of stablecoins, from USD Coin, to Paxos and TrueUSD.
As the arrival of COVID-19 caused widespread financial uncertainty, the market capitalization of stablecoins swelled up collectively to over $7bn in value in a matter of three months – with almost $6bn comprised of Tether investments.
Since the spring time, the rise of DeFi protocols have caused stablecoin markets to swell up by as much as $100 million each day – leaving the industry’s market cap more-than doubling in size since the start of the year.
Furthermore, more emerging trends surrounding the acceptance of stablecoin projects among banks have led to a greater level of acceptance among investors. The Liechtenstein-based Bank Frick recently announced that it would be supporting USD Coin – allowing customers to send, receive and store the stablecoin using their bank accounts.
The meteoric rise of the stablecoin market, coupled with ever-increasing levels of interest in blockchain technology from both banking institutions and big businesses alike means that stablecoins are set to emerge as the cryptocurrency market’s primary form of banking coin. But what will this development mean for coins like Ripple and investors who look to switch their holdings in Bitcoin to Litecoin, for instance, in order to leverage fast transactions?
Eating Into The Crypto Market
Ripple’s formative years brought widespread excitement for the blockchain technology that the XRP coin was built on.
Payments using the coin were set to be swift and free of hefty processing fees that some early crypto assets commanded. The focus of the coin was set on interbank payments, but its early success caused Ripple to expand into a leading crypto payments network around the world.
At the height of its popularity, Ripple was easily accessible on leading crypto exchanges that allowed easy access to digital finance that could be easily traded.
However, Ripple also unwittingly formed the blueprint on how to build a successful stablecoin.
The implementation of stablecoins that are pegged to various assets designed to hold their value amid economic downturns while operating on an easy transactional framework with limited processing fees has placed numerous stablecoins in direct competition with Ripple.
With the arrival of other corporate-backed stablecoins like the JPM Coin and the Utility Settlement Coin Project, it’s clear that the old guard of XRP faces a significant battle to avoid being drowned out by the market’s new upstarts.
The financial might of corporate stablecoins means that Ripple’s swift payment systems may soon be bettered via new transactional developments.
However, there may be some hope for Ripple due to the coin’s longevity in a rapidly expanding market. Ripple has helped to onboard over 300 customers during its lifespan, and possesses a greater level of crypto experience compared to its competitors.
It’s clear that stablecoins are here for the foreseeable future, and even hold the potential to overhaul national fiat currencies in mainstream usage. With market caps inflating exponentially, the old guard of un-tethered cryptocurrencies may be at risk of losing out as more adopters look to find practicality and consistent prices within crypto assets.
For Ripple, the notion of competing to recapture its place as the industry’s preferred coin for transactions seems too whimsical given the financial might of these new players introducing stablecoins into the market place.
Instead, what was once looked upon as one of the world’s most promising cryptocurrencies will have to tap into its experience to adapt away from its swift transactional roots. The cryptocurrency market is based on natural selection, where only the most innovative survive. In this unforgiving climate, many of the pragmatic cryptocurrencies of yesterday will be required to explore new blockchain developments elsewhere to maintain their relevance to adopters.
Digital Securities
Wave Financial Makes First 1000 Barrel Purchase for ‘Kentucky Whisky 2020 Digital Fund’
Tokenization is beginning to attract increased attention from investors with this past week bringing multiple examples of important markers being met. First, INX met its minimum threshold for token distribution, with $7.5M USD raised. Second, Wave Financial completed its first purchase of bourbon/whiskey for tokenization through its Kentucky Whisky 2020 Digital Fund.
Whisky – A Different Approach
What is intriguing about these events is the underlying assets. To date, the vast majority of tokenization efforts have surrounded real estate. In this instance, however, the underlying assets are a trading platform and Kentucky Bourbon/Whisky.
Although investors have taken an interest in alternative assets such as wine and art for decades, the fund by Wave Financial represents one of the first efforts to tokenize an asset such as bourbon/whisky.
“For investors to gain exposure to real assets that have impressive investment fundamentals such as whiskey is very difficult, but now it is possible via our fund. Following the launch in March we are delighted to have completed our first tranche time sensitive capital raise and purchased 1,000 barrels of physical premium Kentucky bourbon whiskey on behalf of our investors” – Benjamin Tsai, President and Managing Partner of Wave Financial
Other examples of niche tokenization efforts include:
CurioInvest – Fractional investing in rare automobiles
TheArtToken – Fractional investing in fine art
Progress Made
Although reaching this first marker is an important moment for Wave Financial, it is just the first on a long road. With Wave Financial expecting to tokenize between 10,000-20,000 bottles, this current crop of 1000 only represents 5-10% of its goal.
“With our unique access to Wilderness Trail’s whiskey production capacity for this year remaining open, we are in a great position to continue the capital raise for the fund.” – David Seimer, CEO of Wave Financial
If Wave Financial is able to reach its end goal, this would represent the tokenization of an entire years-worth of bourbon/whisky from manufacturing partner, Wilderness Trail Distillery.
A Full Set of Macallan Whisky
For those wondering if Bourbon/Whisky can indeed represent a good investment, look no further than Macallan.
Matthew Robson, 28, was the recipient of one bottle of Macallan single malt scotch whisky on his birthday, for 18 consecutive years. He recently made the decision to sell this collection, which was left untouched over time. This decision resulted in a sale, bringing in $56,000 USD.
While not an example of tokenization, the appreciation in the Macallan Whisky collection is exactly what investors are after. Providing the whisky is properly cared for, it is a product that will not deteriorate over time, and is only produced in limited runs. Furthermore, there will always be a consumer demand – simply put, people like to drink. For each of these reasons, Wave’s Kentucky Whisky 2020 Digital Fund may just go on to prove quite successful for investors thinking outside of the box.
Speaking with Benjamin
When the Kentucky Whisky 2020 Digital Fund was first announced, we were fortunate to have completed an exclusive interview with one of its fund managers – Benjamin Tsai.
As the President and Managing Partner of Wave Financial, Benjamin Tsai was able to provide unique insights into the fund, Wave Financial, and the digital securities sector at large.
To learn more about each, make sure to peruse this discussion HERE.
Wave Financial
Founded in 2018, Wave Financial is headquartered in Los Angeles, California. As a Registered Investment Advisor with the SEC, Wave Financial is able to offer investors opportunities such as the fund described here today. In addition, Wave Financial offers various consultation and treasury management services to its clients.
CEO, Dave Siemer, currently oversees company operations.