Occasional musings on crypto from an early investor, entrepreneur, and two-bit idiot.
TBI's Daily Bit

Safe Harbors

April 20, 2018
Daily Bit

The VC's have apparently moved in to save the day. (Or themselves.)

Both the WSJ and NYTimes have reported that a number of top-flight investors and crypto law firms met privately with the SEC last month to discuss token regulation.

What happened?
The “Venture Capital Working Group”, a self-organized squad that included Andreessen Horowitz, Union Square Ventures, and law firms Cooley, Perkins Coie, and McDermott Will & Emery, headed to Washington D.C. last month for a private meeting with the SEC’s Division of Corporate Finance. The group proposed the creation of a “safe harbor” provision for some virtual currencies, and argued digital tokens should generally be exempt from securities laws if they achieve “full decentralization” or “full functionality.” The regulators apparently expressed skepticism about granting such a broad exemption and even indicated they were still considering whether virtual currencies like Ether should be categorized as a security.

I still don’t get how the law works.
Right now, there's a test the SEC uses to determine whether something is a security. The "Howey Test" arose from a 1946 Supreme Court case SEC v. W.J. Howey Co., which laid out a four-pronged rubric for assessing whether something could be classified as a security. Specifically, “an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person [1] invests his money in [2] a common enterprise and [3] is led to expect profits [4] solely from the efforts of the promoter or a third party.” 

Okay, what are the possible scenarios going forward?
+ The good news is that the SEC cannot extend its authority beyond the confines of the Howey Test. It can classify a token as a security, or it can leave it alone, but it can't create a new category or regulatory framework. The SEC does have the administrative authority to adopt a "safe harbor" provision, though, a specific interpretation of the Howey Test that carves out token projects that abide by certain standards. Projects that effectively proved they were not mere speculative tools whose appreciation relies on the "efforts of others" (i.e. the issuers) could find safe ground. Unfortunately, safe harbors generally can't be applied retroactively. But this would be better than the alternative...

+ The nightmare scenario would be a categorical classification from the SEC that all tokens are, in fact, securities. This would mean any token sales that had not been sold in compliance with U.S. securities law (i.e. registering with the SEC or qualifying for and relying on one of the exemptions provided) could be on the wrong side of the SEC. This could lead to civil offense charges, and likely result in wholesale dissolution and "rescission" where projects would need to refund their investors and face substantial monetary penalties.

What does this all mean?
If you're a token issuer that did an ICO without consulting a securities lawyer or following existing securities laws, you should be worried, which is why your investors and lawyers went to DC.

Before you panic, two reminders: first, the SEC is seriously debating the definition of security as it applies to all cryptoassets--including ETH--which makes the sheer scale of a crackdown daunting to pursue in practice; second, any actual changes in the law would have to come from Congress (or legal precedent stemming from new court proceedings), not the regulators themselves. That will probably take quite a while. Hence the attractiveness of a "safe harbor" provision that mirrors similar efforts in the late 90s internet.  

A safe harbor would keep the good times and innovation rolling while still providing the SEC the flexibility to pursue bad actors with shitty exit scams, and keep a close eye on the form of poorly managed sales that enrich professional investors at the expense of Joe Sixpack.

You don’t need to be anti-government to support crypto. But TBD whether anyone in DC cares.


(h/t to Katherine Wu for the help on this one. Any corrections were hers. Any errors mine.)


I Like Pictures

This was me during our strategy session yesterday.

h/t @wmougayar

Red Pillz

The volunteer army at Messari is building a free, open-source library that anyone can use as a resource, so you can go down the crypto rabbit hole a bit more efficiently.

Today we look at one of the lesser-known privacy cryptos, Zcoin. The project shares a number of similarities to Zcash, since both are based on academic work from Johns Hopkins cryptographers. But the team opted for more tested RSA zero-knowledge proofs to provide anonymity for its users. Both Roger Ver and the Chilean government make guest appearances in the report so check it out.

Check back Monday as we look at some new crypto sectors. As always, send us feedback!

Eight tokens down. Thousands to go. 

TBI's Compression Algorithm

0x announces a new version for compliant peer-to-peer trading. 0x is creating a decentralized peer to peer trading platform that will allow for users to trade ERC20 tokens. The v2 of the 0x protocol would allow developers to plug their own custom smart contracts into the 0x pipeline, thereby extending its functionality. With this new release, 0x introduces the concept of an optional permissioned liquidity pool, which could be used to ensure the pool would only remain accessible to Ethereum addresses that met certain requirements. The (optional) permissions would be required to ensure that institutions with specific compliance requirements can trade with peers that satisfy the same set of requirements. Medium

Jill Carlson writes about the failure of Venezuela's sovereign ICO. The Venezuelan regime, on the brink of sovereign bankruptcy and locked out of conventional capital markets, launches a cryptocurrency scheme to raised funds through ICO mechanisms for their national token currency, the Petro. While in normal circumstances that is not necessarily and good or bad thing, the state of Venezuela's humanitarian crisis complicates the analysis of the issue. Jill makes the argument that the Petro is intended to bail out the regime from having to feel real policy pressure to improve the state of the country. Medium

ICO funding in 2018 thus far surprasses entire market for 2017 . Coindesk reports that so far in 2018, the ICO market has raised more money (at $6.3 billion now) than the entire 2017 ICO market. Both the average funding round and the rate of project funding are higher in this calendar year, as well. It is clear that regulatory risk has not deterred token issuers--  ICO as a fundraising model is likely going to continue. Coindesk

Still confused on what Token Curated Registries are? Max Bronstine’s latest medium post delves into the world of TCRs. Worth the read. Medium

Quick Bits (Don’t read that, I read it for you)

Choke Points (Exchange news)
+ Beijing-started crypto exchange Huobi continues its global expansion, announcing plans to open up an office in London.
+ Local Bitcoins made $27 million in revenue in 2018. One of the OGs in bitcoin marketmaking continues to plod along under the regulatory radar. 

Startup Signals (ICOs, Cryptos, and Startups)
+ Rare Bits, a blockchain-based marketplace for digital assets (e.g. CryptoKitties), raised $6 million in venture funding from investors that include Spark Capital, First Round Capital, and Craft Ventures. In the world of securities regulation, building a digital asset "marketplace" is smart. 

The Powers That Be (Legal/Reg/Policy)
+ Cryptocurrency mining chips have been added to a list of imports that must undergo standards examination by South Korea’s Customs Service.  
+ Belgium donated €2 million ($2.4 million) to support the U.N’s World Food Programme (WFP) and its technology projects, including its blockchain-based payments pilot for refugees.

BigCo Noise (Enterprise initiatives)
+ Batavia, the UBS and IBM backed blockchain-based trade finance platform, conducted its first live cross-border transactions involving corporate clients.

+ FINRA suspends Arthur Breitman, co-founder of Tezos, from associating with broker-dealers for two years "to resolve allegations that he made false statements about his side venture while working at Morgan Stanley." 
+ The latest MIT Technology Review interviews Amber Baldet, former head of J.P. Morgan’s Blockchain Department, and she apparently “smashed a few assumptions” throughout the conversation.
+ Vitalik long-form interview with the Financial Times (paywalled). Great stuff. 

Did I miss something big?

Send me the link, your twitter handle and your best imitation compression algorithm write up. If I really whiffed, I’ll include your bit tomorrow (with attribution).


Shameless Plugs

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