Ether : Is it a security?
And, why it does not matter.
I do not care if Ether, or any cryptocurrency striving to decentralize, is a security. I do not care because if the centralized Development Co. is doing their job, if the project metrics trend towards decentralization, and if they have built a community of users and third-party contributors, then it won’t f*cking matter what label the SEC or [insert regulator here] slaps on it.
Sorry, let me back up. I think I threw gas on the cryptocurrency vs. security debate a few weeks ago with the “Fuck it. I’m tweeting it.” tweet string heard around the crypto-twitter world in which I called XRP a security due to the centralization of Ripple Co.
These tweets were the direct result of my frustration of the blatant pumping of XRP and the centralization Ripple Co presented to the network.
I did not take the decision lightly to call XRP a security.
My frustration with XRP and the 2017 ICO boom came down to one central tenet of what a centralized cryptocurrency really represents— a Development Co’s desire for power and a desire to profit. The retention of the vast majority of the token supply by Ripple Co (60+%) and similar token developers is the most obvious case of a central authority to control and profit from what is likely a security. Controlling interest and technical power cannot coexist with the desire to profit in a truly decentralized project.
I was drawn to the world of cryptocurrencies because these projects represent tools to decentralize power and, as a result, self-empower anyone. These projects are very very similar to the original versions of the internet with mass distributions of information and peer-to-peer connections. Today, the internet is predominantly not peer-to-peer, but the infrastructure lends itself to something unstoppable when used properly or if a centralized service provider is on your side when another actor strikes. This is demonstrated by the founder of Telegram fighting to keep Telegram operating in Russia despite government attempts to shut it down.
Obviously, we need to remove the need for centralized service providers from the internet infrastructure and incentivize distributed networks of providers to power the unstoppable internet of the future.
This same is true for our money. Our money and securities must be unstoppable. Centralized cryptocurrencies, crypto-assets, and the tokens strapped on top of these protocols do not carry this unstoppable attribute. As a result, many of the newest ICO projects are at risk of being labeled securities. These centralized cryptocurrencies are at risk for failure for the same reason as many startups — team dynamics and expertise. This is why early-stage investors want to know the people developing the project; it is a factor for assessing the likelihood of success. Bitcoin and alts seeking decentralization remove the need for any single team, replaced by a network of GitHub avatars, nodes, and address strings.
So, is Ether a security? Is it centralized? Is it unstoppable?
Ether — Not a sure thing.
From a practical standpoint, regulators do not like pursuing cases that are not sure things. Despite what Ripple trolls will tell you, I’ve actually dealt with the SEC and state regulators in the past and they will not pursue actions if you have your sh*t together and have a defensible argument. The current state of the Ethereum network highlights that this is not a home-run case. While many believe ether was a security when issued for the pre-sale, others believe the Ethereum network is too decentralized for investors “to expect profits solely from the efforts of the promoter or a third party” (i.e. common enterprise element of the Howey Test). I based a lot of my argument that XRP was a security on the premise that the security analysis requires analysis at issuance and post-issuance.
Last Friday, after reading Nathaniel Pomper’s article about VC’s seeking a safe-harbor from the SEC for some cryptocurrencies including Ether (link), I started writing why I believe Ether was a security at issuance but is no longer a security due to trending decentralization. Then, I stopped writing. I stopped because it’s no longer intellectually interesting to me (more on that below) and the heads of the SEC and CFTC have already confirmed my position that a security token can later lose the status of a security (SEC statement and CFTC statement).
Also, crypto-lawyer twitter was already ramping up for a battle.
Ether is NOT a Security Camp
Peter Van Valkenburgh at Coin Center — https://coincenter.org/entry/no-ether-is-not-a-security
Ether is a Security Camp
Preston Byrne — https://prestonbyrne.com/2018/04/23/on-ethereum-security/
XRP is a Security
Me — see links in all of my tweets above. Plenty of other resources on this topic if you dare stick it in the google box.
XRP is NOT a Security Camp
Ripple’s Chief Market Strategist* and the incredible reporting of CNBC — https://www.cnbc.com/2018/04/12/ripple-says-its-cryptocurrency-xrp-is-not-a-security.html
*Yes, this is the job title of the clearly biased Ripple employee who is the supposed expert on this matter. His actual job is to create a market strategy for XRP according to an article produced by CNBC (link). The irony is incredible.
I think crypto-lawyers really enjoy this debate because our laws do not contemplate a technology that could remove a centralized promoter from the equation post-issuance of a security. I previously laid out my stance on how I would analyze a security token post-issuance for decentralization with my XRP tweets and supporting evidence. When applied to Ether post-issuance, the DAO fork and the creation of Ethereum Classic are the biggest factors that suggest centralization of control while also, interestingly, suggesting a lack of control, given that the Ethereum Foundation no longer supports the original chain (ETC). However, I think most other network metrics (contributions, nodes, miners, and distribution on ETH ownership) suggest a trend towards decentralization. Jackson Palmer’s project AreWeDecentralizedYet is one of the better resources to gauge decentralization of Ethereum and other networks. If you have opinions on the matter and think other metrics should be tracked, then contribute on GitHub, as Jackson open sourced it, too.
Why the debate is boring to me.
The Ether security debate is not intellectually stimulating to me because the security analysis is not black and white. Regulations are enforced by people looking at a spectrum of gray. These people have agendas. These agendas are incentivized by sure things furthering said agendas. This creates an enforcement feedback loop. BitConnect and AriseBank are examples of easy bets for regulators, unlike Ether.
The SEC security analysis is also not interesting to me because I’m more interested in the technology that makes regulation very hard to enforce. Yea, I am an attorney telling you to create technology that evades enforcement (not the law because that’s not how words work). While some regulation makes sense, I tend to prefer market-based regulation in the form of standards and collective agreement to abide by them (same-same-but-different). Decentralized exchanges, onion routing, end-to-end encryption for messaging apps, and decentralized browsers are where we are taking this thing. These will empower the revolutions of the future while the wars rage on maps that do not see bodies of water. (Watch the war of the future in real-time here).
So, what do we do now?
Successful Projects
If you are a successful centralized project (read: the ones that raised the most money with a team that wants to continue building), you should be negotiating a settlement right…about…now. Here are my predictions of how most will go down: (i) some insiders may be barred from operating SEC-regulated entities for a period of time; (ii) projects will pay a fine that is enough to make a headline for regulators but not detrimental to investor interest; (iii) some investor funds will be returned; and (iv) some of these projects will exchange the unregistered security tokens tokens for new tokens. These new tokens will either (a) intentionally avoid characteristics the SEC found relevant to the security analysis, or (b) the new tokens will be registered as security tokens. The registered security tokens will have the added features of regular disclosures, potential voting, or income rights. Yes, these are the features you probably wanted out of your token pre-sale anyway.
Unsuccessful Projects
As for the unsuccessful centralized projects (read: fraudulent projects or projects that did not raise a lot of money or with a team that does not want to continue building), these settlement negotiations will not go as well. With less money for good attorneys, (i) insiders, promoters, and maybe even some service providers will be barred from the securities industry; (ii) project creators will settle with admissions of some number of security law violations; and (iii) funds will be returned to investors. Meanwhile, the fraudulent centralized projects will fight the SEC and/or become fugitives of the law. These fugitives will make for a boring television documentary in 2019.
Interestingly, both the successful and unsuccessful centralized projects include both bad actors and people who were more worried about raising a bunch of money with a white paper rather than building a product and community to enable decentralization.
The Decentralized Projects
Meanwhile, there is an entirely different class of projects that either was a security in the beginning but no longer have a central authority or never took money in the first place. Impossible? Nope. Talk to Bruce. He’ll tell you all about Ravencoin.
Any SEC action on a decentralized project will (a) be a mistaken application of law likely induced by people they are trying to protect (read: incumbent wall street types); and (b) be very hard to enforce. Enforcement will occur on the on and off boarding ramps for USD and FIAT. Technical enforcement beyond FIAT will be next to impossible because nothing spurs ingenuity like a government actor trying to shut down your internet project. See, History of the Internet History as your example.
/end
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