How Using The Word “Value” Totally Wrecked Munchee’s ICO
Tokens are a great way to fund new, ambitious projects but it is exceptionally important to understand the fine difference between a security and an “in-game” token (game being your product/project). A decade of working for a major Wall Street firm has made me realize one thing: you respect the regulators. Don’t be a crypto munchee.
According to the SEC’s order, before any tokens were delivered to investors, Munchee Inc. refunded investor proceeds after the SEC intervened. Munchee was seeking $15 million in capital to improve an existing iPhone app centered on restaurant meal reviews and create an “ecosystem” in which Munchee and others would buy and sell goods and services using the tokens. The company communicated through its website, a white paper, and other means that it would use the proceeds to create the ecosystem, including eventually paying users in tokens for writing food reviews and selling both advertising to restaurants and “in-app” purchases to app users in exchange for tokens.
According to the order, in the course of the offering, the company and other promoters emphasized that investors could expect that efforts by the company and others would lead to an increase in value of the tokens. The company also emphasized it would take steps to create and support a secondary market for the tokens. Because of these and other company activities, investors would have had a reasonable belief that their investment in tokens could generate a return on their investment.
How SEC Killed Munchee’s ICO
Munchee, a little known startup out of San Francisco which was developing a Yelp meets Instagram food review app, got contacted by the SEC within a few hours of launching its token sale (on Nov 1st 2017). The startup was advised that it was in violation of US securities laws, and needed to cease and desist from that activity. It complied promptly and refunded the money to investors for tokens already sold. No penalties were issued to it.
The SEC order released on Dec 11th 2017 lays out the case against Munchee. This is exactly what almost every single ICO does: they actively talk about increasing the value of their tokens, talk about profit, advertise to speculators and so on.
The takeaway from this is if Munchee’s token sale can be shut down, by the same parameters, so can almost any other ICO as well. It is a matter of which comes to their attention, and where they choose to focus their resources. They have the precedent and can “munch” on any ICO fairly quickly. All it takes is an email or a phone call — and your months/years of planning for an ICO is out the window.
As the Commission discussed in the DAO Report, tokens, coins or other digital assets issued on a blockchain may be securities under the federal securities laws, and, if they are securities, issuers and others who offer or sell them in the United States must register the offering and sale with the Commission or qualify for an exemption from registration.
Some notes from reading this
- While Munchee claimed to have performed the Howey test, it did not publish its detailed legal findings on why its token was not a security.
- One small diagram object referenced how the MUN token would increase in value!
- Made references to increasing value of remaining tokens by burning some existing ones.
- Made references to maintaining liquidity of the token and making it available on several exchanges.
- Linked to 3rd party YouTube video which was presenting the MUN token as a way to profit.
- Promoted the token on special crypto currency forums meant for speculators.
- Essentially anywhere and everywhere “value of the MUN token” phrase was used, it was cited by the SEC in its order!
Purchasers had a reasonable expectation that they would obtain a future profit from buying MUN tokens if Munchee were successful in its entrepreneurial and managerial efforts to develop its business. Purchasers would reasonably believe they could profit by holding or trading MUN tokens, whether or not they ever used the Munchee App or otherwise participated in the MUN “ecosystem,” based on Munchee’s statements in its MUN White Paper and other materials. Munchee primed purchasers’ reasonable expectations of profit through statements on blogs, podcasts, and Facebook that talked about profits.
Munchee’s ICO related documents and communication on social media should be required reading for anyone contemplating a token sale on what not to do going forward. This is a good read as well:
More Munchee links:
- https://s3.amazonaws.com/munchee-docs/Munchee+White+Paper.pdf
- https://medium.com/@vankhoa21991/introducing-munchee-token-a-blockchain-based-restaurant-review-rating-social-media-platform-1917567a2e9c
From their whitepaper:
Within 30 days of the conclusion of the token sale event, MUN will be available for trading on at least one U.S.-based exchange and the organization will use its organizational supply to ensure that there is a sufficient liquid market. The organization will seek to work with additional exchanges in the future.
Reminder #1: Constrain yourself to building a “game” to be played with using your tokens
First thing to realize is your startup’s blockchain-driven product here is a game with a set of incentives for various participants. This game can be played with a token — that is the only purpose it is meant to serve. It is not meant for speculative investment.
These tokens can be bought, or gained through some activity within the product. Purchasing the tokens also allows the game to be built in the first place, and then enables users to play within it. The way the tokens are distributed within the game are simply internal game mechanics.
I am using the word game here repeatedly because that is what your blockchain-driven product is. If its more than a game, then it is a security.
Consider this: when users play a game you designed, such as a pinball machine, do they expect to get rich in the process ? No, they are just playing with tokens, which has value within that ecosystem. But if you tell them that:
“hey, if you purchase a token for a $1, play this pinball machine for a bit, and then you can get twice your investment or higher back as I keep on improving the pinball machine” — at that point you are selling a security, and violating securities laws as you haven’t registered/obtained an exemption for it.
Violating securities law in the US has landed people in prison in the past. The next wave of such folks will be some very token-rich fellows. Munchees got lucky.
When you do your “ICO”, you need to be careful about every single word, like or tweet or re-tweet you or anyone related to you writes or speaks anywhere. You are building a game, which requires tokens which serve as the game’s currency, and allow the game to be built in the first place. The game capitalists get to reap rewards within the game when it is built. That’s how you need to think about this otherwise you are down on a slippery slope.
The moment you/anyone in your firm makes a declaration or through actions which even hints that the monetary value of that token could be increased by the actions of you/your firm — that token is now a security. If you are based in US or Canada, you are unnecessarily fucking with the regulators by crossing this line.
When do securities laws kick in
In the US, securities regulation kick-in when you sell to US residents/ investors (from anywhere in the world), or are based in the US.
Similarly, in Canada, being based here or having Canadian investors put you under local securities laws. From http://www.osc.gov.on.ca/en/our-approach.htm:
Securities laws in Canada will apply if the person or company selling the securities is conducting business from within Canada or if there are Canadian investors.
This is great overview of the Canadian landscape:
Sidebar: Canadian startups incorporating in the US ?
It used to be a norm for Canadian startups to setup a US legal entity as well for the purposes of raising funding from US investors. But given the token climate, does it still make sense, as then you come under the jurisdiction of the SEC ? By not being a US entity, not allowing US-based investors, and not engaging in speculative play at all — isn’t that the best way to proceed here for Canadian startups ? How about just using the token sales to build out your platform as was the original intention ?
Reminder #2: Do not promise returns of any kind anywhere and do not talk about value!
For instance, Ted Livingston, the CEO of Kik, declared on Twitter in reference to the digital currency called Kin which they launched, about how Canadians missed out on “$100mm in gains due to weak guidance from OSC”.
If as a Canadian, after reading that tweet, I bought a significant share of Kin on public exchanges (which don’t restrict buyers based on nationality unlike as it is done in an ICO), and subsequently lost significant value (like Kin did) won’t I have a case to sue Kik for misrepresenting that as security ?
This is not a good idea. Participating in speculation is a recipe for disaster as in unwanted regulatory attention. In the US, this is what led the SEC to kick Munchee’s ICO to the curb, where Munchee decided to not go ahead with it, and also ended up refunding the money to investors — but could have faced worse penalties, and now has shut down altogether. Violating securities laws carry jail time and stiff penalties. Its a question of enforcement — why be on the flip side of the rules here ?
Reminder #3: It’s not worth it to be involved in shaping your token’s market for a voodoo market cap!
Coinmarketcap.com also ranked higher than most U.S. news websites, and even Alibaba.com , a major Chinese retailer site that was ranked 174th globally.
That is quite a feat for a company that doesn’t have a corporate office, nor any clear outlet to the outside world save for a Twitter and Facebook account. The website doesn’t disclose any company officials, nor does it provide any contact beyond a general support email.
Market cap figures for crypto are calculated by the leading site coinmarketcap.com based on circulating supply. If you hold X number of tokens, that means that contributes to the total perceived market cap, even though there may not be a buyer for that full X number of tokens. Your ability to cash out USD from significant speculation in token holdings is limited to a very particular window of opportunity. In the Kin example below (refer other links), it seemed to me that if someone sells more than a 0.001% of that token which is not liquid enough, then that is likely crashing its value and crashing the value of the remainder of the holdings.
At the end of the day this market cap figure is the key driver of greed which can put you in trouble with the regulators while not driving anything significant to your bottomline — it doesn’t make much sense.
If the crypto market cap is a hokey pokey number, then what is the benefit to you in enhancing the trading ability, listing it on various exchanges, promoting it as a store of value and so on — all of which could attract unwanted regulator attention and distract you from your core value proposition.
Other people pumping/dumping your token, and where it happens someone advertises your token to a grandma on Facebook, who then loses some $$ — that would not make for a great story. You, will be in trouble in such a scenario. As humans we are optimists — bad stuff always happens to other people. Why did Munchee get picked — a small, inconsequential startup doing only a $15MM token sale, and it actually had a product in the market ? There is a dart board somewhere..
But my lawyer says..
First, and most disturbing to me, there are ICOs where the lawyers involved appear to be, on the one hand, assisting promoters in structuring offerings of products that have many of the key features of a securities offering, but call it an “ICO,” which sounds pretty close to an “IPO.” — SEC Chairman
While the SEC has issued a number of warning shots over ICOs, and filed charges against several companies, this appears to be the first time Chairman Clayton has singled out the lawyers who helped facilitate the ICOs. In effect, he said some lawyers are colluding with companies to sell securities without a license.
Other posts I wrote in this series
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