Summary

[1] I was running this case against a developer before the Court and I hope this article will bring into focus industry practices that are often not in plain sight to the ordinary man on the street. Basically the case can be summarised as hijacking more land than originally agreed in the Joint Venture Agreement (“JVA”). And the developer got away by suggesting that the acreage stated in the JVA was only an estimate (ie “more or less”) even though the hijacked land was more than 0.7 ACS or 2832.8 square meters or 30492 square foot as it encompasses a public road not previously agreed. The developer also argued that he has the absolute power to take more land above that is agreed as the local authority would not have approved this development unless this road was built at the expense of my client the landowner’s land. My client was not consulted nor aware of this requirement until he saw this built road for the first time after the construction screen/fence was removed. Not only did my client failed to get compensation for this hijacked land, instead he was chastised as “opportunistic”. This cautionary tale should be a wake-up call for those who are considering a Joint Venture with a sleek developer bearing gifts. On a personal level, this unsavory affair also pitted family members against each other, making this litigation even more bitter than usual.

Introduction

[2] The fact that a contract is titled with the word “Joint” is deceptively attractive underscoring the benefits of working together for a promised goal but what happens when things go wrong ? A JVA is about collaboration by specific performance and termination is always not the first remedy, unlike other contracts. It is like a de-facto relationship peppered with dirty secrets and disappearing documents. Reconciliation is often preferred but sometimes parties do end up in court to seek redress. JVA is a common form of collaboration, especially for property development but is applicable to any form of venture. The “Joint” refers to the outcome and not how the parties deal with trust or fairness to each other in particular when there is an imbalance of influence or power. Typically, a JVA usually involved a developer with “some” cash and a landowner with idle land without the means to develop. In most cases, it is a rare find, as the idle land must be free of any encumbrances and its location in great demand for built areas like housing or commercial properties. Unless the landowner is facing some financial difficulty, the landowner is usually in a very good position to negotiate or even sell the land if he or she so pleases. The ritual to knot the Joint Venturers together starts with the all-important courtship. The developer will come bearing gifts and promises to vow the landowner or in some cases an immediate family member to get a leg inside. This article is about knowing how property development works and how to protect one’s interest vide this JVA as a landowner. It may be too late for my client who consulted his brother but it really pays to have a lawyer who understands not only the law but the development process to go through any JVA with a fine toothcomb. This JVA will normally be drafted by the developer’s lawyers and the landowner will have little say unless he or she is willing to hire a lawyer to go through the fine prints. This is not to say that all JVAs are biased. Unless one is conversant with the property development process then one should also be careful particularly to its companion document known as the Power of Attorney.

Power of Attorney (“POA”)

[3] This document can be found separately or within the JVA itself. Basically, being the landowner, you should never give any Power of Attorney to the developer or limited at best. I say this again. This is because with this document the developer can leave you out of the loop when it comes to obtaining approvals from the authorities leaving you without any authority to even ask what is happening as the former will not recognise your rights as landowner anymore. The developer, on the other hand, will argue that this POA is a necessary evil as it will assist and speed things up as it deals with the mundane paperwork and negotiations with the local authority.

[4] In law, only the titled landowner can deal with the local authority in matters of land development and because of this, the developer’s lawyers will draft a very wide POA to encompass all foreseeable situations to avoid having to bring the landowner to see the full picture. The only limitation common in all POA is a clause that says the donor of the power (landowner) shall only agree to ratify and confirm all that the Attorney (developer) shall lawfully do or cause to be done. This means that the donor of the power can refuse to ratify unlawful acts such as taking (stealing) more land that was not part of the JVA. It is common for the developer or donee to get an “irrevocable” power of attorney which literally means the power cannot be revoked (other than by death or by reason of mental illness). It is very foolish to grant an “irrevocable” POA. There is no requirement for a POA to be “irrevocable” power as its function is merely to allow the developer to do things or acts that otherwise should be done by the landowner, unless the latter is disabled. Further, this is a joint venture and not a transfer of rights such as an assignment where it is not reversible. Lastly, if you must give one make sure to include a “sunset” clause for this POA so that this power will be extinguished when certain conditions are not fulfilled within a time frame.

[5] As a landowner in a JVA, I strongly urged you to be actively involved beyond having to fix your signature for applications before the local authority and to understand the approval process. Seek independent lawyers to explain the documents you are about to sign and include this as an expense for the developer. To rely on a joint venture partner’s words is foolish and will only end up in tears. Again, for the same reason, this is also why the developer does not want the landowner to be active being fearful that the landowner having knowledge will dictate more benefits as the project progress by blackmail. Obviously this is a partial view where there is an imbalance of influence.

[6] Lastly, it is common for a developer to include the power to endorse the Sale and Purchase Agreement (“SPA”) for its own entitlements with third parties. To be fair, the developer has every right to sell its entitlements but the question is why is it necessary to have this power to endorse said sale on behalf of the landowner? It is not the case where the landowner is preventing a sale to a third party but merely that he or she is endorsing the sale being a landowner as part of the land is packaged as part of the developer’s entitlements. The better view is that this power should not be given to the developer as there is a chance to sell their entitlements even before they exist without the knowledge of the landowner as the said endorsement was done by the developer under the POA.

[7] In fact, this is what happened to my client’s case, the developer was actually selling “lots” from a building plan without his knowledge and endorsing the sale on his behalf under the POA. These “lots” are mere drawings and could not be “entitlements” from the JVA as the project had not even started. That is the reason why the developer wanted this power to sell and endorse whether they are qualified or not as they can get away with it. Loans are necessarily sought by the third-party purchaser and as part of the sale, the bank will ask the landowner to indemnify any losses in case the project failed by given an undertaking (using the land as collateral). Therefore it is also important to avoid giving any power for the developer to give any undertaking for third-party loans or in any way encumbered the land and have this stated in the Power of Attorney if you must give one.

Developer’s Entitlements.

[8] As with all property development, the reason for the developer to get in bed with the landowner is so he or she could flip or sell their entitlements eventually for handsome profits without much outlay. Be very careful here as in most cases, the developer will contract that their entitlements be sold as soon as the local authority approved the “building plan”. This is known as selling off the plan. But in developed countries, the banks will only finance the development when 90% of the Lots are pre-sold. As for developing countries like Malaysia, the banks will finance off the plan. The banks will also demand that the landowner be responsible for the borrowers’ loan should the project failed even though this is the responsibility of the developer. The reason to include the landowner is that the developer has no collateral and the developer has a power of attorney to act for the landowner unless the landowner explicitly negative this in the POA. Therefore it is very important for the JVA to state very clearly that the land cannot be encumbered whatsoever as mentioned above. A better reason is not to allow the developer any rights to their paper entitlements until the all-important Certificate of Completion and Certificate of Fitness to Occupy are issued. As the landowner, if there is any ready entitlement, the JVA should state that the landowner has the first right of choice to the entitlements before the developer. This is so in order to determine the developer is not entitled until the landowner had selected.

Land Owner Entitlements.

[9] For many landowners, they do not have the financial means and know-how to develop their piece of land and therefore dependent on the developer. The landowner’s goal is to get his entitlements at the best bargain. Usually, the ratio is 1 in 3 or even 1 in 2 depending on the saleability and type of development property for sale. In practice though, it is very important for the landowner to secure both Certificate of Practical Completion (“CPC”) and Certificate of Fit to Occupy (“OC”) from the developer and or its architect as proof that the project is completed to give rise to the entitlements. These two pieces of paper will determine whether the JVA is completed and nothing else. The landowner should never accept any other Certificates in substitute and if unsure must get the developer to admit those certificates are conclusive evidence that the project is completed.

[10] This means the JVA must state very clearly when both documents are expected, the effect of both in law and the consequences of delay (if any). I have seen attempts by lawyers acting for the developer to present other documents arguing these are “equivalent” to blindside the landowner into accepting that the project is completed so handover can take place with his signature.

[11] Landowner must be very cautious here as a project is not completed until the Architect issues this CPC and the local authority issues this “OC”. The local authority will never issue this “OC” without the pre-requisite CPC but there is the exception. In my case, the developer’s lawyers went to court to ask for a judicial review after the local authority rejected their “OC” application for the fifth time. For unknown reasons, the Judge managed to persuade Counsel for the local authority to issue this “OC” without CPC. This created an anomaly because insurers are now refusing to give coverage as technically the project is not completed yet.

How Developer gets around the above issues.

[13] It is common for a developer to include a clause in the JVA that says that in the event they cannot complete the entire project, they will pay an amount (to be determined by its architect) as a deposit or as a bank guarantee on contract so to ensure there are sufficient payments to see through the completion of the landowners’ entitlements only. In short, the developer is touting the case that the landowners are in safe hands even if the project failed. This sounds very attractive to the landowner as seemingly there is “nothing to lose”.

[14] In theory this is correct but in practice, this may be challenging. In the event, the developer cannot complete the project (due to bankruptcy or lack of funds), there is a high chance this amount will be claimed by creditors which includes the employees of the developer and also for any taxes owed. The landowner will be forced like others to wait for their share (if any). To get around this, the funds may be held in a trust account instead of a bank and pray that these funds will be sufficient to pay off outstanding debts first (to workers or suppliers) before work can be resumed. Secondly, the local authority and architect could not simply issue certificates for “part” of an incomplete project. This means while the Lots are completed in terms of work, no certificates could be issued rendering these finished entitlements, valueless.

[15] Another reason why the developer is keen to offer this “nothing to lose” scheme is to tie up the landowner so there is no new suitor or “opportunity cost”. It is up to the developer to continue completing the landowner’s entitlements but there is no time frame and a the same time, the developer will be trying to sell the remaining unfinished project to someone else. As long as the JVA is not terminated, the developer still has the opportunity to turn this around by including this clause.

[16] One simple way for Developers to finance the development is to sell to related entities (subsidiaries) or friends who will be able to resale later at a mark-up. Again recognizing the land as collateral, the banks will lend money to the buyer cum borrower and pay off the developer on a schedule for work completed. As I said above, the developer can execute the Sale and Purchase Agreements on behalf of the landowner due to the power of attorney. In my view, developers should have the financial ability to finance said development without seeking indirect loans, otherwise, the developer has no skin in the game which is outrageous. I would include a clause in the JVA that represents the developer is financially sound to carry out this development without seeking any loans.

[16] Developer will also entice the landowner with a smaller scale project using less land but after the JVA and POA are signed, submit a different plan to be approved by the local authority known as the ‘bait and switch’ job. The only way to get around this is to make sure the POA and in the JVA says very clearly that all development plans or amendments must be approved by the landowner first. The developer will also say that as its architect is a professional, he or she will be the impartial referee between the landowner and developer in the event there is any dispute like amending the development plan and hence landowner’s interest is protected. This is more like a fairy tale as the architect will obey and listen to whoever is bound to pay their fees which are usually the developer. I am not suggesting the landowner should get his own architect but at the very least, make sure the architect is reputable and not a relative of the developer. It would be useful to get the architect to acknowledge as a party contracted in the JVA by both, he also has a duty and responsibility to the landowner being the other joint venture partner. This can be done by including a special clause in the JVA to bind the architect.

[17] In most development, the local authority would require some “infrastructure” to be included such as access roads, sewerage, lights, drains, parks, etc that would require more land beyond as agreed to in the JVA. The local authority may not approve the final development unless this is agreed and this usually comes in the form of “amendment” to the development plan (after the initial approval). Don't be surprised as I have seen dozen of amendments approved on the plan itself. The developer will argue that this is a requirement by the local authority which cannot be resisted. And with the POA being so broad, the developer has the absolute authority to use the landowner’s land for the joint development as it sees fit including concealing this from the landowner. To be fair, such circumstances could only arise where the local authority had already set their eyes on having this infrastructure in their Local Plan (another planning instrument). They have not done anything to date as they do not have the funds to purchase the targeted land to build this until the developer presented this opportunity in seeking their approval. In my view, the local authority has no power to place a precondition for approving the development plan for a partial road to be built without compensation to the landowner. This issue is now on appeal.

Fiduciary relation and good faith in Joint Venture Agreements.

[18] I have included this as the last line of defence but in practice, this should have been the first line of attack. This means your lawyer should have drafted the JVA in a manner where the interest of the landowner is safeguarded due to the imbalance of power. A duty of care is owed by the developer to the landowner as the law recognised the unequal relationship as per the High Court of Australia case of Jenyns v. Public Curator (Q.) 90 CLR [1953–54] 113 Dixon CJ, McTiernan and Kitto JJ have this to say at p. 133:

“We are not here dealing with any of the traditional relations of influence or confidence -solicitor and client, physician and patient, priest and penitent, guardian and ward, trustee and cestui que trust. It is a special relationship set up by the actual reposing of confidence. It is therefore necessary to see the extent and nature of the confidence reposed and whether it involved any ascendancy over the will of the person supposedly dependent on the confidence.”

[19] Similarly reference can also be made to the Australian Supreme Court case of Brian Pty. Ltd. v. United Dominions Corporation Ltd. [1983] 1 NSWLR 490. Samuels JA at p. 506 says that after reviewing the authorities, he is of the opinion that joint venturers owe to one another the duty of utmost good faith due from every member of a partnership towards every other member.

[20] In Malaysia, I can do no better by referring to the leading case of Newacres Sdn. Bhd. v. Sri Alam Sdn. Bhd [1991] 1 CLJ (Rep) 321 and I quote “The Judges here were talking about fiduciary relations between the parties.” referring to the above cases (at page 332 para e). “We would, with respect, accept this proposition which goes to show that if the agreement of 2 October 1980 entered into by the litigating parties is indeed a joint venture agreement then their relationship is a fiduciary one.” (at page 333 para a-b).

[21] But this may not be as simple as merely labeling your contract as a Joint Venture Agreement to stand. The opposition may want to argue that not every Joint Venture Agreement must end up with a fiduciary relationship, some may not be at all as given the scope and terms agreed upon. To check whether the “property development” type of Joint Venture falls into this category, we need to observe and decide whether the terms of the contract are to pursue a mutual aim — one in which each of them has an interest — the situation is likely to be very different. The terms will need to express a dependence with each other, place trust and confidence in the other, to cooperate to achieve the outcome to which their contract is directed, and to do so for the benefit of each. In the case of Adventure Golf Systems Australia Pty Ltd v Belgravia Health & Leisure Group Pty Ltd [2017] VSCA 326 [188]), his Honour reinforced this “joint interest” by saying “Although, no doubt, each party has its own individual and legitimate interest in entering into the bargain, the bargain is one not merely for the achievement of that interest, but also for the achievement of the joint interest. That, I think, is one reason why parties to a contract that may properly be described as one of ‘joint venture’ have been found to owe fiduciary obligations to each other.”

[22] Once a fiduciary relationship is established in law, the joint venturer must not exploit the other for his benefit only. In Adventure Golf Systems Australia Pty Ltd v Belgravia Health & Leisure Group Pty Ltd [2017] VSCA 326 [120], his honour said and I quote :

“The essence of a fiduciary relationship is that one party to the relationship is obliged to act in the interests of another party (or, in the case of a partnership or joint venture, their joint interest) to the exclusion of the former’s self-interest. As a result, the fiduciary is prevented from entering into any engagement in which the fiduciary has, or could have, a personal interest conflicting with that of his or her principal; nor is the fiduciary allowed to retain any benefit or gain obtained or received by reason of or by use of its fiduciary position or through some opportunity or knowledge resulting from it.”

[23] In conclusion, parties should pay attention to how the terms were agreed upon in the JVA as stated by his honour “More often than not, commercial transactions which were negotiated at arm’s length between self-interested and sophisticated parties on an equal footing do not give rise to fiduciary duties.” Ibid [125] and in most cases may not be “automatic” as suggested rather a detailed factual enquiry will be required in each case where parties seek to establish fiduciary obligations within a joint venture framework.

[24] There is an old saying a contract cannot be fair unless both parties give up something of value. Note, as usual, this is general commentary only and does not constitute legal advice.

1. Difference between Bitcoin/Ethereum etc and Libra (FB crypto-coin)

1.1 While FB is busy working on its new Libra Crypto-coin (backed by a basket of local assets), let us cut the hype and get down to the numbers to see why Libra could be the next real bitcoin or not. It is common knowledge, Facebook users come from these top 4 countries are India, US, Brazil and Indonesia with 260,190,120,120 million users respectively. (source https://www.statista.com/statistics/268136/top-15-countries-based-on-number-of-facebook-users/) Notice 7 of countries are still developing countries which beg the question of why is FB based in US when its clients are elsewhere and why do users from developing countries flock to FB. As far as I am aware this may be due to subsidizing vide mobile-telecommunication costs, but that is another topic.

1.2 The main issue is about exchanging fiat currency to crypto-currencies whether it is bitcoin or Libra and none of the developing countries cited above are friendly to crypto-currencies. (source https://www.investopedia.com/articles/forex/041515/countries-where-bitcoin-legal-illegal.asp) Facebook herein”FB” said that Libra is an asset-backed crypto-currency and I quote from FB’s white paper “though, it will be backed by a collection of low-volatility assets, such as bank deposits and short-term government securities in currencies from stable and reputable central banks. “ Further, according to FB, any interest earned from these assets will be applied “the costs of the system, ensure low transaction fees, pay dividends to investors who provided capital to jumpstart the ecosystem”. (source https://libra.org/en-US/white-paper/#the-libra-currency-and-reserve) The value of Libra is set against this basket of low volatility assets to make it stable. This is unlike Bitcoin or Ethereum which has no asset backing and more like USDT (also known as Stablecoin or Tether). I can submit that these developing countries would argue that such crypto-currency could potentially undermine its local currency if it is readily available to its citizens on demand vide whatapps or messenger. A far as I am aware bitcoin and other crypto-currencies have not made such an impact on said countries because it is still relatively hard to have access to them and hence not that popular. Again this may change with Libra.

2. The Libra BlockChain and running the Libra network

2.1 FB is using a new programming language “MOVE” for implementing custom transaction logic and “smart contracts” on the Libra Blockchain and supposedly “easier to write code that fulfills the author’s intent, thereby lessening the risk of unintended bugs or security incidents.” This means coders have to learn something new which begs the question of how much better it has to be than say Solidity to draw on support and development. FB uses the LibraBFT consensus protocol instead of Proof of Work (“PoW”) saying it is more energy efficient than “PoW” used by Bitcoin and Ethereum currently. Consensus protocol means everyone has to agree to something in order to accept a transaction instead of using a time delay in PoW to avoid double spending of the same token/coin. Ethereum had in the past month announced that it is moving to Proof of Stake (“PoS”) as well by 30 June 2019 dubbed Ethereum 2.0 to include Casper being Phase Zero and Sharding known as Phase One. Casper would require validators to have X amount of ETH to be eligible by staking said X amount. Initially, Libra will only partner with approved validators (so call founding members) and instead of staking coins, they will stake their equipment and service costs to run the nodes. I suppose the “punishment” for unbecoming behavior is to be kicked out of the network. Unlike Ethereum, Libra Blockchain is a single data structure that records the history of transactions and states over time as opposed to “blocks” of data. (https://libra.org/en-US/white-paper/#the-libra-blockchain)

2.2 It also applied a “gas”price which is designed “..to reduce demand when the system is under a higher load than it was provisioned for (e.g., due to a denial-of-service attack). The system is designed to have low fees during normal operation when sufficient capacity is available.” In so far as validators also known as node operators, FB is looking to initially support at least 100 validators and would be able to evolve over time to support 500–1,000 validators. (https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf at page 18 under “Advantages of the HotStuff paradigm”).

2.3 It uses the HotStuff protocol with some extensions as follows: 1. validators collectively sign the resulting state of a block rather than just the sequence of transactions 2. a pacemaker that emits explicit timeouts, 3. unpredictable leader election mechanism 4. use aggregate signatures that preserve the identity validators who sign QCs. (https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf at page 18 under “HotStuff extensions and modifications”)

2.4 In terms of performance, the initial launch of Libra protocol is designed on paper at least to support 1,000 payment transactions per second with a 10-second finality time between a transaction being submitted and committed. (https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf at para 8)

2.5 Basically, unlike the mainstream crypto-currencies like Bitcoin or Ethereum, node operators who are founding members (for now) can receive dividends from the “Libra Investment Tokens” and “new user incentives and transaction rebates”. These are special tokens in exchange for the node operators to invest in the ecosystem but are only available to founding members. Accordingly, Libra Investment Tokens represent an expectation of returns from interest on the future reserve, further incentivizing the validators to keep the system operational. Because the assets in the reserve are low-risk and low-yield, excess returns for early investors will only materialize if the network is successful and the reserve grows substantially in size. FB plan to gradually transition to a proof-of-stake system where validators are assigned voting rights proportional to the number of Libra coins they hold. (https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf at para 9.2)

2.6 However given the low yield return from these assets, FB stop short of discussing any incentive or security for the validators beyond that it will move to a proof of stake protocol in the near future. This is disheartening as the heart of the network are these validators, whether they stay on by spending their resources to back up the network or not is a question of profitability rather than purely to support FB’s ambition to reach the unbanked. FB says that ”….more research is needed to determine how best to maintain long-run competition in the ecosystem while ensuring the security and efficiency of the network. Furthermore, as stake-based governance introduces path dependence in influence, it is essential to explore mechanisms for protecting smaller stakeholders and service providers.” (https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf at para 9.3 “Validator Security and Incentives”) While “stake slashing” was mentioned in passing as an example. Most node operators would need to be incentives otherwise they may not be interested and it is not as simple as turning on a switch from Libra from Bitcoin or Ethereum or vice-versa.

2.7 Not much is said about insurance and custody of Libra coins either. These may be important in the event of fraud or theft as these are not uncommon be it by external or internal parties. This is not a question about whether it can happen but rather when it will happen. The difference with crypto-currencies is price volatility for example, Bitcoin within a year it can drop to USD 3,000 and in next 10 months back to USD 10,000 while 6 years ago it was worth less than USD 100. This means the custodian needs to be adequately capitalized in such an event or to put aside some coins in a compulsory compensatory fund. In Libra case, the value is fixed but given the size and magnitude, this amount is not pocket change either and will certainly invite the attention of those who are minded to exploiting the codes which are open-source.

2.8 In summary, FB is suggesting that for the moment it is only interested in working with reputable partners but as it trends towards “PoS” the votes will be based on Libra Coins open to others. In my view, this would be misconceived as clearly none of the reputable founding members had many years of experiences in running nodes within a crypto-currencies environment. Other than having a deep pocket and interest to get access to FB’s users’ data, there isn’t much to contribute.

3. AML/CTF and KYC challenge

3.1 Obviously Libra is not anonymous (like Bitcoin or Ethereum) so while it may satisfy the KYC part, there is still the CTF/AML part which FB will have to maintain, a task that is every compliance banker’s nightmare. FB has no experience in this and having a former Paypal president to lead is not the same as running the operations. The minimum requirement for KYC is an official government issue identity card with photo. FB’s Calibra wallet seems to be the answer as it also required photo id. According to FB, Calibra will be a regulated entity. Second, Calibra’s financial data is separate from Facebook’s social data. The exceptions are 1. Preventing fraud and criminal activity 2. Payment processing and service providers 3. Aggregated data. Calibra will also use your FB data to improve services for you. This probably means targeted ads. (Source https://scontent.fkul16-1.fna.fbcdn.net/v/t39.2365-6/65083631_355528488499253_8415273665234468864_n.pdf?_nc_cat=106&_nc_oc=AQn9Q667CHyg8C6RRiiOvEp48lMqYfQRA18ZiHGWbrXyPC0_yWMPXJ17cASAGK5eY44&_nc_ht=scontent.fkul16-1.fna&oh=41073fa601d6cc8efc55599017415c66&oe=5DBFB7C3)

4. Getting fiat currency into the Libra system.

4.1 Libra will initially rely on reputable partners like paypal or others to secure the exchange side of the business making funds already with these licensed entities to be tokenized. This is brilliant as there is no duplication. This may cause crypto-currencies exchanges to see some business decline as folks shift from “trading” with mainstream crypto to using Libra, particularly dropping less popular crypto-currencies like XRP and so on which is bank-centric. Accordingly, Calibra may integrate with cryptocurrency exchanges, but will not act as an exchange.

5. Cashing out

5.1 Again quoting from FB white paper, it says “The association envisions a vibrant ecosystem of developers building apps and services to spur the global use of Libra. The association defines success as enabling any person or business globally to have fair, affordable, and instant access to their money. For example, success will mean that a person working abroad has a fast and simple way to send money to family back home, and a college student can pay their rent as easily as they can buy a coffee.” (source https://libra.org/en-US/white-paper/#how-to-get-involved)

5.2 With respect this is unrealistic, as this assumes FB’s platform is the only universe in town. In reality, we interact with non-FB users or simply those who still want to deal with cash rather than Libra like my mum. Hence there is a need to cash out, for example, using the EMV network of ATMs. In remote areas where there are unbanked, I envisaged as others have like in M-Pesa that small shop entities facilitating the cashing out as well as cashing in (taking of funds). These entities should be regulated in their respective countries like in Indonesia, India and Brazil, the largest 3 where FB users are in the hundreds of millions. Here FB will have to compete with existing local payment methods as well and to ensure the integrity of those who are on the front-line of their Libra network. As far as I am aware FB had not applied for any money transfer licenses in said countries other than in the US and in the EU. Obviously, I am sure said countries would be happy to accommodate FB for a license provided always that FB will share data with them as other banking entities do.

5.3 So in conclusion, Libra can be said to be a convenient token representing some value that works well in a closed or connected environment much like EMV networks, the only difference is that FB did not start out as a bank or a money transfer company like Western Union or Moneygram. However, it saw an opportunity to monetize its users’ social connections as another effort to draw more interest to its platform and at the same time learn and collate about their purchasing habits. Currently, this is only available to the banks. FB already have businesses on its platform so Libra is not only a peer to peer but will also be B2C. This is just the beginning as there will be opportunities like lending using Libra as the underlying currency. But for the banks, this may be a wake-up call, a loud one. For example, it is time for JP Morgan to move with its much-hyped JPM Coin. After all, if I have a choice I would not use Libra as it is issued by a non-banking corporation with limited protection or insurance to cover my funds unlike FDIC insured banks where all I have to do is to convert at will within the same platform. And long before Libra, there is paypal and my own prepaid peer to peer payment (US Patent 8,650,126) which basically solve the unbanked problem. The good news is that users now have another choice instead of just texting their friends they can send some coins. But the biggest beneficiary here is probably still FB as they will eventually be able to issue unlimited tokens as much as the like of the Federal Reserve to print paper currency, thanks to the founding members who will chip in close to USD 1 billion to kick start this. Hopefully, the central banks will also give FB a run for its Libra.

[1] While Bitcoin zoomed up to USD 9000 recently, the reported USDT (also known as Tether with the same name as its creator) fiasco continued to expose the dealings and vulnerability of crypto-exchanges. (https://www.newsbtc.com/2019/04/27/bitcoin-price-reaction-to-tether-fiasco-may-signal-strong-fundamental-strength/) This gravity-defying USDT also known as a “stablecoin” is still hovering around 1 USD even after Tether admitted that its coin USDT was only backed by 74% cash in reserve (green line below), (https://coinmarketcap.com/currencies/tether/).

[2] USDT exists because we have a fiat currency such as U.S. Dollar (“USD”). This USD in turned is backed in “full faith and credit” by the U.S. Government. The creator of USDT said every USDT is backed by 1 USD which can be exchanged for Bitcoin or any of the crypto-currencies hence the term “stablecoin” as for every USDT must equal to 1 USD subject to any variance due to supply and demand.

[3] A number of reasons can be offered by arm-chair critics for USDT to stubbornly refusing to go below USD 1 such as — no USDT to borrow in order to short. The reality is that there was no panic selling when this Tether’s fiasco was first reported. There was also speculation that this parity float is managed by “interested” parties who are merely buying and selling to each other within this range as they have huge portfolios that are not ready to see a decline in value anytime soon. Unlike the stock-market, USDT’s creator actually holds a huge reserve of USDTs to pair with USD. According to one report citing Tether’s lawyer suggesting that USDT’s creator had invested in Bitcoin and is now leveraging on its rise to support USDT’s price and the case ought to be dismissed as the claims are too wide. (https://micky.com.au/new-high-is-tether-behind-bitcoins-latest-price-spike/)

[4] To many newbies it is easy to think all crypto-exchanges are the same and not distinguishable to stock-exchanges save for the licensing requirement. The fact is that almost all crypto-exchanges suffered from the inconvenience of having to store or vault their clients’ digital assets (crypto-currencies) with them. This is unlike stocks with “script” or digital version placed under custody by a third party such as ‘computershare’ or ‘state street’ for example. The reasons why there is limited custodian offerings can be attributable to issues such as ..”private key management can become exceptionally cumbersome, and creating more efficient methods to access cold storage funds without sacrificing security are paramount.” (https://www.forbes.com/sites/yoavvilner/2019/04/01/digital-asset-custody-has-a-growing-ecosystem-to-make-it-easy/#219d45ff66dd)

[5] Pending the arrival of a reputable custodian services provider, the combined custody of digital assets within the exchange can be awkward and represent another cost or even liability to the exchange. On the one hand, the exchange may argue that in order to trade online, the digital assets need to be verified as to their existence by having them deposited or stored first (in the exchange’s wallet). The next question is how safe is these wallets as very little is known about the “security” measures behind these exchanges which have mushroomed. Exchanges are not new. For those with memory back to 1995 there was an earlier digital currency known as “E-gold” (backed by gold/silver) and in its hey-days, this exchange was second only to Paypal. However, the U.S Government in mid-December 2005 decided to shut the exchange for failing to secure a money transmitting license and attracting “carders” who trafficked in stolen credit and debit card numbers. (https://www.wired.com/2009/06/e-gold/).This means even if the exchange is “legitimate” but somehow attracted the “wrong” type of clients, the U.S Government may still take action leaving innocent clients’ funds frozen. Even after 20 over years, save for Anti-Money Laundering requirements, most governments are still dragging their feet when it comes to regulating exchanges preferring either to ban outright, limited licensing or leave these exchanges to their own devices.

[6] Besides the “wrong” type of clients, exchanges also attract all kind of hackers attempting to steal users’ digital assets conveniently aggregated under one platform. While governments are likely to issue warnings about questionable exchanges from time to time, nothing much been done to mitigate or to avoid further challenges. The question is not whether it will happen again but rather when and which exchange. China notably took the most drastic step by banning all their exchanges including foreign ones from reaching into China. (https://www.scmp.com/business/banking-finance/article/2132009/china-stamp-out-cryptocurrency-trading-completely-ban) And more recently in April 2019, China also tried to ban bitcoin mining which shows it does not have much faith and control over exchanges even after banning them. This speaks volume as one of the largest exchange by turnover started in China before moving to Malta. China is however supportive of block-chain technology the backbone of crypto-currencies. (https://cointelegraph.com/news/report-china-leading-world-in-blockchain-projects)

[7] Be that as it may, for those wanting to trade crypto-currencies, the obvious question is which exchange ? For unconventional products, reputation alone is not enough. And it is not good practice to offer referral fees to onboard clients as this shows similarity to online casino outfits. We can take a page from the financial markets where over the years through ups and downs, we know that clear reporting/supervision are mandatory and insurance for deposits necessary to build trust with the service providers. Even with supervision, short-comings are not uncommon as we discovered recently in the long overdue Australia Banking Commission Inquiry Report where even reputable institutions were caught charging deceased clients for non-services. (https://treasury.gov.au/publication/p2019-fsrc-final-report/). Far from any supervision or reporting, most exchanges would formulate how best to manage their own risks internally. Given the absence of any transparency, the argument for no supervision or “self-regulation” will not see much support beyond the firewalls of these exchanges. Some may say that the very nature of crypto-currencies being decentralized is sufficient as check and balance is built by consensus but that is a separate matter as most exchanges are in fact a centralized platform. This means a single entity is operating the platform with a centralized database, not a distributed ledger even though actual transactions are recorded on the currency-blockchain itself (the blockchain is publicly available while the former is not). As I said above, as users’ digital assets are effectively held by these exchanges under their software and various terms, this means exchanges have to act in good faith by erring on the side of caution. To date based on the many reported incidents, there is no evidence to suggest good faith is being practiced.

[8] When faced with hacked accounts or theft, most exchanges are known to either close shop or to repay their clients in cash or in kind like shares. In most cases, there were no discussion or negotiation and the exchange would unilaterally decide how best to resolve without depleting its remaining funds or reputation. The better approach is to direct this to an arbitrator or ombudsman. In the recent Binance fiasco where about USD 40 mio was looted from ‘hotwallets’, Binance decided that it was cheaper to simply refund these losses from its “Secure Asset Fund” which is like a compensation fund. Accordingly, there isn’t many details about how the hacker(s) managed to by-pass Binance’s “security”. (https://techcrunch.com/2019/05/07/binance-breach/)

[9] Even though this “repayment” may be the end solution for theft, this does not create confidence as it shows exchanges are vulnerable to theft on the one hand or worst concealing thefts on the other by not reporting. In the Tether’s case, the Bitfinex-exchange said nothing about any shortfalls until the New York Attorney General filed a complaint demanding documents. In reply, Tether and Bitfinex claimed that court filings by the New York Attorney General’s office were “riddled with false assertions.” (https://cointelegraph.com/news/nyag-requests-that-bitfinex-be-forced-to-release-tether-deal-documents)

[10] Who should be blamed? As in the USDT-Tether-Bitfinex fiasco, in order to promote USDT and to get this “stablecoin” to the market, Tether-Bitfinex procured the services of “shadow banking service”. In Bitfinex’s case, it used an outfit named Crypto Capital. (https://www.theblockcrypto.com/2019/05/01/indictment-reveals-new-clues-to-the-crypto-capital-situation/) The modus operadi of Cryto Capital was to set up bank accounts around the world to accept funds (from the exchanges’ clients) by masking them as real estate transactions which got them into trouble. One may argue that had the regulators sanctioned Hong Kong-based Bitfinex and all other exchanges to use regular banking services, they would not have to resort to using shadow banks. This argument is an after-thought as it is well known that banks are required to inquire/report the activities of their users when their computer system flagged “suspicious” activities. Exchanges could candidly inform the banks that the accounts are for crypto-currencies trading which is lawful in Hong Kong. For some banks, they are prepared to do business depending on their relationships with individual exchanges. As I understand, Bitfinex wanted unfettered fiat currency deposit and withdrawal access from their previous bank(s) but this was denied and Cryto Capital presented itself. It would be reckless to say this exchange was misinformed about how Crypto Capital is able to deliver when “reputable” banks failed. They were prepared to take this risk to promote USDT and concealed the fact their previous bankers had terminated their services, directly exposing their clients to risk associated with shadow banks acting as its agent.

[11] Licensed banks are gatekeepers of the fiat currencies. These banks monitor every transaction and have a duty to see third payment processors that relied on their networks and platform are vetted and approved by its “correspondent” banks. This is for the same reason fiat currency like the USD must be cleared on-shore by a US Bank such as WellsFargo even though both BitFinex and Tether are based in HK and owned by iFinex which is registered in the BVI (another offshore tax haven).

[12] Notwithstanding the allegations against Tether-BitFinex-iFinex being played out in the US Courts, the fact is that most exchanges are not known to be transparent about its security protocol and risk management means we have to look at indicators for clues. The availability of insurance protecting users’ digital assets while in the custody of the exchange is a positive indicator as insurers are averse to risk. Given the marketing hype, we should be vigilant by considering the exchanges’ user agreement first, a must read for newbies. For this purpose, I will consider two exchanges that managed to procure insurance for its users in the last 6 months. In Australia, Independent Reserve offered some explanation about its insurance policy which is worth reading here. (https://www.independentreserve.com/help#insurance-policy).

[13] The exchange did not provide the actual policy due to privity of contract. In practice, one should get confirmation from the insurer/underwriter but in this case, the exchange did not even name the insurer/underwriter. According to its explanation, its policy will cover lost private keys (ie your password) when it is stored in cold wallets (ie on a piece of paper) and only when this exchange followed a set of protocols to generate, stored and retrieve this password. The explanation says in “….to cover the loss of cryptocurrency private keys for specific set of named cryptocurrencies where the private keys have been generated and stored offline by Independent Reserve in cold storage wallets. This insurance policy provides cover on a named perils basis insuring only against:” (underlined is my emphasis).

[14] Under a named perils policy, the burden of proving the losses is on the insured (ie the exchange) for and I quote ”…physical loss or damage; third party theft; and/or deliberate or dishonest acts of named Independent Reserve employees that cause a loss of the private keys needed to propagate a transaction on the blockchain of specific named cryptocurrencies.” in a “coldwallet” situation. This can be translated as requiring a physical break-in to this exchange’s safe or some hardware (where “coldwallets” are stored) to cause loss or damage or to steal these paper-hardware based passwords and where it involves the exchange’s employees’ there are further steps of identifying them and showing this was a deliberate or dishonest act. The main difference between hot and cold wallets is that the latter is off-line and the former is accessible online. Hypothetically, one can assume this insurance policy will not cover a situation where an employee’s pet (dog) accidentally chew up paper-based passwords pending transfer to the safe. Usually, this type of policy comes with a ceiling amount and is less expensive than “all-risk or open peril policy”. Under an all-risk policy, the burden is on the insurer to prove that the peril causing the damage is not excluded. It should be noted that this policy does not cover any breaches to “hotwallets” ie online. Hotwallets may be covered under Independent Reserve’s premium account membership at extra cost but the payout is against the capital of this exchange (not from this insurer/underwriter). Unfortunately, we are unable to obtain any audited financial statements about this exchange’s capital structure even though it was founded in 2013, it remains very much a private entity and no disclosure is needed.

[15] Another indicator is the availability of third party’s audit reports. Even in Australia where exchanges are required to comply with AML and KYC/CFT reporting by registering with Australian Transaction Reports and Analysis Centre (AUSTRAC), no audit was asked nor produced. A financial audit while limited to accounting will at least inform the public about its revenue and funding processes as opposed to SOC 2 audit that looks at controls related to the security, availability, processing integrity, confidentiality, and privacy at a service organization. SOC stands for Service Organizations are internal Control reports on controls that directly relate to the security, availability, processing integrity, confidentiality, and privacy at a service organization. In the US, we are minded of an exchange named “Gemini” (a reference to its founders — Winklevoss brothers) touted to be the world’s first cryptocurrency exchange and custodian to complete the rigorous SOC 2 Type 1 examination.( https://medium.com/gemini/gemini-completes-soc-2-review-a-worlds-first-for-a-cryptocurrency-exchange-and-custodian-d923790506d0). SOC 2 Type 1 refers to a report on the fairness of presentation of the service organization’s system and the suitability of the design of controls as of a specified date. While that is commendable, Gemini should be touting SOC 2 Type 2 which is a report on the fairness of presentation of the service organization’s system and the suitability of the design and operating effectiveness of controls over a period of time (say 1 year).

[16] For completeness, Gemini also touted its “insurance” coverage being available for “hotwallet” without one’s account being compromised (https://gemini.com/user-agreement/#digital-asset-insurance). Notice the difference that in Independent Reserve, “hotwallet” is not covered. Again this is commendable as “hotwallet” is more challenging than “coldwallet” but at closer inspection, this subtle distinction is actually a qualified coverage. In layman terms, this policy is only available when the hacker had compromised the “hotwallet” without breaching the user’s account first. This means the hacker was able to steal one’s digital assets without breaking into the user’s account. The rationale here is that users’ account are more vulnerable due to the nature of individual user’s password (either weak or strong) and therefore no cover is applicable where the user’s digital assets are stolen while online. For Gemini’s policy, the insured will need to show the hacker broke into the system with admin’s privilege as opposed to user’s privileges, a higher level of intrusion to steal the assets. In plain language, where the user’s account was compromised and assets were stolen online then there is no compensation under this policy.

[17] For those considering investing in crypto-assets, it is likely governments will introduce some kind of digital coins exchangeable for fiat currency at par in the near future and governments’ sanctioned programs have sound reputation than exchanges. Facebook, a well-regarded giant on the social platform will be looking at its own coin in the near future for payments within its platform although there is no suggestion for an exchange (https://www.theguardian.com/technology/2019/may/24/facebook-plans-to-launch-globalcoin-cryptocurrency-in-2020). By introducing a digital currency to replace cash, governments and the private sector will be able to learn more about its citizens-users by analyzing their transactions which to date is still the exclusive domain of banks. It also carries drawbacks as illustrated in a cited paper including instability to the banking sector (https://hackernoon.com/the-future-of-central-bank-digital-currency-cbdc-64797b645887) Until then, it is submitted that more policy/regulation focusing on transparency should be formulated to weed out rogue exchanges which have gotten “respectable” by procuring services offered by reputable parties as a marketing edge. The alternative view is either to use an open source decentralized exchange or to split your trades to more than one exchange and to store digital assets offline as a form of investment as opposed to trading because it is unlikely one can beat the trading bots.

Introduction/Casper

[1]The much awaited “Casper” upgrade is not yet implemented by Ethereum. Briefly Casper, it is in my view is a software to manage an investment scheme which comes under the Australia’s Corporations Act 2001 (Cth), that requires licensing and approval for the promoters. But first what is Casper ? For the sake of not repeating what others have already done, Casper is described in ( https://blockgeeks.com/guides/ethereum-casper/ ) as follows:

“Casper has implemented a process by which they can punish all malicious elements. This is how POS under Casper would work:

The validators stake a portion of their Ethers as stake.

After that, they will start validating the blocks. Meaning, when they discover a block which they think can be added to the chain, they will validate it by placing a bet on it.

If the block gets appended, then the validators will get a reward proportionate to their bets.

However, if a validator acts in a malicious manner and tries to do a “nothing at stake”, they will immediately be reprimanded, and all of their stake is going to get slashed.

Casper is not one specific project. It is an amalgamation of two research projects which is currently being undertaken by the Ethereum dev team. The two projects are:

Casper the Friendly Finality Gadget (FFG)

Casper the Friendly GHOST: Correct-by-Construction (CBC)”

[2]This is how another explains this recently when Casper codes were updated in May 2018. (https://www.coindesk.com/first-version-ethereums-casper-upgrade-published/)

Vitalik Buterin, who created ethereum, addressed the Casper upgrade at a conference in Toronto last week, calling it “hopefully one of the more joyous experiences in ethereum in a fairly short time.”

Once implemented, Casper FFG will alter ethereum’s software so that updating the blockchain involves a combination of proof-of-work — the electricity-intensive “mining” familiar from bitcoin — and proof-of-stake. The latter employs validators to update the ledger through a voting system within which users, sometimes called stakers, put down deposits of ether, which they risk losing if they attempt to cheat.

In its initial stages, Casper will retain ethereum’s current proof-of-work protocol to do most of the heavy lifting, using proof of stake to validate “checkpoints” periodically. Because the network can only handle so many validating nodes, the minimum deposit will start off at 1,500 ether, or $1.1 million at the current exchange rate.

The plan is eventually to move to a fully proof-of-stake system and to lower the minimum stake, but there is no definite timeline for that transition at present.

[3]Yet another to morph this complex idea in a simple way as described by V Buterin in https://www.coindesk.com/ethereum-casper-proof-stake-rewrite-rules-blockchain/

What separates Casper (and other more recent versions) from traditional PoS, is that it punishes participants who don’t play by the rules.

Buterin described it with a rough analogy: imagine 100 people sitting around a circular table. One person has a bundle of papers, each with a different transaction history. The first participant picks up a pen and signs one, then passes it onto the next person, who makes a similar choice.

Each participant only gets $1 if they sign the transaction history that most of the participants sign in the end.

“And if you sign one page and later sign a different page, your house burns down,” Buterin added, arguing that this is probably a good incentive to sign the right piece of paper.

[4]So the basic features of Casper is that Validators have to deposit ethers (ETH is the symbol for ether used for services on the Ethereum network) as a stake in the system to keep them honest. They are the ones that are going to sign the transactions and those that sign the wrong or questionable transactions will get their “houses burn down” as put by Buterin, the creator of Ethereum. It is like, instead of having licensed bankers looking after your financial records and able to sue them when they steal from you, you are asking strangers, automated programs called “pools” or even your mum and dad with “stakes” in the system to bet the transactions (for services) are valid of not before appending them to the block. Welcome to the brave new world of decentralised.

[5] At the Toronto Developer Community conference (“DevCon”) in May 2018, we have more definite answers to what and how Casper will account as seen in the colour slides below (courtesy of David Lim).

[5A] The significant finding here is the relationship between what is being staked and the return. According to Buterin, this is “Validator returns are proportional to the inverse square root of total deposits” In lay man terms this means the more deposits the less the return as seen below. This is only an example and not the actual figures to illustrate an inverse relationship between total deposit and returns.

[6] For example we can have a case where we started with 9 Validators with 1,500 ETH (min each*) and tenth with 2500 so total is 16,000 ETH. The inverse square root of 16,000 is 1/126.5 = 0.007 or 0.7% return on their ETH. These people will be making 0.7% return on their stake. The one with 2500 will be the lead signer and the rest will follow. Now assume in the second period two validators come on board with 4,500 ETH each making total deposit to be 25,000 ETH. The inverse square root of 25,000 is 1/158.1 = 0.006 or 0.6%. This means every Validator will be making 0.6% in the second period which is lesser. Note there is no distinction between those with more ETH, everyone get the same rate which is different with banks where they reward you more for more deposits.

• *Deposit is now 32 ETH — https://www.trustnodes.com/2018/06/16/casper-sharding-merger-confirmed-constantinople-back-table Casper and sharding are merged.

[7]In fact, Vitalik Buterin, ethereum’s inventor, estimates an initial ten million ETH will be staked, “Currently, an expected value is 10 million ETH staking at 5% interest, which is 500,000 ETH per year (~0.22 ETH per block).” (https://www.trustnodes.com/2018/04/20/ethereums-inflation-reduced-80-within-months-hybrid-caspers-specification-launches). In the same article, the author also remarked as follows:

“That means ethereum, and nodes, will basically get a decentralized savings account. Like the penny dividends in stocks, or the near 0% interest rate on your savings, ethereum will also automatically increase the amount of eth you have at a very competitive rate of 5%.”

[8]Obviously this can be achieved by participating in a stake pool which is like a “savings bank” in a smart contract.

Managed Investment Schemes

[8]Now no doubt the above scheme of taking deposit and paying an interest prima facie will raise some financial issues. For example, by receiving interest is this a deposit taking instrument or generally is this an Managed Investment Scheme as defined in section 9 of the Corporations Act 2001 (Cth) herein “Act” ? ASIC the Corporation regulator in Australia had considered this in general terms as:

“Managed investment schemes are also known as ‘managed funds’, ‘pooled investments’ or ‘collective investments’. Generally in a managed investment scheme:

people are brought together to contribute money to get an interest in the scheme (‘interests’ in a scheme are a type of ‘financial product’ and are regulated by the Corporations Act 2001 (Corporations Act))

money is pooled together with other investors (often many hundreds or thousands of investors) or used in a common enterprise

a ‘responsible entity’ operates the scheme. Investors do not have day to day control over the operation of the scheme. “

(https://asic.gov.au/regulatory-resources/funds-management/)

[9] With this in mind, this article will now consider whether Casper could fall under the definition of a managed investment scheme by which it has to be regulated to protect the innocent and not so savvy investors. To narrow down the definition, ASIC had excluded investments that are not managed investments schemes include: regulated superannuation funds, approved deposit funds, debentures issued by a body corporate, barter schemes, franchises, direct purchases of shares or other equities, schemes operated by an Australian bank in the ordinary course of banking business (eg term deposit) or retirement village schemes. It is clear Casper does not fall into any of these categories.

[10] In brief, Casper provides a mechanism where ETH can be deposited and interest (calculated by a formula above as decided by Buterin) are earned by ‘validating’ transactions on the Ethereum network. To validate this, let us go through the 3 elements under Section 9 of the Act:

A. The first element in par (a) of Section 9 — the definition requires that:

(a) “people contribute money or money’s worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether the rights are actual, prospective or contingent and whether they are enforceable or not);”

[11] In Casper, holders of ETH (a well known crypto-currency) contribute to a staking contract under Casper’s protocol which is locked up for the duration where they are used as collateral to validate transactions. If the stakers/Validators signed on the wrong transaction, then their stake will be burned. This means they will lose their deposits and of course there is no interest at all. The first issue is whether ETH is “money” in the ordinary sense. ETH or Ether is the unit of currency in Ethereum. It is a token that can be exchanged for services on the decentralised platform. Bitcoin is a digital form of money and payment system as Bitcoin is not used for its services, its utility is merely to “transfer” from A to B, whereas Ether is a means of buying services within Ethereum. Ethereum network is programmable using Solidity to do a number of things like issuing more Tokens (ERC 20 format) in exchange for Ether like the one seen in https://token.depositoffer.com. I also noted that in the case of Burton v Arcus (2006) 32 WAR 366 at para 51, their Lordships had made it clear that at para 51 and I quote “51 It is settled that the broad words of the definition of “managed investment scheme” should not be read down.” In the same Judgment at paragraph 56 & 57, it says

“56 This element was described in par 19.6 of the explanatory memorandum to the Managed Investments Bill 1997 as “incorporating a purposive element in the definition”. In other words, the money or money’s worth must be contributed for the purpose of acquiring the relevant rights to benefits.

57 The word “contribute” means, in this context, to pay or supply. It is implicit in the first element in par (a) of the definition, in the context of the definition as a whole and the provisions of Ch 5C, that the people will pay or supply the money or money’s worth to or as directed by the promoter or operator of the scheme.”

(https://jade.io/article/10795)

[12] I am also fortified to note that “Money” is defined as “money includes a payment order” under definition in the Corporations Act 2001 and as it is not disputed that ETH is used for paying for services on the Ethereum network, then as per its usage it must also be “money”. With that in mind, by staking ETH, the stakers or Validators are contributing them as ‘money’ to acquire rights to benefits or as directed by the promoter or operator of the scheme. There is no issue about earning interest as Buterin had already advanced that. Repeating the above, Buterin said it is expected the value of contribution is 10 million ETH receiving 5% of ETH per annum. In Section 9 of Act, “interest” in a managed investment scheme was defined in terms which corresponded to those in par (a) of the definition of “managed investment scheme”. In particular, “interest” was defined to mean “a right to benefits produced by the scheme (whether the right is actual, prospective or contingent and whether it is enforceable or not)”.

B. The second element in par (a) of the definition of “managed investment scheme” has three aspects as summarized below:

(a) the contributions or some of them “are to be pooled, or used in a common enterprise”;

(b) the purpose of the pooling, or use in a common enterprise, must be “to produce financial benefits, or benefits consisting of rights or interests in property”; and

(c ) those benefits must be produced “for the people … who hold interests in the scheme” (whether as contributors or as people who have acquired interests)

[13] The Federal Court has said that knowing where resources are located and that the resources are available to the members fulfills the pooling condition. At paragraph 90, the learned Lordships explained :

In our view there is no justification for limiting the meaning of the word “pooled” by requiring that it involve a fund. In common experience many things other than money are pooled, including motor vehicles, typists and skills or talents. In such cases, there is no identifiable fund. Further, in its second sense the word “pool” does not necessarily involve a “physical concept”. The purpose for which particular resources arepooled may be fulfilled simply by knowing where resources are located and that they are available. Two other definitions were advanced by his Honour, namely “any aggregation of the interests or property of different persons made to further a joint undertaking or end by subjecting them to the same control and common liability” and a “common fund or combination of interests for the common adventure in buying or selling”. These definitions seem to be designed to meet specific situations and not to provide an exhaustive definition of the term “pool”

(Brookfield Multiplex Ltd. v Int’ Litig. Funding Partners Pte. Ltd [2009] FCAFC 147) (see https://jade.io/article/118716).

[14] In Casper, stakers or Validators can either run their own stake operation or pooled together with others (say when they do not meet the 1500 ETH or just recently change this to 32 ETH) into a pool which will optimize for staking/validation operation. Be that as it may, each staker or Validator by themselves individually with 1500 ETH/32 ETH as minimum will not be able to run Casper. This is because the benefit of a decentralized system such as Ethereum is to have many independent nodes doing validation by Validators as they do now with miners. This means there must be a pool of funds collectively even though those Valdiators act individually to protect their own stake.

[15]Even if I am wrong, in the alternative “used in a common enterprise” is also satisfied as it is not disputed that all stakers are there to validate (being the “common enterprise”) and to validate they need to offer their deposits minimum 1,500 ETH/32 ETH. For this effort of validating, they will be rewarded or receive a benefit which depends on the total stake deposits. As mentioned the larger the stake deposits the lower the return the Validators will received. The High Court in their Judgment in Australian Softwood Forests Pty Ltd v Attorney-General (NSW); Ex Rel Corporate Affairs Commission [1981] HCA 49; 148 CLR 121 considered this “common enterprise” and held that at para 133;

“An enterprise may be described as common if it consists of two or more closely connected operations on the footing that one part is to be carried out by A and the other by B, each deriving a separate profit from what he does, even though there is no pooling or sharing of receipts of profits. It will be enough that the two operations constituting the enterprise contribute to the overall purpose that unites them. There is then an enterprise common to both participants and, accordingly, a common enterprise. ”

(see https://jade.io/article/66934).

[16] As to par ( c) above, to produce financial benefits, or benefits consisting of rights or interests in property, for the people (the members) who hold interests in the scheme, we again say that the promise of interest in the form of payout of ETH is not in dispute and is the root of this Casper protocol; otherwise there is no reason why Validators would stake their ETH for nothing. While one would argue that ETH is not “property” (real or personal) because it exists digitally as a computed figure in the user’s wallet as recorded on the blockchain, the fact that this figure exist at all clearly represents a benefit which can be used on the Ethereum network, as long as it is greater than zero. We also noted that under Section 229(2)(c ) of the Act, a financial benefit does not have to involve money as read below.

229(2)(c ) giving a financial benefit that does not involve paying money (for example by conferring a financial advantage).

[17] However, this “financial benefit” is only for Chapter 2E (Related party transactions) of the Act for members of a public company only and may not be applicable to unregistered managed investment schemes. In any event, Casper will still be paying out ETH at 5 percent per annum and ETH can be used for paying for services on the Ethereum network is not in dispute. Given that ETH is liquid and convertible to fiat currency on a number of domestic and global digital currency exchanges, we say this limb is likely to be satisfied.

C. The last element to complete this managed investment scheme is the members do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or to give directions)

[18] In the judgment of Burton v Arcus (2006) 32 WAR 366 at [81]-[83], his Lordship said that day to day control means control-in-fact and “does not, of course, require that there be activities in relation to the scheme on each and every day or even on most days during the term of the scheme.” In Casper, the scheme requires the Validators to stake their ETH in return for validating transactions, which is a day to day affair. The ETH stake is to ensure Validators will act in good faith or lose everything. However this ‘validation’ process had nothing to do with the overall scheme of Casper which is operated by codes written by the Ethereum folks. In short, the Casper’s codes run the scheme of things by managing the members’ processes of validation to ensure the block-chain records those transactions and checking for malicious acts. The codes determine how much Validators or stakers will be paid in terms of interest rate by a formula and obviously the same codes will burn all the ETH belonging to a Validator who had wilfully acted in bad faith. Validators also do not have no control over the membership side of the scheme and all validators are bound by the code. Unlike miners in the Proof of Work Scheme, Validators seem to have less control and are only tasked with validation in return for promise of ETH. We say this limb is likely to be satisfied since Validators cannot be said to have day-to-day control over the operation of the scheme which is programmed or coded once implemented.

[19] We say based on the above, it is likely to be unlawful under Australia’s Corporations Act as an unregistered managed investment scheme.

Now Casper 2.0 (Hybrid Version) -19 June 2018

At the time of writing, Justin Drake of Ethereum’s Sharding research team said through Reddit:

“We are considering changing the Ethereum 2.0 roadmap to skip Casper FFG with 1500 ETH deposits. Instead Casper and sharding validators would be unified from the get-go in the beacon chain, and deposits would be 32 ETH.”

[20] This will essentially change the system’s dependence on the central PoW chain to the beacon-chain itself. (https://bitcoinexchangeguide.com/ethereum-casper-v2-updates-proof-of-work-sharding-plasma-ffg-upgrades/)

Concluding remarks

[21] It is by no coincidence that there are similarities between Australia’s managed investment scheme, United Kingdom’s collective investment scheme, Hong Kong’s collective investment scheme and United State’s Howey Test for an investment contract. The following elements (1) an investment/contribution/arrangement (2) pooling of funds/common enterprise (3) profit/financial reward/benefit/return (4) management by someone other than the investor but obviously decided by different case precedents. As our conclusion is likely that Casper will fall under the definition of a managed investment scheme but unregistered, it may be of some insight to also consider the repercussion of implementing Casper for members based in Australia. While members are not the promoter, it may still be against the law to operate an unregistered managed investment scheme in this jurisdiction by simply running a node (updating Casper or taking a pool of ETH for instance) and to make or accept an offer in relation to an interest in an unregistered managed investment scheme in this jurisdiction (See Section 601ED(5) and Section 1020A of the Corporations Act). This may result in criminal penalties, compensation orders, injunctions and/or winding up of the scheme. Section 601EE(1) of the Act provides that member or in this case “Validators” may apply to the Court to have the scheme wound up. By Section 601EE(2) of the Act, it says “The Court may make any orders it considers appropriate for the winding up of the scheme.”

[22] Casper will be implemented by coders from the Ethereum Foundation which is based in Switzerland outside of Australia. However, once the codes are released onto the Ethereum network, it is up to individuals in Australia and indeed anywhere in the world who would want to be part of this Scheme by depositing their ETH as stake by updating their softwares. As the entire scheme is operated by machines in a decentralized platform, this makes the task of winding up an unlawful scheme impossible as it means shutting down machines/nodes of the Validators anywhere in the world. Of course the Court can shut down machines/nodes in Australia but that would mean higher interest rates will be offered as the deposit stakes get smaller; attracting more to stake in other jurisdictions. Be that as it may, the real benefit of Casper is that its code regulates itself and the Validators, making regulation redundant I would say….unless the entire crypto-currencies is a ponzi scheme (as suggested by some banker) as there is nothing to back all these ‘currencies’ which only truly exist in a ledger (block-chain) run by those Validator’s machines/nodes.