Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Stephen Palley: The Regulatory Landscape for Cryptocurrencies and the SEC's Case Against Kik

Episode Date: June 25, 2019

The complex and evolving regulatory landscape for cryptocurrencies has been a topic for many years. After a long period of waiting, the SEC started pursuing fraud causes in the last 1-2 years. But the recent lawsuit against Kik is the first time that the SEC goes after a large, non-fraud case. We were joined by lawyer Stephen Palley to discuss the Kik case, the US regulatory landscape and recent announcement of the Libra cryptocurrency promoted by Facebook. Topics covered in this episode: The SEC lawsuit against Kik The potential path of the process and how it could resolve in the end Why the Kik case is unlikely to provide any regulatory clarity in the next few years What a settlement in the Kik case could look like Whether the Howey test is still a sensible way to regulate securities How US regulators will deal with decentralized exchanges Stephen's thoughts on Libra Episode links: Annotated Guide to the SEC's Complaint against KIK - Katherine Wu Kik and the SEC: What’s Going On and What Does It Mean for Crypto? - Katie Haun Kin Sets Up $5 Million DefendCrypto.org to Take on the SEC - Unchained Podcast SEC vs. Kik: The Lawyers Speak - CoinDesk Episode 135 with Stephen Palley: Lawmodynamics – How to Sue a DAO Stephen Palley on Twitter Sponsors: Vaultoro: Trade gold to Bitcoin instantly and securely starting at just 1mg - http://vaultoro.com Azure: Deploy enterprise-ready consortium blockchain networks that scale in just a few clicks - http://aka.ms/epicenter This episode is hosted by Brian Fabian Crain & Friederike Ernst. Show notes and listening options: epicenter.tv/293

This is Epicenter, episode 293 with guest, Stephen Paley. This episode of Epicenter is brought to you by Valturo, the gold hedging platform for the crypto community. Trade gold to Bitcoin instantly and securely, starting at just one milligram. Go to Voltoro.gov slash epicenter to get early access to their V2 platform and to start trading. And by Microsoft Azure. Do you have an idea for a blockchain app but are worried about the time and costs, it will take to develop. The new Azure blockchain dev kit is a free download that brings together the tools you

need to get your first app running in less than 30 minutes. Learn more at aka.m.s. Hi, and welcome to Epicenter. My name is Brian Parmen Crane. And my name is Frederica Ernst. And I'm Sebastian Gugio. So we spoke with Stephen Paley today. Stephen has been on the podcast before.

He's kind of one of the most outspoken or an articulate crypto lawyer. often, you know, kind of railing against some of the excesses in the ecosystem, but very thoughtful, and he was right with a lot of prediction, as we talked about in this episode. So, yeah, we dove into some of the current regulatory issues and the kind of landscape, so hopefully you'll enjoy that and get some good strategic insights about where this whole field is going. So before we go into the episode, we did want to cover briefly.

last week there was the cosmos conference so it was called the Interchain Conversations in Berlin Sebastian myself Sonny and Mayher so four of our five hosts were all at the event so yeah there's a bunch of content

coming out from that as well now yeah and I just want to say I feel like we missed you were really sad that you couldn't be there but I hope everything went well I was sad I couldn't be there either but I had unmovable meetings with regulators. Yeah. Well, I hope things are moving along on that front.

But yeah, I thought it was a really great event. So one thing, I guess a couple takeaways from this event. One is it was great to finally be able to put a face on a lot of these usernames and avatars. And also, I think just like generally connecting with some of the members of the Cosmos team that I hadn't had the opportunity to connect with very much before. One of the other takeaways, and Brian, you can probably speak more to this than I can, there seems to be a really nice level of cohesion between validators. So effectively, you guys

are competing against each other for delegations, but that didn't stop you from organizing a dinner for validators where a lot of them showed up, you know, and there's a lot of very thoughtful and cordial discussions about a lot of the issues that you face and how to solve those and how to get through those challenges in the future. So I think that's really encouraging that there's this healthy ecosystem where people are open to collaborating, even though they're competing against each other. Yeah, totally.

I mean, I've been working on Cosmos for two and a half years, and then it was kind of still, you know, there was this tendament world before that. And this was the first larger event. So it was long overdue. So it was really great to just meet all these people. And so that was great. And I agree with you.

I think there is a sort of healthy community and a healthy way of thinking about things. And when it comes to, yeah, to validate us, of course, there's competition, but it's also, you know, kind of working on the same thing and trying to make the same ecosystem thrive. So I think there's kind of both of that. And I think the collaborative side is very strong at this point. And hopefully we'll stay like that. Yeah, hopefully. We'll see how long that stays in the status quo. The other thing, which was great, is to see the level of thoughtful discussion around governance. So atom holders are bestowed with this, very, and validators with this power to govern the network and implement changes to the network and to the protocol. But people are still very careful about implementing breaking changes.

or changes that could really mess with some of the economics and so on and so forth. And so there is this process of sort of rough consensus that comes before people actually start making proposals. And I thought that it's a really great example of like a liquid democracy being implemented and sort of at scale. So I'm really looking forward to seeing where that goes as well. Yeah. Yeah. I mean, the governance system in cosmos is really, simple, pretty basic in its features, but it's been working pretty well. And I think over time, it will become much more sophisticated and complex. But so far, so far, I would say since the cosmos launch, and I think there's been maybe seven governance proposals made that were actually

being voted on. Others have, including you, Sebastian, right, had some ideas for changes. Yeah, it looks like that is actually going to be, well, someone worked on it at the hackathon without even knowing that I had proposed it. And as I mentioned, I think, Zaki, I said, someone much smarter than me will, like, implement this thing. Yeah. So, yeah, I think that so far works great.

And it is an interesting experience in on-chain governance. I think it's at least the one I've been most closely involved. I've been seen. I guess there's some others like Decred that I haven't followed so much. But at least from what I've seen, it's been the one that's been most visibly success so far, though it's of course short. Yeah, I'm sure someone, I'm sure someone from Dash will also let us know that that there's

governance in Dash. Not to diminishing any of those governance models, but yeah. So regarding this bonus content, so if you haven't already seen it on our feed, by this time we would have released two bonus episodes. So we did a live recording of the podcast on stage in front of the audience, which included with myself, Brian, Mayer, and Sunny. And we talked about blockchain interoperability and some of the challenges there and things like composability

and how different networks are addressing that. So we hope you'll like that. It's something that I think we'll try to keep doing in the future of future events. Already I've got ideas for dot-con in August. And another session that is also part of this bonus content is a Q&A that I did with Jay at the very beginning of the event, which sort of set the stage and for the discussions to come.

So that's episode one. And then there's a part two of this bonus content, which is your validator panel, Brian. So you did a panel with four of the validators and really insightful there. And then part two of episode two is Sunny's governance discussion, which was very animated. And sunny came out on stage, dressed as a Byzantine general. and and debated with or organized debates with different members of the Cosmos community on things like plutocracy

and should dictatorships, should Cosmos enabled safer dictatorships and things like that. So it was really fascinating. I'm even more sorry, I missed this now. Yeah, that thing was really great. So if you subscribe to the podcast on the main feed or on Spotify, Google Podcasts, or Stitcher,

you've probably seen this content already pop up in your podcast player. if you listen through the LTV network feed, content will not be available there. It's only available on our proprietary feeds. So you can just go in your podcast player, look for Epicenter, and subscribe there. And then you'll have access to this bonus content

and all the bonus content that we'll be putting out in the future. So with that, here's Frederica and Brian's interview with Stephen Paley. So we're here today with Stephen Paley. Stephen is actually on the podcast before quite a few years ago. He wrote this wonderful article back then, How to Sue Adal. And that was, when did we have we on? Let me just check. Three years ago.

Exactly three years ago. Actually, June 13, 2016. And Stephen has been very articulate in the blockchain space. He's been writing about a lot of legal issues, often quite, you know, kind of critical of the space. So he's been a welcome voice, a contrarian voice, at least in some ways. Oh, come on. Just call me a status chill. You know you want to.

Exactly. And of course, now a lot has been happening. And we recently had to kick actions. And so we wanted to have Stephen on and talk a little bit about that, but also some other regulatory question. So thanks much for joining us again, Stephen. It's my pleasure. Glad to be here.

So tell us a little bit. So last time you spoke, you were actually. actually still primarily dealing with having insurance and construction law, if I remember correctly. And then you were switching a law firm and you've built a crypto law practice since then. How has that been? So I have this funny law practice where I feel like I've got my feed in, really in three spaces at this point. One is I've got a very old school, almost 19th century kind of Dickensian practice where I help

companies collect money from insurance companies. I'm an insurance coverage lawyer. So I'd negotiate insurance policies for large corporate clients, and then when insurance companies don't pay, I sue them or negotiate, as the case may be. And so I find myself dealing with, you know, old insurance policies, some of which have language that literally dates back to the 19th or even 18th century in some cases. And the, you know, take depositions of people about an insurance placement process, that bears absolutely no resemblance to anything having to do with crypto. What's interesting, though, is insurance is all about trust, really, which is sort of how I ended up focusing on crypto, which was sort of long story short.

We may have talked about this last time I was on, but I was building a dispute resolution platform to solve a trust problem in litigation and dispute resolution. and I stumbled, basically, long story short, I stumbled onto Bitcoin as an interesting technological solution to how do you program, how do you create programmatic dispute resolution without an intermediary? So my own technology company, which I built five years ago now called Impasse Breaker, was a failure. I'm really good at practicing law, but I had no idea how to build a technology. technology company. I taught myself to program reasonably well, but that led me into helping clients

build technology. So I helped another client with an advertising platform and micropayments was a problem, which also made cryptocurrency interesting to me. This was in 2015. And yeah, I went, I had my own firm for a while. I joined Anderson Kill three years ago around the time that we last spoke. And the firm about a year and a half ago very graciously allowed me to create a cryptocurrency, virtual currency practice, focusing mostly on disputes. And also, I said we should accept Bitcoin and they said, okay. So the firm also blessed that. We use BitPay, so it's not like we're actually taking keys. And then for the last, I don't know, eight or nine months, I've been doing a bunch of writing.

I work with the block crypto, which is a wonderful crypto media platform, which I'm sure you're familiar with. So sometimes I feel like I wear a little bit of a journalist platform, which is kind of fun. Journalism is kind of like law, except you don't have a subpoena power. And I focus mostly on legal developments in the space. So that's kind of what I've been up to in a nutshell, a nutshell since we last spoke. If you're holding a significant portion of your net worth in crypto, you're probably waiting

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With Voltoro, your gold is 100% insured and secure it in vaults deep in the Swiss mountains protected by Brinks. Every single gram of gold is audited and holdings are made transparently available on their website for anyone to verify. And most importantly, it's quite literally your gold. choose to have it delivered to you at any time. To learn more and to get access to Voltoro's brand new V2 platform, which includes an interface overhaul and trading in dash, like coin, ether, and silver, go to voltero.gold slash epicenter. That's V-A-U-L-T-O-R-O dot gold slash epicenter. We'd like to thank Vulturo for their support of the podcast. There's been, of course, lots of developments in the crypto space. You know, things are moving quickly. But if you were,

to give, I don't know, very three-minute kind of high-level take on in the last three years, what do you think have been the most important developments? And maybe developments have surprised you the most when it comes to like, you know, crypto regulation and law. That sounds really arrogant, but I'm honestly not really surprised by very much. I think I predicted very accurately that there would be, regulatory crackdown. I'm not the only person who predicted it, but we were, I kind of at some points I felt like

I was the guy in front of a bar where there were free drinks and food that happened to be laced with arsenic, saying, you know, guys, everybody like during the ICU boom saying, you know, maybe think twice about eating all of that. There's like, there's a price you'll pay. But that all happened rather as expected, and I think we'll see more of that. I think is 2019 winds down and 2020 winds up. That will continue to happen. I have to say, I suppose I've been a little bit surprised at Tezos and how broadly and widely that is spread in spite of litigation involving it.

I didn't necessarily see that. I think it also, it may end up going to show that litigation and regulatory enforcement won't necessarily stop everything. That actually, maybe that particular project has been a little bit of a surprise to me. And that's not a, it's not necessarily, I'm not making a prediction about value or the market. I'm just noting that it's apparently continued to thrive and the technology is, I've heard a lot of accolades and maybe I didn't see that necessarily coming. Sometimes what's interesting is trying to figure out how litigation and regulatory enforcement will impact something that maybe is centralized in certain ways but decentralized in other ways.

I suppose I've also been a little bit surprised to not see some sort of public enforcement related to Ethereum. That's been a little bit of a surprise to me, but honestly, not that much. The sale itself was at a time when the technology was new. Getting Bitcoin was not something that was easy for folks. I'm not sure everyone quite understood what had happened. I think that the Dow report is almost sort of an inflection point for, for U.S. regulators for the SEC in particular. But, you know, for the most part, things have

happened as perhaps sort of as expected. It'll be interesting to see sort of how Libra and Bitcoin play out on parallel tracks. I'm not quite sure what the right take is there at this point. I guess I was also, you know, I think we'll talk about Libra in a little bit more detail. I'm not surprised that there have already been calls for congressional hearings, and I believe one member of Congress has already sent a letter to Libra saying, cut it out, cease and desist. It's not surprising that Congress is upset. I mean, it's Facebook is, you know, it's an organization that doesn't get a lot of love in Congress. I'm a little bit surprised at how fast it came. That's sort of my recent, that's surprising to me.

Do you have anything that's surprising to you? that surprised you in a positive way. Because all of the things you mentioned are kind of like, I can't believe they kind of got away with it sort of things, right? It is incredibly cool that you can send value around the world almost instantly and convert it to Fiat almost instantly. Take Gemini, for example. Somebody can send you, I mean, Brian, you can send me a Bitcoin or Ether

and I'd have it in my... wallet, my own private wallet in, you know, let's say 15 minutes, I could then send it to Gemini and they could wire me money within two hours. That's actually, that's amazing. It's also, like, if we want to talk about positive, it's funny you should say that because a good friend of mine has pointed out to me more than once. People like a bull more than a bear. So the advice that I was given was like, your insights are really interesting, but like maybe try to be like more bullish about things, but I am who I am, but I just like Popeye. It's incredible, literally, that 10 years after the white paper were having congressional hearings where people are talking

about the stuff. I went to an event at the SEC two or three weeks ago, and the SEC is fully engaged in an interest in the space. Remember, that white paper is 10 years old, right? And we had an entire day with high-level people at the SEC grappling with the technology and not just focusing on enforcement, but thinking about how it can be useful. So what got me interested in the space is actually the technology, not the law. I was wearing a technologist hat when I discovered Bitcoin. And I'm still incredibly bullish about the long-term potential of programmable money, peer-to-peer programmable money without an intermediary, without a Swiss foundation. I think that that is, I got it when I saw it, and I still think that that has incredible potential. I think we've come

long way in 10 years. Was that bullish enough for you? Yeah, that was that was bullish enough. You said earlier that the Dow report was kind of seen as an inflection point in in the ecosystem and recently the SEC has taken action against a number of projects most recently against KIC. Can you give us a little bit of background about that? About KIC? Yeah. Sure. So in was it where at what year are we in? 2019. So in 2017, shortly after the KICICO, the SEC apparently commenced an investigation, considering whether or not the tokens that KIC sold were investment contracts and securities under U.S. federal law. It was a fairly long and involved process. It involved testimony under oath.

that it involved subpoenas of documents, and apparently involved millions of dollars in legal fees. Towards the end of that process, I believe in the fall, November 16, 2018, to be precise, the SEC had essentially wrapped up its conclusion. It sent something to the Kicks lawyers saying, we think that we've made, basically, we've made a preliminary determination

to recommend that the commission file an enforcement action against your client's Click Interactive and the Kin Ecosystem Foundation. alleging violations of a part of U.S. securities law that require you to register a security with the SEC before selling it to the public. I'm oversimplifying a bit. This was called a Wells notice, and in the U.S. once you receive a Wells notice, you can write a letter back to the SEC, a well submission trying to convince the SEC not to sue you. Kick did that. Yeah, Kik and Kinn did that actually, and apparently it wasn't good enough, at least as respects Kik.

the SEC sued them on, let me get you the date, on June 4th, 2019, in federal court in the Southern District of New York, the SEC filed a lawsuit against Kick Interactive, alleging that it violated the portion of the U.S. securities law that require you to register a security before selling it. It's a pretty long lawsuit, 49 pages. See, I've got my yellow stickies on all of the interesting parts. And, you know, it's, I think Brian, you listen to a presentation I did last week with a coin desk, as I said, I was asked about how long this would take. I mean, a federal court lawsuit of this nature and complexity. It could take two to three years to resolve. It could take another year or two to go up an appeal, four or five,

six years before we see any sort of resolution. I know that folks with KIC have said they're prepared to go to the Supreme Court, whether the Supreme Court considers this and decides to reconsider the Howie test, they do have very fine lawyers. The SEC does too. I'm skeptical that this makes it to the Supreme Court, but it's certainly a possibility. But, you know, I think one of the questions is, is this lawsuit going to give us clarity about the law and the application of the Howie test to tokens at any time of the future? I don't think so. Not in the near future, anyway. I mean, the question, let's say to take this to the Supreme Court, so I guess is that in the end, though, how kind of clarity would come about?

Is that like, you know, somebody takes it to the Supreme Court and then the Supreme Court says, okay, you know, the how he tests reinterpreted this way when it comes to crypto tokens, or do you think this is going to play out some different way? Answering that requires a little bit of sort of framework about how law works, the United States, the Howie test is a test that comes from a Supreme Court case. And there are a bunch of different ways that law is created in the United States. One way is we have judgment law, case law, common law that interprets statutes. And that's what the Howey test is. But you also have laws themselves. So you have the Securities Act of the Securities Act of 1933, the Exchange Act

of 1934, which are federal statutes. Those are laws as well. Well, then we have administrative agencies, essentially, like the SEC, which are given authority by statute to promulgate regulations. So you've got statutes, you've got regulations, you've got cases. Judges only decide the cases that are before them. So it's theoretically possible, though I think unlikely, that a federal court is going to say, You know what? How we test an investment contract analysis that doesn't apply to crypto tokens.

I can't figure out why a court would say that. What is so special about this asset class that a court would create an exemption to old and established judge-made interpretation of the securities act? It's possible. But it seems unlikely. it's more likely that you would get quote-unquote regulatory clarity or you'd get maybe a different way of saying it as sort of an exemption for tokens to Securities Act if you had congressional action or you had exemptions that were created by state legislatures.

Because in addition to complexity of federal law and the United States, things are even more fun because we've got 50 states, the District of Columbia, and some territories as well, all of which have their own lawmaking power and their own courts. It's a federal system, right? The short answer is it's unlikely that this is the case that's going to change the lay of the land anytime soon. I did see a story this morning about proposed legislation that would change credited investor rules in the United States

and would allow people with less income and fewer assets to invest in certain types of assets. That might be an answer, sort of a change to crowdfunding laws. But I don't see the SEC creating a broad exemption for tokens anytime soon. It just, I don't, I don't see that as being within their, um, they're sort of their, their ambit or their view of their ambit. Cool. Thank you, Steven.

Maybe quickly for the benefit of, uh, all our listeners, would you be able to give us a short description of what the how it has. actually entails and what it determines and how it applies maybe with an example of KIC, so we can kind of tie this in. Sure. The Securities Act of 1933 and the Exchange Act of 1994 have a definition of securities that includes investment contract. Investment contract is not a defined term.

The Supreme Court in 1947, 1948, I always get confused, but in an old case, called the SEC versus Howie define an investment contract as an investment of money in a common enterprise with an expectation of profits solely from the managerial or entrepreneurial efforts of others. That's paraphrase, but that's the basic idea. So it's a three-part test. Investment of money. Courts have held for some time that cryptocurrency can be an investment of money.

Money doesn't necessarily mean state-sanctioned fiat. It can be ether. It can be Bitcoin. It can be Brian coin, right? It could be Pally coin. You know there's a Palli token out there, by the way? It's P-A-L-L-Y, something to do with that. I thought they were trolling me, but it's decentralized social friendship, something like that.

And then the common enterprise is basically a sort of a joint venture, if you will, an agreement to do something together. The expectation of profit solely from the managerial or entrepreneurial efforts of another, there's actually a pretty good explanation of how the SEC views that in this case. Let me see if I can find it. Basically, the SEC says investors who bought kin tokens, KIC sold something called KIN tokens. Investors who bought kin tokens through the offering and component sales made an investment

of money in a common enterprise with KIC, and they reasonably expected that they would get profits because of the entrepreneurial and managerial efforts of KIC and its agents. So basically, they bought money, they bought tokens in a passive way, pulled together, expecting that somebody else would do everything necessary to give the thing value. That's it in a nutshell. And that sort of definition of investment contract applies in the investment and non-investment space.

Now, the test has gotten some criticism and people have asked for, you know, more. quote unquote clarity with respect to crypto. I mean, I guess when people ask, particularly people in crypto, often of a libertarian bent, ask for more regulation. I kind of wonder about that because sort of the nice thing about that common law judgment test is it's dynamic, right? It's not a static test. It is principles based, the SEC would say. It applies to the facts and circumstances of specific cases.

And, you know, if you, well, I don't like the term utility token, it does describe something that is not an investment contract and not a security. You could think of a software token as being a key that gives you access, for example, to a digital rights management platform that gives you access to music. Or in the case of ether, that allows you to write something, the utility of the thing is the ability to write to a distributed essential. database. Now, I know there are people out there who will say it's not really a database, but let's call it that. It gives you, Ether gives you the ability to write data, right? So things that have existing utility, they could be tokens. Like the thing that allows me to access iTunes, there is a software token someplace that gives me the ability to access that library to access my songs. There's nothing about a token in and of itself that is inherently

a security. There's nothing about a token that is inherently an investment contract. It's how it's used. And I think the SEC, it's full of, you know, smart people who can look through the maze and the fog of white papers and look at something for what it actually is, whether or not, And I think the problem that a lot of the token sales had and the problem that the SEC points to in the kick sale of the kin tokens was in many cases, the token was being sold to fund the creation of a thing that did not exist yet with the expectation that by doing so, the people buying that token would profit from it. That's essentially, that's not necessarily a correct statement of the Howie test, but it's a correct statement of the business problem. This episode of Epicenter is brought to by Microsoft and the Azure Blockchain Workbench. Getting your blockchain from the whiteboard to production can be a big undertaking.

And something as simple as connecting your blockchain to IoT devices or existing ERP systems is a project in itself. Well, the folks at Microsoft had you covered, you already know about the Azure blockchain Workbench and how easy it makes bootstrapping your blockchain network pre-configured with all the cloud services you need for your enterprise app. Their new development kit is the IFTTT for blockchains. Suppose you want to collect data from someone in remote location via SMS and half that data package in a transaction for your HyperLedger Fabric blockchain. The development kit allows you to build this integration in just a few steps in a simple drag-and-drop interface. Here's another

great example. Perhaps you're an institution working with Ethereum and rely on CSV files sent by email. One click in the Devkit and you can parse these files and have the data embedded in transactions. Whatever you're working with, the Devkit can read, transform, and act on the data. To learn more and to build your first application in less than 30 minutes, visit aka.m.m.s slash epicenter. And be sure to follow them on Twitter at MSFT blockchain. We'd like to thank Microsoft and Azure for their supportive Epicenter. So KIC as a company exists 10 years before the token sale, right? So basically they had a messaging app that was actually fairly popular for a while with kids and teens,

and they were failing to monitorize that. And also it was slowly going out of favor mostly because apparently there were rampant child predators on the platform. So they said they were going to conduct this token sale of the KIN token, which would be used as a form of payment on this platform that they were going to build. So what's the argument that Kin is making that this is not a security? Well, they say it's a currency and that the SEC doesn't have authority to regulate currency and that it's regulatory overreach. And they also say that the Howie test is effectively out of date

and shouldn't apply to token sales such as this one. They also, they don't say this explicitly, but I try to put myself in the shoes of their lawyers and looking at the SEC complaints. So one of the, if you go to paragraph seven of the lawsuit, and for folks out there who are interested, you can get a copy of this lawsuit. I'm fairly certain it's available on the SEC website. You'll link to it in the show notes. Okay, yeah, yeah.

So you'll be able to look at it yourself. You go to paragraph seven, you can see a theme that runs through. the complaint. I'll quote. Based with a shrinking financial runway, KIC decided to pivot to an entirely different business and attempt what a board member called a Hail Mary pass. Kick would offer and sell one trillion digital tokens in return for cash to fund company operations and a speculative new venture. For those of you who are outside of the United States and aren't familiar with American football, a Hail Mary pass describes a move late in a football game. Like there's like one second left where the quarterback throws, you know, from one side of the field all the way to the other side of the field,

hoping that one of the players catches the ball and makes it into the end zone to win the game. That's a Hail Mary pass. So basically what the SEC says is, you know, you were a failing business. You needed to make money. We got all your documents. We read all of the emails. it is clear that this was an investment scheme that you wamped up using fancy crypto lingo, but basically you were raising money because you couldn't go to capital markets,

so you couldn't go back to your investors. And I think if I were responding to that argument, I would say, you know, it's true. The company needed to make money, right? The company, times weren't good. However, just because times aren't good doesn't mean there's something wrong about creating a new product to do better. If that was the case, you'd have to sue every company that was facing hard financial times. What we did, they would argue perhaps, is what we did was what any smart company would do when faced with a difficult financial situation, changing technology.

We innovated, right? We pivoted. We built something new. And if you're going to criticize us for falling on hard financial times, that is a false narrative. It's a narrative that is unfair, and it's a narrative that you can apply to anybody. You can't penalize us because we tried to innovate. That's exactly what we did here. That's what I would argue. And, you know, suppose if they're watching, they can steal my argument, right? But that's a, it's not a bad argument. Now, the SEC tells what's interesting about this lawsuit is 49-page lawsuit, 46 pages of it are facts or allegations, the story, right? Two, maybe three pages of it describe the legal claims.

So the SEC is banking on this, I'm telling a really strong factual story that supports a very, very narrow legal theory. And that's, there's something about that that is tactically interesting. What is your prediction? Like, how do you think this is going to play out? It's not like from a fact standpoint. Like, the narrative is not a great narrative for KIC. You also have, where is it?

They use the word investment a lot. There's a reference to a Bitcoin meetup where Kik CEO said people are going to make a lot of money. They talked about getting listed on exchanges. This is a great quote, and it's probably one of the worst ones. There's an email where a KIC employee admitted to another by email when discussing the lack of guidance. They'd received about the crypto stickers. It was a picture of a honey badger holding a boombox saying ledge jam. That was, I guess, supposed to be one of the bits of utility, where the employee said,

basically it doesn't really matter. The whole point is to make our legal department happy, not the use. users who are actually investors and probably could care less that they got a sticker pack for their $10,000 investment, a dozen dollar investment. And kin, like, stuff like that doesn't look great. But if you are defending kick, you're going to say all this facts are irrelevant, right? It doesn't matter what an employee said this was. They're not lawyers.

You have to look at the actual thing. You have to look at the SEC's, you know, authority to regulate. the space, you have to look at what it actually is. So ignore all of that. And if you do that, you'll see either it's currency, not security, or the Howie Test is wrong. It needs to be updated. Look, I mean, they could win. If I were betting, and I probably wouldn't bet on this, but if I were betting, at this point, just based on the complaint, it's looking pretty good for the SEC. My prediction, which is, total guess. I have not spoken with lawyers for either side. I don't know. I don't know the folks

would kick. My guess is this settles. My also guess is that it didn't settle previously because the SEC wanted too much. But you also have to understand how this played out. Ordinarily in a lawsuit, if I prepare a lawsuit against somebody, I don't have their files. I don't have their their awful emails. I have not taken, I have not examined their witnesses under oath. The SEC already did that. Like for the last 18 months before it filed this lawsuit, the SEC sent out subpoenas, examined witnesses, got all of the files. Then they received Kicks legal analysis in the form of their well submission. So what's unusual about this is the SEC already knows the other side case already knows the universe of documents. It's unusual for a case to begin that way.

They also, well, they can't take every case. And while it's true that, you know, they have, their resources are constrained by budgets, it's the U.S. government. The fact that KIC might raise $5 or $10 million or $20 million doesn't matter if the SEC wants to make this a priority. The SEC has a much larger budget and has effectively, basically unlimited resources if it chooses to go after someone. And the fact that they did means they think they've got a really solid case. And this is, by the way, it's a beautifully written complaint. I'm sure that Kicks Lawyers will write a beautifully written answer, a motion to dismiss,

but it's top-notch legal work. The other interesting nuance, too, is that for those who follow this area of litigation to law closely in the United States, this is not a securities fraud lawsuit. So the SEC is not claiming that there was any sort of fraud or intentional misconduct. They are saying that this is a security and you had to register. That is a violation that does not require proof of intent. All you have to show is that it was a security and there was a failure to register, period, pull. stop. I suspect the case will settle. I'm guessing I may be wrong. You stated that the SEC in principle has an unlimited amount of money to go after this. So KIC is also unusual for a startup in the

sense that they also have a lot of money. So basically, how do you think this would have played out differently if KIC hadn't raised $100 million two years ago? Well, there are lots of other companies who raised lots of money in ways that may have violated securities laws, this was a lot of money and they were pretty public about it and they set a lot of things in public that I'm sure caught the SEC's attention. My suspicion is that there are, so investigations are private. The SEC does not disclose their existence during the investigatory phase. I suspect that there are scores of other companies who raised, some of whom raised more money. some of whom raised less money, who are in the middle of an investigation as well, and who perhaps

have looked at this and thought, well, we don't want to be involved in litigation with the SEC for the next three, four, five years, and are seeing this as encouragement to settle. They kind of poked the SEC in the eye by saying, we're going to create a fund called, you know, they created a website called Defend Crypto, and they basically told the SEC to come and sue them. So the SEC did. Maybe not the best people to taunt. You know, if you genuinely, I don't know these people. I don't know how sincere they are in their beliefs.

But if you sincerely believe that you didn't do anything wrong, and the SEC is out to shut you down and they shouldn't, and you have the resources. So maybe you fight. Sometimes the government's wrong. I mean, the beautiful thing about the United States, and one of the things I love about being a lawyer is just because the government says something is so doesn't mean they're right.

You can fight. Now, usually the SEC doesn't do this unless they think they're going to win, but they lose sometimes. The Dow report came out in 2017. Do you think anything that happened before is fine? Do you think the SEC will come after any projects that did token sales before, be Ethereum or early token sales, early Dap token sales? I have no idea. I would be completely speculating.

It is, I believe that they cited the Dow report in this lawsuit. I mean, I remember reading also some previous SEC things, and there was always like, you know, we've published a Dow report, we told that this was, and you still went ahead and you did it afterwards. Yeah, I think that's right. I think that's a, I think that represents a bit of an inflection point. I mean, I go back to the Ethereum token sale. It really, I don't remember how many people invested at the time.

Around 10,000. Around 10,000. They were, and you had to be able, you had to have Bitcoin to invest, right? They didn't take anything else. Yeah, yeah, Bitcoin. So you had to know how to set up a wallet, how to work with private keys. You had to know how to get crypto. You had to know how to receive Ether.

It was highly technical. I don't think it's unfair for a regulator to look at that and say, well, all right, like, technically, that looks like it was a securities offering, but the reality is maybe we understand how gas works. And maybe it was something that was a hobbyist deal at the time. So we're not going to come after you for that. I don't think that that's an unreasonable approach. some of my friends in the space, you know, may not like that, but I can see how regulator might look at that and say, okay, it was early days. We weren't watching it. Maybe you didn't know what you were doing. I suspect that they probably had some sense, but that's not a conversation

I was part of. I do think, however, though, once that report came out, it became harder for people to claim like they didn't know. sort of done this, they've like, they've ratcheted up the pressure. And I believe this is the first, there have been some settlements in failure register cases with a variety of penalties. This is the first lawsuit in federal court. So there are a couple of ways that the SEC can go after you if you violate securities laws. One is they can institute administrative proceedings, which are before an administrative law judge. Basically, it's sort of, oversimpley. It's kind of in front of the regulator, right?

The other way is to go to a federal court in front of a federal judge. And the judiciary in the United States is a different part of the government than the regulators are. So this is the first time that I believe they've gone to federal court in the case of a failure to register a token sale. The other cases have all involved basically orders instituting proceedings. They've been effectively consent orders in an SEC administrative proceedings. They've kind of ratcheted up the pressure and the sanction and the penalty that they've applied. And this appears to be sort of a next phase in ratcheting up, if you will. So maybe just a final question on the kick stuff.

You mentioned that you expect a settlement here or you think it's likely. What could such a settlement look like? Maybe not, but you'd have to look at other settlements that the SEC has entered into. to in other cases, there'd probably be some sort of requirement of a rescission offer where the SEC would require kick to give people the ability to sell their tokens back. They'd be required to register file reports. I suspect, given the fact that they made the SEC file a lawsuit, there'd probably be some sort of civil penalty that would be imposed.

So basically think of it as a fine. They might also require disgorgement or repayment of a certain amount of profits to the SEC. I mean, given that, you know, it may be that the sanction is so onerous that Kik views it as a, they don't survive if they settle in the terms that the SEC is requiring. that may be an issue that needs to be, you know, that would have to be fleshed out. And obviously it involves facts that I'm not privy to. Well, thanks so much. Let's talk about another thing that's, you know, this often discussed, but highly confusing when it comes to the U.S., the SEC's approach, which is that they've said that, you know,

Ether sale was basically security, but now it's not a security. And at some point, this thing became not a lot of security. a security and I think they use the terms efficiently decentralized at some point. Now with KIC as well, right, they're not saying that the token today is a security. So it's kind of unclear whether they consider it to be a security today. But I think it's been the kind of premise of all of these people using the SAF to race that, okay, it's a security, but then at some point it launches and it won't be a security anymore. So how do you think that's going to play out?

But first of all, do you think there is going to be this process of going from security, not security? And how are we going to know when, what is what? So I don't think the SEC has ever squarely said in anything that is official that ether is or is not a security or that the token sale was or was not a security's offering. There have been some. I think they said like probably is something like that. There's been some statements that have come close to that.

but I think they've been misinterpreted by certain people. There's that sufficiently decentralized business came out of speech by William Hinman last year. I don't see any reason why something can't start as a security and then become not a security. I certainly think that is possible in the case of Ether. It doesn't, to me, look like it is a security at this moment in time as to whether or not the token sale was a securities offering. I don't think I'm not going to opine on that. Maybe it was, maybe it wasn't. We'll be up to the SEC to decide if it's going to take any action within.

I believe there'd be a five-year statute of limitations, which is that's coming up pretty soon, right? Now, the thing about a statute of limitations, of course, is that can be told or that can be state or prevented by private agreement. I think that this sort of latest round of enforcement activity and some of the recent litigation makes it difficult for people building new platforms to sell tokens for. things that do not yet exist. It creates a layer of complexity that's difficult in the United States. I don't know if that really answers your question, but I guess I would say if you want to use

a token, like build a platform, sell the token. If you want to raise money, raise money. Can you raise money by giving people a promise to receive tokens in the future with the expectations that the tokens may not be securities. I suppose to. I mean, talk to a good securities lawyer. And by good securities lawyer, I mean somebody who will tell you if you're wrong, which you don't want as somebody who's going to just bless what you're doing because

you're paying them a lot of money. You need to talk to somebody who's willing to get fired for giving you candid advice. I like my good friend, Lewis Cohen, who's actually somebody I'd recommend that people consult with if they're thinking about engaging one of these transactions. He made a really interesting point in that CoinDesk thing that we did last week, and he's made it on Twitter, and I've had conversations with him about this. What he's pointed out is that in other jurisdictions, token sales are governed by, you don't have securities regulators looking at them. The laws that tend to apply are consumer protection laws.

And that's sort of an interesting model to think about if you're trying to find alternative ways to regulate these. transactions or to ensure consumer protection in the United States. It's more of a policy issue than a what can I do now? I guess what I would say is if you're selling to people tokens with a promise of future utility, that is a securities issue that needs to be pinned down. I never liked the SAFT model. It seemed confusing to me. But I don't do transactional securities work.

So it's not, those are not things that I ever necessarily blessed. But I certainly don't see any conceptual reason why something can't start as a security and become a non-security. That doesn't answer the question of what happens if, let's say you sell a token that is an unregistered security, it becomes a non-security, you still have liability for the unregistered securities offering. That's sort of a fundamental existential question and problem. And I don't know why anybody would want that. You said that in other countries, regulators are concerned themselves more with consumer protection, whereas the SEC is mostly concerned with investor protection. Yes.

Do you think this is a distinction that should be removed? Do you think the Howie test is still applicable or sensible? Should it be replaced? And if so, by what? Because basically, if you look at things that the regulators let people do, despite the fact that they are universally agreed to be bad for you, so for instance, just go take out a payday loan or something, that's not forbidden.

It's heavily regulated, but sure. Yeah, it's heavily regulated. So you said that in other countries, regulators concern themselves mostly with consumer protection as opposed to investor protection like the SEC does. Where do you see the difference between the two? That's an interesting question.

So if your focus is consumer protection, you might not have the same sort of limitations on who is able to put their money into a project. You might not have income requirements, or sort of asset holdings requirements, you might focus more on avoidance of fraud, as opposed to limiting who is able to participate in the funding of projects. Now, we do have obviously active consumer protection regulators in the United States, both on the federal and state level. So, you've got the FTC on the federal level, and on the state level, you've got, you've got,

We've got similar regulators and you've got state attorneys general who enforce unfair and deceptive practices laws. So some of those actually include carve-outs for securities for investor investment-related claims. I'm not sure if that answered your question, but I guess the question would be like, can you protect consumers by applying a framework that doesn't require you to decide that a token is or is not a security, I'd rather focus on sort of overall consumer protection. Now, I guess from the SEC perspective, one of the ways that they achieve investor protection is by requiring not exactly transparency, but disclosure, right? the reason why you have to file quarterly and annual reports, for example, or other reports

with the SEC is so that your investors can understand what sort of the material facts about an enterprise and what risks are that are related to the investment. I guess the question would be, is there something better about doing that within the framework or rubric of consumer protection laws as opposed to securities regulation? So I guess what I'm getting at is there's many products that consumers can readily engage with that are difficult to understand and may lose you money and people are still entitled to engaging with them so they can go to a pay-day loan service or people can take out a loan against their credit card. Or you can smoke cigarettes.

Or you can smoke, yeah, exactly, or you can smoke cigarettes. whereas investing in securities is not only something that can be difficult to understand, it can also be something that is immensely lucrative. So in a way, it could actually be seen as locking people out. Right. So the answer might be, look, we don't want to lock people out. We want to protect them against fraud. And in order to broaden the pool, people who can participate,

maybe by putting $25 or $100 in a project, we don't want to rigidly apply securities laws, so we'll look to consumer protection laws instead. I suppose that's a possibility for that sort of change to happen in the United States. You're talking about years of lobbying. And, you know, I mean, sort of in the broad scheme and scale of history, that's hardly an impediment to change. It may take a little bit while longer than people would prefer. So one of the interesting things is, of course, to look at the, you know, U.S. also in the kind of broader context of, you know, the technological change and the regulatory landscape in the competition there.

We've seen a bunch of things recently, including, you know, U.S. exchanges like Bitrex and Polonics, like delisting a lot of coins for Americans and Binance's shutdown. Sure. Access and some other ones. At the same time, we have new decentralized exchanges that, you know, still at this point, maybe usability and volume is pretty low. But probably in a few years, you know, that will be a real alternative. So how do you think the U.S. regulators are going to deal with, you know, one, the international pressure and competition and two, you know, just ways like decentralized exchanges to circumvent

their rules? I don't think the SEC will care necessarily that offshore exchanges are freezing Americans out of the ability to buy certain tokens. I just don't think that that's anything they are particularly concerned about. If there's a desire for American investors slash consumers to have access to other sorts of asset class. that's something that probably requires legislation or either a specific legislation or legislative pressure on agencies. As far as decentralized exchanges, so I went to this thing at the SEC, it was sponsored by FinHub. It was almost three weeks ago now. Time flies. And it's clear that they're grappling with decentralized exchanges. One of the things that they asked a bunch of times,

they were asking questions about custody and things that suggested that they're thinking about how pure peer-to-peer exchange without sort of a custodial intermediary what that means and how that would work within sort of the framework of existing U.S. securities laws. I thought that was interesting. It's certainly something that they are aware of, familiar with them thinking about. but I will say that just because you call something a Dex doesn't mean that it is and we know that that's their view because they shut down in effect a decks six months ago in the United States.

I can't remember the name of the exchange, but just because you call it a Dex, like if it's a Dex and name only but there's really just a guy or a company in the middle, they will view that as potentially, I suppose, a broker-dealer, but someone who is acting in an intermediary capacity. Sure. That was ether delta. And I mean, the argument there was exactly, right? That it, okay, it's sort of a dex, but not really that decentralized.

So there's still this guy we can go after. And that's, of course, what you exactly expect. But then there will be dexes that are not like that. I mean, I think already there are some like uniswap or like Dutchex that are, you know, pretty genuinely decentralized. So they're basically. So they're matching engines, basically? So Uniswap basically has almost like a smart contract that you can kind of like trade with.

So it has kind of a reserve of assets. And then it always has a price and you can basically change one asset for the other. But there's no order books. There's no kind of off-chain entity that has to like match trades and something like that. So there's no way to really shut that down. There's no custody. There's no custody. But there's no custody. I think there was still third parties that matched trades.

And they earned a fee. They had a centralized order book. I mean, this is also true for uniswap and truly decentralized exchanges. They also take a fee. But they neither have custody nor maintain any sort of order book that matches trades with each other. Well, the SEC is paying attention. I mean, that's probably the most, maybe the most prescient insight. You know, if folks are working in this space and they're doing anything that looks like

they are helping, they're either selling securities, selling something, it looks like a security or helping facilitate trade, trading of securities, talk to a good securities lawyer. Somebody who handles transactional securities work. That's not an advertisement for me, by the way. I don't do transactional securities work. but call my buddy Lewis Cohen. He's quite good.

And there are plenty of other lawyers out there who do that as well. But I think the lesson is, the lesson that I take away on the transactional side is just because it's new technology, just because you call it a Dax or peer-to-peer, it doesn't mean that traditional securities laws don't apply. It's a good idea to ask. And by the way, just because you're doing something on blockchain doesn't mean that a regulator can't figure out who you are. So there's another topic we wanted to talk with you.

And I think it's a very interesting and novel topic. And of course, everyone's been paying attention to it, which is that Facebook is launching its coin now. I mean, it's been kind of known for a while, but now there's details. Libra and there are,

yeah, interesting structure there. And of course, there will be interesting regulatory and legal issues. So what's your take on Libra? So I guess Facebook would probably say it's not really Facebook that's launching it. But everybody in the world seems to think that it is.

It was kind of their concept, right? And they created an association. I believe it's going to be in Geneva, right? Is where the Libra Association is, the Libre Foundation. You guys are in Switzerland, right? I'm from Switzerland, and actually I am in Switzerland at the moment, yes. So like Geneva, not Zug is interesting. Are the restaurants better in Geneva?

That's what I heard. Perhaps. I mean, Zoug's a tiny place, so probably, yes. So I thought it was interesting that they used a, The Swiss foundation structure, though I believe almost all of those countries are American. Pardon me, almost all the companies involved in the project are American. So there are two takes. One is Facebook sees that there's something really useful about being able to use money in app, right?

In China, I haven't been. my understanding is if you want to pay for something, you've got to use is it at WeChat? Basically, you can't, it's difficult to use Fia. So there's like a huge business opportunity. By the same token, no pun intended, Facebook has to look at it and think, you know, if we try to launch our own money, everybody is going to come down on this hard. We're going to have huge regulatory risk.

How do we get these rails? How do we get a payment rail and sort of cash within our app? How do we get consumer acceptance? without taking on all of that risk. Well, let's get other people who are involved in the space, including Visa and MasterCard, who've got relationships with merchants so they can socialize this with merchants. How do we create something that gets rid of some of our regulatory risk and also maximizes the ability to get people to accept this?

Because, I mean, peer-to-peer micropayments, one person's another in-app that is connected to money that you can actually use to buy stuff. It's an incredibly powerful idea. Whatever you think of Facebook, it is technology that makes sense. And these are also whether or not you use Facebook, whatever you think of the company or the companies involved, it is a massively scalable stack that is international, that is always on that billions of people use. And I don't think, like, one of the first things that happened was there was an immediate

call for congressional hearings. I understand in Europe, there's been some. some governmental regulatory pushback as well. I got to believe that they saw this, predicted it, and are prepared for it. I have no idea if it's going to launch and be successful, but these are companies that have a massive amount of money, aren't scared of testifying in front of Congress, and have a really powerful, really powerful tech.

I don't, and most people, I think I pointed this out in some tweets a couple of days ago, Most consumers don't really care that these companies aren't looking out for them and abuse or use their data for profitable purpose. So I think it's a mistake to understate the likelihood of their potential success. I also believe that because they have an incredible amount of money, they can work through some of the legal issues. You've got money transmission issues. You maybe have securities a lot of issues. You've got consumer protection issues. but, you know, they've got armies of lobbyists and lawyers,

and they've got companies that can, like, one of the key links is being able to socialize this technology with merchants. And Facebook and Visa, man, they can, like, having them involved is pretty brilliant. Yeah, for sure. So I think it can't be understated how much money is behind this. So if you look at Facebook alone, Facebook's cash reserves exceed the Ethereum ecosystem by quite a lot. So basically if you take the market cap of ether plus all tokens that live on top of ether,

that's still less than Facebook actually has in cash reserves. So yeah, so there's a lot of money behind this. So what do you think is the motivation for Visa and MasterCard to partake in this? Because currently they take to the tune of 2 to 3% per transaction, right? So do you think that that will carry through? to this global coin model, or do you think they have just realized that they won't be able to bank on that forever? I mean, all they had to do is pay $10 million to involve, and for companies of that size,

it's nothing. They can find it in their sofa. Like, it's just not real money. It's probably worth taking a look at. It does seem like it does feel like the future, the bill of it, like, micropayments, on Facebook, why would you not be willing to take a look at that if your MasterCard or Visa to experiment? They also have had, you know, MasterCard and Visa have had some litigation over payments and fees. They believe there was just an antitrust settlement in the last year

for about $6 billion by merchants against, is it MasterCard or Visa or both? I don't recall. So part of it is, I'm just sort of conceptualizing the idea in my own mind. Part of it is, can you create an offshore foundation that allows you to build rails you can monetize while at the same time laying off the regulatory and legal risk to that association? So can you have your cake and eat it too? I think that business problem for enterprises associated with public blockchain is you don't have control over software development. You don't know the quality of the data that is being incorporated into the block.

So if you're running a node, you don't know what it is that you have. So I've been curious about the willingness or ability of enterprises when they really think about the risk to participate in a public blockchain ecosystem. It's not a question of sort of the utility of Bitcoin either, by the way. It's a question of how to Fortune 500 companies look at risk. This is a way, I understand it's also not, strictly speaking, necessarily a kind of a traditional blockchain data model. I haven't dug into those technical details yet. But this is sort of a way to, if you think of Bitcoin as answering a question, how do we send

money quickly, or maybe Ethereum, how do we create programmable? money. If you think about sort of generically the question of how do we send money quickly over borders without significant fee, it sort of answers that question. And, you know, the ability to do that within WhatsApp is, I mean, it's massive. Having a wallet that is a cash equivalent that doesn't have any exchange rate risk, you know, if you can do that, it's a huge win. I'm, I don't. I I don't know about the antitrust scrutiny or competition scrutiny that this will face by regulators, but if you can thread that needle, it's a huge win. If not, I mean, you know, the financial, the investment at this point is immaterial to the folks who are involved.

I don't necessarily buy that sort of meme of we want to bank the unbanked. I think it's a, if you want to be cynical, it's a sort of, it's a cynical, cynical use of a meme for profit-taking companies. Maybe that's what they really want to do, but a lot of the unbank don't actually have money to begin with. So I guess the question is, does this provide, does creating this unit of exchange make it easier for people to make money doing certain things, maybe?

Absolutely. I think it would be very interesting to see, yeah, to see kind of what the regulatory issues that brings up and how there's also a contrast with pure blockchain projects because probably they'll be quite different. Thanks so much for joining us today. It was great to... It's my pleasure.

Enjoyed it. Yeah, to dive into these things. And yeah, we'll look forward to keep following your work. And of course, this is a topic that we'll keep on giving. And I'm sure we'll be still speaking about it three years from now as well. Sounds good. Speak to you in three years time, Stephen. All right.

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