The Breakdown - SEC vs. EOS: Securities! Settlement! Scandal!

Episode Date: October 1, 2019

The SEC's $24m settlement with EOS has been all anyone has been able to talk about for the last day or so. In this episode, we look at the four camps of reactions: the "they got off easy"; "you're all commies"; "it's about the consistency"; and the pragmatists. We also discuss the "Crypto Rating Council" and the general state of the SEC's securities law determinations. Insider baseball with big implications for the evolution of the industry.  Watch: https://www.youtube.com/nathanielwhittemorecrypto

Welcome back to another Crypto Daily 3 at 3. What's going on, guys? It is Tuesday, October 1st. We are officially in the thick of fall and we are officially in the thick of regulatory action, right? So today we're going to talk about kind of one big topic that has a bunch of little different parts of it rather than the traditional 3 at 3. And this is something I'm going to be experimenting with a little bit more. When there's a 24-hour cycle where everyone is talking about one big thing, I want to just hone in on that thing and really focus there rather than necessarily just kind of arbitrarily finding two other stories that are, you know, significantly less important or less relevant for that day.

And so let's see how you guys like it. Let me know. Use the comments. Hit me up on Twitter. But we're going to be talking about, I think, kind of obviously, this SEC settlement with EOS. But we're going to start backwards, actually, a little bit from the first thing that made everyone on Crypto Twitter Act like they were a legal expert yesterday morning, which was the announcement. which was the announcement of the Crypto Rating Council. So basically the idea here is that Coinbase Cracken, I think Circle, and a couple of others in the exchange and custody space,

came together to effectively try to create a self-regulatory type of body where they're giving a designation to how likely the SEC is to consider something of security or not. And so they rated it on a one to five scale with one being the least likely. So Bitcoin gets a one and five being the most likely. So this is definitely a security. And this was actually relatively big news. It was picked up by the Wall Street Journal. It was picked up obviously by all the crypto outlets. And so there was a lot of chatter about this in the morning, right?

So Larry over at the block, he says this is a massive deal. They've joined forces to develop a system to rate which tokens are likely securities. The group is calling themselves crypto rating counsel. The rating system will be made public. Scoring system is based on previous court decisions and statements. And then he goes on to maybe give what, you know, his take in it, right? So this is kind of the key thing. He says, in my opinion, the rating system creates a massive conflict of interest. All the companies that join this consortium are massively incentivized to rate the vast majority of tokens as non-securities. Coinbase listed some very questionable tokens including XRP, Tezos, Eos, and he goes on and on and on.

So there's the, they actually showed kind of the first list too as well. So you have the ones are Monero, Lightcoin, Die, Bitcoin. The twos are things like Zcash, Ethereum, Chainlink, Algorand, which raised a bunch of eyeballs. And then over on the other end of the spectrum, you have like Maker as a 4.5, Polymath is a 4.5. XRP is a four, Auger is a 3.75. And so anyways, a lot of people were talking about this yesterday morning. And it was interesting. So like I said, Larry's kind of thought process was one type of sentiment, right, that there's

these conflict of interest. Bruce Fenton says this is a head scratcher, great respect to the company's involved, but this seems odd. Either something is a security or it's not. So he's taking umbrage with the one to five. ranking, Eric Voorhees, who we'll hear from again later, says, either something is a security or not. That's a quote. If this were the case, perhaps the SEC should release the list so that an entire industry doesn't have to spend millions of dollars reading tea leaves and arguing and auguring

the patterns of the birds. So the point here being that as much as we like that clarity, it's not there. That's Eric's argument. Now, Marco Santori wrote a long thread on this, and it's really interesting. So basically he talks about a number of different elements of this. He calls it, and I think this is good, a hot or not for the Howie test. So basically, the council will take notice of your crypto, publicly rated according to a proprietary framework on a scale of likelihood of security status whether you want it to or not. It's just a series of legal conclusions, devoid of reasoning, a scattershot blasts of facts aimed haphazardly out of Howey's four short barrels. So why should they publish this? Why, I understand it?

should we applaud their effort? Well, actually, we should. As an industry, this stuff is basically the best we've got. That's right. It's a twist. So basically what Marco goes on to say is that effectively that a huge amount of effort is wasted on time and money is wasted on this question of whether companies are going to get sued for doing whatever it is that they want to do. And in his estimation, he says basically Congress can't help. The SEC can't help. And so his SEC logic, I think, is important. He says, on one side, they're stuck with the existing laws, which are too ambiguous to offer meaningful guidance. On the other, besieged by negative headlines no matter the direction they choose. Anyways, their job isn't helping its investor protection. So what's left,

industry efforts to self-regulate. But this is not an industry for which self-regulation comes naturally. Right. So basically, there's a bunch of things going on. But the way that I would sum it up is that why it's interesting is one it's some attempt at self-regulation. Two, there are clear questions of the incentives of the actors involved, right? You know, it's exchanges. Exchanges want to be able to list things. Marco and others are kind of saying that this is maybe the best that we've got is these attempts at self-regulation. My feeling, my take on this is that I do think that there has to be some amount of

this sort of in the absence of clear guidance. And I don't believe that it's as clear as just things are securities or not. In fact, as we'll see, that's really murky. But I think that it behooves the industry to at least try to self-regulate, right? Like ultimately, regulators are going to do whatever they're going to do in the name of investor protections. They're going to try to, but their job isn't to to make things work for this industry, right? And I think as an industry, the more that we can try to define the space that is logical, roughly consistent with what the goals and objectives of those regulatory bodies are, and actually comply with that in a voluntary kind of way, the better, right?

And I think that there are promising strands of kind of self-policing, let's say, if not self-regulation in the crypto space. you have things like, you know, Masari trying to bring transparency through voluntary disclosures and trying to kind of normalize that with social, with kind of social pressures, right, instead of just actual laws or rules. So I don't know. I mean, like, I kind of, I'm sympathetic to the argument of just how conflict of interesty this is. I think there are likely ways that might have been better to do it. But I do think that ultimately, you know, we're going to have to have bodies that are cross-organization within this industry that represent the perspective and the shared perspective

after some amount of times on task of what industry actors think is the lay of the land. So I don't know. It kind of is a it's a little bit neither here nor there because ultimately the SEC is going to do what the SEC is going to do, which brings us to the bigger news, which was the SEC and EOS. So this is Preston Byrne here joking and basically connecting the thread between the Crypto Rating Council and the SEC News. He says, guess that blockchain ratings agency they announced today should move EOS from a 3.5 to a 5.0. And he shared the SEC news that SEC orders blockchain company to pay $24 million penalty, $24 million penalty for unregistered ICO. So what happened? Basically, long story short, the SEC and EOS settled with EOS for violating securities law.

Specifically, they settled for $24 million. That's the penalty that EOS has to pay. And it's basically for not registering the, for not registering the securities offering, right? And so, Catherine Wu did one of her now infamous annotations of the letter, both the letter that, basically the two parts, the waiver letter and the settlement, right? So the waiver letter is the what the law firm of EOS sent to the SEC offering as it's kind of suggested settlement, and then the settlement is what the SEC sends back. So she annotated both of them, and there's a couple key points. So one, like she says here, this is actually a pretty straightforward registration charge.

It's about the fact that they block one offered in sole securities that were required to be registered through the commission, and they weren't, right? She says, and this is actually really the tone of her whole annotation, this is actually a huge win for EOS. Basically, the SEC said that there was no fraud or criminal conviction in the sale, which is really important, right? So this is, the SEC has this complaint against block one for offering an unregistered security, that unregistered part being the key issue there, but does not find criminal violations or any fraud activity, right? There's a whole bunch else in here. I highly recommend you read the rest of it, as you can see.

There's some interesting precedents. By the way, this really shows geoblocks by itself is not enough. And she goes into the whole thing. So really, really valuable reading. But that's the lay of the land. So to sum up, EOS got sued by the SEC, suggested a settlement. Settlement was taken. They paid $24 million.

It was for offering an unregistered security. There was no criminal charge. There was no fraudulent charge. And so basically the whole damn crypto world freak the F out about this, right? So it's a huge case. Eos is much de-loved. let's say they raised, you know, they were in some ways were the epitome of ICO excess because of how much they raised, right? Over $4 billion around the world.

You know, they epitomized in some people's minds the inevitable re-centralization of cryptocurrencies that aren't fully decentralized out of the gate with the block producer idea. they have kind of been sort of a flop relative to the amount of money that's gone in. And so it's just that for some people, EOS is kind of like the exact opposite of Bitcoin in some ways, although I guess XRP is that for others. But the point is that there's not a lot of love lost for EOS with everyone in the crypto community, basically who's not the EOS community. And the EOS community has been a hell of a lot quieter over the last six to 12 months. So the crypto world was kind of ready to freak out about this.

And so what were the different camps of that freaking out? Because this is, I think, where it gets really interesting. So camp one is they got away with murder. So this was kind of like the general base level case. As soon as this news came out. So Gabor from Van Eck, he says, Block 1 raised $4 billion in unregistered securities offering, paid $24 million penalty.

Tell me how the SEC is out to protect investors. And there were 100 different versions of this tweet. it was all over. It was kind of like that was the first line of communication, of kind of reaction, rather. But then you had this whole second camp, which was basically, I jokingly call it, you're a bunch of commies. And so you have Rand Newner here to say, help me understand. You're upset that Block 1 only got fined $24 million. I'm upset that they got fined at all. You have Bruce Fenton again who says, crypto Twitter sounds more like a Chey Guevara rally tonight. What a bunch a silly status. Who the heck are people, are the people complaining that the government didn't

levy an even larger fine? What? This is a profoundly bad take. I can't even. And so he's all frustrated again that like there's these folks who are theoretically against this sort of highly interventionist government who are, you know, angry, arguing angrily for a greater penalty for this project. You have Eric Voorhe again, who we heard from before. He says, really sad. to see so many in the crypto world upset that Block 1 wasn't fined even more by the SEC. They had 24 million taken from them. Some of y'all are more like Elizabeth Warren than Satoshi Nakamoto. And so again, this is kind of, like I said, the camp one was you got away with murder. Camp two was you're a bunch of commies. Camp three, which is kind of bringing it back to balance,

was it's about the consistency, right? And so we have on that actual, that same thread from Eric Forges, stop into Cripp says, am I upset? No. Do I think the if they're going to insist on regulating things should be more consistent about it. Yes. Do I expect them to be? No. Would I like to see the SEC go away? Yes. Do I expect them to? No. So you have a, you have that whole line, which is kind of just the, there's a consistency thing. So what does that consistency mean? And so Larry, again, from the block, he says, if I was Blockstack, I'd feel like shit right about now. BlockSack, we're going to raise $23 million in a compliant utility token offering. They spent $2 million to comply with all the which is 8.7% of the total raise.

They also can't list their tokens on cryptocurrency exchanges, which means no liquidity. Eos, on the other hand, didn't ask anyone for approval, skirted all regulations imaginable, and it ended up allegedly raising more than $4 billion. The SEC slapped them on the risk and they paid a $24 million fine. That's 0.6% of the total raise and they are listed everywhere. Eos has a huge advantage over BlockSack in nearly every way.

The SEC's fine yesterday sets a horrible precedent. Why would anyone do what BlockSack did? struggle for cash and get no liquidity, they can go for a mega raise, advertise on Times Square, and then get away with it. And so he's kind of taking it to Cask. And I think that that's, to me, this is a lot of people I think found this, there's a compelling question around the consistency of application of the law, right? Like to the extent that we're going to apply laws or regulations, it should be theoretically a fair playing field. Isn't that kind of the idea, right? and and some people said it's not the SEC's job to to make a fair playing field but that actually

is part of its job is to make markets work fairly right so this was all the the camp of consistency was I think buffered when a little later in the day SIA basically announced that they had also reached a settlement with the SEC for a 2014 raise of, I think they raised something like $120,000 or $140,000, and they were forced to pay $225,000. So they had to pay, you know, as John Keller says here, pay, can someone please explain to me why SESIA has to pay the SEC 187% of what it raised, while Block 1 only has to pay 0.6% of what it raised. So again, a lot of folks who are in that, there's a real inconsistency here. And then you have the folks who are a little bit more on what I might call just the pragmatist,

rationalist, what can we learn, what can we take away point of view. So Peter Van Valkenberg from the Coin Center says there is no original sin, there is no transubstantiation, a presently functional and decentralized cryptocurrency need not be forever tainted by its crowdfunding origins, and the agreement and investment contract does not necessarily transmute into the token. So what he's saying in kind of poetic language is that one of the things that this seems to suggest is that a token can be a security when it's offered for sale and then not necessarily a security later, which is something that we've seen indications of before and this kind of reinforces, right? So that's one piece of the one piece of the kind of pragmatic takeaways, right?

Then you have Paley over here who says basically is kind of going out. after the idea that somehow this sets a precedent that it's a good idea or you're allowed to do ICOs, right? So he says the only precedent that the EO settlement sets is that you might get a better deal if you don't kick the SEC and the shins, start a settlement fund online and say, sue me, obviously referring here to kick. And then he goes on and I think, you know, he talks about how he he doesn't expect additional criminal action. And he says this, which I think is important. It might seem off-brand for me, but I actually think settling the bulk of the early silly-ish non-fraud ICO cases and letting people remain in business if they have functioning tech

and widely distributed tokens make sense. That's really the rub of it for him and I think is the important note is that basically it doesn't necessarily benefit anyone for those projects that weren't out-and-out scams that weren't out and out-and-out frauds that are still going, even if people don't like them, to punish them rather than just kind of do this type of settlement. And he goes on to point out that effectively, one, that everyone was in the same boat. Even two years ago, there was still misunderstanding. Some of it made worse by lawyers about was and wasn't acceptable. Punitive business ending sanctions in non-fraud cases involving this area of emerging tech don't make sense to me. Then he goes out to point out that there's so much actual fraud that dwarfs everything that happens

in crypto in other markets that it really doesn't behoove the SEC to focus there. Now, one other category of what the precedent might be comes from Philip over at ARCA. He says after Block 1, real projects like Ripple will not be shut down by the SEC. They will find them, but it won't be death. They should be extremely bullish signal for XRP. It's clear they hired Mary Joe White and Andrew Cesarini to negotiate a settlement not to fight the SEC. And XRP jumped 7.4% about 12 hours before public announcement of EO's settlement. Someone with inside knowledge got the jump on that.

I have no idea if anyone at XRP had inside knowledge or if it's just the vagaries of the markets. But the point he's making there basically is that if your thing exists in the wild, it's more likely that you are going to be able to pay to clean things up than just actually be existentially shut down or brought up on criminal charges. And then, of course, there's bully with the ultimate pragmatist take, which is the financial opportunity. He says paid group leaders are furiously trying to figure out which cryptocurrency will settle with the SEC next. So anyways, let's let's maybe break it down just for a minute and then

we'll wrap up. So what's my take? One, this is the way the world has always worked, period, right? Huge money equates to power. And the ways in which money equates to power might be different. They might be changed. In this case, it has to do with lawyers who know other lawyers, who know judges, who know, like whatever, right? Like it's about the quality of legal defense, the ability to buy your way out of it. $24 million is a huge amount of money, except in the context of having $4 billion raised, right? You know, and so I think this is actually what frustrates some people about, you know, an actor like Blockstaff trying to work in good faith and spending $2 million. At least they had $2 million to spend to do it the right way, right?

But the idea that somehow this new industry wasn't going to be subject to the reality that money is power is, you know, I think faulty. and I think that we can and we should fight against that. So I don't mind people being up in arms about it. I think it's a good thing. But the reality is that money is power. And it always has been and it's hard to imagine a future in which it's not. What's more, brazenness has a really good track record in business, right? If you look at the people who have kicked down the doors of, you know, public markets in the last whatever,

or private markets in particular, rather, in the last 10 years, it's people like Travis Kalanick at Uber, who are take no prisoners, ask for forgiveness, not permission, and really don't even ask forgiveness, right? Like, whatever set of incentives there are, and it's way beyond the scope of this one conversation right now, you know, money is power and brazenness is a great way to get money. So, you know, maybe other companies or other projects that did want to do real meaningful things should have raised $4 billion so they could fight the system in their own way. But, you know, here we are. So that's number one. Number two, I do think that this reinforces the need for as much damn clarity as the SEC can give us, right?

It is frustrating to look at someone like a block stack who spent all that money on compliance, but, you know, who were able to raise effectively less than what EOS will, you know, will pay in a fine. And I think it's especially frustrating to go even farther down the line where all of a sudden the $2 million in legal fees that it take to actually, took to actually make that legitimate registration that Blockstack did work, that cuts off a huge array of projects, right? So all of a sudden, this technology, which is inherently disruptive and differentiated, is just playing a game of compliance arbitrage. And only the projects that can afford to raise that sort of money in advance can actually do anything. So I do think that it really does reinforce the need for as much, as much, as much possible clarity from the SEC and better

pathways for organizations to actually do things above board. Otherwise, it just makes sense to go away. And we've talked about it before on this. I know some people are skeptical that entrepreneurs will move for regulatory clarity, but it makes sense to me, right? Like, I have a family. I'm here, and I'm not starting a protocol. But if I were, there's no friggin way I'd do it here. It just doesn't make any sense. So anyways, more regulatory clarity. Number two, desperately needed. Number three, we got to remember that, you know, for all of those folks who are frustrated and flustered, it still doesn't change anything about what a success or failure EOS is today. And right now, it's very hard to argue that EOS is in a better position now than it was six months ago. It really is.

So just keep that in mind as we're like, let's, to the extent that we can separate that set of feelings about EOS from, from this question, I think is important, right? Like, money can buy power and influence, but what money can't buy is success necessarily when it comes to an innovative new technology and innovative new social system and innovative new money. So for those of you who are angry and frustrated, don't despair. Finally, it's just a good reminder that if you really want a totally different system, you have to opt out all the way. And there is a reason that people keep coming back to Bitcoin and people are so excited about Bitcoin is that it just is such an anomaly in the history of the world of anything that touches money, right? A leaderless organization that doesn't have a single company, it doesn't have a boss, it doesn't have a marketing department. You know, it's part of why it sits over in that one column in both the crypto ratings counsel's estimation and really in the SEC's estimation is that it's just, it truly is a different phenomenon. And people are annoyed and they're sick of hearing that over and over, but it's just the case, right?

And I think that it's a particular legacy of that asset. So lots of reasons, again, when you see this, to find your way back to Bitcoin. But that's all for today. What do you guys think? I'm interested to see which camp do you fall in. Are you in the they got away with murder camp? You're all a bunch of commies camp. It's about the consistency camp or the pragmatist camp.

Or is there some other camp that I've just missed entirely? Anyways, guys, thanks for watching. Thanks for listening. And I will be back tomorrow. All right, guys, peace.