Tag: cryptocurrency

SEC Begrudgingly Approves Bitcoin ETP

We all saw this train coming down the tracks. Even the hacker who took over the SEC’s Twitter account announcing the approval, merely jumped the gun. The Securities and Exchange Commission, by a 3-2 vote, authorized a dozen spot Bitcoin exchange traded products.

Gary Gensler’s SEC has been trying stem the tide and prevent crypto from becoming more legitimate by denying any form of SEC authorization. Last year’s loss in the Grayscale’s court case was the break that could not be plugged. In the original Grayscale Order, the SEC determined that the proposal had not established that the CME bitcoin futures market was a market of significant size related to spot bitcoin, or that the “other means” asserted were sufficient to satisfy the statutory standard. The U.S. Court of Appeals for the D.C. Circuit held that the SEC failed to adequately explain its reasoning. The court vacated the Grayscale Order and remanded the matter to the SEC. “Because we don’t like it” is not a sufficient reason.

That didn’t stop Chair Gensler from slapping crypto.

“While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse bitcoin. Investors should remain cautious about the myriad risks associated with bitcoin and products whose value is tied to crypto.”

He points out that “the vast majority of crypto assets are investment contracts and thus subject to the federal securities laws.”

Commissioner Peirce countered:

“[O]ur actions here have muddied people’s understanding of what the SEC’s role is. Congress did not authorize us to tell people whether a particular investment is right for them, but we have abused administrative procedures to withhold investments that we do not like from the public.”

The SEC has allowed crypto to take step towards more credibility, liquidity and lower costs.

Personally, I don’t see ordinary people using crypto. They just trade it. I appreciate the blockchain infrastructure and potential innovation to move money cheaply. Criminals love it. It’s an easy way to move money around anonymously.

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The One with the Stoner Cats

With the onset of the crypto winter, the Securities and Exchange Commission is continuing to bring cases against crypto companies. The latest is against a funding model for animated series: Stoner Cats. The producers wanted to try finding a crypto method to fund the production.

It started off as Kickstarter mixed with Non-Fungible Tokens. The tokens were digital pictures of the animated characters on the production. I think that’s okay and the tokens would not likely to be securities. You initially buy the NFT from producer to be able to watch the series. That’s like buying a movie ticket. That funds the production of the series.

Then the producers added in a royalty feature. When the NFT is traded from the initial buyer to secondary user, the producers take a 2.5% fee that gets passed to the actors and producers. I still that’s okay and doesn’t move the tokens into the treatment as a security.

Under the Howey test, it’s clearly a pooled investment and it’s success is clearly due to the efforts of the production team. The question is there an expectation of profits required by the third prong of the Howey test?

The cash flow from re-sale fee goes to the producers, not the token holders. So, the expectation of profits does not flow directly from the success of the production.

The SEC focused on the potential increase in value of the tokens.

“[I]t led investors to expect profits from their entrepreneurial and managerial efforts, because a successful web series could cause the resale value of the Stoner Cats NFTs to rise in the secondary market.” …

“Investors were also told that “the more successful the show, the more successful your NFT” will be.”

There are plenty of securities offerings that investors look to an increase in value and not to a payment of dividends. Those equity offerings still offer investors a residual claim on the business, even if they don’t get cash flow.

The SEC seems to hang it’s charges on the marketing efforts of the producers that the NFTs could increase in value if there is demand for the series. But of course that is part of the pitch to token holders and the whole NFT eco-system. Buy these tokens and they will increase in value. NFTs occupy this space between commodities and securities.

There is probably an interesting legal analysis and this could be an interesting court case. However, the producers settled with the SEC, agreed to return funds and destroy the NFTs.

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Ripple is Sometimes a Security (?)

The big challenge with crypto is how it fits into regulatory schemes that were drafted almost a century a go. Add in the politically driven split between the regulation of commodities by the CFTC and the regulation of securities by the SEC and you get a mess. Slap in the variable structures used by crypto issuers when selling crypto tokens and you get a tangled mess.

This challenge just got messier with the recent decision in the case of the Securities and Exchange Commission v Ripple Labs.

The definition of a “security” includes an “investment contract.” The meaning behind that term was established in the 1946 case of the SEC v. W.J. Howey. The decision created a three prong test:

(1) invests his money (2) in a common enterprise and (3) is led to expect profits solely from the efforts of the promoter or a third party.

Bitcoin largely falls outside the definition. You don’t expect a dividend on Bitcoin. You’re investing for the rise in price alone. There is no meaningful company behind it trying to find a way to make a profit. Bitcoin is more like a commodity.

Some will argue a currency. But currencies are used as a store of value to buy things. I don’t think Bitcoin is being used to buy many legal goods.

Ripple Labs comes along and sells the XRP token to generate cash to build out the Ripple platforms, some of which will use the XRP token. The facts are a bit murky about whether the XRP coin holders would get some of the profit from the Ripple platforms.

The court looked first at the past sales of XRP tokens directly to institutional buyers and decisively finds that the XRP tokens are securities. “When the value of XRP rose, all Institutional Buyers profited in proportion to their XRP holdings.” (page 18)

For some weird reason, the court then finds that indirect sales and sales on exchanges are not investment contracts. Since they were blind bid/ask transactions, the buyers didn’t know if the money was going to Ripple or to a secondary seller.

So institutional buyers get more protection than retail buyers under the court’s reasoning. That seems to be the opposite approach of the protective regulatory approach of the SEC.

That also seems weird in the reality of exchanges for “securities.” An investment would be a security if it’s bought directly from the issuer and possibly not a security if it’s purchased from a secondary seller.

Under the court’s decision, crypto is looking very good. Sales of “investment contracts” to institutional investors can rely on the private placement regime. Sales to retail investors through an exchange would not be an investment contract.

Weird result. The product’s status as a security is dependent on how it’s sold. Doesn’t sound right to me. I assume the SEC will appeal this result. I think this will just be a temporary win for Crypto.

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ZuckBucks and Securities

Facebook is looking to get into banking. Or Cryptocurrency. Whatever you call it, Facebook is looking to launch a global currency: Libra.

The big problem is mashing together the current lack of trust in Facebook with the hype of blockchain technology. As a result, Libra talks little about Facebook and lots about blockchain.

It’s not clear that Libra is using blockchain like other cryptocurrencies and it’s not clear that it can be used outside of Facebook.

Bitcoin and other cryptocurrencies have failed as currency because so few merchants will take it as payment. Facebook is potentially allowing the widespread use of Libra by making it the payment of choice through the Facebook platform.

Unlike Bitcoin, Libra is intended to be stable in price. It’s value will be pinned to an underlying portfolio of bank deposits and government securities. The focus is spending Libra, not investing in Libra.

As for the investment part, the underlying Libra asset returns will be used to fund investments in the platform and any remaining returns would be paid as dividends to the early investors.

The details are a bit sparse, but it sounds like Libra would not be a security to the everyday purchaser, but could be a security to the early investors.

Those early investors are a consortium of participants that will provide the governance and manage the currency. They will also need to pony up at least $10 million in initial funding.

I assume that Facebook and rest of the Libra Consortium are going make sure Libra does not trip over securities laws.

The big problem is going to be money laundering, sanctions limits, and cross-country transfers. Libra is being touted as panacea for the unbanked. However, the unbanked include the criminal elements who do not have access to banking system. I suspect this will be the bigger challenge of Libra.

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A Court Rules that an ICO was not a Securities Offering

Last month, I wrote about the complaint filed by Securities and Exchange Commission against Reginald Ringgold and his Blockvest initial coin offering. One of the Blockvest’s marketing ploys was to note its membership in the Blockchain Exchange Commission.

The SEC managed to obtain an emergency court order to halt a planned initial coin offering of Blockvest, which falsely claimed that it was approved by the SEC. The order also halts ongoing pre-ICO sales.

After a hearing and Mr. Ringgold’s presentation of his side of the story, the court decided to deny the SEC’s motion for a preliminary injunction. The court found that there are disputed facts about the nature of Blockvest’s status that makes it unclear if the tokens were securities.

The main defense of Mr. Ringgold is that Blockvest was only in the test stage. The 32 “purchasers” of the Blockvest tokens were test users. It was not clear that the test users had an expectation of profit or that their purchase were actually at risk while Blockvest was testing.  The SEC and Mr. Ringgold had different stories of what documents were made available to these testers that induced them to buy the Blockvest tokens.

The “Buy Now” button on the Blockvest website didn’t work.

My reading of the decision is that Blockvest was not yet an ICO so there was no securities offering. The SEC action has stopped it. The Court found that it’s unlikely that Mr. Ringgold will make the offering.

While there is evidence that Ringgold made misrepresentations shortly after the complaint was filed and prior to having retained counsel, Ringgold, with counsel, now asserts he will not pursue the ICO and will provide SEC’s counsel with 30 days’ notice in the event they decide to proceed. By agreeing to stop any pursuit of the ICO, Plaintiff does not oppose the preliminary injunction concerning compliance with federal securities laws. Therefore, Plaintiff has not demonstrated a reasonable likelihood that the wrong will be repeated.

It looks like it’s a win for both sided. The SEC stopped Blockvest before it could take money from the public and Mr. Ringgold managed to avoid immediate SEC action.

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Blockchain Exchange Commission

Worried about the security of your cyptocurrency? How about having the Blockchain Exchange Commission protect you.

It won’t.

According to a complaint filed by Securities and Exchange Commission, Reginald Ringgold is a founding member of this very prestigious-sounding, regulatory-sounding Blockchain Exchange Commission. According to it’s LinkedIn page:

The mission of the [Blockchain Exchange Commission] is to protect investors; and assist in maintaining fair, orderly, and efficient markets within the Blockchain Digital Asset Space. The [Blockchain Exchange Commission] strives to promote a market environment with Decentralized Governance and reliance on distributed ledgers rather than internal ledgers that can exploit the public’s trust.

You might want to compare that to the What We do Page on the SEC’s website:

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

Even more fun, the BEC lists it’s address on LinkedIn as 100 F Street NW in Washington D.C. You may know that better as the SEC headquarters.

It looks like the BEC has cleaned up its website, removed its claims of investor protection and stated its address in San Diego.

The information about the BEC came out in an SEC complaint against Blockvest and its founder, the same Reginald Ringgold.

“Don’t look for the needle in the haystack…just buy the whole haystack.” – Reginald Ringgold

The SEC won’t approve Bitcoin ETFs, so Blockvest is creating a token as a fund. The offering is some pool of something that does something, blockchain, blockchain… The whitepaper is a bunch of nonesense.

The Securities and Exchange Commission obtained an emergency court order to halt a planned initial coin offering of Blockvest, which falsely claimed that it was approved by the SEC. The order also halts ongoing pre-ICO sales.

There is no bigger red flag than stating that an offering is approved by the SEC.

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“Crypto is the Mother of All Scams”

It looks like the testimony will not be subtle at the Senate Banking Committee today entitled: Exploring the Cryptocurrency and Blockchain Ecosystem.

Peter Van Valkenburgh, Director Of Research at Coin Center, spends his time trying to explain blockchain by calling it decentralized computing. I’m going to guess that his presentation falls on ears that have no idea what he’s talking about.

Nouriel Roubini, Professor of Economics at the Stern School of Business at New York University, is much less subtle. He titles his testimony:
Crypto is the Mother of All Scams and (Now Busted) Bubbles While Blockchain Is The Most Over-Hyped Technology Ever, No Better than a Spreadsheet/Database.

Actually calling this useless vaporware garbage a “shitcoin” is a grave insult to manure that is a most useful, precious and productive good as a fertilizer in agriculture.

He goes on to attack the premise of cryptocurrency. Financial crises happened before fiat currencies and central banking. There were many bubbles and busts before central banking. We all note tulipmania. He takes the position that central banking helps avoid currency runs that occur when a bubble bursts. It may be hard to make this point when the wounds of the 2008 financial crisis still feel fresh.

Professor Roubini also points out the environmental consequences of cryptocurrency. He cites a figure of $5 billion a year spend on energy costs.

My personal take on bitcoins and other cryptocurrency is that they have been a boon to criminals and money laundering. The loose attitude for the exchanges on reporting suspicious transactions has been a boon for moving illegal money around from person to person and laundering it back into the legitimate money system.

Then add in the pump and dump mechanisms of other smaller coin ecosystems, you have fraudsters getting money from ICOs. More money when they fraudulently prop them up, then use them to transmit the proceeds outside the legitimate banking system.

Last night, the International Monetary Fund warned that cryptocurrencies “could create new vulnerabilities in the international financial system.” Cryptocurrency valuations crashed as a result.

You can also add in the “whales” of Bitcoin when talking about stability. Thirty-two Bitcoin wallets collectively own about 1 million bitcoin (i.e 5% of all bitcoins). Five of those wallets are lost. The owner lost the private key and cannot access the accounts. That represents 212,000 coins worth about $1.3 billion. That to me, is an incredible concentration in ownership that can’t lead to anything good.

Fraudulent Coin Offerings

I’ve been highly critical of cryptocurrency. It doesn’t act like a currency: people are not using it to actually buy goods and service (at least not legal goods and services).  The world of coin offerings has been the wild west. In many instances, the sponsors are just ignorant of the securities law implications of their coin offering structures. Others are scams or turn quickly into scams.

The most recent coin offering to come crumbling down is the CTR Token sponsored by CentraTech. The SEC charged Sohrab Sharma and Robert Farkas with masterminding the fraudulent Initial Coin Offering.

What was the case for using Centra? I read through the whitepaper and it’s full of nothing. There is some nonsense abut currency conversion and storing coins in the Centra Wallet. As near as I can tell the only thing Centra Token did was get the boxer Floyd Mayweather to endorse it.

Centra Tech claimed that it was producing a debit card backed by Visa and MasterCard that would allow you to instantly convert hard-to-spend cryptocurrencies into U.S. dollars.  The SEC alleges that Centra had no relationships with Visa or MasterCard.

Sharma and Farkas stated that funds raised in the Initial Coin Offering would help Centra Tech build a suite of financial products. This turned it into a securities offering because the offering claimed that token holders would be paid “rewards” of 0.8% of the total revenue that Centra earned from Centra Card transactions. That makes the ICO a securities offering.

This goes back to the Howey definition of a “investment contract” as “investment in a common enterprise with the expectation of profit to be derived through the essential managerial efforts of someone other than the investor.” If it meets the definition of “investment contract” its a security.

“Endorsements and glossy marketing materials are no substitute for the SEC’s registration and disclosure requirements as well as diligence by investors.” – Steve Peikin, co-director of the SEC’s Division of Enforcement.

My Favorite part of the fraud is the use of fictional executives. “Michael Edwards” was listed as the Chief Executive Officer and Co-Founder of Centra, with an impressive LinkedIn profile. He had an M.B.A. from Harvard University and an extensive career in banking, most recently as a Senior VP at Wells Fargo. Edwards was not a real person. A photo of Edwards used in an early version of Centra’s website was that of a Canadian professor of Physiology and Pathophysiology with no relationship to the company. Later versions of the marketing materials included instead a picture of one of Defendant’s relatives purporting to be of “Edwards.”

The big surprise is that it took the SEC this long to build a case. The New York Times put together a profile of the company in October that was full of red flags.

Several weeks ago Sharma and Farkas received subpoenas from the SEC about the Centra ICO.  I would assume that they realized their time was short. According to the SEC’s complaint, Farkas made flight reservations to leave the country around April 1. That must be what put the SEC and the Department of Justice on an accelerated schedule. Farkas was arrested before he was able to board his flight.  Sharma was also arrested.

As of March 30, Centra’s bank accounts were depleted and most of its employees had been terminated according to the SEC complaint.

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Pump and Dump Cryptocurrency

Cryptocurrency is a lawless land.

Ten days ago, the Securities Exchange Commission and the Commodities and Futures Trading Commission issued a joint statement on virtual currency:

“When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws. The Divisions of Enforcement for the SEC and CFTC will continue to address violations and bring actions to stop and prevent fraud in the offer and sale of digital instruments.”

Take a look at BigPump.org. Go ahead and take a look. I’ll wait.

“We do pumps…. Big pumps.”

Right there on a public website, the group advertises its strategy for pumping and dumping cryptocurrency. It came to my attention through an article by Paris Martineau:
Inside the Group Chats Where People Pump and Dump Cryptocurrency.

I was skeptical that a strategy that was so brazenly illegal would be so easy to spot. So being skeptical, I dug into the underlying information. There it was, publicly displaying a pump and dump scheme.

In their defense, they claim their pumping schemes are fair. Of course, there is also a note that premium pumps will be coming soon. I have to assume that those premium pumps are less fair to those outside the premium group.

It does not take much to find examples of pump and dump. Look at this chart for the Crave cryptocurrency.

Some people made a bunch of money by rallying interest in this cryptocurrency and selling at the top before the price.

That is not the way a price chart for any “currency” should look. It’s not the way chart should look for any investment.

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