Learning From The ICO Experts — The People Behind CoinList, Tezos, and Scalar Capital
This week, we got a break from our professors and heard from a few experts in field.
- Joshua Slayton, cofounder of Coinlist
- Kathleen Breitman, cofounder of Tezos
- Jordan Clifford, cofounder and managing director of Scalar Capital
- Mitzi Chang, partner at Goodwin Procter
Joshua Slayton — CoinList
Joshua, cofounder of Coinlist and the founding CTO of AngelList kicked off by asking “Who in this class is a crypto millionaire?”
Not a single person raised their hand. Most people in class are probably hoping they didn’t entirely miss the wealth creation that owners of cryptocurrency have enjoyed over the past few years. Joshua also asked who in the class has bought into an ICO, and several hands went up.
Joshua started CoinList as a spinout of AngelList, which was founded in 2010 to facilitate startup seed financings. In 2013, they launched online fundraising and since then over $700M has been invested online through their platform.
As with any innovation in the securities world, it is smart to have an open discussion with the SEC. AngelList has a No-Action Letter.
“Most no-action letters describe the request, analyze the particular facts and circumstances involved, discuss applicable laws and rules, and, if the staff grants the request for no action, concludes that the SEC staff would not recommend that the Commission take enforcement action against the requester based on the facts and representations described in the individual’s or entity’s request.” — SEC Website
Compliance with AngelList
For every investment they do on AngelList, they comply with FinCen’s Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations by collecting the name, address, social security number or passport, and crosschecking with watch-lists.
They also comply with SEC regulation which means they use a securities registration exemption — 506(b) or 506(c) — and check for investors’ accreditation ($200K income for 2 years, or $1M net worth excluding the value of your primary residence).
- Reg D — 506(b): All investors must be accredited and sophisticated, and you cannot solicit publicly during fundraising
- Reg D — 506(c): All investors must be accredited and sophisticated, but general solicitation is permitted. However, there are much stricter requirements to accredit investors
- Reg Crowdfunding (CF): Non-accredited investors are permitted, but there is a $1M fundraising limit total, as well as a limit of 5% — 10% of net worth limit per investor
- Reg A+: You can raise up to 50M from unaccredited investors and solicit from the public, but there are a lot of burdensome requirements so AngelList does not support.
AngelList supports 506(b) offerings, CoinList supports 506(c) offerings, and Republic supports Reg CF offerings. They don’t support Reg A+.
Beginning of CoinList
In late 2016, Protocol Labs planned an ICO for their FileCoin project. The market was heating up so timing was pretty great. AngelList founder Naval Ravikant was an investor in Protocol Labs and had already been a cryptocurrency investor for some time. Protocol Labs decided to work with AngelList to create CoinList, and in mid-2017, the FileCoin ICO raised $257M on the platform — at the time the largest ICO ever.
At CoinList they believe that every ICO is a securities offering, and so they comply with Reg 506(c) in all cases.
How CoinList Does an ICO?
An ICO on the CoinList platform goes through investor checks to comply with KYC/AML and anti-terrorist activity. They confirm all investors are accredited under 506(c). You can even use crytoassets to confirm you meet the net worth requirements for accreditation. Investors can upload a message cryptographically signed using the private key of their wallet, proving that they own assets worth over $1M.
Investments are done via SAFT and there are no direct token purchases. Payment can be made in USD, ETH, or BTC.
Predictions
Joshua shared a few predictions with the class. He thinks that there will be a SEC crackdown on non-compliant ICOs, and that more investors will sue those making offerings that aren’t compliant.
He wondered whether we’ll still be calling tokens “utility” tokens, especially if projects don’t come to fruition as quickly as they plan.
Joshua also thought securities tokens will grow in popularity — company equity, real estate, etc will get tokenized, and those tokens will be regulated at the smart contract level.
Lastly, Joshua thought that collectible tokens like CryptoKitties will grow in popularity. It’s possible that coin value is tied to brands or popularity instead of a protocol or technology driving a network. Collectibles wouldn’t be securities just like trading cards or beanie babies are not securities.
Kathleen Breitman — Tezos
Kathleen kicked it off with a quick overview of the Tezos project, which she describes as a “future-proof” smart-contract system. It facilitates a digital commonwealth — an organization that organizes itself amongst a group of people with a shared interest.
The Tezos team believes the blockchain is a commons. Commons generally suffer from governance issues (e.g. who owns what and how do we distribute it?), and maintenance issues (e.g. who will mow the lawn?). So we need to come to a consensus on how the protocol evolves on the blockchain. Tezos in theory will account for this and allow upgrades to be pushed once the network comes to a consensus.
Bitcoin runs into this problem. Some people support a hard fork and some people don’t. If you could put your coins behind your perspective, that might be a good way to make decisions. If you have a mechanism to survey and assess the community and push an update out, there would be a lot less in-fighting. Tezos aims to have their token holders make decisions together to govern the platform and improve it over time.
Currently, Tezos is most well known for raising $232 million over a period of two weeks in July 2017. Since then, it has been the subject of SEC scrutiny for the potential sale of unregistered securities without a proper exemption.
They have also been the subject of lawsuits asserting the same — that Tezos presale contributors were buying the right to acquire Tezos currency once the network became operational. Plaintiffs say it was really a securities offering. The Tezos team described the presale purchases as donations to the Tezos Foundation.
We discussed this securities regulation regime last class, so I’ll leave it up to readers to decide whether this sounds like a securities offering or not.
One exciting thing Kathleen mentioned about Tezos, was that 6,000 Ethereum wallets opened in 2014 when it launched. When Tezos launched its fundraiser, 30,000 wallets opened. The Tezos team thinks that things follow Metcalfe’s Law. — the value of a telecommunications network is proportional to the square of the number of connected users of the system — in simpler terms, wider distribution will lead to a more valuable network.
For those following this closely, Kathleen said they’ll be launching something in “several weeks.”
Jordan Clifford — Scalar Capital
Jordan, the cofounder and managing director of Scalar Capital and a CoinBase alum discussed how and why he invests in cryptoassets.
Jordan was inspired by the cypherpunk quest for digital money (you can read the digital manifesto here). The cypherpunk movement started in the late 1980s and now encompasses any activist advocating for the widespread use of cryptography to create social and political change. They started with a mailing list and informal meetings in San Francisco.
The first idea for digital money was in Blind signatures for untraceable payments, by David Chaum in 1983. The idea was that digital money could enable transactions without as much friction as in person. There were early attempts at digital money in 1990 with Digicash and 1996 with E-Gold. These attempts failed due to a central point of control which was necessary to avoid the double spending problem. Bitcoin solved this with the Proof of Work Consensus.
While payments are a huge application for cryptoassets, there are also applications in storage and computation, smart contracts, decentralized exchange, privacy, and governance.
Jordan discussed the “token generation event” as a birth of a new asset. This can happen in a few different ways. In the case of Basecoin or other ICOs, there’s a presale, then maybe a private sale and then eventually a public sale of the token. Bitcoin is on the other end of the spectrum where there was no issuance of tokens before mining began. This likely leads to the least level of centralization and is the most egalitarian because you are not just selling to insiders.
Jordan outlined the questions he asks when considering whether to invest in a cryptoasset.
- Who is going to buy and hold the token in the future? Why?
- Is the technology built? If not, is there a credible plan?
- Does the system require trust or is it trust minimizing? How well does it preserve privacy?
- Are there proper incentive structures to keep the miners, developers and relayer nodes doing their jobs?
- Who is contributing to the project? Are they credible and do they have enough skin in the game?
- How big is the community? Is it growing? Productive?
- Is there novel code or cryptography? Has it been peer-reviewed? Are there good testing practices?
Mitzi Chang — Goodwin Procter
Mitzi went through some legal considerations for token sales.
In the U.S. there are obviously several regulatory regimes that apply. SEC Chariman Jay Clayton has made a few comments about how he views ICOs.
“I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security” — SEC Chairman’s speech, November 9, 2017
“I think that now we have given the market a sufficient warning where we can move from level-setting the field to enforcing it … Where we see fraud, and where we see people engaging in offerings that are not registered, we are going to pursue them because these types of things have a destabilizing effect on the market” — SEC Chairman’s statements, November 16, 2017
“Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law.” — SEC Chairman’s testimony to Congress, February 6, 2018
The SEC has also provided official guidance that tokens “may” be securities, and that celebrities touting ICOs that are securities must abide by anti-touting rules.
They also sent a Cease and Desist Order to Munchee, a company that offered tokens to raise capital for their platform. In this case, the SEC said that even if the tokens had a practical use, it would not preclude the token from being a security.
If federal and state securities regulation applies, you have to register it with the SEC or comply with an exemption. But you also need to comply with the Investment Company Act, Investment Advisors Act, Broker-Dealer registration, and Securities Exchange Act registration.
On February 6th, the SEC and CFTC chairs gave joint testimony before congress and provided three buckets for potential regulation.
- Distributed ledger technology: likely requires the least amount of regulation
- Cryptocurrency: requires protection against fraud and market manipulation
- ICOs: requires the most securities law regulation
In addition to the SEC, there are other agencies that have jurisdiction to regulate in this space:
- CFTC regulates virtual currencies as commodities
- FinCen and state money transmitter laws regulate money transmission
- IRS treats cryptocurrency as property and is subject to capital gains tax
The Commodities Futures Trading Commission (CFTC) regulates commodities, which include virtually all goods and articles, including gold, corn, oil and virtual currencies. The CFTC also regulates transactions in contracts for future delivery of commodities and swaps involving commodities. According to the CFTC, most tokens are commodities.
One somewhat unanswered question is whether a SAFT (a Simple Agreement for Future Tokens) is a commodities future. Most companies currently treat SAFTs as securities.
FinCen is important because if a token is a currency, you need to think about whether you are a money transmitter. Money transmission is receiving money or something of value from one person and transmitting to another. If you are a money transmitter, you have to be licensed.
There are also “Know Your Customer” (KYC) and anti-money laundering requirements, US export control regulations regarding software, OFAC sanctions programs that include certain countries and blocked persons lists, as well as things like the New York bit license, which requires any company engaged in virtual currency business activities or issuing a virtual currency to obtain a license.
Mitzi also noted that these are just the regulations for the United States. China has banned all ICOs and many other jurisdictions are making statements on ICOs and regulatory compliance.
It was great to have Mitzi review this stuff and explain the regulatory regimes to be aware of.
Class Q&A
We set up a Reddit page before the class, and the most upvoted questions got asked to the panelists. Below are a few interesting answers.
A dating app on the blockchain since it’s mostly men in the crypto world — Kathleen Breitman
Non-crypto friends that are into Ripple and TRON — Jordan Clifford
While I was in Ukraine, someone was kidnapped for their private keys — Joshua Slayton
Any business that has a middle-man, but most of that is 5–10 years away — Jordan Clifford
Payments and finance are the low-hanging fruit. Next is securities, real estate. — Kathleen Breitman
Go after obvious bad actors. It gives the space a bad name. — Jordan Clifford
Since we only invest in cryptoassets, we can help with things like technical advice, recruiting, strategy and other challenges they might face. — Jordan Clifford
This is part four of a series on UC Berkeley’s CS 294–144: Blockchain, Cryptoeconomics, and the Future of Technology, Business and Law.
You can read part one, part two, and part three here.
