New SEC lawsuit could decide the fate of dozens of blockchain projects
Howey test —
The SEC says Kik’s initial coin offering was an unregistered sale of securities.
The Securities and Exchange Commission has filed a lawsuit against social media company Kik over its creation and sale of a Cryptocurrency called Kin back in 2017. Kik is vowing to fight the lawsuit, setting the stage for a landmark ruling on how securities laws apply to the sale of digital tokens online.
The case is important because the Kin sale was one of thousands of so-called initial coin offerings held in the last three years. The Kin sale generated almost $100 million in revenue, and coin offerings have collectively raised billions of dollars. Most organizers did not file the kind of disclosure forms that the law requires for conventional stock sales.
The big question is whether the law required them to do so. We don’t yet have a clear answer, largely because the SEC has been slow to address the issue.
In the months during and after the 2017 ICO boom, the SEC focused on cases where ICO promoters allegedly committed outright fraud. But those enforcement actions did little to clarify the legal status of mainstream projects like Kin.
As a result, dozens of high-profile Cryptocurrency projects are still operating in a legal gray area. It’s not clear if they’ve broken the law or what penalties they might face as a result, but the penalties could be serious. And more importantly, the strict legal requirements for issuing securities to the public could make initial coin offerings effectively illegal.
Most companies go out of their way to avoid confrontation with federal regulators, but not Kik. Instead, the company has used the case to rally the Cryptocurrency community behind it. Last week, Kik announced a crowdfunding campaign to raise millions of dollars to cover its legal costs. The case could determine the fate of dozens of other Cryptocurrency projects that have raised money through coin offerings.
“The whole point is to make our legal department happy”
People buy all sorts of things—from gold to real estate to baseball cards—in hopes of making a profit. But only certain types of investments are legally considered securities, a category that triggers a range of legal obligations.
A security exists when someone invests in a common enterprise expecting to profit from the management efforts of a third party. Apple stock, for example, is a security because shareholders invest in Apple (the common enterprise) and are counting on Tim Cook and his employees to generate profits that will get paid back to Apple shareholders.
In a letter to the SEC last fall, Kik argued that Kin is nothing like this. Kik argued that Kin’s primary value comes not from its investment value but from its potential use as a currency. People can use Kin to buy goods and services in the growing Kin economy. The fact that Kin’s value might go up over time doesn’t make it a security any more than baseball cards or gold are securities, the company argued.
But in its Tuesday lawsuit against Kik, the SEC argues that Kik’s own marketing efforts focused on opportunities to subsequently sell Kin at a profit—not on its potential use as a medium of exchange.
“Kik allegedly told investors that rising demand would drive up the value of Kin, and that Kik would undertake crucial work to spur that demand, including by incorporating the tokens into its messaging app,” the SEC said in a press release.
The SEC points out that by the end of the Kin crowdsale in September 2017, Kin had only been implemented as an ERC-20 token on the Ethereum Blockchain. The Ethereum network is not known for its scalability, and widespread use of Kin on the Ethereum Blockchain would likely bring the network to its knees. Kik planned to deal with this by migrating t