Against Tokens (and token Crowdsales)

Part of a two-part series. See Against Tokens: Part II (Token Harder).

Yesterday, I was having lunch with Tierion’s Wayne Vaughan at our local Irish diner when our conversation turned to a rather distressing recent development we’d both noticed in the “blockchain” space.

That development is that certain people who frankly should know better are openly discussing whether speculative investment in “crypto crowdsales” (for the uninitiated, this is the practice of creating a Bitcoin clone or some other distributed protocol, and selling “coins” or “shares” in the protocol directly to the public in exchange for investment funds) should be encouraged.

Long have I been a vocal critic of these schemes. Usually I keep my critiques general (or to myself). Occasionally, when a scheme promoter’s abuse of their users becomes sufficiently outrageous that I feel comfortable calling them out, I’m happy to get specific. 

My blog posts on Bitshares and the DAO (and this on the DAO too) speak for themselves. The tl;dr version of my view on altcoins/appcoins is this: it’s all rotten. 

Worse, we’ve been here before.

Back in 2014, it seemed a new hot “bitcoin 2.0” was being released every other week ( be it Dogecoin, Auroracoin, Maidsafe, SwarmCoin, Bitshares, or otherwise). Most of these experiments ended in failure or a slow fade. Now, it seems, for reasons known only to God, the appcoin concept is back on the table again and is being seriously discussed.

I didn’t like alt/appcoins when I first saw them (except Dogecoin because it features a cute dog). And I don’t like them now.

When, with my two outstanding co-founders Casey and Tyler, we founded a smart contracts and blockchain company of  our own, we did so in the context of the “altcoin boom” – a time when there were going to be thousands if not millions of cryptocurrencies, all with tokens to be bought and sold.

There was a ton of exceedingly dumb Bitcoin money on the table back then, and if you wanted to get your hands on it,  rolling a new “coin” was the surefire way to do so. Dozens of projects went ahead on this basis, and so did their pre-product, pre-revenue token launches, raising five, ten, twenty million dollars a pop. 

We didn’t do that. We decided to build a software company instead. And while this took a lot more work with a significantly smaller budget, I don’t regret doing it this way for a second. 

I can’t speak for Casey and Tyler, but back in 2014 when we founded our smart contracts company, I was setting out to give people the utility of the blockchain without the coins – the permissioned blockchain. In late 2014 we released what is, to my knowledge, the first blockchain client that did exactly that.

There were a lot of reasons that we set out to do this – chief among them that a distributed BFT database with access controls that have public-key cryptography baked in from the start was likely to be (and has since proven to be) a very useful enterprise tool.

However, in the back of my mind, there was a hope that the advent of a open-source blockchain that would be entirely free to use would put down, once and for all, the distasteful, dishonest, and potentially unlawful promotion of commercially nonsensical investment schemes by dubious actors with questionable motivations.

Free blockchains would outcompete the public blockchains, realising greater efficiencies at a far lower cost. And in so doing they’d expose “coins” for what they really were: well-marketed repackaging of very interesting and powerful distributed database technology which took very interesting and powerful software and turned it into investment fraud. 

Despite taking a ton of flak for evangelising the “blockchain without Bitcoin” concept over the last three years, for the most part, the plan has worked. Private chains did, as predicted, prove useful in enterprise, and are furthermore more performant than their public counterparts. As a result, “permissioned blockchains” have seen significantly better traction with honest businesses than their appcoin counterparts.

But that’s only half the battle won. Unfortunately, the quasi-religious allure of “decentralisation” and the possibility of instant, overnight wealth – far from receding – has only grown stronger in recent months. Much as during altcoin boom, the meteoric rise of Ether and Steemit has reignited interest in these “products.”

I’m not going to write chapter and verse on the subject here. But I am going to put down a marker, for future reference, as follows:

1. Offering appcoins to retail investors as an investment, and then operating the scheme without registration, is probably against the law

This is not the place to argue finer points of international securities and banking law, but simply to point out that there are two camps.

Among those whose opinion on this subject matters (lawyers), the pro-appcoin camp features Coin Center’s Peter van Valkenburgh and Cardozo Law School’s Aaron Wright, both of whom I respect. Against, are myself, and practically every other practitioner I know. 

We can only make educated guesses as to what the legal position actually is, since law enforcement has yet to make any firm moves against any scheme promoters on the sole basis that token sale schemes are unlawful. The closest they’ve come is the Securities and Exchange Commission’s action against Josh Garza/Paycoin in respect of the “hashlet” mining contracts (which, it is alleged, were in fact artifices to defraud). On a very different note, we should take notice of FinCEN’s civil enforcement action vs Ripple Labs for operating as an unregistered money services business. 

New appcoin issuances will be vulnerable to regulatory attack from both directions.

There are limited cases where private sales of these things might be able to get around the regs. My guess is that traditional transactions will nearly always be preferable as we aren’t exactly seeing firms like Kirkland & Ellis or Cravath, Swaine & Moore falling over themselves to do the first “cryptotoken issuance.” Probably because it took them even less than the ten seconds it took the rest of us to figure out that crypto-token issuances are a legal-technical crap sandwich par excellence.

And before you mention it, Switzerland and the EU have these laws too – different laws, with different requirements, that would need to be complied with as well at the same time if you’re selling securities there. America is not alone in this respect. 

2. There is no such thing as a “digital asset”

Sorry to disappoint, GDAX.

Unlike much of the libertarian literature (such as Murray Rothbard) which Bitcoin aficionados are known to read, law categorises property into very detailed, well-defined categories. Take, for example, a “chose in possession,” chose being the French word for “thing,” which is effectively tangible personal property (a pen, a desk, etc.). 

This should be contrasted with a “chose in action,” literally a “thing in action,” i.e., something which has no existence save that which is recognised by a court of law in the context of an action (a proceeding or lawsuit). A chose in action is a right to sue. Debts, shares, and other documentary intangibles fall within this category of property. 

With any chose in action (with a share, e.g.) there are very rigid formalities which need to be complied with. An entity must exist. It must have constitutional documents. Those constitutional documents will set out, among other things, the classes of shareholders and what they say will determine the rights of those shareholders vis-a-vis each other and the company. In turn, shareholders’ legal status as shareholders (as recognised by a court) will determine their rights vis a vis the rest of the world (e.g. in a bank bail-in situation).

This is of relevance when looking at, say, an insolvency scenario when a company is being wound up and a distribution of assets needs to take place, or when a change of course is needed and the shareholders decide to throw the incumbent management out.

The number of formalities that need to be complied with is daunting. Complying with them is not easy and requires expert help. So when I see something like this: 

Screen Shot 2016-08-12 at 15.29.36.png

…I don’t see “tokens” which are “shares” in a “company.” I see no company; I see no shares; I see no rights.  I see no formalities. I see nothing, except perhaps a cargo cult corporation. Because a chose in action is that which a court will enforce – not what the issuer says it is. 

Screen Shot 2016-08-12 at 15.46.01.png

An “equity token” that isn’t backed by equity documentation – which a scheme promoter is encouraging people to buy on the basis that it is equity – isn’t equity.

A “debt token” that isn’t actually constituted in a debt instrument – which, despite the fact that it was issued in exchange for nothing, is being traded on the public markets at a discount to “par” – isn’t necessarily a contractual debt. 

These are actionable misrepresentations. They might also be securities fraud or a Ponzi scheme.

3. The game theory is really hard

Even Bitcoin doesn’t get it right. 

4. Grow up

There are just certain things that grown-ups have to do. 

One of those things is obeying the law. Another one is working your ass off before you get paid. 

The arguments in favour of appcoin crowdsales are dangerously close to a teen-ager’s gripe that their allowance isn’t high enough (make it easy to get investment capital! IPOs are too expensive!) These complaints reflect the fact that many of the people who are advocating for appcoin-friendly law reform have little to no experience of what it’s like to do business in the real world. 

Venture capital is supposed to be hard to obtain. VCs know that out of hundreds of people with an idea, of which perhaps a dozen actually have a good idea, of that, perhaps one or two will be able to execute with alacrity and build a sustainable business out of it. 

Similarly, IPOs are supposed to be expensive. Because you need a team of expensive lawyers and bankers to make sure that what you’re selling on the capital markets corresponds exactly with the marketing material you’re selling it with, and that all of the relevant tax, regulatory, and disclosure requirements have been met in full so that people can fairly assess the risk that they’re taking.

By way of example, BitFinEx’s “debt coin” was rolled in three days. I find this incredible – I’ve never done a listed bond deal that took less than six weeks, and have worked on debt instruments which were negotiated for six to twelve months.

It’s not that the tech of a “DebtCoin” issued in this way is superior. To the contrary, my suspicion is that the legal structuring component may be deficient. 

All in all, it comes down to the advice our parents and math teachers gave us when we were young. Don’t cut corners, do the work, and you’ll get the right result. 

Don’t sell internet funny money. Sell software and services.

Do it the other way, and… well. Only time will tell. 

Postscript: Tuesday, 16th of August, 2016


3 thoughts on “Against Tokens (and token Crowdsales)”

  1. It’s good to hear the voice of sobriety among so much illusion and unfounded libertarian fantasy. I find your articles very relevant in order to get a more comprehensive frame of the big crypto-picture.

    However, my question is: How do we leverage current technology, distributed ledgers, decentralized networks and cryptographic protocols to improve and disrupt (in the sense of “make evolve”) the current legal framework?… And on the other hand, how do we employ sound legal science into the ongoing “crypto” innovation?

    In other words: How can blockchain improve the legal space, and how can the legal framework help improve and strengthen the current blockchain (including the crypto-financial AKA “digital assets”) ecosystem?

    My intuition tells me it’s possible, and that most of current holes you mention around the crypto space are just the natural characteristics of a (yet) immature technological innovation. Nothing that can’t evolve with the proper analysis and engineering.

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