Ether was (probably) a security

This is a follow-up from my post last week titled “Whether Ether is a security.”

Turns out that Ether very probably was a security, per this morning’s report in the Wall Street Journal:

Looking forward to writing the follow-up, “Ether is a security,” in due course, although I will not be able to write it until such time as a federal judge has a chance to weigh in on the matter. Until next time, then.

Whether Ether is a security

Disclaimer: English lawyer, not practising this year, yes in England “practise” is spelled with an “S” when used as a verb, ergo I’m not your lawyer and this blog post is not legal advice. 

UPDATE, 27 APRIL 2018: @hasufl has written a follow-up to this post exploring the Ether pre-sale distribution’s dataset in more detail. I highly recommend reading it.

I am often asked, directly, whether I think this coin or that one is a security (and thus required to be registered with the SEC before being offered to the public) or not. Virtually every time I demur.

Part of the reason for this is that although I am a securitization lawyer by training, I am not, as yet, U.S. qualified and the Howey test is a U.S. question. Most of the reason for this is that the question of whether a thing is or is not a security is a highly fact-dependent and, sitting from my perch on the East Coast and not in the offices of the issuers of these coins, I am in a very bad position to ascertain what is going on behind a company’s closed doors, what’s in their private correspondence and what intentions lay behind their issuances.

As I said to Marc Hochstein, Coindesk’s editor in chief, this morning when asked me that very question about Ripple and Ether,

I think that neither Ethereum’s promoters nor Ripple Labs’ promoters have satisfactorily answered that question to date, and that it is their job rather than mine to do so. Let me just say that if I were starting a software company in the United States today, given the noises being made by the SEC and by other financial services regulators I would not put an exchange-tradable token at the center of the offering unless that token were a representation of a legally-recognized interest and structured on the basis that the token will be regulated by the securities laws.

Whether Ether and/or Ripple are in fact investment contracts under the SEC v. W.J. Howey test is now an issue of public concern, with financial services culture hero Gary Gensler arguing that Ether might be classed as a security (properly, an “investment contract”), and Coin Center’s Peter van Valkenburgh arguing that it shouldn’t because a sufficient degree of “decentralization” should exempt a cryptocurrency from regulation.

Suffice it to say, in what will not come as a surprise to many of you, I tend to agree with Gensler as to the U.S. position. Law is, of course, a local phenomenon; thus when it comes to England and Wales, my home jurisdiction, I do not think Ether tokens as they exist today should be classified as a security, as I set out in more detail here.

But talking about law is boring. Talking about decentralization is exciting, hip and fun. For this reason, rather than quote chapter and verse on the Howey test, I am going to talk about the “Decentralization Defence” that we’re hearing cryptocurrency advocates wheel out in response to Gensler’s comments.


Peter’s Coin Center piece argues Ether is not a security because it has successfully managed to out-decentralize other cryptocurrencies:

But today, the value of ether and the functionality of the Ethereum network is not reliant on the Foundation, rather it flows from the efforts of thousands of unaffiliated developers, miners, and users. That decentralization is hard to differentiate from Bitcoin’s, a cryptocurrency Gensler suggested is almost certainly not a security for the very reason we’re discussing: no discernable third party (no common enterprise) upon whom we rely for any expectation of profits.

I’m going to disagree with that, on three points.

1. Horizontal Commonality

A common enterprise can be established horizontally, i.e. when investors have shared interests in a common fund. The authorities may need to stretch existing precedent if they wish to argue that a headless Nakamoto Scheme is capable of forming such an enterprise. Whether law enforcement intervenes and how will be fact-dependent. I can think of a number of different theories they could use but they do not bear repeating here.

2. Github

Github is also a very obvious central point of failure for the purposes of the decentralization analysis. There’s a main repo. Who controls it and how is relevant.

Yes, Bitcoin has a repo, too, and I don’t think Bitcoin is an investment contract. But the background facts for Bitcoin are quite a bit different than those for Eth (and in my view having a Github repo with admins, in every case, would be a factor weighing in favour of a finding of commonality / weighing against a finding of decentralization).

3. The pre-sale

Here we are not looking at the obvious concerns around the presale, its terms and its legality. We are asking whether the pre-sale was actually a decentralized exercise, with decentralized results, that would militate against a finding of horizontal or vertical commonality.

Despite Coin Center’s protestations to the contrary, the fact is that nobody actually knows how decentralized the world’s supply of Ether is. The ecosystem feels and looks decentralized, in that no single person or group has claimed or has appeared to exercise dominion over it. But that doesn’t mean such a person or group doesn’t exist.

In my view, most of the Ether sold in the 2014 token pre-sale in exchange for Bitcoin may have been paid out to one person or, more likely, a handful of close associates working in concert. My reasons for believing this are anecdotal, but based mainly in this chart which shows the inflow of BTC to the Ethereum wallet address during the Ethereum pre-sale:


Compare this to the curve for, say,  23y = x^7:

Screen Shot 2018-04-24 at 12.10.17 PM.png

Now compare it to a random Kickstarter…


…Or the Tezos raise, which was 30 times the size of the Ethereum raise with what we should expect are many, many more contributors, thus offering an ostensibly much larger sample size:


I could grab plenty more ICO fundraise charts but hopefully by now you’ve caught my drift: while ICO raises are sort of similar in that we usually see an initial rush of investors that gradually tapers off, with a little boost just before the sale ends, the initial two week-period of the Ethereum pre-sale looks more than merely typical, there’s very little randomness in it – it looks perfect. Seeing as human beings are generally imperfect, that’s what makes it a worthy candidate for forensic analysis. “Donations” from Eth-heads around the world not only flowed into the Ethereum Project’s wallet in great quantities, but they flowed in with the mathematical precision of a power function, 24 hours a day, 7 days a week, for two weeks straight. Notable too is the fact that ICOs tend to front-load contributions into the first days of the raise; Ethereum, by contrast, seemed to save the bulk of the contributions for later on.

My preliminary conclusion is that human beings engaged in financial speculation do not usually behave in the manner the Ethereum chart appears to show. This is especially true when we consider that the Ethereum community was as small as it was back in 2014. If someone wants to science the daylights out of this and show how unlikely, given what we see with other ICOs, it is that the Ethereum pre-sale curve is the result of natural, random market conduct, by all means. The data’s all there on the blockchain.

I’m thinking that, unless Vitalik subtly managed to telepathically hack everyone’s brains so buyers would participate in the pre-sale in an organized fashion, it would appear that a lot of Ether – enough Ether to move markets or, if the system migrates to proof-of-stake, enough to play a meaningful role in determining consensus on a block-by-block basis – was sold to not a lot of people. Depending on what those people then did (marketing? Other promotion?) this may be relevant for showing a common enterprise through vertical commonality, which is a lot easier to demonstrate than horizontal commonality. If the degree of influence is so significant that those holders can call the shots on consensus or market movements, well, that’s pretty significant for a securities analysis.

Summing up, unless we can show that this Ether has been sold into the wider market, this chart lends itself to the proposition that Ethereum is not as decentralized as we might hope. If true, this fact likely has legal consequences and rather undermines the “Decentralisation Defence” being put to the regulators by industry lobbyists.

Stablecoins are doomed to fail, Pt. III: SAGA

Previously on this blog, I’ve predicted that stablecoins are doomed to fail and I’ve pointed out when they do in fact fail. Logic, however, appears to have done little to curb the market’s enthusiasm for these schemes, nor does the prospect that the more ridiculous these schemes’ marketing becomes, the more likely it is that they will catch my attention and be summarily pilloried on this blog.

With that said it is my great pleasure to introduce you to SAGA Coin, through the medium of interpretive dance:

This is without a doubt the least informative piece of cryptocurrency marketing I have ever seen.

SAGA merits some attention in that it appears to have garnered a number of heavy-hitters on its advisory board including but not limited to Cornell’s Emin Gun Sirer, Jacob Frenkel, and Myron Scholes. I am naturally wary of “advisory boards” as, being one of the first enterprise blockchain entrepreneurs, I know that the only folks worth a damn on boards of any description are people who either work with you full time or have given you a substantial quantity of money. Given the recent episode with the Tapscotts claiming that Satoshi Nakamoto and Joseph P. Kennedy were on their advisory board, I therefore approach any claims that this person or that one is an “advisor” with a healthy degree of skepticism.

So how does the damn thing work?

I mean, if SAGA’s opening marketing gambit is a bunch of barefoot dancers, in various states of undress and pretending to have gross motor control issues, evolving into creatures capable of wearing a cheap suit, surely the product they’ve built is way too complicated for peons like us to understand, right?


By allowing participants to both buy and sell SGA, Saga’s smart contract acts as a market maker.

To buy SGA tokens, participants send funds to Saga’s Smart Contract, where they are kept as part of the variable reserve of conventional currencies, hosted by reputable banks.

The primary purpose of Saga’s reserve is to ensure participants can sell SGA; the contract will always offer to buy SGA, drawing on funds from the reserve.

The SGA token will be available for purchase starting Q4 2018.

Well that was easy. Basically SGA is giant pool of liquidity obtained from existing holders of Ether. The pool of liquidity exists to buy SGA at a particular Ether-denominated price.

I’m not sure how many times I have to say this before the market realizes what’s going on here, or before developers need to figure out that they should take a basic course in economics before trying to build an economic system, but here goes: what SAGA proposes is not anything new and it’s certainly not worthy of the name “stablecoin.” It’s a subsidy scheme which amasses a huge amount of collateral up front to create a price floor for a product the subsidy scheme sells in exchange for the collateral.

Governments do this all the time with, e.g., wheat or milk. It’s an expensive, low-tech solution that is dependent on having enough subsidy firepower to ensure that you can pay for any differences of opinion your scheme has with the market.

It works when governments do it because they use hundreds of millions of citizens as a source of liquidity. It works in crypto because people have a stupid amount of overnight gains they need to do something with, and there’s not enough dollar liquidity to immediately withdraw the entire wedge.

Given that much of the collateral will be denominated in Eth this means that the scheme will likely be exposed to Eth – although the scheme claims most of this will be exchanged out to USD, one wonders how consistently these liquidity facilities will be available or how efficient it will be to pay the punishing conversion/withdrawal fees from Coinbase and the like as compared to just going out and, y’know, buying actual dollars.

Screen Shot 2018-03-22 at 9.38.19 AM.png

This wouldn’t be so bad if it were fully-backed. Problem is, it’s not:Screen Shot 2018-03-22 at 10.22.21 AM.png

How I read this is: “if you invest 100 Eth for 100 SAGA, we’ll fix the price of SAGA at a multiple of what you invested in and use the collateral to support that inflated price.”

No bueno.

“B-but Myron Scholes is advising them! And he won a Nobel Prize!” I hear you exclaim. Well lah-dee-dah. I know an eminent economist, too, and we concluded that trying to go full-trustless in a system such as this is supremely inefficient from a cost of capital perspective and downright crazy from an investment perspective. I am willing to wager some different nobel prizewinners e.g. Paul Krugman or Robert Shiller, both of whom have chimed in critically on the crypto phenomenon in recent months, would agree.

It strikes me that the SAGA scheme, as with many others, invites those with more Ether than brains to part ways with their cryptocurrency in exchange for something which promises to hold value pegged to some third assets, like a dollar, when they would be better off just going out and buying actual dollars instead.

But hey, at least it’s got a cool dance video. Eat your heart out, Basecoin.

Careful ICO investing, my friends.


The American ICO is Dead

Disclaimer: I’m not your lawyer, this is a blog, this is not legal advice, and I’m admitted only in England and Wales.

Before we talk about ICOs, let’s talk about marmots.

Writing last August, I predicted an event which I call the “Zombie Marmot Apocalypse” – a regulatory binge whereby the American federal authorities would decide that the whole “utility token” thing was cute but ultimately completely illegal. And whither America, whither the world.

At the time, this was an unpopular opinion, and not widely held. I argued that:

The list of enforcement actions in the various categories mentioned above (will be) a prelude to simultaneous dawn raids at the major exchanges and the homes and offices of the major ICO promoters, with a variety of agencies in a variety of countries co-ordinating their activities. Most liquidity (will dry) up; the few remaining legal on-ramps for liquidity (will) have nothing in which to put it. Billions in paper gains (will be) lost.

So why did I call this the “Zombie Marmot Apocalypse?”

Those who know me well will be aware that I use the word “marmot” in blog posts and elsewhere as a subtle dig at the overwhelming and everpresent Dunning-Kruger-fuelled sanctimony of blockchain entrepreneurs – the newer and more idealistic the entrepreneur is, the worse his affectation tends to be.

When I coined the term “Zombie Marmot Apocalypse” I was genuinely trying to convey some marmot imagery I encounter on a near-daily basis in marmot season in Connecticut. Close your eyes and imagine a horde of cute and fuzzy animals as adorable as they were unstoppable, advancing towards you, inch-by-inch, paw-by-paw, and gunning for your plants.

That is the true meaning of fear.

What I live with every day (not kidding, this is the actual marmot)

I don’t really mind that much, if I can be completely honest with you. I’m glad that my garden makes the marmots happy, and I enjoy their company, even if it means I have to work from home to shoo the little bastards away from my peppers for most of the summer.

Those of you without gardens will have an even more positive experience still. If you haven’t broken any securities laws and you’re just doing normal stuff, like taking a hike in the Pacific Northwest, being attacked by a marmot can actually be a fairly pleasant experience:

But we’re not talking about normal people today. We’re talking about coin fundamentalists. People who are willing to go on the record to the New York Times and say garbage like this:

“Sometimes I think about what would happen to the future if a bomb went off at one of our meetings… it would set back civilization for years.”

If you’re a creature without a central nervous system – such as the individual quoted above, a venture capitalist, a head of lettuce or some other form of vegetable – encounters with marmots can be far more harrowing. Imagine, if you will, that you are a tomato plant, luxuriating in the summer sun. All is well in your world; a gardener tends to you and you live in a pleasant little universe hemmed in by a fence, accompanied by many other legumes just like you, safely protected from a dangerous world beyond.

In other words, you live in San Francisco.

Suddenly, a large, furry, foreign, dark, blob from the east appears, scales the fence, and is inside your little bubble/enclosure. It surveys its terrain. Then it looks straight at you. It approaches. Closer. Closer. Oh god, it’s almost here. You stand there, rooted to the ground. You realize your world is about to change. You’re just not sure how.

Then it eats you.

That, my friends, is the Zombie Marmot Apocalypse.

From my vantage point, this is what is happening in Silicon Valley this month: a bunch of people floating around in a mania-induced vegetative state have suddenly found a hungry ground squirrel in their proverbial back yard, and this is such an unexpected change of pace that abject panic has ensued. People have been running around for the last four years thinking that just because flogging unregistered crypto-coins was something that other people were getting away with right now meant everyone could get away with it forever.

So if we’re being honest with ourselves, where are we now?

1) ICO v. 1.0, at least in America, is dead.

Long live ICO 2.0.

The public-presale-of-tokens-that-pretend-not-to-be-securities field appears to be well and truly dead following the issuance of 100-ish subpoenas to market actors big and small by the Securities and Exchange Commission. Why anyone thought it was a smart idea to market these things in the Southern District of New York is anybody’s guess.

I’ve said chapter and verse about why certain types of ICO are rubbish, but what I haven’t said so often – in part because the platforms only recently came into existence – is that the ICO 2.0 platforms like Prometheum, T-Zero, Templum and Harbor are super interesting since they acknowledge, right off the bat, that blockchain capital markets tokens will be regulated and assume that a distributed system will be more efficient than existing solutions (which are not “centralized” as much as they are “multiple-centralized” with separate independent stacks each confirming for their owners the work done by other transaction counterparties).

In the case of some of these projects there are very serious tech and investment heavy-hitters standing behind them (Chris Pallotta for Templum and David Sacks for Harbor, e.g.) which tells me immediately these companies will be doing things correctly from the start, unlike the 2014 blockchain set, and not be racking up a ton of legal-technical debt which they’ll have to pay down later.

So I’m actually optimistic about the prospects of the ICO 2.0 space. Which isn’t really going to be “ICO 2.0” as much as it’s going to be “Automated Securities Issuance 1.0.” Assuming these outfits get legal right, the demand for high-risk investment is as great as it’s ever been. ICO 2.0 has the potential to be 10x what ICO 1.0 was.

The European Union is another ball game. Although for the moment the EU/EEA jurisdictions are apparently friendlier to the ICO 1.0 schemes, as my friend David Gerard points out, European authorities appear appallingly poorly-advised and are failing to apply a even a modicum of skepticism to the claims presented to them by blockchain technologists. It’s not hard to understand how they could make this mistake; there is a blockchain echo chamber of sorts which is slowly eating the world, on account of the fact that there is a ton of money to be made in selling and promoting “blockchain,” and almost no money to be made in telling people to ratchet back their expectations.

2) Money Transmitter laws are back.

Back in 2014, when “coins” were all the rage rather than “DApps” or “smart contracts,” I remember attending panel after panel of “Bitcoin law” where the lawyers would constantly ram home KYC/AML and very little else. That aspect of compliance has been fairly comprehensively dealt with by big firms like Coinbase. As the market consolidated, the need for de novo legal opinions on that question surely subsided (as, no doubt, did the demand for lawyers to write them). KYC/AML lawyers thus became less popular on the conference circuits as securities lawyers were more in vogue.

Being a securitization bod, I enjoyed my profession’s fifteen minutes in the sun, and had waited for that moment for a long time – I was raising the securities law issue years before it was cool. And for the last 18 months or so, as the attention of developers everywhere has been focused squarely on the securities aspects of token issuance, a lot of expertise has spent a lot of hours considering the application of public offering rules in relation to tokens.

Different law firms adopted a range of different answers. Some firms operating in the EU and the US appear to have been willing to opine that ICO tokens are more akin to a kickstarter and not an investment (a conclusion so unreasonable I have trouble understanding how they reached it). Other firms endorsed a two-step issuance process using a contract called a “SAFT,” which I’ve written about before, and which is reportedly now under the regulatory microscope. Still others refused to provide favorable opinions of old-school ICO schemes and instead recommended treating the token as a security from day 1 (assuming for the purposes of this discussion that “ICO token” means companies pre-selling tokens as an investment product rather than a coupon tradable 1:1 for some physical asset or licence). For what it’s worth I fall into the latter camp.

What a lot of people have missed is that it’s possible for an ICO operator to be both a money transmitter and a securities issuer at the same time. As put here on the marmot blog in August and October, KYC/AML rules still apply if you’re issuing a crypto-token.

But, as usual, nobody listened to the half dozen or so good crypto-lawyers who saw this maelstrom coming a year ahead of time:

Following the decision of a very senior federal judge yesterday, we know that multiple federal agencies can have very broad jurisdiction where cryptocurrencies are concerned. Nor should we expect jurisdiction to be exclusive to one agency or another, even w/r/t the same conduct. Ergo we could see enforcement occurring on multiple prongs at the same time:

So goodbye securitizers, hello Bank Secrecy Act and Proceeds of Crime Act once again! The KYC/AML lawyers will be thrilled.

3) Exchanges, wallets, and more… Hoooo boy.


And not just trading venues. Per the SEC’s announcement:

Some online trading platforms may not meet the definition of an exchange under the federal securities laws, but directly or indirectly offer trading or other services related to digital assets that are securities.  For example, some platforms offer digital wallet services (to hold or store digital assets) or transact in digital assets that are securities.  These and other services offered by platforms may trigger other registration requirements under the federal securities laws, including broker-dealer, transfer agent, or clearing agency registration, among other things.  In addition, a platform that offers digital assets that are securities may be participating in the unregistered offer and sale of securities if those securities are not registered or exempt from registration.

4) Lawsuits

Investors in ICOs are kind of like gremlins. They’re cute now, but if you don’t handle them with the utmost care they will transmogrify on you into these vengeful and extremely dangerous critters called “plaintiffs.”

I could list a number of class-action lawsuits here regarding ICO issuances or insider dealing which have been filed in the last 60 days, but will refrain from doing so. If you’re really keen to find out who’s suing whom Google is all the resource you need.

Summing up


  • the ramping up of enforcement actions against non-compliant ICOs; and
  • the emergence of compliant “ICOs” using blockchain back-ends which are actually taking aim at legacy infrastructure,

it’s shaping up to be a very interesting year in blockchain tech.

Live Free or DAICO

If you want to lose your liberty in a hurry, there’s no better way to do it than a DAICO.

What’s a “DAICO,” I hear you ask? Well, it’s a new kind of automatic, Ethereum-based investment scheme that allegedly combines

  • “the best aspects of DAOs” – “distributed autonomous organizations,” a long-winded neologism for “software that runs on a blockchain” – and
  • ICOs, or “initial coin offerings,” schemes where companies launch their own “coins” and sell them as investments to the public without filing a registration statement or publishing a prospectus.

Oh, I should add that Vitalik came up with the DAICO concept. It is, therefore, automatically brilliant.

Except it isn’t.

Given the fact that the original DAO’s inflexibility caused its implosion, and given recent regulatory developments, I am astounded that anybody would think it prudent to launch one. But launch one they have.


The basic idea behind this new crypto hustle is that ICO investors can prevent their dev teams from absconding with investor funds, or withdrawing too much funding too quickly, by locking up the Ether they give to these developer teams in a smart contract, and granting the investors a right to vote to either

  • increase disbursements from the pool, or
  • blow up the deal and return the ICO funds to investors on a pro rata basis.

There are, of course, problems with this approach. The first is that tokenholders are generally passive rather than active investors: the original DAO could pass resolutions with a simple majority drawn from quorum of 20% (meaning as little as 10% +1 of the investors could bind the remaining 90%). No resolution ever passed because none of the tokenholders actually cared enough about what the DAO was doing in order to participate. Their primary motivation was to sit on their hands and wait for their investment to pay off.

When we consider that there are more responsive ways to ensure capital is used well (such as, say, putting an investor director with wide discretion and a veto power on a startup’s board) it strikes me that the existing solution is more responsive and fit for purpose than the quite binary, all-or-nothing DAO solution.

Second, I feel like I’m taking crazy pills here, because the SEC literally wrote a report about the original DAO scheme, likened it to a security, and cited as authority for this proposition not one but TWO cases relating to an infamous 1970s pyramid scheme that landed its promoter in federal prison for nearly a decade.

These facts diminished the ability of DAO Token holders to exercise meaningful control over the enterprise through the voting process, rendering the voting rights of DAO Token holders akin to those of a corporate shareholder. Steinhardt Group, Inc. v. Citicorp., 126 F.3d 144, 152 (3d Cir. 1997) (“It must be emphasized that the assignment of nominal or limited responsibilities to the participant does not negate the existence of an investment contract; where the duties assigned are so narrowly circumscribed as to involve little real choice of action … a security may be found to exist … .

[The] emphasis must be placed on economic reality.”) (citing SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 483 n. 14 (5th Cir. 1974)). By contract and in reality, DAO Token holders relied on the significant managerial efforts provided by and its co-founders, and The DAO’s Curators, as described above. Their efforts, not those of DAO Token holders, were the “undeniably significant” ones, essential to the overall success and profitability of any investment into The DAO. See Glenn W. Turner, 474 F.2d at 482.

To which the crypto world responded, “whatever, YOLO, we’ll just launch it in Switzerland.” Putting philosophical arguments about the moral case for exercising extraterritorial jurisdiction to one side for the moment, recent litigation in the ICO world has shown that U.S. federal courts are willing to reach across borders in securities litigation. Ignore America at your peril.

Third, if you haven’t seen Jay Clayton’s testimony before the Senate last week on ICOs, it was savage:

There should be no misunderstanding about the law. When investors are offered and sold securities – which to date ICOs have largely been –they are entitled to the benefits of state and federal securities laws and sellers and other market participants must follow these laws…

I believe every ICO I’ve seen is a security.

Unless you’re a tech journalist in which case it was “cautiously optimistic” – an opinion no lawyer I have spoken to since shares:

So where we’re left is this:
Most DAOs appear to be a legal no-no, per the SEC (and likely other national securities regulators as well).
Most ICOs appear to be a legal no-no, also per the SEC (and likely other national securities regulators as well).
Most DAO users are less interested in managing their chosen project than they are in offloading their coins at a massive profit on new entrants as quickly as possible.

To close, a DAICO is nothing more than a new acronym for the same old bad ideas. The broken DAO concept, in particular, requires extensive rethinking and movement onto private/permissioned blockchains in order to shed its pyramid scheme-like qualities and serve a useful function. On account of which I am completely amazed that anyone would want to combine the DAO and ICO concepts under any circumstances.

Be smart. Don’t let smooth-talking marketers convince you otherwise – find a straight-shooting lawyer who will tell you what you need to hear. (If you’re of two minds about it, I know a few good lawyers in this space and would be happy to point you in their direction.)