Ted Livingston, CEO of Kik and the founder of the Kin Foundation, and Patrick Gibbs, partner at Cooley, announce the formation of the $5 million DefendCrypto.org fund at Coinbase Custody to fight the SEC in court. Kik and Kin are hoping that a lawsuit would eventually result in a new Howey test for crypto tokens, to determine which ones are a security. In this episode, they explain has happened so far between them and the SEC to bring them to this point and what their main arguments are. Plus they defend themselves against some of the evidence against their case and we discuss what they can expect going forward.
Read the full show notes on Forbes.com: http://www.forbes.com/sites/laurashin/2019/05/28/kin-launches-5-million-defendcrypto-fund-to-take-on-the-sec/
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Episode links:
DefendCrypto: https://www.defendcrypto.org
Kik: https://www.kik.com
Kin: https://www.kin.org
Ted Livingston: https://twitter.com/ted_livingston
Patrick Gibbs of Cooley: https://www.cooley.com/people/patrick-gibbs
Kik’s Wells response: https://www.kin.org/wells_response.pdf
Kin white paper: https://www.kin.org/static/files/Kin_Whitepaper_V1_English.pdf
The DAO report: https://www.sec.gov/litigation/investreport/34-81207.pdf
Kathryn Haun of A16z Crypto’s blog post: https://a16z.com/2019/05/15/kik-and-the-sec-whats-going-on-and-what-does-it-mean-for-crypto/
Importance of the Kik and Kin Foundation case by the Blockchain Association: https://medium.com/@BlockchainAssoc/the-potential-kik-and-the-kin-foundation-case-has-major-consequences-for-the-open-blockchain-de8ed616a1c
Breaker Mag on Kik’s fight with the SEC: https://breakermag.com/how-kiks-looming-sec-fight-could-unfold-and-why-it-will-define-blockchains-future/
Video of Ted at the San Francisco Meetup: https://youtu.be/rqN7srwqRf8 https://www.theblockcrypto.com/2019/01/31/video-shows-kik-ceo-discussing-ico-pre-sale-it-will-become-super-valuable/
Kik chooses Stellar: https://www.coindesk.com/two-chains-no-more-kik-selects-stellar-over-ethereum-for-crypto-token-launch
Kik chooses Stellar and Ethereum: https://www.coindesk.com/ethereum-and-stellar-mobile-messenger-kik-embraces-two-blockchains
Next Web story: https://thenextweb.com/hardfork/2018/12/06/kik-kin-cryptocurrency-blockchain-2/
Kik pre-sale: https://www.coindesk.com/mobile-messenger-kik-raises-50-million-ahead-75-million-ico https://www.coindesk.com/why-big-investors-are-betting-real-money-on-a-kik-cryptocurrency
SEC Framework: https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets
Token Taxonomy Act: https://medium.com/@BlockchainAssoc/the-token-taxonomy-act-is-back-and-we-need-it-more-than-ever-d2cbf0154776
Transcript
Laura Shin:
Hi, everyone. Welcome to Unchained: Your No-Hype Resource for All Things Crypto. I’m your host, Laura Shin. If you find it impossible to keep up on all the news in crypto, find out what I think are the top stories every week by signing up for my email newsletter. Just go to Unchainedpodcast.com and enter your email address into the box right on the Home page. Sign up today.
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Laura Shin:
My guests today are Ted Livingston, founder of Kin and founder and CEO of Kik, and Patrick Gibbs, partner at Cooley. Welcome, Ted and Patrick.
Ted Livingston:
Good to be here.
Patrick Gibbs:
Thank you, Laura.
Laura Shin:
I think this is a first for the podcast but we are announcing news today on the show. Ted, why don’t you tell everyone Kik’s plans?
Ted Livingston:
Yeah. So first of all, thanks, Laura, for having us. So just a bit of background. We’ve been in the crypto industry for quite some time now. We launched our own cryptocurrency, Kin, back in 2017. The Kin ecosystem continues to grow, there’s over 40 apps where you can earn and spend Kin live today, and in the last month over a million people have earned Kin and over 300 thousand people have spent Kin, making Kin one of the most used crypto currencies in the world.
So that’s been great, that’s been really exciting, but the continued challenge for us has been the lack of clarity on the regulatory side and so over the last year and a half we’ve also been working with the SEC, you know, they first reached out to us three days after our token sale. Then when they started to ask us for some comments and some meetings and then you know, some subpoenas and then formal testimony, and just trying to work with them to understand crypto to create that clear guidance we all need, and after spending 18 months and over 5 million dollars trying to work with them, just continue to be super frustrated a bit at the lack of clarity and so you know, it’s recently felt important to us and not just for us but for the whole industry like we need clarity here because this is really starting to hurt our business, and so we’ve put together Defendcrypto.org and what that is, is it’s saying the only way we’re going to get clarity is if somebody goes to court, and so we are prepared to do that.
You know, we need a new Howey test and that new Howey test is going to come from a ruling in a court case. We have great facts, we have great circumstances, we have a great team, great lawyers, and so we’re in a unique position to create this clarity not just for us but for everybody else, and so we’ve created an account with Coinbase Custody to make sure the funds are available to…because these things are expensive, we put 5 million dollars of Bitcoin, Ether, and Kin into that Coinbase Custody account, but we’ve also opened up contributions for any other project or individual who’s frustrated with the current status of clarity and regulation to contribute alongside to make sure there’s the funding there to create the clarity we all need.
Laura Shin:
And so the way you phrase that it wasn’t totally clear to me. Do you definitely intend to take your case to court?
Ted Livingston:
We hope so, we hope so, so you know, the way this works is the SEC would take us to court and they haven’t done that yet. They haven’t decided to make a recommendation to our knowledge that they would recommend to Commission to authorize a case against us so that hasn’t happened, yet but at this point we hope it does because it’s become clear that that is the only way we are going to get the clarity we need.
Laura Shin:
Okay, so something that I need to understand is essentially they notified you that they intended to take an enforcement action against you. You wrote this Wells response back to them and actually publicized it which as far as I understand is pretty unusual and you know, kind of indicates that the discussions weren’t necessarily going well, and so I believe that there was a deadline last week or sometime in the last couple weeks where the SEC needed to take a vote about whether or not they would pursue an enforcement action against you, and have you heard of the outcome of that decision or if they’ve taken a decision?
Ted Livingston:
We have not but maybe Patrick, I’ll turn it over to you.
Patrick Gibbs:
Sure. Laura, you’re correct. The SEC sent the company what’s called a Wells notice which is a notice that the staff intends to recommend to the Commission itself that the Commission approved the filing of an enforcement action. The response that we filed that you’ve alluded to was our Wells response and there is a presumptive timeframe after the SEC serves the Wells notice of six months within which the Commission is supposed to make a decision as to whether or not to bring an enforcement action.
That deadline can be extended internally at the SEC and often is and so we don’t read too much into the fact that they haven’t filed an action yet. They very likely extended that deadline and are still in the process of going to the Commission to get permission to file an action.
Laura Shin:
And so in this case where you know, they have done a number of enforcement actions and essentially the ICO issuers that they were taking the actions against agreed to the terms, but essentially you know, I think what you’re saying is you’re not agreeing. Then is it that the only course of action at that point is that then they would take you to court, or how would it end up that they would end up suing you?
Patrick Gibbs:
That’s correct, the settlements that they’ve announced so far have been actions where the SEC has threatened to file an enforcement action against a certain seller and rather than litigate with the SEC the seller has decided to settle the case, and so the SEC simultaneously files a case as well as the settlement and they don’t actually litigate any disputed issues, so that’s exactly what Ted means when he says we need clarity from a court decision. If the SEC files an action against Kik or the foundation we intend to fight it and litigate it and ask a court to decide whether or not the sale of Kin tokens amounts to an investment contract or security.
Laura Shin:
Okay, and so let’s now talk about what it is that you hope for from such a case. You mentioned that you hope that there would be kind of a new Howey test and for listeners who don’t know we’ll just review what the Howey test is and why it’s important for crypto, but essentially this test is what has been used so far to determine whether or not tokens would be considered securities and so in order for a token to be considered a security it has to be…and there are essentially four prongs of this Howey test and you have to meet all four prongs.
So that would be that the token has to be one, an investment of money in two, a common enterprise, and three, with an expectation of profits, four, dependent on the efforts of others and so Ted and Patrick, when you say that you are…or at least the Defendcrypto website sees that your case will hopefully set a precedent that could serve as a new Howey test for crypto currencies, as far as I understand these kinds of new laws end up taking years you know, to go through the higher courts which are the ones as far as I understand it that do create these types of laws, so how would a new law years from now help the industry which moves much, much faster than that?
Ted Livingston:
Patrick, do you want to talk about timing?
Patrick Gibbs:
Sure. Laura, you’re correct that the core process can take a number of years to work through a case and then even after if something gets resolved at the trial level there can be appeals, so there’s no question that this process will take some time, but in the absence of the SEC giving appropriate and clear guidance itself, this is really the only option, so it’s a fair question and I think we certainly would have preferred for the SEC to have laid out clear guidelines and guidelines that are consistent with the limits of their statutory authority.
They haven’t done that and so this is really the only way we can see to get to that clarity and to get to the right result, but it will take some time.
Laura Shin:
And so let’s actually also then just dive a little bit more into what exactly it was that the SEC took issue with. What was their exact reasoning for bringing the enforcement action, was it about the sale itself or was it that they believe that Kin is currently a security meaning that it has not become decentralized like Ether which the SEC has implied was a security at the time of its sale?
Patrick Gibbs:
That’s a good question. The SEC hasn’t been crystal clear with us about exactly what it is they think is a violation and what it is they would include in an enforcement action. I think we know for sure that the SEC staff at least believes that the sale of kin initially in 2017 involved an offer or sale of securities under the Securities Act of 1933. We disagree with that but we know that’s part of their theory.
It’s not clear to us whether they are also going to take the position that later transactions or transfers of Kin are covered by the Securities Act, so we don’t know for sure.
Laura Shin:
Well, that’s interesting. How did it get that…I mean, you guys were talking for more than a year so how is it that you actually don’t know what they take issue with?
Patrick Gibbs:
Also a very good question. There’s no way for us to force them in this process to lay out in detail what they intend to do in enforcement action. We can ask but we can’t force them to tell us, and maybe I’ll back up just a little bit. The Wells notice is supposed to give notice to the person on the receiving end of actions that the SEC staff is proposing to take. In practice all they do is send you a letter and says the staff believes there’s been a violation of Section 5 of the Securities Act of 1933. They don’t lay out or articulate in any detail what their theory is and so we’ve had some conversations with them where they’ve described their theory at some level but not in great detail and we unfortunately don’t have any way to force them to lay it out for us in any detail.
We’ve noted that in discussions with the SEC and we’ve asked for a more explicit description of everything they would include in enforcement action. They have declined to give us that level of detail.
Ted Livingston:
That’s been part of the frustration with this whole process is you know, even behind closed doors it’s hard to know exactly what they’re saying or exactly what they want so you’re sort of guessing a little bit. When you look at the other settlements they’ve done, the part that concerns us the most is that in every case the projects have said and yes, it was and is and will be a security and for us, you know, a currency that’s being used by hundreds or thousands of people in dozens of apps, that would just be a complete deal breaker.
You know, if the only way you could buy something from the Apple app store was to first go out to your broker dealer and buy a share of Apple stock then obviously nobody would do that and so that’s the part that we have the most trouble with is you know, if this were a security it just simply would not work and that’s why the 1933 Securities and exchange act explicitly excludes currencies from the definition of securities because otherwise there would just be way too much friction and they wouldn’t work.
Laura Shin:
But wait, so you are in a way I think jumping a couple steps because if you don’t even know whether or not the enforcement action is around the sale itself or around the current status of Kin, then how do you know that whatever the enforcement action is would result in your users having to treat every single transaction of Kin like a stock sale or purchase or whatever?
Patrick Gibbs:
Yeah, it’s a good question. We know for sure that if they bring an enforcement action it will raise the question of whether the initial sale of Kin in 2017 involved an offer or sale of a security so we know that we will resolve that question, and that has been one of the key questions that has I think slowed down or stopped a number of projects in the US or has caused them to go overseas, so we’re quite sure that an enforcement action would resolve that question of the initial sale.
It’s true that we can’t force them to also bring a claim asking whether more recent or current transactions in Kin involve offers of sales of securities, although I think if they were to file an enforcement action that asserted claims based on the 2017 sales but didn’t try to assert enforcement jurisdiction over transactions that are happening today, I think that would be a very telling and important signal because I think the reason they wouldn’t bring that claim is just they didn’t think they could win.
Ted Livingston:
And I think it’s also important that you know, we’ve asked this question in our discussions, you know hey, look at Kin today, look at all the usage it has, can you at least confirm that that is not a security, that those are not security transactions, and they have been unwilling to do that.
Laura Shin:
All right. Okay. Yeah, I mean, I didn’t realize that you didn’t even know what they were going to bring the enforcement action for and so then presumably you also don’t know what they would ask you to agree to. You’re just going off the previous settlements where the issuers did agree to classify their tokens as securities and therefore do you know, the proper, I’m not sure if it’s yearly or quarterly or whatever filings that they have to do, but they did agree to that, so you’re just assuming that they would offer you similar terms, is that why you’ve decided that if it comes to that then you’ll fight this?
Patrick Gibbs:
That’s not quite right and I should say as a general matter lawyers typically don’t get into discussions about settlement conversations and so I’m going to try to respect that. We have had discussions with the SEC. We have tried to find a resolution, we sent that in our Wells response so that’s not revealing anything that isn’t already public, so we have had specific conversations with them and we’ve been unable to get to a resolution that would permit the ecosystem to continue.
I think you could look at the other settlements they have done to get a sense of what kinds of things they are demanding that make it impossible, but we’ve definitely had discussions with them and we have not been able to get them to a resolution that would allow the project and the ecosystem to continue.
Laura Shin:
All right, so now let’s talk about the main points you would argue in court about why the Kin token sale should not be considered a securities offering. I think Ted has actually gotten into some of these a little bit but why don’t you go ahead and just lay out you know, top line what would be the main points you would argue in your favor.
Ted Livingston:
So maybe just we can go into the specific points in a moment, but I think it might be helpful to come back to you know, what the Howey test actually is, like everybody hears about it, they read about it, they see the four prongs, but what actually happened? What actually happened is this gentleman, William John Howey, owned a bunch of orange groves in the 1930s and he broke up all those orange groves into plots and he offered the plots for sale.
But when buyers would come he’d say no, you can buy the plot but what I’ll do for you is I will farm your plot, I’ll then take those oranges, I’ll bring them to market, I’ll sell them, I’ll get the money from that, and then I’ll come back and I’ll give you the money, and you know, the investor is going wow, that sounds great, like how much money do you think I’m going to make? And Howey said oh, you know, last year we made 20 percent profit so I think you can expect at least that, but you know, we think next year it could be even more.
And the investor said wow, that sounds great, like but how do I know if I give you this money that you’re going to come back and give me the profits? And Howey said, I know what we’ll do, we’ll sign an investment contract. We’ll sign a contract that says you give me the money, I’ll go ahead, I’ll do all this and I’ll come back and I’ll give you the profits. That is what the Howey test is and that makes sense. Now the investor and Howey are in business together.
That’s not what we did. you know, instead imagine Howey had said listen, I have a bunch of land, you can come in, you can buy some of it from me and I’m not going to farm it for you, I’m not going to sell orangs for you, it’s your land. I hand you the keys and that’s it. We’re not going to sign a contract and we are not going to be in business together, and so the investor says maybe I’ll buy it because you know what? Maybe the area will become more valuable in the future and I’ll be able to sell my land to somebody else for a profit and Howey says you know what? I don’t know if you will or you won’t, I don’t know if you’ll make a profit, but I know one thing for sure, you won’t get a dollar of profits from me.
That’s what we did, and so I think it’s very important you know, the Howey test where it gets pulled apart to understand what actually happened. The investors and Howey were getting in business together but that’s not what’s happening in crypto networks and that’s why when the Dow report came out in 2017, the guidance on that, we were really excited because before that they hadn’t given guidance that the Howey test was the right test. But once they did, for us it was clear that well, then, obviously these things are not securities and so I think that’s been a big challenge, you know, walking that back and now we have all these extra factors we have to consider, that’s been the big frustration.
Laura Shin:
So the one thing I would say, because I did notice that a big part of your Wells response kind of indicates or claims that you guys thought that oh, it was so clear that these were not securities offerings, but surely you must have known that pretty much from the beginning like every team that has done an ICO has known they might run afoul of securities law, like if we look at the very first ICO, Mastercoin, JR Willett, the guy behind that, was told by numerous people he ran that risk. The Ethereum team when they did their token sale they were super concerned and delayed their sale for months getting that all buttoned up.
Back in 2016 when the ICO wave started I would often ask teams if they were trying to skirt securities law, the you know, July 2017 Dow report indicated that the Dow tokens were securities. So this was like a known issue, so why did you not check with the SEC?
Patrick Gibbs:
First of all, you have to consider the SEC’s normal process for that sort of thing. It is very difficult and it takes a very, very, very long time for the SEC to give that kind of forward-looking advice, usually in the form of a no action letter. I mean, here we are in 2019 and they have only just recently released what I think is the very first no action letter relating to a cryptocurrency and that matter has been pending for well over a year.
So it’s not practicable in a business that’s moving as quickly as this business was in 2016, 2017, to go and ask the SEC for a no action letter like that because the process just takes too long, and in a situation where in our view it’s quite clear that what we were doing is outside the scope of the SEC’s authority, we don’t generally think we have to go and ask the SEC’s permission to engage in business activity that is outside the scope of their authority.
They are in the context of cryptocurrencies have been mapping out a extremely expansive and extremely aggressive view of the scope of their own authority and the scope that they have mapped out is frankly much broader than I think people expected it to be when all of these token offerings took place.
Laura Shin:
All right, so when I asked Ted about the main points you intend to argue in court you instead kind of talked a little bit about Howey, how you know, the actual Howey case is actually quite different from the way crypto tokens work, so why don’t we again now talk about what main points you want to argue in court.
Patrick Gibbs:
Sure, and I think keeping in mind the facts of Howey is an important way to remember sort of what the test is supposed to illuminate, but I understand the question. So we have a number of points of difference with the Commission. As Ted already mentioned, we believe that Kin is a currency which is specifically excluded from a definition of a security, so that’s one point.
Totally separately from that, though, we also think that the circumstances around the offering and sale of Kin do not meet the requirements of the Howey test for an investment contract and I think it’s worth just briefly noting that the question here is not whether the tokens themselves are a security. The tokens themselves are clearly not a security and the only angle the SEC has laid out for regulating offers and sales of tokens is not on the ground that the things themselves are a security but rather that the circumstances surrounding the offering or sale of a particular token creates an investment contract and the Howey test is designed to tease out whether or not those circumstances have created an investment contract.
I think that perspective is important, and you’ve correctly identified the four elements and we disagree with the SEC on a number of them starting with common enterprise and as Ted was describing the Howey test, he used the kind of the plain language of whether people are getting into business together.
I would say the more technical legal way of putting that is there are lots of cases that say where someone sells an asset to another person and it’s a simple transfer, you give me money, I give you this asset and there’s no ongoing promises or obligations. That is not a common enterprise. It doesn’t support the notion of an investment contract, it’s just a sale of an asset so we think that’s one reason why there’s no investment contract here.
Another reason here is there’s no expectation of profits. Here the SEC has spent a lot of time talking about the subjective expectations or desires of people purchasing tokens. If you go look at the settlement orders that they have written up, they focus very heavily on the subject of intent of purchases. We don’t think that’s the right way to test for an investment contract under Howey.
Under Howey the test should be what were purchasers led to expect, meaning what were they offered or promised? What did the seller say that would support the creation of an investment contract that would lead people to expect profits from the efforts of another? So it should be looking objectively at what was said by the seller to ask whether the seller was promising people profits based on the efforts of another. We don’t think hat’s what happened here, we don’t think that Kik was offering people the chance to buy a token to make a profit from someone else’s efforts.
If you look at the totality of what Kik was saying about Kin, what they were proposing and what they were offering was a digital currency for use in a new digital economy, a new way for people to buy and sell digital products and services. They were not telling people buy this token and you can make money based on my work, that’s where Ted’s comparison to the fact that the Howey case I think is quite powerful.
So we don’t think people were led to expect profits and we don’t think people were led to expect profits from the efforts of another. There are many cases where a sale of an asset whose value will increase or decrease based on market effects, supply and demand, that does not equal expectation of profits from the efforts of another, it’s just that you will profit or lose based on market movements.
That’s the case here. Price of Kin increases or decreases based on market forces, supply and demand, not based on Kik going out and running a business that generates profits that are going to be shared with people who own the tokens, again the contrast with the Howey case I think is quite powerful. So those are the main points that we intend to argue in the case and that we’ve laid out in the Wells response.
Laura Shin:
One other thing that I want to highlight also is you know, about this argument that people are using this, you know, that it’s not just an investment, that this has utility, that it’s used as a medium of exchange, is you also previously had Kik points which was sort of like a centralized currency and that had as far as I can tell from you know, what you’ve said about this, had sort of successfully demonstrated that a currency makes sense for your system, that it would be embraced by your users.
And so the other thing that I want to highlight about that is that another argument that I think you’ve made is your idea to have this currency is as a new business model, something that would kind of align with your values better and enable you to not have to rely on the advertising-based model of revenue that a lot of these other social media companies use, and I’m just wondering now, do you feel like the fact that general public opinion has sort of swung against that business model will help your case and is that something you intend to play up?
Ted Livingston:
Sorry, what I’m not sure I understand the question. What do you mean by public opinion has swung against…
Laura Shin:
Oh, I mean, you know, just look at how Facebook sort of in the dog house right now and everybody’s, you know, the GDPR thing, everybody’s against having their data being used and having their selves manipulated.
Ted Livingston:
Totally. I think you know, we have 40 developers in the ecosystem now, it’s growing. Some of the largest communities in the world, beauty communities, comedy communities, track communities, people are really excited about this. You know, for a long time as a consumer developer there was no good way to make money. The only way was with advertising and advertising was monopolized by a few big companies making it very difficult for Kik and thousands of other developers to monetize their creation.
So the idea that there’s now a new fundamentally different business model, a way where as a developer you can make money, but not only make money but do it in a way that’s great for your users and then also do it as part of this bigger team, all these developers coming together and competing as one has been very exciting for a lot of developers out there so I think it’s been a huge benefit. You know, the world is realizing just how much power these big centralized companies have and how dangerous that is for the future of society.
Laura Shin:
Another thing that I find surprising about the fact that the SEC was planning an enforcement action against you is that it has become clear that they consider whether or not the network was functional on day one to be an important factor in determining whether or not the token would be considered a security, so I know you guys delayed launching your network three times in order to make them functional on day one, so did that come up at all in your conversation with them?
Patrick Gibbs:
It did. I think that’s another area where the SEC’s approach to this thing frankly surprised a lot of people who had spent a lot of time thinking about these issues before the SEC started speaking. I think that the SEC as a general matter has set a very, very, very high bar for what they would consider utility or functionally, much higher I think than people expected going in.
Now having said that, they also had not drawn a very clear line. I don’t think anybody can really say with certainly where that line is drawn. All they’ve said is that they think Ethereum and Bitcoin are sufficiently decentralized and functional but they haven’t really said where that line is drawn, and everything else that they’ve spoken to they’ve said is not sufficiently functional or decentralized, so yes it’s come up. I think that is one area where they set the bar in the wrong place frankly.
Laura Shin:
So essentially it sort of sounds like even though you had the network functional from day one, that wasn’t enough for them and so maybe people have been reading the tea leaves incorrectly that they…
Patrick Gibbs:
I think that’s right.
Laura Shin:
Oh. Oh, interesting. So you have this other class of arguments where you’re arguing that Kin is a currency and therefore not a security, and this kind of goes into some of the definitions in various laws and stuff. Can you explain that for readers who don’t have a legal background, or listeners?
Patrick Gibbs:
Sure. Sure. I’ll do my best. So there are two main statutes that regulate securities and securities transactions in the United States. They are the Securities Act of 1933 and the Securities Exchange Act of 1934. Each of them has its own definition of what is a security and therefore what’s regulated by the Act, and in each case there’s a very long list of things that the statute says are a security and then in each case there are provisions that say you know, what’s not a security, and courts have said over the years that the definition of a security under these two separate acts, the ’33 act and the ’34 act, are basically the same and so you know, it should be the case that something either is or is not a security for purposes of both statutes.
So what we’ve pointed out in our Wells submission is that the ’33 Act which is the statute that we’re talking about here that requires offers and sales of securities to be registered unless they come within some exemption, it doesn’t list currency as one of the things that is a security. The 1934 Act which has essentially the same definition of a security actually specifically says that something that is a currency is not a security, that it’s carved out of or exempted from the definition of a security and there’s nothing in the securities laws, either the ’33 Act or the ’34 Act that tells you that currency for that purpose has to be a government-issued or government-backed security, it just uses the word currency, and the ordinary definition of currency is something that’s used as a medium of exchange which we think describes Kin precisely and we think we fall within that exemption.
Laura Shin:
All right, so we’re going to discuss the factors less favorable to Kik’s and Kin’s side after this break, but first a quick word from our fabulous sponsors.
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Laura Shin:
Back to my conversation with Ted Livingston of Kik and Kin, and Patrick Gibbs of Cooley. All right, so we’ve gone over most of your arguments, many of which are very good, but there’s of course the other side and you know, I know you don’t know exactly what it is that the SEC is taking issue with but there’s general knowledge around kind of what you know, what their concerns are and as people probably know, Kathryn Haun, the GP of a16zcrypto who’s a former federal prosecutor, she wrote a blog post about this and in her blog post she actually was talking about how during her time as a law clerk…she clerked for Supreme Court Justice Anthony Kennedy, and I also when I read this I was like I totally know what she’s talking about because this I know from being a journalist where you can hear one side and think oh, wow, the other side has got nothing or you know, they’re dirty bastards or whatever you think, and then you read or talk to the other side and you think oh, man, the first side is toast or they’re totally duplicitous or you know, whatever.
So well, I actually don’t know the SEC’s reasoning for wanting to bring an enforcement action against you. I did reach out to them but haven’t heard back. If they do respond to me before publication of this podcast I will update the episode, however I can at least look at your Wells response and some of the other evidence and see what the weak points are, and so what Katie noted in her post and a lot of the evidence shows that purchasers did seem to buy Kin for usage purposes, however, she says, “That won’t matter as much as the evidence around Kik, what Kik led purchasers to expect.”
And this has to do with that third and fourth prongs, you know, that there was an expectation of profits depending on the effort of others, and as you know there’s been a lot of references to a video of Ted at the San Francisco Bitcoin Meetup in June 2017 and at one point in the video Ted, you say “By setting aside 30 percent of the Kin tokens for ourselves, if Kin were as popular as Ether is today, that 30 percent would be worth 9 billion dollars. That’s awesome. We’d give some back to investors. You invested 50 million, maybe we’ll give you 500 million out of that 9 billion.”
Slightly later in the video you say “Maybe developers, the Kin may get rewarded and they will hold onto them. Actually that’s one of the things, you can become a stakeholder. You can share in the economic upside and the creation of this ecosystem.”
And then from the same video you said “We are using Kik to boost the value of Kin,” and in the Kin white paper you guys wrote “To establish an economy around the new currency Kik must help to establish Kin’s fundamental value.”
So just here in you know, multiple verbal and written quotes we see that Kik was indicating that profits could be expected and that Kik would be the entity that would make that happen. What’s your response to that?
Ted Livingston:
I think that’s a great question, Laura. You know, I went back recently when it came out and watched that video again and I think the context here is really important. You know, what I was explaining in that Meetup and in many other places is just simply how crypto economics work. You know, why does Bitcoin work? Well, Bitcoin works because you an guarantee the scarcity of a digital asset, so supply is fixed so if demand goes up then the value will go up. So this is almost like explaining the law of gravity, I’m just explaining what the innovation is that makes this so exciting, and so really what the price of any of these assets is worth is just a function of demand.
How many people want it, how many people are buying it because they want it, and so when I talk about Kik I talk about Kik can be part of creating that initial demand. You know, Kik’s users will want to use Kin like they use Kik Points and just a statement of fact.
But in the same video there I also make it clear that one, you know, somebody says well, can you guarantee the price of Kin? No, I absolutely cannot guarantee the price of Kin. You know, if nobody wants it then demand will go down and the price will go down, and I also said if only Kik were to adopt Kin then it should also be worth zero because at any point Kik could decide to no longer integrate Kin into their app, so that’s where I made it clear that you know, nobody’s guaranteeing the value of this. The value is purely a function of demand and demand will only come and grow if it’s a whole ecosystem of developers that form around it.
Now some people could buy Kin because they want to use that ecosystem. Some people could use Kin because they wanted to integrate it into their apps. Some people could use Kin because they hoped it would become more valuable, but that does not make it a security, that does not mean we are in business together, it just simply means we own a similar asset, no different than you and I owning a house in the same neighborhood.
Laura Shin:
Another point is that it seems as if from the start the Kin Foundation was in control of Kin and in your white paper you’re saying things like over time Kik will work to structure and form the Kin Foundation and then you go on to describe the responsibilities of the Kin Foundation which would be to manage the supply of Kin and distribute the tokens and that will help other services start using Kin, and you conclude “Ultimately the Kin Foundation will facilitate the entire ecosystem’s transition to a fully decentralized and autonomous network.”
So if Kik is the one that’s creating the Kin Foundation and setting its goals, then it sort of seems like the two entities aren’t super separated, and then on top of that the two entities together controlled what would be 90 percent of the tokens because you create 10 trillion and you sold 1 trillion, Kik kept 3 trillion and the Kin Foundation kept 6 trillion, so even assuming that the SEC would agree with you that Kik and Kin were separate entities, how could the network be considered decentralized if two entities hold 90 percent of the tokens?
Patrick Gibbs:
I think that the ownership of the tokens is fundamentally different from control over the network for one thing, and the Kin token right now is operating on a network with a number of independent nodes and neither Kik nor the Foundation has control over that network in the sense that either one of them would be able to decide to make changes to the way the network works, and in fact other node operators completely independent of Kik and the Foundation could if they got together and voted, they could make changes, even over Kik’s or the Foundation’s objections, so the fact that Kik and the Foundation own a large number of tokens does not give them control over the network.
More importantly for my perspective for purposes of the Howey test, the question is whether people were led to expect profits from the managerial or entrepreneurial efforts of another and so the question has to be assuming someone was led to expect profits and we don’t think they were, but even if you assume that, you have to look at what is the conduct or the activity that is expected to lead to profits and the kind of infrastructure work that Kik and the Foundation have done is not the effort that’s going to lead to profits because it’s not going to affect the value and determine the value of the token is going to be affected by large numbers of independent actors offering products and services that people want in exchange for Kin, and Kik alone can’t do that and isn’t proposing to do that and never told people that it would. The language that Ted and Kik used in describing Kik’s anticipated role in the ecosystem was a participant, not a landlord, and I think that captures it very well.
And so it is not from Kik’s entrepreneurial or managerial efforts that profits are going to come, and to get even more granular a lot of people who are buying and selling Kin are developers who are buying and selling it to use it within their business and they’re going to make money, not by just holding Kin and waiting for a value to increase, they’re going to make money by offering products and services that people want in exchange for Kin and then they will exchange Kin for dollars or some other currency that they will use to pay their expenses or earn their salary or whatever.
That has nothing to do with any efforts by Kik or the Foundation, so I think that the key is to focus on what is the activity that is going to or might lead to people profiting and is that within the control of Kik or the Foundation, and it’s not in our view.
Laura Shin:
But to go back to your earlier point about control of the network, as we know there have been a number of technical changes that happened with the network where for instance the Kin blockchain started on Ethereum, then it was using both Ethereum and Stellar and now it’s on a private fork of the Stellar blockchain, and every time one of these announcements was made about this move, as far as I can tell it was Kik that was the entity that decided that you know, all these decisions.
So in that sense you know, it’s quite different from the Ethereum hard fork where there was this very public decision where for a while it wasn’t clear how it was going to go and the community members were weighing in on all these different venues and then there were these carbon votes and you know, it was like all these other actors were engaged and there was even…I saw this article from last December on Next Web where it said that Kik was choosing the validators for the blockchain, it was creating this federated blockchain, so in that sense it really does feel like Kik has been the one that’s been controlling the network.
Patrick Gibbs:
There’s no doubt that the network has evolved over time and there’s no doubt that Kik and the Foundation have done early work to get the network launched and underway, but that’s why I keep hammering on the entrepreneurial or managerial efforts as contrasted with someone who creates you know, an infrastructure, right? I mean, you could imagine someone who builds a marketplace and invites all kinds of other people into the marketplace to come in and offer their products for sale.
We don’t think that that kind of infrastructure building which itself does not lead to profit, is entrepreneurial or managerial within the meaning of the Howey test. There are cases out there including one we cited in our Wells response dealing with someone who created a ticket exchange and that entity had complete control over the infrastructure, the network, the exchange itself but because people were going to make money by making their own decisions about buying and selling tickets, it was not deemed to be an investment contract, we think very similar circumstances exist here.
Kik’s and the Kin Foundation’s efforts to get the network up and running are not profit-generating entrepreneurial or managerial efforts. That said, it has evolved over time to where I think it is now quite decentralized and so even without regard to all the other factors, where we are now is a situation that we think is decentralized and it’s not within Kik’s or the Foundation’s control.
Laura Shin:
One other question I wanted to ask about the expectation of profits was that just before your ICO you also had a presale that raised 50 million dollars from venture capital firms like Blockchain Capital, Pantera Capital, and Polychain Capital, so if the Kin tokens were not an investment, why were these VCs buying these tokens?
Ted Livingston:
During the presale I think what’s important is we weren’t selling them Kin, we were selling them a future right to acquire Kin and so in that case you know, out of the abundance of caution it made sense to do that as a securities offering, but that doesn’t make Kin itself a security. When we look at Kin again we come back to the Howey test. It’s like the land and you know, and there’s a community there and all sorts of people are showing up because they think it’s going to be a great community.
At this point we have over 40 independent companies who have all joined a community, have a piece of the land and are improving their piece of land and that’s improving the whole area, and so some people are buying land to come use it, come visit it, and then some people are buying land and goes wow, this is becoming a great neighborhood. But again, that doesn’t make it a security.
Patrick Gibbs:
This gets back to my point that even the SEC’s theory is not the token itself is security. The SEC’s theory is that under some circumstances the offer and sale of a token creates an investment contract and so you have to look at the circumstances of each offer and sale, and Kik treated the presales as an offer and sale of an investment contract because the circumstances of those transactions and what was being offered to the purchasers was very different from what was being offered to people who bought tokens in the token distribution event.
The presale participants were being offered the right to acquire Kin in the future at a discount to the price it was offered to the public, assuming a sale took place, so what was being sold to the presale participants was not just the token itself but the right to acquire tokens in the future at a certain price under certain circumstances which is different from what was being offered and sold to participants in the token distribution event.
Laura Shin:
Right. I just feel like if I’m an everyday person and I know that a VC buys this token a month before it’s possible for me to buy it, or they buy a promise, you know, I guess maybe did you use a SAFT or something?
Patrick Gibbs:
Yes.
Laura Shin:
Yeah, then you know, I probably would be expecting profits from the same purchase. But anyway, so let’s move on. One other thing I wanted to ask about was in your Wells response you keep citing this Blockvest decision that the SEC initially lost but that was later reversed when the court did indeed determine that the SEC was right, that token sales can be investment contracts, so I just wondered if that development would affect any of your arguments you know, differently from what you published.
Patrick Gibbs:
It doesn’t in my view. We cited the original opinion in Blockvest as an example of a rigorous application of the standard and in particular the court’s focus on what was offered or promised to purchasers as opposed to just the subjective intent of the purchasers. After that initial decision the SEC went back to the court and presented additional information that changed the court’s mind about that particular case, but that changing of the court’s mind was based on the evidence in that particular case, has nothing to do with the evidence in this case, so in other words we were citing that case as an example of how one should properly apply the framework, but the facts in that case were dramatically different from the facts in ours and so the fact that the SEC submitted additional evidence and changed the court’s mind about the facts in that case doesn’t affect our arguments at all.
Laura Shin:
And then also in the Wells submission you said “Currently more than a year after the token distribution event, token issuers and industry participants alike are still unclear as to what types of tokens fall within the definition of a security” and obviously in the last couple months now the SEC has released a framework for digital tokens. Has that changed your opinion at all? Do you feel that that has brought more clarity?
Patrick Gibbs:
I don’t think so at all. I think if anything it’s the opposite. The framework that the SEC has most recently discussed I don’t think makes it possible for someone to know in advance which side of the line they’re falling on. It is a very large number of different factors that the SEC says it will consider in making a judgement, but it doesn’t actually tell anyone where the line is and so I don’t think that guidance actually helps people know in advance whether a given offer or sale is one that the SEC is going to say involves an investment contract.
Laura Shin:
I also wanted to ask in general about this choice to go to court. Do you think that this route would be antagonistic to regulators and sort of negatively predispose them to this industry, because I know you know, there are these other options where you could push for kind of a clearer framework or an exemption of some sort or something where essentially you kind of work with the regulators more.
Patrick Gibbs:
I think that’s a totally fair question and as we said in the Wells response, we have certainly tried to find a solution that doesn’t involve litigation and we haven’t been able to do that, and the fundamental problem is that in our view the SEC is extending its regulatory reach to things that are not within its statutory authority and to some extent that’s just an issue that has to be resolved.
Ted Livingston:
And I think just to add to that, I think the point where we’re at with the industry what’s become so dangerous is the entire industry is operating under this cloud of fear of what will the SEC think and we’re now starting to see the real impact of that of the industry in the US starting to fall behind. You know, it’s one thing to you know, go in and try to educate the SEC, we spend a lot of time doing that. It’s one thing to produce all these documents, do all these subpoenas, do all this testimony. It costs millions of dollars, that’s another thing, but at this point now what’s the most worrying thing is we are falling behind.
You know, I look at Coinbase and they come out and they built this amazing product, they’re early, they built an amazing team, but they’re operating with this uncertainly and that makes it really hard, you know, what will the SEC think, what will the SEC think, what will the SEC think? And then you know, less than two years ago or something like that you have Binance come out and say listen, what we should do is we should do everything Coinbase Is doing except we won’t do it in the United States because that will let us move a lot faster.
And fast forward to today and Binance is now the number one exchange in the world, it’s replaced Coinbase. You know, Coinbase has been Binanced and I think that’s where we finally said enough is enough and you know, and when we speak to people in the industry we need to stop living under this cloud of fear of what will the SEC think, what will the SEC think because we all know this is the next mega trend of technology and by always having to ask ourselves what will the SEC think, we are giving ourselves a fundamental handicap to being able to compete on the global stage.
So enough is enough, we need to come out, we need clarity, and the only way we’re going to get that is if we go to court, so let’s do that.
Laura Shin:
I love your concern for American companies because you are a Canadian company, right?
Ted Livingston:
We are a Canadian company. We have lots of American companies in the ecosystem. You know, I like to think Kin is a little bit the little brother and sometimes it takes the little brother to tell the older brother what are you doing here? You know, as a Canadian I grew up, I consider myself like you know, I follow the American elections more than the Canadian elections. The American market is very important to us and developers and consumers and so we made a decision, no, we want to include the US in what we are doing. That’s the only way we’ll be able to build something amazing for the world.
But now in hindsight that’s looking like a mistake, you know, that now we are at risk of being Binanced ourselves. Somebody says wow, Kin, great idea, let’s do that everywhere except in the United States, and then racing ahead, and that’s the part where I think it has a lot of entrepreneurs, a lot of projects who want to serve the United States because the United States be part of this, are starting to wake up and say whoa, what are we doing here, like we believe in this so much, there’s such an opportunity here, but we’re going to lose and that’s so unfair and so wrong and so that’s why we need to take this to court.
Laura Shin:
So just so I understand also, I mean, I sort of asked this earlier but because we have this like very concrete effort, I want to know like why not throw your efforts behind getting the Token Taxonomy Act passed which that would create a class of “digital tokens” that are not considered securities?
Ted Livingston:
So we can do many of these things in parallel and we are. We think the Token Taxonomy Act is great but it will also take a very long time and so speaking to senior people in Washington, people there are telling us like listen, these acts are great and we want to get them through and we appreciate the support and the help, but the fastest way to get clarity is somebody has to go to court and so that’s what we’re doing.
Laura Shin:
All right, so something else that I want to understand is in your Wells response you wrote “Further, any action will not only harm Kin purchasers who the commission purports to protect, but it will carry the ill effects of regulating through enforcement,” so what do you mean by that?
Patrick Gibbs:
So what we mean by that is the distinction I was trying to allude to earlier, we think that the best way and the right way to regulate is to set up a set of rules and standards in advance that apply to everybody so that people can know in advance how to do a transaction that is or is not covered by securities laws, but the SEC in this instance instead of getting ahead of the issue and issuing an affirmative and comprehensive set of guidance has been regulating by bringing individual enforcement actions against specific sellers involving specific facts, none of which tells you how the standards apply to a set of facts that are a little bit different or a lot different from those facts and so you have to look at each of the individual settlement orders and try to interpret them and try to figure out how the SEC might apply that analysis to a different set of facts which makes it extremely difficult for people to predict how the SEC is going to come out on their project, and we’ve actually noted in the Wells response that some folks at the SEC have actually said that the SEC is making an affirmative decision not to give that kind of prospective affirmative guidance because in their view people will just find a way to work around it which in my view is just another way of saying comply with it, and so we think that’s just fundamentally the wrong attitude, they should be sending a clear set of rules that applies to everybody that are specific enough that people can actually know in advance how to comply with them.
Laura Shin:
Yeah, that was a very, very interesting part of the Wells response. People should definitely read that if they get a chance. Essentially Valerie Szczepanik, she was saying you know, oh, if we make a clear guideline then basically people will essentially use that to kind of skirt around the rules. That’s what she implied, and then you know, you responded saying well, no, actually, then we’ll use it to make sure that we’re you know, doing things the right way, so yeah, I think you know, these are different interpretations.
So one last thing that I just want to circle back to. I think we touched on this briefly at the beginning but I just need to understand, so at this point you’re sort of in this waiting period trying to figure out whether or not you know, you’re going to find out if the SEC is going to pursue the enforcement action or not, so just walk me through the different scenarios that could essentially lead you to ending up in court versus not.
Patrick Gibbs:
Sure. So where we are in the process is the staff has told us that the staff intends to go to Commission and ask for the Commission’s permission to file an enforcement action against us. We have submitted our response. What happens from there is the staff does some additional work and at some point goes to the Commission itself, the commissioners and asks the commissioners to approve of the filing of an enforcement action.
We don’t know right now when they intend to do that but we believe they do intend to do it and so the one gating item here is whether the Commission will sign off on the filing of an enforcement action against Kik and as I’m sure you know and as you’ve discussed on your own podcasts, there are commissioners with different views about these things so I wouldn’t want to be in the business of publically handicapping what the commissioners will do, but that’s one gating item is whether or not the Commission agrees with the staff and approves of the filing of an enforcement action.
If they do, then I would expect that the staff would file an enforcement action in fairly short order after that.
Laura Shin:
And then so if that happens then you know, how will you respond and how would that end up in court?
Patrick Gibbs:
So if they were to file an enforcement action I think they would most likely file it in court, in a Federal court. I’m not sure where they would file it but that would just kick off…it’s essentially a lawsuit between the SEC and Kik and/or Kik and the Foundation and so we would respond as we think appropriate to the lawsuit and the case would proceed like any other lawsuit but with the government on one side.
Laura Shin:
And then if the commissioners don’t agree then maybe the enforcement action would not go through in which case then you would have set up Defendcrypto and maybe it wouldn’t go to use?
Patrick Gibbs:
That’s hypothetically possible. I think one can look at the enforcement actions that the SEC commissioners have approved and reach your own conclusions about the likelihood. But yeah, I mean, our Wells response is basically an argument to the commissioners that they should not approve the filing of an enforcement action.
Ted Livingston:
And I think at that point that would be great guidance. I know it’s not legal guidance but you know, this is a very public situation right now. You know, we’ve read the Wells notice, we’ve read the Wells response, so if the Commission…you know, we hope the Commission, the four commissioners will vote not to go ahead and if they do they will unlock a ton of innovation and excitement in this industry because they’ll be implicitly saying what Kin did was okay, and that would be actually the first time…not the first time, one of the first early times, recent times of a new cryptocurrency project coming out and where they’re actually implicitly saying it’s okay.
So either way this is where we want to force clarity. Either it doesn’t go ahead and it’s implicitly okay or it does go ahead and we get a court to make a judgement and you know, that becomes the new Howey test. We can stop referring to an orange grove from the 1940s and trying to say you know, this is what it means for crypto currencies in 2019, and we can start to have a new Howey test, maybe it will be called the Kin test, who knows, that actually makes sense and I think that’s exactly what the industry needs.
Laura Shin:
Yeah. Well, you are not the only ones saying this. Recently Jeremy Allaire of Circle published a pretty pointed blog post where he argued that essentially these tokens have the characteristics of commodities, currencies, securities, forget what the other one…oh, and that they have utility or…anyway, I’m forgetting, but the thing is that he was like they’re just new and they’re not typical securities you know, because they have these multiple functions, they’re just something new that needs to be regulated in a new way, and he also took the SEC to task for the framework and said that it essentially just created even more uncertainly and actually roped in a lot more actors in these crypto networks than had been previously thought would fall under the SEC’s purview.
So I think this is sort of coming to a head in the industry now so we’ll see how things play out. Well anyway, where can people learn more about Kik, Kin, and Defendcrypto?
Ted Livingston:
People can learn more about Kin at Kin.org, and people can learn more about Defendcrypto at Defendcrypto.org. This is where we’re coming together as an industry and you know, we started to talk to people about it and it’s just been overwhelming the support we’ve received which has just been so exciting to get, and you know, one of the interesting things here is at first people are excited yes, finally, this is the clarity we need, we’re so glad somebody’s stepping forward to get the clarity, but then fear. Wait, I’m not sure if I should contribute, I’m not sure what the SEC might think.
And I think that just shows like the messed up state of the industry as we’ve sort of lost focus of who the customers are, the developers, and the consumers, and now everybody’s building for the regulator and there’s fear of people even speaking their mind because what will the SEC think and could they punish me and my project and I’m afraid, and so when I talk to people about that I’m like just listen to what you are saying. Just listen to what you are saying, you’re operating out of so much fear.
This is why it is time to defend crypto and people are getting really excited about that. We’re so excited to see this support and you know, a little bit honored and humbled that you know, we didn’t want to be the ones to go first, we didn’t choose it, we don’t even know why we were chosen, but here we are and to have the industry rally behind that to Defendcrypto you know, we’re really excited about that and what we can all do together to create the clarity we need to compete on a global level and take advantage of this mega trend of an opportunity and for wanting to include the United States not to be a fundamental handicap as we do that.
Laura Shin:
All right. Well, it sounds like we should leave it there. Thank you so much for joining us today.
Ted Livingston:
Thank you.
Patrick Gibbs:
Thanks for having us.
Laura Shin:
To learn more about Kik, Kin, and Defendcrypto, check out the show notes inside your podcast player. If you are not yet signed up for my email newsletter go to Unchainedpodcast.com right now to get my thoughts on the top crypto stories of the week, and be sure to check out our new channel on YouTube. Unchained is produced by me, Laura Shin, with help from Fractal Recording, Anthony Yoon, Daniel Nuss, and Rich Stroffolino. Thanks for listening.
