ICOs at the End of 2017: What We Think We Know and What We Don't Know
wsgr.com
wsgr.com
ICOs seem to be a new way to raise from unsuspecting investors aka a way of separating people who have too much money and not enough common sense from their money. The fact that it is utilizing a blockchain technology has nothing to do with the actual mechanisms at work here, focusing on the use of blockchain in negotiating ownership and value is actually harmful here.
The real technology isn't glamorous at all and has been in operation ever since Charles Ponzi "innovated" the concept in the 1920's.
How can they compete with economies of scale? And how will they prevent data centers of disks being created (centralizing forces)? If they manage to stay decentralized, how will the very public team defend all the illegal and/or illegitimate content that gets hosted on there? How will they defend against the FBI ordering them to shut it down? Why would people pay more for a slower or less reliable storage solution?
It's very questionable that they were able to make bold claims and get millions of dollars from people who do not have a clue that FileCoin and "distributed storage on the blockchain" is DOA unless you want to store your 3d printed gun designs in the cloud. But in that case, the team building it should've been anonymous...
To answer some of your questions, storj's network consists primarily of people who are renting out their unused hard drive space. Economic of scale doesn't really matter because the people renting the space are just trying to make a few extra bucks per month and they have already paid for the hardware.
They have no way of preventing centralization of disks but the whole network is decentralized. The file you upload is being hosted on thousands of different disks.
Like all companies, they will probably comply with FBI/DMCA orders to the best of their abilities. The issue for them and the FBI is that all data uploaded to the network is encrypted at the point of upload so it is impossible for the FBI/DMCA to find it. These decentralized file hosting systems don't allow public sharing of the download links/keys (yet at least).
Also the reason I pay for storj over say google is because storj is cheaper and has higher redundancy requirements. I have files that I absolutely can never risk losing and storj allows you to pay for the service anonymously while other services do not. In the world of data breaches everywhere, the less information the company has about you, the better.
OK so hypothetically, if this decentralized storage thingie made the sellers a profit, there would be at least 1 rational and greedy seller who would take that profit, invest it in more disks, and save on costs compared to other folks, right? In other words, if I have 100,000 computers in a data center with central cooling system, the total electricity costs will be less than the total cooling costs of 100,000 individuals each with their own 1 computer. Furthermore, the total bandwidth costs of the 100,000-computer data center will be cheaper than the total bandwidth costs of 100,000 individuals with 1 computer each (economies of scale).
How can you say that "there is no way to prevent centralization" and then follow up with "the whole network is decentralized", when the cost structure obviously makes more sense for this distributed storage to all be controlled by a handful of resourceful entities?
Then those 4-5 data centers just become an encrypted Dropbox, right? So like, SpiderOak?
I haven't made the analysis but maybe Airbnb works because it is actually more profitable for an entity to host 100 airbnbs then to have a regulated hotel with 100 units, in which case the analogy doesn't work because that's the crux of my argument.
In the case of decentralized storage, this is not the case, as we've seemed to have agreed. Which means this:
1- The 4 data centers will host 99% of the available storage because it's so profitable for them
2- Because the supply of storage on the network is so high, the reward given to the hosters goes down (this is how FileCoin works I'm guessing, the reward needs to come down to close to the overall cost of the suppliers, like difficulty adjustments in Bitcoin)
3- Because the costs of the data centers which now have millions of disks all under centralized electricity/infrastructure is so low, the reward becomes lower than the cost of being an individual storage supplier.
4- At this point, the individuals with "latent resources" have no incentive to put these on the network, and actually are incentivized to sell the disks instead, because at least that way they'll make money.
5- Who is incentivized to BUY these disks? See #1
That's how economies of scale work and why they will make FileCoin useless.
The answer is that there are other factors outside of the scope of your defined economy at play.
Just like in Bitcoin, my free CPU cycles are better kept free because if I try to mine Bitcoin I would have to leave my computer on 24/7 and it would cost me more than the BTC rewards I'd very rarely receive?
We've literally just swapped free CPU cycles for free disk space, and we both know PoW is centralized and it's not worth individuals with a laptop to mine, but somehow the free disk space won't suffer the same fate?
edit: Also even if FileCoin doesn't throw off a ton of ETH, presumably there will eventually be a wide array of services like the FileCoin network that you can transparently trade your liquid crypto assets into. For example, consider a person who happens to have 50TB of disk they don't need for the next month but would like to perform some low latency rendering jobs on the RenderCoin network during that time instead. They could easily just trade one for the other, increasing market efficiency for those resources. This example would be a small transaction in terms of ETH, but multiply that across the entire set of all computing resources, across all services, and it is a potentially tectonic shift in effective allocation of resources.
People paid up to $5/token to participate in Filecoin. Steep starting point to actually increase market cap when there exists two hundred million Filecoin tokens.
I thought the idea was extremely straightforward compared to almost every other ICO: you pay tokens to have files hosted for you, and you get paid tokens to host other people's files. Or are you saying that you think they won't manage to implement that?
A quick chat with an attorney who is an SEC specialist basically said "if it breathes" i.e. involves money that ICO is seen as a security. The SEC putting together the digital division which covers cryptocurrency tokens is part of what led to him saying this. Basically fish in a barrel.
It is in my opinion that any US-based ICO is now in a lottery as to whether they get the SEC visit.
Not legal advice at all, just sharing an excerpt from a coffee chat.
But I've talked with prominent lawyers about this distinction and securities laws are flexible enough to include practically any product in their purview.
The Howey Test isn't the only test that courts and regulators have created.
There are several tests floating amongst the states and various federal circuits, which can and have deemed otherwise benign products and services as things that should be registered as securities with the most onerous costs and distinctions.
A California country club's member fees were deemed securities under one framework.
And every kickstarter and centrally issued product can under other frameworks.
There is nothing wrong with your analogy. The securities regulators generally don't try to stifle all commerce so far.
The idea that all ICOs will experience this form of securities discrimination - just for the mere fact they are using cryptographic hashes and get a lot of revenue/capital - is just as logically unsound.
But they could. Just like almost every product or service could. When they do it will quickly evolve securities law towards a more apt framework. Its not about "securities or not" its about consumer and investor protection, and this is currently the tool available.
If they do, the best strategy for an organization raising money through an ICO is to use that money in as transparent and ethical a manner as possible.
If it's the former, Eve Online is at minimum, a money transferrer. If it's the latter, it's just a store that accepts gift cards.
I'm pretty sure that is enough to avoid it being deemed a security under the SEC's jurisdiction. There needs to be an expectation of future profit. (Not a lawyer.)
First, the Howey Test is the only test from the Supreme Court.
Second, that is a multipronged test, a product/service which wasn't registered as a security but still passes or fails one prong isn't enough to say it is or isn't a security.
THIRD, there are multiple other tests in various federal circuits.
Fourth, there are tests created by states relevant at the state level.
Fifth, most people are just lucky that securities frameworks haven't been applied haphazardly to everything under the sun.
I hear this statement repeated a lot, but that seems unlikely to be an absolute requirement. That is, even if every instrument sold for future profit is a security, that doesn't mean everything else isn't. Do you have a source for that statement?
> The test of whether there is an "investment contract" under the Securities Act is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others; and, if that test be satisfied, it is immaterial whether the enterprise is speculative or nonspeculative, or whether there is a sale of property with or without intrinsic value.
https://supreme.justia.com/cases/federal/us/328/293/case.htm...
But that was not my question. You, and others have also in conversation, stated that has a requirement for something to be legally regarded as a security. That is what seems unlikely to me.
The very decision you quoted starts out with:
> the Securities Act of 1933 defining "security" as including any "investment contract,"
Note the word "including". That A is B does not mean that B is A. There are other forms of securities, and this document alone should not lead anyone to believe that if they only append to their contractual terms that tokens are to be regarded without use or value, that they somehow would not legally be selling securities anymore.
That's not to say they wouldn't do it to advance themselves internal to the justice system, where that kind of conviction would have forward-looking value.
It'd be so easy to spin ICOs as a matter of fraud that's taking advantage of uninformed investors, a Ponzi scheme, or any of the other buzzwords that historically work pretty well in convincing voters of criminal financial activity.
Whether or not you actually view ICOs as any of these things is incidental to whether or not an AG with career ambitions would be able use that rhetoric to gain votes.
Indeed. The fact that ICO's have generally been fraudulent get rich schemes aids greatly in this "spin" of which you speak.
I've never held elected office. I defer my opinion to those who do. They say ICOs represents a golden trifecta between (a) fraud against moms and pops, (b) complicated financial instruments and (c) Silicon Valley arrogance.
There will be penalties for failure to register securities, for failure to meet reporting and other registered securities requirements, and shareholder clawback lawsuits.
People who are doing ICOs will just move to where they can have their business be successful. If USA/Europe or Asia ban ICOs then all the devs will just move to another country where it is legal, maybe russia?
https://www.cnbc.com/2017/07/18/hot-digital-currency-trend-m...
https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_co...
Do you have any more recent examples?
Sales before and after the bulletin are subject to the same laws.
[0] https://etherparty.io/ico/contribute
[1] https://www.sec.gov/divisions/corpfin/internatl/foreign-priv...
>"Every potential participant in the fundraiser is responsible for determining the legality of participation within their jurisdiction."
This has been settled law for 70+ years.
When one of the biggest law firms feels the need to preemptively issue a public statement pretending they don't understand how the law works, you know shit is about to get crazy.
Filecoin is supposed to have "commercial usage". But the insiders extracted 2/3 of the cash already.[1] As far as I can tell, the "Filecoin Storage Network" doesn't exist. There's no software you can download. You can't actually store data yet. If ever. A key point from WSGR is that if the ICO precedes the service becoming active, it's a security.
[1] https://tokeneconomy.co/the-analysis-filecoin-doesnt-want-yo...
The value of the token can't come primarily from the person or entity promoting the token sale, but whether there is commercial usage or not is largely orthogonal to whether or not something is a security.
> Our current view is that once the value of the tokens is primarily driven by their commercial usage, rather than by the efforts of the token sponsor or other developers, the tokens should no longer be deemed to be securities. The SEC has not yet addressed this question.
http://consumer.findlaw.com/securities-law/what-is-the-howey...
The entire point is that you can't get out of going to prison by saying "Our thing is X, therefore it can't also be Y."
From your own link:
> The final factor of the Howey Test concerns whether any profit that comes from the investment is largely or wholly outside of the investor's control. If so, then the investment might be a security. If, however, the investor's own actions largely dictate whether an investment will be profitable, then that investment is probably not a security.
WSGR's position: once tokens are used primarily for commerce, the value will be determined by commercial usage and not by the offerors, so that:
> Tokens that are solely utility tokens should not be securities. If a token-based platform is fully developed and the tokens are widely used commercially on that platform, the tokens generally should not be securities.
And they're wrong. If a token is primarily used for commerce then it's value might come primarily from that usage, or it might not. But it certainly isn't some sort of get-out-of-jail-free card.
I'm still not sure exactly why this didn't happen, but if people can agree that Uber isn't a Taxi, then I think they can also come to the conclusion that an ICO token isn't a traditional security... the world just isn't as black-and-white as we often like to think, and legislators are human beings that have a lot more flexibility around enforcement than people imagine.
At that point, Uber pulled out the brakes and that changed their view on regulations permanently.
Source---straight from Travis (TK) himself.
The question around Uber was whether the laws would be changed to make them a taxi, which after much lobbying they weren't, but they were already fine under the existing laws. As kenbaylor says below, Uber themselves thought the laws would quickly be changed to make their business illegal, so they didn't even get into that market until Lyft forced them to do so.
The difference is that Uber was not created to fleece the masses via investment pump and dump scheme.
As of now, ICOs are purely pump and dump. They are modern day unregistered securities, promoted via modern day version of faxes
taxi drivers are selling their medallions that they used to offer service. They are selling these medallions at a loss because a competitor is eating their lunch.
"Is this token being marketed as an investment opportunity?"
Wrong. What matters is whether the person buying the token is doing so because they think it's going to go up in price. The person selling it could explicitly say that it will never be listed on an exchange or go up in value, but if the person buying it thinks it will go up in value, then the person selling it has committed securities fraud. (That's slightly simplified, but that's the general idea.)
There are plenty of people on this thread (myself included) who believe regulators are overdue in cracking down on this space. No need to invoke a bogeyman.
No, it's based on the language of a statute that's about a decade older.
Now, the statute may be based on older financial models, but that doesn't control the case law, and disrupting the financial model doesn't, in and of itself, amend the statute underlying the case law.
The SEC is fucking up pretty hard at the moment and doing real damage. Their actions in the IPO market, meant to protect advisors, have resulted in only pump-and-dump crap like snapchat and blue apron going public, while all the gains from real growth tech companies are being retained by VCs, sovereign wealth funds and investment banks, while retail investors holding index funds miss out.
I think this is a major factor contributing to widening gap between the super-rich and everyone else. There are a lot of ICO scams, however giving vague guidance and forcing ICOs out of their own jurisdiction when clearly people are still investing in tokens as a speculation/profit vehicle is worse than useless. Token-holders need the ability to change management, dissolve companies and reclaim cryptocurrency investment if companies are mismanaged or scammy, and they need to have the right to see how funds invested are being spent.
However, if you think financial regulators are at all happy with the nature of ICOs you only have to read between the lines of what they have said.
That's because it's illegal to sell coins if the primary motivation of the buyer is to make money from their increased value. It's literally illegal for the company to let you invest in it via ICO's while providing a mechanism for the money from the ICO to make it back to you after the company has used it to get to market.
See all of the responses here:
https://news.ycombinator.com/item?id=15293604
i.e. there are no responses there.
Does this mean that SAFEs are also securities? I imagine so, and they are usually given to accredited investors. I have also seen them being given to contractors and employees as partial payment in equity.
Is paying a non-accredited contractor in SAFE a possible issue with the SEC? If not, how are SAFTs different?
Well, obviously, stocks and future interests in stocks are the basic textbook examples of securities. On SAFEs specifically, see, e.g., https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_sa...
“Some issuers have been offering a new type of security as part of some crowdfunding offerings—which they have called the SAFE.”