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CRYPTOS ANALYZED: SECURITY OR NOT SECURITY (PART 2)

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TRANSCRIPTION OF VIDEO:

Hello and welcome to Legal Briefs crypto currency edition and everything else cool. I am attorney Jeremy Hogan – your humble guide today to the dangers that lurk in your cypto currency from the local friendly United States Securities exchange commission.and we will be Analyzing  Cardano, Doge, XRP – that’s an easy one – PolkDot and finally … Uniswap in Part II of the Crypto Legal Briefs Danger Ratings.

In putting this together for you, I realized that The test in the U.S. for whether something is a security is so outdated and difficult to apply to non-traditional assets like crypto currencies that sometimes I think it’s done intentionally that way – just to guarantee lawyers full employment.  That’s what some of the conspiracy types think.  But I’m going to let you in on a little secret:  come here, closer.  (Whispering) Sometimes conspiracies are true – watch. This.

Tarzan is actually Elsa’s brother.  Mind.Blown.

Welcome back and let’s get into this law stuff and look at Cardano, Doge, XRP, Polkadot and Uniswap.. First, our legal disclaimer – see below.  It basically says not to take me serious – which I certainly don’t do myself.

In the United States of Merica we use a legal test developed back in the 1930s for whether something is sold  as a security and therefore is subject to regulation by the government.  Crypto currencies and the people and companies that issue them generally think that  the crypto currencies they issue are NOT securities and therefore do not jump through the very expensive and time-consuming hoops  that the government requires of securities issuers.

In your mind, a security is an issuance of stock.  One share of Apple stock for example gives you ownership of a piece of the company.  Because that stock is a security, Apple has to disclose everything about the company and those disclosures and such all go through the Securities Exchange Commission.  Apple has to tell stockholders EVERYTHING about the company, income, expenses, profits, everything except its foreign child labor practices apparently.

But in any case, a stock is a security but here in the states the definition has been stretched much broader than that!  The case law says that a security is anything that is sold or transferred for value in which the purchaser is relying on the seller to increase the value of the thing purchased.  The legal jargon for the test is whether:

“there is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Originally, the profits had to be “solely” derived from the efforts of others but that requirement has since been eroded away.  Also, the SEC has been successful in arguing that simply marketing a crypto-currency in a certain way can be evidence that there was a common enterprise for profit between the seller and buyer.  So we see that the definition has even been stretched further out over the last 80 years or so.

Full employment. For securities lawyers at least.

So, I’ve done my research and let’s start with Cardano and give it a Legal Briefs danger rating. 

Cardano is a very interesting legal analysis.  Cardano is basically an alternative to Ethereum and its digital token is the “Ada” coin – named after Ada Lovelace, the 19th century mathmatician who was the first person to propose an algorithm to be carried out by a machine – in other words, she was the first computer programmer.

The original NERD.

Also, did you know she was the only child of Lord Byron, one of my favorite Romantic poets and author of my personal favorite long form poem Don Juan. I love it when two things I’m interested in collide like that.

The Ada token was initially released in an ICO – a sale to raise money to build the ledger and such, and that is always problematic.  In fact, the general thought at the SEC is almost all ICOs are sales of secutities.   HOWEVER, Cardano did something that was legally very smart.  It’s initial coin offering took place in my old stomping grounds of Japan which as you may have heard is very legally friendly to Crypto. About 95% of the ICO was to Japanese nationals and from there sales went into the exchanges for sales to Americans. Very smart Cardano.  Because the SEC’s long arm does not stretch all the way across the Pacific.  Whether Cardano could have a problem with Japanese Regulators, I will leave that Cytp Eri to look into –

 So that’s it – end of analysis?  Not quite because if you are an SEC lawyer looking to guarantee your future employment, you might think:  An ADA token was sold a Japanese investor in an ICO and that Security then made it’s way onto an exchange where the exchange then sold it to an American.  And the SEC regulates that exchange!  SO, I am going to sue the exchange for the sale of an unregistered security!

Far fetched?  Perhaps – but also consistent with some statements from Chairman Gensler that the SEC would focus on exchanges and such.  So because of that, we will say that there is some danger there because as soon as the SEC sues exchange #1, the other exchanges will all delist.  But , it’s never been done before so the danger is somewhat remote.  For that reason we give the ADA token a Legal Briefs danger rating of … 2.5 out of 10.

It’s theoretically possible but nothing like this legal argument has ever been made before so with all that is going on in the securities markets, I would not expect anything to happen.   Rest at ease and rest in peace Ada Lovelace.

Ok, that was a big one so let’s move on now to the infamous Doge coin.

That is a pretty dog.

So, Doge coin was begun by two software engineers in 2013 as a kind of joke. And in that vein, the manner in arriving at my conclusion for the Doge coin was more interesting than my conclusions because I could not find much of anything in regard to how Doge was originally distributed so I turned to Twitter for help (always a mistake) and asked for help – which led to this:

Stuart Lord told me that 2 guys  saw a nickel with dog poopoo on it and thus the first Doge was born.

Thank you sir for the input.

And The Don chimed in

“Elon Muck made a poopie..and there it was.”

And finally my friend FreeWilly stuck with the dog theme:

“I think it was sold over the counter at the pet store.”

That was the cleanest response.  There is NOT much love in the XRP community for Doge Coin apparently.

But fellow Twitter newbie Wesley Dunow came to the rescue and got me the correct answer:

Looks like a genius disguised as a lumber jack to me.

He pointed me to an article which states that within one week of Doge coins creation 6.58 Billion had already been mined and 95% of all Doge coin was mined within the first year.

So, there was no ICO – no sale. A decentralized ledger and lose-knit community of funny strange people.

Anyways, back to our legal analysis. I think the SEC would only be more of a joke if it sued a joke coin so I see no problems on the horizon here.  But really, who would you sue?  Elon Musk for market manipulation? I officially offer to rep him pro bono if that happens – call me Elon.  But, it’s not going to happen and even if it did, it wouldn’t effect the price directly.

SO, Doge coin gets a 10 out of 10 for being cool and quirky and a

2 out of 10 on the Legal Briefs danger rating.  Put that decentralized collar on and Doge coin is tick free forever.

And NEXT on our list – I kid you not, is XRP. The Legal Briefs SEC danger rating for XRP is officially:

That’s the danger rating but I hope it ends like this:

Except not as long an ending as the Lord of Rings and without 15 minutes of hobbits jumping up and down on a bed.

NEXT, my personal favorite, Polkadot – not because of the technology but ..I like the name.  Cute.

Polkadot is a recent platform which is designed to connect other blockchains together in a single network all strung together in parallel – kind of like Christmas tree lights. And if you want to turn on the lights, you will need the DOT coin which is currently sold on major exchanges.  But is it possibly in the SEC hot zone?

Let’s start with the bad news: The Web3 Foundation which designed and set up the Polkadot platform had a number of ICOs starting in 2017 and has apparently raised almost $200 million to date.  And to make matters worse, the ICOs took place before the Polkadot platform was fully functional.  This is bad because sales of the DOT coin look more like an investment contract where buyers are relying on the efforts of the developers to increase the value of the tokens because when the tokens are sold before there even exists a platform to use them on – the inherent value of the token is Zero – nothing, so of course you are relying on the developer to make the platform so that the coin has some value.  Not good for PolkaDot.  To make matters worse, here was what happened to the initial tokens:

50% to investors

8.4% to private sale investors – likely exchanges.

11.6% were kept by the Web3 Foundation for future fundraising and

30% were allocated to Web3 to develop and build the infrastructure.

That’s all bad.  Now here’s the good.  First, the Web3 Foundation is a non-profit corporation and even better it is organized outside of the United States in the beautiful country of Switzerland – homeland of Albert Einstein and outside the jurisdiction of the SEC. In addition, the ICO sales were NOT made available to Chinese and Americans due to the exact “regulatory” concerns we are talking about in this video.

All of that is good and smartly done.  Good  job Polkadot legal team.  However, the SEC is the securities AND EXCHANGE commission so the danger remains that the SEC could attack the exchanges if it concludes that DOT was sold in the character of a security and certainly if a U.S. company had sold it like the DOT ico did, it was definitely in the danger zone as far as the SEC. And we cannot sweep this danger under the rug as SEC chair Gensler recently set his sights on exchanges and trading companies.

Polkadot and its coin land squarely in the middle of the Legal Briefs danger rating and that is a 5 out of 10.

If the SEC has a couple more beers at the bar, Ms. Polka dot is going to start looking very attractive.  Until then, you are fine.

Which takes us to our final coin to analyze. Uniswap – which I didn’t really know much about until today. I kept thinking it was called Bi-swap for some reason…maybe that’s a website.

My understanding of Uniswap is that it allows individuals to trade any Ethereum based coins without an exchange getting involved.   How exactly I don’t understand but I found a great video explaining it:

He lost me at algorithm.

In any case, what’s interesting about  UNiswap – developed by Uniswap Labs, from a legal standpoint is that last year the network began trying to decentralize itself by distributing tokens through an air drop.  So last year if you had even said the word “Uniswap” you were given 400 Uni tokens. Meanwhile, Uniswap Labs staff and such received about 40% of the Uni supply which would be released over a 4 year period – similar to Ripple’s escrow.

It’s an interesting approach to releasing tokens because under current securities laws there is a relatively strong argument that the airdrop was the transfer of a security. The analysis is somewhat convoluted but don’t take my word for it – attorney Stephen Palley up in the DC law firm of Anderson Kill – which is a great name for a law firm – said back in 2020 that UNI was “almost certainly” a security.

And that’s where things get really interesting because the airdrops are of course free – Uniswap Labs didn’t have an ICO – there was no profit made from the airdrop. So the nuts and bolts of it is, if the SEC sue Uniswap Labs and wins – what is the result?  There are no profits to “disgorge” from Uniswap so what incentive does the SEC have to file the lawsuit?  The principal of the matter?

Which leads us to our conclusion that although Uniswap might be open to enforcement from other regulatory bodies, the chance of an SEC lawsuit, with no tangible result to show, seems rather remote.  Uniswap will get a 4 out of 10 on the Legal Briefs danger rating:

And that is where the current state of US Securities laws leaves us. As Attorney Palley states in a written plea to the SEC:

“We have an obligation as lawyers to steer our clients in the right direction. We’ll continue to do that but if anyone from the SEC is listening…We could use a little help.”

Well put Mr. Palley and thank you out there for watching. Remember that if you are honestly trying your best and just don’t get it, it never hurts to ask for a little help.

Jeremy Hogan
Jeremy Hogan
Attorney Jeremy Hogan is a partner at Hogan & Hogan.