Startups Need Clarity When it Comes to Digital Currencies
TLDR: Telegram paid $18.5 million and returned the proceeds of its coin offering back to investors as part of a settlement with the U.S. Securities and Exchange Commission. The agency sued the firm last year for raising $1.7 billion through an initial coin offering to fund the development of its blockchain project, known as the Telegram Open Network. The settlement comes as U.S. cryptocurrency firms continue to seek regulatory certainty for the industry, including clear guidelines for digital coin offerings.
What’s Happening This Week: Policymakers are continuing to discuss the merits of digital payments and currencies, even as federal agencies crack down on blockchain and crypto-focused startups.
The U.S. Securities and Exchange Commission announced this weekend that it reached an $18.5 million settlement with messaging app Telegram after filing an injunction last year to halt the firm’s $1.7 billion digital coin offering. The SEC said that Telegram’s offering—which would have supported its Telegram Open Network blockchain project—constituted an illegal securities offering. As part of the settlement, Telegram agreed to return more than $1.2 billion that investors provided for the firm’s TON digital currency.
The settlement comes after other high-profile run-ins between the SEC and cryptocurrency firms seeking to offer digital currencies to investors. The SEC is continuing to fight with messaging app Kik over the company’s sale of $100 million worth of its Kin digital tokens in 2017, with the agency filing a motion for summary judgement last month seeking to end the ongoing dispute.
Earlier today, lawmakers on the Senate Banking Committee held a hearing to discuss the digitization of money and payments—an issue that has received renewed attention as people across the globe increasingly turn to digital services amid the ongoing coronavirus pandemic. Senate Banking Committee Chairman Mike Crapo (R-Idaho) stressed the importance of federal certainty for the cryptocurrency industry during the hearing, saying that “the U.S. must have clear rules of the road in place that protect businesses and consumers without stifling innovation.”
Why it Matters to Startups: Most major federal securities laws were written in the wake of the Great Depression, well before digital computers—much less cryptographically secure digital assets—even existed. Not surprisingly, these laws fail to provide rules that cleanly apply to digital tokens. The resulting uncertainty about how to distribute digital assets to investors and users in a manner consistent with federal securities laws has long plagued the developing blockchain industry.
Many companies, including Telegram and Kik, believed it was legal to sell their digital tokens to users without registering with federal agencies because their tokens are more than just an investment vehicle. Unlike traditional financial assets like stocks and bonds, these digital tokens allowed holders to access services on digital networks. Existing federal laws did not provide a clear answer for startups trying to figure out whether their digital assets were more like a traditional security subject to registration rules, or more like a functional item exempt from securities regulation. Rather than work with industry to provide more clarity, the SEC has moved to assert control over the cryptocurrency industry by filing lawsuits and injunctions to prevent firms from moving forward with unregistered initial coin offerings. While the Telegram settlement doesn’t mean that all token distributions violated securities laws, it raises the possibility that the SEC will take a more aggressive stance towards companies that relied on fundraising techniques many in the industry believed were compliant.
While Kik and Telegram were existing companies with established products that didn’t depend on a digital token to function, early-stage startups in the blockchain and crypto sectors often need to distribute their tokens widely in order to build a functioning network. Because these tokens provide value to users that want to use the underlying network, blockchain startups could kill two birds with one stone by selling tokens to potential users, getting tokens in the hands of users to build up network effects, and raising funds to scale their products. But without clearly defined regulations for conducting these token distributions, entrepreneurs could be prematurely forced out of the sector over the fear of being sued for illegal securities offerings. Failing to provide clear rules for entrepreneurs seeking to build blockchain-powered networks risks driving the industry overseas and limiting job growth at a time when the country can least afford it.
Some policymakers, however, have recognized problems with the lack of clearly defined regulations and guidelines, and are working to provide greater certainty for cryptocurrency startups. Bipartisan legislative bills, such as the Token Taxonomy Act from Reps. Darren Soto (D-Fla.) and Warren Davidson (R-Ohio), would “exclude digital tokens from the definition of a security.” As Engine noted in a statement following the bill’s introduction last year, this type of proposal supports startup activity and innovation by “providing clear rules supporting an emerging technology without constraining future growth.”
Even with the global attention cryptocurrencies have received over the past several years, however, lawmakers have been slow to address the numerous roadblocks faced by these innovative companies. It’s vital for policymakers to continue working with startups and entrepreneurs to provide much-needed clarity for the cryptocurrency industry.
On the Horizon.
The House Small Business Committee is holding a hearing at 10 a.m. tomorrow to hear from the U.S. Small Business Administration about the status of the Economic Injury Disaster Loan Program.
The Senate Judiciary Committee is holding a markup this Thursday at 10 a.m. on the EARN IT Act, legislation that would force Internet companies to comply with yet-to-be-determined best practices for identifying and removing child sexual abuse materials from their platforms.
