Blockchain and the Law

SEC Qualifies Blockstack and YouNow Regulation A Offerings

Blockstack

On July 10, the Securities and Exchange Commission (the “SEC”) qualified Blockstack PBC’s (“Blockstack’s”) offering circular, enabling Blockstack to commence sales and distribution of up to $40 million worth of its Stacks Tokens (“Stacks”) under Regulation A. This marks the first time in history that the SEC has qualified a Regulation A offering of blockchain-native digital assets.

We previously covered the initial public filing of Blockstack’s April 11, 2019 preliminary offering circular (which was originally filed by Blockstack’s subsidiary, Blockstack Token LLC) here. Blockstack Token LLC subsequently filed an amended preliminary offering circular on May 16; then Blockstack filed a further-amended version on July 10.

The SEC’s decision to qualify Blockstack’s offering circular represents a milestone for Blockstack, as well as the blockchain industry as a whole. It is a key step down what may be a viable pathway for companies to raise capital to develop open, cryptographically secured networks powered by digital assets.

Much, however, remains to be determined from a regulatory standpoint, including:

  • At what point, if at all, can Blockstack realize its stated ambition to no longer treat Stacks as securities under the federal securities laws? While Blockstack’s stated ambition is theoretically consistent with recent SEC staff guidance, which stated that the analysis of whether a digital asset represents an investment contract (and thus, a security) may change over time, the SEC’s guidance only provides a litany of factors that may be relevant to this determination; there is no bright line.
  • Will Blockstack need to register the Stacks as a class of equity securities under Section 12(g) of the Securities Exchange Act, and thereby become a fully-fledged public reporting company? Conspicuously, the final offering circular removes disclosure contained in the May 16 version stating Blockstack’s determination that Stacks should be classified as “debt” (as opposed to “equity”) securities, thereby taking them outside the purview of Section 12(g). And while Regulation A contains a conditional exemption from Section 12(g) for Tier 2 offerings such as Blockstack’s, the exemption requires (among other things) that the issuer utilize a SEC-registered transfer agent, which Blockstack is not doing.
  • Are persons who run validator nodes on the Blockstack network required to register as broker-dealers under the federal securities laws? Are these persons, or Blockstack, required to register as a clearing agency or transfer agent under the federal securities laws? Must Blockstack register with FinCEN as a money services business, or obtain a BitLicense from the New York State Department of Financial Services? The offering circular (along with exhibits thereto) sets forth Blockstack’s reasoning for why, in their belief, no such registration or licensing is required. However, this does not mean that applicable federal and state regulators will agree.

These uncertainties – among others – should be carefully considered by market participants moving forward with similar offering structures. Nevertheless, the value in the precedent that Blockstack has now set is undeniable.

YouNow

Indeed, other companies are already moving forward with similar approaches. Most notably, yesterday, the SEC also qualified the Regulation A offering circular of YouNow, Inc. (“YouNow”), for up to $50 million worth of Props Tokens (“Props”). Rather than solicit cash (or cryptocurrency) consideration for the sale of Props, YouNow and its affiliate, The Props Foundation Public Benefit Corporation, will use YouNow’s Regulation A program solely to distribute Props as rewards and grants to users, developers and other contributors within YouNow’s network of consumer-facing digital media applications.

Who’s next?

As Bitcoin’s Price Moves Dramatically, ETF Proposals Remain at a Standstill

On June 26, the price of bitcoin surged to a 12-month high of nearly $13,900 (up about 35% on the month) before losing more than $1,700 in a span of 15 minutes, then rebounding slightly and closing the day at around $12,800. All the while, retail and institutional investors seeking to gain exposure to this volatile asset class through an exchange traded product continued their wait. The Securities and Exchange Commission’s (“SEC”) evaluation of the listing proposals filed by CBOE BZX Exchange, Inc. (“CBOE”) and NYSE Arca, Inc. (“NYSE Arca”) – first covered here – remains ongoing and could continue through September.

Initially, the SEC had 45 days from each proposals’ publication in the Federal Register to issue a decision or request an extension. The agency may extend this deadline up to a total of 240 days.

The SEC has extended its deadline twice since the proposals were filed in January, citing the need for further analysis of the proposals’ conformity with the anti-fraud and anti-manipulation provisions of Section 6(b)(5) of the Securities Exchange Act of 1934. In March, the SEC requested public comment on several additional policy questions under consideration for what, if approved, would be the first bitcoin exchange traded product. So far, the SEC has received 49 comment letters for the NYSE Arca proposal and 35 for the CBOE proposal.

On May 1, 2019, NYSE Arca amended its proposal in response to SEC concerns. Such information includes evidence regarding the maturation of the bitcoin market in recent years, the product’s resistance to market manipulation, and how the structure and operation of the proposed Bitwise Bitcoin ETF Trust would protect investors.

A registered bitcoin exchange traded product would open up bitcoin investing to a broader segment of the population by making it possible for investors to get exposure to bitcoin without the sometimes perilous processes of purchasing bitcoin on the open market and managing the public-private key pairs associated with direct bitcoin ownership. It remains unclear if or when exchange traded products will be available. For now, all we know for certain is that the SEC will continue their evaluation, and that bitcoin’s price will continue to move.

Cover Article: Practical Law – The Journal, June/July Issue | “Supply Chain Management – Implementing Blockchain Technology”

We are happy to report that our recent in-depth Practice Note on Blockchain as applied to Supply Chain Management was selected to appear as the cover story for the June/July issue of Practical Law – The Journal. Read the full text here.

SEC Sues Kik for ICO

On June 4, 2019, the U.S. Securities and Exchange Commission (the “SEC”) filed a complaint in the Southern District of New York against Kik Interactive Inc. (“Kik”) alleging violations of Section 5 of the Securities Act of 1933 (the “Securities Act”).

The complaint arises from Kik’s offer and sale of $100 million worth of blockchain-based digital assets known as “Kin Tokens” from May to September 2017.

In that time period, Kik sold Kin Tokens both (1) to accredited investors pursuant to Simple Agreements for Future Tokens (or “SAFTs”) and (2) in a general public sale to purchasers in select jurisdictions, including the United States.

The SEC claims that Kik thereby offered and sold unregistered, non-exempt “investment contracts” – a form of securities – in violation of Sections 5(a) and 5(c) of the Securities Act.

(According to the SEC, although Kik attempted to sell discounted Kin Tokens under the SAFTs in satisfaction of the exemption from registration provided by Rule 506(c) under Regulation D, the subsequent delivery of Kin Tokens to SAFT purchasers in September 2017 constituted an offer and sale of securities that was either part of the same offering as the general public sale or alternatively, should be integrated with that offering. And, because Kik did not take reasonable (i.e., any) measures to verify that purchasers in the general public sale were accredited investors, the offering as a whole failed to satisfy the requirements of Rule 506(c) and thus was required to be registered with the SEC.)

Kik has been vocal in their opposition to the enforcement action and commitment to litigate.

In January 2019, Kik made its Wells Response publically available in a blog post entitled, “Four Commissioners at the SEC are About to Vote on the Future of Crypto in the U.S. You Need to Know Why We’re Fighting Back.”

More recently, Kik teamed up with other market participants to launch Defend Crypto, a donation platform that has raised over $4.4 million worth of digital assets to fund Kik’s litigation war chest.

Finally, in response to the SEC’s complaint, Kik’s General Counsel reportedly stated that:

For the reasons set forth in our Wells Submission, the SEC’s complaint against Kik is based on a flawed legal theory. Among other things, the complaint assumes, incorrectly, that any discussion of a potential increase in value of an asset is the same as offering or promising profits solely from the efforts of another; that having aligned incentives is the same as creating a “common enterprise”; and that any contributions by a seller or promoter are necessarily the “essential” managerial or entrepreneurial efforts required to create an investment contract. These legal assumptions stretch the Howey test [the four-pronged test for determining whether a transaction, contract or scheme constitutes an investment contract] well beyond its definition, and we do not believe they will withstand judicial scrutiny.

If Kik does indeed proceed to trial, its outcome will, one way or the other, reverberate throughout the industry. Stay tuned.

Dueling Bitcoin White Paper Copyright Registrations – What Does it Mean?

The plot has thickened in the longest-running “whodunit” in the blockchain space: Who is Satoshi Nakamoto, the pseudonymous creator of Bitcoin and author of the white paper that started it all, Bitcoin: A Peer-to-Peer Electronic Cash System? Published in 2008, Nakamoto’s paper proposed a form of electronic cash that would operate purely peer-to-peer, without the need for a trusted intermediary (such as a centralized financial institution) and in a verifiable manner that protects against the “double-spend” problem. That white paper served as the launch pad for the Bitcoin network and inspired blockchain’s proliferation. Over a decade later, the true identity of Nakamoto and whether Nakamoto is a single person or a collective remain a mystery, despite speculation and multiple claims to the digital throne.

Recently, claimants turned to intellectual property registrations in their campaigns for recognition. In April 2019, Australian entrepreneur Craig Wright (who has long claimed to be Nakamoto) sparked controversy in the blockchain community by filing two copyright registrations claiming authorship of Nakamoto’s white paper (Reg. No. TXu002136996) and the original Bitcoin source code (Reg. No. TX0008708058). In the wake of Wright’s claims, on May 24, 2019, Wei Liu, reportedly a cryptocurrency entrepreneur and a Chinese citizen with an address in California, upped the ante by also filing a copyright registration (Reg. No. TX0008726120) asserting that he had in fact authored the white paper.

The gauntlet, it seemed, had been thrown down. Continue Reading

Should Your Portfolio Companies Implement Blockchain?

Proskauer partners Daniel Ganitsky and Jeff Neuburger address five factors for private equity firms to consider when evaluating the critical business decision of implementing blockchain-based technology solutions for their portfolio companies:

Daniel Ganitsky: Technology is causing private equity firms to deal with a whole new set of questions for their portfolio companies. The use of blockchain technology is one of those questions. Given operational factors and the fact that private equity firms often provide additional access to capital, it may make sense for private equity firms to consider using blockchain technology in their portfolio companies.

Jeff Neuburger: There are a number of factors that a private equity firm should consider in evaluating blockchain for their portfolio companies.

Continue Reading

Blockstack Announces SEC Filing for $50 Million Regulation A Token Offering

On April 11, Blockstack Token LLC (“Blockstack”) filed a preliminary offering circular with the SEC for a $50 million token offering under Regulation A of the Securities Act. The offering circular is now under review with the SEC and must be qualified (i.e., cleared) by the SEC before sales of Blockstack’s tokens (“Stacks Tokens”) can be effectuated under the program.

Blockstack’s offering circular is notable because it treats the Stacks Tokens as securities today but discloses that the issuer expects the Stacks Tokens will, at some point in the future, no longer be required to be treated as securities under the federal securities laws. This approach is consistent with recent SEC staff guidance, which stated that the analysis of whether a digital asset represents an investment contract (and thus, a security) may change over time, depending on how the asset is used, offered and sold. Blockstack states that it will refer to the Framework for “Investment Contract” Analysis of Digital Assets, recently published by the SEC’s Strategic Hub for Innovation and Financial Technology, for regulatory guidance in connection with making this determination.

If the SEC qualifies Blockstack’s offering under Regulation A, it will be the first time the SEC has done so for the offer and sale of a blockchain-native digital asset. Continue Reading

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