Bad News for Crypto Projects in the U.S.
On November 7, 2022, United States District Judge Paul J. Barbadoro issued a memorandum and order in District of New Hampshire Case No. 21-cv-260-PB titled “Securities and Exchange Commission v. LBRY, Inc.” As I’ve already said before, a decision in this case would have wide-ranging implications for projects in the cryptocurrency sector, and given how the case was decided, none of these implications are good.
LBRY, Inc. was founded in May of 2015 to create “the first decentralized, open-source, fully encrypted content distribution service built using the same blockchain technology that underlies Bitcoin.” The LBRY Network’s native token, LBC, was used to compensate miners as well as be spent on the LBRY Blockchain to publish content, tip content creators and boost channels/content in search results.
Notably, LBRY, Inc. did not have any sort of initial coin offering (unlike many of the projects which have been targeted by the SEC). However, LBRY, Inc. reserved a pre-mine of 400 million LBC (out of a total maximum possible circulation of 1 billion LBC), for things like encouraging network adoption, building partnerships and to help pay for operations.
Although LBRY, Inc. was initially self-funded, from about September of 2016 onward, it relied almost exclusively on its pre-mined LBC to fund operations. In total, almost 200 million LBC was sold by LBRY, Inc. or used to compensate software developers and other employees.
In its decision, the court relied on the three-pronged “Howey Test” (which I explain in detail in this post if you aren’t already familiar with it) to determine whether LBRY, Inc. “offered or sold securities in interstate commerce without filing a registration statement.” According to the court, the first two prongs of the Howey Test (i.e., “an investment of money” and “a common enterprise”) were not in dispute, suggesting that the parties had agreed both of those prongs were satisfied. As a result, the decision focused exclusively on the third prong, namely, whether there was an “expectation of profits to be derived solely from the efforts of the promoter or a third party.”
The court ultimately determined there was such an expectation of profits for two reasons:
- LBRY, Inc. made several public comments about the price of LBC appreciating as well as asserting that “the long-term value proposition of LBRY [was] tremendous,” and encouraging LBC holders to “continue holding” on to their tokens.
- Even if LBRY, Inc. had not made the kinds of statements described above, “any reasonable investor who was familiar with the company’s business model would have understood the connection” between an increase in the value of LBC and the efforts of LBRY, Inc., because “by retaining hundreds of millions of LBC for itself, LBRY … signaled that it was motivated to … improve the value of its blockchain for itself and any LBC purchasers.”
What it Means for Crypto Projects
What does this mean for crypto projects? If you take the language of the decision at face value, it means the following:
- Any crypto project which has allocated pre-mined tokens for its own use;
- Sold those tokens either directly or indirectly (via an exchange) to fund its operations; and
- Is either:
- based in the U.S.; or
- has made its tokens available to be purchased by U.S. residents (either directly or indirectly via a centralized or even a decentralized exchange)
is probably in violation of Section 5 of the Securities Act of 1933 unless it has registered with the SEC or is otherwise exempt from registration.
And because virtually all crypto projects (at least that I am aware of) do all of the things listed above, that means virtually all crypto projects are violating the law.
This is bad.
Like, really bad.
And although some commentators have asserted that Judge Barbadoro’s decision is “not the law,” until another judge (or Congress) says otherwise, this sort of crypto legal wishcasting is not particularly meaningful and could in fact prove dangerous if any crypto projects rely on such assertions to conduct business that violates the law.
I wish I had some positive spin to put on all of this, but I have to be honest with you – I don’t. This is a bad result and I was hoping that it would have gone the other way.
If you’re concerned about how this decision may apply to a crypto project that you’re involved with, now would probably be a good time to consult with an attorney to discuss your options.
Until next time…
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