Chitra Ragavan


How A 1920s Florida Citrus Land Baron Created The Acid Test For Crypto Tokens

This year alone, technology startups have raised a staggering $3.2 billion through Initial Coin Offerings, or ICOs, with the cumulative value of token sales skyrocketing by more than 1100 % in the past year alone, according to CoinDesk’s ICO Tracker.  Also known as “Token Sales,” ICOs enable startups to raise money for their projects by selling crypto coins as a form of equity both to sophisticated investors and the average public. This democratization of fundraising through ICOs has generated a level of excitement, some say greed, comparable to the old days of gold prospecting in the Wild West. “Anytime you have new concepts that are disruptive to old ways of doing things,” says Paul Atkins, CEO of Patomak Global Partners, “That gets a lot of people interested and focused.”  Including at the U.S. Securities and Exchange Commission, (SEC), where Atkins once served as a commissioner. In July, the federal agency issued an investigative report warning startups that their tokens could constitute securities and  subject to federal securities laws. “We seek to foster innovative and beneficial ways to raise capital,” said SEC Chairman Jay Clayton, “While ensuring – first and foremost – that investors and our markets are protected.”  But the SEC report, much of it based on an obscure 1946 Supreme Court test called the Howey test involving Florida citrus grove investments, has only raised more questions than it has answered and has token lawyers reaching for their legal tomes to see exactly how that historic case relates to modern day digital assets. As ICOs skyrocket in popularity as a viable alternate form of capital raising, and given the steep penalties for non-compliance with securities laws, there’s a growing sense of urgency around finding ironclad answers to some of these challenging questions. For instance, what constitutes a security when it comes to digital tokens? How does the Howey test apply to the different examples of tokens surfacing daily? And most importantly, how can startups issue tokens without running afoul of the law. “Lots of tokens, especially the tokens we’ve seen over the last year, probably have passed the Howey test, which is a bad thing when you’re a token seller,” says Marco Santori, a partner and head of the fintech practice at Cooley LLP., and a noted ICO expert. “It’s the one test you don’t want to pass.”  The New Paradigm The Howey test stems from the 71-year-old Supreme Court ruling, Securities and Exchange Commission v. W.J. Howey Co. et. al., which centered around the definition of a key term in the 1933 and 1934 federal securities laws, “investment contract.” The Court issued the four-pronged test to define such a contract. “They said an investment contract is an investment of money, in a common enterprise, with the expectation of profits, solely from the efforts of others,” says Lee Schneider, who is a partner at McDermott, Will & Emery and heads up the law firm’s fintech and broker-dealer practices. He has written extensively about ICO regulation.  The test poses two fundamental questions, outlined in this recent explainer video by prominent crypto lawyer Peter Van Valkenburgh, Director of Research at the Washington, D.C., based Coin Center. “First, is the thing being sold as an investment contract?” says Van Valkenburgh. “And the second, is there a person upon whom investors are relying. And you have to answer yes to both of these for it to be a security.” Van Valkenburgh offers an example of a security by comparing gold to Apple stocks. Gold has inherent value that doesn’t ride on the continual efforts of others, he says. But the value of Apple stocks by their nature, are heavily dependent on the efforts and successes of Apple CEO, Tim Cook and his management team.  The SEC applied a similar rationale to tokens in the matter of  The DAO, or Decentralized Autonomous Organization – a stateless, crowdfunded, for-profit, virtual blockchain entity – created by the German organization – to sell “DAO Tokens” to raise capital.  The agency asserted that the tokens met the four-pronged Howey test in structure and function and were therefore deemed securities. Describing  crypto tokens as “the new paradigm,” the SEC asserted that token sellers must comply with federal securities laws, “regardless of whether those securities are purchased with virtual currencies or distributed with blockchain technology.”  Hewing to the Statute  The SEC decided not to pursue enforcement actions in the DAO case. But others may not be so lucky. Schneider says he counsels new clients “in very stark terms,” to fight the temptation to skirt federal securities laws. “Look, don’t commit fraud,” Schneider tells them. “You should not commit fraud here.” Joshua Ashley Klayman of Morrison & Foerster says she advices startups to use a simple rule of thumb when launching tokens. “No matter where you are in the world, whatever jurisdiction you are launching from, if you are marketing or selling to U.S. persons, then U.S. securities laws are going to apply to you,” says Klayman, “And if that token is a security, you need to either register or you need to find an exemption.”  Amid all this hand-wringing, many in the ICO community have complained that the SEC missed the mark with the DAO report by failing to provide a clear bright line test for digital tokens. The SEC did not respond to requests for comment. But former commissioner Atkins says the agency was right to be cautious. “They have to hew to the statute, and things are changing all the time in the real world, so they would never want to get caught you know, saying this is the bright-line test,” Atkins says. “And then suddenly they find, a year or two down the road, that things have changed and they don’t then want to be in the position of saying, ‘Oops, never mind about that, and now we’re going to smash you in the head.’” From Citrus to Crypto  Many legal experts say the Supreme Court ruling’s securities broad stroke has enabled it to stand the test of time for more than seven decades even as the nature of securities has morphed dramatically. Unlike today’s digital assets, the 1946 ruling had to do with a much simpler investment asset — citrus groves, owned and operated by a Florida land baron named W.J. Howey, who is widely considered the father of asset-backed securities. And although citrus and crypto couldn’t

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The Iowa Beauty Queen, The Russian Technocrat And Their Cannabis Crypto Launch

The cannabis industry, one of the fastest growing sectors in the economy today, also has some of the toughest banking problems. Put simply, it is buried in cash, thanks to the illegality of the drug, the crush of laws and banks shying away from any and all weed proceeds. Blockchain and cannabis industry watchers believe that cryptocurrencies could be a game changer for the marijuana sector. In recent years, a number of weed coins have proliferated, including HempCoin, CannabisCoin, DopeCoin, and PotCoin, each taking a slightly different approach to solving the cash dilemma. “Once, virtual currencies and weed belonged together on the dark web;” said Lionel Laurent in a recentBloomberg Businessweek article, “Now, they’re being pitched as asset classes on track for mega-growth.” Today, Paragon, a company formed by model and Iowa beauty queen Jessica VerSteeg and backed by her millionaire Russian technocrat husband, Egor Lavrov, will launch an ambitious but controversial Initial Coin Offering (ICO) for a new cryptocurrency, ParagonCoin (PRG) to facilitate cannabis related transactions on the company’s soon to launch blockchain platform. Both cannabis and blockchain industry experts say that if successful, the platform could create transparency in the cannabis supply chain and create much-needed standards in this shady, largely illicit sector. “There’s definitely a need for the platform that they’re proposing in the cannabis industry,” says Teemu Paivinen, an entrepreneur and investor at Zeppelin Solutions, a blockchain consulting and security audits firm. “And I think there’s a big opportunity there.” But although backed by some veteran cryptocurrency advisors and partners, the ParagonCoin ICO has generated considerable controversy as well. Critics on social media forums have said the token is overhyped and overvalued. One Redditor described the token launch as nothing but a “blatant cash grab.” Critics also say the company lacks transparency and accountability. “And this might be the reason some people have been slugging them up pretty substantially in the social media,” says Simone Giacomelli, CEO and founder of Vulpem Ventures, “Because whenever there’s not enough detail or clarity, some of the more detail oriented auditors might flag this as a lack of credibility.” VerSteeg and Lavrov say their motives are transparent and above board. “We don’t need money in our own lives. We don’t need fame,” says VerSteeg. “Out of our own desire to help, we decided to make it for the community.”  [Ed note: Investing in cryptocoins or tokens is highly speculative, and the market is largely unregulated. Anyone considering it should be prepared to lose their entire investment.] Cash Crop Currently, because use, sale and possession of cannabis are illegal under federal law, every aspect of the industry is cash-based because, by law, the proceeds can’t be put in a bank. That means cash payments for growers, buyers, sellers, PR firms, lawyers, accountants, real estate agents, landlords and delivery people. Even taxes are paid in cash.  VerSteeg’s and Lavrov’s goal is to sop up cash from cannabis related services. “If we move just 1% of the industry’s cash into PRG,” says Lavrov quietly, “You can imagine the value. It’s a $100 billion industry.” In addition to the cash problem, lack of regulation has led to inconsistencies in lab purity results, difficulties in patient verifications, and numerous data integrity problems. “You have no way of trusting the information that you are being fed, so to speak,” says David Sonstebo, a futurist and founder of IOTA. The non-profit foundation has built a next-gen distributed ledger technology called Tangle, which Paragon will eventually be using. A blockchain platform could solve these problems. A blockchain is a  distributed ledger that creates immutable, tamper-proof records of transactions, and smart contracts to enable logic and automation. “With the sequences in place, you can prove the provenance from seed to weed to however you ingest it,” Sonstebo says, “And I think that is very important in order for cannabis to be accepted as a legitimate crop instead of just being like this drug for stoners.” A New Ecosystem The Paragon blockchain platform is designed to connect cannabis players through an open-source blockchain network with different data access permissions for different participants. Because of federal patient privacy rules, patient data would be stored off the blockchain. But verification of their data would take place on the distributed ledger. “You cannot see my medical history,” says VerSteeg. “But what you can see is my doctor’s name, my expiration date, and like a blue check thing saying this is a valid ID saying I can buy medical marijuana.” Paragon members could use the PRG tokens to pay for all cannabis services and benefits except buying or selling of the drug, which would be illegal, says Lavrov. In fact, Lavrov says, if anyone attempts to use PRG to buy or sell cannabis, Paragon will report them to the authorities. “Our business is not touching the substance itself in any way,” Lavrov says, “So even though we are a cannabis-related startup, we’re not buying, not selling, not creating a market for cannabis itself.” Members could also use PRG for casting votes on the locations of Paragon shared office spaces and priorities for spending community reserve funds. “They are not doing this ad hoc, hey, let’s get a quick money grab,” says IOTA’s Sonstebo. “By doing it the way they are doing it, at least as defined in the white paper, they are creating a very collective community effort around it, and I believe that’s a very good approach.” Terrible Tragedy The Paragon blockchain evolved from a personal tragedy that touched VerSteeg deeply. In 2015, VerSteeg lost her boyfriend, Tyler Sash to an overdose of painkillers.   Sash was a former standout safety for the University of Iowa who won a Super Bowl during his rookie season with the New York Giants. He was always playing in pain from injuries, concussions and chronic shoulder problems and asked VerSteeg if he could smoke weed to prevent addiction to painkillers, she recalls. “And I said, ‘No, Ty, you have to trust these NFL doctors; you’ll never get addicted,” says VerSteeg.  But after suffering five concussions and being cut from the Giants roster before the 2013 opener, Sash returned home to

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