In the middle of this year, the much-anticipated Telegram had to reach a settlement with the US SEC, returning $1.2 billion to Telegram Open Network investors and paying a fine of $18.5 million. U.S. securities laws have always been the sword of Damocles hanging on all cryptocurrency projects, and the long-standing “cooperative” model may provide a way out for the cryptocurrency founding team to learn from.
Written by: Jesse Walden and Connor Spelliscy, the former is the founder of crypto venture capital firm Variant Fund and former partner of a16z, the latter is the partner of broadband network venture capital firm Connectivity Fund Compilation: Lu Jiangfei
By progressively decentralized way, many successful startups encryption money into a project or user agreement owners, many of the founding team aim to do is worry about their issue of tokens will be treated as securities regulators Therefore, it was forced to “force” to withdraw when the project/protocol token was issued.
Another option is that the founding team of an encryption project can build a platform on its own to create a democratic structure based on ” members co-ownership ” so that they can confidently participate in the token issuance. This method allows the founding team to Improve the rights and interests of stakeholders, community decision-making capabilities and product quality at the expense of leadership.
Problem: founders give up leadership and hinder innovation
When a cryptocurrency project enters the token issuance stage, the founding team often feels “uneasy” and sometimes has to choose to withdraw from the project. The reason for this phenomenon is mainly because they worry that after continuing to participate in the encryption project, regulators may treat the relevant tokens as securities, which will increase regulatory risks.
So, what are the potential problems if the founding team continues to participate in cryptocurrency projects? In fact, if token holders obtain expected profits from the management or entrepreneurial efforts of others, such tokens may be considered securities. Therefore, if the regulatory agency discovers that the tokens purchased by the token holders are expected to ” profit from the efforts of the founding team “, then the tokens issued by the relevant project will be considered securities.
In order to avoid such risks, the cryptocurrency founding team often distances itself from the “specific part” of the project. The main measures they take include:
- Avoid public discussion of related tokens;
- Avoid providing UI;
- Avoid participating in project/agreement governance.
Some encryption currency founding team will choose to exit the project, and provide tools for open-source community, which provides for the right to lead a center of opportunity, but also a commendable way, because decentralized control and ownership of the network and encryption An important principle of the ownership economy . But the problem is that once the founding team leaves the project, users will also lose, such as:
- Unable to obtain more knowledge and information about encryption projects;
- That could lead to the risk of losing leadership.
We believe that policymakers may prefer the founding team to continue to participate in the governance of encryption projects, so as to not only provide help and support to consumers, but also meet the regulatory goals of protecting consumers. But the problem is due to the regulatory body has not been given clear guidelines, many of the founding team ultimately chose to give up to participate in the project.
In fact, if the cryptocurrency network adopts the ” cooperative ” model of co-ownership, co-operation, and benefit-sharing, they can be assured of issuing tokens and decentralizing ownership, while continuing to ensure their leadership in the development of the project. Don’t worry about whether it will violate securities laws and regulations.
It should be noted that this model is not suitable for all cryptocurrency project founding teams! In most cases, this mode does not even work properly!
Of course, many cryptocurrency networks have unknowingly adopted this “cooperative” model, or their methods actually have a lot of similarities with the “cooperative” model. One of the biggest benefits of this model is: the founding team communicated to the user is control / ownership, rather than securities. If the “cooperative” model of the cryptocurrency network is not very obvious, then the founding team should consider certain trade-offs and decide whether to make their crypto network more similar to the “cooperative”, which also means that they can issue tokens after we continue to play a leadership role in the project, or continue to make a meaningful contribution to the project.
To this end, the founding team must be committed to integrating the values and processes of the “cooperative” into their project structure (though they do not necessarily need to be legally merged into an organization similar to a cooperative). Regulators are usually more concerned when assessing the “securities” economic realities, rather than too much emphasis on form, so when they review the project will focus on monetary items to consider whether encryption attempt to use “cooperative” mode.
In fact, after several iterations, the organizational structure of “co-op” mode is relatively mature, will basically give priority to collective interests and stakeholders involved.
In this article, we will focus on US law and the “cooperative” model, but for the cryptocurrency founding team, the advantages of similar organizational structures in different jurisdictions must also be considered. For example, Nexus Mutual has transformed its decentralized insurance alternative organization into a ” discretionary mutual benefit society “, which is a common “cooperative” model in the UK and Australia, but there is no similar organization in the United States. .
In addition, the article does not provide a comprehensive legal analysis, but will “co-op” mode is seen as an alternative mechanism, and hope to discuss issues related to encryption currency team and consultants. If you think this structure is useful, you need to have a deeper understanding and discussion with a lawyer who is familiar with blockchain law and related organizational structures.
Potential solution: Let the cryptocurrency network follow the “cooperative” code rules
What is a cooperative?
A cooperative is an autonomous association of one kind by an individual ( “Members”) a voluntary basis through a jointly owned and democratically controlled by the enterprise (enterprise) to meet their common economic, social and cultural needs and aspirations.
Different from the traditional share ownership model, the income distribution of the members of the cooperative is not proportional to the initial investment of these members, but is determined by their labor, hard work and success in the cooperative. This method is also called ” mutual benefit.” “. The more members “visit” the cooperative, the more services they receive, and the more cooperative income is distributed to these members.
Cooperatives can be similar to traditional enterprises because they are very similar in certain functions and practices, such as:
- To develop organizational policies established by the board of directors election;
- Hire a manager to be responsible for the company’s operations.
There is not much red tape to create a cooperative. Take the United States as an example. You can register and establish it according to the laws of each state, or you can operate as an unincorporated association. In terms of cooperative governance, some state governments in the United States have performed very well, such as Wyoming and Minnesota.
Currently, the market the two most common forms of cooperatives are: consumer cooperatives and producer / marketing cooperatives.
- The owner is the consumer cooperatives purchase goods or services from the consumer cooperatives, REI, Navy Federal Credit Union and Pedernales Electrical Coop belong to consumer cooperatives;
- Owner producer / marketing cooperatives are commodity producers, co-workers on the processing and marketing of products, Sunkist and Dairy Farmers of America belong to the producer / marketing cooperatives.
It is worth mentioning that, although there are many similarities between the cooperatives and traditional enterprises, cooperatives, but there is a fundamental difference in the ownership / control and distribution of benefits and traditional enterprises, these differences are mainly the following:
- Cooperative owned and controlled by the members, rather than shareholders – co-leaders are usually elected by its members, who are users of products or services. And different companies, in the election of directors, the introduction of each member has one vote, rather than the number of shares held with voting rights.
- Depending on the number of return is assigned to members of cooperatives members – By contrast, in the enterprise, revenue is allocated according to the number of shares held by the shareholders to them. The use of cooperatives includes many activities, such as buying/selling goods from cooperatives or selling goods through cooperatives.
- Members of the cooperative is set up in order to receive services, not to get financial returns from liquidation event – with different shareholders, cooperative members want more services, such as building the market for a certain product, or perform a specified function. However, it is also possible to attract members to join the cooperative through incentives, such as providing members with some financial returns. For example, members can take advantage of cooperative purchasing power to obtain larger discounts. Regarding the financial advantages of cooperatives, we will explain further below.
- Capital is usually provided by members and debt holders, rather than equity investors – In general, the cooperative to raise funds in the following ways:
- Direct contributions through membership fees;
- By reaching an agreement with the member, withholding a part of the member’s net income according to the sponsorship;
- Keep a portion of the income from each product sale. But recently it has begun to explore a variety of other cooperatives financing mechanisms, such as the sale of preferred shares, preferred shares that is both debt and equity. Preferred stocks are considered debts because preferred stocks usually provide interest and can eventually be redeemed at face value, and preferred stock holders can also obtain certain other rights, such as pro rata rights and pre-emption rights Wait.
When analyzing whether encrypted tokens will be classified as “securities”, why does the “cooperative” model provide a useful framework?
“Ownership” involving cooperatives will not be considered securities.
On the cooperative ownership, the United States there are two more well-known cases, one is the United Housing Foundation, Inc. prosecutions Forman and the other is B. Rosenberg and Sons, Inc. sued St. James Sugar Cooperative case, Inc.’s. According to the final rulings of these two cases, U.S. law will not consider tokens that represent membership or similar ownership of stocks in cooperatives as securities. In both judgments, the court held that the ” stock “and not within the scope of the definition of securities.
In reviewing these two cases United Housing and B. Rosenberg prosecution, a legal industry commentator pointed out: “the” Securities Act “that members of the cooperative are unique, even though names and forms with the Securities somewhat similar, but by establishing the principle of cooperation The relationship is the real reason for the regulatory authorities to identify and exclude investment instruments from the identity of securities.”
In the United Housing lawsuit, the U.S. Supreme Court ruled that the “stocks” that give buyers the right to reside in a housing cooperative are not securities. The reason for this decision is partly because these “stocks” do not have the characteristics associated with stocks in the traditional sense, and these so-called “stocks” cannot be transferred to non-lessees , nor are they allocated based on the number of shares they own Voting rights, and more importantly-these “stocks” cannot appreciate. In addition, cooperatives do not want to seek and attract investors. On the contrary, they emphasize that the nature of cooperatives is ” non-profit .”
In the B. Rosenberg lawsuit, the U.S. Supreme Court ruled that the “stocks” in the cooperative marketing agencies were not securities, partly because such “stocks” were not transferable, did not pay dividends, and each member could only vote once. In addition, the court ruled that another reason for the present case “stock” is not securities, securities trading is considered to have a significant feature, namely: Investors only by the prospect of a third party efforts to obtain return on investment driven, but if the transaction is a purchase For a desire to “use the purchased goods,” the Securities Law does not apply to such transactions.
The U.S. Supreme Court referred to the ” Howey Test ” in both lawsuits and found that the investment in the cooperative did not reflect the capital investment in the joint enterprise (the profits of the joint enterprise were entirely derived from the efforts of others), and the development of the cooperative direction depends entirely on their own efforts to co-op members. In fact, the members of the cooperative have an appropriate degree of control over the organization (that is, the desire for profit depends on the efforts of the members themselves, not the efforts of others), so it also proves that the things they invest in are not “securities.”
If you want to know more about the judicial treatment of ” other people’s efforts ” in the Howey test, you can refer to Foxfield Villa Associates LLC’s lawsuit against Robben. This case also discusses the issue of limited liability companies (LLC) and some key conclusions of the Schaden Test. And usage actually applies to cooperatives.
Money may not need to encrypt network formally became cooperatives to benefit from favorable “treatment than securities.”
Cryptocurrency projects may not need to be merged into cooperatives in order to benefit from the favorable “non-securities treatment” provided to cooperatives by the court. In fact, encryption currency project may only need to have some of the elements to merge the cooperative structure, these elements make money selling on behalf of the economic substance of (economic substance) is similar to the economic substance of cooperative shares.
B. Rosenberg in the lawsuit, the US Supreme Court held that the scope of the word clear “securities”, it should first of all be ignored its name or form, but to focus on economic realities (economic reality). Courts and regulatory agencies often discuss and apply this principle in the context of cryptocurrencies. For example, when discussing cryptocurrencies, the US Securities and Exchange Commission official William Hinman once stated: “…I acknowledge that the Supreme Court has He admitted that if someone just for consumption and purchase of assets, then this probably is not an asset securities …… However, the economic substance of the transaction will always depend on the legal analysis, rather than a label. “
As we said in the previous article, this article is definitely not to provide a comprehensive legal analysis. If you think the structure of cooperatives is useful, you need to have a deeper understanding and discussion with lawyers who are familiar with blockchain laws and organizational structures. Others are welcome to join in and learn more about related topics.
How should token projects apply these lessons?
For the founding team of cryptocurrency projects that issue tokens, they should consider whether their organizations have enough functions to merge or have merged into cooperatives in order to benefit from this unique structure and “non-securities treatment”. In this case, the token holders will be entitled to membership in the network, a certain amount of interest in the use of cooperatives and / or other benefits. So, how do we use certain functions of cooperatives in cryptocurrency projects? In response to this problem, some brief discussions will be made below:
Democratization of decision-making
The democratization of decision-making can take the following two measures:
- Tokens allow holders to vote for the project’s management and board members;
- Tokens allow holders to vote on the protocol upgrade.
Many encryption currency network has allowed token holder is contributing to network management, decision-making power but these tokens are usually proportional to the number of holders of some tokens with their holdings, rather than giving each person / entity equal voting rights , Regardless of the number of tokens they hold.
Although there is a certain democratic decision-making, but when effective leadership election of the members of professional, cooperatives can still function effectively in their daily roles may be similar to company executives. If the founding team of a cryptocurrency project wants to continue to assume a formal leadership role, it can take the following methods, such as:
- He can serve as board positions by election;
- He can be held management positions by way of appointment;
- Can become a leading member of an informal cooperative.
Cooperatives may also need some form of KYC protocol, so that you can verify the user’s unique personality (KYC may also be effectively addressed other governance issues, such as Sybil attack).
Limit the transfer of tokens and focus on token utility, not price
Encryption currency project can transform organizational structure, you can begin marketing, this token holders will not only expect to profit by tokens, but you want to be excited to receive related services through the purchase of tokens. In addition, tokens should be non-transferable (except non-members of the cooperative but intend to use the services of people), this feature in fact been instances, such as DeFi insurance program Nexus Mutual, the project will be a number of decentralized Exchange (DEX) and automation Market maker (AMM) included in the white list, these decentralized automation market makers and exchange members only to authenticated transactions. Presumably, this model can expand liquidity as the network scale and membership base expand.
In the Union Housing and B. Rosenberg cases mentioned above, the U.S. Supreme Court held that the “stocks” representing the rights and interests of cooperative members are not securities, partly because these “stocks” cannot appreciate (at least not financially). And it can only be transferred to other people who actually use the services of the cooperative. But in reality, the value of the assets held by the cooperative is unlikely to remain stable, and changes in value will eventually be passed on to the members of the cooperative.
Another basis for judgment is whether it is possible for token holders to gain income from the behavior of “buying tokens”, but this is actually very easy to judge. The U.S. Federal Court has realized that the “stocks” of cooperatives are not necessarily a kind of securities. Although the value of the “stocks” of cooperative members may increase and make them profitable, the possibility of obtaining income may be the same as that of “members from cooperatives.” access to goods and services in the core purpose of “relevant. Not only that, the US Securities and Exchange Commission’s regulatory attitude in this regard is actually relatively clear. They have already sent ” no action letters ” to several cooperatives whose “stocks” have the ability to appreciate or depreciate. This also means that they will not deal with these institutions. Take enforcement action.
However, limiting the transfer tokens, tokens focus on practicality rather than price, does not rule out two things:
- An efficient trading platform for the cooperative society;
- Allow members to profit from participating in cooperatives.
For example, in DeFi Nexus Mutual insurance program in which there is a clause in the charter business requirement that: when considering the interests of all members, not Nexus Mutual profit before closure, but individual members can be achieved by Nexus Mutual transaction Profit from underwriting on the platform. On average, members who purchase insurance may experience losses, while members who choose to underwrite profits. Overall, the entire project did not achieve profitability.
Obviously, examples of Nexus Mutual description: relative to other assets, if the assets held by the cooperative itself has value (for example, cooperatives hold ETH, while the dollar prices have increased ETH), then the members can benefit from the collective.
According to the sponsorship of the token holders to the network, the proceeds will be distributed to the token holders
Many network encryption currency has been allowed to change this principle, such as tokens allow holders to be compensated by mortgage loans or tokens. In the cryptocurrency industry, one of the best examples of distributing proceeds to token holders based on their sponsorship of the network may be UMA ’s Developer Mining. In this case, development Participants can get rewards based on the total lock-up amount of the financial contract they designed. In other words, developers will be based on their use of the network to get the reward.
For cooperatives, the encryption technology actually provides an opportunity to improve the traditional way of sponsorship. For example, it is easier for the cryptocurrency network to track user behavior and timely launch tokens with inflation characteristics, aiming to reward those members who use tokens earlier.
Rely on financial contributions from members, debtors, preferred shareholders…and others?
Contributions by members of the cooperative (Crowdfunding “distant relative financing mode”), debt financing and the sale of preferred stock to raise funds, such as Nexus Mutual funds can be raised through the sale of its NXM tokens to members, these members can use these tokens to use intelligent contract, on the one hand can enhance intelligence coverage of the contract, on the other hand can also enhance market participation. However, financing methods similar to Nexus Mutual have not been tested in the United States, but it is encouraging that there are already some promising cooperation models that are leading innovation in the digital age.
Provide consistent project information disclosure
In determining whether to encrypt the money will be identified as “securities” this problem, disclosed to the token holder transparency and consistency of project information may be encrypted currency founding team is also advantageous, and provide consistent information disclosure project It is actually very convenient for open source encryption projects.
In 2012, Minn-Dak Farmers Cooperative successfully applied for a “No Action Letter” from the U.S. Securities and Exchange Commission. The lawyers of the cooperative believed that the reason why regulators agreed that Minn-Dak Farmers Cooperative was exempt from securities registration was partly willing to do so because they had already provide sufficient information to members.
In addition, the U.S. court will use the Schaden Test when assessing the ” efforts of others ” in the Howey test. One of the most important factors in this test is to see whether investors have ” access to information. ” Encryption monetary items disclose information more readily available, the easier it is to prove tokens are not “securities”, because the main purpose of the “Securities Act” is to protect investors by promoting full disclosure of the information needed investment decisions.
For further discussions on cooperatives and cryptocurrencies, please refer to the previous article ” Past, Present, and Future: From Cooperatives to Encrypted Networks ” by the author of this article, Jesse Walden.
The content of this article is for reference only and should not be used as a basis for legal, business, investment or tax advice. Regarding these issues, you should consult your own investment advisor. The references to any securities or digital assets in this article are for illustrative purposes only and do not constitute investment advice or an offer to provide investment consulting services.
