Should Gini Operate in the United States?
(The following article is adapted from a letter we prepared for the U.S. Securities & Exchange Commission.)
As we published in SEC Commissioner Says SEC Should Not Coddle American Investors and CFTC Begins to Crackdown on Cryptocurrency Scams, we are very happy to see the recent law enforcement actions against the egregious scams that have tarnished the blockchain / cryptocurrency industry. In fact, the entire reason Gini exists is to create a more stable, equitable, sustainable, and safe environment to help Gini stakeholders avoid being victimized by all these scams and market manipulations. So, there’s no question that we believe the SEC and CFTC serve an important role in the U.S. financial system; and a rational regulatory regime is certainly necessary to preserve the integrity of every capital market.
The people that are involved in Gini are thoughtful and respected engineers (e.g., from Cambridge, Harvard, etc.), academic scholars, and former executives of substantial companies with reputations that are beyond reproach. So, we are certainly not scammers and we know the importance of AML/KYC with respect to fraud-prevention, counter-terrorism financing and giving consumers clarity on the nature, risks, terms and conditions of any product or service. In fact, the entire Gini website is a humanitarian testament to our deep and authentic concern for the well-being of humans in the U.S. and around the world.
However, we are very concerned about the dark cloud of regulatory ambiguity that has enveloped the U.S. blockchain/cryptocurrency industry over the past year. Specifically, we do not want any legitimate blockchain/cryptocurrency project to be trapped in a twilight zone of regulatory uncertainty. This twilight zone often leads to over $100,000 in oppressive, wasteful legal and administrative expenses just to obtain an opinion from lawyers who themselves do not have any meaningful clarity about whether the SEC will or will not act against a particular cryptocurrency project. This regulatory ambiguity has led to an egregious waste of time, resources, and talent as millions of Americans meander aimlessly through a maze of regulatory uncertainty that is choking the life out of the U.S. blockchain / cryptocurrency industry today.
In contrast, regulatory agencies in Switzerland and Singapore have a much more explicit, clear and methodical approach, which is why they are now attracting more talent and capital for blockchain-based projects to their countries than the U.S. This will have far-reaching negative consequences for the U.S. as it falls behind other countries in the important FinTech sector. Rather than being trapped in the crude and never-ending “utility” vs. “security” token box, regulators in those countries have thoughtfully and rationally distinguished between equity tokens, debt tokens, cryptocurrencies, asset-backed tokens, token-based collective investment vehicles, and token-based commercial products that are bought/sold in commerce like any other widget, and thus, have nothing to do with the capital markets. Each of these manifestations of a blockchain-based token are clearly different; and thus, respectfully, they should be perceived very differently from a regulatory perspective.
The crude distinction between “utility” and “security” tokens is grossly inadequate because the concept of “utility” is often extremely subjective and the concept of a “security” is extremely broad and has many adverse consequences for a nonprofit company’s ability to survive under an avalanche of regulatory and compliance processes and expenses. As a U.S. Citizen, respectfully, I believe our government and regulatory agencies can do better than this; and SEC Chairman Clayton’s “they’re all securities” approach is already having adverse consequences on the competitiveness of the U.S. economy as the technical infrastructure of U.S. financial institutions falls behind their counterparts in other countries.
With those considerations in mind, please provide a definitive answer—and ideally, an official No-Action Letter—regarding how the SEC will perceive the Gini cryptocurrency based on the following facts so that we can have clarity about whether the Gini Foundation can safely operate in the U.S. or not.
- Gini will be managed by a nonprofit foundation and the software source code will be open source.
- The nonprofit foundation’s financial statements and software source code will be periodically audited by credible, well-known, third-party auditors.
- Unlike all other major cryptocurrencies, the Gini cryptocurrency money supply will be at least 95%-owned by the general public after the full distribution is complete. Additionally, we have ecosystem stability mechanisms to enforce and preserve broad distribution and ownership to prevent high concentrations of crypto wealth and power from corrupting the ecosystem.
- We have spent several years developing the principles and incentive structures associated with the Gini cryptocurrency to ensure that our team’s incentives are authentically aligned with the public interest. In fact, we believe the fundamental reason all the other major cryptocurrency projects today are so scam-infested and manipulated by crypto-whales is because their founders did not design their money supply distributions, incentive structures, consensus protocols, ecosystem governance systems and associated technologies to account for the dark side of human nature.
- All the major cryptocurrencies today are dominated by a tiny number of crypto-oligarchs, which is disgusting to anybody who wants to participate in an equitable and sustainable ecosystem. In contrast, the fundamental purpose of the Gini cryptocurrency is to eliminate all the fraud and manipulation that plagues many fiat and crypto markets today and to create a more equitable and sustainable system of value exchange between ecosystem participants.
- The Gini cryptocurrency will be used in the nonprofit Gini Store and within a unique ecosystem of like-minded stakeholders who appreciate the principles of ecosystem integrity, stability, equity and sustainability. With the Gini cryptocurrency, consumers will be able to buy goods and services just as easily as they can in other fiat-based commerce environments. Thus, from a purely functional perspective, the Gini cryptocurrency is no different than a loyalty program rewards system, or a credit card-based points system, or any of the thousands of public and private, perfectly legal, and unregulated currencies in circulation in the U.S. and around the world today, none of which are defined as regulated “investment securities”.
- By definition, a currency has utility as a medium of exchange, store of value, and unit of account. However, when any currency is initially produced and purchased from a mint or manufacturer (e.g., the nonprofit Gini Foundation), that purchase is simply a commercial transaction like the purchase of any other product or service. Whether the value of a private currency appreciates or not is incidental to its primary utility value and primary purpose as a medium of exchange, store of value and unit of account.
- Secondary Markets. After a product (e.g., a widget, baseball cards, cryptocurrencies, etc.) is produced and delivered to a primary consumer of that product, that product might be subsequently re-sold into a secondary market like eBay or Amazon Marketplace. However, that secondary market is a commercial marketplace of human participants directly interacting with one another, not a securities exchange. Thus, any decentralized marketplace software designed to simply connect people to one another in a safe and stable human market (not an HFT market), in which the decentralized software does not take possession or control of any stakeholder’s funds or currency as a custodian—that decentralized market cannot be reasonably defined as a “securities exchange”. Thus, respectfully, a decentralized market for any commercial product (lollipops, cryptocurrencies, etc.) cannot be reasonably perceived and regulated any differently than eBay.
- At a high level, the Gini project is no different than Ethereum or Bitcoin, which certainly are not securities. At a lower level, the Gini cryptocurrency product is being designed and manufactured with the following features (among others):
- Cryptographic digital signatures to prevent fraudulent transactions.
- Automated stakeholder node voting to achieve consensus-based transaction verification.
- Vote delegation to ensure voting quorums, which ensures broad-based transaction consensus and broad-based, democratic human consensus on major ecosystem governance issues.
- An innovative database structure to connect all transaction blocks in a linear, immutable historical chain, which achieves a unique combination of ledger integrity, high speed and throughput.
- Public ledger integrity that is computationally efficient to verify back to the genesis block.
- Built-in auditing mechanisms that simultaneously protect user privacy and allow authorized auditors and authorized government authorities to audit transactions as required by each country’s applicable laws.
- A database structure that enables the implementation of aggressive pruning, sharding, and snapshotting; these features ensure long-run scalability, meaningful decentralization, and high speed and throughput.
- Exceptionally strong and inherent resistance to “double-spend attacks,” “51% attacks,” “DDoS attacks,” and “Sybil attacks,” among others, which provides strong public ledger integrity.
We are working to build a minimum viable product (cryptocurrency) before we engage any general public stakeholders. However, there are many good reasons to distribute a cryptocurrency to a broad population of stakeholders as soon as possible; and those reasons have nothing to do with selling securities. In fact, distributing a currency and corresponding purchasing power to the largest population possible is essential to preventing unhealthy concentrations of wealth and political power in any ecosystem. Indeed, unhealthy and unsustainable concentrations of wealth and political power are what causes the rampant market manipulation, fraud and scams in many crypto and fiat markets today.
Every non-governmental organization must sell their products/services to generate the financial resources to be self-sustainable. This is true for all for-profit and nonprofit organizations. As a nonprofit organization, Gini generates revenue from donations and the sale of our primary product (a cryptocurrency) to stakeholders who want to benefit from its utility value (medium of exchange, store of value, unit of account; more stable, equitable, and sustainable ecosystem, etc.). Again, it’s easy to see that the Gini cryptocurrency product is not a security; it is just like selling any other widget that free-market participants want to buy, which produces revenue and cash flow that our nonprofit foundation needs to pay for further development of our unique technology and ecosystem.
Sale vs. Pre-Sale Transactions. Some people think there is a material distinction between the sale of a cryptocurrency that is already produced and the pre-sale of a cryptocurrency that is still in production, which will be delivered at a later date. They claim this somehow spawns a “security”. No, it doesn’t. As a manufactured product, there is no difference between the pre-sale of a cryptocurrency and the pre-sale of any other widget or product.
Thousands (Probably Millions) of Products and Services Are Pre-Sold Everyday. When a product is sold (or pre-sold), the company receives revenue from the transaction. In accrual accounting, if a product is pre-sold, the company credits their cash account and credits their deferred revenue account. (The matching debit entry is often ignored temporarily.) Then, when the product is delivered, the company debits their deferred revenue account and credits their revenue account. Nowhere in this process is there any notion of an “investment security”.
In fact, the pre-sale process is the entire business model of Kickstarter and many other similar crowd-funding platforms. Just like a customer would pay a private minting facility or a Kickstarter seller in advance to produce and deliver a carefully engineered coin(s) or widget as soon as possible at some point in the future, early Gini stakeholders will pay the nonprofit Gini Foundation in advance to produce and deliver a carefully engineered and quality-assured cryptocurrency (product) as soon as possible.
Pre-Sales Generate Receipts, Not Securities. Within the context of a pre-sale transaction, the buyers of the product (cryptocurrency) receive a receipt that confirms their proof of purchase. That receipt is issued to the customer as confirmation that the goods (cryptocurrency) will be delivered as soon as possible in the future. Then, the customer is protected by well-established consumer protection and contract laws, which provide clear rules and penalties for bad-faith merchants who commit fraud or commercial malpractice. In this particular regard, Gini is no different than any other nonprofit (or for-profit) merchant that pre-sells a product in exchange for cash, which is classified as a deferred revenue entry in its accounting books. Thus, such a transaction is an obligation (generally, a short-term liability) to deliver a product at some future point in time, not a debt or equity security.
The Possibility of Appreciation is Not the Definition of a Security. Whether a widget, lollipop, da Vinci painting, Gibson guitar or cryptocurrency that is offered to the general public appreciates in value or not is incidental to the underlying nature of the transaction: It is a commercial sales transaction in which a product is carefully engineered, purchased by a customer for cash and then the product is delivered as soon as it is ready to ship to the customer. There is no notion of an “investment security” anywhere in this process.
A Presumption of Speculative Intent is Not Universally True. One or more stakeholders might mentally say, “I want this product because it’s going to increase in value,” but many others will say, “I want this product because it has desirable utility value in the form of a more stable, equitable, sustainable, and intellectually stimulating ecosystem of like-minded stakeholders, which is far more meaningful and valuable to me than any other cryptocurrency project that I’ve ever seen.” Thus, any presumption that people would buy the Gini cryptocurrency only for speculative investment purposes would be a false and arbitrary assumption in many (probably most) cases. Regardless, speculative purchases are not the definition of a security, either.
Cryptocurrency Projects Can’t Have it Both Ways. I suspect many cryptocurrency project teams would rather ignore this entire discussion because they have been ignoring (exploiting) the complexity of these issues for years. However, they can’t have it both ways: Either their initial (primary market) cryptocurrency/token sales (“ICO”) transactions are structured as revenue, or debt (liability), or equity transactions. If they’re structured as equity/debt, then they’re IPO securities and should be registered with the SEC accordingly (Reg A/A+/S1) or exempted (Reg D/CF). In fact, there’s no need for a misleading new “ICO” label because any transaction that is actually structured as an equity/debt security is fundamentally no different from an IPO, which means the blockchain/cryptocurrency industry should stop pretending there is a difference in those cases.
Classifying Taxable Transactions. In contrast to an IPO of securities, if the transactions are classified and structured as revenue (e.g., the Gini Launch), then they’re taxable transactions within an income tax regime just like any other commercial transaction. If the projects are operating as for-profit entities, then they owe taxes on their sales. If they operate as nonprofit entities and can credibly substantiate their benefit to society, then the IRS should grant them a tax exemption as it does for over 1 million other tax-exempt nonprofits.
Bogus / Self-Serving Projects Should be Taxed as For-Profit Entities. There’s nothing wrong with for-profit projects, but if a project team claims to be operating as a nonprofit entity for the benefit of society, but they’re clearly operating for their own self-interest as evidenced by their sloppy management, little or no accountability, little or no transparency, misleading public statements, high concentration of crypto wealth in their own accounts (and their cronies’ accounts) relative to the rest of the ecosystem, etc. (as nearly all of them do today), then their tax exemption should be rejected and they should owe applicable taxes on all their cryptocurrency/token transactions.
Existing Consumer Rights & Anti-Fraud Laws Are Sufficient. If a project team elects to explicitly structure their crypto/token sales as debt/equity transactions with a stock purchase agreement and/or loan agreement with each of their stakeholders, then they should be regulated as securities and the terms and conditions of their contracts should explicitly grant the recipient ownership interests, profit-sharing rights, and/or creditor rights to the cash flows and assets of their organizations. If the transactions are not explicitly structured in that way, then they should be automatically classified and taxed as ordinary commercial transactions on a mark-to-market basis and existing consumer rights and anti-fraud laws are already sufficient to prevent/punish the most egregious scams and crimes.
Respectfully, when understood accurately, there is nothing fundamentally different about cryptocurrencies/tokens with respect to how a society should classify them between equity, debt (securities) and all other ordinary commercial products (commerce). Thus, there should be nothing fundamentally different with respect to how governments regulate and tax them. Within this context, the private marketplace should be allowed to determine the winners and losers within the cryptocurrency industry, the existing tax regime should be applied to ensure that project teams’ incentives are aligned with the public interest, and existing anti-fraud and consumer protection laws should be invoked to enforce justice against fraudsters on a case-by-case basis, as is necessary and customary in all aspects of any civil society.
Gini is Performing a Launch Event, Not an ICO. For all the reasons above, none of the intended use cases of the Gini cryptocurrency can be accurately defined as “investment securities”. Thus, it’s not accurate to classify any Gini cryptocurrency sales event as an “ICO”. Rather, it’s more accurate to describe the first time that Gini cryptocurrency is available to the general public just like a grand opening or the launch event of a popular store. That’s why we are performing a Gini Launch Event (“Gini Launch”) in early 2019, not an ICO.
In summary, we hope it is clear that Gini is creating and offering a cryptocurrency, not an investment security. Additionally and respectfully, when we sell (or pre-sell) the Gini cryptocurrency to the general public (after we’ve already demonstrated an enormous investment of time and resources that will be obvious to all stakeholders at that time), there should be no legal, ethical or public interest requirement to restrict the Gini Foundation with Reg D or Reg A+ or any other securities regulatory regime because the Gini cryptocurrency is not an investment security. To force us to conform to a costly, time-consuming and deeply frustrating regulatory regime that is unnecessary to achieve the SEC’s public policy goals would be substantially unlawful and would severely diminish the purpose and progress of the Gini Foundation if it is based in the United States.
Several Gini team members are U.S. Citizens; so, it would be much easier for us to stay in the U.S. and showcase the Gini Platform as a shining example of the kind of quality and integrity that the U.S. cryptocurrency industry can produce. However, if the SEC does not provide a No-Action Letter or some other concrete and permanent assurance that the Gini cryptocurrency is not going to be falsely classified as an investment security, then we will be forced to operate in other jurisdictions. That would be a significant loss for millions of Americans who would then be unreasonably blocked from participating in the Gini ecosystem. It would also be a significant step backward for the entire blockchain/cryptocurrency industry.
The Gini Team
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