Bitcoins

Satoshi was a Copycat and Maybe a Criminal

Capital Markets, Investors, Technology ,
Satoshi was a Copycat

When I started looking at bitcoins and cryptocurrency in 2015 I was already 65 years old.  Many of the early adopters and proponents of bitcoins were in their 20s and 30s.  Even today most BTC enthusiasts are shocked when I tell them that there was a popular digital currency a decade before Satoshi wrote his famous paper.

In 1999, at the tail end of the dotcom era, two aspiring entrepreneurs named Spencer Waxman and Robert Levitan launched a digital currency called flooz through their website called Flooz.com.  They promised that flooz would disrupt the new online retail industry and become the preferred medium of exchange for shoppers and merchants worldwide.

Flooz was backed by a lot of VC investors to the tune of $35 million. It had a celebrity spokesperson, Whoopi Goldberg, who appeared in radio and TV ads and in newspapers and magazines. Her face adorned the sides of NY transit buses, hawking flooz as the future of currency. Does any of this sound familiar?

A significant number of retail customers loved the whole idea. More than 125,000 new accounts were opened in the first 90 days.  In the first 12 months, roughly $25 million in flooz currency was purchased and used.

Flooz customers would sign up to Flooz.com. They would purchase flooz certificates for specific retailers, which they could then use themselves or pass along to a gift recipient via email. Because the flooz certificates did not fluctuate in value no one ever thought that these were securities or that they needed to be regulated in any way.

This helped the retailers build traffic in the new internet marketplace and a variety of names you would know signed up. You could buy chocolates from Godiva, cookies from Mrs. Fields, and clothing from J. Crew. Tower Records, Barnes and Noble and Starbucks signed on. You could buy Swiss Army knives, all kinds of delicacies to eat, and cigars to smoke.

There was an expanding group of retailers and continuing adoption by a fast-growing customer base. Notwithstanding the company filed for bankruptcy and went out of business within 2 years.

Business school students spend hours poring over the case studies of businesses that succeed and an equal time studying businesses that failed. The dot-com era gave us plenty of both.

The dot-com era, for those of you who were not there, was a heady time when arrogant VCs tried to put lipstick on every pig of a company that came along as long as the company’s business plan included the “internet”. If you replace the word “Internet” in that last sentence” with “blockchain” or “crypto” the similarities to what is occurring in the marketplace today will become obvious.

One of the great failures of the dotcom era was a company called Pets.com.  Its business model, selling pet food and pet supplies directly to consumers made a lot of common sense. Consumers spend a lot of money in this market every year. People who purchase pet food are usually repeating customers, month to month.  

There is also the fact that home delivery of a 20lb. bag of dog food made a lot of sense to people who were loading them into and out of the trunk of their cars every month.  Capped off by the fact that Pets.com actually charged less than most brick-and-mortar pet supply stores, this one had all the makings of a winner.

There were several VCs invested in this. One of the early investors was Amazon.com.  Amazon was still selling mostly books at that time. Pets.com sold far fewer distinct products. Amazon felt that with fewer products to sell, it could lend Pets.com logistical support.

Like Flooz, Pets.com had a large advertising budget and a celebrity spokesperson, in this case, a canine sock puppet. The spokes-puppet was everywhere, on the Today Show, the Tonight Show, and at Macy’s Thanksgiving Day Parade. There was even a Superbowl ad.

The company went public in February 2000 raising more than $80 million. The venture funds made a profit but the investors in the IPO lost big.  Nine months later, Pets.com closed its doors and liquidated.

The problem was that Pets.com never made a profit. It hemorrhaged money both before and after the IPO.  Its low prices, coupled with the fact that it absorbed shipping costs on those big bags of dog food and the fact that it spent a lot on its advertising campaign, meant that the company lost money on every order.

Why would an underwriter take a company public if it was losing money?  Why would the underwriter price the offering at $11 per share when that valuation was a fantasy? That is the question no one asked at the time. 

The answer was that the VCs and the underwriters were in bed together. Each IPO made a lot of money for both.  It was actually a con game. VCs invest in each other’s portfolio companies, bumping up the valuations with each round, hoping for an IPO to dump the grossly over-valued shares on the public.

Historically, at least since Ben Graham, earnings were the metric by which a stock’s price was judged. That began to change in the 1980s junk bond era.

Junk bonds were issued by companies that lacked the cash flow to make interest payments on bonds with lower interest rates. They promised that the infusion of cash would spur their growth to the point that they could make higher interest payments. Very few actually did. 

Carry that forward 10 years when research analysts at the big Wall Street firms underwriting the dotcom stocks started to value growth over income. They claimed that the new internet era required new metrics.

I asked many of the analysts, including several I cross-examined under oath if they had ever seen the idea that growth should supplant earnings as a metric in the valuation of a company in a peer-reviewed journal. I never got an affirmative answer, nor would I have expected to get one.

Then, as now VCs are self-serving con artists. The valuations they spit out mislead investors and are part and parcel of a scheme to defraud them.

Venture capital is a marginal activity in the capital markets. In many ways, the JOBS Act has made what they do obsolete.  Raising seed or growth capital has never been easier or less expensive. Unfortunately many people in the Reg. CF space have adopted the VC pricing model and mislead even the smallest, most inexperienced investors.  

There is one more thing about flooz. Before it closed its doors Flooz.com it was notified by the FBI that as many as one in five of its gift cards had been purchased by Russian mobsters using them to launder money. The same is clearly true about bitcoins.

My early investigations into BTC in 2016 produced reports of Australian law enforcement officers seizing $12 million in BTC from a human trafficking ring. That was followed by several thousand ICO offerings that raised multiple billions of dollars from unsuspecting investors and just disappeared.

Flooz was a template for the crypto crimes that are running today up to and including FTX.  People who tell me that I don’t understand crypto as the future of currency and finance never mention flooz. As far as the future of crypto as a currency is concerned, if you don’t know flooz, you don’t know squat.

The crypto con game follows the flooz game plan right down to the Superbowl ads and celebrity endorsements. The end game is the same, dump crypto onto small, uninformed investors.

I will continue to blow my whistle at Fidelity Investments which is trying to legitimatize BTC for retirement accounts. I have read the research reports that support that recommendation. They would make the worst of the dotcom era analysts blush. Fidelity was still claiming BTC is a superb store of value after the price dropped from $60 to $16.

Fidelity isn’t buying and then selling BTC to make a legitimate spread. They have been mining BTC since at least 2014.  They have a minimal cost basis on each bitcoin that they are selling at $20,000 each.

Markets run in cycles. There was a tech boom and bust in the 1960s that coincided with our race to the moon.  There were companies back then raising capital for the next shiny new tech products.

There were certainly scams and certainly victims of those scams. But nothing that had the power and reach of the internet and social media to falsely pump up valuations and make a lot of people believe them.

Perhaps the biggest red flag is Satoshi himself. There are people who worship at his feet. There are people who call him a modest genius who shuns the limelight. They refer to Satoshi as someone who changed capitalism forever.

Will Satoshi come out of the shadows if he gets a Nobel Prize for his achievement? Will he fly to Stockholm and humbly thank his mother for pushing him to study and his mentors for inspiring him to think?

Personally, I think Satoshi is a construct of Russian oligarchs who created a system to launder their money and a narrative to legitimize it. Satoshi’s paper came about only 8 years after Flooz.com shut down.

Am I being too cynical?

Actually, I am just following the money. Un-named “whales” dominate the market bitcoin trading market. It is certainly plausible that bitcoins were created by mobsters as a way to launder their money and not the other way around.

Besides, I would rather think of Satoshi as an international criminal than a shy, misguided genius.

It’s the romantic in me. 

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Fidelity’s Folly- Part II

Capital Markets , ,
bitcoin

I stopped writing about Bitcoin (BTC) in October 2020 because by then most people realized that, as an investment, BTC is foolish at best. My last article on the subject was about Fidelity Investments which was an outlier because it was a cheerleader for cryptocurrency.

At that time Fidelity was proposing to allow its brokerage customers to keep their BTC in Fidelity’s custodial “vault” and see their holdings valued on their Fidelity statement.  I suggested then that by just taking custody of its customers’ BTC, Fidelity might be considered a “facilitator” of its purchase.  Adding crypto holdings to the statement of mainstream investments might give people the idea that BTC is a mainstream investment, which it is not. 

Predictions

By October 2020 most of the predictions made by BTC self-styled experts in 2016-2018 had failed to come to pass. Banks had not been disrupted.  The US dollar and other fiat currencies were still accepted virtually everywhere. There was not a BTC ATM on every street corner.  No real change in the world banking system was on the horizon. Much of the hype in 2020 came from the same people who had been hyping BTC since 2016 and earlier.

My article was in response to a report published by Fidelity’s Director of Research that suggested that BTC was a “potentially useful” asset for “uncorrelated return-seeking investors”. The report said that “in a world where benchmark interest rates globally are near, at, or below zero, the opportunity cost of not allocating to bitcoin is higher.”   

Stock brokerage firms that merely execute their customers’ orders to buy and sell owe very little duty toward those customers. They are expected to handle the execution and bookkeeping by industry rules and practice, but little more.  Consequently, these “discount” brokerage firms have little liability if a customer loses money because they invested incorrectly. 

The report from Fidelity’s Director of Research in 2020 further suggested that bitcoin’s market capitalization “is a drop in the bucket compared with markets bitcoin could disrupt.” As I noted at the time, that report certainly sounded to me like a “buy” recommendation for BTC.

When a stock brokerage firm issues a recommendation more rules come into play. There must be a “reasonable basis” underlying the recommendation.  The rules governing research reports require more than a crystal ball look into the future.

Get Rich Quick?

Then as now, there is no real data about BTC for anyone to research. You cannot analyze BTC in any traditional way. They are merely a few lines of computer code, generated by a computer.  You can plug in and get rich but that is not going to disrupt the global banking system. 

Fidelity’s Director of Research based his recommendation to buy BTC, not on facts, data, or any traditional analysis, but rather on his speculation that BTC would result in a titanic disruption in the global financial system.  And that is what BTC is, not an investment but speculation. 

That fact is important because last week Fidelity announced that beginning mid-year it will permit financial advisors managing 401(k) retirement plans to invest in BTC as well.  Fidelity has about 23,000 of these advisors on its platform. If only 10% of those purchase BTC in the amount of 10% of the funds they are managing, the price of BTC is likely to sky-rocket.

Congress created 401(k) plans under the Employee Retirement Income Security Act of 1974 (ERISA).  Managers of ERISA plans are held to a fiduciary standard and are expected to invest the funds entrusted to them as a “prudent” person would. No one considers speculation in a retirement account to be “prudent”.

DOL Says NO

Congress assigned regulation of these retirement plans to the Department of Labor (DOL). There are about 800,000 different private pension plans in the US covering about 140 million people. Total assets held by these plans exceed $10 trillion, so it is pretty easy to understand that this is a big business. 

Fidelity has been planning this move for some time. It has been inching up to accepting crypto in 401(k) accounts for at least 2 years.  What is interesting here is that just about one month before its announcement, the DOL essentially told Fidelity, and all ERISA account advisors, not to purchase crypto in 401(k) accounts.

On March 10, the DOL issued Compliance Assistance Release No. 2022-01(CAR) on the subject of “401(k) Plan Investments in “Cryptocurrencies”.  The DOL is aware that firms were marketing investments in cryptocurrencies to 401(k) plans as potential investment options for plan participants.  The CAR lays out the DOL’s reasoning why cryptocurrencies do not belong in retirement plans.

The first reason the CAR lists is because an investment in cryptocurrencies is highly speculative. Highly speculative investments are never prudent for a 401(k) retirement plan.

No one asked Fidelity to respond to the CAR, but they did.  In this case, we get a rare glimpse of Fidelity’s rationale supporting this bold move to offer BTC to ERISA accounts and account managers. 

While Fidelity says that it understands that the CAR “effectively deems the selection of cryptocurrencies for investment in a 401(k) plan to be imprudent” it suggests that the DOL can’t possibly mean ALL cryptocurrencies. Fidelity suggests further study and guidance for the DOL as to which cryptos may be OK for 401(k) plans and which are not.

Notwithstanding its request for more clarity and its request that the CAR is withdrawn, Fidelity’s response can only be read as an admission that it understands the DOL means that crypto of any kind does not belong in a 401(k) or any retirement plan.

Fidelity also argues that it is not specifically designating BTC or any crypto as investments that they are offering to these plans. If a plan manager wants to add some BTC to the portfolio, Fidelity will guide the manager to a different landing page, where the purchase will be made through a different Fidelity company, not the ERISA plan funnel.

That argument is unlikely to hold water as what the DOL was complaining about in the first place, was people marketing crypto to these retirement plans. However Fidelity books these trades, it is still Fidelity’s cheer-leading for BTC that is causing those trades to occur.

To be clear, even though the primary regulator of these 401(k) plans has said no, Fidelity has gone ahead and decided that it will facilitate the purchase of BTC in these accounts. The lawyers and compliance officers who gave Fidelity the green light, need to stand up and explain themselves.  

In its most recent research, (April 2022) Fidelity asserts that BTC is an “aspirational store of value”. Fidelity’s argument for BTC is specious at best, but that does not matter. In that report, Fidelity specifically acknowledges that BTC is a speculative investment. Notwithstanding, Fidelity continues to target retirement fund administrators with positive commentary about BTC.

I would suspect that the DOL was addressing Fidelity when it issued the CAR.  As any lawyer will tell you, Fidelity is essentially telling the regulator to shove it. Fidelity knows that the CAR has not been withdrawn.  In my experience, regulators hate to be ignored. 

I also suspect that the DOL has a contingency plan for this. It has already gotten support from the AFL-CIO which has specifically and publicly supported the issuance of the CAR. The CAR alone will dissuade some of the fund administrators Fidelity is targeting, but Fidelity apparently intends to offer crypto to any retirement account that wants it.

The DOL also has the benefit of several US Supreme Court decisions that support the idea that ERISA accounts require “prudent” investments and that plan fiduciaries need to help eliminate “imprudent” investments.  As Fidelity can be shown to be trying to influence plan administrators to purchase imprudent investments, some courts might just agree that Fidelity has stepped into a fiduciary relationship with the plan investors.     

I suspect that any court that looked at the facts presented here might support a cease-and-desist order against Fidelity. I would not be surprised if it came from the securities regulators in Fidelity’s home state of Massachusetts.   

I cannot for the life of me figure out how Fidelity got itself into this mess. Fidelity enjoyed a reputation as a company that sold mutual funds to mom-and-pop investors. There are more than 25 million people in the 401(k) plans that Fidelity services. Why would Fidelity go against the DOL for the right to sell highly speculative investments that most of those people would never want in their retirement plan?

Sooner or later, I suspect someone will write a book about Fidelity’s attempt to put lipstick on the pig that is BTC and pawn it off on retirees.  The SEC has been threatening to hold compliance directors responsible for allowing practices that harm investors. If Fidelity moves ahead, as I suspect this would be an ideal opportunity for the SEC to make a statement and demonstrate that they are serious and ask the compliance director at Fidelity to explain himself.

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Fidelity’s Folly: Bitcoins for All?

Capital Markets, Investors, Law , ,
Fidelity

Fidelity Investments

People keep asking me what I think about Fidelity Investment’s announcement that it will act as a custodian for bitcoins and other cryptocurrencies. As anyone who follows me knows, I don’t think very much of it at all. 

Fidelity has made it clear that it is “all in” on cryptocurrency. Its website notes that: Fidelity Investments “operates a brokerage firm, manages a large family of mutual funds, provides fund distribution and investment advice, retirement services, Index funds, wealth management, cryptocurrency, securities execution and clearance, and life insurance.” 

Fidelity would certainly wish to expand each of those profit centers. With bitcoins and cryptocurrency there is the potential for enormous growth if Fidelity can turn them into just another “investment”. It can’t, even though it is trying very hard. 

Just last week, Fidelity’ Director of Research published a report that suggested that bitcoin is a “potentially useful” asset for “uncorrelated return-seeking investors”. The report said that “in a world where benchmark interest rates globally are near, at, or below zero, the opportunity cost of not allocating to bitcoin is higher.” 

Please do not be impressed with that gooblygook. There is no real data about bitcoins for the Director of Research to research. You cannot analyze bitcoins in any traditional way. They are merely a few lines of computer code. This report is reminiscent of the type of justification that analysts gave in the dotcom era for supporting stocks, with no income, trading above $100 per share. 

The report further suggests that bitcoin’s current market capitalization “is a drop in the bucket compared with markets bitcoin could disrupt.” That certainly sounds like a “buy” recommendation to me.

The primary markets that bitcoins might disrupt are banks. In truth, bitcoins, when used as payment in commercial transactions, disrupt nothing. Banks and banking are not going away.   

If you consider how many payroll and Social Security payments are already deposited directly to recipients’ accounts and how many of those recipients pay their electric power or insurance company “on-line” it is fairly easy to see that converting the deposit to bitcoins before you make the payments is an extra step not likely to find favor.  

The one thing that will cause the current price of bitcoins to appreciate is a lot more investors willing to buy them and hold on. That is the strategy being pushed by Fidelity with the blessings of “pseudo” market professionals. 

Last month, Fidelity stated that it had polled a number of the “professional” fund managers and investment advisors who are currently its customers.  Apparently enough advisors would consider bitcoins for their advisory clients to warrant Fidelity acting as a bitcoin custodian. 

Some number of advisors who already use a Fidelity platform will certainly purchase some amount of crypto currency for their clients’ accounts.  That “professionals” are buying bitcoins is likely to be used by Fidelity as a reason to advertise them to average, small investors as “what the Pros” are buying. 

In 2 years, Fidelity may have many billions of dollars’ worth of bitcoins held in accounts on its platform. That will not make it the right thing to do.

Law and Economics, which I taught back in the 1990s, studies how our interwoven markets interact with the laws that regulate them. Judges interpret those regulations, often influenced by what they perceive the regulators intended to accomplish.

The regulations that govern our financial markets (equity, debt, currencies and insurance) have evolved over the centuries with the markets that they regulate. The introduction of something as novel as crypto currencies into the financial markets should be expected to suffer some adverse legal consequences. 

As a matter of law, every Registered Investment Advisor (RIA) and anyone investing other people’s money is held to a fiduciary’s standard of care.  Fiduciaries are usually required by law to: 1) act in the best interests of their clients, 2) preserve and protect the assets entrusted to them and, 3) when investing to act as a “prudent” investor would act.

A fiduciary’s duty to its client or beneficiary is a much higher standard of care than in any ordinary commercial transaction. To satisfy that standard often means taking “extra” care to mitigate obvious risks.

Fiduciaries become fiduciaries when people trust them to hold their property or to act on their behalf.  People most often trust fiduciaries because they have specific expertise in the matter at hand. Both fund managers and RIAs fit that description. Both are held to a fiduciary’s standard of care and their conduct is most often judged against that of other experts in their field. Most investment professionals will never purchase any crypto currency for their clients.

Fidelity, the fund managers and RIAs who do purchase bitcoins and store them at Fidelity obviously believe that the price of bitcoins (currently in the range of $10,000 a piece) will appreciate and perhaps double or more.  It is certainly possible this could happen.  Two years from now the price of a bitcoin might have risen to $20,000 each and possibly higher. Many of the bitcoins held at Fidelity will have been purchased at close to that amount.   

Let’s assume that for some reason or another, in a 90-day period, the price drops back to $10,000 each.  That could result in several billion dollars in actualized losses as some will “hold” all the way down in hope of a rebound.  Does Fidelity shoulder any liability for these actualized losses?

The Fund Managers and RIAs certainly do. Unlike most litigation, where the burden of proof is on the plaintiff, in many states, fiduciaries are required to demonstrate the reasons that they made the offending investments.  Much of the case will be dependent upon what the advisors can show were their reasons for buying bitcoins in general and also specifically on the day and at the price that they did. They will also have to demonstrate why they held on as the price deteriorated.

Given that there are no fundamental reasons for purchasing bitcoins I suspect that most will try to defend themselves arguing that bitcoins are a hedge against adverse results in the rest of the portfolio. That argument is likely to fail. 

Bitcoins are, after all, a commodity, and putting aside the fact that most RIAs are not trained or licensed to sell commodities, gold would be a more accepted hedge if that is what the RIA wanted to do. If nothing else gold is unlikely to lose 1/2 its value in a short period of time, which bitcoins have already demonstrated they can do. 

Litigation

Fidelity’s role as a platform or clearing firm might save it in Court but these customer claims are more likely to be heard by arbitrators appointed by FINRA, especially if Fidelity is named as a respondent. I have been an arbitrator and argued many cases in front of others. They are more likely to be older and their view of bitcoins will probably be closer to Beanie Babies, than as a new form of currency that trades in a very opaque market. 

Fidelity

Two recent cases brought by the SEC will not help Fidelity’s defense either. The first is SEC v. ICO Box, where the SEC alleged that the platform “facilitated” the sales of more than 30 different crypto currencies. “Facilitated” is a word that will make defense lawyers crazy. 

By the time that these claims get to a hearing I suspect that complaining customers will be able to present a banker’s box or two of “reports” written by Fidelity that suggest that RIAs purchase bitcoins for their customers. That should certainly be viewed as a “facilitation”.

The other case is called SEC v. Lorenzo.  Lorenzo was charged with copy and pasting an e-mail written by someone else and sending it to prospective investors. The SEC alleged that Lorenzo “disseminated” misleading information in order to make the sale. Given the outrageous claims made by many in the bitcoin world, some Fidelity employee is more likely than not to resend a report or article that Fidelity cannot defend.

The mutual fund industry, Fidelity’s core business, is under great stress to lower the fees it charges investors.  For all the BS that you may hear about how Fidelity’s actions in embracing crypto is “cutting edge” or “visionary”, it makes more sense that Fidelity is touting crypto to make up for revenue lost elsewhere.

If you’d like to discuss this or anything related, then please contact me directly HERE

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Two Years of Crypto Market Memories

Capital Markets, Issuers, Law , , ,

I first looked at bitcoins in the Spring of 2017 because a friend asked me for my thoughts.  The price of a single bitcoin had run up sharply and the ICO craze was proceeding at full speed.   Up until that point I knew very little about either blockchain or cryptocurrency. 

I spoke with people who were actually developing blockchain projects for the big tech companies. I read a lot of articles which they thought would help me and a lot of other articles that I found through my own research. I spoke with traders, regulators, and with a lot of people who thought that they had cryptocurrency all sorted out.  There seemed to be a wide spectrum of thought about cryptocurrency, how it might be regulated (if at all) and whether it would augment or supplant the established financial order.  

I concluded that the bitcoin market was in a classic bubble, the price rising only because of hype, and the new money that hype always attracts. I was not alone in that opinion.  Still some intelligent sounding people were making an argument for continued price appreciation to ridiculous levels.  And that was what a lot of people wanted to hear. 

I wrote an article about my research, my thoughts and predictions for bitcoins.   https://laweconomicscapital.com/2017/06/the-bitcoin-bubble/   The article got the attention of a lot of people who were also trying to understand cryptocurrency and ICOs.

The article ends with an invitation to the securities lawyers who were writing the disclosure documents for ICOs to contact me for a professional conversation.  I would have had difficulty preparing those documents.  I confessed my professional curiosity to any and all that might satisfy it. 

A lot of lawyers and other professionals did contact me.  Many of the lawyers were doing what lawyers are supposed to do, marshaling the facts and applying the law as they saw it.  But it was clear that there was not a unified position as to what the facts regarding any cryptocurrency actually were. 

Some lawyers approached ICOs as if they were issuing securities and some as if they were issuing anything but securities.  Before the SEC issued its DAO Report, (July 2017) I was of the mind that a token offering might be structured so as not to be a security. Once the DAO Report was issued, it was clear to me that the SEC saw tokens as securities and would look at an ICO as the sale of securities with all that entailed.

The DAO Report led to a robust discussion, on line and off, with those same lawyers and professionals and more.  The discussion became somewhat convoluted as many non-lawyers often in other countries felt comfortable discussing the finer points of US securities law. A great many of those commentators had interesting takes on the Howey decision that no competent US lawyer would ever present to a judge.  Many of those “experts” just ignored the dozens of other cases cited by the SEC in the DAO Report and many other cases that should have been germane to the discussion. 

There was an interesting undercurrent of lawlessness in the cryptocurrency world.  It was impossible to search for articles about cryptocurrency without coming across many quoting regulators around the world who were reporting cases of money laundering and fraud.  That has not changed.  Fans of cryptocurrency were often happy to ignore these transgressions even though it was obvious that regulators would not.

By now I have read several hundred white papers for ICOs. Some were written by lawyers; other white papers were written by either monkeys or idiots. Some of the latter were using templates because the thought of actually hiring a lawyer to prepare documents for a multi-million dollar financing did not make sense to them.

These white papers are supposed to tell potential investors what they needed to know so they could make an informed decision whether or not to send their money.  That was rarely the case. I recall one white paper where the principals of the firm refused to disclose their last names. 

People were claiming to have advanced degrees they never completed and to have worked at firms where they were never employed.   Quite often, outrageous claims were made about the size of the market to be served and the profits to be made.  If these same founders had been sued by investors in a prior company for fraud, investors in this new company would never hear about it. 

I had my bio and picture hijacked and included in a white paper. So did many other people.  There was no way for any investors to know if what they were being told was true.  Very often, it wasn’t.

These ICOs were being sold by networks of unregulated, self-validating crypto “experts and advisors”.  They traveled in packs to frequent crypto conferences around the world.  They cross-validated each other in articles on websites that had popped up and which reached many thousands of people around the world. Some crypto “experts” developed 6 and 7 figure lists of social media followers.

An issuer could engage any number of these crypto gurus and just pay them in the tokens to be issued.   The “advisors” would notify their followers about the token sale and urge those followers to cough up real fiat money to buy them.  Along the way the advisors were selling tokens that they had gotten for nothing in exchange for their sales efforts.  

Several otherwise intelligent people tried to convince me that this was not just a dressed up pump and dump scheme playing out over and over again. The results were certainly the same because most people who bought the tokens in these ICOs were left holding the bag.

A significant number of the ICOs were out and out scams which, sadly, many people refused to see.  Fifty million dollars raised here; one hundred million there, all going down the toilet of financial history.  It got so bad that several of the large social media platforms banned ads for ICOs. Several countries banned the sale of ICOs altogether.

Many of the ICOs claimed that they were not selling securities but “utility” tokens instead.  That died down significantly after the SEC published its Cease and Desist v. Munchee toward the end of 2017.  https://laweconomicscapital.com/2017/12/sec-v-munchee-will-the-crypto-currency-community-listen/

Along the way some really bright lawyers thought that ICO offerings might be structured as SAFTS. I saw it as an attempt to solve a valuation problem by promising to set the value down the road.  They were touted as making the ICO market less risky. To me they looked to be a riskier “derivative” and began to write an article that said so. But I never finished that article. 

In short order one of the NYC laws schools published their research and pulled back the curtain on SAFTS. After that most securities lawyers stopped talking about them.  SAFTS were a financial flash in the pan and not a very good one at that.   

I also had conversations with a number of groups that wanted to develop a realistic scheme to regulate ICOs and cryptocurrency trading across borders.  Each failed because most of the participants had never worked at or had dealt with any market regulator.  I wrote e-mail after e-mail trying to explain that transparency is only useful if everyone in the market was honest and that without significant penalties for dishonesty no regulatory scheme can work.  All that fell on deaf ears and each of those groups disbanded.

I also spoke with several people who wanted to create trading platforms for cryptocurrency but most of whom had no idea what a trading platform does or how it operates.  I would ask questions like: What would be the minimum standards for listing on your trading platform?  It was apparent that they had not even worked out that simple, basic and necessary issue. When I asked about market-makers and liquidity I got a series of blank stares.

Today, at least in the US, most lawyers have accepted the fact that any ICO sold here will be the issuance of a security and that US securities laws will have to be followed.  

To sell securities to investors in the US the securities must be registered with the SEC or specifically exempt from the registration requirement.  Registration is an expensive and often lengthy process. By mid-to-late 2017 a number of lawyers were reporting that they were filing registration statements for ICO offerings with the SEC. Apparently, many never got approved.

Securities offerings in the US do not have to be registered if they comply with regulations which provide guidelines for un-registered offerings. Un-registered offerings are generally sold only to institutions and wealthier investors who have no real interest in owning crypto currency.  These unregistered securities are not intended to be traded.

More than one lawyer has reminded me in the last few months that unregistered securities can be transferred after 12 months if the company is putting financial information into the market or if the tokens are listed on a crypto exchange outside the US.  I am not certain that they have thought that idea through.

Investors in an unregistered offering in the US are usually required to attest to the fact that they are making a long term investment and not intending re-sale.  That is why most companies in the US that sell unregistered securities provide those investors with income from dividends or interest.   So if you are selling unregistered securities with the promise of liquidity and re-sale, you are likely to confuse everyone, except perhaps the judge who will ultimately set you straight.

Companies from around the world have always wanted to tap the US for capital investment.  It is often a difficult process for any company and especially for start-ups and smaller companies.  In the ICO market, it became apparent that political borders and local regulations were not considered to be important by the issuers.

Investors who should have seen the shoddy disclosures as a problem seemed happy to invest, convincing themselves that if the offering “complied” with the laws of the country of origin, then protections afforded to them by US law were unnecessary.   A lot of people who were touting blockchain because it was supposed to promote transparency were willing to invest in crypto offerings that provided none. 

Today, people are spending money to “tokenize” real estate, fine art and many other tangible items as if there was a market for those tokens or if it made any sense to create one.  If I can buy 1/10,000,000 of a Picasso, do I get to hang it over my fireplace for 20 minutes? 

If you are selling shares in a building that you call “tokens” and tell me that you believe that all of the laws pertaining to real estate syndications would not apply, I would suggest that you really need to re-think what you are doing.  There are established rules for selling “asset backed” securities in the US.  Not surprisingly, most of the articles I read about “tokenizing” this or that fail to mention those rules and most of the people with who I am now speaking who are preparing to “tokenize” this or that offerings do not seem to be considering them.

Back in 2017 a lot of regulators told me that the ICO boom came upon them suddenly and that they did not have the staff or budget to deal with them.  They do now and there is every indication that the leniency some regulators have exhibited is about to come to a screaming halt.  

Bitcoins, BS and Banking

Capital Markets , ,

I do not believe in Bitcoins because the whole idea behind them smacks of alchemy. For centuries, going back to classical Greece, people believed they could turn lead into gold. A great many, otherwise intelligent people spent a lot of time in this pursuit from the Middle Ages into the 20th Century.

In the latter half of the 19th Century people believed that the new Industrial Age would come up with a mechanical contraption to solve every problem. There were people peddling mechanical contraptions which claimed that you could put a lead bar in one end and a gold bar would come out the other. The process or internal workings of the machine were not disclosed and they became known generically as “black boxes”.

Today, thanks to new technology, you can buy a machine, plug it in and every so often it will send a few lines of computer code to an electronic wallet. You can then exchange that code for a lot of cold hard cash.  That is exactly what a Bitcoin is, just computer code that can be replicated by a machine. They may have value today; but sooner or later those lines of computer code are more likely than not, to become worthless.

For these lines of code to retain value people must be willing to buy them after they are manufactured. As the price increases, more and more people will likely start manufacturing them especially if the next generation of machines are more efficient or cost less.  Sooner or later there will be more code in the market than the market wants and the price will drop. That of course is just basic economics.

Basic economics is something that is often absent from any discussion about crypto-currency. It seems that many people who support crypto-currency, who are passionate about it and who are absolutely certain that it will prevail and disrupt the world are people who have technical backgrounds.  Some of those who are most adamant in the defense of crypto-currency have backgrounds in totally unrelated fields. They gained their insight into finance by having a credit card or reading economic theory in magazine or blog articles.

Most economists, including a Nobel Prize winner or two and most people who have worked in finance or banking dismiss crypto-currency as a fad.  On more than one occasion, a negative pronouncement by someone with stature in economics or finance has led to the crypto-enthusiasts mocking economics, economists and anyone who has worked in finance.  More than one has suggested that I and others are just too old to understand the new Blockchain technology that forms the underlying platform for crypto-currency.

Blockchain is essentially a decentralized ledger. It is a method of bookkeeping where each participant to a transaction creates a record of the transaction which is matched and verified with the other participants to the transaction.

When I wanted to learn about Blockchain I spoke with people who are working in Blockchain at large companies and universities in the US and around the world.  What they told me is that we may see Blockchain coming into various industries in the next few years. Initially they expect that it will be used in supply chain and logistics applications.

What I do not hear from these same people is a lot of enthusiasm for Blockchain in the financial sector.  FINRA assembled a panel of Blockchain experts in 2016 that looked at various functions in the financial markets that might be made more efficient by Blockchain. The overall conclusion was that Blockchain development still had a way to go.

There will certainly be decentralized ledgers within various financial companies and for some financial tasks. The entire world of finance is based upon checks and balances, supervision of employees, and repeated audits. Some of that has been automated since the 1970s.

The financial markets need to keep the bad actors out. Decentralization does not do that. If anything it is the opposite.  Blockchain verifies the transactions but not the people behind them.

A decentralized system prides itself on anonymity and anonymity invites bad actors.  If you read what the regulators of the banking and financial markets around the world have published, they continually share two main concerns about crypto-currency; money-laundering and tax avoidance.

Crypto-defenders will argue that far more money is laundered through banks. Banks spend a lot of money trying to curtail money laundering. The crypto-industry spends virtually nothing. The fact that there are other ways to launder money is no excuse for the creation of a new system that makes money laundering easier.

In the past few months banks, bankers, stockbrokers and serious investors have all given the thumbs down to crypto-currency. Recently the large credit card companies announced that their credit cards can no longer be used to purchase crypto-currencies. The largest stock brokerage firms will not purchase crypto-currency as an investment for their customers. Most professional investment advisors realize that they cannot purchase crypto-currency for their clients and satisfy their obligations as fiduciaries.

Part of the reason is that the crypto-currency industry itself cannot decide if crypto-currency is a security, commodity, currency or a whole new asset class. There is so much divergent opinion within the crypto-community that anyone who reads a few dozen articles on the subject is likely to be confused rather than enlightened.

Much of that divergent opinion is caused by the fact that these are legal definitions being interpreted by non-lawyers. I will not apologize for thinking an opinion written by a non-lawyer with a technical background living in Europe, Asia or Australia about how something should be defined under US law should carry little weight.

That does not stop the crypto-community from hanging on the word of every hack with a keyboard who holds himself out as a crypto-expert.  For an industry barely 2 years old, there are enough people holding themselves out as “crypto-experts” to fill Yankee Stadium at least once, perhaps more.

If all was well in crypto-land I would never have heard about Tether. Tether is a crypto-currency that is exchangeable into US currency at a fixed rate.  It claims to have a cash reserve of $2 billion to back up each and every Tether coin that has been issued.  People have questioned whether the owners of Tether really have secured $2 billion and the owners have repeatedly refused to respond with simple proof that the $2 billion is there. In any legitimate industry this question would never have to be asked more than once.

Theft and fraud are rampant in the crypto-currency world.  Electronic wallets are routinely hacked. Estimates run as high as 10% of the money sent to ICOs may have been hacked from the ICO’s wallet and hundreds of millions of dollars have been stolen from the various secondary market exchanges where the crypto-currency is traded.

Fund raising using crypto-currency (ICOs) has reached a fever pitch and has attracted a significant amount of scoundrels. Very few ICOs fund projects that are worthwhile ventures and most cannot be considered worthwhile investments by any stretch of the imagination. Telling the whole truth about the venture being financed is becoming the exception rather than the rule. Following existing laws regarding investment offerings is an anathema to the crypto-industry.

On more than one occasion an ICO has listed someone as an advisor who has never heard of the company or never agreed to be an advisor. I know this to be true because a few months back someone alerted me that my picture had been included in an ICO offering even though I had not given permission for the company to include it. This actually happens way too often.

There was actually one ICO that was so brazen that the people behind it raised a few million dollars and then took down their website leaving only the picture of a phallic symbol. The people who invested in this ICO got the shaft in more ways than one.

What I find most ridiculous about crypto-currency advocates is their overwhelming dislike for banks and their absolute but incorrect belief that crypto-currency and Blockchain will replace banks and send them to the rubbish heap of history.

Some of these people are European based Socialists who have always hated banks, which is their prerogative. But they have unsuccessfully been trying to supplant banks since the French Revolution. Blockchain is not going to help them.

Other people hate banks because they assert, incorrectly, that banks were the cause of the stock market crash in 2008.  I do not know of a single instance of a bank putting a gun to someone’s head and making them take out a loan that they could not afford to repay. The real estate bubble that preceded the crash might better be laid at the feet of the thousands of real estate brokers who encouraged people to buy homes with the foolish notion that real estate always goes up in value.

The most vocal group of bank haters seems to be millennials who have very little experience dealing with banks, but who constantly tell me that they do not trust them. They tell me that banks charge too much and that the world needs better platforms to make payments.

A payment platform like PayPal works quite well and is a big step up from the way banking worked 20 years ago. All it actually does is move money from my bank to a vendor’s bank quickly. Blockchain may make these payments systems better and faster.

I think these advocates will be disappointed to find that banks will ultimately take the best Blockchain has to offer and utilize it in such a way as to fire significant numbers of employees and make more money. Blockchain may actually strengthen the banking industry rather than displace it.

The problem with the idea that crypto-currencies will replace banks is that banks do a lot more than just facilitate payments. The primary function of banks is to aggregate and intermediate capital.  Banks take deposits from a lot of people and use the funds to make loans to small businesses and to make mortgage loans to homeowners.  The consumer side of these transactions can be done with a peer-to-peer approach and an app. You can apply for a small loan or a mortgage from your smart phone, but you are still borrowing from a pool of money held at a bank.

Banks also make large loans. On any given day General Motors or Dow Chemical may float a bond issue to borrow a few hundred million dollars. On the same day the State of New York may float a bond issue to fund a highway or bridge project or new university dormitory. There may be a hundred or more of these large loans and bond financings taking place around the world every day.

It is not likely that these large complicated financings will ever be done with an app on a smart phone.  These bonds are sold to syndicates of commercial banks. This requires that capital be pooled and that large entities have control over those pools of capital. Bank depositors do not decide how the bank invests the money they deposit.

This is the antithesis of the decentralized world envisioned by crypto-enthusiasts. In their world, the crypto-currency is held in electronic wallets over which only the owner has control.  No banks or centralized entity has access to those crypto-funds. There are no banks or similar entities to pool those funds and make the large loans upon which the global economy depends.

Crypto-enthusiasts have no answer to how these large loans might be made in a decentralized financial world. They do not care that banks evolved to where they are because of the need for large loans to fund large companies and large projects.

The US capital market is not a stodgy outdated system screaming for reform. It is a large, dynamic system that handles trillions of dollars of transactions every day. Virtually every transaction settles with every party happy.

It is way past time for the Blockchain industry to leave crypto-currency and the bank-haters behind and to focus on the applications for Blockchain in existing financial institutions and other industries.

 

 

 

 

SEC v. Munchee – Will the crypto-currency community listen?

Capital Markets, Issuers, Law , , , ,

 Just about 2 years ago I wrote a blog article about the first Securities and Exchange Commission (SEC) enforcement action involving equity crowdfunding, SEC. v. Ascenergy.  The SEC action against Ascenergy highlighted the need for the crowdfunding industry to step up and protect the investors from fraud.  That made good common sense because the crowdfunding industry needs investors to survive.

Notwithstanding, most of the crowdfunding industry ignored that enforcement action.  It still largely refuses to carefully vet the offerings that are put on the platforms for investors’ consideration or conduct meaningful due diligence to verify that what the companies are telling investors is true.

Recently the SEC brought what is considered its first action against an Initial Coin Offering (ICO), SEC. v. Munchee Inc.  An ICO is essentially a sub-set of crowdfunding and each offering should be governed by the JOBS Act and the anti-fraud provisions of the securities laws.

A lot of people in the ICO industry will disagree because they believe that they can construct an ICO offering that is not selling securities. The SEC has been clear that it has not seen an ICO that was not a securities offering. Most good securities lawyers agree with the SEC.

Accepting that simple truth would put many people in the ICO industry out of business.  I am referring to the many ICO consultants who charge a lot of money for bad advice. Some of the people who advised Munchee are well known in the crypto industry. Anyone want to bet that they will never mention their participation in the failed, non-compliant and illegal Munchee offering when someone asks about their track record?

On the same day as it announced the Munchee Cease and Desist Order, SEC Commissioner Jay Clayton issued a statement about how the Commission will likely view ICOs. Much of the commentary since has focused on the Commissioner’s statement and not on the enforcement action. That is a mistake.

The Commissioner’s statement covers more ground and speaks in somewhat general terms. It represents the view of the most important regulator in the ICO world, but it is still a statement about generalities that is open to some interpretation.

The enforcement action actually gives more of the “meat” of what the SEC deems illegal conduct. A cease and desist order may become the subject of litigation or appeal. The SEC staff tends to choose its words carefully. It sets forth the facts and the offending conduct, the jurisdictional basis for the action and the reasons why the conduct violates the law.  It is a road map of how not to conduct an ICO offering and everything in it should be scrutinized carefully.

So what, exactly, did Munchee do wrong?

Munchee claimed it was offering “utility” tokens and not securities. It claimed to have performed an analysis of the offering using the test denoted in SEC v. Howey case. I suspect that it did not.  The Munchee white paper lists a dozen officers and advisors not one of whom is an attorney. It provides links to a half dozen PR pieces about the offering but not the attorney’s analysis that these tokens were not securities. The failure to provide a copy of that evaluation was not lost on the SEC staff. They mention that fact specifically in the order.

If an attorney had done the analysis Munchee would set forth the attorney’s name or provided a copy of the evaluation. “Advice of counsel” can be a defense to an SEC action such as this one and Munchee declined to set forth that defense.

A lot of people claim to understand Howey and a lot of articles have been written by people who are not qualified securities lawyers and are claiming to explain it. An evaluation of the offering under the Howey test involves a lot more than just reviewing Howey.

The Order in Munchee refers to Howey and also the SEC’s July 2017 Dao Report.  That report reviews over 30 other cases that have applied the Howey test to various investment offerings. The Order specifically refers to several of those cases which are important to any discussion of this subject.

A lot of people seem to think that if you can use the token for some commercial purpose it is a “utility” token. The Order in Munchee should dispel that idea once and for all.

Purchasers of a Munchee token (MUN) would join a network of people writing reviews of various restaurants. Munchee would pay users in MUN for writing the reviews and would sell both advertising to restaurants and “in app” purchases to app users in exchange for MUN tokens.

Munchee also said it would work with restaurant owners so diners could buy food with MUN tokens and so that restaurant owners could reward app users–perhaps those who visited the restaurant or reviewed their meal in MUN tokens. As a result, MUN tokens would increase in value.

Howey defines a security as an investment premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. The argument here might have been that MUN owners might get a profit based upon their own efforts.

But Munchee intended to do much more. It intended to cut off the number of MUN at a fixed amount.  It intended to facilitate a secondary market where people could buy and sell MUN. Because you could buy MUN, not use them or do anything and later sell your MUN for an appreciated price, it should be abundantly clear that your expectation of profits had nothing to do with you and must therefore be derived from the efforts of others.

Let me offer a simple example: You can purchase a membership in COSTCO. The membership allows you to shop in their stores and buy goods in bulk at a discount. You also get free snacks and inexpensive hot dogs. The membership is recorded on the company’s records and you get an ID card with your picture that is checked every time you enter the store so it cannot be transferred to anyone else.  No one would think that a COSTCO membership is a security. But the SEC has declared some other memberships to be securities.

If COSTCO decided to cut off the number of memberships and allow them to be transferred, it might be fair to assume that the price would appreciate. That alone might make them into securities. Transferability, or the lack of it, is not itself the only indicator. A lot of unregistered securities cannot be freely transferred. But once your token can be transferred at a potentially appreciated price, you should certainly consider that you have crossed the line.

The other big issue raised by the SEC staff in the Munchee Order was the way in which the MUN were sold. Munchee posted information about the offering and the MUN White Paper through posts on the Munchee Website, and on a blog, Facebook, Twitter, and Bitcoin Talk.

This type of general solicitation is specifically permitted by the JOBS Act and is the type of marketing that is needed when a company is trying to raise $15 million without a brokerage firm selling the securities for them. If Munchee had accepted the fact that these were securities, this would not have mattered as long as they did not exaggerate the facts or the potential return.

At the same time, Munchee did not advertise the offering of MUN tokens in restaurant industry media to reach restaurant owners and promote how MUN tokens might let them advertise in the future which is what you might expect if the tokens were being sold for their “utility”. The SEC staff picked up on that fact.

Instead, Munchee and its agents promoted the MUN token offering in forums aimed at people interested in investing in Bitcoin and other digital assets. Munchee made public statements or endorsed other people’s public statements that touted the opportunity to profit, not necessarily the opportunity to use the MUN.

The Order states: “MUN tokens were to be available for purchase by individuals in the United States and worldwide.”  It notes that Munchee intended to use “10% of the offering proceeds ($1.5 million) to make sure Munchee is compliant in all countries.” While that sounds fairly innocuous, as I said, the SEC staff chooses the language it puts into these orders carefully.

There are countries where no crypto-currency or tokens can be sold, so saying it can be sold “worldwide” indicates that the offering is a scam. In a securities offering, it is common for the offering materials to set forth the countries where the offering is being made.  Most telling is the fact that you need to be certain that you are “compliant” before you make the offering, not after. The Howey test does not apply anywhere except the US.

The simple truth is that I would have been happy to help this company raise $15 million for a lot less than $1.5 million in full compliance with securities laws. I would have advised them to sell stock in the company and then memberships separately. They would have had a successful offering and money to market and sell memberships at a lower, more reasonable price where many more people might have joined.

The lesson here should be obvious. If you are claiming to offer a utility token, demonstrate its utility and sell it to people who may want to use it. If you are seeking investors, then stop telling yourself you are not selling a security. Hire lawyers and comply with the rules.

The time, effort and expense that the founders of Munchee expended developing their app and their business, went nowhere.  With the JOBS Act the opportunity for funding a small business has never been greater. If you want money from investors, stay between the white lines.

Cannabis and Crypto-Currency-The Blind Leading the Blind

Capital Markets, Investors, Issuers , , ,

A few weeks back I wrote a blog article where I stated that I was not interested in preparing the legal paperwork for any company that was raising funds for a cannabis related company. In the same article I said that I would also decline the opportunity to prepare the paperwork for an initial coin offering (ICO).  Either would be lucrative for me but in both cases I saw significant problems for the investors.

I might have predicted that people would start sending me the paperwork for ICOs that were looking to fund cannabis businesses seeking my thoughts and comments. Two stick out as examples of how not to raise money for your cannabis business.

In July, the US Securities and Exchange Commission (SEC) issued a report on ICOs. Crypto-currency is all the rage this year with some offerings raising millions of dollars in a matter of minutes and coins when issued quickly appreciating in price. Bitcoins for example have been appreciated significantly this year and some people think that Bitcoins are a legitimate investment, an assertion that is questionable at best.

The SEC correctly concluded that most crypto-currency offerings would fall within the definition of a security and thus its jurisdiction.  There was really no surprise as the SEC initiated about a dozen enforcement actions against crypto-currency issuers before it wrote its report.

Because an ICO is the offering of securities it is required by law to either 1) register with the SEC or 2) be exempt from registration assuming that an exemption is available. In either case, the issuer of the coins is required to give potential investors all the facts that would be material to making an investment decision.

If investors who purchased the coins got a discount on an ounce or two of marijuana the coins might not be securities. These two cannabis ICO offerings are clearly offering securities.  In both of these cases, investors profit if the underlying business profits which is more than enough for these to be securities and the SEC to have jurisdiction.

There are some facts which the SEC and any securities lawyer would consider to be material. This would include who is running the company; how much money is being raised and what will it be used for; the basic structure of the company’s ownership; how investors get paid and how much they might expect; an idea of the size of the market in which the company intends to compete and the names of the companies that are its major competitors.

Nothing really earth shattering,but the SEC has been reviewing offerings and ruling on how these facts are disclosed for decades. Making the disclosures correctly requires a fairly good idea of what the SEC expects and an equally good idea of the operation of the business offering the securities which is why securities lawyers who prepare offerings really have to know what we are doing.

The first cannabis ICO I looked at was for a company called Growers International.  Like all ICOs it uses a “White Paper” (which it prefers to call a “Green Paper”) instead of a traditional prospectus.  I doubt that it was prepared by a securities attorney. (I would suggest that you might add the words “Like, cool” or Yeah, man” between the sentences and it would read like the script of an old Cheech and Chong movie but I do not want to insult Cheech or Chong.)

From the Green Paper: “Q: Why should I trust the team? How do I know this isn’t a Pump & Dump situation?  A: We ask that all investors do their research on the people behind Growers International. Our lead developer has found success in both the cryptocurrency arena as well as in the cannabis industry. If there is any question regarding the legitimacy of the project, we encourage investors to reach out to Ryan (Lead Dev) personally on slack.”

It is always a good idea to research the people who are running any company into which you are making an investment.  In this case the “Green Paper” discloses the management to be: “Lead Developer: Ryan Wright (34, California / Taipei); Blockchain Programmer: Eddie E. (48, New Zealand); Web / API Developer: Michael J. (32, Maidenhead, England); Social Media Director: Devvie @Devnullius (40, Sweden); Community Coordinator: Jeremy Toman @MadHatt (37, Canada) who prefers the name ‘Tyler Dirden’ or ‘MadHatt’;Graphic Designer & Cryptocurrency Consultant: Chris S. @Elypse (26, Detroit); Community Manager: @DayVidd and Bitcointalk Manager & Financial Consultant: Dr. Charles @drcharles (26, USA).”

I suspect that if you contact Mr.Wright as suggested he will vouch for them all if he bothered to ask their last names. Do not bother to ask about Members of the Board of Directors as they have apparently not yet been appointed, so one Director might turn out to be Pablo@Escobar.

The other cannabis related ICO I reviewed is prepared more professionally but still, in my opinion, misses the mark by a good country mile. The company is called Paragon Coin, Inc. It is in the process of raising $100 million through the ICO. Just to be clear Paragon supports the cannabis industry, it does not appear that it intends to grow or distribute cannabis itself.

Paragon intends to bring block chain to the cannabis industry.  It intends to use a distributed ledger to bring order to this fragmented industry. According to the White Paper the company intends to “offer payment for industry related services and supplies through ParagonCoin; establish niche co-working spaces via ParagonSpace; organize and unite global legalization efforts through ParagonOnline; bring standardization of licensing, lab testing, transactions, supply chain and ID verification through apps built in ParagonAccelerator.”

All that is fair enough and the names and pictures of the operating personnel are included. Their education and work histories going back 10 years which I would have expected to see are not present.

The White Paper clearly notes that cannabis is not legal at the federal level and asserts that it will only operate in states where it is legal. This is the prime oxymoron of the cannabis industry.  Illegal at the federal level is illegal everywhere. Marijuana is a Schedule I drug and possession or sale is a felony in all 50 states. That is a fact about which that the cannabis industry does not want to think and largely ignores.

The Paragon White Paper describes one of the Risks of investing in its coin offering as follows:

CERTAIN ACTIVITIES INVOLVING MARIJUANA REMAIN ILLEGAL UNDER US FEDERAL

LAWS. SUCH ACTIVITIES INCLUDE BUT ARE NOT LIMITED TO: (A) DISTRIBUTION OF MARIJUANA TO MINORS, (B) TRANSPORTING MARIJUANA FROM STATES WHERE IT IS LEGAL TO OTHER STATES, (C) DRUGGED DRIVING AND OTHER ADVERSE PUBLIC HEALTH CONSEQUENCES, (D) GROWING MARIJUANA ON PUBLIC LANDS, (E) MARIJUANA POSSESSION OR USE ON FEDERAL PROPERTY, AND

(F) OTHER CRIMINAL ACTIVITY OR VIOLENCE ASSOCIATED WITH THE SALE OF MARIJUANA. TO THE EXTENT THE COMPANY AND/OR PARAGON COIN, INC. MAY NOT PREVENT CERTAIN OF ITS USERS FROM USING PRG TOKENS IN VIOLATION OF US FEDERAL LAW, IT MAY SUBJECT THE COMPANY AND/OR PARAGON COIN, INC. TO CIVIL AND/OR CRIMINAL LIABILITY AND THE UTILITY, LIQUIDITY, AND/OR TRADING PRICE OF PRG TOKENS WILL BE ADVERSELY AFFECTED OR PRG TOKENS MAY CEASE TO BE TRADED.

This derives verbatim from the Cole Memorandum which was written in 2013 as a direction from the US Department of Justice to Federal prosecutors as to how they should allocate their resources when they decide who to prosecute and for what. It never made cannabis legal anywhere.

More importantly, the Cole Memo it is not an Act of Congress or Federal regulation and not binding on the current administration in any way. Any suggestion that it will continue to be followed under the current administration is wishful thinking given the Attorney General has repeatedly stated that it will not.

Medical marijuana has been legal in California for more than a decade. That did not stop the federal government from raiding and closing down a large medical dispensary in Oakland, CA in 2012. Parenthetically, Paragon’s initial co-working space is slated to open in Oakland, California.

Perhaps the most troubling aspect of this offering is that it intends to fund the use of block chain, a relatively unsecure distributed ledger to link the many growers and suppliers in the cannabis industry. If successful it may well deal a serious blow to the cannabis industry it is trying to support.

One of the leading ICO platforms, Coinbase, has been engaged in a two year battle with the Internal Revenue Service which wants a list of all the people who use its platform to trade Bitcoins. The IRS alleges that people are trading the coins profitably and not reporting the gains and paying the taxes. The US government has also alleged that drug cartels and other bad actors use crypto-currency to launder money.

If you are in the cannabis industry you have certainly heard stories of how the DEA would obtain the customer lists of hardware stores that sold supplies for hydroponic growing. Everyone who was a customer did not use these supplies to grow cannabis but the government used those lists to identify and prosecute people who did.

If you have a “decentralized” list of a large group of people who are on the list only because they are affirmatively in the cannabis business as Paragon wants to create, how long do you think it will take for the US Government to obtain it? Think that will be difficult because Paragon never touches any marijuana or sells it?

The CEO of Paragon, Jessica VerSteeg, is also CEO of AuBox which the White Paper describes as “an upscale marijuana delivery service in the SF Bay area”. That is more than enough “probable cause”for the DOJ to get its hands on Paragon’s distributed ledger and the names of every company that uses it. The icing on the cake will be when they tell the judge that the cannabis industry is full of drug cartels and money launders which, of course, it is.

When you write the risk factors for a securities offering, it is important to disclose all of the things that might reasonably occur.  Assuming that this ICO raises the $100 million that it seeks, it is certainly within the realm of possibility that the Attorney General might just seize that money under the federal asset forfeiture provisions. The people behind this offering somehow refuse to accept that there was an election last November and that there is a new sheriff in town.

What I took away from these two offerings was a sense that they were prepared by amateurs who were attempting to do something that was way over their head. In this current administration, raising money for a cannabis company waves a red flag in front of the US government. Compounding that fact by raising money through an ICO just increases the size of that red flag, exponentially.

I personally do not think that there is any hope for Green International but Paragon did not demonstrate that it needed $100 million and could have certainly raised a lesser, more reasonable amount in a more traditional fashion which is what I would have advised them to do if they had asked me.

 

 

Is Technology Changing Finance?

Capital Markets, Economics , , , , , , ,

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first place.to

Classifying Crypto-Currency

Investors, Issuers, Law , ,

Is a Bitcoin a currency or a security?

This is a question that may interest only a small number of geeks and lawyers, but there is a lot of money already in the crypto-currency market and a lot more on the sidelines waiting to jump in if this question is answered satisfactorily.

The key concern is regulation especially if crypto-currencies are ruled to be securities. The securities markets are regulated in virtually every country and the penalties for issuing securities without following those regulations can be severe.

The history of crypto-currencies traces back to Bitcoins which were introduced in Japan in 2009. The coder who introduced them wanted Bitcoins to be considered to be a currency and used as such, hence the name “coins”.  Had he called them “Bitcode” many of the questions about what they are might never have been asked. At the same time much the market for Bitcoins might not have developed.

Part of the allure of crypto-currencies is the fact that some people see them as part of an alternative financial universe. These people seem to believe that crypto-currencies are part of a trend to replace traditional banks and banking.

Bitcoins store value and are a medium to exchange value,which are two prime attributes of currencies.  But having attributes of currencies does not make them currencies.  That point seems lost on many of the people who are insistent that Bitcoins and similar crypto-currencies are currencies. They are not.

Historically, most people who hated fiat currency preferred to use precious metals such as gold or silver for trade, although other commodities, most notably salt have been used over the centuries. But the simple fact is that fiat currencies work because they are almost universally accepted.

Proponents of crypto-currencies argue that they are becoming more and more accepted and that acceptance will increase.  But accepting crypto-currencies as an exchange of value will not make them currencies in the strictest sense. Salt, after all is just salt, no matter how it is used.

If we accept the fact that Bitcoins were mislabeled to give them the appearance that they were currency that is “mined” and kept in electronic “wallets” strictly is a marketing ploy we can free our thoughts for the real issue; are crypto-currencies a security?

The US Securities and Exchange Commission (SEC) has issued several Investor Alerts warning people to avoid investments and especially Ponzi Schemes that are funded by or which purchase Bitcoins and other crypto-currencies.  But the SEC has not come out and said the coins themselves are securities and that is significant.

The SEC has statutory jurisdiction over securities and the securities markets but not all investments are securities. Your home, for example, or other real estate can be a good investment, but is not a security. The same is true of gold bars or bullion; works of art or collectables and all commodities that trade on commodity exchanges.  All are investments, just not securities or the SEC’s problem.

I wrote a blog article about Bitcoins a few weeks back that got a lot more views than most of my articles because crypto-currency is a very hot topic. Several people forwarded legal opinions to me that specifically addressed the issue of whether or not crypto-currencies were a security.  Several of those legal opinions were written by excellent lawyers at excellent law firms. I was not really surprised to see that they reached opposite conclusions; some thought the coins were securities; some thought they were not.

Each of the opinions was interpreting one US Supreme Court case, SEC v. Howey, which basically defines a security as the “investment of money in a common enterprise with an expectation of profits predominantly from the efforts of others.” Law school students studying securities law spend a considerable amount of time with this case and later cases that applied it.  Any legal opinion asking the question “is this a security” will certainly review Howey and apply its reasoning to the facts at hand.

Personally, I do not think that the Howey test applies to crypto-currencies at all.

Let me take a step back and re-frame the question. If a crypto-currency is not a security, what is it?  I think that if a crypto-currency is clearly something other than a security, especially if it is something already regulated under different statutes, it should go a long way to settling the question. So what, exactly, are we dealing with?

Any crypto-currency is nothing more or less than multiple lines of computer code; a long string of ones and zeros.  Computer code is recognized by law as intellectual property which can be copyrighted and is covered by a substantial body of law both in the US and internationally. No one classifies computer code as a security.

The shares of Microsoft Corp. are a security, not the operating system that it sells. That distinction is why I believe that the coins themselves are not a security.

The last time that I heard so many securities lawyers asking the question “is this investment a security” was in the late 1970s.   At that time the marginal tax rate on the highest earners in the US was 50%-70%. If you earned over a certain amount you would pay one-half of the overage to the IRS.  Perhaps not surprisingly, there seemed to be a lot of doctors, business owners and entertainers with this problem.

An industry grew up to provide this group with a series of “tax sheltered” investments.  These transactions were intended to take advantage of IRS rules that provided tax credits and accelerated depreciation when certain physical items were purchased in a business context.  To qualify for the favorable tax treatment, the item purchased had to have a business purpose, be placed in service during the calendar year and not be a security.

In many cases leverage was employed. A doctor would put down $20,000 and sign an $80,000 non-recourse note for the item.  If the tax credit was 50% of the purchase price, then the doctor would save $50,000 from his tax bill for his $20,000 investment; more in subsequent years when he depreciated the value of his $100,000 item over time.

One of the more famous of these tax shelters was a company that sold lithographic masters of artwork from famous artists.  If you bought the master that had been created by an artist such as Andy Warhol, you might make 500 prints from the master before it wore out. If you could sell the lithographs for $200 a piece you could pay back your note, recoup your $20,000 down payment and still save $50,000 on your taxes.

If you sold those lithographs over a period of years, the price might fluctuate. A Warhol lithograph would likely at least retain its value and it could be exchanged for other works of art if you dealt with the right gallery or broker. That did not make the lithographs into a currency even though they had these key attributes of a currency.

Most of these investment programs came with an opinion letter written by a securities attorney that attested to the fact that selling a physical “item” did not involve the sale of securities because the sale did not satisfy the Howey test.  I wrote a few of those opinion letters back in the day because the law was pretty clear that a “thing” was not a security. As far as I can remember the SEC never brought a regulatory action against one of these investment programs taking the position that the items were securities.

The IRS did, however, take issue with a number of these tax sheltered investment programs. They disallowed the credits and deductions that the programs offered and ultimately changed its rules to close the loopholes.  The IRS is not bound to legal opinions and frequently judges the tax treatment of any investment long after the investment is made.

A key issue was whether you were buying a thing or a business. The same is true today. A coin offering might be a security if the coin owner receives a portion of the profits of that company when they purchase the coin.

The SEC is not bound by a legal opinion on the question “is this a security “.  As I said I read several opinions regarding crypto-currencies that went both ways, albeit on slightly different facts. What I did find surprising is that none of the opinion letters that I read, mentioned the fact that the IRS categorized crypto-currency tokens as “property”, not a “security” back in 2014.

The IRS’s classification is also not binding on the SEC.  But given the fact that the IRS had made this determination that the sale of a crypto-currency would be treated as property for tax purposes and the US Copyright Office will issue a copyright on computer code (but not on a stock certificate) I think any legal opinion regarding the classification of a crypto-currency under securities law should mention both.

Several of these opinions were rendered in connection with specific Initial Coin Offerings (ICO). Again this term is intended to create the look and feel of an initial public stock offering (IPO).  This is marketing and it is intended to create the impression (falsely) that an ICO is just like the offering of a security. Of course, if the SEC should assert that these ICOs were actually selling securities because they had the look and feel of securities and attempt to sanction the people behind them, these same people would be screaming that they did no such thing.

In most of the offerings that I reviewed, buying a coin in the ICO neither conferred ownership of the project nor did it promise any payments, so it would not be difficult to opine that all you were getting was a digital coin, not a security. If coin purchasers receive anything other than just the digital coin, then the issue gets murky.  Given that there have already been close to 1000 coin offerings, some very different from others, it can get very murky.

Just to be clear, this article is my opinion of a fairly new legal issue. It is not intended to be specific legal advice as regards one coin offering or another.

If someone came to me with a proposed ICO and sought my opinion I would probably counsel them as follows, just to keep them out of potential legal difficulty.

1) If you intend to use the proceeds of your coin offering to fund your new business then call the coins what they are: “Great New Tech Company Start-up Commemorative Digital Medallions”. This is just truth in packaging. Why call them coins or currency when they are not?

2) Account for the sale proceeds on your books as if you were selling any intellectual property.  If you wrote and sold a book about writing computer code and used the proceeds to fund your code writing business, you would not enter the sale proceeds on your books as an investment.

3) Go about your business and stay under the radar. There are certainly regulators who believe that the whole idea of crypto-currency is a scam.  At the same time, it does not seem to be difficult to raise money using these digital coins. There are multiple reports of multi-million dollar raises being accomplished within hours.  I can see no reason why anyone trying to raise money in this market would write numerous articles or give interviews bashing banks or Wall Street firms or proclaiming crypto-currencies as the new form of unregulated capitalism.  The best way to attract regulators is often to publicize how much money you are making in an “unregulated” business.

If you do want a formal legal opinion letter that your ICO is not the offering of securities, I would be happy to review the facts and prepare one for you. I probably charge a little less than the big Wall Street law firms.  I know that you will understand that I will need to be paid in US dollars not whatever coin you are issuing.  I cannot use your coins at the market, gas station or movies and it is probably going to be a long, long time before I can.

 

 

The Bitcoin Bubble

Capital Markets, Investors ,

In the normal course, I do not do requests for this blog.

I have a job writing articles for a reputable publication. I write the articles that my editor assigns to me.  For the blog, I generally write about something that interests me. Usually, it is based on something that I have read or a conversation that I have had.

In the last few weeks, several people have asked me for my opinion regarding Bitcoins. The truth is I really do not have one. I think that they are a fad. They may be around for a while but ultimately I do not see that they will become a legitimate part of mainstream finance.

More and more people are investing in Bitcoins and more and more businesses are accepting them for payment. The recent run-up in their price has generated a lot of interest. Note that I said price, not value. Bitcoins have no inherent value.

A lot of people seem to confuse Bitcoins with blockchain. Blockchain or distributive ledger technology is just that ledgers; bookkeeping records of transactions that are created by parties to the transactions. Blockchain ledgers are public and every transaction is broadcast to everyone to reduce cheating.  Both FINRA and the US Federal Reserve have looked at blockchain and essentially yawned.

There is nothing inherently wrong with keeping various parts of transactional ledgers disbursed but I fail to see the benefit. The idea is to replace the institutional intermediaries like banks with digital ledgers where a lot of people enter their own transactions. This assumes that everybody in the system is honest.

Using blockchain, it is possible to effect transactions instantaneously everywhere in the world.  If I make an on-line purchase from a merchant they may not get my payment for a day or more.  The transaction is in fact, instantaneous, but the bank or banks in between slow it down so that they can have use of that money overnight.  With a large bank that can result in an enormous profit.

It would seem logical that a blockchain is only as secure as its weakest link and more susceptible to hacking and data breaches than any of the large banks or the US Federal Reserve.  And no matter where and how the ledgers are kept, every bank and public company that uses the blockchain system will still have to be audited once a year.

This brings us to Bitcoins which is essentially a string of computer code and which touts itself as a cryptocurrency. Bitcoins are not the only cryptocurrency. There appear to be more than 100 but Bitcoins seem to have the lion’s share of the market and are subject to the most hype.

I have some experience trading currencies in the foreign exchange market and teaching about them. When I was very much younger, I bought and sold currencies on the black market in Mexico and Italy.  So I think that I am qualified to peel back the curtain and take a reasonable look at Bitcoins and to size them up against other currencies.

When I did, what I found was essentially nothing.

Perhaps a unique aspect of Bitcoins is where they come from.  Bitcoins exist only on a distributed ledger and are the brainchild of an unknown computer programmer who first published the idea in 2008 and then the software to create the system in 2009.

The number of Bitcoins in the world increases every time someone, usually a cryptographer I suspect, solves a complicated mathematical puzzle. If you perform any task and receive a reward for doing it, I suspect that the IRS will consider that to be a taxable event.  I have yet to see IRS guidance on the subject, but I have no doubt that the IRS will catch up to this.

If you looked at this from the outside and said that a group of sophisticated cryptographers was going to create a code and that code would be accepted as money, you would be right to be skeptical.  Who, besides another cryptographer would want it?

Records of Bitcoin transactions are kept on blockchain ledgers and a lot of the trading is anonymous. A lot of people seem to think that most Bitcoin transactions are being made by criminals seeking anonymity. That may or may not be true, but the anonymity that comes with Bitcoin transactions would certainly attract a criminal element.

People who swear that Bitcoins will soon become the currency of choice usually make several arguments. When you examine them, it is obvious that none hold any water.

Bitcoin advocates argue that Bitcoins are no worse than any fiat currency. If the government can just keep printing money without anything behind it, why should not the marketplace be able to do the same?  As a member of the generation that first coined the phrase “question authority,” I think I am qualified to respond.

There was a lot of debate when President Richard Nixon took the US off of the gold standard in 1971.  Most of the people who favor Bitcoins today were not yet born and know nothing of the debate that took place then.  While it is true that the US no longer exchanges currency for gold at a fixed rate of $35 per ounce there is still a lot of gold stored at Fort Knox and elsewhere.  Most of it was purchased at $30 an ounce or less and at current prices would still back some portion of outstanding US currency.

Gold itself is a monetary fiction.  People have sought it and accepted it as an exchange for other items of value going back into antiquity. In reality, it is a rock. Once or twice every year someone walks along the bank of California’s Sacramento River and picks up a sizeable nugget. Any monetary system needs a hitching post and for centuries gold has been it.

Gold and all currencies are based on our willingness to accept them for things we consider to be valuable.  All currency is about perception.

In addition to gold, and perhaps more importantly, the largest asset held by the US government is land. Land has had value going back to feudal estates because they were places where you could grow crops and later build factories. Land adjacent to a river or shoreline has always had extra value.

The US government owns millions of acres of valuable land.  You might speculate about how much it would get if it sold the 98% of Alaska that it still owns but it is easier to add up the value of the someplace like Camp Pendleton, California with its miles of Pacific shoreline just waiting to be turned into high-rise condos, theme parks, and golf courses.

What is behind Bitcoins? Nothing. All fiat currencies are not created equal.

Currencies must be accepted in exchange for other goods and services. While more and more merchants are accepting Bitcoins, in most cases average wage earners in the US are required to pay their rent or mortgage in dollars and also their health and car insurance, groceries, cable, and phone bills.  There is not a lot left over for Bitcoin transactions.

I can get a meal from most street vendors in almost every country in the world with a US $20 bill.  In the aggregate street vendors sell a lot more meals every day than does McDonalds and McDonalds does not accept Bitcoins either.

Currencies function as a place to store value.  The recent run-up in the price of Bitcoins is an example of how poorly they perform that function.  There has been no countervailing deflation of the dollar to justify the increase in Bitcoin prices nor underlying economic events to explain it. The price of Bitcoins has run up based purely on speculation. The hype has created demand and the run-up has fed off of itself.

If the price of Bitcoins can increase that quickly, certainly the price can decrease that quickly. Would you want to contract to perform a service for one Bitcoin, perform that service today, send an invoice at the end of the month and be paid 30 days later?  The purchasing power of that one Bitcoin 30 or 60 days from today could be substantially less. Without stability Bitcoins are essentially useless as currency.

That is why many articles about Bitcoins refer to the tulip bubble in the 1600s. In both cases, prices were based upon what economists call the greater fool theory.  Everyone believed that the price would increase and bid the price up until there were no more buyers.  The bubble burst and the last fool got left holding the bag. I do not care if Bitcoins continue to go up until they reach $10,000 each or higher.  At the end of the day, someone will get left holding the bag.

A more recent twist on Bitcoins is their use in venture capital. Several companies have claimed to have raised millions of dollars by selling stock for Bitcoins or other cryptocurrencies.  They call them initial coin offerings (ICOs). Several companies profess that they have raised millions in a matter of hours. That may be because holders of Bitcoins cannot spend their coins in very many other places.

I could not locate a prospectus for one of these offerings. I do not believe that any were registered with the SEC. I would particularly like to see how the attorneys who wrote the disclosures handle the “risk factors” relating to the Bitcoins that the company received for its shares. Call it professional curiosity.

If I took anything away from my look at Bitcoins it is that there is a lot more hype than substance.  A lot of people seem to think that it is possible to create wealth by solving a mathematical puzzle. But Money for Nothing is a song by Dire Straits, not an economic reality.