The demise of the Telegram Open Network (TON) means the days of crypto projects raising significant amounts of money by pre-selling tokens have come and gone, well-known cryptocurrency lawyer Stephen Palley told Modern Consensus.
Telegram CEO Pavel Durov announced on May 12 that his messaging platform’s active involvement with TON is over—using a blog post to lambast the U.S. judge who effectively stopped the project from going ahead.
The company was in a long-running and bitter legal dispute with the Securities and Exchange Commission (SEC) over the $1.7 billion it raised by pre-selling 2.9 billion gram tokens to 175 rich investors, some of them American. The agency has described that sale as an unregistered securities offering, and thus unlawful.
Palley, a partner at Anderson Kill who co-chairs the law firm’s blockchain and virtual currency group, said there was always a good chance that Telegram’s battle with the SEC was going to end in tears.
Nonetheless, Palley believes it could have huge ramifications for crypto projects that have raised money using a Simple Agreement for Future Tokens (SAFT)—especially if they are based in the U.S.
More problems ahead
In a telephone interview about Telegram’s predicament, Palley told Modern Consensus: “It’s no surprise the fact that they hired an expensive, very good law firm, and that it was no protection against the fact that the SEC viewed the token as a security—and that’s apparently what a federal judge thought as well.”
He predicted that Telegram’s decision to throw in the towel doesn’t bode well for the likes of Kik and XRP, both significant projects in litigation, as TON’s case “has some suggestive precedential value that a judge will certainly look at.”
Palley has urged U.S. companies that have used SAFTs to assess whether this is the best course of action. “I think it’s going to create problems for other people in the space,” he said. “This is what happens when you push against a regulator thinking money and lawyers will buy your way out.”
Under the SAFT model, a company pre-sells tokens to a group of wealthy, or accredited investors, calling that a securities sale. The idea is that when the blockchain launches, those investors will resell them to the general public. But, because those tokens could then be used on that blockchain, they would no longer be securities bought and sold as an investment. That in turn means they could then be resold to retail investors without an initial public offering (IPO).
A blow to U.S. investors?
Telegram’s admission of defeat comes after a U.S. court ruled in March that the SEC had “shown a substantial likelihood of success” in proving the company had distributed unregistered securities. The judge also concluded that the issuance of Gram tokens to investors in the U.S. and worldwide should be delayed. That order caused Durov to throw in the towel.
Palley argued that SAFTs are rarely a model of clarity—and told Modern Consensus that he has seen agreements that haven’t been reviewed by lawyers in some cases. He went on to say this approach to raising money has probably now run its course—going the same way as “the ICO pump and dump days” of 2017.
The D.C.-based attorney doesn’t necessarily believe that it is going to be impossible for crypto and blockchain projects to raise money in the U.S., or for American investors to get involved. “The most innovative projects that I see now are the ones that aren’t reliant on easy money tokenization, they do other things,” he said, adding: “It’s a pain in the ass to raise money, it’s not easy. You don’t get something for nothing.”
According to Palley, “it may be possible” for projects that used the SAFT model to go ahead if they have non-U.S. investors—and he warned: “I think that every case is different. I can’t speak to any case specifically. Anyone that used the SAFT model will need to re-evaluate whether there is a way to unwind their projects.”
Durov has struggled to hide his incredulity at the U.S. legal system. He compared Telegram’s use of a SAFT to several people pooling their money together to build a gold mine, and split the revenues from the precious metal it produces.
According to the CEO, the ruling was like a judge telling these intrepid investors: “Many people invested in the gold mine because they were looking for profits. And they didn’t want that gold for themselves, they wanted to sell it to other people. Because of this, you are not allowed to give them the gold.”
Perhaps the main source of Durov’s exasperation is how the U.S. court ruled that Gram tokens couldn’t be distributed globally because of the risk that it could still be accessed by American citizens in other territories.
Insisting that “every other country on the planet seemed to be perfectly fine with TON,” Durov wrote: “This court decision implies that other countries don’t have the sovereignty to decide what is good and what is bad for their own citizens. If the U.S. suddenly decided to ban coffee and demanded coffee shops in Italy be closed because some American might come there—we doubt anyone would agree.”
With Telegram’s vision of creating an “open, free, decentralized exchange of value and ideas” in tatters, Durov described a vicious circle where “you can’t bring more balance to an overly centralized world exactly because it’s so centralized.”
And warning that the baton would now need to picked up by the next generation of entrepreneurs, he wrote: “Unfortunately, we—the 96% of the world’s population living elsewhere—are dependent on decision makers elected by the 4% living in the US.”
The $1.7 billion bomb
There had been a ton of drama in the run-up to Telegram disassociating itself with TON. Last week, a rebel band of software developers and validators had launched a rival platform known as the “Free TON Blockchain.” It appeared to be based on the same protocol that underpinned TON. Frustrated by the delays and the roadblocks imposed by the SEC and the courts, the breakaway group’s message was simple: Telegram can no longer be involved in this enterprise.
In the immediate aftermath of that calamitous court ruling in March, Telegram had seemed determined to press on with TON—but had admitted that the launch would need to be delayed until April 2021. Attempting to appease investors and salvage the project, the company offered them a choice: you can either have 72% of your capital now, or wait a year to get a refund of 110%—guaranteed by Durov personally.
Alas, once again, the regulatory uncertainty meant it was bad news for Americans who had invested in Gram tokens. They were later told that the 110% option—effectively a loan agreement—wouldn’t be available to them, leaving them with no choice but to write off 28 cents on the dollar.
Now that is the case for all 175 gram token investors. Assuming they bought equal shares (which seems unlikely) each investor lost $2.7 million on a $9.7 million investment. And, Durov doesn’t have to pay any of them back out of his own pocket.
Disclosure: Modern Consensus founder Ken Kurson sits on the board of Ripple.