Telegram Michael Mathias 2021-05-31 Monday (pdf)
CCH: comments CryptoChemist.net
In preparation for the significant information that will be shared in the next segment, I’d like to share a few background concepts. Understanding these next items will make it easier to grasp what will follow.
Ecosystem Companies and Regulation
Regulatory action is a normal occurrence in business and was expected to happen in several jurisdictions, especially since the ecosystem was part of the emerging blockchain industry and featured an innovative minting model and a referral-based marketing program. Regulatory inquiries were expected and welcomed. Ecosystem companies were ready to address any concerns raised and quickly respond after consultation with qualified attorneys. However, throughout the course of the ecosystem’s history since 2016 and with activities in over 180 countries around the world, there have been just two jurisdictions where any formal regulatory action has been taken: one in Canada (British Columbia) related to DasCoin and the other in Poland related to NetLeaders.
The NetLeaders organization established and maintained formal relationships with attorneys in over 20 jurisdictions to address any regulatory issues that might develop over time. Despite the fact that NetLeaders never sold licenses in the United States, John Pretto made sure to have NetLeaders retain the services of one of the top network marketing attorneys in the US to vet the marketing program and ensure full compliance. Throughout the world, the US has been widely seen to have the most evolved set of legislation around the type of referral-based marketing programs NetLeaders was using.
Email from Canada
In most jurisdictions around the world, formalities matter. For example, a regulatory letter is usually sent through registered mail to the formal company address to provide a record, emphasize the importance of the matter and add gravitas. But perhaps in Canada, things are just more informal.
On May 16th 2018, a one-page cease and desist letter was emailed to a DasCoin press address (firstname.lastname@example.org) by the British Columbia Securities Commission (BCSC) for “potentially offering or promoting securities without registration.” The letter was sparse on details, lacked substantiation of any type and had a general tone of speculation. The rationale for the action seemed to be that “in certain circumstances, these types of offerings may be distribution of securities.” The two legal teams that reviewed the letter both felt it was an unusual combination of an enforcement action without any supporting evidence.
Apparently, it was essentially a form letter. British Columbia’s agency filed 11 cease and desist letters (representing 32% of the CryptoSweep enforcement action taken by “over 40 jurisdictions” as part of Operation Cryptosweep from the North America Securities Administrators Association, or NASAA), and all of the BCSC’s submission were cease and desist letters citing the same issue: “potentially offering or promoting securities without registration.” All of the other actions listed on NASAA’s Operation Cryptosweep web page show links to multiple-page formal court orders that cited actual violations. The BCSC was the only regulatory agency that sent out 1-page cease and desist letters for “potentially” violating regulations (undoubtedly, it’s the lightness of these letters that prevented the NASAA organization from publishing a link to each letter – unlike virtually all other actions on their website, each of which provides a link to formal court orders with considerable substantiation).
Despite the weakness of the letter, legal counsel for DasCoin advised that it was best for the company to acknowledge receipt of the letter and request the justification for the action. The attorneys cautioned not to push too hard, as it was likely that one of the 11 cases filed by the British Columbia agency would be used to “make an example of” as a deterrent for other companies. So legal counsel recommended to not pursue the matter any further than a reply by email. Consequently, a reply was sent to the British Columbia Securities Commission, but a response was never received back from them. Just a month prior to receiving the letter from BCSC, in preparation for the first listings on public exchanges, DasCoin management received an 8-page opinion letter from a highly qualified Singapore law firm confirming that DasCoin was a utility token (and not a security) and providing detailed substantiation.
In an update from Operation Cryptosweep, apparently there was no company that was “made an example of” by the British Columbia Securities Commission. No formal filings seem to have been made against ANY of the 11 companies that the agency cited. As a matter of fact, 5 of the 11 letters filed by British Columbia (over 45%) have been withdrawn by the regulator, with the updated NASAA.org site showing those cases with the following language: “(RESOLVED per regulator)”. This underscores the weakness of the cases presented by the BCSC, especially when juxtaposed to the rest of the NASAA’s list. Check for yourself on the updated Operation Cryptosweep web page:
All other cases except those filed by the BCSC feature formal court orders with extensive details and substantiation of violations.
Public Blockchains vs. Permissioned Blockchains
The fintech industry is still very new and is interdisciplinary by definition. This creates an environment of professional insecurity, as there are no experts in the field with PhDs in fintech and 30 years of experience, and in addition there are innovations emerging on a daily basis. This backdrop of insecurity and innovation creates interesting dynamics within the industry – as well as strong ideology. Within the cryptocurrency community, one of the most divisive issues has to do with the way blockchain technology is configured. It amounts to a battle between fundamental conservatives and practical progressivists. In a public blockchain, anyone is free to join and participate in the core activities, such as reading, writing and auditing. Whereas in a permissioned blockchain, permissions within the blockchain are granted to certain participants. Permissionless architecture is less expensive to defend, more efficient and can increase performance. While the majority of the industry ideologically favors public blockchains (and some of them believe that complete openness is the only true embodiment of blockchain technology), there is a growing segment within the industry who believe that permissioned blockchains also have a place in the industry and are valid for certain use cases, particularly within the commercial realm. Bitcoin (BTC), Ethereum (ETH) and Litecoin (LTC) are examples of public blockchains, while Ripple (XRP), VeChain (VET) and Hedera Hashgraph (HBAR) are examples of distributed ledger technology that feature permissioned architecture.
2017: The Year of Hype for Cryptocurrencies and ICOs
The threat emerged within the banking industry in 2017. This was arguably when cryptocurrencies reached a new level of public consciousness, mainly due to the rise in value during that year of Bitcoin which started out with the currency trading below $1,000 and ended with it having surpassed $20,000. ThIs was also the year when the term “ICO” (Initial Coin Offering) became a popular term. With the hype growing about cryptocurrency and blockchain, it became increasingly difficult to maintain (and then acquire) bank accounts for businesses that were in any way involved with cryptocurrencies. Many businesses lost their bank accounts in 2017 and even individuals known to own cryptocurrency were having their long-established bank accounts terminated. Exchanges were especially vulnerable to this dynamic. One source claimed that US-based exchange Bitfinex lost over 40 bank accounts.
At an investment conference in 2012, hedge fund manager Bill Ackman presents a 342-slide presentation that opened his attack on Herbalife. Over the course of the next five years, Ackman would famously place a $1 billion short on Herbalife’s stock through his Pershing Square Capital fund, stating that the company’s stock price would eventually fall to $0. While the multi-level marketing company expected revenue to reach $10 billion by 2020, Ackman said it was a predatory pyramid scheme destined to fail. It was Ackman’s contention that Herbalife distributors obtained their monetary benefits primarily from recruitment rather than the sales of goods and services to consumers. Finally, in February of 2018, Ackman removed the short bet and ended up taking a loss of $760 million. Meanwhile, another activist investor, Carl Icahn, who had taken the other side of the bet, gained approximately $1 billion. Today, Herbalife has been in business for over 40 years, generated annual global sales of $5.5 billion last year and has a market cap of $6.2 billion.
Bias Against Network Marketing
The Herbalife attack by Ackman illustrates the public perception difficulties that legitimate network marketing companies must endure at times. While there have been companies like Amway, Herbalife and Avon that have built long-term substantial businesses using network marketing principles, there have also been companies that have abused the concept by operating pyramid schemes or engaging in predatory consumer practices. According to the SEC, in a pyramid scheme, participants make money by recruiting new members by doing one or more of the following: promise of a high return in a short period of time, not selling an actual product or service, and placing heavy emphasis on recruiting new members. When properly constructed, the mechanism of network marketing can be a very powerful and successful marketing force. However, even when compliant and fully legitimate in their marketplace offerings, new network marketing companies can encounter resistance and come under attack, particularly early in their development.
Polish Growth Story
Poland represents the third-fastest growing economy in the EU and enjoyed 28 years of unbroken growth prior to a slight downturn in 2020 due to the impact of the pandemic. The European Commission forecasts 3.1% growth in 2021 followed by a stronger 5.1% rebound in 2022. It is its sixth most-populous member nation at nearly 40 million people. Its population is intelligent, entrepreneurial and open to opportunity. There is also a long tradition in Poland of embracing innovation. Given the innovations that come with the fast-growing fintech realm and the intelligence and industriousness of the Polish population, it was understandable that there would be strong interest in blockchain technology and cryptocurrencies within Poland.
Amber Gold Ponzi Scheme
This was one of the largest financial scandals in Polish history. Over 50,000 Polish investors lost over $200 million. It turned out to be a classic Ponzi scheme, and the company’s founder was convicted and went to prison. It raised serious questions about the effectiveness of the Polish justice system and government because of the perception that authorities failed to act against the company. Amber Gold seemed to operate as a legitimate financial institution, despite red flags from the regulators and the criminal record of its young owner. Scrutiny was even focused on Donald Tusk, the then Prime Minister, due to business dealings his son had with a company owned by Amber Gold. Poland’s top prosecutor at the time later admitted that the prosecutors were negligent in failing to heed multiple warnings since 2009 about Amber Gold from the PFSA.
The scandal had significant political implications, severely hurting the Civic Platform (PO), the political party in power at the time (which would subsequently end up losing the 2015 elections). Predictably the then Opposition party, Law and Justice (PiS) pushed for further investigation into the matter. Upon arrival in office in 2015, the party quickly set up a special parliamentary committee to investigate the scandal. The investigation was meant to uncover negligence and wrongdoing of public official and public institutions. High profile witnesses in the public hearings included the former Polish Prime Minister Tusk, his son Michael Tusk and former Finance Minister Jacek Rostowski. Former public officials were publicly ridiculed for having not taken action.
Consequently, in the aftermath of this public investigation, it became important for the new ruling party to establish a new precedent of taking action against anything that looked like Amber Gold. With a newly-politicized judicial system following the PiS win, there was plenty of incentive to find a new financial threat against the Polish people and make a supreme example out of it. So there was a swing from the previous administration’s complacency to the other extreme of what could be described as hyper-sensitivity and hyper-vigilance among the country’s prosecutors. To show the country its strength and its diametrically different approach, the new party was eager to take swift and strong action against any offenders.
Politicization of the Polish Judicial System
In October 2015, there was a political shift as the Law and Justice Party (PiS) became the ruling party of Poland, after 8 years under the rival Civic Platform Party (PO). Law and Justice is a national conservative, Christian democrat, right-wing populist political party in Poland. When PiS came to power, they immediately started to start making changes within the judicial system. It’s been widely reported that the judicial system has lost its independence and has become highly politicized. PiS has been massively disruptive to the over 6,000 public prosecutors in the Polish system. This systemic insecurity has undoubtedly fueled an environment of fear and hyper-sensitivity among those working within the system.
Since PiS came to power in 2015, the country has slipped from 29th to 41st in Transparency International’s corruption-perceptions index. The Polish government’s changes to the court system was strongly criticized by the European Commission in 2020, and launched a series of infringement procedures against the country. Poland is also under an Article 7 procedure over concerns it is backsliding on the rule of law, which could see it lose voting rights in the European Council. The Commission deemed Poland deficient in the four main areas reviewed: national justice systems, anti-corruption frameworks, media freedom and checks and balances. The sticking points in Poland are the right-wing government’s moves to take control of the justice system, especially the judiciary. The report states that “the double role where the minister of justice is also the prosecutor general has raised particular concerns, as it increases vulnerability to political influence.”
Confidence in the Polish legal system is now so low that two EU member states (Netherlands and Germany) have recently suspended all performance of extradition to Poland on a systematic basis. Courts in Netherlands, Germany, Slovakia, Spain and Ireland had been deciding to suspend performance of European Arrest Warrants to Poland on a case-by-case basis, but the new measures systematically suspend all extradition requests to Poland from Germany and Netherlands.