Does the SEC’s ICO Lawsuit Against Kik Go Too Far?

June 6, 2019, 8:02 PM UTC

Since 2017, the Securities and Exchange Commission has been sending warning signals to the cryptocurrency industry over so-called “initial coin offerings” (ICOs), which entail selling digital tokens to the public that can—in theory at least—one day be used to participate in an online service. Those warnings have so far come in form of public statements and settlements. But on Tuesday, the agency brought out the heavy artillery by suing social media company Kik in federal court, alleging the company’s $100 million ICO amounted to an illegal sale of unregistered securities.

The lawsuit did not come as surprise, especially as a foundation tied to Kik recently launched a “defend crypto” campaign, whose purpose, in the words of Kik’s CEO, is to “fight the SEC in court.” The campaign, which invited others to contribute to its legal battle, was akin to waving a red flag in front of the regulator.

The allegations set out in the SEC’s lawsuit are not flattering to Kik. In its court filing, the agency airs the Canadian company’s dirty laundry, revealing among other things that it was losing money at the time it decided to sell digital tokens to the public. While Kik has framed its ICO as an opportunity for users to contribute to its digital platform, the SEC portrays it as a hail-mary money-grab by a desperate company. The agency also notes that Kik’s digital tokens have lost half their value since the sale.

The SEC lawsuit is not a surprise, but still it’s a shame. Unlike many other companies that held ICOs, Kik was not a scam or a fly-by-night operation. As Fortune reported in 2017, the company had been experimenting with tokens for years with “Kik Points,” a type of digital money that traded hands up to 300,000 times a day. The SEC’s decision to come down heavy on Kik came in the name of protecting investors, but it also risks punishing early innovators in the blockchain economy.

Then, there is the agency’s own dithering. Back in 2016 when companies of all sorts were conducting ICOs worth hundreds of millions of dollars, the SEC had nothing to say. It was only in July 2017 that it finally offered guidance to the effect that ICOs could amount to an illegal sale of securities. During this time, the technology underlying the token economy was taking enormous leaps forward—making it difficult for tech companies to wait around for regulatory instruction. Ironically, if Kik had rushed its ICO out the door prior to the July notice, it would likely be in the clear today. Instead, its decision to go forward two months later—in September 2017—is why the company faces its current predicament.

Since then, the SEC has stated that some ICO projects, like the cryptocurrency Ethereum, are not securities because they are sufficiently decentralized. But the commission then failed to offer a practical way for companies to know when a given blockchain project was sufficiently centralized. Instead, as cryptocurrency company Circle laments, the SEC has created a legal rabbit hole that involves evaluating 25 factors that are then subject to an additional 11 considerations. No one is sure how to make sense of all this.

The SEC has since offered one “no action” letter for a blockchain project involving tokens for pre-paid rides on various jets, ensuring the digital fares were on solid legal ground. But as lawyers and others quickly pointed out, the letter was akin to the agency blessing the sale of tokens to ride the subway—and did nothing to clear up the grey areas surrounding ICOs. Indeed, one SEC Commissioner asked if—under the terms of the “no action” letter—she should wonder if her Starbucks card was a security.

All of this is depressing news for the fledgling crypto industry, as well as for investors and consumers who might partake in it.

Meanwhile, jurisdictions in Switzerland, Asia, and elsewhere are rolling out crypto-friendly legal regimes, and this creates a very real risk the U.S. could end up being a laggard when it comes to important new financial technology. The SEC could have similarly found a way to encourage useful crypto projects while reining in the bad actors. Instead, with the Kik lawsuit, it has doubled down on its hard line stance—leaving would-be entrepreneurs to wait and worry.

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