The story behind the SEC's $1.7bn block on Telegram's cryptocurrency
Telegram Open Network and its cryptocurrency Gram face US legal proceedings
At the time it sounded like the breakthrough that blockchain and cryptocurrency enthusiasts had been dreaming of.
In early 2018, at the peak of the crypto hype, Telegram Group Inc, owner of the messaging system Telegram that had already acted as an unofficial sounding board for the growth of digital coins, announced its own Initial Coin Offering (ICO) to fund a blockchain-based subsidiary the Telegram Open Network (TON). A Telegram cryptocurrency was on its way.
Investors already giddy with expectation after the surge of Bitcoin prices, were primed for what seemed to be an offer they couldn’t refuse. And when the tranches of tokens were made available for sale they were eagerly snapped up raising a total of $1.7bn (£1.3bn, €1.53). Within a short space of time, TON had achieved the second biggest ever raise for an ICO.
Telegram’s Open Network would deliver Gram, a Telegram cryptocurrency and a coin to rival Bitcoin and Ethereum. It would also power what would be the biggest and most scalable blockchain network so far. And with Telegram's 300 million registered users all potential owners of the coin the resale opportunities would surely be huge.
Yet a year-and-a-half on the world is still waiting for the release of the TON and the actualisation of the Gram. A project that promised so much is now mired in legal proceedings. And some pundits have even suggested that Telegram’s failure to launch TON could be the bullet that kills the blockchain dream and might even have a profound impact on the future of cryptocurrencies.
A cancelled launch
Telegram had committed to launching its network and its Gram coin on October 31, 2019. All seemed on track until mid-October when the news broke that the US Securities and Exchange Commission (SEC), which regulates the nation’s financial affairs, had secured an emergency restraining order against the Telegram Group and TON for their token sale. Telegram would not be able to sell or distribute the Gram tokens in the US.
While disappointed at the time, many crypto champions saw the news as a minor set back. After all, Telegram had generated a lot of interest from its sale. Also given that its founders, the Durov brothers, were originally from Russia, and that its business was registered not in the US but in Dubai with operations run from the UK and holdings in the British Virgin Islands, surely interest from the SEC would be something of a minor diversion. TON surely didn’t rely on US backing? Or did it?
So why then were established investors so excited by TON and the Telegram cryptocurrency? First, it was issued at the peak of crypto fever when Bitcoin’s price was more than $16k, twice what it is today. Secondly, investors knew Telegram had huge potential reach for TON through its network of 300 million users.
Most importantly, combining that reach with technology and a forward-thinking protocol could solve some of the issues that had dogged TON’s main potential rival, the Ethereum network. Just like Ethereum, TON is more than a new crypto coin, it also underpins the entire new blockchain network that Telegram hoped to launch. TON offers developers the chance to house their apps in decentralised way fulfilling the initial dream of Ethereum’s founder to create an Internet where hosting is not the preserve of tech giants such as Amazon and Microsoft but of blockchain networks across the planet.
Just like Ethereum, in order that people could pay for hosting, TON issued a coin, the Gram. So TON’s supporters point to the fact that while the Gram is a security, it is much more too.
Given the timing and the ambition of the ICO it was not really a surprise that the TON coin sale was popular. CoinDesk reported that the messaging platform was looking to raise up to $600m in a pre-sale and another $700m through a public offering. It smashed those figures, hitting $1.7bn overall. Crucially, Telegram forbade the sale of the Gram coins on secondary markets until the full launch, which it promised would be within a year.
The US vs Telegram
However the SEC was keeping a watchful eye and the TON ICO was one of many factors that spurred it on into starting to develop a regulatory framework for cryptocurrency within the US.
Many countries, from Belarus to Switzerland, have already developed systems which are largely designed to be encourage blockchain and cryptocurrency-based enterprises. The SEC sees things differently. In April 2019, it issued its guidance for the launch of crypto tokens, which instantly sparked off a series of court cases.
One of the key missions was to help token issuers determine whether or not their cryptocurrency would qualify as a security offering. If the project was deemed to be a security then it would subject to the regulatory framework surrounding existing US securities.
Factors include an expectation of profit, whether a single or at least central group of entities are responsible for specific tasks within the network, and whether a group is creating or supporting a market for a digital asset.
On October 11, the SEC made its move against Telegram Group Inc. Days before TON’s proposed launch, the SEC filed an emergency action and slapped a restraining order on the next phase of the project.
With the prospect of Gram tokens being resold in the US within days Stephanie Avakian, co-director of the SEC’s Division of Enforcement announced, “Our emergency action today is intended to prevent Telegram from flooding the US markets with digital tokens that we allege were unlawfully sold. We allege that the defendants have failed to provide investors with information regarding Grams and Telegram’s business operations, financial condition, risk factors, and management that the securities laws require.”
According to the SEC complaint, Telegram failed to register their offers and sales of the tokens. Telegram argues that it has complied with the SEC regulations and points to the fact that it used the Simple Agreement for Future Tokens, or SAFT, legal structure to raise money from accredited investors.
However the SEC takes an alternative view. “Telegram’s marketing materials reasonably led purchasers of Grams to view them as an investment into a common enterprise from which they could hope to profit based on Telegram’s efforts to develop a business,” the SEC said. As a result, the investors “acquired substantial quantities of Grams that would far exceed any purported use of the Grams in whatever ecosystem Telegram promised in the future.”
It also argues that Telegram allowed the investors to buy Grams with a goal to later resell them with profit on a broad secondary market and did not take steps against that.
Many crypto observers expected that Telegram would continue with its October 31 launch regardless and ignore the US intervention. However, rather surprisingly it responded by postponing its launch and offering a new date of April 2020.
When the SEC began to issue information about why it was so keen to talk to Telegram the extent of interest in the project by US investors became clear. Telegram’s $1.7bn raise in their 2018 token sales came from 171 total purchasers. It turned out that 39 of them were from the US, including established investors such as Kleiner Perkins and Benchmark, who between them invested as much as $424.5m, more than a quarter of the investment. Unusually too the Telegram ICO was funded not by Bitcoin and Ethereum, as was the custom at the time, but via fiat cash. The good news for Telegram’s founders is that they were then unaffected by the slide in value for cryptocurrencies in 2018. In fact if we assume a moderate 4 per cent interest rate, Telegram’s treasury yields as much as $68m per year. There is clearly a lot of money at stake.
Date in court
Telegram’s team will make its case to the US courts that its Gram token is not a security on February 18, 2020. In the meantime the SEC has been gathering evidence and is asking for documents and interviews with the company’s advisors. This week it asked the High Court of England and Wales to obtain the testimony and documents from a financier named John Hyman. The UK resident was pivotal in raising TON’s funds and was described by Telegram CEO Pavel Durov (pictured) in January 2018 as the chief investment advisor at Telegram and the person who “runs the distribution of Grams.”
Hyman is, according to the SEC, a reluctant witness who has so far ignored requests for information. Hyman currently works at Gram Vault, the custodian for Grams, and is working with TON’s largest investors. Gram Vault has also been collaborating with crypto custodian Anchorage which, according to email exchanges seen by the SEC, was expected to be Telegram’s partner serving US customers. It is not known yet how Hyman intends to respond.
At this juncture the future of the Telegram Open Network looks to be in the balance. If the US court rules in favour of the SEC then the network would be outlawed in the US and the owners potentially hit with significant fines.
One other option would be to settle out of court. Another company that conducted a high profile ICO, Block.One, recently agreed to a $24m settlement with the SEC. Yet ultimately this is really only a “parking fine” for an enterprise that raised $4bn in Ether.
So will Telegram take this route? Maybe not. Lisa Bragança, a former SEC enforcement branch chief in Chicago who now runs her own law firm, has said: “Telegram may have been one of the 80 or more crypto-token firms that received an SEC subpoena. It is likely that the SEC tried to settle with Telegram before the end of the federal fiscal year on September 30.”
Yet even if the SEC were to win in court it would be foolish to write Telegram and its TON off yet. It has a massive global database and a significant warchest. It could in theory bypass the US and focus TON’s activities in other parts of the globe.
TON’s image and credibility would certainly have taken a knock, but the enthusiasm of crypto champions could still mean that the Gram ends the first year of the new decade as a very desirable coin.
There is clearly a long way to go with this story.
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