How much money would you give a company in exchange for digital tokens in a business ecosystem that looked like this?
If your answer is “fifteen million dollars,” you'd probably see eye-to-eye with the fine minds behind Munchee Inc. But the SEC has a different view. In early November regulators smothered Munchee's initial coin offering in its crib, and on Monday the SEC's cyber unit dropped a cease-and-desist order outlining why Munchee Inc might have violated a securities law or two when it plied its unfortunately named MUN tokens on the crypto-investing public.
Other ICOs: take note.
Unlike previous SEC actions around ICOs, this one doesn't rest on allegations of outright scammery; indeed, there's an actual Munchee App you can download in order to find restaurants and become a “food-influencer.” There's nothing in the SEC's order to suggest that Munchee Inc didn't intend to use the capital it raised as advertised: to foster a virtuous cycle of verified food reviews and token-based restaurant discounts, which together would offer “an immutable and verifiable blockchain-based solution” to the problem of shitty Yelp reviews.
But along the way the folks behind Munchee Inc made a fatal error: They promised profits profits profits!
In their white paper, Munchee Inc described how they would retire tokens as restaurants paid it fees, which “could potentially increase the appreciation of the remaining MUN tokens.” On the official Facebook page they linked to a third-party Youtube video that blared “199% GAINS on MUN token at ICO price!” On a podcast (yes, the SEC is among the three people listening to your crypto podcast), a Munchee Inc cofounder outlined how “the more restaurants we have, the more quality content Munchee has, the value of the MUN token will go up.”
And there was this:
Given all of these data points, “MUN token purchasers had a reasonable expectation of profits from their investment in the Munchee enterprise,” the SEC says. And that “reasonable expectation of profits” part is pretty much what tips a token sale into a security sale:
Based on the facts and circumstances set forth below, MUN tokens were securities pursuant to Section 2(a)(1) of the Securities Act. MUN tokens are “investment contracts”.... Among other characteristics of an “investment contract,” a purchaser of MUN tokens would have had a reasonable expectation of obtaining a future profit based upon Munchee’s efforts, including Munchee revising its app and creating the MUN “ecosystem” using the proceeds from the sale of MUN tokens.
Not all ICO marketers are so dim as Munchee Inc. Many of them are currently engaged in rhetorical gymnastics to present their capital-raising activities as simply the sale of tokens for a specific utility, and not as investments for the profit-seeking speculator. Few ICO white papers spell out the expectation of future price appreciation as explicitly as that of Munchee Inc.
But! The SEC isn't resting on the profits-expectation alone to determine whether something is a securities offering:
Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling – such as characterizing an ICO as involving a “utility token” – but instead requires an assessment of “the economic realities underlying a transaction.”
One of the “economic realities” that the SEC points to in its Munchee order is its marketing strategy:
They likened MUN to prior ICOs and digital assets that had created profits for investors, and they specifically marketed to people interested in those assets – and those profits – rather than to people who, for example, might have wanted MUN tokens to buy advertising or increase their “tier” as a reviewer on the Munchee App.
As we've noted before, this marketing mismatch is one of the central contradictions in the current ICO space. Prudent cryptopreneurs are straining to excise any talk of profits or investment returns from their pitches, focusing only on the stated utilitarian purposes their tokens will serve. But they're doing all this at conferences and web venues attended pretty much solely by investors whose involvement is purely speculative. Any assessment of the economic realities underlying the ICO market today will find plenty of investors and business operators, but few actual end-users.
Still, we've yet to see the SEC target any ICO purveyors who managed to refrain from promising big fat profits. There hasn't been an ICO action whose legal case rests entirely on the idea that the “economic realities” of a sale made it a securities offering, sans explicit mention of profits. Yet it looks like the SEC is moving in that direction.