Kik Interactive prepares for legal battle against the SEC in crypto crackdown

The crackdown on crypto went into full swing this month as the U.S. Securities Exchange Commission (SEC) launched a lawsuit against Canadian-based Kik Interactive for conducting a $100 million securities offering of digital tokens.

Cryptocurrency can’t be regulated easily because of its decentralized nature, but the add-ons to crypto-culture, such as Initial Coin Offerings (ICOs) are still still subject to government regulation.

An ICO is an unregulated fundraising method using cryptocurrency in support of a new project. They’re used mostly by tech startups looking to avoid the strict regulatory process of capital-raising required by venture capitalists or banks. During an ICO, a percentage of the cryptocurrency is sold in exchange for fiat funds, or other cryptocurrencies, with the biggest coin being Bitcoin.

It’s not like this is a clear-cut case of government overreach either, as in many cases plenty of ICOs have turned out to be outright fraudulent, including this ironically fraudulent ICO raising money for a website to educate investors on how to spot fraudulent ICOs.

Image courtesy of coinsquare.com.

The outcome of this case will help determine what future investors can expect from ICOs and maybe go towards clearing up a lot of the unanswered questions about how crypto is regarded.

For example, the SEC is pursuing cryptocurrencies because they think they’re securities, while the Commodities Futures Trading Commission (CFTC) interprets them as commodities. Both are government agencies and both contradict one another.

And that brings us to Kik Interactive

Kik Interactive’s story is typical for most companies.

It found a market niche and created a product to fill it. In this case, it was started in 2009 by a group of University of Waterloo students, who lamented the availability of apps on their smartphones, and decided to rectify the problem.

They had their first product, Kik Messenger, by October of the following year and like all nascent companies, set out to conquer the world. Then it took off, courtesy of Twitter, getting one million registrations in 15 days.

Research in Motion—now Blackberry (BB.T)—took their app off of the blackberry within a month, and sued them for patent infringement and trademark misuse, which drained the company’s coffers until they settled three years later.

In 2015, the company sought to raise capital following the lawsuit, and went the traditional route—contracting with Valiant Capital Partners, Millennium Technology Value Partners, and SV Angel for $70.5 million—followed by $50 million investment from Chinese Internet giant Tencent to build the “Wechat of the west.”

By 2017, Kik CEO Ted Livingston’s principle idea had changed into the development of a decentralized ecosystem independent of traditional revenue models like advertising or e-commerce by offering developers kin tokens based on interactivity and attention from users. The company would develop Kik apps and bots that focused on the user experience.

“Before, you built a big community with all these users and you either sell their attention to advertisers or you try to sell them stuff directly that maybe they don’t want or don’t need or expect for free. What if we create a place where consumers can come, hang out and provide value to each other? What if that alone was how we make money? That’s what a cryptocurrency enables,” Livingston said in an interview with the Financial Post.

This time Livingston cut out the middleman and went straight to the people via an ICO on the ethereum blockchain. He offered investors access to their proprietary cryptocurrency, Kin, in exchange for $100 million. Half of which came from U.S. Investors.

This is where things started getting dicey because American funds draw SEC oversight if securities are involved and in 2017, the SEC declared that ICO tokens can qualify as securities, and therefore are under their purview.

Kik’s lawyers argue that Kin is a token and not a security. The difference being that the token will be used as currency within their system to purchase goods and services rather than a security be traded upon.

But that contradicts something that Kik said earlier,

“Kik told investors they could expect profits from its effort to create a digital ecosystem. Future profits based on the efforts of others is a hallmark of a securities offering that must comply with the federal securities laws,” said Robert Cohen, chief of the Enforcement Division’s Cyber Unit.

The SEC contends that Kik should have registered the Kin ICO as a security because it met the definition of an offering under the Howey test. The test relates to Securities and Exchange Commission v. W.J. Howey Co.

The test is based off of four characteristics:

  1. a monetary investment
  2. entry into a common enterprise
  3. an expectation of profits
  4. dependent on the efforts of others.

Last week, Kik launched a fundraising campaign, and contributed $5 million of its own cryptocurrency funds towards fighting the lawsuit. To date, the campaign has raised an additional $4.5 million in crowdfunding in assorted cryptocurrencies for the cause.

“This is the first time that we’re finally on a path to getting the clarity we so desperately need as an industry to be able to continue to innovate and build,” Kik CEO Ted Livingston said.

Regardless of what happens this is going to be one to watch.

—Joseph Morton

Disclaimer: ALWAYS DO YOUR OWN RESEARCH and consult with a licensed investment professional before making an investment. This communication should not be used as a basis for making any investment.

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