SEC goes after Manchester startup for issuing its own cryptocurrency
Jun. 27—W hen Jeremy Kauffman launched his startup company LBRY Inc. in 2016, he hoped to dethrone YouTube and similar video-sharing companies with the same blockchain technology that Bitcoin used to redefine the notion of money.
He didn't reckon on having to deal with the U.S. Securities and Exchange Commission.
But in March, the SEC filed civil complaints against LBRY in U.S. District Court in Concord.
The agency, which polices fairness in the securities markets, claims that the cryptocurrency tokens issued by LBRY amount to an investment that must be registered with them. The company said the tokens, or LBCs, are valued at a nickel currently. Viewers use the credits to access videos and other LBRY online content.
If the SEC gets what it wants, the Manchester-based virtual company could end up having to return more than $10 million it has generated from LBCs, which could bankrupt the company as $8 million of that has been spent growing the company, according to Kauffman.
"We have no idea why they're prosecuting us," he said. "Everyone is scratching their heads on this case. Why go after LBRY? They're a bunch of nerds trying to do the right thing."
The SEC claims LBRY raised more than $5 million in capital over five years issuing 13 million LBCs. Investors were sold the idea that the LBCs might be worth billions once the LBRY network is built out, the agency asserts. The SEC says LBRY then used the proceeds to build the company.
In court filings, the company acknowledged creating LBCs — Kauffman said they are mined the same way Bitcoin and other cryptocurrencies are created — but he said the money used to launch the company did not come from LBCs.
In a LBRY media campaign, the company warns that the SEC's enforcement action against the company is a threat to any business employing the advances of cryptocurrency into their technology.
The SEC has brought similar actions against companies associated with cryptocurrencies, especially when they use the currency to generate capital, observes Stephen McKeon, an associate professor of finance at Oregon University who specializes in cryptocurrency regulation.
For example, last year, the SEC announced a settlement with the Telegram Group to return more than $1.2 billion to investors and pay an $18.5 million civil penalty for issuing digital tokens without registering as a security.
The five SEC commissioners are divided about how to approach such cases, with one member calling for a temporary safe harbor for companies to issue unregistered cryptocurrencies to generate capital in their launch phase.
A challenge to regulate
The regulatory landscape is continually evolving, with technology advancing quicker than regulation, and agencies trying to play catchup, McKeon said.
"It's a continuous cycle," he said. McKeon said he is not familiar with LBRY and did not want to comment on the case.
The SEC, which was established in the aftermath of the Wall Street Crash of 1929 and now employs about 4,200 federal workers, does not regulate Bitcoin and many other cryptocurrencies. That is because Bitcoins are not created by companies for investment purposes; they are created by individual miners, McKeon said. The mining is done by computer programmers, who solve complicated mathematical problems.
Instead, Bitcoin and other cryptocurrencies are regulated by the Commodities Futures Trading Commission.
Kauffman said his LBCs are a commodity more than anything else, and he compares them to tokens used at Chuck E. Cheese.
LBCs are awarded to producers for placing content on the LBRY platform and on an associated website, Odysee.com. Prices of LBCs have ranged from less than a penny to more than a dollar, he said.
The SEC has told LBRY its lawyers are wrong and it must follow the law, but it won't provide any guidance about how, Kauffman said.
What's needed, he said, is a clear line from the SEC as to what can and can't be done, which it won't or can't provide.
"It's so Kafkaesque. I wasn't the biggest fan of government before. Now it's radicalized me," Kauffman said.
Kauffman speculates about why the federal government has suddenly come pressing down on his particular enterprise: Politicians don't want a platform that could not suppress the speech of someone like former President Donald Trump; YouTube is rattled by his company; the SEC finds it easier to go after small companies in a campaign to regulate cryptocurrency.
Kauffman, who says his degrees are in physics and computer science, moved to New Hampshire in 2015 and is on the board of the Free State Project.
In 2011, he co-founded TopScore, an online company for scheduling events and activities. The founders sold it to a private equity company in 2019.
He served on a state commission to study cryptocurrency regulation, which delivered a final report last year.
On the commission, Kauffman helped to fashion legislation that called for New Hampshire to take a hands-off approach to cryptocurrency regulation, said state Rep. Keith Ammon, R-New Boston.
A YouTube competitor
LBRY Inc. is located in a second-floor office on Hanover Street across from the Palace Theatre in downtown Manchester. It has 15 employees, three of whom live in New Hampshire and two live in Massachusetts, he said. The rest work remotely, some from other countries, he said.
LBRY is structured with the same blockchain technology that tracks and stores Bitcoin. Kauffman said the decentralized platform will prevent censorship of materials that creators place on LBRY. Not even Kauffman can control material placed on the platform.
"The key word for LBRY is decentralized. That's the dream. To have something that can't be attacked," said.
The company's website Odysee.com, which is more user-friendly than LBRY, ranks 2,650th worldwide in traffic, according to Amazon's Alexa tracking company. Kauffman said it logs more than 2 million visits a day.
One day recently, the Odysee.com home page had dozens of video offerings. They included a 47-second video of the liftoff of the Shenzhou manned Chinese rocket, an 11-minute podcast critical of the COVID-19 vaccine, and a nine-minute video about the Dyson Airwrap hair-styling product.
Such is the user-generated content that launched YouTube, which Ammon said now focuses on pushing Stephen Colbert and James Corden videos.
Of the more than 10 million pieces of content available through LBRY, at least 95% are free and don't require users to download the LBRY software, Kauffman said.
Videos that are not free require LBCs to access them. Creators also earn LBCS when viewers tip them for their content.
So who suffers?
In a lengthy response to the SEC complaint, LBRY lawyers assert the SEC is trying to squeeze a new technology into its outdated version of what's a security. Such enforcement, the lawyers warn, will drive blockchain technology and jobs out of the United States.
Oregon University's McKeon said the SEC holds on to pretty basic principles about what a security is and isn't. He said the SEC would find it hard to regulate a fully mature cryptocurrency such as Bitcoin because no company is attached to it. The currency exists as an emergent property of software running on many different computers.
"There's no 'there' there," he said.
In the case of companies that issue their own cryptocurrency, it is more of a judgment call, McKeon said. For example, the more widely distributed the cryptocurrency, the less likely it would be to look like a security, he said.
Kauffman said his lawyers tell him the SEC is treating his case differently. The agency is playing hardball even though there is no fraud, no mischaracterization of the LBCs to buyers, and no complaints filed with the SEC, he said.
"There's no victim," Kauffman said. "Government's the victim."
