Tezos, a blockchain technology project that made headlines

in July by raising $232 million, has been hit with its second class-action lawsuit in less than a month. It's the latest blow for the project's founders, husband-and-wife team Arthur and Kathleen Breitman. The Breitmans promised to build a blockchain with a revolutionary new governance model that would avoid the kind of strife that has plagued the Bitcoin world over the last few years. Instead, Tezos itself has been engulfed in controversy since its fundraiser ended. The couple is locked in a bitter conflict with Johann Gevers, the man they picked to lead the Tezos Foundation.

The big question hanging over the Tezos project is whether its so-called initial coin offering violated US securities laws. Those laws require companies to register with the Securities and Exchange Commission (SEC) before they can offer securities to the public. The lawsuits argue that, legally speaking, the Tezos crowdfunding campaign was a sale of securities, and so the Breitmans broke the law by ignoring SEC rules. Of course, there would have been little reason to file lawsuits if the Tezos project were a smashing success. But the launch of the Tezos network is now months overdue. Anxious investors are starting to wonder if anything will come of their investment.

Tezos sold tokens on a network that didn’t exist

The Tezos project has lofty goals. In a 2014 white paper, Tezos founder Arthur Breitman argued that Bitcoin had a poor governance model. The network depends on everyone following the same set of rules, and those rules aren't easy to change—a problem that has become increasingly obvious over the last three years. Breitman wanted to solve this problem by developing a blockchain protocol capable of modifying its own rules. The Tezos protocol has multiple layers, with a low-level "network shell" providing generic blockchain functionality but leaving most of the important decisions to higher levels of the stack.

Tezos is supposed to have built-in mechanisms for modifying the rules of these higher-level functions. A Tezos user can propose a modification to the rules, which can be accepted or rejected by other users. In theory, this should make the network much more flexible than conventional blockchain networks. The big problem is that the Tezos network doesn't exist yet. People who bought into the July presale were buying the right to receive units of the Tezos currency once the network became operational.

And the lawsuits charge that the Breitmans misled investors about how long that would be. In a May blog post, Arthur Breitman wrote that "all of the functionality described in the whitepaper has been implemented to this date, except for gas metering." The big remaining tasks, he said, were "finishing a security addition," "optimizing smart-contract storage," and "testing our network on a large scale and performing external security audits."

In his May post, Breitman predicted the Tezos network would be up and running "in a three- to four-month period." He said it might take as long as six months to finish, though he added that "Based on my assessment of the remaining development that does not seem likely, but it's not impossible."

That was written almost six months ago. The Breitmans now say that they expect to launch the network next February, and they acknowledge that it could take even longer. The Tezos organization itself has been plagued with infighting. The Breitmans chose to conduct their fundraising through the Tezos Foundation, a non-profit entity that they helped to set up in Switzerland. (As Kathleen Breitman put it, Switzerland has "a regulatory authority that had a sufficient amount of oversight but not like anything too crazy.")

Legally speaking, a Swiss non-profit organization is supposed to be independent from commercial interests, so the Breitmans tapped Gevers, a Swiss engineer, to run the Tezos Foundation. Meanwhile, the Breitmans have no formal role in the foundation's management, but they've been able to exert plenty of informal pressure. Gevers says the couple hasn't relinquished control over the group's tezos.ch domain name. The Breitmans have accused Gevers of self-dealing and have attempted to oust him in a boardroom coup. They've encouraged other board members to re-organize the foundation and delegate key functions to a subsidiary that would be under the Breitmans' control.

But Gevers is having none of it. He insists that he has an obligation to maintain the foundation's independence and safeguard the hundreds of millions of dollars in cryptocurrency entrusted to him by Tezos users. (We've asked both Breitmans and the Tezos Foundation for comment and will update if we hear back.) For now, investors' money—which has swelled in value as the value of bitcoin and ether has continued to rise—is managed by the foundation. The plan is for the foundation to acquire the Breitmans' for-profit company after the company develops and launches the Tezos network. Only then will users get their allocations of Tezos cryptocurrency—something that might not happen for months, even after the network is officially launched.

Tezos claimed investments were really donations

People who bought into the Tezos presale were buying the right to acquire Tezos currency in the future, once the network became operational. Plaintiffs say this is evidence that the pre-sale was really a stock offering, little different from a corporate IPO. US law requires anyone who offers stock to the public to register with the Securities and Exchange Commission. The Breitmans didn't do that.

Instead, they tried to skirt those requirements by describing investors' purchases as donations to the Tezos Foundation. But the lawsuit argues that this was a sham. Even the Breitmans themselves didn't really seem to believe it. "What we're going to do is allow as many people who want to buy into the crowdsale over a two-week period," Kathleen Breitman told Reuters in May. When Reuters asked Tim Draper, one of the biggest early investors in Tezos, how much he "donated" in the fundraiser, he responded, "You mean how much I bought? A lot."

The US Securities and Exchange Commission is charged with enforcing securities laws. So far, the agency has enforced the rules with a light hand. In July, days after the Tezos fundraiser had ended, the SEC ruled that a 2015 fundraising effort called the DAO had violated securities laws. But the SEC decided not to press charges in that case, merely warning that future crowdsales could get their organizers in legal hot water. But disgruntled Tezos investors aren't waiting for the SEC to crack down on Tezos. They're filing their own lawsuits based on the project's alleged violation of securities laws. Both lawsuits against Tezos point to SEC statements warning that unregistered ICOs could run afoul of securities laws.

"If it walks like a duck, and it quacks like a duck, it's a duck," this week's lawsuit argues.

The stakes are high for the Breitmans. If they lose the lawsuit, they could be forced to return the money they raised in the crowdsale, and they could face further action from the Securities and Exchange Commission. But the case could also have broader significance for the cryptocurrency world. Tezos was one of the most successful coin offerings conducted in 2017, but there have been many others like it. Most of them have not registered with the SEC, and others have offered the public tokens on networks that haven't been created yet.

If the courts decide that Tezos violated securities laws, it could put many of this year's other ICOs in legal jeopardy. The SEC hasn't begun prosecuting anyone in the cryptocurrency world for violating securities laws, but it could start doing that at any time. And a court ruling against Tezos could put pressure on the SEC to act.

Chuck Reynolds

Marketing Dept
Contributor
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