Telegram’s TON network and coin were destined to fail with regulators, experts say. So, what’s left of the project?
Telegram Open Network is off to a very uncertain future. Earlier this week, Telegram CEO Pavel Durov announced his company’s “active involvement with TON” was over, following a drawn-out legal battle with the United States Securities and Exchange Commission.
The project remains decentralized, however. Although TON lost its main ideologist, an independent community of validators has recently launched the blockchain platform separately from Telegram. So, what is TON without Durov’s supervision, and should other high-scale crypto projects — such as Facebook’s Libra — be even more worried about the SEC coming after them?
What was Telegram’s idea for TON?
TON is a blockchain platform aimed at facilitating payments and hosting decentralized applications beyond the scalability levels of Visa. Its in-house tokens are called Grams (GRM).
The project was initiated by Telegram, an open-source encrypted messenger co-founded by two Russian entrepreneurial brothers, Pavel and Nikolai Durov. Per the roadmap, TON would be integrated into the Telegram application, which boasts over 400 million monthly users worldwide and is favored by the blockchain and cryptocurrency community.
TON began to gain recognition soon after Telegram first announced the idea in 2017, and in one year’s time it reportedly raised almost $1.7 billion in two private token sale rounds, which remains one of the most financially successful initial coin offerings to date.
However in October 2019, just a few days ahead of the release date, the SEC stepped in with a lawsuit that accused Telegram of violating U.S. securities law by holding an unregistered security sale. Because the SEC had managed to get a temporary restraining order against Telegram and TON, the project release was put on hold. In March, a U.S. court recognized that the SEC had “shown a substantial likelihood of success” in proving that Telegram’s Grams were unregistered securities.
On April 30, after a series of launch delays, Telegram offered a reimbursement plan for its investors, offering them to either opt for an immediate refund at 72 cents on the dollar or “loan”’ their stake to the platform for 12 months in exchange for repayment at 110 cents on the dollar scheduled for April 30, 2021. Telegram subsequently agreed to provide the SEC with “its communications […] regarding any agreements offered or entered into with the Initial Purchasers” of the Gram tokens by May 20.
Nevertheless, Durov announced on May 12 that Telegram was discontinuing its TON project and explicitly criticized the U.S. government’s involvement and efforts to prevent the launch of the decentralized project, writing:
“Unfortunately, we — the 96% of the world’s population living elsewhere — are dependent on decision makers elected by the 4% living in the US.”
“A case study in how to do absolutely every single thing wrong”
Unlike the majority of ICOs, TON wasn’t a public offering. According to the documents Pavel Durov filed with the SEC at the time, a minimum investment of $1 million was required to partake in the Gram token sale. Although the investor list has not been publicly disclosed, a number of U.S. venture capital firms including Benchmark, Sequoia Capital and Lightspeed Venture Partners are said to have participated in the offering.
The sale was likely limited to accredited investors in order to avoid scrutiny from U.S. regulators. Public documents from 2018 show that Telegram had informed the SEC that both of its twin $850 million offerings were allegedly made under Rule 506(c) and/or Regulation S under the Securities Act of 1933, so the offering was not required to be registered with or qualified by the SEC. Since the SEC filing, the company has publically stressed that the tokens should not be associated with expectations for profits, implying that they do not constitute securities as per the Howey test.
The SEC’s argument, in turn, rests on the assumption that because some TON investors were based in the U.S. — the complaint states that $424.5 million belonged to 39 U.S.-based purchasers — the potential Gram holders “will be able to sell billions of Grams into U.S. markets” and therefore continue the unregistered token sale.
“The U.S. federal securities laws do have a broader reach than many may realize,” John Berry, a partner at Munger, Tolles & Olson LLP and a former SEC senior officer who worked at the agency for over eight years, told Cointelegraph. He outlined several possible scenarios for how Telegram could deal with the SEC to get TON back on track:
“Fix the fact that it raised money in the past without following the SEC’s registration rules and register the sale of the Grams with the SEC if it wants to raise more money by selling Grams. Both of those will require cooperating with the SEC. The only other option for Telegram is to press forward with its appeal of the Telegram trial court ruling that said Telegram violated the registration rules — if Telegram wins its appeal, then it could go forward with its fundraising without registering the Grams at all. But that appellate option will take some time as Telegram’s appeal winds its way through the appellate court process.”
Tom Trowbridge, the president of financial technology firm Triterras and a former executive of Hedera Hashgraph — the company that also limited its 2018 ICO to accredited investors to comply with U.S. regulations — told Cointelegraph that “Telegram is a case study in how to do absolutely every single thing wrong in structuring and building a compliant project.” He elaborated:
“If Telegram was comfortable with TON being a security, the SEC would have little issue. But to be classified as a utility, SEC cares about 5 things: decentralized governance, a functioning independent ecosystem, coin release commensurate with use, decentralized value creation and a US investor base. Telegram was 0-5.”
According to Trowbridge, Telegram “couldn’t have made it any easier” for the SEC to shut down its blockchain project: “The SEC was able to do so while remaining 100% consistent with its previous actions and guidance in the space. And the allowance of projects like Hedera to release their coins show the SEC does want to allow compliant projects to proceed.” Carol Goforth, a professor at the University of Arkansas School of Law, also highlighted certain problems with Telegram’s offering in a conversation with Cointelegraph:
“Keep in mind that a different issuer might get a different result in a different court, but the extremely broad reach of the Telegram order (foreclosing the issuance of GRAMs anywhere during the pendency of the case) creates a huge potential problem for an issuer who wants to be compliant. Note that there ARE exemptions available for purely foreign sales, although Regulation S has some difficult requirements.”
Not every issuer might care about the SEC’s opinion, Goforth continued, and the agency might have a difficult time trying to block a company that has no assets in the U.S. and operates from a jurisdiction with different rules. “However, for a truly global offering that wants to be in compliance with varied national laws, the Telegram order is quite problematic,” she argued.
Konstantinos Stylianou, an associate professor of competition law and regulation at the University of Leeds, was not surprised by Telegram’s capitulation either, telling Cointelegraph that “TON ran into a very specific problem, the definition of securities, and SEC’s stance on this is well-known,” adding:
“Financial regulators have to be strict by nature; they are the main gatekeepers to financial markets. Sometimes this means that they adapt belatedly, but we’ll get there. TON was a straightforward case that the SEC had replayed with KIK and the outcome was all but certain.”
Why TON itself is still alive
TON is an open-source project, and Telegram has stressed before that it has no control over the blockchain. In fact, the company published TON’s entire code on Github in October 2019. That allowed “Free TON,” an independent community of validators, to launch a TON-based blockchain earlier this month.
“Free TON was born because Telegram could not launch the network,” Ron Millow, Free TON’s “communications evangelist” and the chief business development officer at TON Labs — a third-party group of the blockchain’s infrastructure developers — explained to Cointelegraph:
“We are extremely saddened to see them forced to walk away from the fight, but theirs was just one battle. The free software has a life of its own and cannot be stopped, and so it gave a community the necessary motivation to pick up where they left off.”
According to Millow, the major difference between Telegram’s TON and Free TON is that the latter was launched “without any investors and by a community rather than an entity.” Free TON developers are “ecstatic” about their project, Mitja Goroshevsky, Free TON’s “technology evangelist” and the chief technology officer of TON Labs, told Cointelegraph, adding:
“We are flooded with support from all over the world with developers wanting to join the community and help it grow. Not counting all of our other groups and channels, just the developer groups jumped to almost 3,000 members in the span of a week, 2,035 of which at this moment have signed the Free TON Declaration of Decentralization.”
Some people from the original TON community are skeptical of the initiative, however. One of the founding members of TON Community Foundation who partook in the blockchain project’s development told Cointelegraph that without Telegram’s resources and its audience of almost half a billion users through its messenger app, adoption will be a tough task:
“I don’t think that ANY TON project that is or will be launched without the Telegram direct support will have any significant adoption. […] Most of those who participated in TON (except those who initiated the Free TON) were attracted to the whole story because of Telegram’s user base.”
Daniel Perez, the head of TON Spain, told Cointelegraph that launching TON without Durov “feels pointless.” He is also leery about TON sidekicks, namely the Free TON initiative. “I doubt Pavel Durov gave them permission to use the name TON in launching an alternative called ‘Free TON,’” he said, referring to the Telegram CEO’s letter where he warned readers to not trust projects with their “money or data” that use the “TON” abbreviation.
When asked about this, a Free TON community representative told Cointelegraph that Durov’s message doesn’t apply to them because they don’t ask people for money or delicate data: “Free TON supports this statement. The Free TON community will never ask for money or private data other than a name when signing the Declaration of Decentralization, without which of course there cannot be a signature.” However, according to the Free TON website, users are required to state their name, country, email address and Telegram username to join the network and sign the declaration.
As previously reported by Cointelegraph, the Free TON community has issued around 5 billion TON Crystal tokens, which are similar to Grams. Specifically, the Free TON blockchain browser shows that there are 5,000,547,737 TON Crystal tokens as of press time. 85% of them are distributed to Free TON partners and users, and 10% are intended for developers. The remaining 5% will be used to reward the community’s validators. Additionally, Free TON has recently announced that they are launching the first validator contest on May 18.
Should others be worried?
When asked whether Telegram’s capitulation might have larger repercussions for the industry, most experts found this scenario unlikely. Stylianou told Cointelegraph that the credibility or trustworthiness of the crypto market will not be affected, while regulatory laws will eventually recognize its unique features: “In fact, the convoluted securities definition that hasn’t yet caught up with the reality and potential of the crypto-economy is the problem, not the other way around.” Goforth shared a similar sentiment:
“Blockchain has such potential for a secure, rapidly accessible, tamper-resistant chain of title (and for other uses as well) that I do not see any possibility that it will fall by the wayside. In addition, as regulation develops further, I am hopeful that the SEC will eventually propose exemptions targeted to cryptoassets, at least in part to fulfill that agency’s mission to facilitate efficient functioning of our capital markets.”
As for Libra, another high-scale project that has been facing the SEC’s scrutiny, its chances to pull through may be higher. According to Trowbridge, Libra “has already taken lessons from Telegram” by launching its decentralized governance of companies and by making substantive changes to the platform after receiving feedback from regulators.
For Goforth, the initial question for Libra is not one of compliance, but whether buyers would purchase it for anything other than use. “As a stablecoin, the price would not generally be expected to fluctuate, and thus Libra might not make a suitable speculative investment,” she argued. “If Libra goes ahead, it will be a vote of confidence in the crypto-economy,” Stylianou concluded. “But that still doesn’t foretell ICOs fate.”
