The Securities and Exchange Commission (SEC) is suing messaging app Kik for an unregistered securities sale. Kik sold $100 million worth of tokens called Kin during an initial coin offering (ICO) from May 2017 to September 2017. The startup, which is backed by the likes of China’s Tencent and Union Square Ventures, claims that the tokens were utility tokens, meaning that investors bought them without any expectation of profit. But the SEC claims Kik’s ICO was a securities sale.

SEC: Kik was a startup in distress

Kik casts its battle with the SEC as one about the status of its tokens and the future of cryptocurrency regulation. But the agency has a different take on the matter. In its filing, the agency has portrayed Kik’s ICO as the “Hail Mary Pass” of a faltering startup with declining revenues and number of users.

“Kik’s costs have always far outpaced its revenues and the company has never been profitable,” the filing states. From mid-2015 to mid-2016, Kik had revenues of $2.2 million and expenses worth $29.2 million. As the number of its daily average users dropped from 10 million in January 2016 to six million in January 2017, the company’s revenues also fell to $1.5 million. Meanwhile, its expenses increased to $32.3 million in 2017. In late 2016 and early 2017, Kik hired an investment bank to try and sell itself to a larger tech company but found no takers.

To shore up its survival prospects, the startup hit on the idea of a “pivot” towards blockchain tech, a move that an investor in the company described as a “Hail Mary Pass.” It turned out to be a successful one for Kik since the startup was able to raise $100 million from private and public investors. Out of that amount, $49 million came from accredited investors through a Safe Agreement for Future Tokens (SAFT). The agreement promises future equity in a product that does not yet exist. About $50 million of Kik’s funds came from the general public. The SEC claims that Kik raised $55 million from U.S. investors, bringing the startup’s offering under its purview. (Most countries are yet to formulate or comment on ICO regulations.)

There are two main contentions in the SEC’s charge against Kik. The first one is that the decentralized economy that Kik marketed did not exist when the startup offered its tokens to investors. The second, and more serious charge, is that Kik did not provide important financial information to investors regarding the investment opportunity promoted by Kik. This included details about its current financial condition, future plans of operation and budget, proposed uses of investor proceeds etc. This information is necessary for securities sales within the United States.   

What Are the Implications of the Case?

The case is a high-profile one and commentators claim that it could determine the future course of cryptocurrency regulation. In recent years, the SEC has increased its crackdown on dubious offerings within the crypto ecosystem and commented on the status of prominent coins. If the federal agency wins, then the existing status quo will be maintained and crypto companies will have toe its line in regulatory matters. A Kik victory, however, could force the federal agency to reconsider its stance and amend existing rules to evaluate tokens.