When TQuroum’s Global Summit was underway this past Monday September 30th, 2019, a new entity emerged calling themselves “Crypto Rating Council” (“hereinafter CRC”) found at https://www.cryptoratingcouncil.com. The news has circulated widely that they rated Tezos a 3.75, but there’s reasons to be skeptical as discussed below.

If Tezos is a 3.75 and Algorand is a 2.00, did Algorand’s score reflect when the Algorand foundation repurchased tokens? (See https://twitter.com/AlgoFoundation/status/1157080267519135745) Also, what do the bullet points under the score mean? When you say decentralized development efforts what do you mean by decentralized efforts? Decentralized node validators? Governance? ***On a side-note, I am working on an academic article about decentralization and I hope to have it published by the end of this month if all goes well.

Who are they?

According to their website, CRC’s founding members include a conglomerate of cryptocurrency exchanges, financial firms, and custodial firms including: Coinbase, Kraken, Circle, Grayscale, Anchorage, Bittrex, Genesis, and Cumberland. According to their “About Us” web-page, CRC is: “a diverse group of leading crypto financial services firms committed to the responsible growth and maturation of cryptocurrency markets and related financial infrastructure and trading services. Our members share a belief that practical compliance tools can help cryptocurrency exchanges, custodians, trading desks, investment firms, and other financial services providers support the growth and adoption of this important asset class and related blockchain technologies in the U.S. and around the world.” (emphasis added)

Disclaimer: I do enjoy using all the exchanges listed as members especially Coinbase and Kraken, so this article is a little heavy for me.

CRC’s F.A.Q. page also states that CRC, “is a member-owned and operated organization whose purpose is to assess whether any given crypto asset, or whether the development, issuance, and use of such asset have characteristics that make it more or less likely to implicate federal securities laws. The CRC will publish a simple rating for most assets it reviews to indicate the results of its analysis as a reference for operators, developers, and the public.” What does this mean? Stated differently, this means that CRC is owned and operated by the 8 organizations listed above and their goal is to evaluate and rate cryptocurrencies on whether they believe they are a security or not under U.S. law. Only the 8 organizations can manage CRC and what they publish and no one else. That’s the distinction that comes with member managed as opposed to manager managed which allows managers or outside people to run the organization. So, if Binance wanted to be a member or have a say in their ratings, they would need to become a member otherwise they would need to just email and hope that the CRC reads their email.

How does it work?

CRC claims, “[e]ach question in the framework is assigned a points-based weighting to reflect its relative importance, the sum of which create scores for each Howey factor. Those scores are then scaled into a final rating between 1 and 5.” (Howey factors meaning factors that the US Supreme Court came up with from the case Howey v. USA and its progeny. For a quick refresher on Howey factors, see my article: found here) The point system can then be interpreted as a scale where a 1 rating being less likely to be a security and a 5 rating being more likely considered as a security. (Note: CRC says this is not intended to be legal advice, but in my view it comes pretty close to being legal advice which as other implications which I’ll save for a later date to discuss.)

Let’s review:

Now that we sort of know who the CRC is, what they do, and how they do it, let me raise a few questions for the readers to think about. On first impression those are some heavy hitters in the cryptocurrency space that are backing the CRC, but before anyone decides to give CRC any weight or credence in their “rating” system, let me raise a few questions for readers to think about based on missing information on their website. (Note: My fear is that by having so much weight or clout by being such large “trusted” entities for crytocurrency exchanges, it will indirectly influence people’s decisions. Also, if I overlooked or missed any information below, message me below, by email, telegram, or any other platform and I will gladly review and make necessary changes/edits to this article.)

Questions to think about:

1.We know who the member organizations that make up the CRC, but who are the teams working on this? What outside counsel are they using? According to CRC’s website we know the process goes like this:

Members select cryptocurrencies → outside counsel (lawyers) → outside counsel creates a memo and score → members’ legal team and technical experts receive outside counsel memo and score and vote to modify or ratify score.

But the one glaring question remains is who is working on this in terms of outside counsel to the members’ own legal team and technical experts? Then the follow up question is how much involvement do the technical experts have when members vote? Everything is based on context and without any, it’s hard to evaluate the veracity of this information.

a) Why is this important? Well, in the cryptocurrency space, I am constantly preaching do your own research and if you trust someone, you need to verify. How are we able to verify any of the possible teams who had any input on these scores and that they’re legal experts in this field? Secondly, how much weight is given to the technical experts once the memo and score is sent back to the members? The reason I ask this question is because a technical expert might be an expert in computer code, but that doesn’t mean they are necessarily an expert on law so without any information on how the final review is done, how do I know your score is legally sound and not manipulated/dominated by opinions of technical experts rather than lawyers? Because after all, this is a legal question and not a technical answer we are trying to answer.

2. What are the series of “yes or no” questions that the CRC came up with based on the Howey test? How many are there? Did they incorporate any of the SEC Digital Framework guidance? (Keep in mind that the SEC digital framework guidance is just guidance and is not law, but at the very least the people who drafted the guidance are attorneys.)

a) Why is this important? First, in the cryptocurrency sphere, transparency is king. Think about the premise of cryptocurrency and how public block explorers make information verifiable. In CRC’s case so far, none of the information they have given in terms of the rating system is verifiable. All they have done so far is come to conclusions without showing you their work. This runs against the basic tenant of cryptocurrency. This is essentially the same thing of when you’re in grade school and your math teacher only gives you partial credit on a math problem because you forgot to show your work.(Yes, I was notoriously guilty of this problem in grade school.) You might have gotten the answer correctly, but because you did not show how you arrived at your answer, you’re not given full credit.

3. What factors in Howey test did they decide to weigh more heavily than others? Under CRC’s framework since each question is scored, is the overall score averaged and out of how many possible points? Or is it a sliding scale that they’re using to come up with their score? If so, how does that sliding scale work?

a) This is important because it is similar to question 2 described above. As of right now, it seems like there is a black-box for information on how they reached their conclusion. There’s no context to how CRC arrived at their score. [If there are 4 factors in the Howey test and your point scale is 1–5 does that mean you’re asking only 4 questions and giving a score up to 5? I am speculating here because that’s all I can do at this point without any more information.]

4. When outside counsel began their review of rated cryptocurrencies, what information are they using and when was the information they’re using collected/produced? This question also applies to the members’ legal team and technical experts.

a) Why is this important? Well, we all know the cryptocurrency sphere moves and develops fast with new protocols etc., so if you’re using information about a cryptocurrency produced in 2016, it could very different by 2019. For instance, as SEC officials have stated before that they believe Ethereum in its inception was more likely a security, but it has evolved to the point where it’s “sufficiently decentralized” to possibly escape the security status. (See https://www.sec.gov/news/speech/speech-hinman-061418)

5. Does the ratings listed reflect the current state of the respective cryptocurrency network or does it reflect the cryptocurrency network near the time of launch/inception? This is related to question 4 listed above.

a) Why is this important? Same reasons as listed under question 4.

I certainly do applaud the CRC and their efforts to help add some clarity to the cryptocurrency space in terms of the whether a cryptocurrency is a security or not, but their attempt so far has left more questions than answers. I also applaud the CRC on taking the reign and trying to make sense of a very difficult legal concept. If the CRC is trying to provide an easier framework or guidance for evaluating whether a cryptocurrency is a security or not, the fact that I raised the questions above shows a lack of transparency and keep in mind that when the SEC released their digital asset framework guidance, they stated that they did so for the, “reduction of these information asymmetries through required disclosures protects investors and is one of the primary purposes of the federal securities laws.” (See Framework for “Investment Contract” Analysis of Digital Assets, (2019), https://www.sec.gov/files/dlt-framework.pdf.) The law is messy especially for new technologies that do not conform with existing laws and before we have any regulations that require disclosures, people need to always do their own research and verify everything that’s been stated by people/experts, including me and what I am writing about! Be like the state of Missouri, also known as the “Show Me State”. Be skeptical in what people are saying and in the end, tell them to “Show Me” your work or proof behind what you’re claiming, because after all, cryptocurrencies are based on provable mathematical expression and the basic premise is proof.

Stay tuned for more!

By: Alexander Liu, Esq., licensed to practice law in the State of Louisiana (Civil Law) and the State of Missouri (Common Law).