There are only a few months between the most successful ICO of 2017 and a turmoil of fights, lies and a flood of lawsuits at Tezos. In the meantime the company grew richer every day.

Tezos generated $232 million in fall 2017 through a sensational Initial Coin Offering (ICO). It was the largest of its kind to date. But instead of working on the promised product, the founders publicly quarreled with their leaders. The following class action suits for securities fraud could become a negative precedent for many companies that have collected funds through ICOs.

Ethereum on their honeymoon

Tezos is first and foremost the story of the young couple Kathleen and Arthur Breitman. Kathleen Breitman worked at Cornell University in New York as a consultant for Accenture, among others. After a short time as Strategy Associate with the Blockchain consortium R3 she founded with her husband Tezos. It was her husband Arthur, who brought the enthusiasm for Bitcoin thanks to his mathematical background — at a time when hardly anyone knew about it.

Arthur & Kathleen Breitman. Source: Everipedia.

Arthur Breitman took a printout of the entire Ethereum codebase on his honeymoon. While Ethereum was for Breitman already an advance over Bitcoin as a world computer, he found its governance mechanism too central — controlled by founder Vitalik Buterin and the Ethereum Foundation. To eliminate these weaknesses, in 2014 he wrote a white paper for Tezos, a self-amending cryptocurrency that could assimilate the best ideas on the market: “Tezos truly aims to be the last cryptocurrency”.

Special train to Zug

Johann Gevers. Source: Everipedia.

Breitman met Johann Gevers in the still manageable crypto scene. The South African living in Switzerland recommended financing Tezo’s idea through an Initial Coin Offering (ICO). Gevers had previously founded the digital payment provider Monetas. In his search for a place of jurisdiction that was favorably disposed towards alternative means of payment, he finally found what he was looking for in the Kanton of Zug in Switzerland. Zug was a small and rather poorer federal state when corporation tax was reduced to 0 percent in the 1940s. Today there are 29,000 companies per 115,000 inhabitants.

The Kanton of Zug has a particularly generous legal model for non-profit foundations. These are often founded by industrialists in order to give family assets to a good cause, but above all to save taxes. This model became the core of a flourishing crypto landscape whose companies wanted to implement ICOs with legal security.

Canton Zug in Orange. By Tschubby [GFDL or CC BY-SA 3.0], from Wikimedia Commons

Since foundations have to be non-profit organizations, active lawyers used a backdoor: First, an independent foundation is established to support an open source platform. Since with open source the intellectual property is freely usable for everyone, a non-profit aspect could be derived.

In order to support the public interest, no tokens would be sold at the ICO. Rather, the foundations accepted monetary values as donations and returned tokens as gifts. The foundation would then — under state supervision — use the money exclusively to build up the open source platform. A donation is not an investment. Therefore, the Foundation does not need to fear that the US Securities and Exchange Commission (SEC) and other financial supervisory authorities will impose severe conditions on it.

Anyone who now thinks that this is a cunning backdoor will be confirmed in August 2018 that the SEC thinks so, too. But more of that later.

In the meantime, Zug goes one step further and is the first municipality to pay taxes in cryptocurrencies. This is important because ICOs receive their funds in ether and sometimes also in bitcoin. Since many crypto companies have difficulties to exchange their crypto money for fiat, this is an advantage.

The mother of all ICOs

ICO Result 8 days before the sale ends. Massive.

Gevers and the Breitmans planned an ICO and set up a foundation for it. Gevers assumed the position of President of the Foundation. The Breitmans had no direct influence on the foundation in order to preserve the appearance of the non-profit character. Gevers got the sole right to sign documents. He would unlock the resources for a second company (Dynamic Ledger Solutions) — that of the Breitmans — to develop the software and community of Tezos.

The ICO raised the largest sum ever collected: $ 232 million.

From then on: downhill instead of tailwind

The contract between the Tezos Foundation and Dynamic Ledger Solutions provided that the latter owned the source code — the intellectual property. The foundation would buy the software within nine months for 8.5 percent of the amount recorded in the ICO.

But the coming months offered nothing but a publicly fought, small, dirty war between Gevers and Arthur Breitman. They voiced mutual accusations of incompetence, unethical influence of the foundation board and disagreement over personnel issues.

“Within weeks, the entirety of the Tezos Foundation, as documents later revealed, would consist of three directors, zero employees, two HR complaints, and open hostilities with the people who owned the actual intellectual property,” wrote journalist Gideon Lewis-Kraus, in WIRED. By the same time, the value of Tezos had almost doubled, as the ICO’s cryptocurrencies had risen sharply.

The Breitmans tried to remove Gevers from his post in October 2017, which the public did not miss. A Tezos community group published a detailed account of Gevers, portraying him as a confused libertarian driving all his companies to ruin. However, research by Reuters found more than just quarreling C levels. Not only was the marketing documents for the ICO exaggerated. Much worse was the proof that Katherine Breitman “sold” the token in her sales pitches. Named investors confirmed that they were not interested in the Tezo platform at all, but only bought the Token TEZ as an object of speculation.

It was therefore not surprising that one week after Reuters’ article, the first class-action lawsuit against Tezos was filed in the United States. The allegation: sale of unregistered securities and securities fraud.

While the ship Tezos slowly began to sink, the prices for Bitcoin, Ether, and Co. continued to rise in autumn 2017. Soon the Tezos fortune was worth more than a billion dollars. But without consensus, no one had access to it. “It’s not a corporate-governance matter anymore, it’s a hostage negotiation,” Katherine Breitman said.

In the meantime, the Breitmans had set up a second foundation and financed the development of the product from their own savings. One might almost wonder whether the ICO was necessary at all. In February 2018 Gevers resigned, sweetened by a settlement.

The Tezos duck quacks

Unfortunately, not everything was good for Tezos afterward. Although the sum of all tokens is worth $1.6 million, the Breitmans face new, serious problems. The foundation ICO in the Kanton of Zug did not offer the desired security from being considered a security — pun intended. The SEC followed the principle of the Howey test to determine whether an asset was a security:

1. is it an investment made with money?

2. is it possible to make profits from the investment?

3. is the investment made in an ordinary company?

4. Can profits be made by advertisers or other third parties?

In the case of Tezos, the SEC did not believe that it was a donation, but rather a security. The saying “If it walks like a duck and if it quacks like a duck, it is probably a duck” is often used in this case. In August 2018, the US courts ruled that lawsuits against Tezos in the US and in respect of securities were admissible. It is likely that an avalanche of lawsuits is rolling in on Tezos. It is equally likely that it will enthrall many other Zug-based ICO companies. More about this development on Fintelegram.

The former COO of the Tezos Foundation told the journalist Lewis-Kraus “I was astonished at how this anarcho-capitalist community was going to cannibalize themselves.”

The aftermath

On 30 June 2018, the mainnet of Tezos went live. They actually made it, giving proof to all doubters that they actually want and are able to create a blockchain product. But then the market is in a downward spiral, the mood is bad and there are not many good news emerging form the blockchain industry. Tezos is up and running with some sort of system without much fanfare. In the meantime the SEC-backed lawsuits are looming over the project.

This story is published in The Startup, Medium’s largest entrepreneurship publication followed by + 378,907 people.

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