Why India Needs Crypto
Telegram’s TON is Over: The Full Saga Behind the Failed Blockchain Project
On Tuesday, May 12, Telegram founder and CEO Pavel Durov announced the end of the Telegram Open Network (TON), the firm’s highly-anticipated blockchain platform. The company had raised almost $2 billion in 2018 to fund the development of TON and its native cryptocurrency.
In an article titled “What Was TON And Why It Is Over,” published on Durov’s own Telegram channel Tuesday, he explained that Telegram was officially ending its work on TON due to regulatory obstacles it faced in the United States in the lead up to the platform’s launch.
As Durov’s post states, the platform — whose launch date had been repeatedly delayed over the past seven months — aimed to be an open-source, decentralized blockchain protocol with a focus on speed and scalability.
Since October 2019, the U.S. Securities and Exchange Commission has engaged Telegram and TON in a legal battle over the nature of TON’s native cryptocurrency, Gram. The SEC argues that Gram is a security and that launching it — anywhere in the world — violates U.S. securities laws.
The ongoing dispute escalated in late March and early April, when a New York district court ruled in favor of the SEC’s argument that Grams are securities.
What is Telegram?
Referred to as the preferred messenger app in the crypto space, Telegram is an encrypted cloud-based messaging app with over 400 million users worldwide, as of late April. The app was created in 2013 by Durov and his brother, Nikolai, the Russian entrepreneurs who also created the country’s largest social network, VKontakte (VK).
In April 2014, Pavel was reportedly dismissed as CEO of VK and forced to sell his stake in the firm. He left Russia soon after, reportedly obtaining citizenship in St. Kitts and Nevis. Since the incident, and along with the rise in Telegram’s popularity, Pavel in particular has been hailed globally as an advocate for freedom, privacy and decentralization — especially as Telegram faced government attempts to shut the messenger down in Russia, Iran and China, among other states.
News of Telegram’s plan to launch its own blockchain platform emerged in late 2017. The TON whitepaper, first leaked to the public in January 2018, highlights scalability and speed, claiming the network could eventually compete with VISA or Mastercard.
By the first half of 2018, the company had raised over $1.7 billion dollars in what many referred to as a private initial coin offering (ICO). As investors reportedly noted at the time, however, Telegram’s token sale had little in common with the public ICOs whose popularity peaked in 2017. During the public ICO frenzy, a slew of blockchain projects — or those who claimed to be — sold their tokens to the general public, usually in exchange for major cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH).
Instead, Telegram’s sale of Grams — or, to be more specific, IOUs to deliver Grams, referred to as “Purchase Agreements” in court documents — had more in common with venture capital funding. Grams were sold for fiat money, specifically euros and U.S. dollars, to a select group of high-profile investors.
Between February and March 2018, Telegram held two consecutive rounds of private fundraising, raising $850 million each time.
According to the SEC’s October 11, 2019 court filing, $424.5 million of the raised capital came from 39 U.S. investors, who purchased a total of 1 billion Gram Purchase Agreements.
The purchase agreements that Telegram sold to TON investors promised that the launch of the network, and the concurrent delivery of the actual Gram tokens, would take place on October 31, 2019.
Telegram filed for exemption from US securities law
When Telegram undertook its two private fundraising sales of Gram, the firm was evidently careful to comply with applicable regulations, at least in regard to U.S. investors. In the U.S. — notorious for its lack of regulatory clarity and guidance around crypto, especially in regards to securities law — Telegram made a point of filing for exemption with the SEC for both of its purchase agreement sales.
By filing the SEC’s Form D (Notice of Exempt Offering of Securities), Telegram acknowledged that the Gram purchase agreements could be considered securities under U.S. law. Form D allows the issuer to sell securities within the U.S. without registering with the SEC, if the sale meets certain requirements.
As the SEC notes on its website, accredited investors who purchase securities under this exemption are not allowed to sell said securities for “at least six months or a year without registering them.”
The SEC admits in court documents that Telegram included a warning in the Gram purchase agreements, evidently playing it safe, that stated that “the offer and sale of this security [the Gram purchase agreement itself] has not been registered under the U.S. Securities Act of 1933” and “may not be offered, sold or otherwise transferred…except pursuant to an effective registration statements.”
SEC cracks down on TON
On October 11, 2019, twenty days ahead of the planned launch of TON, the SEC filed an emergency action and temporary restraining order to stop Telegram from launching TON. The move marked the beginning of the end for the TON project.
The SEC asked the court to stop Telegram from “delivering Grams to any persons, or taking any other steps to effect any unregistered offer or sale of Grams[.]”
The SEC’s action, filed with a district court in New York, accused Telegram Group Inc., and its subsidiary, TON Issuer Inc., of violating federal securities law — despite the firm’s attempts to obtain exemptions for its private sales.
First of all, the Commission flatly stated that it considered both the purchase agreements (the Gram IOUs) and the Gram tokens themselves securities. Grams, the SEC argued in its complaint, thus had to be registered as securities before they were launched and distributed to investors.
The SEC divided its argument that Telegram was violating securities laws into what appears to be two main points. The first violation, the Commission alleged, already happened: the sale of Gram purchase agreements in 2018 did not in fact qualify for exemption.
The second violation, according to the SEC, is more future-oriented. The agency argues that Grams themselves are securities and that Telegram “intends” to sell “or otherwise distribute” Grams to the public once TON launches.
“Telegram offered and sold securities and intends to offer and sell Grams to the public in the future,” the SEC concluded in its complaint.
The SEC made it clear that it believes that Telegram intended for Grams to be traded on exchanges as soon as the token was launched.
Secondary markets selling ‘Grams’ before launch
In the summer of 2019, reports emerged that cryptocurrency platforms were selling Gram tokens, though the tokens themselves had, of course, yet to be launched. Neither of the exchanges had access to actual Grams, nor were these secondary, speculative sales publicly approved or endorsed by Telegram or TON. But the moves indicated the demand and hype building up around TON in the lead up to its planned launch.
The two most well-known cases were crypto exchanges Liquid and Bitforex, which announced their Gram sales in June and July 2019, respectively. Liquid announced that it was the “exclusive platform” for the sale of Gram, stating that it had received a supply of Grams from the largest investor in the token in Asia. Bitforex claimed that it had 1 million Gram available for sale, “[f]ollowing a direct agreement with a participant in Telegram’s original private token sale.” More specifically, Bitforex said what it was selling users were actually “Futures Physical Delivery Contracts” in exchange for USDT.
Gram purchase agreements as securities
The SEC’s October 2019 legal proceedings put Telegram and its TON ambitions in a very difficult predicament. The company shored up its defenses and delayed the launch from October 31, 2019, to April 30, 2020.
In Telegram’s defense, filed on January 14, 2020, the firm accused the SEC of conflating its assessment of the purchase agreements and the tokens themselves, as well as using deliberately unclear arguments.
Given that Telegram, by all reports did in fact sell Gram purchase agreements to accredited investors in the U.S., why wouldn’t the sales be exempt from securities law?
The crux of the SEC’s allegation hinges on the notion that the accredited investors in TON were in fact “underwriters.” According to the SEC’s complaint, underwriters “include all persons who might operate as conduits for securities being placed into the hands of the investing public.”
The SEC argues that the TON investors are underwriters as they are “likely to promptly resell millions of them [Grams] into the public markets.” Not only will investors “promptly resell” their Grams for profit, but Telegram itself will “facilitate these sales,” the SEC alleged.
The SEC also pointed to expectations of profit in its argument, alleging that the initial investors were motivated by these expectations to act as “conduits” for selling Grams to the public. Evidently, the SEC’s argument for why an exception does not apply in this case is focused on the intent of both Telegram and the initial investors:
“The exemptions for private offerings do not apply to Grams because, among other things, the Initial Purchasers intended to resell Grams that they purchased at a steep discount to new investors. Indeed, if they could not engage in these resales, none of the Initial Purchasers’ investments would be profitable”
The “steep discount” refers to the fact that the Gram purchase agreements were sold at a lower price than what Telegram allegedly expected the price of Grams to be when they launched.
More broadly, the SEC’s argument claims that Telegram had always planned for the large-scale distribution of Gram, stating that the blockchain was “designed from inception to require the Initial Purchasers to immediately distribute their holdings to the public.” The SEC’s complaint continues:
“Telegram has, with its offers and sales to Initial Purchasers, begun a distribution of securities, which involves the flow of securities from an issuer through conduits and out to the public at large”
Speaking about its concern, the SEC uses explicitly hypothetical language, stating:
“Defendants plan to sell billions of securities that will quickly come to rest in the hands of U.S. investors without providing those investors important information about their business operations, financial condition, risk factors and management.”
For its part, Telegram argues in its defense that the 2018 purchase agreements with accredited investors and the delivery of the Grams when the TON blockchain is launched constitute two distinct transactions. They should, according to the defense, be scrutinized separately from a securities law perspective. The SEC should, by this logic, conduct the Howey test at the launch of the TON blockchain and not before.
Telegram also noted that it had spent 18 months soliciting advice and guidance from the SEC and had met with and communicated with the agency many times. Yet the firm claims it did not receive “meaningful guidance” and that the SEC’s complaint was unexpected and “rushed.” Telegram also criticized April 2019 guidance on determining whether or not digital assets are securities, released by the SEC’s Strategic Hub for Innovation and Financial Technology, as being too vague.
Telegram further argued that the question of whether or not the Gram purchase agreements were securities was irrelevant, as the sale was exempt from registration requirements. Telegram’s defense criticizes the SEC’s focus on the purchase agreements being securities — and its inclusion of private communications between the firm and investors — emphasizing that the firm filed for exemption precisely because of this possibility.
Gram tokens as securities
In addition to the Gram purchase agreements being securities, the SEC stated that it considers Gram tokens themselves — which have yet to be launched — also securities.
In the October 2019 complaint against Telegram, the SEC stated that its ruling on the yet-to-be-launched tokens also has to do with expected profit:
“Grams are securities because the Initial Purchasers and subsequent investors expect to profit from Telegram’s work: the development of a TON ‘ecosystem,’ integration with Messenger, and implementation of the new TON Blockchain.”
The SEC uses the so-called “Howey test” to determine whether or not an asset is a security, and more specifically an “investment contract,” in the U.S. If it is, then the asset must be registered with the SEC in order to be sold on U.S. markets.
Investment contracts, as the SEC summarized in their complaint, are “instruments through which an individual invests money in a common enterprise and reasonably expects profits or returns derived from the entrepreneurial or managerial efforts of others.”
In the case of Gram, the SEC determined that the tokens should be classified as investment contracts. Explicitly using the language of the Howey test, the SEC’s conclusion was that purchases of Grams — both via purchase agreements and actual, potential tokens — fit the bill of a security:
“The Initial Purchasers’ purchases of Grams, and any subsequent purchases of Grams, were and will be an investment of money, in a common enterprise, with an expectation of profits, derived primarily from the current and future entrepreneurial and managerial efforts of Defendants and their agents to build the TON Blockchain and drive demand for Grams. Consequently, Telegram’s offer and sale of Grams to Initial Purchasers, and any upcoming, offers, sales, or distributions of Grams were and will be offers and sales of securities.”
Telegram says Gram is not a security, but a currency or commodity
Telegram’s defense refuted the SEC’s interpretation of the Howey test on the actual token Gram based on two points. Telegram argued that Gram, upon launch, could not be considered to be a “common enterprise.” The firm also refuted the notion that purchasers of Gram tokens could have expectations of profit based on Telegram’s efforts.
Both of Telegram’s arguments are based on its previous statements that the TON blockchain will be decentralized and open-source when launched and that Telegram will not maintain control over its development. A post from Telegram on Jan. 6 — which the firm quoted in its response in court — states “Telegram does not, and cannot, guarantee that anyone will adopt or implement such features or provide such services, on any given timetable or at all.”
Telegram argues that Gram, when launched, will function as a currency or even a commodity, like gold or silver. In its legal defense, the firm states that “Grams are intended to function as a store of value and a medium of exchange on the TON Blockchain, similar to the functionality of Bitcoin.”
Unlike securities or stocks, Telegram argues that Gram tokens do not represent “any equity or other ownership interest in Telegram, any rights to dividends or other distribution rights from Telegram, or any governance rights in Telegram.”
Telegram’s claim that Gram would function as money is a notion laid out in TON’s documentation to investors. The firm explained that Gram would be the native cryptocurrency of the TON blockchain and as such could be used with the ecosystem of decentralized applications expected to form around it, similar to ETH within the Ethereum ecosystem.
In its original complaint, the SEC attempted to refute the notion of Gram as money by stating that none of the potential uses of Gram that Telegram described “existed at any time and Grams do not have legal tender status in any jurisdiction […] There are not now and have never been any products or services that can be purchased with Grams.”
The statement appears to imply that decentralized cryptocurrencies — such as BTC or ETH — need to be legal tender to function as money. About Gram’s use for potential services and tools built on TON, Telegram’s response to the SEC was that third-party developers had already begun creating applications for Gram, a trend it would expect to continue.
The Telegram and TON connection
Despite Telegram’s repeated claims that it would not control or oversee the development of TON after it was launched, one of the SEC’s main claims centered on the very opposite notion. At stake, again, is one of the pillars of the Howey test — expectation of profit based on Telegram’s work.
The SEC alleges that Telegram made it clear that profits from Gram were in fact directly related to the firm’s performance, claiming:
“Telegram emphasized to investors, and some Initial Purchasers stated in communications that they understood, that Telegram, Messenger, and the Durovs were integral to the success of the TON Blockchain project and Grams.”
The SEC highlighted the relationship between the TON blockchain and the Telegram messenger, arguing that the initial investors in TON were under the impression that there was an “inextricable connection between Grams and Messenger.”
According to the SEC’s complaint, Telegram’s indication of interest document to investors stated that the firm would “use proceeds generated by the sale of Grams to develop and launch the TON Network and develop associated functionality within Telegram Messenger.”
Other documents from 2018, the SEC reported, contain even more explicit references to Telegram’s user base providing for mass adoption of Grams.
The Commission also emphasized Telegram’s privacy-centric features in stating that “once Grams are distributed to the public, it may be difficult, if not impossible, to trace who has purchased Grams and/or to know who is a current investor in Grams.”
The SEC complaint concludes on the topic:
“The Offering Documents and other communications made clear in other ways that investors could reasonably expect Defendants’ efforts for the enterprise to continue after the launch of Grams and that Telegram and/or its founders would retain a financial interest and the primary role in the success of the proposed TON even after the launch of Grams.”
Telegram’s defense points to the timing of the statements quoted by the SEC in refuting the claims. The firm argues that statements about Telegram’s qualifications and involvement in building TON were, naturally, provided to the sophisticated investors taking part in the sale of Gram purchase agreements in 2018.
However, Telegram argues, the firm was careful not to publicly comment on Telegram’s plans for TON. As of the Jan. 6, 2020 post especially, the firm had make explicitly clear that by the time the public could buy Grams, Telegram itself would no longer control the project.
The court’s ruling: Telegram’s ‘scheme’
On March 24, 2020, the U.S. District Court of Southern New York’s Judge P. Kevin Castel ruled in favor of the SEC in the commission’s ongoing case against Telegram and promised to stop TON from launching.
Judge Castel’s ruling supported the SEC’s principal argument that the entirety of the TON project’s sale of Grams was an unregistered offering of securities:
“Examining the totality of the evidence and considering the economic realities, the Court finds that the SEC has shown a substantial likelihood of success in proving that the 2018 Sales were part of a larger scheme, manifested by Telegram’s actions, conduct, statements, and understandings, to offer Grams to the Initial Purchasers with the intent and purpose that these Grams be distributed in a secondary public market, which is the offering of securities under Howey.”
In response to the March 24 ruling, Telegram filed a notice of appeal to the U.S. Court of Appeals for the Second Circuit that same day. Three days later, the firm filed a letter to the court bringing up the issue of implications for non-U.S. investors, which, Telegram reports, constituted 70 percent of investors. The letter also added that Telegram could “implement safeguards” to prevent U.S. investors from purchasing Grams in the future.
Despite Telegram’s appeal and offer to exclude U.S. citizens entirely, the judge was unmoved. On April 1, the court ultimately upheld its March 24 ruling, denying Telegram the ability to freely distribute Grams to any person/entity within or outside of the U.S.
The Judge specifically noted that Telegram had not expressly noted the international scope of the SEC’s original complaint in their January 2020 response, which made it seem like an after thought evidently weakened its argument in the March 27 letter.
The final ruling also somewhat clarified the SEC’s original claims by referring to Telegram’s alleged securities violation as an “entire scheme.” According to the judge, the argument isn’t about whether purchase agreements or Gram tokens themselves were securities — rather the security is Telegram’s “entire scheme” of first selling to accredited investors with the intention that those investors would then sell Grams to the public.
Interestingly, neither the SEC nor the Judge explicitly brought up the timing window for the resale of securities that is laid out in Rule 506, mentioned above.
The final ruling concluded that this allegedly intended private-public sale is “likely to involve U.S. purchasers,” meaning, in the SEC’s eyes, it must be stopped entirely.
In Tuesday’s post announcing TON’s shutdown, Telegram’s CEO attempted to explain the SEC’s — and consequentially the court’s — logic using a gold mine as an analogy, where TON is the gold mine and Grams are the gold:
“Imagine that several people put their money together to build a gold mine – and to later split the gold that comes out of it. Then a judge comes and tells the mine builders: ‘Many people invested in the gold mine because they were looking for profits. And they didn’t want that gold for themselves, they wanted to sell it to other people. Because of this, you are not allowed to give them the gold.’ […] A judge used this reasoning to rule that people should not be allowed to buy or sell Grams like they can buy or sell Bitcoins.”
In the wake of the court ruling, Telegram sent a letter on May 4 to U.S. TON investors in particular, telling them to leave the project. The firm cited “uncertain regulatory attitude in the United States” as the reason behind the move.
Telegram told U.S. investors that it would refund 72 percent of their funds. The move was an update from another notice to all TON investors on April 30, which left them with a choice of taking either the 72 percent refund right away or waiting until April 2021 for a 110 percent refund via loan. April 2021 also became the new target launch date for the blockchain project.
Telegram’s April 30 notice to investors indicated that the firm was still speaking to regulators and left open the possibility that other methods of repayment may become available by TON’s launch:
“We are continuing to engage in discussions with the relevant authorities in connection with TON and the issuance of tokens to the original purchasers. If we obtain the relevant permissions prior to April 30, 2021, purchasers who opted for the loan will have the further option to receive Grams or potentially another cryptocurrency on the same terms as those in their original Purchase Agreements (to the extent allowed by applicable regulatory restrictions).”
Telegram reaffirmed its commitment to investors by adding that, in the event that the SEC does not allow the issuance of any cryptocurrency by the April 30, 2021 deadline, the company will repay its debt via equity (the firm is currently 100 percent owned by its CEO).
The company’s news release, which was circulated via email to TON investors, ended with a measured but still optimistic note:
“We are thankful for your trust and support over the last two years. We are very proud of the technology we built for TON, and regret that the project has not yet been permitted to launch.”
Devs launch TON version without Telegram
Given TON’s open-source nature, developers outside of Telegram and TON could technically work on it and launch it separately.
Last week — even before the news of Telegram’s withdrawal from TON — a startup announced that it was doing just that. The firm, Ton Labs, launched their own version of the TON blockchain — effectively a hard fork — dubbed Free TON. The startup is not officially associated with Telegram or the original TON, but it did previously run TON’s test network.
Ton Labs said its goal is to make the network available to the public without waiting for Telegram to pass regulatory obstacles, specifically those with the SEC.
“The network must not be censored, it must go to the world,” TON Labs chief technology officer Mitya Goroshevsky said on a live-streamed Zoom call on May 7. During the call, the team launched the network’s genesis block.
In yesterday’s post, Durov noted the likelihood that projects separate from Telegram and TON would potentially use the project’s code and brand. He clarified:
“No present or past member of our team is involved with any of these projects. While networks based on the technology we built for TON may appear, we won’t have any affiliation with them and are unlikely to ever support them in any way.”
The statement is in line with what Telegram has previously publicly stated:
“The code for the TON Blockchain will always be open source and publicly viewable. Once it is launched, Telegram will occupy the same position as any other party with respect to the TON Blockchain and will not have any control over, any unique rights within, or any responsibility for the management of, the TON Blockchain.”
Telegram’s decision to drop TON
In his post on Tuesday, Durov expressed frustration and sadness in the face of the SEC’s battle to block the launch of the TON blockchain.
Telegram’s founder explained that the firm was, in the end, giving up on launching its blockchain platform globally because of the obstacles it had faced with U.S. regulators specifically.
In the post, Durov explained that the decision to halt TON leans on what he sees as the U.S.’s hegemonic hold on global finance and technology. Explaining the reason why the firm is giving up its highly-anticipated project of 2.5 years, he stated:
“This court decision implies that other countries don’t have the sovereignty to decide what is good and what is bad for their own citizens […] Sadly, the US judge is right about one thing: we, the people outside the US, can vote for our presidents and elect our parliaments, but we are still dependent on the United States when it comes to finance and technology (luckily not coffee).”
Durov’s criticism of the US
In a separate post published in Russian on May 7, Durov responded to a recent video from one of Russia’s most popular YouTube bloggers. The video featured Russian expat entrepreneurs who had moved to Silicon Valley and become successful there. Durov criticized what he saw as the video’s onesidedness, laying out seven reasons for entrepreneurs not to move to Silicon Valley.
In effect, his post criticizes not only the tech industry hub, but U.S. policy and living standards in general, including high taxes, a police state and inaccessible healthcare among the seven reasons. He concluded the article with the statement:
“America is still able to lure some of the already established entrepreneurs and developers from around the world with cheap investor money, but moving to the United States today is akin to buying an asset at its peak value.”
Crypto community reacts
On crypto Twitter, industry commentators generally met the news of TON’s shutdown with disappointment, and a touch of scorn.
Michael Arrington, founder of TechCrunch, commented on the court’s decision in a tweet on May 12, calling it “absurd”:
The Block founder Mike Dudas expressed disappointment at the turn of events, also taking a jab at Telegram’s record funding:
Meltem Demirors, chief strategy officer of CoinShares, also questioned the massive funding round in a tweet the same day, stating:
“[…]perhaps one can create ‘decentralization, balance, and equity in the world’ without $1.7B for a token?”
New York Times tech reporter Nathaniel Popper, who often covers crypto and blockchain, provided a different, more cynical perspective. He argued that Telegram’s decision to fight the case was ill-advised:
Is Durov protecting Telegram?
Considering all of the elements of Telegram’s (still technically ongoing) saga with the SEC, some major questions remain: why wouldn’t Telegram just register Grams as securities in the U.S. after the SEC’s complaint? What was really at risk when Durov made the decision to shut down such a high-profile and anticipated project?
For now, the industry can only speculate. However, in his last post, announcing the end of TON, Durov provides what could be taken as a hint at the deeper motivations behind his decision.
When Telegram’s CEO notes U.S. dominance in technology and finance globally, he specifically states that the U.S. “can use its control over Apple and Google to remove apps from the App Store and Google Play.” He continues:
“So yes, it is true that other countries do not have full sovereignty over what to allow on their territory. Unfortunately, we – the 96% of the world’s population living elsewhere – are dependent on decision makers elected by the 4% living in the US.”
The mention of removing apps seems to be no accident, given that Durov has faced multiple major government bans of the Telegram app. Possibly for Durov, and for Telegram more broadly, the stakes of complying with U.S. regulations could be the existence of not just TON, but the Telegram app itself, whose main avenues for distribution are controlled by two U.S. giants.