Cryptocurrency: the Origin and Growth of Coinopoly

Mired in the aftermath of the U.S. financial crisis, the year 2009 may have started one of the largest financial revolutions since the birth of paper currency in 1690. Much like its predecessors, cryptocurrency faces an uphill battle of understanding, trust, and proper regulation. Eight years since its inception, cryptocurrency has maintained its allure with startups and financial intermediaries, but is still a misunderstood concept to many. We hope to clarify this misunderstanding in a series of posts, beginning here with the basics of cryptocurrency and later discussing blockchain, initial coin offerings, and the current laws and regulations applicable to this industry.

Cryptocurrency is, by any other name, a currency—a medium of exchange used to purchase goods and services. Or, as some have suggested, cryptocurrency is a “peer-to-peer version of electronic cash.” However, this currency has two qualities that distinguish it from traditional bills and coins. First, cryptocurrency is a virtual currency that is created through cryptography (i.e. coding) and developed by mathematical formulas through a process called mining. Secondly, unlike traditional bills and coins that are printed and minted by governments around the world, cryptocurrency is not tied to any one government, and thus is not secured by any one government. This is often referred to as being decentralized.

Cryptocurrency is based on a cryptographic code that can be created (as described by Ethereum here) or based on existing open source software available through platforms like GitHub. Open source software is freely accessible code intended to be shared and improved. We discussed it in more detail in one of our previous blogs. The readily available open source software is what makes cryptocurrency decentralized—no one person or entity has the ability to control how many types of cryptocurrency are out there. According to Coinmarketcap.com, currently, there are close to 900 different cryptocurrencies. In comparison, there are about 180 currencies in the world that are recognized legal tender, and virtual currency is not among them.

As a decentralized currency, cryptocurrency is not subject to the inflationary pressures of legally recognized tender. For example, the cryptocurrency Bitcoin has a finite number in circulation, meaning the 21 million outstanding Bitcoins are all there will ever be. Because it cannot be reprinted or minted, like government backed bills and coins, its value is determined by basic economic principles, including supply and demand and allocation of scarce resources. A finite number of Bitcoins means that when the demand for Bitcoins increases and the supply stays the same, then the price of Bitcoin would increase, and vice versa.

Being a decentralized currency comes with flaws, especially as it relates to value. Giving someone a $20 bill has immediate and apparent value because it is backed by the full faith and credit of the U.S. Treasury. A cryptographic code on the other hand has initially little value. This is where the term “mining” comes in. The owner of the original code of the cryptocurrency works with miners to build the currency’s value. In other words, the original coin holder—the developer of the code—needs to exchange the coin for something. The original coin holder will provide coins to miners and, in exchange, the miners will process transactions by confirming and writing them into the distributed ledger. These transactions are recorded as blocks in a long list on the ledger, which creates the blockchain (which will be discussed in detail in the next post). Whether it is an ordinary bank account to withdraw cash from or it is cryptocurrency’s distributed ledger, both function as a historical record of value based on entries (i.e. transactions) from the third-party servicers—banks when dealing with cash or miners when dealing with cryptocurrency.

Of course, the virtual coin only has value if it can be exchanged for traditional goods and services, like the $20 bill. This heavily relies on marketing the cryptocurrency as a valid form of payment; not unlike paper money back in 1690. As described by Chris Ellis, developer of Feathercoin, “Money is a ledger, it is a tool that people will use as a way of achieving their goals and satisfying their needs.”

Various cryptocurrencies have developed into household names, such as Bitcoin, Ethereum, Feathercoin, and many others because of the potential use now available to cryptocurrencies. Cryptocurrencies can be stored and carried around in different types of wallets, including physical wallets that look like paper money, flash drives, and online wallets, and can be exchanged for goods and services at restaurants, online retailers, television providers, and even donated to charitable organizations. Our law firm, for example, accepts Bitcoin payments. As opposed to concerns from critics that this is just Tulipmania and we are ascribing value to an otherwise valueless item, the potential for cryptocurrencies as a medium of exchange is enormous.

The growth in cryptocurrencies begs the questions regarding security, rules and regulations, and ultimately how to utilize the blockchain and cryptocurrencies in other sectors or the financial industry. The following posts in this series will cover these issues and more in depth.

This article is not legal advice, and was written for general information purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its authors, Andrew Silvia and Arina Shulga of Ross & Shulga PLLC.  We are a New York-based law firm specializing in advising individual and corporate clients on various aspects of corporate and securities law, including initial coin offerings.

Endorsement Guidelines for Social Media Influencers

Social media influencers have become an essential component of many marketing campaigns.  Influencers have audience that listens to what they say.  Building a relationship with an influencer enables the brand to reach the influencer's audience that is more likely to buy the brand's offerings based on a peer review rather than ads. Many big brands ask influencers to partner with them and offer them compensation for posting blogs, tweets or videos about their products.

All this is legal so long as influencers clearly disclose what, if anything, they get from the brands in return for their posts as well as any relationships that exist between them and the brands.  In March 2017, the Federal Trade Commission ("FTC") issued more than 90 letters to brands and influencers warning them about appropriate disclosures.  Some of these letters are available here.  

In the letters, the FTC reminded both endorsers (influencers) and marketers (brands) that endorsers must disclose any "material connection" that exists between them because such connection can influence the weight or credibility that consumers give to the endorsement.  A "material connection" may consist of a business or family relationship, monetary payment, or the provision of free products to the influencer.   

The FTC letters refer to the Endorsement Guides that apply to both marketers and endorsers.  There is also a helpful FTC staff publication "The Endorsement Guides: What People are Asking" that describes the Guides in a Q&A format.  The publication explains that if an endorser is acting on behalf of an advertiser, then what the endorser is saying becomes commercial speech that may violate the FTC Act if it is deceptive.  

It doesn't mean that endorsers have to disclose everything.  The test here is whether knowing about the gift, the incentive or the special relationship would affect the weight or credibility the viewers give to the recommendation.  There is no needed disclosure if the influencer bought the product herself.  There is also no needed disclosure if the store was giving out free samples to all its customers and the influencer received one of them.  However, disclosure would be warranted if the brand / advertiser gave something of value to the influencer in exchange for posting a review.  For example, a reviewer of restaurants would need to disclose if she received any free meals at the places she reviewed.  Or, in my case, I would need to disclose in this blog if I wrote a review of a book that the publisher sent to me for free.  Or, according to the FTC letter, Sean Combs would have had to disclose that he is the owner and director of AQUAhydrate when he posted on Instagram a picture of two bottles of AQUAhydrate water and wrote "Let's GO!!! @aquahydrate #balance #hydrate #tryIT."

So, to summarize: 

• Endorsers must disclose all material connections, including financial, family or friendship ties to the brands;
• Such disclosures must be clear and conspicuous, such that they appear above the "more" button in an Instagram post and are not hidden among the hashtags; and
• Endorsers should avoid unclear and confusing hashtags.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.

Why Small Businesses Need Buy-Sell Agreements

One of the agreements that comes up time over time in my practice is a buy-sell agreement.  These are contracts between shareholders of a corporation, partners of a partnership or members of a limited liability company and the business entity itself (although, as you will see, this is optional).  The buy-sell agreements ensure that the business interest of either deceased, disabled or departing owner is transferred to the entity or the co-owner(s) according to the predetermined and agreed upon guidelines.

Why Do You Need a Buy-Sell Agreement

In the absence of a buy-sell agreement in the case of death, the decedent's business interest will pass by the terms of his or her will or the laws of intestacy. This means that the remaining owner could become business partners with people who have little or no interest in running the business or the necessary skills to do so.  Alternatively, the heirs could sell the decedent's interest in the company to an unknown outside buyer who may not unfriendly to the remaining owner.  A buy-sell ensures business continuity while providing the needed cash to the deceased partner's family to handle estate tax and funeral expenses.

A buy-sell agreement can also resolve issues surrounding a business owner's disability.  Imagine a business owner who is critical to the business' operations but becomes disabled.  This could potentially be devastating for the business.  The remaining owner would be left alone to handle business operations while trying to figure out for how long to pay the disabled partner and from what source.  The disabled partner may want to be bought out, or his or her spouse and children may want to step in to run the business instead.  The disability buy-sell addresses the issue of the purchase of the disabled owner's interest, continued salary payments and management continuity.

Buy-sell agreements are also used in the cases of:

• termination for cause (such as when the owner stops performing his or her duties or becomes convicted of a crime)
• personal bankruptcy 
• divorce
• voluntary retirement
• loss of professional license.

Funding Buy-Sell Agreements

There are four different ways to fund a buy-sell.

One way is to put aside cash from earnings and create a savings plan, often referred to as the sinking fund.  The danger here is that the fund could get diverted to pay for urgent business-related expenses, leaving the buy-sell underfunded.

Another way is to borrow the money.  However, not all businesses can obtain good terms on a loan.  Also, loan repayment would decrease the company's cash flow and impact credit availability.

The third way is to pay the buyout price over an installment period that is agreed to ahead of time in the buy-sell agreement.  Here, it is the departing owner who faces most of the risk.  He or she risks not getting the full buyout price if the business fails, since the ability to grow the business is now in the hands of the remaining partner(s).

The fourth and final way is to buy life or disability insurance on the lives of the owners.  A permanent insurance policy can also be used for retirement buyouts. However, insurance is not available for all types of buyout scenarios outlined above.  So, some combination of the payment methods is needed to fund a  comprehensive buy-sell agreement.

Entity or Cross-Purchase Buy-Sell

One last thing that I'd like to mention is that sometimes it makes more sense for the owners to buy insurance on each other (a cross-purchase arrangement) than for the company to do so (stock redemption).  In such cases, the company itself is not a party to the agreement.  Each individual partner is the owner, beneficiary and premium payor of the policy on the life of the co-owner.  This may make sense from the tax planning perspective.  I am not a tax specialist, so I encourage to consult with one about this.

If, for example, there are two owners, each of whom has invested $100,000 in the business and holds 50% of its stock.  The company is currently valued at $700,000.  Owner A dies.  The company uses its death insurance proceeds to buy out A's shares.  A's shares become treasury stock.  B remains the sole owner of the corporation.  B's shares are now valued at $700,000 - the full value of the corporation.  B's basis in the stock is $50,000.  When he sells his shares, he realizes taxable gain of $650,000.  On the other hand, if A and B cross-insured each other, then upon A's death, B would pay $350,000 to A in insurance proceeds to purchase A's stock.  B's basis in the stock would then be $400,000.  So, his realized taxable gain on the sale of this stock would be much smaller, $250,000.  In this oversimplified scenario, using a cross-over arrangement results in significant tax savings for the surviving partner.

In conclusion, I recommend for all small and closely held businesses to consider entering into buy-sell agreements or including buy-sell provisions in their shareholder, partnership or operating agreements.  Drafting buy-sell agreements requires not just legal, but also financial and tax expertise.  It is worth the investment of time and money to ensure successful business continuation.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.