Ethereum just got overrun with cats; the cats are literally slowing down the network with their feline machinations, their idiosyncratic personalities, and yes, their breeding… lots of cat breeding… on Ethereum. The cats are called CryptoKitties. Just like bitcoins or ether, CryptoKitties are peer-to-peer tradeable, provably scarce digital items that are accounted for by an open blockchain network. Unlike those cryptocurrencies, each item (each kitty) is unique with its own set of attributes: striped, droopy-eyed, slow (yes, slow is one), and many more.
Rather like some of the ICOs you might have read about, there is a company that is selling some of these digital items and financing its operation from those sales. From their FAQ:
The CryptoKitties team releases a new “Gen 0” CryptoKitty every fifteen minutes (up until November 2018). The starting price of “Gen 0” CryptoKitties is determined by the average price of the last five CryptoKitties that were sold, plus 50%.
There are complicated and controversial legal arguments about why some ICOs might be unregistered securities issuance while other might not be. The SEC has yet to offer a bright line test but has identified a few specific projects as securities and indicated that it looks to the flexible test for an “investment contract,” the so-called Howey Test, in order to determine whether any particular token sale is securities issuance. Our framework for securities regulation of cryptocurrencies has outlined the nuts and bolts of that standard and advocated for an innovation friendly approach since 2015.
CryptoKitties look less like securities under that flexible test for a few reasons. One important prong of the test is whether buyers are relying on the managerial efforts of others for profits. First of all, CryptoKitties aren’t marketed as profit-making investments, and ownership of a Cryptokitty doesn’t give you a right to dividends or revenue streams from the Cryptokitty team or anyone else for that matter. Sure people might hope that they can flip a kitty for a profit but people feel that way about other non-securities like real estate, gold, or (appropriately) beanie babies. And sure you can breed two kitties to get more cats which you could of course sell, but that alone certainly doesn’t make them securities any more than real life purebred pets.
This is starting to sound a bit like an actual case about securities law and real life animals, the case was SEC vs. Weaver Beaver (yes, that’s the actual name). Here’s Bob Davenport, a regional director of the SEC back in the 1970s:
The beaver case was a case called SEC versus Weaver’s Beaver Association. One defendant appealed to the U.S. Supreme Court, which denied cert. A fellow in the Salt Lake area started a company called Weaver’s Beaver Association. They sold pairs of beaver, all over the United States and in foreign countries. These were purportedly domesticated beaver. You would buy a pair of beaver for several thousand dollars, and these beaver would have little beavers, called kits. Then these little kits would grow up, and they’d have more kits. And you would end up with this large herd of beaver. The beaver were to be sold to other purchasers. They had a marketing arm, where they would sell your pairs of beaver. There was going to be a tremendous demand for beaver pelts in coats, beaver hats, and everything—it’s coming back. So they sold millions and millions of dollars of these beaver. The salesmen represented that you could take possession of your beaver, and you can raise them in your own backyard, but if you don’t have the capabilities, we have beaver ranches all through the West—Montana, Wyoming, et cetera.
It didn’t end well:
We’ll take care of your beaver for you for a hundred and fifty or a hundred seventy-five dollars per beaver per year, until you can sell it. Nobody could take care of beaver; you can’t put it in your bathtub. The purchasers would have to leave the beaver on the ranches. What happened was that all these beaver and their kits that was being sold to people could not be re-sold, because the Association was too busy selling their own beaver to take time to sell your beaver.
So these people ended up with a large number of beaver, and they’re paying all these ranching fees. It was just a disaster. They really weren’t selling domesticated beaver; instead they were flying the beaver down from Canada and purchasing them from trappers in Canada at approximately twenty dollars a beaver. They’d fly them into Salt Lake, put tattoos in their back foot, in the web, and start selling them. They’d sell them for three thousand a pair and up.
The SEC came after Weaver Beaver because it was clear that the economic reality of the scheme wasn’t just beaver sales! Weaver was selling shares of a “profitable” beaver farm. You weren’t buying a beaver to take it home with you; you were buying it to get rich, and you relied on Weaver to take care of your beavers, breed them, sell the kits and give you the profits. Nobody actually took delivery of their beaver (you are shocked, I know).
So why are CryptoKitties different? Because you can and do actually take delivery of your CryptoKitty. You don’t have to keep them in your bathtub, you just connect to the open Ethereum network and check up on the blockchain to find your cats. You don’t have to rely on the CryptoKitty team to take care of your cats or breed them for you, the cats don’t eat and “breeding” is just an ethereum transaction that you (and only you) can make by using any free and compatible Ethereum software client and by signing the transaction with your Ethereum private keys. And you don’t rely on the CryptoKitty team to find buyers for your cats, or buy them back from you, all sales are peer-to-peer and any ethereum user in the world can find you and offer to buy your little bundles of kitty joy (or breed with it!). Also there’s no sad beaver relocation, caging, and tattooing, just happy little bits of digital fur ball coursing over the world’s increasingly renowned global computer, Ethereum. That last one isn’t part of the Howie Test but it makes me happy to live in the future we got.