Fuse’s No-Action Relief: Honest And Honestly Odd

Also, DoubleZero Is Centralized And Misled The SEC: Part 3 of N

Fuse Energy’s SEC no-action relief is notable, and notably different, from l’affaire DoubleZero. It is different mainly for two reasons.

First, Fuse’s letter requesting the relief describes, in broad strokes, the actual Fuse system. There are a few caveats to that we will discuss below. But at a high level this not like the DoubleZero letter which, plainly, was not honestly describing the real DoubleZero system.

The second reason is something clever that we did not expect: not only does Fuse claim their token is non-functional as an investment — they have made a real effort to brick the token’s investment utility. Buying their token, $ENERGY, will of course let you speculate on the price of $ENERGY. There is nothing they can do about that. But it does not let you derisk any future use of the Fuse system or claim any sort of stream of revenues from that system. DoubleZero is built around a token staking scheme. Fuse does not have anything like that.

The caveat on the first point is that Fuse is not done yet and it is not fully open-source. They do not even claim it will be open-source. So we are left trusting the documentation and reasoning about how this thing might plausibly work. If they are lying that is just straight-up fraud so the no-action relief will be the least of their problems. We have no reason to believe they are lying. We have no reason to believe the system is even sufficiently-completely-built that there is existing tech to misrepresent.

Speculative statements about something you are going to build are fine. And this is not a situation where we have read the not-open-source code and are just trolling. We have not even looked. This piece takes Fuse at their word just as our DoubleZero discussions take them at their word. In both cases we consider only the requests for no-action relief and the publicly-released code.

What Fuse Does

So, on to the details of Fuse. Fuse is an energy provider. It gives people electricity. The Fuse token is used to buy discount vouchers for the Fuse system that must be used near-immediately. And the token is distributed pro-rata based on contribution to the ongoing network. Plus there are some team and investor tokens with an unlock schedule. These are a non-trivial slice of the system but they do not convey any sort of future rights to use the system or acquire discounts except at the then-prevailing price. Token redemption for discounts and services is based on the USD value of those tokens at the time of redemption.

This is not like airline miles where you know it costs 100k miles or something for certain classes of flight for the next year or some other longer period. And where you can buy or sell points at fixed prices for some other reasonably-long time period. Fuse tokens are floating price things and you use them to buy network services based on their then-prevailing USD price. You can do the same thing with BTC or equities or USD or any other currency. The tokens are just some thing that goes up and down in price and you can exchange for services at a floating price.

The Fuse tokens do not allow you to derisk future energy purchases. No risk is reduced because the stuff you will mechanically buy with tokens will still have a price denominated in USD. The documentation makes clear that $ENERGY tokens are the means of payment but:

[t]he redemption value of the Tokens for Fuse Goods and Services will be based on the average market price of the Tokens on third-party unaffiliated digital asset markets at the time of the redemption.

As a result the tokens are perfectly fine for speculation — they may well go up in USD value so you can afford more USD-priced discounts — but anything works for speculation.

What These Tokens Do

This is not like buying a $5 coupon for a shop — it is like buying a voucher for an unknown discount at a shop that you can redeem whenever you like what that shop is offering on that day. Would you sign a contract that gave you to option to pay the prevailing market-price for gold at some fixed time in the future? What about at any time for the indefinite future? Such contracts are not dangerous. But they are also not particularly useful. You already have the right to pay the prevailing market price for anything sold at the market because that is what “at the market” means. Like $ENERGY these are, formally, contracts but they provide little if any useful risk transfer. In this sense buying the tokens does not look much like a financial transaction.

Not much, but maybe a little bit. The tokens do not really look like commodities in that they are not directly useful for anything. If you own a pile of wood that, in some sense, derisks the future construction of a building. With Fuse the tokens only have value to the extent the entity keeps going. That is shared with all types of coupons (i.e. if the company goes under then they go to 0) but has nothing to do with physical commodities.

It is also a little bit like an equity. But then again you can stockpile energy company stock and plan to sell it to pay your electric bills as they come do and…that is not really a lower-risk arrangement than just paying out of your future salary or savings in a bank account or, for that matter, planning to launch your own token and sell it to cover electricity expenses.

Shop coupons are not securities. Airline miles are not securities. Collectibles are not securities. This Fuse thing has tried quite hard to not work as an investment. This is not like DoubleZero at all. Fuse admits they are the central operator of the system and that the tokens are worthless if they go away. Fair enough. Fuse hands out tokens programmatically but it does nothing programmatic about the yield on those tokens or the USD value of those tokens. This does look like a hotel chain giving you a voucher for a free weekend after a few expensive week-long stays.

Fuse, the company and central coordinator, is a required element of this thing. In the above example the hotel chain is also a required central operator. But if we go back to the DoubleZero case the contrast is stark. DoubleZero misrepresented whether there was a central, controlling, party. They claimed there is no central control when there plainly is. And then, after making that false claim, DoubleZero relied on SEC v. Koscot Interplanetary, Inc. 497 F.2d 473 (5th Cir. 1974) to argue that:

Neither the Foundation nor any other person has sufficient discretionary control over the Network, or is otherwise engaging in individual efforts that could reasonably be called the “critical determinants of success” of the Network.

If we accept DoubleZero’s (false!) predicate then under Koscot DoubleZero is probably in the clear. Incidentally this alone renders the no-action relief moot because DoubleZero’s relief depends on facts that do not apply to DoubleZero.

Fuse does something completely different. Fuse admits the truth that there is an essential central component of the system. So the argument never touches Koscot. Fuse just makes the case that their token is purely for utility and does not work as an investment vehicle. Just because an asset does not work as an investment does not necessarily mean it cannot be a security. But the argument is worth considering.

Plastering “this is not an investment” on top of an equity mutual fund probably will not work. But Fuse tries hard to make their tokens useless as investments so, again, there is no dishonesty or misrepresentation.

What Did Fuse Accomplish Exactly?

We certainly accept that it is possible to take sufficient action to ensure your token is not a security. Fuse has done a credible job here. Nobody we are aware of has ever claimed every token with a central issuer is necessarily a security and this is, truly, one of the better efforts we have seen. $ENERGY is a claim on whatever slice of profits the operator of Fuse Energy wants to share with token holders under whatever definition of profits that operator wants to use. That feels more like caveat emptor than “unregistered security.”

Here the cases of Fuse and DoubleZero vary wildly. DoubleZero operates around a yield-earning staking scheme for the DoubleZero tokens. There is no way they can argue their token, 2Z, is useless as an investment product if the protocol itself revolves around a way of earning yield on 2Z. Fuse, on the other hand, is honest about the central control and leans into the “does not work as an investment” angle. Whether this effort is sufficient is a legal question but there is a lot of daylight between Fuse and DoubleZero.

We agree with Fuse that something does not become a security just because someone, somewhere, buys it expecting the price to go up. If a product is clear and honest that it does not work as an investment — which requires, for example, the token not revolve around a yield-earning staking scheme — then misguided “investor” expectations should not cause a problem for the issuer. Tell me the difference between stupid and illegal and I’ll have my wife’s brother arrested. Selling to idiots, ahem misguided web3 “investors,” is not a crime as long as you do not lie to them.

Fuse has leaned in pretty hard on the marketing front:

The receipt of a SEC No-Action Letter marks a rare milestone, both for Fuse and the wider crypto industry. It underscores a continued commitment by the SEC to engage with teams and to support the compliant advancements of the industry as a whole…To the @SECGov and our counsel @lathamwatkins: a sincere thank you for your deep and continued engagement throughout the past few months. What an amazing achievement.

This is surely promotional activity. But, again, it looks different from DoubleZero. In that comment the letter Fuse is touting as great for the project is actually about the project. Podcast comments also are consistent with the system as described elsewhere in public. Honestly promoting a thing that is not a security has a name: advertising. Normal advertising.

This also means, helpfully for Fuse, that they have not put Commissioner Peirce in the same awkward position as DoubleZero. This comment is not dangerous for the project in the same way her endorsement of DoubleZero’s letter was:

ICYMI: the SEC staff recently issued a common-sense no-action letter for another DePIN project, this one related to decentralizing the provision of energy and optimizing its use.

Why? Because the letter applies to the project. Now if Fuse goes off and changes things such that the letter no longer applies…that would be bad. Fuse has talked itself into a corner because now it needs to build something consistent with the terms of the letter. Why? Because not only are they required to stick to the letter to get the no-action relief but doing otherwise will make them look like a bad faith actor to the SEC. DoubleZero, on the other hand, backed the SEC into a corner by misrepresenting their own system and accepting endorsements based on false premises.

The Meta

The way this is supposed to work is you promise the regulator you will do X and then you do X. The builder is supposed to be the one stuck in a corner circumscribed by the terms of the regulatory relief. Trying to do this the other way around where you box the regulator in and effectively dare them to admit they were used and come after you…that is a higher risk approach. It is also, we will acknowledge, higher reward as there are then no limits on what you actually build beyond your own risk tolerance.

What is interesting here is that Fuse is making the case that the token itself is just a random speculation vehicle with a side-dish of mechanical utility to pay bills. And we agree Chuck-e-Cheese tickets are not securities. Now it remains to be seen how easy it will be for the team and investors to sell their hefty allocation of tokens given this lack of economic utility but…speculative stuff often goes up, sometimes very far up, and stays there for a while. Good luck to them. We look forward to watching how this one plays out.

Fuse’s No-Action Relief: Honest And Honestly Odd was originally published in ChainArgos on Medium, where people are continuing the conversation by highlighting and responding to this story.