ANALYSIS: City Crypto Coins Are Becoming the Mayor’s New Clothes

New York Mayor-elect Eric Adams has made headlines by declaring his support for a New York City cryptocurrency, emulating the MiamiCoin that Miami Mayor Francis Suarez has been promoting since August. These endorsements are a new development in the evolution of cryptocurrencies, and an apparent milestone in government acceptance of them.

The idea that a mayor who governs a major crypto business hub and “gets it” should back a city cryptocurrency is having a moment. But, having watched the rise and fall of crypto trends for more than a handful of years, I can’t help finding this moment to be akin to a famous one from Hans Christian Andersen’s “The Emperor’s New Clothes"—when the leader shows off his new “outfit,” which he believes to be so brilliant that it is invisible to unfit officials and foolish people. Nevertheless, these new crypto fashions appear likely to be a source of relatively little embarassment, even if they prove to be lacking in substance—more akin to a missing hat than to an entire missing outfit.

What Are These City Coins?

The city cryptocurrencies in recent media reports are not issued by city governments themselves. Their creator is CityCoins, an enterprise that does not claim to be affiliated with any city government or part of any formal public-private partnership. CityCoins has been announcing city-branded crypto coin projects on its own initiative, then issuing the coins after gaining mayoral endorsements. It is noteworthy that the city councils that are supposed to be responsible for city government financial and budgetary issues appear not to have been involved in these decisions.

CityCoins announced the MiamiCoin project in its first tweet June 2 and, after the mayor of Miami publicly endorsed the coin in July, launched it in August. NYCCoin launched on Nov. 10 after New York Mayor-elect Adams won the Nov. 2 mayoral election and immediately declared his support for the coin. CityCoins has declared that it will next create an AustinCoin, but that coin does not exist yet since the mayor of Austin, Tex., had not endorsed it as of Dec. 14.

What a CityCoin actually is, and what purpose it serves, are riddles wrapped in enigmatic terminology. “CityCoins are cryptocurrencies that allow you to support your favorite cities while earning Bitcoin (BTC) and Stacks tokens (STX),” according to a description on CityCoins’ website. “CityCoins are powered by Stacks, a blockchain that enables smart contracts on the Bitcoin network. Aside from being programmable, CityCoins have two immediate functions upon launch: mining and Stacking.”

Regarding what “mining” and “Stacking” mean, the website’s FAQs provides the following explanations.

“CityCoins are mined by forwarding STX (the Stacks token) to the CityCoins smart contract on the Stacks protocol,” the website says. “The winning miner can claim their rewarded CityCoins from their Stacks address at any time.” In other words, a person acquires a MiamiCoin or NYCCoin by obtaining Stacks tokens, forwarding the Stacks tokens to CityCoins, letting CityCoins mine for them, and then claiming the mined coins.

The benefit to the city comes from the next feature described on the CityCoins website: “30% of the STX that miners forward to the Stacks protocol is sent directly to a wallet that is reserved for each city that is part of the CityCoins ecosystem. The mayor of a city may elect at any time to accept the reserved wallet to access the treasury for use by the city.” This 30% cut provides the millions of dollars of financial benefit to Miami that Mayor Suarez has proudly proclaimed. Miami’s city wallet held approximately 10.6 million STX, equivalent to about $19.8 million, as of Dec. 14, according to a website cited in a CityCoins press release.

Stacking provides “rewards” to holders of CityCoin tokens. The website describes the process as follows: “The remaining 70% of the STX that miners forward to the Stacks protocol is distributed to holders of CityCoins who choose to stack their tokens. Stacking requires holders to lock their CityCoins for determined ‘reward cycles.’ Stacking CityCoins earns STX rewards. STX rewards can further be stacked on Stacks to earn BTC rewards.”

Utility in the long term is another claim in the CityCoin FAQs: “CityCoins are programmable and will have additional utility over time. The possibilities of CityCoins become endless as cities one by one begin to claim their protocol contributions and communities and software develop around their respective CityCoins. CityCoins communities will create apps that use tokens for rewards, local benefits, access control (to digital or physical spaces), trading, lending, smart contract execution, and more.”

When Howey Met City Coins

The existence of a rewards program for MiamiCoin and NYCCoin holders raises a significant question: whether CityCoins adequately took into consideration the SEC’s history of finding violations of the federal securities laws in crypto token sales.

The SEC issued its first enforcement action against a crypto token sale in 2017, and since then the agency has found in numerous cases that crypto token sales were sales of unregistered securities violating the federal securities laws. The SEC has used the test from SEC v. W.J. Howey Co. to assess whether token sales represent sales of securities. Under the Howey test, a sale of securities occurs when there is an investment contract, defined as “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”

MiamiCoin and NYCCoin appear to be dangerously close to meeting the definition of a security under the Howey test, despite CityCoins stacking its description of them with language creating superficial distinctions from the exact words of that definition.

“Investment of money in a common enterprise.” CityCoins mines MiamiCoin and NYCCoin in exchange for Stacks forwarded by persons who will become the holders of the coins. CityCoins may have an argument that this transaction merely provides mining services, rather than receiving investments of money, but the SEC may consider the distinction not to be substantial. Moreover, investment of cryptocurrency in a common enterprise appears to occur in the coins’ other function, Stacking, when holders of MiamiCoins or NYCCoins lock them for a reward cycle to earn Stacks rewards.

“Reasonable expectation of profits.” CityCoins promises that holders of MiamiCoin or NYCCoin will receive “rewards” for stacking their coins (70% of the Stacks forwarded for CityCoins mining), and Bitcoin rewards for stacking their rewarded Stacks on Stacks. These expectations of receiving rewards of Stacks and Bitcoin look a lot like a reasonable expectation of profits.

“Derived from the entrepreneurial or managerial efforts of others.” Exactly who handles the MiamiCoin and NYCCoin tokens that holders choose to “stack” in return for rewards is left unstated. The handler may be a blockchain-based software protocol rather than a person. Whoever does it, management of the Stacks rewards program has to occur, and the holders of MiamiCoins and NYCCoins are not doing it themselves. The SEC has already established in an August enforcement action that decentralized finance (DeFi) protocols that remove human decisionmaking do not exclude a transaction from the definition of a security under the Howey test, and the SEC is likely to apply that reasoning in any scrutiny of CityCoins.

Aside from arguing how the Howey test applies to stacking things on top of other things (which would bear a certain resemblance to Monty Python’s “Royal Society for Putting Things on Top of Other Things” sketch), CityCoins could make the further argument that MiamiCoin and NYCCoin are utility tokens, sold mainly for their “additional utility over time” rather than as investments. Numerous token issuers have made similar arguments over the years. However, the SEC has been consistently skeptical of such claims since 2017, and SEC Chair Gary Gensler has re-asserted the agency’s enforcement policies in 2021.

Nowhere on its website has CityCoins addressed compliance with the securities laws or stated that it has taken them into account, as of Dec. 14. CityCoins may have done its due diligence of the securities law compliance risks and conducted its CityCoin offerings accordingly, such as by registering the coins as securities, offering them under an exemption from the registration requirement, or concluding after a thorough analysis based on the SEC’s history of enforcement actions that each CityCoin would not be considered to be a security. Such due diligence is not evident in CityCoins’ public statements, however, and that absence is cause for concern.

If You Want to Get Ahead, Get a Hat

As significant as these legal and regulatory issues may be, market forces present potentially greater—and unavoidable—threats to the future of CityCoins. Coins are inherently volatile assets. Bitcoin, for example, has gone through numerous boom and bust cycles since 2009, with more than one in 2021 alone. Moreover, CityCoins will face competition from other coins offering competing utility, a new and attention-getting meme, or less risk of SEC enforcement action. There is no guarantee that demand for newly mined CityCoins will continue to exist, or that significant usage of them will ever emerge.

CityCoins has launched in a year of cryptocurrencies quadrupling in market value to more than $3 trillion, joke cryptocurrency Dogecoin rocketing to new heights fueled by Elon Musk tweets, and the joke-on-top-of-a-joke Shiba Inu memecoin riding Dogecoin’s coattails to a market value of more than $50 billion. Warnings that downward volatility may endanger the ambitious crypto plans of city mayors are already emerging, and the sale of city-branded crypto coins will not be immune to such market forces.

A mayor endorsing a city-branded cryptocurrency is clothing himself in the risks of CityCoins. But even if the benefits fail to materialize—like the proverbial emperor’s new clothes—the risks to that mayor and the city appear relatively limited. “I own this failure” would not even have to be said, since neither the mayor nor the city has any ownership stake in CityCoins, or even any apparent contractual relationship with it. The cost to the mayor would be nothing, aside from some embarrassment and negative news headlines.

Meanwhile, CityCoins give a mayor free publicity as a crypto-friendly forward thinker, which can only help to attract crypto businesses to a city, and add free money for the budget, without imposing new taxes or issuing municipal bonds. So the enthusiasm of these mayors for CityCoins makes sense. Like a flashy hat, their city-branded crypto coins can draw attention while exposing the bearer to limited consequences if they disappear. Unlike the emperor’s new clothes, they appear to present little risk of completely undermining a mayor’s standing or crypto-friendly policies.

CityCoins map of planned and already launched city cryptocurrencies, as of December 13, 2021

CityCoins.co

The upcoming year may bring major new developments for the concept of city-branded crypto coins. In addition to Austin, there are 15 further cities where CityCoins claims to be “coming soon": three in the United States (San Francisco, Los Angeles, and Las Vegas) and 12 outside the United States (Mexico City, Rio de Janeiro, Amsterdam, Lisbon, Berlin, Lagos, Cairo, Dubai, Singapore, Seoul, Tokyo, Sydney). Further noteworthy legal issues are likely to emerge if and when the concept expands further.

Bloomberg Law subscribers can find information on U.S. federal and state regulatory actions toward crypto assets on our Fintech Compliance resource, including the new Financial Technology Developments Tracker.

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