Draft Case

IIMA/Temp/F&A0549

Tezos: Governance in the Cryptocurrency World

In November of 2017, Arthur and Kathleen Breitman, the founders of Tezos, confronted a
governance crisis that threatened to destroy their project and expose them to serious legal risk.
All development activities in Tezos were stalled after a bitter governance dispute led to the
Breitman losing access to the funds raised through an Initial Coin Offering (ICO) four months
earlier. Moreover, a series of class action lawsuits in the United States alleged that the $230
million ICO of July was an illegal security offering and demanded compensatory damages in
addition to refund of the investment1.

Background2

Tezos project was conceived by the Breitmans, a husband and wife team based in Northern
California. Arthur Breitman had released3 a white paper in 2014 touting Tezos as “a solution”
to the shortcomings of existing cryptocurrencies such as Bitcoin and Ethereum. The following
year, the Breitmans formed DLS to hold all the Tezos-related intellectual property. Kathleen
Breitman became the Chief Executive Officer, and Arthur Breitman the Chief Technology
Officer of DLS. The couple’s home served as the corporate headquarters of Tezos.

In mid-2016, the Breitmans began posting on popular internet forums their plan for a 2017
“crowdsale4” to support Tezos’ ongoing operations. In May 2017, it was revealed that the
venture capitalist Timothy Draper had taken a minority position in DLS through his firm
Draper Associates Crypto. A well-known technology investor, Draper brought publicity
along with his cash. Media reports described him as “the first prominent venture capitalist to
openly embrace initial coin offerings” and observed that the mere fact of his involvement had
“significantly raised Tezos’s profile.”

As a prelude to the project’s fundraising efforts, the Breitmans and DLS established the Tezos
Foundation (TF). Based in Switzerland, the purportedly independent not-for-profit entity was
intended to oversee the ICO, after which it would acquire DLS and assume full responsibility
for the technology’s future development. While DLS shareholders, as a part of this handoff,
stood to receive 8.5% of all the funds raised and 10% of all the tokens created, the takeaway
for individual contributors was less concrete. Rather than adopting a direct tokens-for-capital
system, the Foundation would reward donators by “recommending” (to the decentralized
Tezos user network) that they be awarded a commensurate token allocation.

The ICO that commenced on July 1, 2017 raised the market equivalent of approximately $ 232
million in Bitcoin and Ethereum by its July 14 close. By December 2017, the value of the funds
raised had become over $ 1 billion due to a surge in the value of cryptocurrencies.

Prepared by Prof. Samir K. Barua and Prof. Jayanth R. Varma, Indian Institute of Management
Ahmedabad.
Cases of the Indian Institute of Management, Ahmedabad are prepared as a basis for classroom
discussion. They are not designed to present illustrations of either correct or incorrect handling of
administrative problems.
© 2019 by the Indian Institute of Management, Ahmedabad.
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Blockchain Technology5

The blockchain is the technology underlying the cryptocurrency Bitcoin created by its
pseudonymous inventor, Satoshi Nakomoto, in 2008/2009. The idea of blockchain as
currency, underlying Bitcoin is briefly described in Exhibit 1.

Very soon after its invention, people realized that the blockchain was a valuable infrastructure
that could be used to maintain any kind of shared data and run any kind of shared
computation. Ethereum introduced the idea of a blockchain capable of running arbitrary
computations that could support a wide range of smart contracts – voting, blind auctions, safe
remote purchases, micropayment channel. Like the bitcoin blockchain, the ethereum
blockchain also has a cryptocurrency (ether). However, ether is no longer the purpose of the
blockchain. It is merely the fuel (“gas”) on which the computing engine runs.

Innovation at Tezos

A blockchain can be used to run many different contracts, but all these contracts run under
the same protocol underlying the blockchain. The protocol itself does not change. It is like an
unchanging constitution under which many different laws are enacted and enforced.

The Bitcoin and Ethereum blockchain do not have any provision for amendment of the
underlying protocol itself. Changes in the protocol can be accomplished only by the creation
of a new blockchain (known as a “hard fork”) through a process akin to revolutions in the real
world. Ethereum split into “ethereum” and “ethereum classic” in a hard fork in July 2016,
while Bitcoin split into “Bitcoin” and “Bitcoin cash” in a hard fork in August 2017.

The new idea in Tezos was that of making the blockchain self-amending. Tezos came up with
the idea that the blockchain protocol itself could be amended by a consensus process similar
to the normal blockchain consensus process. Just like the possibility of amending the
constitution may make revolutions unnecessary (or at least less frequent), amending the
protocol would make hard forks unnecessary. Tezos described itself as a “self-amending
cryptographic ledger” or as a “decentralized blockchain that governs itself”.

Like all blockchains, Tezos also needed a cryptocurrency (XTZ also known as Tez) to
incentivize large number of parties to support the integrity of the Tezos Network.

Operations, Governance and Values6

Tezos described the relationship between DLS and TF as follows:

"[DLS] is a US-based company currently controlled by its founders, Kathleen & Arthur
Breitman. It owns all of the Tezos-related intellectual property (IP), including the source code
of the Tezos cryptographic ledger, logos, and trademark applications associated with the
name Tezos, domain names, and goodwill arising from a set of a relationships with several
contractors and potential customers in the financial technology market.

[TF] is a Swiss foundation based in Zug. Its directors are Johann Gevers, Diego Ponz, and
Guido Schmitz-Krummacher. As a legal entity, it operates independently from DLS, though
DLS advises [TF] closely on technology."

The TF described its role as promotion and development of new technologies and
applications, especially in the fields of new open and decentralized software architectures
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with a dominating, but not exclusive focus on the promotion and development of Tezos. A
part of the contributions would be used to purchase all shares of DLS. TF had the right to
engage subcontractors to perform some or all of the development and execution of the Tezos
Project.

The terms of the fund raiser described the rights (or lack thereof) of the contributors to the
ICO: Contributions made to TF were non-refundable donations, and the applicable law was
Swiss law. When TF judged that the Tezos project had developed adequately to allow the
Tezos Network to be launched, it would recommend the following allocation of XTZ (tez):

◦ A little less than 80% to the contributors.

◦ About 10% to TF itself.
◦ About 10% to finance the purchase of the shares of DLS by TF (these tez would be
transferred to the shareholders of DLS as consideration for this purchase).
◦ An amount of approximately $ 1.3 million to advisors, management and early backers of
Tezos.

Exhibit 2 provides more details on operations, governance and values of Tezos, while Exhibit
3 contrasts the structure and process used by Tezos with the more traditional approach that
used by Ethereum.

Key People7

The founders of Tezos were Arthur and Kathleen Breitman. Arthur Breitman was born in
France and educated at École Polytechnique in math, physics, and computer science. He then
went on to a career in quantitative finance, including positions at Goldman Sachs and Morgan
Stanley. Kathleen Brietman held a BA from Cornell University and worked at The Wall Street
Journal, Bridgewater Associates, Accenture, and R3 prior to Tezos.

The President of the Board of TF was Johann Gevers who described himself as follows:

"I am the founder and driver of Crypto Valley, the world’s leading cryptofinance ecosystem,
and founder and CEO of Monetas, an award-winning transaction platform that brings the
world’s most advanced financial and legal services to everyone with a mobile phone.
Cryptofinance technologies are revolutionizing the global financial landscape and will
profoundly improve the lives of people everywhere by enabling them to live in freedom and
to generate limitless prosperity.

I have twenty-five years’ experience in business, finance, and technology, including extensive
international experience and cultural fluency from living and working in 7 countries on 4
continents in 5 languages. I’m a Chartered Financial Analyst and Chartered Accountant with
degrees in commerce, science, and the humanities."

Another member of the TF Board was Guido Schmitz-Krummacher. According to his linkedin
profile, he was an attorney at law (specialization in international company law), and
Managing Director at Sielva Management SA, a company that provided “representative
offices and board members for national and international daughter companies, mother
companies, Family Offices and Holding companies”. His linkedin profile advertised his
services openly: “Looking for an experienced board member for your Swiss or international
Company?”
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The third member of the board was Diego Ponz, whom Tezos described as a computer
scientist and entrepreneur with an expertise in combinatorial optimization. A Business
Analyst - Product manager at CoEnzyme, in his LinkedIn profile, he described himself as
follows:

“I build custom solutions using optimization, predictive analytics, business intelligence,

visualizations and web technologies.”

DLS had a small team of core developers in addition to Arthur Breitman. The development
team was primarily located in Paris, France and worked in partnership with OCamlPro, a
software company with deep expertise in OCaml, the programming language chosen for
implementation of Tezos. Most of the developers had Ph.Ds in Computer Science and
expertise in programming language theory.

Tezos also boasted of several high-profile advisors:

• Zooko Wilcox was a computer scientist and the leader of the ZCash project. ZCash
was a cryptocurrency designed to provide complete privacy of transactions using
zero-knowledge cryptography. Bitcoin by contrast allowed users to remain
pseudonymous, but all transactions were completely public.
• Emin Gün Sirer was an Associate Professor at Cornell University and a Co-Director of
the Initiative for Cryptocurrencies and Contracts (IC3) at Cornell. He had made many
significant contributions to the Bitcoin and Ethereum communities.
• Andrew Miller was an Associate Director of the Initiative for Cryptocurrencies and
Contracts (IC3) at Cornell and an advisor to the ZCash project. His research interests
were broadly in computer security and focused on the design of secure decentralized
systems and cryptocurrencies.

The Governance Crisis8

The first public news of the governance crisis that was enveloping Tezos came on October 19,
2017, and on the same day, the founders (Arthur & Kathleen Breitman) published a letter to
the Tezos community giving their version of events:

“The momentum we had prior to the fundraiser has slowed despite the resources now
available for supporting the project. … At the time of the fundraiser, the Tezos foundation
took over the responsibility of financing the development of the Tezos ecosystem. … From the
outset, we worked nonstop to make the transition as smooth as possible, making suggestions
to the foundation to help them continue the work we had been doing. However, getting
anything done proved difficult. Recruiting came to a standstill and communications to the
community languished waiting for approval.”

The news raised the fundamental governance issue as to whether the responsibility for
financing the development of Tezos till successful launch rested with TF or with DLS. The TF
had of course committed to buy out DLS after the network was launched, but did it also have
to finance the development till then? This issue assumed even greater importance because the
letter by the founders contained a proposal (to reduce bottlenecks and avoid
micromanagement) that could effectively move the control of the purse strings from the TF to
the founders. They suggested:

"… set up a structure whereby most operations will be conducted by a wholly owned
subsidiary, Tezos AG. Under this structure, the foundation council will approve a budget for
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Tezos AG, allowing the company to operate with less overhead than if each decision were
made at the foundation council level.

… it would be beneficial for the project to formalize our (Arthur and Kathleen’s) roles going
forward. These will most likely be within Tezos AG, the subsidiary."

While all this would have been a serious governance challenge for Tezos, it was completely
eclipsed by the explosive allegation of self-dealing against the president of the board of TF:

“In early September we became aware that the president of the Tezos Foundation, Johann
Gevers, engaged in an attempt at self-dealing, misrepresenting to the council the value of a
bonus he attempted to grant himself.”

The founders alleged that Gevers “attempted to pressure the other members of the foundation
council to award him a contract that would, among other things, grant himself a bonus worth
$ 1.5 million at the then valuation of the Tezos token. He misrepresented this as being worth
only $ 300,000.”

Gevers on his part claimed that “the Breitmans have attempted to bypass the Swiss legal
structure and taken over control of the foundation, and have acted destructively, causing
months of delays in the Tezos project” and that the Breitmans’ interference in his work “was
incompatible with the needed independence of the foundation”.

Some media reports suggested that “a Tezos Foundation internal inquiry is likely to clear
president Johann Gevers of all allegations of financial impropriety.” Apparently, the bonus
was to be paid in Tezos token and the differing monetary values arose from valuing the Tezos
token at its ICO price instead of the secondary market price at the time of the dispute.

US Securities Law9

Less than two weeks after the Tezos ICO closed, the United States Securities and Exchange
Commission (SEC) published a report (see Exhibit 4) stating that cryptocurrencies and ICOs
could be securities under US law:

“Whether or not a particular transaction involves the offer and sale of a security – regardless
of the terminology used – will depend on the facts and circumstances, including the economic
realities of the transaction. Those who offer and sell securities in the United States must
comply with the federal securities laws, including the requirement to register with the
Commission or to qualify for an exemption from the registration requirements of the federal
securities laws. The registration requirements are designed to provide investors with
procedural protections and material information necessary to make informed investment
decisions. These requirements apply to those who offer and sell securities in the United States,
regardless whether the issuing entity is a traditional company or a decentralized autonomous
organization, regardless whether those securities are purchased using U.S. dollars or virtual
currencies, and regardless whether they are distributed in certificated form or through
distributed ledger technology.”

The SEC was only reiterating the four-pronged Howey test laid down by the US Supreme
Court in 1946 to determine whether an arrangement was an investment contract and therefore
a security. The four independent elements of the Howey test are:

1. An investment of money,
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2. In a common enterprise,
3. With an expectation of profit,
4. Derived predominantly from efforts of others.
All the above elements must be present for a token or a coin to be regarded as security.

The Breitmans had tried to circumvent the US securities laws by: a) having a Swiss foundation
to run the ICO, stating in the Terms and Conditions that the contract underlying the ICO
would be governed by Swiss Law and subject to the jurisdiction of Swiss courts, and b) calling
the ICO a donation instead of a sale of securities.

Litigation against Tezos

The class action lawsuits filed in the US from November 2017 alleged that Tezos had violated
US securities laws and misled investors. The facts in favor of the litigants were:

• DLS’ role in establishing and aiding the Tezos Foundation rendered the two entities
deeply intertwined, if not functionally interchangeable, throughout the ICO process.
Further averments, including a former TF director’s detailed description of the
Breitmans’ “control” over the Foundation and the Breitmans’ regular, expansive use
of the word “we,”.
• The participation of US based investors in the ICO using an interactive website that
was hosted on a US based server and run primarily by Arthur Breitman in the US.
• The marketing of the ICO almost exclusively targeted US residents.
• The US based interactive website at tezos.com where the ICO was conducted
contained a single sentence directing users to “refer to the legal document that will be
issued by the Foundation for more details”. Investors however were not required to
read this legal document (hosted on the Swiss website tezos.ch) that was not even
linked to the interactive website. [Such attempts by a website to bind its users by
inferring affirmative assent are known as “browsewrap” agreements as distinguished
from “clickwrap” agreements, that ask users specifically to engage with the website -
generally by checking a box - to show their contractual consent. Courts are more
circumspect about enforcing browsewrap agreements.]

Fighting a class action suit in the US is in general expensive and stressful. The governance
crisis made the situation much worse. While the Breitmans were reported to have asked TF to
bear their legal fees, it was not clear that TF was even permitted to do so under its mandate.

Increasing Regulatory Concern10

The events at Tezos had to be viewed in the backdrop of increasing scrutiny of

cryptocurrencies by regulators and lawmakers. Excerpts from the “Hearing on the Oversight
of Virtual Currencies11” by the “Unites States Senate Committee on Banking, Housing and
Urban Affairs” highlights the dilemmas being faced by regulators. The committee was in
session on February 6, 2018 to listen to testimony of the SEC Chairman, Jay Clayton and the
CFTC Chairman, J. Christopher Giancarlo.

During the hearing, Senator Elizabeth Warren (D, Massachusetts) queried, “In 2017,
companies raised more than four billion dollars through ICOs. How many of those companies
registered their ICOs with the SEC?”

The SEC Chairman, Jay Clayton, replied, “Not one.”

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Senator Warren continued, “And, as of today, how many companies have registered for
upcoming ICOs?”

SEC Chairman, “Not one.”

Senator Warren, “Could you please say a word about why that is so?”

SEC Chairman speculated that because of the novelty of the blockchain, some people might
have believed that these coins were not securities, but then rejected any such exception with
a firm, "I disagree with them."

Senator Warren, “I understand you as saying it is a violation of the law.”

SEC Chairman, “Yes.”

The SEC Chairman also said, “From what I have seen Initial Coin Offerings are securities
offerings. ... You can call it a coin, but if it functions as a security, it is a security.” He
elaborated, “I believe every ICO I have seen is a security.”

The CFTC Chairman, J. Christopher Giancarlo provided a somewhat different perspective on

cryptocurrencies. “Putting things in perspective” he said that the total value of
cryptocurrencies in the world was about $ 313 billion, while the global money supply was
about $ 7.6 trillion and the total value of gold, an investment asset, was about $ 8 trillion. He
then narrated how he and his wife, despite efforts had largely failed to get all their three
college-going children interested in financial markets. However, the same children got all
excited a year back when they learnt about bitcoin and started asking him whether they
should invest in bitcoins. Continuing his testimony, he said, “It strikes me that we owe it to
this new generation to respect their enthusiasm about virtual currencies with a thoughtful,
balanced response and not a dismissive one. Yet, we must crack down hard on those who try
to abuse their enthusiasm with fraud and manipulation.” He said the key to dealing with
cryptocurrencies was “educating ourselves and the public about this new innovation.”

Resolving the Crisis

The governance crisis and regulatory challenges confronting Tezos required urgent action by
the TF Board, ICO investors, US and Swiss regulators, and the broader Tezos community. But
the primary burden of resolving the crisis was on the Breitmans. Tezos was their creation, and
they had spent four years of their lives on it. It was up to them to correct past mistakes and
put Tezos back on track, but Swiss law did not appear to give them any voice in how TF was
run.

As they sat looking out the window of their living room sipping their morning coffee on
February 11, 2018, Arthur and Kathleen looked at each other in silence and wondered how to
rescue the Tezos Project.
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Exhibit 1 Bitcoin: Blockchain as Currency

The blockchain involves several interesting ideas:

1. Distributed/Replicated Data: Instead of a ledger maintained by a trusted party like a bank or a

government department, the blockchain relies on a replicated (digital) ledger where many
parties (potentially all parties) maintain a copy of the ledger. This not only eliminates the need
for a central trusted party, it also makes the system more resilient. Even if some copies of the
ledger were to be lost, there would still be many surviving copies of the ledger.

2. Cryptographic integrity: Replication of the ledger solves the problem of some copies being lost,
but the more important risk is that some copies could be corrupted. The system needs to
determine which copies are genuine and which have been tampered with. A digital record is
very different from a handwritten ledger where any overwriting or alteration is obvious on careful
inspection. If some cells in a spreadsheet are altered, no trace of the alteration is visible even
under the most careful inspection. The blockchain uses cryptographic integrity tests to allow
detection of any kind of alteration. Even if many copies of the ledger are corrupted, the system
can still identify the genuine copies and rely on them.

3. Protocol: All computers in the network have to use the same processing logic to determine
which transactions are valid and which are invalid. Every computer on the bitcoin network runs
the same open source software to ensure this.

4. Consensus: Distributed data with cryptographic integrity tests ensure that the data is safe once
it has been written onto the ledger. Consensus rules dictate how the network agrees on the
new data to be written to the ledger. On the internet, majority rules do not work because it is
easy for the same person to “vote” under many different names and IP addresses. Nakomoto
introduced the idea of proof of work which he described as “one CPU one vote”. The majority
of the computing power in the network has to agree on every new data to be written to the
ledger.

5. Incentives: The most important question that remains is why should so many parties expend
time and money running computers for “public good”. Nakamoto’s idea was to incentivize
participants by allocating newly created bitcoins to those who do the hard computing work
required for the proof of work consensus to work. Bitcoins serve a paradoxical double role in
the system: the blockchain exists to support bitcoin, but the blockchain itself is supported by
incentives paid in bitcoin.
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Exhibit 2: Operations, Governance and Values 12

The TF described its role as follows:

• TF promotes and develops new technologies and applications, especially in the fields of new
open and decentralized software architectures. A dominating, but not exclusive focus is set on
the promotion and development of the so-called Tezos protocol and the related technologies,
as well as the promotion and support of applications using the Tezos protocol.
• It remains at TF’s sole discretion to decide how to use the received Contributions to develop
and execute the Tezos Project. A part of the Contributions will be used to purchase all shares
of DLS. This part maximally amounts to 8.5% of the Contributions made. If this part has not
been used (partially or entirely) for the purchase of the shares of DLS, it may be used by TF at
its own discretion to further develop and maintain the Tezos Network and the Tezos Project.
• TF has the right to engage subcontractors to perform some or all of the development and
execution of the Tezos Project.
Documents issued by DLS stated:
• Tezos wants to foster the creation of multiple, decentralized core development teams who will
compete for endowment from the TF.
• The primary task of TF is to ensure the functionality of the network. To this end, TF will, at a
minimum, retain the original development team at the current annual cost of $900,000. This will
cover maintenance, as well as some integrations and proposals. Over four years, this will cost
TF $3.6 million.
• The Tezos protocol currently benefits from research in the formal verification and programming
language communities at no cost. The initial development team of Tezos has a strong
philosophical commitment to formal verification and a keen interest in researching new
consensus algorithms for blockchains. TF will look to fund research in this area with its
endowment from the fundraiser.
The terms of the fund raiser described the rights (or lack thereof) of the contributors to the ICO as
follows:
• Contributions made to TF are non-refundable donations.
• Contributions could be made in bitcoins or ether (which would be converted into bitcoin at the
prevailing exchange rate). Each bitcoin contributed was likely to receive 5000 XTZ. While the
minimum contribution was 0.1 bitcoin, there was no cap on the contribution, and therefore the
number of XTZ to be issued. Contributions could be made during a contribution period of two
weeks, but early contributors would receive bonuses of up to 20%.
• TF would work on the promotion and development of the Tezos protocol, the Tezos software
client, and applications using the Tezos protocol.
• When TF judged that the Tezos project had developed adequately to allow the Tezos Network
to be launched, it will recommend the following allocation of XTZ (tez):
– A little less than 80% to the contributors.
– About 10% to TF itself.
– About 10% to finance the purchase of the shares of DLS by TF (these tez would be
transferred to the shareholders of DLS as consideration for this purchase).
– An amount of approximately $ 1.3 million to advisors, management and early backers
of Tezos.
• Since the Tezos Network will be operated by an independent community of participants around
the world using Tezos software client, TF cannot guarantee that the community will actually
adopt the recommendation on the above initial allocation of XTZ.
• Despite reasonable efforts to develop and complete the Tezos Network, it is possible that such
development may fail and that the Tezos Network and any XTZ will not be created, become
useless and/or valueless due to technical, commercial, regulatory or any other reasons.
10 of 14 IIMA/Temp/F&A0549

• The Contributor represents and warrants that the Contributor deeply understands the
functionality, usage, storage, transmission mechanisms and intricacies associated with
cryptographic tokens, such as bitcoin (BTC) and ether (ETH), and blockchain-based software
systems and intends to use XTZ to participate in network governance, mining activities or
connecting private networks. The Contributor is not contributing to obtain XTZ for the purpose
of speculative investment.
• The applicable law is Swiss law. Any dispute arising out of or in connection with the creation of
the XTZ and the development and execution of the Tezos Network shall be exclusively and
finally settled by the ordinary courts of Zug, Switzerland.
Tezos enumerated the following key aspects of its principles and values:
• Non-dogmatism: We value hard rules and will follow them to their natural conclusion, but not to
their absurd conclusion.
• Non-aggression: Regardless of its other goals, the Tezos governance mechanism should not
be used to initiate force or fraud against others.
• Use of the governance mechanism: All protocol changes should go through the Tezos internal
governance mechanism when possible.
• Preserving the interest of token holders: The goal of our governance mechanism is to protect
the interest of each token holder, irrespective of their stake, in their capacity as a token holder.
Generally speaking, this means favoring decisions that tend toward increasing the value of the
tokens.
• Evolution, not revolution: Our ability to amend almost all aspects of the ledger is not a carte
blanche to change the protocol willy-nilly. Our goal is to provide a clear governance framework
to supervise protocol evolution.
• Commerce: Embracing open source and making volunteer contributions to collective projects
does not preclude us from embracing markets, commerce, and profit-making.
• Valuing scholars: We pay close attention to scholars and are proactive in incorporating their
work.
• Innovation and stability: We aspire to protect a minimal core of functionality in order to preserve
the tokens resiliency but, beyond that level, innovate wildly in order to maximize its utility and
its odds of success.
• Formal verification: An explicit goal of the Tezos project is to fully formalize and verify the
protocol. We rely on strong typing, pure functions and all the programming techniques which
allow for easier reasoning about the code.
• Rich protocol: To consolidate the economic value of the token, we seek to incorporate the most
valuable features of general interest at the protocol level, rather than through smart contracts.
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Exhibit 3 Comparison of Fund Raising by Ethereum and Tezos

Ethereum Tezos
Governance Nonprofit foundation Nonprofit foundation with independent
controlled by the founders board.
Operating company For-profit company controlled by the
subsidiary of foundation. founders.
External investors in for-profit company.
Reward for Share of tokens was allocated Share of tokens was allocated to Advisors,
founders, to individual developers. Management, Founders and other persons.
developers Share of tokens was allocated to for-profit
company.
Share of funds raised was allocated to for-
profit company.
Description of fund Purchase of tokens Nonrefundable donation
raising
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Exhibit 4: The DAO episode and SEC investigation report 13

The DAO was created by a German corporation, Slock.it, and Slock.it’s co-founders with the objective of
operating as a for-profit entity that would raise a corpus (in the form of the Ether cryptocurrency) through
the sale of DAO Tokens to investors. The Ether would then be used to fund various projects the returns
from which would flow to the DAO token holders as a return on their investment in DAO Tokens. All the
governance decisions relating to The DAO (including which projects to fund and on what terms) was
governed by smart contracts (computer code) executing on the Ethereum blockchain. The DAO is one
example of a Decentralized Autonomous Organization, which is a term used to describe a “virtual”
organization embodied in computer code and executed on a distributed ledger or blockchain.

In April-May 2016, The DAO conducted an initial coin offering in which it sold approximately 1.15 billion
DAO Tokens in exchange for a total of approximately 12 million Ether then valued at approximately $150
million. After DAO Tokens were sold, but before The DAO was able to commence funding projects, an
attacker used a flaw in The DAO’s code to steal approximately one-third of The DAO’s assets by moving
the Ether from The DAO’s Ethereum Blockchain address to an Ethereum Blockchain address controlled
by the attacker. Although the diverted ETH was then held in an address controlled by the attacker, the
attacker was prevented by The DAO’s code from moving the ETH from that address for 27 days.

During this period, there was a heated debate within the Ethereum community on whether to take some
action to restore the stolen money to the original holders. Finally, the core Ethereum developers led by
Buterin decided on a “hard fork” of Ethereum which moved all the funds of The DAO to a special
“withdrawal-only” contract that allowed the holders of The DAO tokens to withdraw their Ether. A group of
ideological dissenters who saw the hard fork as censorship by a powerful cabal refused to adopt the hard
fork and split from the mainline blockchain. This new blockchain was dubbed “Ethereum Classic” and
while being worth only about 2.5% of the main Ethereum, it still typically ranked among the top 25
cryptocurrencies and was actively traded on cryptocurrency exchanges.

In July 2017, the SEC published a report of its investigation on whether The DAO, Slock.it and its co-
founders and intermediaries may have violated the federal securities laws. The SEC determined that DAO
Tokens are securities under US law, and deemed it appropriate and in the public interest to issue the
report of investigation to advise those who would use a distributed ledger or blockchain-enabled means
for capital raising, to take appropriate steps to ensure compliance with the U.S. federal securities laws.
However, the SEC determined not to pursue an enforcement action in this matter based on the conduct
and activities known to the SEC at this time.

1The first law suit was Alejandro Gaviria v. Dynamic Ledger Solutions, Inc, filed on November 13, 2017 in the United
States District Court, Middle District of Florida. In the same month, several other cases were filed in the United States
District Court for the Northern District of California including GGCC, LLC, et al., v. Dynamic Ledger Solutions, Inc
et al.; Okusko v. Dynamic Ledger Solutions, Inc. et al.; Baker v. Dynamic Ledger Solutions, Inc. and MacDonald v.
Dynamic Ledger Solutions, Inc. Ultimately, all the cases were consolidated into a single class action lawsuit as In Re
Tezos Securities Litigation in the United States District Court for the Northern District of California (Case No. 17-cv-
06779-RS). At the time of writing this case, this last litigation was still in progress after the judge denied a motion to
dismiss; we have drawn heavily on the legal proceedings in this case which we refer to below as In Re Tezos.
2 This section is based almost entirely on the “Order on Defendants’ Motions to Dismiss”, In Re Tezos, August 7, 2018.
3 Till April 2016, Arthur Breitman worked for a brokerage firm, Morgan Stanley. Morgan Stanley required that all
employees request and receive approval from the firm prior to engaging in any outside business activity. The rules
issued by the Financial Industry Regulatory Authority (FINRA) forbade employees of brokerage firms from
engaging in any outside business activity without providing prior written notice to the firm. Breitman, therefore,
published the White Paper under the pseudonym of L. M. Goodman, and did not notify Morgan Stanley of his
involvement in Tezos. (see Financial Industry Regulatory Authority Letter of Acceptance, Waiver and Consent No.
13 of 14 IIMA/Temp/F&A0549

2017056612801 dated April 18, 2018.

https://www.finra.org/sites/default/files/fda_documents/2017056612801%20Arthur%20Robert%20Meunier%20
CRD%205726300%20and%205090765%20AWC%20sl%20%282019-1563385764292%29.pdf retrieved March 21, 2019).
4Crowdsale is an event where a company with a cryptocurrency project sells a part of the tokens in exchange for
money.
5The material about Bitcoin and Ethereum is from their primary source documents: Satoshi Nakomoto, “Bitcoin: A
Peer-to-Peer Electronic Cash System”, https://bitcoin.org/bitcoin.pdf, retrieved April 14, 2013. Ethereum White
Paper, https://github.com/ethereum/wiki/wiki/White-Paper retrieved December 17, 2017. Solidity by Example,
https://solidity.readthedocs.io/en/latest/solidity-by-example.html retrieved December 17, 2017. What is gas,
http://www.ethdocs.org/en/latest/contracts-and-transactions/account-types-gas-and-transactions.html#what-is-
gas retrieved December 17, 2017.
6This section is based on “Order on Defendants’ Motions to Dismiss”, In Re Tezos, August 7, 2018 and the following
documents from the tezos.com website: DLS and the Tezos Foundation: Transparency memo,
https://www.tezos.com/dls retrieved December 11, 2017. Tezos Contribution and XTZ Allocation Terms and
Explanatory Notes, https://www.tezos.ch/pages/static/Tezos%20Contribution%20Terms.pdf retrieved December
11, 2017. Tezos Overview https://www.tezos.com/static/papers/Tezos_Overview.pdf retrieved December 11, 2017.
Tezos: Philosophy and Values, January 18, 2017, https://www.tezos.com/static/papers/principles.pdf
7 The biographic details of the key people are primarily from the tezos.com website (Tezos Overview
https://www.tezos.com/static/papers/Tezos_Overview.pdf retrieved December 11, 2017), supplemented by the
following sources. Johann Gevers: Personal website, http://johanngevers.com/ retrieved December 18, 2017 as also
his linkedin profile https://www.linkedin.com/in/johanngevers/ retrieved December 18, 2017. Guido Schmitz-
Krummacher: linkedin profile, https://www.linkedin.com/in/guidos1/ retrieved December 18, 2017. Diego Olivier
Fernandez Pons: linkedin profile, https://www.linkedin.com/in/diego-olivier-fernandez-pons/. His name seems to
be spelt differently in different documents. The Tezos Overview document calls him Diego Ponz and the official Swiss
registry record
(https://www.zefix.ch/en/search/entity/list/firm/1303506?name=Tezos%2520Foundation&searchType=exact)
for the Tezos foundation gives the name as Diego Olivier Fernandez. E. Gün Sirer: profile at Hacking, Distributed,
http://hackingdistributed.com/egs/.
8 This section draws on the following sources. Class Action Complaint in Alejandro Gaviria v. Dynamic Ledger
Solutions, Inc, in the United States District Court, Middle District of Florida. “The Path Forward: A letter from Arthur
& Kathleen Breitman to the Tezos community”, October 19, 2017, https://medium.com/@arthurb/the-path-forward-
eb2e6f63be67 retrieved December 18, 2017. Reuters, “Special Report: Backroom battle imperils $230 million
cryptocurrency venture”, October 19, 2017, https://www.reuters.com/article/us-bitcoin-funding-tezos-
specialreport/special-report-backroom-battle-imperils-230-million-cryptocurrency-venture-idUSKBN1CN35K,
retrieved December 7, 2017. Vigna, Paul, “Tezos Raised $232 Million in a Hot Coin Offering, Then a Fight Broke Out;
Management battle is threatening the deal and highlighting the risks of initial coin offerings”, Wall Street Journal, 19
Oct 2017. Jeff John Roberts, “Is Tezos in Trouble? Crypto Firm Beset by In ghting After $232M ICO”, Fortune, October
19, 2017 http://fortune.com/2017/10/19/tezos-ico/ retrieved December 25, 2017. “Tezos Foundation probe ‘set to
clear president Gevers’”, December 10, 2017, https://www.swissinfo.ch/eng/bonus-row_tezos-foundation-probe-
set-to-clear-president-gevers/43742376. “Exclusive: Tezos founders push for legal bailout from Swiss foundation”,
December 1, 2017, https://www.reuters.com/article/us-bitcoin-tezos-lawsuits-exclusive/exclusive-tezos-founders-
push-for-legal-bailout-from-swiss-foundation-idUSKBN1DV4K0. Various posts in the r/tezos sub-reddit
https://www.reddit.com/r/tezos/
9This section is based almost entirely on “Order on Defendants’ Motions to Dismiss”, In Re Tezos, August 7, 2018 and
“Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO”, United States
Securities and Exchange Commission, July 25, 2017, https://www.sec.gov/litigation/investreport/34-81207.pdf
10This section is based on: The United States Senate Committee on Banking, Housing, and Urban Affairs hearing
entitled, Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S.
Commodity Futures Trading Commission, February 6, 2018.
https://www.banking.senate.gov/public/index.cfm/hearings?ID=D8EC44B1-F141-4778-A042-584E0F3B9D39
14 of 14 IIMA/Temp/F&A0549

11https://www.banking.senate.gov/hearings/virtual-currencies-the-oversight-role-of-the-us-securities-and-

exchange-commission-and-the-us-commodity-futures-trading-commission
12This section is based on “Order on Defendants’ Motions to Dismiss”, In Re Tezos, August 7, 2018 and the following
documents from the tezos.com website: DLS and the Tezos Foundation: Transparency memo,
https://www.tezos.com/dls retrieved December 11, 2017. Tezos Contribution and XTZ Allocation Terms and
Explanatory Notes, https://www.tezos.ch/pages/static/Tezos%20Contribution%20Terms.pdf retrieved December
11, 2017. Tezos Overview https://www.tezos.com/static/papers/Tezos_Overview.pdf retrieved December 11, 2017.
Tezos: Philosophy and Values, January 18, 2017, https://www.tezos.com/static/papers/principles.pdf
13This section is based on “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934:
The DAO”, United States Securities and Exchange Commission, July 25, 2017,
https://www.sec.gov/litigation/investreport/34-81207.pdf and DuPont, Q. (2017). “Experiments in algorithmic
governance: A history and ethnography of ‘The DAO,’ a failed decentralized autonomous organization” in Bitcoin
and Beyond (pp. 157-177). Routledge.