A Coindesk investigation found that Polychain’s former General Partner, Niraj Pant, inked a secret side deal with one of its portfolio companies, Eclipse Labs, breaking the fund’s policies and putting it at odds with investors—and potentially, regulators. The revelations also underscore why regulators believe the industry needs more oversight.
Let’s examine what happened, why it matters, and the potential long-term implications. And, while VC deals may not directly impact you, we’ll also look at how you can remain compliant with IRS regulations governing cryptocurrencies.
What Happened?
Polychain, a prominent San Francisco-based crypto venture fund, says that its former GP, Niraj Pant, broke its policies by secretly accepting “advisor” tokens from Eclipse Labs. And worse, the $13.3 million deal came just days after Pant directed Polychain to lead Eclipse Lab’s $6 million pre-seed funding round—an apparent conflict of interest.
“Polychain was unaware of the financial relationship between Eclipse and Niraj Pant until after his departure from the firm,” a Polychain spokesperson told CoinDesk. “Polychain has robust policies and procedures surrounding employees serving in advisory roles. Following Mr. Pant’s departure from Polychain, the firm became aware that he violated its policies.”
While Mr. Pant insists he signed the actual agreement after the fact, CoinDesk sources say Eclipse Lab’s former CEO, Neel Somani, promised Pant a 5% advisory stake before the pre-seed deal closed. Notably, that stake was higher than any employees or outside investors other than Mr. Somani and Polychain itself.
Polychain’s official policy states that employees must pre-clear transactions in their personal accounts that may present the appearance of impropriety while also disclosing the holdings in their personal accounts and transactions. Since Mr. Pant’s advisory role began while he was still at Polychain, they may have required him to make a disclosure.
After leaving Polychain, Mr. Pant went on to found Ritual, a platform for crypto applications to integrate with artificial intelligence models. Notably, Ritual received $25 million in funding from Polychain. Mr. Pant has also been a prominent thought leader and speaker in the crypto community over the past couple of years.
Why It Matters
These revelations come amid increasing scrutiny from financial regulators like the Securities and Exchange Commission (SEC). Over the past several years, the SEC has argued that many tokens are de facto securities, sought to regulate many crypto exchanges, and cracked down on outright fraud in the space.
By quietly inking a side deal with a startup, Mr. Pant may have breached a fiduciary duty to Polychain’s LPs and potentially violated securities laws by failing to disclose material information. These actions could undermine the industry’s efforts to improve its image following the collapse of FTX and other high-profile controversies.
Of course, the secretive nature of these cash-for-tokens schemes is partly to avoid arming the SEC with evidence in their fight to prove that tokens are likely securities. After all, if investors, rather than “users,” received the majority of the distributed tokens, it would be difficult to argue that the token sales weren’t, in fact, securities offerings.
Aside from regulatory concerns, these backroom deals make it difficult for participants in crypto ecosystems to understand tokenomics. Like many organizations, Eclipse Labs doesn’t disclose investor ownership percentages to the public, and owners often promise future tokens well before a project goes live.
In this case, Polychain’s investment in Eclipse Labs appears to have paid off with a 10-fold increase in value since its original investment. So, for their part, the fund’s LPs are unlikely to complain to regulators about an unsavory conflict of interest. However, the same may not be accurate for a future side deal impacting the VC space.
Staying Compliant
Polychain and other prominent investment firms often have extensive ethics policies in place. For example, Polychain’s SEC filings suggest that employees must disclose their holdings and transactions on an initial and annual basis. These efforts can help companies weed out potential conflicts of interest while discouraging them in the first place.
However, the enforcement of these policies remains unclear. For example, Mr. Pant went on to found Ritual and raise $25 million in capital from Polychain. Polychain declined CoinDesk’s question on whether its relationship with Ritual had changed because of Pant’s alleged policy breach or whether it learned of the breach before it invested.
The revelations of impropriety could put these rules and regulations in the spotlight moving forward. That’s because if the industry is unable to police itself, regulators have a stronger case for increasing enforcement on their side. And more investors complaining of conflicts of interest could increase pressure on regulators to take action.
Beyond the SEC
While everyday traders and investors don’t need to worry about securities regulations, you do need to worry about the Internal Revenue Service (IRS). Like the SEC, the IRS has become increasingly aggressive in cracking down on tax evaders by adding a crypto question on Form 1040 and other efforts to gather intelligence.
A Barclays analysis found that crypto investors are collectively paying the IRS at least half of what they owe, resulting in an estimated $50 billion per year tax gap. The agency recently hired thousands of new staff members, engaged with crypto-savvy consultants, and continues to invest in efforts to trace crypto transactions between parties.
ZenLedger’s platform makes it easy to import transactions with a few clicks and see a comprehensive overview of your portfolio and tax situation. Source: ZenLedger
Fortunately, ZenLedger makes it easy to comply with IRS rules and regulations to avoid making accidental mistakes or omissions on your tax returns. Our platform automatically aggregates transactions across your wallets and exchanges, computes capital gains and losses, and generates the necessary tax forms.
You can even access unique tools like our comprehensive dashboard showing your open positions across your wallets and exchanges and tax loss harvesting tools to identify legal opportunities to save on your taxes each year. That way, you don’t have to worry about any surprises during tax season or an unexpected audit!
If you forgot to include crypto transactions on past tax returns, you may want to consider making an amended return to keep your tax obligations up to date. Doing so could avoid future problems and potentially avoid costly penalties and interest.
The Bottom Line
Former Polychain GP Niraj Pant’s secret side deal with one of its portfolio companies, Eclipse Labs, probably isn’t much of a surprise to crypto insiders. But the revelations put a regulatory spotlight on the industry at a time when the SEC is already cracking down on the projects for token offerings that look a lot like securities offerings.
If you trade crypto assets, ZenLedger can help you comply with IRS rules and regulations to avoid running afoul in your own accounts. Our platform aggregates transactions across wallets and exchanges, computes your capital gains and losses, and generates the paperwork you need to file each year.
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
