How the Greatest Decentralizing Force for Crypto Projects Is the SEC
How does the SEC determine if a token is a security? Why is DeFi particularly hard to regulate? What will regulators do about stablecoins? On Unchained, Greg Xethalis, chief compliance officer at Multicoin Capital, and Collins Belton, founding partner at Brookwood P.C., dive into crypto regulation, discussing securities laws, DeFi regulation, and why the US should be promoting stablecoins rather than trying to shut them down. Highlights:
- why the SEC and CFTC have not announced bigger crypto enforcement news at the end of their fiscal years
- why the SEC is going after DINO (decentralized in name only) companies
- what the Howey and Reves tests areand how the SEC uses themto determine whether an asset is a security or not
- why Collins and Greg think the SEC has recently begun been applying Reves more often
- why they think centralized crypto lending products should not be considered securities under the Howey test
- whether new legislation needs to be written for cryptocurrency-based products
- what makes Collins think the SEC is being “disingenuous” regarding the SEC registration process for crypto companies, like Coinbase
- how regulators will end up handling DeFi and why both Greg and Collins are long-term optimistic
- how the US government has a “great history” of respecting privacy and encryption
- why regulatory pressure is likely to build up around centralized crypto exchanges and what we can learn from the EtherDelta case
- why Collins thinks most cryptocurrency companies should be regulated
- why the SEC is the best motivator for forcing protocols to fully decentralize
- how smart contracts could theoretically be used to standardize SEC Commissioner Hester Peirce’s Safe Harbor proposal
- how blockchain data makes cryptocurrency companies more transparent and easier to regulate than centralized entities
- what Collins and Greg think will happen with stablecoin regulation going forward
- why the US should be pushing to make dollar-pegged stablecoins more prominent
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- Twitter: https://twitter.com/collins_belton
- LinkedIn: https://www.linkedin.com/in/collins-belton-10226283/
- SEC charged DeFi Money Market
- SEC charged EtherDelta
- Howey Test and Reves Test
- SEC Chair Gary Gensler indicated that crypto lending and staking platforms most likely fall under US securities law
- Gensler noted that Coinbase lists “dozens of tokens that might be securities.”
- Gensler thinks crypto exchanges need to register with SEC
- dYdX airdrops token, but not to US customers
- Uniswap Labs investigation
- Preparing a stablecoin report
- BlockFi NJ extension
- NJ, TX, AL move against Celsius
- BlockFi CEO wants federal regulators to weigh in on crypto lending regulation
- Preston Bryne believes lending products are securities
- Investigation of Binance
- Contract with the Department of Homeland Security
- Coinbase will not be launching Lend
- Coinbase is prepping a pitch for regulators
- Filing with National Futures Association
- Armstrong tweetstorm referencing “sketchy” SEC behavior
- Possible stablecoin regulations proposed by NYT
- Wall Street Journal article on stablecoins
- a16z on stablecoin regulation
- Former regulators joining a16z
- Former regulators joining Binance
- Sam Bankman-Fried on the importance of USD to crypto markets: https://twitter.com/SBF_FTX/status/1427179474538287104?s=20
Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host, Laura Shin, a journalist with over two decades of experience. I started covering crypto six years ago. And as a senior editor at forums was the first mainstream media reporter to cover cryptocurrency full-time. This is the October 5th, 2021 episode of Unchained.
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Today’s guest is Greg Xethalis, general counsel at Multicoin, and Collins Belton, founding partner at Brookwood PC. Welcome, Greg and Collins.
So we are recording on Friday, October 1st. Yesterday was the last day of the SEC and CFTC’s fiscal year. I think a lot of lawyers in this space, and I, were expecting that there might be some enforcement actions. There were, but they were kind of small and not like super worth diving into, in a big way — we could touch on them. But I’m curious, Greg and Collins, if you have an opinion as to why we didn’t see any big enforcement actions from these regulators.
Well, I think from my perspective, I mean the federal government is typically pretty good about keeping a close lid on enforcement actions as they’re going on. And in particular, where they stand. Sometimes you’ll hear about information sweeps or things will leak out, but it’s typically not in the interest of parties who are being investigated or for the prosecutors themselves to have things come out in the open.
And obviously, there are a lot of really complex issues that don’t necessarily always fit neatly into a calendar. Little surprise that the closest thing we had to a major crypto action or settlement was a relatively di minimus settlement with Kraken regarding their margin trading program, as well as a handful of actions that appeared to be only tangentially related to crypto from the CFTC. So a little surprising.
It’s interesting that you say that to Greg. Because I think one of the other things that we maybe don’t appreciate as lawyers in this space too, is that there was some movement. One on the DMM and DMG case. I think for a lot of us in crypto, we didn’t view that as that impactful because the view was that’s not really DeFi. But at the same time, maybe there’s an internal view that that’s setting some major precedent for them potentially being able to pursue DeFi.
And then I think the other interesting thing, which has obviously been in the news and we probably can’t talk about specifics here, given client confidentiality, but just generally speaking, I think it’s pretty well known that there has been a slew of investigative kind of requests. Not necessarily subpoenas, but just, hey, we’re looking into this space. And I do think that maybe a bit more of a blitz than what people appreciate. So perhaps it’s just that this year, a lot of the attention was more privately focused rather than publicly focused — is at least one theory I had.
And Collins, just to make sure all listeners are on the same page, tell us what the DMM and DMG cases were.
In the DMM and DMG cases, I think that it stood for decentralized money management or something. That was the ticker for the two tokens. And it essentially was extensively promoting itself as kind of like a yield farming, yield aggregation play. So for those that are kind of familiar with DeFi, you may be aware of that, but for those that aren’t in very, very simple terms, they’re essentially telling people that they had a programmatic way for people to deposit money and then have it be essentially managed on a non-custodial basis in order to generate returns. That obviously raises questions generally in the legal industry. But in particular, the issue here was that one, these folks were not actually using programmatic enforcement or any type of non-custodial mechanism. They were just committing fraud, taking folk’s money, and then managing it themselves.
And then secondly, they actually weren’t actually managing that. But the important, or potentially important, thing is that at least the SEC framed it as, hey, this is a DeFi offering and we’re going after it because we think the tokens themselves are securities. One has an equity security. One has a note under that Reves analysis. I know we talked about that a few weeks ago and we’ll get into that. And then they also layered in the fact that there was fraud and/or some type of deception. So that latter part is what I think was really material. But the former part was really important because it’s suggested two really important things.
One they’re obviously looking at what they think is DeFi. And two, they’re now looking at securities that beyond just the Howey test. I think that was the first or maybe second time we saw in a settlement or an enforcement action where they explicitly referenced a Reves. Greg, correct me if I’m wrong. I think that was the first or second time in a formal order for digital assets where they referenced it.
I think that’s right. It had previously been discussed at least one of the trio of no action letters that came out in 2019. I think it may have been pocket full of quarters, potentially a Reves discussion or turnkey. It was one of the two. I think it’s reflective of our two definitions of decentralized in name only (DINO). This was an example where I think a lot of people in the space pointed at that action and said, well, this is not really DeFi. This is decentralized in name only in that they are literally just putting decentralized on the name. Whereas that same term of DINO was used again in congressional hearings, I think a couple of weeks by a couple of folks, including Chair Gensler, to refer to decentralized projects that perhaps vary on some gradation of actual decentralization. He was taking the perspective that these were not really decentralized in significant material ways.
Yeah. And I think for the DMM and DMG cases, that’s, those are the ones, as you said they were called decentralized in name only. But I noticed that SEC Commissioner Hester Peirce also called them that. I don’t know if she coined the phrase or not, but clearly there is at least somebody at a high level in the SEC who makes the difference between projects like that versus ones that are legitimately either decentralized or trying to be. I’m not sure what her view is on that.
We’ve mentioned the Reves case a few times, and I just want to make sure people understand what that is and why that’s significant. As you said, this was brought up in the context as another way to look at this question of whether or not a token is a security, after the Howey test. Can you give us a sense of what that case says and then how it would apply here?
Reves versus Ernst and Young is a Supreme court case from 1990 that addressed sort of a fundamental issue of whether or not a note is a security. And to put some context in that, there are a number of federal securities laws. The three that we probably most about when we’re talking about is what is the definition of a security would be the 1933 Act, the Securities Act, the Securities Exchange Act of 1934, and the Investment Company Act of 1940, together with the Investment Advisors act of 1940. The ’33 and ’34 acts have fundamentally the same definition of security. And it lists out a litany of different types from the standard stuff like equity, to the more flexible definitions like investment contracts that everyone in the crypto space is very familiar with thanks to the Howey test, which is how courts will interpret whether a particular scheme is an investment contract.
Reves takes a look at a different set of that definition, which is notes, and in some cases, some might try and also apply it to evidence of indebtedness, which are codified as types of securities. There’s a an explicit presumption that a note is a security unless it fits certain families of notes that are known to be more commercial in nature than investment in nature. So in the Reves case, the court set out a slew of categories. I think it was seven or eight categories that were called families of commercial arrangements. And if your specific instrument, your note, was within that those seven families of commercial non-security notes, they would not be deemed to be a security. For ones that were not clearly within those seven families, the court established a test that looked at four different categories on a balancing test.
So in, in Howey it’s three or four, depending on how you want to look at the definition, three or four prongs, and all of them must be satisfied to be a security. Whereas in Reves, it’s a balancing test. It’s not quite as algorithmic. And those things, those factors that you look at are the motivation of the seller and the buyer in the transaction. Is it commercial in nature? Or is it investment in nature? The plan of distribution of the instrument, is it being broadly distributed to the public, or is it more specific and bilateral or closely distributed? The reasonable expectations of the investing public, what people think of it as a security. The presence of an alternative regulatory regime, which is probably the most important one that that we look at in a lot of cases for the crypto community. Is there an alternative regulatory regime that applies that would make something that might otherwise be a note or a security note into something that would be viewed as a non-security?
So what do you think the SEC is doing by now applying Reves a few times here? Like if you’re kind of reading the tea leaves, what would you say is maybe the next evolution and their application of existing case law, I guess it is to the crypto space?
I think we’ve looked at where they’re applying it and it’s often been in these lending type of programs where we’ve also seen action on the state level. While the initial actions that were targeted at BlockFi from New Jersey, Alabama, Texas, and Kentucky — a lot of that focused on Howey. But a few of the states, particularly Texas, also referenced Reves. And I think some of the conversation around it targets Reves. In no small part because some of these relationships do look a little bit more like a debt relationship than an investment into an enterprise. So I dunno, Collins, if you want to chime in on that.
I mean, I definitely agree. I think where I’m expecting to see it most applied or most trotted out is going to be in the context of the type of lending or potentially, I wouldn’t call it necessarily rehypothecation, but rehypothecation like activities. I think those are probably the most prominent areas where they’ll look to raise it in the DeFi context. Now obviously for centralized entities, and it goes to a point that you raised Laura, I think it’s in some ways sometimes easier to make that argument for from at least the government’s perspective, as I view it, because it’s a lot easier to say, hey, you’ve got somebody who’s taking in this capital who may either be managing it, or at least be subjecting that capital to whatever other downstream flows are in their business. And like Greg was talking about, the ’33 Act, the ’34 Act, and the ’40 Acts, all of those are largely predicated on the existence of intermediaries and how we either want to constrain their behavior or prescribe some type of behavior that they should be taking.
And so when you’ve got those traditional actors mapping that framework on it, it’s is a little bit easier for the same reason. I think you start to see why the distinctions that folks like Hester and some in the crypto community want to make between kind of a truly decentralized protocol versus a CeFi protocol or a semi-centralized protocol is really material. Because in the absence of those intermediaries, some of the questions and the natures of the questions potentially change and maybe normatively they should is what I think a lot of people want to argue on the policy side.
Okay. So let’s actually just focus the next part of the discussion on things that are obviously centralized. Which would be lending products from companies like BlockFi or Celsius. Or this proposed a product from Coinbase called Coinbase Lend, which they ended up deciding not to pursue because the SEC threatened to sue them if they did. So when you look at those, what’s your opinion? Do those look like securities to you according to this precedent that we’ve discussed here? Or would you say it looks like something different and maybe not a security?
So I’m going to preface this just by saying I previously worked with some of the folks, so I can’t necessarily speak on their particular business models. I guess I would generally say, I think that if there is an argument on the securities law side of things, it’s not fruitful from my perspective to focus on the notes or certificate of indebtedness or investment contract analysis.
My public position has generally been shoehorning in these assets into those tests is not the appropriate way to do so. At the same time, I’m happy to concede, particularly with some of the arrangements that I’ve seen, and not with these three particular companies, but others that I’ve talked to over the years, or seeing in their business models, I’ll definitely concede that I think some of these models will almost certainly constitute securities — but not because they are in evidence of indebtedness to accompany or not because it’s a note like investment that traditionally falls in those categories.
And I don’t think it even is one of these things where they’re necessarily managing people’s money in the way that we would expect an equity contract. I think the more appropriate way, and this is where I struggle with the SEC’s approach right now, is to say, look, we’ve got, like Greg said, a litany of definitions here. I mean, it’s like 30 or 40 definitions. Two of which are things like participation in a profit-sharing scheme, or things like an asset backed security or a bond. Those three categories are much more appropriate to discuss. Participation in a profit-sharing scheme have sometimes relied on the Howey test, which is why I think that it shows why treating those as equity instruments is probably not the right move. But I would say it’s a harder argument to say something like a central entity issuing you a receipt that entitles you to some coupon payment in the future, doesn’t look like a bond, or it doesn’t look like some type of asset backed security, but that’s going to require that they build out the jurisprudence in the case law.
And I think that’s important for us to push. Because if we’re saying, hey, we want guidance, we want clarity, where are the lines? What are we looking to do? Them saying, hey, we’re going to shoehorn it into this test that doesn’t really fit either of these parameters, but you guys should just figure it out, is not appropriate. Especially if you’ve got a large institution, that’s looking to follow our laws, that’s registered publicly, that’s reaching out to them. At a certain point, you might have to say, look, it’s incumbent on us, as the rule maker, we have rulemaking authority, to start expanding our previous guidance and started applying our frameworks to existing definitions. So that’s generally my perspective there without necessarily taking a view on any of those three products.
YI’m sort of in the same boat with Collins, as I’ve done a little work in the space in the past. So I don’t want to go too deep on specifics. At the same time, one thing that I think it’s worthwhile to note is this isn’t the only scheme out there. Crypto is not the only industry that has relationships like this.
For example, within the investible asset market, you have securities lending programs that are operated by broker-dealers, and you have a commodity rehypothecation that’s operated by a number of commodity warehouse storage facilities, where you do have custodians who are rehypothecating and utilizing underlying assets outside of a bank framework and outside of a securities framework. I think one of the things that you do look at there, and perhaps it is returning it to Reves, is what’s basically the purpose of the relationship? Does it look like a commercial relationship or does it look like a an investment relationship?
And it’s a nice reminder that all of these lending programs are not created and structured in the same way. So we’ve got two prominent programs from reasonably well-regulated US exchanges. Coinbase proposed their Lend product. Gemini and Genesis Trading have the Earn facility that is is actually a situation where Gemini customers lend to Genesis and it’s facilitated by Gemini. But those are programs that you could make an argument is a add on to a relationship that is principally commercial in nature. The custodial relationship, the exchange-business relationship that was preexisting. And this starts to look a little bit more like securities lending or commodities rehypothecation. It’s a little different when the entire purpose of the scheme and the arrangement is to facilitate this interest bearing account. So I think there are some distinctions which may create some nuance, but I otherwise agree with Collins that it’s not apples to apples when we’re trying to look at what these products should be weighed at against, vversus something like an ICO, where I think Howey is probably a pretty appropriate court doctrine to look for.
And then would you agree with Collins, and correct me Collins if I don’t summarize your position accurately, but it seems like you were saying that you felt that there should just be new legislation to deal with these new types of products that maybe aren’t covered by existing regulation?
Not even necessarily new legislation. The definitions that I described to you are already included in the Securities Act and the Exchange Act. The reason why the SEC prefers to default to an investment contract or a note is that there’s established case law. And there are two reasons why that’s important.
One, there’s a roadmap for them to follow. They can reuse prior work. And then that really does matter for lawyers, as we don’t aim to recreate the wheel every time. But the second is that extending case law or getting new case law can be a bit of a risky business, particularly for a regulatory body. Because if they are wrong, then it establishes precedent that many, many other people in the industry may want to follow. And it may incentivize behavior that they may want to dissuade.
Now, obviously there’s a question as to whether they should want to dissuade behavior that a judicial body has determined is legal. Regardless, administrative bodies are still political organs and they are impacted by both political realities, but also just administrative priorities. So I think that it’s not necessarily promulgating new laws. I certainly think we should be considering that in some areas. To be Frank for a lot of the securities law matters, I don’t necessarily think that’s needed. And this is kind of important. Again, I’m assuming we’re still all focused on the centralized components here, because I think in the decentralized context, it’s a bit different.
But one of the things that we’ve been talking about, and it really frustrates me that it’s not more publicly known, is that a lot of these exchanges, I don’t think their problem is, hey, these are securities, and we don’t want to offer securities. For the most part, in practice for the end-user, and even for the exchanges, other than the compliance function, it’s not really going to be a huge difference for them whether they’re issuing like this asset from a BD entity or a money transmitter. They’re going to have very similar requirements in terms of customer identification.
Now, yes, there are other obligations that will apply to a securities entity that may not apply to a money transmitter. But at the end of the day, for the most part, your customers, they’re not really exposed to that, outside of maybe a little bit more data collection. Even internally, most of the stakeholders aren’t exposed to that, it’s just additional compliance costs.
So what frustrates me is that Coinbase has a broker-dealer. And as do many other US entities. The reason why they can’t offer these products right now is not because they’re intransigent and don’t want to like offer any security. Like for them would be the same thing at the end of the day, right? I come to Coinbase or you just redirect me to Coinbase securities, I sign up with the same account. You have the same information. It’s not going to be a huge difference to me either way. And then I can get my Lend product.
The reason why they can’t is actually because the sec also won’t allow FINRA to approve crypto custodians as BDs. So we have broker-dealers that are in the crypto business, but none, or at least none that are currently active, that I’m aware of as of this month, that are allowed to essentially fully satisfy a certain set of rules that apply to broker-dealers that custody. And so we’re in this weird catch 22, where we have people that are saying, hey, I’m willing to register and be this regulated entity, go ahead and regulate me. And I bought an entity. We’re ready to go once you approve the license.
And the SEC is saying, yeah, hold off, we’re not sure, but also this is a security, so you need a securities entity. It’s a very bizarre situation. And I think it’s a very important point because I see so many people with these takes of, oh, these guys don’t want to follow the law or something. And it’s like, Coinbase bought this broker-dealer, I think in like 2019, with the expectation of being able to offer a crypto securities. And it’s just been almost three years with no approval.
So I think it’s a bit disingenuous when I hear Gary and many other folks saying, hey, come and talk to us. When it’s like, hey, they haven’t just talked to you. They bought a BD, they put it through the licensing process. And now they’ve just been waiting for two years. It’s very disingenuous to put it like everyone’s shooting from the hip because we’re in tech or something like that.
And I think it wasn’t even just one. I think they actually bought a couple of BDs. One was a Robo advisor. I think it was two or three around 2018 or 2019. And I think it’s been a significant point of frustration. I’m not a broker-dealer lawyer, but some of the BD lawyers in the space, I think one remarked to me that she had something like 50 clients in the pipeline trying to get the ball moved forward with with FINRA and the SEC.
Which is not to say that there aren’t some tough issues. But when we look at the industry, and the criticism of the industry that sometimes takes place, the level of intractability of this system to quickly adapt to what’s happening in the market. It’s not just on the companies that are building it. It’s also in the need to have a regulatory environment that responsibly promotes responsible innovation.
Yeah. Actually just listening to you guys talk, it made me think, and this is just me guessing, I have done no reporting into this other than just talking to crypto lawyers. I mean, I haven’t spoken to anyone at the SEC or anything like that. But just listening to this, it makes me think, oh, it’s probably just, they haven’t figured out how they want to regulate this space. And so they’re just trying to keep people in a holding pattern. What do you think of that theory?
I think it’s right, but I mean that’s problematic when you’re publicly saying to people come in or register and do it the right way. People go to do it, and you say, okay, we’ll get back to you in three to five years. That’s not reasonable. It’s extremely frustrating sometimes to see some of the statements publicly as though everyone in crypto is running around dodging clients. And I can definitely, kind of co-sign what Greg has said. I mean, two years ago I knew somebody saying that maybe it’s the same person and they had 20 or 30 people waiting. So I can only imagine that the list has grown. I’ve talked to FINRA about this issue. I’ve had people talk to the SEC.
It’s strange when you talk to them and there’s s almost like a sympathetic recognition. Like, hey, we get it. We’re working really hard.
I would appreciate that, but for the fact that you you turn on the news and you’ve got somebody saying, hey, these guys don’t want to comply. And it’s like, what’s going on? And let’s not understate the reality here. A significant swath of crypto actors are probably not great actors, and we should be cleaning these folks up, but that’s the thing, right? If we were focused on them, we could do that.
I guess I’ll end my little mini ran here, which by saying, it’s funny, because sometimes you see people say, oh, like 90% or 95% of these are valueless. Well, first of all I don’t think the hit rate in regular startup is that much higher.
But secondly, at this point, there’s 30,000 plus companies. That’s still 3,000 companies that are valid. Like, that’s a huge amount of companies with tens of thousands or hundreds of thousands of people working for them. It’s no longer like, oh, hey, you’ve got 12 legitimate actors and 50 million bad actors. It’s like, even if you want to take the most draconian 95%, 99% of people are bad actors, that’s still hundreds of companies — almost as much as the Fortune 500. So at this point, I think it’s a little, like I said, it’s frustrating to have the condescension when people are acting in good faith and there’s a wide swath of actors that are trying to make that outreach.
First off, I completely agree with what Collin said. There is a degree of frustration, not just with the slow progress, but also the narrative that’s being created around it. What I don’t want us to lose sight of is there also are a lot of people who are working very hard on both the political side, as well as on the regulatory side. People working within these regulatory bodies who are taking great pains to actually understand and try. The difference is that that doesn’t always lead to policy or affirmative movement that actually allows innovation to occur here in the US.
One of our continuing themes of concern over the course of 2021, is is this the year that more and more of crypto gets pushed outside of the US both on a development side and also on the market side. The number of opportunities for participation in this exciting new ecosystem gets smaller and smaller. Collins can probably speak better to what we saw yesterday with geoblocking. And I know we’re still on CeFi, but when we get to DeFi, talking about what’s going on with geoblocking of US IPs.
It’s a shame. And I think it’s important that we work to elevate the parties in the regulatory apparatus or the political apparatus who are working to try and promote reasonable and responsible regulation, and to be able to foster a crypto ecosystem here in the US.
Why don’t we discuss DeFi momentarily, because we’re already halfway through the show. But first, a quick word from the sponsors who make the show possible.
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Back to my conversation with Greg and Collins. So there’s so much more to be said, even just about the centralized crypto world.
But let’s talk about DeFi because I feel like that’s really probably the major issue here. I almost feel like a lot of this discussion is subtext for what’s going on in DeFi. When you look at what’s happening with the regulators and where things are going, what do you think is going to be the regulatory stance toward DeFi?
Long-term, I actually am more optimistic than I think one, most people probably are, and two, my public posting probably suggests. I guess I’ll preface this all by saying, sometimes I think people think that I’m like despondent, but it’s really more so that I think we have a flawed, I mean, incredibly flawed, I mean, this is coming from me. Like my family’s history is mired in the flaws where I country. But while it’s flawed, I think we have one of the best arguments for constantly aiming to hold truth to power.
And that’s because we’ve structured a system that ostensibly gives the people as much power as you might see in the modern world. Now, that’s probably more loaded, despite the amount of caveats I tried to add here. I think I prefaced what I’m about to say with that, just because I think there’s this view in crypto, like all governments are bunk, we’ve got to burn everything, nothing will ever get done.
I’m actually not that guy. Most people think I’m like a cyber punk. I may lose some bonafides with them. I genuinely think society has been like a pretty good improvement on the human condition. And I think American society, despite its flaws, has been a pretty good upgrade in large part because we’ve had this strong respect for privacy rights and freedom of expression.
And so right now we do have a lot of people pushing back. There’s a combination of people that are objectively worried, the old world is changing on them. It seems crazy and novel. There is real criticism and concern that you’ve got a bunch of people flipping god knows what, and people running around laughing at people to stay poor — probably not a great look. And there’s a host of other things that really are causing anxieties about the rise of crypto. And I think that’s translating into our policy bodies.
We’re also starting to see, like I think Greg, you raised this, we’re starting to see some of the politicians say, all right, hold on, hold on. Maybe we don’t have to have a knee jerk on this. Part of that’s because crypto people are starting to wield their political influence. But part of it is because I think some of these folks, like Ron Wyden and other people were, were around for the dawn of the internet. And they said, look, this was really important to us. Not only did it help boost our economy, it significantly, in large part, helped with our domestic and foreign policy — in spreading our foreign policy. And I think in crypto, we’re starting to see some people recognize the same things. And so this is a long-winded way of saying immediately in the near term, yeah. there’s going to be a lot of friction.
Particularly on derivatives lending, those types of things, because they are both the most disruptive to the traditional system and can bring the most gain to people. Which means it can display some of the traditional incumbents. But they do objectively represent some of the more dangerous aspects of things too. As we’ve seen today, right? Like if you take SocGen is now putting in assets to be collateralized on MakerDao. It’s huge. It’s fantastic. It’s like something that we’ve all been waiting for to see for a while, even as like a DeFi maximalist, love to see DeFi being able to be bridged into the real-life.
That said, you could imagine in the future where you’ve got that or something like that built on top of Ethereum. And then those things are being lent out on something like a Sushi’s Bento Box. And then Bento Box is being used with Cream and somewhere downstream, something breaks. And suddenly some pension fund is out $30 million because SocGen invested in something.
Now this isn’t to scare them off from their Maker investment. That’s not possible today. This is years in the making. But I think all of those things are now at the fore, where people are saying, look, we’ve got to address this. I’m optimistic that the long-term view is going to be a lot of pain. And ultimately, just like the internet, decentralized tech will not be stopped.
Disruptive technology, traditionally shapes or forces society to shape itself around it versus the other way around. So to me, this was always coming. In 2018, I moved my stuff from centralized exchanges. In 2019, I largely tried to stop using stablecoins. Now we’ve got decentralized options.
I think people need to prepare for the next two to three years before people realize, hey, there’s a world where, at least in America, I think America in particular, but generally across the world, we’ve got a unique governmental body that respects privacy rights, that respects freedom of expression. And this technology really helps to codify that.
If we do it right, we can actually leverage it to continue to spread a lot of our ideals, which is probably important in a time where like your position as a hegemon is consistently under assault. So I think it’s a long-winded way of saying it’s going to be painful in the short term, but I’m not pessimistic that truly decentralized protocols won’t have a lasting position and America and global society long-term.
Hm. Okay. So Greg, give you a response and also let’s bring up this geo-fencing issue because this is maybe some of the short-term pain that Collins mentioned.
And first I want to echo what Colin said about the respect for privacy. I know the narrative over the course of the last couple of months, starting with the Infrastructure Bill and Abe Sutherland has had a lot of really great thought leadership. He’s put out about 6500i, which is the subsection that treats crypto-like cash for a transaction reporting requirements and filing forms 8300 with the IRS for every transaction over $10,000.
Despite the fact that in the post bank secrecy act environment, we do have what feels like a bit of a strangulation of financial privacy, which is one of the elements that DeFi and crypto in general hopes to to ensure for its users. But at the same time, the US government does still have a great history of respecting individual privacy — or at least aspiring to respect it.
And even if we look at the way encryption is viewed around the globe, the US is still a pretty darn good actor at respecting the right to encryption, which is, in an information era, probably one of the most important rights we can have. I do want to echo that. I think that’s a a very great point.
I think that Collins has talked about it recently. I know it’s the, the tension that I usually point to most in trying to figure out how DeFi grows in America is when you have a regulatory system that’s focused on intermediaries. Not just because they’re the best position to be regulated, but because they are regulated because they are in the best position to oversee and to bring order to a market. It is very difficult for a regulatory infrastructure that has been built up over the course of, in some instances, basically a century, for it to move and adapt to a technology that seeks to build systems without intermediaries.
We’ve seen regulation adapt very quickly or reasonably quickly to the internet. But this is another step beyond that. It’s also not a perfect step beyond that. And it gets to the geoblocking point. DeFi doesn’t exist in a vacuum. It is touched and entered, if you will, typically through interfaces, that by definition are centrally managed. And I think that in the near term is where we likely see the most tension. If you’re actually looking for an enforcement precedent that directly touched some element of DeFi. The best one to look at is the enforcement action for EtherDelta, where it was a decentralized exchange, in the element that it had decentralized custody. The website never touched the assets themselves. At the same time, it served as an interface and it provided certain oracle functions and helped facilitate the magic.
The SEC entered into a settlement order with the founder of EtherDelta, the operator of EtherDelta, that basically identified it as an ATS, without identifying what the actual securities that were being transacted. But that’s a separate gripe along the lines of the broker-dealer arguments. But there, the SEC perhaps appropriately looked at, okay, there is a centralized portion of this that is controlled, that is administered. And even if the custodial portion is a decentralized thing that we either shouldn’t be regulating, or that we don’t really understand how best to regulate now, they can look at the interface and say, okay, we, we know pretty well how to regulate this. And so when we look at how DeFi operates now, there’s again varying gradations of how decentralized it actually is on the protocol level. Whether or not there’s still administration, whether it’s not there’s effective control, how we consider governance, tokens, how we consider multi-sigs.
But there still are typically user interfaces. They aren’t the only way to access these protocols, but for the normal retail user, you’re going to go to a website that’s controlled by a central party, that serves as a gate into this protocol. And the question really to me is when we’re looking at is their authority to regulate these interfaces. Are they Verizon, or are they EtherDelta? Is it an