Decentralized Exchanges: The Legal Take

Transcript

it's uh half past four swiss time so we will respect swiss tradition and uh and uh begin almost on time um i'm very happy to to welcome you i'll be your host with karen uh garen lawrence here uh today um so my name is gaber jacquarn i'm a phd candidate at university of geneva um i'm a consultant and i'm the co-chair of the regulatory working group which is the the the the group of the in the crypto valley association taking care as its name suggests of the legal question relating to blockchain and there are many of them um one of them that strucks us the most during our last call and where the reason why we wanted to make this uh

this small uh event was that we we felt that we could have um some legal clarity regard to the decentralized exchange question so um basically the the there are news the the disadvantage exchange is a hot topic right now there are many many legal questions uh coming up and um we are happy to provide you with a great panel of experts uh technical and legal expert that will hopefully answer all your questions in this regard so you have uh the possibility to ask questions at any time during the the session so you have a q r

uh um tool uh linked to zoom it's uh not a mystery to to most of them so i'll not epilogue it on that one but we will ask your question during the the the talk uh mediated by karen uh so feel free really to ask any question and well we will select them so that you can have a more interactive and more direct um talk with our speakers um without further delay i'll just introduce you to the few participants we have uh uh the first one is alexandra by tomi jills she's our technical expert she works as a risk manager at javi

and she's advising also a project in the crypto space uh that she will talk to you about um the next speaker is daniel daniel rosser he's our legal expert from the u.s side of the so from the common law with a common law perspective he's a a partner at goodwin and procter llp and he's specializing in securities and blockchain law uh last but not least but uh from our speaker's side is the is rituality guy he is a swiss legal expert with regard to uh to decentralize exchange and and blockchain related questions at ml mayor lustenberger

last but not least is the the mediator karen karen she's the karen lores is the is the co-chair of the regulator working group she's also a lecturer at the university of zurich and she has her own consulting firm always in between zurich and dubai i've talked too much now i'll hand it over to karen so that we can get down to the hurt of what our decks and what is all the fuss about decks carrying your own thank you so much gabrielle for this introduction hello everyone my name is karin loretz i'm very happy to be the moderator of this panel and i'm super excited about discussing um decentralized exchanges it's a super

hot topic everyone is talking about d5 about decentralized exchanges so this space the d5 space has definitely taken off uh we as a regulatory working group of crypto valley association thought we should shed light on it from a legal and regulatory perspective but also from from a technical perspective because often it it really gets forgotten and um i think it's very important that we talked about what is actually what does decentralization or what is the notion of decentral or decentralization actually mean and um i would like to start um

asking the question to alex um what is actually the difference between a decentralized exchange a dex and the centralized exchange from a technical perspective maybe more yeah so uh the two are quite different and decentralized exchanges are pretty new as well so the technology behind decentralized exchange is less advanced so just in terms of process the key difference is uh in a centralized exchange the data is processed internally in dedicated servers with its with their own security processes so that means that um the the client's funds are escrowed and managed within this this centralized system um and so

uh the the entity behind the exchange is in control of all the information and also in control of the assets listed on the exchange uh on the other hand so a decentralized is a peer-to-peer marketplace on the blockchain so all these operations occur on these public blockchains and are visible by everyone as well as the smart contract and the operational organization behind it so some of the key advantages of that is that because it's on the blockchain and it's non-custodial so the customer that you don't as a customer you don't have to give up control over your funds and it's also uh peer-to-peer so

it's permissionless anyone can participate in a decentralized exchange there's two key ways to participate either you can be a liquidity provider and so that's that's basically you become the exchange and you provide liquidity to the exchange and you get some of the fees or either you just use it to exchange funds which you can choose both a centralized or decentralized exchange to do that so now the real technical aspects of it is how these funds are exchanged and so uh that varies from a centralized exchange where actually this technology has been used for decades on traditional markets and so typically centralized exchanges

they use a technique called order matching and so all the it's it's a system which matches all the buy and sell order it's quite quite interesting if you look at it it creates kind of a pyramid structure and and you can see uh all the different transaction volume at different price levels and so effectively the liquidity can be waiting to be exchanged so the transactions can happen really really fast uh within many seconds sometimes in the extreme cases of algorithmic trading so that on the other hand so that's kind of the challenging part to implement in a decentralized uh manner and so uh decentralized exchanges

are also called automated market makers because there's basically uh a mathematical algorithm that describes how the tokens can be exchanged within with each other so um it's it's kind of it's you probably also heard the concept of bonding curve in in the cryptocurrency space and it is it's the same concept where a curve defines the relationship between token a and token b and so typically in this curve uh there is a invariant variable that's called k and it's a variable that stays the same while all the other variables can change so the price of the tokens the balances of the tokens in that liquidity pool

change but then it has to reconcile back to this uh invariant uh and it's so it's a bit if if you know a bit about physics it's a bit like a hydraulic system where one side reduces the energy goes to the other side which increases to balance things so um typically for example unisop which is uh the biggest decentralized the formula is quite simple it's x times y so balance of token a times balance of token b equals k and so that's it that's the that's the mathematical formula that allows to exchange now bit that has allowed billions of exchanges so so different uh decentralized exchanges

have different formulas which have different benefits or uh lead to different risks um and and this is evolving really fast with many new decentralized exchanges emerging and new ways to do it and and so one of the one of the announcements and one of the latest releases is unit v3 which uh in addition to this constant formula also uh introduces kind of an order matching mechanism similar to centralized exchanges where uh users can provide liquidity to specific ranges as you said so um it's very interesting so

they're like developing constantly right i mean uni swap for example it's already version three and they don't exist for a very long time right yeah exactly so version two was last summer and uh just before last summer now version three but um it's it's it's it's the beginning of this new technology and so there is a lot of improvements to be made and and so that's why it's progressing so so fast basically one of the big dangers of decentralized exchanges in particular for liquidity providers is impermanent loss so to return to this invariant the algorithm will do it whether it loses money or it

makes money so so basically all the the arbitrage that happened on the exchange the liquidity providers kind of carry that cost i find this topic very interesting and maybe we can discuss it later when we talk about liabilities um because yeah this is a very interesting topic and i'm not sure if a lot of people know about it which which would be interesting to touch touch on it i would um as you said and i would like to pick it up so unlike uh traditional exchanges a dex has no possession of an order book or custody that's what you said instead um you um they use like um there is a peer-to-peer peer

transaction so meaning that the users they transact um directly with themselves right and there is no central server who does the matching or whatsoever so from a regulatory perspective um i was wondering or maybe also other people were wondering what is how are taxes actually regulated and do they fall under any specific regulations are they are they're licensed or do they actually need a license like a centralized exchange or a traditional exchange and if not um when do um taxes fall under like the regulatory uh framework or

framework or requirements and maybe later from a swiss perspective it would be um interesting to hear what's what's the swiss perspective yes of course um the swiss perspective is actually we have our regulatory principles are basically that we apply our existing laws to all types of exchanges we we look at the function what functions like an so it's if it functions like an exchange it must also be regulated as an exchange that's the the basic principle of the swiss regulator finma and a second principle says that

the the technology is not relevant we have a technology neutral approach so therefore usually we go and say we also have in switzerland that the usual three pillars of different exchanges we know actually based on the existing legislation we have stock exchanges multilateral trading facilities and organized trading facilities so what functions like that must be regulated like that now we all that with taxes we have different levels of decentralization um we have taxes where at least some functions are organized in a

central way but in in a perfect world there would exist the perfectly decentralized exchange now one could think of that switzerland with just releasing its new dlt law in august of this year will solve this kind of problem with regulating decentralized exchanges however also there the we have a fantastic new type of exchange license uh covering dlt based exchanges obviously but also there it is focused rather on centralized or at least partly decentralized providers because

as in the the existing legal system the deregulator always connects to a kind of operator being an individual or a company but we always need an operator where we can connect the regulatory duties and that's exactly where the fully decentralized environment gets actually in conflict with the principle of the regulator to regulate exchange activities because this is a financial market activity actually if there is no person or operator we can connect then who who can we regulate in the end and

there's another question if it's would be really perfectly perf perfectly decentralized then we even don't know which jurisdiction is actually responsible for regulated this exchange because that's regulation regulation is always lies in the responsibility of every jurisdiction so this is the main problem we have so the short answer for fully decentralized exchanges is actually that as of now they are not really regulated and also the federal council in switzerland wrote in in his uh ex-plan

explanatory reports to this new law that he had not intended to cover fully decentralized exchanges however switzerland will follow international developments and maybe also try to regulate and as of now we see that the swiss regulator finma already tries to to catch somehow this d5 structure speeds decentralized exchanges or other d5 structures somehow they they really they just at the beginning of this year started to escalate some some really precedent cases internally where they really have a close look at

decentralized structures and they try to find some some sort of link to to the structure itself maybe it's not a classic operator but maybe they they they search for elements like someone who receives fees of every transaction for example someone who who operates at least the login website and has a permanent contractual relationship to the user such things they are looking for at the moment and then they try to construct at least something like um this person is supporting the the exchange somehow in in doing the

exchange activity that's like they try it and we also see it in the aml area where we have first drafts with such approaches which finra tries to regulate and we see it in the also in the draft consultation report of the fatf regarding vas and vesps so that's where we stand we will come to that later as well to the fatf guidance which was just recently published but the interesting thing that you're saying is that the new dlt like framework which switzerland has published doesn't actually regulate fully decentralized exchanges right

exactly yeah yeah this is the case i guess the the easy answer is that also our administration did not know how to do it back then yeah well i thought maybe if you can but they didn't forget it because they explicitly mentioned it right and said that it's out of scope which is very interesting yeah then i would like to hear the u.s perspective on taxes so what is the u.s perspective is it dex defined as an exchange under the securities law or is subject to any regulatory compliance or

legal compliance requirements um what is the u.s view danielle sure yeah sure i mean as you mentioned you know decentralized exchanges are um are relatively new and certainly the current you know kind of increase in activity around them is very new but i think to give you at least an indication of where the u.s regulators may be it's helpful to um to look at a settlement involving the sec which is the u.s securities regulator and it's called ether delta now it came out in november of 2018. so obviously a couple of years ago now and as alexander was describing you know the technology has changed probably significantly since this this project but i think it gives you an indication of at least

how the sec was looking at at these issues at the time and at least one approach they may take going forward and thinking about exchanges so ether delta just to give a little bit of background build itself as a decentralized exchange right they describe themselves as a decentralized and they asserted that there was no exchange owner holding the funds the sec looked at that issue and also ultimately reached a different conclusion in terms of how decentralized the exchange was but i think the analysis is what's instructed from a u.s perspective right so under the u.s securities law just a little bit of background it's unlawful for an exchange to affect the transaction in a security or to

report a transaction unless the exchange is either registered as a national exchange or is exempted from that registration so that's kind of at the high level what the legal standard is and then the question becomes what's the definition of an exchange under u.s law which is exactly what you just post and that definition is relatively broad and it really it captures any organization or association or group of persons which maintains a marketplace or facilities for bringing together purchasers or sellers of securities right a very broad definition that is meant to cover a variety of exchanges that is applied in the u.s using what the sec describes as a functional test and it really has two parts the first is

is this enterprise bringing together for orders of securities multiple buyers and multiple sellers that's kind of part one part two is is there an established non-discretionary method for these transactions right something that's observable established happens time and again now applying that test the sec concluded that ether delta not withstanding its description as a was an exchange that was subject to the federal u.s securities laws um and it did that because it felt that ether delta not notwithstanding its description as that decentralized exchange really met both components it was a marketplace it brought together orders of buyers and sellers

and the sec found that those transactions included securities because the underlying um the underlying you know issue there was were these digital tokens securities and obviously the us has a very different framework from switzerland and the eu in terms of what a security is but under u.s law you have the concept of an investment contract so if you have an exchange of money if you have kind of common interest commonality and you have an expectation of profits based on the efforts of the promoter in many cases the founder that can be enough to constitute a security under u.s law and so from the sec's perspective ether delta was transacting in or facilitating transactions and tokens

that under u.s law were viewed as securities okay so that's the first prong of the functional test satisfied in the sec's view have a marketplace buyers and sellers purchasing with the sec considered to be securities the second component was well was there a sort of a sort of rigorous and predetermined routine for these transactions in the case of ether delta they had a smart contract that operated on the ethereum blockchain and that smart contract constituted what the sec called an established non-discretionary method of trading and so that was the second problem that was satisfied and so from the sec's perspective that meant that ether delta was an exchange that would be regulated

under u.s law and then the question became okay well was it registered no was it subject to any sort of exemption no at least none that that it had applied for and so therefore from the sec's perspective ether delta was in violation of the law and was subject to liability as an unregistered and and so the last question then became well well who's actually liable here because ether delta had been sold and in this case the sec actually held the founder liable and the the sec's thinking was that the founder there exercised complete and soul control over ether delta's operations he'd written the contract that was on the ethereum

he was the one who controlled those operations related to trading and he should have known that those actions would have led to violations of u.s law so in this case they went and looked at the founder but this all begs the question which i think we're going to talk about next as to whether in fact this was a decentralized exchange right from the sec's perspective the founder controlled either delta and so one might argue well this is all well and good but this isn't november 2018 and really it was a centralized exchange notwithstanding the description um and i think that then raises the questions of decentralization that i imagine karen you may want to jump to next exactly yeah that's a very interesting question um what what does like decentralized

mean so how does one measure that whether it's fully decentralized what the rato already mentioned and when is it isn't it not really fully decentralized can you give us some like guidance there because somehow people maybe get a bit lost i mean what is is it just if you label it as decentralized is that sufficient of course not but when is it really and truly decentralized i'm really i really want to know that from a swiss and from a u.s perspective and also from a technical perspective which could be quite interesting who wants to go first alex sure so so from a technical perspective

i mean being decentralized so um i think it's about uh the level of control the central entity has over uh the decentralized exchange so typically who controls the listing of new assets is it and i think in the case of ether delta for example that was one of the specific points identified the founder controlled the assets listed on the whereas if you look at uh one of the most decentralized exchanges today any anyone can create a new liquidity pool and list a new asset so operationally basically uh all the processes and the upgrades have to

happen not just from the team behind it but also from the community and from different contributors what is your view from a swiss perspective or broader perspective of course um decentrality in decentralization in connection with usually means we have a look actually it's what david then you know told you before that also in switzerland today simultaneously puts together bits between several participants

and if they conclude a contract based on non-discretionary rules on the platform and we have actually i would say if we have a look at the value chain of an exchange it's ex order matching and execution clearing and settlement and we must have from a swiss perspective a look at every step of this and when i remember back we had the first stacks uh projects i had clients they always told me yeah we are fully decentralized in the end we saw that yes they have p2p function so the fund flows were between the users

and not over the platform so that's good decentralized fund flow but they they did an order book matching like a centralized exchange a classic one over the platform so the the bid and asks have been uh yeah connected to each other on the platform and therefore this one was not is was obviously not fully decentralized especially the matching function so with the fully decentralized taxes as alex also explained we have also the matching process is not done by an order book but it's simply with this algorithm and liquidity uh providers and swaps it's

it's functioning in a completely different way so uh also there we then don't have this matching process on the platform so it's it's completely another mechanism and that's basically what we from also from a legal point of view ces fully decentralized further as i told you um the regulator is simply also looking for other connexis now so if you want to really be fully decentralized it must actually be simply the software code running for itself without any intervention and without any gatekeeper and actually also not anyone having control over this kind of software or

smart contract and that's at least from a swiss legal yeah thank you that's interesting um very interesting i mean daniel if i as your client let's say i'm your client what would you what would you say from a u.s perspective so that i am really on the on the safe side and follow like previous projects that actually failed or were yeah not regulated that's an exceptionally challenging question i'll explain why so in the us as as i mentioned in ezra knows it's a very

different um legal structure not just because it's a common law structure but just the approach to um digital assets in the u.s is very different it's actually governed by a test called the howie test which was set forth by the us supreme court highest court in the united states in 1946 so as you can imagine it was not designed for cryptocurrency digital assets any of the issues that that we're talking about now the concept of decentralization actually first came up in the well came up in a way that was well publicized in the u.s in mid-2018 and that was in the context of icos and the question of whether offerings of digital tokens would be

or whether if they were sufficiently decentralized they were not and so one approach might be to think about whether decentralization in the context of decentralized exchanges could be thought of the same way and so you might then ask okay well what did the decentralization mean in the context of icos and it was never defined has never been defined but the two touchstones that i think folks in the u.s think about are bitcoin and ether right those are projects where um at least the view is that the founders at this point are no longer required for the project to run and not just on a technical level but also kind of on a practical level when we're talking about use cases and the number of operations transactions etc

and so you know there may be others but those are two that at least the u.s regulators have pointed to either through their either explicitly or through an action in terms of enforcement actions as examples of decentralized projects and so one then might think about in the context of decentralized exchanges the same sorts of principles if you have a founder of a decentralized exchange is that founder still entirely or primarily you know pick your adverb responsible for the decentralized exchange in its operation or has it developed sufficiently that the founder could and in fact did step back such that it is decentralized and is running

without you know the significant influence or control of that founder ether delta which i talked about a few minutes ago is an example where the sec was of the view that the founder was in fact exerting complete control so label label it decentralized or not and their view it was centralized um so then sorry what if the funders left let's say they left the project what happens then it's a very interesting question and i think it depends in part on how that project evolves so for example there are projects where there may be a few [Music] a few entities or individuals who are not the founder but who are out ultimately exerting control over the

project in terms of improving technical amendments potentially approving um economic amendments if you have governance tokens and you could see a scenario where um you know that they may be considered to be exercising some level of control i don't think that's something we've seen in the us and i think that the arguments why um that wouldn't be appropriate if these folks were were not really controlling the network but that could be one issue um you know another issue could be even if the founder left um under the u.s securities laws depending on the founders activities and the period of time when he was controlling the network one could still he could still be liable in some way right it's almost the converse of ether delta where the company left

and so they went after the founder but you could see the opposite happen in some scenarios as well i would think it hasn't happened at least that i'm aware of with respect to a u.s regulator so it's kind of an inference but yeah yeah um i just want to ask gabriel do we have any questions so far far from the audience yes we have many questions from the audience um one arbitrarily i'm sorry guys uh but um we have a question from tobias dalberge and he says basically that do you believe that if the the centralized exchange or the semi-decentralized exchange are regulated too hard

people will inevitably go towards more and more decentralized solution hence uh making the state lose its grip you so just create the platform lose the key and the control make the money you know in a derivative way do you think it affects the regulatory outlook at some point interesting question who who wants to take it i mean i guess i can start um the short answer is i don't know but um i guess a couple of thoughts would be that i think there the point about innovation and regulation stifling innovation is

certainly one that's been made in the us as i'm sure folks on this call are aware of and discussed at length but i think that does need to be balanced against the understanding what the regulator's role is right the regulator's role ultimately is to protect investors and and so at on some level there is a balance between innovation but also making sure you have a sufficient regulatory framework in place to protect investors from projects that from which they need protection right in the u.s i think back to the the ico era and there were a large number of those projects that were ultimately proven to be fraudulent and and i think that that illustrated on the one hand you know you want regulatory clarity

absolutely and you want a regulatory environment that doesn't stifle innovation absolutely but at the same time you want an environment that protects investors so that they don't find themselves in a situation where unwittingly they are put in harm's way because there isn't you know a sufficient framework in place and obviously different countries are doing it different ways and i imagine my sense is that most countries are still trying to figure out exactly the best way to do it but i would just say that there's a lot of focus on stifling innovation and rightfully so but i think there also needs to be focus on protecting investors which ultimately really is at least in the us and i imagine in switzerland as well the principal focus of the regulator definitely yes and um maybe i want

to um hear alex's view um you're very connected to the space right you know a lot of people in the d5 space what do you think um how or how would you answer the questions will people just try to go and go more decentralized so ultimately decentralized and lose the key or whatever what do you think is it yeah i think that's that's clearly the direction the space is going and protocol after protocol whether it's a decentralized exchange or other type of d5 protocols i think it's clear that uh the decentralization is in process it's something that doesn't happen in

one day because you know it's especially like over the weekend actually there was a vulnerability discovered in the smart contract that was four years old so if there is a vulnerability vulnerability and the protocol is fully decentralized it's quite hard to patch and um and so actually you know decentralization is a is a process it's an ideal um i think a lot of a lot of protocols are taking it really seriously i would like regulators to um be more considerate as well for for the challenges uh that come with decentralization and it's true i mean the tendency also i've observed in the spaces there are more and more anonymous contributors and

and so you know that is to protect oneself from regulation mostly and and it's risky because in the end the loser is the consumer which you know is not protected doesn't have there's not that identity layer provides some sort of consumer protection so yes i think that's a very good point i mean we should also or the regular a regulator should not forget that there is also i mean maybe he pushes all um the projects into a direction which is neces which isn't necessarily the best for the market or for the investors as well which is very much risk or riskier than if it was just a

semi decentralized project right um later you you wanted to say something i think yes i i can simply i agree to to daniel's and alex's points actually and it is the case we have on the one side that the regulator looking out for the investors protection on the other side we have in the ideal fully decentralized world it's actually not possible to enforce but all the gray areas are going to be difficult to handle and it's also it's it's a fact license licensing and regulation imposes huge costs on the operator

and on the clients or the investors so investor protection is not only protects them from faulty or fraud or whatever but the regulator should actually also consider the costs he lies on the investors in the end and yeah unfortunately this is not so much the perspective of the swiss regulator to be honest swiss regulator says investor protection that's it and we are not here to to to foster that the competitivity of the swiss market financial market and so on so that's a little bit the pity but uh in the end it there should be some sort of a

actually i see it i see it exactly as you already thought but i think that it's very similar um in the eu as well and this has like become very prominent after the financial crisis where it was all about like investor protection so investor protection is always much heavier than than whatever like innovation or anything else so this is what what i've seen um in the past uh over 10 years now um yeah which is um yeah a bit sad to be honest yeah gabriel do you have any other questions that you would post or like to post from

the audience we have we have many questions from the from the audience uh one of them uh which came back a few times under quite a kind of format for instance from tibo or from kellol basically um the question is the regulation is kind of crushing the the blockchain dispersation so do you believe that the regulation will kind of make decentralization not great again i mean do you believe actually the regulation will actually disable decentralization i want to hear this from alex

[Laughter] so i'm not sure i catch the full question so operators or founders would just be tempted to what do you mean disabled decentralization so the the fact that we have the regulatory requirements coming from the regulators now we have more and more detail that decentralization will in the end be possible from a legal standpoint that's basically the idea of the the question yeah well yeah i mean you know i think um from a legal standpoint you know it's definitely more challenging every year hopefully you know everyone is understanding each other better you know

the decentralized protocols understand the need for regulation and for consumer protection and and same thing regulators understand the need for decentralized services because also like you know we're constantly reminded of the weaknesses of centralization and and so you know there are a lot of risk with decentralization but you know centralized entities also uh you know leak information suffer hacks so um it's not it's you know like i think you know it's it's not uh it's it's important to keep a mitigated approach and you know the full picture rather than fall into one or the other what um what i've seen um

in the last couple of weeks that or months even or years that i talked to to the space in general about decentralization and about texas or dao's or whatever um a lot of people are of the opinion that using a blockchain to create an exchange central operation and so on doesn't remove the creator's responsibility and we already touched based on it do you think that is right i i have the impression that this is quite like um quite a strong belief in in in the space that as long as you like say

well i i don't i don't have like any like central operations so that's why i'm not i'm not responsible for anything i don't have any liabilities so maybe we we already talked about responsibilities but maybe the liabilities do you see um like any any issues there i mean just to dive a bit more deeper in into the topic of decentralization um do you um there is a risk for someone who um who sets up a dex without fully being fully decentralized on the liability side let's say from an investor protection

perspective or whatever i'm happy to go first i think from a u.s the short answer again is i apologize for nothing it would be clear it depends and it depends on um on when it's set up how it's decentralized i mean i understand as a technical matter one can implement a protocol that is decentralized but as a practical matter when that has to get upgraded is it the founder who's doing the upgrading is it the community is and if it's the community is it a broad community or is it a community that really consists of five to ten folks who are doing the acting right there's a whole spectrum as raito described a very wide spectrum and gray area of

decentralized decentralized and so if you're in in that gray area then i would say that you potentially in the u.s have exposure um have liability exposure on a couple of different levels right if for example you are something like ether delta maybe less centralized but that sort of setup or even if you're a more decentralized exchange but you're trading what are considered in the us to be securities which are many digital tokens for example you may you may be considered an exchange you may be subject to registration and if you don't register you could be liable that's kind of the story of the either delta in addition in the u.s if you are engaging in secondary

in unregistered securities again what could be many of the tokens that could be a second source of liability and so the question of whether the founder could be liable for either of those and there are other sources liability as well but the question whether the founder could be liable for those i think again comes back to the question of of a what does decentralization mean and b how do you measure it as a practical matter in addition to as a technical matter because clearly without the technical decentralization that which is a threshold without that then you have an issue just right off the bat but let's assume you have technical decentralization how about the operation of the exchange and how centralized or decentralized that operation are the use cases in that exchange right

all of those factors i think at least from a u.s perspective regulators would be likely to look at and that would all factor into um the amount of risk a founder may have so we're basically coming back to what is um what is decentralization what does decentralized mean so erito what is your view is it similar in switzerland as well or you have already had some experience with finma so um finma goes after some decentralized projects but why do they want to find out if they're really decentralized or what is the reason yeah in the end it's it's yeah the basic elements are what

dave daniel already told us and i told you before with this all gray area cases with decentralized centralized whatever and in switzerland you have this as in the u.s i guess this basic also criminal uh principle that the that if you operate in exchange or something needs a license and you don't have this license um you are getting criminally liable actually that's the first one that's small kind for the the criminal prosecutors finma has told before wants to protect the investor

and if we have some central elements it's always uh yeah we all know that centralized elements are very uh it's easy for fraud it's easy for miss misfunctions or whatever and finma wants to prevent that and that's why finmeiser look at it and if there's a central operator then it's clear it's going to be regulated if and finma is a very wide approach even if she sees that we have not a classic operator but maybe we have someone who provides the codes then we have someone who's

was operating the login web page and we a third one earning the fees and finma sees that they somehow work together then they simply applies the group approach to them and maybe also enforces its kind of regulatory instruments it has in the end so it's also this kind of group approach which gets also very popular on the regulatory side for such structures we see that with finma but we see that also in the fatf's proposal yeah this is very interesting because usually you go after one person or after company right yeah there is no company so the approach

now is which is which is something new is just okay we just go after a group of people who seem to be involved in the project or who seem to have an a role or an important role right this is very interesting okay um before we go to the next um topic which will be aml um gabriel maybe you can um pose other questions like additional questions uh two small questions maybe one for retto uh uh nobody is from the eu here but someone was interested to know if mika was solving the issue of decentralized so maybe you can give just a quick

answer on that and then we have two questions uh linked together that are related more to a topic where daniel would be competent i guess that is the the sec reach on a fully decentralized exchange would sec find itself competent what is the extraterrestrial competence of the sec with regard to dex so i'll leave a again and then leave you continue guys thanks gabriel to be transparent here i really don't know the answer if taxes are regulated under me car i know that mikar will introduce at least

a full framework for for all kinds of crypto assets uh it's the separation between what falls underneath it stays underneath it and now everything other including stable coins are being regulated and at the same time they will also amend its uh regulations for trading platforms that's for sure but i really don't know if they are really also able to catch fully decentralized structures i don't think so but uh yeah and on the latter question it's interesting that question was asked because when raito and karen were

talking about the jurisdictional reach of various countries and how it applies to decentralized exchanges actually had a similar thought um it's a it's a very interesting question like rachel and his question i would say the short answer is i'm not sure i know how they would do it but i think it depends on again the facts and circumstances so as an example if the if the decentralized exchange while decentralized is being run however we're defining that term out of the u.s so think that the technology is a system even happens i think that would be a scenario where um one might think it more likely that the sec would seek to assert jurisdiction if you're in

a scenario where you know the the actual technology is being run out of europe or asia non-us country then i think a second question would become and this would also apply even if it will run out of the u.s where are the parties entering into the transactions and if the short answer is well everywhere because it's decentralized so some in the u.s some in europe i think one might expect that the the regulators would at least assert jurisdiction over those parties or those transactions involving the u.s party now the next question would likely be what we'll find but how do you figure that out if you have anonymous folks engaging in transactions develop as alexandra said

and if you're not really sure which transactions are occurring where and i think that's where it becomes from a technical perspective increasingly challenging and so i think that's an issue that the regulator would have to grapple with but i think you know it depending on the facts and where the the project's located and on the assumption that at least some of the folks are located in the u.s i think one might expect that the regulator would believe that it would have jurisdiction at least over the subset of transactions where one of the parties is in the u.s and how you figure out which transactions those are how many transactions those are i think those are very challenging question that would be a case-by-case sort of analysis i see so what i can say is that it's

um it's not an easy topic also from from a regulatory or from a a regulator's perspective i have to say um the regulator just tries to gets like bits and pieces and tries to to grab some people and to make them maybe liable or responsible but it's it's very interesting that the regulator really doesn't exactly know what to do um which hands me over to the next um topic which i'm particularly interested which is aml so we haven't talked about the aml issues or maybe not issues on on taxes and um the fatf latest guidance which later already

mentioned in the beginning essentially defines like non-fungible tokens as virtual assets and the updated version also discusses like stable coins um d5 projects um non-fungible tokens taxes and they're like taxes are considered as vasts as virtual assets uh providers and um which means that basically the revised guidance suggests suggests imposing aml and kyc towards taxes or dex applications what is your opinion on that um alex maybe

do you think that's a good idea to to have aml and comply aml and kyc rules towards taxes yeah actually france has passed such a regulation requiring i think in the future uh in the next year or so for all crypto wallets to be like linked to an identity and um i struggled to see how this can be implemented today given how far we've already come and and you know i think you know actually most cryptocurrency users now you know they have various wallets and and and you know i mean

you know they are declared i mean although they're not directly aml because you you need to declare your your capital so in a way like the regulator does have some information about who owns what but um yeah i'm not really sure i think this is this is really um this is really opposed to the decentralization ideology um that you know aims for permission-less system because you know it today like well we're in switzerland we're in london so we're privileged but actually billions of people don't have access to financial services and and that's partly because of who they are where they come from sometimes which religion they belong to

so if you start putting aml and kyc that's gonna that's gonna really kill the ideal of a universal access to finance um daniel do you have an opinion on that on a fatf's uh new lower latest guidance or the proposal let's put it this way jeff i don't have anything on fbi less of a u.s focus but on the broader question of kyc aml and in the u.s there's also what's called ofac so there are a list of of countries um you know

residents of whom of which excuse me aren't able to kind of transact insecurities in the u.s and so those different kind of regulatory layers exist in the u.s and so for projects that are going to comply with u.s regulators and these are not the sec these are other regulators um you know kycaml and then these ofac requirements um come into play and so i certainly take alexander's point that that it may be counterproductive in terms of making or at least maybe at odds with a better way to say it in terms of making you know digital currency available to large numbers of folks who don't have access to it but kind of from a u.s regulatory perspective i think that as a general matter kycaml and ofac

would apply now the next question becomes well who who does it if you have a truly and that again is a that comes back to the gray area we've talked about at some great length right it's how decentralized is it and and would you want the founder to do it and if the founder does it does that undermine the argument that it's if the founder is actually doing all of which are very good questions and and kind of lead back to one point which isn't directly related to aml but just thought i would flag in the u.s you see actually even discussion and perhaps disagreement among some of the sec commissioners about how to deal with um getting from a to b a when a project is launched to be when it is decentralized as a practical matter right because in many cases even once

it's launched and even once the technology is purely decentralized getting to a what folks would consider decentralized as a practical matter can take some time development of users all the rest of them and so there is a there's discussion and there hasn't been a resolution about how to deal with that issue because if you were to look at most projects early on i would imagine folks might say that they were not decentralized i think folks might say that about ethereum at the time of this launch if you were to look at it later maybe a different story and so then the question becomes well what do you do in that interim period for projects that are trying to get decentralization and i think this and that's a question in the u.s that i think folks are still thinking about perhaps and switzerland in the eu as

well um and it relates to kyc aml and olfact in the u.s in terms of should it need does it need to be done who should do it and who's responsible if it's not done but it also relates more broadly i think to the issues we've been discussing and as you said and if um kyc is done does it then lead to the point that the dex is not fully decentralized again i mean then there is none of uh none of the decentralized exchanges are then actually fully uh decentralized right which is also a bit yeah how do you do you see it from perspective i think this is the point you mentioned is

exactly what makes me think sometimes when i read again this fatf proposal it's at least to a part wishful thinking because if it's fully decentralized you don't have this kind of central person doing the kyc but i i see obviously the regulator's perspective they somehow want to to catch this kind of of institutions or or yeah contracts i guess because they are somehow replacing the existing existing financial system and they they want to catch as if they are catched if they are acting in the already

existing centralized world but it does not fit to to the case and on the other side we have at least from a swiss door perspective but i think it's also from the fatf at least the international original perspective that aml is actually always connected to the power to dispose actually over assets this is is the the connecting points to doing kyc and having the contact to the client the point of sale the contractual relationship this is the point where you have control and you have control over the assets

that's why you are a financial intermediary and i guess this is also the point we are discussing this also in switzerland in parallel with this a new dlt act which also changes some aml uh provisions it's the same discussion in the end finma tries to to get institutions into aml which only support somehow transactions with virtual assets but in the end it goes back to who we can we catch and let's catch him exactly and the traditional world always has at least a

company or a person who's liable who who you can actually grab and catch and now if it's decentralized there is no one so then the regulator whoever tries to to somehow find someone right yeah and the regulator has and also the legislators they have not found the concepts to really capture decentralized structures in a good way we see it or this also in in other areas of our life for example with the autonomously driving vehicles where we also discuss how do we regulate the liability if there's damage somehow

by such a vehicle it's somehow these are the same questions in the end and we our established legal concepts are not ready as of now but uh it's it's a kind of development yeah i i 100 agree with you and it's actually a nice um uh idea to yeah make the peril of autonomous cars or self-driving cars it's very similar so we have self-driving or self-moving um financial institutions kind of who are not financial institutions um gabriel we have a couple of minutes left

to take questions um i want to give the opportunity to maybe pose two or three or whatever so 50 questions exactly uh i'll try to i'll try to uh i selected a few uh question that i think was interesting uh first one would be for alexandra okay how can one technically avoid working and don't take it bad daniel working with people located in usa except blocking ip from u.s address how can let's assume that i have a dex i want to create the decks but i don't want to have the sec

nosing around because anyone could actually be find a jurisdiction in the us if someone lives there how do i avoid that technically speaking so i mean technically speaking as far as i understand um the blocking the ips and then also doing some legal disclaimers that amer us-based investors are not authorized on the platform as far as i know that's all that's possible to put in place there are a lot of ways to hijack those ip blocks and and and i know of american based

uh users that use these techniques such as a vpn to kind of change the location of their connection and and and break those those barriers but yeah i'm on the technical side but i'm not actually on the development side so i'm not aware of all the solutions maybe okay uh so maybe a question for uh for retto um do we have uh we had daniel talked theater delta case do we have uh some dex cases in under swiss law do we have finma who take definitely who took definitive ruling on some case that are well known we have the problem is a little bit that the

cases are not publicly known we certainly have some finma no action letters that's when people or projects file within their their view of its project and ask finma is it regulated what we do or not and such letters exist we have one from a client in the house where the the simple connection to the real world was that the the project had wanted to establish a company in switzerland and the company would have earned a fee for every transaction being done over the decks and finma actually had the standpoint that

this kind of company would be to read regulated and have a license only because of this very small connects so um yeah this helped me to to link it to the next question so we know how traditional exchange can make money how does a dex makes money if she he cannot like even you know have his fee uh being uh vested without qualifying as a as a type of exchange i mean it says awkward question to the to the board that was asked by katarina how does the dex makes money maybe otherwise stopping index i think it's important to say that

although uh it's not a centralized entity a dex uh is a decentralized autonomous organization and so as such it's still an organization that's composed of kind of independent units and and so these units um so this organization is exchanging mostly by our forum and so all the decisions uh are passed by vote of token holders actually it's quite possible to put in place fees for the exchange and so um the biggest decentralized exchange is unit swap but it was fork so that means so one of the reasons it's decentralized one of the factors is that the code is open source so that means

anyone can read the code copy it duplicate it and then create exactly the same thing over again but as a competitor now so that's what happened to unit swap with sushi sushi swap and so in sushi for example there is the possibility to stake the sushi token which is the governance tokens that decides on everything and when you stake it you generate a return you you get part of the fees and so uh you get kind of a fiat crew accrual token which is called x sushi so it's completely possible to to have a treasury to manage that treasury to direct funds to development or to growth or to different upgrades as a decentralized organization

okay thank you um i have a question of my own uh thank you a lot guys for uh we are kind of reaching the the time and uh um i had a question on my own and i will take the the opportunity to ask it uh i feel like you know a biologist sometimes uh we're kind of trying to draw up a new species we're trying to to to to take all the stuff to to in our driving to to drop this kind of new beast and i have a question regarding to if you were the regulators uh how would you supervise how would you monitor those kind of decentralized exchange if you had a pen

in your in your hand and you could like draft up a convenient way to to regulate the decks how would you do it that's a tough question but a very good you have two minutes someone for an answer what would be the best way to regulate those those entities in the end one way to start and i think the problem one of the problems of the regulators right now is just understanding what's happening you know and for me like i've been working in blockchain now for three years and a half

you know at nearly two years but you know i'm still struggling to catch up with everything that's going on in the space and the degree of innovation so um yeah i think before before regulating the real important thing is regulators hiring experts that have really worked and decentralized organizations and and understandings you know yeah like the challenges of decentralization the risk of decentralization because i think you know especially like when you look at uh some rules over uh for example in from online information and the right to be forgotten and they were kind of the the mindset is completely different than than to centralized entity and there really

needs to be an evolution in the philosophy of the regulation itself i agree on that and i just wanted to mention i mean if you see the fatf proposal on their latest guidance you see that they don't differentiate between like a fully decentralized exchange and the semi-decentralized exchange they just think okay a decentralized exchange needs to be regulated somehow we need to like push them into kyc and they ml direction but i think they as you said alex they need to understand that there is like it's not just one decks and the rule applies to all it's like it there is like

some degrees actually of of decentralization and if a decentralized exchange is fully i think um then it should really fall out of scope as it is in switzerland right now so thank you a lot guys um i'll hand it over to to karen yes so i think we actually reached um the time so thank you all of you thanks uh alex thanks daniel and thanks leto thanks gabriel as and thanks everyone for listening to our um conversation i hope you liked it feel free to contact us or to connect

with us on linkedin if you want to to join the cva or the regulatory working group actually then just just feel free to contact either gabrielle or myself we're happy to have very good regulatory and compliance specialists and legal specialists in the crypto space so that we can contribute something to the to the whole environment space thank you so much and wish you all a good evening bye bye guys