Risks & Regs: Brick by Brick

Transcript

so when I Was preparing for this talk um I went on t.com and I searched for interesting crypto legal and Regulatory talks and there was a sum total of zero hits that that came up um I think it's a little challenging to to make a crypto legal and Regulatory talk interesting but um I'll give it a try one of the things that uh I hear a lot in the industry um from crypto entrepreneurs is it's very hard to get straight answers from a crypto lawyer um you ask them a question and the answer is always yes or no it depends um I'm only licensed to practice law in one

jurisdiction um I only know one area of law um you just can't get a straight answer if you're trying to build a crypto project launch a new token um uh uh you know you can't there's no straight answer and the answer is it's it's really you know um not their fault um it's because the laws that implicate that are implicated by crypto is uh very very broad um so as an example if you're trying to set up a new exchange um or a new um you know uh payments institution um and just take the US for instance there's 50 states um in the federal government and there's MTL laws money transmission laws in you know every one of these 50 states um uh and they're all

different and there are different Regulators um and enforcement agencies for all of these laws um and that's just this and and that's just you know money transmission if you're trying to issue a token um a lot of times there are other laws involved Securities derivatives banking sanctions um you know uh broker dealer Investment Company investment adviser there's a whole slew of laws that come into play when um you're trying to deal in the crypto space this is in the US um as you all know crypto is global the moment you launch a token the moment you go open loop the moment you uh launch a project um it becomes immediately Global um anyone can use it around the world and the number of laws that are applicable to your project instantly multiplies literally thousands

and thousands of them in Japan for instance here um the laws have been um actually very clear since 2017 Japan was one of the earliest countries to actually regulate um uh crypto financial institutions um but in other places us for instance unfortunately they' really struggle to come up with clear and workable um laws affecting uh uh the crypto industry so how do we think about um crypto laws and regulations um the way I like to think about it um I like to go back to uh first principles um why do we even have crypto regulatory laws um why do we even regulate the industry um what motivates um you know everything that we're we're doing um uh

when it comes to crypto laws and regulations um and there are a couple of pretty basic first principles that I think everyone can think of about when um uh you think about uh uh crypto laws and regulations so for instance investor protection um making sure that investor assets are protected safeguarded um kind of a no-brainer um but also things like disclosures um and making sure that um participants and users in a space um actually know what they're getting into making sure that we have a well-informed um and educated um uh user base in the industry um Market Integrity making sure

that the markets that we create um and the markets that we um uh uh you know participate in are fair and transparent that you know there's no bump and dump going on there's no um uh uh you know insider trading there's no Market manipulation conflict of interest stuff like that a third principle um that I'm sure a lot of us have wear off is uh preventing Financial crimes now crypto currencies and and and financial assets and money in general is used for um you know buying food and water and that's all great but so the the the the uh means by which money launderers and terrorists um launder money and buy nuclear weapons and stuff like that so

you have to think about how to prevent Financial crimes um as well as systematic systemic risks um which is how you know when individual actors when the sum of their action summed up together can potentially create additional risk for the industry so for instance you know it's fine it's totally fine for a bank to say when the price of an asset hits a certain threshold we're going to sell the asset but if every Bank starts doing that that's not going to work because the price of that asset is going to is going to plummet there's another principle um that Regulators like to use when they think about regulating the crypto industry and um uh it's go to next slide um same risk same

regulations um this is a principle that a lot of regulators think about when they try to regulate a new technology and it makes sense intuitively you know if you are dealing with the same set of risks for you know even though it might be uh a different set of activities um if you have the same set of risks um then you should have the same regulations as well and a prim example of this is what happened with FTX um where was for formerly serving as GC um obviously we all know what happened with FTX you know customer funds were misappropriated um and customer loss funds um and FTX made very clear to Regulators around the world that the crypto industry suffers

from the same risks as a lot of traditional financial institutions and that as a result crypto Financial intermediaries like crypto exchanges should be subject to the very same regulations as well and so in the past year just in the past year Alone um uh number of agencies around the world have you know basically released laws and regulations um basically saying that you know Financial intermediaries whether you're crypto or otherwise you're subject to the same laws as uh uh traditional Financial intermediaries as well but as we all know centralized Financial intermediaries are not the only players um in a crypto industry or you know we wouldn't have a crypto industry in the

first place um one of the key Innovations of the crypto industry is obviously decentralization um it's in fact one of the most powerful tools um in the toolbox uh for crypto entrepreneurs how should we think about the role of decentralization as it applies to crypto regulations now decentralization actually turns to there's no Financial regulations on its head because one of the fundamental premises of traditional Financial regulations is um uh focused on centralized Financial intermediaries it's it's it's a

two-sided coin of control and liability or if you ask Peter Parker with greater control comes greater greater power comes greater responsibility how should we think about the role of this added ingredient of decentralization as it applies to uh crypto regulations and there's an interesting set of analogy uh uh analogous uh laws and principles that have actually emerg in analogous industry um that um I often like to think about and I think could be helpful uh uh for for the crypto industry to think about as well and um uh it actually started here in Japan um in in in the 1970s um this

is sorry this is this is the um uh uh the VHS recorders um vhhs recorders were were invented 50 years ago um here um in Japan and by the time uh Sony created betamax um in the 80s it was all the r around the world everyone was using it to record uh content and um uh Hollywood was was extremely pissed off because for the first time they they've lost the the the control over the means of distribution they've lost the means to control how their content was distributed because anyone can now record a show and pass it along and what came out of this is um so Hollywood Suit Sony and um you know huge kudos to the Su the Sony um uh uh you

know team for actually fighting um Hollywood tooth and nail and they took this case all the way up to the Supreme Court um and the US Supreme Court in that case held that if a technology developer is simply developing a neutral technology that can be used for both good and bad um substantial non-infringing use is is the legal term but just think about it as you know neutral technology that can be used both good and bad then the developer is not liable if users use that technology um uh to do illegal acts to do something bad now fast forward two decades some of us in our 30s and 40s might remember Napster um uh came about in the late 90s

this is basically a decentralized you know PTP file sharing software um anyone could download any piece of movie you know music um any any any other content you wanted as long as you could find the seeds to You Know download it from your friends and um again Hollywood was pissed off um because they couldn't control it anymore so they suit Napster in uh uh the early 2000s and it went up to the knife circuit in the US and um even though it was decentralized P2P file sharing um uh uh the knife circuit found that uh Napster was actually liable for the illegal acts of its users because it had maintained a centralized registry um of where to find

the seed so you know if you if you download Napster you want to you know download a movie or a Content um Napster gave you a centralized registry for how to actually find those seeds so Napster got shut down now the industry there went even a step further um a few years later and they came up with Kazar and grer a number of other um uh file sharing PP protocols and these guys were fully decentralized um there was no centralized registry anymore um everything was p and um uh you know lots of people started using it and again the the you know Hollywood was was extremely pissed off and they suit grer again and this is another case

that went up to the US Supreme Court and the US Supreme Court found that even though groer was fully decentralized it was fully p P it was still liable for the actions of its users because it had specifically marketed and targeted um uh users for those illegal conduct if you think about it that's actually intuitive because it's like if you manufacture knives you if you manufacture knives with the intent or or just you know selling it to chefs and restaurants that's all fine if you manufacture knives with the intent and marketing it um to murderers then you know you should be H liable I hope that you know some of that rings a bell to to some of the folks in the

audience because the very same arguments um actually applies um uh I think in our industry and I think you know from how we should think about the liability of developers when they launch a decentralized product to you know on the range of spectrum from fully decentralized to fully centralized how we should think about things like you know centralized um uh uh Registries centralized ized oracles um centralized uh uh you know parts of a smart contract um multi- wallets and stuff like that and also how we think about marketing and talking about the products that they're building I think there's a lot of interesting lessons that could be um learn from

there um decentralization itself though is is not the only interesting thing about um about crypto industry though another property that I like think about a lot is immutability and you know which basically means you know if you if you commit something to the blockchain it's it's it's there forever how should we think about the epical ability of you know this principle to to you know finance and and and financial regulations well if you've worked in traditional Finance um uh or in like a bank or investment uh uh company or anything like that um you'll probably remember that one of the key key things

about uh uh traditional Financial regulations is uh you know for every user let's say have a user I want to buy you know share of a share of Tesla stock there's a whole set of laws regulations internal processes procedures manuals governing you know how user transactions are recorded are accepted transmitted stored um record keeping stuff like that and if you think about that that's kind of interesting because we have none of that on the blockchain like if I'm trying to figure out what assets I held on the blockchain um on ethereum you know three years ago what transactions I've engaged in um I can just look up ether scan I can just type in my address

and it will you know the the entire list of transactions will actually come out um I don't have to rely on you know thousands and thousands of financial intermediaries reconciling their records among each other um uh to have confidence you know 100% confidence that my records and my asset history on the blockchain is actually accurate and so the question that that comes up is is there a way to actually use this property of the blockchain to actually help uh reduce trusts um that we need in our centralized financial institutions and the sexiest name I could come up is uh unfortunately just just this trust minimized centralized

financial institutions in other words is there a way that we could use a public blockchain like ethereum to allow them to achieve not just traditional Financial auditability but also cryptographic security of transaction records and histories and that's exactly what we've actually done at at the backpack so backpack is a centralized exchange um uh uh and they've built the entire exchange uh just like a blockchain um there is multiple instances of the same exchange node running you you know on different servers and in order for any transaction to be approved on backpack um what it's a deposit withdrawable you know buy sell

trade has to be approved by all of the nodes the only property of a blockchain that we don't um inherit is censorship resistance because as a as a regulated centralized exchange we do have to prevent nov Koreans and Iranians from using the exchange but other than that we take all of the transactions on the exchange put into a merco tree we published a root onto a public blockchain like ethereum um and that allows us to actually inherit all of the properties um uh of of public blockchains things like uh replayability uh verifiability so the entire history of backpack exchange is replayable and verifiable um

from day one um just like how you can go on you know ethereum protocol type in your address you can see the entire history of transaction records um you can do the same thing with uh back exchange you can you know with any user account um you can actually look it up and see the entire history replay the entire history of the exchange um uh uh uh and have confidence that that is that is actually um accurate now for us it's it's it's not just about it's you know it's not just about reducing risk um for us you know for a user to be able to verify you know their

records right now if you go to broker dealer you know there's tons of Records you have to see through the broker dealer you know if you raise a challenge they have to reconcile records across you know tons of different intermediaries um uh uh but you know for a user to verify their records we think that you know obviously you can hire you know lawyers and Auditors and all that stuff that's that's all good but um it shouldn't be that that hard for centralized intermediaries if they adopt this approach they actually just give you a copy of the exchange code and um and and the proves on ethereum and you can just verify the whole history yourself and for us it's it's not just about reducing risk um we think it's fundamentally a better way of actually

doing things for for a centralized financial institution um uh uh you know for some of us who might be aware um the way that currently transactions are processed on even the largest exchanges n NASDAQ is um there's a complicated convoluted web of nominee Holdings and beneficial Holdings and just thousands of intermediaries in between and we believe blockchain can help us all do better by leveraging the immutability properties of public blockchains we think that we can bring a lot more fair disclosure transparency and accountability to um centralized financial institutions because we believe that anything that

you do on the blockchain um is fundamentally better and we call it sex on the blockchain thank you thank you hey give it up for Canon Make Some Noise yeah that's what I'm talking about I like that do you have the like greatest opportunity to name your kid beer and his name would be beer can do not do not miss this opportunity all right are you ready now

thank you man are you ready all right hey drum roll please drum roll thank you [Music]