Gabriel Shapiro: ZeroLaw – A Philosophy of Securities Laws for Tokenized Networks (#328)

Transcript

this is epicenter episode 328 with guest Gabe Shapiro hey there Sebastian here you know the podcaster lives in a relationship is too unbalanced you know us a lot better than we know you and we want to narrow that gap so please do me a favor and answer our audience survey it takes four minutes and it will help us to continue producing content that informs and inspires you you can find the survey at epicenter dot rocks slash survey and at the end I'll tell you how you can get a free keep key hardware wallet courtesy of shapeshift - thank you for your time so thanks in advance and on with the show hi welcome to epicenter my name is Sebastian Cuchillo today our guest is

Gabe Shapiro Gabe is a lawyer at the firm zero law they're experts in the area of tokenization dows and blockchain engineering Gabe has written a four-part series of monster blog posts where he shares his philosophy of securities law for tokenized networks this is an amazing piece of work it takes about an hour and a half to read all posts but I would strongly recommend everyone to read them now let's try to understand why this is important and why it's so timely at the moment for the last few months there's an SEC Commissioner by the name of Hester Pierce you may have heard of her she also goes by the name of crypto mom and she's been pushing for this idea of safe harbor and under her proposal tokens would be exempt from being classified as securities for a

period of three years and this is so that projects could build an initial development team with the intention of becoming mature and becoming more decentralized until which point the SEC would no longer consider them to be securities now just as we were recording this interview with Gabe Commissioner Pierce posted an opinion piece on coin desks where she essentially asks the industry what do you think of my proposal tell me if this is right tell me if this is wrong and we want to improve it and fix it which in my opinion really shows the the openness of the SEC and particularly if this Commissioner to create an environment where the crypto industry can thrive and there have been a number

of reactions to this this call for for feedback there's been a number of reactions also to the proposal in general some positive some more negative and Gabe also published an open letter in which he provides his feedback and his thoughts and his philosophy on how the safe harbor proposal can be improved so we'll link to Gabe's articles his open letter and Hester Pierce's opinion piece in the show notes so here's what you'll learn in this interview Gabe's background and how he got involved in crypto the classifications that we tend to give tokens like equity software products commodities currencies and

examples of why these classifications can be misguided we got a crash course on securities law and the Howey test we went deep into the Exchange Act of 1934 which is an often forgotten piece of important legislation but that has tremendous impact on companies that issue securities we talked about Gabe's philosophy and how securities law should be applied when it comes to issuing tokens and launching networks and we talked about the safe harbor proposal what it is what it encompasses how it defines things like decentralization and network maturity and Gabe's thoughts on how it can be improved so I want to

thank Gabe for coming on the podcast Brian and I did this interview and he was incredibly articulate and sharing his philosophy helping us understand securities law and also how things could evolve in the future before I go to the interview I want to tell you about some interesting developments epicenter is the official podcast partner of ECC and we're so happy to be doing this with Peppo we're gonna have a dedicated podcast booth in the main networking area upstairs it'll be like epicenter Mission Control and we'll be recording interviews over the three days and posting a lot of content to Peppo will be soliciting the community's questions for the people that were interviewing

and also getting people to share just what they're learning and the takeaways and the takeaways from the conference also we're having a casual drinks meetup on Wednesday the fourth if you want to register for that you can go to epicenter dot rocks slash Paris Meetup and thanks to Peppo for also sponsoring the drinks meetup so if you're not going to eat see see if you can't make it Peppo is the best place for you to follow what's going on and to follow the conference I wasn't at East Denver but I followed all throughout the weekend on Peppo and I felt like I was there so download Peppo go to pepper calm epicenter and you could follow me there you could also follow the epicenter community where we'll be posting all the

content from eat Cece we're also brought to you by the nervosa ecosystem Grants Program the nervous blockchain went live recently and they are funding innovative ideas and development to the ecosystem and the protocol I don't need to go into detail about how nervous works there to alert architecture that provides security and scalability because we had Kevin Wang the co-founder on the podcast just a couple of weeks ago on episode 326 so if you haven't heard that interview I would definitely recommend you check it out but if you're a developer and you're seeking funding for an innovator idea or if you're just interested in making a significant contribution to building the nervous infrastructure please explore the nerveless Grants program they are

funding projects actively and they have a total of 30 million dollars in funding available so to connect with the team and learn more about the grants program including how you can apply and what kind of grants are available please go to nervosa org slash grants slash epicenter that lets them know we sent you and here you can find all the information you need and with that here's our interview with Gabe Shapiro [Music] we're here today with Gabe Shapiro and Gabe so first of all this closer we have been working with him as our lawyer through course one so I've been kind of known Gabe for a while and work with him and he's he's a very thoughtful on lots

of questions around securities law and and crypto and sort of understands both very well decrypt aside as well as the legal side and of course this is an endless topic that gives so much rise discussion and Gabe's written really very in-depth and detailed yes sort of series of post about trip the securities law and sort of his philosophy of what it should look like so we want to dive into that today and yeah thanks so much for joining us Gabe my pleasure so I guess let's let's start with our you know our typical question of what's your background and how did you you know how did you regionally kind of get

bitten by the cryptid bug and get into this field sure so my original legal background is actually fairly traditional I've been a corporate attorney based almost exclusively in the bay area for 10 years and the first seven years of that I worked at you know really really big law firms there California offices doing almost exclusively by side technology mergers and acquisitions so I did like I represented Facebook in the Facebook whatsapp deal did a bunch of deals for Oracle did a bunch of deals for eBay big public to public deals some of them you

know in many billions of dollars working very traditional law firms right alongside of that you know I always had this interest in technology obviously most the deals were for technology clients and I got interested in sort of cryptography mainly from the perspective of messaging apps like whatsapp I'd done the whatsapp acquisition so thinking about end-to-end encryption and so on as I was researching that you know I started running into crypto currencies and one day I was reading about this new one called aetherium and something called smart contracts and it actually was one of these Eureka moments when I about what smart contracts were because I realized though this is basically you know in escrow without a bank I deal

with escrows all the time but with banks as an M&A lawyer you know I could sort of immediately see where this was heading and the potential utility so that was sort of end --is-- of 2015 early 2016 and the first meetup I ended up going to was if you can believe it or not nick szabo talking at in a theory of meetup which nowadays would be unheard of and since he had this legal background and was talking about all the all the legal issues around blockchain and the law that pretty much sealed the deal for me and you know then there was no looking back and into then what what has your kind of like journey through the blockchain space look like I know you did some some work on I hear you that's right yeah so

initially you know I was pretty tentative I kept my normal job and all that but the in 2018 I joined up with a company called grid Plus which is a consensus spoke they needed someone in-house for legal and I sort of raised my hand worked with those guys for about six months to get them set up in the meantime colleague of mine from Hogan Lovells named Lewis Cohen had started a boutique called DLX specializing in representing Blackfeet clients so I kind of thought hey representing lots of blockchain clients is better than representing one so I moved over there worked there for a while and then subsequently I met some guys who were really interested in building out sort

of a tokenized stock platform for aetherium that we ended up calling the Xero law org augmentation protocol so you know I focused on that for a while you know and that was sort of like my last big kind of commercial project and in the meantime I've been representing clients like chorus one and some others let's get into your you know your article so first of all give us a little bit like once you take after being sort of active working in the legal space especially around securities law in the blocks in space after a few years and that you know what sue but you overall take and what motivated you to write this like series of posts right so basically you know back in 2017

when ICO mania was going hard and the SEC first started releasing its actions against tokens most of us lawyers you know we're having a lot of discussions at the time about what all that meant reading the tea leaves where judges would come out on the issue etc and while we knew there were open questions about it I think we all thought that those would be long resolved by now you know it's been like nearly three years and still very few of them are resolved and still even lawyers who understand the technology reasonably well and are good lawyers understand the law still debate with each other all the time and have very very different opinions and so my desire having spent

kind of three years in the trenches debating with everyone and thinking about it a lot changing my own opinions quite a bit in that time and debating with myself a lot was to try to write something that cuts through a lot of the noise and deals a little bit more at the conceptual level right because I think people get very green you know they're they're going through the elements of the Howey test and they're drawing analogies to pass cases is it token like in orange is it like receipt for delivery of future whiskey what is it and just to just to think about the tokens and the network's themselves in in the purest possible terms with with the fewest preconceptions as possible and just try to think about how do the people who actually buy them and like them and use

them as well think about them and why do they value them and then try to go from there about how that relates to the securities laws so that was sort of the approach and that was the reason for still writing about tokens and securities laws three years later so one thing that strikes me as interesting here is that it like you said it's been three years and US regulators and lawyers are still debating this in the US why do you think it's taking this long I mean speaking from the other side of the pond it seems that in a lot of other jurisdictions you have these things have been pretty much solved already here in France there's a pretty robust framework for doing stos I know there's sort of similar climate in

Germany in places like that so why is it that this is so complicated in the US maybe so as not to be too prejudicial like I almost like compare the like the recent FinCEN guidance to the SEC guidance right in FinCEN's guidance so they came out they were they said in their guidance certain things are not subject to money transmission right like if it's non custodial and you know they they sort of said what do we not have power over and they were willing to say that in their guidance up front right and that's one thing that the SEC has really not been willing to do they say what might be securities right and they try to you know cite some of the factors that would lead them to be especially

inclined to say that something is a security but they're never sort of tying their own hands and in advance saying that they they won't say something is a security except for these no action letters you know that were granted and somewhere around the last 12 months that are so conservative right in terms of fact pattern that you know anyone looking at that fact pattern without the SEC weighing in would say that they're not securities and and so to me that is a bit of a problem I'm happy with many of the things that the SEC has done but I do think that that's an area where it's it's fallen down a little bit and being unwilling to go out on a limb and ever say that that there's something that they they wouldn't consider a security okay I mean people tend to

qualify and classify tokens in many different ways you know sometimes as equity as software products as currencies commodities even give us some examples and explain why people usually get these wrong yeah again you have to separate the the legal from the conceptual right legally speaking for example you know bitcoin is a commodity right it's commodity because there are futures that relate to Bitcoin and that automatically makes Bitcoin a commodity as a matter of law but the intuitive concept of a commodity right you think about you know oil you know you think about wheat you think about these things

I mean these they gold right these things are sort of like have constraints of nature associated with them they're not they're not synthetic things that that humans make there they're not things that depend for their value on a network of humans working together in accordance with certain rules and so at a conceptual level you know tokens and token networks are very different from commodities a lot of people analogize tokens in 2017 to licenses and that was sort of one of the main arguments for why they wouldn't be securities because there's an exception under our securities laws to the effect that if something is bought mainly for a consumer purpose that that

it's not a securities transaction now if you think about tokens they're clearly actually not software licenses because the software involved is is you don't need a token to get it right you could go on to the gap github right and you can download the gap software client and you now have a software client that embodies all the protocol rules of aetherium the tokens not getting you that you could spin up your own private network of that right and you could be using that and you didn't need to go and buy eath to do that right so so to me that clearly seems wrong but what is specific to eath right as what people call 'if it's actually a specific network right it's it's the way you can

figure that software client to point add may net ID one right and and that's the network you want you want the token on that network and if you think about that that starts to make sense as a framework right because why is the token on that instance of the etherium software more valuable than the one I just spun up at home it's because there are all these other people using that particular network it's it's a selling point so to speak it's something everyone has converged on and the more people that converge on that network the higher the value of that token will be and really in a certain sense all these tokens are actually designed to to track the value

of that network they people do things like make them finite in supply or you know restrict the rate at which they are the new issuance is done right and so it's almost like they've been set up on purpose to you know appreciate indefinitely as the value of this network so that's sort of how I came up with the idea of well what really are you investing in with a token you're not investing in the token itself it's not like buying a bottle of whiskey and you got the bottle of whiskey because you could drink the bottle whiskey without the distillery here the equivalent of the distillery is like the network and you need that network to use that token so really it's a method of investing in this specific network and it seems to be

relatively good at tracking the value of that network over time so you describe this as network equity it was the first time that I've heard that I heard that term can you explain you know what that is and how it differs from the concept of equity and a company as we've come to know it sure yeah in this case I mean equity and I was being sort of a little bit deliberately provocative right because I knew a lot of lawyers would complain about using the word equity because you know usually equity means it's a it's a claim on the assets of a corporation after all of its debts were paid right that's what that's what a stock is in fact unless it's preferred in which case it may have more debt like rights but we also use terms like brand

equity right what does brand equity really mean it's like it's like the value that's associated with a certain brand yeah that that's that's the idea I could have called it also like a share of network value right and that would have been a little bit more of a neutral term but I wanted to kind of hit people over the head with the idea that tokens are not investments in it of themselves they're they're letting you track the value of something else and so it's it's sort of at least equity like but it doesn't necessarily entitle you to dividends and payments after liabilities and so on although if you look at proof of stake networks starts to look even more you know like a piece of equity right you you stake in and you get payments as a result of owning it not

exactly the same as a dividend but somewhat similar you know and so on yeah I mean I would tell you that we'll dive into this a lot more but maybe maybe take the Prince to the last point up that people would often use I remember for example kick you start in their argument I think is like oh but it's a currency what's your take on on that like the idea that oh tokens are currency in these networks sure I think they are currency but the analogy I use in my article right is that is is the old company scrip right so there used to be these company towns and there actually are still provisions in the

corporate codes of most states in the US where you could take a stock certificate and you could tear it into pieces and those little pieces are scrip and they don't have any of the rights of a stock holder well but they still can have value and if you put you know say there were ten pieces you put ten of them together now you have the rights of a shareholder again so there used to be these company towns where a script would trade you know that's a kind of currency right but but it's not a very good currency right it's it's a currency in a very weak sense and it still may be a security right because it depends on the will of this company but if suddenly lots and lots of company town started accepting the same scrip right and that it that it spread all

across the nation and it may be spread to other nations then it looks more like a currency it's very similar I think with blockchain networks as they become more decentralized this thing that you know initially starts to look like it maybe have a lot to do with some particular group of people who first created it it starts to look more like a universal thing and it's - not so much depend on any any particular person and so over time it's going to look more and more like a currency right so I do think it has aspects of a currency but I think legally speaking toward the beginning of its life it's not so much best viewed as a currency as most likely security depending on the circumstances of its

launch and who's controlling the network you know that's kind of a coherent argument but let's let's get into a little bit like what securities lawyers and then kind of come back to to your argument of how it should apply in the crypto instance so first of all the Howey test you know most of most listeners will have heard of that and have some familiarity of it but can you just very briefly run us through what Howey test is and how it has kind of been applied in crypto space sure so yeah and this is a you know the key thing I would say here that maybe some people still don't get even though a lot of people talk about the Howey test is

that it's a test for one type of security called an investment contract there's a whole list of types of securities in the 33 act stock bonds blah blah blah right investment contract is one of them the test is basically that when someone has made an investment of money and it doesn't have to be money that can be a contribution of your time that could be an opportunity cost as well that you encourages by locking up some funds for a period of time an investment of money really an investment of value with a reasonable expectation of profits which are not just profits in the sense of excess of revenues over costs but any type of capital

appreciation any type of gain from predominantly from the entrepreneurial efforts of others in a common enterprise then the law says that if that test is met then there something called an investment contract exists which is a security now that security in most of the case law is not something it's not a contract that people wrote down and said I hereby agree to make efforts for you to help you make profits usually it's quite the opposite usually they did a bunch of other things that don't look like securities but when you sort of look at the total picture it says should be a securities transaction and so the

law implies the existence of a security called an investment contract you kind of alluded to it right that basically seems like what a lot of projects have done in the crypto space is sort of take this Howey test and then try to argue that you know they're not they don't fall in this bucket I guess mostly it has been around the last point why this effort of others point that's right sometimes common enterprise you know I like probably you know something like crypto kitties and of tees right why are they not securities I think a big part of the reason it's the lack of a common Enterprise right because it's not like dapper labs is keeping a copy of the

same NFT you know that that it mints each time and so it's not similarly situated to each buyer but you're right typically they're hanging their hat on the efforts of others so oftentimes that the how we test is brought up and you know we've heard about the Howey test numbers of times but the exchange act isn't necessarily the first thing that people will cite when talking about tokens and the possible security status what is the exchange act and what does it have to do with all of this yeah so moot you're exactly right most of the discussion has just been around fundraising activity which is covered by what we call the 33 act and that you know the core of that act is every sale

of securities has to be either registered with the SEC or exempt from registration very simple the 34 Act deals with what happens next what happens when you have a security and then you want to start trading it after the initial fundraising so there's a whole set of secondary market regulations around that and a little bit depends which one's apply depend on what type of security it is there are two main categories debt securities and equity securities if it's an equity security it's much more highly regulated so now you're now you're kind of getting at my diabolical reason why I called it Network equity is to suggest that maybe some of the regulations under the

Exchange Act such as relating to limitations on insider swing trading of the security rules about how you solicit votes to the extent that tokens may be voting securities may be relevant early on in a networks life while it's still effectively controlled by a small group of people can you go a little bit more in depth as to the the requirements in the exchange act like I mean I guess it would be interesting to understand where a lot of crypto projects maybe are failing to comply to the laws under which that which fall under the Exchange Act sure

so the big one is if it's an equity security there's a rule called 12 G that says that if it's if the security is held by more than 499 unaccredited investors or more than 1999 investors overall and the issuer has at least 10 million in assets at the end of a fiscal year that the issuer is required to become an exchange act reporting company what is an exchange act reporting company think of Apple think of Tesla fully public companies that's a very expensive regime that really only mature high value companies are equipped to deal with and what are the interesting

things is that in pretty much all of the settlements that the SEC entered into with token issuers Paragon arefox etc other than block one part of the remediation that was ordered of those issuers was they had to become 12 G reporters and none of them ended up successfully doing it so far but so clearly the SEC at least implicitly thinks that these may be equity securities so once you're an exchange act reporter you become you have to file 10 KS you have to file 10-qs these are long annual reports of a lot of financial information you also have to publish a lot of information this I think is probably more relevant to

tokens than the financial stuff information about okay who are your officers your directors who owns 5 percent or more of the security and you have to report about those things and even if someone even if a third party goes out and it requires 5% or more of the of the total outstanding tokens that person is just independently having nothing to do with the issuer they're required to report with the SEC about their holdings so these are the types of these are the types of regulations that apply under the Exchange Act and of course there are a lot of sort of just pure market-based rules like like for example all the rules about securities exchanges right

and then having to register right those are under the Exchange Act as well yeah I just wanted to be play looping on this this thing you said so yeah there have been various settlements 50 SEC right like Paragon being one thing and a bunch of others and do you mind just elaborating a little bit on you said that none of them have been able to basically comply you live up to these reporting requirements that they've agreed to in the settlements so like how did those cases play out in the end yeah I'm curious about that myself they basically just totally flaked on the sec they made some preliminary filings the SEC made some comments and you know from what I understand they they just kind of

you know scattered to the winds said they ran out of money and I'm sort of waiting for the other shoe to drop on that one but you know it does go to show that it's look I don't know let's assume for the moment that that those teams were attempting to comply in good faith with the order I'm not totally surprised that they were having trouble doing so because it's just it's not a reporting regime that's designed for startups it's designed for something like Apple you know or like let's say uber you know that that had great funding and really built up a business over ten years and then it's ready to IPO right so I'm not surprised that they ran into problems that's an interesting point I think like

that that is one of the things about I guess regulation that applies to crypto that I mean we talked about this recently also with Yahoo News see in terms of sort of kyc compliance and things like that is that a lot of these regulations were just not meant to be applied to startups and regulators are either having a hard time or not wanting to you know have that regulation evolve I mean in terms of in terms of the exchange act I mean just broadly looking at most of the big crypto networks you know based on what you're telling us with with regards to proper reporting you know insider trading etc it would seem like some of them might be failing to report or might be failing to be compliant with this exchange Act why do

you think we haven't seen you know a lot of these projects getting sued by their token holders and it seems like no one's really talking about this let me pick up on two things you just talked about so the one one thing I would say about the you know just going back to the point about the exchange act and it being difficult to comply with there is something called regulation A+ right which was sort of designed to be an IPO for startups right you know because people do recognize that this is a problem and they would like companies to be able to get access to the public market sooner so that's why regulation A+ was passed and what enables you to do is raise 50 million from the public up to 50 million and you have a much

lighter reporting regime still a reporting regime but lighter you actually get an exemption from those tougher reporting obligations for some period of years now there are some tweaks that might need to be made to that for tokens like there's a transfer agent requirement and stuff but so there's not no option for startups it's just that you have to decide to use it at the beginning which would require that you labeled your tokens as a security from the beginning and none of these projects did now as to why more projects haven't gotten pegged that again is a complicated question you know I think it's one of the reasons is that in the SEC can only go after so many things there's a private right of action as you point out under the securities laws for people who feel like they got

ripped off a lot of people made money you know from a lot of tokens and a lot of people who bought tokens are not the kind of people who make good plaintiffs right because my sense is a lot of them may not have paid taxes on their crypto for many years you know a lot of them may not be US citizens right a lot of them may not want to kyc themselves in order to pursue a complaint even if they did lose money so I actually think on the on the private action side there's quite a bit of that going on and on the SEC side there's a lot of how do you unscramble the egg we went after some it didn't really deliver a good result for investors the block one result is interesting right because they had a lot of money still they paid

a really big fine and they weren't required to register the tokens as securities so you know in a sense it was a big win for the SEC I'm not quite sure what holders got out of it but on the other hand no EOS holders from the original sale were probably damaged because the token went up a lot so there's a lot of that sort of thing going on just real politic but you could probably see more I think the SEC doesn't want to kill the technology so they've been pretty judicious about what they've gone after and when and why kick and telegram have been their two big targets to date and I think the reasoning behind that is it's a clear case of here are two companies that use tokens kind of in lieu of an equity

financing right and I think one of the things the SEC rightly doesn't want to happen in the markets is is they don't want to create a strange situation where a certain type of financing that implicates the securities laws or maybe ought to implicate that securities laws is given preferential treatment and the whole market just gets distorted toward that due to a weird loophole in the laws I actually do think they're very smart about what they go after and they're not just trying to tyrannize the entire market let's take a step back we play because one of the things that you've discussed quite a bit in your post is sort of to say okay let's look at the culture of the cryptocurrency industry let's look

at you know some if there may be undesirable behavior some of the strange incentives and how you know securities laws ask cost that so can you talk a little bit about that like what's your take about you know kind of what's wrong in the blockchain industry and what it has to do with securities law what's wrong is basically it's just a strange species of hypocrisy in effect we know why we like tokens people want the tokens to increase in price people want to be trading the tokens people view the tokens as investments in the network at the early stage in the team they're evaluating the when they're thinking about buying the tokens they're looking at who the people on the team are just

like they would be if it was a start-up the people who are at the in the project they're looking giving up the token allocations just like they would be whacking up equity and a valuable you know potentially valuable hot startup these are investments let's just view them as investments that's how people think of them right there are exceptions of course crypto kitty n F T's right whatever but for a vast majority of cases they are investments and we've been trying to stick our heads in the sand to try to get regulatory arbitrage and argue that it's like buying cotton candy you know at the amusement park or something and it's just not the part of point of my article is they can be investment and still ultimately not be securities right because the SEC

our director Hinman from the court finishin of the SEC came out with this amazing speech called when how he met Gary plastic about how basically efj may have started out as being a security in its early days and over time it basically turned into a public Commons controlled by no one and so now it the securities laws just don't really make sense to apply to that we need to figure out what that point in time is and define it better for people right which is what I think the purpose of a safe harbor should be but what we shouldn't do is just keep pretending that they're not investments cuz it's just not true and it's just kind of dumb and it'd be better if we could just all admit what

the things are and pursue them for the reasons we want to and then figure out how the regulations do with it maybe justifying our points on this what do you think have been the negative effects of people as you sort of described it I guess kind of skirting around the issue so many negative effects right because if everyone was open about the fact that the tokens are investments and what regulations applied then the teams could try to do their best to give the the buyers what they're looking for which is gains they could be like Elon Musk is a Tesla he owns a lot of the stock he's

always trying to make the stock go up sometimes he gets a little too aggressive with that and the SEC gets mad at him right but the team's could be trying to deliver value to the people who are owed that value because they invested and instead perversely they're driven to do the exact opposite thanks for the money this was basically free money to us I'm sorry the token price is going down we can't do anything about it we can't get it listed on new exchanges we can't market it and go to the world you know and say why people should be buying this token because we're we're driving value to the platform every day that's just crazy right I think I saw an interview of the you know some talk vitalik was given a while

ago and people were asking questions of the audience and one guy stood up he had the the temerity to ask about each price and they like dragged a guy out of the room now imagine an Apple stockholder conference right I'm not saying specifically for aetherium because now it is you know fairly far along but like--imagine and out like an apple stock and someone asked him cook about Apple price and they like dragged the guy out of the room this should not be happening right Vitalik should feel free to answer some question about eath price and honestly I kind of feel like he should feel at least a little bit of an obligation and say something about eath price because after all that's why the vast majority of the people I bought it it just gotten topsy-turvy because of this desire to try to pretend that it's

not a security and doesn't have investment reasons for buying it I love the clarity and what you just said that's just sort of point that out good I'd say one did as you proposed what would that look like Esther Pierce right commissioner Pierce came out with safe harbor proposal recently and without getting into too much in the weeds on it which he proposed is is basically let these networks launch just only apply the fraud rules to them for the first three years and then after three years tests basically whether the network is mature that maybe overlap somewhat with sufficiently decentralized and decide whether their securities I think that

goes a little far I don't even know if the SEC has the power to just say yeah we're just gonna say that we like something so much the securities laws just don't apply to it for three years just to clarify they said yeah okay networks launched and only fraud rules apply would that mean that for example public token sales like we saw in sort of 2017 like you could do that sort of thing yes and not just sell to accredited investor and all that yeah you could sell to anyone I don't think that's going to end up being supported you know by people outside the space or by many people outside the space but I do think what we should do right is clarify this point of when does

it stop being a security if it starts out being a security when does it stop right because a lot of even the most conservative members of the the staff of the SEC seem to be somewhat aligned with that approach right eh even Clayton you know seems to be someone aligned with that approach what I think would look like is somewhat like what block stock did they did a regulation A+ offering they had to now to get that in and of itself is someone expensive and probably too expensive the SEC could do things to lower the cost of doing a regulation A+ offering they could do things they could make a more specific a more crypto specific variation of reggae plus I believe that's within their power so for example they could say that right now there's a rule that if you did a

regulation A+ offering for an equity security you get this kind of like indefinite plus 2-year ish reprieve from rule 12 G if you use a transfer agent you process all transactions through a transfer agent well this is crypto we don't want to process transactions through a transfer agent that's going to make it useless but the SEC could say okay if it's crypto the blockchain is the transfer agent they could totally do that and in fact block stack took that position in its filing and the SEC qualified the filing you could use something like that reason why a lot of that's not enough for many people in the industry as they say well block sack

isn't trading on coinbase this is very bad right okay what I say to that is coinbase get your act together go register as a securities exchange why can't you do that create a crypto create a queen based crypto securities Pro or whatever right and have that be registered as a securities exchange and then those things could train there what about Dex's personally I think that a true Dex is just facilitating a peer-to-peer trade and I don't believe that that ought to be required to be registered as a securities exchange the SEC if they agree with me on that they could clarify that publicly to the world right and that would be a way that even non reggae plus even sort of things if you'd in private placements that

eventually become freely trading you know those could trade on there even and that would be an even less expensive path so there are these ways I think what we should do is not try to keep fighting the basics of American securities law but focus on this this idea of mutation and say in the meantime let's improve the crypto securities rails so that even when things are securities they can trade relatively freely and with people being protected and hey by the way there are also all still all these things called like stos and stuff like that like tokenized stock and things like this where it's never going to stop being a security and an incidental benefit of improving the crypto securities rails for tokens that are temporarily securities is it will

also improve the crypto securities rails for all those things and that may actually become the basis for fundamentally improving the infrastructure of all of our public securities markets this type of approach I think is more holistic more forward-looking is actually embraces crypto more in the long term and I think it's what we should do just to clarify that so what you're saying basically what you're proposing is that like a project could go and raise funds maybe through some sort of you know regulated reg D exemptions or selling to accredited investors or maybe there could be something like a reggae plus something like what block stock did but you know maybe cheaper simplified

version that's more kind of geared around crypto so what exactly does this let's say there was this 3-year safe harbor like what does that do well so under Commissioner Pierce's version the parts are just mentioned about needing reg D or reggae plus you wouldn't need those you just get out of everything for three years and coinbase could trade the tokens for three years even though they're securities under my version that wouldn't be the case you would need you know reggae plus or you need to do right D they wouldn't be able to trade it on normal coin base but you'd also have some benefits right you wouldn't have to like immediately be go become Apple there's a difference in vision there which way will it go I

don't know right the key thing that ever that both proposals have in common though is you have to pin down some type of concept and you have to tell people in advance when with this no longer be considered of security that's the concept of network maturity under Commissioner Pierce's definition it's that the either the network is functional for its kind of originally advertised purpose or its kind of no longer controlled by anyone under my version it's a it's a kind of a three prong test it's that there's there's no longer functional control of the network there's no longer economic control of the network and the initial development team has sort of fulfilled all of its promises it's performed the investment

contract so to speak the investment contract has been performed there no longer is an investment contract and it's no longer a security that's kind of the idea but that would imply that there would need to be an investment contract that's right to begin with which in most cases there are not any sort of formal investment contracts in these cases under my version one of the ideas would be you file with the suc at the beginning in order to take advantage of the safe harbor and you basically say what the investment contract is so now instead of it being a bunch of implicit fuzzy promises they are they promises or they're not promises are they merely forward-looking statements in a white paper and in some forums and in some slack channels you now have the benefit of everyone knowing we are the founders

of this project here is what we're going to do when we do this we will go away and the network will have to stand on its own and I just think that's better for everyone for the team for the buyers for the market and it lets you kind of say yeah instead of the investment contract being applied by law now there's one written down on paper and it's actually like objectively measurable do you think that this aligns with the incentives of founders like in your proposal do you feel that everyone's incentives are aligned in a way that the founders can feel that they have made money from this project because they're also looking to make money right like let's be honest about that by having an investment contract in which they promise to it at some point leave the project can they

still be aligned that sense by the way they don't have to leave they just have to stop being sort of the biggest contributors and they have to give up control that's kind of the more important thing right if you're contributing and you don't have control that doesn't implicate the securities laws the one way it's worse for them right is the same way that Travis Kalani ak had to wait you know until sort of an uber IPO until he could really cash out this would go kind of in stages right initially the you know founders would have something that's relatively illiquid and hard to price just like in a normal startup over time it would become more liquid and easier to price right and they would have exit

opportunities along the way and they would probably want to titrate that over time so that you know they're selling a little bit at each stage of the way and if they've done their job well the value of the token will go up and up and they'll actually want to hold on to it they won't want to sell at the earlier stage they'll be Wally wanting to sell as late as they can I think it aligned the sin of way better it's more like a traditional company trajectory what do you think the role of foundations is in this context and what are some of the criticisms that you have with regards to the way that many icos have structured themselves as Swiss foundations I'm not trying to impugn anyone right uh all these projects are doing good work etc but from you know kind of a let's

cut through the noise here the foundations are basically you know they're getting massive tax benefits right because the proceeds of the token sale are not treated as income ironically if they were sold as securities they wouldn't be taxed as income either Rika's AV capital contributions but you know really I see it as you know that's another distortion because the people didn't want to call them securities now suddenly it's like oh I'm saying for securities law purposes I'm selling this product oops that means I'm going to be taxed on all this stuff but really I just want to use it as capital to build the project so I now need to find some other way of not getting taxed on it let's say we're not really a company let's say we're a non-profit but I think a lot of these foundations or basically

run like companies they're basically right you know because all the people in them hold a bunch of the token everything they're doing is driving profits to those people you know it's just happening in a disguised way that's really what I think is going on it would be better look it'd be better if they were just companies to be honest with you it could just you know naked lis pursue what they're actually doing you know which is driving value to this instrument and benefiting the people who bought it and the people who work at the foundation who hold it I think what Zeke ash has done to decentralized governance and again they're in a little bit of different boat they never did in ICO so who knows if their thing exactly was covered by a securities laws to begin with but it's very interesting right because the foundation is sort of one

player that's contributing value there's also a company called the electric coin company that's a for-profit thing that has venture investors that's some of the things that does are related to Z cash some not and they've set up a complicated sort of to taunt between those two main players for how to govern the network and that looks pretty decentralized to me but most of them are not don't have that going on right it's really the foundation is that the elephant and they're basically running the show just a brief interjection on on the Foundation's first I'm personally I actually find it it's kind of a nice vehicle in that they do have a sort of like explicit purpose right like IDs in Switzerland right here they have like

description of like okay this is what the money has to be spent on and then they're like audited and supervised and so there is kind of actually it's a little bit like what you described in in the sense that there's kind of like some sort of promise made and then the funds have to be used to that you know it's very different from something like a block one date where you have this for-profit came in iron company and like they can do whatever they want with the money but there's no which I think they did also payout like some asset dividend right to the shareholders what I think should be you know in the United States as a pure corporate law movement we have this new trend that even some of the old-school Delaware law junkies are getting into now called public benefit

corporations right which are corporations that maybe run for profit in a certain sense but are able to they're not sort of solely for the benefit of their stockholders we've just begun scratching the surface on the potential for that but I think that kind of new entity which is sort of like it's for the public benefit but it's not exactly not-for-profit is kind of what might end up ultimately being the right vehicle for these open source software Network Commons you know to be governed under but no one's really you know kind of fully explored that yet you have a you know sort of coherent pieces for how you think it should play out now I'm

curious what do you think will actually happen like what's your prediction of how we see this thing develop in the next year or two years Oh beyond that I have no idea man I won't even say flip a coin you know get a Dungeons & Dragons you know dice and roll that right cuz that's got like what like 16 size or something and no one knows it's too crazy man I mean that's what that's what keeps me in the space don't forget we've got so many other x factors out there like what will the CFTC do about defy right and so all the swaps you know and synthetic derivatives that are being created in defy and what will FinCEN do you know secretary just sort of the Treasury secretary just kind of sort of

threatened last week that a bunch of new guidance and or regulations are coming about that so there are many X factors I couldn't tell you I could see something I would say it's equal odds that we give free rein to I cos again and that there you know there's like another like massive crackdown you know where everything has to go underground and some of it depends on how the next election goes and who gets appointed as the next SEC commissioner and all this kind of thing it's fascinating and no one knows we have the telegram case I think this week this week the motion for summary judgment on whether the distribution of grams under telegrams pre purchase agreements with this

investors should be enjoined on the basis of securities laws that could have a huge effect which way that goes down and I don't know which way it will go down it would be great for all these regulators the CFTC the Securities Commission everything like to align on some kind of coherent regulation and all their respective sort of jurisdictions but that's never gonna happen that's anything that involves like lots of coordination or like oh we'll create a new agency and it'll be a new set like that's gonna be the hardest of all right and therefore it's also the least likely I would say there's sort of a final topic eminent to dive into a little bit which is you know we've talked about the

SEC and US securities law pretty much the entire episode now of course blockchain space is you know probably the most certainly one of the most kind of international and global industries out there is and kind of you know almost every project is global from the get-go all these networks are with teams distributed entities in many places token holders users all over the place how do you think dad impacts first of all what makes sense for the u.s. to do and like how do you assure the will approach that and you know kind of like how this is all gonna play out it's very tough right that's the objection that a lot of people raised so

like well look foreign jurisdictions are much more liberal about this we can't have everything out of sync you know the US needs to kind of get in sync personally people are gonna hate me for this people are gonna think I'm a g-ghost I do think that world financial market regulators tend to ultimately follow the United States right part of that is because you know the United States and its international proxies start strong-arming little local jurisdictions like malta into doing you know whatever like look at what happened with Panama this is a great example in Panama something called in the United States bearer shares are illegal you guys know what barriers are it's like a company issues a stock certificate it's like whoever is physically holding this

stock certificate in their hand owns a million shares you know of this company right that's basically what it is that the last state in the United States to ban bearer certificates was Wyoming and that was in 2007 I think they're illegal in every state sorry why are they illegal in the u.s. they're a great tax dodge right so basically the federal government you know pressured all the states to ban this because it's an amazing just like crypto the same thing you know who now hates crypto the most out of every agency the IRS but Panama and worldwide most jurisdictions now banned barriers but Panama was like the haven it was like whatever the Cayman Islands or Gibraltar are for tokens

right Panama was that for like companies that want to issue bearer shares eventually even they had to capitulate right and they they didn't want to like go so far they want to totally lose face by like banning them but they set up this like complicated structure where they have to be held you know effectively they totally nullified them it took a little while but all the every time these like special jurisdictions come up that are kind of like hey come to us because we give you better laws for the cool stuff you want to do it never lasts the bigger countries that want the tighter regulations always win and the other thing I would say is that the US laws are different from other securities laws really just in the sense of these investment contract how we test thing

right where it kind of tends to suck everything in and and other jurisdictions don't have that but as these proof of steak networks get more popular or existing proof-of-work networks transition into proof of stakes and you have voting you have staking to get network rewards right and you have companies like crackin that's going to make that incredibly easy for people to do with putting in no work and these sorts of things Tasos where you vote and it's this automatic upgrade when regulators even I think outside of the US start looking revisiting their 2017 if guidance in light of those things I think they're gonna have a rethink because that starts

to look like securities under the laws of nearly any jurisdiction I don't know ultimately but if I had to bet I would bet that the the international laws start becoming are more likely to start becoming like the u.s. laws then the US laws are likely to start becoming like the international laws which is why I want the u.s. to say that within the laws you can have this evolution and that once it's of the real cypherpunk deal decentralized it's a peer-to-peer thing and we're not trying to get in the middle of that that to me would be an incredible result well that would certainly be desirable and let's hope that things go that way I guess you're right I mean one of the things that will have a massive influence on this is the result of the next u.s. election it's

unfortunate to consider what the results of that might be but I guess we'll have to see what happens then maybe we'll have you on again after that happens depending on the results I would love to thanks for coming on good my pleasure guys thank you so much for having me thank you for joining us on this week's episode we released new episodes every week you can find and subscribe to the show on iTunes Spotify YouTube SoundCloud or wherever you listen to podcasts and if you have a Google home or Alexa device you can tell it to listen to the latest episode of the epicenter podcast go to epicenter TV slash subscribe for a full list of places where you can watch and listen while you there be sure to sign up for the newsletter so you get new episodes in your inbox as they're released if you

want to interact with us guests or other podcast listeners you can follow us on Twitter and please leave us a review on iTunes helps people find the show and we're always happy to read them well thanks so much and we look forward to being back next week [Music]