Devcon2: Regulatory Considerations for Dapp Development

[Music] but I'm welcoming I'm going to give a quick introduction to the next speaker who is uh coin centers Peter van valkenberg and I I will speak for a few minutes first because um as executive director of the foundation I am also um the main point person for compliance and Regulatory and legal issues and we um are very um we pay a lot of attention to these things because it does make a difference we live in a real world where there are real concerns for any type of blockchain company startup organization and uh every jurisdiction is different we operate in a number of them so um something that I strongly believe people should take seriously for your own benefit for your own protection and for to be able to further the innovation technology that we all do here that we all support um we are not the that organization that is more like a 501c4 we are truly a um you know where a Swiss stiff which is closer to 501c3 and we support research and development and the education and Outreach that surrounds it however we still have to deal with um regulatory considerations and I've personally invited coin Center to come and make this presentation so that we can um address it and get it out of the way and enjoy the rest of the the more the technical uh presentations that we have lined up for the uh next three days so um Peter yeah thank you so much Ming thank you so it is a tremendous honor to be sharing the stage with all of you I didn't know you'd still be here um but honestly the work you all do is incredibly inspiring to me uh a humble uh regretting liberal arts graduate who foolishly went to law school um but uh thank you so thank you Ming and thank you to the ethereum foundation for inviting me um my name is Peter I come from coin Center I come from the government but I'm here to help um unfortunately I have to do something super lame and give a disclaimer uh because I'm a lawyer uh I am a lawyer but I'm not your lawyer um the following talk is for educational purposes sorry um if you need a lawyer you should hire a lawyer does this clicker work it does okay so what the hell is coin Center coin Center uh is a nonprofit that's based in Washington DC and I'm going to put our mission up here but it's probably better if I just talk about a little bit of my background so I um as I said decided to go the liberal arts route went to law school while I was in law school I started becoming very interested in Bitcoin this was around 2012 I got very close to setting up a pretty powerful mining rig and then there were exams and other things and I got distracted and it's one of my big regrets in my life but nonetheless um learning about the technology while also learning about the law uh gave me a unique perspective I thought I always wanted to work in copyright law or digital privacy um because those are areas where the internet has already disrupted a lot of expectations as to what is possible to enforce from a government Poli policy perspective and what is not um but Bitcoin came around and gave me an opportunity to work in a very new area that's being disrupted which is financial services regulation which is the internet as far as truly decentralizing it and building it the way it should have been built from the beginning so I uh I got a Google Fellowship to go work in Washington DC in policy I worked first for a think tank that was doing copyright and surveillance this was around the time of this doden links and then a a a guy named Jerry breedo who I share a number of mutual friends with came up to me and said hey Peter do you want to be the director of research at a Bitcoin Think Tank and I laughed I laughed at that and um I said that's ridiculous nobody would do that and no such thing exists but then I said yes um and we've been around now for two years so our passion is defending these open networks so in a nutshell Mission aside we want to be to decentralized Computing networks with open consensus mechanisms to cryptocurrencies in general what the eff was to the developers of the early internet a point where you can find a gobet with policy makers and DC where we can communicate the value of the technology where we can set uh an anchor bias in some policy makers so that they don't see this as just another way to sell drugs or um subvert authorities um we have a full-time professional staff with three attorneys on staff we have support from a number of key businesses in the space um some of the big Bitcoin startups among them but also some of the Venture Capital firms that are financing a lot of the work in this space but actually over half of our support comes from individuals who are passionate about this technology and want to see it flourish um additionally I should point out that like the eff we're not a trade Association we set our own agenda we don't represent specifically any of these companies as I said we want to help smooth the path to decentralizing all the things and so if people want to support us in our mission and believe in the work we do we take their support now what do we do we do education policy resarch and advocacy education is sort of the big part of this because especially when we started two years ago the amount of knowledge on the ground in Washington DC and in policy circles globally was very poor when it comes to what a cryptocurrency is and how it works and what it can do we also do policy research where there is a existing law that potentially applies to something you're doing using the technology and there is an open question as to how that existing law should be enforced because the existing law is drafted in a vague or a broad way we develop policy research that advocates for a way to enforce that law that allows Regulators to still meet their statutory obligations because that's what Congress put them there to do that's what their legislatures and their respective States put them there to do but still provides the freedom to innovate as much as is possible so we're trying to find a peaceful Way Forward basically we have we have a series of plain language explainers of discret topics in this space we have a fantastic backgrounder by vitalic explaining Bitcoin in a way I mean whoa explaining ethereum in a way that will make sense to policy makers we deal with a number of different topics also at the legal intersection of these Technologies some of these are also useful resources for developers aside from policy makers because they explain a difficult legal construct like ofac which is us sanctions law we develop policy reports that deal with bigger topics like Securities regulation uh access to banking for companies and consumer protection laws particularly uh difficult in the United States with the state-by-state money transmission licensing setup and periodically uh most of our advocacy has done uh face-to-face meetings with policy makers but we do periodically uh file in regulatory proceedings so just recently for example we filed with European Securities and markets Authority I don't know if any of you have seen the paper they put out they basically said something like we're really excited about blockchain for Securities but we understand that it will only ever be closed or permissioned ledgers that will be used in these systems personally I think there is value in permissioned ledgers I think there is lwh hanging fruit in reconciling Silo data structures even if it's through a Consortium consensus mechanism but I think that the conclusion that only a closed consensus mechanism is suitable for high-grade financial services is premature so we filed a comment in this explaining how so many of the advances that are essential to financial services uh are being developed in the open space uh the Pioneers here are the people working on ethereum are the people working on zcash for example with zero knowledge proofs you mentioned ring signatures earlier the only way that all be privacy for financial services data is through the things that are being developed in large part on these open networks we testify we've briefed members of the European Parliament we've had several different engagements uh in our two years and we love ethereum we really do so in the early days we focused mostly on bitcoin and there's a reason for that um this was about two years ago it was hard enough to get a meeting with someone in Washington DC to discuss Bitcoin but at least Bitcoin was something they already knew about and they already wanted some answers about that is beginning to change now and we start to talk more about just open consensus uh mechanism driven networks and what they can do and the idea I think of having a general purpose decentralized Computing system is incredibly exciting so again thank you for all the work that you do and explaining that to policy makers is one of the most worthy things I think I can do with my time uh in DC so with that I'm going to turn to the less happy side of the talk uh and talk about some regulatory considerations for people who are developing decentralized applications and that means this talk is going to be about Securities laws so why Securities laws first because they're heavy duty regulation these are laws that say Seek permission do not seek forgiveness and if you didn't seek permission there will be strict penalties additionally a lot of crowd sales and pre-sales May subject developers of these Technologies to Securities regulation several scams over the years have drawn attention to this area already um and several vocal pundits many of them from the closed or Consortium consensus mechanism um side of the technology will freely tell you that they think that all appcoin or crypto crowd sales qualify as unregistered Securities issuance and I think that's wrong and I think we need to correct those misunderstandings now why us Securities laws there's a couple things here if you have any purchasers for say an app token in the US any of them you are potentially subject to us Securities regulations and if you're in a country if you're based in a country that has friendly relationships with the US extradition could be possible um so this is some serious stuff the US Securities laws are by far the most broadly applied of all Securities laws and there's a couple reason for that so in other jurisdictions there's generally a statute a piece of legislation that enumerates specifically which financial products are regulated as Securities and then usually which are not what are excluded in the US there is no such enumerated list in the statute there's an undefined term that says investment contracts and the federal courts have interpreted that term and continue to interpret that term to apply to various different schemes Additionally the US Securities and Exchange Commission is already investigating the uh scammy cryptocurrency paycoin paycoin fans and the Dow uh I can say has gotten the attention of staff at the SEC and they are actually surprisingly well informed um we've tried to help correct some misapprehensions they had about it and generally flesh out their information but they are surprisingly well informed so why are US security laws broadly applied the definition of security includes an undefined term as I said the term has been defined by federal courts courts have sought to ensure that the definition is inclusive in order to reach and this is a quote from a case the countless and variable schemes devised by those who seek the use of the money of others for the purpose the promise of prophets and that language comes from a case called the SEC versus hoe and it's from that case that we get the hoe test for what is a security or not so in order to really understand these issues we need to quickly actually look at the Howie case I think like a lot of uh strange and vaguely alarming stories it begins in Florida Howie was a um he owned an Orange Grove in a hotel and he would invite uh Rich new englanders down to flor is my mic this mic's working now great I'm going to put this here this is working and he would invite Rich new englanders down to his hotel in Florida and give them a tour of the Orange Groves and he'd say look behold the the beauty of Florida's orange fields and then inevitably the New Englander would say something along the lines of oh the Orange Groves uh they're so beautiful and how I would say w it's funny you asked that the Orange Groves are for sale and then he'd proceed to sell him one acre of the many acre orange groves that he that he owned basically he was partitioning his property into a number of parcels into a number of parcels and um and selling them uh as property now when you bought this property you'd also be pressured into signing a contract and that contract would say uh how how no I think now I'm gone we'll just go with this so you'd be signing a you'd be signing a contract that says um you look to hoe in order to maintain uh the fields the soil to pick the oranges to sell them at market for a profit is this working now okay good louder okay good so you look to hoe to maintain the soil the trees pick the oranges sell them for a profit and he will give you the profits from the land that you bought so it needless to say the Orange Grove turned out to be less profitable than many might have expected there was a lawsuit it went all the way up to the Supreme Court and the Supreme Court says this is the exact kind of thing that we want the Securities and Exchange Commission to have jurisdiction over so that's why this is the formative case and from that they created the ho test which has a number of elements I won't go into specifically but what's notable is that it is immaterial whether the shares in the Enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed by the Enterprise and sales of such nominal interests in physical assets have since that case been extended to all manner of things sales of uh beaver pelts sales of condos sales of minks of gold bullion of golf course memberships and Condominiums all of these has been have been interpreted as issuance of Securities rather than just sales of a physical object or asset and with the sec's interest in paycoin it is not unreasonable to assume that cryptocurrencies or some cryptocurrencies may be added to that list of sales of nominal assets or transfers of nominal rights to assets that qualify as securities and it's because of their interest in paycoin that we created a framework for Securities regulation so if you are interested in this area I highly recommend you go to our website coin center.org and you look at the whole framework it's posted there and you read it if you're a developer you will not need to read the first two sections which explain these Technologies to policy makers you can skip to the third which draws legal conclusions based on the applicable legal tests and the aspects of the technology that are s into that test so I'm going to skip through this here are the key findings for people who are developing appcoins or dap tokens the following are less likely to be treated as Securities if the token was purchased for its use value rather than merely with the expectation of profits so the line of cases here that build on the hoe test uh deal with Condominiums actually so in New York for example plenty of people will buy a share of a housing Co-op now is the person issuing those shares issuing a security the Supreme Court and uh some of the federal circuit courts have found no that is not the case because while people may expect the condominium that they buy to go up in value they also may be buying it to live in it to rent it it has utilitarian value and those are not the things we regulate as Securities another Factor the token was purchased after oh by the way on this previous one the utilitarian value ethereum or ether is a very good example of this so yes lots of people speculate as to the price of ether why isn't ethereum a security well one reason is that ether is essential to using the ethereum virtual machine you can't run contracts unless you fund them with gas basically and there's this utilitarian core value proposition that saves it potentially among other factors from being a security token was purchased after application is already up and running so words pre-sales are going to be more suspicious and the line of cases Here Comes actually from golf courses and Country Club memberships so basically if you were a developer and you were building a golf course and you wanted to sell memberships to the golf course but the the golf course wasn't built yet you were actually going to likely be found uh as an issuer of a security on the other hand if the golf course is already built and you were selling memberships in those cases courts have said that that is not a security so I don't know if this is interesting to other people or if it's just my being a huge dork for the law but these are two things that the community actually I think would agree on as far as ways to prevent scams or as ways to judge what is real and what is a scam so if you haven't built anything if you have no hope of necessarily proving anything but you're asking for money more likely to be a scam and if you are um selling something that is purely speculative that has no obvious use case more likely to be a scam so the law actually lines up pretty well finally the token's value is dependent on the purchaser's own efforts or the efforts of a large number of other unaffiliated investors users or developers the intuition here is that if I buy gold bullion from an open market I am not buying a share of the gold bullion industry or the gold industry there's multiple people who make gold valuable people who dig out of the ground people who find industrial uses for it people who find jewelry type uses for it so if there's really a widespread community that gives value to the thing less likely to be a security and then the last thing I want to talk about is some things to avoid so one big one is just using language that suggests that this is a Securities issuance this shouldn't ever happen initial coin offering that comes from initial public offering it's almost like you're playing a joke on the SEC which is funny to some people I guess but as a community I think we should find it more uh frustrating or annoying um profit sharing is another term that commonly comes up in Securities issuance so if you're using this language to describe your application and the tokens that you're going to be giving for that application or selling for that application you're basically asking for scrutiny from the SEC and that's fine you know I I think freedom is freedom I love the open internet I love the emergence of amazing things and Technologies and I'm not here to tell you not to do things I just want to say you should consider the regulatory risks when you do them and not including language like that is one easy way to hedge some of your regulatory risk and this is the big one endorsing risky Ventures or claiming endorsements so the Securities laws penalize people who are promoters of unregistered Securities just as much as they penalize issuers so if you're thinking should I um endorse should I put my face on this particular decentralized application think carefully consider your appetite for regulatory risk and then more importantly if you are building something and thinking of putting someone else's endorsement onto some public materials think very carefully have a conversation with them make sure they understand what they're potentially signing up for it's sort of it's it's sort of be a mench because these have potentially dire consequences and so an endorsement should only come when there's truly been an endorsement so in conclusion please please please please um think about your regulatory risk appetite when you develop these things when you contemplate having a crowd sale or a pre-sale and please feel free to contact me personally at coin Center um if you have questions related to this um we'd love to learn what you're building and talk about the path forward because there are definitely legal ways to go forward um by structuring the way you actually develop your technology from a a issuance point of view thank you very much Peter Van valkenberg of coin Center