Moving Past the Ashes of FTX: A Conversation on DeFi Policy with Danny, Sarah, Mya & Miller

We appreciate you being here to discuss uh to hear a discussion about the state of play for crypto regulation specifically with regards to DeFi and especially in the wake of FTX which was a catastrophic event for the entire ecosystem but really on Capitol Hill where one in three legislators in the current session have had gotten uh funding gotten donations from SPF's orbit. Now his presence is a a negative on the space and so we're here to discuss that with Miller White House Lavine from the DeFi Education Fund, Sarah Milby from the Blockchain Association, and Maya Shafani from NER. So let's just jump right into it. Before we get to um FTX though, I want to actually talk about the news of the day, which is that the SEC staff has said in court that they believe that that Binance US is operating an unregistered securities exchange. Now, this isn't the official stance of the commission yet, but at the very least, we now know that SEC staff think that these crypto exchanges, specifically Binance US, are breaking securities law.

Um, so I just want to start the conversation there because it's breaking news basically. Um, Sarah, can you just give us some insight into how we should interpret this news? Yeah, thanks for the question. I think there's a lot going on at the SEC. Gary Gendler's been very active in the last two years since he started as commissioner there.

Um, and I don't think it's that surprising that we're seeing in the wake of FTX, which was a large centralized exchange platform for the SEC to be turning its attention to other platforms it thinks might be posing some sort of issues or risk to consumers. Uh, whether or not all the tokens on Binance are securities is actually done through a test called the Howie test. It's a special analysis. Um, and every single token has to have the Howie test applied to it. You can't just do a blanket a blanket statement that all these tokens are securities.

So, I would challenge what the SEC has been saying there. But at the same time, there is a chance that one single token on that exchange might be a security. And we've seen, you know, with Coinbase and Ripple, Coinbase decided to delist Ripple when it thought it might be a security or the SEC SEC had alleged that. So, there are potential consequences like that here, too. But well, I guess we'll just have to see what happens.

Yeah. Uh, I just want to add to that. Uh I do think that in general the SEC also with its action against Paxos and B USD was also indirectly targeting Binance uh US. So I think there's it's part of a bigger scheme that's happening right now from the SEC strategy. Uh it's hard to tell what they're going to do next, but I do envision a few more enforcement actions uh coming up.

Oh, for sure. I would have to agree with you on that point. Um, now to broaden the scope of the conversation and talk about education for a second. Miller, you know, you're doing a lot of work in DC trying to educate people. I'm pretty sure that the legislators in DC get a lot of attention.

What I'm really curious about are the people on the state level. Like in Illinois, we recently saw a bill put forth that basically insists that validators have the ability to reverse transactions if ordered to do so by a court. Now, that's like impossible um to do and it's not going to the bill isn't going to go anywhere. But just the fact that it's been put forward, I think tells you a lot about how much work there is left to do on the state level, especially and it becomes especially important when you when you think that uh there's not going to be much action that goes through DC at least in the short term. So, Miller, how do we think about the states in this situation?

Yeah, I think states across crypto issues are going to take a variety of approaches. Illinois being one example, be it on uh you know, property rights is essentially what they were legislating on or on uh mining restrictions. New York uh signed one into law in December. But on the other hand, uh, last week in Montana, they passed a bill that would, uh, prohibit, uh, local governments from discriminating against mining operations in Montana or charging them higher electricity rates. So, I think across the board there's going to be probably 50 different approaches to uh, crypto issues until there's action at the federal level.

I think uh as far as you know how the industry should be thinking engaging at the state level, most states do have uh like blockchain groups uh of companies or individuals. They're highly effective. They'll be more effective than folks coming from DC will be at the state level. Um so I I definitely encourage uh folks to support those groups and uh um back them. Also to add one other thing that I think states are working on in the US is DAO law.

Um so we saw Wyoming uh we have I think Colorado is in progress right Sarah. Uh and BA is actually working on the on Colorado developing their own uh DAO law as well. So that's more relevant to web 3. Now Sarah do you think that we're going to have to depend on the states for the action in these uh in these arenas? I think in the short term when there's a divided Congress this year, so the House is controlled by the Republicans and the Senate is controlled by the Democrats and the key committees who are in charge of creating crypto legislation aren't seeing eye to eye with each other, not only across the aisle, but also on the biccameal level.

So between the House and the Senate, it's very unlikely that any type of crypto legislation is going to be passed this year. So in the wake of that kind of lack of a action, I think the states have a really good opportunity to forge ahead and really lead the path on what crypto legislation should look like. And a lot of people joke that or just even say that the states are a testing ground for different types of regulation. And I do think that we're seeing that come into fruition and that will continue especially as Congress is not taking any big action. And my you probably have the best perspective from being inside of an organization like a specific organization that has you know economic incentives and is a business.

You guys over here you're the you're the policy wonks. You're a polyon too but you're you're focused on a single entity. Really? Yeah. I I want to be clear.

We're we're an NGO nonprofit based out in Switzerland. All right. Fair enough. Yes. But we still care about US policy because DeFi is obviously borderless.

Um and you know when we look at what's happening in the US it it is frustrating from like a web 3 perspective because no one's coming out with actual legislation and then like you mentioned there's different states coming out with different rules. So it's hard to kind of decipher how to go about like having users here you know um so it is a bit challenging on that end. Uh but I I do find that working with other layer ones has been very helpful to kind of go talk to u members on the hill and also just with regards to different states you could also approach it that way as well cuz I imagine at least at this point the considerations that the layer ones are thinking about are the same across the board. It's not like the SEC or regulators are going after chain X for what reason why. It's more a systemic issue, which I think is a little scary because it means everyone has the same base problem.

Definitely. And I think like obviously I don't think it's going to pass, but the Warrant Act was something that we were really concerned about because essentially it was going to implement AML KYC obligations for validators and miners for every transaction. And that would be extremely difficult to implement and does not fit into a DeFi world. You know, we're peer-to-peer. We're not a centralized exchange.

Uh so that was something that we we really cared about this year, but I don't think it's going to pass, right, Sarah? It's just Yeah, hopefully not. But that bill, yeah, it's effectively a ban on crypto because it would make miners KYC any transaction that they're validating or mining, which is not only impossible, but would permission the chain even if it were possible. And uh, you know, why would you mine or validate in the US if you had that obligation? Not to mention that are you really going to impose, you know, on me running a validator in my closet a BSA obligations?

It's a ridiculous notion and it's not a serious bill. Now, Miller, the do you think that uh it would make a difference to educate uh legislators more especially on the Warren bill? Like are they willing to hear the reasoning that you put forth or is it sort of uh legislators have these uh presumptions baked into what they're thinking and that they're not willing to change? Uh, I think it depends on who you talk to. Well, for the Warren bill, I think we can talk.

Yeah, sure. Like, so folks that are considering co-sponsoring it or who have been asked to, I think most are are very open-minded about uh the potential implications of the bill, learning what it would do, whether it would accomplish its objectives, which it wouldn't, etc. I don't think that the bill's author or sponsor, Senator Warren, uh, uh, has any illusions about what the bill would do. I think the intent is is to ban uh that activity in the United States. Now, to zoom back out and think about FTX for a second, uh Sam Beck Freed had a lot of say and a lot of he was pushing very hard for a very a very specific bill last legislative session called the DCCPA.

uh could you uh Sarah could you tell us a little bit about what that bill will try to do and whether in this new session it or anything close to it has any chances of uh moving forward? Yeah, definitely. Uh so the DCCPA or the digital consumer uh digital commodity consumer protection act was introduced last year in the Senate agriculture committee and the agriculture committee actually has jurisdiction over the CFTC which is a financial markets regulator. So even though they oversee futures of pork and wheat, they also oversee futures of Ethereum and Bitcoin. Um the proposal would give the CFTC the ability to impose a regulatory regime on spot markets.

So at the exchange level where people are making transactions between one token and another. um it would impose prohibitions on certain types of risky trading practices. It would have um different types of disclosures imposed on those entities as well. And one of the biggest problems, which I think Miller can speak to as well, is that there are really sweeping large definitions in the bill that could encompass DeFi and put these types of regulations that were originally intended for centralized entities onto these def DeFi networks. Yeah, that's right.

you know it it for example define trading facility so broadly that it would capture something like the unis swap protocol and coinbase and then apply regulations designed for custodial centralized exchanges to everything that met the definition. So for example it would obligate the unis swap protocol to use a qualified custodian to uh custody the assets of the the protocol's customers. you know, just complete it was illogical given that the functionality of dexes and centralized exchanges are completely different. Uh just didn't envision uh uh or acknowledge that there were multiple ways to go about trading digital assets. Um so that was I think the primary issue that folks had with the bill.

um you know on the uh from the centralized exchanges perspective there were some obligations that uh they had issues with but from a defi perspective uh it would impose obligations designed for centralized exchanges on protocols uh which doesn't work. Now Maya can you tell us how the conversations you've been having around DeFi have changed in the wake of FTX's collapse? That's a really good question. Um, are you saying like in regards to talking to regulators or in general as a community? I can discuss both if you'd like.

I whichever one you think more interesting but I can I can hit on both. Um but so as a community I think it all made us think especially like from a technological perspective like how can we set up parameters to avoid some of the things that happened you know with FTX and what can we build to kind of combat some of those issues you know so that's something that I think we're thinking about at near especially when we release new products uh on the other hand like from a regulatory perspective I think it caused uh a lot of challenges with communicating on that front because I think people who already had a fear mentality with regards to crypto kind of fell deeper into that and then the people who were pro crypto obviously were like oh FTX is just one bad actor you know the technology itself is great like we still believe in it but then there's the other side who's like well this is a great example for why crypto should not exist and all these uh projects like you know they're doing illegal stuff. Uh so I feel like there is a bit of challenge on that end but I still feel like there's a lot of hope and there's a lot of work to be done on the education side and just I think more facetime on the hill and with regulators in general like whether it's in the US, UK or EU uh is going to be great for web 3 overall because it'll allow us to also share what we know about what we're building because you know if you're not working in the industry you don't have that insight at your hand you know you have to actually do deep research on your own and sometimes I'm afraid that that's not being really done especially like when you look at the Warren Act like that's not applicable to validators and and minors so how could that even be encompassed in it um so that's my take on that Miller how has the playbook changed and is it a winning strategy for to go to legislators and regulators and say Look, FTX wasn't a crypto fraud, although it had elements that were only possible with crypto, but it was mainly just a big old fraud, right? This wasn't some breaking the chain situation. It was just taking money that wasn't theirs to take.

So, is that that's the message, but is that something that people are listening to right now? Yeah, I think that people who are open-minded appreciate that. That's what John Ray, the new CEO, the liquidator, uh, testified in Congress. I think you said good oldfashioned embezzlement or something like that. And it's true.

Uh but I do think that I mean I I cannot understate the credibility hit that crypto has taken not just in DC but especially in DC. Uh it is definitely you know made the the hill higher and steeper in a lot of ways unfortunately. Uh but I think that from you know a DeFi perspective my impression has been that DeFi lost the least so to speak in that uh the folks that do have a nuanced understanding of crypto DeFi the differences between those two things appreciated that uh you know this was a CFI issue and uh if a DeFi protocol is decentralized and non-custodial you can't have embezzlement. Uh but I do agree uh I do agree that for most folks uh you know there's no differentiation between crypto and bitcoin even it's just all crypto and uh the crypto guy you know uh executed a massive fraud and uh if folks don't have a nuanced understanding of what's going on then that is the impression that they take away. Now uh here's an interesting one for you Sarah.

Why are we even talking about regulating DeFi? Not that no one should be doing it, but if like in the the spirit of DeFi is one of permissionlessness and uh just global having global reach and not being you know beholden to one jurisdiction. DeFi as a as a as an industry if you will doesn't care if and where regulation is. So what role like does the blockchain assoc associate have in shaping that conversation? Yeah.

So I think why we're talking about regulating DeFi in the first place comes from mostly the fact that traditional finance is being mirrored in a lot of ways in DeFi. And for a regulator, they don't have the nuanced understanding of the technology to understand why when you're using code to execute certain transactions, that's very different from going through a custodial intermediary, which have been traditionally the focus of where regulations are applied. So for that reason, I think a lot of what we're doing is providing the kind of education to show regulators why traditional finance like the the application of traditional finance regulations don't map well onto DeFi. It's not to say that there might not be some regulation one day of DeFi and it might be really specific to where the user is based. So if you're an American and operating in the US, you might have certain regulations as an interface provider or something like that.

Um, but it's really, I think, highlighting the the way the technology is being used and giving those kinds of demonstrations to the members of Congress that's making a real impact for them so they see the difference of when you're on your bank account app on your phone sending money through zel versus using some sort of DeFi protocol to do a similar action. Yeah, I think DeFi is just so revolutionary in a lot of ways that it it I mean it really upends the entire approach to uh accomplishing public policy objectives in financial services that the US has adopted to date. I think that makes it scary. Uh you know if you're a regulator for good reason it it should be scary in a in a lot of ways. Uh so I I sympathize to a certain extent and I think that's why DeFi was like top of mind for regulators.

I would say from late 2021 through the end of 2022. Uh uh I think that you know the events of 2022 have pushed it down the priority list rightly. Now, I we're we're moving pretty slowly in the US, but in Europe especially, there's a whole lot of new uh legislation and regulations that are about to come online through a package known as Micah. Um Maya, could you tell us a little bit about what Europe is up to and how we should be thinking about in the US? Yeah.

Um we've been talking to EUCI a lot about Mika. Uh Mika has been uh is going into its final draft. it's going to go into I think they're voting on it in April. Um but there is a bit of worry that they're going to include a few extra provisions around DeFi and um I forgot if they're also going to include some some provisions on um Dows as well, but EUCI is great for a contact for that. But on the UK side, one thing that we're really excited to work on and one thing that I do appreciate about that jurisdiction is they're actually taking the time to ask the industry like what do you guys think is good legislation here.

So UK uh recently has really taken a proactive approach about um asking us and they put out a consultation and within the consultations there's like three chapters that are relevant to uh the DeFi industry. Uh and they talk about miners, validators, how they should be treated. They even ask us like what we think the path to decentralization is and what the regulatory challenges are from our perspective. Uh so we're working on responding to that letter and hopefully uh the UK actually takes that into consideration as they're drafting their own legislation. But I think what they're doing is great and they're trying to like harbor a positive crypto approach versus like what we're doing in the US which is just enforcement after enforcement action.

So yeah. Yeah. In the view of the SEC, well, what the SEC is doing this regulation by enforcement and the industry is saying, well, we're not being clear SEC about the rule, what the rules are, to which the SEC responds, the rules are what the rules are, and you're just not reading them correctly. Uh, and so it's sort of talking past each other in both directions. It's not really a situation that uh will have a happy ending unless uh something changes.

Yeah. And something is going to change. Um but yeah, no I mean I think to to Gendler's credit to a certain extent he's been pretty clear in the last week even everything but Bitcoin in his view is a security. I think that's as clear as the chair can get unfortunately for the SEC. He's wrong on the law and that'll be vindicated in court.

Yeah. And don't forget that you could register as well but he doesn't tell you how to register. He just says that you can go ahead and register. Yeah. Well, the question I guess that brings up the question, this time next year, are we all just going to be orange grove farmers?

Like, will there be an ETH Denver at all? Are we just celebrating an unregistered security right now? In the view of Gary? Probably. But is that something that we should genuinely be concerned about, Sarah?

I mean, I don't think so. Uh, I work in crypto policy, so I have to be irrationally optimistic. Um but no I mean I I don't think that there is any world in which uh this industry and ecosystem doesn't have a major role in the US economy. Uh you know a revolution is not a dinner party. We're trying to change how economic systems are uh uh function in really fundamental ways.

That's not going to be easy. Um, so I think that, you know, over the long term, uh, uh, I have no doubt and I know it feels like there's a little bit of doomsday happening coming out of Washington. There's been a lot of action recently that's hurting the industry, but that's not to say that there isn't action we can take to push back against that. There's legal recourse that we're looking into. Um, there's legislation that can be made and pushed forward in Congress.

The states can get involved as well. So even though it feels like there's a lot happening, it moves much more slowly than you think in Washington and will definitely take more than a year for these things to get worked out and gives us a good runway to be able to push back against them. Now, we've only got two minutes left. I want to just hear wrap-up thoughts from all of you. We'll start with you, Maya.

What should we be most uh thinking about in the year ahead and where should we be putting our energies on this topic? I mean I would uh say like what Miller what both of you guys are doing is great is just education and actually working together as an industry versus each person going off and doing their own initiative. I think collaborating is going to be and having a united voice is going to be very important when the regulators are you know carrying out the way they are especially on the US side. I think Rebecca Reddig said this, but I think 2023 is the year of the use case. So, the more that we can show Congress why crypto is really here for good and improving people's lives and people are interacting it within it or with it in ways that aren't nefarious, the better for us.

and we can use those on the hill and show people why Senator Warren's bill is unwarranted and doesn't work and why she should actually care about promoting the innovation in the space. Yeah, I think the the biggest difference like an individual who is just following crypto policy on Twitter uh can make is to get involved with the state level blockchain groups. uh at the state level just individuals have a much bigger voice and uh state legislators really only care about people in their state rightly so. Uh so I think that is the best way for folks like on an individual basis to get involved and yeah to Sarah's to Sarah's point uh you know when crypto is used at a mass scale uh by consumers every day a lot of our problems will be solved. So keep building and uh uh yeah mass use is a very potent policy tool.

Great. Well, thank you all for joining us. Thank you. Thanks. [Music]