Decentralization and Regulatory Challenges - Scott Lewis, Josh Ephraim, Tuongvy Le, and Jolie Yang

Welcome to our panel on D5 regulation um we have uh you guys can't hear us on the back sorry that's much louder I'm Scott Welcome to our panel on D5 regulation uh we have Josh V and Jolie [Music] I will let them introduce themselves sounds good I'm Joshy from uh associate general counsel at Paradigm crypto investment firm hi I'm V I'm at band Capital crypto I lead Regulatory and policy there hi my name is Jolie I work at coinbase as a product Council I'm working on all things base cool so we're just gonna get started uh give you your background and no okay um yeah uh all right so first uh we're gonna talk about a little bit about the SEC and how it works um one thing you may not hear a lot about on Twitter is kind of the SEC rule making process um it's not just all judges and uh litigators and so I guess the first thing is like what is the SEC rulemaking process how does it work and why is that important for a good functioning regulatory system yes I can take that one so you know we hear this term regulation by enforcement a lot and I think you know people can like mean different things by it but I think what it's meant to convey um is this idea that you know in the capital markets you have some new like product or service or offering or activity um and maybe it's not clear how the regulations apply or whether the regulations apply but instead of you know an agency like the SEC going through a rule making process where they put out at a proposed rule for instance they could say um you know we know these like crypto tokens are sort of new and different and weird maybe the existing Securities like registration regime doesn't quite work for crypto tokens so why don't we come up with like a new rule for that so they would put out the rule the public the public would then have a chance to comment on it and then they would decide whether to adopt it so that's what rulemaking is um as we all know that is not what the SEC has done instead they've told the industry what they think about crypto through enforcement actions almost exclusively so since crypto got on their radar in like 2017 they haven't proposed a single rule to address any anything in the crypto ecosystem instead they've brought I think like over 100 enforcement auctions by now so that I think is what people mean when they say regulation by enforcement and that is how the rulemaking process would fit into that if that's the approach that they've chosen to take which they haven't so that's how the rulemaking would work and does anyone want to talk about why that's good or I mean so I I can talk about that a little bit I think it's it's obviously helpful for builders in the space to have certainty as to what they're building and what what rules they need to play play by I know uh like that's why I became a lawyer was to help help Founders figure out like okay here are the rules and hear how here's how you can build in this space here we're just kind of stuck guessing because there aren't rules and the SEC has uh has has only uh regulated by enforcement which I think um there's regulation by enforcement has gotten a lot of criticism which I think is fair in theory sometimes it's nice to not get the rules on the books right away in a nascent industry um you know you might not know what the rules should be in the first year or two of a new technology at this point I think crypto's been around um long enough that we're kind of begging for some certainty there um but uh but yeah we can talk more about that like just like from my perspective as not a lawyer like I live in a liberal democracy I expect the government to do things in ways that are responsive to the people that live under it and little dictatorships within the federal government are not what are federal government should be about and like I don't see that coming through in how the SEC has approached crypto um but back to being a moderator um okay just like off of the SEC uh moving kind of on to the Department of Treasury uh uh can the Department of Treasury regulate defy uh what sort of things could they do if they wanted what powers do they have so you know the SEC and what they do in crypto I think does like take up a lot of the oxygen in the room a lot of times um but you know what everyone I think building in crypto in defy needs to realize is that the treasury Department is actually very powerful and probably has a lot of existing authority to crack down on much of the crypto ecosystem so you know obviously we all saw that when ofac which is a part of Treasury sanctioned tornado cache um so that's one power that treasury has to go after crypto and to go after defy in particular there's another department or another unit in treasury called fincen which is the financial crimes enforcement Network and that's the unit in treasury that um they're charged with enforcing the bank secrecy act and that's the law that governs Money Services businesses which are basically just businesses that are engaged in like transactions in currency and money including digital assets right so coinbase and circle and a lot of these centralized crypto platforms are registered msbs and that's why they have to comply with with things like kyc they have to kyc every user they have to implement all sorts of AML compliance measures like transaction reporting monitoring record keeping things like that so you know treasury is putting out a report on DFI either this month or next month that is supposed to make recommendations with respect to D5 in particular and it's possible that some of those recommendations could involve those types of requirements on D5 protocols and applications so that's something to look out for and it's possible that they could interpret you know their existing authority to do those sorts of things without having to get you know without having to go through Congress to pass new laws and just to if you don't mind jumping in a little bit here to kind of build on that why treasury is so important is that they can cover anything so even if you are just on the protocol infrastructure level say that you are running a validator they can influence whether you can validate transaction that has touch distinction wallet and these are all instances and then they can move up the stack so there's the infrastructure layer then there's the smart contract level there's the wallet level and these are all parts that the Department of Treasury has potentially jurisdiction in providing guidance as to whether kyc information is needed what whether you're considered money transmitter and so it's definitely a department that we should all keep an eye out for changing gears a little bit uh in D5 there's a lot of protocols with no upgradability no governance uh they're just running autonomously on chain um let's say there's a regular regulatory requirement or enforcement action against a fully autonomous protocol what would happen and are the developers and deployers of those protocols potentially at risk I guess so I don't think there's a simple answer to that we've seen um we've seen a few cases like Oogie Dao where the you know the Dow has been served or attempted to be served uh based on just like posting in a chat which you know I don't think is uh is is actual service for any lawyers in the audience um so I think what happened did my mic go out oh here we go um I think what would happen in practice is you serve the Dow no um you know developers they're actually working on it would come forward to accept service um and ultimately uh there's no one to defend and it creates a kind of a a precedent where you'll get a summary judgment against whatever the autonomous service is for whatever they're doing and basically everyone's afraid to go work work on that on that service moving forward because they're worried that they'll be liable or served individually um as a developer um on on the protocol I agree I think it's pretty complex I think um there is there is something to be said like if you're just a developer and putting out software there's a there's a carve out for that kind of activity but a lot of times in reality and practice is it's not just autonomously running and I think that's a question that a lot of people have to think about is are we still being able to upgrade smart contracts is somebody still governing over the protocol um it's it's very rare I think to just put software out there and then um you don't have to do anything about it I think there's some aware instances where that has happened but in reality a lot of projects you can identify a core team you can identify maybe a handful of members who are still contributing directly into the protocol and I think that's that's where it gets a little bit murky I so I would point out though as like many of you probably know um the developers of tornado cash got rid of the admin key I think in 2020 right so um at the time they were sanctioned like two years later no one actually I mean those smart contracts or at least the ones that were sanctioned actually were autonomous as far as I understand um so I mean they didn't go after the developers true but as we know in the Netherlands I believe one of the developers is still in jail and they he hasn't been charged yet which is totally insane but I think this is the theory that they're going with right that he developed this protocol and even though it is now autonomous fully autonomous these smart contracts and have been for years now he could still be criminally liable would like U.S uh rights change that at all or maybe that's too much it's too deep in the weeds I I don't know um I think it's still a really unsettled question of what sorts of criminal or civil liability Developers could face um I mean just going back to Oogie down right like they went after the doubt but they also went out after the founders for their role in developing this protocol that they're now saying is um an unregistered or illegal like derivatives platform so you you can definitely be held liable for developing something that you know is unlawful and there's also a pending case in the UK um for I think what was it called tulip trading limited um it's basically kind of an unfounded case of someone claiming to be Satoshi Nakamoto um ensuing Bitcoin core developers to like give him his keys back um but it's moving forward and ultimately there if if they reach the wrong conclusion in this court case there could be serious liability for for developers working on things like that um so it's kind of scary um all right stable coins who ultimately decides whether custodial stable coins are securities and what types of factors will they look at no no um I think you know it's a complicated question um but obviously um the in the U.S the SEC is going to look at whether those are securities under Howie which I think everyone in the um in the audience has probably heard of Howie which is kind of a sad state that all of you non-lawyers know about this um U.S court case from 1946. um but then there's there's a reuse for asserts and Young from I think 1990 which talks about um a lot of the the um the factors that that will be evaluated in a in a stable coin do you want to add on that yeah but yeah that's all I got I was just going to apologize to everyone because you now have to learn a new test and it's called Reeves but that that could be the test that you know the SEC applies to go after certain kinds of stable coins um but I I don't know what their theory is I mean we know because paxo said that they received a wealth notice from the SEC um that they're busd the stable coin that they issue in partnership with Finance is an unregistered security um I mean it hasn't been charged yet so that's one thing but if the SEC does go after something like busd I think it's important to just take a step back I know there's a lot of fun about like what does this mean for stable coins in general um but I but I would caution against like reading too much into that because this could be something that is very specific to just you know whatever this like paxos Finance partnership was with respect to busd and it doesn't necessarily mean that the SEC thinks that all stable coins or even all centralized custodial stable coins are securities I think they would look at a lot of factors right like you know does it bear interest I know most stable coins don't um but does it bear interest either you know does the stable coin issuer give interest on the stable coin directly or does it work with an affiliate that gives interest right so I could see a theory where they say you know um paxos is not giving interest on busd but they have this partnership with binance and binance has this crypto lending program where you can earn interest on busd or their pegged version or their wrapped version of it so I don't know what the theory is going to be but I think it is going to be like you have to look at it very specific to the facts of every situation I think they would look at you know what is the mechanism that the issuer uses to maintain the value of the stable coin I think there are a lot of different factors and [Music] um yeah there are a lot of different factors so it's sort of hard to know what an action against busd would mean for all stable coins okay now we're going to move to the layer two that has no plans to launch a token Network um how is coinbase approaching decentralization with layer twos and bass uh and how will coinbase well let's just do that yeah hello okay that works um yes you're right we have no plan to launch a token um and we've been very explicit about that but we are also very caught cognizant and very dedicated to decentralized and that is um in our commitment to being permissionless and I think this comes in multiple ways I know a lot of people have questions about okay we're operating a single sequencer what does that mean um are you going to freeze funds if you are I don't know a bridge operator and I think like these are all very valid questions and all questions that we're wrestling with during this test net phase as we figure out how are we working with the optimism team to kind of make sure that our decentralization path is in line with theirs we chose to vote to build on ethereum for a reason and that is because we want to have the security of ethereum and then also to per continue to promote the ethos of decentralization and permissionless all throughout the stack on the sticky Windsor level on our smart contract level and we're working towards it cool one question just I have is do you think bass will make maybe the coinbase user that's never really adventured on chain do you think bass will make those users more comfortable uh with not with self-custody and having control of their private keys and how is coinbase or how are you thinking about that that's a really good question because I think what we're struggling with often and maybe this is what we're all seeing is like what's the real world utility that we can give to users that will make them come on chain and so um at least recently we've seen there's a lot of different dapps experimenting with a lot of things from nft to gaming to Identity and these are everything that we want for our users but we just have no place to put them because frankly we've thought about how do we bring users on chain but during the peak of the bull run last year it was hard it was the gas were just crazy we couldn't comfortably think about putting them into one chain without stressing it and then just have creating a bad experience but I would say like the key part of bringing users on chain is not just the L2 but it's also our current custodial wallet so we have all these various wallets that's if you're not comfortable like you could come to coinbase as a retail user get you used to what these like tickers and what these coins are and then bring them into on-chain and that is through whether that's like our MPC wallet which is you can you don't have to store your you don't have to know your entire seed phrase in order to have one and you don't have to fear that you can't recover your account that's another way to start accessing defy and dapps and then and then once we get you there maybe we'll then help you bring on to a self-custodial journey through our coinbase wallet and so we kind of see all of this as um you know just a part of the journey to bring them on chain how does how did the current regulatory environment affect how coinbase built um it's funny because yesterday we had a team off-site with the optimism team and they asked us what is your top worry and then it's like regulatory regulatory regulatory those are three of our that's our top three like worries um and I think that's because it's fluid it's not clear as we all see there's um we're still trying to figure out what's what's top of mind for Regulators how will it change in a couple months that's something that is always a moving Target and so I like think that it's very important as Builders to be super flexible in recognizing like these are maybe what The Regulators are thinking Regulators are thinking about then how do we square that with our commitment to decentralization and one thing I think that came out of this narrative or like this team building exercise is that decentralization is super important but unfortunately a lot of times like Regulators probably think that decentralization means that we're trying to skirt rules in rule of law and I think that's not true and I think a lot of people need to continue and to help spread the message that just because we're committed to decentralization that means we're going to have better security we're going to have better experience for users and it doesn't mean that we're trying to break laws and that we're just you know trying to go Rogue um kind of on the regulatory environment and building uh [Music] have organizations and projects not based in the U.

S become more reluctant to recruit and hire america-based Developers and like what are what are y'all seeing questions around that four teams that might want to pay and employ people that work and live and love the United States I can take that as you know my perspective working at a VC that's investing in a lot of these these projects um I think ultimately the US's regulatory reach is extremely broad so if you're talking about a project that has absolutely no Nexus to the U.S period Then I think definitely they're going to be hesitant to hire someone that's based here um I think that fact set is pretty rare because most projects um will have or I don't know about most but many projects will have um either customers in the U.S people in the U.S uh they Market in the U.S there's there's some relation to the United States I think you see in in the SEC going after uh doe Quan like you know a lot of people would have said he had no Nexus um but clearly they're you know the SEC is saying there there is um you know there is there this is affecting us users um and U.

S citizens residents um so I think that fact pattern is is really unusual and so probably not a worry if you are based in the U.S um I think you just have to understand that you are subject to um the regulatory regimes here um hopefully that's a good thing because people aren't gonna you know I I think there's there's a lot of um mixed messaging of hey okay maybe if I move the founding team over to Dubai or Panama or some other entity then I'm protected the SEC can't go after me the Department of Justice can't go after me um and that's just like you know probably not true maybe it makes it a little bit more difficult to you know get a subpoena and make you produce documents subject to that but um I think there's pretty there's a pretty narrow set of companies that have no or companies protocols whatever that have no um Nexus to the US I'll just add to that um you know I've been in this job since last May um and you know a big part of what I do at Bain is I advise our portfolio of Founders almost all very early stage projects and I can say that for the first time since I started I'm starting to get questions from our Founders about should they start thinking about moving abroad and it's really heartbreaking because you know we have incredible developers and entrepreneurs in this country and you know just the fact that we can't get our act together to create a regulatory environment of certainty and stability for them it's just I mean it's it's a shame but it's also inexcusable especially given the progress that's being made abroad right the EU Japan South Korea Hong Kong Singapore all these other jurisdictions are recognizing the benefits of crypto and they're trying to come up with a framework they're not just pursuing the industry and shutting down the industry through enforcement actions and Shadow Banning and all of this stuff um so it's just it's a shame uh and it's really really disappointing to see so I I don't know if you want to talk about what's going on in Congress I know Scott you're really active but you know that's sort of Our Last Hope right now I think yeah maybe maybe just a little bit uh first I just want to give a shout out to uh Tom emmer and Kristen gillibrand also the center for my home state of Tennessee Bill Hagerty um who've been sort of championing the crypto cause on the hill um and I think it's really important that we as a community kind of celebrate and amplify those voices um because when we do amplify those voices on social media um that validates their decision to kind of take a risk for us um and one other thing just to like because there's people listening and I don't think this is well known in the crypto Community uh just because a politician maybe works with someone like Elizabeth Warren on an issue they may not be actually High conviction anti-crypto they might just be collaborating on a thing and when is a community on social media if we kind of come out and dunk on them very publicly that sends a message to the staff of that uh leader and the leader that we don't like them and what might be kind of a low conviction feeling it out maybe they're a little bit skeptical of crypto that can turn light skepticism into high conviction no and so like I know it's really hard to say hey like here's how you should behave on Twitter because it's like we don't know all these people but I think it's important to like start thinking about um how these decisions are being made to support or oppose crypto because it isn't necessarily a partisan issue it doesn't fit neatly within the two-party system of America and we should not make it that um and that's just kind of like my take uh I also just like wanted to touch coinbase as I'm sure we've all seen the pop-ups and notifications about coinbase getting a little bit uh more active in Grassroots organizing and I just maybe Jolie want to talk a little bit about her perspective on like what coinbase is doing um I'm um crypto435 I'm not sure folks have seen it but it's our effort to make sure that everybody across all congressional districts have the information they need so that they can go to their legislatures because we cannot forget that the state governments can also impact crypto directly on the projects that you're working on or operating in um even if you are not headquartered there and so I highly recommend sign up for crypto 435 get updates it will give we'll be giving information and updates about what our key issues that are coming up who to call and I think this is all just important information because Grassroots organize organizations and everything like that is like the most powerful tool I think that we have to influence state government and then it's also up to I think industry players like all of us to make sure that we're also trying to push um like crypto up at the hill and making sure that legislation understand that where regulation is needed what should be left for innovation um so that we can and to make it also open to the public so that it's not just I think so as some of us think it's just back door talks among um industry players thank you everyone we're at the end of our time I think we succeeded I hope we didn't scare you too much yeah promise is kept okay foreign