The State of Crypto Regulation

is niraj agarwal and a great panel to talk about the state of crypto regulation uh perhaps here in the united states and beyond got some amazing speakers some great friends uh and the leading experts in the space so raj i'll let you take it from here uh thanks david so uh privacy is very much a topic related to regulation so i'm glad we have that segway uh i'm joined here today by um jerry and peter jerry beato and peter van vockenberg my colleagues at coin center zai masari of the law firm davis polk and preston byrne of anderson kill so thanks everyone for joining thanks for having us yeah um so we don't have that much time and there's a lot of legal minds on the stage who i know tend to love to fill time so i'll just jump right into it i figured the best way to go about this is people ask me policy questions all the time and i almost never really know the answer so ask i'll relay those questions to all of you the number one thing on people's minds is sort of what happened with the fincen rule making right you'll all remember the um the the big flare-up towards the end of the trump administration about a new rule uh people know that we were successful in in pushing the rule into the new administration but now uh the question is what what happens now right where is what's the state of that so given that uh jerry is my boss i'm gonna go to him first bias very good um so i'll give sort of the brief answer of what happened where we are and then see what other people have to say um but you're right um the big concern for everybody is that this rule um for reasons that we can go into if you want um would have been very bad for uh cryptocurrency just across the board and it was being rushed through right and we weren't really having an opportunity to try to um communicate how we could maybe get good results without having such a terrible rule and the best hope was to try to get it not be final before the end of the trump administration right and have the rule-making process continue into the by administration because we were fairly certain that the reason it was being rushed was because the secretary of the treasury secretary mnuchin was driving this and he wanted to get it done before he left office now that we were successful with thanks to all the community coming together in getting this rule pushed into the but administration exactly what we thought would happen is happening which is they've pumped the breaks they have issued basically 60 more days of comment period for this rule which puts it back into a not a rush thing this is now a normal rule making process and um just from conversations and statements from fitzson we feel pretty comfortable you know kind of we expect that at this point the worst aspect of the rule the counterparty identification piece that were being driven kind of personally by the secretary are not necessarily at the top of the priority for vincent anymore and uh i expect that at the end of the day when a rule is issued because there one probably will be one at the end of the day in two or three months um what we'll see is the creation of a new cash transaction report for cryptocurrency which is not something that um we like because we don't like the bank secrecy act period but um it's not something it basically just creates parity between crypto and um legacy financial institutions so it's not something we can really complain about uh so yeah tightly relevant to our ethereum heavy audience uh so let's say the counterparty piece is is gone for now uh you the the ten thousand dollar reporting threshold what would that mean for say for d5 for like sending money uh from coinbase to uniswap or something like that somebody else should i go you should go in there there's a siren going by my house right now good excuse peter you're right should i go ahead yeah go for it preston i don't want to cut you off um yeah i mean look it would mean that um entities subject to the rule uh that is financial institutions would need to create transaction reports with respect to transactions and value above ten thousand dollars um i think to to my mind rather than you know what this specific rule means for d phi um i think there are a lot of questions about how the administration um whether the pre just previous one or the current one um you know how in general is the administration going to think about d5 and how regulators going to think about d5 because um i think i would just make two points one is um it's a mistake to think that they're not thinking about defy right um it's a big mistake because they are um and second um i think it's a mistake to think that they're just gonna look at defy exactly like they looked at um the last sort of um boom in crypto regulation which is ico tokens right um d5 is different and i think they're going to look at it differently um so sorry nero jade i took the question in a different direction but i think it's a much bigger question than just like you know how would the travel rule and the ctr requirement apply to d5 the specific problem with the the counterparty identification rule which now might be dead we can't rest yet but might be dead is it required name and physical address so if i was uh using ethereum through coinbase for example and wanted to send to a smart contract what is coinbase going to record as my counterparty uh there is no name you know human name and physical address behind a uniswap contract or or any other smart contract on the ethereum blockchain so that doesn't mean that you know aml and kyc regulations aren't important and you know maybe certain transactions to certain smart contracts should trigger a suspicious activity report because of something that the exchange noticed about the transaction that looked like it might have to do with money laundering but the exchange shouldn't be required to have this very specific record-keeping requirement that is non-uh negotiable of a name and physical address for things on the ethereum blockchain that never have had physical addresses um so zaid to the you actually brought up a question that i was going to ask earlier anyway preston um as a close observer of the the regulatory space what what's different in sort of it seems like we're in a new cycle whatever the traders call it right what's different this time from what you're seeing between uh 2017 and now um what's different uh the people who are being stupid about regulation have better code um so i think that's the i think that's the long and short of it is that the the projects that are breaking the law are at least doing so in a creative and interesting fashion that that i can i can really uh you know take time to read their white paper i mean there's there's it's an interesting distinction right there's some projects which is sort of barreled straight on and they've gone and they said okay you know we're gonna do it i'm not gonna name it by name but some projects have said oh oh oh no we need a token let's go push out a token as quickly as we can and i think that in some instances like for example like sushi swap um it is more of a borderline case from a securities law standpoint uh than this straight up 2017 you know we're just going to pre-sell tokens and then have nothing uh and you know there'll be contracts and all the rest of it it'll really be a security in this instance it's closer to the borderline but i still think on the wrong side of the line um where more people it's more interesting is we're seeing companies that are just doing protocol development um so they're just publishing software and then they're trying to build value-added services on top of it so like imagine something like lightning or a layer two technology and then a company will say well there are other ways that we can monetize otherwise than providing a token we can provide some type of hosted you know environment for people to go run these things on or something like that where they're not directly participating uh in any financial activity but instead what they're doing is they're an information content provider for the purposes of section 230 of the communications decency act which means that basically they're you know more as long as they're not conspiring with anyone to break the law they're more or less immune and on the right side of the line there's the same list we're publishing some code and we happen to run like an aws type service or we happen to have some client software which which works with that code and if you want to you know use it and pay us to do this particular you know programmatic function then that's something we're willing to do and so so that's that's interesting so people those kinds of projects are not quite as uh there are some projects which are being very clever about it which aren't saying listen we're trying to cash out uh you know cash out on our users and just run away with some coins part in the language but they're actually developing interesting products so i think that's the difference is that there's innovation and that's actually happening yeah one day we're gonna have to do a whole cryptocurrency and 230 panel with with preston because i know i love 230. it's a lot of fun i think it's right there there's running code for the d5 craze whereas the ico craze was just about raising money on promises of future code which is kind of like right in the heart of sec's jurisdiction yeah yeah so peter i guess to that point um because speaking of the running code thing like rather now that there's something that exists in the world and then there's sort of a fair distribution mechanism of something like a governance token or something like that how does that change the the thinking around the the regulations for something like that i i mean so the argument that it it takes this partially out of the sec's jurisdiction is not at all rock solid and i wouldn't want to present it that way but it goes to the point that you know maybe you know the token actually has a real use and isn't just a way to raise capital on promises of building something that will in the end return profits so so you know i've never been a huge fan of the the the shorthand version of this which is it's a utility token it's not a security because it's a impoverished and way too simple analysis but at least there is there is more of a credible argument that these things are being used by people to do real things in the world unlike a a paper stock certificate uh which is of course not used it's just a marker of you know profits that are owed to an investor can i can i say another way that things are a little bit different now um yeah it's that the in the ico boom going to the utility token point um the networks that were being launched were being or promised or being developed um all tended to promise um all kinds of utility that were like you know maybe a different kind of communications or maybe electricity metering or maybe file storage right all kinds of different things now what you're seeing is a lot of these um or where you're seeing the most action are projects are developing services that are financial in nature and so the projects themselves even if they are not issuing a token or are issuing a token in a maybe more reasonable way the servers that they're providing themselves are would would otherwise be subject to regulation if done by a central party so uh you know the kind of activity that happens on you know in decentralized exchange typically you would see through a centralized regulated entity like the nasdaq or whatever and just to jump in niraj this is like a topic that's very near and dear to my heart as you might imagine um jerry i 100 agree and i think there's two aspects to this that are really interesting first of all you're exactly right um a lot of these services or services that not only could be offered by financial intermediaries but in fact are right and those financial interviews are regulated for it and let's be honest i think it really befuddles regulators how to deal with the same service being offered and frankly done in a disintermediated fashion that's not how regulators think about their jobs right and so and that's fine right i think that's really very very interesting um but i think it's a mistake to think that's the end of the story right i think that's the big beginning of the story and sorry jerry i wasn't um implying oh yeah yeah yeah not not i'm just saying hypothetically um and then you know it's just the beginning right they're gonna start to think about how to how to deal with this because the consumer protection concerns are there you know all of the same issues you know financial stability frankly as these projects get really big um are there and then the second point is you know on the governance token topic it's so interesting because um i think you know in a lot of ways these tokens were designed to avoid um howie analysis under the sec's digital asset framework and the million factors um but i don't know that the sec is just going to look at that framework and say we're all good here right they're going to take a big step back and say do these things look like equity what do they what what does it mean to have a vote um what are these things actually i mean that's going to be very interesting over the next year well i hope i hope the audience is listening very carefully to this last section because i recall in uh at one ethereum conference the coin center team went up and basically explained that the icos are uh probably not a great idea and sadly that wasn't enough to uh to slow things down um okay so i guess shifting gears a little bit another question that is sort of like top of mind for basically anyone i talk to is just what now that the body administration has come in there's some some appointments are known um kind of what what are the tea leaves as they say right uh what what are what what are you expecting so um i'll start with jerry um well so i um well niraj you know i just talked to a reporter a little bit ago about what does a gensler scc mean for crypto um and the answer i give to that is you know so gary gensler was nominated to be sec chair and gary is somebody who um is very very um expert in cryptocurrency right he was teaching about um cryptocurrency at mit most recently um and i you know i think that's positive because um you've got a regulator who uh understands the technology and so much of i think what we face and i'm sure you guys in private practice phase two is when you go in to talk to regulators you spend most of your time explaining the technology and uh disabusing them of of uh mistaken ideas etc so having somebody who um gets it in an expert way and is a fan of the technology is great on the flip side i think some will say is yeah but gary gensler is also a pretty uh activist progressive um when it comes to you know investor protection consumer protection um so isn't that bad for crypto um and he's so expert he's gonna know where all the bodies are buried and you know my view of that is well no um uh i think that just gets you to have the conversations that you have to have sooner rather than later right because you're gonna have those conversations and with gary at least you're gonna be able to have them uh right away um so i honestly don't you know if i i'd love to know what jai thinks or sorry zai thinks about this um but i don't expect the secs policy or you know sort of guidance toward what's inside and outside the line is going to change much under gensler i think what you might see with him is um different emphases of who um is targeted when and what you know and why for enforcement and things like that nah these guys are going to fight yesterday's war just like they did last time they're going to be three years behind the curve it's very clear where congress is looking to regulate which is at the moment it's facebook twitter and all those guys so i think i don't expect anything at least for two years um on on the regulatory front you know they'll these people are still like what's what is this bitcoin of which you speak um is still going to be the mood um in the white house because these you know they're just these people were last in power when 2016-15 so you know they're they're not going to move very quickly i don't think yeah so the agenda is a little full oh sorry go ahead i had to disagree actually um gary's been eyeball deep in crypto at mit um he knows the stuff um i think that i agree with jerry i don't think he's gonna necessarily try to move the line on what's a security and what's not a security i mean he testified what was it now 2019 or so in front of congress about um his views about basically how everything's a security i don't i don't really think he thinks that anymore um but i but i do think that's going to be really different you know just talking about this about the sec in particular is that um his bent is regulatory right um to be honest jay clayton just said not in my backyard like i don't want any crypto activities happening in any entity that's regulated by the sec i don't think that's appropriate i don't want retail investors in this which is ridiculous because crypto is inherently a retail product um but i think um you know a 2b chairman gensler is going to take a very different view on that i think if he does anything quickly-ish and precedent take your point quickly in washington is different than quickly anywhere else it's going to be to bring into the fold crypto into the scope of activities that regulated entities can do whether that's broker dealers exchanges investment funds um for otherwise that's my prediction that's all positive yeah that's creating a safe space for everybody yeah i do think that one one additional factor is that stable coins and you know preston you mentioned big tech companies facebook you know uh made a big splash by creating the libra association which has been since renamed and that has elevated the crypto conversation in washington because politicians see facebook and they see crypto together now and it's no longer this weird cypherpunk uh looming threat far in the distance like bitcoin that they don't understand maybe it's something much more immediate that they can have a hearing about and you know grill mark zuckerberg on so i think the stable coin aspect has accelerated the regulatory timeline to a certain extent and we'll see how that if that's for better or for worse yeah it seems like uh for example the mastercard news from yesterday i think time time is moving real fast this week uh really highlights that um another question i get fairly often is about proof-of-stake uh just it's a big thing in the ethereum world uh kind of all eyes are on that so how does that if at all change the the regulatory outlook for it right does it change for example coin center believes that i know that uh that miners aren't transmitting money that type of thing like what changes here so my perspective it doesn't change anything i presented in front of the cftc's technical advisory committee about the difference between proof of work and proof of stake as consensus mechanisms you just need to treat proof of stake as if it's proof of work minors and instead of making a proof by hashing something they're simply proving with cryptographic keys that they control x amount of funds that are bonded or subject to slashing or any number of other possible combinations it shouldn't change the regulatory status of the blockchain verifier whether the proof is done using a bunch of computers or a bunch of ether i think from from a first principle standpoint though there is a difference so if you were to restart ethereum from scratch tomorrow and you were going to start as a proof of stake coin i think that is something where the initial distribution and then the subsequent consequences of that distribution that looks a lot like a security right so that when in that context i think proof of stake still has some regulatory weakness that a proof-of-work system might not and i don't have a dog in this fight you know i'm not a big you know bitcoin hodler who wants ethereum to go away or anything um but i just don't think that what they're i'm in this instance you know it was clear that ethereum the crowd sale was a securities offering it's clear that they just decided it was so early they're like we're going to let it slide and i think if you were going to do it again um you know the regulatory treatment would be different but now that the genie is out of the bottle i don't think anyone proposes to put it back in how would i mean i'm sorry not to ask a question but i'm curious what uh you guys think about this uh if adopted how would hester purse's commissioner purse's uh proposal for a safe harbor affect that calculus right because you're right person it's kind of a chicken and egg problem um staking is uh some would argue a better consensus mechanism certainly perhaps and more environmentally friendly et cetera et cetera you want to foster that kind of innovation but if there's chicken and egg problem with how do you do the distribution without running a file of the law as a regulator somebody like i don't know chairman genzler who wants to allow retail folks to engage in a safe way you would want to have something like a safe harbor that would give space for projects to be able to have a distribution does it does that make sense i mean yes but if you wanted to do that you're basically dispensing with the definition of an investment contract that we've used for 75 years um because what you're saying is people can distribute critters and those critters are going to be held for speculative purposes uh and they look a lot like shares and a lot like you know securities but you're allowed to just you're not dispensing you're um it's forbearance right forbearance is a very important tool that regulators have so maybe i could propose a way to thread this needle right because in my own view safe harbor doesn't really make sense here right because i think preston you're exactly right that that's a safe harbor from what from the definition of security like that's not how the sec usually views things right on the other hand um and one of my partners wrote an article about this that's really good the other reality is once something's a security um that doesn't have to mean that the full weight of the securities laws like crushes the thing right instead you could come up with a middle road that provides for um a way to address the consumer protection and disclosure and other kinds of concerns the sdc might have with the product like that but still let it be distributed to the world gain decentralization um and get into the hands of people who want to use it without crushing it beforehand and that to me seems like a sensible regulatory path i think the safe harbor idea probably isn't the way but that there must be another way i think the other thing to consider there may there may be what i like to call an alien proof of work out there which isn't as you know there is a discussion around bitcoin's proof of work as being environmentally damaging i'm not taking a position in that discussion but that one of the stated benefits of proof of stake is that it allows people to participate without having that high amount of capital expenditure where you have to go set up you know mining equipment whatever you can participate in consensus by buying a set quantity of coins there are other you know proposals out there to have different types of work being performed in particular proofs of space and proofs of time or vdfs which are being developed in the ethereum ecosystem and periph on the periphery of the ethereum ecosystem which might allow people with ordinary hardware to you know obtain coins and allow these systems to distribute coins without necessarily needing to distribute them from a central source uh in the genesis block so that's a that's a different development and i think that would have different regulatory consequences the engineers will save us yeah essentially that's great love it um so jumping back to d5 because i just thought of this as a question um so i'm just like the the concept of decentralized exchange is big time on everyone's mind right everyone's using you to swap and whatever but getting all these crazy coins um so we're often asked uh how is this regulated right peter you wrote an op-ed that was very well received about that uh do you want to just summarize like the the there's no such thing as a decentralized exchange idea yeah i mean in brief the the provocative title there's no such thing as a decentralized exchange boiled down to look if it's actually decentralized it's not a noun it's not like a thing like um i'm not going to name any of the particularly popular decentralized exchanges but you know you know what they are if it's really decentralized it's a verb i decentral i had a decentralized exchange with jerry which sounds kind of you know fun um and so there's varying levels of centralization in the space and the question is always are the people who are performing those centralized um activities whether it's maintaining a front-end website whether it's writing the code itself instantiating on the on the blockchain or benefiting somehow or transferring a governance token that relates to the changing the parameters of the decentralized exchange are any of those activities subject to regulation um the the remaining centralized choke points and then you know the the article just goes through three topics that are relevant to answering that question one are these people potentially regulated for anti-money laundering purposes by fincen you know they need to find some way to know their customers in whatever it is they're doing because we've got people changing money here the short answer is usually not vincennes been very clear that if there is no person holding custody uh of crypto for other people then they are not a money transmitter they don't need to do the full bank secrecy act compliance which is all the aml and everything like that the next question is securities law much harder the next question is security is a much harder question and then the third topic is the first amendment and the constitution like if all you're doing is writing software are you protected from regulation so that's the that's the short version of the piece i'm looking at you i feel like you may have a take on that no i mean peter basically got it covered that's that's uh basically anything i'd say this is a great day for me i'm i'm mellowing with old age what can i say yeah we've got maybe a minute left so is there any i guess besides call your lawyer is there any uh final points that you want to make to the ethereans that are listening i mean it's kind of i think we've all kind of touched on it if um if you're building something don't think i mean we want to get to a world where we can build systems that are completely decentralized and as a result they are not subject to regulation right so there's you don't have to worry about it um but you need to think very carefully about what you're building to make sure that that is what you're doing and you might want to talk to a lawyer to make sure that you know how you're doing it really is going to be is going to put you in a place where you're building something that is not subject to regulation yeah and i guess the only other thing i'd add is don't don't hang bait out there either this is what niraj was referencing when when when i spoke at devcon in 2016 i think it was i was like stop using the term ico not because you're trying to hide from the sec but just because you shouldn't be taunting the sec by using a term that comes straight from ipo which is exactly what they regulate and in this case like don't think that it's really cool to build a project where people are going to trade tokenized gamestop you know synthetic tokenized game stock like that is obviously a regulated activity and if you're out there pumping that your tool as a way to trade securities illicitly it's not a good thing it's not going to be good for you honestly that's a question i get a lot is that is that legal i don't i don't know nothing is i mean if you're facilitating you know buyers and sellers coming together uh to trade securities you're supposed to be registered as a national securities exchange and alternative trading system wow what a debate this has been fantastic and i feel like we covered more in about what 30 minutes than most legal conferences do in a month so thanks everybody for this wide-ranging discussion i think uh everyone learned a lot and you probably have a lot of very scared people at the other end of the computer thanks for that