This pod was so good I re-listened and took some notes. Good follow on to the Brian Brooks / a16z crypto school lecture which was higher-level and from couple of years ago. Interesting to see that since then
- Not much progress at all on defining securities / having an overarching framework – it’s still regulation through enforcement
- We now have the opposite of the ICO model: projects sell in private rounds to accredited investors and then progressively go more public
- To avoid their tokens being classed as securities have some teams who have very thin explicit value on their governance tokens – eg Uniswap and dydx, and the company earns the fees
- Background: commercial attorney on buy-side mergers deals for big tech firms (Fb, eBay)
- Did the Fb – Whatsapp deal, got exposed to a lot of issues around encryption, that’s how we got interested in crypto
- War stories from VC days. Exposing weaknesses in early legal setups of startups who went through this stuff too fast (eg being able to force a company to do an asset deal – buying the assets rather than shares)
Trad vs crypto deals
- Last cycle crypto was exact opposite of what you’d do in traditional finance, as was starting with the public offering (ICO)
- Now crypto is back to raising from angels/VCs on private basis (comply with securities law as selling to accredited investors) then going more public over time
- Often these rounds are combined equity & token. Interesting difference: fiduciary duty is to maximise equity value, not token value. Unclear what duties are to token holders. Lots of conflicts of interest, under-discussed. This stuff hasn’t been litigated yet.
US Regulatory turf war
- There’s a turf war going on on this subject. Scrambling to be seen as being tough on crypto.
- Best way to get some of this regulatory power is to start a ton of enforcement actions/investigations. “SEC is carpet-bombing the industry” currently
- Right now even if you acknowledge that something is a security, or an AMM is a securities exchange, you can’t go to the SEC and do the proper registrations, the framework isn’t there yet. For example FINRA wouldn’t accept a “broker dealer” which has both securities and non-securities
- Blockstack tried to go through a “regulation A+” path, then had to close that service as was too onerous to comply
- EOS went other path, raised a ton and then only got slap on the wrist fine
- There will be a lot of litigation and selective enforcement
- Please focus on creating a workable framework
- Hester Pearce (SEC commissionner) proposed a safe harbour. Give projects 3 years to sufficiently decentralise. Do key reporting: market manipulation. Securities fraud enforcement remains
- Right now there’s a catch 22: if you’re sufficiently decentralised you don’t have to comply to securities law as there isn’t one actor who would be responsible for doing so. But to get sufficiently decentralised you need enough liquidity and to have liquidity you need to be a security (so anyone can buy your token)
- Focus on problems: whale abuse, insider abuse. Like public companies, should have special reporting just for these (eg Musk sells stock, has to disclose)
- But all the other reporting on the operations of the projects we care much less about. Do we care how much Uniswap Labs spends on engineers?
- As a16z say in their proposed web3 policy goals: “Disclosure-based regulation was resoundingly successful in developing efficient, safe capital markets over the course of the 20th century. However, traditional forms of disclosure are not well suited to web3 platforms and protocols, which historically have been highly transparent, open source, and auditable. New disclosure standards should take advantage of the benefits of the technology and should focus on consumer understanding rather than strict technical adherence to legacy rules.”
Enforcing DeFi projects
- Will be going after the software teams, and a little after the VCs
- Paradoxical because software devs don’t own or run any of the critical code (smart contract) – but they wrote it, and own brands, run frontends
- More decentralised projects like Sushi, individuals more at risk as might not have LLC shielding them. Will increasingly go anon
- Last similar enforcements – Napster, MegaUpload – actually a bunch of builders in DeFi are too young to remember these
What regulators care about
- Some politicians seeing the opportunity to cater to crypto demographic – young, affluant
- Remember the biggest frauds of all time – Enron, Madoff – were SEC-reporting companies
- “A conspiracy without conspirators” – just how the system is, lots of complex machinery
- US-backed stablecoins could be seen as an extension of US hegemony on financial system – but regulators don’t seem to be seeing it like that
- USDC and USDT so huge as centralised. UST (on Terra) more decentralised – if can scale would be great as much harder to regulate/shut down
Optimal structure for a token company
- If you want to prioritise least likelihood of token being a security define very thinly what the token does. Try to exclude US citizens. All revenue flowing to a company. Uniswap, dydx.
- Thinks this is the most unethical. As surely some people will think that value accrues to the token, which provides exit liquidity to the team (and no disclosures on their sales!)
- Opposite direction: all the value goes to the protocol/token holders. There is no equity in the co. Sushi.