Deep Dive Episode 224 – Regulating the New Crypto Ecosystem: Necessary Regulation or Crippling Future Innovation?

Cryptocurrency. Decentralized finance. Nonfungible tokens. Once only experts on the cutting edge of financial services were familiar with these terms. Now, with the emergence of digital assets within the global financial system, crypto, DeFi, and NFTs are becoming part of the mainstream financial services lexicon.

The rapidly emerging crypto ecosystem faces uncertainty within a regulatory regime designed for very different institutions and securities. In response, on March 9, 2022, President Biden issued an executive order, “Ensuring Responsible Development of Digital Assets,” which ordered agencies to submit policy recommendations based upon multiple principles such as: providing consumer protection, ensuring U.S. financial system stability, mitigating systemic financial risk, responsibly developing digital assets, and examining the creation of a U.S. Central Bank Digital Currency (CBDC). Supporters of increased financial regulation over cryptocurrency see this as a necessity to provide security essential to ensuring financial stability and consumer protection within the digital asset space. Others view these federal regulatory efforts as a threat to future opportunities for economic innovation.

At a live Regulatory Transparency Project event, following remarks from SEC Commissioner Hester M. Peirce, an expert panel including Jerry Brito, Ryan Selkis, Todd Phillips, and moderator J.W. Verret discussed current and future efforts at regulation of cryptocurrency and its implications for innovation, financial stability, and consumer protection.

Transcript

Although this transcript is largely accurate, in some cases it could be incomplete or inaccurate due to inaudible passages or transcription errors.

[Music and Narration]

 

Introduction:  Welcome to the Regulatory Transparency Project’s Fourth Branch podcast series. All expressions of opinion are those of the speaker.

 

On June 14, 2022, The Federalist Society’s Regulatory Transparency Project hosted an in-person event featuring a panel discussion on regulating the new crypto ecosystem, “Necessary Regulation, or Crippling Future Innovation?” The following is the audio from the panel discussion. Please enjoy.

 

Prof. J.W. Verret:  Well, we’re joined by a terrific panel today. The plan was pretty simple on my part. Just find the smartest people you follow on Twitter on crypto, and bring them all in a room, and just kind of do a response panel to Commissioner Peirce’s speech. And so we’re going to go through, give each of our panelists five minutes to offer some introductory remarks, then we’re going to do another round of some back-and-forth. And then, my hope is, a significant amount of time for audience Q&A. So be thinking of some good questions. We’ve already had some great questions tonight — this afternoon. 

 

So, first, introductions. So, to my right is Ryan Selkis. You can follow him on crypto as TwoBitIdiot, although, to the contrary, very insightful, thoughtful, and his writings have been a big part of my crypto journey. His annual report is kind of the thing to follow on crypto. And he leads a firm called Messari, often described as the Bloomberg of crypto. He might agree that maybe Bloomberg is the Messari of traditional finance, right Ryan? 

 

Todd Phillips, to my left. Todd is the Director of Capital Markets and Corporate Governance at the Center for American Progress, also a great follow on Twitter, and a fun debating partner, discussion partner. I always learn a lot from Todd. Todd has a new report out with the Center for American Progress, on cryptocurrency regulation across securities, commodities and banking, has a lot of provocative thoughts in there. Some things I want to debate with him further. But a report that I’ve learned a lot from, and I highly recommend to everyone. 

 

Jerry Brito joins us. Jerry needs no introduction because he’s been at every crypto event FedSoc has had over the last ten years. But Jerry leads the Coin Center, the leading think tank in cryptocurrency regulatory issues. And not just — think tank is an incomplete description, because Coin Center does a lot of things, and, in fact, just announced a new lawsuit against the Treasury Department over a new crypto-related reporting rule that was passed last year.

 

So we’ve got a terrific panel. And let me turn it over. Let’s do a round each. Let’s try to keep intros to five minutes. Ryan, go ahead.

 

Ryan Selkis:  All right. So I’m going to go first. 

 

Prof. J.W. Verret:  You’re going to go first.

 

Ryan Selkis:  That was a little bit out of order. So, we’re going to start with the spiciest take, as my Twitter handle might imply. So, I’m the only non-lawyer on this panel, which might relieve some of you. But I’m out of my depths, in certain respects. I am an analyst, a longtime investor, and, as J.W. mentioned, an entrepreneur. I’ve started a couple of different companies within the crypto-sphere — actually, intimately familiar with one of the ones that is immediately impacted by Hester’s remarks, Grayscale. Back when I was at Digital Currency Group, I worked on launching some of those products. 

 

More recently, my company, Messari, is a data analytics platform that some people call the Bloomberg of crypto, but we actually started with a little bit of a different mandate and called ourselves more of an EDGAR-like repository, where we actually work on data standardization structures, disclosures, equivalents. We actually work with 30 of these open protocols on behalf of their communities to put together the equivalent of bottoms-up quarterly reporting for these assets. 

 

So, I would argue that there’s probably no one in this room — arguably, in the industry — that’s done more in whistleblowing and transparency efforts than I have. I broke into the industry whistleblowing the Mt. Gox bankruptcy. I was, I think, a few years ahead, respectfully, of the SEC on Ripple, in terms of talking about the overstatements that they had with their market cap and some of the shenanigans that they had with insider transactions and obfuscating some of their marketing materials, versus what the reality was, as they were distributing these tokens. And I work on this with my team full time, trying to solve some of these information problems.

 

I want to try to keep my remarks relevant to Commissioner Peirce’s comments, though. And I want to leave everybody with one number, as they walk away from the session today. And that’s six billion dollars. That is the amount of investor capital that is currently locked and underwater because of the SEC’s policies towards exchange-traded products. And, in particular, the allowance for Rule 144 quasi-ETFs, like Grayscale’s, that trade at a persistent, up to 30 percent discount now, versus what their underlying asset value is.

 

Not only that, but, you have five to ten percent costs for the futures-based exchange-traded products. So you’ve got inferior vehicles that are public, that could be corrected with minimal effort on the part of the SEC, if these spot ETFs would be seriously considered and allowed. It would create minimal friction for the investors. And, in fact, you could close the $6 billion gap overnight, because the custodian of the largest quasi-ETF, Grayscale, is Coinbase. So, for a retail investor or professional investor to actually redeem their shares, if they were just allowed, it would take about one click at the moment that these products were actually approved. 

 

So, if we’re looking at the SEC’s mandate to protect investors, promote fair and efficient markets, and, ultimately, promote capital formation, the fact that this has not yet been approved, I think is disappointing, to say the least. And I promised that I would behave myself. So I have stronger words on that, for sure. But this is the one thing that I think if we could fix as an industry, it would be for the benefit, not only for the folks that are in the industry full-time, but, most importantly, for the investors that are underwater, to the tune, again, of $6 billion. 

 

Prof. J.W. Verret:  All right, Todd, go ahead.

 

Todd Phillips:  Well, thank you J.W., for inviting me to come here. I just want to start off by saying that comments here are my own and not representative of my organization. I hate to do this, but I have no thoughts on the spot Bitcoin ETF

 

Ryan Selkis:  That’s fair.

 

Todd Phillips:  So, I don’t know if we’ll have a lively debate about that, because I just — I don’t know. I did want to talk about disclosures really quickly. So, in 1946, the Supreme Court decided SEC v. Howey. It provided what I think is a great test for determining whether investment contracts were securities and subject to the securities laws. The Howey test explained that an agreement will be considered an investment contract if there’s an investment and a common enterprise with a reasonable expectation of profit to be derived from the entrepreneurial or managerial efforts of others. We can talk about that definition.

 

This four-part test, I think, appropriately includes, within the scope of the securities laws, those financial instruments for which investors would benefit from the disclosures of the securities laws, and excludes those for which investors would not benefit. So if you’re investing money and relying on product developers or promoters to create profit, you need information about how those investments will be used, in order to decide whether or not you do want to invest capital in that project. 

 

The ’33 Act governs a security’s initial sale, and requires an issuer to file a registration statement detailing its senior officers, how will it use the proceeds, records of its prior profits and losses, etc. The ’34 Act governs the secondary market. It requires securities issuers to periodically update investors on their activities, so that, in addition to prohibiting insider trading and market manipulation, securities may be bought and sold in a fair and competitive marketplace.

 

So how does this apply to crypto? Back in about 2017, there used to be a lot of ICOs, in which an issuer would sell crypto tokens to the public to fund the development of their applications or protocols. The SEC said that these are clearly securities. I think everyone can agree with that. But, today, the industry has become a lot more nuanced. VC firms invest in protocol developers by taking a stake in them. Those developers develop crypto protocols, and the protocols will then airdrop or otherwise distribute tokens to users of other protocols, and just airdrop into wallets, trying to get them to switch.

 

Holders of these airdrop tokens can have voting rights, the right to receive profits from the protocols, and have the right to sell and otherwise trade these airdrop tokens. So, are these tokens securities? I would say yes. I know that there’s a lot of disagreement about that. The reason I would say yes is because there are plenty of lower-court cases explaining that the Howey test applies to situations where gift recipients sell their securities and make a market. That’s SEC v. Sierra Brokerage Where investors expect a profit, either from the issuer or from selling into the secondary market — that’s Gary Plastic — and where investors may be required to perform some duties, Lino v. City Investing.. 

 

But, perhaps more importantly, the goals of the securities laws would be served, as applied to the people who are airdrop tokens, or who buy the tokens in the secondary market. So even putting aside the Howey test, just the people who receive these and sell these need the information that would come from a ’33 Act filing and a ’34 Act filing. The people who are airdrop tokens need information to help them figure out the price for which they can sell those tokens, and the people who might buy them need information about whether they can buy them and resell them again for a profit. They need this information.

 

Who should be the entity that drafts these disclosures? I think that’s the $64,000 question. I’m not sure I have an answer. Many crypto projects are open source. Anyone can suggest edits to an application’s code. Usually, there is one entity that writes most of the new commits and holds the most governance tokens. Maybe this person could be the one who issues the securities disclosures. I don’t know. But, regardless, we shouldn’t lose sight of the fact that when people buy these tokens, they’re investing in a profit-making activity, and they need disclosures. If these disclosures can’t be offered, then perhaps the tokens shouldn’t trade.

 

In conclusion, we need to find a way to ensure that the people who are buying these tokens get information, whether that’s through the securities filings, whether that’s through Congress enacting a new statute, or something else.

 

Prof. J.W. Verret:  Thank you, Todd. Jerry?

 

Jerry Brito:  Well, thank you, J.W., for inviting me here. And thanks to all of you for coming. I’m really thrilled to be here. So, look, just by way of remarks, I think, what I can say is maybe give you a little bit of perspective about sort of the view that Coin Center brings to these questions and these debates in the crypto space. And J.W.’s right. We are a think tank, in the sense that we do plain English, “just the facts,” education. 

 

If a policymaker wants to understand, mechanically, how does Bitcoin work, we can explain that. And we do policy thinking where we identify gaps where the technology has maybe outpaced the law. There’s a gap, and policymakers are going to want to fill that gap. And so we make — we publish policy papers that identify alternative ways to fill those gaps and make recommendations.

 

But at the root of what we do is really a civil liberties mission. What we exist to do is to make sure that the right to write code and to publish code and to read and run that code and to do all of that privately, is maintained. Because, these are, first and foremost, constitutional rights. And, so, when we do our policy thinking, you’ll notice that so much of what we do is make sure that those rights are respected in any law proposal that is put forward on crypto. 

 

And what this brings up is, in the crypto space — let me take a step back. The whole reason for being of crypto is to decentralize many of the activities that, today, or previously, took place through intermediaries, so, a bank, a broker, a payments processor. If you want to expand it to non-financial uses, something like a file-storage server, or a social media network. These things can now be done in such a way where there is no single provider of these services. That’s the whole reason for being of crypto.

 

And in the crypto space, you still have services that are provided by intermediaries, and are going to be properly subject to the exact same regulations that any intermediary previously would have been, and you’re going to have new forms of doing business where there is no more intermediary, where you just have persons engaging with each other in a peer-to-peer fashion. And so that is really where I think the most novel and interesting questions are, and where the answer usually is. There’s no sort of prophylactic regulation that you can do, because these are just people engaging with each other. 

 

So, when it comes to things like ETPs, centralized spot exchange regulation, lending products, it’s appropriate that the SEC and the other similarly situated regulators engage. And I hope that they do so in a thoughtful way, engaging with the industry, but totally appropriate. But then you have areas where there’s activity where there is no intermediary. There is nobody doing anything except publishing code, reading code, writing code, etc. 

 

And when you get to those spots, really, there probably isn’t any place for licensing or prohibitions, or any kind of prior restraint on those activities. Now, there are always going to be laws that allow for policing of fraud, and the like. You have the FTC, you have other kinds of state attorneys general have authorities that allow them to police for fraud. But it really shouldn’t be any sort of prior restraint. And so that’s what we focus on. So I’ll stop there.

 

Prof. J.W. Verret:  Okay. And I’ll say, to Jerry’s point, I can think of crypto projects I’m not proud of, maybe even some I’m invested in that I’m not proud of. But I can also think of some that I’m incredibly proud of. And one example is arweave, which has a token, it’s a decentralized data storage product, and it was used by the opposition in the Hong Kong protests to store their newsletter, their freedom, opposition newsletter, when the CCP censored them. So, very, very — there are real stakes in this that are non-financial, that are important.

 

So, I’ll go through and ask each panelist a quick question, just for discussion. Feel free to ignore my question if you have something else you want to respond to. This is just to kind of get us going. So, Ryan — so Messari, you’ve done, and before that, you’ve kind of served the role of —as a journalist, as an analyst — information intermediary. The SEC has kind of a love-hate relationship with intermediaries, think credit-rating agencies, think underwriters, investment analysts. 

 

So, on the one hand, current — we’ve heard from regulators, “Just comply. The law is clear.” As I try to think that through, past the speeches from Chairman Gensler, how would a crypto project comply with Reg — S-K and Reg S-X.? And how would it help us at all? At some point, a few years ago, he kind of intimated maybe Ethereum is a security, or sales of it is a security. If the Ethereum Foundation filed, what would that filing look like? Like, the Ethereum Foundation owns some Ethereum tokens. But you wouldn’t really learn a lot about the Ethereum network from that filing if you think through the accounting under the assumption.

 

So what do those disclosures look like? What should they look like? What do we need to know about “tokenomics”? How is going on Messari better than going on EDGAR, in that kind of new world? Paint a picture for us.

 

Ryan Selkis:  Well, I appreciate that leading question. When we started the company, it was with a mindset that regulators were going to come knocking on basically every project that pursued an initial coin offering in 2017, and most of them were pre-utility, pre-network. They were clearly fundraising mechanisms. And there was going to be the need for tracking the progress of those projects, and whether they were delivering against their roadmaps or stated missions, and, then, how, then, tokens were going to get distributed over time, how they’d be used.

 

Our thesis from day one was that when these networks are in use, regulation of the tokens themselves as securities would very often break the underlying functionality of the network. So, if the Hong Kong protestors had to file a Form 4 every time that they wanted to store a newsletter, or had to go through a transfer agent, there’s some ridiculous constructs that clearly break down when you talk about this new technology. 

 

So we thought about the spirit of existing securities law, and, more importantly, of existing consumer protection standards. What we’ve done since is try to go almost section-by-section for a quarterly filing. And I think Commissioner Peirce’s safe harbor proposal is pretty cleanly mapped to this. And, in fact, we tried to triangulate some of our offerings so that it was very much in line.

 

If you look at the work that one of our research teams does internally, it’s almost like getting the business description and risk factors for these protocols, but in an open-source way, because most of these communications happen in Telegram and Discord and on Twitter and Medium, and kind of other public forums. GitHub is a repository for a lot of this information. The blockchains themselves can be parsed. 

 

You need a little bit of technical aptitude to be able to get this data and get these KPIs, but if you have the right teams in place, that are properly motivated to put this information together, we, as an industry, can basically come up with the equivalent of generally accepted accounting principles, but specific for this new technology. And, in fact, we do that as well, and we’re working with dozens of teams on this type of construct.

 

Same thing with governance activities and the equivalent of corporate actions. These are alerts that you can find, that you can categorize, and that you can standardize, mostly in an open environment in an open way, so that people understand what’s going on. Now, the important thing here is are we an intermediary, or are we a contributor to this open-source information industry that we’re trying to operate and be good citizenships of. The truth, of course, is that we’re a little bit of both. 

 

But my thesis from day one with the company, and where we’ve tried to steer the company — because we think it’s in the best interest, not only for our customers, but the entire industry — is the concept of open data paid tools. So a lot of the information that we produce, that I just mentioned, is open and free for investors, for enterprises, for end-users. And it’s one of the top areas that people have come to rely on us for, over the course of the last few years.

 

Obviously, some of the tools that we have — the alerting infrastructure, our data API — that’s more like a traditional data company. But I think the industry will be healthier if more companies and regulators, hopefully, can rally around this as a standard, because the thing that Commissioner Peirce got right, especially with the safe harbor, is at time zero, any time that there’s even the kernel of an idea in someone’s head, it’s going to be centralized, because it has to start somewhere. 

 

Over time, it would become decentralized, and what I think the safe harbor does, is it gives us a little bit of a time period to actually get this right and allow innovators and the folks that Jerry’s trying to protect at Coin Center the time to kind of do the right thing, in accordance with the spirit of existing regulations and laws, but also account for the fact that this is a new technology, and these truly are decentralized systems that might not necessarily, at scale, have a centralized disclosure. 

 

Prof. J.W. Verret:  Good. So, Todd, I want to talk about a couple of things, two thoughts that you spurred for me. One — feel free to ignore the first one, because it might just be kind of securities lawyers nerding out, and the more generalized audience might not be as interested. But this is FedSoc, they’ve got a lot of legal audience. So, the question, I’m fascinated by the question of are airdrops securities, because this is really at the heart of the Howie test application to where we are now. A lot of projects launch in this way, rather than the old ICO method that was a lot closer to Howey. Case law — very sparse. 

 

And the only case law we have that I found in the treatises — and I found a few treatises where old securities law professors say, “Oh, sure, airdrops are securities, because, look, spinoffs were securities 20 years ago. So that’s fine.” Not enough for me. I’m not convinced, because, in part, that old case law is about spinoffs of subsidiaries in which the parent company held stock. So we’ve already decided it’s stock, even before anything happens. And the question is whether distributing that stock is a sale of securities. Courts have decided it’s a sale. But we’re in a different place with airdrops, because we don’t even know whether it’s a security yet. 

 

And I think airdrops have gotten better than they used to be. They used to be a few settlements, with SEC involved — someone who, yeah, gets an airdrop in exchange for doing some very specific things. So it seems like they’re kind of being paid to do it. Now, the airdrops are after the fact. The airdropper, so to speak, takes a snapshot of the blockchain, and looks at things, activities, that seem to be people involved in the chain or in related chains that might be interested in our chain. But there’s no quid pro quo, so it’s a much closer case. I don’t know if you want to debate that a little bit with me. Are airdrops securities? We’ve only got a couple of settlements, at this point. Not much.

 

And the second question, I think we have a lot more common ground than either of us like to admit when we get in our Twitter debates. 

 

Todd Phillips:  I think that’s right. 

 

Prof. J.W. Verret:  One of the interesting things about Commissioner Peirce’s safe harbor is it’s called a safe harbor, but to get into the safe harbor, you’ve got to do a lot of stuff. There’s a laundry list of stuff you have to disclose, a lot of stuff. And the Reg X proposal that’s kind of a fork of her safe harbor, that I’m really proud she mentioned, really great work by the folks at the LeXpunK Army — what a great name, right?

 

Their safe harbor has even more requirements to get in. Like, if you’re a whale, crypto whale looking to dump, you hate the Reg X proposal, because it’s not in your favor. It doesn’t help you at all. It’s a very long-term vision. And an ecosystem supportive vision to comply with that Reg X idea. 

 

The SEC has done exemptive relief in the past when pension funds start voting a lot and talking to each other. It was a big problem here. We’re all deemed to be soliciting proxies, just by talking to each other’s pension funds. SEC comes along and says, “Okay, we understand it. We’ll do a lot of exemptions for pension funds to help them talk to each other about proxy votes.” Internet comes along, it took the SEC a while to say, “Okay, fine, you can distribute proxies, via this new email thing.” 

 

It took them a while, like well after email was a thing that we were all doing they eventually came along. “Okay, fine, CEOs, you can say something about your company on Twitter, and we won’t call it a Reg F-D violation.” It was like 2010 before they did that. It took a while. But they came around. I think we all know they’re going to have to come around on some kind of crypto-specific guidance, and even something we might call an exemptive action. Uh-oh. But an exemptive action that has a laundry list. Meet me in the middle here. How do we get there?

 

Todd Phillips:  So I agree with you that I think exemptive relief is going to be necessary to get to a place where people are willing to register these tokens, and that they’re going to be able to trade on securities exchanges or crypto non-securities exchanges or something. I am sure that exemptive relief is going to have to be a part of that. I am sure the SEC is going to have to come out with guidance about what it thinks of the Howey test, and where it imagines the bounds of its authority. And I think the SEC needs to come with this and say, “This is our understanding. This is the bounds of where our enforcement actions are going to go. And if you don’t like it you can sue us, and we’ll have a court figure it out.” I think that’s what everyone here is looking for — for, really, some good — a good answer of what is a security and what is not.

 

I’ve also heard folks say that they would like the SEC to write a rule about how it interprets the Howey test. Because the Howey test is a Supreme Court-made rule, I don’t know if the SEC can change that through rulemaking. But that is something that I’m sure people much smarter than me can figure out. 

 

As for our airdrop securities, I think that they are, and I think that they should be considered a security. We need the securities law disclosures. If investors want to buy and sell these things, they need securities laws disclosures. And I think that, even if an airdrop doesn’t meet the exact investment contract definition, which is what the Howey test was about, it’s entirely possible that we could call these things shares in the protocol. My understanding is the Supreme Court has not — there is still some room for the courts or the SEC to decide this is what a share is, this is what a share isn’t. And it’s entirely possible that they could get there.

 

I don’t know what the SEC is going to do, but the Commissioner is shaking her head no, but I’ll just reiterate. I think that the disclosures are necessary. And either that comes from the securities laws or that comes from a new statute, that comes from the new commodities laws that Congress creates. The end thing I want to get across is just that investors need this information.

 

Prof. J.W. Verret:  Just one point — I think we agree on that point. What I’m asking is, would you be okay if we worked on it together, if the disclosures come as part of the exemption? The laundry list of disclosures required, because that’s what the Commissioner is proposing with Reg X — can we do disclosure via, you know? Because a lot of SEC exemptions have — they don’t seem like exemption really, when you read them, because they’ve got a long list of stuff you’ve got to do. Would you be okay with that approach, at least open to talking about it?

 

Todd Phillips:  I would definitely be open to talking about it. 

 

Prof. J.W. Verret:  Okay, good. Jerry.

 

Jerry Brito:  If there’s one thing that I could add to that, because we’ve looked at this for five years as a company, as a model, it is extremely difficult to get any protocol to be open-minded about making disclosures on behalf of an entire community, if you’re, like, a foundation, for instance. Because there are strong disincentives to make yourself look as if you are a centralized party capable of making these disclosures. And it’s a little bit of a reflexive argument. 

 

But this is important, because the biggest opportunity to regulate some of these players, and one of the biggest information gaps right now in the market is who holds the tokens, because who holds the tokens, ultimately, is what’s going to drive whether there’s significant selling pressure in a market environment like we’ve seen today, or if there’s major governance decisions. Who’s actually going to hold the voting power to push through protocol changes in some of these decentralized systems?

 

That’s something that we could do today. You could go to the regulated funds that are above a certain threshold. You could go to the exchanges that already work well with all these regulators, and you could understand where are the thresholds of ownership, who actually owns material stake in these markets, and regulate the edges, instead of trying to pigeonhole one or two entities that might be at the periphery at some point, based on the evolution of a protocol, and then making it a disclosure on behalf of an entire global ecosystem.

 

Prof. J.W. Verret:  Does that work, though, at the initial stage, the initial —

 

Jerry Brito:  That’s something I think the safe harbor would absolutely help, in that interim stage. And so you could apply for some exemptive relief, a safe harbor, during the process of decentralization. But we’ve also got a problem where we’ve got thousands of assets that are already out the door right now, that are going to have to be coming into compliance, and there’s going to be some remediation in place. 

 

One of the best ways to do that, and start to chip away at some of these information asymmetries, would be to look at the largest investors that are above the $150 million threshold, for instance, and the exchanges that are already regulated, because those are the central chokepoints as custodians of these funds. 

 

Prof. J.W. Verret:  There’s just no way around it, one of the problems we’ll always have is kind of large investor disclosure, will disclosure. If they’re dividing across multiple wallets, anonymity is the twist we don’t have in regular securities disclosures.

 

Ryan Selkis:  Well, you can do it as a regulator, right? It’s easy for a fund or an exchange to obfuscate that from public view, and, in fact, it’s probably going to be the norm. If you’re Fidelity, you don’t want to accidentally disclose that one of your material investors executed a transaction, and then, through blockchain forensics, you were able to track that was a major counterparty, that was a major specific client. 

 

That would be a big no-no. And that’s an argument for some privacy features on blockchains In fact, that suggests that you’re going to need regulation at the edges and at the investor level, or you might never get this information, because you might not be able to procure it or ultimately use even forensics to get this information, since you can pass these wallets through tumblers or all of these other privacy-preserving techniques at scale.

 

Prof. J.W. Verret:  Jerry, you want to jump in?

 

Jerry Brito:  Yeah, I just wanted to say, and I’m sure, when you asked the question, “are airdrops securities?” it’s kind of a shorthand that you’re using. Because an airdrop is just a technical means of distributing a token. 

 

Prof. J.W. Verret:  I guess, specifically, does the airdrop count as sale?

 

Jerry Brito:  Right. And so we just need to be careful that we don’t just say that any application of an airdrop would necessarily need the thing to be a security, because I can imagine writing a smart contract that is not updatable, that does some function, maybe it’s a random number generator. I airdrop the token to a selected population of folks. And then they can use that airdrop to do whatever the function of the smart contract is. And maybe those things start trading for value, because that thing is valuable. I’m not sure what the application would be there.

 

Prof. J.W. Verret:  Yeah, I don’t think that’s a security, but there are some people who argue that just because you anticipate future value by the creation of a secondary market, you are selling securities, even though you are giving them away for free. 

 

Jerry Brito:  Yeah, good luck. The other thing I would say is that I’m not sure — I’d be curious to know what the threshold for guidance would have to be for it to be satisfactory, because we’ve already seen guidance from the SEC. We had staff guidance about how they do Howey analysis when they look at digital assets, and it still leaves — you can still find corner cases within there. Which is why I like something like the safe harbor, because it allows for a period where any ambiguity is kind of put off so that it can be addressed before there’s another hard look that’s taken.

 

Prof. J.W. Verret:  In interpreting its own legal authority, the SEC is always very generous. Always, very, many times generous. I have a question for you, Jerry. So, one of the theoretical constructs behind the Patriot Act — and people don’t think of it this way in the media, but The Federalist Society is a debating society. If you’re not familiar, that’s what we are. And our debates are quite serious. I first came to FedSoc during the Patriot Act days, and those debates between Libertarians and Conservatives were hot. They still are, and they should be. They’re professional, but very impassioned. 

 

So there’s this kind of implicit bargain behind anti-money laundering BSA that’s kind of been bred in by courts that, like, once you use the banking system, you’ve kind of given away privacy, because it’s part of the privilege of third-party custodianship of your assets. So crypto is redefining that bargain. And you’re defending that redefinition of that bargain. Or is it not? Is the bargain new? Is it a post-AML world that we’re moving toward?

 

Jerry Brito:  Well, so a couple things. So, the Bank Secrecy Act, which is what creates our anti-money laundering regime, was challenged on constitutional grounds, because, what it basically does is it requires financial institutions to turn over information about their customers, regardless of whatever contract they have with their customer, and without a warrant. Just on a systematic basis, you have to turn over this information to the government about your customers. And it’s a surveillance requirement. And this was challenged on constitutional grounds right after the BSA was enacted in the ’60s. And the court said that it was constitutional, on very narrow grounds. 

 

And the — what the court said is that there is something called the third-party doctrine, which says that if you voluntarily hand over information to a third party, and that third-party needs that information for a business purpose, so, for example, a bank needs to know who you’re writing a check to, and the amount, in order to do the business, if you’re doing that, on those very narrow grounds, because you’ve voluntarily given up this information that the person you’re giving it up to, the financial institution you’re giving it up to needs for business purpose, you’ve given up your expectation of privacy. And so there’s a third-party doctrine exemption to the traditional Fourth Amendment warrant exemption.

 

Okay, so add crypto to the mix. When you add crypto to the mix, and I’m sending you a Bitcoin transaction from my self-hosted wallet to your self-hosted wallet, we’re not implicating a financial institution at all. And it’s like, as if I hand you a hundred-dollar bill. And when I give you a hundred-dollar bill, there is no BSA requirement that we report that. There’s no financial intermediary that is subject to the BSA there. So I would say that it’s not so much an undermining of the BSA, as it is just sort of orthogonal to the BSA, in large part.

 

Prof. J.W. Verret:  What about, though, so — so far, been a few charges involving money laundering that involve something else. It’s a tack-on to something else. So let’s assume that some of the cases involve somebody who did a bad thing. I don’t know if the charge was appropriate or not, but maybe did kind of a bad thing that was kind of a felony. So, money laundering, basically, is if there’s a predicate act, and you’re trying to conceal the proceeds of the felony. Money-laundering is pretty easy to kind of tack on, right? 

 

So there are people that use technologies in crypto that are innately anonymous by their nature. So we’ve had money laundering charges just because, post-bad thing, you — and it even may have a recent charge, where a pre-bad thing may have used privacy technology. What do you think about that? Most of those cases have settled, and it’s kind of blustering. But what do you think about kind of overcharging in money laundering, as a threat to what you’re talking about?

 

Jerry Brito:  As a threat to what I’m talking about?

 

Prof. J.W. Verret:  As a threat to the post-BSA or non-BSA vision for blockchain transactions.

 

Jerry Brito:  I mean, it sounds to me like you’re asking what I think about money-laundering as a crime, period. Because it doesn’t really matter what technology you employ, in that, in the money-laundering aspect, you’re going to be charged with, it’s a tack-on.

 

Prof. J.W. Verret:  It just feels like it’s expanding beyond the really difficult things you have to do to money-launder cash, versus just using Samouri Wallet on my app, which is a lot easier.

 

Jerry Brito:  Yeah, but if you’re doing the things that would give up — that would meet the elements of a charge of money-laundering, you’re money-laundering, whatever technology you happen to be using. And the question is, should we have money-laundering as a tack-on crime?

 

Prof. J.W. Verret:  Maybe that’s the next FedSoc panel. Let’s get ready for questions. As we get ready for questions to come up, I’ll ask just a question of the panel. So, there’s a DeFi developer, Andre Cronje, who’s been talking recently about a kind of a view of crypto, the crypto regulatory sphere. He was, for a long time, was a DeFi developer, kind of way out there in the unregulated space, and is, more recently, kind of looking to develop in the more regulated space. 

 

Anyway, he kind of describes it as this, that there will be the safe part of crypto, where your grandma can onboard, do a little bit of crypto investing. Then they’ll be stretching out into the increasingly unregulated, more kind of Wild West, badland-sphere of DeFi and such. And that’s an accurate portrayal of how the West was kind of developed, right? And, by the way, I don’t see anybody sauntering toward the mics. You all should be sauntering toward the mics. 

 

What do you all think about that, as a vision for the intermediate term, at least, that there’ll be the unregulated badlands of DeFi, there’ll be the more regulated sphere, as a way this kind of develops, onboarding of retail through regulated products, and tradfi partnerships with crypto, and then evolution of code-based things that are very hard to regulate, even if you try. They’ve got meet-space interfaces, but the actual protocols themselves are just distributed decentralized technology. Is that –let’s stay in the same order. Ryan, what do you think about that, that badlands — the safe, St. Louis, Dallas versus Lonesome Dove kind of Wild West?

 

Ryan Selkis:  I mean, I think that’s more or less right. I think you have to preserve the badlands, just from a civil liberties standpoint. And if you think about the folks that are going to be committing code to the badlands, if it’s strictly peer-to-peer code that anyone can run, if the individual users so choose to run that technology, I think it should be fair game. Now, the reality is not many people are going to use that by default. They’re going to use services. They’re going to use products that abstract away all the technical complexity of these assets. 

 

And so the reality is you’re going to see regulated edges that make the underlying protocols trivial to use. A perfect example is email. Anyone can use SMTP. Most people in this room probably don’t know what SMTP is. They know what Gmail or Outlook is. Those can be the clients that actually deploy this technology and wrap it in a way that is going to be safer and easier for folks to send emails. I think the same is going to be true for DeFi. And I think DeFi, as a result, is ultimately going to transform the backend, not only of most financial services, but of most of our modern tech stack. 

 

That’s what’s so exciting. I think that’s the opportunity ahead. And because that’s the size of the opportunity, I think it’s a little bit crazy for people to expect that everything is going to be the badlands. We’re going to need some regulated edges and some sophisticated standards, whether that’s through legislation or smart rulemaking that help the regulated edges do this in a way that’s thoughtful, but ultimately compliant. And they can be a little bit more proactive about that.

 

Prof. J.W. Verret:  Todd?

 

Todd Phillips:  So, I think that, just with any technology, anything, you are going to end up having some of those badlands. That being said, I think that most of DeFi governance tokens are securities. I think Congress made the explicit intention in the securities laws that we want to protect retail investors by putting in place these disclosure requirements, putting in place the trading, the regulation of exchanges, things like that. 

 

And I think that, to the extent we’re talking about retail, I do think that they need to be protected. In the securities markets, there has been created the public markets, versus the private markets. I think the private markets are far too big. And I think the SEC really should shrink them and make sure that everyone receives the disclosures. But I see that there is a role for private markets, to some extent. I imagine the same thing could happen here with DeFi. I’m not exactly sure where the line is, and I’d have to think about it more.

 

Prof. J.W. Verret:  And it’s a little bit of a Catch-22, isn’t it, that if you tell crypto, “Well just raise money with a Reg D offering,” at the same time some at the Commission are trying to shrink the size of the Reg D offerings with changes to the credit definition, credit investor definition. But I take your point.

 

Todd Phillips:  And I think most people raising money for DeFi should do a traditional securities offering.

 

Prof. J.W. Verret:  Well, Jerry?

 

Jerry Brito:  So, the justification for the regulation that we’re talking about here tends to be that there’s information asymmetry of some kind that we’re trying to cure with these disclosures and other kinds of regulation. So, if we’re, instead, talking about having some other part be true peer-to-peer networks of open-source software, where the connections and everything is completely transparent, and you have smart contracts that are auditable by anybody who can read the code, then you don’t have the information asymmetry problem. 

 

And so, no regulations necessary. And so I wouldn’t call that a badland. I would call that an alternative way that we shouldn’t encourage. And I think Ryan’s right. We’re not going to see that be the place where most of the activity happens immediately. But you can imagine that growing. 

 

Todd Phillips:  Wait, but I disagree. I think there is an information asymmetry. You do have some people who were the ones who created the protocol that’s running. They know the ins and outs of potentially very complex software. And there are other people who have been airdropped a token and they need to figure out what they’re going to do with this. Do they participate in helping govern the protocol, or do they sell it off to a third party? 

 

One of the great things about these securities laws is Congress said, “We want companies, registrants, to file pieces of information providing pretty good information that folks need to have to be able to adequately value these securities. The same kind of thing should happen with DeFi. Of course, you will always have, someone will always have more information than someone else. But we at least need these standardized disclosures that have pretty sufficient information for people to adequately appraise the values of the tokens.

 

Jerry Brito:  So, as I said earlier, whether any particular uses of an airdrop would constitute a securities of fact and circumstances — things we’d have to go look at, like, who’s doing the airdrop? Is there a continuing relationship with the project and the tokens, etc., etc? But, but — 

 

Todd Phillips:  I’m not really talking from a —

 

Jerry Brito:  Let me finish.

 

Todd Phillips:  Sure.

 

Jerry Brito:  But, the fact that you have a developer who, by virtue of being the developer, has more information about the software and the system, because, as you say, they built it, they know the insides and out, as you say, as long as the smart contracts and everything is completely transparent and open source, then, by definition, they — they may have more experience with it, but they have no more information than anybody else in the world who can look at that smart contract.

 

And, if, as I said, you have peer-to-peer networks that are transparent, open to anybody, and the source code is open source — and, by the way, what I’m describing here is what Commissioner Peirce has as the requirements for her safe harbor, or among the requirements for her safe harbor — as long as you have that, there really is no information asymmetry, even though somebody might be more experienced with it.

 

Ryan Selkis:  Two things — one, nobody reads SEC filings. Two, the financials on the blockchain can’t be manipulated or forged — they can, in a public securities disclosures framework. So, I think those are two really, really important facts. And the whole concept of quarterly reporting is actually an anachronism, when you can look day-to-day at the activity that’s happening on a given public blockchain.

 

Todd Phillips:  Yeah, but we see a lot of exchanges where the trades happen off-chain. You can’t look at the transaction history of something that is off-chain.

 

Ryan Selkis:  Yeah, but that’s exchange regulation. That has nothing to do with what’s the underlying protocol.

 

Jerry Brito:   Yeah. As you said, the underlying protocol.

 

Todd Phillips:   But, you’re still valuing the underlying token, based on the transactions that everyone sees. This is part of securities regulation. This is part of markets regulation. 

 

Prof. J.W. Verret:  There are some exchanges that would like to register as under Reg ATS. They’ve been hitting a wall, just like the Bitcoin ETF. Would that be a solution to what you’re talking about?

 

Todd Phillips:  Listen, I have no idea what the SEC is doing or what the Commissioners have planned. 

 

Prof. J.W. Verret:  Do you want to call the Commissioner? 

 

Todd Phillips:  I’ve got to say, I don’t know the answer to that. I mean, what I do think, and I’ll say it again, is I think it’s really important to have a document where someone can go to look at all of the information they need to adequately assess the value of a security. There will always be additional information out there you can find. But I think the SEC and the markets just need this standardized information so that people don’t have to go around scouring hidden parts of the internet to figure out what the value of these things are.

 

Jerry Brito:  What’s hidden? Nothing’s hidden.

 

Todd Phillips:  I use that proverbially.

 

Jerry Brito:  I can give you a demo after this.

 

Todd Phillips:  I got it. I know how the internet works.

 

Prof. J.W. Verret:  And I’ll grant you that I’ve approved a lot of smart contracts. And I don’t know how to code. I don’t know anything about code. But I rely on intermediaries, and the reputational sanction of intermediaries. Sometimes that works, sometimes it doesn’t. But I think that’s probably how part of this will have to, no doubt, evolve. 

 

We’ve got some questions, so we’ve got — why don’t you go ahead, please.

 

Questioner 1:  Thank you. And Ryan, something you said kind of spurred a question in my mind. When Commissioner Peirce was talking about the two alternatives of a surveillance agreement, or some demonstration of sort of uniqueness and the underlying product being on the immutable transparent blockchain, I’m wondering to what degree the industry has been trying to drag the SEC along, in terms of the uniqueness prong or option, by the very nature of the product, and how those conversations are going, or how they’re evolving, and if there’s been any progress in that regard.

 

Ryan Selkis:  I’m actually not a lawyer, like I said, so some of the other folks on this panel might be better suited. Maybe Jerry has a thought or two on this. I think the big issue is we can point to the blockchain transactions all day long, but, at the end of the day, these spot ETFs are going to price off of centralized exchange feeds. 

 

The question is whether there’s going to be anomalies between Coin Base and Gemini, and Kraken, which fit pretty cleanly under U.S. regulatory framework because they’re based here, or, whether the SEC is going to require full international coverage of 90 percent of the daily traded volume before they’re satisfied that there’s sufficient lack of market manipulation, and whether all of those exchanges need to enter into surveillance-sharing agreements.

 

Prof. J.W. Verret:  I couldn’t add anything more to that, other than to say that, just as a spectator on the sidelines, every time it seems that there’s an applicant who makes a filing answering the SECs previous objection, and saying, “Oh, no, well, actually now we have custodians. Now we have this. Now we have that.” There’s just a new objection that’s put forward. 

 

Jerry Brito:  I think the primary objection is at what point is a ten basis-point spread between two international exchanges just irrelevant, compared to the 30 percent discount that public market investors are currently facing with these inferior products that are allowed to list and have no path to redemption, short of an ETF approval. That’s really the SEC’s mandate. 

 

It’s like — the magnitude of those two differences is laughable on its face. And anyone that you kind of explain this to — because they are a technically complex product — but anyone that you explain this to can see that the SEC is using market manipulation as an excuse and failing catastrophically when it comes to investor protection.

 

Questioner 2:  Good afternoon. I’m pretty new to this, so I apologize if my question isn’t super specific. But last week, Senator Lummis, in talking about her new bill, said that, “We’re trying to just fit the digital asset world into our current regulatory framework.” To what degree do you think that’s a good idea? Or is this an opportunity to create a new framework for new types of assets? 

 

Jerry Brito:  These aren’t new assets. I mean, honestly, things like Bitcoin and Ethereum are commodities, and so derivatives based on them would be regulated by the CFTC. Tokens that are issued in certain ways are going to be securities. So I don’t think we need to invent some new category specific for digital assets. I just think we need to be smart and clear about what bucket particular things fit into. 

 

Todd Phillips:  Yeah. I agree with that. I think these things are commodities, and they can be securities. I don’t know exactly what you call an NFT, but I think the Federal Trade Commission has authority to regulate them. I think that the CFTC, or some agency, needs authority over the commodity spot market, because right now no regulator has full regulatory authority over that market. But, other than that, I think maybe some tweaks around the edges.

 

Ryan Selkis:  I think the technology is very, very different. I think that we should be looking at the spirit of the law. And we should be looking at this as new technology, and how do we adapt to it. And I know that’s inconvenient, because it requires a little bit of a cooling-off period, and maybe some years, before the infrastructure can be developed that will satisfy regulators’ desires. But, fundamentally, I think that trying to regulate and seek disclosures from a central party that’s responsible for the maintenance of the protocol is the wrong approach. 

 

And the right approach is looking at the major holders of the assets. And you can do that by looking at the regulated edges, and the investors and custodians that actually hold these things. But I don’t know if that’s going to get worked out in the Lummis-Gillibrand Bill, or what that path is. I just think existing securities law, if we’re trying to jerry-rig tokens to that 90-year-old framework that was written pre-computer, it’s going to be pretty difficult. 

 

Prof. J.W. Verret:  Yeah, just to jump in — I think its technological uniqueness is part of what makes these assets very morph able. And regulation’s not designed to deal with morph able assets. Outside of law, just trying to think about valuation issues around these things is very complex, because, just take Bitcoin. Bitcoin has attributes of stored value. It has aspirations to be a currency, and is, in some ways, used as payment, but limited so far. And some of these have attributes of both of those things, and also some utility value on the network, and also some attributes as a traditional security. So they’re very morphable in that way, and dependent, in part, on how the individual user is using them. 

 

I like the energy behind the new bill, and I want to salute it. I have some concerns about that particular Title III of that bill, and the fact that it takes — I’m a big fan of Commissioner Peirce’s, not just because she’s here — her safe harbor, because it’s simple, and I think that has to be simple. I think that the design that’s in the bill is overly complex, and that complexity can bring back some of the interpretive questions that got us to some of the difficulties we have with Howey now. So that’s my concern there. I’d keep plugging away at that and working with the staff on that particular title of the bill. But I love the energy behind it, absolutely. Do you have a question?

 

Questioner 3:  Thank you all for being here today. So I work for ALEC, the American Legislative Exchange Council, so I was very intrigued by the title of today’s presentation. We’re going to be considering a model policy addressing crypto regulation at our upcoming conference. I guess I’m interested in getting some perspective on why there’s so much interest in the states regulating cryptocurrencies, rather than determining it at the federal level, just because, I know for businesses, it’s quite expensive to comply with all those state-based regulations. Thank you.

 

Todd Phillips:  I’m sorry, was the question, why the —

 

Jerry Brito:  State versus federal regulation, and what — 

 

Prof. J.W. Verret:  More interest in state-based regulation of crypto assets.

 

Todd Phillips:  Why industry is more interested in state-based?

 

Questioner 3:  Yes. Just because my impression — like, I understand why state legislators are interested in determining it by their state, but then, for some — I’m surprised that so many industry leaders are interested in it being determined by the states instead of the federal government. 

 

Ryan Selkis:  The current federal regulatory regime is hostile. So we’ll go, we’ll fight anywhere that we need to, until there’s more common sense. That’s the short answer. That’s not the lawyerly answer. That’s why I can say that. 

 

Prof. J.W. Verret:  I’d love to talk to you more, though, about state competition. In a prior life, I was supportive of the FinTech charter competition idea. Not only the federal FinTech charter, but also state-based FinTech charters. And, the issue, the problem with banking and financial chartering reaching the ideal of interstate competition for chartering, the way that LLC chartering enjoys competition, is the ability to have mutual recognition is limited by the fact of the FDIC’s kind of oversight.

 

If the FDIC is supportive, then it’s great, and you can make it happen. If they’re not, then it’s not possible. So, I’d love to talk more about that, because Wyoming started to get in the game, a few others. And I’d love to talk more about that, because I think it has promise, particularly for using limited-purpose bank charters to facilitate things like stable coins.

 

Todd Phillips:  This is not directly answering the question, but I think that when we’re talking about national, or even international markets, national or international transactions, I think it’s important to have federal regulations, so that you don’t have just state-by-state-by-state regulation. One of the, I think, great things about the securities laws is that if you are selling a security in our state, you have to follow one set of rules, as opposed to 51-plus different standards. And, again, I think a lot of these things are securities. It seems like we may get federal commodity regulation soon. So I think that the federal regulation is the way to go. 

 

Ryan Selkis:  I think that some of the state-by-state issues are not necessarily about securities law, in particular. Some of it’s about legal incorporation. So, how do you think about these protocols? Are they LLCs? There’s a pretty big push to regulate these entities as unincorporated entities, unincorporated associations — that’s right? Unincorporated associations — and so you might need Wyoming, Colorado, Texas, some experimentation at the state level, which is exactly how the LLC ultimately came to fruition 30, 40 years ago.

 

Questioner 4:  So, there’s been some persistent frustration with the regulation-by-enforcement approach, and particularly with the regulation-by-settlement-agreement approach. And it’s been suggested several times, including by this panel, that if someone would just take the SEC to court, everything would come out, positions would be crystalized, and at least a court would settle it. The core of my question is, is that naïve? And I’ll give a specific reason why I ask that. 

 

That was argued for the Ripple matter, which is still going on. And the complaint in Ripple offered two potential interpretations: either XRP itself is a security, or XRP is a token, and you layer on top the promises made by the various Ripple executives, of number go up, and continued development, and stuff like that. And that package is a security. And industry observers have commented on this many times. Ripple has said, “Well, which one are you arguing?” And, as far as I can tell, the SEC has been absolutely unwilling to clarify its position. So I’m wondering if you could comment on that.

 

Prof. J.W. Verret:  I have some thoughts on the Ripple litigation. I’m actually doing a panel at 7:00 — a podcast at 7:00 tonight — you all should listen — with John Deaton, who’s been very involved with that litigation, and a couple of other folks. There’s a lot to say there. Sometimes court challenges against agencies can go against you. Sometimes you can get the opposite answer you want, that’s true. That particular litigation, I think, probably will not get the far-reaching reinterpretation of Howey that I’d prefer. It will probably be either settled, or outcome on other grounds. 

 

Although, I think, I still contend that even though a circuit-by-circuit analysis of Howey, which is what most lawyers will do for you, the SEC has a lot of discretion. And the odds are in their favor. But, if this case were reconsidered by the Supreme Court today, they would have a chance to look at the original language in Howey. That language is pretty strict. I won’t belabor it, but there are some qualifiers on that language that are pretty strict. They have been watered down a lot by circuit courts over the last couple of decades. So, maybe there’s a chance there. But, generally speaking, APA challenges are probably the way to go to get some clarity. And I have a lot of thinking on that, but we’ll keep that discussion going.

 

Todd Phillips:  I think that, because the Howey test is a court-made test — again, I don’t really know the extent to which the SEC can weigh in here. It definitely has enforcement discretion. But the extent to which it can decide what is an investment contract or not, I don’t know. I think that court-by-court challenges is probably the way that we are going to figure this thing out. I think, right now, the big one appears to be the Ripple case. I think it will take a while for that case to wind its way up through the courts, potentially, up to the Supreme Court. I think it makes a lot of sense to file in a bunch of different districts and a bunch of different circuits, and just have this kind of bubble its way up.

 

Jerry Brito:  Yeah. I agree with Todd.  I think that having this as a judge-made law — and the only way we’re going to get real clarity is by getting more judge-made law, more common law kind of develop around this. Now, I agree with Commissioner Peirce when she says we don’t want to have regulation by enforcement where you wait until you have some big, massive case that you then have a settlement, and that becomes a template for the whole industry. 

 

But, at the same time, I wish more in the crypto industry would go to court when faced with an SEC enforcement action, because that’s the only way we’re going to get — ideally, you can have the SEC and parties who wish to do something that is ambiguous or that implicates under the law in some way, come to an agreement of how best to do that, maybe using some of the SEC’s authority to exempt. But, short of that, let’s go to court. Why not?

 

Todd Phillips:  I will also — oh, sorry.

 

Ryan Selkis:  I was just going to say, I’ve been advised publicly not to talk about my interest in suing the SEC. But I do think the Grayscale, the spot ETF issue that we spent some time talking about is probably in the best position of anyone historically to do this very publicly, because they’re from a position of strength, number one, given how underwater the assets are on the public markets, and this is truly in the best interests of investors. 

 

And, number two, they win in either scenario. Either they push through a spot ETF, or they lose and they have about a billion dollars of annual revenue that’s basically locked in perpetuity, as long as these are Rule 144 vehicles where there’s no redemption mechanism. Actually, it was a billion; now it’s about 500 million. But, still, that’s not bad for a product that’s on autopilot. So I think they’re in a great position to do this, and I think it would be a service to the whole industry. Hopefully, they win.

 

Todd Phillips:  I was going to add — just to advertise myself really quickly — last year, in the Administrative Law Review, I published an article where I talked about how I think agencies should do more articulating policy via adjudication cases. And there are democratic ways you can do that. I think, as Commissioner Peirce said, bringing cases to articulate this without getting input from the public is probably a problematic way to do it. But I do think there are ways to get public comments in these adjudications through amicus briefs, and things like that. And I think the agencies, including the SEC, should really consider that as a model. Thank you.

 

Prof. J.W. Verret:  I foresee a long future of us doing opposing amicus briefs. And I think it will be fun.

 

Todd Phillips:  I think it will be fun.

 

Prof. J.W. Verret:  Question?

 

Questioner 4:  Hi everyone. Ryan, this is, I guess, initially at you, and then to the broader panel. So, there’s been a lot of talk about crypto winters. Or, as Andreessen Horowitz, I think, aspirationally terms them, price innovation cycles, where you have, at kind of its essence, huge spikes and then troughs where kind of interest goes away. And, during those times of diminished interest, there’s real innovations, and they lead towards the next run. During this one, notwithstanding the kind of broader macro-environment, what are some of the opportunities that you see that regulation, when brought appropriately to the space, can provide and kind of help bring some guardrails and guidelines? And what are some of the risks, where potentially overregulation can stymie some of that innovation?

 

Ryan Selkis:  That’s funny. That’s like the pump-up song for us down 70 percent, right? So, I think there are a couple things to remember. One, every cycle, it’s a much higher low, typically. So that period of consolidation is from a significantly higher base. This is too much. And there’s one important by-product of that, which is that regulators, institutions, will lose interest. And this has almost been like a cloak of armor for the industry, in previous cycles. 

 

It’s like, things are going sky-high. This is a bubble. It’s going to end badly. And then it kind of does end badly. But there’s no contagion, necessarily. Regulators and policymakers have very short attention spans. The media helps perpetuate this narrative, because then they pile on, and they say, “Bitcoin is dead. Crypto is dead.” And the next thing you know, we get to hide in plain sight for another few years of an installation cycle. 

 

So I would love to see more thoughtful regulation, and a lot of collaboration with policymakers in this cycle. But, in a prolonged period of winter, if the end results of those conversations are going to be negative, I think the industry has historically shown an ability to kind of retrench and batten down the hatches to basically avoid the worst. So, survive, advance, delay, until we have a little bit more sophistication on the part of the policymakers that are going to be driving this agenda forward.

 

Prof. J.W. Verret:  I think that was the crypto defense lawyer’s conference next door. Anybody else have any closing thoughts. Let’s do one just last word from anyone. 

 

Todd Phillips:  This has been great. We have much more, I think, in common, than you would expect from seeing us go at it on Twitter. 

 

Prof. J.W. Verret:  All right. Thanks everybody. Thanks to our great panel for this discussion. 

 

Jerry Brito:  And thank you to Commissioner Peirce. 

 

[Music]

 

Conclusion:  On behalf of The Federalist Society’s Regulatory Transparency Project, thanks for tuning in to the Fourth Branch podcast. To catch every new episode when it’s released, you can subscribe on Apple Podcasts, Google Play, and Spreaker. For the latest from RTP, please visit our website at www.regproject.org.

 

[Music]

This has been a FedSoc audio production.

Jerry Brito

Executive Director

Coin Center


Todd Phillips

Director, Financial Regulation and Corporate Governance

Center for American Progress


Ryan Selkis

Co-Founder and CEO

Messari


J. W. Verret

Associate Professor of Law

Antonin Scalia Law School


Financial Services & Corporate Governance

The Federalist Society and Regulatory Transparency Project take no position on particular legal or public policy matters. All expressions of opinion are those of the speaker(s). To join the debate, please email us at [email protected].