Bankless - What's the Point of Securities Laws? with Mike Selig

Episode Date: January 5, 2023

Yesterday, on the show we had lawyer Brian Frye, who gave us novel takes securities. You can find that episode here: https://youtu.be/jo1ZuhuCVZE  In today's episode, David continues down the securities rabbit hole with special guest Mike Selig. Mike is a crypto lawyer at Willkie Farr & Gallagher, former a regulator at the CFTC and a frequent contributor to Coindesk about the state of crypto regulation. ------ Osmosis | Your Gateway into the Cosmos Ecosystem www.osmosis.zone/bankless  ------ SUBSCRIBE TO NEWSLETTER: https://newsletter.banklesshq.com/?utm_source=banklessshowsyt  ️ SUBSCRIBE TO PODCAST: https://availableon.com/bankless  ------ BANKLESS SPONSOR TOOLS: KRAKEN | MOST-TRUSTED CRYPTO EXCHANGE https://bankless.cc/kraken  UNISWAP | ON-CHAIN MARKETPLACE https://bankless.cc/uniswap  ️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum  EARNIFI | CLAIM YOUR UNCLAIMED AIRDROPS https://bankless.cc/earnifi  ------ Topics Covered: 0:00 Intro 5:35 Mike's Background 6:55 Why Securities 10:20 Investing Contract 13:00 Where's the Line? 20:11 Asset vs. Schemes 24:38 SEC Regulation 29:00 NFTs as Membership 36:48 2023 Regulation 42:51 SEC vs. CFTC 47:25 The Solution to Security Laws 50:40 Centralization 55:10 Current SEC Administration 1:01:30 Decentralization Theatre 1:04:50 Closing & Disclaimers ------ Recources: Mike Selig https://mobile.twitter.com/mikeseligesq  ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://www.bankless.com/disclosures 

Welcome Bankless Nation to a special live stream. Today on the show, we are continuing the conversation down the crypto rabbit hole of securities, which is, again, a unique conversation to have, but one that is very, very important for the crypto space. Yesterday on the show, on the State of the Nation with Ryan, we had Brian Fry, who is a securities lawyer and also crypto-native. And we had a fantastic discussion as to what securities laws really are, because I think the current understanding of the broad crypto industry is actually missing a lot. little bit of the mark as to why we have securities laws, because securities came before the SEC was even a thing. So I've been going and researching the 1929 stock market crash, the securities

acts of 1933 and 34, and getting back down to first principles of what it means to be a security and what securities laws are. And this has been a supremely interesting exploration into this world of securities. And today on the show, we're bringing on another crypto securities lawyer, Mike Seleig, who also recently wrote an article for CoinDesk about the current state of regulation as it comes to the crypto industry. And so we are going to continue the same conversation we had yesterday, but then also get into a little bit more details as to what the crypto industry can expect out of the regulators in 2023. What are the cases to watch? What should we be paying attention to? And how do we get out of the SEC the things that we want? So I hope you stay tuned for this fantastic and hopefully

very educational conversation. Before we get into this conversation with Mike Seelake, however, we've got to talk about our friends and sponsors at Osmosis. Because Osmosis, if you guys are not familiar, is the epicenter of liquidity in the Cosmos ecosystem. And so if you have some extra time this bear market to go exploring some frontiers, check out osmosis. It is where all assets in the cosmos ecosystem get their liquidity. But it's not just a decentralized exchange. There's other things you can do on osmosis as well because of what it is as an app chain in the cosmos ecosystem. So there's a link in the show notes if you want to explore the frontier of liquidity in the cosmos ecosystem and as well as seeing what the app chain ecosystem can do. So without further

do, we're going to get into the conversation with Mike Seleck. And just again, as a reminder, I'm going to make the claim and we're going to have this conversation with Mike in a second that if we re-roll the dice of humanity over and over and over again, we will come up with securities laws over and over and over again. These securities laws are an innate fact of financial instruments and financial assets. And so understanding why that is true, I think is incredibly important for the crypto industry, because what are we doing in crypto? We are speed-running the history of money and finance. We are speed-running the history of human coordination. In securities laws and the spirit of securities laws and why they are actually bullish for our financial

assets, understanding why this is true, is deeply important for building the crypto industry the right way. So that is the meta for the overarching meta for why we are doing this episode. So I'm excited to have these conversations with Mike. But first, before we get there, a moment to talk about some fantastic sponsors to help you go bankless. Cracken has been a leader in the crypto industry for the last 12 years. Dedicated to accelerating the global adoption of crypto, Cracken puts an emphasis on security, transparency, and client support, which is why over 9 million clients have come to love Cracken's products. Whether you're a beginner or a pro, the Cracken U.S. is simple, intuitive, and frictionless, making the Cracken app a great place for all to get involved and learn about

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I'll see you in the Discord. Bankless Nation, we are here with Mike Seelig, who is a securities lawyer, although not yours, at Wilkie Law, Farr, and Gallagher, a former regulator also at the CFTC and a frequent contributor to CoinDesk about the state of crypto regulation. Mike, welcome to the show. Thanks, David. Glad to be here. I want to give a quick disclaimer. I'm a lawyer, but I'm not your lawyer.

Nothing that I say today should be regarded as legal, financial, or professional advice to your own research, call your own lawyer. And glad to be here. Thanks, Mike. Thanks, Mike. I called you a securities lawyer. Is that right? And maybe you could also just give the bankless nation a little bit more of an

illustration of your background. Yeah, so I started off at the Commodity Futures Trading Commission, worked for a former commissioner, Christian Carlo, also known as Crypto Dad, back when he was a commissioner. My background is kind of a hybrid between commodities and securities regulation. But ever since really 20, 1560, when crypto started to take off, I focused on financial regulation as applied to crypto assets. And that's really my practice.

Fantastic. Fantastic. And you've watched the conversation that we had yesterday on the show. And I would highly encourage all bankless listeners who are listening to this that have not heard that conversation to definitely take the time to listen to that because this is a paired conversation. We're going down. We're doing the lessons of securities today.

this week on the Bankless Nation. And Mike, I just kind of want to continue that conversation with you. But maybe we can start at Bearer Bones' first principles. And I think there's a lot of general misunderstanding in the crypto space as to what it means to be a security and why securities laws exist. So maybe you can put on your advocate for securities, if you can put on that hat. Like, why should we pitch to the Bankless Nation, why we should understand what securities are, why we need to, and why to be, it.

would behoove us to be educated on this front. Yeah, absolutely. So, I mean, taking a step back and just thinking about what the term security means, right? It is a legal term of art that is in the Securities Act of 1933 as well as the 34 Act and subsequent securities laws. The idea of a security is kind of an amalgamation of a number of different types of investment instruments. So stocks, bonds, notes, and a catch-all term called investment contracts. And the SEC has primarily focused on this term investment contracts in the world of crypto assets. So that's important table setting, right? Because when we're thinking about securities, we're not thinking about all types of securities. We're really focused on this term investment contracts. Okay, investment contracts. And one of the

conversations that we were having yesterday with Brian was that we should be bullish on securities, or at least security-like properties. And there's this innate relationship between security-like properties and assets that have number go up properties. Can you talk a little bit about that and kind of where you see the spirit of securities laws coming in? Yeah. So, I mean, these security-like features are really investment-like features, right? And there are reasons to be bullish about commodity investment-like features. You know, certainly gold, silver, other commodity assets have appreciated over time and have similar characteristics to many investment assets. The big difference between what we kind of put in the securities bucket and think of as

securities is probably just that they're man-made or issued by some central person, right? When we look at these types of investments, like we look at collectibles, digital collectibles, Pokemon cars, I think you were talking about Magic the Gathering and Pongs, all these types of collectibles and investment-like aspects, assets, they have some security-like features. They appreciate over time that they may appreciate, I think, you know, Pokemon cars appreciated when everyone was stuck at home during COVID playing Pokemon on their switch. And they said, you know what, I've got all these Pokemon cards. Let's trade and sell them.

So assets can appreciate based on efforts of the issuer of that asset, the seller of that asset, others in the marketplace. And then based on decentralized marketplace features, right? Like wheat might appreciate in value or oil might appreciate in value because there's an embargo or because there is an OPEC action. So markets are decentralized. there are many things that can be produced using other assets, using other inputs, and they can have security investment-like features. But security, again, the term of art, and we need to really think about whether things are

investment contracts, whether they are notes, stocks, bonds, other types of securities, or are they just commodities or other kind of collectible assets? And, you know, the term commodity is also a term of art under the Commodity Exchange Act. So these are all legal terms that we're thinking about here as opposed to, you know, is something in investment. or something, a commodity in the common sense. And you're using this phrase term of art. And my interpretation of what you mean by that is that there's an art to it in that it's not a science.

It's all kind of like a vibe. Is that what you mean? Yeah, I think the investment contract concept, that that's really a vibe, right? Some of the other terms within the Securities Act, they're a bit more concrete. So we have stocks. And there's some case law on that, you know, there's certain features of stocks that, you know, there's certain features of stocks that. that make them stocks, right? There's distributions, there's voting rights, there's things of that nature,

and case law has sort of that out. And it's not as kind of nebulous and squishy as the investment contract definition, which we'll get to you in a minute. And then there's notes. And notes similarly kind of have an established history. There's certain features that accompany notes, and there's what's known as the Reeves test, where we look at kind of the family resemblance to notes.

But the concept of investment contract, this was really a catch-all prophylactic remedial term included within the definition of security in the 33 Act that comes from a pretty long history of state blue sky laws where there were these investment schemes and you give your money to some promoter and the promoter goes out, pulls the money with maybe other people's money and runs some sort of profit generating scheme. And you know, you're looking for the protections of the securities laws in that case because if they don't register that security, they might disappear tomorrow. You might have no recourse against them.

There might be broker dealers and investment advisors that are touting these securities without any controls over what they're doing to drive up the price. And the securities laws really came out of England in like the 1700s. Going back actually as early as the 1,200s, there were some stock-related laws. But the securities laws were really a product of bubbles, like the South Sea bubble, where you give your money to some enterprise, and they're going out and, you know, striking deals in South America and trying to drive up the price, and you get these bubbles. And there was a bubble act of 1720 that basically said there were a bunch of investors that were

giving their money to these schemes, and the schemes were going nowhere. They were just intending to flip these securities. And that's why we got the protection of the securities laws in the United States after the Great Depression and the idea of broadly defining a security and include all of these different types of arrangements and products is to capture as much of the investment-like products that kind of create manias and bubbles and lead to investor harm that the SEC is designed to protect. Yeah, I think that's been really the big aha moment I've had going down the 1929 stock market bubble rabbit hole.

It was a it was the, the rest of the. resonance between what we just went through in the crypto industry in the 1929 stock market bubble is pretty strong. But that's probably only true because all bubbles have the same properties about them, more or less. And so what characterized the 1929 stock market bubble? Credit and consumer credit. Perhaps that was synonymous from defy yields and also what we're seeing at Genesis and all of that contagion. But then also there are these like assets, perhaps they're called NFTs or or pooled. or defy tokens that these teams just created. And now there's this like very now loud, noisy bull market that in order to get attention in the bull market, you need to be a promoter of what you are doing, which is,

if that, if every, and then everything unwinds and then people get harmed. And then the SEC comes in and like, well, we should have really gotten in there, which is what exactly happened in the 1929 stock market bubble, like consumer credit, unregulated promoters of financial assets all created these reasons that we needed to create the SEC in the first place. And so this is what I want really the crypto industry to really understand is that if we keep having these bubbles, we're going to attract regulators and they're going to do things that we don't necessarily want them to do. And so we need to self-manage and get ahead of this by and if we want to keep the SEC from having overbearing and overly restrictive regulation of our industry, we need to solve that problem ourselves,

and that begins with education, which is why we're having these conversations here on the bankless show today. And so, Mike, I want to throw this question to you is, like, you've put some emphasis on this term investment contract, but then you've also labeled a bunch of other security-like properties that might exist in an asset. So, but how do we know when an asset goes from just like an art? You've talked about art of commodity, art of security, security, security like properties. Where do we know when the line is between just this financial asset that has a bunch of security like properties and the security that needs to be regulated by the SEC? How do we discover where that line is? Yeah, absolutely. So let's start just with

the term commodity under the Commodity Exchange Act, right? Everything virtually is a commodity except onions and motion picture box officer receipt. So the CFDC has as the broadest definition a jurisdictional definition out there, right? But then the SEC regulates any commodity that's a security. And so, you know, securities are commodities as well. But if they're, you know, the SEC gets jurisdiction over that. Investment contract is just one type of security. There are other types we just discussed, notes being one. And the SEC has said that certain crypto assets are notes and kind of has alluded to the idea that even Ether might be, if it's not an investment contract, a note because of the staking rewards associated with that.

And so really the exercise of analyzing crypto assets under the securities laws is one of looking at the features and the full scheme around the crypto asset and determining if it fits into any one of these buckets like stock, note investment contract. The SEC has focused on investment contract in virtually all of the cases. And the investment contract definition is defined in the Howie case, 1946. Supreme Court opinion where the court found that investment contract is a transaction, a contract, or a scheme where a person invests money in a common enterprise with the reasonable expectation of profits to be derived from the efforts of others. And so in every circumstance,

you're looking for a transaction, a contract, or a scheme. And as the court in the telegram case, you know, a few years back said, crypto assets are just computer code. They're not not securities in and of themselves. They don't fit within any enumerated category of a security. There is a world where they might have certain security like, stock-like, note-like features. And so maybe they fit within one of those enumerated categories in that sense, but there's no digital asset or crypto asset category.

When you're looking at investment contracts, though, you're looking for a contract, transaction, or scheme. So the token might be part of an investment contract, might be offered together with a broader scheme such that the scheme is kind of embodied or envelops that token. So when you trade it, the scheme trades with it. And so in the Howey case, the Supreme Court was looking at an arrangement where people purchase lots of orange groves paired together with a management contract. And the orange grows themselves were not securities, just like a token itself is not a security. It is that pairing of the two. It's the broader scheme that makes it a security. And so,

because the Howie company sold these management contracts where they're going to manage the groves for the customer and then sell the oranges to generate profits for the customer and think, you know, crypto arrangements where there's certain features where there's a central operator that's driving profits for the holder. Those types of arrangements fit pretty well within the investment contract world. But take it a step further and say that the Howie company built some technology that was going to manage the groves for the holders, right? And the technology is kind of self-operating.

Maybe it's governed by all of the holders of these plots of land and they may maintain it. You're not relying on the efforts of any promoter in that case. And so maybe in that situation when you transfer the two, you're not really relying on any other. It's no longer potentially enveloped within an investment contract because there's no efforts of others. Or if you just transfer the Orange Groves themselves, you know, you're just transferring maybe a token without any sort of, management or entrepreneurial efforts associated with it. So that might not be a security. And so we really need to think about securities.

It's somewhat mutable because there's a world where these tokens get enveloped within security world for a period of time. But that might not be the case forever. And there's a famous speech by former director of corporation finance at the SEC Bill Hinman where he said, you know, Ether, when initially sold, pre-sold, was a security. But over time, you know, I was at DevCon several months. months ago, there's thousands of developers packed into a massive convention center. You know, Ethereum is a massive project. It's decentralized. It's very much like the wheat

markets I mentioned, where, you know, an action of the Ethereum Foundation might not even be as significant as an action by a significant DFI protocol. We just saw with Solana, you know, there was movement of certain projects over to Polygon, and that caused, you know, movement within the price of Solana. And so these are decentralized ecosystems. You can't really pin it down one person. And that's really what distinguishes kind of these network like assets from typical securities that are associated with a defined business enterprise. There's a point that I really want to drill down on that I think you made that I'll try and reiterate and correct me if I'm wrong. But you delineated between the actual crypto asset,

be an NFT or ERC20 token. You're separating the asset from this scheme. And what you're saying is that the asset is not the security. It's the broad scheme that makes and the asset that is a security. And so it's not just the token. It's a token that's associated with a scheme. And maybe a scheme has like a negative connotation, but I don't think we mean that. Really, we just mean like effort by a coordinated team,

a sort of system of value capture into the asset itself. And so while the asset might be the body of the security, It's really the broader scheme that's around this asset that makes the whole entire thing a security. And so to put this into more concrete terms, maybe there is an NFT project out there that has a collectible JPEG associated with it. And there's a mince price for like 0.05Eth. And the team that is creating this mint contract for this NFT also has very large ambitious plans that the, NFTs can access in the future, in the future time. And so they have a roadmap and they have a financial asset and they have a collectible

JPEG and there's a coordinated team that wants to build a metaverse. Like, is this a scheme? Like, how do we think about this thing? Because this is a very common pattern that we see in the NFT space. Yeah. I mean, the NFT space has repeated a lot of the sins of the 2017-2018 vintage ICO space, right? And, you know, the ICOs really grew out of the, you know, Ethereum Y paper where anybody can issue a token. And so once the SEC actually, ironically, brought its first real enforcement action, although it was done through an investigative report against the Dow for selling Dow tokens, that kind of kicked off the bull run of ICO tokens, ironically.

But the idea of a lot of these tokens was that let's offer a roadmap. And let's say that we're going to sell this token and it's going to have all sorts of utility. So it was kind of like steady lads deploying utility. Like let's build this thing up and continue over time to provide new features and functionalities. And the SEC was like, wait, like this is exactly what we're warning against, right? Because the idea is that you're relying on some team to continue to develop and bring value to the tokens. And there's nothing wrong with a team working on building on some open source code project. And I think that's a big distinction.

And a lot of the NFT projects have moved towards CCO, which I think is a massive move in the right direction. Because the idea behind crypto is really open source community products that are permissionless. And anybody can kind of use them, build on them and take them to the next level. And you're not relying on some specific team. The team might play an important role and contribute, but they're not the single efforts that you're looking to drive value. And so I do like to distinguish kind of these network assets that are really distributed and decentralized. And you can't point to any single person in the middle, as Gary Gensler would say, that's

driving value. And, you know, you might have OPEC driving value to oil, but they're certainly not controlling the world's oil markets, many would say, at least. And so I think that that's really the key distinction when you're thinking about investment contracts. Of course, you can have other, you know, distributors. And I think this is an issue, a lot of DFI projects are dealing with now, right? You've got a governance token, but you turn on a fee switch, and now everybody's getting distributions by holding the token.

And those security-like features, and maybe we embrace the securities laws there. And we can get to you later, you know, the complications in doing that under the current administration. But that's really the distinction. I think it's a product design choice. You can say, like, we're going to decentralize this project as far as it can go, and we're going to open it up. or we're going to go, you know, very much like security-esque products where you get a distribution. Maybe you have to make periodic disclosures and offer prospectus and comply with the securities laws in that world.

One of the arguments that we were going back and forth on yesterday with Brian was that the SEC only really wants to regulate things that it wants to regulate. And so if it deems that it doesn't want to regulate a cat JPEG, then it will deem that to not be. a security. And so, which is like an interesting, he called this the fifth prong of the Howie test, right? Like we have the first four prongs,

like, efforts of a coordinated actor, investment contract, all that stuff. But then we got to this unspoken fifth prong that we, that Brian was saying existed, which is like the fifth prong being,

does it feel like a security? Which is, in my mind, like, invalidates the first four prongs because if the fifth prong is just like, yeah, but is it really like security, like,

in does the SEC want to regulate it? And if the answer is yes, then it's a security. If the answer is no, then it's not security. Do you have a take on that fifth prong? And also do you have a take on how much the SEC actually wants to regulate some of this industry? Yeah, the SEC regulates capital formation, raising capital to go deploy that capital in some way to build an enterprise. And the idea of the investment contract, as I knew of it earlier, right? It's this remedial provision or definition within the term security. And the idea is to capture these schemes with security-like features that don't neatly fit in any other category. So the SEC has that authority.

Courts have kind of chipped away at some of that authority. I mean, the Supreme Court opinion was pretty broad. It's been broadened by some court. It's narrowed by others. But the idea really is there are these schemes where people give money to somebody. and that person kind of raises capital, forms capital, to go deploy it and do something. Like when I've got this first edition, you know, Charazard card, right? Like, I don't care about the Pokemon company's success.

The idea is that I bought this collectible and maybe they're successful, maybe not, but I'm not giving them capital to go deploy it in some way. I don't have a contractual business relationship with them in the same way that people giving money to the, you know, South Sea company to go explore South America. America did. And the securities laws over time have focused on these types of assets. There have been circumstances where the SEC is regulated like chinchilla farming operations and cattle embryos and all sorts of coin collections and things like that, whiskey warehouse receipts. But in every instance, there's been some promoter at the middle that's really organizing the efforts and you're looking to

them to deliver profits. You're not buying some collectible. And I think if you're looking at some of NFT projects, for example, you know, things like cromies squiggles, there's art work, or crypto punks that really have historical and cultural relevance. You know, some might say other NFTs similarly have that kind of relevance. The SEC is looking into some of these projects, but the idea behind some where you're buying into a private discord maybe to kind of scheme to whitewash trade or do things like that, like that might look a bit more like a scheme, but I think, You have to analyze the facts and circumstances of every offering under the investment contract definition.

If you're giving people dividends, maybe it's a stock. But otherwise, you know, you're looking at the facts and circumstances in each instance. And so I think the fifth prong of Howie concept, you know, it's a good mental model to think through this stuff. But the SEC is really focused on capital formation. They're not trying to just regulate every investable asset class. the art markets have been around for for centuries and they've never been regulated securities markets. There are futures contracts on, you know, art. Like you can buy, you know, a future Coons painting that's going to be done in three years and sell the rights to that beforehand. So there's all sorts of kind of financial-esque markets around art. You know, I've been through several of these Christie's auctions with, with NFT artists. And the process is very similar to kind of

doing a public offering or doing any sort of financial offering, right? But the asset itself is kind of distinct in a certain way, even if you get certain security-like features embedded in these products. Yeah. One thing I want to ask about is like there's a world where, like, I don't know why this example came to mind, but it does, is like Alameda's pitch deck was something along, like, invest in us because we have no risk returns and it goes like it goes up and up and up and that's what it does. That's what it does. If that was, if that pitch deck was put into like a token

mint contract, that would be the most security like thing of all time because they're promising returns. They have this scheme where they have this proprietary trading strategy, which they claim is just a money printer and then there's soliciting investment. Super duper security, probably. And then on the other hand of things, at least in the NFT world, there's like, hey, we have these cute JPEGs and also this fun community and if you own one of these JPEGs you get to go to our party and to me that seems much less like a scheme and much more like a club and and so like yeah there's a difference between promising future returns and not not even promising but explicitly providing raw utility that is not in the future because they're already doing it today and so like there's a there's a

spectrum here of course and a lot of these NFT projects are just just about a a social club that you use the NFT to put out boundaries as to who's in the club and who's not. And so is that, that seems to be pretty damn safe to me. What about you? Yeah. So there's been things like seat licenses, right? Like you buy a, you know, an NFL team seat license and you can go to all the games, get all the tickets, playoff tickets, all of that.

There have been golf country club memberships, all sorts of kind of, and also other types of, you know, club, social club arrangement. The SECs looked at some of these as investment contracts. There have been no action letters that deal with some of these types of products. And the seat license, for example, you might get seats, you can ticket so you can sell. You might be able to sell the seat license at a profit. But the idea is that it has some consumptive utility. And so that's why people focused on utility over the years because it's like you deliver enough utility and it's more of a consumptive good.

There's a case called Foreman that looked at condominiums and said that, you know, if you can use and consume, the product, like the Orange Groves and Howie without the management contract, that's not itself an investment contract. But, you know, if you add on other types of security-like features, it might become more of a scheme. So if you have an investment club, as opposed to just a social club, that's a little bit different. If everybody is getting together, and there are plenty of these investment club dows that are done as, you know, the tokens are securities like Flamingo and pleaser and others. The idea is that everybody's getting together, pooling funds and going and making investments, and that's fine. But if you're going with a social club and doing that sort of

stuff, that might not be fine. And so it's really drawn the line between what's the purpose, why are you getting together? It's a little bit squishy, you know, golf country club memberships. People were flipping them and view them as investments, but people were potentially just getting them like golf, right? And they can be transferable because, look, like, you know, you get a pass to a community and, you know, a lot longer when you use it, you might as well have the economic freedom to go sell it at a profit if it's valuable. That's not necessarily security. And, you know, the SEC, much of the law around what is and is not an investment contract

has been handed down through these no action letters. And one of the commissioners Hester Purse is kind of commented on this. It's like a secret garden, right? Like, it's very hard to navigate this body of law because it's not judge-made law. And that's really somewhat the approach the SEC is taking now, but through enforcement, which we can get to you later. But, yeah, these no action letters provide a lot of the contours that you might look at when you're considering whether your community is some sort of scheme or if it's really just a community.

But I think there's absolutely the case we made that many of these communities are not security, you know, investment club type arrangements. And you look at many of the popular ones, they've CCOed their tokens to make clear that the artwork is open source and can be used. And a lot of the technology developed by these, these Dow's have also been kind of open source. Yeah, so there's a bunch of conversations in there that I want to unpack with you. One of them is like, where are the various bits of flags that come up on a various project and what they what can be doing and as they get more and more scheme like what are those lines but then also i kind of want to just ask you like what's your take on the SEC's appetite for even coming into this

world uh in a in a way that's beyond like we'll talk about like enforcement actions and and and stuff like that and like i think you're also keeping your finger on the pulse of just like the decisions to watch in 2023 so i want to get your takes and perspective on all of these things but first a moment to talk about some of these fantastic sponsors that make the show possible. Uniswap is the largest on-chain marketplace for self-custody digital assets. Uniswap is, of course, a decentralized exchange, but you know this because you've been listening to Bankless. But did you know that the Uniswop web app has a shiny new Fiat on ramp?

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And we are back talking about securities, everyone's favorite subject. And like, there's a tweet that you wrote that I want to get your take on and unpack a little bit with you. And so you tweeted out, while crypto projects continue to push the boundaries of decentralization and community

governance, the SEC and CFTC will likely push the boundaries of their existing authorities through novel enforcement actions. And this was also featured in your Coin Desk article about the state of crypto regulation going into 2023. Can you talk a little bit about what this means and what the bankless nation should be paying attention to as we go into 2023 as it relates to regulation? Absolutely. So I think regulation and decentralization are kind of counterbalancing factors, right. There's a great documentary about steroid use called Bigger, Fast, or Stronger, and there's this scene where the producer goes out and buys a bunch of ingredients and gets a bunch of guys off the street to go create a new supplement. And they mix all

the ingredients together and they mix a bunch of rice powder in and they sell the product. It costs them about a dollar to make. They sell it at 60 bucks. And they say that it's a proprietary blend. You don't know exactly what's in there. The reason we have the law, that we do in the securities world is to regulate stuff like this, right? You are a prospectus, you require disclosure, you want to people to understand what they're buying. In the world of decentralization, a lot of this is open. It's open, permissionless, you can read the code.

The vast majority of the information's out there. I think projects are working on trying to get as much out there as they can to the extent they're decentralizing. If you look at something like big, point there's really nowhere to go find some proprietary information, maybe if, example, you have some special information, but you don't necessarily need the same regulatory structure around those products. There's a, there's a quote, you know, sunlight is said to be the best disinfectant from

former Supreme Court Justice Brandeis. That's really the idea behind the securities laws. Get all this information out into the open, reduce information asymmetries. with decentralized projects, that's just not, that you don't have the same rationale. The SEC is going to continue to kind of push the boundaries of its authority to find these central promoters, central actors that are controlling projects. And over the past several years, we've seen the SEC bring actions against telegram, against kick, against Ripple, against many of the token issuers that have put out coins and have engaged in

efforts to drive the value of those coins, put out roadmaps, all the sorts of things that we've discussed. The SEC is focused on the initial sales of those tokens, and that's an important distinction. At the time a token is sold, like Ether, for example, it might be involved in an investment contract scheme. Tomorrow, it might be fully decentralized. and there's no longer those promoters. The SEC is generally focused on these first instances of issuance and sales that kind of lead up to potentially decentralization of the product. The future is going to be a bit different

because we have so many decentralized projects today, or at least projects that are attempting to decentralize through Dow's and other types of structures. So the SEC now needs to take it to the next level and try to pursue some of these more decentralized. projects. That is going to be an important distinction between some of the new cases that we'll see brought by the SEC in the future. We also have secondary markets that the SEC has largely disregarded in its cases to date. It brought a few against Poloniacs. There's a case against

a decentralized exchange, early decentralized exchange. These types of cases really were settled, did not really go very far. But now we have cases like Wahee, where or the SEC is pursuing an ex-employee of Coinbase for Insiders trading on Coinbase. And so now we're looking at secondary markets for tokens that were sold, potentially securities initially, but the question is whether there's securities today. And there are a bunch of arguments that might be made around decentralization as to why they're no longer securities, why they're more akin to the orange groves being sold separately or with that technological, you know, method of governing the process of selling the oranges.

And that's going to be something to watch. And then just the general argument around there's no business relationship between a project and the person that purchase it in the secondary market, potentially, if they didn't purchase it in the same way that a venture capital fund goes and purchases from the issuer. So those are going to be some key things to watch going forward. And then similarly on the CFDC side, they're bringing cases with respect to their authority in spot markets, which is limited to anti-manipulation and fraud. So they're looking at things like did somebody sell a token associated with some sort of fraudulent scheme and that token they would deem to be a commodity or some sort of stable coin. There's a case brought against BitFinex involving Tether. So these types of fraudulent related claims. And then also cases where there is a registration violation.

So a project deploys a smart contract based futures exchange gives it to a Dow. this is what happened in the Uki case, if people are following that. And the CFDC pursues both the developers as well as the Dow itself for liability for violating certain futures laws. And so these are the sorts of things to watch in the space. As technology decentralizes and evolves, the regulators are going to need to get creative with their authorities because their authorities are primarily focused on centralized intermediaries as opposed to these decentralized. protocols and platforms. And yesterday on the show, I put up that spectrum of assets, right?

And on the left side, I had the CFTC who regulates commodities. And on the right side, I had the SEC who's regulating securities. And then I had these lines where, like, those regulations stop. And then we have this middle ground, which is just a lot more of a nebulous stuff. And so from what I'm hearing you say right now, it's kind of like we have the commodity, the CFTC and the SEC kind of encroaching from both sides. the SEC from the security side and the commodity and the CFTC from the commodity side. But in the middle is, or like what buffers them is the concept of decentralization.

As in your, I think what you're saying is that the SEC has really gone after some of the obviously and overtly centralized orgs who totally issued a security because that was the low-hanging fruit. And you're saying that the SEC is going to start to work upwards a little bit and try and go after more and more decentralized project. and whether or not they are successful is going to be determining where that line is as to in the crypto industry as what the SEC can regulate. And so is that a fair take of how you think this is going to go? Yeah, regulation of crypto is a zero-sum game between these agencies, right? So you've got the SEC trying to push the boundaries of its authority over investment-like instruments through this investment contract framework.

that gets applied retroactively versus the CFTC that's saying that a bunch of these assets are already sufficiently decentralized. They trade in markets very similar to wheat and corn and other commodities. And so you've got this kind of encroachment of both from various sides and trying to figure out what fits into what bucket. And NFTs are a little bit different because they have non-fundability and so they may not be commodities. But that's really the idea that you have two regulators trying to stake their claim.

and the CFTC is seeking additional authority over crypto. It's very likely that in the near future, we'll see the CFTC regulating crypto spot markets that are non-security crypto spot markets. And so they're on a mission to kind of stake their claim, show that they're the cop on the beat for these non-security crypto markets. And the SEC is doing the same thing, except the SEC probably wants to take the vast majority of it,

as Gary Gensler said. So it's like the illustration of this like we have the CFTC, the SEC and then the crypto industry. And we're like in this three way Mexican standoff. Everyone's pointing their guns at each other. And the CFTC is looking at the SEC and saying, hey, I want to regulate crypto. SEC is looking at CFTC and it's like, hey, we want to regulate crypto. And then there's a crypto industry. It's like, we don't want either of you two people.

Is that kind of a fair way to illustrate this? I think that's right. I think that the issue is that most people are okay with the CFTC taking some authority there, because CFTC doesn't even have the ability to regulate these spot markets. So it's okay to have some fraud and manipulation protections. That's a good thing as investors in the space. The SEC is trying to take jurisdiction, but they're not willing to put out any new rules for crypto. And so the market structure, which we can get into later, you know, it doesn't really fit for crypto.

And so crypto's like, hey, back off. We don't want to be under this tent because it doesn't work for the way that technology functions. If the technology could be incorporated within the security structure, why not? I mean, it might afford enough protections that makes investors come from all over the world to get into crypto markets. I mean, I think there's definitely some hesitation that these markets are totally unregulated on behalf of some in the space. others would prefer for it to be less regulated. But certainly the solution for crypto regulation under the SEC umbrella shouldn't be as comprehensive as other types of securities because they're just different, right?

They're decentralized. There's not really the same disclosure issues in many cases. And I thought that the example from bigger, faster, stronger is really helpful to think about this because, you know, as consumers we want, we don't want a proprietary blend. We want to understand what's in there. It's kind of what FTX was offering. Like, we didn't know what was happening in Sam's box. But in this, in Defi, we kind of have an idea of what's happening in the box.

And so I think that that's an important distinction and something that regulators should consider as they're developing new rules, which really are required for crypto to work within the securities umbrella. And that's the point I really, really want to drive home, is that like, all right, if listeners are fearful of this, like, oh, like, the power of crypto is going to be, like, inoculated by the SEC. or CFTC, like they're going to take all the fun out of it, they're going to take all the point out of it. The solution to securities laws and probably a seemingly large number of CFTC, like, you know, regulatory aspirations, the way that we fight back against this is the thing that we've already been doing in the crypto space in the first place and the whole point of this movement, which is decentralization. And so, like, there was that recent case against, like, Avri, who was manipulating markets in, in defy. They went after the guy, not uniswap or AVE, and why didn't they do that? Why didn't the CFTC go after

the markets on which the market manipulation occurred on? It's because they're decentralized. And it's going to, my take is that it's going to be the same thing with the securities markets, is that if the, if the ire of the SEC comes upon us, the way that we fight back with them is by being decentralized and making sure that there is no line between the private coordinators of an asset and the public markets who are buying that asset. And what does that look like? That looks like a doubt. That looks like a decentralized organization where there is no central party. And all of a sudden, the SEC has no one to go after. And so they can't really find the point to sue or to take to court. And so the way that we fight back by this encroachment of the CFTC on one side and the SEC on the other,

is just by decentralizing everything. Is that a fair take, Mike? I think that's a fair take. There are certain things that have to occur on regulated platforms as the laws exist today. So if you want to offer a national securities exchange, you do have to register with the SEC. So if you're offering tokens, even if it's on a decentralized platform and those tokens of securities, you're subject to SEC regulation and registration, similar on the CFTC side. That's what happened with Fuki Dow.

And so there's decentralization up to a point, but there are many things that don't require registration with a regulator. Dow's don't necessarily, you know, always engage in activities that are regulated activities. And so the idea of decentralization takes a lot of these tokens out of the SEC regulation bucket, but it doesn't necessarily take the platforms out of the bucket. But that might be something that's subject to change, right? Because if you're looking at a D5 protocol that works exactly as designed, Mango, for all its laws, worked as it was designed, that doesn't mean that market manipulation is legal. And so there are issues potentially with kind of the tactics used to drive up the price and engage in that sort of behavior. but the idea that some of these platforms require registration and comprehensive oversight,

that's really an open question because everything's on the table. You can use these at your peril. And if you enjoy using them and it works the way you expect it to work, what's the real consumer or investor harm? And then this one last angle I want to ask about before we wrap up is going back to that Hillman speech in 2018 that talked about the transition of a security industry to a commodity. And while I was doing a little bit of research for this, for this like whole rabbit hole I'm going down, coin center actually when they, when they have a page about is ether a

security? And they argue, I think if I'm interpreting that page correctly, they argue that the investment contract for ether did make that investment contract a security. And then when ether is issued out on the actual blockchain in the Genesis block, Ether got distributed in the Genesis block of Ethereum, it became not a security anymore in that moment. So Ether, the currency, has never been a security, but the note, the investment contract that people pay their Bitcoins or wired funds to, that was a security in that interim time when payment was made and then Ether was distributed. That very small part of time was a security. And there's also this catch-22 out of the Gensler administration where Gensler's like, hey, like, token issuers, come in and chat with me,

also register your security, but it feels like a trap because once you become a registered security, you can't become an unregistered security. There's no way out of that room. Like you get stuck in there and there's no way to decentralize and become a commodity. And so can you talk about like this concept of starting centralized and the need to be able to actually have viable paths towards decentralization while also being compliant by the SEC? Like this is like the frontier that we need out of the SEC, right? Yeah, that's right. And if we're looking at investment contracts, if you don't have other security-like features that put you in one of the other buckets, the token isn't the security. It's that investment contracts. The scheme, it's a legal wrapper that envelops the token.

You transfer the token. The investment contract might go with it. If you've got a centralized scheme, somebody that buys that token might be looking to the same person that sold it to the original purchaser. So you have potentially a common enterprise in a scheme. The idea, The idea that a token can separate out from that investment contract and trade as a non-security is not really that, you know, it's kind of fairly simple and should be the standard that everybody embraces, I think, in this industry, because the tokens themselves are just computer code. And so if you buy one of these tokens, if it has the security-like features, it should be traded

like a security. But if at a later state, it's no longer enveloped in that investment contract scheme, then you can say, look, it's decentralized at this point in time and we're not going to treat it like a security. And so that's really what the Hinman speech encapsulated around ether and other crypto assets. The current administration doesn't necessarily agree with this view, but it really embodies what the case law says. The case law is focused on these contracts, agreements, schemes, transactions, not on like any sort of chinchilla or orange or anything like that. So the SEC has been very broad in characterizing crypto assets as crypto asset securities or non-security crypto assets, but really it's not the crypto asset. It's the investment contract.

And the SEC refuses under this administration to characterize them any differently. But under the Clayton administration and the prior administration, that was really the way that we looked at these assets. And getting a crypto asset offered to the public as a non-security is also not impossible feat. Like you can offer something like a stable coin that doesn't increase in value. And so there's no expectation of profits, even though it's centralized. There are things that are like NFT tickets that might not really necessarily increase in value. They're just the right to go. go participate in something or a POAP or that sort of thing. And so I think there's there's really a need to distinguish between the type of asset that

you're evaluating and not lumping everything into like crypto asset securities or non-security crypto assets. There's this kind of scheme that runs on top of a lot of these products. And the scheme doesn't last forever in every case. It may have a half-life depending on when the project decentralized. Yeah, right. And that idea of the scheme not lasting forever is at the root of what crypto is, right? That's why Satoshi left Bitcoin is because he needed to end the scheme of his existence.

That's why the Ethereum Foundation has never really gone after and been the client team. They've supported many client teams, right? So that's something that's very true to the ethos of this industry is we need like centralized parties to come and start the thing. but then not finish the thing, let the community finish the thing. That's always been the ethos. And so that's very much aligned with what we want out of crypto. Like I've got one last question for you. Like it kind of seems to me that we're not really going to get out of the current SEC administration what we want out of the current SEC out of the SEC. Do you agree with that take? And if you do agree with that take, like how do we deal with that? Like, where do we go from here?

I do agree. I mean, when I was first at the CFDC, we are a new administration coming right out out of Gary Gensler's prior CFTC. And what Gensler had done under the Dodd-Frank Act, which had been promulgated in 2010, we were crafting regulations around that. A lot of these regulations took what was already designed for the futures markets and applied it to swap trading facilities, that were new facilities developed under the Dodd-Frank Act.

rather than craft kind of tailored regulations around how swaps trade and the swap regime, Gensler chose to just take pretty much what we had for futures and apply it to swaps. He ignored a lot of the industry commentary saying that this wouldn't work or it was not optimal for swaps, pushed forward with those regulations. And so when I was at the safety see later, we were evaluating a lot of that. And we noticed that it really just didn't work for a lot of the market. and we provided a commentary on that. But the Gensler approach is very much, let's push forward and pull everything into the existing regime rather than craft and tailor new regulations.

He has said that for crypto, the only new rules we might need are kind of very tailored disclosure rules similar to how we have different disclosures for asset back securities. So it's very unlikely that if we continue to have. how a Gensler led SEC, we'll see new rules, new market structure for crypto assets. Instead, the approach is that every crypto asset or the vast majority of crypto assets in Gensler's view are securities. And so the issuers of these securities should register them with the SEC. The exchanges, broker dealers, investment advisors in this space should all register with the SEC. And we should just treat everything like the existing securities market. What do we wind up with the same securities market we have today?

Nothing new for crypto, not taking into account the fact that you can go on to a decentralized exchange, hook up your ledger wallet or your metamask, pull assets off, trade them in very different ways than you can securities, notwithstanding the fact that these aren't certificated like other securities, you don't need clearing houses in the same way. So the Gensler approach is not to create a new regime. It's just flupe it all in the same regime. get everybody to register, do public offerings. It doesn't work for crypto. If we get a new, you know, SEC administration, possibly that will change. We don't know. It really depends where things shake out. The SEC's approach is going to be to bring enforcement actions to define the contours of its jurisdiction, to push from these Section 5, which is a, you know, securities offering that was required to be registered. The SEC's brought primarily Section 5

cases over the years, as well as some fraud and other things, to push from those cases, to bring cases involving secondary markets and involving decentralized projects. And that's going to be what defines the contours, so what's the security. And if you wind up in that security bucket, you really have no choice but to quite the securities loss. A lot of these projects move overseas to avoid this. But if blockchain assets are freely transferable, can transfer across wallets, throughout the world, it's very difficult to just push all this innovation overseas.

And that's not the right thing for this country either. And so I think we're at a little bit of an impasse with the CFDC being the, I don't want to say it's an easier regulator to deal with, but right now they don't even have the authority to comprehensively regulate the markets. And so it gives a little bit of time for legislators to craft legislation that, that appropriately regulates the markets. And so a lot of crypto projects are going to be pushing the boundaries of this decentralization narrative to get outside the scope of the SEC's jurisdiction. And I expect this year we'll see some big cases decided like Ripple. This Wahi case could

resolve this year. The Uki Dow case is kind of continuing to go on this year. So some of these cases will provide a little bit more clarity on where the boundaries lie, but I do view this as a year of decentralization versus regulation. The projects are going to push the boundaries, form Dow's, continue to kind of move outside of the regulatory perimeter, or at least try to do so, where the regulators are just going to continue to kind of march forward into that territory. And it's really hard to say where it winds up. But I think the, FTX implosion has really ticked off a lot of the regulators and a lot of folks on the hill. And we're seeing banking regulators kind of warning banks against investing in crypto assets

and just a lot of negativity. But the crypto industry is really strong and resilient. And we've gone through these periods before. I mean, I remember 2013 when everybody on the hill basically was anti-crypto. And I think we'll pull through. So it's just going to be a little bit of a battle this year. Yeah, well, the crypto industry is certainly not known for backing down from battles, that's for sure. Definitely one thing that's kind of stands out to me, it's maybe ironic is that like the actions of the SEC are pushing the crypto industry to be more and more decentralized.

And the more and more the decentralized the crypto industry becomes literally the, that's the solution towards securities laws. Like, why do securities logs exist? It's because there's information asymmetries between centralized, parties in the public market and if everything just becomes decentralized, then that problem is solved. But the ironic thing is that I don't think the SEC is going to see it that way. They're going to only view it as decentralization theater or fake decentralization and not accept that things are actually becoming decentralized and they're going to

continue to march and try and go after more and more decentralized projects and not accept that the decentralization that does exist in these projects is actually real. Do you have any thoughts on that? I think that's right. Meaningful, true decentralization is going to be critical. It's not about decentralization theater. Projects need to move towards Bitcoin, towards Ethereum, really build out the value proposition to a distributed network of users

and focus on that ethos as opposed to an ethos of let's just create a centralized team that runs the Dow and controls everything. And, you know, one guy's going to hold the admin multisig, and that's going to control the smart contracts, and we'll call it a Dow because people vote on that. Like, we really will need to see meaningful decentralization to see these projects escape SEC scrutiny and enforcement actions. But there are many projects that are moving in that direction,

and I do see it as a viable way to escape the regulatory perimeter, but that's just not to say that every project will meet that stringent criteria. And the SEC is going to be pursuing everybody. I think they're not necessarily going to back down from taking harder cases because they view their jurisdiction pretty broadly. But even Gary Gensler has admitted that he does not view certain crypto assets that look like digital gold to be securities. And so there is a at least a sliver of assets that fit within this.

There's a line somewhere. Security crypto assets. Yeah, there is a line. And ether, you know, there's pretty good arguments that ether fits in that bucket. The CFTC currently regulates ether futures. They've also viewed assets like Tether to be non-securities. So there's a bucket. I mean, there's a world where at least some of these more, and the key feature, right,

that Gary Gensler is looking at is decentralization because what else? I mean, the utility of digital gold is not so so encompassing that it's like a condominium unit. It really is this decentralization aspect that drives the analysis. And that's where, of course, and the SEC is going to push to kind of sniff out the projects that are less decentralized. Well, Mike, I have learned a ton on this show. So thank you for joining me. while I'm going down this security's rabbit hole and being an excellent guide. If people want to learn more about you and what you do and read some of your stuff,

where should they go? Yeah, I'm on Twitter. So Mike Seleague ESQ. I'm also on LinkedIn and you can Google me. I write for Coin Desk from time to time. And yeah, love to chat if anyone wants to reach up. We'll put all of those links in the show notes and more. Mike, thank you so much for coming on the show today.

Thank you. Appreciate it. Bankless Nation. You know the deal risks and disgamers. Crypto is risky. Defi is risky. You can lose what you put in. Some of these assets might try and be regulated by Gary Gensler,

but if they do, we will fight them back, if that is what is deemed justified. But you can lose what you put in. We are headed west. This is the frontier. It's not for everyone, but we are glad you are with us on the bankless journey. Thanks a lot.