Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Gabriel Shapiro: ZeroLaw – A Philosophy of Securities Laws for Tokenized Networks

Episode Date: February 25, 2020

Gabriel Shapiro is an independent attorney who has spent the last two years focusing on the tokens and crypto. He has published several pieces diving deep into US Securities Law, in which he shares his vision and philosophy for how Tokenized Networks should be regulated. In light of the recent “safe harbor” framework proposed by SEC Commissioner Hester Pierce, Gabriel offers his thoughts and suggests how these measures could be improved in a way that would benefit the entire industry.Topics covered in this episode:Gabriel’s background and how he got into the blockchain spaceWhat motivated Gabriel to write his series of postsWhy Securities Laws in the US appear more complex than other countriesThe classifications we give tokens - commodities, currenciesThe Howey Test and how it applies in the crypto spaceWhat the Exchange Act 1984 is and the impact this has on companies that issue securitiesWhy crypto networks not complying with the Securities Law aren’t being punishedWhat is wrong in the blockchain industry and what it has to do with Securities LawGabriel’s philosophy and how Securities Law should be applied when issuing tokens and launching networksThe Safe Harbor proposal - what it is, how it defines things like decentralization and network maturityGabriel’s thoughts on how things can be improvedEpisode links: ZeroLaw WebsiteTokenizing Corporate Capital StockAn open letter to SEC Commissioner Peirce on token safe harborsSize Does Matter — Part 1, Gabriel ShapiroSize Does Matter — Part 2, Gabriel ShapiroSize Does Matter — Part 3, Gabriel ShapiroSize Does Matter — Part 4, Gabriel ShapiroEthereum’s ‘Bazaar’ Development Model Will Pay Off in 2020Hester Peirce: Tell Me How to Improve My Safe Harbor ProposalPreston Byrne: Peirce’s Safe Harbor Proposal Would Be Hilarious if It Weren’t so SeriousZeroLaw TwitterGabriel Shapiro TwitterEpicenter Meetup at EthCCEpicenter 2020 Audience SurveySponsors: Pepo: Meet the people shaping the crypto movement - https://pepo.com/epicenterNervos: If you’re a developer or project seeking funding for an innovative idea, check out the Nervos Grants Program today - https://www.nervos.org/grantsThis episode is hosted by Sebastien Couture & Brian Fabian Crain. Show notes and listening options: epicenter.tv/328

This is Epicenter, Episode 328 with guest Gabe Shapiro. Hey there, Sebastian here. You know, the podcaster listener relationship is too unbalanced. You know us a lot better than we know you, and we want to narrow that gap. So please do me a favor and answer our audience survey. It takes four minutes, and it will help us to continue producing content that informs and inspires you. You can find the survey at epicenter.orgs slash survey, and at the end, And I'll tell you how you can get a free keep key hardware wallet, courtesy of ShapeShift, to thank you for your time.

So thanks in advance. And on with the show. Hi, welcome to Epicenter. My name is Sebassiqio. Today our guest is Gabe Shapiro. Gabe is a lawyer at the firm Zero Law. They're experts in the area of tokenization, Dow's, and blockchain engineering. Gabe has written a four-part series of monster blog posts where he shares his philosophy of securities law,

for tokenized networks. This is an amazing piece of work. It takes about an hour and a half to read all posts, but I would strongly recommend everyone to read them. Now, let's try to understand why this is important and why it's so timely at the moment. For the last few months, there's an SEC commissioner by the name of Hester Pierce. You may have heard of her. She also goes by the name of Crypto Mom. And she's been pushing for this idea of safe harbor. And under her proposal, tokens would be exempt from being classified as securities for a period of three years. And this is so that projects could build an initial development team with the intention of becoming mature and becoming more decentralized, until which point the SEC would no longer consider them to be securities.

Now, just as we were recording this interview with Gabe, Commissioner Pierce posted an opinion piece on coin desks, where she essentially asks the industry, what do you think? of my proposal, tell me if this is right, tell me if this is wrong, and we want to improve it and fix it, which in my opinion really shows the openness of the SEC, and particularly of this commissioner, to create an environment where the crypto industry can thrive. And there have been a number of reactions to this call for feedback. There's been a number of reactions also to the proposal in general, some positive, some more negative. And Gabe also published an open letter. in which he provides his feedback and his thoughts and his philosophy on how the safe harbor

proposal can be improved. So we'll link to Gabe's articles, his open letter, and Hester Pierce's opinion piece in the show notes. So here's what you'll learn in this interview, Gabe's background and how he got involved in crypto, the classifications that we tend to give tokens like equity, suffer products, commodities, currencies, and examples of why these classifications can be misguided. We got a crash course on securities law and the Howie test. We went deep into the Exchange Act of 1994, which is an often forgotten piece of important legislation, but that has tremendous impact on companies that issue securities. We talked about Gabe's philosophy and how securities law should be applied when it comes to issuing tokens and launching

networks. And we talked about the safe harbor proposal, what it is, what it encompasses, how it defines things like decentralization and network maturity, and Gabe's thoughts on how it can be improved. So I want to thank Gabe for coming on the podcast. Brian and I did this interview, and he was incredibly articulate in sharing his philosophy, helping us understand securities law, and also how things could evolve in the future. Before we go to the interview, I want to tell you about some interesting developments. Epicenter is the official podcast partner of ECC, and we're so happy to be doing this with Pepo. We're going to have a dedicated podcast booth in the main networking area upstairs.

It'll be like Epicenter Mission Control, and we'll be recording interviews over the three days and posting a lot of content to Pepo. will be soliciting the community's questions for the people that we're interviewing, and also getting people to share just what they're learning and the takeaways from the conference. Also, we're having a casual drinks meetup on Wednesday, the 4th. If you want to register for that, you can go to epicenter.rox slash Paris meetup, and thanks to Pepo for also sponsoring the drinks meetup. So if you're not going to eat CC, if you can't make it, Pepo is the best place for you to follow what's going on and to follow the conference. I wasn't at East Denver, but I followed all throughout the weekend on

Pepo, and I felt like I was there. So to download Pepo, go to pepo.com slash epicenter, and you can follow me there. You could also follow the epicenter community where we'll be posting all the content from ETCC. We're also brought to you by the Nervos ecosystem grants program. The Nervos blockchain went live recently, and they're funding innovative ideas and development to the ecosystem and the protocol. I don't need to go into detail about how Nervos works. They're tool-lar architecture that provides security and scalability because we had Kevin Wang, the co-founder on the podcast just a couple of weeks ago on episode 326. So if you haven't heard that interview, I would definitely recommend you check it out. But if you're a developer and you're seeking funding for an innovative idea,

or if you're just interested in making a significant contribution to building the Nervos infrastructure, please explore the Nervos Grants program. They are. funding projects actively and they have a total of $30 million in funding available. So to connect with the team and learn more about the grants program, including how you can apply and what kind of grants are available, please go to nervos.org slash grants slash epicenter. That lets them know we sent you and here you can find all the information you need. And with that, here's our interview with Gabe Shapiro.

We're here today with Gabe Shapiro. And Gabe, so first of all, this closer, right, we have been working with him as our lawyer through Corius Swan. So I've been kind of known Gabe for a while and work with him. And he's very thoughtful on lots of questions around securities law and crypto and sort of understands both very well the crypto side as well as the legal side. And of course, this is an endless topic that gives so much rise to discussion. and Gabe's written really very in-depth and detailed, yeah, sort of series of post about crypto securities law and sort of his philosophy of what it should look like. So we want to dive into that today.

And yeah, thanks so much for joining us, Gabe. My pleasure. So I guess let's start with our, you know, our typical question of what's your background and how did you, you know, how did you originally kind of get bitten by? to crypto bug and get into this field? Sure. So my original legal background is actually fairly traditional. I've been a corporate attorney based almost exclusively in the Bay Area for 10 years.

And the first seven years of that, I worked at really, really big law firms, their California offices, doing almost exclusively by-side technology. mergers and acquisitions. So I did like, I represented Facebook and the Facebook WhatsApp deal, did a bunch of deals for Oracle, did a bunch of deals for eBay, big public to public deals, some of them, you know, in many billions of dollars, working very traditional law firms, right? Alongside of that, you know, I always had this interest in technology. Obviously, most of the deals were for technology clients. And I got interested in sort of cryptography, mainly from the perspective of messaging apps like WhatsApp. I'd done the WhatsApp acquisition. So thinking about

end-to-end encryption and so on. As I was researching that, you know, I started running into cryptocurrencies. And one day I was reading about this new one called Ethereum and something called smart contracts. And it actually was one of these Eureka moments when I read about what smart contracts were because I realized, oh, this is basically, you know, an escrow without a bank. I deal with escrowes all the time, but with banks as an M&A lawyer, you know, I could sort of immediately see where this was heading and the potential utility. So that was sort of endish of 2015, early 2016. And the first meetup I ended up going to was, if you can believe it or not, Nick Zobo talking at an Ethereum meetup, which nowadays would be unheard of. And since he had this legal background and was talking about all the legal issues around blockchain,

and the law, that pretty much sealed the deal for me. And then there was no looking back. And so then what has your kind of like journey through the blockchain space look like? I know you did some work on Ethereum. That's right. Yeah. So initially, you know, I was pretty tentative. I kept my normal job and all that. But in 2018, I joined up with a company called Grid Plus, which is a consensus spoke. They needed someone in-house for legal. And I sort of raised my head. hand worked with those guys for about six months to get them set up. In the meantime, colleague of mine from Hogan Lovels named Lewis Cohen had started a boutique called DLX, specializing in representing blockchain clients. So I kind of thought, hey, representing lots of blockchain

clients is better than representing one. So I moved over there, worked there for a while, and then subsequently I met some guys who were really interested in building out sort of a tokenized stock platform for Ethereum that we ended up calling the Zero Law Org Augmentation Protocol. So, you know, I focused on that for a while, you know, and that was sort of like my last big kind of commercial project. And in the meantime, I've been representing clients like Chorus one and some others. Let's get into your, you know, your article. So first of all, give us a little bit like what's your take after being sort of active working in the legal space, especially around securities law in the blockchain space after a few years and that? You know, what's your

overall take and what motivated you to write these like series of posts? Right. So basically, you know, back in 2017, when ICO mania was going hard and the SEC first started releasing its actions against tokens. Most of us lawyers, you know, were having a lot of discussions at the time about what all that meant, reading the T-leys, where judges would come out on the issue, et cetera. And while we knew there were open questions about it, I think we all thought that those would be long resolved by now. You know, it's been like nearly three years. And still very few of them are resolved. And still even lawyers who understand the technology reasonably well and are good lawyers understand the law, still debate with each other all the time and have very, very different

opinions. And so my desire, having spent kind of three years in the trenches, debating with everyone and thinking about it a lot, changing my own opinions quite a bit in that time and debating with myself a lot, was to try to write something that cuts through a lot of the noise and deals a little bit more at the conceptual level, right? Because I think people get very green, you know, they're going through the elements of the Howie test and they're drawing analogies to past cases. Is a token like an orange? Is it like receipt for delivery of future whiskey? What is it? And just to think about the tokens and the networks themselves in the purest possible terms with the fewest preconceptions as possible and just try to think about how do the people who actually buy them and like them

and use them as well think about them and why do they value them and then try to go. go from there about how that relates to the securities laws. So that was sort of the approach. And that was the reason for still writing about tokens and securities laws three years later. So one thing that strikes me as interesting here is that it, like you said, it's been three years and U.S. regulators and lawyers are still debating this in the U.S. Why do you think it's taking this long? I mean, speaking from the other side of the pond, it seems that in a lot of other jurisdictions,

You know, these things have been pretty much solved already here in France. There's a pretty robust framework for doing STOs. I know there's sort of similar climate in Germany and places like that. So why is it that this is so complicated in the U.S.? Maybe so as not to be too prejudicial. Like I almost might compare the like the recent FinC guidance to the SEC guidance, right? In FinC's guidance, so they came out, they said in their guidance, certain things are not subject to money transmitting.

right? Like if it's non-custodial and, you know, they sort of said, what do we not have power over? And they were willing to say that in their guidance up front, right? And that's one thing that the SEC has really not been willing to do. They say what might be securities, right? And they try to, you know, cite some of the factors that would lead them to be especially inclined to say that something is a security. But they're never sort of tying their own hands and in advance saying that they won't say something is a security. except for these no action letters, you know, that were granted in somewhere around the last 12 months that are so conservative, right, in terms of fact pattern that, you know, anyone looking at that fact pattern without the SEC weighing in would say that they're not securities. And so to me, that is a bit of a problem. I'm happy with many of the things that the SEC has done. But I do think that that's an area where it's falling down a little bit and being unwilling to go out on a limb and ever say that that there's something that they wouldn't consider a security. Okay.

I mean, people tend to qualify and classify tokens in many different ways, you know, sometimes as equity, as software products, as currencies, commodities even. Give us some examples

and explain why people usually get these wrong. Yeah. Again, you have to separate the legal from the conceptual, right? legally speaking, for example, you know, Bitcoin is a commodity, right? It's a commodity because there are futures that relate to Bitcoin and that automatically makes Bitcoin a commodity as a matter of law. But the intuitive concept of a commodity, right? You think about, you know,

oil, you know, you think about wheat. You think about these things. I mean, these gold, right, these things are sort of like, they have constraints of nature associated with them. They're not they're not synthetic things that humans make. They're not things that depend for their value on a network of humans working together in accordance with certain rules. And so at a conceptual level, tokens and token networks are very different from commodities. A lot of people analogize tokens in 2017 to licenses. And that was sort of one of the main arguments for why they wouldn't be securities

because there's an exception under our securities laws to the effect that if something is bought mainly for a consumer purpose, that it's not a securities transaction. Now, if you think about tokens, they're clearly actually not software licenses because the software involved is you don't need a token to get it, right? You could go onto the Geth GitHub, right, and you can download the Gath software client and you now have a software client that embodies all the protocol rules of Ethereum. The token is not getting you that. You could spin up your own private network of that, right, and you could be using that,

and you didn't need to go and buy ETH to do that, right? So to me, that clearly seems wrong. But what is specific to ETH, right, as what people call EF? It's actually a specific network, right? It's the way you configure that software client to point at Mainet ID1, right? And that's the network you want. You want the token on that network. And if you think about that, that starts to make sense as a framework, right?

Because why is the token on that instance of the Ethereum software more valuable than the one I just spun up at home? It's because there are all these other people using that particular network. It's a shelling point, so to speak. It's something everyone has converged on. And the more people that converge on that network, the high, the value of that token will be. And really in a certain sense, all these tokens are actually designed to track the value of that network. People do things like make them finite in supply or restrict the rate at which they are, the new issuance is done. Right. And so it's almost like

they've been set up on purpose to, you know, appreciate indefinitely as the value of this network. So that's sort of how I came up with the idea of, well, what really are you investing in with a token? You're not investing in the token itself. It's not like buying a bottle of whiskey and you got the bottle of whiskey because you could drink the bottle of whiskey without the distillery. Here, the equivalent to the distillery is like the network and you need that network to use that token. So really, it's a method of investing in this specific network. And it seems to be relatively good at tracking the value of that network over time. So you described this as network equity.

It was the first time that I've heard that I heard that term. Can you explain what that is and how it differs from the concept of equity and a company as we've come to know it? Sure, yeah. In this case, I mean equity. And I was being sort of a little bit deliberately provocative, right, because I knew a lot of lawyers would complain about using the word equity. Because usually equity means it's a claim on the assets of a corporation. after all of its debts are paid, right? That's what a share of stock is, in effect, unless it's preferred, in which case it may have

more debt-like rights. But we also use terms like brand equity, right? What does brand equity really mean? It's like the value that's associated with a certain brand. Yeah, that's the idea. I could have called it also like a share of network value, right? And that would have been a little bit more of a neutral term. But I wanted to kind of hit people over the head with the idea that tokens are not.

not investments in it of themselves. They're, they're letting you track the value of something else. And so it's sort of at least equity like. But it doesn't necessarily entitle you to dividends and payments after liabilities and so on. Although, if you look at proof of stake networks, starts to look even more, you know, like a piece of equity, right? You stake it and you get payments as a result of owning it, not exactly the same as a dividend, but somewhat similar, you know, and so on. Yeah, I mean, I would say we'll dive into this a lot more, but maybe to bring sort of a last point up that people would often use, I remember, for example, KIC used that in their argument, I think, is like, oh, but it's a currency. What's your take on that, like the idea that tokens are currency in these networks? Sure, I think they are currency.

The analogy I use in my article, right, is that is the old company script, right? So there used to be these company towns, and there actually are still provisions in the corporate codes of most states in the U.S. Where you could take a stock certificate and you could tear it into pieces. And those little pieces are script and they don't have any of the rights of a stockholder, but they still can have value. And if you put, you know, say there were 10 pieces, you put 10 of them together. Now you have the rights of a shareholder again. So there used to be these company towns where script would trade. You know, that's a kind of currency, right?

But it's not a very good currency, right? It's a currency in a very weak sense. And it still may be a security, right? Because it depends on the will of this company. But if suddenly lots and lots of company towns started accepting the same script, right? And that it's spread all across the nation and it may be spread to other nations. Then it looks more like a currency. It's very similar, I think, with blockchain networks.

as they become more decentralized, this thing that initially starts to look like it may be have a lot to do with some particular group of people who first created it, it starts to look more like a universal thing. And it starts to not so much depend on any particular person. And so over time, it's going to look more and more like a currency. So I do think it has aspects of a currency, but I think legally speaking toward the beginning of its life, It's not so much best viewed as a currency as most likely security, depending on the circumstances of its launch and who's controlling the network. You know, that's kind of a coherent argument. But let's get into a little bit like what securities law is and then kind of come back to to your argument of how it should apply in the crypto instance. So first of all, the how it tests, you know, most of most listeners will have heard of that and have some familiar.

of it. But can you just very briefly run us through what the Howie Test is and how it has kind of been applied in the crypto space? Sure. So, yeah, this is a, you know, and the key thing I would say here that maybe some people still don't get, even though a lot of people talk about the Howie Test, is that it's a test for one type of security called an investment contract. There's a whole list of types of securities in the 33 Act, stock, bonds, blah, blah, blah. right investment contract is one of them the test is basically that when someone has made an investment of money and it doesn't have to be money that can be a contribution of your time that could be an

opportunity cost as well that you incurred just by locking up some funds for a period of time an investment of money really an investment of value with a reasonable expectation of profits which are not just profits in the sense of excess of revenues over costs, but any type of capital appreciation, any type of gain. From predominantly from the entrepreneurial efforts of others in a common enterprise, then the law says that if that test is met, then there are something called an investment contract exists, which is a security. Now that security in most of the case law is not something, it's not a contract that people wrote down and said, I hereby agree to make efforts for you to help you make profits.

Usually it's quite the opposite. Usually they did a bunch of other things that don't look like securities. But when you sort of look at the total picture, it should be a securities transaction. And so the law implies the existence of a security called an investment contract. you kind of alluded to it, right? That basically seems like what a lot of projects have done in the crypto space is sort of take this how we test and then try to argue that, you know, they don't fall in this bucket. I guess mostly it has been around the last point, right, this effort of others point. That's right.

Sometimes common enterprise, you know, like probably, you know, something like Cryptokitty. NFTs, right? Why are they not securities? I think a big part of the reason is the lack of a common enterprise, right? Because it's not like Dapper Labs is keeping a copy of the same NFT, you know, that it mince each time. And so it's not similarly situated to each buyer. But you're right, typically they're hanging their hat on the efforts of others. So oftentimes the Howie Test has brought up and, you know, we've heard about the Howie Test numbers of times. But the exchange, Act isn't necessarily the first thing that people will cite when talking about tokens and the possible security status. What is the Exchange Act and what does it have to do with all of this? Yeah, so you're exactly right. Most of the discussion has just been around fundraising activity, which is covered by what we call the 33 Act. And that, you know, the core of that act is

every sale of securities has to be either registered with the SEC or exempt from registration, very simple. The 34 Act deals with what happens next. What happens when you have a security and then you want to start trading it after the initial fundraising? So there's a whole set of secondary market regulations around that and a little bit depends which ones apply, depend on what type of security it is. There are two main categories, debt securities and equity securities. If it's an equity security, it's much more highly regulated. So now you're now you're kind of getting at my diabolical reason why I called it network equity is to suggest that maybe some of the regulations under the Exchange Act, such as relating to limitations on

insider swing trading of the security, rules about how you solicit votes to the extent that tokens may be voting securities may be relevant early on in a network's life while it's still effectively controlled by a small group of people. Can you go a little bit more in depth as to the requirements in the Exchange Act? I mean, I guess it would be interesting to understand where a lot of crypto projects maybe are failing to comply to the laws under which fall under the Exchange Act. Sure. So the big one is if it's an equity security, there's a rule called 12G that says that if it

If the security is held by more than 499 unaccredited investors or more than 1,99 investors overall, and the issuer has at least 10 million in assets at the end of a fiscal year, that the issuer is required to become an Exchange Act reporting company. What is an Exchange Act reporting company? Think of Apple. Think of Tesla. Fully public companies. That's a very expensive regime that,

that really only mature high-value companies are equipped to deal with. And what are the interesting things is that in pretty much all of the settlements that the SEC entered into with token issuers, Paragon, Airfox, etc., other than Block 1, part of the remediation that was ordered of those issuers was they had to become 12G reporters and none of them ended up successfully doing it so far. But so clearly the SEC at least implicitly thinks that these may be equity securities. So once you're an Exchange Act reporter, you become you have to file 10ks. You have to file 10 cues. These are long annual reports with a lot of financial information. You also have to publish

a lot of information. And this I think is probably more relevant to tokens than the financial stuff. Information about, okay, who are your officers, your directors, who owns 5% or more of the security, and you have to report about those things. And even if a third party goes out and it acquires 5% or more of the total outstanding tokens, that person is just independently having nothing to do with the issuer, they're required to report with the SEC about their holdings. So these are the types of regulations that apply under the Exchange Act. And of course, there are a lot of sort of just pure market-based rules, like for example,

all the rules about securities exchanges, right, and them having to register, right? Those are under the Exchange Act as well. Yeah, I just wanted to briefly loop in on this thing you said. So, yeah, there have been various settlements with the SEC, right, like Paragon being one thing and a bunch of others. And so do you mind just elaborating a little bit on you said that none of them have been able to basically comply or live up to these reporting requirements that they've agreed to in the settlement. So, like, how did those cases play out in the end?

Yeah, I'm curious about that myself. They basically just totally flaked on the SEC. They made some preliminary filings. The SEC made some comments. And, you know, from what I understand, they, they just kind of, you know, scattered to the winds, said they ran out of money. And I'm sort of waiting for the other shoe to drop on that one. But, you know, it does go to show that it's, look, I don't know. Let's assume for the moment that those teams were attempting to comply in good faith with the order. I'm not totally surprised that they were having trouble doing so because it's just it's not a reporting regime that's designed for startups. It's designed for something like Apple, you know, or like, let's say Uber, you know, that had great funding and really built up a business over 10 years and then it's ready to IPO, right? So I'm not surprised that they ran into problems. That's an interesting point. I think that is one of the things about, I guess, regulation that applies to crypto that. I mean, we talked about this recently also with Yaya Funnusi in terms of sort of KYC compliance and things like that.

A lot of these regulations were just not meant to be applied to startups. And regulators are either having a hard time or not wanting to, you know, have that regulation evolve. I mean, in terms of the Exchange Act, I mean, just broadly looking at, most of the big crypto networks, you know, based on what you're telling us with with regards the proper reporting, you know, insider trading, et cetera, it would seem like some of them might be failing to report or might be failing to be compliant with this exchange act. Why do you think we haven't seen, you know, a lot of these projects getting sued by their token holders? And it seems like no one's really talking about this.

Let me pick up on two things you just talked about. So the one thing I would say about the, you know, just going back to the point about the Exchange Act and it being difficult to comply with, there is something called Regulation A-plus, right, which was sort of designed to be an IPO for startups, right? Because people do recognize that this is a problem and they would like companies to be able to get access to the public market sooner. So that's why Regulation A-plus was passed. And what enables you to do is raise $50 million from the public, up to $50 million. and you have a much lighter reporting regime, still a reporting regime, but lighter, you actually get an exemption from those tougher reporting obligations for some period of years.

Now, there are some tweaks that might need to be made to that for tokens, like there's a transfer agent requirement and stuff. But so there's not no option for startups. It's just that you have to decide to use it at the beginning, which would require that you labeled your tokens as a security from the beginning, and none of these projects did. Now, as to why more projects haven't gotten pegged, that again is a complicated question. You know, I think it's one of the reasons is that the SEC can only go after so many things. There's a private right of action, as you point out under the securities laws for people who feel like they got ripped off.

A lot of people made money, you know, from a lot of tokens. And a lot of people who bought tokens are not the kind of people who make good plaintiffs, right? because my sense is a lot of them may not have paid taxes on their crypto for many years. A lot of them may not be U.S. citizens, right? A lot of them may not want to KIC themselves in order to pursue a complaint even if they did lose money. So I actually think on the private action side, there's quite a bit of that going on. And on the SEC side, there's a lot of how do you unscramble the egg? We went after some.

It didn't really deliver a good result for investors. The Block 1 result is interesting, right? Because they had a lot of money still. They paid a really big fine, and they weren't required to register the tokens as securities. So, you know, in a sense, it was a big win for the SEC. I'm not quite sure what EOS holders got out of it. But on the other hand, no EOS holders from the original sale were probably damaged

because the token went up a lot. So there's a lot of that sort of thing going on, just real politic. But you could probably see more. I think the SEC doesn't want to kill the technology, so they've been pretty judicious about what they've gone after and when and why. Kick and Telegram have been their two big targets to date. And I think the reasoning behind that is it's a clear case of here are two companies that use tokens kind of in lieu of inequity financing, right? And I think one of the things the SEC rightly doesn't want to happen in the markets is they don't want to create

a strange situation where a certain type of financing that implicates the securities laws or maybe ought to implicate the securities laws is given preferential treatment and the whole market just gets distorted toward that due to a weird loophole in the laws. I actually do think they're very smart about what they go after and they're not just trying to tyrannize the entire market. Let's take a step back briefly because one of the things that you've discussed quite a bit in your post is sort of to say, okay, let's look at the culture of the cryptocurrency industry. Let's look at, you know, some of the maybe undesirable behavior, some of the strange incentives, and how, you know, securities laws has caused that.

So can you talk a little bit about that? Like, what's your take about, you know, kind of what's wrong in the blockchain industry and what it has to do with securities law? What's wrong is basically it's just a strange species of hypocrisy, in effect. we know why we like tokens. People want the tokens to increase in price. People want to be trading the tokens. People view the tokens as investments in the network at the early stage in the team. They're evaluating when they're thinking about buying the tokens. They're looking at who the people on the team are, just like they would be if it was a startup. The people who are in the project,

they're giving up the token allocations, just like they would be whacking up equity and a valuable, potentially valuable hot startup. These are investments. Let's just view them as investments. That's how people think of them, right? There are exceptions, of course, Cryptokitty NFTs, right? Whatever.

But for the vast majority of cases, they are investments, and we've been trying to stick our heads in the sand to try to get regulatory arbitrage and argue that it's like buying cotton candy, you know, at the amusement park or something. And it's just not. The point of my article is,

they can be investments and still ultimately not be securities, right? Because the SEC or Director Hinman from the Corp Finn Division of the SEC came out with this amazing speech called when Howie met Gary Plastic about how basically Eiff may have started out as being a security in its early days. And over time, it basically turned into a public commons controlled by no one. And so now the securities laws just don't really make sense to a. apply to that, we need to figure out what that point in time is and define it better for people, right, which is what I think the purpose of a safe harbor should be. But what we shouldn't do is just keep pretending that they're not investments because it's just not true and it's just kind of dumb. And it'd be better if we could just all admit what the things are and pursue them for

the reasons we want to and then figure out how the regulations deal with that. Maybe just the final points on this. What do you think have been the negative effects of people, as you sort of describe it, I guess, kind of skirting around the issue? So many negative effects, right? Because if everyone was open about the fact that the tokens are investments and what regulations applied, then the teams could try to do their best to give the buyers what they're looking for, which is gains. They could be like Elon Musk is a Tesla. He owns a lot of the stock. He's always trying to make the stock go up. Sometimes he gets a little too aggressive with that and the SEC gets mad at him, right? But the teams could be trying to deliver value to the people who are owed that value

because they invest it. And instead, perversely, they're driven to do the exact opposite. Thanks for the money. This was basically free money to us. I'm sorry the token price is going down. we can't do anything about it. We can't get it listed on new exchanges. We can't market it and go to the world and say why people should be buying this token because we're driving value to the platform every day. That's just crazy, right? I think I saw an interview, you know, some talk Vitalik was given a while ago.

And people were asking questions at the audience. And one guy stood up, he had the temerity to ask about ETH price. And they like dragged the guy out of the room. Now, imagine an Apple stockholder conference, right? I'm not saying specifically for Ethereum, because now it is, you know, fairly far along. But like imagine an Apple stocker, and someone asked Tim Cook about Apple Price and they like drag the guy out of the room. This should not be happening, right? Vitalik should feel free to answer some question about Heath Price. And honestly, I kind of feel like he should feel at least a little bit of an obligation to say something

about Heath Price because after all, that's why the vast majority of the people have bought it. it's just gotten topsy-turvy because of this desire to try to pretend that it's not a security and doesn't have investment reasons for buying it. I love the clarity in what you just said. I just want to point that out. Good. Let's say one did as you propose. What would that look like? Hester Pierce, right, Commissioner Pierce, came out with a safe harbor proposal recently. And without getting into too much in the weeds on it, what she proposed is, is, basically let these networks launch, just only apply the fraud rules to them for the first three years. And then after three years, test basically whether the network is mature, that maybe overlap somewhat with sufficiently decentralized and decide whether they're securities.

I think that goes a little far. I don't even know if the SEC has the power to just say, yeah, we're just going to say that we like something so much. The securities laws just don't apply to it for three years. Just to clarify, this idea, okay, networks launch and only fraud rules apply, would that mean that, for example, public token sales like we saw in sort of 2017, like you could do that sort of thing? Yes. And not just sell to accredited investor and all that. Yeah, you could sell to anyone. I don't think that's going to end up being supported, you know, by people outside the space or by many people outside the space. but I do think what we should do, right, is clarify this point of when does it stop being a security?

If it starts out being a security, when does it stop? Right? Because a lot of, even the most conservative members of the staff of the SEC seem to be somewhat aligned with that approach, right? Even Clayton, you know, seems to be somewhat aligned with that approach. What I think would look like is somewhat like what Blockstack did. They did a regulation A plus offering. They had to, now to get that in and of itself as somewhat expensive and probably too expensive. The SEC could do things to lower the cost of doing a regulation A-plus offering.

They could do things, they could make a more specific, a more crypto-specific variation of reg A-plus. I believe that's within their power. So, for example, they could say that right now there's a rule that if you did a regulation A-plus offering for an equity security, you get this kind of like indefinite plus two-year-ish reprieve from Rule 12G. If you use a transfer agent, you process all transactions through a transfer agent. Well, this is crypto. We don't want to process transactions through a transfer agent. That's going to make it useless.

But the SEC could say, okay, if it's crypto, the blockchain is the transfer agent. They could totally do that. And in fact, Blockstack took that position in its filing, and the SEC qualified the filing. You could use something like that. Reason why that's not enough for many people in the industry is they say, well, BlockSack isn't trading on Coinbase. This is very bad, right? Okay, what I say to that is Coinbase, get your act together, go register as a securities exchange. Why can't you do that? Create a crypto, create a Coinbase Crypto Securities Pro or whatever, right? And have that be registered as a securities

exchange, and then those things could train there. What about Dexes? Personally, I think that a true dex is just facilitating a peer-to-peer trade. And I don't believe that that ought to be required to be registered as a securities exchange. The SEC, if they agree with me on that, they could clarify that publicly to the world, right? And that would be a way that even non-reg A plus, even sort of things issued in private placements that eventually become freely trading, you know, those could trade on their even, and that would be an even less expensive path. So there are these ways. I think what we should do is not try to keep fighting the basics of American securities law, but focus on this idea of this idea of,

mutation and say in the meantime, let's improve the crypto securities rails so that even when things are securities, they can trade relatively freely and with people being protected. And hey, by the way, there are also all still all these things called like STOs and stuff like that, like tokenized stock and things like this, where it's never going to stop being a security. And an incidental benefit of improving the crypto securities rails for tokens that are temporarily securities is it will also improve the crypto securities. rails for all those things and that may actually become the basis for fundamentally improving the infrastructure of all of our public securities markets this type of approach I think is more

holistic more forward-looking is actually embraces crypto more in the long term and I think it's what we should do just to clarify that so what you're saying basically what you're proposing is that like a project could go and raise funds maybe through some sort of, you know, regulated, reg D exemptions or selling to accredited investors, or maybe there could be something like a reg A plus, something like what Blockstack did, but, you know, maybe a cheaper, simplified version that's more kind of geared around crypto. So what exactly does this, let's say there was this three-year safe harbor? Like, what does that do?

Well, so under Commissioner Pierce's version, the part you just mentioned about needing reg D or reg A plus, you wouldn't need those. You just get out of everything for three years. And Coinbase could trade the tokens for three years, even though their securities. Under my version, that wouldn't be the case. You would need, you know, Reg A plus or you'd need to do Reg D. They wouldn't be able to trade it on normal Coinbase. But you'd also have some benefits, right? You wouldn't have to like immediately go become Apple. There's a difference in vision there. Which way will it go? I don't know, right? The key. thing that both proposals have in common, though, is you have to pin down some type of concept,

and you have to tell people in advance, when would this no longer be considered a security? That's the concept of network maturity. Under Commissioner Pierce's definition, it's that either the network is functional for its kind of originally advertised purpose, or it's kind of no longer controlled by anyone. under my version, it's a kind of a three-prong test. It's that there's no longer functional control of the network, there's no longer economic control of the network, and the initial development team has sort of fulfilled all of its promises. It's performed the investment contract, so to speak. The investment contract has been performed. There no longer is an investment contract,

and it's no longer a security. That's kind of the idea. But that would imply that there would need to be an investment contract. That's right. To begin with, which in most cases there are not any sort of formal investment contracts in these cases. Under my version, one of the ideas would be you file with the SEC at the beginning in order to take advantage of the safe harbor, and you basically say what the investment contract is. So now instead of it being a bunch of implicit fuzzy promises, are they promises, are they not promises, are they merely forward-looking statements in a white paper and in some forums and in some Slack channels, you now have the benefit of everyone knowing we are the founders of this project,

here is what we're going to do. When we do this, we will go away and the network will have to stand on its own. And I just think that's better for everyone, for the team, for the buyers, for the market. And it lets you kind of say, yeah, instead of the investment contract being applied by law, now there's one written down on paper and it's actually like objectively measurable. Do you think that this aligns with the incentives of founders? Like in your proposal, do you feel that everyone's incentives are aligned in a way that the founders can feel that they, have made money from this project, because they're also looking to make money, right? Like, let's be honest about that. By having an investment contract in which they promised to

at some point leave the project, can they still be aligned in that sense? By the way, they don't have to leave. They just have to stop being sort of the biggest contributors. And they have to give up control. That's kind of the more important thing, right? If you're contributing and you don't have control, that doesn't implicate the securities laws. The one way it's worse for them, right, is the same way that Travis Kalaniak had to wait, you know, until sort of an Uber IPO, until he could really cash out. This would go kind of in stages, right? Initially, you know, founders would have something that's, you know, relatively illiquid

and hard to price, just like in a normal startup. Over time, it would become more liquid and easier to price, right? And they would have exit opportunities along the way. And they would probably want to titrate that over time so that, They're selling a little bit at each stage of the way. And if they've done their job well, the value of the token will go up and up, and they'll actually want to hold onto it. They won't want to sell at the earlier stage.

They'll be wanting to sell as late as they can. I think it align the incentives way better. It's more like a traditional company trajectory. What do you think the role of foundations is in this context? And what are some of the criticisms that you have with regards to the way that many ICOs have structured themselves as Swiss foundations? I'm not trying to impugn anyone, right? All these projects are doing good work, et cetera.

But from, you know, kind of a let's cut through the noise here, the foundations are basically, you know, they're getting massive tax benefits, right? Because the proceeds of the token sale are not treated as income. Ironically, if they were sold to securities, they wouldn't be taxes income either, right? Because they'd be capital contributions. But, you know, really I see it as, you know, that's another distortion. Because the people didn't want to call them securities, now suddenly it's like, oh, I'm saying for securities law purposes, I'm selling this product. Oops, that means I'm going to be taxed on all this stuff. But really, I just want to use it as capital to build the project. So I now need to find some other way of not getting taxed on it. Let's say we're not really a company. Let's say we're a non-profit. But I think a lot of these foundations are basically run like companies. They're basically, you know, because all the people in them hold a bunch of the token. Everything they're doing is driving profit. to those people, you know, it's just happening in a disguised way.

That's really what I think is going on. It would be better, look, it'd be better if they were just companies. To be honest with you, it could just, you know, nakedly pursue what they're actually doing, you know, which is driving value to this instrument and benefiting the people who bought it and the people who worked at the foundation who hold it. I think what Zcash has done to decentralize this governance, and again, they're in a little bit of different boat. They never did an ICO, so who knows if their thing exactly was covered by a security

he's lost to begin with, but it's very interesting, right, because the foundation is sort of one player that's contributing value. There's also a company called the electric coin company that's a for-profit thing that has venture investors. That's some of the things it does are related to Zcash, some not. And they've set up a complicated sort of detaunt between those two main players for how to govern the network. And that looks pretty decentralized to be. But most of them are not, don't have that going on, right? It's really the foundation is the elephant and they're basically running the show. Just a brief interjection on the foundations first. I personally I actually find it, it's kind of a nice vehicle in that they do have a sort of like explicit purpose, right? Like at least in

Switzerland, right? You have like a description of like, okay, this is what the money has to be spent for and then they're like all they did and supervised. And so there is kind of actually it's a little bit like what you described in the sense that there's kind of like some sort of promise made and then the funds have to be used to that you know which is very different from something like block one did where you have this for-profit came in ion company and like they can do whatever they want with the money that there's no which i think they did also pay out like some massive dividend right to the shareholders what i think should be you know in the united states as a pure corporate law movement, we have this new trend that even some of the old school Delaware law junkies

are getting into now called public benefit corporations, right, which are corporations that may be run for profit in a certain sense, but are able to, they're not sort of solely for the benefit of their stockholders. We've just begun scratching the surface on the potential for that, but I think that kind of new entity, which is sort of like it's for the public benefit, but it's not exactly not-for-profit is kind of what might end up ultimately being the right vehicle for these open-source software network commons, you know, to be governed under. But no one's really, you know, kind of fully explored that yet. You have a, you know, sort of coherent thesis for how you think it should play out.

Now, I'm curious, what do you think will actually happen? Like, what's your prediction of how we see this thing develop in the next year or two years? or beyond that? I have no idea, man. I won't even say flip a coin, you know, get a Dungeons and Dragons, you know,

dice and roll that, right? Because that's got like, what, like 16 size or something? And no one knows. It's too crazy, man. I mean,

that's what keeps me in the space. Don't forget, we've got so many other X factors out there, like what will the CFTC do about defy, right? And then all the swaps,

you know, and synthetic derivatives that are being created in defy. And what, will Finsen do? You know, secretary, just sort of, the Treasury secretary just kind of sort of threatened last week that a bunch of new guidance and or, you know, regulations are coming about that. So there are many X factors.

I couldn't tell you. I could see something, I would say it's equal odds that we give free reign to ICOs again and that, you know, there's like another like massive crackdown, you know, where everything has to go underground. And some of it depends on how the next election goes and who gets appointed as the next SEC Commissioner and all this kind of thing. It's fascinating and no one knows. We have the telegram case, I think this week, this week the motion for summary judgment on whether the distribution of grams under telegrams pre-purchase agreements with this investors should be

enjoined on the basis of securities laws. That could have a huge effect, which way that goes down, and I don't know which way it will go down. It would be great for all these regulators, is the CFTC, the Securities Commission, everything, like to align on some kind of coherent regulation in all their respective jurisdictions. That's never going to happen. No, I don't know. Anything that involves, like, lots of coordination or like, oh, we'll create a new agency and it'll be a new set.

Like, that's going to be the hardest of all, right? And therefore, it's also the least likely, I would say. There's sort of a final topic I wanted to dive into it a little bit, which is, you know, we've talked about the SEC and U.S. securities law pretty much the entire episode. Now, of course, blockchain space is, you know, probably the most, certainly one of the most kind of international and global industries that there is. And kind of, you know, almost every project is global from the get-go. All these networks are with teams distributed, entities in many places, token holders, users all over the place. How do you think that, in the context? How do you

think that impacts, first of all, what makes sense for the U.S. to do and how the U.S. should or will approach that and, you know, kind of like how this is all going to play out? It's very tough, right? That's the objection that a lot of people raise are like, well, look, foreign jurisdictions are much more liberal about this. We can't have everything out of sync. You know, the U.S. needs to kind of get in sync. Personally, people are going to hate me for this. People are going to think I'm a jingoist. I do think that world financial market regulator, tend to ultimately follow the United States, right? Part of that is because, you know, the United States and its international proxies

start strong arming little local jurisdictions like Malta into doing, you know, what it will. Like, look at what happened with Panama. This is a great example. In Panama, something called in the United States, bearer shares are illegal. You guys know what bearer shares are. It's like a company issues a stock certificate. It's like whoever is physically holding this stock certificate in their hand owns a, a million shares, you know, of this company, right? That's basically what it is. That the last state

in the United States to ban bearers certificates was Wyoming. And that was in 2007, I think. They're illegal in every state. Sorry, why are they illegal in the U.S.? They're a great tax dodge, right? So basically the federal government, you know, pressured all the states to ban this because it's an amazing, just like crypto. The same thing. You know, who now hates crypto the most out of every agency, the IRS. But Panama, and worldwide, most jurisdictions now ban bearishers. But Panama was like the Haven. It was like whatever the Cayman Islands or Gibraltar are for tokens, right?

Panama was that for like companies that want to issue bearer shares. Eventually even they had to capitulate, right? And they didn't want to like go so far. They didn't want to totally lose face by like banning them. But they set up this like complicated structure where they have to be held, you know, effectively they totally. nullified them. It took a little while, but every time these like special jurisdictions come up that are kind of like, hey, come to us because we give you better laws for the cool stuff you want to do,

it never lasts. The bigger countries that want the tighter regulations always win. And the other thing, I would say, is that the U.S. laws are different from other securities laws, really just in the sense of these investment contract, how we test thing, right, where it kind of tends to suck everything in. and other jurisdictions don't have that. But as these proof of stake networks get more popular or existing proof of work networks transition into proof of stakes and you have voting, you have staking to get network rewards, right? And you have companies like Cracken that's going to make that incredibly easy for people to do with putting in no work and these sorts of things. Tesos, where you vote and it's this automatic upgrade. When regulators even, I think, outside

of the U.S. start looking, revisiting their 2017-ish guidance in light of those things, I think they're going to have a rethink because that starts to look like securities under the laws of nearly any jurisdiction. I don't know ultimately, but if I had to bet, I would bet that the international laws are more likely to start becoming like the U.S. laws than the U.S. laws are likely to start becoming like the international laws, which is why I want the U.S. to say that within the law, laws, you can have this evolution, and that once it's the real cypherpunk deal, decentralized, it's a peer-to-peer thing, and we're not trying to get in the middle of that. That, to me, would be an incredible result. Well, that would certainly be desirable, and let's hope that

things go that way. I guess you're right. I mean, one of the things that we'll have a massive influence on this is the result of the next U.S. election. It's unfortunate to consider what the results of that might be, but I guess we'll have to see what happens then. Maybe we'll have you on again after that happens depending on the results. I would love to. Thanks for coming on, Gabe. My pleasure, guys. Thank you so much for having me.

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