Invest Like the Best with Patrick O'Shaughnessy - Preston Byrne - Crypto-pocalypse - [Invest Like the Best, EP.72]

Starting point is 00:00:00 This episode of Invest Like the Best is brought to you by Paxos. I have personally interviewed Paxos's CEO, Chad Kaskarilla, on this podcast before, and I'm excited about how they're changing the crypto landscape. Whether you're a small fintech or a large financial institution, with Paxos crypto brokerage, you can offer your customers crypto buying, selling, transferring, and more, all with Paxos's easy to integrate APIs. Paxos takes care of everything in the back end from licensing and compliance to custody and exchange. You can start offering crypto to your customers within months. I've gotten a no Paxos over the years and have been personally impressed with their track record.

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Starting point is 00:01:04 I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfield guide.com. Patrick O'Shaunicey is a principal and portfolio manager at O'Shaunacy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunacy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

Starting point is 00:01:39 Clients of Ashanti Ascente Ascent Management may maintain positions in the securities discussed in this podcast. My guest this week is Preston Byrne. Preston is a vocal critic of the crazy prices and projects in the world of cryptocurrencies. His background is in the legal world and also as a founder and former COO of Monax, which made the first open source permission blockchain client. As Preston says, he is a blockchain without Bitcoin guy who believes that this cryptocurrency, Media will end in some sort of apocalypse for token holders and ICO issuers. We tackle several issues from his broad skepticism of crypto assets to the potential regulatory reaction from major governments to types of coins like stable coins, which Preston views as analogous to perpetual motion machines.

Starting point is 00:02:32 Like the Hash Power documentary, this episode and other Hash Power singles are brought to you by Fidelity Investments, a company that is constantly researching and experimenting with emerging technologies like crypto assets and blockchain to improve the lives of their customers. Fidelity provides a comprehensive set of products and services to individual investors, employers, and financial advisory firms. For more information, please visit Fidelity.com. Please enjoy our conversation, and for any crypto investors out there, let me know if this affects your opinion of the investing prospects for cryptocurrencies, generally speaking. Let's talk in some detail about your notion of a Nakamoto scheme. So I think you had called some aspect of something a Ponzi scheme and then gone back and refined that idea a little bit.

Starting point is 00:03:20 So maybe refresh on Ponzi schemes or pyramid schemes. schemes, they're a little bit different, and then what you now call a Nakamoto scheme and what's distinct about it? So Ponzi schemes and pyramid schemes are what a lot of people who have first, particularly old men, in my experience, they look at Bitcoin and they go, well, this is a Ponzi scheme. And they look at it as a Ponzi scheme because, you know, particularly lawyers, a lot of old lawyers I was spoken to, they look at it and they say, well, there's no rights or obligations, there's no one to deliver, they see this shell, and they just see people putting money in and somehow getting money out. So they say it's a Ponzi. What a Ponzi scheme is is when you have one person who sits on, you know, cash flows. So money comes in, money goes out. And they use the money that's coming in to pay the returns to earlier investors in the scheme and presumably to enrich themselves at the same time. So basically, it's one operator centrally managing a scheme where they're fraudulent. They're saying, well, you know, the accounts are fraudulent and the scheme's fraud. Bernie made off. Prime example. So basically, eventually, if you have a rush on withdrawals, of course, the cash flows.

Starting point is 00:04:23 don't meet the outflows. And so what happens is the scheme collapses under its own weight. Alan Stanford, another prime example. So with a pyramid scheme, slightly different, that's a little more decentralized in that you have a person at the top of the pyramid who then recruits two or three or four more, and then they recruit two or three or four more. And they pay commissions to people up the ladder until eventually you go down a sufficient number of levels.

Starting point is 00:04:44 And the person at the top, if they've managed to recruit another 16 people gets a big payout. And then the 16 say, well, he got rich. so I'm going to go do the same and go recruit more. Of course, that also runs out because, you know, it's like the old Persian king, you know, with grains of rice on a chessboard. If you keep doubling and doubling and doubling, you run out of space really, really quickly, especially after 64 of them, for example.

Starting point is 00:05:08 You know, you wind up having more people than there are atoms in the observable universe. So that doesn't really work either. So you run out of victims and the scheme collapses under its own weight. A Nakamoto scheme, the term Nakamoto scheme, is really a way of, thinking about Bitcoin as a sort of updated Ponzi pyramid scheme, but one for the digital age. So Bitcoin operates very much like a pyramid scheme or a Ponzi scheme legally. There is no underlying subject matter which makes it valuable.

Starting point is 00:05:36 It is simply valuable because other people want to buy into it and people buy out with new investor funds that have entered the scheme. So that is very classically a kind of Ponzi-ish arrangement. But where it differs is that it's headless. So what the scheme does, instead of having identifiable cash for, lows to identifiable people. As it puts the cryptocurrency exchange between the buyer and the seller, it then abstracts the demand to enter the scheme and the demand to leave it as aggregate demand and

Starting point is 00:06:01 aggregate supply. There's no fundamental underlying thing that the law recognizes as a legitimate subject of a sale. And then what happens is they just carry on and the thing runs itself. So the Nakamoto scheme is basically just saying, look, it's not a Ponzi scheme. It's not a pyramid scheme. Someone figured out a way to automate those kinds of interactions for a peer-to-peer cash system. But when you introduce speculation into that equation, it starts operating a heck of a lot like

Starting point is 00:06:26 your classical Ponzi scheme. I remember when I first started exploring this stuff, reading a post you had written called the original bear case for crypto. And at the time, kind of approaching this as a novice myself, just being amazed that the market cap of all the coins was something like $150 billion when I first started looking at it. And I think in your piece it was $170 billion, something in that range. And now it's 790 or, you know, it changes by the day. But it would be really fun having read the three-part piece to kind of go through that bear case for crypto as you laid it out, starting with that first one. And I think you've got kind of a couple different levels of apocalypse down to light regulation or something like this. So maybe we could start with the most extreme, which is, I think you called the Marmot Apocalypse.

Starting point is 00:07:10 It was the zombie marmot apocalypse. So by way of background for your listeners, I wrote a series of blog post called The Bear Case for Crypto in several parts. And basically, you know, in broad strokes, the first bit is that there's a huge regulatory risk. The second bit is that there is a liquidity risk. And the third bit is basically that grandma is going to come up eventually and start suing people. And when you piss off grandma, that's never good for anybody. But in the first bit, the regulatory part, there are three different sort of subcategories of, you know, it's kind of like asking what stage of cancer you have, if that makes sense. So if you're very early stage cancer, you know, it's very light chemo, that kind of stuff.

Starting point is 00:07:52 And so if we're early stage in terms of, you know, this bubble taking off and being getting quite entrenched in society, then it's likely that the regulators are going to take some time to get up to speed with it. They're going to need more time, you know, and considerably more time a year or two before you start seeing major enforcement actions. And a lot of the projects that we're seeing today are going to pass by unnoticed. I think that's where we were in 2014. So there were a great many projects that were started in 2014.

Starting point is 00:08:19 Some are active, some are not. But generally speaking, I think the only real major enforcement that we've seen from that era was a scheme called pay coin, which actually took place here in Connecticut. And a guy named Josh Garza, he was selling mining contracts that turned out to be something more akin to Ponzi schemes. He then had a cryptocurrency, which said that it had a price floor, which promptly broke. So price-paid cryptocurrencies are not good for anyone who's ever read my blog. And so that was that kind of phase. The second phase is when you start to see more aggressive enforcement, but not full on.

Starting point is 00:08:51 And that's where I think we are now. So we've seen China cracking down in various different ways. We've seen South Korea now doing some tax investigations. The SEC has been not quite as quick off the line, but I think they're probably doing their diligence. I don't think there was sleep at the wheel by any means. The DOJ has said nothing, which is quite interesting. And you haven't really seen too much by the state securities regulators of state attorneys general yet. And I suspect that's because those are primarily driven by

Starting point is 00:09:17 complaints, which we haven't had, because as long as everyone's getting rich, nobody's complaining a whole lot. So that's kind of phase two. Phase three is the zombie marment apocalypse. And that is a sort of nightmare scenario where you have where you see, you know, enforcement actions, exchanges getting shut down because of money laundering offenses. Sort of imagine what happened to BTCE a couple months ago, but then happening to exchanges that operate here in the United States or exchangers that operate in the United States. It's certainly conceivable, I think, or the United Kingdom or any other Western country, whereas BTC, he was Russian. I think, you know, the guys back home have been, you know, probably in a dialogue with the authorities and therefore

Starting point is 00:09:58 given something of a free pass. Query how long that can continue, particularly as Congress and other entities start to acquire some cognizance of how this all works and the numbers that are being presented to regulators start to look like things like long-term capital management or Enron. or indeed Bernie Madoff. So we're now in the territory with the notional figures that are involved exceed those three scandals by some margin. And so the question is whether this is going to be allowed to continue or whether this is going to spook the regulators into making very aggressive action and demanding reform by market participants. So that's the, that's the regulatory angle. And a lot of entrepreneurs, entrepreneurs don't care usually when you go, you know, you could wind up in an orange jumpsuit for this. They're like, whatever, Yolo. You know, it could be Mark Zuckerberg as well. why don't we do that? But my background is as an English structured finance lawyer. So I clearly look, you know, when the only tool you have is a hammer, the whole world looks like a nail. So my training is to go and identify those risks. And so, so that's just how I look at it. Can you get into the sausage factory a little bit with this issue in particular where you've got

Starting point is 00:11:02 a whole bunch of interested parties here, one of which is a very powerful kind of venture capital backed, technologists backed, some of the smartest people that I've ever met are hugely behind this movement. But the extent to which they have sway over the regulatory path, kind of who the various parties are that are influencing this and how that actually happens. Like I talked to Peter von Valkenberger as an example as part of the Hash Power series, who's a really thoughtful guy. And obviously he is trying to help thoughtful regulation happen, but from the perspective of someone that supports cryptocurrencies and blockchain. So can you talk a little bit about like who the major players are that might influence when and to what degree there will be new regulation in the U.S. specifically?

Starting point is 00:11:44 So in terms of who is influencing when new regulation will come about, and this isn't necessarily U.S. specific, it's going to be when a prosecutor needs to make their career on something, or when some politicians get spooked because they start getting angry letters from their constituents, which I don't really think has happened anywhere. And then on the flip side of that, of course, who are the formal lobbyists in cryptocurrency? You have Perri-Anne Boring's group down in D.E. and you have Coin Center with Peter and Niraj and Co. But really, apart from that, there isn't a formal lobbying effort. So what it is is you have the regulators looking in from outside and seeing all of the glorious

Starting point is 00:12:20 claims that have been made. And you know, the cryptocurrency can do this and it's wonderful and it's going to bank the unbanked and do this and do that. They don't necessarily have the technical chops on the regulators side or, frankly, on the venture capitalist side either to really sense test those claims. I remember about two years ago when people were starting looking at enterprise blockchain, There were VCs who were saying, well, this can never possibly work. You need the mining in order for the Bitcoin to happen.

Starting point is 00:12:43 And you're like, well, no, you don't. That's just a consensus mechanism. You can swap it out and use something else. So they wrap their heads around that eventually. So I think there's a degree of misunderstanding as to how the technology actually works, what its limitations are, what it can do. That tends to be quite serious on the regulator's side, somewhat serious on the VC's side. But then again, the VCs have the interest in making sure that the startups,

Starting point is 00:13:05 their funding attract public interest. and that people buy and use their services and that sort of thing. So I don't think generally across the industry, we're having a serious enough conversation about how serious the limitations are on the technology. And in particular, people are very reluctant to stand up and challenge claims that are made by people who support the technology.

Starting point is 00:13:26 So if someone says Bitcoin will make the world more equal and make things financially great for everybody, and you look at it and you go, well, actually the genie coefficient of the Bitcoin universe is 0.8. 9, which is about 2% worse than North Korea. Genie corn efficient, meaning wealth concentration. Correct. So it's very, very, the wealth in Bitcoin is concentrated in very few hands,

Starting point is 00:13:48 in fact, more so than, you know, if it were a standalone economy than any other economy on Earth. So it's really hard. And then people will say things like, well, Bitcoin will disrupt governments and render them obsolete. So there are all of these forward-looking statements that we see being made about this currency, which is basically, you know, operates in society as an investment, but which no one really has standing to challenge. And if they do, they get shouted down by by legions of people on the internet who say, no, no, no, you're wrong about everything. So we have this very compelling sales pitch with not a lot pushing back against it. Maybe we can get into a little bit on the notion of a digital asset. And I think you've written

Starting point is 00:14:26 in a few spots about utility of blockchains being intrinsic to the blockchain itself versus a token or a coin being some claim on some external thing. So maybe you could kind of outline that important difference and from a legal perspective why that's important. Blockchain's kind of ape real-world assets and real-world things. They feel like them, but they're not legally the same as what you would understand to be a stock or a bond or a share. So if I have a stock or share in a company somewhere

Starting point is 00:14:56 or a debt instrument, a bond, some other type of note, the reason that has any value at the end of the day is because I can take that thing to a court and I can ask the court to enforce it. So legally we call these things an action or things in action. They only have existence when you go and file an action with a court

Starting point is 00:15:12 and then go and seek its enforcement. And then you can send men with guns around to the debtor or to whoever else owes you that obligation and you can enforce that obligation against them in the form of a judgment debt or order for specific performance or something else.

Starting point is 00:15:25 So that's what these things are. They're really just evidence. It's evidence of an agreement which we trade and we trade, freely and whatever. But at the end of the day, sitting behind it, there's always the threat of enforcement, which is going to happen through the legal system, which is going to happen with the police or with bailiffs or the sheriff or whoever else you need to get on your side to go and enforce it. With the crypto assets, it's a slightly different situation in that

Starting point is 00:15:51 you don't have ownership as such, because everyone's kind of disclaimed ownership. So with Bitcoin, Satoshi has not turned around and asserted his intellectual property over the database. similarly, none of the users of the system would have standing, or if they did have standing, they certainly haven't asserted, a database right or something similar over the Bitcoin database. So it's one of these weird things where everyone has kind of said, you know what, we're not going to touch it, we don't want to own it, we don't really want to opt in to any part of the legal system, because if we do that expressly, then the legal system knows how to deal with this thing that we're running around in trading.

Starting point is 00:16:24 And chiefly, that would, if you basically said it was a right to anything, it would become a security. And if it becomes a security, then obviously within that regulatory regime. So with Bitcoin, the asset is intrinsic. It has value because people think it has value. It's basically just to write permission, a UTXO, that you have on this database. And people will buy it from you because they think it is money. But legally, there's nothing underpinning it.

Starting point is 00:16:48 And so as a consequence, if people stop buying it, it disappears. It has very little meaning. So it's dependent. It's basically a giant meme with no legal substance as such. What do you think about the idea, Adam Ludwin's idea of really the only value in these things being this idea of censorship resistance, that censorship and judgment resistance, that maybe what you just described is the only feature. So the fact that I'm willing to own Bitcoin and ascribe to it value, and let's say I'm a true believer that thinks that in 10 years I'm going to be able to access my Bitcoin and somehow use it as to do something productive or preserve value through time. or one of the things that people want here that no governments can have any say over, and that I'm basically relying on like global hash power to be the security underneath it

Starting point is 00:17:33 versus some judgment system. Yeah, I think that's a little overrated because at the end of the day, it's, you know, there's the old XKCD cartoon, which is, you know, ha ha, zounds. I've got this RSA, three million bit password. You'll never be able to break this. And they're like, well, yeah, why don't we just go around his house with a, you know, with a rubber hose and a $5 wrench, just beat him up and then we'll get what we want. governments have been around for a really long time and they know how to get stuff done and sometimes

Starting point is 00:17:58 that stuff can be incredibly unpleasant. I agree with Adam in that Bitcoin is a very censorship-resistant system more so than almost any other, more so than any other distributed system or network system I can think of. But is that why people use it fundamentally at the end of the day? I don't think so. I think it's more basic than that. People use these things primarily for gambling and speculation. I think that's the main use case is that it's an unregulated penny stock, of the 21st century. And whether we want to admit it or not, that's always been a compelling proposition. People have always wanted to go into casino, the promise of instant riches, as we've seen with ripple of late. So there are people who got in at two cents, and now it's, of course,

Starting point is 00:18:37 worth $2. And so they're running around saying, hey, look, my Lambo, isn't it wonderful? And that's really compelling to people who are weak-minded and even people who are quite strong-minded when they said, well, hold on a second. What am I missing out on? So I think that's the primary value prop of cryptocurrencies. That's what people are used. using them for, they're not using them for censorship resistance. And the guys who would use them for censorship resistance, like, you know, Amir Taki or Cody Wilson or any of the sort of original, you know, crypto anarchists, those guys are all using other stuff now. So they're all using Minero and other cryptocurrencies that haven't been speculated on so wildly and so as a

Starting point is 00:19:13 consequence they work. So maybe what, from a money perspective, what we're looking at is not one cryptocurrency dominating because cryptocurrencies are kind of their own worst enemies. When they become too successful, they become unusable. So maybe it's the ecosystem itself, which is worth something. And so one cryptocurrency will rise and another will fall at the same time. And, you know, gradually as Bitcoin or Ethereum becomes too unwieldy, something else will rise up to take its place. Can you say more about why that idea is true that as they become more successful, they become unusable? Why is, why is that a necessity? Why couldn't some new cryptocurrency, let's say it's Minero violate that idea? Blockchains don't scale. And the bigger they get, the more unwieldy they get.

Starting point is 00:19:51 So there was a claim that was made. Let's use just Ethereum as an example. Zero Hedge, that fine pillar of American journalism, the old gray lady. So Zero Hedge had an article on it sometime over the summer when the enterprise Ethereum alliance, that august group of startups and financial institutions united for a better world, decided to, in their infinite wisdom, or someone in it, I suspect, in their infinite wisdom, decided to tell Zero Hedge that Ethereum was planning to scale. to a million transactions per second, sending the price to $2,000 per coin. And so I don't know who did it. I don't know why anyone would say that. So one of those predictions has actually turned out to be somewhat true. I think it's at $1,500 a coin now. The other one that it's ever going to run a million transactions per second is twaddle. It will never happen.

Starting point is 00:20:42 And the reason for that is quite fundamental. It's that you're constrained by the speed of light. That is your enemy when you're running a global distributed system. it takes something like 14 milliseconds for the speed of light to go halfway around the world and that's in a straight line which never happens because it gets routed through all sorts of other things. Every transaction that gets propagated on that network gets propagated to a bunch of other computers who then have to verify it

Starting point is 00:21:05 and then repropagate it. So everything about one of these distributed networks in this instance, Ethereum is slow. The hardware that is running it is slow. The fact that it's widely distributed means it's going to be slow. No transactions are going to head in a straight line. the fact that you have to go great distances means it's going to be slow. And all of that is going to operate to slow down what this system can do and prevent it from scaling efficiently.

Starting point is 00:21:29 So people are making these wild claims about these systems. But the fact is, every time we see one of them being used on a global basis, it becomes more unwieldy, the larger it gets. As the price goes up, the fees go up because the fees are priced per byte. And so if it's, you know, Satoshi's per byte, so if a Satoshi becomes more expensive, assuming that the transactions are the same size, you're not going to be. going to get cheaper transactions, they're going to be more expensive. Proponents would place a lot of hope or desire for the future in off-chain scaling. So things like Lightning Network or Layer 2 or side channels or whatever, why do you think we might not figure out some way of innovating a solution to this problem so that the on-chain

Starting point is 00:22:08 scaling doesn't ever have to happen, that we can use it as like a settlement layer, use Bitcoin as a settlement layer, and basically have all the smaller, higher-volume transactions happen in a less secure way, but in a way that's still tied to the underlying blockchain. I would rather use Coinbase, to be honest with you, than use Lightning. Because at least with Coinbase, I know where this stuff is. I can track the transaction. I have a record. I can do things like screenshots. And at the end of the day, if they screw up, I can sue them and get some money back potentially. So I think that if that's the approach we're taking, it doesn't make a whole lot of sense to say, you know, well, payment channels are going to fix everything. Because in order for that to work, every user of the

Starting point is 00:22:42 network has to be opening and closing several payment channels per day, which means they need to be leaving their computers on, which not everybody does. So a lot of these solutions assume a lot about how dedicated and committed your average user is going to be to the Bitcoin network. And most of them, frankly, are not. They probably log in once, buy some Bitcoin, turn the thing off. And I have some friends in law school now who are basically going, well, yeah, I don't know, I bought some.

Starting point is 00:23:04 Here's my Coinbase account. You know, what should I buy next? And I'm like, no, I'm not doing that. We're not playing this game. But yeah, basically, I think you might as well just go with a centralized solution at that point because it's going to be faster and more efficient. and it's here now. And then you just assume that your settlement layer is going to be Bitcoin,

Starting point is 00:23:20 and you have, you know, Coinbase is your bank, and you just have a deposit at Coinbase, which you can withdraw at will, and then if the fees are reasonable, you can go send it somewhere else. When you study most manias, you brought up in one of your posts, the railway mania. And when you study most manias, typically there's something very exciting at the core of it that kicks it off. And oftentimes that thing, once the mania has, once the bubble has inflated and popped, still become a key part of the kind of technology establishment of the future.

Starting point is 00:23:45 But there's all sorts of misallocation of capital that happens in that middle period. So maybe talk about that, maybe even using the analogy to railways, with the vision on assuming this is a bubble, we'll take that for granted right now. And it pops and it goes down 95% or whatever the percentage is. Kind of what comes next? Like what's still exciting about it to you? What's exciting to me is the I always thought. And so I started when I started my company.

Starting point is 00:24:11 back in 2014, we started that with the view that we wanted to take back control of data from the big data service providers. So we were building a prototype on Ethereum, or rather an Ethereum TestNet. What we did is we decided we were going to automate organizational governance for a 501C6 nonprofit organization on a blockchain. So we wrote a paper, you know, your typical crypto white paper, except ours was actually good and wasn't trying to sell anything. We then described the functionality. It was kind of, you know, it was, there was shareholders. or governance, this sort of thing. And we said, look, this is a way that if you want, you can take a bunch of people in a bunch of different places, and you can coordinate your actions like

Starting point is 00:24:49 you would in a Google Doc, like you would on Amazon S3 or whatever else, and you can do it without actually using the third-party service provider. So you can have this infrastructure, which is yours, which you control, which no one can see, or well, you know, which no one's going to have access to other than you. If you need to, you can run a VPN and do it over that. But this is a way that you can all talk to each other and keep in sync without needing some big stack very far away, running all of that infrastructure for you. So you're going to move all that onto your own, your own platform and run it that way. And that's because we saw then, and I think it's just as true now, we saw what, you know, centralization has risks. Those risks are political in

Starting point is 00:25:25 nature. We saw today that Twitter is actively censoring conservative political opinions, the much maligned conservative political opinions in the United States today. Greatly victimized group of people, no doubt, in case you can't tell them, I'm a little biased. But I think there's a major risk in putting too much power into the hands of tech companies, full stop. And I think blockchains allow us with Bitcoin, it's, yeah, it's pure to pure money. But what's it really allowing you to do? It's allowing you to run an accounting system without a bank. It's allowing you to run an accounting system without a credit card company.

Starting point is 00:25:57 It's taking out the middleman. And you can reskin it and tell it to manage whatever set of legal rights you want, as long as you have some trustee somewhere in whom those rights are vested. And when you do that, then you can have it operate totally normal, totally in harmony with the legal system. But what you've done is you've taken someone else's servers out of the equation and you're running nothing yourself. So I think at the end of the day, that's where we're going to wind up,

Starting point is 00:26:18 where you'll have companies doing, they'll be doing their internal treasury services on a distributed ledger instead of doing it through their bank. That's one thing you could potentially do. So one of very many. At the end of the day, you don't really need the coins to achieve any of that distributed infrastructure that doesn't rely on third-party cloud services. You can use hyperledger for that. So I always think about things from the perspective of an investor and the meme that's caught on in addition to Bitcoin is this fat protocol idea that the value associated with these networks, that they have some use case, they do something for people, and that the value accrues to the token holder, right?

Starting point is 00:26:55 So the token is the unit of exchange and a little mini economy. Certainly there have been some companies, Coinbase, the best example, traditional companies that are enormously valuable that looks like any other financial intermediary, charging a point or whatever it is on either side of the business. transaction. In that world, what is the incentive to build that technology? It sounds like you're saying we don't need tokens or coins where value will accrue, but the incentives are always such that people build stuff because they are incentive to do it financially. That's why people are entrepreneurs. So how do you think about like the motivations and the installation of that technology in the absence of a return to investors in coins? I think that the, have you seen the movie aliens? Of course. You know when they're all sitting in the drop ship and build. Paul Paxton's totally freaking out. And then, you know, Cigernie Weaver is sitting there and she goes, you know, I say we take off and nuke the entire site from orbit. When the SEC published its Dow report over the summer, they effectively nuked the fat protocol thesis from orbit. That is what they did. And the language that we're using to describe it says it all. It's that in form and substance, we have companies that are saying, hey, we've got this piece of the protocol which you can own as an investment. And so if it's an investment here in the United States, the question is, have you got a prospectus or does an example?

Starting point is 00:28:09 apply. In Britain, same thing. Have you got a prospectus or do you have an exemption? Well, if you don't, or if it's money or money's worth that you're trading with other people, you know, have you KYC'd them, have you done AML? I don't think that the rules are going to go away anytime soon. And they shouldn't go away. They're there for very good reasons. So I don't think that makes a whole lot of sense. In the current environment, obviously, people can raise a lot of money really quickly and then deploy that very quickly to go and build out these networks. And that pushes all the right buttons for people who support that thesis. It says, hey, you know, people are interested in this. But whether it's sustainable or not, depends on whether we can get the regulators okay with it.

Starting point is 00:28:45 I don't think that your average Silicon Valley VC has really had a whole lot of interaction with financial services regulators over the course of their career. A Wall Street banker or lawyer, however, will have had that degree of interaction. And I was talking just the other day to a very senior structured finance partner at a very eminent global law firm. And they all had a whip round and discussed it and they agreed. They said, we have no idea why these guys don't have the same concerns we do, considering for all of our deals, this idea of selling an investment or something that feels like one, and the compliance, which goes along with it, is so central to it that we make sure we're not only on the right side of the line, we're a mile away on the right side of the line.

Starting point is 00:29:26 So in the current environment, it looks like, yeah, go do the token, bootstrap the protocol, get lots of interests, get a trading on an exchange, all of that sends all the right key indicators to the VC. You have, you know, tens of thousands of new users a week. It's getting press, you know, people write about it. They're excited, you know, shills on Twitter, running around and harassing people who say, well, maybe we should calm this down a little bit. The XRP shills are just insufferable. I'm just going to put that out there. So it's, which is, which is interesting. But right, so it pushes everyone's buttons because they see the virality of it. But I don't think they see the legal technical debt that they're building up by following

Starting point is 00:30:05 that approach. And so that, it makes perfect sense to continue on that angle, as long as there are no consequences for doing so. If the day should come, when there are consequences for doing so, then we're going to see the real cost of following that route. And then the question is, does it make sense without a token? Maybe describe Ripple for a minute. It's something we haven't spent a ton of time exploring on this podcast, in large part because it really hadn't done anything. And then since the last one, it's exploded in value. So maybe give your perspective on what it is, what its promises and why that maybe is going to be hard to fulfill. Well, so, I mean, Ripple's a bunch of different, I mean, Ripple Labs is a company founded by,

Starting point is 00:30:41 you know, Chris Larson, and then they've got David Schwartz and Stefan Thomas who've been around forever. And they've done a bunch of different things over the years. Obviously, I've never worked with or for them. But they did, so what did they do? The first project was XRP, which was basically, you know, if you talk to Peter Todd, he'll tell you it's centralized. If you talk to Ripple, they'll tell you it's not centralized.

Starting point is 00:31:00 You know, I'm not going to go into that in any depth here. But there's a cryptocurrency. it's proof of stake. Ripple more or less determines the consensus of the network as far as I understand it, and that's that. And then had two other projects. One of them, the name escapes me. It was a sort of smart contract oracle type project, and the other was called interledger, which is a very similar project to your hyperledger style distributed ledger. And so my understanding of what they do is primarily they're doing distributed ledger implementations at interledger at banks, which is derived from the Ripple Consensus ledger rather than XRP. Of late, of course, we've seen XRP's price go through the roof,

Starting point is 00:31:33 so I can imagine they will have to have had changed their stance on that somewhat because it seemed a couple years ago that they were almost like, oh, no, no, that's kind of our red-headed cousin that we don't pay too much attention to. And, you know, we're just going to put them over here in the closet and not pay much attention to XRP because, you know, it's blockchain without Bitcoin now. And this was like 2015. But now, of course, things have changed. So Ripple is just, it's a company that has a cryptocurrency.

Starting point is 00:31:57 They also have a really interesting, you know, distributed ledger proposition. Again, my understanding was that they were going into things like Treasury services. And so, yeah, they're trying to keep a toe in one ocean and a toe in the other, sort of enterprise and cryptocurrency. And that's a story we see more than once. I know of other startups which have basically said, look, we're not ruling out the coin thing because there's so much interest in it. I'm always fascinated by the early stages of, I guess we're not the old stages anymore, but this insane onramping of users onto Coinbase or whatever and real fiat money now coming into the cryptocurrency sphere where there's, there's, I think market cap

Starting point is 00:32:33 is a really kind of flawed metric for thinking about this because you could say that Bitcoin's got a whatever, 200 and whatever it is today, hundreds of billions of dollars of market cap. But if any meaningful chunk of that tried to actually liquidate into Fiat, it would be a fraction of that. And that's largely because when you add up the total amount of Fiat that's gone into the ecosystem relative to its kind of notional market cap, I think it's tiny. Right now it's growing very quickly. But I think one of your key points is whenever that reverses, it could be a really scary proposition. a run on the bank, grandma getting pissed off, or whatever. So talk about, and maybe the answer is just

Starting point is 00:33:08 regulation, heavy-handed regulation coming down the pipe, but talk about what you think might precipitate that kind of reversal in the, you know, relatively near-term future. Sure. So I called that a run on the bank and I caught a lot of flack for it, including from Matt Levine, who was like, he was like, yeah, okay, great, it's like people are selling, prices are going down. I don't understand what the point is. It happens with securities all the time. But I think the difference between your Cryptosphere and something like shares in Apple or Amazon. The psychology of the buyer is very, very different when they're purchasing some cryptocurrency and they're purchasing stock in a company, which is going to go in their 401k or something like that. The difference is that

Starting point is 00:33:47 with cryptocurrency, they think it's money. With the cryptocurrency, you show a dollar balance. And similarly with a, you know, with a brokerage account, you can also see a dollar balance how much all the securities in it are worth. But I think that here people are really looking at it more like security, not more like securities, more like cash. in the bank, which they were expecting to simply just go up in value. In some cases, there are anecdotal reports, which I expect are true. I had no reason to disbelieve them, that people are doing things like spending money on credit cards, for example, to go and at 20% interest to go and get exposure to the market. So with that is our background. The thing that will

Starting point is 00:34:22 freak people out is the thing that freak people out, we haven't had one of these in a very long time. It's a run on your bank. So if someone goes to Coinbase or somewhere else, and there isn't someone on the other end of that trade or there isn't enough liquidity to go and satisfy the withdrawal demand, then what will happen is withdrawals will be cut off and people will panic and they will say, hold on a second, oh my God, I can't get my money out and they'll try to move to whatever dwindling pools of liquidity are left. What could precipitate that? Potentially an exchange getting taken down by a regulator is one thing which could do it. And there are some, I don't want to name names, but there are some suspicions about whether

Starting point is 00:34:57 certain cryptocurrencies are being legitimately issued or some tokens which are meant to be backed by by money. People are wondering, you know, where's an audit potentially that proves that those tokens are actually backed by the money that the issuer claims it is backed by. So in the case of Tether, just for example, they claim it's backed by $1.2 billion of Fiat sitting somewhere sitting somewhere, but there's been no disclosure basically saying that we in fact have $1.2 billion of cash sitting idly in a bank account somewhere, which would be rather a lot of money sitting idly in a bank account. So any one of those things could trigger a loss in confidence.

Starting point is 00:35:30 We don't know when it could happen or how or from what, but those are just some proposals. And then, you know, this is a meme on the way up. It's going to be a meme on the way down. A change of expectations is sort of reverse network effect or inverse network effect, which pushes prices down. This can't go up forever. It's a mathematical certainty that that can't happen. I saw you writing about this just today or tweeting about it or something about this reverse network effects,

Starting point is 00:35:54 which is a really interesting idea. Everyone, it's such a popular buzz phrase, especially in Silicon Valley, because positive network effects are so incredibly, it can be so incredibly valuable. It can create such a moat around a product or business or service. So maybe talk about that idea of reverse network effects relative to these positive ones. Blockchain's a journey. I'm saying this sarcastically for your listeners. Blockchain, but it is a journey. It's a process where you first get exposed to something like Bitcoin.

Starting point is 00:36:22 You have no understanding of it whatsoever. You then dive in because it's, it's. profoundly, it's an attractive idea. And then when you pair it up with trading and all those other things, it's very, very attractive. And for me, when I looked at it, I dove in headfirst because I'm generally quite pessimistic about everything, wound up becoming quite pessimistic about it, and started sort of deconstructing it. Tim Swanson was another guy who thinks along very similar lines. And so we became the early Bitcoin skeptics back in the day. And so it continued being so ever since. I think similarly for everyone else who's getting into the market now, they may be enthusiastic now,

Starting point is 00:36:58 but the question is what will turn their enthusiasm. Well, I can't spend the damn thing. It's not accepted anywhere. The value's gone down. It's cut in half. I couldn't get my funds out in a week. So there are going to be a lot of really disappointed people, just as we have been disappointed before them in the infrastructure that the cryptocurrency world is built. And so that could be something which repeated hundreds of thousands of times then creates something where people say, well, hold on a second. Maybe Monaro is actually better. I like Monaro because I like Ricardo, the guy who founded it. He sent me a rock Hirax, which is kind of a marmot-like creature, but a cuddly toy of a rock Hirax in the mail once. When a cryptographer asks you for your mailing

Starting point is 00:37:36 address, like never say yes, right? Because it's like, what are they going to do? Like steal my identity? I don't know. It's like, what's your address mate? I was like, okay, here's my address. It sends me this cuddly toy. And so basically Minero's the best ever since. Or like Zecash or something like that. Or someone comes up with something which is more. scalable. I know of one project in San Francisco. I don't think I can name what it is because I don't want to blow their cover, which is looking at more of a distributed way of running a blockchain. I know that IPFS and Filecoin, for example, there has been talk in the past of potentially mounting a blockchain onto the IPFS data store. So if you could do that, then you have one of the

Starting point is 00:38:15 potential solutions to scaling if that makes sense. I'm not technically astute enough to tell you whether that is or isn't the case. But those are some potential solutions. If someone does that and Bitcoin doesn't or Ethereum doesn't, you could see a migration over to that because suddenly you have something which is usable instead of downloading a 200 gigabyte client onto your computer, which takes four weeks to sync. So that's how those things happen. And I don't think people are quite aware enough that the software they're using is not well written and not very user-friendly. Talk about stablecoins a little bit. This is something that you've written a lot about recently. it's a popular topic. I hate them. We know you hate them. We'll get into why. I think that the core

Starting point is 00:38:54 underlying attraction of a stable coin or something that just has stable value like a U.S. dollar might is that you know you can conduct commerce with it. You can pay for stuff. You can use it as a means of exchange. If there was a cryptocurrency which had all the technological benefits and the digital benefits that a digital currency might have, but you could rely upon it to have some similar purchasing power this week as it has next week. That could be a really neat technology. So first, do you agree that that is something useful that we should, let's assume that a stable coin was possible, which I know you don't think it is. But is that something that's desirable? First, I don't want to presume you think that. And then we'll get into why there are significant problems with this

Starting point is 00:39:35 idea in your opinion. So I mean, it's possible for sure. We have electronic money today, which is redeemable against some deposit somewhere. And so it's electronic money. When you hold the thing, but there is a deposit somewhere which corresponds to what you are what you were spending. The idea of the stable coin is that you can take, it's again getting back to this intrinsic idea, it's that you can take a cryptocurrency on which people are speculating, which has value because people are speculating on it. And then you can set up incentive arrangements around that speculation on the cryptocurrency, together with a price feed, which is determined by some computer external to the system,

Starting point is 00:40:12 which allows you to peg the price of a certain amount, of collateral in that cryptocurrency to whatever that third party thing is. So it could be a dollar, it could be an ounce of gold, it could be something else. So basically what you do is you set up a derivative contract of sorts where someone has a long position and a short position. And as the price of the underlying collateral pool moves up or down, someone either wins or loses on that trade. And then if it goes too far out of whack on the downside, it closes it out. And then you go and pay someone whatever, you know, whatever amount of cryptocurrency they're entitled to. The problem what this is is that it's basically a perpetual motion machine because you can't, you know, people say, well, perpetual that's a criticism.

Starting point is 00:40:50 People make it about technology. Well, no, I mean, it is a criticism. When you say something's impossible, you run the risk of someone who has seen a lot of technological development or someone who thinks they've seen a lot of technological development and know what's going on, saying, well, no, you're just, you know, you're just being a Luddite and you don't understand how things work and you don't understand how technology advances. In this instance, it's not really a question of the tech. It's just a question of human behavior. And that is that the only way you can maintain those pegs is if people continue to buy the underlying asset which you're selling, which supports that price. If people stop doing that, then the peg breaks and the collateral will eventually erode itself. And that can happen for any number of reasons. It can happen because people have a loss of confidence. It can happen because the team winds up and goes away somewhere else and goes to Tahiti with their ICO money for any number of reasons.

Starting point is 00:41:39 So basically, the schemes are not sustainable. except under an environment of ever-increasing prices, which is mathematically impossible. This hasn't stopped a bunch of bright young things from Stanford and Princeton from attempting this. But I think the stable coin is kind of, how to put it, it's late-stage crypto. It's a bunch of guys who've been trained to think you can unit-test everything, thinking you can also unit-test human behavior and predict with certainty all of the outcomes. The problem with that, of course, is that once you know that you're being unit-tested and you know the rules of the game, you can go game it,

Starting point is 00:42:11 because we're self-aware. And that's what stablecoins basically. That's their inevitable fate. So we saw this with BitShares a few years ago. There was a stable coin that created it within a hundred hours. It fell flat on its face because no one had confidence in it. And so they started pulling their money out. And so they had to turn the system off. Similarly today with Die and MakerDAO, which is another stable coin scheme, there was a loss of confidence in that scheme because of some event, we don't know what caused it. But I'm presuming it's some event extrinsia or external to that system. So they said, well, we've built this wonderful little closed system that in theory works really well. But one trader was like, you know what, I don't want to play anymore.

Starting point is 00:42:47 I need this money now, and I'm not going to play along with this whole dollar price thing. I'll sell it for 70 cents. I'll sell it for 60 cents. It really doesn't matter. Pulled all their money out. And so the peg didn't hold. So it's this idea that you've got these bright young guys saying, well, hey, look, we can build this system, this computerized automatic money system, which works, without really understanding that the reason something has value is because people are looking at it,

Starting point is 00:43:10 not because the algorithm says it should. Setting aside price and the market cap of these things and kind of the madness that's happened in the last couple of years, sitting today and looking back to 2014, which sounds like when you got really involved starting a company, what would you tell yourself now that you know about blockchains that's most interesting from the perspective of you back in 2014? So what have you learned most outside of just the investment side

Starting point is 00:43:35 and the speculative aspect of all this? I mean, the investment side is actually the thing I've learned most about, and that's chiefly that gambling is very, very easy to sell. So if I had to go back to 2014, I might have, I might have, I wouldn't have ICOed, but I might have taken some different positions than I ultimately took. In terms of the tech, the adoption curve has been very slow. So it's getting something to production in this world is very, very hard. There are very few companies which are ready to do it.

Starting point is 00:44:04 Generally, those companies are large banks. And then the sales cycle for those banks is agonizing. I mean, it takes a year, you know, just to get approval for a follow-on from an initial prototype. So it's one of those things which if I could go back and tell myself what I was getting myself into, maybe run a little leaner and a little quieter and wait until there's more budget available to do this because it's just taking a lot of time because the technology is so different from everything that everyone's already using. And it's not really coming from it, at least until very recently, it wasn't coming from the main enterprise vendors. I don't think Oracle has a blockchain offering.

Starting point is 00:44:39 I know Intel does now, IBM does, Microsoft does, Oracle does not, Amazon does not. So, and they weren't going to really jump if you walked in as a small startup and said, hey, why don't we just like go like a redo your whole back end? You know, all this stuff you've been using for 20 years. And trust us, we incorporated last week. It'll be fine. So I think if I, if there were any lesson, it would be that. That it's going to, it will take every bit of the 10 years.

Starting point is 00:45:03 I think 20, 24, 25, it'll just be embedded. No one's going to notice that it's there. But it will take really every, every minute. of those 10 years. Say a little bit more about that. So 2025, describe specifically what you mean by embedded or ubiquity or whatever. So there are a couple of things which need to be fixed from a usability perspective. One of them is key management. There are no really good solutions. There are a couple. Ledger Labs is a fairly good key management solution, but it's focused primarily on cryptocurrency. Similarly, there are no really good like outstanding user interfaces for DAPs.

Starting point is 00:45:34 You know, Ethereum is there, but it's not great. It's slow. It's clunky. So the infrastructure just isn't there yet. We haven't really seen people starting to use this stuff as part of the core of their businesses. It's still a curiosity and a toy. That's not a bad thing. I think it was Chris Dixon. I could be wrong, who said, you know, it's a toy today, but that means, or maybe Chris Dixon or Fred Wilson, one or the other, they say everything that there is to be said, right? So it's a toy today, but it's still a toy. We're still not seeing someone saying, you know what? I'm going to go put real transactions for real money, for real customers running on this system if they're a core bank, or you're one of the globally significant financial institutions. So that's what we're not seeing yet.

Starting point is 00:46:16 But we'll get there in due course. Let's talk a little bit about we haven't talked explicitly about ICOs. You wrote somewhere that when you hear tokenization, you should really just replace that in your mind with cutting corners. So talk about your perspective on ICOs, which I think is almost universally negative, but why, why it's negative. And if there are any positive aspects to this, as a use case of cryptocurrencies, which is raising a lot of money really quickly with very few barriers. So I think the, without being overly pessimistic, I can be overly pessimistic online and on Twitter because there, you know, there just aren't enough characters and it's just more fun that way to get people riled up, you know, because I'm sitting there and someone's, you know, getting bent

Starting point is 00:46:53 out of shape. I'll send them a marmit picture or something to just annoy them. It's great fun. So I'll try to be more diplomatic here. So with ICOs, I said yes, it's cutting corners. What they address is is a huge demand for higher yield investments. People have been sitting around on very low, you can't get interest in a bank account in the United States. That doesn't happen. And people want to, they have an appetite for a little bit more risk. And so I think ICOs have addressed that appetite for risk. And that tells me that there's a market there, an addressable market, which could use blockchain technology as part of whatever solution you build to give people access to investments, to give them disclosures relating to those investments, to have

Starting point is 00:47:34 have a more direct way of communicating with an investor about an investment that they own and potentially, you know, getting them more involved with that investment. Because if you've got, let's say you've got a smart contract which says this is your share and whatever, you could go and consult that investor automatically about a shareholder meeting. You wouldn't have to actually go and summon them to the shareholder meeting in order to, you know, go through the motions and that sort of thing. So that's one potential way of looking at it. The reason I say it's cutting corners is because a lot of people are selling things which are designed like

Starting point is 00:48:04 which work like investments, which are treated like investments. But at the end of the day, aren't really investments. So I've seen a couple of like real estate coin this or real estate coin that where someone goes, well, it's a real estate investment thing. And I'm going to go buy this house and I'll put it all together so that way you get the return or the Dow, another prime example. This is a decentralized company. We're going to go invest in other companies. They're going to have their own tokens and you're going to get the return. And people are like, great, this is amazing. Let's go invest in the Dow. But if you looked at all the little moving parts between there. It's like, okay, I take the tokens, I put them into the Dow. There's no contract, which says,

Starting point is 00:48:36 what happens? I just know that I get these Dow tokens back for the ether I put in. Then the Dow takes the ether I put in and it gives it to another company. Fine. That still works. That company issues tokens, okay, reward tokens. Those reward tokens capitalize back into the value of the Dow tokens. Didn't say how. There was no mechanism for some company that went and issued its own ERC20s to then go and capitalize back into the Dow tokens. It was just kind of like, oh, no, no, and that will happen. Magic happens because they've, done it through the Dow structure. And then I go take that value, which is capitalized in my Dow tokens, and sell it to somebody else who wants it because decentralization, right? If you were

Starting point is 00:49:13 a lawyer, you'd go, okay, well, you're paying money in here, and then you're paying money there, and then this company does that, and there are certain rights which you're going to take in exchange for, let's say that company liquidates, and there's a contract which says that when you liquidate, we turn around, we sell the assets, the proceeds of that sale go to this entity. Those proceeds are then distributed in accordance with this waterfall. So it ties all of the little pieces together and makes a coherent whole. That's how a legal transaction works. The Dow and a lot of the ICOs have seen, they're cargo cult versions of, so it's the cargo

Starting point is 00:49:45 cults of the East Pacific, what I'm referring to, or after the Americans came in during the Second World War, some of the people who lived on the islands would go and build mock airways and planes out of bamboo in thinking that if they did that, cargo would arrive from, you know the people in the sky. So basically it's and Richard Feynman called that cargo cult science. It has the appearance and trappings of science. It makes perfect logical sense, but it's missing something. It doesn't get to the essence of what you're trying to achieve. So similarly with the Dow and a lot of these I seeos, I look at it and I go, this is cargo cult law. You are kind of brushing over the surface of what you're trying to accomplish. But I mean, you're kind of touching on it. It looks right.

Starting point is 00:50:25 It feels right. You're selling it. People have, there's a little contract. They get a token. and that kind of feels like owning a share. They can see what their balance is worth if they have it on Coinbase or whatever else. But if you then just kind of dust off the surface and look underneath, none of the machinery that's necessary and none of the work that needs to be done is actually there. So you don't have a mechanism by which, and that'll come out.

Starting point is 00:50:46 We'll start to see more of it as people start to get annoyed with ICOs that are non-performant. They'll say, well, hold on a second. You sold me this thing, and there's actually no means for me to connect one and the other. No recourse. No recourse, no nothing. And so I think the SEC went after one, guy. There's an emergency order a short while ago who was doing real estate and diamonds. And I think

Starting point is 00:51:04 they probably took, I haven't looked into it myself, but my guess is they probably took one look what was going on and said, this doesn't join up. This doesn't make sense. And so there's a lot of that out there starting with the Dow, which kind of got away with it. And since then, there have been a bunch more. And so we'll see more of that. But that's what I mean when I say it's cutting corners. You haven't done the necessary work in order to provide what you're purporting to sell. What are the conditions under which these things will be legally viewed as security? So I think it's the Howie test. What does that mean? I've heard from a lot of proponents who are certainly pro cryptocurrency and blockchain technology that they would love some opinion from the SEC and they'd love more regulation because it would remove some degree of uncertainty and allow people to really start building. So what do you think about the security label itself and kind of how it will come and when it might come for ICOs generally? So subject to the proviso, then I'm not yet a U.S. qualified lawyer, and I'm an English qualified lawyer. I will be very happy to, and this is not legal advice. I will be happy to talk about my understanding of that concept. So just starting with the way things work in England, just by way of comparison. In England, they've incorporated a lot of European law, which tends to be big, long codes, which set out everything in full as fully as they can. So they have a list of things, and they say, if it's not on this list, it's not subject to the prospectus directive, and it's not, part of this regime. And so I looked at the list in the UK. And the FCA made some comments,

Starting point is 00:52:30 basically the UK's equivalent of the SEC. And they said, well, we don't think a lot of these tokens are going to fall within that list in that regime. And I think they're right. Because when you look down that list in England, try as I might, I can't see anything on there, which tells me that a blockchain database with the Genesis block that had some tokens, which are retained by the issuer, and then the remainder are sold to people on the public, there's a big exhaustive list, and that's not on it. So it's not a security. It might be something else. There are all kinds of other representations that you make.

Starting point is 00:52:58 When you sell these things, you could say, you know, it's going to go up in value to X, and if it doesn't do that, then you're committing fraud, for example. So there's a whole bunch of stuff to consider, but that's how that works. There's a big list. Cryptocurrency's not on it, not a security. The U.S. has a slightly different regime in that they have a common law test. So it's kind of musher. And it asks four factors, and it says, you know, there's a scheme,

Starting point is 00:53:19 is there an investment of money with an expectation of profit from, you know, the efforts of others in a common enterprise, basically is how it works. I've just mangled it horribly, but that's basically how it works. And if you satisfy those four criteria based on subjective, objective, but also fact specific analyses, then you may have something called an investment contract, which is regulated in the same way as a security. So with the Dow, for example, the SEC looked at that and they said it's probably going to be a security because if we look at it, it kind of walked like a duck, bottled around, it looks like a duck, and it quacks. This is a duck very clearly, because it's it behaves like one. So as a consequence, the test is deliberately mushy. I don't think the

Starting point is 00:53:58 ICO companies really are going to get very much mileage out of asking the SEC to be more specific because the test is not designed to be specific. It's designed to be general and vague. And I think that there's a alternative approaches, the UK and the U.S. It's interesting to see because so much of our legal system derives, here, derives from the English legal system. Those two differing approaches. But that's basically the difference. We have a mushy test in the states. And as a consequence of that, I don't think people should expect anything but mushy answers. And that's why the American securities lawyers, who I know, are really extremely careful when they're marketing or when their clients are selling securities into the market.

Starting point is 00:54:37 There are a list of exemptions which, so the consequence of being an investment contract is that either you need to have a prospectus, which you issue, and then sell in accordance with the applicable regulations, or an exemption, a range of them, which don't really bear getting into here, needs to apply. And so if you're a reason, you're going to be. And so, if you you look at it from that perspective, American securities lawyers are really, really careful about either, okay, we need a prospectus, or we're going to stay very carefully within this very well-delineated statutory exemption to that prospectus requirement. I realize I should have asked you this before we started. I'm curious if you now or have ever personally owned any cryptocurrencies. I have. I owned

Starting point is 00:55:14 a very small amount of Dogecoin, which I sold. So a while ago. And that's it. And there's a reason for, And more interestingly, I was offered a 13,000 ETH from the pre-mine, which is now worth about $16.5 million. And I turned it down on the basis that it would compromise my professional independence as, well, for two reasons. One, at the time, the company, my company was competing with them for Mineshare. So it didn't really make a whole lot of sense to go and, you know, take free coins. And two, I had an inkling then that I would probably have a big problem with ICOs later down the line as I do now. and I don't think I could really make a coherent argument. I don't think I could turn around on the one hand and say,

Starting point is 00:55:56 I've been made rich by ICO coins, and then on the other say, but I think ICOs are bad. So to answer your question, no, I don't really, I don't play. And ultimately, the objective is so that, the objective of doing that is that when you ask yourself in cryptocurrency, what role do you want to play, right? Some people are traders, some people are economists, some people start businesses,

Starting point is 00:56:17 some people are boosters and community managers, some people are lawyers. And I made a decision, you know what? I'm going to be one of them. And in order to do that best or do better than the others, the way to go about it is to be professionally independent and to give advice based on your client's needs rather than your own financial interests. There's some lawyers who don't do that, and I think I'm a little uncomfortable with that, but that's why.

Starting point is 00:56:40 With that as a backdrop, what has you most excited, let's say a couple years from now? I think it sounds like you might remain mostly on the sidelines until some of this mania has passed. But if you could design it perfectly, what would your involvement be from a legal standpoint or otherwise once this thing kind of settles in? So I think there's some interesting stuff going on in the broker-dealer space. There are a lot of people who are looking at ICOs and saying, you know what? The infrastructure that's being built here is actually more effective and cheaper and faster than the sort of paper-heavy infrastructure we've been working with previously. So there are companies who are looking to see whether this crypto infrastructure, although it takes some shortcuts on the legal side, they're also taking, it's total reimagining of how you should move value around and how you should transfer title to property. So as a consequence of that, there are things about it, which are much more efficient than the way we did things before.

Starting point is 00:57:33 The idea that, for example, let's look at a bond transaction, right? So a bond transaction has probably five or six banks involved, maybe fewer, maybe three. a bunch of law firms and a bunch of bondholders. And currently the way that they figure out what the state of play is, is each of them has a paper copy of a big document, which we refer to somewhat offensively as a transaction Bible. And you go and get the Bible, and you see all the deeds of amendment,

Starting point is 00:57:56 and you see what the state of play is. And you have to go track it down because it's in document storage, somewhere in East London, you know, it's a building somewhere. And then you figure out what's going on based on going through a couple of reams of paper and then checking, you know, records on Bloomberg's and printouts like that. there is absolutely no reason whatsoever that shouldn't be on a blockchain, which is running between the various transaction parties. So you can see the exact state of the documents, how they've changed over time, what the state of the payments are, whether a payment waterfall has been triggered or not, whether a certain event has taken place or not, what the rating is of that instrument and how that interplays with your waterfalls. So there's a whole bunch of things that you can take that process and make it very, very simple and much quicker to refer to.

Starting point is 00:58:40 As a consequence, so let's look at it from the perspective of the various parties. The banks, when they're sending notices, that becomes easier. So that's automatic and very, very straightforward. The law firms who will be administering those documents in that process, their clients aren't paying $2,000 for some junior associate to look through reams of paper for a day and a half in order to figure out what the state is of a clause three of the trust deed or something like that. So that's introducing a lot of digitization into areas which have not been digitized. So that kind of stuff where you just have the ability to pull these things up. And in addition, you have a really good, so this is really the most important thing. You have an outstanding chain of evidence, which, and that's what law is about, right?

Starting point is 00:59:22 You have to go prove that something happened at a certain time in a certain way and you've got consent in a certain way, which is why we sit around and shuffle paper and get people's signatures and make PDFs and make 20 copies of them and circulate CDs. It's a nightmare. So I think all of those kind of old world procedures are very much overdue an update. And that will happen within the next 10 years is that someone is going to say, okay, well, we have a service. It'll probably be a law firm, to be honest with you, that will turn around and go, we have a service that we offer. It's digital, it's faster, it's cheaper. You don't pay for as many billable hours.

Starting point is 00:59:54 And we manage the ongoing lifecycle, the transaction for you. So it just goes in ports straight back in your back office, as you like. So things like that. or there's another project, Utility Settlement Coin, which a bunch of banks are doing in London. Things like that, I think, will be incredibly valuable to the ecosystem. Can you describe that in a little more detail? So utility settlement coin is a project between four or five different banks. I haven't heard anything out of it in a while.

Starting point is 01:00:15 But basically, it's four or five different banks who said, let's do our own distributed ledger where we settle transactions among each other, and we have a coin which does it. So they took the theory that they do a lot of business with one another. And so they said, well, you know what? We're just going to have a coin which does it. So that way we don't need that third-party service provider or whoever else we're using. to do it. Similarly, you could think of something like, I don't know, HSBC and Citigroup do something like 35% of their FX business with each other. So they could turn around and say, you know what?

Starting point is 01:00:41 Instead of, instead of doing this the way we're currently doing it, why don't we just have all of our trades running on this one chain between us? We have perfect visibility or we're, because we're entitled legally to see what's going on between us. And that way we make our record keeping on either side of this a lot easier. Is that kind of what Ripple maybe is proposing to do between banks or the insight here is basically, look, this kind of indelible, well-protected database is a great way if we're doing constant exchange of value for us to do this and just get away with all this, all this lousy old infrastructure. Am I thinking about that right with Ripple? Not XRP, but Ripple, yes. My understanding of what their interledger business was, was that

Starting point is 01:01:21 exactly. And so my understanding of, well, most of what their bank business is is based around the interledger. I mean, I don't work there. I don't know what it is. But that's, you know, as a market observer who has a reasonably good, you know, idea of what's going on. That was my understanding of what that was for. XRP, totally different kettle of fish, speculative mania, all that. So that's a very separate issue. So you have to describe a little bit about why the constant returning to marmots. Marmots. So marmots are actually my superhero origin story. So I was about 12 years old and we had this issue with woodchucks in our yard. They were everywhere. They were digging holes and everything. Where'd you grow?

Starting point is 01:01:59 Connecticut. So eastern Connecticut. So we had these woodchucks that were digging up everything, and I was handed a rifle and told to do my duty. And after waging the briefest of wars with these these adorable little critters, I just decided I couldn't do it. And they kind of became my spirit animal as a consequence. That then became a in-joke in my early days at Monax, which was at the time called Eris Industries. One of the three co-founders is a quantum mathematician. And he and I, he was trying to explain quantum information to me. And I was like, I don't, what is this superposition? And everyone understands it now because there are enough YouTube videos. But nobody understood it back then. That was ancient history. And so he tried to

Starting point is 01:02:36 explain it in terms of giving a cookie to a marmot because he knew I like marmots. So he said, well, you're giving the cookie to the marmot. You're not giving the cookie to the marmot. You're giving it to the marmot and not giving it to the marmot. And you're doing neither at the same time. I was like, well, this makes perfect sense. And so if you explain things in marmit terms, I can understand software. This is perfect. So anyway, it just became an in-joke. It then spun wildly out of control. And I decided to assist doing it, despite the fact that it drove people crazy. It drove my investors crazy. It drove the market crazy. It drove people on Twitter crazy until eventually they broke and they started liking it.

Starting point is 01:03:09 So that was my objective there. If you could have everyone out there that's, you know, you mentioned that blockchain is a journey. And that's a really good way of putting it. I certainly went on it where its initial appeal, just the different angles that you can explore behind it are, it seem endless, right? It's just endlessly fascinating topic. So it takes a long time to even understand what the hell it is you're looking at. But for those out there that are, let's say, earlier on in that journey, are there any reference materials, whether it be a post, a book, an idea, a person, a YouTube clip, it could be anything that you think might be most just generally valuable. No, there aren't because there aren't. I would say there really aren't any reference sources

Starting point is 01:03:49 which are valuable because the important thing, the important thing when thinking about blockchains is knowing your business extremely well, knowing what you do backwards and forwards, and then asking yourself a very simple question, what does a distributed system that everyone can read have to do with what I'm trying to accomplish here and does it make it more efficient? And it's really that simple. So you can go and dive in and read 100 different books by 100 different authors, most of whom have no idea what they're talking about and have not built, deployed,

Starting point is 01:04:21 or designed a single blockchain system in their entire lives, and they'll sit there and tell you how it's going to revolutionize everything. everything. But fundamentally, the skeptical view of this is to say 99.8% of what's going on in blockchain right now is garbage. And the 0.2%, which isn't garbage, is when someone understands their use case backwards and forwards, and they've figured out why they want a distributed system there. For me, as a lawyer, that is the automatic transaction Bible. It makes perfect sense. I know it very, I know the space very well. I've said, you know, this is an idea which potentially has could get some traction in 10 years. There are people in supply chain, Leanne Kemp of Everledgeer.

Starting point is 01:05:00 She understands diamonds backwards and forwards. And she said, you know what? A distributed system automates these relationships really well. So can you describe that in a little bit more detail? Maybe I don't know if you know the particulars of that diamond example, but supply chain is something that my ears have been perked to that. It started to come up more and more as an interesting use case for this. So maybe describe why that's interesting. Apologies to Leanne if I mangle her startup. But my understanding of whatever ledger does by way of it. So supply chains are, are supply chains. Generally, supply chains are you've got a box of something and it's got to get passed through a dozen different hands before it arrives at your doorstep. You want to

Starting point is 01:05:38 know at every stage what's happened to it, what the condition of the thing is, because what you're getting and what you're liable to pay for depend in large part on how it gets to you and in what condition. So it's important to track what's going on with things as they move through the stream of global commerce. Everledger. in particular looks to diamonds in that diamonds apparently all have registration numbers and they can be identified by reference to size, you know, light characteristics, you know, refraction, whatever, some scientific magic I don't understand. And sometimes people claim because they say, oh, well, my house was broken into and my diamond was stolen or diamonds actually do get stolen. And then

Starting point is 01:06:13 they turn up later at some shop down the road and they get resold again. So Everledgeer, my understanding, is that it's a database which is designed to link up the police, the shops, and insurers, so that you can figure out if someone has made a claim against a diamond, and they said, well, you know, I've lost my diamond. Okay, we'll pay out $6,000 to you. Here you go. Go away. Two months later, the same thing turns up in the shop.

Starting point is 01:06:37 You go and you interview the shopkeeper who brought that in while it was Joe Bloggs's wife who brought it in. And it turns out she was the one who made the original claim. You do that and you reduce your insurance fraud. So it's a way that you can spread that out and make sure everyone's looking at the same data, which is verified and they say, well, I've identified that this diamond was, you know, it originated here. We can track where it went. And in addition to that, we know if it's been stolen, someone can report it's stolen, and we can go and put a black mark against it so we can track what happens to it when it

Starting point is 01:07:03 turns up later on down the line. So it's a way of getting better information about what's going on in the supply of diamonds in a particular place so that you can avoid insurance fraud. That's my understanding. Why is it being distributed an advantage there? Why couldn't that just be a central, you know, data provider? Primarily political reasons. Nobody, so if you have a central data provider, my experience with the banks is that that really bothers them, that you're, basically, that's just a cloud service. So what they would rather do is they'd rather say, you know what, there's a bit of public information, which everyone is entitled to in this consortium that we're running. And so in order to achieve sort of equality of arms, we're willing to share that data,

Starting point is 01:07:44 as long as we have a stake in operating it. But if, for example, let's say Deutsche Bank said, You know, we've just built this new platform called Deutsche Note, and we're going to go run all of our transactions through it. And guess what, guys, you can outsource all your stuff to us, too. Well, you know, Bank of New York is going to look at them and go, no, absolutely not. We're not letting you run the system because then you have all of the power. But at the same time, they still have an interest in coordinating their activities. So it's really political more than anything else. How do you get two organizations to trust each other over information that they're passing back and forth very frequently

Starting point is 01:08:14 without having the issue of one of them being responsible for all the infrastructure? So if you're firmly in the bear camp on, let's say, the investment prospects of the various cryptocurrencies, but you had to identify someone that you would think of as in the bull camp that you respect or you think is thoughtful. Ari Paul. Ari. Yeah, hands down. One of the more thoughtful guys I've met, he knows what he's doing. And actually, I'm surprisingly, a buddy of mine from high school, guy named Chris Dannen. I had no idea. Oh, sure, the Ethereum. He wrote the Ethereum book, right? Did he?

Starting point is 01:08:47 Yeah, I'm pretty sure he wrote a book on Ethereum, yeah. Yeah, so he knows his stuff. And we crossed paths like about eight or nine, almost a year ago now. And I was like, dude, what? Like, seriously what? And so, yeah, Ari and Chris both know what they're doing. So I'd say in the Bull Camp, those are the two guys at point, too. So a good almost bow tie on this whole conversation because Ari was the guy that kicked off

Starting point is 01:09:08 my entire journey here. Everyone listening will know that because he and his partner, Matthew, at Block Tower, are the two that basically cued up my whole journey, right? So introduce me to everyone that I should talk to. So it's been fun to do that with those guys. The closing question that I ask everybody is for the kindest thing that anyone's ever done for you. Kindest thing anyone's done or said for me

Starting point is 01:09:30 was a friend of mine in New York City when I left Monax sort of earlier in the summer of 2017. A buddy of mine sort of was like, I was a bit disappointed about the circumstances of my departure. And one person, who knows who he is, kind of shook me out of it. And was like, dude, get it together. Like, get writing again. And this is before I hadn't blogged anything.

Starting point is 01:09:52 And you can tell when I'm in a bad mood because I haven't written anything in six months. And so he's like, dude, get it together. Like, whatever. And we went up to Porkfest in New Hampshire, which is a libertarian sort of anarchist festival and had a great time. And, yeah, I would say that person is the one who, that's shaking me out of my, or getting me back to my senses. That's the nicest thing anyone's done for me in the space. Well, this has been a refreshing kind of counterpressing.

Starting point is 01:10:14 point to most of the other explorations I've done of cryptocurrencies and blockchains, really illuminating. So thank you very much for your time. Thank you. Pleasure. Hey, everyone. Patrick here again. To find more episodes of InvestorFieldguide.com forward slash podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com forward slash book club. After you sign up, we'll receive a full investor curriculum right away, and then three to four suggestions of new books every month. You can also follow me on Twitter at Patrick underscore Oshag, OSHAG.

Starting point is 01:10:51 If you enjoy the show, please leave a quick review for us on iTunes, which will help more people discover Invest Like the Best. Thanks so much for listening.

Invest Like the Best with Patrick O'Shaughnessy - Preston Byrne - Crypto-pocalypse - [Invest Like the Best, EP.72]

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