On The Brink with Castle Island - Jake Chervinsky (Compound) on straddling crypto-anarchy and regulation (EP.41)

Episode Date: February 10, 2020

Jake Chervinsky the General Counsel of Compound joins the podcast. In this episode we discuss:  - The history of securities markets in the US - The Howey test in plain language - Whether commodities can transmute to securities, and vice versa - Why markets function best with regulation - The purpose of open finance - Being a bitcoiner at an ethereum-focused company 

What's up, everyone? This is Nick Carter with another episode of On the Brink with Castle Island. So today we have Jake Trevinsky on the show. Jake is the general counsel of compound. I would describe compound as a decentralized money market built on Ethereum. It's one of the most popular defy or open finance applications in use today. So our conversation is interesting because Jake is one of the most erudite and forthcoming lawyers currently active in the crypto space. He also straddles a middle ground. So he's needed to be a newfound. an idealist who believes the law is irrelevant in this new paradigm, nor is he a skeptic that thinks it's only a matter of time before regulators bring everything crashing down. So in our conversation today, Jake explains how current securities laws relate to crypto markets

in plain language, which I found incredibly useful. He also discusses some of the crypto-focused legislation currently proposed in Congress, why markets have and need regulation. what it's like being a bitcoiner working out an Ethereum focus company and his view of what the objectives of open finance are. This is easily one of the most educational conversations I've had on the podcast, and I think everyone has something to learn from Jake. Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated.

The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more into Britain's ailing economy with a new round of quantitative easing. You print a couple trillion dollars and all of a sudden people start to worry. So out of this worry, we have something called the Bitcoin. Bitcoin. Hello and welcome to On the Brink. I'm Nick Carter and I have the pleasure of having Jake Trevinsky in the studio with me today. Jake is the general counsel at Compound. Welcome to the podcast. Hey, Nick, thanks for having me.

So Jake, it's a real pleasure to have you in. I consider you to have an extreme breadth of understanding over kind of legal questions in crypto. And unlike a lot of the, you know, kind of crypto-native lawyers, you don't write off the whole industry, which is great. So, yeah, I'd love to first start with how you made your way into the kind of crypto space or the crypto law space even? Yeah, for sure. So I first came across Bitcoin in 2013. I graduated law school that year and went to work for a law firm in Washington, D.C. It was doing a mix of litigation, compliance work, internal investigations. And one of my main responsibilities was to cover all the news coming out of Finson. And this was right after Finson had put out its first guidance on

what they were then calling virtual currency exchangers and administrators. When was that? That was, I want to say middle to 2013. So I was starting at my firm in the fall of 2013 and had to write basically just like a paragraph discussing what Vincent had said and what this whole virtual currency thing was. And I literally did just enough research to write the one paragraph. And that was as far as I thought about Bitcoin. I basically dismissed it like many people do the first time they come across it.

It seemed to me like World of Warcraft Gold or something like that. I had played video games when I was a kid. And I just thought this is some fake asset that doesn't have any value. Pretty much forgot about it for a few more years. Came across it again in 2016 for the second time. I had left my firm. I was working as a law clerk for. a federal district judge in Los Angeles and we were interviewing clerks to take over

later terms and one of them had just left a crypto exchange in San Francisco so I thought wow this crypto thing still exists maybe I missed something and so I asked this guy during the interview oh crypto that seems interesting what's going on there and his answer was nope not interesting at all very happy to leave the exchange not looking back nothing to see there and I thought oh great So I didn't miss anything. And then it was another year until I would say early 2017 when I came across Bitcoin for the third time. Third time was the charm.

It was an article about price that really got me to pay attention. So I think Bitcoin had just hit $3,000 in early 2017. That sounds right. And all these articles come out about Bitcoin hitting a new all-time high. And I thought, you know, if this thing is going to have this much value, maybe I should figure out what's actually going on. And that's really when I fell down the rabbit hole and really saw sort of what it was and what it was good for and haven't really looked back since.

And what was it that interested you in joining compound as GC? Yeah. Well, so after I got interested in Bitcoin and crypto generally, I started doing some work in the industry. So initially it was just a personal interest. I never thought I would be doing work related to crypto at all. But the firm I was working for was a litigation boutique that specialized in international disputes and investigations, mostly involving fraud and misconduct.

So naturally, this is a pretty good fit for the crypto industry of 2017, especially at the height of the ICO bubble. And I had done a fair amount of securities litigation in the past. And so my firm started doing ICO cases. So a lot of it was responding to subpoenas from the SEC. We also represented other market participants. So, you know, investment advisors and, you know, folks who were doing commodities trading and things like that. So we were getting CFTC subpoenas, DOJ inquiries, things of that nature.

And I was really enjoying working in the space, but didn't really feel like I was contributing in any meaningful way. Defending ICOs was not my idea of a constructive effort to advance the technology that I've come to find extremely interesting and powerful. And so I decided, let me take a step back from litigation and jump into the industry full time. And so I started looking for companies where I thought that I could make a difference, where my experience and skills handling regulatory compliance issues would be of most benefit. and I came across compound and thought it was super interesting and I've been loving it ever since. Wow. So you, yeah, you have a pretty unique kind of placement here in terms of being familiar with like FinCEN issues and then having done litigation in these securities law cases. Yeah, I think I had the perfect training as a lawyer to get into this space. So I did financial services litigation a lot for very large financial institutions.

So I sort of understood from the outside looking in how the finance industry worked. I did a lot of anti-corruption and anti-money laundering compliance and investigations. Saw how all those regulations worked. Like I said, some securities litigation. So, yeah, I think in terms of getting training to jump into this industry, I think I probably had it as good as it gets. So starting with securities law, this is often a very contentious topic among Bitcoiners, I would say, or even just, you know, crypto folks generally, because there's this, you know, admittedly libertarian ethos in the industry where we believe in free markets and we want to keep the government's grubby hands out of everything. But then at the same time, you know, you witness some of the malfeasance that goes on in the crypto industry and you see the harm that it does. And you want to, you see the harm that it does. And you, you want to put an end to it, or speaking for myself at least. And so then people will always get upset with you and say, well, you know, we should just let the free market sort it out. But unfortunately,

the free market doesn't sort everything out. And you have these eras where essentially, you know, grifters or fraudsters are able to proliferate and do well in total, in the absence of regulation, which is what we saw for a long time in crypto. So I'm of the camp that markets are a little bit like a sports game, basically. So you need a referee and you need rules for them to function. And if there are no rules, then the game just doesn't get played, you know, in a fair way. And the integrity of the game suffers, right? So if there was no referee in the NFL, there would just be tons and tons of dirty hits every play and it would be disastrous.

It might be interesting, but I don't know if anyone would watch it because, like, the QBs just get destroyed every play. So, you know, I feel that U.S. securities laws are really the foundation of the extremely vibrant equity market that we have in this country, the most vibrant equity market in the world, in part because, you know, we sat down and I guess it was the 20s or the 30s and really figured it out. And that was building on a long, you know, tradition. A lot of people think it's due to common law that our legal system is. so well suited to shareholder rights and so on. However, there's a big tension there with this potentially, you know, decentralized ethos of crypto. So I'm assuming that you think security,

the existence of securities law is a good thing generally. I do, yes. You know, I am a bitcoiner. I would describe myself that way. I definitely identify with the healthy skepticism and sometimes distrust that big learners have of government and of regulation. I totally understand that. But I think the problem is the one you identify about markets, which is markets don't function perfectly. And sometimes you do need some regulation in order to keep markets functioning efficiently and to level the playing field for market participants that have different access to information. And ultimately, that's what the securities laws are about, at least the 33 and 34 acts, are really just about disclosing information so that the purchasers of securities have the same

access to information as the sellers of securities. And like you mentioned, so the laws arose in the 1930s. They really came out of the Great Depression and the bust at the end of the Roaring 20s. So the Roaring 20s were basically full of extraordinary access to capital and all of these investment opportunities that appeared to be coming back from overseas after World War I. So all these companies were saying, look at post-war Europe, give us money, we will go make a ton of profit for you with this business that we're going to launch in Germany or somewhere like that. The problem, of course, was that there was no real business and all of this ended up being the kind of Ponzi scheme that after it runs for long enough

collapses. And the response to this in the 1930s was to say, if you want to sell securities on the promise that your purchasers will profit from your efforts, you need to give them access to information about how you're going to make that money, what it is that they're investing in. And that's the regime that we've had in place for the last 80 or 90 years. It works really well. It's worked extremely well for capital markets in the U.S. When you don't have the protection of that kind of disclosure regime, what you get is the 2017 ICO bubble. Honestly, I think the ICO bubble is the best arguments in history perhaps for why you need securities laws because if you don't, then your market is going to look like a whole bunch of

fraudsters scam each other out of money and a lot of innocent people getting hurt. And people fixate on the few ICOs that, you know, really delivered. But in those cases, it's because the person running it was, you know, exceptionally virtuous or had extreme amounts of commitment to the idea. But there were no token holder protections that I can really identify behind any of these ICOs. There's very little in the way of recourse. We've only just now begun to see situations where token holders are able to actually exercise a claim on the treasury, if they so desire. So Digix, Dow just agreed to basically refund token holders to give them a pro rata claim on the treasury. But for the most part, this has not been the standard. So even pointing

to those exceptions, I don't think it really vindicates the notion of an ICO, because the, the ultimate, like the structure behind the thing was on sound. Right. I mean, I think that the ICOs that worked, for better or worse, probably got lucky. When you had as many as there were, I mean, how many ICOs were there in 2017, a few thousands, probably? You're going to have a handful just as a matter of probabilities that are going to end up succeeding. You're also going to have a handful that are outright scams. So we saw legitimate Ponzi schemes. When I say legitimate, what I mean is clearly a Ponzi scheme

as opposed to simply accused of being scammie in some vague kind of way. And then you're going to have a huge number in the middle between those two extremes that are just bad investment opportunities, bad investment decisions. And that's really where the securities laws kick in in giving purchasers information that they need to assess whether the investment is good or not. and that's really how so many people lost money.

I like the way you put it where, in which ICOs are a great case study and why regulation is necessary. I mean, look, I think it's also important to recognize that disclosure isn't a cure for every ill having to do with the securities issuance, right? You can get disclosures and still be fooled or make a bad investment decision or not truly understand the risks of the investment that you're making. But I think that disclosure is the single most important medicine for the problem of the information asymmetry between issuers who are looking to use other people's money and the people who are trying to make a profit off of that money. But it presumably has to be paired with a legal context where you can have recourse if the disclosure is false or you've been lied to.

Right. And that's the goal of the federal securities laws here in the case. the US is if you issue a security and you're doing it through a public offering, you have to register it and you have to make certain disclosures when you do the sale and also on a quarterly and annual basis and also for certain special events, right, you have to disclose all of this to your investors. If you don't do that, then your investors have a cause of action against you for issuing an unregistered security. The remedy for that is to get your money back, right, rescission, which is the right remedy, I think, for that kind of violation.

The problem that we've seen in the ICO space is that the statute of limitations for bringing a claim for issuance of an unregistered security is one year after the issuance. And problematically, so many of these ICOs happened in 2017, and a year had gone by before any of these investors really understood that what they had done was to buy an unregistered security and that the token wasn't going to make them all the money that they thought they were going to make and that they should bring some cause of action. So that's one of a couple reasons why there hasn't been the type of cleanup after this whole mess that you would normally see. And why is it that I have the figure in my brain of five years in terms of a statute of limitations? So the SEC's statute of limitations

is five years for basically all claims, for compensatory or punitive damages, the SEC has five years. Private investors have only one year. It's really one year to bring a suit from the time of the violation or three years from the time of the discovery of the violation. It's called a statute of repose. And there's a different limit for fraud claims. So there's a two-year statute of limitations for securities fraud. But the problem is, When private investors no longer have standing to bring these claims, the only thing you can do is wait for the SEC to step in. And of course, the SEC's goal and the purpose of the Division of Enforcement is protection of investors, and yet the Division of Enforcement hasn't done very much in this space so far. Because the sheer magnitude of ICOs presumably overwhelmed them.

That's possible. I'm not sure about that. Compare this to what happened with the rise of the internet around the turn of the century. So in 1999, 2000, 2001, the SEC was doing sweeps of hundreds of people and companies who were doing fraudulent stock issuances and pump and dump schemes that were basically enabled only because of the internet. The internet was one way of describing it is a huge increase in the total address. market for fraud, right? The internet connected scammers with a whole lot more targets than they had ever seen before. And so in the early days of the internet, you had very prevalent pump and dump

schemes, penny stocks, things like this. And the SEC's reaction was several sweeps where they filed complaints against dozens, hundreds of companies and people at a time. There's no reason they couldn't have done that for the ICO bubble. I think the big difference was just the confusion around whether to classify digital assets as securities or not. In the internet case, these were stocks that were being pumped and dumped, right? They were dot-com stocks or they were other penny stocks that were just being pumped and dumped or manipulated. So they already had a framework to understand. There was no question, right? Stocks or securities, no questions asked. When you have to apply the Howie test, which is a very old test that granted

has had a lot of development in Kays Law over the years. It's not that complicated to apply, but it is new. It's a jump from what the SEC had dealt with before. I think it took them a while to figure out what they really wanted to do with this space. And they still haven't really taken a serious shot yet at any of the big players in the space. They're just starting now with Telegram, I think.

Yeah, similar to the Internet, which introduced, broad in the market for CAMs. I think blockchains also do that in terms of making value easily transmissible between untrusted entities. So, you know, I don't know if we'd ever seen Ponzi's of this magnitude on a kind of direct to quote-unquote customer basis. If you look at some of the size of a few of these Ponzi's like BitConnect and Plus token one coin, they're truly.

wateringly large. And this is because the investors in the Ponzi's were given instructions to buy Bitcoin and then, you know, buy the, by the asset, buy one coin or buy plus token, which they, you know, and because of the infrastructure that sprung up globally to facilitate the trading of fiat to Bitcoin, they were able to get access to these things. Whereas before, you know, if someone wanted to defraud you, I don't know, you'd have to send them a wire or something, I guess. Right. So it's interesting to think about. the fact that the existence of crypto means that fraud is now possible on a mass global scale. Right. And remember also that with the internet, if you're going to pump and dump a stock,

the stock is at least trading on some kind of regulated exchange, whereas something like BitConnect or Plus token isn't. You really can access it from anywhere. There's basically no friction between the, you know, this scammer and the target of the scam. Honestly, I think we're just seeing the start of this. And I'm, don't get me wrong, as bullish as anyone about the future of Bitcoin and this industry. But imagine how many people haven't yet learned how to access Bitcoin or how to get access to ether or something like that, but who could be tricked into one of these scams somewhere down the road. I think this is a problem we're going to deal with for a long time. And with, you know, with pumping and dumping stocks, you're jurisdictionally confined.

in the crypto era, we have entire regions that, you know, like Big Connect was targeting Southeast Asia, for the most part, and, you know, and India. And, you know, there's no constraint there on how big this thing can get. Right. Basically, none at all. And, you know, it's the people who learned how to perpetrate these scams on the Internet in the early days, who in some cases have come over to this. space. So just as one example, I don't know if you followed the Quadriga story at all, but Gerald

Cotton was pretty well known for being on these forums in the early days that were basically devoted to Ponzi schemes. I mean, the guy was training to commit scams on a massive basis, and crypto was the right opportunity for someone like him to hear. He found the perfect fertile ground, and I think interesting to the legacy of Quadriga is that the Canadian securities regulators are being extremely onerous in their treatment of centralized exchanges. Right. So maybe that's a silver lining. You know, they're really embracing this, well, it seems to be the case that they're embracing

this notion that exchanges for the most part can't be trusted to hold bitcoins on behalf of depositors. Yeah. They came out with guidance recently. That was very interesting. Basically what it said, if I'm summarizing it correctly, is that Canadian exchanges have to be non-custodial, that basically their users have to be able to access and take custody of their own assets without any further intervention by the exchange. That's a huge decision

in a country that has a pretty significant amount of crypto activity. Yeah, so the Canadian Central Bank does these amazing polls of Bitcoiners. I don't know why they do it, but I don't know if you've come across this. So the Bank of Canada is very interested in knowing how many Bitcoiners that are in Canada. So they've done these surveys three years in a row. The last one found that I believe it was 8% of respondents were owners of Bitcoin. Very interesting. And they even did trivia questions like is Bitcoin fixed in supply, stuff like that to determine someone's understanding of Bitcoin. This sounds like the friendly version of what the IRS started doing here this year, which is asking everyone on their tax returns if they've held or traded any

cryptocurrency during the previous fiscal year. Maybe it's just because I have this mental image in my head of a disarming Canadian central banker, just kindly asking people on the street. But it's much less sinister when you imagine them doing it as opposed to the IRS. I think so, yeah. Yeah. I mean, I don't believe they're doing it for, you know, nefarious purposes just like out of curiosity. Right.

But yeah, there's a sizable, you know, Bitcoin population in Canada, and this is really going to affect them. Right. And it's, it goes to show how regulators can react when terrible things happen. Right. And sometimes I think you do need that stimulus to get regulatory movement. It's something that we haven't really seen yet in the U.S. On any number of fronts. And I think that if you were to ask the exchanges in the U.S.

how they would feel about the SEC or some other regulator of competent jurisdiction adopting a rule like this, I think the U.S. exchanges would be very unhappy about it. So we'll see how far that comes in the U.S. And I think they would have the tools to lobby against it successfully, probably. There seems to be, and I mean, you can speak more to this. There is a bit of an industry devoted to communicating the sentiments of exchanges to D.C. Yeah, that's true. I mean, I also think that the CSA in Canada is probably a bit more nimble

than regulators and politicians here in the U.S. You know, if you wanted congressional action from the U.S. Congress on something like this, you would be waiting for years and years. It's just how slow our process moves. But yes, in general, you're right. There is a pretty strong voice lobbying on behalf of the centralized exchanges in the U.S. to look out for their business in D.C. Yeah, you know, I sometimes wonder, or I've only just recently begun to wonder, what the industry would have looked like if regulators had adopted this non-consumption. custodial standard from the start, you know, that we would have had many, many fewer bitcoins

held in a custodial manner, which might on balance have been good because we would have had fewer of these significant exchange hacks, which exploit this kind of the honeypot nature of exchanges. Yeah, I think you're right. And I think, you know, it may be that the Canadian exchanges in complying with this requirement will stumble across a better business model that serves customers better, that still makes them a reasonable margin, and maybe we will see that come to the U.S. eventually. But it's hard to imagine that right now, given how the exchange business currently runs.

Yeah, you know, a lot of Bitcoiners are incredibly adamant about this, not your keys, not your coins thing. And I totally agree with that. I mean, that is the reason this technology exists is to allow extremely strong ownership of an asset. And that ownership, you know, gives rise to all the other ancillary qualities that we like about, coin, you know, sensor resistant, permissionless, you know, generally speaking, more convenient to send than a wire or something. So that's great. However, there is always going to be a section of society that wants custodial access. They want intermediation. Because as we've seen with this Peter Schiff episode, it's actually, you know, still quite difficult to custody your coins as much

as we wish it weren't. So I for one am a believer that we should just acknowledge the reality that there are essentially Bitcoin banks that exist and try and ameliorate that as much as we can. So let's maybe see if we can hold them accountable, maybe ask them to do proof of reserves, to prove that they're not doing some sort of fractional nonsense like Quadriga. So that's my view is that we should bite that bullet, basically. Obviously, compound is kind of non-custodial in nature. So what do you think about this trade-off where we accept that there are these banks that serve as crypto users? I mean, should that be something we do not encourage?

I mean, I think in the short and even medium term, there's no way around it. Because there are so many people who either don't care about self-custody or just aren't interested in going through the process of learning how to do it right. And especially when you see someone like Peter Schiff, let's assume that he's telling the truth when he says he lost his keys to his Bitcoin wallet, I think he's probably just trolling us all, but that besides the point. I think there is a real fear among people that this is what will happen to them if they try to self-custody.

And mostly people aren't used to that in today's day and age, right? We all grow up being told to go to the bank and give. them more money and trust that they'll give it back when we want it. So to me, I think that self-sovereignty, like you said, is the most important aspect of Bitcoin, without which we basically don't get any of the other important benefits. On the other hand, if we want more people to get access to this asset class, and there are a lot of different reasons why you might want to do that, we're going to have to accept that some of them are only going to do that through a custody model.

And what that means is trying to make the custody model as effective and secure as possible. So, you know, I like proof of reserves. I like the idea of proof of keys. I think it's good for us to keep these exchanges honest and make sure that we withdraw any crypto that we're holding on exchanges from time to time. But yes, I mean, I think that we're stuck with this model, basically, until some future that's very hard to imagine now. Yeah, one thing I worry about, though, is that we,

increased amount of fragility in the system if we have these centralized intermediaries which you know mediate our access to these coins i think there's probably some certain threshold of custodial bitcoins for instance where um the system becomes essentially captured and then the governance of the system becomes much more a function of what those large exchanges or you know third party providers want as opposed to this kind of anarchic kind of open source governance that we have today. So you can imagine a future world where 80% of bitcoins are held with, you know, three or four large custodians slash exchanges. And maybe there's a repeat of the 2X episode, but this time it's successful because they've extremely,

they're bargaining from a position of strength where they can say, well, you know, like fine, you can violate our wishes if you want, but in fact, we will only serve this fork, which is the KYC fork of Bitcoin. You know, I don't think that. that's too far-fetched, you know, and it'll probably look more subtle than that. But that's something I'm certainly nervous about. Yeah, it's not too far-fetched. I wouldn't say I'm terribly nervous about that yet. I think there are reasons to think that what happened to gold, which is sort of like what you're describing, right, basically all gold is custodied by centralized vaults. And no one really owns gold, except for maybe in sort of small amounts on the grand

scale. I think there are reasons to think that Bitcoin is inherently resistant. to that kind of capture. I think most importantly, you don't need to put Bitcoin in a vault in order to keep a chain of custody to make sure that it is verified, right? We can verify the entire supply of Bitcoin basically at will. So I think there's one less pressure to centralize in that way.

I also think that Bitcoin has value outside of simply holding it, right? The more interesting technology that gets built on Bitcoin, the more value there's going to be in having actual bitcoins on the network as opposed to having a claim to bitcoins held by some custodian. And so I think there will always be a significant demand and a growing demand for actual bitcoins as opposed to just private investment trust or an ETF or something like that.

This is something that you can measure in commodities by looking at the futures curve. So you can see whether there's a convenience yield of having the spot product itself as opposed to just having exposure to it in the form of the future. So interestingly, in the history of Bitcoin, correct me if I'm wrong on this, Bitcoin has normally been in Contango, which means your future is traded a premium to spot, which kind of implies there's actually a cost of exposure to spot Bitcoin, which I guess makes sense because custody is something you have to pay for normally,

and any of these that trade Bitcoin don't necessarily want Bitcoin. They want the synthetic Bitcoin. But I definitely agree. I mean, if we can't figure out anything to do with Bitcoin, as opposed to just holding it, then this whole enterprise has probably been a little bit futile. Yeah, yeah. Well, and also in terms of looking at the metrics right now,

there are probably market inefficiencies that are skewing this one way or the other, right? So when you say that the futures markets are in contango, do you mean CME? Do you mean Bitmex? Do you mean Bitfinex? There might be reasons why there's more money flowing through some of these venues than others. I think it's hard to draw any firm conclusions right now. I also think it's important to remember that when we talk about Bitcoin banks, you and I sitting here in Cambridge are still thinking of these banks in terms of the fairly well-functioning financial system in the developed markets. If you're in an emerging market, which is where Bitcoin is probably somewhat more useful,

right, if you're under threat of hyperinflation of your local currency, or if you don't have a bank where you can store value because the banks themselves are the criminal enterprises in the country where you live, well, guess what? You're going to want actual Bitcoin that you can self-custody. And so I think that that will probably keep Bitcoin banks from at least taking over the entire world where, you know, there are these use cases for Bitcoin in the emerging markets. Yeah, it's a big irony of Bitcoin, I would say that the places where it is the easiest to get exposure and the most convenient and the cheapest to get exposure are the places where it's really the least required. You know, I mean, I certainly think as an American or a Westerner with a functioning financial system, it's still entirely appropriate to want to have exposure to Bitcoin.

But the places where it is most relevant are the places where, you know, the risk of confiscation. is very high where the legal system doesn't work very well and where the banking system doesn't work, which is not the U.S. Right. So it's always a little funny to me that, you know, most capital allocated Bitcoin is American, right, if I had to guess. Yeah. Well, I think you're right.

It's, you know, first of all, the money that the risk capital that is willing to get into, what I would say is still a fairly speculative asset class, is mostly in places like the U.S. and other developed markets. Also, as you say, it's much easier to get access in the U.S. where you can open up an account with Coinbase or Gemini or Cracken or some other exchange, whereas in a lot of other places it's much harder to get access. But again, I think this is one of those things that you just have to give enough time and then access and user experience will improve across the board. So returning to securities law, you have made a very strong case for the existence of, you know, actually. actual disclosure regimes and, you know, I think it's a very good point and I definitely agree. Would you say that the letter of securities law conflicts at all with the realities that crypto assets

have brought to bear? Is there anything fundamentally new or different about crypto assets or virtual currencies, whatever you want to call them, that makes the current securities law as written in this country look antiquated or in need of refreshment? I would say maybe or probably yes, but I would say it's too early to know exactly. So I don't think that we're quite ready yet to make any fundamental changes to the securities laws. I think we're still in a phase where we're trying to figure out if, there are digital assets other than Bitcoin that have real value. It seems to me that the most

likely digital asset that may have value that also may require some change to the securities laws are these governance tokens that are being used in the defy world or what I prefer to call the open finance sector of the crypto industry, where you have a token that gives you some specific rights over a particular protocol. and may even entitle you to compensation in one way or another, but doesn't look like a traditional equity security. And the problem with applying the securities laws to that type of token is the disclosure regime

doesn't really match up with the types of information that you would want if you are an investor buying one of these types of tokens. On the other hand, having no disclosures at all seems problematic as well, because there may be information asymmetries that you want to address during some period of time where this token exists and is circulating and is being used, but yet the holders

of the token are relying on the efforts of some other team or a group of people to bring value to the token. I think we don't really have an answer yet about what type of disclosure regime would be appropriate for that circumstance. By and large, though, I think that the securities laws apply pretty well to most digital assets, And certainly, I think that the Howie test is pretty well suited for the types of investment contracts that we've been seeing for the last couple years. Yeah, I'm not a lawyer by any means, but I tend to think that the Howie Test is a pretty common sense test of whether there's an investment contract. It certainly seems to make sense to me.

Yeah, look, it's a principles-based test. It has four fairly clear elements that are not terribly hard to apply. all four seem to make good sense as to why you would want them satisfied before you call something an investment contract. And I don't honestly think it's that hard to apply to the context of a digital asset. There's nothing really unique about a token that gives rise to an investment contract versus some other type of arrangement that gives rise to an investment contract. It's my view that a lot of regulators were, for lack of a better word, bamboozled by some of the decentralization theater, as Angela Walsh, puts it, exhibited by some of these token issuers who were very careful to portray their efforts as not managerial and not central. But ultimately, you know, the reality is that, you know, many of these teams, most vast majority in my estimate, you know, there was a, a thing. third party administering the project and so on. Yeah, I mean, do you think that it is simply

ignorance on the part of the regulators in terms of being so hands off for so long or a desire to see how this market developed? I wouldn't say it was ignorance. I think that I think that if you put yourself in the mindset of a regulator, especially at the SEC, where they're overseeing the largest and most important capital markets in the world, crypto is a very very, very very, very small piece of their mandate. I don't think that, at least in the early days, it was worth really the SEC taking much of a look at this space. And I think things just blew up much faster and much bigger than anyone had really imagined. I think by that point, there were enough arguments being made and like you said, enough decentralization feeder

being put on, that it did send confusing signals to the regulators about where they should focus their attention and how they should go about enforcing the laws. You know, the SEC, rightfully so, is very concerned about stifling innovation in the U.S. The last thing that the SEC wants to do is push true innovation that could yield benefits to Americans overseas because they came down too hard too early without understanding what was really getting built. I also think that there were a lot of seemingly attractive. but ultimately deeply flawed legal theories as to why these tokens were not securities,

despite looking like they satisfied the Howie test. So I think the best example of this was the theory of consumptive use. And just to sort of give the context for this, for anyone who doesn't know, an investment contract under the Securities Act of 1933 is defined by the Howie Test as an investment of money in a common enterprise with an expectation of profits derived solely from the efforts of others. The test has been changed a little bit since then, but that's the basic formulation. However, there's sort of an exception to this rule that says if you're obtaining a financial instrument, not for the purpose of expecting profit, but rather because you are going to use

this instrument for your own purposes, like a consumer good or something like. that, then it is not a security. The classic example would be a luxury watch that you buy from a fancy watchmaker. That's what I was going to say, actually. Exactly, right? So you're buying the watch to wear it and to tell the time. Now, granted, you might think it's going to go up in value. If you hold it for 50 years, you may be trusting the watchmaker not to make another 10 million of those watches so that it would become less scarce and lose value. Nonetheless, the securities laws would say the watch is not a security, and neither are other consumptive or consumer use goods. Because your primary objective is for decoration as opposed to simply for speculation.

Exactly. So you're not expecting profit derived from someone else's efforts. You're just buying something you want to use. Now, the early theory, I say early, I mean 2017 time period. The early theory of these tokens was the utility token, right? The app coin. What I would call it, called basically as the friction coin, right? For some reason, you're going to pay for a service using this random token that someone created instead of using dollars or Bitcoin or something else. I think that theory has totally fallen apart.

I don't think there is a single app coin or consumptive use utility token that succeeded out of the many hundreds or even thousands that came out in 2017. But that narrative, I think, slowed down the SEC from really going after some of these projects. Yeah, it's interesting. You know, if you think about the Birken bags created by Hermes, it seems to me that people actually do primarily buy them for investment purposes.

But I guess the SEC isn't really too keen on quibbling over luxury bags. Well, yeah, you have to draw the line somewhere, right? I mean, what you don't want to say is that the securities regulations apply to anything you buy that you think may increase in value, period, or else everything in existence. would be regulated, and that's not a recipe for a well-functioning market. Yeah, no, I'm definitely persuaded by that. It is interesting. The utility token narrative has completely faded away now, as we have met with empirical reality,

which is something I really like that we can evaluate outcomes here because of the transparency, the semi-transparency that the on-chain nature of these things gives us. And we can go now and look at all of the most popular touted utility platforms and see how many, transactions a day they're doing. I can pretty much guarantee you it'll be in the single digit thousands for the most popular of them. And for the most part, those transactions are not usage related. They are related to people just trading the tokens. Right, right. But so, you know, the reason I bring that up is if utility tokens had worked, right, if that theory had made sense and had been successful, then we might have wanted to change the securities laws to address the

types of disclosures that you would make if you're selling a token to fund the development of a network that uses the token for consumptive purposes. But since we now know that, or at least it seems pretty clear to me that that is not a business model that makes much sense, we don't need to waste the time to come up with the type of disclosure regime you would want if it did. And that's why I think that the main theory in DC around modifying the security. securities laws is we should wait until we really know what these things are good for, if anything, before we start changing the laws. So it seems like you're referring to the Token Taxonomy Act. I gather that you're not the biggest fan of this proposed legislation. No, I'm not.

So for the uninitiated, what is the central conceit of the Token Taxonomy Act? The point of it is to carve out from the definition of a regulated security a certain type of digital token that would not be subject to any of the compliance obligations imposed by the federal securities laws. And the way that the proposed bill tries to define those digital tokens is basically by tracking the language of decentralization. But as I'm sure you would agree, the term decentralization means very little and is very hard to define. And especially hard to define in very precise terms that you would put into a statute. And so the way that the language came out basically said that most tokens that live on blockchains aren't securities, period. sort of regardless of their other characteristics and sort of regardless of the characteristics

that make most types of investment contracts regulated under the law. My take on it in general is, like I said, we're a little too early to do something like that. I also think that if we are going to create a new classification for digital securities, we need to make sure that we're at, clarity, not more uncertainty. And when you change a law that's been on the books for 90 years

and has decades of case law and precedent explaining exactly what every single word of the test means and giving you examples of circumstances where the test is met or the test is not met, when you change the law, you throw all of that out the window. And I don't think, based on my reading of the draft bill, that we would benefit from doing that at this point. I mean, I very much align on the decentralization point. I'm not the first critic of this word, which is bandied about. I actually just remembered my master's thesis, which I wrote in 2016, 17, and I tried to define decentralization in a crypto context, and it gave me fits.

Right. And at the time, I split it up into political as in who makes the decisions over the system, protocol as in where is the authority, you know, this would refer to hash power stake, and then architectural in terms of, well, what does the actual node topology look like? And even that I felt was an extreme simplification. And I think now in 2020, the thinking has come along sufficiently far that we understand that decentralization on its own is not something to be fetishized. And in fact, it's a false target most of the time.

So really the thinking is, okay, what's the purpose of having decentralization? What are the objectives? So I'm a little encouraged by that, just by what I see in the discourse, but then we return to these notions of, quote, unquote, sufficient decentralization, which we've seen in the quote unquote Hinman test, which we haven't covered yet. And this seems to be something that policymakers are taking seriously, which is maybe a little vexing. Yeah, it's frustrating for me as a lawyer because I think we were starting to understand what decentralization meant in technical terms, right, in terms of the structure of the network. Bill Hinman, the director of the division of corporation finance at the SEC then gave a speech, the when you're referring to, in July of 2018, where he basically said, if a token is, quote, unquote, sufficiently decentralized. then it negates the fourth element of the Howie test, the efforts of others prong of the Howie test. The problem is the way that he was describing decentralization

was very different from how that term had been used in the technical sense. So what he was talking about was decentralization of efforts to bring value to the token and therefore profit to the holders of the token. He was not talking about technical decentralization in the sense of, can you control the network? by having 51% of the hash rate, for example.

And so I think that that injected a lot of confusion where people thought technical decentralization would somehow help them escape the fourth prong of the Howie test. And that's really not true. That's interesting. I remember when he gave those comments, and I thought it was a little silly, to be frank, because the Ethereum Foundation was still active,

have still had lots of coins, which traced back to the Genesis block, and I felt that their entrepreneurial efforts were sufficient that maybe the SEC should have thought more carefully about that. But my feeling on that was that the Hinman test, if it were ever really codified in any meaningful way, which I don't really believe it has, would give rise to like a cottage industry of consultants who would help you beat the Hinman test by making various like cosmetic alterations to your protocol? Well, it kind of already has, in a way.

So, I mean, I think your fears might have been realized. There are a lot of lawyers out there. Love to hear it. I think they understand how to deal with this. You know, I think, in a way, though, the Hymond test doesn't need to be codified. The Hymond test is just a really simple explanation of how you apply for separate elements to a particular set of facts and circumstances. I actually think him nailed it from the start.

I mean, I think he gave us a very succinct and clear answer to the question of how and when a digital asset can evolve from a security to a non-security by overcoming the reliance of token holders on the efforts of the issuer or a promoter in order to get profit from their investment. It's honestly just like any other test that has a series of elements that you apply to a set of facts. So think about this. Think about this in terms, so I'm a former criminal defense attorney, so my mind immediately goes to criminal law. So forgive me for this, but think about this in terms of a charge for possessing a controlled substance, right? Okay. So if you're charged

with possessing a controlled substance, you have to, number one, be in possession, number two, of a controlled substance. Number three, knowingly, right? Basically three elements. to that charge. So let's say you, Nick, have some cocaine in your pocket, which of course you don't, but just for the sake of argument, let's say you do. If you have an eight ball of cocaine in your pocket and you know you have it, then you are violating the law that criminalizes possession of the controlled substance. If you then take that bag and throw it out the window, you are no longer possessing that cocaine and you are therefore no longer at that moment in violation of that law. Now, that does not immunize you from the fact that you had committed a violation of the law,

but you no longer satisfy one of the elements of the offense. Therefore, you are no longer in violation at that moment. That's all Hinman is saying about the investment contract analysis. If you negate the fourth element of the Howie test, in other words, no one is relying on you anymore to do anything managerial or entrepreneurial to bring value to the asset that you sold them, then the asset is no longer a security. Actually, a very simple explanation of how the law works in every context. I think the SEC should hire you is their attache for the crypto industry

because you explain it far better than anybody I've ever, than any of the press releases, I think, have said. It certainly makes sense to me. I just might dispute their reasoning in the one case that they've really applied it. Yeah, and I think that that's totally fair. and also a separate issue, right? So one issue is how do you look at the law? The second issue is how do you apply the law to the facts?

And I think it was important that Hymann noted that he was leaving out the question of whether Ether was a security when it was first created and was only looking at the facts and circumstances as he saw them at that moment. But I think you're right to be skeptical in general about how you apply this test to any digital. asset. I just felt that it might inculcate a certain amount of moral hazard where we had issuers

specifically orienting themselves to beat the Hennman test while not necessarily, you know, adhering to like the spirit of the law. Yes. And I think there is some of that. I think the way to differentiate the good actors who are trying to do this right from the ones who are trying to do the ICO thing, but get away with it, is whether they sold tokens to raise money to fund the development of the network. And Hinman has actually given a few speeches since then. And one thing that he has emphasized a few times is the SEC wants to see companies do traditional fundraising, right? They want to see companies sell equity in a traditional Silicon Valley sort of way to raise money to build the network that they want to build. if the network will benefit from a token, create the token later, and don't distribute the

token to the public until after the protocol or the network is fully built out. And the issue really is with projects that are raising money by selling the token on the promise that the token will later have value because of the work that they're going to do. So I think that's a helpful heuristic anyway to differentiate whether projects are going about this the right way or the wrong way. Yeah, and I think the truth is the most tokens didn't want to create a token for the sake of lubricating some digital economy, but they wanted to create it as a form of financing. You know, that's just the reality of it with very few exceptions. You know, like having a volatile token, you know, free floating on the market is a pretty bad U.X, even if there is some requirement that there's a token involved.

and I would just suggest using a stable coin in that case. You know, and I think you go back to utility tokens and you look at the thinking there, the issuers were conflating a capital raising mechanism and the like lubrication for the network. If they'd really honestly wanted to have a token to be the, you know, whatever, a representation of the computational resource,

they wouldn't have issued that to the public and brought about all these issues of securities laws. They would have just, you know, created it once the network was live, but, you know, they needed financing. Right. This thinking, like, took over the whole space in 2017. Like, VC was considered to be, like, this obsolete, like, anti-deluvian, old-fashioned idea. Right, and this all got wrapped up in the meme of democratizing venture capital, right?

opening up these great opportunities for investment to mom and pop on Main Street and not just you, Nick, working at your venture from. Yeah, I'm a little biased on this topic. But whenever I hear like, oh, yeah, let's broaden access to capital for like mom and pop, I think let me issue my, you know, garbage asset to mom and pop because they're not sophisticated enough to know the difference. Right, right. And, you know, I totally reject the concept of democratizing venture capital like we were talking about before, there's a reason that venture capital firms are able to invest in certain much more

risky, much less likely to succeed investments on the basis of much less information than retail investors are able to do. And if you want to change that, then you should change the regulation, and there is some effort to do that now in terms of the accredited investor standards. But don't just throw all of the laws out the window and go back to the Wild West. I mean, that's what we saw and it didn't end well. Yeah, I mean, I think there's real reasons for why having specialist firms evaluate investments is a good idea. And I think it really just comes down to the cost of acquiring information.

If you're a retail investor and you're investing small dollars, you will not be motivated to spend a lot of effort finding out the relevant information. And you also won't be in a position to acquire that information. You'll be at a disadvantage. This is the disclosure framework you talk about. A venture capital firm is able to acquire a larger fraction of that security, and they're also highly motivated to perform extreme diligence. You know, that's what we do all day.

So because there's like a certain critical threshold, I think, underneath which you're not able to stomach the costs involved in diligence, that to me is what logically excludes. smaller investors from investments. Now, if you have an intermediary like Angelist or something that does a lot of that work for you or like a kind of a structure where information is much more available, I think that's fine. But you're basically going to be exploited if you can't afford the resources to acquire this kind of necessary diligence information. Right. I agree. That's my view on the topic. Now I think the accredited investor laws are like maybe a little bit quaint and are due for an

update for sure. But yeah, I think there's a ton of risk involved in liberating this to anybody, although that sounds a little paternalistic and so on. Well, there is an element of that, right? I think you don't necessarily want the government telling people how much risk they can take on, right? And, you know, when you talk to people who have a really solid understanding of SEC policy. For example, Hester Perce, one of the SEC commissioners, what she'll say is it's not the SEC's job to stop people from losing money, right? It's the SEC's job to create a level playing field for everyone. I think the issue with the accredited investor was is that to create that level playing field, a line is drawn based on wealth, and that's not really the best way to

determine whether someone should be exposed to a certain type of risk. And that is why there was some effort to change these laws. But honestly, the bigger problem isn't so much the accredited investor laws as it is the demise of public offerings. So it used to be 30, 40 years ago that the IPO markets were very liquid and very open to basically anyone. There were a lot of companies going public. That was the main way of raising funds to build a company. That has totally changed in the last 30 years or so. And so it's really less. an issue about the accredited investor rule and more an issue of how hard it is for companies to go public and therefore fewer investment opportunities for non-accredited investors.

The other thing that I think people miss is the fact that there's this adverse selection in terms of the opportunities available to different classes of investors. So if we were to get rid of all the accredited investor laws, you know, the startups, you know, like the Valley startups, they would still want to raise from venture firms. They wouldn't want to raise small dollars because having a thousand investors on your cap table it would be extremely difficult to tolerate, basically. So the only opportunities available to retail at that point

would be the worst ones, basically. So, you know, it's not like if we remove this accredited investor restriction, the Ubers of the world would be going around offering their seed round to, like, the general public. that still wouldn't happen. They would still go to venture firms. So people really feel hard done by a lot of the time by this exclusion, but it's not like they would magically all of a sudden have access to these great early-stage opportunities.

For sure. And don't forget, the accredited investor rules are a deregulatory measure. If you eliminate the accredited investor rules, basically what you're saying is every issuance of a security must be registered. period. The accredited investor rule, which is regulation D, is an exemption from the registration requirement that says, if you only sell to accredited investors, you don't have to register. So if you eliminate that exemption, you're basically imposing more regulations on everyone. So it makes frankly no sense at all to eliminate the accredited investor rules.

So unfairly maligned is the conclusion there. One thing that I thought was interesting was CFTC Chairman Heath Tarbert, I believe, said that these assets which are deemed to have transmuted from commodity to security, or actually lawyers tell me that that's not the precise disjunction, that something can actually be both a commodity and a security at the same time. So commodity is the default and then security is the Boolean, yes or no, just to be precise. So something which is deemed to have undergone this transmutation might also undergo that in reverse. Yes. So he said this at the FinTech Summit, which I thought was interesting.

That would be unprecedented, I think. Well, actually, as would the initial security to non-security or investment contract to the dissolution of that contract, right? Well, it wouldn't be unprecedented in the traditional finance world. So there are cases in federal circuit courts where you take non-securities and then you wrap them in a certain way that turns them into securities. So the best example of this was a certificate of deposit program run by Merrill Lynch. This is in the early 90s where the certificates of deposit themselves were not securities. But they were being distributed by Merrill Lynch to Merrill customers. Merrill was doing analyses to say whether the CDs were, you know, good or bad, whether they would pay off or not, and they were doing all kinds of other underwriting activities with their customers.

And the court said, even though the CDs on their own are not securities, when you wrap them into this program that Merrill Lynch is running, the entire thing becomes an investment contract. So actually, that wouldn't be unprecedented at all in the traditional financial system. And then presumably if they ceased doing the underwriting, then it returns to not be an explicit Sure. So yeah, if you took one of the CDs out of the Merrill program, then it would no longer represent an investment contract. And again, going back to the example before, when you're applying any four-element test, like the Howie test, the question always is, given the facts and circumstances at this moment, are all four elements of this test satisfied? So let's say you've thrown your bag of cocaine from your pocket, you know, down the hallway. You're not possessing it anymore. Well, if you'll pick it back up, guess what?

You're possessing a controlled substance knowingly again, right? And the same thing is true for a token that represents an investment contract. Depending how it is treated, it could go back and forth between treated like a security or not a security. So do you believe the Bitcoin went through this transmutation, although it wasn't strictly sold or pre-sold, but you still had to commit capital to get access to it. You know, and like on day one, the genie coefficient of Bitcoin ownership was one, and then over time it reduced and so on. So, and, you know, Satoshi was undergoing these managerial potentially efforts and then over time left the project and so on. Did Bitcoin go through

this transformation, or was it never applicable? It's hard to say. I hesitate to give you a firm answer one way or another, but I would say there is a very reasonable argument that there was a period of time when Bitcoin was a security, that anyone who obtained Bitcoin invested money. They had to mine, right, which is an expenditure of resources. Costly. It's a common enterprise. Everyone was holding the same asset. If Bitcoin went up in value, everyone would succeed together. If it went down in value, people would fail together. There was an expectation of profit, obviously. People were buying Bitcoin or obtaining it. thinking it would go up in value.

The question, as always, is that fourth prong? Are they expecting profit based on the managerial or entrepreneurial efforts of Satoshi, or some control group of core developers? So the question is, in the early days, was Satoshi so essential to the future of the project that if he stopped managing the development of the project, the whole thing would have collapsed. If so, then yes, Bitcoin was likely a security at that time. That's very challenging because the nature of these systems, they need periodic upgrade. They have these loci of control where there needs to be essentially a single entity

administrating things. If there's a hard fork, there needs to be a quote unquote hard fork coordinator. Otherwise, the system fragments. And you know, you can't quite achieve this dream of truly distributed control, especially at the governance layer. You know, a lot of Bitcoiners don't like that word governance. But, you know, even today, there's a relatively small number of individuals that realistically determine the code that goes into the next implementation of Bitcoin Core, which is, you know,

the sole, kind of the major client for Bitcoin. So I find that very tricky, but, you know, it makes sense to me. Certainly initially in the early days, Satoshi was essential. It's a hard call. I think, you know, even now, if there were an argument that Bitcoin is a security based on the small number of people you mentioned who exert, let's say, disproportionate influence over the future of the protocol, the question is still, are you going to make profit because of those efforts? And are those the essential managerial or entrepreneurial efforts that will cause the enterprise to succeed? fail. I think now there are so many people building on Bitcoin that there is no one party, very clearly no one party, that you would need disclosures from in order to accurately assess the value proposition of investing in Bitcoin, very much like gold. You don't need disclosures from one particular gold mine or refiner or jeweler in order to understand if gold is a good investment or not.

and I think that's where we are now with Bitcoin. But this is why it's so important to draw the distinction between technical decentralization, right? How many people are you looking to keep the network running versus how we test decentralization? How many people are you looking to further efforts to bring profit to the asset? Even if there is one extremely large gold mine,

although in that case they probably could move the price of gold, but maybe that would fall under some sort of different... Well, yeah, so if all it is is the ability to move the price, then I think it's harder to say purchasers of the asset are relying on your entrepreneurial or managerial efforts in not manipulating the price in order to make profit, right? So, you know, these are all facts and circumstances, principles-based analyses, but I think that's probably how that breaks down. That's rather tricky, actually.

You know, it never really occurred to me that Bitcoin might have been a security under U.S. law in the earliest days. Yeah, well, I'm not, I don't want to go on record saying that, or else I'll be the least popular person in this industry, but it is an interesting academic question, at least. So on the topic of open finance, we won't call it, we won't call it DFI here. So we'll honor your open finance appellation. What would you, so open finance is rather different from Bitcoin, you know. Bitcoin is a rather specific and stringent trust model, and Bitcoin, and Bitcoin,

owners are very defensive of that. Perhaps rightly so, because all the other non-state money has kind of failed in spectacular fashion. So it demands extreme rigor, very strong commitment to centralization, to cheap validation. Open finance is a little bit different, I guess. What would you describe its central purpose as?

I would say the central purpose of open finance is to take the same principles underlying Bitcoin. and apply them to slightly more complex financial activity than simply sending value back and forth between two or more parties. I think that, you know, it's hard to speak for the entire open finance base, just like it's hard to speak for any group of people involved in crypto. But at least my perspective is the mission of open finance

is very much the same as Bitcoin in terms of creating self-sovereign money that is censorship resistant, permissionless, and trust minimized. I think the different trade-off for open finance than Bitcoin is willingness to minimize trust somewhat less than the ruthless trust minimization, which some people would like to call trustlessness, although I would object to that in the way that they describe Bitcoin. But basically, the idea is just to take those same principles and apply them to the slightly more complex financial activity of swapping different assets or creating interest rate markets or creating stable value all without intermediaries. That's the point. I think something that trips people up

a lot is the fact that Bitcoin's purpose is, you know, somewhat nebulous, but also rather easy to define in these kind of urgent moral terms even, you know, the history of trusted third parties from a monetary perspective is a history of failure, and we've created an alternative, and that's important for people. In fact, it's an existential question for many people. So that's a very kind of cogent and ultimately rather simple story, right? In terms of open finance, I think it's a little bit harder to describe the urgency of basically the creation of permissionless derivatives or other financial products, right?

Yeah, I think that's fair. I mean, I guess I have the privileged position of being a bitcoiner who works on a project that is at this moment exclusively on Ethereum, which is an interesting position to be in. I think a lot of people pick one or the other and are not interested in both. I'm very glad to be sitting with someone who at least seems open to the idea that there might be more than just Bitcoin. I like the tradeoffs that Bitcoin has made. I think that Bitcoin is far and away more likely to succeed than any other application of a public blockchain. I don't think Bitcoin should change anything about its tradeoffs or trust model. I think that Ethereum specifically and smart contract platforms generally are a different project at their core. I think the project for Bitcoin, if I were to summarize at least what I think is most important, about it is separating money from state using digital scarcity, the solution to the double spend problem. That's basically what it is. The mission of open finance is not just separating money from state, but rather rebuilding the entire financial system, or at least as much of it

as can be rebuilt, using autonomous software instead of third-party intermediaries. So when we're talking about Bitcoin banks, I think that in a way open finance is the response to, to the concern about the inevitability or potential inevitability of institutions taking over Bitcoin, which is to say we don't need them for any financial activity. Let's see how much we really can disintermediate them. I feel like being a blockchain pluralist is a lonely pursuit. Yes, and pluralist is hard as well because that might imply more than two that have value. And if you were to ask me after Bitcoin and Ethereum, what is the third next?

most likely public blockchain to succeed, I would not have an answer for you. And I say public blockchain because I think private enterprise blockchains are basically useless. Or if they are useful, then they're only useful in terms of automating back offices of large financial institutions, and that's not why I'm here. So really, it's Bitcoin and Ethereum, as far as I can tell right now. Yeah, I'd align with that. It's interesting that you talk about Bitcoin banks, you know, contrasted with open finance models. In some ways, having a Bitcoin bank with a, for instance, a proof of reserve out of station, seems like an inferior, inferior, more complex solution to the problem of basically demonstrating that some collateral exists

and then providing a service to end users. Yeah, I think that's right. What so far are the most interesting applications of open finance that you've seen? I guess you might be biased on this a little bit. Well, I won't say compound. I will say Maker, I think at this moment, is the most interesting application of open finance. I'll explain why. Staple coins are something that I think most people are interested in for good reason.

Either you're a trader and you don't want to have to trade back into fiat on some exchange, or perhaps you want access to dollars and you can't get actual dollars, so you want something that will represent the value of the dollar. The problem, of course, is most of the stable coins in the market now create the exact same problem that we're trying to solve, which is trust in a centralized third party to manage a treasury that allegedly backs the asset that claims to be worth a dollar, right? And honestly, this doesn't seem to work out too well in the crypto space

when you see things like Tether, which had some issues telling the truth, it seems. I don't want to disparage them too much, but there were concerns for a while about whether Tether was actually backed one-to-one, as they had always claimed that it was $1 for every one Tether. Then it turned out it wasn't, and then it turned to... that there was this whole situation with crypto capital, which was basically operating like a shadow bank, spare everyone the details on that.

But there's a real problem with reintroducing this trust model into the stable coin markets, which seem pretty important for the development of crypto market structure. So enter Maker, which is a mechanism to create stable value without requiring deference or trust in a centralized third party that tells you are managing assets backing those stable coins. There are other issues that you

replace with the centralized custody issue, which is the model that Maker uses in order to try to maintain the peg between die and the dollar. Query whether that model is better than relying on Circle or Gemini or some other company like that to just custody the dollars for you. But if you're really interested in decentralization, I think it is foolish to dismiss the idea that you can create stable value through a trust-minimized, intermediary-free system. I think it's very powerful if we can do that. Yeah, and the issues with Tether that we've seen, I think, they trace back to just the very nature of Tether itself, which is that it had to, or BitFenax or the parent company, had to rely on these shady counterparties for payment processing,

because they couldn't really get access to normal banking because of the nature of their business, so then they get scammed. Actually, the same thing happened to Kudriga. They ended up just taking a bath on a lot of these payment processors that ended up being shady. So it's kind of an interesting situation where some of these stable coins, especially Tether, are kind of on the margins, on the fringes of finance. Because of their very nature, they're more likely to be basically screwed over. by some of their counterparties, crypticabot,

but all of their problems trace back to that, really, and try to remediate this loss. In the context of Maker, so, you know, an issue a lot of people point out is, in solving this issue of custodial attestation, of some balance in a bank account somewhere, they then have this over-collateralized model, and then people accuse that of being capital and efficient,

and so on, which is really, my reaction to the system as, you know, a finance person, capital efficiency is king, especially in like early stage startups. You say, okay, well, what's your cost to acquire a customer? And so when I think about stable coins, I think about the reality that it costs dollar to create a USDC, maybe even cost 74 cents to create a tether, but then it costs, you know, buck 50 to create a die. And I think that from an evolutionary perspective, the costlier one is less likely to succeed because people prefer capital would be efficient, or at least in a world where capital is costly, which in negative interest,

way, world, everything's upside down. But so, you know, I don't believe that can be ameliorated if we are to retain the trustlessness. That's kind of just the necessary nature of the system, right? Yes, that's the trade-off, right? And I would say one person's inefficiency is another person's use case, right? So think about Bitcoin. Bitcoin is not efficient, right? Blockchains are not efficient. In fact, blockchains are intentionally slow and inefficient. For a reason, the slowness and inefficiency gives you the benefit of decentralization. I think we're saying the same thing about the open finance space, which is, yes, taking $100 worth of ether, and then saying, let's just pretend like this is only $67, and that way it can fluctuate up

down and it doesn't really matter because it'll still be worth at least the $67 that I claim. It's very inefficient, no doubt about that. But that may simply be the cost of having decentralized stable value. And I think the same thing may be true for much of the open finance base, which is you need over collateralization in order to get away with pseudonymity or anonymity and trust to minimization. The second that you start identifying individuals is when you lose most of the benefits of these public blockchains. And similarly, when you start trusting third parties to issue tokens that they claim are backed by dollars that they're holding somewhere, that they may

occasionally give you an attestation for, but they won't give you audits for. And you don't really know what's going on. Maybe it's worth the trade-off to suffer that inefficiency in order to have a system that is fully and completely transparent, that you can see operating in real time on chain and know exactly what the risks are and whether you want to engage or not. I think that's so well stated. I'm not strictly speaking a maker user, but I do look at the data on chain all the time because I find it fascinating that we have. And even I, you know, Coinmetrics is tagged a bunch of exchanges. So you can actually look at these things. It's not quite the same, of course, because you don't always have perfect confidence that you've tagged all the wallets and so on.

But that is one of the things I like the most, maybe the thing I like the most about the crypto industry, is this transparency, which is that you can assess the risk in real time. Right. And I think, you know, that's, to me, one of the most important aspects of this entire industry. You know, I became a lawyer in the wake of the global financial crisis. and I saw the fallout from the lack of transparency in the finance industry. And I saw the repercussions of a group of people who thought that they could engineer risk out of finance. I think of Bitcoin as a rebellion against that, and I think that open finance is just one more step that potentially increases the attack surface in search of a different type of benefits.

which is to say no one is trying to engineer risk out of finance. We're trying to engineer transparency of risk into finance. And then people can decide in an opt-in basis whether they want to take on that risk or not. Jake, this has been an absolute pleasure. Thank you. This has been an education. Yeah, this was a lot of fun. Thanks for having me.

Where can people find you, follow your work? So the best place to find me is on Twitter. I am at J. Chervinsky, J-C-H-E-R-V-I-N-S-K-Y. And, yeah, that's the best place to find me. My DMs are open if anyone wants to get in touch. Well, thank you, Jake. It's been a pleasure having you on. All right, thanks very much.