On The Brink with Castle Island - SEC Commissioner Hester Peirce on the journey ahead (EP.596)

Episode Date: February 13, 2025

SEC Commissioner Hester Peirce joins the show. In this episode we discuss: The past several years of digital asset policy at the SEC Different ways that regulators have the potential to stymie technical innovation through policy SAB 121 The impact on the SEC's policies on capital formation in the digital asset industry The role of Congress, specifically with regards to market structure The future of token disclosures Tokenization and how a regulatory framework could emerge in this category Advice to founders You can follow Commissioner Peirce on X.

Today on the show, I sat down with SEC Commissioner Hester Peirce. Listeners of this show will know that we have long been big fans of Commissioner Perce and are proactive work to promote pro-innovation policies in the blockchain sector. In this episode, we discussed the past, the present, and the future of the SEC as it relates to blockchain technology. We talked about the role of Congress and the path forward. And we talked about some tangible advice for founders in the digital asset ecosystem. I think you'll enjoy this one.

So without further ado, here's my conversation. with SEC Commissioner Hester Purse. Matt Walsh and Nick Carter are partners at Castle Island Ventures. All of these expressed by them or the guests on this podcast are solely their opinions and do not reflect the opinions of Castle Island Ventures. Guests and host may maintain positions in the assets discussed in this podcast. You should not treat any opinion expressed by anyone on this podcast as a specific inducement to make a particular investment or follow a particular strategy,

but only as an expression of their personal opinion. This podcast is for informational purposes only. 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 to 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. Commissioner Perth, thank you so much for coming on the podcast. I feel like this has been a long time coming. We've wanted to have you on for quite a while. Well, Matt, it's a pleasure to be here. I am a big follower of your show. I love to listen to it.

I, of course, have to give you my disclaimer, which is that my views are my own views as a commissioner, not necessarily those of the SEC or my fellow commissioners. Awesome. I'm used to hearing that disclaimer and no surprise. I'd love to just start this maybe with a personal question of what has it been like for you to work at the SEC for the past few years? Obviously, there are a lot of great people there and I enjoy working there. But from the perspective of crypto policy, it's been extremely frustrating because I feel like it's been one bad decision after another. So, yeah, I'm happy that we're in a new day. You said you listened to the podcast.

You might have heard us say this before. But I'm kind of surprised that you're still there, given everything that you've had to push through at the SEC. Did you ever consider leaving the agency? Yeah. I mean, I've been there for a long time. And I thought that it would be good to have a new voice come in there. So that certainly has crossed my mind. The reason that I'm staying on for a little bit now is I really am looking forward to Paul Atkins arriving.

I work for him. I know how he thinks, and I think it will be good for the agency and good for capital markets. In an ideal state, I'd be curious how the agency is really meant to function with regards to dissents around different commissioners having different points of view. Is that a collaborative process? Does that happen in a vacuum? And how should that work in principle? I mean, I think that it's a five-member commission for a reason. You want to have different people with different perspectives on things. And so it's natural that you're going to get some dissents, concurrences, and things like that. And we do get along as people and as colleagues, we get along with each other. So we can share our thoughts about things. And I'm a little predictable on some of these things. So it's no surprise that I'm going to be dissenting on some of these things. But I think that, we could do a better job maybe learning from each other sometimes. I think we all have something to learn from one another on these issues. But I really felt, and I think you captured that when you said, what's it like to be there, it really did sometimes feel like it was hard to get people to pay attention. And that's probably on me. If I had done a better job making my points, maybe we would be

in the position four years ago of doing something proactive instead of just continuing year after year, not to do anything proactive. When I had gotten started in this industry initially when I was working at Fidelity back in 2014, it always struck me that there would be a fair amount of education necessary to really talk to the regulators, explain how the technology works, explain some of the product ideas. And as that went forward, I started to notice that some of these regulators really start to get it, you being the leading one, really with the initial Safe Harbor proposal. I'm sort of at a loss as to why we ended up in this situation.

in some respect with the SEC. And I get that question a lot. Why did the agency try to prevent some of these companies from getting off the ground and some of the intermediaries from actually accessing this market? Wondering if you can speak to that. I mean, I think it's kind of a multi-stranded thing. One is there was and is a lot of bad activity that is being perpetrated either in crypto, in the name of crypto. So that scares people. And understandably so, a regulator is going to look at that and say, why do I want that in my jurisdiction at all? I'd rather just shut that down. And so I think it is hard to see through that bad activity. And then there have been a lot of promises about all the great things that crypto was going to do. And many of those things, as with any new technology that's

being tried and applied, it doesn't all work. So of course, some things aren't going to work. So if you see the bad conduct and you're not seeing these massive changes, I think that leads to saying, well, whatever, we're just going to use the regulatory process to kind of shut this down. I was enthusiastic that Chair Gensler would come in and he had taught about this at MIT. I was thinking, we're going to have someone who really does understand this and really can figure out a good regulatory regime. He had built a regulatory regime for swaps when he was at the CFTC. I didn't love everything about that regime, but he had stood up a regime. In my experience, it didn't seem he found this technology so interesting. Frankly, you guys talk a lot about Operation Choke Point. And I think

there are different ways for Operation Choke Point to manifest itself. In one way is, you can just come in with regulations and you can make it really unattractive for people to participate in the industry. You're always talking about Sab 121, or you were, which was helpful for me. I thought it was a problem, but you and others really underscored for me that it was a problem. And that's a way of keeping legitimate actors out. So I feel like it's sort of a confluence of events that just led to this really negative spiral. You hit on it and wouldn't be a Castle Island podcast without talking about Sab 121. But when I really step back and reflect on the past few years, I totally agree with you on the bad behavior. In a lot of ways, I was hoping that the SEC would be a little bit more

active or maybe it's the DOJ and cutting down on some of these unregulated offshore venues. I think that would have been healthier for the industry. Same thing for ICOs, actually, in the earlier days. the clearly unregulated securities offerings that were happening. But when I look at the past two or three years, Sab 121 inclusive of this, it does feel like there is a bigger force at play to just choke off the industry. You have the debanking on the banking regulator's side. We were seeing that left and right. And then with respect to the SEC, if you can prevent the banks from coming in and custodying these assets and being active in stable coins, that is just a great way to stymie innovation and prevent startups who want to sell into those institutions from getting off the ground.

Is it as easy as just the leadership at the SEC not wanting to do anything with the technology, or is there a bigger political force here that was trying to shut this down? I don't know. We can speculate about that. I mean, I think there's a lot of pressure to have a financial system that's very intermediated because it's very easy to, easy is not the right word, but it's easier to regulate a financial system that has a lot of very large intermediaries because you know who to go to when there's a problem. So maybe there's some of that. I think that a lot of people's motives, even people who are not favorable toward crypto, are good motives. There may be bad motives too. I don't know. I think the better thing to focus on is

how can we change that? It's not only something like Sab 121, but it's also how do we interact with investment advisors who have some crypto in their portfolio. How do we interact with auditors that are trying to figure out how to do proof of reserves? There are lots of different ways that we interact with this. And so I think a lot of it was negative. I hope we can turn it positive. I will just say in response to your wish that the SEC had been more active in some ways. One is, and I'm always harping about this, I think it's really important. I say this. We do have jurisdictional boundaries. We're supposed to focus on activity. in the U.S. And there are some instances when we're looking at stuff outside that has an effect

in the U.S. But really, the goal is for us to regulate here. And so I think what I find so sad is that if we had set up a good regulatory regime in the U.S., people probably wouldn't have done stuff outside the U.S. And if they had, people might have said, well, why aren't you in the U.S. where there's a good regulatory regime and we can rely on the fact that there's some regulation there. And so I think we pushed stuff out of the U.S. that didn't end up helping American people, and we wasted a lot of time. And then with respect to ICOs, yes, I mean, some activity is securities activity, but again, you've got to build some kind of a framework that works for people to do those kinds of things. And you might be able to do the initial offering through one of the existing exemptions.

But because there was no long-term way for getting those tokens out into the broader world, It just, again, cultivates bad activity. Yeah, I think that's spot on. On your first point on the unregulated offshore venues, there was a time, it was a few years ago now before they collapsed, but there was a time when I actually would say that FTCS was maybe our biggest mess. Because when we had looked at some of the early rounds, we said, well, this is an unregulated offshore venue, clearly serving U.S. citizens with securities on the platform. And they also run this market-making firm. This is clearly a conflict of interest. there's going to be U.S. alternatives here that pop up, but there didn't end up being that.

And so it ended up for a short period of time. We're lucky we didn't invest in it, I suppose. But it's interesting to think through just the deployment of capital and how that's been altered by the ambiguity in the regulatory climate. Yeah, absolutely. That's really scary for a regulator to see that, to see if you do your job badly, you can contribute to some really bad things happening. That's been a little bit the lesson of my career because I was around during. obviously the financial crisis of 2008. And I think some of that stem too from bad regulation. So it is definitely daunting when you think about that. One of the things I'd love to get your take on is

just the role of Congress in defining what a market structure should look like here versus the role of the SEC and maybe a collaborative relationship with the CFTC. How much can you do at the SEC here and where does Congress need to step in? I mean, I think we can do a lot initially just saying, here's what's within our jurisdiction, here's what's outside. And then if it's within, we can write some rules for that. I do think at the end of the day, Congress will want, I mean, it does want to come in and allocate jurisdiction for the stuff that I don't think is really covered by anyone now. So if you have platforms that are trading things that are not securities and they're not futures, where do they fit? That's where Congress is looking to try to figure out

who that should go to, is it the CFTC, is it us? In the interim, the CFTC and we can work together to help do some of the groundwork, what's helped them understand what the landscape is and where regulatory authority might make the most sense, but ultimately, obviously, that's going to be their call. So I think we can work in parallel. Now that we are sort of taking a more proactive look, I think our technical assistance to Congress can be more valuable as well. Once we understand what Congress wants to do, we can tell them whether this will fit with how we look at traditional securities markets. And I think that can be helpful as I try to frame this out. I mean, it's not an easy task for them. Definitely not an easy task. But it does seem like there's just

an order of magnitude, more engagement and knowledge in this current Congress than there was in the past one, particularly in the financial services committees. Yeah, I mean, there's a lot of knowledge. I'm impressed that people who have so many other things to do have time to figure this stuff out. The other thing we have to be thinking about is we're looking at the industry as it is now, but we also want to make sure that whatever we build is going to work in the long term, because it's really hard to change legislation. Hard to change statutes. It's hard to change regulations. When I talk to institutional allocators that are deploying to funds, they always ask around the use cases. So within crypto, you clearly have a store of value use case, Bitcoin

being the leader there. You clearly have this open source operating system use case, the smart contract platforms, Ethereum, Solana, Monad, whatnot. And then Stablecoins is just clearly a breakout killer app where I think it's 70% of every transaction on a blockchain is a U.S. dollar moving. You see international remittances is popping up as a great use case. But there are so many more use cases that could be there if there was regulatory clarity on how to bring one of these things to market. And so many companies have not gotten started over the past four years because of that, because of just the personal risk that the entrepreneur would need to take and all of the brain damage. And I think in a lot of ways, these things would have to be

some sort of a security out of the gate to raise capital. And then the token itself, obviously, hopefully would not be at some point. But you were onto this really early with the safe harbor proposal. Curious how you're thinking has maybe changed over time or do you still think that could be something that we'd put into place? Yeah. I mean, I think something like that could work just to make sure that people have a way to get the ecosystem working, get people using it without having the fear of the securities law overhang, but also keeping a little pressure on people to actually keep doing something, not just launch the tokens and then run away. I'm looking forward to what people have to say about an approach like that. I think we can design something like that,

certainly for the short term and then trying to figure out if that's really the right long-term solution or if there's some better solution. I think we do have to think about the complexity of if you have something where something is going to morph from a security to a non-security, that is going to raise a lot of questions around where is the line? When does that change happen? You don't want to have to switch trading platforms because something has switched from a security to a non-security. So I think if we focus on the fact that the token itself is probably often not the security. I mean, it may be sold as part of an investment contract, and that's fine. But the token itself, unless it has security like characteristics, probably is not. I think that might help us

not have to draw those lines. I don't know. We'll see. I'm looking forward to just getting a lot of input on that point. Unfortunately, we've really muddled the discussion by not being very legally precise by going out there and saying, well, we think all of these tokens or securities. When I don't know that, I mean, I certainly don't look at it that way. It's unusual to have investment contracts that trade on secondary markets. So this is all a little bit of a new territory for us. Our interpretation of the Howie test has been very broad in my view. So we've got to figure it out. But I think the safe harbor is a place that the discussion can at least start. Yeah, I think it was a great starting point. You brought up disclosure.

in your answer there. And that's something that was just totally eye-opening to me during the SEO phenomenon, that you would dive into the actual network data and you'd look at the addresses of the core team or maybe some of the early investors and you would see really bad behavior or you would see something in a white paper that was just not represented on chain. So I've always thought that it would be a great opportunity to build a disclosure framework, first of all, for the government maybe to have one. But I'm also curious if there's a role for private industry in pushing something like that as a standard, how do you think that could evolve

in terms of just disclosing ownership, investing schedules and things like that? I think that would be great. I think it would benefit everyone to have that out there. And this is another example of where regulation has actually discouraged disclosure. So now I think the industry may be more empowered to come up with some kind of standard.

And we can bake that into regulation to the extent we think that it's evergreen, that it's not going to change a lot. And I think some of the things that you raised are exactly the kind of thing I want to get to. I mean, people need to understand that the white paper actually is consistent with the code. They need to understand what the development team is thinking about. Is this really just an opportunity for them to very opportunistically dump a lot of tokens on people and then just run and abandon things?

I'm really excited to see now that we have a more positive regulatory approach to see good behavior being rewarded and bad behavior being punished. Yeah, me too. I don't know. Does that end up looking like an Edgar system for crypto assets? Or how do you think this could evolve? Maybe it's just telling people you've got to make these disclosures and they have to be available to the public.

I don't know that we need to set up a formal edgar system. Because again, whatever we build, it needs to recognize that a lot of these. teams are very small, and they're not going to have lots of lawyers. They may not have any in-house lawyers. They may be relying on outside counsel, and they can't pay a lot for that. So I want to make sure whatever it is, it's something that's doable. And I think we can probably look at how things are going in Europe to see how their disclosure system is working and whether that's helpful to us. Yeah, that's interesting. I think Mika certainly could be a model that could be explored. Although I was looking at one of those disclosures the other day, and they had a lot about

Scope 3 greenhouse gas emissions and things like that. That's not really where I want to spend our disclosure efforts. Do you think the SEC will actually just focus on capital markets and investor protection? Yeah, that would be nice. You brought up the role of lawyers, and it strikes me that the lawyers have been doing great in this market. I mean, there's just a lot of defense attorneys, and probably the SEC spent a fair bit of money on some of these cases. So I guess just a general question around how should the agency really function when it comes to spending taxpayer dollars, prosecuting some of these things that are, to say the least, like not very clear? Yeah, I mean, I think that's the big question for us is how do we spend our regulatory resources?

And it does matter which tool you use for what, because litigation is very expensive for us. It is certainly expensive for people that we're litigating against. And so it's a tool we use, but we should use it judiciously, and we shouldn't be using enforcement actions to try to write rules, which we were absolutely trying to do. That's not good for anyone. It's expensive. You've got people at the SEC who are experts in policy, and they're not at the table when you're having an enforcement settlement negotiation with someone. They may be consulted, but they're not driving that negotiation. And same on the outside. I mean, you hire litigators to litigate these cases. You're not hiring a regulatory lawyer to do this. So it's just been a really bad use of resources. And as a result,

we haven't had as many resources to go after the truly bad actors. Now, some of that stuff, again, may not be within our jurisdiction, but we can be on the lookout for it. We can be referring it to other regulators. I think if we get to a better place regulatory, will have more enforcement resources to use in better ways. That makes total sense. One of the areas that I've been interested in for a long time, but we haven't deployed a lot of capital against, is this idea of tokenized securities.

So things that maybe exist in the real world or net new instruments that are online, but they're actually securities. They want to be securities. And it's been hard for us from an investment perspective because we see a lot of really good ideas, but there are clear regulatory impediments to some of these things working in terms of secondary markets and the definition of custody. How are you thinking about that? And I know that you've put out a really great piece around the journey begins, which is February 4th, you put up this statement, and it does touch on this. So I'm curious how you're thinking about that category.

Yeah, I mean, I think it will be an area that we see a lot of people trying to innovate and experiment. I think it hasn't really happened very much because anything that had any kind of mention of tokenization or any kind of mention of blockchain. I think people were scared to engage with us about that. There's been some experimentation, and I think that's great. We've seen money market funds tokenized. I think people have started to step into it, but I expect we'll see a lot more of that.

I don't know where it will go. I think it's exciting to think about the possibilities. You can take a bond, and if you can tokenize it, you can make sure that all the data travels with that bond instead of having a lot of documents on the side. I think that it could be more efficient in a lot of areas, but I'm not the technologist. I'll leave that to you guys to figure out what's going to work and what's not. But I think it certainly will see some more movement in the U.S. on that. One of the things I wrestle with is a venture investor with this category is let's say that there was a framework in place and hopefully there is soon. And so all of the centralized institutions can do this type of activity, tokenized securities, moving it around. I completely understand how that could reduce cost at some of the these institutions, there'd be potentially net new financial instruments. It's not obvious to me what the venture scale startup opportunities are necessarily in some of those categories. But

if you could actually take some of these securities and interface with public blockchains in a defy context, I think that could get really interesting. Do you think that's a bridge too far to figure that part out right away, or could that be part of this? I hope people will be thinking about that. You guys talk all the time about public versus permission blockchains. The benefit comes from having a public blockchain and figuring out what you can build on top of it. So I think that's what I'm excited to see people experimenting with. And there'll be a lot of need to educate us regulators on a lot of things. I think this is going to be an area where regulators will have to be able to get comfortable with this stuff. But I think that for me is where I think a lot of the really interesting innovation

will happen. Again, I look more to people who actually are thinking about this all the time and investing, putting their money where their mouth is to see what really is going to take off and what won't. Yeah, it's instructive that at least stable coins work in this context. And I would argue a lot of those are not securities. Maybe some of them end up being, who knows. But just to show what you can do with a U.S. dollar and to extend that idea to other types of assets, I think that's the design space that a lot of entrepreneurs would like to explore. And good first step would be getting the centralized secondary trading venues up and running. But I think the next question for a lot of people is, well, what else can I do with this? Can I have this as a collateral asset in a defy pool?

It'll be fun to watch what happens. Just flipping this back towards my side, what should we be thinking about as investors in this space and what should we be advising entrepreneurs. There was a time when coming in and register was offered to us and it turns out that was a really, really bad idea. Yeah, I'm sorry. Yeah. What should we be telling our entrepreneurs? We really do need people to come in and talk to us and try to figure out what registration would look like if that's the right thing or what can we carve out that clearly isn't within our space and how can we provide clarity to people so that they can be comfortable. Because one of the things, I've seen over the past several years is that people have said to me, hey, Hester, there's something

that I would like to do, but I'm concerned that you might come back five years later and say there's a securities angle. I actually don't think there is, but you might tell me there is. And so people have held off. I guess it would be helpful for me, for people to come in and say, here are areas that would be helpful for you to make clear or not within your jurisdiction. And then if people have ideas about what does a good disclosure regime look like? What should the broker-dealer regime look like? Do you want to have a special purpose broker-dealer framework or do you want to throw that out and just work with the existing broker-dealer framework? What does custody look like for investment advisors? How should we be thinking about that issue? So I do want people to talk to us if people have particular

projects that they're trying to do and they want no action relief. I mean, our doors are open there as well. people need to be patient. It's going to take us a while to sort through all this, but we really do want to hear from people. I know that is going to take a while because people really feel they don't trust that they can really come in and talk to us, but I hope that gradually people will realize they can do that. Yeah. Well, I think the fact that you've stuck around and Commissioner Ua really seems to be attuned to these same issues. Yeah, he is. Gives people a lot of comfort that it's not a trap this time. You're not going to step on our mind. I mean, I think that's part of the reason we need to move fast and try to get things in place so that people can really trust that this is going to last also. And Congress will be very helpful in that as well. Is there anything the industry is doing now that you would advise us to try to stop? I mean, there is certainly some bad behavior going out there. I worry about the self-inflicted wounds more than anything. This industry has shown an amazing propensity to just get in its own way over the years. Yeah, there are a couple things. One, I would say, don't commit fraud. good start. Second, I would say, remember the lessons from the traditional financial world. You don't get a pass on over leverage. You've got to think about what bad things could happen and prepare for those.

And in this world, sometimes those things can happen much faster because it's just code working. If you do something, you can have a really negative consequence very quickly. So prepare for that. Think about that. But I mean, that's stuff that you guys all know. I think in terms of interacting with the SEC, remember that we've got limited resources and that we're trying to work through things. So when you brand something into us, something like you're trying to get an ETP through, remember that having it as buttoned down as possible is going to be helpful. I know everyone's trying to get in line first, but you have to think about the fact that if we've got to look through your filing and their technical problems with it, that's time taken away from working on a filing

that actually is ready to go. And then my other piece of advice is just really basic. We iterate. That's how we have worked with traditional financial markets. So if you can say, okay, look, Hester, here's something that you guys did in the traditional financial markets. We're trying to take it one step further or we're trying to apply that same principle here in these markets. That's helpful to us. We can hang our hat on what we did before and then we can say, look, what we're doing now is just an extension of that. And then being willing to have that conversation with us. If we ask questions, come back with answers and be willing to say, okay, SEC, if you're not wanting to move forward, explain to us why not. What's the sticking point?

Be willing to press us when we say no, to understand why we're saying no, that can get us further faster. That makes total sense. So from where I sit, it feels like kind of a new day. I am seeing investment firms that are starting to mobilize around, okay, maybe we'll move from an ERA to an RIA, we're going to expand our strategy. Certainly seeing just a lot more startups get off the ground. It's been very, very busy since November over here, and a lot of interesting categories that you wouldn't necessarily have seen entrepreneur quality as high a couple of years ago. So people leaving big tech firms to start ambitious projects. Do you feel that energy? Is that visible to the SEC at all that this is actually already having a positive effect? Yeah, I think I'm seeing

glimmers of that, that is exactly what regulatory clarity can do. Because if you're asking someone to leave a comfortable job at an established company to start a venture only five years later to have the government basically shut that venture down and take away everything that you've been working on, people aren't going to do it. But if people know, okay, I know I'm going to run into some regulatory obstacles, but I'm going to have a regulator that I can work through those obstacles with, it's worth taking that risk. And that has always been the kind of country the U.S. has been, is that we've been a country that's rewarded people taking those risks, being willing to step away from a comfortable career into something new to try something new. And we need to be the

best country in the world to do that. So I hope that in this little area where I'm working, I can help contribute to that. Well, I think that's a great place to leave it. I guess I'll close by just saying thank you for all that you've done to bring some of these. issues to light. It's often felt like no one was really understanding the plight of some of these entrepreneurs. So really appreciate you hanging in there. Matt, I appreciate it. And I appreciate what you all do to try to help us regulators and others understand what's going on in the industry. Well, thanks so much. We'd love to have you on again soon. Sounds good. Take care. Thanks for listening to another episode of On the Brink with Castle Island. To find out more about

Castle Island, visit castle island.V.C. To listen to all of our podcast episodes, please go to On the Brink-Podcast.com or just click on the tab in our website. Thanks for listening.