On The Brink with Castle Island - Weekly News Roundup 10/18 (Deals, Telegram, Libra, CFTC) (EP.09)

Episode Date: October 18, 2019

Matt and Nic from Castle Island Ventures review the top stories of the week in the cryptoasset industry. This week's topics include:  - Deals - Telegram SEC action - Libra defections - Grayscale product - CFTC Op-Ed  

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. Welcome to another episode of On the Brink. I'm Matt Walsh. And I'm Nick Carter. And Nick, we had a busy week. A lot of news and some more SEC enforcement actions. Yeah, I don't think we expected something this big.

Yeah, so we'll get into it. We're, of course, referencing is Telegram. And it seems like we're going to start to have SEC enforcement updates more regularly on the pod. Maybe that will just become the subject matter of this podcast. We might need to start getting a lawyer in here on Fridays. That might be the move. Maybe we should get Preston in. Preston would be good.

He's local too. I know. We should hit him up. So as usual, why don't we start it off with some deals in fundraising? And as a reminder, the reason why we run through these financings every week is we often get questions from people that are looking to break into the industry, looking for which companies are hiring and you know if you follow some of these companies that are raising money they're usually hiring right after so good ones to keep an eye on um so the first one this week is a company

called layer one so this is a san francisco based company entering the mining space they raised a lot of money so 50 million dollars at a 200 million dollar valuation uh peter teal shasta ventures uh DCG so layer one is uh founded by Alex legal um he's uh a bitcoiner and this is an interesting startup because the thesis behind layer one is that bitcoin mining is more a function of your efficiency uh you know you're operating efficiency as opposed to your hardware advantage so Alex believes that the pace of uh innovation in ASIC development is slowing as we reach those kind of thermodynamic limits uh you know at the kind of seven nanometer level and that the miners that are successful in the future will be those that are sort of vertically integrated

and have unlocked all those sort of operational efficiencies. So that's kind of the thinking behind layer one. So it sounds like they have a massive complex being built out in Texas, so it'll be an exciting one to keep an eye on. Yeah, the other thing I like about this is that it's bringing mining back to the U.S., which is both kind of a feel-good story in that maybe it'll alleviate some of those risks about all the miners being rated overnight, you know, in Sichuan province or anything like that. And, yeah, it's probably healthy for Bitcoin overall to have mining be more globally distributed. So that's, that's one to keep an eye on. Another company that raised this week, a company called Icon Loop. So this is a South

Korean decentralized identity company. They raised $8 million in Series A financing. A Korea Technology Finance Corporation led that round. We had another company, a company, called Juno, which is a platform building banking services on top of Ethereum. They raised $3 million from Polychain, Sequoia, and Dragonfly. And then we had two actually Ripple-related investments. So Bitso, a Mexican crypto asset exchange, has raised an undisclosed amount of capital from Ripple, Coinbase, and Pantera. And these exchanges just continue to be really attractive businesses, even internationally, I think. They've been basically the only businesses that have been super viable so far in the industry. And then the last one, Ripple has

invested $750,000 into bread, which is a crypto wallet company that also did an ICO. Speaking of ICOs, let's transition into Telegram. So Friday night, my phone started to blow up a little bit because the SEC filed an emergency restraining order against Telegram. So this is the messaging app for those of you who are not familiar. They raised. $1.7 billion in a token sale in the form of a SAFT. And I guess we'll just define that really quickly. So a SAFT is a simple agreement for future tokens. This is fashioned after the Y Combinator safe,

the simple agreement for future equity. And it's a structure that was pioneered by Marco Santori when he was a lawyer at Kuli. Basically, what the SAFT tries to do is establish a security such that when you're selling the tokens, you're not selling an unregistered security. So that might sound confusing, but the idea is you buy a security,

they go through the normal registration processes, and then at some point when the platform, the underlying blockchain network is ready to be deployed, the idea is that that SAFT would convert into tokens that are not securities. They would essentially transmutate. Did I characterize that correctly? Yeah, the way I'd put it is that the thing

that is being sold to, you know, professional investors or institutional accredited investors is essentially a voucher or a spot in line for a future token. So the thing that's actually being sold is the security is the voucher. And then what the network is ultimately launched, the theory, the legal thinking is that the token itself is not a security. And, you know, because it has some magical amount of utility. So we've seen. So we've seen. seen enforcement actions against ICO projects before. Many of the ones that we've seen so far are the ones that just threw up an Ethereum address and had people donate or participate rather in the crowd sale. This one, I think, caught some people by surprise in the sense that it's a project

that raised via SAFT. It's a project that raised from some enormously high profile investors, including benchmark capital, Sequoia, and Lightspeed. And so let's dig into it. What did you make of the SEC's restraining order? Yeah, so I think this one was kind of a shock to the industry because you had some of the most sophisticated funds involved in this one. And by any measure, the predominant view in the industry was that the SAFT was essentially airtight. And I think if you read the SEC's complaint,

the legal engineering on display in the SAFT is meticulously deconstructed by the SEC. and I would actually encourage all of you to read it. It's about 30 pages. If you have some pleasure reading time over the weekend, it's a... It actually reads pretty easily, and it's kind of a brutal complaint. So, you know, for context, Telegram only sold about 400 million or so worth of vouchers for slots for grams to U.S. investors out of the 1.7 billion raise.

So most of the raise was actually to non-U.S. investors. But the SEC felt that they had standing and they had this applied to their jurisdiction. One thing I found was interesting is that part of their justification for this was that some of the flows for the sale went through correspondent banks based in the U.S. So, you know, one thing I hear a lot in the industry is, well, you know, like the SEC doesn't have jurisdiction. this is a sale between two counterparties that are non-US. But, you know, in fact, if your transaction even touches the U.S. banking system, the SEC is going to use that to invoke standing.

Yeah, yeah. The SEC certainly feels like it has a standing to execute upon that. So, I mean, I guess let's just dive into this from the perspective of, does this imperil the SAFT in general? Should other projects and investors that are investing in some of these pre-launch networks, these smart contract platforms, utility token networks, should they be worried that this sets a potential precedent for the SAFT not being able to transmutate? Yeah, I think it would give me pause if I was an investor in SAFTS for sure,

because I think this is the first time the SEC has really made their feelings clear. I mean, in the offering, they actually don't even name-check the SAFT, but it's clear that they're attacking the logic of the SAFT. And, you know, like this case hasn't been resolved yet. We'll see what happens. The telegram actually just responded to the SEC yesterday, saying that the injunction was unfair. But basically, the crux of the SEC's argument comes down to the fact that, you know, the grams are securities and are likely to remain securities because they're very much relying on the entrepreneurial efforts of the Durovs. everybody's expecting profit.

They're buying these tokens in quantities that are far greater than if they simply wanted to just use telegram, you know, in a transactional manner. And, you know, there was an investment in money. All the prongs of the Howie Test are meant. The interesting thing is that the SEC, you know, goes on to say in the complaint that the investors, you know, the venture funds and the accredited investors who bought the offering in the first place are likely, quote, to promptly resell millions of them into the public markets, end quote. And so the SEC actually suggests that the investors are acting more as underwriters than they are acting as kind of buyers, as ultimate buyers. So the SEC is saying, in fact, most of these funds that bought the private offering

are going to be distributors for the token. And, you know, they actually go into detail on underwriting. They say Congress has enacted a broad definition of underwriter to include, all persons who might operate as conduits for securities being placed in the hands of the investing public. That's in the 33 Act. So, you know, the SEC is pretty declarative on this point. They're basically suggesting strongly the lot of the funds that were investing in this offering are actually acting as distributors, as underwriters, and that, you know, that doesn't free them from the burden of providing necessary disclosure to the ultimate kind of retail public that would be

buying these things. And that's why they got this injunction, because Telegram, their launch date was getting closer and closer. And the SEC is afraid that if the tokens are delivered to the initial cohort of buyers, they would be distributed to the public. And these things, which they believe are still securities would, you know, start to proliferate wildly among retail investors with no controls and obviously no disclosure because there has been no disclosure. And that's clearly what was about to happen here. I mean, all of the major custodians were starting to gear up to add this asset. You had the exchanges that were also putting infrastructure in place to support it. But, I mean, the common sense test really follows that what you're saying about the investment firms going in

there and not actually seeing this as something that they're investing to get the utility of the network makes a lot of sense because it's not like benchmark capital is going in there in saying, we just want a bunch of these tokens so that we can use them on the network. Clearly this is an investment. They're seeking a financial return. I mean, this idea that you would invest in a SAF so that you would have access to a tokenized network that you would just use the, you know, to transact and to do messaging is like, that's ridiculous. Yeah. And the SEC is pretty clear on this point. They say there is no utility because the network doesn't exist yet. And you know, at inception, the network is going to be pretty primitive. Like a lot of the things that

the Durov said they were going to build are not built yet. So there's no mystical utility. And furthermore, it's not the job of a venture fund to go and spend a lot of time, you know, tooling around with some transactional network. It's their job to invest in things which are likely to yield a return. Yeah. That's exactly right. And so the kind of dirty little secret of this industry right now is that most of these projects that have raised via SAFT have investors that are just waiting for the assets to get hopefully liquid and listed on some of these venues, both inside the United States and outside,

in the hopes that they can sell some of these assets and make that return. And who's going to be buying that? Who's the other side of that transaction? It's retail investors who are just going to get crushed. So, yeah, you can probably tell that we're pretty sympathetic to the SEC's reasoning on this. And, you know, I think it's worth explaining a little bit why.

So, you know, I'd compare this to, like, a biotech startup with no revenue and no IP yet, just some potentially speculative early pipeline R&D, which has yet to come to market, doing an IPO and selling to retail. I mean, I guess that happens, right? But even then, they have to actually disclose what the nature of their product is. Because Telegram right now, for all intents and purposes, the Grams and the Grams Network, the T-O-N network doesn't exist. It doesn't meaningfully exist. So we're talking a pre-product startup, which is being sold in billions and has sort of an implied network value in the multiple billions,

which is being sold to retail investors. And if you read through the document, you'll find the word disclosure in there about 10 times. And that's really what it comes down to. You know, the SEC is pretty clear on this front. They say that securities markets are not like regular markets for good. securities markets come with additional burdens and protections because if there are no protections for the ultimate investors, you just get a market of Ponzi's and garbage, which is exactly what we've seen in crypto for the last five years. So, you know, that's why the 33 Act is so clear on that front. And not only do they insist upon proper and clear disclosure, they have very stiff penalties for if you lie in your offering documents. So, you know, that's part of the reason a lot of people

say the WeWork, IPO fell apart because they were forced in their S-1 to basically tell the truth about their business. And that thing got, you know, teased apart by a bunch of bloggers and analysts and the press. But that telegram investors never had the chance for that to occur because there was no, you know, mandatory disclosure and there were no penalties for lying on the offering documents. So I think it's a pretty common sense thing. I mean, we're talking about. securities markets, we're not talking about markets for fruit. You know, there's really, there should be serious penalties for failing to inform the ultimate end user and the ultimate buyer of these things about the nature of the business. You know, this is, this, the KIN case is

also pretty definitive on this point. You know, if the buyers of the, the KIN, ICO had known that the business was going to use the, the token sale to kind of keep themselves a lot. and that the business itself was on life support, they might have had paused and they might not have bought the thing. So I think that there's a couple, there's going to be a couple interesting things that come out of this. One is just what's going to happen to the, you know, there are probably 30 projects that come to mind off top of my head

that have raised over $20 million worth of SAFs. We have some very, very high profile venture funds that have over half of their portfolio in essentially these SAFs, these companies that are going to be doing token. network networks. So the stakes are pretty high. I think that what we're going to start to see here is a return of capital probably. So Telegram's already out there talking to their investors about either extending the deadline on the convertible or returning what they have in the bank, which it sounds like it's 77% of the total capital that they still have. So they would be returning. I think,

you know, the other thing is that the SEC appears to have been investigating and in conversations with Telegram for about a year, almost all of these other projects, I would guess that the SEC is already in communications with asking for documents and investigating. So we have a few lists in the newsletter. Why don't you list a couple of those so everybody knows which SAFs kind of we're talking about? Yeah. So in my mind, the most high profile projects, if you just look at the ones that have raised the most money that have the most high profile investors, the ones that could be imperiled here,

it would be DFINITY Filecoin, Pocod, Orchid, Ava Labs, Daglabs, Newsefer, SpaceMesh, MobileCoin, Handshake, Oasis Labs, Scale, Coda, Celo, Dapper Labs. I mean, there's a lot of others, but I think just those probably gets you 70% of the way there on kind of the total market for SAFs. My guess is that on that list that I just rattled off, there's north of $3 billion easy. worth of SAFs and you know some funds like I said have stakes in like five or six of those yeah so you know to be clear if if the SEC's challenge to telegram holds up and the legal engineering present in the SAFT is found to be essentially invalid under US law that affects all of these good night and good luck more to come on that so another story this week that caught my attention was Facebook's Libra Consortium.

So the dropouts continue here. So MasterCard, Visa, eBay, Stripe, Mercado, Pago, and Bookings Holdings have all dropped out this week. That follows PayPal last week. So these departures from the consortium happened on Friday in anticipation of this Monday was actually the kickoff and the election of the board of directors for the Libra Consortium. So Facebook has one board seat, I believe, out of the five. And so there's sort of this deadline that was being forced. But the interesting thing to me was that the departures came on the heels of some letters that were sent to these companies from U.S. senators. So Brian Schatz, Democrat from Hawaii and Sherrod Brown, Democrat from Ohio, expressed their concerns for the network and sent pretty strongly worded letters to all of the Libra members and put a ton of pressure on them to drive.

up. Yeah, it was kind of interesting seeing senators exert their influence to stop, you know, tech company creating software. But I guess in this case, we're talking about, you know, something that's absolutely critical to the U.S.'s strategic objectives, which is their dollar, which they use for a variety of strategic purposes, both offensively and, you know, for the projection of soft power. So it kind of stands the reason they would be super hostile to this thing. I think we're starting to see this get very political. There was another level. letter in support of Libra. The name of the senator escapes me right now, but it was the senator from South Dakota, I believe, sent a letter to Anchorage, who's a Salt Dakota entity on the custody

side in support. So we're starting to see a little bit of a fracture. The other thing here is that you know, Facebook is going to be, Zuckerberg is going to be appearing before Congress in the next few weeks. I think this is going to continue to play out and get a lot more political before before less political. And in his speech yesterday about, you know, content moderation online, there was no mention of Libra. So my guess is that in front of Congress, he's going to get a lot of questions about that. Yeah, I continue to think that the big issue here is going to be around the basket, the

basket of fiat currencies that comprise the Libra dollar or whatever it's going to be called. And if that basket is not super heavy on U.S. dollars and U.S. treasuries even, I think that this is going to be a tough network for them to get off the ground. Yeah, I think the messaging to Facebook right now is all your problems will go away if you fill this thing with dollars. Yeah, if they just did a stable coin, I think that this would launch. If they just did a U.S.D.C. style, you know, what Circle and Coinbase did, basically, I don't think this would be very controversial. Yeah, I think it's kind of an insult to, you know, the U.S. government if Facebook, one of the largest U.S. companies, is creating an alternative unit of count and filling this thing with Swiss francs and Japanese yet and so on. So we'll see. More to come on this. It's kind of, they're taking such a beating that it's almost, I'm almost starting to hope that they can get this thing off the ground. I'm starting to, I wouldn't say feel bad for them, but I think some of this criticism is really over the top.

Yeah, and I think some of it is likely due to the fact that Facebook has been super politicized for the last two years and everybody hates them because they're not doing a good enough job of censoring their political opponents and so on. Right. You know, it is the biggest story of the year. And if it does launch, then you're going to see three billion people worldwide with access to a digital wallet, which I think would be good for the whole ecosystem. Yeah. And to some degree, Facebook is kind of serving as an ablative shield. for the cryptocurrency industry at large. And they're soaking up a lot of that attention, you know, while the rest of these projects are just building passively. So overall, it would be nice to see them get off the ground on this. Okay, moving on.

So did you read this CFTC op-ed? So there was an interesting op-ed in the Wall Street Journal written by former CFTC chair, Chris Jan Carlo, and the former CIO chief innovation officer of the CFTC, Daniel Gorphine. Corfine, who led Lab CFTC. So they wrote this op-ed. The title of it was,

we sent a man to the moon, we can send a dollar to cyberspace. And it proposes essentially what looks like a Fed coin. So they want the U.S. government to allow for the creation of a digital dollar with a blockchain protocol. They wanted to be maintained by a non-governmental group, but administered by banks and payment companies. And the idea is that the cash that would be brought into the platform

would be held in escrow accounts directly with the Fed. So basically they're proposing a network that would tap directly into the Fed and allow for dollars to be more easily transferred throughout the system. We might have a different view on this. I think that this is a pretty cool idea. Yeah, I think this is one that we disagree on. I find these central bank digital currencies to be kind of sinister in that for the most part they seem to be motivated by a desire.

by central bankers to exercise super granular control over monetary policy. You know, this is the kind of thing that would permit them to impose very deep negative interest rates at will if they want it, for instance, which they can't do with cash. Well, to be clear, I agree with that point. And furthermore, I think that some of the privacy implications here, if implemented improperly, would be catastrophic. Where I think that a digital dollar gets really interesting is more of a market structure issue around the settlement of various types of securities. And so if you think about the like the repo markets, for instance, and all of the operational complexity of moving treasuries and dollars on an overnight basis

and some of the cost in that system, what if you could just move these digital bear assets from institution A to institution B in a pretty quick way? I think that's interesting. I think this could also be the type of thing that could push the dollar's dominance internationally a lot more aggressively. So I do think that from just a scale and efficiency standpoint, this could solve some of the problems that are inherent with the wire process and with ACH. And it seems like regardless of what happens, we're going to get these central bank digital currencies in some jurisdiction or other.

Yeah, China, right, being the first one, I think that this is happening in real. real time in China and you want to talk about surveillance. I mean, they're going to have the full blown see everything type of version over there. Another story I saw this week was Grayscale received FINRA approval for a publicly listed security to represent its digital large cap fund. So Grayscale is the subsidiary of digital currency group, a company started by Barry Silbert. So these are the guys that have GBTC, the Bitcoin Investment Trust. And so the idea is that they have this trust, which after a year, after you purchase it at Nav, you can sell it on the secondary market.

It trades on the OTCQX under GBTC, trades at a premium to the underlying. But it's a pretty popular product because it's one of the few ways that you can buy exposure to Bitcoin through a brokerage account, like unfidelity, for instance. So this approval will mean that this digital large cap fund, which has Bitcoin, Ethereum, ripple, Bitcoin Cash, and Lightcoin in the basketball. basket, we'll be trading on those OTC markets under the ticker, GDL CF. So pretty interesting. I mean, what do you make of this? Yeah, we're talking the first index funds publicly available for cryptocurrency at large. I have a bit of a hesitation because I think there's sort of a taxonomy

issue. I mean, you know, Bitcoin, Ethereum, Bitcoin Cash and Lightcoin, to me resemble virtual commodities. You know, I'm not even sure currency is the right word for any of them. And then Ripple, on the other hand, is essentially a kind of like a frequent flyer mile equivalent controlled entirely by one company Ripple Lab. So I don't think Ripple is commodity like at all. I mean, the rest of the ones in that sample were created through proof work and miners had to, you know, sacrifice something to create them similar to the way gold mining works, whereas XRP was completely printed out of thin air. I thought that the Ripple guys just stumbled upon XRP,

and that's how they just discovered it. Yeah, it's like oil. Just gushing out of the ground. Blue gold, they called it. Yeah, and they found it, yeah. I often think that, you know, Ripple is just an unregistered security, but that's just my opinion.

Yeah, I like to see, it's so funny to see Garlinghouse holding forth about, you know, startup business models these days, where they're not profitable and how you have to find a path to profitability. To be clear, the only way that they make money is by selling XRP to the general public. It's not by selling the subscriptions of their money transmission software. Yeah, you just dump a bunch of XRP every quarter on unsuspecting retail who think that it's a better Bitcoin. It's good business if you can get it.

Yeah, it's a really good business. I wouldn't think it'll be around for much longer, but we'll see. That is our weekly ripple bashing segment. We'll try to keep one of those every single week if we can. It's what the people want. Did you see that Satoshi, the smallest unit possible of Bitcoin as Satoshi has been added to the Oxford English Dictionary? That's a big day. That was the final validation we needed for this thing to become legitimate.

Yeah, we're finally there. So we've got an exciting episode coming with Zach Prince, the co-founder of BlockFi on Monday. So definitely stay tuned for that. And everyone, have a great weekend. We'll see you next week.