The Breakdown - A CFTC Commissioner Proposes a New Definition of Retail Investor

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Circle, and FTCs, and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, October 18th, and today we are talking all things crypto, including the CFTC's proposed new definition for retail investors. Before we get into that, however, if you are enjoying The Breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us in the Breakers Discord. You can find a link in the show notes or go to bit.L.Y slash

Starting point is 00:00:45 breakdown pod. Also a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. All right, folks, well, as I said, today we are hop-skipping and jumping around the world for a grab-bag show of so much interesting news, primarily from the crypto space. And where we're going to start is with a discussion around the term retail investor and what it means. So first, let's talk about how we colloquially use some common terms. On the one hand, there are institutions or institutional investors. This is a massively broad spectrum that includes everything from pensions on the most risk-averse end to family offices and hedge funds on the other side that can be much more risk-taking

Starting point is 00:01:24 and then even more types of quote-unquote institutions or institutional investors in the middle. Everything else, nominally speaking, are retail investors, or at least that's how we refer to them. Now, as you can probably spot, the definition then is pretty expansive. And more than that, if it really just says all individuals, it doesn't account for differences such as experience or trading history. Whatever the definitions are, retail investors, quote unquote, have been a big part of the story of the changes in markets over the last half decade or so. Zero fee, aka payment for order flow brokerage apps like Robin Hood brought in an entirely new audience to stock trading. Permissionless crypto exchanges, meanwhile, gave them something that they could actually beat institutional investors to the punch on,

Starting point is 00:02:08 which for many bolstered their confidence. When COVID hit, this new group of investors had some time, some new injection of cash, and of course, a hell of a lot of memes. This is famously when people like Barstool Sports Dave Portnoy got into trading on stream. One of the things that was interesting about that COVID period was that they beat big investors to the recovery. This wasn't necessarily out of some huge market insight, but instead, because of a certain base-level cynicism, a belief in the money printer-go-Burr meme, and utter faith in the Fed put. Now, this also coincided with the rise of the Wall Street bets crowd. This group added another dimension of a sort of cynical rah-rah revolutionism to the markets, a sort of question of

Starting point is 00:02:50 what happens if a big group of people decide to learn the rules of your game, but then not play by them. That was one of the most fascinating market and frankly social psychodramas of the last couple years. Now, how sustainable that retail investor push was and how influential it will be in the long remains to be seen. I have my own theories about this that are roughly aligned with the can't unsquease a tube of toothpaste sort of idea, but that I think is for a different show. Now, the interesting bit of news in this domain this morning is a bit of discussion around the possibility of new definitions for retail investors. CFTC Commissioner Christy Goldsmith Romero has pitched a new way of defining retail investors as the regulator prepares to take the role of

Starting point is 00:03:29 overseeing crypto markets. The CFTC has traditionally dealt with derivatives and commodities markets, which have long been the domain of institutional investors. Recently, however, the CFTC has seen an influx of retail investors as access to markets has improved. Those same types of apps that we were talking about before gave smaller investors the ability to trade options and futures as well. In an interview with CoinDesk on Friday, Commissioner Goldsmith Romero said that the way that the CFTC currently thinks about retail investors is too broad. It, quote, includes just regular people all the way up to somebody with $10 million. Instead, she proposed a new category of investors, so the CFTC could treat smaller crypto investors differently to large

Starting point is 00:04:06 institutions. The goal would be to have more modest limits and greater protections for retail investors. Quote, you want to make sure that you can provide expanded access to retail investors, but in a way that's safe and affordable for them, which might look very different than how the institutions or how a high net worth individual might purchase. Keys to this proposal would be things like limits to the amount of leverage a retail investor could access and, quote, more consumer protections, maybe more disclosures, written in a way that regular people can understand. The proposal would go through a feedback process and Goldsmith Romero says that she'd like to hear from people with ideas and who don't agree with her view. Quote, I'm having to listen to all of that to try to get it right.

Starting point is 00:04:41 I'm just throwing out a concept of something that I think is not quite set up right. Our definition of retail really doesn't work for this asset class. Now, of course, In course, in the securities world, the SEC has a similar concept, which is used to gate off some complex investment opportunities as exclusively for accredited investors. These are investors who earn $200,000 a year or have at least a $1 million net worth. Under these rules, accredited investors are unable to interact with markets with far fewer disclosure requirements and rules. So let's pause here and talk about accredited investor rules for a moment. I have long been vocal on this show about my antipathy for them. Let's hold aside the fairly extreme side of the argument,

Starting point is 00:05:17 which is the libertarian-ish idea that people should be able to spend their money on whatever they want, that the idea of investor protections in general is inherently paternalistic, and also inconsistent in the context of other things like casinos and lotteries being totally okay. Let's assume, for the sake of this public policy discourse, that we're never getting to that pole of the ideological spectrum. And even if that is one starting point, let's assume that people recognize that there are lots of predatory practices out there that can be dangerous, especially for inexperienced or newer investors.

Starting point is 00:05:46 Still, even with all that, a key. problem of accredited investor rules as they currently stand is that they quite literally enshrined the idea of the rich getting richer. Accredited investor rules choose something, assets or monetary means, that actually doesn't necessarily say anything about a person's capacity to understand markets and invest well. It could be that they were born well. It could be that what they're good at is valued by society and remunerated well with salary. But again, that just says generally they're smart and or talented, not that they're either of those things with regards to investing. I think the most defensible argument for accredited investor rules is that it says they have a higher threshold to lose

Starting point is 00:06:19 money. But still, this is debatable. A person with one million in assets who makes a $1 million bet on a startup that goes to zero, his every bit is broke as a person who starts with nothing. Now, I would characterize the last few years as having some positive movement around this. There are more explorations now of using other alternative means to accredit people. For example, knowledge tests that show that people have spent time to actually understand what's going on in markets. Ultimately, even if one has studied every book on the subject, markets are humbling and still full of risk. No performance on a test can guarantee success when investing. However, as soon as the investor protection conversation moves from, do they know what they're doing and getting themselves into,

Starting point is 00:06:56 and do they have the ability to appropriately assess risk in the context of their own life, to, it's not okay for people to take losses? Well, then we're in a whole different discussion. It's not totally clear yet what these new CFTC definitions would do with regard to these types of questions, but it is pretty clear that this is where the industry's head is at. Commissioner Christie Goldsmith-Romero tweeted, with more retail investors coming into derivatives markets because of crypto, the CFTC should separate household retail from professional and high net worth. Then we can tailor customer protections to ensure expanded access to households is safe and affordable.

Starting point is 00:07:28 Establishing a household retail investor category could give them more consumer protections. For example, disclosures written in a way that regular people understand or could be used when weighing rules on the use of leverage. Sam Bankman-Fried from FTCS shared this, and said 100% agree on disclosures, knowledge tests, etc. For what it's worth, I don't know that it necessarily makes sense to be crypto-specific. I think that having at least mandates for disclosures and knowledge-based tests for all FCMs and DCMs facing retail could make sense. From where I said, this is a positive conversation to be had, and Commissioner Goldsmith Romero seems to be entering it

Starting point is 00:08:00 with a lot of good faith. It's a lot easier to influence the shape of these rules in a common-sense way on the upfront than to try to change them later. Want to keep more profits when trading? the best possible prices and trade with 50% lower fees on Nexo Pro. The new spot and futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources. Utilizing the complete Nexo suite allows you to earn interest and borrow funds as you wait for the next trade setup. Visit pro.nexo.io. That's p.r.o.n-nexo.io and sign up today. This episode is brought to you by Circle, the sole issuer of USDC, and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way to send money around the globe.

Starting point is 00:08:55 USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted stable coin. The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees.

Starting point is 00:09:36 One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana and FFSA. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. With that, though, let's move on to some other parts of the industry. If the first story was all about retail, let's talk institutions for a minute. MasterCard is deepening their involvement in the crypto space as per an announcement this week. MasterCard has partnered with crypto platform Paxos to help financial institutions offer crypto trading to their customers.

Starting point is 00:10:14 powered by MasterCard's new crypto source program, the payments giant will assist institutions with crypto compliance rules, verify transactions, provide anti-money laundering and identity monitoring services. John Lambert, MasterCard's chief digital officer said, quote, there's a lot of consumers out there that are really interested in this and intrigued by crypto, but would feel a lot more confident if those services were offered by their financial institutions. It's a little scary to some people still. Now, this is an interesting point of discussion for the community. On the one hand, one of the key headline banner stories of this bear market is institutions and traditional finance institutions in particular, building a huge amount of market infrastructure to participate

Starting point is 00:10:55 in the crypto and digital asset space. It is very clear that these institutions are not treating this bare market as a winter from which this industry will not recover, but as a down market on something that still has a lot of value and a lot more story to play out. This could represent a whole new set of people coming into crypto, and for that reason many crypto industry participants are excited. At the same time, I do think there's a fear that the TradFi players of the world are going to subsume a lot of the activity and upstarts and everything is going to be gated by traditional banks. To some extent, I think this process is inevitable, and mostly being bullish on the fact that these institutions are making such a big bet even in a down market

Starting point is 00:11:32 is a really positive sign. When it comes to where people will actually trade and engage with crypto, to some extent the market's going to sort that out. And to the extent that we want to be focused on making sure that incumbents don't get a preferential leg up, the place to look is around regulatory approvals. This is why Custodia Bank's suit against the Federal Reserve, for example, is so important. Investor and advisor Eric Weiss writes, developments like this, FASB, NASDAQ, Bank of New York, Fidelity, etc. Make the current prices a gift for those who read the writing on the wall and have courage. Speaking of BNY, one quick update there. BNY Mellon CEO, Robin Vince, has discussed some further details about the bank's new crypto custody offering during their conference call for

Starting point is 00:12:11 third quarter earnings. He said, quote, what we've heard from our clients is that they want institutional-grade solutions in the space. He cited their research, which showed 75% of clients are currently investing in crypto or considering it, with 90% expecting to do so over the next few years. Vince said B&Y Mellon considers their crypto offering to be a very long-term play and expects full-scale adoption to be years or even decades away. He also added that the bank isn't putting a ton of capital behind their crypto projects yet. Now, moving to some perhaps less fun parts of the industry. The SEC and the CFTC are now conducting a probe into the collapsed crypto hedge fund Three Arrows Capital. They're trying to determine whether the fund misled investors about their balance sheet

Starting point is 00:12:50 and whether the fund should have registered with the two agencies. This is all coming from Bloomberg reporting, who is citing two sources familiar with the matter. Singapore-based 3AC filed for bankruptcy in July, saying that its business had, quote, collapsed in the wake of extreme fluctuations in cryptocurrency markets. The fund, of course, took heavy losses related to the collapse of the Terra-USD algorithmic stablecoin in May, and was also rumored to have taken losses. on the grayscale Bitcoin trust arbitrage in 2021. The collapse of 3AC rippled throughout the crypto industry, with major firms including Celsius and Voyager being pushed to bankruptcy following

Starting point is 00:13:20 3AC's default on loans. All told, creditors claim they're owed billions from 3ROS capital. At the end of June, the Monetary Authority of Singapore, which is the city-state central bank and primary financial regulator, reprimanded 3AC for misleading it with allegedly false disclosures, allowing the firm to exceed regulatory limits on size, with firm founders Suu and Kyle Davies locations still unknown and unable to be reached by their attorneys, liquidators in the bankruptcy proceedings have recently asked the court to allow subpoenas to be served by email and Twitter message. Now, one of the interesting things about this new involvement of the SEC and the CFTC is that it sounds like they're looking more into

Starting point is 00:13:55 jurisdictional issues rather than just conduct. It's not clear where that jurisdiction might come from, but perhaps it's around their dealings and disclosures with U.S. regulated firms rather than about the 3AC business directly. Now, to the extent that it is that, it could be a relatively important case when it comes to expanding regulators' jurisdiction, even if that's just in terms of perception among crypto funds rather than any material change in their reach. Now, when it comes to the Twitterati, there are lots of comments like this. NFT Machine writes, it's endlessly hilarious to me that they waited until everyone was broken and impoverished to start pursuing legal convictions.

Starting point is 00:14:27 Now, the issue, to be fair, is that in the absence of real regulatory clarity, enforcement is basically all any of these agencies have. Of course, I'm not apologizing on their behalf. I've said before. I think the SEC has lots of things that it could have been working on that would have positively impacted the industry like articulations about their beliefs around what makes a digital asset of security. However, the point remains that in the regulatory environment we have, it is inherently almost all reactive. Speaking of legal precedent, Crypto Venture firm Paradigm has become the third

Starting point is 00:14:55 group to ask to appear before the court in the case between the CFTC and the Okie Dow. Paradigm wants to argue that the CFTC should serve individual Dow members directly, rather than serving the Dow as an organization via a message to an automated help bot on the Dow's website. Paradigm filed their request with the court on Monday and views the CFTC's argument that any voting member of the Dow should be held liable for the actions of the Dow overall as fundamentally threatening DAO's in general. The lawsuit, of course, involves Okie Dow offering unregistered leverage and margin crypto trading to U.S. citizens. The Dow is since geo-fenced U.S. customers from access but has not responded in court to the CFTC. A response was due on Friday,

Starting point is 00:15:31 allowing the CFTC to move forward and seeking a ruling without the Dow's presence to defend its actions. The Crypto-legal community mobilized in response to this situation. The Defy Education Fund and Lexpunk Army, represented by veteran crypto lawyer Stephen Paley, have both filed amicus briefs in the case. Amicus briefs are advice to the court from an independent third party, which seeks to assist the court in deciding novel or complex legal questions. Paradime then is the third to seek to file an amicus brief in the matter. Now importantly, the crypto legal community are not aiming to defend the actions of Okie Dow. Instead, they are just hoping to question the CFTC's treatment of Dow voters as an unincorporated association and the extraordinary service of the lawsuit via chatbot.

Starting point is 00:16:09 Paradigms filing read, quote, A key characteristic of DAO's is that unrelated anonymous people come together to decide whether to adopt ad hoc proposals about how to run the underlying protocol. A person might choose to participate once or many times, but the community of people making decisions on the DAO was fluid, ever-changing, and different for each proposal on which they vote. Paradigm said the attempt to define all token voters as members of the same association, quote, threatens to seriously distort the law. It also noted that, quote, the commission's action appeared designed to produce a default judgment by admitting it has not located any individual

Starting point is 00:16:39 token holders in the Okie Dow while threatening to hold token holders jointly and severely liable. The commission has created a strong disincentive for anyone to appear and defend this action, and indeed no defendant has yet appeared. The judge in the case has already ruled that the service of the Dow was valid, but has set a hearing in November to hear arguments from the crypto law parties about why that order should be set aside. Justin Slaughter, the policy director at Paradigm writes, this is Paradigm's first amicus brief, but it won't be our last. We drafted this because we fundamentally believe momentous public policy decisions shouldn't occur because of technicalities. The CFTC faces a lot of novel questions regarding how to approach Oki Dow, and again, that we may

Starting point is 00:17:14 disagree with them on some fine points of law and policy. But those are the discussions that should occur via the active engagement on regulations, or even the adversarial thrust and repost of the court system. government can't skip a step by suing folks without letting them respond and declaring victory and a void. We felt it was important to speak on behalf of those who couldn't speak, and we will continue to do so for everyone's sakes. Rodriguez, whose legal at Paradigm says, While we are not a party to the case, we thought it was necessary to speak up against the CFTC's attempt to expand liability to unsuspecting technology users and impair the ability of Dow's to operate in the U.S.

Starting point is 00:17:47 The American court system is built around the concept of fair notice and adversarial argument, ensuring that no one, especially the government, can win by engineering one-side's default. Yet the CFTC's action against the Dow seems designed to go unopposed and did not provide notice to the persons it seeks to hold accountable. The CFTC is attempting to expand its power by winning a suit against the fictitious defendant that is unsurprisingly absent. That is fundamentally unfair. So, of course, that last line is why this all matters. It's not a question, per se, of Okie Dao's actions. It's a question of whether there's someone to actually defend them. The argument of this amicus brief in many crypto lawyers is that the CFTC is trying to chalk up a W without actually

Starting point is 00:18:27 playing the game. So I think that will be an important hearing to watch in November. Anyways, guys, that is the view from here. Tons going on. Never a dull day in this space. And of course, that's why we love it. For now, I want to say thanks again to my sponsors, nexo.io, circle and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - A CFTC Commissioner Proposes a New Definition of Retail Investor

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