The Breakdown - DeFi Grows in Institutional and Regulatory Importance

Episode Date: August 20, 2021

First, on the Brief: Banks and bitcoin  Coinbase’s cash reserves Brian Quintenz’s CFTC departure   In the main discussion, NLW addresses decentralized finance’s (DeFi) place in regulations as crypto continues to be on the minds of policymakers. Contention across U.S. regulatory bodies remains as the Federal Reserve’s concern with stablecoins, the Treasury Dept. with the infrastructure bill and the Securities and Exchange Commission’s Gary Gensler attempting to create the broadest reach on crypto regulations his organization can manage. In The Wall Street Journal’s recent interview with Gary Gensler, the SEC chair claimed a particular focus on DeFi. He stated that core software developers, promoters and sponsors would be centralizing factors, calling the term DeFi a “misnomer.” How will DeFi’s future unfold as it becomes increasingly important for both investors and regulators? Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Only in Time” by Abloom. Image credit: Feodora Chiosea/iStock/Getty Images Plus, modified by CoinDesk.

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 Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, August 19th, and today we are talking about some signs of defy's growth in institutional and regulatory relevance. First up, however, let's do the brief. First on the brief today, Wells Fargo goes Bitcoin. Wells Fargo has registered a new private Bitcoin fund with U.S. regulators. The fund is operated in partnership with the breakdown sponsor Nidig, as well as FS Investments,

who have worked together on other funds such as I believe the Morgan Stanley Bitcoin funds. According to a Coin desk source, the new Wells Fargo fund is passively managed. Earlier reports had suggested it would be an actively managed fund for wealth clients. On top of the Wells Fargo news, J.P. Morgan's passive Bitcoin fund, also a partnership with Nidig, was also filed with the SEC today. So if you want to know what people think of Bitcoin, just keep watching what they do, not what they say. Next on the brief today, the scars of past crypto winters run deep. According to a report from the Wall Street Journal, Coinbase has a pretty significant cash reserve.

At the end of June, those reserves stood at $4.36 billion. dollars. That's up from $1.1 billion at the end of last year. Coinbase's CFO, Alessia Haas, said, We want to ensure that we maintain those cash reserves so we can continue to invest and continue to grow our products and services in the event that we go into a crypto winter. She also said that part of it could go towards acquisitions. I just want to point out that in a market that so many think is absolutely baddie because it's disconnected from fundamentals, Coinbase as a company is not only profitable,

but is keeping a large number of cash reserves on hand in the event of a rainy day, something which basically no other companies do. So, I don't know, man. Maybe crypto has something figured out that other industries have forgotten. Last on the brief today, Brian Quintends is stepping down from the CFTC. Brian Quintends is one of the most vocal advocates for crypto among the U.S. regulatory ranks. The CFTC Commissioner's term technically expired last April, and he had previously planned to step down by October 2020 but ended up sticking around,

which he's legally allowed to do until the end of this year. He has been fierce about giving crypto a fair shake in policy discussions, as well as advocating for the CFTC's role in regulating crypto. According to the Wall Street Journal, he'll be gone by the end of the month and headed to the private sector, where he intends to quote, keep innovation, particularly related to cryptocurrency and defy, relevant to my career. From all of us at the breakdown, good luck, Brian, and thank you for your service. With that, let's move to our main discussion. The most notable story about crypto in a mainstream outlet today comes from the Wall Street Journal.

The headline reads, Crypto's defy projects aren't immune to regulation, SEC's Gensler says. With the subtitle, some peer-to-peer trading and lending projects have features that may trigger the need for regulation, Chairman says. We'll talk about the specifics of their conversation with SEC Chairman Gary Gensler, but first, just a little reminder about what's going on right now. First, absolutely undeniably, the importance of crypto to this Congress and to this administration has grown. There are a variety of reasons for that. Some are concerned specifically with investor protections. Others are concerned with systemic risk to markets due to the interaction of crypto

and traditional finance. Others, on the flip side, are focused on ensuring that this major potential engine of American economic growth isn't impeded or regulated offshore. And finally, it increasingly appears that there is a contingent who genuinely views things happening over here as a threat to monetary policy and the government's control over money. Given so many different focuses and concerns, it perhaps won't surprise you that there is a fair bit of internal competition to determine who has the jurisdiction to regulate crypto. There is the Fed talking about stable coins, which is something that will likely talk about tomorrow or on the weekly recap. Then there's the Treasury, which, if you followed the madness of the infrastructure bill was revealed to be the puppet master,

pulling the strings and trying to give themselves an extremely wide berth to write crypto tax rules as they saw fit. Congress and the Senate are as complex as you would expect from bodies with hundreds of members representing even more different interests, and as I mentioned on yesterday's show, it's clear that a fair bit of our allyship in government power comes from members in those bodies. And then, of course, there's the Securities Exchange Commission, the SEC. Many had high hopes when Gary Gensler was appointed SEC chair. I mean, this was someone who had taught crypto classes at MIT, right? My defense of Gensler in the past has been that I think that the people who are arguing

that crypto represents a systemic risk are much more problematic than the people who are arguing that crypto needs better investor protections, and I still think that. However, I also think that Gensler's recent actions and statements show that he is absolutely trying to carve out for himself a significant swath of power to regulate crypto as he sees fit at the SEC. see. The problem I have with this is that it sort of assumes by default that all these digital assets are securities. This is different from the approach that some have suggested of the relevant offices coming together in a working group to come up with a shared assessment of who

should be regulating what and how, which just kind of makes sense to me. The breakdown is sponsored by NIDIG, the institutional grade platform for Bitcoin. As long-time listeners know, NIDIG is a major force in the Bitcoin space, and they're now making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers to offer Bitcoin. That mainstream access is critical for all of us, and you can learn more about it at nydig.com slash nLW. That's nydig.com forward slash NLW. The latest front that Gensler has opened up in his war to get more authority is this interview with the Wall Street Journal. Here are some of the highlight quotes. The WSJ writes, but Mr. Gensler, who took over in April,

said projects that reward participants with valuable digital tokens or similar incentives could cross a line into activity that should be regulated, no matter how decentralized they say they are. Quote, there's still a core group of folks that are not only writing the software like the open source software, but they often have governance and fees. There's some incentive structure for those promoters and sponsors in the middle of this. Going on, he said the term defy is, quote, a bit of a misnomer. These platforms facilitate something that might be decentralized in some aspects, but highly centralized in other aspects. So a couple problems. First is that he seems to be using a recent SEC action against a company that was using defy as a marketing term

to reflect the whole industry when the whole point of their action against this firm is that it wasn't defy at all, and it wasn't a firm that anyone who's involved with defy has any interaction with. So already we have a definitional issue there. I don't think I've ever heard anyone argue. that the SEC shouldn't go after scams, so there's that. Second, with the caveat that I'm not a lawyer, it does seem to me sort of patently obvious that there are some areas of the way that DeFi works that might challenge the way that we designate securities today. One of the key determinants of a security is not just the expectation of profits, but the

expectation of profits based on the work of others. Where DeFi gets complicated is the extent to which the work of protocols is being done by the people who hold and earn the token, stakers and liquidity miners. As C.R. and Murphy writes, in Defy, fees go to users of DAPs, not protocol creators, dear Gary, as do liquidity mining rewards. Gensler's focus on founders is concerning to some others as well. Larry Sermak from the block wrote, what's troubling is that he's basically hinting at going after DFI founders and devs, because they still maintain the code and play a role in governance. Mike Dutas, formerly of the block now over at Paxos, hits it even more of the hypocrisy or at least confusion of the mission of the SEC here.

wealthy accredited U.S. investors can invest in all defy and crypto projects easily via non-U.S. entities. So the only thing Gensler is protecting is small investors from having a fair shot at accruing the knowledge, wealth, benefit, and participation in the future of finance. Dutus also writes, it's going to be fun when the future of finance all moves offshore, and the U.S. loses out on the benefits. Well done with the continued own goals. As for my take, I do think that there are credible discussions to be had about whether all of these assets a priori constitute securities. I would have hoped for different, but so far, Gensler feels very much like a, when you're a hammer, all you see are nails, kind of an SEC leader.

Once again, Commissioner Hester Purse finds herself a voice of reason for creating space for the possibility, just the possibility, that a securities framework developed four decades before the first personal computers, six decades before the beginnings of the commercial internet, and eight or nine decades before the invention of Bitcoin might have some gregory. gaps when it comes to working for a natively digital age. The counterpoint, of course, is that there was never going to be a time that Defi wasn't going to come under regulatory scrutiny. In fact, it seems in so many ways designed to be regulatory catnip. I suppose now feels as good a time as any to try to actually get that sorted. And speaking of get it sorted, there are definitely some moves

to shore up DeFi's regulatory vulnerabilities. Specifically, I'm seeing more and more discussion about separating decentralized protocols from centralized user interfaces. Check out, for example, this effort from investor Adam Cochran. He tweeted the other day, Over the past months, it's become clear the importance of decentralized front ends for DFI protocols. For that reason, I've started building out and funding a Dow to create them. We know that in many jurisdictions, regulators are putting undue pressure on protocol

developers by going after the front ends the protocol team maintains, with loose arguments about the separation of that front end from the protocol itself. Given that, I'm starting an initiative called open frontends to design lightweight, stand-alone, unofficial, open-source front-ends for each major protocol, one by one. I'll be personally funding the first few front-ends, but in the future, move it to a model where it generates funding from Gitcoin grants and from Dow managed referral revenue for any protocol that has affiliate programs. The goal here is not to replace the front-end of any project, nor to create high-quality front-ends, but instead create front-ends that are highly

self-contained, reliable, and lack the need for human update. Being able to access and use defy projects in any jurisdiction on any device with any level of connectivity is an important equalizer and right. While there is no indication to think that any project will have their official front end shut down, we know there is risk of increasing censorship and even business continuity. And so it's important to build open infrastructure for our decentralized future. I think it's a super interesting initiative and certainly would ratchet up the censorship resistance of that space as a whole. Now, while defy seems to be growing in importance for regulators, it also seems to be growing in importance for institutional investors. Perhaps these things are not unconnected.

Galaxy Digital today launched the Defy Index Fund that is a passively managed vehicle that follows the performance of the Bloomberg Galaxy Defy Index. The fund is seeded by NZ funds, which is a New Zealand pension fund that manages over $2 billion. That fund will offer exposure to uniswap, Ave, Maker, Yerne, and more. This institutional honeypot could turbocharge assets in Defi as well as create more powerful allies for favorable regulatory treatment. On that front, fintech collective has raised another $250 million round. $200 million of that is slated to go into the firm's existing fintech and digital asset strategies with the other $50 million going into a D5 fund that can invest in both equity and tokens. Most interesting, as usual, to me, is the list of investors,

which includes the state of Wisconsin Investment Board and the teacher's retirement system of Illinois, both historically very conservative organizations, which, again, gives credence to the idea that Defi is getting more acceptable and even more interesting to an institutional investor set. Finally, one last note to wrap up the earlier discussions around politicians. One of the things that was the biggest bummer for many around Gensler was when he explicitly said that he agreed with former SEC Chairman Jay Clayton that pretty much all cryptos he had seen were securities. During his term, Clayton showed such a rigidity to his thinking that it was extremely hard to move the needle much with him. He started the approach of policy by enforcement

that Gensler seems happy to continue. Well, now that Clayton is out of office, he has no problem at all taking lucrative positions all over the crypto industry. The custodian fireblocks has just added him as a member to its board of advisors. And let's be clear, first, this is the way of the world, the way of free markets. Second, the move makes total sense from fireblocks standpoint, so good on them. But it's still a little frustrating to see someone who is willing to hold back an industry when in a position of power, only to flip around and be more than willing to take that industry's money when they're out. But I guess we shouldn't be surprised. Anyways, guys, I hope you're having a great week, and I appreciate you listening as always. Until tomorrow, be safe and take care of each other.

Peace.