The Breakdown - How the Crypto Industry Thinks It Should Be Regulated

Episode Date: October 16, 2021

On this edition of the Weekly Recap, NLW looks at two new policies frameworks released by companies in the crypto and web3 space. The first comes from Coinbase and argues that there should be a new overarching regulator for digital assets. The second comes from venture capital firm Andreessen Horowitz and is a holistic approach to what they call the third generation of the internet.

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 Saturday, October 16th, and that means it's time for the weekly recap. This week, there was an interesting little trend and wrinkle on the week, which is that clearly the crypto industry is tired of waiting for regulatory clarity and has decided to start giving policy makers some options and perspectives of our own. This week, two different companies proposed very different types of policy frameworks. I'm going to do a bit of a dive in to give the TLDR on them and then share some of the

social commentary around them as well. First up, let's talk Coinbase. Obviously, Coinbase has been in the regulatory spotlight throughout the year. First, in terms of everything around their initial public offering, or I should say their direct listing, that's the way they went public. But either way, as the first U.S. crypto exchange to go public, there was a lot of regulatory discussion then. That has only intensified as regulators have gotten very, very aggressive about crypto yield programs. A few weeks ago, the Coinbase CEO publicly wrote that the SEC had been acting sketchy, which seems to have won them no fans inside the SEC. Part of what Coinbase's complaint was is that in a recent trip to Washington where they met with

over 75 policymakers, the SEC wouldn't meet with them. Still, the fruits of those meetings are now becoming clear. Brian Armstrong tweeted this week, today we're launching our digital asset policy proposal, DAP, which we hope will chart a course for clear regulation of cryptocurrency and Web 3 in the U.S. It's critical to bring clarity to this space and ensure America remains a financial leader. This is not about Coinbase. We completed more than 75 meetings with stakeholders in government, industry, and academia to help shape this proposal, and we feel it represents a consensus point of view. It's inclusive and democratic by design. Web3 is upon us and represents an enormous opportunity for America to not just retain its status as a financial hub, but also to encourage

innovation, create jobs, and grow the economy. Coinbase also released a companion editorial in the Wall Street Journal. To get a sense of the overview of this policy proposal, let's turn now to a thread from Fariar Shirazad, the chief policy officer over at Coinbase. He writes, Today we launched Coinbase's digital asset policy proposal, safeguarding America's financial leadership. We've consulted with U.S. policymakers, crypto experts, and academics from across the country. Our goal is to thoughtfully and respectfully engage in the public conversation about the future of our financial system. That conversation, we believe, requires recognition of two concurrent and broad developments. One, the blockchain-driven and decentralized evolution of the

internet. Two, the emergence of a distinctive asset class that is digitally native and empowers unique economic use cases. We recommend four core pillars to inform future US regulation. First, we need a new and digitally native framework for how we regulate digital assets, one that doesn't encumber innovation, inclusion, and financial empowerment for all sectors of society. Second, as they are efficiently done today, end-to-end crypto services must sit within a single regulator. Its authority would include a new registration process established for marketplaces for digital assets or MDAs. Third, instill consumer confidence by providing robust customer protection. This can be achieved through enhanced transparency processes, including tailored disclosures to inform

purchasers of digital assets. Fourth, promote interoperability and fair competition. To realize the full potential of digital assets, MDAs must be interoperable with products and services across the crypto economy. This can empower and protect a thriving consumer and develop. ecosystem. Now, you'll see that there's a lot of substance, but a lot of words, to put it bluntly, in all of these sort of proposals, and that's inherent in the public policy process. You have to be really comprehensive and kind of long-winded to talk about edge cases and all the different important things. But I want to try to distill down to what I think is the most significant part of Coinbase's proposal, the one that I think is the most likely to ring loudly in Washington.

And that's the idea, as they say in their GitHub, that we should, quote, designate one regulator for digital asset markets. So let's read that section of their GitHub proposal. This one regulator of digital asset markets would have authority that included, one, a new registration process established for marketplaces for digital assets, MDAs, two appropriate disclosures to inform purchasers of digital assets. MDA regulation should support the efficiency benefits of straight through processing. MDA should be authorized to perform the full life cycle of digital asset services, including digital asset trading, transfer, e.g. Wallet services, custody, clearing, money, payment, staking, borrowing, and lending, and related incidental services. The regulator should be authorized

to offer different registration paths for different kinds of MDAs, depending on the scope of activities they provide. Regulation should focus on equal and open access to digital asset trading for all market participants, retail and institutional. A dedicated self-regulatory organizations or SRO should be established to strengthen the oversight regime and provide more granular oversight of MDAs. All registered MDAs should be required to be members of the SRO. The SRO should establish the self-certification process that an MDA would use to make a digital asset available for trading on its platform. The framework would preempt state-by-state registration and related regulatory requirements. The treatment of platforms and services that do not custody or otherwise control the assets

of a customer would need to be inherently different from an MDA that holds and controls customer assets and is therefore not addressed by this framework. So there is a lot here to unpack, but like I said, I think it's the most significant part. Let's actually zoom out again to their companion blog post to see how they articulate it. Again, they write, the crypto economy is defined by two concurrent innovations, the blockchain driven and decentralized evolution of the internet and the emergence of a distinctive asset class that is digitally native and empowers unique economic use cases, both of which have manifold impacts on our financial system. The changes made possible, by these two innovations are transformational, but do not easily fit within the existing financial

system, which assumes that the structure of our financial markets will remain largely as they have been in the past. Our financial regulatory system is predicated on the ongoing existence of a series of separate financial market intermediaries, exchanges, transfer agents, clearing houses, custodians, and traditional brokers, because it never contemplated that distributed ledger and blockchain technology could exist. A new framework for how we regulate digital assets will ensure that innovation can occur in ways that are not hampered by the difficulty of transitioning from our legacy market structure. What's really being discussed here is that crypto exchanges are not a one-to-one replacement for traditional stock exchanges. Instead, they are a one-to-one replacement

for a huge number of intermediaries in the traditional financial world. This brings enormous benefits in terms of efficiencies and cost to consumers, but it is something that is fundamentally new and not reflected in existing statutes and regulations. I want to actually go back to a tweet I read yesterday in the context of a Bitcoin Futures ETF, this one coming from Raul Paul of Real Vision. He writes, this is the old financial market trick.

You now have to add multiple new intermediaries who all make profits. The ETF provider, clearinghouse, futures broker, administrator, auditor, law firm, CME, and hedge fund ARBS. Wall Street gets richer and retail investors lose again. At core, what Coinbase is arguing, and what many in this crypto space will rightly point out is that the types of institutions that are

interacting with crypto and digital assets are fundamentally different and need to be looked at as such. This is different than many of the discussions happening in Washington now, in which certainly some are open to a new Uber regulator for all digital assets, but in many cases where people are simply looking for clarity around what their department does and how they're supposed to interact with other regulators on different issues. Now, as I said, I really truly believe that this is the thing that's likely to resonate most in Washington. This argument that marketplaces for digital assets, MDAs, which is a coin-based term, are fundamentally different in that they integrate a huge number of different activities regulated in different ways

in the traditional financial markets. That, to me, is the part of this that is going to cause the greatest amount of conversation. But I should also note that they also articulate three policy the objectives that we should be focused on, including enhanced transparency through appropriate disclosure requirements, protect against fraud and market manipulation, and promote efficiency and strengthen market resiliency. This is a good point to bring in a post from FTX, disclosure. I work on marketing with FTX, but I haven't had any hand-in or visibility into this until I read it myself. FTX published a post called establishing the policy goals for crypto markets, the FTX perspective. And this was the same week as Coinbase, right? Four goals are listed. One, consumer

investor protection, which is focused on disclosures, so similar to Coinbase. Two, promoting market integrity. Again, this overlaps with the protects against fraud and market manipulation idea. Three, identification and prevention of financial crimes and four, ensuring systemic safety and soundness. Overall, the point here is that there's a lot of shared sentiment, and it's notable that these efforts were completely independent and saying a lot of the same things, which seems to me to be the basis for the start of consensus within the crypto industry around how at least exchanges should be looked at. This podcast is sponsored by NIDIG, the institutional-grade platform dedicated to building a more inclusive financial system through Bitcoin. To find out more about NIDIG and their mission to bring

Bitcoin to all, go to nidig.com slash NLW. That's NYDIIG forward slash NLW. There was, however, another policy framework introduced that I wanted to mention, and this time it was from Entresen Horowitz, A16Z, one of the best-known and biggest venture firms in Silicon Valley. Their companion blog post starts, Today, we're excited to announce the release of How to Win the Future, a policy agenda for the third generation of the internet. It will be a living document housed in our new Web3 policy hub, alongside a growing array of resources for leaders in government, academia, civil society,

and the private sector, who are working to build a shared vision for the future of the web. If the past decade has taught us anything, it's that we need an affirmative strategy to shape the role of technology in open societies. In this context, Web3 isn't just a new wave of innovation, it's an opportunity for a reset. Policymakers and regulators can take advantage of the tools provided by Web3 to build an internet that will be better at unlocking opportunity, securing data, and solving critical challenges for society.

So let's talk for a second about the difference between crypto or digital assets and Web3. To me, crypto is a specific digital asset sector with a new type of asset, digital tokens, that trade on new types of venues like centralized crypto exchanges, of which I just articulated how they're different from traditional exchanges, as well as decentralized exchanges, which are even more fundamentally different than anything we have now. Those new assets traded on new venues create new types of thorny issues. Web 3 is enabled by cryptos, but is really more about human organization and the way that internet-based companies or collectives are brought together. To radically oversimplify this, Web 1 was one to many, websites that distributed info and content through channels that they owned.

Web 2 was many to many. It enabled people who had formerly only been concerned, to also be creators, but they were mediated through extraordinarily powerful centralized platforms. People had voice, but it was voice that could be taken away and controlled by the centralized actors. We've seen just how profoundly those centralized decision makers can impact society. These platforms are something unlike anything that has ever existed in terms of either the public or private sector and have created a lot of problems for all the potential good they've created as well. Web 3 promises to be many to many but organized in a disintermediated web. It removes the centralized platforms and does so by creating new novel incentive and reward

structures for participation. And that, of course, is where crypto and digital assets and tokens come in. The point here that I'm trying to make is one of these things is about digital assets and how they're traded. The other is about what you can do when those things exist. They are clearly related and overlapping, but they are, I believe, distinct. Now, in their presentation, Andriesen Horowitz dramatized the problems of the current model right now, saying,

The world has two tech paradigms. Both are flawed. They point to the digital authoritarianism of China on the one hand, or the problems of big tech on the other, and they say that something new is needed, something new that is decentralized, disintermediated, etc. A lot of people really liked this framework. Ryan Selkis of Massari said, the A16Z policy framework is phenomenal, build a better decentralized internet, tailor regulations to specific activities, harmonize oversight rules, modernized disclosure norms, clarify tax reporting rules, introduced Dow's as a new org structure and tackle the ESG challenge. Brian Brooks, the former comptroller of the currency and former CEO of Binance U.S., said,

let's add an on-discrimination principle. Bank lending shouldn't be favored over defy lending. Traditional securities shouldn't be favored over decentralized tokens. Exchanges shouldn't be favored over dexes, et cetera. Like I said, I think this is about a new type of internet native organization. It's about crypto and tokens only in so far as those things potentially change how incentives work inside networks and offer alternatives to an industrial era or organization model. But of course, not everyone was super into this. One critique had to do with a

prioritization issue. Bitstein tweets rampant inflation, supply chain shortages, total financial surveillance state, it's a great time to focus all our energy on sound money and savings, which is why A16Z wants to focus on making the world safe for Tamagotchi art on the blockchain instead. My take is that this is really about different priorities, but in free societies, one of the most salient political debates is what we should prioritize, so this is a worthy discussion to have. Another critique, however, I find even more salient is the way ESG is really sort of just shoved in here. One slide says align Web 3 with ESG. Most modern blockchains use energy-efficient proof-of-state consensus mechanisms. But many projects are going much further and leveraging the technology to

support environmental, social, and governance initiatives. Policymakers should work with industry leaders such as MakerDAO, and flow that are working on cutting-edge, carbon-neutral, or negative technologies, and paving new ground on how the Web 3 and ESG movements interface. When it comes to the Bitcoin blockchain specifically, policymakers should continue working with the Bitcoin community to foster greater levels of sustainability and reliance on renewable energy. They also had a slide that showed Bitcoin as proof-of-work and energy-in-efficient, and Ethereum as energy-efficient, right from the time that it started in 2015, despite the fact that it has not transitioned to proof-of-stake yet. Now, the point that that particular slide was

trying to show is that there's been an evolutionary move in many of these layer-one blockchains from proof of work to proof of stake, but it certainly revealed a bias. So what's my takeaway? Well, I think that the A16 framework is valuable. I think it might be too wonky to really have a lot of resonance, but as a way to jumpstart the conversation, great. To me, the issues that need to be solved first aren't really Web3 issues per se, even if that's what you care most about. They're digital asset issues. Digital assets and how they're traded and custodied and all those things are really the building blocks around which any version of Web3 will be built, and without them, the whole point is moot. I also am no critic of A16Z. We did a promo swap on this show a few weeks ago.

I think they have a ton of smart people. But I also think it's not just reasonable but necessary to always ask about people's incentives. VCs in general, and again, this is saying nothing about Andrews and Horowitz specifically, have an incentive to invest in VC-backable things. That's, in fact, their financial mandate, their fiduciary responsibility. That doesn't mean we shouldn't live, listen to their perspective, or that we should take all of their experiences compromised by conflicts of interest. In fact, one can and probably should argue that VCs should be in a better position than most to see the future and adapt to it, even if it clashes with their priors. Over the long term, the best VCs are going to be the ones who can change their framework

based on what the world is teaching them over time. But it's okay to ask these questions. I think a great example of this debate is summed up by an exchange between Joe Wisenthal from Bloomberg and Ryan Selkis again from Masari. Joe tweets, if Facebook's control of the internet is incompatible with an open, healthy society, as implied by the second image on the first slide, then why does A16 Z's Mark Andresen serve on its board? Ryan Selkis kind of snarkly responded, I agree, he should be canceled for investing early in the largest Web 2 company in the world. The experience certainly won't inform how we can build a better version via Web 3. My point is that both of these are reasonable starting points for a great debate, and I'm glad that

A16Z and Coinbase are starting these conversations. I'm glad that many folks are saying that these things are friggin' awesome and they're excited to see this new framework laid out and that this is what leadership looks like. I'm glad others are calling them out that there are some conflicts here that we need to keep in mind to contextualize how we view this. Ultimately, when you open up a public policy discussion, it won't really work unless the public discusses the policy, and right now that's exactly what's going on. So I, for my part, am stoked that this week featured such a strong focus on different parts of the industry, starting to articulate in complete and clear terms what it believes are the ways that we should think about regulation going forward. I think that's going to do

nothing but add value to the space, even if we come to very different conclusions that what anyone has written and shared this week. It continues to feel like we're moving to a new, heightened and more dramatic phase of this industry's evolution, and I certainly am here for it, but for now, I appreciate you listening. I hope you're having a great weekend. And until tomorrow, be safe and take care of each other. Peace.