The Breakdown - On the Frontlines of the SEC Safe Harbor Proposal With CoinList President Andy Bromberg

Episode Date: February 10, 2020

Last week, SEC Commissioner Hester Peirce proposed Rule 195 to give token projects a 3 year safe harbor. This proposed period would allow them to distribute tokens without fear of violating securities law so long as they achieve certain standards of decentralization in that time. Coinlist is a platform for compliant token sales. On this episode of The Breakdown, Coinlist CoFounder & President Andy Bromberg and @nlw discuss: The cost of regulatory clarity in the US, including projects leaving US shores Historic approaches to “compliant” token sales and what problems they still leave What Commissioner Hester Peirce’s proposed Rule 195 includes  The potential implications for the US crypto markets  The chances that Rule 195 comes to pass

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond, with your host, NLW. The Breakdown is distributed by CoinDesk. Welcome back to The Breakdown. It is Monday, February 10th. And today we have some expert insight onto one of the biggest pieces of news from last week. Obviously, last week saw some pretty exciting events. We had a billion dollars locked in D5. for the first time. We saw Bitcoin achieve a price of 10,000, a big psychological barrier over the weekend. We saw the Federal Reserve get into the central bank digital currency game more than they have before, admitting that they're, of course, researching and exploring. But we also had an SEC commissioner,

Hester Pierce, who's been one of the most active and engaged pro-crypto commissioners, in fact, undoubtedly the most active and engaged pro-crypto commissioner, propose a new rule called a safe harbor rule. Rule 195 could possibly totally change the face of the crypto industry in the U.S. In short, the rule would give crypto projects three years to prove that they were sufficiently decentralized such that they weren't in violation of securities law. The challenge for crypto teams today who want to use a token as part of their, system is that they run the risk of having offered or having done an illegal securities offering.

Currently, you can see the SEC going back through old ICOs from the 2017-2018 vintage and going after projects that were unregistered securities offerings. So this safe harbor rule would actually give those teams that were operating in good faith and who went through a set of disclosures the chance to actually offer tokens and not just to accredited investors, which is a big shift. Now, the response has been somewhat mixed. There are those who are fundamentally skeptical of tokens and don't think that any grace period is going to actually solve the issues of incentive

alignment that they bring, which has to do with the fact that they're a form of pseudo-equity rather than actually coming with the rights of equity. There are others who think that three years is not a sufficient amount of time to actually, quote-unquote, decentralize a project or reach sufficient. decentralization, whatever that metric may mean. Then, of course, there's a lot of folks who have been working on this issue for a while who are very excited about this possibility. One of those is Andy Bromberg. Andy is the CEO of CoinList, which is a spinoff of Angel List, and CoinLis is a platform that has strived since its launch in late 2017 to offer a better, more compliant platform

for token sales. That's been their goal. As such, they're obviously incredibly invested in what a compliant token sale actually looks like in how to do it. So Andy, as you'll hear in this interview, is very enthusiastic about these changes. He's very enthusiastic about what they might mean and thinks that it could actually address some of the most fundamental issues that are driving in some cases companies to go start abroad to actually leave the U.S. to find more favorable regulatory regimes. So let's listen in to this interview and then we'll come back for a recap at the All right. I am here with Andy Bromberg from Coinless. Andy, thank you so much for taking some time today and joining us here. Thanks for having me. All right. So you and I were just talking a little bit before this about the significance of this news that we heard in this proposal from Hester Pierce last week. And so I thought maybe we could kick off by just having you quickly summarize what Commissioner Pierce is actually proposing. And really just what the news was.

One of the big issues in crypto and in new tokens, I think, for the past couple of years has been the question of securities law and its applicability, particularly the United States, to this industry. And the key question there is, are these tokens treated like securities, which is a pretty highly regulated type of asset regulated by the Securities and Exchange Commission, of which Commissioner Pers is a commissioner? Or are they not securities? And are they regulated in some other way and not under that set of rules? For a long time, this is kind of have been an issue for the industry because people, if tokens are treated like securities, there are a bunch of requirements on how they can be bought and sold and transacted, which makes

it much more challenging to reach their potential as global assets that anyone can access. What happened yesterday is that Commissioner Perce, who's one of five SEC commissioners, released a proposed safe harbor, Rule 195. This is a statement that if the other commissioners agree to it, that would exempt tokens that meet certain criteria from securities law entirely and make it so that they can be freely traded and used and sold and bought without falling under the purview of the SEC. There's a lot of new ones we can go into in terms of what the actual parameters of this are. But at a high level, she said, if you're launching a token and the intention is that within

three years, the network becomes mature, so it becomes decentralized and functional and can't be governed by a single party, for that three-year period, at least you can, while you're developing it, you can treat it as a non-security, and it can be freely used, freely bought and sold on exchanges, freely transacted in order to reach that end state of network maturity. Now, put a pin in the Safe Harbor proposal and actually go back a couple years to give some of our listeners the context for how we got to the point where this might be important, right? And so this is obviously maps very closely to the story of coinless. You guys have been kind of on the front lines of trying to figure out this question of how tokens are going to be designated with regards to securities law and what people can do with them.

So maybe can you just take us back to, you know, 2017, 2018 as you started to look into the space and get involved with this space, what were our assumptions around securities law then? How is that evolved? And how has it forced you guys to evolve along the way? Absolutely. So I'll even take a step further back than that, pre-2017, there were a small number of ICOs and token sales, but you can think about Ethereum or MasterCoin or any of these way back in the day. And at that point, securities law wasn't really a consideration for people. They were just selling these tokens, and there wasn't a whole lot of attention paid to those laws. But then in 2017, everyone started to realize, and this was, you know, after the Dow hack and kind of more people were getting into the space and certainly more lawyers were getting to the, the space, everyone realized that these token sales could possibly be considered offerings of securities. And particularly, if you were pre-selling a token where the funds would be used to develop that network, and then eventually the users would get the token when the network went live, everyone realized, hey, these might be securities. We need to treat them really carefully and

cautiously. And what ended up becoming the paradigm in 2017 was softs, simple agreements with future tokens or similar types of documents. And Coinless dealt with a lot of these. What these effectively were were explicitly securities. They were pieces of paper that you signed that said, I'm investing $10,000 into this project. And in return, they are promising to give me tokens when the network is live at some point in the future. But that piece of paper is a security.

And the hope was that the tokens themselves that would be delivered at some point in the future would not be securities. But at that point, and for the past couple of years, there's really been no way to tell whether or not a token is a security or not. And so that promise has been really difficult to fulfill for teams because they've been looking at it and they've been saying, well, we'd like to distribute tokens to our investors, but we can't get comfortable with the idea that those tokens aren't securities because the SEC hasn't given us guidance to that effect yet.

And so it's really slowed down the pace of innovation here. We've seen teams do a couple different things. One is that just a couple teams, block stack and props, both of whom we worked with, decided to bite the bullet and say, you know what, we're going to release our tokens. We're going to consider our token securities. We're going to conduct what's called the reg A plus offer. And that's really costly. It takes a long time, requires a whole bunch of infrastructure buildout and limits what the token is really allowed to do, but at least was a way to get into users' hands, treating it as a security and dealing with the compliance that came with it. But the other dynamic that started happening, and this is something that was playing out a whole lot in the last year or so, is that teams were looking at this lack of clarity in the United States, this inability to tell whether or not a token was a security and saying, you know what, we don't want to deal with that.

It's not worth it for us to have this kind of limbo state. We're not willing to go down this reg A plus path of treating the token like the security and dealing with all the issues that come with that. we don't want to sell to investors where they might just have to hold it indefinitely because we can't get comfortable that the token is not a security. So we're just going to leave the U.S. We're going to issue the token outside the U.S. We are only going to sell to investors outside the U.S. Maybe even our team's going to be based outside the U.S.

And so a lot of these teams ended up just moving and leaving the U.S. alone and not accepting U.S. investors. In our eyes, it's a painful solution. And certainly some of those people were customers of ours and had successful sales, but we don't want to leave the U.S. out of this. There is incredible innovation that can be performed here in the United States. There are great investors that should have access to these assets in the United States. And for this period, it's just been really hard to justify that. And so now with Commissioner Purrace's new safe harbor, if it were to get approved, that would reopen the floodgates and allow capital resources to flow into the United States would allow innovation to occur here. would really kind of open up the gates for getting back to where we were, where everyone, everywhere could develop tokens, invest in tokens and participate in the potential upside of this industry. One of the things that I think is really interesting and is a part of the conversation around tokens that often gets left off is basically a lot of our conversations are couched in or colored by the experience of the ICO boom, right? when there was such an incredible flood of capital into these companies or into these projects,

I guess, that we tend to forget that the original idea, at least for a lot of sincere projects, let's put it, of tokenization was not about a fundraising mechanism. It was about a network distribution mechanism where the idea of the token was that it actually played some role in overcoming the bootstrap effect and early network effect. where there was not enough value for early users, right? If you're going to go compete with a Facebook or an Amazon or any of the networks that dominate our lives, you need some reason for people to come early before network effects have kicked in. Tokens were theorized to be a really interesting opportunity for that. And now, of course, there's a million other use cases that were

theorized for tokens, but it turned out that their power as a fundraising tool was so immense and that they changed the nature of friction in fundraising so intensely that that became a came the entirety of the story. And I feel like what some people are excited for and the innovation they're looking to come back is the ability for these things not to just be viewed strictly through the lens of traditional fundraising mechanisms, right, which is what securities law was, but as something that has, again, multiple different types of utility holding aside for the fact that there's, again, serious cynicism around the utility token idea. Yeah, I think that's exactly right. I mean, this is part of what I think is so impressive about this proposed safe harbor.

And it demonstrates this real depth of understanding from the commissioner about how these projects can work. She puts in there that in order to use this safe harbor and treat your token as non-security, the team that is initially developing it has to make an effort to have the token be listed on exchanges, on compliant exchanges. But what she's recognizing there is that the reason these networks are powerful and the reason they should exist and the reason they should be classified as a different type of asset is because distribution to a wide set of people is key to their success. That for a lot of assets out there, talk about equity, for example, companies can be very successful just having a couple shareholders and not distributing the asset widely. But in order for these tokens

to be successful and to fulfill their promise, they need to be distributed. We need to be in the hands of many different users to decentralize that network. And, And that's actually built into this safe harbor, which again, I think it's just shows this real depth of understanding in terms of what these assets should be used for. And yeah, I think this will let us get back to that vision that certainly tokens can be used for fundraising. But more importantly, I think some of the best token fundraisers that have happened have had that dual mandate.

One, raise money for the team to develop the project. But two, for them to get the tokens in the hands of a lot of users that the network can be successful and decentralized as it launches. The hope is that this will enable much more experimentation with these different models, with these different use cases, because people feel comfortable doing that experimentation, building it out, not worrying about the regulatory effects of what they're doing and being able to feel comfortable under the safe harbor. So I think that there's a lot that people are very excited about in this. I think, especially at core at this stage, just the fact that we have a representative voice who's arguing for more openness

and more kind of pro-innovation policies. The critiques that I've seen have tended to focus around whether this actually solves some of the problems with token sales as it relates to incentives for projects to deliver or enforcement around bad practices. What do you think the downside, if any, is or unaddressed questions are with this proposal? So I actually don't have that same concern. The reality is anyone in any industry, token or otherwise, can raise money and try to run away with it. And it happens.

You know, if you go on the SEC's website and you look at the press releases that they put out, there are tons of cases where someone raises money for inequity for a venture or raises debt and runs away with the money or misuses it. And that's just a reality of doing business. Now, what you have to be able to do is go after that person to appropriately disincentivize that from happening. And what this safe harbor includes is disclosures the teams have to make in order to claim the safe harbor around who's on the team.

What are the identities of the people developing it? What are their backgrounds? And those are the sorts of things that make it so that if a team does do something bad, which will happen and happens in every other industry, that the investors can chase ask for them and get what's due to them. I actually think prior to this, these assets were way less regular. People are running token sales without any disclosures. There are people unnamed behind these projects sometimes. And now there will be some legal burden on them to make appropriate disclosures about who they are, what the use of funds is, details about how the network's going to work.

And hopefully that makes it much cleaner, start to finish, and makes it less likely that the people will run away and exit scam or do anything like that. like that. It's not a concern of mine other than at some level. You just always have to be mindful of those things. But again, that's true of crypto and non-crypto industries. And I think, too, it's reasonable to say that there's a difference between the security enforcement side of the law and designing the law in the first place to set the framework. And it's not necessarily the job of the framework to figure out exactly how punishment is going to be met it out for violation of that framework.

This Great Harbor does contemplate that consumer protections are still a really important part of this. There's a whole bunch of different ways that assets can be regulated. The SEC is just one of them. And so this safe harbor doesn't mean these assets are not totally unregulated and do whatever you want. Consumer protections against fraud still exist. And people have ever right to chase after bad actors, even with the state harbor.

Another one of the interesting elements of this is that it actually enables non-accredited investors to participate, which has been one of the beefs of many folks in the crypto ecosystem of who have this sort of libertarian bent to them around people should have autonomy and sovereignty to do what they wish with their money. There was actually a comment from Marco Santore as he did a threat about this. He wrote, if you think SAFs just let rich people buy cheap tokens to dump expensively on poor people, you're really complaining about the accredited investor standards, so you should love this proposal. It gives retail the same access as VCs, which I thought was another interesting point just about this framework, that it does answer a lot of things that have been brought up as problematic by the

crypto community. Absolutely. That's been one of the biggest barriers that securities law has put in front of the crypto industry is how the primary offerings work, the accredited investor rules, and how that restricts who's allowed to buy. And it speaks to your earlier point about distribution. Token sales treated as securities, sure, they were still a way to distribute to users, but only accredited users.

And that's a very small set of the population and a lopsided one. And everyone should have the chance to participate in the upside of these projects. Everyone should be able to participate in the distributions that we can make these networks as decentralized as possible. So the removal of that requirement, in addition to the removal of restrictions on trading tokens that might be securities, both of those are going to absolutely change the industry if the safe harbor comes to pass. So that, I guess, is the next question is, what is the likelihood of this coming through? Historically, this particular SEC has not been particularly friendly with notable exceptions. And I've even seen commentary to the effect that people don't think that an SEC under Clayton

will actually ever really be pro-crypto. What do you think? Yeah, you know, there's no way to know for sure. I'm optimistic, and I'll tell you the two reasons why I'm optimistic. One is that I'm not inside her brain, but I find it unlikely that Commissioner Perth would have introduced this without feeling at least some level of confidence or optimism that it would pass. Otherwise, it's a fairly futile gesture. And so I think that she has to be feeling some optimism about this. But more importantly, it's a really reasonable proposal. If she came out with a safe harbor that

It was much looser, didn't require the disclosures that this one requires, didn't make the assurance that this one makes, and just didn't have those requirements in there. Then I would be saying, okay, this is just a statement that she's putting out there. But she took the time and her staff did and put in the effort to really understand everything. And I think come up with a really down-the-middle proposal in terms of what's required of these teams in order to clean the safe harbor, what the continuing conditions will be how it's going to work. I think all the commissioners, whether they're pro-crypto or not, they are smart and reasonable. And I think it's hard to read this proposal and throw it out the window. Now, will there be discussion and argument over some of the details? Absolutely, both from

the industry and from the other commissioners, I imagine. But I think she put together a really reasonable down-the-middle proposal, and that dramatically increases chance of passing. Will it happen. I don't know when will it happen. I don't know, but I'm optimistic about this one after a couple of years of failed attempts to do something similar by different folks in DC. Well, I really appreciate the perspective. I guess as we wrap up, is there, what else, if anything, should people know about this proposal or how should they engage with it, do you think? What can people who support this proposal do to help it actually come to pass? I love that question. Two things. First of all, look at

it, really read it, think about what you like about it and what you don't like. There will be a period where there's feedback accepted and comments. And so just thinking about that and coming up with where things are changed or where things should be praised in this proposal is really important. But even more than that, be vocal. The industry support of this proposal will be meaningful. The commission pays attention to that. Staffors pay attention to that. Other people in D.C. pay attention to that. And I think it's a really important flag in the ground for us to plant as an industry that we are supportive of this proposal. I think sometimes crypto gets this wrap that we don't want to engage with DC at all. We don't want to deal with any of it. If the government's

suggesting something, we want no part of it. When we get a proposal like this that's reasonable and will allow companies to be successful, that's a chance to come out really strongly and say, we're supportive of this. We think this is a reasonable proposal. We think we can work out of these conditions. We think that innovation can occur under this safe harbor. And the more people that join that course, the more powerful it will be, the better chance there is that this gets past. And we all get to get back to doing work in the United States and building great crypto projects here. Well, Andy, thank you so much for your thoughts. I know this is an area that you've spent an inordinate amount of time thinking about working on and trying to work within and around the system

as best you can. So very exciting to hear that for the first time in a long time, I feel like there's this excitement and optimism about possibilities that just hasn't been there for a while. We've got hope. Yeah, no, it's my. My pleasure. Thank you for having me on. This is a really fun conversation. So really interesting stuff from Andy there. To me, one of the more salient points or one of the more relevant points, I think, is Andy's response to my question about whether this can actually go through, whether there's any chance that Rule 195 could come to pass. His response was basically that he can't imagine that Commissioner Pierce would be this invested and would actually take the time

to float this full proposal, right? Not just mentioned it in speeches, as she's been doing for a while, but to actually come and bring a full proposal for review if she thought this didn't have a chance. Now, obviously, we'll have to wait and see, but there is a chance that this is a fundamental moment for this industry, where we look back and see that there was something that was different afterwards. But what do you guys think?

Is Rule 195 a good thing? Should we be enabling projects that are behaving in good, faith to actually experiment with tokens. Are tokens just a bankrupt enterprise destined only to enrich the founders, as some have claimed? What do you guys think? Let me know on Twitter at NLW. And as always, guys, thanks for listening, and I'll be back with the breakdown tomorrow.