The Breakdown - The American Argument for Tokenizing Everything

Starting point is 00:00:04 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. What's going on, guys? It is Sunday February 2nd, and that means it's time for Long Read Sunday. 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 on the Breakers Discord. You can find a link in the show notes or get to bit.ly slash breakdown pod. All right, friends. to another Long Read Sunday. Sometimes I'm not exactly sure what I'm going to read for this episode,

Starting point is 00:00:42 but this week it was very clear. Robin Hood's CEO Vlad Tennev wrote a piece in the Washington Post called An Investing Revolution is Coming. The U.S. isn't ready for it. His subtitle says it all. Cryptotechnology can democratize access to opportunities offered by early stage private companies. So we're going to be reading that, as well as a companion piece by lawyer Aaron Brogan called Put Securities on Chain. First, we will do the piece from Vlad, once again turning it over to an AI version of myself from 11 labs. Quick note on that, by the way, I've been getting more comments lately around people not enjoying the AI version. I'm not sure to what extent it's the novelty wearing off versus model degradation, but I'm going to experiment with retraining another version

Starting point is 00:01:21 of my voice and see if it does better. For now, though, I'm going to throw it over to the AI to read this piece by Vlad Tenev, An Investing Revolution is coming and the US isn't ready for it. Looking to invest in some of the world's most exciting companies? Good luck. Open AI, valued at $157 billion is still private. So is SpaceX at $350 billion. Not to mention Canva, Revolute, Stripe, Anthropic, each worth tens of billions. That doesn't mean these companies don't have investors. They do. A small circle of wealthy backers with access to early stage investment in private companies. Many of those insiders are sitting on profits as high as 1,000 times their initial investment or more, which everyday investors can't partake in. This investment gap is worsening as companies increasingly avoid

Starting point is 00:02:06 going public. The United States has roughly half as many public companies as it did in 1996. Meanwhile, accredited investor rules, which generally restrict private market investments to those with a net worth over $1 million or income of over $200,000, shut roughly 80% of U.S. households out of the private market. There is a solution that can open this door and usher in the most inclusive investment revolution since stock trading shifted from physical trading floors to electronic systems. Yes, it's crypto. Stay with me, even if you're skeptical. When many hear crypto, they think its chief use case is meme coins, whether of presidents, dogs, or frogs. To understand the coming trading revolution, however, we should start thinking of crypto in a

Starting point is 00:02:46 different way, as a technology that enables the partitioning and trading of all assets, including real-world ones such as private companies. Here's how this can work. Crypto's blockchain technology allows for the fast, easy, and secure creation of digital tokens, which can confer ownership claims to something of value. The power of this process, called tokenization, lies in the flexibility of the technology to divide and distribute rights to almost anything, so that they are tradable like a stock. Real-world assets, such as private companies, can be tokenized with only minor changes to the existing legal documents that govern ownership claims to these assets.

Starting point is 00:03:20 Through a similar process, you could tokenize a Picasso, the Washington Wizards, carbon credits, or a favorite musician's publishing rights. Anyone with a mobile phone could trade any tokenized asset in any quantity 24-7, a technological step-change improvement over our current stock markets. That's where the investing revolution begins. Tokenizing private company stock would enable retail investors to invest in leading companies early in their life cycles, before they potentially go public at valuations of more than $100 billion.

Starting point is 00:03:48 This would also benefit the companies themselves, enabling them to draw additional capital by tapping into a global crypto retail market that is growing increasingly sophisticated and investment savvy without sacrificing the private company protections they are used to, such as employee vesting and stockholding requirements. There are, of course, ways to open up access to private markets without crypto, including through specialized secondary trading platforms such as Equity Zen. Though these platforms have made meaningful progress in increasing access to private markets, they're still limited to accredited investors.

Starting point is 00:04:19 They also lack the combination of global scale, open infrastructure and low friction that makes crypto technology a natural choice for this use case. So the technology already exists, but there is a regulatory roadblock. In the United States, private company's stock and similar assets are regulated by the Securities and Exchange Commission, which has yet to provide the regulatory clarity to enable listing securities on domestic crypto platforms and make them available to retail investors. As a result, the United States risks ceding this market to the rest of the world. Already, the European Union, Hong Kong, Singapore, and Abu Dhabi have implemented more comprehensive

Starting point is 00:04:51 regulatory frameworks for security token offerings and digital exchanges to facilitate trading. U.S. laws stipulate that securities exchanges, clearing agencies, and transfer agents register with the SEC and regularly update disclosure documents. There are several issues with this when it comes to crypto, a technology these laws don't account for. For instance, these functions are often performed not by organizations, but rather by distributed open source computer software, running on thousands of servers around the world. It's currently impossible to register open source computer software and thus unfeasible to comply with existing regulations. Still, because private company stock is already regulated as a security by the SEC, the commission is

Starting point is 00:05:30 best position to swiftly modernize our securities laws and make tokenization of real-world assets possible. President Donald Trump's recently announced Digital Assets Working Group, as well as the new Crypto Task Force underacting SEC Chairman Mark Yu Yeda, give hope for a new regulatory framework. Three main changes are needed. First, in a global market where anyone can freely invest in thousands of crypto projects of varying pedigrees, the current wealth-based accreditation requirements for private investments are nonsensical and anachronistic. Limiting retail access to these investment opportunities has likely led to a net destruction of wealth by concentrating the upside from private market investing within roughly 20% of the population. If accredited investor rules must exist, they should be based

Starting point is 00:06:10 on knowledge of investing and its risks or self-certification, not how rich you are. Next, there needs to exist a security token registration regime, allowing companies to create token offerings that are open to U.S. investors. This would also provide an alternative path to the traditional IPO, which has become so bloated and labor-intensive over the past two decades that only the largest companies can justify going public. And finally, we need a clear set of guidelines for what U.S.-based broker dealers and exchanges, both centralized and decentralized, must do to list these tokens and make them available to the public legally and safely. Of course, startup investing comes with the expectation that most investments will go to zero. The risks are highest where the opportunity for upside is

Starting point is 00:06:51 greatest, at the earliest stages. It is likely that part of the SEC's slowness to adapt to this new technology comes from the challenges of protecting investors from scam tokens, fake businesses, and bad actors. Still, these risks can be managed with appropriate guardrails, such as enhanced disclosure. It's time to update our conversation about crypto from Bitcoin and meme coins to what blockchain is really making possible, a new era of ultra-inclusive and customizable investing fit for this century. The world is tokenizing, and the United States should not get left behind. If you've been around Bitcoin for long enough, you've heard the turn. hoddle and the name Leden.

Starting point is 00:07:28 Lennon has been the go-to leader in Bitcoin lending for over six years. They help clients unlock the liquidity of their Bitcoin, allowing them to hoddle while still accessing the wealth of their BTC. They've been battle-tested with their focus on transparency, security, and trust, allowing them to build a proven track record of client's success and security. Letton has helped tens of thousands of clients harness the value of their digital assets, issuing more than $6.5 billion in loans over the years. But as the crypto industry says, don't trust verify.

Starting point is 00:07:53 check out Ledin's Trust Pilot or their reviews on social media. And to learn more about what your Bitcoin can do for you, check out ledden.io slash borrowing. That's LEDN.com. Please visit leaden.io slash legal for product terms and disclosures. Product availability varies by jurisdiction. Hello, friends. I am thrilled to share that Ledger is once again partnering and sponsoring with the breakdown.

Starting point is 00:08:19 Many of you know, but for those of you who don't, ledger is the most secure hardware wallet for your crypto and logins. It's trusted by 7 million users and secures 20% of the world's digital assets. What's more, Ledger is a lot more than wallets. Over the recent years, they've built a comprehensive ecosystem of products and services, all of which are designed to make digital ownership more secure and accessible. You can buy your Bitcoin with Ledger and Ledger Live and so much more. Basically, not only did they want to keep your assets secure, they want you to be able to do more with them. Ledger's newest devices, the Ledger Stacks and Ledger Flex introduced the world's first

Starting point is 00:08:51 secure touchscreens, making it easier and safer to manage your transactions and assets. Alongside Ledger Stacks and Ledger Flex, the company also launched the Ledger Security Key app, offering a safer alternative to traditional passwords and enhancing your digital security. If you are in this space, you owe it to yourself to at least check out Ledger and their ecosystem what they have available to you. So thanks, once again, to Ledger for sponsoring the show. Now next up, we switch over to Put Securities on Chain by Aaron Brogan. This week in a Washington Post op-ed, Robin Hood's CEO Vlad Tenev called for a new approach to capital markets in the United States. He suggested a number of policies modernizing accredited investor standards as an old favorite among finance wonks, but one stood out.

Starting point is 00:09:32 There needs to exist a security token registration regime, allowing companies to create token offerings that are open to U.S. investors. Here, Tenev seizes upon the skeleton key to unlock cryptocurrency's full potential. Here's how securities markets work in the United States. By default, companies aren't really allowed to sell equity. at all. The Securities Act of 1933 defines securities and prescribes conditions and penalties for selling them. If a company wants to raise money, it hires a lawyer like me and either registers or finds an exemption like Reg. D. Most choose an exemption and go private. And as Tennev points out, many of those choose to stay that way, Open AI, SpaceX, or Stripe. But exempt securities do not trade easily. They're generally encumbered by contractual and regulatory restrictions that make them a liquid. For the richest few

Starting point is 00:10:17 companies, this might be fine, or even the point. But not for most. Without liquid secondary markets, investors can only realize profit through dividends. And where investors cannot realize gains, primary markets run correspondingly dry. Registered securities, on the other hand, are highly liquid on the secondary market. This means that investors typically jump to participate in an initial public offering. But this process is also restricted to the richest companies by its massive price tag. PWC estimates that even relatively small initial public offerings cost millions of dollars, along with millions more in annual legal fees and compliance. This is still before considering the onerous transparency and forfeiture of control that come with registration.

Starting point is 00:10:56 For these reasons, now even top firms avoid going public, Tenev says, It's no secret this is a problem. Washington, D.C. recently tried to address it by creating regulation crowdfunding, reg CF, in the 2012 Jobs Act. The idea was to make exempt securities more accessible to small and medium businesses, SMBs. But they just couldn't help themselves. Familiar restrictions on secondary liquidity hamstring the program. Combined with still significant compliance costs, the result will never be a meaningful segment of U.S. capital markets. Instead, the solution came from outside. Ethereum developers introduced the ERC20 standard in 2015, allowing anyone to create an arbitrary number of tokens and

Starting point is 00:11:34 sell them into instant liquidity. Project founders could restrict resale as they chose, but in practice, the best projects developed deep, efficient markets quickly. These fungible tokens took various names and functions, but practically for a time, they were the Internet's capital market. On top of secure, trustless blockchain technology, the crucial breakthrough was just letting people buy and sell tokens freely. It turns out this is a product people really want, and initial coin offerings grew 100x between Q1 and Q4 of 2017. This Halcyon moment couldn't last. Holy unregulated markets were a sink for scams, and the subsequent SEC campaign to end cryptocurrency fundraising is well documented. These days, it is extremely difficult

Starting point is 00:12:13 to make a legal primary token sale in the U.S. projects are left to give tokens away for free. Even then, a single successful hyperliquid air drop created more value in a day than all Reg CF offerings from 2021 to 2023 combined. Rather than gesture to the past, though, Tenev emphasizes the future. Tokenizing private company stock would enable retail investors to invest in leading companies early in their lif cycles, enabling them to draw additional capital by tapping into a global crypto retail market, it would provide an alternative path to the traditional IPO. He calls this tokenized real-world assets. I call it a regulatory third way. Sitting between exempt securities and public offerings, the SEC should promulgate rules that allow projects

Starting point is 00:12:55 to sell securities in the form of cryptocurrency tokens with limited compliance and disclosures, combining the relative simplicity of a private placement with the secondary liquidity of a public offering. We already know the first-order effects of such a system. In 2017 and 2018, more than 2,000 projects sold tokens to raise over $13 billion. As Tenev points out, the risks are highest where the opportunity for upside is greatest, and many of those early crypto companies failed. Many survived, though, and are still building today. Early investors grew rich, and their leaders remain faces of the industry. The second order effects are where the real value accrues. Compared to any traditional securities offering, cryptocurrency token launches are trivially cheap.

Starting point is 00:13:36 By some estimates, there is as much as a trillion dollars of potential S&B capital demand in the United States. This suggests vast potential for on-chain fundraising. Nobody knows what access to this capital would mean. Some would no doubt be vaporized. But there is real potential that underserved markets experience asymmetric growth. Of course, there are risks beyond lost investments, too. A liberalized cryptocurrency regime might display some or all of the current public securities regime. This would, in effect, radically decrease the compliance and disclosure requirements for public companies, possibly undermining market efficiency and increasing deceit. But why anchor to the status quo? A third-way regime can require disclosures without being as onerous as public registration.

Starting point is 00:14:16 Consumer protection need not arise from laws that were written before running water was ubiquitous, much less cryptographically secure blockchain networks. It's not obvious that public securities would vanish anyway. The relative cost of compliance diminishes at scale. From a Sure companies, investors will probably demand traditional disclosures and be willing to pay a corresponding premium in exchange. If they don't, maybe these laws time has come. It's hard to imagine anyone arriving at the contemporary regime from first principles. The president can launch a meme coin, but tokens tethered to business fundamentals are prima facie illegal. So here I second what Tenev says. It's time to update our conversation about crypto from Bitcoin and meme coins

Starting point is 00:14:55 to what blockchain is really making possible. Let's put securities on chain. All right, back to Real NLW here. A couple things that I think are interesting about this conversation. I've talked extensively about my feelings about accredited investor laws, so I won't rehash that here. I simply think that there's got to be a better way to ensure that people don't get caught in scams than to fundamentally limit what they can and can't do.

Starting point is 00:15:18 Now, in terms of other parts of this conversation that stand out to me, one that I think is important is Vlad's articulation of what really is a new, weird space that hasn't historically existed between public and private markets. This has been brewing for a decade and a half now, but with companies going to Series E, F, G, before ever going public, and really if they could wanting to stay private for basically as long as they can, there's a huge area where companies have been significantly de-risked, and it feels like a different category of investor could be playing. It could also make the system work better,

Starting point is 00:15:48 giving insiders liquidity. So I think holding aside that whole tokenization piece, thinking about what that hinterland between public and private markets should be and how it should be operated is fertile ground for discussion. Second, when it comes to the demand for this sort of stuff, I actually tend to think that resentment around not being able to get in on the gains of tech helped make people fall out of love with it in the first half of the 2010s. In the second half of the 2010s, everyone got mad at tech for political reasons on both sides of the aisle. But before the 2016 election, there had still been already a decrease in trust around big tech, and I think part of it was seeing how

Starting point is 00:16:21 many people were getting rich and how regular people were being excluded. That felt to me like it drove a huge amount of the demand for ICOs in 2017. Point being, finding ways to meet that demand more positively than the ways that people do it now is probably a good thing. Third, one thing that's very clear to me is that the SEC is going to have to answer these questions, and probably sooner rather than later. The limiting factor on what people build next in this new pro-crypto America is going to be entirely around questions of how tokens are handled by the law, all the infinite variety and myriad types of tokens. It's going to take concerted effort to figure it out, but on the other side, a huge amount of financial activity is just waiting to be unleashed.

Starting point is 00:17:01 Lastly, it's very notable to me that neither of these essays include any sort of real argument for what the updated social norms around disclosures and the new tokenized regulatory regime should be. In other words, these folks, and me as well, clearly don't want accredited investor laws in the same way, but what's meant to replace them? What type of disclosures are important? It feels like there's actually a ton of fertile room for innovation here, especially that blockchains are inherently more transparent than the private ledgers that run stock markets and the like. Point being, this is definitely an area that seems to me where a challenge could become an opportunity real quick, and I will be excited to see who takes that on. For now, that is going to do it for this week's Long Read Sunday.

Starting point is 00:17:38 Appreciate you listening, as always. And until next time, be safe and take care of each other. Peace.

The Breakdown - The American Argument for Tokenizing Everything

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