The Breakdown - The Government Game Plan: Call Ether a Security, Tax the Crap Out of Bitcoin Mining

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. The breakdown is produced and distributed by CoinDes. What's going on, guys? It is Saturday, March 11th. And today we are catching up on all the crazy news, which any other week should not have needed to wait until the weekly recap for you to hear. But before we dive into that, a quick note. There are two ways to listen to The Breakdown. You can hear us on the CoinDesk Podcast Network, which comes out.

Starting point is 00:00:37 every afternoon alongside other great coin desk shows, or you can listen on the breakdown-only feed, which comes out a few hours later. Wherever you're listening, if you're enjoying the show, I would so appreciate it if you would take the time to leave a five-star rating or review, it makes a big difference. All right, so guys, listen, as I was prepping this, I was still kind of reeling from the news that Silicon Valley Bank has failed. Maybe it will have sunk in by the time you're listening to this, but at the moment, I think that people are really kind of underestimating it still. I've barely begun to wrap my head around potential systemic implications, but just in the

Starting point is 00:01:11 startup scene, it's still so significant. We're in a moment where it is now extremely likely that some startups will live or die on the basis of whether or not they banked with SVB and whether or not they got their money out. Brad Hargreaves summed it up like this. He wrote, Silicon Valley Bank closure and receivership is going to have a massive impact on the tech ecosystem. SVB was not just a dominant player in tech, but were highly integrated in some non-traditional ways. A few things we'll see in the coming days and weeks. One, SVB was incredibly

Starting point is 00:01:41 integrated into the lives of many founders, not just their startups, bank and lender, but also provided personal mortgages and other financial services. A whole mess for FDIC or eventual buyer to unwind. Two, any uninsured balances at SVB, those above 250K, are in jeopardy. FDIC plans to pay them out, quote, as it sells the assets of SVB. Lots of startups exclusively banked with SVB as this was a covenant of their debt. CEOs yesterday faced a hard choice, pull your deposits and go into default on your venture debt, or risk losing everything if the bank failed. Many chose to hold tight, as SVB's outright failure seemed outlandish. Now they may not be able to make payroll next week. Unpaid wages pierced the corporate veil, so boards are incredibly sensitive to employing workers

Starting point is 00:02:24 they may not be able to pay. Expect mass layoffs later today, Monday at latest. And given the weak fundraising environment, a number of startups have been reliant on venture lenders, e.g. SVB, not aggressively pursuing amortization of debt or triggering default for covenant foot faults, e.g. Cash balances. How will FDIC handle this? Mass defaults? Having run a startup through the global financial crisis, this is the first thing I've seen since that that is even vaguely reminiscent of that time. Total cluster. Now, just to give it some balance in a sense of what might transpire over the weekend, I also wanted to read a thread from Bob Elliott, the CIO at Unlimited. He writes, the FDIC has taken SVB in receivership and will manage its resolution. This has

Starting point is 00:03:04 happened hundreds of times over the last decade and there is a well-tested game plan. The bank closes Friday and folks will not have access to their deposits over the weekend. During that time, the FDIC will figure out whether the bank will be fully wound down or sold to another bank at whole or parts. We will learn more soon on that. Either path will result in insured depositors having full access to their 250K on Monday. Then the FDIC has already said, it will make an initial payment for uninsured deposits next week, as well if it is in receivership. That's a positive sign. If the bank remains in receivership and wound down, additional payments are made based on the asset sales that eventually come. The best path is to find a buyer this weekend for the assets and transfer the deposits

Starting point is 00:03:40 and assets quickly. It is notable that the bank was halted before the FDIC closed it at noon. This suggests that the FDIC was already there and ready. Suggests the FDIC and Fed already have a good sense of what is going on at the bank and have run the numbers. Nothing is surprising to them and they likely have already done some resolution work. Overall promising, but by no means certain. Odds are we will all learn a lot more over the weekend. The Fed and the FDIC will want to instill confidence in the market and limit knock-on impacts before the futures open on Sunday night. It'll be a long weekend. It feels like fall of 08 a little, but with much less panic. These regulators have had 15 years working on this. There's a lot more expertise and experience. The stakes are

Starting point is 00:04:18 better known. All that is a likely positive for how this gets resolved to VB, depositors and the system. Anyway, there will be a lot more to discuss on this next week, but I do now need to use part of the weekly recap to cover some of the truly huge things that in any other week would have gotten their own show. And let's start, obviously, with the news from Thursday night out of New York. On Thursday evening, New York State Attorney General Letitia James filed a lawsuit against Ku-coin. She accused the Seychelles-based exchange of operating an unregistered securities exchange accessible to New York residents. The lawsuit had been brought under New York State's Martin Act, which is a 1921 law that gives

Starting point is 00:04:53 the Attorney General powers to investigate securities fraud and bring both civil and criminal actions. In addition to the claims of offering securities for sale without the required registration, the Attorney General also claims that Ku Koecoin was operating as an unregistered commodity broker dealer and that they failed to respond to subpoenas. Now at this point, you will know that I am very much burying the lead because the three examples of securities offerings that they gave were one, interest-bearing accounts in the form of the Ku-coin earned product. No surprise there. Luna and U.S.T. tokens again, no real surprise. And this is the big one. Ethereum tokens. Yes, this is a lawsuit accusing Ethereum of being a security. Now, we'll get into

Starting point is 00:05:31 what those arguments are in just a second, but there is a little bit of nuance that's actually worth explaining here. So these tokens are also claimed to be commodities, which is defined extremely broadly under the Martin Act as any foreign currency or any other good article or material. As for their classification as securities, the Martin Act definition is investments of money and common enterprises with profits to be derived primarily from the efforts of others, which is essentially the same as the Howey test at the federal level. It's likely that both commodities and securities definitions are being argued as a matter of legal strategy, i.e. to avoid the lawsuit failing if token classification is clarified by the SEC or the federal courts. In other words,

Starting point is 00:06:05 it may be legal strategy more than a meaningful attempt to define the tokens by the Attorney General. But still, it's obviously a big deal for this lawsuit to define Ethereum as a security, and three of the 28-page filing is dedicated to arguments for why. Which honestly, ironically, is kind of gratifying after having the SEC say that everything is a security forever without defining why. Now, most of these three pages cover the same points that have been put forward over the eight years since the Ethereum ICO within the crypto community. Central to the claim is the existence of a common enterprise standing behind Ethereum, which the filing identifies interchangeably as both the Ethereum Foundation and the developers of the network. Quote,

Starting point is 00:06:41 ETH's development and management is largely driven by a small number of developers who hold positions in ETH and stand to profit from the growth of the network and the related appreciation of ETH. The filing points to the Ethereum Foundation as having conducted the 2015 ICO, quote, as a means of promoting the development of the Ethereum blockchain by paying expenses incurred by developers, paying for legal contingencies, research, and further development. It also notes that both the Ethereum Foundation and Vitalik Buterin personally are believed to have retained a significant quantity of ETH. These arguments obviously echo the concerns around the pre-mine of Ethereum, quote-unquote, making it a risk of being labeled to security as compared to Bitcoin.

Starting point is 00:07:15 The filing also refers to the transition of proof of stake, claiming that, quote, Buterin and the Ethereum Foundation played key roles in facilitating the recent fundamental shift. The filing argues that one Ethereum developer said his team was, quote, granted permission by the Ethereum Foundation to work on the merge. This was something quickly refuted on Twitter, but that's not really the point of where we are right now. The filing stops short of talking about proof of stake consensus as a form of dividend, but notes the fact that, quote, Eath holders can now profit merely by participating in staking.

Starting point is 00:07:42 Now, beyond the existence of a common enterprise, the lawsuit also sets out to argue that profits are derived from the efforts of others. To that end, the filing states that the Ethereum Foundation's website says that many ETH users, quote, see it as an investment similar to Bitcoin and other cryptocurrencies. The filing also references the implicit promises surrounding deflationary monetary policy that were present from the beginning. Quote, the ICO documents included representations that ETH production would dramatically slow over time, resulting in ETH becoming increasingly scarce and thus more valuable.

Starting point is 00:08:09 It also adds that, quote, the Ethereum Foundation claims on its website that users of Ethereum see it as a digital store of value because the creation of new ETH slows down over time. While avoiding making comparisons to a dividend, the lawsuit claims that, quote, since transitioning to the proof-of-stake consensus, the value proposition has altered significantly because possession of ETH translates directly to profit potential by earning staking rewards. Now, a lot of crypto-twitter said, hey, this validates the idea that the transition to proof of stake turned Ethereum into a security.

Starting point is 00:08:36 But that's not really the argument the Attorney General is making. Instead, the NYAG seems to be using the merge simply as another example of the Ethereum Foundation's continued control over the protocol and its development team. as well as a clear example that the source of profits for Ethereum investors is not from individual effort, but rather the efforts of developers in providing a staking yield. Now, the key wrinkle in this case is that the lawsuit is only against Ku-coin. No one representing Ethereum or Luna is listed as a defendant. This has been a common recent litigation tactic of regulators.

Starting point is 00:09:08 It was seen in the SEC's insider trading lawsuit against a former Coinbase employee, which listed 10 small-cap tokens as securities, as well as the SEC's objection to the Voyager bankruptcy plan. In the Voyager case, the judge expressly rejected the SEC's argument that it was enough to assert that Voyager's native tokens were securities without going through the due process of bringing those allegations in a specific court hearing. This case is somewhat analogous. Allegations about the Ethereum Foundation and Ether's status as a security have been made without affording anyone the standing to defend those claims as a party to the lawsuit. The biggest difference here again is that the Attorney General has at least provided legal analysis

Starting point is 00:09:42 of their claims rather than making the assertion and then moving on. Still, Jake Chavinsky, of the Blockchain Association, raise these due process concerns, tweeting, Call me crazy, but I think if an enforcement agency wants to accuse a person of breaking the law, they should bring an action against that person, not some random, unrelated third party who can't or won't show up to defend the case. I agree entirely that if they really wanted to have this fight, they'd go after one of the many other more obvious targets, Coinbase, consensus, the Ethereum Foundation itself.

Starting point is 00:10:11 But I also don't believe for a second that this action was done in the dark, or that it wasn't approved, signed off on, etc., by other and, antagonist in this environment, most notably Gary Gensler and the SEC, which means there's some other game being played here. If I were a betting man, I might think that this is an opening salvo to see if the fear of Ethereum being labeled a security gets anyone to delist or take actions along those lines. In other words, it's a shaking of the coconut tree. On a more legal level, it's probably an attempt to get some summary judgment because Lord knows Ku-coin isn't going to show up and defend itself. Anyway, as you would expect, there was a fair amount of Bitcoiner

Starting point is 00:10:44 I told you so is I'm on Twitter, but I found myself in the Alex Gladstein camp when he retweeted the ETH News and said, it may not happen, but best be prepared for a now-they-fight-you-phase in America, where authorities try to ban Bitcoin mining and declare everything else an unregistered security. Alex's point, of course, is that just because this didn't represent them going after Bitcoin does not mean they like Bitcoin. And more to the point, does not mean they will not go after Bitcoin, even if it's on a different access. Within minutes, literal minutes of this tweet, we got news that the U.S. Treasury Department has proposed a 30% excise tax on power supplied to U.S. crypto mining facilities. There you go. Anyways, a provision of the department's

Starting point is 00:11:32 Green Book, which is a list of tax proposals and explanations for the president's budget proposal, would create a phased in excise tax on electricity used by companies, quote, using computing resources to mine crypto. Companies would also be required to report their annual electricity usage as well as the mix of energy resources used. The 30% tax would be phased in at 10% per year over the next three years. What's more, the goal of the tax is explicitly stated as reducing the amount of mining machines in the U.S. Quote, the increase in energy consumption attributable to the growth of digital asset mining has negative environmental effects and can have environmental justice implications as well as increase energy prices for those that share an electricity grid with digital asset miners.

Starting point is 00:12:12 digital asset mining also creates uncertainty and risks to local utilities and communities, as mining activity is highly variable and highly mobile. An excise tax on electricity usage by digital asset miners could reduce mining activity along with its associated environmental impacts and other harms. Now, for this to go through, both houses of Congress would need to pass a budget that included this provision. And it's highly unlikely that that actually happens. But it is a clear indication of the Biden administration's view on the energy use of crypto mining. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3,

Starting point is 00:12:50 happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, brand leaders, entrepreneurs, and more. Use code Breakdown to get 15% off your paths. Visit Consensus.com. or check the link in the show notes. Troy Cross gives a pretty clear point on what this means.

Starting point is 00:13:23 He writes, 30% is a de facto ban, end of the mining industry in the U.S. if it were to happen. Parentheses, it won't. Bitcoin itself wouldn't care. Bitcoin related emissions, they'd go up. Geron Millerud, an analyst at Luxoran Mining, agrees, saying a 30% excise tax on electricity used for Bitcoin mining would render a significant share of the U.S. mining industry uncompetitive.

Starting point is 00:13:44 If this is implemented, the mining industry will move. elsewhere. Dennis Porter, the head of the Satoshi Action Fund, which is getting legislation passed at state levels all over the country, says, a 30% tax on miners would be unfair and targeted discrimination. It would effectively kill Bitcoin mining in the U.S. Imagine if we put a 30% tax on internet companies in the 90s. It would have ensured all the jobs and economic growth occurred outside the U.S. Zero X Fubar rights feel so disgusted. This is anti-American authoritarianism. An absurd degree of misguided central planning that will wreck any semblance of functionality in an already

Starting point is 00:14:16 crumbling country. People are free to use electricity however they want. Bob Burnett, the CEO of Barefoot Mining, said maybe not for long. Quote, I've said several times publicly that this is one attack vector on Bitcoin, but everyone, even non-Bitcoiners, needs to fight this tooth and nail. Creating different rates for power consumption based on usage is a massive infringement on privacy, and it sets a precedent for the government to make moral judgments on energy use. If we let this cat out of the bag, everything from your microwave to your hot water heater becomes fair game for a similar tax. Now, there are also other industrial sector implications as well, with the most obvious one being AI. Nick Carter writes, AI, bros, I want you to watch the proof of work debate very

Starting point is 00:14:54 carefully. The playbook they're running to harass Bitcoin miners under the guise of environmentalism. Phony academia, sycophants in the press, and opportunistic politicians. They will run it on you. Are you ready? You think they'll just stop with Bitcoin? Because GPU farms rendering pornographic wifus have so much more social utility? Buckle up. In their upside-down world, all electricity consumers need to ask the state for permission. All resources are zero sum. No matter how many clean or additive your energy sources are, it's all fair game for political attacks. And right on cue, less than like 12 hours from when Nick wrote that, Bloomberg published a piece called Artificial Intelligence is booming. So is its carbon footprint. So bringing it back

Starting point is 00:15:33 to crypto, I thought that this point from Dystopio Breaker was really, really salient and something to leave us with. They write, I'm pretty sure that U.S. regulators don't care about, quote, pushing the industry offshore. Because they don't see it as an industry, they see it as crime and pushing crime offshore is good. I tire of seeing this line of defense because it doesn't work. It presupposes that the regulatory bodies understand what crypto is trying to do or its value proposition. They mostly don't, and that's the problem to solve. Like, imagine making this argument about poker in 2010. No, you're pushing the industry offshore. Yeah? That's the goal. It's bad and we hate it and we don't want it here. The only workable solution I can see is grassroots action,

Starting point is 00:16:08 making it politically unviable to ostracize crypto tech. We're far away from that. And so, my friends, that is where we are this Saturday, reeling from the second biggest bank failure in American history, dealing with the designation of Ethereum as a security, and now a proposed 30% Bitcoin mining tax on top of all of that. Trust me then when I say that I truly, truly hope you are somewhere with your family, touching grass, having fun, and getting prepared for the fights to come. Until tomorrow, be safe and take care of each other. Thanks.

The Breakdown - The Government Game Plan: Call Ether a Security, Tax the Crap Out of Bitcoin Mining

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