Unchained - How Coin Center Is Helping Define The 'Big Fuzzy Gray Area' Of Blockchain And Cryptocurrency Law

Episode Date: October 18, 2016

As blockchains and cryptocurrencies evolve, there are times when the technology outpaces the law. That's when Coin Center steps in. The non-profit, which represents the technology, not the industry, and aims for regulators to keep a mostly hands-off attitude, has already helped shape questions around which types of Bitcoin wallet providers are financial institutions and whether new coins being offered represent securities. And answering these questions has drawn it back into previous cases involving everything from Florida orange groves to Manhattan co-ops to golf club memberships. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Forbes Podcasts. Hi, everyone. Welcome to Unchained, a Forbes podcast produced by fractal recording. I'm your host, Laura Shin, a Forbes contributor covering blockchain, cryptocurrencies, and fintech. Thanks for tuning in. If you've been listening to the show and like what you've been hearing, please review, rate, and subscribe to Unchained on iTunes or wherever you get your podcasts. It helps spread the word about the show. For today's episode, I'm speaking with Jerry Brito and Peter Van Valkenberg,

executive director and research director respectively of coin center a non-profit research and advocacy center focused on the public policy issues facing blockchain and cryptocurrencies. Hi, Jerry and Peter, welcome to the show. Thanks for having us. Hi. Jerry, let's start with you. How did you learn about Bitcoin and blockchain and come to found Coin Center? So I first heard about Bitcoin in February 2011 on a security podcast that I listened to and it sort of hit all the right buttons for me. my whole career I'd spent in technology and policy. And I sort of fell down a rabbit hole. And I was very lucky to be in the right place to the right time.

Somebody working in technology policy in Washington, D.C. at a time where very few people were paying attention to this. And so I began to write about it, began to ask people around town in D.C. on the hill of federal agencies. So you guys thinking about this. And people really weren't. And some who sort of had closer jurisdiction, maybe were short. had to have heard of it and knew they should be paying attention, but they weren't. And so again, I was at the right place at the right time, began to write about it.

I was at the Mercatus Center at George Mason University at the time, and eventually developed something called Bitcoin, a primer for policymakers, which was an introduction to the technology, how it works, why it's important, and what are the regulatory implications. And in 2013, helped the Senate Homeland Security Committee develop the first hearings on Bitcoin, testified at those hearings.

So, again, just really was very lucky. you'd be it to right place in the right time to sort of be the DC guy on this technology. And around the same time, there was, again, increasing interest from government about this technology. Policymakers were beginning to see that, you know, this intersected with consumer protection, with anti-money laundering rules, with tax rules, with commodities and securities rules. And so they were going to be paying attention to this, and they wanted to ask questions about it. But there was nobody, you know, it couldn't pick up the phone and call Bitcoin. And so it sort of became apparent that there needed to be a serious, incredible resource center for not the industry, because we don't represent the industry, but for the technology.

And so myself and some other folks who were very interested in seeing that happen founded Coin Center about two years ago. That's some really interesting distinction you make between the technology and the industry. What do you mean by that? So Coin Center, as you mentioned, is an independent nonprofit. And what that means is that we're not a trade association. So we are more like the Electronic Frontier Foundation, more like the EFF, which represents the rights of users to use the internet for the internet to remain open. And we're less like and probably not like at all the Internet Association, which represents the interests of Google and Facebook. So while the Internet Association and the EFF have lots in common, a lot of the same interests at stake, one represents industry.

and you have corporate members that direct the organization. The other is an independent nonprofit that sets its own agenda and is really looking out for the technology to remain free and open, and that's what we are. We exist to make sure that open blockchain networks remain free and open and that users have a right to use them, and that Tudac Center will be regulation, that that regulation is rational,

and that it is a slight touch as possible. And how do you do that? What does Coin Center do? So, you know, a harder mission is to, make sure that open blockchain networks get the same regulatory treatment that the early internet did. So the early internet boomed and flourished into what we have today in large part because the government policy was one of being completely hands-off and to the extent that it was necessary to regulate for there to be light-touch regulation.

That was the explicit policy of the United States towards the internet and that worked out very well. And so we want to replicate that for open blockchain networks. And we do that really in three ways. We do education, we do public policy research, and we do advocacy. So the education piece is where we spend probably most of our time, especially half over the past two years. And that is simply making sure that regulators, members of Congress, folks in state legislatures at all different levels, have the information that they need about technology. How does it work?

Just basically clear up any misunderstandings about how the technology operates and how. works and we answer those questions what regulations might be affected. And so we do that through backgrounders that we publish that are sort of short just effects, sort of primers on discrete topics of the technology. That's what's all on our website. We do that through one to many briefings, one-on-one briefings, meetings. As we have these conversations, eventually we get to questions where we don't have the answers to those questions.

And that's because there are typically questions of law and policy where the law has outpaid, or I should say the technology has outpaced law, where the technology now allows for things that the law never contemplated. And so there's a gray area. There's a gap. And regular is going to be looking to fill those gaps. And so that's where the second thing that we do comes in, and that's policy research and really what Peter leads at Coin Center.

So there we engage in the policy thinking and develop sort of the policy positions of how should you fill those gaps that regulators will fill. You know, if left to their own devices, they will fill them. But we want to help them by developing thinking that says, here's the gap, here's the issue, here are different alternative ways that you might fill that gap, and here's our preferred route, because it's a route that allows you to regulator to meet your end, but in doing so, you don't do any inadvertent harm, and you do it in the most light touch possible way that preserves of freedom to innovate for innovators.

And then the last thing we do is advocacy, which means lobbying, right? So we lobby on behalf of those preferred policy outcomes. We will testify at hearings, either in Congress or the legislature. We will file regulatory comments sort of advocating for those preferred policy solutions. And just out of curiosity, where do you get your funding? So our funding, about half of our funding, so our budget is about a million dollars a year. We're a staff of five, three of us are attorneys. And about half of our funding comes from individuals, just an individual persons who care very much about this technology.

The other half comes from investors and companies in the space. And among those, we're very happy to have really some of the top people in space, including Andreessen Horowitz and Union Square Ventures and Digital Currency Group, as well as Coinbase, BitPay, BitGo, Zappo, circle, blockchain, that info. I hesitate to begin to list them because I'm afraid I'm going to leave some out, but anybody you can think of. But also some of the near players, including Zcash, the Ethereum Foundation, block stack, you know, basically from across the landscape. Okay. And Peter, how did you learn about Bitcoin and how did you want a Bitcoin Center?

Sure, sure. So I guess it was, I think it was my first year of law school at NYU, and a friend of mine was chatting with me on G-Chat. The two of I were always the dorks back in high school, and he told me about Bitcoin. And what year was that? 2011, yeah, this new electronic currency. And I got real close to setting up a mining node, actually. And inevitably, I think it was probably exam season for first years at law school. And if you know what that's like, that's miserable. So I kind of lost interest. unfortunately, in this mining node, which was one of my bigger regrets going forward. I've always been sort of a self-loathing liberal arts grad who always partially wished that he dropped out and just learned to code. But anyway, focused on technology policy law because of probably that regret and also because the space is really fascinating throughout law school, mostly looking at digital copyright law

and digital privacy. My sort of hero legislation is the Digital Monium Copyright Act, not the anti-circumvention provisions, but specifically the safe harbor for notice and takedown, which makes copyright a little less onerous for intermediaries like Google, and really allow those companies to flourish and make the Internet as useful as it became. And I always think that without those laws, we would have seen probably the migration of a lot of companies away from the U.S. and Silicon Valley would probably not be the thing that we know it all today as this hub for innovation. So I thought I'd be focusing on copyright. And like I said, digital privacy.

It wasn't long after that the Snowden Revelations came out after I graduated from NYU law. And I worked at a think tank in D.C. under a Google Policy Fellowship grant, which is a fantastic program. But again, still working on, say, copyright issues and privacy and keeping Bitcoin in the back of my head, something that I would tinker with and play with and think about and regret not. mining those years earlier until Jerry we share a lot of mutual friends from his time at Mercatus and George Mason Jerry came to me and said hey Peter do you want to be the director of research at a Bitcoin think tank and I think I laughed and I said that's that's ridiculous no such thing exists and nobody in the right mind would do that but then a minutes later of course said absolutely yes where I sign up and that was two years

ago now a little bit more now and we've just been making a go of it. And it's been by far the most exciting legal policy work I think I could have ever imagined, probably more exciting than what I imagined, because copyright and digital privacy are areas that the Internet disrupted existing expectations of what could be enforced. A lot has already happened. A lot's already been written. And in many cases, we're at a sort of stalemate between the need to enforce existing laws and the capabilities of the technology and where we draw the line as to what's possible and what needs to be prohibited. Whereas with Bitcoin, that line is not a line. It's a big, big, fuzzy gray area. And that means there's so much work that I think

we can do to move the needle on the future of permissionless innovation here, as compared to, say, with more traditional internet technologies. And so what has your role been at CoinCenter? Sure. So I'm the director of research, which means a few things. So as Jerry said, our main job, especially in our first year of operation, was education. Somebody at the Treasury, someone in Congress or a staffer, they want to be able to call Bitcoin to ask, you know, hey, what are you doing? There is no CEO of Bitcoin. So Coin Center plays a role where we can help educate them about what the technology is, what people are doing with it. And so for me, that means especially coming out with a series of really plain English explainers that in 2,000

words or less deal with a discrete topic of the technology. So something like how private is it, how anonymous is it? Because, of course, there are these rumors that Bitcoin is this perfect, you know, nebulous, dark network that is perfect for facilitating, you know, drug deals and things like that. As it turns out, of course, Bitcoin is actually surprisingly transparent. And with blockchain forensics, law enforcement can actually get a pretty good picture into what people are doing and how money is moving around in the Bitcoin network. So we have a backrounder that, as I said, is a short piece that's written in non-tech speak. And it's actually written by Adam Ludwin in this particular case. He wrote

our privacy black rounder. I think you had him on your show before. And it just lays out, you know, this is what visibility we actually have into transactions. And it's not nearly as anonymous as it's famed. And we also write some of the backgrounders. I had the luxury of getting to write the backgrounder on mining, which is always sort of the doomsday question when you're talking with a policymaker that say, okay, sure, peer-to-peer money. That sounds great. But what's this mining thing? And there's all kinds of issues there stemming from, in part, the choice of the word mining,

when in reality what they're doing is validating signatures on transaction messages and being rewarded for that. But then you have to say, oh, what does signature validation mean? And, oh, we're going to explain elliptical curves now. So finding a way to explain that, any number of other things in plain English is a big part of my work. But then, as Jerry said, whenever we have conversations with policymakers about what the technology enables, inevitably there comes this point where they say, well, we regulate some of those activities. And we're used to regulating the financial institutions that would have performed those activities for people. What happens when people are performing these activities on their own? How does

the law, which is usually calibrated or written to intersect by regulating intermediaries, how does the law apply to direct personal interaction with a protocol like Bitcoin or Ethereum for that matter? So figuring out the policy thinking that needs to be developed. in order to present, as jury said, the various avenues that regulators might choose, because they're going to choose an avenue. Being able to present those different avenues, what it would look like to regulate in one way versus another, and then also finally advocate for an avenue that we believe would allow the regulator to feel like they've upheld their statutory obligations. They are tasked by Congress to regulate, but still preserve the freedom to innovate. That is an always

an interesting question in this space. So to go back to the Digital Millennium Copyright Act, for example, you had copyright liability that applied to third parties who shared content, basically. So the user uploads a video to YouTube and Google gets in trouble, even though it wasn't Google that uploaded the video. The DMCA was an avenue of enforcing copyright law that still had some fidelity towards the purposes of copyright law. We're still going to enforce some of copyright law here. But we can't do it in a way that presents massive liabilities to Google, so we choose a compromise. We choose the notice and takedown system. You can ask to have a video removed, and if Google has a system for allowing people to ask and complying with those asks and challenging

them when they're frivolous, then we can move forward. With Bitcoin, it's very much the same thing. So multi-sig wallets is a great example. Some of the stuff that say like Ben and Mike at BitGo have worked on. In a multi-sig wallet situation, you have someone who looks almost like a financial institution. You know, there's this wallet product. The customer puts their bitcoins in this online wallet product, right? But for those of us who know the technology, BitGo's wallet and any multi-sig wallet is much more exciting than that.

It's not that you're giving your bitcoins to a company. It's that they've given you a software platform that will allow you to generate these three keys and you the customer can hold two of them and Bitco is just there holding a third key in case anything ever happens to one of your keys. So this is a great situation for say consumer protection in the financial context because BitGo is not a fiduciary custodian in this case. If they were to get hacked or if those guys were to go crazy, which they're not going to, they're awesome guys. But if if something terrible was to happen to Bitco, the consumer still has control over their money. That's an amazing new business model as compared with the normal custodial, you know,

we hold your money for you type model that you see in financial institutions. How does consumer protection regulation apply to a company like that? Should they get a money transmission license? We don't think that that makes sense at all because they're not custodial. They don't have that sort of solvency risk. But how do you write or interpret existing money transmission laws such that BitGo is not included in those existing regulatory rules. With AMX Platinum, you have access to over 1,400 airport lounges worldwide.

So your experience before takeoff is a taste of what's to come. That's the powerful backing of Amex. Conditions apply. Basically, you need to come down to a definition of what it means to actually control Bitcoins on behalf of someone else. And BitGo, as I think many people would agree, and we've made good progress, convincing many policymakers on this point does not have control of your bitcoins. They store one key of three. They are a backup recovery service. They are not a custodian. So coming up with that definition of control, trying to get it into new regulations when they come from the states, say the New York

Bit license or California's AB 1326, trying to make regulators aware of the differences between, say, a multi-sig wallet, a software wallet, and a hosted wallet or a fully custodial wallet, that's where the policy research really comes in, where we try and develop legal language and advocacy materials that will push for, as I said, this way forward where we can still protect consumers, but do it in a way that doesn't jeopardize the vibrancy of the technology and the vibrancy of the American innovative scene. These details are super fascinating, like these kind of, you know, case examples that you're giving. I love that story. And I know Coin Center recently celebrated its two year anniversary, what have been its main accomplishments during that time? And if you have really

specific examples like that, that's great. So, you know, I think you can divide it into two buckets. One maybe is more on the defense, the other one more sort of proactive. And on the defense, again, And it's kind of hard to point 21 thing because it's more about education and making sure that policymakers don't make easy to avoid mistakes. And it's making sure that regulators understand the technology and don't do something stupid. And it's hard to tell stories that don't make a particular policymaker look stupid. But we've had situations where, you know, a member of Congress, will be very concerned about the illicit uses of Bitcoin or other cryptocurrencies.

And they may be thinking of holding a hearing about this. And we're able to go in there and talk to them when they're thinking about that and say, you really don't need to hold a hearing about this because we're happy to answer all your questions. And actually, law enforcement is doing very well going after bad guys here and also this technology is making, you know, consumers much better off. It's something that you would appreciate. And then the hearing doesn't happen. So it's, so a lot of that is what we do is sort of avert things that could otherwise go wrong.

More behind the scenes. It's like the FBI then. You only get noticed for your failures, never for your successes. That's right. That's right. On that friend or something we have done is we helped found something called the Blockchain Alliance, which is a public-private forum between law enforcement and many of the companies in the industry as well as academics and nonprofits like Coin Center.

Yeah, Jason and Ellen were on the show. Yeah, great. And so you know what it does is very simple. It's just sort of a clearinghouse where law enforcement has questions about the technology or where we send a subpoena, they have a clearinghouse of being able to talk to exchanges and others in the industry who might be able to answer those questions. And it's also very good because it does a couple things. It provides a clearinghouse service.

Number two, it helps law enforcement understand the limits of what they can expect the industry and ecosystem to do because there's some questions that an exchange, can't answer because they don't have the information. And so making sure law enforcement understand the limits of what they can expect and ask is, I think, valuable to everybody. At the same time, these are small startups that are sometimes being overwhelmed by law enforcement requests. And to the extent you can streamline those, but also helps the small startups.

You know, I think on the more proactive side, it's a lot of the work that Peter was just talking about, which is developing the policy. policy thinking that hopefully will become the policy that's adopted. So give you some examples with that. Peter is talking about definition of control, which is very important because those companies that have control of consumer funds are likely going to be subject to regulation. They're going to subject to licensing, subject to anti-money laundering regulations, et cetera, et cetera.

But those who do not have control should be completely outside of that. So defining control is very important to make sure that we exclude multisic providers, we exclude miners, that we exclude nodes on the Lightning Network, that we exclude software wallets. It should all be excluded. And so I'm very happy to say that we've developed good policy thinking, good language about what that definition is, and it is one that now, I think, is largest. It's becoming sort of the consensus definition.

For example, the Uniform Law Commission, it is in its current draft of its national uniform act for digital currencies. We hope that will pass next year. So that's very important to us. And what does that give me more details? So basically, as you know, each state has its own money transmission licensing regime. So for example, the New York BIT license was probably the first one, but each state has its own. And what that, the problem there is, is that today you have dozens of states individually coming up with their own regime of how they're going to regulate Bitcoin or other digital currencies or other. And specifically regulate the businesses that hold other people's Bitcoin for them.

It's one of the things. A lot of people think, oh, California is going to regulate Bitcoin as if they're going to regulate the whole thing. And this is, in some ways, what we're trying to do is make sure they only regulate custodial companies. But that's not us usually fighting a regulator. It's helping them understand there are some companies that hold other people's Bitcoins. They're basically like a bank or a money transmitter, and there are some that are not.

They're doing something like mining. They might just be a person in their basement running a full node that relays transactions. Does that person transmit money? No, they're transmitting Bitcoin transaction messages. But that's by no means a clear or obvious distinction to someone who doesn't understand the technology. And that's an important point because I think a lot of people think that we, Coin Center, is pushing for regulation. We want to see Bitcoin regulator. We want to see these companies regulated.

And that's not the case. We think about it this way. If we say nothing, regulators will regulate. And that regulation that they develop will encompass, not just the custodial companies, but it will encompass potentially the miners and the lightning nodes. And this person in their home who has a node that they're running in. It's going to encompass all these people. So the alternative to that is that, yes, we advocate for regulation,

because it will be regulation, that is much more limited. and limited to only those people who really should be regulated because they are holding customer funds and posing a risk. So that said, you have to do that state by state because each state is developing its own law. And that's very cumbersome and wieldy. And then you can imagine being a company that needs to get 50 licenses. It's very expensive, time-consuming.

And each state's going to have a different law. It's a little bit different. So the Uniform Law Commission is a national body of mostly academics. and some regulators. And they develop uniform laws. For example, uniform commercial code, which governs contracts, which is adopted by just about every state and country, comes from the ULC.

The ULC develops uniform laws, that then the states are free to adopt. And today they're developing a uniform digital currency act. Uniform regulation of digital currency businesses act. It's a great, I don't even know what the abbreviation for that would be. It's ugly. So we... So our definition of control has been influential there.

And then same thing in security space. Our thinking on securities regulation of cryptocurrency issuance, I think has been very influential. Yeah, can you talk about that a little bit more? Because I know that this summer there were a number of blog posts that VCs are writing. and we are seeing some buzz about these new networks that are offering what people are sometimes calling app coins. Right. Where, you know, you need their token to operate on their network, whether it's, you know, some kind of decentralized Dropbox service they have or like a decentralized Reddit or whatever it might be. There have been other guests that have spoken about this trend.

And so, you know, what is it that you are seeing from the regulators in terms of their attitude toward these? So the question there has always been, is Bitcoin a security? Is Ethereum or Ether a security? You know, when is a token, a coin, a security? And then if it's a security, well, who is the issuer, who is the promoter? Did they register with the SEC? Did they follow the rules? And, you know, for us, we'd seen many different enforcement action from the SEC over the years,

but they've sort of been sort of tangential to Bitcoin and other digital currencies, because they've been enforcement actions where you had a clear Ponzi scheme, something like Bitcoin Savings and Trust, where the guy promised, you know, outsides returns, and he was just paying new customers with old customer money, right? Or old customers with new customer money, I should say. You would be a bad ponzi. You would be a bad point. But it just so happened that the payment system there was Bitcoin.

He could have been using dollars. He could have been using bananas. It just so happened that it was Bitcoin. And then when the SEC enforced against a typical policy scheme, Bitcoin is in the headline. And the SEC had to say something like investments made using Bitcoin are still investments under our test for securities. But that's a fairly obvious thing. You're not going to suggest that people never invest Bitcoins in things. Of course they do.

What we saw, though, and this is a very obvious. probably two, you know, a year and a half ago. What we saw, though, is that there would soon come a case. There would soon come a time when the SEC would have to bring an enforcement action against a Ponzi scheme of some kind where the security in question was, in fact, a cryptocurrency. And what very much looked like that was a case called Paycoin. And the SEC is presently investigating Paycoin. And Paycoin was an open cryptocurrency.

cryptocurrency network with mining. It was a... Staking. Staking. I keep saying, my AP keeps correcting me. It's proof of stake, not proof of work, but it is an open source code repository that was forked from pure coin, which was forked from light coin, forked from Bitcoin. Just as so many other alt coins have been forked and developed, many of them totally not scams, very interesting projects. Ethereum probably being one of the most interesting and certainly most well adopted second to Bitcoin right now. And so, you know, when SEC, they're investigating now, they probably will charge the folks who issued pay coin and promised the people who were buying pay coin from them that Amazon would soon integrate pay coin.

They were promising that their company would always pay a floor of $20 for these tokens. So people bought them with an expectation of profit given the promotion that they had done. and then these people made the money and ran away, Paycoin collapsed. At some point, something like that, the SEC is going to say, this is a security. And so the question would be, for us, was going to always be,

when the SEC says that paycoins a security, are they going to simply say pay coins to security, or are they going to say cryptocurrencies are securities, which would be bad, because something like Bitcoin really should not be considered. And even if they said pay coins of security, and left it at that, it would leave open the question, okay, well, but that was a cryptocurrency. So what differed about Paycoin versus, say, Bitcoin or Ethereum or Steam or any of the other

tokens out there? What differed between Paycoin and those other tokens that made Paycoin a security and these other things not a security? And if nothing differed or if they're silent on the matter of what differed, then we're all in a sort of, again, a big legal gray area, which is unsettling for entrepreneurs in this space, I think. So you think, well, I think, well, I'm a, in a sort of, in a sort of, I have this great idea for this app token that'll power a decentralized platform that'll allow people to come together online and agree on something like the best posts on a Reddit like thing or something like that. But maybe I don't want to do this because I don't want the SEC knocking in my door for failing to register as offering a security. And that's quite reasonable because

actually the penalties for failing to register as offering a security and issuing it nonetheless are very strong. They're very, you know, they're calibrated to stop that behavior at any cost, basically. And so the question is, I think, one of competitiveness, and it is a question about U.S. law specifically. Coin Center aspires to be fairly global in scope, but our expertise is very much with U.S. laws. But in the securities context, that's actually probably the right focus anyway. International securities laws generally are drafted in a way that's much more circumscribed, where the securities regulator has the power to basically come in and enumerate through rulemaking of sorts, what things are securities and what things are not. In the U.S., there's no such rulemaking

and enumeration. There's a flexible test, which was actually set by the federal courts, for what kinds of innumerable scams, and that's actually a quote from the Howey case, will be the sort of scams that we regulate as securities. And this four-part test, which I won't go into the specific of, can be applied flexibly. It can be applied to cover any different type of offering, and potentially something like Paycoin would fit very well into that test. Well, can you actually go into the specifics? Because as far as I can understand, I think that's going to explain replay. We'll geek out. It'll be good.

So the Howie test has four parts. It's an investment of money in a common enterprise with the expectation of profits, dependent or reliant on the efforts of a third party promoter. Investment, common enterprise, expectation of profits, third party. party promoter. And if you meet these, then you are a security, you're issuing a security, in which case all these regulations apply. Right, right, right. So you can see how this is an open test, and actually the case where that test was formed was a case about an Orange Grove. So it's the Howie test. And the guy in question in this case was W.J. Howie, who owned an Orange Grove

in Florida. He would invite rich New Englanders to come vacation, winter in Florida, stay at the hotel near the Orange Grove. He tore the Orange Grove with them, and the New Englander would say something like, oh, the Orange Groves, they're so beautiful. And then W.J. Howie would say, well, it's funny, you should say that. The groves are for sale. And then they basically negotiate a deal where the New Englander would buy us, I'm a New Englander. I'm sorry, I'm making New Englander sound like suckers,

but the New Englander would buy a small track of the grove. So he's partitioning this multi-acre orange grove into little pieces, and you would own this land. You'd have a deed to it. it basically. But you'd also sign a contract with W.J. Howie, where he would maintain the trees, pick the fruit, take the fruit to market, sell it, get a good price, and give you the profits from your piece of the orange grove. And what the Supreme Court said in the Howey test was this is not a real estate deal. This is not people buying land in Florida because they want to

live on it or develop it themselves. They're buying, they're investing their money in this common enterprise of growing oranges. They're expecting profits because they expect the grove to be profitable, and they're relying on W.J. Howie to make this grove profitable. This is a security. This is the thing we're supposed to regulate. It doesn't matter that there's no stock certificate or formal or the formalities of offering a share. It doesn't matter that all you have is what they say, what they call on the case, a nominal interest in the assets of the enterprise. So I'm, I'm I know I just seem to just talk about oranges for the last two minutes, and this sounds crazy. It's just like pay coin.

It's just like pay coin. It's not like Bitcoin. It's not like Bitcoin. And so our framework basically goes in and looks. Just to say what our framework is. You're asking about what sort of things we do, certain things we're accomplished. So seeing that this was going to come, we develop a framework. This is part, and it's not available on our website.

Our money transmission framework is there. Our securities framework is there where we lay out to how we test. and we say this is how it applies to pure coin. Here's how it applies to Bitcoin. These are different things. And also now it becomes very useful for people who are building app coin-based application. So go ahead. Right, right, right.

Actually, let's talk about how it's not why Bitcoin is not. Exactly, exactly. So it's easiest to start with why Bitcoin is. So because we can look at the Howie case, I'm selling off, you know, pieces of land that will grow fruit. And I'm giving, and you're getting at the profits from that. This is a profitable deal where you own a nominal interest in the assets of the shared enterprise. So pay coin, Josh Garza, the guy who is the serial scam artist actually, he had previous schemes before this, who created Paycoin, is selling tokens from a decentralized, well, an open source at least cryptocurrency. You're buying nominal interests to the assets of this cryptocurrency as a common enterprise.

and who are you relying on when you expect profits from pay coin? You're relying on the guy who, as Jerry said, promised Amazon integration, said, Amazon, Amazon's not interested. We are working on a deal with Amazon. Amazon's not going to use Bitcoin. You're going to buy all your Amazon goods with Paycoin. You'll be able to buy anything you want. And you're going to rely on the guy who promised that in two months after the pre-sales over,

we'll re-buy buy these paycoins from you at $20 because they'll probably be worth more than that, but we want you to know that there's always a guaranteed minimum value. You're relying on this guy, who's the only guy developing this software, I mean, it's a fork of peer coin. So you go to the GitHub repository, you fork it, you put your brand on it. He changed like a couple lines of code, honestly. And there were some really sketchy stuff in there, too. So as I said, it's a proof of stake cryptocurrency where there's no mining. You stake some of your value to take part in the consensus mechanism, to do the transaction validation. and to get rewarded.

There were some staking nodes that were specifically identified in the code that earned supernatural returns. So basically we have to ask ourselves, well, who are those special stakers? Of course, they were also the pay coin developers. So everyone thinks this is just a very fair deal, very open technology.

Really what this is, is a common enterprise led by one scammie dude, taking in investment, giving out nominal interest to the assets of the common enterprise, Josh Garza is W.J. Howie of the 21st century. Or maybe he's Charles Ponzi, actually, because the cloud mining operation he had set up before that, as I said, he's a serial scam artist, was an empty warehouse where he claimed to be giving you access to a Bitcoin mining rig. But as Jerry was saying, he was really just paying old investors with new investors money.

So the SEC is looking at Garza and has actually charged him for basically. perpetrating a Ponzi scheme in this cloud mining operation, they're going to turn to the next thing he did, which is pay coin, and they are looking into that now. So how is Bitcoin different? So how is Bitcoin different? How can they say Paycoin, selling these paycoins is a security, but selling Bitcoins isn't a security? And there are a number of things here.

So we go through the prongs. Was there an investment of money? Well, people do invest their money in Bitcoin. You need to meet all the prongs, though. So if that one's meant, we're not doomed yet. Common enterprise. With Bitcoin, this is a really difficult thing to actually get your head around. Bitcoin isn't really a common enterprise in the way that a going concern or a corporation is a common enterprise. Bitcoin's like an industry. There are all of these unaffiliated individuals, unaffiliated developers, unaffiliated corporations and companies working loosely together on the Bitcoin project, very much like there are many people in the gold industry.

Some of them are mining it out of the ground. Some of them are making jewelry out of it. Some of them are finding industrial uses for gold. So this isn't a common enterprise because it would be absurd to call the gold industry a common enterprise. If I buy a gold ring or a piece of gold bullion, I'm not relying on any particular company in that space to back up the value of my purchase or to make profits from that purchase. I'm relying on an industry. And we don't regulate the entire gold industry as the issue of the security. So Bitcoin looks more like a commodity in that sense than a security, whereas Paycoin, we really were relying on one corporation, on one going concern. So that's one of the main reasons Bitcoin doesn't fit. Another useful question, though, is say, why doesn't Ethereum fit?

Why doesn't an app token for a decentralized Reddit? Why doesn't that fit? Because maybe there's fewer people working on this thing. Maybe it is a bit more, you know, cohesive or coordinated and not quite. is distributed, what saves those things that are not scams and are really cool innovations from being classified as securities. We get into this in our framework as well. And the logic for why those things aren't securities, aren't good fits for securities under the Howey test and the associated case law is kind of interesting. It comes from lines of cases about condominium

sales and about golf courses. So just those two points, just to go into them. There's a history, especially inside New York City, of selling co-op shares in real estate, and people buy them to live in the apartment building. They don't buy them because they expect to profit wildly from owning a share of this real estate development. And the building's already built, so it's not really a speculative investment. It's something you could do just to live in it or rent it out. In a number of cases, the federal courts have said that those are not securities, owning those shares. Even if they appreciate it in value, even if you buy them as a speculative intent in the money,

You buy them because you could use it, because you could live there. It is an actual, it's got utilitarian value. Of course, if you buy the apartment in the giant tower in New York City right now that has 10 foot by 10 foot windows and is taller than the Empire State Building, you probably are expecting that it's going to be a good investment, although it might be overinflated actually, probably, I think. Who knows? But the bottom line is there's a utilitarian value to that thing, and that in a line of cases has saved those offerings from being concerned. considered securities. You can think of this in the case of Kickstarter as well, where people will give money to get a GIGA, like a Pebble smartwatch, which I'm wearing right now, actually,

and I love, go pebble. That's not a security because basically you're giving your money in order to get the useful thing. I have this watch. That's what I want. So something like Ethereum is useful. You actually need Ether in order to run smart contracts. There's a lot of buzz about smart contracts, but there are some fundamentals there that are very real. the programmatic algorithmic control of money to do cool things, to automatically pay people for providing valuable computing resources, to automatically pay people dependent on the results of some sort of smart contract that measures, I don't know, whether it's raining in Peoria or not,

those are really cool applications. And the only way you can build an open, decentralized platform for powering smart contracts is by having a scarce token that rewards people for giving their computing power to that shared network as a resource. So you need Ether to do that. And you need Ether to run smart contracts. Just as you need a home to live in it, you might buy a home also for its speculative value. You need Ether to use it for smart contracts.

And you might buy it also for its speculative value, saved from being a security if we use the same condominium case law as an analogy for the Ethereum space. Ether is referred to as gas. And in many ways, it's the same thing. You buy gasoline to power a car. You can also stockpile gasoline, the expectation that it's... going to go up in price. Exactly. Exactly.

So the other line of cases is golf courses, and I'll try to be brief with that one. The golf course country club cases talk about when you sell an interest in the thing, whether you sell it before you've built the thing or after you've built the thing. So this is why this is relevant. You're probably already thinking about pre-sales of app tokens, basically, which there have been many of. In the history of golf course development, something our possible future president knows a lot about and might have been sued actually for it should be interesting but anyway lots of people would

decide to sell memberships to the country club before the country club was built they're like get in the ground floor and the new links in Scotland it's going to be worth a lot in the future those offerings were treated as securities by the federal courts in other cases where the golf course is already built and memberships are being sold those offerings were not treated as securities more like the Cool. This leads us to something, so for example, Steam, which is an app token that creates a decentralized Reddit, did not do a preset. That's very good, at least in my opinion, for an appraisal of whether Steam is a security. Steam's also useful. So some of the same arguments we discussed in the Ethereum context are there. Steam's also decentralized. Other people can run and develop Steam clients. It's not just one company. But a big thing about Steam's initial token, um, discerally, um, distribution is that there was no pre-sale. So it's kind of like these golf course cases. We're not saying, hey, buy these golf course memberships or these memberships to the future decentralized Reddit, and then we'll build it and it will be awesome. We're saying, hey, you want to get access to be able

to vote up content or vote down content? Here's an access token. It's a membership to use a thing, not a speculative investment in a thing. Right. That's very interesting that this team got that part, right? I know there's some talk in the community that they didn't get us. other aspects, right? Because I think the distribution of the tokens maybe is a little bit less than ideal at the moment. But that's... Well, but you've raised an interesting point. And you're not talking about securities law when you talk about it. You're talking about, which is very cool, you're talking about community norms. One of the amazing things, though, about these community norms is that they actually jive pretty well with the Howie test, as if there's really nothing

new under the sun. Scams look like scams and non-scams don't look like scams. And communities have always evolved to try and ferret out the scams by having norms, like, like, hey, you should do your distribution this way. Hey, you shouldn't take money from people without some sort of obvious basis for the value of your thing until it's on the table. And security laws evolved in this context as well. And it's kind of cool to think that even when we move into the world of crypto finance or whatever scary term you want to label it, we still have the same community norms evolving, people criticizing other people for offering things that they don't think are right. But we also might have the same legal flexibility and the same legal tests that would still be just as applicable, like the Howie test.

associated case law. You mentioned the upcoming election and you know, you guys have been in the space in the last two years. And, you know, this summer we saw proposal to have a pro-national Bitcoin policy. The SEC is going to have this fintech form where they talk about blockchain technology. You know, just briefly in a couple lines, how would you say the attitude of policymakers and legislators have changed and what might we expect the impact to be from the election? So the heartening thing, you know, sort of working in this in earnest for two years and even for a few years before that, has always been that policymakers, especially in Congress, especially at the higher policymaking levels in the administration, are very open and receptive to this technology. And they're open to innovation and they want to see a flourish in the United States. It's important to them.

So it's always been very positive, right? the concern about illicit uses and the more, and the closer you get down to the lower levels within particular agencies that have jurisdiction, either with anti-money laundering or with securities, they're going to have more and more concerns, but it's concerns that you can address. So that's generally been the attitude. The elections are going to have, it's going to be interesting, right? So I know that Hillary Clinton's transition team, in a technology paper did mention blockchain technology broadly. And so I think there's just a general positive attitude there.

Donald Trump has not really said much about this. So it's sort of a question mark there. But Republicans often are more free market in orientation. And so you can imagine they might be sort of receptive to a light-touch approach. I think what's going to be more interesting is how Congress ends up and how the balance of power is. Because right now nothing is happening in Washington. Nothing is getting through Congress. And so to the extent you want to have a national policy that's favorable to cryptocurrencies,

you need things like a safe harbor for non-custodial uses of these technologies, right? That says to the states, you shall not permission, you shall not require a license. from those firms that are not to not pose risks. That's something we'd like to see come out of Congress. Like the multi-sig companies we were talking about earlier, for example, but also minors and any number of other people. Yeah, and so we hope we end up with a sort of arrangement between the House, the Senate, and the White House

that can work together to pass pro-innovation policy. Great. Well, where can people learn more about CoinCenter and get in touch with you? So if you visit coincenter.org, you'll see everything you need there. We have a newsletter that's weekly that you can subscribe to. And we are also, as I say, a small nonprofit. So you can also support us by donating the website as well. Okay, great. Well, thanks to both of you for coming on the show.

Our pleasure. Thanks for having us. Thanks for joining us today. If you're interested in learning more about Jerry and Peter and Coin Center, check out the show notes, which are available on my Forbes page, Forbes.com slash sites slash Laura Shin. And if you've been enjoying the podcast, please remember to review, rate, and subscribe to it in iTunes or your preferred platform. Thanks again for listening.