Unchained - The US vs. Crypto: Jake Chervinsky on Crypto's Legal and Regulatory Status - Ep. 635

Starting point is 00:00:00 If we accept the government's premise that the developer of a piece of software that they then put out into the world to be used by any person for any means, including potentially for illicit means, is liable for that future use, even if that future use is unanticipated and even if they are not personally involved in that future use, I think that means that basically all open source software developers around the world are subject to liability for all sorts of crimes that they cannot anticipate. Hi, everyone. Welcome to Unchained, your no-hype resource for all things Crypto. I'm your host, Laura Shin, author of The Cryptopians. I started covering crypto eight years ago and as a senior editor of Forbes was the first Metrameter partner to cover cryptocurrency full-time. This is the April 23rd, 2024 episode of Unchained. Pocodot is the original and leading layer zero blockchain with over 2,000-plus developers. And the Pocodot 2.0 upgrade will be a massive accelerator for the ecosystem. making it faster, more secure, and adaptable. Perfect for GameFi and Defy to build, grow, and scale. Join the community at pocadot.com network slash ecosystem slash community. Betmoot activated. The scorebed app here with trusted stats in real-time sports news.

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Starting point is 00:02:56 Today's topic is the state of crypto regulation. Here to discuss is Jake Trevinsky, chief legal officer of variant. Welcome, Jake. Hey, Laura, thanks for having me. There is a ton of legal and regulatory issues that are happening in crypto right now, from the Uniswap Wells notice to the Coinbase case, to the tornado cash case. And we'll be diving into a number of these specifically. But before we do that, you've reached out to me to do this episode.

Starting point is 00:03:24 Why is that? Why is this a significant time in the ongoing story of crypto regulation and policy? Well, it's like you said, Laura, there's just so much going on all at once. And I felt like now was a good time to cover all the most recent developments and also talk about what's going to happen next. And you know, it's been a while since I've last been on the show. And I have a new job since since the last time we spoke. I was previously head of policy at the Blockchain Association. And now I'm chief legal officer at Variant, which is an early stage venture. capital firm investing in crypto companies. And so I've seen over the last few months what founders are dealing with day to day and what's blocking them from getting to build the technology and the products and services that they really want to launch in the world. And it's given me a new perspective on sort of how important these legal and regulatory and policy issues are. So I thought now is a great opportunity for us to catch up and go over what's going on now. All right. Well, let's start with a tornado cash case. This is one that the industry seems to view.

Starting point is 00:04:24 as a bit more existential to crypto because the government, in this case, the Department of Justice and the FBI, has gone after open source developers. And we know from the fact that the government has done something unprecedented, which is sanctioning the tornado cash software, that it seems to view the fact that North Korea has been using tornado cash as a circumstance that requires extraordinary measures. So what would you say is at stake in this case? Yeah, well, in the case, I think what's at stake is the right of software developers to build and launch open source software without being held liable for how third parties use that software in the future. And, you know, of course, it is extraordinarily important that the government is able to root out bad actors anywhere in the financial system, including in crypto. But the problem with this case is the government has alleged that the developers of Tornado Cash are liable for how the Lazarus Group, and other bad actors use that software, even though the developers made that software immutable by putting it on a public blockchain and giving up any ability to make any changes to that software.

Starting point is 00:05:36 And in that environment, there is no justification for the government to say that software developers should be liable for third-party misuse of the tools that they created. And I think we wouldn't be having this argument if we weren't talking about the context of crypto. In the traditional context, the creator of a neutral tool that can be used for good or for bad isn't held liable when other people use that tool for some illicit purpose. And I think the government is really treating crypto dissimilarly from everything else just because crypto is unpopular and is viewed as having some type of risk that other types of tools may not have. But that's not a justification to imprison software developers merely because they decided to release

Starting point is 00:06:21 least a tool that could be used by some third party. And so it's very important, and I was very proud to co-write an amicus brief with Amanda Tuminelli at the Defi Education Fund, explaining why it is inappropriate to apply both sanctions laws and also to charge a software developer with conspiracy to commit money laundering just because of how some third party used the tool that they developed. So in this case, as you mentioned, the government alleges that Roman Storm and Roman Seminoff, who are some of the tornado cash developers, created the software and the user interface that enabled North Korea to launder

Starting point is 00:06:57 up to $1 billion worth of stolen crypto. And they charged the two with first, conspiracy to operate an unlicensed money services business, two, conspiracy to commit money laundering, and three, conspiracy to violate the International Emergency Economic Powers Act, which means that they violated sanctions. So can you explain a little bit what the standard is for the government to prove these conspiracy charges,

Starting point is 00:07:20 beyond a reasonable doubt? Yeah, sure. And I'll take that in the context of the sanctions charge and also the money laundering charge, since those are the two issues that we wrote about at the Defi Education Fund. And there are a couple of things that are required for both of those charges. First, the government has to demonstrate mens rea, which is the legal term for criminal intent. In other words, that the developers of tornado cash intended that this software be used in some illicit way. And in order to do that, the government in the indictment fundamentally misrepresents

Starting point is 00:07:55 how the technology works. The government describes Tornado Cash as a service that is being offered by the developers of the protocol. And to do that, they combine all these different elements of the technology. They combine the immutable smart contract protocol, which is the actual technology that was used by bad actors like the Lazarus Group in North Korea, with other parts of the ecosystem, including the torn governance token and the relayer registry and the user interface. And we could spend a lot of time going into what each of those elements actually does. But the important point here is that the Tornado Cash developers did not have any role in operating the actual smart contract protocol that bad actors used.

Starting point is 00:08:38 So they had no intent with respect to any of those transactions. In addition, on the sanctions side, the government should have to prove some direct or active engagement between the tornado cash developers and those bad actors who are sanctioned parties. And in every case that we saw, and we look through dozens and dozens and dozens of cases in which the government had made similar allegations of sanctions violations. Every single case involved some active or direct engagement between the defendant and the sanctioned party. There is no allegation in this case that the tornado cash developers had any direct interaction

Starting point is 00:09:15 with North Korea or any other sanction party, only that they became aware that some sanctioned parties had been using the tool that they created. And in our view, that is not sufficient to sustain a conviction for sanctions violations. Similarly, on the money laundering side, the government should have to prove as a matter of law that the defendants agreed to conduct a transaction, which was money laundering. In other words, a transaction that was made for the purpose of concealing the source or nature of some ill-gotten gains. And again, in this case, the Tornado Cash developers didn't conduct transactions merely because they launched an immutable, neutral tool that other people could use even without their ongoing involvement at all.

Starting point is 00:10:01 So the government did not allege sufficiently that the defendants actually facilitated any transactions that could constitute money laundering. And so that's why, in our view, the indictment should be dismissed. So now let's Talk about the government's shaping, I guess, of the situation. In their complaint, they gave evidence that the developers were in charge of the user interface from August 2019 to May 2020. They also talk about how the developers made payments to host the Tornado Cash website, as well as payments to a provider that enabled it to handle large amounts of traffic. It talked about how the founders received large portions of the TORN allocation,

Starting point is 00:10:44 8% each and ways that the staking on tornado cash was designed to increase the value of torn. And then the government also highlighted certain conversations that the developers had, such as one in which one of the developers wondered whether they should implement, know your customer features in a tornado cache, or discussions around what they should or should not say in order to not get the impression that they had any control over tornado cash. So when you look at these facts, you know, especially I think the one where they were in charge of the user interface for a period, those things I do think, and this is just my opinion, are sort of feathers in the cap in the government's case. So how do you look at those facts, you know, in this case? And what do you think the defense's best defense arguments are? Absolutely. And, you know, I'll start by saying my analysis of this issue is solely based on this. the allegations in the indictment. So I'm not trying to give an opinion about whether or not these

Starting point is 00:11:45 developers ultimately should or will be convicted. But when the government indicts someone, in other words, when they charge someone with a criminal offense, it is their burden to explain in the indictment all of the facts necessary in order to show that there is criminal liability. And all of the facts that you just outlined, to me, are circumstantial, but do not get to the heart of the charges that the government alleges. They do not establish. any direct active engagement between the developers and any sanctioned party for sanctions purposes. And they do not establish that the defendants, the developers, conducted any transaction or agreed or attempted to conduct any transaction that could support a conspiracy to commit

Starting point is 00:12:27 money laundering. And as you said, yes, they did operate the user interface and they were involved in torn governance and they did profit in some way from having torn tokens according to the indictment. But none of those allegations established criminal liability because there's no allegation that, for example, the Lazarus group used their user interface. Now, if there was that allegation, that would establish potentially an active and direct connection between the developers and a sanction party, or it might establish, you know, some of those chats that you mentioned, which again sort of look bad from a 30,000 foot view. None of them are direct statements between the developers and a sanction party. If some of them were,

Starting point is 00:13:07 if there were emails between the developers and some sanctioned party, right, a hacker in North Korea, helping the hacker figure out how to use tornado cash to launder the proceeds of some other hack, that would be a totally different story. But the indictment just doesn't have those allegations. Instead, when I read the indictment, what I see is a government that is deeply suspicious of a financial system that they cannot surveil and cannot control. But just like they can't control the immutable smart contracts, that make up tornado cash, neither could the developers. There was no way for the developers to put compliance into tornado cash after those smart contracts were immutable. And so holding them liable for failing to do something that is literally impossible as a technical matter, I think is deeply

Starting point is 00:13:53 inappropriate. So what are the next steps? I believe there was a motion to dismiss and the DOJ will respond to that soon. Talk a little bit about what is going to happen and kind of which milestones you're going to be watching for. Absolutely. So as you said, there is a pending motion to dismiss the indictment. That's the motion that we at the Defi Education Fund filed an amicus brief in support of. The government will respond. There may be an oral argument, which I believe is set for June. The court will then rule on the motion to dismiss the indictment. I'll be honest, it's a very difficult standard to meet in order to get an indictment dismissed. So although we certainly think that the court should take the motion very seriously. I think it's likely that the case will move forward beyond

Starting point is 00:14:40 the motion to dismiss stage. What that means is that there will be discovery. So the defendants will be able to ask the government for information. Similarly, the government will be able to continue asking and collecting more information from the defendants. And then eventually there would be pretrial motions and a trial. That's a pretty far ways out. So that could be at the end of this year, these cases also tend to get delayed somewhat by discovery disputes and other pre-trial motions that need to be resolved. So we could be looking at next year before there's a trial. And of course, there's always the chance that the government will decide to walk away from the case. I think that's rather unlikely or that the defendants will decide to change their plea of not guilty to guilty and accept a plea

Starting point is 00:15:24 as some other defendants in the crypto context have decided to do. So this is definitely one that we'll be watching, I assume, for the rest of this year at least. You know, if this were to go in a direction that's bad for crypto, what would the ramifications be for beyond tornado cash? Could it affect the rest of defy or? I think that there's an impact for the entire crypto industry, but not only the crypto industry, because the theories of criminal liability that the government puts forward in this indictment are not specific to digital assets. really, they affect every software developer working on open source software. If we accept the government's premise that the developer of a piece of software that they then put out into the world to be used by any person for any means, including potentially for illicit means, is liable for that future use, even if that future use is unanticipated, and even if they are not personally involved in that future use, I think that means that basically all open source software developers around the world are subject to lie,

Starting point is 00:16:28 for all sorts of crimes that they cannot anticipate. And that, in a sense, spells doom for the open source movement. This would be like saying that the Linux Foundation and the Linux developers are liable for Iran using Linux to operate its missile program or its attack on Israel. And of course, that I think is a preposterous concept. And that's why I think the government cannot move forward on this theory of liability. All right. So let's circle back to Tornado Cash in a moment, but let's first also now talk about the $62.5 million hack on Munchables on the blast chain by a North Korean deaf who managed to get hired onto the Munchables team. And this was just the latest in a string of incidents over the last few years in which

Starting point is 00:17:14 the North Koreans obtained crypto from DFI. And the proceeds of those exploits are believed to fund the regime's nuclear program. You know, in light of the hack, the blast in Munchables community was trying to to figure out what to do. Some of, you know, the people in the community advocated for a rollback of the blast chain. Eventually, some crypto community members such as Zach XBT were able to negotiate with the dev and get them to return the money. I'm sure regulators and lawmakers were watching this incident. It was very riveting on crypto Twitter. What do you think the takeaway was of, you know, these regulators and lawmakers in terms of their views on how crypto-neutral

Starting point is 00:17:57 needs to be regulated? It's a great question, and I was following this very closely like everyone else was, and I don't have any information about exactly what happened beyond what's been publicly reported. And I think we still don't have a full picture of exactly who this developer was, how the money was returned, and what the negotiations looked like. But I think to answer your question from the outside looking in, I think there are a couple of lessons here. One is about the critical importance of improving cybersecurity standards in crypto. You know, when regulators and policymakers look at the potential for bad actors like the Lazarus Group to abuse the crypto ecosystem, they're looking at it on sort of two sides of the potential illicit transaction. On the one hand,

Starting point is 00:18:43 they look at stopping these bad actors from getting access to funds in the first place. And that's a cybersecurity issue, right? That requires the industry to develop best practices for how to make sure that these types of protocols are not vulnerable to attack. And then on the other side of the transaction, let's assume that there is going to be a hack of some type of protocol like this, because ultimately it's impossible to stop in every case. Policymakers then look at denying the bad actor the benefit of using those funds. And here I think we have a great example of the industry coming together

Starting point is 00:19:18 and figuring out how to stop North Korea from being able to expulrate these assets, from Blast into some other type of protocol where they could then use those funds in order to, you know, benefit from the hack. And, you know, there, I think we have to ask these very tough questions about what the responsibility is of a team that has a centralized sequencer like Blast does. And that really was the heart of the dispute or the conversation, you know, overnight on Twitter about whether the chain would be rolled back or whether there would be some other, you know, state change that would resolve this issue or whether the team behind blast would just let the transactions continue in what would otherwise be a decentralized fashion. And I think what we see is

Starting point is 00:20:05 where there is centralization, there is some obligation, not necessarily legal or mandated by policy, but frankly a moral obligation to ensure that bad actors are not able to abuse this ecosystem. And I think there's a really interesting philosophical debate that we can have about centralization versus decentralization. Obviously, the reason that many of us are here in the first place is to build neutral and permissionless systems that anyone can use, including bad actors. But when it comes to North Korea, a brutal dictatorship that is committing extraordinary human rights abuses, trying to build nuclear weapons, I don't think there's much room for us to debate whether or not we should be denying those people the benefit of the ecosystem that we've developed. So I think in this case, it was a pretty clear

Starting point is 00:20:53 answer as to what to do. So obviously, this is such a thorny situation, you know, as you just mentioned, it's quite serious if a regime like North Korea is able to steal billions of dollars of crypto. And yet at the same time, you know, as the industry talks about, our country has certain principles around free speech, around privacy as a right. You know, many people in the world of crypto believe in a decentralized world of finance that creates more access to financial services and helps level the playing field democratizing finance. So given these different competing objectives, what do you think is the best way for crypto to approach defy, you know, keeping in mind the risks of an actor like North Korea, you know, getting its hands on illicit

Starting point is 00:21:48 crypto? Yeah. Well, I think there's a couple of things that we have to consider. I think first of all, do absolutely believe and frankly have been motivated deeply to work in the space by the idea that the financial system, as it exists today, is too exclusionary. In other words, we're making a bad job of deciding the trade-off between access and risk. Right now, the vast majority of human beings around the world do not have access to the financial system. And I think that's the wrong decision because we are excluding so many billions of people who are not actually a risk, just because the only way we figured out how to address risk is to say we have to identify each and every person who interacts in the system and then exclude anybody who we cannot identify or who we think poses

Starting point is 00:22:33 an unreasonable risk. And I do think that's the wrong trade-off. So I just want to validate that what we are working on in Defi, in my view, is absolutely the right thing for us to work on. The second thing is the cat's already out of the bag, in a sense, right? This technology exists. It will not be uninvented. And so what we need to do is figure out what is the best way to mitigate risk in a permissionless, censorship-resistant, trust-minimimized environment. And I don't think that the right answer is to simply throw up our hands and say, this whole thing is totally decentralized. Let's just give up on any type of risk mitigation and let anything and everything happen. There are really great companies in this space that are

Starting point is 00:23:14 building compliance tools that don't make this same mistake of being exclusionary at their core, of saying if we cannot identify you, you will not have access to the system, but nonetheless, that identify potential risks and stop those transactions from occurring. This is a developing sector within the industry, frankly, which is crypto-native decentralized compliance tools. We've seen some sort of early versions of this, things like anti-money laundering or sanctions compliance oracles, things that can get plugged in directly at the base layer that will exclude, for example, addresses that have been added to the sanctions list. Now, that's one useful step.

Starting point is 00:23:54 I think it's also incomplete. And so I think the challenge for us in the industry is to figure out how can we build better crypto-native compliance tools that will mitigate risk without simply going to the other end of the spectrum where many policymakers want to go and saying the only way to address all of this is the way we've been doing it for the last 50 years, which is to centralize everything and then exclude the vast majority of human beings from the system. All right. I mean, this is a very thorny issue. I have a feeling that we'll be grappling with exactly, you know, what the right balance is between those different ideals for quite a while. But let's now turn to issues regarding crypto and the securities exchange commission. This obviously has been an ongoing story for quite some time. Let's just talk about the Coinbase case. This case rests on an assertion by the SEC that a dozen or so tokens are securities.

Starting point is 00:24:51 And I wonder, you know, how the courts are going to proceed, given that that may not be proven. Are they just going to accept that from the SEC? Or, you know, how do you think that aspect of it will play out in the courts? Yeah. So maybe a quick update on the Coinbase case, and then I'll talk a little more about where we go from here. So most importantly, Coinbase filed a motion for judgment on the pleadings, which basically says, even if we accept all of the SEC's factual allegations in the complaint, in the enforcement action that the SEC filed against Coinbase, nonetheless, the complaint should be dismissed as a matter of law

Starting point is 00:25:29 because the SEC's interpretation of the securities laws is incorrect. And there were a few different arguments that Coinbase made in that motion. The most important one, which you've had several other guests come onto the show to discuss, is the definition of an investment contract under the Howie test. And also sort of before you get to the Howey test, whether or not you can have an investment contract in the absence of a real contractual obligation. The way Coinbase describes this is a post-sale obligation on the part of the creator of the token with respect to the holders of the token. And Coinbase's argument was that an investment contract literally requires a contract,

Starting point is 00:26:12 not necessarily a written one, but at least one that is implied by law. In other words, if someone creates a digital asset, but they have no post-sale or post-distribution obligations to the holders of that asset, the asset cannot be an investment contract and therefore cannot be a security. And they look through decades of securities law precedent to establish that a post-sale obligation has always been necessary under the securities laws. Now, unfortunately, the judge in the case, Judge Thaler disagreed with Coinbase and ruled against them on this key issue in her order on the motion for judgment on the pleadings.

Starting point is 00:26:48 And instead, she seemed to adopt the SEC's interpretation of investment contract, which which sort of is every digital asset is a security because there is an ecosystem around the token, even though the creator has no post-sale or post-distribution obligations. And they don't really define what this ecosystem concept means, but they sort of look, sort of squint at the general, you know, world around a token and say, this sort of feels securities like. And the court adopted that as its ruling. Point Base has decided to seek an interlocutory appeal of that issue in the case. And I'm glad that they did that because this really is a pure and controlling question of law, which is the first element that's required in order to

Starting point is 00:27:37 appeal an issue before proceedings in the district court have been finished. So Coinbase and the SEC are now going to argue to Judge Thaler that she should allow the case to go up to the Second Circuit on appeal right now instead of moving forward with discovery and a motion for summary judgment and then a trial as a case ordinarily would proceed before there would be any appeal. And my hope is that Judge Thaler will agree that this issue is a controlling question of law, that there is a substantial ground for disagreement about whether or not the SEC or CoinBell. base is right in its interpretation, and that frankly, resolving this issue will benefit the litigation by making it move more quickly, because getting an answer to this question truly is critical for us to understand where the SEC's jurisdiction begins and ends in the context of crypto. The last thing I'll add to this before I stop, and let you get a word in, Laura, is we're seeing different rulings from different judges on this issue. It's really an odd

Starting point is 00:28:38 situation where everyone knows that we do not know what the law is. Because if you look at the ripple case, Judge Torres, just down the hall from Judge Thaler, right, in the very same district court, came out on the opposite side of this issue and said a token as it trades on a secondary market is not itself an investment contract, that you only have an investment contract in the context of a transaction involving the creator of the asset where the creator of the asset is exchanging some promise of future efforts for some consideration, money from the person who purchases the asset. And so in an environment where you have two different, very intelligent district judges in the same court coming out on opposite sides of the issue, that's when we know

Starting point is 00:29:26 we need to get this issue into the appeals court to get an actual answer what the law is. And so the appeals court then would rule on specific tokens or what exactly would result from that? So the appeals court wouldn't look at specific tokens. Instead, what the appeals court would do is analyze this question of law. What does the term investment contract in the Securities Act of 1933 actually mean? Can you have an investment contract in the absence of an actual contract where the creator of an asset has some post-sale or post-distribution obligation to the holder of the asset? And the court would only resolve that one issue and then kick the case back down to the district court to proceed with the litigation. Now, if the Second Circuit Court of Appeals were to say, yes, we affirm Judge Fela's decision. there can be an investment contract, even if there's no contract, then the case would just proceed

Starting point is 00:30:23 as it has or as it would if Coinbase did not seek an interlocutory appeal. But if the Second Circuit says, no, this opinion is wrong. There must be some post-sale obligation in order for there to be an investment contract. I think in that case, the SEC would either have to amend their complaint to add more facts to demonstrate that one of these assets satisfies that requirement, or else Stichfela would have to dismiss at least those allegations in the complaint. And remind me, I feel like it was Judge Fala, who was the one who said that the way the SEC was going about it made her feel like even Beanie Babies would be securities. It's that ecosystem argument.

Starting point is 00:31:04 Am I remembering that correctly? You are, and I have to say, many of us in the crypto law world were a little bit surprised by how her order came out based on how the oral argument in January sound. And during that oral argument, which went on for about four hours, and Judge Fala had very specific and very intelligent questions, she raised exactly this issue that you just mentioned. She asked the SEC lawyer, what is the limiting principle that distinguishes a security from a non-security commodity? Because if we accept this theory of an ecosystem, establishing an investment contract, as the SEC has put it forward, then basically every single commodity in the world, every single luxury goods, that has a secondary market price where someone says, I'm buying this, I think it's going to go up in value. And I think in part, its value will go up because there's a company that created it. And that company will continue to succeed. For example, my favorite example is Nike sneakers, right?

Starting point is 00:32:03 There's this whole secondary market for sneakers. One would assume that if Nike just went out of business, then the value of those sneakers would fall. So by buying sneakers, you're buying into this vague sort of concept of an ecosystem around sneakers. why are sneakers not securities and why isn't Nike registering them with the SEC? Another example is there's an apparel company called Supreme, very popular company that is very trendy, and they decided to sell a brick. And when I say a brick, I literally mean like a red brick that have the word Supreme in it.

Starting point is 00:32:36 And these things were selling for hundreds of dollars only because Supreme is a luxury brand that created an ecosystem around the sort of luxury status of its apparel. Well, why isn't Supreme a securities issuer and why isn't it registering its bricks with the SEC? And so we all sort of thought that when Judge Fela identified this problem of a lack of a limiting principle in the SEC's ecosystem theory that she was going to side with Coinbase and say the limiting principle for the SEC's jurisdiction over investment contracts is a post-sale or post-distribution obligation on the part of the creator of the asset. And I think that if this issue goes up to the second circuit, that is how they will find.

Starting point is 00:33:22 Yeah, I mean, my theory maybe would be that she was leaning that way but didn't want to definitively rule and wanted there to be discovery to explore the issue or something like that. Would that make sense? I'm not a lawyer, but would that make sense. I mean, I would like to believe that. I think the problem is that when you read her a she does lay out the law as she views it. And she does validate the SEC's theory in a way that suggests she wasn't just kicking the can down the road. And she could have done that, by the way. She could have written a very short order saying, this is a factual issue. And I don't know how to rule on this issue until there's more discovery. Let's punt this issue until the motion for summary judgment stage.

Starting point is 00:34:03 When instead of accepting all of the facts alleged by the SEC in the complaint as true, instead there's an actual review of what the facts are about these assets. And she decided not to do that. So that's why I think she did make a statement of law that is concrete enough that we should, you know, get an opinion from an appellate court before we move forward in this case. All right. So in a moment, we'll talk a little bit more about the Coinbase case and then segue to the Wells notice that Uniswap received. But first, a quick word from the sponsors who make this show possible. Pocod is the original and largest layer zero blockchain with over two. thousand-plus developers, and the anticipated Pocodot 2.0 upgrade will be a massive accelerator

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Starting point is 00:36:49 care-aluminum-free deodorant. It'll keep you feeling fresh for up to 72 hours. And when you smell good, you feel good. Visit Dove.com to learn more. Back to my conversation with Jake. So there were a few other elements of the SEC case with Coinbase. that are interesting. One of them was staking is also an issue. Can you talk a little bit about that portion of the SEC's case against Coinbase and what you think could happen there? Absolutely. So one of the

Starting point is 00:37:21 SEC's other allegations is that Coinbase's staking service is a securities offering in and of itself, totally irrespective of the security status of any of the underlying assets that Coinbase was allowing users to stake. And basically, the SEC's argument is, Coinbase is providing a managerial or entrepreneurial service by taking care of and investing user assets into these staking protocols. And that this alone satisfies the Howey test, the requirement of reliance on the efforts of others in order to expect profit. And, you know, Coinbase had what I thought was a very strong argument against the SEC's allegation. There were sort of a few arguments there.

Starting point is 00:38:06 One is that there was no reliance on managerial or entrepreneurial efforts. People weren't relying on Coinbase's skill and expertise in decision-making. Rather, Coinbase was offering a ministerial and administrative service, which they described in full to their users in their terms of service. So users knew exactly what they were getting into and didn't have the type of securities-like relations. Dependence on someone else's skill and expertise that characterizes an investment contract. Cleanbase also argued that there was no risk of loss. In other words, there was no investment of money, which is the first prong of the Howey test.

Starting point is 00:38:48 If there's no investment of money, in other words, if the investor hasn't actually put some capital at risk, they haven't given money to some entrepreneur to use in order to generate profit, then there's no investment. contract. And Judge Fela disagreed, at least based on the facts alleged in the complaint, with Coinbase's defense, and said that this is sort of a factual question, that the case has to proceed on this issue in order to determine whether or not the nature of a staking service is entrepreneurial and managerial, which implies an investment contract, or more administrative, which would suggest no security exists. I think one really important takeaway, though, from the section of the order on staking is how Judge Fela addressed to this question of an investment of money,

Starting point is 00:39:35 which is she did validate and actually wrote an extraordinarily clear and compelling explanation of how there is only an investment of money when there is a financial risk of loss to the investor. And she said, here there is a potential risk of loss because the investors, based on the way the complaint is framed, could lose their money in a staking service. But I think that that explanation of the law is really important for the rest of the industry, especially in the context of air drops, which, as you may know, have really become the main way that tokens are now distributed in the industry. Tocons are not sold to the public. They're given away for free to the public. And so I think one really important element of this order is validating the industry's legal and regulatory strategy of air drops as a mechanism of distributing tokens without running afoul of the securities laws. All right. So, yeah, we'll see what happens there. So, you know, one other thing that I wanted to call out about the Coinbase case is the judge. is ruling that Coinbase is not acting as a broker in its wallet. Obviously, this was a win for the industry, but I was curious, since this is one judge in one jurisdiction, is there a chance that another judge could overturn that or that this would

Starting point is 00:40:57 not be binding for some reason? So it's a great question. It is a huge win for the industry and especially for the defy sector in the industry. And again, I was really glad that the Defy Education Fund filed an amicus brief on this issue I was also very glad to hire at Varian, the lawyer who wrote that brief at Kravath, Dan Barabander, who's now Deputy General Counsel here at Varyant. And I think it is extremely important to distinguish between a broker, which is someone who is in a principal agent relationship with a customer. Again, making decisions on behalf of the customer from a software provider, which is how the opinion

Starting point is 00:41:36 frames Coinbase. Coinbase provided through wallet a piece of software that, users could use in order to discover prices on decentralized exchange protocols and then decide for themselves whether or not they wanted to execute transactions. But at no point was Coinbase acting as a broker either managing customer funds, since Coinbase wallet is totally non-custodial, or making decisions on behalf of users whether or not to execute transactions. So to answer your question, is it possible that some other judge would disagree with Judge Falo's ruling in this case? I suppose it's possible, and I know we'll talk a little bit about uniswap, and it does seem that it's possible the SEC will try to take another shot at this issue by going after uniswap on a similar theory. But I would not expect a judge to disagree because, at least to me, it seems so obvious that Judge Fela's opinion here is correct, that where you have a non-custodial piece of software that merely gives users the ability to discover prices and then decide for themselves whether or not they want to execute transactions, the developer of that piece of software is not acting as a broker.

Starting point is 00:42:43 All right. So now let's talk about the SEC Wells Notice to Uniswap, which, you know, as I'm sure people know by now, is something that happens when the agency intends to sue the recipient of the Wells Notice. At issue are three things. First, is the wallet or the web app a broker. Second is the unit token, a security. And third is the decentralized exchange, a securities exchange. You know, what do you think the C's chances are of prevailing in court on these three matters. So I'll get that in the second, but first, I just have to say how much I respect the way that Uniswop Labs has been handling this issue. You know, the conventional wisdom from defense lawyers, including me when I was in private practice, representing companies like Unoswap Labs on Wells notices from the SEC and the CFTC is to be very quiet about these things, to not say anything, to keep your head down, to hope that you can convince the agency. not to bring an enforcement action. And, you know, that is a really important aspect of this process.

Starting point is 00:43:50 A Wells notice does not mean that the agency will bring an enforcement action. It means that they believe as a preliminary matter that there could be a violation of the law. And they are giving the target of the investigation an opportunity to convince them that they should not move forward with the enforcement action. And Uniswap Labs should have the same opportunity as everyone else to do that. My guess is the reason Uniswop Labs felt comfortable talking about the Wells Notice publicly is because we all know the SEC is not engaging in a good faith process of giving targets of investigations in crypto a genuine opportunity to convince them that their theory of the law is wrong. So Uniswap Labs, I think is, and I'm just speculating here, but I would imagine that they feel that the SEC is going to move forward with an enforcement action. When that would happen is up in the air, you know, in the next few months, I would imagine that we'll find either the Unoswap Labs is in court or we'll have, you know, some confidence that the SEC has decided to back down from this investigation. Now, to finally answer your question, you know, what are the SEC's chances of prevailing in court? You know, it's hard to speculate about that without knowing exactly what the Wells notice says. And we don't know exactly what the SEC's allegations. might be. Also hard to speculate about what uniswap lapse defense arguments would be, although we know

Starting point is 00:45:14 they have some of the best lawyers in the world to defend this case. In my opinion, though, just based on those few issues that you outlined, I think the SEC is going to have an extraordinarily hard time in court for a couple of reasons. One is what we were discussing earlier about what an investment contract is and what it means in the context of the distribution of a digital asset. You know, if the SEC wants to go to court and argue that the Uniswop governance token is a security, they're going to find themselves running up against the airdrop that Uniswap Labs conducted. As far as I'm aware, Uniswap Labs never sold a token to a retail investor. And if they didn't sell a token to a retail investor, in my opinion, there is no investment of money under the Howie test

Starting point is 00:46:02 because there is no person who entrusted their capital with Uniswop Labs on some promise of post-distribution efforts in order to increase the value of the asset. So I think the SEC is going to have a really hard time getting over that preliminary issue. And that is actually the beginning and the end of that analysis, no investment of money, no investment contract according to the Howie test. But even beyond that, I think that Uniswap Labs has an extraordinarily strong argument in favor of sufficient decentralization, which is sort of a whole can of worms in and of itself. But to me, when you look at the uniswap ecosystem, what you see is exactly what Bill Hinman described in 2018 when he looked at ether and the ecosystem around Ethereum and saw no single party with

Starting point is 00:46:53 privileged access to information that should have to be disclosed in order for the public to understand the investment that they are making. So I assume that Uniswomen. Labs would be making an argument on the basis of sufficient decentralization as well. Now, the other allegations that the SEC might bring that you mentioned, the wallet issue, we just talked about in the context of Coinbase, you know, I don't think that Uniswap wallet is meaningfully distinct from Coinbase wallet. I don't think that Uniswap Labs is in custody of user funds or making decisions to execute transactions on behalf of users. So I'm not sure what the SEC would argue in terms of Uniswap wallet.

Starting point is 00:47:32 making Uniswap Labs into a broker. And then lastly, the question of whether the developer of a protocol that allows users to engage in peer-to-peer transactions is somehow operating and exchange goes all the way back to the beginning of our conversation about Tornado Cash, when you have developers of an immutable smart contract protocol that will continue to operate exactly as it is designed, even if the developers stop work on the protocol completely and disappear, it's very difficult to imagine them being viewed as the operators of the protocol in a way that would subject them to regulation. So that's just my very speculative non-legal advice, since of course I'm not here to give anyone

Starting point is 00:48:17 legal advice, but my sort of take on the initial issues that we've seen come up publicly around the Uniswap Wells notice. Yeah, and I just wanted to ask quickly when I named those three issues. I heard Hayden Adams, you know, the CEO of Uniswap Labs, talk about those as the three points at issue, I guess, with the SEC. So do you think he was just making a conclusion based off his interactions with the SEC? Or like, he didn't seem to say we don't really know what they're going to sue us for. He just named those three. So I didn't know where he's getting that.

Starting point is 00:48:55 Yeah, no, you know, I don't want to speak for Hayden. So I wouldn't do that. but I will also say that the chief legal officer at Uniswop Labs, Marvin Amori, who's a phenomenal lawyer, wrote a Twitter thread on the day that the Wells Notice was announced. He also identified those three issues in his Twitter thread. So although we haven't seen the Wells Notice and we don't know exactly what the SEC is saying in it, I think it's pretty fair for us, at least in the public, to be discussing those issues based on what both Haven and Marvin have said. Okay. Well, one question that I did want to ask is, The last couple times Uniswap Labs upgraded the protocol and released new versions. They did also issue restrictive business licenses that prohibited other commercial ventures from using their code for, in the case of V3, two years after its release and then for V4-4 years. And these moves are controversial even within the crypto community. And I wondered if you felt that those licenses would give room for the SEC to make its case. It's a great question. I think that those decisions are controversial from a philosophical perspective,

Starting point is 00:50:04 given the open source nature of the crypto industry. I'm not sure how they factor into the securities laws, though. For example, let's take the SEC's potential allegation that Uniswap Labs is an unregistered national securities exchange by virtue of the protocols that they've deployed. the definition of an exchange is a person or group of persons who bring together buyers and sellers of securities in a marketplace. And the fact that they have a license to the intellectual property for the code that they developed does not mean that they are operating the protocol in a way that brings together buyers and sellers of securities in a marketplace.

Starting point is 00:50:46 So I don't think that their mere ownership of intellectual property necessarily gives the SEC any type of argument on that issue. You know, similarly on the broker question, ownership of intellectual property to software that allows users to discover prices and then make their own decisions about executing transactions doesn't mean that the owner of that intellectual property is suddenly a broker. The definition of a broker is someone who executes transactions on behalf of customers. And the sort of one level deeper is someone who participates in the chain of distribution of securities at key points. And just because Uniswap Labs owns intellectual property to wallet software doesn't mean that they are in any way participating in the chain of distribution of securities. So I think, again, a philosophically controversial question, whether it's right for developers of technology in this industry to maintain rights to intellectual property and not allow others to simply fork and reuse their code freely, but I'm not sure that it's relevant under the securities laws. All right.

Starting point is 00:51:51 So as we've been discussing, the SEC has been going after some huge fish in crypto, Coinbase, and Uniswap. But the other big one that they recently went after is Ether. There was news reported that they are doing an investigation into the Ethereum Foundation. Details on exactly what that's about or what the purpose are scant. What is your theory about what's going on there? So, yeah, this is another case where I don't know any more than everyone else does. So I'll offer my sort of raw speculation about what might be going on, although I think it's unconfirmed that the SEC is even conducting this investigation or what it's about.

Starting point is 00:52:27 So we're sort of in the gray area of speculation here. But I think it's fair to say a couple of things about the SEC and its views on Ether. One is that the SEC is deeply antagonistic to this entire industry. And with the exception of Bitcoin, the SEC views every single asset that's ever been issued in crypto as a security that it believes it should have jurisdiction over. And that includes ether. And the reason we know that, I think, is because we've heard Chair Gensler testify in Congress and, you know, speak on CNBC and another, you know, financial media and get asked about ether and about Bitcoin. And he's only ever been willing to say that Bitcoin is not a security, but he's never said anything like that

Starting point is 00:53:13 about ether. So I think it's, it's fair to say the SEC takes a dim view on its own statements. in 2018 through Bill Hinman, that ether is not a security. You know, the other thing is we're coming up on the deadline for the SEC to decide whether to approve or deny a spot ether ETF. And that's sort of forcing the SEC's hand to come up with, in my opinion, some argument why the spot ether ETF should be denied. You know, the SEC got a lot of political pushback when it approved the spot Bitcoin ETF, even though it was essentially mandated by the DC circuit in the gray scale,

Starting point is 00:53:49 case. And so I think this sort of explains the atmospherics of why the SEC would be looking into Ether right now. The rumor that I've heard, and I think this is widespread enough that I'm happy to share it here on Unchained, is that the SEC is trying to distinguish or would be trying to distinguish Ether as a proof of work asset from Ether as a proof of stake asset, as if staking somehow turns Ether into a security. And my personal opinion, is that is not an intelligent or strong argument at all. There have been a couple articles written recently about why staking does not convert ether into a security. We can go, you know, sort of deep into that issue if you want to. But the sort of high level is no matter why there is

Starting point is 00:54:36 some expectation of profit, the third prong of the Howey test, you still have to look at the fourth prong of the Howey test to determine whether it is a single party that is relied upon for their managerial and entrepreneurial efforts in order for holders of the asset to realize that profit. And when you look at Ether, the Ethereum Foundation is not in any way a central party carrying out managerial or entrepreneurial efforts merely because any person in the world can stay ether and then earn a profit from having done so. So I don't really think that that argument holds any water, although the rumor is that's how the SEC is trying to get out of the sort of tough position they're in, having already said that ether is not a security, and the CFTC having

Starting point is 00:55:21 allowed the listing of ether futures, which basically means the CFTC has determined itself that ether is not a security, but rather is a commodity. Yeah, Samson Enzer of Cahill, Gordon, and Rydell came on my show and also gave another theory, which is that he felt that this was a way for the SEC to fish for reasons to deny the spot ether ETFs. What do you think of that theory? I think it's a reasonable theory. Samson's a great lawyer, and I think that his explanation of that issue was very astute. Honestly, though, I don't think that's why the SEC would deny the ETHR ETH, although I do think that they will deny the ETHER ETH, so we could talk about why that is. But to me, it's really important to recognize that we're in the middle of an election year,

Starting point is 00:56:10 and people are looking at the Biden administration as a whole very carefully to decide. whether they want to support President Biden in his re-election campaign or whether they don't. And one thing they're looking at is the coherence of the administrative apparatus in the Biden administration. And for the SEC to deny the spot Ether ETH on the theory that Ether is an unregistered security would essentially be like declaring open civil war within the administration on the CFTC. There is no way fundamentally to square the SEC saying that Ether is an registered security, with the CFTC saying it is a commodity, a non-security that justifies the rise of the futures market, which is a decision that they've made. And really importantly,

Starting point is 00:56:57 Chair Benham at the CFTC has not backed down from his view that Ether is a commodity. You know, just recently, the CFTC in briefing in one of their enforcement actions, once again said that Ether is a commodity. And so I don't think that Chair Gensler, even as aggressive as he is, wants to declare war on the CFTC and turn this sort of cold-turf war into an open, hostile, hot war. So that's sort of my view on where that stands. All right, yeah, we will talk about the E3-TF and political issues, but first I want to ask about a few other SEC cases. One is that there was this debt box case where the SEC was severely reprimanded by a judge in Salt Lake City for what the judge called an abuse of power. He described how the

Starting point is 00:57:50 agents were basically caught lying to the judge multiple times. And I wondered how you felt the facts of that case would affect how judges either like perceive the SEC or, you know, just what approach they take in deciding cases between the SEC and the crypto industry that come before them, if at all. I think it will. I think honestly that it will work an irreparable damage to the SEC's reputation. And, you know, a lot of folks in the crypto industry have been celebrating this order. And I totally understand that because I think it makes us all feel seen, you know, that a federal judge is identifying and calling out the SEC's bad behavior in a way that we all have been for a really long time does feel validating. But honestly, to me, it's really just very sad that we, live under an administration, under leadership at the SEC, that does act this way. And I think just to zoom out for a second, and to talk a little bit more about the philosophy of enforcement and how these agencies operate, there's a decision that every leader of a regulatory agency has to make with respect to enforcement, which is, will we only bring cases where it is very clear to us that we are

Starting point is 00:59:07 right on the law and that we are going after bad actors? Or will we test new theories in court and take on litigation risk and act not as a neutral arbiter that is respected by all, but instead to act as any ordinary litigant who is just trying to push as far as we possibly can in order to win as much as we possibly can? And I think that this SEC has clearly decided on the latter. They are taking extraordinary litigation risk and their perspective, not just on the law, but on where they stand with respect to the industry that they regulate, is one of total hostility and antagonism. And I think that that culture has bled into the way that the line enforcement attorneys at the SEC operate. Now, look, there are some phenomenal people over at the SEC,

Starting point is 00:59:56 so I don't mean to impugn the entire agency. But I think the fact that you see this level of misconduct, that the judge calls a gross abuse of power and goes on to say that it wasn't just these attorneys, but rather it was indicative of a systemic problem at the SEC. To me, that is a function of this SEC leadership, taking the wrong perspective on its own role as a regulator in a way that has, again, irreparably damaged its reputation. And that's not just with respect to how other judges will view them in enforcement actions, but it's also with respect to how the industry that it regulates, views them. You know, you hear us talk all the time about lawsuits that we are going to file against the SEC. That is very unusual. Typically, there's a great deal of respect for agencies like this.

Starting point is 01:00:44 There's a deference to their judgment, you know, whether mandated by law in the Chevron doctrine, or simply because the view is these are the folks who are really trying to get it right. They go to work every day thinking, what is right for the country as opposed to how can we win and how can we expand our own power? And I think it's really done, again, extreme harm to the SEC itself and also to the country that they've proceeded this way. Well, so it seems like the industry is fighting back. There's at least two different lawsuits in the works where it seems like the industry's

Starting point is 01:01:16 approach here is to kind of bring their own case in order to try to set precedent or to, yeah, just set something that would apply to the wider industry as a whole. And I'm talking about the Legilex case and the Defi Education Fund along with Deba. Can you describe both of those cases what they're trying to accomplish and then also analyze whether you think those cases will be good for setting the types of precedent that they're aiming for? Absolutely. And first, let me describe generally speaking what this strategy is because this is something that I've been working on personally for a very long time, starting when I was at the Blockchain Association and continuing now as a board. member at the Defi Education Fund, which is one of the co-plaintiffs on the Beba case. This is a strategy of impact litigation. In other words, for a very long time, the industry was essentially

Starting point is 01:02:09 sitting ducks waiting for the SEC to pick issues that it thought it could win, and also to pick jurisdictions where it felt the law favored its perspective on those issues. And the idea of impact litigation is to go on offense, to say, we actually think that we, we have the better view on some of these issues. And instead of just waiting around for the SEC to come and attack us, we're going to proactively bring those issues to the court to get rulings that give us clarity and explain the law in the way that we view it. And that's really what the Legilex and also the Bebba case are, the first of two that I hope are the first two of many cases that the industry will bring against the SEC and frankly other regulators where we feel that we have the better interpretation of the law than they do. The Legilex case is one that addresses essentially the same questions as those involved in the Coinbase case. Is the operator of a centralized exchange liable for securities transactions by virtue

Starting point is 01:03:12 of secondary market trading in digital assets? It's this question of whether digital assets can embody investment contracts as they trade in secondary markets between total strangers to the original creator of the asset, where the creator of the asset has not made any promise of post-sale or post-distribution efforts to the holders of those tokens. And so that's really, in my view, what the Legilex case is directed toward, is distinguishing between, as Judge Torres said in the Ripple case, primary transactions that can constitute investment contracts where you have a seller of an asset who does promise some post-sale obligations to the purchaser of the asset, versus an exchange that merely creates a market for the secondary market trading of those assets.

Starting point is 01:03:58 So that's the Legulex case. The Beba case is a little bit different. The Beba case is a case in which an apparel company has decided to create a digital asset essentially as a discount for the purchase of some of its bags and other apparel that it produces. And Beba has expressed in its complaint that it fears that the SEC will show up, and say that that asset is a security, because again, the SEC thinks basically every digital asset in the world is a security. And it tests the question of whether an investment of money can exist in the absence of an actual transfer of money from the recipient of a token to the

Starting point is 01:04:41 creator of the token, with some promise that the creator of the token will use that money in order to bring profit to the holder of the token. Because Beba only ever eardroped its token and only plans to ever conduct air drops in the future. And in Beba's view, and also in the view of the DeFi Education Fund, if there's no risk of loss to the purchaser of an asset, then there's no investment contract. So that's the sort of first part of the Beba case. The second part, and this is frankly what I find most interesting

Starting point is 01:05:11 of all the issues that we've discussed so far, is a challenge under the Administrative Procedures Act to the policy that the SEC has adopted of saying, all digital assets are securities merely because they are digital assets and there's some sort of type of ecosystem around them. And this is a policy that the SEC has never written down. It's one that we've only seen the SEC express through regulation by enforcement. The SEC goes to court and takes this view without ever actually telling the industry, here's what we think the law is, and following the requirements of the APA, which is notice and comment, giving the public an opportunity

Starting point is 01:05:52 to participate in the rulemaking process and explain that the SEC's perspective on digital assets is wrong. And so I think the Administrative Procedures Act claim in the Bebba case is extraordinarily important so that the court can weigh in on the fact that the SEC is essentially writing law on its own without any oversight from Congress, without any authority from Congress, and without any input from the public as the law requires. One quick question about the Leggelex case is because it is similar to the Coinbase case, is it duplicative in some way, or is there something different about it that would help it to apply, you know, to all exchanges generally? So I, in a sense, it's duplicative, but no more than the SEC's own cases against different exchanges around the country. So, you know,

Starting point is 01:06:37 the SEC didn't just bring these allegations about a secondary market being a securities exchange in the Coinbase case. They've also done that in the Binance case in D.C. They've done it in their case against Cracken in the Northern District of California. And here what Legilex is doing is seeking an order that will bear on all of those different cases. And, you know, the point of this in many ways is, as I was explaining before, in order to get clarity on the law, we do need more than just one judge to weigh on on these questions. You know, one district judge can't establish what the law is. Just like Judge Thaler and Judge Torres may take a different perspective on what an investment contract means, despite being in the same district, we could see a difference of opinion in

Starting point is 01:07:22 district judges around different districts in different circuits in the country. And ultimately, I think that what we need in order to get clarity on the law is to get these issues above the level of the district court into the appeals courts. And then, I think ultimately, to get these issues up to the United States Supreme Court. And the best way to do that is for as many circuits in the country to weigh in on these questions as possible. So we'll get a ruling, hopefully, from the Second Circuit because of the Coinbase case and the DC Circuit because of the Binance case and the Ninth Circuit because of the Cracken case. And now hopefully the Fifth Circuit because of the Legilex case. And I would say any person who is seeking to

Starting point is 01:08:02 launch a business as Legilex is in their home jurisdiction can bring a case like this against the SEC in order to get clarity in the district and the circuit where they reside on what the law is. And you could imagine a world where, unfortunately, the law in New York is different from the law in Texas. And that's different from the law in California. And that's different from the law in the District of Columbia. And if that's the case, then we need to know that as soon as possible in order ultimately to get regulatory clarity. again, either from the United States Supreme Court, observing that the law, which should be the same for everyone in the country, is actually different because these courts are ruling differently, or to use the fact that the courts simply do not know what the law is to convince Congress

Starting point is 01:08:48 that it's their job to pass new legislation that actually clarifies how digital assets should be regulated. This issue of exactly what unhosted wallets are and whether or not they can serve as a type of broker has come up in a few different cases recently, and we've discussed them in this episode. We did see that this weekend, the IRS took its own stab at it by releasing a draft 1099D-A form, which did list unhosted wallets as a type of broker. Why do you think this issue keeps coming up and how likely is it that you think this designation will actually go through? Yeah. So this is the IRS's latest move in the long-running saga of their implementation of the tax provisions that Congress included in the bipartisan an infrastructure bill in 2021. And, you know, folks may remember that one of the amendments that

Starting point is 01:09:38 the infrastructure bill made was to expand the definition of a broker under the tax code to include what I think is an extraordinarily vague term that no one really understands. What the tax code does is it requires brokers who are essentially middlemen for transactions involving covered assets to identify the customers that they have and then replace. on those transactions to the IRS. And the purpose of this, of course, is to make sure the IRS knows what capital gains or losses the customer had to make sure that the customer isn't evading taxes. And, you know, the Treasury Department and the IRS specifically have always been very concerned about tax evasion in the crypto industry. And my personal view is I think those

Starting point is 01:10:24 concerns are really unfounded. There's not great evidence that there is that much tax evasion in crypto as compared to the rest of the financial system. But in order to address that perceived concern, the Treasury Department asked Congress to expand the definition of broker, ostensibly to include all sorts of folks in the crypto industry. And what happened in the bipartisan infrastructure bill is that the definition of broker became broader, but also much more vague. The term was expanded to include people who regularly provide a service that effectuates transactions on behalf of customers. And the IRS has seemingly tried to use that definition to apply to software developers, who, again, are building tools that users can use in order to execute their own transactions. Now, we saw this last year when the IRS finally came out with a notice of proposed rulemaking

Starting point is 01:11:19 saying how they wanted to implement this new definition of broker. And what they said was unhosted wallets, which is a term that I hate to use because I'm not really sure what it means, but that unhosted wallets are in some way brokers. And just last week and over the weekend, we saw the IRS put out their draft form 1099 DA, which is the form that brokers would use in order to report transactions for their customers. And one of the options on the form is to select the type of broker, and they included unhosted wallets as one of the types of brokers. Now, for me, this is very disappointing because in my last job, as head of Paul,

Starting point is 01:12:00 at the Blockchain Association, we spent a lot of time trying to explain to the IRS how silly it would be to treat inanimate software as if it is a person acting as a middleman for customers. But it seems that the IRS is either not understanding or is deciding to ignore those arguments and is moving forward with this idea that unnotested wallets should be treated as if they are brokers. Now, what this might mean is the developer behind wallet software would somehow be responsible for identifying all of the users of that wallet software, even though there is fundamentally no way that they could do that because all they've done is publish open source software.

Starting point is 01:12:42 Now, in my view, you know, proceeding that way would be not only a violation of the IRS's statutory authority, I don't think that's what the definition of broker means, but also it would be a violation of the constitutional rights of those users to freedom of speech and to financial privacy. I also think it's a violation of the Administrative Procedures Act because it's arbitrary and capricious and simply doesn't make any sense, which typically doesn't pass muster under the APA. Well, given all the things that we've discussed in the episode, it does really seem like Defi is in the crosshairs in the U.S. And I wondered what you thought the prospects were for it to thrive in the U.S. or whether we will see it just really not be a part of the U.S. economy and instead go offshore. I'm still confident that defy can thrive in the U.S.

Starting point is 01:13:30 And, you know, as I mentioned, at Variant, I spend most of my time talking to founders and entrepreneurs who are building this technology. And, you know, I'll say here what I say to them, which is there is hostility to Defi in the U.S. But our job is not to be scared by regulators into leaving the country. Our job is to figure out what the law is and then to comply with the law. I still think that under current law, developers can create and launch products and services in DFI in the United States. I think then the hope for DFI comes down to how effectively we explain to policymakers why this technology matters so much.

Starting point is 01:14:11 That requires us to be active in D.C. in a way that we have been before, but need to be 10 times moreover in the future, explaining to members of Congress and also to regulators how important D.Fi is and why we should have policy that support. rather than chills innovation in the DFI space. We also need entrepreneurs to build really cool stuff that people in the U.S. just want to use, right? I think that's the key that unlocks all of this is when folks are really using DFI because it provides them just a better service, a better product than the traditional financial system can provide them.

Starting point is 01:14:45 And I think we're just around the corner from seeing that happen. You said earlier in the episode that you think that SEC will deny ether ETFs. Why do you think that? and what do you think their reasoning will be? I think there are sort of two reasons to be skeptical and maybe pessimistic about the ETHR ETH, although it pains me to do that because, of course, I love Ether and I care a lot about Ethereum.

Starting point is 01:15:09 And I think the SEC should approve the ETHRETF. But first, I think we have to be honest about the political reality here. The SEC is not friendly toward this industry. And approving an ETHRETF would be a massive sign of validation from the SEC for the industry, one that I do not see Chair Gensler deciding to do. You know, I also think that it's important to look at what happened with the spot Bitcoin ETF, which was a split vote of the commissioners to approve the spot Bitcoin ETF.

Starting point is 01:15:40 Despite the fact that the D.C. Circuit essentially said the SEC had no ground to deny the ETF. We still saw a vote of three to two among the commissioners. Chair Gensler siding with the Republican commissioners, Purs and UADA, to approve the Bitcoin ETF. But we also saw a dissent from Commissioner Crenshaw, which said the SEC still should not have approved the spot Bitcoin ETF despite the gray scale ruling. And I think if you look not even that carefully at what Commissioner Crenshaw said in that dissent, you'll see exactly what reasoning the SEC could use in order to deny a spot E3

Starting point is 01:16:18 ETF, essentially what the SEC could say, and this comes straight from Commissioner Crenshaw, is that the idea of correlation between the futures market and the spot market is not in and of itself sufficient in order to address concerns about market manipulation and fraud, which have to be addressed under Exchange Act Section 6B5, which is the rule that the SEC has previously used to deny applications for spot crypto ETFs. And so I think, you know, the SEC, may decide to deny on that basis. I think they'll be sued. I think they will lose in court again, but I think the political reality is that SEC leadership would rather not support the industry, go back to court, litigate this issue again, and then lose rather than do us all of favor by approving the

Starting point is 01:17:05 ETF. Last week, Senator Cynthia Lemis and Kirsten Gillibrand proposed stable coin legislation. You are definitely not a fan of what this is proposing. Explain what it is proposing in why. that is. Sure. So I'll start high level, which is to say we all want to get stable coin legislation done. And I think that there is bipartisan, bicameral agreement that the stablecoin market is important enough that it's, and also clear enough to understand that it is time for us to pass some legislation to address the reasonable risks that are posed by stable coins. I think the problem is that this bill makes some really poor decisions about how the stable coin market. market should be regulated. And, you know, I testified in Congress almost exactly a year ago

Starting point is 01:17:53 and gave my views on behalf of the Blockchain Association about how stablecoins should be regulated. And the very first principle that I explained to Congress was that stablecoin legislation should focus on centralized custodial stable coins because we understand what the risk is of an ordinary financial institution maintaining custody of funds and then creating an asset which functions is a liability for those funds. We know how to regulate that type of market. Instead, though, the Lummis Gillibrand Payment Stablecoin Act bans every other type of stable coin that does not fit that model.

Starting point is 01:18:31 It has a definition early in the bill of what it describes as an algorithmic payment stable coin. But it doesn't just apply to something like Terra or UST, what we in the industry would think of as an algorithmic stable coin. That is a stable coin that has no collateral at all, that uses some concept of supply and demand in order to attempt to incentivize a stable market price without actually collateralizing the asset. Instead, the bill essentially bans die and rye and fracks and every other type of stable coin that the defy world has decided to create. I think that's a total mistake. It kills innovation in a way that is totally unnecessary.

Starting point is 01:19:13 The bill also says that stablecoins can only be issued essentially by depository institutions, that is banks. I view the bill in essence as a set of regulations that creates a large regulatory mode for the banks at the expense of companies like Circle, which should be able to issue their stablecoin USDC without having to go to the prudential regulators and get a bank charter. But essentially the bill says that's not possible. Now, look, it pains me a little bit to be criticizing this bill so much because senators, Lummis, and Gillibrand have generally been extraordinarily good on issues related to crypto. They're widely viewed as champions for the industry. And, you know, I think as friends, it's our job to tell our friends when they've gotten it wrong.

Starting point is 01:20:02 And so that's why I've been vocal in saying, I do not think that this bill makes the right decisions about those issues. All right. Well, last question. Thank you also for answer. this sort of marathon of questions when there's really so much to cover. We're obviously in an election year and Congress is another element or another body in our government that could affect all these different proceedings and everything that's happening with crypto policy. And obviously they've been sort of not a big part of the action here. And I wondered how you thought the election

Starting point is 01:20:40 could affect those prospects and also what you thought, you know, a second Biden administration or a second Trump administration could mean for how crypto is regulated in the U.S. Well, certainly the presidential election is extraordinarily important for us in crypto. And I think it's frankly pretty hard to predict what a second term for either of those, you know, presidents current and former would look like. You know, in President Trump's first term, He was not a fan of crypto. He really didn't say much about it, but his one statement about Bitcoin was essentially that he didn't like it. He thought that it was just thin air and he liked the dollar better. And his administration was very mixed on crypto. Some leaders within the administration were very supportive, like Brian Brooks, who was heading up the OCC at the time. Some were very critical and really sought to hamper the industry, such as Secretary Mnuchin at the Treasury Department, who on his way out of office, essentially tried to implement KYC for unhosted wallets. And so it's really unclear what a second Trump term would look like. President Trump has made a couple of statements publicly about crypto

Starting point is 01:21:52 recently. I have to be honest, none of them have made me feel a great deal of confidence that he's changed his personal views on the industry. I think most folks in the industry think that a second Biden term would be worse than whatever a second Trump term would bring. Just because the assumption is we would have more of the same. And unfortunately, I think that is likely true. My hope would be that a more moderate and more pro-innovation, pro-business strain of thought within the Democratic Party would take over from the very anti-business,

Starting point is 01:22:25 anti-innovation, progressive wing of the party, led by Elizabeth Warren, who really has been able to set financial policy for the Biden administration. I do hold out hope that we would be able to see a shift in leadership in that way. Unfortunately, the election is coming somewhat closer now, we're only about six and a half months away, and thus far, the Biden administration has shown no sign of changing course. So it does seem that they are running the reelection campaign on the same hostility to business and to the crypto industry, specifically that we've seen for the last three years. The other piece of this, as you

Starting point is 01:23:00 mentioned, is Congress. And I think that it really is time, you know, not just with stable coin legislation, but broadly speaking with respect to market structure, these questions about the SEC and the CFTC and mayor jurisdiction over the industry, I think it really is time for Congress to step in and decide what the law should be instead of leaving us all in this sort of haze of regulatory uncertainty.

Starting point is 01:23:25 And what we need in order to have that is a Congress that can actually work together, right? Folks who instead of, you know, fighting over the most minute details and letting politics get in the way of ever, you know, folks who really understand these issues and want to address them directly. And that requires us in the industry to get much more involved in raising our voices as part of the election. That's partly with campaign contributions and financial support for candidates who understand

Starting point is 01:23:54 these issues and want to address them. We've done, I think, a really great job so far, funding some of our PACs, political action committees, and also making direct donations to candidates who have stated on the record their views on crypto in a positive way, it also means calling our Congresspeople and making sure they understand that they should be taking these positions as part of their elections because there are millions of Americans who are going to vote based at least in part on what their candidates' views are on crypto. So I think it's going to be a really important election for us to watch. Yeah. One thing I just have to note is it does feel like post-FTX that's really affected things. Although I do feel

Starting point is 01:24:33 like I'm seeing more of a negative impact amongst the older politicians, whereas the younger ones are perhaps more positive on crypto. Well, Jake, I can't thank you enough for going through all of these issues in such an informed manner. Where can people learn more about you and your work? Well, thank you, Laura. It's always a pleasure. And folks can find me either on Twitter or I guess X at J. Chavinsky or on Warpcast or

Starting point is 01:25:00 Farcaster at the same handle. and yeah, feel free to reach out to me to chat about anything interesting to you. Great. Well, it's been a pleasure, happy you on Unchained. It's great to be here again, Laura. Thank you. Thanks so much for joining us today. To learn more about Jake and Cryptro Regulation in the U.S. Check out the show notes for this episode. Unchained is produced by me, Laura Shin, with all from Matt Pilchard, Juan Aranovich, Megyn Gavis, Shashok, and Market Korea. Thanks for listening.

Starting point is 01:25:32 Unchained is now a part of the Coin Desk Podcast Network. For the latest in digital assets, check out Market daily five days a week with host noelle atchison follow the coin desk podcast network for some of the best shows in crypto

Unchained - The US vs. Crypto: Jake Chervinsky on Crypto's Legal and Regulatory Status - Ep. 635

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