Episode 115:

Gabriel Shapiro (@lex_node)

On The Bright Line Test For

“Sufficient Decentralization”

Transcript:

 

Sasha:

Okay. Hello everyone! And welcome to the HODLCast. Today, we have a very special guest, Attorney Gabriel Shapiro, or his Twitter is @LexNode. So Gabriel, thank you so much for taking the time. I’m really looking forward to talking to you about your recent article, about the decentralization. You’ve done a lot of writing on the various securities issues and tokenization. So I’m really looking forward to this. Can you give just a little of your professional background and how you got involved with Bitcoin?

 

Gabriel:

Sure! Yeah. So basically before I got into all this crazy cryptocurrency stuff, I have for about eight years. I was a rather traditional Silicon Valley corporate lawyer doing primarily by-side representations of public tech companies in mergers and acquisitions deals. At the Silicon Valley offices, I worked with some of the big Wall Street firms doing Le Boff, Weil Gotshal, Hogan Lovells. And I did all sorts of deals in connection with that. In 2016, when I first read about ethereum smart contracts, and of course as a lawyer, I said, “What’s a smart contract? What the heck does that mean?” Right? It sort of piqued my interest. And it just so happened that the first Ethereum meetup in my area after that was, and this just goes to show how much times have changed.

 

It was Nick Szabo giving a talk at an Ethereum meetup. And of course Nick Szabo has a JD, has really contextualized even pre-blockchain was contextualizing some of the things that are now relevant to blockchain as either displacing law or mechanizing law in some way, and so on. So it just made sense to me as a lawyer, and that was a great sort of opening for me to get more involved. And I’ve kept getting more involved ever since then.

 

Sasha:

Definitely! The cryptocurrency legal space is very lucky to have you with the writing you’ve been doing and the research. So the article, I think it came out April 15th, defining decentralization of law. So why is decentralization important to define?

 

Gabriel:

Yeah, the reason why it’s important to define, for legal purposes is that, perhaps surprisingly, regulators and politicians have shown a surprising willingness to give it legal significance. For example, William Hyndman, who’s the director of CorpFin at the SEC, gave a famous speech in 2018, called “When Howey Met Gary Plastics”, in which he sort of implied that Ethereum, if once was a security, would that it had stopped being a security, and the reason he cited for that, and as well as for Bitcoin not being a security is that, it had become “sufficiently decentralized”, and that he listed like a long list of somewhat chaotic factors, as to how to determine whether this would be the case. I think the idea is very important, but I didn’t think the list was all that helpful. And then, also FinCEN, on the sort of money regulation front, published some guidance last year, which doesn’t really speak so much of decentralization per se, but does draw a lot of distinctions based on whether a platform or the holding of virtual currency is custodial or non-custodial. And I would say that, that’s just kind of another way of saying decentralization, because the idea behind custody is that, someone controls something if it’s decentralized, then no one really controls it, and so it’s basically the same thing under different words. And so of course, if was stop applying, when something is decentralized, then you have to be able to define what that point is, right? So that’s why it’s important to define it in some way.

 

Sasha:

And just for the listeners that might not be as entrenched in the legal side. So basically, what you just described, so that FinCEN one and the SEC are looking at decentralization. So what happens if something is decentralized or not decentralized with the SEC and with FinCEN? What is that difference for the company or the blockchain project?

 

Gabriel:

Right. It in theory, and of course we’re speaking at a high level here, because there’s no law that says when it’s decentralized, X happens. But in theory, what would happen is, if a token had at one point been considered a security because it was a small team of people sort of controlled it. Once it has became decentralized, it would no longer be subject to the securities regulations. So for example, if that token traded on Coinbase, Coinbase is not a registered securities exchange, Coinbase wouldn’t get in trouble anymore for trading it on its exchange. If someone was brokering a deal between two people, for one person to buy it from the other, and taking a percentage of the deal value as a fee, and that person wasn’t a registered securities broker dealer, once the point of decentralization was reached, it would be fine for that person to do that even though they’re not registered, because it’s not a security anymore. So that’s the areas in which it makes a difference, at least for securities law purposes.

 

Sasha:

Yes. Big difference, I suppose. I believe you submitted some comments to SEC commissioner Hester Peirce’s proposed framework. Can you give us an overview what the current Howey test is? How does a company become centralized? Like a security or non-security and the SEC’s view, and what is commissioner Peirce’s framework going to change?

 

Gabriel:

Right! In the United States, at the federal level, we have two main securities laws. The securities act of 1933 and the securities exchange act of 1934. Both have their own definitions of security, which are only slightly different. Essentially it’s a long list of things, and it says things like shares, bonds, profit interests, and then it has this sort of catchall category. And those are so called enumerated securities. Because we know what these things are, we know what a share of stock is, right? But then there’s this sort of catchall term investment contract, right? And there’s a wide body of case law dating all the way back from 1933 onward about what that word means. And it turns out that any type of arrangement that basically has the same types of risks to an investor as say buying a sheriff stock wood, or some other type of obvious security. If it has those same types of risks just in a more complicated and disguised form, then that will still be subject to the securities laws. It will be called an investment contract. And so the test for that is what we call the Howey test. And it’s very simple. It’s whether a reasonable person would invest in the offering in a manner that with a reasonable expectation of profits, predominantly from the efforts of some group of people in the context of some type of common enterprise, and discussions about what common enterprise mean and get very technical. So I’ll ignore that like the SEC did and its guidance and just say some type of common enterprise. So that’s the basic test. And the idea is that, the securities laws exist for the protection of investors and for markets. And it’s a substantive law. It’s not a formalistic one. So if people invent some clever way to give all the same benefits and risks as security and just call it something different and disguise it in various ways, it’s still going to be treated as a security.

 

Sasha:

Oh! That was one of the most eloquent explanations that I’ve ever heard.

 

Gabriel:

Thank you. And so further to your question, you asked about how Commissioner Peirce’s proposal would affect that. All these tokens, while in fact they may be securities, really the only thing we care about for this type of security is the anti-fraud rules. And for everything else, let’s just not apply all these complicated disclosure rules, and trading rules, and exchange rules, and broker dealer rules, and all these other things to this. Let’s just let them trade because they’re just of different from stock. And let’s give an issuer three years to try to get the token to the point where it’s essentially just used for a utility, or it’s otherwise kind of decentralized. And if at the end of those three years it still looks like a security, then it’ll start getting regulated as a security again for all purposes. That’s essentially her proposal.

 

Sasha:

And so I think you went on to very nicely define what we could use as the definition for sufficiently decentralized. But maybe, and I think, I forgot to ask any questions around this when I send them to you. But maybe we could talk about some of the challenges of what you just described in the framework. If something is not sufficiently decentralized at the three year mark, what are the implications to the company, to the exchanges holding it to the SEC?

 

Gabriel:

Right! Well under Peirce’s test, as long as it was functional, they’d still be fine. They don’t actually have to be decentralized, unless you just consider kind of any peer to peer network to be sort of inherently decentralized. But most people don’t. So under my kind, of the kind of alternative framework that I’ve advocated for, look at the relevant dimensions of control and power, right? And assess whether there’s anyone who really bears unique responsibility for this thing. And if no one sort of does, that’s the point where it’s over with. And I can describe that more precisely. But if that test weren’t met, I think that’s your question, then the issue would have a big problem, right? Because there are rules of presumably over these three years, the token would have become very widely distributed among a lot of people. And the basic rule we have is that, when a security becomes widely distributed, the issuer has lots and lots of expensive regulations to comply with. Typically, they have to become an exchange act reporter. And that’s like the same reporting obligations as like Apple, Inc. has, which is a huge, very centralized thing. So the consequences of not meeting the test after having a three year safe Harbor would be disastrous. For that reason, I don’t think there should be a three year safe Harbor. I think you should regulate it as a security for as long as it’s centralized, and when it becomes decentralized, then you let the regulations go.

Sasha:

Yeah. Because what we saw in 2017 with so many of those ICOs, they never built the product. Nothing happened with it. So hear in 2020, all of these things would have been given a safe Harbor, but now would be the deadline, and they would be deemed certainly centralized at this stage. They wouldn’t have met any network maturity test. So it would be a nightmare for anyone holding it, trying to figure out what they can do with this coin or where it could be listed because of it’s currently listed, say on cryptocurrency exchanges. Someone could at least trade it for Bitcoin on there, but if the exchange had the end their relationship with that token because the token didn’t meet network maturity or sufficient decentralization, then it would really hurt the investors more.

 

Gabriel:

That’s right! It’s a tough problem to solve.

 

Sasha:

Yeah. But I guess the contrary to it is that, it gives tokens a path to get started or get launched this way.

 

Gabriel:

That’s right! So I think Peirce thought about it the right way, which is if you’re going to give this sort of free period and have the potential penalty of being a security at the end, you got to make it very easy not to be a security at the end. On the other hand, if you want to have a tougher test for when’s things something stops being a security, which I think is the really the test under existing law, I think the test articulated by Hyndman is a difficult one to meet, and so on. Then you don’t want to give this initial free period. Instead, you only want to let the regulations go when it makes sense to do so.

 

Sasha:

And in your article, you talked about principles based approach, a standards based approach or rules based approach to the concept of decentralization. You also mentioned a securities law, a tripartite. So could you go through that with us?

 

Gabriel:

Yeah, for sure! I think that one of the criticisms that I got of some of the earlier things I said about this was, “Well, you can’t test.” And actually people have criticized Hyndman’s speech said, “Well, what is it sufficiently centralization means? This is a useless doctrine.” No one who knows how to define it. And if you did define it, then that would be bad because of people would just gamich to meet that definition, but they wouldn’t really be decentralized when you actually looked at all the facts, and so on. And so, I just think that type of view is not giving sufficient credit to the creativity of lawyers in defining things and interpreting things. So really most laws have kind of layers to them, right?

 

The principle that the law is based on, right? So people will go and they’ll look at like the comments that the legislators made to the law when it was passed to try to understand it more deeply and interpreted in light of that. That’s sort of the principles rather than the words, then there’s sort of standards, right? So for interpreting the words on the page, we have canons of construction. And then sometimes over certain sets of words, like the word investment contract, and even more specific standard will develop about the right way to interpret that word. And that will become a way of making that a little bit more clear and predictable in results, and keeping all the courts consistent, etcetera. And there’s a little bit of loss in that because the standard might not fully reflect the principles, but it probably reflects the principals pretty well, nearly on average, like most of the time, right? And then there’s sort of like an even further one which is you could say like a bright line test, right? And the bright line test is even worse at fully honoring the principles than the standards were, right? But it does have this benefit that, if people just stick to that, they know they’re on the right side of the law, and they don’t have it reduces transaction costs and everything else. So a great example of how this works totally independent of tokens is the private placement rules for securities, right? So we have the securities act of 1933, people can go and look at the policy reasons for that as reflected at the time, historically. That’s the principles. Then we have the sort of the rule itself, which just says that an offering by an issuer that doesn’t involve an underwriter or a broker dealer, and that is not public isn’t required to be registered with the SEC. And that’s kind of a standard. It’s not as good as fully understanding all the principals involved, but that’s a little bit too labor intensive. And so we can interpret that language and most of the time, most people will agree on it. However, for really fringe cases, you might have to revert back to the principles and there might still be some uncertainties and extra transaction costs because of that. And then there’s a third thing, which is rules that the SEC passed that are sort of especially conservative versions of a private offering. And the SEC says, “Hey, if you take this especially conservative approach, which is very clear, and in some cases even numerical, like don’t offer to more than 35 non-accredited investors and you’re good. Right?” And that’s totally arbitrary, right? In terms of the original principles of “why 35, why not 36, why not 20?” Right? But it’s quite conservative. And it has the benefit of if people are willing to take that conservative path, they don’t have to deal with all these uncertainties of a principle or a standard. So that’s sort of the framework. And I think we should do the same thing for an idea like sufficient decentralization, right? The Howey test, the sort of the already existing standard, and we can just keep testing over and over again whether that’s met, but people have complained it’s too vague, right? So you can develop a more specific standard which I propose that would be kind of like a flexible test for decentralization, still a little bit murky. And then you could even go even further and develop like a really specific rule where you say, “Okay, if less than 10% of the tokens are owned by any affiliated group, and less than 10% of the hash power is controlled by any affiliated group. And there are at least three different development teams that are unaffiliated who understand the code and work on it, that sort of thing.” It doesn’t have to be those exact numbers. Then people could comply with that. And yes, they would face some costs by being more conservative than they absolutely had to be under the broader approach. But they would gain the benefits of not having to go and argue with people about that and face litigation costs and so on. So I think you need all three, right? -to have a good legal system. And I think when you consider that that’s how a lot of laws work already, it becomes a lot less crazy to think that there’s this point of sufficient decentralization and that it should matter legally.

 

Sasha:

Yeah, absolutely! And it would be so nice. Well, I kind of think there’s a bit of a clear path right now since we got those turnkey jet, no action letters and stuff, there’s a very basic path for that, but no one wants an access token. They want something, that’s the purpose of most of these things. But what are some of the non-legal approaches to blockchain governance and do you think these kind of approaches matter?

 

Gabriel:

So I’ll be a little bit of a contrarian and I’ll say there are no non-legal approaches to blockchain governance because everything implicates the law. But however, I do think there’s a spectrum, right? And some are quite legalistic, right? Like for example, Z cash. The Z cash community, I’ll say, recently sort of reformed its governance, because they have a unique structure, where the protocol, a portion of the mining rewards from each block actually have always gone to developers. Initially, it was styled as sort of a reward for effort already done, so to speak, pay me for the sweat equity I already put in. And then in this reform version, the idea is it’s fronting the cost of continuing development on almost sort of like a grant from the network, so to speak.

 

And they have a lot of legal stuff involved in that. There’s a foundation called the Z cash foundation. There’s a for profit entity called the electric coin company, and they jointly own the trademark and like ticker symbol and logo for Z cash, under a legal agreement. And they also have legal agreements relating to how this pool of funds that comes out of the protocol gets spent, and where it resides before it’s spent and so on. So that’s quite legalistic. On the other end of the spectrum is Bitcoin, right? Bitcoin doesn’t have a foundation because there was no ICO, so there was no initial pool of funds for anything. We don’t even know who its creator is, so you can’t really try to impose any legal obligations on him. And there are no contracts sort of among the core devs or as far as we know, among the miners about how they need to interact with each other. It’s quite chaotic. Really tries to minimize the law and there are probably pros to that. There are cons to that as well, right? But that would be kind of the extreme end, I think, of non-legal blockchain governance.

 

Sasha:

Sure. And I remember at the beginning, people talking about the autonomous decentralized organization. And my legal partner at DLT, Greg Karch. When we were first talking about it a couple of years ago, and he was really quick to point out anything that’s a non-legal entity, it’s going to default as a partnership and then what happens, it does as everyone should equally liable because partnership doesn’t offer a limited liability. So yes, it’s very interesting. Like the laws are there and if people want to think they’re outside of them.

 

Gabriel:

Yeah, exactly! Right! And there actually was this kind of laughable and it won’t survive a challenge. But there’s some like New York, a class action litigator or something who somehow convinced a judge in New York to issue him a judgment against like all Bitcoin node operators for losses, fraudulent trading, and all kinds of problems on the theory that all Bitcoin node operators are a general partnership and are jointly and severally liable for any and all losses that have occurred to anyone on Bitcoin for any reason. And so some judge was, I think it was like a magistrate judge or something, but he was actually crazy enough to give this guy this judgment. And so now this lawyer will presumably go out and try to find some node operator who has a big pocket and who can try to enforce this against. But it’s kind of silly in the case of Bitcoin because what is a partnership?

 

The co-ownership of a business for profit. There’s no co-ownership among node operators. In fact, they may be in competition with each other, right? But for other types of networks, it’s actually not as crazy, Right? Think about like EOS for example, and the validators on that. So what is it like 32 validators, block producers rather. And supposedly they do have some agreements among them,kind of colluding and stuff. Is it crazy to consider that a general partnership? I don’t think so. I think it actually kind of makes sense.

 

Sasha:

Yeah. And they’re not anonymous either. But they are spread out across multiple jurisdictions, which would be US. They could extradite people, but unless there’s some major loss.

 

Gabriel:

Well that’s the brilliance of a partnership, right? Because all you need is one. Then he’s jointly liable for the whole thing.

 

Sasha:

Yeah. That would be dead like scary territory if it ever anything ever came like that for the all the different validators. And Gabriel, some people have said that people running proof of stake nodes, that those could even be considered securities. Have you examined that line of thought at all? Or do you have any opinion on it?

 

Gabriel:

Yeah! Potentially, this could be the case. In certain cases, let’s just assume for the sake of argument that the native token involved is not a security, right? Let’s take cosmos, right? Let’s assume atoms are not securities. But let’s assume that there’s still a relationship between a particular validator to whom people are delegating their validation rights, and those people, right? Potentially. And if that validator, to make it interesting, let’s assume the validator, like this is not the only thing they do. Like it’s a company that does a variety of things like steaks on a bunch of networks or whatever. Also provide software development services. That’s our thing. It’s diversified. And let’s just say we’re to say, “Hey, if you stick with me on like all these other validators that I’m competing against for your money, I will give you not just the rewards that would otherwise come to you from the network. But I’ll actually give you the same percentage of those whatever percentage that you’re getting of those rewards. I’ll give you the same percentage of the first 20% of my overall profits for my business.” Right? That would clearly be a security, right? Now just start making that more modest, right? Okay. Now it’s just that, if the network were set up in a way where one validator based on can just be way better skilled at the other like a lot of the validators, this turns out not to be the case in practice, but let’s just say a lot of the validators were getting slashed, just like really, really technically hard, let’s say to maintain the requisite uptime.

 

But like one validator had like figured out a great system for always maintaining uptime. It was proprietary and so people who invested with this validator just did much better than anyone else. And that might be a security, right? Because you’re making money from their entrepreneurial efforts and it’s going to keep going up over time. So it’s definitely possible whether it’s the case in actuality on any of these networks. Yeah, I haven’t seen one yet that I think is like clearly a security, I’m assuming there’s nothing extra added, like particularly like validators or cosmos. Like the protocol handles everything. Like the vouchers don’t even know who the people sticking with them are, right? And they never have custody of their funds. I don’t really see it in that case.

 

Sasha:

Thank you. And what are some kinds of power in blockchain systems?

 

Gabriel:

Yeah. So I think like this is the key, right? If you want to define what is decentralization, you should look at each category of power that kind of matters for the value of the network. And then you say, “Who holds that power? Is it very widely distributed? Or is there sort of like one or a few people who kind of basically control it all, right? Or control the majority of it.” So reasonable minds could differ on what these how to characterize this, but the ones that stand out to me is like, “okay, there’s validation power, right? Which is just really just means it’s a read, accessible blockchain. Anyone can go and look at it and validate the whole history of the blockchain.” Right? A lot of networks could have that in theory. But what if it’s like super, super hard to run a node? Like only a professional can do it because the data requirements are so high or whatever. Yeah. Then it might not be very meaningful and maybe validation power is centralized, but like in Bitcoin, for example, small blocks, right? I think validation power is decentralized. Another type of power is what I call consensus power. And that’s really ownership of the means of block production. You could almost think of it as like a Marxist thing about the order ownership of the means of capitalism, right? So in Bitcoin, that’s A6, right? If that A6 ownership is very, very concentrated, and I believe it is, then you wouldn’t say that consensus power is decentralized.

 

Now, however, this doesn’t mean that the network overall is centralized. It just means that dimension of power is centralized. You have protocol client power which is kind of like the core devs, right? They write the software, they control the most popular client, Bitcoin core, and it gets a big horn gas in the case of etherrum, and that’s a form of power because they can change the rules. And people may make steps that updated software and then the whole thing will change, right? Economic power is kind of like how concentrated is ownership of the token, right? And the reason why that matters, even though the network can be like secure against double spends and stuff if it’s assuming it’s a proof of work network, Bitcoin can be secure even if like two guys own Bitcoin, because the concerns are separated, but still if like one guy owns 50% of Bitcoin or something, they have massive power, the value cause they get like start dumping it very cheap, and that’s a reason why you might want to apply a lot of it, right? So that should matter for measuring whether law applies. And then what I kind of define as user power, and user power is kind of like just everything else. It’s the one that has the most diversity, I think, across different blockchains. For example, in ethereum, I would consider like Maker DAO to be a user of ethereum, and Maker DAO probably has a whole lot of influence over things that happened with ethereum because it has wide adoption, and a lot of the other adapts, use it and a lot of people rely on it and so on. But also individual, just some guy in his garage running a node, he also has some power, right? Because he might refuse to take a new version of the protocol that’s released by the core developers. And if some other people do that, then most suddenly you have a contentious network fork. So all these sources of power matter. Now I think one of the benefits to like a flexible standards or principles based test, let’s say, is that you can look at all of these in a lot of richness and detail and you can say something like, “Well, on Bitcoin, yes, the mining power is very concentrated.” But however, it’s actually their checks and balances. Because if the miners try to do something that the devs don’t like, the devs push back. If the devs try to do something that the miners don’t like, the miners pushed back by saying, we won’t upgrade our nodes software. And that then there’s this kind of user power thing that comes in and that may kind of like be the deciding vote in a loose sense. And so just because mining power is somewhat centralized or just because core development is so much centralized, a judge could still say under a flexible test, I still think Bitcoin is decentralized, and I don’t think the securities laws should apply to it. So that’s the benefit there. And of course, by contrast, if you take a more rule based approach because that to avoid sort of setting adverse incentives and encouraging decentralization theater, you have to set it very conservatively, that same flexibility might not be there, right? Because you would just look at the consensus power, you say. Three guys own all the A6 now this is not decentralized, right? So that’s why you need both a standard and a rule, in my opinion, because both are useful in different contexts.

 

Sasha:

And what would be a flexible test for decentralization?

 

Gabriel:

The one version I came up with, the shortest version of it is, and this would be a judge kind of deciding this, right? Picture it that way.

 

Sasha:

Oh my god! I can never picture a judge having the depth knowledge on this stuff, so scary. But they can read your articles.

 

Gabriel:

Sure! And they can take expert testimony, and all the things that would be needed in a trial and they could get informed, right? And a judge would look at, say it according to my test, look at all the facts and circumstances, and if either of the following two conditions is satisfied, then it’s decentralized, right? No single person or group of affiliated person controls the open network system or the consensus economics or protocol of the system, right? So look at it overall. Look at each dimension. No one’s in control of any dimension. That’s kind of the most conservative version of it. And this is where the extra flexibility comes in. A person or group might control one or more of those aspects, but control over the other aspects of the system is widely distributed in a manner that limits the effects of the controlling group, right? Then you sort of neuters them, right? Guys holding Bitcoin. A6 could be one guy, could just be one guy holding all the A6, but he’s very limited in what he can do because if he starts to give himself extra rewards or something, people will revolt, and the value of the network will go down. And because they hold A6, which are non-repurposable, their own capital will be destroyed. And I think a judge looking at that set of factors would say it doesn’t matter that the mining power is very concentrated because in practice, there’s not a lot they can do. So that’s the kind of flexibility that would exist under this general standard.

 

Sasha:

Okay. And then what kind of bright line aspects could also be incorporated? And why would those bright line aspects be necessary?

 

Gabriel:

Right! So for the bright line test, I proposed a much more conservative test for the reasons I previously mentioned. And it’s somewhat arbitrary, right? I’m not wedded to the specific numbers and so forth. But what I ended up saying is, it’s clearly decentralized if less than 10% of the network tokens are own bias, sort of any identifiable person or affiliated group of affiliated persons, less than 10% of the means of determining consensus are owned by any person or group of affiliated persons. There are substantial funding independent of the initial development team available for research development and maintenance of the software involved in the network. And that research development and maintenance are really that funding is not directly or indirectly controlled by the initial development team.

 

That one in particular, you could imagine reframing in different ways. You could say, “Well, there’s a diversity of independent development teams that are working on it and they have the resources to do so.” Again, lots of ways to define this. Since this is a safe Harbor, which really means you got to look back, you got to think about someone who’s thinking about launching a new network, and they want to rely on this, right? What should that team have to do in order to get the benefits of this safe Harbor? In my opinion, they should have to say, when they raise the money, they should have to say, “Here’s our roadmap.” Right? And they shouldn’t be off the hook until they either complete that roadmap as advertised, complete a modified version of it approved through some reasonable process. It could be on chain voting or it could be something else, or they’re just kind of forgiven by it. Again, from the set of token holders who were trusting them to complete it. And I don’t think they should be off the hook until they do that. Because they advertise this from the beginning that it’s going to be this way and people bought on that basis. And it’s not just the primary purchasers who may be in privative contract, but it’s also people bought in the secondary market. So contract law is not enough.  You need the regulation to support. To me that’s important. They did what they said they would do, basically. That was my idea for how to define a bright line test.

 

Sasha:

I love that idea. Yeah. Have a road map and if you hit it, you’re okay. And the people that own the tokens being voting for it. And that’s kind of there too with the fraud. I would say the roadmap that would have to be proposed at the beginning would be a material fact. And I think the standard is if you lie about a material fact and misrepresented, then you’re in violation of securities act now.

 

Gabriel:

That’s true! But of course, the one complication of that is they may not have been lying. They might just have been overly optimistic. And I think that’s honestly the case for almost all these ICOs. Like I don’t think most of them were committing fraud. I just think they were like very naive. They may be like very smart developers, but they didn’t have experience in business, or even like experience on a big like software development team like Google has, right? And so they just didn’t understand how hard it would be to do the stuff that they wanted to do. We should set the law in a way that it strongly disincentivizes even sort of like non fraudulent naive tag.

 

Sasha:

Yeah. Because I mean they’re still taking people’s money. Even if they didn’t know, they thought they were building something that they couldn’t build. But then there’s the disconnect too, between the CEO or the main promoters and the development team. As soon seen that happened a lot where a development team or a company might hire a development team that says they can build it in a certain way and that never comes to fruition. So whose fault is it then when it doesn’t work out?

 

Gabriel:

Right, exactly!

 

Sasha:

Yeah. With this technology, it is very complicated because I feel like it only people that understand the technology really well should be offering these products really. And we thought the exact opposite of that, relying on advice of others about technology they didn’t understand. Now I was speaking with a couple of other attorneys at Tone Vays’s conference, I’m confiscateable with that and Jason Seabirds and David Silver about Commissioner Peirce’s proposal. And they were ready to take that it would never get approved. I kind of hope it doesn’t get approved. And that something like your test comes to fruition, are you willing to make any opinion on that?

 

Gabriel:

Sure! I think they’re right that it will never get approved by the SEC, or certainly not this set of staff at the SEC who knows, it turns over every four years in theory, right. So who knows, you might get very different people in there. Maybe it changes, but I’d be skeptical that any SEC adopts it or even anything that’s sort of like, “Oh, for three years only fraud applies, or for some period.” I don’t think that’ll happen. But I wouldn’t rule out that some legislative proposal that’s sort of has the DNA of Hester Peirce’s proposal, maybe with some modifications, etcetera could get passed. Because what’s happening over time is that, blockchain companies are making a lot of money.

And when there’s an industry, there’s lobbying, right? And politicians need to raise money for their campaigns, and they make promises and so on. And so it really depends on how threatening crypto is kind of seen by the political majority, if it’s not seen as particularly threatening, and there are some politicians who for their own ideological reasons or because of campaign contributions or whatever want it, then it could get passed almost kind of like semi apathy by most people. So I wouldn’t rule that out. I really wouldn’t. To me, that’s not the best because Congress’s laws tend not to be very precise. And then like a lot of times it may look good at first, but then as it really sort of ends up getting interpreted in the market, you realize there’s some hole.

 

And so like, actually it could end up like being worse than the Howey test in some ways, right? And so who really knows? So personally, I think it’d be better if like intellectuals define this at the regulatory level and get regulatory buy-in. And the other benefit of that is that you have this really great, and this is really my mantra and I think it’s the brilliant insight behind Hyndman’s speech is this idea of this law is a poison pill for centralization, right? So if you’re centralized, you’re going to face a bunch. That means you pose risks to people, people are trusting you. And that means you going to be regulated. But if you could figure out a way through clever protocol design and distribution of power where trust is not really required anymore, then you get this amazing benefit occurs.

 

The costs of the law are no longer needed. Because the risks that the law is trying to prevent are no longer present. And I just really believe that’s the right way for law and these systems to interact. And the risk of creating these, what these new legislations that just kind of arbitrarily carve out a token under some definition from a bunch of laws is that, it won’t have the richness of what is a truly decentralized system versus not. And personally I think that’s what we’re really going for here, and I think everyone should try to preserve that as much as possible.

 

Sasha:

That’s really the genius of Bitcoin, what you just described. And I don’t know about you, but I’ve been getting a lot of inquiries from no coiners, like friends from lifetimes ago about Bitcoin lately. Have you experienced any of that?

 

Gabriel:

Yeah, there’s definitely been an uptake. In fact, I even had like some friends who like lost money by holding too long after 2017, right? And were like talking to me about crypto back then and again, later on they’re like, “Ugh!” They were all mad about it and now they’re interested again. They’re like, “Well I think what I could do is I could just like play small bets or like every single small token and like they go out so much.” And I’m like, “Ugh!” But I have been seeing this increased interest. And I think what really happens is, it’s unrealistic to think normal people will have cypherpunk motivations like yearly ever. This like idea of the store of value and all that, like I believe in those memes, but most people are never going to care about them. They will care under one and only one condition, which is that they can make money from investing in the things. And so recently, there’s been more upward volatility, so to speak, as well as a lot of media attention that says, “Oh, you know, in a financial downturn, maybe Bitcoin and that sort of thing.” That increases people’s interest.

 

Sasha:

And like you pointed it out, they always want not Bitcoin, but the next best thing kind of thing. So I wonder, do you think we’ll see another ICO wave? Or I was just done with my ideas.

 

Gabriel:

In a loose sense, yes. I think we almost certainly will, but probably, it won’t be called ICOs, and it probably won’t really be the same as what ICOs in 2017 were. What I’m seeing, in a weird sense, the tokens that are being offered now are a whole lot more obviously like securities in most ways than “utility tokens” ever were because there’s like a pool of funds sitting in a smart contract and the token gets you a share of the revenue in that, and it gives you the ability to vote. So they look a lot more like shares of stock. Sometimes a little bit more like debt securities. But the interesting now in one sense, you might look at that and you might say, “God, no lessons were learned.” The only lesson that was learned was like, utility tokens are a bad investment. And maybe, the people who liked to trade in stock where it’s a wrong back in the day, let’s do something more than that. But I actually think there’s a deeper consciousness, because I think the other thing people have realized, again, due to the way regulators have positioned themselves about decentralization, etcetera, is if you could launch something that actually is a much better investment than a utility token. But if the whole community are the ones that are responsible for the changes in value of that, and it’s everyone kind of betting on each other in an unaffiliated way and cooperating, then maybe, the regulations don’t apply to that. But we don’t know that. Because Hyndman’s future was about investment contracts. It wasn’t about things that tactically meet the definition of shares. But on the other hand, there is this sort of overarching principle and securities laws that interest in true general partnerships are not securities. And so maybe a lot of these things are true general partnerships like we were talking about earlier, just to bring everything full circle and undoubtedly that’ll be the next wave. Not utility tokens and that sort of thing.

 

Sasha:

And do you think they will ever get on the stock market? Or how far are we in that?

 

Gabriel:

I think my hope is what will happen is that, crypto securities or crypto things that are very similar to securities will sort of deterritorialized or subvert existing securities markets and there will be this kind of blending between like the customer role and the equity owner role, for example. And I think they’ll always probably be like a NASDAQ that just trades these like stocks, but not even NASDAQ itself may have like a second one that’s more like token based and more creative, right? Stock is a very standardized thing. It’s almost all common stock, public stock, right? It doesn’t even get as creative as like placing preferred stock and common stock in the same market. Because they think we’re too stupid to handle that. But why? There’s so much creativity that can be done in the financial realm. And so many interesting ways of using possible appreciation and value to align incentives around how a platform is governed and what types of things it sensors and who accesses it. And all these tough questions that platform like Facebook are facing now, those should not be getting decided by Mark Zuckerberg. Those should be to getting decided by the collective of Facebook users. And so if Facebook was redesigned in a different way where the use of it was also like the equity ownership of it, and the voting of the representative for it and so on, you could really transform society. And that’s why I stay involved in these things despite all the shakiness and uncertainties and everything else, because that transformative power for our capital markets and our really our society exists.

 

Sasha:

Yeah. And it’s the same kind of voting could be used for content and censorship rather than immediately deciding what gets saved up or down based on my Facebook community. It would be more sensors.

 

Gabriel:

Or you could have shards, you could have Facebook shards, right? So that the consequences of really so much about these systems. Like what’s the real value proposition of Bitcoin? To me, it’s that you have the option of exiting a given governmental Fiat system, right? And so this right of free exit is core. If you just had like viable Facebook shards so that the consequences of getting the platform wasn’t as bad because you could still go and kind of use it amongst a slightly overlapping community. That would be huge, right? And we need that because our public sphere is like dying right now. You don’t want like a company that’s controlled by one guy, Mark Zuckerberg, to be in control of the entire democratic public sphere of discussion, or like a really big chunk of it. That’s bad. So I do think this type of stuff, if we get it right, and don’t either get too greedy, or be too conservative, but somewhere in the middle, I think we can unlock all that stuff.

 

Sasha:

And even we can’t get too rebellious. Like we need to work regulators so that we could move them based on the principal’s approach that you described to get sounds or either just stay out of the regulation. So things like 2017 were terrible because it brought so much light to this very small, very new industry that doesn’t need all this regulation. Yet perhaps others would argue the regulations very good. Or they keep the scammers out, but what do you tell the random people that asked you like, “Oh, Hey, should I buy Bitcoin right now?”

 

Gabriel:

I don’t really give them an answer because I’m not a trader, right? I’m not good at figuring out when to buy it and when to sell it. Well I like the name of this podcast, because for people like me, I still think HODL is the best strategy. I tell them to try to understand it, right? That’s the first thing I tell them. “Why does this thing Bitcoin exists? What is good about it?” Right. And then buy it. Once you have an idea about that, “do you believe that it will go up in value because it’s very useful to people? Or are you just like, you heard someone say that it might go up and you’re buying it. I mean what type of person do you want to be in life? You just want to be out-lemming who blindly follows just like random things that rumors that you hear and stuff? Or you actually like want to understand it?” Because I’ve always been of the mindset, like I would rather make less money on something that I knew it was a smart bet that I made it then like accidentally make a bunch of money  just because I got lucky cause I did something random that I didn’t fully understand, but like someone smarter than me made it work, right? That’s just me. I think a lot of people would actually just like getting rich either way, right? So if they don’t care how it happens, so that’s fine too. It’s all good.

 

Sasha:

Well, the first process you can probably duplicate throughout your life, research, profound decision. And so, where can people find you?

 

Gabriel:

Probably the best single place is my website, which is dealninja.law. All my articles are linked on there, and my social media, my past clients I’ve represented. And there’s a contact form through which you can email me. That would be the best spot.

 

Sasha:

And what kinds of clients do you like working with?

 

Gabriel:

It varies. I would say, still the larger percentage of my work is actually for like fairly “normal companies”, right? Doing like preferred stock financings and mergers and acquisitions. On the blockchain side, I like to work primarily with developers, right? And the earlier they can find me, the more likely I am to want to work with them. Because the strange thing about this technology is you can’t like first design the product and then go to a lawyer and say, “is it legal or not?” What we really should be doing with this technology is inviting a lawyer the whole, every step of the way. Because if they’re good at the law and they understand blockchain, like I’ve tried to learn to code and stuff like that, then they can really participate in the product development cycle. And you’re much less likely to go down a rabbit hole that’s gonna end up being useless to you, right? So that’s my kind of ideal situation I would say for working with crypto clients. But I’m willing to talk to anyone pretty much.

 

Sasha:

Excellent! Well, thank you so much for taking the time today. I learned a lot from you as I have from all of your articles. One more question. You call yourself an autonomous lawyer. What is that? What does that mean?

 

Gabriel:

Yes! Autonomous law. Some people thought it just meant like you’re alone or something, but it’s not true. I’m part of a firm. But to me, it’s a law practiced in the consciousness that comes from understanding the power of the types of systems we’ve been talking about in this discussion. And the ability to set incentives through crypto economics, and distribute power more widely and so on. And I honestly think that the consciousness I’ve gotten from working on blockchain stuff has infected my other areas of practice. Like I look at M&A deals in a much more game theoretical and functionalistic way now than I did before I got in blockchain. And so it’s practicing with that type of mindset, rather than a mindset of there’s a certain way of doing things, and it’s legal and you try to almost try to like shove things into the box as much as possible. Like embrace the full spectrum of possibilities. Take these principles about how to give people the right incentives and stuff and how to really think deeply about the regulations and whether they apply in certain situations and be creative, right?

 

Sasha:

Yeah! Very good! All right, well, thank you so much. And I started taking transcripts of the podcast too, if you want, I’ll send you the transcript.

 

Gabriel:

Oh, cool! Awesome! That’d be great! Well, thank you so much for having me. It was interesting getting your views as well. So you’re in that group, the hardcore crypto law group, right?

 

Sasha:

Yeah!

 

Gabriel:

Awesome! Okay, so we should just keep talking. And anytime you want to chat about anything, I’m always available.

 

Sasha:

Oh, absolutely! Thank you.

 

Gabriel:

Awesome! Thanks so much! Have a great weekend.

 

Sasha:

Thanks! You too.

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Sasha Hodler · Hodlcast Ep. 101 with Tatiana Moroz and Bobby LeeHodlcast 101 with Tatiana Moroz & Bobby Lee In this new installment of the Hodlcast, Sasha gets in touch with Bobby Lee (no, not the one of Mad TV fame) to discuss his entry onto the wallet market...

The PredictionCast

Sasha Hodler · The PredictionCast - 2020!Written by Emoji Nakamoto & Artwork by Indelible Trade Ups, Downs, Forecasts And Laughs in this Year’s PredictionCast 2019 was an incredible year for Crypto. As the fog of bull market mania lifted, clear eyes and productive...

LLC, PBC, or NonProfit?

Many startups struggle deciding what type of business entity will be right for them. Here, we will identify the differences of each structure, the Limited Liability Company, Public Benefit Corporation, or 501(c)(3) Nonprofit Organization. All three structures offer...

Ready for your Title 31 Exam?

The Internal Revenue Service (IRS) is auditing companies who registered with the Financial Crimes Enforcement Network (FinCEN) as a Money Service Business (MSB) involved in the Bitcoin space – it’s called a Title 31 Exam. These exams were typically reserved for Indian...

International Breach of Contract

How to deal with a breach of contract when the breaching party lives in another country? I’ve seen this a number of times when an American company contracts with a foreign company for services in the cryptocurrency industry -- and then the foreign company fails to...

THE LONG ARM OF NEW YORK

THE LONG ARM OF NEW YORK

WILL BITFINEX AND TETHER PROVE THEY DID NOT DO BUSINESS IN NEW YORK? Today Bitfinex and Tether, replied to the OAG with two documents, an affidavit by their attorney, Stuart Hoegner, and a Reply Memo supporting their Motion to Dismiss. Bitfinex and Tether are...

The Saga Continues… USAG v. Bitfinex/Tether

The Saga Continues… USAG v. Bitfinex/Tether

Sasha Hodler · HodlCast Ep. 81 A deep dive into Bitfinex with Amy Castor The saga continues — NYAG v. Bitfinex/Tether Quick Summary of the recent NYAG Decision and Order: IN THE MATTER OF THE INQUIRY BY LETITIA JAMES, ATTORNEY GENERAL OF THE STATE OF NEW YORK, v....

SUMMARY of the May 9 FinCEN Guidance

SUMMARY of the May 9 FinCEN Guidance

“This guidance does not establish any new regulatory expectations or requirements.” https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf TL;DR An MSB needs to register with FinCEN, (it’s free, you file Form 107), get an...

SUMMARY of the May 9 FinCEN Guidance:

FinCEN's recent guidance begins with the caveat, “This guidance does not establish any new regulatory expectations or requirements.” https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf TL;DR An MSB needs to register with...

The FinCEN Travel Rule

The FinCEN Travel Rule

I came across a new (to me) aspect of the Bank Secrecy Act recently — rule [31 CFR 103.33(g)] (the “Travel Rule”) which requires all financial institutions to pass on certain information to the next financial institution, in certain funds transmittals involving more...

Grow Your Blog Community

With Wix Blog, you’re not only sharing your voice with the world, you can also grow an active online community. That’s why the Wix blog comes with a built-in members area - so that readers can easily sign easily up to become members of your blog. What can members do?...

Design a Stunning Blog

When it comes to design, the Wix blog has everything you need to create beautiful posts that will grab your reader's attention. Check out our essential design features. Choose from 8 stunning layouts Your Wix Blog comes with 8 beautiful layouts. From your blog's...

Now You Can Blog from Everywhere!

We’ve made it quick and convenient for you to manage your blog from anywhere. In this blog post we’ll share the ways you can post to your Wix Blog. Blogging from Your Wix Blog Dashboard On the dashboard, you have everything you need to manage your blog in one place....

Bitcoin Hedge Fund Rules

Bitcoin Hedge Fund Rules

In today’s article, we will explore whether a Bitcoin hedge fund requires Securities and Exchange Commission (SEC) or Commodities and Futures Trading Commission (CFTC) registration. What is a Bitcoin Hedge Fund? A Hedge Fund (or Private Fund) is when you put two LLCs...

Florida Money Transmission after the Espinoza Opinion

Florida Money Transmission after the Espinoza Opinion

On January 30, 2019, the State of Florida appealed forcing Mr. Espinoza to relive the trial for his 2013 and 2014 localbitcoins.com sales to undercover cops. See http://www.3dca.flcourts.org/Opinions/3D16-1860.pdf. The counts against Mr. Espinoza include: Count...

Bitcoin & the FBAR

Bitcoin & the FBAR

I had the opportunity to participate on a Legal Panel with David Silver at the Unconfiscatable, Bitcoin not Blockchain Conference put on by Tone Vays in Las Vegas. It was quite an honor to be part of it; the conference was hands down the best Bitcoin event I’ve...

The Bitmain Lawsuit

The Bitmain Lawsuit

Gor Gevorkyan v. Bitmain, Inc., Bitmain Technologies, Ltd. And DOES 1 to 10 A lawsuit was filed in the Northern District of California against Bitmain on 11/19/2018. See https://www.scribd.com/document/393971649/Bitmain-Class-Action In a brief summary, the Plaintiff...

SEC’s November 16 Comments

Ready or Not, Here They Come, You Can’t Hide, Gonna Find You and Make You Register & Refund First and foremost, today’s expansive press release was made with the following disclaimer: “This statement . . . is not a rule, regulation, or statement of the Securities...

Operation Choke Point

I was skimming the facebook page of a soon-to-be-podcast guest, Kingsley Edwards, and came across a disturbing article describing Operation Choke Point.[1] The name of the Operation struck me as odd and after a few lines of reading, I knew it was the problem facing...

Know Yo Customer

Know Yo Customer

This is not legal advice, just my opinion. I’ve met many brilliant entrepreneurs bravely navigating the alphabet soup of the American crypto regulatory environment. Today’s post is focused on the importance of knowing your customers (“KYC”) if you are a Money Service...

Mr. Terpin v. AT&T

Mr. Terpin v. AT&T

Terpin v. AT&T Inc., AT&T Mobility, LLC, and DOES 1–25 One of the biggest news stories of the week was Michael Terpin (“Mr. Terpin”) suing AT&T after getting his sim-card hijacked. These types of hacks through the phone company are not a new phenomenon,...

OCC Banking Charter for FinTECH

OCC Banking Charter for FinTECH

Is this The End of State-by-State Money Transmission Licensing? The Office of the Comptroller of the Currency, U.S. Department of Treasury (“OCC”) came out with some big news on Tuesday, July 31, 2018. Now crypto (fintech) companies can apply for special-purposes...

Removing a member from an LLC

Removing a member from an LLC

Unfortunately, business relationships don’t always work out as expected, and you may need to remove your partners from their equity ownership / member position in your LLC. Hopefully this process is clearly defined in your Operating Agreement. If not, it can quickly...

Giving Tokens the Hammer

Giving Tokens the Hammer

The 2009 invention of Bitcoin has forever changed financial technology. Through the rise of economic innovation, Cryptocurrency makes it possible for any person or company to create a coin or token linked to their brand—and to give it a plethora of functionality. Some...

CFTC Employees are now allowed to Trade Crypto

CFTC Employees are now allowed to Trade Crypto

Upon first seeing this headline, my thoughts were, “uh oh, things are going to get a lot less productive over at the CFTC!” I remember my first few months of trading, it can be highly addictive!  The important thing here is that we got another layer of clarity to...

Bitcoin & Taxes

Bitcoin & Taxes

After the recent ruling in the case with Coinbase, Bitcoin Tax has been a hot topic, and I wanted to try my hand at navigating it. This is not legal or tax advice.Only 800-900 Americans reported any bitcoin tax related events between 2013-2015, even-though there were...

Bitcoin & Estate Planning

Bitcoin & Estate Planning

Bitcoin & Estate Planning Agenda: 1. Get a will 2. Make a tax plan 3. Dig some holes in your backyard (or find an executor you trust) Disclaimer – This is not legal or investment advice. T'is the season to be... morbid. Have you thought about what would happen to...

What is Bitcoin

What is Bitcoin

What is Bitcoin? Over the past few weeks, as the Bitcoin price has soared, lots of people have been reaching out to ask me, "What is Bitcoin?" It prompted me to start this blog- and while I am a licensed attorney in Florida - I want to preface that this is not legal...

Celebrity Backed ICOs

Celebrity Backed ICOs

Anyone who endorses ICOs or any kind of Cryptocurrency should be careful not to overstep the Securities Laws and potentially be prosecuted for a Pump and Dump scheme. After the recent Senate Hearing on Feb 9, 2018, Securities and Exchange Commission (“SEC”) Chairman...

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