However, the two-page letter contained a remarkable amount of FUD. For example, it contained this assertion: "A single Bitcoin transaction could power the average U.S. household for a month." Just a moment's reflection should reveal the absurdity of that claim. Nevertheless, those kinds of claims help create and reinforce a narrative about proof-of-work consensus being energy inefficient, which these days is a dangerous thing to be accused of being. That narrative, in turns, softens the ground for more serious action by governments. 

We saw the same dynamic at play with the recent passage of a bill in the New York Assembly that would impose a moratorium on "behind-the-meter" proof-of-work mining by carbon-fueled energy generators. In practice the bill's effect would be pretty narrow, but it furthers a pernicious narrative that can and will drive policy. And here's a tweet from the World Economic Forum last week that has the highest misstatements per second I've ever seen. Talk about misinformation.

World Economic Forum @wef

A change in the way bitcoin is coded could almost eliminate its environmental impact. Learn more: ow.ly/M7n850ISvJk

1:00 AM ∙ Apr 27, 2022

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Over the years many smart Bitcoiners have valiantly sought to counter FUD with ad hoc corrections of the misinformation that's constantly produced. They also regularly release factual data on the state of mining's energy use for anyone who’s interested in digging into the details. Just this morning a group of Bitcoin luminaries released a thoughtful line-by-line refutation of the congressional Earth Day letter. The goal of all this is to set the record straight, which is admirable and necessary, but I'm not sure it's sufficient to counter the false narrative about proof-of-work mining. 

Efforts to debunk the FUD quickly run into Brandolini’s Law, which Wikipedia defines like so:

Brandolini's law, also known as the bullshit asymmetry principle, is an internet adage that emphasizes the difficulty of debunking false, facetious, or otherwise misleading information, especially in comparison to the difficulty of creating the misinformation in the first place. It states that "The amount of energy needed to refute bullshit is an order of magnitude larger than is needed to produce it."

Folks like the members of Congress who sent the letter to the EPA have the luxury of "just asking questions" or engaging in simplistic deductions, like dividing Bitcoin's electricity inputs by number of transactions. Honest deboonkers, on the other hand, face the challenge of having to be nuanced, and nuanced in a way that requires lots of technical understanding to fully grok. And even then a response or debunking won't get anywhere near the same amount of attention from the dominant media as the FUD that precipitated it.

So what a can be done? 

First it's important to note that while this is a problem that affects all proof-of-work networks (including Ethereum), it is really seen as a Bitcoin issue. For all kinds of reasons, both fair and unfair, proof-of-work is increasingly synonymous with Bitcoin, and will be more so if and when Ethereum switches to proof-of-stake. We also have to understand that while the FUD narrative is a problem that affects all Bitcoiners, it's something that the mining industry is best positioned to address.

In the decade I've been working on Bitcoin in Washington I've seen several serious but ultimately abortive efforts to create the equivalent of a "milk board" for Bitcoin to drive its own narrative and counter false ones. The reason these efforts have never come to fruition is that while everyone in Bitcoin is threatened by false narratives and the policies they can spawn, no individual has the incentive to dedicate the resources that are necessary to seriously counter the threat. Instead the incentive is to free ride, and even when there are some who are willing to pitch in for the common good, they typically (and understandably) will want to individually call the shots on message and strategy, which in turn limits the scale of common efforts.

What Bitcoiners face is a collective action problem.

That concept was best explored by economist Mancur Olson, a thinker who's had a great influence on me. In particular, I've long been keen on his thinking on how collective action problems are overcome. His key insight is that the size of the group matters. Here's how Wikipedia explains it (emphasis mine):

In contrast to the traditional theory the group size plays a decisive role in Olson's theory. Concerning the optimal group size it has to be stated that small groups possess the tendency of suboptimal provision with public goods. But large groups often fail to provide themselves with a collective good at all. The smaller the single share of a member is the less is the optimality. This means that larger groups are less efficient. Moreover, it is important to consider not only the number of members of a group but also the size of each individual. The individual with the highest gain will most likely pay for the most part of the public good. “Normal” members will most likely not pay but nevertheless consume the public good, which is known as the so-called "free-riding", this can only be wiped out in groups which provide benefits only to active members. This results in the tendency of the exploitation of the great by the small. An optimum can only be reached, if the marginal costs are equally high as the marginal gain. There cannot be an over-optimality as in that case some individual had to have higher marginal costs than marginal gain and would cease the payment to provide the good, which would lead to a suboptimal provision of the public good.

In the end this leads to the conclusion that even though they tend to provide a suboptimal amount of a public good smaller groups are more efficient than larger ones which fail more likely to obtain even a minimal amount of a public good the larger they are.

If you'd like to go deeper on the theory, I would heartily recommend The Logic of Collective Action: Public Goods and the Theory of Groups by Olson or, for a more accessible application of the theory to politics, Government's End: Why Washington Stopped Working by Jonathan Rauch.

That all said, it seems pretty clear to me that the largest possible group that will ever be capable of taking serious steps to combat FUD on Bitcoin's energy use, and that also has a sufficiently direct incentive to do so, is the mining industry—and even it may be too big. Efforts to organize at a scale larger than the mining industry will likely fail, especially if the larger size is due to the inclusion of folks with less-direct incentives to contribute. 

In my view, any systematic defense or (better yet) positive marketing campaign for proof-of-work will only come from the Bitcoin mining industry. Miners have a clear, short-, medium- and long-term interest in the matter at hand. Miners are few relative to the millions of people with an interest in Bitcoin worldwide or even just in the U.S. And because it is a relatively small industry, free-riding can more easily be policed through informal reputational mechanisms and the like. So, miners need to unite. 

On that front, it won’t do to only engage in ad hoc or small upstart efforts. It also probably can't be done effectively through broader industry groups that represent a wide array of interests and have to constantly and understandably juggle priorities. And while a well-resourced mining industry trade group could be the ultimate outcome, it doesn't have to be the first step. Miners should instead consider forming a professionally managed coalition to address their immediate concerns about energy FUD. (If you don’t know what an issue coalition is, here's a Washington Post article on how they work.) And again, while the temptation will be there to make a coalition broader and include VCs and investors and exchanges and others with a vested interest in Bitcoin's success, the better path would be to read Olson, keep it tight, and think of expanding only after an effort has had some success. 

Now that we know who’s best positioned to act, the next question is, what should they do?

To answer that I'd ask myself another question: Who are you trying to convince? I'm not sure I have a good answer to that, but answering it clearly and deliberately should be the first order of business. I doubt that people like Biden's EPA administrator, or the 22 members of Congress who sent him a letter on Earth Day, are the folks most primed for a positive proof-of-work message. I also don't think that the general public is a good target; given inflation, rising crime, war in Europe, and the rest, I'm not sure they're primed to care much about this stuff or vote one way or another based on it. 

The folks to reach, in my view, are the Joe Manchins and Kirsten Sinemas and Mitt Romneys of the world who form the vital center of policymaking that's more or less reasonable, open to persuasion, and that should be in control in an evenly divided nation. It's also the Joe Weisenthals and Kevin Rooses of the world who'd give one a fair hearing in the dominant media. What’s missing, therefore, is not more data, or more research, or more thoughtful analyses—there's thankfully plenty of that. What's missing is a serious and targeted lobbying and communications effort (i.e. going out and talking to people).

What’s the message?

Again, I'm not sure I have the answer, but there are a couple of ways to think about that. First, one has to contend with the compelling notion that arguing on the climate maximalists' terms means one's already lost. For example, conceding the desirability or even physical possibility of net-zero emissions in a few decades' time (without a concomitant human calamity) means one has already implicitly agreed to unachievable policy aims. Why concede that "renewable energy" is preferable to other sources of energy simply by virtue of them having been categorized as "renewable"? Ethanol requires vast expanses of otherwise-food-producing land and tons of petroleum-derived fertilizer; solar requires energy-intensive production of polysilicon; and nuclear isn't even classified as "renewable" by some climate maximalists. And why concede on the concept of "ESG" with its inscrutable and movable goal posts? Trying to make Bitcoin fit into an "ESG" box without realizing that the box is just a tool for social control, and one that Bitcoin will never be allowed to fit in, is a probably a fool's errand. 

It would take guts to stake out that kind of position because it runs so counter to the dominant narrative, but it has the advantage of comporting with physical reality in the long run. And in the long run should appeal to the American sensibilities and our bias for markets, innovation, and optimism.

Another way to approach this (and not mutually exclusive with the above) is to make the case that if one really believes that electricity generation that emits greenhouse gasses is bad, then it's bad no matter the use to which the electricity is put. If one believes a kilowatt of coal-generated electricity is harmful, then it's harmful whether it powers a Bitcoin miner or an electric vehicle. It should follow then that the way to address the negative externality of emissions in a manner that comports with American values of choice, competition, and fair play, is to target the electricity production, not to pick winners and losers among competing uses of electricity. And a reasonable way to do that is to impose a Pigovian tax—that is, a tax on the externality, which in this case is emissions-producing electricity generation, not any particular use. This should have the benefit of not just disincentivizing high-emission electricity generation, but also incentivizing the development and use of low- or no-emission electricity, all while leaving allocation to the market.1

Although I have to admit I haven't thought through the implications of implicitly conceding on the advisability of a carbon tax, what I like about this message is it's simplicity. It doesn't require one to justify or apologize for Bitcoin's use of electricity. Instead it puts the onus on those who would single out Bitcoin to explain why they want to tinker at the margins targeting specific uses rather than addressing the root problem, and why they think they have a better grasp than the market on what's a valuable use of electricity. They'd also have to answer whether their goal is not just limiting green house gas emissions, but rather limiting the use of electricity itself, which is anti-growth and anti-human. This is a message that should appeal to the vital center I mentioned above, but what do I know.

As a final word I'll say that if the mining industry undertakes this challenge it should recognize that there likely is no ultimate victory to be had. I doubt there will a point in our lifetimes when the matter is settled one way or another. Instead it will be a Sisyphean undertaking that's the price of living in a liberal democracy.

Nota Bene

State pension fund pushing Mastercard to address ghost gun purchases

What Can Elon Musk Do with Twitter? - Cato Institute

Mr. Crypto Goes to Washington - Apricitas

Sanctions on Russia Won't End the Dollar's Reserve Currency Status - Apricitas

Inter-Elite Competition and Institutional Destruction - Discourse

Michael Lind: The End of Progressive Intellectual Life - Tablet

Last week the IMF released its semiannual Global Financial Stability Report and it included a deep dive into DeFi. There’s probably little in the report you don’t already know, but it gives great insight into how global regulators are thinking about DeFi.

In contrast to the headline-grabbing FUD from grandstanding politicians, the report is sober and thoughtful. The benefits are acknowledged forthrightly. For example: “DeFi has the potential to exhibit cost-efficient financial intermediation by bypassing and shortcutting the intermediation chain.” And: “Consequently, DeFi offers broad access to players of any size and has no need for custodian service, potentially improving efficiency and financial inclusion.”

The risks are also fairly assessed: 

Similar to traditional lending, DeFi is not free from market, liquidity, credit, operational, and cyber risks. DeFi lending can incur losses under unfavorable market conditions, and liquidity mismatches can be a cause for failure to meet redemption requests. Moreover, it appears to be more vulnerable to cyber and AML/CFT risks, due to loopholes in computer code and the anonymity of the platform.

What’s most interesting, though, is the commentary that shows how regulators are beginning to come to grips with the new reality that crypto creates. For example (emphasis added):

DeFi poses unique challenges to regulators. DeFi’s elevated market, liquidity, and cyber risks may need adjustment to the regulatory perimeter, but DeFi’s anonymity, lack of a centralized governance body, and legal uncertainties render the traditional approach to regulation ineffective.

To date financial regulators have taken for granted centralized intermediaries that are the leverage points for control. Crypto eliminates the need for intermediaries, and with it the “traditional” vector of control. Regulators therefore find themselves needing to control the behavior of “anonymous” individuals without the help of a compliant “centralized governance body.”

A couple of things can be said about this. First is that it’s precisely the elimination of intermediaries that accounts for the efficiencies that the report touts as benefits. This creates a bit of a paradox for regulators. Second, many of the risks that regulation exists to address are risks created by the historical necessity of intermediation. Custody risk is an obvious example, but so is the kind of information asymmetry that may no longer exist in a transparent, on-chain environment. So, the elimination of intermediation also eliminates some justification for regulation.

Another thing to say is that it was totally predictable that regulators would eventually come to these conclusions, and indeed it was predicted. In a paper Houman Shadab, Andrea O’Sullivan, and I wrote in 2013 (!) for the Columbia Science and Technology Law Review, we said,

This is a new world for policymakers. In the past, to achieve a public policy goal, they only needed to regulate a handful of intermediaries. The perceived benefits of the public policy goal very often outweighed the cost associated with regulating the few intermediaries. If there are no intermediaries, but only thousands or millions of users interacting peer-to-peer, then the costs of enforcement may well outweigh any perceived potential benefits of regulation. In this new world, regulators should take into consideration the increasingly high cost of information control into their cost-benefit calculus. Doing so may lead policymakers to conclude that efforts to control only make sense as a last resort.

If top-down regulation is increasingly not a cost-beneficial option for achieving public policy goals, policymakers will have to consider realistic alternatives, such as focusing on resiliency and adaptation. These are concepts borrowed from biology and ecology. Resilience is the capacity of an ecosystem to recover quickly from a shock, while adaptation is the change an organism or species undergoes to become better suited to a new environment.

While the IMF report shows that regulators are indeed coming to terms with the fact of a new reality, they don’t yet seem to be opting for the strategies of adaptation and resilience that we discussed in our paper. Instead, they’re still looking for ways to exert control. That is, while they’ve gotten past “denial” and “anger” stages of grief (at least in this report), they seem to be stuck in the “bargaining” stage.

What they propose is that regulation should focus on “centralized entities in the crypto asset ecosystem” like exchanges and stablecoins. More specifically, they suggest that regulators could “restrict the exposure of regulated firms to DeFi markets (especially markets not subject to proper regulation or self-regulation), which could slow the pace of growth while addressing the risks of interconnectedness with regulated markets.” Translation: place restrictions on centralized crypto actors that limit which kinds of (or which specific) smart contracts they are allowed to interact with.

We’ve seen an increasing number of regulators worldwide place restrictions on how centralized exchanges can interact with “self-hosted” wallets in the name of AML, and I suspect we’ll begin to see this being done in the name of financial regulation as well. This will like be self-defeating since it will encourage individuals to further avoid centralized intermediaries. While strategies of “resilience and adaptation” beckon, regulators will probably want to try every possible lever before they reach the “acceptance” stage (hopefully without spending too much time in “depression”).

With that in mind, I’m not sure how to assess this final recommendation from the report (emphasis mine): 

As a second step, authorities can directly regulate key functions within DeFi. To manage the risks generated by protocol developers, measures could include public-private collaboration on code regulation through either ex ante guidelines on operational and risk parameters (including operational and cyber resilience) or ex post code reviews and audits that can identify areas vulnerable to risk and help deliver policy objectives. Ex ante measures can be combined with greater disclosure and user education to help identify platform-specific risks, closing the information gap between retail and institutional investors.

On the one hand, this is an explicit call to regulate code. On the other, it’s couched in terms of “public-private collaboration” to develop “guidelines” and conduct “user education” and other mushy language. Maybe the report’s authors are not too sure themselves how far they want to push. 

In the short term I expect we’ll see attempts to restrict the publication of code (like the pending SEC rulemaking on the definition of “exchange”). Doing so would be unconstitutional in the U.S. and, while it may require fighting all the way to the Supreme Court, I’m confident such restrictions won’t stand legal scrutiny. Globally there’s less protection for code, but ultimately I think regulators will find that the costs of enforcing such controls will outweigh any benefits they seek to get. And in a footnote the authors of the report hint that outright bans don’t work:

Despite the implementation of restrictions, an estimated 1.7 million Egyptians hold crypto assets. Many crypto asset service providers operate offshore; users can take advantage of virtual private networks to obscure their location, demonstrating the difficulty in enforcing regulations.

With any luck, in the long term what we’ll get a settlement that’s be beneficial for everyone involved. I’m optimistic.

Nota Bene

In a new episode of Tangents, the podcast from Coin Center, Peter and I walk through our argument that the SEC’s proposed reinterpretation of “exchange” would violate the First Amendment because it is a prior restraint on speech, in particular on persons publishing decentralized exchange software. Video below and audio is here. Peter also discussed this topic with Laura Shin on the Unchained podcast, and you can see that here.

Since I know you can’t get enough podcasting, here’s more. In the new episode of Worker & Parasite, my book podcast with Stably, we discuss Beyond Good and Evil by Friedrich Nietzsche. Please keep in mind we have no idea what we’re talking about.

And finally, check out Neeraj on the new episode of Vice’s Cryptoland series. Our boy is all grown up.

Jerry Brito @jerrybrito

Wow. Now this is great communication. So proud to work with @NeerajKA

2:10 PM ∙ Apr 21, 2022

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Switching to Substack

I’ve long resisted the allure of Substack for a bunch of reasons, but I’m giving it a shot. I’m retaining the ability to switch back to self-hosting if it doesn’t work out. Let me know what you think and if it changes anything for you. You can hit reply to get in touch as usual, but with Substack posts now have a comment section as well, so feel free to post there. And as always, it would really mean a lot to me if you shared this with friends you think might like this newsletter.

I’m back from some much needed R&R. Hope you missed me as much as I missed you.

Today I want to provide some commentary on a recent speech by SEC Chairman Gary Gensler on the subject of crypto regulation. Before I do that, though, I want to commend to you a comment letter written by Peter Van Valkenburgh, and filed on behalf of Coin Center on Thursday, in the SEC’s rulemaking proceeding to change what counts as an “exchange” subject to registration with the Commission.

SEC’s proposed interpretation of “exchange” is unconstutional

You can read Peter’s summary here, but the entire letter is worth reading. Bottom line, the proposed change would make it so that the trigger for registration would no longer have to be conduct; mere speech would suffice. That is, if you made available decentralized exchange smart contracts, and people used them, you’d be considered an exchange and required to register with the SEC as a National Securities Exchange or ATS. As a result, it would be illegal to publish code unless you first registered with the SEC. But, as Walter said in the Big Lebowski, that is a prior restraint on speech which the Supreme Court has roundly rejected.

Peter’s comment makes it clear that the SEC’s proposed change is unconstitutional and the Commission should scrap it. If it is finalized as drafted, we or someone else in the crypto space will no doubt file a First Amendment challenge in federal court and, as Peter outlines, the current Supreme Court is itching to stand up for commercial free speech rights against regulatory prior restraints.

One thing that is very annoying about this proposed rule is that in its 200 pages it doesn’t once mention crypto or DeFi or decentralized exchange. I can imagine the SEC would say that’s because crypto was not the motivation for this rule change. As several commissioners have stated, who they primarily seek to capture with the change are providers of so-called “communications protocol systems” that facilitate the trading of fixed income and government securities (like certain Bloomberg Terminal services, I imagine). Indeed, in considering the burden of the proposed change (as required by law), the proposal states that “the Commission estimates the total number of Communication Protocol Systems to be 22,” which would only make sense if you were completely ignoring crypto.

But it just doesn’t pass the smell test that folks as smart and steeped in crypto as the leadership and staff of the SEC did not see that the language in the proposal is so broad that it would cover a massive array of systems including decentralized exchange. Indeed, it didn’t escape the attention of Commissioner Peirce, who dissented from the proposal and warned in her statement on the matter:

A final message to those who operate any service that is designed to facilitate any communication between potential buyers and sellers of any type of security: Read this release. Even if you have nothing to do with government securities or even fixed-income, or with traditional securities, read this release. Preferably as soon as it is published on the Commission’s website. It covers a lot of ground, and you should not assume that it has nothing to do with you, because it probably does.

This all suggests an attitude to the regulation of crypto that can only be described as Machiavellian.

Gensler on Crypto Markets Regulation

Which brings me to Chairman Gensler’s speech of April 4 on crypto markets. It is a recapitulation of statements he’s been making in interviews, congressional testimony, and elsewhere for some time, but now collected in on place. The speech addresses three topics: “platforms”, tokens, and stablecoins.

By “platforms” he largely means crypto exchanges, and he draws no distinction between centralized and decentralized systems. I won’t address that distinction beyond what I’ve already said above about the comment letter we just filed and pointing you to this piece on why “decentralized exchange” is a verb and not a noun. Instead I’ll focus on centralized exchanges. Gensler says exchanges should register with the SEC because (emphasis mine):

[T]hese platforms likely are trading securities. A typical trading platform has dozens of tokens on it, at least. In fact, many have well in excess of 100 tokens. As I’ll address later, many of the tokens trading on these platforms may well meet the definition of “securities.” While each token’s legal status depends on its own facts and circumstances, given the Commission’s experience with various tokens that are securities, and with so many tokens trading, the probability is quite remote that any given platform has zero securities.

Saying that some exchange-traded tokens “may well meet” the definition of securities also reminds me of Walter in the Big Lebowski. In particular when he says in eulogizing Donny that, by scattering Donny’s ashes at a beach in La Jolla, he was doing what “may well have been his dying wishes.” That scene is funny because Walter couldn’t know what Donny’s wishes were. Here it’s funny because the SEC won’t say any particular token is a security but nevertheless expects exchanges to submit themselves to comprehensive regulation based solely on an untested likelihood.

Chairman Gensler has often referred to the SEC as a “cop on the beat.” Imagine if police could stop and arrest you because you “may well” be committing a crime. Perhaps given your demographic profile there’s some probability that you’re likely committing some crime, so maybe you should turn yourself in. That would be ridiculous, of course, and it’s no less ridiculous here. ¡Que ridiculo! as Maude Lebowski would say.

In response to his entreaties, one can imagine an exchange saying to Chairman Gensler, “We certainly want to be in compliance with the law, and it’s not our intention to ever list a security on our platform, so can you please tell us which of the tokens we list is a security so that we may immediately delist it?” A probability doesn’t cut it. Before the Commission can expect an exchange to register it needs to say exactly which listed tokens are the securities. And that brings us to the “tokens” part of Gensler’s speech.

On tokens, Gensler says:

The fact is, most crypto tokens involve a group of entrepreneurs raising money from the public in anticipation of profits — the hallmark of an investment contract or a security under our jurisdiction. Some, probably only a few, are like digital gold; they may not be securities. Even fewer, if any, are actually operating like money.

It’s not so straightforward. That description omits the “common enterprise” and “efforts of others” prongs of the test for an investment contract. There are certainly entrepreneurs who raise money from investors by making promises of efforts they will make to build a token network, and such parties should certainly register their securities offerings with the SEC. But that doesn’t mean that resultant tokens are securities any more than the land sold in the Howey case was ever a security—even if it was part of an unregistered investment contract at some point.

At the very least this has never been decided by a court, and certainly not by the Supreme Court, which is the only way we’re ever going to get certainty about when a token is a security. (I have little confidence we’ll get the answer out of Congress anytime soon.) So, if the SEC is so confident that most tokens are securities, and that as a result exchanges that list them are securities exchanges, then it should bring enforcement actions against token issuers, and not simply settle, but litigate the cases in court so we can all get some actual binding precedent.

To date the SEC has been pretty reluctant to file in court against token issuers. The notable exception is the case against Ripple, brought under the last chairman, and which may not even decide the status of XRP as a security. As a result of that suit, XRP was widely delisted from exchanges, and it’s far from a forgone conclusion that the SEC will win the case.

If the SEC won’t bring cases against a particular token issuers and try them in court, perhaps a prospective token issuer should bring a pre-enforcement challenge against the SEC to get federal courts to opine once and for all about when a token is a security. (If you would be interested in funding such a lawsuit against the SEC, please reach out as I’d like to talk to you.)

Finally, Chairman Gensler addressed stablecoins. He doesn’t really say much of substance as far as the application of the securities law to stablecoins goes, but he notes that they “raise issues for investor protection.” For my part I have little more to say about stablecoins than I already have elsewhere. As I told the President’s Working Group on Financial Markets when it was investigating stablecoins, “To the extent an issuer is not authorized by a prudential regulator or is not backing a stablecoin with dollars and safe assets approved by a regulator, but is instead backing it with riskier assets or a basket of assets, then the securities laws apply.” So then the question is, where has the SEC been? Again, not in court despite the investor protection concerns.

Various and Sundry

On March 30 I spoke on a panel discussion titled “Crypto and National Security: How to Validate American Innovation and Verify U.S. National Security” hosted by the National Security Institute at the Antonin Scalia Law School at George Mason University. Other panelists were Sheila Warren of CCI and Juan Zarate of K2 Integrity and it was moderated by Laura Shin. You can watch the panel discussion here.

Last week I participated in a conversation with Axios reporter Lucinda Shen “on the most consequential trends in cryptocurrency and what’s next for regulation.” Also on the program was a conversation with George Mason University associate professor of law J.W. Verret (who has a great crypto newsletter himself). You can watch the program here.

Nota Bene

If You Use a Bank Account, Don’t Get on the Wrong Side of the Government - Discourse

Arthur Hayes: Energy Cancelled

Crypto picks its battles with Biden - Protocol

A short one this week as it’s my birthday weekend and I should spend it with my family rather than bloviating here. If you’d like to do something nice for my birthday, please consider forwarding this to a friend who may be interested or sharing it with your followers. Word of mouth is what grows this newsletter and growth is what keeps me writing it :)

The “big news” from last week was that Sen. Kirsten Gillibrand (D-NY) and Sen. Cynthia Lummis (R-WY) announced at a POLITICO fireside chat that they were working together on a comprehensive crypto bill. Ahead of the event, the buzz had been that Sen. Lummis would be announcing a democratic co-sponsor for the bill that she has been previewing since at least December and that earlier this month she said she was “putting the final touches” on and was “almost ready.”

What struck me about the event was that Sen. Gillibrand repeatedly referred to the effort as a nascent one. She said, “We’re really at the beginning of the process in terms of writing legislation, but also talking to stakeholders, talking to regulators, talking to industry experts so that all voices are part of this legislative process.” What this tells me is that while she’s signing on to work with Sen. Lummis on a bill, it doesn’t sound like she’s signing on to co-sponsor the bill that Sen. Lummis has already drafted.

That makes perfect sense. If she’s going to be the lead co-sponsor of a comprehensive bill to regulate a whole industry, Sen. Gillibrand will no doubt want to co-author it from the ground up after consulting widely with stakeholders. That seems to be a process that’s starting now.

What’s great about Gillibrand joining Lummis in this effort is not only that she makes it a bipartisan affair, but that she sits on the Agriculture Committee, which oversees the CFTC and will have jurisdiction over the bill. Lummis sits on the Banking Committee. You’ll need bipartisan buy-in from both committees for the bill to have legs.

Bitcoin for Oil and Gas?

With the “crypto can help Russia evade sanctions” stories dying down, a different narrative exploded last week: Russia plans to accept Bitcoin in payment for oil and gas exports.

All of the stories reporting this are sourced to a single statement made by Pavel Zavalny, chair of the energy committee in the Russian Duma. When you see his full statement, however, it’s clear his reference to Bitcoin was a throwaway line:

“When it comes to our ‘friendly’ countries, like China or Turkey, which don’t pressure us, then we have been offering them for a while to switch payments to national currencies, like rubles and yuan,” Zavalny said during the press conference. “With Turkey, it can be lira and rubles. So there can be a variety of currencies, and that’s a standard practice. If they want bitcoin, we will trade in bitcoin.”

His meaning, clearly, is that they’ll trade in whatever is convenient for the ‘friendly’ buyers (while ‘unfriendly’ nations must pay in Rubles). Even though it’s certainly significant he said Bitcoin and not gold or something else, there was in reality no announcement that Russia is accepting, or proposing to accept, or even seriously considering using Bitcoin in any systematic way.

We’re in uncharted waters these days, so who knows, it could happen, but I doubt it’s likely. Assume Russia accepts Bitcoin for oil and gas, what does it do with the Bitcoin then? What Russia wants to do with export revenue is spend it on imports that it needs, primarily from China. Bitcoin, of course, is banned in China, so I doubt Russia is going to find many in China willing to accept it. Well, one might think, they can convert into another currency before spending it, but of course that’s going to be difficult if not impossible given the sanctions in place. And more to the point, if they are going to end up with another global currency like dollars, euros, or yuan, why not just accept that in the first place?

DeSantis is Cool with Crypto

An item that in my view got less attention than it warranted is that Florida Gov. Ron DeSantis announced he’s in support of the state accepting cryptocurrency for tax payments.

What’s relevant is not the fact that Floridians may be able to pay taxes with Bitcoin. Ohio became the first state to accept Bitcoin for taxes under then-state-treasurer Josh Mandel and it was a total flop, with “fewer than 10 transactions in just under a year of operation.”

What’s eye-catching is just the fact that DeSantis is clearly A-OK with crypto. According to polls he is the preferred candidate for the 2024 Republican nomination for president after Donald Trump, who’s been hostile to crypto. Crypto may end up with a binary choice in the Republican presidential primary.

Various and Sundry

Worker and Parasite is a bi-weekly book discussion podcast I do with Stan Tsirulnikov and on the latest episode we talk about The End of History and the Last Man by Francis Fukuyama. Agree with it or not, the book is a masterpiece, and I think this is one of our best episodes. You can listen and subscribe here.

On March 30 at 4 p.m. I’ll be speaking on a panel discussion titled “Crypto and National Security: How to Validate American Innovation and Verify U.S. National Security” and hosted by the National Security Institute at the Antonin Scalia Law School at George Mason University. Other panelists are Sheila Warren of CCI and Juan Zarate of K2 Integrity. It will be moderated by Laura Shin. You can register to watch online here.

Worth Reading

The Multipolar World Dies in Ukraine - Palladium

So Elizabeth Warren introduced a bill as expected, but it did not include the Mnuchin self-hosted wallet rule as I feared, which is good. (It’s my understanding that the Mnuchin rule was in an early draft of the Warren bill, and I can only guess that the fact that the rule has nothing directly to do with Russian sanctions led it to be dropped.) Nevertheless, the Warren bill is still awful.

It seeks to penalize anyone who without knowledge or intent, whether directly or indirectly, facilitates sanctions evasion using cryptocurrency. That means that all miners, node operators, and protocol and smart contract developers would be on the hook for merely publishing code or relaying data. The bill also seeks to punish ordinary Russians crypto users who are likely against Putin and his war. The bill is unnecessary, over-broad, and unconstitutional, and we explain why in our full analysis, which you can read here.

On the bright side, I don’t believe Warren’s bill will get traction. It does not have bipartisan support, doesn’t seem like it will be attached to anything ‘must-pass’, and flies in the face of what experts and the Administration recommend regarding crypto and sanctions. Additionally, Sen. Warren thoroughly embarrassed herself with her performance at the Senate Banking Committee Hearing at which she announced the bill. It had been a serious, sober, and edifying exchange between members and experts before he arrive to grandstand.

You should watch that. Her committee brings before it the world’s foremost expert on tracking crypto for law enforcement, and instead of asking questions to learn, she tries to bully him into accepting a false narrative for her own purposes. As the kids say, not a good look. I wonder if some of her co-sponsors aren’t having second thoughts. And I doubt the effort in the House will be more serious given the companion bill is being led by Rep. Brad Sherman.

Finally on this topic, I’m often asked why Elizabeth Warren is so intensely against crypto when one would think that, given everything else she stands for, she should be enthused by crypto. Obviously, I can’t read her mind, and I think it’s good practice to take people at their word unless and until they prove themselves to be mendacious. But here’s some speculation about why someone in her position might be so hostile.

While you’d think that crypto would be right up the alley of a progressive who campaigns against big banks and big tech, it would be all too human for them to instead see crypto as a competitor to, and substitute for, all the policies they have spent their whole life developing and championing. And giving in to this jealous instinct is easy when crypto is associated with their outgroup (i.e. right-wing free-market libertarian ideology). Given the logic of negative partisanship that I’ve discussed before, anything the outgroup is for, one must be against. And given what I’ll discuss in the second half of this newsletter, it’s not surprising that this perception of crypto persists even though, as Kevin Roose put it accurately in the NYT this past weekend,

There are right-wing Bitcoin maximalists who believe that crypto will liberate them from government tyranny; left-wing Ethereum fans who want to overthrow the big banks; and speculators with no ideological attachments who just want to turn a profit and get out. These communities fight with one another constantly, and many have wildly different ideas about what crypto should be.

In any event, I will let you know if the Warren bill amounts to much more, but I don’t think that’ll be the case.

Maxis Sure Love Their Tendies

I inadvertently started a feud on Twitter last Tuesday when I innocently asked, “Why do people think making Bitcoin legal tender will do anything?” That day I had seen two persons announce their Senate candidacies on a platform of making Bitcoin legal tender, which seems to me to be an obviously ridiculous thing to do. I wanted to know why people thought legal tender status matters.

What I got back was a deluge of confusion, illogic, and hostility that I was not anticipating. I doubt I have to explain to subscribers of this newsletter why legal tender status is not the number one policy priority for Bitcoin, and normally I’d just ignore these long-shot political efforts, but I think it’s worth addressing this legal tender thing for a couple of reasons. First, I think there are a lot of well-meaning people who are genuinely confused about the law, and it is worth jotting down some clarifications for future reference. Second, I think the fanaticism I encountered skews the public’s perception of Bitcoin, and that’s not a good thing. So, humor me as I address this topic.

In answer to my question, I got three main types of responses:

1. Legal tender status means capital gains tax on Bitcoin transactions would be eliminated

2. Legal tender status would be a symbolic stamp of approval from the government, which would take “banning it” off the table

3. Legal tender status would force people to use Bitcoin (thus making number go up or, more charitably, emancipating the people from financial tyranny)

Let’s take these in turn.

There is absolutely nothing about legal tender status that has any effect on capital gains tax. There just isn’t. All legal tender status means is that courts will recognize the tendering of the designated medium as sufficient to discharge a money debt. That’s it. It means that if a court finds you owe me $1,000 for breach of contract, you can have that debt discharged by tendering $1,000 that I will have to accept. If you tender something other than legal tender (say, $1,000 worth of rice or USDT), I can accept it if I want to, but if I don’t, then the debt isn’t discharged. It has nothing to do with taxes, and the section of the tax code that deals with capital gains doesn’t mention legal tender at all.

The idea that making Bitcoin legal tender will eliminate capital gains is some kind of meme legend. One surprisingly common reason for the confusion that I discerned from the replies I got is that some people think that the reason capital gains isn’t owed on the disposition of dollars is that dollars are legal tender. Of course, the reason there’s no capital gains owed on the disposition of dollars has nothing to do with legal tender; it’s that one doesn’t experience capital gains in dollars because the dollar doesn’t fluctuate in value against the dollar.

It’s also probable that the myth persists because it’s heavily promoted for some reason by people who seem to know better. When I pointed out that a law making Bitcoin legal tender would have no effect on capital gains tax, one booster of the theory replied that it “depends on how the language is drafted.” Well, by that logic a law to make daylight saving time permanent could eliminate all capital gains on Bitcoin if it was drafted to include a clause that did so. So I guess it would be fine if I went around saying that making daylight saving time permanent removes capital gains tax from Bitcoin? And that passing a daylight saving law should be the top priority for the Bitcoin community.?

If what you mean by “making Bitcoin legal tender” is “making Bitcoin tax free,” then you should say that. Otherwise you’ll confuse matters and make yourself look like you don’t know what you’re talking about.

After some back and forth with commenters on what legal tender would and wouldn’t accomplish legally, some resorted to the idea that the point of pursuing legal tender status was largely symbolic. It would confer on Bitcoin a sense of legitimacy and allay the fears of some that it is fringe or that the government will ban it. While that’s not a completely illogical idea, it’s strategically preposterous when you think about it for more than a second.

There are so many concrete challenges right now from government that it makes no sense to make a long-shot symbolic gesture one’s top priority. Like what? On the reactive side, the tax provisions of the infrastructure bill become binding on Jan. 1, 2024 and are no joke; Hawaii is deciding the future of crypto in the state right now and it’s not looking great; the SEC is quietly considering an expansion of regulation aimed at decentralized exchange protocols like Bisq; we have just a few months to try to influence the reports that will come out of the Biden executive order, etc. On the proactive side, we desperately need a de minimis exemption from capital gains for personal transactions, like the one Coin Center has gotten introduced in the last three Congresses and that has now been adopted by Sen. Lummis. These are what top priorities look like, not symbolism like legal tender status. And the fact that Bitcoin has so many challenges before it should give one a clue about how likely it is that Congress will anytime soon bestow upon Bitcoin legal tender status. Again, why would you argue a merely symbolic issue with such a low probability of success is the single issue that matters most?

Finally, there was one type of response to my question that was at least clear and accurate about what legal tender status would accomplish under law, and that is that it would force a great number of persons who would not otherwise adopt Bitcoin to do so.

Some folks mistakenly argued that legal tender status would force merchants to accept BTC, but of course that is not true. Dollar bills are legal tender, but no doubt you’ve seen stores that do not accept cash. (No, they’re not breaking the law.) Again, legal tender law only applies to debts; it requires creditors to accept the designated medium in payment of a debt. It does not require persons to accept anything they don’t want for goods, services, labor or anything else. Others understand this and nevertheless point out that essentially all businesses in the economy are creditors, and legal tender status would force them all to accept BTC if tendered.

First I’ll point once more that given all the challenges and skepticism Bitcoin faces from government, it seems unlikely (unthinkable?) that the same government will choose to force all businesses to accept Bitcoin. More importantly, however, using the coercive power of the state to force Americans to use Bitcoin is reprehensible and certainly not the way we should want to see Bitcoin succeed. (I’m surprised I have to say this to Bitcoiners.) And putting aside morality, I’m not sure such coercion is practical. For one thing, if a debtor tenders BTC for a USD invoice, will the reaction of a creditor caught unawares be to embrace the tech, or rather to make a note to never again extend credit to that debtor?

Finally, I hesitate to even raise the question, but why Bitcoin? Why not give legal tender status to some other cryptocurrency? Or to all of them? Or to anything else? I’m afraid to ask because the answer to that will likely be religious in nature and to that there can be no counter. All I can say to those who will listen is that we’re all in the same boat. Those policy challenges I mentioned above (and more I didn’t) don’t discriminate among coins, so it makes little sense to segment political activism by coin. It’s self-defeating.

Additionally, law should be technology neutral. It shouldn’t favor one technology over another. Instead it should only foster an even playing field and allow for competition. For example, to the extent we’re concerned about the environmental impact of Bitcoin’s electricity use and see it as a negative externality, the correct policy prescription would be to place a tax on CO2-emitting electricity generation, not on proof-of-work mining specifically. Yet by embracing policy positions that favor Bitcoin over other technologies, one gives up the ability to credibly make an argument for tech neutrality under law.

Anyhow, thanks for letting me get all that off my chest, and here’s to an uneventful week.

Various & Sundry

On March 30 at 4 p.m. I’ll be speaking on a panel discussion titled “Crypto and National Security: How to Validate American Innovation and Verify U.S. National Security” and hosted by the National Security Institute at the Antonin Scalia Law School at George Mason University. Other panelists are Sheila Warren of CCI and Juan Zarate of K2 Integrity. It will be moderated by Laura Shin. You can register to watch online here.

Nota Bene

The Latecomer’s Guide to Crypto - NYT

Lawrence H. White: Thinking Straight about Bitcoin’s Social Costs and Benefits

The truth about Ukraine’s far-Right militias - UnHerd

El Salvador’s Volcano Bond Will be Issued by a Tiny State-Owned Energy Company, Not the Government

Ukraine Is Buying Bulletproof Vests and Night-Vision Goggles Using Crypto - CoinDesk

On Thursday, Peter, Neeraj, and I recorded a podcast in which we discussed the new Biden executive order on digital assets and the continuing sanctions saga (video, audio). In particular we talked about the media narrative around these topics and the possibility of sanctions-driven crypto legislation in the short term.

For my thoughts on the EO I’ll refer you to a twitter thread I wrote in reaction. In short, I think expectations that it would deal a blow to crypto were obviously wrong, but so are over-optimistic interpretations of the EO as equivalent to the Clinton Administration’s “Framework for Electronic Commerce,” which set the policy vision for a hands-off approach to the Internet and fostered its explosive growth. That policy document was the culmination of a two-year process of study and consultation, while this EO is just a starting whistle. The ultimate outcome is not yet determined and we’ll have to work hard to make sure it’s positive. In the meantime the upshot is that, in stark contrast to many naysayers in Congress, this administration has made it clear that our ecosystem is socially and economically important and that it’s in the U.S.’s interest to lead (rather than hamper) its development.

That brings me to the sanctions saga and what could flow from it. The media continues to propagate a narrative of fear and concern that is unwarranted by the evidence they cite. Here are two examples that particularly rankle Neeraj.

First, the Wall Street Journal published a story last week in which Secretary Yellen said that the U.S. would continue to monitor Russian efforts to evade sanctions however they took place. She is then quoted as saying, “I often hear cryptocurrency mentioned and that is a channel to be watched. It’s not that that sector is completely one where things can be evaded.” So, what’s the headline of that story?

I mean, you can’t make this up! The other example is a type of headline we saw used across several outlets. It basically takes the fact that an executive order on crypto was signed and marries it to the unrelated fact that some folks are expressing concerns about sanctions, which leaves the impression that the former is spurred by the latter.

Sadly, headlines are the only thing most people will read, especially on social media, and it’s hard to understand how these headlines shouldn’t be considered “misinformation”. There’s seemingly no accountability.

Top prize, though, goes to Reuters with a story headlined, “Russians liquidating crypto in the UAE as they seek safe havens.” To support the proposition in the headline, that Russians are liquidating assets, the story cites one anonymous source described as an executive at “a crypto firm.” What did this person say? “We’ve had like five or six [inquiries] in the past two weeks. None of them have come off yet – they’ve sort of fallen over at the last minute, which is not rare - but we’ve never had this much interest.”

It’s enough to drive you crazy. They’ve had “five or six” inquiries? That never materialized into anything? That’s it?

The executive goes on: “We have one guy – I don’t know who he is, but he came through a broker – and they’re like, ‘we want to sell 125,000 bitcoin’. And I’m like, ‘what? That’s $6 billion guys’. And they’re like, ‘yeah, we’re going to send it to a company in Australia’.”

I kid you not. This is in a Reuters article. The anonymous source claims that a person whose identity he does not know asked for help selling $6 billion of BTC (which would be about a third of Bitcoin’s daily volume – i.e. very noticeable) in order to send the money to that jurisdiction notorious for money laundering: Australia.

Maybe instead of anonymous “executives” who overuse the word “like”, Reuters should quote someone who knows what he’s talking about like FBI Director Christopher Wray who said on Thursday at a Senate Intelligence Committee hearing:

The Russians’ ability to circumvent the sanctions with cryptocurrency is probably highly overestimated on the part of maybe them and others. We are, as a community and with our partners overseas, far more effective on that than I think sometimes they appreciate. …

We have built up significant expertise both at the FBI and with some of our partners, and there have been some very significant seizures and other efforts that I think have exposed the vulnerability of cryptocurrency as a way to get around sanctions.

What he means is, a sanctioned oligarch cannot move $6 billion to Australia using crypto!

Now I want to say it again as I’ve said it in my last two missives: Could crypto be used to evade sanctions? Absolutely. Will it? It would not surprise me if on the margin it is. Given that, should we be concerned? Only as much as the White House, Treasury, and now the FBI have said they are, which is not too much because the system works. Is the level of concern expressed by some politicians and reflected in headlines justified? Absolutely not.

And yet, I have no doubt we’ll get more of these headlines and more unsubstantiated stories. And I don’t doubt they will be cited by politicians as evidence for why we need legislation to further restrict the use of cryptocurrency – even though it is the crypto industry’s partnership that allows the FBI and Treasury to be so confident in their ability to prevent sanctions-busting, and even thought the President manifestly wants to take a considered approach to crypto.

In particular I’m thinking about Senator Elizabeth Warren who on Tuesday announced she is drafting a bill “to ensure crypto isn’t used by Putin and his cronies to undermine our economic sanctions.” NBC reported this about the bill:

One of the draft provisions in Warren’s proposal would seek to make it easier to verify the identities of customers and transfers to private crypto wallets by requiring financial institutions to keep detailed records and submit reports to the Treasury Department. The Treasury Department’s Financial Crimes Enforcement Network, known as FinCEN, is in the preliminary stages of drafting a similar rule, but Warren’s bill would codify that requirement.

This sounds like a reference not to a rule that FinCEN is “preliminarily” drafting, but to the shelved last-minute rulemaking that former Treasury Secretary Steven Mnuchin tried to ram through at the end of the Trump Administration. This rule is often referred to as the “self-hosted wallets” rule since it would place severe limitations on how exchanges could interact with persons who self-custody their funds. It would require exchanges to collect name, address, and other information about the send or recipient of funds over $3,000 if that person is not receiving or sending the funds from another exchange. This means it would require exchanges to collect information about persons who are not their customers, as well as collect sender/recipient information in situations where it is impossible to do so, such as when the “recipient” is a smart contract, thus severely limiting the ability of centralized exchanges to interact with DeFi. At the time we explained the problems with the Mnuchin rule this way:

Because compliance with the rule would often be impossible, it is, in effect, a “secret” and therefore undemocratic and extra-legal ban on certain types of otherwise innocent transactions. It will hamper law enforcement efforts to track illicit payments activity by pushing more users of the technology to self-custody their own cryptocurrency. Finally, it would mandate the unconstitutional, warrantless search and seizure of private information, and would obligate financial institutions to keep and report to government lists of persons engaged in the exercise of their First Amendment rights to assemble anonymously.

The rule was shelved in large part thanks to an unprecedented protest from the cryptocurrency community. In a fifteen-day window that included Christmas and New Year, Coin Center worked with other digital rights groups, such as the EFF and Fight For the Future, to rally the public and together sent nearly 2,000 personal letters to Secretary Mnuchin and filed over 7,500 substantive comments in the rulemaking – more comments in one proceeding than FinCEN had received cumulatively in its history. Members of Congress also objected.

Now, while it’s certainly concerning that Sen. Warren seems poised to introduce a bill to codify Mnuchin’s proposal, it won’t be a red alert if it goes through the regular order of deliberation and debate in the Senate and House. I’m certain that if it gets appropriate consideration, members will understand how foolhardy (and unconstitutional) such a measure would be, and the bill will go nowhere.

What I worry about, however, is that it could be attached to a fast-moving “must-pass” bill like a Ukraine aid package or an omnibus government funding bill. In such a circumstance there would be little time for careful discussion, and in an environment of misleading headlines it could move. If that were to happen, I would certainly expect the community to go to Defcon 1 and its vociferous reaction to the Infrastructure Bill last summer would probably pale in comparison.

So, we’ll have to keep our eyes peeled. The next thing to watch is a Senate Banking Committee hearing scheduled for this coming Thursday. It’s on crypto and illicit financing and will no doubt touch on sanctions. Ms. Warren is a member of the committee. So far the only announced witness is Jonathan Levin of Chainalysis.

The good news is we have allies on the Hill. For example, just last month Rep. Warren Davidson introduced a bill aimed directly at protecting the use of self-hosted wallets.

Various and Sundry

As I mentioned at the top, I recorded an episode of Tangents from Coin Center on sanctions and the EO with Peter and Neeraj. You can watch or listen and subscribe.

Nota Bene

Bitcoin May Serve Many Masters in the War in Ukraine - Bloomberg

Gyges Lydia: The Cryptonative’s Guide to US Financial Regulators

Francis Fukuyama on the endgame in Ukraine

Hu Wei: Possible Outcomes of the Russo-Ukrainian War and China’s Choice

A Serious Proposal on US Energy - Doomberg

You Can Have Geothermal Power Everywhere If You Drill Deep Enough - Treehugger

In the many conversations I had last week with reporters and policymakers in D.C., there was general confusion not just about whether Bitcoin could be used by Russia to evade sanctions, which I’ve already addressed, but about the crypto ecosystems reaction to the sanctions. This was summed up in this tweet from a public policy veteran:

OK, I’ll try to explain.

The first thing to say is that crypto exchanges are all complying with sanctions obligations. I mean, it’s the law. If they don’t comply, they face existential penalties. They have all announced that they will do so and I have seen no government official say that they are doing otherwise. Further, what government officials are saying about crypto is that they are not concerned about it. Here’s the White House:

“The scale that the Russian state would need to successfully circumvent all U.S. and partners’ financial sanctions would almost certainly render cryptocurrency as an ineffective primary tool for the state,” said Carol House, the director of cybersecurity for the National Security Council, during a webinar on Wednesday.

This echoes an earlier statement from the Treasury Department:

“The scale of what they have to move, and where they have to move things from, [crypto’s] not necessarily going to be that concerning,” said Todd Conklin, counselor to the deputy Treasury secretary. Any attempt to move that much money through exchanges would contribute to “a bit more of a spike in the crypto market, in my view, than has been observed lately.”

And that brings me to what we’ve been seeing in the market. While ruble trading of crypto has surged since the invasion of Ukraine began, it’s still in the tens of millions of dollars, which as the officials above noted is just not enough to make a dent on sanctions. And to the extent there are sanctioned individuals who get their hands on some crypto, they’re not going to be able to convert it into the dollars or euros they really want because the exchanges are watching. As I told The Washington Post on Thursday:

“The scale of the sanctions we’re seeing are so massive, there just isn’t the depth in crypto for the kinds of evasion we’re trying to prevent. And if an oligarch tries to move $10 billion, it will be completely obvious and spotted by people in the industry who run the on- and off-ramps,” said Jerry Brito, executive director of the crypto think tank Coin Center. “This is such a red herring.”

So what is all the fuss about?

Well, aside from some media outlets and politicians who seem to be willfully ignoring reality in order to drive attention or a particular agenda, I think a lot of the confusion stems from the fact that cryptocurrency exchanges have refused to stop doing business with Russians.

“Wait, what?” you may be thinking? “I thought the exchanges were complying with sanctions.”

They are, but there are no sanctions on ordinary Russian citizens. The sanctions apply only to certain banks and certain individuals. Nevertheless, many Western firms have voluntarily stopped doing business with Russia altogether. Some have done so out of conviction, but many others have done so under public pressure.

In particular, Ukraine’s 31-year-old Vice Prime Minister Mykhailo Fedorov has been “Twitter-shaming” (as AFP put it) Western firms into dropping all contact with Russia:

“We need your support – in 2022 modern technology is perhaps the best answer to tanks, multiple rocket launchers and missiles,” he wrote in a letter he tweeted out Friday to Apple chief Tim Cook.

By Tuesday the iPhone maker had announced sales were halted in Russia, and Apple Pay services were limited. …

Fedorov’s callouts only gathered pace after his tweet seeking Cook’s support, with subsequent ones noting Ukraine’s government had asked Google, Netflix, YouTube and Facebook to cut off Russia. …

“There are literally millions of people on the internet wanting to try and do something,” said Omar Wasow, an assistant professor of politics at Pomona College in California.

“So if he (Fedorov) does this callout of a particular company, and then thousands of people like and retweet what he’s doing that’s going to get the attention of those companies’ social media managers and ultimately CEOs,” he added.

Last Sunday Fedorov took aim at crypto exchanges, asking them to block not only sanctioned officials, “but also to sabotage ordinary users.” This was followed up by an official letter from the government of Ukraine to several exchanges requesting the same.

Unlike so many other firms, cryptocurrency exchanges have not been cowed by the public pressure to boycott all Russians. While they will certainly comply with sanctions obligations, they said, they would not be preemptively sanctioning ordinary Russians. The rationale is simple: Ordinary Russians don’t deserve to suffer because of Putin’s actions anymore than ordinary Ukrainians. To limit their access to cryptocurrency is to cut off one of the last means they have to preserve their savings before they melt away in the ruble’s collapse.

I think this has very much annoyed people who have little regard for the rule of law and who are used to getting their way with threats. Here’s Hillary Clinton last Monday:

I was disappointed to see that some of the so-called crypto exchanges, not all of them, but some of them are refusing to end transactions with Russia for some philosophy of libertarianism or whatever. Everybody—and if there has to be legal or regulatory pressure—everybody should do as much as possible to isolate Russian economic activity right now.

Well, she gets some things right and some things wrong.

She’s wrong that libertarian idealism is the only reason to eschew cutting off all transactions with Russia.[1] Targeting ordinary citizens who could be the West’s greatest allies against a regime they did not choose is not a good strategy. At least that’s what the Obama Administration thought when they designed the first sanctions on Russia after the invasion of Crimea.[2] Here is Deputy National Security Advisor Daleep Singh in Senate testimony (emphasis mine):

Before 2014, the United States had never imposed sanctions on a country the size of Russia. It was the tenth largest economy in world, with a GDP roughly the size of Italy. More important than its size was the complexity of Russia’s economy and its connections to the rest of the world. Russia was and is of systemic importance in global energy markets, ranking second and third in the production of natural gas and oil, respectively. Its largest banks were comparable in size and complexity to Lehman Brothers before 2008. Given the high stakes involved, our objective was clear: design a menu of options that could deliver economic costs while minimizing spillovers to the U.S. and global economy.

We pursued this objective by first writing down a set of guiding principles that remain instructive. Sanctions against a large, complex, and integrated market economy such as Russia should be: (1) powerful enough to demonstrate U.S. resolve and our capacity to impose overwhelming costs; (2) responsible to limit contagion through the U.S. and global financial system; (3) targeted to avoid the appearance of punishing the Russian civilian population and, in doing so, strengthening Putin’s domestic narrative; (4) calibrated to increase the chance of partnering with European and international allies; and (5) staged to preserve scope for escalation or de-escalation, in addition to learning from previous steps.

Imagine that. You don’t want to be seen as punishing the civilian population, giving them every reason to believe Putin’s claims that the West is attacking them rather than the regime. It should be obvious that you don’t want Facebook to ban Russians, you want Russia to ban Facebook, so it’s clear who’s hurting citizens. The same applies to crypto exchanges.

As an aside, I’ll say that the frenetic rush to sever all ties with Russia seems a bit out of control, perhaps rising to the level of a moral panic, and it could easily play right into Putin’s hands. It’s not only Russian cats that have been banned from international competition, but a global cancer treatment nonprofit has cut off Russian doctors and patients, Airbnb is restricting not just Russian hosts but also Russian users from making new reservations as guests, even OnlyFans has frozen the accounts of Russian and Belarusian models. What’s more likely? That the Russian people affected by these boycotts will blame Putin and rise up against him? Or that they will feel betrayed by the Western companies they trusted and depended on and will be more receptive to Putin’s propaganda?

Now, what Clinton gets right—even if parenthetically—is that it would indeed take “legal or regulatory pressure” to force crypto exchanges to do as she wishes. Again, ordinary Russians are not subject to the sanctions. If the government believes they should be, then there is a process to achieve that through legislation or executive action. If all Russians are added to the sanctions list, exchanges will duly block them. That is a feature and not a bug of a liberal democracy with the rule of law. Without such processes there is no accountability. And to dissent from public pressure and shame campaigns is laudable and very American. To insist on one’s rights (i.e. “come back with a warrant”) is how we don’t lose them.

So to answer the question we started with about what’s the right approach for the crypto industry in the current situation, it’s simple: Comply with sanctions, but don’t cut off ordinary Russians who are not sanctioned. It’s the right thing to do, it’s the strategically smart thing to do, and BTW, it’s probably also good business when a large portion of your clientele is idealistically libertarian.

A Lack of Imagination

Before I wrap up, I want to say once again that while the threat of Russia using crypto to evade sanctions is completely speculative and devoid of any data or even anecdotes, the good that crypto has been doing since the start of this conflict is concrete and obvious. Not only have ordinary Russians and Ukrainians had an avenue to preserve their savings in the face of currency collapse, but Ukrainian causes (including the Ukrainian government itself) have raised over $55 million through crypto. That’s more than twice what the UN has pledged in aid to Ukraine.

Of course, some will have to find a way to minimize and dismiss this obvious positive development. From The Washington Post:

Lee Reiners, a former senior associate at the Federal Reserve Bank of New York, was skeptical of the argument that cryptocurrency is necessary for donations. “Ukrainians are not the ones cut off from the global financial system, so there’s nothing stopping them from receiving donations via GoFundMe, the Red Cross, or any other platform and [nongovernmental organization],” Reiners wrote in an email. The need to convert donations into traditional currency also undercuts the idea that cryptocurrency is somehow more decentralized, he said. “Last time I checked, you can’t buy Javelins [missiles] with bitcoin.”

Where to begin? As a matter of fact, Ukrainian NGOs tried to raise funds through traditional crowdfund platforms like Patreon and were summarily suspended for violating Patreon’s policy against fundraising for military activity. And even if Ukrainians had no problems receiving donations, that doesn’t mean people who want to donate will be able to. As I said about the crypto crowdfunding in my last missive, “What I love about this is that given crypto’s nature, anyone in the world can pitch in—even people in Russia and China or even Canada.” As a reminder, last June, Russian dissident Alexei Navalny’s NGO turned to crypto in order to receive donations from Russians because Putin’s government had designated the group as “extremist” and move to ban payments to it.

And yes, it’s true that you can’t buy Javelins with bitcoin. But as Michael Chobanian, CEO if the Ukrainian crypto exchange Kuna.io that is working with the government, told The Washington Post last week, “We obviously can’t buy nuclear bombs or rockets, [but] most nonlethal things you can buy with crypto.” Bloomberg reported yesterday that “Ukraine has already spent $15 million of the donations it received in cryptocurrencies on military supplies, including bulletproof vests that were delivered Friday . . . About 40% of the suppliers are willing to take crypto.”

If Hillary Clinton is disappointed in exchanges that follow the law and take what is (by their lights) a principled stance just as are the firms who are boycotting Russia, then I’m disappointed in the reflexively anti-crypto attitudes I’ve encountered over the last week. They belie incredible shortsightedness and a lack of imagination. I would ask those folks to please reflect on this:

Nota Bene

JP Koning: Is gold safe from sanctions?

Ukraine’s Deadly Gamble - Tablet

Tyler Cowen: Cancel Culture Against Russians Is the New McCarthyism

TRM Talks: Russia Sanctions (with Treasury and White House officials). Here is a short clip you can watch without registration.

Ukraine Buys Military Gear With Donated Cryptocurrencies - Bloomberg

Various and Sundry

A new episode of Worker & Parasite, my book podcast with Stably, is out. In it we discuss This Is Not Propaganda by Peter Pomerantsev, which is about information war and our modern post-fact reality, so very timely. You can listen and subscribe here.

FYI tonight I’ll be speaking at the CryptoMondays event in Greenwich, CT. Details and registration here.

Finally, the Coin Center Annual Dinner will take place on Friday, June 10, during Consensus 2022. Table sponsorship opportunities are now available and they’re going fast.

[1] It’s funny she couldn’t help herself but be so disdainful and dismissive of a small ideological minority that nevertheless probably exists in greater numbers than the margin of votes by which she lost her presidential bid. Some people never learn.

[2] Hat-tip to Matthew Pines for bringing this to our attention.

What a remarkable few days it’s been. While I thought Russia would invade Ukraine, I only imagined they would do so in the Donbass. By going as far as he has, Putin has put in motion a series of events that will change Europe and the world forever. And it’s incredible to watch it all transpire in real time and on one’s screens.

But we’re here to talk about crypto, and boy what a role is it playing. There are two narratives here, a positive one and a negative one.

First, Ukraine and Ukrainian NGOs have received over $20 million and counting in crypto donations, according to Elliptic. (Patreon had kicked out these NGOs on Thursday because raised funds would be used for weapons.) Most remarkably, the Ukrainian government itself set up crypto addresses to accept funds.

The amounts received there will no doubt help, but more than anything it is a way for Ukraine to ask people around the world to put a little skin in the game in solidarity. (FYI I created a web page that live tracks the amounts received at the @Ukraine addresses in BTC and ETH.) What I love about this is that given crypto’s nature, anyone in the world can pitch in—even people in Russia and China or even Canada.

Crypto also seems to be proving as a lifeline to some who otherwise would be cut-off from their bank money.

So, what we’re seeing is that crypto is what it is: permissionless and censorship-resistant. It’s not perfect, but it is more than useful in situations in which the alternative is no access to funds at all. I don’t understand how some can’t see that there’s value in cryptocurrency.

Now, because it’s permissionless, if the good guys can use it, then so can the bad guys. It’s just like the internet in that respect. And so we’ve seen a lot of hand-wringing over whether Russia will be able to use Bitcoin and other crypto to evade sanctions.

NYT: Russia Could Use Cryptocurrency to Mitigate U.S. Sanctions

POLITICO: Russia’s hidden tool to undermine sanctions

WSJ: U.S. Looks to New Measures to Punish Russia for Ukraine Invasion

Bloomberg: How Russia, Billionaires Could Use Crypto to Go Around ‘Severe’ US Sanctions

Sounds scary, but let me point out a few things.

First, while the Ukrainian grass-roots use of crypto in this conflict is evident, its use by Russians to evade sanctions is speculative. None of the articles I’ve read show that Russia has any crypto or has any plans to use it. I mean, where exactly is it going to get billions of dollars of crypto right now? And who exactly is going to accept it? It’s certainly physically possible, but completely speculative at this point.

Second, the people that matter seem to understand this. In the articles driving the sanctions-busting narrative, once you get past the breathless speculations of analysts and consultants, you get to the assessments of government practitioners on the front lines. This is from the POLITICO piece linked above:

Treasury officials say they aren’t overly worried about crypto undermining the effort to choke off the Kremlin’s access to capital. Laundering large amounts of money through a dizzying array of digital wallets and exchanges is expensive, time-consuming and would likely be visible in the broader crypto market, given the massive investment portfolios of individuals and institutions named in the sanctions.

“The scale of what they have to move, and where they have to move things from, [crypto’s] not necessarily going to be that concerning,” said Todd Conklin, counselor to the deputy Treasury secretary. Any attempt to move that much money through exchanges would contribute to “a bit more of a spike in the crypto market, in my view, than has been observed lately.”

And from the WSJ article (emphasis added):

Targeting the country’s access to cryptocurrencies, such as bitcoin and ether, would take sanctions policy into uncharted territory. Blocking transactions would be challenging, since by nature private, digital currencies are designed to exist without borders and for the most part outside the government-regulated financial system.

The Biden administration is in the early stages of exploring the area, with the aim of disrupting economic activity in the country, The Wall Street Journal reported Friday, citing an administration official. Sanctions on Russia’s crypto activities would need to be crafted in a way that didn’t destroy the broader crypto market, which might make imposing them difficult, the official said.

And here is Chainalysis, one of Treasury’s top partners, in a useful thread:

So, while we won’t be able to prevent some journalists, politicians, and consultants from overhyping the risk that crypto could pose, the reality is that crypto won’t undermine sanctions in any significant way, and the folks that matter understand that. Serious folks in government can see right through speculation, like this from the NYT (emphasis added):

Should it choose to evade sanctions, Russia has multiple cryptocurrency-related tools at its disposal, experts said. All it needs is to find ways to trade without touching the dollar.

The Russian government is developing its own central bank digital currency, a so-called digital ruble that it hopes to use to trade directly with other countries willing to accept it without first converting it into dollars. Hacking techniques like ransomware could help Russians steal digital currencies and make up revenue lost to sanctions.

And while cryptocurrency transactions are recorded on the underlying blockchain, making them transparent, new tools developed in Russia can help mask the origin of such transactions. That would allow businesses to trade with Russian entities without detection.

Where to begin? The digital ruble doesn’t exist, but it’s ‘a tool at Russia’s disposal’? And all Russia needs to do is find sellers who will accept it? Would you want to accept digital rubles today? What of these new Russian-developed tools to mask crypto transactions? They don’t explain it or give any source or reference. And to think that ransomware could make up income lost to sanctions is to misunderstand the scale of the blockade being imposed. The whole thing is preposterous.

Could crypto be used to evade sanctions? Of course. Could it be used at a scale that would seriously undermine the measures being taken this week? I don’t see how. Will legitimate crypto intermediaries comply with sanctions obligations? Better than a lot of banks, if recent history is any guide.

That all said, things could change in the future. No doubt the sanctions against Russia’s central bank have been a wake up call for nations all around the world—even Western ones. The vast majority of Russia’s foreign currency reserves have been paralyzed, and what gold and other instruments it has in its vaults is of limited use right now. It would not surprise me to see states, including China, take a lesson from these events and choose to diversify into an asset that is a scarce commodity that can be self-custodied like gold, but that is also weightless and can move at the speed of light. But as I say, that’s in the future.

Why Due Process Matters

Before I go I want to bring to your attention a remarkable article by Canadian researcher Howard Anglin on the weaponization of the financial system by his country’s government. His point is that cutting people off from their money is essentially equivalent to putting them in jail, and therefore due process is paramount.

As during the October Crisis [of 1970], the lack of legal safeguards on government action increases the likelihood of mistakes. Given that many of the people who donated to the convoy seem to have a less than perfect understanding of the law and of how their donations could be used, doing away with questions of mens rea (guilty intent) and normal burdens of proof means the government can freeze first and ask questions later. By then, it could be too late. A lawyer interviewed by the CBC opined that, in some cases, risk-averse banks “may just decide to shut the person’s account down” without bothering to sort the guilty from the innocent. The long-term consequences of such overreach would be worse than temporary incarceration.

The government’s action is troubling enough, but what should really disturb us is the ease and invisibility with which it is being done. When we can’t see the consequences of government conduct, the risks of government misconduct increases. A government that sends in riot troops to dispel a crowd will rightly pay a price if the police commit abuses. But the diffuse and anonymous nature of financial enforcement mean that sweeping repression can easily go undetected. It is the political equivalent of using drone strikes instead of boots on the ground.

What makes Canada’s recent actions so dangerous isn’t just that financial intermediaries were deputized to restrict the freedom of individuals (this actually happens all the time), it’s that it was done without any due process or transparency. I encourage you to read the whole thing.

The reason it resonated so much with me is the parallel I see with our recent fight to spike Rep. Jim Himes’s proposed gutting of all transparency and administrative checks on “special measures” the Treasury Secretary can take under the Bank Secrecy Act. Many people have not understood why Coin Center kicked up such a fuss over this provision, some going so far as to wonder whether we were raising the alarm for attention or as a fundraising gimmick.

Well, if you think the Canadian government’s recent behavior under the Emergencies Act is unjustifiable, the Himes provision would have made such actions possible not just when the government declares an emergency but at any time. If the provisions were to make it into law, the Secretary of the Treasury would be able to issue secret orders to cut off certain accounts or transactions or types of transactions without any due process whatsoever. The public would have no way to know how the government was using its powers, there would be no way to check the power. Completely insidious.

So yeah, I think we were more than justified in raising the alarm especially since we knew from dealing with this same provision in the past that only drawing public attention would cause its sponsor to reconsider its scope. It was the right call and I’m glad we did it.

Without transparency and due process individuals can be cut off with little recourse, and having cryptocurrency then can be of little use as crypto-skeptic Doomberg recently wrote in a good article:

Imagine you donated C$50 to the Freedom Convoy before it arrived in Ottawa, an action Trudeau has retroactively decided disqualifies you from participating in modern society. (This is not a hypothetical, at least if this Canadian Member of Parliament’s tweet is to be believed). Your bank accounts have been frozen, credit cards canceled, and access to your brokerage account denied. Further, imagine you have accumulated some Bitcoin in a cold storage wallet (i.e., on a flash drive in your possession), carefully ensuring that it is outside Trudeau’s reach. How are you going to pay your mortgage, car payment, tuition expenses, or buy groceries with it? The answer is you can’t. Does that wallet represent a store of value that might be reactivated in the future should the government change its stance towards you, or is itself changed altogether? Absolutely. Does it represent a practical medium of exchange, one that is useful during this personal crisis? Absolutely not.

Well, if you’ve been “switched off,” then yes, your bitcoin will be cold comfort, and the fact that you might be able to barely get by on the margins of society just proves the point more. But to me that misses the point a bit. What about the rest of the time when martial law hasn’t been declared but we still face a politicized financial system? That’s when you need access to an alternative that may not be perfect, but is the kind of escape valve that is necessary for a liberal open society.

As Doomberg says, “The answer to government weaponization of the financial system isn’t a new financial system. It’s a new government.” Well, without transparency to know how the system is being used, and without public input to push for new government, all the token fundraising in the world isn’t worth much. And that’s why we have to prevent process-gutting measures like the Himes provision from becoming law. I’m glad we have.

And P.S. the Ukrainian vice prime minister’s call on crypto exchanges to freeze the accounts of all Russian persons without any due process is incredibly disappointing. “It’s crucial to freeze not only the addresses linked to Russian and Belarusian politicians, but also to sabotage ordinary users,” he wrote. He’s at war, so I can understand where his sentiment comes from, but ordinary Russians are no more to blame for what’s happening than ordinary Ukranians. Jesse Powell had the right response.

Various and Sundry

There’s a new episode of my book review podcast with Stably available. This time we discuss Not Born Yesterday: The Science of Who We Trust and What We Believe by Hugo Mercier.

Last week I had a discussion (debate?) with Dr. Oonagh McDonald on her new book Cryptocurrencies: Money, Trust and Regulation, which was hosted by the Federalist Society. Video is now up.

Next week, on Monday, March 7, I’ll be the featured speaker at the CryptoMondays meetup in Greenwich, Connecticut. You can register to attend here.

Nota Bene

A moment of clarity - Noah Smith

Bitcoin Can Fix Financial Deplatforming of Canada’s Truckers—But It Won’t Be Easy - Reason – This is by my friend and colleague Andrea O’Sullivan (who is an essential follow on Twitter BTW.) I’ll point out that Block (née Square) is working on precisely the challenges that Andrea identifies with their lightning,self-custody, and decentralized exchange initiatives. Good luck to them, and hurry up.

I was wrong, we need crypto - David Heinemeier Hansson

Last week I was in Denver. Erik Voorhees and the amazing folks of ShapeShift DAO hosted a fundraising dinner for Coin Center taking advantage of the fact everyone was in town for ETHDenver. We had an amazing time and I couldn’t be more grateful for the love and support we were given.

One question I got asked several times was whether crypto is becoming as partisan an issue as it seems to folks outside of DC. Many of the folks coming to ETHDenver are the furthest thing from right-wingers, and so the partisan turn in crypto that they perceive rightly baffles them. Here’s how I explained it.

For over a decade, crypto managed to be a non-partisan or bi-partisan issue. That means that we had champions and detractors on both sides of the aisle. One of our earliest supporters in Congress was Democratic congressman Jared Polis (now governor of Colorado) who helped found the Blockchain Caucus with Mick Mulvaney, a Republican who went on to serve as Donald Trump’s chief of staff. One thing they could agree on was their strong support of crypto.

It was great meeting Vitalik the founder of Ethereum. We had a great conversation and we look forward to working together to make Colorado the first digital state. pic.twitter.com/ZK3fSpxdtM

— Governor Jared Polis (@GovofCO) February 19, 2022

On the other side you’ve had Democrats like Brad Sherman, who’s always been an anti-crypto reactionary, and folks like Republican Senator Chuck Grassley, who’s been skeptical since Mt. Got days because of crypto’s misuse by illicit actors.

And then you had the vast, vast bulk of folks in Congress who didn’t know much about crypto and had no strong view either way.

As a good representative body should, the views in Congress on crypto nicely tracked public opinion. Check out this Morning Consult poll from December headlined “Crypto Is Getting Increasingly Political in Washington. The Rest of the Country Isn’t as Polarized.” It found that “an identical share of Republicans and Democrats said that there are ‘too many’ regulations on cryptocurrency” and that “notably, 45 percent of Democrats and 58 percent of Republicans didn’t know or had no opinion on the amount of cryptocurrency regulation.”

So what’s changing?

While we still have champions and detractors on both sides, along with a majority of members of Congress without a strong opinion, I think what’s changing is that the most vocal champions and detractors are sorting themselves along party lines. What I mean is that the most vocal detractors are generally all Democrats, while the most staunch champions tend to be Republicans. That doesn’t mean the partisan divide is any bigger than it’s ever been, but it will certainly be perceived this way.

Unfortunately what happens once this perception starts taking hold is that the majority of uncommitted members with low-information begin to take their cues from the vocal leaders on the issue from their party. Think of it this way: Imagine a Democratic Senator who hasn’t staked out a position on crypto because it’s never been a priority for their constituents and they’re not on any relevant committee, but they’re increasingly getting questions about it. They’ll look around and think, “Well, Elizabeth and Sherrod (who I trust and agree with on most things) think this stuff is pretty bad, and Ted (who I really don’t like) is all-in for it. OK, I guess I know what side I’m on.” Same goes for the other side (“I trust Cynthia, and I disagree on everything with Elizabeth”).

It’s hard to blame members for using the common heuristic of seeing where the rest of their tribe is on matters of low saliency for them. And even if they don’t agree with the pro- or anti-crypto position their party is coalescing around, if it’s not a very salient issue for them, their incentive will be to back those in their coalition regardless to ensure that they’ll be back on the issues that matter to them. This is the same coalitional instinct that drives uniformly partisan views on such disparate issues as abortion, gun laws, climate, and pandemic response. There’s no reason why people who agree on one of those topics should necessarily share uniform views on the rest, and yet they’re the most reliably partisan issues in Congress.

Abortion is a great case on point. Here’s Nate Cohn writing in the New York Times in December:

Abortion is one of the most polarizing issues in Washington. Congressional Democrats and Republicans all but unanimously back their party’s view on abortion, and many highly engaged activists feel the same way.

But the public’s view of abortion is far more complicated.

Despite decades of partisan fighting, Americans are not as neatly divided on abortion as politicians and activists. There are Republicans who support abortion rights, Democrats who oppose abortion and a surprisingly large group of voters who appear to have muddled or conflicted views. Overall, 26 percent of voters hold a different view on abortion than the presidential candidate they supported in 2020, according to data from an AP VoteCast election survey of more than 100,000 voters.

I fear this is what’s happening to crypto. It’s not a partisan issue for the public, but it will be for politicians and activists. It’s almost inevitable given the incentives of our two-party system to foster two coalitions of disparate interest groups only vaguely held together by ideology.

I can easily imagine an alternative world where Donald Trump shut down access to the financial system for Black Lives Matters protesters who then had to rely on Bitcoin for donations. In this world Elizabeth Warren is the champion of crypto as a counter to the big banks, DeFi as a more transparent alternative to Wall Street, and web3 as a bulwark against the big tech giants. In this world Ted Cruz is crypto’s fiercest critic given its use by North Korea, terrorists, and drug cartels.

It was probably going to happen one way or another. As soon as one party was perceived as being more pro- or anti-crypto (through the actions of crypto’s most vocal champions or detractors) a spiral of sorting was going to be kicked off.

I recently finished reading Not Born Yesterday: The Science of Who We Trust and What We Believe by French cognitive scientist Hugo Mercier. In it he explains that Americans are actually not very polarized on issues. Instead, they are affectively polarized (emphasis mine):

U.S. citizens are not all that ideologically polarized. However, they are perceived as being so: several studies observed that “people significantly misperceive the public to be more divided along partisan lines than it is in reality.” For example, the attitudes of Democrats and Republicans on free trade are remarkably similar, being very close to the middle of the road, with a slightly more positive view for Republicans. However, Democrats are perceived as being anti–free trade (which they aren’t, on average), and Republicans as being strongly pro–free trade (which they aren’t, again on average). These mistaken perceptions are driven by news consumption. In some countries, this means TV, but the most reliable driver of inflated perceived polarization is the heavy consumption of online media. This makes sense: a TV channel can attempt to portray the other side as made up of crazy extremists, but on social media, these crazy extremists are there for all to see, and it is easy to forget that they represent only a sliver of the population. Social media don’t make us more polarized, but they make us think we are; more precisely, social media don’t push their users to develop stronger views but, through increased perceived polarization, they might contribute to increased affective polarization, as each side comes to dislike the other more.

So it’s not that we’re more intensely disagreeing on political questions; it’s that we’re becoming more intensely tribal, something that’s largely fueled by dislike of the outgroup. The more we dislike the other side, the more prepared we’ll be to adopt the views of our co-partisans on matters of little importance to us and the less receptive we’ll be to contradictory information that supports the position associated with the outgroup. There’s no reason why one’s position on gun confiscation should predict one’s position on climate policy, but there are a uniform Republican and Democratic views on each and they’re largely fueled by in group signaling and negative partisanship.

And so we’ll get more of this:

As Trudeau has gone full dictator in Canada and stealing Canadian’s Crypto wallets, Democrats and Big Banks are lining up to take their cut of #Crypto and #blockchain.

Joe “the big guy” Biden always gets his cut.

Protect Crypto currency owner’s rights.

— Rep. Marjorie Taylor Greene (@RepMTG) February 17, 2022

Which is only going to drive otherwise sensible folks in the big mass of people who don’t have a view one way or another on crypto to just put it in the pile of outgroup ideas they reflexively abhor based on nothing more than affect. It’s the human condition.

So what’s the silver lining? If there is one, it comes from the Morning Consult poll I cited above:

Rather than partisan affiliation, the biggest split in opinion on cryptocurrency regulation comes in generation. Fifteen percent of millennials and 14 percent of Gen Z adults said they believe cryptocurrency has too much regulation, compared to just 2 percent of baby boomers who said they think cryptocurrency is over-regulated. Seven percent of Gen Xers said there are too many regulations on cryptocurrency.

Here’s hoping we can get past this.

Various and Sundry

I’ve got two gigs coming up.

First, on Wednesday, February 24, I’ll be interviewing Oonagh McDonald in a Federalist Society fireside chat on her new book, Cryptocurrencies: Money, Trust and Regulation. You can register to listen in here.

Second, on Monday, March 7, I’ll be the featured speaker at the CryptoMondays meetup in Greenwich, Connecticut. You can register to attend here.

Also: Check out my good friend and colleague Alex Sternhell on a recent podcast discussing crypto lobbying in DC.

Mandatory Reading

Reality Honks Back by N.S. Lyons is the most perceptive take I’ve seen on the Canadian trucker situation.

Nota Bene

Coalition of US crypto firms unveils travel rule compliance platform, TRUST — This is worth reading alongside J.P. Koning’s 2020 article about the London Bullion Market Association’s “good delivery” rules for gold (and his suggestion that such a system should be applied to Bitcoin).

Bitcoin (BTC) Isn’t Good for Laundering Money, Does It Need to Be? - Bloomberg

The Watchful Eye of the U.S. Dollar — Alchemist

The FATF recognises its human rights blind spot - The Blind Spot

Gas-Station ATMs Are a Banking Battleground - WSJ

Money That Won Melania Trump NFT Came From Melania Trump Wallet - Bloomberg

Why the word ‘freedom’ is such a useful rallying cry for protesters | CBC Radio

Hello fellow nerds! This newsletter (which is neither a letter nor does it typically convey news) has now surpassed 1,000 subscribers! Thank you so much for entertaining my idle musings. Please do send it to friends who you think might like it as word of mouth is the only way it keeps growing, and growth motivates me to keep blathering.

Today we tackle a regulatory conundrum, which is my favorite kind of conundrum.

The SEC recently proposed a regulatory change to expand the universe of entities that would qualify as regulated securities exchanges. This proposed change may have potential implications for DeFi, and in particular decentralized exchange even though there isn’t even a hint of the words DeFi, crypto, or anything of the kind in the proposal.

Exchange Act Rule 3b-16 currently states that one is a regulated exchange under the Act if one:

(1) Brings together the orders for securities of multiple buyers and sellers; and (2) Uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.

If the SEC’s regulatory proposal is finalized as currently drafted, it would amend Rule 3b-16 to read like so (changed parts in bold):

(1) Brings together buyers and sellers of securities using trading interest; and (2) Makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade.

Do you see the difference? Today you’re on the hook for registering with the SEC as an exchange or ATS if you bring together “the orders for securities” of multiple buyers and sellers and do so “using” certain methods for matching orders to result in a trade. That is, if you’re engaged in the pretty specific conduct of taking orders, matching those orders, and executing trades. In contrast, the standard under the new rule doesn’t require this same kind of clear conduct. Instead, you’d be a regulated exchange if you bring together not orders, but buyers and sellers expressing trading interest and you also make available to them protocols* by which they can interact and agree to trade with each other.

As I understand it, the proposal is mainly aimed at something like a Bloomberg Terminal through which buyers and sellers can find each other using chat functionality that includes the ability to express non-firm interest in certain transactions at certain prices and then agree with each other (through the system) to a trade. I have no opinion if expanding the rule to cover this kind of system is justified or not. However, the language of the new proposed rule is written so broadly that it’s difficult to see how it wouldn’t cover decentralized exchange even though, again, neither DeFi nor crypto nor anything related is mentioned in the proposal.

SEC Commissioner Hester Peirce pointed out as much at the end of her dissent from the proposal:

A final message to those who operate any service that is designed to facilitate any communication between potential buyers and sellers of any type of security: Read this release. Even if you have nothing to do with government securities or even fixed-income, or with traditional securities, read this release. Preferably as soon as it is published on the Commission’s website. It covers a lot of ground, and you should not assume that it has nothing to do with you, because it probably does.

Yes, of course it does. It’s right there in black and white. Bringing together buyers and sellers by “making available” protocols which they can use to find each other and agree to trades, an SEC lawyer could easily argue, is what a DEX protocol developer does. So, of course, we’ll be engaging in this proceeding.

BUT.

Isn’t it weird that in none of the proposal’s 654 pages is decentralized exchange or crypto mentioned? And isn’t it weird that, as Peter has pointed out, the proposal states that the Commission estimates that only 22 protocol systems will be affected by the rule change? It really seems like they never intended this change to cover DeFi at all. It seems like it really was aimed just at a small, specific universe of trading systems.

What to make of that? Is this a devious plan by the Commission to sneak through a rule change aimed at DEX by dressing it up as something else?

I doubt it. Even if its potential application to DEX wasn’t lost on some folks at the SEC, a proposal like this is serious business with a lot of process.** Additionally, the law is set up precisely to prevent such a sneak attack. This is well put:

If the SEC adopts this rule as is, and the next day brings an enforcement action against the developer of a DEX protocol, that developer could argue in court that the SEC didn’t follow proper administrative procedure because it did not give any notice whatsoever that DEX would be covered and, as noted above, that its economic analysis didn’t consider DEX or anything crypto-related.

There’s a catch, however.

If we and others file comment letters in the proceeding for this proposed rule and bring up DEX and DeFi and crypto, then the SEC will be obligated to respond to those comments when they finalized the rule. That would be the first Commission statement ever on DEX and they would likely say, yeah, it fits the new broad definition and we think people who “make available” such protocols need to register as exchanges. As a result of filing comments that bring up DEX, therefore, the community would be soliciting a response that does away with the procedural argument that there was no fair warning.***

This reality has led some to wonder whether it might make more sense for the crypto community not to file in this proceeding at all. The argument is that if the Commission didn’t realize that the rule change would cover DEX, or at least is pretending it didn’t realize, then the crypto community might be best served by equally pretending to be just as ignorant in order to preserve procedural challenges in court. I don’t think that makes much sense and here’s why.

First is the simple fact that there is no way to control what the community will do and it’s inevitable that someone will file a comment about DEX. Indeed, folks already have. As I said about the blowback that the VC-led push to rebrand crypto as “web3”, crypto a movement, not just an industry, and an open-source one at that, which means that while consensus is possible, unanimity never will be.

Second, I’m not sure getting a Commission statement on DEX is such a bad idea. I keep hearing folks say they don’t want regulation by enforcement. Well, the alternative is regulation by rulemaking, which is what this proceeding is doing. If we can get a clear statement from the Commission that its new rule will cover DEX protocol developers, then those developers should have the grounds to immediately sue the SEC themselves. Depending on how broadly the Commission were to say the rule applies, one could imagine a community-funded suit brought by a solo open-source smart contract developer on First Amendment grounds. (👀)

Finally, let’s not be cynical. Given the fact that we have an administrative state, we shouldn’t give up the only means we have to keep its policymaking accountable: commenting in regulatory proceedings. I know the world today can lead one to give up hope, but it’s not impossible that data and arguments shared via the comment process could lead the Commission to reconsider its rule and make valuable changes. It’s not like the SEC is a monolith. Right now the chairman is being challenged by the two other Democratic commissioners on one of his top priorities–the new ESG rules—handing the Biden Administration another humiliating setback.

Various and Sundry

Because life is short, I only produce two podcasts and this time I’ve got one of each to share with you.

On Tangents from Coin Center, Peter and I recently discussed how we explain “staking” to policymakers who sometimes are confused about how that word is used in different cryptocurrency contexts.

What is “Staking” (for policymakers)? — Tangents from Coin Center - YouTube

In this episode of Tangents, Peter and Jerry discuss a new backgrounder just published by Coin Center that explains what is “staking” to policymakers who som…

And on Worker & Parasite, my book discussion podcast with Stably, we discussed Against Everything: Essays by Mark Greif.

* FWIW the proposal also deleted the word “multiple” so that presumably you could have just one buy and one seller being brought together.

** BTW, whether it’s a devious scheme or a total coincidence ultimately doesn’t matter. The proposed black letter rule is the same.

*** That said, unless they redo it, which they might well do or pretend to do, I’d think the economic analysis argument would still be available.

Well, that was quite a week.

When I woke up on Monday I had no idea it would be like that, but here we are and it’s not over yet, though we can see the finish line. We just need to keep pushing and not let up until it is clearly fixed.

Related to all that, I keep getting asked if what we are seeing lately is a coordinated campaign to attack crypto. Congress keeps sneaking in crypto-hostile provisions in priority bills, mining is getting elevated scrutiny, the White House is preparing an Executive Order focused on crypto regulation, the SEC just published a proposed rule that (without mentioning crypto) seems targeted at DeFi, and just yesterday Decrypt reported on a supposed administration strategy to curb stablecoins and hand over the industry to banks.

Let me address the Decrypt article first since I was quoted in it and I want to make sure folks don’t think I endorse the whole sweep of the piece. The idea that the “Biden Administration is pursuing a crafty strategy to tame an industry it views as a threat” is one way to put it. Another way to put it is that the laws on the books are being enforced, whether we like those laws or not.

As I say in the article, the tenor of the conversation in DC started to change with the announcement of Libra. The reason for that is that Libra’s perceived potential scale, combined with antipathy for Facebook, made folks on all sides and at all levels scrutinize the scheme the way they don’t scrutinize any old new crypto firm or project. What they found, among other things that concerned them, was that Libra inadvertently or not was proposing to issue a security in the guise of a stable value coin. This led them to look at the wider stablecoin market and what they found were stablecoins that are essentially securities or things that look very much like bank deposits but being offered by non-banks. Given the growing size of the market, they got to work enforcing the law, and very slowly at that (between Libra and the toothless President’s Working Group report two and a half years passed).

So, what financial regulators are beginning to say is, hey if you’re going to engage in these kinds of deposit-taking activities, then you’ve got to be regulated as a bank, and if you’re not, we don’t see how you’re not offering a security. That regulators would seek bank regulation for stablecoin issuers shouldn’t be surprising (indeed it wasn’t to the likes of Paxos and Gemini, which from day one got state trust charters to issue their coins; Paxos now has a federal charter too). Do you call that a “Plot to Hand the Crypto Industry to the Big Banks,” as the Decrypt article is titled? Or is it just slow, boring, obvious enforcement of (however-imperfect) existing law to a fast-moving industry? I’m not saying it’s good, I’m just saying it’s not a conspiracy.

I’m also not saying it’s fair, and that brings me to a point I’ve been making on Twitter and elsewhere over and over again. I’m quoted in the article this way:

According to Brito of Coin Center, the legal status of stablecoins is more akin to the money used in PayPal or Venmo transactions. In such transactions, customers don’t send actual dollars to each other but rely on companies to debit or credit their accounts using internal funds. A dollar sent via Venmo, or a stablecoin, serves as money, but that doesn’t mean it’s treated as an investment overseen by the SEC.

My point, however, isn’t that because stablecoins and PayPal are functionally the same thing, and because PayPal today isn’t regulated as a bank or by the SEC, then stablecoins cannot be either. To the contrary. My point is that if stablecoins are securities or must be bank-issued, then I don’t see why PayPal and the like shouldn’t be as well. If the products present the same risks, as I think they do, they should be no distinction in how they’re regulated, and I’m not sure securities regulation or piecemeal and diverging state-by-state regulation is the way to go.

So, back to the original question: Is there a coordinated attack on crypto being waged by the powers that be in Washington?

Well, again, that’s one way to look at it. Another way to look at it is that one year ago we went from having a Republican executive branch to a having very progressive administration with Democrats controlling both houses of Congress. And one year is about how long you’d expect it to take for a new administration to get in the groove of things and really start executing on policy it’s been developing.

In many ways, crypto is a victim of its own success. It has a gotten incredibly big, which in general I’m very happy about. But that also means it’s going to naturally draw a lot more scrutiny than it did a decade ago when it was on no one’s radar. Combine that with an executive branch and a Congress that focuses more on possible risks than potential rewards, and that embraces the precautionary principle, and you shouldn’t be surprised to see the amount of incoming that we’re seeing.

Is this all “coordinated”? I mean, I guess to the extent that there’s interagency coordination, but really I think the perception of coordination goes beyond that. I think what people sense as a plot is actually just a threshold being reached. Crypto has crossed a threshold, for better and for worse, and so there’s just an emergent zeitgeist that leads to a lot of attention, both positive and negative.

None of what I’m saying should be seen as downplaying the challenges we’re facing. It’s just to say that while it’s tempting to think that crypto represents a heroic and existential threat to powerful forces that recognize the threat and have developed a cunning master plan to destroy it, what I know of government and Occam’s Razor leads me to believe that the more likely explanation for the ills that currently befall us is that the tectonic plates of crypto and the federal government, which have for some time been approaching each other and even touching here and there, are finally, in a real way, slowly beginning to collide.

That all said, we’re just going to have to work harder than ever and devote more resources to policy and politics and litigation than we’ve had to, and the good news is that it’s being done. I have no way of accurately measuring this, but my sense on the ground is that the number of people working full-time on crypto policy or lobbying has grown at least 10x over the past twelve months. The amount of political giving has also similarly exploded, exemplified by the announcement today by CMS and of a $20 million crypto-focused PAC. Big litigation is also coming. This is spontaneous order in D.C. I’m afraid.

The other good news is that the federal government is not as omnipotent as we like to fear. Consider the executive order that we expect in a week or two. Here’s how Bloomberg describes it:

The proposed directive would charge federal agencies to study and offer recommendations on relevant areas of crypto – touching on financial regulation, economic innovation and national security, said the people, who asked not to be named discussing plans that are still under consideration.

The initiative will also aim to coordinate agencies’ work on digital currencies throughout the executive branch, the people said. The plan would push departments that have given scant attention to crypto to focus on it. Officials have also considered appointing a White House crypto czar to act as a point person on the issue, one person said.

So, it’s a coordinated plot to. . . “coordinate agencies’ work” and “study and offer recommendations”? I have no idea what’s in it, so I don’t want to get too comfortable, but it’s not going to surprise me if (much like the PWG stablecoin report) this order is about coordinating and studying and getting ducks in a row, not about big policy shifts, especially since some of the most on-point agencies are independent and the White House can’t just boss them around. It’s also going to be about telling the likes of the CFPB, FTC, Commerce, maybe even EPA, to look at crypto, which they basically haven’t done at all. In some ways this might not be bad at all; for example, there are a ton of crypto scams that rightfully deserve CFPB and FTC scrutiny. And as for a crypto czar, who knows, if one’s appointed it might even be someone that gets it. Cross your fingers on all this.

Why does it seem like Congress keeps trying to sneak in anti-crypto provisions in unrelated, massive, “must-pass bills”? There’s nothing deliberately nefarious about this. Here’s how I explained it to Vice this week:

“Because of how politically divided Congress is, the way that anything passes Congress are these giant must-pass bills,” Jerry Brito, executive director of Coin Center, said in an interview. “Some bills to rename a courthouse or rename a post office pass, but anything of substance does not pass on its own. It passes when it’s attached to some massive must-pass bill like the infrastructure bill or the National Defense Authorization Act, which funds the military.”

Again, the only thing that passes Congress today are massive bills to keep the lights on (which is why they’re called “must-pass”) and the only way you get any little bill you’ve been sitting on passed is to get it attached to one of these big unrelated ones. Let me be clear: this is a disaster and it leads to things sneaking through without getting the scrutiny that would accompany a bill going through regular order. This is why whenever one of these massive three-thousand-page bills is published we have to scour it for stuff that would affect crypto and, when we find something, scramble to get it fixed before the bill passes. It sucks, but it’s not a completely deliberate ploy by congress to sneak things through because it’s not as if there’s a real alternative way that small bills can get passed.

As for the letter that Elizabeth Warren (and seven other members of congress who are not getting any headlines) sent to miners demanding an unreasonable amount of business information and, essentially, asking them to justify their completely legitimate use of energy, the miners should take a page from the playbook of other tech companies who’ve received such performative letters from Congress and respond in length and politely but offer no information they don’t want to. Elizabeth Warren is one senator and, while they should certainly be respectful, they don’t have to justify themselves to her. In less than a year it is likely she will be in the minority in the Senate.

And as for the proposed SEC rule that seeks to expand regulation of exchanges to include “making available a communications protocol for expressing trading interests” is a big deal if it is what we think it is. The good news is that it looks like a total overreach, but I’m going to save that for the next missive when I’ve have a chance to look at it more closely.

Have a good weekend.

Happy new year, everyone. Today there’s no real main course, more of an assortment of tapas.

Let’s start with follow up from my last missive on the Canadian model of cryptocurrency exchange regulation. I got several great replies that I’d like to address.

One very smart commenter took issue with my assertion that regulating custodial exchange balances as securities leaves no room for bailments. He points out that the Canadian regulation only applies to trading venues (i.e. where one can buy and sell crypto). If there was a safekeeping service where a customer could deposit bitcoins and then withdraw them at a later date, but the service did not offer buying or selling, that service would be providing bailment that would not be regulated as a security.

That is fair enough, but the question I’d ask is, what is it about facilitating trading between bailees (without any other associated promises) that turns a bailment into a security? The famous whisky receipts case, SEC v. Glen-Arden Commodities, Inc., is instructive here. This case is often invoked for the proposition that selling receipts (i.e. tokens) for a bailed commodity amounts to an investment contract. But the facts of the case are more nuanced than that.

Bottom line, what was sold to investors in that case was more than mere receipts that could be redeemed for gallons of whisky, but also a set of promises and projections of profit. From a good explainer on the case:

Before launching into a recitation of the facts of the case, the court, after citing Howey, noted that “[I]t is clear then that the manner in which the Scotch whisky warehouse receipts were sold, the information given, profits predicted, services promised and the obligations to be assumed by the purchasers were at all times relevant to the proceedings before the court.” The recitation of facts would demonstrate that there was a lot more to the offer and sale of the receipts in question than a simple offer and sale of evidences of ownership of casks of whisky.

The evidence established that the defendants’ mode of operation was to recruit salesmen familiar with neither the Scotch whisky business nor investment practices, provide these salesmen with a “canned” sales pitch along with sales literature and direct them to potential customers solicited through mass merchandising techniques such as newspaper advertisements and the indiscriminate use of mailing lists. The training of the salesmen consisted of meetings at which defendants or their employees provided data on the price of Scotch whisky, the cost of insurance and cooperage and the profits which could be anticipated from an investment in Scotch whisky warehouse receipts.

The evidence also established that representatives of the issuer of the receipts (“WWR Issuer”) informed prospective purchasers at promotional meetings that: (i) the WWR Issuer would utilize its expertise in selecting the type and quality of Scotch whisky and casks to be purchased; (ii) receipt-holders could call the WWR Issuer to obtain current information about the Scotch whisky market; (iii) the WWR Issuer would provide the cooperage of the whisky; (iv) the WWR Issuer would provide two insurance policies to protect the investments; (v) when the receipt-holders wished to sell their whisky, the WWR Issuer would assist them in making a sale at the current pricing schedule, charging no fee or commission; (vi) the WWR Issuer would handle all administrative details relating to the program; and (vii) customers could expect a doubling of the value of their investment within three to four years and further increments after that.

I don’t know much about Canadian law, but in the in the U.S., while Congress can certainly pass a law that says that deposits that would otherwise be bailments at exchanges will be securities (and like I said last time, I’m very open to that approach), I’m pretty sure that the SEC can't just say that they are. Assuming exchanges are not making any of the promises and assurances that the promoters of the whisky receipts made, what would be the SEC’s argument that bailments of crypto, even on trading platforms, are investment contracts?

Speaking of Canadian law, another reader with lots of experience dealing with Canadian securities regulators on crypto share this:

Anglo-Canadian law has a narrower conception of bailment than U.S. law. There are Canadian and English authorities that suggest only tangible property can be the subject of a bailment. I’m not sure why that should be and perhaps one day an English or Canadian court will have to address the issue more directly and clarify.

Could explain some of the difference.

Finally, I’ll note the Canadians are not playing around. Two weeks ago they sent Binance a nastygram letting them know in no uncertain terms they could not do business there unless they registered:

The Ontario Securities Commission (OSC) is notifying investors that Binance is not registered under securities law in Ontario. This means they are not authorized to offer trading in derivatives or securities to persons or companies located in the province.

Binance represented to OSC Staff that no new transactions involving Ontario residents would occur after December 31, 2021. Binance has issued a notice to users, without any notification to the OSC, rescinding this commitment. This is unacceptable.

No entity in the Binance group of companies holds any form of securities registration in Ontario.

Binance seems to now be complying.

Why web3 rankles

Next I want to address the question of why so many folks in crypto dislike the term “web3” so much.

I don’t get the viscerally negative reaction to “Web3.”

It’s literally marketing language that plays better to new and regulatory audiences to describe the same tech.

Hold your noses and focus on winning.

— Ryan Selkis 📖 🖊🔑 (@twobitidiot) January 4, 2022

Of course, there are many individual reasons, but I think in large part the visceral reaction stems from the fact that this “marketing language” for what until now has been called “crypto” feels imposed on the community in a top-down fashion, rather than the traditional bottom-up, open source fashion through which language and concepts emerge in crypto. In the crypto space, things that come up through that process have legitimacy while there tends to be an immune response to things that individuals or small groups try to promote, even if it’s for everyone’s own good.

In the case of “web3” the word itself has been around for years, but with little real use. That changed around last fall when there seems to have been a concerted effort by some VC firms to change how crypto is talked about, especially with policymakers. It doesn’t help that these marketing materials tended to draw a distinction between web3 and Bitcoin. For example, here is every use of the word “Bitcoin” in a16z’s policy agenda for “the Third Generation of the Internet”:

Policymakers should continue working with the bitcoin community to bring greater levels of sustainability and renewable power use to the bitcoin blockchain. Efforts are already underway: the Cambridge Center for Alternative Finance found that 76% of bitcoin miners use renewables as part of their energy mix, and 39% of bitcoin mining’s total power consumption comes from renewables—twice as much as the U.S. grid.

Rather than fixating on bitcoin’s energy consumption as an excuse to dismiss the potential of the whole industry, policymakers should embrace the value of web3 platforms to support sustainability objectives, such as enhancing the liquidity, integrity, and utility of carbon markets.

The document also includes this chart, which is funny especially because of where Ethereum is positioned above the line.

This is kinda the way Bitcoin maximalists like to draw a distinction between Bitcoin and “crypto” and I don’t find either approach helpful. It leads to resentments and what René Girard would call “memetic rivalry.”

Given the source of the term, I think another reason “web3” rankles so many is its perceived hypocrisy. Here’s an example from someone I respect and admire, former CFTC Commissioner Brian Quintenz who is now at a16z:

.@RepAGonzalez nails it. Why #web3 fixes the broken/tyrannical nature of web2, why #DAOs are necessary to that future, how to keep that innovation in the US, and why all financial regulators should abide by ancient greek Hippocrates’ principle: do no harm. https://t.co/sTOGlSR4qt

— Brian Quintenz (@BrianQuintenz) January 5, 2022

That’s all great stuff, and I very much recommend Rep. Gonzalez’s op-ed (which, by the way, explains the term web3 this way: “web3, which is more commonly referred to as the crypto or blockchain revolution.” Emphasis mine.)

The thing is, Facebook is the pinnacle of "the broken/tyrannical nature" of web2, at least according to Rep. Gonzalez who especially singles out Instagram for opprobrium. So, someone already captured by the kind of mimetic rivalry I’m warning about (perhaps because they’re sensing an illegitimate top-down imposition of a marketing term, and a term that seems to exist to be a contrast to some of the the oldest, biggest, and most important blockchain networks) might ask, “But isn’t Marc Andreessen one of Facebook’s earliest investors and currently serving on its board of directors?”

If marketing and policy folks want the crypto community to embrace the web3 term, they’ve got to convince them, not just expect them to get in line. I hope it doesn’t come as a surprise to them, but crypto is not a business, but a movement. Folks who think they know how best to market to the public or engage with policymakers will find that the community doesn’t follow anyone’s lead simply because of who they are. It’s a lot like open source development. You’ve got to have rough consensus and running code before your patch is accepted, and if you’ve done it right, no one will think of it as your patch.

For my part, I use the term web3 when it’s useful, but whenever I do it’s deliberate. The reflexive and natural thing for me to say is “crypto” or “Bitcoin” and I don’t sense that reflex changing soon.

Bitcoin is a cryptocurrency. It is also the first DAO.

Speaking of evolving terms in crypto, it seems to me that the meaning of the word DAO has of late been (organically, emergently) expanding quite a bit and in a way I don’t think is helpful and I’m going to tell you why. Consider this my contribution to the open source discourse on the matter. (See, this is me modeling.)

To my mind, Bitcoin was the first DAO. It is truly a decentralized autonomous organization. It’s an organization because it is an assembly of people and their machines to accomplish a purpose and that purpose is very akin to the kind of thing that would have previously been done by a corporation (i.e. PayPal, and yes I know Bitcoin does more than PayPal). Bitcoin has customers and it has employees, but it is decentralized so it’s not a corporation. It even has very effective governance, but it’s not based on membership or shareholding or the like. It really is autonomous and unstoppable.

I think we should have many more DAOs like Bitcoin to compete with the services that centralized internet firms now provide. Some would call that web3, and it’s a good vision.

We like the UX pic.twitter.com/oSDdvXxRTx

— chel$ea (@chhlss) January 5, 2022

But many of the DAOs I’m seeing today, at least the ones that are getting a lot of coverage, look just like gussied up Kickstarter campaigns. (BTW, Kickstarter announced they’re pivoting to crypto.) Don’t get me wrong, I really enjoy the creative ways the mob can leverage technology to challenge convention, and I think people should be free to organize to experiment however they want. But if Bitcoin is the model for what an unstoppable DAO can be like, I’m not sure a lot of the Discord-groups-with-a-crypto-balance I see meet the standard. Additionally, from my myopic perspective, the Bitcoin model of DAO has another very attractive feature: it’s not a security.

Most stories you’ll read about DAOs in either the crypto or mainstream business press usually don’t mention anything about law or regulation, but the way the featured DAOs are described usually has me asking myself a lot of questions. Here are a couple new DAOs that recently caught my eye.

Was the author of this piece intentionally trying to evoke the Howey test? https://t.co/8nzRVU3M14 pic.twitter.com/nzcfG7G1VU

— Jerry Brito (@jerrybrito) January 5, 2022

LinksDAO, which raised $10 million in 48 hours, caught my eye because of the way the CNBC reporter described purchasers of its NFTs as relying on the efforts of the promoters to follow through on their promises, which is hilariously close to the Howey test. Of course, as one smart commenter replied, what matters here is whether there’s an expectation of profits. No expectation of profits is why I said a while ago that ConstitutionDAO was not a security.

(Quick aside: FTX announced last week that they will be launching futures markets for ConstitutionDAO’s $PEOPLE token. In their announcement they describe the tokens this way: “the tokens currently possess no rights, governance, or utility other than redeeming them for ethereum from the smart contract held in Juicebox at a ratio of 1,000,000:1”. What will the futures market say $PEOPLE is worth?)

Anyway, according to LinksDAO’s website, buying a LinksDAO token doesn’t get you the promise of a golf club membership once they have bought a golf club, only the promise of the right to purchase a golf club membership once they have bought a golf club. (Per the site’s front page: “Enjoy the perks of LinksDAO including… The right to purchase a membership at the 1st physical club LinksDAO acquires.”) The “Terms of Sale” on the site, though, don’t make any mention of this and actually disclaim any such rights (“You understand and agree that the sale of Membership NFTs grants you no rights and carries with it no guarantee of future performance of any kind by LinksDAO, Inc.”). 🤷

Another DAO that caught my attention recently is BlockbusterDAO. Given the obvious nostalgia meme play, it has gotten some attention. And apparently the daughter of a former Blockbuster CEO has joined BlockbusterDAO’s “core team.” What they want to do is raise $5 million to buy the rights to the Blockbuster trademark and other IP and then use it to launch a (seemingly for-profit) decentralized video streaming service that will show content that they commission and produce. De-Film they call it.

Dish Network owns the Blockbuster brand and doesn’t seem interested in selling it. The DAO’s plan, however, is to raise $5 million, tender an offer to the company, and then engage in a PR campaign creating on the company “pressure to sell”. It would be very humorous if instead of selling, Dish sued the DAO which, after all, is using a trademark the company owns.

From what I can tell they haven’t yet sold any tokens or even solicited any funds, so I’ll be keeping my eye on this one.

Various and Sundry

Self-promotion: Last week I spoke on a panel at the American Enterprise Institute hosted by Jim Harper and alongside other great panelists Chris Giancarlo (former CFTC chairman), Kara Calvert (Coinbase), and Miller Whitehouse-Levine (DeFi Education Fund). Clips of yours truly playing all sided and a link to video of the whole event are in this thread.

Also, there’s [a new episode](https://wap.simplecast.com/episodes/the-sum-of-small-things-by-elizabeth-currid-halkett) of Worker & Parasite, my book review podcast with Stably. We discuss [The Sum of Small Things](https://www.amazon.com/Sum-Small-Things-Theory-Aspirational-ebook/dp/B01MYNT9GW) by Elizabeth Currid-Halkett, which is an updating of Thorstein Veblen’s Theory of the Leisure Class. It seems aspirational class people today care more about inconspicuous consumption, and many signal their status through conspicuous production, like writing newsletters.

Friend-promotion: If you’d like a less jaundiced view of DAOs, web3 and the rest, I recommend you check out my friend Matt Mulder’s newsletter, Muldering, in which he “identif[ies] massive opportunities for building the companies of tomorrow, based on the less than obvious, but really important, trends happening in the world of politics today.” It’s a must read.

When I started writing this newsletter again I said it would help me to think out loud and develop my views on things. Well, today’s letter definitely falls in that category and I hope you’ll let me know what you think. And if you find it interesting and think a friend will too, please forward it to them.

Cryptocurrency exchanges like Coinbase, Kraken, and Gemini allow users to trade commodities like Bitcoin. Because they don’t trade securities or derivatives, they are not regulated or supervised by the SEC or CFTC. They’re not subject to securities regulation any more than a rural swap meet that hosts a lot of selling and trading of commodities.

The problem, some argue, is that crypto exchanges in practice are very, very different from other spot commodity markets. They are much more liquid and deeper and faster. They bring together market makers, retail investors, and sophisticated professional traders in the same venue. In short, they look like securities exchanges and may pose similar risks.

Faced with this situation, a serious government would first confirm (not merely assume) that real risks do exist and, if they do, say, “well, I guess we need to legislate to mitigate the risk because current law doesn’t cover this novel case.” That is, it would pass a new law to cover this unforeseen situation rather than try to fit a square peg into the round hole of existing law and regulation.

Some in Congress are doing just that. Most on-point is the proposed Digital Commodities Exchange Act being developed in the House Agriculture Committee and for which I have a soft spot in my heart. It’s not perfect but it’s pretty practical. There’s also forthcoming legislation from Sen. Lummis that I expect will also address exchange regulation.

Unfortunately, though, Congress is broken these days, so it’s not surprising that regulators in charge of protecting “the public interest” feel they must do something without waiting for Congress to act. It may not be excusable, but at least it’s understandable. And it helps explain’s SEC Chairman Gary Gensler’s campaign to have cryptocurrency exchanges register with the Commission and come under its supervision.

The problem with Gensler’s approach as I’ve observed it is that ,as far as the exchanges are concerned, they’re not trading any securities, only commodities, so the SEC has zero authority over them. To that Gensler says some version of these remarks from August:

A typical trading platform has more than 50 tokens on it. In fact, many have well in excess of 100 tokens. While each token’s legal status depends on its own facts and circumstances, the probability is quite remote that, with 50 or 100 tokens, any given platform has zero securities.

Now, the way I read the law, one has an obligation to register with the SEC if one is listing securities, not if there’s a high probability that one is. I can imagine the exchanges saying something like, “Oh boy, can you please tell us which tokens you think are securities? We’d like to delist them immediately and make sure we’re in compliance with the law.” But of course the SEC isn’t going to “classify” tokens short of an enforcement action, so it finds itself regulating through “agency threats”. This is not good for anyone involved.

The Canadian Model

So, is there some other way that the SEC can legitimately assert its authority without having to first establish that certain tokens are securities (which the exchanges can always just delist)? Canada has developed just such a novel approach and it is pretty seductive.

Essentially what Canadian securities regulators have found is that even when an exchange lists only commodities like Bitcoin, what users actually have and trade are not the commodity tokens themselves, but a security interest in them. From 2020 guidance:

Staff is aware that some Platform operators are of the view that the Platforms they operate are not subject to securities legislation because they only allow for transactions involving crypto assets that are not, in and of themselves, derivatives or securities. However, based on our analysis of how trading occurs on Platforms, we note that some Platforms are merely providing their users with a contractual right or claim to an underlying crypto asset, rather than immediately delivering the crypto asset to its users. In such cases, after considering all of the facts and circumstances, we have concluded that these Platforms are generally subject to securities legislation.

J.P. Koning has been talking about this for some time and suggesting that the U.S. consider copying this approach. From the perspective of an open source crypto rights advocate, there’s a lot to like in the approach.

First, it essentially excludes non-custodial platforms. P2P marketplaces and decentralized exchange protocols always result in actual delivery of purchased tokens, so it can’t be said there is any security interest involved. While there are other theories a securities regulator could apply to cover those platforms, it may not be worth their time if pursuing the Canadian model captures 99 percent of the market.

Second, and relatedly, such an approach could create more demand for non-custodial applications and business models. I wouldn’t mind seeing the further development of DEX ecosystems or the development of novel models that combine a centralized exchange with multisig arrangements, allowing platforms to have no control over user funds. In essence, the Canadian model creates alignment between regulation and the “not your keys, not your coins” ethos of crypto since in some respects both are aimed at the same risks.

Third, it takes a practical approach to token disclosures. This one is important but will take a little bit to explain. . .

Today, if a token represents an investment contract, then the issuer of the token has an obligation to register with the SEC and make required disclosures about the offering. This is simple enough when there is a clear issuer of a token, but in crypto there often isn’t (or isn’t anymore) a clear issuer or promoter on which investors rely. Because this is all a “facts and circumstances” analysis, however, opinions can differ on whether there is or isn’t a party who would have disclosure requirements—i.e. whether a network is “sufficiently decentralized.” The result is that we again find ourselves in a world of “agency threats” where if one is even “near the line,” one is cajoled to register.

Apart from the obvious rule of law problems with this state of affairs is the fact that it’s an invitation for sham disclosures. For example, imagine we find that Bitcoin is a security. Who would be on the hook for filing the registration and disclosures? I can imagine that Craig Wright would be the first in line to do it. You can also imagine that we find that Ethereum is a security. Imagine further that upon such a finding, Vitalik and everyone remotely associated with the Ethereum Foundation takes their cyanide capsule. Ethereum would continue to operate just the same (giving the lie to it being reliant on any person’s efforts), but technically someone would have to file a registration if it was ever to trade legally.

By saying that the security in question is not the token itself, but the derivative contract being offered by the exchange, the Canadian model puts the onus for disclosures on the regulated exchanges. This is very practical and potentially avoids the thorny questions above.

What kind of disclosures would exchanges have to make? In Canada, regulators have granted crypto exchanges “prospectus relief” exempting them from the full standard disclosures they would otherwise have to make and instead they require lighter, crypto-specific disclosures including “a description of the Crypto Asset, including the background of the team that first created the Crypto Asset, if applicable,” and “any risks specific to the Crypto Asset,” etc.

In sum, this seems like a good approach since regulators get to apply the supervision they presume is lacking, exchanges get clarity, investors get protections they didn’t previously have, and the decentralized, open source elements of crypto are left alone.

The Catch

Unfortunately, the Canadian model seems pretty legally suspect to me—at least as it could be applied in the U.S.

To start with, Canadian regulators find that exchanges are issuing “crypto contracts” when they find that a platform is “merely providing their users with a contractual right or claim to an underlying crypto asset, rather than immediately delivering the crypto asset to its users.” But if you look at the terms of service of major U.S. exchanges, you find that the contractual right customers have is explicitly not a claim but actual title. Here’s Coinbase for example:

2.6.1 Ownership. Title to Digital Currency shall at all times remain with you and shall not transfer to Coinbase. … None of the Digital Currencies in your Digital Currency Wallet are the property of, or shall or may be loaned to, Coinbase; Coinbase does not represent or treat assets in User’s Digital Currency Wallets as belonging to Coinbase. Coinbase may not grant a security interest in the Digital Currency held in your Digital Currency Wallet.

I mean, it seems pretty clear that what Coinbase is engaged in here is a bailment and not a securities offering. From what I can tell, it’s perfectly legit to have bailments in fungible commodities even if they are commingled with those of other bailees as with grain at a silo. This stands in direct contrast to what payment app providers tend to do. For example, here is PayPal’s terms of service:

Any balance in your Balance Account represents an unsecured claim against PayPal. … PayPal combines your Balance Account balance with the balances of other Balance Account holders and invests those funds in liquid investments in accordance with state money transmitter laws. PayPal owns the interest or other earnings on these investments. However, the claim against PayPal represented by your balance held in your Balance Account is not secured by these investments and you do not have any ownership interest (either legal or beneficial) in these investments.

Between the two, which one looks more like a security? (I’ve been riding this hobby horse for a while.) Nevertheless, from what I understand it seems Canadian regulators expect the likes of Coinbase to register and are in ongoing discussions with them. In my view, such an expectation essentially leaves no room for the existence of bailments, which is nonsensical.

Canadian regulators appear to have an incredibly narrow view of what it takes to avoid creating a derivative. It’s not enough that you have a clear contract with the customer spelling out full title. Instead, here’s the guidance they give:

Platforms would not generally be subject to securities legislation if each of the following apply:

• the underlying crypto asset itself is not a security or derivative; and

• the contract or instrument for the purchase, sale or delivery of a crypto asset

• results in an obligation to make immediate delivery of the crypto asset, and

• is settled by the immediate delivery of the crypto asset to the Platform’s user according to the Platform’s typical commercial practice.

Only by effectuating “immediate delivery” can one seemingly avoid application of the securities laws. What constitutes “immediate delivery”?

We generally will consider immediate delivery to have occurred if:

• the Platform immediately transfers ownership, possession and control of the crypto asset to the Platform’s user, and as a result the user is free to use, or otherwise deal with, the crypto asset without

• further involvement with, or reliance on the Platform or its affiliates, and

• the Platform or any affiliate retaining any security interest6 or any other

• legal right to the crypto asset; and

• following the immediate delivery of the crypto asset, the Platform’s user is not exposed to insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the Platform.

Later on in the guidance they give an example of what immediate delivery would look like for a Bitcoin trade and it includes that the transfer to the customer be “immediately reflected on the Bitcoin blockchain[.]” This strikes me as unreasonable.

Again, the Canadian model seems to preclude the possibility of bailment arrangements, or at the very least would require that a customer accept sole possession of the crypto before they could send it right back to the platform for bailment (in order to take advantage of the safekeeping services or to be better positioned to execute a quick trade or for whatever reason). It really is nonsensical, again, given the clear contractual agreement between user and exchange that the user retains full title to the commodity.

Check me

Now, I’ve written all this in order to help me figure out what I think about the Canadian model. Writing is a great way to think through a problem. And by sharing it with you hopefully you can call me out where I’m wrong. I know there are a bunch of legal eagles who read this and I hope they’ll hit reply and let me know where I got my facts, assumptions, or analysis wrong. There are also some things I still haven’t mulled through on which I’d appreciate thoughts:

• While it’s the SEC that’s often told to look at what the Canadians are doing, shouldn’t it really be the CFTC? After all, wouldn’t “crypto contracts” be commodity derivatives?

• The CFTC has its own definition of what constitutes “actual delivery” of crypto commodities, but this is only relevant in the context of products where there is some margin trading or other leveraged transactions, right?

What else did I miss? What’s the best case crypto balances on U.S. exchanges are securities? How do the Canadians square their rules with what I imagine is similar bailment law as the U.S.?

Anyhow, I hope that gives you plenty of homework to tide you over the holiday break. I hope you all have a great Christmas and a happy New Year.

That is, unless you securitize them.

The crypto community is not known to leave well enough alone, so I’ve been pretty bemused to see how much “fractionalization” of NFTs is being done. I just want to raise the potential securities law issue so that folks who are doing this, or are thinking of it, can be aware of it because I’m sure regulators are watching.

One of the pioneers of fractionalizing NFTs is PleasrDAO, which describes itself as “an art collective that buys and stewards culturally significant NFTs.” They famously bought the Doge NFT and then proceeded to issue 16,969,696,969 $DOG ERC-20 tokens that represent ownership stakes in the NFT. (It’s probably a little more complicated than that, but that is how it’s generally presented and shouldn’t affect this analysis.) They then sold 20% of the total supply in an auction to the public, allocated 25% of the supply toward a fund for “community programs and continued development,” and kept 55% for themselves. If the Doge NFT is sold to an external party, the FAQs say that “fractional owners are able to trade all their ownership tokens in for the ETH that was deposited by the [external party] on a pro rata basis.”

There are a couple of ways regulators could say this is a security. First, they could say the $DOG tokens simply represent equity in the enterprise and equities are securities. Alternatively they could say that the scheme is an investment contract. Most would agree that there is an investment of money in a common enterprise with an expectation of profit. The question then is whether those profits are “derived from the efforts of others,” typically the promoter. In this case I can imagine regulators saying the fact that PleasrDAO kept 55% of the token supply for itself (80% if they count the “community fund”), as well as all the marketing and community infrastructure PleasrDAO provides, means there’s reliance on their efforts. This is not unlike the case the SEC is making against Ripple.

I don’t know if such a charge would be successful, and there are any number of defenses one can imagine, but that’s probably what the complaint would look like.

The reason I started looking into “fractionalization” is that this week I saw a lot of chatter around PleasrDAO’s latest project: an effort to buy an NFT of art by convicted Silk Road creator Ross Ulbricht being auctioned to benefit his legal defense and other causes. What I found so amazing was that Pleasr created a DAO — FreeRossDAO — not just to fractionalize the NFT if they acquired it, but also to raise funds to bid in the auction, very much like ConstitutionDAO.

In a previous missive I explained why I didn’t think ConstitutionDAO could be said to be offering securities. The main reason is that at the time there were no expectation of profits. Participants understood their contributions as donations and it was made clear that issued tokens did not confer any ownership stake, just the ability to vote in advisory polls about the disposition of the Constitution in the event they won.

FreeRossDAO seems to be trying to follow the same recipe. Their marketing talks in terms of “contributions” and “donations”. However, while it also doesn’t talk in terms of fractional ownership, it does say things like

Once the bid to acquire the Genesis Collection succeeds, contributors will receive $ROSS tokens in return for their contributions pro-rata, serving as both fractional pieces of the Genesis Collection as well as FreeRossDAO’s governance token. Holders of $ROSS can vote on proposals and contribute to the direction of FreeRossDAO. (Emphasis mine.)

And

If FreeRossDAO wins the auction, the NFT will be fractionalized into $ROSS and distributed pro-rata, weighted by contribution. $ROSS will represent governance rights within FreeRossDAO and a fractional part of the “GENESIS COLLECTION” NFT. (Emphasis mine.)

I have no idea what this means. Unlike the Doge NFT, I haven’t found FAQs about whether the NFT can be sold to external parties and what happens to the DAOs assets if there was to be a sale. I’ve heard some involved say that they will use Fractional, the same platform used to fractionalize $DOG. I also asked on the FreeRossDAO Discord and was told that they’ll “probably set a high reserve price on Fractionalize [sic] but yeah in theory it could get bought out, in which case holders would get a share of the sale price proportional to their holdings.” Although they won the auction, they haven’t done this yet as far as I can tell.

Also interesting is that, PleasrDAO promised investors that it would take steps to ensure that the DAO won the auction. In particular, they said

PleasrDAO has seeded the FreeRossDAO multisig with 240 ETH (~$1mm) symbolizing Ross’s sentence. PleasrDAO will donate an additional 240 ETH each time the total amount raised hits a multiple of 2,400 ETH. PleasrDAO will continue contributing if FreeRossDAO gets outbid until PleasrDAO hits its secret max donation.

That is, PleasrDAO committed to continue adding funds to the FreeRossDAO treasury if the bidding at auction went higher than the amount that had been raised (up to a secret amount). This was clearly designed to avoid the fate of ConstitutionDAO whose max bid was known to all other bidders.

Again, I note the word “donation” in the quoted paragraph above. I’m not sure if the means that PleasrDAO was donating free and clear all its contributions to FreeRossDAO, or whether they will get fractional shares pro rata, and I’m not sure how to look it up right now, but that would certainly factor into the securities law analysis a regulator might do.

In any event, FreeRossDAO won the auction yesterday and it’s going to be interesting to see what next steps they take. What worries me is that a regulator looking at all this might see not just a fractional ownership security, but also a fundraiser for a venture fund à la theDAO.

I’m putting all this out here because clearly this tech is letting the community do incredible things and I want folks to know what legal risks there are so they can stay safe. Staying safe means either avoiding doing things that are securities offerings, or offering securities in compliance with law and regulation. What does that look like? It’s not easy, but it’s doable.

Fractional shares of unique, high-price items like fine art, wine, and even race horses are nothing new. Masterworks has been doing this for some time with art. From what I can tell, the way they do it is they first create a Delaware LLC, then that LLC acquires a work, and then Masterworks sells shares in the LLC to investors. In doing so, they register the offering with the SEC. Here is Masterworks’s registration for their first offering: Andy Warhol’s iconic work, “1 Colored Marilyn”.

I know, it’s not easy, but please don’t shoot the messenger. If it was up to me there would be lots more exceptions to the securities laws.

OK that’s all I have this week. Please hit reply and let me know if you have any comments.

A couple of housekeeping items:

I’ve been prevailed upon to put these missives up on the web, but I’m doing so only after two weeks, so the only way to read the latest issue continues to be to subscribe. To that end, please forward this to friends you think might find it interesting.

Finally, a new episode of my book review podcast with Stably is out. We discuss The Uncontrollability of the World by Hartmut Rosa, which was great if depressing. Check it out.

I hope you all had a great Thanksgiving holiday and I hope you’re having a happy Hanukkah. Today, I want to ruminate on a claim I often see on social media: that SEC Chairman Gary Gensler has said that ETH is a security, and that as a result we may see him repudiate the policy outlined in the famous 2018 speech by then-Director of the Division of Corporate Finance William Hinman. I want to explain why I’m not convinced by these claims.

Let’s begin by understanding what exactly Hinman said in his speech. I find that there’s a lot of confusion about what he was communicating even though to me the speech is incredibly clear.

Sales, not tokens

One key message of the Hinman speech is that the proper question to ask is not whether a particular digital asset is a security or not, but whether a particular sale of an asset is a security. He says it once:

To start, we should frame the question differently and focus not on the digital asset itself, but on the circumstances surrounding the digital asset and the manner in which it is sold. To that end, a better line of inquiry is: “Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?”

And twice:

The digital asset itself is simply code. But the way it is sold – as part of an investment; to non-users; by promoters to develop the enterprise – can be, and, in that context, most often is, a security – because it evidences an investment contract. And regulating these transactions as securities transactions makes sense.

What he is saying here is pretty clear. He is just applying the Howey test to digital assets. In the Howey case a guy sold people land along with promises related to the management of the orange groves on the land, and the Supreme Court found those sales to be investment contracts (a kind of security). That is, the Court found the sales, the transactions with its associated promises, to be securities, not the land.

The land that was the subject of the sale was never and will never be a security. That land is still in Florida and has likely been bought and sold many times since Howey, and we don’t say that at some point it “transformed” from a security into real estate. The land itself was never a security; it was always just real estate. In the same way, token sales can be securities yet tokens themselves cannot; at most they can simply represent or control a security interest.

So what are the kind of things that would have to accompany the sale of an otherwise-commodity token in order to make that transaction an investment contract? Again the answer to that comes from the Howey: There has to be (1) an investment of money in a (2) common enterprise with an (3) expectation of profits (4) reliant on the managerial or entrepreneurial efforts of a third party or promoter.

In the Howey case, Mr. Howey didn’t market the land to farmers who wanted to tend orange groves, but instead to tourists. And these tourists bought the land not because they wanted to tend the groves, but as an investment in the agricultural enterprise that Mr. Howey was managing. Most importantly, the buyers of the land relied on those managerial efforts for their expectation of profits. To apply this to a token, you just need to substitute token for land and token network for agricultural enterprise.

When tokens are just tokens

This brings us to the second key point in the Hinman speech. He was trying to answer the question: when can we say that a token that was once part of an investment contract is no longer a part and is now being sold just as a commodity? As he put it:

[W]hat about cases where there is no longer any central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or service available through the network on which it was created?

In the events of Howey, I imagine it’s probably the case that between the time the scheme began and the time of the SEC enforcement action there were some investors who bought land from Howey and sold it to other investors—investors who also relied on Howey’s efforts. Those secondary sales, of course, were also the sales of investment contracts, not just land. But at some point after the Howey decision there was a sale of the land by itself, to a farmer or a developer, who was not relying on anyone else’s efforts for their returns. The land was just land; there was no longer an orange grove enterprise managed by Howey that the purchaser was buying into.

So, the same should hold for a token that was sold at some point as part of an investment contract, but later sold without any reliance on third-party efforts. Analogizing to Howey, Hinman says that if buyers of a token are no longer relying on anyone else’s efforts (even if the token was at some point in the past part of an investment contract), then it sales won’t be investment contracts.

But how can we tell if there is reliance on a third-party or not? As the SEC is fond of saying, that’s a matter of “facts and circumstances” specific to each case, but in general we should be able to say that if “there is no longer any central enterprise being invested in”—that is, there is no longer any Howey Orange Grove Management, Inc. that manages the scheme—then there is no reliance because there is no one on whom one on whom one could be said to rely.

In the case of ICOs, investors are almost certainly relying on the ICO’s issuers to build and launch the network or application. Any secondary sales of tokens while people are still relying on the efforts of the issuer to build and launch the network are also going to be sales of securities. But at some point, if they indeed build and launch the network, and it becomes decentralized (in the sense that the issuer can get hit by a bus and the network would continue to function and others in the community could continue to develop it via open source means), then there is no one person or entity on whom investors can be said to rely. After that, token sales are just sales of commodities. In Hinman’s words:

If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract. Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.

The rationale he gives is important. The securities laws exist to mitigate the information asymmetry that exists between issuer/promoter/manager and investor. In the case where a network no longer has a central developer or manager, and all development and management is done open and transparently via open source and open blockchain means, there is no longer any information asymmetry to mitigate. Indeed, it’s not clear who the SEC would even require to make disclosures in such a case.

So when do we have sufficient decentralization to be able to say that there’s no one person or group that investors are relying on? Well, it’s not a bright line. It’s very much like pornography: you know it when you see it. That said, Hinman did offer a list of indicia. Subsequently the SEC made available a further list of factors it considers. I imagine a court would consider a similar set of factors.

Many folks in our space don’t like that it’s not a bright line. As a fan of the common law and flexible tests, it doesn’t bother me too much. The real problem is that the SEC doesn’t often take cases to court, so we don’t get much development of where the lines are, but that’s a topic for another missive. The important thing is that at one end of the spectrum we have clearly a security and at the other we have something that is not, and it’s possible to start life as part of an investment contract and end up not being related to any such contract and be just a commodity token.

ETH

Which brings us to Ethereum. Here’s what Hinman had to say about it in the speech:

And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.

People focus on the last clause of that sentence (“current offers and sales of Ether are not securities transactions”), but just as important are the first two clauses. First he says, “putting aside the fundraising that accompanied the creation of Ether”. What he’s doing there is going out of his way to say that he is not talking about the Ethereum presale. By implication he is saying that the Ethereum presale may well have been a securities offering, no doubt because at the time of the sale investors relied on the efforts of the promoters to build and launch the network.

The second clause in the sentence is another big caveat: “based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure”. What he’s saying there is that he’s only talking about Ether as it existed at the time of his speech. Not at the time of the presale, not a month before the speech, and (this will become important in a bit) not in the future. He’s saying that his assessment that there’s no central party on whom investors rely depends on the facts and circumstances of the network as he understands them to be at that moment in time in June of 2018.

When Gary Met “When Gary Met Howey”

In 2019. Rep. Ted Budd (probably the next senator from the great state of North Carolina, BTW) sent a letter to then SEC Chairman Jay Clayton asking him if he agreed with Hinman’s speech, and Clayton answered that he did. It would be neat to have a similar letter sent to Gensler, but until then we have to rely on his past public statements to get a sense of his thinking.

I’ve looked for as many such statements as I could find. (It’s been funny because in a couple of the ones that are often cited I’m actually either a co-panelist with Gensler or testifying before a committee he chaired.) What I’ve concluded after looking at all these statements is that in every one Gensler seems to be agreeing (or at least not disagreeing) with Hinman’s analysis. It’s often reported that Gensler has said that Ether is a security, but in every statement that’s cited for that proposition it turns out that he’s referring to the Ethereum presale, not ETH itself today. Here are some examples:

→ MIT Bitcoin Expo (March 2018). He agrees it’s more or less settled that Bitcoin is not a security, but raises doubts about other tokens. He suggests he thinks ETH could be a security, but then adds “maybe not ether because it’s established, but then what do you do [about the others]?” {Twitter Clip} {Entirety on YouTube}

→ MIT Tech Review Business of Blockchain Conference (April 23, 2018). He makes clear his analysis is only about the initial Ethereum offering in 2014. {Clip on Twitter} {Entirety on YouTube}

→ Maryland Financial Consumer Protection Commission Hearing (June 2018). He explains his view that the ETH presale was a securities offering. This hearing took place ten days before the Hinman speech and Gensler bring up the open question about whether “something once being a security can transform to be something else” but doesn’t take a position. {Twitter Clip} {Source Video}

→ Congressional Testimony (July 2018). He discusses what the obligations of the ETH presale organizers should have been. {Twitter Clip} In his written testimony he acknowledges ETH is a commodity like Bitcoin when he says, “While the CFTC has general anti-fraud and anti-manipulation authorities with regard to spot transactions in crypto cash commodities, such as Bitcoin or Ether, the agency does not currently have express registration or plenary rule writing authorities with regard to cash commodities.” (Emphasis mine.) He also quotes the Hinman speech at length to explain that the SEC has taken the position that ETH is not now a security and he expresses no objection to this position.

→ Bloomberg Institutional Investor Conference (2018). He makes clear his analysis is about the initial Ethereum offering in 2014. Literally says “I think Ether when it was done in 2014 would pass [the Howey] test.” in the past tense. He then acknowledges Hinman speech saying that “subsequently the SEC has said that by 2018 is decentralized enough and they’ve said we’ll let it go the other way.” He states no objection to that. {YouTube}

→ MIT Class Lecture (Fall 2018). He makes clear his analysis is about the initial Ethereum offering in 2014. {Clip from Twitter} {Entirety on YouTube} In a previous lecture in the same court he also acknowledges that the SEC’s position was that ETH is not now a security and he doesn’t not express disagreement with that. {Twitter Clip}

Bottom line: I have not been able to find anywhere where Gensler says ETH is a security in the present tense. As far as I can tell, he’s only ever said the presale was a securities offering. On the question of whether a commodity that was once part of a securities offering can later be sold outside, he seems to demur giving a definite answer in the statements he made before the Hinman speech, and after the speech he acknowledges the SEC’s position and doesn’t express disagreement with it.

If you’re aware of some other statement I’ve missed where he says something beyond this, please send it my way as I’d love to be corrected. Additionally, it may be that his public statements don’t completely reflect the entirety of his thinking, or that his views may have changed. But, going on what I have, Gensler’s statements have always been consistent with the Hinman speech.

Now, does any of this preclude any SEC action on Ethereum in the future? No.

Remember that Hinman went out of his way to say that his determination was dependent on the network’s structure at the time of his speech. If there were to be ETH sales in the future where buyers in some way are relying on a person or group for their expectation of profits, then you can certainly imagine the SEC taking the position that those are sales of securities. This would be similar to the ongoing SEC action against Ripple Labs where the SEC’s charge that particular sales of XRP are securities can be made even if one grants that the XRP token itself is not a security.

Any such determination would be consistent with the Hinman speech. After all, it’s just a pretty straightforward application of the Howey test, so I don’t see what rationale there would be for repudiating it.

░ ░ ░

That’s all I got today. I certainly would love to hear your thoughts. Please forward it to anyone you think might enjoy it and encourage them to subscribe. I’m not making these available on the web so the only way to get them is via email.

Finally, I took part in a panel discussion about D.C.-based crypto advocacy on the Bankless Podcast recently. You should check it out. {Audio} {Video} This was in conjunction with a new round of Gitcoin fundraising for Coin Center and other advocacy groups. Because of the quadratic funding mechanism Gitcoin employs, one dollar you give to Coin Center today will be matched to the tune of another $3,000 or so, so you really have no excuse to kick in a buck or two! You can do so here. Thanks!

In his seminal book, The Revolt of the Public, Martin Gurri explores how the modern media environment has simultaneously stripped elite institutions of the authority they once enjoyed and empowered the public to organize into mobs against the elite. This is all a matter of access to information.

The elites were authoritative when there was a scarcity of information. Not only were they the only sources of information, but information about them as people and institutions was virtually non-existent. The internet changed all that. Information became abundant, lessening elite’s power, but just as consequentially information about them grew as well and exposed their all-too-human incompetence, venality, hypocrisy, and vanity.

This same new media environment brought with it the tools for the public to find each other and coalesce into groups that could take action. Elite institutions–from Yale to the New York Times to the Treasury Department–are top-down and hierarchical and distant from the public. In contrast, what Gurri calls “networks,” Howard Rheingold called “smart mobs,” and today we might call “flash mobs” or just mobs, are voluntary associations of equals without hierarchy and without the capacity to develop a specific program.

Here’s Gurri (emphasis mine):

Against this citadel of the status quo, the [new information environment] has raised the network: that is, the public in revolt, those despised amateurs now connected to one another by means of digital devices. Nothing within the bounds of human nature could be less like a hierarchy. Where the latter is slow and plodding, networked action is lightning quick but unsteady in purpose. Where hierarchy has evolved a hard exoskeleton to keep every part in place, the network is loose and pliable – it can swell into millions or dissipate in an instant.

Digital networks are egalitarian to the brink of dysfunction. Most would rather fail in an enterprise than acknowledge rank or leaders of any sort. … Networks succeed when held together by a single powerful point of reference – an issue, person, or event – which acts as center of gravity and organizing principle for action. 

Typically, this has meant being against.  If hierarchy worships the established order, the network nurtures a streak of nihilism.

Examples of these mobs include much of the Arab Spring, Occupy Wall Street, the Tea Party, and more recently the Yellow Vests and BLM protesters. In every instance they stand against some status quo. They are about negation, not for accomplishing some specific thing. As Gurri puts it, “Advocating a positive program would have shattered these groups: participants felt energized by what they opposed, but were murky and divided about what they stood for. In fact, when circumstances demanded that they spell out an alternative to the status quo, [the] movements faltered and splintered.”

And this brings me to ConstitutionDAO.

As you know, it’s a mob that came together in a matter of days on Twitter and Discord for the sole purpose of buying a copy of the Constitution at auction. It raised over $45 million in about a week but lost the auction. Now it is in disarray as its organizing principle has been removed but still sits on tens of millions of dollars. I think there are a couple of lessons here.

First, ConstitutionDAO shows us that modern mobs don’t just have to be about negation. They can be for something, as long as that something is specific and circumscribed. I think r/wallstreetbets presaged this a bit.

DAOs are a new tool in the toolkit of the networked mob. Now the public can not only find each other, communicate, and organize, but they can also raise funds outside the supervision of hierarchical institutions. In my view ConstitutionDAO was so successful at raising funds because they were for a clear, limited purpose–one that could be clearly communicated (memefied) and so narrow that it could draw wide assent. A DAO with a more complicated purpose would not have been as successful.

Second, once the “single powerful point of reference,” the organizing principle, is removed, the whole thing falls apart. But unlike other mobs, DAOs can have treasuries with tens of millions of dollars, so the mob won’t just fade into the mist. Instead they will be forced to decide what to do with the money, and we know that mobs “shatter” when pressed to put forward a specific agenda. A group of disparate individuals came together because they could find agreement over a very broad principle, and then they find they can’t agree on anything more specific.

I’m very keen to see how ConstitutionDAO resolves itself. Because it’s so focal, it will be seen as setting a precedent. I think there are a couple ways it could go.

Option One: The money is returned to participants. In my view this is the best option. For one thing, it’s what people who contributed expected would happen in the event of failure (as far as I understand it). For another, it’s a clean resolution and leans into the strength of mob DAOs, which is doing one big thing. If you want to do another thing, go start another DAO. I recognize this option is not without its problems given Ethereum’s high gas fees, but I still think it’s worth ending this way even if a lot of the money simply goes to miners.

Option Two: Find some other insane thing for the DAO to do. This is the second beset option because it will be difficult to find agreement on what that other big thing should be. If agreement can be found, the thing that’s settled on will probably be lame. That’s because you can’t capture lighting in a bottle twice. The memetic excitement was to do this one particular crazy thing, and you’re not going to be able to recapture that excitement from the same group with anything else. For example, some are trying to retcon the DAO’s mission as buying historical American artifacts–very lame.

If the DAO has to pick something else to do, I hope they do something really insane that’s a continuation of their project. Maybe they take the easy road and go for negation. For example, I saw someone suggest that the DAO buy the creamery that makes Ken Griffin’s favorite ice cream and I guess deprive him of it.

Option Three: Do something serious with the money. This would be the most dispiriting result. Same as Option Two, I think you’d be hard pressed to get enthusiastic agreement among participants, so anything that ends up being done would likely be forced and lame. For example, Decrypt reports that some participants have suggested the funds be used to “create a new Constitution for Web 3.“ Gag me with a flag pole.

I’ve also seen some Twitter charlatans valiantly step forward for the oh-so-selfless task of relieving the DAO of its treasury. Some want to spend it on political campaigns, of all things. I could be a beneficiary of such an outcome, but I can’t think of a more joyless and divisive thing to do. It would also be a real shame to see something this historic be co-opted by a white knight with no sweat equity. Again, people with big ideas should go start their own DAOs.

So, I’ll be watching with interest what happens. There are also other similar DAOs in the works (like this one that wants to buy an NBA team) and I hope they’ll learn some lessons from ConstitutionDAO. I also wonder if we’ll see DAOs adopt programmatic assurance contracts to avoid the problems that come if the specified goal isn’t achieved. Seems like the tech is there.

Let me know what you think. I write this stuff to help me work through what I think but also to get feedback, so don’t hesitate to hit reply.

If you enjoyed this newsletter, consider forwarding it to a friend so they can subscribe. (I’m not making these available on the web; only email.) Also, FYI, a new episode of Worker and Parasite, my book discussion podcast with Stably, is out. We talk about Robert Wright’s The Evolution of God. You can listen and subscribe to it here.

Lately I’ve felt like there’s stuff I want to say to the community that’s not a good fit for Twitter, so I’m once again going to try my hand at putting out a newsletter. I’m going to aim for weekly, but won’t commit to that. It may be more occasional. And I expect it to be more discursive and stream of consciousness than I’ve done in the past. Take it all for what it’s worth. If you’re on this list from a prior iteration of my newsletter, I won’t hold it against you if you bail.

Infrastructure Week

This week the President signed into law the bipartisan infrastructure bill and with it the terrible crypto tax reporting provision it contains. The good news is that this week also saw a flurry of congressional activity aimed at undoing that mess.

First, a group of ten Democratic lawmakers sent a letter to Speaker Pelosi making it clear that the crypto tax provisions in the infrastructure bill are a mistake that need to be fixed. This is important because it makes clear (especially to House leadership) that fixing this is an issue that matters to Democrats as well as Republicans. The effort was led by Rep. Darren Soto (and I believe Rep. Ro Khanna, though I haven’t seen him tweet about it).

Second, three bills were introduced to amend the reporting provisions that are now law:

• Senators Lummis and Wyden introduced (as a standalone bill) the same amendment language they had previously introduced alongside Senator Toomey when the infrastructure bill was being considered in the Senate. It would amend the definition of “broker” to make it less likely Treasury could interpret it to cover miners, developers, and other non-middlemen, but it does not address any of the other problems with the reporting provisions.

• Senator Cruz introduced a bill to repeal all of the provisions.

• A comprehensive bipartisan bill was introduced in the House to fix EVERYTHING wrong with the infrastructure bill’s crypto tax provision—including the unconstitutional §6050I individual reporting mandate. I explained what is does here. This effort was led by Reps. McHenry and Ryan and co-sponsored by Reps. Emmer, Soto, Davidson, Khanna, Budd, Swalwell, Gonzalez, and Brady.

Coin Center supports any and all efforts to fix the reporting provisions. That said, here’s some context to keep in mind about these efforts.

You would think the Cruz bill would be preferable to the others since it just repeals the entire tax provision. All things being equal that would be the case, but all things aren’t equal. Any bill (even if it’s attached to some other package) would have to pass a Congress that is pretty evenly divided, and that means it’ll need bipartisan support. Sen. Cruz is the only sponsor of his bill, and it would be difficult to find a Democratic senator willing to co-sponsor it. Bottom line: There’s enough support in Congress to fix the crypto reporting provision but not to repeal it. That’s a political reality.

The Wyden-Lummis effort reflects that reality. It’s bipartisan but targets a single problem with the crypto reporting provision (the “broker” definition). It’s so narrow because that’s where there is bipartisan agreement, and again bipartisan agreement matters a lot. In this case this bill has a shot of being attached to the next phase of the President’s agenda in the “Build Back Better” legislation that should soon be before the Senate. We’re lucky Sen. Wyden is co-sponsoring since he’s the chairman of the tax committee with jurisdiction.

The House, by its nature, is going to have more room to find common ground, and that reality is reflected in the comprehensive bipartisan bill from McHenry and Ryan. Again, it would fix every single issue we have with the new law. What’s remarkable (and took a lot of work from everyone involved) is that this bill has ten co-sponsors evenly divided between Rs and Ds. And among those you have the Ranking Members of both the Financial Markets and Ways and Means Committees. What that means is that this is not a messaging bill; it has legs.

This reminds me of a line I read a couple days ago in a Bloomberg article about Rep. Beyer’s bill to regulate the crypto market:

The Virginia Democrat introduced a bill in July that observers say is the most comprehensive attempt yet to lay out a regulatory regime for cryptocurrencies. … Still, the bill has not attracted co-sponsors or a companion measure in the Senate, a sign of the difficulties in getting Congress to act on any crypto legislation. Beyer said he is talking to several House Financial Services Committee members about joining his effort.

Actually, getting buy-in from a large bipartisan group of lawmakers on a crypto bill is not impossible when you have a sensible approach.

Speaking of Byer, Peter testified before this week before the Join Economic Committee, which he chairs. You can watch that on YouTube. It’s worth watching to see a replay of the live chat during the hearing, which is hilarious. Makes one understand why every other committee disables chat when they livestream. 😂

ConstitutionDAO

If there’s one thing I like about our community it’s that it constantly makes real the maxim that if you will it, it is no dream. Something as insane-sounding as crowdfunding $45 million to buy a copy of the Constitution can go from concept to done in under a week.

That said, when you move fast, you can break things, so it gives me pause that the code for the DAO platform they’re using has apparently not been audited. 😬 But one thing I don’t think they’ll have to worry about is whether the issuance of the DAO’s $PEOPLE tokens is a securities offering. I’d love to hear a countering opinion, but in my view, while it may have all kinds of other legal challenges, being a security is not one of them.

I went back and looked at the SEC’s 2017 investigative report on The DAO, and that benighted first DAO couldn’t have been more different. It was explicitly for-profit and it was marketed as an investment fund. The point of The DAO tokens was not just to make investment decisions, but to share in anticipated earnings. It was marketed by its creators as an investment vehicle and they made certain promises, like ensuring there would be secondary markets for the tokens.

In the case of ConstitutionDAO I think one would have a hard time arguing there’s an expectation of profit. From what I’ve seen, folks contributing funds seem pretty clear that what they’re making is a donation, not an investment. The tokens they’re getting for their contributions entitle them to vote on governance, but again as far as I can tell it’s clear to everyone those votes are advisory in nature. It’s like a convoluted Kickstarter.

Now, some will point to $PEOPLE/ETH secondary markets that have (of course) already sprung up. Presumably some folks got into ConstitutionDAO with the intention of flipping their tokens for profit. But there’s little difference between that and funding a Kickstarter in order to get and sell the “backer reward” tote bag or whatever. That said, the fact that there are tokens and secondary markets will matter for the future of the project.

What will they do with the funds now that they’ve lost the auction? The plan for this eventuality, as far as I understand it, was always to return the money (minus gas fees) to contributors. But there’s going to be a temptation, now that they’re a going concern, to find some other thing to buy or do. I heard that kind of talk on Spaces last night. That’s perfectly fine, but they should keep in mind that changing the nature of the project can change the legal analysis. I’m thinking here of DAOs that raise funds to buy NFTs and other collectors items in order to increase the value of their tokens. I find that kind of thing pretty awesome, but I wouldn’t be surprised if the SEC comes knocking.

Let me know what you think of this little missive and if I should keep writing it. If you enjoyed it, consider forwarding it to a friend so they can subscribe. (I’m not making these available on the web; only email.) And Happy Thanksgiving. I’m grateful to be a part of such a crazy community.