SotN#17: RETREATING! w/ Jake Chervinsky (BitMEX REKT, SEC Action, is DeFi safe?)

📣 Join us at Invest Ethereum Conference Oct 14th - http://bankless.cc/investeth $25 off w/ “BANKLESS” code ----- 🚀 SUBSCRIBE TO NEWSLETTER: http://bankless.substack.com/ ✊ STARTING GUIDE BANKLESS: https://bit.ly/37Q17uI ❤️ JOIN PRIVATE DISCORD: https://bit.ly/2UVI10O 🎙️ SUBSCRIBE TO PODCAST: http://podcast.banklesshq.com/ 👕 BUY BANKLESS TEE: https://merch.banklesshq.com/ ----- GO BANKLESS WITH THESE SPONSOR TOOLS: 🌐 UNSTOPPABLE DOMAINS - HUMAN READABLE ETHEREUM & CRYPTO ADDRESSES https://bankless.cc/unstoppable 🌈 ZAPPER - ULTIMATE HUB FOR DEFI - ZAP INTO DEFI http://bankless.cc/zapper 💳 MONOLITH - GET THE HOLY GRAIL OF BANKLESS VISA CARDS https://bankless.cc/monolith 🤖YEARN - YIELD-SEEKING MONEY ROBOT THAT FARMS DEFI FOR YOU http://bankless.cc/yearn ------ SotN #16: RETREATING! w/ @jchervinsky (BitMEX REKT, SEC Action, is DeFi safe?) Lots of legal action taken against the crypto world lately! We're bringing Jake Chervinsky from Compound Labs onto the show to help us understand what's going on. - Enforcement actions from the SEC and CFTC - SALT Lending pays fine, must return investor funds, must register token - Kik is official dead, slain by SEC - BitMEX got BitREKT -- CEO Arther Hayes 'is AT LARGE', CTO of BitMEX is in jail But most importantly: Is DeFi immune from this? Does the protocolization of financial instruments save the day? When the spotlight turns to DeFi, are we prepared? Resources linked & discussed When worlds collide Bankless article: https://bankless.substack.com/p/when-worlds-collide-market-monday-a27 The Case for Electronic Cash and Financial Privacy (Coincenter piece that Jake talked about) https://www.coincenter.org/the-case-for-electronic-cash/ Jakes prediction that regulatory action is coming: https://twitter.com/jchervinsky/status/1310626151631671296?s=20 SALT Lending: https://www.coindesk.com/sec-orders-salt-lending-to-refund-investors-in-its-50m-ico Kick KIN ruling: https://www.coindesk.com/kik-sec-ruling Bloomberg scare article: https://www.bloomberg.com/news/articles/2020-10-01/booming-crypto-market-a-potential-haven-for-money-laundering What does BitMEX charge from the DOJ for breaking the bank secrecy act mean for Defi? https://twitter.com/AdamScochran/status/1311729872050544643?s=20 Jay Clayton SEC chair says all stocks may be tokenized: https://www.theblockcrypto.com/post/79783/all-stocks-tokenized-sec-chairman-clayton ------ Don't stop at the video! Subscribe to the Bankless newsletter program http://bankless.substack.com/ Visit the official Bankless website for resources http://banklesshq.com/ Follow Bankless on Twitter https://twitter.com/BanklessHQ Follow Ryan on Twitter https://twitter.com/ryansadams Follow David on Twitter https://twitter.com/TrustlessState Follow DeFi Dad on Twitter https://twitter.com/DeFi_Dad ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time we may add links in this channel to products we use. We may receive commission if you make a purchase through one of these links. We'll always disclose when this is the case.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Hoffman?

  The.

• 2:10David Hoffman?

  The.

• 5:56David Hoffman?

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• 6:39David Hoffman?

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• 7:22David Hoffman?

  money to work in compound and accessing yield, but you can, and you can also swap through Uniswap. What was cool with Monolith is that they will send you a very sexy Monolith Visa card that connects to your smart Monolith smart contract wallet on Ethereum. So it's a really awesome tool to live a bankless life with a savings account that gets software updates. So this is something that you're never going to find out in the real world, but you can still do real world things with, you know, real money and like buy your groceries. So that's just fantastic. Coming soon to Monolith, actually already here to Monolith is now you can buy, die and get it sent to your wallet directly, right? So it's also being an on-ramp. So you don't have to go

• 8:04David Hoffman?

  through your centralized exchange like Coinbase or Gemini or wherever. You can just go straight from your bank account, right into your Monolith checking account, smart contract wallet. So check them out at monolith.xyz.

• 8:19Ryan Sean Adams?

  All right, Bankless Nation, welcome to another episode of State of the Nation. This is episode 17 with, and we have a special guest today, Jake Chervinsky, who is going to tell us a little bit about all of the regulatory action that's been going on in crypto. It has been Heavy the last week and absolutely crazy. David, how are you doing today, sir?

• 8:45David Hoffman?

  Just fantastic. Kind of a interesting and kind of good week to be in the DeFi realm of things because like this is kind of where we get to say like, I told you so like this is why we do DeFi. But also not DeFi isn't really in the state that it should be in order for us to really be saying, I told you so. So a little bit, a little bit of a juxtaposition there.

• 9:06Ryan Sean Adams?

  And if this is your first day of the nation, guys, so Dave and I do this every Tuesday, we release it on YouTube. It's live on YouTube now. So if you're watching on YouTube, you're watching it live. And then the following day, so on Wednesdays, we release it on the podcast stream. So you can catch it that way, too. What we do in these state of the nations is we try to apply the things that are going on, particularly in the past week, to the macro concepts that you read about and hear about on the Bankless Podcast and newsletter. So David, what are we talking about today, man?

• 9:37David Hoffman?

  So much has happened like and talking to like the whole legal side of crypto Twitter, the whole legal side of Twitter is that so much has happened that like just can't keep up because it just came one after another and and first there was BitMEX and then there was Salt and Kick and then and then there's now there's John McAfee and so there's just a big push coming from like the nation state three letter agencies, getting into the world of crypto, saying, you know, drawing a line and saying everyone that's on this side of the line has gone too far, right? And so that has all happened in a week. And so last day of the nation, this wasn't even on our radar. And now this day of the nation, there's so much to talk about with specifically just legal stuff.

• 10:18Ryan Sean Adams?

  And Jake is an expert. He actually like predicted this stuff in a way before it happened. So we're going to start there. I think he's the perfect guest for this. Before we get there, let's talk about what's going on in the Bankless Nation. So David, we released an epic podcast, like the Moloch Slayer podcast yesterday. Give us a sneak peek on that.

• 10:38David Hoffman?

  Yeah, yeah, Moloch's Layer with Amin Soleimani and Kevin Awaki of Gitcoin. In the 2018-2019 bear market, Amin Soleimani kind of gathered everyone around and said like, "You guys, there's this problem called Moloch and Ethereum is currently experiencing it. Like, we're currently having to deal with this." And so, he went over to combat Moloch, he made Moloch DAO. And as a short snippet of what Moloch actually is, Moloch is like the reason why humans always tend to fail to coordinate, right? Like, it's this incentive mechanism that always happens where like, the more and more humans coordinate, the stronger there is an incentive to defect from that coordination because it profits you in some particular way, right?

• 11:22David Hoffman?

  And this is basically the instantiation of the prisoner's dilemma, and it's a really important subject matter. And so, we got Amin and we got Kevin from Gitcoin onto the podcast to talk about Moloch and how Ethereum represents this opportunity for us to experiment and iterate on governance strategies, on incentive mechanisms, to really try and force Moloch to retreat.

• 11:43Ryan Sean Adams?

  So David, I think, guys, David said that was his favorite show. So make sure you check that out. I think it's the topic, just everything about it was spot on. So make sure you check that out. You also have a Meet the Nation coming out later today, right?

• 11:57David Hoffman?

  Later today. With RAC, Andre, yeah. So Andre is a Grammy Award-winning artist, and I really like the guy mainly because I listened to his music in college and to this day, I still listen to it. And, you know, while he was dabbling with music and really pushing his music career forward, he was also like working with Ethereum, like on, you know, just out of interest, out of curiosity, right? And he's one of these guys that was able to take one part of his life and then take this other part of his life and get them to converge, right? And so, this guy released tape on Zora, which was an NFT that went from like $20 to like $900 and that kind of really kick-started like this whole NFT movement. And now, he's doing the RAC token,

• 12:41David Hoffman?

  which is this community token for his fans to be able to express their interest and value in the music that he produces. So, using the example of Ethereum as this like experimental layer for coordinating value, in what we were talking about in the Moloch episode, there's now RAC Andre, who is using this layer to coordinate his fans in a way that other artists have not yet experimented with. So, really interesting stuff.

• 13:06Ryan Sean Adams?

  RAC is a member of the Bankless Nation. He actually, besides you and I, he was the third person to ever don one of these shirts.

• 13:12David Hoffman?

  Yeah, and he was wearing it in the Meet the Nation video, too.

• 13:15Ryan Sean Adams?

  Oh, awesome. That's awesome. All right. Well, I haven't seen that, so I can't wait to check it out. The last thing we got to tell you about is a really exciting virtual conference event called Invest Ethereum that is coming on October 14th. So definitely going to check this out. Vitalik's going to be there. Rin Christensen's going to be there. Other DeFi leaders are going to be there to talk about the future of the Ethereum economy. I think this is going to be the conference maybe of the season. Don't miss it. David, you're also speaking. What are you going to be speaking on?

• 13:47David Hoffman?

  Yeah, so I was actually talking with the guy that was coordinating it, and I was looking at the schedule, and the schedule was just fantastic. And I was going to talk about scaling Ethereum, but then I saw on his schedule that there's a section to talk about Ether, the asset, bullish or bearish. And I was like, definitely put me on that one.

• 14:03Ryan Sean Adams?

  Well, you're bearish, right?

• 14:04David Hoffman?

  Super bearish. And so, yeah, so I have a nice little speaking slot to shill Ether my hardest at CoinDesk. So really happy to see CoinDesk coming around to Ethereum in the Ethereum ecosystem. So tip of the hat.

• 14:17Ryan Sean Adams?

  Yeah, I think that's great. So, you know, support what CoinDesk is doing with this conference. They'll do more about Ethereum if we show support for it. And if you register with the link in the show notes, use the Bankless code, you get $25 off. So that is certainly worth doing. David, I'm going to start with a question we always start with at these State of Nations. What is the State of the Nation this week, my friend?

• 14:40David Hoffman?

  The State of the Nation, I already hinted about this. The State of the Nation is retreating. We are retreating. We talk about this frequently on the Bankless Pod, how like, you know, the Bankless Nation, it's a new type of nation. But these nations conflict, and sometimes old nations aren't too happy about that, right? And so there is, like I said, a clear line was drawn by some of the three-letter agencies of the United States and also of the UK. The UK is also involved here. And they drew a line and said, anyone who's on the other side of this line is, you know, doing unlawful things. And so John McAfee just got arrested. BitMEX got charged with operating an illegal exchange and violating

• 15:21David Hoffman?

  the Bank Secrecy Act. Arthur Hayes is quote unquote "at large." And so some big moves coming from the legacy nation state.

• 15:30Ryan Sean Adams?

  Yeah, we're going to talk about that. So the the nation is retreating right now from the legacy nation state. And I think the big question on everyone's mind, David, is what does this all mean for DeFi?

• 15:40David Hoffman?

  Right.

• 15:41Ryan Sean Adams?

  So our next guest, our guest on today's State of the Nation episode, is going to talk about this. Jake Turvisky, welcome to State of the Nation. You are the General Counsel of Compound. Can you help us make sense of what's going on with these regulations and everything that happened last week, sir?

• 16:01Speaker 02

  I can do my best, and thank you guys for having me on. I'm a longtime fan of Bankless.

• 16:06Ryan Sean Adams?

  Well, fantastic. It's great to have you on. You, I think, are one of the best legal minds that we have in the DeFi crypto space. And like, we're so grateful that you are active here and you're applying your knowledge and your mind here. Maybe we should start with kind of your tweet. And I'm going to put this up on the screen if I can. Your tweet really sort of predicted what would happen last week, I want to say. So you said this on September 28. You said the SEC and CFTC, they both end their fiscal year on September 30, right? There's often a flurry of activity, the EOS settlement, other things that that happened within that time window. And then you said, this week could be interesting.

• 16:49David Hoffman?

  And this was before any news came out, any news at all.

• 16:53Ryan Sean Adams?

  And certainly, it was very interesting. So can can we start with maybe a recap of some of the things that happened this week, Jake?

• 17:01Speaker 02

  Yeah, sure. And yeah, I mean, it turned out to be even more interesting than I thought. So I don't want to take credit for having called all of this. I did not know any of this was coming. Although it is often the case that we see news at the end of the fiscal year, as these agencies are trying to put together their best argument for how they did in a previous year and ask for more money for the next year. So just really quickly, before I jump into a quick summary, I should say, I am General Counsel of Compound Labs, as you mentioned, but I'm not here in my capacity as an employee of Compound. I'm just here to provide my personal opinion on what's been going on in crypto. And in the DeFi space, nothing I say is intended as legal advice.

• 17:45Speaker 02

  Um, so yeah, last week was a pretty big one. I think, um, the first really big decision that came out that's, uh, that related to crypto was an order from the SEC on Salt Lending, which was an ICO from 2017. Um, it was frankly, just another in a long line of these ICOs that has been tagged for an unregistered securities offering. Um, basically Salt Lending sold a token in, I think, 2017. They raised, uh, forty seven million dollars. Um, they did that by selling a token that they said would increase in value based on their efforts of building out this lending protocol.

• 18:30Speaker 02

  And as you guys may know from being around crypto for a while, what you have to do with these tokens is apply the Howey test to see if they represent investment contracts, meaning an investment of money in a common enterprise with a reasonable expectation of profit based on the managerial or entrepreneurial efforts of a third party or promoter. And the SEC basically said this token is an investment contract, meaning it is a regulated security under the federal securities laws. In order to sell it, Salt Lending had to register it with the SEC and make a number of disclosures about their business. By failing to do that registration, they violated the securities laws.

• 19:12Speaker 02

  And so the SEC required them to pay a $250,000 monetary penalty, um, which may not sound like a whole lot of money in comparison to the forty seven million that they raised. But the more important thing that Salt Lending has to do with the token is they now have to register it and treat it like a security. They also have to pay rescission, meaning a refund to all of the initial purchasers of the token, which is potentially a huge amount of money. And, you know, for all we know, put, could put Salt Lending out of business. Uh, and treating these tokens like they are securities is a really significant compliance burden. So this is definitely a pretty significant blow to salt lending and anyone who was, you know, excited about what they were working on.

• 19:56David Hoffman?

  So Jake, you said that this is kind of fits this, the bill as many of the 2017 ICOs and to a very large extent it does, right? It's just another token that was sold that, you know, basically was, you know, and with an, had some sort of social contract of an investment contract. But what's different, I think with this one is that, you know, with previous SEC moves in this, in the 2017 against the 2017 ICO space. This one to me is different because there's nothing fraudulent about this one. There's nothing, there's nothing malicious about salt. It just didn't register, right? And I, and from what I've gathered, the SEC hasn't really made moves like this before, where previously they were going after just kind of the worst offenders and salt really didn't harm anyone.

• 20:41David Hoffman?

  It just didn't follow the rules. Does that map on to your understanding too?

• 20:46Speaker 02

  Uh, yes and no. You know, the SEC, just like any enforcement agency, certainly did start with the overt frauds, right? The malicious actors who were literally trying to steal money from people by lying to them. But this isn't the first enforcement action related to a pure regulatory violation. So for a couple of years, actually, the SEC has come out with other enforcement orders against ICO issuers who maybe didn't mean to do anything wrong, but just weren't paying attention to their obligations under the securities laws. So even dating back to Paragon Coin, which was related to a cannabis business, you may remember, Airfox, Gladius Network, there's been a whole bunch of these.

• 21:29Speaker 02

  Yeah, Munchie was, I think, one of the very first ones. There have been a lot of these and frankly, it's just the SEC going one by one by one through all of these hundreds of ICOs from 2017 and sort of rolling them up in these enforcement actions.

• 21:43David Hoffman?

  Are they going to like catch them all, do you think Jake?

• 21:46Speaker 02

  You know, I don't know. I think probably not, just because there were so many, I mean, probably thousands of these that followed the same structure, right? And it should have been, and I think it was obvious to most people who understood the securities laws back then, that these schemes were not compliant with the registration requirements, where you're selling a token that has absolutely no use or function at all, right? All it does is represent a promise to build a network using the funds raised from the sale of the token, that someday in the future may use the token and give it some value. That's sort of like a textbook investment contract. Um, I think the problem that the SEC has in terms of going after all of them

• 22:29Speaker 02

  is it takes a lot of resources to litigate these cases. And, you know, probably they sent out hundreds of subpoenas and opened up, you know, dozens of investigations, but only so many of those are really worth bringing to fruition and enforcement action. Um, I won't be surprised if we keep seeing more trickle out, week by week and month by month, for the course of years. Uh, in fact, I'm a little surprised. We haven't seen more of them before now.

• 22:55David Hoffman?

  Right.

• 22:55Speaker 02

  But I think that if the SEC was really gonna take care of all of them at once, we would have seen what's called a sweep, where the SEC issues orders or, you know, files complaints against dozens in a single day. And they've done that before. So, you know, in the early 2000s, when there were a lot of um, internet stock scams, the SEC did a sweep where they went after literally dozens of the internet stock companies at once. And they decided not to do that with ICOs. And I think that probably the time has passed for that.

• 23:26David Hoffman?

  Maybe that's because ICOs are inherently just a global phenomenon and it's just kind of harder to track down uh, ICOs than it would be the, the internet tech stock scams?

• 23:36Speaker 02

  Yeah, I think part of that's true. A lot of the issuers are not in the US, so it's, it's harder to, you know, to get them to respond to subpoenas. When we see enforcement orders like this, it's, it's also important to remember, and this is a good segue into the next case we saw last week. Those enforcement orders are negotiated settlements. It's an agreement. Between the issuer and the SEC not to proceed with litigation, which means Salt Lending was negotiating with the SEC for probably months or years about what the settlement would look like. Now, if Salt Lending had refused to settle with the SEC, the SEC's only next step is to file a complaint in a US federal court. And that takes a huge amount of resources and for them to file cases in court

• 24:21Speaker 02

  against dozens or hundreds of ICOs is just not possible, especially when they're outside the US and it would be hard to get jurisdiction over them anyway. Or rather, it would be hard to get them to show up to court, right? They might default and what's the point of that? So, you know, maybe that's a good segue into the next big case from last.

• 24:39Ryan Sean Adams?

  Yeah, so the next one, the next one is KICK, right? Which is probably where you're going, which kind of fits the motif of like, you know, 2017 era ICO. And they actually, I think, took the SEC to the next stage, to the brink. Or maybe tell us, because this looks more like a court settlement case. And so maybe they weren't willing to settle. Can you tell us about the like, the high level of this case?

• 25:06Speaker 02

  Yeah, that's exactly right. So the KICK Foundation also did a public sale of tokens called Kin Tokens. At the time of the sale, you know, at least as far as the SEC alleged and the court found, Kin Tokens didn't have much value. Their main reason for existing was that KICK promised to carry out future efforts that would bring value to the Kin Token. They promised to integrate Kin into their messaging app. So KICK was a company long before the ICO that had a messaging app. And they basically promised to build this ecosystem that would use the Kin Token and would make the Kin Token valuable over time. And unlike someone like Salt Lending,

• 25:49Speaker 02

  the KICK Foundation refused to settle with the SEC. And actually, in a sort of weird, unusual move, the SEC sent them what's called a Wells Notice a couple of years ago. A Wells Notice is a document where the SEC basically says, we are. Planning to recommend an enforcement action against you. This is your last chance to convince us we shouldn't go forward. And Kik wrote a response to that notice, which is very typical. But in very unusual fashion, they published the notice. And basically said, we're taking this fight public.

• 26:23David Hoffman?

  Right.

• 26:24Speaker 02

  Um, which is, which is not usually done.

• 26:25David Hoffman?

  They made a campaign out of it. They made a very directed campaign out of it. And they started this hashtag called defend crypto or something defend defend crypto, I think.

• 26:34Speaker 02

  Weren't they, weren't they also David accepting donations?

• 26:37David Hoffman?

  They accepted donations, right? And so they kind of turned this into like a political campaign saying like the SEC is, uh, you know, bringing down the hammer and coming after us. Uh, and they tried to like, quote unquote, rally the troops behind them to, in order to, you know, fight off the SEC. I have my, my own opinions about the legitimacy behind that. But, uh, Jake, before, before I express those, if you want to kind of continue with the story.

• 27:00Speaker 02

  Yeah, no, it's, it was, uh, very interesting and exactly right. They, they positioned themselves as a representative for the entire sort of like ICO industry.

• 27:09David Hoffman?

  Right.

• 27:09Speaker 02

  To try to fight against the SEC's legal interpretation of the Howey test. And because of that, they refused to enter a settlement with the SEC and said, basically, if you want us, you have to sue us. So they made the SEC file a complaint. They litigated the case for quite a while. They got very quickly to the motion for summary judgment stage. So this is a point where basically the parties say, um, there is no material dispute about the facts, right? There's no real dispute about what happened. The only disagreement is about how the law applies. And both sides argued that even accepting the facts as they are, they were entitled to judgment as a matter of law. Meaning there's no need to go to trial. There's no need to do fact finding.

• 27:54Speaker 02

  Kik said, the law's on our side and the SEC said, no, the law's on our side. And the judge this past week sided with the SEC.

• 28:02David Hoffman?

  Right.

• 28:02Speaker 02

  And said, yes, indeed, the Howey test applies where you sell a token that does not have consumptive value. That you're promising to carry out managerial and entrepreneurial efforts to bring value to the token. The token represents an investment contract and must be registered under the securities laws.

• 28:20Ryan Sean Adams?

  Okay, so Jake, so how similar is this to the like landmark EOS case? I think that happened last year, although like time flies in crypto, right? So and then like the EOS case was interesting because it seemed to me that basically like the fallout from that was that originally in the EOS pre-sale, the ICO, that EOS the token was a security, right? But then it crossed the chasm, it morphed into a token that is no longer a security. First of all, fact check me there to see if that's right. And then how different is that from the Salt case and the Kik Kin case?

• 29:02Speaker 02

  Yeah, so that's partly right and partly unknown. So it's not wrong, we're just not totally sure. So in the EOS case, yes, the EOS token is very similar in a way to the Kin token in that Block 1 had made promises about what they were going to do to bring value to the EOS token. Different promises from Kik, right? Kik promised to build this ecosystem around Kin. Block 1 promised basically to build the EOS blockchain. Initially EOS was just an ERC 20 token trading on Ethereum. It's sort of like represented a claim on future EOS tokens that would later exist on the EOS blockchain, which hadn't been built yet.

• 29:43Speaker 02

  But that was a promise to carry out essential efforts that would bring value to the EOS token. So the SEC basically said the EOS token, when it was an ERC 20, was a security and should have been registered. There was actually no direct conclusion about whether the EOS token was still a security once it was on the EOS blockchain, right? Now Block 1 had already finished carrying out this promise of building the blockchain, but who knows what other promises there might have been that a purchaser of the real EOS token might think the only reason I'm buying this is because Block 1 is going to carry out some managerial or entrepreneurial efforts to bring value to this token?

• 30:26Speaker 02

  That question was just never litigated and the SEC, at least as we, as far as we know, never passed judgment on it publicly.

• 30:32Ryan Sean Adams?

  So that's just a huge to be continued. Like, we don't know, aside from Bitcoin and possibly Ether, that the SEC has made some public comments on. We don't know about like, you know, EOS or any of these other networks, whether the SEC deems them as securities or not.

• 30:49Speaker 02

  Yeah, and that's, I mean, that's pretty typical for, for the SEC. They do not often say when something is outside of their jurisdiction, right? They'll tell you when they think something should be regulated. They don't often publish no action letters, right? Which is a sort of like a formal letter saying either we think something violated the securities laws, but we've decided not to take action against, against it for policy reasons. Or based on our analysis, we do not think that, you know, whatever the scheme was violated the securities laws. They do that very rarely. So it's sort of a standard for us to live in this, this world of uncertainty about what the SEC thinks.

• 31:27Ryan Sean Adams?

  Wow. Well, I guess that's where we're living right now. I, um, you know, the, the, the third case that came up is maybe the most interesting in some ways for DeFi and the topic that we're going to discuss soon. Because it introduces two other government agencies, regulatory bodies. So we were dealing with the SEC in the, in the cases you just mentioned. But now with

• 31:52David Hoffman?

  Let me wrap up the, the SEC ICO conversation, Ryan, and then we'll get to that. So, so Jake, we, we've been dealing with the SEC and ICOs and, and this has been an ongoing topic of conversation every time the SEC does something. Is there any new precedent here? Or is this just a continuation of, you know, the slow, the slow march of the SEC against like the, the haphazardness of the 2017 mania?

• 32:18Speaker 02

  I would say 95% of it is not new. There's nothing particularly unique about salt or kick that teaches us much. I, I would say it is important because an order from a federal court on a motion for summary judgment carries more precedential value than anything we've gotten so far, right? So these enforcement orders that the SEC puts out, like I said, it's a negotiated settlement. It's not the law. It's just what the SEC got someone to agree to settle a case based on. When you have an order from a federal court that carries a lot more value, it still isn't the law of the land. Another district court could find differently in another case on very similar facts.

• 33:01Speaker 02

  But nonetheless, it seems pretty obvious that, that the courts are adopting the SEC's view on these ICO tokens.

• 33:08Ryan Sean Adams?

  Very good. So I guess we have some more information about how the SEC is handling these things, but it seems pretty consistent, at least for the past couple of years. Like, back to kind of the third big thing that happened last week with BitMEX, where basically we introduced two other government, US government regulators, the CFTC, who had something to say about BitMEX, the derivatives exchange, kind of like a Bitcoin, like, bank, if you will, but certainly a derivative exchange. And then also, the DOJ, I believe, had something to say about it. Can you talk about what happened in the BitMEX case last week? And maybe some of the implications or fallout from that, Jake?

• 33:52Speaker 02

  Sure. So, yeah, I mean, just sort of to set the stage here. We've been talking about the SEC up until now, like you said. The SEC is the federal regulator that has jurisdiction over securities, meaning stocks, bonds, investment contracts, etc. The BitMEX action involved three other agencies that are worth knowing. One is the CFTC, the Commodity Futures Trading Commission. They have jurisdiction over commodities derivatives. So commodities are basically anything that trades in a futures contract, literally anything, right? Traditionally, it's been things like wheat and oil and pig bellies, you know, these kinds of things, pork bellies, rather.

• 34:37Speaker 02

  But also, you know, any other types of rights and interests can also be commodities. The CFTC has jurisdiction over trading in commodity derivatives, meaning swaps, options, and futures. So these are financial instruments that derive their value from the underlying commodity. And BitMEX was a derivatives exchange. It traded perpetual swaps on Bitcoin and other digital assets. So that's why the CFTC claims to have jurisdiction over BitMEX. The case also involved the Department of Justice, the DOJ. The DOJ, among other things, is the prosecutor

• 35:17Speaker 02

  Of federal crimes. So in this case, the DOJ indicted Bitmex for federal crimes and I'll I'll get into sort of what the theory of the cases for both the CFTC and the DOJ. The other third agency to know, which wasn't directly involved, but is very important in all of these kinds of proceedings is FinCEN, the Financial Crimes Enforcement Network, which is a bureau of the Treasury Department. They are responsible for for regulation and enforcement with respect to the Bank Secrecy Act, which is the anti-money laundering know your customer rule in the United States. And some of the charges against Bitmex related to the Bank Secrecy Act. So FinCEN was certainly behind the scenes,

• 36:02Speaker 02

  you know, involved in this investigation. But just to give you a really quick summary of the facts and what the charges are. Bitmex, like I said, was a derivatives exchange. They were allowing customers to trade swaps on Bitcoin and other digital assets. They were allowing US customers, at least according to the allegations, to have access to their platform. This meant that under the Commodity Exchange Act, they were a type of regulated entity called a designated contract market or a swap execution facility and had to register as one or the other with the CFTC. Also, because they were accepting and soliciting orders in swaps,

• 36:44Speaker 02

  they were a futures commission merchant, another type of regulated entity under the Commodity Exchange Act. And by failing to register as they were required, they violated the CEA. And that's the basis of the CFTC's complaint against Bitmex. So the CFTC filed a complaint in federal court against Bitmex for those regulatory violations.

• 37:07Ryan Sean Adams?

  And it's important to to realize, right? The reason the CFTC has any jurisdiction there, I think, is because there are US citizens. They charge that there are US citizens involved in Bitmex. They don't regulate for other nations, but because they charged that US citizens were actually like using Bitmex derivative services, that's when it falls into the CFTC's court. Is that correct?

• 37:33Speaker 02

  Yeah, that's right. So you know, all US regulators have jurisdiction in the United States. To some extent, they have extraterritorial jurisdictions. There are cases where US regulators can try to get jurisdiction over ex-US conduct. But even then, only when it is in some way affecting the United States markets. And so the only reason that BitMEX could qualify as a futures commission merchant in the United States is if they are accepting or soliciting orders for derivatives products from US citizens. And you know, I should mention, you know, all of these are allegations. BitMEX plans to vigorously defend against those allegations.

• 38:17Speaker 02

  And we shouldn't necessarily take the government at its word. We've only heard one side of this story. At the same time, you know, we can sort of discuss what the allegations are and compare that to our own experience of seeing BitMEX in action.

• 38:29David Hoffman?

  Right, yeah. And so like the meme about BitMEX is there's this video of this guy who's like patting down people going into a concert. And it's an older guy and he's like, he's like kind of not paying attention. And he's, he's like barely loosely touching the people as he's patting them down. And then he says, okay, you're good. And that's like what people claim BitMEX to be is like, oh, your IP isn't from the United States? You're clearly not a US citizen. Also, we don't do KYC, right? And so like any amount of person with like basic computer skills could be inside of the US and then use the BitMEX derivative platform. And then there's, it's also worthwhile, we should probably talk about in the 2018 Consensus event,

• 39:12David Hoffman?

  which is like crypto's biggest event, yearly event. BitMEX rented out like three Lambos and slapped their logos on the side of them and like parked them outside of Consensus, which is in New York, right? And so like, why would you do that if you're not advertising? What, you're advertising to Germans there? Like, no, we're in New York. And so like, people have known like BitMEX to fly pretty close to the sun with what it should be doing versus what it's actually doing.

• 39:41Speaker 02

  Yeah, I mean, those are all really good points. You know, the Lambos, that's what we would call a bad fact in legal terms, right? It's not helpful for BitMEX's defense. Um, but look, so you know, sort of diving into the nature of the CFTC complaint, qualifying as a futures commission merchant, it's not, um, it's not an offense that, that considers your intent or your knowledge, right? It's what you would call a strict liability offense. If you are serving a US citizen, you qualify as a future commission merchant. It doesn't matter sort of like what efforts you were taking to try to exclude US citizens. Now, there are other charges at issue, which we'll get to in a second, that do require some proof of intent, meaning you know

• 40:26Speaker 02

  that you're serving US citizens, or you've been negligent in trying to exclude US citizens, or even that you've intended to solicit US citizens, right? These are all relevant to other types of charges. But it's just important to remember from a regulatory perspective, setting up geo-blocking or, you know, an IP address filter, it's not going to be enough. That's one of the lessons from this action, to, to escape CFTC jurisdiction. They're, they're gonna, they're going to exert their jurisdiction over you if you have US customers, for sure.

• 40:57David Hoffman?

  I don't think anyone even thought that that would be enough, right? Like, it was, it was basically the bare minimum. And like, I, I'm not a lawyer and you aren't BitMEX's lawyers, but I'm going to go ahead and hypothesize that the lawyers of BitMEX informed the officers of BitMEX that, you know, we should really be doing KYC. And the officers were like, nah.

• 41:19Speaker 02

  I mean, yeah, I don't want to speculate. I guess it, it is hard to imagine a lawyer signing off on this kind of system. And when you read the allegations from the government, it's clear that this wasn't one of these situations where, you know, BitMEX was trying its best, at least so far as the government alleges, to keep US citizens off of, of their platform. A lot of the allegations are that Arthur Hayes and his co-founders explicitly knew that there were US citizens on the platform, and they encouraged US citizens to, to join the platform. In some cases, they It even gone into their back end to change the designation of where some customers lived so that they wouldn't have to use a VPN to get onto the platform. So this isn't, you know, that the kind of situation where it was just a mistake,

• 42:04Speaker 02

  at least as far as the allegations say.

• 42:06Ryan Sean Adams?

  So before we get to the DOJ and FinCEN with respect to BitMEX, I want to ask the question like about the CFTC and like the question of like, why do they care so much, right? And this, this also maybe applies to the, to the SEC. So my impression of SEC is our, our mandate, the SEC might say is to protect retail investors. Right? So is the CFTC similar? Are they basically saying, look, like our overarching, when you zoom out, our overarching mandate is to protect US citizens, retail investors from nefarious actors in this space. And that is why we are taking actions such as this, this BitMEX action. Is that the purpose of the regulatory body?

• 42:48Speaker 02

  Um, I'd say yes, that is definitely part of this. I think it's not all of it. So just like the SEC, right? The SEC has basically three main goals to protect investors, to facilitate capital formation and to ensure fair and efficient markets. The CFTC has sort of similar goals in its mission statement. It is also looking to protect especially retail investors from overly risky financial products. It also is trying to protect the systemic integrity of the derivatives markets in the United States. And, you know, we've seen over the course of years, at least a lot of, a lot of, you know, speculation, at least looking at what happens when the price of Bitcoin moves up and down,

• 43:33Speaker 02

  that it can be tied to what's going on on BitMEX, right? And the, the complaint actually says that there have been trillions of dollars, not billions, trillions of dollars of notional trading in Bitcoin, you know, swaps on BitMEX. So there's no question that BitMEX, at least in the eyes of the government, is systemically important to market structure in digital assets. And we've known for a really long time that that's something the US government wants to clean. This is one of the reasons of many that we don't have a Bitcoin ETF approved by the SEC because of the immaturity of the Bitcoin markets. So part of this, yes, is protecting systemic risk that flows from 100x leverage trading on Bitcoin.

• 44:17David Hoffman?

  Yeah, I want to double down on that point. The Bitcoin ETF is something that is touted as the gateway to opening up access for everyone to Bitcoin. If we get a Bitcoin ETF, our grandmas can have Bitcoin in their retirement pensions. Our parents can have, and us, we can have Bitcoin in our 401ks. Bitcoin with a Bitcoin ETF, Bitcoin can start to get integrated with the rest of the world in a much more compliant and approved manner. And the reason why, one of the cited reasons why we haven't gotten a Bitcoin ETF approved is that because it was labeled that price discovery was happening in offshore unregulated exchanges. You might as well just put in BitMEX there.

• 44:59David Hoffman?

  But in the actual citation, they obviously didn't cite BitMEX specifically. But what other offshore unregulated exchange does price discovery happen? They were talking about BitMEX. And so what would be much more comfortable with regulators is if that price discovery happened on US regulated derivatives markets, in which we have those right now. And so while a lot of Bitcoiners will shed some tears at the loss of their favorite Bitcoin casino, Bitcoin bank, I think over the long term, I think it's a pretty decent commitment to trade BitMEX for a Bitcoin ETF.

• 45:38Speaker 02

  Yeah, I think that's fair. And Ryan, the other thing is, so I said, that's part of it. And the other part of it will lead us to the Department of Justice action that went along with the CFTC's complaint, which is there is an anti-money laundering angle to all of this.

• 45:54David Hoffman?

  This is the big one, right? This is like the big deal.

• 45:58Speaker 02

  Yeah, I think this is the big deal. And you know, if the only violation had been of the Commodity Exchange Act, we probably wouldn't have seen action this strong as we did last week. So, so the deal is, if you qualify as a futures commission merchant under the Commodity Exchange Act, you automatically have an obligation under the Bank Secrecy Act to register with FinCEN and implement an anti-money laundering compliance program. An anti-money laundering compliance program means you have to KYC all of your customers, right? Customer due diligence. And you also have to file any number of reports with FinCEN,

• 46:39Speaker 02

  either for very large transactions in CTRs, currency transaction reports, over $10,000 in value. You also have to file SARs, suspicious activity reports, which tell FinCEN about anything shady going on on your exchange. And as we all know, for a very long time, BitMEX was not doing KYC for any of its customers. Now, there haven't been, as far as I've seen, any allegations of actual money laundering going on through BitMEX. However, who knows what the FBI sort of, you know, has figured out on its own behind the scenes? I think it's reasonable to wonder if there were some other law enforcement concerns about hiding criminal activity or trying to launder funds through BitMEX.

• 47:24Speaker 02

  So the DOJ, in addition to the CFTC, indicted Arthur Hayes and his co-founders on criminal charges, much more serious than just a civil complaint for a Commodity Exchange Act violation, for willfully violating the Bank Secrecy Act. In other words, knowing that they had to set up this anti-money laundering compliance program, and then willfully refusing and failing to do that. And in the indictment, there's a fair amount of, of, of evidence, you know, at least in, in the DOJ's allegations, that Arthur Hayes and his co-founders, you know, knew that they were required to implement this, this AML policy.

• 48:07Speaker 02

  That they were intentionally avoiding doing that. There is sort of one phrase that has has really stuck with people where Arthur said during a debate, I think with Nuriel Rubini, that the reason that they had set up in the Seychelles was it was a lot easier to bribe officials there. You could bribe them with a coconut. So, you know, that doesn't look good and it does sort of show, you know, consciousness of guilt, so to speak, about that violation.

• 48:32David Hoffman?

  Okay, so just to just to recap the meaningful, what's meaningful about this is that like Bitmex and because it wasn't doing KYC or all the other reporting requirements of financial activity on the Bitmex platform was this massive black box of inputs and outputs of Bitcoin, right? And so what pisses off the US regulators is that, you know, they don't know where that money is coming from and they don't know who that money is going to. And so when we are trying to always perpetually get a grasp for where the world's money is in order for us to be able to stop the things that we don't want that money to be used for, Bitmex was a huge thorn in the side of the United States, right? Like, we want to know who's getting funded with what and Bitmex isn't enabling us to understand that, right?

• 49:17David Hoffman?

  And that's kind of what the Bank Secrecy Act is all about.

• 49:21Speaker 02

  Yeah, that's right. The the Bank Secrecy Act, and it's not just the BSA. It's really sort of like the the global system of financial surveillance. So that includes five AMLD and it includes the FATF standards, the Financial Action Task Force. The point basically is to deputize trusted third parties who serve as financial intermediaries to perform surveillance over the transactions that they process on behalf of their customers and report to the governments of the world who that money belongs to, where it's coming from and where it goes. And Bitmex, like you said, was was sort of not playing along with that game and it allowed folks to send Bitcoin to Bitmex. And then, you know, as far as

• 50:06Speaker 02

  a company like Chainalysis or other blockchain analytics services were concerned, they weren't able to track those transactions once they left Bitmex. They wouldn't know sort of who the money was going to or where. So that's why this was a an anti-money laundering concern for one.

• 50:21David Hoffman?

  Right, and from what I've gathered, there were confirmations of Iranian individuals using BitMEX, and Iran is definitely on the "don't touch money from this country" list. And I think listeners can start to get a feel for why this conversation is extremely relevant to DeFi, and we're definitely going to go there. But before we do, I do want to ask, so one BitMEX officer is in jail, and Arthur, the CEO, I guess, is being quoted to be at-large, not arrested, but at-large. And so we can assume that he's on the run. I know you don't like to speculate as a lawyer, Jake, but what do you think is going

• 51:06David Hoffman?

  on behind the scenes here? Is there going to be a deal written between BitMEX and the regulators? Or are they doing the complete middle finger, where they're still processing withdrawals, the domain hasn't been seized, like BitMEX continues to operate? What's your take here with how this moves forward?

• 51:25Speaker 02

  Yeah, so I mean, I guess first of all, it is important to remember that BitMEX, like any other defendant, is innocent until proven guilty beyond a reasonable doubt in a court of law, right? So BitMEX is not required to shut down unless the government tries to shut them down. I think it makes perfect sense that they are still operating as long as they are maintaining their innocence and maintaining that they are still in compliance. In terms of Arthur being at-large, so I've heard reports that he is in Singapore. The US has an extradition treaty with Singapore, so unless Arthur is the kind of guy, and again, we're sort of speculating here, but unless he's going to literally go on the

• 52:08Speaker 02

  run and try to hide from law enforcement for the next 20 years, I mean, I don't see that happening. My guess is he's in contact with the authorities in the US through his counsel, and they're probably working out the details of a self-surrender, and that's very typical. So what you don't want, frankly, is to land at an airport and the FBI is waiting for you. Put in handcuffs.

• 52:31David Hoffman?

  Right, you'll lose all your leverage, right?

• 52:33Speaker 02

  Yeah, so what they're doing probably is talking about the terms of pre-trial release. So, you know, the question is, is Arthur going to be held in jail pending trial? Or is he going to be released on bond? Meaning if he flees and becomes a fugitive, he has to give up some amount of money? Or is he released on some other conditions that will, you know, try to stop him from fleeing? They're just going to work those those terms out and then my guess is Arthur will will show up um and turn himself in at some point. Uh and then we'll see what happens in litigation, you know? We heard reports that Bitmex was being investigated as early as July of last year. So that was the first time that there was a public report of a CFTC investigation.

• 53:16Speaker 02

  Um, also, the the documents that were filed last week imply that there have been depositions and subpoenas that have been responded to. So it seems like Bitmex has been working on this investigation for a long time. My guess, and you saw this in my tweet last week, was that Bitmex was probably trying to work out some kind of settlement, just like these other players have. And it sounds like the deal just fell through and they couldn't work out a deal and that's what led to the government filing charges.

• 53:45David Hoffman?

  Interesting, interesting. Well, one thing that uh concerns me, Jake, is is this was funnily enough, eight on the eight year anniversary of the Silk Road deal. I think that was actually a coincidence uh more than anything. But, you know, for those, just as a quick recap, the Silk Road was the dark net marketplace that leveraged Bitcoin uh in order to facilitate the purchasing of, you know, illicit things, you know, whether it be drugs or, you know, fake documents or whatever. Uh and then Ross Ulbricht got sentenced to eight years in prison and and the Silk Road got seized and taken down. And then a thousand Silk Roads came up in its place, right? Like do new different dark dark net markets that, you know, now those get seized every once in a while, but then ten more crop up in their place, right?

• 54:30David Hoffman?

  Uh and and so what I'm worried, what I'm worried about and what I think why maybe they haven't taken down the Bitmex domain yet is because as soon as you take down Bitmex, you create the incentive for, you know, a hundred other people to make, you know, Bitmex round two, right? And then those become also unregulatable. What's, is there any sort of, you know, previous action or historical lessons that we can learn about how this can be managed?

• 54:54Speaker 02

  Yeah, I mean, you know, look, Bitnext is not the only Bitcoin derivative exchange in the world. It's not the only one that I think is accessible from the US. It's also not the first one that's been the target of an enforcement action. So, you know, one of the, one of the sort of unknown or lesser known pieces of this is in 2016, Bitfinex entered a settlement with the CFTC for basically equivalent charges, right? Operating an unregistered derivatives exchange that was available to US customers. It's just that Bitfinex complied with the, you know, cooperated with the investigation and reached a settlement with the CFTC and set up much better processes to exclude US citizens. So, you know, Bitfinex already went through all of this.

• 55:39Speaker 02

  And as time has gone on, we've seen enforcement orders against any number of other derivatives operators. So, you know, there was one broker, that was a Marshall Islands derivatives exchange that was allowing trading of equity swaps, so like Apple stock denominated in Bitcoin. There was Abra, which was pretty recent. So this isn't really a new story. And, you know, it does seem just sort of like with the SEC and all these tokens, that this is just the CFTC going one by one by one, cleaning up these unregistered derivatives exchanges. Bitnext just happens to be like the big one, right? So it's almost be like if the SEC were to file an enforcement action against Ripple for XRP. It's like this is the big one and we finally, you know, got it last week.

• 56:25Ryan Sean Adams?

  Jake, we're going to come back and talk about the implications for DeFi. Cause I think on the, the question on everyone's mind is, what do all of these actions mean for DeFi? But before we do, we want to show you a couple of our sponsors for Bankless that made this episode possible.

• 56:45David Hoffman?

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• 57:27David Hoffman?

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• 58:11David Hoffman?

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• 58:53David Hoffman?

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• 59:09Ryan Sean Adams?

  Okay, guys, we are back. We've got Jake Ternvitsky and we are talking about regulation and what it means for DeFi. You know, Jake, part of me wonders like, is the kind of regulators is it sort of like the Eye of Sauron from like Lord of the Rings, where it just like it's sweeping the land. And right now, it's it found BitMEX and its eyes turned to BitMEX. And I think the question in everyone's mind is, when, what are the regulators going to do with DeFi? Because DeFi is no longer a small niche market, right? So we have we have Uniswap, and it just last month surpassed Coinbase in terms of trading volume. I think that's a pretty

• 59:51Ryan Sean Adams?

  large market for crypto. How long until the Eye of Sauron turns his eye on like decentralized exchanges, for instance, maybe a Uniswap and DeFi as a whole? And once it does turn its eye on DeFi, what does it do?

• 1:00:08Speaker 02

  Yeah, so it's a funny comparison. I guess it's more like the Eye of Sauron with a two-year lag, right? So and also, I mean, it's not really the Eye of Sauron, because I think we, you know, have a little more respect for our regulators than that. But, look, regulators are already paying attention to DeFi. There's no question about that. There are different levels of understanding about DeFi depending on which regulatory agency you're talking about. But as you're showing here, you know, there is some concern about DeFi and compliance with anti-money laundering laws, like the Bank Secrecy Act. I think this article is a little bit sensational, and I disagree with

• 1:00:49Speaker 02

  that headline, which seems a little bit clickbaity to me, but we can get into that. But, you know, FinCEN in particular is very sophisticated in thinking about DeFi. I guess if the question is, when, if ever, do we see enforcement actions or settlements related to DeFi?

• 1:01:08Ryan Sean Adams?

  My sense is- Before you go on, Jake, just for the podcast listener, so the headline I'm pulling up is called, "Booming Decentralized Finance: A Potential Haven for Money Laundering," and this was published in Bloomberg. That was the headline you're referring to.

• 1:01:21Speaker 02

  Yeah, so I, yeah, I, I, um, I respectfully disagree with the author on that one. We can sort of get into why. I think the risk is a lot lower than that might represent. Um, but you know, I think enforcement actions are a little bit far off. I think that it will just take longer for regulators to understand the technology and then figure out who the right subjects are for regulation and whether and to what extent uh, there have been actual violations of those regulatory frameworks. So I think it's, you know, it's the early days, but just like in 2017, there was a lot of identification of activity that seemed pretty clearly to violate the securities laws. I, you know, I think there are various elements of

• 1:02:02Speaker 02

  I think what people may call DeFi, but which I would dispute as to whether it's really decentralized. Uh, that, you know, in a couple of years, we'll be seeing some pretty obvious enforcement actions related to those.

• 1:02:13Ryan Sean Adams?

  So Jake, what are, what are like the carve outs for DeFi right now? Right? So it, it seems to be there, there is one like, like point of differentiation from a BitMEX versus a, you know, something that's more DeFi, uh, is, is certainly custody of assets. Right? So, um, with BitMEX, you have to deposit your Bitcoin. They retain custody of your assets in order to use their derivative services. With, with most DeFi, you don't have to, like with, with DeFi, that's actually more on the decentralized spectrum. You don't have to do that. A smart contract, ideally autonomous, non-controlled, smart contract kind of takes, takes ownership of that. Is that a key carve out?

• 1:02:51Ryan Sean Adams?

  I guess, and maybe in particular, I think it's more interesting to talk about sort of the, the eye of Sauron with respect to like, um, the Bank Secrecy Act and, and FinCEN. Um, is that going, is that a, a difference? And what other differences will a, a group like FinCEN kind of, uh, make?

• 1:03:08Speaker 02

  Yeah. So I, I wouldn't call it a carve out. I would say it's, it's an important fact that changes whether regulation applies or not. And we always have to remember a couple of things. One is decentralization is not a magic cure, right? It's not a perfect defense to all regulation. Decentralization is a tool that reduces risk in certain ways. And some of the ways in which it reduces risk means that traditional regulations no longer apply the way they do to centralized systems. You also have to remember, regulations don't apply to technology. They apply to people and their conduct. So the question isn't necessarily, is DeFi regulated? Or is a DeFi protocol regulated?

• 1:03:50Speaker 02

  The question is, are there people using DeFi protocols who are subject to regulation? In the example you give about whether a system is custodial or not, that is really important for some regulatory frameworks and some classifications of regulated institutions under those frameworks, including the Bank Secrecy Act. So the main question that we look at under the Bank Secrecy Act and that FinCEN has provided a lot of guidance about is whether or not crypto systems are money transmitters or money services businesses. A money transmitter is an entity that receives funds from one person

• 1:04:32Speaker 02

  and transmits those funds to another person or location. And a money transmitter needs to be registered with FinCEN and it needs to have an AML compliance program, including KYC. A centralized exchange is a money transmitter. It's probably a number of other regulatory classifications as well. But for starters, it's a money transmitter. It receives funds in the form of deposits from its customers. It transmits those funds back to customers at different wallet addresses. Therefore, it is regulated under the Bank Secrecy Act. A DeFi protocol, which is non-custodial, arguably does not perform money transmission. And FinCEN has actually put out some really helpful guidance on this.

• 1:05:15Speaker 02

  In particular, in May of last year, May of 2019, they put out sort of a summary of their analysis of the different categories of market participants in crypto, including users, administrators, and exchangers of digital assets. And basically, from that guidance, the lesson to be learned is a purely non-custodial platform that does not have a centralized operator that is performing this service of money transmission is not a regulated Financial institution and therefore does not need to have an AML compliance program. So that's why being non custodial is very important.

• 1:05:55Speaker 02

  But one thing I'll add to that, though, is being a money transmitter is one of many types of regulated financial institutions. That has to comply with the BSA. Another totally different classification is a futures commission merchant, right? What Bitmex was classified as by the CFTC. If you are a futures commission merchant and FCM, you also have Bank Secrecy Act obligations. Whether your FCM is custodial or not. So being non custodial is not a cure for Bank Secrecy Act regulation.

• 1:06:31Ryan Sean Adams?

  Wow, okay, so like following in the first category, I guess traditionally you'd think of something like a wallet. Right? So like a MetaMask, for instance, you know, not to put specific companies or projects on this, but that would be something that probably falls outside of the Bank Secrecy Act and FinCEN's jurisdiction.

• 1:06:51Speaker 02

  Yes, and FinCEN actually said in their guidance pretty clearly that an a quote unquote unhosted wallet. And by that, what they mean is a wallet that is that is purely under the control of the user is not money transmission, right? The the creator of that unhosted wallet is basically just a software developer that put out a piece of software. But that developer does not have custody of the user's funds. And the user, as long as they're using cryptocurrency on their own behalf, right? For their own account, their own purposes, and they're not performing money transmission for other people. So that's why an unhosted wallet is not subject to Bank Secrecy Act regulation.

• 1:07:30Ryan Sean Adams?

  And that's kind of Jake, the case of like so far, right? That's that's how kind of FinCEN has has issued guidance that that so far that seems to be the case. I guess, you know, maybe the question is, right? So we we talked about earlier, what's the SEC and CFTC, what their goals are, right? But FinCEN, the Bank Secrecy Act goals are completely different. They're they're really like, we're trying to prevent like terrorist types of events. We're trying to Prevent a category of financial activity that like child pornography, these sorts of things that that kind of goes against the laws and ethics of the United States, right?

• 1:08:08Ryan Sean Adams?

  So like, i- is it possible that this kind of mandate starts to creep into these other like transactions? Like, what about individual civil liberties, right? So like, can FinCEN or like the Bank Secrecy Act or the DOJ start to broaden their mandate to say, well, individual US citizens cannot use, say, a Uniswap or some decentralized exchange? Like, how broad is their mandate when their entire reason for existence is to stop terrorist activity? It seems pretty broad.

• 1:08:46Speaker 02

  Yeah, you're you're hitting a really important point. And this, I think, is going to be the policy battle for our space in the coming years. And it's been heating up a lot in just even the last couple of months. Um, so I guess a couple of things on this. The first is FinCEN is a regulatory agency. They do not make the law, they interpret the law. They also can pass their own implementing regulations. But if you want to have a change to the Bank Secrecy Act, that would have to come from the US Congress. Right now, the Bank Secrecy Act, the statute, is what says that only regulated financial institutions are subject to the AML compliance program obligations of the law.

• 1:09:29Speaker 02

  And an unhosted wallet just doesn't fit any of those definitions of a regulated financial institution. So the question is, number one, to what extent might FinCEN want to exert more authority over unhosted wallets or peer-to-peer transactions? And number two, how could the law change to be more restrictive of these kinds of these kinds of transactions? I think stepping back from the technical legal analysis, it is important to note that what we are building is a parallel financial system that allows the transfer of basically any amount of value to anyone, anywhere, almost instantly, almost for free, without any ability of governments to censor or surveil those transactions.

• 1:10:13Ryan Sean Adams?

  Right.

• 1:10:13Speaker 02

  That is a threatening sounding type of technology.

• 1:10:18Speaker 02

  And there is just a really big, ongoing policy question whether regulators are gonna be okay with that. David, you look like you have something to add there.

• 1:10:26David Hoffman?

  Yeah, so this is kind of just like in stark contrast with BitMEX. Like, the reason why so many people like BitMEX and why BitMEX is under the view of the nation state in this present moment is that in addition to the service that it provides, which is regulated by the CFTC, it also provides this by-product service of like a money laundering institution to people that we maybe don't want. And like this, take for example, the Iranian people that were using BitMEX. And from what I hear, were in appropriate ways according to what the United States regulators view as appropriate, right? And that's why they're going after BitMEX. But Uniswap is no different, right? And or insert your decentralized exchange here.

• 1:11:08David Hoffman?

  Like, there's no Uniswap, the protocol will not be doing any reporting or KYC to any sort of regulatory body at any point in time, right? And so the value proposition for people that want to escape the nation-state control, that why there was going, and a motivation to go after BitMEX is going to be that same motivation to go after some sort of decentralized exchange on Ethereum. But now the game is just different. The playing field is just different. Things are constructed differently. And so that's why we're talking about like the issue of like a custodial wallet versus a user-controlled wallet. And unless we want to tie off that previous conversation with anything, let me know.

• 1:11:50David Hoffman?

  But I think what I want to hear about is like, there are platforms on Ethereum where you need to deposit your assets into them in order to participate. And then there are also platforms that you don't, right? For example, Uniswap, you can use Uniswap without depositing your assets there versus an application more like DYDX or Loopring, where you actually do deposit your funds into their system and then use their system and then you withdraw, right? So like, this seems to be where like the new line that we need to differentiate in order for regulators to come in and really understand what's going on here. Is there a line there or is that just kind of an arbitrary difference?

• 1:12:36Speaker 02

  Um, no, I think you're, I think you're on the right track. I mean, I guess, you know, the world we live in right now is a world where regulators are more or less comfortable having surveillance of the on-ramps and off-ramps into the crypto ecosystem, right? So if you want to get US dollars into Ether or Ether back into US dollars, you're gonna have to do that through a regulated exchange. That's why you have an account at Coinbase or Gemini or Kraken or, you know, name your, your, your on-ramp or off-ramp into crypto. But then the transactions, once you're in the crypto ecosystem, right? Once you have your Ether in your MetaMask wallet and you're, you know, moving it around between different DeFi protocols, there is basically no regulation or at least no

• 1:13:20Speaker 02

  requirement of reporting or KYC at that point. I think where we're heading, there's basically two directions we can go from here. One is policymakers understand the benefits and the value of that kind of financial activity, right? The whole point of what we're building is a system where people can actually own their own assets. They don't have to rely on trusted third parties, centralized custodians, to manage their assets for them and also manage their personal identifying information for them. We know how that goes, right? Not terribly well. Um, and also policymakers who understand the civil liberties issues that Ryan was mentioning, right?

• 1:14:02Speaker 02

  I believe that financial privacy is a really important right. And I believe the right to own your own assets is really important. The other version though, and this frankly is what we're hearing more from policymakers now. And I can tell you, you know, I do a lot of work here in Washington DC where I'm based, you know, talking to regulators and legislators about these issues, is a desire to create a fully custodial system, right? Where you cannot withdraw crypto assets from a traditional intermediated financial system.

• 1:14:38Speaker 02

  And the way that they're sort of right now thinking about creating that barrier between the custodial system and sort of the open DeFi system is to say that exchanges, those on-ramps and off-ramps, are not allowed to perform transactions with unhosted wallets, or that they have to KYC unhosted wallets before they can do the transaction. In other words, you have to prove that your Ledger hardware wallet or your MetaMask account is yours before the exchange can allow you to withdraw to that wallet.

• 1:15:10Ryan Sean Adams?

  Oh, my God.

• 1:15:10Speaker 02

  Or there could be transaction limits, right? You can only withdraw $500 a day, something like that. And this is actually heating up as an issue. And I think in the next six months or so, this is something that we need to start arguing about.

• 1:15:23David Hoffman?

  That sounds like a direct attack on the Bankless Nation.

• 1:15:28Speaker 02

  It is. And it sounds, look, it sounds pessimistic, but this is what has happened in Switzerland. So there is the Swiss rule, which says that VASPs, virtual asset service providers, have to verify the beneficial owner of an unhosted wallet before they can do a transaction to that unhosted wallet. This is all under the auspices of the travel rule, which you've probably heard about before. And the result of this basically is Swiss institutions refuse to process transactions to unhosted wallets because they don't know how to comply with that requirement.

• 1:16:01Ryan Sean Adams?

  This is, okay, so David, you wrote a piece on Bankless on Monday about kind of the BitMEX case being sort of like, like dividing the crypto community a little bit. And I've got to say, I'm somewhat divided on it, too, right? So on the one hand, I totally agree with regulator mandate to basically, let's, let's get the bad actors out of the space. So to the extent that BitMEX can like, you know, cheat or like, you know, take funds away, or basically have their, have their service operate as a black box, you have no transparency into going, what's going on.

• 1:16:36David Hoffman?

  And therefore allegedly trade against their own customers.

• 1:16:39Ryan Sean Adams?

  Exactly. So to the extent they were doing that, like, that's a bad actor. Okay, regulator, like, you know, there's a bad actor in the space.

• 1:16:46David Hoffman?

  Do your job and thank you.

• 1:16:48Ryan Sean Adams?

  Yes, but but but the other side of this is to the extent that regulators, not just regulators, nation states want to clamp down on civil liberties, like things that like if I pay you in cash money, David, right? There's no AML KYC going on. If I give you a bar of gold, the transaction has completed and the nation state doesn't need to get involved. And that that's where Jake, like I'm I gotta be honest, I'm pessimistic and it's concerning to me because like even even this week, we get stuff like this. I'm gonna I'm gonna show it on my screen. I tweeted this, but the the Earn It Act is in front of Congress

• 1:17:27Ryan Sean Adams?

  right now. And this is basically legislation that is attacking internet encryption and privacy on the internet. This is in front of the House right now with some supporters bipartisan support. And it's like, we need, we need help with COVID. We like, we don't need this kind of thing like so. I'm worried, quite frankly, Jake, that our boomer, our boomer legislators are gonna go with option two and instead try to institute this whole authoritarian, we need to know every single transaction in and out. There are no peer to peer money transmissions that the government doesn't have an eye into. There's no such thing as financial privacy anymore. Now that it's digital,

• 1:18:08Ryan Sean Adams?

  we somehow have a right to see everything that happens if you're a citizen of the nation. And quite frankly, that is terrifying to me. Jake, is there any hope here? Like, please, say, say, say that someone is willing to preserve our civil liberties at the nation state level.

• 1:18:25Speaker 02

  There is hope. There's definitely hope. I am worried. I'm probably one of the more worried people, you know, working on these policy issues. And I do think we need to take it seriously. But I do think there's hope. I think we have really good arguments. And, you know, I hate to, you know, I hate to be sort of like too much of a patriotic American, but I do think especially we have really strong constitutional arguments, you know, arguments that really speak to American principles about First Amendment rights, Fourth Amendment rights. I think financial privacy. Is something that we care about a lot in America. I don't think we want to have a system like a more authoritarian country like China has set up, where the government can see absolutely

• 1:19:08Speaker 02

  everything that everyone is doing at all times. Um, so I do think we have good constitutional arguments, good principled arguments. I also think we have to look at this from the other side of the equation. So when you go to policymakers and all you do is hand wave about how amazing this new innovative technology is, they don't really hear those arguments as much as they do when you say the risk that you're concerned about is actually pretty low, right? What, think about what the policymakers are concerned about. They're concerned that terrorists are going to use this technology to perpetrate attacks on our country, to hurt innocent people, to carry out crimes that none of us want to happen, right? We do not want to see child abuse in the world or terrorist attacks in the world.

• 1:19:52Speaker 02

  We don't want to see DeFi being used by ISIS and Hamas and Al Qaeda. That is not something that we want. So what we have to do is also make arguments about why those risks aren't that serious right now and why concerns about some future worlds where terrorists are all of a sudden doing all of their business through DeFi, which is not what's happening now. Don't get me wrong, right? There is, is basically none of that happening right now. There's very little actual use of crypto.

• 1:20:21Ryan Sean Adams?

  I mean, they're doing it with, um, bills, right? With Benjamins, with cash.

• 1:20:25Speaker 02

  US dollars, US dollars. By far and away the most used currency for, for criminal purposes. And so you want to say to policymakers, look, we understand the risk. There are ways to mitigate those risks. We're fine with regulation of those on-ramps and off-ramps, right? It's okay for something like Bitmex staff to perform KYC of its customers. Um, but also don't kill the innovation that's happening in this new world that is trying to compete with the centralized version that China is building, right? Or that other, uh, you know, I guess you could call them foreign adversaries of, of the US and, and the sort of Western world where they will control everything that happens on these, on these systems.

• 1:21:08Speaker 02

  Um, don't kill that version of this technology for fear of something that isn't really happening right now. And instead, consider other ways to attack the problem other than the overbroad act of just shutting down all innovation completely.

• 1:21:22Ryan Sean Adams?

  I feel like it's the case, Jake, that we have a kind of a fight on our hands. And what I mean is like so many in crypto, they want to remove themselves from nation-state politics, right? Personally, I don't advocate that at all, right? So like, I think that if we want to preserve our civil liberties, right? We actually have to engage in political discussions. We actually have to vote. We actually have to persuade lawmakers as to our case. Like, it's almost like we have to refight for our constitutional rights in the digital age. Like, because they do seem to be eroding all around us. So like, what can people do, Jake?

• 1:22:07Ryan Sean Adams?

  I mean, it feels like so much of this is just pushed on us and foisted on us. Are there groups talking to legislators in Washington about these issues? Like, should we inform ourselves on who to vote for? What kinds of things can the people do, the bankless nation, do to like push these in the direction of option one rather than option two, where we go full authoritarian?

• 1:22:34Speaker 02

  Yeah, there's a lot that we can do, and I think everyone needs to be engaged in this issue, because if they're not, it's very easy for elected officials to crush this space, right? At the end of the day, our politicians, say what you want about American democracy and the state in which it finds itself today, they are supposed to carry out the will of the people. And so we need to make clear what the benefits of this technology are and make clear what we want to see happen in this space. There's a couple organizations to know about that are working on these issues. One is Coin Center. Coin Center has put out some amazing research and papers on this very issue.

• 1:23:16Speaker 02

  One of my favorite papers is by their executive director, Jerry Barito, on digital cash and financial privacy, arguing why this is extremely important to a free society. That's a really important piece of work to read. There's the blockchain. Association, which is a trade association here in DC. I'm one of the co-chairs of its DeFi working group along with Jason Somansato at Zero X and Brian Avello, who's the general counsel at Maker. And we are engaging with policymakers often to discuss these issues and, you know, argue about why onerous regulation isn't necessary. There's the Chicago DeFi Alliance. We're working on a task force to also advance some of these policy arguments.

• 1:24:00Speaker 02

  But really what people need to do is start getting educated about what the policy arguments are. Why it is important to a free society to have digital cash, why we should not trans, uh, should not treat a public blockchain like Ethereum, like a wire transfer system in the traditional financial system. And, and sort of, you know, why we should allow innovation to flourish, what the benefits are and why they outweigh the risks.

• 1:24:28Ryan Sean Adams?

  You know, I, I guess dangling that carrot in front of our lawmakers is important. And this is all, not all bad news. We saw STC Chair

• 1:24:41Ryan Sean Adams?

  Clayton talk about tokens, like all stocks becoming tokenized at some point in the future. So on the flip side to what, to what you're saying, Jake, there does seem to be kind of a carrot in front of the US, the nation state lawmakers to say, look, you don't want to get left behind of this innovative technology. The future is, is quite clearly digital. It's internet native. It's programmable. If we can somehow preserve our civil liberties in the process, right, then the bankless nation wins. But, but that is, I guess, the, uh, the challenge that's in front of us. Last question for you, Jake, and you, thank you so much for spending time with us on these subjects. It's, it's hard to, to wrap our heads around where we hear these headlines and you've distilled it quite well.

• 1:25:26Ryan Sean Adams?

  But I guess the question is, um, how, how long will it take for all of this stuff to shake out, do you think? So are we talking on the order of years? Like, um, are we talking on the order of, of decades? If things go the optimistic route, where do you see us in 10 years?

• 1:25:43Speaker 02

  Um, I do think it's it's years to decades. It depends. It depends on a lot of different factors.

• 1:25:53Speaker 02

  I it depends on how effective we are in making these arguments. And I mean, just to to to wrap up the the thought that you just put out about Jay Clayton sort of seeming to approve for the first time I've seen about, you know, tokenizing securities. There are policymakers who are on our side. This is not us versus them. Brian Brooks, who's the the controller of the currency, is a big fan of of crypto in general. The deputy director at FinCEN is, you know, sort of a fan of what we're doing. So there are people who sort of identify with with the mission. Or at least are, you know, interested in sort of the benefits that these technologies can offer. But, you know, where do we go in the next 10 years?

• 1:26:37Speaker 02

  I think that it partly depends on what the traditional financial system's response is to crypto as it grows. So one of the fights we haven't really had yet is with the banks, right? So I mean, bring this full circle, right? We're on the bankless state of the nation today. The question is, does JP Morgan and Morgan Stanley and Bank of America and et cetera, et cetera? Did they all decide that it's us versus them? Did they decide that they need to start pushing policymakers to tamp down on what we're building in the DeFi space? Or is there some world where we play together, where there's some new role for those banks to to serve?

• 1:27:20Speaker 02

  And that's something that we've been talking about a lot in the DeFi space. You know, there are ways where it's not necessarily a bankless world. It's just that banks look very different from how they look today, right? They're not custoding our assets. They're not performing this very capital intensive role. They're serving a different purpose. They're service providers. They're sort of launching their own products and services on top of blockchain-based decentralized finance protocols. I think if we can get to that world where this Doesn't seem like such a threat. And we can then make a really strong argument that

• 1:28:00Speaker 02

  supporting innovation in DeFi is good for American citizens and it's good for free enterprise and for for fair and and open markets. That in a way, it is a good response to the geopolitical threat that we're facing now, where there are other countries going more toward a socialist or even more of a communist approach to their own financial systems, then in 10 years, we could be in an extremely good situation where DeFi is the financial infrastructure of the Western world. And no one even thinks twice about the fact that under the hood of the app that you have on your phone is a DeFi protocol

• 1:28:42Speaker 02

  as opposed to a traditional financial software on a on a server or something like that. We just really need to pay attention to what the risks are that we go in the other direction and do our best to to sort of guide policymakers to the right place.

• 1:28:58Ryan Sean Adams?

  I I'm glad we're ending on an optimistic note here because I do think everything you said is optimistic, Jake. And you know, one, one other thing I'll, I'll say is we largely got through the open communication protocol of the internet with a fairly free and neutral and open internet. We did that with the, the help of regulators and legislators. There were bumps along the road. It was not perfect. But but largely, the internet that we had in the 1990s and the 2000s came through relatively unscathed. It's possible we might be able to do that with with DeFi and these open finance protocols. David, you have anything else that's optimistic, man?

• 1:29:36David Hoffman?

  Yeah, Jake, you're talking about how a lot of this depends on what legacy financial institutions do. And I'm reminded of the podcast that we just released on Moloch where it would take a lot for every single legacy financial system to all agree to be on the same page as be anti crypto or anti DeFi, right? Because the, the more banks that sign up to be anti crypto or anti DeFi, the more likely it is for one to defect. And become like the the the C5 D5 bank that spans across both, right? And so that that makes me optimistic that there's always going to be the incentive to be that one bank that's crypto friendly. And then hopefully the market rewards them.

• 1:30:18David Hoffman?

  And then I think the other thing that makes me optimistic, Jake, is that you you rattled off a list of D5 working groups along with Coin Center. That there are actual people like you. So thank you, tip of the hat Jake for for defending the nation. There are people coordinating around the need to to get ahead of this problem, right? And to make sure that when the boomers leading this country are get informed with what's actually going on from people that are in the space. And so Jake, I do see that as your role as perhaps protector of of the D5 nation. So so thank you with everything you do. And also thank you for coming on the bankless state of the nation to get us educated as to what's going on in this world.

• 1:31:00Speaker 02

  My pleasure, guys. Great to talk to you.

• 1:31:02David Hoffman?

  Cheers.

• 1:31:03Ryan Sean Adams?

  All right, guys, this has been State of the Nation. Thanks so much. Of course, none of this was legal advice, as Jake will be the first to tell you. This was also not financial advice. Eth is risky, crypto is risky, so is D5. It's clear that we have some things to work out in the years to come with the nation state. You could also lose what you put in, but we are headed west. This is the frontier. It's not for everyone, but we're glad you're with us in the bankless journey. Thanks a lot.

• 1:31:33David Hoffman?

  I don't think we've done a live stream or a podcast that was more accurately reflected your sign off, Ryan.

• 1:31:41Speaker 02

  I'd so.