Preston Byrne - Crypto-pocalypse - [Invest Like the Best, EP.72]

My guest this week is Preston Byrne. Preston is vocal critic of crazy prices and projects in the world cryptocurrencies. His background is in the legal world and also as a founder and former COO of Monax, which made the first open-source permissioned blockchain client. As Preston says, he is a “blockchain without bitcoin” guy, who believes that this crypto mania will end in some sort of apocalypse for token holders and ICO issuers . We tackle several issues, from his broad skepticism of crypto assets, to the potential regulatory reaction from major governments, to types of coins like stable coins, which Preston views as analogous to perpetual motion machines. Please enjoy our conversation and for any crypto investors out there, let me know if this conversation affects your opinion of the investing prospects for cryptocurrencies. Hash Power is presented by Fidelity Investments For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag Links Referenced Bitcoin white paper The Bear Case for Crypto Hash Power series Zero Hedge Preston tweet on Reverse network effect Show Notes 2:12 - (First Question) –Ponzi scheme vs pyramid scheme vs Nakimoto scheme 5:29 – Why there are regulatory challenges to cryptocurrency 5:33 – The Bear Case for Crypto 9:59 – Who are the most influential people supporting this and how are they swaying the regulatory minefield on this issue 10:28 – Hash Power series 13:23 – Looking into the idea of a digital asset and the difference between blockchain and the token itself 16:09 – What about the idea that cryptocurrency’s only feature is that it’s censorship resistant 18:39 – Why cryptocurrencies become less usable the more successful they are 18:59 – Zero Hedge 21:04 – Why can’t we rely on offchain solutions to solve the scaling issue 22:29 – The idea of bubbles and what happens next in this one 25:41 – What are the incentives to build technology to support cryptocurrencies 29:23 – Explaining Ripple 31:21 – What would precipitate a massive reversal in the inflated valuations of cryptocurrencies 34:52 – Understanding reverse network effects 34:36 – Preston tweet on Reverse network effect 37:45 – The principles behind Stablecoin 42:20 – What has been the greatest lesson that Preston has learned about blockchain he wish he knew when he first got started 44:05 – How embedded will blockchain be by 2024/2025 45:12 – ICO’s, why Preston is not a fan and if there are any positives to them 50:20 – What are the conditions under which these things will be viewed legally. 54:00 – Preston’s history owning cryptocurrencies 55:35 – What has Preston most excited in the space 59:02 – Utility settlement coin 1:00:36 – Why the fascination with marmots 1:02:10 – What to reference before getting started with cryptocurrencies 1:04:03 – Understanding supply chains in block chain 1:07:14 – Some smart people on block chain to follow 1:08:24 – Kindest thing anyone has done for Preston Learn More For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub Follow Patrick on twitter at @patrick_oshag

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

• 0:00Patrick O'Shaughnessy?

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• 0:32Patrick O'Shaughnessy?

  This episode of Invest Like the Best is brought to you by Paxos. I have personally interviewed Paxos' CEO Chad Cascarilla on this podcast before and am excited about how they're changing the crypto landscape. Whether you're a small fintech or a large financial institution, with Paxos Crypto Brokerage, you can offer your customers crypto buying, selling, transferring and more, all with Paxos' easy to integrate APIs. Paxos takes care of everything in the backend, from licensing and compliance to custody and exchange. You can start offering crypto to your customers within months. I've gotten to know Paxos over the years and have been personally impressed with their track record. With clients that include PayPal, Venmo, Revolut and Bank of America, they're the most trusted infrastructure provider for crypto and blockchain.

• 1:16Patrick O'Shaughnessy?

  I'm excited that more fintechs and banks are starting to offer crypto features and Paxos Crypto Brokerage is the best way to get to market quickly and safely. To learn more, visit Paxos.com/Patrick. That's P-A-X-O-S dot com forward slash Patrick.

• 1:35Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com.

• 1:56Speaker 03

  Patrick O'Shaughnessy is a principal and portfolio manager at O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

• 2:28Patrick O'Shaughnessy?

  My guest this week is Preston Byrne. Preston is a vocal critic of the crazy prices and projects in the world of cryptocurrencies. His background is in the legal world and also as a founder and former COO of Monax, which made the first open source permissioned blockchain client. As Preston says, he is a blockchain without Bitcoin guy, who believes that this crypto mania will end in some sort of apocalypse for token holders and ICO issuers. We tackle several issues, from his broad skepticism of crypto assets, to the potential regulatory reaction from major governments, to types of coins like stable coins, which Preston views as analogous to perpetual motion machines. Like the Hash Power documentary, this episode and other Hash Power singles are brought to you by Fidelity Investments, a company that is constantly researching and experimenting

• 3:12Patrick O'Shaughnessy?

  with emerging technologies like crypto assets and blockchain to improve the lives of their customers. Fidelity provides a comprehensive set of products and services to individual investors, employers, and financial advisory firms. For more information, please visit fidelity.com. Please enjoy our conversation, and for any crypto investors out there, let me know if this affects your opinion of the investing prospects for cryptocurrencies, generally speaking.

• 3:43Patrick O'Shaughnessy?

  Let's talk in some detail about your notion of a Nakamoto scheme. So I think you had called some aspect of something a Ponzi scheme, and then gone back and refined that idea a little bit. So maybe refresh on Ponzi schemes or pyramid schemes, they're a little bit different, and then what you now call a Nakamoto scheme, and what's distinct about it?

• 4:01Speaker 04

  So Ponzi schemes and pyramid schemes are what a lot of people who have first, particularly old men, in my experience, they look at Bitcoin and they go, wow, this is a Ponzi scheme. And they look at it as a Ponzi scheme, because particularly lawyers, a lot of old lawyers I've spoken to, they look at it and they say, well, there's no rights or obligations, there's no one to deliver, they see this shell, and they just see people putting money in and somehow getting money out. So they say it's a Ponzi. What a Ponzi scheme is, is when you have one person who sits on a, you know, cash flows. So money comes in, money goes out, and they use the money that's coming in to pay the returns to earlier investors in the scheme, and presumably to, you know, enrich themselves at the same time. So basically, it's one operator centrally

• 4:44Speaker 04

  managing a scheme where they're fraudulent, you know, they're saying, well, you know, the accounts are fraudulent and the scheme's fraudulent. Bernie Madoff. In event, Bernie Madoff, prime example. So basically, eventually, if you have a rush on withdrawals, of course, the cash flows don't meet the outflows, and so what happens is the scheme collapses under its own weight. Alan Stanford, another prime example. So with a pyramid scheme, slightly different, that's a little more decentralized in that you have a person at the top of the pyramid, who then recruits two or three or four more, and then they recruit two or three or four more, and they pay commissions to people up the ladder, until eventually you go down a sufficient number of levels, and the person at the top, if they've managed to recruit another 16 people, gets a big payout. And then the 16 say, well, he got rich, so I'm gonna go do the same, go recruit more. Of

• 5:26Speaker 04

  course, that, that also runs out, because, you know, it's like the old Persian king, you know, with grains of rice on a chessboard. If you, if you keep doubling and doubling and doubling, you, you run out of space really, really quickly, especially after 64 of them, for example, you know, you wind up having more people than there are atoms in the observable universe. So that doesn't really work either. So you run out of victims, and the scheme collapses under its own weight. Nakamoto scheme, the term Nakamoto scheme, is really a way of thinking about Bitcoin as a sort of updated Ponzi pyramid scheme, but one for the digital age. So Bitcoin operates very much like a pyramid scheme, or a Ponzi scheme legally. There is no underlying subject matter which makes it valuable. It is simply valuable

• 6:09Speaker 04

  because other people want to buy into it, and people buy out with new investor funds that have entered the scheme. So that is very classically a kind of Ponzi-ish arrangement. But where it differs is that it's headless. So what you, you know, what the scheme does, instead of having identifiable cash flows to identifiable people, is it puts the cryptocurrency exchange between the buyer and the seller. It then abstracts the demand to enter the scheme and the demand to leave it as aggregate demand and aggregate supply. There's no fundamental underlying thing that the law recognizes as a, as a legitimate subject of a, of a sale, and then what happens is they just carry on, and the thing runs itself. So the Nakamoto scheme is basically just saying, look, it's not a Ponzi scheme. It's not a pyramid scheme. Someone figured out a way to automate those kinds of interactions for a peer-to-peer cash system.

• 6:54Speaker 04

  But when you introduce speculation into that equation, it starts operating a heck of a lot like your classical Ponzi scheme.

• 7:00Patrick O'Shaughnessy?

  I remember when I first started exploring this stuff, reading a post you had written called "The Original Bear Case for Crypto." And at the time, kind of approaching this as a novice myself, just being amazed that the market cap of all the coins was something like $150 billion when I first started looking at it. And I think in your piece, it was $170 billion, something in that range. And now it's 790 or I can't, you know, it changes by the day. But it would be really fun, having read the three-part piece, to kind of go through that bear case for crypto as you laid it out, starting with that first one. And I think you've got kind of a couple of different levels of apocalypse down to light regulation or something like this. So maybe we could start with the most extreme, which is, I think you called it the marmot apocalypse.

• 7:43Speaker 04

  It was the zombie marmot apocalypse. So by way of background for your listeners, I wrote a series of blog posts called "The Bear Case for Crypto" in several parts. And basically, you know, in broad strokes, the first bit is that there's a huge regulatory risk. The second bit is that there is a liquidity risk. And the third bit is basically that grandma is going to come up eventually and start suing people. And when you piss off grandma, that's never good for anybody. But in the first bit, the regulatory part, there are three different sort of subcategories of, you know, it's kind of like asking what stage of cancer you have, if that makes sense. So if you're very early-stage cancer, you know, it's very light chemo, that kind of stuff.

• 8:25Speaker 04

  And so if we're early-stage in terms of, you know, this bubble taking off and getting quite entrenched in society, then it's likely that the regulators are going to take some time to get up to speed with it. They're going to need more time, you know, considerably more time, a year or two, before you start seeing major enforcement actions. And a lot of the projects that we're seeing today are going to pass by unnoticed. I think that's where we were in 2014. So there were a great many projects that were started in 2014. Some are active, some are not. But generally speaking, I think the only real major enforcement that we've seen from that era was a scheme called Paycoin, which actually took place here in Connecticut. And a guy named Josh Garza, he was selling mining contracts that turned out to be something more akin to Ponzi schemes. He then had a cryptocurrency.

• 9:09Speaker 04

  Which said that it had a price floor, which promptly broke. So price-bagged cryptocurrencies are not good for anyone who's ever read my blog. And so that was that, that kind of phase. The second phase is when you start to see more aggressive enforcement, but not full-on. And that's where I think we are now. So we've seen China cracking down in various different ways. We've seen South Korea now doing some tax investigations. The SEC has been not quite as quick off the line, but I think they're probably doing their diligence. I don't think they're asleep at the wheel by any means. The DOJ has said nothing, which is, which is quite interesting. And you haven't really seen too much by the state securities regulators or state attorneys general yet. And I suspect that's because those are primarily driven by complaints, which we haven't had,

• 9:52Speaker 04

  because as long as everyone's getting rich, nobody's complaining a whole lot. So, so that's kind of phase two. Phase three is the zombie market apocalypse. And that is, that is a sort of nightmare scenario where you have, where you see enforcement actions, exchanges getting shut down because of money laundering offenses. Sort of imagine what happened to BTCE a couple of months ago, but then happening to exchanges that operate here in the United States, or, or exchangers that operate in the United States. It's certainly conceivable, I think, that you could, or the United Kingdom, or any, any other, you know, Western country, whereas BTCE was Russian. I think, you know, the guys back home have been, you know, probably in a dialogue with the authorities and therefore given something of a free pass.

• 10:32Speaker 04

  Query how long that can continue, particularly as Congress and other entities start to acquire some cognizance of how this all works, and the numbers that are being presented to regulators start to look like things like long-term capital management or Enron, or indeed Bernie Madoff. So we're, we're now in the territory where the notional figures that are involved exceed those three scandals by some margin. And so the question is whether this is going to be allowed to continue, or whether this is going to spook the regulators into making very aggressive action and demanding reform by market participants. So that's the, that's the regulatory angle. And a lot of entrepreneurs, entrepreneurs don't care usually when you go, you know, you could, you could wind up in an orange jumpsuit for this. They're like, whatever, YOLO. You know, it could be Mark Zuckerberg as well. So why don't we do that?

• 11:17Speaker 04

  But, you know, my background is as an English Structured finance lawyers. So I clearly look, you know, when, when the only tool you have is a hammer, the whole world looks like a nail. So my training is to go and identify those risks. And so, so that's just how I look at it.

• 11:30Patrick O'Shaughnessy?

  Can you get into the sausage factory a little bit with this issue in particular, where you've got a whole bunch of interested parties here? One of which is a very powerful kind of venture capital backed, technologists backed, some of the smartest people that I've ever met are hugely behind this movement. But the extent to which they have sway over the regulatory path, kind of who the various parties are that are influencing this and how that actually happens. Like I talked to Peter von Walkenberger as an example, as part of the Hash Power series, who's a really thoughtful guy. And obviously he is trying to help thoughtful regulation happen, but from the perspective of someone that supports cryptocurrencies and blockchain.

• 12:07Patrick O'Shaughnessy?

  So can you talk a little bit about like who the major players are that might influence when and to what degree there will be new regulation in the U.S. specifically?

• 12:16Speaker 04

  So in terms of who is influencing when new regulation will come about, and this isn't necessarily U.S. specific. It's going to be when a prosecutor needs to make their career on something, or when some politicians get spooked because they start getting angry letters from their constituents, which I don't really think has happened anywhere. And then on the flip side of that, of course, who is, who are the formal lobbyists in cryptocurrency? You have Peri Ann Boring's group down in DC and you have Coin Center with Peter and Niraj and Co. But really apart from that, there isn't a formal lobbying effort. So what it is, is you have the regulators looking in from outside and seeing all of the glorious claims that have been made. And you know, the cryptocurrency can do this and it's wonderful. It's going to bank the unbanked and do this and do that.

• 12:58Speaker 04

  They don't necessarily have the technical chops on the regulator's side, or frankly, on the venture capitalist's side either, to really sense test those claims. I remember about two years ago, when people were starting looking at enterprise blockchain, there were VCs who were saying, well, this couldn't, this can never possibly work. You need the mining in order for the Bitcoin to happen. And you're like, well, no, you don't. That's just a consensus mechanism. You can swap it out and use something else. So they, they wrapped their heads around that eventually. So I think there's a degree of misunderstanding as to how the technology actually works, what its limitations are, what it can do. That tends to be quite serious on the regulator's side, somewhat serious on the VCs' side, but then again, the VCs have the interest in making sure that startups they're funding attract public interest and that, you know, people buy and use their services and that sort of thing.

• 13:42Speaker 04

  So I don't think generally, across the industry, we're having a serious enough conversation about how serious the limitations are on the technology. And in particular, people are very reluctant to stand up and challenge claims that are made by people who support the technology. So if someone says Bitcoin will make the world more equal and make things financially great for everybody, and you look at it and you go, well, actually, the Gini coefficient of the Bitcoin universe is 0.89, which is about 2% worse than North Korea.

• 14:12Patrick O'Shaughnessy?

  Gini coefficient, meaning wealth concentration.

• 14:16Speaker 04

  Correct. So it's very, very, the wealth in Bitcoin is concentrated in very few hands, in fact, more so than, you know, if it were a standalone economy than any other economy on earth. So it's really hard, and then people will say things like, well, Bitcoin will disrupt governments and render them obsolete. So there are all of these forward-looking statements that we see being made about this currency, which is basically, you know, operates in society as an investment, but which no one really has standing to challenge. And if they do, they get shouted down by legions of people on the internet who say, no, no, no, you're wrong about everything. So we have this very compelling sales pitch with not a lot pushing back against it.

• 14:54Patrick O'Shaughnessy?

  Maybe we can get into a little bit on the notion of a digital asset. And I think you've written in a few spots about utility of blockchains being intrinsic to the blockchain itself versus a token or a coin being some claim on some external thing. So maybe you could kind of outline that important difference, and from a legal perspective, why that's important.

• 15:16Speaker 04

  Blockchains kind of ape real-world assets and real-world things. They feel like them, but they're not legally the same as what you would, you know, what you would understand to be a stock or a bond or a share. So if I have a stock, you know, or share in a company somewhere, or a debt instrument, a bond, some other type of note, the reason that has any value, at the end of the day, is because I can take that thing to a court and I can ask the court to enforce it. So legally... Really, we call these things shows as in action or things in action. They only have existence when you go and file an action with a court and then go and seek its enforcement. And then you can send men with guns around to the debtor or to whoever else owes you that obligation. And you can enforce that obligation against them in the form of a judgment debt or order for specific performance or something else.

• 15:57Speaker 04

  So that's what these things are. They're really just evidences. It's evidence of an agreement. Which we trade and we trade freely and whatever. And but at the end of the day, sitting behind it. There's always the threat of enforcement, which is going to happen through the legal system. Which is going to happen with the police or with bailiffs or the sheriff or whoever else you need to to get on your side to go and go and enforce it. With the crypto assets, it's a slightly different situation. In that you don't have ownership as such, because everyone's kind of disclaimed ownership. So with Bitcoin, Satoshi has not turned around and asserted his intellectual property over the database. Similarly, none of the users of the system would have standing, or if they did have standing, they certainly haven't asserted.

• 16:40Speaker 04

  A database right or something similar over the Bitcoin database. So it's one of these weird things where everyone has kind of said, you know what? We're not going to touch it. We don't want to own it. We don't really want to opt in to any part of the legal system. Because if we do that expressly, then the legal system knows how to deal with this thing. That we're running around and trading and chiefly that would if you basically said it was a right to anything, it would become a security. And if it becomes a security, then obviously within that regulatory regime. So with Bitcoin, the asset is intrinsic. It has value because people think it has value. It's basically just a right permission, UTXO, that you have on this on this database. And people will buy it from you because they think it is money. But legally, there's nothing underpinning it. And so as a consequence, if people stop buying it, it disappears. It has it has very little meaning.

• 17:25Speaker 04

  So it's dependent. It's basically a giant meme with no legal substance as such.

• 17:29Patrick O'Shaughnessy?

  What do you think about the idea, Adam Ludwin's idea of really the only value in these things being this idea of censorship resistance? That censorship and judgment resistance, that maybe what you just described is the only feature. So the fact that I'm willing to own Bitcoin and ascribe to it value. And let's say I'm a true believer that thinks that, you know, in 10 years, I'm going to be able to access my Bitcoin and somehow use it as to do something productive. Or preserve value through time or one of the things that people want here. That no governments can have any say over. And that I'm basically relying on like global hash power to be the security underneath it versus some judgment system.

• 18:08Speaker 04

  Yeah, I think that's a little overrated because at the end of the day, it's, you know, there's the old XKCD cartoon, which is, you know, ha ha, sounds, I've got this RSA 3 million bit password, you'll never be able to break this. And they're like, well, yeah, why don't we just go around his house with a, you know, with a rubber hose and a $5 wrench and just beat him up and then we'll get what we want. Governments have been around for a really long time and they know how to get stuff done. And sometimes that stuff can be incredibly unpleasant. I agree with Adam in that Bitcoin is a very censorship resistant system, more so than almost any other, more so than any other distributed system or network system I can think of. But is that why people use it fundamentally? At the end of the day, I don't think so. I think it's, I think it's more basic than that. People use these things primarily for gambling and speculation. I think that's the main use case is that

• 18:53Speaker 04

  it's an unregulated penny stock casino of the 21st century. And whether we want to admit it or not, that's always been a compelling proposition. People have always wanted to go into casino, the promise of instant riches, as we've seen with Ripple of late. So there are people who got in at two cents and now it's of course worth $2. And so they're running around saying, hey, look, my Lambo, isn't it wonderful? And that's really compelling to people who are weak minded and even people who are quite strong minded. And they said, well, hold on a second, what am I missing out on? So I think that's the primary value prop of cryptocurrencies. That's what people are using them for. They're not using them for censorship resistance. And the guys who would use them for censorship resistance, like, you know, Amir Taki or Cody Wilson, or any of these sort of original, you know,

• 19:36Speaker 04

  crypto anarchists. Those guys are all using other stuff now. They're all using Monero and other cryptocurrencies that haven't been speculated on so wildly. And so as a consequence, they work. So maybe what's from a money perspective, what we're looking at is not one cryptocurrency dominating because cryptocurrencies are kind of their own worst enemies. When they become too successful, they become unusable. So maybe it's the ecosystem itself, which is worth something. And so one cryptocurrency will rise and another will fall. At the same time, and you know, gradually as Bitcoin or Ethereum becomes too unwieldy, something else will rise up to take its place.

• 20:10Patrick O'Shaughnessy?

  Can you say more about why that idea is true, that as they become more successful, they become unusable? Why is that a necessity? Why couldn't some new cryptocurrency, let's say it's Monero, violate that idea?

• 20:20Speaker 04

  Blockchains don't scale, and the bigger they get, the more unwieldy they get. So I was, there was a claim that was made, let's use just Ethereum as an example. Zero Hedge, that fine pillar of American journalism, the old gray lady. So Zero Hedge had an article on it sometime over the summer, when the Enterprise Ethereum Alliance, that august group of startups and financial institutions, United for a better world, decided to, in their infinite wisdom, or someone in it, I suspect, in their infinite wisdom, decided to tell Zero Hedge that Ethereum was planning to scale to a million transactions per second, sending the price to $2,000 per coin. And so, I don't know who did it, I don't know why anyone would say that.

• 21:03Speaker 04

  So one of those is actually, one of those predictions has actually turned out to be somewhat true. I think it's at $1,500 a coin now. The other one, that it's ever going to run a million transactions per second, is twaddle. It will never happen. And the reason for that is quite fundamental. It's that you're constrained by the speed of light. That is your enemy when you're running a global distributed system. It takes something like 14 milliseconds for the speed of light to go around the, halfway around the world, and that's in a straight line, which never happens, because it gets routed through all sorts of other things. Every transaction that gets propagated on that network gets propagated to a bunch of other computers, who then have to verify it, and then repropagate it. So, everything about one of these distributed networks, in this instance Ethereum, is slow. The hardware is, that is running it, is slow.

• 21:48Speaker 04

  The fact that it's widely distributed means it's going to be slow. No transactions are going to head in a straight line. The fact that you have to go great distances means it's going to be slow. And all of that is going to operate to slow down what this system can do, and prevent it from scaling efficiently. So, people are making these wild claims about these systems, but the fact is, every time we see one of them being used on a global basis, it becomes more unwieldy the larger it gets. As the price goes up, the fees go up, because the fees are priced per byte, and so if it's, you know, satoshis per byte, so if a satoshi becomes more expensive, assuming that the transactions are the same size, you're not going to get cheaper transactions, they're going to be more expensive.

• 22:25Patrick O'Shaughnessy?

  Proponents would place a lot of hope or desire for the future in off-chain scaling. So things like Lightning Network, or Layer 2, or side channels, or whatever. Why do you think we might not figure out some way of innovating a solution to this problem? So that the on-chain scaling doesn't ever have to happen? That we can use it as like a settlement layer, use Bitcoin as a settlement layer? And basically have all the smaller, higher-volume transactions happen in a less secure way? But in a way that's still tied to the underlying blockchain?

• 22:53Speaker 04

  I would rather use Coinbase, to be honest with you, than use Lightning. Because at least with Coinbase, I know where this stuff is. I can track the transaction. I have a record. I can do things like screenshots. And at the end of the day, if they screw up, I can sue them and get some money back, potentially. So I think that if that's the approach we're taking, it doesn't make a whole lot of sense to say, you know, well, payment channels are going to fix everything. Because in order for that to work, every user of the network has to be opening and closing several payment channels per day, which means they need to be leaving their computers on, which not everybody does. So you're kind of, a lot of these solutions assume a lot about how dedicated and committed your average user is going to be to the Bitcoin network. And most of them, frankly, are not. They probably log in once, buy some Bitcoin, turn the thing off. And I have some friends in law school now who are basically going, well, yeah, I know.

• 23:36Speaker 04

  I bought some. Here's my Coinbase account. You know, what should I buy next? And I'm like, no, I'm not. I'm not doing that. We're not playing this game. But yeah, basically, I think you might as well just go with a centralized solution at that point, because it's going to be faster, more efficient, and it's here now. And then you just assume that your settlement layer is going to be Bitcoin, and you have Coinbase as your bank. And you just have a deposit at Coinbase, which you can withdraw at will. And then if the fees are reasonable, you can go send it somewhere else.

• 24:00Patrick O'Shaughnessy?

  When you study most manias, you brought up in one of your posts, the railway mania. And when you study most manias, typically, there's something very exciting at the core of it that kicks it off. And oftentimes, that thing, once the mania has, once the bubble has inflated and popped, it's still become a key part of the kind of technology establishment of the future. But there's all sorts of misallocation of capital that happens in that middle period. So maybe talk about that, maybe even using the analogy to railways. With the vision on, assuming this is a bubble, we'll take that for granted right now, and it pops and it goes down 95% or whatever the percentage is. Kind of what comes next? Like, what's still exciting about it to you?

• 24:38Speaker 04

  What's exciting to me is the, I always thought, and so I started, when I started my company back in 2014, we started that with the view that we wanted to take back control of data. From the big data service providers. So we were building a prototype on Ethereum, or rather an Ethereum testnet. What we did is we decided we're going to automate organizational governance for a 501(c)(6) nonprofit organization on a blockchain. So we wrote a paper, you know, your typical crypto white paper, except ours was actually good and wasn't trying to sell anything. We then described the functionality. It was kind of, you know, it was shareholder governance, this sort of thing. And we said, look, this is a way that if you want, you can take a bunch of people in a bunch of different places, and you can coordinate your actions

• 25:21Speaker 04

  like you would in a Google Doc, like you would on, you know, Amazon S3 or whatever else, and you can do it without actually using the third-party service provider. So you can have this infrastructure, which is yours, which you control, which no one can see, or well, you know, which no one's going to have access to other than you. If you need to, you can run a VPN and do it over that. But this is a way that you can all talk to each other and keep in sync without needing some big stack very far away, running all of that infrastructure for you. So you're going to move all that onto your own, your own platform and run it that way. And, and that's because we, we saw then, and I think it's just as true now, we saw with, you know, centralization has risks. Those risks are political in nature. We saw today that Twitter is actively censoring conservative political opinions, the much maligned conservative political opinions in the United States today.

• 26:06Speaker 04

  Greatly victimized group of people, no doubt. In case you can't tell, I'm a little biased. But I think there's a major risk in putting too much power into the hands of tech companies, full stop. And I think blockchains allow us, with Bitcoin, it's, yeah, it's peer-to-peer money, but what's it really allowing you to do? It's allowing you to run an accounting system without a bank. It's allowing you to run an accounting system without a credit card company. It's taking out the middleman, and you can reskin it and tell it to manage whatever set of legal rights you want, as long as you have some trustee somewhere in whom those rights are vested. And when you do that, then you can have it operate totally normal, totally in harmony with the legal system. But what you've done is you've taken someone else's servers out of the equation, and you're running the thing yourself. So I think at the end of the day, that's, that's where we're going to wind up, where you'll

• 26:51Speaker 04

  have companies doing, they'll be doing their internal treasury services on a distributed ledger instead of doing it through their bank. That's one thing you could potentially do. So, one of, one of very many. At the end of the day, you don't really need the coins to achieve any of that distributed infrastructure that doesn't rely on third-party cloud services. You can You can use Hyperledger for that.

• 27:11Patrick O'Shaughnessy?

  So I always think about things from the perspective of an investor and the meme that's caught on in addition to Bitcoin is this fat protocol idea that the value associated with these networks, that they have some use case, they do something for people, and that the value accrues to the token holder, right? So the token is the unit of exchange and a little mini economy. Certainly, there have been some companies, Coinbase is the best example, traditional companies that are enormously valuable, that looks like any other financial intermediary, charging a point or whatever it is on either side of the transaction. In that world, what is the incentive to build that technology? It sounds like you're saying, we don't need tokens or coins, where value will accrue. But the incentives are always such that people build stuff because they are incented to

• 27:55Patrick O'Shaughnessy?

  do it financially. That's why people are entrepreneurs. So how do you think about like the motivations and the installation of that technology in the absence of a return to investors in coins?

• 28:06Speaker 04

  I think that the, have you seen the movie Aliens?

• 28:08Patrick O'Shaughnessy?

  Of course.

• 28:08Speaker 04

  You know, when they're all sitting in the drop ship and Bill Paxton's totally freaking out and then Sigourney Weaver's sitting there and she goes, you know, I say we take off and nuke the entire site from orbit. When the SEC published its DAO report over the summer, they effectively nuked the fat protocol thesis from orbit. That is what they did. And the language that we're using to describe it says it all. It's that in form and substance, we have companies that are saying, hey, we've got this piece of the protocol which you can own as an investment. And so if it's an investment here in the United States, the question is, have you got a prospectus or does an exemption apply? In Britain, same thing. Have you got a prospectus or do you have an exemption? Well, if you don't, or if it's money or money's worth that you're trading with other people, have you KYC'd them? Have you done AML?

• 28:53Speaker 04

  I don't think that the rules are going to go away anytime soon. And they shouldn't go away. They're there for very good reasons. So I don't think that makes a whole lot of sense in the current environment. Obviously, people can raise a lot of money really quickly and then deploy that very quickly to go and build out these networks. And that pushes all the right buttons for people who support that thesis. It says, hey, you know, people are interested in this. But whether it's sustainable or not depends on whether we can get the regulators okay with it. I don't think that your average Silicon Valley VC has really had a whole lot of interaction with financial services regulators over the course of their career. A Wall Street banker or lawyer, however, will have had that degree of interaction. And I was talking just the other day to a very senior structured finance partner at

• 29:34Speaker 04

  a very eminent global law firm, and they all had a whip round and discussed it, and they agreed. They said, we have no idea why these guys don't have the same concerns we do, considering for all of our deals, this idea of selling an investment or something that feels like one, and the compliance which goes along with it is so central to it that we make sure we're not only on the right side of the line, we're a mile away on the right side of the line. So in the current environment, it looks like, yeah, go do the token, bootstrap the protocol, get lots of interest, get it trading on an exchange. All of that sends all the right key indicators to a VC. You have, you know, tens of thousands of new users a week. It's getting press, you know, people write about it, they're excited, you know, shills

• 30:17Speaker 04

  on Twitter, running around and harassing people who say, well, maybe we should calm this down a little bit. The XRP shills are just insufferable. I'm just going to put that out there. So it's, which is, which is, which is interesting. But right, so it pushes everyone's buttons because they see the virality of it, but I don't think they see the legal technical debt that they're building up by following that approach. And so that, it makes perfect sense to continue on that angle as long as there are no consequences for doing so. If the day should come when there are consequences for doing so, then we're going to see the real cost of following that route. And then that, the question is, does it make sense without a token?

• 30:53Patrick O'Shaughnessy?

  Maybe describe Ripple for a minute. It's something we haven't spent a ton of time exploring on this podcast, in large part because it really hadn't done anything. And then since the last one, it's exploded in value. So maybe give your perspective on what it is, what its promises, and why that maybe is going to be hard to fulfill.

• 31:09Speaker 04

  Well, so I mean Ripple's a bunch of different, I mean Ripple Labs is a company founded by Chris Larson, and then they've got David Schwartz and Stefan Thomas, who've been around forever. And they've done a bunch of different things over the years. Obviously, I've never worked with or for them, but they did. So what did they do? Their first project was XRP, which was basically, if you talk to Peter Todd, he'll tell you it's centralized. If you talk to Ripple, they'll tell you it's not centralized. I'm not going to go into that in any depth here. But there's a cryptocurrency. It's proof of stake. Ripple more or less determines the consensus of the network, as far as I understand it, and that's that. And then had two other projects. One of them, the name escapes me. It was a sort of smart contract oracle-type project. And the other was called Interledger, which is a very similar project to your Hyperledger-style distributed ledger.

• 31:54Speaker 04

  And so my understanding of what they do is primarily they're doing distributed ledger implementations at Interledger at banks, which is derived from the Ripple consensus ledger rather than XRP. Of late, of course, we've seen XRP's price go through the roof, so I can imagine they will have to have had, changed their stance on that somewhat, because it seemed a couple of years ago that they were almost like, "Oh, no, no, that's kind of our redheaded cousin that we don't pay too much attention to, and we're just going to put them over here in the closet and not pay much attention to XRP, because it's blockchain without Bitcoin now." And this was like 2015. But now, of course, things have changed. So Ripple is just, it's a company that has a cryptocurrency. They also have a really interesting distributed ledger proposition. Again, my understanding was that they were going into things like treasury services.

• 32:37Speaker 04

  And so, yeah, they're trying to keep a toe in one ocean and a toe in the other, sort of enterprise and cryptocurrency. And that's a story we see more than once. I know of other startups which have basically said, "Look, we're not ruling out the coin thing, because there's so much interest in it."

• 32:51Patrick O'Shaughnessy?

  I'm always fascinated by the early stages of, I guess we're not in the early stages anymore, but this insane on-ramping of users onto Coinbase or whatever, and real fiat money now coming into the cryptocurrency sphere where there's There's, I think market cap is a really kind of flawed metric for thinking about this because you could say that Bitcoin's got a whatever, 200 and whatever it is today, hundreds of billions of dollars of market cap, but if any meaningful chunk of that tried to actually liquidate into fiat, it would be a fraction of that. And that's largely because when you add up the total amount of fiat that's gone into the ecosystem relative to its kind of notional market cap, I think it's tiny, right? Now, it's growing very quickly, but I think one of your key points is whenever that reverses,

• 33:33Patrick O'Shaughnessy?

  it could be a really scary proposition, you know, a run on the bank, grandma getting pissed off, or whatever. So, talk about, and maybe the answer is just, you know, regulation, heavy-handed regulation coming down the pipe, but talk about what you think might precipitate that kind of reversal in the, you know, relatively near-term future.

• 33:51Speaker 04

  Sure. So, I called that a run on the bank and I caught a lot of flak for it, including from Matt Levine, who was like, he was like, "Yeah, okay, great. It's like, people are selling, prices are going down, I don't understand what the point is. This happens with securities all the time." But I think the difference between your cryptosphere and something like shares in Apple or Amazon, the psychology of the buyer is very, very different when they're purchasing some cryptocurrency and they're purchasing stock in a company which is going to go in their 401K or something like that. The difference is that with cryptocurrency, they think it's money. With cryptocurrency, you show a dollar balance. And similarly with a, you know, with a brokerage account, you can also see a dollar balance, how much all the securities in it are worth. But I think that here, people are really looking at it more like, not more like securities,

• 34:35Speaker 04

  more like cash in the bank, which they're expecting to simply just go up in value. In some cases, there are anecdotal reports, which I expect are true, I have no reason to disbelieve them, that people are doing things like spending money on credit cards, for example, to go and, at 20% interest, to go and get exposure to the market. So, with that is our background. The thing that will freak people out is the thing that freaked people out, we haven't had one of these in a very long time, it's a run on your bank. So, if someone goes to Coinbase or somewhere else and there isn't someone on the other end of that trade, or there isn't enough liquidity to go and satisfy the withdrawal demand. Then what will happen is withdrawals will be cut off and people will panic. And they will say, hold on a second, oh, my God, I can't, I can't get my money out. And they'll try to move to whatever dwindling pools of liquidity are left. What could precipitate that?

• 35:19Speaker 04

  Potentially, an exchange getting taken down by a regulator is one thing which could do it. And there are some, I don't want to name names, but there are some suspicions about whether certain cryptocurrencies are being legitimately issued or some tokens which are meant to be backed by money. People are wondering, you know, where's an audit potentially that proves that those tokens are actually backed by the money that the issuer claims it is backed by? So in the case of Tether, just for example, they claim it's backed by $1.2 billion of fiat sitting somewhere in a bank account. But there's been no disclosure, basically saying that we in fact have $1.2 billion of cash sitting idly in a bank account somewhere, which would be rather a lot of money sitting idly in a bank account. So any one of those things could trigger a loss in confidence.

• 36:03Speaker 04

  We don't know when it could happen or how or from what, but those are just some proposals. And then, you know, this is a meme on the way up. It's going to be a meme on the way down. A change of expectations, a sort of reverse network effect or inverse network effect, which has, which pushes prices down. This can't go up forever. It's a mathematical certainty that this, that can't happen.

• 36:23Patrick O'Shaughnessy?

  I saw you writing about this just today or tweeting about it. There's something about this reverse network effects, which is a really interesting idea. Everyone, it's such a popular buzz phrase, especially in Silicon Valley, because positive network effects are so incredibly, it can be so incredibly valuable, can create such a moat around a product or business or service. So maybe talk about that idea of reverse network effects relative to these positive ones.

• 36:46Speaker 04

  Blockchain's a journey. That's a, I'm saying this sarcastically for your listeners. Blockchain, but it is a journey. It's a process where you first get exposed to something like Bitcoin. You have no understanding of it whatsoever. You then dive in because it's profoundly, it's an attractive idea. And then when you pair it up with, you know, trading and all those other things, it's very, very attractive. And for me, when I looked at it, I dove in headfirst because I'm generally quite pessimistic about everything, but wound up becoming quite pessimistic about it and started sort of deconstructing it. Tim Swanson was another guy who thinks along very similar lines. And so we became the early Bitcoin skeptics back in the day and so have been continued being so ever since. I think similarly for everyone else who's getting into the market now, they may be enthusiastic now.

• 37:31Speaker 04

  But the question is, what will turn their enthusiasm? Well, I can't spend the damn thing. It's not accepted anywhere. The value's gone down. It's cut in half. I couldn't get my funds out in a week. So there are going to be a lot of really disappointed people, just as we have been disappointed before them in the infrastructure that the cryptocurrency world is built. And so that could be something which, repeated hundreds of thousands of times, then creates something where people say, well, hold on a second. Maybe Monero is actually better. I like Monero because I like Ricardo, the guy who founded it. He sent me a rock hyrax, which is kind of a marmot-like creature, but a cuddly toy of a rock hyrax in the mail once. When a cryptographer asks you for your mailing address, like, never say yes, right? Because it's like, what are they going to do? Like, steal my identity? I don't know. It's like, what's your address, mate? I was like, okay, here's my address. And he said, okay.

• 38:16Speaker 04

  It sends me this cuddly toy. And so basically, Monero is the best ever since. Or like Zcash or something like that. Or someone comes up with something which is more scalable. I know of one project in San Francisco. I don't think I can name what it is, because I don't want to blow their cover, which is looking at more of a distributed way of running a blockchain. I know that IPFS and Filecoin, for example, there has been talk in the past of potentially mounting a blockchain onto the IPFS data store. So if you could do that, then you have one of the potential solutions to scaling, if that makes sense. I'm not technically astute enough to tell you whether that is or isn't the case. But those are some potential solutions. If someone does that and Bitcoin doesn't, or Ethereum doesn't, you could see a migration

• 39:01Speaker 04

  over to that, because suddenly you have something which is usable. Instead of downloading a 200-gigabyte client onto your computer, which takes four weeks to sync. So that's how those things happen. And I don't think people are quite aware enough that the software they're using is not well-written and not very user-friendly.

• 39:17Patrick O'Shaughnessy?

  Talk about stablecoins a little bit. This is something that you've written a lot about recently. It's a popular topic.

• 39:22Speaker 04

  I hate them.

• 39:24Patrick O'Shaughnessy?

  We know you hate them. We'll get into why. I think that the core underlying attraction of a stablecoin, or something that just has stable value like a US dollar might, is that you know you can conduct commerce with it, you can pay for stuff, you can use it as a means of exchange. If there was a cryptocurrency which had all the technological benefits and the digital benefits that a digital currency might have, but you could rely upon it to have some similar purchasing power this week as it has next week, that could be a really neat technology. So first, do you agree that that is something useful that we should... let's assume that a stablecoin was possible, which I know you don't think it is, but is that something that's desirable? First, I don't want to presume you think that, and then we'll get into why there are significant problems with this idea in your opinion.

• 40:09Speaker 04

  So I mean, it's possible for sure. We have electronic money today, which is redeemable against some deposit somewhere. And so it's electronic money. When you hold the thing, there is a deposit somewhere which corresponds to what you are, what you were spending. The idea of the stablecoin is that you can take... it's not... it's, again, getting back to this intrinsic idea. It's that you can take a cryptocurrency on which people are speculating, which has value because people are speculating on it. And then you can set up incentive arrangements around that speculation on the cryptocurrency, together with a price feed, which is determined by some computer external to the system, which allows you to peg the price of a certain amount of collateral in that cryptocurrency to whatever that third-party thing is. So

• 40:53Speaker 04

  it could be a dollar, it could be an ounce of gold, it could be something else. So basically, what you do is you set up a derivative contract of sorts where someone has a long position and a short position. And as the price of the underlying collateral pool moves up or down, someone either wins or loses on that trade. And then if it goes too far out of whack on the downside, it closes it out, and then you go and pay someone whatever, you know, whatever amount of cryptocurrency they're entitled to. The problem with this is, is that it's basically a perpetual motion machine, because you can't... you know, people say, "Well, perpetual motion, that's a criticism people make about technology." Well, no, I mean, it is a criticism. When you say something's impossible, you run the risk of someone who has seen a lot of technological development, or someone who thinks they've seen a lot of technological development and know what's going on, saying, "Well, no, you're just,

• 41:38Speaker 04

  you know, you're just being a Luddite, and you don't understand how things work, and you don't understand how technology advances." In this instance, it's not really a question of the tech, it's just a question of human behavior. And that is that the only way you can maintain those pegs is if people continue to buy the underlying asset which you're selling, which supports that price. If people stop doing that, then the peg breaks and the collateral will eventually erode itself. And that can happen for any number of reasons. It can happen because people have a loss of confidence. It can be happen because the team winds up and goes away somewhere else and goes to Tahiti with their ICO money for any number of reasons. So basically, the schemes are not sustainable, except under an environment of ever increasing prices, which is mathematically impossible. This hasn't stopped a bunch of bright young things from Stanford and Princeton from attempting

• 42:23Speaker 04

  this, but I think what I think the stablecoin is kind of, how to put it, it's late-stage crypto. It's a bunch of guys who've been trained to think you can unit test everything, thinking you can also unit test human behavior and predict with certainty all of the outcomes. The problem with that, of course, is that once you know that you're being unit tested and you know the rules of the game, you can go game it because we're self-aware. And that's what stablecoins, basically, that's that's their inevitable fate. So we saw this with BitShares a few years ago. You know, there was a stablecoin, they created it, within 100 hours, it fell flat on its face. Because no one had confidence in it, and so they started pulling their money out. And so they had to turn the system off. Similarly, today with DAI and MakerDAO, which is another stablecoin scheme, there

• 43:05Speaker 04

  was a loss of confidence in that scheme because of some event, we don't know what caused it, but I'm presuming it's some event extrinze or external to that system. So they said, well, we've built this wonderful little closed system that in theory works really well, but one trader was like, you know what, I don't want to play anymore. I need this money now and I'm not going to play along with this whole dollar price thing. I'll sell it for 70 cents, I'll sell it for 60 cents, really doesn't matter. Pulled all their money out and so the peg didn't hold. So it's it's this idea that, you know, you've got these bright young guys saying, well, hey, look, we can build the system, this computerized, automatic money system which works, without really understanding that the reason something has value is because people are looking at it, not because the algorithm says it should.

• 43:44Patrick O'Shaughnessy?

  Setting aside price and the market cap of these things and kind of the madness that that's happened in the last couple of years, sitting today and looking back to 2014, which is, sounds like when you got really involved, starting a company, what would you tell yourself? Now that you know about blockchains, that's most interesting from the perspective of you back in 2014. So what have you learned most outside of just the investment side and the speculative aspect of all this?

• 44:09Speaker 04

  I mean, the investment side is actually the thing I've learned most about. And that's chiefly that gambling is very, very easy to sell. So if I had to go back to 2014, I might have. I might have, I might have, I wouldn't have ICOed, but I might have taken some different positions than I, than I ultimately took. In terms of the tech, the adoption curve has been very slow. So it's getting something to production in, in, in this world is very, very hard. There are very few companies which are ready to do it. Generally, those companies are large banks. And then the sales cycle for those banks is agonizing. I mean, it takes a year, you know, just to get approval for a follow on from an initial prototype. So it's, it's one of those things which if I, if I could go back and tell myself what I was getting myself into.

• 44:53Speaker 04

  Maybe run a little leaner and a little quieter and wait until there's more budget available to do this. Because it's just, it's taking a lot of time because the technology is so different from everything that everyone's already using. And it's not really coming from it, at least until very recently. It wasn't coming from the main enterprise vendors. I don't think Oracle has a blockchain offering. I know Intel does now, IBM does, Microsoft does, Oracle does not, Amazon does not. So, and they weren't going to really jump if you walked in as a small startup and said, hey, why don't we just like go like redo your whole backend? You know, all these, all this stuff you've been using for 20 years and trust us, we incorporated last week, it'll be fine. So I think if I, if there were any lesson, it would be that, that it's gonna, it will take every bit of the 10 years. I think 2024, 25, it'll just be embedded.

• 45:38Speaker 04

  No one's going to notice that it's there, but it will take really every, every minute of those 10 years.

• 45:43Patrick O'Shaughnessy?

  Say a little bit more about that. So 2025, describe specifically what you mean by embedded and or ubiquity or whatever.

• 45:49Speaker 04

  So there are a couple of things which need to be fixed from a usability perspective. One of them is key management. There are no really good solutions. There are a couple. Ledger Labs is a fairly good key management solution, but it's focused primarily on cryptocurrency. Similarly, there are no really good, like outstanding user interfaces for DApps. Ethereum is there, but it's not great. It's slow. It's clunky. So the infrastructure just isn't there yet. We haven't really seen people starting to use this stuff as part of the core of their businesses. It's still a curiosity and a toy. That's not a bad thing. I think it was Chris Dixon, I could be wrong, who said, you know, it's a toy today, but that means, or maybe Chris Dixon or Fred Wilson, one or the other, they say everything that there is to be said, right?

• 46:30Speaker 04

  So it's a toy today, but it's still a toy. We're still not seeing someone saying, you know what? I'm going to go put real transactions for real money, for real customers, running on this system if they're a core bank or you're one of the globally significant financial institutions. So that's what we're not seeing yet, but we'll get there in due course.

• 46:50Patrick O'Shaughnessy?

  Let's talk a little bit about, we haven't talked explicitly about ICOs. You wrote somewhere that when you hear tokenization, you should really just replace that in your mind with cutting corners. So talk about your perspective on ICOs, which I think is almost universally negative, but why? Why it's negative? And if there are any positive aspects to this as a, let's call this a use case of cryptocurrencies, which is raising a lot of money really quickly with very few barriers.

• 47:13Speaker 04

  So I think the, without being overly pessimistic, I can be overly pessimistic online and on Twitter because there, you know, there just aren't enough characters and it's just more fun that way to get people riled up, you know, because I'm sitting there and someone's, you know, getting bent out of shape. I'll send them a marmot picture or something to just annoy them. It's great fun. So I'll try to be more diplomatic here. So with ICOs, I said, yes, it's cutting corners. What they address is a huge demand for higher yield investments. People have been sitting around on very low, you know, you can't get interest in a bank account in the United States. That doesn't happen. And people want to, they have an appetite for a little bit more risk. And so I think ICOs have addressed that appetite for risk. And that tells me that there's a market there, an addressable market, which

• 47:57Speaker 04

  could use blockchain technology as part of whatever solution you build to give people access to investments, to give them disclosures relating to those investments, to have a more direct way of communicating with an investor about an investment that they own and potentially, you know, getting them more involved with that investment. Because if you've got, let's say you've got a smart contract which says this is your share in whatever. You could go and consult that investor automatically about a shareholder meeting. You wouldn't have to actually go and summon them to the shareholder meeting in order to go through the motions and that sort of thing. So that's one potential way of looking at it. The reason I say it's cutting corners is because a lot of people are selling things which are designed like investments, which work like investments, which are treated like investments, but at the end of the day, aren't really

• 48:41Speaker 04

  investments. So I've seen a couple of like real estate coin this or real estate coin that, where someone goes, well, it's a real estate investment thing, and I'm going to go buy this house and I'll put it all together. So that way you get the return. Or the Dow, another prime example, this is a decentralized company. We're going to go invest in other companies. They're going to have their own tokens and you're going to get the return. And people were like, great, this is amazing. Let's go invest in the Dow. But if you looked at all the little moving parts between there, it's like, okay, I take the tokens, I put them into the Dow. There's no contract which says what happens. I just know that I get these Dow tokens back for the ether I put in. Then the Dow takes the ether I put in and it gives it to another company. Fine, that still works. That company issues tokens, okay, reward tokens. Those reward tokens capitalize back into the value of the Dow tokens. Didn't say how.

• 49:26Speaker 04

  There was no mechanism for some company that went and issued its own ERC20s to then go and capitalize back into the Dow tokens. It was just kind of like, oh, no, no, and that will happen. Magic happens because they've done it through the Dow structure. And then I go take that value, which is capitalized in my Dow tokens, and sell it to somebody else who wants it because decentralization, right? If you were a lawyer, you'd go, okay, well, you're paying money in here and then you're paying money there. And then this company does that. And there are certain rights which you're going to take in exchange for, let's say that company liquidates and there's a contract which says that when you liquidate, we turn around, we sell the assets. The proceeds of that sale go to this entity. Those proceeds are then distributed in accordance with this waterfall. So it ties all of the little pieces together and makes a coherent whole. That's how a legal transaction works.

• 50:11Speaker 04

  The Dow and a lot of the ICOs I've seen, they're cargo cult versions of, so it's the cargo cults of the East Pacific, what I'm referring to. Or after the Americans came in during the Second World War, some of the people who lived on the islands would go and build mock airways and planes out of bamboo in thinking that if they did that cargo would arrive from, you know, the people in the sky. So, so basically it's, and Richard Feynman called that cargo cult science. It has the appearance and trappings of science. It makes perfect logical sense, but it's missing something. It doesn't get to the essence of what you're trying to achieve. So similarly with the Dow and a lot of these ICOs, I look at it and I go, this is cargo called law. You are kind of brushing over the surface of what you're trying to accomplish.

• 50:55Speaker 04

  But I mean, you're kind of touching on it. It looks right. It feels right. You're selling it. People have, there's a little contract. They get a token. That kind of feels like owning a share. They can see what their balance is worth if they have it on Coinbase or whatever else. But if you then just kind of dust off the surface and look underneath, none of the machinery that's necessary and none of the work that needs to be done is actually there. So you don't have a mechanism by which, and that's, that'll come out. We'll, we'll start to see more of it as people start to get annoyed with ICOs that are non-performant. They'll say, well, hold on a second. You sold me this thing and there's actually no means for me to connect one and the other.

• 51:28Patrick O'Shaughnessy?

  No recourse.

• 51:28Speaker 04

  No recourse, no nothing. And so the, I think the SEC went after one guy, there was an emergency order a short while ago, who was doing real estate and diamonds. And I think they probably took, I haven't looked into it myself, but my guess is they probably took one look at what was going on and said, this doesn't, this doesn't join up. This doesn't make sense. And so there's a lot of that out there, starting with the Dow, which kind of got away with it. And since then, there have been a bunch more. And so we'll see more of that. But that's what I mean when I say it's cutting corners. You haven't done the necessary work in order to provide what you're purporting to sell.

• 51:59Patrick O'Shaughnessy?

  What are the conditions under which these things will be legally viewed as securities? So I think it's the Howey test. What does that mean? I've heard from a lot of proponents who are certainly pro cryptocurrency and blockchain technology. That they would love some opinion from the SEC and they'd love more regulation because it would remove some degree of uncertainty and allow people to really start building. So what do you think about the security label itself and kind of how it will come and when it might come for ICOs generally?

• 52:28Speaker 04

  So, subject to the proviso that I'm not yet a US-qualified lawyer and I'm an English-qualified lawyer, I will be very happy to, and this is not legal advice, I will be happy to talk about my understanding of that concept. So, just starting with the way things work in England, just by way of comparison, in England, there's a, they've incorporated a lot of European law, which tends to be big, long codes, which set out everything in full, as fully as they can. So they have a list of things and they say if it's not on this list, it's not subject to the prospectus directive and it's not part of this regime. And so I looked at the list in the UK and the FCA made some comments, basically the UK's equivalent of the SEC, and they said, "Well, we don't think a lot of these tokens are going to fall within that list and that regime." And I think they're right, because when you look down that list in England, try as I

• 53:13Speaker 04

  might, I can't see anything on there which tells me that a blockchain database with the genesis block that had some tokens which are retained by the issuer, and then the remainder are sold to people on the public, there's a big exhaustive list and that's not on it. So, it's not a security. It might be something else, there are all kinds of other representations that you make when you sell these things. You could say, you know, "It's going to go up in value to X and if it doesn't do that, then you're committing fraud," for example. So there's a whole bunch of stuff to consider, but that's how that works. There's a big list, cryptocurrency's not on it, not a security. The US has a slightly different regime, in that they have a common law test, so it's kind of mushier. And it asks four factors and it says, you know, "There's a scheme, is there an investment of money with an expectation of profit from, you know, the efforts of others in a common

• 53:57Speaker 04

  enterprise," basically is how it works. I've just mangled it horribly, but that's basically how it works. So, and if you satisfy those four criteria, based on subjective, objective, but also fact-specific analyses, then you may have something called an investment contract, which is regulated in the same way as a security. So with the Dow, for example, the SEC looked at that and they said, "It's probably going to be a security because," if we look at it, it kind of walked like a duck. Waddled around, it looks like a duck and it quacks. This is a duck, very clearly, because it behaves like one. So as a consequence, the test is deliberately mushy. I don't think the ICO companies really are going to get very much mileage out of asking the SEC to be more specific, because the test is not designed to be specific. It's designed to be general and vague.

• 54:40Speaker 04

  And I think that, you know, those are alternative approaches, the UK and the US. It's interesting to see, because our, so much of our legal system derives here, derives from the English legal system, those two differing approaches. But, that's, that's basically the difference. We have a mushy test in the States, and as a consequence of that, I don't think people should expect anything but mushy answers. And that's why the American securities lawyers, who I know, are really extremely careful when they're marketing, or when their clients are selling securities into the market. There are a list of exemptions, which, so, so, the consequence of being an investment contract is that either you need to have a prospectus, which you, which you issue, and then sell in accordance with the applicable regulations, or an exemption, a range of them, which don't really bear getting into here, needs to apply.

• 55:25Speaker 04

  And so, if you look at it from that perspective, American securities lawyers are really, really careful about either, okay, we need a prospectus, or we're going to stay very carefully within this very well delineated statutory exemption to that prospectus requirement.

• 55:38Patrick O'Shaughnessy?

  I realize I should have asked you this before we started. I'm curious if you now or have ever personally owned any cryptocurrencies?

• 55:45Speaker 04

  I have. I owned a very small amount of Dogecoin, which I sold, so, a while ago. And that's it. And there's a reason for, more interestingly, I was offered 13,000 ETH from the pre-mine, which is now worth about 16 and a half million dollars. And I turned, I turned it down on the basis that it would compromise my professional independence, as, well, for two reasons. One, at the time, the company, my company was competing with them for mine share, so it didn't really make a whole lot of sense to go and, you know, take free coins. And two, I was, had an inkling then that I would probably have a big problem with ICOs later down the line, as I do now, and I don't think I could really make a coherent argument. I don't think, I don't think I could turn around on the one hand and say, I've been

• 56:29Speaker 04

  made rich by ICO coins, and then on the other say, but I think ICOs are bad. So, to answer your question, no, I don't really, I don't play. And, and ultimately, the objective is so that, the objective of doing that is that, you know, when you ask yourself in cryptocurrency, what role do you want to play, right? Some people are traders, some people are economists. Some people start businesses, some people are boosters and you know, community managers, some people are lawyers. And I made, I made a decision, you know what, I'm going to be one of them. And in order to do that best, or do better than the others, the way to go about it is to be professionally independent and to give advice based on your clients' needs rather than your own financial interests. There's some lawyers who don't do that, and I think I'm a little uncomfortable with that, but that's why.

• 57:12Patrick O'Shaughnessy?

  With that as a backdrop, what has you most excited, let's say, a couple of years from now? I think it sounds like you might remain mostly on the sidelines until some of this mania has passed. But if you could design it perfectly, what would your involvement be from a legal standpoint or otherwise, once this thing kind of settles in?

• 57:30Speaker 04

  So I think there, there's some interesting stuff going on in the broker dealer space. There are a lot of people who are looking at ICOs and saying, you know what, the infrastructure that's being built here is actually more effective and cheaper and faster than the sort of paper-heavy infrastructure we've been working with previously. So there are, there are companies who are looking to see whether this crypto infrastructure, although it takes some shortcuts on the legal side, they're also taking, it's total reimagining of how you should move value around and how you should transfer title to property. So as a consequence of that, there are things about it which are much more efficient than, than the way we did things before. The idea that, for example, let's look at a, let's look at a bond transaction, right? So a bond transaction has probably five or six banks

• 58:13Speaker 04

  involved, maybe, maybe fewer, maybe three, a bunch of law firms and a bunch of bondholders. And currently, the way that they figure out what the state of play is, is each of them has a paper copy of a big document, which we refer to somewhat offensively as a transaction bible. And you go and get the bible and you see all the deeds of amendment and you see what the state of play is, and you have to go track it down because it's in document storage somewhere in East London, you know, it's a building somewhere. And then you figure out what, what's going on based on going through a couple of reams of paper and then checking, you know, records on Bloomberg, some printouts like that. There is absolutely no reason whatsoever that shouldn't be on a blockchain, which is running between the various transaction parties. So you can see the exact state of the documents, how they've changed over time,

• 58:57Speaker 04

  what the state of the payments are, whether a payment waterfall has been triggered or not, whether a certain event has taken place or not, what the rating is of that instrument and how that interplays with your waterfalls. So there's a whole bunch of things that you can take that process and make it very, very simple and much quicker to refer to. As a consequence, so let's look at it from the perspective of the various parties. The banks, when they're sending notices, that becomes easier. So that's automatic and very, very straightforward. The law firms who will be administering that, you know, those documents in that process, their clients aren't paying $2,000 for some junior associate to look through reams of paper, you know, for a day and a half in order to, you know, figure out what the state is of clause three of the trust deed or something like that.

• 59:38Speaker 04

  So that's introducing a lot of digitization into areas which have not been digitized. So that kind of stuff where you just have the ability to pull these things up and in addition, you have a really good, so this is really the most important thing. You have an outstanding chain of evidence, which, and that's what law is about, right? You have to go prove that something happened at a certain time, in a certain way, and you've got consent in a certain way, which is why we sit around and shuffle paper and get people's signatures and make PDFs and make 20 copies of them and circulate CDs. It's a nightmare. So I think all of those kind of old world procedures are very much overdue an update. And that will happen within the next 10 years is that someone is going to say, okay, well we have a service, it'll probably be a law firm to be honest with you, that will turn

• 1:00:20Speaker 04

  around and go, we have a service that we offer where it's digital, it's faster, it's cheaper, you don't pay for as many billable hours, and we manage the ongoing lifecycle, the transaction for you, so it just goes and ports straight back into your back office as you like. So things like that, or there's another project, Utility Settlement Coin, which a bunch of banks are doing in London, things like that, I think will be incredibly valuable to the ecosystem.

• 1:00:41Patrick O'Shaughnessy?

  Can you describe that in a little more detail?

• 1:00:42Speaker 04

  So Utility Settlement Coin is a project between four or five different banks. I haven't heard anything out of it in a while, but basically it's four or five different banks who said, let's do our own distributed ledger where we settle transactions among each other and we have a coin which does it. So they took the theory that they do a lot of business with one another and so they said, well, you know what? We're just going to have a coin which does it so that way we don't need that third-party service provider or whoever else we're using to do it. Similarly, you could take, you could think of something like, I don't know, HSBC and Citigroup do something like 35% of their FX business with each other. So they could turn around and say, you know what, instead of, instead of doing this the way we're currently doing it, why don't we just have all of our trades running on this one chain between us? We have perfect visibility or we're, because we're entitled legally to see what's going on between us.

• 1:01:25Speaker 04

  And that way, we make our record-keeping on either side of this a lot easier.

• 1:01:28Patrick O'Shaughnessy?

  Is that kind of what Ripple maybe is proposing to do between banks? Where the insight here is basically, look, this kind of indelible, well-protected database is a great way, if we're doing constant exchange of value, for us to do this and just get away with all this, all this lousy old infrastructure? Am I thinking about that right with Ripple?

• 1:01:49Speaker 04

  Not XRP, but Ripple, yes. My understanding of what their inter-ledger business was, was that exactly. And so my understanding of most of what their bank business is, is based around the inter-ledger. I mean, I don't work there, I don't know what it is.

• 1:02:01Patrick O'Shaughnessy?

  Sure.

• 1:02:01Speaker 04

  But that's, as a market observer who has a reasonably good idea of what's going on, that was my understanding of what that was for. XRP, totally different kettle of fish, speculative mania, all that. So that's a very separate issue.

• 1:02:13Patrick O'Shaughnessy?

  So you have to describe a little bit about why the constant returning to marmots?

• 1:02:18Speaker 04

  Marmots. So marmots. Marmots are actually my superhero origin story. So I was about 12 years old and we had this issue with woodchucks in our yard. They were everywhere, they were digging holes and everything.

• 1:02:31Patrick O'Shaughnessy?

  Where'd you grow them?

• 1:02:32Speaker 04

  Connecticut. So eastern Connecticut. So we had these woodchucks that were digging up everything and I was handed a rifle and told to do my duty. And after waging the briefest of wars with these adorable little critters, I just decided I couldn't do it. And they kind of became my spirit animal as a consequence. That then became an in-joke in my early days at Monax, which was at the time called Eris Industries. One of the three co-founders is a quantum mathematician. And he and I, he was trying to explain quantum information to me. And I was like, I don't, what is this superposition? And everyone understands it now because there are enough YouTube videos. But nobody understood it back then. That was ancient history. And so he tried to explain it in terms of giving a cookie to a marmot because he knew I liked marmots. So he said, well, you're giving the cookie to the marmot, you're not giving the cookie

• 1:03:16Speaker 04

  to the marmot, you're giving it to the marmot and not giving it to the marmot, and you're doing neither at the same time. And I was like, well, this makes perfect sense. And so if you explain things in marmot terms, I can understand software. This is perfect. So anyway, it just became an in-joke. It then spun wildly out of control. And I decided to persist doing it despite the fact that it drove people crazy. It drove my investors crazy. It drove the market crazy. It drove people on Twitter crazy until eventually they broke and they started liking it. So that was my, that was my objective there.

• 1:03:43Patrick O'Shaughnessy?

  If you could have everyone out there that's, you know, you mentioned that blockchain is a journey. And that's a really good way of putting it. I certainly went on it where its initial appeal, just the different angles that you can explore behind it are, seem endless, right? It's just endlessly fascinating topic. So it takes a long time to even understand what the hell it is you're looking at. But for those out there that are, let's say, earlier on in that journey, are there any reference materials, whether it be a post, a book, an idea, a person, a YouTube clip, it could be anything, that you think might be most just generally valuable?

• 1:04:16Speaker 04

  No, there aren't because there aren't. I wouldn't, I would say there really aren't any reference sources which are valuable because the important thing, the important thing when thinking about blockchains is knowing your business extremely well, knowing what you do backwards and forwards, and then asking yourself a very simple question. What does a distributed system that everyone can read have to do with what I'm trying to accomplish here and does it make it more efficient? So, and that's really, it's really that simple. So you can go and dive in and read 100 different books by 100 different authors, most of whom have no idea what they're talking about and have not built, deployed, or designed a single blockchain system in their entire lives, and they'll sit there and tell you how it's going to revolutionize everything.

• 1:05:00Speaker 04

  But fundamentally, the skeptical view of this is to say 99.8% of what's going on in blockchain right now is garbage. And the 0.2%, which isn't garbage, is when someone understands their use case backwards and forwards and they've figured out why they want a distributed system there. For me, as a lawyer, that is the automatic transaction bible. Makes perfect sense. I know it very, I know the space very well. I've said, you know, this is an idea which potentially has, could get some traction in 10 years. There are people in supply chain, Leanne Kemp of Everledger, she understands diamonds backwards and forwards and she said, you know what? A distributed system automates these relationships really well.

• 1:05:39Patrick O'Shaughnessy?

  Can you describe that in a little bit more detail? Maybe, I don't know if you know the particulars of that diamond example, but supply chain's something that my ears have been perked to that. It started to come up more and more as an interesting use case for this. Maybe describe why that's interesting.

• 1:05:53Speaker 04

  Apologies to Leanne if I mangle her startup, but my understanding of whatever Ledger does by way of, so supply chains are, are supply chains. Generally, supply chains are, you've got a box of something and it's got to get passed through a dozen different hands before it arrives at your doorstep. You want to know at every stage what's happened to it, what the condition of the thing is, because what you're getting and what you're liable to pay for depend in large part on, on how it gets to you and in what condition. So it's important to track what's going on with things as they move through the, the stream of global commerce. Everledger in particular looks to diamonds in that diamonds apparently all have registration numbers and they can be identified by reference to size, you know, light characteristics,

• 1:06:35Speaker 04

  you know, refraction, whatever, some scientific magic I don't understand. And sometimes people claim, because they say, oh, well, my house was broken into and my diamond was stolen, or diamonds actually do get stolen. And then they turn up later at some shop down the road and they get resold again. So Everledger, my understanding is that it's a database which is designed to link up the police, the shops and insurers so that you can figure out if someone has made a claim against a diamond and they said, well, you know, I've lost my diamond. Okay, we'll pay out $6,000 to you. Here you go. Go away. Two months later, the same thing turns up in the shop. You go and you interview the shopkeeper who brought that in. Well, it was Joe Blogs's wife who brought it in and it turns out she was the one who made the original claim. You do that and you reduce your insurance fraud.

• 1:07:18Speaker 04

  So it's a way that you can spread that out and make sure everyone's looking at the same data, which is verified and they say, well. I've identified that this diamond was, you know, it originated here. We can track where it went. And in addition to that, we know if it's been stolen, someone can report it stolen, and we can go and put a black mark against it. So we can track what happens to it when it turns up later on down the line. So it's a way of getting better information about what's going on in the supply of diamonds in a particular place, so that you can avoid insurance fraud. That's my understanding.

• 1:07:47Patrick O'Shaughnessy?

  Why is it being distributed? An advantage there? Why couldn't that just be a central, you know, data provider?

• 1:07:54Speaker 04

  Primarily political reasons. Nobody, so if you have a central data provider, my experience with the banks is that that really bothers them, that you're, basically, that's just a cloud service. So what they would rather do is they'd rather say, you know what, there's a, there's a bit of public information which everyone is entitled to in this consortium that we're running. And so in order to achieve sort of equality of arms, we're willing to share that data, as long as we have a stake in operating it. But if, for example, let's say Deutsche Bank said, you know, we've just built this new platform called Deutsche Note, and we're going to go run all of our transactions through it. And guess what, guys? You can outsource all your stuff to us, too. Well, you know, Bank of New York is going to look at them and go, no, absolutely not. We're not letting you run the system because then you have all of the power. But at the same time, they

• 1:08:37Speaker 04

  still have an interest in coordinating their activities. So it's, it's really political more than anything else. How do you get two organizations to trust each other over information that they're passing back and forth very frequently, without having the issue of one of them being responsible for all the infrastructure?

• 1:08:50Patrick O'Shaughnessy?

  So if you're firmly in the bear camp on, let's say, the investment prospects of, of the various cryptocurrencies, but you had to identify someone that you would think of as in the bull camp that you respect or you think is thoughtful?

• 1:09:02Speaker 04

  Ari Paul.

• 1:09:03Patrick O'Shaughnessy?

  Ari.

• 1:09:04Speaker 04

  Yeah, hands down. One of the more thoughtful guys I've met, he, he knows what he's doing. And actually, surprisingly, a buddy of mine from, from high school, a guy named Chris Dannon, I had no idea.

• 1:09:17Patrick O'Shaughnessy?

  Oh, sure. The Ethereum, he wrote the Ethereum book, right?

• 1:09:19Speaker 04

  Did he?

• 1:09:20Patrick O'Shaughnessy?

  Yeah, I'm pretty sure he wrote a book on Ethereum, yeah.

• 1:09:22Speaker 04

  Yeah, so he knows his stuff. And we crossed paths like about eight or nine, almost a year ago now. And I was like, dude, what, what, like, seriously? What? And, and so, yeah, Ari and Chris both know what they're doing. So I'd say in the bull camp, those are the two guys I'd point to.

• 1:09:35Patrick O'Shaughnessy?

  So a good, a good almost bow tie on this whole conversation because Ari was the guy that kicked off my entire journey here. Everyone listening will know that because he, he and his partner Matthew at Block Tower are the two that basically queued up my whole journey, right? So introduced me to everyone that I should talk to. So it's been, it's been fun to do that with those guys. The closing question that I ask everybody is for the kindest thing that anyone's ever done for you.

• 1:10:00Speaker 04

  Kindest thing anyone's done or said for, said for me was a friend of mine in New York City. When I left Monax sort of earlier in the summer of 2017, a buddy of mine sort of was like, I was, I was a bit disappointed about the circumstances of my departure. And one person, who knows who he is, kind of shook me out of it and was like, dude, get it together. Like get writing again. And this is before I hadn't blogged anything. And you can tell when I'm in a bad mood because I haven't written anything in six months. And so I was like, dude, get it together. Like whatever. And we went up to Pork Fest in New Hampshire, which is a libertarian sort of anarchist festival and had a great time. And yeah, I would say that person is, is the one who that shaking me out of my, or getting me back to my senses. That's the nicest thing anyone's done for me in the space.

• 1:10:45Patrick O'Shaughnessy?

  Well, this has been a refreshing kind of counterpoint to most of the other explorations I've done of cryptocurrencies and blockchains really illuminating. So thank you very much for your time.

• 1:10:53Speaker 04

  Thank you. Pleasure.

• 1:10:56Speaker 05

  Hey, everyone. Patrick here again. To find more episodes of Invest Like the Best, go to investorfieldguide.com/podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com/bookclub. After you sign up, you'll receive a full investor curriculum right away and then three to four suggestions of new books every month. You can also follow me on Twitter, at Patrick underscore Oshag, O S H A G. If you enjoy the show, please leave a quick review for us on iTunes, which will help more people discover Invest Like the Best. Thanks so much for listening.