The SEC Declares War on Crypto with Ryan & David

Transcript

bankless Nation I hope you're doing well we spun up this episode in a hurry for you this topic evolved late last week David it feels like the SEC has declared war on crypto staking is not a crime or is it I don't even know anymore with respect to what the SEC is doing what are we going to cover today and who do we have on as our guest yeah not just the SEC there is an entire cross-governmental agency coordinated effort to really apply pressure to the industry across many different vectors uh what is going on we're bringing on Mike selig who is going to it's the second time on Bank list this is the first time we uh he uh perfect timing at the end of December called 2023 the year

of Regulation yes and we are now just six weeks later and here we are uh and so perhaps he called it and so my first question to Mike is going to be uh is this what you expected uh but overall we're just going to get a lay of the land and now that we have more insight into what the SEC is up to along with all the other agencies that are also showing face showing Force what is going on and what yeah I mean this last we left you guys was the roll up which we recorded Thursday and um there was rumors that maybe the SEC was going to say something about staking and they did more than say something since we've recorded our last episode on this subject they actually went about and banned uh staking on Kraken like what's

that about we're gonna talk about that and then also paxos their B USD stablecoin it's under attack so not only staking um also stable coins staking stable coins under attack by this house stable coin a security is a good question that I'd like to know yeah it's the fifth prong of the Howie test does Gary Gensler hate it uh you gotta check that box and see if he does well anyway we've got to explore all of this today and give you guys an update on what's going on speaking of updates David I want to thank our friends and sponsors at metamask learn for building this phenomenal product for onboarding people into web 3 and crypto it is called metamask learn that is learn dot metamask.io to go check the this out David what's on my screen what are we

looking at here so yeah manifest learn is a brand new educational and entertainment platform it's an entertaining platform designed to get you immersed into the world of web3 so of course you will go through the onboarding flow of what is web3 what's a crypto wallet how do I set up my crypto wallet what does it mean to do self-custody what is digital identity starts to unpack some of these very very big questions uh to help get people onboarded into the world of crypto so maybe you are just beginning your crypto Journey maybe uh your parents are annoying you trying to get you to onboard them into crypto if you are so lucky to have parents like this but metamask learn is the place to send them either way so like Ryan said

learn.mask.io there is a link in the show notes to learn all things important about web3 this is uh the Khan Academy for crypto so go check that out guys um all right David um maybe tell listeners what they can expect to hear from Mike in this episode what should we be looking out for yeah so for every single topic there's been a number of topics that are all announced announced revealed in the last like week or so there is SEC versus Kraken what about Kraken staking product really triggered the ire of the SEC there's there's the SEC versus paxos why did whatever paxos is doing with binance stablecoin why did that trigger the irf the FCC then there's the rest of operation choke point which involves

just Senate Banking Committee uh the treasury like all of these different cross-governmental organizations overarching the bite Administration why are they why is this all happening at once well is this the end of the onslaught or is there another barrage coming so these are all the angles that we are going to talk about just to be informed about like all right this is we're six weeks into 2023 is this what the rest of the year is like or is this what a brutal year yeah like why do they hate us so much I don't understand we'll ask Mike that question too guys we're going to get right to the episode but before we do we want to thank the sponsors that made this episode possible including Kraken our recommended exchange for 2023. I guess you can't stake there if you're in the US but you

can in Europe you can't interact with Mike about that we'll be right back Kraken has been a leader in the crypto industry for the last 12 years dedicated to accelerating the global adoption of crypto Kraken puts an emphasis on security transparency and client support which is why over 9 million clients have come to love kraken's products whether you're a beginner or a pro the Kraken ux is simple intuitive and frictionless making the kraken app a great place for all to get involved and learn about crypto for those with experience the redesigned Kraken Pro app and web experience is completely customizable to your trading needs integrating key trading features into one seamless interface Kraken has a 24 7 365 client support team that is globally recognized Kraken support is available Wherever

Whenever you need them by phone own chat or email and for all of you nfters out there the brand new Kraken nft beta platform gives you the best nft trading experience possible Rarity rankings no gas fees and the ability to buy an nft straight with cash does your crypto exchange prioritize its customers the way that Kraken does and if not sign up with Kraken at kraken.com bankless how many total airdrops have you gotten this last bull market had a ton of them did you get them all maybe you missed one so here's what you should do go to earnify and plug in your ethereum wallet and earn if I will tell you if you have any unclaimed airdrops that you can get and it also does poapps and mintable nfts any kind of money that your wallet can claim earnify will tell you about it and

you should probably do it now because some airdrops expire and if you sign up for earnify they'll email you anytime one of your wallets has a new airdrop for it to make sure that you never lose an airdrop ever again you can also upgrade to earn five premium to unlock access to airdrops that are beyond the basics and are able to set reminders for more wallets and for just under 21 a month it probably pays for itself with just one airdrop to plug in your wallets at earnify and see what you get that's e-a-r-n-i dot f i and make sure you never lose another airdrop banklist Nation I want to introduce you to Mike selig who's the council for the digital asset Department over at wilkiefar and Gallagher an international law firm based here in New York City and Mike has been on Bank list before not

talking not too long ago talking about the year ahead for crypto regulation and at the start of this year Mike you wrote an article where you said in the year ahead the SEC and the cftc will likely push the boundaries for the of their existing authorities through novel enforcement actions um Mike we are only six weeks into 2023. is this what you thought would happen is this is this the Playbook that you thought would be coming you know it it's a little bit more coordinated than even I anticipated I think you've seen um actions by the cftc the SEC treasury um within Treasury fincen and ofac evaluating the stuff State Regulators like the New York Department of Financial Services there's a clear uh coordination of efforts amongst the

regulators and and that's a lot more than even I expected here so to really kick these things off uh where there's operation choke point which is not a really an official title that's the title that the community has come up with it's inter governmental coordination that's really all seemingly happening at once but we want to talk about the details on on some of the the intricacies starting with the SEC um SEC and staking is staking now illegal or what are the nuances here do I have to go to jail if I run a validator right so uh the SEC came in with a a settlement with Kraken uh Kraken agreed to pay a 30 million dollar fine to settle with the SEC uh what is exactly

the what did the SEC charge Kraken with and can you just help us unpack this yeah yeah and just first of all to all the anons out there I'm not your lawyer and nothing I say is legal advice today um so what's going on with with Kraken and staking first of all the SEC is not saying that all forms of staking are securities yet they might we'll see but today uh the focus is on these staking programs offered through centralized platforms here Kraken and all of this was settled uh between the the agency and Kraken and so none of this is necessarily law um it's not binding precedent uh Kraken chose to to settle here um but but others may not and so even custodial staking programs May uh be outside the scope of the Securities

laws is just a settlement but what's Happening Here is the SEC is glomming on to centralize custodial staking programs and what happens in these programs is somebody wants to to stake either they don't want to run the software themselves and and stake directly through the um deposit contract maybe they don't have 32 each they decide to go to a custodial provider um hear Kraken uh their crypto assets to crack in or they buy crypto assets on the exchange cracking pools those crypto assets uh and then deposit some of them mistaking uh contract and others it held in reserve and so the SEC is really focused on this this program the pooling of the assets together and providing a return to the to the Staker the return

is not necessarily the same return you would get if you staked directly uh Kraken published a return amount and that could be higher or lower at times than the actual amount that you would earn by staking directly and the rewards are more consistent because if you've got a big pool of crypto assets that you're staking you're going to get rewards much more often not necessarily higher rewards um and in fact the rewards very well could have been lower because if you're staking directly you don't pay fees um but the the idea that there's some crypto assets that don't get staged Krakens potentially managing this reserve and then providing instant liquidity so you don't have the bonding and unbonding periods that you would have and with ethereum you know you can't withdraw until until we get the unlock and so uh just some of the

mechanics look a lot different from staking directly or even liquid staking um and and that's important but not every crypto custodial um staking program is necessarily even comparable to this so you could have a program where you have a state license money transmitter so most of these exchanges and custodians are licensed at the state level they may hold a trust Charter which we'll discuss the making stuff later or they might have state money transmitter licenses and they register with binson as a Money Services business they have the ability to move funds on behalf of customers and so if you deposit crypto assets with one of these third parties they move the funds and there's a deposit contract for you stake it for you they're really just routing

funds to another person or location and that's kind of within the scope of what these guys do like a PayPal or a venmo um so so that direct model is a little bit different than this pooling type model where you have some held back some staked you know a promise fixed return and then of course the SEC is very focused on marketing and so they didn't like some of the marketing language promoting a fixed return promoting you know the expertise and security of the validators operated by uh Kraken here so whether any of this is really fair game or or right within the sense of the Howie test and the law um these are the arguments the SEC made and crack and chose to settle here I um I I guess I want to ask you a few

things about this Mike what's like one is uh in the manner by which the SEC is sort of rolling this out um and this was the uh the video that um Gary Gensler put out and uh has uh his like classroom with Gary um is actually the title and um like this is this is Gary explaining staking to us um with some nice background music and you know it's hilarious that it's actually a picture of a steak as in meat um office hours with Gary Gensler um the way this was approached is very interesting to me so um it was focused on Kraken there was the settlement but what's interesting about the approach is like they didn't like ask Kraken to sort of re-register

or uh tweak certain things and then come back to them it was sort of a flat out you can no longer do this and then a settlement by Kraken I tweeted this under Gary's like you could have mandated proof of reserves required staking transparency supported decentralized staking instead we got another Gary G bandhammer to the head that's really what it's felt like from the crypto industry is this typically the way the SEC kind of rolls out its um what if what you'd call this um penalties or or like prohibitions or is this somewhat unique to this particular case and and to the crypto industry the SEC has the power to both issue

rules and to reinforcement actions these are the two ways that they regulate in most contexts with a new technology a new type of financial product the SEC has open meetings where the industry can come in talk to The Regulators uh work collaboratively with the industry uh they propose rules industry comments on those rules and then they get finalized the SEC rather than engaging with this industry you know under the current Administration is putting out influencer YouTube videos comparing proof of stake to stake um putting out enforcement actions sending Wells notices to everybody really trying to diminish the industry and it shows that they don't at least this Administration doesn't

view it in the same way that they view the asset management industry more broadly or view private Equity or hedge funds they're looking down on the industry putting out office hours with Gary as if this is child's uh you know child's Finance you know Matt Levine's calling it you know fake you know a toy economy of crypto and I think that's really the messaging that they're pushing and so rather than engage and have real hearings and open meetings on this stuff they're just going to bring lawsuits and try and Sue everybody and the industry is probably going to push back Mike the feeling of this video was just patronizing AF like that's what I felt like you're explaining staking to people who have ether staked inside of Kraken as if we don't know anything and

we're just yeah gullible dumb investors you know and like you're trying to teach a classroom um I I don't understand the patronizing approach is that is that a vibe that um he's going for do you think or is this just like how he views the industry What's Happening Here yeah I think that I think this is the the Gensler Vibe I think this is what he wants to do right he wants to delegitimize and minimize the industry whereas what we saw with the Clayton Administration which a lot of us were frustrated with right during the Ico years and the the token sale years where there were so many scams out there so it was it was somewhat reasonable but there were a lot of legitimate companies trying to sell tokens and build in the space and we were frustrated with the

the lack of clarity and guidance but they pulled out a framework they've put out um guidance on on various items um they put out um which we can talk about later something on stable coins which is helpful here um with respect to other things that are going on with against Administration but there's really just been from this Administration a condescending attitude and if you come in you walk out with a subpoena it's it's not the same uh I was talking to someone earlier about going into meeting with the SEC you can't really do that anymore because you walk out with a subpoena or you get Wells and it's just not a friendly uh environment to operate just a quick definition for us what does getting Wells mean so a Wells notice is essentially the the

beginning of an investigation by a regulator such as the SEC or the cfdc they send you a letter that says we're considering bringing a full investigation an enforcement action where we're going to seek civil monetary penalties and other um relief and tell us why you don't think we should do that and they give you a period of time to respond and this current SEC is not giving a whole lot of time to respond and the cfdc frankly is not either and so there's this hurry up and and settle with us attitude um and they're they're wellsing a lot of these crypto industry participants so they're collecting a lot of information and really trying to find uh pressure points really trying to find points of centralization you know we talked about my article

um that I wrote last year kind of on the predictions for this year I think it I predicted that it would be a year of central as a decentralization versus regulation where the the crypto protocol developers are really looking to find ways to decentralize aspects of their products same with even centralized platforms incorporating things like MPC and D5 and web3 into their platforms to further decentralize their offerings so that the SEC can't point to these kind of centralized points of failure like they're doing with with Kraken and some of these actions there's a tweet here on screen that I uh this conversation has reminded me I I saw not too too long ago this is from Jason Gottlieb Gottlieb uh he says I find the sec's all crypto

projects have to do is come in and register line unbelievably insulting it assumes that there's this vast quantity of sophisticated Securities lawyers who are advising their crypto clients nah man screw the SEC YOLO baby and do whatever you want and this is the communication that Gary Gensler and the SEC have put out there it's like oh you are free to come in and be compliant with us uh which is just taking the voice out of so much of the crypto industry and saying that like oh it's it's simple you just come in and do this process and I'm my my skepticism hat is like oh Gary Gensler is putting on a show he's putting on a face for the rest of the world to say like oh the right the wild west of the crypto world isn't

doing what we're asking and coming in and complying meanwhile there are very smart very talented lawyers in the crypto space who see the predicament that we are in and like and it is not matched by the the language out of the SEC I'm assuming Mike that for your conversations with lawyers all over the space that ever this is kind of a consensus View yeah absolutely I mean I work with the former chair of the cfdc um worked with him at the cfdc when he was uh commissioner you know we have credible people in the room trying to work with The Regulators um there are Commissioners at both the SEC and cftc the commissioner Hester purse commissioner Caroline Pham that want this stuff to to move forward want rules want reasonable regulation

um but it's very difficult to uh you know Gary Gensler said on CNBC the other day you just come file a form it's on our website and Jesse Powell tweeted about it like yeah that's exactly why we have a 30 million settlement here because it's not that easy to just file a form um none of this stuff works within the existing Paradigm for Securities regulation which is kind of what we talked about the last time I was on and without exemptive relief and changes to some of the market structure we're not going to be able to have uh crypto within a Securities framework it's just going to be equity on you know Equity Securities on a blockchain Okay so we've hammered out the SEC has a bias against the crypto industry details like that's kind of no surprise to people I want to actually go back to the

to the cracking case specifically because you talked about in the ways that all of the Kraken staking product was different from just raw protocol staking can you talk about just like the line that uh the line that was drawn by the SEC that differentiated Kraken specific flavoring of staking versus like uh I think you'd like differentiated it between liquid staking just talk about the nuances about like what the SEC specifically was going after here and how Kraken staking was different from just any other centralized staking as a service provider yeah absolutely so staking directly is is the cleanest form and that you're on ethereum pulling together your own

32e sending it to the deposit contract staking it directly um you accrue your staking rewards the rewards are generated by the ethereum network they don't come from any sort of third party or centralized intermediary um it's it's very similar to you know on a proof of work chain you earn rewards and the same kind of programmatic fashion um so the SEC hasn't really cast any thought on on directly staking or running a proof of work node or any of that um I want to also be clear so that includes running your unvalidator from your house right direct to protocol um does that also include using some sort of decentralized staking service like uh maybe a rocket pool in the

future Lido have they weighed in on that at all so the SEC is not made of you um public on on any of that I think that is the next step right so we feel most comfortable with staking directly liquid staking and Rocket pool and Lido and others like um liquid Collective these other types of of staking methods uh you know the SEC is not weighed in on but they're much closer to staking directly than staking through any centralized custodium because everybody is putting their eat together in a single smart contract there's no person running a program or collecting that Ethan and saying oh some of these are going to be staked and others aren't and and even if that were to occur with respect to the

programming of the smart contract it's all open source there's there's no information asymmetries the code's out there it goes into a smart contract you get your receipt token and we should be calling these liquid staking tokens instead of liquid staking derivatives that's another point they're not derivatives um but you put your token into the the smart contract back you receive your receipt token and those uh crypto assets that were that are in the smart contract get Associated uh delegated to a validator node um and they get State and you get your rewards from the ethereum network they're passed on to your receipt it looks a lot like regular staking it looks similar to you know if the three of us got together and like we don't have 32e let's pull our youth together um run a node and stake it together and

that's the idea with these liquid staking protocols as opposed to some centralized program where there's other features and I think it's important to note that in the sec's complaints against Kraken they compare kraken's program to staking directly they say that there are these other features that make an investment like that bring up within the scope of the Howie test that uh presumably staking directly or even under um liquid staking protocol but you don't have all these other features um and an important Point here as well is that there's terms of use there's terms and conditions associated with the central platform where you're staking through a program and depending on what's in those terms of use as the SEC pointed out in this instance uh with

Kraken the term said that kraken's creditors could encumber the assets so it looked a lot more like what Gemini is being investigated for uh What uh block 5 was offering uh next so some of these other lending Pro uh programs where users put in assets they're kind of pulled together they may be deployed in whatever way they're deployed but you earn a return on that um and I think in staking from a policy perspective and from just a reasonable person's perspective the two are not the same um some of the features on top of staking are almost not the essential managerial efforts that you would look to the rewards are still coming from the network and so the SEC should be more

focused on these instances where they're being thrown into 3ac and into other you know speculative uh projects as opposed to being deposited in the the ethereum smart contract and receiving rewards it might to be clear other centralized exchanges offer staking as well I mean maybe notably um coinbase um that is custodial staking in the in similar ways that Kraken is why it wasn't uh coinbase why doesn't coinbase have to shut down its staking program right now you know the facts and circumstances of every program are going to determine what the you know whether the SEC views it as a security or whether it meets the definition of a security so without you know speaking to any particular program it's really hard to say and we don't

know what the SEC is looking at frankly uh behind the scenes but every program is different the terms and conditions are different for every program I think it's important if there is a you know a staking program that you look to the terms and conditions and if you have legal and beneficial ownership of your crypto assets and they're just sported on to the protocol uh for staking and you can pull them out at any time there's no features that make it investment-like there's not a reserve of tokens all these features that the SEC focused on and crack in um that can be used as a checklist and framework for evaluating other programs but it's not to say that that you know Kraken chose to settle this you know it's not law it this is only an out of an out of court settlement this is

what's confusing confusing to me so I I think like staking Revenue at least because we could we can track this for coinbase was like 13 percent of their revenue last year or something right it's like that's a lot of money for centralized exchanges so um one it's just you know point of evidence that that coinbase is still operating a staking uh service in the United States has not has not shut that down has not been required to shut down and then like another point of fact is is Kraken has and like it seems like if if what you're saying is true is like um there could be some things tweaked to the policy or or changed about the way Kraken does it and honestly I wouldn't I wouldn't see why why Kraken would have any material reason not to make these changes if that was requested why would

they just go through the process of like okay fine you know you raised some good points SEC there could be similar transparency here we could Safeguard investors make sure that this is uh not um kind of something an asset that some debtor can claim once we do all of that will you allow us to resume our program instead it's just like discontinued pay 30 million dollar fine and then we have like um people like Jesse Powell uh tweeting like look we didn't even there was no form to fill out there was no office hours with Gary where I could like have a discussion with you and like be reasonable about like what we should do for the industry you just turned it off and I don't understand why that hasn't happened uh and like there just

doesn't seem to be consistency here is this story making sense to you yeah you know in under the prior Administration under the Clayton Administration they set up this thing called finhub which is their you know coming and talk to the crypto team at the SEC and in a collaborative way we'll work through exemptive relief and other sorts of issues that was a path for many projects back in the day there were three new action letters granted to crypto projects I worked on one of them the most recent of the three and this was in you know 2019 2020 that we were granted a letter actually for something that looked a lot like a stable coin which was interesting um with respect to some of their other actions and it was very collaborative the fin Hub was open to meeting with

industry and providing relief under the current Administration that's not the case and so it makes it very difficult for centralized exchanges or anybody in the space that wants to comply because they can't come in and ask for these sorts of targeted pieces of relief maybe they they wanted to offer a program that looks a lot like a security under the the guys of the you know Securities laws the relief they would need they'd need to go to the SEC and ask for that relief and typically you would get that in in other contexts but here the SEC is antagonistic and and won't grant that relief and it makes it very difficult you have to run the risk of the product either being a not you know being characterized as a security and having to settle with

the SEC or not being able to offer the product at all I think that's why the crypto industry is not convinced that this chairman is actually trying to help um investors in crypto um it seems much more like this is some sort of theater to score points in some game that you know is not has nothing to do with protecting retail but is maybe political or motivated in other ways I I want to make the point and check me if this is true Mike um Kraken services in Europe are still fully functional Europe obviously has sophisticated uh regulatory bodies as well that are clearly not taking the same position as the SEC so is uh Gensler and this Administration not in net effect driving this business

offshore and making American uh companies in American cryptocurrency exchanges less competitive in the global market and doing a disservice potentially to retail removing an option from the ranks is that the net effect of this that's exactly what's happening here we've got Micah in Europe there's progress towards crypto laws and regulations overseas we don't have that here there was some momentum and FTX kind of blew everything up right and so we don't have any sort of legislation that's being seriously considered at the moment maybe we will but without that legislative package it makes it really hard because The Regulators are just doing their thing they're they're following the the administration's uh

we'll talk about operation choke point later but following this kind of General uh antagonism towards crypto and they have this broad enforcement Authority and without a legislative mandate to go out and pass rules they're just going to keep bringing these actions and they will just want to beat it down over and over again until it's gone and of course it's not going anywhere except for overseas and uh Europe's been a lot more sensible and and not regulating D5 right out the gate they want to focus on the centralized intermediaries which in the United States that seems to be where the SEC is somewhat focused we can talk about mango and some of the you know the actions related to defy as well but they're primarily looking for these centralized intermediaries in their

actions I know um David's going to summarize this in a second but just I I just want to say two more things like uh okay so um first is I don't have assurances that um Gensler won't come after staking pools next um because it seems like he it's somewhat arbitrary in terms of what he comes after and what this what the SEC comes after I'm somewhat worried that maybe some um staking uh what was the term used not derivative but like you know liquid taking staking token might be deemed to security by this Administration next right so like some people are saying well this is great isn't it net effect is a decentralizes

staking and I don't actually think it's great because one it removes an option from the market um increases the barrier to entry to staking but also number two I don't have confidence or trust that this Administration won't come after a decentralized staking Pool Services next is that an unfounded um kind of um you know take or or do you think that's a serious threat here I think the more decentralized the liquid staking protocol and the option to the Staker the less likely the SEC is going to be able to bring a strong case against the the developer of that protocol or or the Dow associated with that protocol I would not put it past the SEC to investigate some of these Dows and in particular some of the governance tokens but the way that

liquid staking protocols can be designed to really focus on decentralization the the users all coming together with their own efforts as opposed to the efforts of Kraken or coinbase or any of the other providers you mentioned earlier um that it's a little bit different in the context of liquid staking so I do think there are arguments there but this SEC is is throwing everything at the wall and seeing what sticks the uh you want to fish with that one sorry yeah just the last thing I wanted to check is an instinct of like okay so the the Machiavellian playbook for you know maybe a Gary Gensler is like wouldn't they want to incent more American centralized exchanges to pull together stake because that is a vector

for control for the SEC and for the state rather than what the net effect is they're driving outside of their borders not only that they're also just driving it towards more centralized providers like if I was actually trying to control an industry and I'm Gary Gensler I actually want to like promote centralized staking services that are based in the US that are under my jurisdiction and that I can control rather than Banning it and so like I'm I'm I'm kind of even questioning whether um Gary Gensler is actually good at this uh you know if if we think maybe he is out for control this seems to be like counterproductive to that this is why I still can't wrap my head around the like just seems like

very capricious and I I don't have a firm sense of why he's doing it like it it doesn't seem like just control is kind of the the element here is there something else I'm missing about this it's hard to say you know what's in Gary gensler's mind at the moment uh aside from a hatred Taurus I'm just kidding um it's really hard to say I think there's this sense at the SEC that a lot of these crypto products are being offered uh by a centralized party and there are investment-like features that bring them within the scope of the Securities laws because there's this counterparty risk where you're relying upon somebody's efforts at managing a pool of money uh

or otherwise to generate returns for for the the user and the SEC hasn't really looked under the hood at the technology to say hey this looks a lot different from a money market fund or some other Financial product they're just grouping it all together and they frankly don't care um you know the the the the view of the SEC is essentially this industry should exist within the Securities regulatory framework but we're not going to change any of the rules associated with traditional Securities such that what you wind up with is equity Securities on a blockchain and all of the benefits and innovation of the technology where there's a way I mean the the security token days where people are just issuing

these security tokens it didn't go anywhere because it was so restrictive and you know we could talk about accredited investor issues and all of that but the the burden of registering a security is massive you have to have a prospectus you have to issue a registration statement there's a pre-effective period there's all of these things that you have to do to comply with the Securities laws that are very complex and that's why you have massive companies that decide to go public and there's a ton of legal work associated with it um and and other work that gets invested there and that's just not going to work for crypto when you're smaller develop companies issuing tokens I think if you uh view this enforcement action uh by the SEC to crack in in silo

that's it'll tell some certain story and maybe yes there are extra services that crack in as a result of the economies at scale was able to provide that particular project that did meaningfully change its nature away from just being a facilitator of taking as a service to something additional a pre-packaged product that started to look like a security at least from the eyes of the SEC I think we took that this story in Silo that interpreting it would produce a certain outcome a certain interpretation but the thing is like there's all these other data points to consider which is like Gary gensler's weird office hours PR campaign that's also infantilizing of the crypto industry and then you also take in the

fact that like sure maybe it maybe it crosses some sort of how we test secure SEC line of like that starts to look like a security but also like what are the risks and downsides and does this also inhibit the Mandate of the SEC which is like to and to create Capital uh facilitate Capital formation right and like and so like sure maybe I'll get we we give the SEC the benefit of the doubt that maybe it does start to look like a security but the also the alternative of that is like there are no risks here because the income is coming from a protocol they are just for being a service operator and so it to me it's like the SEC is just trying to score points more than it is actually doing

its mandate and it's doing this in a way it's like oh like we could we could go after Kraken because on this technicality that they haven't considered because they it's of Common Sense am I onto something here Mike yeah you know when when the merge happened there were all these rumors that Gary Gensler viewed eth as a security and was going to come out and say you know now that we have proof of stake and people are staking these are securities ignoring all the decentralization factors everything related to the fourth prong of how he efforts of others where got a massive decentralized Network um he focused on this expectation of profits prom which you have to you just have to defeat one prong so

staking doesn't make it a security right but but there was that rumor that the SEC was looking at it there was a security I think this is the sec's way of indirectly trying to to go back to that position they're going after the staking as a service providers potentially um and and they're uh looking at different types of staking solutions to effectively make it very difficult to stay to hold these to use um so it so I think it's it's a little bit of a backtracking but also a uh just just a way to get get it either is it fair to say that Gary Gensler and the SEC they are playing a game of scoring points and it is adjacent to the actual Mandate of the SEC which is to

you know protect customers from risk facility Capital formation because that's what it seems like as a you know a retail crypto person it seems like Gary genser is just trying to score points and so is the SEC is that a fair take it's hard to say with the Fallout of FTX there's definitely this concern of what happened with FTX happening at other exchanges and so there's there's this sense of urgency to go and look under the hood of different exchanges that's fair but I think that if that's the case they should issue rules that allow these exchanges to come into compliance and and do the sorts of things that the SEC is looking for them to do as opposed to just bringing these enforcement actions because I I 100 feel confident that most exchanges would walk in the front door if the SEC would work with them give

them exemptive relief that doesn't kill the rest of the industry I I do want to make one point which we haven't talked about so far so far we've been uh doing this broad Strokes thing about the kind of the SEC and that's true there are dissenters SEC uh commissioner Hester purse whom you mentioned earlier wrote uh and then like I I consider this Brave I don't know it's like how common it is to sort of disagree with um your boss I know it's not quite that sort of a relationship uh as you know you have different Commissioners who kind of vote on these on these various um enforcement actions but Hester purse dissented and this is a quote from CNBC from from her descent post using enforcement actions to tell people what

the law is in an emerging industry is not an efficient or Fair Way of regulating and I feel like somebody in the SEC like commissioner Hester purse has been consistently fair I mean I've we've had the opportunity to talk to her on the bank list podcast because she engages with the crypto Community imagine that chairman Gensler imagine actually talking to us evil people rather than just um giving us office hours uh editorials um and she has consistently had a fair approach which is like yes some regulation is needed particularly where there is centralization regulation is needed I I even think that some staking regulation is certainly needed some custodial staking regulation to

encourage transparency but this ain't it uh anyway I just wanted to point that out because um there are people in the SEC and we have tons of people uh in various government agencies that actually listen to bankless and so if you are fighting the good fight internally for um the core values and the reasons that your institution exists uh know that we support you in that fight and I don't want to paint too uh you brought a brush on the SEC but certainly under gensler's leadership this has been uh increasingly hostile towards towards crypto is it time David to talk a little bit about uh not just staking but about paxos and stable coins because what is happening

with that and I feel like I'm barely up to speed with what's been an emerging story over the last couple of days yeah so so Mike we'll get your take on this too because I would love to understand how a stablecoin can become a security so February 13 18th that was yesterday paxos receives SEC notice over binance's stablecoin busd which is a product that paxos provides tool but two binance so the New York Department of Financial Services I think NY DFS instructed paxis to stop minting busd due to a concerns about its relationship with binance and is considering action that the busd is a security in the paxo should have registered the offering under Federal Securities Law how does that make sense now why would

busc be a security and just like what what's the real story here if this is all like what the SEC is telling and showing us can you just tell us what what's actually going on so we all know the Howie test right you know an investment of money and a common Enterprise with a reasonable expectation of profits based on the efforts of others what sort of profits do you expect for the stable coin right it's it's a fixed value so uh it boggles the mind to think through what they're considering when it comes to a stable coin um I mentioned earlier there was a no action letter uh that the SEC issued that I was involved with uh for V coin which was uh issued by m View and it's a stable value coin as well the letter explains that you put a certain fixed

amount in and you can use the token and then they'll with you know allow you to redeem it for that same amount uh and the SEC didn't view that to be a security uh there was also an SEC interpretation from September 2020 where they say that stable coins can be issued as non-securities um they specifically say that whether you know one stable coins of security it depends on the facts and circumstances and they do a case-by-case analysis Gary Gensler in a a speech um several months ago similarly kind of said that stable coins may be Securities based on the facts and circumstances of the offering um whether there's interest involved whether there's an algorithm involved or whatever they can resemble a money market fund for example where you have an interest in a fund uh that maintains

a stable uh dollar value or it could be something else the definition of security is broader than just investment contracts there's other categories things like notes and then there's also what's called evidence of indebtedness which is super broad that they could be looking at with respect to um stable coins because in evidence of indebtedness is just what it sounds like you put something in and then you have this receipt that evidences that you uh put that in and that you have the value of it but historically all these sorts of stored value products have been regulated at the state level and by treasury as like gift cards basically you can load funds into venmo or PayPal or any of these other um custodians and they're regulated at

the state and federal level and you can send those funds to people and stable coins aren't so different from that so it's a bit unusual that we'd see the SEC encroaching here um Gary gensler's also implied that they could be Security based swaps which is another type of security but it's interesting to think about what they're so focused on here the policy concern seems to be that these are the the entry points into D5 that people are taking purchasing these uh stable coins and then using them as a substitute for cash in defy and they're able to earn returns to D5 through yield programs and things like that um and then some of these are exchange tokens and people are staking them on the exchanges and earning yields so it's it's really

hard to say where the SEC is focused here this is all allegations um that there's you know as well as notice out there there's um I think paxos has confirmed that they've received a Wells notice I saw that the other day but we just don't know what's in there or what's going on and Mike what about this story of um Circle this is from coinbase I believe from today no yesterday Circle sounded the alarm on paxos I don't know if this is rumor or a confirmation um what is what is this about is this relevant to the story at all and like if busd is is a security potentially then well then why isn't usdc it's really hard to say every single one of these stable coins will be analyzed

on a facts and circumstances basis there is as I mentioned some very good precedent that would cut against what the SEC is potentially trying to do here and characterizing some stable coins of Securities we really have to look at the individual facts of each product um but but this is very much a when we think about operation choke point um 2.0 an attempt to cut off banking products stable coins access to Banks uh qualified custodians all of that from the the broader sector and potentially away just even if there's casting thought on all of it as opposed to really having the ability to to bring an enforcement action because if you remember with Wells know this is it's trust and intent to potentially bring

enforcement action that doesn't mean that they necessarily will they're investigating um so it's very possible that they've got nothing but maybe they are looking at evidence of indebtedness or some odd category of security here so I'm wondering if you know anything that's going on behind the scenes or can speculate about that uh I know lawyers don't like to speculate about things but I'm going to ask you to see what I can get out of you Mike uh NY DFS spokesperson is quoted saying uh that paxos violated his obligation to conduct tailored periodic risk assessments and due diligence refreshes of binance and binance customers to prevent Bad actors from using the platform and I and I know we're going to turn to this idea of operation choke point which the the kind of the theme Here is that there are

multiple government agencies who have desires and goals and they all come to a table and maybe somebody is like hey there's a bunch of money laundering going around with Finance SEC any way you can take them down the SEC is like oh well bosc kind of looks like a security uh I'll scratch your back uh is there is there anything to this sort of like speculation I don't know I mean it's it's really hard to say I don't know if I have much to add on that you know it's it's there's a whole lot of news going on at the moment and I think everybody's got a new story that they're trying to break and it some of it may be true some of it may not but I think we're gonna have to wait and see on some of this and the current status with busd is

um it has paxos like disbanded it or is it uh it is a down only Supply so they have agreed to no longer issue any new supply of busd uh and so the supply buse is down only and as far as we know busd was a product similar to usdc and that it's just a stable coin kind of backed by Fiat in a bank account somewhere is that right with some speculation that there might have been a fractional Reserve at some point and the one one important distinction so we talked about some of these State money transmitter licenses that that many of the exchanges and custodians have obtained there's also what's called a trust Charter um and so paxos is a New York limited purpose trust Charter they are regulated by the New York Department of Financial

Services as opposed to many of these other um stable coin issues Circle for example um has money transmitter licenses um and is regulated by Regulators across across the country um and and there's What's called the bit license that that many of these State money transmitters have to get the trust companies if they're Incorporated in New York don't have to get that bit license but they're directly regulated by the DFS and so DFS can say hey we don't like this product turn it off um and they can say hey no no new listings for coins they can really exercise a lot of control over these entities um and so if the DFS doesn't like a product or wants to turn off your ability to

self-certify products they can do that and that's a real uh choke point the regulator has over these guys so Mike we need to turn to operation choke point because this is the overarching picture and there's a lot to unpack here uh and so we're going to get to that conversation and more as soon as we get to some of these fantastic sponsors that make the show possible uniswap is the largest on-chain Marketplace for self-custody digital assets uniswap is of course a decentralized exchange but you know this because you've been listening to bankless but did you know that the uniswap web app has a shiny new Fiat on-ramp now you could go directly from Fiat in your bank to tokens in defy inside of uniswap not only that but polygon arbitrum and optimism layer twos

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secure fast cheap and friction free and we are back Mike I want to run through some recent events and I'm going to try and speed run this as fast as possible uh December 7th signature uh one of the most active Bank serving crypto clients announces they'll give their customers all their money back shut down their accounts drawing crypto deposits down from 23 billion down to 10 billion they're also exiting their stable coin business January 3rd the F the FED FDIC OCC released a statement on the risks risks to Banks engaging with crypto not explicitly Banning Banks but strongly discouraging them from a safety and soundness basis January 6th still forget hit with an 8 billion dollar in crypto withdrawals because of fear of bank run and insolvency January 9th

Metropolitan Commercial Bank announces total shutdown of crypto asset related verticals January 21st binance announced that due to policy at Signature Bank they can only process user Fiat transactions worth more than a hundred thousand Dollars January 27th the Federal Reserve denied crypto Banks custodians bank's two-year application to become a member of the Federal Reserve System citing safety and soundness risks I'm about one-third through of a very long list that includes binance Department of Justice Fraud Unit more silvergate stuff protego and paxos more silvergate Bank hit with the class action lawsuit anyways uh if I had the time I would go through every single one of those things but I think listeners get the point is that there is a bunch of bad stuff happening in the world of banks servicing the crypto

industry this has all started in the last 8 to 12 weeks now the SEC comes out with some very big enforcement actions there seems to be a bunch of bad things happening Mike why why now how how did this all of this coordination happen what's the motivation here just like how should we think about all this yeah so there was this presidential um order related to crypto put out last year um kind of encouraging this coordination encouraging some reports and working groups and thinking on crypto didn't expect necessarily for this to be such a a coordinated effort to take down crypto it seemed more positive at the

time and many had that view um but what really seems to happen here uh after FTX is that all of these Regulators start working together under the uh executive branch um and working to to choke off access to the banking system and then also minimize the ability for um financial institutions to really access crypto for investment advisors to provide access to crypto to their their investors um for uh financial institutions to uh go and invest in in crypto or offer custody of crypto all these sorts of products that you'd need for crypto to really take off within the institutional sector the SEC uh treasury um ofac and fincen within the treasury

uh and the cftc seemed to be cracking down on based on some of these these actions and many of which you just named um I think it's important to take a step back and just think about how the the banking sector sector is kind of regulated so you have these State banks that are chartered with the state so Wyoming's a great example because they offer the special purpose depository institution which custodia uh is one of um and so that's a charter you get from the the regular state level and if you want access to the Federal Reserve um you have to go to the Federal Reserve and request a master account um and FDIC the Federal Deposit Insurance Corporation you have to go to that regulator and get that coverage for your customers so there there's kind of

this two-tiered system they also uh there's federal banks as well so you might be a like Anchorage a National Trust Bank and they're regulated by the OCC so there's just various banking Regulators about the federal and state level What's Happening Here and you also have these New York limited purpose trust companies you have state trust companies and these are banking institutions but they're not depository Banks and so um all of the the big names that you'll hear about in the institutional custody space are mostly New York a limited purpose trust uh companies like coinbase custody and others so they have this Charter that they got from the New York Department of Financial Services to operate

um what's happening here is that the uh Federal Regulators are putting out these releases policy releases that they've now entered into the Federal Register essentially saying that they don't view crypto custody and crypto investment as principle and lots of different types of crypto activities as safe and sound bank and they're saying that these State Banks uh that want to be insured by the FDIC or want to access the Federal Reserve or do anything else really related to the federal Regulators they have to uh not engage in crypto activities and so it makes it very difficult um for example for these Wyoming spdis like uh custodia to go and get Federal Reserve Master accounts and so they've

been declined um this is really a tricky uh situation for for custodians the SEC so there's a rumor actually started by one of my colleagues Justin Browder um that the SEC might propose amendments to the custody rule tomorrow that would make it very difficult if not impossible potentially for investment advisors that are registered with the SEC to custody crypto assets and offer crypto assets to their investors and so you know if you're a fund manager and you're registered as an investment advisor and you have a crypto fund the crypto under the custody rule needs to be custody with what's called a qualified custodian

and there's a number of different things that meet the definition of a qualified custodian that's set out in this SEC rule today as a Trust Company arguably you're able to custody crypto as a qualified custodian so you can go to a trust company and put your crypto there they hold it for you and that's that's all kosher with the SEC if they change that definition they would make it impossible or very difficult potentially for all of these investment advisors the custody crypto assets so they would have to before whatever effective date of the rule if it goes into effect uh withdrawal sell and get rid of those crypto assets uh because they couldn't offer those products wind down those funds all of that and this is all rumored it's speculative

um but but there seems to be a leak within you know the SEC because there's a Bloomberg article that dropped today uh confirming that this may be happening um and it would be proposed as a rule it would go through notice and comment but we saw you know in the prior Administration when they were trying to crack down on non-custodial wallets within the treasury they put these things out potentially very quickly and give 30 days for notice and comment and just Ram it through and chair Gensler has done this at the cfdc when he was enacting all the Dodd-Frank regulations after the financial crisis push them through very very fast and so if this happens it could happen very quickly and that would really take you know give a hit to the institutional sector is the net effect of this that it it becomes

harder to self-custody crypto assets as in who where all the crypto assets become custody to go into a smaller more centralized uh more perhaps like State aligned uh entities than what is previous which is a more you know per not permissionless promiscuous isn't the right word but like a more open set of people that can custody crypto assets that gets confined to a much smaller set of people and those people who are able to custody crypto assets or much more State aligned is that a fair description of the net effect of this all as a net effect it I think that there's going to be less institutional access to the banking sector you know as as it stands today it's very difficult to get a bank

account as a crypto company and it was even more difficult years ago uh there are a handful of banks like silvergate and um signature that we're offering access um that's broadened out and you see more Banks offering access but we saw the other day signature was winding down a lot of its crypto clients and so just as any business you know whether you're a small business large business in the crypto sector access to banking is really important um and then investors that want you know asset managers that want to offer crypto products not being able to custody that's going to make it very difficult so yes I think there's going to be a lot more High net worth individuals that just go out and buy crypto on their own and custody at themselves and all of that and rather than using you know a fund manager and so is the motivation

for this like there what is the motivation for this because it kind of just seems like they want to squash the industry from the external perspectives like oh they're like literally just cut off the oxygen and eventually the thing will just Wither on the vine yeah it sounds like the like the executive branch on the back of like SPF and everything every you know everything that happened in 2022 we're just like hey now's our chance and let's like all get together and see what we can do to choke off this fledgling industry in all of our vectors for control we control the banks so what can we do to make it real hard to get a bank account for any sort of crypto company or institution okay check mark let's do that we can see that in process we

control vectors of kind of what securities are and so how can we make that um piece difficult as well and it's like it seems like with this coordinated effort of um some meeting that none of us know about nor we're present for of a kind of the executive branch uh going after a divide and conquer strategy to choke out this fledgling industry from like a serious investor circles uh inside of the United States that's the net that's what it feels like happened is that really what's happening and has anything like this happened in um kind of the U.S regulatory history with respect to crypto previously is there any sort of analogy here

yeah I really think there's an analogy to the 90s when we had what was called the crypto Wars and it was really this war on encryption and cryptography and there was this case Bernstein versus United States where a professor developed this cryptography technology that he put out on his website for students to use and experiment with for teaching purposes and he wanted to broaden it out and distribute it more you know across across borders outside the United States all that so you went to the state department and said is this okay and they essentially said no you're exporting Munitions they compared cryptography to wmds Firearms all these uh illegal weapons at the time uh and exporting that outside the United States uh it was

illegal he fought that to the to the ninth circuit the ninth circuit agreed that this was a free speech issue a First Amendment issue and that really opened up the ability to export cryptography and it was actually a threat for a lot of these programs like Netscape and others where they they incorporate encryption and there's no ability to protect credit card information or other things and this really broadened up the the e-commerce industry and all of that I think here we're seeing the opposite where it's almost this import uh you know embargo placed on crypto where they want to keep all this outside the United States they don't want it here and so they're cracking down on the industry to push it all offshore and there there's tokens that have been sold offshore in the past

and all of that but but for the most part we've had exchanges here they're regulated as money transmitters at the state level as as Money Services businesses at the federal level there's there's become kind of a regulatory framework to offer compliant legal crypto products but if they say they're all Securities and the SEC is not willing to work with the industry to develop a framework for it it all just goes offshore if you can't have a bank account in the United States you've got to go offshore to a foreign bank and start your business there my aim and Foundations all this sort of stuff we're seeing it all go offshore like are they dumb like are are they stupid like here's what I don't understand about this this seems so self-sabotaging the United States right here's a fledgling technology that could be as impactful as

the internet and the us but you know that Ryan what do you think they know do they know that because like how many of these people are just doing a job and their job's like oh I've got the hammer and who am I gonna hit today how did we ever get the internet to happen in the 1990s like how did we ever get kind of like um regulators and our legislators on board with opening up a communication protocol if like they can't see the potential of this fledgling they're so willing to drive it outside of the board borders of the U.S like I I don't know if um those in power realize no maybe they just don't care what's at stake for future generations and for the United

States like we've always sat on Bank list this isn't about whether crypto will succeed or fail the best they can do in the US is like slow it down a little but they can absolutely harm the U.S they can make sure that all of this Innovation happens outside of the United States but they can't like they can't put this back in the in the bottle I mean like the toothpaste has been squeezed out of the tube and they can't like put it back in so like what are they doing it this just just doesn't have coherence are they just hopeful that yeah we'll just like block it in the U.S and drive it outside and then in a few years it'll just go away you know like is that what they expect to happen uh I know this is probably outside of the

the J like it's lawyers don't like to speculate yeah this is I I know this isn't a legal question but I'm just trying to make sense of of any of this and it seems to be the most self-sabotaging move that the United States could do the most the most anti-capitalist anti-entrepreneurial anti um Freedom response that they could take and it it is seeming like the inside of the United States is one of the most hostile countries on Earth to this Freedom giving technology and I'm just like what gives like what this is so dumb I I don't understand it and that now I'm getting into rant territory but like is there anything you would say about this Mike

well if you look at the terms of service for many crypto products out there they will have the united states listed right next to North Korea and Iran on their terms of service it's it's a really bad look for the United States that rather than embracing the technology they're pushing it offshore uh and and the United States is now in line with uh Iran and North Korea on every terms of service I think there's a huge opportunity here and there are many on the hill uh that get it right right like Tom emmer um McCarthy but others are just pushing against it and I think after FTX there was this idea amongst many on the hill that we just don't pass any legislation we just let it go treat it you know as a

an asset class that doesn't belong here that we don't want to recognize in any legislation um and then let Gary Gensler and and Regulatory Agencies go after it and police it in the United States and push it out and this won't last right we're gonna get new administrations in the future the stuff's gonna flourish here but in order to get there we really need to make our voices heard and um to communicate educate Regulators to help them understand that the technology is a generational technology that deserves to be here I can't help but to ask um a large amount of what the net effect of uh the sec's actions and other agencies like the SEC is we call it investor protection in the front but incumbent protection in the back uh and

so I'm wondering Mike is there anything worthwhile to speculate here about how um much the banking sector is is involved here because if you look at the one category of winners here it's the the fact that the banking sector doesn't have to compete with crypto is there anything to this speculation it's possible I mean I think the banks ultimately all see the Merit in this technology so the you know the CEO of Goldman Sachs wrote on op-ed in the Wall Street Journal praising blockchain technology um and I don't think it's that you know blockchain not not Bitcoin kind of movement I think they actually get that there are public permissionless networks like ethereum and others out there that they uh view as as being important for the banking sector as well so I wouldn't

necessarily say the banks are aligned against us but I do think there is this um investor protection Mantra amongst some in the the sector and some on the hill that view this as kind of a shady asset class like when I got into to bitcoin I remember it was like everybody believed that it was uh Magic internet money that the drug dealers were accepting on the internet it wasn't this uh legitimate asset class and I think today you have people trying to throw the same sort of um fear on top of it again well Mike we're going to be fighting the fight for hearts and Minds uh of course on bankless as we do and encourage our community to get involved where they can whether that's calling uh their Senator or a member of Congress Congress or or

writing someone or just making your voice heard will continue to call for call for that for sure I I'm curious Mike if maybe you could sort of close us out on a ray of Hope here so um some of your comments a little earlier almost gave the spirit of like yes this too shall pass this is sort of a phase this is not a permanent situation that the U.S finds itself in um we've gotten we've you know gone through dips and then it come to the other side of accepting uh new technologies in the past that um you know scared the nation state at first and ultimately passed what is your um hopeful case for how we come out of this on the other side where this Tech

technology can actually flourish in the borders of the United States you have a path for that happening yeah you know cryptography survived uh from through the 90s there was this crypto Wars maybe we're in crypto Wars 2.0 now but crypto will survive in the United States it will take time we need to work with The Regulators we need to to fight some of these cases in court and unfortunately without new rules for crypto it really will be the the builders versus The Regulators um the the dev teams need to kind of think through thoughtfully how they're building products decentralization is is an option uh for for many of these protocols and and teams out there uh thinking through how they either trip into the Securities laws or don't that's

important but I think we'll all survive this Pro you know future administrations are going to hopefully be a lot more friendly to CR uh crypto assets and it will just become such an economic uh case that this needs to be here that I I don't think the uh people on the hill will be able to ignore it and and as I mentioned earlier you know Scott McCarthy we've got emmer we've got many on the the hill that are fighting the good fight um the industry needs to just continue to stand with with people like that um and and frankly you know frankly fight some of these cases in court if it comes to it um I think that there are good arguments that many of these companies are going to be able to to raise against the SEC um and they shouldn't let them uh you

know intimidate them into into basically just going with it with the Gensler way oh thank you Mike for walking us through this and make this nation I I hope you felt uh educated in what's going on with this seeming uh war on crypto that the U.S has has launched recently if nothing else we certainly have demographics on our side in another a couple of decades certainly um those that are young now and in crypto will be those in power in uh in our Halls of Congress and on Capitol Hill so we got that going for us anyway we just have to wait them out um Mike this has been a lot of help thanks for joining us today on bankless glad to be here recent disclaimers guys of course I gotta say for for Mike and

for allos none of this has been legal advice not anything like it neither has this been Financial advice of course as we always say crypto is risky so is D5 you could definitely lose what you put in but we are headed west this is the frontier it's not for everyone but we're glad you're with us on the bank list Journey thanks a lot