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Ava Labs x CBER Ep 12: Beyond the Foundation Model: DUNAs and BORGs
31 Plays4 days ago
This episode examines the central role nonprofit foundations have played in supporting blockchain networks. We trace their original purpose, how these entities have become a point of friction for many projects, and how regulatory and policy shifts have opened the door to alternatives. We reference two emerging models: the Decentralized Unincorporated Nonprofit Association (DUNA) and the Cybernetic Organization (BORG).
Guest: Miles Jennings (Head of Policy & General Counsel at a16z crypto)
Paper: The end of the foundation era in crypto - a16z crypto
Recommended
Transcript
Introduction to Blockchain Podcast Series
00:00:06
Speaker
Hi everybody and welcome to Crafting the Crypto Economy. I am Silvia Sanchez from the Avalanche Policy Coalition and today we bring you a special podcast series in partnership with the Crypto and Blockchain Economic Research Forum, also known as the CBER Forum.
00:00:22
Speaker
This is season 3 of 5 new episodes featuring leading faculty from global universities exploring various elements in the blockchain ecosystem. From stablecoins to DAOs and so much more.
00:00:33
Speaker
These episodes are a bit longer from our usual ones since we will be getting deeper. But again, it's kind of challenging to fit in a whole research paper into just one hour. But don't worry, each episode will have its accompanying research paper posted on the website and episode description for further reading.
Introduction of Moderators and Guest
00:00:49
Speaker
Anyway, I'll hand it over to our moderators, Professors Fahad Saleh and Andreas Park. We hope you enjoy.
00:00:58
Speaker
Hello everybody and welcome to another edition of the Crafting the Crypto Economy broadcast presented by the Crypto and Blockchain Economics Research Forum jointly with Awe LXplains. um We're very happy today to have Miles Jennings with us um who is Head of Policy and General Counsel for A16Z
A16Z Crypto's Legal and Regulatory Insights
00:01:16
Speaker
Crypto and he will talk to us about the foundation model.
00:01:20
Speaker
um I'm Andreas Park. I am your co-host together with Farad Saleh from the University of Florida. Malz, welcome to the pod. um We're really happy to have you. You are the second lawyer um that we have talking to us on our podcast. And for us, for Farad and me, this is always incredibly useful because we learn a lot of new things and a different way of thinking that we're normally exposed to.
00:01:43
Speaker
um We're having you here because i think A16s Crypto has ah put out a lot of work thinking very deeply about you know what are the legal and regulatory implications of the crypto economy?
00:01:56
Speaker
um How should we think about organizations that provide crypto services, crypto platforms and the like? in I think this is kind of, as as we now learned over the last years, it's kind of very foundational to have a proper thinking about how crypto entities, whatever you want to call them, organize themselves in such a way that they don't butt against securities law, that they don't butt against all kinds of other laws that could could come in their way. And um now that the U.S. at least has a more open-minded regulatory system and legal system and has ah hopefully abandoned lawfare, um we can actually talk about this in open and and actually think about what the best way would actually be how to organize crypto entities.
00:02:42
Speaker
So you've done some work on this. So tell us about it. So where where do you stand? what Where are you coming from here? and And how do you see the evolution of, let's say, entities that try to develop something in crypto?
Role of Foundations in Crypto
00:02:56
Speaker
Yeah, so I think um just taking a step back, I would say that that I think you know the entity structuring that that we see ah in the crypto space is a good example of where you know positive good intentions kind of led to um you know various approaches that have been you know corrupted over time and that adverse consequences have have resulted. right And so I think a lot of this was all started with good intentions, but over time um you know has somewhat been been kind of going the other direction.
00:03:28
Speaker
so what i would just What I would say from the beginning right is that like there is a a real good purpose for you know foundations in crypto in the sense that you know this this infrastructure that you know blockchains and smart contract protocols um is supposed to be you know credibly neutral and permissionless and you know independent of anyone's control.
00:03:50
Speaker
And so you know from that perspective, foundations can serve as a a good tool to kind of safeguard the credible neutrality of these systems and and you know where there's you know decentralized governance, it can it can act as an effective you know coordination mechanism for governance.
00:04:07
Speaker
um And you know that was was kind of, I think, what the original conception of of these vehicles was, was that you would use them as this tool to to enhance decentralization of the underlying architecture.
00:04:19
Speaker
um But over time, right, in in response to a lot of the ah in ah and in response to a lot of the you know regulatory pressures in the United States, um that started to change. and And so, you know, we started to see these vehicles used for other purposes.
00:04:36
Speaker
And that's really what, you know, has been led to a lot of problems that that we're currently seeing in the market. So maybe we should take one quick step back so that maybe the audience also understands actually what exactly we're we're trying to talk about here.
00:04:51
Speaker
So um let's let's go with Ethereum, although that I think it's not really the example that you have in mind, but maybe we start with them. um i mean, it's it's really, you know, if you forget about um and Bitcoin, and Bitcoin is sort of like self-emerging and, you know, it came out of nothing and and was just bootstrapping itself.
00:05:08
Speaker
um Ethereum works
Impact of US Regulatory Changes
00:05:11
Speaker
fundamentally differently, needed to have ah crowdfunding for its token. Otherwise, you know the the network itself can't really work, right? It's it's kind of mandatory that the token has has money, has monetary value from the get-go.
00:05:24
Speaker
But they chose to build a foundation. And so the story that I heard, having had a one of the the co-founders on on one of my classes, was that they actually had an offer to be bought out entirely by Google and they had very hard discussions at the time whether or not this is actually a step in that action that they wanted to go. And instead they actually said, no, we actually want to make sure that this is open to the world and we build this foundation, which we fund partly from the crowdfunding campaign, or at least implicitly, right?
00:05:52
Speaker
um And then this this foundation will will run the development and and the further work in this blockchain. So this is what they what they came up with and um They have been doing this obviously since 2014, or 2015, depending on how you count it.
00:06:07
Speaker
um And so now you're saying, okay, so maybe in the case of Ethereum, this works, but in other cases, this is not an ideal way how we want to structure um and know the the development of a network and the the progress of and of how we want to run a network. Is is that where we're going?
00:06:24
Speaker
Yeah, that's that's ah that's a good analogy. I think i think that that's exactly right. I think the Ethereum Foundation has has done a ton of things right and has has been has been kind of the model example of of what a foundation you know can do and and and you to help these systems remain open and you know open and permissionless, incredibly neutral.
00:06:45
Speaker
um I think, you know, what, but but you have to remember that that the Ethereum Foundation was started in a different regulatory environment. right And when you know Gary Gensler came into the SEC in 2021, everything really changed.
00:07:01
Speaker
And um you know the the administration became much more hostile ah to you know the technology. And so you know from those underlying principles of foundations being focused on credible neutrality, right they then started to shift to a regulatory strategy.
00:07:18
Speaker
right And in that context is where we've seen kind of them be you you know used in ways I think that were not in line with the original intention and ways that that have ultimately led to you know adverse consequences.
00:07:30
Speaker
So ah before we dive down the rabbit hole, could you maybe just ah clarify what The word foundation, from a legal perspective, what does that mean? like what is it actually You've talked about sort of the importance of credible neutrality and so on, but ah yeah as ah as a legal matter, if you if you declare yourself foundation, what does that mean, if anything?
00:07:49
Speaker
And also, what is it what is it not It's also important. Yeah. I mean, the way to think about a foundation is is essentially just and and ah ah it's like a company, but it doesn't have shareholders. Right. And so it doesn't have obligations to, you know, in the U.S., you know, we have C-Corps and a bunch of other entities. A lot of those come with fiduciary duties where, you know the officers and directors of those companies have to you know maximize shareholder value.
00:08:16
Speaker
Right. And so that is their their kind of overarching goal. Whereas foundations kind of remove shareholders and so they can have a um you know much more broad purpose. right and And so they're they're an ideal vehicle for you know a nonprofit purpose where you're trying to, you know for instance, protect the the credible neutrality of open source technology.
00:08:36
Speaker
So officially from a legal perspective, for instance, why is there Is there a legal relationship, for instance, between a foundation and and then maybe the blockchain that it supports? Or like should I just think of it as, oh, it's a nonprofit and it happens to be doing things that affect this other thing?
00:08:53
Speaker
Well, there's a lot of different shapes and sizes of these things, right? And so I would say in the in the most pure sense, right, you you would see you know a foundation much like Ethereum's where you know it's been funded by with ETH.
00:09:04
Speaker
you know eat And it kind of oversees some ongoing development work, ah helps to coordinate governance-related activity, um and you know advocate for for the technology and also kind of maintain its credible neutrality.
00:09:19
Speaker
um But at the same time, you know the Ethereum Foundation doesn't you know can't just turn off Ethereum tomorrow if it wanted to. And so you know it does have this lamp layer of of kind of separation between it and the underlying blockchain. It it does not control it And that's a that's a key distinction.
Decentralization vs. Control
00:09:35
Speaker
Right. And so I think if you compare that to where we've seen a lot of foundations move over the course of the last administration.
00:09:43
Speaker
Right. You started to see foundations rather than being that tool to enhance decentralization. Right. They were really a tool to um create the appearance of decentralization um without, you know, as ah as a regulatory strategy. Right. So so under securities laws.
00:10:00
Speaker
right And this was established in in you know under the the first Trump administration. right The idea was was that you know these digital assets you know won't be subject to securities laws you know where the underlying systems are decentralized. and And so as a result of that kind of connection between you know existing securities laws called the Howey test and and the concept of decentralization,
00:10:23
Speaker
Right. Where what in that context, decentralization really means reliance on on the ongoing efforts or managerial efforts of of some entrepreneurs. Right. And so when when decentralization was kind of defined legally that way, what resulted was, you know, people trying to eliminate that reliance on ongoing managerial efforts by distributing it across you know several entities um and particularly foundations.
00:10:51
Speaker
And so what what went from being a you know decentralization like in its core ethos as it what it interpreted to mean to builders in the space, decentralization in the context of foundations started to mean what it, you know, interpret what lawyers interpret it to mean.
00:11:05
Speaker
And so then, right, the foundation structures and and token design, network design, right, started to be heavily influenced by lawyers, which is is ah ultimately not a great you know product design and and somewhat got away from the ethos.
00:11:19
Speaker
So you started to see foundations be um you know given much more control over these underlying systems, play a much more integral role with respect to these systems. In some cases, they control the entire treasury of of an or you know of a blockchain system, or they might you know control certain powers with respect to upgradability or things like that.
00:11:40
Speaker
And so as opposed to you know being solely focused on kind of the credible neutrality and organizational matters, right they started to kind of you know have functional control of these systems.
00:11:51
Speaker
and thereby really undercutting the decentralization of them as opposed to, you know, facilitating that decentralization. And so that's why and ah one of the ways that we kind of think that these, you know, these foundation structures have really perverted kind of the original intent, which again was was towards decentralization as opposed to masking, you know, ongoing efforts.
00:12:12
Speaker
So i'm i'm I'm a little, i'm I try to understand also the the whole mindset generally around this. um So I remember in 2017, 2018, we had this ah token boom where a lot of new tokens came out.
00:12:26
Speaker
um Ultimately, I think almost all of them disappeared because they were just not sustainable. And at the time, there's a lot of foundations that were also built, right? So essentially people said, oh, you have this utility token. It's definitely not a security. And now I have this This network, which is supported by a foundation, and you know it's definitely not a firm. And it seemed like the foundations were there, but they're also accountable to nobody, really. right So there's actually nothing that they basically made a promise.
00:12:51
Speaker
um the promise the the The foundation was not directly linked to the token in any any tangible form. right There was nothing that way you would say other than we're going to do something really great here. The token value may therefore go up.
00:13:03
Speaker
There was not even any economic rationale of why the token value should go up. ah is that really Is that the core of the problem? Is that we're actually trying to create artificial separations simply to to for regulatory arbitrage, if you want to call it that?
00:13:16
Speaker
in know In a lot of cases, yes, I think that that's right. I think that the attempt is to try and create a superficial distinction Right and and one of the reasons a foundation vehicle is useful for that is because it's nonprofit.
00:13:31
Speaker
It doesn't have shareholders. And so you can say hey this is just a nonprofit acting on its own. You know to to help out this ecosystem. As opposed to a you know for profit company where you know now if you're if you hold a token that is.
00:13:44
Speaker
You know derived benefit from that you know companies ongoing efforts. it's It's a little bit clearer to make that you know the or draw that kind of um you know an analogy between that token and an equity or you know a share of stock in the company or profits interest in the in the company.
00:14:01
Speaker
And so I think you know as it at its most superficial level, right the foundation was in some cases, right was used to kind of break that distinction or or to draw a distinction there.
00:14:11
Speaker
But then on top of that, rightpe you know, by moving kind of efforts into bit that the the foundation, right, it it was really kind of became a a method or or a shortcut to decentralization, because rather than achieving actual technical decentralization, right, where, let's say the smart contracts are, you know, fully immutable, or the blockchain system has a large validator set, and, you know, can't be controlled by anyone,
00:14:37
Speaker
Rather than kind of aiming for those decentralization targets, which are very hard from a technical perspective, um you know founders were were by you know were given by lawyers a shortcut to decentralization, which was just, hey, let's just move your organizational structure into these various buckets.
00:14:52
Speaker
And that is essentially decentralization itself. I would argue that that is not decentralization at all. Right. and it is And it is a clearly superficial
Legal Implications of DeFi
00:15:00
Speaker
interpretation of what that that construct me or concept means.
00:15:04
Speaker
And as a result, I think that, you know, lawyer design products and and systems are ultimately much less decentralized and and therefore you know not delivering on the promises of the technology.
00:15:15
Speaker
So I'm still struggling a little bit with the sort of, let's say the concept. um And so ah for instance, you know you you've referenced like nonprofits and so on, and obviously something like that much predates you know anything in in the blockchain universe.
00:15:29
Speaker
ah but And so so that's that's like a very easy mental model to think about, I think, for people even you know no matter what their familiarity with this particular topic. But the token seems like something that I would have, outside of crypto context, not be something that I would associate with, like for instance, a non-profit enterprise. And so, for instance, like you described that like level of separation between the Ethereum Foundation and the Ethereum blockchain. So they can't just shut down the chain um you know unless they're the only staker or something like that. But...
00:15:57
Speaker
um ah but but And so separation, let's say, with something like a blockchain, i can think is a relatively easy concept, I guess, in my mind right now.
00:16:08
Speaker
But then when it comes to the existence of this asset that was, I guess, and I'm not even sure exactly what the what the how most foundations organized in this way, but in my head, it's like, okay, so the initial issuance of the token is capital that actually goes into the funding the foundation or something like that? like So in other words, like I'm having trouble...
00:16:28
Speaker
ah thinking about the separation between a foundation and the token that is commonly associated with it. And maybe some of this is just that I'm not familiar with kind of what the initial, what the financing for these foundations actually was. Maybe it has nothing to do with token and I'm i'm sort of making a a wrong association there.
00:16:44
Speaker
No, that's very fair. so so So your typical setup, right, the way that these have been done for the last four years or so, or so right, is that you you set up, a you know, the DevCo sets up a foundation, right, ahead of the token launch.
00:16:57
Speaker
transfers intellectual property but to that foundation associated with the underlying blockchain system. And then, you know, the foundation does the token generation event, right, TGE issues does the airdrop, right? And the allocation schedule then, you know, looks roughly about, you know, I think typically somewhere between 40 to 50 percent goes to insiders. So this is advisors, investors, employees, founders, all of these people, right?
00:17:22
Speaker
And then a large portion goes to the foundation, right, to fund its ongoing operations. And then a large portion goes into a treasury, with that treasury then either being potentially controlled by token holders, right, or controlled by the foundation itself.
00:17:37
Speaker
um And so I think, so that's that's generally how these things have have funded themselves, funded ongoing development activity in an underlying space. and And used in that sense, right, it can help facilitate decentralization in the sense that, like,
00:17:51
Speaker
It is helpful to have a pool of assets that can be allocated to developers building on top of this technology, which you know decreases overall reliance on you know any single dev code within that ecosystem.
00:18:02
Speaker
So used properly, again, these these foundations can um you know facilitate greater or decentralization as opposed to being a workaround. So can I just ask... um um' I'm always struggling with actually just the term decentralization.
00:18:17
Speaker
um i can I think I can understand it when it comes to like a blockchain itself, right? You have validator nodes, they're broadly dispersed across many different entities. But, you know, when it comes to applications running on it, I always struggle to describe what what is it what makes an application that I run, so essentially a service that I want to run, what makes that actually decentralized?
00:18:40
Speaker
is Is there a definite, is there actually a legal definition or is this like, you know, is this like more of a vibe thing? Yeah, sure. So I think, you know, going back to what I was saying earlier, right, the the the the legal kind of conception of decentralization for the last, you know, eight years or so has been focused on, you know, whether people are dependent on ongoing efforts of a handful of actors, right, of of of the entrepreneurs associated with the system.
00:19:07
Speaker
And so, you know, viewed through that context, That is obviously very, very murky. at what point At what point is the value that is being created by a group of entrepreneurs so sufficient that you know yeah we should we should regulate the asset as a security as opposed to regulating it like a commodity?
00:19:24
Speaker
So it's very hard to kind of draw that distinction. Go ahead. Can that can I just interrupt quickly? so so the So one key thing seems to be that there also has to be an asset, right? ah is is that Is that actually the implication?
00:19:35
Speaker
So I'm asking for the following reason. If I look at, let's say, Uniswap, right? So this is an application and in its original form in version two. it You just submit the smart contract that runs on the blockchain and then people are you know free to use it or not, right?
00:19:49
Speaker
I mean, it doesn't require really anything thereafter, right? So that that thing just works. um Except if you think of, well, there's also a website and the website kind of works. So that kind of is something else that needs to happen.
00:20:00
Speaker
But the real reason why we're worried about token about about the foundations itself is because of a token that has to be out there. Is that right? Sure. Yeah. so So somewhat correct. right So the the the the definition I was giving was was looking at how we have regulated digital assets but and whether or not those are subject to securities laws.
00:20:23
Speaker
Right. There is a another context in which you can view decentralization when it comes to other regulatory regimes. Right. And so the question in that context is does decentralization.
00:20:34
Speaker
Right. We define it typically to mean whatever it is that addresses the risks of the underlying regulatory framework. So in the case of DeFi, for instance,
00:20:45
Speaker
Decentralization is often defined to mean disintermediation. Are you removing intermediaries? The reason that that is important is because with respect to financial regulations, right, and this is again outside of the context of like specific securities, we look at regulating intermediaries, securities brokers, dealers, exchanges, right? And the reason that we regulate those intermediaries is because they introduce risk with respect to the users that are that are using those intermediaries.
00:21:11
Speaker
In the context of DeFi, DeFi removes those intermediaries and can function without intermediaries whatsoever. And so as a result, where they are decentralized, where they are disintermediated, right, we would argue that those regulatory frameworks should not apply because the, the, by being decentralized, these systems can remove all of the risk associated with intermediaries and therefore achieve a better regulatory result than any regulatory scheme that was designed to regulate humans could possibly do because you can guarantee outcomes when you have smart contracts and things functioning according to code.
00:21:42
Speaker
Right? so in So in the context of DeFi, you know, I think decentralization is most easily understood as as focusing on disintermediation. In the context of digital assets, right, as I was saying, the focus since two thousand and seventeen eighteen has been on, you know, these ongoing managerial efforts, which is is really a phrase that comes directly from what is called the Howey test,
00:22:02
Speaker
which is is is kind of the the test for so you know determining whether digital assets should be regulated under securities laws or not. um you know But there was an alternative approach out there that I think was was first proposed by Hester Person in 2021 in her safe harbor proposal, which really reframed decentralization as being about control, right? And looking at whether or not you know an individual has control over a system.
00:22:28
Speaker
And in that context, I think it's a little bit more objective and easier to understand, right, whether or not, you know, decentralization is is kind of present. and And if you see, you know, the evolution of that has also now made its way into both the Clarity Act that that passed the House, this is the market structure legislation, as well as the Senate's most recent discussion draft.
00:22:48
Speaker
And so so the idea there, right, is is kind of focused on control, you know looking at whether or not these systems are permissionless, whether or not, um you know, they're credibly neutral, whether or not, you know, the economic value is derived from a blockchain system, right, which can operate without human control or if it's derived from, you know, some off chain business.
00:23:08
Speaker
um And so so going to like. putting that, piecing that all together, right? That means that if when you frame it that way, you don't have to look at whether or not, you know, ongoing efforts are being contributed. You just have to look at whether or not someone controls the system.
00:23:23
Speaker
Because if there is control, then someone can unilaterally change the risk profile, change the probabilistic outcome of of economics for that asset. Whereas if no one controls the system, then no one can do that. And therefore the risk profile of that asset starts to look very different from an ordinary security.
00:23:41
Speaker
I think you partially answered this, but but basically then let me, ah so what I was going to say is that i in the context of discussing digital assets, is there any presumption of a relationship between ah the system and the asset?
00:23:55
Speaker
ah Because for instance, like that, that is actually, I think a question that economists like Andreas and myself struggle with, which is that it's not totally obvious that for instance, things that benefit the Ethereum blockchain necessarily translate into things that provide value or things that sort of increase the value of of the asset ether, right? Like value capture in some sense is kind of a fundamental issue from an economic perspective of the design. I think you sort of ah in some sense touched on it towards the end where you were saying, at least in the control framework you were describing, well, as long as there is some way for me to affect the token price, because I also, for instance, control the system on which the token is settled, then that creates a link. So it's not it like, and so,
00:24:38
Speaker
I guess I was still asked, like, to to what extent does it matter if there is an economic relationship between the technology and the particular asset?
Value Accumulation and Control in Crypto
00:24:47
Speaker
Sure. So it's it's a good question. And I think i think you're you're right on point, right? So the the it really kind of goes to, if if you guys have trouble discerning where the value accrual is coming from, how can we build a regulatory framework around that, right? It's impossible to, like, it's but if you if you can't tell where the value is coming from,
00:25:08
Speaker
then you can't really tell what the risk is. and if you can't tell what the risk is, you can't design a regulatory framework to address that risk. Right now, if you switch over to to something that is based on control,
00:25:20
Speaker
right What I would argue is is that in that context you can have much more objective criteria to evaluate whether or not control is present. Now to your specific question, po i think that I think that value accrual or the the ability for the asset to accrue value from a blockchain system is very important because if you don't have the potential for it to accrue value from the system,
00:25:44
Speaker
then then its value is much more nebulous and and and it's very hard to tell whether or not its value is coming from something that is controlled. So to give you an example, with Ethereum, right, obviously a portion of the ETH is burned with every transaction, creating a direct economic link between ETH, the asset and the functioning of the underlying Ethereum blockchain.
00:26:06
Speaker
Now, it might be very hard to tell, well, what is driving you know transaction flow or what is going to drive future transaction flow? But fundamentally, no one controls the underlying Ethereum blockchain.
00:26:17
Speaker
And as a result of that, you would say that no one controls the value accrual. and And because of that, you know I would say that it's more properly categorized outside of the bounds of of securities laws.
00:26:29
Speaker
um The same thing could be said about, you know, other systems, right, that drive their value from that. Now, let me give you the opposite, right? FTX, right, had a token called FTT.
00:26:41
Speaker
FTT gave people the discounts on trading on FTX, the exchange, right? But Sam Bankman-Fried also promised to the market, right, that he would use a portion of the revenue of of the FTX exchange to go out and buy and burn the FTT tokens.
00:26:59
Speaker
So what does that mean? Well, it means that the economic like and the business model of the token right was inherently dependent on a centralized system that was controlled by a single actor. right And so if we think about that as compared to Ethereum, how are they different? Well, in the case of Ethereum, right the value accrual accrues on-chain and no one controls it. No one can turn it off.
00:27:23
Speaker
right No one can single unilaterally change the the economic outcome associated with that asset. As a result of that, there's very low risk of information asymmetry. In the context of of FTT, very high risk of information asymmetry.
00:27:37
Speaker
At any point, right first, what the revenues of FTX were, completely no transparency. So you have no idea what value they're going to deliver back to token holders. Further, FTX could have just turned off at any point.
00:27:51
Speaker
Right. And like to highlight how significant the risk of information asymmetry was. All we have to do is look at what happened when it was uncovered that FTX was engaged in rampant fraud.
00:28:01
Speaker
Right. the The token holders, FTT holders obviously did not know that when it was discovered, the price of of the FTX got shut down and the price of FTX went to zero. That relationship, right, of FTX to the FTX exchange looks identical to a profits interest, which is regulated like a security.
00:28:19
Speaker
Whereas that type of fraud, that type of of of lack of information parity is not possible with Ethereum, right? you you you have you You have so much greater information parity, which means that you should have a different regulatory framework to to regulate that type of asset versus an app asset like FTT.
00:28:37
Speaker
So can can I also just ask a few more basic questions? so Because I actually try to understand the the bigger context a little a little better. So, i mean, if we if we take a few steps back, one reason why we saw people it calling tokens utility tokens is because they wanted to avoid being called a security. And then they use the foundation model again to be avoided as being regulated as a security.
00:28:59
Speaker
um And there's good reasons and bad reasons ah the way I see it. right so I mean, if you think of a token, whatever that may mean, whatever it may entail, um for security, there is, we have ah it's a particular contract, you basically do something, something comes out, it is meant for investment, right?
00:29:16
Speaker
A token can mean many things, right? So if you if you issue a token, it can be an investment early on, or it will likely be bought by investors early on, but eventually it is it has a use value of some form, maybe, right?
00:29:27
Speaker
It could be in the form of some voting rights. um It's not clear what gives the token value. Sometimes it's clear what it gives it value, but there's of no cash flow rights but embedded in it, which is normally how we think of something to have value.
00:29:42
Speaker
um and So I'm trying to figure out really, ah we um you know obviously these things are all interconnected, but if you had a choice, we have to think of a case. First, we have the token. The token has does stuff, right? So how should we think about the token? What's the right way to even ah set up rules around a token, even if we, you know, within securities law or expanding on securities law? because So for instance, if I give you a token that a token happens to be a security, in principle, i have to give you also a prospectus with it, right? So I think that's the law. that's the law
00:30:18
Speaker
And that's not really... practical in in a world in which you have you know decentralization and self-custody wallets. So is that the first step that we have to address maybe? And then we move and then the foundation thing is is an integral part, but a separate part?
00:30:34
Speaker
Yeah. So I think um it's a little tough tie at the foundation together with the token piece, but let me let me start by addressing your kind of the the taxonomy question that i think you're you're kind of getting at here, right? which is so So we wrote a piece together with i wrote a piece ago with Eddie Lazarin and Scott Commeners, who's ah a professor Harvard, Eddie is our our CTO here, called Defining Tokens.
00:30:57
Speaker
And what we tried to do there is create a taxonomy, and it's a little bit different than other taxonomies because we try to define tokens both in terms of what they what they do and what they don't do, right, to give you a kind of basis for like what the regulatory approach should be to right And what what we really kind of dialed in is when you view the regulatory scheme with respect to you know the decentralization of these assets from a control lens, then it's very easy to define a token right that that has unique properties like Bitcoin, Ethereum, and Solana, and Uniswap, and AVEX.
00:31:33
Speaker
and we And we call those network tokens. And fundamentally what they are are tokens that derive their value right, are reasonably expected to derive their value from a blockchain system. So from a you know blockchain network or a smart contract protocol.
00:31:46
Speaker
And the reason that that is really important, right, is because those underlying systems can function without human intervention and control. Blockchains and smart contract protocols are the only thing in the world that can function without human intervention and control.
00:32:01
Speaker
And so they are the the the the fact that the value is accruing from that source gives network tokens a fundamentally different risk profile than an ordinary security and and and even something like FTT as i was as we were talking about.
00:32:16
Speaker
um So I think it's it's really critical, right, to to to target specifically, you know, what is it about, you know, all of these tokens that we see that actually matters.
00:32:26
Speaker
Now, what I would argue is that the utility of these things does not matter to their risk profile. So the fact that you know ETH is used to to you know in transactions does not matter from from this perspective.
00:32:41
Speaker
The fact that Uniswap tokens are not used for you know consummating transactions does not matter. and And what I would say is the the reason why I think that that is consistent with how securities laws work is that like no one would argue that a share of Amazon stock should not be subject to securities laws merely because you could you could pay for AWS services with that share of stock right if Amazon offered up that as an ability that wouldn't change the characteristic of the asset just by giving it some utility right now now it is an interesting argument that has been used before and and there are certainly cases where
00:33:16
Speaker
you know assets are purely utility tokens and have no investment you know purposes whatsoever where they literally cannot increase in value or decrease. and And we call those in our taxonomy arcade tokens.
Token Definitions and Regulation
00:33:28
Speaker
Right. Those are like rewards points and airline miles and things like that, where they do have utility. Right. But they have no investment purpose whatsoever. And so as a result, you know, we would bucket that very differently from a network token where there is a clear potential for value accrual based on some underlying technology that is functioning without human control.
00:33:48
Speaker
Yeah, so I think we're sort of touching, I think touching into ah sort of something contemporary, which is obviously Congress is currently debating market structure legislation. and I think it takes a stand on some of the some of the aspects that we've been discussing. So i'm I'm kind of curious if you could maybe provide a bit of context on ah the current deliberations, like where where what's been done. I mean, obviously the clarity act has been passed by the House, but the Senate hasn't passed anything.
00:34:13
Speaker
And so if you could just provide a little bit of context on on that. and then also maybe related to what we've been discussing so far. so So just to to tie it all together, right, the reason that that foundations are are pretty critical for network tokens is is they can be used, right, to ensure that that no one is controlling the system.
00:34:30
Speaker
um And, you know, we think in that purpose and and that kind of limited framing, they're very helpful. But where you're just shifting control over the system from, you know, a dev co to a foundation, you really haven't changed the underlying risk associated with the asset.
00:34:45
Speaker
Right. You've just moved it. and And as a result of that, like we think that there is too much dependency on these offshore foundation structures now where people have used it again as a shortcut to decentralization as opposed to building out robust decentralization.
00:35:00
Speaker
Now, at the same time, right, we've been advocating for, yeah you know, use of a domestic entity structure in the United States called the Decentralized Unincorporated Nonprofit Association, right, a DUNA, which was adopted in in Wyoming last year. and And the purpose of that structure, right, is really to to basically um creek provide an alternative pathway that is solely focused on decentralization.
00:35:24
Speaker
So the the DUNA is not a separate legal entity that has, like, you know a board and directors and officers and and and tons of employees. It is purely a a kind of legal wrapper of the things that token holders and decentralized governance have control over.
00:35:38
Speaker
So, you know, where you have not eliminated all control with respect to your system, let's say you, you know, a smart contract protocol can be upgraded. If you have token based governance over that, the DUNA provides you with a a legal entity that allows you to kind of facilitate that type of governance um mechanism without incurring, you know, potential unlimited liability, allows you to pay taxes and do other things.
00:36:00
Speaker
And then there's also you know a structure called Borgs, which are you know basically have been developed to to push you know governance and and various mechanisms of control on chain so that they're transparent for everyone, as opposed to having them be off chain and obfuscated, sitting in the hands of a couple of directors in the Cayman Islands.
00:36:19
Speaker
The last thing I would say on on kind of the foundation structure is like one of the best examples of how this has been kind of a perversion of the original ethos of the space. is that you know right now it's it's like difficult to find attorneys in the Cayman Islands to help you set up these structures because all of them you know sit on the boards of tons of different foundations and just collect fees.
Offshore Foundations and Regulatory Arbitrage
00:36:43
Speaker
that That is, if there's anything that is is more anti, I think what this industry is supposed to stand for, it would be that. and And again, you're you're you're vesting a lot of control and power in these you know in these individuals, which again, think undermines the real promise of this technology.
00:36:58
Speaker
So you said a lot of kind of very interesting and important things there. And actually, so um so instead of pivoting to market structure quite yet, maybe if we could dig in a little bit to what you said.
00:37:09
Speaker
So first, I kind of have a very naive question, um which is, you know, you talked about early on about how Under, I think, the Gensler SEC regime, there was this then tendency to try to, I guess, protect them. like Entities were trying to protect themselves from it. And and this foundation structure was at least like a tactical method to to do that.
00:37:32
Speaker
um but so i'm um And then, of course, when you talk about DUNA as this this sort of new structure, um or I guess like something that that hadn't been in law, presumably, um until until recently, um I'm trying to understand what exactly... like when when these When these entities were setting up foundations to protect themselves against the SEC, were they doing it i ah just purely as a...
00:37:58
Speaker
as a way of giving themselves a legal argument or were they actually on like firm legal footing? Partially what I'm wondering is like, what exactly was the legal architecture? um wanna say objectively, i'm but I'm not sure that makes any sense in this context, but I kinda wanna, I'm trying to understand to what extent was the sort of, ah legal space set and that it was clear what you know these entities could and couldn't do and to what extent was it, look, we think this is our best approach in terms of defending ourselves against the SEC.
00:38:29
Speaker
And then I'd like to dovetail that into like the actual idea of having a new structure, a new legal structure, um because maybe that'll clarify why it might have been needed. Sure. So it's it's it's a there's a spectrum. Right on on one side you have people that were in good faith using the foundations as a vehicle to enhance decentralization to guard the credible neutrality of the system to you know provide grants to people to build on top of these systems and and to advance advance that ecosystem.
00:38:59
Speaker
Right at the other end of the spectrum You have people that had no interest in decentralization whatsoever, but just wanted the legal argument of the appearance of decentralization, right, in order to be able to launch their token and, you know, not attract immediate attention from the SEC.
00:39:15
Speaker
And so that is the most cynical use of these foundations was purely decentralization theater, right, as a way to shortcut decentralization, get a token to market and, you know, extract as much value as possible.
00:39:27
Speaker
And so so, you know, every, all of the the foundations in existence sit somewhere along the spectrum. And I would say that over time, right you know as the SEC got more aggressive um that and and as you know the market heated up in 2020 and 2021 and 2022, that the use of foundations started skewing more towards the bad side of that that spectrum right as opposed to to the good side.
00:39:53
Speaker
And then there's also the idea right that that a lot of this you know shifting offshore you know has kind of very uncertain tax consequences. And so like there's just a lot of of kind of problems with that structure where when we find ourselves now in a regulatory environment that is is much more constructive and much more like wanting to keep this technology here and make the U.S. the center of um of crypto development, right, this off-shoring, this obfuscation, right, and this short-cutting of decentralization really shouldn't be something that entrepreneurs are continuing to pursue because it's ah it's it's kind of a a lot of organizational burden and debt to put on your your your project um when really you should just be focused on building things that consumers want.
00:40:37
Speaker
I see. um And so, ah When it was the case that you had a number of entities cropping up that were, ah let's say, not following the the initial spirit of the idea of what these foundations were supposed to be about,
00:40:50
Speaker
um Were they nonetheless like following the letter of the law as it pertained to that? or was it Because part of what I'm wondering is like to the extent that they weren't, what was the long-run thought process of of how they thought it would go? and but And again, part of it is also just I'm im um trying to understand what like how clear the law was anyway.
00:41:12
Speaker
as so the lot of very yeah The law is very unclear. right there is no There is no line in the sand that you can point to that says, hey, like there's where it is. right And that was one of the really significant problems with the conception of decentralization right in 2017, 18 focused on the efforts of others, because even that test and when it was laid out, right, had some 40 factors, all of which were very subjective criteria.
00:41:38
Speaker
Right. So as a result of that. how How are you supposed to make any sense of it? like and And so the the legal strategy there then right is like, well, look, I'm going to give myself as good of argument as I can to basically attack right the subjective nature of this very broad test to say, no, no one could have been reasonably relying on our efforts.
00:41:58
Speaker
You know hey that person over there couldn't have been relying on our efforts because you know we said that the foundation was going to be in charge and that you know decentralized governance was going to be in control. So so that right there right is is about setting the expectations of random people.
00:42:11
Speaker
That is why the test itself is such a a poor fit for actually incentivizing innovation because fundamentally what it did. right, is it incentivized entrepreneurs to either ah abandon their projects, right, or to mask their ongoing development efforts?
00:42:28
Speaker
Why would you want either of those things when you're talking about a, you know, an innovative, like, technology sector that is very exciting? You want entrepreneurs to be extremely dedicated to their projects.
00:42:39
Speaker
You want them to talk about what they're doing, right? You want that information's asymmetry in the market, right, but the but the regulatory approach created the exact opposite effect. So let's think about the path forward um and in two ways. So we have on the one hand, we have a lot of existing foundations, right? And then we have possibly new projects that you know will go online over the next two, three, or five years or so.
Recommendations for Crypto Foundations
00:43:03
Speaker
um But let's forget about the ones that that but are coming in the future, although I think you have a plan for those.
00:43:08
Speaker
Let's just think about the existing ones. So what is your view? What should they do? What what would you like to see here happening? Yeah, so I think we're, you know, look, I think i think a couple of things, right? First, I think, you know, people should be trying to eliminate their mechanisms and levers of control over these systems wherever they exist, right? So to the extent that, you know, your system was set up to just defer a ton of control to an offshore foundation, like you should you should seek to actually pursue decentralization, right, and eliminate those those levers of control.
00:43:42
Speaker
um You know where assets have been offshore from the United States to you know foreign jurisdictions. You know we're hopeful that Congress will. You know pass some some crypto tax legislation that would allow for a repatriation of those assets to the United States right where projects were developed and kind of created in the United States right to bring it home.
00:44:02
Speaker
and And then, you know, if if those two things are are both possible and achievable, then, you know, one of the things that that allows for is is to people to, um you know, no longer go through this synthetic or, or you know, optical ah decentralization of their organization, right, and actually bring everyone into the same organization so that they can function most effectively.
00:44:26
Speaker
I can't tell you how many times, you know, entrepreneurs have asked me, you know, whether or not their DevCo can be in the same slack as their foundation. And like, nothing could be less important from like a regulatory perspective right and it's it's insane that we've burdened entrepreneurs with having to think about that problem for the last you know eight years and so I think what what we're really hopeful for is that with market structure legislation right we're able to get a very clear definition of of decentralization focused on control and that and that that gives entrepreneurs a much more robust and and clear regulatory framework to comply with that that that doesn't
00:45:04
Speaker
require this gamesmanship and doesn't enact hurdles for them developing technology that people want. So just out of curiosity, I remember there's this graveyard of firms that try to engage with the SEC and they try to actually follow their the the particular rules that the SEC went forward. They registered.
00:45:21
Speaker
And as far as I remember, they all died. right because And i as I recall it in many cases, because the tokens simply couldn't work the way they intended to under the existing law. but So, I mean, here we have an example where I think we have literally companies that were founded and and then they couldn't do what they wanted to do.
00:45:38
Speaker
So, in your view, again, the the changes will then have to happen in terms of the downstream effect, how you can use your token and what that means, or do we have to bring something else in that's new there?
00:45:50
Speaker
Or do we just have to have a different regime of how they're being treated? Yeah, so so what I would say is that there's been a complete 180 shift at at the SEC, which is now you know has a task force set up And they are working you know very hard to be constructive and helpful with industry. yeah they've They've issued the first no action relief in you know over five years with respect to the industry, which has been you know very helpful.
00:46:14
Speaker
They've issued a lot of different guidance on stable coins, on NFTs. right on staking so so all of it is is moving in a very positive direction. Now I still think that that that doesn't mean right that for most projects you know registering your token as a security and going through that registration path is still not a viable option because one of the things that is basically mandated by securities laws right is that the disclosure regime presupposes and almost mandates centralization, right? Mandates control over the underlying project.
00:46:48
Speaker
you You can't comply with your disclosure obligations if you don't know what people are building on top of the thing that you built, right? And so as a result of that, and and you have no control over that thing that you built, right? So as a result of that, securities laws still entrench centralization in a way that I don't know is is can be easily addressed.
00:47:07
Speaker
And so that might be fine for some projects that want to you know maintain centralized control. That pathway should be available. It was not available under the prior administration. I do expect it will be available under this one and that that pathway you know will enable the the assets to trade on or to be used on chain in a way that that allows a blockchain to function. And so if if a project wants to go the centralized route, they could go that way.
00:47:32
Speaker
For projects that are decentralized, we do need a new regulatory framework for for a couple of different reasons. First, we need clear rules of the road as to when you're in securities law land and when you're not.
00:47:45
Speaker
Right. And if you don't have a clear distinction between you know those two regimes, you're always going to have you know bad actors skirting the law to the maximum extent possible. And you're going to have good actors trying to comply with the law to the extent possible.
00:48:00
Speaker
that That differential creates a very significant disadvantage for the good actors who are burdened by regulations, whereas bad actors are not. That is the same paradigm, right, that led to FTX versus Coinbase, right? Coinbase trying to follow the law, FTX not giving a shit, and we saw where that resulted.
00:48:19
Speaker
Right. So so we need a level playing field for entrepreneurs. And that fundamentally requires market structure legislation.
Need for Market Structure Legislation
00:48:26
Speaker
In addition, right, where we do have like assets that are ah you know sitting outside of the the as the the securities law framework.
00:48:34
Speaker
Right. We do need oversight of intermediaries that are handwring handling those assets. So the centralized exchanges. Right. We already saw how that's blown up. brokers, dealers, and things like that.
00:48:44
Speaker
And so we we need that regulatory framework. and And that just cannot exist under the current regulatory regime because because the regulatory agencies do not have the power to oversee that market. so So those are the two kind of areas where market structural legislation can really you know create a regulatory framework that we think will unleash innovation, right as opposed to you know being a real burden on entrepreneurs.
00:49:07
Speaker
About dunas, but maybe given given Miles your last answer, maybe it's a good time to pivot a little bit to talk about the market structure legislation. um So first and foremost, could you provide some context on you know what has been passed, so like what's the content of the Clarity Act, and then also more broadly kind of what you see as the right direction going forward with regard to the actual substance of the legislation?
00:49:32
Speaker
Yeah. um Yeah. So, so far, you know, we we've seen that the House has now passed two market structure bills. Fit 21 was passed last year and Clarity was passed this year, both with broad bipartisan support, which is great because just ah as an aside, bipartisanship is incredibly important, right? You cannot build a technology industry on ah on a partisan issue that is going to switch you know directions every two years or every four years.
00:50:01
Speaker
So it's fundamentally important that that we get, you know, bipartisan support for this stuff. um Now, the the and right now, so the current state of play is, you know, those two bills have been passed, um clarity being the latest one.
00:50:14
Speaker
And the Senate is now working on its own version of market structure legislation, you know, that we're hopeful will continue to move forward and and keep up the momentum and that we'll get a bill signed into law. um As I was mentioning, the the two key kind of elements of of that bill are, you know, token classification, which is whether or not, you know, an asset, you know, should be regulated under securities laws or under commodities laws, right? And then the, the you know, basic intermediary regulatory framework, which is is regulating intermediaries that deal in those assets.
00:50:47
Speaker
You know, both of those, both the Clarity Act and the Senate draft both use a a kind of conception of decentralization that is focused on control and in clarity, it's just called maturity by like a network maturity framework.
00:51:04
Speaker
And in in the Senate draft, it's just about it's just called common control. And so both of those those those regimes seek to look at and and kind of acknowledge the fact that where you know, where an asset that derives its value from a blockchain system,
00:51:19
Speaker
um You know, its w risk profile can change from looking more like a security to being more like a commodity. The information asymmetries associated with that asset can change over time.
00:51:30
Speaker
right, depending on how decentralized the underlying blockchain system is. Where those systems, again, as we've talked about, are controlled by someone unilaterally, um then the the risk profile of that asset might look very much like a security.
00:51:43
Speaker
But where the system is not- i can i just Can I just interject quickly here? just So the security versus commodity, is this is this like a- ah full dichotomy in the sense like, can there be an asset that is neither a security nor a commodity? Can there be an asset that is both a security and a commodity? i mean this from a legal perspective. I don't mean it from like... ah Is there actually firm's threshold? i mean, the way you describe it, it seems to be it' some threshold, right? so so So there can. And every commodity... So the the reason that it gets complicated and the reason that like the Howey test is very complicated is because ordinary commodities can be sold as securities transactions.
00:52:19
Speaker
Right. So if if I and and so so and and that is is how they were applying the Howie test to digital assets in the sense that, um you know, the underlying asset itself is a commodity. It is not a security. It is not an enumerated security. It does not have the characteristics of the enumerated securities under the Securities Act.
00:52:37
Speaker
Right. However, right where those assets are sold right in ah in a transaction that involves an investment of money you know with a reasonable expectation in a common enterprise with a reasonable expectation of profits based on the efforts of others, like that's the Howey test, then then that transaction is subject to securities laws.
00:52:54
Speaker
And so what what we're trying to you know do with market structure legislation, what what Congress is seeking to kind of provide is, okay, a clear delineation. That concept of commodity being sold in a securities transaction is very difficult.
00:53:07
Speaker
Right. So so what we what we want is a very clear application of the law. And I think both bills, right, both the Senate and the House draft apply securities laws to you know primary capital raising transactions.
00:53:19
Speaker
So you're going to go out, raise money to build a blockchain system. We're going apply securities laws to that. But then secondary trading of that asset is not subject to securities laws and is just treated as an ordinary commodities transaction.
00:53:33
Speaker
And so that is the general framework um that ah that is, ah you know, that's applied. Now, that framework itself, right, introduces a little bit of a, you know, potential loophole or a significant potential loophole.
00:53:45
Speaker
And that if I can just avoid securities laws by selling and a two-step transaction, then you've created a pretty big loophole. So to give you an example, if I can raise money from Goldman Sachs to build my project, and then Goldman Sachs can sell all those tokens to the general public.
00:54:02
Speaker
in circumvention of securities laws then you don't have a very good regulatory framework right. So you need you know restrictions on that type of transaction on people you know selling to the general public as part of a two step transaction you know to make money.
00:54:15
Speaker
But if you can kind of close that gap and and and both of you know that gap is closed in in both clarity and the Senate draft right there there are transfer restrictions that are basically put on insiders.
Introduction to DUNA and Its Impact
00:54:25
Speaker
That's how you basically come up with a robust regulatory regime where you can ensure that it allows for progressive decentralization because it allows for market participants to run a validator earn rewards sell those rewards right but at the same time it creates long term incentives by not allowing you know entrepreneurs VCs hedge funds investment banks to you know buy up an asset and then dump it on the market.
00:54:49
Speaker
So can I also ask ah just a, it's again, naive question, but so as I understand the DUNA or DUNES are, is is Wyoming, right? So it's a state act.
00:54:59
Speaker
um Are you proposing or is this actually generally applicable or um can, you know, is there any any conflict with federal law do you need to actually elevate it to federal law to to make it work?
00:55:13
Speaker
No, entity structures are are generally a a state level regulatory or legal regime. Right. So every state has their own, you know, corporate corporate structure. Right. And and every so state's kind of govern those rights.
00:55:28
Speaker
If you if you were to survey, you know, startups, technology startups in the United States, 98 percent of them are probably Delaware C-Corps. Right. And so so people use the the vehicles in the states that have the most robust case law and you know the the best situation for those companies.
00:55:47
Speaker
Wyoming has has long been ah one of the most innovative states when it comes to entity structures. They're actually the state that created the LLC, which is another entity type that is used by lots of of different you know companies and and and projects in the in the U.S. um and And then they they also kind of you know spearheaded the unincorporated nonprofit association, the UNA, which is actually the the kind of parent entity of the the DUNA, which is the the decentralized version of it.
00:56:20
Speaker
So If you look into the future um um and you know just like to see how this will play out over the next few years, um let's say you get your wishes of how regulatory clarity, what what do you think this will do to this entire environment?
00:56:38
Speaker
um What will you see as the advantages? but How do you see this unfold?
Innovation and Consumer Protection Through Regulatory Clarity
00:56:43
Speaker
Yeah, I mean, I think that the the most critical thing to establish is a level playing field for entrepreneurs to compete.
00:56:51
Speaker
across and one that that protects consumers from you know a lot of harm. And I think if we've seen over the course of the last 15 years of this industry's lifecycle, um it has really been slowed down by not having either of those things. right it's It's been a framework that has incentivized and actually advantaged bad actors over over good actors.
00:57:15
Speaker
And that fundamentally has slowed the pace of innovation and has resulted in a lot of consumer harm. I think the right regulation can completely flip that script. um You know, there is going to be a lot of volatility that results. I think that there are a lot of projects that don't want to have to provide disclosures and that providing disclosures would potentially, you know, look poorly on on kind of their ongoing, you know, prospects.
00:57:39
Speaker
um So it it could be bad for some projects, but could be very good for others. But fundamentally, I think that it will move the market toward in a direction that that that does accelerate innovation.
00:57:50
Speaker
you know One of the questions that I often get is you know when we're talking about regulatory structures in the U.S. is you know does the addition of regulation right mean that we're going to be outcompeted by other jurisdictions?
00:58:04
Speaker
And what I would say is is that I think if you look at how our securities laws and capital markets have functioned over the course of the last you know, 80 years, the exact opposite is true. The U.S. does not win. Its capital markets are not the best in the world um because it has a relaxed regulatory regime. It's because it has the best regulatory regime.
00:58:21
Speaker
And so if we can get the regulatory regime for crypto right, I think we will end up with the best crypto markets world. and I think that that is is a precursor to the best crypto innovation. I have to jump in here, right?
00:58:32
Speaker
um Because I'm actually calling from Canada. And um what I see in Canada is ah theres a lot of crickets. Or rather hearing, I hear a lot of crickets. Now, this is not entirely fair. I know that actually our regulators are thinking about this, but they actually have no idea exactly what to do. I think in some part also because there's really no pressure from an industry here.
00:58:53
Speaker
because our industry, our crypto industry has been absorbed or has actually moved south of the border. um And I mean, we we because of this, we're actually facing a number of challenges here. We face challenges that um you know investors or individuals in Canada would like to have access to tokens, that would like to have access to exchanges. We are actually almost exclusively locked out from almost all crypto exchanges and crypto platforms in the world.
00:59:19
Speaker
ah which is is pretty pretty heartbreaking in a way when you try to access a website and it tells you you're from Canada, you
Challenges in Regulating Decentralized Systems
00:59:24
Speaker
can't come. I mean, we all know how to use VPNs, but still. um And there's I think for for a small place like Canada, there's a lot of risk associated with going its own way um in in this space.
00:59:36
Speaker
So if you would have to talk to our regulators and our regimes in Canada and the US are pretty much aligned, we have... what you call how we have a Pacific coin test, for instance, is essentially the same thing.
00:59:47
Speaker
We have very, very similar structure. What would you like, what what do you think um our federal government, for instance, should do? And I mean, securities law is provincial, but let's skip that for a moment. Yeah, I mean, I would be hopeful that that they, you know, look at what the US s does here or the direction that the US is heading and and try and and adopt those principles, right? I think that that the the core principle that that the fact that blockchains can function absent human intervention and control, right, does change the risk profile associated with them. It is impossible to ignore that fact. And and where they facilitate activity, right, that introduces risks, those risks should be addressed.
01:00:26
Speaker
but But it does not mean you should apply a regulatory framework that is very ill-conceived and that does not allow you to to basically capitalize on the benefits of the technology by enabling them to function without human control.
01:00:40
Speaker
I think, you know, the UK is another jurisdiction where I'm very hopeful of. And, you know, EU obviously had gone out in front with with Mika and and and putting that out there. But I think if you look through that, you know, they only really contemplate decentralization in the context of DeFi, don't really kind you know contemplate control in the context of the underlying digital assets.
01:01:01
Speaker
And I think that that's a real failing on on the part of that that regulatory regime. So, you know, it's, getting regulation to work and and be helpful rather than harmful is very, very difficult.
01:01:13
Speaker
You know, Europe has gotten ahead of of the world on a lot of different regulatory schemes, including, you know, AI. But I would say that that a lot of that regulation has been ineffective. And, you know, the the best and havent kind of, you know, side story there is, you know, the Apple has those the new AirPods that that kind of can translate directly for you.
01:01:34
Speaker
you're not lot they're not allowed to sell those and in Europe, right? because Because their AI services are not permissible under their regulatory framework. So you can get that purpose, right, in in Europe, which is like the place where you would want it, right? So it's it's it's kind of insane.
01:01:51
Speaker
And it it just highlights the risk of rate of regulatory approaches, right? You have to get it right. And being first is is not not the goal. getting being Being right is the goal. I mean, the Europeans are...
01:02:03
Speaker
Most of these regulations and also a lot of the discussions that I'm hearing, they often focus really much on centralized players like Coinbase. How should we regulate a Coinbase, right? um How should we regulate you know and an issue if you want of a tokenized asset? Fair enough, right? It's important. But I think there there's very little thinking actually going under the on the on the real feature of blockchains, which is the decentralization, the user control, ah the direct user interaction rather than interaction with intermediaries. I think regulators, generally speaking, and policymakers have a very hard time
01:02:34
Speaker
thinking about a world like that, where but there is actually not a particular party, where there's no regulatory hook in between. I think this is the word that people are looking for. I think this is, it's just really hard for them to to envision this.
01:02:46
Speaker
That's right. And also, you know, looking at at a centralized exchange and seeing an intermediary and saying, hey, we know how to regulate intermediaries. That's very easy, right? and And the ultimate regulatory scheme that applies to centralized exchanges and other intermediaries is likely to look very similar to other regulatory schemes that apply to intermediaries. That just makes sense.
01:03:08
Speaker
But grappling with you know DeFi, grappling with you know the decentralization of a blockchain system, how control impacts the risk associated with its asset, that requires a level of of technical expertise and understanding of how these systems function that that is is really hard for you know regulators to grasp with. And it's just not something you know we've seen in regulatory approaches in the past.
01:03:33
Speaker
So now speaking of this, actually, one this is actually one thing they also notice is you know ah the regulators in Canada, the ones that I'm talking to, are actually quite eager to figure stuff out. right um But I think there is there's a real gap, there's a real difficulty to actually getting a proper understanding of it because simply they don't have access to the kind of information they need. They talk to existing financial players, which they're really good at, but they don't actually provide them with the right information either, right? Because they have their own perspectives. How do you actually solve that conundrum?
01:04:02
Speaker
I think, you know, advocacy, right, and and continuing to to to try and show this. I think One of the most difficult things about the industry is obviously it's not a mono monolith, but but it ends up with a roadside test where anyone can look at it and see what they want to see, right? If you want to look at the industry and see fraud and scams, you can see it. If you want to see centralized control, you can see it, right? If you want to see decentralization, credible neutrality, permissionlessness, you know, censorship resistance, you can see those things too.
01:04:31
Speaker
But it the you know it's it's in the eye of the beholder. And I think that that also makes it very challenging for regulators as well, because there's there's just a million examples of everything in the space. and And it becomes difficult to know, you know, where should, what direction should you be headed in?
01:04:46
Speaker
And so that's it's tough. I don't you know, i'm not saying it's an easy job. It is it is definitely very difficult. And and I think there's a lot of regulators that are in good faith trying to grapple with the technology, the best example of which I think is the SEC at the moment, right which has completely flipped the script on on what was happening during last event. I want to pivot back to DUNA's with the time that we have left. and but but But even before that, I want to also make sure that I'm understanding conceptually how this relates to, for instance, the market structure discussion. So the way I'm thinking about it, and so please do correct me if I'm wrong, is that
01:05:19
Speaker
ah that first part of the market structure legislation you were describing that deals with digital assets and things like when is a digital when is and when it was one of these assets to security or not, um as an economist, I kind of think of it as affecting the incentives of the entities as they organize themselves and so on. And so I kind of in that sense think of the market structure legislation as downstream of should I incorporate as a DUNA or a foundation or whatever.
01:05:44
Speaker
um so first if i get uh if you could say is that is that a reasonable way to think about it yeah well so a couple things i would say that it's it's i think that all of it depends right on the system that you're building and what you're trying to do right so if you are building a system that is So the market structure framework, right, is is going or it will hopefully point projects to and to define decentralization in the context of control.
01:06:16
Speaker
Right. And so where you eliminate control, your regulatory burden reduces, creating an incentive for entrepreneurs to build these systems to be robust and decentralized and everything. So then the question becomes and and the reason for that is is is obvious, right, where they are decentralized, where they are not controlled, the risk of information asymmetries risk to users goes down. so So from a regulatory perspective, you want to incentivize that that automatic kind of risk reduction right over time.
01:06:45
Speaker
So if you're trying to design a system that is not controlled by anyone, right, then the question becomes, OK, how do you get to that point of no control now in some cases?
01:06:57
Speaker
Right. The complete elimination of control is not desirable or beneficial for our users. right If you were to make a smart contract immutable the first day you launched it, you could run the risk that there is an exploit in there that you would have no way to address. right um you know There are bridging bridging smart contracts. There are you know ways to upgrade these these blockchain networks um that you know ah allow people to address vulnerabilities.
01:07:24
Speaker
But where you have to have that lingering level of control, right, you obviously now introduce risk to users that you're going to manipulate that control to extract value. So the the way to think about the DUNA is kind of ah an alternative avenue, right, for you to use decentralized governance mechanisms.
01:07:44
Speaker
This can be token-based governance. It can be validator-based governance, right, node-based, whatever whatever you want. but to to rely on those mechanisms to govern the system that you've created.
01:07:55
Speaker
So where you cannot eliminate control in full, right, then you can use DUNA's and Borg's to create, um you know, decentralized governance systems where you can vest that control in a way that doesn't undermine your your pursuit of eliminating control for purposes of market structure.
01:08:15
Speaker
does that Does that make sense? Yeah, absolutely. This is actually this is a very very good way to ah to to frame this and and very useful for us. And I think actually, i mean, for those of us who who are economists, I think there's a lot of interesting questions that yeah if you actually raise in terms of control.
01:08:29
Speaker
how do we think of the, you know, payoff function value and beyond that and and embedded in this? And um I think this is this is this is great. and And I think we we learned a lot from you here.
01:08:40
Speaker
um And I think we want to be mindful of your time um and and just thank you for all the insights that you've provided. I think this is great. And um yeah, so ah wish I wish you ah good luck that that you that your wishes become true in a legal sense, that you have the ability to push for for what you think, because there seems to be a good plan here.
01:09:01
Speaker
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