Crypto Invest Summit — Pt. 2 of 3: From Boosterism To Skepticism; U.S. Legal Quagmire
This is second in a series of posts on takeaways after last week’s Crypto Invest Summit in L.A. The other posts are Part 1 and Part 3.
Breathless boosterism (2017) vs. matter-of-fact skepticism (2018)
The smart contracts thesis looks to break free from the shackles of the “Bitcoiners.” The goal is to unleash trustless systems for value transfer in the service of incentivization, not just of the resources necessary to maintain decentralized computer networks (e.g., from the miners), but also of off-chain actors and actions. A counter-thesis of the Bitcoiner (e.g., Jimmy Song) — that the centralization, oracles, and other means necessary to create networks for value transfers of non-digital-bearer-instruments substantially undercut the viability of using crypto — seems more widely held than seen. However, like a black hole, even if invisible, this thesis leaves evidence of its existence, namely in a broader skepticism about use cases.
Consider some cross-examinations from the CIS stages of the following crypto projects and concepts:
· Crypto-fiat tethers just combine the worst of the worlds, per Tim Draper.
· Many protocols, like 0x, flounder for lack of associated business models.
· Crypto volatility is a barrier to enterprise adoption.
· Steem’s experiment in crypto-incentivized content suffers from a number of issues, such as the use of witnesses, governance and token economics.
· Attempts at large token-curated registries (e.g., a tokenized Yelp, Zagat’s or Wikipedia) may be biting off more than they can chew, given: 1) their tendency to devolve into popularity contests may make them inferior to expert-based approaches, 2) low voter participation rates can make the cost of manipulating results too low, and 3) the potential to manipulate validators through the use of high stakes.
· There seems some case for solving data problems of social networks, and one CIS presenter, metame (disclosure: advisor), has an intriguing approach encompassing this. Nevertheless, Vitalik himself has questioned whether there’s enough value in mere social network data, thusly: “Paying people for personal data is interesting, but there are concerns about adverse selection: to put it politely, the kinds of people that are willing to sit around submitting lots of data to Facebook all year to earn $16.92 (Facebook’s current annualized revenue per user) are not the kinds of people that advertisers are willing to burn hundreds of dollars per person trying to market rolexes and Lambos to.” Thus, personal data solutions in crypto may have to aim higher or more broadly.
· The many protocols relying in some way on reputation face the persistent prospect of Sybil attacks.
· Related to reputation is vouching for the quality or authenticity of data, but the proposed solutions of oracles and token-curated registries face skepticism, especially from the Bitcoiners’ black hole.
· The ratio of discussions about how to overcome crypto’s challenges (consensus mechanisms, scaling, legality, etc.) to discussions about how crypto could solve problems vexing enterprises remains high, marking perhaps one of the more disconcerting bubbles in the blockchain space.
The need for decentralization
Maybe the most common question which the unconverted pose to blockchain evangelists is “does the project need to use the blockchain?” — but is this query an acid test or a red herring? The most valuable “app” for the blockchain is Coinbase, a centralized token exchange reportedly raising $500 million at an $8 billion valuation. Even ConsenSys execs concede that decentralization is frequently a buzzword. The centralization introduced by the Lightning Network may well be worth it to dramatically reduce payment transfer costs. CryptoKitties are cute, but some wondered whether they would be less so even if produced by a centralized network, and their tech is clever, but does it drive value? True, decentralization aids in censorship resistance, but do loyalty points need such resistance? The power of decentralization to win the “hearts and minds” of entrepreneurs and developers, through incentives enforcing immutable promises to forswear the “bait and switch” of the centralized platforms (a process well described by Chris Dixon), is seen as dependent on first solving key infrastructure problems.
The need for a native token
Core to the value of native tokens is their “abstraction of value” — per a ConsenSys exec — of the utility of the network. For example, ERC20 tokens can avoid fluctuations of the value of ether, which are driven by a much more complex supply and demand equation. Pantera’s co-founder asked rhetorically “why buy a token that is not useful?” and said that bitcoin was the first utility token (to scale, certainly), only valuable if people find it useful (agreed). A blockchain solution without a native token would seem to have difficulty competing with a mere database. If a fundamental innovation of crypto as a technology is to allow for decentralized transfer of value, then you need a way of effecting and tracking these value transfers — that’s what native utility tokens do. By contrast, “security tokens” (more on those later) are by definition not useful. Rather, they are crypto receipts for transactions in rights that ARE useful. For example, if you arrive home to find a stranger squatting there, the deed to your house — tokenized or not — is not what ultimately gets the police to arrest the stranger for trespass. Rather, what does the trick is the verification of your ownership on the property ledger, and the legal rights associated with that ownership, which are ultimately enforced off the chain by the courts and the police.
Continuing U.S. legal quagmire
The consensus view seemed to be that the door to legal U.S. token sales without registration with or exemption from the securities laws is closed. One presenter said the SEC had put the “kibosh” on utility tokens. Another, a lawyer, tut-tutted than anyone thinking the SEC might change its stance on utility tokens was kidding themselves.
Several key constituents in the crypto community do not want to take “no” for an answer on utility tokens, however. A number of presenters said that a top priority remained clear guidelines as to when a token sale was, or was not, a securities offering. One concern is that the regulators may not sufficiently understand the technology (which is not much of a knock, considering the tech’s complex and rapidly changing nature), and that better explanations here could release at least some utility tokens from their current D.C. holding pen. The Brooklyn Project is trying to build a global consensus about how to treat token projects under the laws (and not simply the securities laws). Among its tools are old-fashioned, in-person legislator education, as well as more tech-savvy Telegram channels and Google Docs circulated for comments by interested parties.
To some extent, regarding token sales, the SEC has crafted a position that it is there to help, but in reality it is not doing so. A helping hand apparently appeared in the so-called Hinman speech in June, but a ConsenSys exec (hailing from a white shoe law firm) noted that this was merely a speech, and not binding guidance, and further that the apparent transparency of factors of focus in the speech has proven cryptic in practice. For example, law firms are leery of providing a legal opinion that a proposed project is sufficiently decentralized for its token sale to fall outside of U.S. securities law requirements. As another example, Hinman’s focus on whether token buyers plan to use the tokens apparently rules out the use of sales discounts, even though discounts (such as for volume) are commonplace in product markets. The SEC still has an open door policy to informally discuss how the law might apply to a contemplated token sale. However, what would be more helpful, according to a ConsenSys exec, would be just one SEC no-action letter (non-binding guidance on a fact situation where the SEC would not recommend a securities law enforcement action) on a token sale.
The inconsistencies in the current, conventional view of tokens under U.S. securities law persist. As emphasized by the COO of Phunware, blockchain and crypto are fundamentally innovations for the transmission of value. Thus, the issue is which value transfers are covered under the securities laws. Beginning of rant. Software-defined crypto networks with native currencies offer the potential to harness speculation to drive greater use of those networks. Despite this, the sale of utility tokens to users of networks apparently implicates the U.S. securities laws. The house view of U.S. securities regulators is that the sale of this narrow, technologically bounded device (utility tokens ALL relate to software, whereas the typical security relates to any industry) must be accompanied by securities law disclosure, as opposed to product/service disclosure. It’s as if the purchaser of an iPhone needs to read Apple’s annual report, as opposed to product reviews and e-commerce price lists. End of rant.
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