CryptoCounsel Podcast

The podcast that decodes the most important crypto disputes.

A Conversation with SEC Commissioner Hester Peirce

November  12, 2024

In this episode of the CryptoCounsel, hosts Josh and Frank sit down with SEC Commissioner Hester Peirce to unpack the complexities of cryptocurrency regulation. Together they discuss the recent challenges of SEC regulatory actions and the SEC's potential role in fostering innovation going forward. Commissioner Peirce describes her vision for a more open dialogue between regulators and crypto entrepreneurs. With insights on legal enforcement, collaboration with global regulators, and the evolving landscape of digital assets, this episode offers a deep dive into the future of crypto policy in the United States.

Transcript

Comm. Peirce: I’m really excited because I think we’re going to see a whole new era in innovation once you have a regulatory willingness to engage with innovators.

Josh: Welcome to the CryptoCounsel at Wiley. We are the podcast that decodes the most important crypto disputes in law and regulation. I’m Josh, an international lawyer who does crypto.

Frank: And I’m Frank, a finance and technology litigator who also does crypto.

Josh: It is an honor to welcome our guest, Hester Peirce, who is a Commissioner of the U.S. Securities and Exchange Commission. The SEC has been at the center of the storm for the regulation of cryptocurrency in recent years, and this is a topic that has been right up our alley here at the CryptoCounsel Podcast. So, thank you so much for joining us Commissioner Peirce.

Comm. Peirce: It’s wonderful to be on the CryptoCounsel podcast, so thank you for having me. And I want to start, of course, with my disclaimer, which is that my views are my own views as a commissioner, not necessarily those of the Securities and Exchange Commission or my fellow commissioners.

Josh: Understood. And one thing we like to ask on the CryptoCounsel is kind of the background, the origin story about your exposure to cryptocurrency. Obviously, it’s a new technological development. Tell us about it. How did you first learn about it? And was it an area of focus before you came to the SEC?

Comm. Peirce: Colleagues where I worked before, I was working doing financial regulatory work at a sort of research center, and some colleagues of mine were working on crypto issues at that time. Bitcoin was obviously out and fairly well established, and so they told me about it. I thought it was very interesting and you know, they said there are other people developing other types of crypto assets. And so it sounded interesting to me. I mean, one of the things that really draws me to it is this notion of decentralization and peer-to-peer. Having worked in financial regulation for a long time, I saw that intermediaries can cause problems. They can have, you know, they can cause problems to financial resilience. They can also prevent people from getting access to financial products and services because they can just say no. And so this concept of having a way to transfer value peer-to-peer without a centralized intermediary was interesting to me.

Josh: That’s fascinating. One of the interesting things about the timing here is that Bitcoin, as you said, was in the market, but when you were sworn in as an SEC commissioner, that was in January 2018. Bitcoin was trading around $10,000. The FTX rise and collapse had not happened. Cryptocurrency wasn’t as much at center stage. And so I’m curious, now that you’ve been at the SEC for almost six years or over six years, you’re seen as a champion for the industry. Why have you become such an outspoken leader in this space?

Comm. Peirce: Well, I wouldn’t say that I’m a leader in the space at all. I mean, I’m just a regulator sitting on the sidelines trying to figure out how can we make the rules of this game fair so that everyone can come in and compete. If the market likes you, that’s great. If they don’t, that’s fine too. That’s not really my decision.

When I came to the SEC, one of the things that I was looking at was how does the agency handle innovation? I had been at the agency before, and not surprising, regulatory agencies tend to be fairly conservative when it comes to letting in new products and services and new entrants, dynamic entrants, into the market because you get comfortable dealing with the types of entities that you’ve known and the types of products that you’ve known. And so when you are confronted with something new it can be difficult, and, frankly, when you say yes to something and it goes wrong people come and run to you and say, well why didn’t you stop it? And so, I was hoping that we could find a way to sort of smooth the path for innovators who are trying to innovate in the financial services space.

Crypto was a really nice case study for how we deal with innovation because a lot of the people who are doing things in crypto were approaching it from outside of the traditional financial world. They hadn’t, some obviously grew up in TradFi, but a lot of people came from a technology background and they started to think how can we apply this technology in the regulated space? And so that was a lot for an agency like the SEC or any agency to handle is, how do you deal with this new set of entrepreneurs?

And so that really is what drew my interest. Again, it’s not up to me to make calls. We’re not a merit regulator. So it’s not up to me to make calls on whether a technology is good or bad. It’s really just let me see what I can do to let people come in and try and some of those experiments will succeed. Some will fail.

Josh: You mentioned earlier that one of the aspects of crypto that was interesting to you at the beginning was its decentralized nature. Was it more the newness of the technology, or is there something inherent in that decentralization of finance that was a challenge for regulators?

Comm. Peirce: Well I think there is in the sense that our whole regulatory structure is built around regulating intermediaries. And so when you bring up this possibility that you could have transactions happening without any intermediary, that’s really challenging. And there aren’t easy answers, although I think we can look to the technology for some of those answers. You get, you can get more transparency with this technology, again, you know, as I mentioned, you might have an intermediary that wants to say no to people, whereas the technology says, look, these are the terms, you like them, you can transact, you don’t like them, you don’t have to transact. But everyone knows what the terms are and everyone can come in on the same terms.

And so some of those things address the problems that regulation was really designed to address. Now that’s not to say that there aren’t unique challenges to regulating this technology, there certainly are and I think those are things we have to talk about.

Josh: When it comes to those unique challenges, quite a lot has played out in the courts and for that, maybe I’ll turn to my colleague, Frank, who’s done his share of securities litigation.

Frank: Yeah, we’ve talked a lot about Howey on the podcast and we’re actively involved just by way of full disclosure as counsel to Texas Blockchain Council and the Satoshi Action Fund in the Coinbase case against the SEC in the third circuit, challenging the absence of rulemaking in Coinbase’s mind. But, I’m curious for your views on the roles that the courts should be playing. I think you sort of have recognized that Howey has some limitations, but, you know what should the courts be doing or what could they be doing in light of those limitations?

Comm. Peirce: Yeah, well, I think, you know, far be it for me to tell the courts what to do. You know we bring in our best case and then the court can make its decision. I think, though, there’s so much focus on Howey and it’s really been a challenge because Howey cases have always been a little strange. You know, you can have these things, these assets at the center of these investment contracts that are just normal things that people use or, you know, a cask of whiskey or some sort of an animal that’s being taken care of or the orange groves that were at issue in Howey.

And so what does it mean for something like that to be at the center of a securities transaction? I think we’ve been a little imprecise about that. And part of the reason probably is that we haven’t had assets at the center of investment contracts trading on platforms, trading platforms the way we do with crypto assets. And so it does pose some interesting new questions for us. But I think we’re making a mistake if we’re only viewing this through the lens of Howey and I hope that courts will help to provide some of the legal clarity that we need in this area.

Frank: Yeah, I imagine it must be pretty funny as a technology and innovation forward Commissioner to have to deal with a 1930s era Supreme Court decision as the sort of touchstone in this whole space. I mean it sort of creates these weird conversations that you’re describing and these weird ways of thinking about it.

Comm. Peirce: Yeah, I mean, I think that’s true. I will say that the securities laws are, you know, they’re designed to be timeless. And so this definition of security is broad investment contract is one element as you know. But it really, I think if applied correctly and using the exemptive authority that Congress gave us, we can do a lot with the existing - even though they’re old - securities laws. So I just think it requires a more adept hand than we’ve been wielding so far.

Frank: So, you know, a lot of people out there in the industry and the commentators that are following the court battles have referred to this fight as regulation by enforcement, right? That’s sort of something that people have thrown around a lot. And I guess I’m interested in your views on sort of the limitations on that and also just what a good alternative might look like from the SEC’s standpoint. If they’re not going to regulate by enforcement, what could or should they do instead?

Comm. Peirce: Yeah, I mean I think some of the confusion stems from the fact that people look at the SEC and they say, oh – SEC law enforcement agency. And I say, no actually, that’s not the right way to characterize it. The SEC is a regulatory agency that has an enforcement function which is very important to what it does. But you have to start from point A, which is writing the rules. And then, point B is helping people figure out how to apply those rules in their circumstances. And then point C is enforcement against people who are not complying with those rules.

So clearly, if you have someone who’s wearing a T-shirt that says crypto entrepreneur and is stealing people’s money. Well, I mean, in enforcement cases, the right solution to that – you don’t need a rule because there’s already a rule that says don’t steal people’s money. Now whether that’s us enforcing it or someone else, but there’s already law for that. And so that you should proceed directly to enforcement. But if you’re talking about trying to figure out how does the securities laws, which are complicated, apply to a unique set of facts and circumstances, you can’t just jump to enforcement and you shouldn’t look to your enforcement division to be writing the rules because you’ve got experts in the Division of Investment Management, the Division of Corporation Finance and the Division of Trading and Markets, who are brilliant and have been thinking about these issues, many of them for decades.

And so all we need to do is say “hey, here’s a new set of really interesting challenges – go work with the public and figure out how to solve them” – and then you get a set of rules and then you can enforce those rules. Now, clearly in this area, there are some places where Congress probably needs to come in and figure out where they want the regulatory authority to lie.

But I think there are things we could have done. Tell people, here are some things to think about when you’re assessing whether or not this is a security – this thing that you’re talking about is a security. Let’s work through some of these difficult custody issues for investment advisors. We put out a special purpose broker dealer framework for broker dealers trying to handle digital asset securities as we’ve called them, and yet it was not a practical framework. So go figure out a more practical framework. We can achieve our regulatory objectives without preventing people from being commercially viable. And so there’s a lot of work that we just tried to short circuit with enforcement. And that’s not only not a good way to regulate, but it’s impossible, in the sense it’s inefficient.

You’re fighting all these different enforcement cases and we’ve got a lot of things that we need to do with our enforcement resources. There’s a lot of, in the traditional securities markets, there are a lot of things we could be using those enforcement resources for. If we tried to go and go after every project in the crypto space, we’d be at it for hundreds of years. And so that can’t be the right way to regulate.

Frank: So you mentioned Congress and obviously there has been some activity on the Hill, and now it looks like we’re going to have a new Senate, a new House, and not in terms of prediction, but just in terms of thought exercise, I mean, if we get legislation in this space, in the digital assets space, I mean, you know, what would be an effective way of legislating if that can happen?

Comm. Peirce: Well, I mean I will leave the legislating to the legislators, though I think the SEC should be actively involved in providing them technical assistance and in working with the CFTC, for example, to do some of the sort of the legwork. We could have been doing that now. We could have been holding some joint hearings to talk to people or joint round tables to talk to people. And so we could have done some of that work. But I think ultimately, we need to figure out which aspects of this we think need to have a regulatory framework. And that’s going to differ depending on who you talk to, but a lot of people do want to have some sort of regulation around someone’s doing a token or coin issuance. What’s the disclosure going to be around that? If someone is setting up a trading platform for these things, what kind of rules are going to apply? Are we going to apply the same kind of rules we apply in our equities markets?

So thinking about those kinds of things, and then also remembering that while we think about this through the lens of financial markets now, probably a lot of the innovation will not end up being financial. It’ll end up being crypto technology being applied to solve problems that are not financial problems and, you know, it’s a way of coordinating human activity and so you can imagine a lot of applications that have nothing to do with the financial services industry. As we’re writing rules or as we’re writing legislation, we, as Congress is writing legislation, that’s something that they should bear in mind.

Frank: Yeah, that definitely resonates. I think a lot of people and a lot of clients and folks that we talk to focus on the financial product aspect of the industry and less so the blockchain aspect and to hear the idea that there are maybe two lanes or two sets of rules, not separate, but just that those two use cases have to be accommodated in any legislation or regulation is, I think, refreshing and helpful because they are different and pose different issues in a lot of ways.

Josh: There was a comment from an industry association that, for example, with a recent election, it takes time to count the votes, and the question was, why isn’t this done already? It could be accomplished through the blockchain. And so, you know, people are still thinking through those different exercises.

Comm. Peirce: Yeah, and some of those applications will end up working and some not. I think, you know, there are pluses and minuses to blockchain applications in a lot of these instances. But yeah, let people experiment with those things. I was reminded, I just was cleaning out a closet and I came across my old Office of Internet Enforcement hat from the SEC and I think that’s such a good reminder. Because at the time, you could cabin off this set of activities that was securities activity using the internet. Now, of course, it’s, you know, everyone uses the internet, obviously, and securities offerings, but also in other things. So, if you had taken a set of rules and just written them with just the financial services rule in mind and applied it to the internet, I mean, that would have obviously been really problematic. So I think we just need to be careful of that same kind of thing here.

Frank: Yeah, I mean in the spirit of metaphorically cleaning out closets, Josh and I just did an AMICUS brief in the NVIDIA Supreme Court case, and we had to unpack the legislative history of the PSLRA which was written about the internet and the dot com and it tracks almost exactly to the current crypto space in terms of the things that the legislators were worried about in enacting the PSLRA in quashing innovation in the internet then and now it’s the same concerns happening again coming up in the context of cryptocurrency related disclosures. So it’s just funny that sort of the old is new.

Comm. Peirce: It’s new again.

Frank: Exactly.

Comm. Peirce: So that’s a good reminder to go back and look at some of that and see what we can learn from it.

Frank: Totally. So you mentioned the CFTC as potentially part of a process with the SEC. I’m also curious about something like the FTC, the Federal Trade Commission, which obviously has a consumer protection role. Do you, and I know obviously the SEC doesn’t often necessarily cross paths when it comes to crypto with the FTC, but do you see a role for the FTC to play in the crypto regulation world?

Comm. Peirce: Yeah, absolutely. I mean I think some of the times when you see some of these terrible fraud cases, for example, there’s a real inclination to say, well, wait, we do need to step in. We, the SEC, need to step in. I think sometimes it’s worth saying, I mean, it’s always worth asking, is this within our authority? Even if this is terrible conduct, is this within our authority? And if it’s not, is there another regulator we can hand this off to, and that might be the FTC. I mean they’ve been doing a lot of other things lately, but maybe, you know, maybe they could refocus, and I’m not going to tell them what to do, but there certainly are areas here that I think they could spend their time thinking about.

Frank: And so to bring it back just to your own home base of the SEC, I know you have the Token Safe Harbor proposal and you’re currently thinking about, so we hear, from stuff that I’ve read, a 3.0, anything to share on that at this point?

Comm. Peirce: Well, I think that what we really need to do at this point, and in developing that Safe Harbor, I did talk to lots of people, but I think to get this operational, we really have got to sit down and have a public conversation. Where it’s not done in a back room, it’s not done in an enforcement settlement action. It’s a negotiation, it’s done with a lot of people participating. And then we need to just think about what should a good disclosure regime look like? And so I really think 3.0 needs to be a community exercise basically.

But I have also talked about developing a micro-innovation sandbox which would essentially allow – and it wouldn’t be limited to crypto issues – I think we need this more generally to go back to the point I started with, the SEC does need some nudging when it comes to innovation policy generally. And so this micro-innovation sandbox would say “hey, you come in – you innovator come in, you tell us what you want to do with a notice filing, you put the conditions in there that you’re going to adhere to. You’re obviously covered by the anti-fraud rules, but then you can go. You don’t have to wait for us to give you the green light.”

Now, if you want this to be lasting, you’re going to have to put in conditions that are reasonable, because you ultimately are going to have to work with us at the SEC to develop more permanent relief for you. But I think something like that would allow people to try things in this space that right now I think they’re largely doing outside of the United States.

Josh: That’s kind of one of the concerns we’ve heard from a lot of clients is that this cloud of regulatory uncertainty means, well, what jurisdiction should we look to? Should we go to Switzerland? Should we go to another place, El Salvador where we feel that there’s a friendly regulatory environment we can trust the government to some extent?

Have you had any interaction with regulators or officials from other jurisdictions and what’s been the scope of those conversations – have you learned anything helpful from them?

Comm. Peirce: Yeah, I mean we at the SEC have a lot of conversations, whether it’s through a formal organization like IOSCO, which brings together all the securities regulators, or whether it’s through informal bilateral chats, you know, when I go travel places, I talk to people about what approaches they’re taking. And I think there is a lot to be learned from a lot of different places. The United Kingdom has a more welcoming approach, Switzerland, as you mentioned. Europe’s put together their comprehensive regulatory approach. And then, you know, there are other jurisdictions in the Middle East, Bermuda, you know, there are lots of people that are trying lots of different things. And I think we can draw pieces from what everyone is doing and we can also see what’s succeeding and what’s not.

Ultimately, we have a unique set of securities laws that we have to slot whatever reforms are into. And we also have a unique culture here in the U.S. that I really want to preserve, which is the welcoming culture for innovators. You know, I don’t want to build a place where when someone is thinking of a crypto project, they’re thinking first and foremost of getting permission from regulators. I want people to be able to think of what is the problem I’m actually trying to solve here? How does the technology help me solve that problem? And then how can I work with the regulators to make sure that I can do this in a way that’s compliant?

But I think that really is a mind shift. It shouldn’t – when you see everything being driven by what the regulations are, I think you see a lot of conduct that is not socially beneficial. People are designing things around the regulations instead of saying “hey, let’s work with the regulators to figure out how we can do this.”

And so I’m really excited because I think we’re going to see a whole new era in innovation, once you have a regulatory willingness to engage with innovators. And, you know, then if we don’t see lots of exciting ideas blossom, then there’s a bigger problem that you and your clients need to address about why isn’t this moving forward.

Josh: That is an exciting vision. We had one guest point to the fact that the Chinese government had cracked down on Bitcoin and that in a way that was one of the biggest gifts they had given to the United States because all of that innovation and activity moved. And you can see El Salvador, we’ve had a guest from El Salvador speaking to the same issue about how they are attracting a lot of capital and innovation.

But one of the things that we find amusing in the cryptocurrency space is that this innovation sometimes becomes colorful and kind of fascinating. So I think you’re on record as saying you don’t hold cryptocurrency for conflict reasons, but I have to ask, does that mean you also don’t own any Dogecoin?

Comm. Peirce: No crypto assets for me.

Josh: We’ve learned there’s a new, what’s the hippopotamus, the baby hippo?

Frank: Oh, Moodung or Moodang.

Josh: Yes, so a lot of fascinating developments here but does that affect your ability as a regulator? You know, obviously this takes a lot of different forms and some of it’s pretty amusing, but how do you understand it without owning it?

Comm. Peirce: It affects my ability and I think just being able to experiment with how to buy it, how to put it into your own wallet. You know how to move stuff, how expensive that is, right? All of these kinds of things would be very beneficial for me to be able to experiment with.

They’re good reasons for ethics rules to say, hey we don’t want you who could profit if you’re holding a big chunk of this stuff, you could profit if you develop rules that are favorable. So I get that. Obviously if this crypto becomes more integrated into more elements of our life, those rules are going to be harder to figure out how to apply properly. But no, I would love to be able to experiment a little bit and learn.

Josh: I have to say that’s not entirely surprising to me because we’ve also found incredibly entertaining, a contribution that you and Commissioner Uyeda made to the field with your script about the Shapeshift regulatory story, “As The Crypto World Turns”. And as far as we know, that’s a unique approach to commenting on these issues. How did that idea come about?

Comm. Peirce: I mean, I have been very frustrated, and I’ve stated that many times about how this has all played out because I’ve talked to a lot of people who really have just wanted to know how to proceed. And so that script that I put, that we put in that dissent is basically the script that I’ve heard play out time and again. And it just kind of wrote itself because of that. And that’s a sad commentary on where we are.

Josh: Well I have to applaud you on some good prose from your experience because the last two lines of the script – there’s one from future Shapeshift which says “I did hire a lawyer and the lawyer has even more questions,” and the SEC responds “Sorry, we cannot help any more than we already have – we don’t give legal advice,” which is a point well taken, but you’ve obviously been engaging with companies and counsel in this field. What do you find most helpful when you are engaging with those companies and counsel? How can they be helpful to policymakers like you?

Comm. Peirce: Yeah, I mean one is you’ve got to dumb things down and explain, not for my colleagues, but for me, you’ve got to dumb things down to explain what are you trying to do, explain why the technology is necessary to do what you’re trying to do. And then what exactly are the stumbling blocks that you’re facing? But I think more generally in advising people and engaging with the SEC and I’m hoping that those doors really will open up again and that people will be able to come through and have those conversations.

You’re iterating on what’s already out there. You’re building on precedent, you’re saying look, all we’re trying to do is push this one step further. This is why this is not a problem. And so be thinking about what are the pain points that you’re facing and what do you need to be able to get past those?

Now you’ve got an opportunity and so people need to be coming in with really concrete solutions. Concrete problems that need solving and then concrete solutions to those problems that are mindful of the needs of regulators like the SEC to protect investors, to foster fair, orderly, efficient markets, and so forth.

So concrete ideas, you’ve got to have some sense of what the landscape is. And don’t come in asking us to give you legal advice because we can’t. But I think there is something that we can offer, which is to say, hey, we want to work with you through these problems and we don’t want to sit in a room with you for three years just talking about these things. We actually want to see you get a chance to try what you’re trying to do in the real world.

Josh: That’s definitely an exciting vision. Frank, any other questions?

Frank: Oh, I feel like we have to ask since she’s here. We did reenact the entire script on the podcast, so do we owe you royalties? Do we owe commissioners royalties?

Comm. Peirce: We’re definitely not allowed to accept those. So you’re in good shape.

Frank: Well, we’re going to take our show on the road at some point so you can come and see a live performance maybe.

Josh: Thank you so much for these amazing insights. Do you have any final words you’d like to share Commissioner Peirce?

Comm. Peirce: No, I mean I just appreciate you having me on and my door is always open so CommissionerPeirce@sec.gov. Especially now, I think ideas of how we can move forward in productive, concrete ways are very much welcome and I hope that sometime soon coming to an SEC near you, there’ll be roundtables where we can discuss some of these issues. So, start thinking about what those discussions should really focus on.

Josh: It does really seem that there’s been a turning of the tide at least in terms of the crypto space and it’s going to be exciting to see how that plays out going forward.

Comm. Peirce: Well thanks so much for having me – appreciate it.

Crypto & Consumer Protection: Insights from a Former FTC Official

October 17, 2024

In this episode of the CryptoCounsel, hosts Josh and Frank speak with Duane Pozza, a partner in Wiley's FTC Regulation and Privacy, Cyber & Data Governance practices and a former assistant director of the FTC's Bureau of Consumer Protection. Together they explore the latest trends in crypto enforcement, the role of the FTC, and the evolving landscape of consumer protection in the digital age. From the rise of meme coins to the complexities of Bitcoin ATM scams, Duane shares important insights and advice for navigating the intricacies of this expanding area of regulation.

Cross-Border Digital Trade: Crypto in the Global Market

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In this episode of CryptoCounsel, hosts Josh and Frank speak with Greta Peisch, a partner in Wiley's International Trade and National Security practices. Together, they unpack Russia's use of cryptocurrency to evade sanctions and the evolving landscape of digital trade. Drawing from her experience in the U.S. Trade Representative's Office, Greta discusses blockchain's potential in supply chains, the regulatory challenges of crypto in trade agreements, and how digital trade policy might shift under different U.S. administrations, offering a glimpse into the future of blockchain in global commerce. 

From Court to Code: Smart Contracts and Arbitration

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In this episode of the CryptoCounsel, hosts Josh Simmons and Frank Scaduto delve into smart contracts, blockchain, and cross-border disputes. They explain how blockchain technology can execute contract terms automatically, which enhances efficiency and prevents disputes. They also discuss the opportunities and challenges of integrating this technology into legal and commercial practices, including revolutionary dispute resolution through “on-chain” arbitration. From the New York Convention to innovative platforms like Kleros, this episode offers cutting-edge insights for anyone curious about international disputes or the future of legal tech.

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In this episode of the CryptoCounsel, Josh talks with Andrey Krahmal, the Head of Legal at Peak Mining, for a deep dive into Bitcoin mining. Andrey shares insights into how Peak Mining is pioneering the industry with large-scale, energy-efficient facilities around the world. They explore the challenges and innovations in the crypto mining space, including the strategic importance of energy sourcing, rapidly evolving technology, and stable regulatory frameworks. From Satoshi's legacy to the environmental impact of Bitcoin, this conversation covers the exciting opportunities and risks of being at the forefront of the digital gold rush.

Crypto & Politics: Insights from Former Congressman David McIntosh

August 22, 2024

In this episode of the CryptoCounsel at Wiley, host Josh talks with guest David McIntosh, President of the Club for Growth and former Congressman, to explore the intersection of cryptocurrency and politics. They discuss whether cryptocurrency is a bipartisan or polarizing issue, particularly leading up to the 2024 elections in the United States. McIntosh shares his journey into the world of Bitcoin, the grassroots movement within the crypto community, and how the upcoming election could shape the future of digital currencies in America.

El Salvador’s Bitcoin Nation: A Government Insider’s View

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In this episode of the CryptoCounsel at Wiley, Josh talks with guest Dr. Mardoqueo Tochez, Minister Consular of El Salvador, to discuss the country’s groundbreaking decision to make Bitcoin legal tender. Mardoqueo shares insights on the journey from skepticism to adoption, and the global attention on El Salvador. He and Josh delve into the challenges and successes of integrating Bitcoin into a national economy, with a focus on the intersection of law, economics, and innovation in the world of crypto.

Exploring the AI and Crypto Intersection

July 24, 2024

In this episode of the CryptoCounsel, Frank Scaduto welcomes Nick Peterson, a white-collar and investigations attorney at Wiley, to discuss the intersection of cryptocurrency and artificial intelligence (AI). They explore the concept of AI washing and discuss how crypto mining operations are pivoting towards AI data processing. Nick provides insights on regulatory landscapes, enforcement trends, and practical advice for companies navigating these emerging technologies. Tune in for an engaging conversation that merges the dynamic worlds of crypto and AI.

Transcript

Frank Scaduto:

Welcome to the CryptoCounsel at Wiley. We are the podcast that decodes the most important crypto disputes and litigation and regulation. I'm Frank, a securities litigator who handles crypto disputes. My usual crypto co-counsel, Josh, is not here with me today but I have a very special guest here instead, my colleague, Nick Peterson.

Nick is a white collar and investigations attorney here at Wiley and he's obsessed with another technological space, AI. He and I are going to discuss the intersection of crypto and AI here.

Nick, welcome to the Crypto Counsel podcast.

Nick Peterson:

Great. Thanks, Frank. I'm excited to be here.

Frank

Nick, not only are you a guest on the podcast - with Josh not here, you are going to get the special honor of doing our usual three quick bits. So I'm going to tell you about three things that are happening in the crypto world. You're not a crypto person, but you're going to do your best to play along.

Nick

Okay. Hit me with them.

Frank

All right. Quick bit number one. The Securities and Exchange Commission's Consolidated Audit Trail, CAT, became “fully operational on May 31st of 2024.” CAT is the largest database of retail and institutional trading ever created; contains information on every equity and listed options order and trade processed in the U.S.. SEC-registered broker dealers, exchanges and alternative trading systems now have to collect and report trade information related to every U.S. trade, as well as personal information of every U.S. retail brokerage customer. So, the impact of CAT on the digital asset industry could be massive and industry trade associations and participants are actively calibrating their messaging on the system. CAT sounds really, really big. Nick, what wildlife big cat should we compare it to?

Nick

I think I'm partial to tigers. We'll go with that but yeah, CAT sounds interesting; big impact, huh?

Frank

The tiger is bigger than the lion, I believe. Which is a fact that confounds me a little bit.

Nick

Is, so is that the largest cat?

Frank

I believe it is the largest cat. Although I don't know where the liger fits in that.

Nick

And what about saber-toothed tigers? And we're going back historically -

Frank

Yeah, I feel like we're a technology podcast about historical you know, no-longer-with-us animals.

Nick

I'm very intrigued by those giant animals of yesteryear, like the massive sloths, giant bears, things like that. Favorite exhibits when I go to museums are the giant animals.

Frank

Woolly mammoth. Where are you on woolly mammoth?

Nick

I'm interested in them. I, do they, don't they have like DNA? Woolly Mammoth DNA now? That they're trying to recreate Woolly Mammoths?

Frank

Like Jurassic Park style?

Nick

I think so. I think that they're really doing that. They may be on the verge of, we may be having a podcast.

Frank

I feel like we've identified a new practice area.

All right, well, quick bit number two FTX, their plan to repay creditors is meeting a little bit of resistance in bankruptcy court. Under the plan, FTX proposes to repay up to 118 percent of the claims to creditors with 50,000 dollars or less, which is about 98 percent of the creditors overall in the bankruptcy proceeding. The settlements will be made in cash, but that's not enough according to objections filed by a group of FTX creditors who called the repayment plan - FTX is a topic that Josh and I are probably going to delve more into on this podcast.

But Nick, in the AI world, do you have anyone as colorful as Sam Bankman Fried?

Nick

Not yet, and frankly, I think it's going to be hard to top SBF and some of the other players in the crypto world. The AI world right now at least has a lot of the established tech companies that you're used to seeing. So those are, have been the leaders. There may be people who will pop up and hopefully not in a criminal context, but we may see some eventually but for now, I think it's largely the traditional players that we're seeing.

Frank

And quick bit number three, going back to the SEC, the SEC chair Gary Gensler recently told Congress that the commission might rewrite proposed rules governing broker-dealers' use of artificial intelligence and the handling of customers cryptocurrency assets based on robust feedback from industry participants and other commentators. The proposed rule was designed to regulate use of technology, like predictive data analytics that the commission has said could harm investors by steering them toward trades that they wouldn't otherwise have made. According to Gensler, “we got a robust comment file on the predictive data analytics rule. A lot of people for, a lot of people against.” Gensler didn't say how the rule might change, but he did acknowledge that a recent court decision by the Fifth Circuit Court of Appeals could narrow the SEC's rulemaking power in this regard.

So, Nick, I have this image of a grownup version of Haley Joel Osment's character from the movie Artificial Intelligence providing stock buying tips. Is that what's going on here?

Nick

I would say that's the dream, that's the ideal, if we could get, get to a point, a point here, but no, I think this is the SEC, just like almost every other agency trying to get in on regulating AI and trying to keep their finger on the pulse of what's going on and making sure it doesn't get too out of control.

Frank

So, that is one way in which AI and crypto seem to be intersecting, but today we're going to now talk about sort of three areas that you're seeing either the intersection or maybe the coming intersection of those two spaces and I just want to hear about what you're thinking, what you're seeing from the AI perspective on crypto AI and how they sort of intersect.

So, do you want to just walk our listeners through those three things that you were telling me about before we started recording today?

Nick

Sure, and typically I would lay the foundation and explain what AI, but I'm assuming your listeners are sophisticated enough to know what AI is, have heard of generative AI and the various aspects of AI. I think you may not know the underlying architecture or how AI works, but most people don't and even some regulators may not and the first point I want to circle back to is sort of your last quick hit point about -

Frank

It's a bit, Nick. It's a quick bit. It's a technological joke.

Nick

I - It's all, it's open. My eyes are being opened right now.

Frank

Do you see it?

Nick

I do like it. I like the quick bits.

Frank

So just before, I want to get back to the very serious topic, but Josh and I had a little bit of a devolution in one prior episode because I think you and I and Josh were all of a certain age where 16-bit, 8-bit gaming was important to our lives.

So do you have a favorite 16-bit video game console?

Nick

So, was the original Nintendo 16 or 8-bit?

Frank

That was 8.

Nick

That was 8.

Frank

And then we moved to Super Nintendo and Genesis.

Nick

So I would say I played much more familiar with Super NES, but the Sega Genesis might have had my favorite game, which was World Cup Soccer, which is sort of an odd choice because I don't play soccer and have never played or I haven't really played FIFA Soccer on the newer consoles but World Cup Soccer for the Sega Genesis, where you could choose, I think, one of twelve teams, might be the purest, most excellent game ever created on the soccer stage.

Frank

That's fascinating. I don't think I played that game. We had the NHL game for Sega Genesis, which was epic. My dad and I would frequently play that but I agree with you that the Super Nintendo was the superior console overall.

Nick

Do you remember the Neo Geo?

Frank

Oh yeah.

Nick

Oh yeah, where you could plug it into the arcade. Very interesting. Did you ever think about instead of quick bits, quick bytes, but with a Y? Or that not come across?

Frank

It feels like if we were having a food blog and we were sort of going around sort of getting –

Nick

Quick bites of news? We're workshopping here.

Frank

I will take it back to my crypto co-counsel but anyway, getting back to our conversation in the first area that you were identifying.

Nick

And it's basically that I think a lot of people look at AI as the next big technological thing with crypto being sort of the first wave of some of these issues and there's starting to be some regulation, at least some attention on crypto.

I think when it comes to AI, there has been a lot more attention, a lot more focus by both regulators and legislators, and seemingly every agency is trying to figure out how to handle it. Some of them are passing rulemakings, like we just talked about the SEC rulemaking. A lot of other agencies are looking internally first to how they can build out their AI capabilities and understandings but pretty soon that's going to move. DOJ is paying close attention. FTC, a number of agencies. Then you also have The Hill - Congress is paying close attention. I think there were dozens of bills recently, probably in the last year or two, on at least dozens on what trying to regulate some aspects of AI. There's no comprehensive legislation yet, but I think there's efforts being made in that direction. The states are also going crazy, passing all sorts of AI rules and laws. I think there's something like, I don't want to put a number on it, probably a majority of the states have some type of AI legislation right now, although, you know, again, not too many have comprehensive legislation.

But that's sort of a roundabout way of saying that there are going to be AI laws, AI regulations, that will most assuredly apply to crypto companies as well and I'm not talking necessarily about generally applicable laws that will apply to all companies, but certainly in the tech space that crypto companies should pay special attention to the developments of this AI legislation because they will, I think, be caught up in some of these rules and may not be completely obvious because the legislation will be targeting AI or we have an AI, you know, bill name or whatnot, but it will so swoop in and frankly, I think, crypto has gotten a lot of attention from regulators. AI is getting a lot of attention from regulators. If you combine the two, if there are crypto companies that use AI tools in their company, I think that's going to be a really juicy target for lawmakers who are looking at it and certainly regulators.

So that's something I would just flag. Hey, this is a fast-developing world, a lot of interest amongst the government, on the government side. So just keep a close eye on what's coming down. So, because it will be interesting and crypto companies will likely be not a target, so to speak, but you know, ensnared in some of these regulations.

Frank

Yeah, no, that makes a lot of sense and that's really interesting. One thing that Josh and I have talked about on the podcast and that we see a lot in the crypto space is regulation by enforcement where the SEC is not doing notice-and-comment rulemaking. They're actually going case by case and bringing enforcement actions against crypto companies, crypto exchanges, different kinds of crypto market participants to try to build a body of how the securities laws apply to crypto. Is that happening in AI?

Nick

Absolutely. I mean, they've already said, your quick bit was about the proposed rulemaking from SEC. They're going back to the drawing board. They've gotten a lot of comments but SEC has already acknowledged that they have active AI investigations. There have been a couple of charges and settlements that we can talk about in a little bit involving AI. I don't want to say necessarily AI companies, but involving sort of AI claims and I think there are more that haven't become public. So, I think that's where we're going to start to see the development of some of this AI regulation and certainly DOJ, FTC, some of the other agencies are also looking at it and I believe DOJ has said, we don't need any new laws, the laws on the books are sufficient to enforce the misuse of AI. So at least some of the agencies, DOJ primarily among them, have already taken a position that we can enforce things as written and we can, I don't want to say regulate it, but we can shape the use of it and punish bad actors.

Frank

And are there any prominent examples of AI companies pushing back on that pre-established authority in crypto? It's, there's a huge trend where the crypto companies are actually suing the SEC to say, look, you lack authority to do what you're doing. Has anything like that happened in AI?

Nick

Not yet, just because it hasn't gotten to the point of rulemaking and regulations. I mean they're proposed rules, but there are no final rules. So it's still this enforcement, you know, let's use the laws on the books to try to regulate it. Often what we're seeing is when there are enforcement cases, whether it's SEC or DOJ, there will be an AI component, but it won't be the sole component. There will be other bad acts involved, which, so they have the foot in both worlds and can point to the more traditional bad acts. So, we haven't seen a concerted push at least on how they're handling AI.

Frank

So, do you have a practical piece of advice for companies that may be in this sort of crypto-AI intersection or adjacency, in terms of how to move their business forward in light of this uncertainty?

Nick

I think you just have to be aware. If you are going to incorporate some type of AI tool or make any marketing claims, just be very intentional about it and try to look ahead because there may not be clear risks right at the moment, but that may not be the case a year from now when the AI tool you've incorporated into your business is now starting, you know, will conflict or give rise to obligations under a yet to be passed law.

Frank

Yep, makes a lot of sense. So, this might be a good opportunity to segue into the second trend or topic that you were telling me about, and you were telling me about a term that I had not heard before this podcast. Do you want to share with our listeners what that is?

Nick

Yeah. So the term is “AI-washing,” and really I've only heard the SEC use it and I think they're really pushed, trying to lean into this term and what they mean by that is basically false statements regarding a company's use of AI. Now, we were talking a little bit about this beforehand, and I think this is not the right way to use the phrase “something, something, washing”; like “sports-washing” is when, if your listeners are familiar, usually a country that may have some, you know, bad policies or some other unfavorable aspect to it, dumps a bunch of money into some sporting event or sports teams or whatever to distract the people, the rest of the world basically, from all the other bad stuff they're doing.

That's not really how “AI-washing” is being used. It's not meant to distract people from something else bad going on. It's more of just a, we mean this to be the AI claims are like a veneer that there's no substance to it. There's just the claim and it's used to help; basically, it's fraud and that's already illegal, but now it has an AI bent because they call it “AI-washing”. There have been a couple different cases involving what the SEC terms as “AI-washing”.

Earlier this year, there were two investment advisor firms that settled with the SEC over claims that they used or touted their AI capabilities. That they had these AI tools that could use their customer or client data to make all these more or better investment decisions and, surprise, they did not actually have any such AI tools or capability.

More recently there was, I guess, a complaint filed – charge – against an AI company that claimed to be able to match companies with diverse candidates, or what they termed like, the second-best candidates. So, candidates who'd already been, gotten very far in the hiring process for some companies, and then just for whatever reason were not hired. So it was trying to match companies with diverse candidates in this position, and again, same type of idea, the allegations are that the company didn't have this AI tool that was able to match people.

Now again, they also had other issues - allegations that they forged signatures on documents and basically created a client base when they didn't really have any clients; they just lied to potential investors that they had all these clients. So, there's some other bad actions, but they also have this set of allegations about how they are using their AI or their purported AI tools.

So I think that's something that crypto companies really need to, really any companies for that matter, be cognizant of are any claims that involve the use of AI and I think there's a difference between like puffery or just self-promotional things or aspirational, versus, hey, this is what we are actually doing now and this is how it's a differentiator and this is why you should invest with us, or engage with us, is because we are better than our competitors and better than other companies because we're using this AI feature when that AI feature is not there. Like you can certainly say we're planning to use, or this is where we're working towards but I think you have to be very clear that if you're not there, don't suggest that you're there and using that tool already because that's certainly what SEC is focusing on.

Frank

Yeah, no, makes good sense. I mean, what's interesting for crypto companies is right now many of them are engaged in this existential debate with the SEC to clarify that they are not SEC registrants because a lot of them are decentralized organizations that cannot make disclosures about the operation of their business the way a typical publicly traded company might but there are also, I think, increasingly going to be companies that leverage crypto or blockchain technology that are publicly traded and that are SEC registered, that will have these kinds of disclosures about their technology, whether it's AI or blockchain or something altogether new that's coming down the pike and the fact that the SEC seems sort of to be policing it so aggressively is definitely concerning because I think in describing what technology you're using or how it works or what it does or why it's good or bad, some of that can get pretty heady and pretty opaque for many non tech oriented people. So it does sound like you have to have a special care and maybe the right sort of attorney lens applied to, you know, what can you say to investors and to the public about “product X” or “technology Y”.

Nick

Yeah. I think also with AI and with a lot of the more advanced tools, as you said, it gets really complex and I think how AI tools, especially if it's a generative AI tool and there's some type of a process, you may not know how you're getting certain responses or certain output. So I think just focusing on, well, this is what we hope or expect our tool to do, that's when you have to be very careful because again, you know, and that's going to be what's going to probably be most interesting for companies to use because nobody wants to read about the all, how things work and the architecture of all these dense tools. So just be mindful of that.

My takeaway on this part, be mindful of how any type of claims you're making about your AI tool, especially in these early years when there's, as I said, a lot of attention and a lot of focus by the government on AI stuff; just be mindful of what you're saying.

Frank

My other takeaway from what you're saying is that “AI-washing” is a term that needs to either stop or be explained better.

Nick

Is there another term? I'm trying to think of what would be better than AI-washing because you type in AI washing and only the SEC comes up with making comments about AI or someone commenting on what the SEC is talking about.

Frank

I mean, again, for me, it just, it conjures up Haley Joel Osment's character from AI, running some sort of AI driven, like, power washing or cleaning company.

Nick

Yeah, or, or, maybe the AI Haley Joel Osment, bathing, I don't know. Swimming in the pool? I don't know. What is this? Because he was the kid, right?

Frank

He was he was the kid. Yeah.

Nick

Replaced another kid, I guess, who died prematurely or –

Frank

Wow. You know much more than I do.

Nick

It's all coming back now that we're talking about it, I'm like, oh, maybe I should watch that movie again. I love the Jude Law scenes. The uncanny valley.

Frank

It's three hours of your life.

Nick

That was the - didn’t they kind of try to touch him up a little bit, but you're right, three hours of my life.

Frank

Well hopefully we'll hit the third topic and we probably, hopefully, will not bring up Haley Joel Osment again, but I can't make any guarantees. So, the third thing I think you wanted to touch on was related to mining.

Nick

Yeah, the mining, and that's just, we've seen a couple and we've heard about mining companies that have traditionally mine Bitcoin or other cryptocurrencies that are now transitioning to being AI data centers and, it turns out, everything that AI needs - you know, a lot of computing power - is something that miners have. They have already the technology and the space and it's actually going to be pretty easy for them to, if they want to, switch from mining some type of Bitcoin, or otherwise using the processing power for cryptocurrencies to just pivot and now start working with AI firms who need all that data processing to train AI models, to run AI models, and so we're seeing some, right now I think it's mainly Bitcoin miners make, strike deals with AI companies and I think there may be, moving forward, a tension between the crypto companies and the AI companies as they compete for this processing power that miners are already in position and able to provide.

Frank

Yeah, I mean, Josh and I did an amicus brief for a trade association called the Satoshi Action Fund, and they are aggressively pushing model legislation, state legislation around the 50 states to try to best accommodate mining and I haven't talked to them about this, but I wonder the extent to which, sort of anyone has thought, does this legislation have some potential application to AI or is it somehow going to have to accommodate AI given this convergence of AI and miners in the crypto space? So definitely interesting and something that I think will maybe tie together those two worlds in a very concrete way pretty soon, I imagine.

Nick

Yeah. I mean, maybe you can even envision miners developing their own sort of AI models or AI platforms and not relying on third parties and, you know, getting into the AI space that way. So, I think a lot more to be seen on this front and how they play off each other.

Frank

Fascinating. Cool. Well, Nick, this is really, really interesting. I really enjoyed talking about AI, which is something I definitely do not know as much as you about and hopefully, you learned a thing or two about crypto, but thank you for coming on the podcast.

Any parting words for our listeners?

Nick

Yeah, maybe if you haven't seen it in a while, the Steven Spielberg epic AI is worth another visit.

Frank

It's a, it's a twist of the knife to my heart as a Stanley Kubrick fan but there you heard it folks. Go see the, I think it's a 2001 movie, Artificial Intelligence.

Nick

Ahead of its time, frankly.

Frank

Indeed. Haley Joel Osment was ahead of his time. And with that, thank you for listening to another episode of the CryptoCounsel at Wiley podcast.

Ask a CFIUS Expert: Is Crypto Spying on Us?

July 11, 2024

In this episode of the CryptoCounsel at Wiley, Josh talks with guest Nova Daly, a former U.S. national security official, to delve into the complexities of crypto regulation and international investment. They explore a groundbreaking Presidential divestment order blocking a Chinese-owned company’s operation of a cryptocurrency mining facility near a strategic missile base in Wyoming. Nova and Josh discuss how the divestment, which followed a review by the Committee on Foreign Investment in the United States (CFIUS), highlights broader concerns over potential espionage and national security risks from cryptocurrency operations.

Transcript

Josh

Welcome to the CryptoCounsel at Wiley. We are the podcast that decodes the most important crypto disputes in litigation and regulation. My name is Josh. I’m an international lawyer who does crypto and while I’m sad to miss out on my normal co-host Frank Scaduto today, I am delighted to be joined by our first guest on the CryptoCounsel, Nova Daly. How are you today Nova?

Nova

I’m doing great. Great to be here, Josh. I appreciate the opportunity to talk crypto.

Josh

I’m looking forward to it, particularly because you have the expertise on this critical national security issue we’ll be discussing – a fascinating and unprecedented divestment order by the president. But before we get to that, we typically start with three quick bits. These are some news items in the crypto field and I will share these and maybe have a few questions for you. Are you ready to go?  

Nova

Fire away. 

Josh

Just recently the Supreme court granted cert in a case involving Nvidia, it’s another cryptocurrency case, because the question is whether certain graphics processing units, or GPUs, designed by Nvidia. Whether the revenue from those GPU’s comes mostly from gaming or from cryptocurrency mining. So Nova, do you typically use your GPU’s for gaming or cryptocurrency mining?

Nova 

That’s a fantastic question Josh. One for which I don’t know the exact answer, but I do know this. I don’t do cryptocurrency mining myself. So the answer I think, is gaming and knowing the Nvidia team, great folks out there, I have to say it’s gaming for my side.

Josh

Okay. Second quick bit, the company Robinhood, which has been a bit in the crosshairs of the SEC lately. Recent news is that they are planning to acquire a Luxembourg-based crypto exchange called Bitstamp. So Nova, how would you feel about having a Luxembourg-based crypto exchange?

Nova

Well, I know a lot of things happen in Luxembourg in terms of the business side and corporate headquartering, so I think, you know, I guess I’d generally be comfortable with that, given its history and its business orientation. Yeah.

Josh

Comfortable with Luxembourg. Let’s turn to another part of the world then, final quick bit. The news today is that Nigeria has dropped tax charges against certain Binance executives, but money laundering charges continue to go forward. So, we’re going to be talking about the United States. We’ve mentioned a Luxembourg-based crypto exchange. Now we have some news out of Nigeria in the crypto world. If you were starting fresh with your own crypto operation, where would you put it Nova?

Nova

Well, you know, being a U.S. citizen and U.S. person, I’d probably put it here just so I can monitor it better. But if you’re talking about a mining operation that, that crypto mining operation, there’s a lot of electricity that is needed for that to be sustained. It’s 24 and seven. I might just locate it north of the border in Canada, they got a ton of hydro power. Cheaper, constant, so I might go there.

Josh

Okay. Nova Daly’s Canadian crypto platform. I’m looking forward to that day.

Nova

But it’d be close to the border, it wouldn’t be too far field.

Josh

Keep it in reach. That makes sense. Within reach. It’s not too far. Well, speaking of foreign investments in crypto. We are going to be talking today about a truly unprecedented and groundbreaking decision by the U.S. government. We’re going to drill into some details, but just so everyone knows  what kind of expert we have here. Nova has held senior leadership positions at the U.S. Senate and the Departments of Treasury and Commerce and at the White House. And as I think you’ll come to see all of that experience is relevant here because we’re going to be focusing on, the Committee on Foreign Investment in the United States. Known inside the beltway and to others involved in the foreign investment field as CFIUS. The news out of CFIUS is that a few weeks ago, this spring, President Joe Biden issued an executive order prohibiting the acquisition of certain real estate in Wyoming by a company called MineOne, which was ultimately majority-owned by Chinese nationals. Now there’s a lot to this and I want to take it a step at a time. So let’s start at the beginning. What is CFIUS?

Nova

A good strong question and an important one. What is CFIUS? The Committee on Foreign Investment in the United States. It is not, you know, a disease. Some people thought CFIUS was a disease, but it’s not.  It’s a committee run by Treasury composed of about 15 to 16 different agencies. [00:05:00] Really only nine are voting and two others have non-voting rights, but effectively they review foreign investments, this group led by Treasury review foreign investments and ownership of U.S. businesses or real estate. And they have to decide in concurrence whether to approve it, whether to require, what’s called mitigation and those are steps that allow the committee to deal with national security issues. Or if it’s something that they don’t feel they can address through national security provisions of mitigation, they can recommend that the president block the transaction. So a lot of power and a lot of duties. And in terms of how Global M&A looks at it, CFIUS has become an important institution.

Josh

I might add as well, a lot of bureaucracy. Because we have a lot of agencies on this committee, but one that you mentioned is Treasury. You are a former deputy assistant secretary at the Treasury Department. What was your role with CFIUS?

Nova

So as the deputy assistant secretary for investment security and open investment, actually back then, my job was to effectively run the committee. To administer the process and get decisions out of all these member agencies on where to go with these transactions. I considered myself, a cat herder -- effectively trying to get all these agencies in line and on the right decision path. A lot of negotiation, it was not a job where Treasury had the heavy hand and decided where things went. It really was controlling agencies that make a decision, determine what the national security issues were, and address them or clear the transaction. And then during my time there, we had a new law that got passed as a result of a big investment, Dubai Ports World, which blew up. So we had a new law back then. My job was to implement that law in terms of regulations as well. So, had a lot of different hats.

Josh

And CFIUS covers a lot of different sectors. I’m going to go out on a limb and guess that you did not have any potential cryptocurrency investments in your tenure under your review. Is that right?

Nova

That is absolutely right. Back then during the Bush administration, the Bush II, the big issue there was actually cyber. It was a cutting issue because we really hadn’t delved into it. Most of the acquisitions were hard assets of mines or manufacturing, semiconductors, but really crypto was not something we were doing back then.

Josh

Now it is. And this recent order is one of the very few in history in which the president has prohibited a transaction. Were there any other examples that were similar to that during your tenure?

Nova

Sure sure. And that’s one of the interesting sides of CFIUS is that even though the president is able to take and make a decision on whether to block a transaction. During my time there, the vast majority of transactions died at the cutting table when CFIUS went to the companies and said, “I’m sorry, we are not going to allow this transaction or we’re going to recommend that the president block it.” So it’s your decision. If you want to have the president block it, or you just want to back away from the deal. And for the most part, the companies just backed away. But there’s a total of seven transactions that have been blocked by the president. So, and this is the latest.

Josh

And this one now is about cryptocurrency and that’s why we’re here. The CryptoCounsel. We want to unpack the crypto-specific angles of this to some extent. But CFIUS is not a crypto only committee. It looks like a lot of different dynamics, potential red flags. And here there seem to be a few. We had an investment ultimately owned by Chinese nationals, and it was within a mile of a strategic missile base in Wyoming. So how much of this decision was driven by those factors as compared to the actual use of the property, which was cryptocurrency mining?

Nova

Yeah, this one had to deal with location. You had a foreign investor that was Chinese-owned that had decided to build this facility next to the Francis E. Warren Air Force base in Wyoming. It’s one of three strategic missile bases for the United States, so we’re talking nuclear here. And you know, with crypto mining and cryptocurrency, I mean, you have very advanced technologies that go into being able to process the algorithms to get and mine the data for the cryptocurrencies. Most of that equipment is just processing and servers, but when you have a facility like that, you can put in other equipment, that has other purposes. And I think the U.S. government was concerned that there was equipment in there that was not going to be used for cryptocurrency mining, and it was going to be used for other purposes. And that’s why it decided to recommend that the president block this.

Josh

Interesting. So it does seem that there’s some ambiguity in the president’s decision about what exactly the concern about the technology was. And I’m going to quote it and then ask you about the meaning. So the president referred to the cryptocurrency mining operation as using “equipment potentially capable of facilitating surveillance and espionage activities.” I think that’s DC talk for spying. And so is the president saying that cryptocurrency miners are spying on us?

Nova

That is a great question. And I don’t think the president is saying cryptocurrency miners are spying on us. I’m saying for this particular instance, for this particular investment, the president has said, based on the findings of the committee, that there was or could be equipment that was also in that facility that was also being used for nefarious purposes. And frankly, the tip that came from this, this wasn’t CFIUS finding this transaction all on its own, it was a tip from an outside source. According to The New York Times that was Microsoft that had a facility right next to this cryptocurrency miner. And Microsoft was doing stuff for the Department of Defense. So, Microsoft themselves let the committee know that this is a problem. But going back to address your question -- no, not all cryptocurrency mining is going to have equipment that can or would be used for the purpose of spying or espionage, but in this particular instance, that’s what this committee found.

Josh

And is it that because cryptocurrency mining equipment is big and sophisticated, we get that these are high powered computers. They’re going to be in a temperature controlled warehouse using a lot of energy. But the process of cryptocurrency mining -- and I’ve read that this really was a Bitcoin mine. It is essentially big computers guessing numbers. That’s what they’re trying to do. That’s the hash rate. There’s nothing nefarious about big computers trying to guess numbers. So, is the point, reading through the lines here that, because there were so many big, complicated computers, there could be things hidden within the system doing other activities? Is that the idea?

Nova

Yeah. And I don’t know, expressly the technology or if just all the servers that are located in that facility can themselves be utilized for other purposes, but in order to really, from what I recall in terms of the intelligence, to tap into the things that would be espionage, you have to be outside of the mining enterprise. It requires seeking to or tapping into other electronic information sources or facilities. So, the mining equipment itself isn’t going to do it, but if you have other specialized equipment, that could be the case.

Interesting parallel or a similar transaction to this one was a deal that was brought by President Obama in 2012. It had to deal with wind towers in Oregon - the Ralls transaction. That’s one in which the president, again, took action in blocking that transaction because on top of these wind towers, certain equipment could be placed - this particular facility that got blocked was near another U.S. military facility - but equipment could be placed on top of these wind towers to effectively monitor the kind of activities that the U.S. military is doing. So now moving it to this particular transaction, again, we have a facility that’s processing a lot of data, but other equipment could be placed in that facility that would be used to take other action or to tap in other electronic sources.

Josh

Is there a broader concern here, because I think I read as well that these Bitcoin miners here, and generally in the industry, Bitcoin miners are coming from China or certainly have components from China. Does that mean that we can expect cryptocurrency mining, particularly Bitcoin mining, where you have Chinese supply chain issues?  Is there going to be greater scrutiny going forward for all of this kind of mining?

Nova

Yeah, I do actually think that’s going to be the case. Again, hearkening back to the New York Times article. Apparently, per their finding there’s at least 12 other states quoting Arkansas, Ohio, Oklahoma, Tennessee, Texas, and Wyoming, where there are Chinese-owned or operated Bitcoin mines. And apparently together, these miners use as much energy as 1.5 million homes. So, not only do you have these facilities that could have other equipment electronic equipment used to do serendipitous spying operations, but also you have a critical infrastructure issue where you have a lot of energy that’s being drawn off that if these different mining operations act in tandem, they could certainly have issues that would put grids in jeopardy. Especially since the U.S. really has to improve its electric grids here in the United States.

Josh

That brings us, perhaps back to this question of proximity. Here, this, I think you know, you could draw lines pretty easily with one mile from one of the three most strategic lower 48 military bases for missiles. What’s the distance? How far out can they go? Should we expect a flood of cryptocurrency mining operations -- 5.6 miles from the base? What’s the plan going forward?

Nova

Sure, sure. So it depends on the base. CFIUS has pretty clear guidelines on what facilities are sensitive, and it’s in the appendix to the CFIUS regulations where they list all the facilities. Where real estate holdings carry certain sensitivities and a filing, well the actual ownership creates a covered transaction for CFIUS purposes. For some facilities, you know, it has to be within a mile. If you’re outside a mile then it’s not a covered transaction for CFIUS purposes. For other facilities, if you’re a hundred miles away or even 50 miles away, it’s enough to bring it under CFIUS regular covered transaction rules, and CFIUS jurisdiction. Now if the facility is in an urban area, then it’s outside of CFIUS jurisdiction, but if it’s within an airport, jurisdiction, or an actual port, a shipping port, then that’s going to be a covered transaction.

So the rules are pretty clear. There’s not a lot of wiggle room to them, which means that CFIUS has to really think about what could fall outside of its jurisdiction, but still be a national security issue. And one of the interesting ones was the facility, the Fufeng transaction up in North Dakota, where the facility that was being constructed, a corn mill plant, was outside of CFIUS jurisdiction. But nonetheless presented a national security issue to the base, which, at that time wasn’t listed as a sensitive facility. So, there’s a lot to consider there in terms of CFIUS’ jurisdiction. Nonetheless, for the crypto miners themselves, need to be aware of where you’re located and its sensitivity.

Josh

You probably also need to be aware of reporting issues. You mentioned that this was a public tip. If say an innocuous, Luxembourg-based crypto miner wants to invest in a crypto mine within one of these sensitive areas. Should they just go for it and see what happens -- what’s the alternative?

Nova

Well I think, you know, if they want to ensure -- this is one of the things about CFIUS is that, prior to the new CFIUS law, it was a voluntary process. Meaning companies could choose to file or not choose. And the only repercussion for choosing not to file was that if CFIUS discovered it, they could go back and force a review and mitigate or block it. So there’s always a “sword of Damocles” hanging over the heads of the investors.

With the new rules, there are certain transactions that are mandatory. Those dealing with critical technologies, but looking at the real estate world, it’s not a mandatory filing, but nonetheless, given the sensitivities attached, especially the focus that was done on this particular transaction, I’d strongly suggest that any company choosing to do any crypto mining operation in the United States, be aware of the CFIUS rules in terms of location. And if you’re not, if you can’t follow the rules expressly because sometimes it can be very complicated and sometimes it’s not just the rules that puts you under CFIUS consideration. Sometimes you need a little bit more understanding and counsel, that’s where counsel comes in.

Josh

You mentioned the new law in this space, which is called the Foreign Investment Risk Review Modernization Act. How does that acronym go?

Nova

It goes FIRRMA.

Josh

FIRRMA. It’s a great one. FIRRMA for CFIUS. And it does seem to be hearkening more scrutiny in this space. This is the first acquisition of real estate, where there was a divestment order. Do you think this is a precedent that’s going to be followed in more cases going forward?

Nova

Yeah, absolutely. CFIUS, especially recently, has bolstered its enforcement guidelines and directives effectively telling the public -- look if you have a covered transaction, especially if it’s mandatory and you don’t file it, we can issue penalties, civil penalties that can be $250,000 per violation or up to the value of the transaction. And now, even higher. So, in instances where parties decide not to file or they do, and they’re under mitigation and they violate it, the penalties are significant. And now, you know, there’s a focus on this transaction. I feel as though the committee is definitely looking at the real estate holdings. There’s heightened sensitivity on the hill. I testified before the Agricultural Committee about landholdings, farm and agricultural land holdings by foreign entities. So not only is Congress sort of taking action to address this because they see holes in the application of U.S. national security, but also states themselves are putting up laws and restrictions on foreign ownership of land holdings, not just agriculture.

So it’s really got to know the playing field out there. It’s dynamic, it’s changing and it’s at the forefront of where Congress and the Administration and states themselves are.

Josh

We talked in the beginning about where companies might want to put their cryptocurrency mining operations. Power concerns are a big part of that. Regulatory certainty is a big part of that. We’ve advocated here in an amicus brief on this podcast for greater clarity for these regulations. But a lot of this investment involves foreign investment. This is not just U.S. entities, building cryptocurrency mines in the U.S., crypto is inherently cross-border. What should foreign investors who want to take advantage of some of the benefits of the U.S. market -- what should they do to best protect themselves?

Nova

Yeah, I think the best protection is if you want to get into the space, you know, hire a firm that understands the rules. Not only the rules in terms of crypto regulation broadly, but also the rules in terms of how the U.S. is addressing these things on national security. It’s just smart play and yes, of course, we’re here at the law firm and, you know, we see things in our perspective, but just from a precautionary standpoint. I have had so many clients themselves that, if you just took that modicum of caution and addressed due diligence on the forefront. You know, an ounce of caution saves a pound of . . . you finish the phrase. But the point is that when you address those national security issues upfront, you get counsel in terms of where the rules are and guidelines. Then it secures your investment for the future and you don’t have these issues that can cause substantial costs and substantial penalties if you don’t get it right.

Josh

And this one was really a worst-case scenario because you have no voluntary reporting. You have a public tip. And then a complete divestment order. So it completely rips the rug out of a foreign investment. Rightly or wrongly, that’s what happens here. What’s the opposite -- what’s the greenlight look like? Let’s assume a company does get the right advice and they get this approval. What are the benefits of that -- what’s that going to look like?

Nova

Yeah. So the benefit, I mean, there’s two safe roads to go down. You get advice on where to put something or a facility that’s not going to be in the jurisdiction of CFIUS or create a national security concern. The facility goes up, you run it straight, you know, you’re safe and you’re on safe grounds. The only thing you have to keep your eyes on are where the SEC or other regulatory bodies are going with a regulation broadly.

The other lane is, it has to go on a site or at a facility that’s going to be in proximity to a sensitive site. And, you know, if you’re an investor of good standing internationally. You know, you can go through the CFIUS process, file it. Once you’re done, you’re clear and you’re a known entity with CFIUS and you can grow your business here in the United States, knowing that you’re a known entity and trusted and cleared entity in the United States.

Josh

A cryptocurrency mining business?

Nova

Even a cryptocurrency mining business. Even though, let’s say you know even if it’s a Chinese entity -- obviously, there’s a lot of issues there but you know, and this is what I used to tell my Chinese counterparts in the Chinese government when we’d have discussions is look, go there out front and, if it is a covered transaction, meet with CFIUS and show that there can be a trust developed there. And that’s a big part of it. Governance is trust. A big part of governance is trust, especially in the national security realm.

Josh

I think one of the ironies of this is that what you and what CFIUS and what we are advocating for is a level of transparency, clarity upfront, which is, in a way, exactly what the blockchain technology is trying to do as well. And there’s the irony that here you have a cryptocurrency mining operation designed to be transparent that is so big and complicated, nevertheless, that you could be hiding something in it.

Nova

Ah, that’s right. That’s right. When you have a big facility, you can put a lot of different equipment in there. So it’s best to be a trusted entity and a known entity through that process. And get good counsel, but before getting there and putting the shovel in the ground.

Josh

We’ve talked about CFIUS, FIRRMA, good acronyms, good national security guidance. What’s your final word on cryptocurrency Nova?

Nova

My final word on cryptocurrency is that, you know, it’s gone – I mean look, I’m a neophyte compared to you Josh in terms of knowing this world. But I’ve seen it from sort of the outside. You know, I don’t think it’s going away.

I think it’s going to continue to grow, especially with blockchain and the ability to have a trusted platform where there is value to the currencies that are available. It’s going to continue to grow. And I think people have to keep, especially with any new growth area in the world of finance you have to keep close tabs because, not only the U.S. government, but also foreign governments are deciding how they’re going to address and deal with this new valued system. And so regulations are going to change. So the more you’re engaged, the more you get good counsel and then also advocate for the good policies for it. I know Coinbase and other operators out there do this. They engage the U.S. government, whether it’s the Administration or Congress, to educate them in terms of the platform and its applications. But also to help steer the right rules for the platforms themselves. So, the point is -- be engaged, get good counsel, and help yourself by helping the policy and decision-makers build the right rules, right platform.

Josh

It’s going to continue to grow, it’s going to continue to thrive, just maybe not within a mile of a strategic missile base.

Nova

Let’s not put it there!

Josh

Well thank you so much Nova for joining us. It’s been such a pleasure hearing your insights and thank everyone for listening to the CryptoCounsel.

Nova

Josh, thank you so much. Great to be here.

Dogecoin’s Day in Court

June 20, 2024

In this episode of the CryptoCounsel at Wiley, Josh and Frank try their hand at acting (since Matt Damon was unavailable) to highlight the complexities of crypto regulation and the divergent opinions within the SEC. They also discuss the next frontiers of crypto regulation, from the House of Representatives legislation (FIT 21) to the latest Supreme Court case involving Coinbase, where the court ruled on arbitration clauses without addressing the broader implications for Dogecoin.

Transcript

Josh Simmons

Welcome to the CryptoCounsel at Wiley. We are the podcast that decodes the most important crypto disputes in litigation and regulation. I'm Josh, an international lawyer who does crypto disputes.

Frank Scaduto

And I'm Frank, a securities lawyer who also does crypto disputes.

Josh Simmons

Great to be with you again, Frank.

Frank Scaduto

You too, Josh.

Josh Simmons

We're going to start, as always, with three quick bits about recent news in the field, some hot topics and the first one is that President Biden recently ordered a Chinese owned real estate entity to divest assets near an air force base in Wyoming. This is only the sixth time such a divestment has happened; it happens for national security reasons and the consequence is that the Chinese owned company will have to remove all equipment and improvements at the property. This is a decision that followed an investigation by the Committee on Foreign Investment in the United States. Again, in the alphabet soup of Washington, D.C. that is called CFIUS. So Frank, what was the problem with this Chinese owned real estate?

Frank Scaduto

Josh, we're on a podcast about crypto. I'm going to guess it had something to do with cryptocurrency?

Josh Simmons

You got it, it's about crypto. This facility was going to be a cryptocurrency mining operation. The Chinese owned company had acquired the property in 2022, but that's not enough for national security reasons. The problem here is that it was awfully close to an air force base, but you don't need to hear my words on this. I'm going to quote the president who said that the operation had proximity to “A strategic missile base and key element of America's nuclear triad, and the presence of specialized and foreign sourced equipment potentially capable of facilitating surveillance and espionage activities.” Frank, does this mean that cryptocurrency is spying on us?

Frank Scaduto

Cryptocurrency is the new spy balloon, Josh? I mean, look, blockchains, the whole idea is transparency. You can see everything that's happening, so I think I'm going to say no.

Josh Simmons

This is a thorny one to disentangle. We have colleagues here at Wiley who handle CFIUS matters, so keep an eye out for a future episode on CFIUS and crypto.

But let's turn to quick bit number two. The House of Representatives recently passed a law known as the Financial Innovation and Technology for the Twenty-First (21^st) Century, which is being called “FIT 21”. The law intends to establish clear guidelines for the classification, trading, and regulation of digital assets, that's crypto. So, Frank, House of Representatives has passed a bill, does this mean that all our crypto legal issues have been resolved?

Frank Scaduto

Yep. Let's hit stop recording. Go home. We had a good run, Josh.

Josh Simmons

Wait, did you never see the episode of How a Bill Becomes a Law?

Frank Scaduto

It's been a while, but I guess Congress is maybe not going to get all the way over the hump with this?

Josh Simmons

Takes more than just the House, right?

Frank Scaduto

I think so. That's what they taught us in law school, at least.

Josh Simmons

And people in the field are saying that this is a bill that ultimately the President might veto. Still others in the crypto industry are encouraged that at least a number of folks in the House with some bipartisan support are taking some action; we'll keep an eye on that space.

Crypto update number three, the Supreme Court just decided a major case involving Coinbase. In the case a group of sweepstakes entrants accused Coinbase of telling customers that they were required to purchase Dogecoin to enter into the sweepstakes. This is really the reason for the podcast - I want to know, how much Dogecoin do you own, Frank?

Frank Scaduto

I actually just shifted it all into Dogeverse.

Josh Simmons

I have no idea what Dogeverse is. I'm missing out clearly.

Frank Scaduto

Let me explain. I think the website will make it very clear. Spawned by a collapsing supernova, Cosmo the Doge was born with the unique ability to hyper jump between the stars of the crypto universe.

Josh Simmons

I kind of like Dogecoin better. It was cute, right? It's just a Shiba Inu meme.

Frank Scaduto

So Dogeverse is a multi-chain Doge token. It is similar; it is a meme token, but it can be traded and exist across multiple blockchains.

Josh Simmons

Given how interesting this is and now that the Supreme Court has decided a case, guess what they had to say about Dogecoin.

Frank Scaduto

What did they say?

Josh Simmons

Not much, nothing really, they unfortunately ducked the Dogecoin commentary. It would have been fantastic dicta and instead they reached a relatively straightforward legal conclusion, which was that in this case, there were two contracts at issue, one involving an arbitration clause and another allowing arbitration, and it's a court rather than an arbitrator who decides which contract governs.

Frank Scaduto

So there was no dank memes about Dogecoin in the Supreme Court's opinion?

Josh Simmons

That will be the day when the Supreme Court puts the dank meme in its opinion but for now we have a unanimous decision clarifying the scope and of authority with respect to arbitration clauses and contracts. Which, for an arbitration lawyer, is quite interesting. For crypto fans, generally, they'd probably rather talk about Dogecoin.

Frank Scaduto

Perhaps and dank memes.

Josh Simmons

So those are the three quick bits. Let's get into—

Frank Scaduto

Oh, wait, wait, Josh. Come on, this is our third episode, right? And I've been wondering. We're talking about quick bits. Your favorite 16-bit video game console. I mean, you got to have an answer to this.

Josh Simmons

Is there anything better than the Super Nintendo?

Frank Scaduto

I would say no. I think the Super Nintendo was the superior choice. I had a Sega Genesis and not a Super Nintendo. I would go to a friend's house to play Super Nintendo. Played an inordinate amount of Chrono Trigger as a child and Final Fantasy to a lesser extent.

Josh Simmons

Final Fantasy was fantastic. Final Fantasy III, which they then renamed Final Fantasy VI, because that's the Japanese order.

Frank Scaduto

Very nice, yes, you clearly are a Final Fantasy connoisseur.

Josh Simmons

We're back to Satoshi, who allegedly is from Japan.

Frank Scaduto

I mean, so they say.

Josh Simmons

There's your quick bits but we are going to pick up with this question of cryptocurrency and regulation by the SEC. We've talked about, when is cryptocurrency a security, how's that going to be decided; there's a lot of uncertainty about it but we've talked about the SEC as a singular entity. Why is the SEC a bit more complicated than that?

Frank Scaduto

So, I mean, the SEC is a— it's a commission. It is a number of people who are commissioners. It has a chair who exerts influence over its agenda, that's Chairman Gensler, who we've talked about but there are other commissioners who also get to vote on the actions that the commission takes and a few of those commissioners are more sympathetic to the cryptocurrency industry. For purposes of this discussion, you and I recently saw a dissenting statement by two of those commissioners, Commissioner Peirce and Commissioner Uyeda, in an enforcement action involving ShapeShift AG.

Josh Simmons

ShapeShift AG, that sounds like an interesting company. Where do you think that one's based?

Frank Scaduto

I would say somewhere in Europe.

Josh Simmons

Correct, because if it was a U.S. company it might be “incorporated or LLC” but here, AG, that's a European company, almost certainly and this one, hearkening back to finance, which is where a lot of parallels in the cryptocurrency arise. This one's based in Switzerland.

Frank Scaduto

Ah, excellent and, I mean, as far as I know, putting aside the Switzerland connection, it was one of the earlier innovators in the crypto platform space. I believe it started in 2014. So this is well before some of the kerfuffles that we're now talking about with the SEC even began to ramp up and it was doing its thing until the SEC said, wait a minute, you may be an unregistered dealer of crypto, which we think is a security. So in this particular case, the two dissenting commissioners, Peirce and Uyeda, actually issued a somewhat funny and I think illustrative statement of where we are and where companies need to be thinking about in terms of where we're going. They published a dissenting opinion that also had a television episode scene embedded within it and it was called As the Crypto World Turns.

Josh Simmons

So the SEC is a bit ahead of the Supreme Court who can't get the meme inside the opinion, but the SEC can create a soap opera drama in their dissenting opinions?

Frank Scaduto

The crypto-friendly SEC commissioners are clearly fans of dank memes.

Josh Simmons

What was this soap opera for ShapeShift?

Frank Scaduto

So I think we should just read it. They have a whole scene with lines and I suppose we could just act it out. So one of us gets to be future ShapeShift; do you want to be future ShapeShift?

Josh Simmons

That sounds like me.

Frank Scaduto

And I will be SEC.

Josh Simmons

Okay and before we start to be clear, we're not making this up. This is dialogue written by dissenting SEC commissioners, right?

Frank Scaduto

I mean this is in a opinion of the SEC of those dissenting commissioners available on their website. Anyone can go get it. This is probably the first dramatization of it, I would gather. I don't know if anyone else has.

Josh Simmons

We're all about innovation at the CryptoCounsel.

Frank Scaduto

And for the record, I want our listeners to know this, Matt Damon turned down our request to perform these lines.

Josh Simmons

And to be fair we showed him the audition and he realized he probably couldn't compete.

Frank Scaduto

I mean, let's roll the tape or what is it? I guess I'm not a director, what do you say for start scene?

Josh Simmons

Let's start scene.

I am future ShapeShift—

Hello. I would like to register as a dealer.

Frank Scaduto

Why?

Josh Simmons

Because I think some of the assets that I plan to deal might be deemed at some point by the SEC to be securities.

Frank Scaduto

Which ones?

Josh Simmons

I'm not sure because I can't really understand what criteria you use to decide whether a token offering is a securities transaction and if it is, whether the token that was the subject of the investment contract remains a security in secondary market transactions.

Frank Scaduto

If you don't know whether you're dealing in securities, you can't register and, by the way, if some of the assets you're dealing in are not securities, you also can’t register.

Josh Simmons

So, can you help us think through which assets are securities?

Frank Scaduto

No. We suggest that you read the 2017 DAO report, and it will all be clear to you. You can also look at our enforcement actions if you want.

Josh Simmons

I read it and I've read about your enforcement actions. I still have questions.

Frank Scaduto

Hire a lawyer.

Josh Simmons

I did and the lawyer has even more questions.

Frank Scaduto

Sorry. We cannot help any more than we already have. We don't give legal advice.

Josh Simmons

End scene.

Poor future ShapeShift!

Frank Scaduto

That's powerful. Yeah, I mean, what do they do now? Is it over? Is it just like, close up shop, fire your lawyers, go home, and cryptos, that's it?

Josh Simmons

First, they give a round of applause to these dissenting SEC commissioners for their riveting dialogue but the dissent doesn't get to make the law in the SEC, and so they're going to have to come up with other options. What should they do?

Frank Scaduto

All right. I guess we got to figure that out for them. So one thing that we have been seeing, you and I have talked about this a little bit, is these preemptive litigations against the SEC, suing the SEC to get clarity on what you can do and what you can't do and there's been three, four, five lawsuits in the last two, three months that do exactly that.

Josh Simmons

I know about one of them because we filed the amicus brief in support of Coinbase's litigation against the SEC in the Third Circuit, where they are seeking to require the SEC to engage in rulemaking. That's one path, what else?

Frank Scaduto

So, some of the other paths that we're seeing are in the district courts and the trial level where companies are suing the SEC or the SEC commissioners by name, not just the commission as a regulatory entity to say, we have a product, we have a platform, we have a business strategy, give us a ruling. Is this legal? Is it not legal? And they're obviously alleging, the plaintiffs in these cases, that the SEC has not given enough clarity to prevent these things from going forward and there's not enough of a basis to regulate these ideas as securities. So that they want the courts to say, yeah, here's a ruling, you can go forward and do that. The SEC is not allowed, under the current state of the law, to prevent you from doing that.

Josh Simmons

Did they file the suit against all five commissioners? Why not give an exception to the two commissioners who are on their side with this riveting dialogue?

Frank Scaduto

Yeah. I mean, you'd like to think they get a little bit of credit for that, but alas, they have to name all the commissioners since it's the full commission that has to take up the action. It does raise, I suppose, some interesting questions about how the dissenting commissioners who authored our lovely television episode, how they would approach these lawsuits but for better or for worse, they had to name all of the members of the commission.

Josh Simmons

So that's two different litigations ongoing, both in a way against the SEC. What else?

Frank Scaduto

I think we'll just focus on those real quick before we jump to another. The interesting thing about those is I don't think it's coincidence they have been filed in federal district courts in Texas. Many of them in the Northern District of Texas, which is in the Dallas area and then one in the, I believe it's the Western District, but it's the Waco division because the company, it's a fashion company is actually based in Waco.

Josh Simmons

I would have assumed that the reason they filed in Texas is that they all love barbecue. Is this not true?

Frank Scaduto

I suppose they also love barbecue. I love barbecue. I imagine you do.

Josh Simmons

I do, but I prefer North Carolina barbecue.

Frank Scaduto

[Affirmative Noise] me too. Vinegar.

Josh Simmons

But they filed in Texas, regardless of the barbecue. Why is that?

Frank Scaduto

They did, they did. So, the thinking is that Texas is a jurisdiction that is more likely to be sympathetic to these kinds of lawsuits and these kinds of claims and in particular, Texas is situated in a court of appeals called the Fifth Circuit and the Fifth Circuit is particularly on record as being sympathetic to plaintiffs and it is on record as seeing a lot of regulatory overreach, especially by the SEC.

Josh Simmons

And already we've had competing, disagreeing decisions in the Southern District of New York and so in this Texas litigation there could be competing decisions, there could be divergent outcomes, but the Fifth Circuit where all of those decisions would be appealed, could establish clearer, more favorable law, which makes Texas a favorable jurisdiction.

Frank Scaduto

That's the idea and I mean there is some good sense to it, so I suspect we will see more lawsuits like this, and it is an option for companies who are looking for a path forward for the future ShapeShifts out there to take some action. It's not cheap because filing a lawsuit and litigating it and having to go through that process costs money, but I think for a lot of these companies it's just an investment in their future and in their business model because without clarity, which they don't have many other ways of getting, it's hard to form a plan forward as you see from the ShapeShift situation.

Josh Simmons

It is a really interesting issue from a strategic legal angle because for those who don't follow appellate law closely, even if there are disagreeing outcomes, for example in the Second Circuit which governs New York, and the Fifth Circuit overseeing Texas, that's the kind of split between circuits that could wind itself up to the Supreme Court and that's when ultimately you could have some real clarity from the judiciary on these legal issues that the executive and legislative branches have not been particularly clear on.

Frank Scaduto

Yeah, that's right and what's interesting about these lawsuits is even though they are by specific companies involving specific digital assets and the particular facts that are associated with that, they're clearly drafted with the broader industry in mind and trying to take calculated swings at the commission to get rulings that will hopefully help an entire industry or an entire group of players in the space. They're very well crafted lawsuits and I think we'll see more and I think they make a lot of sense for companies that have the means and are worried about the continued situation as it is.

Josh Simmons

But what's interesting sometimes about the strategic litigation is that while the implications are broad and they could affect the entire crypto industry, the particular parties in a case can be quite narrow in a single store, for example, you mentioned one coming out of Waco. What's that case?

Frank Scaduto

Yeah, I mean, it's a fascinating one. It's by a small fashion company called Biba or Beba, sorry if I'm mispronouncing that, but they basically sell fashion goods; they sell like a duffel bag, I think is what the case is mostly about and they wanted to use a crypto token to essentially promote a discount. They would airdrop it to customers with the idea being that it would give them 30 or 50 percent off the purchase of one of these bags and then they came to realize like, wait a minute, if we do this we may be out of business sooner rather than later, simply because the SEC comes along and says you can't do that. So they decided to partner with the DeFi Education fund and bring this lawsuit to say, look, this is what we're doing, we think we should be able to do it. The SEC shouldn't be able to stop us, help us Court.

Josh Simmons

Hold up. So, a fashion shop in Waco is dealing securities? How is that possible?

Frank Scaduto

They're airdropping digital tokens to offer their customers discounts. I mean, it's the wild thing about crypto is it has these unbelievable applications that ten years ago when the blockchain space started, you thought, okay, cryptocurrency, it's a blockchain, it allows people to basically use it as a currency. Now it's going in all these crazy directions where, I mean this is a small startup company is using it to power their business. And, in fact, I'm looking right here, right now, at one of their duffle bags, lovely, on page 21 of the complaint, but this is not a sophisticated financial boiler room operation abusing crypto for bad purposes. This is a company with a real product, with real customers, who wants to do real good things and it just wants to know if it could do that and that's what this lawsuit is all about. And what's wild— they, hired some really good lawyers to bring it. It's a really good complaint, and this is all bleeding edge stuff, but hopefully between this and some of the other complaints, you'll start to get a body of law, to your point, that can percolate through the courts and then you get, if you get to the Supreme Court and they give you a definitive decision, then that's the ballgame.

Josh Simmons

Let's go back to future ShapeShift in this dialogue because we talked about how that's a Swiss company and one of the challenges facing the U.S. market and foreign companies is that with all of this uncertainty, which is going to take time, even if this litigation goes forward and it results in favorable decisions that clarify the scope of regulation of crypto, that's going to take time. Meanwhile, crypto is moving fast, companies have to make decisions about where to invest. Is a company like ShapeShift AG, based in Europe or based in Asia, are they just going to try to avoid the U.S. market, what happens?

Frank Scaduto

That is an option, I don't think it is a great option. I think if you're a company, you hopefully want to be working and doing business in the U.S. It’s the world's largest capital market. It's a huge opportunity for companies. So, for the solution to be you just avoid the U.S. altogether, I don't think that's terribly realistic and you want the future ShapeShifts to hopefully, not only be doing business here, but be based here. I mean that's the goal with this industry, it's growing, it's going to be huge, it's a part of the future of the economy worldwide. It makes no sense for the U.S. to cede that position to Europe or Asia or some other market simply because we can't get our act together on the regulatory side or what laws govern the rules of the road.

Josh Simmons

Not only that, but companies based outside the United States will have difficulty keeping their operations, keeping crypto trades away from the U.S. market because we're a major economy; there's a lot happening here, and so I think ultimately in the face of this uncertainty companies are going to have to have good advice. They're going to need to think carefully about exactly what their operations are. How do they navigate, whether they're based in the U.S. or somewhere else, how do they navigate this market?

Frank Scaduto

I think the thing that is really important to think about is hiring lawyers and advisors who actually understand this technology. There is a really, really good, recent op-ed in Coindesk, I believe, on this very point, telling people, if you want to get the right advice, get the right results, you have to have people who know this technology and are not just trying to apply old rules or other disciplines to it because something is clearly getting lost in the translation. Securities and Exchange Commission, other regulators, don't seem to have a full appreciation for what's different, what's new, what's unique, and why the preexisting SEC regulatory regime, which goes back to the 1930s, is a good way of dealing with this new technology and this entire new ecosystem.

Josh Simmons

And that's why we're here. We want to help teach you listeners and advise on both the technology and how complicated legal structures, some dating back decades, are being applied and should be applied to that technology.

Frank Scaduto

Yeah, absolutely. Just to go back to some of these lawsuits real quick. Some of them are citing laws on the books that have been around forever but that's what they have to do to get their foot in the door but really, the ask is just, can we please create a current, usable, new set of rules that actually acknowledges where we are technologically?

Josh Simmons

And right now the SEC says no.

Frank Scaduto

At least sort of ask us on a case-by-case basis and from future ShapeShifts example is not always entirely clear what that answer might be depending on what day you ask.

Josh Simmons

But at the same time, you have the House of Representatives passing a bill. You have the courts litigating these issues, so there should be more clarity in time, but until that happens, companies should look for the best advice, be very careful strategically in how they are dealing with regulations, particularly in the crypto space.

Frank Scaduto

Absolutely.

Josh Simmons

Thank you for listening to the CryptoCounsel at Wiley.

A Tale of Two Crypto Cases

June 5, 2024

In Episode 2 of the CryptoCounsel, hosts Josh and Frank decode recent litigation with the SEC and two key cases in the Southern District of New York. In the first case, a judge found that Ripple’s cryptocurrency XRP is not a security when sold to individual investors. But in the second case, a different SDNY judge found that 13 of Coinbase's listed cryptocurrencies are securities. These divergent cases underscore the complexity and uncertainty of applying existing securities laws to cryptocurrencies, which will continue to be contested in the courts.

Transcript

Josh Simmons

Welcome to the CryptoCounsel at Wiley, where we decode the most important crypto issues in litigation and arbitration. I'm Josh, an international lawyer who does crypto disputes.

Frank Scaduto

And I'm Frank, a securities lawyer who also does crypto disputes.

Josh Simmons

Great to be with you again, Frank.

Frank Scaduto

You too, Josh.

Josh Simmons

Last time you told us a little bit about orange groves and definitions of security and how they apply to cryptocurrency. These are the important esoteric and existential issues facing crypto in the U.S. and in the world and today let's unpack a little more how this is going to play out practically before the government, before the courts, but before we do that, our three quick bits to get going. First, recent news is that the former CEO of Binance has been sentenced to four months in prison and in bigger news before that, the former CEO FTX was sentenced for 25 years. Frank, is this fair or not?

Frank Scaduto

I mean, so, the Binance yes, is the short answer, Josh. The Binance CEO pled guilty, agreed to a larger package deal of $4 billion that would be recovered by the government, and did not put the United States Department of Justice through the process that Sam Bankman-Fried chose, which was to go to trial and test his case and that's just what happens when you roll the dice, so fair.

Josh Simmons

In other news, some celebrities have been endorsing crypto. One of those is the famous former NFL star Rob Gronkowski and the news is that he recently settled a dispute, the litigation that was brought against him for his role in promoting a cryptocurrency lender. Does this mean that celebrities should stop endorsing crypto or should they keep going?

Frank Scaduto

I would say you should probably stop, maybe put a pause, cool that for a moment. I will say, I'm not a Boston sports fan, so Gronkowski got what he deserved.

Josh Simmons

I remember, I think it was a Super Bowl ad when Matt Damon came out with, fortune favors the brave. That was in favor of crypto.com, right?

Frank Scaduto

That was when many were starting to think of crypto as maybe not entirely what they had thought it was and could be. So, yes, big turning point.

Josh Simmons

Well, for you celebrities out there, fortune still favors the brave, so don't be too deterred by the recent settlement of this litigation. You agree?

Frank Scaduto

Ah, Matt Damon's doing just fine; very solid career.

Josh Simmons

Third bit today is a little more in line with what we're going to be discussing and this is recent news that the SEC has served a Wells notice on Robinhood, the popular trading platform, which some say suggests that the SEC intends to sue Robinhood. Is this surprising or not, Frank?

Frank Scaduto

Very surprising, Josh. Robinhood has been about as careful as a trading platform in its position can be with respect to crypto. They had actually removed certain tokens from the platform because they were worried that the SEC was going after them, after those tokens that is, and so people had thought that Robinhood was proactively trying to play nice and the SEC doing this is a big shock I think to them and to everyone else that's following the space.

Josh Simmons

If the SEC's goal is something like intimidation or fear, it's probably succeeding because there's a lot of uncertainty but we've talked a lot about the SEC, both in the last episode and with the bits today. So before we get too far into the substance, let's pause. We're Washington, D.C. lawyers. We're wired into Washington. We don't want the alphabet soup to be deprived of the other great acronyms. The Securities and Exchange Commission is only one player in this soup. Who are the other players who could or should be regulating cryptocurrency?

Frank Scaduto

The most obvious one that comes to mind is the CFTC, Commodities Futures Trading Commission. There are a lot of commodities aspects of cryptocurrencies and CFTC already does play a role in overseeing and regulating within the jurisdiction that it does have. So there is some sense that the CFTC and the SEC are the two most obvious ones to do it and then you sort of have a host of what are more behind the scenes, sort of quasi-criminal authorities that deal with Bank Secrecy Act and money laundering regulations that tend to get involved in any sort of currency related matter from a regulatory perspective. So some of those are also in the mix in terms of who is doing stuff and who should be doing stuff.

Josh Simmons

So there's a lot of potential players here and I suspect we'll be seeing more and more as time passes but the SEC has been claiming most of the fame in part because of the litigation and the enforcement actions that it has been bringing. We talked last time about the efforts to require a rulemaking by the SEC, which could provide some potential clarity around this space, but that's not happened yet and instead we have litigation and two cases that have been pending are in the Southern District of New York. Frank, what can you tell us about the Southern District of New York?

Frank Scaduto

So this is the federal court in Manhattan where a lot of financial disputes get litigated and a lot of the law grows from decisions by this court. Obviously, New York being a financial center of the world, this has been a place where a lot of these kinds of cases tend to go and the judges that are very familiar with them. They have a high degree of fluency in the players, the types of cases, the kinds of discovery disputes that are likely to arise, they've tried these cases, it's a bench of people who are either did this in their private practice before they were put on or have certainly— or not just private practice, but also as prosecutors for the Southern District of New York U.S. Attorney's Office or the U.S. the S.C.C. in New York or here in Washington, D.C. So it's a bench of judges who are very familiar with these kinds of disputes.

Josh Simmons

And certainly some of the big players in Manhattan they would know. You could think of Goldman Sachs or J.P. Morgan but there's some new players now and the SEC has been bringing claims against them; those include Coinbase, as we discussed, but also Ripple. What can you tell us about Ripple?

Frank Scaduto

So, the Ripple, well Ripple has a token, XRP that the SEC has—

Josh Simmons

Speaking of acronyms, does XRP stand for something?

Frank Scaduto

If it does, I will have to look it up.

Josh Simmons

I'm sure it's related to x-rays.

Frank Scaduto

So, XRP, the SEC says is a security and therefore needs to comply with all the various securities regulations and they brought this lawsuit against Ripple. It's being heard by a judge in the Southern District named Judge Torres and the interesting thing about this case is it's been one of the few success stories for the crypto industry in terms of a judge putting some real meaningful limits on the SEC's position that all of crypto is essentially a security, or at least everything other than Bitcoin.

Josh Simmons

If I'm remembering correctly from our last episode, the question is whether XRP is an orange grove. Is that right?

Frank Scaduto

Yeah, so you have to, you know, put yourself back in the world as it existed in 1946 and think, how would a judge determine my cryptocurrency dispute using a test about orange groves?

Josh Simmons

So why is XRP not an orange grove?

Frank Scaduto

So some of it is, and some of it isn't. The some of it that is like the orange grove investment contract from that case involves the direct sales of this token to institutional investors, larger investors with a greater degree of sophistication and those folks would have a basis to understand and to expect the generation and common sharing of profits from Ripple as the quote unquote issuer to again put it in security speak but then there was a second group of purchasers of this token. People like you, me, or anyone else who might buy or sell tokens on an exchange and in that situation the secondary market purchases, Judge Torres, she created a distinction for what she called blind bid asks, meaning you don't know who you're buying from, you don't know who you're selling to, and by extension you don't know where that profit is being created, who it's going to. So she said with that group, there is no orange grove analogy that holds. So she said that's not a security.

Josh Simmons

And for those listeners who might not understand the functionality of a cryptocurrency, is that right or wrong about the blind bid ask?

Frank Scaduto

It sort of depends on your vantage point of are you a crypto user because you're speculating on its value or are you a crypto user because there are features of the technology or the ability to use it as a currency to buy and sell pretty much anything increasingly. So for the former group, the speculators, it, you know, there is a little bit of—

Josh Simmons

Let's call them investors to be fair— wait, that could be risky.

Frank Scaduto

Yeah, exactly, not for expectation of common profit from a third party but even with that group in Judge Torres's understanding, there was still this blind bid ask problem that it was essentially an anonymous exchange that you couldn't trace back sort of how this money was generating a communal profit in the same way that the orange grove contract and the growing of the oranges and the sale and then it comes back into a pot of money that gets divvied up among all the people that invested with the Howey Company from that foundational case.

Josh Simmons

And what about the second category? These are those trying to use cryptocurrency as a currency.

Frank Scaduto

For those, I mean, just the notion that it's a security I think it's hard to grasp because it feels a lot like cash or a credit card or any other sort of commodity that money often is. It's not an investment vehicle; it's just something you use to buy and sell stuff. So I think it's much harder for people to see any sort of analogy to the test that governs the securities distinction.

Josh Simmons

Results have been mixed but I have to give my shout out of fortune favoring the brave to those countries around the world who have implemented cryptocurrency as a national currency. That's going to be an interesting development. We'll see how that plays out.

Frank Scaduto

Yeah, there are a few, and I think there will be more and more. I mean, a lot of companies, public companies, even in the United States, use cryptocurrency as a source of stability in their own treasury department. So I mean, countries, large institutions, it's happening.

Josh Simmons

So that's Ripple and XRP, and there's a favorable decision there by Judge Torres that I think many in the cryptocurrency community have been celebrating as a promise, a light at the end of the tunnel for some of these challenges and this uncertainty posed by SEC enforcement actions but that wasn't the final word. There's another case pending in the same court, Southern District of New York, with Coinbase. What can you tell us about that, Frank?

Frank Scaduto

Yeah, so for folks that are not familiar with these courthouses, there's obviously, you know, a courthouse, the Southern District of New York in this case, but then there could be 30, 40 judges that sit in that courthouse, and each one is its own little mini sovereign. They all sort of, obviously, subject to appellate law and Supreme Court law have to apply the law, but they each have their own, you know, balls and strikes to call. So in the Coinbase case of the Southern District of New York, different judge, Judge Fela, she was hearing an SEC challenge to Coinbase's trading platform and whether or not 13 cryptocurrencies that are traded on that platform are securities and therefore whether Coinbase can offer those securities on its platform without registering as a platform to do that and—

Josh Simmons

Why 13 by the way? Is that just chosen by the SEC as an unlucky number, an omen for how they think the case will turn out?

Frank Scaduto

Perhaps. I think it was just the 13 at the time but it did not, obviously, it did not bode well for the fortunes of Coinbase. So those 13, which I believe it must be maybe except for Bitcoin, which maybe they're in fact 14, but the unlucky 13 were found to be securities and Coinbase by extension has to treat them as securities and there's some interesting differences to what Judge Fela did versus what Judge Torres did that I think are illustrative of why this whole regulation by enforcement approach by the SEC is so problematic, which is Judge Fela looked at this broader ecosystem of the cryptocurrency world and the networks that they are attached to and she said, well, even if I can't draw perfect analogies between the cryptocurrencies themselves, and the orange groves from the Howey case, this whole way in which crypto works and the way it came into being and the fact that there is in fact this group of people that launched these, some of these networks, like Ethereum and some of the others and have these native tokens that are a source of currency created by the networks. That's the bigger picture that I'm looking at and I can say that that's more like the orange grove investment contract situation that the Supreme Court uses as its touchstone.

Josh Simmons

Let me pause you there because this word ecosystem, I think is really interesting in this space. I think most of us know what an ecosystem is. Is ecosystem a defined term in the Securities and Exchange Act?

Frank Scaduto

Definitely not. I mean, it is, this is a word that obviously, in the tech world has become very popular and it has no definition or roots in the Securities and Exchange Commission's rules, laws that created them. This is a construct that she's attempting to map onto this new technology.

Josh Simmons

So Brazilian rainforest; that's an ecosystem I can get my mind around. Orange grove. I get that too. The ecosystem of cryptocurrency. It seems like a somewhat vague, amorphous concept on which to be regulating crypto. Do you agree?

Frank Scaduto

Yeah, I think it gets back to some of what we talked about in the first episode, which is there's the technology and then there's the sort of the products or the currencies or the tokens or the things that the technology facilitates and there's innovation happening across both of those aspects, but the network technology, whatever blockchain is created to administer it and how it's designed and coded, that's one thing and then you have the tokens themselves, that's another thing. And then how they're promoted is a third thing altogether and I think, and we talked about this last episode, some judges and some folks at the SEC and some commentators want to collapse all that and I think that's dangerous because behind all this is just sort of neutral technology.

Josh Simmons

Neutral but incredibly complex and sophisticated. I think one of the things that's really tough here is that you have fast moving technology that a lot of people don't really understand from the block chain to particular cryptocurrencies. How are they different? How do they function? At the same time you have an incredibly complex regulatory process; you have complex laws, and even Supreme Court precedent, and how those two come together, I think is why we're here. We want to try to understand how do you apply a complex legal system, often in litigation, which is its own messy thing, to a complex technology and so on that point we now have two opposed decisions. Not directly because as you said, each judge has responsibility for the cases before them, and so they are entitled and allowed to come to different conclusions, but they have. You have the Ripple case. XRP is not a security and then you have the Coinbase case; 13 ominous cryptocurrencies, opposite conclusion. Where does this head? How do we resolve this conflict?

Frank Scaduto

Well, in just those two cases and where they go, they could theoretically go to the same Court of Appeals, which would be the Second Circuit Court of Appeals, which is in New York as well, and then from there they could go on up to the Supreme Court. This process is playing out in courts not only in Manhattan in the Southern District but in other courts across the country and so if conflicts are going to be created in enough of a sizable amount then this stuff will go up through the appellate courts and then possibly to the Supreme Court. The alternative to all that that I think many people would prefer to see would be Congress steps in and says, no, here's the clear law that we're putting in place, and we're giving you a clear regulator who has a clear mandate with clear boundaries. Those are the sort of two options at this point.

Josh Simmons

Well, I think we've been in D.C. long enough to know that the prospects of swift congressional action that is going to holistically resolve this problem are low.

Frank Scaduto

Very low. It would take a large systemic shock to the economy from this industry for I think Congress to do anything. I mean, FTX was what it was, and that has not moved the needle. I think you would need a wholesale crisis, essentially.

Josh Simmons

The states are stepping in, right? So states are regulating. They are doing more but I think there's a third option here, which is why not have more clarity from the Executive Branch of the federal government? Why hasn't there been rulemaking so far?

Frank Scaduto

Well, speaking to the SEC, I think they are just genuinely unprepared to try to create the broad enough set of rules and I think they thrive, the Enforcement Bureau thrives in just going after specific cases, deciding them on the facts and trying to litigate them one by one and the process of building the regulations, I think, is too daunting for them and the other piece of it is is that's only one half of it and the less important half they have to not only do that, but come up with a scheme for if they are subject to SEC regulation, what has to happen? I mean, these are decentralized entities; they're not going to issue public financial reports the way Apple or Google or you know, a publicly traded company does and there's got to be some entirely separate set of consequences for being regulated by the SEC in the case of crypto.

Josh Simmons

So we've covered the legislative branch in the Executive Branch where we think it's unlikely to have clarity in the near future about how to regulate crypto and then we're back to the third branch, the Courts. Are we going to get clarity from the courts? Right now we have mixed outcomes in the Southern District of New York. What are your hopes there?

Frank Scaduto

My hopes are low. I think that judges are trained at dealing with a case in front of them with its particular facts, its particular issues, and you're going to get a very uneven hodgepodge of rules to the point where it might be if you're operating in, New York, you have one set of rules and if you're operating in Texas, you have a different set of rules. It could be that insane.

Josh Simmons

So this is sounding dire, but I want more hope. Crypto is a new frontier; fortune favors the brave. What's the hope when there's these uncertainties from regulation and even litigation? How should crypto companies be approaching this uncertainty?

Frank Scaduto

I think the industry has been incredibly proactive and you see companies like Coinbase who are actively asking the SEC to go through a rulemaking process and they want to contribute to that conversation and come up with a framework that makes sense. So I think there is a lot of proactivity. There is a lot of innovation. I think there will continue to be a lot of energy around coming up with solutions that can comply with the regulations as they currently are on the assumption that all this are subject to SEC enforcement but ultimately the thing that will take the restrictor plates off the whole industry would be a clear pronouncement, it would have to be from the Supreme Court at this point, that there is some aspect of this that is subject to regulation and there is some aspect that is not and some clear rules of the road.

Josh Simmons

I think it's a testament to the crypto industry writ large that they are taking matters into their own hands rather than I think some people look at the entrepreneurial space and there's commentary like move fast and break things but here while crypto is moving fast, they are actually trying to use the courts to get more clarity from the government about regulation. Has this happened in other industries before?

Frank Scaduto

I can't really remember it happening quite this way. Usually it's, you break it and then you ask for forgiveness. The crypto companies are being very proactive in a, I think totally appropriate and healthy way, and I think a lot of these lawsuits that we're seeing from the companies and the developers and the trade associations for which, you know, these companies are members, they're getting out in front of the courts and saying, hey, wait, this is not the right way to do it and I think it's allowing the conversation to happen more quickly and the courts to more thoroughly address the range of issues so that hopefully we'll get a definitive ruling sooner rather than later.

Josh Simmons

Let's hope so. So I think we've covered in the first episode whether cryptocurrency is a security. Unfortunately, the answer is that's not clear. Now we've discussed how are we going to figure it out and that also, it seems is a little bit unclear but one thing that is clear, and you can see this from the actions that the cryptocurrency companies are taking is that this is a thriving industry. It is growing and it's not going to go away because of lack of clarity. So what do you think the next step is in terms of the SEC's regulation?

Frank Scaduto

I think that the, hopefully there will be a turning of the tide and the SEC will lose enough of these cases against the big players in the industry that it will understand it needs to shift tactics and undertake a rulemaking or look to Congress and say, look, you know, if we're going to do something, tell us what but we're at a, we're not quite at a turning point but I think that there is a lot of momentum by the crypto industry to counterbalance and push back on what the SEC has tried to do over the last couple years.

Josh Simmons

Well I think we have a lot of momentum as the CryptoCounsel trying to understand this. You think so?

Frank Scaduto

Absolutely.

Josh Simmons

Well, let's keep at it. We're going to continue monitoring this space. We've talked about SEC regulation and the related litigation, but there are a lot of other topics we could cover here. You talked about money laundering, there's international disputes, a whole host of issues that are coming up with crypto infrastructure, investment, blockchain, and we're going to be covering these. If you are interested in this space, please reach out. Let us know. We'd love to host you on CryptoCounsel at Wiley. Please post a review. Thank you for listening.

Is Cryptocurrency a Security (like an orange grove)?

May 22, 2024

In the first episode of the CryptoCounsel at Wiley, hosts Josh Simmons and Frank Scaduto discuss the evolving landscape of cryptocurrency regulation, focusing on recent disputes and the challenges posed by the SEC's regulatory actions. Using the Howey Test from a 1946 Supreme Court case involving orange groves, they explain how the SEC determines if an asset is a security and how the SEC needs a better regulatory framework for the rapidly growing crypto industry.

Transcript

Josh Simmons

Welcome to the initial episode of the CryptoCounsel at Wiley, where we decode the most important crypto issues in litigation and regulation. My name is Josh Simmons. I’m an international lawyer who does crypto disputes.

Frank Scaduto

And I’m Frank, a securities litigator who also does crypto disputes.

Josh Simmons

I think it’s incumbent upon us, Frank, for our initial episode to say: Why are we doing this? Why are we here?

Frank Scaduto

Who doesn’t have a podcast now, Josh?

Josh Simmons

Ah, but our podcast is going to be special, Frank.

Frank Scaduto

Okay. Well, we are special because we are at a firm that does this stuff day in, day out, at the intersection of technology, finance, law, you’ve got the international piece, and crypto is this wild west of legal issues that really excites a lot of the people like us that work in this space.

Josh Simmons

That’s exactly right. It is fascinating that it transcends borders, as we’re going to get into today. It transcends regulations and existing legal frameworks. We’re a law firm based in Washington, DC, we have about 250 lawyers. We specialize in regulations, disputes, a whole host of issues, and crypto touches on all of it.

Just in the past year, I’ve been working on a dispute involving the largest Bitcoin mine in North America. Now guess, Frank: How deep is the largest Bitcoin mine?

Frank Scaduto

How deep is the basement of your client’s house, Josh?

Josh Simmons

I think it’s actually a ground level, but it’s quite a big warehouse.

Frank Scaduto

Nice. Yeah, no, I mean, this space is just, it’s incredibly wild. I mean, for me, I think you, you know well that I used to be a large bank lawyer, a lot of old school finance companies. And, I also love technology and apparently crypto [00:02:00] was the answer to how could I combine being a large financial litigator with my technology love, and that’s how we wound up here.

Josh Simmons

That makes perfect sense, and we’re going to talk more today about how the securities laws, like orange groves, apply to crypto.

For me, I came at this from an international angle. I’ve had clients in Germany and Cyprus, and they have operations related to crypto and it turns out, crypto seems to be causing a lot of disputes in the world. Why?

Frank Scaduto

It’s just one of those things, Josh.

Josh Simmons

It’s the Wild West, right?

Frank Scaduto

It is.

Josh Simmons

And that’s why we’re here. We want to help you understand this intersection of cryptocurrency, litigation, regulation, we are the CryptoCounsel at Wiley, and we’re going to unpack these issues.

We’re going to start today with something near and dear to the heart of Washington, DC lawyers, which is regulation. We’re going to start this episode as we hope to start every episode with some quick bits. These are some hot news items from recent weeks that captured our attention, particularly when it comes to crypto disputes. And lately there have been a lot of them. One of those disputes is a complaint filed by ConsenSys, the company responsible for Ethereum against the SEC commissioners by name.

And a quote in that complaint is that the SEC is on a campaign to seize control over the future of cryptocurrency, one of the fastest growing and most innovative technologies in the world. Frank, is that an overstatement or an understatement?

Frank Scaduto

I think it is an overstatement, and an understatement, and a fact, all at once.

The SEC is doing way, way too much, too fast with respect to crypto. I think something probably should be done with respect to crypto. I’m not sure it’s the SEC, but the SEC is moving very fast, and these complaints like the one by ConsenSys, we’re going to see a lot more of them, and it’s a healthy reaction to the SEC overreach that’s happening.

Josh Simmons

Perhaps then we should give applause to the ConsenSys team for accomplishing what every complaint should, which is overstatement, understatement, and fact, all at the same time.

Frank Scaduto

Indeed, they did a marvelous job. It’s a very good complaint. And I hope we see it go where it needs to go, which is pushing back against the SEC for the way they are regulating, which is by enforcement in this space.

Josh Simmons

Bit number two, probably the most famous, now infamous, developments in the crypto space in recent years has been the collapse of FTX, the sentencing of Sam Bakeman Freed, and yet some strange silver lining came out that the creditors of FTX in the bankruptcy will recover all of their money plus interest.

Frank, does this mean that we want more companies in the crypto space to go bankrupt or is this just a fortunate timing?

Frank Scaduto

I’m definitely in favor of companies in the crypto space not going bankrupt. I hope they expand and grow and thrive. I will say that news was that they recovered every penny plus interest for the investors who were affected by the collapse of FTX.

The only other situation like that I can remember would be the Madoff situation where the folks who worked on that recovered incredible sums and just a remarkable job by lawyers and doing what they do best, so.

Josh Simmons

It may be ironic that it’s consistent with an argument Bankman-Fried made in the course of his trial, which is that FTX was not insolvent, it just had a liquidity problem.

Frank Scaduto

Yeah, I think that to the extent people were wondering about the truthfulness of Mr. Bankman-Fried the recent revelation of where the money was and that it was attainable, was - it certainly suggested that, that was a large enterprise to ferret away money that succeeded wildly and then was ultimately brought to justice.

Josh Simmons

This is probably not the last we’ll hear of it and Bankman-Fried will have a lot to think about while he’s in prison for a while.

Frank Scaduto

Quite some time.

Josh Simmons

Bit number three, and this is harkening to our topic of today. If the Ethereum complaint managed overstatement, understatement and fact, I’m curious about your thoughts on our own amicus brief where we argued that, in support of Coinbase’s litigation against the SEC, the Securities and Exchange Commission, that the SEC should engage in rulemaking of crypto. Is this an overstatement or an understatement?

Frank Scaduto

It depends who you ask. So our clients in that amicus brief, the Satoshi Action Fund and the Texas Blockchain Council, would say that the SEC should not regulate at all, because the states should be driving that conversation. They should be doing something to put some guardrails around an industry that is growing. In Coinbase’s case, for Coinbase, they desperately want the SEC to regulate in some way, shape, or form to tell them what the heck is going on. What are the rules of the road for an exchange, a platform like Coinbase? It’s really unusual. It is probably the only instance, I could think, where a company is asking to be regulated.

And, it really is just a reflection of the fact that the SEC, by doing its enforcement-based regulation, which is incredibly unpredictable, it’s so much harder for companies to grow, to build, to launch in this space, without a clear understanding of what the rules are. So it is, it is unusual. And depending on who you ask, you might get a different answer, but there should certainly be some regulation. By whom, I think is a really open question.

Josh Simmons

And that is why we are here. We want to be the CryptoCounsel who help companies understand what’s happening in Washington with these regulations, it’s incredibly complex. There’s more and more litigation and we’re going to help you get to the bottom of it. And we’re going to start with basics today.

And the key question, Frank, the question that everyone is asking, everyone is debating in the crypto space. Is cryptocurrency a security?

Frank Scaduto

Yeah, this is the conversation, and it is incredibly complicated.

Josh Simmons

Wait, wait, wait. The way it works is I’m cross-examining you, I need a yes or no answer. Is cryptocurrency a security?

Yes or no, Frank?

Frank Scaduto

What is a security, Josh? These are weighty, weighty questions. Yes, no, maybe, depends. This one has gone in so many odd directions. But let me let’s start with: Why does this matter? What does crypto, in its various forms as a technology as a currency, being a security mean for anyone?

And what it means is, if it’s a security, it means the Securities and Exchange Commission can regulate it, under the SEC’s current regulatory regime. And how that works with crypto is almost impossible because crypto, you typically have a decentralized network with no single promoter or what securities lawyers called an issuer.

So it’s very hard to understand how crypto and crypto companies and the currencies and the tokens and the other products that are associated with this space can operate within the SEC securities regulation regime when they don’t have a central issuer or promoter or group of people who can comply with the regulations they’re being asked to comply with, such as issuing quarterly and annual reports, audited financial statements, all sorts of other disclosures that companies that are listed on a public stock exchange and are truly the issuer of securities, you know, Apple, General Motors publicly traded companies.

They do, under the current SEC regime because it is suited to those more traditional businesses. Crypto is a whole other animal. So, if it is a security, which is the reason everyone wants to know, is it a security, it potentially could gut the entire industry, and at the very minimum, cause it to go outside the United States, which I think is a very bad thing for the country and the industry and its future here.

Josh Simmons

This is the specialty of Washington, DC is creating existential threats. So let’s, break it down to a smaller question first, because you’ve been talking about cryptocurrency generally. What about Bitcoin? I think Bitcoin’s the most understood, most robust cryptocurrency, people have some idea of what it is and how it works.

Is bitcoin a security?

Frank Scaduto

It is not. And I can confidently tell you that right now, because the SEC and chairman Gensler of the SEC has said, and continues to say, Bitcoin is not a security. The reasons why it is not a security, I think we’ll get to in a second.

Let’s layout for sort of the framework for how the SEC and others are attempting to think about whether crypto is a security or not. But Bitcoin as it presently stands is the one and only, it used to be Ethereum was also in this category, and Ether, but now it’s just Bitcoin is the one that has been specially plucked out as not a security, and, and we’ll talk about why in a moment.

Josh Simmons

Well, before we do, I have to share my favorite conspiracy theory on this, because we’ll come back to the SEC Commissioner more I’m sure of Gary Gensler, but in researching the progeny of Bitcoin, where does it come from, who invented it, my favorite idea, well, it must be Gary Gensler, because there’s no other way to justify why it’s not a security, but all the other cryptocurrencies are.

Yes or no?

Frank Scaduto

Yeah.

Josh Simmons

Did Gary Gensler invent Bitcoin?

Frank Scaduto

It is true that Satoshi’s Bitcoin wallet must be, I mean, I’m not even sure what the present value is, but if it is Gensler, as you suggest, and I’m interested to hear more about this, maybe on another episode he would be a very rich man. So perhaps, yeah, but I mean, this whole, is it a security thing, it’s wild to me because, I don’t know if you’re a fan of the Godfather movies. But in the Godfather movies, whenever oranges appear, something bad happens to a character. Right? So, there are many famous scenes involving oranges and then the death of the godfather himself, the character famously finds a horse head in his bed, and the night before he’s got a bowl of oranges on his dinner table, and there are other examples.

Josh Simmons

I know where you’re going with this oranges example, but I hope you’re not saying that something bad’s gonna happen because we’re talking about cryptocurrency.

Frank Scaduto

No, definitely not. But I do feel like every time oranges, enter the conversation of is crypto a security, bad things happen. And that’s because the whole test around which this conversation is revolving is from a Supreme Court case 1946 called Howey and it involves oranges and the sale of orange groves specifically.

Josh Simmons

What did it say?

Frank Scaduto

They said, well, first of all, why were they saying and talking about it in the first place? Security is actually, is a defined term in congressional legislation that the SEC has to follow.

And it has a bunch of specific things like stocks, bonds, things that people are pretty comfortable are securities. But then it has this thing called investment contracts. That’s an example of the things that are securities in the definition. So the Supreme Court in 1946 was called upon to address an issue that arose from an investment opportunity, involving the sale of orange groves. This company, the Howey Company, sold orange grove land to investors, most of whom were tourists at a hotel that Howey also owned nearby. And then they were separately offered, the investors were offered an opportunity to enter into an agreement with the Howey Company for Howey to manage the orange groves, to grow the oranges and other produce, and sell it on the market. And then the investors would receive a portion of the profits. They would essentially pool together those profits and then give people a percentage based on the level of their investment. So the investors profit was dependent on how well Howey did at growing oranges and selling them.

Josh Simmons

And, kudos to the American entrepreneurial spirit. Before there was crypto, there were oranges.

Frank Scaduto

Indeed. Yes. So this is taking place in Florida and they’re growing oranges like gangbusters. People are making a lot of money. And then the Securities and Exchange Commission says, wait a minute, that is an investment contract. You, Howey, were required under securities regulations to register this investment opportunity that you provided to these investors.

And, of course, Howey disagreed, it went through the lower courts, lower courts agreed with Howey and said, no, this is not an investment contract. This is not something we intended in this legislation for the Securities and Exchange Commission to regulate. It went up to the Supreme Court and the Supreme Court said, actually, we disagree.

This is a security. This is an investment contract. And they announced a test. They said, basically, and I will pull it up.

So, the Supreme Court said an investment contract means a contract where someone invests his money, that’s the first thing - in a common enterprise, second thing - and is led to expect profits, that’s the third piece of it - from the efforts of the promoter or third party. That’s the fourth piece of the test.

So you have to have investment, in a common enterprise, expectation of profit. Then that profit is going to come from the efforts of someone who is not you, a third party who you’re placing your trust in. And they said by that standard, by that test, this orange grove opportunity is an investment contract that is a security. And so you have to go ahead and register with the SEC, and meet whatever applicable requirements apply to you. And since then, this has become the cornerstone of every conversation, every court analysis of whether something’s a security. So from 1946 to present day, you and I sitting here now, it’s all funneled through this test.

And there’s been not a whole lot of development by the Supreme Court on the various pieces of that. So the lower courts, the district courts, the courts of appeals, are left to sort through it on a case by case basis and attempt to analogize between selling an investment opportunity in orange groves, to things as sophisticated as these new technologies underlying various crypto networks, currencies, tokens, different sorts of new things that we’ve just never seen before.

Josh Simmons

So let’s start with the easy example we found, where apparently, everyone now agrees that Bitcoin is not a security. Therefore, it is not an investment contract. How does the analogy work with the orange grove? Why is Bitcoin not an orange grove?

Frank Scaduto

So this is the funny thing is the SEC has said it’s not. They have not supplied a ton of analysis. But what people are assuming, and I think this generally tracks, is Bitcoin was created by someone who no one has been able to locate, or maybe a group of people who did it in conjunction. But it is as decentralized as decentralized can be. There is no promoter or central person, or in the case of securities, an issuer who’s sort of driving things.

It is a truly decentralized network of computers, people, mostly anonymous to one another. And then, because of that, it doesn’t meet some of these various tests - the efforts of a promoter or third party, the common enterprise - it’s very hard, to map that concept onto the Bitcoin network, the “Big B”, and little “b”  Bitcoin, the currency that’s native to it.

Josh Simmons

We’ll get into this decentralization because I think it’s one of the key premises and promises of cryptocurrency that the proponents of crypto are championing. Because, historically, finance is centered in the banks, it’s centered in certain institutions, and crypto offers a promise of decentralization. Anyone in the world can buy, sell crypto, if they have computer access. And that’s caused some positive stories, which we’ll cover in later episodes, but it’s also caused a lot of negative stories, potential scams and claims about those, which we’ll get into as well.

But that’s the tension here. Right? The SEC is trying to regulate crypto on the one hand, and on the other hand, there’s a promise from decentralization. There are potential benefits here. Now, setting aside Bitcoin, which is not an orange grove. What about the other cryptocurrencies? This is what’s been in litigation in recent months about the definition of a security as applied to cryptocurrencies. Coinbase has been at the center of it. What’s the analysis looking like? Where’s this heading?

Frank Scaduto

So, since you raised Coinbase, those cases, the one against Coinbase being the most prominent, and now potentially one involving Robinhood, another trading platform, are strange because they don’t even go at the underlying asset, digital asset that is or is not a security.

They’re one step removed saying, well, you’re a trading platform, a broker dealer again to use more traditional securities law terminology, who’s facilitating the sale or the purchase of these digital assets. And so you have to register in order to allow the purchase or sale of these unregistered securities. So, so that, I mean, is a, it’s a whole nother layer of complexity.

But looking at sort of the assets themselves, now we have something like Ethereum, which was, you know, after Bitcoin, the biggest and I think most widely adopted cryptocurrency. And for a long time, the SEC was saying, no, it’s not a security. And, I think they were largely persuaded that it was similar to Bitcoin.

At some point, Ethereum had a fork, it went off in a different direction for reasons we don’t have to address here. And it switched its validation model to a proof of stake model, but moved away from proof of work, which is the one that Bitcoin still uses. And there is a sense among many that it’s the proof of staking that feels a lot like pooling together money in a common enterprise with the expectation of profit, by the efforts of a third party. And I think that is what dragged the SEC in the other direction in saying, okay, well now this looks and feels a lot more like a security.

Josh Simmons

What’s their theory? Because you said that there hasn’t been a clear explanation of why Bitcoin is not a security. What’s the theory, the argument that the SEC is putting forward against Ethereum and the other cryptocurrencies?

Frank Scaduto

Well, I mean, in a lot of these cases, they’re not even putting forward a theory directly in a rulemaking or in a sort of public document that is subject to some scrutiny, a lot of these things are starting as Wells notices by the SEC, which is an investigation outside the public view, where they’re poking around to try to understand the contours of the business that is attached to the technology and whether or not it fits into the test. But I think generally speaking, the SEC is trying to understand and characterize, increasingly in enforcement actions that are happening in court, these companies that are crypto businesses as common enterprises where people are putting their money and someone has to run those businesses to return a certain level of profit to the investors to try to make them feel like any other business. I think at some level, the SEC wants to regulate the cryptocurrency businesses that are out there now as like any other business, regardless of the technology. And what I think the crypto industry and the true believers and the people that know this  better than the SEC, because they’re the ones who built it, the technology and the business is inseparable. And so it is a fundamentally flawed idea that you can regulate something like Ethereum or, you know, its underlying native asset, Ether, and separate the business piece of that. They’re one in the same.

Josh Simmons

And I think the challenge, and I come at this from an international perspective, is that, yes, there could be an appropriate way to regulate this new digital asset. It’s an interesting space. It’s a new frontier. The government always is catching up to the entrepreneurial spirit, trying to figure out how to safely control new assets, new developments. But the challenge here is that with the SEC’s, what’s been called in a lot of the briefs, a regulation by enforcement approach, it’s creating a huge amount of uncertainty for companies in the crypto space. For example, if a company is deciding we want to build a Bitcoin mining facility, we want to invest millions of dollars. They might look at the United States right now, see this cloud of uncertainty and decide: Is there another country? Is there another jurisdiction where we should go? Why do we not want that to happen, Frank? Why should we have this investment happening in the United States? And what should the government be doing about it?

Frank Scaduto

Yeah, I mean, it’s a huge industry. It is a huge driver of innovation and growth in whatever economy it’s going to take residence in.

Right now, the United States is a leader and should continue to be, hopefully. And we should want to grow that cryptocurrency business and let the innovation flourish the same way we’ve let any number of other companies and technologies over the years, whether it’s Ford or a Facebook or whatever sort of stage we are in American history.

So to do what the United States Securities Exchange Commission is doing right now is inconsistent with that happening. And you see it in the ConsenSys lawsuit that you mentioned in the quick bits. I mean, they say point blank. We built this business on the words of the SEC and Gary Gensler, the Chairman, that Ether and Ethereum was not a security.

We built an entire, you know, multi-billion dollar company around it. And now the SEC is saying the opposite. If that’s going to continue without any certainty as to whether, the business, the technology, the product, the service that you’re building in the crypto space. Whether you know for sure that you’re going to be subject to regulation or not, and what that regulation is and how you comply with it, it’s almost impossible for a company to want to set up shop in the United States when it could do so elsewhere without that threat.

It’s existential. I mean, these companies may not exist, if the current SEC trajectory continues.

Josh Simmons

So these are the stakes. The stakes are high. We have digital innovation, but we also have regulation, and there’s a lot of uncertainty about that. We’ve covered this threshold question of: Is cryptocurrency a security?

And as you’ve explained, Frank, there’s going to be a lot more dispute about this, a lot more litigation. So let’s wrap up this first episode with a final word before we tackle in the next episode: How that litigation is playing out and what the consequences are? What’s the final word, Frank?

Frank Scaduto

Final word is: Does it matter what I say or you say, or anyone says on this? Unless and until the SEC is forced by Congress or by someone to stop doing what it’s doing, the courts are going to decide these issues. And it’s really chaotic. It’s sort of a no-win proposition. So we need a better way here in the US. There has to be. . . It could evolve the SEC, it could not evolve the SEC, but it can’t be what we’re doing right now.

Josh Simmons

When you’re starting from an orange grove and going to Ethereum, you’re going to have some trouble with the analogy. But that’s why we’re here to help. CryptoCounsel at Wiley, we are wired into Washington. Thanks for listening.