The SEC Declares War on Crypto

bankless Nation I hope you're doing well we spun up this episode in a hurry for you this topic evolved late last week David it feels like the SEC has declared war on crypto staking is not a crime or is it I don't even know anymore with respect to what the SEC is doing what are we going to cover today and who do we have on as our guest yeah not just the SEC there is an entire cross-governmental agency coordinated effort to really apply pressure to the

industry across many different vectors uh what is going on we're bringing on Mike selig who is going to it's the second time on Bank list this is the first time we uh he uh perfect timing at the end of December called 2023 the year of Regulation yes and we are now just six weeks later and here we are uh and so perhaps he called it and so my first question to Mike is going to be uh is this what you expected uh but overall we're just going to get a lay of the land and now that we

have more insight into what the SEC is up to along with all the other agencies that are also showing face showing Force what is going on and what yeah I mean this last we left you guys was the roll up which we recorded Thursday and um there was rumors that maybe the SEC was going to say something about staking and they did more than say something since we've recorded our last episode on this subject they actually went about and banned uh staking on Kraken like what's that about we're gonna talk about that

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

into web 3 and crypto it is called metamask learn that is learn dot metamask.io to go check the this out David what's on my screen what are we looking at here so yeah manifest learn is a brand new educational and entertainment platform it's an entertaining platform designed to get you immersed into the world of web3 so of course you will go through the onboarding flow of what is web3 what's a crypto wallet how do I set up my crypto wallet what does it mean to do self-custody what is digital identity

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um all right David um maybe tell listeners what they can expect to hear from Mike in this episode what should we be looking out for yeah so for every single topic there's been a number of topics that are all announced announced revealed in the last like week or so there is SEC versus Kraken what about Kraken staking product really triggered the ire of the SEC there's there's the SEC versus paxos why did whatever paxos is doing with binance stablecoin why did that trigger the irf

the FCC then there's the rest of operation choke point which involves just Senate Banking Committee uh the treasury like all of these different cross-governmental organizations overarching the bite Administration why are they why is this all happening at once well is this the end of the onslaught or is there another barrage coming so these are all the angles that we are going to talk about just to be informed about like all right this is we're six weeks into 2023 is this what the rest of the year is like or is this what a brutal year yeah like why do they

hate us so much I don't understand we'll ask Mike that question too guys we're going to get right to the episode but before we do we want to thank the sponsors that made this episode possible including Kraken our recommended exchange for 2023. I guess you can't stake there if you're in the US but you can in Europe you can't interact with Mike about that we'll be right back Kraken has been a leader in the crypto industry for the last 12 years dedicated to accelerating the global adoption of crypto Kraken puts an emphasis on security transparency and client support

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at earnify and see what you get that's e-a-r-n-i dot f i and make sure you never lose another airdrop banklist Nation I want to introduce you to Mike selig who's the council for the digital asset Department over at wilkiefar and Gallagher an international law firm based here in New York City and Mike has been on Bank list before not talking not too long ago talking about the year ahead for crypto regulation and at the start of this year Mike you wrote an article where you said in the year ahead the SEC and the cftc will likely push the boundaries for the of their

existing authorities through novel enforcement actions um Mike we are only six weeks into 2023. is this what you thought would happen is this is this the Playbook that you thought would be coming you know it it's a little bit more coordinated than even I anticipated I think you've seen um actions by the cftc the SEC treasury um within Treasury fincen and ofac evaluating the stuff State Regulators like the New York Department of Financial Services there's a clear uh coordination of efforts amongst the

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

right so uh the SEC came in with a a settlement with Kraken uh Kraken agreed to pay a 30 million dollar fine to settle with the SEC uh what is exactly the what did the SEC charge Kraken with and can you just help us unpack this yeah yeah and just first of all to all the anons out there I'm not your lawyer and nothing I say is legal advice today um so what's going on with with Kraken and staking first of all the SEC is not saying that all forms of staking are securities yet they might we'll see but

today uh the focus is on these staking programs offered through centralized platforms here Kraken and all of this was settled uh between the the agency and Kraken and so none of this is necessarily law um it's not binding precedent uh Kraken chose to to settle here um but but others may not and so even custodial staking programs May uh be outside the scope of the Securities laws is just a settlement but what's Happening Here is the SEC is glomming on to centralize custodial staking programs and what happens in these programs is

somebody wants to to stake either they don't want to run the software themselves and and stake directly through the um deposit contract maybe they don't have 32 each they decide to go to a custodial provider um hear Kraken uh their crypto assets to crack in or they buy crypto assets on the exchange cracking pools those crypto assets uh and then deposit some of them mistaking uh contract and others it held in reserve and so the SEC is really focused on this this program the pooling of the assets together and providing a

return to the to the Staker the return is not necessarily the same return you would get if you staked directly uh Kraken published a return amount and that could be higher or lower at times than the actual amount that you would earn by staking directly and the rewards are more consistent because if you've got a big pool of crypto assets that you're staking you're going to get rewards much more often not necessarily higher rewards um and in fact the rewards very well could have been lower because if you're staking directly you don't pay fees um but the the idea that there's some

crypto assets that don't get staged Krakens potentially managing this reserve and then providing instant liquidity so you don't have the bonding and unbonding periods that you would have and with ethereum you know you can't withdraw until until we get the unlock and so uh just some of the mechanics look a lot different from staking directly or even liquid staking um and and that's important but not every crypto custodial um staking program is necessarily even comparable to this so you could have a program where you have a state license money transmitter so most of these exchanges

and custodians are licensed at the state level they may hold a trust Charter which we'll discuss the making stuff later or they might have state money transmitter licenses and they register with binson as a Money Services business they have the ability to move funds on behalf of customers and so if you deposit crypto assets with one of these third parties they move the funds and there's a deposit contract for you stake it for you they're really just routing funds to another person or location and that's kind of within the scope of what these guys do like a PayPal or a venmo

um so so that direct model is a little bit different than this pooling type model where you have some held back some staked you know a promise fixed return and then of course the SEC is very focused on marketing and so they didn't like some of the marketing language promoting a fixed return promoting you know the expertise and security of the validators operated by uh Kraken here so whether any of this is really fair game or or right within the sense of the Howie test and the law um these are the arguments the SEC made

and crack and chose to settle here I um I I guess I want to ask you a few things about this Mike what's like one is uh in the manner by which the SEC is sort of rolling this out um and this was the uh the video that um Gary Gensler put out and uh has uh his like classroom with Gary um is actually the title and um like this is this is Gary explaining staking to us um with some nice background music and you know it's hilarious that it's actually a picture of a steak as in meat

um office hours with Gary Gensler um the way this was approached is very interesting to me so um it was focused on Kraken there was the settlement but what's interesting about the approach is like they didn't like ask Kraken to sort of re-register or uh tweak certain things and then come back to them it was sort of a flat out you can no longer do this and then a settlement by Kraken I tweeted this under Gary's like you could have mandated proof of reserves required

staking transparency supported decentralized staking instead we got another Gary G bandhammer to the head that's really what it's felt like from the crypto industry is this typically the way the SEC kind of rolls out its um what if what you'd call this um penalties or or like prohibitions or is this somewhat unique to this particular case and and to the crypto industry the SEC has the power to both issue

rules and to reinforcement actions these are the two ways that they regulate in most contexts with a new technology a new type of financial product the SEC has open meetings where the industry can come in talk to The Regulators uh work collaboratively with the industry uh they propose rules industry comments on those rules and then they get finalized the SEC rather than engaging with this industry you know under the current Administration is putting out influencer YouTube videos comparing proof of stake

to stake um putting out enforcement actions sending Wells notices to everybody really trying to diminish the industry and it shows that they don't at least this Administration doesn't view it in the same way that they view the asset management industry more broadly or view private Equity or hedge funds they're looking down on the industry putting out office hours with Gary as if this is child's uh you know child's Finance you know Matt Levine's calling it you know fake you know a toy economy of crypto and I think that's

really the messaging that they're pushing and so rather than engage and have real hearings and open meetings on this stuff they're just going to bring lawsuits and try and Sue everybody and the industry is probably going to push back Mike the feeling of this video was just patronizing AF like that's what I felt like you're explaining staking to people who have ether staked inside of Kraken as if we don't know anything and we're just yeah gullible dumb investors

you know and like you're trying to teach a classroom um I I don't understand the patronizing approach is that is that a vibe that um he's going for do you think or is this just like how he views the industry What's Happening Here yeah I think that I think this is the the Gensler Vibe I think this is what he wants to do right he wants to delegitimize and minimize the industry whereas what we saw with the Clayton Administration which a lot of us were frustrated with right during the Ico years and the the token sale years where

there were so many scams out there so it was it was somewhat reasonable but there were a lot of legitimate companies trying to sell tokens and build in the space and we were frustrated with the the lack of clarity and guidance but they pulled out a framework they've put out um guidance on on various items um they put out um which we can talk about later something on stable coins which is helpful here um with respect to other things that are going on with against Administration but there's really just been from this Administration a condescending attitude and if you come in you walk out with a

subpoena it's it's not the same uh I was talking to someone earlier about going into meeting with the SEC you can't really do that anymore because you walk out with a subpoena or you get Wells and it's just not a friendly uh environment to operate just a quick definition for us what does getting Wells mean so a Wells notice is essentially the the beginning of an investigation by a regulator such as the SEC or the cfdc they send you a letter that says we're considering bringing a full investigation an enforcement action

where we're going to seek civil monetary penalties and other um relief and tell us why you don't think we should do that and they give you a period of time to respond and this current SEC is not giving a whole lot of time to respond and the cfdc frankly is not either and so there's this hurry up and and settle with us attitude um and they're they're wellsing a lot of these crypto industry participants so they're collecting a lot of information and really trying to find uh pressure points really trying to find points of centralization you know we talked about

my article um that I wrote last year kind of on the predictions for this year I think it I predicted that it would be a year of central as a decentralization versus regulation where the the crypto protocol developers are really looking to find ways to decentralize aspects of their products same with even centralized platforms incorporating things like MPC and D5 and web3 into their platforms to further decentralize their offerings so that the SEC can't point to these kind of centralized points of failure like they're doing with with Kraken and some

of these actions there's a tweet here on screen that I uh this conversation has reminded me I I saw not too too long ago this is from Jason Gottlieb Gottlieb uh he says I find the sec's all crypto projects have to do is come in and register line unbelievably insulting it assumes that there's this vast quantity of sophisticated Securities lawyers who are advising their crypto clients nah man screw the SEC YOLO baby and do whatever you want and this is the communication that Gary Gensler and the

SEC have put out there it's like oh you are free to come in and be compliant with us uh which is just taking the voice out of so much of the crypto industry and saying that like oh it's it's simple you just come in and do this process and I'm my my skepticism hat is like oh Gary Gensler is putting on a show he's putting on a face for the rest of the world to say like oh the right the wild west of the crypto world isn't doing what we're asking and coming in and complying meanwhile there are very smart very talented lawyers in the

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

want this stuff to to move forward want rules want reasonable regulation um but it's very difficult to uh you know Gary Gensler said on CNBC the other day you just come file a form it's on our website and Jesse Powell tweeted about it like yeah that's exactly why we have a 30 million settlement here because it's not that easy to just file a form um none of this stuff works within the existing Paradigm for Securities regulation which is kind of what we talked about the last time I was on and without exemptive relief and changes to some of the market structure

we're not going to be able to have uh crypto within a Securities framework it's just going to be equity on you know Equity Securities on a blockchain Okay so we've hammered out the SEC has a bias against the crypto industry details like that's kind of no surprise to people I want to actually go back to the to the cracking case specifically because you talked about in the ways that all of the Kraken staking product was different from just raw protocol staking can you talk about just like the line that uh the line that was drawn by

the SEC that differentiated Kraken specific flavoring of staking versus like uh I think you'd like differentiated it between liquid staking just talk about the nuances about like what the SEC specifically was going after here and how Kraken staking was different from just any other centralized staking as a service provider yeah absolutely so staking directly is is the cleanest form and that you're on ethereum pulling together your own 32e sending it to the deposit contract

staking it directly um you accrue your staking rewards the rewards are generated by the ethereum network they don't come from any sort of third party or centralized intermediary um it's it's very similar to you know on a proof of work chain you earn rewards and the same kind of programmatic fashion um so the SEC hasn't really cast any thought on on directly staking or running a proof of work node or any of that um I want to also be clear so that includes running your unvalidator from

your house right direct to protocol um does that also include using some sort of decentralized staking service like uh maybe a rocket pool in the future Lido have they weighed in on that at all so the SEC is not made of you um public on on any of that I think that is the next step right so we feel most comfortable with staking directly liquid staking and Rocket pool and Lido and others like um liquid Collective these other types of of staking methods uh you

know the SEC is not weighed in on but they're much closer to staking directly than staking through any centralized custodium because everybody is putting their eat together in a single smart contract there's no person running a program or collecting that Ethan and saying oh some of these are going to be staked and others aren't and and even if that were to occur with respect to the programming of the smart contract it's all open source there's there's no information asymmetries the code's out there it goes into a smart contract you get your receipt token and we should be

calling these liquid staking tokens instead of liquid staking derivatives that's another point they're not derivatives um but you put your token into the the smart contract back you receive your receipt token and those uh crypto assets that were that are in the smart contract get Associated uh delegated to a validator node um and they get State and you get your rewards from the ethereum network they're passed on to your receipt it looks a lot like regular staking it looks similar to you know if the three of us got together and like we don't have 32e let's pull our youth together

um run a node and stake it together and that's the idea with these liquid staking protocols as opposed to some centralized program where there's other features and I think it's important to note that in the sec's complaints against Kraken they compare kraken's program to staking directly they say that there are these other features that make an investment like that bring up within the scope of the Howie test that uh presumably staking directly or even under um liquid staking protocol but you don't have all these other features

um and an important Point here as well is that there's terms of use there's terms and conditions associated with the central platform where you're staking through a program and depending on what's in those terms of use as the SEC pointed out in this instance uh with Kraken the term said that kraken's creditors could encumber the assets so it looked a lot more like what Gemini is being investigated for uh What uh block 5 was offering uh next so some of these other lending Pro uh programs where

users put in assets they're kind of pulled together they may be deployed in whatever way they're deployed but you earn a return on that um and I think in staking from a policy perspective and from just a reasonable person's perspective the two are not the same um some of the features on top of staking are almost not the essential managerial efforts that you would look to the rewards are still coming from the network and so the SEC should be more focused on these instances where they're

being thrown into 3ac and into other you know speculative uh projects as opposed to being deposited in the the ethereum smart contract and receiving rewards it might to be clear other centralized exchanges offer staking as well I mean maybe notably um coinbase um that is custodial staking in the in similar ways that Kraken is why it wasn't uh coinbase why doesn't coinbase have to shut down its staking program right now you know the facts and circumstances of every program are going to determine

what the you know whether the SEC views it as a security or whether it meets the definition of a security so without you know speaking to any particular program it's really hard to say and we don't know what the SEC is looking at frankly uh behind the scenes but every program is different the terms and conditions are different for every program I think it's important if there is a you know a staking program that you look to the terms and conditions and if you have legal and beneficial ownership of your crypto assets and they're just sported on to the protocol uh for staking and you can pull them out at any time there's no features that make it

investment-like there's not a reserve of tokens all these features that the SEC focused on and crack in um that can be used as a checklist and framework for evaluating other programs but it's not to say that that you know Kraken chose to settle this you know it's not law it this is only an out of an out of court settlement this is what's confusing confusing to me so I I think like staking Revenue at least because we could we can track this for coinbase was like 13 percent of their revenue last year or something right it's like that's a lot of money for centralized exchanges so

um one it's just you know point of evidence that that coinbase is still operating a staking uh service in the United States has not has not shut that down has not been required to shut down and then like another point of fact is is Kraken has and like it seems like if if what you're saying is true is like um there could be some things tweaked to the policy or or changed about the way Kraken does it and honestly I wouldn't I wouldn't see why why Kraken would have any material reason not to make these changes if that was requested why would they just go through the process of like

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

be reasonable about like what we should do for the industry you just turned it off and I don't understand why that hasn't happened uh and like there just doesn't seem to be consistency here is this story making sense to you yeah you know in under the prior Administration under the Clayton Administration they set up this thing called finhub which is their you know coming and talk to the crypto team at the SEC and in a collaborative way we'll work through exemptive relief and other sorts of issues that was a path for many projects back

in the day there were three new action letters granted to crypto projects I worked on one of them the most recent of the three and this was in you know 2019 2020 that we were granted a letter actually for something that looked a lot like a stable coin which was interesting um with respect to some of their other actions and it was very collaborative the fin Hub was open to meeting with industry and providing relief under the current Administration that's not the case and so it makes it very difficult for centralized exchanges or anybody in the space that wants to comply because

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

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

well that are clearly not taking the same position as the SEC so is uh Gensler and this Administration not in net effect driving this business offshore and making American uh companies in American cryptocurrency exchanges less competitive in the global market and doing a disservice potentially to retail removing an option from the ranks is that the net effect of this that's exactly what's happening here we've got Micah in Europe there's progress towards crypto laws and

regulations overseas we don't have that here there was some momentum and FTX kind of blew everything up right and so we don't have any sort of legislation that's being seriously considered at the moment maybe we will but without that legislative package it makes it really hard because The Regulators are just doing their thing they're they're following the the administration's uh we'll talk about operation choke point later but following this kind of General uh antagonism towards crypto and they have this broad enforcement Authority

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

centralized intermediaries in their actions I know um David's going to summarize this in a second but just I I just want to say two more things like uh okay so um first is I don't have assurances that um Gensler won't come after staking pools next um because it seems like he it's somewhat arbitrary in terms of what he comes after and what this what the SEC comes after I'm somewhat worried that maybe some

um staking uh what was the term used not derivative but like you know liquid taking staking token might be deemed to security by this Administration next right so like some people are saying well this is great isn't it net effect is a decentralizes staking and I don't actually think it's great because one it removes an option from the market um increases the barrier to entry to staking but also number two I don't have confidence or trust that this Administration won't come after a decentralized staking Pool Services next is that an unfounded