The Delphi Podcast Host and GP of Delphi Ventures Tom Shaughnessy sits down with Gabriel Shapiro, General Counsel at Delphi Labs, Delphi’s very own project incubator. The two discuss legal differences between traditional businesses and crypto, the motivations of regulatory bodies, regulation on centralized and decentralized stablecoins and much more!
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Hey, everyone. Welcome back to the podcast. I’m your host, Tom Shaughnessy. I help lead Delphi Ventures. Today, I’m thrilled to be recording from our work office, where I haven’t been in a year, and I have on Gabe Shapiro, who’s GC of Delphi Labs. And I think one of the most well-known, knowledgeable, legal voices in the crypto space. Gabe, how’s it going?
Going well. Glad to be here.
Gabe, you look like you’re ready for the weekend.
Oh, I always look like that. I work on my couch on a lap desk. It’s great.
It’s crazy how much you get done there. Gabe, tell us a bit about your background for those who don’t follow you?
Sure. So I’ve been an attorney for, I don’t know, maybe 11 years now, or something like that. And for a lot of my career, I was basically a Silicon Valley technology, mergers and acquisitions attorney, I would say. So I did a lot of buy-side mergers deals for big tech companies, like Facebook, Oracle, eBay, these types of companies. And I was in the mix, right? I was in the Bay Area. I wasn’t a venture lawyer primarily, so I was more on the due diligence side, like after startup that was super successful, maybe one of my clients would acquire it and I’d have to find all the mistakes that the venture capital lawyers made in the rounds and stuff like that. But I was in that world, basically.
And I just got very interested in blockchain, ironically, by doing the Facebook-WhatsApp deal, because the Facebook-WhatsApp deal, a lot of it was about encryption and things like that, and so I got exposed to those issues. Started researching encryption and that led me to discover cryptocurrencies. And especially, when I found Ethereum and the idea of smart contracts, I was like, “Oh, cool. So automating my job away, that’d be awesome.” And I got pretty obsessed at that point, and in 2018, I took the leap into blockchain full time, right before the bear market hit, perfect timing as always. And I’ve been doing crypto law in one guise or another, ever since then.
I love that. Any war stories from your VC review days, that you could legally share, or anything there, assuming most of it’s hidden?
Well, I think maybe the funniest was when we were doing a deal, and the partner, the head partner on the deal, was a very important partner at the firm, very senior, he’s on all the right ABA committees and all these things. And he really wanted to do the deal as an asset purchase. He wanted to do it that way the whole time. And of course, that’s not as advantageous to the target, because you get to leave behind the liabilities in an asset deal, and so you stick them with it. And so it was a point of contention and we were doing it as a stock deal. And in doing the due diligence, I found some, honestly, arguably fairly minor flaw in the way that they had set up these entities early on.
But it was enough of a flaw where we could argue that everyone was entitled to the Securities Law remedy of rescission. Meaning that they could under the entire deal and get all their money back from the original investment, and just destroy everything. And so of course, he immediately seized upon this, he made it the reason why we had to do an asset deal. So it just shows you how fairly minor things can come back to haunt you, and there’s a tendency for startups to be like, “Oh, we just need to get it done and none of this stuff matters.” And a lot of times that’s true, honestly, but every once in a while, you’ll have some weakness that you never suspected and it’ll be exploited years later by some very OCD-style, big law partner on a totally unrelated deal. So yeah, a lot of war stories like that.
When thinking about the deals you looked at on the traditional side, versus the crypto side, I mean, it seems everything is different. But to your point, these deals close so fast that people might not spend that much time on minute details when things don’t matter, but a week, a month, quarter later, these projects worth hundreds of millions or billions of dollars, so this stuff starts to really matter. What’s the biggest differences you see from, there’s a lot of paths we can go down here and we will later in the podcast, but what are the biggest differences you see, I guess, from the legal side on projects, starting in crypto vers your old world, because like you said, a lot of these guys are just trying to close in a week or so?
So yeah, I would say that they’re actually becoming more similar now. Right? But they used to be very, very different. I mean, the idea of funding a startup through an ICO, which is basically an IPO, and that was the dominant mode of fundraising in 2017 and 2016, that would be crazy, right? It’s actually the exact opposite in the traditional business world. You do a public offering when you’re very, very mature, right? And you do a private offering, when you’re very small, right? You raise from Angels and VCs. So it used to be very different.
Now it’s much more similar, because projects are raising quite sizeable rounds from Angels and from venture capitalists on a private basis. They clearly comply with securities laws at that stage, just limited to accredited investors, or just make it a non-public offering, and you can comply with securities laws that way. So in that sense, they become more similar to each other, but there still are a lot of differences, and I think that many people haven’t fully processed all those differences. For example, if you’re raising for a traditional company, you’re selling equity in that company, and that’s all you’re selling, right? You’re not selling five different types of securities to the same people, because why would you do that? If you wanted five different features, you could just add them in the same security, which is what preferred stock is, right?
It has a little bit of debt, and a little bit of equity, and some voting, and these things. But in these crypto rounds, most often it’s a combined equity and token round, right? And so this leads to many very strange things, because you’re going to have all the same terms that you have in a traditional venture round with preferred stock. Then you’re also going to have these token terms. What does it all mean? Right? Because if you’re as a company that’s selling stock, unless you’re some type of newfangled entity, like a public benefit corporation, which almost no one uses, you have a duty under the law to do what’s called maximizing shareholder value, shareholder value, not token holder, right?
But on the other hand, you also are selling these tokens. Right? And so it all works pretty well when your token holders are the same as your shareholders. But what happens when you launch this token out into the world, right? Or what happens when some of the shareholders own more of the stock than the owner of the token, because they sold some of the token? Well, now it gets very weird, because you have this fiduciary duty to shareholders. It’s unclear what your duty is already token holders, and whether all token holders are the same in that regard? Do you have a duty to every token holder or only to the ones who also hold stock? And it just gets very strange. And I honestly think it’s the contradictions, and the conflicts of interest, are huge and underexplored, so that’s one dramatic difference, I would say.
No, that’s a huge difference. So you have the fiduciary responsibility to the equity side, is there an argument though that these leaders also have to take care of the token holders, because the token holders obviously underpin the security longevity incentives of the project, which then drive the equity, or is that my leaping too much here?
There might be some arguments, but they haven’t really been litigated yet. So there might be some implied fiduciary duty, right? But no one’s been held guilty for violating any that fiduciary duty at any point yet. Right? So at this point, I think most people proceed as if they have no duties to token holders as such, which I think is a pretty perverse result. And it’s one of many catch-22s that we’ll probably discuss which is that, the more clearly you assume responsibility for actually doing something for token holders, the more likely you are to get in trouble with regulators, ironically, and the less you do for them, the lower your regulatory burdens are, which makes no sense, but it is the case.
It’s crazy. It’s handed off and you’re in good shape, but your project’s not, in that case?
Exactly, right. Yeah.
That’s tough. I want to go a bit more to project formation, but I want to shift gears a little bit to talk about regulations that are at the forefront. So there’s a lot going on. Everyone sees a new tweet every day, Gensler this, SEC that. I’m not sure people understand who the regulating parties are and what their powers are, and what they’re actually able to do. Can you dive into, I guess, what you see as the body that would most regulate crypto or have most of an impact, and where they’re at right now?
Well, right now, there’s a little bit of a turf war going on in DC, I would say, on that very subject. And I think that suddenly with the administration change and the Dems, Dems are traditionally pro heavier financial regulation. Elizabeth Warren has become very powerful and she obviously is a career-long heavy financial regulatory person, originally is a law professor. And so there’s now a careerist scrambling to be seen as someone who is very good at being tough on crypto, because if you’re perceived that way, you can get better positions, and more authority, and more power within the Democratic Party. And so there’s a turf war where everyone is trying to get a piece of the pie at the same time. And the best way they can get a piece of the pie is, if they have the authority to do so, just start a ton of enforcement actions and investigations, right?
And then whoever does the most of that and starts winning, will probably end up with a lot of power. So currently the SEC is, I would say, carpet bombing the industry with… I don’t think they’ve gotten to the subpoenas stage with many of them yet, but they’re sending out what are called, request for voluntary information, right? But of course, if you get one of those, you know that they have very strong subpoena authority and they could subpoena you. So you might as well respond to those very falsimile. And so there were a lot of investigations, and conversations, and incipient of disputes brewing already, and the SEC has definitely been the most aggressive and what they will assert is, they will say, “Well, your governance token is a security,” or they will say, “Well, your smart contract protocol,” if you think of something like an AMM, “there are thousands of tokens that are in that, at least one of them is going to be a security.” Right?
We won’t even prove to you which one is security. We’re just going to say, “Isn’t it obvious that at least one is security and therefore, are you running a securities exchange, because you’re involved in this smart contract, and maybe standing up a website that lets people interact with the smart contract?” Or they will say, “Well, for maybe a protocol compound…” and again, I’m not anything I say here about specific things, don’t infer from that, that they’re under investigation, I don’t know, I have no idea, but for something that is like compound or are there any type of lent credit protocol, they will say, “Well, look, it talks about paying an interest rate. It talks about an APY, and a APR, and it talks about borrowing and lending. Isn’t this peer-to-peer lending platform just all the ones that are registered with the SEC, and don’t you have to come register with the SEC?” Right? Now. Of course, these are analogies to the traditional financial world and in my opinion, they don’t exactly hold up most of the time, but those are the types of theories that they’re asserting for why they have jurisdiction.
That’s a good point. I understand the turf war. I understand Why they would want to carpet bomb to get as much power, and be the point person, and gain control. I’m trying to understand, how do you innovate on the legal structure, or what the government is okay with on one side, while also trying to fit this in a box during a turf war, right? You have a turf war, people trying to get control and they’re trying to put crypto into the old buckets that we on the legal side for the last 100 years. But on the other side, you also have an innovation track, hopefully, where the government starts to get okay with this, they innovate a bit, how do those two co-exist together? Or do they not coexist together?
I think right now, they don’t coexist. I hope that they do at some point, but I just think that there’s just a lot of initial skepticism and hostility. I don’t really blame the regulars for it completely, because I do think there’s a lot of bullshit out there, right? There’s a lot of people trying to make something seem decentralized, but it’s really not, and all the benefits are flowing through for a very few people. So I get their skepticism, right? But on the other hand, they don’t really offer solutions, right? Tom Emmer had a good tweetstorm yesterday about this and in his questioning of Gensler a few days ago, during the House Oversight Hearings. But even if someone wanted to say, “Okay, yeah. We think our token is a security.” Or, “We think our smart contract system is a securities exchange.”
They couldn’t go to the SEC, to just do the proper registrations and have it all work. It wouldn’t work, FINRA is not going to accept a smart contract system to some team of software developers, and start treating them as broker-dealers, right? And broker-dealers, they’re not allowed to simultaneously custody securities and non-securities together. You couldn’t have Coinbase anymore because it would be trading both some non-securities tokens and some securities tokens, that’s not allowed, right? So it’s not like a path does exist where even if everyone’s willing to admit that they were securities, they could just come in and make it work.
And a few people did try to make that path work, right? Like Blockstack and there was a project called Props, which I don’t exactly understand what it is, but they did something called the Regulation A+ path, which is where you don’t have to do the full SEC reporting, but you have to do something similar, and there’s some transferability for the securities, but there are also limits on that transferability, but you could sell to retail. You’re not limited to only accredited, and it can trade, but it can only trade in securities venues, right? And so Props tried to do this, and they got the Reg A+ qualification and they ended up shutting down a month ago, with a big announcement of how, basically it was impossible for them to make it work well as a product, while also treating the token as a security and doing the reporting. Because every time that they would want to make any change to the system, of course, software is all about constant changes, they would have to go through basically a new qualification process. It just doesn’t work. Right?
I don’t know the right way to phrase this question. So I’m just going to throw it out there and say that it’s not my view, but when you look back at how this panned out, Blockstack did a Reg A+ offering years ago, they spent a good chunk of their money at the time, to do it before the token was worth a lot more. And then something like EOS, that raise billions of dollars and they got a $24 million fine. So it feels like it’s in the projects’ best interest to innovate and ask for forgiveness later. And this is obviously not my opinion or legal opinion, or don’t go do this, guys, but I’m trying to get your read-through here. It seems like everyone’s in a better position if you push the boundaries a little bit, obviously I’m not saying to do anything wrong, but what’s your read-through on how that panned out?
Yeah. I mean, it’s true. Yeah. I mean, people who asked for permission, had to shut their projects down, refund all the money and never do anything, after spending a year negotiating with the SEC. Right? And people who just did something, became very rich. And that’s because the SEC has limited resources and they’re probably so much distractible, based on where the political winds are blowing, and Clayton when he came in 2017, initially he was like Gensler. He was, “All right, we’re going to crack down on this whole thing.” Right? But after they got a couple of wins under their belt, suddenly they seem to lose interest. Then suddenly there was that out-of-left-field speech about sufficient decentralization, which I like, but what surprised a lot of people, and certainly didn’t paint a clear picture of what people should be doing.
And then there was just this long period where, yeah, people could just do stuff and get away with it, and get really rich. To their credit, I think that this new SEC administration doesn’t want to repeat that what they probably see as being a mistake and that’s why that they are engaging in an unprecedented, I think it is deeper than what they did in 2017, early 2018, just really sending out so many letters and investigations, and really rattling sabers. But at the end of the day, I don’t know how it’s going to go because if he works people hard enough to actually go after all of these projects simultaneously, then he’s going to be the most hated SEC Chair, even by the SEC staff, because they’ll be so overworked, they just don’t have the resources.
That being said, no one wants that. No one just wants to roll the dice and hope that they’re the project that’s not enforced against. It should just be different. It should just be clearer what they need to do, and what they need to do should be something that doesn’t kill the usefulness of the project, and then everyone should just do that, and it should all work. But unfortunately, I think we’re very far from that, and there’s just going to be a lot of litigation and selective enforcement.
Yeah, no, I’m with you. Exhausting everyone would be annoying. And I do think Gensler is trying to help people in need, that maybe need to get up to speed and to protect people. So I’ll give him some credit there. If you had to give advice to Gensler on his current path, what would you say? If you had an hour to talk to him, and maybe to share your views with him, what do you think you’d probably spend the most time on?
Oh, well, I would say that they should not focus so much on the enforcement actions, and focus on creating a workable framework. And I think a lot of people have proposed a lot of interesting ideas on workable frameworks. Some of which are, I would say contradictory with each other, but to me, all that really matters is finding something that works, right? Some people, like Hester Peirce, who’s another SEC Commissioner, right? She proposed a safe harbor, where basically she said, “Okay, there’s a catch-22 here. On the one hand we’re saying, ‘If you’re sufficiently decentralized, you’re outside the ambit of the securities laws, because there are too many different unaffiliated parties. We’re all contributing value and no single one of them would make a lot of sense to make an SEC reporter in the issuer position.’ So we’re saying that, but on the other hand, we’re saying that a project can never get there because if the token is a security, then it’s never going to become liquid enough while being compliant, to actually have that level of decentralization.”
So her proposal was basically, “Let’s cut this Gordian knot. Let’s have them do a fairly simple disclosure. One that’s not as tough as the standard that Apple Inc has for its disclosures, and they can publish that. And then we’ll give them three years to get decentralized. They’ll keep publishing occasional reports about things like insiders doing trading and things like that. And as long as they are sufficiently decentralized by that point, and there’s no one really in control, and it’s a thriving community,” I’m paraphrasing heavily here obviously, “then we’ll give them a pass at that point,” and the only thing that will remain, is just the anti-fraud rules. Right?
“If someone markets the token fraudulently, we’re still going to be able to go, ‘We, the SEC, will still be able to sue them for securities fraud.'” I think that’s a good proposal. I think a more liberal version of Regulation A+, combined with some types of safe harbors for things like AMMs, and saying those are not securities exchanges. So that again, the tokens might be treated as securities, but they could trade, at least in some venues, without breaking the law. I think that could also work, right? I think there are a lot of different things that work. The other day, I proposed an idea, “Well, really all that you care about is will abuse and insider abuse, basically trading against the other token holders who have less information. So just adapt what are called the Section 16 and the Section 13 rules, that currently apply to a public company, insiders, and public company wills, and require reports that. And leave the rest alone.” Because no one cares about…
Do you care about UNISWAP Corporations’ financials? Why would you care about that? Even if you are a huge Uniwell, I don’t think you really care that much about… Maybe you might want to know just their assets and liabilities, or something like that, but it doesn’t need to be audited by a public accountant, and have all their internal controls certified and stuff like that. And the reason why it doesn’t matter, is because it’s not an equity instrument that relates to those funds, right? Whereas if you have Apple stock, the value of the stock is based on it being a residual claim of the assets of the corporation, and so it does matter there.
So they could liberalize these rules and they have done similar things in the past, like for example, for asset-backed securities, when there’s a lot of gray area around that, but that’s what they should be doing, instead of collecting thousands and thousands of documents from software developers who sometimes don’t even have entities, and they don’t even own the software. And sometimes they’ve never raised money by selling anything. Some of these projects haven’t sold a single token to the public, you know what I mean? And they’ve never taken capital in from the public. It’s just a bootstrap thing where the public liked the token and it became valuable, and they had some of it and so on. It’s just very different. And so that’s what they should be doing, but sadly, I don’t think that’s what they’re doing.
No, no. Those are really good topic areas for what they should be looking at. I mean, how does it play out though? Let’s say hypothetically, they go after a few select companies like you said, in your selected enforcement, lay the land, “This is what you guys can and can’t do.” If let’s say they go after one of the big DeFi projects that they can, I guess the question for you is, one, where do they go after? Do they go up to the founders? They go after the protocol level? They go the UI? What do they attack? And then two, how does that pan out? They don’t obviously automatically win. I’m sure there’s some type of case or procedure there, but with that give and take, where do you think they end up at the end of the day, afterward?
Yeah. I don’t know. I don’t think anyone knows. There are a few different directions I could see it going. Well, number one, I mean, it’s clear who they’re going after. They’re going after the software [inaudible 00:25:52], right? And I would say, I think a little bit after venture capital funds. They’re going after them on the theory that, which is true, that they are greatly… It’s like cui bono, who benefits, right? Well, the software developers do benefit a lot, because they do make a lot of money and it’s paradoxical because they don’t own the software, right? And they don’t run the software and they don’t own any infrastructure that the software runs on. Right? It runs on Ethereum, miners run Ethereum, that those software developers have nothing to do with it. They’re not miners, right? They don’t own that infrastructure.
And the smart contract code, other people could fork it, usually, under an open source license, and again, they would have no recourse. But nonetheless, they still are doing very well, that’s undeniable. And so there’s a natural tendency to say, “Oh, these guys are running this as a business. They’re in control. They need to be responsible and we’re going to find a way to hold them responsible.” Right? And they do, often they run websites. Websites aren’t necessary for interacting with the smart contract, but they’re certainly helpful. Right? And they have branding, right? Some of these dev teams have trademarked their branding and own it. So I get it. Right? But ultimately I don’t think it’s the right way to go.
So anyway, so they’re going after these teams and there are going to be some legal battles. The teams that are, I guess I would say Silicon Valley-backed teams, they have a corporation, and employees, and all the stuff, and they sold equity. I think they have an opportunity. I don’t know if they’ll take it or not, where they could most likely pay a fine to the SEC. Right? And then start going into more of this automatic finance route, like Avaya is doing with its institutional fork of the protocol. I think a lot of these teams could do that and they probably would end up rugging the token holders in the process, because I imagine part of the deal is going to be, “Well, you got to say that you’re not going to be providing any efforts to make this token valuable anymore.” Right? You got to prove that.
And so they would basically be rugging the token holders, but they would just say, “Oh, we always said it’s a very limited thing. All it does is decide how these other tokens are spent and doesn’t do anything else. And by the way, Coinbase wants to buy us for a billion dollars because we’re really smart. Bye, guys.” I honestly think that probably will happen in at least a few cases. Now, what about others, right? What about teams, they don’t have an entity, they don’t have venture capital investors? In some ways they’re more vulnerable because they don’t have a backup plan, right? They don’t really have supporters either, right? It’s just completely Deveron. And because they don’t have an entity, a lot of these people might have individual liability, more easily provable anyway, and being more direct personal trouble with regulators, as opposed to being a director of a company and having D&O insurance, and indemnification, and all this stuff.
So for those, I think that they will increasingly go anon, operate in the shadows, so to speak, right? Have multiple passports, this sort of thing. And they’ll just adapt that way and unfortunately some will get in trouble, but a lot won’t get in trouble. And that, again, just the perversity of it, is that this will just lead to less transparency overall and more shady people having a safe refuge, because now everyone’s forced to act as if they’re shady, even if they’re totally honest, right? They still have to act as if they’re almost like a criminal. And so it gives real criminals safe harbor. So it’s just sad, but I think there will be this kind of bifurcated outcome.
That’s super interesting. It’s funny that by having the centralized entity, you’re able to pay the fine and move on somewhat faster than an anonymous group. I guess, taking that a step further though, let’s say you are the decentralized DeFi project. You don’t have the centralized entity to pay the fine, you’re a founder and you drift into the shadows, you’re still violating something though, right? Because, I guess in your example, the centralized company pays a fine because it does something wrong, and it’s going to make changes. But the decentralized company, even though the token can still exist and the project and move forward, they’re still running a foul, something that the centralized company paid a fine for, right? They’re not off the hook?
I think it depends. I mean, I do think in some cases, based on the substance, those types of teams actually do have better legal arguments, because there’s no one really dumping, right? If you think about, what is the registration process that Gary Gensler talks about? Well, it’s something you do before you go public or IPO. Why do you need to do that? Well, as long as it’s venture capital investors sew into venture capital investors, they’re all assumed to be sophisticated, to have equal amounts of information, and good methodologies for valuing things, and so on. And so there’s not a need for the regulation there. But when you go from that situation to an IPO, as we saw with the WeWork thing, they weren’t able to survive this, because the valuation was such bullshit internally, that they basically weren’t allowed to go public.
But the reason why the SEC is there and this registration process required, is because it enables these very sophisticated investors to dump on relatively unsophisticated investors. And so that’s a situation where the government wants to protect people. When you’re in a situation where there are no sharks, so to speak, who just invested money and are looking to flip it at a profit, and there are only builders. Yes, see, builders can still dump and that is still a concern, right? But they put in sweat equity. I just think it’s different. You know what I mean? And I think maybe some of the same policy concerns are present, but they’re present in a much different degree because with this venture capital path, you can really pump something to an absurd valuation with the venture capital investor facing almost no risk. Right?
They just keep putting money in it, and money in it, at these higher and higher valuations. Right? But it’s all just happening on paper and they might face very little risk. Whereas if something doesn’t go through that cycle and it’s just completely bootstrapped by the builders themselves, it’s harder to fake evaluation, because truly the public is discovering that valuation. And there’s no one manipulating the books or staging things for this grand IPO, where they can all dump. And so my personal hope is that, at least some of those teams are not actually violating the regulations, because they’re not going through this traditional capital markets cycle, that triggers people needing that level of protection. But hard to say whether regulators and judges will ultimately end up agreeing with that or not.
That’s pretty interesting. You opened discussion here with how there’s been a pretty big reversal in when these projects raised money versus the traditional world. In a traditional world, private money and then IPO. In crypto, it’s public, then private. Do you see a good argument or do you see the government accepting the new equality that we have? Like instead of me buying Uber when it’s public, everybody can now get started and get invested way earlier, and it’s more optimal and fair. On the flip side, if you don’t have the diligence of a major bank looking through all, everything, and making sure everything’s up to speed. What’s your take there?
Well, I think it depends on the circumstances, right? If you look at a Fair Launch, like Bitcoin are arguably Fair Launch, right? It’s like people debate these things, so it was a problem. If I consider Bitcoin a Fair Launch, or consider like Yearn for example, he got Fair Launch, right? Because the undercoin, yeah, could have taken 60% of the token supply or something, and he took none of it. So in that circumstance, I don’t see how they can complain, right? It’s the ultimate fairness. Now of course, the downside of that circumstance in its extreme form is then, it’s unfair to the builders. Right? They did a bunch of work and they’re making a bunch of other people rich from it, not themselves. Right? So that’s not a great outcome either.
So I think it’ll totally lose in court battles, they will just see the fact that there are people who started this, and there were people who came into it later, and it wasn’t sold to them as accredited investors. Now there’s liquidity mining thing, right? I mean, that’s the other element. Really, you say investing, but generally speaking, they’re not investing. Right? They’re getting it as users of the platform, right? Now, are they using it a little bit more, maybe because of this token thing and that it might become valuable? They probably are, right? And does that mean that’s an investment of money? Maybe, but they’re not really committing capital. They can pull themselves out of liquidity mining at any time and I just think there are a lot of debates there, we’re really at the border of, do these people actually need protection?
What is the risks that they’re actually facing? Because as you’ll find on Twitter, most people just feel they’re getting a lot of free money. I guess the risk is that it creates a market, right? By doing this, it creates a market and then eventually someone will come in, who actually is taking a risk, because instead of getting the token for free through liquidity mining, they’re buying it from someone on a Coinbase. And even though that money is not going to the software team, that person is still taking a risk of some kind, and they want to make sure that that person is protected somehow. But I don’t know, there are always cost protecting people as well. Right? To protect that one person at the cost of everyone else losing the opportunity as a user, to own the product that they’re using, and get upside with almost no risk, it seems a little crazy to me, from a policy perspective, but I don’t know that regulators see it that way, but yeah.
No, no, it’s funny to think about. And the other question I had for you there is, you mentioned people on Twitter, they just care about making money. How much do Americans’ voice actually matter in all of this, right? There’s a much, probably, broader question for you that, I don’t want to go down every path here, but I mean, people missing out on a multi-million dollar DYDX airdrop, I think it’s worth a couple of million at this point, or maybe over a million, I haven’t checked in a while. But that just pisses people off, right? I mean, when does peoples’ voices get loud enough to actually influence this decision? Or is this just too, utopian of a question on my part?
No, I mean, I definitely think it matters, because we can see some politicians are seizing on the opportunity, like Emmer and even… Who else is there? DeLonge, I’m forgetting, not DeLonge, but basically during the debate on the Tax Bill, as well as these recent SEC things. Some politicians were like, “Hey, this is a good opportunity for me. I can get donors who care about this issue. Obviously crypto people have a lot of money. They could spread it around and I can make this part of my platform. I can maybe get some of the youth demographic.” Right? And so the more politicians, who see an opportunity there, the more they will push on the regulators to go lighter, or be more rational, and there will ultimately be progress. But right now, that’s going to take a long time to play out, right? It’s a generational thing. Boomers will die off and we’ll take over. Right? But right now, you’ve-
You’re the new generation.
… you’ve got the Elizabeth Warrens of the world, who are just like… I mean, I’m sure her motivations are sincere. She just sees it all as the same thing, right? Predatory CEOs are the same thing as shadowy, super hackers, are the same thing as God knows what, right? And they’re all just out to exploit the working man and manipulate the markets and, “We got to protect them.” And I get that, but I just don’t think it quite applies the same way to [crosstalk 00:39:20]-
It seems such a propaganda of a lie, it’s like that would be in some commercial in some scary movie.
Exactly, exactly. Yes, at a sufficient level of abstraction, it’s all the same. But the reality is, Enron was an SEC reporting company. It was one of the biggest frauds of all time. Right? Whereas all these systems, are they perfect? Are people completely safe? No, of course not, but it’s all on chain. Everyone can see the risk, everyone can see the code. And the fact that there are some risks, to focus so much on that area, when you have the Madoffs and the Enrons, that happened right under the SECs nose. And then you say, “Oh, the SEC is the cure for this problem, that hasn’t even happened yet with these systems, and so we just need to crush it all.” It just makes no sense. I mean, it just makes no sense.
No, no. I’m with you. It doesn’t make a lot of sense. And building on that point, what do you think the regulators that are super against it, care about? Do you think that they care about crypto undermining the US Dollar and degrading us as a country, as a global power, or do you view this as “Hey, we want to protect our TradFi friends, who have big companies, who are getting disrupted by this,” or do you think it’s more of just, like you said earlier, a power grab, a place of ignorance a bit? I always get asked this question from friends, why does the government hate innovation so much? And I don’t always have a great answer for them, so I’m not sure which bucket you fall into there?
Well, I’ve read a lot of [FRECO 00:41:01] and Nicci in college. And so I’m a big fan of this idea of a conspiracy without conspirators. Basically at a certain level, all these people just have a job, right? And you have a job and you just do your job, and some people might get philosophical about it in their spare time, but it’s like, “I’m an SEC staff. These securities laws exist. They’re defined very broadly. My job is to enforce them. Some politician is yelling at my boss, because she thinks it’s all very risky. So I’m going to go out, I’m going to do my job.” Right? At a certain level, I just think it’s that simple-
Well, okay. But to your point, does it make sense that people like me, even with my question or just simplifying what is just a massively complex machine of just people going to work every day? I mean, it…
I think so, yeah. Yeah. We’re just all caught in this matrix, right? And I’m sure there’s some SEC staff, who thinks what he’s doing is so stupid. Right? But, yes, he do his job. And some days I think what I’m doing is stupid, but I still do my job, right? It’s just what it is.
Yeah. You mentioned something during your discussion. I don’t want to interrupt, when we were talking about the difference between the more centralized projects and the more decentralized ones, you mentioned the idea of personal liability, which I think is something that most people don’t really understand well. They just release code and I’m glad they do. It’s a ton of innovation, but the idea of personal liability for launching a project is pretty massive. What exactly is that? And do you think people understand how much they can be on the hook for here?
Yeah, no. I think people didn’t take it seriously until recently. And in part there’s good reason for that because traditionally, the act of writing and publishing software, hasn’t been considered a high risk activity from a legal perspective, before now. About the closest we ever got to it maybe, is something like Napster, or Megaupload, right? And that’s a distant memory for a lot of people, or in the case of many young people, 20-somethings who were writing DeFi contracts, they didn’t live through that era, right?
And it’s tricky because there’s not one answer, and it works differently under different regulations, right? But the basic idea that we have in most civilized nations, that if you form a business entity, and you capitalize it sufficiently and you do things through that entity, that entity has legal personhood, and if it’s breaking the law, then that entity is the law breaker, right?
And that entity might have to pay a fine, thus placing its capital at risk. But the individual shareholders and managers, they usually aren’t guilty of violating the law, even though they caused the entity to violate the law. Now, so in the general case, if there’s a securities law violation, that’s non-fraudulent. Usually just the entity would pay the price. The problem is that, well, two things, number one, there’s also secondary liability, right? So if you aid and abet the entity violating the law, which requires that you knowingly cause it to violate the law, then you could be personally liable. So that’s the theory in the Ripple case of why Brad Garlinghouse is the defendant.
So that’s always a possibility, right? The other thing is that entities are not a complete shield. If you don’t actually treat the entity as a fully separate thing, you don’t do all the board meetings or when you minted the token, you didn’t pass a board resolution that says, “This corporation is minting these tokens and distributing them here and here,” then you also have these weird multi-sigs, and the relationship of those to the corporation is pretty unclear, “We’re on the multi-sig, work for the corporation,” others just random people from the community. Now you are, even though you have an entity, you are muddying the waters. Right? And it is possible through a theory, known as veil piercing, or through various other types of allegations, you don’t have to hold the individuals liable for violating the law.
And then there’s also an overlay of, if you go look at the Delaware Corporate Code, for example, it says a corporation can be used for any lawful purpose, right? So if you’re not using it for a lawful purpose, then you probably shouldn’t expect that that limited liability will be honored, right? So I think people fetishize in both directions. Some people are like, “Have an entity, doesn’t matter at all,” which is obviously false. Then other people, “Oh, I have an entity. I’m safe.” Neither of those things is true. Right? You have to really think about what you’re doing and the way you’re doing it, and what society has to say about responsibility and look at the specific laws to see what your personal exposure is. But a lot of people are personal exposure.
It sounds like it’s pretty obvious if you know that you’re doing it the wrong way, as my opinion with most legal things, you know if you’re screwing up or you know if you have an entity and you’re obviously not putting the time into it, the board meetings, separate bank accounts, the Multuit, you get it at that point.
Gabe, switching gears, just to close out the discussion. No rush, obviously, but just the different topic area. USDC has obviously been talked about a lot. I mean, people saw the Circle, got a letter of some kind, and they’ve been talking with the government for a couple of months now, obviously USDC, as a stablecoin, is plugged in from everything, from how VCs like us fund deals to yield farming, to just stable payments. It’s billions of dollars in issuance. I think it’s 41 billion or maybe higher, I got to check. But there’s been a lot of discussion on how the government may go after Circle or USDC, if they even will. And I guess the effect of that, and if people should switch to a different stablecoin like UST or others? I was wondering your take there? I know it’s a broad question, but I want to let you take it whichever way you want?
Yeah. So I mean, I am very surprised that stablecoins have gotten as big as they have. I remember discussing with some prospective clients back in 2017, they had some ideas around doing stablecoins, which maybe they hate me forever, because maybe I had talked them out of them. But I just thought, how can this ever really be a thing because, for better or worse, most economists who are influential or have power like Paul Krugman, for example, they don’t believe in the big coiner-type of monetary theory. They believe that it’s a good thing and it’s an essential, it’s one of the most important things in the world, that the government be able to manipulate the money supply, basically at will, right? And that they think this is extremely positive and extremely valuable.
So if you believe that, and in some sense, I mean, who knows? Mumbai might have another Winnmar-like hyperinflation, it might happen, but on the other hand, we survived this COVID thing pretty well. Right? We survived some other things. Even the whole Lehman Brothers thing. Yeah, it caused some problems, but they were able to bail it out and it kind of worked. It could have been much worse. We didn’t have another great depression. So I’m not as skeptical as some people about that. I’m more open-minded. But whether you agree with that philosophy or not, you just have to know that most people in power think it’s a great philosophy.
And so if you have this stablecoin out there, when that reaches a sufficient scale, that will adversely affect the ability of the Fed to control the money supply at will, right? And so of course, they’re going to hate that. They’re going to view that as, “What are the top existential threats to markets, national security, everything possible?” Right? So regardless of the technical, we can talk about technical arguments is a security, blah, blah, blah, they just don’t like it. They just don’t want it and they want to get rid of it, right? And I understand the reasons why and it’s not surprising to me. It’s more surprising to me that it got this far, I guess I would say.
Isn’t USDC though an extension of their power, in a sense? That I’m far from the macro econ on our team? But wouldn’t a plethora of USDC within DeFi and globally, just help their reach because our government’s able to manipulate the underlying US Dollar?
Right. Yeah. I mean, there’s that argument, right? It’s like, “Well, isn’t it a good thing if everyone’s using digital dollars?” Right? And if you really want to see that, over to China or something, to make their digital Yuan, because if USDC is the best digital money, stable product, and everyone starts using it, that’ll be an extension of US hegemony, right? And personally, if I were in power, I probably would see it more like that. Right? But currently, they don’t seem to be seeing it like that. But I agree with all that. Yeah. It’s weird.
Now, it is weird. Let’s say the government goes after a Circle for USDC, and I’m not saying they will, or they won’t, but if they do go after it, what do you think the effects will be on DeFi? Do you think people will just may transfer USBC to another asset and good to go? I’m assuming if the government wanted to effectively go after USDC, they wouldn’t allow some grace period for people to move out of it but…
Yeah. I don’t know what they would do. I would like to think that they would try to unwind it gracefully, and minimize the harm. But I just don’t know. My personal guess is, I think Circle is backed by the right people, and of course has this coin-based relationship, which is not a public company. I don’t think it’s going to get destroyed. I just think it will have to become more regulated. Right? And some of the others might get destroyed and there’s no real rhyme or reason to that, because I think Tether and USDC, at this point, are basically the same, as far as I can tell. They both have this short term commercial papers supposedly, and we don’t really know really exactly what they hold. So I don’t really think they’re that different, but except that one, maybe made better political bets, it might be safer for that reason. But I don’t think it’ll go away completely because it’s too useful, right?
No, I’m totally with you. And I’ll phrase this question, because I know you’re working on a lot of amazing stuff within Delphi, that we can’t totally disclose right now. So I’ll lob this as a dumb question over to you, but UST is obviously an alternative here, and you guys are building within Labs, basically around the entire ecosystem there, on that foundation. Do you view it as, I guess, a better option regulatory-wise or I guess, how do you view the comparison? And I know I’m acting dumb here, but I want to get your view?
Yeah, sure. So well, ultimately I think what can be regulated, will be regulated, right? And obviously something that’s collateralized by an institution with a business entity, and holding bonds and stuff like that, that thing could be more easily regulated than something died where all the collaterals on chain, or something an algorithmic stablecoin, like UST, where it doesn’t have any backing at all. Right? And so I’m always, I think it’s very important to keep pursuing these solutions, but there’s always the question, why is USTT and USDC, why are they so huge? Right? It’s because it’s very easy to scale things on a centralized basis. It’s very hard to scale other things and they’re still experimental.
So, I definitely think UST is going down the right path. And I think it’s one of those things where, if it can scale, it will be great because, I don’t think it is a security, but let’s say for the sake of argument that it were a security, they were definitely a security, right? Still, it’s just going to be very hard to shut down because it just depends, all the arbitrage that holds the peg, could just move to Texas and stuff like that, or they can move to offshore exchanges, where the securities rules are different, and people could keep maintaining the peg and people can keep using UST.
So from that point of view, it’s pure. I don’t know whether it can scale sufficiently but that’s why we’re building on Terra, because if there’s a lot of demand on the Luna side, and there’s a lot of demand on the UST side, that’s extrinsic, not really speculative, but merchants who accept UST and people want to pay for things in UST, as well as people who, I suppose, want to either do governance through holding Luna, or even just speculate on the price of Luna, then the more external drivers of that there are, the more scalable it will be, right? And ultimately, yeah, maybe that could become very, very robust and a usable alternative.
That’s a really good take. Gabe, I have a couple of faster questions for you, to respect your time. I have one potentially longer one for you, we’ll close out on, but formation within crypto projects is hard. Sometimes I laugh at some VCs and they say, “Hey, we’ll copy the safe and the warrant. We’ll change the name, and the amount, and the entity, make a few edits, and we have our legal docs.” That’s rarely the case. What do you think is the optimal formation for a token project? DAO first, you prefer safe and warrants, half key.
There’s so many different ways to form this, and there are a lot of dependencies here. Like if you have an entity or if you don’t have an entity, and you’re going to issue a token, or you’re not going to, there’s so much to go back and forth on here. And I know you’re personally innovating in this a lot and we could talk about that on a future podcast. But I guess right now, without talking too much about what you’re doing on the innovation side, what do you think is the optimal structure legally, for a token company to form?
Well, there’s no one optimal structure because there are catch-22s, right? So it depends on the values of the people involved, and what they want to prioritize, right? If what you want to prioritize, is having the least likelihood of your governance token being a security, and things like that. And your DAO “being a general partnership,” then you probably would do something like UNISWAP or DYDX, or these types of companies, where you just define very, very thinly what the token is. You try to make some efforts at least, to exclude US persons from receiving the token, or maybe even using the smart contracts through your website, and this sort of thing. And all the revenues continue to flow through some corporation, that you just completely own.
Personally, although that may be arguably, have the best security, a lot of defenses, actually it’s the most unethical, because people, they just won’t accept the idea that maybe this token is just almost close to totally useless. They’re still going to give it this value, and be buying it and stuff. And that’s going to give these insiders a lot of exit liquidity that, maybe they don’t really deserve because, why is this token value so hot? I just don’t get it, right? No fees flow to the token holders. It doesn’t decide anything. The same team could produce a new version and they could say, “Yeah, this version, it’s actually governed by some other token.” Right? Or no token. Right? They can do that and they’ve never said that they won’t do that. So these evaluations are absurd for those types of tokens, but that is probably legally the safest thing we could do. On the other hand, if you want to say “No, I want to make sure that this makes sense and that people are treated well.” Right?
Then I think you could go in the exact opposite direction. All of the value goes to the protocol, to the DAO, to the token holders, right? There is no equity, there’s no separate equity. There are no conflicts of interest. Everyone is a 100% aligned on the token, right? And so you’ve got a bridge to that, like in our case for example, we have these joint ventures and basically everyone who’s getting the token, is building the thing, right? There aren’t any really external “investors,” so to speak. And I think that’s a good philosophy if that’s what you’re pushing, because there is this idea under the securities laws, that if you have what’s called a partnership, that the interest in that partnership are presumptive non-security. Why? Because every person is putting in their own efforts and responsible for their own efforts, right?
They’re not relying on the efforts of others. And you don’t want to be a partnership necessarily, but if you’re partnership-like in that sense, where everyone who has this token and is getting value, is also giving value to the person responsible. There’s also a good argument that that should be outside the securities also, for very different reasons than under the other set of projects that I’ve talked about. So those are the two main themes, I would say. Very, very different and only litigation and further developments will tell which one fares better, or however you want to put it. So we’ll see, I guess,
No, that’s fair. And I guess on the structuring, I think what we’ve seen in the space is, there are some really solid external law firms out there, right? I’m not going to name any specifically. I don’t want to play favorites, but there’s also not that many solid lawyers, who both understand crypto and I guess have the incentives to leave a cushy job and to dive in and take the risk, et cetera. Obviously from a finance background, is worth the risk reward, but not everyone has a Gabe Shapiro in their project, right? Not everyone knows where the lines are that you just drew in the sand, to go after that. Is there anything that other lawyers in the space can use, to get up to speed, to follow what you consider to be best practices? Because in my opinion, it’s great for Delphi, candidly, to have someone like you here, but I want to help the entire space move forward and to know how to do this in the best way too. What would be your advice there?
Well, yeah, I mean, that’s why I write a lot, and tweet a lot, and I’m in millions of telegram groups and we started this DAO-like thing called LeXpunK. They got some funding from Curve, and Yearn, and Lido, which is great. And we’re going to do more there, to try to pull more lawyers in and get everyone talking to everyone. But I think that’s what you have to do. You have to talk to people and try to work more like a developer, right? Open source your own work product, and hope that that inspires other lawyers to open source theirs and collaborate. Very hard for lawyers to do this, lawyers hate doing this. It’s culturally completely against their grain, but there’s so much to figure out and, sure, I mean, of course it’s nice to hear I’m so knowledged among all this, but I’m figuring this shit out every day.
You know what I mean? And there are things I said a year ago, that I would think are absolutely idiotic now, right? And there’s just so much to do, and it will only evolve if people put their egos aside and all start collaborating on stuff. And unfortunately, it’s still very antithetical to law firm culture, because law firms want to say, “Oh, we’re the best. We understand the most, but we don’t want to share our form with them. And they’ll take business away from us.” Right? And that’s why it evolved very slowly, unfortunately. So I would say, yeah, if you want to get into it, you can hit me up or there’s other people that you can hit on, find us on Twitter, join telegram groups, join forums. Talk, talk a lot. Talk to regulators, talk to each other and talk to your clients, get your clients to talk to other people’s clients and collaborate and then we will make a lot of progress.
Tom (01: 02 :15):
Gabe, do you think, just the traditional, how developers have been disrupted in crypto, right? Instead of going to Google for four years and making 500K, you just start a crypto project, doesn’t this also disrupt the traditional legal model, where you have like 500 associates, “Why the hell would I want to grind as an associate? Just like grinding at Wall Street in finance, when I could just go crypto full-time?” And I’ll preface that with, I personally learned a ton on Wall Street, I wouldn’t take it back, but begs the question though?
Yeah, no, I agree with you. I think it’s a tremendous opportunity for young lawyers who are smart and understand technology, and don’t want to have, what I call a 10 year cliff on investing their equity in a law firm. Right? Because you could jump into one of these projects and you can get a token grant and give them legal guidance. And you could do very, very well. There are some ethical issues around that, but all this will be figured out. And the people who took calculated ethical risks will, like in any area, they’ll get an outside portion of rewards. So I agree with you. And every time I see a lawyer, I say, “Maybe do one year in a big law or something like that. And then get out of there and join a project.” Right?
I love that. Gabe, I’m excited to have you on for more episodes. There’s a lot of different areas we can go into. We’ll cap this one at an hour, a little over, just that I can get back to work. But Gabe, thanks so much for coming on, man. I know we covered a lot and I really appreciate your time.
My pleasure, anytime.
(00:00:00) – Introduction.
(00:00:35) – Gabriel’s background.
(00:02:17) – War stories from Gabriel’s VC days.
(00:04:17) – Biggest legal differences between projects in crypto and the traditional world.
(00:09:23) – Regulatory bodies that have the most impact on crypto.
(00:13:23) – How motivations to support innovation and regulatory turf wars can coexist.
(00:16:56) – Gabriel’s thoughts on pushing the boundaries of regulation.
(00:20:07) – What Gabriel would say to Gary Gensler.
(00:25:00) – What a regulatory attack on a big DeFi project could look like.
(00:30:05) – Regulation on decentralized teams.
(00:33:39) – Governments and fair launches.
(00:37:03) – How much Americans’ voices matter.
(00:40:13) – What regulators really care about.
(00:42:13) – Personal liability and why it’s important.
(00:46:43) – Regulation and stablecoins.
(00:49:51) – How regulating $USDC would affect DeFi.
(00:52:13) – The regulatory resistance of $UST.
(00:55:06) – The optimal formation for a crypto project.
(00:59:41) – The ways other lawyers can get up to speed on crypto regulation.
(01:02:44) – How crypto is disrupting the traditional legal model.