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In the 7th episode of Block Stars, David Schwartz interviews Ripple's General Counsel Stu Alderoty to once again talk about regulation and the crypto space. While this topic has been broached before, this week's unique take is focused on the legal frameworks and minutiae that brings light to what kind of regulation crypto needs for the industry to boom in the United States.

Starting this week, I'm going to change things up a little. First, I'll respond to a couple few quotes or topics from the podcast that I thought were significant. Then, for those who are interested in reading the summary, it will be written afterwards.

Here we go!

My Thoughts

The Howey Case and Beanie Babies

I really appreciated the more in-depth look at legality and regulation that this podcast took. It's fascinating that a half-century old Supreme Court case is what is driving the securities laws, including dealing with cryptocurrency, today. As they talked about the ruling from the case, I began to wonder: is cryptocurrency a security?

As stated in the podcast, there are several different types of cryptocurrencies. First, there is the category of fiat replacement, like Bitcoin, Litecoin, and even stablecoins like USDC, USDT, and MakerDAO's DAI. These coins literally have a single use-case, which is to be used to transact for services or goods. Certainly, these kinds of coins are not securities.

And then, there's the coins that are designed to be securities, like those attached to real estate or company shares in the stocks and investments markets. As far as I know, most of these, like the ICOs in 2017, are built from the Ethereum blockchain. These security tokens are obviously securities.

But then there's the in-between. What many want to believe are utility tokens, but often times are just coins looking for utility. Many speculators buy these coins in hopes that the utility of the token will increase, and thus the value or price of it will as well. So a majority of these tokens are being used like securities. The issue is whether that specific token will pan out in the end as a utility. But if it doesn't, do those speculators bear the responsibility of the loss they will incur?

Let's go back to Bitcoin. As stated above, and from its whitepaper, Bitcoin was meant to be a currency replacement. But today, almost no one uses Bitcoin for transactional purposes. The VAST majority of uses for Bitcoin are either cold storage or speculation. And so, we come to a new question: if the popular use-case of a coin goes against its original design, how is it classified? Is a coin classified based on popular use-case, or designed use-case?

The Beanie Baby analogy is pretty great. But I think crypto has a little more nuance than a product that literally has no use other than sentiment and collection. Different coins can do vastly different things.

Personally, I believe that crypto and blockchain are the beginnings of a technology that can absolutely change the very foundations of how the world functions. While finances are the obvious sphere where they are applicable now, broadly, blockchain has the potential to change the very infrastructure, from government to the sciences, that societies around the world rest upon. It's an exciting thing to be in the midst of, and something that keeps me pondering and engaged in this space.

“We're not asking for no regulation, we're asking for an even playing field.” (24:44)

I think this is the most important point in the whole podcast. Most entrepreneurs and investors are already making risky bets in the market on what the next big thing is. Given this risk, it's easy to understand that they want to mitigate any other potential hazards that would prevent them or cost them in the long run (which often makes the risk not worth taking).

And so Alderoty saying this made the most sense to me. The industry isn't necessarily looking for absolutely open-field anarchy, but rather wants to make sure that they can continue to work and invest in the space without fearing weird compromises in the near, or perhaps even distant, future. Both short and long term, it's not really about the laws, but about having an equal footing to compete and flourish in a growing and inevitable technological future.

Laws like those enacted in the United Kingdom would be a good start. Though there are concerns, as given above, having a broad template in which to work will help investors, developers, and entrepreneurs continue to invest and build in the space without getting burned. If coins eventually are able to be classified, and then have that classification changed, hopefully it will be a slow methodical change that, intrinsically, won't be about limitation, but the betterment of all consumers in the world.

Final Thoughts

Most of these podcast episodes so far have had people within the Ripple or XRP spheres. But the cryptocurrency and blockchain industry is so much wider than that. I'd really love for Schwartz to interview some other leading figures in the industry—perhaps someone like Vitalik Buterin, Robert Leshner, or even Anthony Pompliano (given that he interviewed Brad Garlinghouse at one point). This way, the podcast really becomes about all the 'Block Stars', and not just the ones related to XRP or Ripple.

If you're curious about my thoughts about other Block Stars episodes, please go here.

Episode Summary

As the General Counsel at Ripple, Stu Alderoty manages everything to do with legality, compliance, and even government relations. He's been working in the financial sector in legal capacities for over thirty years, including working for American Express as well as HSBC, before going to Ripple. He was attracted to it, not only because of Ripple's robust and professional leadership, but also because, as we all know, the blockchain and cryptocurrency industry is in need of good regulatory solutions, especially in the United States.

Given his position, Alderoty has a few thoughts on regulation of crypto. First, as real utility and use-cases begin to emerge in the space, any regulation put in place needs to recognize and support the innovative potential of crypto. It also need to be clear for anyone to understand, as well as adaptable to the growth of the technology. Currently, regulation is a mess, from lack of clarity in some jurisdictions to complete non-existence or even hostile in others.

There are a few that are getting it right, though, such as the United Kingdom, the United Arab Emirates, some East Asian countries. In the UK, their Financial Conduct Authority governmental department regards clarity and fostering innovation as the foundation for their regulation. From there, they categorize digital assets, and then clarify which laws would apply to each of the distinct categories. The UK also recognizes the speculative nature of most crypto assets, but clarifies that speculation doesn't automatically indicate securitization of a token (he brings up the beanie baby analogy here). In this way, they have protected both consumers and the industry while allowing it to evolve.

In regards to the United States, Alderoty suggests that the mass of ICOs that happened in 2017, which led to innumerable scams, has led to an enforcement approach rather than a helpful supportive one from the US government. Schwartz mentions that Jay Clayton, the current chairman of the US Securities and Exchange Commission (SEC), may step down, a move that may affect crypto regulation, but Alderoty hopes that regulation doesn't depend on any single person, but rather a group of principles that are, again, flexible enough to adapt to the changing landscape crypto is bringing to the tech world.

That's not to say that the SEC has done nothing, as they have released a framework for working with digital assets. However, the framework wasn't official regulation. Instead, they used past Supreme Court cases and regulation to simply suggest and guide, rather than set in stone or transparent. Thus, for many, it has created more confusion rather than bring clarity.

The two make a slight (but important) segue into the 1946 SEC v. W. J. Howey Co. case cited in the framework. The important ruling for the case was that if someone invests their money in a “common enterprise” and expects to profit from it solely due to others' efforts, then they've bought into an investment contract, which is a type of security. (I encourage anyone who wants to know more details about the case to listen to the podcast yourself. It's quite interesting!) This case, and many like it, have defined securities in the United States for decades. These rulings make sense in light of the ICO's of 2017, but with tokens that have real utility, whether these rulings apply is quite muddy.

So how does the United States step towards clarity? Of course, the US Congress can create federal legislation around it. But there is also room for state legislators to regulate. But the most helpful step may be if the SEC and CFTC (Commodities Futures Trading Commission) worked with industry developers and consumers to provide a framework as Alderoty summed above. He commends Hester Peirce for her work in this area, having worked with multiple different developers and projects. He also mentions that, with so many different projects, it's easy for regulators to get lost and begin taking everything one at a time. However, it would again be more beneficial to have general regulatory clarity.

The crypto industry, in this way, can be likened to the Internet, in that regulation could either support or kill that industry in its jurisdiction. While the United States' historically has been a leader in innovation and technology, in crypto it seems to have lagged behind. Alderoty even reports a near 20% decline in crypto investments in the United States, and the lack of good regulation so far not only discourages crypto companies from the US, but also may hurt current companies that can't adapt to the technology in the future.

China is, of course, brought up, with its dominance in 5G technology already making impacts around the world. And, more relevantly, the country is already actively developing and testing a digital version of its national currency, in addition to subsidizing Bitcoin and Ethereum mining. This is disturbing, given that the only two cryptocurrencies that the United States has officially recognized are these two coins. These are hints that, crypto companies or organizations are already going offshore instead of investing in the United States, and the fact that they are investing in a competitor to the United States does not seem to bode well for the country.

All is not lost, however. For example, in the United States, it is now law that banks inform their customers upfront how much it would cost to send money overseas. In the current legacy system, this isn't really possible, but with the use of blockchain technologies, it is. Furthermore, the Office of the Comptroller of the Currency (OCC) has issued a notice requesting commentary on what barriers there are to crypto adoption in the US. And if all goes well, blockchain, through good regulation, can bring much more transparency to the financial industry as well as give consumers much better experiences, in addition to potential future innovations that we still haven't thought of, yet.

Even with just a year and a half of experience, Alderoty sees crypto adoption as inevitable rather than optional. Around the world, different countries are already adopting it, and even JP Morgan did an about-face on crypto, issuing a report this past March on the resiliency of the industry in the face of the global shutdown. As crypto companies work with regulators, the hope is that the United States won't get left behind as the rest of the world forges ahead with this new technology. Instead, smart regulation which is principled, flexible, and goal-oriented can foster good, fair, and responsible innovation that grows inside the United States, a much freer market, rather than an oppressive, authoritarian one like China.