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Token Economy
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Thoughts on Etherdelta
The big news this week was the SEC order vs Etherdelta's founder Zach Coburn. In short the SEC has instituted a cease and desist order against Coburn for actively contributing to Etherdelta's violation of Section 5 of the Exchange Act (i.e. operating an unregistered securities exchange). Coburn settled for a grand total of $388K, without admitting to or denying the SEC findings.
To many, Etherdelta represented the archetypical "decentralized exchange", a virtual wild west were any token would have a market, anyone could have a piece of it without having to identify themselves and no one could stop.
While the site is seemingly still up and running (Coburn sold it to a Chinese acquirer at the end of last year), Coburn himself was a dead easy target for the agency:
- clearly identifiable as the sole founder - residing in the US - personally responsible for writing and deploying the smart contract - retaining exclusive control of it and of the centralized servers that maintained the orders - personally responsible for vetting which tokens would be listed - including some whose issuer the SEC has already initiated actions against and many that had the hallmarks of securities - and who was the front face of the exchange on many public forums (the order includes some of his reddit quotes)
So much for a "DEX" and yeah, presumably not a difficult case to win, so much so that Coburn settled. Also, presumably much easier and more symbolic than having to take down a smart contract (the Etherdelta smart contract was actually forked and a similar front end appeared earlier this year). Which sheds some light on the broader SEC enforcement strategy.
Jake Chervinsky made the excellent point that the Agency is deliberately going after the low hanging fruit to, presumably, build enough precedents ahead of more complicated and expensive cases against much better funded and lawyered-up entities. This action also reads a lot like a hidden message to the market: if you collaborate, it won't be that bad after all. We don't know, but ~$400k is potentially small change compared to what Coburn would have made from Etherdelta's profits and sale (interestingly the fact that he was personally profiting from running Etherdelta was not brought up in the order).
The most pressing questions however still remain largely unanswered.
Which of the 500+ tokens that traded on Etheredelta were securities? Would a "fully decentralized" exchange self-run by smart contracts on a blockchain ever fit the SEC definition of exchange ("maintains, or provides a market place"), and if it does, who would be liable for possible violations? A question that is reminiscent of the worrying comments from a CFTC commissioner a couple of weeks back on the possible liability of smart contract developers who could "reasonably foresee" violative uses of their code. And to add to that, the chief of the SEC’s cyber unit just told Forbes that "using any blockchain to create an exchange without central operations doesn’t remove the original creator's responsibility". A hugely important, complicated and scary matter, which make us wonder on what side of the regulatory fence many other existing and new projects will fall.
So what should we be expecting next?
- undoubtedly a wave of new enforcement actions will be hitting the press in the next 6-12 months (note this particular action was announced once settled, there are many others ongoing that we yet don't know about following the SEC's March '18 warning) - there's a material risk that US-based founders will lose drive to experiment in this space, compared to founders from other more friendly jurisdictions (perhaps the decentralized finance movement will start gravitating away from the US, are there any clear signs of this happening yet?) - Any type of exchange with some centralized elements that potentially serves US based customers is likely to, at the very least, start implementing strict KYC/AML and/or IP-blocking (this is already happening, see Idex news from last week) - however, it's only a matter of time before a truly unstoppable, ownerless version of Etherdelta, seeded by a completely anonymous group of developers, makes its appearance. Back when the SEC issued the DAO report we figuratively predicted that "a minority will go for war" and we are doubling down on that call: a wave of anonymous projects is upon us. Work and research on 'fully decentralized' exchanges is gaining traction already.
Ironically, regulation and enforcement can be a catalyst for accelerated innovation and even more decentralization, every time a bit more. Ultimately, the nature of technology is to move faster than the law, and we are probably not too far from a future described by Alex Felix where autonomous agents will not only be executing code, but also writing it. Who'll be liable at that point?
--- Other good reads on the topic:
- Jake Chervinsky's full tweetstorm - Marco Santori's own thread - Coindesk piece featuring comments from Preston Byrne, Stephen Palley and Andrew Hinkes - Peter Van Valkenburgh's take on how DEX could be regulated - Katherine Wu's always fresh perspective.
A must read from Multicoin for every team thinking hard about their token distribution.
The post ultimately describes the benefits of the Livepeer merkle mine, which has pioneered a new approach to getting the tokens in the hands of future users in a permissionless and regulatory compliant way.
While the end results for Livepeer were slightly suboptimal in terms of distribution achieved (Multicoin attributes that to the process not being marketed broadly enough), this is something every team working on a 'work token' or PoS network (where founders and early investors are locked up for years and validators have less capex to recoup by selling down vs PoW miners) will be pressed to look into to avoid excessive concentration of ownership.
Our friend Tobia from Cryptodecks went all ontological this week, attempting to draw the lines between 'fintech' and 'DeFi', with latter being based on trust-minimised software and a thinner layer of 'bureaucracy'.
A very topical post published the day before the Etherdelta news broke, which obviously opens many other questions on the regulatory implications:
"Builders know that in a world of DeFi, gatekeepers can only limit access at the interface layer, but they can’t prevent a hacker coding and deploying the fundamental logic in the first place.
Building on DeFi means dealing with bureaucracy only ex post, and at the interface layer. You don’t need permission to start building."
A great recap of Devcon4 by Cyrus from Scalar, who really managed to capture the essence of the event.
Two things in particular that Cyrus noted really resonate: - "Dapps leverage each other and make use of scalability solutions. Teams actively talk to each other and collaborate." - "The technical diversity was impressive and representative of the bridges the Ethereum Foundation has built with other teams."
Last week we promised we would post some of our favorite presentations, so here you go (though unfortunately some are not yet available so will have to wait for another week of so):
- The Unintended Consequences of Product Design by Taylor Monahan - State of the STARK slides by Eli Ben-Sasson w/ abridged version of his presentation (disclaimer: we are investors in Eli's company) - Smart Contract Security - Incentives Beyond The 🚀 by Philip Daian - Alex Van de Sande on Universal Login (can't find video nor slides...) - Decentralized Identity & Reputation by Sina Habibian (not available yet) - The intro to the Generalized Mining side-event by Jake Brukhman - Cryptoeconomics at scale, focused on Plasma, by the always entertaining Karl Floersch (can't find slides nor video) - "Money is the killer Dapp: crypto in Venezuela" by Alejandro Machado, Eduardo Gomez (nada) - The Ethereum sing-along 🎵 - Bonus: a summary of the crypto-adjacent literature mentioned at Devcon courtesy of Denis from A16Z (perfect Twitter handle for the job!)
Team Cambrial continues to produce excellent content, both online and offline (their side-events at Devcon were👌, including one on the very topic of generalized mining which triggered this post).
"Generalized mining" is very much the talk of the town these days, and there are a number of reasons why an investor could engage in this sort of activity (eg learning/intel, supply boostrapping, making a profit, optimizing fund economics, fiduciary duties). Not all activities though make sense in the eyes of a LP, which is the topic that David, as a fund of fund manager, dives into with this post.
Long and dense read, where the author makes a case for the obsolescence of the cloud computing saas model in favour of the emergence of decentralized, crypto powered software systems.
The main argument is around a structurally lower cost of ownership coupled with more aligned developer incentives, which would make it harder for legacy SaaS businesses to compete based on proprietary software and monopolized service delivery.
This feels like an inevitable software cycle, though timing-wise we could be a decade away before it unfolds in any meaningful way.
We're big fans of what the Token Engineering movement is doing: helping us understand with taxonomy as well as researching forecasting and modeling tools.
Here they explain their research activities, next events and a few recaps of past sessions.
Najva, who builds community over at Spankchain, does a great job at chronicling her reasoning for joining Spankchain and explaining their culture and why it's important.
We are massive fans of projects like Spankchain that are here to build something they really believe in, and do so in a different way, with their own style, and not really caring about other opinions.
A great piece of research about all the different Security Token standards that have come out recently, with the goal of automating regulatory compliance and forcing it at the technology level instead of higher above the stack.
I think this concept needs a pause and a recognition: the fact that you can actually embed compliance (and obviously other types of constraints) inside the protocol itself, should be mind-blowing and opens up immense possibilities for many different areas of trustless interactions.
Regulators and lawyers should be spending most of their time here in our opinion.
Regan from CoinList shares a few topics that founders seeking to raise capital from crypto funds should cover in their reverse due diligence process.
Helpful.
💥Newsy stuff
- Sim swaps. AT&T and T-Mobile are being sued for their lax policies around sim porting, about time. Horror stories continue to unfold, including to one of our readers whose post-mortem we featured a couple of weeks ago. Give it a read and stay safe.
- Scooters. Ford acquired electric scooter startup Spin for a rumored $80-90M. So what? Spin had raised its last two funding round after the Series A as token sales (one utility token and one security token). Unclear how token holders were treated in the sale (reach out if you know!).
- 💨💧(alright, airdrop..). Blockchain.com is panning to airdrop $125M worth of Stellar Lumens into his customers wallets (subject to KYC). This will be Stellar's 3rd and largest airdrop, without conclusive evidence of the effectiveness of such distribution mechanic. - Full-stack exchanges. Binance announced the launch of an institutional grade research arm. In a few years, centralized exchanges will look a lot more like investment banks.
- Initiative Q. Why is everyone talking about this please?
- 🦅Aragon have announced their Flock program. As you remember, we featured their "decentralization" and now the Aragon foundation has structured a program to fund other teams building full-time on the core Aragon contracts and tools. This comes the same week as Aragon launched on Mainnet with thousands of DAOs now live. We are officially in the age of decentralized companies.
- BBVA has syndicated a $150M loan and timestamped it on Ethereum. Not really particularly impressive technically, but gives a sense of what banks might care about.
If you don't already, make sure you follow the moves of Austin Griffith. He ships awesome products at an unseen pace.
His last creation (apparently coded on his flight to Devcon) is a mobile web based burner wallet built on the POA xDAI sidechain that makes receiving and sending DAI stupidly simple and quick. 2 people demoed it to me unprompted at Devcon, a sign that he's something there.
A couple of months back, without much hype Carbon launched a stablecoin on the Ethereum blockchain 1:1 backed by USD in FDIC insured bank accounts, initially available to institutional investors.
Yesterday they announced interoperability with the EOS blockchain, so the Carbon stablecoin can seamlessly move between EOS and Ethereum.
Bitfury finally announced their latest round of funding, which must have taken a while to close judging by the breadth of the investors involved.
It's led by Korelya Capital, and includes participation from private equity firms, banks, insurance groups and Mike Novogratz with Galaxy. Bitfury is doing $500M in revenues.
SEC Commissioner William Hinman announced that the agency is planning to release "plain English" guidance to help developer determine whether their token sales constitutes a potential sale of securities and how it should trade post-ICO.
What seems to be of primary relevance is the expectation of return:
"If someone's offering an instrument for money or other consideration to a third party, and that third party expects the offerer to generate a return or so something that will increase the value of the coin or token or whatever they want to call it, and there's that expectation of return, we're generally going to see that as a securities offering,"
The timing for the guidance is still unclear, but we are hearing end of the year, or latest Q1 2019.
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